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.

Marriage, Outsourcing, and the Gains from Trade

Here's a fun post from Friday's "Free Exchange" blog at www.economist.com. It talks about the "old days" marriage based on specialization and domestic division of labor: it turns out there were economic gains from the chauvanistic structure of men bringing home the bacon, taking out the trash and fixing the car but women staying home with the kids, cooking, and cleaning house. People got married, according to The Economist, and real-life economists Betsey Stevenson and Justin Wolfers of Penn, to exploit gains from trade and specialization on the production side.

But now we trade more. We outsource a lot of responsibilities, such as child care, car repair, and food preparation (people seem to eat out a lot more than my parents did). I have a trade deficit with my mechanic, but am I worried that his shop will become all-powerful and gradually begin to overtake and crush my very existence? No: as long as the economic value of what I produce is about the same as the value as the economic value of what I purchase, things will peter along allright. So what's the value of families and spouses (try not to chuckle, married readers)?

Well, the above-referenced authors boil it down to "complementarities in consumption." Actually, they are more "externalities in consumption," because they are explained by the fact that somethings are just more enjoyable with a partner or group. In other words, we get married, now more than ever, because we like it and because we like our mate (stop that sophomoric chuckling!).

But I think there's more to it. Yes, all of the things above are great things, but why did we evolve this way and what else has it done for us. First, things probably evolved this way because our incomes were rising over the last 200 years. With higher and higher market wages and smaller and smaller family sizes, the benefits of market production began to tip over the benefits of remaining "self-sufficient" in "home production," so women entered the workforce in droves during the 1970s. Second, it's made our lives better, on the whole. Amazingly, labor markets have absorbed women who "immigrated" into the labor market and managed to sustain wage growth. Finally, life is somewhat less risky for women. They are no longer as beholden to their marriage contract for their economic well-being (in terms of income) because they have marketable skills. So, if the louse cheats (or something tragic happens) he's more expendable.

Globalization and Syphilis

This article from the NYTimes Caught my eye. Basically the celebrated discoverers of the New World are partly to blame for the 1494 epidemic of syphilis in Europe. Similar issues are posed today with bird flu, HIV, and so on. It's an interesting point on the fact that "globalization" can have certain externalities, especially in the context of the environment, public health, and national security, especially when it comes to the free movement of people (in terms of tourism as well as immigration). But should this news reinforce or support our "agorophobia" (an interesting term referring to a fear of "going outside" or "fear of the marketplace") about trade and globalization? Heck no! It means we should attack the root of the issue instead of trying to avoid it through restrictions, if you asked me (not that anyone did or will).

Free Markets

For anyone who thought free-market economics was just a pile of crap...
http://cityroom.blogs.nytimes.com/2008/01/10/a-pay-toilet-opens-no-need-to-hold-everything/

Krugman Double Take

Today, we have proof that Krugman is losing it (and let me preface this by saying that I have the utmost respect for Krugman's economic work and revere him highly):

His column says we should "respect" those who "worry" about trade. I disagree, because most of the "worriers" do more than worry-- they also monger fear, distort facts, and advocate protection (like my old bud Lou Dobbs).

But here's his blog yesterday. He's saying that basically saying that the only reason that the housing snafu hasn't wrought recession and despair on the economy is... (drumroll).... TRADE!

So, we should respect people who worry about trade, but trade is the only good thing going for us? Is that anything like being on a sinking cruise ship and worrying about the safety of the life rafts?

-Bang!

Interesting USITC Dispute

Just an interesting tidbit: A Korean company (Samsung) files a complaint with a US bureaucracy (the international trade commission) over unfair trade practices by a Japanese Rival (Sharp).

Populism without Borders

I'm often dismayed at the "populist" opposition to openness to trade, migration and FDI flows. The Free Exchange Blog that I linked to in Thursday's post hits on the point of what exactly is populism. It defines populism as a ideological movement "of" or "for the 'people'." Usually "the people" represent some under-enfranchised group (the middle class or poor) whose interests are often framed to be in opposition to those of the "elite." It cites James Madison economist Barkley Rosser's charge that Lou Dobbs' brand of populism is, essentially, "economic nationalism for the poor." This is the point that I want to touch on, because it raises two important questions about the tide of protectionism that has ebbed in recent US politics.

First, who are "the people" of the populist thought? The Free Exchange authors note that in the origins of the populist movement, there was debate whether the populist movement would be inclusive of blacks, or if "the people" were exclusively white. Today the debate extends to immigrants, both legal and illegal, both present and future. Many "populists" today would like to slam the "Golden Door" of immigration shut, arguing out of concern for the working poor here. But, in effect, the working poor they are most concerned about are only the native citizens. Many economic free-traders are criticized from the left for pandering to US corporate interests to the demise of the American "middle class," or at the exploitation of the poor abroad. Yet, it is precisely out of concern for these two groups that free-traders are out there fighting the good fight.

This brings us to the second issue, which is one that I have discussed several times: Who gains from open-door policies. Abroad, the preponderance of the empirical studies suggest that trade and foreign investment benefit the poor, especially when a country's labor force is free to move internally. China has been criticized as a case where openness has failed to benefit the poor, but the primary reason it has not reached the rural poor in China has to do with how the Chinese government allocates spending on public education, where it authorized foreign investors to build production facilities, and its tight restrictions on the internal migration of labor. So, we free traders fight the free trade fight, in part, for the poor living in less-developed countries.

On this side of the border, the main groups that can be shown to be harmed by either free trade or by immigration are those without a high school education or its equivalent, not quite the lower two quintiles (40%) of the labor force. I would not suggest for a moment that we should not be concerned for these Americans. However, those truly in the "middle-class" quintile (40th-60th percentile) gain, as well as the upper and upper-middle class. In addition, the gains to these groups far outweigh the losses to the poor. Some have suggested that programs could be set up in cooperation with local community colleges to help these adversely-affected Americans acquire skills in export-oriented or non-traded sectors. They have even proposed that the programs could be entirely paid for from the gains accumulated by high value-added sectors and firms, with a wage replacement stipend toboot.

The main point I've tried to make the last couple of days is this: One can be both populist and in favor of borders that are open to trade in goods, sevices and factors. This is one point that has been made by Columbia economist Jagdish Bhagwati. In addition, even if we do oppose immigration, and especially illegal immigration, we have to come to terms with the plain fact that they are here, deserve to be treated with decency, and (along with the poor still living in the countries they come from) deserve to have some inclusion in our populist agenda.

Populism at Home

I saw this on The Economist magazines's blog, Free Exchange. I think there are a couple of debates here: (1) What is the role of "populism" in a democratic free enterprise (market) economy? (2) Can one be "populist" (of the people) and still be pro-globalization.

First, about the tides of populism in America. LOU DOBBS DOES NOT OWN AMERICAN POPULISM. There is a rising tide of populist sentiment in the U.S., and not all of it has the nationalistic xenophobic venom that Mr. Dobbs spews out. Ironically, some of it is coming from the elite (which is odd since the most traditional forms of populism embrace the masses by rejecting the elite). In fact, there is rising tide of "plutonomy" among the elite and among traditionally conservative economic journalists, like George Will (see, for example, this column by Mr. Will). Instead of touting the role of the elite as savers, investors and engines of economic growth, these elites and economic conservatives tout the role of the wealthy in promoting charity and helping the poor. With a smilar irony, I will argue over the next couple of posts that "populism" or promoting the interests of the people CAN be (and often is) mutually compatible with markets, openness to trade, and pro-growth policies, with some caveats.

Now, what is the role of populism in a free market democracy? This is an interesting point because many of the neoclassical school of economic thought talk about the optimality free markets, ignore the politics of democracy (or any other system for that matter), and scorn populist ideas. These ecnomists are right to advocate free markets (most of the time), but their naivity to the political constraints makes them blind to the important questions of income distribution that affect the political feasibility of "optimal" pro-growth policies. (In fact, neoclassical models are fundamentally flawed in this regard because they focus on the "representative agent," or essentially the "average" citizen or mean. This is one reason why their models do so well emprically.) In addition, timing, sequencing, and distributional consequences, as it turn out, all matter. Quick example: from 2000-2006 the US promoted policies that neoclassical economists supported as pro-growth. Real aggregate output increased. Real per capita output increased. Shouldn't this have been good for the "growthies?" However the real median household income declined by 2.1 percent. The middle to lower half of the population sank as the rich took off. Populism thrived. Mr. Bush, meet Speaker Pelosi.

Next up: "Populism without Borders."

Property Tax Pinch

Got this off the AP wire. On the one hand, I feel for people who have lived in a house their whole lives, and now are unable to afford property taxes. On the other hand, what about folks who wouldn't mind paying market value for it, and can afford the taxes? How about this for the solution? I've heard of child sweatshop labor, but I guess we've decided to turn that on its head! Discuss.

-Bang!