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November 10, 2006

Reich: "There’s No Guarantee of Rational Decision-Making in North Korea"

Robert Reich says China is the best hope for a rational outcome to the situation with North Korea:

How to Deal With A Madman with Nuclear Weapons, by Robert Reich: The problem is North Korea is run by a madman who doesn’t seem to mind if his own people starve.

The nation’s survival depends on two to three billion dollars of goods and money flowing in each year in order to feed and clothe the military and prevent a wholesale meltdown of the economy. But it’s already near meltdown.

The administration’s idea would be to tighten the economic vise until – until what?

You see, that’s the issue. Millions of people in that desolate land are already on the verge of starvation. Kim Jung Il doesn’t seem to care. At some point the economic vise could become so tight that even Kim’s military brass don’t get adequate food and clothing, and maybe that drives them to pop him off. But by that time, who knows how many North Koreans will have perished.

Economics assumes people act rationality in their own self interest. But there’s no guarantee of rational decision-making in North Korea, no checks and balances, no high-level council of wise strategists. All power is centralized in Kim Jung Il, who may be nuts. And there’s no obvious successor.

China holds the cards here. China is the only friend Kim Jung Il has in the world. He’s entirely dependent on his colossal neighbor for food and fuel. China doesn’t want his regime to collapse because the ensuing chaos would send millions of refugees steaming into China, and force a takeover of that desolate nation by South Korea. Not even South Korea wants the huge financial burden that would entail – making German reunification look cheap by comparison.

But nor does China want a nuclear North Korea, because that might prompt Japan to adopt nuclear weapons to counter the threat, which could lead to South Korea and even Taiwan to do so, too. If China is smart it will bribe Kim Jung Il to give up his nuclear program.

Kim Jung Il may not be rational, but the Chinese leadership is. And they’re our best hope now for a rational outcome to this mess.

Health Care Reform

I participated in a forum on health care reform today. Governor John Kitzhaber, one of the architects of the Oregon Health Plan and currently a driving force behind the Archimedes Movement for health care reform, was good. He had a surprisingly thorough understanding of the economic issues as well as the politics. If you get coffee at Starbucks, you may seem him quoted on your cup:

The Way I See It #161 One of America’s most cherished political illusions is that we all receive the same healthcare regardless of income. Another is that we don’t ration healthcare. The reality is very different. A change is needed and we have the power to bring it about. -- Dr. John Kitzhaber Former governor of Oregon and healthcare reform advocate.

Kitzhaber does not believe that states, on their own, can do much to solve the health care crisis. However, his experience as an emergency room doctor and as a governor who was actually able to implement substantial reform in Oregon leads him to believe that states can still play an important role:

Meeting this challenge and seizing the opportunity involves three key steps:

1. Articulating a vision of a new health care system.
2. Exposing the contradictions and inequities of the current system.
3. Creating a tension between the status quo and the vision.

The enactment and implementation of the Oregon Health Plan a decade ago offers a real life illustration of the power of this approach. Between 1989 and 1993 Oregon – a state which, at the time, had a population of less than three million people - became the focal point of the national health policy debate largely because we had passed a bill that was illegal. This action resulted from our refusal to be constrained by the existing structure of Medicaid which was created almost a quarter of a century earlier. While the provisions of Medicaid unquestionably made sense in 1965, the environment in which the program exists had changed significantly over the intervening 24 years. Thus, we essentially rewrote Medicaid to address some of its more glaring contradictions and inequities – even though we knew we could not implement our plan without being granted waivers by the federal government.

However, by seeking waivers from the provisions of these laws, Oregon forced federal decision makers to compare the status quo with a different more rational and more equitable vision of how care should be provided to the poor. It created a tension which forced Congress to either defend the current system or to seriously consider a better alternative. Through this process, the shortcomings of the current system were exposed and highlighted and the pressure for change was maximized. The end result was the implementation of the Oregon Health Plan.

I have come to believe that creating this kind of tension is the single most direct and powerful way that individuals can drive the structural change in our health care system that we so desperately need.

Here's the Forum agenda. Tim Duy, our Fed Watcher, runs the program:

The Third Annual Oregon Economic Forum
The Healthcare Crisis – Questions, Perspectives, Solutions
Agenda – October 11, 2006
Oregon Zoo
4001 SW Canyon Road Portland, OR 97221

7:15 a.m.
Breakfast begins
7:30 – 7:40
Dave Frohnmayer , President, University of Oregon
Priscilla Southwell, Associate Dean, Social Sciences, College of Arts and Sciences
7:40 – 8:10
Tim Duy, Director of the Oregon Economic Forum
8:10 – 8:25
ECONOMIC EXPLANATIONS OF INSURANCE AND THE PLACE OF SOCIAL INSURANCE by Professor Mark Thoma - an overview of the economics of social insurance.
MEASURING THE BENEFITS FROM THE REDUCTION OF RISK ATTRIBUTABLE TO MEDICARE by Professor Robin McKnight - who will examine what benefits occur with the reduction of risk.


PANEL PRESENTATIONS, followed by a discussion between panelists and the Governor.

JACK FRIEDMAN, CEO of Providence Health Plans will moderate a discussion of the panelists’ perspectives on the plan set out by the keynote. The panel represents four senior level executives who each have a different stake in the healthcare system.

10 minutes for each panelist

Tom Nelson, COO, AARP, Washington DC
Dr. Bruce Goldberg, Director of Human Services for Oregon, representing the state’s public health systems
 Mohan Nair, Executive Vice President and Chief Marketing Executive, the Regence Group 
Eileen Drake, Vice President, Administration & Legal Affairs of PCC Structurals, Inc. (a division of Precision Castparts Corporation)


Joseph Stiglitz Q & A

A Q&A with Joseph Stiglitz:

Q & A with Joseph Stiglitz, by Daniel Altman, Managing Globalization: We’re truly fortunate to have Joseph Stiglitz’s responses to readers’ questions today.

I sent Professor Stiglitz nine representative questions and asked him to answer five or six. He answered them all - thoroughly...

Q. Since the beginning, economics has sought to perfect “economic well-being” as in, lay down the conditions to maximize well-being and explain faltering well-being. What does this well-being entail? There should be a definition of economic well being that functions independently of capitalist or socialist classifications. Would you care to explain your definition of the one entity that guides all economic theories: “economic well-being”? Himanshu Kothari United States

A. There is no simple measure of economic well-being, and unfortunately, the standard measure, gross domestic product per capita, is misleading. This is important, because ... if we try to “maximize” the wrong thing, there can be serious adverse consequences. I stress the importance of equitable and sustainable development and growth. GDP can be going up, yet most individuals can be worse off (as has been happening in the United States during the past 5 years).

Similarly, GDP can be going up, yet standards of living going down, as the environment becomes degraded... When I was chairman of the Council of Economic Advisers, I pushed for the use of Green GDP, where account is taken both of the depletion of natural resources and the degradation of the environment. ...

Neither will growth be sustained if it is based on borrowing—when debt is used to finance consumption, not investment. ... Today, many are worried about America, whose growth is based on borrowing more than $3 billion a day from abroad.

GDP may be a misleading measure for another reason: it measures the value of what is produced in the country, not the income of the citizens of the country. When a developing country opens up a mine, with low royalties, most of the value of what is produced may accrue to the foreign owners; and when account is taken of the environmental degradation and resource depletion, the country may actually be worse off.

Q. What I find difficult to imagine is why a “superior authority,” such as the government or an international organization, would be able to regulate/decide what is the best trading strategy for any given country/region/community. Why shouldn’t we let the free market forces determine what is the best for the world? What is your opinion on the issue on free worldwide market forces vs. regulation? Guillermo Bona Switzerland

A. Adam Smith, the father of modern economics, is often cited as arguing for the “invisible hand” and free markets: firms... But unlike his followers, Adam Smith was aware of some of the limitations of free markets, and research since then has further clarified why free markets, by themselves, often do not lead to what is best. ...[T]he reason that the invisible hand often seems invisible is that it is often not there.

Whenever there are “externalities”... markets will not work well. Some of the important instances have been long understood—environmental externalities. Markets, by themselves, will produce too much pollution. Markets, by themselves, will also produce too little basic research...

But recent research has shown that these externalities are pervasive, whenever there is imperfect information or imperfect risk markets—that is always. Government plays an important role in banking and securities regulation, and a host of other areas: some regulation is required to make markets work. Government is needed, almost all would agree, at a minimum to enforce contracts and property rights.

The real debate today is about finding the right balance between the market and government (and the third “sector”—non-governmental non-profit organizations.) Both are needed. They can each complement each other. This balance will differ from time to time and place to place.

Q. What is the future of globalization where there is an increasingly greater disproportion between the movements of capital and goods and that of people? Nabil El Aid El Othmani Morocco

A. This disparity in the liberalization of capital and labor is a major problem. Enormous energy has been focused on facilitating the flows of investment and capital, while movements of labor remain highly restricted. This is so, even though the gains to global economic efficiency from liberalizing labor flows are an order of magnitude greater than the gains from liberalizing capital flows. Indeed, liberalizing movements of short term speculative capital has been associated with increased instability, but does not bring enhanced economic growth...

This disparity has large distributional consequences. Because capital can move easily, it threatens to leave a country if it is taxed, or if wages are not tamed, or worker benefits are not cut. The disparity in liberalization is one of the reasons for the growing inequality in incomes that have marked most countries around the world. It is one of the reasons that even when globalization has brought increases in GDP, it has led to the lowering of incomes of many workers.

There is a risk that unless globalization can be made more fair, so that there are more winners and fewer losers, there may well be a back lash. We should remember that globalization is not inevitable. ...

Q. What is the long-term future of globalization, and indeed the global economy as whole, if core problems like the world’s coming water crisis are not addressed? ... Will it take government regulation, an expanded international framework (such as Kyoto), or both? ... Hasan Jafri United States

A. The concerns you raise are real. ...What good would it do ... if we made economic globalization work if, at the same time, we all fried as a result of global warming. Worse still, too often the poor are the most vulnerable. ...

On the other hand, globalization has the potential of helping us address these problems. The Montreal Convention, dealing with ozone-destroying gases, included a provision for trade sanctions against any country that did not comply. The threat of these sanctions was one of the reasons that the agreement was so effective.

The WTO seems to have recognized that trade sanctions can legitimately be imposed to ensure compliance with global environmental agreements. Indeed, one can argue that American firms today have an unfair trade advantage over others because they do not have to pay the full cost of their production—a hidden subsidy. They do not have to pay the cost of their greenhouse gas emissions, as firms in Europe and Japan do. We can actually measure the magnitude of this implicit subsidy.

Q. I would like to know what your thoughts are on China’s ever-increasing strength (dominance) in the global trading system and its effects on small, wealthy, developed nations. ... Linda Bj√∂rgvinsd√≥ttir Iceland

A. China will have an impact on almost every country in the world, rich or poor, small or large, but its impacts will differ markedly from country to country. Overall, I believe that growth is positive sum, not zero-sum: China’s growth benefits not only the citizens of China, but contributes to a strong global economy. Many around the world benefit from the inexpensive goods it produces; China’s large purchases abroad have benefited many producers around the world; and competition from China has kept inflation in check, and that has allowed Central Banks to maintain lower interest rates than they otherwise would have had; and that too has contributed to strong global growth.

But the impacts are varied. China’s rapid growth has been contributing to high commodity prices, which have been enormous benefit to the producers of these commodities, but imposed additional costs on competing users. Many factories both in the advanced industrial countries and in developing countries have found that they cannot compete; factories have been shut down and workers face unemployment, or, when they do get another job, lower wages.

Small economies both are more vulnerable and face more opportunities. They are more vulnerable, because they are often less diversified, and an industry in which they have specialized can be wiped out almost overnight. But they face more opportunities, because if they find a niche in which China has a strong demand, their prospects may be very bright. Parts of Ethiopia are doing so much better today than they have in the past, because China has begun to buy sesame seeds...

Q. You have suggested a ‘tax switch’ and expenditure cuts as possible solutions to the United States fiscal deficit - without hurting growth significantly. What monetary and fiscal steps should China take to reduce its over-dependence on United States consumers and settle down to more sustainable growth rates? Litcy Kurisinkal India

A. China has been intensely concerned about its over-dependence on the United States consumers. As part of its 11th five year plan, announced last March, it has stressed increasing aggregate domestic demand, including consumption. ...

The challenge facing China (unique in the world) is how to get its citizens to consume more. One way is to provide better public social security, health care, and education. Its citizens save as much as they do (savings has amounted to 42 percent of GDP) because they worry about the future; savings are required to protect them. ...

Q. I would like to have your opinion on the recent reconfiguration of voting powers at the International Monetary Fund, and your assessment of how it compares to the dictates for stability of the international financial architecture of the realities of global payments-settlement imbalances and the prevailing situation of accumulated foreign exchange reserves. Malleck Amode Canada

A. As the IMF has increasingly lectured others about the importance of governance, problems in its own political legitimacy have increasingly impaired its efficacy. Granting more voting powers to China and a few other countries that are under represented is a step in the right direction. But even the IMF recognizes that it is only the first step. Critics point out that these changes are unlikely to have much effect on its decisions, and they worry that having granted the most powerful of the underrepresented more voting power, the drive for further reform will weaken.

That would be a shame. The U.S. still is the only country with veto power. The choice of the heads of both the IMF and the World Bank make a mockery of legitimate democratic governance. Neither asks who is most qualified, regardless of race, color, nationality. The American president appoints the head of the World Bank and Europe chooses the head of the IMF. The recent selection of the head of the World Bank highlighted the problems.

The IMF’s new focus on global imbalances is also a step in the right direction. ... The IMF should have long been focusing on such issues—its real mandate—rather than on development and the transition from Communism to the market economy, areas that are clearly not within its core competence, and where its policies were often badly misguided. ...

Q. Has the World Bank changed since you were there, and if so, is it for better or for worse? Michel Monette Canada

A. Of course, the World Bank has changed, and it will continue to change. The world is changing, and any institution that did not change would quickly find itself in deep trouble.

During my time there, the World Bank began to take on an advocacy role—advocating policies that are needed for the successful development of poor countries, even when they were opposed by some of the advanced industrial countries. It has continued to do that, most notably in its opposition to agricultural subsidies by the U.S. and EU which ... so hurt the developing countries which depend on agriculture.

But a central achievement of this period was the recognition that successful development requires a comprehensive approach—there is no magic bullet. ...

Today, it often seems that the only issue that the Bank talks about is corruption. It sermonizes, but does not have a comprehensive set of policies and approaches to attack it... But even were it to succeed in addressing the corruption, that would not be sufficient to address poverty in the Third World. Money can be spent honestly, but incompetently; and even when money is well spent, unless there are appropriate institutions and policies in place, success will be limited.

The challenges facing the Bank are enormous. There is now a consensus on the failures of the Washington consensus; the free market ideology one size fits all policies failed almost everywhere they were tried. Iraq, already suffering from so many other afflictions, is the latest country to be afflicted with the imposition of these policies, part of the conditions for debt relief. ... Hopefully, as the Bank strives to devise a strategy for itself going forward, it will not revert to these failed doctrines, even if put in new terms. What is needed is a new vision.

Sharpe Rethinks CAPM

This came by email. William Sharpe is rethinking the CAPM model and adopting a state-preference approach instead, something co-Nobel prize winner for work in this area Harry Markowitz disagrees with:

Sharpe rethinks the capital asset pricing model, by Joel Chernoff, William F. Sharpe says his pioneering work on the capital asset pricing model is ready for a makeover.

The 42-year-old model - which earned Mr. Sharpe a Nobel Memorial Prize in economics in 1990 - is being revamped because Mr. Sharpe says he found a better way for portfolio managers and business-school students to learn about how portfolios are constructed and how securities are priced.

CAPM, along with modern portfolio theory, developed by Mr. Sharpe's mentor and co-Nobel winner Harry Markowitz, is the foundation of every finance program in the country, if not the world.

His latest book, "Investors and Markets: Portfolio Choices, Asset Prices and Investment Advice," may send investors and academics scurrying. Published this month by Princeton University Press, the book eschews mean-variance analysis - the mathematically complex formula that relates rewards to risks of securities or portfolios - in favor of a "state preference" approach that relies on an easy-to-understand simulation. That approach is based on a model closer to that used in financial engineering than in the ivory tower.

"I think of it as 'beyond mean-variance,'" Mr. Sharpe said in an interview. Whether that approach will work in the real world is unknown. Mr. Sharpe says he is just starting work on applying it to asset allocation. If the approach proves successful, it could result in a shift away from the traditional mean-variance optimizer used in establishing asset mixes and managing securities portfolios. ...

CAPM's flaws

There are numerous reasons for finding a substitute for a mean-variance approach. For one thing, it is ill-suited for considering extraordinary economic events such as bubbles, depressions, hyperinflation or terrorist attacks.

These types of "tail risk" are ignored by mean-variance analysis... "We've come to thinking about risk as standard deviation," Mr. Statman said. "What people want is protection when the economy tanks."

Another problem is that mean-variance analysis assumes that all investors have the same beliefs about the market and the relationship among different assets. In addition, mean-variance analysis ignores taxes, transaction costs and illiquidity. The analysis also assumes that all investors can borrow at the risk-free rate - a major flaw, in Mr. Markowitz's view.

CAPM was a revolutionary concept when Mr. Sharpe developed it in 1964. ... In CAPM, Mr. Sharpe found the most efficient portfolio was the entire market. He also related the risk of an individual security to the entire market, which was termed "beta."

Mr. Sharpe concluded that most of a stock's risk stemmed from the market. The idea of an index fund - passively tracking the entire market - came directly out of CAPM and the "efficient market hypothesis" unveiled a year later by Eugene F. Fama in his doctoral dissertation...

By contrast to mean-variance analysis, the state-preference approach doesn't rely on a normal distribution, and the mathematics is far simpler than in mean-variance analysis.

"The elegance of (the state-preference model) is that you can understand the elements of the various moving parts of the optimization," said Gifford Fong, editor of the Journal of Investment Management...

Taken from research done in the 1950s by Nobel Laureate Kenneth Arrow, an economics professor emeritus at Stanford (Calif.) University, and Gerard Debreu, the late economist, state-preference theory said that there are many possible future states of the world but that only one of them actually will occur.

Investors can assign probabilities of any given state occurring. In a complete market, an investor can buy or sell a security for every possible outcome. These contingent claims are like insurance policies. In fact, this methodology is used in pricing options, Mr. Sharpe said.

Many economists don't like state-preference theory, because it isn't provable, instead relying on a simulator. Some experts also note that it involves a massive amount of calculations.

"I find [the state-preference approach uses] a very general set of assumptions out of which very little specific can be deduced," said Mr. Markowitz. He and Mr. Sharpe will debate their differing views Oct. 16 at the Institute for Quantitative Research in Economics' 40th anniversary conference in Santa Barbara, Calif.

Mr. Sharpe's new book shows that a simulator based on the state/preference model can mimic market behavior and can be used where mean-variance analysis won't work. ...

What's more, Mr. Sharpe's simulator works even when markets are "incomplete" - meaning there isn't a contingent claim for every possibility - and when investors have outside sources of income.

Unlike a mean-variance analysis, however, the simulator finds that it does make sense for some investors to take non-market risk. For example, someone living in Silicon Valley might want to underweight technology stocks to reduce risk, Mr. Sharpe said.

Laurence B. Siegel, director of research ... Ford Foundation's investment division in New York, praised Mr. Sharpe's new work for validating classical finance theory. He said some managers are willing to discard CAPM because of its flaws, but Mr. Sharpe's new work shows equilibrium prices can be set without using a mean-variance analysis. ...

November 9, 2006

Incentives Matter

Staying married, temporarily anyway, for the money:

Incentives matter: divorce in Japan, by a singapore economist: The divorce rate in Japan has increased steadily until 2003, when the rate began to dip ... The increase is credited to cultural changes that have made divorce a more acceptable option. The recent decrease seems to be economically motivated: women are putting off divorce to take advantage of a law passed in 2003 to take effect in 2007 that allows for a better divorce settlement. If this explanation is true, we should see a spike in the number of divorces in 2007.

From Japundit:

Japan is slated to revise its divorce law in April 2007, making women entitled to receive up to half of their spouse’s pension payments. Until now, a woman who divorced her husband could receive only a basic pension up to a maximum of 66,000 yen a month.

On the other hand, we may not see a spike in the divorce rate if husbands have responded to the law by treating their wives better. After all, this law creates financial incentives for them as well.

What Does it Mean to be a Liberal?

Does this define liberals?:

What it means to be a liberal, by Geoffrey R. Stone, Chicago Tribune: For most of the past four decades, liberals have been in retreat. Since the election of Richard Nixon in 1968, Republicans have controlled the White House 70 percent of the time and Republican presidents have made 86 percent of the U.S. Supreme Court appointments. In many quarters, the word "liberal" has become a pejorative. Part of the problem is that liberals have failed to define themselves and to state clearly what they believe. As a liberal, I find that appalling.

In that light, I thought it might be interesting to try to articulate 10 propositions that seem to me to define "liberal" today. Undoubtedly, not all liberals embrace all of these propositions, and many conservatives embrace at least some of them. Moreover, because 10 is a small number, the list is not exhaustive. And ... these propositions will in some instances conflict... My goal, however, is not to end discussion, but to invite debate.

1. Liberals believe individuals should doubt their own truths and consider fairly and open-mindedly the truths of others. This is at the very heart of liberalism. Liberals understand, as Justice Oliver Wendell Holmes once observed, that "time has upset many fighting faiths." Liberals are skeptical of censorship and celebrate free and open debate.

2. Liberals believe individuals should be tolerant and respectful of difference. It is liberals who have supported and continue to support the civil rights movement, affirmative action, the Equal Rights Amendment and the rights of gays and lesbians...

3. Liberals believe individuals have a right and a responsibility to participate in public debate. It is liberals who have championed and continue to champion expansion of the franchise; the elimination of obstacles to voting... They believe, with Justice Louis Brandeis, that "the greatest menace to freedom is an inert people."

4. ...It is liberals who have defended and continue to defend the freedom of the press to investigate and challenge the government, the protection of individual privacy from overbearing government monitoring, and the right of individuals to reproductive freedom. (Note that libertarians, often thought of as "conservatives," share this value with liberals.)

5. Liberals believe government must respect and affirmatively safeguard the liberty, equality and dignity of each individual. It is liberals who have championed and continue to champion the rights of racial, religious and ethnic minorities, political dissidents, persons accused of crime and the outcasts of society. It is liberals who have insisted on the right to counsel, a broad application of the right to due process of law and the principle of equal protection for all people.

6. Liberals believe government has a fundamental responsibility to help those who are less fortunate. It is liberals who have supported and continue to support government programs to improve health care, education, social security, job training and welfare for the neediest members of society. It is liberals who maintain that a national community is like a family and that government exists in part to "promote the general welfare."

7. Liberals believe government should never act on the basis of sectarian faith. It is liberals who have opposed and continue to oppose school prayer and the teaching of creationism in public schools and who support government funding for stem-cell research, the rights of gays and lesbians and the freedom of choice for women.

8. Liberals believe courts have a special responsibility to protect individual liberties. It is principally liberal judges and justices who have preserved and continue to preserve freedom of expression, individual privacy, freedom of religion and due process of law. (Conservative judges and justices more often wield judicial authority to protect property rights and the interests of corporations, commercial advertisers and the wealthy.)

9. Liberals believe government must protect the safety and security of the people, for without such protection liberalism is impossible. This, of course, is less a tenet of liberalism than a reply to those who attack liberalism. The accusation that liberals are unwilling to protect the nation from internal and external dangers is false. Because liberals respect competing values, such as procedural fairness and individual dignity, they weigh more carefully particular exercises of government power (such as the use of secret evidence, hearsay and torture), but they are no less willing to use government authority in other forms (such as expanded police forces and international diplomacy) to protect the nation and its citizens.

10. Liberals believe government must protect the safety and security of the people, without unnecessarily sacrificing constitutional values. It is liberals who have demanded and continue to demand legal protections to avoid the conviction of innocent people in the criminal justice system, reasonable restraints on government surveillance of American citizens, and fair procedures to ensure that alleged enemy combatants are in fact enemy combatants. Liberals adhere to the view expressed by Brandeis some 80 years ago: "Those who won our independence ... did not exalt order at the cost of liberty."

Consider this an invitation. Are these propositions meaningful? Are they helpful? Are they simply wrong? As a liberal, how would you change them or modify the list? As a conservative, how would you draft a similar list for conservatives?

The Great Risk Shift and the Democrat's Economic Agenda

Jacob Hacker is discussing "The Great Risk Shift" this week at Kevin Drum's site:

Jacob Hacker on the Great Risk Shift: ...I want to start by linking the subject of my last guest appearance (with my coauthor and friend Paul Pierson) to this one. In Off Center, Paul and I explained how the Republicans had managed to push through a number of highly conservative policies, despite the fact that their agenda was not particularly popular with—and sometimes outright opposed by—middle-of-the-road voters. The book was about Republican governance... But a consistent complaint was that we didn’t pay enough attention to the Democrats’ failure to articulate a compelling alternative.

Well, you may be surprised to hear me say that the complaint was right—or at least half right. ... For understanding ... the longer-term weaknesses of the Democrats, it’s essential to grasp how the Democratic Party has ceded the high ground on the field it once completely dominated: standing up for ordinary Americans on economic policy. Over the same period in which a whole host of new and newly intensified economic risks have shifted onto American workers and their families, Democrats have mostly clung the old formulas and scripts, failing to develop a compelling argument about how to ensure broad-based prosperity and economic security in an increasingly uncertain world of work and family. In 2004, for example, Bush creamed Kerry among white middle-class voters, and public concerns about foreign threats and moral values weren’t the only reason—the Democratic economic program, such as it was, also rang hollow to many middle-class Americans.

Such a vision is all the more essential today, because ... Democrats now appear poised to take one or both houses of Congress. Winning an election doesn’t always require a positive agenda, and Republicans seem to be doing everything in their power to lose this election on their own. But governing does require vision and goals. And whatever else might be said about Republicans, they’ve had a clear economic agenda—what I call “The Personal Responsibility Crusade.” While doling out special favors to privileged interests, they’ve held up personal responsibility as a magic tonic for all economic ills, and called for an endless stream of tax cuts and tax-free accounts as a means of realizing this ideal.

But what do Democrats stand for? Today, many Americans still say the Democratic label doesn’t stand for much, and on economic policy, they’re right. Democrats are defenders of Social Security and Medicare, to be sure. They are sometimes champions of fiscal rectitude; sometimes skeptics about Wal-Mart; sometimes advocates of the minimum wage; sometimes defenders of organized labor. But what is their overall economic agenda? In an age of dramatic change in the relationship among workers, families, employers, and government, what should be the next social contract that unites Americans and carries them together into the next American century?

I wrote The Great Risk Shift to begin to answer that question. The book shows that the challenges facing our leaders are great... But the opportunities are great, too. The United States is the richest, most dynamic nation in the world. It has the potential to construct new institutions and new policies that would provide security and expand opportunity in ways that aid our flexible, competitive economy, rather than hinder it. There is a huge void in American politics just waiting to be filled by the party and leaders that can speak to this potential, and speak to middle-class Americans anxious about their economic security...

Here's Jacob's follow-up: What is the Great Risk Shift?, by Jacob Hacker.

Phelps: Dynamic Capitalism

The newest Nobel prize winner for economics, Edmund Phelps, writing in the Wall Street Journal on the comparison between capitalism in the U.S., Canada, and the U.K. and that of Western Continental Europe:

Dynamic Capitalism, by Edmund Phelps, Commentary, WSJ: There are two economic systems in the West. Several nations -- including the U.S., Canada and the U.K. -- have a private-ownership system marked by great openness to the implementation of new commercial ideas coming from entrepreneurs, and by a pluralism of views among the financiers who select the ideas to nurture by providing the capital and incentives necessary for their development. Although much innovation comes from established companies, ... much comes from start-ups, particularly the most novel innovations. This is free enterprise, a k a capitalism.

The other system -- in Western Continental Europe -- though also based on private ownership, has been modified by the introduction of institutions aimed at protecting the interests of "stakeholders" and "social partners." The system's institutions include big employer confederations, big unions and monopolistic banks. ... The system operates to discourage changes such as relocations and the entry of new firms, and its performance depends on established companies in cooperation with local and national banks. What it lacks in flexibility it tries to compensate for with technological sophistication. So different is this system that it has its own name: the "social market economy" in Germany, "social democracy" in France and "concertazione" in Italy.

Dynamism and Fertility

The American and Continental systems are not operationally equivalent, contrary to some neoclassical views. Let me use the word "dynamism" to mean the fertility of the economy in coming up with innovative ideas ..., the economy's talent at commercially successful innovating. In this terminology, the free enterprise system is structured in such a way that it facilitates and stimulates dynamism while the Continental system impedes and discourages it.

Wasn't the Continental system designed to stifle dynamism? When building the massive structures of corporatism in interwar Italy, theoreticians explained that their new system would be more dynamic than capitalism -- maybe not more fertile in little ideas, ... but certainly in big ideas. Not having to fear fluid market conditions, an entrenched company could afford to develop radical innovation. And with industrial confederations and state mediation available, such companies could arrange to avoid costly duplication of their investments. The state and its instruments, the big banks, could intervene to settle conflicts... Thus the corporatist economy was expected to usher in a new futurismo that was famously symbolized by Severini's paintings of fast trains. ...

Friedrich Hayek, in the late 1930s and early '40s, began the modern theory of how a capitalist system, if pure enough, would possess the greatest dynamism -- not socialism and not corporatism. First, virtually everyone right down to the humblest employees has "know-how," ... and out of that an idea may come that few others would have. In its openness to the ideas of all or most participants, the capitalist economy tends to generate a plethora of new ideas.

Second, the pluralism of experience that the financiers bring to bear in their decisions gives a wide range of entrepreneurial ideas a chance of insightful evaluation. And, importantly, the financier and the entrepreneur do not need the approval of the state or of social partners. .... Lastly, the pluralism of knowledge and experience that managers and consumers bring to bear in deciding which innovations to try, and which to adopt, is crucial... Where the Continental system convenes experts to set a product standard before any version is launched, capitalism gives market access to all versions.

The issues swirling around capitalism today concern the consequences of its dynamism.

The main benefit of an innovative economy is commonly said to be a higher level of productivity -- and thus higher hourly wages and a higher quality of life. There is a huge element of truth in this belief, no matter how many tens of qualifications might be in order. Much of the huge rise of productivity since the 1920s can be traced to new commercial products and business methods developed and launched in the U.S. and kindred economies. ... There were often engineering tasks along the way, yet business entrepreneurs were the drivers. ...

[I]t is important to note that advances in productivity, in generally pulling up wage rates, make it affordable for low-wage people to avoid work that is tedious or grueling or dangerous in favor of work that is more interesting and formative. ... To date, there is an adequate rate of return to be expected from "investing" in the conception, development and marketing of innovations for the global economy -- a return on a par with the return from investing in plant and equipment, software and other business capital. That is a better option for Americans than suffering diminished returns from investing solely in the classical avenue of fixed capital.

I would, however, stress a benefit of dynamism that I believe to be far more important. Instituting a high level of dynamism ... serves to transform the workplace -- in the firms developing an innovation and also in the firms dealing with the innovations. The challenges that arise in developing a new idea and in gaining its acceptance in the marketplace provide the workforce with high levels of mental stimulation, problem-solving, employee-engagement and, thus, personal growth. ...

A more innovative economy [also] tends to devote more resources to investing of all kinds -- in new employees and customers as well as new office and factory space ...; it also comes through the recruitment of new participants to the labor force. ...[T]he resulting increase of employee-engagement serves to lower quit rates and, hence, to make possible a reduction of the "natural" unemployment rate. Thus, high dynamism tends to bring a pervasive prosperity to the economy on top of the productivity advances and all the self-realization going on. True, ... the dynamic economy has heightened high-frequency volatility and may go through wide swings. Perhaps this volatility is not only normal but also productive from the point of view of creativity and, ultimately, achievement.

Ideals and Reality

I know I have drawn an idealized portrait of capitalism: The reality in the U.S. and elsewhere is much less impressive. .... Do we find evidence of greater benefits of dynamism in the relatively capitalist economies than in the Continental economies as currently structured? In the Continent's Big Three, hourly labor productivity is lower than in the U.S. Labor-force participation is also generally lower. And here is new evidence: The World Values Survey indicates that the Continent's workers find less job satisfaction and derive less pride from the work they do in their job.

Dynamism does have its downside. The same capitalist dynamism that adds to the desirability of jobs also adds to their precariousness. The strong possibility of a general slump can cause anxiety. But we need some perspective. Even a market socialist economy might be unpredictable: In truth, the Continental economies are also susceptible to wide swings. In fact, it is the corporatist economies that have suffered the widest swings in recent decades. ... It may be that when the Continental economies are down, the paucity of their dynamism makes it harder for them to find something new on which to base a comeback.

The U.S. economy might be said to suffer from incomplete inclusion of the disadvantaged. But that is less a fault of capitalism than of electoral politics. ... In any case, we can fix the problem. Why, then, if the "downside" is so exaggerated, is capitalism so reviled in Western Continental Europe? It may be that elements of capitalism are seen by some in Europe as morally wrong in the same way that birth control or nuclear power or sweatshops are seen by some as simply wrong in spite of the consequences of barring them. And it appears that the recent street protesters associate business with established wealth; in their minds, giving greater latitude to businesses would increase the privileges of old wealth. ... A tremendous confusion is created by associating "capitalism" with entrenched wealth and power. The textbook capitalism of Schumpeter and Hayek means opening up the economy to new industries, opening industries to start-up companies, and opening existing companies to new owners and new managers. It is inseparable from an adequate degree of competition. Monopolies like Microsoft are a deviation from the model. ...

I want to conclude by arguing that generating more dynamism through the injection of more capitalism does serve economic justice.

We all feel good to see people freed to pursue their dreams. Yet Hayek and Ayn Rand went too far in taking such freedom to be an absolute, the consequences be damned. ... Since the economy is a system in which people interact, the endeavors of some may damage the prospects of others. So a persuasive justification of well-functioning capitalism must be grounded on all its consequences, not just those called freedoms.

To argue that the consequences of capitalism are just requires some conception of economic justice. I broadly subscribe to the conception of economic justice in the work by John Rawls. In any organization of the economy, the participants will score unequally in how far they manage to go in their personal growth. An organization that leaves the bottom score lower than it would be under another feasible organization is unjust. So a new organization that raised the scores of some, though at the expense of reducing scores at the bottom, would not be justified. Yet a high score is just if it does not hurt others...

The 'Least Advantaged'

What would be the consequence, from this Rawlsian point of view, of releasing entrepreneurs onto the economy? In the classic case to which Rawls devoted his attention, the lowest score is always that of workers with the lowest wage, whom he called the "least advantaged": Their self-realization lies mostly in marrying, raising children and participating in the community, and it will be greater the higher their wage. So if the increased dynamism ... tends to raise productivity, as I argue -- and if that in turn pulls up those bottom wages, or at any rate does not lower them -- it is not unjust. Does anyone doubt that the past two centuries of commercial innovations have pulled up wage rates at the low end and everywhere else in the distribution?

Yet the tone here is wrong. ... Suppose the wage of the lowest- paid workers was foreseen to be reduced over the entire future by innovations conceived by entrepreneurs. Are those whose dream is to find personal development through a career as an entrepreneur not to be permitted to pursue their dream? ... In an economy in which entrepreneurs are forbidden to pursue their self-realization, they have the bottom scores in self-realization -- ... and that counts whether or not they were born the "least advantaged." So even if their activities did come at the expense of the lowest-paid workers, Rawlsian justice in this extended sense requires that entrepreneurs be accorded enough opportunity to raise their self-realization score up to the level of the lowest-paid workers -- and higher, of course, if workers are not damaged by support for entrepreneurship. In this case, too, then, the introduction of entrepreneurial dynamism serves to raise Rawls's bottom scores.

Actual capitalism departs from well-functioning capitalism -- monopolies too big to break up, undetected cartels, regulatory failures and political corruption. Capitalism in its innovations plants the seeds of its own encrustation with entrenched power. These departures weigh heavily on the rewards earned, particularly the wages of the least advantaged, and give a bad name to capitalism. But I must insist: It would be a non sequitur to give up on private entrepreneurs and financiers as the wellspring of dynamism merely because [of the imperfections from these departures]. I conclude that capitalism is justified -- normally by the expectable benefits to the lowest-paid workers but, failing that, by the injustice of depriving entrepreneurial types (as well as other creative people) of opportunities for their self-expression.

Banning Child Labor in India

The problem of poverty induced child labor in India:

India's latest move to stop child labor, by Anuj Chopra, Christian Science Monitor: On a rainy night, ... Raju is busy at work. This timid 10-year-old works 12-hour days serving customers and scrubbing mountains of utensils... After a full day, he often pockets less than a dollar. If there's food left over, he gets a meal. If not, he goes home on an empty stomach.

Concerned about the future of children like Raju, India Tuesday begins implementing a country-wide ban on children below 14 working as domestic help or in the hospitality sector. And punishment for those who choose to defy it is stringent: imprisonment for up to two years and a fine as high as $430.

Children in India are already banned from working in factories, mines, and other perilous jobs. India's Child Labor Act, first passed in 1986, will now carry two more in a list of 57 professions deemed "hazardous" for children.

Child rights activists in India say it's an important step in the battle to stop child labor. But some worry that the government is still not doing enough to provide alternative options for families that depend on income from their children. And many are skeptical about how effective enforcement of the ban will be.

"It is important to remember that the problem won't disappear by just introducing a ban," says Shireen Miller, head of policy at the India branch of the US-based Save the Children organization. "Legislation is a start," she says pointing out that previous legislation hasn't been stringently enforced.

"Now there's a clear signal that [no one] can get away with employing and exploiting children as workers," says Shantha Sinha, an anti-child labor activist who in 2003 won the prestigious Ramon Magsaysay Award. Ms. Sinha recalls how all 34 cases of domestic child labor that she took up last year ... couldn't stand up in court. All of the accused wriggled out of blame, she says, as employing children as domestic help wasn't then prohibited by law. She hopes this ban will reverse such tendencies.

India has the largest number of child laborers on the planet. ... According to the New Delhi-based, National Sample Survey Organisation, nearly 16.4 million Indian children aged 5-14 years are engaged in economic activities and domestic or non-remunerative work. The World Bank puts that figure at 44 million. ...

Ingrid Srinath, the CEO of Child Rights and You (CRY), a New Delhi based NGO, calls the ban notification "insular" and is skeptical that it will do much good in its current form. The ban, he says, does little to address the reasons that compel children to work: backbreaking poverty, family debts, marginalization, and migration of their parents.

A recent study conducted by the International Labour Organization found that "children's work was considered essential to maintaining the economic level of households, either in the form of work for wages, of help in household enterprises, or of household chores in order to free adult household members for economic activity elsewhere."

Raju's father, a daily wage laborer, frets that the ban will only exacerbate his family's financial woes. "At least now, he doesn't steal. He earns his meals with dignity," he says. "If the ban is enforced, he might be forced to beg for alms, or the family might go hungry."

India's Ministry of Labor and Employment hasn't yet spelled out any coherent rehabilitation and education plan for children who they lose their jobs. The Ministry assures that a blueprint to ensure self-sufficiency for the kids will emerge soon.

Activists also say that the ban won't work unless mindsets change. Children are widely employed in the homes of India's affluent and middle classes.

Raju's employer, a coarse, burly man who calls himself Pappu, employs two other kids, 12 and 14. Pappu intends to retain his young employees despite the ban. And if cops pester him, he unabashedly says, he'll do what many Indians often do to give the law a slip - offer a bribe.

He says he doesn't see anything wrong in employing the children. "I give the best I can offer," he says. "I do take care of them. I give them food. The kids won't survive if they don't work."

This notion of benevolence often masks the exploitation and the long-term harm for children, says Ms. Sinha. "Just because children are given food or money doesn't mean that they're benefiting," she says. "They're cheap and work long hours without any question. That's exploitation. The ban now gives weight when we say: 'That's wrong!' "

I believe that, to the extent that there has been a reduction in child labor, international trade has helped to force the changes that brought it about. Of course we shouldn't overlook child labor for the economic benefits it might bring us. But if improvement is fueled by the demand for change as a condition of trade, then closing the doors to trade is not the solution. As much as we'd like to say "stop this before we trade at all," the reality is that economic conditions don't allow the change, at least not easily, and trade coupled with the insistence on steady improvement is a means to overcome this constraint.

Stockholm's Congestion Tax

Sweden's new center-right government has decided to implement a congestion tax:

Sweden watch, by Andrew Leonard: ...The recent electoral victory by a center-right coalition [in Sweden] resulted in many predictions of a swift turn to Milton Friedmanism... But take a look at one of the first major decisions by the new government, ... the reinstitution of a congestion tax in Stockholm. Since members of the coalition campaigned against the tax, and since in a referendum on the tax held at the same time as the general election the majority of voters who lived outside of Stockholm voted against it, the decision came as a bit of a surprise.

Why the change of heart? Simple, really. A trial of the tax conducted for six months earlier this year resulted in lower traffic and cleaner air. Then, after the the trial ended, congestion started to build up again. So, in other words, the tax worked. And in Sweden, whether you're on the right or the left, you like things that work.

The government's plan is to devote revenue from the tax to completing a ring road around the city, which is disappointing to environmentalists. But in the meantime, ... one in five new cars purchased in Stockholm this spring was a "clean car" -- running at least partially on electricity or alcohol -- and thus exempt from the congestion tax.

Perhaps the most telling stat: At the start of the trial, 55 percent of Stockholm residents opposed it. But after a few months sans traffic jams and breathing cleaner air, only 41 percent were against it. ...

Poole: The Economy Can Take Care of Itself

Bill Poole, president of the St Louis Fed, says the economy is self-correcting -- there's not much need for the Fed to get involved. He says, "The FOMC can some of the time – maybe even much of the time – sit back and do relatively little":

St Louis Fed chief says bonds can bring stability, by Krishna Guha, Financial Times: The Federal Reserve could “sit back” and let the bond market play the role of automatic stabiliser in the economy, even amid concern over the housing slowdown, Bill Poole, president of the St Louis Fed, has told the Financial Times.

Mr Poole, ... said that the fall in long-term interest rates within the bond market had reduced pressure on the Fed to respond immediately to signs of economic weakness. “The decline in long rates is working as a built-in stabiliser for the economy,” he said, noting that the fall in bond market rates “will tend to bring down mortgage rates” as well.

By the same token, Mr Poole said, “if we get an upside surprise, the long rate clearly has a lot of room to rise without the FOMC doing anything.” ... “The FOMC can some of the time – maybe even much of the time – sit back and do relatively little, relying on the stabilising effect of market reactions to current data,” he said. “We don’t have to do it all.”

Mr Poole said the Fed would “eventually have to follow through” to validate market expectations, but not immediately. His comments lend weight to the view that the Fed could remain on pause for some time, rather than reacting swiftly to the housing-led slowdown.

Mr Poole said the stimulative effect of lower long-term rates in the bond market would work through several interest-rate sensitive sectors in the economy. “Housing is clearly quite interest sensitive,” he said. “But auto sales are also interest sensitive. Corporate investment is interest sensitive to a degree.”

Mr Poole ... said that risks to growth were more prominent today, relative to risks to inflation, than they were a few months ago. “It seems to me that the pressure on inflation has come off a bit,” he said, noting that house price data might not capture the full extent of declines in house prices. ... Mr Poole said he regarded the policy outlook as “roughly symmetrical”. ...

There are questions about the Fed's ability to control long-rates in the global economy, so the Fed may not have much choice except to "sit back and do relatively little." Even so, my position is more activist, though not to the level of trying to fine-tune every expected movement in output and inflation.

Thinking about fine-tuning reminds me of my sideburns. If I try to fine-tune them and get them even by going from side-to-side, taking a little more off each time to get them perfectly even, I generally end up with no sideburns at all. I've ruined more than one project trying to get things perfect. There's a point where well- enough should be left alone.

For monetary policy, the activist versus passive policy decision rests upon the Fed's ability to control long-term rates, the degree to which long-term rates affect investment and consumption, the lags between policy changes and the effects on the economy as compared to how fast the economy self-corrects, our ability to forecast the economy's future, and our ability to determine the current state of the economy, e.g. variables such as the current natural rate of output and unemployent versus actual conditions, or the inflation rate. There are also different views about which model to use to make these determinations (e.g. Real Business Cycle models versus New Keynesian models), some strongly held, as well as differences among proponents of each model how they should be specified. The large degree of uncertainty concerning some of these effects and linkages, and the difference in views as to the correct theoretical specification to use explain much of the difference in views about how monetary policy should be conducted.

Mishkin: Promoting the Next Great Globalization

Our newest Federal Reserve System governor, Frederic Mishkin, on how globalization of the financial system can help to lift poor countries out of poverty. This was written just before his appointment to the Fed:

Promoting the next great globalisation, by Frederic Mishkin, Commentary, Financial times: While much of the talk about globalisation is of either the “for” or “against” variety, this is a false choice. The real question is whether political and business leaders will take the world in the prosperous direction of the next great globalisation, that of the financial systems of emerging market countries, or the perilous path of the next great reversal, a retreat from free flows of goods, services and capital across borders.

The globalisation of trade and information in the past half century has lifted vast numbers of people out of extreme poverty. World economic growth since 1960 has been the highest ever. There has been a convergence of income per capita and a reduction of poverty in countries that have taken advantage of globalisation by becoming export-oriented. In India and China, globalisation has led more than 1bn people out of extreme poverty.

Countries that have not been able to take advantage of globalisation, such as most of sub-Saharan Africa, have not only seen their position relative to globalisers fall, but have experienced absolute drops in per capita income...

Globalisation is not inevitable, nor does it march immutably forward. What we are experiencing is actually the second great globalisation of trade and capital flows in modern times. The first began in 1870 and ended with the start of the first world war in 1914. The war disrupted capital flows and international trade between nations. The world economy never fully recovered from this Great Reversal and the 1930s saw a global depression, the rise of fascism and the start of the second world war.

Could there be another Great Reversal in which globalisation retreats and the world suffers political, social and economic upheaval and destruction? The answer is yes. In recent years there have been notable electoral successes of anti-globalist politicians in developing countries.

What can be done to help poorer countries reach the next stage of economic development so they can eventually get rich? The development of an efficient financial system will enable emerging market economies to allocate capital to its most productive uses. Institutions need to be created that promote strong property rights and a well-functioning legal system. Institutional reform must be put at the top of the agenda in developing countries. This can be difficult because ... rich elites and special interests have much to lose from anything that encourages an efficient financial system and promotes competition.

The solution is to increase demand within developing countries for more robust financial activity. Financial globalisation helps create these incentives because when domestic companies in developing countries can borrow from abroad or from foreign financial interests, domestic financial firms start to lose business. They will need to find new customers to whom they can profitably lend. ... These firms will need to push for institutional reforms... They will be more likely to encourage legal reforms to protect property rights.

Rich countries can help encourage this institutional development by providing the right incentives. As William Easterly has pointed out in his book, The Elusive Quest for Growth, aid has generally not worked well in promoting development because it has not provided the right incentives for governments to act in their citizens’ interest.

What promotes development is encouraging poorer countries to pursue an external orientation and develop a successful export sector. This not only forces the economy to become more efficient, but creates a demand to improve institutions. In addition to offering technical assistance and greater incentives for institutional development, advanced countries can also help to alleviate poverty by opening up their markets to exports from poorer countries. Those who lose their jobs in advanced countries from this opening of markets deserve our sympathy and our support to find new jobs, but displaced workers can be assisted in other ways than trade restrictions.

Free trade, fuelled by effective financial support, raises productivity in developing and advanced countries alike. “Trade not aid” will help make globalisation work to the benefit of poorer countries. Financial reform in developing nations is the first step in promoting this happier state of affairs.

Edmund Phelps Wins the Nobel Prize in Economics

Edmund Phelps wins the Nobel prize. See Tyler Cowen at Marginal Revolution for a description of his work. The Nobel committee's summary is here.

Paul Krugman: The Paranoid Style

Paul Krugman explains why the right is so paranoid:

The Paranoid Style, by Paul Krugman, Commentary, NY Times: Last week Dennis Hastert, the speaker of the House, explained the real cause of the Foley scandal. “The people who want to see this thing blow up,” he said, “are ABC News and a lot of Democratic operatives, people funded by George Soros.” ...

[I]t wasn’t his first outburst along these lines. Back in 2004, Mr. Hastert said: “You know, I don’t know where George Soros gets his money. I don’t know where — if it comes overseas or from drug groups or where it comes from.”

Does Mr. Hastert really believe that George Soros and his operatives, conspiring with the evil news media, are responsible for the Foley scandal? Yes, he probably does. For one thing, demonization of Mr. Soros is widespread in right-wing circles. ...

More generally, Mr. Hastert is a leading figure in a political movement ... historian Richard Hofstadter famously called “the paranoid style in American politics.” Hofstadter’s essay introducing the term was inspired by his observations of the radical right-wingers who seized control of the Republican Party in 1964. Today, the movement that nominated Barry Goldwater controls both Congress and the White House.

As a result, political paranoia — the “sense of heated exaggeration, suspiciousness, and conspiratorial fantasy” Hofstadter described — has gone mainstream. To read Hofstadter’s essay today is to be struck by the extent to which he seems to be describing the state of mind not of a lunatic fringe, but of key figures in our political and media establishment.

The “paranoid spokesman,” wrote Hofstadter, sees things “in apocalyptic terms. ... He is always manning the barricades of civilization.” Sure enough, Dick Cheney says that “the war on terror is a battle for the future of civilization.”

According to Hofstadter, for the paranoids, “what is at stake is always a conflict between absolute good and absolute evil,” and because “the enemy is thought of as being totally evil and totally unappeasable, he must be totally eliminated.” Three days after 9/11, President Bush promised to “rid the world of evil.”

The paranoid “demand for total triumph leads to the formulation of hopelessly unrealistic goals” — instead of focusing on Al Qaeda, we’ll try to remake the Middle East and eliminate a vast “axis of evil” — “and since these goals are not even remotely attainable, failure constantly heightens the paranoid’s sense of frustration.” Iraq, anyone?

The current right-wing explanation for what went wrong in Iraq closely echoes Joseph McCarthy’s explanation for the Communist victory in China, which he said was “the product of a great conspiracy” at home. According to the right, things didn’t go wrong because the invasion was a mistake, or because Donald Rumsfeld didn’t send enough troops, or because the occupation was riddled with cronyism and corruption. No, it’s all because the good guys were stabbed in the back. Democrats, who undermined morale with their negative talk, and the liberal media, which refused to report the good news from Iraq, are responsible for the quagmire. ...

Which brings us back to the Foley affair. The immediate response by nearly everyone in the Republican establishment — wild claims, without a shred of evidence behind them, that the whole thing is a Democratic conspiracy — may sound crazy. But that response is completely in character for a movement that from the beginning has been dominated by the paranoid style. And here’s the scary part: that movement runs our government.

Previous (10/6) column: Paul Krugman: The War Against Wages
Next (10/13) Column: Paul Krugman: Will the Levee Break?

Here's the essay by Richard Hofstadter:

The Paranoid Style in American Politics, by Richard Hofstadter†, Harper’s Magazine, November 1964, pp. 77-86:

It had been around a long time before the Radical Right discovered it—and its targets have ranged from “the international bankers” to Masons, Jesuits, and munitions makers.

American politics has often been an arena for angry minds. In recent years we have seen angry minds at work mainly among extreme right-wingers, who have now demonstrated in the Goldwater movement how much political leverage can be got out of the animosities and passions of a small minority. But behind this I believe there is a style of mind that is far from new and that is not necessarily right-wind. I call it the paranoid style simply because no other word adequately evokes the sense of heated exaggeration, suspiciousness, and conspiratorial fantasy that I have in mind. In using the expression “paranoid style” I am not speaking in a clinical sense, but borrowing a clinical term for other purposes. I have neither the competence nor the desire to classify any figures of the past or present as certifiable lunatics. In fact, the idea of the paranoid style as a force in politics would have little contemporary relevance or historical value if it were applied only to men with profoundly disturbed minds. It is the use of paranoid modes of expression by more or less normal people that makes the phenomenon significant. [...continue reading...]

November 7, 2006

Latte Price Discrimination at Starbucks?

Randal C. Picker from the Law School at the University of Chicago wonders if Starbucks is practicing price discrimination:

Latte serves up a lesson in bootleg economics, by Randal C. Picker, Commentary, Chicago Tribune: ...[T]he Tribune detailed Thursday in an interesting article about Starbucks and the bootleg latte.

As the Tribune describes it, Starbucks' pricing creates a doppio-latte arbitrage opportunity. ... [H]ere is the strategy as I get it. A doppio is described as a double shot of espresso that would usually be served in an 8-ounce cup. That would set you back $1.75. A latte, which goes for $3.20, is a double shot of espresso plus milk and foam in a 16-ounce cup. Our arbitraging customers order the doppio but ask for it in a 16-ounce cup and then add free milk available in canisters at Starbucks. Pop the cup in a microwave, and you have the latte and have saved $1.45. (This, of course, is just saving money; real arbitrage would mean that enterprising customers would start selling the fake lattes in competition with Starbucks, but the Trib article didn't say anything about that.) ...

Starbucks provides free milk so that customers who want to add milk to their coffee can do so. ... But Starbucks has no simple way to control how "free" milk is used at its stores. Starbucks obviously could post signs or refuse to sell drinks in wrong-sized cups. The cup size limit is the most natural technical constraint; signs would be more directly contractual but would detract from Starbucks' ambience.

Of course, imposing a cup size limit might irritate some customers. Is Starbucks better off without these customers? Perhaps, but there's a more interesting alternative. Starbucks may be engaging in what an economist would call latte price discrimination. That means selling the same thing--the latte--to different customers for different prices. If we assume that the fake latte is profitable for Starbucks even when sold for $1.75, Starbucks may be perfectly willing to allow some of its customers to home-brew using Starbucks ingredients. ...

Although Starbucks probably wouldn't announce a policy of allowing customers to create fake lattes--too many genuine latte purchasers might switch over--it might want to engage in latte price discrimination... So the next time you go to Starbucks, take a good look around. If you order a doppio in a 16-ounce cup, does the barista wink at you? Maybe the barista is being friendly, but maybe, just maybe, you are being told that your fake latte is just fine.

As noted above, it isn't arbitrage. Is it price discrimination? I don't think they're essentially the same product - one's fake. To me, the fake would be a lower quality, lower cost alternative which might still be profitable for Starbucks even with the added milk, but it's not price discrimination. In any case, if Starbucks wanted to price discriminate, there are better ways to do it.

Diversity and Trust

Bad news about our tolerance for diversity:

Harvard study paints bleak picture of ethnic diversity, by John Lloyd, Financial Times: A bleak picture of the corrosive effects of ethnic diversity has been revealed in research by Harvard University’s Robert Putnam, one of the world’s most influential political scientists.

His research shows that the more diverse a community is, the less likely its inhabitants are to trust anyone – from their next-door neighbour to the mayor.

This is a contentious finding in the current climate of concern about the benefits of immigration. Professor Putnam ... delayed publishing his research until he could develop proposals to compensate for the negative effects of diversity, saying it “would have been irresponsible to publish without that”.

The core message of the research was that, “in the presence of diversity, we hunker down”, he said. “We act like turtles. The effect of diversity is worse than had been imagined. And it’s not just that we don’t trust people who are not like us. In diverse communities, we don’t trust people who do look like us.” ...

When the data were adjusted for class, income and other factors, they showed that the more people of different races lived in the same community, the greater the loss of trust. “They don’t trust the local mayor, they don’t trust the local paper, they don’t trust other people and they don’t trust institutions,” said Prof Putnam. “The only thing there’s more of is protest marches and TV watching.” ...

Prof Putnam stressed, however, that immigration materially benefited both the “importing” and “exporting” societies, and that trends “have been socially constructed, and can be socially reconstructed”. ...

The Mummy Speaks, and He's Not Happy

This caught my eye because the byline says it's by Jeremy Bentham at University College London (who's a mummy, or properly, an auto-icon). But it's actually by the Jeremy Bentham Professor of Law which, if Google is correct, is Ronald Dworkin:

Do not sacrifice principle to the new tyrannies, by Jeremy Bentham, Commentary, Financial Times: When a terrorist plot to blow 10 planes out of the sky was revealed in August, John Reid, the British home secretary, said that those who worry about protecting human rights in the campaign against terrorism “still don’t get the point”. ... But it is Mr Reid and others who think like him who still do not get the point. They do not understand what human rights are and why the honour of the British nation would be soiled by their proposals.

Mr Reid thinks that human rights are like speed limits that may be high when the risk is minimal but should be lowered for dangerous stretches of road. That is a misunderstanding of the concept of human rights. It was, indeed, the horror of the 20th century tyrannies that brought [human rights] into prominence and produced international treaties such as the European Convention on Human Rights and domestic statutes such as the British Human Rights Act. ... This is the abstract principle, from which all concrete human rights flow, that the existence and dignity of every human life is of high and equal intrinsic importance.

It is this principle that Mr Reid and his colleagues apparently think now obsolete. It is not, I agree, a principle that seems natural to human beings – we are by nature tribal. But we have struggled for centuries to recognise and enforce equal human dignity, provoked, finally, by our revulsion at the 20th century dictatorships. We think the principle represents the best in us ..., and it is depressing that so many of us seem willing to give it up out of fear of the new tyrannies of jihad.

I emphasise that human rights depend on the abstract principle of equal human dignity, not just to explain why they are so important that we must accept sacrifices to protect them, but also to explain that they may be violated in different ways. There are some acts of government that in themselves reveal a disdain for the value and dignity of a human life. Governments kill or jail people for their political opinions, or torture them for information, or force them into religious practices against their own faith, or rape or humiliate them, or aim to eliminate their race or kind. So, any list of concrete human rights must include rights against such treatment; these acts must be condemned in any nation no matter what its laws and traditions. Nations disagree, however, about what respect for human dignity requires beyond these basic protections and adopt different provisions defining the rights of people suspected or accused of crime. In that way, a nation establishes a distinct conception of what human dignity demands and it shows contempt for a group when it denies them the benefit of that understanding.

This is what politicians of both major parties ask Britain to do now. They want to jail people, who might be innocent, for 90 days without charge, which is a substantial punishment likely to damage the prisoners’ lives even if they are then released. They want to deport aliens who may be innocent to countries where they might be tortured and killed and to introduce evidence in UK trials that foreign torturers have obtained. They ridicule judges who stand in their way and they demand that the law be changed to give them licence to do what they want.

All these proposals contradict central features of British justice that mark this country’s conception of what human dignity requires. The politicians say that the dangers to security are too great to continue to respect established rights. Is the danger really so great? Religious fanatics bent on murder are not the only enemies of society. We face serial killers, drug dealers, muggers, industrial polluters, train operators who skimp on safety and white collar criminals who destroy lives. It is unclear that the dangers these people pose to our security is any less than the danger of terrorism. But no one advocates jailing suspected pension fund embezzlers for 90 days without charge while their hard drives are scoured for encrypted evidence.

If we want to change our practices because we need more security, we must do so at the cost of our own wealth and convenience, not the human rights of others. We must pay more in fares and charges to support more rigorous airport and import security. We must be imaginative in exploring other measures. More effective detection devices than those in use are available. ... But we must not try to steal a little more safety by destroying the lives of people not like us, many of whom are innocent of any crime or conspiracy. Sacrificing principle in the face of danger is a particularly shaming form of cowardice. Where has our courage gone?

Tax Cuts and "Unenlightened Self-Interest"

The explanation for why low-income individuals have voted for Republicans even when it is not in their economic interest to do so usually relies upon an argument involving values. In this October 2003 commentary, Alan Krueger argues there may be a different reason - confusion over who will benefit from policy changes:

Connecting the dots from tax cuts for the wealthy to loss of benefits, by Alan B. Krueger, Economic Scene, NY Times, October 16, 2003: Conservative and liberal political commentators alike have wondered why most Americans have enthusiastically supported two of the largest tax cuts in history even though most benefits will flow to upper-income families. Adding to the conundrum, in public opinion surveys Americans routinely express support for spending more on government programs like education, opposition to government budget deficits, and disappointment that the gap in income between rich and poor has widened -- all of which are in conflict with regressive tax cuts.

In the most extensive analysis yet available, Larry Bartels, a political scientist at Princeton University, gives a simple but persuasive explanation: "unenlightened self-interest." Middle- and lower-income Americans supported tax cuts they suspected went largely to the rich because they thought they, too, would benefit, if only by a small amount, and because they failed to connect the tax cuts to rising inequality, their future tax burden, or the availability of government services.

Professor Bartels analyzed a small battery of questions added to the National Election Survey... The survey turned up some remarkable results, which he reports in "Homer Gets a Tax Cut: Inequality and Public Policy in the American Mind."

For example, most Americans will never have to pay the estate tax, yet 70 percent expressed support for eliminating it anyway. Support for eliminating the tax was nearly as great -- 66 percent -- among people who had strong reasons to favor keeping it: namely, those in families earning less than $50,000 a year who said that the increase in income inequality was a bad thing, that government policy contributed to differences in income, and that the rich pay less than they should in taxes.

Changing the wording from "estate tax" to "death tax" only marginally increased support for eliminating the tax, so people were not fooled by the framing of the issue.

Yet, Professor Bartels said, they were fooled. A separate survey sponsored by the Kaiser Foundation found that half of respondents thought "most families have to pay the federal estate tax when someone dies." Just a third gave the correct answer of "only a few families."...

Several polls have found that the 2001 and 2003 tax cuts were supported by a majority of the public, although, surprisingly, the tax cuts were not as popular as scrapping the estate tax.

People who thought their own taxes were too high were much more likely to support the 2001 tax cut and to oppose the estate tax. Paradoxically, whether someone thought taxes on the rich were too low or too high was irrelevant to their position on tax cuts. Professor Bartels said a misconceived notion of self-interest explains these findings.

Some have argued that Americans are not "demonstrating in the streets" over regressive tax cuts because they are indifferent to inequality. Yet the survey found that 74 percent of respondents recognized that the difference in incomes between rich and poor was larger than it was 20 years ago, and a majority of them considered this a "bad thing." Only one in 20 considered the rise in inequality a "good thing."

Of course, views expressed in polls can differ from actual voter behavior. Recent election results, however, suggest that low-income people who hardly benefit from tax cuts that jeopardize government services still favor tax cuts. ...

Professor Bartels, citing a 2003 Kaiser Foundation survey, points to "a good deal of ignorance and uncertainty about the workings of the tax system and the policy options under consideration." Sixty-one percent of respondents said they had not heard of President Bush's proposal to do away with the dividend tax. Even worse, most people said they paid more in federal income taxes than in Social Security and Medicare taxes, a confusion that has helped keep payroll tax cuts -- which would have stimulated job growth -- off the table. And only 29 percent of people thought high-income people would benefit most from Mr. Bush's proposal to speed up and make permanent the previously enacted tax cuts.

Norbert Schwartz, a cognitive psychologist at the University of Michigan, said he thought the study provided "a powerful illustration of how the combination of low factual information and good political spin creates preferences that aren't in people's interest." ...

Larry Bartels concludes that "most Americans support tax cuts not because they are indifferent to economic inequality, but because they largely fail to connect inequality and public policy." In this sense, Homer Simpson had it backward when he said, "Just because I don't care doesn't mean that I don't understand."

Is the Housing Market Leveling Off?

Alan Greenspan says the worst part of the housing market decline may be over:

Greenspan Says 'Worst' May Be Past in U.S. Housing, by Greg Quinn and Scott Lanman, Bloomberg: Former Federal Reserve Chairman Alan Greenspan said the ''worst may well be over'' for the U.S. housing industry that's suffering its worst downturn in more than a decade.

Greenspan ... pointed to a ''flattening out'' of weekly mortgage applications after they went down ''very dramatically.'' ...

Greenspan's comments may represent a more sanguine view than his successor, Ben S. Bernanke, who said two days ago in Washington that the market is in a ''substantial correction'' that will lop about a percentage point off economic growth in the second half and restrain the expansion next year. ...

Calculated Risk says:

The graph shows the MBA Purchase Index since it's inception in 1990. On a long term scale, I don't see any significant "flattening out".

The graph is here.

The Republican Central Authority

Do conservatives believe in states' rights?

Against Interpretation, by Conor Clarke, American Prospect: More than a decade ago, when Kansas Republican Jan Meyers proposed making welfare reform a state-by-state grant program -- instead of a federally-run entitlement program -- she was under the impression that she was doing her party a favor. It was March of 1993, as Ron Haskins recounts in his Work Over Welfare... “The most important characteristic of block grants,” writes Haskins, “is that they greatly increase state and local, as opposed to federal, control of social programs.” In other words, it was about states’ rights. And Republicans, as everyone knows, just eat that stuff up.

Or maybe not. On October 1, to very little fanfare, the state flexibility elements built into the original Temporary Aid for Needy Families (TANF) program met an ignominious demise. ... In February, ... President Bush signed into law the Deficit Reduction Act of 2005, which changed TANF...

Those new ... rules ... contain plenty that will and should annoy liberals. But it’s worth asking why conservatives aren’t upset about them, too. They certainly are not: In the Senate, 50 Republicans voted for the legislation that created them. In the House, 216 did. And that reflects ... continuing hypocrisy about states’ rights: Republicans are willing to let them go the moment they come into competition with other interests.

In theory, conservatives support states’ rights because they like to see political power decentralized. When the might of government is wielded at a national level, it begins to look a bit like we’re just a hop-skip away from the Soviet gulag. “Part of the birthright of Republicans is wariness about big government,” writes Haskins, on why Meyers’ proposal was so attractive. ...

And whenever the federal will trumps an obvious local preference, the states’ rights people are supposed to get upset. ... But the new welfare rules ... create a set of federal rules. And they link acceptance of those rules to federal funding: states risk losing a good deal of their block grants if they resist. Conservatives don’t seem terribly distressed about any of this. ... Indeed, welfare reform joins a long and ever-growing list of issues -- abortion, gay marriage, and just glance at the GOP platform for more -- in which federalism has been abandoned in the pursuit of a narrow virtue.

That’s a shame, because there’s evidence that, in the case of welfare, flexibility has been good for the states. ... It’s hard to know exactly what effect the new welfare rules and other DRA mandates will have -- though the Center for Budget and Policy Priorities, and others, have had interesting things to say. Welfare rolls will probably fall, just as they did after 1996 welfare reform. (Of course, when you mandate a 50 percent cut under threat of massive grant reductions and drastically limit the welfare options states can employ, it’s a bit hard to imagine any outcome other than states hemorrhaging beneficiaries left and right.)...

But the new rules will create one thing for sure: Bureaucracy. New federal jobs will have to be dreamed up to make sure states are complying. Paperwork will have to be filled out. Fines will have to be imposed. The free market will cry out in agony. There might have been a time when conservatives would have been bothered by this. But not anymore.


The Economist has a survey on talent, "the world's most sought-after commodity":

This survey will argue that the talent war has to be taken seriously. It will try to avoid defining talent either too broadly or too narrowly but simply take it to mean brainpower... It will thus focus on what Peter Drucker, the late and great management guru, called “knowledge workers”. ... The survey will conclude by looking at the widening inequalities that will result from the competition for talent, and weighing up the risks of a backlash against the talent elite.

Here's one of the articles about the potential backlash:

Meritocracy and its discontents, The Economist: In “The Rise of the Meritocracy”, published in 1958, Michael Young ... conjured up an image of a society obsessed with talent. The date was 2034, and psychologists had perfected the art of IQ testing. But far from promoting social harmony, the preoccupation with talent had produced social breakdown. The losers in the talent wars were doubly unhappy, conscious not only that they were failures but that they deserved to be failures. Eventually they revolted against their masters.

The rise of the talent elite has bred resistance, which started on the right. ... But after the second world war the resistance spread leftward. Leftists argued that meritocracies were ... unjust. If “talent” owed more to nature than nurture, as many social scientists insisted, then rewarding people for talent was tantamount to rewarding them for having privileged parents.

This resistance has occasionally boiled over into outright rebellion. Young's book was an opening shot in a successful war against the 11-plus, a British school examination that divided children between a gifted elite destined for academic grammar schools and those consigned to run-of-the-mill secondary modern schools. The 1960s saw widespread student revolts against selection and elitism.

There are plenty of signs that another backlash is on the way... Much of this resentment focuses on growing inequalities. People complain that these are straining the bonds of society to breaking point: a new aristocracy of talent is retreating into golden ghettos and running the global economy in their own interests. ...

In some ways things are worse than they were when Young wrote his book. Inequalities are much wider ... and the talent elite has gone global. ... Samuel Huntington, a political scientist, argues that “ a major gap is growing in America between its increasingly denationalised elites and its ‘thank God for America' public.” On American television personalities such as Lou Dobbs and Bill O'Reilly beat the populist drum against those cosmopolitan elites. ... Across much of the developing world the targets of choice for rioters are rich ethnic minorities and foreigners.

But in other ways things have got much better. The number of winners now is much larger than it was in 1958. In Young's day, the meritocrats concentrated on spotting recruits for Oxbridge and the senior civil service. The rest were labelled failures. Since then, America and Europe have created a mass higher education system, and developing countries are determined to follow suit. ...

Moreover, some problems could prove self-correcting. ... The growing returns to education create incentives for people to get themselves educated, producing a better-trained workforce as well as upward mobility. ...

Above all, there is something appealing about the meritocratic ideal: most people are willing to accept wide inequalities if they are coupled with equality of opportunity. In America, where two-thirds of the population believe that everyone has an equal chance to get ahead, far fewer people favour income redistribution than in Europe.

Growing wealth also means that society can reward a wider range of talents. ... These days, sports stars and entertainers can make millions. There are also ample rewards for all sorts of specialised talents... Takeru “Tsunami” Kobayashi earns more than $200,000 a year as the world's hot-dog eating champion: he can eat more than 50 in 12 minutes.

The backlash is not inevitable, then. But it is sensible to take steps to prevent it. One popular answer is affirmative action, an idea that is making headway even in that last redoubt of old-fashioned meritocracy, the French establishment. However, experience in America—which introduced the practice in the 1970s—suggests that it raises a host of problems. ... The biggest problem with affirmative action ... is that it comes too late. The best way to boost the life-chances of poor people is to intervene much earlier in life—to set them on the right path in kindergarten and primary school and reinforce those lessons in secondary school.

Progressive taxation can help. For much of the post-war period most rich countries taxed talent too heavily, causing bright flight. But today, in America at least, the danger is the opposite...

The best way to head off a backlash is to give everybody a fair chance. This means investing in childhood nutrition and pre-school education. It also means repairing the lowest rungs of the educational ladder. Developing countries need to continue the march towards universal primary education: failure to do so will exacerbate skill shortages as well as widen inequalities...

The rise of a global meritocracy offers all sorts of benefits, from higher growth in productivity to faster scientific progress. It can boost social mobility and allow all sorts of weird and wonderful talents to bloom. The talent wars may be a source of trepidation for companies and countries. But they should also be a cause for celebration.

"In America, ... two-thirds of the population believe that everyone has an equal chance to get ahead."

Many of the arguments for redistribution to overcome growing inequality are based upon the idea that inequality arises, at least in part, from government policy giving unfair advantages to some groups (e.g. favoring firms over unions) or other factors (e.g. corporate governance and CEO pay, differences in educational opportunities). The counterargument has been that the income is not from government policy or other such factors, it is earned through hard work - it is a skill-based premium that is a reward for higher productivity - and hence it would be unfair to take it away. Above, one of the arguments is that the skill-based premium itself, or perhaps talent-based premium is a better word, is undeserved when it arises from genetic advantage rather than superior effort (nature not nurture) and hence these individuals do not deserve the high compensation they receive (If I were seven feet tall, I could play in the NBA too...). Should such "luck" be taxed away?