Month: November 2008

An update on the bailout

Gordon Tullock is a smart man:

When the government said it would spend $700 billion to rescue the nation’s financial industry, it seemed to be an ocean of money. But after one of the biggest lobbying free-for-alls in memory, it suddenly looks like a dwindling pool.

Many new supplicants are lining up for an infusion of capital as billions of dollars are channeled to other beneficiaries like the American International Group, and possibly soon American Express.

Of the initial $350 billion that Congress freed up, out of the $700 billion in bailout money contained in the law that passed last month, the Treasury Department has committed all but $60 billion. The shrinking pie – and the growing uncertainty over who qualifies – has thrown Washington’s legal and lobbying establishment into a mad scramble.

The Treasury Department is under siege by an army of hired guns for banks, savings and loan associations and insurers – as well as for improbable candidates like a Hispanic business group representing plumbing and home-heating specialists. That last group wants the Treasury to hire its members as contractors to take care of houses that the government may end up owning through buying distressed mortgages.

The real lesson here is about the massive fiscal stimulus on its way.  Beware, and don’t be tricked by people simply postulating how the money "should" be spent.

Spin-Free Economics

The subtitle is "A No-Nonsense, Nonpartisan Guide to Today’s Global Economic Debates" and it is by Nariman Behravesh.

I was shocked by how much I liked this book.  I think of it as a kind of contemporary Capitalism and Freedom, although it comes across as less partisan and the coverage is much more global.  I agreed with almost everything the author said and I thought the framing was effective and spot on just about all the time.

Many MR readers already know too much to be the appropriate audience here, but if you wish to give someone an economics book as a gift, or as an introduction to thinking about economic policy, here you go.  I’m still astonished at how remarkably good this book is and yes I did read it all the way through.  Greg Mankiw wrote a very nice blurb for it.

You can buy it here.  Here is the book’s home page.  I haven’t seen any serious reviews yet, nor has Google.

Against team players

When one team wins, another loses.  If the Celtics win the championship, the Lakers cannot.  Sports at the team level, within the context of a single season, is more or less a zero-sum game.  But ranking the quality and fame of players is more multi-dimensional and thus it is more positive-sum.  Maybe the advent of LeBron James diminishes the luster of Tim Duncan (or maybe it doesn’t), but the total amount of fame produced still goes up because of LeBron and his efforts.

Players who maximize team wins are investing more resources into the zero-sum game.  (In fact team players in small markets with few fans are especially destructive of human welfare and it is those players who should be most encouraged to become ball hogs.)  Players who pursue individual glory — even if at the expense of the team — are investing more resources into the positive-sum game and thus they are doing more to benefit society.

So why is it again that we glorify the team players?

Profile of Malcolm Gladwell and *Outliers*

Ever the optimist, Gladwell’s theories assume the good intentions of
everyone involved. Today, as he watches the world’s financial systems
collapse and people’s life savings go kaput, he radiates calm. Rather
than joining the mobs seeking to hang villainous CEOs from the nearest
lamppost, Gladwell counsels his followers to step back, take a deep
breath, and find the procedural flaw in the system that can be fixed.
“I don’t think anybody was being venal or corrupt. It’s not a scandal
as we normally understand scandals,” he says. “It’s a case of the
system being, the risk models being broken, the system not functioning
as it should, regulation not being appropriate to what people were
doing.” Tinker with the risk models, increase the regulatory structure,
Gladwell says, and the problem is solved. That may not be as
emotionally satisfying as punching out a CEO on a treadmill, but it’s a
lot more comforting.

Here is the whole piece, interesting throughout.  Thomas Schelling and Megan McArdle are among those making cameos.  Hat tip goes to Andrew Sullivan.

The ten most irritating phrases?

Here is one list:

The top ten most irritating phrases:

1 – At the end of the day

2 – Fairly unique

3 – I personally

4 – At this moment in time

5 – With all due respect

6 – Absolutely

7 – It’s a nightmare

8 – Shouldn’t of

9 – 24/7

10 – It’s not rocket science

I thank Yang He for the pointer.  At the end of the day, what would you add to this fairly unique list?  With all due respect, I personally, at this moment in time, absolutely shouldn’t of suggested that it’s not rocket science because 24/7 people are saying this and it is literally a nightmare.

A simple model of China’s model of China

Compared to the U.S. economy, the Chinese economy has fewer automatic stabilizers, such as welfare programs and unemployment insurance.  That implies their fiscal policy should, if possible, be especially countercyclical, compared to what is called for in most richer countries.

Chinese leaders view volatility as serially correlated and increasing from the source outwards.  Given Chinese history, they expect that shocks grow and spread rather than dampening down.  So when a shock comes, the demand to hold and indeed hoard very safe assets increases rather than decreases.  Chinese fiscal policy ends up being pro-cyclical rather than countercyclical.  And it is hard to succeed with fiscal policy in the first place.

Fortunately, I’m just making that model up.  Why should we expect lots of mistakes to be made? 

What ended the Great Depression?

There has been recent circulation of the older view that it is World War II, as a kind of giant public works project, which ended the Great Depression.  This claim is not consistent with our best knowledge of the subject.  To survey the cutting edge of the literature briefly:

Christina Romer writes:

This paper examines the role of aggregate demand stimulus in ending the
Great Depression. A simple calculation indicates that nearly all of the
observed recovery of the U.S. economy prior to 1942 was due to monetary
expansion. Huge gold inflows in the mid- and late-1930s swelled the
U.S. money stock and appear to have stimulated the economy by lowering
real interest rates and encouraging investment spending and purchases
of durable goods. The finding that monetary developments were crucial
to the recovery implies that self-correction played little role in the
growth of real output between 1933 and 1942.

Here is another interesting paper on the topic; it focuses on productivity issues and mean reversion.  Here is from a paper by Cullen and Fishback:

We examine whether local economies that were the centers of federal
spending on military mobilization experienced more rapid growth in
consumer economic activity than other areas.  We have combined
information from a wide variety of sources into a data set that allows
us to estimate a reduced-form relationship between retail sales per
capita growth (1939-1948, 1939-1954, 1939-1958) and federal war
spending per capita from 1940 through 1945.  The results show that the
World War II spending had virtually no effect on the growth rates in
consumption that we examined.

Further debunking of the WWII idea can be found in this paper by Robert Higgs, who stresses the difference between standard gdp measures and actual economic welfare.

I also find the experience of the Latin American economies convincing.  The economic recovery of Argentina, for instance, clearly was due to monetary policy, not fiscal policy, which remained tight throughout the period of recovery.  Mexico recovered from the Great Depression relatively quickly and this history also does not fit the fiscal policy view.  Later on, most of the Latin economies experienced commodity booms because of wartime demands and again this was not fiscal policy and of course they were not fighting the war themselves.  The two countries where fiscal policy played a significant role in recovery are, not surprisingly, Germany and Japan and here I am referring to their prewar spending.

A simple theory of which economists cultivate Ph.d. students

If your contribution as an economist is very fundamental, other people will use that contribution whether or not they were your students.  Lots of people use, or critique, the assumption of rational expectations.  So the inventors of RE don’t need students to propagate their fame.  Alfred Marshall’s fame today is mostly independent of the students he had (or did not have).

Having fundamental contributions is correlated with quality but within the top tier of quality there is considerable variation.  Arrow and Lucas had relatively fundamental contributions but in contrast Milton Friedman, Larry Summers, Robert Barro, and Olivier Blanchard are all more applied.  Their demand for students should be higher.  If you are an empirical economist, but invented an econometric technique which is fundamental, your demand for students should be relatively low.  Students might also prefer advisors who are less "fundamental," for fear of being overshadowed or from wanting to avoid the winner-take-all tier of the market.

Since at top schools the percentage of "fundamental" economists is declining over time, we would expect the distribution of doctoral students, across faculty, to become more even.

I thank Amanda Agan and some of her friends for a useful conversation on this topic.

Understanding Fiscal Policy During the Great Depression

My little spat with with Rauchway regarding unemployment during the Great Depression draws in Paul Krugman.  Krugman doesn’t respond to any of my arguments but he does give us the old line that fiscal policy didn’t fail during the Great Depression it wasn’t tried.

Now, you might say that the incomplete recovery shows that “pump-priming”, Keynesian fiscal policy doesn’t work. Except that the New Deal didn’t pursue Keynesian policies. Properly measured, that is, by using the cyclically adjusted deficit, fiscal policy was only modestly expansionary, at least compared with the depth of the slump. Here’s the Cary Brown estimates, from Brad DeLong…Net stimulus of around 3 percent of GDP – not much, when you’ve got a 42 percent output gap.

Now there is actually a lot of truth to this but the way in which Krugman, Rauchway, DeLong and others present this point is esoteric and likely to mislead even many economists.  What Krugman seems to be saying is that the government didn’t spend enough during the thirties (Rauchway, who also cites Cary Brown, says directly "there was never enough spending to achieve the desired effect.")  Yet federal spending during this time increased tremendously.  So what is really going on?  The answer is actually quite simple.

During the Great Depression federal expenditures increased tremendously but so did taxes.  Thus, the reason spending was not stimulative was not that spending wasn’t tried it’s that taxes were also raised to prohibitive levels.  But don’t take my word for it.  Read Cary Brown (JSTOR) whom Krugman, Rauchway, DeLong all cite but none of whom quote at length.  Here is Brown:   

The primary failure of fiscal policy to be expansive in this period is attributable to the sharp increases in tax structures enacted at all levels of government.  Total government purchases of goods and services expanded virtually every year, with federal expansion especially marked in 1933 and 1934.  [But] the federal Revenue Act of 1932 virtually doubled full employment tax yields…

…the highly deflationary impact of this tax law has not been fully appreciated…The Revenue Act of 1932 pushed up rates virtually across the board, but notably on the lower and middle income groups….Personal income tax exemptions were slashed, the normal-tax as well as surtax rates were sharply raised, and the earned-income credit equal to 25 percent of taxes on low income was repealed.  Less drastic changes were made in the corporate income tax, but its rate was raised slightly and a $3000 exemption eliminated.  Estates tax rates were pushed up, exemptions sharply reduced, and a gift tax was provided.  Congress toyed with a manufacturers’ sales tax, but finally rejected it in favor of a broad new list of excise taxes and substantially higher rates for old ones….

The Revenue Act of 1932 was followed by many further tax increases (e.g. Brown notes "…social security taxes began in 1937 to exert a pronounced effect…") many of them, under pressure from the Huey Long wing, designed to "Share our Wealth." Here is a graph of the highest marginal income tax rate which went from 25% to 79% between 1929 and 1940 and here is a graph of the lowest marginal income tax rate which (from a low base) increased by a factor of 10.  (Hat tip to Carpe Diem).

Thus, an accurate portrayal of fiscal policy during the Great Depression – entirely consistent with Krugman – is that we had much greater spending, much greater taxes and not much economic stimulus.  And if supporters of the New Deal argue that fiscal policy was only "modestly expansionary" then it’s quite reasonable to think that once we take into account the supply side effect of taxes and the increase in regime uncertainty then the net effect might even have been contractionary. 

The meta-lists, this time for classical music

The end of the year is coming and so I will digest the numerous "best of" lists for you once again.  These picks are for classical music CDs and they are from Fanfare, the number one source of criticism for new classical releases.  Here are the CDs that appeared more than once on their reviewers’ "best of the year" lists:

Vincent Persichetti: Piano Sonatas; knotty American piano music.

Morton Feldman: The Viola in My Life, I-IV.

Alkan Organ Works, vol.II, by Kevin Bowyer

Bach, Brandenburg Concerti, rerecorded by Trevor Pinnock.

Brahms, Sonatas for Clarinet and Piano, by Manasse and Nakamatsu.

Thomas Simaku, String Quartets; intense, from Albania.

As usual, classical "best of" lists give disproportionate weight to material which had not previously been recorded, in this case the Persichetti which of all the entries is named the most often.  The Brahms is the one most likely to please you, or the Pinnock.  I can vouch for the quality of the others but when it comes to genre they won’t convert the unpersuaded.

The Chinese economic stimulus package

China on Sunday announced a huge economic stimulus package aimed at bolstering its weakening economy and perhaps helping fight the effects of a global economic slowdown.  In a sweeping move at a time when major projects are being put off
around the world, Beijing said it would spend an estimated $586 billion
by 2010 on wide array of national infrastructure and social welfare
projects, including constructing new railways, subways, airports and
rebuilding communities devastated by an earthquake in southwest China
in May.

Here is the story.  Most of this money they would have spent anyway, so what is the net change in the stimulus?  And over how many years is this sum spent?  I think of this as mostly a public relations move.  China wants to tell other countries it is doing lots and it wants to tell its own citizens that it feels their pain and is pro-active.

Is there a gentle way to glide down from 10 to 5 percent growth?  I tend to doubt it.  Are you prepared for a China with negative economic growth for a few years (or more)?  I tend to doubt that too.

Matt Yglesias has interesting commentary; I guess now we’ll see how much an economic surplus is worth when the core macro problem is something other than lack of aggregate nominal demand.

Addendum: Here is further comment.