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January 31, 2007

Paul Krugman: Two More Years

Paul Krugman urges congress to stand up to president Bush and find a way to end the futility in Iraq:

Two More Years, by Paul Krugman, Commentary, NY Times: At a reception following the midterm election, President Bush approached Senator-elect James Webb. “How’s your boy?” asked Mr. Bush.

“I’d like to get them out of Iraq, Mr. President,” replied Mr. Webb, whose son, a Marine lance corporal, is risking his life in Mr. Bush’s war of choice.

“That’s not what I asked you,” the president snapped. “How’s your boy?”

“That’s between me and my boy, Mr. President,” said Mr. Webb.

Good for him. We need people in Washington who are willing to stand up to the bully in chief. Unfortunately, and somewhat mysteriously, they’re still in short supply. ... [It's] amazing ... the extent to which insiders still cringe before a lame duck with a 60 percent disapproval rating.

Look at what ... happened to the Iraq Study Group['s] ... “independent assessment.” If press reports are correct, the group ... watered down its ... recommendations, trying to come up with something Mr. Bush wouldn’t reject out of hand. In particular, says Newsweek, ... All it will do is “suggest that the president could, not should, begin to withdraw forces in the vaguely defined future.” ...

Even now, ... the wise men of Washington can’t bring themselves to face up to two glaringly obvious truths. The first is that Americans are fighting and dying in Iraq for no reason.

It’s true that terrible things will happen when U.S. forces withdraw. Everyone ... realizes that the civil war will get even worse after we’re gone, and that there will probably be a bloody bout of ethnic cleansing...

But nobody — not even Donald Rumsfeld, it turns out — thinks we’re making progress in Iraq. So the same terrible things ... will still happen if we delay ... withdrawal for two, three or more years. The only difference is that we’ll sacrifice many more American lives along the way.

The second truth is that the war will go on all the same, unless something or someone forces Mr. Bush to change course.

During his recent trip to Vietnam, Mr. Bush was asked whether there were any lessons from that conflict for Iraq. His response: “We’ll succeed unless we quit.”

It was a bizarre answer ..., but it makes perfect sense given what we know about Mr. Bush’s character. He has never been willing to own up to mistakes... If he were to accept the failure ... in Iraq, he would be admitting ... to having made the mother of all mistakes.

So Mr. Bush will keep sending other men’s children off to fight his war. And he’ll always insist that Iraq would have been a great victory if only his successors had shared his steely determination.

Does this mean that we’re doomed to at least two more years of bloody futility? Not necessarily. ... He’s still the commander in chief, but the new majority in Congress can put a lot of pressure on him to at least begin a withdrawal.

I’m worried, however, that Democrats may have counted on the Iraq Study Group to provide them with political cover. Now that the study group has apparently wimped out, will the Democrats do the same?

Well, here’s a question for those who might be tempted, yet again, to shy away from a confrontation with Mr. Bush over Iraq: How do you ask a man to be the last to die for a bully’s ego?

Previous (12/1) column: Paul Krugman: Economic Storm Signals
Next (12/8) column: Paul Krugman: They Told You So

Update: From ThinkProgress:

Rep. Jim Moran: Bush Was Warned To Be ‘Extra Sensitive’ About Webb’s Son: ...The right wing has been attacking Webb for his reaction to Bush’s question. Last night, Fox News host Bill O’Reilly said Webb was “rude,” “inappropriate,” and “disrespectful,” because Bush was merely trying to extend a “nice gesture.” The National Review’s Corner called him “classless” and conservative columnist George WIll labeled him “a boor.”

But according to Rep. Jim Moran (D-VA), Bush was told that Webb’s son had a recent brush with death in Iraq and was warned to be “extra sensitive” when talking to the Sen.-elect. ThinkProgress yesterday spoke with Moran’s office and confirmed the congressman’s statement...

Not only did Bush know about it, he was specifically briefed on the incident before meeting with Webb, and was cautioned to be extra sensitive in speaking with Webb about his son.

After such a briefing, Bush perhaps shouldn’t have been so surprised about Webb’s unwillingness to chit-chat about his son.

The Fall in the Dollar and the 2008 Election

Robert Reich on the implications of the fall in the dollar for the 2008 election:

How the Dropping Dollar Affects 2008, by Robert Reich: The dollar is weakening and Hank Paulson couldn’t be happier. Remember, Paulson was hired as Treasury Secretary essentially to do one thing – convince the Chinese to revalue the yuan, in order to increase American exports, revive American manufacturing, and save the industrial heartland ... for the Republicans. Paulson had worked with the Chinese for years as an investment banker ..., but as Treasury Secretary he has had no luck getting China to cooperate because he has had absolutely nothing to offer them.

Yet with interest rates relatively low in America relative to Europe, and the American economy slowing ..., global investors are taking their money out of dollars and putting them into euros, British pounds, and Japanese yen. Presto: The dollar is dropping. As a result, the Chinese – who hold more dollars than almost anyone else – are losing lots of money. Hence, it will make more and more sense for them to stop buying dollars, start selling them, and allow their currency to rise relative to the dollar.

In other words, international currency markets are doing for Paulson what Paulson was supposed to do for the American economy and for Republicans in 2008. That’s okay so long as global investors, as well as China and OPEC ..., don’t get carried away... [I]f the dollar drops too far too fast, everything America buys from the rest of the world begins costing a lot more... That pushes inflation. Meanwhile, the only way we can continue to finance our budget deficit and consumer buying spree is by yanking up our own interest rates. Result: stagflation – inflation combined with no or negative growth. Wall Street goes into a tailspin. Paulson leaves office as the Treasury Secretary who caused the crisis. And Republicans are unceremoniously kicked out of the White House in 2008.

It's starting to become a familiar story: Even though the global economy is taking decisions out of the hands of American officials, the public still credits or blames them for what happens.

There's a lot of time between now and the election. Seeing Republicans "unceremoniously kicked out of the White House" has its attractions, but let's hope Democrats can take the White House in 2008 through good politics and good policy rather than from a crash on Wall Street and a stagnating economy. But if economic difficulties are unavoidable, a Democrat in the White House would be a positive externality.

Post Rapture Post

The post office works in mysterious ways:

Post Rapture Post, The Postal Service of the Saved:

Watch ye therefore: for ye know not when the master of the house cometh, at even, or at midnight, or at the cockcrowing, or in the morning: Lest coming suddenly he find you sleeping. And what I say unto you I say unto all, watch. (Mk. 13:35-37)

The time of the rapture is at hand. The signs described in the Bible that foreshadow the return of Jesus Christ are becoming all too clear. Not all who live during coming Great Tribulation will be spirited away to be with God. The Bible tells us that only those who repent of their sins and follow the teachings of Jesus Christ may enter the Kingdom of Heaven.

Do you know someone who is in danger of being "left behind" because of a sinful life? Imagine if you could write a letter to a friend or loved one after the Great Day of Reckoning. Maybe a message to your family telling them to trust in God, and that everything will be okay. Perhaps you would leave instructions to care for your pets after your departure. ... This is where the Post-Rapture Post comes in.

Just write your letter and it will be hand-delivered immediately following the exodus of the pure from the Earth. But you must be thinking to yourself, "How can the letters be delivered after the Rapture?" The answer is simple. The creators of this site are Atheists. That's right, we don't believe in God. How else would we be able to deliver your correspondence after the Rapture? ...

Do you want to take the chance that your loved ones will have to suffer through your ascension into Heaven without knowing how you really feel in your heart? Sign up for the Post-Rapture Post today... [via Reddit]

I guess there really are markets for everything.

See also: Ask the Experts: What is Bayes's theorem, and how can it be used to assign probabilities to questions such as the existence of God? What scientific value does it have?
[Update: Speaking of markets for everything, Marginal Revolution also notes the Post Rapture Post.]

Environmental Costs in China

This commentary is by the vice-minister of China’s state Environmental Protection Administration:

Comment: China must pay pollution debt now or face bankruptcy, by Pan Yue, Project Syndicate: For a decade, the world has wondered when China’s leaders will recognise the staggering environmental crisis confronting their country.

This year, we got an answer: A new Five-Year Plan that makes environmental protection a priority. A storm of green propaganda has followed, and the government now talks about using "Green GDP" to measure development. But will all this talk amount to real progress?

While the central government admits to some of the environmental degradation caused by rapid economic growth, the picture it paints is incomplete. Consider "Green GDP". This spring, the state Environmental Protection Administration produced the country’s first official estimate of ... environmental losses. According to these calculations, it would cost US$84 billion (RM302 billion ) to clean up the pollution produced in 2004, or three per cent of GDP for that year. But more realistic estimates put environmental damage at 8-13 per cent ... each year, which means that China has lost almost everything it has gained since the late 1970s due to pollution.

China’s environmental problems, complex as the causes may be, can ultimately be attributed to our understanding of Marxism. For most of our recent history, we saw in Marxism only a philosophy of class struggle. We believed that economic development would solve all our problems. In the reform period, this misreading of Marx morphed into an unrestrained pursuit of material gain devoid of morality. Traditional Chinese culture, with its emphasis on harmony between human beings and nature, was thrown aside.

As a result, China’s economy is dominated by resource-hungry and inefficient polluters, such as coal and mineral mines, textile and paper mills, iron and steel makers, and petrochemical factories. Our cities are exploding in size, depleting water resources and creating horrific traffic congestion.

One-quarter of China’s people drink substandard water; one-third of urbanites breathe polluted air. Moreover, the country recently witnessed a spate of environmental accidents. Indeed, on average, China suffers a major water pollution accident every other day.

Although China has signed the Kyoto Protocol and some 50 other international environmental accords, we do little to honour them. ... Unfortunately, unlike Western countries, we cannot afford to wait until our per capita annual GDP reaches US$10,000 before tackling our environmental problems. Our experts predict that the environmental crisis will intensify to a critical stage by the time China’s per capita annual GDP reaches just US$3,000.

Making matters worse, ... the ... concept of a "social contract" based on rights and obligations — the essential values that constitute the most important precondition for effective environmental protection — goes ignored. As a result, environmental protection projects often fail to be included in calculating production costs. Scarcely anyone bothers to consider the environmental costs to, or rights of, the country’s poor and powerless. It is imperative that environmental factors figure in China’s macroeconomic planning in a real way. ...

Finally, China needs a new energy strategy. Industrialised nations have developed and made great use of nuclear, solar, wind and bio-gas, and other renewable energy resources. China’s technological capacities in this sector lag behind even other developing nations such as India and Pakistan, and its reliance on coal is one of the greatest threats to the global climate. For now, there is simply no alternative. But in the long run, clean energy will be the only way to bring economic growth without doing irreparable environmental damage.

Government cannot solve these problems on its own. China’s people have the biggest stake in environmental protection, and so must become the driving force. ... But ultimate power does rest with the government. China’s leaders need to ... move beyond rhetoric. They must give real power to environmental officials to implement laws and close legal loopholes. ...

China is dangerously near a crisis point. The country’s enormous environmental debt will have to be paid, one way or another. China must exercise the foresight needed to begin paying this debt now, when it is manageable, rather than allowing it to accumulate and, ultimately, threaten to bankrupt us all.
[Dual posted at Environmental Economics]

The Hamilton Project and the Populists

Here are two different views of the types of economic policies that Democrats should propose. First, Peter Orszag, director of The Hamilton Project at the Brookings Institution, presents the case for '"cool heads but warm hearts" in economic policy.' Then, Joel Kotkin and David Friedman of the New America Foundation propose public works projects that are intended to improve our infrastructure and reduce inequality.

Here's Peter Orzag:

Cool-headed, warm-hearted economics, by Peter Orszag, Commentary, Boston Globe: The Great British economist Alfred Marshall once spoke of the need for "cool heads but warm hearts" in economic policy. In the face of growing economic insecurity, the Democratic-led Congress taking office in January would do well to heed that approach. For the past three decades, macroeconomic growth has not made American families feel sufficiently secure. Median real wages have stagnated, and families now face substantial new risks...

This insecurity affects not only individual families, but our economy as a whole. It deters individuals from taking the risks -- like starting a new business or taking a new job -- that can lead to economic growth and makes it harder for families to rebound after bad times hit.

Under these circumstances, policy makers who genuinely care about American families' well-being may be tempted to pursue measures that interfere with the workings of the market. Such steps could involve anti-trade protectionism, constraints on hiring and firing, regulatory protections for specific industries, outsourcing restrictions, or requirements that businesses spend a certain percentage of their payroll on health care.

Although this approach may appear to provide much-needed temporary help, the evidence suggests it will ultimately harm the economy. As Nobel Prize-winning economist Paul Samuelson writes , "leaving or compromising free trade policies will most likely reduce growth in well-being in both the advanced and less productive regions of the world. Protectionism breeds monopoly, crony capitalism, and sloth."...

The cool-headed but warm-hearted approach to economic security instead involves stronger education and saving policies, which prepare workers in advance for hard times, and also a revamped system of social insurance and progressive taxation, which cushion the blows that inevitably occur in the process of creative destruction.

Saving and asset accumulation give families a nest egg to draw upon during times of trouble. Many families save too little... We need to adopt a Fast Lane approach that makes saving ... automatic... For example, under an automatic 401(k), workers are enrolled unless they specifically opt out. Their contribution rate automatically rises over time, and their funds are invested in a diversified, low-cost portfolio. ... This system works: Participation rates among new low-wage workers jump from under 15 percent to 80 percent when automatic enrollment is put in place. ... Automatic savings vehicles should be universal.

The tax system can also help. A progressive tax system can help cushion income fluctuations, since it takes less in bad years than good. We could make the tax code both more progressive and more efficient...

The dramatic increases in economic instability demand our response. We can learn lessons from Europe . In the Nordic economies (such as Denmark), market flexibility and competition have been combined with social insurance schemes that protect family incomes but also encourage work. In the continental European countries (such as France and Germany), governments have intervened directly in the workings of the market. The Nordic approach works better. Trying to shut down the process of creative destruction creates macroeconomic stagnation.

As they regain control of Congress, Democrats should remember that a combination of education, saving, social insurance, and progressive taxation would allow the engine of economic growth to continue humming -- while still providing better protection to America's working families.

Next, a different plan. Joel Kotkin and David Friedman of the New America Foundation proposes a public works program to create jobs and reduce inequality:

Rebuilding the middle class, by Joel Kotkin and David Friedman, Commentary, LA Times: Over the last 20 years, the United States has regressed into what one economist calls a "plutonomy" — a society in which the largest economic gains flow to an ever smaller portion of the population. ... [W]orkers losing the most economic ground are not the uneducated and unskilled but those with high school, community college and even four-year degrees. Overall, the middle class, in relative if not absolute terms, has lost purchasing power... Globalization and automation have not only hurt manufacturing workers but also mid-level managers, engineers and software programmers. ...

Is there any way to restore the prospects of middle- and working-class Americans? A comprehensive program to rebuild the nation's highways and bridges, upgrade its ports, construct and expand its energy lifelines and enlarge its public transportation systems could generate hundreds of thousands of good-paying jobs. ..[T]his back-to-basics strategy ... has helped narrow economic inequality in the past by producing more balanced economic growth.

During the 1930s, for instance, the government sought to narrow the enormous wealth disparities caused by the Depression by putting people to work on an unprecedented number of infrastructure improvements. About 3 million workers ... were organized to build roads, bridges and dams. They planted millions of trees in middle America to prevent soil erosion. They built transportation networks that helped cities increase their industrial productivity. Rural electrification programs lifted sections of the Midwest and South out of darkness.

In the 1950s, under the Eisenhower administration, construction began on an interstate highway system that ... made the economy more efficient. By promoting suburban development, the new roads also sparked an unprecedented growth in homeownership...

The result was one of the most balanced periods of prosperity in U.S. history. As ordinary Americans prospered, the share of the nation's wealth controlled by the top 10% of the population fell from nearly 50% in the 1930s to about 30% in the 1960s. Yes, the super-rich did quite well. But coupled with such government programs as the GI Bill and housing for veterans, the infrastructure projects helped give more Americans access to higher education and homeownership.

Both Democrats and Republicans have largely abandoned policies that led to balanced economic expansion. ...[S]ince the mid-1960s, spending on public infrastructure has fallen from more than 3% of gross domestic product to about 2.5%. As the quality of roads, bridges, schools, sanitation and healthcare fell, wealth shifted away from the middle and working classes. ... Of course, lack of infrastructure spending was not the only culprit. But minimal investment in public projects that boost the economy's productivity certainly has not helped. ...

The current favored policy proposals will do little to change economic disparity. The Republican package of high-end tax cuts, pork-barrel spending projects such as the bridge to nowhere in Alaska and near-total neglect of the country's industrial base by generally ignoring unfair trade practices constitutes a veritable formula for continued inequality. ...

Democrats also have few answers. Many focus on increasing the U.S. minimum wage ... But the chief beneficiaries of these policies are younger part-time workers, not primary household wage-earners. ...

The best way to reverse these trends is to return to those policies that produced a vibrant, economically well-balanced society: creating jobs by investing in infrastructure and promoting people's technical skills. According to the American Society of Civil Engineers, $1.6 trillion worth of infrastructure projects are required but yet to be started. ...

Today, many needed public investments can be — and in some places are — privately financed. By steering capital — through tax breaks and incentives — now flowing to speculative Internet stocks and luxury condominiums toward roads, bridges and electricity lines that can carry surplus power from the heartland to urban consumers, productivity can be enhanced and large numbers of blue- and white-collar jobs created.

To be sure, a back-to-basics economic growth strategy would conflict with certain deeply held but flawed political nostrums. Most Republicans would resist any notion that government should have a larger role in promoting the aspirations of Americans, although precisely this belief animated the Eisenhower administration's interstate highway system. Many upscale liberals probably would be hesitant to embrace a full-blown program to rebuild the infrastructure because of its possibly harmful effects on the environment. Others claim that training for "knowledge" jobs should take precedence over that for manufacturing or trade occupations.

All of the essentials — capital, a willingness to work and a undeniable need to rebuild our infrastructure and expand worker skills — for a program that would directly address our steadily worsening class divide are already in place. All we lack now is the political willingness to embrace this opportunity.

Let me try to reconcile the two views. One difference is that the Hamilton Project has a long-run focus. It concentrates on changing saving behavior, increasing human capital through education, and so on. The idea is to promote long-run economic growth and increase the share of that growth accruing to the lower end of the income distribution.

The publics works proposal and many other populist policies have a much shorter-run focus. In the long-run we are all dead the saying goes, so let's fix things now, get people back to work, enhance security by insulating business and workers from unfair foreign competition, and so on.

I don't think these two views are mutually exclusive to the extent many make them out to be, though there are some conflicts such as over trade barriers. Those who focus on long-run growth worry that populist policies enacted to solve short-run economic problems and inequities will reduce economic growth and end up making the middle class and poor worse off rather than better off as intended.

But not all short-run polices are the same. Some policies can help rather than hinder long-run growth, particularly those directed at enhancing our economic infrastructure. There is much that needs to be done, and since so much of that need is in the form of public goods, there is plenty of room for government to take a more active role.

In the long-run we may all be dead, but our children, their children, and so on won't be and we need to make sure they inherit the economic capability we would want to have available to us in their place. We cannot ignore infrastructure, savings, education, and other policies that make us all better off over time, and as Democrats begin addressing the needs of today, the long-run goals should be part of the discussion. But the short-run needs attention too and if we are smart, we can and should find ways to help without sacrificing our long-run potential.

Questions for the Committee on Capital Markets Regulation

At the Financial Times, there is an "Ask the expert: US capital markets" where you can ask Glenn Hubbard questions about the recent report recommending that regulations be changed to, among other things, make it more difficult for shareholders to file lawsuits:

Ask the expert: US capital markets: Q&A: US capital markets The committee on capital markets regulation, chaired by Glenn Hubbard, a former economic adviser to President George W. Bush, has recommended that companies and auditors should be better protected against costly shareholder lawsuits to stem the tide of litigation endangering the competitiveness of US markets

The findings of the influential group are part of wide-ranging efforts by business leaders and politicians to rein in a regulatory and legal system they say is stifling the ability of the US to compete with financial centres such as London and Hong Kong.

The committee also calls for excluding small companies from some of the more demanding provisions of the Sarbanes-Oxley legislation.

Mr Hubbard will be online for an hour on Tuesday from 12pm GMT (7am US eastern time) to answer readers’ questions on why US capital markets have fallen behind.

Post a question now to or use the online submissions form below.

I used the submission form:

Dear Dr. Hubbard:

Thanks for the opportunity to ask questions. I have several:

1. Given that the Committee on Capital Markets Regulation received $500,000 from the C.V. Starr Foundation, a group with strong ties to Maurice R. "Hank" Greenberg, the former AIG chief who is fighting civil charges filed by the New York attorney general, and given that two other committee members, Wilbur L. Ross Jr and Kenneth C. Griffin, contributed a few hundred thousand dollars more, why should we believe the Committee was independent? Is it a coincidence that the committee's findings are favorable to the donors?

2. Can you describe how the interests of investors, the public, businesses, etc. were represented in the make-up on the Committee? For example, who represented the interests of individual shareholders on the Committee?

3. What empirical work is available to support the Committee's recommendations beyond what is in the report? Is there a substantial body of work published in academic journals to support these recommendations? Or are they based upon a narrower set of papers that have not been thoroughly checked for robustness?

4. Echoing Larry Summers, will you encourage the administration to "focus as intensely on helping the American manufacturing, American agriculture and American health-care industries as it is on this particular aspect of financial services"? What steps can you point to that the administration has taken to help with these problems?

Thank you,

Mark Thoma
Eugene, Oregon

I have more questions, but didn't want to overdo it. If you have questions for Dr. Hubbard, the form is here.

Robot-Human Sociology

Have you hugged your sociable robot today?:

Robotic pets may be bad medicine for melancholy, by Stephanie Schorow, MIT News Office: In the face of techno-doomsday punditry, Sherry Turkle has long been a proponent of the positive. In her books ... Turkle has explored the relationship between human and machine and found much to ponder and even praise.

But now the director of the MIT Initiative on Technology and Self has a confession: "I have finally met technology that upsets and concerns me."

Turkle ... outlined her concerns about the implications of increasingly personal interactions between robots and humans during a ... lecture... Turkle, a clinical psychologist, spoke earnestly and openly about her fears, acknowledging that some parts of her research "gave me the chills" on a very personal level and that she is "struggling to find an open voice."

A pioneer of the now accepted notion that "technologies are never just tools," Turkle set the stage with a discussion of her work on machines as "evocative objects" and "relational artifacts." ... From Furbies to robotic dogs like Aibo to pocket "pets" like Tamagotchis to Paro, a robotic baby seal that responds to touch, children and even adults are forming bonds with machines, showing that the killer app may be "nurturing." That is, rather than the computer taking care of us, we take care of the computer, Turkle said.

Increasingly sophisticated robots--with big eyes that follow our faces or which respond to human voice and touch--trigger "Darwinian" responses in us; we are "wired" to react to objects that track our movement, Turkle said. "This is not about building AI with a lot of smarts," she said. The impact is "not on what it has but how it makes people feel."

One of Turkle's concerns was triggered by the effect of a sophisticated interactive doll, Hasbro's "My Real Baby," and of the Paro seals on the elderly. She left a few "My Real Baby" dolls (which were not a big retail hit with children) in a local nursing home, and when she returned later, she found that the staff had bought 25 of them because of the soothing effect on the residents.

"The only one who's not happy here is the sociologist," said Turkle, raising her hand. That soothing response was based on a sham, she believes. "What can something that does not have a life cycle know about your death, or about your pain?"

She cited the case of a 72-year-old woman who, because she is sad, says she sees that her robotic toy is also sad. "What are we to make of this relationship when it happened between a depressed woman and a robot?" Turkle asked.

The Q&A period triggered a lively debate over whether such bonding is necessarily bad. A questioner brought up the issue of how the elderly bond to pets. "A dog doesn't talk. A dog doesn't say, 'I love you,' ' Turkle said, although at least one listener insisted his dog does talk, in a fashion.

Turkle isn't sure what a dog can sense. "What I do know is Paro knows nothing. That sense of self soothing was with an object that knows nothing," she stated. Ultimately, human-like robots will be "test objects by which we are finding out new stuff about ourselves," Turkle said.

The GOP's Affection for Protection

Ever since the Democrats took control of congress, there has been an attempt to drive a wedge between the populist and free-trade factions within the party. Daniel Gross notes that the wedge is not confined to Democrats, the "Grand Old Protectionists" have a history of erecting tariffs and other trade barriers without any help from Democrats:

Grand Old Protectionists, by Daniel Gross, Commentary, Washington Post: Since the midterm elections, concerned internationalists have fretted that the incoming Democratic Congress will curtail the nation's free-trade policies. In Slate, Jacob Weisberg identified the new breed of protectionist Lou Dobbs Democrats. "So is America headed for a bout of protectionist class warfare?" worried the Economist. "With the Democrats having won a majority in Congress, and disquiet over globalization growing, a party faction that has been powerless -- the economic populists -- is emerging," Louis Uchitelle wrote in the New York Times. Washington Post columnist Sebastian Mallaby, reflecting the consensus, concluded that "the two parties have opposing attitudes on the subject of trade: Republicans see it as a source of growth, Democrats as a source of inequality."

However, these arguments misunderstand the new politics of trade. It's not a left-right split. Since 2000, Bush Republicans have done as much as Democrats, if not more, to erect trade barriers and tariffs. President Bush has talked a good game about free trade, and his administration has negotiated bilateral free trade agreements with Australia, Colombia, Morocco and several other countries. But just as free trade was a bipartisan project in the 1990s, this decade's anti-trade backlash has been bipartisan as well. Sens. Charles E. Schumer (D-N.Y.) and Lindsey O. Graham (R-S.C.) share little in common besides a desire to slap huge protective tariffs on Chinese goods. And all by themselves, Republicans have done great damage to the cause of free trade in the past several years.

In March 2002, for example, Bush proudly signed "temporary safeguards" that imposed tariffs of 8 percent to 30 percent on most steel imports for three years. This was a classic Karl Rove option play: Advance the Republican cause in formerly Democratic strongholds of Ohio, Pennsylvania and West Virginia at the expense of the companies and workers in industries nationwide that consume steel. When the World Trade Organization ruled the tariffs illegal, and retaliatory tariffs were set to be imposed on goods produced in Florida and other politically sensitive states, Bush ended the so-called safeguards in December 2003.

In May 2002, Bush signed the Farm Security and Rural Investment Act, which Republicans passed without much help from Democrats. Just six years after President Bill Clinton signed the 1996 Farm Bill, which slashed agricultural subsidies, Bush jacked up federal payments by as much as 80 percent ... and offered new subsidies... He even revived ... subsidies ... that Clinton had killed. Bush's signing of this bill led the Economist to brand him just about the worst thing the magazine can call anybody: an anti-globalizer. ...

In fact, some analysts have blamed the failure of the Doha Round of global trade talks this year on the U.S. refusal to alter its expensive anti-consumer, anti-free trade farm policy. There's more. Earlier this year, Bush proposed dropping the absurd 54 cent-per-gallon tariff on imported ethanol, first enacted in 1980 (although he didn't recommend cutting the 51 cent-per gallon tax credit for domestic ethanol producers). The Republican Congress, filled with members from big corn-producing states, said no.

Even as lame ducks, Republicans in Congress haven't been unanimous voices for free trade. In mid-November, more than 60 Republicans voted against a proposed free-trade deal with Vietnam, ... embarrassing the president on the eve of a state visit. The Wall Street Journal noted that a vote had been delayed in part because Graham and fellow GOP Sen. Elizabeth Dole (N.C.) had put the bill on hold, pending measures protecting U.S. textile companies.

With the GOP base now shrunk to the Old Confederacy (sugar, cotton, peanuts) and the Great Plains (corn, wheat, soy), look for more of the same protectionism. Senate Minority Whip-elect Trent Lott (Miss.) doesn't like free trade in agricultural products any more than he likes affirmative action.

There's one other critical Republican failure when it comes to free trade. ... Free trade has exposed U.S. workers to global competition on an unprecedented scale. In recent years, wages have stagnated (despite massive increases in corporate profits and steady economic growth), jobs have become more insecure, and benefits ... are being wiped out. Is free trade the cause of all these woes? Not necessarily. Does free trade coincide with all these woes? Absolutely.

Rightly or wrongly, many Americans, even those who reap the gains of trade daily, identify free trade and globalization with their declining financial security. And the response of Bush and congressional Republicans has essentially been: tough. Companies facing ferocious overseas competition won't provide health care benefits anymore? Open a health savings account. Companies won't provide pensions? Privatize Social Security and cut benefits.

This you're-on-your-own attitude has ultimately been more damaging to the cause of free trade than anything the Democrats could do. Yet, in coming months, we're sure to hear a great deal of talk tarring Sen. Harry M. Reid (Nev.) and Rep. Nancy Pelosi (Calif.) as the present-day incarnations of Sen. Reed Smoot and Rep. Willis C. Hawley, the sponsors of the disastrous Smoot-Hawley Tariff Act of 1930. By slapping massive tariffs on a vast range of imported goods, Smoot-Hawley helped turn a recession into the Great Depression.

But Smoot and Hawley were Republicans. And so was President Herbert Hoover, who signed that disastrous legislation into law. Today, the protectionist gene may no longer be dominant among Republicans, but it's still an important part of the GOP's DNA.


Given recent discussions here, and given that I can't even agree with the claim in the opening sentence that "Predicting financial markets is more of a gamble than traditional economists will admit," I think I'll just present this without further comment:

It's a gamble: UH econophysicists meld science, economics, by Joseph McCauley, Eurekalert: Predicting financial markets is more of a gamble than traditional economists will admit, and making sense of such numbers is more like trying to decipher noise blasting from a loudspeaker, says one University of Houston econophysicist, who leads one of the world's most preeminent groups of its kind.

Joseph McCauley, a UH physics professor with a dual appointment as a senior fellow in the economics department at the National University of Ireland, Galway, leads the UH group. The team's main discovery, backed up by empirically based modeling of market dynamics, is that financial markets are unstable. Associate Professor Kevin Bassler, Professor Gemunu Gunaratne and Professor George Reiter – all of the physics department – round out the UH econophysics group that applies their newly discovered models and methods to solve problems in economics.

McCauley will be the only invited physicist to speak in an economic workshop – "Financial fragility and technological progress with heterogeneous agents and social interactions" – Dec. 14-15 in Trento, Italy. He will weigh in with his perspective on the subjects of macroeconomics (the overall aspects and workings of a national economy) and microfoundations (in which the macroeconomic model is built up from the actions of individual agents).

McCauley and his colleagues contend that a market is made up of "noise" in the strictest mathematical sense of a random and persistent disturbance that obscures clarity. Using techniques developed in physics such as entropy – the study of randomness or disorder – challenges the common belief in economics that market statistics have structure and tend toward equilibrium.

"Traditional economics is based far less on empirical studies than its econophysics counterpart," McCauley said. "For instance, deregulation is an example of economists relying on a belief and not hard analyses. Also, histograms – a traditional economist's tool – do not represent normal distributions. Even Nobel Prize-winning economists approach market statistics with a wrong mathematical model already in mind, and the model always fails. Physics helps us understand the information that goes into these models better."

Gunaratne uses the analogy of a pollen grain being heated up in water to illustrate how the randomness of motion is analogous to what happens in a market. Just as a physicist observes the increase and decrease in the temperature of water as variables that agitate or slow the motion of a pollen grain in an experiment, an econophysicist applies these sorts of principles to other such variables in a financial market. In trying to understand this randomness, he said, it is apparent that markets are not bell-shaped curves with symmetry and normal distribution. Instead, financial markets are more like radio static, but with non-bell-shaped noise, with stock prices continually moving up and down in ways that puzzle standard statisticians.

Focusing primarily on the foreign exchange (FX), a 24-hour-a-day traded world market, McCauley, Gunaratne and Bassler say studying the FX yields better information as the largest, most liquid market that dominates other markets because of its sheer volume and volatility. They model both the market dynamics and option pricing by deducing correct models from real market statistics, which is the opposite of what economists do. Broadening the UH econophysics program, their colleague Reiter focuses more on models of the economy, including production and consumption with results that show how individuals' preferences adapt to economic circumstances, a part of reality he said is missing from standard economic models.

"Whatever the specific focus, this relatively young subfield that merges the two disciplines of physics and economics helps us move toward applicable models for use in analyzing markets and economies more effectively and accurately," Bassler said.

Having established one of only a handful of Ph.D. programs across the globe with a specialization in econophysics, UH's physics department in the College of Natural Sciences and Mathematics has recognized a need for educating physics students in this area since the modeling, analytical and computational skills of physicists are exactly the skills needed to study financial markets and the dynamics of the economy in a practical way.

"We realize this is still met with skepticism in more traditional arenas, but we're convinced econophysics will play the leading role as world economies become increasingly more complex and harder to decipher, and the misleading notion of ‘self-regulating markets' will be slaughtered," McCauley said. "To the extent possible in the social realm, we want to create economic theory as science and avoid the ‘mathematized ideology' – as I've coined it – of mainstream economics that is currently the ideology used in the unregulated free market."

Okay, one comment besides the fact that economics is not the stock market. If the econophysicists have something better to offer, great. I'm listening. But until they do have something better, a little less criticism of the models we use would be appreciated (e.g. "Nobel Prize-winning economists approach market statistics with a wrong mathematical model already in mind, and the model always fails. Physics helps us understand..."). Because when your "main discovery, backed up by empirically based modeling of market dynamics, is that financial markets are unstable," I'm not sure that a condescending attitude has yet been earned.

Get Smart?

Alice Amsden of MIT has a plan to "lift countries out of poverty" using "the 'get smart' approach taken by Franklin Roosevelt and his political heirs through the Kennedy-Johnson years.":

Economist portrays a new Democratic moment, by Ruth Walker, MIT News Office: Alice Amsden sounds like a latter-day New Dealer, or maybe a Kennedyesque New Frontierswoman, when she talks about the foreign policy options facing the new Democratic Congress. ...

Amsden clearly hopes the new Congress will move to foster the kind of economic growth in the developing world that will fight terrorism by depriving it of oxygen. That means allowing developing countries to deviate, in some instances, from free-market orthodoxy in order to protect and support fledgling industries.

She's calling on the Democratic Party to "redefine laissez-faire," from "do it our way" to "do it your way" and stand up to the banking industry, whose interests U.S. economic policy generally serves, she maintains.

She also suggests that African countries band together into a cartel--or something very much like it--to get better, fairer prices for the minerals that make up so much of their wealth. If the nations of Africa can't come up with something like OPEC to stand up to foreign owners of mines and plantations, political instability and violence there are bound to get worse, she projects.

Amsden ... describes two approaches to international economic development Washington has taken over the past several decades. Only one of them has actually helped develop international economies, according to Amsden.

She contends that what has really worked to lift countries out of poverty is the "get smart" approach taken by Franklin Roosevelt and his political heirs through the Kennedy-Johnson years.

The other approach is the "get tough" stance of Ronald Reagan and the free-market absolutists around him, always eager to force foreign markets open to American goods.

"It's funny how free trade comes with so many strictures," she observes in an interview. "'You must do this! You must do that!'"

To buttress her argument that the earlier approach was more effective, she produces a very simple bar chart based on World Bank data and labeled "Growth in Income 1950-1980 and 1980-2000." As a whole, economies, both developing and developed, grew much faster in the earlier period, the chart suggests.

"No one wants to know about these early growth rates," Amsden says. Some might see simply the effects of the postwar reconstruction boom playing out, but Amsden sees policy choices at work.

In that earlier period, the United States was "a country for experiment," Amsden says, borrowing a phrase from President Kennedy's close adviser, Arthur Schlesinger Jr.

During that period, "Washington funded research for a Green Revolution that raised farmers' rice yields from the Philippines to Pakistan," she says. The United States supported land reforms in Japan that were emulated in Korea and Taiwan. This helped equalize national incomes and encourage higher savings, she explains.

Successive Washington administrations were so focused on the Cold War that reliably noncommunist allies were allowed a little slack--even by President Nixon--on development policy.

One of the policies they pursued was one she champions today as a development tool: import substitution. This enabled former colonies to start producing their own versions of products they once imported, and "upskill" the jobs of their workers.

All these policies, and Washington's support of them, add up to what Amsden calls a "get smart" approach.

It led to a global boom that abruptly shut down at the time of the global debt crisis of 1982, she says. She calls Paul Volcker, chair of the Federal Reserve at that time, "a great guy," but says that he "pulled the plug on prosperity" around the world.

The three developing countries that survived this shock--China, India and Taiwan--were countries that had notably not opened their financial markets, Amsden says.

While I agree that the Washington consensus ("get tough") has not worked they way advocates promised it would and that a new approach is needed, I can't endorse some of the specific remedies suggested here as the "get smart" alternative. The evidence that, for example, import-substitution policies spurred growth is mixed at best and these policies are "now universally scorned." [See also "A case for import substitution?" by Arvind Panagariya of Columbia University.]

Looking for Risk in All the Wrong Places

How we get snookered by our fears and by those who exploit them:

Why We Worry About The Things We Shouldn't... ...And Ignore The Things We Should, by Jeffrey Kluger, Time: It would be a lot easier to enjoy your life if there weren't so many things trying to kill you every day. ... There's the fall out of bed that kills 600 Americans each year. ... Will a cabbie's brakes fail when you're in the crosswalk? Will you have a violent reaction to bad food? And what about the ... father and grandfather who died of coronaries in their 50s probably passed the same cardiac weakness on to you. ...

Shadowed by peril as we are, you would think we'd get pretty good at distinguishing the risks likeliest to do us in from the ones that are statistical long shots. But you would be wrong. ... We pride ourselves on being the only species that understands the concept of risk, yet we have a confounding habit of ... building barricades against perceived dangers while leaving ourselves exposed to real ones. ...

Sensible calculation of real-world risks is a multidimensional math problem that sometimes seems entirely beyond us. And while it may be true that it's something we'll never do exceptionally well, it's almost certainly something we can learn to do better.


Part of the problem we have with evaluating risk, scientists say, is that we're moving through the modern world with what is, in many respects, a prehistoric brain. We may think we've grown accustomed to living in a predator-free environment in which most of the dangers of the wild have been driven away..., but our central nervous system--evolving at a glacial pace--hasn't got the message.

To probe the risk-assessment mechanisms of the human mind, Joseph LeDoux, a professor of neuroscience at New York University .., studies fear pathways in laboratory animals. He explains that the jumpiest part of the brain--of mouse and man--is the amygdala... When you spot potential danger--a stick in the grass that may be a snake, a shadow around a corner that could be a mugger--it's the amygdala that reacts the most dramatically, triggering the fight-or-flight reaction that pumps adrenaline and other hormones into your bloodstream.

It's not until a fraction of a second later that the higher regions of the brain get the signal and begin to sort out whether the danger is real. But that fraction of a second causes us to experience the fear far more vividly than we do the rational response...

"There are two systems for analyzing risk: an automatic, intuitive system and a more thoughtful analysis," says Paul Slovic, professor of psychology at the University of Oregon. "Our perception of risk lives largely in our feelings, so most of the time we're operating on system No. 1."

There's clearly an evolutionary advantage to this natural timorousness. If we're mindful of real dangers and flee when they arise, we're more likely to live long enough to pass on our genes. But evolutionary rewards also come to those who stand and fight, those willing to take risks--and even suffer injury--in pursuit of prey or a mate. ...

These two impulses--to engage danger or run from it--are constantly at war and have left us with a well-tuned ability to evaluate the costs and payoffs of short-term risk... That, however, is not the kind we tend to face in contemporary society, where threats don't necessarily spring from behind a bush. They're much more likely to come to us in the form of rumors or news broadcasts or an escalation of the federal terrorism-threat level from orange to red. It's when the risk and the consequences of our response unfold more slowly ... that our analytic system kicks in. This gives us plenty of opportunity to overthink--or underthink--the problem, and this is where we start to bollix things up.


Which risks get excessive attention and which get overlooked depends on a hierarchy of factors. Perhaps the most important is dread. .... The more pain or suffering something causes, the more we tend to fear it; the cleaner or at least quicker the death, the less it troubles us. "We dread anything that poses a greater risk for cancer more than the things that injure us in a traditional way, like an auto crash," says Slovic. "That's the dread factor." In other words, the more we dread, the more anxious we get, and the more anxious we get, the less precisely we calculate the odds of the thing actually happening...

We also dread catastrophic risks, those that cause the deaths of a lot of people in a single stroke, as opposed to those that kill in a chronic, distributed way. "Terrorism lends itself to excessive reactions because it's vivid and there's an available incident," says Sunstein. "Compare that to climate change, which is gradual and abstract."

Unfamiliar threats are similarly scarier than familiar ones. The next E. coli outbreak is unlikely to shake you up as much as the previous one, and any that follow will trouble you even less. In some respects, this is a good thing, particularly if the initial reaction was excessive...

The problem with habituation is that it can also lead us to go to the other extreme, worrying not too much but too little. Sept. 11 and Hurricane Katrina brought calls to build impregnable walls against such tragedies ever occurring again. But despite the vows, both New Orleans and the nation's security apparatus remain dangerously leaky. "People call these crises wake-up calls," says Dr. Irwin Redlener, ... director of the National Center for Disaster Preparedness. "But they're more like snooze alarms. We get agitated for a while, and then we don't follow through."


We similarly misjudge risk if we feel we have some control over it, even if it's an illusory sense. The decision to drive instead of fly is the most commonly cited example, probably because it's such a good one. ... The most white-knuckle time of all was post--Sept. 11, when even confident flyers took to the roads. Not surprisingly, from October through December 2001 there were 1,000 more highway fatalities than in the same period the year before... "It was called the '9/11 effect.' It produced a third again as many fatalities as the terrorist attacks," says David Ropeik, an independent risk consultant..

Then too there's what Ropeik and others call "optimism bias," the thing that makes us glower when we see someone driving erratically while talking on a cell phone, even if we've done the very same thing, perhaps on the very same day. We tell ourselves we're different... What optimism bias comes down to, however, is the convenient belief that risks that apply to other people don't apply to us.

Finally, and for many of us irresistibly, there's the irrational way we react to risky behavior that also confers some benefit. It would be a lot easier to acknowledge the perils of smoking cigarettes or eating too much ice cream if they weren't such pleasures. ... This is especially true since, in most cases, the gratification is immediate and the penalty, if it comes at all, comes later. With enough time and enough temptation, we can talk ourselves into ignoring almost any long-term costs. ...

If these reactions are true for all of us--and they are--then you might think that all of us would react to risk in the same way. But that's clearly not the case. ... Some skydive; others can't imagine it. Not only are thrill seekers not put off by risk, but they're drawn to it... "There's an internal thermostat that seems to control this," says risk expert John Adams of University College London. "That set point varies from person to person and circumstance to circumstance."

No one knows how such a set point gets calibrated, but ... findings support the estimate that about 40% of the high-thrill temperament is learned and 60% inherited...


Given these idiosyncratic reactions, is it possible to have a rational response to risk? ... One way to start would to be to look at the numbers. Anyone can agree that a 1-in-1 million risk is better than 1 in 10, and 1 in 10 is better than 50-50. But things are almost always more complicated than that, a fact that corporations, politicians and other folks with agendas to push often deftly exploit.

Take the lure of the comforting percentage. In one study, Slovic found that people were more likely to approve of airline safety-equipment purchases if they were told that it could "potentially save 98% of 150 people" than if they were told it could "potentially save 150 people." On its face this reaction makes no sense, since 98% of 150 people is only 147. But there was something about the specificity of the number that the respondents found appealing...

There's also the art of the flawed comparison. Officials are fond of reassuring the public that they run a greater risk from, for example, drowning in the bathtub, which kills 320 Americans a year, than from a new peril like mad cow disease, which has so far killed no one in the U.S. That's pretty reassuring--and very misleading. The fact is that anyone over 6 and under 80--which is to say, the overwhelming majority of the U.S. population--faces almost no risk of perishing in the tub. ...

Risk figures can be twisted in more disastrous ways too. Last year's political best seller, The One Percent Doctrine, by journalist Ron Suskind, ... hit risk analysts where they live. The title of the book is drawn from a White House determination that if the risk of a terrorist attack in the U.S. was even 1%, it would be treated as if it were a 100% certainty. Critics of Administration policy argue that that 1% possibility was never properly balanced against the 100% certainty of the tens of thousands of casualties that would accompany a war. That's a position that may be easier to take in 2006, with Baghdad in flames and the war grinding on, but it's still true that a 1% danger that something will happen is the same as a 99% likelihood that it won't.


It's not impossible for us to become sharper risk handicappers. For one thing, we can take the time to learn more about the real odds. ... We can do better, ... and leaders in government and industry can help. The residual parts of our primitive brains may not give us any choice beyond fighting or fleeing. But the higher reasoning we've developed over millions of years gives us far greater--and far more nuanced--options. Officials who provide hard, honest numbers and a citizenry that takes the time to understand them would not only mean a smarter nation, but a safer one.

Paul Krugman: Economic Storm Signals

Paul Krugman senses trouble ahead:

Economic Storm Signals, by Paul Krugman, Tough 2007, Commentary, NY Times: “It’s tough to make predictions,” Yogi Berra is supposed to have said, “especially about the future.” Actually, his remark makes perfect sense to economists, who sometimes have trouble making predictions about the present. And this is one of those times ... economists’ assessments of the current state of the U.S. economy, never mind the future, are all over the place.

And here’s the bad news: this kind of confusion about what’s going on is what typically happens when the economy is at a turning point... At turning points, the various indicators ... often point in different directions, so that both optimists and pessimists can find data to support their position.

The last time things were this confused was early in 2001, when most economists failed to realize that the United States was sliding into recession. If that sounds ominous, it should: the bond market, which has a pretty good record of forecasting recessions, is pointing toward a serious economic slowdown next year.

Before I explain what the bond market is telling us, let’s talk about why the economy may be at a turning point. Between mid-2003 and mid-2006, economic growth in the United States was fueled mainly by a huge housing boom... That housing boom has now gone bust. But the optimists and pessimists disagree both about how bad the bust will get and about how much damage the housing slump will do to the economy...

Most, though not all, of the ... economic numbers that came out this week were ... substantially weaker than expected. Pessimists feel vindicated by the downbeat data. Nouriel Roubini..., who has been forecasting a housing-led recession for some time, ... predicts zero growth for the current quarter. Economists at Deutsche Bank say the same thing.

But that’s still a minority position; most forecasters are still telling us not to worry. So whom should you listen to? And how can you avoid believing what you want to believe?

Maybe the best answer is to look at what the financial markets say. Not the stock market, which is a notoriously bad indicator of the economy’s direction, but the bond market. (Paul Samuelson, the Nobel Prize-winning ... economist, famously quipped that the stock market had predicted nine of the last five recessions).

Since last summer, when the housing bust became unmistakable, interest rates on long-term bonds have fallen sharply. They’re now yielding much less than short-term bonds. The fact that investors are willing to buy those long-term bonds anyway tells us that these investors expect interest rates to fall. And that will happen only if the economy weakens, forcing the Federal Reserve to cut rates. So bond buyers are, in effect, betting on a future economic slowdown.

How serious a slump is the bond market predicting? Pretty serious. Right now, statistical models ... give roughly even odds that we’re about to experience a formal recession. And since even a slowdown that doesn’t formally qualify as a recession can lead to a sharp rise in unemployment, the odds are very good — maybe 2 to 1 — that 2007 will be a very tough year.

Luckily, we’ve got good leadership for the coming economic storm: the White House is occupied by a man who’s ideologically flexible, listens to a wide variety of views, and understands that policy has to be based on careful analysis, not gut instincts. Oh, wait.

Previous (11/24) column: Paul Krugman: When Votes Disappear
Next (12/4) column: Paul Krugman: Two More Years

Democrats versus Drug Companies

Robert Reich wonders if Democrats will be able to stand up to Big Pharma and allow Medicare to negotiate lower drug prices with drug companies:

A Test Case for the Dems: Big Pharma or Medicare Bargaining for Lower Drug Prices, by Robert Reich: When I worked in Washington, the biggest lobby – after Big Oil, and the big military contractors – was the big pharmaceutical companies – Big Pharma. Early in the Bush administration Big Pharma pushed the new Medicare drug benefit through Congress, releasing a $600 billion dollar gusher in their direction. The bill included a guarantee that Medicare wouldn’t use its huge bargaining leverage to negotiate lower prices with the drug companies – an extra bonus. If this isn’t corporate welfare, I don’t know what is.

Nancy Pelosi has announced that one of the Dems first priorities ("first hundred hours") would be to end this ban and have Medicare use its bargaining clout to get lower drug prices for seniors. But Big Pharma is already on the attack. ...

The only thing that might stop the new Congress from going through with this sensible plan is huge bargaining power of a different kind. I'm talking now about politics. Because when it comes to campaign contributions and Washington lobbyists, Big Pharma has more bargaining clout than almost anyone. It has already lined up former Democratic congressmen and officeholders to lobby their old colleagues. And it’s showering the Hill with money. Already Max Baucus, the upcoming head of the Senate Finance Committee, is expressing doubts about the new Democratic plan.

Watch this one closely. Will Pelosi pull it off in the "first hundred hours?" This will be a major test case of whether Dems are willing to stand up to one of the truly powerful Washington lobbies.

How Independent Was the Committee on Capital Markets Regulation?

Yesterday, a report was released detailing the ways in which recent regulation may have harmed the ability of U.S. firms to compete with foreign firms. Here's a typical account:

Panel Urges Relaxing Rules For Oversight, Greg Ip, Kara Scannell, and Deborah Solomon, WSJ: A blue-ribbon committee on financial regulation has called for better protection of auditors, company employees and outside directors from authorities and lawsuits, as well as less-detailed rule-making and lower-key investigations.

The Committee on Capital Markets Regulation's report, to be released publicly today, is one of the most high-profile efforts to date to address concerns that excessive regulation -- much of it a response to recent corporate scandals -- is adding to corporate costs, stifling the public securities markets and causing the U.S. markets to lose business to foreign competitors.

"The United States is losing its leading competitive position," the 148-page report says. One reason is "the growth of U.S. regulatory compliance costs and liability risk." ...

The report makes 32 recommendations, of which six relate to easing the application of Section 404 of the 2002 Sarbanes-Oxley Act governing internal company-financial controls. The SEC already plans to present new guidance on section 404 on Dec. 13. Companies have complained that the section is expensive and onerous to implement.

Other recommendations call for setting a higher bar for regulators or private litigants to go after outside auditors, independent directors and company employees, especially when they act in good faith. It also recommends Congress cap auditors' liabilities, as some European countries do. ...

I haven't had the time to study these proposals yet, so I can't say a lot about them (please comment if you can help here). However, typical of this administration, it pays to find out who is behind the report to expose potential biases:

Report on Corporate Rules Is Assailed, by Carrie Johnson, Washington Post: Investor groups sounded alarms yesterday after it emerged that a foundation with ties to a pair of well-heeled business donors and an executive battling civil charges had funded a controversial new report seeking to slash corporate regulation.

The Committee on Capital Markets Regulation, which argues that U.S. markets are suffering under overzealous enforcement and unwieldy rules, said it received $500,000 in financial support from the C.V. Starr Foundation. The charity has longstanding ties to Maurice R. "Hank" Greenberg, the former American International Group chief who was ousted from his post last year and is contesting civil charges filed by the New York attorney general.

Two committee members, Wilbur L. Ross Jr., a private investor, and Citadel Investment Group manager Kenneth C. Griffin, contributed "a few hundred thousand dollars" more, Ross said in an interview. The panel was formed this year with support from Treasury Secretary Henry M. Paulson Jr., a former chairman of the Wall Street firm Goldman Sachs.

The lengthy report released yesterday recommended that businesses and boards of directors get increased protection from private lawsuits. Panel members also urged Congress to curtail the power of state officials to charge financial and audit firms with crimes. Businesses should face criminal charges only as a "last resort," the study says.

Consumer advocates seized on the issue to question the study's conclusions and the motives of the panel's members, who include top executives from some of the nation's largest accounting and investment firms as well as people with close ties to the Bush administration. ...

The group's 32 recommendations include rethinking the mission of the Securities and Exchange Commission to make it less antagonistic to business... SEC commissioner Roel Campos, a Democrat, warned yesterday that rolling back a system of regulation that has protected U.S. investors for decades could have profound and costly consequences if it went too far. ...

Barbara Roper, director of investor protection at the Consumer Federation of America, went even further, asserting that the capital markets group had preordained its conclusions and carefully selected statistics to make its case that more companies were listing their stocks on foreign markets because of burdensome U.S. rules.

"You could take every single step on their list, and when you were done, you would have done nothing to reverse recent trends, and in the meantime you would have made it significantly more difficult to hold corporate criminals accountable for their crimes," Roper said.

R. Glenn Hubbard, the former leader of President Bush's Council of Economic Advisers who co-chaired the capital markets panel, told reporters that "this commission was entirely independent of any donor." ...

The members of the capital markets committee were tilted more toward industry rather than investor advocates. "Where are the people who represent institutional and individual investors?" said Duke University securities law professor James D. Cox. "I see this as a very pro-executive position, well intentioned but misguided."...

Update: Brad DeLong's sidebar says this is worth reading:

Summers Challenges Paulson Campaign, WSJ Washington Wire: Larry Summers, the former Clinton Treasury secretary, challenges the campaign led by today’s Treasury secretary, Henry Paulson, to ease up on regulation to help U.S. financial markets and Wall Street firms do better in global competition, particularly with London. Responding to this week’s report by the private-sector Committee on Capital Markets Regulation, Summers tells The Wall Street Journal: “Some of the specific suggestions are valuable, but the approach goes wrong in focusing so heavily on competitiveness when there is also much that needs to be done to better protect investors and assure the integrity of those who oversee and manage America’s largest corporations.”

“I hope the Bush administration,” he adds, “will focus as intensely on helping the American manufacturing, American agriculture and American health-care industries as it is on this particular aspect of financial services.”

New York Governor-elect (and current Attorney General) Spitzer blasted the report. “The logic of their argument and the facts they rely upon are wrong,” Spitzer says. Moreover, the proposals seek to reign in state prosecutors who pursue fraud and who stepped in “when the SEC was doing nothing.”

Methodological Issues in Economics

Continuing a recent conversation on methodological issues within economics, this is part of a much longer article "The Philosophy of Economics" from The Stanford Encyclopedia of Philosophy. It was written by Daniel M. Hausman:

2. Six central methodological problems

Although the different branches and schools of economics raise a wide variety of methodological issues, six problems have been central to methodological reflection concerning economics:

2.1 Positive versus normative economics

Policy makers look to economics to guide policy, and it seems inevitable that even the most esoteric issues in theoretical economics may bear on some people's material interests. The extent to which economics bears on and may be influenced by normative concerns raises methodological questions about the relationships between a positive science concerning “facts” and a normative inquiry into what ought to be. Most economists and methodologists believe that there is a reasonably clear distinction between facts and values, between what is and what ought to be, and they believe that most of economics should be regarded as a positive science that helps policy makers choose means to accomplish their ends, though it does not bear on the choice of ends itself.

This view is questionable for several reasons. First economists have to interpret and articulate the incomplete specifications of goals and constraints provided by policy makers (Machlup 1969b). Second, economic “science” is a human activity, and like all human activities it is governed by values. Those values need not be the same as the values that influence economic policy, but it is questionable whether the values that govern the activity of economists can be sharply distinguished from the values that govern policy makers. Third, much of economics is built around a normative theory of rationality. One can question whether the values implicit in such theories are sharply distinguishable from the values that govern policies. For example, it may be difficult to hold a maximizing view of individual rationality, while at the same time insisting that social policy should resist maximizing growth, wealth, or welfare in the name of freedom, rights, or equality. Fourth, people's views of what is right and wrong are, as a matter of fact, influenced by their beliefs about how people in fact behave. There is evidence that studying theories that depict individuals as self-interested leads people to regard self-interested behavior more favorably and to become more self-interested (Marwell and Ames 1981, Frank et al. 1993). Finally, people's judgments are clouded by their interests. Since economic theories bear so centrally on people's interests, there are bound to be ideological biases at work in the discipline (Marx 1867, Preface).

2.2 Reasons versus causes

Orthodox theoretical microeconomics is as much a theory of rational choices as it a theory that explains and predicts economic outcomes. Since virtually all economic theories that discuss individual choices take individuals as acting for reasons, and thus in some way rational, questions about the role that views of rationality and reasons should play in economics are of general importance. Economists are typically concerned with the aggregate results of individual choices rather than with particular individuals, but their theories in fact offer both causal explanations for why individuals choose as they do and accounts of the reasons for their choices.

Explanations in terms of reasons have several features that distinguish them from explanations in terms of causes. Reasons justify the actions they explain. Reasons can be evaluated, and they are responsive to criticism. Reasons, unlike causes, must be intelligible to those for whom they are reasons. On grounds such as these, many philosophers have questioned whether explanations of human action can be causal explanations (von Wright 1971, Winch 1958). Yet merely giving a reason — even an extremely good reason — fails to explain an agent's action, if the reason was not in fact “effective.” Someone might, for example, start attending church regularly and give as his reason a concern with salvation. But others might suspect that this agent is deceiving himself and that the minister's attractive daughter is in fact responsible for his renewed interest in religion. Donald Davidson (1963) argued that what distinguishes the reasons that explain an action from the reasons that fail to explain it are that the former are also causes of the action. Although the account of rationality within economics differs in some ways from the “folk psychology" people tacitly invoke in everyday explanations of actions, many of the same questions carry over (Rosenberg 1976, ch. 5; 1980).

An additional difference between explanations in terms of reasons and explanations in terms of causes, which some economists have emphasized, is that the beliefs and preferences that explain actions may depend on mistakes and ignorance (Knight 1935). As a first approximation, economists can abstract from such difficulties. They thus often assume that people have perfect information about all the relevant facts. In that way theorists need not worry about what people's beliefs are. By assumption people believe and expect whatever the facts are. But once one goes beyond this first approximation, difficulties arise which have no parallel in the natural sciences. Choice depends on how things look “from the inside", which may be very different from the actual state of affairs. Consider for example the stock market. The “true” value of a stock depends on the future profits of the company, which are of course uncertain. In 1999 and 2000 stock prices were far above any plausible estimate of their true value. But what matters, at least in the short run, is what people believe. No matter how overpriced shares might be, they were excellent investments if tomorrow or next month somebody would be willing to pay even more for them. Economists disagree about how significant this subjectivity is. Members of the Austrian school argue that these differences are of great importance and sharply distinguish theorizing about economics from theorizing about any of the natural sciences (Buchanan and Vanberg 1989, von Mises 1981).

2.3 Social scientific naturalism

Of all the social sciences, economics most closely resembles the natural sciences. Economic theories have been axiomatized, and articles and books of economics are full of theorems. Of all the social sciences, only economics boasts a Nobel Prize. Economics is thus a test case for those concerned with the extent of the similarities between the natural and social sciences. Those who have wondered whether social sciences must differ fundamentally from the natural sciences seem to have been concerned mainly with three questions:

(i) Are there fundamental differences between the structure or concepts of theories and explanations in the natural and social sciences? Some of these issues were already mentioned in the discussion above of reasons versus causes.

(ii) Are there fundamental differences in goals? Philosophers and economists have argued that in addition to or instead of the predictive and explanatory goals of the natural sciences, the social sciences should aim at providing us with understanding. Weber and others have argued that the social sciences should provide us with an understanding “from the inside", that we should be able to empathize with the reactions of the agents and to find what happens “understandable” (Weber 1904, Knight 1935, Machlup 1969a). This (and the closely related recognition that explanations cite reasons rather than just causes) seems to introduce an element of subjectivity into the social sciences that is not found in the natural sciences.

(iii) Owing to the importance of human choices (or perhaps free will), are social phenomena too “irregular” to be captured within a framework of laws and theories? Given human free will, perhaps human behavior is intrinsically unpredictable and not subject to any laws. But there are, in fact, many regularities in human action, and given the enormous causal complexity characterizing some natural systems, the natural sciences must cope with many irregularities, too.

2.4 Abstraction, idealization, and ceteris paribus clauses in economics

Economics raises questions concerning the legitimacy of severe abstraction and idealization. For example, mainstream economic models often stipulate that everyone is perfectly rational and has perfect information or that commodities are infinitely divisible. Such claims are exaggerations, and they are clearly false. Other schools of economics may not employ idealizations that are this extreme, but there is no way to do economics if one is not willing to simplify drastically and abstract from many complications. How much simplification, idealization, and abstraction is legitimate?

In addition, because economists attempt to study economic phenomena as constituting a separate domain, influenced only by a small number of causal factors, the claims of economics are true only ceteris paribus — that is, they are true only if there are no interferences or disturbing causes. What are ceteris paribus clauses, and when if ever are they legitimate in science? Questions concerning ceteris paribus clauses are closely related to questions concerning simplifications and idealizations, since one way to simplify is to suppose that the various disturbing causes or interferences are inactive and to explore the consequences of some small number of causal factors. These issues and the related question of how well supported economics is by the evidence have been the central questions in economic methodology. They will be discussed further below in Section 3 and elsewhere.

2.5 Causation in economics and econometrics

Many important generalizations in economics are causal claims. For example, the law of demand asserts that a price increase will (ceteris paribus) diminish the quantity demanded. Econometricians have also been deeply concerned with the possibilities of determining causal relations from statistical evidence and with the relevance of causal relations to the possibility of consistent estimation of parameter values. Since concerns about the consequences of alternative policies are so central to economics, causal inquiry is unavoidable.

Before the 1930s, economists were generally willing to use causal language explicitly and literally, despite some concerns that there might be a conflict between causal analysis of economic changes and “comparative statics” treatments of equilibrium states. Some economists were also worried that thinking in terms of causes was not compatible with recognizing the multiplicity and mutuality of determination in economic equilibrium. In the anti-metaphysical intellectual environment of the 1930s and 1940s (of which logical positivism was at least symptomatic), any mention of causation became highly suspicious, and economists commonly pretended to avoid causal concepts. The consequence was that they ceased to reflect carefully on the causal concepts that they continued implicitly to invoke (Hausman 1983, 1990, Helm 1984, Runde 1998). For example, rather than formulating the law of demand in terms of the causal consequences of price changes for quantity demanded, economists tried to confine themselves to discussing the mathematical function relating price and quantity demanded. There were important exceptions (Haavelmo 1944, Simon 1953, Wold 1954), and during the past generation, this state of affairs has changed dramatically.

For example, in his Causality in Macroeconomics (2001) Kevin Hoover develops feasible methods for investigating large scale causal questions, such as whether changes in the money supply (M) cause changes in the relate of inflation P or accommodate changes in P that are otherwise caused. If changes in M cause changes in P, then the conditional distribution of P on M should remain stable with exogenous changes in M, but should change with exogenous changes in P. Hoover argues that historical investigation, backed by statistical inquiry, can justify the conclusion that some particular changes in M or P have been exogenous. One can then determine the causal direction by examining the stability of the conditional distributions. Econometricians have made vital contributions to the contemporary revival of philosophical interest in the notion of causation. In addition to Hoover's work, see for example Geweke (1982), Granger (1969, 1980), Cartwright (1989), Sims (1977), Zellner and Aigner (1988).

2.6 Structure and strategy of economics

In the wake of the work of Kuhn (1970) and Lakatos (1970), philosophers are much more aware of and interested in the larger theoretical structures that unify and guide research within particular research traditions. Since many theoretical projects or approaches in economics are systematically unified, they pose questions about what guides research, and many economists have applied the work of Kuhn or Lakatos to shed light on the overall structure of economics (Baumberg 1977, Blaug 1976, Blaug and de Marchi 1991, Bronfenbrenner 1971, Coats 1969, Dillard 1978, Hands 1985b, Hausman 1992, ch. 6, Hutchison 1978, Latis 1976, Jalladeau 1978, Kunin and Weaver 1971, Stanfield 1974, Weintraub 1985, Worland 1972). Whether these applications have been successful is controversial, but the comparison of the structure of economics to Kuhn's and Lakatos' schema has at least served to highlight distinctive features of economics. For example, asking what the “positive heuristic” of mainstream economics consists in permits one to see that mainstream models typically attempt to demonstrate that an economic equilibrium will obtain, and thus that mainstream models are unified in more than just their common assumptions. Since the success of research projects in economics is controversial, understanding their global structure and strategy may clarify their drawbacks as well as their advantages.

Ray Fair: Interpreting the Predictive Uncertainty of Presidential Elections

A colleague emails to let me know about a new paper on presidential elections by Ray Fair (thanks Jeremy). The paper, which is forthcoming in the Journal of Political Economy, looks at the problem of determining the degree of uncertainty in predictions of election outcomes and argues that the standard errors released along with traditional polling data miss "an important type of predictive uncertainty..." Fortunately, the uncertainty "can be estimated using data from political betting markets." To adopt this betting market approach, the paper imposes a ranking assumption (explained below) to restrict the number of possible admissible outcomes. The paper then shows that if this assumption is correct, and there is empirical evidence from betting markets provided in support of the assumption, it implies that political parties "should spend all their money on a few states, which seems consistent with their actual behavior." So now you'll know why your state was either skipped or bombarded with advertising last presidential election:

Interpreting the Predictive Uncertainty of Presidential Elections, by Ray C. Fair, September 2006, International Center for Finance, Yale University, WP No. 06-25, Cowles Foundation, WP 1579: 1 Introduction A common way of assessing the uncertainty of election predictions is to use the standard errors that are released by polling organizations. Almost all polling organizations release both a mean prediction and a standard error of the mean prediction. This paper argues that there is an important type of predictive uncertainty that is not captured by these standard errors and that can be estimated using data from political betting markets. Section 2 presents this argument and uses data from the Intrade[1] political betting market to provide estimates. The idea is that there are a number of possible "states" or "conditions" of nature that can exist on election day, of which one is drawn on election day. The uncertainty is which condition will be drawn.

A "ranking" assumption about dependencies across U.S. states is presented in Section 3 that greatly restricts the possible conditions of nature than can exist on election day. ... As restrictive as this assumption seems, it will be seen that the assumption is strongly supported by the Intrade data. Section 4 is concerned with the question of how the two political parties should behave regarding campaign spending across states if the ranking assumption is correct. They should spend all their money on a few states, which seems consistent with their actual behavior. This result is contrary to results in the literature that are based on the assumption of independence across states, where there is some spending in all states.

2 Predictive Uncertainty

Conditions of Nature on Election Day A standard error from a poll measures sampling uncertainty. The larger the sample size, the smaller the standard error. Consider for sake of argument that every eligible voter in a state was asked the day before the election whether he or she was planning to vote and for whom. This would yield a mean vote share with a standard error of zero.[2] On this score, there would be no uncertainty left. The argument here is that there is still uncertainty...

There are many reasons people might do something different on election day than they told the pollster on, say, the day before the election they would do. The weather may be different than they expected, which may affect their decision on whether to vote. They or family members may wake up ill or cranky, which may change their decision to vote or for whom to vote. They may have lied to the pollster and voted for a different candidate than they said they would. They may have changed their mind as they were in route to the voting booth, perhaps because they had not thought much about the election until then or because of a conversation they had a few hours before with someone they trusted. Reasons like these have been advanced many times in discussions of polling results, and the main point here is simply that they may pertain even on the day of the election. This type of uncertainty would not be captured even with a poll of every eligible voter on the day before the election. ...

Measurement Using Intrade Data It should be clear that polling data cannot be used to measure the type of uncertainty that is the concern of this paper. This uncertainty exists even if there is no sampling error. Fortunately, political betting markets do provide a way of measuring this uncertainty. ...

3 The Ranking Assumption: A Restriction on the Possible Conditions of Nature

The Ranking Assumption The ranking assumption is easy to describe. Rank the states by pi [the market's assessment of the probability that a particular candidate, e.g. Bush, will win state i] ... using the Intrade data. The assumption is then that there is no condition of nature in which Bush wins state i and loses a state ranked higher than i. If, for example, Texas is ranked higher than Massachusetts, then in none of the n conditions of nature does Bush win Massachusetts and lose Texas. There may be conditions in which Bush wins Massachusetts (Kerry makes some serious error), but in these conditions Bush also wins Texas.[5] It is common in previous work to assume some form of independence. ... [footnote 5: Ed Kaplan has pointed out to me that given a ranking like in Table 1, under the ranking assumption there are only 52 possible outcomes... This compares to 251 possible outcomes, about 2.25 million billion. A remarkable economy of outcomes has been achieved by the ranking assumption!] ...

The ranking assumption does not, of course, directly concern different sets of the n possible conditions of nature. It simply puts restrictions on the n possible conditions of nature that exist on election day. If state i is ranked ahead of state j, then in no condition of nature does Bush win j and lose i. The concept of different sets of the n possible conditions of nature is not needed.

The Ranking Assumption and the Intrade Data It will now be seen that the ranking assumption is strongly supported by the Intrade data. ...

5 Conclusion This paper has argued that there is an important type of election predictive uncertainty not captured by polling standard errors. It can be measured using prices from political betting markets...

The ranking assumption puts severe restrictions on the possible conditions of nature than can exist on election day, but it is supported by the Intrade data ... and by the actual outcome of the 2004 election. It will be interesting to see how it does in the 2008 election.

If the ranking assumption is correct, the stochastic simulation results in Section 4 show that the two political parties should spend only in a few states. The larger the variance of the estimation errors, the larger is the number of states in play, although even for large variances the number of states in play is small.

North Korea: Engage or Isolate?

Martin Wolf says we need discard the Bush foreign policy doctrine and start again:

Tear up the Bush doctrine, by Martin Wolf, Commentary, Financial Times: US voters have now repudiated those who sought to impose democracy by force abroad. ... George W. Bush is still president. But he is damaged political goods. That is good, because change is desperately needed.

The signal feature of this administration has not been merely its incompetence, but its rejection of the principles on which US foreign policy was built after the second world war. The administration’s strategy has been based, instead, upon four ideas: the primacy of force; the preservation of a unipolar order; the unbridled exercise of US power; and the right to initiate preventive war in the absence of immediate threats.

The response to the terrorist outrage of September 11 2001 reinforced the hold of all these principles. The notion of an indefinite and unlimited “war on terror” became the fulcrum of US foreign policy. It led to the idea of an “axis of evil” connecting Saddam Hussein’s Iraq to theocratic Iran and Kim Jong-il’s North Korea. It brought about the justified invasion of Afghanistan, but also the diversion into Iraq. Not least, the idea of the war on terror led to the indefinite imprisonment of alleged enemy combatants without judicial oversight, toleration of torture, “extraordinary rendition” of suspects, the extra-territorial prison at Guantánamo Bay and, by indirect means, the abuses at Abu Ghraib. ...

The US must now start again. It must design a foreign policy for the current age. In doing so, it should discard almost everything the Bush administration has proclaimed. ...

Here's one idea for North Korea from the comments at Martin Wolf's Economist's Forum:

Monty Graham: Martin Wolf is of course right - US foreign policy under the Presidency of George W. Bush, largely driven by the ideology of so-called “neo-conservatives”, has been one enormous fiasco, one whose repercussions are likely to reach quite a long time into the future. The urgent question of the moment is, how does one go about reversing this fiasco? ...

Let me make one modest and specific proposal for a reversal of US policy that affects one of the countries designated by Bush as part of the “Axis of Evil”; this country is North Korea. In the on-going negotiations between the US and South Korea to create a free trade agreement between the two countries, a demand by the South Korea government has been that products made in the Kaesong Industrial Complex, an “economic zone” located in North Korea but largely managed by South Korean firms, be included... To date, the US has indicated that this demand is unacceptable and ... it could be a “deal-breaker”...

But, in the long run, the demand is not unreasonable. Indeed, the process of economic reform and movement towards a market system in China ... began with Chinese experimentation with “special economic zones” during the 1980s, where these zones were not wholly unlike the Kaesong Industrial Complex. The success of the special economic zones in China emboldened a sometimes reluctant Chinese leadership to undertake widespread economic reforms in the early 1990s, reforms that directly led to the very rapid growth and development of the Chinese economy that has occurred during the past 15 years or so. There is no guarantee, of course, that the Chinese experience would be repeated in North Korea, but there is also no strong reason to believe that success at Kaesong might not embolden further economic reform in North Korea..., where the change would almost surely be for the better. Indeed, there is evidence that there is a rising generation of North Koreans (including importantly younger military officers) who seek market-driven reform as a means of improving North Korea’s economic performance. But current US policy, which is pretty much to do as much as possible to prevent North Korea from conducting any sort of commerce with the rest of the world, creates major disincentives for North Korea to undertake serious economic reform. ...

Thus, a change of attitude on the part of the US towards the status of the Kaesong Industrial Complex could prove to be a constructive first step towards a new and more fruitful policy towards North Korea. Moreover, such a step can be taken in the context of a negotiation being undertaken with South Korea and hence this step need not involve any direct interaction with North Korea itself. ...

Indeed, ...[this] might not even require that the US accede fully to the South Korean demand that products from Kaesong be covered under a Korea-US free trade agreement. Rather, the United States, ... could indicate that ... it would be willing to reconsider this issue at some time in the future subject to certain conditions being met. Such conditions might include ... that North Korea must stop its current practices of counterfeiting and circulating US currency and manufacturing for export narcotic drugs such as methamphetamine. Indeed, for the US to express even this little bit of flexibility in the free trade negotiations might send a signal to the North Koreans that there might be a better path for that nation to take than the one it is currently taking.

As noted, my proposal as outlined above is but a modest one, and a lot more than just this proposal will be needed to undo the damage that a misguided US foreign policy has created. However, as goes the Chinese proverb, the longest journey starts with a single step, and the step that I propose would be, I submit, in the right direction.