Grasping Reality with Both Hands

Calculated Risk on Underemployment

The Risk writes:

Calculated Risk: Part Time for Economic Reasons Hits 9 Million: Not only has the unemployment rate risen sharply to 8.5%, but the number of workers only able to find part time jobs (or have had their hours cut for economic reasons) is now at a record 9.0 million. Of course the U.S. population is significantly larger today (about 305 million) than in the early '80s (about 228 million) when the number of part time workers almost reached 7 million. That is the equivalent of about 9.3 million today, so population adjusted this isn't quite a record - yet - but it is getting close. And the rapid increase is stunning ...

The Recession Is Now One Year Old

So says Floyd Norris. So say we all:

First Birthday for the Recession?: The Federal Reserve chairman, Ben S. Bernanke, declined on Monday to say whether we are in a recession. The only reason to avoid doing so is that it would not be reassuring to admit the obvious. The National Bureau of Economic Research has yet to certify there is a recession, but otherwise there is no doubt.... [J]ust as he began his testimony, the Conference Board released its index of coincident indicators. That index not only confirmed that a recession is under way, but it provided powerful evidence that it began in 2007, or in January 2008 at the latest.

The overall index of coincident indicators is down 1.2 percent from its record high, set in October 2007. Since 1960, every time the index has fallen by at least 1 percent, the bureau later concluded the economy was in recession. The argument now is when the recession began. Those who scorned the idea that there was a downturn earlier this year now say it began in the third quarter of this year. They pointed to growth in gross domestic product in the second quarter as proof there was no recession, but that argument is unpersuasive.... G.D.P. growth is only one indicator the bureau uses. The others are real income, employment, industrial production and wholesale-retail sales. Those are the four items that make up the index of coincident indicators.

In the seven recessions since 1960 — the only ones during which the index of coincident indicators was calculated — the bureau later concluded that the recession began within two months of the beginning of the decline in the coincident indicators. This time the index began to decline in November 2007. So the possible range is from September to January. In all likelihood, this recession either has reached its first birthday or will soon do so.

Since World War II, only two recessions have lasted a year or more. Both the 1973-75 and the 1981-82 downturns lasted 16 months. This recession is likely to last longer than that. If so, it will become the longest downturn since the 43-month recession that lasted from August 1929 to March 1933...

A Very Large Invisible College Indeed: Analogies to teh Great Depression

So I surf to Mark Thoma's website physically located 400 miles north of my office in order to find the smart things being written eight feet to my north, on the other side of my office wall. Barry Eichengreen:

From Wall Street to Main Street: Lessons from the Great Depression: A couple of months ago at lunch with a respected Fed watcher, I asked, “What are the odds are that US unemployment will reach 10% before the crisis is over?” “Zero,” he responded, in an admirable display of confidence. Watchers tending to internalise the outlook of the watched, I took this as reflecting opinion within the US central bank.... The Fed and Treasury were on the case. US economic fundamentals were strong. Comparisons with the 1930s were overdrawn.

The events of the last week have shattered such complacency. The 3 month treasury yield has fallen to “virtual zero” for the first time since the flight to safety following the outbreak of World War II. The Ted Spread, the difference between borrowing for 3 months on the interbank market and holding three month treasuries, ballooned at one point to five full percentage points. Interbank lending is dead in its tracks. The entire US investment banking industry has been vaporised. And we are in for more turbulence. The Paulson Plan, whatever its final form, will not bring this upheaval to an early end.... So comparisons with the Great Depression.... Which ones have content, and which are mainly useful for headline writers? 

First, the Fed now, like the Fed in the 1930s, is very much groping in the dark. Every financial crisis is different, and this one is no exception. It is hard to avoid concluding that the Fed erred disastrously when deciding that Lehman Bros. could safely be allowed to fail. It did not adequately understand the repercussions for other institutions of allowing a primary dealer to go under. It failed to fully appreciate the implications for AIG’s credit default swaps. It failed to understand that its own actions were bringing us to the brink of financial Armageddon.

If there is a defence, it has been offered [by] Rick Mishkin, the former Fed governor, who has asserted that the current shock to the financial system is even more complex than that of the Great Depression. There is something to his point. In the 1930s the shock to the financial system came from the fall in the general price level by a third and the consequent collapse of economic activity. The solution was correspondingly straightforward. Stabilise the price level, as FDR did by pumping up the money supply, and it was possible to stabilise the economy, in turn righting the banking system.

Absorbing the shock is more difficult this time because it is internal to the financial system. Central to the problem are excessive leverage, opacity, and risk taking in the financial sector itself. There has been a housing-market collapse, but in contrast to the 1930s there has been no general collapse of prices and economic activity. Corporate defaults have remained relatively low, which has been a much-needed source of comfort to the financial system. But this also makes resolving the problem more difficult. Since there has been no collapse of prices and economic activity, we are not now going to be able to grow or inflate our way out of the crisis, as we did after 1933.

In addition, the progress of securitisation complicates the process of unravelling the current mess....

That said, we are not going to see 25% unemployment rates like those of the Great Depression. Then it took breathtaking negligence by the Fed, the Congress and the Hoover Administration to achieve them. This time the Fed will provide however much liquidity the economy needs. There will be no tax increases designed to balance the budget in the teeth of a downturn, like Hoover’s in 1930. Where last time it took the Congress three years to grasp the need to recapitalise the banking system and provide mortgage relief, this time it will take only perhaps half as long. Ben Bernanke, Hank Paulson and Barney Frank are all aware of that earlier history and anxious to avoid repeating it.  

And what the contraction of the financial services industry taketh, the expansion of exports can giveth back.... The ongoing decline of the dollar will be the mechanism bringing about this reallocation of resources. But the US economy, notwithstanding the admirable flexibility of its labour markets, is not going to be able to move unemployed investment bankers onto industrial assembly lines overnight. I suspect that I am now less likely to be regarded as a lunatic when I ask whether unemployment could reach 10%.

Three points. (1) We could inflate our way out of it--in the 1930s we had a 30% product price deflation, and now we have had a 30% housing price deflation. Balanced inflation would remove the debt overhang in both cases. We may well not want to resolve the problem via inflation--and I suspect that even by raising the theoretical possibility I have reduced my chances of attaining high office in the Eccles Building to something indistinguishable from zero--but we could.

(2) Barry is right. Particularly, it looks as though Barry is right about Lehman Brothers. In retrospect, the decision to let Lehman fail without rescue, control, or supervision looks to be the first significant misstep that Bernanke and Paulson have made in the past fifteen months. Clearly it looked to them to be a good idea at the time, and clearly they have more information than I do, and it is impossible to dance this dance and put every foot right. I'm sure that had I been at the Treasury or the Fed I would have made worse mistakes by now than they have made. But:

It looks like it is the failure to cushion the losses of the creditors of Lehman than has produced the need for emergency action. If the Fed and the Treasury had offered Sunday night to buy as much of Lehman debt as the market offered at 75% of the previous Friday's market price, I don't think we would be staring into this particular abyss right now.

(3) Nevertheless, I said a year ago that if the unemployment rate stays below ten percent then it is a win for monetary policy. And I still think we have an 80% chance of achieving that...

Econ 101b: March 12 Lecture: Inflation and Unemployment

Lecture Audio

---

• Review:
  • Understanding the IS Curve
  • Investment and the Real Interest Rate
  • The Task of the Federal Reserve
• Background:
  • Okun's Law and the Phillips Curve
• Federal Reserve Behavior:
  • The Taylor Rule and the MPRF
  • Equilibrium: The Phillips Curve and the MPRF
  • Understanding Fluctuations
• Expectations:
  • Static Expectations: π^e is constant...
  • Adaptive Expectations: π^e_t+1 = π_t
  • Rational Expectations: π^e_t+1 = E[π_t+1]
    • Expectations Spreadsheet: http://www.j-bradford-delong.net/2008_xls/20080306_101b_dynpcurve.xls

Antitrust Protectionism

Alex Tabarrok observes that if Microsoft-Yahoo really were anticompetitive and likely to generate monopoly rents for the merged entity, Google would be being very quiet right now:

Marginal Revolution: Antitrust Protectionism: Best evidence that the merger between Microsoft and Yahoo will increase competition?

Publicly, Google came out against the deal, contending in a statement that the pairing, proposed by Microsoft on Friday in the form of a hostile offer, would pose threats to competition that need to be examined by policy makers around the world.

Rubber Tomato Blogging: Hoisted from Comments

Hoisted from Comments: JRoth writes:

Grasping Reality with Both Hands: Brad DeLong's Semi-Daily Journal: I think that you have severely misused or even misunderstood the supermarket tomato. I know that you have a major weakness for rhapsodizing the plenty of industrial agriculture, and I would agree that a world that contains shippable tomatoes is a better one than one in which tomatoes are a 3 month/year treat for most Americans. But I would not agree that the "rubber tomato" exclusively is a preferable substitution - and thanks to centralized capitalist planning, that's what we had in American for close to 50 years. Americans, with their metis, did not choose cheap rubber tomatoes to the exclusion of local, ripe ones (which are scarcely more expensive when in season) - they had rubber tomatoes forced upon them, even in high summer.

I can honestly say that I did not taste a fresh, worth-eating tomato for the first 20 years of my life - that is the legacy of the rubber tomato.

The fact that other varieties are now available for purchase (when in season) is a much-belated correction to the centralized capitalist planners, who were not interested in creating a product for sale only 9 months of the year. Just as Germany no longer ruins its forests, supermarkets no longer force rubber tomatoes on their customers. That the bad practice has stopped is not a defence of the practice.

And I have to ask: "Why not? Why didn't you taste a tomato worth eating for the first twenty years of your life? What stopped you? Was some commissar standing over your parents waving a kalishnikov? Or did your parents just not think it was worth the extra money?"

Alex Tabarrok on the Economics Nobel Prize

He writes:

Marginal Revolution: Mechanism Design for Grandma: Ok, Grandma may still have some difficulty but in honor of today's Nobelists, Hurwicz, Maskin and Myerson let's give it a go.  Suppose that you are selling a rare painting for which you want to raise the maximum revenue.  There are two potential buyers, Tyler, who values the painting at $100,000, and Alex who values it at $20,000.  The problem would be simple if you knew this information - you would then set the price at $99,999 and Tyler would buy maximizing your revenue.  But how much Tyler and Alex value the painting is their own private information.  How then should sell the painting?

One possibility that springs quickly to mind is an auction.  In a standard English open-cry auction Alex and Tyler will bid for the painting and the bids will keep rising until Alex is forced to drop out at $20,001.  Thus the auction earns you $20,001.  Not bad, but is this the maximum revenue possible?...

You want to design the mechanism to achieve a certain outcome.  The mechanism can be as complicated as you want but it must satisfy certain conditions.  First, the bidders must participate voluntarily....  At the end of the day the bidders must expect to be at least as well off as if they did not play the mechanism game.... Second, there is an incentive compatability constraint. You don't know how much Alex and Tyler truly value the painting so suppose that Tyler mimics whatever Alex does - Tyler can do this since he values the painting at least as much as Alex does.  It follows that whatever outcome the mechanism assigns to Alex, Tyler must get at least as much.  This is a significant constraint because it means that if you want Tyler to do something different than Alex, and you do, you want Tyler to bid more, then you must give Tyler something in return. Thus, even in the optimal mechanism you, the seller, are not going to get everything. Tyler is going to walk away with some surplus....

Maskin and Myerson proved something very useful about mechanisms with these types of constraints.  It turns out that if you follow the constraints then you can restrict attention to mechanisms in which Tyler and Alex always tell the truth about their values, this is called the revelation principle....

In the case of auctions the direct mechanism is well known, a second price auction.  In a second price auction the high bidder wins but pays the second highest-bid.  In this auction it makes sense for every bidder to bid his true value....

The basic set-up of agents with private information submitting "bids" which are then fed into a mechanism resulting in outcomes is very general.  How to raise taxes, regulate a monopolist, fund a public good (here's my own contribution to mechanism design), allocate organs, assign interns to hospitals, split common costs, allocate electricity across a grid - all can be thought of as mechanism design problems.   The tools that Hurwicz, Maskin and Myerson developed and their methods of paying attention to participation and incentive compatability constraints and using the revelation principle helps us to design, at least in principle, the best solutions to all of these problems.

Who Benefited from North American Slavery?

A handout from two-and-a-half years ago that I want to revise for this year's version of American Economic History...

Revised version:

http://delong.typepad.com/113_F07/20070910_cuibono.pdf

Snatch the Pebble from My Hand, Grasshopper!

Tyler Cowen teaches Ezra Klein one of the arcana imperii:

Ezra Klein: Drinking Strategies: I'm not yet finished with my copy of Tyler Cowen's Discovering Your Inner Economist (it's very good, though!), so maybe this is included deeper into the book. But given that Cowen upholds that expensive drinks subsidizes food, particularly at fine restaurants where they make hefty margins off wine, etc, do we have any data on what the average mark-up is? If it's high, presumably the most cost-effective strategy be to forego drinking in fine establishments -- what you can't get at home is such fine cooking, and this way it's being subsidized for you. If it's relatively modest, there's certainly some added utility, even if it's partly imagined, to pairing a nice meal with good drink, so maybe it's worth it...

Alas, my highly favorable review of Discovering Your Inner Economist is still in the editorial process at the Chronicle of Higher Education.

But I will say that I did once try to convince Bob Hall at a restaurant in Palo Alto not to order wine: the fact that the wine would cost four times retail would, I said, depress me and lower my utility. Even though I wasn't paying for it, I would still feel as though I was being cheated, and as I drank the wine that would depress me more than the wine would please me.

He had two responses: (i) "You really are crazy." (ii) "Think, instead, that it's coming straight out of the Hoover Institution endowment, and order two bottles."

How Costco Became the Anti-Wal-Mart

Steven Greenhouse has a nice story about Costco, where we dropped $500 last weekend:

How Costco Became the Anti-Wal-Mart - New York Times: Mr. Sinegal begs to differ. He rejects Wall Street's assumption that to succeed in discount retailing, companies must pay poorly and skimp on benefits, or must ratchet up prices to meet Wall Street's profit demands.Good wages and benefits are why Costco has extremely low rates of turnover and theft by employees, he said. And Costco's customers, who are more affluent than other warehouse store shoppers, stay loyal because they like that low prices do not come at the workers' expense. "This is not altruistic," he said. "This is good business."

He also dismisses calls to increase Costco's product markups. Mr. Sinegal, who has been in the retailing business for more than a half-century, said that heeding Wall Street's advice to raise some prices would bring Costco's downfall. "When I started, Sears, Roebuck was the Costco of the country, but they allowed someone else to come in under them," he said. "We don't want to be one of the casualties. We don't want to turn around and say, 'We got so fancy we've raised our prices,' and all of a sudden a new competitor comes in and beats our prices."

At Costco, one of Mr. Sinegal's cardinal rules is that no branded item can be marked up by more than 14 percent, and no private-label item by more than 15 percent. In contrast, supermarkets generally mark up merchandise by 25 percent, and department stores by 50 percent or more. "They could probably get more money for a lot of items they sell," said Ed Weller, a retailing analyst at ThinkEquity.

But Mr. Sinegal warned that if Costco increased markups to 16 or 18 percent, the company might slip down a dangerous slope and lose discipline in minimizing costs and prices.

Mr. Sinegal, whose father was a coal miner and steelworker, gave a simple explanation. "On Wall Street, they're in the business of making money between now and next Thursday," he said. "I don't say that with any bitterness, but we can't take that view. We want to build a company that will still be here 50 and 60 years from now"...

Two-Buck Chuck Strikes!

From ABC channel 6:

6abc.com: California's Wine Surprise: Charles Shaw Chardonnay, better known as "Two Buck Chuck," beat hundreds of other wines and was named the top prize in a prestigious tasting competition in California.

"The characteristics that we look for in our gold medal winner & a nice creamy butter, fruity & it was a delight to taste," said 2007 California State Fair Commercial Wine Competition judge Michael Williams.

The affordable wine beat out 350 other California chardonnays to win the double gold. Second place went to an $18 bottle, and the most expensive wines at the event, at the price of $55, didn't even medal.

To find this prize winner, you need not go to a fancy wine shop or elite retailer. Charles Shaw Chardonnay is mass produced in California and only sold through the quirky Trader Joe's grocery stores.

"We choose to sell good quality wines at $2 a bottle because we think it's a fair price," winemaker Fred Franzia told ABC News' Ryan Owens. "We think the other people are charging too much."

Get What You Pay For?

After its big win, ABC News decided to put the cheap stuff to a blind taste test and see if it would repeat the victory. It was disguised and served along with chardonnays of various prices, including a $120 bottle.

In this test, Caroline Styne, co-owner and wine director of two trendy Los Angeles area restaurants, judged the wines -- but to a different outcome. She ranked "Chuck" dead last, but second-to-last was the $120 variety.

No one said this was an exact science. Just ask the chief judge of the competition that gave the gold to a wine that costs less than a latte.

"There's going to be people out there that don't like the wine and that's OK," said chief judge G. M. "Pooch" Puchlowski. "You know, there are a lot of wines I don't like. & So you drink what you like, don't drink what you don't and you go home a happy camper."

Tyler Cowen Fears the Virginia Department of Transportation

In the mid-1990s Tyson's Corner was already a kind of "lasciate ogni speranza" place. I cannot imagine what it is like now--or what it will be like in the future:

Marginal Revolution: The destruction of Tysons Corner?: can't wrap my mind around how Tysons Corner will keep going.  The plan is to take one of America's most successful "edge cities" and centrally plan it into a walkable neighborhood, yet that is to happen while five major roads -- three of them multi-lane highways -- will continue to carve up the whole area.

Have I mentioned they will build elevated rail service to Dulles Airport?  This sounds quaint and European but there is already a dedicated, virtually traffic-free road to that airport, in addition to three or four totally usable back routes.  The new rail line will sit atop Route 7 (the major artery), necessitating its widening and the destruction of the side and access roads which make transversing the area a workable proposition.

Quotations like this scare me:

VDOT has agreed to narrow the eight future lanes of Route 7 to 11 feet from the standard 12, to allow for two additional pedestrian crossings beneath the aerial line and to build eight-foot sidewalks. "We've always emphasized that we need wider sidewalks, we need more pedestrian crosswalks, we need to slow traffic down," Stevens said...

I have heard construction will take six to eight years, which I assume means eight to twelve years.

Aesthetically you may or may not like what Tysons Corner has become, but at this point there is no turning back.  I simply do not see how an already traffic-heavy Tysons Corner will survive this onslaught.  The theory is that enough people will live in nearby condos (didn't the real estate bubble just burst?) that in the proverbial long run traffic will fall.  Betting markets, anyone?  When people rely on an area as one part of their programme for auto-based, carry-around-big-packages, lug the kids, multiple stops, mass transit doesn't have much of a chance.

I've already made my plans ("Find new Persian restaurant with Zereskh Polo") for avoiding the area altogether, quite possibly for the rest of my adult life...

Felix Salmon on the iPhone

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

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

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

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

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

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

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

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

Mark Thoma Is Irate This Morning: Modelling the Social Value of Microsoft

Mark Thoma's ire is roused by Robert Barro, in the Wall Street Journal. Mark sends us to an article in which Barro attributes the entire consumer plus producer surplus of the personal computer industry to Bill Gates:

Economist's View: Robert Barro: Bill Gates' Charitable Vistas: Mr. Gates delivered a commencement address that focused... on his own personal philanthropy. His implicit theme was that so far what he has accomplished may have been good for him and Microsoft shareholders, but it has been no great contribution to society. He suggested that with a personal fortune of about $90 billion... it is time for him to give something back.

I find this perspective hard to understand.... Microsoft has been a boon for society and the value of its software greatly exceeds the likely value of Mr. Gates's philanthropic efforts. Here is a sketch of a simple model of Microsoft's social value....

In 2006, its revenue was $44 billion, with earnings of $13 billion. This money was generated by creating something consumers value.... [T]he social value... comes from the increase in productivity created when businesses and households use [Microsoft] software. The social benefit equals the value of the extra product, less the total paid for the software..... A conservative estimate... is that the social benefit of Microsoft's software is at least the $44 billion Microsoft pulls in each year... capitalized... a valuation of $970 billion.... Mr. Gates is creating a benefit to the rest of society of about one trillion dollars -- or more than 10 times his planned donations. And this counts only the likely future benefits, giving no weight to the past....

Mr. Gates's plan is ... to use the Bill and Melinda Gates Foundation to reduce world poverty, with an emphasis on advances in health. This is a noble goal. But it will likely just supplement the much larger existing programs... that have been carried out for many years by international organizations and governments... a checkered record. Although Mr. Gates is probably smarter and more motivated than the typical World Bank bureaucrat, he likely won't do much better....

[T]he key question for poverty alleviation is how to get Africa to grow like China and India... opening up to markets and capitalism.... [F]oreign aid had nothing to do with the successes [at reducing poverty] and did not prevent the African tragedy.... Perhaps the Gates Foundation will run more efficient aid programs than we've seen in the past, but I wonder.... [Gates] is kidding himself if he believes that the efforts of the Gates Foundation are likely to provide society anything like the past and future accomplishments of Microsoft...

The problem, of course, is that although Barro's model is a simple model, it is the wrong model.

In the absence of Microsoft, people would not sit in front of dark screens and do all calculations and sorts by hand. In the absence of Microsoft, its programmers would work for other computer companies--IBM, Sun, ATT, Digital Research, Apple, Go, et cetera. In the absence of Microsoft, its customers would buy operating systems and office suites from other computer companies as well. In the absence of Microsoft, production would in all likelihood be somewhat less efficient--in the absence of a single dominant software near-monopolist like Microsoft, more programmers would spend more time essentially duplicating one another's work as competitors went head-to-head with directly competing products. In the absence of Microsoft, margins would be lower because of lower market power--and so distribution would be somewhat more efficient. In the absence of Microsoft, invention and innovation in software might be faster (because a dominant, innovative monopolist can break the lockin effect created by obsolete standards) and might be slower (because a dominant, non-innovative monopolist that has a reputation for predatory pricing like Microsoft can create a "death zone" around it in which no profit-seeking firm dares innovate).

Whether the net social value of Bill Gates is positive or negative depends on his impact in creating and shaping Microsoft: relative to its competitors and to its alternative paths of development, did he make it more of a lockin-breaking innovator or a death zone-creating predator? Did he do more to make Microsoft a company that takes advantage o economies of scale or more to make Microsoft a company that raises profit margins? I'm on the side that thinks that Microsoft has been a considerable net plus. But others I respect see it is a net minus. And my judgment that the net social value of Bill Gates is large and positive is not because I attribute the total producer plus consumer surplus in the industry to him and him alone: I am not that naive, and not that slow-witted.

Underbelly Praises Sam Bowles

It writes:

Underbelly: "If We Knew How to Do That,
We Would Not Be Poor": While others are sorting out the question whether neoclassic econ is a Mafia (link, link), allow me to share this anecdote copped from one of the most interesting and original microeconomics textbooks I’ve ever seen:

Like the overnight train that left me in an empty field some distance from the settlement, the process of economic development has for the most part bypassed the two hundred or so families that make up the village of Palanpur. They have remained poor, even by Indian standards: less than a third of the adults are literate, and most have endured the loss of a child to malnutrition or to illnesses that are long forgotten in other parts of the world. But for the occasional wristwatch, bicycle, or irrigation pump, Palanpur appears to be a timeless backwater, untouched by India’s cutting edge software industry and booming agricultural regions. Seeking to understand why, I approached a sharecropper and his three daughters weeding a small plot. The conversation eventually turned to the fact that Palanpur farmers sow their winter crops several weeks after the date at which yields would be maximized. The farmers do not doubt that earlier planting would give them larger harvests, but no one the farmer explained, is willing to be the first to plant, as the seeds on any lone plot would be quickly eaten by birds. I asked if a large group of farmers, perhaps relatives, had ever agreed to sow earlier, all planting on the same day to minimize losses. “If we knew how to do that,” he said, looking up from his hoe at me, “we would not be poor.”

--Samuel Bowles, Microeconomics: Behavior, Institutions, and Evolution, pp. 24-25 (Princeton Paperback ed. 2004)

There must be 100 books entitled “Microeconomics”—-a thousand? This one is so far out of the conventional mode that it might count as a violation of the British Trade Descriptions Act. It’s far closer to what might have passed as “Political Economy”—-Economics before the Mafia took over. Lots more attention to the structure of economies than you would expect in a standard Micro intro. Yet in detail (at the micro level?) it is actually fairly conventional stuff: all the individual items appear to come out of the standard toolbox. The unconventional ordering gives them a fresh and invigorating spin.

Hitsville, USA, Increasing Returns, and Path Dependence

Tom Slee writes:

Whimsley: Predicting hits may be like predicting the weather: [P]hysicist turned sociologist Duncan Watts writes about how cultural hits may be, like the weather, impossible to predict. It comes down to how much we like stuff because it's good and how much we like it because other people like it. If it's the latter, then it becomes impossible to predict at some point. What's nice is that they did some experiments to demonstrate some of this in the lab.... A side effect of this would be that there is a strong limit to the effectiveness of recommendation schemes from Amazon and Netflix and so on.... Here's a few paragraphs from the article:

Conventional marketing wisdom holds that predicting success in cultural markets is mostly a matter of anticipating the preferences of the millions of individual people who participate in them.... The common-sense view, however, makes a big assumption: that when people make decisions about what they like, they do so independently of one another. But people almost never make decisions independently... in part because what we often want is not so much to experience the “best” of everything as it is to experience the same things as other people and thereby also experience the benefits of sharing.... Ultimately, we’re all social beings... our mutual dependence has unexpected consequences, one of which is that... when people tend to like what other people like, differences in popularity are subject to what is called “cumulative advantage.”... random fluctuations can blow up, generating potentially enormous long-run differences among even indistinguishable competitors.... Madonna would have been popular in this world, but in some other version of history, she would be a nobody, and someone we have never heard of would be in her place.

Rachel Friedberg Goes on Vacation

Greg Mankiw directs us to a... I guess it's a celebrity profile... of Rachel Friedberg:

Calculating Paradise - washingtonpost.com: Calculating Paradise: Beach Economics: By Laura Blumenfeld: Washington Post Staff Writer :Saturday, April 21, 2007; D01 PROVIDENCIALES, Turks and Caicos -- The plane came from the north and landed near warm sand. Rachel Friedberg, a Brown University economist, stepped out, holding her black wool pea coat, squinting. "Skin cancer. Dehydration. Sunstroke," she muttered. "Sand sticking to your body." The New England professor had arrived for vacation in Turks and Caicos, one of the Caribbean's fastest-growing economies. "Why would people on purpose, on purpose, go where the land ends, and stare at undifferentiated nothingness? Think of the opportunity cost of that time."

Lucid blue water makes most travelers forget about work. But for Friedberg, economics infuses everything: the equilibrium price of conch shells; the asset-value implications of Bruce Willis's beach compound; the labor market impact of a Filipino, rather than a Bahamian, massage therapist digging her oiled thumbs into Friedberg's sacrum.For the constant economist, Turks and Caicos offers something more exciting than night scuba diving: a case study on the economics of hyper-growth. Real GDP is growing at more than 14 percent, faster than China's growth of about 10 percent per year. The annual number of tourists surged from 88,000 in 1996 to an estimated 200,000 in 2006. Hotel and restaurant GDP was $155 million per year in 2005, of which hotels accounted for $142 million.

The self-governing British territory, 575 miles southeast of Miami, had been overlooked by tourists and investors until recently. Over the past four years, the pro-development government upgraded the airport and encouraged Carnival to build a $40 million cruise center in Grand Turk. A famous designer invested in an island and other celebrities followed. In Grace Bay, developers built sand palaces like Point Grace and the Palms, attracting such wealthy guests as Sean "Diddy" Combs and Sen. John F. Kerry (D-Mass.).

As Friedberg drove along the narrow coastal road from the airport, crews were laying power lines to accommodate growth. For every finished building, there seemed to be two under construction. The government levies no income tax, capital gains tax, inheritance tax or exchange controls. Administration posters fluttered from the lampposts: "Don't Stop the Progress!!! Bigger and Better in 2007." The car stopped at Northwest Point, one of the island's best sites for snorkeling. Turks and Caicos lies on the third-largest coral-reef system in the world. In the winter, herds of humpback whales pass 800 yards off the beach....

Friedberg, for her part, signals "pale, fashion-oblivious nerd," she said. Squeaking as she walked in $8 rubber sandals, Friedberg approached two sleek guests. They run XOJet, a private jet airline. For a one-way flight from the United States to the islands, said Kathleen Brennan, an executive in an orange bikini, XOJet charges $15,000.The price is reasonable, said XOJet chief executive Paul Touw, because the teak-and-glass villas here cost $7 million to $20 million. "These people could probably afford it," Touw said. With the profusion of private jets, Friedberg told Touw, "Turks and Caicos competes in the same market as Maryland's Eastern Shore." Either way, it's about three hours to the beach. On Grace Bay, the average price of properties rose 27 percent in three years, according to one study....

Friedberg dropped into the chair in Brinkley's whitewashed bedroom and asked, "When you're faced with people who have infinite money, how do you set a price?""These people have people working for them who examine every penny," Morgan said. "They'll dispute irrigation bills. We bill them for tiki fuel, and they're like, 'Why are you billing us for that?' ""But what's the market structure?" Friedberg inquired. And on went the professor, for five sugar-sanded, icing-blue-sky days, until she was back on the runway, on the plane, with the engines vibrating her armrest.Friedberg looked outside, down at the pale blue water. "Why would people purposefully leave? Why should universities be in freezing, miserable places instead of here, now that there's the Internet?" But the economist knew why. She sighed and said, barely audible over the revving engines: "Agglomeration effects."

Benjamin Barber Hates Us for Our Freedom

Benjamin Barber hates us for our freedom: ur freedom to go to restaurants named "Stuff Yer Face" on Easton Ave. in New Brunswick, NJ, that is. Tyler Cowen and his mesnie get properly medieval on Barber:

Marginal Revolution: Benjamin Barber's Consumed:

There is actually [sic] a restaurant in New Jersey called Stuff Yer Face, and fast food generally is about stuffing your face: about nutrition, fueling up, taking in the calories, food as instrumentality, eaters as mere animals responding to biological imperatives.

The subtitle of the new book is How Markets Corrupt Children, Infantalize Adults, and Swallow Citizens Whole. Here is the restaurant's home page, with sound.

Posted by Tyler Cowen on March 28, 2007 at 01:44 PM in Books | Permalink

Comments

The title works even better if you replace "Markets" by "Socialism". Posted by: dearieme at Mar 28, 2007 1:50:41 PM....

Even more surprising is that stuff yer face isn't bad, at least for college food (it's right next to rutgers). It's one of the few places on easton ave serving food that you would eat while sober. The beer selection is pretty good as well. It's not a fantastic place, but it's better than the name suggests. Posted by: Anonymous coward at Mar 28, 2007 3:09:39 PM

Stuff Yer Face was also Mario Batali's first cooking job, while attending Rutgers. As the Anonymous Coward points out, it's decent enough for a stromboli and beer place (it was one of the places where we sent our out of town relatives who came for our wedding and were looking for something to eat the night before the wedding) Posted by: Bg Porter at Mar 28, 2007 3:48:26 PM....

Benjamin Barber is an arrogant gasbag. He believes in replacing his preferences in place of everyone else's. He thinks that "we" should be exporting more jazz and less Britney Spears. His view of markets is more-or-less neo-Rousseauian. He believes in sort of "directed democracy" even though he won't admit it. Barber is the type of dude who gives political theorists a bad name. He's typical of the reason that many of the smarter ones go into PHILOSOPHY departments so that they can be free of his ilk. The dude is a sophist and a very, very, VERY poor man's Michael Walzer. Posted by: Jeebus at Mar 28, 2007 3:50:21 PM

I don't know the context, but at face value it seems really odd to complain about people having an instrumental view of food. Is food supposed to be an end in and of itself? I suppose if you viewed getting pleasurable sensations from consuming food as being an non-instrumental usage of food, he'd kind of have a point, but it can hardly be argued that that is a vice of fast food resturants, which tend to make food that a good chunk of the population does enjoy eating. Posted by: MattXIV at Mar 28, 2007 3:59:43 PM

about nutrition, fueling up, taking in the calories, As opposed to anorexia, malnutrution, and throwing-up? food as instrumentality, As opposed to food as an object of mere aesthetic contemplation? eaters as mere animals responding to biological imperatives, As opposed to space aliens responding to cosmic imperatives? Barber is a sententious twat. And I mean that in the best way possible...

Another Sign of the Impending Apocalypse

At the Ferry Building at the bay end of Market Street, Peet's sells a "Scharffenberger mocha freddo" for $4.30. Can the fabric of the universe sustain the existence of the $5 coffee drinks that are clearly only a year or two away?

Ummm... Externalities?

Ummmm... Perhaps there are powerful externalities to acquiring the knowledge about how to work with closed carbon cycle technologies? Balancing off the costs of market failures against government failures is fine. But David Boaz's assuming that there are no market failures anchors--well, this gets him classified as those off in the Gamma Quadrant whose works go to the bottom of the to-be-read pile:

Cato-at-liberty » But: On the way home, my mind wandered as “All Things Considered” reported on a biodiesel refinery in Washington state. And then I heard a familiar opening line from the tech millionaire who is now the CEO of Imperium Renewables, which built the refinery.

I’m a pretty conservative guy, generally. I’ve voted Republican my whole entire life. And I’m very skeptical of the government’s role in any kind of market.... But, in this case, there’s no other way to do it but with government support and mandates.

Turns out biodiesel is profitable with a federal tax subsidy of up to a dollar a gallon, and with the anticipation of restrictions on greenhouse gases. So a guy who’s normally “very skeptical of the government’s role” supports subsidies in this case because there’s “no other way to do it.” But that’s the whole point of markets and prices–to tell us what economic endeavors make sense. If Hawaiian sugar, or South Carolina textiles, or biodiesel fuel isn’t economically viable without subsidies, then that means it’s not the best use of our limited resources.

One of the values of a political philosophy--sometimes dismissed as “ideology” or “dogma”--is that it gives us a rule, a set of principles, for deciding such questions. We don’t have the time to look at all the data and decide what we think about every issue, and we’re certainly all subject to personal biases on the issues that touch us. There are lots of speakers I’d personally like to shut up, but if I remember that I do believe in the First Amendment, I realize I have to allow even offensive speech. I may want Amtrak to run fast trains between Washington and New York, or I may want to keep my own factory in business. But if I remember that the free-market economy produces the best results for all of us, then I will accept the outcomes of the market process.

People should think about the benefits of the whole libertarian system--free markets, free speech, freedom of religion, constitutional limits on government--whenever they’re tempted to say “I’m for freedom, but...”

I wouldn't call the fact that your ideology detaches you from reality a "value" of it, David. That's not the right word.

The Price of Oil in Arabia

Alex Tabarrok writes:

Marginal Revolution: It's quite surprising that the major consumers of the world's oil have not been able to agree to an oil tax under the auspices of something like the Kyoto Protocol. It's surprising because if the major consumers of oil all increased taxes they would end up bearing very little of the burden.

The result is a simple application of the theory of tax incidence. The burden of a tax falls on those who can least afford to escape the tax. The world's demand for oil is inelastic but the supply is even more inelastic. What is Saudi Arabia, for example, going to do with its oil except sell it? The oil is already fetching a price well above cost so if there is a world tax on oil that's like a tax on land - Saudi Arabian land to be precise - and a tax on land is born by land owners not by consumers...

Alex is right. A tax needs to be a general tax on energy that raises the price of energy in order to affect greenhouse gas emissions: a tax on inelastically-supplied energy alone won't do it. That said, a tax on oil is still worth doing: the governments of the energy-using core would make better use of the money than the Al-Saud and As-Sabah families (and, alas! it looks like they would make better use of the money than the governments of Nigeria and Venezuela as well). And there are foreign-policy reasons for lessening our dependence on the Middle East.

Members of the Pigou Club should take note. For the Pigou Club to work to alleviate global warming the Pigouvian tax must reduce the global consumption of oil (not just say US consumption) but with the supply of oil being very inelastic that's not going to happen. A tax could drive high-cost US producers out-of-business but the major world producers are going to keep selling even with a high tax. In other words, membership in the Pigou club has few privileges unless you can put the major producers under (does that advice sound familiar?). If you want to tax Hugo Chavez, however, please do join the Ramsey Club.

Saudi Arabia's oil won't last forever, however...

When the long-run comes, supply will be elastic once again. And the long run does come. Always.

Offshoring Will Be Big: But How, Exactly?

Alan Blinder on "offshoring":

Offshoring and Inequality | TPMCafe: By Ganesh Sitaraman: You probably didn’t notice Princeton economist Alan Blinder’s testimony to the Joint Economic Committee a few weeks ago, but Blinder has peered into the future and identified a crisis that’s just waiting to explode. It’s called offshoring – the movement of jobs or business processes to other countries. So far offshoring has only touched a few areas – manufacturing notable among them--but Blinder thinks that up to 29% of American jobs are offshorable, including many service-industy jobs. Even if only half those jobs go overseas, that’s a crisis of epic proportions....

[T]he dividing line between jobs that are deliverable electronically (and thus are threatened by offshoring) and those that are not does not correspond to traditional distinctions between high-end and low-end work.

The added danger of offshoring is compounded by the rising inequality America has seen since the 1970s. Earnings from work for less-skilled and less-educated workers can't keep up with earnings of the elites in society. These troubles, caused by the market, not by government, have in the last few years been “piled on by enacting tax cuts for the rich while either permitting or causing large holes to emerge in the social safety net.” So when your job is offshored, you’ll be worse off because of the recent erosion of the nation's social and economic safety programs....

Blinder offers two solutions:

First, we need to repair and extend the social safety net for displaced workers. This includes unemployment insurance, trade adjustment assistance, job retraining, the minimum wage, the EITC, universal health insurance, and pension portability--plus other, newer ideas like wage loss insurance.

Second, we must take steps to ensure that our labor force and our businesses supply and demand the types of skills and jobs that are going to remain in America rather than move offshore. Among other things, that may require substantial changes in our educational system—all the way from kindergarten through college.

Preliminary Inequality Reading List

A Preliminary Inequality Reading List:

Thomas Piketty and Emmanuel Saez (2004), "Income Inequality in the United States, 1913-2002" http://elsa.berkeley.edu/~saez/piketty-saezOUP04US.pdf

Samuel Bowles and Herbert Gintis (2002), "The Inheritance of Inequality" http://www.umass.edu/preferen/gintis/intergen.pdf

Lisa Barrow and Cecilia Rouse (2005), "Does College Still Pay?" http://www.bepress.com/cgi/viewcontent. cgi?article=1097&context=ev

Paul Krugman (1993), "The Rich, the Right, and the Facts" http://www.pkarchive.org/economy/therich.html

Paul Krugman (1992), "Inequality and Ignorance" http://www.pkarchive.org/economy/IgnoranceInequality.html

Paul Krugman (1996), "The Spiral of Inequality" http://www.motherjones.com/news/feature/1996/11/krugman.html

Paul Krugman (2002), "For Richer" http://www.motherjones.com/news/feature/1996/11/krugman.html

Paul Krugman (2006), "Graduates vs. Oligarchs" http://www.truthout.org/cgi-bin/artman/exec/view.cgi/48/17995

Thomas Lemieux (2004), "Residual Wage Inequality: A Re-Examination" http://emlab.berkeley.edu/users/webfac/saez/e291_s04/lemieux.pdf

Orley Ashenfelter and Cecilia Rouse (1998), "Schooling, Intelligence, and Income in America: Cracks in the Bell Curve." November, 1998. http://www.irs.princeton.edu/pubs/pdfs/407.pdf

Cecilia Rouse (1997), "Further Estimates of the Economic Return to Schooling from a New Sample of Twins." July, 1997. http://www.irs.princeton.edu/pubs/pdfs/388revised.pdf

Claudia Goldin and Ceci Rouse (2000), "Orchestrating Impartiality: The Impact of Blind Auditions on Female Musicians,"American Economic Review, 90, no. 4 (September 2000): 715-741. http://www.jstor.org/view/00028282/ap000014/00a00030/0?currentResult=00028282%2bap000014%2b00a00030%2b0%2c01%2b20000900%2b9995%2b79999099&searchID=8dd55340.10893069360&frame=noframe&sortOrder=SCORE&userID=8070c9f8@princeton.edu/018dd5534000501264bc2&dpi=3&viewContent=Article&config=jstor

Mark Thoma reads Edward Bellamy on inequality: http://economistsview.typepad.com/economistsview/2006/12/how_inequality_.html

Bookmarks on del.icio.us tagged with "inequality" by jbdelong: http://del.icio.us/jbdelong/inequality

Ben Bernanke on Inequality

Mark Thoma directs us to David Wessel's summary of Ben Bernanke's Omaha speech:

David Wessel: Federal Reserve Chairman Ben Bernanke cautioned that widening inequality may make Americans "less willing to accept the dynamism... so essential to economic progress," but warned politicians to avoid responding by limiting the flexibility of labor markets or erecting barriers to international trade and investment.

Wiser responses, he said, would be to improve education and training and cushion the dislocations caused by technology and globalization, such as making health and pension benefits more portable and offering retraining and job-search assistance to displaced workers....

"Although average economic well-being has increased considerably over time," he said "the degree of inequality in economic outcomes has increase as well... for at least three decades," he said, wandering beyond the boundaries of the aspects of the economy over which the Fed has direct influence.... [Bernanke] documented the inequality trend and detailed reasons behind it -- from the extra wages that employers are willing to pay workers with formal education to the decline of unions to the impact of globalization, which he said has been "moderate and almost surely less important than the effects of... technological change."...

[H]e offered three principles that he said are "broadly accepted in our society" -- economic opportunity should be as widely distributed and equal as possible, economic outcomes needn't be equal but should be linked to a person's contributions and people should get some insurance against "the most adverse economic outcome."

"We... believe," he said, "that no one should be allowed to slip too far down the economic ladder, especially for reason beyond his or her control."

Mr. Bernanke... avoided any mention of tax policy, a favorite tool of Democrats interesting in reducing the inequality produced by market forces.

The Symmetry Argument for Cooperation in One-Shot Prisoner's Dilemma

A commenter writes:

http://delong.typepad.com/sdj/2007/02/tom_slee_tells_.html: The claims made by Axelrod in favor of tit-for-tat are wildly overblown, and frequently just plain wrong. Anatol Rapoport cannot really be blamed for his sloppiness, although he did (re)invent the Symmetry Fallacy that purports to demonstrate that it is rational to co-operate in the one-shot Prisoners' Dilemma. A good place to read a game theorist's reaction to all of this is in Ken Binmore's "Playing Fair: Game Theory and the Social Contract I," Chapter 3, (MIT Press, 1994).

The Symmetry Argument is not the Symmetry Fallacy. I think that it's remarkably deep and subtle, raising many of the issues that arise in Newcomb's Problem.

To review the one-shot Prisoner's Dilemma game. A and B play a one-shot game. Each has two strategies: C(ooperate) and D(efect). A and B are identical. Each is a self-interested being, caring only about his or her own payoffs--they are neither altruistic nor envious. Each is a logical being, understanding the structure of the game and capable of following the strategic logic to its conclusion. The payoffs to this one-shot game are as follows:

---

Basic Prisoner's Dilemma

	B Cooperates	B Defects
A Cooperates	(2,2)	(-5,3)
A Defects	(3,-5)	(-4,-4)

---

Here is the traditional argument for the traditional dominant-strategy equilibrium:

A thinks: "Whatever B does, I am better off doing strategy D. Moreover, whatever I do, B is better off doing strategy D. It would be best for us both if we both did strategy C. But I cannot afford to do C--I would do better doing D, and B knows I would do better doing D. For both of us, strategy D strictly dominates. So I would have to conclude that B was insane or irrational to expect B to do strategy C--and even if B does, I am still better off doing D than C." B thinks the same.

Here is the Symmetry Argument for doing strategy C:

A thinks:

B is identical to me. I am a logical thinker. B is therefore a logical thinker, who will think the same thoughts I think. There are, however random elements--what B had for breakfast, for example--that may lead B to choose a different strategy than me. Let's model those random elements by a random variable b drawn uniformly from [0, 1]. And let's model the logical, systematic part of B's deliberations by having B choose a number p, so that B chooses strategy C if b < p and chooses strategy D otherwise.

What number p will the logical part of B choose?

Well, the best model I have of the logical part of B is what number p I have chosen. Viewing myself as an agent whose logical thought is identical to that of B, what number p will I choose? Let me calculate my expected return as a function of p. It is:

2p² - 2p(1-p) - 4(1-p)²

This is maximized for p = 1. So I should choose p = 1--should always cooperate--and expect a payoff of 2.

Should I take the problem one step further? Should I reason that since B is choosing p = 1, I should choose to defect, and thus get an expected return of 3? Ah. But if I choose to defect, I am choosing my own p = 0, and my forecast of B's choice of p changes as well, and my expected return is not 2 but -4.

A has to confront two truths. On the one hand, A's payoff is greater by one if A chooses to defect rather than to cooperate. On the other hand, if A plays the dominant strategy of "defect" then A's expectation of their payoff drops by 6. +1 or -6? The issue of which truth to act on is, I think, the same issue we find in Newcomb's Problem.

I am a dominant-strategy guy. If you find the Symmetry Argument convincing--well, Grasshopper, you have once again failed to snatch the pebble from my hand. But I feel the force of the other side: If you find the Symmetry Argument an obvious fallacy--well, Grasshopper, you have once again failed to snatch the pebble from my hand.

If you set up as an axiom of rationality that a rational, logical agent must always choose to play a dominant over a dominated strategy--well, Grasshopper, you have begged the question, and you have to answer the next order question: why you think that your rational, logical agents are smart?

Applied Utilitarianism: The Price of Oranges in Berkeley

The big frost that devastated the California citrus crop was two weeks ago, yet prices did not jump immediately. Only recently have the prices of boxes of small EZ-peel oranges at Trader Joe's risen, from $4.99 to $7.99 a box.

This tells us that such oranges are not storable--if they were, Trader Joe's would have kept them in the back until now, and so made an extra $3 a box. This also tells us that the memory of eating oranges is not storable either--it it were, consumers would have gorged themselves on oranges as soon as they realized they were going to be scarce this winter, and so saved themselves an extra $3 a box.

What other goods can you think of that are "nondurable," in the sense of neither being storable by producers or sufficiently memorable to consumers? What goods are "durable" in either of these senses.

Note to Self: Talk to Dan Sumner

Brink Lindsey says that I should talk to U.C. Davis's Dan Sumner to learn about the long-run collapse of Newt Gingrich's constructive "Freedom to Farm" initiative...

ARE Department Website: Daniel A. Sumner is the Frank H. Buck, Jr., Professor in the Department of Agricultural and Resource Economics at the University of California, Davis and the Director of the University of California, Agricultural Issues Center. He participates in research, teaching, and directs an outreach program related to public issues facing agriculture. He has published broadly in academic journals, books, and industry outlets. His research and writing focuses particularly on the consequences of farm and trade policy on agriculture and the economy.

In 1995, he was honored by the American Agricultural Economics Association for his agricultural policy contributions. In 1996 he and co-authors won the AAEA award for Quality of Research Contribution, and his book series related to national farm policy reform was awarded an Honorable Mention for Quality of Communication.

Prior to beginning his current position in January 1993, Sumner was the Assistant Secretary for Economics at the United States Department of Agriculture where he was involved in policy formulation and analysis on the whole range of topics facing agriculture and rural America -- from food and farm programs to trade, resources, and rural development. In his role as supervisor of Agriculture's economics and statistics agencies, Sumner was also responsible for data collection, outlook and economic research.

From 1978 to 1992 Sumner was a Professor in the Division of Economics and Business at North Carolina State University. He spent much of the period after 1986 on leave for government service in Washington, D.C. During 1987-88 he was a Senior Economist at the President's Council of Economic Advisers and was Deputy Assistant Secretary at the USDA from 1990-92.

Sumner was raised on a fruit farm in Suisun Valley, California and was active in 4-H and FFA activities as a youth. He received a bachelors degree in agricultural management from California Polytechnic State University in San Luis Obispo in 1971, a masters degree from Michigan State in 1973, and a Ph.D. in economics from the University of Chicago in 1978.

Value Chains

Lance Knobel writes:

: I went to an interesting unconference on talent today at Electronic Arts. I was involved in a discussion on "the big pipe": the need to reform the US education system so the country can have the talent necessary to thrive in the coming decades. One point we agreed on was the need for companies both to understand and lobby about the importance of education.

An executive from Starbucks made the excellent point that CEOs have a limited bandwidth for issues. For many, healthcare looms far larger than education. After all, she said, Starbucks spends more annually on employee healthcare than on purchasing coffee

The Minimum Wage and the EITC

From the Archives: The Minimum Wage and the EITC:

The Minimum Wage and the EITC: Archive Entry From Brad DeLong's Webjournal: I like the EITC. Come the Day of Wrath, my best pleading will be the role I played in 1993 in the Clinton administration in expanding the EITC.

But the EITC is a program that uses the IRS to write lots of relatively small checks to tens of millions of relatively poor people who satisfy picky eligibility rules. This is not the IRS's comparative advantage. The IRS's comparative advantage is using random terror to elicit voluntary compliance with the tax code on the part of relatively rich people. The EITC is a good program, but it a costly program to administer, and it is administered imperfectly to say the least.

The minimum wage, on the other hand, is nearly self-enforcing: its administrative costs are nearly nil, for workers (legal workers, at least) have a very strong incentive to drop a dime on bosses who violate it. From a government-administrative and error-rate perspective, it's a very cost-effective program.

The right solution, of course, is balance: use the minimum wage as one part of your program of boosting the incomes of the working poor (being well aware of its likely disemployment effects of the wage floor and of its sending lots of money to the wrong households), and use the EITC as the other part (being well aware of its administrative complexities and errors and the disemployment effects of the phase-out range). Try not to push either one to the point where its drawbacks grow large. Balance things at the margin.

Keynes: Wage Flexibility and Full Employment

The General Theory of Employment, Interest and Money, by John Maynard Keynes:

From Chapter 19: Changes in Money-Wages: Thus the reduction in money-wages will have no lasting tendency to increase employment except by virtue of its repercussions either on the propensity to consume for the community as a whole, or on the schedule of marginal efficiencies of capital, or on the rate of interest. There is no method of analysing the effect of a reduction in money-wages, except by following up its possible effects on these three factors.

The most important repercussions on these factors are likely, in practice, to be the following:

(1) A reduction of money-wages will somewhat reduce prices. It will, therefore, involve some redistribution of real income (a) from wage-earners to other factors entering into marginal prime cost whose remuneration has not been reduced, and (b) from entrepreneurs to rentiers to whom a certain income fixed in terms of money has been guaranteed.

What will be the effect of this redistribution on the propensity to consume for the community as a whole? The transfer from wage-earners to other factors is likely to diminish the propensity to consume. The effect of the transfer from entrepreneurs to rentiers is more open to doubt. But if rentiers represent on the whole the richer section of the community and those whose standard of life is least flexible, then the effect of this also will be unfavourable. What the net result will be on a balance of considerations, we can only guess. Probably it is more likely to be adverse than favourable.

(2) If we are dealing with an unclosed system, and the reduction of money-wages is a reduction relatively to money-wages abroad when both are reduced to a common unit, it is evident that the change will be favourable to investment, since it will tend to increase the balance of trade. This assumes, of course, that the advantage is not offset by a change in tariffs, quotas, etc. The greater strength of the traditional belief in the efficacy of a reduction in money-wages as a means of increasing employment in Great Britain, as compared with the United States, is probably attributable to the latter being, comparatively with ourselves, a closed system.

(3) In the case of an unclosed system, a reduction of money-wages, though it increases the favourable balance of trade, is likely to worsen the terms of trade. Thus there will be a reduction in real incomes, except in the case of the newly employed, which may tend to increase the propensity to consume.

(4) If the reduction of money-wages is expected to be a reduction relatively to money-wages in the future, the change will be favourable to investment, because as we have seen above, it will increase the marginal efficiency of capital; whilst for the same reason it may be favourable to consumption. If, on the other hand, the reduction leads to the expectation, or even to the serious possibility, of a further wage-reduction in prospect, it will have precisely the opposite effect. For it will diminish the marginal efficiency of capital and will lead to the postponement both of investment and of consumption.

(5) The reduction in the wages-bill, accompanied by some reduction in prices and in money-incomes generally, will diminish the need for cash for income and business purposes; and it will therefore reduce pro tanto the schedule of liquidity-preference for the community as a whole. Cet. par. this will reduce the rate of interest and thus prove favourable to investment. In this case, however, the effect of expectation concerning the future will be of an opposite tendency to those just considered under (4). For, if wages and prices are expected to rise again later on, the favourable reaction will be much less pronounced in the case of long-term loans than in that of short-term loans. If, moreover, the reduction in wages disturbs political confidence by causing popular discontent, the increase in Liquidity preference due to this cause may more than offset the release of cash from the active circulation.

(6) Since a special reduction of money-wages is always advantageous to an individual entrepreneur or industry, a general reduction (though its actual effects are different) may also produce an optimistic tone in the minds of entrepreneurs, which may break through a vicious circle of unduly pessimistic estimates of the marginal efficiency of capital and set things moving again on a more normal basis of expectation. On the other hand, if the workers make the same mistake as their employers about the effects of a general reduction, labour troubles may offset this favourable factor; apart from which, since there is, as a rule, no means of securing a simultaneous and equal reduction of money-wages in all industries, it is in the interest of all workers to resist a reduction in their own particular case. In fact, a movement by employers to revise money-wage bargains downward will be much more strongly resisted than a gradual and automatic lowering of real wages as a result of rising prices.

(7) On the other hand, the depressing influence on entrepreneurs of their greater burden of debt may partly offset any cheerful reactions from the reduction of wages. Indeed if the fall of wages and prices goes far, the embarrassment of those entrepreneurs who are heavily indebted may soon reach the point of insolvency, %u2014 with severely adverse effects on investment. Moreover the effect of the lower price-level on the real burden of the National Debt and hence on taxation is likely to prove very adverse to business confidence.

This is not a complete catalogue of all the possible reactions of wage reductions in the complex real world. But the above cover, I think, those which are usually the most important.

If, therefore, we restrict our argument to the case of a closed system, and assume that there is nothing to be hoped, but if anything the contrary, from the repercussions of the new distribution of real incomes on the community's propensity to spend, it follows that we must base any hopes of favourable results to employment from a reduction in money-wages mainly on an improvement in investment due either to an increased marginal efficiency of capital under (4) or a decreased rate of interest under (5). Let us consider these two possibilities in further detail.

The contingency, which is favourable to an increase in the marginal efficiency of capital, is that in which money-wages are believed to have touched bottom, so that further changes are expected to be in the upward direction. The most unfavourable contingency is that in which money-wages are slowly sagging downwards and each reduction in wages serves to diminish confidence in the prospective maintenance of wages. When we enter on a period of weakening effective demand, a sudden large reduction of money-wages to a level so low that no one believes in its indefinite continuance would be the event most favourable to a strengthening of effective demand. But this could only be accomplished by administrative decree and is scarcely practical politics under a system of free wage-bargaining. On the other hand, it would be much better that wages should be rigidly fixed and deemed incapable of material changes, than that depressions should be accompanied by a gradual downward tendency of money-wages, a further moderate wage reduction being expected to signalise each increase of, say, 1 per cent. in the amount of unemployment. For example, the effect of an expectation that wages are going to sag by, say, 2 per cent. in the coming year will be roughly equivalent to the effect of a rise of 2 per cent. in the amount of interest payable for the same period. The same observations apply mutatis mutandis to the case of a boom.

It follows that with the actual practices and institutions of the contemporary world it is more expedient to aim at a rigid money-wage policy than at a flexible policy responding by easy stages to changes in the amount of unemployment; -- so far, that is to say, as the marginal efficiency of capital is concerned. But is this conclusion upset when we turn to the rate of interest?

It is, therefore, on the effect of a falling wage- and price-level on the demand for money that those who believe in the self-adjusting quality of the economic system must rest the weight of their argument; though I am not aware that they have done so. If the quantity of money is itself a function of the wage- and price-level, there is indeed, nothing to hope in this direction. But if the quantity of money is virtually fixed, it is evident that its quantity in terms of wage-units can be indefinitely increased by a sufficient reduction in money-wages; and that its quantity in proportion to incomes generally can be largely increased, the limit to this increase depending on the proportion of wage-cost to marginal prime cost and on the response of other elements of marginal prime cost to the falling wage-unit.

We can, therefore, theoretically at least, produce precisely the same effects on the rate of interest by reducing wages, whilst leaving the quantity of money unchanged, that we can produce by increasing the quantity of money whilst leaving the level of wages unchanged. It follows that wage reductions, as a method of securing full employment, are also subject to the same limitations as the method of increasing the quantity of money. The same reasons as those mentioned above, which limit the efficacy of increases in the quantity of money as a means of increasing investment to the optimum figure, apply mutatis mutandis to wage reductions. Just as a moderate increase in the quantity of money may exert an inadequate influence over the long-term rate of interest, whilst an immoderate increase may offset its other advantages by its disturbing effect on confidence; so a moderate reduction in money-wages may prove inadequate, whilst an immoderate reduction might shatter confidence even if it were practicable.

There is, therefore, no ground for the belief that a flexible wage policy is capable of maintaining a state of continuous full employment; -- any more than for the belief than an open-market monetary policy is capable, unaided, of achieving this result. The economic system cannot be made self-adjusting along these lines.

If, indeed, labour were always in a position to take action (and were to do so), whenever there was less than full employment, to reduce its money demands by concerted action to whatever point was required to make money so abundant relatively to the wage-unit that the rate of interest would fall to a level compatible with full employment, we should, in effect, have monetary management by the Trade Unions, aimed at full employment, instead of by the banking system. Nevertheless while a flexible wage policy and a flexible money policy come, analytically, to the same thing, inasmuch as they are alternative means of changing the quantity of money in terms of wage-units, in other respects there is, of course, a world of difference between them. Let me briefly recall to the reader's mind the three outstanding considerations.

(i) Except in a socialised community where wage-policy is settled by decree, there is no means of securing uniform wage reductions for every class of labour. The result can only be brought about by a series of gradual, irregular changes, justifiable on no criterion of social justice or economic expediency, and probably completed only after wasteful and disastrous struggles, where those in the weakest bargaining position will suffer relatively to the rest. A change in the quantity of money, on the other hand, is already within the power of most governments by open-market policy or analogous measures. Having regard to human nature and our institutions, it can only be a foolish person who would prefer a flexible wage policy to a flexible money policy, unless he can point to advantages from the former which are not obtainable from the latter. Moreover, other things being equal, a method which it is comparatively easy to apply should be deemed preferable to a method which is probably so difficult as to be impracticable.

(ii) If money-wages are inflexible, such changes in prices as occur (i.e. apart from "administered" or monopoly prices which are determined by other considerations besides marginal cost) will mainly correspond to the diminishing marginal productivity of the existing equipment as the output from it is increased. Thus the greatest practicable fairness will be maintained between labour and the factors whose remuneration is contractually fixed in terms of money, in particular the rentier class and persons with fixed salaries on the permanent establishment of a firm, an institution or the State. If important classes are to have their remuneration fixed in terms of money in any case, social justice and social expediency are best served if the remunerations of all factors are somewhat inflexible in terms of money. Having regard to the large groups of incomes which are comparatively inflexible in terms of money, it can only be an unjust person who would prefer a flexible wage policy to a flexible money policy, unless he can point to advantages from the former which are not obtainable from the latter.

(iii) The method of increasing the quantity of money in terms of wage-units by decreasing the wage-unit increases proportionately the burden of debt; whereas the method of producing the same result by increasing the quantity of money whilst leaving the wage unit unchanged has the opposite effect. Having regard to the excessive burden of many types of debt, it can only be an inexperienced person who would prefer the former.

(iv) If a sagging rate of interest has to be brought about by a sagging wage-level, there is, for the reasons given above, a double drag on the marginal efficiency of capital and a double reason for putting off investment and thus postponing recovery...

Risk, Uncertainty and Irreversibility, Decision Theory, and Global Warming

Alex Tabarrok protests that you should not do expensive and irreversible things before you know what is going on. I think that there is an important distinction to be drawn in decision theory between (a) risk on the one hand, and (b) the interaction of uncertainty and irreversibility on the other.

In general, briefly: As a baseline, you should start out thinking that you should do what it would be best to do if your central-case forecast were to come true. And then:

1. Relative to that baseline, you should do more of things that reduce risks: a prudent portfolio should have some gold or silver in it (not much!) to guard against the potential inflationary collapse of fiat money systems and other political risks.
2. Relative to that baseline, you should do less of things that increase risk: invest less in risky enterprises, and dump less carbon dioxide and methane into the atmosphere.
3. You should delay doing expensive and irreversible things until you are confident that they are needed.
4. You should prevent processes that could cause irreversible or incredibly-expensive-to-repair damage until you are confident that their effects will be harmless.

The first two principles are the appropriate ones for dealing with risk. The last two principles are appropriate for dealing with the interaction of uncertainty and irreversibility.

Thus if congress were on the verge of banning open-carbon-cycle power generation and vehicle operation in 2010, I would think that that was a bad idea because of principle 3. But congress isn't. The uttermost limit of political feasibility over the next decade is a fifty-cents-a-gallon-equivalent tax on carbon emissions. And that seems well-covered by principle 2.

Here's Alex:

Marginal Revolution: Uncertainty is the Friend of Delay: Regarding global warming and what to do about it, Brad DeLong approvingly paraphrases Tyler, "uncertainty is not the friend of doing nothing." Bearing in mind the obvious dangers of contradicting both Brad and Tyler let me counter with "uncertainty is the friend of delay."... Suppose... that we are uncertain... there is a strong argument for delay. The argument comes from option pricing theory applied to real options. A potential decision is like an option, making the decision is like exercising the option. Uncertainty raises the value of any option which means that the more uncertainty the more we should hold on to the option, i.e. not exercise or delay our decision....

Applying the theory to global warming isn't easy because our decisions involve many options and exit costs; but if we think that our knowledge of the extent, cost, cause and solutions to global warming are increasing at a faster rate than the danger of global warming then delay of any major decision is a rational policy at the present time.

And Tyler Cowen rebuts:

I see the difference between us as such: you write: "making the decision is like exercising the option...". But many costly decisions increase option value. Such decisions include more R&D, more savings, a compensation fund, investment in greater economic flexibility and response capabilities, and so on. Anything we do counts as a "decision," so we cannot postpone decisions per se. We can and should postpone relatively irrevocable decisions, and under that heading "consumption" is a prime candidate. The correct implication of your argument is that when uncertainty increases, we should (under some specific conditions outlined in my post) consume less, which is close to my point of view...

Victor argues:

I agree on the difficulty in applying option theory to global warming policy. There’s a myriad options with varying cost/lead-time trade-offs. The uncertainties are considerable, have many dimensions, and the flow of information to resolve them is stochastic. But option theory doesn’t always argue for delay. If your doctor said there was a chance you had a flesh-eating bacterial infection that would take several days for the tests to resolve, would you delay or accept treatment? It’s a no-brainer if the treatment was just taking a bottle of antibiotics, but if your arm is turning red immediate hospitalization for intravenous antibiotics might be the optimum strategy. Acting now can preserve options going forward. At a simple level for communication, an insurance framing of the problem works better for me.

Moving to Opportunity Twelve Years Later

The excellent Jon Hilsenrath and Rafael Gerena-Morales have an article http://online.wsj.com/article/SB116727318376761110-email.html about the Clinton-era "Moving to Opportunity" pilot program. And, coincidentally, a correspondent asks me this evening if it is indeed the case that high relative poverty among African-Americans today is principally due to residential segregation, and whether residential segregation is in turn principally due to African-Americans' preference to live near other African-Americans.

There are certainly other powerful causes of residential segregation. You can see some of them at work in this gem from the 1994 Wall Street Journal about "Moving to Opportunity" that I have filed away:

"Clinton's Wrecking Ball for the Suburbs": By James Bovard: 4 August 1994: Pamela Price was delighted when she found she could use her new government housing voucher to move into a luxurious apartment complex with a heated swimming pool, four spas, six tennis courts and two air-conditioned racquetball courts.... Ms. Price is the beneficiary of a federal housing policy called "income integration" -- which consists largely of moving welfare recipients into affluent neighborhoods, theoretically to improve their prospects of leading safe and productive lives. But these Section 8 vouchers from the Department of Housing and Urban Development end up sowing chaos in suburban neighborhoods, rewarding dependence on the state and alienating middle class Americans who end up paying for recipients to live in apartments that they themselves could not afford. Amazingly, Congress is on the verge of passing a $60 billion housing act that will greatly expand this program....

At Manhattan Plaza in New York City, Section 8 pays for apartments with wood parquet floors and on-premise swimming, racquet and tennis facilities.... Section 8 certificates were used to entitle welfare families to move into an apartment complex in Silver Spring, Md., that includes a heated pool with water jets, microwave ovens and "deluxe modern kitchens with convenient breakfast bars."... HUD raised Section 8 subsidy levels in Plano, Texas, to $684 for a two-bedroom and $900 for a three-bedroom apartment.... [T]he median rent in Plano, Texas, is only $586 a month....

The unfairness of this hasn't gone unnoticed... outraged private citizens.... Nevertheless, Housing Secretary Henry Cisneros is expanding the Section 8 program.... The flood of former public housing residents has turned parts of some nearby towns into a "Section 8 corridor." Officials in Pacesetter, Ill., claimed that "a sudden influx into the neighborhood of subsidized families about six years ago turned a borderline neighborhood into a slum."...

[P]ublic controversies over misbehaving Section 8 recipients have exploded.... [C]rime and declining property values caused by Section 8 clients have become a major political issue.... the irresponsibility of a privileged class of renters... Trouble-making public-housing residents will not be transformed into angels simply by moving them into different neighborhoods...

The "Moving to Opportunity" pilot program was never expanded. Let me give the mike to Jon Hilsenrath and Rafael Gerena-Morales:

How Much Does A Neighborhood Affect the Poor?: JON E. HILSENRATH and RAFAEL GERENA-MORALES: December 28, 2006: The Moving to Opportunity program, started in 1994, was a mix of liberal and conservative policy: hatched by Republican Jack Kemp and implemented by the Clinton administration. But later that year, in Baltimore -- one of the five cities participating -- suburbanites rebelled against the idea that poor families from troubled environments would be flocking to their neighborhoods. Plans to move additional families were canceled...

And the results from follow-ups are that the effects of "Moving to Opportunity" were mixed--good for girls, bad for boys:

How Much Does A Neighborhood Affect the Poor?: JON E. HILSENRATH and RAFAEL GERENA-MORALES: December 28, 2006: Can a family escape poverty by getting out of the neighborhood where it takes root?... About two million families currently use "Section 8" vouchers that allow them to move with subsidized rent.... Beginning in 1994, the federal government offered a lottery for housing vouchers to families in five major cities. Families were randomly assigned to different groups. One group received vouchers to be used specifically to subsidize rents in neighborhoods where poverty was low. About 860 families eventually moved. Another group, of 1,440 families, wasn't offered vouchers and, initially at least, stayed in high-poverty neighborhoods. Researchers have since tracked and compared the fortunes of the two groups.

The program, called Moving to Opportunity, was administered by HUD.... Earnings of families who relocated to low-poverty areas averaged just $9,376 in 2001, a half-decade after they moved. That's just 3% higher than the $9,108 earned by those in the control group, a statistically insignificant difference.... In a 2002 survey of 3,521 adults in the program -- most of them women -- 18.5% of people who moved to low-poverty neighborhoods suffered bouts of major depression, significantly lower than the 26.3% who felt depressed in the control group....

Among nearly 800 teenage girls, 83% of those who relocated to low-poverty neighborhoods had either graduated from high school or were still in school five years after the move, compared with 71% in the control group. Alcohol use was lower. Arrest rates were lower. And mental-health measures improved. Away from the violence of the ghetto, girls seemed to flourish.

Teenage boys didn't. School participation deteriorated and property-crime rates, mental distress, and smoking all increased among those who moved with the vouchers, compared with teenage boys in families who didn't move. For property crime, there were 58 arrests for every 100 boys who moved to low-poverty neighborhoods, compared with 22 arrests for every 100 boys in the control group.... [R]esearchers expected they would respond well to safer, more-affluent environments. Instead, many seemed to feel isolated in the new places, or harassed by police, and they acted out. "It seems like the boys were less able to make social connections to their new areas," says Jeffrey Kling, a Brookings Institution economist who designed many of the Moving to Opportunity studies and interviewed participants...

The Stern Review on Global Climate Change Once Again

Bill Nordhaus has placed his critique of the Stern Review on Global Climate Change (on the internet at http://www.hm-treasury.gov.uk/independent_reviews/stern_review_economics_climate_change/sternreview_index.cfm) in yellow covers: it is now NBER working paper 12741 at http://papers.nber.org/papers/w12741.pdf (available for free at http://nordhaus.econ.yale.edu/SternReviewD2.pdf). Nordhaus is extremely smart, extremely hard-working, extremely knowledgeable on this issue, and plays it straight. Nevertheless, I find myself dissatisfied.

I am not dissatisfied with where Nordhaus gets: I believe that he is right in assessing that Stern's conclusions depend on assumptions about what we today owe the future that are not obvious, that are at least debatable, and that I do not think I share.

I am dissatisfied with how Nordhaus gets there.

Specifically, the hackles on my back rise when Nordhaus writes:

Suppose that scientists discover that that a wrinkle in the climatic system will cause damages equal to 0.01 percent of output starting in 2200 and continuing at that rate thereafter. How large a one-time investment would be justified today to remove the wrinkle starting after two centuries? The answer is that a payment of 15 percent of world consumption today (approximately $7 trillion) would pass the Review’s cost-benefit test. This seems completely absurd. The bizarre result arises because the value of the future consumption stream is so high with near-zero discounting that we would trade off a large fraction of today’s income to increase a far-future income stream by a very tiny fraction. This bizarre implication reminds us of Koopmans’s warning quoted above to proceed cautiously.... The large damages from global warming reflect large and speculative damages in the far-distant future; the impacts now, as in today, are small; and, as I will suggest below, the 20 percent cut in consumption from global-warming might be reduced by an order of magnitude if alternative assumptions about discounting are used...

The only thing I agree with is the final lines: our conclusions about the steps we should take immediately to deal with global climate change would be reduced by an order of magnitude if alternative (and perhaps, I think, better) assumptions about discounting are used. But the rest:

My first problem is with the framing, which Nordhaus uses to generate phrases like: "bizarre result," "completely absurd," and "bizarre implication." A more neutral way of framing the issue would be to say that the Stern Review estimates that each $1 we invest today in reducing the impact of global warming will improve the state of things in 2200 by $36 (adjusted for inflation) then. Is that a good investment for us to make on behalf of our great-great-grandchildren? Perhaps, perhaps not. 2200 is far away. But a 36-to-1 payoff is a big one. On the other hand, people in 2200 will probably be richer and have better technologies than we do; that is a reason to think that efficiency should not be considered separately from issues of distribution, for we don't usually ask the poor (i.e., us now) to pay to improve the condition of the rich (i.e., them in the future).

The question of whether we today should, or are morally obligated to, make the 36-to-1 two-century investments that the Stern Review is debatable. It is worth doing if we have a hurdle rate for such investments of less than 1.8% per year or so. I think our hurdle rate should probably be bigger than that, but I am not sure. I am, however, sure that Stern's position that we should be making such high-payoff long-term investments is neither "completely absurd," "a bizarre result," nor "a bizarre implication."

My second problem is with Nordhaus's rhetorical attempt to shrink the magnitude of the potential problem by talking about the "large and speculative damages in the far-distant future." The implicit economics underlying this rhetoric is that because investing in controlling global warming is a risky and uncertain proposition the appropriate hurdle rate to apply is greater than the hurdle rate on safe investments like long-term inflation-indexed government bonds. But this economics is simply wrong. As Tyler Cowen puts it, uncertainty is not the friend of doing nothing. Investments in controlling global warming are not risk-increasing but risk-reducing ones: they are more like buying insurance than like speculating on unproven technologies. The appropriate hurdle rate is thus lower, not higher, than that for sure things.

And this leads to my third problem with Nordhaus: his claim that:

The Review’s unambiguous conclusions about the need for extreme immediate action will not survive the substitution of discounting assumptions that are consistent with today’s market place...

I don't see that at all. The 20-year inflation-indexed U.S. government bond interest rate is currently 2.1% per year. That is today's marketplace. The appropriate discount rate to be used for long-term risk-reducing "insurance" investments is less than the risk-free rate, and seems plausibly less than 1.8%. I don't buy the assumption that our judgments should be ruled by the prevailing configuration of financial market prices--I am not confident that the market is without failure along this dimension. But Nordhaus apparently does. And as best as I can see the discounting assumptions in today's marketplace are entirely consistent with the conclusions of the Stern Review.

John Quiggin has an excellent discussion of all these issues and more at: http://johnquiggin.com/wp-content/uploads/2006/12/sternreviewed06121.pdf.

And my not-completely-informed views about the economics of controlling global warming are:

---

What Do We Owe Our Great Grandchildren?

What do we owe our great-great-great grandchildren? What actions are we obligated to do now in order to diminish the risks to our descendants and our planet from the increasing likelihood of significant global warming and its associated climate change?

Everybody--well, almost everybody: ExxonMobil, U.S. Vice President Richard Cheney, and their paid-for servants and deluded acolytes are exceptions or pretend to be exceptions--understands that when human burn hydrocarbons carbon dioxide goes up into the atmosphere, where it acts like a giant blanket, absorbing infrared radiation coming up from below and warming the earth.

Everybody understands that we really do not know how much global warming a given amount of extra carbon dioxide produces. We have models, we have forecasts, we have projections, but global warming might be a much smaller and might be a much larger problem than the central-case projections of climate models suggest. Everybody--well, almost everybody: ExxonMobil, U.S. Vice President Richard Cheney, and their paid-for servants and deluded acolytes are exceptions or pretend to be exceptions--understands that here uncertainty is not our friend, and certainly not an excuse for inaction. Uncertainty about its effects should lead us to do more to guard against global climate change than if we knew global warming would proceed exactly as the central-case projections forecast.

Everybody--well, almost everybody: ExxonMobil, U.S. Vice President Richard Cheney, et cetera, et cetera--understands that the world's governments, non-profit institutions, and energy companies ought to be spending a much bigger fortune than they currently are on research: research into technologies that generate power without adding carbon dioxide to the atmosphere, research into technologies that such carbon out of the atmosphere into forests or oceans, research into technologies that cool the earth by reflecting more of the sunlight that lands on us.

Everybody--well, almost everybody: U.S. Vice President Richard Cheney, et cetera, et cetera--understands that the burden of dealing with global climate change over the next two generations should be carried by the rich countries of the world. They got to take an easy carbon emissions-intensive path to industrialization and riches. It looks like China, India, and company will not be able to take such an easy path, and it would be unfair to penalize them for the loss of the easy hydro-carbon burning road.

Everybody--well, almost everybody, et cetera, et cetera--understands that now is the time to build the international institutions that will manage our reactions to global climate change over the next several centuries. Now is not the time to disrupt these institutions, or to prevent their creation.

What there is real dispute about is what else we should be doing right now and in the next decade. We economists like to think of things in terms of prices. And when we economists see something going wrong in the sense of having destructive side-effects, we like to tax it. Taxing it makes the individuals who are undertaking actions feel in their wallets the destruction they are causing elsewhere. Maybe the action is still worth doing, and maybe not. Imposing a tax--imposing the right tax--on those who are, say, driving low-mileage SUVs is a way of harnessing the collective intelligence of humanity to deciding in which case the bad side-effects are a reason to stop. But it has to be the right tax.

An SUV going ten miles in the city and burning a gallon of gasoline pumps about 3 kilograms--6.5 pounds--of carbon in the form of carbon dioxide into the atmosphere. Should the extra tax on this--and on all carbon emissions--appropriate for global warming be on the order of five cents a gallon, fifty cents a gallon, or a dollar fifty a gallon? Our views will change as we learn more, but at the moment whether the tax should be five or fifty cents a gallon hinges on a question of moral philosophy: how much do we believe that we owe our distant descendents?

Australian economist John Quiggin has a very illuminating discussion on his website http://johnquiggin.com/wp-content/uploads/2006/12/sternreviewed06121.pdf. The Stern Review on Global Climate Change (on the internet at http://www.hm-treasury.gov.uk/independent_reviews/stern_review_economics_climate_change/sternreview_index.cfm) which comes down more on the side of fifty cents a gallon, immediately, does so because they project that spending today to reduce carbon emissions is a very good investment for the future. If the world grows in per capita income at about 2% per year, a marginal expenditure of roughly $70 today in cutting carbon emissions would be worth it if it were to enrich the world of 2100 by about an extra $500 of year-2006 purchasing power, once all the damages to the world economy and environment from global warming, costs of adjustment, and so on are taken into account. This looks like a very good deal to Nick Stern and his team.

On the other hand, critics point out that the world today is poor: average GDP per capita at purchasing power parity today is roughly $7000. We expect improvements in and the spread of technology to make the world of 2100, at a 2% per year growth rate much richer than the world of today: $50,000 per capita of year-2006 purchasing power. We today can use the marginal $70 per capita, critics say, much more than the richer people of 2100 will need the $500 they would gain from not having to suffer from the effects of global climate change.

What critics don't often say is that the same logic applies to the world today. The U.S., Japan, and Western Europe today have average incomes of roughly $40,000 per capita. The poorer half of the world's population today have incomes of less than $6,000 per capita. I believe that the same logic which says that we today need our $70 more than the people of 2100 need an extra $500 also tells us that we ought to tax the world's rich in the OECD more and more to fund world development as long as each extra $500 in first-world taxes generates even as little as $70 in extra poor-periphery incomes. If we in the world's rich now are stingy toward the (likely to be much richer) future and want to leave them our environmental mess to deal with, we should be lavish toward our poor brothers and sisters today. If we today are stingy toward our poor brothers and sisters now, we should be lavish toward our descendents.

If you protest that distributional considerations militate against our spending a lot today to reduce global warming risks to the future, you had better be enthusiastic about massive programs to reduce current U.S. and global inequality. At least, that is what you had better be if your positions are based on some moral principle--rather than on the principle that what we have, we hold, and nobody is going to pry it from our hands.

Price as a Signal of Quality?

Sometimes a high price is just a high price:

BoingBoing: Chocolate-obsessed blogger's exposé on costly candy, Noka: BB reader Egg Syntax says,

Noka makes obscenely expensive chocolate ($2080/lb in small doses). This superb exposé from a very, very serious chocolate geek reveals that they buy widely-available chocolate and remold it at up to a 6,956% markup. Excellent reading and a good reminder that price is often not proportional to quality.

Link to "What's Noka Worth?" on dallasfood.org.

I can't speak to the veracity of the claims in this exhaustive (10! part!) investigative series, but I couldn't stop reading it. I don't even care much about the subject in general -- I hardly eat sweets at all, myself -- but the scientific references and geeky specificity made this a riveting read. It's more about economics and the psychology of luxury goods than chocolate alone...

Paramus, NJ

Tyler Cowen directs us to Paramus, NJ:

In This Town, Even a Mall Rat Can Get Rattled - New York Times By KEN BELSON: It is fitting that the first store drivers heading south on Route 17 see as they enter town is a Stop & Shop. After all, Paramus is one of the nation's strongest shopping magnets, generating roughly $5 billion a year in retail sales.... [F]ew places rival the sheer concentration of stores in this otherwise unremarkable suburb 18 miles northwest of Times Square. In an already densely populated state, Paramus has more parking spots than people. Four major malls and dozens of smaller shopping centers are packed into 10 square miles.... The town has 27,000 residents, and about 2,700 stores. There is a Saks Fifth Avenue and a Sears; at least two dozen chains, including Borders, Old Navy and Macy's, have more than one outlet within Paramuss boundaries.

It is a Faustian bargain that brings 200,000 cars a day into town during December, turning the roads into virtual parking lots, but also keeps property tax rates in Paramus relatively low -- $1.55 per $100 of assessed value, compared with $3.88 in Maywood, the next town over. And there is no sign of letup: two of the four malls are spending $100 million each to spruce themselves up, big-box stores are sprouting where strip malls and bygone department stores once sat, and traffic seems to get worse each year....

Residents have groaned about the traffic for years, but largely put up with it because of how much money visitors spent in the town's stores. They also won reprieves on Sundays, when the town prohibits sales of practically everything, making Paramus a virtual ghost town...

The fact that Paramus grows even with Sunday closures is, I think, the most fascinating thing in the article>

Competition for American Producers from High-Cost First-World Labor

Toyota Rising:

Toyota Could Become World's No. 1 Car Maker in 2007 - WSJ.com: By YOSHIO TAKAHASHI and ANDREW MORSE December 22, 2006 12:12 p.m. NAGOYA, Japan -- Toyota Motor Corp. said Friday it aims to produce 9.42 million vehicles next year, a level that will likely vault it past struggling U.S. auto giant General Motors Corp. as the world's top car maker.

Toyota's new production targets represent a 4% increase from the 9.04 million vehicles the Nagoya-based company expects to produce in 2006. Indicative of Toyota's increasing reliance on foreign markets: Overseas production will jump 8% to 4.27 million vehicles, while domestic production will rise just 1% to 5.15 million vehicles.

GM, which hasn't released a forecast for next year's production, expects to build 9.18 million vehicles in 2006, up from the 9.11 million vehicles it produced in 2005.

Though widely expected, Toyota's official production plans highlight the diverging fortunes of the world's two truly global car companies. Toyota has ramped up production in North America, Asia and other parts of the world to take advantage of surging demand for its fuel-efficient passenger cars, such as the Camry and the hybrid Prius. It plans to open new plants in China, Thailand and Russia to meet demand for its cars.

Meanwhile, GM is in the midst of a painful restructuring after racking up a $10 billion loss last year. The Detroit-based company has already posted $3 billion in losses this year as sales of big sport-utility vehicles and trucks falter amid persistently high oil prices. The company plans to shutter more factories as part of its restructuring.

Jared Bernstein Writes in on Alan Reynolds

Hoisted from comments:

Grasping Reality with Every Limb: Brad DeLong's Semi-Daily Journal: Intellectual Garbage Collection: The Unreliability of Alan Reynolds: The problem with Reynold's critique is that he latches on to a few correct points about the limitations of the IRS SOI data, then he:

• ignores the work others have done to correct these problems;
• way overstates the bias from these problems;
• ignores other data that do not suffer from these problems; *having ignored all the inconvenient evidence to the contrary, misleadingly concludes there's no inequality problem.

He's not nuts. Some changes in inequality as measured by the IRS SOI data (the main source for Pik&Saez) are induced by income shifting due to tax changes. But while that can explain a spike in one year to the next, it doesn't explain longer trends in income concentration found in that and every other data set we have.

Also, analysts at IRS have worked hard to try to deal with some of these shortcomings. Take a look at this paper--the figures and tables clearly show an increase in inequality since 1988 income measures that correct for some of the inconsistencies.

http://www.irs.gov/pub/irs-soi/06asapetska.pdf

I won't belabor the CBO points others have made, other than to say that these data go the furthest towards addresses all the concerns raised by Reynolds. Sorry if these tables don't align correctly--I just pasted them in from excel.

They show real household income changes, since 1988. 2000 was an economic peak and the year before the bursting financial bubble took a big bite out of high incomes (large capital losses), so you see more inequality if you stop there. But I've include the latest CBO year too--02-03--to show that the old pattern is returning.

Pretax        1988-2000  1988-2003  2002-2003
Bottom fifth     15.6%      9.6%      -1.3%
Mid fifth        11.2%      7.5%      -0.4%
Top fifth        35.3%     19.0%       2.3%
Top 1%           68.4%     25.1%       5.9%


Posttax       1988-2000  1988-2003  2002-2003
Bottom fifth     17.7%     13.7%      -1.4%
Mid fifth        12.9%     13.1%       0.7%
Top fifth        30.9%     20.0%       3.9%
Top 1%           60.4%     22.1%       8.2%

Source: CBO

You simply can't write about this stuff in good faith and leave all this information out, unless you're trying to push an agenda that's dependent on misleading.

Gordon's Notes Rents a Car

The struggle over price discrimination continues:

Gordon's Notes: Car rental: enter gold number, price jumps $200: The 'arms race' of modern pricing continues apace. I priced a personal 5 day van rental twice on Travelocity - once with no loyalty number added and again with the loyalty number.The price of loyalty, was a $200 increase. Yes, I would pay Avis for the joy of being a loyal customer.

To their credit Travelocity listed Avis twice after I entered my registration number, once at the disloyal price and again at the inflated loyal price.These days it is increasingly foolish to do any price negotiation directly with a travel related vendor.

Intellectual Garbage Collection: The Unreliability of Alan Reynolds

A correspondent asks why she should presume that Alan Reynolds is wrong when he claims that statistics showing rising inequality are cynically and fraudulently manipulated--that, as Reynolds writes in the extremely bad and low-quality intellectual neighborhood that is the Wall Street Journal editorial page:

Senator-elect Jim Webb recently complained on this page of an "ever-widening divide" in America, claiming "the top 1% now takes in an astounding 16% of national income, up from 8% in 1980." Those same figures have been repeatedly echoed in all major newspapers, including this one. Yet the statement is clearly false.... The top 1% of tax returns accounted for 10.6% of personal income in 2004. But that number too is problematic. The architects of these estimates, Thomas Piketty of École Normale Supérieure in Paris and Emmanuel Saez of the University of California at Berkeley...

The incessantly repeated claim that income inequality has widened dramatically over the past 20 years is founded entirely on [Piketty and Saez's] seriously flawed and greatly misunderstood estimates of the top 1%'s alleged share of something-or-other. The politically correct yet factually incorrect claim... fill[s] a psychological rather than logical need. Some economists [i.e., Thomas Piketty and Emmanuel Saez] seem ready and willing to supply whatever is demanded. And there is an endless political demand for those able to fabricate problems...

The first reason is that Alan Reynolds is playing intellectual three-card monte. He opens his op-ed by attacking Senator-elect Webb's belief that income inequality has risen steeply since 1980, but in the body of the op-ed--as he writes to economist Mark Thoma's Economist's View--"[I said that] there is no clear evidence of a sustained and significant increase in inequality since 1988.... I very carefully did not say there was no such evidence about 1981-87..." That is sufficient reason right there.

However, there are more reasons. We have experience with Alan Reynolds. The last time I noticed Alan Reynolds on inequality was last March, when he wrote:

The Top 10 Percent, Again: [T]he eternal ambition of Robin Hood economics is to steal money from those who earned it and "redistribute" it to those with more political clout. When in pursuit of such a worthy cause, it appears quite respectable to torture innocent statistics. Those deploying statistics in this campaign take special care to select their favorites. Washington Post columnist Steven Pearlstein.... "in 1979, the top 10 percent of households earned 33 percent of all pretax income. By 2003, their share had climbed to 44 percent. The shares of everyone else declined." Where did [Pearlstein's] numbers come from? They certainly didn't come from the Census Bureau.... Pearlstein's statistics obviously didn't come from the CBO... [which] estimates that in 1979 the top 10 percent of households earned 39.3 percent of all pretax income. By 2003, their share had dropped to 38.3 percent (or 33.7 percent after taxes).... It is easy to see why the CBO is not Pearlstein's favorite source of income statistics...

At the time Reynolds's claim that CBO showed no rise in household income inequality since 1979 surprised me, because I had read a report by the careful Isaac Shapiro and Joel Friedman of CBPP on the CBO study which said something very different:

New CBO Data Indicate Growth in Long-Term Income Inequality Continues, 1/29/06: CBO issues the most comprehensive data available on changes in incomes and taxes for different income groups.... The new CBO report highlights the degree to which income gains have become increasingly concentrated at the top of the income scale over the past two and a half decades.... The top one percent of the population received 12.2 percent of national after-tax income in 2003, up from its already-large 7.5 percent share in 1979...

Sure enough, Reynolds is wrong. CBO estimated that for all households the income of the top tenth in 2003 was 37.2%, compared to 30.5% in 1979. Reynolds's 39.3% and 38.3% came not from "Table 1: All Households", but instead from Table 3, "Elderly Households".

As Paul Krugman wrote at the time, defending Pearlstein:

: [F]or [Pearlstein's] pains, he was smeared by someone at the Cato Institute who needs help -- technical help. Hint to Alan Reynolds: check which table you're looking at before claiming that Congressional Budget Office data refute a statement you don't like...

Emmanuel Saez's office is seven doors north of mine on the west corridor of Evans Hall. He is an extremely thoughtful, intelligent, careful, and fair-minded economist, trying his very best to tell it straight. He deserves much better than to be smeared by people who are not careful--who get their tables mixed up--and are not fair-minded--i.e., "I very carefully did not say there was no such evidence about 1981-87."

---

UPDATE: More "Unreliability":

Back in 1992, in an article, "The Rich, the Right, and the Facts" for the American Prospect http://www.prospect.org/print/V3/11/krugman-p.html, Paul Krugman tangled with Alan Reynolds's earlier incarnation--the one in which he said that claims that the top 1% share of wealth and income had risen over 1983-1989 "can't really be taken seriously." Quite a difference from today, when Reynolds writes:

[I said that] there is no clear evidence of a sustained and significant increase in inequality since 1988.... I very carefully did not say there was no such evidence about 1981-87...

Here is Paul:

The Unofficial Paul Krugman Web Page: Wealth is typically much more concentrated than income.... [B]ecause wealth is so concentrated, it is difficult to measure accurately from sample surveys: a random survey of a few hundred or even a few thousand people will contain only a handful of really wealthy people.

Nonetheless, researchers at the Federal Reserve Board have tried to use sophisticated sampling procedures to deal with this problem.... In March, 1992 they released a working paper that showed a sharp increase in the concentration of wealth even since 1983, with the share of the top 1 percent of families rising from 31 to 37 percent....

When the Federal Reserve wealth study came out, it was immediately attacked by Alan Reynolds in the Wall Street Journal.... Reynolds's main argument was that the study, based on a survey of 3,000 families, could not be reliable about the top 1 percent, since thirty families is too small a sample. This was an interesting reaction, since the Fed study carefully explains that they used a two-stage procedure... [with] over 400 families in the top 1 percent. In fact, the study is written in the form of a working paper on statistical methodology, and the issue of sample size is raised immediately. One can only conclude that Reynolds did not bother to read the study before attacking it....

The wealth dispute was a minor part of the distribution controversy, but it was revealing about the desperation, unscrupulousness, and sheer lack of competence of today's conservatives...

---

And Paul is right. Here is Reynolds:

"Who Gained in the 1980s? Everybody" By Alan Reynolds. 1,344 words. 7 May 1992. The Wall Street Journal. PAGE A14. English (Copyright (c) 1992, Dow Jones & Co., Inc.): Jerry Brown was incensed that "the top 1% have more wealth than the bottom 90%."... The source of Gov. Brown's remark was a New York Times story, loosely based on a Federal Reserve survey. This front-page story claimed the wealthiest 1% had 37% of all net worth in 1989, up from 31% in 1983.... Estimates of the share of wealth owned by the top 1% can't really be taken seriously. After all, 1% means just 31 families among the 3,143 sampled. Some years ago, the late Warren Brookes uncovered that a similar Fed survey had been grossly distorted by an error involving a single individual. This time, perhaps the survey stumbled upon Donald Trump, Leona Helmsley or Mike Milken (in which case a newer survey might already look a bit different)...

Don't Believe It, Matt! Income Inequality Did Rise! A Lot!

Matthew Yglesias falls into a trap. He makes the mistake of crediting an empirical claim--in this case Alan Reynolds's claim--on the editorial page of the Wall Street Journal. The claim is that there is:

http://online.wsj.com/article/SB116607104815649971.html?mod=googlenews_wsj no clear trend toward increased inequality after 1988 in the distribution of disposable income, consumption, wages or wealth. The incessantly repeated claim that income inequality has widened dramatically over the past 20 years is founded entirely on [Piketty and Saez's] seriously flawed and greatly misunderstood estimates of the top 1%'s alleged share of something-or-other. The politically correct yet factually incorrect claim that the top 1% earns 16% of personal income appears to fill a psychological rather than logical need. Some economists seem ready and willing to supply whatever is demanded. And there is an endless political demand for those able to fabricate problems for which higher taxes are, of course, the preferred solution. In Washington higher taxes are always the solution; only the problems change.

Matthew writes:

Matthew Yglesias / proudly eponymous since 2002: Alan Reynolds' argument that we've been mis-measuring inequality by using flawed tax return data.... [T]his seems like an important project and I'll be eager to read the lengthier, non-op-ed form of his argument along with, one hopes, commentary on it from people better-equipped than I to evaluate the work...

Matthew thus forgets the two rules of reading the editorial page of the Wall Street Journal:

1. When you feel tempted to credit a surprising empirical claim found on the editorial page of the Wall Street Journal, your first step should be to lie down until that feeling goes away.
2. When you are tempted to believe that something on the editorial page of the Wall Street Journal brings new information to the party and sheds new light on the facts, don't.

One thing you can't learn from Reynolds's op-ed is that, back in their original paper that they wrote six years ago and published in 2003 http://elsa.berkeley.edu/~saez/pikettyqje.pdf, Thomas Piketty and Emmanuel Saez thoughtfully considered many of the claims made by Alan Reynolds. Here is some of what they wrote back then:

[W]e build new homogeneous series on top shares of pretax income and wages in the United States... based primarily on tax returns data published annually by the Internal Revenue Service... as well as on the large micro-files of tax returns released by the IRS since 1960.... We argue that both the downturn and the upturn of top wage shares seem too sudden to be accounted for by technical change alone. Our series suggest that other factors, such as changes in labor market institutions, fiscal policy, or more generally social norms regarding pay inequality may have played important roles in the determination of the wage structure. Although our proposed interpretation for the observed trends seems plausible to us, we stress that we cannot prove that progressive taxation and social norms have indeed played the role we attribute to them. In our view, the primary contribution of this paper is to provide new series on income and wage inequality.

One additional motivation for constructing long series is to be able to separate the trends in inequality that are the consequence of real economic change from those that are due to fiscal manipulation. The issue of fiscal manipulation has recently received much attention. Studies analyzing the effects of the Tax Reform Act of 1986 (TRA86) have emphasized that a large part of the response observable in tax returns was due to income shifting between the corporate sector and the individual sector [Slemrod 1996; Gordon and Slemrod 2000]. We do not deny that fiscal manipulation can have substantial short-run effects, but we argue that most long-run inequality trends are the consequence of real economic change, and that a short-run perspective might lead to attribute improperly some of these trends to fiscal manipulation....

[...]

[T]he evidence suggests that the twentieth century decline in inequality took place in a very specific and brief time interval. Such an abrupt decline cannot easily be reconciled with a Kuznets-type process. The smooth increase in inequality in the last three decades is more consistent with slow underlying changes in the demand and supply of factors, even though it should be noted that a significant part of the gain is concentrated in 1987 and 1988 just after the Tax Reform Act of 1986 which sharply cut the top marginal income tax rates (we will return to this issue)....

[...]

Our long-term series place the TRA86 episode in a longer term perspective. Feenberg and Poterba [1993, 2000], looking at the top 0.5 percent income shares series ending in 1992 (respectively, 1995), argued that the surge after TRA86 appeared permanent. However, completing the series up to 1998 shows that the significant increase in the top marginal tax rate, from 31 to 39.6 percent, enacted in 1993 on did not prevent top shares from increasing sharply. From that perspective, looking at Figures II and III, the average increase in top shares from 1985 to 1994 is not significantly higher than the increase from 1994 to 1998 or from 1978 to 1984. As a result, it is possible to argue that TRA86 produced no permanent surge in top income shares, but only a transitory blip. The analysis of top wage shares in Section IV will reinforce this interpretation. In any case, the pattern of top income shares cannot be explained fully by the pattern of top income tax rates....

[...]

From 1970 to 1984 the top 1 percent share increased steadily from 5 percent to 7.5 percent (Figure IX). From 1986 to 1988 the top shares of wage earners increased sharply, especially at the very top (for example, the top 1 percent share jumps from 7.5 percent to 9.5 percent). This sharp increase was documented by Feenberg and Poterba [1993] and is certainly attributable at least in part to fiscal manipulation following the large top marginal tax rate cuts of the Tax Reform Act of 1986 (see the discussion in Section III above). However, from 1988 to 1994, top wage shares stay on average constant, but increase very sharply from 1994 to 1998 (the top 1 percent wage share increases from 9 percent to 11 percent). While everybody acknowledges that tax reforms can have large short-term effects on reported incomes due to retiming, there is a controversial debate on whether changing tax rates can have permanent effects on the level of reported incomes. Looking at long-time series up to 1998 casts doubts on the supplyside interpretation that tax cuts can have lasting effects on reported wages.

Part of the recent increase in top wages is due to the development of stock options that are reported as wages and salaries on tax returns when they are exercised. Stock options are compensation for labor services, but the fact that they are exercised in a lumpy way may introduce some upward bias in our annual shares at the very top (top 0.1 percent and above). To cast additional light on this issue and on the timing of the top wage surge, we look at CEO compensation from 1970 to 1999 using the annual surveys published by Forbes magazine since 1971. These dataprovide the levels and composition of compensation for CEOs in the 800 largest publicly traded U. S. corporations.... Consistent with the evolution of top wage shares, average CEO compensation has increased much faster than average wage since the early 1970s. Therefore, the increase in pay gap between top executives and the average worker cannot be attributed solely to the tax episodes of the 1980s....

[...]

Similarly, the huge increase in top wage shares since the 1970s cannot be the sole consequence of technical change. First, the increase is very large and concentrated among the highest income earners. The fractiles P90–95 and P95–99 experienced a much smaller increase than the very top shares since the 1970s. Second, such a large change in top wage shares has not taken place in most European countries which experienced the same technical change as the United States. For example, Piketty [2001a, 2001b] documents no change in top wage shares in the last decades in France. DiNardo, Fortin, and Lemieux [1996] argue that changes in institutions such as the minimum wage and unionization account for a large part of the increase in U. S.... Changing social norms regarding inequality and the acceptability of very high wages might partly explain the rise in U. S. top wage shares observed since the 1970s...

Economist's View: An Interview With David Card

Mark Thoma sends us to An Interview With David Card. Definitely, definitely worth reading.

Thinking About the Minimum Wage

Macroblog provides an excellent reading list on: Modern Labor Economics And The Minimum Wage

Macro-International-Growth Lunch: Wed Dec 6 2006: U.C. Berkeley Department of Economics: Banerjee, Duflo, and Munshi (2003) "The (Mis)allocation of Capital"

Macro-International-Growth Lunch: Wed Dec 6 2006: U.C. Berkeley Department of Economics

Notes on Abhijit V. Banerjee, Esther Duflo, and Kaivan Munshi (2003) "The (Mis)allocation of Capital," Journal of the European Economic Association 1(2–3), 484–494 http://www.mitpressjournals.org/doi/pdf/10.1162/154247603322391125?cookieSet=1

How economists use the neoclassical benchmark:

• At Chicago: Assume that the economy is at the neoclassical benchmark, and demonstrate that whatever exists is, in some subtle sense, constrained Pareto-optimal efficient--except where ham-handed government intervention has caused messes.
• At Berkeley: Investigate the deviation from the neoclassical benchmark that can be caused by one single but significant market failure, demonstrate that this deviation matches up to some important feature of the real world, and demontrate that a clever, subtle, and strategic government intervention can move us to a situation that is constrained Pareto-optimal.

Banerjee, Duflo, and Munshi set out to hunt down this neoclassical benchmark, and show that the real world is so far from it that the benchmark's utility as a base of operations--in either the Chicago or the Berkeley sense--is... severely limited.

Their claim: capital markets in India simply don't work. Firms employing less than 50 people where the marginal product of capital is on the order of 100% per year can't get additional financing to exploit these opportunities.

---

And now to the paper: Abhijit V. Banerjee, Esther Duflo, and Kaivan Munshi (2003) "The (Mis)allocation of Capital.: Journal of the European Economic Association 1(2–3), 484–494 http://www.mitpressjournals.org/doi/pdf/10.1162/154247603322391125?cookieSet=1

Simple implications of the theory of credit markets:

• A firm is credit constrained if the marginal product of capital in the firm is higher than the rate of interest that firm is paying on its marginal rupee of borrowing.
• If a firm that is not credit constrained is offered some extra credit at a rate below what it is paying on the market, then the best way to make use of the new loan must be to pay down the firm’s current market borrowing, rather than to invest more.
• By contrast, a firm that is credit constrained will always expand its investment to some extent.
• For unconstrained firms, growth in revenue should be slower than the growth in subsidized credit.
• If we do not see a gap in these growth rates, the firm must be credit constrained.

Priority sector rules in India:

• All banks in India are required to lend at least 40 percent of their net credit to the “priority sector,” which includes small scale industry (SSI), at an interest rate that is required to be no more than 4 percent above their prime lending rate.
• In January, 1998, the limit on total investment in plants and machinery for a firm to be eligible for inclusion in the small scale industry category was raised from Rs. 6.5 million to Rs. 30 million. [Rs. 1 = $0.02; GDP/capita = Rs. 40,000 per year]

Data obtained from one of the better-performing Indian public sector banks:

• From the loan folders maintained by the bank.
• Data on profit, sales, credit lines and utilization, and interest rates.
• 253 firms (including 93 newly eligible firms
• Including 175 firms for which we have data from 1997 to 1999.
• We can allow small firms and big firms to have different rates of growth
• The rate of growth to differ from year to year
• We assume that there would have been no differential changes in the rate of growth of small and large firms in 1998, absent the change in the priority sector regulation.

The change had an impact:

• Credit limits granted to firms below Rs. 6.5 million in plant in machinery (henceforth, small firms) grew by 11.1 percent during 1997
• Credit limits granted to firms between Rs. 6.5 million and Rs. 30 million (henceforth, big firms) grew by 5.4 percent.
• In 1998, after the change in rules, small firms had 7.6 percent growth while the big firms had 11.3 percent growth.
• By 1999 new equilibrium.

Table 1: http://delong.typepad.com/images/20061206_misallocation_image003.png

Results

• Bank credit as the outcome for the firms where there was a change in credit limit: The coefficient of the interaction BIG-POST is 0.24, with a standard error of 0.09.
• Whether or not a file is brought out for a change in limit has nothing to do with the needs of the firm, but the internal dynamics of the bank.
• This additional credit in turn led to an increase in sales. The coefficient of the interaction BIG-POST in the sales equation, in the sample where the limit was increased, is 0.21, with a standard error of 0.09 [column (5)].
• By contrast, in the sample where there was no increase in limit, the interaction BIG-POST is close to zero (0.05) and insignificant [column (8)].
• The effect on profit is even bigger than that on sales: 0.75, with a standard error of 0.38.
• The IV estimate of the impact of bank credit on profit is 2.7. This is substantially greater than 1, which suggests that the technology has a strong fixed cost component. We can use this estimate to get a sense of the average increase in profit (net of interest) caused by every rupee in loan. An increase of Rs. 1,000 in the loan corresponds to a 1.04 percent increase. Using the coefficient of loans on profits, an increase of Rs. 1,000 in lending therefore causes a 2.7 percent increase in profit. At the mean profit (which is Rs. 37,000), this would correspond to an increase in profit (net of interest) of Rs. 999. Consistent with firms being credit constrained, this suggests a gap between the marginal product of capital and the interest rate of about 100 percent.
• This data does not tell us anything about the efficiency of allocation of capital across firms—it remains possible that capital does have the same marginal product in all its uses.

Tirupur is a smallish town in Southern India which dominates the Indian knitted garment industry:

• Through a good part of the 1990s the industry in Tirupur was growing at 50 percent or more.
• The industry was traditionally dominated by a single local caste group, the Gounders.
• Our basic strategy is to compare the investment behavior of Outsiders with that of the Gounders.
• Gounders are a small, wealthy, agriculturist community from the area around Tirupur who have moved into the local knitted garment industry over the last three decades because there is not much scope for more investment in agriculture. They have virtually no industrial presence outside Tirupur. Going into local knitted garment business, or helping a family member or friend get set up in the business, is therefore one of the best ways to use their considerable wealth.
• Outsiders have few strong ties in Tirupur, being from hundreds and even thousands of miles away. Moreover, they are from communities that have many alternative opportunities for investing their money. We would expect the Outsiders not to have the kind of capital access enjoyed by the Gounders.

Data: A survey of 147 exporters in 1995:

• Gounders own about twice as much capital and maintain capital-production and capital-export ratios 1.5 to 2.5 times as high as the Outsiders
• Columns (2) and (3) tell us that Gounders start with a higher capital-output ratio, and maintain that advantage at every level of experience.
• Do Gounders simply simply make better use of capital? The data on exports and production clearly rejects the possibility that the Gounders are more productive in general.
• Outsiders start out producing and exporting less but grow faster and overtake the Gounders by the time they have been in business about five years. Average output for Outsiders who have six years or more of experience is significantly higher than that of the Gounders.

Table 2: http://delong.typepad.com/images/20061206_misallocation_image006.png

Conclusion

• Capital markets in India are very far from the neoclassical ideal.
• The gap between the marginal product of capital and the market interest rate seems to be at least 70 percentage points.
• The gap between the marginal product of capital and the rate paid to savers is even larger.
• Investors who on average are less productive may invest as much as three times more than their more productive counterparts.
• All this is not necessarily surprising given that the legal system is slow, inefficient and sometimes corrupt, and defaulters usually get off lightly.
• But it does raise questions about the usefulness of the neoclassicalbenchmark.

Annals of Low-Quality Sociometry

People who are too eager to believe that Black-White test score gaps are immutable and permanent, episode MMCCLXXIV:

The Washington Monthly: CLICK THE LINK....Here is a complete post from Andrew Sullivan last night:

The Black-White Test Score Gap: It isn't going away. Charles Murray and James Flynn debate why here.

Really?

The fact that Charles Murray thinks the gap isn't going away is hardly news, but does James Flynn agree? That would be dispiriting indeed.

But there's no need to give up hope. Here's what Flynn really said:

We analyzed data from nine standardization samples for four major tests of cognitive ability. These data suggest that Blacks gained 4 to 7 IQ points on non-Hispanic Whites between 1972 and 2002. Gains have been fairly uniform across the entire range of Black cognitive ability.

That sure doesn't sound like "it isn't going away" to me. Murray and Flynn aren't debating "why," they're debating "whether." And Flynn has the better of the argument.

What To Do

Stefan Geens discovers the Pony Principle:

He applies it to Roger Altman and Alan Blinder, who he says labor in vain.

I agree that Altman and Blinder labor in vain, but I join them. They have good ideas.

Pessimism of the intellect, optimism of the will!

RGE - Altman and Blinder: Can't we all just get along?: Writing in the WSJ today, Roger Altman and Alan Blinder engage in admirable but wishful thinking about what Congress could do to repair the US economy in the next few years.

They propose a bipartisan effort to raise the minimum wage, boost the Earned Income Tax Credit, move towards universal health insurance, fix social security, reduce the US' dependence on oil and gas, provide better education and training, and also bring back pay-as-you-go financing.

Would you like a pony with that?

We fully realize that only a few of these policies can be promulgated right now. But a year hence, the policy window will have closed tight and the (presidential) political window will be wide open. So time is short. After watching the recent election results, we'd hate to be an empty-handed politician facing the voters in 2008.

Here's what's more likely to happen, unfortunately: Free trade will suffer, dismantled by populist politicians who think international trade is a mercantilist proposition. And the political window may already be closing, as the race for the White House starts earlier than ever.

---

The Economic Front - WSJ.com: [I]n recent decades the fruits of economic growth have not been widely shared, and we Americans have been growing apart. Notably, the middle class has fallen much further behind the rich; and recently, real wages have lagged behind productivity while profits have soared.... The problem is both deep-seated and longstanding... there is no magic bullet.... But a few obvious steps would help.

For starters, the Democrats have pledged to raise the federal minimum wage, which is now at its lowest (relative to other wages or prices) in a half-century. Making the Earned Income Tax Credit more generous would also help.

Beyond that, our government needs to repair and thicken the badly tattered safety net for the middle class. Tens of millions of Americans live in fear that a major health problem could reduce them to penury.... Health insurance poses complex problems that will not be solved easily or cheaply. But it is well past time that we started moving judiciously toward universal health insurance. Covering all children is a sensible first step.

Retirement security is another worry of the non-rich majority.... Fixing Social Security is not that difficult with a little bipartisanship and a dose of goodwill -- two more things the voters want. That said, all realistic solutions involve moderating benefit growth and/or raising more revenue.... The federal budget deficit, the negative personal saving rate, and our massive borrowing from abroad are all evidence that America is focused too much on the present and not enough on the future. We need a multidimensional investment strategy to change that orientation.

Two of the top priorities should be equipping our work force to cope better with the rapidly globalizing economy, and reducing our dependence on oil and gas. The first requires more and better education and training. The second requires a greater commitment to research on alternative energy technologies, plus serious conservation measures by consumers and industry....

[M]aking hard choices is what grown-ups do, and the voters were telling the politicians to grow up.

The federal budget deficit is a concrete example.... With the baby boom generation about to retire, the budget should be in surplus. But instead, we face cumulative 10-year deficits of $3.5 trillion -- and worse after that. You can blame this sorry state of affairs on either excessive tax-cutting or on profligate spending -- take your pick. It's more accurate to blame both, because fiscal discipline has utterly broken down.... Speaker-elect Nancy Pelosi has promised to restore pay-as-you-go financing -- a bipartisan set of budget rules that were originally adopted under the first President Bush, but then brushed aside under his son. Unfortunately, when paygo went, so did any pretense of fiscal discipline. A coincidence? We think not. The new Congress should bring back paygo immediately.

SONY Drives for PS3 Market Share at Launch

SONY spends a fortune to launch the PS3:

Paul Kedrosky's Infectious Greed: Tearing Down the PS3: Losing Money on Every Sale, etc.: iSuppli has out its teardown of the PS3, and it contains some fascinating factoids:

• Sony is losing an astounding $306.85 to $241.35 in manufacturing and component costs per PS3, depending on the configuration
• Cell processor costs are a rock-bottom $85
• In the entire history of iSuppli's teardowns it has only seen three semiconductors with 1,200 or more pins; the PS3 alone has three such chips

The size of the loss per unit is, my recollection, the largest in the history of the gaming industry. It is a fairly remarkable demonstration of how the industry has changed, especially when you consider that the PS3 is delivering supercomputer levels of performance.

Richard Posner Debates Milton Friedman

A thing that, as George Shultz likes to remark, everybody likes to do when he is not there to answer--and, alas, he will never answer again.

Judge Posner writes:

The Becker-Posner Blog: Milton Friedman--Posner's Comment: Perhaps his most important general contribution to economic policy was the simple, but when he first propounded it largely ignored or rejected, point that people have a better sense of their interests than third parties, including government officials, do. Friedman argued this point with reference to a host of issues, including the choice between a volunteer and a conscript army. With conscription, government officials determine the most productive use of an individual: should he be a soldier, or a worker in an essential industry, or a student, and if a soldier should he be an infantryman, a medic, etc.? In a volunteer army, in contrast, the determination is made by the individual--he chooses whether to be a soldier or not, and (within limits) if he decides to be a soldier what branch, specialty, etc., to work in. A volunteer army should provide a better matching of person to job than conscription, and in addition should create a more efficient balance between labor and capital inputs into military activity by pricing labor at its civilian opportunity costs.

But this is in general rather than in every case. The smaller the armed forces and the less risk of death or serious injury in military service, the more efficient a volunteer army is relative to a conscript one. These conditions are not satisfied in a general war in which a significant fraction of the young adult population is needed for the proper conduct of the war and the risk of death or serious injury is substantial--the situation in World War II. For then the government's heavy demand for military labor, coupled with the high cost of military service to soldiers at significant risk, would drive the market wage rate for such service through the roof. Very heavy taxes would be required to defray the expense of a volunteer army in these circumstances and those taxes would have misallocative effects that might well exceed the misallocative effects of conscription.

I mention this example because I find slightly off-putting what I sensed to be a dogmatic streak in Milton Friedman. I think his belief in the superior efficiency of free markets to government as a means of resource allocation, though fruitful and largely correct, was embraced by him as an article of faith and not merely as a hypothesis. I think he considered it almost a personal affront that the Scandinavian nations, particularly Sweden, could achieve and maintain very high levels of economic output despite very high rates of taxation, an enormous public sector, and extensive wealth redistribution resulting in much greater economic equality than in the United States. I don't think his analytic apparatus could explain such an anomaly.

I also think that Friedman, again more as a matter of faith than of science, exaggerated the correlation between economic and political freedom. A country can be highly productive though it has an authoritarian political system, as in China, or democratic and impoverished, as was true for the first half century or so of India's democracy and remains true to a considerable extent, since India remains extremely poor though it has a large and thriving middle class--an expanding island in the sea of misery. What is true is that commercial values are in tension with aristocratic and militaristic values that support authoritarian government, and also that as people become economically independent they are less subservient, and so less willing to submit to control by politicians; and also that they become more concerned with the protection of property rights, which authoritarian government threatens. But Friedman seemed to share Friedrich Hayek's extreme and inaccurate view that socialism of the sort that Britain embraced under the old Labour Party was incompatible with democracy, and I don't think that there is a good theoretical or empirical basis for that view. The Road to Serfdom flunks the test of accuracy of prediction!

I imagine that without the element of faith that I have been stressing, Friedman might have lacked the moral courage to propound his libertarian views in the chilly intellectual and political climate in which he first advanced them. So it should probably be reckoned on balance a good thing, though not to my personal taste. His advocacy of school vouchers, the volunteer army (in the era in which he advocated it--which we are still in), and the negative income tax demonstrates the fruitfulness of his master micreconomic insight that, in general, people know better than government how to manage their lives. But perhaps not always...

Let me channel Uncle Milton on one point: replacing a volunteer army with conscription does not get around the "very heavy taxes" with their enormous "misallocative effects" needed to man a wartime army. It simply loads those taxes onto a small group: young adult men (and these days women). It leaves the rest of us scot-free. But it is a redistribution away from the draftees--not an improvement in efficiency.

As to Posner's other points--Friedman's faith in markets, Sweden as a personal affront to Friedman, Friedman's excessive confidence that economic freedom would bring political freedom with it, and the falsification by reality of the main argument of The Road to Surfdom--I think they are very good ones.

Economic History Seminar November 13, 2006: William Sundstrom

He comes up from Santa Clara to talk about:

William Sundstrom (2006), "The Geography of Wage Discrimination in the Pre-Civil Rights South" (San Jose: Santa Clara University).

Abstract: Before the civil rights movement of the 1960s, the pay gap between African-American and white workers in the south was large overall and quite variable across locations. Using 1940 census data, I estimate the white-black earnings gap for men across separate county groups called "state economic areas," adjusting for individual differences in schooling and experience. I show that the gap was significantly greater where blacks were a larger proportion of the workforce, plantation institutions were more prevalent, more of the population was urban, and white voters exhibited more segregationist preferences. These results are consistent with descriptive evidence that discrimination in southern labor markets operated through discrimination in job assignments, which prevented black workers from acquiring skills on the job and also depressed wages through a crowding effect.

"The 'lynching' variable doesn't do much in the regressions, and isn't correlated with much of anything except general poverty..."

Economic Outlook

Glenn Rudebusch at the SF Fed thinks that we have dodged a bullet: that the decline in housing investment will not send the economy into a recession:

Economist's View: FRBSF: Economic Outlook:

• On balance, any spillover from the housing slowdown to the rest of the economy appears to have been offset by four important factors that are supporting growth. The first of these factors is the solid growth in employment, with associated increases in labor income. The solid pace of hiring this year raises questions about whether recent flagging GDP growth reflects a transitory lull rather than a substantial slowdown. The second factor supporting growth is the recent drop in energy prices. The third factor is the recent increases in equity markets, which bolster household wealth. And, finally, as the fourth factor, borrowing costs--especially conventional fixed mortgage rates--continue to be relatively low.
• A crucial question facing policymakers is how soon will core inflation return to a more comfortable level. One reason for cautious optimism is that inflation expectations appear to remain contained, as various indicators of these expectations are in the same range that has prevailed over the past two years. Therefore, this year's surge in price inflation has not changed the market's view about where inflation will eventually be returned to by the Fed.

• In contrast, the upside risk to the inflation outlook from labor market pressures appears to have been growing. As the FOMC noted in its October 25 statement: "the high level of resource utilization has the potential to sustain inflation pressures." Since then, the labor market continues to tighten, and the unemployment rate fell to 4.4 percent in October, the lowest level since May 2001.

David Wessel Writes About CEO Pay

David Wessel on CEO pay:

Capital - WSJ.com: It is obvious that the bigger the company, the more the CEO gets paid. That fact has inspired more than a few big acquisitions. An old rule of thumb holds that for every 10% increase in a company's size, the CEO's pay goes up 3%. But that doesn't explain recent patterns.

Messrs. Gabaix and Landier, squash partners who majored in mathematics at the École Normale Supérieure in Paris, realized that it isn't only how big a company is that matters; it is how big other companies are. It is about keeping up with the corporate Joneses.

And how much did U.S. companies grow in the past 25 years as CEO pay rose sixfold? Measured by stock-market capitalization, the value of all their shares, the companies grew sixfold, the pair discovered. "If all companies increase in size," Mr. Landier says, "the amount people are willing to pay for the same talent goes up."... CEOs aren't better than they were a quarter century ago, and there isn't much difference among them. But being a little bit better CEO than your competitor is worth a lot of money, just as it is to superstars in opera or baseball....

If Messrs. Gabaix and Landier are right, tweaking corporate-governance rules won't restrain CEO pay. "Firms with bad corporate governance pay the CEO more, but it's a really small effect -- only about 10% on average," Mr. Gabaix says....

Perhaps. But Harvard labor economist Lawrence Katz points out that the Gabaix-Landier model suggests that if the No. 15 company has a deviously clever CEO who finds a new way to engorge himself (think backdating, again), then the impact of that behavior will be magnified as it spreads to CEOs of even bigger companies.

And if they are right, then CEO pay hasn't much to do with motivating CEOs to work harder, and there is little economic harm to be done by taxing them more heavily.

"CEOs are paid what they're worth to their companies, and their high pay reflects the extraordinary value of their talent," Gregory Mankiw, another Harvard economist and a former adviser to President Bush, wrote on his blog after a Gabaix seminar. "But the supply of talent is inelastic" -- that is, paying more wouldn't produce more Jack Welches -- "and the allocation of talent would not be affected if everyone faced high tax rates." (Messrs. Gabaix and Landier shudder at this suggestion.)...

The market cap of U.S. companies rose mightily from the 1940s through the 1970s, yet CEO compensation didn't soar much faster than the typical worker's pay.

What changed? Frank Levy, an MIT economist, has a hunch: "Coming out of World War II, and the Great Depression before that, a lot of people were very afraid of extensive labor unrest. The whole framework of collective bargaining, a decent minimum wage, high marginal tax rates, etc., were all designed to head that off."

For a while, fear topped greed. But fear of unions and of government restraints on the market forces Messrs. Gabaix and Landier describe faded around 1980. Greed took over.