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August 31, 2009

Economist's View - 5 new articles

"John Stuart Mill as a Social Science Founder"

Daniel Little discusses John Stuart Mill's significant contributions to the creation of a positivist science of society:

John Stuart Mill as a social science founder, by Daniel Little: John Stuart Mill was Britain's leading thinker when it came to issues having to do with logic and scientific knowledge in the mid-nineteenth century. His System of Logic was first published in 1843 and was reprinted in numerous editions, and it constituted a comprehensive treatment of scientific knowledge and inference within the empiricist tradition.

The book devoted an entire section to the logic of what Mill referred to as the "moral sciences" (Book VI, published separately as The Logic of the Moral Sciences). He defined the moral sciences as those areas of study having to do with human dispositions, character, and action, extending from psychology to social science. The conception of social science knowledge that he presents has had a deep impact on subsequent thinking about "scientific" social analysis and is worth examining again. (Here is a link to the Gutenberg etext edition of the System of Logic.) Mill developed a general vision of science that was derived from the best current examples of progress in the natural sciences, and he then applied this vision to the effort to understand human and social phenomena scientifically. Putting his vision simply, science consists of the discovery of general causal laws based on systematic empirical observation. It lays the framework for a positivist conception of social science, and it prepares a charge of "Not scientific!" to social scientists who deviate from these central positivist tenets.

The social sciences barely existed in 1843; so it is intriguing to see how Mill thought about the task of creating a social science. For one thing, he had virtually no good examples to work with; political economy was just about the only significant piece of rigorous social analysis that existed. The topics considered by modern sociology were only beginning to gain rigorous attention, and political science took the form of analysis of the interests and policies of specific nation states. Mill was very much interested in the work of Auguste Comte -- the thinker who introduced both "sociology" and "positivism" into the philosophical lexicon, and Mill wrote a critical essay about Comte's philosophy in 1865 (Auguste Comte & Positivism). But Comte's writings did not provide good examples of detailed empirical study of social phenomena. One of Comte's central goals was to discover laws of development for civilizations -- a far cry from the way we would define the focus of sociology today. Here is a summary definition of the science of society that Mill offers:

Next after the science of individual man comes the science of man in society--of the actions of collective masses of mankind, and the various phenomena which constitute social life. (Book VI, chap. VI, sect. 1)
In several earlier postings I've referred to the important role that philosophical ideas played in defining the aims and goals of the social sciences. Mill's writings certainly fall in the category of foundational, guiding ideas. So let's see what guiding ideas are expressed in the System of Logic for the social sciences. Prediction. Mill opens his discussion of the social sciences by quoting a passage from Condorcet with evident approval on the role of prediction in the sciences and history. Condorcet draws an explicit parallel between the predictive capacity of some of the natural sciences (e.g. astronomy) and the development of history; if history is made by men, then we should be able to learn the laws of behavior and use them to predict history (Book VI). This captures Mill's conception of social science: social developments are the result of individual actions and behaviors; individual actions are subject to laws that can be discovered in psychology and ethology (the science of human development); and therefore, in principle, historical outcomes are governed by these laws as well. So the goal of the social sciences is to discover the laws of behavior that permit us to predict behavior and social outcomes. Laws and regularities. Mill firmly believed that science involves the discovery of laws and regularities. A body of observations that lacks organizing regularities cannot be considered to be a science. So for Mill, social science research too must involve the discovery of laws of social behavior and social dynamics. "Are the actions of human beings, like all other natural events, subject to invariable laws? Does that constancy of causation, which is the foundation of every scientific theory of successive phenomena, really obtain among them?" (Book VI, chap. I, sect. 2) Mill's answer, ultimately, is affirmative: there are such laws of individual behavior and choice. In reflecting on the status of weather phenomena he writes:
Yet no one doubts that the phenomena depend on laws, and that these must be derivative laws resulting from known ultimate laws, those of heat, electricity, vaporization, and elastic fluids. (Book VI, chap. III, sect. 1)
He distinguishes between exact sciences (where a few general laws govern virtually all variation) and inexact sciences (where we need both fundamental laws and secondary influences in order to explain observed behavior). His example of an inexact science is tidology.
By combining, however, the exact laws of the greater causes, and of such of the minor ones as are sufficiently known, with such empirical laws or such approximate generalizations respecting the miscellaneous variations as can be obtained by specific observation, we can lay down general propositions which will be true in the main, and on which, with allowance for the degree of their probable inaccuracy, we may safely ground our expectations and our conduct. (Book VI, chap. III, sect. 1)
And this model seems to capture his entire conception of scientific understanding: we understand a phenomenon when we have identified the primary causes that bring it about (and the laws that correspond to these); and the secondary influences that disturb or modify the workings of the primary causes (with their laws as well).
The science of human nature is of this description. It falls far short of the standard of exactness now realized in Astronomy; but there is no reason that it should not be as much a science as Tidology is, or as Astronomy was when its calculations had only mastered the main phenomena, but not the perturbations.... (Book VI, chap. III, sect. 2)
The subject, then, of Psychology is the uniformities of succession, the laws, whether ultimate or derivative, according to which one mental state succeeds another, is caused by, or at least, is caused to follow, another. (Book VI, chap. IV, sect. 3)
So Mill believes that a science of behavior is possible, issuing in a set of regularities of behavior. And he believes that we can also arrive at a science of development, which he refers to as "ethology"; this is a description of the ways in which circumstances influence individual character. Ethology too issues in laws and regularities, according to Mill.
A science is thus formed, to which I would propose to give the name of Ethology, or the Science of Character, from ἦθος, a word more nearly corresponding to the term "character" as I here use it, than any other word in the same language. (Book VI, chap. V, sect. 4)
This leads to a general conception of how social change works:
All phenomena of society are phenomena of human nature, generated by the action of outward circumstances upon masses of human beings; and if, therefore, the phenomena of human thought, feeling, and action are subject to fixed laws, the phenomena of society can not but conform to fixed laws. (Book VI, chap. VI, sect. 2)
Methodological individualism. So laws govern individual actions. What about social phenomena? Mill sees social phenomena as the combination of multiple individual actions. And he believes that it is self-evident that the laws of the compound derive from the workings of the laws of the parts.
The laws of the phenomena of society are, and can be, nothing but the laws of the actions and passions of human beings united together in the social state. Men, however, in a state of society are still men; their actions and passions are obedient to the laws of individual human nature. Men are not, when brought together, converted into another kind of substance. (Book VI, chap. VII, sect. 1)
So social laws and regularities ought to be explained on the basis of individual-level laws and regularities. This is a pretty clear statement of the principle of methodological individualism. Parallel to the assumption of methodological individualism is a strong inclination on Mill's part towards the idea of inter-theoretic reduction: the laws of the compound should be reducible to the action of the laws of the composing entities. So social laws should be reducible to laws of psychology, combined with factual descriptions of the particular circumstances that surround given societies. Methods of agreement and difference. Quite a bit of attention has been directed to Mill's methods of agreement and difference within the field of comparative historical sociology. It is startling, therefore, to realize that Mill himself felt that these families of methods were not relevant or applicable to social phenomena. Appeal to these methods in the social sciences, Mill maintains, is to succumb to the fallacy of the "chemical or experimental method" in the social sciences (Book VI, chap. VII, sect. 1). The problem is that the conditions for the application of these methods are impossibly stringent when we come to consideration of the causes of complex social events like revolutions or civil wars. There are always innumerable differences between the cases; so the methods of difference and similarity cannot direct us to the unique differentiating causes.
The Method of Difference in either of its forms being thus completely out of the question, there remains the Method of Agreement. But we are already aware of how little value this method is, in cases admitting Plurality of Causes; and social phenomena are those in which the plurality prevails in the utmost possible extent. (Book VI, chap. VII, sect. 4)
Mill offers an alternative preferred method, the deductive method. "However complex the phenomena, all their sequences and co-existences result from the laws of the separate elements" (Book VI, chap. IX, sect. 1). The deductive method involves identifying these separate elements; discovering their fundamental properties and regularities; and deducing the interactions that occur among them to produce the complex outcome.
The Social Science, therefore (which, by a convenient barbarism, has been termed Sociology), is a deductive science; not, indeed, after the model of geometry, but after that of the more complex physical sciences. It infers the law of each effect from the laws of causation on which that effect depends; not, however, from the law merely of one cause, as in the geometrical method but by considering all the causes which conjunctly influence the effect, and compounding their laws with one another. (Book VI, chap. IX, sect. 1)
The plurality of causes that is explicit in the deductive method leads Mill to qualify the scope of prediction that is possible in the social sciences. Because it is not possible to precisely determine the joint effect of multiple causes, predictions are generally approximate rather than exact.
It is evident, in the first place, that Sociology, considered as a system of deductions a priori, can not be a science of positive predictions, but only of tendencies. We may be able to conclude, from the laws of human nature applied to the circumstances of a given state of society, that a particular cause will operate in a certain manner unless counteracted; but we can never be assured to what extent or amount it will so operate, or affirm with certainty that it will not be counteracted. (Book VI, chap. IX, sect. 2)
(Daniel Hausman gives a good exposition of this method of explanation in "The Deductive Method" (Essays on Philosophy and Economic Methodology).) The aim of sociology. Mill believes that the most fundamental aim of sociology is to derive a set of governing laws for the whole of society from the laws of individual action and ethology, and to permit the scientist to explain the particular features of the total state of society. He describes the "state of society" in these terms:
In order to conceive correctly the scope of this general science, and distinguish it from the subordinate departments of sociological speculation, it is necessary to fix the ideas attached to the phrase, "A State of Society." What is called a state of society, is the simultaneous state of all the greater social facts or phenomena. Such are: the degree of knowledge, and of intellectual and moral culture, existing in the community, and in every class of it; the state of industry, of wealth and its distribution; the habitual occupations of the community; their division into classes, and the relations of those classes to one another; the common beliefs which they entertain on all the subjects most important to mankind, and the degree of assurance with which those beliefs are held; their tastes, and the character and degree of their aesthetic development; their form of government, and the more important of their laws and customs. (Book VI, chap. X, sect. 2)
This sounds pretty much like what we might call "macro-sociology" -- an effort to describe and explain the large-scale features of a given society. So the goal of sociology is to discover laws of behavior at the individual level that permit deduction of the features of society in which these individuals live, given the current circumstances. Sociology should provide a theory providing an understanding of the broad sweep of history, the totality of human individual and social actions.
The doctrine which the preceding chapters were intended to enforce and elucidate--that the collective series of social phenomena, in other words the course of history, is subject to general laws, which philosophy may possibly detect--has been familiar for generations to the scientific thinkers of the Continent, and has for the last quarter of a century passed out of their peculiar domain, into that of newspaers and ordinary political discussion. (Book VI, chap. XI, sect. 1)
A sociological imagination? In spite of Mill's evident interest in the foundations of a science of society, he shows little evidence of possessing a lively sociological imagination. He does not seem to have paid much attention to the actual social processes and changes underway in Britain in the beginning of the nineteenth century. There is almost no description or comment concerning the social circumstances of nineteenth-century Britain -- subjects that were of great interest to Mill as a reformer. It is striking to compare his writings with those of Tocqueville, who observes and conceptualizes a wide range of concrete social activity and behavior. Mill remains on a highly abstract plane: are there social laws? How do social laws relate to individual laws? How does evidence support or undermine various social hypotheses? (See an earlier posting on Tocqueville.) So here we find almost all the elements that came to define the framework of positivist social science: the doctrine of the unity of science, the insistence on the primacy of the discovery of laws and regularities, the doctrines of methodological individualism and reductionism, and the assumption that the natural sciences provide a regulative guide to the social sciences (naturalism). Mill's writings about the social sciences set the stage for the development of a positivist paradigm that impaired the disciplines from adopting the fluidity and pluralistic viewpoints that they would need. The shortcomings of Mill's philosophy of social science derive from his most basic assumptions. He treats the creation of a science of society as primarily a methodological and epistemic problem; he takes it for granted that the "phenomena" of the social world are entirely analogous to the phenomena of the natural world. But this is an error of social ontology. Social phenomena are not relevantly analogous to natural phenomena. "States" are not like "metals", and social processes like contention are not like physical processes of mixing and heating. And if Mill had devoted more of his analytical intelligence to the problem of discovering, analyzing, and explaining the actual social phenomena of contemporary Britain, he might well have been drawn to a less positivist construction of sociology.


(Here are several earlier postings that are relevant to this topic:
  • philosophical frameworks of the social sciences link
  • how does philosophy help guide the social sciences? link
  • why a philosophy of social science? link
  • proto-social inquiry link
  • components of positivism link
  • a non-naturalistic approach link
The unifying thread to these posts is the question, to what extent did philosophical presuppositions influence the development of the social sciences?)

"The Savings Rate Has Recovered…if You Ignore the Bottom 99%"

Yves Smith suggested this. I don't know if it's correct or not, as noted below most of the numbers are speculative due to data limitations, but the question of how recent changes in saving vary with income does seem like a question worth asking:

Guest Post: The Savings Rate Has Recovered…if You Ignore the Bottom 99%, by By Andrew Kaplan, a hedge fund manager: It has become fashionable among equities managers of the bullish persuasion to argue that a strong recovery in GDP will occur in 2010 because the "structural adjustment period" of moving back to a more normal savings rate has been completed. We've gone from a savings rate of barely 1% in 2008 up to 4.2% in July (ok, so the argument sounded better when the number was 6.2% in May, but still…).
The story goes something like, "consumers took a little time to recognize that their home equity had disappeared, but now they've adjusted their savings rates toward the desired level to reflect the fact that they need to save a larger proportion of income for retirement…so this effect will no longer be a drag on growth in coming quarters."
This is the kind of conventional wisdom which could only emerge among folks in the 99th income percentile who spend their time primarily with other folks in the 99th income percentile. You don't have to look at the data (mortgage delinquencies, foreclosures, credit card defaults, bankruptcies) all that hard to see a very different picture. In fact, it is almost certainly true that the savings rate for 99% of the US population is negative. These people (a/k/a "all of us") are drowning. And to the extent that our savings rate is less negative than it was one or two years ago, that simply reflects the reality of reduced home equity and unsecured credit lines rather than any conscious effort to reach a "desired level" of savings.
A little data might help here. Unfortunately, there really IS no good data on PCE (personal consumption expenditure) and savings stratified by income percentile. There are a couple of surveys, the triennial "Survey of Consumer Finances" by the Federal Reserve and the "Consumer Expenditure Survey" by the Bureau of Labor Statistics, but the self-reported data is laughable. For 2007, the Consumer Expenditure Survey showed a personal savings rate of 18.4%. In the same year, the Bureau of Economic Analysis, which calculates the savings rate as a residual from actual income and expenditure data, showed a savings rate of 1.7%. Either the Consumer Expenditure Survey does a poor job of sampling, or people who fill out surveys are really big liars.
Fortunately, there IS some pretty good data on income stratification in the United States, and a few assumptions can help shed some light. Economists Thomas Piketty and Emmanuel Saez have made careers of studying US income inequality using IRS data, which goes back to 1913. The most recent data available (for 2007) showed that the top 14,988 households (0.01% of the population) received 6.04% of income, the highest figure for any year since the data became available. The top 1% of households received 23.5% of income (the second highest on record, after 1928), while the top 10% received 49.7% of income (the highest on record).
The fortunate 14,988 had an average income in 2007 of $35,042,705. They had an average federal tax burden, according to Piketty and Saez, of 34.7%, leaving them after tax income of $22.9 million. If you assume a 50% savings rate among this group, you get total savings of $171.5 billion. This is nearly ONE HALF of the total savings for the entire country implied by a savings rate of 4.2% ($365 bn) reported in this month's Bureau of Economic Analysis data.
I've never actually had an after tax income of $22.9 million, so I couldn't say for sure whether a 50% savings rate is a reasonable assumption, but I'm going to go out on a limb and say that it is, just based on the pure physics of spending money. Buying cars, clothes, and fancy dinners, even at Masa, won't get you there…the math doesn't work. Buying a private jet could get you there, but most people, even rich people, don't buy one of those every year. The only EASY way to spend more than 50% of $22.9 million on an annual basis is to buy lots of houses…but the definition of "personal consumption expenditure" used by the BEA specifically excludes purchases of real estate. They use an imputed rent calculation instead. So I'm going to stick with my 50% number.
If we expand our survey to the top 1% of all households, we find an average income of $1.36 million for 2007. These folks had an average federal tax burden of just under 33%, so their after tax income averaged $916 thousand. If you assume this group had a savings rate of 33%, you get total savings of $452 billion (remember, $171.5 bn of this comes from the top 0.01%, we're assuming a savings rate of around 25% of after tax income for the "poorer" 99% of the top 1%) This is more than 100% of the personal savings of the entire population, according to the BEA data. It implies that 99% of the US population still has, on average, a negative savings rate of around 1.3%. If you subtract the next nine percent, which likely still has a positive savings rate, the data for the bottom 90% becomes even more depressing, implying a negative savings rate of close to 5%.

Paul Krugman: Missing Richard Nixon

If we're lucky, we might get health care reform that is almost as good as what Richard Nixon offered in the early 1970s:

Missing Richard Nixon, by Paul Krugman, Commentary, NY Times: Many of the retrospectives on Ted Kennedy's life mention his regret that he didn't accept Richard Nixon's offer of a bipartisan health care deal. The moral some commentators take from that regret is that today's health care reformers should do what Mr. Kennedy balked at doing back then, and reach out to the other side.
But it's a bad analogy, because today's political scene is nothing like ... the early 1970s. In fact, surveying current politics, I find myself missing Richard Nixon.
No, I haven't lost my mind. Nixon was surely the worst person other than Dick Cheney ever to control the executive branch.
But the Nixon era was a time in which leading figures in both parties were capable of speaking rationally about policy..., our political system's ability to deal with real problems has been degraded to such an extent that I sometimes wonder whether the country is still governable.
As many people have pointed out, Nixon's proposal for health care reform looks a lot like Democratic proposals today. In fact, in some ways it was stronger. ... Nixon proposed requiring that all employers, not just large companies, offer insurance.
Nixon also embraced tighter regulation of insurers, calling on states to "approve specific plans, oversee rates, ensure adequate disclosure, require an annual audit and take other appropriate measures." No illusions there about how the magic of the marketplace solves all problems.
So what happened to the days when a Republican president could sound so nonideological, and offer such a reasonable proposal?
Part of the answer is that the right-wing fringe, which has always been around ... has now, in effect, taken over one of our two major parties. Moderate Republicans, the sort of people with whom one might have been able to negotiate..., have either been driven out of the party or intimidated into silence. Whom are Democrats supposed to reach out to, when Senator Chuck Grassley..., who was supposed to be the linchpin of any deal, helped feed the "death panel" lies?
But there's another reason health care reform is much harder now...: the vast expansion of corporate influence.
We tend to think of ... a huge army of lobbyists permanently camped in the corridors of power, with corporations prepared to unleash misleading ads and organize fake grass-roots protests against any legislation that threatens their bottom line, as the way it always was. But our corporate-cash-dominated system is a relatively recent creation, dating mainly from the late 1970s.
And now that this system exists, reform of any kind has become extremely difficult. That's especially true for health care... The health insurance industry ... has become a political behemoth, one that is currently spending $1.4 million a day lobbying Congress. ...
Given the combination of G.O.P. extremism and corporate power, it's now doubtful whether health reform,... if we get it ..., will be anywhere near as good as Nixon's proposal, even though Democrats control the White House and have a large Congressional majority.
And what about other challenges? Every desperately needed reform I can think of, from controlling greenhouse gases to restoring fiscal balance, will have to run the same gantlet of lobbying and lies.
I'm not saying that reformers should give up. They do, however, have to realize what they're up against. There was a lot of talk last year about how Barack Obama would be a "transformational" president — but true transformation, it turns out, requires a lot more than electing one telegenic leader. Actually turning this country around is going to take years of siege warfare against deeply entrenched interests, defending a deeply dysfunctional political system.

"An Interview with Barney Frank"

links for 2009-08-31

August 30, 2009

Economist's View - 3 new articles

"An Echo Chamber of Boom and Bust"

Robert Shiller says the global recovery in economic confidence is being driven by a social epidemic, the contagion of ideas, and huge feedback loops:

An Echo Chamber of Boom and Bust, by Robert Shiller, Commentary, NY Times: The global signs of a recovery in economic confidence seem puzzling.
It is a large and diverse world, after all, so why should confidence have rebounded so quickly in so many places? ... Economic analysts often turn to indicators like employment, housing starts or retail sales as causes of a recovery, when in fact they are merely symptoms. For a fuller explanation, look beyond the traditional economic links and think of the world economy as driven by social epidemics, contagion of ideas and huge feedback loops that gradually change world views. These social epidemics can travel as swiftly as swine flu: both spread from person to person and can reach every corner of the world in short order. ...
The popularity of the term "green shoots" shows the kind of social epidemic underlying our changing thinking. The phrase was propelled in Britain by Shriti Vadera, the business minister, in January, and mutated into a more contagious form after Ben Bernanke, the Federal Reserve chairman, used it on "60 Minutes" on March 15.
The news media didn't need to change the term for different cultures around the world. With nothing more than a quick translation — brotes verdes, pousses vertes, grüne Sprösslinge, etc. — it is now recognized as a symbol of a revival coming soon.
All of this suggests that a social epidemic is supporting renewed confidence. This confidence can keep growing by contagion, as a kind of self-fulfilling prophecy, and we may see the markets and the economy recover further.
But in an economy that is still unstable, the stories could also morph into different forms, the price feedback could turn downward and the dynamic could turn ugly again — just as it has in the past.

It seems quite reasonable that the spread of information (wrong or right) can reinforce trends in economic activity, and hence magnify and propagate shocks, but as noted in a part of the article not included above, this doesn't help us much with the problem of predicting turning points in economic activity. Predicting when the stories suddenly "morph into different forms ... is actually very complex. And even when feedback mechanisms are straightforward, they can produce very strange outcomes, not predictable very far into the future..."

"Why Doesn't This Generation's Intellectuals Fight This Generation's Wars?"

If the premise is correct, then what's the answer?:

Cowards, every single one of us?, by Chris Blattman: Early in the 20th century, the West's intellectual elites rushed to fight the Spanish civil war. The same could be said of World War II. It's hard to imagine the same today. What happened...: why doesn't this generation's intellectuals fight this generation's wars?
Cowards, every single one of us? Possibly, but I see a few other explanations.
The economist in me says it could be comparative advantage at work. Technology has played an increasingly important role in war. A sensible government would direct its best educated patriots to engineering and intelligence.
The armed forces also face more competition for idealistic talent. We've seen 10,000% growth in the number of international NGOs in the last 60 years. Those who want to fight injustice have many more options.
There is also the perception, probably real, that the army is no longer a friendly place for intellectuals. A consequence of competition and comparative advantage?
Three generations have also witnessed the examples of Gandhi and Dr. King, and the gospel of non-violent action. ...
But the answer that appeals most to me: today's battles are not drawn along intellectual lines, but religious ones. The Spanish Civil War was the left's stand against fascism and the subjugation of the European working class, and the way the West would be run. There is a battle for hearts and minds, but not within our own society.


The Vietnam war was not a religious battle, it was portrayed as an ideological battle against communism, yet the intellectual elites did not rush to join the battle, so I'm not sure the last answer explains the change. But I don't have anything better to offer, so I'll leave it to all of you to resolve whether the premise is correct and, if so, why this change has occurred.

links for 2009-08-30

August 29, 2009

Economist's View - 4 new articles

Stiglitz: Thanks to the Deficit, the Buck Stops Here

Joseph Stiglitz repeats a warning that he and others have made in the past that, like it or not, the dollar's days as a reserve currency are numbered. Thus, instead of resisting this change -- as we have -- "it's better for us to participate in the construction of a new system than have it happen without us":

Thanks to the Deficit, the Buck Stops Here, by Joseph E. Stiglitz, Commentary, Washington Post: Beware of deficit fetishism. Last week we learned that the national debt is likely to grow by more than $9 billion. That's not great news -- no one likes a big deficit -- but President Obama inherited an economic mess from the Bush administration, and the cleanup comes with an inevitably high price tag. We're paying it now. ...
There are ... consequences, however, that we're missing in the debate over all this red ink. Our budget deficit, as well as the Federal Reserve's ballooning lending programs and other financial obligations, will accelerate a process already well underway -- a changing role for the U.S. dollar in the global economy.
The domino effect is straightforward: Higher deficits spark market concerns over future inflation; concerns of inflation contribute to a weaker dollar; and both come together to undermine the greenback's role as a reliable store of value around the world. ...
Anxieties about future inflation can lead to a weaker dollar today. So, are these anxieties justifiable? ... The worries are justified, even though Fed Chairman Ben Bernanke ... assures us that he will deftly manage monetary policy... This is a tough balancing act... Anyone looking at the Fed's record in recent years will be skeptical of its forecasting skills and its ability to get the balance right.
In addition, international markets understand that the United States may face strong incentives to reduce the real value of its debts through inflation...
Like it or not, out of the ashes of this debacle a new and more stable global reserve system is likely to emerge, and for the world as a whole, as well as for the United States, this would be a good thing. It would lead to a more stable worldwide financial system and stronger global economic growth. ... Discussions on the design of the new system are already underway. ...
The United States has resisted these changes, but they will come regardless, and it's better for us to participate in the construction of a new system than have it happen without us. The United States has seen great advantages with the dollar as the world's reserve currency..., particularly the ability to borrow at low interest rates seemingly without limit. But we haven't seen the costs as clearly: the inevitable trade deficits, the instability, the weaker global economy. The benefits to us are likely to shrink, and rapidly so, as countries shift their holdings away from the dollar. ...
America should show leadership in helping shape this new structure and managing the transition, rather than burying its head in the sand. We may have preferred to keep the old system, in which the dollar reigned supreme, but that's no longer an option.

Hoover's "Pro-Labor Stance" Did Not Help to Cause the Great Depression

In a new paper, Lee Ohanion claims that Herbert Hoover's call for "business leaders to be gentle to their workers" helped to cause the Great Depression. Brad DeLong explains why this claim does not hold up to closer scrutiny:

Herbert Hoover: A Working Class Hero Is Something to Be, by Brad DeLong: Oh Noes! Andrew Leonard reads Lee Ohanian:
Herbert Hoover: The working man's hero - How the World Works - I did not need a cup of coffee to wake up this morning -- I just checked my e-mail, and saw the subject header: "Hoover's pro-labor stance helped cause Great Depression, UCLA economist says."
Without reading the message, I knew instantly who the economist must be -- Lee Ohanian.... Last we saw of Ohanian... he was arguing that FDR's New Deal policies extended the Great Depression and resulted in "less work than average" for American workers. Which might be true, if you don't count anyone who got a job through "the Works Progress Administration (WPA) or Civilian Conservation Corps (CCC), or any other of Roosevelt's popular New Deal workfare programs." Makes sense -- if you don't count Roosevelt's pro-labor programs, he doesn't end up very pro-labor!
So now we have "What -- or Who -- Started the Great Depression?," a 68-page paper Ohanian has been working on for four years that is sure to become a never-to-be-extinguished talking point for New Deal haters, union-busters, and opponents of all kinds of government intervention in the economy. Here are some key points, taken from the press release pushed out by UCLA.
Pro-labor policies pushed by President Herbert Hoover after the stock market crash of 1929 accounted for close to two-thirds of the drop in the nation's gross domestic product over the two years that followed, causing what might otherwise have been a bad recession to slip into the Great Depression, a UCLA economist concludes in a new study. "These findings suggest that the recession was three times worse -- at a minimum -- than it would otherwise have been, because of Hoover," said Lee E. Ohanian, a UCLA professor of economics.
According to Ohanian, these pro-labor policies including pressure for job-sharing and propping up wages handcuffed industry's ability to respond flexibly to the post-crash economic contraction.
After the crash, Hoover met with major leaders of industry and cut a deal with them to either maintain or raise wages and institute job-sharing to keep workers employed, at least to some degree, Ohanian found. In response, General Motors, Ford, U.S. Steel, Dupont, International Harvester and many other large firms fell in line, even publicly underscoring their compliance with Hoover's program. "By keeping industrial wages too high, Hoover sharply depressed employment beyond where it otherwise would have been, and that act drove down the overall gross national product," Ohanian said. "His policy was the single most important event in precipitating the Great Depression."
Hoover as the pro-labor liberal! Never mind that Hoover spent decades after his spectacularly failed presidency bemoaning the country's New Deal turn to Bolshevism. And never mind that the definitive conservative economic treatment of the Great Depression, Milton Friedman and Anna J. Schwartz's "A Monetary History of the United States," pinpoints monetary policy mistakes by the Federal Reserve as the crucial catalyst that turned a stock market crash and recession into a Depression. Never mind the now-fading cultural memory of the United States, which somehow remembers Hoover as being bad for labor, and Roosevelt being good. All that pales against the necessity of making a key political point relevant to today's financial crisis.

There is a germ of information buried in the pile: Hoover did urge business leaders to be gentle to their workers because, he assured them, the Great Depression would soon be over.

But Hoover's interventions do not appear to have had much effect. If you take the degree of government-sponsored union power and wage rigidity in post-WWII Europe to be 100, then FDR's New Deal counts as a 30 and Herbert Hoover's "can't we all just get along?" White House meetings count as a five. If Hoover's inviting businessmen to the White House could push the unemployment rate up from 4% to 23%, simple extrapolation would then suggest that Roosevelt's labor-market policies ought to have pushed unemployment up to 118%--and unemployment in post-WWII Europe ought to have averaged 384%.

It simply does not appear as if Hoover's exhortations had much effects. Average wages in manufacturing stood at $0.55 in 1930, at $0.51 in 1931--an 8% cut--and $0.44 in 1932--a 20% cut. Coal miners' hourly wages went from $0.66 in 1930 to $0.63 in 1931 to $0.50 in 1932--a 25% cut. Skilled male manufacturing workers' wages went from $0.66 an hour in 1930 to $0.63 in 1931 and $0.56 in 1932. You had the same 20% cut in nominal wages over 1930-1932 as you had over 1920-22 (but a 50% decline in industrial production in the 1930 and only a 30% decline in industrial production in the 1920s). The argument would have to be that if not for Hoover, firms would have cut wages much, much faster than they in fact did. In 1996 Ben Bernanke and Kevin Carey, in their "Nominal Wage Stickiness and Aggregate Supply in the Great Depression," plotted real wages and industrial production levels in 1932 relative to 1929 for 22 countries:

Four countries--Australia, Argentina, Hungary, and New Zealand--have low relative real wage levels in 1929 not because employers have cut wages but because they are small open economies and had already undergone massive currency devaluation by 1932: wages were more or less where they were in 1929 but the domestic price level was much higher because the currency was worth less. the rest of the countries were still on or not yet far off the gold standard. Some--Germany and the U.S.--had relatively low real wages and were doing horribly. Some--Norway and Japan--had relatively low real wages and were doing well. And some--Belgium, France, the Netherlands, the United Kingdom, and Switzerland--had relatively high real wages and were doing middling. The scatterplot strongly suggest that Hoover's interventions (a) were too feeble to make the U.S. a more-than-average country in the downward rigidity of its nominal wages, and (b) that at least as of the end of Hoover's term, how deep the Great Depression was in your country had very little to do with whether your internal nominal wages level had fallen far or not. As Eric Rauchway points out, to blame the Great Contraction of 1929-1932 on government interference in the labor market creates a very strong presumption that thereafter the Great Depression should have gotten much worse rather than eased--for the interferences in the 1930s, starting with the NIRA, were much larger deviations from laissez-faire:

[H]ere's the thing: if you want to say, "I'll take 'Causes of the Great Depression', Alex," you have to be prepared with an explanation for (a) why things got so bad under Hoover and (b) why they then got better under Roosevelt.
Monetarist models explain this: the gold standard was deflationary, and going off the gold standard helped countries out of the Great Depression. Hoover didn't go off the gold standard. FDR did. Things got better.
Keynesian models explain this: Hoover didn't do enough to stimulate demand. Roosevelt did more (though still not quite enough).
Ohanian's model doesn't explain this.

And I would like to raise a further caution. Ohanian is working in a framework in which nominal demand--the total dollar flow of spending--is constant. In such a framework lower wages lead businesses to cut their prices and so the same flow of demand buys more goods, and that induces firms to hire more people and produce more. Jacob Viner, Milton Friedman's teacher, strongly cautioned against this line of argument in 1933 because a decline in wages was part of an "unbalanced deflation." Wages fell, but debt principal and interest payments did not.

In Viner's view, and in mine, if wages had fallen faster and further, goods prices and real estate prices would have fallen further and faster, more banks would have gone into bankruptcy, the bank failures would have shrunk the money supply even more, the velocity of money would have fallen even further, and the Great Depression would have been even worse.

Larry Summers and I wrote a paper about this back in the 1980s.

Milton Friedman's teacher Jacob Viner always argued that it was "unbalanced deflation" -- i.e., declines in asset prices and wages and incomes while debts remained the same -- that was the cause of the Great Depression. So did monetarist school founder Irving Fisher. Ask yourself: if everybody's salary in America were to be cut right now by 25 percent -- but everyone's mortgage payment, everyone's credit card balance and interest payment, and every corporation's debt interest payments remained the same--would we see a recovery or another chain of financial bankruptcies that would push the economy down further?

"When Carbon is Priced, Who Ultimately Pays?"

Who pays the costs of a cap and trade system for carbon emissions? This analysis of who pays based upon the legislation passed by the House in June suggests that "the distributional consequences have been addressed fairly effectively," and that "Strong opposition to the legislation will probably be based more on ideological grounds than distributional concerns":

When carbon is priced, who ultimately pays?, by Corbett Grainger and Charles Kolstad, Vox EU: Climate change legislation is winding its way through the US Congress. In June (2009), the House passed complex legislation involving, among other things, a cap and trade system for carbon emissions in the US. The legislation passed by the slimmest of majorities – 219 to 212 with 3 not voting. Although most Republicans opposed the legislation, a significant number of Democrats, primarily those from coal-rich or rural districts, also voted no. Politics is local, even for global warming.

The Senate will consider similar legislation in September, and its passage is likely to be even more difficult. Several issues are at the core of the opposition:

  1. The competitive effect on industry. Will higher costs cause US industry to lose market share to foreign producers? In order to win over skeptics, legislators mandated import tariffs on goods from countries without climate legislation (such as China). President Obama has subsequently condemned such mandatory trade barriers.
  2. The burden of increased energy prices on lower-income individuals. The poor often drive older cars, commute further to work, and in other respects consume goods and services differently than wealthier members of society. Furthermore, to the extent that energy is a necessity, one would expect price increases to hit the poor particularly hard. In other words, carbon regulation may be regressive.
  3. The burden of higher prices for consumers in states heavily reliant on coal-based electricity. Coal has the largest carbon emissions per unit of heat energy of any of the fossil fuels (by a wide margin) and thus will be hit hard by any legislation.

Measuring the burden of a carbon price

It is important to distinguish between a tax's statutory incidence (i.e., who writes the check to the government) and its ultimate burden (who ends up paying the cost of the tax). A cap-and-trade system is not a tax in the normal sense, but it does induce a tax-like carbon price change. Raising the price of carbon increases the costs of doing business, and those costs may be passed on to consumers, workers, or owners.

The Congressional Budget Office estimates that the House legislation will result in an initial price of carbon on the order of $15 per ton of CO2 (CBO 2009a).1 Because CO2 is mostly O2, simple chemistry tells us that this amounts to a price on carbon of about $55 per ton.

When the price of carbon increases, the direct effect is that fuels that consumers and industry purchase will be more expensive. There is also an indirect effect, in the sense that industries that use fossil fuels will see costs rise and will pass some or all of those increased costs on through increased prices of goods and services. The simplest example is electricity. Higher fuel prices raise the costs of generating electricity, which may in turn lead to increased electricity prices. A subtler example is construction, which would face both higher fuel prices and higher raw materials prices, due to the carbon price faced by producers and transporters of those raw materials.

It turns out that tracing the effect of an increased price of carbon through the US economy is not so hard. The US national accounts track how much industries buy from other industries in order to produce. It is straightforward to calculate how a CO2 price would affect the prices of different products in the US economy, assuming that industries are able to pass on all of their extra carbon costs to their consumers. Disaggregating the US economy into nearly 500 different industrial sectors and using a fairly recent characterisation of nationwide consumption patterns, we have estimated the increase in costs associated with a $15/ton price of CO2 (Grainger and Kolstad 2009).

This is probably an overestimate of the effect of a carbon price on product prices for two basic reasons:

  • Some industries will simply not be able to pass on the entire extra cost due to competitive pressures.
  • People and firms typically substitute away from goods that see price increases.

This may involve simply doing without or switching to other goods. Predicting how much of the carbon price can be passed on or how carbon users will change behaviour is not easy.

The effect of a carbon price on industry

The first political issue we address is how badly specific industries would be affected by a price on carbon. Of the approximately 500 industries considered, only five are estimated to see a cost increase in excess of 5%. Table 1 shows the top ten industries facing expected cost increases. Although some sectors do see significant cost increases, what is striking is how few industries see costs increase more than a few percent.

Table 1. Ten highest impact sectors from $15 per ton carbon price

How regressive is a carbon price?

A second political issue in the debate over climate regulation is how regressive a carbon price may be. The US Consumer Expenditure Survey tracks consumption decisions by households throughout the income distribution. Coupling that with data on interindustry transactions allows us to trace a $15 price on CO2 through industries to consumers. As before, this will be an overestimate of the effect on consumers, since we assume that industry can pass on the full carbon price to consumers and consumers do not change their behaviour in response to an elevated carbon price.

In order to understand how regressive or progressive a price on carbon may be, it is important to estimate the fraction of household income that may be absorbed by the carbon price. It turns out that there are several measures of income that may be relevant. One is simply conventional income. Another is lifetime income, based on current expenditures, smoothing out the fact that we tend to earn less early in life and more later but spend based on our expected lifetime income. Two more variations relate to household size. It is cheaper to keep one household of two people than two households of one person, so we can adjust income to "equivalent" income, reflecting the economies of scale in operating a household.

Figure 1 shows the carbon price burden as a fraction of income for different US income groups.

Figure 1. Burden of $15/ton tax on CO2 equivalent, as a fraction of income


As can be seen from the figure, a price on carbon is regressive in that lower income households spend a larger fraction of their income on payments to carbon. Although the effect differs depending on which measure of income is used, the qualitative story is the same. For very low income (less than $35,000 per year), the burden as a fraction of income is highly sensitive to income, increasing substantially as income drops. For greater incomes, the burden is somewhat regressive though not remarkably so, dropping from 1.5-2.5% for $35,000 incomes to 1-2% for the highest income bracket.

In fact, the House climate legislation contains specific provisions to offset the regressive aspects of the cap and trade program. The Congressional Budget Office has analysed these components of the bill and has concluded that the lowest quintile would actually see a gain of 0.2% whereas the highest quintile would see a cost of 0.1% (CBO 2009b). Virtually all of the regressivity has been neutralised, though regional differences may still persist, an issue addressed by Hassett, Mathur, and Metcalf (2009).


The politics of climate change regulation is as much tied up with the distribution of costs as their overall magnitude. Our analysis of the burden of the legislation passed by the House in June suggests that the distributional consequences have been addressed fairly effectively. Strong opposition to the legislation will probably be based more on ideological grounds than distributional concerns.


Congressional Budget Office (2009a) CBO Analysis 5 June 2009. Congressional Budget Office (2009b), "The Estimated Costs to Households From the Cap-and-Trade Provisions of H.R. 2454," (Washington, DC, 19 June 2009) EPA (2009) "EPA Analysis of the American Clean Energy and Security Act of 2009 HR 2454 in the 111th Congress," 23 June 2009. Grainger, Corbett and Charles Kolstad (2009), "Who Pays a Price on Carbon?", NBER Working Paper 15239. Hassett, Kevin, Aparna Mathur and Gilbert Metcalf (2009), "The Incidence of a US Carbon Tax: A Lifetime and Regional Analysis," Energy Journal 30.2 (2009): 155-177.

1 The CBO (2009a) estimates a price of $15 per ton of CO2 equivalent in 2011, rising to about $26 per ton in 2019. The EPA (2009) estimates slightly lower prices – $13 in 2015 and $16 in 2020.

links for 2009-08-29

August 28, 2009

Economist's View - 6 new articles

Bernanke and Regulation of the Financial Sector

Economics of Contempt says I gave in too easily:

Bernanke's Reappointment, by Economics of Contempt: Bernanke's reappointment seems to be the topic of the day, so I suppose I'll weigh in as well. I think Bernanke absolutely deserves a second term. He reacted early and aggressively when strains in the funding markets first appeared back in the fall of 2007, after the two Bear Stearns hedge funds failed and the ABCP market shut down, and he's kept his foot on the gas ever since. Everyone seems to be praising Bernanke for his "creativity" in responding to the financial crisis. While the Fed's various liquidity facilities have indeed been creative, they were almost certainly designed by the New York Fed's markets desk, not Bernanke. What Bernanke deserves credit for is his willingness to use these new and decidedly non-traditional facilities without hesitation. Like Paul Krugman said, a different Fed chairman might well have balked at these new facilities. Bernanke's willingness to approve the AMLF—the most creative of the new lending facilities—probably saved the entire prime money market fund sector, which was experiencing a full-blown bank run. (The Fed pumped $122 billion into money market funds in the first 7 days of the AMLF—and bear in mind that only money funds that were experiencing specified redemption pressures were even eligible for the AMLF in the first place.) People who, like Kevin Drum, oppose Bernanke based on his regulatory views, simply haven't been paying attention. Drum claims that Bernanke "inherited and then perpetuated weak regulation of consumer loan products, something that aggravated the housing bubble." It's true that Bernanke inherited weak regulation of mortgages, but it's simply not true that he perpetuated that weak regulation. That sounds more like what Drum thinks Bernanke probably did (if he had to guess, and without looking at the record). In reality, the Fed adopted new regulations on subprime mortgages over a year ago, and there was nothing "light touch" about them. The Fed started the process of adopting new regulations on subprime mortgages way back in 2006, and the explicit focus from the beginning was on curbing the abuses of 2004/2005. But a Fed chairman can't just wave his magic wand and have new regulations appear in Federal Register—the rulemaking process takes time. And when it comes to something like Reg Z, which is both controversial and complex, it often takes even longer than normal. Bernanke can't be blamed for sweeping the regulatory effort under the rug either. He devoted the bulk of his semiannual Humphrey-Hawkins testimony—the most high-profile testimony a Fed chairman gives—to the need for more regulation of subprime mortgages in July 2007. (He made the case for subprime mortgage regulation again a few months later, in even longer testimony.) The Board of Governors approved the final rule in July 2008. Mark Thoma, who previously argued that Bernanke will be an effective regulator, actually concedes Drum's point, saying that his argument is probably "based more on hope than on evidence." Don't give up so easily, Professor Thoma! If anything, Thoma's argument is the one based on evidence, while Drum's seems to be based on a flawed memory. [Read Barry Ritholz's post on disingenuous Bernanke bashing as well.]

Did Hetrodox Economists Get it Right?

After feeling like I overstated the case, I invited Barkley Rosser (or anyone else) to respond to my claim that "heterodox economists did not do a better job of "calling" the recent crashes and crises than did mainstream or conventional economists." I don't think the list below of people who called the crisis is particularly well defined, e.g. how do you leave off people like Raghuram Rajan, should Krugman be on it, and so forth, and the definition of what it means to have called it can be questioned. But I was the one who first invoked the list (I got it from Steven Keen's site), and I agree that the list as formulated is slanted toward non-conventional economists. I also agree with Barkley's response to my invitation to respond:

I do not think this is going to be easy to determine. It involves not only identifying "who called it," (preferably publicly) and who did not, as well as this sticky wicket of "who is heterodox" and who is not (having just pointed out that it is unclear whether I count or not, and I called a lot of it, and there is question about whether Dean Baker is heterodox, who certainly called a lot of it and very early).
What certainly is clear that the clearly orthodox, and here I would say those who accepted (and many still accept) rational expectations and some sort of equilibrium associated with that, have been very wrong, with basically none of them "calling it." ...

Here's the counterargument:

Did Heterodox Economists Do Better At "Calling It" Than Mainstream Ones?, by Barkley Rosser: In a posting and comments yesterday, Mark Thoma at economists view, , argued that heterodox economists did not do a better job of "calling" the recent crashes and crises than did mainstream or conventional economists. Of course, part of the issue here involves both who one counts as "calling it," and also how one labels economists. In the comments, a list provided by Steve Keen of 11 who "called it," was invoked, with Thoma, at least, claiming that it did not show any preponderance of the heterodox. The list is as follows:
Dean Baker,US Wynne Godley, UK Fred Harrison, UK Michael Hudson, US Eric Janszen, US Stephen Keen, Australia Jakob Brochner Madsen and Jens Kjaer Sorenson, Denmark Kurt Richebacher, US Nouriel Roubini, US Peter Schiff, US Robert Shiller, US.
Keen categorizes these as follows in a private communication with me: 5 as Post Keynesian (Baker, Godley, Hudson, Keen, Sorenson), 2 as Austrian (Richebacher, Schiff), 2 as "from neoclassical backgrounds," but "mavericks" (Roubini, Shiller), one sort of a combination of Austrian and Post Keynesian (Janszen), and one unclear (Harrison). This looks about right to me to the extent I know about these people, although I note that Thoma claims that Baker is not "heterodox." I have not asked Dean, and he may not wish to comment, although he was once-upon-a-time a co-blogger on the predecessor to this blog, maxspeak, prior to starting his own punchy blog, Beat the Press. About four of these people I know nothing about. I also note that there are quite a few others who can make the claim of having "called it" (I like to include myself in that gang, at least to some degree), and I also know that some of those are conventional, more or less, such as Andrew Lo of MIT, although he is now pushing a non-conventional theory about evolutionary financial dynamics. In any case, I think that the heterodox have the edge here, even if it is not clear what constitutes being in that category.

"Beware Authoritative 'Inside Washington' Sources"

Robert Reich says incremental reform of health care won't work, and he gives an example to illustrate why incremental reform isn't always the best way to proceed:

Beware Authoritative "Inside Washington" Sources Who Say The Public Option is Dead, by Robert Reich: ...Years ago, as the story goes, Britain's Parliament faced a difficult choice. On the European continent drivers use the right lanes, while the English remained on the left. But tunnels and fast ferries were bringing cars and drivers back and forth ever more frequently. Liberals in Parliament thought it time to change lanes. Conservatives resisted; after all, Brits had been driving on the left since William the Conquerer's chariot. Parliament's compromise was to move from the left to right lanes -- but incrementally, on a voluntary basis. Truckers first.
But his main point is to be careful of reports of authoritative voices saying that "the public option is dead, that the President won't be able to get a comprehensive health care bill, and that the White House and congressional leadership already know the best they'll be able to do now is move incrementally":
Washington, D.C. is an echo chamber in which anyone who sounds authoritative repeats the conventional authoritative wisdom about the "consensus" of inside opinion, which they've heard from someone else who sounds equally authoritative, who of course has heard it from another authoritative source. Follow the trail to its start and you often find an obscure congressional or White House staffer who has seen some half-assed poll number or briefing memo, but seeking to feel important hypes it a media personality or lobbyist who, desperate to sound authoritative, pronounces it as truth. In any other place on the planet it would be called rumor, gossip, or drivel. In our nation's capital it's called "inside information." The process would be harmless except that it creates self-fulfilling prophesies. Since most of our elected representatives would rather not stick their necks out lest they lose their heads, they tend to rush toward whatever consensus seems to be emerging -- which, of course, is based on authoritative reports about the emerging consensus. In the last few days authoritative sources have repeatedly told me that the public option is dead, that the President won't be able to get a comprehensive health care bill, and that the White House and congressional leadership already know the best they'll be able to do now is move incrementally... The rightwing media fearmongers and demagogues have won. Don't believe it. The other thing about Washington is how quickly conventional authoritative wisdom changes, especially when the public is still in flux over some large matter. Rightwing fearmongers and demagogues thrive only to the extent the mainstream media believes they're thriving. Although polls continue to show that while most Americans like the health care they're getting, they also dislike their insurance companies, worry that they or their families will be denied coverage, and are anxious about the increasing co-payments, deductibles, and premiums they're facing. Most are still eager for reform. In addition, we've come to the point where health-care incrementalism won't work. [explains why, and also explains the need for a public option]... When you go through the logic, it starts to look a lot like comprehensive reform. ... So forget the authoritative sources. Mobilize and organize. We can get comprehensive, meaningful health care reform if we push hard enough. And we must.

Health Care Reform and Entreprenuership

I've also argued that if we don't reform health care, people who think they will be able to keep their current health coverage will find out otherwise, and that health care reform will have a positive effect on entrepreneurship:

Fixing Health Care Is Good for Business, by Gary Locke, Commentary, WSJ: ...There has been a lot of talk about the 47 million Americans who do not have health insurance. But health-care reform is just as important to the majority of Americans who have health insurance now. Absent reform, the price of an average family's insurance will nearly double over the next decade—to $25,000 from $13,000.
No less troubling are the stories I hear from CEOs, entrepreneurs and workers. Rising health-care costs are crushing American companies—particularly small businesses that are the source of much of our economic vitality. ...
The pernicious price of runaway health-care costs also has a dampening effect on entrepreneurship.
How many aspiring owners of businesses are locked in jobs they don't like for fear that striking out on their own would cause them to lose their health insurance? The Small Business Majority, a national advocacy group, estimates there are as many as 1.6 million. ...
The bills working through Congress are moving in the right direction... We must keep moving forward. ...
Because insurance costs are obscured by the employer based system that we rely upon for much of our health insurance, most people don't realize how much they pay for insurance now, let alone the costs they will face in the future. This lack of transparency about the actual insurance costs faced by a typical family creates unnecessary confusion and fear. When, for example, people hear that reform means they might have to pay, say, $8,000 for insurance coverage, they balk at the figure even though it actually saves money and would result in their receiving higher wages (research suggests that the total wage plus insurance bill that firms pay is relatively stable so that a fall in the cost of insurance translates into higher wages). And even if people know how much the insurance costs, the belief may be that the employer is actually paying for the insurance, or at least a significant portion of it, but that is not what research on the incidence of the insurance costs suggests.

Paul Krugman: Till Debt Does Its Part

Should you be worried about the national debt, or the politicians in charge of it?:

Till Debt Does Its Part, by Paul Krugman, Commentary, NY Times: So new budget projections show a cumulative deficit of $9 trillion over the next decade. According to many commentators, that's a terrifying number, requiring drastic action — in particular, of course, canceling efforts to boost the economy and calling off health care reform.
The truth is more complicated and less frightening. Right now deficits are actually helping the economy. In fact, deficits here and in other major economies saved the world from a much deeper slump. The longer-term outlook is worrying, but it's not catastrophic.
The only real reason for concern is political. The United States can deal with its debts if politicians of both parties are, in the end, willing to show at least a bit of maturity. Need I say more?
Let's start with the effects of this year's deficit. ... Consider what would have happened if the U.S. government and its counterparts around the world had tried to balance their budgets as they did in the early 1930s. It's a scary thought. If governments had raised taxes or slashed spending in the face of the slump, if they had refused to rescue distressed financial institutions, we could all too easily have seen a full replay of the Great Depression.
As I said, deficits saved the world.
In fact,... the ... White House forecast shows a nation stuck in purgatory for a prolonged period, with high unemployment persisting for years. If that's at all correct — and I fear that it will be — we should be doing more, not less, to support the economy.
But what about all that debt we're incurring? That's a bad thing, but it's important to have some perspective. ...
Here's one way to look at it: We're looking at a rise in the debt/G.D.P. ratio of about 40 percentage points. The real interest on that additional debt (you want to subtract off inflation) will probably be around 1 percent of G.D.P., or 5 percent of federal revenue. That doesn't sound like an overwhelming burden.
Now, this assumes that the U.S. government's credit will remain good so that it's able to borrow at relatively low interest rates. So far, that's still true. Despite the prospect of big deficits, the government is able to borrow money long-term at ... less than 3.5 percent, which is low by historical standards. People making bets with real money don't seem to be worried about U.S. solvency. ...
So is there anything to worry about? Yes, but the dangers are political, not economic.
As I've said, those 10-year projections aren't as bad as you may have heard. Over the really long term, however, the U.S. government will have big problems unless it makes some major changes. In particular, it has to rein in the growth of Medicare and Medicaid spending.
That shouldn't be hard in the context of overall health care reform. After all, America spends far more on health care than other advanced countries, without better results, so we should be able to make our system more cost-efficient.
But that won't happen, of course, if even the most modest attempts to improve the system are successfully demagogued — by conservatives! — as efforts to "pull the plug on grandma."
So don't fret about this year's deficit; we actually need to run up federal debt right now and need to keep doing it until the economy is on a solid path to recovery. And the extra debt should be manageable. If we face a potential problem, it's not because the economy can't handle the extra debt. Instead, it's the politics, stupid.
Update: A response to Jim Hamilton:
The burden of debt. by Paul Krugman: I respect Jim Hamilton a lot, so I take his criticism seriously — and he raises questions that others raise too about my relatively sanguine assessment of the debt situation. Yet I think that he and others are quite wrong, on several counts.
First off: the assertion that the post-World War II debt was sui generis, that it offers no guidance on what we can afford. It's true that right after the war it was possible to get a drastic reduction in spending easily, since we didn't have to fight the Axis any more. But let's take a slightly later start date: in 1950, federal debt in the hands of the public was 80 percent of GDP, which is in the ballpark of what we're looking at for 2019. By 1960 it was down to 46 percent — and I haven't heard that anyone considered America a debt-crippled nation when JFK took office.
So how was that possible? Was it through drastic cuts in defense spending? On the contrary: we're talking about the height of the Cold War (with a hot war in Korea along the way), and federal spending actually rose as a share of GDP. So yes, it wasn't entitlement programs, but it wasn't exactly discretionary either.
How, then, did America pay down its debt? Actually, it didn't: federal debt rose from $219 billion in 1950 to $237 billion in 1960. But the economy grew, so the ratio of debt to GDP fell, and everything worked out fiscally.
Which brings me to a question a number of people have raised: maybe we can pay the interest, but what about repaying the principal? Jim gets scary numbers about the debt burden by assuming that we'll have to pay off the debt in 10 years. But why would we have to do that? Again, the lesson of the 1950s — or, if you like, the lesson of Belgium and Italy, which brought their debt-GDP ratios down from early 90s levels — is that you need to stabilize debt, not pay it off; economic growth will do the rest. In fact, I'd argue, all you really need to do is stabilize debt in real terms.
So where Jim Hamilton has us paying $1 trillion a year to service $9 trillion in debt, I have us paying $225 billion — 2.5% real interest on that sum.
Now, how does that compare with the tax base? Hamilton rather mysteriously compares debt service only with current personal income taxes. If we use the overall tax take, and talk about what that tax take will be a decade from now, things look much less severe.
So: in 2008, with revenues already depressed by the recession and housing bust, the federal government took in $2.5 trillion in revenues. If we assume 2.5% real growth* and 2% inflation, by 2019 that would rise to $4 trillion. So debt service costs due to the next decade's deficits would be less than 6 percent of revenue under current law.
So, to review: to make the debt look scary, you have to dismiss the post-World -War II experience, even though it turns out that the 50s offer a quite good lesson; assume that in the future the federal government will have to amortize debt over a quite short period, even though it never had to in the past; compare this inflated debt burden with a narrow piece of the federal tax base; and ignore the likely growth in the tax base over the next decade.
I'm not convinced.
*Contrary to what some think, we'd actually expect growth over the next decade to be somewhat above trend, as the economy picks up some of the current slack. That's what the historical record tells us actually happens.

links for 2009-08-28