Money Monopoly

Marshall Auerback says California is challenging the federal monopoly on money creation:

Schwarznegger to Obama: Watch and Learn, by Marshall Auerback: According to the San Diego Union-Tribune, Republicans and Democrats alike embraced legislation last Friday that would make California IOUs legal tender for all taxes, fees and other payments owed to the state.

Effectively, California is using its IOUs to create a currency. If this bill passes it would allow California to deficit spend just like the Federal Government and with the IOU's acceptable as payment of state taxes, it instantly imparts value to them. In effect, what you have is a state of the union creating a sovereign currency right under the noses of Treasury, Fed. They are stumbling their way into it... It will be viewed as a stop gap measure at first, and then could very well become entrenched as states realize they have a way to escape balanced budget requirements. ...

The ... Federal government retains this monopoly under our existing monetary arrangements. If California is successful here in allowing its IOUs to pay tax, it has profound constitutional ramifications. ...

It will be interesting to see what the exchange rate is between California IOU and US currency - the IOUs do offer a yield, so should be less than par by design. I wonder if NY is next.

This is like some sort of return to the 13 colonies with all kinds of ersatz currency floating about. It's hard to believe the Rubinite wing of the Democrats will just let it be, given the threat it represents to Wall Street's prevailing economic interests, but it is an understandable response...

There are political benefits for Obama...: If the Federal government allows this proposal of the state of California to go unchallenged, it would relieve the President of a major political quandary, which is, does he help California and then open himself to aid requests from other states?..., or, does he let California go and lose 56 electoral votes in the next election?

By allowing them to "solve" their own problem in the manner proposed by the legislation he avoids the quandary. And ... they just might let them do it until the import is fully understood.

It is true that this legislation represents a profound break from all federal laws. It is almost bound to incur some sort of constitutional challenge, representing as it does, a profound threat to the Federal government's currency monopoly powers. But this is another instance where Obama's inattentiveness to the ramifications of the states' respective fiscal crises has come back to haunt him. This situation would not have arisen had Obama embraced a simple revenue sharing plan with the states (so that the states' respective fiscal policies would be working in harmony with his proposals, rather than mitigating the impact of the Federal fiscal stimulus), as recommended by any number of prominent economists...

It will be interesting to see how this plays out. As California goes, will the nation follow? ...

Setting aside the particulars of the California case and whether or not the IOUs are actually functioning as money - that's debatable - very, very generally, the federal government has a budget constraint just like everyone else, well sort of like everyone else anyway -- most of us can't levy taxes or print money. Federal government finances must satisfy

G - T = ΔM + ΔB,

where Δ means "change in," G is government spending, T is taxes, M is the money supply, and B is bonds. The left-hand side is the deficit, and the right-hand is how it is financed. Thus, when G is greater than T so that there is a deficit in a given budget period, it must be financed by printing new money (ΔM) or issuing new bonds (ΔB). (If it helps, think of G as being 100 and T being 70 so that the deficit is 30. The deficit can be financed by printing 30 new dollars, by borrowing 30 dollars from the public, or some combination of the two)

Now, for states, ΔM is zero since that would be money creation, and they are not allowed to do that. Thus, a state's budget constraint is:

G - T = ΔB

This must be satisfied each budget period. Because this constraint must hold each budget period, notice what happens if there is a legal or political debt limit -- in some states it is effectively B=0 -- and B is already at the limit (which means ΔB cannot be positive since that would add to the debt). If the state's budget deficit rises in a recession due to decreased tax revenue and increased spending on social services, then G must fall to eliminate the deficit, or new taxes must be levied, and the cutback in spending and/or increase in taxes makes the recession worse.

But what if a state was suddenly granted the power to print money? Then it could pay for that year's deficit without increasing bonds (i.e. debt) any further, i.e. G - T could be financed solely by ΔM if it so chooses. That is, the state now has the constraint

G - T = ΔM + ΔB

If B is maxed out politically or legally so that ΔB must equal zero (or be negative), then a deficit, G - T, could still be financed with ΔM.

Having fifty different currencies isn't necessarily bad, there are pros and cons to having a single currency across all fifty states, i.e. to forming currency union. With a currency union, individual members lose the ability to conduct independent monetary policy - there is one money and one policy so everyone in the group gets the same treatment - but that is less costly when the the economic differences among the members of the union is small and the same policy is generally applicable. There are many advantages to having a single currency (no exchange rate uncertainty and lower transactions costs to name just two), and for countries considering forming a currency union, there is a list of factors that are cited as working for or against unification. Many of these factors involve social, political, economic, and geographic factors, and generally, though not always, the more similar the countries are, the more likely it is that a currency union will be beneficial (e.g. similar levels of development, a similar mix of products, similar legal institutions, same language). In the case of the fifty states within the U.S., I believe the advantages of a single currency far outweigh the disadvantages, and states should not be allowed to create their own currencies.

“Boiling the Frog”

What are we waiting for?:

Boiling the Frog, by Paul Krugman, Commentary, NY Times: Is America on its way to becoming a boiled frog?

I’m referring, of course, to the proverbial frog that, placed in a pot of cold water that is gradually heated, never realizes the danger it’s in and is boiled alive. Real frogs will, in fact, jump out of the pot — but never mind. The hypothetical boiled frog is a useful metaphor for a very real problem: the difficulty of responding to disasters that creep up on you a bit at a time. ...

I started thinking about boiled frogs recently as I watched the depressing state of debate over both economic and environmental policy. These are both areas in which ... it’s very hard to get people to do what it takes to head off a catastrophe foretold. ...

Start with economics: ...Most economic forecasters now expect gross domestic product to start growing soon, if it hasn’t already. But all the signs point to a “jobless recovery”...

Now, it’s bad enough to be jobless for a few weeks; it’s much worse being unemployed for months or years. Yet that’s exactly what will happen to millions of Americans if the average forecast is right — which means that many of the unemployed will lose their savings, their homes and more.

To head off this outcome — and remember, this isn’t what economic Cassandras are saying; it’s the forecasting consensus — we’d need to get another round of fiscal stimulus under way very soon. But neither Congress nor, alas, the Obama administration is showing any inclination to act. Now that the free fall is over, all sense of urgency seems to have vanished.

This will probably change once the reality of the jobless recovery becomes all too apparent. But by then it will be too late to avoid a slow-motion human and social disaster.

Still, the boiled-frog problem on the economy is nothing compared with the problem of ... climate change. ... At this point, the central forecast of leading climate models — not the worst-case scenario but the most likely outcome — is utter catastrophe, a rise in temperatures that will totally disrupt life as we know it... How to head off that catastrophe should be the dominant policy issue of our time.

But it isn’t, because climate change is a creeping threat rather than an attention-grabbing crisis. The full dimensions of the catastrophe won’t be apparent for decades, perhaps generations. ... Unfortunately, if we wait to act until the climate crisis is ... obvious, catastrophe will already have become inevitable.

And while a major environmental bill has passed the House, which was an amazing and inspiring political achievement, the bill fell well short of what the planet really needs — and despite this faces steep odds in the Senate.

What makes the apparent paralysis of policy especially alarming is that so little is happening when the political situation seems, on the surface, to be so favorable...

After all, supply-siders and climate-change-deniers no longer control the White House and key Congressional committees. Democrats have a popular president to lead them, a large majority in the House of Representatives and 60 votes in the Senate. And this isn’t the old Democratic majority, which was an awkward coalition between Northern liberals and Southern conservatives; this is, by historical standards, a relatively solid progressive bloc.

And let’s be clear: both the president and the party’s Congressional leadership understand the economic and environmental issues perfectly well. So if we can’t get action to head off disaster now, what would it take?

I don’t know the answer. And that’s why I keep thinking about boiling frogs.

links for 2009-07-13

“The Hottest Places in Hell are Reserved for Those Who, in Times of Moral Crisis, Maintain a Neutrality”

Tom Bozzo says to watch this video [parts of transcript below]:

Bill Moyers Journal: BILL MOYERS: Wendell Potter ... worked for CIGNA 15 years and left last year. ... why are you speaking out now?

WENDELL POTTER: I didn't intend to, until it became really clear to me that the industry is resorting to the same tactics they've used over the years, and particularly back in the early '90s, when they were leading the effort to kill the Clinton plan. ...

I was beginning to question what I was doing as the industry shifted from selling primarily managed care plans, to what they refer to as consumer-driven plans. And they're really plans that have very high deductibles, meaning that they're shifting a lot of the cost off health care from employers and insurers, insurance companies, to individuals. And a lot of people can't even afford to make their co-payments when they go get care... But it really took a trip back home to Tennessee for me to see exactly what is happening to so many Americans. I ... went home, to visit relatives. And I picked up the local newspaper and I saw that a health care expedition was being held a few miles up the road, in Wise, Virginia. And I was intrigued.

BILL MOYERS: So you drove there?

WENDELL POTTER: I did. ... It was being held at a Wise County Fairground. ... It was a very cloudy, misty day, it was raining that day, and I walked through the fairground gates. And I didn't know what to expect. I just assumed that it would be, you know, like a health-- booths set up and people just getting their blood pressure checked and things like that.

But what I saw were doctors who were set up to provide care in animal stalls. Or they'd erected tents, to care for people. I mean, there was no privacy. In some cases-- and I've got some pictures of people being treated on gurneys, on rain-soaked pavement.

And I saw people lined up, standing in line or sitting in these long, long lines, waiting to get care. People drove from South Carolina and Georgia and Kentucky, Tennessee-- all over the region, because they knew that this was being done. A lot of them heard about it from word of mouth.

There could have been people and probably were people that I had grown up with. ... And that made it real to me. ...

It was absolutely stunning. It was like being hit by lightning. It was almost-- what country am I in? It just didn't seem to be a possibility that I was in the United States. ...

I had been in the industry and I'd risen up in the ranks. And I had a great job. ... I was insulated. I didn't really see what was going on. I saw the data. I knew that 47 million people were uninsured, but I didn't put faces with that number.

Just a few weeks later though, I was back in Philadelphia and I would often fly on a corporate aircraft to go to meetings.

And I just thought that was a great way to travel. ... You're sitting in a luxurious corporate jet, leather seats, very spacious. And I was served my lunch by a flight attendant who brought my lunch on a gold-rimmed plate. And she handed me gold-plated silverware to eat it with. And then I remembered the people that I had seen in Wise County. Undoubtedly, they had no idea that this went on, at the corporate levels of health insurance companies. ...

I didn't know exactly what I should do. You know, I had bills of my own. And it was hard to just figure out. How do I step away from this? What do I do? And this was one of those things that made me decide, "Okay, I can't do this. I can't keep-- I can't." One of the books I read as I was trying to make up my mind here was President Kennedy's "Profiles in Courage."

And in the forward, Robert Kennedy said that one of the president's, one of his favorite quotes was a Dante quote that, "The hottest places in hell are reserved for those who, in times of moral crisis, maintain a neutrality." And when I read that, I said, "Oh, jeez, I-- you know. I'm headed for that hottest place in hell, unless I say something." ...

BILL MOYERS: Your own resume says, and I'm quoting. "With the chief medical officer and his staff, Potter developed rapid response mechanisms for handling media inquiries pertaining to complaints." Direct quote. "This was highly successful in keeping most such inquiries from becoming news stories, at a time when managed care horror stories abounded." I mean, you knew there were horror stories out there.

WENDELL POTTER: I did. I did. ...

BILL MOYERS: You were also involved in the campaign by the industry to discredit Michael Moore and his film "Sicko" in 2007. ...

BILL MOYERS: So what did you think when you saw that film?

WENDELL POTTER: I thought that he hit the nail on the head with his movie. But the industry, from the moment that the industry learned that Michael Moore was taking on the health care industry, it was really concerned. ... They were afraid that people would believe Michael Moore. ...

The industry has always tried to make Americans think that government-run systems are the worst thing that could possibly happen to them, that if you even consider that, you're heading down on the slippery slope towards socialism. So they have used scare tactics for years and years and years, to keep that from happening. If there were a broader program like our Medicare program, it could potentially reduce the profits of these big companies. So that is their biggest concern. ...

[P]art of the effort to discredit this film was to use lobbyists and their own staff to go onto Capitol Hill and say, "Look, you don't want to believe this movie. You don't want to talk about it. You don't want to endorse it. And if you do, we can make things tough for you." ...

BILL MOYERS: Now, that's exactly what they did, didn't they? They ... radicalized Moore, so that his message was discredited...

WENDELL POTTER: Absolutely. ... It worked beautifully. ... The film was blunted. It--

BILL MOYERS: Was it true? Did you think it contained a great truth?

WENDELL POTTER: Absolutely did.

BILL MOYERS: What was it?

WENDELL POTTER: That we shouldn't fear government involvement in our health care system. That there is an appropriate role for government, and it's been proven in the countries that were in that movie.

You know, we have more people who are uninsured in this country than the entire population of Canada. And that if you include the people who are underinsured, more people than in the United Kingdom. We have huge numbers of people who are also just a lay-off away from joining the ranks of the uninsured, or being purged by their insurance company, and winding up there.

And another thing is that the advocates of reform or the opponents of reform are those who are saying that we need to be careful ... because we don't want the government to take away your choice of a health plan. It's more likely that your employer and your insurer is going to switch you from a plan that you're in now to one that you don't want. You might be in the plan you like now.

But chances are, pretty soon, you're going to be enrolled in one of these high deductible plans in which you're going to find that much more of the cost is being shifted to you than you ever imagined.  ...

BILL MOYERS: Why is public insurance, a public option, so fiercely opposed by the industry?

WENDELL POTTER: The industry doesn't want to have any competitor. In fact, over the course of the last few years, has been shrinking the number of competitors through a lot of acquisitions and mergers. So first of all, they don't want any more competition period. They certainly don't want it from a government plan that might be operating more efficiently than they are...

BILL MOYERS: And they do what to make sure that they [remain profitable]?

WENDELL POTTER: Rescission is one thing. Denying claims is another. Being, you know, really careful as they review claims...

But another way is to purge employer accounts, that-- if a small business has an employee, for example, who suddenly has have a lot of treatment, or is in an accident. And medical bills are piling up, and this employee is filing claims with the insurance company. That'll be noticed by the insurance company.

And when that business is up for renewal, and it typically is up, once a year, up for renewal, the underwriters will look at that. And they'll say, "We need to jack up the rates here...," Often they'll do this, knowing that the employer will have no alternative but to leave. And that happens all the time.

They'll resort to things like ... dumping, actually dumping employer groups from the rolls. So the more of my premium that goes to my health claims, pays for my medical coverage, the less money the company makes. ...

BILL MOYERS: When a member of Congress asked the three executives who appeared before the committee-- if they would end the practice of canceling policies for sick enrollees, they refused. Why did they refuse?

WENDELL POTTER: Well, they were talking to Wall Street at that moment. ...

BILL MOYERS: This is the key question for me. Can health reform that includes a public plan actually rid our system of the financial incentive on the part of the insurance industry to provide less for more?

WENDELL POTTER: It will help. It would help. Would it rid it? No, I don't think it would, because of the for-profit structure that is now dominant in this country. But the public plan would do a lot to keep them honest...

Fiscal Policy: “The Right and the Obvious Thing To Do”

Two things seem relatively clear. First, given the projected baseline for the economy, the previous stimulus package was too small. It was big enough to help, but it won't give anything near the boost the economy needs. Second, the original baseline was far too optimistic.

So I agree:

Fiscal Policy: The Obama Administration Is Not Making Much Sense These Days, by Brad DeLong: ...Last December the Obama administration to be decided on a fiscal stimulus package which they believed would have minor effects on the economy in the first two quarters of 2009 and major effects--would push unemployment down below what it would other wise have been by more than half a percentage point--starting in the third quarter of 2009. They believed that the economy was not that weak, and that with the fiscal stimulus package taking effect unemployment would be peaking now at a rate of 7.9%.

Instead, unemployment is now probably in the 9.5-9.7% range--and without the stimulus package it would right now have turned out to be above 10%:

The financial crisis of last fall hit the economy's levels of production, spending, and employment much harder than people thought at the time. If we had known then what we know now, it would have been prudent then to propose twice as large a fiscal stimulus program as the Obama administration in fact did propose. ...

All in all, it looks like the unemployment rate in 2009 is going to average 1.2 percentage points above where the administration last December thought we would be. ...

It is interesting and important to note that the excess unemployment now forecast over 2009 relative to last December's forecast is of the ... magnitude ... of ... a $170 billion shortfall.

If I were running the government, I would be trying to make up that GDP shortfall right now: I would be rushing a clean $170 billion--$500 per citizen--aid-to-states-that-maintain-effort package through the congress this week. It would seem the right and the obvious thing to do.

At least that much, and the sooner the better.

The Caritas in Veritate: Justice

The only time I ever got an F on an exam, or even close, was in a religious studies course I took to fulfill general education requirements. You know how some of you don't get math? I felt the same way. I somehow managed to pass the course, but I had no foundation whatsoever in the topic going in, and I just didn't get it.

So I am going to let others comment on the Pope's Caritas in Veritate:

Mixing morals and money. by Christopher Caldwell, Commentary, Financial Times: To judge from his encyclical Caritas in Veritate, published this week, Pope Benedict XVI agrees with those who say that something has gone wrong with the way the world does business. ... The encyclical is not anti-global or anti-capitalist. ... Business and finance have not created new excesses. They have opened new routes for an arrogance already present in the hearts of men.

The Pope, in perhaps his most radical passage, laments the “hegemony of the binary model of market-plus-state”. ... Business and government have become specialised fields; each follows a logic that dispenses with the insights of religion. Globalisation can break down cultures, and with them the moral systems in light of which it can be judged. ...

Unfortunately, one of the lost insights concerns justice. The Pope would like us to think about justice as having three aspects. There is commutative justice (the idea of properly judging the prices of things), distributive justice and social justice. National governments, which used to address the second and third, no longer have full power to do so. The global institutions that have replaced them tend to be concerned only with commutative justice – and they do a bad job, the Pope thinks, of judging the value of labour. “If the market is governed solely by the principle of the equivalence in value of exchanged goods, it cannot produce the social cohesion that it requires,” he writes.

It is on the subject of justice that the Pope gives voice to a striking insight: “In the global era, the economy is influenced by competitive models tied to cultures that differ greatly among themselves. The different forms of economic enterprise to which they give rise find their main point of encounter in commutative justice.”

The marketplace is a narrow meeting place... Most of what is distinctive and valuable about the cultures of trading partners gets left out. ... The idea that globalisation expands our horizons is an optical illusion. The same holds true of our technological gadgets. They may give us more instruments for communicating, the Pope says. But “it does not follow that they promote freedom or internationalise development and democracy for all”.

The Pope is optimistic that globalisation does not make loss of identities inevitable. One hopes he is right. But ... he ... has no more luck than others have had in figuring out how to produce distributive justice in this day and age. ...

The Pope’s surprisingly firm political recommendation is for increased global government, based on existing institutions. He urges a “reform of the United Nations and likewise of economic institutions and international finance, so that the concept of the family of nations can acquire real teeth”. But this begs the very question... Before such institutions can be legitimately constituted, we need to know what their principles are. ...

Benedict is certainly right to say that, if we wish to protect the environment, “the decisive issue is the overall moral tenor of society”. He is right to attack the presumption of technologically advanced societies that “confuse their own technological development with a presumed cultural superiority”. And he makes a convincing case that the recent financial failures are best understood in the context of a wider moral failure.

Nick at Open Economics (he's at Notre Dame) has been writing about each chapter in the Pope's "social encyclical." Here, he discusses Chapter 3:

Caritas in Veritate, Chapter Three, Open Economics: Now for a discussion of Chapter 3 of Pope Benedict XVI’s social encyclical, Caritas in Veritate. As I mentioned in my last post of this series, Chapter Three is where Benedict most directly addresses the idea of the economy. Benedict says from the outset that the economy has been misconstrued and abused for much of human history:

Then, the conviction that the economy must be autonomous, that it must be shielded from “influences” of a moral character, has led man to abuse the economic process in a thoroughly destructive way. In the long term, these convictions have led to economic, social and political systems that trample upon personal and social freedom, and are therefore unable to deliver the justice that they promise.

He ... distinguishes between different levels of justice in the context of markets:

In a climate of mutual trust, the market is the economic institution that permits encounter between persons, inasmuch as they are economic subjects who make use of contracts to regulate their relations as they exchange goods and services of equivalent value between them, in order to satisfy their needs and desires. The market is subject to the principles of so-called commutative justice, which regulates the relations of giving and receiving between parties to a transaction. But the social doctrine of the Church has unceasingly highlighted the importance of distributive justice and social justice for the market economy, not only because it belongs within a broader social and political context, but also because of the wider network of relations within which it operates. In fact, if the market is governed solely by the principle of the equivalence in value of exchanged goods, it cannot produce the social cohesion that it requires in order to function well. Without internal forms of solidarity and mutual trust, the market cannot completely fulfil its proper economic function.

This section strikes me as incredibly important. It is thoroughly Polanyi-esque, implicitly arguing that the economy is embedded in society and needs to be treated as such. There is also this notion of trust that is introduced. I think trust would often be categorized by economists as an “institution,” something that can likely be made exogenous when thinking about the economy, but this is naive, Benedict argues. Trust is both a foundation of and a result of the economy.

The emphasis on social and distributive justice is also important because it forces the faithful to think outside the usual Christian paradigm of justice vs. mercy. Social justice is not simply an option, as mercy might be, but a necessity. Casting the economy in these terms forces the faithful to work so that the economy does not just enable, but guarantees, social justice.

Next, Benedict seeks to redefine economic activity. In this section, I’m beginning to see some contradictions cropping up. First,

Economy and finance, as instruments, can be used badly when those at the helm are motivated by purely selfish ends. Instruments that are good in themselves can thereby be transformed into harmful ones. But it is man’s darkened reason that produces these consequences, not the instrument per se. Therefore it is not the instrument that must be called to account, but individuals, their moral conscience and their personal and social responsibility.

So, it’s not the economy’s fault; it’s the people who are running it. By the same token, however,

Economic activity cannot solve all social problems through the simple application of commercial logic…The Church’s social doctrine holds that authentically human social relationships of friendship, solidarity and reciprocity can also be conducted within economic activity, and not only outside it or “after” it. The economic sphere is neither ethically neutral, nor inherently inhuman and opposed to society. It is part and parcel of human activity and precisely because it is human, it must be structured and governed in an ethical manner.

To reconcile these two sections, I think we need to realize that the first paragraph is not an endorsement of charity-based capitalism. When reading the second paragraph, particularly the part about the economy not being ethically neutral, it seems that Benedict is calling on humans to structure the economy in a just manner. Thus, the blame is not so much on humans who fail to act charitably, but on those who perpetuate an economic system that inherently leads to injustice.

Benedict then continues with ideas of embeddedness:

Today we can say that economic life must be understood as a multi-layered phenomenon: in every one of these layers, to varying degrees and in ways specifically suited to each, the aspect of fraternal reciprocity must be present. In the global era, economic activity cannot prescind from gratuitousness, which fosters and disseminates solidarity and responsibility for justice and the common good among the different economic players.

Then, in another important move, Benedict calls for people to reenvision enterprise:

What is needed, therefore, is a market that permits the free operation, in conditions of equal opportunity, of enterprises in pursuit of different institutional ends. Alongside profit-oriented private enterprise and the various types of public enterprise, there must be room for commercial entities based on mutualist principles and pursuing social ends to take root and express themselves. It is from their reciprocal encounter in the marketplace that one may expect hybrid forms of commercial behaviour to emerge, and hence an attentiveness to ways of civilizing the economy.

This is sort of a call for an economy that fosters more Mondragons, not just for people to create more Mondragons. In other words, we must create an economy where socially-oriented enterprises like Mondragon are not simply headed for failure.

Along these same lines,

In order to defeat underdevelopment, action is required not only on improving exchange-based transactions and implanting public welfare structures, but above all on gradually increasing openness, in a world context, to forms of economic activity marked by quotas of gratuitousness and communion. The exclusively binary model of market-plus-State is corrosive of society, while economic forms based on solidarity, which find their natural home in civil society without being restricted to it, build up society.

And now, recognizing the limits of traditional business:

Old models are disappearing, but promising new ones are taking shape on the horizon. Without doubt, one of the greatest risks for businesses is that they are almost exclusively answerable to their investors, thereby limiting their social value…Moreover, the so-called outsourcing of production can weaken the company’s sense of responsibility towards the stakeholders — namely the workers, the suppliers, the consumers, the natural environment and broader society — in favour of the shareholders…Today’s international capital market offers great freedom of action. Yet there is also increasing awareness of the need for greater social responsibility on the part of business.

To conclude the section, Benedict again shifts the focus to these issues in the context of globalization:

humanity itself is becoming increasingly interconnected; it is made up of individuals and peoples to whom this process should offer benefits and development…Despite some of its structural elements, which should neither be denied nor exaggerated, “globalization, a priori, is neither good nor bad. It will be what people make of it”…It is necessary to correct the malfunctions, some of them serious, that cause new divisions between peoples and within peoples, and also to ensure that the redistribution of wealth does not come about through the redistribution or increase of poverty…Unfortunately this spirit is often overwhelmed or suppressed by ethical and cultural considerations of an individualistic and utilitarian nature.

Benedict, in a Stiglitz-esque fashion, concludes by calling for a more just globalization, one that does not suppress ethics with so-called free market ideology. A more just globalization, in summary, will keep the economy in its proper place, embedded in society. It will be welcoming toward socially-oriented enterprises that operate under a stakeholder model. All this is essential to his notion of social justice. The lack of the social justice is not the fault of the economy, but of the people who have helped perpetuate the current structure of the economy. Of course, all this still leaves the question, how will the economy transition, and who will bring that about? Benedict pays lip service to political freedom throughout this chapter, but this obviously is still lacking. How will this develop into more practical recommendations? Stay tuned.

“Trumped by Darwin?”

Robert Frank returns to the point he made in Alpha Markets, i.e. that Charles Darwin provides the "true intellectual foundation" for economics. Though the example this time is male elk rather than bull elephant seals, the central point - and it's one worth giving more thought to - is that "Individual and group interests are almost always in conflict when rewards to individuals depend on relative performance." In these situations, which occur frequently in economic and social relationships, the assumption in neoclassical economic models that the maximization of self-interest is consistent with the maximization of social interest does not hold, and failure to recognize this has " undermined regulatory efforts ... causing considerable harm to us all":

The Invisible Hand, Trumped by Darwin?, by Robert Frank, Commentary, NY Times: If asked to identify the intellectual founder of their discipline, most economists today would probably cite Adam Smith. But that will change. ... Charles Darwin ... tracks economic reality much more closely. ...

Smith’s basic idea was that business owners ... have powerful incentives to introduce improved product designs and cost-saving innovations. These moves bolster innovators’ profits in the short term. But rivals respond by adopting the same innovations, and the resulting competition gradually drives down prices and profits. In the end, Smith argued, consumers reap all the gains.

The central theme of Darwin’s narrative was that competition favors traits and behavior according to how they affect the success of individuals, not species or other groups. As in Smith’s account, traits that enhance individual fitness sometimes promote group interests. For example, a mutation for keener eyesight in hawks benefits not only any individual hawk that bears it, but also makes hawks more likely to prosper as a species.

In other cases, however, traits that help individuals are harmful to larger groups. For instance, a mutation for larger antlers served the reproductive interests of an individual male elk, because it helped him prevail in battles ... for access to mates. But as this mutation spread, it started an arms race that made life more hazardous for male elk over all. The antlers of male elk can now span five feet or more. And despite their utility in battle, they often become a fatal handicap when predators pursue males into dense woods.

In Darwin’s framework, then,... [c]ompetition, to be sure, sometimes guides individual behavior in ways that benefit society as a whole. But not always.

Individual and group interests are almost always in conflict when rewards to individuals depend on relative performance, as in the antlers arms race. In the marketplace, such reward structures are the rule, not the exception. The income of investment managers, for example, depends mainly on the amount of money they manage, which in turn depends largely on their funds’ relative performance. Relative performance affects many other rewards in contemporary life. ...

In cases like these, relative incentive structures undermine the invisible hand. To make their funds more attractive to investors, money managers create complex securities that impose serious, if often well-camouflaged, risks on society. But when all managers take such steps, they are mutually offsetting. No one benefits, yet the risk of financial crises rises sharply. ...

It’s the same with athletes who take anabolic steroids. ...

If male elk could vote to scale back their antlers by half, they would have compelling reasons for doing so, because only relative antler size matters. Of course, they have no means to enact such regulations.

But humans can and do. ... Darwin has identified the rationale for much of the regulation we observe in modern societies — including steroid bans in sports, safety and hours regulation in the workplace, product safety standards and the myriad restrictions typically imposed on the financial sector.

Ideas have consequences. The uncritical celebration of the invisible hand by Smith’s disciples has undermined regulatory efforts to reconcile conflicts between individual and collective interests in recent decades, causing considerable harm to us all. ...

[And, again, for those who might be interested, see also Paul Krugman's: What Economists Can Learn from Evolutionary Theorists Synopsis.]

“Is Benefit-Cost Analysis Helpful for Environmental Regulation?”

 Robert Stavins notes that:

With an exceptionally talented group of thinkers - including scientists, lawyers, and economists - now in key environmental and energy policy positions at the White House, the Environmental Protection Agency, the Department of Energy, and the Department of the Treasury, this question about the usefulness of benefit-cost analysis is of particular importance

Here's his (balanced) discussion. Points four, five, and eight struck me as particularly noteworthy:

Is Benefit-Cost Analysis Helpful for Environmental Regulation?, by Robert Stavins: ...[Does] economic analysis - in particular, the comparison of the benefits and costs of proposed policies - play ... a truly useful role in Washington, or is it little more than a distraction of attention from more important perspectives on public policy, or - worst of all - is it counter-productive, even antithetical, to the development, assessment, and implementation of sound policy in the environmental, resource, and energy realms. ...

For many years, there have been calls from some quarters for greater reliance on the use of economic analysis in the development and evaluation of environmental regulations. As I have noted in previous posts on this blog, most economists would argue that economic efficiency — measured as the difference between benefits and costs — ought to be one of the key criteria for evaluating proposed regulations. ... Because society has limited resources to spend on regulation, such analysis can help illuminate the trade-offs involved in making different kinds of social investments. In this sense, it would seem irresponsible not to conduct such analyses, since they can inform decisions about how scarce resources can be put to the greatest social good.

In principle, benefit-cost analysis can also help answer questions of how much regulation is enough. From an efficiency standpoint, the answer to this question is simple — regulate until the incremental benefits from regulation are just offset by the incremental costs. In practice, however, the problem is much more difficult, in large part because of inherent problems in measuring marginal benefits and costs. In addition, concerns about fairness and process may be very important economic and non-economic factors. Regulatory policies inevitably involve winners and losers, even when aggregate benefits exceed aggregate costs.

Over the years, policy makers have sent mixed signals regarding the use of benefit-cost analysis in policy evaluation. Congress has passed several statutes to protect health, safety, and the environment that effectively preclude the consideration of benefits and costs in the development of certain regulations, even though other statutes actually require the use of benefit-cost analysis. At the same time, Presidents Carter, Reagan, Bush, Clinton, and Bush all put in place formal processes for reviewing economic implications of major environmental, health, and safety regulations. Apparently the Executive Branch, charged with designing and implementing regulations, has seen a greater need than the Congress to develop a yardstick against which regulatory proposals can be assessed. Benefit-cost analysis has been the yardstick of choice.

It was in this context that ten years ago a group of economists from across the political spectrum jointly authored an article in Science magazine, asking whether there is role for benefit-cost analysis in environmental, health, and safety regulation. That diverse group consisted of Kenneth Arrow, Maureen Cropper, George Eads, Robert Hahn, Lester Lave, Roger Noll, Paul Portney, Milton Russell, Richard Schmalensee, Kerry Smith, and myself. That article and its findings are particularly timely, with President Obama considering putting in place a new Executive Order on Regulatory Review.

In the article, we suggested that benefit-cost analysis has a potentially important role to play in helping inform regulatory decision making, though it should not be the sole basis for such decision making. We offered eight principles.

First, benefit-cost analysis can be useful for comparing the favorable and unfavorable effects of policies, because it can help decision makers better understand the implications of decisions by identifying and, where appropriate, quantifying the favorable and unfavorable consequences of a proposed policy change. But, in some cases, there is too much uncertainty to use benefit-cost analysis to conclude that the benefits of a decision will exceed or fall short of its costs.

Second, decision makers should not be precluded from considering the economic costs and benefits of different policies in the development of regulations. Removing statutory prohibitions on the balancing of benefits and costs can help promote more efficient and effective regulation.

Third, benefit-cost analysis should be required for all major regulatory decisions. The scale of a benefit-cost analysis should depend on both the stakes involved and the likelihood that the resulting information will affect the ultimate decision.

Fourth, although agencies should be required to conduct benefit-cost analyses for major decisions,... those agencies should not be bound by strict benefit-cost tests. Factors other than aggregate economic benefits and costs may be important.

Fifth, benefits and costs of proposed policies should be quantified wherever possible. But not all impacts can be quantified, let alone monetized. Therefore, care should be taken to assure that quantitative factors do not dominate important qualitative factors in decision making. ...

Sixth, the more external review that regulatory analyses receive, the better...

Seventh, a consistent set of economic assumptions should be used in calculating benefits and costs. Key variables include the social discount rate, the value of reducing risks of premature death and accidents, and the values associated with other improvements in health.

Eighth, while benefit-cost analysis focuses primarily on the overall relationship between benefits and costs, a good analysis will also identify important distributional consequences for important subgroups of the population.

From these eight principles, we concluded that benefit-cost analysis can play an important role in legislative and regulatory policy debates on protecting and improving the natural environment, health, and safety. Although formal benefit-cost analysis should not be viewed as either necessary or sufficient for designing sensible public policy, it can provide an exceptionally useful framework for consistently organizing disparate information, and in this way, it can greatly improve the process and hence the outcome of policy analysis.

If properly done, benefit-cost analysis can be of great help...

links for 2009-07-11

Haiku Economics

Why the sudden popularity of Haiku Economics??? This is from Steve Ziliak:

Dear Mark:

The economic recession -- something -- is bringing increased attention to "haiku" and "Haiku Economics."

The first fundamental assumption of haiku economics is: Less is more and more is better. The idea seems to be catching on with financial traders as much as with poets and political speechwriters.  The unemployed, it seems, can't resist it, and more than a few economists (heedless of Bentham) have put pens to verse.

Last week (July 2nd, 2009) brought a fine introductory article on "haiku economics," by Erica Alini, at the Real Time Economics blog of The Wall Street Journal.

In May I was interviewed -- in haiku form -- by the Chronicle of Higher Education (Steve Kolowich);  there followed from the (fun to do) Chronicle interview three separate appearances on National Public Radio.  Inspired by my interview, NPR issued a "recession haiku challenge." 

The outpouring of hundreds of haiku about economics, written by NPR listeners, was rather shocking, even to NPR, the journalists said.  News of the NPR haiku-economic explosion has spread by now to many other sites related and unrelated to public radio. For example:

  • Vinca LaFleur, a former speechwriter for Bill Clinton who now blogs at the West Wing Writers' Podium Pundits, has picked up on it.
  • On Dec. 31, 2008 The Wall Street Journal (Mary Pilon) did a page one article on the nationwide outpouring of haiku and other short verse and again my work was featured.
  • In August or September of 2008 Freakonomics/New York Times issued a haiku-economic challenge to which hundreds of economists and others responded.

By way of introduction, I first learned haiku from a friend and adopted teacher, Etheridge Knight (1931-1991), a great American and African American poet with whom I was in close contact between 1987 and 1991.  This was in Indianapolis, back in the days before Robert Bly was a household name and well before Yusef Komunyaaka had been to Princeton or had won a Pulitzer Prize and so through Etheridge and his companion, the poet Elizabeth McKim, I got to know the underbelly of an important body of American poetry, haiku included.  (Etheridge Knight's teacher was Gwendolyn Brooks, a U.S. Poet Laureate from Chicago.  She discovered Knight while he was serving time at the Indiana State Pen, in the early 1960s.)

Etheridge used to urge me to put haiku and economics together.  I told him yes, and then I went into another world - - into a Ph.D. program not in the Writers' Workshop but in Economics!

About 10 years later, in 2001, I was teaching econ at Georgia Tech in Atlanta when I began to understand how these two arts and sciences fit together, and I've been writing and teaching "haiku economics" ever since. Now, a few years on, I see that haiku and economics converge more than they collide at the level of principles, or so I argue.

Haiku economics won't solve all our aching problems.  But, as I argue in my forthcoming article, haiku can and does serve as more than economic pain relief, 17 syllables at a time, plus or minus a small standard deviation!

“Are Depressions Necessary?”

Chris Hayes takes up a notion I've never been very fond of, that recessions are necessary and healthy since they clear out inefficient firms, and spur the development of new innovation during the recovery phase. (Why do I think this is unnecessary? The entry and exit of firms driven by innovation and the development of new products can be part of a full employment equilibrium, that is, cycles are not needed to clear out old firms and spur innovation. Imagine an economy where a new idea allows a slightly more productive firm to enter a market and displace a less productive firm, and the workers migrate from the old to the new firm over time. If this happens at a constant rate in aggregate over time, there won't be any cycles at all, but we still manage to clear out the inefficient firms and replace them with more innovative rivals. The displaced workers from the the innovation driven structural adjustment are part of the natural rate of unemployment in such an economy):

Are Depressions Necessary?, by Christopher Hayes, The American Prospect: ...Are economic contractions, like the one we're currently experiencing, a good thing? ... It would be career suicide for any elected official to suggest that the widespread stress, misery and heartache being wreaked by ... contraction were are a good thing. But scratch the surface a bit and you'll find a surprisingly vibrant school of thought, one that reaches back all the way back to the Great Depression, that holds precisely this view.

Famed economist Joseph Schumpeter said that "a depression is for capitalism like a good, cold douche," one that rinses off accumulated dysfunction. Robber baron Andrew Mellon (who served as Herbert Hoover's treasury secretary) welcomed the Great Depression with these infamous words: "It will purge the rottenness out of the system. High costs of living and high living will come down. People will work harder, live a more moral life. Values will be adjusted, and enterprising people will pick up the wrecks from less competent people"

It's not hard to find this same view among bankers, financiers and sundry Wall Streeters today. ...

The stakes for this argument are very high: if steep economic contractions are like forest fires, a necessary part of the system's self-calibration, we should more or less let them burn. If they are more like five-alarms raging through dense city neighborhoods, we should call in the fire department.

Newsweek and Washington Post columnist Robert Samuelson is perhaps the most prominent and outspoken Mellonist writing today...

Paul Krugman, to put it mildly, disagrees. ... What animated much of this advice was not just a rigid and dogmatic economic consensus, but also the puritanical normative assessment that a wicked economy must now pay its penance. (Of course said penance was never paid by those who caused the crisis: It was paid out of the pockets of the starving, the poor and working class.)

It's exactly this notion that Krugman seeks, above all, to dispel. ...

"...The ... business cycle may have little or nothing to do with your more fundamental economic strengths and weaknesses. [B]ad things ... can happen to good economies."

...More broadly, Krugman's point is that, contra Samuelson, recessions, and depressions and assorted downturns are not useful, cleansing opportunities to "purge the rottenness out of the system," but more often vicious cycles, auto-catalytic processes that result in massive amounts of human suffering, and waste human capital and an economy's productive capacity. More like the forest fire caused by a careless camper than the natural cleansings produced by mother nature.

The technical implication of this view for crisis management is that when an economy is stuck in a deep recession, like the one in which we are now mired, normal bromides of Chicago-style economics, those to which Samuelson clings so closely, cease to apply. ... Krugman ...[believes] deft and active management is necessary. Suffering is no badge or courage, but a sign of failure. ...

As Krugman persuasively argues, economies need management and policy to ... be saved from their own tendency to spiral into disaster, to cycle through booms and busts... Samuelson and those of the Mellonist school have an innate distrust of politics; meddlesome and vulgar and prone to demagoguery. Lately the political system as seemed to be working over-time to confirm their worst fears.

But ultimately there is not economics without politics, and as terrifying as this may be, economists can't save us from this crisis. Only politicians can.

Are Small Banks the Answer for Developing Countries?

This week at The Economist:

Justin Lin, the World Bank’s chief economist,... in his guest Economics focus column ... argues that developing countries should base their financial systems on small, local banks:

The size and sophistication of financial institutions and markets in the developed world are not appropriate in low-income markets. Small local banks are the best entities for providing financial services to the enterprises and households that are most important in terms of comparative advantage—be they asparagus farmers in Peru, cut-flower companies in Kenya or garment factories in Bangladesh. The experiences of countries such as Japan, South Korea and China are telling. Those countries managed to avoid financial crises for long stretches of their development as they evolved from low-income to middle- and high-income countries. It helped greatly that they adhered to simple banking systems (rather than rushing to develop their stock markets and integrate into international financial networks) and did not liberalise their capital accounts until they became more advanced.

Mr Lin concludes:

Leave the developed markets to worry about how to reform their highly evolved financial systems. To make sustained progress in lifting the weight of the extreme poverty that will remain after the crisis has subsided, low-income countries need to make their financial institutions small and simple.

Over the course of the next week, we will devote this blog to a discussion of Mr Lin’s column, posting responses from our correspondents, invited experts from the academic and policy worlds, and our commenters. We'll be collecting the entire series of posts here. Do stop by and contribute to the debate.

Here is the lead Essay: Walk, Don't Run by Justin Lin

Here are the responses so far:

Here is my response:

Small banks need help, by Mark Thoma: I agree with many of the points in the article regarding the potential that small and simple banks provide. But while small and simple banks can help to overcome many problems, by themselves they may not be enough fully serve the financial needs within developing countries.

There are two issues here. The first is to determine the types of financial products that best suit the needs of people and businesses within developing countries, and the second is how to best deliver those products to the people and businesses who could benefit from using them.

Small banks and microfinance of the type emphasised in the article can meet many of the financial needs in developing countries, for example the need that farmers have to borrow funds to purchase seed and fertiliser, and then repay the loans at harvest, can be met in this way. But other needs require more sophisticated financial products. The ability to hedge price risk through futures markets, the need for insurance against crop failure, the need to purchase farm equipment through pooling arrangements that share the costs among end users, and the problems brought about by seasonality require more sophisticated products and arrangements. The point is that not all of the financial needs in agricultural, small scale manufacturing, and services are simple, even in developing countries.

Can these more complex financial needs be satisfied, or are there important barriers within developing countries that prevent these products from being used?

One big barrier is, as noted in the article, the lack of information on the financial history and worthiness of potential borrowers. This information takes time to develop and that is where small banks can play an important role. First, they can develop relationships within the community that overcome this informational barrier. Local knowledge allows the bank to assess credit risk more accurately, and to more efficiently serve the needs of the community. Second, as small banks gain information about the credit histories and worthiness of people and businesses within their local areas, that information must be preserved and made available system wide so that more comprehensive systems can emerge (the article has good suggestions about how to begin this process).

There is a third way in which local banks can help, and that is for the small banks to be embedded within a larger financial system so that the small banks can make available products that local banks cannot provide on their own. It is not clear, for example, how price hedging and crop insurance can be provided solely through small local banks, hence the need for small banks to be part of a more comprehensive system.

Importantly, linking local banks to financial markets more generally does not require that the local banks give up the stability cited in the article as a reason for developing countries to prefer the small bank approach. The 7,630 community banks in the U.S. used as examples of the stability small banks can provide are fully integrated into the global financial system, but they have, quoting from the article, "so far been only mildly affected by the financial crisis as they continue to deal with the same small local clients that they have for years". Finally, a fourth advantage of embedding small banks in this way is that it also helps to set the stage for the development of more comprehensive and sophisticated financial markets as the countries develop over time.

But simply providing a link to larger financial markets with more diverse products is not enough. These products are complex, and borrowers must be able to trust that the lenders will not take advantage of their superior information about the characteristics and risks of these products.

While I believe that lenders will manage to overcome their asymmetric information problem and successfully determine who is, and who is not a good credit risk within the local communities they serve, I am less confident that borrowers can overcome their asymmetric information problem regarding the use of sophisticated financial services. I don't mean to imply that people within developing countries are less able to understand how complicated financial products work, or less able to understand how to use them safely than people in developed countries. But in many cases the knowledge of and experience with these products is fairly limited, and in any case the recent financial crisis in the U.S. shows that consumers in advanced countries often lack the information they need to fully understand the characteristics of some products such as mortgages. So this is a general problem.

The response in the U.S. has been to develop a Financial Products Safety Commission, and to take other steps to provide consumers of these products with the information they need to make good decisions. Developing countries need a small scale version of this, i.e. someone or some institution that people within the local community can trust to give them the advice and information they need to make informed decisions. Ideally, that would be the local bank acting as the conduit to these products, e.g. the bank or some other financial institution would pool local resources and purchase the required products in an agency relationship, but there is reason to doubt that the bank would act in the investors' best interests.

This is an area where, I think, information and coordination problem among small farmers and producers is severe enough so as to require some type of government or outside agency intervention to help. I agree that complex financial products can be problematic in the wrong hands, and that many people who could benefit from these products lack the information they need to use them safely, but I don't believe that this means people in developing countries should not have access to products that can expand their investment opportunities and limit risk. They should not be limited to only those products that small, independent banks can provide on their own. But small farmers, manufacturers, and service providers cannot overcome the failures that cause these markets to malfunction without help. Therefore, it is up to outside agencies or the government to either step in and create optimal market conditions through regulation and other means, which would likely be difficult given the severity of the problems that must be overcome, or to provide substitutes for the financial products the market cannot provide effectively, e.g. government price guarantees and government provided insurance against catastrophic crop failure, which shouldn't be as difficult. I don't mean that these activities shouldn't be guarded and cautious, but small and simple banks cannot, by themselves, fully meet the needs of the communities they serve.

Paul Krugman: The Stimulus Trap

Everybody makes mistakes. But not everyone can admit their mistakes, and then take the steps needed to overcome them:

The Stimulus Trap, by Paul Krugman, Commentary, NY Times: As soon as the Obama administration-in-waiting announced its stimulus plan — this was before Inauguration Day — some of us worried that the plan would prove inadequate. ...

The bad employment report for June made it clear that the stimulus was, indeed, too small. But it also damaged the credibility of the administration’s economic stewardship. There’s now a real risk that President Obama will find himself caught in a political-economic trap.

I’ll talk about that trap, and how he can escape it, in a moment. First, however, let me ... ask how concerned citizens should be reacting to the disappointing economic news. Should we be patient, and give the Obama plan time to work? Should we call for bigger, bolder actions? Or should we declare the plan a failure and demand that the administration call the whole thing off? ...

When there’s an ordinary, garden-variety recession, the job of fighting that recession is assigned to the Federal Reserve. ... Reducing rates a bit at a time, it keeps cutting until the economy turns around. At times it pauses to assess the effects of its work; if the economy is still weak, the cutting resumes. ...

Normally, then, we expect policy makers to respond to bad job numbers with a combination of patience and resolve. They should give existing policies time to work, but they should also consider making those policies stronger.

And that’s what the Obama administration should be doing..., stay calm in the face of disappointing early results,... the plan will take time to deliver its full benefit. But ... be prepared to add to the stimulus now that it’s clear that the first round wasn’t big enough.

Unfortunately, the politics of fiscal policy are very different from the politics of monetary policy. For the past 30 years, we’ve been told that government spending is bad, and conservative opposition to fiscal stimulus (which might make people think better of government) has been bitter and unrelenting even in the face of the worst slump since the Great Depression. Predictably, then, Republicans — and some Democrats — have treated any bad news as evidence of failure, rather than as a reason to make the policy stronger.

Hence the danger that the Obama administration will find itself caught in a political-economic trap, in which the very weakness of the economy undermines the administration’s ability to respond effectively. ... The question is what the president and his economic team should do now.

It’s perfectly O.K. for the administration to defend what it’s done so far. ... It’s also reasonable for administration economists to call for patience...

But there’s a difference between defending what you’ve done so far and being defensive. It was disturbing when President Obama walked back Mr. Biden’s admission that the administration “misread” the economy, declaring that “there’s nothing we would have done differently.” There was a whiff of the Bush infallibility complex in that remark, a hint that the current administration might share some of its predecessor’s inability to admit mistakes. And that’s an attitude neither Mr. Obama nor the country can afford.

What Mr. Obama needs to do is level with the American people. He needs to admit that he may not have done enough on the first try. He needs to remind the country that he’s trying to steer the country through a severe economic storm, and that some course adjustments — including, quite possibly, another round of stimulus — may be necessary.

What he needs, in short, is to do for economic policy what he’s already done for race relations and foreign policy — talk to Americans like adults.

Don’t Expect a Quick Recovery

One of the reasons I've argued this recovery will be slow is that we cannot simply bounce back to where we were before the problems started as we could in some past recessions. We need to move resources out of housing, out of finance, and out of autos, and those resources need to find productive employment elsewhere in new or growing industries, and that is not very likely until things improve. Consumers need to save more and consume less, as they are starting to do, and this too will require adjustment. So does this mean we should expect a U-shaped recovery instead of a V-shaped recovery? Robert Reich says it's neither, this is an X-recovery:

When Will The Recovery Begin? Never., by Robert Reich: The so-called "green shoots" of recovery are turning brown in the scorching summer sun. In fact, the whole debate about when and how a recovery will begin is wrongly framed. On one side are the V-shapers who look back at prior recessions and conclude that the faster an economy drops, the faster it gets back on track. And because this economy fell off a cliff late last fall, they expect it to roar to life early next year. Hence the V shape.

Unfortunately, V-shapers are looking back at the wrong recessions. Focus on those that started with the bursting of a giant speculative bubble and you see slow recoveries. ... That's where the more sober U-shapers come in. They predict a more gradual recovery...

Personally, I don't buy into either camp. In a recession this deep, recovery ... depends on consumers who, after all, are 70 percent of the U.S. economy. And this time consumers got really whacked. Until consumers start spending again, you can forget any recovery, V or U shaped.

Problem is, consumers won't start spending until they have money in their pockets and feel reasonably secure. But they don't have the money, and it's hard to see where it will come from. They can't borrow. Their homes are worth a fraction of what they were before, so say goodbye to home equity loans and refinancings. ... Unemployment continues to rise, and number of hours at work continues to drop. Those who can are saving. Those who can't are hunkering down...

Don't expect businesses to invest much more without lots of consumers hankering after lots of new stuff. And don't rely on exports. The global economy is contracting.

My prediction, then? Not a V, not a U. But an X. This economy can't get back on track because the track we were on for years -- featuring flat or declining median wages, mounting consumer debt, and widening insecurity, not to mention increasing carbon in the atmosphere -- simply cannot be sustained.

The X marks a brand new track -- a new economy. What will it look like? Nobody knows. All we know is the current economy can't "recover" because it can't go back to where it was before the crash. So instead of asking when the recovery will start, we should be asking when and how the new economy will begin. ...

“Cities and Stimulus”

Did cities receive too little of the federal transportation stimulus money?:

Lisa Schweitzer on Cities and the Stimulus, by Richard Greene: From her blog:

One of my fantastic students from Virginia Tech, Eric Howard, posted this piece from today’s New York Times on Facebook. The NYT author argues that:

Two-thirds of the country lives in large metropolitan areas, home to the nation’s worst traffic jams and some of its oldest roads and bridges. But cities and their surrounding regions are getting far less than two-thirds of federal transportation stimulus money.

The reporter goes on to quote outrage from mayors. They also get information from one of my favorite experts, Rob Puentes at Brookings. As usual, Rob has a very good point here: this package isn’t just about business as usual revenue allocation–which has always had a strong rural bias due to the structure of the Federal representative system (as Owen D. Gutfreund points out). This rural strength made way more sense 150 years ago than it does now.

So, of course all of these smart people are right in that cities aren’t treated very well in the stimulus, as they aren’t treated very well in Federal politics in general.

However, we have to ask ourselves: would it really be sensible to hand out this money on a per capita basis either?

The main argument for cities and against suburbs and small towns is an economy of scale argument. Those arguments underpin the “costs of sprawl” research. Urbanization and density of human settlement lower the cost of providing infrastructure because of all the sharing we city folk do: the same sidewalk can serve thousands per day instead of a handful of people per day, as in a low-density settlement.

Thus, cities should somewhat expect to receive less per person than other places. The key point is just how much less per person should we expect urban infrastructure to cost, given all this sharing. The problem with sharing, of course, is that sharing leads to congestion after a certain point in population growth, thereby raising costs for everybody and requiring either dispersal of population or additional infrastructure.
While planning and planners are hard-wired to think in terms of increasing density, building duplicate systems (ie increasing capacity) in congested areas is only one means of cost sharing: the other, more macro-scale approach is to direct more growth to areas with excess capacity or price congested facilities and shift more of the revenue generation burden back onto users instead of looking for Federal funds.

This latter approach is, I think, where we are ultimately heading with infrastructure finance in the new urban world. Do we have compelling arguments for why the Federal government should be involved in urban infrastructure if all they going to do is return revenues to source (the per capita/population distribution argument). Anti-federalists can and do make strong arguments for local funding of intracity systems, like metro rail systems, while Federal dollars should go to intercity and interstate projects.

So while the NYT and urban mayors are probably right in that this distribution of funding is skewed, they haven’t really told us what the right distribution would look like, other than to say that cities are important and they need more money. Of course they are and they do, but it isn’t as though some of the poorest places in this country aren’t places like the Central Valley rather than places like Los Angeles, and it’s not as though Boston doesn’t depend on connectivity between rural Florida and Boston for all parts of the freight and US food system.

[For more on this, see Ryan Avent.]

links for 2009-07-10

Oh, So Now There Are No Green Shoots?

By now you know the non-farm payrolls report came out and the job loss for June was worse than expected, fortunately the weekly jobless claims number stunk too (small humor attempt). And of course the stock market puked down yesterday.

The tenor of the comments on CNBC seemed to be that oh well, forget it about it now, this after the occasional berating of people who were not so bullish before the June data printed. This sort of manic tone that investors are exposed to from various parts of the media has the potential to be dangerous.

I write often about panic selling and panic buying, letting manic commentary in the media influence your thinking can precipitate panic trading. Think about the last few years from a very big picture. How bad is this really? And how much has changed in the last three months? This has been pretty bad, though not Armageddon, and not much has changed in three months. The stock market rallied a lot and that made some people feel better.

In late December I said I thought there would be a huge rally for no reason at all--it would just happen. I was obviously a couple of months early but it happened. This was not a prediction where I went out on a limb. After markets scare the hell out of people they have violent snapback rallies, this is just how it works.

For the last few weeks, maybe longer, I have been saying I thought there would be one more run down that would scare the hell out of people. I don't think a scare the hell out them decline would take out the old low but I don't know. This is not really a prediction where I am going out on the limb either because...say it with me...this is just how it works. The violent snap back rally, which I have also referred to as feel good rallies reassures people that things are ok and then the market tanks one more time bring it to what John Hussman has called the revulsion stage. Maybe it won't happen this time but the chances are good that it will.

There was no Armageddon or Great Depression 2.0 in the first week of March, we were not completely out of the woods in May, there will be no Armageddon or Great Depression 2.0 if we go down to SPX 700 this summer. I think this is shaping up to what I said months ago which was that the way out will be a stumble along the bottom.

Hopefully long time readers, and more importantly our firm's clients, will realize that my view has been steady as opposed to flip-flopping with each data point that comes along. Aside from probably being unhealthy, constant flip-flopping is more likely to be wrong.