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May 25, 2009

Economist's View - 5 new articles

"Auctions and Politicians"

David Warsh explains why "companies reflexively oppose auctions" of public property such as forests or the airwaves: properly designed auctions can prevent government giveaways to the rich and powerful:

Auctions and Politicians, by David Warsh, Economic Principals: Last September, when Treasury Secretary Henry Paulson first described to a startled world his $700 billion plan to deal with the emerging financial crisis, it was with these words: "And we'll use – you know, we're working through the processes, but there will be some form of auction process."

Eight months later, the first auctions of those toxic assets are still a month away – assuming the Public Private Investment Plan ... gets off the ground on schedule. Even now, its success is not assured.

Unmistakable, however, is the centrality of auction technology to the twenty-first century – indeed, of economic engineering in general. Newly-created markets resting on "some form of auction process" can be found for commodities of all sorts these days, from electricity and advertising to carbon emission and radio-spectrum rights.

That such new machinery might be equal to the task was anything but obvious fifteen years ago when Federal Communications Commission Chairman Reed Hundt boldly presided over the first successful modern high-tech auction, designed to carve up the emergent national market for broadband personal communication services. Congress had only required that he sell the relevant frequencies, rather than give them away. ...

The auction was a smashing success, and not just because it raised a lot of money for the government. Its bigger pay-off was the way it offered a complicated industry a way to begin working on the same page. Its design protocols quickly became the template for many other auctions in many other industries. And before long, it was clear that new tools were regularly being added, not just auction techniques, but clearinghouse techniques that addressed various market failures. Yet as recently as 2002, when Harvard University professor Alvin Roth wrote "The Economist As Engineer," there was still something novel about the proposition that economic engineering was becoming close kin to chemical engineering or medicine.

Not any more! Auction technology has blossomed around the world, and called into existence a whole new industry, replete with firms, entrepreneurs, consultants, counter-consultants and even a few gunslingers. ...

That's because auction technology has become a feature of life on the World Wide Web so familiar that it is scarcely noticed that competitive bidding determines what you see every single time you make a search, or call up a page that displays advertising. For a while, that was the province of the warriors who wrote the big engines' code. Today, however, big-name economists advise all the top firms: Harvard's Susan Athey is Microsoft's chief economist, Berkeley's Hal Varian is chief economist for Google, Caltech's Preston McAfee leads a group at Yahoo. Lawrence Ausubel, of the University of Maryland, is helping ICANN, the Internet's governing body, organize an auction of new top-level domain names. (Roth's Game Theory, Experimental Economics and Market Design Page is a cornucopia of information on developments and emerging trends.)

For all their success organizing private markets, economists still often face an uphill struggle when it comes to winning government work. The reason is simple: auctions are all about, as the old saying goes, getting the most feathers out of the goose. The geese in the government flock are all owners or would-owners of something the government used to license at nominal rates or ignore altogether – the right to broadcast on a certain frequency, to harvest timber in a national forest, to send pollutants into the air. They would have paid for the privilege in the past – a relative or two on the payroll, good seats at the baseball game, a bundle of campaign contributions.

But whatever they paid for the privileges they received probably would have borne little relation to the worth of the franchise. That's precisely the information an auction is designed to elicit, along with the cash. No wonder companies reflexively oppose auctions; auctions cost them cash. So spend freely to avoid them.

That's why, for example, the US Department of Transportation earlier this month canceled plans to auction landing slots for New York's three busiest airports. The Bush administration had sought the measure, hoping to cut delays at the chronically congested airports (and, of course, raise some much-needed cash). The airline industry lined up against the proposal, so did Democratic congressmen. Incumbent airlines will continue to profit; frequent travelers will continue to suffer delays.

Similarly, the banking lobby, among the nation's strongest interest groups, has so far successfully opposed Treasury Department attempts to put up for bid banks' questionable (now "legacy") assets. ...

Even when overwhelming pressures bring about some fundamental change in the regulatory apparatus, you can count on industry to oppose the auction mechanism. That's the case with the landmark legislation to limit greenhouse gas emissions through a cap-and-trade permit system expected to be taken up by the full Congress in July. President Obama campaigned on a promise to auction the permits. But a coalition of Midwestern and Southern Democrats teamed up to alter the bill, and when its language was released last week it turned out that fully 80 percent of the permits would be given away at first ..., with the portion of permits to be sold at auction slowly rising to 100 percent by 2030. Consumers will experience higher prices only slightly less slowly, but owners of capital will have twenty years to adjust. The gradual transition is a price the president is said to be willing to pay in order to pass the bill into law. Equality of sacrifice will take a back seat to the goal of capping carbon emissions, a tradeoff noted with special force by journalist Matt Yglesias.

But the historical momentum in this case is clearly on the side of equality. Auctions, especially auctions of government property, are not a tool of the rich, especially when coupled with egalitarian principles of distribution (for instance, the proposition that every citizen should benefit equally when the radio spectrum is sold). As principles of market design become more thoroughly articulated and widely understood, the sphere of governmental discretion will shrink. More and more, politicians will be forced to play by the rules. ...


Is Colin Powell the Answer?

Bruce Bartlett:

Colin Powell: Republican, by Bruce Bartlett: Yesterday, Colin Powell restated his continued membership in the Republican Party. But he didn't really explain why. It seemed more like an act of defiance than a statement of fact—no one is going to tell him what part of the bus he can sit in and no one is going to tell him what political party he can be a member of. That's fine, but if Powell is going to make a point of staying in a party that doesn't particularly want him—former Vice President Dick Cheney has more or less told him to leave—then Powell has a responsibility to do more than give the occasional television interview criticizing the GOP's lack of inclusiveness; he needs to engage it on a systematic basis. Powell has to accept that he is in a unique position to command attention and lead the Republican Party—or at least that part of it that isn't consumed with defending the indefensible on torture or living in a fantasy world where the economy would be booming today if it just wasn't for Obama's budget deficits.

It's a pretty small constituency these days—most of those, like me, who share Powell's views have left his party to become independents—but it may be enough to build a foundation that can offer a meaningful challenge to the dominant Cheney-Limbaugh-Palin wing of the Republican Party that views all efforts to expand its membership as a sell-out to be resisted at all cost, even if it means further political losses. But at the end of the day, the job of a political party is to win elections and to win elections it must be inclusive, not exclusive. Thus the ultimate message Powell has to offer Republicans is the most persuasive one of all—follow him and win or follow Cheney-Limbaugh-Palin and lose. Personally, I would like to see Powell follow in the steps of Dwight D. Eisenhower and run for president—I'll sign up for his campaign today even if it means having to rejoin the Republican Party. But if he is serious about not wishing to do that, then Powell has a responsibility to help those who share his vision by lending his enormous credibility, popularity and fund-raising ability to their efforts. If he fails to do so he risks being seen by history as someone who walked away when the times demanded that those who share his beliefs stand and fight for what they believe.

Throughout history many of mankind's greatest leaders have been those who took on leadership responsibilities only very reluctantly. I hope Powell changes his mind and becomes the leader that the Republican Party desperately needs. After all, he is the one who said, in essence, that he would rather fight than switch.

Right now the Republican Party seems to be controlled by the old guard, the people who grew up with and still have the fear of communism, people who can never forget Vietnam, and so on (the Tareyton ad with the slogan "would rather fight than switch" hinted at in the last line began in 1963, appeared on TV from 1966-1971, and, according to Wikipedia, the "then-fresh slogan was adopted by supporters of Barry Goldwater during the 1964 campaign for the presidency."). Their villains may have changed, but the world is still framed by the battles of the past.

Most of them are getting along in years, and their days in control are numbered by the march of time, but who will still be there to take over for them once they give up the reins of power? There is a new generation of Republicans ready to take the Party in a new direction, or at least disassociate themselves with the craziness, but they do not yet have a voice strong enough to stand up to the "Cheney-Limbaugh-Palin wing" and fight for control of the Party. As much as I agree with Bruce Bartlett that this is necessary for the health of the Republican Party going forward, and as much as I agree with others that in the long-run it is best if the two parties are competitive, I am not sure that Colin Powell is that leader. I hope he surprises me, and in any case he can and should be an important part of the fight, but I think the answer is elsewhere.

But where?


Paul Krugman: State of Paralysis

Will California be a trend setter once again?:

State of Paralysis, by Paul Krugman, Commentary, NY Times: California, it has long been claimed, is where the future happens first. But is that still true? If it is, God help America.

The recession has hit the Golden State hard. The housing bubble was bigger there than almost anywhere else, and the bust has been bigger too. ... What's really alarming about California, however, is the political system's inability to rise to the occasion.

Despite the economic slump,... California has immense human and financial resources. It should not be in fiscal crisis; it should not be on the verge of cutting essential public services and denying health coverage to almost a million children. But it is...

The seeds of California's current crisis were planted more than 30 years ago, when voters overwhelmingly passed Proposition 13... Property tax rates were capped, and homeowners were shielded from increases in their tax assessments even as the value of their homes rose.

The result was a tax system that is both inequitable and unstable. ... Even more important, however, Proposition 13 made it extremely hard to raise taxes, even in emergencies: no state tax rate may be increased without a two-thirds majority in both houses of the State Legislature. And this provision has interacted disastrously with state political trends.

For California, where the Republicans began their transformation from the party of Eisenhower to the party of Reagan, is also the place where they began their next transformation, into the party of Rush Limbaugh. As the political tide has turned against California Republicans, the party's remaining members have become ever more extreme, ever less interested in the actual business of governing.

And while the party's growing extremism condemns it to seemingly permanent minority status ... the Republican rump retains enough seats in the Legislature to block any responsible action in the face of the fiscal crisis.

Will the same thing happen to the nation as a whole? ... America's projected deficits may sound large, yet it would take only a modest tax increase to cover the expected rise in interest payments — and right now American taxes are well below those in most other wealthy countries. The fiscal consequences of the current crisis, in other words, should be manageable.

But that presumes that we'll be able, as a political matter, to act responsibly. The example of California shows that this is by no means guaranteed. And the political problems that have plagued California for years are now increasingly apparent at a national level.

To be blunt: recent events suggest that the Republican Party has been driven mad by lack of power. The few remaining moderates have been defeated, have fled, or are being driven out. What's left is a party whose national committee has just passed a resolution solemnly declaring that Democrats are "dedicated to restructuring American society along socialist ideals," and released a video comparing Speaker of the House Nancy Pelosi to Pussy Galore.

And that party still has 40 senators.

So will America follow California into ungovernability? Well, California has some special weaknesses that aren't shared by the federal government. In particular, tax increases at the federal level don't require a two-thirds majority, and can in some cases bypass the filibuster. So acting responsibly should be easier in Washington than in Sacramento.

But the California precedent still has me rattled. Who would have thought that America's largest state, a state whose economy is larger than that of all but a few nations, could so easily become a banana republic?

On the other hand, the problems that plague California politics apply at the national level too.

Update:

Oops — column notice: Alert readers may notice that the last sentence of today's column doesn't seem to make sense in context. That's because it's not supposed to be there; it's a fossil from an earlier draft. My fault — I was filing from a remote location in a very different time zone, and didn't check properly. Urp.


Global Imbalances and Future Crises

I've been trying to figure out how much danger there is of a sudden unwinding of global imbalances that could extend and potentially deepen the recession. I've been worried there is a chance this could happen, but Barry Eichengreen explains that there are "two hopes for avoiding this disastrous outcome":

Fix global imbalances to avert future crises, by Barry Eichengreen, Commentary, Project Syndicate: Future history books, depending on where they are written, will take one of two approaches to assigning blame for the world's current financial and economic crisis.

One approach will blame lax regulation, accommodating monetary policy, and inadequate savings in the US. The other, already being pushed by former and current US officials like Alan Greenspan and Ben Bernanke, will blame the immense pool of liquidity generated by high-savings countries in East Asia and the Middle East. All that liquidity, they will argue, had to go somewhere. Its logical destination was the country with the deepest financial markets, the US, where it raised asset prices to unsustainable heights.

Note the one thing on which members of both camps agree: the global savings imbalance – low savings in the US and high savings in Chinaand other emerging markets – played a key role in the crisis... Preventing future crises similar to this one therefore requires resolving the problem of global imbalances. ...

Whether there is a permanent reduction in global imbalances will depend mainly on decisions taken outside the US, specifically in countries like China. One's forecast of those decisions hinges, in turn, on why these other countries came to run such large surpluses in the first place.

One view is that their surpluses were a corollary of the policies favouring export-led growth that worked so well for so long. China's leaders are understandably reluctant to abandon a tried-and-true model. They can't restructure their economy instantaneously. ... They need time to build a social safety net capable of encouraging Chinese households to reduce their precautionary saving. If this view is correct, we can expect to see global imbalances re-emerge once the recession is over and to unwind only slowly thereafter.

The other view is that China contributed to global imbalances not through its merchandise exports, but through its capital exports. What China lacked was not demand for consumption goods, but a supply of high-quality financial assets. It found these in the US, mainly in the form of Treasury and other government-backed securities, in turn pushing other investors into more speculative investments.

Recent events have not enhanced the stature of the US as a supplier of high-quality assets. And China, for its part, will continue to develop its financial markets and its capacity to generate high-quality financial assets internally. But doing so will take time. Meanwhile, the US still has the most liquid financial markets in the world. This interpretation again implies the re-emergence of global imbalances once the recession ends, and their very gradual unwinding thereafter.

One development that could change this forecast is if China comes to view investing in US financial assets as a money-losing proposition. US budget deficits as far as the eye can see might excite fear of losses on US Treasury bonds. A de facto policy of inflating away the debt might stoke such fears further. At that point, China would pull the plug, the dollar would crash, and the Fed would be forced to raise interest rates, plunging the US back into recession.

There are two hopes for avoiding this disastrous outcome. One is relying on Chinese goodwill to stabilise the US and world economies. The other is for the Obama administration and the Fed to provide details about how they will eliminate the budget deficit and avoid inflation once the recession ends. The second option is clearly preferable. After all, it is always better to control one's own fate.


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