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

Felix Salmon on the iPhone

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

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

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

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

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

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

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

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

Ronald Reagan on Free Trade!

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

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

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

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

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

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

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

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

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

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

That's the perspective from National Review.

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

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

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

Dr. Jekyll, meet Mr. Hyde.

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

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

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

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

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

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

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

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

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

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

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

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

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

The Weak Link Theory of Economic Development

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

Annals of Government Failure: Silphium Edition

The extinction of silphium:

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

The consumer surplus from silphium was enormous:

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

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

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

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

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

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

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

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

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

The Economics of the iPod

Hal Varian writes:

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

The industrial policy that Dani recommends is one that focuses:

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

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

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

Eddie Lazear Has Jumped the Shark

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

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

This is not good.

Ronald Reagan on the Budget Deficit!

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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