Z: **Inactive:** Brad DeLong--Economics Only

Felix Salmon on the iPhone

He quotes Paul Kedrosky on the iPhone as a disruptive, non-crippled technology:

Finance Blog - Market Movers by Felix Salmon: iPhone to Support Wifi Calling - Portfolio.com: Paul Kedrosky has an interesting op-ed in the WSJ today, saying that the reason people desperately want the iPhone is that it isn't crippled:

These people want to be liberated either from bad phones or from bad phone companies. They want to choose a device that does all the things they want to do -- calling, being entertained, consuming information -- not all the things their phone company thinks they should do (and then be charged $5 a month per feature for the privilege). They want phones that make it possible to do calls over wi-fi, to the point that cellular companies could potentially become irrelevant.

The massive upwelling of grassroots support for the iPhone shows that a revolution has been building for some time. Now it's here. Cell phone carriers are going to have to respond by cutting the length of contracts and eliminating exclusivity, and most important, by finally being responsive to their market. If not, iPhones (or their successors) will finish them off.

Of course, the irony here is that the iPhone is exclusively locked in to AT&T for the next five years; that it requires a two-year contract; that it won't make calls over wi-fi; and that in general it's not half as revolutionary as Kedrosky seems to imply that it is. But we're only at iPhone 1.0, today. Will wi-fi calls and the like come in the future? Surprisingly, the answer seems to be yes, according to an interview with Steve Jobs and AT&T CEO Randall Stephenson, also in the WSJ:

Mr. Jobs: We obviously thought about VoIP. You still need a cellular phone because you're not always going to be in a Wi-Fi hotspot. One you have a cellular phone plan, it costs you zero incremental dollars to use it when you're making the next phone call. VoIP, while an interesting technology, didn't seem to be a big breakthrough to us. But others might feel differently, and others may make Web-based VoIP clients available for the iPhone – I think someone's already working on that...

Mr. Stephenson: Absolutely -- in fact Wi-Fi is just an enhancement to your existing wireless capability.... You could not have thought of VoIP on a wireless handset until you start thinking about Wi-Fi capabilities on these handsets. That doesn't intimidate us at all. I think it's a very nice enhancement to an existing service.

This is great news. As Jobs knows full well, the incremental cost of the next phone call is not zero on a cellular phone plan: not if that phone call would take you over your allotted minutes, and certainly not if the phone call is international. It seems that Jobs and Stephenson are OK with wi-fi based calling, which will be a godsend to people who travel or call a lot internationally.

Ronald Reagan on Free Trade!

From Douglas Brinkley, ed. (2007), The Reagan Diaries (New York: Harper Collins: 9780060876005).

Thur Mar 19 1981: The auto task force met with Cabinet--still some disagreement about any quotas on Japanese imports. Some even with regard to a Japanese voluntary cutback. The V.P. summed it up nicely. He said we're all for free enterprise but would any of us find fault if Japan announced without any request from us that they were going to reduce their export of autos to America?

There was no dissent. I told them I'd heard enough I would make a decision. Privately I told Al Haig to call Amb. Mansfield and have Mike advise "Ito" before his visit that we were threatened by a bill in Cong. to set a quota. An announcement by Japan of a voluntary cutback could head that off. We'll see what happens. Al then told me he felt he was being undercut by other agencies etc. I worry that he has something of a complex about this. Anyway I've arranged that he and I meet privately 3x a week.

Kennedy Center in the evening for "Little Foxes" starring Liz Taylor. She was darn good--so was the show.

Dr. Dow-Jones and Mr. Wall Street Journal and Rupert Murdoch

Rupert Murdoch is about to buy the Wall Street Journal. This is a big deal. But I think that almost everybody is thinking about what this means in the wrong way.

To understand what Rupert Murdoch's forthcoming purchase of the Wall Street Journal means, you need to start with the fact that there is a good Wall Street Journal and a bad Wall Street Journal. The good Wall Street Journal is the news pages as built up by Norman Pearlstine, with past and present stars like Al Hunt, Davie Wessel, Alan Murray, Ron Suskind, Walt Mossberg, Greg Ip, and a galaxy of others: the finest, smartest, hardest-working, and most professional group of star news reporters in the world. The bad Wall Street Journal is the editorial page of ethics-free right-wing--no, not right-wing, Republican wingnut--partisan hacks. As Ken Auletta put it in an excellent New Yorker article a couple of years ago, describing the bad Wall Street Journal:

Annals of Communications: Family Business: The New Yorker: the opinion page... Robert Bartley.... From 1972 to 2002... ran the editorial page... as if Bartley owned and operated his own private newspaper... a non-stop campaign on behalf of supply-side economics, a return to the gold standard... and prosecuting the Cold War.... The predominantly Democratic Bancroft family... would have preferred “a less acerbic editorial voice.... There is a lot that I think is beyond the pale.”... [T]he editorial page... omitted facts that contradicted its assertions.... crossed a line in advancing its ideology...

Henry Kissinger once famously said of a statement that "it had the added advantage of being true." For the bad Wall Street Journal of the editorial page--at least when I have dealt with them--truth is simply irrelevant: to show them person-to-person that they are factually wrong makes no impact at all. Few like the bad Wall Street Journal, not even those who usually find it useful. Here's one view:

On the Wall Street Journal Editorial Page: ...smug rich-guy arrogance... blithe indifference to actual human nature... "arrogant elites"... out in the open, brazen and unashamed... dubious factual assertions... mischaracterize... our views... hostile and insulting... [we need] to correct the record because [of] you and... [your] friends...

That's the perspective from National Review.

The contempt for the bad Wall Street Journal is returned. Here's Auletta from the New Yorker again, quoting Bartley on Norman Pearlstine, the head of the good Wall Street Journal:

When I asked Robert Bartley, the Journal’s former editorial-page editor, to describe Pearlstine’s legacy, Bartley... carved up his former colleague.... “[C]irculation was down. Advertising was down.... [R]eporters won prizes for writing books beating up on our subscribers and advertisers.... Norm’s a very creative guy--the three-section newspaper was his.... I don’t think he’s good at sustained effort”...

Bartley's criticism of Pearlstine's Wall Street Journal, in a nutshell, is that Pearlstine had forgotten what he was paid to do: Pearlstine thought he was paid to report the news and inform the subscribers, but in Bartley's view that was wrong--what Pearlstine was paid to do was to deliver eyeballs to advertisers by printing stuff that made subscribers and advertisers feel good and righteous.

Dr. Jekyll, meet Mr. Hyde.

Some Journal insiders--even some on the news side--say that this Jekyll-and-Hyde relationship is all to the advantage of the good Dr. Jekyll. Nobody serious believes the editorial page, they say; it serves as a comics page for the older and more-wingnutty subscribers, a source of daily comfort food for those who still denounce, "that Communist, Franklin Roosevelt," and who have always thought that the depth and duration of the Great Depression were the fault of the New Deal--that if the free-marekt tidal wave of falling wages and massive bankruptcies had been allowed to purge the economy for 1933 and 1934, by 1935 and 1936 all would have been well. But, this faction says, the editorial page delivers up perhaps half a million extra subscribers a year, and that money flow pays for the finest news-reporting operation in the world.

Other Journal insiders say that it is the bad Mr. Hyde that is sucking the blood of Dr. Jekyll. Nobody would pay attention to the wingnuts of the editorial page, they say, were it not for the fact that they come at the back of a very, very good newspaper. 50,000 people a month read the American Spectator, where Bartley's crew belongs. 1,000,000 people a day at least glance at the Wall Street Journal editorial page. The reporters in the news division are thus in a morally ambiguous position as journalists: the stories they write inform the public, and the public they attract then turns to page A16--and is there misinformed.

We outsiders speculate and argue about which of these perspectives is closer to the truth. We do not know. But we do know that this is the shape of the organization that Murdoch wants to capture.

Now Rupert Murdoch of the News Corporation has pulled a chair up to this poker table, and wants to buy the Wall Street Journal. Figure that he can sell off other parts of Dow Jones, Inc. for enough money that the long-term net investment by News Corp. will be on the order of $2 billion. Why might Murdoch want to spend so much money to do such a thing?

One possibility is that Rupert Murdoch likes to keep what he has and that he has sons: the thirty-something Lachlan and James (and a daughter, Elizabeth). His sons will already be rich beyond the wildest dreams of avarice. Giving his sons roles at News Corp. has proven difficult: he still wants to run the show, and people whom he has hired and had long-term relationships with want to go around him if they don't like what his sons are doing. But there is nobody at the Journal with strong personal ties to Murchoch. If Murdoch buys the Wall Street Journal and spins it off, then at least one of his sons can become an independent global power broker in his own right without Murdoch having to loosen the reins at News Corp. It's like a medieval German emperor creating his son Duke of Swabia: it's a real job, an important job, a very powerful job, and a job that keeps the son occupied without forcing the father to begin the surrender of his own power before he is ready. That might be what is going on. But if it is Murdoch is playing his cards very close to his vest.

A second possibility is that Rupert Murdoch thinks that in the age of new-media convergence the Wall Street Journal has the brand and the authority and the staff to make it an excellent launching pad, worth a $2 billion bet. Can Murdoch synergize the Journal's brand on TV and via new media in a way to further boost his fortune? Perhaps. Many fortunes will be made in financial news when the technological shift that has replaced the Mergenthaler and wood pulp with the microchip and the fiber-optic cable finally shakes itself out. Why, Murdoch may be asking himself, should the biggest fortune be made by Michael Bloomberg and not by him? That might be what is going on. But if it were, and if Murdoch had a real chance at the synergies, there would be other bidders by now.

A third possibility--by far the most likely, IMHO--is that Rupert Murdoch is one of the boys who just wanna have fun. It would be more fun shaping the opinions of the world through both News Corp.'s current properties and the world's preeminent global financial newspaper than through just News Corp.'s current properties alone--plus it would be more fun receiving the bowing and scraping that the world's powerful would engage in to placate the owner of News Corp. plus the Wall Street Journal than just the bowing and scraping that accrues to the owner of News Corp. alone. That is probably what is going on.

Which of these three possibilities is truest has implications for what is likely to happen to a Journal under Murdoch ownership, and whether the Murdoch purchase is a good thing.

If the first possibility is true--if the best analogy to what is going on is that this is the equivalent of a medieval German emperor creating a son Duke of Swabia--then it is surely good news for the world. A relatively young, energetic proprietor with deep knowledge of the news business--and Murdoch's children fit that bill--would in all likelihood be as good a steward of the excellent social asset that is the Wall Street Journal's news section. And it can't be bad for the editorial pages. Whatever happens to them has to be an improvement.

If the second possibility is true--that Murdoch wants to keep the Journal's strengths as he uses the brand as a new-media synergy launching pad--then the Murdoch purchase is probably good news for the world. Murdoch will then leave the news pages--the Journal's major strength--intact. And although Murdoch is as right-wing as Bartley and company, there is a key difference: Murdoch can be bought, or at least rented. A Journal editorial page run by Murdoch might well wind up supporting a Tony Blair or a Hillary Rodham Clinton: it would be wignutty when that was in Murdoch's interest; sane right-wing when that was in Murdoch's interest; centrist when that was in Murdoch's interest. A Journal editorial page run by the current regime would be wingnutty 24/7, as it is today. Neither would be a source of news or information--both would bear a completely random relationship to the truth--but the Murdoch version would be less destructive.

But by far the most likely is the third possibility. And if the third possibility is true, then Murdoch's purchase is probably bad news. It is true that the Wall Street Journal's editorial page will improve, as its positions are aligned less with winguttery and more with the interests of whoever has rented Murdoch for that particular afternoon. But the news pages will deteriorate. Murdoch will tell China's State Council and other political interests with whom he seeks to deal that the situation is delicate, that he cannot interfere openly with the news process, that it will take time, and so forth, but that if they make it worth his while he will do what he can do--and in the long run if they give him rope they will not be disappointed. Murdoch will tell his employees on the Journal news desks that he is under enormous pressure, that he understands the importance and delicacy of the situation, that it will take time, and so forth, but that they need to be patient and give him rope and they will not be disappointed. In reality, Murdoch will use the rope they give him to hang one or both of these groups--but which we will not discover for a while: Murdoch is a professional at this, after all.

So: as the Murdoch acquisition of the Journal moves forward, watch carefully. If Murdoch's children wind up being the effective proprietors of an organization run separately from News Corp., be happy. If Murdoch spends his time and energy leveraging the brand in new media space, reshaping things into the editorial pages to please his political contacts, and leaving the news pages alone to run themselves, then be happy.

But if Murdoch starts running the Journal the way he runs his other properties, be alarmed. Be very alarmed.

The Weak Link Theory of Economic Development

Hoisted from Comments: Bruce Wilder on the weak link theory of economic development:

Some years ago, I was privy to the efforts of a company trying to build maritime shipping containers in China.

A shipping container is not a particularly sophisticated manufactured product -- more sophisticated than simple textiles, certainly, but most shipping containers include no motorized machinery. The most sophisticated aspects are the forged corner parts, which bear weight and must interlock with mounting hardware, and the requirements for dimensional consistency. The sides are pressed from rolled steel, and the floors are hardwood (at the time, teak was still used, when available), and the structure is riveted, bolted and welded together.

Despite rock-bottom wages, the container plant in China was consistently unprofitable. Why? Parts did not arrive on schedule. The quality of steel, forgings, other parts and finishes (paint) sourced locally was irregular. The local power grid was unreliable: power failures interrupted production and voltage spikes and brownouts damaged equipment. Local workers required a lot of training and supervision, and there was considerable turnover. Industrial services necessary to maintain the production equipment were difficult to obtain. Parts and repairs for the production equipment could be time-consuming to obtain. The purity of local water supplies impacted production quality. The list went on and on, with always the same result: finished output and productivity in the plant sucked big-time.

The venture changed hands and I lost track of them, but I would assume that successors eventually succeeded.

Such a concrete example may be instructive in reminding that high productivity is a result of getting very nearly everything right in a complex system.

CDOs: Mark-to-Model and Donner-Party Economics

Saskia Scholtes and Gillian Tett of FT on mark-to-model:

Saskia Scholtes and Gillian Tett of FT: As head of the financial stability unit at the Banque de France, Imène Rahmouni-Rousseau travelled to America this month to look at the current turmoil in the US subprime mortgage world. Although initially that had seemed an all-American saga, Ms Rahmouni suspected that French and other European investors also held assets linked to subprime securities. So on behalf of her central bank she wanted to assess the risks. What she discovered surprised her. There was little confidence about how to value the holdings. “Pricing data are difficult to obtain,” she says. It is a discovery being shared by numerous other policymakers and investors around the world as the fallout widens from a subprime lending boom, in which US banks provided vast amounts in home loans to financially stretched borrowers who put little money down and gave no proof of income. Among the casualties have been two hedge funds run by Bear Stearns, the Wall Street investment bank.

Until recently, when late payments and defaults on these mortgages spiked higher, the problem drew little attention. This was because, through the magic of so-called structured finance, risky assets such as subprime mortgages could be packaged into attractive investment products. These elaborately constructed securities, called collateralised debt obligations (CDOs), are designed to yield juicy returns while also carrying high credit ratings. They have proved popular with hedge funds as well as with longer-term investors such as pension funds and insurance companies, many of which have bought billions of dollars of such securities in recent years – thus providing the liquidity that was then channelled into mortgage loans.

But heavy losses incurred at the two Bear Stearns hedge funds as a result of such financial haute couture have prompted fears that the CDO emperor may turn out to have no clothes. Such a revelation could threaten the value of investor portfolios around the globe – not just in the mortgage sector but in the way many sorts of company fund themselves. This is because unlike stocks listed on an exchange or US Treasury bonds, CDOs are rarely traded. Indeed, a distinct irony of the 21st-century financial world is that, while many bankers hail them as the epitome of modern capitalism, many of these new-fangled instruments have never been priced through market trading.

Instead, products such as CDOs, which are designed to be held until they mature, have often been valued in investor portfolios or on the books of investment banks according to complex mathematical models and other non-market techniques. In addition, fund managers and bankers often have broad discretion as to what kind of model they use – and thus what value is attached to their assets.

So when Wall Street creditors last week threatened fire sales of CDOs seized from the stricken Bear Stearns funds, thus creating a market price for them for the first time, they also threatened to create a wider shock for the system. Fire sales rarely realise anything close to the previously expected value of assets. But if these deals went ahead, they would provide a legitimate trading level that would challenge current portfolio valuations.

In the event, Bear Stearns’ creditors sold only a fraction of the assets put up for auction. Market participants suggest that this was in part because bids fell far below expectations, with traders increasingly reluctant to take on CDOs tainted with subprime exposure. But the crisis at Bear’s funds has left investors, brokers and regulators asking an uncomfortable question: can the pricing models that have provided the foundations for this new financial edifice really be trusted? Or will valuations turn out to be over-optimistic and result in further investor losses? “Investors are slightly more cautious, becoming more picky and asking more questions,” says Michael Ridley, co-head of high-grade debt capital markets at JPMorgan. “They want us to lift the lid off the box a bit more.”

To an extent, the valuation problem for CDOs reflects the fact that the frenetic pace of innovation seen in the financial industry this decade has outpaced the development of its infrastructure. It has often been the case that when new instruments emerge in the banking world, the market is initially quite illiquid, meaning that the level of trading is low. But the murky nature of new products has rarely had broad systemic implications, because they have typically occupied a small niche.What makes the CDO sector unusual is that it has exploded at such a breakneck pace with bankers packaging bonds, loans and other debts into ever more complex structures. Last year alone, about $1,000bn (£500bn, €745bn) in cash and derivatives CDOs was issued in Europe and the US, according to data from the Bank for International Settlements. More than one-third was composed of asset-backed securities, often including low-grade mortgages.

As this explosion has occurred, some corners of this universe have already become relatively widely traded and transparent. Every day in the London and New York markets, for example, billions of dollars worth of deals are struck involving indices of derivatives on well-known corporate bonds – making it easy to obtain prices.

However, many other such products are created by bankers directly with their clients and then simply left to sit on the books of an investor.

Since such instruments typically last three to five years – and the CDO boom is so recent – many have not come to the end of their life. Nor have they been traded. Christopher Whalen of Institutional Risk Analytics, a consultancy, says: “The lack of a publicly quoted market for CDOs and like assets is exacerbating the liquidity problems for these assets beyond the underlying economics, for example, in subprime real estate.”

To compensate, investment institutions and banks use a variety of techniques to assign a value to these instruments in their accounts. In some areas, third-party data groups exist that can offer price estimates. However, the pace of innovation is so intense that it is hard for these providers to keep up with all corners of the market. So in many cases, investors are turning to alternative techniques to create prices. One tactic used by hedge funds entails asking several brokers for price quotes and taking an average. Results vary – not least because dealer banks may hold positions in these instruments themselves.

“It is very easy for hedge funds to shop around to find valuations that suit them best and then book their assets at that,” says one banker who advises hedge funds. “Going back to the bank that sold you a CDO and asking for a price is rarely likely to produce an accurate picture.”

Another approach is to estimate valuations based on the ratings the instruments receive from credit rating agencies. Yet this does not offer a fail-safe valuation method either. The rating agencies have been downgrading bonds backed by subprime mortgages in recent weeks but critics say they have been slow to act and face difficulties in analysing the market.

Christian Stracke, analyst at CreditSights, a research company, says: “With so little truly relevant historical data on the behaviour of subprime mortgages, and with such massive structural changes having occurred in the mortgage landscape in recent years, any time-series analysis approach is little more than a not-so-educated guess.“ Moreover, while ratings attempt guidance on the chance of default, they offer no indication of how market prices could behave – as the rating agencies stress. As the BIS noted in its annual report this week, ratings reflect expected credit losses rather than the “unusually high probability” of events that “could have large effects on market values”.

That means that on the rare occasions that instruments are traded, a large gap can suddenly emerge between the market price and its book value. This week Queen’s Walk Fund, a London hedge fund, admitted it had been forced to write down the value of its US subprime securities by almost 50 per cent in just a few months. That was because when it was forced to sell them, the price achieved was far lower than the value created with the models the fund had previously used – which had been supplemented with brokers’ quotes.

But unless circumstances arise that force a market trade, valuations often remain at the investment managers’ discretion. While managers say they strive to assign honest values, these are often difficult for an outside accountant to verify, since the techniques used are invariably highly complex. Moreover, incentives do not always encourage fair valuations: hedge fund managers, for example, are typically paid a percentage of the profits they book, giving them a vested interest in reporting a high asset valuation. At best, this means that the valuations of CDOs, for example, may often lag behind any swings in broader asset classes; at worst, this ambiguity may enable hedge fund managers or investment bankers to keep posting profits – even when markets fall.

But Amitabh Arora, head of interest rate strategies at Lehman Brothers, points to a further potential impact from the Bear Stearns upheaval. “The bigger risk now is that it calls into question CDOs as a financing vehicle in the corporate credit market – I think in the next six to 12 months we will see a significant reassessment of CDOs as a financial vehicle not just in the subprime world but the corporate world too.”

Adil Abdulali, a risk manager at Protégé Partners, a fund of funds, recently studied the performance of hedge funds and discovered clear statistical indications that they tend to stage-manage their earnings [known in the industry as “smoothing” them] when they trade illiquid instruments. “Conservatively, 30 per cent of funds trading illiquid securities smooth their returns,” says Mr Abdulali.

Some bankers and policymakers argue that this is simply a teething problem that will fade as structured finance becomes more mature. History suggests that most opaque, illiquid markets eventually become more transparent when they grow large enough – and behind the scenes, the Bear Stearns hedge fund problems are prompting bankers and investment managers to re-examine their valuation techniques. “We are getting a lot of calls from worried people,” says one third-party data provider.

However, history also shows that large-scale structural dislocations – such as a serious mispricing of assets – are rarely corrected in an orderly manner. Thus the big risk now is that if thousands of banks and investment groups suddenly have to slash the value of the securities they hold, the wave of accounting losses might at best leave investors wary of purchasing all manner of complex financial instruments. At worst, it could trigger more distressed sales and a broader repricing of financial assets, not just in the subprime sector but in other illiquid markets too.

“If every CDO [manager] was forced to mark to market their subprime holdings, it would be – well, I can’t think of a strong enough word to describe what it would be,” confesses a US policymaker.

These assets do have finite lifetimes. Unless nominal asset values crash over the next five years, CMOs and CDOs held for the next five years until maturity will pay off at or close to their model value. Only those with faulty capital structures who are thus illiquid today are in trouble, and they aren't in big trouble unless the numbers of those willing, rich, liquid enough to take on the risk of holding more CDOs and CMOs and with the analytical capability to price them are small.

As long as underlying asset values don't collapse, this is a redistribution: those hedge and other funds leveraged and without liquidity lose big, and those hedge and other funds that are liquid gain big. The caravan moves on, and the returns of those who make it down the California side of Donner Pass look very impressive, with the flesh-stripped bones of the illiquid and their investors scattered near Donner Lake for future archeologists to examine.

Annals of Government Failure: Silphium Edition

The extinction of silphium:

Damn Interesting » The Birth Control of Yesteryear: Unfortunately, modern science will probably never determine whether... [silphium] was an effective form of parenthood prevention.... By the end of the first century AD, following a fifty year decline in silphium numbers, the Roman historian Pliny the Elder recorded the plant's lamentable extinction.... The cause of the herb [silphium's] eradication is uncertain, however the most widely accepted theory is that over-harvesting coupled with livestock grazing caused the silphium population to decline beyond recovery. This trend may have started around 74 BCE when the region was absorbed into a Roman senatorial province. This change gave control of the laserwort crop to a long series of one-year-term governors who were largely motivated by short-term profits...

The consumer surplus from silphium was enormous:

Damn Interesting » The Birth Control of Yesteryear: Approximately 2,600 years ago--around 630 BCE--the Greek island of Thera was plagued by drought and overpopulation. According to legend, an assortment of settlers were selected to sail south to establish a colony in more hospitable climes. The men and women apprehensively put to sea, and the gaggle of enterprising Greeks eventually erected the city of Cyrene on Africa's northern tip. There, the settlers encountered a local herb which would ultimately bring them and their progeny fantastic wealth.

The prized plant became such a key pillar of the Cyrenean economy that its likeness was stamped upon many of the city's gold and silver coins. The images often depicted a regal-looking woman sitting in a chair, with one hand touching the herb and her other hand pointing at her genitals. The plant was known as silphium or laserwort, and its heart-shaped fruit brought the ancient world a highly sought-after freedom: the opportunity to enjoy sex with very little risk of pregnancy.

The silphium plants were giant fennels which grew wild along the dry hillsides of the Mediterranean coast. It didn't take long for the Greek settlers to discover its value as a food source, and the vegetable flesh came to be prized as a delicious garnish, while pleasant perfumes were coaxed from its yellow blossoms. Over time further uses for the wild fennel were found, such as the resin extracted from its stalks and roots which was used to treat cough, sore throat, fever, indigestion, snake bite, "warts in the seat," epilepsy, and a host of other disagreeable ailments. But of all of the plant's virtues, the silphium was certainly most prized for its pregnancy-preventing properties.

As word of the birth-control wonder-herb spread through ancient Europe, Africa, and Asia, a market for the versatile fennel developed rapidly. The seeds became widely used among the world's wealthier nations, including the citizens of ancient Greece, Rome, Egypt, and India. By some accounts the silphium seed was also a potent aphrodisiac, a property which considerably compounded its perceived value. The Roman bard Catullus famously alluded to its sexual properties in one of his love poems, where he declared that he and his lover would share as many kisses as there were grains of sand on Cyrene's silphium shores. More plainly, "We can make love so long as we have silphium."

Despite the efforts of the Cyreneans and their would-be competitors, the silphium industry stubbornly resisted expansion. Men worked long and hard to propagate the plant, but the notoriously cantankerous laserwort mocked all efforts at cultivation. It refused to sprout anywhere outside of its narrow swath of wild growth along the coast of the Mediterranean Sea. Though this limitation necessitated strict guidelines to prevent over-harvesting, the natural scarcity served to maintain the herb's high value. Occasional silphium smugglers penetrated the supply chain, but aside from these rare exceptions the royalty of Cyrene maintained a comfortable monopoly on civilization's contraceptives.

For centuries the north African city thrived on its laserwort bounty. The seeds of the fickle fennel came into such high demand that they were eventually worth their weight in silver. The Roman government went so far as to store a cache of the herb in the official treasury. Most of the primitive silver and gold coins from Cyrene were stamped with images of the silphium, some depicting just a single heart-shaped seed. It is thought by many historians that this ancient icon of unfettered lovemaking is the origin of today's ubiquitous "I love you" heart symbol.

Unlike many other medicines of its time, silphium was not thought of as a mere folk remedy; Scholars and doctors of the day openly praised the plant's effectiveness as a contraceptive. Ancient Rome's foremost gynecologist--a physician named Soranus--wrote that women should drink the silphium juice with water once a month since "it not only prevents conception but also destroys anything existing." Alternatively, a tuft of wool could be soaked in the juice and inserted into the vagina as a pessary. The herb's effectiveness and widespread use is evidenced by the observation that Rome's birth rate decreased during laserwort's heyday, despite increasing life expectancy, plentiful food, and relatively few wars or epidemics....

The extinction of silphium is now considered to be among humanity's earliest environmental blunders. If laserwort was indeed more effective than the alternatives, then the bygone birth control is certainly deserving of its glowing reputation...

I had never known why Cyrene was important enough to warrant a place in the list of "Parthians, and Medes, and Elamites, and the dwellers in Mesopotamia, and in Judaea, and Cappadocia, in Pontus, and Asia, Phrygia, and Pamphylia, in Egypt, and in the parts of Libya about Cyrene, and strangers of Rome." Writing in the fourth century C.E., Ammianus Marcellinus says that Cyrene is a deserted, ruined city.

The Economics of the iPod

Hal Varian writes:

An iPod Has Global Value. Ask the (Many) Countries That Make It: Who makes the Apple iPod?... [A] number of Asian enterprises, among them Asustek, Inventec Appliances and Foxconn... do final assembly.... Greg Linden, Kenneth L. Kraemer and Jason Dedrick... applied some investigative cost accounting to this question....

The retail value of the 30-gigabyte video iPod that the authors examined was $299. The most expensive component in it was the hard drive, which was manufactured by Toshiba and costs about $73. The next most costly components were the display module (about $20), the video/multimedia processor chip ($8) and the controller chip ($5). They estimated that the final assembly, done in China, cost only about $4 a unit....

At each step, inputs like computer chips and a bare circuit board are converted into outputs like an assembled circuit board. The difference between the cost of the inputs and the value of the outputs is the “value added” at that step.... The profit margin on generic parts like nuts and bolts is very low, since these items are produced in intensely competitive industries and can be manufactured anywhere. Hence, they add little to the final value.... [H]ard drives and controller chips have much higher value added....

[T]he $73 Toshiba hard drive in the iPod contains about $54 in parts and labor. So the value that Toshiba added to the hard drive was $19 plus its own direct labor costs. This $19 is attributed to Japan....

The researchers estimated that $163 of the iPod’s $299 retail value in the United States was captured by American companies and workers, breaking it down to $75 for distribution and retail costs, $80 to Apple, and $8 to various domestic component makers. Japan contributed about $26 to the value added (mostly via the Toshiba disk drive), while Korea contributed less than $1.... [U]naccounted-for parts and labor costs involved in making the iPod came to about $110. The authors hope to assign those labor costs to the appropriate countries....

The real value of the iPod doesn’t lie in its parts or even in putting those parts together. The bulk of the iPod’s value is in the conception and design of the iPod. That is why Apple gets $80 for each of these video iPods it sells, which is by far the largest piece of value added in the entire supply chain.

Those clever folks at Apple figured out how to combine 451 mostly generic parts into a valuable product. They may not make the iPod, but they created it. In the end, that’s what really matters.

Does China's Rise Make Things Harder for Other Developing Countries? Yes.

Michael Kremer convinced me the answer was "yes." Now Dani Rodrik weighs in:

Dani Rodrik's weblog: Does China make it harder for other developing countries to make it?: Yes, according to FT's Alan Beattie. He writes in today's FT:

Being a developing country used to be easy. You followed leaders - Japan, Hong Kong, Taiwan, South Korea - up a well-trodden ladder from agriculture through manufacturing to services. Starting with tilling the soil, you moved on to turning out T-shirts, then toys, then tractors, then television sets, and ended up trading Treasuries.

The rise of China has made that less straightforward. Not only is the first rung harder to reach, thanks to the hundreds of millions of rural migrants to Chinese cities still willing to work for low wages stitching garments, but also exports of goods from China's coastal industrial fringe are rapidly becoming more sophisticated, threatening those halfway or more up the ladder. While the shoemakers of Italy and the steelmakers of Pennsylvania may complain loudly about Chinese competition, those with more to worry about are middle-income Asian countries geographically and economically close to the Middle Kingdom. So what is a poor developing nation to do? 

There are two schools on thought on this, as Beattie notes. One thinks that government cannot possibly do much and they better get out of the way, after taking care of the usual list of fundamentals of course:

For countries such as the Philippines, without a big arsenal for public investment, policy recommendations from most business people for competing with China involve no magic elixir. Governments should improve logistics, infrastructure, the business climate and education; try, possibly, to spot specialities emerging and support them, but otherwise get out of the way. They warn against governments crashing into the market having decided what the economy is likely to be good at and then promoting it at all costs.

The other school (which includes me) thinks that by following this route you not only remain in a rut, but you also miss out on the most important lesson from China's success: the need for the government to be strategic (and yes also flexible) in supporting industries. You do need an industrial policy--but... not of the traditional type...

The industrial policy that Dani recommends is one that focuses:

http://ksghome.harvard.edu/~drodrik/UNIDOSep.pdf: not on the policy outcomes-—which are inherently unknowable ex ante—-but on getting the policy process right. We need to worry about how we design a setting in which private and public actors come together to solve problems in the productive sphere, each side learning about the opportunities and constraints faced by the other.... [I]ndustrial policy is as a discovery process—-one where firms and the government learn about underlying costs and opportunities and engage in strategic coordination.... It is the information externalities generated by ignorance in the private sector that creates a useful public role.... Yes, the government needs to maintain its autonomy from private interests. But it can elicit useful information from the private sector only when it is engaged in an ongoing relationship with it-—a situation that has been termed “embedded autonomy” by the sociologist Peter Evans (1995)....

[I]nnovation in the developing world is constrained not on the supply side but on the demand side. That is, it is not the lack of trained scientists and engineers, absence of R&D labs, or inadequate protection of intellectual property that restricts the innovations.... [T]he demand for innovation is low... because entrepreneurs perceive new activities to be of low profitability.... [A] useful analogy to keep in mind is with education and human capital. For quite a while, policy makers thought that the solution to poor human capital lay in improving the infrastructure of schooling.... [I]t became evident that the increase in schooling did not produce the productivity gains that were anticipated (Pritchett 2004). The reason is simple. The real constraint was the low demand for schooling—-that is, the low propensity to acquire learning—-in environments where the absence of economic opportunities depress the return to education...

The problem is that we now more-or-less now how to do light-industrial export-led development. We don't know how to do much of anything else. So "adopt a pro-development industrial policy" isn't much help. For China's rise has made it much harder for Mexicos, South Africas, and Perus to take that road.

Eddie Lazear Has Jumped the Shark

It may be time for Eddie Lazear to leave the President's Council of Economic Advisers and come back to Stanford: an economic adviser who finds himself not advising but being advised by a vice president is doing no good at all:

A Strong Push From Backstage | Cheney | washingtonpost.com: Lazear, who is otherwise known as a fierce advocate for his views, said that he may argue a point with Cheney "for 10 minutes or so" but that in the end he is always convinced. "I can't think of a time when I have thought I was right and the vice president was wrong."

This is not good.

Ronald Reagan on the Budget Deficit!

From Douglas Brinkley, ed. (2007), The Reagan Diaries (New York: Harper Collins: 9780060876005).

Interesting how Reagan never asked his economic advisers: "Well, isn't what you are telling me now inconsistent with what you told me last year?" Easy to bamboozle. And nobody appears to have tried to unbamboozle him:

Tue Sep 8 1981: Back on schedule--9 AM in the office. First of what will be several budget meetings. Hi interest rates are going to force more budget cuts or we won't meet our 82, 83, and 84 targets. I've given the order--we'll cut and we'll meet the goals we set for ourselves. We have to convince the money market that we mean it and that means some cuts in defense. But we have to do that in such a way that the world sees us as keeping our word to restore our defense strength. It can be done.

Thur Sep 10 1981: Dropped in on meeting of Ec. Advisors--a roomful of our country's greatest economists. None of them could explain why interest rates are so high.

Sun Oct 17 1981: Over to the cabinet room for a 10 AM meeting. Another bomb--the latest figures on deficit projections--bad. It seems our success is actually hurting us. Inflation is a tax. We have brought inflation down so much faster than we anticipated that tax revenues will be lower than we figured. We force the prospect of low inflation and lower interest rates--all of which is good--but gigantic deficits and that's bad.

Fri Nov 6 1981: We're going to have to build in more open time around meetings with Congressional leaders. Met 1st with Sen. leaders and meeting went 45 min. over time. Then the House Leadership which of course started late but ended later. The meetings were about the economy. With our plan barely started unforeseen things such as the high interest rates, etc. have increased the estimated deficit and make a balanced budget by '84 look unlikely. On the hill they automatically start thinking of tax increases. We differ and I think with good reason. I believe we reduced the differences between us but the press is going wild with its usual irresponsibility.

Thur Nov 12 1981: It looked like everything was going wrong today. The "Big 3" were waiting with a "what to do about Stockman" question. Before we could get into that--had a meeting with leadership Repub. of the House and Sen. on the budget--Stockman present. He asked for the floor--got up and told them he'd made a stupid mistake, etc and they applauded.

Back in the Oval Off met with staff, George B. and Don Regan. I didn't go along with one or two who wanted to fire Dave--nor did Don R. or George B.

Dave came over he and I had lunch. I had lunch--he couldn't eat. He stood up to it and then tendered his resignation. I got him to tell the whole thing about his supposed friend who betrayed him, then refused to accept his resignation. Told him he should do a "mea culpa" before the press and clear the misconceptiono that had been created by the tory. He was all set to go and did--taking their questions head on.

Tue Dec 8 1981: First a meeting to hear the 1st 1983 budget review. We who were going to balance the budget face the biggest budget deficits ever. And yet percentage wise they'll be smaller in relation to GDP. We have reduced Carter's 17% spending increase to 9%. The recession has added to costs and reduced revenues however so even with that reduction in govts. size we fact a large deficit.

Thur Dec 10 1981: Met with Council of Ec. advisors. While one or two spoke of possible tax increases after 1982 the others (majority) said no. Tax increases don't eliminate deficits they increase govt. spending. The general consensus was that our plan is the proper medicine for the recession and we should stick to it. That's what I intended to do all the time. [I.e., doesn't know that the (outside the administration) Economic Advisory Council isn't the (inside the administration) President's Council of Economic Advisers...]

Mon Dec 14 1981: Met with Paul Volcker. I'm not sure he sees the need to let the increase in money supply go forward in the upper range of their moderate schedule. The recession is because they slammed the door in April and kept it closed until Sept.--almost Oct. Our plan will get the Ec. moving again only if the Fed. allows--not an upward surge--but a moderate growth geared to Ec. growth.

Thur Dec 22 1981: A budget meeting. We've finally come together on the cuts--probably won't get all we ask for from Congress. They're so used to spending (for votes) they're getting edgy with '82 being an election year. The recession has worsened, throwing our earlier figures off. Now my team is pushing for a tax increase to help hold down the deficits. I'm being stubborn. I think our tax cuts will produce more revenue by stimulating the economy. I intend to wait and see more results.

Mon Jan 11 1982: Repub. House leaders came down to the W.H.--Except for Jack Kemp they are h--l bent on new taxes and cutting the defense budget. Looks like heavy year ahead.

Wed Jan 20 1982 The day however was a tough one. A budget meeting and pressure from everyone to give in to increases in excise taxes tied to Federalism program. I finally gave in but my heart wasn't in it.

Tue Apr 20 1982: Met with Repub. Cong. Leadership. The budget was the subject. I think they were relieved to learn that I'm willing to compromise some in return for a bi-partisan program. I called Tip O'Neill--I'm not sure he's ready to give. Tip is truly a New Deal liberal. He honestly believes that we're promoting welfare for the rich.

Fri Nov 19 1982: Back to a Cabinet meeting on the budget. Our deficits are structural as well as recession caused. We have a built in increase in the budget which is automatic--we must deal with it.

Mon Jan 3 1983: A tough budget meeting and how to announce the deficits we'll have--they are horrendous and yet the Dems. in Cong. are saying there is no room for budget cuts. Met with a group of young Repub. Congressmen. Newt Gingrich has a proposal for freezing the budget at the 1983 level. It's a tempting idea except that it would cripple our defense program. And if we make an exception on that every special interest group will be asking for the same.

Tue Jan 4 1983: Brkfst. with GOP leaders (Sen.). Gave them bad news about deficits. They agree the law that says we must project 5 yrs ahead is crazy but we still have to do it. No economist can predict more than 1 yr. ahead (if that) with any degree of accuracy.

Mon Apr 18 1983: A Budget briefing by Dave S. If the Dems. have their way the recovery will be over before it starts. They must give us the spending cuts we want or we face a trillion dollar deficit over the next 5 yrs.

Mon Jun 15 1987: A meeting with bipartisan Cong. leaders--Byrd, Jim Wright, Bob Michel, Bill Armstrong etc. We talked mainly about the budget and the Dems. of course took no blame for the deficit. I sort of corrected them on that with the 50 year history of deficit spending under Dem. control.

The Small Place of Economists in a President's Mind

From Douglas Brinkley, ed. (2007), The Reagan Diaries (New York: Harper Collins: 9780060876005).

It is interesting--but depressing--to recognize that Ronald Reagan did not know the difference between a group of prominent outside economists brought in to the White House compound for a day or so--an economic advisory council--and the economists on his personal staff who worked for him--the Council of Economic Advisers, a group of three who were headed during the Reagan administration by Murray Weidenbaum, Marty Feldstein, Bill Niskanen, and Beryl Sprinkel:

Thur Dec 10 1981: Met with Council of Ec. advisors. While one or two spoke of possible tax increases after 1982 the others (majority) said no. Tax increases don't eliminate deficits they increase govt. spending. The general consensus was that our plan is the proper medicine for the recession and we should stick to it. That's what I intended to do all the time.

Justin Fox on the Washington Post's take on Cheneynomics

Compared to the rest, this is boring--but important:

The Curious Capitalist: Today brings us the economic-policy chapter of the big Washington Post series on how Dick Cheney runs America. It's not nearly as dramatic or sinister.... Economic policy is like that, I guess.

One big takeaway is that economic policy in the Bush administration is run not by the Treasury Secretary... but by the Vice President.... [P]olitical considerations, combined with a very facile supply-side view of how the economy works, that drove Cheney's thinking on the subject.... Cheney leaves behind on the economic front... persistent budget deficits (albeit, I always feel obliged to point out, much smaller deficits relative to GDP than those of the 1980s and early 1990s), an economy that's still growing and dynamic but has clearly seen better days, and a bunch of huge, as-yet unresolved problems, from the U.S. trade relationship with China to the future funding of Social Security and especially Medicare. Apparently Cheney was against the expensive new Medicare drug benefit, but he was accommodating enough to let the President have his way on that.

Oh, and one other interesting moment in the article. Ed Lazear apparently needed Cheney to tell him that the mortgage-interest tax deduction is popular:

When Edward P. Lazear, chairman of the White House Council of Economic Advisers, broached the idea of limiting the popular mortgage tax deduction, he said he quickly dropped it after Cheney told him it would never fly with Congress. "He's a big timesaver for us in that he takes off the table a lot of things he knows aren't going to go anywhere," Lazear said...

This is really too bad. One role of the CEA is to keep chipping away at issues that are not politically possible now, but may become so in ten years. Curbing the mortgage interest deduction is one of these.

The Social Impact of Microsoft Once Again

Here's a comment http://delong.typepad.com/pdf/20070626-thoma-barro-microsoft.pdf on Robert Barro's claim that the social value contributed by Bill Gates is roughly equal to Microsoft's total revenue:

Bill Gates's Charitable Vistas - WSJ.com: In 2006, [Microsoft's] revenue was $44 billion, with earnings of $13 billion. This money was generated by creating something consumers value. Only Microsoft's competitors could believe that this much market value, revenue and earnings would have been created by delivering products that have little value to society. Suppose that a copy of a new version of Windows sells for $50 (and is typically charged as part of the price of a personal computer). Microsoft's revenue from Windows would then equal $50 multiplied by the number of copies consumers snap up. Microsoft's earnings are the revenue less production and development expenses. But that's not the social value. That comes from the increase in productivity created when businesses and households use the software. The social benefit equals the value of the extra product, less the total paid for the software. Almost by definition, the benefit has to be positive. Otherwise, why would consumers willingly pay for Windows? A conservative estimate, in a model where software serves as a new variety of productive input, is that the social benefit of Microsoft's software is at least the $44 billion Microsoft pulls in each year.... Mr. Gates is free to do what he wishes with his $90 billion. But I think he is kidding himself if he believes that the efforts of the Gates Foundation are likely to provide society anything like the past and future accomplishments of Microsoft. And, frankly, I would have preferred to get the $300 per person "Gates Grants."

Barro's defense of this claim is at http://economistsview.typepad.com/economistsview/2007/06/robert-barro-sk.html#comment-73987582.

I don't buy it. Barro's model doesn't address the major issues that have to be dealt with in assessing the social utility of Microsoft:

http://delong.typepad.com/sdj/2007/06/mark_thoma_is_i.html: Whether the net social value of Bill Gates is positive or negative depends on his impact in creating and shaping Microsoft: relative to its competitors and to its alternative paths of development, did he make it more of a lockin-breaking innovator or a death zone-creating predator? Did he do more to make Microsoft a company that takes advantage of economies of scale or more to make Microsoft a company that raises profit margins? I'm on the side that thinks that Microsoft has been a considerable net plus. But others I respect see it is a net minus...

And I don't think Barro uses his own model correctly. He gets to the conclusions that the ratio of the social value of Microsoft to its total revenue is (a) roughly one, (b) does not depend on how substitutable Microsoft's products are with those of other intellectual-property holders, and (c) depends primarily on the share of "idea factors" relative to "standard factors" in the economy's production function. These seem to be wrong: artifacts of an extra term Barro adds to the production function in order to get a balanced-growth path out of the model.

Proper use of Barro's model leads, I think, to the conclusions that:

• The ratio of the social value of Microsoft to its revenue could be very big--much more than one--or very small--much less than one--and there is certainly no reason to think that it is about one.
• The ratio will be large to the extent that Microsoft's goods are radically different from those of others, and small to the extent that Microsoft's goods have close substitutes made by others.
• As long as Microsoft's goods are not radically different from those of its competitors, the share of "ideas" in the economy's overall production function has relatively little to do with this ratio.

But, as I said, the big issues with Microsoft have to do with its effect on the pace of innovation. Was it a lockin-breaking innovator that provided a platform--shoulders on which others can stand? Or was it a death zone-creating predator that discouraged innovation and experimentation in broad market segments? My reading is that it was more of the first. But I am happy to be educated.

Ezra Klein: Every Man A Doctor, Purchaser, and HMO

Oh, this is funny--in a sick sort of way:

Ezra Klein: Every Man A Doctor, Purchaser, and HMO: It's pretty funny to watch Michael Cannon explain how, if you didn't hurt yourself too badly, and you happen to be a professional health care expert deeply steeped in theories of consumer cost control, you can use an HSA to bring down costs on your torn ACL. So we get lines like "I heard a tear, not a crack — which suggested soft tissue damage, but no broken bones. The only reason I used that information to rule out an X–ray was because I had a financial incentive to avoid unnecessary spending." That's all for the good, when it's all for the good. On the other hand, that's just a hop, skip, and a jump away from "She had shortness of breath, but no radiating arm pain, so she decided to wait through the weekend because she couldn't afford the ambulance ride. She died."

That's not my collectivist impulses spinning some implausibly hellish scenario, by the way. A recent study looked into what happens if you increase cost sharing on pharmaceuticals in Medicare. In other words, what happens when the patients have what Cannon calls a "financial incentive to avoid unnecessary spending." The answer? "[S]ubjects whose benefits were capped had higher rates of nonelective hospitalizations, visits to the emergency department, and death. In addition, subjects whose benefits were capped had lower pharmacy costs but higher hospital and emergency department costs, with no significant difference in total medical costs between the two groups."

They did try and bargain down care, and even skip some pharmaceuticals. But their choices led to neither better outcomes nor lower spending. Instead, they died more often, and we paid for their ambulance rides more frequently. Everyone's a loser!

What is the true social marginal cost of an x-ray, given that Michael Cannon is already using the doctor's time for a diagnosis? $50? Is there a chance an x-ray might pick up something bad that an MRI wouldn't? Does Michael Cannon really want to gamble on his ability to distinguish a "tear" from a "crack" in the middle of a soccer game? Apparently he does.

Poor John Updike. Poor New Yorker. The Great Depression Once Again

Oh, this is sad. Really sad. Depressing. And pathetic. It is really too bad that the New Yorker gave Amity Shlaes's book about the Depression, The Forgotten Man to John Updike to review. A competent editor would have chosen a reviewer who knew economics and history. But Updike is lost from the start:

Laissez-faire Is More: [Shlaes tells us that the 1929] crash preceded an underlying problem, deflation, caused by not enough money in circulation as banks failed and shut their doors; a number of dollar-starved communities—Salt Lake City; Ventura, California; Yellow Springs, Ohio—issued their own scrip, while Presidents Hoover and then Roosevelt supported policies, like the gold standard, aimed at a nonexistent inflation...

We need to stop right there. Roosevelt abandoned the gold standard. That Updike thinks that Roosevelt spent the 1930s clinging to the gold standard to control "a nonexistent inflation" is the first sign that he has lost the game of intellectual three-card monte Amity Shlaes is playing with her readers. If Milton Friedman were here, he would blow the whistle at that point.

Updike goes on:

[T]he gravest problem, as Shlaes sees it, was government “intervention, the lack of faith in the marketplace.” Both Presidents tried to lift wages, when letting them sink would have liberated businesses to start hiring and resume business as usual. Business knows best...

Once again, Milton Friedman would blow the whistle if he were here. The main thing reducing the stock of money was bank failures. The main thing causing bank failures was falling prices of all kinds--of real estate, of consumer goods, and of labor. More of what Milton Friedman's teacher Jacob Viner called "unbalanced deflation" would have produced an even deeper depression.

If only Updike knew this. If only Updike knew that nearly all economists--from Milton Friedman to Ben Bernanke to John Maynard Keynes to John Kenneth Galbraith on left--believed that further and faster deflation would have made the Great Depression worse! Here's John Maynard Keynes's argument: "Changes in Money Wages" http://www.marxists.org/reference/subject/economics/keynes/general-theory/ch19.htm. It was written in 1936, and still reads very well today. But nobody told Updike.

Hoove... was a dynamo... he favored government intervention, as long as it didn’t violate his sense of the Constitution, and sought control over economic events that would, according to Shlaes, have gone better if left alone.... Shlaes pursues her thesis through the thirties, few heroes emerge, and the most highly placed two are not apt to figure in many liberal pantheons: Calvin Coolidge and Andrew Mellon. Coolidge... is presented as a kind of Zen saint, a pillar of inaction.... [Shlaes] underlines Mellon’s honorableness, private generosity, and public spirit...

But she doesn't tell Updike that at the bottom of Mellon's personality was a pronounced social-darwinist streak, a belief that you had to be cruel to be kind. And Updike, of course, doesn't know. So he cannot quote Herbert Hoover's retrospective judgment of Mellon, that the policies Mellon had convinced him to follow made the Great Depression much worse:

[T]he “leave it alone liquidationists” headed by [my] Secretary of the Treasury Mellon... felt that government must keep its hands off and let the slump liquidate itself. Mr. Mellon had only one formula: “Liquidate labor, liquidate stocks, liquidate the farmers, liquidate real estate.” He insisted that, when the people get an inflation brainstorm, the only way to get it out of their blood is to let it collapse. He held that even a panic was not altogether a bad thing. He said: “It will purge the rottenness out of the system. High costs of living and high living will come down. People will work harder, live a more moral life. Values will be adjusted, and enterprising people will pick up the wrecks from less competent people”...

Updike forges on, lost in the swamp, so lost that he is unable to protest Shlaes's libel that that Roosevelt was practically a fascist and her argument--argument--a very serious argument that has never been made in such detail or such care--that Roosevelt wanted to make the government boss people around because he couldn't use his legs:

Shlaes, in a bold stroke of psychologizing, lays the hyperactivity to “the restlessness of the invalid.” She goes on, “Like an invalid, the country took pleasure in the very thought of motion.” More ominous was Roosevelt’s totalitarian tendency: “His remedies were on a greater scale and often inspired by socialist or fascist models abroad.”

Updike watches Shlaes make the claim that that communist Roosevelt hired other commies as New Dealers:

One of Shlaes’s chapter-length detours deals with a junket... to investigate and report on conditions in the Soviet Union.... [T]he economic commentator Stuart Chase.... Stuart Chase upon his return wrote, “Laissez-faire rides well on covered wagons, not so well on conveyor belts and cement roads.” Collectivism was the inevitable direction. After all, Chase wrote, “why should Russians have all the fun remaking a world?” The poisoned chalice was passed around...

But then she doesn't:

But “few New Dealers were spies or even communists,” she reassures the reader....

At the end of his review, Updike tries to fight back:

[T]he Depression slogged on, ending only in 1940, as the government decisively hiked defense spending.... My father had been reared a Republican, but he switched parties to vote for Roosevelt.... The impression of recovery-—the impression that a President was bending the old rules and, drawing upon his own courage and flamboyance in adversity and illness, stirring things up on behalf of the down-and-out—mattered more than any miscalculations in the moot mathematics of economics. Business, of which Shlaes is so solicitous, is basically merciless.... Government is ultimately a human transaction, and Roosevelt put a cheerful, defiant, caring face on government at a time when faith in democracy was ebbing throughout the Western world. For this inspirational feat he is the twentieth century’s greatest President, to rank with Lincoln and Washington as symbolic figures for a nation to live by.

A better New Yorker editor would have chosen a reviewer who at least knew what an aggregate demand curve was. Here's my take:

http://delong.typepad.com/sdj/2007/02/arnold_kling_vs.html: I, at least, think that as far as recovery was concerned the macroeconomic good done by the New Deal vastly outweighed the structural bad. Any reasonable counterfactual involving no New Deal that I can see has things a good deal worse in the middle and late 1930s than they were in our reality.

But there is an argument to be made that an even better New Deal would have been possible, and ought to have been attainable.

Had Milton Friedman been special assistant to and whispering in the ear of Fed Chair Marriner Eccles in 1936-1938, he would have successfully headed off Eccles's boneheaded idea of raising reserve requirements on banks. Then the late 1930s would have been a much happier time. Had FDR given his baton in 1933 to trustbuster Thurman Arnold rather than to cartelizer Hugh Johnson and had the initial round of the New Deal increased rather than decreased the degree of competition in the American economy, then... well, the neoclassical part of my brain thinks that 1934 and 1935 would have been somewhat happier--but the Fundie Keynesian part of my brain thinks that Hugh Johnson's NRA was irrelevant because aggregate demand was a much bigger problem then than aggregate supply....

The New Deal essentially dusted off and implemented the unsuccessful Progressive Era program for the reform of American finance that had been pushed by the likes of Louis Brandeis during the 1900s and the 1910s. And Louis Brandeis was definitely on the side of the upwardly-mobile and the smart and technically competent, as opposed to the side of old wealth and new thrift.... Financial markets function well for the economy only when they do a good job of seeking out and transmitting information.... This requires that people be incentivized to seek out and uncover important pieces of information by being able to profit handsomely from doing so--which requires that there be a bright visible line between what you can do and what you can't, between legitimate research and illegitimate insider trading. The SEC as born in the New Deal has always found it relatively difficult to draw such a bright visible line....

[On the other hand] financial markets also function well only when they mobilize great masses of savings from scattered individuals by giving them confidence that their investments are liquid in that they can be bought and sold at a fair price.... Smart financial regulation attains a point of balance. There is... a general worry that the system the New Deal has left us pays too much attention to the desirability of a level playing field for buyers and sellers, and not enough to the desirability of having truly informed buyers and sellers....

[L]et's not lose sight of the fact that even badly-handled as it was, really-existing deposit insurance [implemented during the New Deal] was a mammoth improvement over no deposit insurance at all. I think that that is a good thumbnail summary of the entire New Deal: badly-handled, but a vast improvement over the preceding system and over the politically-viable alternatives--with the exception, I would argue, of Agriculture Support and the NRA, which did little if any good at immense long-run cost...

Links: I like J. Bradford DeLong's Journal of Economic Perspectives article http://econ161.berkeley.edu/pdf_files/Keynesianism_Pennsylvania.pdf and his still unpublished attempt to get at the guts of the economic advice Joseph Schumpeter and others were giving in 1933 http://econ161.berkeley.edu/pdf_files/Liquidation_Cycles.pdf--what John Maynard Keynes called "extraordinary imbecility." An online for-pay version of Joseph Schumpeter et al. (1934), The Economics of the Recovery Program is at< http://www.questia.com/library/book/the-economics-of-the-recovery-program-by-douglass-v-brown-edward-chamberlin-seymour-e-harris.jsp>. Schumpeter and company were fiercely critical of the New Deal. A contemporary review of their book by Princeton's Otto Nathan is here http://links.jstor.org/sici?sici=0022-3808%28193408%2942%3A4%3C537%3ATEOTRP%3E2.0.CO%3B2-D.

Wikipedia has good background entries on Huey Long http://en.wikipedia.org/wiki/Huey_Long, the Bonus March http://en.wikipedia.org/wiki/Bonus_march, and Father Coughlin http://en.wikipedia.org/wiki/Charles_Coughlin.

For Eichengreen and Sachs on abandonment of the gold standard--which Roosevelt did in 1933--as the key to even partial recovery from the Great Depression: "Exchange Rates and Economic Recovery in the 1930s" http://scholar.google.com/scholar?num=100&hl=en&lr=&safe=off&c2coff=1&client=safari&q=Eichengreen+and+Sachs&btnG=Search

Ben Bernanke's analysis of the role played by unstemmed financial panics, industrial bankruptcies, and bank closings is Ben Bernanke (1983), "Nonmonetary Effects of the Financial Crisis in the Propagation of the Great Depression," American Economic Review, 73, (June) pp. 257-76 at google scholar >http://scholar.google.com/scholar?num=100&hl=en&lr=&safe=off&c2coff=1&client=safari&q=Nonmonetary+Effects+of+the+Financial+Crisis+in+the+Propagation+of+the+Great+Depression&btnG=Search>. Ben has a nice speech about money, gold, and the Great Depression http://www.federalreserve.gov/boarddocs/speeches/2004/200403022/default.htm.

Milton Friedman and Anna Schwartz's account of the role played in the Great Depression by gold-standard and other policies that contributed to the sharp decline in the money supply is in the "Great Contraction" chapter of their Monetary History of the United States http://scholar.google.com/scholar?num=100&hl=en&lr=&safe=off&c2coff=1&client=safari&q=Monetary+History+of+the+United+States&btnG=Search.

Poverty Traps: The High Price of Investment Goods in Poor Countries

Tyler Cowen notes the "relative prices and relative prosperities" literature. It is an updating of Prebisch-Singer: that poor countries have really lousy terms of trade that grow worse over time, and this greatly hinders their development by making it extremely expensive for them to import the high-quality technology-carrying capital goods that they need.

See Caselli and Feyrer (2007), Klenow and Hsieh (2006), DeLong (1997), Jones (1994), DeLong and Summers (1991), and problems 4, 5, and 6 from Problem Set 3 of the DeLong-Rosenberg fall 2006 version of Economics 101b.

Tyler quotes from Caselli and Feyrer:

Marginal Revolution: The marginal product of capital, and policy irrelevance: The May 2007 Quarterly Journal of Economics offers up a fun piece on the marginal product of capital, earlier version here.  The bottom line is startling, though it requires only a simple model:

Francesco Caselli and James Feyrer (2007), "The Marginal Product of Capital" http://www.aeaweb.org/annual_mtg_papers/2006/0106_1430_0703.pdf: Whether or not the marginal product of capital (MPK) differs across countries is a question that keeps coming up in discussions of comparative economic development and patterns of capital flows.  Attempts to provide an empirical answer to this question have so far been mostly indirect and based on heroic assumptions.  The first contribution of this paper is to present new estimates of the cross-country dispersion of marginal products.  We find that the MPK is much higher on average in poor countries.  However, the financial rate of return from investing in physical capital is not much higher in poor countries, so heterogeneity in MPKs is not principally due to financial market frictions.  Instead, the main culprit is the relatively high cost of investment goods in developing countries.  One implication of our findings is that increased aid flows to developing countries will not significantly increase these countries’ incomes.

Tyler concludes

The rough equality of financial rates of return means that [financial] capital [does] flow to where it is most productive.  That means if a country receives some aid, and converts that aid into useful capital goods, less capital flows into your country.  A version of neutrality holds.  Of course there is no reason to focus on aid in this argument.  Most one-off improvements (or destructions) wash out in the longer run, due to subsequent adjustments in the capital stock.  The one-off improvements matter only if liquidity and credit imperfections hinder the international mobility of capital; such imperfections would mean that transfers could bring about a permanently higher level of capital...

This claim that policies to boost capital investment in poor countrise will not help (much) is, of course, true only if the rich who save and invest have time preferences corresponding to those of society as a whole, and only if the private profits earned by investors are in line with the social benefits produced by investment.

Here is how Larry Summers and I formulated it back in the early 1990s, and I believe that we were correct:

Begin with the large divergence between purchasing power parity and current exchange rate measures of relative GDP per capita levels. The spread between the highest and lowest GDP per capita levels today, using current exchange rate-based measures, is a factor of 400; the spread between the highest and lowest GDP per capita levels today using purchasing power parity-based measures is a factor of 50. If the purchasing power parity-based measures are correct, real exchange rates vary by a factor of eight between relatively rich and relatively poor economies. And the log GDP per capita level accounts for 80 percent of the cross-country variation in this measure of the real exchange rate, with each one percent rise in GDP per capita associated with an 0.34 percent rise in the real exchange rate.

Why? Because real exchange rates are such as to make the prices of traded manufactured goods roughly the same in the different nation-states of the world, putting to one side over- or undervaluations produced by macroeconomic conditions, tariffs and other trade barriers, and desired international investment flows. Thus the eight-fold difference in real exchange rates between relatively rich and relatively poor economies is a reflection of an approximately eight-fold difference in the price of easily-traded manufactured goods: relative to the average basket of goods and prices on which the "international dollar" measure is based, the real price of traded manufactures in relatively rich countries is only one-eighth the real price in relatively poor countries.

This should come as no surprise. The world's most industrialized and prosperous economies are the most industrialized and prosperous because they have attained very high levels of manufacturing productivity: their productivity advantage in unskilled service industries is much lower than in capital- and technology-intensive manufactured goods.

And a low relative price of technologically-sophisticated manufactured goods has important consequences for nation-states' relative investment rates. In the United States today machinery and equipment account for half of all investment spending; in developing economies--where machinery and equipment, especially imported machinery and equipment is much more expensive--it typically accounts for a much greater share of total investment spending (see Jones, 1994; DeLong and Summers, 1991).

Consider the implications of a higher relative price of capital goods for a developing economy attempting to invest in a balanced mix of machinery and structures. There is no consistent trend in the relative price of structures across economies: rich economies can use bulldozers to dig foundations, but poor economies can use large numbers of low-paid unskilled workers to dig foundations. But the higher relative price of machinery capital in developing countries makes it more and more expensive to maintain a balanced mix: the poorer a country, the lower is the real investment share of GDP that corresponds to any given fixed nominal savings share of GDP.

The gap between nominal savings and real investment shares of GDP that follows from the high relative price of machinery and equipment in poor countries that wish to maintain a balanced mix of investment in structures and equipment is immense. For a country at the level of the world's poorest today--with a real exchange rate-based GDP per capita level of some $95 a year--saving 20% of national product produces a real investment share (measured using the "international dollar" measure) of only some 5% of national product.

In actual fact poor economies do not maintain balanced mixes of structures and equipment capital: they cannot afford to do so, and so economize substantially on machinery and equipment. Thus here are three additional channels by which relative poverty is a cause slow growth:

First, the fact that investment in general--taking equipment and structures together--is expensive relative to consumption goods and services in poor countries provides them with an incentive to diminish their nominal savings effort: to reduce the share of nominal incomes saved.

Second, the fact that relative poverty is the source of a high real price of capital means that poor countries will have a low rate of real investment corresponding to any given nominal savings effort, and thus a low steady-state aggregate capital-output ratio corresponding to any given nominal savings effort.

Third, to the extent that machinery and equipment are investments with social products that significantly exceed the profits earned by investors (see DeLong and Summers, 1991), the price structures in relatively poor developing economies lead them to economize on exactly the wrong kinds of capital investment...

---

References:

"The Singer-Prebisch Thesis," Wikipedia http://en.wikipedia.org/wiki/Singer-Prebisch_thesis (accessed June 25, 2007).

J. Bradford DeLong (1997), "Cross-Country Variations in National Economic Growth Rates: The Role of 'Technology'", in Jeffrey Fuhrer and Jane Sneddon Little, eds., Technology and Growth (Boston: Federal Reserve Bank of Boston) http://www.j-bradford-delong.net/Econ_Articles/Growth_and_Technology/Role_of_Technology_.pdf (accessed June 25, 2007).

J. Bradford DeLong and Lawrence H. Summers (1991), "Equipment Investment and Economic Growth," Quarterly Journal of Economics 106: 2 (May), pp. 445-502 http://www.j-bradford-delong.net/movable_type/archives/000606.html (accessed June 25, 2007).

J. Bradford DeLong and Joseph Rosenberg (2006), "Problem Set 3: Economic Growth: Further Explorations," U.C. Berkeley Economics 101b, Fall 2006 Version http://delong.typepad.com/print/20060911_101b_f06_ps3.pdf (accessed June 25, 2007).

Francesco Caselli and James Feyrer (2007), "The Marginal Product of Capital" http://www.aeaweb.org/annual_mtg_papers/2006/0106_1430_0703.pdf (accessed June 25, 2007).

Chang-Tai Hsieh and Pete Klenow (2006), "Relative Prices and Relative Prosperity" http://www.klenow.com/RPandRP.pdf (accessed June 25, 2007).

Charles Jones (1994), "Economic Growth and the Relative Price of Capital," Journal of Monetary Economics 34, pp. 359-82 http://elsa.berkeley.edu/~chad/JonesJME1994.pdf (accessed June 25, 2007).

Richard Thaler: Slippery Slope Arguments Should Be Avoided Unless There Is Proof that the Slope Is Greased

Via Pinky and the Brain: Richard Thaler:

Pinky and the Brain: Richard Thaler: Libertarian Paternalism: Let's recapitulate. People make mistakes, so sometimes they can be helped. It is possible to help without coercion. That is libertarian paternalism. The concept can be and is used in both the public and private sectors. For example, in London, pedestrians from abroad are reminded by signs on the pavement to "look right" because their instincts from back home are to expect traffic to approach from the left. No one is forced to look right, but fewer pedestrians are hit by trucks.

Another example comes from Sweden, which launched a partial privatization of their social security system in 2000. The plan was open to any fund, which meant that participants faced 456 options. There was also a very well-designed default fund -- using private managers selected by the government -- that offered global diversification at very low fees (16 basis points). By any standard, both ex ante and ex post, the participants who selected their own portfolio of funds did worse than those who took the default plan. The main mistake the government made in designing this plan was to discourage participants from choosing the default fund, perhaps thinking, as Mario does, that choosing for oneself is always the best approach.

Mario thinks we are naïve about government. We think he is naïve about firms. Does he think that the companies that offered stock options to student loan officers to induce them to feature their loans had the "actual preferences" of the students at heart? Maximizing profits does not always mean maximizing the welfare of the customers.

Finally Mario seems to have a phobia about slippery slopes. I guess he thinks that if governments start with signs that say "look right," the next thing you know we will have Prohibition coming back. By the same logic, we should worry that if libertarians succeed in eliminating rent control that we will be soon down the slippery slope toward anarchy. Slippery slope arguments should be avoided unless there is proof that the slope is greased. In our case, by insisting, as we do, on only libertarian paternalism, the slope runs into a brick wall before it even gets started. And besides, what is the alternative? Inept neglect?

John Succo on Pricing CDO Mortgages

John Succo:

Minyanville : Actual prices where traders can really buy and sell is substantially lower than where investors are marking their positions. I asked a large broker firm to send over its smartest math person on Collateralized Debt Obligations (CDO) structuring.  I wanted to know what I am missing: why is the market so sanguine in the face of deteriorating collateral values in the mortgage market?  One of my firm's theses has been that, as the mortgage market deteriorates, investors holding CDO as an investment would realize losses and this would feed into other risky asset classes.  Why aren’t losses being seen when the market is clearly deteriorating?

The team that came over was headed by a very smart gentleman. He was very good at math and very straightforward. Working for a broker I was prepared for some sugar coating. I didn’t get any. The answer is simple and scary: conflict of interest. He explained that due to the many layers of today's complicated credit products, the assumptions used to dictate the pricing and outcome of CDO are extremely subjective. The process is so subjective in fact that in order to make the market work an “impartial” pricing mechanism must exist that the entire market relies upon.

Enter the credit agencies. They use their models, which are not sensitive to current or expected economic activity, but are based almost entirely on past and current default rates and cash flow to price the risk. This of course raises two issues.

First, it is questionable whether "recent" experienced losses over the last few years really represent the worst of the credit market (conservative). But even more importantly, it raises a huge conflict of interest: the credit agency's customers are the very issuers of the tranches they rate. The credit agencies, therefore, need to compete for business based at least in part on the ratings they are willing to give these tranches. As a result, they will only downgrade when forced to by experienced losses; not rising default rates, not a worsening economy, but only actual, experienced losses. Even more disturbing, they will be most reluctant to downgrade the riskiest tranches (the equity tranches) since those continue to be owned by the issuers even after the deal is sold. So even though the mortgage market has deteriorated substantially, mark-to-market losses by those holding the CDO paper have generally not been realized simply because the rating agencies have not changed their ratings for all the above reasons.

Accounting rules only require holders of the paper to mark prices according to the accepted model, not actual prices. For example, below is a chart of the actual BBB minus tranch of the mortgage-backed securities pool from November '06 to present. Actual prices where traders can really buy and sell is substantially lower than where investors are marking their positions.

The levels at which investors are carrying the paper is not reflecting underlying reality as the holders simply hold their collective breath and the rating agencies ignore a worsening environment.

I asked them what would force the rating agencies to change their ratings and the response was “it's just a matter of time if the market continues to deteriorate, for the agencies at some point will be forced by the cumulative losses to acquiesce." Because these losses have been compressed, any re-adjusting of ratings by these agencies are likely to result in a massive repricing of risk.

Michael Clemens on the Real Immigrant Underclass: "The People Who Wanted To Come, But Could Not"

Michael Clemens of the Center for Global Development, with a good rant, including bonus New Republic bashing:

Global Development: Views from the Center: The Real Immigrant Underclass: The People Who Wanted To Come, But Could Not: The New Republic's lead editorial (free registration required) blasts the now-moribund Immigration Reform Act for including a provision to admit hundreds of thousands of temporary workers each year. It bitterly condemns America's "unsavory tradition" of "importing non-Europeans to do the difficult tasks that our own citizens shun" as part of a "shadowy underclass". To the editors, this is "the tradition of the African slave ship, the Chinese coolie, and the Mexican bracero" and is "one of the worst ... instincts in American democracy".

I take a breath and count to ten. First, and emphatically, we must set the brutal, coercive slave trade completely and irrevocably apart from Chinese and Mexican immigration, which has been almost universally voluntary. Forcing Africans to come to this country and work for nothing was indeed far beyond unsavory and it did reflect, in its time, the worst instincts of this country. A colossal difference lies between this and the braceros' decision to come here and work for pay. Slaves were indeed "imported" as subhuman commodities. Mexicans and Chinese chose to come. And allowing people to voluntarily pursue their dreams is not something for which we should hang our heads in shame.

Now: What is the alternative to admitting Chinese and Mexicans to do "difficult" work here in a "shadowy" underclass? The alternative was not mass admission of unskilled labor with full citizenship, which would have been politically impossible and continues to be. For most of them, the alternative was not to come at all, and the temporary worker provision of the Immigration Act embodies a sophisticated understanding of this fact. If the US had not admitted Chinese and Mexicans in the past, those people would have remained where they were: doing far more difficult work in a sub-sub-underclass in the places they came from --- not just shadowy, but completely invisible to Americans. How do we know it was that bad where they were before? Because despite the enormous hardships of coming here, both groups kept on choosing to come, for many decades. Immigrants, bluntly, are not stupid; they know what makes them better off, and they act on it.

The failure of the Immigration Reform Act means no temporary worker program, so fewer people will have that chance for a better life. The way the editors of the New Republic excoriate that provision of the bill, you'd think the bill's collapse is a victory in the fight against poverty.

Those editors would appear to prefer that the non-Europeans who have been afforded tremendous opportunities to improve their lives here had stayed home and kept their desperation out of sight, out of mind -- as the bill's failure ensures many more will. If the New Republic didn't prefer this, it might point out that admitting Chinese and Mexican laborers is precisely the act of setting them free from the very, very "shadowy underclass" in which they lived prior to coming here, when most did much more "difficult" work for a lesser reward. It might note that giving those enterprising people a chance is one of the best "instincts in American democracy", one that is not emulated by other rich democracies like Japan.

It might also point out that it was the precisely the halting of Chinese immigration, via the unapologetically racist Chinese Exclusion Act of 1882, that indeed reflects our "worst instincts". Was that law any less repugnant because building railroads is "difficult" work?

This doesn't mean that there are no problems with immigration and assimilation here; those need to be solved. But let us not patronize the migrants. "Saving" them from the conditions they face here, if that means sending them home or not admitting them, means "saving" them from something they have told us loudly that they prefer --- by voting with their feet. Full and immediate citizenship for hundreds of thousands of unskilled Mexican laborers a year is politically infeasible, and the temporary worker program was a great shot at an outcome that still would have made a lot of people better off. Now we face the alternative, which is that those people will never have the chance to come, or will try to come through very dangerous and harmful illegal channels. The New Republic might like the sound of that, but I don't.

Whatever you think of how America has handled the people it did let in, the fact is that it did let them in, and many other countries simply have not and do not allow as many people to better their lives in this fashion as we do. That is a distinction of which we can be proud. It is light years away from the slave trade. The death of the Immigration Bill and its temporary worker program means more people will be "saved" from the chance to pursue their dreams and see their hard work better rewarded. Now there's something to be ashamed of.

Jim Hamilton and Mark Zandi on Interest Rates

In the Wall Street Journal:

Econbrowser: Econoblog on interest rates: I was pleased to participate in the latest Wall Street Journal Econoblog with Mark Zandi, Chief Economist and co-founder of Moody's Economy.com. Here's a brief preview of what you can find over at the WSJ. Our topic was the following question:

Treasury-bond yields, a benchmark for market interest rates, scared investors earlier this month with a sharp rise, and pull back. What was behind the uptick? And what does it mean?

And here is part of what we said.

Hamilton: Long-term bond yields are generally procyclical, falling with the decreased spending and borrowing that accompanies an economic slowdown. Indeed, a lot of us look at the spread between long-term and short-term yields as a predictor of what is going to happen to economic growth. When the 10-year yield fell below the overnight fed funds rate from 2006:Q2 to 2007:Q1, that was followed by slower than average real GDP growth. But if investors are now expecting stronger growth, that could explain why nominal rates, TIPS yields, the dollar, and stocks have all risen together...

Zandi: Behind the higher rates is slowly evaporating global liquidity. This is most evident in tighter monetary policies across much of the globe. Central banks ranging from the European Central Bank to the Chinese Central Bank are in the midst of a series of tightening moves. Indeed, the Federal Reserve is the only major central bank not expected to tighten policy again before the year is over....

Given that 80% of mortgage loans are fixed rate loans, this will be another significant hurdle for the housing market to overcome. The spring selling season was already a bust prior to the run-up in long-term rates. Home sales are being hit hard by the tightening in lending standards in response to the stunning erosion in mortgage credit quality. It will be very difficult to make any progress in reducing the bulging inventories of new and existing homes without further substantial cuts in housing construction and house prices.

Hamilton: Unfortunately, Mark is exactly right about housing. I had been among those who incorrectly predicted that lower mortgage rates would arrest the housing downturn last fall. I think we did see some evidence of a rebound, but then the sector was hit badly by the tightening lending standards Mark mentioned. Now with mortgage rates back up and, as Mark also noted, the inventory of unsold homes, it's hard to find any reason for optimism in this sector. But the housing bust has been subtracting 1% from annual GDP growth for a year now. What we've clearly seen is that, unless some other part of the economy follows it down, a recession in housing need not mean falling overall GDP.

There's much more over at the WSJ...

The Evolution of Household Income Volatility

Karen Dynan, Doug Elmendorf, and Dan Sichel report on changes in household income volatility. They find increases, but somewhat smaller increases than Moffitt and Gottschalk (and Gosselin) and much smaller increases than Hacker:

The Evolution of Household Income Volatility: Karen E. Dynan, Chief of Household and Real Estate Finance Section, Division of Research and Statistics, Federal Reserve Board; Douglas W. Elmendorf, Senior Fellow, Economic Studies; Daniel E. Sichel, Assistant Director, Division of Research and Statistics, Federal Reserve Board: Using data from the PSID, we find that household income has become noticeably more volatile during the past thirty years. We estimate that the standard deviation of percent changes in household income rose one-fourth between the early 1970s and early 2000s. This widening in the distribution of percent changes is concentrated in the tails of the distribution, and especially in the lower tail: Changes between the 25th and 75th percentiles are almost the same size now as thirty years ago, but changes at the 10th percentile look substantially more negative. The boost in volatility occurred throughout the 1970s, 1980s, and 1990s, albeit not at a steady pace. Households' labor earnings and transfer payments have both become more volatile over time.

"Orthodox" and "Heterodox" Economics Once Again

I'm going to duck and let Barkley Rosser duke it out with Thomas Palley.

Barkley says that leading American Keynesian or neo-Keynesian or new Keynesian Ben Bernanke--former co-editor of the flagship American Economic Review, former chair of the Princeton Economics Department, former chair of the President's Council of Economic Advisers, current chair of the Board of Governors of the Federal Reserve and of the Federal Open Market Committee, one of America's leading economists in institutional, research, and policy arenas--has "heterodox ideas." He is, according to Barkley, a "non-orthodox mainstream" economist who has spent his career "reviving a non-orthodox idea, financi