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May 31, 2009

Economist's View - 5 new articles

"Alpha Markets"

Robert Frank says Charles Darwin provides the "true intellectual foundation" for economics, and that his account of "the complex relationship between individual and social interest" is the key to understanding the financial crisis:

Alpha markets, by Robert H. Frank, Commentary, CIF: Though Adam Smith is almost universally regarded as the father of modern economics, most economists will eventually see Charles Darwin's ideas as the true intellectual foundation of our discipline. Smith's modern disciples celebrate his invisible hand theory, which says markets harness individual self-­interest to serve society's interests. Smith himself was more circumspect, claiming only that self-interested actions often lead to socially benign outcomes. But that claim is remarkable enough. Competition among greedy producers often yields innovations that result in cheaper and better products for everyone.

It was Darwin, however, who better grasped the complex relationship between individual and social interest. And we must turn to his account if we are to understand the recent meltdown in financial markets. His deep insight was that natural selection favours traits and behaviours according to their effect on individual organisms, not groups. Sometimes individual and group interests coincide. But interests at the two levels often conflict.

Male body mass is a case in point. Most vertebrate species are polygynous, meaning that males take more than one mate if they can. The qualifier is important, because when some take multiple mates, others get none. The latter don't pass their genes along, making them the ultimate losers in Darwinian terms. So it is no surprise that males often battle furiously for access to mates. Size matters in those battles. And hence the evolutionary arms races that produce larger males.

Bull elephant seals often weigh more than five times as much as females. But their size is a handicap, making them far more vulnerable to sharks and other predators. Given an opportunity to vote on a proposal to reduce their weight by half, bulls would have every reason to favour it. But they have no such opportunity. And any bull that weighed much less than others would never find a mate.

Similar conflicts arise when individual rewards depend on relative performance. This payoff structure, common in financial markets, helps explain why those markets sometimes fail catastrophically. Wealth managers' salaries depend primarily on how well their investments perform in relative terms. Funds offering higher returns immediately attract cash from rival funds. If the invisible hand functioned as Alan Greenspan and other modern disciples of Adam Smith imagined, there would be no problem. Investors would be fully compensated for any additional risk they took in search of higher returns. But human brains forged by natural selection don't work as assumed in economics textbooks.

As our brains were evolving, immediate threats to survival loomed everywhere. Natural selection thus favoured a nervous system keenly sensitive to immediate relative payoffs, much less so to distant ones. Anyone disinclined to seize immediate gains at the risk of having to incur costs in the future would experience low relative rewards in the short run. And when competition was intense and immediate, such individuals often didn't survive to see the long run.

In market settings, a nervous system biased in favour of short-term relative reward is a recipe for disaster. When the price of an asset like housing is rising steadily, unregulated wealth managers can create leveraged investments that generate enormous rates of return. Even in the early years of this decade, many experienced analysts were warning that several mortgage-backed securities were poised to tumble. But investors faced a tough choice: they could earn high returns by continuing to invest in them, or they could move their money elsewhere. Many rejected the latter strategy because it would have required watching friends and neighbours pass them by.

Wealth managers felt compelled to offer the risky investments, since many customers would otherwise desert them. Managers also knew there would be safety in numbers when things soured, since almost everyone had been following the same strategy. The resulting collapse was inevitable.

Adam Smith's invisible hand is a truly extraordinary insight. But when rewards depend on relative performance, it doesn't always deliver.

The financial meltdown that caught Adam Smith's disciples off guard would not have surprised Darwin. One of his central themes was that because much of life is graded on the curve, wasteful arms races create conflict between individual and social interests. The good news is that unlike other animal species, humans can often resolve such conflicts through intelligent regulation.

Also see Paul Krugman's: What Economists Can Learn from Evolutionary Theorists Synopsis.

"Incarceration as a Labor Market Outcome"

John Quiggin makes a good point:

Incarceration as a labor market outcome, by John Quiggin: I wasn't all that surprised that Bryan Caplan didn't like my interpretation of our bet on EU and US unemployment rates, which was that the combined rates of unemployment and incarceration in the US would exceed those in the EU over the next ten years. I was, however, surprised by the vehemence with which libertarian-inclined* commenters here and at Crooked Timber objected to this interpretation.

A string of them echoed Caplan's argument that

From a labor market perspective, though, Quiggin's incarceration adjustment would only make sense if you thought that most or all of the people in jail would be unemployed if they were released.

Caplan has missed my main point. I'm not suggesting that incarceration is disguised unemployment (though obviously it reduces measured unemployment). Rather, I'm saying that, like unemployment, incarceration should be regarded as a (bad) labor market outcome. If you want to evaluate the performance of the labor market, you need to look at both.

There's nothing radical or leftist about this viewpoint: it's one that is at least implicit in all economic models of the labor market of which I'm aware, and is most particularly explicit in that of the Chicago School*. Most of the crimes for which people are imprisoned in the US can be understood as reflecting economic choices which in turn are determined primarily by the labor market in which those choices are made. This is obviously true of property crime and drug dealing, and it's true, directly or indirectly, of lots of violent crime as well. As Gary Becker put it (quoting from memory here) "a burglar is a burglar for the same reasons as I am a professor". ...

There's plenty of statistical evidence from scholars like Glenn Loury to show that criminals ... are drawn disproportionately from groups with bad labor market prospects: poor, disproportionately black, facing low wages and high risk of unemployment. But well-done case studies are often more convincing, so I'll point to the Venkatesh study of Chicago drug dealers reported in Steve Levitt's Freakonomics. Venkatesh found that most street dealers were making less than minimum wages, and were motivated by the very low probability of surviving to attain the only high-paying job realistically available to them, that of the local kingpin. Even more striking was the observation that, when gang members learned Venkatesh was a university professor, they approached him in the hope that he would be able to wangle them jobs as janitors - otherwise an ambitious, and probably unattainable aspiration.

The Chicago theory on which the case for flexible labor markets is based predicts that the lower is the return associated with the "outside options" of employment or reliance on social insurance, the higher will be the incentive to engage in crime as a way of making a living. ... That is, other things equal, low wages and weak or non-existent unemployment benefit systems can be expected to lead to higher crime rates, higher rates of imprisonment or both. ...

So, I would argue, my interpretation of my bet with Bryan Caplan is the more relevant one in terms of policy evaluation. The proportion of bad labor market outcomes is better measured by the sum of unemployment** and incarceration (expressed as a proportion of the labour force) than by unemployment alone.

* Or maybe shmibertarian: as we saw during the Bush era lots of alleged libertarians are quite comfortable with extreme use of state power as long is doesn't touch their bank balances. On the other side of the coin, I should note that the Cato Institute has done some very good work on this subject, including publishing this Glenn Loury piece. ...

Not all prisoners are the result of bad labor market outcomes, and an index of labor market outcomes may weight these two pieces of information differently, so I'm not sure a simple sum of unemployment and incarceration is the optimal measure of labor market performance. But it does seem adequate as a first approximation, or at least better than the unemployment rate alone, and the underlying point is valid.

A Lump of Coal for Obama

More disappointment with the new leader:

Obama walks a fine line over mining, by Tom Hamburger and Peter Wallsten, LA Times: With the election of President Obama, environmentalists had expected to see the end of the "Appalachian apocalypse," their name for exposing coal deposits by blowing the tops off whole mountains.

But in recent weeks, the administration has quietly made a decision to open the way for at least two dozen more mountaintop removals. ... The list included some controversial mountaintop mines. ...

The administration's decision ... sheds on relations between the mining industry and the Obama White House,... environmentalists ... say they feel betrayed...

The issue is politically sensitive because environmentalists were an active force behind Obama's election, and the president's standing is tenuous among Democratic voters in coal states. ... Moreover,... halting mountaintop mining could eliminate jobs and put upward pressure on energy prices in a time of economic hardship.

Coal advocates have solicited help from officials as high up as White House Chief of Staff Rahm Emanuel. And the issue has sparked contentious debates within the administration, including one shouting match...

Although environmentalists had expected the new administration to put the brakes on mountaintop removal, Rahall and other mining advocates have pointed out that Obama did not promise to end the practice and was more open to it than his Republican opponent, Arizona Sen. John McCain.

A review of Obama's campaign statements show that he had expressed concern about the practice without promising to end it. ... And his EPA administrator, Lisa Jackson, has said that the agency ... would "use the best science and follow the letter of the law in ensuring we are protecting our environment." Soon afterward, the agency in effect blocked six major pending mountaintop removal projects...

But this month, after a series of White House meetings with coal companies and advocates..., the EPA released the little-noticed letter giving the green light to at least two dozen projects. ...

Ed Hopkins, a top Sierra Club official, said some of the projects that have now obtained the EPA's blessing "are ... large and potentially destructive..." "It makes us wonder what standards -- if any -- the administration is using," Hopkins said. ...

Environmentalists were stunned to learn from Rahall's office May 15 that the EPA had given its blessing to 42 out of the 48 mine projects it had reviewed so far -- including two dozen mountaintop removals.

The news came in a letter ... from ... the EPA's acting assistant administrator, who wrote, "I understand the importance of coal mining in Appalachia for jobs, the economy, and meeting the nation's energy needs."

Carbon Offsets

Robert Frank argues for carbon offsets as a complement to carbon taxes or cap-and-trade:

Carbon Offsets: A Small Price to Pay for Efficiency, by Robert H. Frank, Commentary, NY Times: Are carbon offsets a good thing? They are intended to reduce the environmental impact of consumption. Traveling by plane, for example, causes carbon dioxide to be emitted into the atmosphere, so travelers can pay a specialist to offset those emissions some other way — perhaps by planting vegetation or installing renewable-energy technologies. It all sounds reasonable.

Yet carbon offsets have drawn sharp criticism, even ridicule. ... But the criticism is misguided. If our goal is to reduce carbon emissions as efficiently as possible, offsets make perfect economic sense.

Consider the decision of whether to buy a hybrid car. ... Many people drive so little that they wouldn't save enough on gasoline to recoup the higher cost. Yet many such people buy hybrids anyway, because they think they are helping the environment. Well and good, but they could help even more by buying a standard car and using the savings to buy carbon offsets. ...

Of course, carbon offsets alone won't eliminate global warming. People also need stronger incentives to take into account the environmental consequences of their actions.

President Obama has proposed attacking the problem with a carbon cap-and-trade system. ... This approach was first used in the United States to address acid rain... Compared with more traditional regulatory measures, the auction method substantially reduced the cost of achieving the law's air-quality target.

As people learn more about such an approach, they seem less likely to oppose it. ... A carbon cap-and-trade system is functionally similar to a carbon tax. ... Carbon offsets are no substitute for the stronger incentives inherent in carbon taxes or cap-and-trade, but they can reinforce their effects. Both carbon taxes and permit auctions would also generate revenue that could be used to buy additional carbon offsets. ... Carbon offsets, though much maligned, are an excellent idea. If you want to help reduce carbon emissions, consider buying some.

links for 2009-05-31

May 30, 2009

Economist's View - 5 new articles

"The Fall of the Mall"

Compares sales in the first quarter of 2009 to the same quarter in 2008. "The deeper the red, the steeper the loss."

Reich: The Future of Manufacturing

Robert Reich:

The Future of Manufacturing, GM, and American Workers (Part I), by Robert Reich: What's the Administration's specific aim in bailing out GM? ... Even if the U.S. were to seal its borders and bar any manufactured goods from coming in from abroad--something I don't recommend--we'd still be losing manufacturing jobs. That's mainly because of technology.

When we think of manufacturing jobs, we tend to imagine old-time assembly lines populated by millions of blue-collar workers who had well-paying jobs with good benefits. But that picture no longer describes most manufacturing. I recently toured a U.S. factory containing two employees and 400 computerized robots. The two live people sat in front of computer screens and instructed the robots. In a few years this factory won't have a single employee on site, except for an occasional visiting technician who repairs and upgrades the robots. ...

What happened to manufacturing? In two words, higher productivity. As productivity rises, employment falls because fewer people are needed. In this, manufacturing is following the same trend as agriculture. ... America can generate far larger crops than a century ago with far fewer people. New technologies ... have ... made farming much more productive.

Manufacturing is analogous. ... Since 1995, even as manufacturing employment has dropped around the world, global industrial output has risen more than 30%.

We should stop pining after the days when millions of Americans stood along assembly lines and continuously bolted, fit, soldered or clamped what went by. Those days are over. And stop blaming poor nations whose workers get very low wages. Of course their wages are low; these nations are poor. ... When America blocks their exports by erecting tariffs and subsidizing our domestic industries, we prevent them from doing better. ...

Want to blame something? Blame new knowledge. Knowledge created the electronic gadgets and software that can now do almost any routine task. This goes well beyond the factory floor. America also used to have lots of elevator operators, telephone operators, bank tellers and service-station attendants. Remember? Most have been replaced by technology. Supermarket check-out clerks are being replaced by automatic scanners. The Internet has taken over the routine tasks of travel agents, real estate brokers, stock brokers and even accountants. With digitization and high-speed data networks a lot of back office work can now be done more cheaply abroad.

Any job that's even slightly routine is disappearing from the U.S. But this doesn't mean we are left with fewer jobs. It means only that we have fewer routine jobs... Technophobes, neo-Luddites and anti-globalists be warned: You're on the wrong side of history. You see only the loss of old jobs. You're overlooking all the new ones.

The reason they're so easy to overlook is that so much of the new value added is invisible. A growing percent of every consumer dollar goes to people who analyze, manipulate, innovate and create. These people are responsible for research and development, design and engineering. Or for high-level sales, marketing and advertising. They're composers, writers and producers. They're lawyers, journalists, doctors and management consultants. I call this "symbolic analytic" work because most of it has to do with analyzing, manipulating and communicating through numbers, shapes, words, ideas.

Symbolic-analytic work can't be directly touched or held in your hands, as goods that come out of factories can be. In fact, many of these tasks are officially classified as services rather than manufacturing. Yet almost whatever consumers buy these days, they're paying more for these sorts of tasks than for the physical material or its assemblage. ...

The biggest challenge we face over the long term -- beyond the current depression -- isn't how to bring manufacturing back. It's how to improve the earnings of America's expanding army of low-wage workers who are doing personal service jobs in hotels, hospitals, big-box retail stores, restaurant chains, and all the other businesses that need bodies but not high skills. More on that to come.

Yes, it isn't the jobs that are lost to technology that are of concern, it's the jobs we create to replace them, the speed at which those jobs are created, and how those jobs are distributed (both within and across countries). Even though the value of what has been created with the resources that have been freed by technology has exceeded the value of what has been lost, the distribution of those benefits has been very unequal.

"Redistribution, Height Taxes, and Utilitiarianism"

I don't think I'll comment on any of the underlying philosophical issues:

Mankiw, Redistribution, Height Taxes, and Utilitiarianism, by Mathew Yglesias: Via a distraught Conor Clarke, I see that not only did Greg Mankiw once write a cheeky paper arguing that maybe we should impose a height tax, he also goes in for some odd philosophical claims. To try to reconstruct his argument, he believes:

  1. The main arguments in favor of redistributive taxation are grounded in utilitarianism.
  2. Utilitarian theory supports taxing tall people more heavily than short people (this is the thesis of the paper).
  3. Therefore, people should either sign on for the height tax or else abandon their support for redistribution.

He concludes with this:

A moral and political philosophy is not like a smorgasbord, where you get to pick and choose the offerings you like and leave the others behind without explanation. It is more like your mother telling you to clean everything on your plate. If you are a Utilitarian redistributionist, the height tax is like that awful tasting vegetable your mother served up because it is good for you. No matter how hard you might wish it wasn't there sitting on your plate, it just won't go away.

I think there are a ton of mistakes being made here. This goes back to a point I was making a while ago about how dangerous it is that the public discourse is so dominated by low-quality freelance philosophy done by people with PhDs in economics. I'm fairly certain that if Mankiw were to walk over to Emerson Hall he could find some folks ... who could explain to him that there's little grounds for the belief that a commitment to utilitarianism is the main justification for redistributive taxation.

So point one is factually wrong.

But that aside, I think the "smorgasboard" argument is a confused way of thinking about moral reasoning. A great many crucially important questions in normative ethics are easy. Is it okay to murder Greg Mankiw to steal the money in his pocket? No, it isn't. But a lot of foundational questions in ethical theory are hard. And a lot of meta-ethical questions are hard. ... There's a certain hyper-literal sense in which these questions all form a hierarchy. First I must decide where I stand on meta-ethics. Am I a reductive moral realist? A quasi-realist? A practical reasons theorist? An old-school "moral facts are facts too, damnit" moral realist? Are there theological issues in play? Then I need to decide if I'm a utilitarian (and if so, what kind of utilitarian!) or maybe some other kind of consequentialist or maybe I have a more Kantian view. So then depending on those answers, I can say "killing Greg Mankiw to steal the money in his pocket is wrong because…" and then lay the whole thing out.

I think what Mankiw is implying with the "smorgasboard" argument is that this is how people should actually engage in moral reasoning. ... Maybe killing Greg Mankiw really is okay? And if I'm not uncertain, if I say "the reason it's wrong to kill Greg Mankiw and steal his money is that the murder would reduce net utility" then the murderer can counter with "well, if you believe in utilitarianism, you ought to believe in a height tax." Then I say "well that sounds wrong!" And then, having debunked utilitarianism, Mankiw gets shot and everyone agrees that justice has been done.

Something's gone wrong there. We don't abandon considered convictions about normative issues that quickly. Murder is wrong. If forced to contemplate the alleged contradiction, there are a bunch of things we might want to consider. Maybe the analysis of the height issue has gotten something wrong, utility-wise. After all, though the paper is clever, it's hardly a comprehensive review of all of the hedonic issues in play. Or maybe utilitarianism isn't the best theoretical grounding for the conviction that murder is wrong. Or, maybe the height tax thing actually is a good idea, albeit an unrealistic one. ...

George Bush and Bill Clinton Love Fest

What's the deal with this?:

Bush-Clinton Policy Talk Strikes a Congenial Tone, by Jim Rutenberg, NY Times: Former President Bill Clinton really misses the presidency. ... Former President George W. Bush hardly misses it at all....

But that was practically where the differences stopped as the two former presidents appeared for the first time on a stage together to discuss national and international policy. Each earned more than an estimated $150,000 for the appearance. ...

And as they settled into overstuffed chairs, Mr. Bush and Mr. Clinton became something of an ex-presidents' support group, avoiding direct critiques of each other, or, for that matter, their future club member, President Obama...

When Mr. Clinton said one of his biggest regrets was the lack of United States action during the mass killings in Rwanda, saying "I have no defense," Mr. Bush responded, "I think you're being a little tough on yourself." He added that Mr. Clinton's lament that he should have sent troops ignored the fact that such deployments are not so simply done.

When Mr. Bush ... defended his policy toward the Darfur region of Sudan, Mr. Clinton got his back, in return. "I think he did about all he could do," he said. ...

If there was anything that even bordered on a sharp exchange, it was the discussion over Iraq.

Mr. Clinton said he would have preferred for Mr. Bush to have given weapons inspectors more time in Iraq before invading and, in the meantime, "concentrated on Afghanistan."

Mr. Bush said, with a hint of irritation, "I don't buy the premise that our attention was distracted," a rejection of the argument that the Iraq war came at the expense of progress in Afghanistan. ...

Afterward, even audience ... expressed surprise at the level of congeniality. ...

links for 2009-05-30

May 29, 2009

Economist's View - 5 new articles


In my heart of hearts, I'm pretty libertarian. I really don't want government looking over my shoulder and telling me what I can and cannot do.

Where I part with many libertarians - perhaps due to my background - is in the idea that government is almost always at odds with liberty. In my case, government played a key role in providing me with opportunity - education is one example, without tuition of $100 per semester at a state school, I probably would not have gone to college - but the opportunities government provided me go beyond education (and also see the examples given in the article for women and minorities).

Governments also need to intervene to prevent monopoly and political power from building up. Without such interventions, power will tend to concentrate and we will likely be exploited in one way or another, so government needs to ensure that our opportunity to enter a particular business - that our economic opportunities generally - are not limited by these factors.

I'm doing this in a bit of a rush (during a seminar, but don't tell), so one more quick point. I was very disappointed in the silence from many libertarians when the Bush administration was taking away, one by one, many of the liberties we enjoy. It was hard not to conclude that for many, the label of libertarian is simply an excuse to be concerned with little more than their own pocketbook.

In any case, I agree with much of what Bruce Bartlett has to say:

Liberaltarians?, by Bruce Bartlett, Commentary, Forbes: I recently attended a dinner with a group of prominent liberal and libertarian bloggers to see if there is a community of interest that might lead to closer cooperation on some issues.

On the surface, there would appear to be potential for an alliance. Libertarians tend to be liberal on social issues, favoring such things as gay marriage and drug legalization; and also liberal on defense and foreign policy, opposing the wars in Iraq and Afghanistan, and opposing torture and restrictions on civil liberties in the name of national security.

But libertarians are conservative on economic policy--favoring a free market with virtually no government intervention except the enforcement of contracts, and no government spending or taxes except those to pay for a very minimal police force and military.

Libertarians' views on social policy and national defense make them sympathetic to the Democrats, while their views on economic policy tend to align them with the Republicans. If one views social, defense and economic policy as having roughly equal weight, it would seem, therefore, that most libertarians should be Democrats. In fact, almost none are. Those that don't belong to the dysfunctional Libertarian Party are, by and large, Republicans.

The reason for this is that most self-described libertarians are primarily motivated by economics. In particular, they don't like paying taxes. They also tend to have an obsession with gold and a distrust of paper money. As a philosophy, their libertarianism doesn't extent much beyond not wanting to pay taxes, being paid in gold and being able to keep all the guns they want. Many are survivalists at heart and would be perfectly content to live in complete isolation on a mountain somewhere, neither taking anything from society nor giving anything.

An example of this type of libertarian thinking can be found on the Web site of a group called the Campaign for Liberty. It pays lip service to the libertarian philosophy on foreign and social policy, but says little about them. The discussion of economic policy, however, is much greater. But its only major proposal is abolition of the income tax. No ideas on how government spending would be cut to make this possible are put forward except to eliminate the congressional pay raise. Perhaps this group really believes that will be enough to abolish the income tax, but I suspect not. Whoever wrote these talking points is simply pandering to the stupid, the ignorant and the unsophisticated.

One is not likely to run into that type of libertarian at a Washington dinner party. These libertarians tend to be well-educated, arriving at his or her philosophy through reading obscure books or random contact with some libertarian in graduate school. They don't own guns--probably never even fired one, don't mind paying taxes too much, have no particular nostalgia for the gold standard and certainly would not choose to live in isolation on a mountaintop. They are cosmopolitan, urbane, articulate and interested in ideas more than just about anything else. They are not especially career-oriented--they are happy to be paid less than they probably could make as long as they don't have to compromise their principles and can do work that advances the cause. For the most part, they aren't family-oriented or religious, and they mostly fit the stereotype of a nerd.

But even these metro-libertarians tend to be more concerned about economics than social or foreign policy. The Cato Institute publishes an annual survey of economic freedom throughout the world, but produces no surveys of what countries have the most political or social freedom or those that have the most libertarian foreign policy.

Furthermore, economic freedom tends to be determined primarily by those measures for which quantifiable data are available. Since it is very easy to look up the top marginal income tax rate or taxes as a share of GDP, these measures tend to have overwhelming influence on the ratings. As a result, countries like Denmark, which are very free every way except in terms of taxes, end up being penalized. Conversely, authoritarian states like Singapore don't suffer for it because they have low taxes.

An unstated implication of these rankings is that freedom is the highest good--the thing that brings the greatest happiness to the most people. Since low taxes are taken as the sine qua non of a free society, one would therefore expect the happiest countries to be the lowest-taxed countries. In fact, this is not the case. Based on a recent study by the Organization for Economic Cooperation and Development, most of the world's happiest countries are high-tax countries.

Taxes and Happiness, 2006

Country Happiness Index Taxes/GDP

Denmark 8.0 / 49.1

Finland 7.6 / 43.0

Netherlands 7.6 / 39.3

Norway 7.5 / 43.9

Switzerland 7.5 / 29.6

New Zealand 7.4 / 36.7

Australia 7.4 / 30.6

Canada 7.4 / 33.3

Belgium 7.4 / 44.5

Sweden 7.4 / 49.1

United States 7.3 / 28.0

Source: OECD

At the liberaltarian dinner, many of the liberals persuasively argued that the pool of freedom isn't fixed such that if government takes more, then there is necessarily less for the people. Many government interventions expand freedom. A good example would be the Civil Rights Act of 1964. It was opposed by libertarians like Barry Goldwater as an unconstitutional infringement on states' rights. Yet it was obvious that African Americans were suffering tremendously at the hands of state and local governments. If the federal government didn't step in to redress these crimes, who else would?

Since passage of the civil rights act, African Americans have achieved a level of freedom equal to that of most whites. Yet I have never heard a single libertarian hold up the civil rights act as an example of a libertarian success.

One could also argue that the women's movement led to a tremendous increase in freedom. Libertarians may concede the point, but conservatives almost universally view the women's movement with deep hostility. They think women are freest when fulfilling their roles as wife and mother. Anything that conflicts with those responsibilities is bad as far as most conservatives are concerned.

In short, there is a theoretical case to be made for liberals and libertarians at least continuing a dialogue. But for it to go anywhere, libertarians must scale back their almost single-minded focus on economic freedom as the sole determinant of liberty. They must work harder to defend civil liberties and resist expansion of the police state whether it involves suspected terrorists, illegal aliens or those who enjoy smoking marijuana.

Libertarians should also be more outspoken about America's disastrous foreign policy, which Obama seems to be doing very little to fix. This would seem like an obvious area for cooperation. The main problem seems that neither liberals nor libertarians are up to challenging the loudmouthed bullies on talk radio and Fox News who equate anything less than a 100% commitment to the "war on terror" as treasonous.

I believe there should be more balance in the libertarian strategy, with civil liberties and non-interventionism having closer to equal weight with economic freedom.

In return, liberals can learn something important about economics from libertarians. Liberals often turn to government to solve social problems simply because that is their default position. But often, there are private-sector alternatives that may in fact be superior. The rich diversity of America's states and localities shows there are many different ways of dealing with social problems that don't necessarily require more government.

I hope the dialogue continues.

Paul Krugman: The Big Inflation Scare

Money sitting in banks doing nothing but providing insurance is not inflationary, and worries that rising government debt will force policymakers to generate inflation are unfounded:

The Big Inflation Scare, by Paul Krugman, Commentary, NY Times: Suddenly it seems as if everyone is talking about inflation. Stern opinion pieces warn that hyperinflation is just around the corner. And markets may be heeding these warnings: Interest rates on long-term government bonds are up, with fear of future inflation one possible reason...

But does the big inflation scare make any sense? Basically, no — with one caveat I'll get to later. And I suspect that the scare is at least partly about politics...

First.... It's important to realize that there's no hint of inflationary pressures in the economy right now. ... Deflation ... is the ... present danger.

So if prices aren't rising, why the inflation worries? Some claim that the Federal Reserve is printing lots of money, which must be inflationary, while others claim that budget deficits will eventually force the U.S. government to inflate away its debt.

The first story is just wrong. The second could be right, but isn't.

Now, it's true that the Fed has ... been buying lots of debt both from the government and from the private sector, and paying for these purchases by crediting banks with extra reserves. And in ordinary times, this would be highly inflationary: banks, flush with reserves, would increase loans, which would drive up demand, which would push up prices.

But these aren't ordinary times. Banks aren't lending out their extra reserves. They're just sitting on them — in effect, they're sending the money right back to the Fed. So the Fed isn't really printing money after all.

Still, don't such actions have to be inflationary sooner or later? No. The Bank of Japan ... purchased debt on a huge scale between 1997 and 2003. What happened to consumer prices? They fell. ...

Is there a risk that we'll have inflation after the economy recovers? That's the claim of those who look at projections that federal debt may rise to more than 100 percent of G.D.P. and say that America will eventually have to inflate away that debt...

Such things have happened in the past. ... But ... modern examples are lacking. Over the past two decades, Belgium, Canada and ... Japan have all gone through episodes when debt exceeded 100 percent of G.D.P. And the United States itself emerged from World War II with debt exceeding 120 percent of G.D.P. In none of these cases did governments resort to inflation to resolve their problems.

So is there any reason to think that inflation is coming? Some economists have argued for moderate inflation as a deliberate policy, as a way to encourage lending and reduce private debt burdens. I... made a similar case for Japan in the 1990s. But the case for inflation never made headway ... then, and there's no sign it's getting traction with U.S. policy makers now.

All of this raises the question: If inflation isn't a real risk, why all the claims that it is?

Well,... it's hard to escape the sense that the current inflation fear-mongering is partly political, coming largely from economists who had no problem with deficits caused by tax cuts but suddenly became fiscal scolds when the government started spending money to rescue the economy. And their goal seems to be to bully the Obama administration into abandoning those rescue efforts.

Needless to say, the president should not let himself be bullied. The economy is still in deep trouble and needs continuing help.

Yes, we have a long-run budget problem, and we need to start laying the groundwork for a long-run solution. But when it comes to inflation, the only thing we have to fear is inflation fear itself.

Fed Watch: A Return to a Nasty Dynamic?

Tim Duy:

A Return to a Nasty External Dynamic?, by Tim Duy: At the moment, the economic dynamic is exceedingly complicated. An understatement, I fear. The crosscurrents in the data and the markets are treacherous, and I suspect will have Fed officials scratching their heads. Hold steady with existing plans? Step up the liquidity provisions? More actively engage plans to tighten policy? The latter option seems almost inconceivable; for the moment, the debate will focus on the issue of further easing. At this point, I think the Fed will sit tight, allowing further easing to come from the already active TALF program, rather than expanding outright purchases of Treasuries.

The core issue is the steep rise in Treasury yields, which apparently were kept in check only by the expectation that the Fed would continued to gobble up the endless stream of securities issues by the US Treasury. The Fed sank that hypothesis at the last FOMC meeting, and a subsequent statement by Federal Reserve Chairman Ben Bernanke made clear that the Fed does not have a 3% target on 10 year Treasury yields. Since then, yields have climbed as high as 3.75% before prices rebounded today, bringing yields down to 3.61%. Should we be concerned with the gains?

Brad DeLong argued a few weeks ago that the Fed's reluctance to cap rates was a policy error in the making. Indeed, it would seem that rising yields are toxic for debt heavy balance sheets, especially where housing is concerned. Officials repeatedly point to the importance of supporting housing prices, a policy that would be undermined as rising Treasury yields boost mortgage rates higher. And while we have seen some stability in recent months in existing homes sales - of which foreclosures and distressed sales are no small part - the recent Case-Shiller data makes clear that housing markets remains under severe pricing pressure:

Home prices in 20 major metropolitan areas fell in March more than forecast as foreclosures surged, threatening to extend the housing slump.

The S&P/Case-Shiller home-price index decreased 18.7 percent from March 2008, matching the drop in the year ended in February. The measure declined 19 percent in January, the most since data began in 2001.

In contrast is the view that rising yields signal an unambiguously positive environment in future months, a sentiment echoed by US Treasury Secretary Timothy Geithner:

Geithner, 47, also said that the rise in yields on Treasury securities this year "is a sign that things are improving" and that "there is a little less acute concern about the depth of the recession."

Likewise, Alan Blinder is confused by thoughts that the Fed would attempt to control yields at all:

Blinder said he's "more dubious" about the Treasury purchases themselves. Any reduction in long-term rates makes it more difficult for U.S. banks to generate earnings to make up for what the Fed estimated earlier this month would be $600 billion in losses under adverse economic conditions. "It makes it harder for them to earn their way out," he said.

So we are stuck with two apparently contrasting views. On one hand, rising long rates and the related steepening of the yield curve should indicate improving economic conditions - after all, rising yields simply imply that market participants are gaining confidence to put their money to work in more risky endeavors. The steeper yield curve should boost bank earnings and, in time, encourage lending. On the other hand, higher yields may undermine support for the housing market, thus extending the downturn. The Wall Street Journal believes the Fed is choosing the positive spin:

Federal Reserve officials believe the recent sharp rise in yields on U.S. Treasury bonds could reflect a mending economy and a receding risk of financial catastrophe, suggesting the central bank won't rush to react -- even though some investors see danger in the government's rising cost of borrowing.

The WSJ is most likely correct. Indeed, I too want to believe the first story; the steep yield curve should be a clear signal that economic activity is poised to soar. Two things are holding me back. First, the 10-2 spread went positive in mid-2007, which should have indicated that the expected Fed easing later that year would catch fire and the economy would be clear of recession territory by mid-2008. Oops - the signal was premature. Something was different (just as I had come to embrace the yield curve's signals). My second concern is that rising yields indicate capital is fleeing the US, and the shape of the yield curve is being influenced significantly by shifts in patterns of foreign central bank purchases. And while the resulting depreciation of the Dollar will support US growth over time, the transition can be very disruptive. Interestingly, the Wall Street Journal story quoted above does not point to this possibility.

As Brad Setser highlights, the current dynamic is eerily similar to that of late 2007 and early 2008. In hindsight, this should have been anticipated. Financial market stability has improved dramatically as Federal Reserve Chairman Ben Bernanke and Geithner have made clear that no major US bank will be allowed to fail. It just won't happen. That stability makes way for a reversal of the flight to safety, and the Dollar comes under pressure, and, with it, US Treasuries. The reversal must be strong - note how Treasuries sank this week despite a clear escalation in North Korean rhetoric, which should have driven some safety trades. Moreover, with the US consumer widely expected to not be a driver of growth going forward, market participants look toward the emerging markets for growth. In essence, the Fed's ZIRP policy combined with stable financial markets once again makes the Dollar carry trade attractive. Since old habits die hard, this should "force" foreign central banks to accumulate Treasury assets - and it has.

In this scenario, stable financial markets are now pushing for further reduction in the US external deficit. To be sure, while the deficit is much smaller, it still exists . And, once again, it looks like much of the world, from the Fed to the Treasury to the emerging market central banks, are resisting the adjustment as it requires continued soft domestic demand in the US to limit imports. Eventually, that resistance will reveal itself. For example, additional US weakness will be offshored to those regions not supporting the Dollar - hence Euro and Yen strength. And commodity prices might catch a stronger bid. Indeed, this explains the gains in oil in recent weeks.

But Brad identifies an important twist on that story:

Third, the rise in central bank reserves isn't translating into a rise in demand for longer-term US bonds. Central banks are just buying short-term bills. That presumably is one of the reasons why long-term rates are rising now – while they remained (surprisingly) low back in 2006, 2007 and 2008. Central banks weren't willing to buy long-term notes at 2% — or even at 3%. Maybe they just didn't want to lock in low rates. Maybe they feared a mark-to-market capital loss if rates rose. Or maybe they fear that inflation will rise, eroding the real value of longer-term claims. In some sense, it doesn't matter. The dynamics of the market changed …

Brad has more in a subsequent post. It is almost as if foreign central banks know that the endgame of everyone's behavior is inflation, and thus avoid longer dated securities. Not a particularly comforting thought - but one consistent with the steady rise in the 10 year Treasury-TIPS breakeven spread. Perhaps too foreign central banks realize that if the Fed is no longer willing to be a buyer of last resort of longer dated Treasuries, why should they?

How will the Fed behave in this environment? Presumably, if inflation expectations were to rise significantly, policymakers would need to respond by chasing long rates. After all, they have made clear that the target range is 1.7-2%, and want to anchor inflation expectations at those levels. With this in mind, expect policymakers to continue to emphasize their readiness to wind down their programs and raise the Fed Funds rates, when necessary, in order to combat inflation. Also, policymakers will likely turn attention toward commodity prices, particularly oil - saying something to the effect that they are keeping their attention on energy costs, but remain focused on the wide output gap, which suggests disinflation pressure in wages and core prices.

It remains difficult, however, to imagine that the Fed is truly ready to start reversing policy in the near term. Despite green shoots, US economic growth remains anemic. The green shoots really don't look all that green. Initial jobless claims may have peaked, but they are certainly not dropping at a rate consistent with a strong rebound. Hovering just above 600,000 claims a week promises to sustain weak employment reports in the months ahead, as long as rising unemployment. Can we see a policy reversal with unemployment rates on the rise? Consistent with ongoing job market weakness, policymakers continue to commit to a sustained period of near zero rates. See Federal Reserve Vice Chair Donald Kohn last week:

In my view, the economy is only now beginning to show signs that it might be stabilizing, and the upturn, when it begins, is likely to be gradual amid the balance sheet repair of financial intermediaries and households. As a consequence, it probably will be some time before the FOMC will need to begin to raise its target for the federal funds rate. Nonetheless, to ensure confidence in our ability to sustain price stability, we need to have a framework for managing our balance sheet when it is time to move to contain inflation pressures.

Moreover, the financial stability we have seen in recent months is clearly dependent on the willingness of the Fed to commit large quantities of liquidity in various guises. Policymakers are wary that financial markets can stand on their own, and will not be eager to speed up their eventual withdrawal. Start-stop policy would certainly impose a fresh policy uncertainty that could trigger a new chapter in the crisis. No, policymakers will not change course unless a new disorderly Dollar-commodity price dynamic emerges. Even then, Bernanke kept the accelerator to the floor as such a dynamic took hold in the early part of 2008. I would imagine that the bar to policy reversal is very high at this point.

What about additional easing? From Bloomberg:

"The market expects the Fed to enhance buying of Treasuries very soon," wrote David Ader, head of U.S. government bond strategy at Greenwich, Connecticut-based primary dealer RBS Greenwich Capital, in a note to clients. "The bear market in Treasuries is having an impact on other things. Mortgages were the most notable victim."

I was expecting more easing last month, believing the output gap would prod policymakers forward. And there is no indication that the Fed is planning to back off the TALF program (they are even expanding it too include "legacy" but possibly soon to be "toxic" assets.) But I am now wary that the Fed will increase the size of the expected Treasury bond purchases at this juncture. This is especially the case if they view rising rates as consistent with economic healing. Moreover, questions of outright monetization of the debt would intensify if the Fed appeared to be compensating for a lack of sufficient demand from the private sector, thereby driving more market participants, including central banks, out of the market.

So where does this leave us? In a environment pushed and pulled by contradictory trends:

  • The wide US output gap suggests there is plenty of room for monetary and fiscal stimulus to operate without triggering higher interest rates. Yet rates have moved higher, and while I can't say that 3.7%, or even 4.7%, or even 5.7%, would be surprising given the pace of Treasury issuance, the rapidity and direction of the move should give one pause - especially given the likelihood of prolonged US economic weakness. The rate increase should give policymakers pause, too.

  • The continued existence of the current account deficit suggests the US remains dependent on capital inflows. To be sure, the need is not as great as a year ago, but significant nonetheless. Failure to attract those inflows would trigger downward pressure on bonds and Dollars.

  • Greater financial stability should force market participants out of low yielding assets. But, absent a safety flight to US Dollars, there is no reason those assets have to be in the US. Low short term rates - and the Fed's promise to keep those rates low for an extended period of time - open up opportunities for a Dollar carry trade that yields capital outflows.

  • If so, we would expect downward pressure on the Dollar and upward pressure on long rates. The former supports export growth and import compression, while the latter helps prevent the decline from becoming disorderly by attracting capital into the Dollar and by further import compression (slower domestic demand).

  • If foreign central banks choose to resist these trends, we would expect global reserves to rise. We are seeing this. The shift to purchasing at the shorter end of the yield curve, however, indicates that global central banks are wary of taking on additional Treasury risk. Perhaps they are finally beginning to choke on the debt.

  • Downward pressure on the Dollar, in addition to the liquidity provided by central bank reserve accumulation, should put upward pressure on commodities. This is particularly evident in oil prices. This will increase headline inflation, and with it inflation expectations among the general public.

  • US labor market weakness appears inconsistent with a sustainable inflation dynamic; thus, rising oil prices simply cut into domestic demand. In this circumstance, the Fed will be inclined to hold policy steady, rather than exacerbating oil driven weakness by tightening. Tightening policy would also reverse the evolving stability in financial markets and threaten a new credit crunch. And given the Fed's willingness to accept a benign view of the yield increase, they are not likely to increase Treasury purchases. Policy on hold. This may again have the side effect of putting relentless downward pressure on the Dollar. This is probably necessary to achieve further rebalancing of economic activity, but I suspect in the near term it will be disruptive. Alternatively, the dynamic could be reversed again by a new crisis that drove flows back to Dollars. There may be so much directionless liquidity flowing through the global financial system that it just starts constantly shifting here and there, looking for a home.

Bottom Line: I want to believe that the rapid reversal of Treasury yields is a benign, even positive, event. This is likely the Fed's view; consequently, the Fed will hold steady on policy. Challenging this benign view is that the reversal appears to be lock step with a return to dynamics seen in 2007 and 2008 - exceedingly low US rates encouraging Dollar outflows, stepping up the pace of foreign central bank reserve accumulation and putting upward pressure on key commodity prices. I worry that policymakers have forgotten the external dynamic that was hidden by the crisis induced flight to Dollars last fall. Indeed, capital outflows (indicated by a foreign central bank effort to reverse those flows) would signal that much work still needs to be done to curtail US consumption to bring the global economy back into balance. Policymakers are unprepared for this possibility.

"Moyo's Confused Attack on Aid for Africa"

More "Mud-Wrestling on African Aid":

Moyo's confused attack on aid for Africa, by Jeffrey Sachs, Ms. Dambisa Moyo's recent Huffington Post article exposes the confusions that underlie her slashing attacks on aid. Most importantly, she seems to believe that sub-Saharan Africa was economically prosperous and then was pushed into poverty by aid. She makes the following statement: "No surprise, then, that Africa is on the whole worse off today than it was 40 years ago. For example in the 1970's less than 10% of Africa's population lived in dire poverty -- today over 70% of sub-Saharan Africa lives on less than US$2 a day."

Let's parse that statement for a moment. World Bank researchers Shaohua Chen and Martin Ravallion (2007) prepare the benchmark under-$2-a-day historical headcount data going back to 1981. According to their figures, headcount poverty under $2 a day was 74% of the population in sub-Saharan Africa in 1981 and 73% in 2005. Other prominent estimates that go back to 1950 or 1970 also contradict Moyo's statement, by showing high and persistent poverty. All of the macroeconomic time series by Maddison (1995), Summers and Heston (1988), and others tell the same story; the majority of Africa's population started out impoverished at the time of national independence in the 1960s and 1970s, and a majority remains impoverished till today.

If we move beyond the GNP and income measures, the enormity of Africa's long-term poverty challenges become even more apparent. As we have documented elsewhere, Africa's literacy, agricultural productivity and urbanisation rates were very low in 1970. Rural poverty was pervasive. Africa's road coverage, electrification, rail network, and other infrastructure were sparse at best and typically non-existent in rural areas. Aid did not kill Africa.

Despite the persistence of poverty, many conditions in Africa have in fact improved in recent decades. Child mortality has declined from 229 per 1,000 births in 1970 to 146 per 1,000 births in 2007. Adult literacy has increased from around 27% in 1970 to around 62% in 2007. Primary school net enrolments have increased from around 53% in 1991 to around 70% in 2007. Aid has played a helpful role in this. Yet aid was very limited, averaging around $35 per African per year since 1960. Aid has never been properly resourced or targeted for a focused period to end the poverty trap and thereby to break the dependency on aid.

Africa's differences with other regions lie not in aid, but in circumstances and history. Unlike South Asia, for example, Africa has not yet had a Green Revolution of higher food yields, the formative event of India's economic takeoff from the late 1960s. India is a civilisation of great river systems and large-scale irrigation, thanks to the Himalayan snowmelt and glacier melt and the annual monsoon rains. Africa is a continent of rain-fed (non-irrigation) agriculture. The original Green Revolution, in which India's food output per land area rose markedly, came in the irrigated systems of Asia, not the rain-fed systems of Africa.

US aid heavily subsidised India's Green Revolution while World Bank opposition to aid for African agriculture from the 1980s until recently played an opposite and adverse role, holding back a similar breakthrough for Africa. It was the absence of aid for African agriculture rather than its presence that cost Africa mightily. And one can go on. Africa's tropical disease burden, heavy concentration of landlocked countries, decline of aid for infrastructure during the 1980s and 1990s, and misguided attempts by Africa's creditors to collect debt servicing under "structural adjustment programs" during the 1980s and 1990s all played their part.

Moyo now campaigns against the kinds of aid that can keep millions of African children from dying or being maimed for a lifetime through the consequences of serious episodes of disease. She advocates cutting the aid that has allowed more than 2 million Africans access to life-saving AIDS treatment, since governments are involved. Almost unimaginably, she opposes the distribution of anti-malaria bed nets for Africa's hundreds of millions of young people on the alleged grounds that it has put bed net producers in Africa out of business. In her own words:

"Finally, with respect to Mr. Sachs' remark that I would see nothing wrong with denying US$10 in aid to an African child for an anti-malarial bed net -- even labelling me as cruel; I say, if working towards a sustainable solution where Africans can make their own anti-malaria bed-nets (thereby creating jobs for Africans and a real chance for continents economic prospects) rather than encouraging all and sundry to dump malaria nets across the continent (which incidentally, put Africans out of business), then I am guilty as charged. Don't forget that the over 60% of Africans that are under the age of 24 need jobs not sympathy."

The confusion underlying this remark is staggering. There are hundreds of millions of Africans at risk of a killer disease, around 200 million cases of the disease, and around 1 million preventable deaths per year, yet Moyo is opposed to urgent help if nets are not produced in Africa. She seems both unmoved by the massive suffering and unaware that Africa has gone from producing exactly zero long-lasting insecticidal nets (LLINs) a few years ago to several million per year now, with thousands of jobs in the local industry, as a result of the demand for nets created by aid for malaria control.

She takes no note of the fact that global aid for malaria control is also training tens of thousands and soon hundred of thousands of rural Africans as community health workers; and seems to be unaware that unchecked malaria has long devastated Africa's economy while malaria control is finally emptying the hospitals, putting mothers and fathers back to work and children back to school, and contributing to the boost in Africa's productivity and economic growth of recent years. She says that if her position against aid for LLINs is deemed to be cruel, then yes, she is "guilty as charged."

Moyo is not offering a reasoned or evidence-based position on aid. Everybody that deals with aid wants to promote financial transparency and market-led growth, not aid dependency. We and others have recommended many successful mechanisms to limit corruption and ensure that aid reaches the recipients, as is happening in the disease-control programs. The purpose of aid should indeed be to break the poverty trap through targeted investments in an African Green Revolution; disease control; children's education; core infrastructure of roads, power, safe drinking water and sanitation, and broadband; and business development, including microfinance and rural diversification among impoverished smallholder farmers.

Moyo wants to cut aid off dramatically, even if that leaves millions to die. African leaders - like President Ellen Johnson Sirleaf of Liberia, Dr. Awa Coll-Seck of Roll Back Malaria, and Ministers Charity Ngilu and Beth Mugo of Kenya - have fought for Africa's poor and have used aid to save lives and help economies to prosper. These leaders disagree fundamentally and urgently with Moyo's attacks. They recommend more aid, fully accountable and properly targeted, to meet urgent needs.

Since the record shows that Africa has long been struggling with rural poverty, tropical diseases, illiteracy, and lack of infrastructure, the right solution is to help address these critical needs through transparent and targeted public and private investments. This includes both more aid and more market financing. That combination will indeed ensure that private markets and African entrepreneurship can succeed.


Chen, Shaohua and Martin Ravallion (2007), Absolute Poverty Measures for the Developing World, 1981-2004, World Bank WPS4211 Maddison, Angus (1995) Monitoring the World Economy: 1820-1992. Paris: Development Centre of the Organization for Economic Co-operation and Development, 255. Summers, Robert, and Alan Heston (1988). "A New Set of International Comparisons of Real Product and Price Levels Estimates for 130 Countries, 1950-1985." Review of Income and Wealth 34 (March) 1-25.

links for 2009-05-29

May 28, 2009

Economist's View - 5 new articles

"Fermi Problems"

My oral exam was a bit different from this:

Fermi problems, by Steve Hsu: Princeton University Press sent me a copy of Guesstimation: Solving the World's Problems on the Back of a Cocktail Napkin, by professors Lawrence Weinstein and John A. Adam. The book is a compendium of Fermi problems -- that is, problems which are simply stated and whose answers can be estimated at the order of magnitude level through simple logic from a few factual inputs.

The classic Fermi problem is: How many piano tuners are there in Chicago?

When I took my oral exam as a first year graduate student at Berkeley, theoretician Geoff Chew (a former student of Fermi's) asked me:

1. How many blades of grass are on your front lawn?

2. What is the ratio of paved to unpaved surface area in Iowa? (He had earlier asked where I grew up.)

Luckily I got them both right. The experimentalist in the examining pair, Paul Richards, held up a cylindrical metal device of some sort and asked me what it was -- to this day, I still don't know :-) I suppose I was destined to be a theorist!

Physicists are constantly solving Fermi problems in the course of their work, because it's the first step in sizing up any potential project, theoretical or experimental. ...Watching someone work out a Fermi problem in real time reveals a lot about their brainpower. Wall Street firms, consultancies like McKinsey, Microsoft and even small startups have been known to ask these kinds of questions of job applicants. This book discusses similar problems in a business context.

The difficulty of most Fermi problems is limited, unless the problem requires some specialized knowledge. But I like them slightly better than puzzles or brain teasers which rely on esoteric tricks that the solver either gets or doesn't get. A former collaborator of mine came up with the following (slightly broadening the genre) one evening while I was visiting U Chicago:

1. If the sun stopped radiating energy, what temperature would the surface of the Earth cool to?

2. In the above scenario, could humans survive using current technology if given enough time to prepare?

Weinstein and Adam's book is a nice collection. ...

Here are some you can try, e.g.:

  1. In the 1989 Loma Prieta earthquake in California, approximately 2 million books fell off the shelves at the Stanford University library. If you were the library administrator and wanted to hire enough part-time student labor to put the books back on the shelves in order in 2 weeks, how many students would you have to hire? (You may assume that the books just fell off the shelves and got a bit mixed up but books in different aisles did NOT get shuffled together.)

  2. Estimate the total number of sheets of 8.5 x 11 inch paper used by all the students in one semester.

  3. How many notes are played on a given radio station in a given year?

  4. How many drops of water are there in all of the Great Lakes?

  5. If you drop a pumpkin from the top of a ten story building what is the farthest a single pumpkin seed can land from the point of impact?

  6. How many flat tires are there in the US at any 1 time?

Suppose I want to ask a Fermi problem the next time I give an oral exam, what are some good questions related to economics?

[Oops - I thought I was saving a draft - I didn't mean to publish this yet as it wasn't quite ready - oh well, I lost part of a post last night on health care costs, so this is par for the course lately.]

"Housing Starts, Remittances and Macroeconomic Developments"

Federico Mandelman of the Atlanta Fed:

Housing starts, remittances and macroeconomic developments, by Federico Mandelman: Recent evidence collected by the Dallas Fed's Pia Orrenius suggests that apprehensions of undocumented workers attempting to cross the U.S.–Mexican border are a good predictor of the overall American job market. Simply put, if one wanted to predict job market conditions in July of a given year, one should examine immigrant apprehensions in January. Orrenius finds that more immigrants attempt to cross the border from Mexico (and more of them are caught doing so) when immigrants believe the U.S. economy would offer more jobs in the near future.

One area of the economy that relied heavily on immigrant labor was housing. The following chart plots monthly U.S. housing starts (lagged five months) and remittances to Mexico. ... I use remittances as a proxy for migrant Mexican labor.

Figure: Housing Starts and Remittances to Mexico 052809

Note: Remittances in U.S. dollars. Housing starts indicate new, privately owned housing units. Source: Bank of Mexico (remittances), Haver Analytics (housing starts)

The correlation between the two data series is strikingly high. ... Of course, the results are not unexpected as the construction industry heavily employs immigrant labor. ...

Migrant workers enter the country in response to upturns in domestic labor demand, and that upturn results in higher remittances both because of the increased number of immigrants but also because the existing stock of immigrant workers is earning more. Conversely, a downturn in labor demand should be reflected in lower remittance flows because of out-migration as workers return home and because of lower earnings among the remaining stock of migrants. But what happens when some of those workers have entered the country illegally?

In a study published in 1997, Belinda Reyes found that about two-thirds of the undocumented immigrants returned to Mexico within three years upon arrival. In a recent paper I wrote with Andrei Zlate, we explore the implications of changes to enforcement policies for the U.S./Mexican border on undocumented labor and remittances. We find that increased border enforcement during the last decade has broken the typical pattern of flows of undocumented workers. Basically, while increased enforcement makes it harder/more expensive to enter the country, it also reduces the incentive for those already in the country to leave. Why? Because of the high cost/risk associated with reentering the United States in the future.

In a recent paper, Carolina Rodriguez-Zamora adds support to our claims. She finds that as the U.S. Department of Homeland Security increases the amount of resources spent policing the border undocumented immigrants tend to stay longer.

Increased enforcement protects the existing stock of undocumented immigrants from additional competition, and this development can put upward pressure on wages when U.S. labor demand is high. When labor demand is low, rather than returning home, these individuals could remain in local labor markets, placing additional downward pressure on wages.

"Crazy Compensation and the Crisis"

Alan Blinder urges "corporate boards of directors and, in particular, of their compensation committees" to create compensation plans for financial firms that discourage excessive risk taking:

Crazy Compensation and the Crisis, by Alan Blinder, Commentary, WSJ: Despite the vast outpouring of commentary and outrage over the financial crisis, one of its most fundamental causes has received surprisingly little attention. I refer to the perverse incentives built into the compensation plans of many financial firms, incentives that encourage excessive risk-taking with OPM -- Other People's Money.

What, you say, hasn't huge attention been paid to executive compensation...? Yes. But the ruckus has been over the generous levels of compensation,... not over the dysfunctional incentives...

Take a typical trader at a bank, investment bank, hedge fund or whatever. ... Unfortunately, their compensation schemes ... offer.. them the following sort of go-for-broke incentives when they place financial bets: Heads, you become richer than Croesus; tails, you get no bonus, receive instead about four times the national average salary, and may (or may not) have to look for a new job. ...

[L]et's consider the incentives facing the CEO and other top executives... For them, it's often: Heads, you become richer than Croesus ever imagined; tails, you receive a golden parachute that still leaves you richer than Croesus. So they want to flip those big coins, too.

From the point of view of the companies' shareholders -- the people who provide the OPM -- this is madness. ... Traders and managers both want to flip more coins -- and at higher stakes -- than shareholders would if they had any control, which they don't.

The source of the problem is really quite simple: Give smart people go-for-broke incentives and they will go for broke. Duh.

Amazingly, despite the devastating losses, these perverse pay incentives remain the rule on Wall Street today, though exceptions are growing. ... These wacky compensation schemes have puzzled me for nearly 20 years. ... But the issue could be considered an intellectual puzzle until the bottom fell out. ... after an orgy of irresponsible risk taking... [T]he consequences for the real economy have been devastating. ...

What to do? It is tempting to conclude that the U.S. (and other) governments should regulate compensation practices.... But the ... executives, lawyers and accountants who design compensation systems are imaginative, skilled and definitely not disinterested. Congress and government bureaucrats won't beat them at this game.

Rather, fixing compensation should be the responsibility of corporate boards of directors and, in particular, of their compensation committees. These boards, ... are supposed to represent the interests of stockholders, not those of managers. ... The unhappy (but common) combination of coziness and drowsiness in corporate boardrooms must end. ... For example, top executives could be paid mainly in restricted stock that vests at a later date, and traders could have their winnings deposited into an account from which subsequent losses would be deducted.

Comprehensive reform of the financial system will probably take years. The problems are many and complex, and the government's to-do list is not only long but also a political minefield. Yet fixing compensation incentives does not require any government action. It can be done by financial companies, tomorrow. Too bad they didn't do it yesterday.

But how is the board of directors chosen? See also:

The SEC's Proxy Access Proposal, by Lucian Bebchuk: The Securities and Exchange Commission voted last week to ask the public to comment on a proposal to let shareholders place director candidates on the corporate ballot. The adoption of such a rule would be a useful step toward the necessary reform of corporate elections. ...

"The Cost Conundrum"

Why are health care costs in McAllen, Texas twice as much as costs in El Paso County even though they have similar demographics?:

The Cost Conundrum, by Atul Gawande, The New Yorker: ...McAllen, Texas ... is one of the most expensive health-care markets in the country. ... El Paso County, eight hundred miles up the border, has essentially the same demographics. ... Yet in 2006 Medicare expenditures (our best approximation of over-all spending patterns) in El Paso were ... half as much as in McAllen. ...

links for 2009-05-28