Results for “markets in everything”
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Robert Solow on Hayek and Friedman and MPS

The TNR essay is here, prompted by the publication of Angus Burgin’s The Great Persuasion: Reinventing Free Markets Since the Great Depression.  Excerpt:

The MPS was no more influential inside the economics profession. There were no publications to be discussed. The American membership was apparently limited to economists of the Chicago School and its scattered university outposts, plus a few transplanted Europeans. “Some of my best friends” belonged. There was, of course, continuing research and debate among economists on the good and bad properties of competitive and noncompetitive markets, and the capacities and limitations of corrective regulation. But these would have gone on in the same way had the MPS not existed. It has to be remembered that academic economists were never optimistic about central planning. Even discussion about the economics of some conceivable socialism usually took the form of devising institutions and rules of behavior that would make a socialist economy function like a competitive market economy (perhaps more like one than any real-world market economy does). Maybe the main function of the MPS was to maintain the morale of the free-market fellowship.

Solow neglects to mention that Milton Friedman turned out to be right on most of the issues he discussed (though targeting money doesn’t work), that MPS economists shaped at least two decades of major and indeed beneficial economic reforms across the world, or that some number of the economists at MIT envied the growth performance of the Soviet Union and that such remarks were found in the most popular economics textbook in the profession.  You can consider this essay a highly selective, error-laden, and disappointing account of a topic which could in fact use more serious scrutiny.

By the way, if you read Solow’s own 1962 review of Maurice Dobb on economic planning (JSTOR gate), it shows very little understanding of Hayek’s central points on these topics, which by then were decades old.  Arguably it shows “negative understanding” of Hayek.

Or to see how important Friedman’s work on money and also expectations was, try comparing it with…um…the Solow and Samuelson 1960 piece on the Phillips Curve (JSTOR), which Friedman pretty much refuted point by point.  Here is the closing two sentences of that piece:

We have not here entered upon the important question of what feasible institutional reforms might be introduced to lessen the degree of disharmony between full employment and price stability.These could of course involve such wide-ranging issues as direct price and wage controls, antiunion and antitrust legislation, and a host of other measures hopefully designed to move the American Phillips’ curves downward and to the left.

And Solow wonders why the Mont Pelerin Society and monetarism were needed.  Solow should have started his piece with a sentence like “Milton Friedman was not right about everything, but most of his criticisms of my earlier views have been upheld by subsequent economic theory and practice….”

Greg Ransom…telephone!

For the pointer I thank Peter Boettke.

How much would it matter if we deregulated health insurance across state lines?

From Sarah Kliff:

Allowing insurance sales across state lines comes up perennially as a way to drive down the cost of health care.

Conservatives argue that allowing a plan from a state with relatively few benefit mandates – say, Wyoming – to sell its package in a mandate-heavy state (like New York) would give consumers access to options that are more affordable than what they get now.

Liberals tend to argue this is a bad idea, contending that it would create a “race to the bottom,” where insurers compete to offer the skimpiest benefit packages.

A new paper from Georgetown University researchers suggests a third possible outcome: Absolutely nothing at all will happen. They looked at the three states – Maine, Georgia and Wyoming – that have passed laws allowing insurers from other states to participate in their markets. All have done so within the past two years.

So far, none of the three have seen out-of-state carriers come into their market or express interest in doing so. It seems to have nothing to do with state benefit mandates, and everything to do with the big challenge of setting up a network of providers that new subscribers could see.

“The number one barrier is really building that provider network that’s attractive enough to get patients to sign up,” said lead study author Sabrina Corlette. “To do that, you have to offer providers attractive reimbursement rates, which makes it difficult to get them in network.”

Corlette and her colleagues talked to insurers and regulators in all three states. And they heard this barrier come up again and again: Entering a new state is really difficult, whether there are benefit mandates or not. “We kept hearing about the cost of building a provider network that’s strong enough to market,” she said.

Imitation Ain’t Easy

On the Syfy tv show Alphas one of the characters is able to see something once and learn it perfectly. Thus, she can learn a martial art, or how to fix a car, or how to speak a language just by imitation. This ability is rightly considered a superpower. Yet, in economic models it’s assumed that everyone has this ability.

Imitation, however, is difficult even when knowledge is freely available. In Launching I give the example of The French Laundry Cookbook which promises that with “exact recipes” and “simple methods” that “you can now re-create at home the very experience the Wine Spectator described as ‘as close to dining perfection as it gets.'” Yet despite exact recipes and simple methods we don’t see imitations of the restaurant twice named the best in the world popping up in Muncie, Indiana (trust me on that one).

Similarly, in Apple v. Samsung the jury found that Samsung copied Apple and indeed they copied Apple well enough to survive but nowhere near well enough to eliminate Apple’s monopoly power as Eli Dourado points out:

According to a recent article at Fortune, Apple sells 8.8% of mobile phones, but it has 73% of profits in the market. Samsung sells 23.5% of phones and earns 26% of profits. Everyone else is barely breaking even or losing money.

This does not look like a market in which Apple’s competitors are successfully copying it. It looks like a market in which Apple’s competitors are trying to copy Apple, and failing.

The point of patents is to incentivize innovation through a grant of monopoly. But what Apple’s success, pre-verdict, clearly shows is that in many markets, mobile computing among them, it’s a lot harder to copy innovations than you think. Apple’s real innovation is putting designers in charge and building a corporate culture in which everything is subordinated to making elegant products that people want to use. I’d like to see Samsung try to copy that, but I think the difficulty of doing so gives Apple all the monopoly it needs.

Zingales on Education Equity

Luigi Zingales has a good op-ed on education in today’s NYTimes:

… scholars like me…work in the least competitive and most subsidized industry of all: higher education.

We criticize predatory loans by mortgage brokers, when student loans can be just as abusive. To avoid the next credit bubble and debt crisis, we need to eliminate government subsidies and link tuition financing to the incomes of college graduates…Just as subsidies for homeownership have increased the price of houses, so have education subsidies contributed to the soaring price of college.

…These subsidies also distort the credit market. Since the government guarantees student loans, lenders have no incentive to lend wisely. All the burden of making the right decision falls on the borrowers. Unfortunately, 18-year-olds aren’t particularly good at judging the profitability of an investment…

Last but not least, these subsidized loans keep afloat colleges that do not add much value for their students, preventing people from accumulating useful skills.

Instead of subsidies Zingales, drawing a page from Milton Friedman, proposes income-contingent loans.

Investors could finance students’ education with equity rather than debt. In exchange for their capital, the investors would receive a fraction of a student’s future income — or, even better, a fraction of the increase in her income that derives from college attendance. (This increase can be easily calculated as the difference between the actual income and the average income of high school graduates in the same area.)

As I wrote about earlier, Bill Clinton received a loan like this from Yale’s law school and later created a national program but it didn’t get very far (although Obama wants to expand the program). Australia, however, implemented an income contingent loan program in 1989. Australian students don’t pay anything for university when they attend but once their income reaches a certain threshold they are charged through the income tax system.  Many other countries are experimenting with income contingent loans.

Lumni is a private organization, started by economist Miguel Palacios (here is his book and Cato paper on human capital contracts), that is funding loans like this right now.

One point that Zingales doesn’t examine is adverse selection – an income-contingent loan will appeal most to people who want careers with low-income prospects, say in the non-profit sector. (Redistribution of this type was one of the reasons for the Yale law school program.) Thus, the program works best when incomes differ due to luck. My guess is that the adverse-selection problem can be handled if education venture capitalists are left free to price.

We are all stagnationists now

Here is Jim Hamilton, on peak oil, scary tag at the end:

…we should not dismiss the possibility that there may also have been a nontrivial contribution of simply having been quite lucky to have found an incredibly valuable raw material that for a century and a half or so was relatively easy to obtain. Optimists may expect the next century and a half to look like the last. Benes and coauthors are suggesting that instead we should perhaps expect the next decade to look like the last.

On this issue I am more optimistic than Hamilton.

Alternatively, here is Cardiff Garcia from the FT, with a survey of recent pessimistic thought on productivity, citing (but not necessarily endorsing) Nomura:

…we think it more likely that the economy will grow at a trend pace near 2.5%, which, coupled with normalization in productivity, implies the sustainable underlying pace of monthly gains in private payrolls is in the low-100k range or lower.

Karl Smith has a very useful blog post.  Addressing me, he writes:

My position perhaps more clearly stated is that if all markets were clearing then phenomena such as: lack of educational improvement, globalization, de-industrialization, skew of technological improvement towards information technology, energy shortages, etc would show up in wages.

My view is this.  When real factors are slow, it takes much longer for the private sector to manufacture its own ngdp and also of course rgdp.  (You can pursue a separate argument about how quickly the Fed can fix things, but given that they haven’t, for whatever reason, the previous claim still holds.  We can make multiple margins of comparison, even if a perfect Fed would clear everything up.  We don’t have a perfect Fed.)  Much of North Dakota has full employment, but most of the nation does not.  With a stronger real economy along the right dimensions, we would have more jobs, but we don’t.  The long term where everything shows up in wages can take a while to arrive.  Nothing in this view requires one to tell stories — be they true or not — about companies which cannot find quality computer programmers.  A final point is that labor force participation may be the job market number that really matters.

Here is an excellent post by Will Wilkinson on Obama, Romney, meanness, and Ben Friedman.

More from Edward Conard, on proprietary trading

Rather than demanding an end to default-prone subprime lending funded with hair-triggered short-term debt, bank critics have, ironically, demanded an end to proprietary trading, which they view as unnecessarily risky, but which was inconsequential to the cause of the Crisis.  In a world where banks underwrite and trade risk, what constitutes proprietary trading?  When a bank takes credit-default risk by making aloan, is it taking proprietary risk?  It is, without a doubt.  But loaning money is what banks do.  When a bank like Goldman Sachs seeks to unwind that risk by shorting mortgages prior to the downturn, is that proprietary trading?  Yes.  So is borrowing short and lending long.  With banks now primarily underwriting, pricing, and trading risk rather than merely funding loans, restrictions on proprietary trading unnecessarily imperil banks and distort capital markets to restrict banks to only the long side of the trade.  restricting banks to long-only positions substantially increases withdrawals in the event of a panic.

I would stress that the real problems come when the overwhelming majority of banks go heavily long on some fairly simple assets — usually real estate — in an overly optimistic way.  Think Ireland, Iceland and the United States during the last crisis, among many other instances.  Once the short-term debt behind those banks starts to unravel, all hell breaks loose and the central bank can at best limit but not stop the carnage.  That is the main problem financial regulation should be trying to address and it isn’t easy.

I am much less worried about “rogue trades” or “rogue investments” at individual banks (or non-banks), even very large ones.  Such trades surely exist: think LTCM or even Continental Illinois.  Ex post, there is usually a way to plug the gap, if only by having the Fed backstop a deal.  After all, the rest of the banking system is sound in these scenarios.  Prop trading may increase the chance of this second problem, but arguably it decreases the chance of the first and larger problem.

You can buy Conard’s stimulating book, Unintended Consequences, here.  Conard, by the way, does object to how the government implicitly subsidizes the short-term debt of the major U.S. banks and he views that as the root of the problem behind proprietary trading, not the trading itself.

Why did the U.S. financial sector grow so large?

Edward Conard, author of Unintended Consequences: Why Everything You’ve Been Told About the Economy is Wrong, offers a hypothesis.  He suggests the underlying cause is the (relatively recent) prevalence of risk-averse foreign capital:

With an abundance of risk-averse offshore capital, the constraint to increase investment and risk taking has been the capacity of risk underwriters, not capital providers.  Today, Wall Street uses financial innovation to decouple risk from investment capital and predominantly sells risk to risk underwriters, which is no different from an insurance broker or insurance company.  Wall Street deconstructs, prices, underwrites, syndicates, trades, and makes markets for risk.  Because Wall Street now performs the more abstract function of syndicating risk rather than merely raising capital, people — even people as well informed as former president Bill Clinton — have naively concluded that these transactions serve “no economic purpose.”  Risk underwriting is every bit as important as funding investment, perhaps even more so in today’s economy where the trade deficit leaves us awash in risk-averse short-term debt to fund investment provided someone else underwrites the risk.

So far I find parts of this book brilliant and other parts dead wrong.  In any case it is full of substance, it is one of the must-read books of the year, and once I finish it I will be giving it a second read through right away.

Investing in Greece: Only for the Filthy Rich

If a small company wants to sell shares to investors it must demonstrate to the SEC that the investors are “accredited,” basically wealthy, or otherwise it must go through a long and burdensome process to make an offering to the public. According to one account, Greece has considerably more peculiar requirements:

Antonopoulos and his partners spent hours collecting papers from tax offices, the Athens Chamber of Commerce and Industry, the municipal service where the company is based, the health inspector’s office, the fire department and banks. At the health department, they were told that all the shareholders of the company would have to provide chest X-rays, and, in the most surreal demand of all, stool samples.

Greek banks were not much better:

Once they climbed the crazy mountain of Greek bureaucracy and reached the summit, they faced the quagmire of the bank, where the issue of how to confirm the credit card details of customers ended in the bank demanding that the entire website be in Greek only, including the names of the products.

“They completely ignored us, however much we explained that our products are aimed at foreign markets and everything has to be written in English as well,” said Antonopoulos.

Take this with a grain of salt but the World Bank does rank Greece 135th in the world (186 countries ranked) in ease of starting a business.

Assorted links

1. Measuring the output gap, an excellent post looking at capacity utilitzation and changes in inflation rates to back out an answer to this question.  The bottom line is that the output gap probably isn’t nearly as large as is often claimed.  And Karl Smith comments, I would note the connection between the ppf and trust.

2. Obama’s hardline turn against medical marijuana.

3. Markets between everything and everyone, and Literary Saloon reviews Allan Meltzer.

4. Testing Milton Friedman, new TV show with Caplan, Yglesias, Dalmia, Williams, others.

5. Graphs about Hollywood.

The tipping point

Suppose that of the N member-states, F (e.g. 3, as is the case at the moment of writing) have ‘fallen’ out of the money markets and into the EFSF’s bosom. The EFSF must then finance their debts entirely until the Crisis ends. To do so it must seek loan guarantees from the N-F still solvent member-states. It is extremely easy to show that the contribution (as a portion of their GDP) of the N-F solvent member-states to the ‘fallen’ member-states, let’s call it αF (where the subscript indicates the number of ‘fallen’ states that must be supported) equals some newfangled debt-to-GDP ratio: The numerator is the total debt of the ‘fallen’ and the denominator is the total GDP of the still solvent member-states. (See here for a brief proof.)  The reason I choose to call αF a toxic ratio is that, with every member-state that ‘falls’, this ratio rises even if GDP and debts remain the same. Moreover, every new casualty boosts the toxic ratio αand guarantees that yet another member-state will join the rank of the ‘fallen’. And as if this were not enough, nothing can stop this process while everything else remains the same. Including the potential size of the EFSF.

Here is more.  Thus enter the ECB and its bond-buying.  Do Italy and Spain now count as belonging to “the fallen”?  Or have they just returned from “the fallen”?  Or maybe a bit of both?

How well is fiscal austerity working in the UK?

With the Wednesday release of a mediocre gdp report, we are hearing that the United Kingdom austerity program is proving a macroeconomic failure.

Let’s look at the timing of the cuts:

So far, about GBP9 billion of the government’s fiscal tightening has occurred. However, around GBP41 billion of tax increases and spending cuts will begin to take affect from the start of the new fiscal year on April 5.

Some of the particular cuts were announced in October and at that time Ken Rogoff doubted whether half of them would end up taking place.  So the cuts are in their infancy and arguably their credibility is still somewhat in doubt or at the very least has been.

A lot of the weak gdp report is blamed on construction, with some excuses drawn from snowstorms.  There does exist an extreme rational expectations view, in which the last-quarter weakness of construction was based on the expectation that government spending cuts would start arriving later in April and thus new houses should not be built.  Alternatively, it could be that after the greatest real estate bubble in history, the UK market is overbuilt.  Weak UK growth dates to some time back.

Also recall that in many open economy Keynesian models, fiscal policy AD effects are to some extent — or completely — offset by exchange rate movements (pdf).  And the fiscal multiplier is basically zero when the central bank targets inflation.  Furthermore it is not obvious that the UK has been in a liquidity trap.   When it comes to drawing Keynesian conclusions about practical fiscal policy, the theory here is a house of cards.

The UK economy suffers from a more serious technological stagnation than does the United States, in this case more forward looking than backward looking.  Their pharmaceutical innovation seems to be drying up, they are overspecialized in finance, the “residential tax haven” status of the country may not yield continuing growth at high rates, tourism is OK but not enough, and their manufacturing base eroded some time ago, with nothing like a German-style comeback.  The teacup sector aside, why should anyone be optimistic about that economy?

Two other considerations:

1. The case for the cuts is not that they will spur growth, but rather forestall a future disaster.  That’s hard to test.  A second part of the case is that not many political windows for the cuts will be available; that’s hard to test too.  On that basis, it’s fine to call the case for the cuts underestablished, but that’s distinct from claiming that poor gdp performance shows the cuts to be a mistake.

2. Let’s say the cuts lower government consumption and raise private consumption, and that government consumption is wasteful but private consumption isn’t (and long-run growth is given by the Solow-like expansion of the international technological frontier.)  That’s a good case for making the cuts, but they still won’t show up as higher gdp.  The government consumption is valued into gdp figures at cost, so even cuts proponents with a good case don’t have to be predicting higher gdp.

I doubt if the UK fiscal austerity program will much boost their growth rate, which is likely low in any case and for non-Keynesian reasons.  Simply citing a low UK growth rate is not a test of their fiscal policy, for a number of reasons detailed above.

*The World in 2050*

The author is Laurence C. Smith and the subtitle is Four Forces Shaping Civilization's Northern Future

This book is excellent on at least two questions:

1. Which environmental problems remain real, even taking into account the dynamic adjustment properties of markets?

2. Why the northern countries will grow in economic and political importance over the next forty years.


Extraction industries will favor projects nearer the water.  Looking ahead, our northern future is one of diminishing access by land, but rising access by sea.  For many remote interior landscapes, the perhaps surprising prospect I see is reduced human presence and their return to a wilder state.

My main criticism of this book is that it does not direct enough criticism at government water subsidies and their role in worsening this environmental problem. 

Here is the book's rather non-Hayekian close:

No doubt we humans will survive anything, even if polar bears and Arctic cod do not.  Perhaps we could support nine hundred billion if we choose a world with no large animals, pod apartments, genetically engineered to algae to eat, and desalinized toilet water to drink.  Or perhaps nine hundred million if we choose a wilder planet, generously restocked with the creatures of our design.  To be, the more important question is not of capacity but of desire: What kind of world do we want?

Definitely worth the read.  I don't agree with everything here, but this is a book (very well-written by the way) which should be making a splash.  For the pointer I thank a loyal MR commentator.

Why I assign less weight to the liquidity trap argument

A few people have been asking me about this, so here is a summary statement of some points:

1. The liquidity trap argument implies that the money-short bonds margin doesn't, at current magnitudes, matter.  I am more closely wedded to marginalism than that.  The argument also sees all the action (or should I say, non-action) in one margin, the money-bonds margin.  The money-goods margin matters too.  In the liquidity trap argument, everything is decided by one irrelevance result at a single margin in a highly complex multi-trillion dollar economy.

2. Short-term interest rates being zero, and short-term interest rates being almost zero, are very different cases, especially for understanding nominal shocks and whether they can stimulate aggregate demand.  Unless short-term rates are literally the same as the rate on cash, asset swaps still can succeed.  And QEII isn't be the same as simply switching the term maturity of the debt, as Krugman has suggested.  There will be nominal effects also.

3. Even Keynes didn't believe he had ever seen a liquidity trap, including in the Great Depression.

4. Most of the good predictions of the liquidity trap models are covered by recognizing there are lots of unemployed resources and weak business confidence.  

5. Consumer spending just rose 2.6 percent and business profits are high, yet we are in a liquidity trap?  What exactly is the story here?  "We can get spending up by 2.6 percent but not a smidgen higher"? 

6. The stock market responded positively to the announcement of QEII and the TIPS spread went negative; both are the opposite of what a liquidity trap model would predict.  Markets don't seem to think the liquidity trap idea is a very useful one and that alone creates real positive effects from monetary policy.  If markets don't believe in a liquidity trap, that's enough for the trap not to bind.

7. Monetary policy worked quite well in the Great Depression, when it was tried.  And on Japan I am persuaded by Scott Sumner.

These points are a less fundamental, but they are still relevant to the debate, if not always to the substantive issue itself:

7. There are different liquidity trap models.  For instance I often see the "short nominal rates are zero" model being confused with the more stringent "money demand is a bottomless sink" model.  It's only the latter case — clearly not true today — which generates the extreme results of liquidity trap models.  Otherwise the money-goods margin remains operative and monetary policy can succeed.

8. Some of the LT models imply upward-sloping AD curves and downward-sloping AS curves, yet I don't see anyone applying those assumptions consistently to other decisions, such as tax policy for instance.

9. If a liquidity trap is to persist beyond the short run, something must be preventing the marginal product of capital from adjusting upwards and solving the problem.  In other words, a non-short-run version of the liquidity trap has to be combined with an account of problems on the real side.

10. I see liquidity trap proponents spending a lot of time criticizing naive versions of real business cycle theory, bond market vigilante arguments, and so on.  They spend less time engaging the most serious criticisms of the liquidity trap argument.  A study of the liquidity trap literature does not raise one's confidence in the idea, though it might sound OK if the relevant alternative seems sufficiently bad.

11. Whether or not we should use fiscal policy depends on how well our government can target and mobilize unemployed resources; you don't need a liquidity trap to address that argument.

12. Ultimately I view the liquidity trap idea as a kind of shaggy dog that's been pulled out of the closet.  If it's going to be made convincing, it needs a lot more work than simply repeating that some short-term interest rates are near zero.

El Salvador observations

The best meal was whipped yucca with chicharrón and vinegar, sold next to Tazumal.  The ubiquity of corn products means the country has less culinary variety than any of the other eighty lands I have visited.  There is a Taiwanese restaurant in San Salvador, however.  Olocuilta is a pupusa paradise — go there from the airport.

In Suchitoto, Garett bought a first-rate tortilla for 5 cents and had trouble changing his one dollar bill.  If Mankiw abolished the penny, how would the country — which uses the U.S. dollar — cope?  Or would they keep pennies as legal tender and all pennies would flow there?  How small would a country have to be, to experience hyperinflation from such an influx?  Could they put up a penny barrier?

El Salvador has good infrastructure (real roads), the electricity always runs, and the country embodies petty bourgeois values.  It is much richer than Nicaragua, Honduras, or Guatemala and it feels quite Protestant.  The crafts are weak, but volcanoes, lakes, and birds abound.  Their economic policies are quite good, and therein one sees both the potential and limits of economic advice.

On the road, we debated in what year the United States attained current El Salvadoran living standards (measured at $4400-$5800); I thought by the late 1920s.  The existence of penicillin makes the numerical comparison difficult, though in favor of El Salvador.

We saw a dead guy on the side of the highway; apparently he was struck down by a passing car.  Ill-advised pedestrian walks are a problem for many El Salvadorans in the United States as well.  “More guns, less crime” I joked to Alex as we drove through the center city.

It is an excellent country for a three-day trip.