Month: December 2008

Our colleague, Richard Wagner, a leading light in the public choice revolution, wrote the following remarkable question for the 2005-2006 graduate political economy preliminary exam at George Mason.

Joseph Schumpeter claimed that capitalism would give way to socialism largely for ideological reasons. This does not seem to have happened, at least directly. But might it be happening indirectly? Consider, for instance, a significant change that has occurred in the economic organization of debtor-creditor contracts. Not too long ago, lenders held their loans in their portfolios. They would lose if the borrower defaulted, which gave the lender a strong incentive to monitor the borrower, particularly for large loans. Now, lenders split their loans into numerous small pieces and disperse them throughout the economy. (For instance, many people who hold mutual funds and retirement accounts will find that they are holding small pieces of large loans made by commercial banks.) The burden of non-performing loans is thus dispersed throughout the economy rather than residing with the original lender. Does this development weaken the incentive of lenders to monitor borrowers and thereby weaken overall economic performance? That is, can market transactions generate institutional arrangements that impair the market economy? However you address this topic, do so clearly and cogently.

I am sorry to say that none of the students got the answer right.  Of course, very few of their teachers, here or elsewhere, got the answer right, either.  Kudos to Dick for his prescience.

I thank David Levy for the pointer.

The stock market sure looks like a bubble now but it’s actually very difficult to distinguish bubbles from rational behavior when dividend growth rates can change and must be forecast. Ironman has an excellent post on this at Political Calculations, titled Acceleration, Amplification and Shifting Time.  See also the simple model discussed in my paper with Gary Santoni which Ironman kindly cites.

I don’t deny that bubbles exist, by the way, my point is that the fact that they are difficult to distinguish from rational behavior is one reason that they exist.   

The title is mine, not Dave Leonhardt’s, but this passage is his:

[H]ere’s a little experiment. Imagine that a Congressional bailout effectively pays for $10 an hour of the retiree benefits… the U.A.W. agrees to reduce pay and benefits for current workers to $45 an hour – the same as at Honda and Toyota. Do you know how much that would reduce the cost of producing a Big Three vehicle? Only about $800…. An extra $800 per vehicle would certainly help Detroit, but the Big Three already often sell their cars for about $2,500 less than equivalent cars from Japanese companies….

Leonhardt points out that labor costs account for ten percent of the cost of producing an American car.  Felix Salmon, in a very good post, has a separate point:

Just for starters, think for a minute about the car czar’s responsibility for Opel, and the negotiations which are going to start up between the US and German governments over the European marque’s fate. On the one hand, Opels are clearly the kind of thing which Congress wants GM to make more of. But they want GM to make those cars in America, not in Europe. And GM has already asked the German government for money to keep Opel going.

You’ll find it here.  And here is his current forecast (with which I agree):

Paul Krugman, winner of this year’s Nobel economics prize, said on
Monday that the world could face a Japan-style, decade-long slump…

"A scenario I fear is that we’ll see, for the whole world, an
equivalent of Japan’s lost decade, the 1990s — that we’ll see a world
of zero interest rates, deflation, no sign of recovery, and it will
just go on for a very extended period," he told a news conference.

"And that’s unfortunately very easy to see happen."

If it is any (minor) consolation, growth is usually understated during such downturns, because it is more likely to take the form of hard-to-measure quality improvements rather than big expenditure-intensive projects. 

One thing here is that as best I can tell none of the five countries – US, Japan, Germany, France, Korea – with substantial auto industries are willing to let their national favorites fail. And yet there seems to be substantial global overcapacity in car manufacturing. If a few of the existing firms are allowed to fail, then the survivors will be in good shape. But if nobody fails, then all the firms worldwide will be left suffering because of overcapacity problems, all potentially drawing bailouts and subsidies indefinitely.

Here is more.