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December 31, 2008

Economist's View - 3 new articles

"Should We Fear a Trade Backlash?"

More and more I have been asked why we should allow immigration when there is so much domestic unemployment. It's a hard question to answer, more so when you are talking to someone who is looking for a job and having a hard time finding one. Similarly, people ask why we should allow imports on the belief that restricting them would help with the domestic employment situation.

But one problem with protectionist measures is that they are like standing up to see better at a basketball game. If everyone is sitting down and you stand up, you will, of course, see better. You will be better off, so there will be a tendency to want to stand up, particularly during crucial parts of the game. But if everyone else stands up too, the result is different. Nobody can see any better than they could sitting down (on average), and they are less comfortable standing than they were sitting. All that happens as each person tries to stand up and improve their situation is that everyone is made, collectively, worse off. (I realize some people do prefer to stand - especially during the exciting periods of the game - but for the purposes of the example I'm assuming the the highest utility outcome is where everyone is sitting. If you don't like this example, think of a crowded freeway and someone leaving for work early to beat the traffic. If that person is the only one to leave early, or one of the few, it works, but if everyone tries to leave early, you get the same old freeway problems but everyone had to get up earlier - so they are worse off.). Same with protectionism. If one country imposes protectionist measures by itself, the measures can be helpful and hence there is a tendency to do this, but when all countries follow suit and retaliate with their own set of trade restrictions, it makes everyone worse off.

Will governments repeat the "Smoot-Hawley-like backlash against trade" that occurred during the Great Depression? Barry Eichengreen says that could happen, but fortunately we've learned a thing or two since then. e.g. the value of fiscal policy, and hopefully that will keep the crowd under control:

Should we fear a trade backlash?, by Barry Eichengreen, Commentary, Project Syndicate: With more than a whiff of depression in the air, is a Smoot-Hawley-like backlash against trade about to follow? ... The danger exists. ... Other economic aspects of the 1930s that many of us thought we would never see in our lifetimes have reared their ugly heads. ...

Some of these fears relate to the protectionist rhetoric of Barack Obama... Then there are the bailouts for General Motors and Chrysler. A subsidy for domestic auto producers is functionally equivalent to a tax on the US sales of foreign producers. Finally there is the fear that the US fiscal stimulus package ... will be rendered less effective if the increased demand is allowed to leak out in the form of increased imports. US politicians will be quick to react with protectionist measures if they see that today's spending programmes, which create a debt burden for future generations, fail to stimulate the American economy and only benefit other countries.

Fortunately there are reasons for thinking that this danger is overstated. First, the growth of multinational production and global supply chains has altered the political economy. Protecting US auto producers no longer automatically benefits US parts suppliers when the Big Three source many of their parts from Canada. Foreign companies with an interest in the maintenance of free and open trade are better represented in the political process than they were in the 1930s. ...

Second, in 1930 Congress resorted to Smoot-Hawley out of desperation over its lack of alternatives. It was not that the Congress ... resorted to a tariff to maximise the employment-creating impact from expansionary fiscal policies. Rather the tariff was imposed instead of expansionary fiscal policies, there as yet being no understanding of the case for fiscal stimulus. The danger of a tariff as a convoluted employment-creating policy is now less, precisely because we understand that there are direct ways for the government to stimulate demand, namely by cutting taxes and raising public spending.

Finally, if fiscal stimulus and the Fed's zero interest rate policy mainly suck in imports, then the dollar will decline in response to the widening current account deficit. This will shift demand back toward domestic goods, venting the pressure for a protectionist response. This is no mere hypothetical: we have already seen the dollar falling in anticipation of just these developments. This is fundamentally different from 1930, when the US and other countries were on the gold standard and there was no scope for the exchange rate to adjust. ...

Today, in contrast to the 1930s, our politicians have no shortage of policy levers. They just need to pull the right ones.

"When Handed a Lehman..."

Harold Meyerson:

The Big Bailout Lessons, by Harold Meyerson, Commentary, Washington Post: Two things we learned about our ... economy in 2008: Lesson One: If it's big and you don't regulate it, you end up nationalizing it. ...[U]nregulated and underregulated capitalism ends up confronting democratic governments with a subprime choice: Either let a major institution go down and watch as chaos follows (the Lehman option) or funnel gobs of the public's money into such institutions to avoid such Lehman-like chaos. ...

When the American financial industry came tumbling down this year, the laissez-faire ideologues of this most ideological administration indulged their ideology just once, allowing Lehman to go under. Thereafter, as one giant institution after another tottered under the weight of dubious deals, the administration tossed ideology out the window and funneled money to the banks.

Laissez faire be damned, the ideologues concluded: When handed a Lehman, make Lehman aid.

The lesson for 2009 couldn't be clearer: To avoid nationalization, you need regulation. Or, the lesson's ideological corollary: To avoid socialism (to whatever extent throwing public money at banks is socialism), you need ... the willingness to restrain capitalism from its periodic self-destruction...

Lesson Two: In matters economic, the Civil War isn't really over. ...Abraham Lincoln ... might detect in the congressional war over the automaker bailouts a strong echo of the war that defined his presidency. Now as then, the conflict centered on the rival labor systems of North and South. Now as then, the Southerners championed a low-wage, low-benefits system while the North favored a more generous one. And now as then, what sparked the conflict was the North's fear of the Southern system becoming the national norm. ...

Over the past century, of course, the conflict between North and South has been between union and non-union labor. The states of the industrial Midwest and the South ... developed two distinct economies. Residents of the unionized north enjoyed higher ... paychecks and ... higher public outlays on health and education, than did their counterparts in the union-resistant South.

But, just as Lincoln predicted, the United States was bound to have one labor system prevail, and the debate over the General Motors and Chrysler bailout was really a debate over which system -- the United Auto Workers' or the foreign transplant factories' -- that would be. ...

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December 30, 2008

Economist's View - 3 new articles

"How to Prevent the Great Depression of 2009"

Roger Farmer says the Fed needs to target an asset price index "to prevent bubbles and crashes":

How to prevent the Great Depression of 2009, by Roger E.A Farmer, Financial Times: ...Since world war two, economic policy in most western democracies has been based on Keynesian economics. But although policy makers still rely on Keynes' ideas, academics gave up on his theories 40 years ago and went back to classical economics... The result has been 40 years of disconnect in which policy makers are tinkering with the engine without a manual. ...

We have seen economies stagnate for a decade or more in the past - the UK in the 1920s, the US in the 1930s and Japan in the 1990s - and it would be presumptuous to think that this cannot happen again when the existing dominant paradigm says that it could not happen in the first place.

Classical economists argue that falling wages will restore equilibrium; but this is based on the belief that the labour market works like an auction in which employment is determined by demand and supply.

It ignores the very real frictions involved in searching for a job by both households and firms that can lead to many possible equilibrium employment levels just as Keynes argued in the General Theory. ...

So where do we go from here? The only actor large enough to restore confidence in the US market is the US government. The current policy of quantitative easing by the Fed is a move in the right direction but it does not, as yet, go nearly far enough.

It is time for a greatly increased role for monetary policy through direct intervention of central banks in world stock markets to prevent bubbles and crashes. Central banks control interest rates by buying and selling securities on the open market.

A logical extension of this idea is to pick an indexed basket of securities: one candidate in the US might be the S&P 500, and to control its price by buying and selling blocks of shares on the open market.

Even the credible announcement that a policy of this kind was being considered should be enough to boost the markets and restore consumer and investor confidence in the real economy.

Critics will argue that this policy is dangerous socialist meddling. But I am not arguing that the government should pick winners and losers: only that it should stabilise a broad basket of stocks.

This policy would still allow poorly run firms to fail but it would not allow all firms to fail at the same time. Although the free market is very good at deciding how many left and right shoes to produce, it cannot prevent systemic risk that arises from the psychology of herd behaviour. This is a job for Uncle Sam.

As I've noted many times, most recently here, I am also warming up to the idea of having the Fed target an asset price index in addition to inflation and unemployment. But there are lots of questions to be answered first. What growth rate in the stock price index should we target? Should it be 8%? Lower? Higher? What is the correct time frame? Day to day fluctuations are quite volatile, we wouldn't want to react to every movement in the index, so how do we come up with a core measure that gives us an indication of the long-run trend in stock prices? Does value weighting, as in the S&P 500, give the optimal index, or would some other weighting scheme do better? Do we only include financial assets, or should other asset prices such an housing price index also be targeted? If so, how would we do that? When targets are in conflict, how much weight should deviations of the asset price index from its target value be given relative to deviations of inflation and output from their target values? Will it still be true that it is optimal for the Fed to react by raising the federal funds rate more than one to one in response to changes in inflation? How will adding another source of variation to the federal funds rate affect its smoothness? We don't fully understand why interest rate smoothing is an important component of the Taylor rule, but it does seem to be an important, so how will this change will affect smoothness (it depends upon how the coefficients in the Taylor rule are adjusted after the new piece is added)?

And that's just a few of the questions, I'm sure I've overlooked many more (and please feel free to fill in the missing pieces in comments). Thus, while I certainly think this is a fruitful area to investigate, particularly in light of recent experience with the housing and stock price bubbles, we have more thinking to do and more regressions to run before we are ready to implement this kind of policy.

Finally, even with theoretical and empirical support, I'd be wary that asset price targeting alone will be enough to prevent problems in asset markets from developing in the future. Asset price targeting is a complement to other measures such as regulatory and enforcement changes, not a substitute, and I think it would be a mistake to believe simply twiddling with the policy rule will be enough to avoid another financial market meltdown that threatens the wider economy.

Update: Barkley Rosser, in comments, with an opposing view:

I spoke on the matter of "battling bubbles" at the Galbraith conference in New York. In November. I specifically suggested not doing something like this, or more generally not trying to use broad interest rate policy to influence speculative markets. However, I did support more targeted interventions in specific markets where there was good evidence of a serious speculative bubbles. I argued for using more specific regulatory tools along the lines suggested by Robert Feinman, such as changing margin requirements, or for housing tightening rules on mortgages, or for commodities, using buffer stocks (Strategic Petroleum Reserve, etc.) for interventions.

The real downside of using broad monetary policy to tamp down general stock market bubbles has been seen. It was called the Great Depression.

Also, keep in mind that we have not had a stock market bubble in recent years. We have had bubbles in housing and in oil and in some other commodities, but the P/E ratios have been pretty reasonable. The recent plunges of the stock market are not crashes of bubbles (the 2000 decline was, especially for dotcom stocks). Rather these are fundamental declines based on rationally expected declines in future profits and dividends.

Oh, and I do not see setting any sort of rule for this sort of thing as making any sense. It will have to be discretionary and case by case, keeping in mind that any such interventions will always be strongly opposed by those who are in the middle of making money from the bubble.

Update: Tyler Cowen adds to the dissenting voices.

Update: Given the recent discussion about whether the current recession is due to a reduced willingness to work, I debated leaving this line about "contagious laziness" in, but didn't. Angus at Kids Prefer Cheese fills the void:

Wow, speaking of Laziness.....: Roger Farmer writing December 30th 2008 in the FT:

"In classical economics, the prices of stocks are determined by fundamentals and the fundamentals of the economy are sound. The US had the same stock of factories and machines in August that it had in July and the US workforce has not been afflicted by a sudden attack of contagious laziness."

Franco Modigliani writing in the AER, March 1977:

"Sargent (1976) has attempted to remedy this fatal flaw by hypothesizing that the persistent and large fluctuations in unemployment reflect merely corresponding swings in the natural rate itself. In other words, what happened to the United States in the 1930's was a severe attack of contagious laziness!"

Ouch! Can't one of the all-time greats of Macro get any love in this day and age???

"Disagreeing With Martin Feldstein On Defense Spending"

Stan Collender rebuts Martin Feldstein's call to use increased defense spending as a stimulus measure:

Disagreeing With Martin Feldstein On Defense Spending, by Stan Collender [Creative Commons]: As I said about a month ago, its not always smart to disagree publicly with an economic icon, especially when he's Martin Feldstein. Nevertheless, a Feldstein article published on Christmas Eve in the Wall Street Journal is so wrong that it and he deserve to be called out.

The title of the article -- "Defense Spending Would Be A Great Stimulus" -- says it all. It's Feldstein's contention that additional military spending should be part of whatever economic stimulus package Congress and the Obama administration adopt in a few weeks.

Here are my objections almost paragraph by paragraph.

First, Feldstein opens his article with this: "The Department of Defense is preparing budget cuts in response to the decline in national income." All my sources tell me this is absolutely false; the Pentagon is now planning to increase spending by a healthy amount, but it won't be the 13+ percent that several months ago it was insisting was needed. A 5 or 6 percent increase is now considered likely and, with little or no concern about inflation this year, that will be a substantial increase in DOD buying power.

Feldstein starts the third paragraph by saying "A temporary rise in DOD spending on supplies, equipment and manpower should be a significant part of that increase in overall government outlays." But Pentagon spending increases, especially the number of people in uniform, are almost never temporary. In most cases, DOD and its supporters on Capital Hill generally look at what was spent the previous year as sacrosanct and consider anyone who tries to reduce it anti-military, or worse.

Putting a permanent increase in military spending in place now will only mean that there will be additional pressure to raise taxes or cut other spending several years from now when inflation and the deficit return as issues.

Feldstein then repeats the same mistake in the fourth paragraph when he insists that after a "short-term surge" in outlays in 2009 and 2010, the spending increase should then be "tailing off sharply in 2011." He should know better. Personnel costs go up rather than down in future years and military procurement projects typically take many years to complete with comparatively little spending in the first year or two. In other words, major procurement projects would be about the worst type of stimulus spending.

That makes Feldstein's recommendation towards the end of the piece that the stimulus include additional "fighter planes and transport aircraft" and ships a bit ridiculous.

Feldstein tries to justify he recommendation by saying that problem with the delayed and multi-year spending of major procurements can be partially dealt with by the Pentagon buying of materials and components in advance and then "holding them in inventory" until they are needed. He then admits that this would be "wasteful" and, therefore, in effect also admits that this would violate one of his own stated principles (see below) for stimulus spending.

The fifth paragraph, where Feldstein says the government should increase the number of people in uniform by 15 percent, also makes no sense. Yes, it would provide jobs for (if we believe his number) 30,000 people. But not only would they be locked into those positions for years, the overall increase in the number of people in uniform that supposedly would be done temporarily would likely be very hard to reduce in the future.

Later in the article, Feldstein justifies the additional personnel spending by saying that it would be an excellent way to provide job training for these men and women when they reenter the private sector. But on a per person basis, that may be the most costly form of job training the federal government provides.

It's also at direct variance with something Feldstein talks about in the sixth paragraph -- the absolute need by those designing the stimulus package "to avoid wasteful spending." He says that one way to avoid waste "is to do things during the spending surge that must eventually be done anyway." But if the military threat to the U.S. doesn't require a 15 percent increase in personnel, doesn't that mean that the additional people in uniform aren't needed? If so, wouldn't adding them be "wasteful" according to Feldstein's own definition? And if the Pentagon thinks these people are needed, why doesn't it just propose that and justify the increase in spending that would result on that basis?

Finally, something that's not in the Feldstein piece: dollar for dollar, military spending doesn't provide as much an economic return as domestic spending. Building an extra tank or missile that then sits idle because it's not needed provides a one-time boost to the economy. But building a road, bridge, tunnel, sewer, or information superhighway that is needed continues to provide benefits as people, goods, and information travel faster, less expensively, and far more productively than would have otherwise been the case.

That means that starting with the headline, Feldstein was seriously mistaken.

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December 28, 2008

Economist's View - 2 new articles

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Was Risk Misperceived, Misrepresented, or Misallocated?

We know that excessive risk taking was a factor in the financial crisis, but why people were willing to take on excessive risk?

There are several explanations for this. In one class of models, misperception of risk generates excessive demand for risky assets, housing and financial assets in particular. There are a variety of stories about why risk is misperceived, ratings agencies failed to do their jobs, risk assessment models turned out to be wrong, people believed that housing prices would continue to go up, and so on. The key is that in this class of models the misperception of risk gives people a false sense of security, and induces them to take on more risk than they can handle.

In another class of models, risk is misrepresented. Here, there is out and out fraud or other practices where, essentially, people know that the house is made of cards, but advertise it as being made of bricks anyway, and assure people that it is perfectly safe. Fraud could cause the victim to misperceive risk, so this is related to the first class of models, but I am trying to separate excessive risk taking brought about by intentional misrepresentation from excessive risk taking brought about by errors in judgment (or, perhaps more accurately in some cases, from negligence).

In a third class of models risk is misallocated, and there are two strands of risk misallocation models. In one, the mechanism that causes people to take excessive risk is knowledge that the government will step in and cover any potential catastrophic losses (risk is reallocated from the private to the public sector). This is the moral hazard problem, and the claim that government intervention led to excessive risk taking has been leveled pretty much wherever government has played a role in housing and financial markets, even when the role has not been very large.

In the second strand of risk misallocation models, the cause of excessive risk taking is market failure due to principal agent problems (e.g. when mortgage brokers are paid according to the number of loans that pass through their hands rather than according to the quality of the loans, and hence have no incentive to monitor risk). Market failures of this type can cause excessive risk taking because the person taking the risks does not face the full consequences of their decisions when the risky decisions turn out to be wrong. Why not take a big risk if you win on the upside, but you don't have to pay the full cost (or any of the costs) on the downside? However, unlike the first strand of risk misallocation models where there is too much government intervention, here the problem can arise when government fails to regulate markets properly, so the problem is often the result of too little government intervention rather than too much.

In a final class of models government is also blamed, but this time government is a bully that forces banks - through regulation or moral suasion - to make loans that are overly risky. The very thoroughly discredited models blaming the Community Reinvestment Act for the financial crisis fit into this class, and the models blaming the CRA are the most prominent member of this category. For that reason, I'll call these models "misguided" and set them aside.

So which was it, misperception, misrepresentation, or misallocation? In the following, Tyler Cowen focuses on the misallocation of risk due to government induced moral hazard. My own view is that misallocation of risk did play a role, but I think risk misallocation due to market failures, i.e. the failure of regulation, was more important in generating the crisis than moral hazard brought about by implicit or explicit government guarantees. I also think the misperception of risk was important, perhaps even more important than the misallocation of risk (though these are sometimes hard to separate):

Here's Tyler Cowen:

Bailout of Long-Term Capital: A Bad Precedent?, by Tyler Cowen, Commentary, NY Times: The financial crisis is a result of many bad decisions, but one of them hasn't received enough attention: the 1998 bailout of the Long-Term Capital Management hedge fund. If regulators had been less concerned with protecting the fund's creditors, our current problems might not be quite so bad. ...

At the time, it may have seemed that regulators did the right thing. The bailout did not require upfront money from the government, and the world avoided an even bigger financial crisis. Today, however, that ad hoc intervention by the government no longer looks so wise. With the Long-Term Capital bailout as a precedent, creditors came to believe that their loans to unsound financial institutions would be made good by the Fed — as long as the collapse of those institutions would threaten the global credit system. Bolstered by this sense of security, bad loans mushroomed. ...

The Long-Term Capital episode ... was important precisely because the fund was not a major firm. At the time of its near demise, it was not even a major money center bank, but a hedge fund with about 200 employees. Such funds hadn't previously been brought under regulatory protection this way. After the episode, financial markets knew that even relatively obscure institutions — through government intervention — might be able to pay back bad loans.

The major creditors of the fund included Bear Stearns, Merrill Lynch and Lehman Brothers, all of which went on to lend and invest recklessly and, to one degree or another, pay the consequences. But 1998 should have been the time to send a credible warning that bad loans to overleveraged institutions would mean losses, and that neither the Fed nor the Treasury would make these losses good.

What would have happened without a Fed-organized bailout of Long-Term Capital? ... Fed inaction might have had grave ... economic consequences,... and the economy would have probably plunged into recession. That sounds bad, but it might have been better to have experienced a milder version of a downturn in 1998 than the more severe version of 10 years later.

In 1998, there was no collapsed housing bubble, the government's budget was in surplus rather than deficit, bank leverage was much lower, and derivatives markets were smaller and less far-reaching. A financial crisis related to Long-Term Capital, however painful, probably would have been easier to handle than the perfect storm of recent months.

The ad hoc aspect of the bailout created a precedent for what has come to be called "regulation by deal" — now the government's modus operandi. Rather than publicizing definite standards and expectations for bailouts in advance, the Fed and the Treasury confront each particular crisis anew. ... So far, every deal — or lack thereof, in the case of Lehman Brothers — has been different.

While there are some advantages to leaving discretion in regulators' hands, this hasn't worked out very well. It has become increasingly apparent that the market doesn't know what to expect and that many financial institutions are sitting on the sidelines, waiting to see what regulators will do next. Regulatory uncertainty is stifling the ability of financial markets to engineer at least a partial recovery. ...

I should add that I agree with Tyler that government action, or in some cases inaction, and in still other cases poorly though out action, particularly by the Treasury, has left far too much uncertainty in markets.


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December 27, 2008

Economist's View - 3 new articles

Are Workers Unwilling to Work?

Inventory to Sales Ratio

I am going to go out on a limb and assume this is the result of unintended inventory accumulation rather than, say, firms building up inventories in anticipation of an economic boom that is just around the corner. If so, then this is not a good omen for labor demand.

Why is the word demand highlighted? The graph is mostly an excuse to note this from Brad Delong:

Casey Mulligan says--wait for it--that the reason that unemployment is the 7% it is right now rather than the 4.4% it was two years ago because workers today face "financial incentives that encourage them not to work":

Are Employers Unwilling to Hire, or Are Some Workers Unwilling to Work?: Employment has been falling over the past year... if total hours worked had continued the upward trend they had been on in the years before the recession, they would be 4.7 percent higher than they are now.... [Today s]ome employees face financial incentives that encourage them not to work.... [T]he decreased employment is explained more by reductions in the supply of labor (the willingness of people to work) and less by the demand for labor (the number of workers that employers need to hire)...

pgl adds:

Believe it or not this explanation made it in print:

Because productivity has been rising ... the decreased employment is explained more by reductions in the supply of labor (the willingness of people to work) and less by the demand for labor (the number of workers that employers need to hire).

As pgl notes, Casey Mulligan doesn't tell us why labor supply suddenly shifted inward, he promises that will be divulged later, but he does have a solution to the unemployment problem. He calls for--wait for it--tax cuts:

Why would some people have fewer incentives to take a job in 2008 than they did in 2006 and 2007 (and employers fewer incentives to create jobs)? I will tackle that question in my next post, but even without a specific answer we learn a lot about today's recession from the conclusion that labor supply – not labor demand – should be blamed. First of all, it suggests that a fundamental solution to the recession would encourage labor supply (perhaps cutting personal income tax rates, so people can keep more of their wages), rather than tinker with demand.

Tax cuts could also work by increasing the demand for goods and services and hence the demand for labor, but this is a supply-side explanation where workers refuse to work at the wages being offered to them and decide to stay home instead, so that is not the mechanism he has in mind.

Dean Baker isn't buying the labor supply explanation. As he notes, a key component of this explanation is the claim by Mulligan that, "Unlike in the severe recessions of the 1930s and early 1980s, productivity has been rising." But why has productivity been rising relative to previous recessions? Dean Baker explains:

The one piece of data that drives this story is the apparent strength of productivity growth in this downturn relative to prior ones. But, there is a real simple story that can explain this pattern.

If we assume that in prior downturns firms were reluctant to lay off workers, both because of union contracts and also because they recognized the cost of turnover and hiring new workers, then we would expect sharp downturns in productivity growth as soon as there is a downturn in demand.

Now, imagine that firms are not constrained by union contracts and don't worry about long-term costs, so that they quickly layoff workers when there is a falloff in demand. Voila! productivity does not fall off in the same way in this downturn.

That would be my story. We can try to do some more careful examination of declines in productivity sector by sector, but I suspect that this is what explains the difference in productivity patterns across downturns.

Whatever the explanation - and productivity is not easy to measure so the relationships in the data can be questioned - I find it highly implausible that worker's unwillingness to accept the jobs being offered to them is the source of the current employment problem.

The American Recovery and Reinvestment Plan

Larry Summers outlines the incoming administration's plans for economic recovery:

Obama's Down Payment, by Lawrence Summers, Commentary, Washington Post: ...President-elect Barack Obama ... will face what may well be the bleakest economic outlook since World War II. ...

As difficult as these conditions are, however, the Obama administration also inherits an economy with great potential for the medium and long terms. Investments in an array of areas -- including energy, education, infrastructure and health care -- offer the potential of extraordinarily high social returns...

In this crisis, doing too little poses a greater threat than doing too much. Any sound economic strategy in the current context must be directed at both creating the jobs ... and doing the work that our economy requires. ... Our president-elect ... is crafting a broad proposal, the American Recovery and Reinvestment Plan, to support the jobs and incomes essential for recovery while also making a down payment on our nation's long-term financial health.

A key pillar of the Obama plan is job creation. In the face of deteriorating economic forecasts, Obama has revised his goal upward, to 3 million. .... The Obama plan represents not new public works but, rather, investments that will work for the American public. Investments to build the classrooms, laboratories and libraries our children need to meet 21st-century educational challenges. Investments to help reduce U.S. dependence on foreign oil by spurring renewable energy initiatives... Investments to put millions of Americans back to work rebuilding our roads, bridges and public transit systems. Investments to modernize our health-care system, which is ... key to driving down costs across the board. ...

We must focus not on ideology but on drawing the best ideas from all quarters. That is why, for example, in key sectors such as energy, Obama is pushing for both public investments and the removal of barriers to private investment. It is also why his plan relies on both government spending and tax cuts to raise incomes and promote recovery. ...

There will be no earmarks. Investments will be chosen ... based on what yields the highest rate of return for the economy and monitored closely not just by officials but also by the public as government becomes more transparent. We expect to evaluate and to be evaluated rigorously to ensure that Washington is held accountable for how tax dollars are spent.

Some argue that instead of attempting to both create jobs and invest in our long-run growth, we should focus exclusively on short-term policies that generate consumer spending. But that approach led to some of the challenges we face today -- and it is that approach that we must reject if we are going to strengthen our middle class and our economy over the long run. ...

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December 26, 2008

Economist's View - 3 new articles

Paul Krugman: Barack Be Good

How can the incoming administration manage to navigate the "treacherous political waters safely" as it attempts to rescue the economy?:

Barack Be Good, by Paul Krugman, Commentary, NY Times: Times have changed. In 1996, President Bill Clinton, under siege from the right, declared that "the era of big government is over." But President-elect Barack Obama, riding a wave of revulsion over what conservatism has wrought, has said that he wants to "make government cool again."

Before Mr. Obama can make government cool, however, he has to make it good. Indeed, he has to be a goo-goo.

Goo-goo, in case you're wondering, is a century-old term for "good government" types, reformers opposed to corruption and patronage. Franklin Roosevelt was a goo-goo extraordinaire. He simultaneously made government much bigger and much cleaner. Mr. Obama needs to do the same thing. ...

Like the New Deal, the incoming administration must greatly expand the role of government to rescue an ailing economy. But also like the New Deal, the Obama team faces political opponents who will seize on any signs of corruption or abuse — or invent them, if necessary — in an attempt to discredit the administration's program.

F.D.R. managed to navigate these treacherous political waters safely, greatly improving government's reputation even as he vastly expanded it. ... How did F.D.R. manage to make big government so clean?

A large part of the answer is ...oversight... The Works Progress Administration, in particular, had a powerful, independent "division of progress investigation" devoted to investigating complaints of fraud. This division was so diligent that ... a Congressional subcommittee ... couldn't find a single serious irregularity that the division had missed.

F.D.R. also made sure that Congress didn't stuff stimulus legislation with pork: there were no earmarks in the legislation ... for the W.P.A. and other emergency measures.

Last but not least, F.D.R. built an emotional bond with working Americans, which helped carry his administration through the inevitable setbacks ... that beset its attempts to fix the economy.

So what are the lessons for the Obama team?

First, the administration of the economic recovery plan has to be squeaky clean. Purely economic considerations might suggest cutting a few corners in the interest of getting stimulus moving quickly, but the politics of the situation dictates great care in how money is spent. And enforcement is crucial: inspectors general have to be strong and independent, and whistle-blowers have to be rewarded, not punished as they were in the Bush years.

Second, the plan has to be really, truly pork-free. Vice President-elect Joseph Biden recently promised that the plan "will not become a Christmas tree"; the new administration needs to deliver on that promise.

Finally, the Obama administration and Democrats in general need to do everything they can to build an F.D.R.-like bond with the public. Never mind Mr. Obama's current high standing in the polls based on public hopes that he'll succeed. He needs a solid base of support that will remain even when things aren't going well. ...

Democrats are off to a bad start on that front. The attempted coronation of Caroline Kennedy as senator plays right into 40 years of conservative propaganda denouncing "liberal elites." And surely I wasn't the only person who winced at reports about the luxurious beach house the Obamas have rented, not because there's anything wrong with the first family-elect having a nice vacation, but because symbolism matters, and these weren't the images we should be seeing when millions of Americans are terrified about their finances.

O.K., these are early days. But that's precisely the point. Fixing the economy is going to take time, and the Obama team needs to be thinking now, when hopes are high, about how to accumulate and preserve enough political capital to see the job through.

"An Eisenhower Moment" for Infrastructure?

What can the incoming administration learn about infrastructure spending from Eisenhower's experience in creating the interstate highway system?:

Eisenhower's roads to prosperity, by Tom Lewis, Commentary, LA Times: ...President-elect Barack Obama vowed to "create millions of jobs by making the single largest new investment in our national infrastructure since the creation of the federal highway system..." The story of President Eisenhower's decision in 1956 to create the interstate highway system ... holds lessons that the new president and the country would do well to heed.

Eisenhower was the first Republican to occupy the White House after Herbert Hoover, who in the 1950s still wore a mantle of shame for his role in the market crash of 1929 and its aftermath. Eisenhower had an almost pathological, but healthy, fear that he might be blamed for allowing the nation to fall into another depression. When a mild recession ... pushed the unemployment rate above 5%, Eisenhower ... asked for solutions.

The highwaymen at the Bureau of Public Roads ... heeded the call. They reported that each federal dollar invested in construction generated close to one half-hour of employment. ... Workers across America, not just those who built the roadways, would benefit -- in cement and steel plants (50 tons of concrete and 20 tons of reinforcing steel go into each mile), in paint and sign manufacturers and in heavy equipment factories and oil refineries. ...

Eisenhower realized that he could not fail with highways. Americans wanted more roads for their postwar cars. Construction would prime the economic pump ... and help secure the nation's future. He signed ... the $25-billion Federal-Aid Highway Act to build a 42,000-mile interstate highway system by 1972. Ultimately the cost would escalate to more than $130 billion, and workers would not finish the roads until 1993...

Eisenhower wasn't afraid to create a huge public works program, and unlike today's presidents, he wasn't afraid of taxes. ... The 1956 highway bill levied a tax of 3 cents on each gallon of fuel -- equal to 24 cents today. The revenue went into a dedicated highway trust fund. ...

Eisenhower's interstates are an essential part of our culture. ... In 1956, Eisenhower likely didn't fully realize that he was creating not just a public works program but an economic and social blueprint for the next 50 years. Now, along with every other aspect of our infrastructure, the interstates are crumbling. Irresponsible legislators rail against the current federal highway tax of 18.4 cents a gallon -- far less in today's prices than Eisenhower's 3 cents. Seduced by easy money, governors consider leasing parts of the highway system to foreign companies.

So the lessons for Obama are clear: Don't be afraid to propose bold -- and often expensive -- programs that improve the nation's infrastructure and peoples' lives, and don't be afraid to pay for them with taxes.

It is said the 44th president is taking office at a Lincoln moment and a Roosevelt moment. True enough, but it can be an Eisenhower moment as well.

Keeping the budget in balance while the economy is struggling is not good policy. If the goal is to stimulate the economy and to create new jobs, then the "clear" lesson - the advice to pay for the spending on infrastructure by raising taxes - is wrong. The new infrastructure does need to be paid for, but the time to do that is when the economy is healthy, not when it is under performing.

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December 25, 2008

Economist's View - 4 new articles

Stiglitz: We Need Bold Action

Joseph Stiglitz doesn't think policymakers are likely to support a stimulus package that is large enough to avoid a "vicious negative spiral":

The dismal economist's joyless triumph, by Joseph E. Stiglitz, Project Syndicate: ...Economists are good at identifying underlying forces, but they are not so good at timing. The dynamics are, however, much as anticipated. America is still on a downward trajectory for 2009 — with grave consequences for the world as a whole. ...

[E]ven if Obama and other world leaders do everything right, the US and the global economy are in for a difficult period. The question is not only how long the recession will last, but what the economy will look like when it emerges.

Will it return to robust growth, or will we have an anemic recovery, à la Japan in the 1990's? Right now, I cast my vote for the latter, especially since the huge debt legacy is likely to dampen enthusiasm for the big stimulus that is required. Without a sufficiently large stimulus (in excess of 2 percent of GDP), we will have a vicious negative spiral: a weak economy will mean more bankruptcies, which will push stock prices down and interest rates up, undermine consumer confidence, and weaken banks. Consumption and investment will be cut back further.

Many Wall Street financiers, having received their gobs of cash, are returning to their fiscal religion of low deficits. It is remarkable how, having proven their incompetence, they are still revered in some quarters. What matters more than deficits is what we do with money; borrowing to finance high-productivity investments in education, technology, or infrastructure strengthens a nation's balance sheet.

The financiers, however, will argue for caution: let's see how the economy does, and if it needs more money, we can give it. But a firm that is forced into bankruptcy is not un-bankrupted when a course is reversed. The damage is long-lasting.

If Obama follows his instinct, pays attention to Main Street rather than Wall Street, and acts boldly, then there is a prospect that the economy will start to emerge from the downturn by late 2009. If not, the short-term prospects for America, and the world, are bleak.

"Taking the Long-View"

Ban Ki-moon, Secretary General of the United Nations, says "We stand on the threshold of a new multilateralism":

Taking the Long View, by Ban Ki-moon, Project Syndicate: The coming year will be a narrative of tension - a series of difficult choices between the imperatives of the present and those of tomorrow. How we resolve this tension will be the measure of our vision and our leadership.

As a community of nations, we face three immediate tests in the coming year.

The first has just begun. ... I am speaking, here, about climate change, the one truly existential threat. ... Some argue ... that, amid our current difficulties, we cannot afford to tackle climate change. I say we cannot afford not to. The future of the planet is at stake.

Our second test is economic. Clearly, we need a global stimulus. Major economies have responded to the current crisis with ambitious fiscal and monetary rescue plans. The emergency G-20 summit in Washington in November showed that governments are working together to coordinate policies. Those efforts were broadened at a more recent meeting in Doha.

All of this is welcome. But we need to do more. Above all, we need to think boldly and freshly. If we are to spend our way out of the financial crisis, we should be smart about it. And that means that these expenditures must be investments. They must be sustainable, so that we are ... using those funds to lay the foundations of a more stable and prosperous future.

China has shown leadership. Fully one-third of its recently announced $586 billion economic stimulus program will be channeled into green growth and infrastructure. The Chinese have seized an opportunity to address several challenges at once - to create jobs, conserve energy, and combat climate change. The United States under President Barack Obama plans to do the same. ... Other nations should follow suit. We will never usher in an era of sustainable prosperity in the absence of a big, global push, with all nations moving in the same direction. If ever there were a time for bold and ambitious vision - a chance to chart a new and better path - it is now.

Our third test is a matter of pragmatic principle. ... During the coming year,... we must act in a spirit of global solidarity. Measures we take to deal with the financial crisis must be in the interests of all nations - the poorest as well as the rich and powerful. Aid programs for developing nations should be considered a part of any global stimulus and long-term economic recovery plan. At the very least, that means not using the financial crisis as an excuse to reduce international aid and development assistance. ...

We stand on the threshold of a new multilateralism. The pendulum of history is swinging back toward the United Nations and collective action. The challenges we face as a community of nations today are increasingly those of collaboration and cooperation: fighting climate change, rebuilding the global financial system, and promoting sustainable development.

In this interconnected world, the challenge is to see the nexus among these three sets of problems. With vision, we will find solutions to each that are solutions to all. But it will take leadership to translate that vision into action, just as it will take leadership to balance our larger long-term interests against the fierce urgencies of now.

Our Unconscious Rationality

As long as we don't think about things consciously, we appear to be "really good decision makers after all":

Our unconscious brain makes the best decisions possible, EurekAlert: Researchers at the University of Rochester have shown that the human brain—once thought to be a seriously flawed decision maker—is actually hard-wired to allow us to make the best decisions possible with the information we are given. ...

Neuroscientists Daniel Kahneman and Amos Tversky received a 2002 Nobel Prize for their 1979 research that argued humans rarely make rational decisions. Since then, this has become conventional wisdom among cognition researchers

Contrary to Kahnneman and Tversky's research, Alex Pouget ... has shown that people do indeed make optimal decisions—but only when their unconscious brain makes the choice.

"A lot of the early work in this field was on conscious decision making, but most of the decisions you make aren't based on conscious reasoning," says Pouget. "You don't consciously decide to stop at a red light or steer around an obstacle in the road. Once we started looking at the decisions our brains make without our knowledge, we found that they almost always reach the right decision, given the information they had to work with."

Pouget says that Kahneman's approach was to tell a subject that there was a certain percent chance that one of two choices in a test was "right." This meant a person had to consciously compute the percentages to get a right answer—something few people could do accurately.

Pouget has been demonstrating for years that certain aspects of human cognition are carried out with surprising accuracy. He has employed what he describes as a very simple unconscious-decision test. A series of dots appears on a computer screen, most of which are moving in random directions. A controlled number of these dots are purposely moving uniformly in the same direction, and the test subject simply has to say whether he believes those dots are moving to the left or right. The longer the subject watches the dots, the more evidence he accumulates and the more sure he becomes of the dots' motion.

Subjects in this test performed exactly as if their brains were subconsciously gathering information before reaching a confidence threshold, which was then reported to the conscious mind as a definite, sure answer. The subjects, however, were never aware of the complex computations going on, instead they simply "realized" suddenly that the dots were moving in one direction or another. The characteristics of the underlying computation fit with Pouget's extensive earlier work that suggested the human brain is wired naturally to perform calculations of this kind.

"We've been developing and strengthening this hypothesis for years—how the brain represents probability distributions," says Pouget. "...We wanted to see if, in fact, humans are really good decision makers after all, just not quite so good at doing it consciously. Kahneman explicitly told his subjects what the chances were, but we let people's unconscious mind work it out. It's weird, but people rarely make optimal decisions when they are told the percentages up front." ...

Pouget says a probabilistic decision-making system like this has several advantages. The most important is that it allows us to reach a reasonable decision in a reasonable amount of time. If we had to wait until we're 99 percent sure before we make a decision, Pouget says, then we would waste time accumulating data unnecessarily. If we only required a 51 percent certainty, then we might reach a decision before enough data has been collected.

Another main advantage is that when we finally reach a decision, we have a sense of how certain we are of it—say, 60 percent or 90 percent—depending on where the triggering threshold has been set. Pouget is now investigating how the brain sets this threshold for each decision, since it does not appear to have the same threshold for each kind of question it encounters.

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December 24, 2008

Economist's View - 5 new articles

Keynes and Morality Plays

Paul Krugman says this is a "Great piece by Martin Wolf":

Keynes offers us the best way to think about the financial crisis, by Martin Wolf, Commentary, Financial Times: ...Like all prophets, Keynes offered ambiguous lessons to his followers. ... Now,... in another era of financial crisis and threatened economic slump, it is easier for us to understand what remains relevant in his teaching. I see three broad lessons. ...

The ... most important lesson is that one should not treat the economy as a morality tale. In the 1930s, two opposing ideological visions were on offer: the Austrian; and the socialist. The Austrians ... argued that a purging of the excesses of the 1920s was required. Socialists argued that socialism needed to replace failed capitalism, outright. These views were grounded in alternative secular religions: the former in the view that individual self-seeking behaviour guaranteed a stable economic order; the latter in the idea that the identical motivation could lead only to exploitation, instability and crisis.

Keynes's genius – a very English one – was to insist we should approach an economic system not as a morality play but as a technical challenge. He wished to preserve as much liberty as possible, while recognising that the minimum state was unacceptable to a democratic society with an urbanised economy. He wished to preserve a market economy, without believing that laisser faire makes everything for the best in the best of all possible worlds.

This same moralistic debate is with us, once again. Contemporary "liquidationists" insist that a collapse would lead to rebirth of a purified economy. Their leftwing opponents argue that the era of markets is over. And even I wish to see the punishment of financial alchemists who claimed that ever more debt turns economic lead into gold.

Yet Keynes would have insisted that such approaches are foolish.

Markets are neither infallible nor dispensable. They are indeed the underpinnings of a productive economy and individual freedom. But they can also go seriously awry and so must be managed with care. ... So the task for this new administration is to lead the US and the world towards a pragmatic resolution of the global economic crisis...

As was the case in the 1930s, we also have a choice: it is to deal with these challenges co-operatively and pragmatically or let ideological blinkers and selfishness obstruct us. The objective is also clear: to preserve an open and at least reasonably stable world economy that offers opportunity to as much of humanity as possible. We have done a disturbingly poor job of this in recent years. We must do better. We can do so, provided we approach the task in a spirit of humility and pragmatism, shorn of ideological blinkers ...


I particularly liked this:

Keynes's genius – a very English one – was to insist we should approach an economic system not as a morality play but as a technical challenge.

That's the point of my favorite Keynes quote, where he declared of the Great Depression, "we have magneto trouble."

What's been striking me lately is how many people who talk and write about macroeconomics just don't get Keynes's essential point — the fact that economies can suffer from insufficient aggregate demand because people want to acquire liquid assets rather than real goods. Not to single out any one commentator, but this morning I read this:

Government spending doesn't increase aggregate demand. All it does is transfer spending power from one party to another by borrowing from or taxing the public.

That's exactly the infamous "Treasury view" from the 1920s, against which Keynes had to struggle. And it's still out there.

Anyway, good for Martin; we're going to need every possible voice to counter the niggling nabobs of negativism.

More from Krugman on morality tales:

So the crucial innovation in The General Theory isn't, as a modern macroeconomist tends to think, the idea that nominal wages are sticky. It's the demolition of Say's Law and the classical theory of the interest rate in Book IV, "The inducement to invest." One measure of how hard it was for Keynes to divest himself of Say's Law is that to this day some people deny what Keynes realized – that the "law" is, at best, a useless tautology when individuals have the option of accumulating money rather than purchasing real goods and services. ...

But the classical model wasn't the only thing Keynes had to escape from. He also had to break free of the business cycle theory of the day.

There wasn't, of course, a fully-worked out theory of recessions and recoveries. But it's instructive to compare The General Theory with Gottfried Haberler's Prosperity and Depression[3], written at roughly the same time, which was a League of Nations-sponsored attempt to systematize and synthesize what the economists of the time had to say about the subject. What's striking about Haberler's book, from a modern perspective, is that he was trying to answer the wrong question. Like most macroeconomic theorists before Keynes, Haberler believed that the crucial thing was to explain the economy's dynamics, to explain why booms are followed by busts, rather than to explain how mass unemployment is possible in the first place. And Harberler's book, like much business cycle writing at the time, seems more preoccupied with the excesses of the boom that with the mechanics of the bust. ... Keynes saw it as his job to explain why the economy sometimes operates far below full employment. That is, The General Theory for the most part offers a static model, not a dynamic model – a picture of an economy stuck in depression, not a story about how it got there. So Keynes actually chose to answer a more limited question than most people writing about business cycles at the time.

Again, I didn't understand the importance of that strategic decision on Keynes's part the first time I read The General Theory. But it's now obvious to me that most of Book II is a manifesto on behalf of limiting the question. ...

And Keynes's limitation of the question was powerfully liberating. Rather than getting bogged down in an attempt to explain the dynamics of the business cycle – a subject that remains contentious to this day – Keynes focused on a question that could be answered. And that was also the question that most needed an answer: given that overall demand is depressed – never mind why - how can we create more employment?

A side benefit of this simplification was that it freed Keynes and the rest of us from the seductive but surely false notion of the business cycle as morality play, of an economic slump as a necessary purgative after the excesses of a boom. By analyzing how the economy stays depressed, rather than trying to explain how it became depressed in the first place, Keynes helped bury the notion that there's something redemptive about economic suffering.

"Economists' Pretensions About Science"

Gavin Kennedy continues his crusade against the myth of the invisible hand:

An Evolutionist Speaks Out About Economists' Pretensions About Science, by Gavin Kennedy: Massimo Pigliucci, professor in the departments of Ecology and Evolution, Stony Brook, NY, contributes an important piece of work in the Blog, ('a site devoted to positive scepticism') (here):

Economics learns a thing or two from evolutionary biology

Economics is supposed to be a solid discipline, founded on complex mathematical models (and we all know math is really, really difficult). They even give Nobel prizes to economists, for crying out loud! And yet, economics has always had to fight off the same reputation of being a "soft" science that has plagued sociology, psychology, and to some extent even some of the biological sciences, like ecology and evolutionary biology. Indeed, like practitioners in those other fields of inquiry, some economists admit of being guilty of "physics envy," that is, of using the physical sciences as the model for what their field ought to be like. Turns out even the assumption that a good science should be modeled on physics is "flawed," to use Greenspan's apt phrase.

A recent article by Chelsea Wald in Science (12 December 2008) puts things in perspective by asking how it is possible that so many smart people in the financial sector made irrational decisions over a period of years, despite clear data showing there was a problem, and eventually leading to a worldwide economic crisis that is at the least poking at, if not shaking, the foundations of capitalism itself.

Part of the answer is to be found in the persistent idea in economics that "markets" work because people are rational agents who act in their own self-interest and have perfect, instantaneous access to relevant information about the businesses they are considering investing in. Economists are not stupid, and they know very well that perfect rationality, complete information and instant access are all light years away from the reality of how markets operate. And in fact recent models have relaxed these assumptions to some extent. But it is so much more tractable to model things that way! After all, physicists do it too: remember those problems in Physics 101 that started "consider a spherical cow…"?

Perhaps not surprisingly, there is another science that has been inspiring economists for some time now: evolutionary biology. The old "efficient markets hypothesis" underlying classical models is being replaced by the "adaptive markets hypothesis," where Adam Smith's invisible hand becomes more directly analogous to natural selection.

As evolutionary biologists have found out, natural selection is not an optimizing process, but a satisficing one, meaning that it produces whatever outcome happened to be achievable at a particular historical moment and that works "well enough" for the problem at hand. Moreover, it does so while "wasting" a lot of resources and often marching straight into dead ends (just think that over 99% of the species that ever existed went extinct). The emerging picture is much more realistic than the rationalist paradigm, but it sure is a lot more messy too.

There is another lesson to be learned from evolutionary biology that will not make economists, or the public at large, particularly happy: when complex systems evolve over time the paths they take is contingent on historical accidents (as opposed to being deterministic, like the laws of macro-physics, outside quantum mechanics). Sociologists, psychologists, ecologists and evolutionary biologists will readily tell their economic colleagues that it is certainly possible to explain past events (the extinction of the dinosaurs, the dot-com bubble) by the use of sufficiently complex causal-historical models. What seems to be out of reach, however, is precisely what economists want most: predicting the future, the hallmark of "good" science.

The moral of the story is that all of the above is not a failure of economics, sociology, psychology, ecology or evolutionary biology. It is the predictable outcome of the fact that these sciences deal with complex, historical systems, unlike much (though not all) of physics. The real assumption we need to get rid of is the highly persistent and pernicious one that physics is the golden standard by which all other sciences ought to be measured. Now if we only could convince federal funding agencies of that...

What a breath of fresh air from Professor Massimo Pigliucci! I wish (more in hope than expectation) that fellow economists will read all of his article. But because there are large dollops of research-grant money – and even bigger salaries from financial institutions (and government agencies) – available to smart-talking economists, who tell the grant agencies exactly what they want to hear, there is a steady demand for the services of 'future predictors' and no amount of their constant failures to do better than tossing a ten-pence coin could do, will curb the willingness to believe those in the prediction business.

It's at least as bad as the historians of the immediate past, when they already know what has happened, who cannot agree on what caused, led to, or contributed to whatever is the latest 'fine mess' we're in.

The historical precedents for this quite silly state of affairs goes back to classical times, and almost certainly farther back than that. Romans believed in 'omens' and fortune tellers, and even great generals, who pitted their lives against formidable foes, eagerly listened to what soothsayers and mystics had to say about the next few hours in decisive battles.

Among economists, we have bought the unscientific myth that if we spend a century creating beautiful mathematical models of an imaginary economy, without people in all their complexity and unpredictability, and our competence is judged by our understanding of the model, but not the reality of real economies!

We are a 'hard' science and much 'superior' to 'wishy-washy sociology, psychology and history, even though it is well-known that humans are not 'well behaved' like physical objects. We are not like wooden pieces on a chess board, as Adam Smith put it.

It is worrying too that just as more economists begin to realise that "the old 'efficient markets hypothesis' underlying classical models is being replaced by the 'adaptive markets hypothesis,' into which realisation, the oldest nonsense in modern economics (invented as a mass myth from the 1950s), is being re-introduced into the latter, under the guise that the metaphor of "Adam Smith's invisible hand", such that it is to be regarded as "more directly analogous to natural selection."

Please spare us from this spurious nonsense; it's bad enough that the proponents of the so-called scientific basis of economics have got away with their claims that the mystical disembodied body part was the 'most important idea' of modern economics, which is something that they never got from the texts of Adam Smith (see my paper: 'Adam Smith and the Invisible Hand: from metaphor to myth', 2008 and downloadable from the homer page of Lost Legacy).

The myth of the invisible hand is a fabrication to support propaganda for corporate bodies to behave with all the monopolistic spirits and protectionism of the 'merchants and manufacturers' of his day, against whom Adam Smith railed in Wealth Of Nations because they persuaded legislators and those who influenced them (and they 'bought' not a few) to assist them in narrowing the competition and raising prices.

Hawkish Fiscal Policy

Martin Feldstein argues that military spending should be part of the stimulus package:

Defense Spending Would Be Great Stimulus, by Martin Feldstein, Commentary, NY Times: The Department of Defense is preparing budget cuts in response to the decline in national income. The ... budgeteers ... apparently reason that a smaller GDP requires belt-tightening by everyone.

That logic is exactly backwards. As President-elect Barack Obama and his economic advisers recognize, countering a deep economic recession requires an increase in government spending to offset the sharp decline in consumer outlays and business investment... Although tax cuts for individuals and businesses can help, government spending will have to do the heavy lifting. ...

A temporary rise in DOD spending ... should be a significant part of that increase in overall government outlays. ... The increase in government spending needs to be a short-term surge ... but then tail ... off sharply in 2011 when the economy should be almost back to its prerecession level of activity. Buying military supplies and equipment, including a variety of off-the-shelf dual use items, can easily fit this surge pattern. ...

An important challenge for those who are designing the overall stimulus package is to avoid wasteful spending. One way to achieve that is to do things during the period of the spending surge that must eventually be done anyway. It is better to do them now when there is excess capacity...

Replacing the supplies that have been depleted by the military activity in Iraq and Afghanistan is a good example of something that might be postponed but that should instead be done quickly. ...

Industry experts and DOD officials confirm that military suppliers have substantial unused capacity... With industrial production in the economy as a whole down sharply, there is no shortage of potential employees who can produce supplies and equipment. ...

Now is also a good time for the military to increase recruiting and training. ... As a minimum this would provide education in a variety of technical skills -- electronics, equipment maintenance, computer programming, nuclear facility operations, etc. -- that would lead to better civilian careers for this group. It would also provide a larger reserve force...

The current two-year stimulus period provides an opportunity for additional temporary spending increases with high payoffs. Investments in port security would reduce a major homeland vulnerability. Expanding the government's language training programs ... would provide more translators... Additional infrastructure for the FBI would remove an important constraint on the number of new FBI agents. ...

A substantial short-term rise in spending on defense and intelligence would both stimulate our economy and strengthen our nation's security.

In the Long-Run, We are All Healthier

Jacob Hacker argues that health care reform should be part of the stimulus package:

A Healthy Economy Medicine is the best stimulus, by Jacob S. Hacker, The New Republic: As we move deeper into the recession, most economists are urging President-elect Obama to spend big money right away in order to stimulate ... the economy. The sticking point for a lot of people, however, is the long-term budget picture...

In fact, we have a magic bullet for short-term spending and long-term saving--health care reform. During the campaign, skeptics complained that a health care overhaul would involve a lot of upfront costs and that the saving would only come later. But that's exactly what we need right now. Health care involves major spending in the near future, but, more than other initiatives, it will put a brake on federal outlays in the far future.

All this argues for temporarily throwing fiscal caution to the wind when it comes to health care reform. The idea of spiking the deficit now may seem frightening, but it's a lot better than the alternative--and it could actually make it easier to bring universal health care to America. ...

The typical items on the stimulus menu--infrastructure spending, general aid to the states, benefits for the jobless, investments in new forms of energy--have a lot going for them. But they shouldn't blind us to the fact that government health spending is also an extraordinarily effective way to boost the economy. ...

[F]ixing health care isn't just a recipe for better access to medical care. It's an immediate economic lifeline for working families, giving them back part of their income to use on other things. It's also a rescue package for state and local governments burdened by Medicaid and S-CHIP, for doctors and hospitals who treat the uninsured and inadequately insured, for community institutions that help people in distress--in short, for all the rapidly fraying threads of our health care safety net. Put simply, most of the money we spend upgrading coverage and spreading it to the uninsured is going to go directly into the pockets of people who need help now. ...

The beauty of all this spending is that it will mean higher wages and employment, a more flexible labor market in which people feel free to change jobs or strike out on their own without risking their health and finances, and, yes, less pressure on public and private budgets down the road. We'll be running up hefty federal bills for a while. But we'll be doing so confident we're going to improve the economic standing of millions of Americans and our long-term budget situation in the bargain.

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