## Ten Things Worth Reading, Mostly Economics: February 12, 2010

Greece fills the role of such a sinner... the country has fabricated its figures. Yet Ireland and Spain have also experienced dramatic fiscal deteriorations.... These countries were not long-term fiscal sinners. The conventional wisdom also declares that once fiscal adjustments have been made and flexibility introduced, the affected economies can return to growth.... This conventional wisdom is, alas, nonsense.... So long as the European Central Bank tolerates weak demand in the eurozone as a whole and core countries, above all Germany, continue to run vast trade surpluses, it will be nigh on impossible for weaker members to escape from their insolvency traps. Theirs is not a problem that can be resolved by fiscal austerity alone. They need a huge improvement in external demand for their output....

What would happen if governments [like Spain or Ireland] also slashed their spending? In an economy without monetary or exchange-rate offsets to austerity, any reduction in spending is likely to lead to at least an equivalent short-run reduction in output.... [W[hat is one to make of comparisons with Germany’s “competitive disinflation” of the early noughties? The answer is that they are irrelevant. First, Germany’s fiscal deficit peaked at only 4 per cent of GDP in 2003. Second, Germany was able to offset extreme domestic demand weakness with robust external demand... as much as 70 per cent of the increase in Germany’s GDP between 1999 and 2007 was accounted for by the increase in its net exports.

Germany needs to return the favour. More precisely, the only way for eurozone countries to slash huge fiscal deficits, without their economies collapsing, is to engineer another private-sector credit bubble or a huge expansion in net exports. The former is undesirable.... So what is to be done? If the aim is to avoid disaster, the answer is temporary fiscal support for the struggling countries, robust aggregate demand in the eurozone as a whole and a substantial rebalancing of that demand, led by Germany....

Alternatively, the vulnerable countries could be left to dangle in the wind. But a currency union whose core country not only exports deflation, but also stands aside as members collapse is in deep trouble. Germany alone can decide whether it wants this union to prosper, or not.

The failures of Long Term Capital Management, Enron, WorldCom, the stock market crash of 1987, and the collapse of the dot-com bubble had left [the Price-is-Right version of the Efficient Markets Hypothesis] in serious trouble. But after 2008, as Alan Greenspan, one of its main proponents for many years, told a Congressional committee, the “whole intellectual edifice collapsed.” The “efficient market” still has its hard core defenders but their ranks are in disarray and suffering notable defections. This has been described in considerable length by Justin Fox in his book “The Myth of the Rational Market.” A shorter version is in Ken Davidson’s “Reality be Damned, The Legacy of Chicago School Economics” in The American Interest, November/December, 2009. More recently the story has been given a gossipy treatment in a recent article in the New Yorker by John Cassidy (January 11, 2010). Perhaps the most devastating is the remarkable mea-culpa by Judge Richard Posner.... Despite catastrophic events, it is folly to expect the suffering of millions and an onslaught of inconsistent facts to wipe out an economic theory whose tenets were and still are so convenient for so many powerful economic interests. At present the defenders of the efficient market hypothesis are engaged in trying to pin the cause of the financial crisis on the government. (If the financial crisis was the result of government policies, then one could still plausibly claim the market to be rational, efficient, etc.) Their targets include the mortgage practices of the quasi-government lenders, Fannie Mae and Freddie Mac, the Community Reinvestment Act of 1977, the low interest rates of the Federal Reserve, and a pessimistic speech by President George W. Bush. The problem with this “blame-the-government” approach is the disproportion between these purported causes and economic effects. As Paul Krugman noted, “[N]one of the proposed evil deeds of policy makers were remotely large enough to cause problems of this magnitude unless markets vastly overreacted. That is, you have to start by assuming wildly dysfunctional markets before you can blame the government for the crisis; and if markets are that dysfunctional, who needs the government to create a mess?”

Sens. Max Baucus and Charles Grassley released a wide-ranging jobs bill, which everybody agrees has a decent chance to get bipartisan support and a better chance to create a disappointing number of jobs. The bill provides an exemption from Social Security payroll taxes for every worker hired in 2010. The exemption is capped at $106,800. It also provides a$1000 tax credit reward for keeping the employer on payroll for more than a year. The cost: $13 billion over 10 years. The bill also allows companies to write off up to$250,000 of certain capital expenses. The problem, everybody seems to agree, is that the reason most employers aren't hiring is not that they are afraid of incurring more payroll taxes. Instead, it's that there is not enough demand for their products or services to boost profits they would use to hire more workers.

The derision for this bipartisan bill is -- sigh -- bipartisan. Hugh Hewitt scoffs at the idea that employers will respond to a $1000 gimmick. Steve Benen and other liberals think the bill is way too small to work. I've been back and forth on the potential success of tax incentives for hires. My history of writing about hiring tax credits is long, but the history of their unqualified success is short. When the CBO looked at the 1970s New Jobs Tax Credit, they found... well, very little evidence to prove either its efficacy or wastefulness. A bit of cheeriness to end: CBO's economic models project that the payroll tax credit is one of the more efficient ways to stimulate employment -- bested only by increasing aid to the unemployed (who'll spend it quickly, making unemployment insurance a no-brainer way to lift sagging demand). Silicon Valley's teardown analysts these days don't even wait for the body to arrive before publishing their autopsy reports. Case in point: the estimated bill-of-materials for Apple's (AAPL) iPad issued Wednesday by iSuppli, an El Segundo, Calif., company that specializes in so-called virtual teardowns. Retail prices for the device, which is scheduled to start shipping in March, range from$499 for a 16GB Wi-Fi-only model to $829 for a 64 GB version that also works with AT&T's (T) 3G network. Using the components described in the product's spec sheet and making educated guesses about who might supply them, iSuppli... estimates that Apple's mark-up ranges from 117% for the low end unit to$147% for the high. The most profitable model would appear to be the mid-range, 3G-ready 32-GB iPad, with a sticker price of $729 and an estimated manufacturing cost of$287.15...

The Institute for New Economic Thinking is an organization, started with a grant from George Soros and headquartered in New York City, which supports creative thought and open discourse to advance reform in economic thinking and policy worldwide. In hosting conferences and funding research grants, INET seeks to confront the flawed mechanisms in our economic and financial infrastructure and develop of new paradigms in economic understanding.

Mission: To develop and support a community of scholars to create fresh insight and thinking in economic theory and reliably inform those responsible for designing and making economic policy.

[T]he British economy from 1760 to 1913... passed through a two stage evolution of inequality. In the first half of the nineteenth century, the real wage stagnated while output per worker expanded. The profit rate doubled.... After the middle of the nineteenth century, real wages began to grow in line with productivity, and the profit rate and factor shares stabilized. An integrated model of growth and distribution... includes an aggregate production function that explains the distribution of income, while a savings function in which savings depended on property income governs accumulation. Simulations... show that technical progress was the prime mover behind the industrial revolution. Capital accumulation was a necessary complement. The surge in inequality was intrinsic to the growth process. Technical change increased the demand for capital and raised the profit rate and capital`s share. The rise in profits, in turn, sustained the industrial revolution by financing the necessary capital accumulation. After the middle of the nineteenth century, accumulation had caught up with the requirements of technology and wages rose in line with productivity.

7) GRAPH OF THE DAY: CBO's Guesses of the Effectiveness of Stimulus Measures:

8) SECOND GRAPH OF THE DAY: Via Jeff Weintraub:

9) BEST NON ECONOMICS THING I HAVE READ TODAY: HBlake Hounshell and Jeffrey Goldberg:

Blake Hounshell: Israel is using up a lot of the goodwill it had built up in the 1990s, when eminent statesmen like Yitzhak Rabin and Shimon Peres made good-faith efforts toward peace with the Palestinians. Since then, the country has been governed by a series of unimaginative right-wing leaders who have pandered constantly to their settler base and chosen to solve political problems through the use of force. Benjamin Netanyahu and his Likud Party may have their fingers on the pulse of their public right now, but their agenda is not one that appeals to most Americans, who strongly support Israel's right to exist but have little interest in underwriting the permanent occupation of the West Bank.

Jeffrey Goldberg: Hounshell has it right. It seems as if many people in the American elite have decided that Israel is just as dysfunctional (and, sometimes, as brutal) as its Arab foes. Americans don't like intractable crises, and the Israeli government needs to understand this (it needs to understand, as well, that young American Jews are less likely to be reflexive defenders of Israel than their parents are).  At the risk of repeating myself (unavoidable on a blog, I guess), it will be risky for Israel to pull out its settlements from the West Bank, but it will be fatal for Israel to remain in the settlements, for moral and demographic reasons. What Israel needs is a leader who will step forward and say, "Here is the way things should look," and then present an outline for the creation of a viable Palestine. The settlers will go nuts, but that's what they do. Hamas will go nuts, because that's what it does. But Hounshell is right: What is needed is a Rabin. I tend to think that Netanyahu has the potential to be this leader. Maybe it's more a hope than a reality at this point, but only someone from the right can bring the majority of Israelis to the painful compromises that are obviously necessary. And, to make the obvious point, one of the reasons this compromise is necessary is because American public opinion is one of Israel's most important battlegrounds.

10) HOISTED FROM THE ARCHIVES: DeLong (1997): Review of Haynes Johnson and David Broder, The System: The Death of Health Care Reform in 1993-1994:

I had been avoiding reading The System--Washington reporters Haynes Johnson and David Broder's account of the catastrophic collapse of the Clinton Administration health care reform effort--for a number of years. The worst hours of my life in 1993-1994 were those I spent providing analytical support for health care reform. I watched the catastrophe approach and then saw the crash, the product of a three-fold bankruptcy: moral, intellectual, and political.

The moral bankruptcy was on the part of the Republican Party's power structure, which thought (correctly) that placing the government into total gridlock was a road to political success, and cared not at all for making public policy better along any dimension.

The intellectual bankruptcy was on the part of President Clinton and the senior White House domestic policy staff, which never solved the puzzle of how to construct and sell a plan to make the American health care system better, and which was totally clueless with respect to how to construct a coalition to support reform.

The political bankruptcy was on the part of the Democratic congressional majorities in House and Senate, which ultimately failed to pass even a ghost of a bill to reform America's health care system along any dimension. The combination of these three bankruptcies has left America in 2000 with a health-care system even more wasteful and inefficient and even worse at delivering health care to the poor than we had a decade ago.

Participating in this was a dark experience. And it left me with a profound sense of guilt: a lot of people would lose the chance for better medical care because my side--me, my political allies, and those whom we had chosen to lead us--failed to do our job. But this past weekend I picked up The System and read it on the planes while on the way back from Yellowstone. I found it a good book: largely accurate, an engaging read, fair (and sometimes more-than-fair) to all the participants. It reminded me of why my political commitments are what they are, and solidified them. I did have three quarrels with the book:

• Because Johnson and Broder are journalists whose principal sources are politicians and "media affairs people" and not policy analysts, they show little sign of understanding the substance of health care policy.

• Johnson and Broder take the failure of health-care reform as a "metaphor" for the failure of the American political "System." It wasn't a metaphor for anything. It was a policy debate...