Grasping Reality with Both Hands: Economist Brad DeLong's Fair, Balanced, and Reality-Based Semi-Daily Journal

Short-Term Costs of Long-Run Fiscal Stupidity

I'm glad I'm not a Republican. Just saying.

---

J. Bradford DeLong: Project Syndicate: Back in 1981, America’s Republican Party gave up all belief that the government’s budget ought to be balanced. The idea took hold that tax cuts should be undertaken all the time, at every opportunity, because reducing taxes supposedly raised revenue.

Irving Kristol, sometime editor of the magazine The Public Interest and one of the intellectual midwives of this idea, later wrote that he was interested not in whether it was true, but in whether it was useful. Years later, he spoke of his “own rather cavalier attitude toward the budget deficit and other monetary or fiscal problems. The task...was to create a new...conservative... Republican majority – so political effectiveness was the priority, not the accounting deficiencies of government...” Now it has become clear that John McCain – who once criticised George W Bush’s tax cuts as imprudent and refused to vote for them – has succumbed to this potion. He appears to be proposing further tax cuts that promise to cost the US Treasury some $300bn a year, to “offset” them with cuts in earmarked spending accounted for at $3bn a year, and somehow to balance the budget.

We know the consequences: McCain’s fiscal policy is likely to be standard Republican fiscal policy – and since 1981, standard Republican fiscal policy has increased the ratio of gross federal debt to GDP by nearly 2% per year. By contrast, a typical post-WWII Democratic administration has reduced the debt-to-GDP ratio by more than 1% per year. This is one of the issues at stake in this year’s presidential election.

Policies that ignore the level of government debt lead to the currency’s collapse, depression (due to the resulting disruption of the sectoral division of labour), and high inflation – perhaps hyperinflation. Often, the guilty blame the economic catastrophe on the sinister manipulations of foreigners like the “gnomes of Zurich” or the IMF. The US is far from that point. But even in the shorter run – over the next two presidential terms, say – the costs of a high deficit and rapid debt growth would be substantial.

A growing debt-to-GDP ratio would, in the first instance, crowd out investment, as resources that would otherwise go to fund productive investment instead support private or public consumption. Since 1981, the US has been lucky in that inflows of capital from abroad financed the growth of government debt. At some point, this will stop, and increases in deficits will trigger capital flight from the US. Suppose that over the next eight years larger deficits trigger neither extra capital inflows nor capital outflows, and suppose that a lower-investment America is a poorer America, with a gross social return on investment of 15% per year. By 2016, America’s productive potential would be smaller by an amount that would reduce real GDP by 3.6% – $500bn real dollars, or roughly $3,000 per worker. In a poorer America, fewer businesses would find it worthwhile to entice secondary workers from families into the labor force, and perhaps 500,000 net jobs would disappear.

In getting from here to there over the next eight years, a higher-debt America would see productivity growth slow by perhaps a third of a percentage point per year. Average unemployment would then have to rise in order to keep workers’ demands for real wage increases at a level warranted by productivity growth. The gross correlations between productivity growth and average unemployment found in the 1970’s, 1980’s, 1990’s, and 2000’s would increase the economy’s natural rate of unemployment by about one-fifth of a percentage point, costing an additional 500,000 jobs.

And a higher-debt America is one in which savers and lenders would have a justified greater fear that the government would resort to inflation in order to repudiate part of its outstanding debt. The Federal Reserve would then have to fight inflation – putting upward pressure on unemployment – in order to reassure savers and lenders of its willingness to guard price stability. There are not even crude gross correlation-based estimates of the size of this effect, but economists believe that it is very real. Would it cost a negligible number of jobs? A quarter-million? A million?

Add it all up, and you can reckon on an America that in 2016 that will be much poorer if McCain rather than Barack Obama or Hillary Rodham Clinton is elected president. Other countries that are counting on exporting to America would be affected by slower growth and lower employment in the US.

However, under McCain, the wedge between public spending and taxes would be larger, Americans would feel richer, and they would spend more at the expense of “posterity” eight years down the road. Ronald Reagan might have approved. After all, as he put it: “Why should I do anything for posterity? What has posterity ever done for me?” Or was that Groucho Marx?

Another Bite at the "Infant Industry" Apple...

J. Bradford DeLong (2008 Draft), "April 25: Long-Run Growth Revisited: Endogenous Growth" http://www.j-bradford-delong.net/2008_pdf/20080424_industrial_policy.pdf

Needed: More Aggregate Demand: The Keynesian Cure

J. Bradford DeLong (2008), "The Keynesian Cure," for Project Syndicate: BERKELEY -- It is not yet foredoomed that the world economy will undergo a substantial recession in the next three years or so: we might still escape. But governments should play it safe by starting to take more steps now to cushion, soften, and shorten the period of high unemployment and slow or negative growth that now looks very likely.

It is a fact of nature – human nature, at least – that prudent and appropriate policies now will later seem excessive. At some point, the world economy will begin expanding rapidly again. But it would be most imprudent to assume that the turning point is right now, and that things are as bad as they will get.

Perhaps the best way to look at the situation is to recall that three locomotives have driven the world economy over the past 15 years. The first was heavy investment, centered in the United States, owing to the information technology revolution. The second was investment in buildings, once again centered in the US, driven by the housing boom. The third was manufacturing investment elsewhere in the world – predominantly in Asia – as the US became the world economy’s importer of last resort.

For 15 years, these three locomotives kept the world economy near full employment and growing rapidly. When the high-tech boom ended in 2000, the Federal Reserve orchestrated its replacement by the housing boom, while investment in Asia to supply the US market was chugging along at an increasing pace.

Many today are complaining about Alan Greenspan’s monetary stewardship, which kept these three locomotives stoked: “serial bubble-blower” is the most polite phrase that I have heard. But would the world economy really be better off today under an alternative monetary policy that kept unemployment in America at an average rate of 7% rather than 5%? Would it really be better off today if some $300 billion per year of US demand for the manufactures of Europe, Asia, and Latin America had simply gone missing?

The first locomotive, however, ran out of fuel seven years ago, and there is no clear technology-driven alternative leading sector, like biotechnology, that can inspire similar exuberance, rational or otherwise. The second locomotive began sucking fumes two years ago, and is now coasting to a halt, which means that the third – the US as importer of last resort – is losing speed as well: the weak dollar accompanying the housing finance crash makes it unprofitable to export to the US.

The world economy, as John Maynard Keynes put it 75 years ago, is developing magneto trouble. What it needs is a push – more aggregate demand. In the US, the weak dollar will be a powerful boost to net exports, and thus to aggregate demand. But, from the perspective of the world as a whole, net exports are a zero-sum game. So we will have to rely on other sources of aggregate demand.

The first source is the government. Fiscal prudence is as important as ever over the medium and long term. But for the next three years, governments should lower taxes – especially for the poor, who are most likely to spend – and spend more.

The second source is private investment. The world’s central banks are already cutting interest rates on safe assets, and will cut them more as the proximity and magnitude of the likely global slump becomes clear.

But low interest rates are entirely compatible with stagnation or depression if risk premia remain large – as the world learned in the 1930’s, and as Japan relearned in the 1990’s. The most challenging task for governments is to boost the private sector’s effective risk-bearing capacity so that businesses have access to capital on terms that tempt them to expand.

J. Bradford DeLong: The End of the Age of Friedman

J. Bradford DeLong: Harvard professor Dani Rodrik -- perhaps the finest political economist of my generation -- recently said on his blog that a colleague has been declaring the past three decades "the Age of Milton Friedman."

According to this view, the coming to power of former US president Ronald Reagan, former British prime minister Margaret Thatcher and former Chinese leader Deng Xiaoping led to an enormous upward leap in human liberty and prosperity. I say yes -- and no -- to this proposition.

Friedman adhered throughout his life to five basic principles: strongly anti-inflationary monetary policy; a government that understood that it was the people's agent and not a dispenser of favors and benefits; a government that kept its nose out of people's economic business; a government that kept its nose out of people's private lives; and an enthusiastic and optimistic belief in what free discussion and political democracy could do to convince people to adopt principles one through four.

Measured against these principles, Reagan failed on numbers two and four and adopted the first one only by default -- former Federal Reserve chairman Paul Volcker's anti-inflation policy in the 1980s dismayed many of Reagan's close aides. Thatcher failed on number four.

And Deng, while a vast improvement over his predecessors -- former Soviet leaders Vladimir Lenin, Joseph Stalin, Nikita Khrushchev and former Chinese leader Mao Zedong -- failed on all five, with the possible exception of number three. We do not know what Deng's desired set of economic arrangements for a system of "socialism with Chinese characteristics" was, and, in all likelihood, he did not know, either.

But I say yes in part to the "Age of Friedman" proposition, because only Friedman's set of principles self-confidently proposed both to explain the world and to tell us how to change it.

Still, I would build up a counterbalancing set of principles, because I believe that Friedman's principles do not, ultimately, deliver what they promise.

My principles would start from the observation that market economies and free and democratic societies are built on a very old foundation of human sociability, communication and interdependence. That foundation had a hard enough time functioning when human societies had 60 members -- eight orders of magnitude less than today's 6 billion.

So my principles would then be developed from Karl Polanyi's old observation that the logic of market exchange puts considerable pressure on that underlying foundation. The market for labor compels people to move to where they earn the most, at the price of potentially creating strangers in strange lands. The market for consumer goods makes human status rankings the result of market forces rather than social norms and views about justice.

This critique of the market is, of course, one-sided. After all, other arrangements for allocating labor appear to involve more domination and alienation than the labor market, which offers opportunities, not constraints.

Similarly, "social norms" and "views about distributive justice" usually turn out to favor whomever has the biggest spear or can convince others that obedience to the powerful is obedience to God. Market arrangements have a larger meritocratic component than the alternatives, and they encourage positive-sum entrepreneurship, making it easier to do well by doing good.

Nevertheless, the distribution of economic welfare produced by the market economy does not fit anyone's conception of the just or the best. Rightly or wrongly, we have more confidence in the correctness and appropriateness of political decisions made by democratically elected representatives than of decisions implicitly made as the unanticipated consequences of market processes.

We also believe that government should play a powerful role in managing the market to avoid large depressions, redistributing income to produce higher social welfare, and preventing pointless industrial structuring produced by the fads and fashions that sweep the minds of financiers.

Indeed, there is a conservative argument for social-democratic principles. Post-World War II social democracy produced the wealthiest and most just societies the world has ever seen. You can complain that redistribution and industrial policy were economically inefficient, but not that they were unpopular. It seems a safe bet that the stable politics of the post-war era owe a great deal to the coexistence of rapidly growing, dynamic market economies and social-democratic policies.

Friedman would say that, given the the world in 1975, a move in the direction of his principles was a big improvement. When I think of former US president Jimmy Carter's energy policy, Arthur Scargill at the head of the British mineworkers' union and Mao's Cultural Revolution, I have a hard time disagreeing with Friedman about the world in the mid-1970s.

But there I would draw the line: While movement in Friedman's direction was by and large positive over the past generation, the gains to be had from further movement in that direction are far less certain.

Three Different Cures for Three Types of Financial Crises

From the Taipei Times -- Project Syndicate:

Three cures for three crises by J. Bradford Delong: Tuesday, Jan 01, 2008, Page 9:

A full-scale financial crisis is triggered by a sharp fall in the prices of a large set of assets that banks and other financial institutions own, or that make up their borrowers' financial reserves. The cure depends on which of three modes define the fall in asset prices.

The first -- and easiest to handle -- mode is when investors refuse to buy at normal prices not because they know that economic fundamentals are suspect, but because they fear that others will panic, forcing everybody to sell at fire-sale prices.

The cure for this mode -- a liquidity crisis caused by declining confidence in the financial system -- is to ensure that banks and other financial institutions with cash liabilities can raise what they need by borrowing from others or from central banks.

This is the rule set out by Walter Bagehot more than a century ago: Calming the markets requires central banks to lend at a penalty rate to every distressed institution that would be able to put up reasonable collateral in normal times.

Once everybody is sure that, no matter how much others panic, financial institutions won't have to dump illiquid assets at a loss, the panic will subside. And the penalty rate means that financial institutions can't profit from the investment behavior that left them illiquid -- and creates an incentive to take due care to guard against such contingencies in the future.

In the second mode, asset prices fall because investors recognize that they should never have been as high as they were, or that future productivity growth is likely to be lower and interest rates higher. Either way, current asset prices are no longer warranted.

This kind of crisis cannot be solved simply by ensuring that solvent borrowers can borrow, because the problem is that banks aren't solvent at prevailing interest rates. Banks are highly leveraged institutions with relatively small capital bases, so even a relatively small decline in the prices of assets that they or their borrowers hold can leave them unable to pay off depositors, no matter how long the liquidation process.

In this case, applying the Bagehot rule would be wrong.

The problem is not illiquidity but insolvency at prevailing interest rates. But if the central bank reduces interest rates -- and credibly commits to keeping them low in the future -- asset prices will rise. Thus, low interest rates can make the problem go away, while the Bagehot rule -- with its high lending rate for banks -- would make matters worse.

Of course, easy monetary policy causes inflation, and the failure to "punish" financial institutions that exercised poor judgment in the past may lead to more of the same in the future. But as long as the degree of insolvency is small enough that a relatively minor degree of monetary easing can prevent a major depression and mass unemployment, this is a good option in an imperfect world.

The third mode is like the second: A bursting bubble or bad news about future productivity or interest rates drives the fall in asset prices. But the fall in values is larger. Thus easing monetary policy won't solve this kind of crisis, because even moderately lower interest rates cannot boost asset prices enough to restore the financial system to solvency.

When this happens, governments have two options. First, they can simply nationalize the broken financial system and have the Treasury sort things out -- and ideally reprivatize the functioning and solvent parts as rapidly as possible. Government is not the best form of organization for financial intermediation in the long term, and even in the short term it is not very good. It is merely the best organization available.

The second option is simply inflation. Yes, the financial system is insolvent, but it has nominal liabilities and either it or its borrowers have some real assets. Print enough money and boost the price level enough, and the insolvency problem goes away without the risks entailed by putting the government in the investment and commercial banking business.

The inflation may be severe, implying massive unjust redistributions and at least a temporary grave degradation in the price system's capacity to guide resource allocation. But even this is almost surely better than a depression.

Since late summer, the US Federal Reserve has been attempting to manage the slow-moving financial crisis triggered by the collapse of the US housing bubble.

At the start, the Fed assumed that it was facing a first-mode crisis -- a mere liquidity crisis -- and that the principal cure would be to ensure the liquidity of fundamentally solvent institutions.

But the Fed has shifted over the past two months toward policies aimed at a second-mode crisis -- more significant monetary loosening, despite the risks of higher inflation, extra moral hazard and unjust redistribution.

As Fed Vice Chair Don Kohn recently put it: "We should not hold the economy hostage to teach a small segment of the population a lesson."

No policymakers are yet considering the possibility that the financial crisis might turn out to be in the third mode.

Creative Destruction's Reconstruction: Joseph Schumpeter Revisited - ChronicleReview.com

Creative Destruction's Reconstruction: Joseph Schumpeter Revisited: my review of Tom McCraw's excellent Schumpeter biography for the Chronicle of Higher Education. Thanks to Alex Kafka for editing it into shape.

---

Print: Creative Destruction's Reconstruction: Joseph Schumpeter Revisited - ChronicleReview.com: http://chronicle.com/free/v54/i15/15b00801.htm: From the issue dated December 7, 2007: THE MATERIAL WORLD: Creative Destruction's Reconstruction: Joseph Schumpeter Revisited

My guess is that average literate Americans know of three 20th-century economists: John Maynard Keynes, Milton Friedman, and Alan Greenspan. Perhaps they also know of Paul Samuelson (but as textbook author, not economic theorist), of Friedrich Hayek (but think that he is the father of an actress), and of John Kenneth Galbraith (as William F. Buckley Jr.'s friend who appeared on TV). The rest of us disappear into a blur of gray suits, spectacles, and, usually, baldness — an assemblage of personalities too bland to be successful accountants.

In Prophet of Innovation: Joseph Schumpeter and Creative Destruction (Belknap Press/Harvard University Press, 2007), Thomas K. McCraw, an emeritus professor of business history at Harvard Business School, tries to add another name to the list — Joseph Schumpeter. From the start, you should know that I am partial to Schumpeter; McCraw quotes me and Larry Summers saying that if Keynes was the most important economist of the 20th century, then Schumpeter may well be the most important of the 21st. McCraw's fascinating book details why that is so, but McCraw, too, is so partial to Schumpeter that he fails to fully explain how Schumpeter tripped himself up over a political understanding as clumsy as his economic understanding was brilliant.

Schumpeter was born in 1883 in what is now the Czech Republic, and died in America in 1950. When he was four, his father died. When he was 10, his mother remarried and moved to Vienna, where his aristocratic stepfather helped him enter elite schools. He was a star: youngest professor in the empire at 26, finance minister of Austria (briefly) at 36, a bank president, and then a professor again. His mother, wife, and newborn son died in rapid succession in 1926 — an awful and tragic shock. He was important enough for Harvard to pluck him from Europe in 1932 to make him one of its superstars. And, after his move to America, he was one of the most famous American economists.

But as fascinating as his life was, it is Schumpeter's economics that sing to me, because he tried to set long-term economic growth — entrepreneurship and enterprise — at the top of the discipline's agenda.

Over the previous two and a half centuries, three different economic worldviews, in succession, reigned. In the late 18th and early 19th centuries, Adam Smith's was the key economic perspective, focusing on domestic and international trade and growth, the division of labor, the power of the market, and the minimal security of property and tolerable administration of justice that were needed to carry a country to prosperity. You could agree or you could disagree with Smith's conclusions and judgments, but his was the proper topical agenda.

The second reign was that of David Ricardo and Karl Marx. Their preoccupations dominated the late 19th and early 20th centuries. They worried most about the distribution of income and the laws of the market that made it so unequal. They were uneasy about the extraordinary pace of technological, organizational, and sociological change, and about whether an ungoverned market economy could produce a distribution of income — both relative and absolute — fit for a livable world. Again, you could agree or disagree with their judgments about trade, rent, capitalism, and machinery, but they asked the right questions.

The third reign was that of John Maynard Keynes. His agenda dominated the middle and late 20th century. Keynes's theories centered on what economists call Say's Law — the claim that except in truly exceptional conditions, production inevitably creates the demand to buy what is produced. Say's Law supposedly guaranteed something like full employment, except in truly exceptional conditions, if the market was allowed to work. Keynes argued that Say's Law was false in theory, but that the government could, if it acted skillfully, make it true in practice. Agree or disagree with his conclusions, Keynes was in any case right to focus on the central bank and the tax-and-spend government to supplement the market's somewhat-palsied invisible hand to achieve stable and full employment.

B ut there ought to have been a fourth reign, for there was a set of themes not sufficiently explored. That missing reign was Schumpeter's, for he had insights into the nature of markets and growth that escaped other observers. It is in that sense that the late 20th and early 21st centuries in economics ought to have been his: He asked the right questions for our era.

He asked those questions in a book he wrote while working at the University of Czernowitz in his mid-20s: the Theory of Economic Development. Previous first-rank economists (with the partial exception of Marx) had concentrated on situations of equilibrium. In that model, development is a gradual process, in which competition keeps goods high-quality and affordable, and the abstemious owners of capital await the long-term rewards of deferred gratification.

Schumpeter pointed out that that wasn't how market economies really worked. The essence of capitalist economies was, as Marx had recognized before him, the entrepreneur and the innovator: the risk taker who sets in motion new and more-efficient ways of making old or new products, and so produces an economy in constant change. Marx saw that the coming of capitalist economies destroyed all feudal, traditional, and patriarchal relationships and orders. Schumpeter saw farther: that market capitalism destroys its own earlier generations. There is, he wrote, a constant "process of industrial mutation — if I may use that biological term — that incessantly revolutionizes the economic structure from within, incessantly destroying the old one, incessantly creating a new one. This process of Creative Destruction is the essential fact about capitalism. It is what capitalism consists in, and what every capitalist concern has got to live in."

In a later book, Capitalism, Socialism, and Democracy, Schumpeter wrote that the traditional view of competition must be abandoned. "Economists," he said, "are at long last emerging from the stage in which price competition was all they saw. ... However, it is still competition within a rigid pattern of invariant conditions, methods of production and forms of industrial organization ... that ... monopolizes attention. But in capitalist reality as distinguished from its textbook picture, it is not that kind of competition which counts but the competition from the new commodity, the new technology, the new source of supply, the new type of organization — competition which commands a decisive cost or quality advantage and which strikes not at the margins of the profits and the outputs of the existing firms but at their foundations and their very lives."

Entrepreneurs innovate new ways of manipulating nature, and new ways of assembling and coordinating people. It is important to stress that a Schumpeterian entrepreneur is not an inventor, but an innovator. The innovator shows that a product, a process, or a mode of organization can be efficient and profitable, and that elevates the entire economy. But it also destroys those organizations and people who suddenly find their technologies and routines outmoded and unprofitable. There is, Schumpeter was certain, no way of avoiding this: Capitalism cannot progress without creating short-term losers alongside its short- and long-term winners: "Without innovations, no entrepreneurs; without entrepreneurial achievement, no capitalist ... propulsion. The atmosphere of industrial revolutions ... is the only one in which capitalism can survive."

Schumpeter's ideas lay waste to economists' smooth graphs of long-run growth trends and economic evolution. Growth produces progress and wealth, but in unforeseeable ways and in discrete lumps that create many small winners (for example, the people who can now buy their shirts at Wal-Mart for $8.99 as opposed to $12.99 at its less-efficient competitors), a few huge winners (for example, the Walton family of Bentonville, Ark.), and notable substantial losers (the Main Street merchants of the Mississippi Valley, the Great Plains, and the Sun Belt).

Schumpeter, like his contemporary Karl Polanyi, feared for the long-term survival of capitalism. Bureaucrats and ideologues threatened by creative destruction would resist it. The challenge for the government in managing the market thus becomes not just the Adam Smithian task of securing property rights, enforcing contracts, and providing civil order, but also the tremendously difficult job of managing the creative destruction so that capitalism does not undermine and destroy itself for essentially political reasons. Schumpeter did not think the beast could be managed, because democracy is hostile to great inequalities, and socialism even more so.

Capitalism, however, inevitably generates these mammoth inequalities through creative destruction. The combinations of market economies and political democracies that we see today in the richest countries in the world were, Schumpeter thought, unlikely to be stable. No country that wanted to see rapid economic growth could afford to remain a political democracy for long.

He did not think governments could maintain enough social insurance to counter the destructive part of capitalism without strangling the sources of rapid growth. But why Schumpeter's Capitalism, Socialism, and Democracy places so much blame on "democracy" is unclear to me: Oligarchs fear change at least as much as democratic electorates do.

All told, Schumpeter's economic theorizing was keen, but his political judgment was abysmal. Franklin D. Roosevelt was not a communist aiming to abolish elections and turn himself into a dictator — but Schumpeter thought he was. Efforts to boost demand and employment in 1933 via deficit spending, abandoning the gold standard, and trying to keep interest rates as low as possible were not counterproductive and destructive — but Schumpeter argued that they were. He was, to put it mildly, unsuccessful as finance minister for the brand-new post-World War I Austrian Republic. He erred greatly in his assessment of Germany: A strong Germany was not a stabilizing bulwark against Bolshevism and a source of peace, order, and strength in Europe — at least not in Schumpeter's day.

Moreover, truth be told, even Schumpeter's academic judgment was not that great. His Theory of Economic Development is genius. Much of Capitalism, Socialism, and Democracy is superb. His pre-World War I essay "The Sociology of Imperialism" is also very fine. It argues that imperialism and empire were from an older political tradition given new power and energy by modern capitalism's explosion of wealth, but that in the long run, market capitalism was unsympathetic to imperial domination. Why pay to rule when you can get almost all of what you want through trade? Nevertheless, there are many dry holes and detours in Schumpeter's academic work.

Indeed, Schumpeter's writing late in his career is, in my view at least, not worth reading. The signal-to-noise ratio is simply too low. For instance, the dull, posthumous History of Economic Analysis grades thinkers of the past depending on how closely they were able to approach what Schumpeter regarded as the proper vision and analytical tools of his present.

I think he had decided that he was a Great Man, and that Great Men write Great Books, and so anything that was not a Great Book was beneath him. But the two Great Books written in economics while Schumpeter was working on his were written by people who were not trying to write Great Books but who had something important to say. Keynes's The General Theory of Employment, Interest and Money says that demand management through fiscal and monetary policy can make Say's Law true in practice even though it is false in theory. Samuelson's Foundations of Economic Analysis says that mathematics is a superbly useful language for economics.

Thus Schumpeter's influence was limited. He died half a decade later than Keynes, but Keynes's reputation put Schumpeter's in near-total eclipse for more than a generation. McCraw greatly prefers Schumpeter's Business Cycles to Keynes's General Theory, which he scorns as having no mention of any individual businesses in its 400-odd pages.

McCraw is thus too devoted to his subject to see one essential strand of Schumpeter's story: the academic undervaluation that resulted from his political delusions. This is not the place to write about the rhetorical excellence and the analytic diamonds in Keynes's General Theory (that place is Paul Krugman's introduction to Keynes's book). But I can say that General Theory develops, justifies, rationalizes, extends, applies, and shows economists how to use what had by then become the author's standard themes and approaches in a way that Business Cycles, the History of Economic Analysis, and even Capitalism, Socialism, and Democracy do not. Back in 1970, the economist Harry G. Johnson pointed out that all successful founders of schools not only are geniuses with profound insights but also provide a road map that tells their followers and successors what to do to make a successful academic career within the school. Schumpeter did not do that second part.

Perhaps this next century will give Schumpeter's work its proper place as the power of innovation to transform, create, enrich, and destroy makes itself manifest globally. And while we marvel at how much he got right, we can hope Schumpeter was wrong in his political analysis. One great test of our era will be whether creative destruction can flourish alongside public order and political liberty. If not, we're in big trouble. But if so — and I'm an optimist on the point — the results could be a marvel.

J. Bradford DeLong is a professor of economics at the University of California at Berkeley.

Section: The Chronicle Review Volume 54, Issue 15, Page B8

The Dollar and Its Implications: Project Syndicate

Taipei Times - archives: Is the dollar leading us into a depression?

The falling US dollar has emerged as a source of profound global macro-economic distress. The question now is how bad that distress will become. Is the world economy at risk? There are two possibilities. If global savers and investors expect the US dollar's depreciation to continue, they will flee the currency unless they are compensated appropriately for keeping their money in the US and its assets, implying that the gap between US and foreign interest rates will widen. As a result, the cost of capital in the US will soar, discouraging investment and reducing consumption spending as high interest rates depress the value of households' principal assets: their houses.

The resulting recession might fuel further pessimism and cutbacks in spending, deepening the downturn. A US in recession would no longer serve as the importer of last resort, which might send the rest of the world into recession as well. A world in which everybody expects a falling US dollar is a world in economic crisis.

By contrast, a world in which the US dollar has already fallen is one that may see economic turmoil, but not an economic crisis. If the US dollar has already fallen -- if nobody expects it to fall much more -- then there is no reason to compensate global savers and investors for holding US assets.

On the contrary, in this scenario there are opportunities: the US dollar, after all, might rise; US interest rates will be at normal levels; asset values will not be unduly depressed; and investment spending will not be affected by financial turmoil.

Of course, there may well be turbulence: When US wage levels appear low because of a weak US dollar, it is hard to export to the US, and other countries must rely on other sources of demand to maintain full employment. The government may have to shore up the financial system if the changes in asset prices that undermined the US dollar sink risk-loving or imprudent lenders.

But these are, or ought to be, problems that we can solve. By contrast, sky-high US interest rates produced by a general expectation of a massive ongoing US dollar decline is a macroeconomic problem without a solution.

Yet so far there are no signs that global savers and investors expect a US dollar decline. The large gap between US and foreign long-term interest rates that should emerge from and signal expectations of a falling US dollar does not exist. And the US$65 billion needed every month to fund the US current-account deficit continues to flow in. Thus, the world economy may dodge yet another potential catastrophe.

That may still prove to be wishful thinking. After all, the US' still-large current-account deficit guarantees that the US dollar will continue to fall. Even so, the macroeconomic logic that large current-account deficits signal that currencies are overvalued continues to escape the world's international financial investors and speculators.

On one level, this is very frustrating: We economists believe that people are smart enough to understand their situation and capable enough to pursue their own interests. Yet the typical investor in US dollar-denominated assets -- whether a rich private individual, a pension fund, or a central bank -- has not taken the steps to protect themselves against the very likely US dollar decline in our future.

In this case, what is bad for economists is good for the world economy: We may be facing a mere episode of financial distress in the US rather than sky-high long-term interest rates and a depression. The fact that economists can't explain it is no reason not to be thankful.

Freakonomics Clones

I have a review of Freakonomics clones in the Chronicle of Higher Education Review http://chronicle.com/weekly/v54/i11/11b01501.htm:

In the beginning were the Steves--Steve Dubner and Steve Levitt, that is. And Steve Dubner interviewed Steve Levitt, who taught at the University of Chicago and had won the American Economic Association's Clark Medal as the outstanding young economist in his two-year cohort. And Steve Dubner and Steve Levitt begat, or conceived or brought forth, Freakonomics, which sold many copies and populated the land. And the publishers of America looked upon Freakonomics, and saw that it was good.

And the publishers of America said, "Let us commission and publish many books sort-of like Freakonomics, for here is a previously-unexploited market segment, and there is unexpectedly-high demand for books that use economists' reasoning presented in clear prose to investigate and explain curious events and patterns in our social life. And let there be marketing campaigns. And TV appearances. And review copies."

And Basic Books and Robert Frank begat The Economic Naturalist. And the Free Press and Steven Landsburg begat More Sex Is Safer Sex. And Dutton Press and Tyler Cowen begat Discover Your Inner Economist. And they were fruitful, and multiplied, and replenished the Earth, and subdued it: and had dominion over the fish of the sea, and over the fowl of the air, and over every living thing that moveth upon the Earth.

And there was evening and there was morning, another day...

My favorite is Tyler's Discover Your Inner Economist.

Global Imbalances: Now More China's Problem than Ours

Now that the dollar has dropped 43% from its high against the euro, the process of global rebalancing has finally begun. The U.S. trade and current account deficits have begun to shrink relative to American and world GDP. Asian current account surpluses are about to start to shrink as well--especially if growth slows markedly in America in the aftermath of the end of the housing boom. At the moment Europe is feeling most of the pain, as its currency's value has risen furthest and fastest against the dollar. But Latin America and Asia will start to feel some economic distress as well, as the United States steps out of the role in the global economy it has occupied for a decade: that of the world's importer of last resort.

As long as the unwinding of global trade and capital flow imbalances proceeds slowly and smoothly, the magnitude of economic distress created by the global rebalancing should be relatively small. It will not seem small to exporters and their workers who lose their American markets, or to Americans who lose access to cheap capital provided by foreigners. But on the scale of the global--well, the next few years are certain to bring up some more threatening and more serious political-economic problem than the unwinding of global imbalances. Yes, the United States might well enter a small recession--the odds are roughly 50-50. Yes, an American recession might spill over to the rest of the world and cause a world recession. Yes, growth over the next five years in the global economy is unlikely to be as rapid as growth in the last five years. But a formal recession is not an overwhelming probability, and is likely to be small. We as a species appear to have a safe harbor in sight: the fears of a truly hard landing--that global investors would wake up one morning, suddenly recognize the unsustainability of the U.S. current account, dump dollars, and bring about a crash of the global economy to rival what 1997-1998 did to the Pacific Rim economies--were not overblown and y not passed, but the dire scenarios they painted are becoming less likely with each day that passes.

However, there are two scenarios for the unwinding of global imbalances that could easily come to pass and that could cause regional if not global depression.

The first unpleasant scenario that has not yet begun to recede over the horizon might come to pass if China does not accelerate the rise in value of the renminbi, and continues to attempt to maintain full employment in Shanghai, Guangzhou, and elsewhere not by stimulating domestic demand but by trying to further boost exports by keeping the renminbi stable against the dollar and falling in value against the euro. The effort to maintain the dollar-renminbi exchange rate at a level China's State Council approves of has already led to an enormous increase in the financial liquidity of China's economy. We see the consequences in inflation in real estate and stock am. We have not seen it in rampant and uncontrolled consumer price inflation. If China does not accelerate the rise in value of the renminbi, we might well see a large burst of consumer price inflation in China in the next two or three years. If so, the economic and political consequences would be dangerous for Asia's economy--a choice between the destructive runaway inflation familiar from much post-WWII Latin American experience on the one hand and stagflation on the other. But the dangers from this scenario will be largely confined to Asia.

The second unpleasant scenario is more dangerous, and dangerous for the entire world. In this scenario, once again China does not accelerate the rise in value of the renminbi, and continues to attempt to maintain full employment in Shanghai, Guangzhou, and elsewhere not by stimulating domestic demand but by trying to further boost exports by keeping the renminbi stable against the dollar and falling in value against the euro. But this time the Chinese government manages to restrain domestic inflation, and so the trade deficit of America with Asia stops falling and starts rising again, alongside a rising trade deficit of Europe with Asia as well. Latin America finds itself in difficulties as it is priced out of its export markets. And five or six years hence the world economy faces the danger that it faced two years ago--although this time the fear is not of a sudden crash in the value of the dollar, but a sudden crash in the value of the dollar and the euro against Asian currencies.

Four years ago I would have said that the principal source of international economic disorder was made in America. That has passed as a result of the decline in the value of the dollar and the ebbing of the political strength of right-wing populist factions in the United States that seek ever-greater redistribution to the rich fueled by ever-increasing tax cuts and ever-rising long-run deficits. Today the principal source of international economic disorder is made in China, in the form of factions inside China's government that hope to avoid a more-rapid appreciation of the value of the renminbi. I cannot judge the strength of these factions, or whether they know that while the ebbing of the U.S. current account deficit and the decline of the dollar lessens the urgency of adjustment for the rest of the world, it does not lessen the urgency of adjustment for China.

Nixon-era U.S. Treasury Secretary John Connally once said to a group of European worthies that while the dollar was America's currency its misalignment was Europe's problem. There is an analogy to today: the dollar is America's and the euro is Europe's currency, but their misalignments against the renminbi and other Asian currencies are increasingly becoming Asia's problem.

Alan Greenspan on the Scales

J. Bradford DeLong (2007), "Alan Greenspan on the Scales" (Project Syndicate):

THE release of Alan Greenspan’s ghostwritten memoirs, The Age of Turbulence, has elicited charges that he was not such a great central banker after all.

The indictment contains four counts: that he wrongly cheered the growth of nonstandard adjustable-rate mortgages, which fuelled the housing bubble; that he wrongly endorsed Bush’s tax cuts; that he should have reined in the stock market bubble of the 1990s; and that he should have done the same with the real estate bubble of the 2000s.

To the first two counts, Greenspan now pleads guilty. He says that he did not understand how the growth of nonstandard mortgages had lured borrowers and investors into bearing dangerous risks. He was, he now says, focusing on how fixed-rate mortgages are relatively bad deals for borrowers in times of low inflation — which was a mistake.

Greenspan also pleads guilty to a mistake in early 2001. He thought that he was giving balanced testimony to congress on government budget issues. He testified that it was important to run surpluses to pay down the debt, but that surpluses must not be so large that the government winds up owning American industry. He also testified that tax cuts were better than spending increases to keep surpluses from growing too large, but that the uncertainty was enormous, so that any tax cuts should be cancelled if they threatened to bring us back to an age of deficits.

Robert Rubin and Kent Conrad warned him that the press would not interpret his testimony as being balanced, and that congress would interpret it as an excuse to abandon fiscal discipline. And they were right.

Greenspan also pleads guilty to misunderstanding the character of the Bush administration. He thought that his old reality-based friends from the Ford administration were back in power. He thought that he — and Treasury Secretary Paul O’Neill — could win the quiet “inside game” for sensible policy without resorting to an “outside game” that would make his reappointment in 2004 unlikely. He was wrong.

But how serious are these policy-political crimes to which Greenspan now pleads guilty? In my view, they are misdemeanours. Against them you have to set what former treasury secretary Larry Summers calls Greenspan’s “golden glove” performance at avoiding and minimising recessions during his years at the Fed.

The felonies of which Greenspan stands accused are the other two charges. Here, Greenspan holds his ground, and pleads not guilty.

The only way, he says, for the Fed to have kept stock prices in reasonable equilibrium ranges in the late 1990s would have been to raise interest rates so high that they hit the real economy on the head with a brick. Interest rates high enough to curb stock market speculation would also have curbed construction and other forms of investment, raised unemployment, and sent the economy into recession. To cause a significant current evil in order to avoid a possible future danger when our knowledge is limited and our judgments uncertain is, Greenspan believes, unwise.

Greenspan mounts a similar defence concerning the housing bubble. High construction employment has been good for US workers in the past half-decade. Higher interest rates to reduce the housing boom seem, even in retrospect, ill advised if the cost is mass unemployment.

But Greenspan would have served the country and the world better if he had slowed the growth of non-standard adjustable-rate mortgages and had he been less of a loyal Republican working the inside game of trying to convince Bush’s political advisers that good policy was important, and more of a nonpartisan steward of America’s long-term fiscal stability. Of course, such a Greenspan would never have been reappointed.

All in all, Greenspan served the US and the world well through his stewardship of monetary policy, especially by what he did not do: trying to stop stock and housing speculation by halting the economy in its tracks.

Project Syndicate, 2007.

http://www.project-syndicate.org

Los Angeles Times: 'The Age of Turbulence' by Alan Greenspan

We are live at the LA Times with my review of Alan Greenspan's The Age of Turbulence. Here is the beginning:

'The Age of Turbulence' by Alan Greenspan - Los Angeles Times: FOR nearly 20 years Alan Greenspan, as head of America's central bank, was the most powerful economic central planner the world has ever seen. What did he do? Roughly twice a year, the Federal Reserve chairman had to make a substantive decision about whether to raise, lower or keep the level of U.S. interest rates the same.

Why is that important? To lower interest rates is to make the future more valuable relative to the present; to raise interest rates is to make the future less valuable. When the future is more valuable, more people in the economy focus their eyes on it and more actions are taken that will have an effect in the future: the building of factories, investment in research, construction of houses and apartments. To lower interest rates is to shift economic attention and focus from the present to the future. To raise them is to shift that balance back again.

Isn't this odd? Don't we have a market economy? Why should a central planner be setting interest rates? The only reason is that this system appears to work less badly than the alternatives we have tried. Institutions and human psychology lead financial markets to bounce back and forth between exuberant greed and catatonic fear. Times of fear generate high unemployment. Times of greed are likely to be times of destabilizing inflation. Whether the justification is in the terms of Milton Friedman, John Maynard Keynes or -- as Greenspan put it early in the Clinton administration, confusing everybody -- the pre-Keynesian Swedish school, economies seem to function better when intelligent, skilled and public-spirited technocrats perform the calming, coordinating and leaning-against-the-wind role of managing interest rates to curb greed and fortify fear with some low-interest-rate courage.

Greenspan is world famous because he was very good and very lucky at this role...

---

'The Age of Turbulence' by Alan Greenspan

The oracle speaks on life, money and politics. By J. Bradford DeLong, Special to The Times September 17, 2007

For nearly 20 years Alan Greenspan, as head of America's central bank, was the most powerful economic central planner the world has ever seen. What did he do? Roughly twice a year, the Federal Reserve chairman had to make a substantive decision about whether to raise, lower or keep the level of U.S. interest rates the same.

Related Stories - Greenspan: 'The Iraq war is largely about oil'

Why is that important? To lower interest rates is to make the future more valuable relative to the present; to raise interest rates is to make the future less valuable. When the future is more valuable, more people in the economy focus their eyes on it and more actions are taken that will have an effect in the future: the building of factories, investment in research, construction of houses and apartments. To lower interest rates is to shift economic attention and focus from the present to the future. To raise them is to shift that balance back again.

Isn't this odd? Don't we have a market economy? Why should a central planner be setting interest rates? The only reason is that this system appears to work less badly than the alternatives we have tried. Institutions and human psychology lead financial markets to bounce back and forth between exuberant greed and catatonic fear. Times of fear generate high unemployment. Times of greed are likely to be times of destabilizing inflation. Whether the justification is in the terms of Milton Friedman, John Maynard Keynes or -- as Greenspan put it early in the Clinton administration, confusing everybody -- the pre-Keynesian Swedish school, economies seem to function better when intelligent, skilled and public-spirited technocrats perform the calming, coordinating and leaning-against-the-wind role of managing interest rates to curb greed and fortify fear with some low-interest-rate courage.

Greenspan is world famous because he was very good and very lucky at this role. During his tenure at the Federal Reserve, he made roughly 36 substantive decisions about the direction interest rates should go. Six times I disagreed with him. Five of those six times, I was wrong. (The sixth? In the summer and fall of 2000, as the dot-com stock-market bubble crashed, I would have been cutting interest rates had I been sitting in Greenspan's chair; he waited for more information to see how much the fall in stock-market values would affect high-tech investment spending before he acted.)

That is an amazing record -- much better than Barry Bonds', and Greenspan clearly has never been on steroids. It is certainly much better than most economists I know could have done. Now this veritable rock-star economist-technocrat has written "The Age of Turbulence" with Peter Petre (who wrote the autobiographies of Gen. H. Norman Schwartzkopf and IBM head Thomas J. Watson Jr.). The voice in the book is Petre's. In a sense, this is too bad: Greenspan's voice is unique and a good window into his mind. But it is also nearly incomprehensible, even to trained professionals. And Petre has done a superb job of translating Greenspanese into English.

"The Age of Turbulence" is three books in one.

The first tells us who Greenspan is. It is the one that will speak to non-economist non-financier readers. The stories are wonderful: of a professional-caliber jazz clarinetist in New York in the 1950s, playing his sets and then reading his economics books during the breaks while fellow musicians go backstage to party and get high. Of a 26-year-old "math junkie" being knocked back on his heels by his philosophical guru, Ayn Rand, objectivist author of "The Fountainhead" and "Atlas Shrugged," when she pulls Descartes' "I think, therefore I exist" move on him. Of an economic advisor trying to educate, serve and guide Presidents Nixon, Ford, Reagan, Bush I, Clinton and Bush II. (Nixon wasn't just anti-Semitic, Greenspan tells us, but anti-everyone: "I don't know anybody he was pro.") Of inviting NBC News correspondent Andrea Mitchell, now Mrs. Greenspan, back to his apartment to read his essay on monopolies.

The second book gives Greenspan's view of the world and is, I think, least successful. He is trying to convey complicated and subtle technocratic ideas about the global economy -- its current structure and how it functions -- in a way that is comprehensible to general readers whose purchases drive bestseller lists. My students will read it because it will be on the midterm. But the book's target audience is likely to find this world tour a slog, and they are not incentivized by midterms.

The third book -- Greenspan's account of public policy -- is making the biggest splash as news. But it is news only in a very peculiar sense. That Greenspan and other committed small-government Republicans have been horrified at the turn their party has taken and have desperately sought some way to take it back from the cynical media consultants and political hacks who now run things is well-known -- to readers of Ron Suskind's "The Price of Loyalty" and Bruce Bartlett's "Imposter" and a host of people who know people who know Bush administration undersecretaries. Greenspan's much-quoted judgment in the book -- that current Republican office holders "deserve to lose" elections because they sold their principles for power and "ended up with neither" -- should come as no secret. Yet stories over the last few days have breathlessly reported selected phrases from the new book, characterizing them, as the Washington Post's Bob Woodward did, as "unusually harsh criticism [of] President Bush and the Republican Party" for abandoning "the central conservative principle of fiscal restraint."

It is not surprising that a prominent economist with a lifelong commitment to sound money and sound public finance does not like the policies the current government has followed.

One piece of this third book is worth noting: Greenspan's defense of his tenure as Fed chief. Why does he need a defense? Thirty-five out of 36 decisions is a very good batting average. But one could indict him on four counts: that he should not have, but did, support the Bush tax cut of 2001; that he should not have, but did, encourage new U.S. homeowners to get adjustable-rate mortgages -- ARMs -- in the early 2000s; that he should have done something to abort the dot-com bubble of the late 1990s; and that he should have done something to prevent the real estate bubble of the 2000s.

The first two counts are misdemeanors, and Greenspan pleads guilty. He says that he was warned that his testimony on the proposed 2001 tax cut would send a different message than he intended and that he ignored those warnings, which proved correct. Greenspan says his support for a tax cut was nuanced and partial, provided there were triggers to prevent budget deficits but that his statements were interpreted by the news media and politicians as a blanket endorsement. He adds that he did not understand how institutionally corrupt and thus unconcerned about good budget policy his Republican Party had become by early 2001. He says he did not properly understand in the early 2000s the large effect low teaser interest rates and prepayment penalties would have in leading new and financially strapped homeowners into deals that were not in their best interest.

The other two counts could be considered economic felonies, and here Greenspan stands his ground. Given the state of investor psychology, he says, he could have aborted the stock market and housing bubbles of the late 1990s and the early 2000s but only by paying an unacceptable price in idled factories and unemployed workers. He may be right and he may be wrong in this judgment -- I don't know. I do know that this is a judgment call, a difficult aspect of monetary policy.

I also know that Greenspan's judgment on monetary policy is very good, and looks to be better than mine.

J. Bradford DeLong, a former deputy assistant U.S. Treasury secretary, is a professor of economics at UC Berkeley.

Fear of Finance

For Project Syndicate:

We are at that turn of the intellectual cycle where the world's great and good become fearful of finance: distrustful of the rich and high-paid people who live very well indeed and work behind computer screens in the cores of the world's major cities doing... well, doing something that doesn't look like work, or productive, or useful. Each turn the fears are similar: paper-shufflers are doing better than makers, speculators are doing better than managers, traders are doing better than entrepreneurs, rootless global cosmopolites are doing better than those with their toes and ancestors in the soil, arbitrageurs are doing better than accumulators, the clever are doing better than the solid, the (financial) market is more powerful than the (regulatory, bureaucratic) state. This, the current of opinion goes, is an inversion of the normal and the natural and the just. We must cast down, as Franklin Delano Roosevelt put it, the "money changers" from their "high seats in the temple of our civilization." We must "restore the ancient truths" that growing, making, managing, and inventing things should have higher status, more honor, and greater rewards than whatever it is that financiers do.

Truth to be told, there is a lot to fear in finance. The rewards to the successful are staggeringly outsized. The punishments to the unwary are brutal. The average investor in individual stocks achieves risk-adjusted returns of the overall global stock market return--call it 6% per year in inflation-adjusted terms--minus 3%. The average investor in a managed mutual fund receives the overall return minus 2%. The average investor in an index fund receives the overall return minus 0.5%. Since the average return must be average, the informed financiers pocket the vast gaps that the poor trading strategies of the uninformed and the rash open up between their returns and the average. And it is true that nothing visible is created.

Truth be told, the scale of modern global finance is staggering: more than $4T of mergers and acquisitions this year, with tradeable and (theoretically) liquid financial assets reaching perhaps $160T by the end of this year, all in a world where annual global GDP is perhaps $50T. Martin Wolf of the Financial Times quotes the McKinsey Global Institute as estimating that world financial assets, which today are more than three times world GDP, were only equal to world GDP in 1980 (and to only two-thirds of world GDP in the aftermath of World War II). And then there are the numbers that sound very large and are hard to interpret: $300T in value of "derivative" securities; $3T of wealth managed by 12,000 global "hedge funds"; $1.2T a year committed behind the screen of "private equity."

But things are created in our modern financial system: important things, and valuable things--both positive and negative.

Consider the $4T of mergers and acquisitions this year, as companies acquire and spinoff branches and divisions in the hopes of gaining synergies or market power or better management. Those owners who sell these assets will gain roughly $800B relative to what the pre-merger speculation value of their assets had been. The owners of the companies that buy--the shareholders of the acquirers--will lose roughly $300B in market value, as markets take the acquisition as a signal that managers are exuberant and uncontrolled empire-builders rather than flinty-eyed trustees maximizing payouts to shareholders. This $300B is a tax that shareholders of growing companies think is worth paying (or perhaps cannot find a way to avoid paying) for energy in their corporate executives.

There is left a net gain of roughly $500 billion in global market value. Where does this come from? We don't know. Some of it is a destructive transfer from consumers to shareholders as corporations gain more monopoly power, some of it is an improvement in efficiency coming from better management and more appropriate scales of operations, and some of it is an overpayment by those who become irrationally exuberant when companies get their names in the news that will be taken back over time as irrational exuberance dissipates. The proportions? We don't know.

Let us, however, guess that the proportions are 1/3, 1/3, 1/3. Then several conclusions follow:

The first is that, once we look outside transfers within the financial sector, the total global effects of this chunk of finance is a gain of perhaps $340B in increased real shareholder value from higher expected future profits counterbalanced by a loss of $170B in future real wages, for households will find themselves paying higher margins to companies with more market power.

Subtract one number from the other and get a net gain of $170B of added social value in 2007: it's 0.3% of world GDP, equal to the average product of 7M of the world's workers. In one sense we should as a globe be glad that we have our M&A technicians, well-paid as they are, hard at work: it is very important that businesses with lousy managements or that are operating at inefficient scale be under pressure from those who think they could do better, and can raise the money to attempt to do do so. We certainly cannot rely on shareholder democracy as our only system of corporate control.

The second conclusion is that the gross gains--fees, trading profits, and capital gains to the winners--of perhaps $800B from this year's M&A--are greatly in excess of the perhaps $170B of net gains. Governments have a very important educational, admonitory, and regulatory role to play in this business: people should know the risks and probabilities, for they may wind up among the $630B worth of losers. So far there is little sign that they do. Third, finance has long had--since before the days of J.P. Morgan it has had--an interest in stable monopolies and oligopolies with high profit margins, while the public has an interest in competitive markets with low margins. The more skeptical you are of the ability of government-run antitrust policy to offset the monopoly power-increasing effects of M&A, the more you should seek for other sources of countervailing power--which means progressive income taxation--to offset any upward leap in income inequality.

The eighteenth-century Physiocrats thought that only the farmer was productive--that the rest were somehow cheating the farmers out of their fair share. The twentieth-century Marxists thought that only the factor worker was productive--that the traders and the organizers were somehow cheating the factory workers out of their fair share. Let us educate and regulate our financial markets so that outsiders who invest are not sheared. But let us not make the mistake of fearing finance too much.

China and Economic Growth: Hoisted from the Archives (What I Am Thinking About Right Now Department)

Hoisted from the archives: http://delong.typepad.com/sdj/2006/01/china_and_econo.html:

A somewhat different take on Ben Friedman's Moral Consequences of Economic Growth than the review I wrote for Harvard Magazine. Written for Caijing http://caijing.hexun.com/english/home.aspx:

---

Up until 8000 or so years ago, it was crystal-clear why humans should pursue greater wealth--understood as better spearheads, more knowledge of the local environment, and occupation and control of regions where game was abundant and nourishing plants plentiful. Back when our ancestors were hunter gatherers life was short--high infant mortality plus all the attendant risks of the hunting-and-gathering ecological niche--and quite brutish: low technological levels and being always on the move meant that levels of comfort were low, and the absence of literacy meant that the cultural depth and historical memory of the band could not grow very deep. Life before agriculture was not especially nasty: our hunter-gatherer ancestors were for the most part healthy, well-nourished, alert, and engaged for their short lives. But greater wealth for the band and the individual had very clear benefits: fewer of your babies died, you had a greater chance of living through the next winter, and you had a greater share of what comfort was attainable.

For all of the past 8000 years since the invention of agriculture, the benefits of pursuing greater wealth have been much, much greater than back in the hunter-gatherer days. For the vast majority of the human race, agriculture has been a poisoned cup. Malthusian population pressures have--until the last century or so--kept our numbers high enough relative to our technological expertise that the overwhelmingly large majority of humans have been close to the edge of starvation and well over the edge of malnutrition. If the typical adult male hunter-gatherer human grew to be 5'8", the typical adult male peasant-farmer human over the past several millennia has only grown to be 5'2"--or less. Here too the benefits of increasing wealth for the individual and the group are obvious: richer people have more food and a better diet; their children aren't as protein-deprived and so grow taller, stronger, and smarter; their ability to engage in conspicuous consumption via something as simple as having meat on the table gives them status and social power; plus they have access to the amazing depth of riches of human culture. The rich have enough food that they aren't hungry (and good-enough quality food that their brains and bodies can grow, and their immune systems remain strong), enough clothing that they aren't cold even in the winter, enough shelter that they are not wet, and enough literacy and access to culture that they are not bored.

We are still in the agricultural age, or, rather, many of us are still in the agricultural age, or--perhaps and we hope--we are about to exit from the agricultural age. Perhaps one billion humans today have lives that are effectively equivalent to those of our pre-industrial ancestors. Perhaps two billion have lives better than those of our pre-industrial ancestors, but not better enough: they are still, sometimes, hungry and malnourished; they are still, sometimes, cold; they are still, sometimes, wet; and they are often bored. But there are three billion of us whose children have life expectancies greater than seventy or more years, who are well-fed, who are warm, who are dry, and who if we are bored it is largely our own fault. We three billion vary enormously in wealth, from Bill Gates down to farmers growing watermelons under plastic sheets outside of Shanghai. We are all able to do the important things: live a healthy life, fall in love, make plans for the future, watch our children grow, and play status games with each other--status games in which everyone (except Bill Gates) is both a winner and a loser, for as one journalist who covers Silicon Valley's "post-economic" says, they quickly find that the problem with owning a Gulfstream 4 as your personal jet is that you start meeting people who own a Gulfstream 5.

Why then are we still focusing so much on economic growth--on making more and more things, and becoming richer and richer--when at least the most prosperous three billion of us have what we need? More than two centuries ago Adam Smith--in his first book, The Theory of Moral Sentiments--mused on the puzzle of the prosperous merchant who drives himself mercilessly and ruins his eyesight pouring over his accounts all so that he can sit in the sun at leisure in his old age. John Maynard Keynes thought that at least the most prosperous of countries were on the verge of a cultural transformation: he thought that his peers' great-grandchildren would pursue not wealth and accumulation but rather human excellence and the cultivation of mental and aesthetic faculties. Yet the pursuit of wealth continues.

One reason that we still pursue wealth is that we are, collectively, not yet wealthy enough. Half the human race is still desperately poor. But give it another century, and the whole world may well be rich enough to strike any of our agricultural-age ancestors as being a total material utopia. Will we still accumulate and strive to be richer then? The answer is that we will because we will be playing the relative-status games of conspicuous consumption: I am richer than you. But should we?

My old Harvard professor Benjamin Friedman has just written a book, The Moral Consequences of Economic Growth (New York: Knopf), which implies that we should still strive for economic growth and increasing wealth. He argues that the wiring of our brains is such that the process of becoming richer relative to the reference point provided by our parents and their peers has a large number of beneficial moral as well as material effects. First, there is the effect of wealth on whatever upper class a society happens to develop. It was John Maynard Keynes who wrote that it is a much better idea for somebody to tyrannize over his bank balance than over his neighbors. Adam Smith wrote in the Wealth of Nations about how the growing wealth of London made it attractive for the British aristocracy to abandon their feudal armies and private wars and move to London to take up positions in society and at court. A society that is growing richer will have an upper class that focuses on gaining stutus by demonstrating its wealth as power-over-nature, rather than demonstrating its power as power-over-people). Adam Smith wrote about how wealth. The senior cadres in the days of Mao Zedong's dotage struggled not to display their wealth and cultivation to each other but rather to display their power to move people around as if they were counters on some giant game board, to China's immense cost.

Friedman makes a powerful argument that—-politically and sociologically-—modern societies are like bicycles. As we all know, the laws of physics (specifically the conservation of angular momentum) make a bicycle extremely stable as long as its wheels are spinning fast and it is moving forward rapidly, but extremely unstable as it slows to a halt. Friedman argues that whenever the wheels of economic growth stop—-in the sense not even of a depression but just of stagnation--political democracy, individual liberty, and social tolerance are greatly at risk even in countries where they are well established, and even in countries where by any standard the absolute level of material prosperity remains high. If you want all kinds of non-economic good things, Friedman says--like openness of opportunity, tolerance, economic and social mobility, fairness, and political democracy--rapid economic growth makes it much, much easier to get them.

Consider, for example the case of Japan during the Great Depression in the 1930s. Rising unemployment and declining incomes in Japan in the 1930s certainly played a major role in the assassinations and coups by which that country, which was a functioning constitutional monarchy with representative institutions and a government focused on economic development in 1930, to a fascist military dictatorship by 1937--a dictatorship that could be dragged into a major attack on China by the initiative of relatively low-ranking military officers in the region of China that they had occupied and called the puppet state of Manchukuo. In western Europe the calculus is equally simple: had there been no Great Depression in Germany in the 1930s, there would have been no Adolf Hitler in power, no Nazi dictatorship, and forty million fewer Europeans would have murdered in the 1940s. The saddest book on my shelf is a 1928 volume called Republican Germany: An Economic and Political Survey, the thesis of which is that after a decade of post-World War I political turmoil, Germany had finally become a stable, legitimate, democratic republic. And only the fact that the Great Depression came and offered Hitler his opportunity made it wrong.

We are all very fortunate that we live in a world in which the great powers of 1940 took action--even if their action was much too long delayed and much to hesistant--to destroy the German Nazi and Japanese Fascist-Militarist regimes. Winston Churchill's pushing British Prime Minister Neville Chamberlain and French Premier Edouard Daladier to declare war on Nazi Germany in 1939, and Franklin Delano Roosevelt's ultimatum to Japan to withdraw its military from China or face a complete embargo on exports of oil from the United States, the Middle East, and Indonesia were acts of great statesmanship in pursuit of world peace. But would World War II have taken place in the absence of the Great Depression? Probably not?

Even in the United States--where we Americans believe that our political democracy and obedience to the order of law are unshakeable--the 1930s were a politically tumultuous decade. The story of Huey Long in Louisiana (fictionalized in Robert Penn Warren's brilliant novel All the Kings Men, crypto-fascist radio broadcasters like Father Coughlin over the airwaves, California's treatment of Depression-era migrants from other states that we read about today only in The Grapes of Wrath, and the white-hot hatred for Roosevelt as a class traitor--up until his dying day, my grandfather who lived to be 98 would still say the country was lucky to have survived Roosevelt.

And, of course, I draw powerful lessons from Friedman's argument. I consider that there are some today in Washington who look forward to a future in which China is in some sense America's "enemy" and that "national greatness" requires that the United States fight a new Cold War in Asia. There are those who work for Vice President Cheney's office who think that trade with China is a bad idea: it creates a pro-China lobby that will stop any attempts by the United States to slow down China's growth and acquisition of technology. Better, they think, to try to keep China as poor and barefoot as possible for as long as possible.

From my perspective, this is totally insane. In all likelihood, China a century from now will be a full-fledged post-industrial superpower whatever the policies of the United States. The national interest of the United Staets is to maximize the likelihood that that superpower will have a representative government presiding over a prosperous, open, and free society? The China policy of the Clinton administration was to try to do whatever we could to speed China's growth in the expectation that rapid economic growth would have greatly beneficial moral, sociological, and political consequences for the evolution of China. As sociologist Barrington Moore wrote two generations ago, those countries that crossed the bridge from agrarian to industrial civilization most easily and peaceully were those with a rapidly growing, prosperous middle class will be interested in liberty and opportunity. Such a rapidly-growing Chinese middle class would be a much more powerful force for prosperity, opportunity, freedom of thought, and representative government in China than a battalion of lecturing neoconservative think-tankers in Washington D.C. or a host of remotely-guided cruise missiles on U.S. warships based in Pearl Harbor.

Let's all try to keep the bicycle that is modern China moving forward as fast as we can.

---

Triggered by http://www.thomaspmbarnett.com/weblog/2007/07/neocons_chinese_target_old_new.html and http://jamesfallows.theatlantic.com/archives/2007/07/gary_hart_lynne_cheney_and_war.php

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

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

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

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

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

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

That's the perspective from National Review.

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

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

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

Dr. Jekyll, meet Mr. Hyde.

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

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

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

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

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

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

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

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

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

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

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

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

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

Thinking About the Unfortunately Thinkable: Iran--and Bush

It is widely believed that the ruling regime in Iran is seeking to build nuclear weapons.

Perhaps this is not true. Perhaps the ruling regime in Iran is merely seeking to persuade everybody that it is seeking to build nuclear weapons. A country's political leverage is maximized when it is nearly able to acquire nuclear weapons but has not yet done so. Its neighbors and the world's great powers then have powerful incentives to persuade it not to do so. It can, theoretically at least, extract significant concessions in return for abandoning its nuclear ambitions. And because it does not yet have nuclear weapons, it is not yet an imminent threat to the survival of its neighbors, and very far indeed from being an imminent threat to the great powers.

Let us hope that the ruling regime in Iran is merely seeking to persuade everybody that it is seeking to build nuclear weapons in order to extract concessions in return for abandoning nuclear ambitions that it does not have. But let us not bet on that hope: it is a hope that is likely to be in vain. It really does look as though the ruling regime in Iran is attempting to acquire nuclear weapons.

This is too bad. If Iran's ruling regime were thinking straight, they would not want to have nuclear weapons. Nuclear weapons do provide an element of deterrence, yes. A country with nuclear weapons is unlikely to suffer an all-out attack by a neighbor aimed at conquering it and overthrowing and hanging its government. A country with nuclear weapons is unlikely to suffer a surgical attack by a great power--an attack either endorsed or not endorsed by the Security Council--that has lost its patience and seeks cheap and easy "regime change." A country with nuclear weapons will find that its soldiers, diplomats, heads of state, and heads of government will be treated with extra respect. These are all advantages to the regime of possessing nuclear weapons.

But there are also disadvantages to the people and to the regime of possessing nuclear weapons. If your internal decision-making processes become deranged enough to carry you to or over the brink of pointless war--as Egypt's did in 1967, Pakistan's did in 1970, Argentina's and Israel's did in 1982, Iraq's did in 1979 and again in 1991, Israel's did in 2006, and so on--then the situation is much more dangerous and much more likely to end in genocide or near-genocide if you have nuclear weapons than if you do not. You also need to fear your own majors and colonels with their fingers on the button. And if you acquire nuclear weapons, your neighbors will too. Then you need to fear not just your own internal decision-making processes and your own majors and colonels but their internal decision-making processes and their majors and colonels as well.

Most of the time things will go well when neighboring countries are able to shatter if not destroy and inflict megadeaths on each other in less than half an hour. Human beings, after all, live in close contact with and are nearly all capable of using deadly force on each other. Yet very few of us are killed by our next-door neighbors. Most of the time we live out our lives in peace with our neighbors even though every kitchen in the world contains weapons of personal destruction. Can't we comfortably expect nations to do the same? If Khrushchev and Kennedy and Eisenhower, Nixon and Brezhnev and Mao could have bu