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September 29, 2009

Economist's View - 7 new articles

"New Income Inequality Data: Surprising and Frightening"

Bruce Judson is worried about what the latest reports on economic inequality say about our future:

New Income Inequality Data: Surprising and Frightening, by Bruce Judson: The newest economic inequality numbers ... are frightening. Yesterday, the Associated Press released an article titled, US income gap widens as poor take hit in recession. The opening paragraph of the article, based on recent census data, reads:
The recession has hit middle-income and poor families hardest, widening the economic gap between the richest and poorest Americans as rippling job layoffs ravaged household budgets.
The article ... failed to mention that the Census Bureau considered the differences between 2007 and 2008, with regard to economic inequality, statistically insignificant. But, whether the Census Data shows a meaningful increase, or not is irrelevant. The Census Data reports that, contrary to the almost universal expectations of economists, economic inequality most likely did not decrease in 2008. Experts had anticipated that the declines in income of the rich would lead to a reversal in this groups ever–widening share of our national income. Instead, the Census reported that the 2008 income losses by the top 10% of Americans were offset by larger losses among middle class and poorer Americans. ...
Early next week, my new book It Could Happen Here will be released... The book is an in-depth look , based on a historical analysis, of the implications of our historically high levels of economic inequality for the nation's ultimate, long-term political stability. As economic inequality grows, nations invariably become increasingly politically unstable: Should we complacently believe that America will be different?
A central conclusion of the book is that once economic inequality reaches a self-reinforcing cycle it is halted only by inevitably controversial, hard-fought, bitterly opposed government action. ... In 1928, economic inequality was near today's levels. Franklin Roosevelt succeeded in reversing the trend toward the continuing concentration of wealth, but it was a turbulent battle. ...
In FDR's era and in our own, money brings power: both explicitly and implicitly, in hundreds of different ways, both large and small. Today, the wealthiest Americans, together with a number of financial and corporate interests that act on their behalf, protect their ever-increasing influence through activities that include, among others, lobbying, supplying expertise to the councils of government, casual conversation at dinner parties, the potential for jobs after government service, the power to run media advertisements that influence public opinion. Indeed, MIT economist Simon Johnston, writing in The Atlantic asserted that the U.S. is now run by an oligarchy...
The new inequality data suggests that the potential problems for the nation associated with the concentration of wealth and power are even more severe than previously recognized. Two weeks ago, I wrote that "Once income concentration becomes a reinforcing cycle of the kind we are witnessing, it is never stopped by pure market forces." This mechanism is now in full swing. ...
The great strength of American democracy has always been its capacity for self-correction. However, Robert Dahl, the eminent political scientist, recognized that political power fueled by wealth may ultimately neutralize this central aspect of our democracy. In his 2006 book, On Political Equality, Dahl wrote:
As numerous studies have shown, inequalities in income and wealth are likely to produce other inequalities..
The unequal accumulation of political resources points to an ominous possibility: political inequalities may be ratcheted up, so to speak, to a level from which they cannot be ratcheted down. The cumulative advantages in power, influence, and authority of the more privileged strata may become so great that even if less privileged Americans compose a majority of citizens they are simply unable, and perhaps even unwilling, to make the effort it would require to overcome the forces of inequality arrayed against them.
In the chapter following this quote, Dahl notes "that we should not assume this future is inevitable." He's right. But he was clearly concerned. ...
Many current Executive Branch initiatives deserve our support and praise: However, nothing proposed to date will effectively halt growing economic inequality, and its corrosive impact on our economy and the long-term future of the nation. ...
My analysis in It Could Happen Here concludes that without a vibrant middle class, the the American democracy as we know it, is not sustainable. Before the Great Recession, the middle class was in far worse shape than was generally acknowledged. In an economy with a record number of job seekers for every available job, the potential for nearly one-half of all home mortgages to be underwater, and increasing foreclosures, the collapse of the middle class will accelerate. With each job loss and each foreclosure, another family becomes a member of the former middle class.
America has never been a society sharply divided between have's and have not's. Unfortunately, this new data says to me we continue to head in that direction. Economists assumed that the Great Recession would be a circuit breaker that would halt this advance, at least temporarily. It did not. ...
Could our democracy survive a transformation into a nation composed principally of a privileged upper class and an underclass that struggles from paycheck to paycheck that lacks basic economic security. My analysis of a broad sweep of history, suggests it could not.
We will only stop the growth of economic inequality if the President and the Congress are ready to fight in the style of Franklin Roosevelt. FDR was a divider not a conciliator. Before World War II, he fought an all-out war at home. Today, "There's class warfare, all right," as Warren Buffett said, "but it's my class, the rich class, that's making war, and we're winning."
I fervently hoped that we have not passed the point of no return, described by Professor Dahl. The recent news shows we are one step further on this road. If we continue down it, our nation may be on the path to becoming a House divided against itself, which ultimately cannot stand.

Are you as concerned as he is? I don't know if we are headed down the path of no return or not, but the part that concerns me is that recent changes in inequality do not seem to be driven by market forces that properly evaluate and reward productive activity.

Republicans worry a lot about the effect that small changes in tax rates would have on economic activity (something there's not a lot of evidence to support) because taxes distort the relationship between effort and reward. But if the rewards have become generally separated from productive effort, particularly the large rewards at the very top of the income distribution where the Republicans argue these incentive effects are the strongest, then there are large distortions in the system that have nothing to do with taxes. That is what Republicans ought to be worried about if they are truly concerned with ensuring that the rewards people receive match their productive effort.

Social Mobility

Andrew Leigh says this is a "a terrific piece on social mobility":

American dreams, by Peter Browne: When Barack Obama spoke to schoolchildren at Wakefield High School in Virginia last week, he drew on his own experiences to argue that all young Americans, regardless of their family's wealth and income – even kids who "goofed off" at high school, like he did – have the potential to rise to the top. ...
But how typical is [this]? ... The seductive idea that anyone can move up the income scale might mean that Americans are more tolerant of a degree of inequality that would cause much deeper unease in many other western countries. ...
[R]ecent research drawing on a series of studies from Europe, the United States and Australia ... has concluded ... that among comparable countries, the United States has an unusually rigid social system and limited possibilities for mobility. ...
President Obama is no doubt aware of this research, and has made oblique references to the problems facing low-income families and neighborhoods in speeches and interviews. But the mobility myth is so widely believed and so deep-seated that it's not surprising he hasn't tried to confront the problem head on. When the Economic Mobility Project [2] surveyed 2100 adults and ran ten focus groups earlier this year it found that respondents overwhelmingly believe that personal attributes – "like hard work and drive" – are the prime determinants of how economically successful an individual can be. A smaller majority also disagreed with the statement that "In the United States, a child's chances of achieving financial success is tied to the income of his or her parent."
As the studies show, that statement is true for ... a higher proportion of American children than in most comparable countries. Among the twelve countries analyzed by economist Anna Cristina d'Addio in a 2007 OECD report,... the United States was in a group of four – with France, Italy and Britain – where family background plays the greatest role in influencing adult income. Children born into a poor family in any of these countries had a much lower chance of breaking into a higher income group than in any of the other countries in the study. ...
Britain came out worst, with around 50 per cent of a person's income explained by his or her parents' income. ... Italy and the United States weren't far behind, at around 47 per cent. At the other end of the range were Denmark, Norway, Finland and Canada, where parental income explained less than 20 per cent of the child's eventual earnings. ...[I]t's those four countries, rather than the United States, that come closest to realizing the American Dream.
Some studies have found that mobility is not only limited in the United States but has worsened in recent decades. ...
Why do some countries fare so badly...? The OECD report offers the most comprehensive list of likely factors, but its conclusions are tentative. ... But looking at the factors that the OECD believes contribute "significantly" to differences in mobility, it isn't hard to see why the United States performs badly...
First, there's the problem of entrenched income inequality. "In general," says d'Addio..., "the countries with the most equal distributions of income at a given point in time exhibit the highest mobility across generations." Among the twelve countries examined in the report, the United States has the most unequal distribution of income. ...
Equally interesting is the role of immigration in pushing up mobility. Overall, immigrants tend to be more upwardly mobile than the broader population. ... Yet the United States doesn't seem to have gained the ... benefits from migration... This clearly has something to do with how well migrant students perform at school. ...
The other key factor identified indirectly by the OECD, and more explicitly in a new Economic Mobility Project [8] report, is a strikingly low level of mobility among black Americans. ... The author of the Project's report, New York University sociologist Patrick Sharkey, finds that growing up in a high-poverty neighborhood "increases the risk of experiencing downward mobility and explains a sizable portion of the black-white downward mobility gap."
These neighborhoods usually suffer from other warning signs for low mobility identified in the OECD report, including a high rate of male unemployment at the time of a child's birth and a high rate of relationship breakdown. ...
For Barack Obama, the ... reform that's causing him the most difficulty at the moment – healthcare – also has implications for economic mobility. Child birth-weight is a "significant" factor in explaining low mobility, and the child's mental health and parents' physical health are "significant and large" factors, according to the OECD. Like any measures designed to break down the rigidity that keeps many Americans poor, improvements in health will take some time to influence overall mobility. But a system of health insurance for all Americans would certainly have an impact in the long term.

Ironically, the remarkable rise of Barack Obama could make it harder for Americans to recognize the shaky foundations of the American Dream. And the fact that so many people continue to believe the myth could make the problem worse. As the American researcher Isabel Sawhill writes, "When those who are relatively poor believe that they or their children will rise in status over time, they are less likely to complain about the status quo and more likely to accept the prevailing system." ...

Is it true that we tolerate inequality because we believe we are highly mobile, and that merit rather than family background is the most important factor in determining social outcomes? Even if it were true that merit is the most determinant of social mobility, that is not enough. The opportunity must be present before those with merit can take advantage of it, and ensuring that everyone has a chance to succeed is an important step in fixing the mobility problem. Nothing will ever be completely equal, some people will always have more opportunity than others to get ahead, but we could do a whole lot better than we are doing now at creating the opportunity for people to reach their full potential.

I am not generally predisposed to redistributive policies, and the best solution to the mobility problem is to ensure everyone has an equal chance to succeed. But since equal opportunity is a long way from reality, I believe that redistribution that compensates for differences in opportunity is justified.

"An Inside Look at How Goldman Sachs Lobbies the Senate"

I am not as negative toward naked short-selling as Matt Taibbi (feel free to convince me I'm wrong), but his insights into the lobbying effort against financial reform are useful, and I share his concerns about the distortions (e.g. regulatory capture) this brings to the reform process:

An Inside Look at How Goldman Sachs Lobbies the Senate, by Matt Taibbi: ...Later on this week I have a story coming out in Rolling Stone that looks at the history of the Bear Stearns and Lehman Brothers collapses. The story ends up being more about naked short-selling and the role it played in those incidents than I had originally planned..., but it turns out that there's no way to talk about Bear and Lehman without going into the weeds of naked short-selling...
It's the conspicuousness ... that is the issue here, and the degree to which the SEC and the other financial regulators have proven themselves completely incapable of addressing the issue seriously, constantly giving in to the demands of the major banks to pare back (or shelf altogether) planned regulatory actions. There probably isn't a better example of "regulatory capture" ... than this issue.
In that vein, starting tomorrow, the SEC is holding a public "round table" on the naked short-selling issue. What's interesting about this round table is that virtually none of the invited speakers represent shareholders or companies that might be targets of naked short-selling, or indeed any activists of any kind in favor of tougher rules against the practice. Instead, all of the invitees are either banks, financial firms, or companies that sell stuff to the first two groups.
In particular, there are very few panelists — in fact only one, from what I understand — who are in favor of a simple reform called "pre-borrowing." Pre-borrowing is what it sounds like; it forces short-sellers to actually possess shares before they sell them.
It's been proven to work, as last summer the SEC, concerned about predatory naked short-selling of big companies in the wake of the Bear Stearns wipeout, instituted a temporary pre-borrow requirement...
The lack of pre-borrow voices invited to this panel is analogous to the Max Baucus health care round table last spring, when no single-payer advocates were invited. So who will get to speak? Two guys from Goldman Sachs, plus reps from Citigroup, Citadel (a hedge fund that has done the occasional short sale, to put it gently), Credit Suisse, NYSE Euronext, and so on.
In advance of this panel and in advance of proposed changes to the financial regulatory system, these players have been stepping up their lobbying efforts... Goldman Sachs in particular has been making its presence felt.
Last Friday I got a call from a Senate staffer who said that Goldman had just been in his boss's office, lobbying against restrictions on naked short-selling. The aide said Goldman had passed out a fact sheet about the issue that was so ridiculous that one of the other staffers immediately thought to send it to me. When I went to actually get the document, though, the aide had had a change of heart.
Which was weird, and I thought the matter had ended there. But the exact same situation then repeated itself with another congressional staffer, who then actually passed me Goldman's fact sheet.
Now, the mere fact that two different congressional aides were so disgusted by Goldman's performance that they both called me on the same day — and I don't have a relationship with either of these people — tells you how nauseated they were.
I would later hear that Senate aides between themselves had discussed Goldman's lobbying efforts and concluded that it was one of the most shameless performances they'd ever seen from any group of lobbyists, and that the "fact sheet" ... was, to quote one person familiar with the situation, "disgraceful" and "hilarious." ...

"The Side He Picked in Economics was an Odd One"

David Warsh on Irving Kristol:

The Straw That Stirred the Drink, by David Warsh: Irving Kristol, who died earlier this month at 89, meant many different things to many different people. One way to remember him is as the editor who, with his friend and City College of New York classmate Daniel Bell, founded The Public Interest in 1965, at just the moment the phenomenon known as "the counterculture" was beginning to grip the popular imagination of the West.
The first issue featured Robert Solow on "Technology and Unemployment," Daniel Patrick Moynihan on "The Professionalization of Reform," Nathan Glazer on "The Paradoxes of Poverty," Jacques Barzun on "Art – By Act-of-Congress," Daniel Greenberg on "The Myth of the Scientific Elite," Martin Diamond on "Conservatives, Liberals and the Constitution," and Daniel Bell on "The Study of the Future."
And for the next fifteen years, while the Americans lost their way in Vietnam, the Soviet economy stagnated, the Chinese people suffered Mao Tse Tung's Cultural Revolution, The Public Interest was the quarterly that kept its head, serving as a focal point for meliorists of all kinds. Magazines such as People, Money and Rolling Stone built huge audiences in those years; The Public Interest rarely sold more than 12,000 copies. But the people who read it would in due course take over the nation's politics.
An extraordinary galaxy wrote for Kristol in those days on nearly every social issue of the day (Bell, a professor of sociology at Harvard, cut back his participation after the two disagreed on the presidential election of 1972): Peter Drucker, Milton Friedman, Seymour Martin Lipset, James Coleman, Robert Nisbet, Henry Fairlie, Aaron Wildavsky, William Bennett, James Tobin, Richard Zeckhauser, Thomas Schelling, Herbert Stein, Gordon Crovitz, Anthony Downs, David Gordon, John Meyer, Jeffrey O'Connell, Paul Starr, Christopher Jencks, Charles Reich, Michael Novak, Charles Lindblom, Josiah Lee Auspitz. They were conservatives and liberals alike, but the quarterly's content steadily trended over the years towards the stance that in time would become known as "neoconservative." (A terrific full issue-by-issue archive can be found here.)
Kristol "was able to pick a side without losing his clarity," wrote David Brooks in his New York Times column last week.
The side he picked in economics was an odd one. A 1975 issue featured a pair of articles: "The Social Pork Barrel" launched the career of a young Michigan Congressman, David Stockman, who would become budget director for Ronald Reagan; and "The Mundell-Laffer Hypothesis – a New View of the World Economy," by Wall Street Journal editorial writer Jude Wanniski, introduced the world to economists Arthur Laffer and Robert Mundell, and their newly-invented brand of "supply side economics."
The striking thing about Wanniski's article was its anti-establishment tone, anti-Chicago as well as anti-Cambridge, Mass. The new hypothesis might be as transformative as the Copernican Revolution, he averred – or at least that of John Maynard Keynes. Mundell and Laffer's enthusiasms for a gold standard, fixed exchange rates, large tax cuts and tight money were picked up and greatly amplified by the editorial page of The Wall Street Journal. The Republican Party was divided – insouciant economic populists in one wing, sober technocrats in another.
In the neo-conservative firmament, the stars of ordinarily first-magnitude conservatives Milton Friedman and Martin Feldstein dimmed, while Laffer and Wanniski brightened. The success of The Way the World Works, Wanniski's 1979 book for editor Midge Decter, nearly ripped apart the boutique social science publisher Basic Books, where Kristol worked as an editor as well.
By then The Public Interest was losing its force. As James Q. Wilson wrote the other day in The Wall Street Journal, "It began to speak more in one voice and the number of liberals who wrote for it declined." Daniel Bell quietly resigned, in 1980. It didn't matter. The Republicans were in power; and Kristol was ready for a second act. He would become widely known as "the Godfather" of neo-conservatism, dispensing favors and advice as a political activist operating out of the American Enterprise Institute in Washington.
In its obituary last week, The Economist summed up this second act of Kristol's career: "American conservatism, before he began to shake it up, was dour, backward-looking, anti-intellectual and isolationist, especially when viewed from the east coast. By the time Mr. Kristol … had finished with it, it was modern and outward looking, plumped up with business-funded fellowships and think tanks and taking the lead in all policy debates."

Success profoundly changed the game. The Cold War ended. The discipline and sense of fair play seemed to go out of civic life. There hasn't been anything like The Public Interest since. But for fifteen crucial years in the late '60s and '70s, Kristol's editing was the straw that stirred the drink.

I'm running short on time, so I'll leave the commentary to all of you, but I will note this:

Irving Kristol explains where the economics articles he published in The Public Interest came from:

Among the core social scientists around The Public Interest there were no economists.... This explains my own rather cavalier attitude toward the budget deficit and other monetary or fiscal problems. The task, as I saw it, was to create a new majority, which evidently would mean a conservative majority, which came to mean, in turn, a Republican majority - so political effectiveness was the priority, not the accounting deficiencies of government...

"Crunch Time: The Fight to Fix the Financial System"

Simon Johnson and James Qwak wonder how much political capital the administration is willing to use to meaningfully reform the financial system:

It's Crunch Time: The Fight to Fix the Financial System Comes Down to This, by Simon Johnson and James Kwak, Commentary, Washington Post: The next couple of months will be crucial in determining the shape of the financial system for decades to come. And so far, the signs are not encouraging.
The Obama administration is trying to refocus our attention on regulation, beginning with the president's speech in New York two weeks ago. ... Barney Frank, chairman of the House Financial Services Committee, says that he still plans to pass a regulatory reform bill before the end of the year.
But in a clear indication of trouble ahead, Frank signaled his intention last week to scale back the proposed Consumer Financial Protection Agency, one of the pillars of the administration's reform proposals. ...
We have criticized the administration's reform proposals, in particular for not going far enough to address the problem of financial institutions that are "too big to fail." But we support much of what was in the original package... The question now is how hard Obama and Geithner will fight for it.
Financial regulation, like health care reform, has entered the phase where speeches and proposals matter less than arm-twisting and horse-trading on Capitol Hill. With health care, President Obama attempted to go over the heads of Congress, directly to the American people. With financial regulation, that is no longer an option, given the extent to which it has faded from public consciousness. Instead, the administration is playing on the home turf of the banking industry and its lobbyists. ... Is Obama up for this fight? ...
Elections have consequences, people used to say. This election brought in a popular Democratic president with reasonably large majorities in both houses of Congress. The financial crisis exposed the worst side of the financial services industry to the bright light of day. If we cannot get meaningful financial regulatory reform this year, we can't blame it all on the banking lobby.

The initial bill needs to be as strong as possible, and I agree that the administration needs to do what it can to prevent the bill from being scaled back. However, the initial legislation won't be as strong as I'd like even if the administration does prevail. But I hope we aren't thinking that we'll take one stab at financial reform and then we'll be done with it. Like climate change and health care, it will require a series of bills to achieve effective reform.

"Come Dine with Me: The Economics"

Chris Dillow says the British TV show Come Dine with Me "raises important issues about the nature of rationality and preferences":

Come Dine With Me: the economics, by Chris Dillow: It's insufficiently appreciated that Come Dine with Me raises some profound issues in economics. Here are three:
1. The importance of norms of fairness. The format of CDWM is simple. There are four people. Each hosts a dinner party for the other three. The guests score their host out of 10. The person with the highest score wins £1000.
In this game, the optimum strategy for a guest is to score their hosts zero. This would mean the maximum score one's rival hosts could make would be 20, which in a normal game would not usually be sufficient to win. So, if your three rivals play normally, scoring them zero greatly increases your chances of winning.
If everyone knows this, we end up in a Nash equilibrium in which everyone scores zero; this is a one-shot game with scores revealed only after all four dinner parties, so tit-fot-tat doesn't apply.
But this never happens. Even contestants who claim to want to win score their rivals reasonably. This suggests that norms of fairness overwhelm selfish optimization*.
This raises the question, though: why is CDWM so different from Golden Balls - which is a pure Prisoners' Dilemma game - where we often see the selfish defect-defect strategy?
The answer, I suspect, lies in the abundance effect. The difference between CDWM and Golden Balls is that in the latter money is much more salient. And research (pdf) shows that, the more people think about money, the more selfish they behave.
The lesson is that context - not just incentives - matter.
2. The trickiness of inter-personal comparisons of utility. Let's assume that games are scored purely according to perceptions of fairness. It doesn't follow that everyone has an equal chance.
Take, for example, two people. One is a gourmand, used to fine dining and the highest standards. The other has low expectations. Our gourmand might well score a fair-to-middling dinner much lower than the diner with low standards. On this account the gourmand would have more chance of winning than the other diner, even if both are cooks of equal ability.
One might question the justice of this. More importantly, it raises the question: why should expressed preferences carry so much weight when they can be heavily affected by factors which should perhaps be irrelevant?
3. The importance of ordering. The four people are strangers. This means the first host is in a different position to the last host. The first is likely to judged heavily on his food, as the guests barely know him. But later hosts are more likely to be judged on personality as well, as by then the four have gotten to know each other.
This can cause diners to regret their earlier scores. We saw this last night, when Rachel said that, had show known how big an arse Stuart - the first host - was, she would not have scored him so highly.
This poses a big problem for conventional rational choice economics. It typically takes preferences as given, and revealed by choice. However, CDWM shows that preferences are sensitive to the order in which options appear. For Rachel, the choice: "score Stuart, then score Josh" yielded a different result than "score Josh, then score Stuart" would have done. I suspect this is related to Allais's paradox.
So, CDWM raises important issues about the nature of rationality and preferences. Watched even in narrow economists' terms, it is much more interesting than politicians' waffle about the crisis.
* Or it could be that the producers just tell the contestants not to play silly buggers.

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