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As a strong proponent of the GM bailout I feel obliged to answer Ozimek’s challenge.

I would like to know on what grounds those who wanted a GM bailout would reject a BP bailout. I will aknowledge in advance I believe there are important differences, but do they?

The first and most obvious is that the GM bailout was during a time of amazing uncertainty. I believed at the time and still contend today that there was a serious possibility of Great Depression II and the collapse of a major industrial concern would have increased those risks.

Second, the auto industry is lumpy. GM produces the ultimately differentiated product. The units are highly branded. Their parts are uniquely designed. Indeed, entire factories are fabricated for purpose of producing a specific vehicle and would have to be completely retooled to produce anything else. 

Third, all three US manufacturers were tied together through the supply chain. This not only magnifies the intensity of a collapse but also has unique consequences for labor.  US manufacturers used UAW labor while foreign manufacturers do not. This makes the two imperfect substitutes and would have contributed significantly to a difficult transition.

Now, we can have a long debate over WHY the auto industry is this way. The maze of regulation and standards that means upstart auto companies using interchangeable parts don’t have a serious chance. The auto dealer protection laws that promote mega concerns. The UAW itself. The list goes on.

However, you make policy with the economy you have, not the economy you wish you had. The one we had was one in which GM was a large heavily entwined mega concern that would have taken down much of the domestic industry and paralyzed large swaths of the labor market all during a time of unprecedented uncertainty.

BP on the other hand produces the classic perfectly competitive product. Its completely fungible. Its traded on an exchange. It has a healthy futures market. Its exactly what a textbook economic product should look like. Shortages will be sorted out in the markets, prices will respond and equilibrium will be restored.

Moreover, I don’t know of any particular reason why the small amount of BP labor that there is would be immobilized. The only issues that I for see are

1) What happens to BPs liabilities. Presumably they are simply taken up by the Feds and ultimately the taxpayers. In this case perhaps a “back door bailout” is appropriate, in which BP is forced to make payments over time to the injured parties.

2) What happens to BPs capital. I don’t know how smoothly the capital markets in the oil industry function. Now given that the rig wasn’t even owned by BP but leased I have a hard time imagining that capital doesn’t flow well in the oil industry, but you never know.

David Leonhardt has a good article that is making the rounds about how it increasingly looks like non-market means of energy regulation are going to be how we fight climate change, rather than a much more efficient market oriented approach like carbon taxes. Matt Yglesias rightly lays blame at the feet of conservatives who have worked hard to stigmatize taxes in the public’s mind, and have thus poisoned anything labeled a tax; even good, market oriented things:

But overall what you’re seeing here is that creating a political culture in which “tax” is a four-letter word doesn’t eliminate the demand for government to try to achieve certain goals, including curbing negative externalities. It certainly doesn’t kill off “big government.” What it does is cut out efficient solutions to public problems, push the impact of government policy off the balance sheet, and generally obscure what’s going on.

I agree with all of that, but I think that many liberals also share the blame for a failure to pass a carbon tax because of their high demand for and tolerance of inefficient and wasteful energy policies. Part of the problem is exactly demonstrated by Yglesias and Leonhardt in their acceptance of the sort of command and control government policies they recognize are inferior to a carbon tax. Here is Leonhardt on energy efficiency:

The ideal energy policy, in fact, would include some ironclad rules and regulations, because people do not always respond rationally to prices. Consultants at McKinsey & Company argue that many families and businesses could already save money by taking simple energy-saving steps, yet they don’t do so. Building standards could overcome their inertia.

And Yglesias agrees that “an ideal world would still retain a role for a certain amount of command-oriented regulation, especially on the efficiency side.” This is several paragraphs after David told us that:

Under a command-and-control system, businesses and consumers have to focus not just on carbon use but also on the details of the government’s rules: the intricacies of vehicle and building standards, the types of appliances that qualify for subsidies, the fine print of the Energy Department’s loan applications. Each bit of compliance brings costs.

And how does he know that these costs are outweighed by the benefits? If we’re talking about government subsidies for weatherization, then you’ve got inefficient bureaucracy on both sides: the tax collection and the subsidy dispersal. In addition, weatherizing the country on a grand scale obviously involves a lot of bureaucratic problems and the use of government contractors above market wages, both of which introduce more inefficiency into the problem. And yet there is high demand for such policies from liberals, and it seems to me a completely unwarranted optimism about their cost effectiveness.

A similar example is found in Leonhardt’s discussion of vehicle mileage standards:

Fuel economy rules have cut per-mile gasoline use by 40 percent since 1975. As a result, vehicles have made more progress on energy efficiency than office buildings, houses and apartments.

Have fuel economy rules caused per-mile gasoline use to fall, or has technology, wealth, and a growing preference for high-mileage cars done it? And are cars getting more energy-efficient faster than buildings because of regulations, or because the energy efficiency is more transparent and observable in vehicles than in buildings? Apparently we need professionals to come in and tell us whether buildings are energy efficient or not, but no such service is required for cars. Energy regulation has I’m sure had some impact, but less than real prices, preferences, and technology. But David, in contrast, just assumes regulation has done all the work here. Again, this shows an unwarranted liberal optimism for command and control energy regulation, even in the middle of an article about the downsides of command and control energy regulation!

The problem here is twofold: conservatives hate taxes, and liberals have too much demand and tolerance for inefficient and wasteful energy policies. So the clear path for politicians is to avoid taxes and use the inefficient command and control instead. This is why I get so bothered about things like fuel economy standards: they are substitutes for making the right choices; both in a political capital sense, and in a real economic sense. To the extent that inefficient command and control policies actually help prevent global warming, they decrease the optimal price, welfare gains, and therefore benefits of a carbon tax.

If politicians knew that liberals were going to resist inefficient attempts to stop global warming, then they wouldn’t be so happy to substitute them for efficient policies like carbon taxes. Yes we would be better if conservatives would examine taxes on their merits, but we would also be better off if liberals got as outraged as libertarians about higher fuel economy standards. Every time a politician proposes an inefficient policy liberals should shoot them down and say “No! You do it the right way this time!”

There are libertarians and conservatives who want to cooperate on this, but every crappy energy policy that gets passed with liberal support undermines the notion that cooperating with liberals will result in policy that is not incredibly wasteful and inefficient. It’s hard to bargain for something as a group when you know that half of the group will settle for a shit offer.

Provocation of the day: it is increasingly looking possible that BP may be in serious trouble, and there is a non-zero chance of bankruptcy; if the worst case does begin to emerge for BP, should the government give them a bailout? I would like to see this provocation evaluated by proponents of the GM bailout.

Clearly, the direct jobs impact will be lower than a GM bankruptcy, since GM employed somewhere around 200,000 and BP has only 23,000 employees. But the argument for bailing out GM was based primarily on indirect impacts, with proponents citing a 3 to 2 million job loss number. Since petroleum is in input in…well, all industries, a shock to oil prices would have a much wider negative impact than a shock to the automotive supply chain. Since automobiles are durable goods, the impact of a GM bankruptcy would have traveled mostly up the supply chain, whereas a BP bankruptcy can travel both up the supply chain and down it, all the way to businesses and consumers who use it as a productive input. You can be very much for higher gas prices via a carbon tax while still very much opposed to a shock to gas prices, and you don’t have to be a Real Business Cycle theorist to believe that it would have serious macroeconomic effects.

There’s also the problem that not bailing out BP could jeopardize future claims against them, and that the alternative scenario of a bankruptcy may allow them to shake some of their obligations that will result from fines and litigation. So if a $5 billion bailout increases our odds of recovering $50 billion in fines by 11% then it is worth it on those grounds alone.

Here is James Surowiecki arguing that you can’t be against a BP bailout and for a new jobs bill:

…the great virtue, from a stimulus point of view, of giving the loans to BP is that the money will be immediately put to work in the economy, as opposed to dribbling out over the next six to eighteen months, which is what will happen to much of the spending in the jobs bill. From a Keynesian perspective, there are few things we could do that offer as much immediate bang for the buck as keeping BP in business. In the end, if you opposed the jobs bill, then it makes sense to oppose a BP bailout. But I don’t really see how the combination of being in favor of the jobs bill and in favor of letting BP go under makes sense.

Just kidding, the paragraph of his was really originally about GM and the stimulus bill:

…the great virtue, from a stimulus point of view, of giving the loans to the automakers is that the money will be immediately put to work in the economy, as opposed to dribbling out over the next six to eighteen months, which is what will happen to much of the spending in the stimulus package. From a Keynesian perspective, there are few things we could do that offer as much immediate bang for the buck as keeping G.M. in business. In the end, if you opposed the stimulus package, then it makes sense to oppose an automaker bailout. But I don’t really see how the combination of being in favor of the stimulus and in favor of letting G.M. go under makes sense.

I would like to know on what grounds those who wanted a GM bailout would reject a BP bailout. I will aknowledge in advance I believe there are important differences, but do they?

This is the chorus call of everyone from political pundits, to governments, to professional and academic economists.

Most all of the calls I’ve seen have been for the government to “do something”, like pass the jobs bill…but I think that’s unlikley to do anything useful…so I want to delve into the problem.

The problem, as I see it, is a flow problem. Small and medium businesses are the main apparatus that employs people. However, due to recent financial problems that were greatly exacerbated by a tight monetary policy, these companies are facing a situation where they are pressured by suppliers for prompt payments (<30 days), while their largest customers make payments in longer intervals (>90 days). This cashflow problem is where the financial sector comes in — or should be coming in — to provide bridge funding. Unfortunately even at the zero lower bound, these businesses are having trouble finding funding due to lack of demand (or monetary disequilibrium, a higher demand to hold cash), so the real interest rate remains stubbornly immobile (what Paul Krugman would call a liquidity trap…but not me!).

Since our monetary authority seems unwilling (not unable) to set a price level target in order to spur an increase in velocity, we’re forced to look into more creative solutions. One very interesting solution comes from the Social Trade Research Organization in the form of their Commerical Credit Circuit (C3). This is how it works:

  1. A participating businesses secure a invoice insurance up to a predetermined amount, based on creditworthiness and claims on third parties.
  2. Business A then opens a checking account with the clearing network (CCC) and electronically exchanges the invoice for clearing funds, and pays it’s supplier (business B) immediately through the CCC.
  3. Business B then only needs to open an account with the CCC. Then it faces two options; cash the claim in for legal tender (at the cost of paying the interest for the outstanding period, and banking fees), or pay it’s own suppliers which the obtained clearing funds (zero cost).
  4. At the time of maturity, the network gets paid the amount of the invoice in legal tender, either by business A, or the insurance company (in the event of bankruptcy). Whoever owns the claim at that point can then cash their CCC claim for legal tender without incurring interest costs.

This type of system not only provides businesses with liquidity (and thus, boosts demand for goods and services, thus decreases the demand to hold the medium of exchange — raising velocity), it works to stabilize macroeconomic output by operating in a counter-cyclical nature. As the velocity of legal tender declines, the velocity of CCC claims increases proportionately; smoothing out macroeconomic fluctuations, and providing a tool which businesses can use to remain solvent (provided they are not already a large credit risk!).

These types of solutions can be implemented immediately (as in, this minute; given the proper agreement), and do not require the vagaries of Congress. In a world where monetary disconnects have (and will continue to) become more frequently common, it is important to have a micro-stabilization tool in order to mitigate the macro-effects of monetary disequilibrium. Japan has already experienced this, and the Euro-zone looks to be heading in the same direction. The Fed is not nearly as conservative as the BOJ, but if *real* crises become more frequent (as some economists predict), and the Fed continues to rest on its hands (as they did in this current crisis), then it is definitely worth it to explore different options.

CNBC is reporting that BP is looking to place up to $10 Billion in debt as early as next week.

This will be a key test. I do not believe BP will be able to survive the aftermath of this crisis without smooth access to substantial credit. Already we are looking at $20 Billion for the escrow fund and up to 14.7 in fines from EPA. We have not begun to talk about lawsuits filed by the individual states.

Suppose that we are looking at total damage in the $60 Billion range. This represents something on the order of three years of profit for BP at the current rate.

We are also looking at the possibility of a double dip recession in Europe that could bring down the price of oil. Falling oil prices, huge increases in debt, $30 – $60 Billion in direct payments. This is risky territory for BP and if it cannot finance that level of debt at reasonable rates its future is questionable.

Via Kevin Drum, UCLA economist Ed Leamer seems to be very pessimistic about the near-term growth prospects:

The forecast for GDP growth this year is 3.4 percent, followed by 2.4 percent in 2011 and 2.8 percent in 2012, well below the 5.0 percent growth of previous recoveries and even a bit below the 3.0 percent long-term normal growth. With this weak economic growth comes a weak labor market, and unemployment slowly declines to 8.6 percent by 2012.

And then Kevin Drum indicts Congress, ostensibly for dropping on the ball in passing the weak jobs bill, which should probably read “useless jobs bill”…but I can imagine that Mr. Drum would like other fiscal measures as well.

So, why the persistent unemployment? Well, today’s CPI report shows that inflation edged lower by .2 percent. Just as worrying, the 5yr TIPS spread is currently at 1.68%, which is a full .32% below previous trend. We’re looking at a long path of grinding price and wage deflation to the new trend, which is +-6% below the previous NGDP trend from the Great Moderation.

Make no mistake, this is a failure of monetary policy to boost expectations of future NGDP. Getting mad a Congress is an exercise in futility.

On Twitter, Matthew Yglesias admitted to being confused by this chart. Being the accommodating person that I am, I attempted to explain it to him on Twitter, but because of the limitations of the format I think that I only ended up confusing him even more. So I’m going to take a crack at it here. First, the offending chart:

[Click Image to Enlarge]

Now, from what I can gather from the notes, what this chart shows is the change from baseline targets of gross debt-to-GDP for each country on the x-axis*, and the baseline increase in health and pension expenditure from previous trend (extrapolated to 2030) on the y-axis. In this case, if you find the United States, what the point represents is that the IMF is forcasting US yearly debt-to-GDP to be 12% of (current) GDP higher than target, and that health and pension spending will be 6% higher YoY than baseline.

It is a more confusing chart than I had originally thought when I attempted to explain it to Matthew…but I hope that sheds some light on the implications…or at least the implications that I understand from the chart.

*For reference: The US target gross debt-to-GDP ratio is 60%, Japan’s is 200%, and emerging economies’ are 40%.

Karl raises some good points in his response to my post. Namely, just because right now there is a lot of obvious low-hanging fruit in terms of efficiency and addressing externalities; that is not always going to be the case.

However, I would like to keep pointing out that for a given level of taxation, taxes on consumption are likely to raise more revenue than taxes on production. In reality, it is likely that as we institute a broad-based tax on carbon (I still think the financial services tax is wrong on merits), we could probably trade off by relaxing income taxes, instead of removing them. And, due to irrationality, it’d most likely end up being the personal income tax that is the target. It is definitely easy to envision how both converting emitting rights (and other environmental rights) into property combined with taxes could come to dominate Federal revenues in a short amount of time — allowing for even the abolishing of income taxes (although again, personal would likely have to come before corporate or capital gains).

However, beyond the well defined area of VAT, Payroll, and Carbon taxes, it the landscape does become quite gray. Pigouvian taxes are meant to deal with externalities, but what many progressives identify as externalities are hardly so. Smoking, for instance. Or “unhealthy” food. Neither of these things, under careful cost-benefit analysis, cost the public any money at the margin. Indeed, both may actually save the public money in the long run. These are cases of (wishful?) paternalism masquerading as externalities.

However, as I’ve argued in a post that I can’t seem to find anymore, you could easily raise 8-10% of GDP while making the Payroll tax more progressive (i.e. exempting the first $25,000 of income, removing the cap, and raising the highest rate to around 20% [total]), and I can imagine that a VAT+Carbon tax could easily raise another 10% (at a BOTE 20% combined rate)…and you are already at the historical trend.

Thus, there is quite a bit of room to maneuver from simply these three taxes alone. Perhaps these are the only taxes that the Federal government will need (even with the inevitable public health care)…and we can leave it to the states to fight about what “paternalalities” to go after.

Narayana Kocherlakota, the newish president of the Minneapolis Fed, has a new paper out discussing how to devise an optimal bank risk tax. The creativity of his solution shows the value of having a theoretical economist, or at least a creative economist, heading up the Fed.

He begins with the observation that bailouts are inevitable, there is no mechanism to prevent this, and that any bailout possibility is going to make banks behave riskier. An ideal solution forces banks to pay for the implied guarantee at a risk adjusted rate. This is in contrast to something like deposit insurance, where every bank pays the same fees regardless of how risky or safe. So how do you do this?

Kocherlakota suggests that every financial institution must issue a “rescue bond”, for which the coupon is equal to 1/1,000th any bailout funds paid to that financial institution. In most years this bond will pay zero, and only when they receive bailouts will owners of them receive any money. Thus the price of the bond represents 1/1,000th of the discounted expected value of the transfers of the funds to the bank, and so the government should charge the financial institution a tax equal to 1,000 x the value of the bond.

It sounds like a good idea to me, but I worry about a couple of things. First, there appears to be a recursion problem.  If a bank is an expected $10 billion short of solvent, and markets understand that, then rescue bonds will demand that the banks be taxed $10 billion. By the time this is knowable, the government can’t really credibly take the $10 billion from the bank, because then they will just be $20 billion in the hole, and they will be taxed $20 billion, etc. The only way this works is if it sounds the alarm far enough in advance that banks are solvent enough to be taxed and turn their behavior around.

For instance, if the price of rescue bonds indicated 2 years in advance that AIG was headed towards insolvency and caused the government to tax them at higher and higher amounts until were forced to turn their behavior around, then it might work. However, if in August of 2008 the price of rescue bonds indicated that AIG was going to be bailed out to the tune of $90 billion by the end of October, it’s not like the government could have actually taxed them $90 billion discounted by two month.  And if they did the bailout would just have gone up to $180 billion.

So to the extent that this plan works, it has to mean that the financial crisis reveals itself sort of slowly, rather than coming on quickly and unexpectedly. Then again, if it does happen too fast the government just won’t follow through on the tax, so maybe it’s worth a shot.

In principle I agree heartily with my co-bloggers on the benefits of a Liberaltarian alliance. On the blackboard, at least, there are dozens of major policy shifts that could give us government that was less intrusive, in terms of deadweight loss, and more effective in achieving progressive aims.

However, are we creating a new public choice nightmare? Rather than rent seeking through influencing elections, we would have rent seeking through externality digging. Finding and analyzing externalities is as much art as science. Moreover, the science on many big issues is preliminary.

I am already dismayed by our attempts to tax our way to national health. Health is a poorly understood process as is and health based taxes simply provide a further incentive to jump to conclusions. Its not completely clear how salt influences hypertension, for example, and if it even does so outside of a select subset of the population. Yet, we already have calls for a general salt tax.

Dietary fat was public enemy number one in the last decade but is increasingly exonerated as a major cause of morbidity. Now we are attacking high fructose corn syrup and the soda industry. There is a reasonable case to be made here but it is far from open and shut.

Last year I had several people in my office arguing for either a tax on non-organic foods or a subsidy on organics. To date, I have seen no evidence that organic means anything. However, do enough studies and I am sure one will show up. Type I errors do occur.

At all points I urge caution but when tax dollars are on the table caution is the last thing we are likely to get.

I wanted to add some thoughts to Niklas’s post on the liberaltarian bargain of getting rid of corporate taxes in exchange for a carbon tax and a financial services tax. There are a couple of additional costs and benefits to consider here.

First, on one level this is the opposite of industrial policy. The U.S. has a demonstrated competitive advantage in financial services, and taxing that may cause many of those firms to go overseas. I know a lot of critics of the finance sector like to show charts about how large their profits have gotten over the year as evidence that it needs to get smaller, but I have never seen those numbers broken out by profits on domestic vs international customers and activities. I would bet that much of the banking sector growth has involved a growing dominance of the Wall Street as an international financial hub, and so those gigantic profits won’t somehow be magically transferred to other industries, but will instead simply go abroad. But maybe that’s a good thing, I don’t know.

Now, on the benefit side. I find myself increasingly thinking like Will Wilkinson that taxes which we usually consider value neutral like income taxes and corporate taxes are not value neutral, but are taxes on labor effort and business activity. And so we should consider if we have to discourage some activities, which ones do we want to discourage. Pollution is certainly better to discourage than business activity, and maybe financial services are too, I don’t know.

Another potential benefits depends on how elastic businesses location decisions are with respect to these taxes. Will lower corporate income taxes cause a large number of corporations to relocate to the U.S.? If so, then perhaps this can be a cudgel with which to encourage international adoption of the carbon tax and financial service tax. This is important because the effectiveness of both is largely dependent on international adoption. Other countries experiencing a large exodus of corporations to America may have little choice but to abolish their own corporate taxes, and thus may need to switch to carbon and financial service taxes to replace the lost revenue. If international adoption is a goal then we should think about choosing a bundle of taxes that will cause the largest economic drain from other countries unless they choose the same taxes. Of course, given the current potential for years of sluggish worldwide economic growth, these also need to be taxes that if we all adopted them would encourage growth, which means no protectionism. This proposed tax swap seems like the best option here.

Another benefit is that this will effectively remove the tax deductibility of  interest payments for businesses. (It has been awhile since I’ve taken corporate finance, so I might be mistaken here). The incentives created by this policy lead businesses to take on a greater level of debt, and while I have not seen it discussed much, it seems like not having that policy would have meant businesses were less vulnerable to the credit crunch. Here is Interfluidity on the wisdom of getting rid of this policy:

Eliminate the tax deductibility of interest payments by businesses. Debt financing externalizes the risks of business activity and magnifies social costs, while equity financing concentrates risk among stockholders who signed up to bear it. Yet under current rules, taxpayers literally pay firms to get rid of stockholders and take on ever more debt.

If I am correct that getting rid of corporate taxes would eliminate this problem, than that seems like a huge benefit.

In all there is much to consider with this proposal, and the potential upsides are really huge. I can’t express how much I would love the fact that, as Kevin Drum points out, it would “remove forever Congress’s ability to provide quiet subsidies and corporate welfare handouts for their buddies”. Nevertheless, it is a dramatic proposal in terms of its scope and impact, and I hope to see it fleshed out more in the blogosp-… wait, what am I saying? The un-populism of this idea ensures it will never be enacted, so it doesn’t really matter anyway.

As a general rule of thumb, I view people who dismiss a “liberal-libertarian alliance” out of hand to be unreasonably reactionary, and mostly going with their heart — and not their head — which I nearly always view as a bad thing. In any case, since it is rather reasonable liberals who often dismiss “liberaltarianism”; I like to take it upon myself to highlight areas, identified by liberals, where their views and the views of (pragmatic) libertarians overlap.

Kevin Drum serves up a choice example:

Here’s the pitch: corporate income taxes are a drag on businesses and are ultimately paid by consumers anyway. That’s bad. Conversely, a tax on carbon would reduce our oil use and spur energy efficiency. That’s good! Likewise, a tax on financial transactions would reduce speculative volatility and help stabilize the financial sector. Also good! So we’d trade one bad tax for two good Pigovian taxes.

I think he has a wrong idea on the “Tobin tax”, or the marginal effect of speculative activity on market efficiency…but at least we’re moving in the right direction. I think that a carbon tax would, in the long run, allow for relaxing of the personal income tax as well. Indeed, if we promoted consumption taxes along these lines, there would be no need for an income tax at all. By eliminating income taxes, not only would we rid ourselves of something I find to be morally repugnant, but we would also be increasing the efficiency of our tax regime. That means lower taxes on net would produce greater revenue. A Pareto improvement!

These type of welfare-enhancing deals can be found literally everywhere, if one has the inclination to look. They’re oftentimes subtle but nevertheless are nearly always an improvement over the status quo.

David Roberts lists a few well-taken points regarding the EPA analysis of the Senate’s climate bill:

So what’s the verdict? Overall, EPA finds that the impacts of APA will be broadly similar to the impact of the House’s American Clean Energy and Security Act (ACES), i.e., affordable.

But of course his first point (which is the quite insane selling point of carbon caps) is that the costs to the consumer would be negligible:

The impact on U.S. consumers will be “modest.” Says the report: “Average household consumption is reduced, relative to the no-policy case, by 0.0-0.1% in 2015, by between 0.0-0.2% in 2020, by 0.2-0.5% in 2030, and by 0.9-1.1% in 2050.” Averaged over 2010-2050, households will pay an extra $79 to $146 a year. Not exactly a steep price to pay to avoid catastrophe. (Incidentally, overall household consumption will continue to rise, even with the mild constraints of the bill.)

Not a steep price to pay to avoid what catastrophe, exactly? If consumption continues to rise, and this bill does very little to curb the most inefficient methods of power generation (current fixed coal-fire power plants) by using the price mechanism of the marketplace (the extra $79-146 could easily come from increased transportation costs), then are we really avoiding catastrophe?

According to evidence we have seen from the run-up of energy prices in 2007-08, demand becomes closer to unit-elastic at greater-than $3 a gallon for gasoline. Thus, if the extra costs to consumers are, in fact, in transportation costs…that might induce some of this sort of behavior. However, if those costs are diffuse among all kinds of energy use (general production, gasoline, heating oil, etc.) you might not ever hit a point where elasticities would cause people to make a change. That seems to be what the EPA is telling us.

I haven’t had much time to go through the bill, but I’m sure that there are plenty industry giveaways, rent seeking, etc. involved…and remember, this is a fairly ‘weak’ bill. So what is the point? The EPA doesn’t happen to measure the highly intangible “benefits” of avoiding catastrophic climate change…however, if there is near zero price incentives — maybe they were right not to measure the benefits. Maybe there are none at all.

Update: I should have also added that if you are serious in your belief that using carbon energy is harming the planet, then what you want to do is raise the price of carbon until it induces a change. You want to punish people for indulging. That’s the point. Supporting a weak (or useless) bill so you can pat yourself on the back later when it gets passed and claim that you “got something done” is pointless.

I know everyone has seen this story and I have nothing to add, but I have to point out that this is the greatest opening paragraph for a newspaper article I have ever read in my entire life:

A middle-aged American construction worker, on a self-proclaimed mission to help American troops, armed himself with a dagger, a pistol, a sword, Christian texts, hashish and night vision goggles and headed to the lawless tribal areas between Afghanistan and Pakistan to hunt down, single-handedly, Osama bin Laden.

The rest of the article is also incredible. Yes, he’s crazy, we don’t want to encourage this, and he would most likely have ended up as a chess piece for the Taliban, but this guy is pure American, blind, stupid, Charles Bronson ballsy-ness, and someone needs to make a movie about him. I mean you could not write a better movie poster tagline than this quote from his sister:

“I’m guessing that he wanted to do one last thing for his country before he died,”

Felix Salmon and Ryan Avent have a very interesting discussion going on the externalities of homeownership. Overall I agree with Felix that you could argue all night about the upsides and the downsides of homeownership, and I’m not going to try and estimate which is larger (not right now anyway). However, I do think that Felix is being too optimistic when he argues that the length of time renters stay in one location is increasing, or will be increasing, by enough to make them willing to make the long-term investments in their neighborhoods or energy efficient appliances that homeowners make.

According to the 2008 American Community Housing survey, the median year that homeowners had moved into their homes was 1998, whereas the median year that renters had moved in was 2005 and in fact, as a Census footnote mention, the later part of 2005.  So the median tenure was 10 years for homeowners, and let’s called it 2.5 years for renters. The chart below shows the percent of renters and homeowners by the year they moved in.

By comparison, in 2004 the median year homeowners moved into their current houses was 1995, and the median for renters was 2001. So the median tenure for homeowners was 9 years, and for renters it was 3. The following chart showing distribution by year moved in has a similar story as above:

This means that between 2004 and 2008 the average tenure for homeowners increased slightly (from 9 to 10), while the average tenure for renters decreased slightly from 3 to 2.5, but overall I would call these numbers relatively unchanged. The vast majority of renters, around 67% in 2004 and 2008, moved in within the last 3 years.

So I don’t see evidence here for Felix’s contention that renters are staying in their homes longer, and homeowners are staying for shorter periods of time. There are more ACS years, and if someone has the time to compile a time series of this data it may be that a story more consistent with Felix will show up, but the numbers I pulled don’t show it.

Via Arnold Kling, we learn a little about the dynamics of even simple networks (like the game of life):

Why is that? In general, a bureaucratic system is one in which normal market forces have been systematically suppressed. In such an environment, there tends to be a sea of (relative) mediocrity, sometimes punctuated by little islands of excellence. Further, the islands of excellence tend to be randomly distributed. They do not correlate with much of anything.

Indeed, this is what you find when you run a simulation of the Game of Life while during each period, adjacent agents play a “Prisoner’s Dilemma” game to determine the winner. If you program agents to have a random strategy (i.e. tit4tat, always defect, etc) endowment at the beginning of the game, with a random “memory”, you will find that the network falls into a sort of equilibrium of a certain strategy, until one strategy “innovation” reaches a tipping point at random, and takes over the board.

That description, of course, makes it hard to visualize the consequences…but it is in this same fashion that rational humans settle into bureaucracy fairly quickly, and how innovations in other parts of the network can actually harm agents in other parts of the network. The difference between human networks and the GoL w/ PD is that humans can consciously attempt to suppress innovation that looks to harm their future position. Arnold comes to the conclusion that this represents a failure due to lack of “economic competition”. I tend to take a more nuanced view, as this type of bureaucracy is a feature of even private companies, so they are hardly immune to the problem. If you take the principle of “creative destruction” seriously, you would have to acknowledge that fact…as it seems to be the mechanism most responsible for such phenomena.

Does the lack of profit motive or competition tend to make the government abnormally bad at doing things? Most likely…but I think most of the adverse effects have to do with the way the network is structured.* Introducing competition can work wonders at times, but it can also cause other problems.

*Unfortunately, consciously designing networks to maximize efficiency and avoid complexity catastrophe is something at which humans are not the best.

Whenever I talk about the small role that medicine has played in expanding life expectancy I like to point out that there are many procedures which by all accounts do wonders for the patient. However, rather than comforting us, this leads us to suspect that the mediocre returns from medicine writ large are because some doctors are killing many of their patients.

Hospital transmitted infections are an obvious culprit yet another one seems be to radiation.

As you can see from the chart Americans get MOST of their radiation exposure from medical procedures. But to me that’s not what truly troubling. What is truly troubling is that unlike natural sources there are many people in this country who have never or only very rarely been exposed to medical radiation.

That means there must be some others who are just getting gobs of it. Way more that the 899 millisiervert US average.

One complaint about congestion pricing is that it would push people out of the market. But in theory this is not necessarily so. The common sense story is that the price of driving rises, so the quantity of driving demanded decreases, and thus less people drive. But it depends how people shift their behavior in response to higher prices. There are many ways to respond to higher driving costs that don’t mean less total people travelling by car.

For instance,  more individuals could begin carpooling. A new study points to an increasing trend in carpooling, and finds that gas prices are indeed inversely related to carpooling. The charts below show that the trend over the past few years has been of decreasing single-drivers, and that carpooling has been the predominant alternative to single-drivers, with the percent carpooling to work doubling from 4% to 8% (and shame on the author for not using 0% as the Y-axis intercept!):

Another way people could respond to higher prices is to drive during times when prices are lower, that is if prices are set in relation to congestion. Neither this nor carpooling represents any decrease in quantity, if quantity is taken to mean the number of people using non-public transportation automobiles for travel.

In addition, there are currently people who would prefer to drive places, but due to the time-cost of money decide not to drive there because they don’t want to wait in traffic. Driving could increase among these people.

In the end the number of people traveling by car in response to congestion prices is an empirical question, and there very well may be conclusive evidence that, contrary to the arguments I’ve presented here, the relationship is negative. I would be interested to see any such studies.

Foreign policy and economics blogs will overlap in subject matter today as the Pentagon announces it has discovered $1 trillion in mining reserves in Afghanistan, a country with a GDP of $12 billion. One issue that will be discussed much is ‘Dutch Disease”, which describes the negative economic outcomes that can often be associated with a high level of resource wealth like oil or minerals. I can’t tell you much about the necessary or sufficient conditions for avoiding Dutch Disease, or how likely it is for Afghanistan, but I can give a brief overview of how “Dutch Disease” is supposed to work.

One mechanism by which resource wealth translates to negative economic outcomes is the so-called “spending effect”. This is where a large increase in resource export revenues causes a large increase in demand which drives up the price of non-tradeable goods relative to tradeable goods because the prices of the latter are determined on the world market. This effect can also work via currency appreciation, which further hurts the competitive position of local non-resource tradeables.

An example of this would be a huge growth in the diamond industry driving up the prices of haircuts and homes because they are non-resource tradeables whose prices are determined locally. These higher consumer prices then increases the reservation wage high enough that the costs in the local clothing industry, a non-resource tradeable whose prices are determined on the world market, go above world prices and thus the industry suffers.

Another related mechanism is the crowding out effect, where other industries are crowded out as resource related industries dominate and soak up inputs like labor and energy. One example would be that there is simply not enough energy for the manufacturing sector, as the energy industry enters into long-term supply contracts with mineral and oil extraction companies, and supply remains relatively fixed.

One important industry that can be affected by both the spending effect and crowding out is manufacturing, which due to learning-by-doing and backward and forward linkages is often an important engine for economic and human capital growth in developing countries.

It is my impression that Dutch Disease is a controversial subject area in economic development, and I look forward to a healthy debate on it in the blogosphere.  A question for bloggers who know more about Afghanistan: prior to this discovery, would Afghanistan becoming the next Saudi Arabia be considered a best case or worst case scenario?

Via Ryan Avent I find this comment by Frank McArdle on congestion pricing:

“The plan put forth by Charles Komonoff to price some taxi trips and other trips off the road through price increases gets to the heart of the equity debate over congestion pricing: who gets pushed out and who gets the benefit. …Using the money to subsidize further mass transit may be the hook that gets the government to impose the system,but there can be little question that the faster trips will be to the benefit of those who can pay and those who can’t will be asked to shift their trips to other modes or other times.”

Of course this is going to be true of removing many inefficiently low price floors. When you allow the consumption of good to be rationed by non-price means, moving to price rationing means that those with the lowest willingness to pay will be pushed out of the market. For normal goods the income elasticity if demand is positive, and so income and willingness to pay will tend to be correlated, and less wealthy people will be pushed out of the market. If equity concerns you in the context of this below market price floor -which is exactly what lack of congestion pricing is, a price floor at zero- then what price floors won’t you support? Rent control? Price floors on food? Certainly hard rules against price gouging should be supported.

Elsewhere, Megan McArdle writes that since most commuters dislike congestion pricing, she’s suspicious of claims that it will make them better off:

All the people commuting by car seem to think they will hate it.  And that makes me think that they probably will.  It will make the traffic flow more quickly, but it will also cost them something like $200 a month.  That’s a lot of money for most people, to do something faster that they can now do more slowly for free.

There’s obviously something intuitively compelling about this argument, and the high level of unpopularity of many proposed congestion price plans does make me wonder whether the prices they are proposing are set too high, and whether planners are overestimating the time value of money in this context. In the end though, I think we would probably observe the massive unpopularity even if congestion were priced efficiently, because price controls tend to be fairly popular ideas. Price gouging and the other examples of price floors that I mentioned above are good comparisons. Even when they understand that non-price rationing will lead to things like waiting in line for gas and store shelves being emptied, people tend to be in favor of rules that try and prevent price gouging, and so presumably think they make them better off. And yet I think most economists, and certainly Megan, would agree that price gouging rules and other types of non-price rationing do in fact make people worse off despite the fact people don’t believe it.

So while I agree that in general if people believe something will make them worse off those concerns should be taken seriously, when it comes to the benefits of markets and price rationing people can just flat out be wrong.

From Political Wire

"No white folks have an ‘e’ on the end of Green. The blacks after they left the plantation couldn’t spell, and they threw an ‘e’ on the end."

— South Carolina State Sen. Robert Ford (D), quoted by the Charleston Post and Courier, saying that race have played a role in Alvin Greene’s (D) surprise victory since he was the only black candidate in a primary with a majority of black voters.

Being born and raised in Greensboro, North Carolina this immediately raised a red flag. After all I didn’t know my town’s namesake was an illiterate former slave (having died 60 years before the Civil War and all) and I’d swear he looks white to me.

Nathanael Greene

File:Greene portrait.jpg

David Shaengold suggests:

Even if you don’t care at all about the environmental damage caused by the petroleum industry . . . you should still support efforts to reduce our oil consumption. In fact, the more miraculous and unique you believe the properties of oil are, the more you should support this reduction. It’s true that petroleum combines energy density with portability at room temperature and pressure in a way that no other substance does. . . What’s astonishing is that we know that it’s irreplaceable and we know that there’s a quite finite amount of it easily extractable, and yet we continue to use it with utter profligacy. . . . Will we someday be unable to fly across the country because we couldn’t bring ourselves to stop paving over greenfields with petroleum so that our petroleum-gulping SUVs could park in front of our petroleum-clad houses?

Ok, so this is what markets are good at – distributing limited resources through time and space. What markets are bad at is accounting for externalities and public goods.

The public policy argument over oil doesn’t boil down to whether oil is good or bad or should be saved or consumed, that is for individuals to decide. The public argument is over whether or not there are social costs to petroleum usage not captured by the market.

It can be difficult for people to internalize just how economically destructive our immigration policy is. I think this is why some many folks can’t believe what a “free lunch” changing the policy would be. From my comments.

[Massive Immigration] sounds about as helpful as keeping our debt problems from hurting us now by taking on more debt to get us through now. It temporarily makes now better (or at least feel better, so far its not clear it has actually made now any better in reality), but it puts a clear increased burden on the future.

Not only is it not clear that immigration puts an increased burden on future generations, but its fairly clear that it decreases it.

The reason this is possible is because our current immigration policy is preventing literally 100s of millions of productive private transactions from occurring. It is a restriction of the free market far, far greater in scale than all of the other statist policies we have combined.

To be clear, its not just that controlled immigration is more economically destructive than all  the other command and control policies of the US government combined. Its that it is nearly an order of magnitude more destructive.

The reason is two fold. First, labor constitutes 70% of the productive inputs in the country. Immigration policy explicitly restricts that. You can think of it as a national union, a national cartel or nationwide state sponsored monopoly. The essential fact is that the market is being constrained in its dominate input.

Second, it is being constrained on massive scale. What I consider conservative estimates show that the US workforce would be 60% larger if we had an open immigration policy. Imagine a nationwide union that constricted labor supply so tightly that an additional 40% of the workforce was made unemployed. We’d be talking about a nation with a current unemployment rate of 50%.

Could you imagine any economic gains from disbanding that union? Could you imagine any increase in tax revenues? Any reduction in the burden on current and future taxpayers?

Even if one assumes constant returns to scale at the national level – and I believe there are reasons to expect increasing returns in technology innovation – US GDP would expand from approximately $13.5 trillion to $21.3 trillion.

The US government would move from running a structural deficit of about 4% of GDP to a small structural surplus. And, that is assuming that immigrants cause an immediate proportional increase in the size of all government programs except Social Security, Medicare and Defense.

We end up with a 60% larger National Science Foundation and a 60% larger National Institute of Health. We have a 60% larger profitable market for pharmaceutical companies and an increase of 60% in the largest market for consumer technology.

Now if all of this seems to good to be true – an impossible free lunch – consider that it already happened once before. We are living in a country created by massive immigration and it is the economically most powerful, technologically most advanced and most militarily dominant nation in the world.

The enormous gains predicted by theory have happened before and they were indeed revolutionary. The population explosion of the United States changed the course of human history. It expanded the scope of democracy, pushed forward the frontiers of science and lifted millions of German, Irish and Italian immigrants out of grinding poverty.

Gallup estimates that the US population could surge by 180 Million if everyone who expressed a desire to move to the United States did so. Indeed, the number would likely be higher as in Gallup’s hypothetical asked for first choices and presumably the United States is the second choice of many potential immigrants.

So far most anti-immigration folks have expressed the most concern over Hispanic influx. Perhaps, they would be comforted to know that most would be Americans are Asian.


In any case immigration is the most important policy facing the United States over the medium term.

First, an increase in immigration permanently dilutes the costs of military action. Military expenditures are invariant to the population. Yet, over the long term this is actually a much larger concern than either Social Security or Medicare. As China, India and Brazil industrialize, either the United States will have to drastically increase the percentage of GDP spent on the military or it will have to relinquish its position as a world superpower.

I know that seems like a fine idea to many, especially to many libertarian minded folks. However, liberal democracy has flourished almost entirely under the canopy of Anglo-American hegemony. It is entirely possible that a truly multi-polar world could sustain liberalism but it is not, however, entirely certain. To my mind the maintenance of the Open Society is our primary responsibility and I am not inclined to leave it to chance.

Now let me be clear. I am not an evangelical liberal. I don’t see it as necessary or even in all cases desirable to attempt to spread the basic principles of the Open Society.  I do see it, however, as crucial to maintain the Open Society where it currently exists.

Second, immigration temporarily dilutes expenditures on Social Security, Medicare, and interest on the national debt. However, temporary counts for a lot. The future is inherently uncertain and so truly pushing off consequences into the future is inherently a net gain. There is a chance of catastrophe, in which case your sacrifices were useless and there is a chance of explosive growth, in which case your sacrifices were unnecessary. These are real possibilities and should not be ignored.

It also gives additional time to prepare for changes in Social Security. One possibility is that the continued shift away from physically intensive jobs will mean that in 50 years a retirement age of 70 is feasible even if in 25 years it is not.

In addition, it gives more time for changes in the medical industry. Our current projections for Medicare are based on the assumption that medicine will experience excess cost growth indefinitely. Obviously, this is impossible. Something will happen which slows the growth of medical spending. Stretched far enough into future the cost curve has to bend. If for no other reason then because eventually medicine will be 95% of GDP and thus the two growth rates will be essentially identical.

Third, the rate of world wide technological progress is likely proportional to the number of people living in countries at or near the technological frontier. Increasing the number of Americans increases the growth of technology generally.

Fourth, immigration is the most effective poverty elimination program known. Not only does it dramatically increase the standard of living of the immigrants but remittances to home countries by immigrants represents a greater transfer of resources than all foreign aid combined.

UPDATE: Conor Friedersorf adds the guilt angle

Fat tail events are events that have a very (sometimes infinitesimally) small probability of occurring, and are (sometimes) hard to anticipate. Some examples; the sun extinguishing within the lifetime of anyone alive today, a relatively unknown econ blogger being added as a contributor to a much larger site, or a large oil spill…or even a large coffee spill…

Okay, maybe spilling coffee has a more normal distribution…but the point is, these type of “unknown unknown” situations are hard to anticipate (and often catch us unprepared), are hard to address after the tipping point has been reached, and often succumb to the amount of complexity involved, so the best we can come up with are ad hoc solutions that may or may not work, but are almost always sub-optimal. The video shows this fact comedically, and there is a lot of room to make fun of things like calling James Cameron or Kevin Costner may seem silly in the face of the complexity (because of availability bias*) but are certainly made with good intentions given the information.

*Availability bias tells us that Kevin Costner stars in movies and doesn’t respond to disasters because of the frequency with which we’ve seen him in movies…however his company seems to be keen on responding to disasters.

You may remember that there was significant debate over health care reform a few months back. At the time I acknowledged that while I couldn’t follow all of the byzantine implications of the new law, as far as I could tell, in many ways, it was a whole bunch of nothing.

Nothing on net on the budget side because it cut some programs and expanded others – raised some taxes and expanded some other tax credits. All in all it looked mostly to be a wash.

Nothing on the health side, because marginal spending on health care is unlikely to have any measurable impact on health.

In its latest report the CBO seems to at least agree with the first point.


From the Beige Book report [H/T Ryan Avent], we learn that by the Fed’s own forecast (the one that the use to gauge whether they are hitting their targets), real growth going forward will average 3%-4%, and with a trend rate of inflation around 1%, nominal growth will average 4.5% (best guess).

This is trend growth from the Great Moderation. What is so worrisome about this? We are +-5% below the long-run trend rate of growth in NGDP from the Great Moderation.

This is a tacit admission by the Fed that it is, indeed, okay with allowing the economy to downshift to a lower trend growth path. As I said in a comment to a recent post by Scott Sumner:

If the monetary authority “deems” it acceptable to stick with a lower level path for NGDP, then all fiscal policy can hope to do is “round out” a few jagged edges in the transition by cushioning the hardships (unemployment) that arise from disequilibrium in the face of sticky prices.

I think DeLong has a good point about borrowing costs, but that in-and-of itself doesn’t make the case for the government borrowing, because fiscal policy can’t be aimed at boosting inflation if the monetary authority is targeting inflation (or NGDP) from a lower level. However, the case can probably be made that we as “a society” should invest in some things that we “need” while borrowing costs are abnormally low. Of course, that “need” is subjective.

So, if during a recession we let the target path of NGDP fall by $1.3tn, and just kind of pick up our boots and trudge the same rate of growth from the new level, fiscal policy isn’t going to magically boost us back up to the old level.

…and that is rather depressing.

In addition to global warming, congestion, geopolitical costs, oil spills, and health problems like asthma and allergies, we now have another externality to gasoline consumption to justify a pigouvian tax: drunk driving. A new study by Chi et al (6 co-authors!) uses data from Mississippi to show that lower gas prices are related to drunk driving related accidents. The authors claim the study is the first to examine this relationship, and is important because from a theoretical perspective the relationship could be positive or negative.

The ways that gas could inversely relate to drunk driving are obvious: lower prices make it cheaper to drive and give people more disposable income, which means it’s less expensive go out drinking and driving and people have more money to do so. In addition, the marginal cost of driving a to a farther away bar decreases. Also, higher gas prices may cause people to shift to different modes of transportation, like walking or taking the bus, which (freakonomists aside) are less likely to result in drunk driving accident.

A positive relationship is less obvious, but could result if gas prices increases enough that the negative wealth effect (more expensive gas makes you poorer) is severe enough that it creates economic hardship, which can lead people to drink more.On the face of it, the positive relationship seems much less likely than the negative relationship, and this is what the empirical evidence found in this study suggests. The chart below shows the indexed values of drunk driving accidents and gas prices.

These results increase the growing gap between the nominal price of gas and the true cost of it, and strengthen the case for a pigouvian tax… not that externalities, efficiency, or empirical realities seem to matter much in the political debate on this issue.

A caveat though: these results should not be taken as dispositive but rather suggestive. The empirical analysis is pretty simple, does not get into a really serious attempt to examine causality, and has some fairly serious omissions. For instance, the authors do not control for weather in their analysis. They mention that it would be difficult to aggregate to the monthly level, but I think average temperature would probably suffice. Second, and relatedly, they do not control for seasonality. This is pretty important in a time-series context where you are very likely to see both drunk driving and gas prices increase in the summer and decrease in the winter. Finally, and this is a more minor econometric point, they choose between a poisson and negative binomial regression models by selecting the one with the higher log-likelihood, which I do not believe is a sufficient means to determine whether there is enough overdispersion in the data to warrant the use of negative binomial over poisson. More importantly, they don’t tell us whether the use of negative binomial, or OLS for that matter, affects the results compared to poisson, which would have taken 30 seconds to determine and would tell us something about the robustness of their econometric results. Given that the relationship between prices and accidents disappears for males when the analysis is partitioned by gender, it is not hard to believe that the results are potentially not robust.

All that said, the authors do argue that nobody has empirically examined this issue before, and the results are highly theoretically believable. In fact, I find the theory alone strong enough to conclude that a relationship is likely. At the very least when thinking about gas prices we should consider that drunk driving may be yet another cost of low gas prices, and this study should definitely be enough to prompt more research into this.

Matt Steinglass at the Economist laments that voters require politicians to be overtly religious, and is even more bothered by laws that do so. He is specifically creeped out by an (unconstitutional) law which bans anyone who “denies the existence of the Supreme Being” from holding state office in South Carolina. Eight other states, it turns out, have similar laws on their books. This prompted Matt to ask the following hypothetical:

So the federal constitution’s rule against “tests” of religion for public office has been upheld. But this seems to me to set up a don’t ask-don’t tell situation. What if a sitting governor, apart from any such test, were to just get up and announce: “There is no God”?

My guess is that it depends on where they are when they do it. If it was done inexplicably in the middle of one of the many ceremonies or ribbon cutting events that governors attend, it would probably be met with the some concern. Or if they were at a state funeral for some dignitary or war hero it would probably be even worse.

Delivery is also important. In any situation it would always be worse to stand up and announce “there is no God” while in the audience and interrupting someone else’s speech rather than in the middle of one of their own. Interrupting Obama during the State of the Union in the same style that Kayne West did to Taylor Swift would likely be the worst possible way to do it.

Saying it once at a normal speaking volume and then sitting down immediately is probably best, while screaming it over and over again would be worst, with a repetitive, tearful whisper somewhere in between.

Governor: “There is no God!”

There are probably very few times and places where a politician could get away with it. Maybe the only good time to and place would be during a particularly religiously hateful Pat Robertson speech. I could see voters responding well to that.

One the problems with Sea Steading is finding people who are willing to put up with the high price and daunting environment all in the pursuit of a little freedom. However, one group you might want to target is those pursuing experimental drugs not yet legal in the West.

According to Megan McArdle the biggest part of a drugs cost in the clinical trial. I would have assumed that the R&D costs were concentrated further back into the research end. Yet, if she is right then there is the potential for some extremely beneficial gains from trade.

If drug companies can find a potential compound cheaply and Sea Steaders are willing to self-experiment then billions of dollars could be made and possibly hundreds of thousands of lives saved.

The obvious benefit for Sea Steaders is early access to drugs and access to drugs that would have been unprofitable to put through a clinical trial. The advantage for drug companies is that even causal observation of the results and side effects from the Sea Steaders experience could help to focus their mass market clinical trials on the most effective drugs. Its essentially human research on the cheap.

Robert Waldmann suggests that we use special interest politics to our advantage:

Those of us who fear global warming want to make it more expensive to burn coal. One way to do this is to impose absurdly high wages and restrictive work rules on coal mines. We know how to drive prices up. It is easy. Militant unions have shown the way.

I propose the American Power and Give Coal Miners a Break Act. The idea is to impose a special minimum wage for coal miners (which must be even higher than the wages they get) *and* to require time and a half if they work more than 30 hours a week. This implies a higher price of coal, lower demand for coal , and, oh look 30 hours a week, just as many employed coal miners.

I am not sure what I think about this. The obvious retort is that we don’t want to provide intellectual justification to this type of politics. As James Hamilton likes to say, “a glass of wine may be good for the heart but a glass a day is not the best advice to give to an alcoholic”

On the other hand, I have become increasingly convinced that fighting what economist think of as public choice problems is really trench warfare against genetically engrained human tendencies. We might be able to convince one generation that the Corn Subsidy is a bad idea but that will do absolutely nothing to prevent the next generation from proposing the Local Food subsidy.

People want to reward activities that look like a good idea and are simply not inclined to be skeptical about their ability to discern good ideas from bad. Nor are they sensitive to their ability to create special interest groups via benevolently intentioned public policy.

Perhaps over time we can combat this problem by expanding an understanding of public choice theory, but I don’t think its possible to turn the tide simply by accumulating victories on individual issues.

And given that you “Make policy with the electorate you have, not the one you wish you had” I see a strong case for Waldmann’s proposal.

This all, of course, based on the assumption that we want to take costly action to prevent global warming, which is a whole ‘nother can of worms.

This comes from F.M. Scherer’s paper on pharmaceutical innovation written for the Handbook of the Economics of Technical Change:

New chemical entities does not include biologicals, new formulations and uses of existing products, and new combinations of previously approved products, but it is a standard measure of pharmaceutical innovation. Another useful piece of information from Scherer provides is a sample of estimates over time of the cost of clinical trials, which have increased substantially.

Now read Megan McArdle’s excellent new piece in The Atlantic on the decrease in pharmaceutical innovation. It is not an optimistic piece, and in true McArdle style she concludes that maybe we haven’t fixed the hard problem because it’s a hard problem that can’t be fixed. She tries to offer a bit of good news at the end of the piece, but it is a minor condolence:

But even if nothing works, look on the bright side: at least we won’t have to pay for so many pricey new drugs.

Robin Hanson says that his students liked the idea of publishing all medical data, eschewing privacy concerns in exchange for the ability to better examine the impact of lifestyle, environment, genetics and health care in determining health outcomes.

For researchers this could mean vastly better analysis. For consumer, it might mean being able to accurately shop the best doctors, hospitals and most importantly, procedures.

Since, I was kid this seemed like a good idea to me. Indeed, my younger self always wondered why the government didn’t just give out free medical care in exchange for data. At the time I thought science was omnipotent and if we couldn’t cure a disease it must be because we didn’t have access to the right data. Public data I reasoned, would lead to virtual immortality.

I am not quite – quite – as naive as all that today. Nonetheless, I see the benefits as much greater than the costs. I strongly suspect that privacy concerns only really matter when its only one or a few people whose information is private.

Everyone has something “wrong” with them. Some embarrassing medical fact or potentially “damaging” information. Yet, potential employers, lovers, and lenders can’t discriminate against everyone. 

If anything it seems that public medical information would work to erase the stigma associated with certain diseases. Can it be shameful that grandma is going senile when everyone knows that seven other women on the same street are too. Is it embarrassing to take Viagra when over half the men your age at your workplace are known to do so as well?

Karl pushes back against my post on the social costs of strategic default. He offers several points worth addressing, the first of which is whether or not the perceived moral or social costs of strategic default are a significant driver of homeowner decision-making. He points out that 1) negative equity is the primary driver, and 2) there are other indirect costs to foreclosing, like taking a hit on your credit score. I definitely agree on both points. However, Louis Zingales and his coauthors provide evidence that the social and moral costs are a quantitatively important determinant of the foreclosure decision for homeowners:

Ceteris paribus, people who consider it immoral to default are 77% less likely to declare their intention to do so, while people who know someone who defaulted are 82% more likely to declare their intention to do so.

Those sound like quantitatively important numbers to me. To gauge whether the perceived social and moral costs matter, imagine if they evaporated overnight, and tomorrow the decision became purely economic for people. According to Zingales, on average it is economically profitable to strategically default once a home is more than 10% underwater. First American CoreLogic estimates that there are currently around 11.2 million homes underwater, and 4.9 million underwater by more than 25%, so we’ve probably got somewhere between 5 to 10 million homeowners who would strategic default in this hypothetical. If this change in behavior was permanent, I have to think rates would go up significantly.

I’m not advocating that affecting this moral perception (or growing lack thereof) is something public policy should target, and Karl is probably right that it would probably be impossible to do so even if we wanted to. I also won’t disagree with his advice that individuals facing the foreclosure decision should make the rationally self-interested decision. But in deciding whether to let go of existing social and moral perceptions about strategic foreclosure, people should consider that their homeownership was subsidized by past generations, and their walking away will cost future generations. In the end, whether people choose to value that is, as Karl points out, a matter of personal utility maximization.

It’s also something the pundit class should consider as they advocate for strategic default, especially given that many are otherwise concerned with issues intergenerational fairness. They may feel this is outweighed by other fairness or efficiency aspects, which is fine, and a debate to have. But it should be considered.

Of course, the comments policy of the blog pertains to my comments, and I will never (personally) delete comments. I wanted to let the people that comment on my blogs know that I don’t have a whole lot of time to respond to all of the comments…and I generally don’t like to respond without having something substantive to say, or a new angle in which to think about something…or a clever joke, etc.

But I do read all of the comments I receive, and I do think about, and appreciate all of them! Just please don’t get discouraged by my lack of response.

I have found that thinking about network theory sheds an entirely new light on the problems that face corporations — both fledging and established — as well as governments around the world. The principle problem that faces governments around the world is that of lurid inefficiency, bureaucracy, and inability to act in the face of changing, and ever-accelerating problems that happen in the real world. My last post on this subject is just the tip of the proverbial iceberg when it comes to these types of problems.

When asking the question of what is causing government incompetence, you will invariably get one of two answers from the right and left, respectively:

  1. The government is not constrained or incentivized by the profit (/loss) motive that necessitates firms in the private sector operate efficiently. Governments very rarely face losses, and because humans have such a hard time envisioning fat-tailed events, it’s hard to even grasp (at least in the developed world).
  2. The government has been co-opted by special interests which put the profit motive before the “will of the people”, and thus steer policy away from the “social good”. What we need is enlightened figures to (magically?) weed out corruption and bring the focus of democratic government back to its true spirit — the people.

Sound familiar? When you hear these things, you should roll your eyes, for while there is a hint of truth in both statements, neither is absolutely true.

On the right, the profit motive often leads to incredible bureaucracies that very often lead to corporate demise — just like governments. Just look in the newspapers and you will see two (now-more-famous) letters littering the headlines — did you ever think they would be seriously looking down the barrel of bankruptcy? How about when Microsoft was going to take over the world…did that ever happen? Same was said about IBM, and they were out-competed by a college kid with $1,000 startup capital. Privatizations can also go bad. For instance, the privatization of directory service (“411”) in Britain, which led to higher prices and worse service because search costs were simply too high.

On the left, hoping for change through more enlightened souls…philosopher kings, as it were…is an exercise in futility. And thus the left is constantly being discouraged by just about everything that goes on in government — and especially by “Mr. Hope and Change” Obama (from what I hear). Maybe it’s representativeness bias (as I have quite a few leftist-liberal friends, and read quite a few leftist-liberal blogs). Oddly, having led so many long fights for “progressive change”, one would think they would understand the type of network effects they are up against! However, the overarching point is that sometimes government isn’t the answer simply because these type of network effects arise naturally, are aren’t willed by the “special interests”. Sometimes when things need to adapt to changing conditions quickly, government (regulation) just isn’t going to be the best solution. Postal service, for instance…and to some extent the operation of public transit.

In any case, this post was intended to raise awareness among the more pragmatic in the two broad camps — the next time you’re dissatisfied about something that goes on in government (or indeed, even at your workplace), take a minute to look at the network. Oftentimes you’ll find that something that seems stupidly trivial to you (i.e. if you were an omnipotent dictator able to make every rational decision immediately, or Homo economicus) — like switching from black to blue pens — quickly becomes a near-insurmountable obstacle, even in areas where it would offer a Pareto improvement. It’s not anything to do with bad people, or even lack of competition…it’s the network.

I’m hoping at least a few of my more influential readers pick this up because I would really like to hear a variety of opinions.

Paul Kurgman argues that the G20s new found emphasis on deficit cutting is misguided and I tend to agree with him. However, clearly their are smart people on the other side.

What I want to know is what do these individuals envision happening as a result of irresponsible levels of government debt. What are the consequences they see for the US, the Eurozone, the United Kingdom, etc.

I ask because from where I sit we are looking at substantial consequences from a lack of aggregate demand. Perhaps, there are those who find aggregation distasteful but surely: low to non-existent inflation, very low government interest rates both absolutely and in relation to the private market, weak retail spending, weak hiring, high unemployment, below trend GDP and government revenues all combine to create a disconcerting picture.

And for me at least, its hard to square that picture with concerns about runaway debt or inflation.

From the Onion

Majority Of Government Doesn’t Trust Citizens Either

WASHINGTON—At a time when widespread polling data suggests that a majority of the U.S. populace no longer trusts the federal government, a Pew Research Center report has found that the vast majority of the federal government doesn’t trust the U.S. populace all that much either.

According to the poll—which surveyed members of the judicial, legislative, and executive branches—9 out of 10 government officials reported feeling "disillusioned" by the populace and claimed to have "completely lost confidence" in the citizenry’s ability to act in the nation’s best interests.

"All the vitriol and partisan bickering in Congress has caused most Americans to form negative opinions of the U.S. government," Pew researcher Amy Ratner said. "However, over the same time period, the government has likewise grown wary of U.S. citizens, largely due to their utter lack of foresight, laziness, and overall incompetence."

Added Ratner, "And the fact that American Idol is still the No. 1 show on television doesn’t exactly make our government burst with confidence."

HT: Mankiw

Peter Orszag has an illuminating post about a subject that is sort of ‘common knowledge’ to anyone who has had to deal with multiple government agencies at once, and that is the technology gap between the private and public sectors:

When many of my colleagues went from the cutting-edge, social media-focused Obama presidential campaign into the federal government, they remarked that it was like going from an X-box to an Atari.

Indeed, a significant IT gap has developed over the past decade and a half between the public and private sectors – and that is a big part of the productivity divide between the two. Closing this IT gap is key to boost efficiency and make government more open and responsive to the wants and needs of the public.

This is a classic example of a complexity catastrophe. Recall that networks face a tradeoff between two opposing forces: degrees of possibility and degrees of freedom. Large networks have an advantage in informational scale; that is, its information processing power increases exponentially upon the addition of extra nodes. This property of networks is likely the key which allowed humanity to advance technologically, instead of simply building stone tools more cheaply.

Of course on some level, the larger the network, the more densely connected the nodes (although humans have invented hierarchy as a way to partially mitigate this problem). As I mentioned in my linked post, more nodes creates greater complexity. While increasing the degrees of possibility of the network, it also decreases the degrees of freedom which the network has to react to specific shocks. This is the reason that Peter Orszag’s speech probably amounts to little more than that — a speech. The government obviously has the means to update its information infrastructure, however due to the fact that changing one part of the network virtually necessitates changing many others, some that don’t even interact in any meaningful sense, once a standard has become entrenched, it becomes very hard to change the network configuration.

Whereas the silicon valley startups that the Obama campaign whiz kids came from had exceptional degrees of freedom to adapt and react to changing technological forces (a thin network, so to speak), the government is exactly the opposite — and people who are accustomed to having large degrees of freedom ostensibly find this problem very frustrating. Indeed, information technology could save the Federal government untold amounts of money, and even make transfer payments more economically efficient — unfortunately, 250 years of lawmaking structure is running up against a decade of rapid technological change…and thus we have a disconnect between possibilities and freedom, a complexity catastrophe.

[H/T Matt Yglesias]

One of my co-bloggers argues

My concern is that there is an intergenerational unfairness to current homebuyers walking away. Past generations didn’t think of a mortgage like ruthless businessman, but rather felt some moral duty towards repayment. This made lending to homebuyers less risky, and thus kept interest rates down. Current homeowners benefitted from these lower rates, and therefore received a transfer of wealth from past generations. If the current generation abandons those social mores against strategic foreclosure and begins walking away from their mortgages en masse, then future generations will have to pay higher interest rates.

To the extent lower interest rates are the result of the rectitude of my forbearers, I say thank you. But, you must forgive if me if I am skeptical about the extent.

First, as Arnold Kling often repeats the classical wisdom at Freddie Mac was that foreclosures were driven by home equity. Now, we can be charitable and argue that this is because an underwater family has fewer resources with which to uphold its moral duties. I suspect, however, it also has to do with whether or not selling was strictly more profitable than walking away.

Second, walking away is not free. Walkers become subprime borrowers for at least 7 years and you might have noticed that the subprime market is not offering the most attractive of terms these days.  Now yes, some would-be walkers were subprime borrowers to begin with, so the net penalty is not that great.

There were, however,  those of us who mentioned that this might pose a moral hazard problem for banks who chose to make these loans. We were assured though that the Gaussian Copula had taken care of all of that and such parochial concerns need not trouble the scions of the big five investment houses.

Third, Caveat Emptor and all that. This is capitalism, not pot-luck at the local senior center. One can’t seriously suggest that we try to adjust international interest rate spreads by getting millions of agents to act against their economic interest.

If you really think coordination is key here then we can talk about public policy measures – expanding the recourse of banks to come after homeowners for the difference. Allowing creditors to garnish wages. Even having the government step in to reduce Social Security benefits in exchange for making up the difference between your collateral and your loan value.

Generally speaking, however, I think free people can write contracts and I would hope multinational financial institutions can read them. 

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