Dumb and Dumber

Usually, the empirical impact of a policy proposal on relative prices or incentives has at least some bearing on its efficacy. In the case of the Gas Tax Holiday proposed by Hillary Clinton, it doesn't. Simply put, this proposal is a lose-lose. Let me explain.

If you remove the tax on gasoline for the summer, the policy will either reduce the pump-price of gasoline, or it won't. If it does, then by all accounts it will benefit average users by $70, using the most generous estimates of the Clinton campaign (which she even admits to some extent defies the estimates of the "quote-unquote experts" – and that would be spread out over all three months of the holiday). But wouldn't this contradict the other goals of Ms. Clinton's platform? Wouldn't it (among other things) make us more dependent on foreign oil, make the terrorists richer, encourage people to continue driving at their current levels, increase emissions, and create a strain on the federal budget in a time of unprecedented deficits?

But, OK. Demand for oil is pretty inelastic. Maybe it won't affect the price at all. But wait, since the price would then be unaffected, wouldn't that raise share of the end-user price that the private suppliers get, increase the record profits of gas companies, increase the revenues of oil-rich regimes that support terror, have no impact on households, and still create a strain on the federal budget in a time of unprecedented deficits?

In the end, we all lose. Another reason not to vote for a desperate lying woman who thinks she is entitled to the nomination because she stuck by her philandering husband and doesn't even have an economist heading her economic policy team of advisers.

Happy holidays.

The Gains from Trade and Migration

I've always told my class that the gains from trade are large, about ten years ago (dating myself here) people were estimating the welfare costs of trade restrictions in the United States to be about $55,000 per job saved, assuming that the short run job losses literally vanish … forever… It puts a little perspective on the trade gains and welfare losses from restricting trade.

I've always believed the gains from migration to be smaller, but still positive. For example, some studies estimate the per capita gains for native US citizens to be about 0.25%, and a fair argument could be made that migration to the US is much more disruptive to the distribution of income than trade is. What's left out of this calculus is the huuuuuuge benefit per capita to the world on the whole, and to developing countries in particular.

Last week's Economist discusses this issue, citing an article by Kym Anderson and L. Alan Winters. What surprised me was that they estimate the global gains from migration to be much larger than the global gains from trade. The authors cite models that have predicted the gains from trade to be around $300billion per year worldwide. Similar techniques estimate the gains from just 3% of the worlds workforce migrating across borders to be about $675billion per year by 2025. These numbers are mind-boggling, especially if you consider the fact that just 3% of the world population currently resides in a country other than the one in which they were born – with existing controls and restrictions on immigration. So, taking the combined gains from trade and migration, we're basically looking at welfare gains of about a trillion, or about $150 per person per year – a sum that's far from trivial for the 60% of the world's population living on less than $2 a day.

Not only that, but the article mentions that the gains from trade of $300billion may be understating things. Computational models estimate the global cost of trade restrictions to be as high as $2.5 trillion.

Getting Tanked on French Air

Boeing's steamed this week (and for that matter, since early March) over recent developments in the Air Force's contracts for new midair refueling tankers. Basically, their beef is that that the Air Force awarded a 35 billion dollar procurement contract for new tankers to replace the KC-135 (which, as it turns out my father piloted). The subtleties of their complaint accuse Airbus/Northrop (parented by EADS) of insider trading and that there were illegal actions in the procurement of the contract. There couldn't be a thicker slice of baloney in the books.

Procurement contracts for government spending are one of the most common non-tariff barriers employed by the United States and countries in Europe (ever see a state trooper driving a Honda instead of a Crown Vic?). So if they can pitch a fit and claim wrongdoing in some way, they will. I'm a little surprised, however, that they tried to be creative by alleging illegal trading practice instead of invoking the usual "American Jobs" argument (perhaps because Airbus is going to be doing most of the assembly that normally occurs in France at plants in Alabama, USA). This shows some real ingenuity in the lobbying process! What's funny is that if anyone has insider status for such contracts, it's the Boeings and Lockheeds, not the Airbuses and Embratels of the industry.

Export Taxes and Hunger

Last week I lectured on trade policy to my undergrads. I mentioned that the United States Constitution prohibits Export Taxes, and I got a predictable response. "Why would a government want to tax exports?" one clever student asked. I used it (as was my intention) to explain the concept of Lerner Symmetry, which basically illustrates that in terms of relative prices, output and welfare, an export duty is equivalent to an import tariff in the way it affects (damages) an economy. The basic idea is that both of these instruments limit trade and so it doesn't matter which end you limit it from: coming or going. A tariff de facto restricts exports as well as imports. I then gave a couple of examples of how countries use export taxes to advantages in a similar way to tariffs: for example, when the US threatened tariffs if Canada didn't limit soft lumber exports, the Canadians brilliantly achieved the limitation with a tax on exports. The net result was the same as if the US had imposed the tariff, except the Canadian government got the tax revenue instead of Uncle Sam.

The more real answer is that once a politician gets something in his (her) head that something is a good idea for accomplishing some political end, there's virtually no stopping him. No matter how noble the cause, politics can be pretty nasty about finding a way to blunder it, but it's not always their own fault. Developing countries have been applying duties for some time now on food exports, with the goal of retaining greater quantities of food for a hungry domestic population. The issue was discussed in this week's Economist. But the question is: "Does this do the job?" In short, yes, if Lerner symmetry holds theoretically. The whole point behind these policies, and behind the principle of Lerner Symmetry is that the change will not impact the world price much. In effect, in order for producers to continue exporting with the duty, the world price must be able to cover the domestic costs (domestic market price) plus the tax (otherwise, continue supplying the domestic market to avoid the tax). So, whereas taxes on imports increase the domestic price of imports, taxes on exports decrease the domestic price of the exported good. It is exactly this that policymakers rely upon when they impose such a "recipe for trouble" on the economy. Sure the adverse effects outweigh the good they do, but the duties do make food cheaper. And, conveniently for a eggheaded economist like me, they illustrate and rely upon a theorem that seems counterintuitive at first blush.

Basically, the policies boil down to a second-best solution: they do the job, but of all the options that could do it, trade taxes are among the worst. Better would be to subsidize consumption directly, perhaps by taxing non-food goods and transferring the revenues to poorer households in the form of in-kind transfers. The reason the duties are laid on, the Economist correctly points out, is political expedience, but I think that this keen observation oversimplifies the issue. Many countries have extreme difficulties collecting taxes other than those from trade, and many solutions that would be best solved by direct subsidies are often more than inexpedient; they're infeasible. In nerdy terms, there's an important political constraint that the writers at the Economist isn't taking into account. Then again who am I but a bookish economist who only knows abstract inapplicable theories?

Free Trade and the Liberal Bourgeoisies

I blogged last week about two groups cited as opposing free trade. The first were the working class of developed countries – this group is correctly concerned about their own jobs, incomes, families, and livelihoods. Although trade is good overall, it hurts some groups because the gains are uneven, and this group is the most likely to suffer in the short run.

The second group consisted of "liberal hippies" who are sort of caricatured as English professors (no offense intended to the English professors in my own college) and their idealistic young students. Their ideas are romantic, and their ends are admirable and include: reducing global poverty, saving the environment, ending armed conflict in the globe, child labor, gender and racial discrimination (er, reducing them, that is), and so on. Their means for accomplishing them on the other hand are somewhere between self-conflicting and patently stupid because they almost always include imposing trade restrictions on countries who appear to be behaving in an unsatisfactory way or tying these issues to trade negotiations. Oh, what a tangled web they weave…

Let me start though with the empirical evidence on such issues:

Poverty: With a few exceptions, trade has been found to alleviate poverty in most countries that are "open." Viet Nam is a good example, where textile industries boomed as a result of trade, which was paired with the adoption of better technologies in the rice sector and a win-win or poor families. Here's another story from NPR on China, and a complementary piece, also from NPR. It's an interesting tale of factories in China shutting down, which seems sad at first, but digging deeper, much of the jobs lost are due to the fact that labor markets are becoming more competitive, workers are seeking jobs with other firms, and wages and labor standards are increasing.

Environment: The effect of trade on the environment is tough to pin down. The only thing that can really be said is that assuming trade leads to greater productivity, higher incomes and a "growth spurt" in developing countries, then it will also lead to increased demand for energy resources, and put greater strain on the environment. There are two problems with this proposition. First, even if it is valid, liberal hippies have to concede the point on poverty to make it true. If trade leads to growth and increases household consumption of carbon-emitting fuels, then it is probably because they are less poor. To restrict trade would be to deny poor families the opportunities that greater wealth brings and we would be inflicting poverty on 60% of the world's population in an attempt to put a band-aid on environmental harm. Second, the proposition above assumes that with growth these economies will stupidly continue to use the same harmful technologies and not adopt cleaner ones. Even China has recognized that they need to resolve this issue, with an increasing number of "zero energy/zero emissions" skyscrapers being built and carbon capture technology being better investigated.

Child Labor, Social Issues, etc.: Globalization brings these issues more to our attention than anything else. These things have always been problems, but they have been greater problems in closed countries, and in poorer countries. Even the United States and Britain, when they were first industrializing, struggled with problems of child labor and various forms of wage and employment discrimination. These problems tend to be more effectively alleviated by extending economic freedom, which is what openness to trade does, not denying it, which is what restrictions do.

A good book on the "human face" of globalization is In Defense of Globalization by Jagdish Bhagwati. It should be required reading for anyone considering opening their pieholes on the topic of trade and globalization.

It's actually going to be a fun week – I see two good articles on trade and globalization in this week's Economist, so you'll get to hear my thoughts on them.

Bang

Following the Market

Prices serve their purpose! If you want people to conserve gas, let the price go up. (Further, some research suggests to let it push past historical highs if you really want changes in fixed investments like automobiles and furnaces, etc. to make the conservation behavior more permanent.)

Check this out from the New York Times. America's Biggest news publication, USA Today, has stopped following the campaign busses on the campaign trail. Which is what economists have been saying all along – if oil is truly scarce (or costly to the environment) then the price should be allowed to climb to let the market ration it to valuable users. In this case we get a double-benefit: less gas consumed and fewer voices chattering about the election! Yipee!

Bang

The Chasm between Trade Economists and the Public

Arrogant economists (myself included) too often talk down to the working public about the gains from trade. Take this, from a New York Times Article by Gregory Mankiw:

NO issue divides economists and mere Muggles more than the debate over globalization and international trade. Where the high priests of the dismal science see opportunity through the magic of the market's invisible hand, Joe Sixpack sees a threat to his livelihood. This gap in perspective grows especially wide whenever the economy experiences short-run difficulties, as it is now.

Now, if I just lost my middle class job, and met this guy in a bar, I'd probably call him an asshole and punch him in the nose. It points out two things about economists: 1. We are arrogant S.O.B.'s, and; 2. We have an awkward sense of humor. I think his point would be more well-taken if he were more deprecating of economists, like so:

NO issue divides pinheaded economists and working class heroes more than the debate over globalization and international trade.

In either case, the globalization debate is trivialized by viewing it this way. First, there are multiple groups in opposition to trade and outsourcing. First you have the "working class heroes" who work hard, earn their keep, and view their jobs as under attack. This group tends to be socially conservative, vote republican (especially as the influence of unions has waned in their ability to prop up democratic candidates) have 2.2 kids to worry about, and be influenced by their own interests (with some help from Lou Dobbs). These folks want a better life for their children. Secondly, there is the "liberal hippie" crowd. This group opposes globalization for a diversity of reasons including a genuine concern for workers in foreign countries, poverty, the environment, women's rights, genocide, public health, and so on. This group tends to be pretty well educated, socially liberal, vote democratic, not have kids, and be influenced by English and Sociology Professors.

The arguments against free trade are not stupid or ill-informed, but on the national stage they rest on two common logical fallacies: 1. The fallacy of composition, and; 2. The "post-hoc ergo propter hoc" fallacy. The fallacy of composition is basically arguing that what's true of part of the economy is true of the economy at-large. In other words, it is a poor argument to say that a declining steel sector means a declining US economy, or that job losses in one area mean job losses in the aggregate. The second is the fallacy of assuming that correlation implies causation. For example, we trade with China and I lost my job does NOT imply that trade stole my job (it also doesn't mean that I won't find a job doing something else, or that my wages must fall).

Which group has more valid concerns, and ones that are better-supported by economic theory and empirical evidence: the Joe Sixpacks, or the English Professors? Well, as it turns out (and as much as I HATE Lou Dobbs), it's the Joe Sixpacks and their hero, Lou Dobbs. Let me set one thing straight: TRADE IS GOOD – THE GAINS FROM TRADE ARE POSITIVE IN THE AGGREGATE AND ON A PER-CAPITA BASIS. But, the distributional consequences of trade (and ANY major change in policy that impacts relative prices for that matter) are severe and the negative effects (though "small" in the aggregate) are highly concentrated among a relatively small number of people who bear none of the fault for their situation. But these consequences usually only last for the "short-run," and workers who seek employment in expanding (export-oriented) sectors can sometimes put themselves in a better position than the one they were in before the layoffs, but not always.

With trade, low-skill wages may fall in a country like the United States even in the long run, which is unfortunate. And it would be heroic to ask the Joe Sixpacks to sacrifice their own well-being to raise the living standards of people in China or Indonesia. But the skill intensive goods (and services) that we export will more than compensate and we may be able to subsidize low-skill wages to compensate for the losses. In addition, the impact of offshoring on wages (even with the goods simply shipping back to WalMarts in the US) is not clear. If the offshoring is able to reap gains in the form of scale economies in a vertically-integrated global supply chain then wages in the US may rise.

Diamond-Water Paradox, Revisited

How much diamonds cost relative to something as essential as water is one of the oldest puzzles in economics. The simple answer at first was scarcity – diamonds are scarcer than water, right? Well, that's not the whole picture, because the diamond market is riddled with a small number of people willing to pay a whole heckuva lot for a really pretty rock, all water is pretty homogeneous, and the diamond market itself is well-controlled by the DeBeers cartel. What's more, scarcity or not, not everyone is willing to pay even amount of their income for a diamond, whereas they would gladly give their own lives for more water.

I've blogged before about ethnic conflict and economic incentives (new path to victory and economic development in Iraq), and I kept wondering about some of the ethnic conflict and genocide. Basically, I'm running out of examples of conflicts that are purely ethnic in nature – the only one I can come up with is Palestine.

While most of Africa's famous conflicts and genocides revolve around diamonds and the high rents that can be captured by controlling their extraction, and much of the middle east fights over oil, some places have been a bit more difficult to understand. The answer might simultaneously explain their underdevelopment, difficulty developing institutions, and propensity for conflict. What might turn out to be the case is that they aren't really fighting over ethnicity or differences in traditions, but they're fighting over water, that essential resource (and arguably "public good") that every agrarian culture needs to break out of the Malthusian Trap. The sides of the fight are simply lining up on ethnic lines, which is interesting enough, but won't contribute to a solution (and neither will the military might of the US and Europe). By focusing on ethnicity instead of economics, we make the mistake of patching the problem with a band-aid (at best) by policing the conflict rather than driving to the root of the problem.

Clearly I've done some over-simplification of the problem here, but although the problems of the moment are complex, the solution is simple – water is coming at too high a price.

Not Institutions???

I was baffled last week when it was suggested that incentives and institutions mean very little in struggling economies because of some sort of genetic selection bias. How bout this from the WB, posted on the economist: http://www.economist.com/daily/chartgallery/displaystory.cfm?story_id=10835590

Institutions don't make the difference? Perhaps a handful of ability bias (maybe harsher conditions in Britain stirred innovation and made it more difficult to produce surviving progeny for low-ability low-income types – that would be somewhat consistent with the story). But, it's no secret that ability, reward for merit, and success can generate a virtuous cycle – successful entrepreneurs and a growing upwardly-mobile middle class creates demand for better institutions which fosters growth.

Incentives don't matter? I'll ask the question I posed over lunch: Why does corruption WORK then. Why would a bribe in these countries (which are just genetically predisposed to value leisure and be less patient) WORK in greasing the wheels to accomplish anything? You could MAYBE make the argument that you're paying for people NOT to work, but really? People DON'T work on a constant basis; that's why stuff doesn't get done to certify business licenses, zone, approve loans, enforce contracts, etc. That's why it fails.

Cocky Economists

I perused some quotations of econmists recently, and there were some interesting ones here's one from JM Keynes:

"If economists could manage to get themselves thought of as humble, competent people on a level with dentists, that would be splendid." The Future, Chapter Five.

Here's a related quote from a journalist for the KC Star (which I have to credit to Adam McKinnie as well because he signs his emails with it:

"For the person who stands steadfast in the face of life's big questions, the movies or music or painting or poetry is nothing more than a pleasant diversion, something to pass the time. The person who is rock solid in his or her beliefs, who never battles with doubt, who feels he's on the one true path and sees no point in exposing himself to the thoughts of others -- that person has no need of art. That person should buy a bass boat." -Robert W Butler, KC Star

I think the world is telling me to shut the hell up for a couple of days.

Bang!

Are We All Keynesians?

This week, The Economist has an Economic Focus article on Keynesian stimulus. In 1971, Richard Nixon, the former budget-hawk, strident anti-communist, and all around grumpy conservative, said, "I am a Keynesian now." To put his remark in context, Nixon's 1971 statement of faith was an eerie play on a 1965 headline from (what most of his Republican supporters would call) a liberal commie rag (Time Magazine) stating "We are ALL Keynesians now." In fact that headline was merely a quotation of Milton Friedman, monetary economist at the University of Chicago, and author of the anti-interventionist treatise, "Free to Choose." I guess the implication was that here was the last bastion of conservative economic thought, conceding that the Keynesian approach had won out.

But before long, supply-side ("cost-push") inflation (mostly from oil prices) created a resurgence of classical ideology favoring low taxes, balanced budgets, and laissez-faire. And this new blood in the field of economics, led by the likes of economists Robert Lucas, Robert Barro, Thomas Sargent, Arthur Laffer and journalists Jude Wanniski and Robert Bartley, had a valid point about the long-run implications of Keynesian policies. In fact, the Supply-side movement got its inspiration, not from disdain for Keynesians (although this was not wonting), but from the Austrian school of thought and Joseph Shumpeter (who predicted the eventual collapse of communism in the 1930s). This school of thought was acutely aware of the importance of politics and institutions in the efficacy of any type of economic system, but generally supported market capitalism. Their political voice was Ronald Reagan, at least rhetorically (most people debate how "conservative" Reagan really was – he ran humongous deficits, and pulled unprecedented amounts of executive "discretionary spending" out of congress).

Now, we've come full-circle. Clinton (William Jefferson) signed entitlement reform, balanced the budget, began talking about "market incentives," and promoted free markets through globalization and the WTO. For him it was a luxury, for the economy was doing well through no fault of the government, yet he deserves praise for not screwing it up. "W" did his part for the conservative cause by lowering taxes, but has done very little to balance the budget, promote market competition, or improve transparency and independence in the bureaucracy, all of which "true" supply-siders would say are as essential as tax cuts themselves for promoting long run economic health.

So where do we stand on the intervention issue? Does Keynesian intervention "work?" Yes. The short run is important, from both an economic and a political perspective. Intervention can smooth the business cycle and ease the pain of recessions, but not as much as the "old school" Keynesians thought, and it is usually poorly implemented, as The Economist points out. Two aspects are especially key: Timing and Targeting. Often times fiscal policy fails (or does more harm than good) because the political process cannot respond in time, and the "stimulus" hits as the economy is already recovering on its own. This causes the economy to overheat and produce inflation. In addition, governments need to have the discipline to reign things in during a boom. This usually doesn't happen because spending and other interventions create "rents" for interest groups and entrenched bureaucracies, who then lobby and pressure to have these benefits continued. Good targeting requiress that spending should be distributed in a way that maximizes impact. This is a political hornet's nest: Is the "right" target one that creates private sector externalities such as infrastructure and public goods, or is it one that eases the pain for workers and families impacted by the downturn? So, I'll leave it at that, and hopefully each of the 3 readers that see this might have some thoughts.

Bang!

Income Inequality and Statistical Lies

The NY Times (of all publications) is making the case this week that income inequality ain't so bad, and the Economist has latched on in its free exchange blog. (Some of my readers might be shocked that a pinko-liberal-hippie-commie rag would say such a thing. Personally, I like the NY Times, and I think it's a heckuva lot more objective than some of the alternatives out there, while still actually saying something.) The basic case is that household income statistics don't tell the whole story, and that's true enough. Their answer: consumption statistics, an equally silly figure. They note that among the bottom 1/5 of incomes, consumption (on average) is about twice their taxable income. So what? If retirees, students, recipients of government transfers, and the disabled are consuming more than what they report as taxable, isn't that kind of the point? Should we just tear down programs so the statistics will better conform with the "true" extent of income inequality? Hmm. In addition, most of the disparity in the consumption averages versus the income averages comes from change in net wealth. All it really takes is a handful of really wealthy retirees who earn nothing and spend a million dollars to throw that part of the statistical accounting totally out of whack.

Basically, what I'm saying here is that you can't just look at income, and while consumption may be a better measure of welfare for "most" families, you can't focus on that either. Statistically, the means don't justify the ends (of the distribution). In this case, you have to treat zero-income households differently (in statistics we call it "censored" data), which means you have to actually do some dirty work with the data.

Bang!

Counting at the New York Times

Does anyone find it a coincidence that the NY Times is pretty much the only major news source that has a way of "counting" delegates earned by each democratic candidate so that Hillary ends up ahead of Obama thus far? CNN, NBC, and the AP all have Obama in the lead in some fashion, but the Times seems to think that some of the caucus results don't "count" yet.

Obama Defeats Clinton!

It's over! The votes are all in! Obama defeated Clinton this week. Obama defeated Clinton with his Audacity of Hope – Bill Clinton… in the Grammy's I waited a bit too long on that one, but it's all in good fun.

The Incentive of the Stickk

I've got plenty bugging me this morning, as I learn of new bits of stupidity surrounding the credit crunch and bond market. I want to, instead, focus on a lighter bit from the economist this week on incentives to keep yourself to your own everyday commitments. Then-MIT Economists John Romalis and Dean Karlan (each has moved on - to Chicago and Yale, respectively) wanted to lose weight. So each set a goal, and if one made the goal and the other didn't he had to pay a hefty $10,000 fine; if neither made it the one farthest from their goal had to pony up $5,000.

So they brought the idea to the masses: http://www.stickk.com/ lets people put their money (or simply their pride) where their mouth is. All monies go to charity (if you really want to make it an incentive, choose a charity you don't particularly like such as an opposing political party). The catch is that you have to have a credible monitor who will report you when you fail and you should make sure what ever "stickk" you choose, it is sufficient to motivate you. We should remember the example from Steven Levitt's Freakonomics where daycare companies charged a fee for late pickups... and tardiness increased, proving that pecuniary incentives can sometimes be weaker than our own consciences.

Bang!

The New Path to Victory

The Pentagon is revising its plan for "winning" military engagements around the world. An important part of the new plan is politics: "The most important tasks we are doing in Iraq and Afghanistan are building host-nation institutions, including security forces and governance. We need to attract the very best officers into these specialties to be successful at these tasks,” said LTC Yingling, a vocal internal critic of current tactics. The generals for their part are listening to some of the discussion: I would propose that more discussion is needed, because there is little evidence that strong governance and democratic institutions can lead to moderation, compromise and economic freedom.

One thing that is clear is that a military presence is insufficient in ensuring that the Iraqi and Afghani people are able to support themselves. This has lead to the conclusion that a political solution is needed. It is argued that political freedom and democracy are a necessary condition for stability and prosperity in the long run. But, while this may the case, basic economic needs must be met. Our experience with "transition projects" such as those undertaken in Eastern Europe have shown that democratic institutions in the absence of economic opportunities in the private sector fall flat on their face. In short, people could give a damn about democracy if they feel that the result will fail to provide them with the opportunity of the "pursuit of happiness." Corruption and ethnic divisiveness all qualify as examples of things that can erode these opportunities. Furthermore, oil profits and other assets of the state emerge as focal points of infighting which democracy cannot solve by itself. What is needed is a strong judiciary, which is fair and blind to race, ethnicity, or politics, and this takes time to develop.

I fear that the plan that may result will resemble the strategies brought to Russia (which our Washington Consensus fouled up roally) rather than the slower grassroots approach taken by Hungary, but it may be too late. The disintegration of the rule of law, as well as the laws themselves has left a vacuum that cannot allow the much-needed private economy air to breathe.

Economic Development in Iraq

Yesterday, VMI hosted Hon. Robert M. Kimmett, Deputy Secretary of the Treasury to give some "remarks" about the Treasury's involvement in economic development in Iraq. His speech was dignified, and well-written, but clearly had been vetted for reasons of security, and probably politics. He remarked how the Treasury has taken an elevated role in helping develop Iraq economically, as our military helps them remain secure militarily.

One important issue in the development of Iraq is the role of oil and natural resources, and the risk of contracting a "Dutch Disease" or "resource curse" whereby profits generated by high prices and favorable terms of trade in the resource sector for exports essentially "crowds out" private investment in the manufacturing sector. So, when we met, I asked him about it whether this was a risk for Iraq, and answered, "no…" and went on to list a number of sectors in which Iraq has seen substantial progress. They included (in no particular order): the construction of roads, the building of schools, hospitals, and agriculture. But, with the exception of agriculture, sectors mostly represent "public goods," and most countries for which the resource curse is applied DO see impressive development in the provision of these public goods. Examples include Dubai, Saudi Arabia, and even Norway.

What is more troubling is how this economic structure might contribute to perpetuation of ethnic tensions. Put in broad terms, when there are factions in a society that identify on ethnic grounds, violence and tensions tend to arise on two fault lines: (1) they arise on the basis of control over the rents received from some strategic resource, and; (2) the ability to control the provision of public goods and confiscate their use for your own faction (and, exclude their use from the other).

The State of Trade in the Union

Mr. Bush, like a number of other closet isolationists out there called tonight for us to "level the playing field" with respect to trade. Essentially what he means by this is that we should negotiate trade agreements and push other countries to open their own economies to us before we'd be willing to open our own. I think that this is a good idea in principle, and it is a well-documented fact that developing countries (those "cheap labor" countries Lou Dobbs reviles so) have higher levels of trade restrictions than the US and other high income countries. However, making the ultimatum that we will not open if you do not match us misses two important points: First, trade is not a zero-sum game and even unilateral openness improves welfare both at home and abroad, and second, his insistence that developing countries reciprocate ignores the historical foundations of GATT (now the WTO) and the provisions and principles of the treaties on trade entered into by the US since World War II.

I'll pass on the virtues of unilateralism versus multilateralism, because it will bore those who have read past posts on trade. The basic history of trade restrictions in developing countries goes roughly as follows. A lot of people rightly worry that export-biased growth can lead to lead to a secular decline in export prices (a deterioration in the terms of trade), especially for developing countries whose comparative advantage is typically in primary commodities like sugar, coffee, bananas, oranges, or even oil (before OPEC). This deterioration can lead to a welfare reduction for these countries, even when real output (physical quantity of goods) is increasing. This is the basic "Prebisch Thesis." It was thought that restricting trade, and therefore substituting industrial imports from rich countries for domestic production, would help in the industrialization and development process. It was a fancy version of the old "infant industry" argument for tariffs, but it was much more convincing and coherent because the Prebisch Thesis was well supported by empirical evidence. But as with the old infant industries, these babies essentially never grew up. In addition one thing that was neglected was that growth (even in a primary commodity sector) can have the potential of freeing up economic resources to expand and diversify the economy. The eventual result, in the best case scenario, can create enough momentum for a developing economy, that auto makers in India eventually begin outsourcing to the US and the UK (which actually happened a couple weeks ago, by the way).

Bang!

This Little Piggy…

For the second year in a row, President Bush is on the warpath over "earmark spending" commonly known as "pork projects." These add-ons are frustrating and are a nice straw man for a grouchy executive. Yet how significant are they?

Earmark "pork" spending was about $17 billion in 2007; the federal budget deficit was $450 billion, give or take a billion here or there. Discretionary spending is budgeted money that the President negotiates into the budget and over which he (or perhaps she at some point in the future) has discretion. In 2000, federal discretionary spending was about $584 billion; by 2007, it was $1.05 trillion – George Bush, defender of small government has almost doubled his own personal corner of the budget, according to the Economic Report of the President. By contrast, Bill Clinton, that tax-and-spend liberal, entered office with discretionary spending at $531 billion; when he left it was $584 billion. That amounts to a 12.5% increase in 8 years compared with Bush's 90%+ increase in just 7.

Mr. Bush says he favors workers and small business, yet the combined budgets of Commerce, Labor and the Small Business Administration fell (in nominal terms) from $18.3 billion to $17.8 billion. Facing threat from climate change, wildfires, and rising energy prices, the combined spending on the Interior, Energy and the EPA went from $33.8 billion to $23.5 billion. Of course the 800 point elephant in the room is international discretionary spending, which is largely going to the war in Iraq. I've consistently believed that regardless of what you believe about the war in Iraq or the global war on terror, I've never thought that Iraq was the theater that gave us the most "Bang" for our federal buck – I still do, and the explosion in discretionary spending underscores that point. I'm not saying that I disagree with Mr. Bush (and other tax-cutting, big-spending republicans like Richard Nixon and Ronald Reagan) in principle that smaller government is good. Rather, I'd say that I want conservatives to start being true to their rhetoric.

Be Cheery

Be cheery, says The Economist magazine. Extreme poverty is plummetting world wide. I agree.