Z **Inactive** Worthwhile Economics Read by Brad DeLong

Samuel Brittan: The wrong kind of Third Way

FT.com / Columnists / Samuel Brittan - The wrong kind of Third Way: When a book entitled Supercapitalism: the Battle for Democracy in an Age of Big Business (Icon Books) landed on my desk I took it for just another of the many anti-capitalist diatribes so beloved by publishers. Its author was Robert Reich, a former US secretary of labour who parted company from the Clinton administration on the grounds that it was not interventionist enough. But I was glad I persevered. For it turned out to be one of the most interesting books on political economy to appear for a long time.

During the postwar decades up to the early 1970s, the Bretton Woods system of semi-fixed exchange rates worked, after a fashion; and countries seemed able to combine full employment with low inflation and historically rapid growth and diminishing income differences. Reich calls them a “not quite golden age”. It was “not quite” because of the treatment of women and minorities and the prevailing conformist and authoritarian atmosphere.

It has been succeeded by what Reich calls supercapitalism, in which the cult of the bottom line has replaced the cosy oligopolies of postwar decades, once-dominant companies shrink or disappear, new ones spring up overnight and the financial sector is (or was until recently) in the driving seat. He rightly dismisses many of the popular scapegoats – or heroes – of the process. The changeover began well before Ronald Reagan or Margaret Thatcher could influence anything. Free-market economists have been preaching essentially the same message since the 18th century. It is extremely unlikely that there has been a radical change in the psychology or morality of business operators. His own candidate is the technologies that have empowered consumers and investors to get ever better deals.

Unfortunately, many of these same consumers have lost in their capacity as citizens. He cites the failure of the political process even to attempt to correct the increasing skewness of US income distribution. In later pronouncements he has attributed the subprime loan disaster in part to the failure of supercapitalism to raise the incomes of the mass of wage earners who have been impelled to resort to borrowing as a substitute. Moreover, Congress has performed abysmally in correcting market failures in environmental and other areas. He has a non-partisan explanation: the staggering increase in business lobbying expenditures affecting Democrats as well as Republicans, as a result of which the political process, far from correcting the distortions of unbridled capitalism, has made them worse.

But for me the novel point of the book is his utter dismissal of the prevailing idea of appealing to the “social responsibility” of business to improve matters. This is a notion that particularly appeals to soft centre politicians such as David Cameron’s Conservatives in Britain as a new kind of Third Way. Reich argues that it is the job of the democratic political process by laws, taxes and other interventions to harmonise the pursuit of money-making with the public good. “The job of the businessman is to make profits.” He is completely unabashed by the charge that he sounds like Milton Friedman and indeed quotes the late Chicago professor approvingly several times. He argues that the so-called stakeholders who insist on being consulted before legislation is drafted are increasingly companies whose interests might be affected. One result is the “corruption of knowledge”. We should beware of claims that a company is doing something for the public good. Corporate executives may donate some of their shareholders’ money to a genuinely good cause or forbear from polluting the atmosphere to forestall a greater legal or fiscal burden. But in that case such actions are likely to be limited and temporary, “extending only insofar as the conditions that made such voluntary action pay off continue”.

Similarly we should beware of a politician who blames a company for doing something that is legal. Such words are all too often a cover “for taking no action to change the rules of the game”. Above all, “corporations are not people. They are legal fictions, nothing more than bundles of contractual agreements ... A company cannot know right from wrong ... Only people know right from wrong and only people act.” One example of the “anthropomorphic fallacy” is when companies are held criminally liable for the misdeeds of their executives. Not only are the genuinely guilty let off too lightly but many innocent people get hurt. For instance, “the vast majority of Andersen employees had nothing to do with Enron but lost their jobs nonetheless”.

I have two reservations. One is that I cannot share Reich’s confidence that a revived and effective “democracy” would be a cure-all. You only have to see where democratic pressures are driving US energy policy. Second, there is a danger that the Friedman-Reich position could inadvertently give sustenance to the “I was only doing my job” defence for evil actions. You do not have to hold shares in a company selling arms to Saudi Arabia, or work for it. But do not deceive yourself that such individual gestures can be a substitute for a change in policy.

Stefan Klasen: Journalism and science: Hepatitis B and missing women

From <>:

Journalism and science: Hepatitis B and missing women | vox - Research-based policy analysis and commentary from leading economists: Robert Barro and Steven Levitt, in their role as popular columnists, promoted a Harvard graduate student’s article which refuted Amartya Sen’s claim that discrimination accounted for the 100 million “missing women”. In his role as editor, Levitt published the article in the Journal of Political Economy. Now that the article’s central claim has been refuted – most notably by its author – it’s time to tell the ‘morality tale’.

In late 2005, a paper by Emily Oster, published in the Journal of Political Economy (JPE), claimed that the reason that China (and to some degree South Asian countries) had large female deficits was not gender differences in mortality (pre-and post-birth) – as argued by Amartya Sen and others for years – but the fact that higher prevalence of Hepatitis B carriers there led to naturally higher sex ratios at birth. Around 45% to 70% of the alleged 100 million victims of anti-female discrimination were missing due to this biological relationship. In China it was more than 75%.

The finding made waves. It not only stirred debate in academic circles but was also promoted by Robert Barro in Business Week and Steven Levitt in Slate. The intense academic debate produced at least seven further papers on the subject published in the American Economic Review, the Population and Development Review, and several working papers still in the review process. Most of them criticised particular aspects of the arguments advanced by Oster, with her replying to some of these criticisms.

A few months ago, Emily Oster posted a new paper on her web site with the title “Hepatitis B does not explain male-biased sex ratio in China” where she reports that there is in fact no link between Hepatitis B carrier status and the sex ratio at birth in China (Chen and Oster, 2008). This amounted to a complete retraction of the earlier claim. The details and arguments are summarised in my companion column on Vox and are also available in Klasen (2008). As I just told the story, there is nothing particularly unusual about it – in fact, it could appear as a shining example that the academic community is able to weed out erroneous empirical claims through further research. Moreover, Emily Oster should be commended for not only invariably responding to the many criticisms of her work, but also for undertaking new research to examine these criticisms and then retracting her claim as soon as that research made her original claims untenable.

Troubling timing

But closer inspection of the details and timing of the events leave some open and rather uncomfortable questions. Consider the timing of events. A first draft of the paper, dated 5 February 2005 and labelled “preliminary and incomplete”, was posted on her web site in early February of 2005. Oster was a second-year Ph.D. student at Harvard at the time. The paper was also sent around to people doing research in the field (including me) and several people started providing detailed comments and pointing to some of the weaknesses in the argument.

While this work-in-progress was on-going, Robert Barro took these preliminary and incomplete findings and published a column in Business Week on 28 February 2005, summarising her paper. He claimed that “biology explains a good deal of the missing-women puzzle”, while previously “the presumption was that the excess mortality came from discrimination against women by men and government”. There was no mention of potential problems with the data or the analysis, mostly because at that stage there had been no opportunity to scrutinise these claims at all.

A second version of the paper was produced in March and sent off for publication soon thereafter. Later it became clear that the paper had been submitted to the Journal of Political Economy, then edited by Steven Levitt. In May 2005, while Oster was (according to a message sent to me) still waiting for a first response and referee reports from the JPE, Levitt published, together with Stephen Dubner, a column in the online magazine Slate entitled “The search for 100 million missing women.” There, Levitt described Oster’s arguments and the way she had arrived at them. He stated: “If you believe Oster’s numbers – and as they are presented in a soon-to-be-published [!] paper, they are extremely compelling – then her detective work has established the fate of roughly 50 million of Amartya Sen’s missing women.” Here Levitt, who is both editor of a top economics journal (with very high ranking and associated high rejection rates) and columnist for a general-interest online magazine, clearly mixes his two roles. No wonder that after the pre-announcement in Slate, the paper was then indeed accepted at the JPE later that year and published as the lead article in the last issue of 2005.

That column generated a lot of public discussion about this argument and many of the concerns raised by critics of the claims were then made public as well. In early July 2005, I joined the public discussion and posted a detailed set of comments on the findings on my web site (still available there) which I had previously sent to Oster – they are now appearing in amended fashion as Klasen (2008). In September 2005, the Population and Development Review (PDR), arguably the top journal dealing with demographic issues in developing countries, took the unprecedented step of publishing a criticism of the Oster paper by Monica Das Gupta before Oster’s paper had even been published. That paper focused on a few key weaknesses of the argument, and exchanges between Oster and Das Gupta in the PDR continued in 2005 and 2006.

Similarly, other parts of the evidence were scrutinised by Abrevaya (2008), Ebenstein (2007), and Lin and Luoh (2008). That last paper, which started as a working paper in 2006 and will now be published in the December issue of the American Economic Review, posed a particular challenge to Oster’s claims as it used the data of 3 million women and their off-spring to show that there was no link between mother’s Hepatitis B status and the sex ratio at birth in Taiwan. This was by far the largest data set and most compelling evidence from a country with a “missing women” problem, suggesting that the link was just not there. This paper, as well as persistent criticism of her work, led Oster to undertake further research, extending a large dataset from China to tackle the issue. That research clearly showed that in China there was no link between Hepatitis B and the sex ratio at birth and thus the missing women problem.

Lessons learned

Thus after the three years of intense research, several top-level publications, two entertaining columns, and much public and private discussion, we are just about exactly where we started. We have learned a few things on the way (also about how remarkably quickly some research results make it to the public and into top journals), but maybe a consultation of a Ph.D. thesis by the (late) Anouch Chahnazarian at Princeton, published in 1986, would have obviated the need for all of this. In his dissertation, he examined factors affecting the sex ratio at birth, including the prevalence of Hepatitis B. He concluded by saying that “the negative relationship observed here between birth order and the sex ratio at birth in children of carrier parents fails to provide an explanation of the unusually high sex ratios at birth observed at higher parities in China, a country of high hepatitis B prevalence (p.135).”

Jared Bernstein: Trickle Down...R.I.P.

TPMCafe | Talking Points Memo | Trickle Down...R.I.P.: Look for this obituary in tomorrow's paper:

Trickle-down economics died yesterday morning at 10AM. The cause of death was a data release from the US Census Bureau, but trickle-down had been ailing from lack of empirical support for decades. Also known as "supply-side economics," trickle-down was the love child of Ronald Reagan, Arthur Laffer, and Jude Wanniski. It is survived by Larry Kudlow and Co., and the editorial page of the Wall St. Journal.

That's what you should see, but you probably won't. Let me explain. The Census Bureau released some new data on Tuesday that strongly contradicts supply-side, trickle-down economics, but the truth is that if this brand of hucksterism could be brought down by evidence, it would have died long ago.

First, the new data. Every year the Census Bureau releases info on middle-class incomes and poverty for the prior year. So today's release refers to last year's data. Median household income, inflation-adjusted, was up slightly in 2007, but poverty rose too.

But the annual data are not of great interest here. Since 2007 was the last year of an economic expansion that began in 2001, that makes it an economic peak: the last year of a cycle. Which means we can now, for the first time, compare the results from this peak to the peak of the prior cycle: 2000.

Economists like such comparisons because they evaluate a given outcome across similar years in the cycle. If you were to compare, say, trough to peak, you'd expect things to improve. But peak-to-peak is considered the legit way to compare like-to-like.

So here are some key peak-to-peak comparisons:

Real (inflation-adjusted) median household income was essentially unchanged between 2000 and 2007 (it was $300 lower last year than in 2000, but the difference is not statistically significant).

This is the first cycle on record where the real median household income failed to surpass its prior peak.

For working-age households, real median income is $2,000 below its 2000 level.

Poverty rates were 1.2% higher in 2007 than in 2000, up from 11.3% to 12.5%, an addition of 5.7 million to the poverty rolls. This is the worst cycle for poverty on record. The second worse was 1979-89, a decade also dominated by trickle-down economics.

What is trickle-down? It's the set of economic policies based on the notion that if you provide economic incentives to the wealthy by cutting their taxes (or, as the supply-siders put it, "letting us keep our money") while deregulating industry, you'll unleash a tsunami of economic activities that will enrich even the least advantaged among us.

The theory doesn't make sense even on its face. Why would people work harder only if you cut their taxes? After all, their after-tax income goes up, so they might decide they can work less and still be as well off. Or, if you raise their taxes, they might decide to work harder to make up the after-tax losses.

No matter...this stuff is not based on logic. It's largely a rationale for upward redistribution that's been kept alive by the vested interests who benefit from it. Reagan put this stuff on the map, but GW Bush brought it back with a vengeance, and McCain goes even further. He extends the supply-side Bush tax cuts, and lards on about $75 billion more in corporate tax cuts on top of that.

The evidence from the 1980s and the 2000s shows that trickle-down works fine, if by "down" they mean "up." But is there any counter-evidence that shows the impact of a different policy regime on middle-class and low-incomes?

Exhibit A is the 1990s. When he came into office, Clinton eschewed supply-side, cutting taxes on lower-income households and raising them at the top end. Obama takes a similar approach.

Now, take a look at Figures 5 and 6, and especially Table 2 in this document, drawing on today's report from the Census. There you will see evidence of the strong real growth in median incomes and sharp declines in poverty that occurred over the 1990s, contrasted with the opposite trends in the 2000s.

Remember those working-age households that lost a couple of grand in the 2000s? Their income was up 10%, or $5,200 in the 1990s (1989-2000). Had this growth rate prevailed in the 2000s, their median income would have gone up $3,600 instead of falling $2,000.

Note that these results are strongest for minorities. The median household income of African-American households grew 22% in the 1990s and fell 5% in the 2000s. Note also the poverty results from black children (Table 2 from the above link). If evidence were bullets, trickle-down would perish in a pool of blood.

Yet, its obit is premature. It lives on in the Republican platform, the right-wing think tanks, and conservative media (really, in the mainstream media...you may recall that during a Democratic primary debate on ABC, Charles Gibson claimed that due to the magic of supply-side, capital gains tax cuts pay for themselves).

Frankly, I'm not sure how to kill it, and am earnestly interested in any ideas you might have for exposing and discrediting this deeply damaging ruse. In the meantime, the best we can hope for is to throw its practitioners out of the White House and Congress.

Pranab Bardhan: What does this authoritarian moment mean for developing countries?

FT.com | The Economists’ Forum | What does this authoritarian moment mean for developing countries?: As the petro-authoritarianism of Russia flexes its muscles and the economic prowess of China struts in Olympic glory, developing countries in the world might start rethinking about the lectures on democracy and development they have heard all these years from the West. This is at a time when advanced capitalist democracies are reeling under the shock of unregulated financial overreach and years of living beyond their means, a far cry from the end-of-history triumphalism of capitalist democracy of less than two decades back.

The Chinese case in particular is reviving a hoary myth of how particularly in the initial stages of economic development authoritarianism delivers much more than democracy. This is also backed by the memory of impressive economic performance of other East Asian authoritarian regimes (like those in South Korea and Taiwan in the recent past). The lingering hope of democrats had been that as the middle classes prosper in these regimes, they then demand, and in the latter two cases got, the movement toward political democracy.

But the relationship between authoritarianism or democracy and development is not so simple. Authoritarianism is neither necessary nor sufficient for economic development. That it is not necessary is illustrated not only by today’s industrial democracies, but by scattered cases of recent development success: Costa Rica, Botswana, and now India. That it is not sufficient is amply evident from disastrous authoritarian regimes in Africa and elsewhere.   Even if we were not to value democracy for its own sake (or regard it as an integral part of development by definition), and look at it in a purely instrumental way, it is worth reiterating the several advantages of democracy from the point of view of development. Democracies are better able to avoid catastrophic mistakes, (such as China’s Great Leap Forward and the ensuing great famine that killed nearly thirty million people, or a massive mayhem in the form of Cultural Revolution), and have greater healing powers after difficult times. Democracies also experience more intense pressure to share the benefits of development among the people, thus making it sustainable, and provide more scope for popular movements against industrial fallout such as environmental degradation. In addition, they are better able to mitigate social inequalities (especially acute in India) that act as barriers to social and economic mobility and to the full development of individual potential. Finally, democratic open societies provide a better environment for nurturing the development of information and related technologies, a matter of some importance in the current knowledge-driven global economy. Intensive cyber-censorship in China may seriously limit future innovations in this area.   All that said, India’s experience suggests that democracy can also hinder development in a number of ways. Competitive populism– short-run pandering and handouts to win elections– may hurt long-run investment, particularly in physical infrastructure, which is the key bottleneck for Indian development. Such political arrangements make it difficult, for example, to charge user fees for roads, electricity, and irrigation, discouraging investment in these areas, unlike in China where infrastructure companies charge full commercial rates. Competitive populism also makes it difficult to carry out policy experimentation of the kind the Chinese excelled in: for example, it is harder to cut losses and retreat from a failed project in India, which, with its inevitable job losses and bail-out pressures, has electoral consequences that discourage leaders from carrying out policy experimentation in the first place. Finally, democracy’s slow decision-making processes can be costly in a world of fast-changing markets and technology.   The hopes of democrats relying on the middle classes in authoritarian regimes have not always borne fruit. Latin American or South European history has been replete with many episodes of middle classes hailing a supreme caudillo. The police state in China shows no signs of loosening its grip soon, despite the spectacular progress in the opening of the economy. While there has been some relaxation in controls over individual expressions of thought, and some open middle class grumbling over pollution and forcible acquisition of property, the state never fails to clamp down on political activities that have even a remote chance of appearing to challenge the monopoly of power of the central authority.  Most people in the Chinese middle class are complicit in this in the name of preserving social stability, as long as opportunities for money-making and wallowing in nationalist pride keep on thriving.   So markets and capitalism will not do their political cleansing job automatically.  On the contrary, markets often sharpen inequality, and the resultant structures of political power, buttressed by corporate plutocrats and all-powerful lobbies, may even hijack or corrupt the democratic political process, a phenomenon not unknown in some industrial democracies. Thus both for democracy and development other social forces and movements for civil and economic rights for the common people have to be pro-active and eternally vigilant.

John Dizard: State injection for Fannie and Freddie will offset pain

John Dizard: State injection for Fannie and Freddie will offset pain: Most of the time, the path to survival in financial bureaucracies is through company-party-line on-message bullishness. That's particularly true in the US, where pessimism about the future is not just bad business, but unpatriotic.

Not true today. More than sufficient electric shocks have been administered to the rats. Now, the corporate rodents know that PowerPoints projecting trees growing to the sky are going to get you fired, not promoted. Short-sellers are no longer bad people, but prophets. That's part of the reason why the optimistic case for equities is still generally dismissed.

There are, however, substantive points made by the equity bears. The most coherent come from the credit people, who point out, grimly, that you can't have a recovery if you don't have the bank lines or fixed income buy side to support the spending. The damage done from write-offs and shaken confidence is so severe, they say, that it will be impossible to finance growth in any kind of demand, at least in the visible future. No bank capital, and no securitisation markets, mean we will all be reduced to post-apocalyptic bands of looters, hunter-gatherers, and, I suppose, bankruptcy lawyers.

Since the more cautious credit people saved their clients some of their capital, they deserve a listen. Greg Peters, the Morgan Stanley credit strategist, says: "Once the banks and credit institutions pull back their reins, they keep them pulled back for a long time. The more optimistic consumer economists don't understand this because this is very different compared to any other experience they have gone through. It is impossible to calculate the impact of the breakdown of securitisation."

That's true. Of course, we did have some economic activity even before the securitisation of subprime and alt-A mortgages, and before collateralised loan obligations replaced actual corporate loans. We survived on iceberg lettuce and coleslaw before we knew there were such things as arugula and cilantro.

Still, to the point raised by Peters and the other cautionary voices, there are answers. First, Fannie Mae and Freddie Mac need to be nationalised, in the sense that the federal government injects capital in the form of preferred equity and direct credit support, wiping out the existing common. I believe it is critical that that takeover leaves the privately held preferred stock of the government-sponsored enterprises in place. Preserving the value of GSE preferred issues is very much in the taxpayers' interest, as it makes possible the recapitalisation of the rest of the banking system.

Most of the discussion of the need for a federal takeover of the GSEs has concerned their credit losses on subprime and Alt-A paper. However, even if a private recapitalisation could be done to offset those, the GSEs would not have sufficient capital to handle the long-term risk of the maturity mismatches on their highly leveraged balance sheet.

Let's say there's a great economic recovery, housing prices stabilise, and the interest rate curve becomes more normal. The rise in long-term rates would lead to an extension of the maturity of mortgage portfolios, which would need to be offset by hedging activities. Significant declines in the long end would also need to be hedged, as homeowners refinanced. I don't believe the interest rate swaps market will have the capacity or willingness to take on that risk at any payable price. One way or another, these institutions will spend a considerable time with negative equity. Again. The only way to handle that is with government ownership.

No doubt there are bankers and lawyers explaining all this to the Washington "leadership", in the respectful, but urgent, tones trust and estate lawyers use when telling dim heirs that they need to sign a document lest Mummy's bequest become valueless. It could take a little while for the political managers to accept that they need to shred yet another set of talking points.

Then, all of those fiduciaries worried about making that 8 per cent return assumed in their actuarial pro formas will have a way to keep their jobs: buy new issues of bank cumulative preferred stock.

How could they have confidence in the banks? Because the banks will be able to put a lot of their housing paper to those newly recapped GSEs. On the other hand, they may want to hold on to at least some of that paper. There are a lot of housing-related securities that will take real losses on foreclosures and steeply discounted liquidation sales. There is also a lot of paper that was marked to a very illliquid market. Away from Florida, Nevada, Arizona, parts of the Rust Belt, and California, there is a lot of solidly financed property in the US, and a significant part of the paper it supports will be marked up in value. That will be another source of additions to bank capital.

We won't be getting another consumption-led boom for a long time. The US will recover, though, and sooner than the credit tribe thinks. There will be exports, import substitution from transplanted factories, cheaper oil and government-financed infrastructure spending. Capital flight from Europe will help finance the construction of our next perpetual motion machine.

When everyone regains their confidence, I'll get bearish again

James Hamilton: What's Real About the Business Cycle?

James Hamilton (2005), "What's Real About the Business Cycle?"

This paper argues that a linear statistical model with homoskedastic errors cannot capture the nineteenth-century notion of a recurring cyclical pattern in key economic aggregates. A simple nonlinear alternative is proposed and used to illustrate that the dynamic behavior of unemployment seems to change over the business cycle, with the unemployment rate rising more quickly than it falls. Furthermore, many but not all economic downturns are also accompanied by a dramatic change in the dynamic behavior of short-term interest rates. It is suggested that these nonlinearities are most naturally interpreted as resulting from short-run failures in the employment and credit markets and that understanding these short-run failures is the key to understanding the nature of the business cycle.

Federal Reserve Bank of St. Louis Review, July/August 2005, 87(4), pp. 435-52.

Weir and Skocpol: State Structures and Social Keynesianism: Responses to the Great Depression in Sweden and the United States

Margaret Weir and Theda Skocpol (1983), "State Structures and Social Keynesianism: Responses to the Great Depression in Sweden and the United States"

Acemoglu, Johnson, and Robinson: An African Success Story: Botswana

Daron Acemoglu, Simon Johnson, and James A. Robinson (2001), "An African Success Story: Botswana"

McMillan, Horn, and Rodrik: When Economic Reform Goes Wrong: Cashews in Mozambique

Margaret McMillan, Karen Horn, and Dani Rodrik (2003), "When Economic Reform Goes Wrong: Cashews in Mozambique"

Paul Krugman on American Richistan

Paul Krugman: Now That’s Rich: Last weekend, Pastor Rick Warren asked both presidential candidates to define the income at which “you move from middle class to rich.” The context of the question was, of course, the difference in the candidates’ tax policies. Barack Obama wants to put tax rates on higher-income Americans more or less back to what they were under Bill Clinton; John McCain, who was against the Bush tax cuts before he was for them, says that means raising taxes on the middle class.

Mr. Obama answered the question seriously, defining middle class as meaning an income below $150,000. Mr. McCain, at first, made it into a joke, saying “how about $5 million?” Then he declared that it didn’t matter because he wouldn’t raise anyone’s taxes. That wasn’t just an evasion, it was a falsehood: Mr. McCain’s health care plan, by limiting the deductibility of employer-paid insurance premiums, would effectively raise taxes on a number of people.

The real problem, however, was with the question itself.

When we think about the middle class, we tend to think of Americans whose lives are decent but not luxurious: they have houses, cars and health insurance, but they still worry about making ends meet, especially when the time comes to send the kids to college.

Meanwhile, when we think about the rich, we tend to think about the handful of people who are really, really rich — people with servants, people with so much money that, like Mr. McCain, they don’t know how many houses they own. (Remember how Republicans jeered at John Kerry for being too rich?)

The trouble with Mr. Warren’s question was that it seemed to imply that everyone except the poor belongs to one of these two categories: either you’re clearly rich, or you’re an ordinary member of the middle class. And that’s just wrong.

In his entertaining book “Richistan,” Robert Frank of The Wall Street Journal declares that the rich aren’t just different from you and me, they live in a different, parallel country. But that country is divided into levels, and only the inhabitants of upper Richistan live like aristocrats; the inhabitants of middle Richistan lead ample but not gilded lives; and lower Richistanis live in McMansions, drive around in S.U.V.’s, and are likely to think of themselves as “affluent” rather than rich.

Even these arguably not-rich, however, live in a different financial universe from that inhabited by ordinary members of the middle class: they have lots of disposable income after paying for the essentials, and they don’t lose sleep over expenses, like insurance co-pays and tuition bills, that can seem daunting to many working American families.

Which brings us to the dispute about tax policy.

Mr. McCain wants to preserve almost all the Bush tax cuts, and add to them by cutting taxes on corporations. Mr. Obama wants to roll back the high-end Bush tax cuts — the cuts in tax rates on the top two income brackets and the cuts in tax rates on income from dividends and capital gains — and use some of that money to reduce taxes lower down the scale.

According to estimates prepared by the nonpartisan Tax Policy Center, those Obama tax increases would fall overwhelmingly on people with incomes of more than $200,000 a year. Are such people rich? Well, maybe not: some of those Mr. Obama proposes taxing are only denizens of lower Richistan, although the really big tax increases would fall on upper Richistan. But one thing’s for sure: Mr. Obama isn’t planning to raise taxes on the middle class, by any reasonable definition — even that of the Bush administration.

O.K., the Bush administration hasn’t actually offered a definition of “middle class.” But in May, the Treasury Department — which used to do serious tax studies, but these days just churns out Bush administration propaganda — released a report purporting to show, by looking at the tax bills of four hypothetical families, how the middle and working class would be hurt if the Bush tax cuts aren’t made permanent.

And when the Center on Budget and Policy Priorities looked at the report, it made an interesting catch. It turns out that Treasury’s hypothetical families got all their gains from the so-called middle-class provisions of the Bush tax cuts: the Child Tax Credit, the reduced tax bracket for lower incomes and marriage penalty relief.

These all happen to be provisions that Mr. Obama proposes leaving in place. In other words, the Bush administration itself implicitly defines the middle class as consisting of people making too little to end up paying additional taxes under the Obama plan.

Of course, all the evidence in the world won’t stop Republicans from claiming, as they always do, that Democrats are going to impose a crippling tax burden on ordinary hard-working Americans. But it just ain’t so.

Calculated Risk: Fed: Delinquency Rates Increased Sharply in Q2

Calculated Risk: Fed: Delinquency Rates Increased Sharply in Q2: Credit card delinquency rates are at 4.9%, about the same level as the peak of the '01 recession. Credit card delinquencies peaked at 5.45% during the '91 recession.

Commercial real estate delinquencies are rising rapidly, and are at the highest rate since Q1 '95 (as delinquency rates declined following the S&L crisis).

Residential real estate delinquencies are at the highest level since the Fed started tracking the data (since Q1 '91).

Although there is credit deterioration everywhere, the rise in CRE delinquencies is especially significant. The Fed defines commercial as "construction and land development loans, loans secured by multifamily residences, and loans secured by nonfarm, nonresidential real estate", and many of the problems are probably in the C&D loans.

Paul Kedrosky Has Fun with Ben Bernanke's Last Year and This Year Speeches

What a year does to Ben Bernanke's wordcloud:

Jagdish Bhagwati: The selfish hegemon must offer a New Deal on trade

FT.com / Comment & analysis / Comment - The selfish hegemon must offer a New Deal on trade: In the 1980s, Japan was feared in the US to be a lethal combination of Superman and the evil genius Lex Luthor in a classic case of what I have called the Diminished Giant Syndrome.

Members of Congress famously smashed a Toshiba radio cassette recorder on the steps of Capitol Hill in protest in 1987. Great Britain at the turn of the 19th century had been marked by similar diffidence, despair and recrimination when Germany and the US were emerging on the world scene. There, Sir Howard Vincent entered parliament festooned with mops, pails and brushes marked “Made in Germany”.

US hegemony survived the exaggerated threat from Japan. But the US is now once again a fearful giant. Many Americans see trade as a peril rather than an opportunity. This has turned the US from what the economist Charles Kindleberger famously called an “altruistic” hegemon into a “selfish” hegemon.

On the back of economic anxiety in the country, many in both political parties (although far more among Democrats) see freer trade now as a costly giveaway to others at the expense of the US. They ask: “What is in it for me?” Only an agenda for institutional change, one that addresses the true causes of the anxiety in the US today, has a chance of returning trade policy to sanity.

The US role in the failed Doha trade talks illustrates the collapse of American leadership. Here, the US has been the central spoiler, refusing to cut its trade-distorting subsidies significantly even though they are universally recognised as intolerable. Its latest offer was to cap them at $14.5bn (€9.84bn, £7.76bn) but that well exceeded current payouts, estimated at $9bn. With only 2m farmers in the country, the US still attacked India for asking for an enhanced “special safeguard mechanism” to be used in case of an import surge, when India has far smaller, often subsistence, farms and nearly two-thirds of its population in rural employment.

While making negligible concessions itself, the US was insisting on difficult concessions from India, made even more troublesome politically because of the insubstantial offer on US subsidies. Besides, when the Doha talks started, the developing countries were not even supposed to be making concessions in agriculture. Throughout the Doha negotiations, the office of the US trade representative and US Congress pointed a finger at others – at Brazil, then at India and then also China – but have never considered their own roles.

The US has also muscled in to its bilateral preferential trade agreements (nearly all with small, developing nations) conditions unrelated to trade at the expense of their partner nations. Thus a country that is hardly an exemplar on labour rights, where the right to strike has been severely restrained since the Taft-Hartley legislation more than half a century ago, where union membership in the private sector has declined to less than 10 per cent of the labour force, and which has not ratified all the International Labour Organisation’s core conventions, has had the effrontery to impose standards on others in these PTAs. Why?

It is evidently not because it practises what it preaches and demands. Rather, it is because the labour lobbies believe, without any compelling evidence, that American wages have been stagnant because of competition from the developing nations. Further, they believe that if one could only stand Thomas Friedman of “flat earth” fame on his head and flatten the earth by raising these countries’ labour costs up to US levels, that would help reduce competition. In short, this is what economists call “export protectionism”.

What is doubly offensive about this exercise of political muscle is that it is advanced in the language of altruism: not by saying frankly that it is because “our unions are worried about competition” but by pretending that it is “in your workers’ interests”. An altruistic hegemon would not be playing these games; a selfish hegemon will do little else.

Senator Barack Obama does not quite get this. By asking, as part of his agenda for change, that the US should now impose even more draconian labour requirements in future PTAs, and that the North American Free Trade Agreement should be revised to incorporate yet tougher labour requirements, he is making export protectionism, and the reputation of the US as a selfish hegemon, worse, not better. Some change.

Change is indeed in order, although along totally different lines. It must reflect a holistic view of the new reality that the US confronts. In particular, the economic anxiety that overwhelms US workers today stems from the increased fragility of their jobs.

First, as with Japan in the 1930s, when one-dollar blouses flooded the world, India and China today are growing and exporting rapidly. They are like Gullivers in a Lilliputian world economy. They create tsunamis for specific industries where their exports concentrate.

Second, competition has intensified. As exemplified by the Boeing-Airbus saga, the margins of competitive advantage have shrunk. No chief executive or any of his workers in tradable industries leads a happy life any more as there is always someone, from somewhere, breathing down his neck. I call this new phenomenon “kaleidoscopic comparative advantage”. It leads to volatility of jobs, as you have an advantage today and can lose it tomorrow.

Third, labour-saving technical change continuously threatens assembly-line jobs for the unskilled. The assembly lines continue but increasingly do not have workers on them; they are managed from a glass cage by skilled operators whose jobs increase instead.

The agenda for institutional change has to address this fragility of jobs, enabling unskilled and skilled workers to face the new uncertainties. To illustrate: higher education will have to be recast to reduce the proportion of time spent on specialisation: this would enable an easier response to shifting skill requirements as the kaleidoscope turns. Unskilled workers will have to be helped and encouraged to acquire skills and therefore increase their ability to shift to other jobs, even as they continue to work.

Senator Obama promises change but he needs a deeper understanding of the anxiety-causing “new epoch” to define his new agenda shorn of protectionism. John McCain, the Republican presidential candidate, admirably stands for free trade but shows no evidence whatsoever of comprehending that this needs to be situated in an institutional context that requires a serious overhaul. Who will ultimately offer us the right New Deal?

The writer, university professor, economics and law, at Columbia University and senior fellow in International Economics at the Council on Foreign Relations, has just published ‘Termites in the Trading System: How Preferential Agreements Undermine Free Trade’. His next book on US trade policy, ‘Terrified by Trade: Institutional Change to Address Anxiety and Contain Protectionism’ (Oxford) is to be published in spring 2009

Adam Posen and Arvind Subramanian: A Global Approach Is Needed to Beat Inflation

Op-ed: A Global Approach Is Needed to Beat Inflation: The world's top central bankers meeting in Jackson Hole this weekend should do more than bemoan their respective financial risks. They should hammer out a joint approach to reducing global inflation, centred on a common public commitment to tighter monetary policies. Moreover, with the European Central Bank and a few emerging market central banks (such as those of Brazil and India) having taken the lead, the spotlight should be on the US Federal Reserve and People's Bank of China. They must participate in this effort, rather than try to free-ride—which would only delay and increase the cost of their own inevitable tightening.

The view of many central bankers is that there are few if any gains from monetary policy coordination. This view profoundly misreads the present situation. Inflation today is a global phenomenon arising from negative real interest rates and global demand running ahead of supply. This is especially true of commodities, but is also driven by declining potential output growth in the United States and western Europe. Thus, monetary tightening remains urgently needed, despite the recent decline in commodity prices.

Although containing inflation is now a common priority in much of the world, in the United States and China short-term objectives are leading to lax monetary policies, generating negative global spillovers of higher inflation. There is a game of "chicken" being played. Each country is attempting to duck the pain of monetary contraction, hoping that others will bear the burden of adjustment. This is not only unfair, but self-destructive. It weakens their perceived commitments to price stability, while stoking their own inflation.

Monetary tightening remains urgently needed, despite the recent decline in commodity prices. In contrast, tightening monetary policy in a coordinated fashion would benefit all participating countries and would be aligned with the enlightened self-interest of the United States and China.

First, the extent and duration of interest rate increases that any one nation must undertake would be reduced. With reduced demand abroad there is a spillover that diminishes inflation in other countries: If everyone tightens rates, the marginal pressures on energy prices and demand are reduced for all countries. The United States would have to tighten less if China tightened and allowed its exchange rate to appreciate (and vice versa).

Second, the commitment to price stability would become more credible for all participating. While there are some brave efforts under way to reduce inflation, many central banks will find it difficult to carry through on commitments. A global pact to raise rates together will make it easier for individual central banks to stick to plans despite domestic opposition.

Third, a credible global pact could have a significant impact on market expectations. This would immediately lead to reductions in prices, especially commodity prices. It would also limit dislocations in exchange rates arising from divergent beliefs about countries' monetary policy paths. Both would ease the inflation-fighting effort.

Fourth, monetary coordination would help offset inflationary pressures from fiscal expansion. Aggressive fiscal expansion is coming in most countries. In developing nations, there is pressure to cushion the social cost of rising food and energy prices; in the United States, the imperatives began with the financial turmoil and will soon encompass healthcare and infrastructure spending. Thus, looser fiscal policy globally will increase the challenge for monetary policy to cut inflation.

Last, an international agreement to tighten would allow China to exit its self-imposed currency predicament. China's single-minded pursuit of mercantilist objectives produces inflation and overheating at home. US efforts to get China to shed these objectives sound hypocritical when the United States seems to be opting for excess stimulus itself, ignoring spillovers. On the other hand, if the People's Bank and the Fed tightened in coordination with most central banks, domestic concerns about competitive depreciation would be muted. Moreover, Chinese tightening would facilitate reduced inflation among Asian countries fearful of losing competitiveness vis-à-vis China, again contributing to a global reduction.

Grand schemes for macroeconomic policy coordination have a mixed record. At present, however, the world faces a common threat from inflation. A joint public commitment by the world's monetary policymakers to the common goal of reducing inflation would be powerful, effective, and fair. That is what central bankers should bring home from Jackson Hole.

Steven Pearlstein: When Progress Is A Walk in the Park

When Progress Is A Walk in the Park: A trip to New York City is normally not my idea of how to spend a beautiful weekend in August, but for the fact that it was the last chance to visit with our daughter before she headed off for a year at a marketing consultancy in London. By midafternoon Sunday, we had had about all the culture, concrete and consumption we could take. So we put on running gear and headed to Central Park.

What a treat it turned out to be. I've been in Central Park several times in recent years and knew progress had been made in restoring the luster to Olmstead's jewel since management of the park was handed over to a private conservancy that had become a pet project of the Manhattan plutocracy. On this outing, I was blown away by how well manicured and maintained this enormous and varied public space was -- the lush ball fields, the carefully restored iron and masonry work, the magnificent sculptures and working fountains, the perfectly trimmed trees and bushes. I didn't find a streetlamp, a water fountain or a bathroom not in working order.

What made it all the more remarkable was the number of people using the park that Sunday afternoon, tens of thousands of all ages and backgrounds, riding, lounging, strolling, rowing, jogging, skating, eating, reading, painting, throwing, kicking, swinging, canoodling, talking or listening to live music. Yet despite the crowds, it never felt overcrowded.

There are, it seems to me, important lessons for economic policy in the Central Park success story.

The first is a reminder of the importance of creating and sustaining public facilities that are accessible to everyone and nourish a sense of community. Over the past 20 years, the tendency has been for those who can to abandon public schools, public transportation, public recreation, with the result that American society has become increasingly segregated by class and polarized by political ideology. In Central Park, I found hints that Americans were eager to reverse that trend.

The second big lesson is that investment in public infrastructure can have big payoffs. The Central Park Conservancy calculates that it invested $350 million over the past 20 years to restore the park to its former glory and requires $37 million a year to maintain it. That may sound like a lot of money, but when compared with the enhanced property values in the surrounding neighborhoods, the increased tourism it has helped to spawn and its contribution to making the city a more attractive place to live, my guess is that the return on investment easily equals that of the average hedge fund.

That doesn't mean that all spending on public purposes can be characterized as investment (an old liberal trick) or that all investments can be expected to have the same payback as Central Park. But it does put the lie to the idea that Americans no longer have the money to build and maintain the quality schools, libraries, parks, roads and public transportation systems required for an advanced economy. Collectively, we have the money. What we haven't had is the political will to raise the taxes necessary to make these high-payoff public investments.

Conservatives and Republicans see in the Central Park success story further confirmation of their belief that government is inept. After all, it took a private organization, relying primarily on private donations, to turn things around. Liberal Democrats would no doubt reply that if New Yorkers hadn't been scared away by tax-cutting ideology and had been willing to raise and spend $350 million of public funds for Central Park, the city's parks department could have accomplished the same feat.

There's something to both arguments.

Because of the power of special-interest groups and public employees, government spending priorities are too often misplaced and too many government agencies fail to use the money they have to deliver quality, efficient service. That's why outsourcing has become so prevalent, why charter schools have become so popular, and why so many state and local officials are turning to public-private partnerships and social entrepreneurs to tackle some of their toughest challenges. What Democrats in Washington have yet to realize is that this isn't about rejecting government or shrinking it -- it's about redefining it.

At the same time, it's important to remember that in terms of economic impact there isn't a big difference between a nonprofit raising $350 million in private donations to fix up Central Park or city government raising $350 million through a well-designed tax system to accomplish the same purpose. As we should have learned from the tech and housing bubbles, there is no guarantee that private investment will always be wiser than public, and there are plenty of examples of public managers and workers who perform as well as or better than their counterparts in the private sector. The idea that every dollar collected in taxes is a dollar lost from the economy is nothing but political propaganda.

What struck me most about my visit to Central Park, however, was the old-fashioned pride that New Yorkers take in the their spectacular public amenity -- a pride reflected in how they dressed, the courtesy they showed one another and the instinct to pick up the occasional piece of litter left by someone else. As I left, it struck me that the candidates most likely to prevail this fall will be those who figure out how to tap into the yearning to tackle and solve a big problem, to restore pride in the public realm and to reaffirm that sense that we're all in this together.

Krishna Guha: Democrats’ vision of healthcare for all

FT.com / Home UK / UK - Democrats’ vision of healthcare for all: If Barack Obama is elected president in November, one of the biggest – perhaps the biggest – item on his domestic agenda will be healthcare.

With 47m people in America uninsured and widespread frustration over rising premiums, health reform is a huge issue. It is also central to the Democrats’ strategy for addressing middle-class anxieties and dealing with the cost of an ageing population.

David Cutler, a Harvard professor, helped craft the Obama health plan. In an interview in his offices at the National Bureau of Economic Research in Cambridge, Massachusetts, he sets out three objectives.

“One is to cover everybody. The second is to bend the curve on health cost inflation. The third is to have a public health system that works.” The key to expanding coverage, he argues, is to make insurance “more affordable and more accessible”.

The plan envisages tax credits for low- and middle- income people to buy insurance – which would probably end up in the region of $110bn to $120bn (€70bn-€76bn, £56bn-£61bn) a year.

“We don’t have a specific subsidy schedule in mind, but the cost of tax credit systems is typically in that range, and we are comfortable with that,” Mr Cutler says. The net cost of the whole health plan after planned savings would be $50bn-$65bn a year, which would be paid for by reversing the Bush tax cuts for high-income households.

An Obama administration would create geographically based health exchanges where individuals without company plans could buy a private or public plan.

Mr Cutler says there would be a “minimum federal standard” for plans offered on exchange, but he adds: “You would not want to specify it too much.”

Critics say lobbyists would exploit the national standards to entrench wasteful spending. Mr Cutler says Mr Obama believes that with the right kind of process it should be possible to avoid reform being hijacked by vested interests. To stop companies off exchange from cherry-picking healthy customers – and leaving only the sickly on the exchange – an Obama administration would ban risk-based pricing of all individual insurance plans.

Mr Cutler says “98 or 99 per cent of people would be covered without a mandate” that requires people to have insurance. But a mandate could be added later.

Mr Obama “does not have any religious objection to mandates”, he says. “The issue of no mandate was not to save money. It was because he didn’t feel comfortable mandating something that didn’t exist.” The Obama campaign believes it is possible sharply to improve value for money in healthcare and save $200bn a year – $2,500 per household – within four years, though only a fraction of this is assumed in its budget plan.

“We overpay for health a lot,” says Mr Cutler. “Anywhere from 40-45 per cent of medical spending is not contributing to medical outcomes at all.”

Most economists agree a lot of cash is wasted – but disagree on the solution. Mr Cutler says the Obama campaign took every good idea it could find and said: “Let’s do all of them.”

These strategies include increased focus on prevention, including use of drugs to manage conditions such as diabetes; smarter purchasing using data from digital medical records and comparative effectiveness trials; and reduction of administrative costs by pooling individuals.

The Obama plan includes $10bn a year for five years to put medical records online. “That sets you on a path for a fundamental transformation of healthcare.”

Mr Cutler claims the Republican contender John McCain’s health plan is “much more radical” than Mr Obama’s. He argues that by eliminating tax breaks specific to corporate health plans (the money is redeployed as individual tax credits), a McCain administration would speed the collapse of corporate healthcare.

Many economists think it would ultimately be good to sever the link between jobs and health insurance. But Mr Cutler says: “You have to build a new home before you tear down the old one.”

Douglas Holtz-Eakin, senior policy adviser to Mr McCain, says nothing in the McCain plan would make companies less willing to provide health plans.

He believes the Obama plan risks “repeating all the mistakes of the past”. It would see government take on tens of billions of dollars of private insurance costs.

“It sets up a new government insurance programme and sets up a large new health bureaucracy at the same time,” he says. The idea that the solution to US healthcare problems lies in Washington “is at odds with everything we have learned”.

Mr Cutler rejects the “big government” charge. He says the Obama plan would achieve “big things” in an “evolutionary rather than revolutionary way”.

Stan Collender: Bush Midsession Budget: Profound Sadness

Bush Midsession Budget: Profound Sadness | Capital Gains and Games: It says more about me than I should probably admit, but back in 2000 I found the  prospect of paying off the national debt to be very exciting. 

To me, the pledge to do that, which Bill Clinton made towards the end of his presidency and George W. Bush made as his years in the White House were just beginning, was absolutely thrilling.  Because of the lower annual interest payments that would result, no other change then being seriously talked about had the potential to alter the long-term federal budget outlook as positively and permanently.

That's why I found the mid-session review of the budget released yesterday to be so depressing.  It was the official notice that the pledge, and all the good things that would come from it, would not be fullfilled.  It was also time to admit that the budget politics, economics, and limits of the past decade would continue...and continue...and continue.

That's just not a happy occasion for anyone but those of us who blog, write, and talk about the budget. Business will be booming.

None of this was a surpise, of course.  The prospects for paying down the national debt firmly ended back in the first year of the Bush administration.  And the close to $490 billion deficit that OMB projected for 2009 has long been assumed or leaked.

Nevertheless, the release of the midsession review on July 28, 2008 should be noted as the official date when the dream of a very different budget debate and fiscal policy opportunities died.

I'll have more about the following shortly.  But other observations:

The bad news absolutely is understated.  The $482 billion projected fiscal 2009 deficit will actually be closer to $600 billion before the year is over.

The much-ballyhooed Bush administration pledge to cut the deficit in half was a gimmick.  There clearly was no commitment to do it more than once (that is, if there really ever was a commitment to do it even once).

From a budget, deficit, debt, interest rate, and fiscal policy perspective, the Bush administration is leaving the country so much worse off than it found it that it will likely hamstring the next president and Congress in ways that aren't yet fully understood.

Based on what we now know for sure about next year's budget, none of the presidential candidates' promises should be taken seriously.  Unless they, the country, and those lending us money are willing to tolerate much higher nominal deficits and a larger debt than has so far been imaginable, the next president's options will be severely limited.

More to come.

Dani Rodrik: Breakdown

Project Syndicate: CAMBRIDGE – The world economy has seen globalization collapse once already. The gold standard era – with its free capital mobility and open trade – came to an abrupt end in 1914 and could not be resuscitated after World War I. Are we about to witness a similar global economic breakdown?

The question is not fanciful. Although economic globalization has enabled unprecedented levels of prosperity in advanced countries and has been a boon to hundreds of millions of poor workers in China and elsewhere in Asia, it rests on shaky pillars. Unlike national markets, which tend to be supported by domestic regulatory and political institutions, global markets are only “weakly embedded.” There is no global anti-trust authority, no global lender of last resort, no global regulator, no global safety nets, and, of course, no global democracy. In other words, global markets suffer from weak governance, and therefore from weak popular legitimacy.

Recent events have heightened the urgency with which these issues are discussed. The presidential electoral campaign in the United States has highlighted the frailty of the support for open trade in the world’s most powerful nation. The sub-prime mortgage crisis has shown how lack of international coordination and regulation can exacerbate the inherent fragility of financial markets. The rise in food prices has exposed the downside of economic interdependence without global transfer and compensation schemes.

Meanwhile, rising oil prices have increased transport costs, leading analysts to wonder whether the outsourcing era is coming to an end. And there is always the looming disaster of climate change, which may well be the most serious threat the world has ever faced.

So if globalization is in danger, who are its real enemies? There was a time when global elites could comfort themselves with the thought that opposition to the world trading regime consisted of violent anarchists, self-serving protectionists, trade unionists, and ignorant, if idealistic youth. Meanwhile, they regarded themselves as the true progressives, because they understood that safeguarding and advancing globalization was the best remedy against poverty and insecurity.   

But that self-assured attitude has all but disappeared, replaced by doubts, questions, and skepticism. Gone also are the violent street protests and mass movements against globalization. What makes news nowadays is the growing list of mainstream economists who are questioning globalization’s supposedly unmitigated virtues.

So we have Paul Samuelson, the author of the postwar era’s landmark economics textbook, reminding his fellow economists that China’s gains in globalization may well come at the expense of the US; Paul Krugman, today’s foremost international trade theorist, arguing that trade with low-income countries is no longer too small to have an effect on inequality; Alan Blinder, a former US Federal Reserve vice chairman, worrying that international outsourcing will cause unprecedented dislocations for the US labor force; Martin Wolf, the Financial Times columnist and one of the most articulate advocates of globalization, writing of his disappointment with how financial globalization has turned out; and Larry Summers, the US Treasury chief and the Clinton administration’s “Mr. Globalization,” musing about the dangers of a race to the bottom in national regulations and the need for international labor standards. 

While these worries hardly amount to the full frontal attack mounted by the likes of Joseph Stiglitz, the Nobel-prize winning economist, they still constitute a remarkable turnaround in the intellectual climate. Moreover, even those who have not lost heart often disagree vehemently about the direction in which they would like to see globalization go. 

For example, Jagdish Bhagwati, the distinguished free trader, and Fred Bergsten, the director of the pro-globalization Peterson Institute for International Economics, have both been on the frontlines arguing that critics vastly exaggerate globalization’s ills and under-appreciate its benefits. But their debates on the merits of regional trade agreements – Bergsten for, Bhagwati against – are as heated as each one’s disagreements with the authors mentioned above.

None of these intellectuals is against globalization, of course. What they want is not to turn back globalization, but to create new institutions and compensation mechanisms – at home or internationally – that will render globalization more effective, fairer, and more sustainable. Their policy proposals are often vague (when specified at all), and command little consensus. But confrontation over globalization has clearly moved well beyond the streets to the columns of the financial press and the rostrums of mainstream think tanks.  

That is an important point for globalization’s cheerleaders to understand, as they often behave as if the “other side” still consists of protectionists and anarchists. Today, the question is no longer, “Are you for or against globalization?” The question is, “What should the rules of globalization be?” The cheerleaders’ true sparring partners today are not rock-throwing youths but their fellow intellectuals.

The first three decades after 1945 were governed by the Bretton Woods consensus – a shallow multilateralism that permitted policymakers to focus on domestic social and employment needs while enabling global trade to recover and flourish. This regime was superseded in the 1980’s and 1990’s by an agenda of deeper liberalization and economic integration.

That model, we have learned, is unsustainable. If globalization is to survive, it will need a new intellectual consensus to underpin it. The world economy desperately awaits its new Keynes.

Joseph Stiglitz: Fannie’s and Freddie’s free lunch

FT.com / Comment & analysis / Comment - Fannie’s and Freddie’s free lunch: Much has been made in recent years of private/public partnerships. The US government is about to embark on another example of such a partnership, in which the private sector takes the profits and the public sector bears the risk. The proposed bail-out of Fannie Mae and Freddie Mac entails the socialisation of risk – with all the long-term adverse implications for moral hazard – from an administration supposedly committed to free-market principles.

Defenders of the bail-out argue that these institutions are too big to be allowed to fail. If that is the case, the government had a responsibility to regulate them so that they would not fail. No insurance company would provide fire insurance without demanding adequate sprinklers; none would leave it to “self-regulation”. But that is what we have done with the financial system.

Even if they are too big to fail, they are not too big to be reorganised. In effect, the administration is indeed proposing a form of financial reorganisation, but one that does not meet the basic tenets of what should constitute such a publicly sponsored scheme.

First, it should be fully transparent, with taxpayers knowing the risks they have assumed and how much has been given to the shareholders and bondholders being bailed out.

Second, there should be full accountability. Those who are responsible for the mistakes – management, shareholders and bondholders – should all bear the consequences. Taxpayers should not be asked to pony up a penny while shareholders are being protected.

Finally, taxpayers should be com pensated for the risks they face. The greater the risks, the greater the compensation.

All of these principles were violated in the Bear Stearns bail-out. Shareholders walked away with more than $1bn (€635m, £500m), while taxpayers still do not know the size of the risks they bear. From what can be seen, taxpayers are not receiving a cent for all this risk-bearing. Hidden in the Federal Reserve-collateralised loans to JPMorgan that enabled it to take over Bear Stearns were almost surely interest rate and credit options worth billions of dollars. It would have been easy to design a restructuring that was more transparent and protected taxpayers’ interests better, giving some compensation for their risk-bearing.

But the proposed bail-out of Fannie Mae and Freddie Mac makes that of Bear Stearns look like a model of good governance. It sets an example for other countries of what not to do. The same administration that failed to regulate, then seemed enthusiastic about the Bear Stearns bail-out, is now asking the American people to write a blank cheque. They say: “Trust us.” Yes, we can trust the administration – to give the taxpayers another raw deal.

Something has to be done; on that everyone is agreed. We should begin with the core of the problem, the fact that millions of Americans were made loans beyond their ability to pay. We need to help them stay in their homes, including by converting the home mortgage deduction into a cashable tax credit and creating a homeowners’ Chapter 11, an expedited way to restructure their liabilities. This will bring clarity to the capital markets – reducing uncertainty about the size of the hole in Fannie Mae’s and Freddie Mac’s balance sheets.

The government should set a limit to the size of the bail-out, at the same time making it clear that, while it will not allow Fannie Mae and Freddie Mac to fail, neither will it be extending a blank cheque. There may need to be a drastic reorganisation. There should be a charge for the “credit line” (any private firm would do as much) and, given the risk, it should be at a higher than normal rate.

The private sector knows how to protect its interests; the government should do no less. As long as the credit line is extended, no dividends should be paid. To ensure that the government is not simply bailing out creditors who failed in due diligence, at least, say, 25 per cent of any notes, loans or bonds coming due that are not lent again should be set aside in an escrow account, to be paid only after it is established that taxpayers are not at risk. Any government loans should be cumulative preferred debt: the taxpayers get paid before any other creditors receive a dime. To discourage moral hazard the interest rate should be at a penalty rate and, reflecting the rising risk, increase with the amount borrowed. Finally, the government should participate in the upside potential as well as the downside risk: for instance, by taking shares (which it might later sell) or, as it did in the Chrysler bail-out, warrants.

We should not be worried about shareholders losing their investments. In earlier years, they were amply rewarded. The management remuneration packages that they approved were designed to encourage excessive risk-taking. They got what they asked for. Nor should we be worried about creditors losing their money. Their lack of supervision fuelled the housing bubble and we are now all paying the price. We should worry about whether there is a supply of liquidity to the housing market, so that those who wish to buy a home can get a loan. This proposal provides the necessary liquidity.

A basic law of economics holds that there is no such thing as a free lunch. Those in the financial market have had a sumptuous feast and the administration is now asking the taxpayer to pick up a part of the tab. We should simply say No.

The writer, 2001 recipient of the Nobel Prize for economics, is university professor at Columbia University. He is co-author with Linda Bilmes of The Three Trillion ­Dollar War: the True Cost of the Iraq Conflict

John Berry: Offshore Drilling Claims Are a Political Hoax

Gmail - (BN) Offshore Drilling Claims Are a Political Hoax: John M. Berry - brad.delong@gmail.com: Commentary by John M. Berry

Aug. 1 (Bloomberg) -- It's absurd to argue that ending the moratorium on drilling off parts of the U.S. coasts would quickly bring down the high price of gasoline.

This chimera is being touted by President George W. Bush and other Republican politicians, including the party's presumptive presidential nominee, Senator John McCain of Arizona, to deflect blame for what it's costing for a fill-up.

To get around the fact that it would be a decade or more before any oil would be likely to flow, a few partisan analysts have said that the cost of gasoline would fall right away. They argue that the prospect of additional oil supply in the future would lead oil companies to produce more oil immediately because they would expect prices for crude to be lower later on.

Well, wouldn't that depend on whether a producer had the capacity to pump more oil today, and whether it thought lifting the moratorium would add a significant amount of oil to future supply relative to future demand?

There are good reasons to question whether another 1 million or 2 million barrels of crude a day would make much difference in prices when world consumption is running at 85 million barrels a day.

About a fourth of all U.S. oil production is already coming from offshore wells, primarily in the central and western portions of the Gulf of Mexico that aren't covered by the moratorium.

In a May 2007 forecast, the Interior Department's Minerals Management Service, which oversees exploration and drilling on the outer continental shelf, said that oil production in the Gulf was likely to increase from 1.3 million barrels a day last year to about 2 million barrels by 2010.

In other words, production was expected to rise by about 700,000 barrels a day over a three-year period. That would be a gain of about 14 percent over the 5.1 million barrels produced daily last year in the U.S.

Yet somehow that sort of forecast based on industry projections and announced discoveries had no discernable impact on world crude oil prices.

Why would anyone assume that opening other coastal areas -- which may or may not harbor large quantities of oil that might or might not be economic to produce sometime in the future -- will have an immediate impact on today's oil prices?

Nevertheless, the assertions continue: lift the moratorium and gasoline prices will fall. And since McCain's Democratic opponent, Senator Barack Obama of Illinois, is opposed to ending the moratorium, he therefore is responsible for high gasoline prices.

Drilling proponents point to an estimate from the Minerals Management Service that there are probably about 76 billion barrels of oil waiting to be discovered offshore.

The problem is that little of that oil -- perhaps about 18 billion barrels -- lies in areas subject to the moratorium. A third of the total is off the coast of Alaska, where drilling is extraordinarily difficult and expensive, and most of the rest is in the Gulf of Mexico where drilling is permitted.

Some 3.5 billion barrels in the Minerals Management Service estimate are off the Atlantic coast in the Baltimore Canyon, an ideal geologic formation in which to find oil. It runs from east of Cape Cod all the way to North Carolina.

Beginning in the late 1970s, huge tracts were opened for exploration and oil companies jumped at the chance to drill. About 35 wells were sunk off Cape Cod, New York and New Jersey at a cost, including purchases of the leases, of almost $3 billion.

The result? Nothing. Neither oil nor gas was found.

Another ideal formation, the Destin Dome, in the eastern Gulf Coast area off Pensacola, Florida, was another major disappointment. Exxon Mobil Corp. spent heavily to acquire leases and found no commercial quantities of oil or gas in what became known as ``Dusty Dome.''

Years later, natural gas was found in the Dome. Yet, as a result of political pressure generated by environmental concerns, oil companies were paid to give up their leases. The gas has never been produced.

At a July 15 press conference, Bush said that he had lifted an executive order that had restricted offshore drilling since the early 1980s. Now, he said, ``the only thing standing between the American people and these vast oil resources is action from the U.S. Congress.''

Republicans are hoping that the public, believing their foolish claims that drilling will lower gasoline prices, will put enough pressure on Democratic opponents during the August congressional recess that begins today to pass legislation to end the moratorium this fall.

Meanwhile, both Bush and congressional Republicans have refused to take a step that really could reduce gasoline prices. That is to release a portion of the light, low-sulfur crude in the U.S. Strategic Petroleum Reserve.

In an earlier column I explained why that action might bring down prices in a way opening more environmentally fragile coastal waters to more drilling can't. Obviously Bush, McCain and their allies would prefer to mislead the American people and escape blame for effects of their past lack of action on the nation's energy problems.

John Quiggin: Yet more on fiduciary obligation

From <>:

Yet more on fiduciary obligation — Crooked Timber: Yet more on fiduciary obligation by JOHN QUIGGIN on JULY 31, 2008

I’m planning a further post about the notion of ‘creative capitalism’, but before I get on to it, I thought it might be useful to clear up some of the confusion surrounding the alternative view, that managers have a ‘fiduciary obligation’ to act solely in the interests of shareholders, reflected in debate at my blog, at CT here (including this and here) and at the Creative Capitalism blog.

A surprising number of people seemed to want to argue that, even in the absence of any legal enforceable obligation, and therefore any reasonable ex ante expectation on the part of investors, managers are morally obliged to put the interests of shareholders before their own, and before the interests of any other stakeholders. This ethical absolutism is particularly odd when it is combined with a willingess to endorse breaches of implicit contracts with workers and, as in Richard Posner’s post, hypocritical pretences of corporate altruism.

This kind of claim about the moral responsibility of managers as agents runs against the whole body of literature on principal-agent relationships, which takes a starting point the assumption that agents will pursue their own objectives within the constraints of their contractual relationship with the principal. It’s up to the principal to design the contract in a way that aligns the interests of principal and agent (this is called incentive-compatibility).

The other point raised by Daniel is that the concept of maximizing profits is too ill-defined to act as a real constraint on managers. Hence, if fiduciary obligation is to made an implementable policy, it must be tied to something more concrete.

There is one coherent version of fiduciary obligation that satisfies the incentive compatibility requirement. This is the view that managers are obligated to seek the maximum possible increase in the stock price (after taking account of dividend payments), and that they should be motivated to do so by being paid largely or wholly in stocks or options. This is consistent with fiduciary obligation if the shareholders are taken to be the specific group who hold shares when the manager is appointed, and whose interests are therefore aligned with the manager’s. Finally, stockholders can use lawsuits to protect themselves against opportunistic manipulation of stock prices.

This approach was highly popular during the 1990s, but the dotcom boom in particular showed its weaknesses. On the one hand, it turned out that stock price manipulation was easy to do and hard to prove, while the remedy of stockholder lawsuits came to be seen as a cure worse than the disease. On the other hand, as the principal-agent literature predicts, risk-averse managers don’t want their entire return tied to the vagaries of a stock price. So, they’ve not only sought to write contracts that guarantee them a large risk-free income, but they rewritten those contracts ex post when the terms called for them to share the losses of stockholders.

So, the idea of managers as agents who share the interests of stockholder-principals is problematic, and the idea of managers as capitalist saints who subordinate their own interests and objectives to those of an abstract body of stockholders is nonsensical. That doesn’t provide a positive basis for any alternative corporate objective to the pursuit of profit (including rents captured by managers) in some form or another. I’ll come to this point, I hope, in my next pos

Barack Obama on the Economy

Barack Obama: I’ve often said that this election represents a defining moment in our history. On major issues like the war in Iraq or the warming of our planet, the decisions we make in November and over the next few years will shape a generation, if not a century.

That is especially true when it comes to our economy.

Most of you probably know this – not just because whenever you open the paper or turn on the TV, you see reports of more job losses, more foreclosures, and prices rising at the pump, but because you feel the effects of all this every single day. You’re working harder than ever to pay bills that are bigger than ever. You’re driving less and saving less. You’re struggling to balance work and family. You’re worried about the value of your home and whether you’ll be able to afford college for your kids and still retire at a decent age.

For millions of families, these anxieties seem to be growing worse with each passing day, causing many people to lose faith in that fundamental promise of America – that no matter where you come from, or what you look like, or who your parents are, this is a country where you can make it if you try.

Now, part of the reason people are struggling is due to fundamental changes in our economy. Over the last few decades, revolutions in technology and communication have made it so that corporations can send good jobs wherever there’s an internet connection. Children here in Missouri aren’t just growing up competing for good jobs with children in California or Indiana, but with children in China and India as well.

But what we also have to remember is that it wasn’t simply globalization or a normal part of the business cycle that got us where we are today. It was irresponsible decisions that were made on Wall Street and in Washington. In the past few years, we have relearned the essential truth that in the long run, we cannot have a thriving Wall Street and a struggling Main Street. When wages are flat, prices are rising and more and more Americans are mired in debt, the economy as a whole suffers. When a reckless few game the system, as we’ve seen in this housing crisis, millions suffer and we’re all impacted. When special interests put their thumb too heavily on the scale, and distort the free market, those who compete by the rules come in last. And when government fails to meet its obligation – to provide sensible oversight and stand on the side of working people and invest in their future – America pays a heavy price.

So we have a choice to make in this election. We can either choose a new direction for our economy, or we can keep doing what we’ve been doing. My opponent believes we’re on the right course. He’s said our economy has made great progress these past eight years. He’s embraced the Bush economic policies and promises to continue them. Our country and the working families of Missouri cannot afford that.

These policies haven’t worked for the past eight years and they won’t work now. We need to leave these policies in the past where they belong. It’s time for something new. It’s time to restore balance and fairness to our economy so it works for all Americans, recognizing that we must grow together, Wall Street and Main Street, profits and wages.

That starts with giving immediate relief to families who are one illness or foreclosure or pink slip away from disaster. To help folks who are having trouble filling up their gas tank, I’ll provide an energy rebate. To help hardworking Americans meet rising costs, I’ll put a $1,000 tax cut in the pockets of 95% of workers and their families, including 3 million folks here in Missouri. To help end this housing crisis, I’ll provide relief to struggling homeowners. And to protect retirement security, I’ll eliminate taxes for seniors making under $50,000 a year.

If Senator McCain wants a debate about taxes in this campaign, that’s a debate I’m happy to have. Because while we’re both proposing tax cuts, the difference is who we’re cutting taxes for. Senator McCain would cut taxes for those making over $3 million. I’ll cut taxes for middle class families by three times as much as my opponent. Let me be clear: if you’re a family making less than $250,000, my plan will not raise your taxes – not your income taxes, not your payroll taxes, not your capital gains taxes, not any of your taxes. And unlike my opponent, I’ll pay for my plan – by cutting wasteful spending, shutting corporate loopholes and tax havens, and rolling back the Bush tax cuts for the wealthiest Americans.

But in this election, we can do something more than just provide short-term relief. We can secure our long-term prosperity and strengthen America’s competitiveness in the 21st century. It won’t be easy. It won’t happen overnight. But I refuse to accept that we cannot meet the challenges of our global economy. I’m running for President because I believe we can choose our own economic destiny.

We can choose to go another four years with the same reckless fiscal policies that have busted our budget, wreaked havoc in our economy, and mortgaged our children’s future on a mountain of debt; or we can restore fiscal responsibility in Washington.

We can go another four years with a broken health care system that’s leaving millions uninsured, driving millions more to financial ruin, and making it harder for manufactures to compete; or we can finally solve our health care crisis once and for all. We can guarantee health care for anyone who wants it, make it affordable for anyone who needs it, and cut costs for businesses and their workers by picking up the tab for some of the most expensive illnesses and conditions.

We can choose to do nothing about disappearing jobs and shuttered factories for another four years, or we can encourage job creation in the United States of America. We can end tax breaks for corporations that ship jobs overseas and give them to companies that create jobs here in this country. We can make sure that our trade agreements work for both Wall Street and Main Street. And we can create nearly two million jobs by investing in our crumbling infrastructure and building new schools, roads, and bridges.

And if anybody tells you we can’t afford to make these investments, you just tell them that if we can spend $10 billion a month in Iraq, we can invest some of that money right here in the United States of America. That’s what we can do in this election. The choice is ours.

We can go another four years without truly solving our energy crisis; we can choose my opponent’s plan to give $4 billion in tax breaks to oil companies at a time when they’re making record profits, or we can finally make America energy independent so that we’re less vulnerable to oil price shocks and $4 a gallon gas. We can invest in renewable energies like wind power, solar power, and the next generation biofuels. And we can create up to five million new, green jobs that pay well and can’t be outsourced. That’s what we can choose to do in this election.

We can choose to stay mired in the same education debate that’s consumed Washington for decades, or we can provide every child with a world-class education so they have the skills to compete and succeed in our global economy. We can invest in early childhood education, recruit an army of qualified teachers with better pay and more support, and finally make college affordable by offering an annual $4,000 tax credit in exchange for community or national service.

These are the choices we face in November. We can choose to remain on the path that’s gotten our economy into so much trouble, or we can reclaim the idea that in this country, opportunity is open to anyone who’s willing to work for it.

In the end, that’s all most Americans are asking for. It’s not a lot. The people I’ve met during this campaign in town halls and living rooms; on farms and front porches – they know that government can’t solve all their problems, and they don’t expect it to. They’re willing to do their part – to work harder and study more and replace the remote controls and video games with books and homework. They believe in personal responsibility and self-reliance. They don’t like seeing their tax dollars wasted.

But they also believe in an America where jobs are there for the willing; where hard work is rewarded with a decent living; and where you can actually build a better life for your children and grandchildren. That’s the promise of this country, and I believe we can keep it if we choose a new direction for our economy, a different course for our country, and get to work in the months and years ahead. Thank you.

Pete Davis: Please Promise to Balance the Budget Eventually

Please Promise to Balance the Budget Eventually | Capital Gains and Games: I sympathize with Stan on this one, but I must side with Andrew.

The next President of the United States will face a fiscal mess, which will sharply curtail his options on the war and on the economy.  Fulfilling some campaign promises quickly will be required in the first 100 days to establish credibility.  If energy prices don't ease, the economy may stay weak, requiring more fiscal stimulus.  No matter who is president, most of the Bush tax cuts will be extended, the AMT may be abolished (I hope!), and a lot of high priority items will insure that we run large deficits for the foreseeable future.

That doesn't mean we should forget about balancing the budget.  The trick is to promise to balance it eventually.  Waiting for good times to balance the budget quickly simply doesn't work.  It takes a long time to establish the culture of deficit reduction on Capitol Hill.  It takes a long time for deficit reduction policies to bear enough fruit that more of the same becomes possible.  In 1981, we passed the largest tax cuts in U.S. history to that point, and, in 1982, we immediately began closing tax loopholes and shaving spending.  Deficit reduction took another step with Gramm-Rudman-Hollings in 1985 and again in 1987, but we didn't do the heavy lifting until 1990 and again in 1993.

Even when the deficit is huge and needs to expand, there are always ineffective and wasteful tax and spending programs that can be jettisoned.  Large agricultural subsidies to large corporations make no sense when food prices are at record highs.  Large energy subsidies to large oil companies make no sense when oil prices and profits are at record highs.  Spending 16% of GDP on health care with no discernable improvement in health outcomes compared to when we spent much less makes no sense.  Subsidizing insurance for flood and fire prone areas just encourages development that should occur elsewhere.  We've just discovered large pools of offshore tax evasion that should be pursued no matter what.  When we bail out large entities, like Bear Stearns and Fannie Mae and Freddie Mac, we should protect taxpayers by giving them warrants or other shares in future profits as compensation.  The list of sensible things to do no matter what fiscal condition we're in is quite long and should be pursued.

The next president should pursue important priorities while keeping a tight rein on as much spending and tax policy as possible.  One thing I learned on the Senate Budget Committee in the 1980s, it's a lot easier to go after a wide range of spendng cuts and tax loopholes than it is to go after a few.  Every deficit reduction measure is subject to intense lobbying.  The more deficit reduction proposals, the less lobbying can be concentrated on a single proposal.  The more you ask for initially, the more you get. 

The next president might also be well advised to set an overall percentage spending increase limit on entitlements, on domestic discretionary spending, and on defense spending.  That would force the government to set priorities.  That in itself is a very important part of the game.

The American public understands the need to balance the budget a lot better than its elected officials do.  As long as they perceive a basic sense of fairness about how deficit reduction is pursued, they will support it.  They understand the heavy debts we're piling up on their children.  They understand that the world's leading powers have historically declined because they couldn't stop spending, mostly on wars.  They understand what everyone in Washington says, but does little about -- the path we're on is unsustainable.  It's not too late to change it, but it will take a long time.  Let's get started.

Chris Blattman: When Things Fell Apart

Chris Blattman's Blog: When things fell apart:

Working in Uganda in the early 1980s, I came to learn what it meant to live in a world of violence. Among the reasons my colleagues in the Ministry of Cooperatives welcomed the overthrow of Idi Amin was that with Uganda no longer a pariah state, they could now attend international conferences.

And among the reasons they attended such conferences was that they could then sleep, for they need not fear the arrival of soldiers in the night.

Insights like this reminded me of something of which I was but fleetingly aware: not only the fragility of life, but also its political premise. I knew then that I would some day have to return to the issues to which that recognition gave rise.

Thus Bob Bates opens his new book, When Things Fell Apart. Now a senior professor of government at Harvard, he looks back at years of study and service to understand the roots of conflict and violence in Africa.

African states and societies developed distorted economies in the decades after independence. By the 1970s and 80s, these state structures were precariously perched. Bates describes the collapse that ensued: how plunges in commodity prices and pressures to democratize destabilized regimes, reignited old disputes, and plunged much of the continent into disorder.

What's unusual about this book: it's short, it's readable, and it's intelligent. Normally, if I get just two of the three, I'm thrilled.

Bates holds the same theory as I do: volatility in commodity prices drives conflict through the center, not the periphery. Falling prices don't make rural farmers more willing to rebel; rather falling prices lead to falling state revenues, undermining the apparatus of control.

The problem: I think we both may be wrong. The data (so far) don't support the theory. After many years in library basements copying numbers from ancient African statistical yearbooks, I have the numbers to test it. And so far: no result. Watch this space for more...

Tanta: Duelling Discourses of Debt

Calculated Risk: Duelling Discourses of Debt: Gretchen Morgenson has another wowser in today's New York Times. This one comes with not just a lengthy narrative packed with details about her "exemplary" borrower, but a video in which we hear the borrower's own version of events, as well as seeing her in her "natural habitat."

I confess that I find this video utterly fascinating. The story it tells is all too common; the "analysis" is trite; the implied but never explicitly suggested "solution"--that people like Diane shouldn't be "allowed" to borrow more than they can "afford"--undoubtedly stays unarticulated because the reporter has no intention of being forced to unpack or defend her assumptions about borrower agency, lender paternalism, or the economics of consumer spending.

Indeed, what is fascinating about this video is precisely the near-total contradiction between what the interviewee, Diane, has to say about herself, and what the voiceover and commentary by Morgenson has to say about Diane. That and the loving camera focus on class cues--the repeated panning on the tchochkes, the six! perfectly unnecessary shots of chubby Diane smoking, the capture of the chain-link fence--which tries but never quite succeeds in erasing the impact of Diane's articulate, polite, rather engaging self-presentation. It is as if the camera must keep reassuring itself--the reporter, us--that Diane is "really" an unsophisticated dupe of the lenders, a perpetual victim of circumstances and missteps, by making sure we (the Times reader) see her as "tacky." All the while the camera also records Diane's voice, telling a candid, crisp story that utterly contradicts the reporter's.

The very first thing we hear and see in the video is Diane saying, "I'm not good with money." Immediately, in an apparently unscripted moment, she then deals with the interruption of a collection call from a credit card lender by dropping her phone into the dishwasher and shutting the door on it. "Better?" Diane says, ruefully, quite clearly suggesting to us that she is highly self-aware. Her playful little over-the-top dramatization of her pattern of dealing with mounting debt (hiding the phone in the dishwasher rather than simply hanging up or turning off the ringer), combined with her forthright claim that she is "not good with money," establish from the very beginning that Diane sees her situation as mostly about her own choices, her own habits, and her own willingness to deny certain realities.

Yet the very first voiceover, immediately following this scene, says "Diane McLeod's debt is the result of financial missteps, unfortunate circumstances, and a lending industry willing to extend her more credit than she could possibly repay." Here we have the classic conceit of journalism: there is the interviewee, telling her story in her own words and gestures, a "little picture" story that focuses unswervingly on her necessarily parochial view of her own behavior--her impulsive spending, her inability to avoid traps even when she recognizes that they are traps, her ability to make denial of reality look and feel like a rather charming insouciance. And there is the reporter, "adding context" by moving the story into the "big picture," forging the connections to the "larger issues" about the finance industry and the economy that the interviewee never makes, "limited" as she is to her own subjective experiences.

However, it's a journalistic technique that works better, in my view, when the journalist's narrative doesn't outright contradict the interviewee's narrative. If it does, we have the right to expect some explanation: why is the journalist's narrative more plausible than the interviewee's? How is it that the journalist both relies on the facts provided by the interviewee to build a story, but also concludes that the interviewee's version of events is dubious? Without having these questions answered, we begin to fear that the journalist simply is unable to see the contradiction.

Morgenson, breaking into Diane's narrative, tells us that "more and more Americans like Diane McLeod are facing financial ruin. For years, they've spent more than they earned, and they've used credit cards and other debt to do so, and now they're really under a mountain of borrowings. It leaves them in a position where only one incident, whether it's a job loss, a divorce, an illness, can push them right over the edge."

This claim is followed immediately by a gratuitous scene of Diane heading into the backyard for a smoke with the dogs. (In America in 2008, nothing labels you "underclass" more than being a smoker.) The voiceover says, "Diane's financial troubles began back in 1996. Her husband's business was failing, and ultimately her marriage failed as well. Diane . . . grew depressed."

Diane herself then picks up the narrative: "I paid gas, electric, and telephone on the credit cards because there was no income. If we had a fight sometimes I would go out and shop and buy something to make me feel good."

The reporter doesn't seem to notice that Diane actually reverses the sequence here: in her telling, the job loss/marital troubles predated the debts, and in fact caused them, in two ways. She used the cards as "emergency money" to pay utilities during an income gap, but she also gets depressed and starts buying stuff to "feel good." In Morgenson's version, the overspending and debt happens first, and then the job loss/marital troubles force it to stop.

In the very next segment, Morgenson takes us "big picture" again to talk about credit card company practices that exacerbate debt. "These companies would levy late fees and overlimit fees on her," Morgenson says, "because they allowed her to spend more than her limit." The implication is that if the credit card lenders had taken control of the situation and cut Diane off, she wouldn't have spent so much. (Somehow I can imagine the credit card lender calling Diane to tell her she was over her limit, and the phone ending up in the dishwasher.)

What does Diane herself say? Apparently, she became depressed again early this year and just stopped paying bills. Her credit card lenders cut her off. "Old habits still weren't dead. I didn't have credit cards, but when I got paid, I would be buying things . . . shoes, clothes, handbags. . . ." Throughout the video, we find Diane repeatedly attributing her spending not so much to her too-high credit card limits, but to the entertainment value of QVC and eBay and her use of buying as therapy, to the point that when there is no more credit limit she simply spends her paycheck. A detail that isn't in the video but is in the accompanying article is of interest here:

Almost immediately after she refinanced, in late 2005, the department store where she worked her second job, as a jewelry saleswoman at night and on weekends, cut back her hours. She quit altogether. . . .

The implication, again, is that the loss of the second job was one of those "unfortunate circumstances" that "sent her over the edge." But several paragraphs above that, we discover that Diane is paying 27% on a $1,500 account "at a local jewelry store." Diane certainly wouldn't be the first person in the world to discover that a part-time job in retail is simply more exposure to seductive consumer goods that she ends up purchasing, spending as much or more than she makes, and that losing a job like that is probably good news for the household finances.

What are we to make, ultimately, of these duelling narratives? Morgenson glances off the issue only once, in the article (not the video):

Ms. McLeod, who is 47, readily admits her money problems are largely of her own making. But as surely as it takes two to tango, she had partners in her financial demise.

What does this mean, exactly, beyond the truism that there has to be a creditor for every debtor? My sense is that Morgenson's biggest concern is simply to make sure we don't mistakenly feel sorry for these creditors; she goes to some length to show that they made profits on Diane (although whether those profits will survive the coming charge-offs when she declares bankruptcy is hardly certain). I guess if any of you were in danger of feeling sorry for lenders, this is a useful corrective. As far as I can tell, Diane never lied to a lender or induced anyone to extend credit by fraudulent means; anyone who can read a credit report could have seen that she has been a serial debt pyramider since the mid-90s and she never tried to hide that. It frankly never occurred to me for a moment to feel sorry for her creditors.

The contradiction that continues to concern me, though--which remains unresolved--is the total mismatch between the consumer's own explanation of her behavior, which is a psychological one of the "shopping addiction" variety, and which implies that her experience has involved a lot of miserable life events that can only be relieved by compensatory spending, and the reporter's "economic" explanation which focuses on what lenders do to Diane, and that implies that her "bad times" only threaten her continued spending rather than inspiring it. In one narrative, debt-funded consumer spending is "sustainable" until you lose your job or get sick or get divorced. In the other narrative, unsustainable debt-funded consumer spending is the response to losing your job or getting sick or getting divorced.

I think getting a handle on this problem matters. We are continually being treated to this kind of schizoid message in the media as a whole. Morgenson herself wrote an angry article just a few months ago on frozen HELOCs that didn't simply grossly overstate the cost of unused credit lines. It explicitly chastised lenders for lowering credit limits:

Reeling from losses on their wretched loan decisions of recent years, lenders are preventing borrowers with pristine credit and significant equity in their homes from tapping into credit lines that they paid dearly to secure. . . .

[B]orrowers who have contacted Mr. Kratzer say they are in the middle of home improvement projects that they can no longer finance, or have college tuition bills that they were going to pay using the credit lines. Now they can’t.

Medical expenses, another reason that borrowers tap their equity lines, are also posing problems for some homeowners.

And small-business owners who use home equity lines to bridge cash-flow gaps throughout the year are also being stricken by these curbs, Mr. Kratzer said. He has also heard from people who paid down some of their home equity lines, expecting to be able to draw on them again. Now they are out of luck.

Diane McLeod once had "good credit," according to the Times. She once used credit to "bridge cash-flow gaps" of her self-employed husband's. She once felt entitled to continue to spend as she expected to when the account was opened, even down the road after she had spent too much, because the credit company "allowed her" to. She once believed that the appraised value of her home had nowhere to go but up. Isn't it possible to conclude that these mean lenders who are lowering people's credit lines are actually doing folks a favor, by preventing another crop of Dianes? Why is it that in one case we have irresponsible (and highly profitable) lenders who should have taken the responsibility to cut off the credit but didn't, and in the other case credit tightening is "unfair"?

I can't help but think part of the problem here is a class issue. The video goes out of its way to portray Diane as a working-class woman who simply cannot be trusted with credit. (And she certainly helps with that.) The "real" middle class, who have "pristine credit" and are going to be sending their kids to college, not adding their kids to the mortgage so that money can be spent on knick-knacks and $70 handbags, have the right to be outraged when the lender forces them back to spending only what they earn or have saved. I really think the "class cues" in the video are just too heavy-handed to miss.

Whether derived from certain assumptions about class or not, though, these contradictions floating around--Morgenson is just the one who is best at distilling "conventional wisdom," not the sole source of it--are at the heart of our inability to decide how to regulate the lending industry, and have been for a long time. Arguments over fiduciary responsibilities and lender obligations to offer only "sustainable" or "affordable" credit always crash on our unwillingness to accept lender paternalism, our belief that at least some of us have the "right" to borrow and spend as much as we want to as long as the bills are "paid on time" (but the balances aren't necessarily "paid down"). They also, of course, tend to fall on the competing responses to the threat of recession: as we approach the possibility that a lot of us might suffer job loss, illness, and divorce, as it were, is it time to "stimulate" things by continuing to offer easy credit for the purchase of $70 handbags, or time to cut off the credit spigot so that the debt load doesn't get any worse?

The metaphor of "Two Americas" is getting a touch cliched, but I am nonetheless tempted by it. It's as if there's an America in which spending is "healthy" and is only interrupted by "misfortune," and another America in which spending is always "unhealthy," a dysfunctional attempt to compensate for the rather frequent experience of lost jobs, failed businesses, divorces, illness. One America should be allowed to decide for itself how much it wants to borrow and spend; the other needs to be cut off or turned down by "responsible" lenders because they cannot control themselves.

Where I part company with Morgenson, I suspect, is really that I don't think this distinction is as easy to make as she does. My suggestion first made some time ago that "we are all subprime now" was an attempt to resist the division of the world into "prime" and "subprime," the "pristine" HELOC borrowers of Morgenson's earlier piece with the irresponsible bankrupts typified by Diane McLeod. The irony is that I actually largely agree with Morgenson that lenders should take much more responsibility for denying applications that don't make sense or cutting off credit limits on existing accounts that have clearly become unsustainable. I just think that this sort of behavior will inevitably disappoint some of the "pristine" borrowers as much as it does the shopaholics. It has to; if the point is to cut off borrowing before it ends in disaster, then you have to cut off more than a few borrowers who don't happen to think they're anywhere near disaster yet, thank you very much. Or who think of themselves as engaging in "good spending" (home improvements, tuition, small businesses), not "bad spending" (anything from QVC), the assumption being that only "bad spending" should be cut off, even though debt is debt. I cannot see how asking lenders to exercise the discipline that consumers don't (or won't) can possibly be "painless." Prevention is indeed generally worth a pound of cure, except that you have to listen to a lot of whining from those being "prevented." Nobody much likes seeing the punch bowl go away when the party is still going strong. Nobody much likes seeing the punch bowl stay on the table until everyone has passed out and thrown up on each other, either.

That, ultimately, is what makes me feel like this video is "cheap." It's just too easy to get readers of the Times to agree that the Dianes of the world should have their credit cut off before they buy more junk. What is difficult is getting the New York Times demographic to agree that its own credit should be cut off. The fact that even so set up, Diane manages to come across as a real, complex, rather appealing person in spite of it all, rather than a self-pitying passive "victim of predators," is to me the video's real redeeming quality. After too much exposure to people like this, courtesy of the media, I found myself ready to take Diane, warts and all, on her own terms and actually wish her well, even while I hope it's a long, long time before she buys another house. Good luck, Diane.

Ricardo Caballero: Moral Hazard Misconception

Moral hazard misconception: Here we go again. Two pillars of the US and world financial system, Fannie Mae and Freddie Mac, have become embroiled in the current financial turmoil. To be sure, nobody in its right mind expects these institutions to stop operating; the issue instead is whether, how and when a government intervention takes place.

Treasury secretary Henry Paulson has just announced a first package of all out support that involves contingent credit and possibly equity. The terms of the latter are yet unclear but they harbor hope that Treasury has realized how dangerous its previous anti-stockholders strategy had become. Only last Friday the rumor had it that Secretary Paulson was insisting that any potential government rescue plan would not benefit the companies’ shareholders. In fact, if he were to continue with the modus operandi he adopted during the recent Bear Stearns intervention, not only shareholders would not benefit, but they would be “exemplarily” punished.

The standard rationale for such strategy is that doing otherwise would invite “moral hazard.” That is, it would encourage excessive risk taking by equity holders as they can count with government insurance for their errors and mishaps.  A slightly more cynical interpretation is that a bailout carries a political cost by giving the appearance of favoring the rich over the working families struggling with foreclosures.

Unfortunately, while either of these motivations is a sound one during normal times, Secretary Paulson’s anti-“moral hazard” strategy has been extremely counterproductive in the current economic environment of systemic distress and recurrent flight-to-quality episodes. This policy simultaneously hampers the private sector’s ability to solve the crisis and exacerbates the likelihood of further panics. There are two reasons for this backfiring.

First, a private sector solution to the current crisis requires fresh capital injections into financial institutions. However, in an environment of widespread uncertainty where the instinctive reaction is to run away from risk-taking, private capital is likely to remain on the side for much too long. Thus, the optimal policy response is to encourage and leverage private risk-taking, not to discourage it with a pending threat of exemplary punishment were a fragile situation turn worse, regardless of cause. Economic policy risk is compounding the private sector’s reluctance to capitalize financial institutions.

Financial institutions and leveraged institutions more generally, are subject to coordination failures whereby a sudden loss of confidence can cause the demise of an otherwise sound institution. Granted, better managed and capitalized institutions are less likely to encounter a run - it is not a surprise that it was Bear and Stearns rather than JP Morgan that went under a few weeks back - but no institution is immune to panics, as long as it is providing its socially useful liquidity transformation and intermediation role. It has always been understood that it is good economic policy to help financial institutions ride crises of this kind, and that a central role of policymakers in such events is to stabilize expectations with the hope that once the panic is gone, it is private rather than public funds that foster the recovery. In fact, it is this perspective that led both the FED and the Treasury to support Bear Stearns on the days preceding the weekend’s forced fire sale.  By punishing equity holders, the Treasury chose to hurt those that it had invited to stabilize the situation just a few hours earlier. In doing so, it may have damaged its ability to leverage its policies with private capital support, a key aspect of policy success in dealing with a coordination failure problem.

Second, during periods of high uncertainty and the potential for runs, large or coordinated shortsellers are more likely to succeed in triggering socially inefficient panic-selling. Rumor-mongering and persistent selling pressure eventually weaken wary investors and depositors. Unfortunately, by choosing to punish shareholders, Secretary Paulson has rewarded shortsellers and raised their ammunition to cause further financial instability.  Again, while shortselling plays a very useful role during normal times, it can turn into a source of instability during periods of high uncertainty.

In summary, given the extreme fragility of the current economic scenario, there is no  doubt that it is better to err on the side of inducing “moral hazard” than to risk discouraging private capital markets initiatives and eliciting speculative attacks and wasteful predatory behavior. Failing to assess the relative risks correctly and obsessing over “moral hazard” at this time, carries the great danger that the financial system may succumb to a much more serious flight-to-quality problem.

Jeffrey Frankel: No Libertarians in Financial Crises

“No Atheists in Foxholes.” — No Libertarians in Financial Crises. | Jeff Frankels Weblog | Views on the Economy and the World: Someone this week asked me what I thought of policy-makers who ex ante profess a free-market ideology and acute sensitivity to the dangers of moral hazard from financial bailouts, but who toss that ideology overboard when faced with a financial crisis.  The reference was to Treasury Secretary Henry Paulson’s lobbying this week in support of a rescue for Fannie Mae and Freddie Mac, the two big home mortgage agencies, following on the rescue of Bear Stearns.   My reply was:  “They say there are no atheists in foxholes.   Perhaps, then, there are also no libertarians in financial crises.”

There are more egregious cases than Hank Paulson of inconsistencies between ex ante promises by policy-makers not to bail out and ex post bailouts when disaster strikes.    (Indeed, some amount of change in position may even be rational for an office-holder, though I would draw the line at false statements.)    I reserve my disdain for those who go around lecturing others on the evils of bailouts, only to out-do the officials they criticized when their own turn in the hot-seat comes.     An example I have in mind concerns the members of the starting team in the Bush Administration who had lectured the Clinton Administration on the evils of its allegedly excessive bailouts of emerging markets in the 1990s, only to engage in worse when they themselves were faced with the Argentine crisis that began in 2001.  There was no particular reason to rescue the Kirchner government.   Argentina in 2003 would have been the perfect place to refrain from rolling over an IMF program, thereby putting a limit on the moral hazard problem.   The Clinton Treasury had done this with Russia in August 1998 despite high costs in terms of systemic contagion.   Yet the Bush White House continued to push the IMF to bail out Argentina.  Apparently the failing lay in simple inexperience and lack of awareness that any such choices are always difficult.   (See pages 9-11 of my article on Managing Financial Crises, in the Cato Journal, Summer 2007.)    The Administration was very much following in the footsteps of the Reagan Administration, which talked tough at first when the international debt crisis hit in 1982 but which then participated in comprehensive IMF-led bailouts of Latin American debtors who had been pursuing far worse macroeconomic policies than the emerging market governments of the 1990s crises.     Incidentally, before writing this blog post, I checked into the World War II origins of the sentence “There are no atheists in foxholes.”     I discovered to my surprise that this expression was intended, and is still considered, as a put-down of atheists, and that their lobby protests its use.     Of course the proposition is not literally true; indeed some soldiers lose their pre-existing belief in God when confronted with the horror of war.   But let us stipulate that those who suddenly face death more often find religion than lose it.  What strikes me as odd is that the expression is apparently normally interpreted as meaning that people who profess atheism don’t really mean it, and that their true colors come out under pressure.     I had, apparently erroneously, thought rather the reverse.   (Indeed, Richard Dawkins argues that vast numbers of people who would no more bet on the existence of God than on the existence of the Easter Bunny, nonetheless call themselves “agnostics” rather than atheists, to avoid rocking the boat.)      I had always taken the expression to mean that mankind’s hunger for religious beliefs comes from a desperate desire for divine intervention – or, failing that, comfort – when confronting death.  Something more along the lines “There are no unsoiled underpants in foxholes.”     I am in sympathy with the character in a novel who said “That maxim, ‘There are no atheists in foxholes,’ it’s not an argument against atheism — it’s an argument against foxholes.”    So what’s my point?    Not to argue that governments should intervene always  (nor that they should intervene never).  The lesson for government officials is that wherever they choose to draw the bailout line – one hopes the line strikes an intelligent balance between the short-run advantages of ameliorating a serious financial crisis and the longer-run disadvantages of moral hazard — they should think through the system ahead of time.  They should take the appropriate regulatory precautions during the boom times, which correspond to the bailouts that will inevitably come during the busts.      Long ago, the United States worked out the approximate right answer for banks:  there will always be rescue of small depositors ex post when banks run into serious trouble, and so under our system, (i) deposit insurance provides formal guarantees and (ii) banks must pay the price ex ante through reserve requirements, capital requirements, and active regulatory oversight.  What we now need to do is design the analogous sort of system for non-banks.   It should not come as a surprise to high officials that there are such things as financial crises anymore than it should come as a surprise to soldiers that there are such things as bombs.   It shouldn’t be necessary to alter one’s fundamental beliefs when crisis strikes, in the absence of truly unforeseeable developments.

Justin Fox: Frank Raines thinks 'private capital is essentially unlimited.' Has he tried to get a loan lately? - The Curious Capitalist - Justin Fox - Economy - Markets - Business - TIME

Frank Raines thinks 'private capital is essentially unlimited.' Has he tried to get a loan lately?: Franklin Delano Raines, who ran Fannie Mae before being forced to resign amid an accounting scandal in 2004, and still owns stock in the company, has a very strange op-ed today in the Washington Post. Raines starts out by arguing that the loan losses so far at Fannie Mae and Freddie Mac are actually pretty manageable. He may be right about that, he may be wrong. I'm really not the one to judge, although Bert Ely told me pretty much the same thing and Bert's no friend of the Fanniefreddieplex. But then Raines writes something that seems patently wrong:

The Treasury proposals, curiously, substitute government capital for private capital. Fannie and Freddie have served their housing mission for decades by marshalling private equity from around the world. Federal capital funds are inherently limited, while private capital is essentially unlimited.

Fannie was created as the Federal National Mortgage Association in 1938 because some other guy named Franklin Delano and his allies in Congress concluded that private capital needed government help to find its way into the mortgage market. The reason that Fannie and Freddie have subsequently been able to marshal private funds from around the world so successfully is in large part because investors assume that, if things go really wrong, U.S. taxpayers will take care of them. That is what has enabled the Fanniefreddieplex to outbid purely private rivals over the decades and build such a dominant role in the mortgage business. And perhaps more important, it is what has enabled them to keep funding loans even after private investors soured on non-Fannie-Freddie (and let's not forget Ginnie) mortgage securities last summer. (More after the break.)

In fact, it is the performance of what are called the government-sponsored enterprises over the past year--and during the credit crunches of the early 1980s and early 1990s, and the mini-crunch of the late 1990s--that offers the single best justification for their existence. They make loans when others are too bearish to dare. Don't believe me? Take a look at this chart, which I'm rerunning from a post a couple of days ago:

Raines argues that private capital is "essentially unlimited." But one of the defining aspects of private capital markets is that they go through big swings between fearing risk and embracing it. Right now they're fearing it big-time, unless told that taxpayers stand ready to help out if things go bad. At this moment, in the mortgage market, the promise of what Raines calls "federal capital funds" appears essential to accessing the private capital needed to keep the housing market from completely freezing up (as it did in the early 1930s, before government got into the mortgage business in a big way).

The main point of Raines's piece seems to be that the Fanniefreddiebashers in the White House are to blame for all the companies' troubles. I would agree that critics of the two companies seem remarkably blind to the essential service they're providing during the current financial crisis. But Raines's depiction of them as successful private companies that aren't really reliant on taxpayer backing sounds a lot like somebody who was born on third base hitting a triple. Not that Raines was born on third base; he's a remarkable self-made success story. Fannie Mae is not.

C. Eugene Steuerle: Dealing with the Original Sin Driving Health Costs

Dealing with the Original Sin Driving Health Costs: Dealing with the Original Sin Driving Health Costs: In budget policy, myths are progress's number one enemy. One silly fiction now making the rounds is that we don't know how to judge the relative value of different types of health care, so we can't control health care costs—at least not for now. Like many myths, this one contains an element of truth—there is a lot we don't know. So what? It's still a myth that we know too little to act.

Suppose you are married and you and your spouse are debating how your daughter Daisy should spend her time. You believe that she should be studying, practicing piano, and avoiding TV. Your spouse believes that educational TV and organized play groups are the way to go. Meanwhile, the kid plays in traffic every day. Every day, new opportunities arise for the child, you learn more, and she reveals new capabilities and limitations. A headlined study indicates that kids are getting fat in idle gear, another that watching Cookie Monster addicts them to sugar. This new knowledge clarifies your choices, but it doesn't improve your ability to make decisions. You disagree as much as ever, and there Daisy is—still playing in the street.

What's wrong with this picture, anyway?

Why can't these parents realize that making decisions requires neither perfect agreement nor perfect information? And what makes them think that they aren't "deciding"—albeit by default—to let Daisy play in traffic? Clearly, rectifying their original sin by getting the kid out of the street should be the parents' first move. U.S.-style health care has its own original sin. Insurance, whether public and private, fixes it so my doctor and I bargain over what you will pay for each health benefit I receive. Maybe you pay because we're in the same health plan or maybe because you're a taxpayer. Either way, you'll pay if I demand more, if my doctor decides I need more tests, if she refers me to other providers, or if I need specialists' help.

If something valuable costs little or nothing, demand is potentially unlimited. Close to unlimited demand for health care means it absorbs ever-rising shares of national income. And that means that health reform will ultimately fail unless I can no longer freely shift costs to you and the income of providers, insurers, and intermediaries no longer are determined largely by how many things they do, not their value.

Even if this original sin in health care didn't relentlessly drive health costs up, it still distorts health care spending itself. Research on chronic care trumps research on cures because cures are often less profitable to drug companies. Expensive end-of-life care, no matter that it is often of limited value and sometimes involves needless pain, prevails over preventive health care, some forms of which don't even qualify for health care subsidies.

Reform doesn't end debate. If health insurance costs aren't allowed to spiral out of control, then someone must decide that some prices are too high, that some services are too costly, and that one provider is too expensive relative to another.

But who? Here we act like the parents of the child playing in the street. Some of us don't want government to decide. After all, how can it know which new technology to bet on or what is best for each person? Some of us don't think that individuals should or could decide either. How can we non-experts pick the right medical care—especially while under the scalpel?

Some of us don't trust intermediaries and providers to live with a fixed pot of money. Hollywood tells us that health maintenance organizations create greedy physicians, while insurers in that world deny us treatment just to make a buck.

But these issues aren't insurmountable. Government, providers, intermediaries, and individuals, at least at time of insurance purchase, can all be made to face up more to the cost side of the health care equation. Every day we wait to act, perverse incentives undermine health care by driving employers and individuals out of the market for insurance and chew up dollars that could be spent on other societal necessities.

Before darling Daisy gets maimed or killed, we need to return decisionmaking to every part of the health care system, from government to individual to providers to intermediaries. Just because hot debates will ensue doesn't mean that we don't know what to do.

Noam Scheiber on Peter Gosselin: 'High Wire - The Precarious Financial Lives of American Families,' by Peter Gosselin - Review - NYTimes.com

Book Review - 'High Wire - The Precarious Financial Lives of American Families,' by Peter Gosselin - Review - NYTimes.com: One of the most memorable lines from George W. Bush’s convention speech in September 2004 introduced the concept of an “ownership society.” “Ownership brings security, and dignity and independence,” the president declared.

The line was memorable not just for its soothing cadences, but because it arguably marked the high point of the Bush era. Within six months, Bush would win re-election and unveil the centerpiece of his ownership agenda, Social Security privatization. Six months after that, not only was Social Security privatization dead: its staggering unpopularity had weighed down the entire administration.

Peter Gosselin probably didn’t set out to explain the collapse of the Bush economic agenda in “High Wire: The Precarious Financial Lives of American Families.” But his trenchant book could easily be read that way. An economics reporter with The Los Angeles Times, Gosselin demonstrates that Bush’s ownership agenda completely misread the economic zeitgeist. Americans have seen their financial situations grow far less stable over the last few decades, he reports. Against this backdrop, the prospect of assuming still more risk, as Bush proposed, gave many of them agita.

Scouring the data, Gosselin finds that the income of a middle-class family in the early 1970s typically rose or fell by no more than 17 percent in a given year; today, that range is plus or minus 26 percent. And it’s not just the middle class who’ve seen their incomes fluctuate wildly. The most affluent tenth of the country saw a slightly greater rise in volatility.

The cause of this increased turbulence, Gosselin says, is a changing labor market and a decades-long erosion of the corporate and social safety net. A generation ago, when unemployment relief was more generous, when companies provided liberal health and pension benefits and private insurers weren’t as stingy as they are today, a serious illness or the loss of a job usually wasn’t devastating. Now, such a setback is much more likely to bring economic ruin.

Gosselin’s argument isn’t entirely new. In recent years, academics like the Yale political scientist Jacob S. Hacker and the Harvard-trained sociologist Elisabeth Jacobs have devoted countless megahertz of computing power to documenting these trends (both are mentioned in the book). Though his treatment of the numbers is rigorous and lucid, Gosselin adds more value with his hair-raising stories of arbitrary job loss and evaporating retirement funds.

Gosselin has an eye for spotting leaks in places you thought were treated with risk-resistant shellac. That health coverage you think you have? As Rebecca Rowlands learned during her fight with ovarian cancer, the insurer can withdraw it upon discovering the most innocent error in your paperwork. That homeowners policy you’re currently on? As the Tunnell family learned after losing their house in a wildfire, the insurer can unilaterally gut your coverage with a single opaquely worded notice.

One of the book’s few limitations is that Gosselin’s characters can seem like abstractions. We learn enough to understand their problems, but not enough to feel real empathy. Such is not the case in a chapter called “Unjobs,” however, where we meet a former Arthur Andersen executive named Bruce Meyer.

Meyer is part of a growing army of economic zombies who look to the untrained eye like successes but who lost their livelihoods years ago and have yet to fully replace them. Meyer still occupies a spacious home in a tony Atlanta suburb, with a BMW and a Jeep Cherokee out front. He meets with business associates and even does high-profile charity work. But he hasn’t held a steady job for more than five years. The only things that sustain him are the odd consulting gig and years of savings. In the best passage of the book, Gosselin describes Meyer’s membership in the Kettering Group, a networking organization for down-on-their-luck executives. That there would be enough Bruce Meyers to form a club, and enough Kettering Groups to spawn a “nationwide phenomenon,” is a gruesome reminder of how few of us are insulated from the current insecurity.

The only thing missing from “High Wire” is a satisfying account of the rise in risk — the causes as opposed to the consequences. Gosselin often lays the blame at the feet of greedy executives, who, he says, have abdicated their responsibilities to workers — and in the case of insurers, to customers. He tends to anthropomorphize corporations, as when he writes that “employers have become less interested in maintaining career-long ties to their workers.”

There is no doubt that some corporations refuse to show loyalty and pay generous benefits even though they could. Likewise, insurance companies are increasingly skilled at skimming off the safest bets and denying coverage to the rest.

But to attribute the long-term rise in risk primarily to corporate malevolence misses the point. The years following World War II, which Gosselin posits as a model of corporate responsibility, were a historical anomaly: American companies faced little competition from war-flattened Europe and Asia. They could buy labor peace with rising wages and benefits. But with the resurgence of Japan and Western Europe in the 1960s and ’70s, American profit margins declined and workers got squeezed. Later on, the ease with which companies could tap foreign labor (along with pressure from Wall Street to show steady profit growth) further frayed the labor-management relationship.

These trends are of more than just academic interest. Easing the anxieties Gosselin describes requires understanding the forces that produced them. If greed and malevolence are the chief culprits, then aggressive regulation should suffice. But if the changes are structural and irreversible, we may have to rethink the role of government in the economy. Something akin to the Danish model might make sense. The Danes have one of the most business-friendly economies in the world — corporations can hire and fire with relative ease, taxes on profits and investment are low — but also one of the most generous welfare states. Perhaps not surprisingly, while Gosselin does offer a few sound policy recommendations, his discussion here is brief and somewhat scattershot.

Still, this is basically a quibble. In November, voters will face a choice between a Democrat who talks about alleviating the risks bearing down on lower- and middle-income Americans and a Republican who, in effect, promises to continue the Bush administration’s economic policies. Voters confused about how this choice affects their daily lives should read Gosselin’s book from cover to cover.

Nouriel Roubini on the endgame for Bretton Woods II

Nouriel Roubini on the endgame for Bretton Woods II - The Curious Capitalist - Justin Fox - Economy - Markets - Business - TIME: The Bretton Woods system of managed currencies unraveled in the early 1970s, leaving a decade of economic trouble in its wake. In recent years there's been a lot of talk of Bretton Woods II, the informal setup in which emerging market countries link their currencies to the dollar. That arrangement is of course under a lot of pressure. There's been lots of debate about whether China, the Persian Gulf countries, and others will keep buying U.S. assets to fend off a big rise in the value of their currencies vs. the dollar. Now Nouriel Roubini has written an epic post (you have to register to read the whole thing) arguing that this discussion becoming irrelevant:

[E]ven if the BW2 economies were to resist further their currency appreciation and desperately hold on BW2 - as the rate of accelerated forex accumulation in 2008 so far suggests – the result, like the demise of BW1 shows, would be a rise in global inflation that would – at some point – destroy BW2 as rising inflation would erode the competitiveness of the BW2 club. Thus, either way we are now closer to the end game of BW2: formally BW2 is still alive and well as the reserve accumulation is as aggressive as ever or even more aggressive than in 2006-2007 among many – but not all – members of the BW2 club. But continuing with BW2 is leading now – with certainty – to inflation becoming so unhinged in the BW2 club that the basis of undervalued currencies and export-led growth will be destroyed by the real appreciation that a rise in inflation induces.

I'm not entirely sure what this means. But I think it's bad news for Wal-Mart.

Ezra Klein: A Limited Health-Care Success in Massachussetts

A Limited Health-Care Success in Massachussetts: Everyone who looks at the Massachusetts health reform plan sees what they want to see. But evaluated on its own terms, the plan says much about the pitfalls and promises of reform: "Right now the Gov. Romney/Massachusetts' plan gets a failing grade on the ground," says Cato's Michael Cannon. "Massachusetts's pioneering plan to provide universal health coverage is off to a good start," enthuses The New York Times.

Signed into law on April 12, 2006, Massachusetts' health reform has become a Rorschach test for reformers: Advocates of free-market plans see the failure of government intervention. Single-payer supporters see the folly of private heath insurance. What very few are seeing is the Massachusetts plan.

But the Massachusetts plan is an interesting experiment in its own right. The product of a compromise between former Gov. Mitt Romney and an overwhelmingly Democratic state legislature, the Massachusetts plan is one state's attempt to rationalize its insurance market and get within spitting distance of universality. The plan made insurance more straightforward to buy, merged the individual and small-business markets to increase their purchasing power, implemented subsidies to make it more affordable for low-income residents to purchase health insurance, and instituted an individual mandate that forces nearly all residents to show proof of coverage or face a financial penalty.

All of which makes the Massachusetts plan a fairly ambitious initiative. But compared to the problems facing health-care, it's extremely modest. Health care reformers talk a lot about "comprehensive health reform." They mean reform that addresses all three parts of our health-care crisis: access (how many people have care), cost (how much they're paying for it), and quality (how good it is). The Massachusetts plan was not comprehensive health reform -- it did virtually nothing for cost or quality. (The legislation even set up a commission to look into cost and quality -- politician-ese for doing nothing). Rather, the Massachusetts plan sought something far simpler: Spend what money was necessary, and impose what penalties were necessary, in order to achieve something very close to universal health coverage.

Did it succeed? We don't know yet. The plan has a three-year implementation process and we're about halfway through. The early evidence suggests that the plan is on track to achieve its goals. But even if it were to prove fully successful, it wouldn't be enough to solve Massachusetts' health-care problems, much less the nation's. Without solving cost, you can't solve health care. The question is whether expanding coverage helps create the political incentives to face down cost.

Much of what we do know comes from an Urban Institute survey that studied working-age adults in the fall of 2006, which was before the plan's implementation, and then surveyed them again in the fall of 2007, a year after the plan came into effect. Over that time period, the uninsured rate for working-age adults dropped by about half, to 7.1 percent. The uninsurance rate for adults with incomes below 300 percent of the poverty line dropped by 11 percent. And this study tracked the period before the individual mandate really went into effect, at which point the program saw its largest surge in enrollment. The best estimates now suggest the uninsured rate is somewhere between 5 percent and 7 percent.

Covering this many adults has cost a fair amount of money, and the Massachusetts plan is coming in at about $150 million over budget. The reason? There are more uninsured people in Massachusetts than experts originally thought, and the response has been more enthusiastic than expected. Some of the plan's opponents have used this to blast the plan as a typical case of inefficient government. "They make it sound like the Big Dig," complains Jon Gruber, an MIT economist heavily involved in the plan's creation. "It's not. We're covering the uninsured and it turns out there's a lot of the uninsured. If you were doing the Big Dig and it turned out the tunnel was six times as long, you wouldn't be surprised it cost six times as much."

Insofar as the plan's point was to cover the uninsured, covering more of the uninsured may be pricey, but it's not a failure. It's an expensive success. A more relevant measure of the plan's efficiency is costs per enrollee, which have been lower than expected. Cost per enrollee came in under budget in 2007, by about $2 a month. In other words, the program is operating a bit more efficiently then expected, but covering more people than anticipated.

As for the individual mandate, there's very little data, because it didn't kick in till this year. Essentially, there are two questions with the mandate: Is it feasible (can the state gather the information for enforcement?), and is it sustainable (what's the political fallout when the mandate comes into effect?).

Here's what we do know: The underlying mechanism has proven extremely successful. The mandate is enforced through the tax code: All residents of Massachusetts have to report their insurance status, including proof of coverage, on their tax forms. Last year 98.4 percent of the state complied. That clears up the first question: The mandate's underlying mechanism actually works. People will report their coverage status, which means you can figure out who does and does not have insurance, and act accordingly. Next comes implementation: Does the mandate enrage those exposed to it? Does it compel them to purchase insurance? Some of both? We should know the answer in about a year.

For now, however, the program enjoys broad public support. According to the Urban Institute, 68 percent of working-age adult residents approved of the plan in the fall of 2006. In the fall of 2007, a year into implementation, 71 percent approved. Similarly, a Harvard School of Public Health survey found 61 percent approval in September 2006. Come June 2007, 67 percent approved. The program is becoming more, rather than less, popular with time.

Presumably, that's because the plan is succeeding at what it set out to do -- increase health-care coverage in Massachusetts. But it's failing at what it never tried to do -- substantially cut costs. With health costs rising at their traditional velocity, the Massachusetts plan is currently an unsustainable success. Jon Kingsdale, executive director of the Commonwealth Health Insurance Connector Authority (the plan's governing body) concurs: "I don't think a major increase in access is ultimately sustainable unless we contain costs."

As care becomes less affordable, fewer people can afford it. As Kingsdale says, "We have a national policy on cost containment. Every year, when there are double digit increases [in health spending], we throw another 2 million people on the rolls of the uninsured." In theory, the individual mandate forbids that response. The subsidies, which are available to people earning up to 300 percent of the poverty line, mean the state is committed to footing the bill for low-income people. The mandate presumes residents can afford coverage, and it'll spark a political revolt if voters find themselves penalized for not buying a product they can't afford. In other words, one of two things can happen: Either Massachusetts can figure out how to control costs, or it can let the program become unaffordable and repeal the legislation.

This is, at least in the abstract, the political logic of focusing on access first: Expanding access creates pressures that force the system to figure out how to control costs. There's evidence this is beginning to happen in Massachusetts. The legislature is beginning to consider cost-control measures. "We call it health care reform 2," says Kingsdale. If they fail, the Massachusetts plan will go down in history as an interesting, well-intentioned, but ultimately inadequate experiment. But if their commitment to coverage leads it to stare down costs, it can look forward to the day when everyone looks at the plan and sees the same thing: a success.

Felton and Rienhart: The First Global Financial Crisis of the 21st Century

The First Global Financial Crisis of the 21st Century | vox - Research-based policy analysis and commentary from leading economists. A VoxEU.org Publication. Edited by Andrew Felton and Carmen Rienhart:

• http://www.voxeu.org/index.php?q=node/1352
• http://www.voxeu.org/reports/subprime/preface_intro.pdf
• http://www.voxeu.org/reports/subprime/section1.pdf
• http://www.voxeu.org/reports/subprime/section2.pdf
• http://www.voxeu.org/reports/subprime/section3.pdf
• http://www.voxeu.org/reports/subprime/chronology_glossary.pdf

Bernanke and Gertler: Agency Costs, Net Worth, and Business Fluctuations

Ben Bernanke and Mark Gertler (1989), "Agency Costs, Net Worth, and Business Fluctuations," American Economic Review, Vol. 79, No. 1, (Mar., 1989), pp. 14-31 http://www.jstor.org/stable/pdfplus/1804770.pdf

Gali and Gambetti: On the Sources of the Great Moderation

Jordi Gali and Luca Gambetti (2008), On the Sources of the Great Moderation:

The remarkable decline in macroeconomic volatility experienced by the U.S. economy since the mid-80s (the so-called Great Moderation) has been accompanied by large changes in the patterns of comovements among output, hours and labor productivity. Those changes are reflected in both conditional and unconditional second moments as well as in the impulse responses to identified shocks. Among other changes, our findings point to (i) an increase in the volatility of hours relative to output, (ii) a shrinking contribution of non-technology shocks to output volatility, and (iii) a change in the cyclical response of labor productivity to those shocks. That evidence suggests a more complex picture than that associated with "good luck" explanations of the Great Moderation.

Beaulieu, Cutler, Ho, and Horrigan: The Business Case for Diabetes Disease Management: A Case Study of HealthPartners and Independent Health Association

Nancy Dean Beaulieu, David M. Cutler, Katherine E. Ho, and Dennis Horrigan (2003), The Business Case for Diabetes Disease Management: A Case Study of HealthPartners and Independent Health Association

Diabetes is one of the most common—and most costly—chronic diseases.... Analysis of two health plans with established diabetes programs shows that the business case for diabetes disease management is weak. The initial costs for such programs are substantial, and plans may not be able to reap the potential savings until 10 years after a health plan member is enrolled in the program. The authors estimated that net savings under the HealthPartners diabetes management program would be only about $75 per patient. Although the economic returns to health plans would be minimal, there would be substantial potential gains to society. For example, a diabetic patient who spent 10 years in the program would experience a benefit of $31,000 in improved length and quality of life. At Independent Health, researchers found that diabetes testing rates and some results improved after the initiation of the plan’s disease management program, but they failed to find proof of substantial short-term medical cost savings attributable to the program...

Gianmarco I.P. Ottaviano and Giovanni Peri: Immigration and National Wages: Clarifying the Theory and the Empirics

Gianmarco I.P. Ottaviano and Giovanni Peri (2008), "Immigration and National Wages: Clarifying the Theory and the Empirics":

This paper estimates the effects of immigration on wages of native workers at the national U.S. level. Following Borjas (2003) we focus on national labor markets for workers of different skills and we enrich his methodology and refine previous estimates. We emphasize that a production function framework is needed to combine workers of different skills in order to evaluate the competition as well as cross-skill complementary effects of immigrants on wages. We also emphasize the importance (and estimate the value) of the elasticity of substitution between workers with at most a high school degree and those without one. Since the two groups turn out to be close substitutes, this strongly dilutes the effects of competition between immigrants and workers with no degree. We then estimate the substitutability between natives and immigrants and we find a small but significant degree of imperfect substitution which further decreases the competitive effect of immigrants. Finally, we account for the short run and long run adjustment of capital in response to immigration. Using our estimates and Census data we find that immigration (1990-2006) had small negative effects in the short run on native workers with no high school degree (-0.7%) and on average wages (-0.4%) while it had small positive effects on native workers with no high school degree (+0.3%) and on average native wages (+0.6%) in the long run. These results are perfectly in line with the estimated aggregate elasticities in the labor literature since Katz and Murphy (1992). We also find a wage effect of new immigrants on previous immigrants in the order of negative 6%.

Hufbauer and Adler: Why large American gains from globalisation are plausible

Gary Clyde Hufbauer and Matthew Adler (2008), "Why large American gains from globalisation are plausible":

A popular headline figure quantifying the US payoff from globalisation at $1 trillion per year has been criticised by Dani Rodrik and other sceptics. Here is an explanation and defence.... In May 2007, Dani Rodrik took us to task on his blog for exaggerating the benefits.... Rodrik resurrects arithmetic developed by Frank Taussig (1927) as a "reality check" on our calculations.... The partial equilibrium formula cited by Rodrik essentially confines the benefits of globalisation to the "welfare triangles" generated when tariffs are abolished. As calculated by Rodrik, the welfare triangles total not more than 0.25%of US national income, around $35 billion of potential gains if all US tariffs were abolished. By contrast, our conservative estimate suggests that full global liberalisation would ultimately increase US national income by about 4.1%, about $570 billion based on GDP in 2007....

Why do our estimates differ so much from Rodrik and the World Bank?... Rodrik and the World Bank authors disregard services.... More importantly, though... both Rodrik’s quick calculation and the World Bank study ignore powerful forces that enormously expand the payoff from policy liberalisation.... "Rightsizing" inputs to the needs of industrial producers; lowering the true cost of household purchases below the advertised inflation rate; "sifting and sorting" firms so that the most efficient expand and the least efficient shrink; curtailing the markup margins associated with monopolistic competition stimulating laggard industries (remember autos and steel) to match the productivity of foreign competitors; reducing the enormous international differences that prevail in prices for traded goods, and enjoying the benefits of internal and external returns to scale....

Josh Bivens along with Jared Bernstein... embrace the same antiquated arithmetic as Rodrik... they leave out forces like induced productivity, shifting and sorting, and returns to scale...

De Grauwe: Cherished myths fall victim to economic reality

Paul De Grauwe (2008), "Cherished myths fall victim to economic reality":

Take the hugely influential idea that financial markets are efficient.... The credit crisis has destroyed the idea that unregulated financial markets always efficiently channel savings to the most promising investment projects.... This boom and bust cycle cannot have been an example of efficient channelling of savings into the most promising investment projects.... There is a second idea that is likely to become the victim of the financial crisis. This is the idea found in macro economic models, that individuals are supremely well-informed creatures...

Cascio: Can Young Americans Compete in a Global Economy?

Elizabeth Cascio (2008), "Can Young Americans Compete in a Global Economy?"