Grasping Reality with Both Hands: The Semi-Daily Journal Economist Brad DeLong

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 b