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November 8, 2009

Economist's View - 4 new articles

Does Doing Nothing Cost Nothing?

Failure to enact health care reform will be costly:

The cost of not enacting health care reform, by Linda J. Bilmes and Rosemarie Day, Commentary, Boston Globe: Much of the health care debate is focused on whether the country can afford the $850 billion the Congressional Budget Office estimates it will cost. ... This debate ... assumes that doing nothing will cost nothing. It turns out that not expanding health insurance is a pretty costly option...
Several major medical studies have determined that people with health insurance have lower death rates compared to the uninsured, fewer medical ailments, and better all-around health. This means more individuals contribute to the economy for longer. Not having health insurance means these economic benefits are lost.
For example,... Americans ... die each year because of a lack of health insurance. These deaths are largely because of failures to diagnose illness and to limited access to good quality care. ... A new study ... puts the number of deaths among Americans between the ages of 18 and 64 associated with lack of health insurance at 44,789 a year.
The premature death of thousands of Americans can be translated into monetary terms using the economic "value of a statistical life." ... US government agencies typically use a figure around $7 million to represent the lost economic output from each death. If we conservatively use only half of the government figure, or $3.5 million, it suggests that the ... cost to the US economy of 40,000 deaths is ... more than a trillion dollars over a 10-year period - even taking future inflation into account - well above the cost of enacting a health care package.
A second way to estimate the cost of not enacting health care legislation is in terms of life expectancy. US life expectancy - at 78.11 years, ranks around 40th in the world and well below countries with universal health care. If we were to match Canadian life expectancy, for example, that would translate into an extra two years and 1 month of life expectancy for every American.
Economists use another measure for the value of an additional year of life, adjusted for the quality of life. ... Most insurance companies, and many countries around the world, ... implicitly ascribe the value of an additional year of human life at $50,000... If the United States ... were able to ... insure at least 15 million more Americans, ...[r]aising the US life expectancy to match Canada ... would translate into $150 billion in economic value over three years.
Less health insurance ... also impairs the quality of life - and hence the productivity - of those who are living. This is evident in comparing the health of Americans who live in states with high levels of insurance with those who do not. ... People living in states with the highest insurance levels have better health indicators, including fewer low birth weight babies, lower infant mortality, and lower death rates from diabetes, heart disease, strokes, Alzheimer's, and some types of cancer (cervical, colorectal). ... Moreover, the annual death rate ... was lower... It is tricky to put a precise number on the economic loss from poorer life quality, but we can be sure the economic loss is substantial. ...
Without health care reform, the economic cost imposed by premature deaths and avoidable illnesses will continue to grow... Congress needs to weigh carefully the substantial cost of doing nothing.

"Conditional Altruists"

Daniel Little wonders what accounts for the spontaneous occurrence of cooperation and collective action:

Assurance game, by Daniel Little: How does a group of people succeed in coming together to contribute to a collective project over an extended period of time? For example, what leads a group of unemployed workers to travel to the capital to lobby for an extension of unemployment benefits, or a group of expatriate Burmese people in London to attend demonstrations against the junta? What motivations are relevant at the individual level? And what circumstances are most conducive to creating and sustaining collective action? Purely self-interested egoists won't make it -- that is the message of Mancur Olson's Logic of Collective Action: Public Goods. The maximizing egoist will reason that the activity will either succeed or fail independent of his/her own participation. If it succeeds then he will enjoy the benefits of cooperation; and if it fails he will have avoided the wasted costs of participation. Either way the egoist does better by refraining from participation. So collective action in pursuit of a public good is all but impossible within a society of rationally disinterested egoists. As Amartya Sen observes in "Rational Fools" (link), "The purely economic man is indeed close to being a social moron." But we know that this conclusion does a bad job of describing real social life. People in villages, communities, political parties, religious organizations, public television audiences, and ethnic groups do in fact often succeed in getting themselves organized and mobilized in pursuit of a public good for the group. Often the level of mobilization is below the level that would be optimal for production of the good for the population; often it is fairly straightforward to identify the symptoms of incipient free-riding; but ordinary social experience and history alike are replete with examples of voluntary collective action. Many theories can be articulated in order to account for the spontaneous occurrence of collective action. People may be irrational; they may be motivated entirely by non-utility considerations; they may be governed by norms of solidarity beyond their rational control; they may be disciplined by grassroots organizations that punish defectors; there may be an evolutionary basis hard-wired into the human cognitive-deliberative system that favors cooperation; or, for that matter, there may be a hard-wired impulse towards punishing defectors from common projects that tips the balance of utility calculation for would-be free-riders. But here is a factor that seems to be a credible observation about social motivation and that still makes sense of the behavior in deliberative terms. Many real social actors seem to be what might be called "conditional altruists": they are willing to contribute some effort or personal resource to a collective project if they have grounds for confidence that a reasonable number of other members of the group will contribute as well. (Jon Elster explores the idea in The Cement of Society: A Survey of Social Order.) And it isn't that these actors make a calculation error along the lines of the fallacy of unanimity -- "I want the benefits of the collective action, and it won't occur without me." Instead, they seem to reason in ways that would please a communitarian: "I'm a member of this group, I believe that other members will do what's good for the group, and I'm willing to do my part as well." This is a fairly explicit willingness to sacrifice the benefits of free riding. But the conditional part is important as well: the conditional altruist is calculating about the likelihood of success in the collective undertaking, and is willing to participate only if he/she judges that enough other people will contribute as well to make the undertaking feasible. Conditional altruism thus attributes a common moral psychology to social actors, which we might refer to as the "fairness factor." Individuals are willing to factor collective goods into their calculation of the costs and benefits of action, and they have some degree of motivation to act in accordance with a proposed collective action that would benefit them even if they could evade participation. They are disposed to act fairly: "If I benefit from the action, I should take my fair share of creating the benefit." (Allan Gibbard's Wise Choices, Apt Feelings: A Theory of Normative Judgment offers an effort to bring together the evolutionary history of the species with a philosopher's analysis of moral reasoning.) If fairness or conditional altruism are real components of human agency (for all or many human beings), then we can identify a few factors that are likely to increase the likelihood of cooperation and collective action. Measures that increase the actor's assurance of the behavior of others will have the effect of eliciting higher levels of collective action. And it is possible to think of quite a few social circumstances that have this effect. A shared history of success in collective action is clearly relevant to current actors' level of assurance about future cooperation. Shared history can be made more powerful in the present through the currency of songs, stories, and performances that highlight earlier successes (Michael Taylor, Community, Anarchy and Liberty). Researchers who study peasant village communities emphasize the importance of face-to-face relations among villagers; individuals know a good deal about the past behavior of their neighbors, which can provide a better basis for predicting their future cooperative behavior (Robert Netting, Smallholders, Householders: Farm Families and the Ecology of Intensive, Sustainable Agriculture). And members of small, stable communities also know that they will need to interact with each other long into the future -- increasing the cost of non-cooperation today (Robert Axelrod, The Evolution of Cooperation: Revised Edition). What is particularly interesting about this topic is the fact that actual social outcomes show a wide range of variations in the degree of self-interest and fairness that seems to be present. Some groups seem to act more like Mancur Olson egoists; others (like Welsh coal miners) seem to act as though they have a very high "solidarity and fairness" quotient. So no single answer to the question of collective action seems to work: "people are rational egoists," "people are altruists," or "people are conditional altruists." Rather, a given opportunity for collective action seems to display a mix of all these styles of reasoning. These variations could be the result of several independent factors: differences in the formation of individuals' moral psychology (emphasizing individualism or community from infancy); differences in current institutional settings (arrangements that make future interactions seem more likely to each participant); even potentially differences in personality or the genetic basis of decision-making across individuals.

I'm sure that there is work in experimental economics that probes the boundaries of this feature of practical reasoning. Ordinary social experience informs us that people have different levels of willingness to undertake sacrifice for a group's projects. And having a more nuanced empirical understanding of how people behave in the settings of potential cooperation and collective action would help refine our understanding of the thought-processes and styles of reasoning through which individuals decide what to do. Here is an interesting paper by Ernst Fehr and Klaus Schmidt titled "The Economics of Fairness, Reciprocity and Altruism – Experimental Evidence and New Theories."

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"Why Do Central Banks Have Assets?"

Nick Rowe says central banks hold assets for three reasons:

Why do central banks have assets?, by Nick Rowe: If you look at the balance sheet of a central bank, you will see it has liabilities (mostly currency) and assets (normally mostly government bonds/bills). Why do central banks have assets? Do they need them?
The wrong answer is that central banks need assets to "back" the value of the currency, and that paper currency would be worthless otherwise. The right answer is: since the government gets all the profits from a central bank anyway, there's no point in giving the government the assets; that owning assets lets the bank reverse course and reduce the money supply if it ever needs to; and it stops the accountants freaking out.
Let's deal with the wrong answer first. According to the "backing" theory of the value of money, the value of a central bank's currency is equal to and determined by the value of the central bank's assets backing the currency. (This is different from the fiscal theory of the price level, which says that the value of currency plus bonds is equal to and determined by the present value of primary fiscal surpluses.)
The backing theory sounds good. How can intrinsically worthless paper money have value? Because it is backed by valuable assets. It's just like shares in a mutual fund, which have value equal to and determined by the value of the assets in the fund.
Here are three arguments against the backing theory of money:
1. The assets of central banks are normally nearly all nominal assets, denominated in the same currency as the liabilities. Suppose the price level were to double magically overnight, and the real value of currency halved. The real value of the bonds held by the central bank would also halve. So a magical doubling of the price level would not violate the equality between the value of the currency and the value of the assets backing it. The backing theory leaves the price level indeterminate. It could only pin down the price level if the assets were real assets. If (say) 10% of the bank's assets were real (gold reserves, plus the building), then a 1% loss of its real assets (the building burns down) would cause a 10% jump in the price level.
2. Suppose a mutual fund held bonds, but all the interest on the bonds (minus the administrative expenses of running the fund) were handed over to some third party, and not to the owners of shares in the mutual fund. Who would want to own shares in that mutual fund? The net present value of the dividends paid to the shareholders would be zero, so the shares would be worth zero too. But this is exactly what central banks do. Every year central banks earn profits from the interest on the bonds they own, minus administrative expenses, and hand the whole of that profit to the government, not to the holders of currency.
3. We don't need "backing" to explain why money has value. People want to hold a stock of money because money is a medium of exchange, and holding a stock of the medium of exchange makes shopping easier. This creates a (stock) demand for money. Provided the central bank restricts the supply of money, the intersection of demand and supply curves creates a positive equilibrium value of money (a finite price level). Now you could argue that if paper money were worthless it could not function as a medium of exchange, so you need to assume paper money has value in order to explain the value it has, so the demand and supply theory of the value of money begs the question.
There is some truth in this criticism of standard theories of the value of money. There are indeed two equilibria: the normal one, where paper money has value, and a weird one, where it is worthless. But Ludwig von Mises, for example, addressed this problem in 1912 with his Regression Theory of Money. Historically, money needed to be commodity money, or have commodity backing, in order to get started. But once it does get started, as a social institution, the demand for a medium of exchange supplements the industrial demand for the commodity, and the commodity backing can eventually be withdrawn as custom keeps us out of the weird equilibrium. (When Cambodia reintroduced paper money, after the fall of the Kymer Rouge, it could not create paper money ex nihilo, but initially made it convertible into rice, IIRC.)
A Ponzi scheme is a financial institution with liabilities and no assets backing those liabilities. Paper money can operate just like a Ponzi scheme, but with one important difference. Mr Ponzi promised his clients high rates of interest and/or capital gains. They would not have held his liabilities unless they believed him. The Bank of Canada promises zero interest, zero nominal capital gains, and a minus 2% real rate of interest on people who hold its paper money. Mr Ponzi could not deliver on his promise, even if he hadn't spent the assets. The Bank of Canada can deliver on its promise, even if it gave away all its assets, provided the (real) demand for its paper money does not fall over time more quickly than 2% per year. (If the real demand for money were falling at 2% per year, a constant nominal supply of money would yield 2% annual inflation).
The Bank of Canada does not need assets, because the long run growth in the (real) demand for its paper exceeds the real interest rate at which people are willing to hold its paper. If Mr Ponzi could have met the same test, he wouldn't have needed assets either. People are willing to hold paper money, even at very negative real rates of return (Zimbabwe), because doing so makes shopping easier.
The only reason that the value of a central bank's liabilities are roughly equal to the value of its assets is that whenever the difference between them (its net worth) gets too big, the bank hands its profits over to the government. If central banks choose to keep assets equal in value to their liabilities, and only hand over their annual profits to the government, then saying the value of their assets determines the value of their liabilities gets causality reversed. It is the value of their liabilities that determines the value of their assets.
So why do central banks hold any assets at all? Three reasons (funny how 3 is a magic number):
1. It makes no difference to the owners of the central bank (the government) whether the central bank keeps the bonds and hands the interest over to the government each year, or whether the central bank gives the bonds to the government. The government gets the interest either way; it just passes through another pair of hands. It's a wash.
2. Normally the real demand for paper money grows at about 3% per year (roughly the same as GDP growth rate), but sometimes it rises faster than this (like last year), and sometimes it falls (like next year?). If the demand for money falls, the central bank needs to reduce the supply of money to prevent inflation, and it reduces the supply of money by selling assets. If it had given away all its assets it wouldn't be able to do this.

3. Accountants like double-entry bookkeeping and balance sheets and stuff so they can keep track of things. They like to record assets on one side, and liabilities on the other side, to make sure that everything adds up, to check that everything's been properly recorded. So they like to list currency as a liability of central banks (even though it isn't, because there's no promise to redeem it, or pay interest on it), and assets on the other side. An accountant would freak out if he recorded currency as a liability and couldn't find an equivalent value of assets. He would say that the central bank is a Ponzi scheme. Which of course it is. And it's just not worth the hassle of trying to explain to accountants that some Ponzi schemes are sustainable, really.

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