Monthly Archives: September 2011

Dr. Copper and Mr. Gold: A conversation

Definitely worth a read.

TheMoneyIllusion

via Dr. Copper and Mr. Gold: A conversation.

Forget the Future? Pension Uncertainty and Scaling Back Today’s Consumption, or evolving into Monkeys

Read the last part if nothing else.  As a species, I think we suffer and benefit from our ability to imagine things that might go wrong, or how we wish the world was versus how it is.  Technically, I think Professor Kahn may understate the chance that lower interest rates can increase investment (I).

When I was an undergraduate, I was taught that in a closed economy that C+I+G=Y.   Given that I’m back at the LSE, I’ve been pondering this deep macro identity.   Government spending, G, is going to decline as we try to cut the deficit.   I, private investment,  is frozen as firms are puzzled about what will happen next so that leaves "C" — consumer spending.
Won’t consumers be kind enough to spend our way out of recession?   Ricardian Equivalence posits that forward looking consumers anticipate coming tax increases and this expectation that their permanent income is lower than reflected by today’s income leads consumers to cut back consumption now and save today.
Now a pinch more bad news.   Today’s Daily Telegraph reports that 60% of individuals surveyed in the UK do not believe that their pension will give them enough money to live on in retirement.   Now, I don’t know where this expectation comes from but if a substantial percentage of U.S adults of working age believe this then they will respond by scaling back their consumption today to save more for the future.
It is too strong to call this a self fulfilling prophesy but this is an ugly case highlighting how expectations of the medium term influence choices today.
In the Keynesian consumption function, men are monkeys who do not ponder the future.  In that model,  today’s consumption is solely a function of today’s income.  Would our economy be in stronger shape if we had less of an ability to imagine the future?  Must we evolve into monkeys?

Forget the Future? Pension Uncertainty and Scaling Back Today’s Consumption
Matthew E. Kahn
Tue, 20 Sep 2011 07:55:00 GMT

The Romance of Technology

Anybody in the energy industry should find this compelling reading.

Jo Walton:

Rothfuss Reread: The Wise Man’s Fear, Part 4: Well Over The Hill: Stargazer considers the poetry of real life power generation:

Somewhere, right now, a turbine is spinning in superheated steam above a great flame, gnawing ceaselessly day and night as a vast swarm of servants scurry about the globe to feed its insatiable appetite so that you may read these words from afar or speak to distant loved ones. Nations pour out gold and blood onto desert sands and throw away lives down deepest caves, burn down whole forests and flood river valleys that once were home to millions, all in the name of feeding those flames. Adepts labor cleverly to reduce inefficiencies as much as possible through ever more intricate patterns scrawled in copper and silicon, inventions from the University doubling your gas mileage and letting your cell phone hold its charge a little bit longer. And the most foresighted of those adepts dream of harnessing the greatest fire of all, ever circling overhead, by stealing right from the sky its power, or harnessing it through its stepchild, the ever-restless softly blowing Wind.

The Romance of Technology
J. Bradford DeLong
Sat, 24 Sep 2011 16:27:00 GMT

Slouching Towards Socialism

 

Below is comment on Ezra Klein by Karl Smith.  It suggested Klein is pushing socialism.  I don’t favor subsidies to business just because they’re small, and I don’t think Karl Smith does either.  I think Smith may be missing the Klein point:  policies are defending by emphasis on the benefits they have on popular groups.  For example tax cuts may help the old money rich, but to sell the tax cuts you emphasize a small group of small businessmen that benefit from the cuts.

 this by Ezra Klein really is pushing a socialistic agenda.

Most Americans don’t like the idea that someone who makes money by playing the market gets taxed at a lower rate than they do. But they do like the idea of Google. So argue that the tax change will hurt the next Google.

Similarly, most Americans don’t like the idea that as the rich have gotten richer over the past few decades, they have also gotten huge tax cuts. But most Americans do like the idea of small businesses. So if you want to keep the tax cuts for the rich, argue that they help a small number of small businesses which are both taxed at an individual rate and bringing in more than $250,000 in income a year.

But this is a very bad way to defend very broad policies. If Jackson is right, and there is something special about tech investment that we would like to subsidize, then perhaps we should subsidize it directly. That would be far cheaper than taxing all capital gains at a lower rate. Similarly, if we want to do more to help profitable small businesses, we can offer them targeted subsidies, or specific tax breaks.

Here Ezra has now dispensed with even the pretext of combating externality. If we “like” Google we give Google special favors. If we like small business, we give small businesses favors.

It precisely this effect -  that the whims of the electorate or the wide-eyed plans of the politicians could directly manipulate the industrial organization of the US economy – that makes socialism paralyzing.

Now, obviously it is impossible to stop all efforts at industrial policy and planning. However, there was self-limitation in the social hypocrisy that we are just trying to combat externality. At least then you have to come up with some plausible case and it can be attacked by the other side as being senseless.

However, if we are descending into simply shoveling money towards favored industries because we like them – no pretense necessary – then we are slouching towards socialism.

Filed under: Economics

Slouching Towards Socialism
Karl Smith
Thu, 22 Sep 2011 21:05:29 GMT

Nobel Speculation: Armen Alchian, Harold Demsetz and Benjamin Klein Should Win the Prize in 2011

 

Its time to dust off (and slightly update) an old post for its annual republication around this time each year.   With the start of the school year comes another fall tradition here at TOTM: Nobel speculation.

More specifically, every fall I yell from the rooftops that some combination of Armen Alchian, Harold Demsetz and Ben Klein should win the award.  In 2006, I argued that the UCLA trio outperformed the more conventional and popular trio of Holmstrom, Hart and Williamson by standard citation measures. In 2007 I repeated my call for the UCLA trio (hedging my bets by also pulling for GMU colleague Gordon Tullock — another well deserving candidate) and was disappointed again.  2008?  I’m nothing if not consistent.  In October 2008 I wrote:

I’m sticking with the UCLA economists: Alchian, Demsetz and Klein for contributions to the theory of the firm, property rights, and transaction cost economics.  An Alchian and Demsetz prize is probably more likely, but Klein’s contributions with Alchian to the theory of the firm along with his own subsequent extension of that work (see my article on Klein’s contributions to law and economics here) makes the trio especially formidable.

The disappointment was a little bit more salient in 2008, as Thomson Reuters listed Alchian and Demsetz in their list of top 3 possible picks.  What a tease.  Well, its not quite October yet, but I thought I’d get an early start this year and release my 2009 predictions:  Armen Alchian, Harold Demsetz and Ben Klein for contributions to the theory of the firm, property rights and transaction cost economics.

Alchian’s contributions to economics and law and economics are Nobel worthy. Armen’s classic paper with Harold Demsetz (AER, 1972) remains influential in the theory of the firm literature and is listed as the 12th most important paper in economics since 1970 by Kim et al.  Klein, Crawford and Alchian’s seminal analysis of vertical integration and the holdup problem (JLE, 1978) ranks #30 on this list.  With two hits in the top 30 economics papers since 1970, there is no doubt that Armen had impacted the field.  Susan Woodward, a former co-author of Alchian, has authored a wonderful chapter on Alchian’s contributions to law and economics that will appear in the Cohen & Wright Pioneers of Law and Economics volume (there will also be essays on Klein and Demsetz).  As I’ve written previously, Alchian also thrives by other measures of scholarly output.  Cite counts do not begin to do his body of work justice.  Consider, for example, that Armen’s teaching style is the stuff of legend (I say this having the great benefit of having Armen on my dissertation committee, but also sharing as colleagues two Bruin economists that studied under Alchian and knowing many more).  Tales are abound of the careers of economists-in-the-making that Armen influenced in one way or another.  Nobel Laureate William F. Sharpe captures some of this in his autobiographical exposition explaining Alchian’s influence on his own career:

Armen Alchian, a professor of economics, was my role model at UCLA. He taught his students to question everything; to always begin an analysis with first principles; to concentrate on essential elements and abstract from secondary ones; and to play devil’s advocate with one’s own ideas. In his classes we were able to watch a first-rate mind work on a host of fascinating problems. I have attempted to emulate his approach to research ever since. When I returned to pursue the PhD degree, I took a field in microeconomics with Armen and he also served as chairman of my dissertation committee.

Alchian has also contributed greatly to the law and economics movement through his involvement in the George Mason University LEC judicial training programs.  In an important antitrust policy speech, former FTC Chairman Timothy Muris and my GMU colleague articulates a sentiment I’ve heard repeatedly from those who went through the program or watched Armen teach:

Armen Alchian was unexcelled in teaching economics to lawyers. He often presented economics socratically – a technique familiar to lawyers. For years Armen was one of the most popular instructors in Henry Manne’s programs for teaching economics to lawyers. In short courses, he taught literally hundreds of federal judges and law professors.

As Armen’s long-time collaborator William Allen put it in his own letter to the Nobel Committee on Armen’s behalf:

Economics is a broad discipline in methodology, as the Committee is fully aware, ranging from detailed historical, institutional, legalistic description to totally abstract, arcane theory. All such approaches, techniques, and emphases are appropriate. But there is much specialization among the members of the fraternity. And, increasingly, the profession has dealt in rigorous, elegant manipulation, even when the work is purportedly empirical—and even when the substantive results hardly warranted such virtuoso flair. Professor Alchian is a splendid technician, and he has contributed significantly and conspicuously to general “theory.” But, in contrast to many, he has always appreciated that the final payoff of Economics is elucidation of the real workings and phenomena of the world. I know of no one at any time who has had a finer sense of how to use economic analytics to explain the world. Sometimes the explanation requires involved, complex analysis, and Professor Alchian does not fear to use the tools which are required; what is uncommon is his lack of fear in using the MINIMUM tools which are required. In large part, his peculiar genius (the word is used advisedly) is to make extraordinarily effective use of elemental, and often elementary, techniques of analysis. And a host of people—many of whom are now in strategic positions in universities, in government, in the legal system, in the world of business and finance—have enormously benefited from the tutelage of Professor Alchian. … I present Armen Alchian as a giant—a giant who, because of his lack of pretension, is easily overlooked by laymen and even by some supposed professionals—who has greatly honored his profession and uniquely contributed to its usefulness. He would grace the distinguished fraternity of Nobel Laureates.

Well said.

Here are some Alchian links for interested readers:

As strong as the case for an Alchian Nobel is, the likelihood of a solo Nobel in the areas of the theory of the firm or property rights is unlikely.  And what better way to share the prize than with two co-authors who have made substantial and significant contributions, but individually and collectively, to economic problems involving the theory of the firm, property rights and transaction cost economics taking a similar methodological approach and bringing distinction to the UCLA School of economics.  I’ve written extensively about Klein’s contributions here.  But the most well known contributions (in addition to Klein, Crawford Alchian (1978) and the important exchange between Coase and Klein concerning asset specificity, vertical integration and contracting) include Klein & Leffler (1981), Priest & Klein (1984), Klein and Murphy (1988) and Klein (1995) and Klein (1996) ranging on topics from the role of reputation in the design and performance of contracts, the seminal model of litigation and settlement, vertical restraints, and the economics of franchising.

Demsetz’s contributions to economics are perhaps the most well known of the trio, including the coining of the phrase “Nirvana Fallacy,” but a cursory list as a refresher for the Nobel Committee:

  • 1967, “Toward a Theory of Property Rights,” American Economic Review.
  • 1968, “Why Regulate Utilities?” Journal of Law and Economics.
  • 1969, “Information and Efficiency: Another Viewpoint,” Journal of Law and Economics.
  • 1972 (with Armen Alchian, “Production, Information Costs and Economic Organization,” American Economic Review.
  • 1973, “Industry Structure, Market Rivalry and Public Policy,” Journal of Law and Economics.
  • 1979, “Accounting for Advertising as a Barrier to Entry,” Journal of Business.
  • 1982. Economic, Legal, and Political Dimensions of Competition.
  • 1988. The Organization of Economic Activity, 2 vols. Blackwell. Reprints most of Demsetz’s better known journal articles published as of date.
  • 1994 (with Alexis Jacquemin). Anti-trust Economics: New Challenges for Competition Policy.
  • 1995. The Economics of the Business Firm: Seven Critical Commentaries.
  • 1997, “The Primacy of Economics: An Explanation of the Comparative Success of Economics in the Social Sciences” (Presidential Address to the Western Economics Association), Economic Inquiry.

And of course, most recently, Professor Demsetz released his newest book, From Economic Man to Economic System on Cambridge University Press.

I know, its early for this stuff.  But its time to break the streak.  Maybe this is the year ….

P.S. Comments about whether the Nobel Prize is a “real” Nobel or not will be immediately deleted for lack of creativity.

Filed under: economics, nobel prize

Nobel Speculation: Armen Alchian, Harold Demsetz and Benjamin Klein Should Win the Prize in 2011
Josh Wright
Sat, 24 Sep 2011 04:54:46 GMT

The Great Macroeconomic Policy Debate – How to restore growth?

Urbanomics

via The Great Macroeconomic Policy Debate – How to restore growth?.

 

The biggest macroeconomic challenge now is to manage a recovery from the stubbornly persistent economic slowdown. But a fierce ideological battle is on about what strategy is required to achieve economic recovery.

Everyone agrees that across both US and large parts of Europe, household, bank, and government balance sheets are suffering from huge debt over-hang. As households cut back on consumption and banks refuse to lend, businesses are postponing investments. The high unemployment rates show no signs of coming down and the economies remain stuck at the trough, far longer than the aftermath of previous recessions. Governments, the only other agency capable of engineering a turn-around, are faced with huge sovereign debts and battered fiscal positions. With interest rates at zero bound and even extraordinary quantitative easing measures already having been tried out, monetary policy appears to have limited traction. So what is the way out?

Conservatives are unambiguous in their advocacy of fiscal austerity and placing deficit reduction at the center of the macroeconomic agenda. They fear about the dangers of inflation taking hold and bond-market yields rising. They claim that the fiscal and monetary expansion of the last decade or so has produced several excesses that need to be wrung out before any meaningful economic recovery can begin. To this extent they advocate immediate re-balancing of public finances with policies to cut government expenditures, raise revenues (albeit without raising taxes), and carry out structural reforms.

They admit that while this will generate some short-term pain, it will be for the long-term good. They argue that this will generate “contractionary expansion“, restoring market (business, investor, and consumer) confidence and shaping expectations and thereby encouraging business investments. See Robert Barro (academician), Stephen King (Business), and Wolfgang Schauble (politicians) advocating austerity and fiscal consolidation over expansion.

Liberals differ and propose further fiscal and monetary expansion as the only way out of this mess. The argue that the high persistent unemployment rates should be the central focus of policy makers. They point to historical evidence from US in 1930s and recently from Japan, to argue that unless governments undertake aggressive Keynesian stimulus spending and unconventional monetary expansion, the economy risks being stuck at the bottom for a long time.

They also point to the evident inability and reluctance of businesses to invest in such uncertain and weak environments, especially that of the job-creating but credit constrained small businesses. They see government spending as the only source of generating additional aggregate demand. They also argue that the ultra-low interest rates provide an excellent opportunity for governments to invest in infrastructure and other long-term spending so that the platform for longer-term growth is laid at the cheapest cost. They see little evidence of government spending crowding out private borrowing, inflation emerging as a concern anytime soon, or bond-markets catching cold. See Martin Wolf (Journalist), Mark Zandi (Business), Adam Posen (policy maker) and Dani Rodrik (academician) advocating expansionary policies.

There are also some others who have refrained from taking an explicit position, preferring to suggest specific measures. Some like Ken Rogoff have rightly argued in favor of policies that directly address the issue of cleaning up household and bank balance sheets. To this extent they advocate inflating away debts with a slightly higher inflation target, something which Olivier Blanchard, the IMF Chief Economist too had advocated earlier. However, the efficacy of higher inflation targeting has been questioned on credible enough grounds by Raghuram Rajan.

Interestingly, both sides invoke the magisterial historical examination of sovereign debt crisis, induced by various factors including banking collapses, by Carmen Reinhart and Kenneth Rogoff. Conservatives point to their finding that high-levels of growth dampen growth. Liberals point to their findings about the deep nature of recessions that follow banking collapses and argue that government support therefore is essential for expediting recovery.

All these views carry considerable ideological baggage and are evidently constrained by the need to accommodate their respective ideological predilections. Warts and all, the main issue is about which mixture of policies would be most effective in enabling a sustained recovery. An objective assessment reveals inconsistencies or practical difficulties with both sides.

The problem with the conservatives’ position is that if all the actors – governments, businesses, financial institutions, and households – are badly constrained, then where would the thrust for recovery come from? Their argument is that debt restructuring and the dynamics that get generated could restore market confidence and thereby pull the economy up the recovery path. But, given the depth of the problems, will it carry the momentum required to pull the economy out? Even traditionally conservative institutions like the IMF have raised serious doubts about fiscal austerity arguing that it could hurt incomes and job prospects. Further, the experience in the current recession with such policies is hardly encouraging.

As several estimates of growth required to bring unemployment in the US to normal levels and also bridge the yawning output gap show, the scale – magnitude and time – of growth required to restore normalcy in the medium term is substantial. In the absence of a strong engine or anchor, what will be the source of this growth? The justifiable fear then is that the recovery process could go on for years.

The fundamental premise of the liberals’ argument is that it is necessary to do everything possible to pull the economy out of recession. They fear, based on historical precedent, that in the absence of aggressive expansion, the unemployment problem will assume structural nature and become a socio-economic problem, and a lost decade will be inevitable. I am inclined to believe that this fear too has strong justifications. However, some of the liberals policy measures are not fully supported by fact and appear to based more on hope than objective considerations.

Their hope is that aggressive fiscal and monetary actions will buy enough time for the markets to repair battered balance sheets of all parties and set the stage for a sustainable recovery. But what if it does not? The trillions of dollars so far spent on fiscal and monetary stimulus in the US had not had the expected impact (there could be a counterfactual problem here). What is the certainty that more rounds of stimulus will work? More critically, it is possible that the amount of stimulus required to make any meaningful dent is so large as to make it fiscally and politically impossible. In the circumstances, expansionary policies would be merely throwing money down the drain.

So, if the fears of inaction appear well-justified, and the possible policy alternatives are fraught with deep uncertainty, then are the developed economies set to suffer a long and tortuous period of restructuring, high unemployment and low growth? Is this the inevitable cost of the excesses that got built-up over the past decade or so? Is it desirable to have a medium-term period of de-leveraging that is necessary to wring out the excesses and distortions, rebalance balance sheets, and achieve normalcy? In the meantime, is it appropriate if public policy refrains from anything proactive (either expansionary stimulus or austerity) and confines itself to the provision of a basic minimum social safety to those worst affected by the economic weakness?

Unfortunately this approach too appears untenable. It presupposes a longer period of high unemployment rates and economic weakness. However, there are widespread concerns about its long-term impact on the labour force itself. Longer the people stay unemployed, greater the difficulty to rejoin the workforce. Skills will atrophy and productivity will decline. The socio-economic impact of this will be pernicious. The long-term impact on America’s labour force and the economy in general will be damaging. See also this excellent study by Alan Krueger and Andreas Mueller.

Then there is also the danger of Japan. That country ahs been stuck in the trough for nearly two decades now and no end appears in sight. Though there are considerable dis-similarities, there are exists striking similarities – similar asset crashes, huge public debts, aging work-force, and possibly a nominal zero-interest liquidity trap. The magnitude of the downside associated with these risks are so huge that not doing anything proactive appears unwise.

In view of all the aforementioned, and given the extremity risks, inactivity may not be desirable. But there is no clarity on which strategy is most effective in stimulating a recovery. In the circumstances, the only alternative may be to throw everything at the problem and hope that some mixture of policies does enough to put the economy in the recovery path.

Bipartisan Failure

This  seems spot on.  Obama is on the wrong track and yet the opposition is likely even worse.

The theory behind Obama’s policies is Keynesian: that a temporary package of tax cuts and spending increases can provide a short-term boost while the economy returns to self-sustaining growth. Many economists agree with this logic, but the underlying economic theory is much weaker than supporters realize. It fails on two counts.

First, the US economy needs more than a temporary stimulus to return to self-sustaining growth and full employment. Our growth and employment problems are structural, and need a structural response. Second, the stimulus might not actually stimulate very much even in the short term.

The housing boom between 1998 and 2008 was an indirect reaction to the loss of manufacturing. As the US shed manufacturing jobs in the 1980s and 1990s, the Federal Government and Federal Reserve tried to compensate by boosting jobs in construction and other sectors shielded from international competition (so-called non-traded sectors). The Fed cut interest rates and the White House and Congress promoted housing finance, including through reckless deregulation and irresponsible behavior by government-backed entities like Fannie Mae. These efforts produced a temporary boom in housing, followed by the bust in 2008.

Obama and his advisors have believed, in effect, that they can reignite the housing boom. Rather than reacting to the underlying problem — the loss of manufacturing competitiveness — they have acted as if a bit of pump priming and the passage of time will recreate consumer-led growth in housing, autos, and other sectors.

One of the common errors of our recent policy debate has been the belief that various studies of the Congressional Budget Office (CBO) "prove" that the stimulus measures have raised employment and output. Careful readers of the CBO reports know that the CBO has proved nothing of the sort. The CBO reports have assumed that the stimulus works, relying on multipliers found in its mathematical models of the US economy. The CBO hasn’t in fact re-examined its model for purposes of estimating the impacts of the stimulus policies.

This point is especially important to understand.  The estimates that the stimulus created (or saved) jobs are based on models and equations that assume impacts from the stimulus.  They don’t truly measure it.

Obviously the most simple criterion of if the stimulus worked is if it achieved the levels of employment expected.  Clearly that hasn’t happened.  You can argue that things would be worse without the stimulus, but ultimately that can never conclusively measured.

Obama is right that the Republican vision of relentless tax cuts, deregulation, and shrinking government is the road to ruin. Yet Obama’s alternative of short-term and shortsighted stimulus is only marginally better. Neither approach is getting America back on track.

America requires at least a decade of well-designed and well-executed national investments in people, infrastructure, and innovative technologies, in order to boost competitiveness and renovate the economy. Yet such an effort requires serious plans, careful deliberation, and higher taxation on deadbeat corporations and the super-rich. (Obama’s endorsement of lowering corporate tax rates in return for ending loopholes augers poorly once again, since it invites yet another gimmicky tax negotiation in the interests of the rich.)

Was Marx Right?

Umair Haque

via Was Marx Right?.

The Likely Reaction to the President’s Speech

House Condescendingly Approves $400 In Added Stimulus | The Onion – America’s Finest News Source.

From Megan McCardle on the President’s Speech

While I voted for the President and may again, I find he doesn’t seem like a bold leader. Here a suggestion of why:

… there’s rather a big poison pill for Congress in here: Obama has proposed no pay-for. Or rather, he proposed that Congress figure out how to pay for it:

The agreement we passed in July will cut government spending by about $1 trillion over the next ten years. It also charges this Congress to come up with an additional $1.5 trillion in savings by Christmas. Tonight, I’m asking you to increase that amount so that it covers the full cost of the American Jobs Act. And a week from Monday, I’ll be releasing a more ambitious deficit plan — a plan that will not only cover the cost of this jobs bill, but stabilize our debt in the long run.

One gets the dreadful feeling that the more ambitious plan may consist of asking Congress to find another couple of trillion under the couch cushions.

As MuniLass said over Twitter,

Obama: “Here’s the deal: I take credit for the new spending now; you take credit for making politically unpopular cuts later.”

This is becoming a signature move for Obama. As far as I can recall, he has never taken the risk of proposing anything even potentially unpopular; even with something like health care, he let Congress take the lead. Eh voila–anything you like in the plan is a product of his wise leadership, while anything unfortunate is, y’know, the not-perfect stuff he had to sign in order to get Americans health care.