Monthly Archives: April 2015

I Wish I Knew More About the Wisconsin John Doe Investigations

Posted on by

David French writes,

For dozens of conservatives, the years since Scott Walker’s first election as governor of Wisconsin transformed the state — known for pro-football championships, good cheese, and a population with a reputation for being unfailingly polite — into a place where conservatives have faced early-morning raids, multi-year secretive criminal investigations, slanderous and selective leaks to sympathetic media, and intrusive electronic snooping.

That is not the way that the story has been covered elsewhere. For example, here is Wisconsin Public Radio six months ago.

As others were charged and convicted in what eventually became known as “John Doe One,” Democrats increasingly tried to make sure Gov. Scott Walker was politically wounded, partly because the probe grew to include people who were helping Republican election efforts in 2010 while working for Milwaukee County.

The heat on the governor grew again over the past 12 months, after news of “John Doe 2” came out. That second investigation looked into alleged illegal campaign coordination in 2011 and 2012 between Walker, other Republicans and the conservative group Wisconsin Club for Growth.

Obviously, French’s account is meant to arouse libertarian ire. However, there is nothing in the WPR account that would suggest anything other than a legitimate, successful probe into political corruption.

Are there any progressives willing to believe French’s version? Are there any conservatives or libertarians willing to believe WPR’s version?

Ken Rogoff on the State of the Economy

Posted on by

He writes,

The steady decline of real interest rates is certainly a puzzle, but there are a host of factors. First, we do not actually observe the true economic real interest rate; that would require a utility-based price index that is extremely difficult to construct in a world of rapid change in both the kinds of goods we consume and the way we consume them. My guess is that the true real interest rate is higher, and perhaps this bias is larger than usual. Correspondingly, true economic inflation is probably considerably lower than even the low measured values that central banks are struggling to raise.

Read the whole thing. It is part of an interesting symposium on secular stagnation. Pointer from Mark Thoma.

Rogoff also supports the hypothesis of financial crowding out.

Whether by accident or design, banking and financial market regulation has hugely favoured low-risk borrowers (governments and cash-heavy corporates), knocking out other potential borrowers who might have competed up rates. Many of those who can borrow face higher collateral requirements. The elevated credit surface is partly due to inherent riskiness and slow growth in the post-Crisis economy, but policy has also played a large role. Many governments, particularly in Europe, have rammed down the throats of pension funds, banks, and insurance companies. Financial repression of this type not only effectively taxes middle-income savers and pensioners (who receive low rates of return on their savings) but also potential borrowers (especially middle-class consumers and small businesses), which these institutions might have financed to a greater extent if they were not required to be so overweight in government debt.

The Wartime Economy

Posted on by

The first and second world wars were characterized by entire societies being mobilized for war. In order to out-fight one another, countries had to out-produce one another. During both wars, England attempted to blockade Germany using surface ships, and Germany attempted a counter-blockade using submarines. During World War II, the location of oil, rubber, and tin helped determine strategy. In the decades following World War II, the Defense Department budgets remained high in order to deal with the Korean War and the Cold War, leading President Eisenhower to issue his famous warning about a military-industrial complex.

Wartime economies involved central planning, as governments sought to control production and allocation to serve military needs. I argue that trade is the central economic activity. But in a wartime economy trade takes a back seat to planning, production and allocation.

I believe that the wartime economy had influence long after wars ended.

1. In the 1930s, intellectuals looked back fondly to the economic mobilization of the first World War. Many of the first New Deal planning bureaus, most notably the NRA, were modeled on wartime agencies. Roosevelt’s team used the metaphor or war, and the phrase “moral equivalent of war” came into use. (Decades later, President Carter famously declared that higher oil prices required a response that was the moral equivalent of war.) In contrast to the free market’s aimless satisfaction of base consumer desires, the wartime economy was considered more rational and purposeful.

2. The story told in MIT and the Transformation of American Economics shows the influence of the wartime economy. The MIT economics department was funded lavishly by the Defense Department, as MIT’s research agenda was useful in planning, production, and allocation.

One of the mathematical tools that became popular in postwar economics, linear programming, is designed to help the central planner solve a resource allocation problem. The classic textbook on linear programming, written in the late 1950s by Dorfman, Samuelson, and Solow, was only just beginning to fade from use in the late 1970s when I was in graduate school.

I believe that the research methods and textbooks that came out of this MIT-centered transformation were too heavily influenced by the wartime economy. Economists worked very hard to develop tools for “seeing like a state.” They lost track of the way that an economy does not have to resemble a wartime economy.

1. The patterns of specialization and trade can emerge, without being centrally planned.

2. The economy does not maximize an objective function. If anything, it maximizes subjective functions. Value depends on what is in the consumer’s head, and this information is not accessible to the central planner.

3. Costs cannot be measured objectively by adding up the prices of inputs. All costs are opportunity costs, and opportunity costs are subjective.

4. Trade is a technology If you think in terms of a production function, new patterns of trade shift the production function.

Look at it and Think About it

Posted on by

That is John Cochrane’s advice on the unit root issue.

A unit root means a random walk component. A random walk will eventually pass any upper and lower limit. Look at it [the unemployment rate]. That’s as stationary a series as you’re going to find in economics. (“Look at it” and “think about it” are the Cochrane unit root tests.)

Yes, unemployment like other stationary ratios in macro (consumption/GDP, hours/day, etc.) have important and frequently overlooked low-frequency movements. But they are far from random walks, and they like unemployment have a very large transitory component at business cycle frequencies. When unemployment is above 8%, it is a good bet that it will decline over the next 5 years.

AIG in Hindsight

Posted on by

That is the title of a new NBER working paper by Robert McDonald and Anna Paulson (ungated versions). They conclude,

Much of the discussion about the crisis has focused on liquidity versus solvency. The two cannot always be disentangled, but an examination of the performance of AIG’s underlying real estate securities indicates that AIG’s problems were not purely about liquidity. The assets represented in both Maiden Lane vehicles have experienced write-downs that disprove the claim that they are money-good. While it may seem obvious with the benefit of hindsight that not all of these securities would make their scheduled interest and principal payments in every state of the world, the belief that they could not suffer solvency problems and that any price decline would be temporary and due to illiquidity was an important factor in their creation and purchase.

My random comments:

1. This is valuable work. I am really glad to see a retrospective audit of this important bailout.

2. I view the conclusion as saying that this truly was a bailout. The Fed was not acting as a hedge fund of last resort, buying temporarily undervalued assets that otherwise were just fine.

3. This also throws Gary Gorton under the bus. Gorton said that AIG’s problems were collateral calls, meaning illiquidity rather than insolvency. Note that Gorton is not included in the list of references, at least in the ungated version. Note also that the authors write that AIG’s problems were both liquidity and solvency.

4. Bob McDonald and I shared an apartment our first year as MIT grad students. He has written a treatise on derivatives.

Trade as a Technology

Posted on by

A while back, I threatened to put together an introduction to economics that runs counter to the “seeing like a state” tradition in textbooks that Paul Samuelson started. I call this “teaching emergent economics,” and as my thoughts develop I will post them in this category. Here are thoughts on trade as a technology.

1. David Friedman in his textbook, The Economics of Everyday Life, pointed out that we can grow automobiles in Iowa by growing grain, putting it on ships to Japan, and having the ships come back with automobiles.

2. In theory, we do not need to produce anything in order to have an interesting economy. Suppose that several of us receive regular endowments of different goods. Trading among ourselves can produce gains.

3. In an actual economy, we engage in production. However, we engage in production primarily for exchange. Centuries ago, a farmer produced for subsistence. But in the past two hundred years, in advanced countries farmers have produced for exchange.

4. In fact, production for exchange is so important that GDP only measures production for exchange. It counts goods and services that trade at market prices, not the value of home cooking.

5. The fixed-proportions concept of production is very misleading. It is particularly misleading as a way of describing an entire economy. When people think in terms of fixed proportions of resources needed to produce goods, they imagine running out of resources. Instead, as some resources become scarce and their prices rise, substitution emerges. People make different consumption choices. Producers come up with different recipes for producing goods and services.

6. Even without fixed proportions, a production function can be a misleading concept. If you have two economies with identical production capabilities, one economy can be much better off than the other. If the first economy takes optimal advantage of trading opportunities and the second economy does not, then the first economy will be better off. It will appear that the first country has greater “total factor productivity,” although its advantage has nothing to do with production per se.

7. If an entrepreneur invents a new product or a new production process, that necessarily creates a new trading opportunity. If an entrepreneur invents a new trading opportunity (think of eBay), that is equivalent to inventing a new production process.

8. Thus, we can think of entrepreneurs in terms of how they affect trading opportunities. They alter trading patterns in response to price changes that in turn signal surpluses and scarcities. And they test new trading opportunities, sometimes in the form of new products or production processes.

What I’m Re-reading

Posted on by

Violence and Social Orders, by North, Weingast, and Wallis. A major theme is that there are natural states, or limited-access orders, in which only a minority of the population enjoys political rights and economic opportunity. One quote:

One of the principal institutional issues that emerged in this chapter concerned the problems of constraining personality: putting the king under the law. At the level of societies, the head of the dominant coalition–whether the pope or the Catholic Church, the emperor of Rome, or the king of a European state–reflects the realities of these natural states: the ruler is often above the law. This allows him or her to adjust the rules, privileges, rights, and laws to suit the needs of the coalition as the fortunes of various elites rise and fall. Elites gaining power must be granted more privileges and rents while those losing power also lose privileges and rents. The rules is not free to make these decisions at his discretion, but must instead attempt to maintain a coalition to support the natural state. Failure to do so risks coups, civil war, and other forms of disorder.

In an open-access order, where essentially all adults have political rights and economic opportunity, the challenge of bringing the head of state under the law has presumably been met. Sometimes, I am not so sure.

Also, consider another quote:

Party competition forces parties to compromise and to moderate interest group and constituency demands. Rent-creation cannot be the primary product of party competition in open-access orders. . .Because parties need to gain the support of many interests, they must temper the (rent-creating) demands of each, lest the associated extreme positions hinder the party’s electoral prospects.

If the authors are not careful, they will seem to have explained why the sugar lobby and the real estate lobby are ineffective in the U.S. and why the teachers’ union is ineffective in Maryland. They will have explained why we have such a simple tax code, and why it is so easy for unlicensed health care providers and unaccredited schools to gain traction.

. . .the interests active on any issue are endogenous. If a group attempts to extract too much, then other groups who are not normally active on an issue are likely to begin paying attention and become active. . .The endogenous approach suggests that a few open access order markets might be cartelized and protected, such as agriculture, and certain markets regulated to produce rents, such as airlines in mid-century United States. However, these markets are the exception, not the rule.

They wish to claim that rent-preservation is the essence of limited-access orders, but it is incidental and held in check under open-access orders. Perhaps they could cite Uber’s so-far successful breakthrough into the transportation market as an example in which the open-access order was able to activate enough support for Uber to prevent its destruction by incumbent taxi companies.

However, reading these passages, I found myself inclined to disagree with the authors. I tend to give more credit to the power of interest groups and less credit to the ability of the open-access order to confine rent-seeking. I think of the sugar lobby, the housing lobby, the teachers’ union in Maryland, occupational licensing in health care, . . .But to the authors’ point, the size of these rents probably is dwarfed by the size of entitlements, which are policies directed at the broader public. And yes, they will make a frontal assault on the Olson-Downs view that special interests always win.

Why California is Losing Sustainability

Posted on by

Joel Kotkin writes,

Desalinization, widely used in the even more arid Middle East, notably Israel, has been blocked by environmental interests but could tap a virtually unlimited supply of the wet stuff, and lies close to the state’s most densely populated areas. Essentially the state could build enough desalinization facilities, and the energy plants to run them, for less money than Brown wants to spend on his high-speed choo-choo to nowhere.

Pointer from Don Boudreaux, who recommends the entire essay.

My one criticism is that it not an essay written to convince people to change their minds. To me, the most interesting challenge is to find a way to explain to environmentalists that markets are a subtle, sophisticated calculation mechanism for sustainability. (Incidentally, I am not certain that desalinization is quite at the point where it meets the market test.) Of course, markets can and do come up with imperfect answers. But people who claim to have better answers often do not.

Do Unit Roots Ruin the Concept of Potential GDP?

Posted on by

Roger Farmer re-litigates an old controversy about macroeconomic data, concluding

What do we learn from this? Much the same as we learn from the fact that unemployment has a unit root. Just as unemployment can remain persistently high, so GDP can remain persistently below trend. There is no evidence that the economy is self-correcting.

Pointer from Mark Thoma. My comments:

1. Although unemployment has a unit root, Ed Leamer finds that there is some persistence to changes in payroll employment. See his textbook. You might also Google Kling-Leamer-momentum-employment.

2. Unit roots in macro data cause a huge problem. If you don’t correct for them, you get spurious correlation. If you do correct for them, you tend to get noise. That is one reason I call macroeconometrics The Science of Hubris.

3. In stock market returns, econometricians have been able to identify long-term mean reversion even though the short run is a random walk. Can something similar be done with GDP data?

4. If real GDP truly is nonstationary, then how can we rescue the concept of potential GDP? If you think of the economy as ultimately self-correcting, then what it corrects to is potential GDP. If the economy is not self-correcting, then the concept of potential GDP can have no objective basis.

I come to this issue with a desire not to praise the concept of potential GDP, but to bury it. From a PSST perspective, there is no such thing as potential GDP. The patterns of specialization and trade that are sustainable now are the patterns that are sustainable now. There were other patterns that were sustainable in the past, and entrepreneurs will discover still other patterns sustainable in the future, but right now we cannot describe those alternative patterns as potential. Right now those alternative patterns are either not sustainable or yet to be discovered.

Exit, Voice, and Technocracy

Posted on by

Tim Harford writes,

several economists suggested structures that would put decision making at arm’s length from politicians, delegating it to technocrats with the expertise and incentives to do what is right for Britain.

He reports on interviews he had with several mainstream economists. Pointer from Mark Thoma.

What this tells you is that mainstream economists distrust voice (the political process), as I do. However, for mainstream economists, the preferred alternative is fantasy despotism, with technocrats in the role of despots. For me, the preferred alternative is exit, with people given more opportunities to choose among different governing bodies. See the widely-unread Unchecked and Unbalanced.