Month: August 2009

How to deal with power-addicted politicians

by  Tyler Cowen in

This has been a fruitful dialog.  Two days ago Matt Yglesias made a list of how progressives should respond to the public choice critique of big government:

– This is why it’s important to be a civil libertarian and to be much
more skeptical than the political/media mainstream is of the idea that
what’s at stake in these debates is really a “balance” between a
“security” imperative and some airy “values.” It is overwhelmingly
likely that various secret police powers are simply going to be abused,
rather than put to some productive-but-liberty-infringing use.

– This is also a reason to be skeptical of ideas about discretionary regulatory fine-tuning. You always could
improve outcomes by abandoning rigid rules (with “do what you want”
counting as a rigid rule) but in practice you probably won’t.

– I think this also counts on a reason to prefer systems that rely more on career civil servants
and less on political appointees. Bureaucrats have their own
distinctive psychopathologies, but they’re different, and it’s helpful
to have them in more tension and balance than exists in the United
States.

– It’s also important to have in place systems for effective
monitoring of elected officials. A Canadian voter elects one federal
official–a Member of Parliament. An American elects four–a President,
two Senators, and one Representative. Americans don’t have four times
as much time as Canadians to pay attention to what politicians are
doing or to learn the issues; our politicians are just being monitored
less. When you consider the proliferation of things like independently
elected school boards, district attorneys, sheriffs, etc. keep in mind
that this diffusion of responsibility is a good way for the egomaniacal
to evade responsibility.

– If that leaves us with too few veto points, the thing to do is not to have additional houses of legislature, but Swiss-style (as opposed to California-style) direct democracy, where the actions of a unicameral legislature can be checked by the voters.

I agree with much of the list (for one thing, however, I think voting for a fewer number of politicians will have a very small beneficial effect in terms of voter attention); the question is what should be added to it.  "Smaller government" is a question-begging answer even if you favor that outcome.  It's a list of what will get you to better governmental outcomes, whatever you think those might be.

Too big to fail fact of the day

by  Tyler Cowen in

Large
banks with more than $100 billion in assets are borrowing at interest
rates 0.34 percentage points lower than the rest of the industry. Back
in 2007, that advantage was only 0.08 percentage points, according to
the FDIC. Such differences can cause huge variance in borrowing costs
given the massive amount of money that flows through banks.

Here is the article and I thank Ralph S. for the pointer.

A second-best theory of libertarian bailouts

by  Tyler Cowen in

Pete Boettke cannot bring himself to utter those few little words.

Let me nudge him (and others) again and try to make things easier for him.  General pro-market or anti-government arguments don't rule out the recent bailouts.  Let's take the hardest, least Friedman-friendly case, the insolvent banks.  For insolvent banks (and for some of the illiquid banks, which might have failed without bailouts), the alternative to those bailouts is calling in deposit insurance and the bankruptcy courts, both of which are, for better or worse, forms of government intervention.  In particular today's bankruptcy procedures are ill-suited for disposing of a large financial institution in a timely manner and this can be considered a form of gross government failure.

Note that even when the Fed "bails out" a large investment bank, or insurance company, they are checking a chain reaction which would likely spread to some commercial banks, thus bringing in deposit insurance as well, not to mention further bankruptcies.  And that's not even considering that Congress probably would have stepped in, I'm just looking at laws already on the books.

So if you're "opposed to financial bailouts," as a libertarian, you're not for the market.  You're saying that one scheme for governmental disposition is better than another.  Of course you are entitled to that opinion but the sheer force of libertarian doctrine is not necessarily on your side.  The general pro-market and anti-government arguments are not necessarily on your side.  I think it is quite plausible for a libertarian to believe that the Fed is "less bad" than the bankruptcy courts and the FDIC.

Now, all things considered, I don't see why this "libertarian two-step" move should be needed.  I think it's enough to simply ask whether the bailouts were a good idea and proceed accordingly.  But if you're concerned about compatibility with libertarian principle, this is one simple way of seeing why my view fits right in.  In fact I think it is the more libertarian of the views under consideration, as it keeps the very worst of the government interventions on the table at bay.

Addendum: Overall I think U.S. bankruptcy law works fairly well, just not relative to the high speeds of market demands when a major financial institution goes bankrupt; Lehman showed this.  This is an under-reported source of "regulatory uncertainty."  (Prepackaged bankruptcy ideas may help, possibly.)  If you are calling for the application of bankruptcy law to major banks, you are calling forth that regulatory uncertainty and yes I do think it is worse than the regulatory uncertainty from a bailout.  The result is that credit markets freeze up and that also leads to other bad interventions.  Another set of problems springs from the difference between a bank and bank holding company; current law doesn't handle this well although changes are in the works most likely.  Of course it is a kind of "super-libertarian" alternative to abolish deposit insurance in the midst of a crisis, as some of you recommend, would you really do that?  I don't think so.

*Ayn Rand and the World She Made*

by  Tyler Cowen in

That's the new Ayn Rand biography, written by Anne C. Heller.  It is a truly excellent, first-rate biography, at least up through my current p.111.  I know Ayn Rand is an emotional topic for many of you, pro, con, or somewhere in between.  But my praise of this book is analogous to how I might praise a biography of Jean Rhys or W.C. Handy.  It's simply a very good book by any objective [sic] standard and it should be of interest to any student of intellectual history, American popular fiction, libertarianism, or for that matter American history.

Did you know that Rand met her husband by deliberately tripping him?  Or that she received WPA funds during the New Deal? 

The author is by no means a "Randian" but she is willing to praise the famous Atlas Shrugged "money speech" as "original, complex, and although somewhat overbearing, beautifully written."  She nominates We the Living as Rand's most persuasive work in a literary sense.

Here is one blog review of the book, which is in any case recommended.

What do kids find worth fighting over?

by  Tyler Cowen in

Maybe Alchian and Demsetz would not be surprised:

A team of leading British and American scholars asked 108 sibling pairs in Colorado exactly what they fought about.  Parental affection was ranked dead last.  Just 9% of the kids said it was to blame for the arguments of competition.

The more common reason the kids were fighting was the same one that was the ruin of Regan and Goneril; sharing the castle's toys.  Almost 80% of the older children, and 75% of the younger kids, all said sharing physical possessions — or claiming them as their own — caused the most fights.

Nothing else came close.  Although 39% of the younger kids did complain that their fights were about…fights.  They claimed, basically, that they started fights to stop their older siblings from hitting them.

That is from the new book NurtureShock, by Po Bronson and Ashley Merryman, which I found interesting at times.  "Interesting enough to read" is perhaps its category.  Here is a WSJ review.

I should add that I don't think the cited research settles the matter.  Children might fight over toys as credible signals of parental affection, caring more about the signal than about the toy per se.

A cost-benefit analysis of high-speed rail

by  Tyler Cowen in

Matt Yglesias points us to this survey of costs and benefits from a Dallas-Houston high-speed rail link.  I'm not convinced by many of the particulars of the argument, which claims to show that the link is a good idea.  For instance will the train line really be built with green energy?  Will 80 percent of flyers take the train?  Is Madrid-Barcelona a good analogy? 

More generally, my jaw dropped when I read the denouement:

In this more comprehensive model that takes into account trivialities like regional population growth and a reality-based route, the annual benefits total $840 million compared with construction and maintenance costs of $810 million.

I'm not sure what discount rates he is using but even if we put that problem aside this screams out: don't do it.  Given irreversible investment, lock-in effects, and required hurdle rates of return, this still falls into the "no" category.  And that's an estimate from an advocate writing a polemic on behalf of the idea.  I'm not even considering the likelihood of inflation on the cost side or the public choice problems with getting a good rather than a bad version of the project.  How well has the Northeast corridor been run?

So, on high-speed rail, count me as still unconvinced.  Nonetheless if you know of a good cost-benefit study, of a single rail link, not in the Northeast corridor, favoring HSR, let me know in the comments.  I'll try to read and report on it.

General remark: It's not about population density per se.  It's about how many independent, hard-to-connect nodes the system has and that is why high-speed rail on the whole works better in Europe or Japan than in many other locales.  To give an example from a slightly different realm, I live right near the Metro in a high-density suburban area.  Yet I don't take the Metro to my Arlington office, which is about two minutes from a Metro stop.  I'd rather do the 37-minute drive.  Why?  Because I stop at the supermarket and the public library on my way home at least half of the time or maybe I stop to eat at Thai Thai.  If those conveniences were right next to my house I'd consider the Metro but they're not.  The fact that my neighborhood has lots of people doesn't help me any.  In Tokyo you could live for years within the confines of many (most?) individual city blocks.

Three Textbooks on Economic Growth

by  Alex Tabarrok

Lately, I’ve been reading lots of textbooks on economic growth. Here are a few:

Introduction to Modern Economic Growth by Daron Acemoglu: Weighing in at just under 5 pounds and 1000 pages this is the Mas-Colell, Whinston, Green of economic growth. It’s hard not be impressed by Acemoglu’s mastery of the subject and for a handful of top graduate programs this is clearly the book for the next generation. The title, of course, misleads in a revealing way–this book is first and foremost a book about modern economic theories of growth and, in particular, the math behind those theories.  Acemoglu is too good an economist to write a book just about the math–there is good material here especially in areas where Acemoglu has made important contributions such as directed technological change and political economy–but the economic insights can easily be lost in this massive tome.  Acemoglu is a good guide to the math but there is no effort to communicate to a larger audience.  Empirical work is occassionally cited, but rarely discussed in much depth.

The Economics of Growth by Philippe Aghion and Peter Howitt: Also aimed at the graduate market this book is the David Romer of economic growth.  Still more of a guide to models rather than to economic growth per se but key empirical work is presented and one does find the words “motivating evidence.”  Simplified models with a touch of empirical analysis drive the book forward.  Combined with a few empirical papers and a bit more background on the theory and this would make a good graduate text for all but the top programs.  Careful questions will prove useful to professors.

Economic Growth (first edition here) by David Weil.  One of the best textbooks I have ever read on any subject – this is the book to get.  Weil’s book covers more topics with greater wisdom and wit than any of the other books and this is first and foremost a book about economic growth rather than about theories of economic growth.  Weil is good on the basic models and especially on tying theory to empirical work.  Ostensively aimed at the undergraduate market, there is a huge amount here for professional economists and graduate students. After passing their prelims on dynamic programming, this is the book that graduate students should read to discover the real questions that are in need of answers.  I learned the most from this book.

What did Milton Friedman favor?

by  Tyler Cowen in

Responding to my initial post, David Henderson gets himself into a bit of trouble when he writes:

He's [Tyler] correct that Friedman wanted the Fed to increase the money supply. I don't think I'm pretending when I say that I don't think Friedman advocated bailing out banks during the Depression. As I think Friedman would have, last fall I advocated an increase in the money supply while opposing a bailout. Those two, contra Cowen, are separable.

When it comes to 1929-1931, Friedman favored the Fed a) buying up a lot more bonds, and b) serving as a lender of last resort to failing banks. They are separable but Friedman favored both.

In the Monetary History, Friedman and Schwartz approvingly quote Walter Bagehot about the need to do whatever is required, however bold or desperate, to stop a banking panic.  Part of the passage runs like this:

The way in which the panic of 1825 was stopped by advancing money has been described in so broad and graphic a way that the passage has become classical. “We lent it,” said Mr. Harman [one of the Bank’s more senior directors] on behalf of the Bank of England, “by every possible means and in modes we have never adopted before;…

Here is Charles Goodhart quoting Friedman on why the Fed should have been a lender of last resort to troubled banks.  Or see p.269 of the Monetary History, where Friedman and Schwartz explain how it was too difficult for banks to borrow from the Fed at favorable rates in the early 1930s.  Or read this Friedman interview.

In the comments Bruce Bartlett, channeling Friedman, responded:

There's no way the Fed could have expanded the money supply in the early 1930s without bailing out the banks. How do you think the money supply declined in the first place? It's because banks failed and their deposits disappeared. To keep those deposits from disappearing in an era before deposit insurance would have required keeping bankrupt banks afloat.

Friedman's model was not one of allowing a boost in currency to substitute for the broader monetary aggregates.  An article in The Freeman is clear, if perhaps even a bit exaggerated:

Friedman and Schwartz argued that all this was due to the Fed’s failure to carry out its assigned role as the lender of last resort.

You might try to draw a distinction between "lender of last resort" and "bailout" but Bernanke's emergency lending is usually considered part of the bailout package.  No one is suggesting Friedman would have favored each and every part of the bailouts that we have seen.  The point is that Friedman favored some bailouts in the past and probably would have favored some this time around as well.  You don't have to think he would have voted for the first Paulson proposal.

Oddly, Henderson in his post takes offense because I suggest that libertarians try to run away from the idea that Friedman favored Fed action beyond simple monetary policy.  Henderson then tries to run away from the idea that…Friedman favored Fed action beyond simple monetary policy.

I now recall that a related point was made by Paul Krugman, although I find that piece problematic in some other ways. 

Here are a few sounder history of thought claims:

1. Friedman and Schwartz argued that if the Fed had been more on the ball with monetary policy earlier on, the lender of last resort actions would not have been needed. That is distinct from opposing such actions in the time of necessity, when necessity comes.

2. At times Friedman suggested that the rise of deposit insurance limited the importance of the lender of last resort role.  (How he would have thought about rescuing the shadow banking system is an interesting question.)  A related issue hovers here, namely whether support for deposit insurance constitutes support for bailouts.  It seems to me it does, though my original point does not rely on this judgment.

3. Friedman thought that "simple" monetary policy, combined with "simple" Fed lending would go pretty far in stopping a banking panic, yet this view was not borne out in the very recent crisis.  In any case it's wrong to conclude that Friedman was necessarily opposed to more vigorous action, if such action would turn out to be needed.  If you read Friedman as a whole his focus is not on drawing particular lines to circumscribe Fed action, but rather doing whatever is needed to keep the banking system up and running. 

On the broader issue of the bailouts, read Megan McArdle's latest, excerpt: "To a first approximation, I'd say that the bailouts are the reason that we won't have a single-payer health system or actual national automakers any time soon."

*This Time is Different*

by  Tyler Cowen in

The authors are Carmen Reinhart and Kenneth Rogoff and the subtitle is Eight Centuries of Financial Folly.  Here is the book's home page.

This book is of course self-recommending.  By "self-recommending" I mean it is obviously worthwhile and it looks as if I have read some of the content in advance.  By self-recommending I also mean…that I haven't read it yet.  Nonetheless someone needs to recommend it, so it recommends itself.

China fact of the day

by  Tyler Cowen in

It is almost unheard of for ordinary Chinese citizens to volunteer to donate their organs after death. Only about 130 people have pledged to donate their organs since 2003, the newspaper stated, quoting Chen Zhonghua, a professor at Tongji Hospital’s Institute of Organ Transplantation in Shanghai.

Here is more; the story concerns the Chinese trying to move away from harvesting the organs of deceased prisoners.

Here's a good blog post on a new Chinese leisure activity.

The Process Produces the Equilibrium

by  Alex Tabarrok

David Leonhardt makes an interesting argument about why employers don't choose employee health insurance carefully.  The argument is interesting because it is wrong but in a subtle way.

The bottom line: The cost of insurance comes mostly out of employees' paychecks. If insurance costs more, employees are generally paid less. If insurance costs less, employees are paid more. The cost of insurance does not have a big effect on employers’ overall compensation costs.

That’s why no one should be surprised that employers don’t make for good consumers of insurance. And it’s why insurers are not operating in a very competitive marketplace.

The premise is correct, employee compensation comes out of wages.  The subtle mistake is to forget that this is only true in equilibrium.  Imagine that a single employer was able to buy for his employees equal quality health insurance at a lower price. Would wages at that firm rise?  No, an employer only has to pay workers what they could earn in another job.  If other firms aren't paying more then this firm need not raise wages even though its costs have fallen.  Thus an employer that reduced health insurance costs while keeping real compensation the same could pocket the savings as profit.  It's only when other firms follow suit–also in an attempt to cut costs and earn excess profits–that wages at all firms rise, eliminating the excess profit everywhere.

The process produces the equilibrium.  You can't have one without the other. 

If you are still uncertain, here's another way of making the same point.  Imagine that an employer provided his workers with better health insurance at the same cost. Employees would then flock to this employer pushing down wages and increasing that firm's profit.

So do employers fail to choose insurance carefully?  Given the costs of health insurance and the profits to be made by cutting costs (holding quality constant), I have my doubts.  Nevertheless, it could still be the case that giving employees more choices about which insurance firms to patronize could improve things on some margins as Leonhardt also argues in a related column today.