What I’m Reading

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The Rebirth of Education: Schooling Ain’t Learning, by Lant Pritchett. In short, it is an informed polemic against top-down, state-run school systems in underdeveloped countries, notably India. Tyler Cowen mentioned it, but otherwise it has received no play anywhere. Maybe it is just too contrary to conventional wisdom for people to grasp.

It is possibly the best book I have read this year. It immediately vaults onto the list of libertarian classics. This is in addition to being an important book about education in underdeveloped countries.

I will have to finish it and then re-read it before writing a more comprehensive review.

A Winning Argument?

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Sheldon Richman writes,

Undoubtedly the nonlibertarian will respond that government officials were duly elected by the people according to the Constitution, or hired by those so elected. Thus they may do what is prohibited to you and me. This reply is inadequate. If you and I admittedly have no right to tax and regulate others, how could we delegate a nonexistent right to someone else through an election? Obviously, we can’t.

Read the whole thing to get the context. Or read Michael Huemer’s book to get an even lengthier treatment of the argument.

I think that most people want their own liberty, but they fear the liberty of others. I like to use the acronym FOOL, which stands for Fear Of Others’ Liberty. I think that many of us are FOOLs. I count myself a FOOL, at least to some extent.

Once you are a FOOL, then you may be willing, yea, eager, to delegate the job of constraining someone else’s liberty. We don’t all want to be policemen or prison guards, but most of us are glad that there are people doing those jobs.

If I delegate the job of constraining someone else’s liberty, then, unless I happen to be a despot, those who have the power to constrain someone else’s liberty have the power to constrain my liberty as well. That is roughly what we mean by equality before the law.

In short, I think it is reasonable not to be persuaded to become a libertarian by the sort of arguments Huemer or Richman make. Instead, a FOOL can say, “I do not want violent criminals running around free. I want to delegate to someone else the power to arrest and incarcerate them. I understand that this power might be used against me, but I am willing to live with that.”

Consider Paul Romer:

Across the world, public safety is the most important task facing city governments. In many poor countries, crime holds back the kind of urbanization essential for economic development. Closer to home, Detroit shows us that if they can, people will flee a city that fails to provide basic public safety.

Of course, one day you concede to the government the power to arrest and incarcerate violent criminals, and the next thing you know you have created an institution with the power to penalize people who sign contracts that provide “inadequate health insurance.”

It frustrates me that there are so many FOOLs who support the government using its power to penalize people who sign such contracts, or to penalize people who sell big-gulp soft drinks, or what have you. In short, whatever consensus that might have once existed in favor of limited government has evaporated.

Sometimes, the FOOLs want what amounts to despotism. It happened to Germany in 1933. There seems to be an echo today in Venezuela (the term “enabling law” has a chilling ring to it).

Perhaps there is no way to maintain a consensus for limited government, in which case there is not much middle ground between anarchy and despotism. But to most people, it is plausible that there is a middle ground, and you have to recognize their point of view if you want your arguments to register with them.

Secular Stagnation? Seriously?

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Paul Krugman endorses the idea. Pointer from Mark Thoma.

My own first reaction to Larry Summers’ talk was to write

there are so many problems with Summers’ story that one does not even know where to begin.

Tyler Cowen writes,

I don’t mean this in a rude or polemic way, but the arguments we have been reading do not yet make sense.

Cowen’s stagnation story is that the pace of innovation has slowed, resulting in declining growth in aggregate supply. In contrast, Summers’ story is one of a permanent shortfall of aggregate demand, due to an excess of desired saving over desired investment, which can only be eliminated at a negative real interest rate.

Here are some criticisms that come to mind.

1. If “the” full-employment real interest rate is negative, then why do we need quantitative easing? Why does not the excess of saving over investment not by itself drive long-term rates to zero?

2. Summers wants to claim that full employment has been achieved in recent years because of asset bubbles. However, in a world of negative real interest rates, there is no such thing as an asset bubble. Real assets have infinite value in such a world.

3. As Tyler points out, it is hard to reconcile positive economic growth with negative real interest rates. We have had positive economic growth, even since 2008.

4. As Tyler also points out, we observe higher interest rates for risky assets. In fact, if you want to understand the low interest rates that Summers and Krugman are talking about, then my suggestion is to “follow the guarantees.” In one way or another, the U.S. government has provided a guarantee on many investments. Government bonds are one example. Mortgages are another.

5. The prime rate at banks averaged 5 percent from 2001-2004, almost 7 percent from 2005-2008, and 3.25 percent from 2009-2012. Inflation over these periods averaged 2.3 percent, 3.4 percent, and 1.5 percent respectively, so that the real rate of interest has been positive throughout.

6. Summers’ revival of the secular stagnation hypothesis has not been broadly peer reviewed. Before people jump on the bandwagon, I would wait until it has been evaluated by a broader range of economists.

Low Interest Rates

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Why are long-term nominal interest rates still low (the ten-year Treasury is about 2.7 percent)? I think that two of the standard explanations cause difficulties for the PSST view. Consider:

1. The Fed is doing it. This is problem because from a PSST perspective, the Fed should have very little effect on interest rates, particularly long rates. Yes, I know that the Fed is intervening in long-term credit markets, but it is still not a large player relative to total debt outstanding.

2. There is weak aggregate demand. This works well from an AS-AD perspective, but not from a PSST perspective.

Here are the explanations that might be consistent with PSST.

3. We are experiencing a bond bubble. A lot of irrational investors (foreign, perhaps?) are pushing bond prices higher than they ought to be.

4. Inflation is over-stated, particularly in the U.S. The prices of internationally tradable goods are falling. So the real interest rate is actually high. The rise in official inflation measures is in sectors like health care and college tuition, and there are no leveraged plays in those sectors. (If prices were rising for manufactured goods, you could borrow money to build factories and make lots of money. There is no comparable way to take advantage of rising college tuition or health care spending.)

I think I like (4) the best. What it suggests is that if you have your savings in a money market fund earning very low interest, you are actually doing well, as long as you do not face paying for college or paying for your own health care. Your personal cost of living is probably falling. What should concern you is the possibility that the government will find it necessary to adopt much more inflationary policies in order to pay its bills. If that happens, you will need some real assets in order to avoid having your savings wiped out.

David Brooks and Mark Shields on Obamacare

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The transcript is here.

At one point, Shields says

this is beyond the Obama administration. If this goes down, if the Obama — if health care, the Affordable Care Act is deemed a failure, this is the end — I really mean it — of liberal government, in the sense of any sense that government as an instrument of social justice, an engine of economic progress, which is what divides Democrats from Republicans — that’s what Democrats believe.

At this stage, they are inclined to put the blame on the American people. Here is Brooks:

My big thought is, are we no longer the kind of country in which you can pass this sort of thing? And by that, I mean, when you were passing the New Deal or the Great Society, there were winners and losers.

But the losers felt part of a larger collective and they said, OK, I’m going to take a hit for the team. We may no longer have that sense of being part of a larger collective, so when you’re a loser, you just say, I’m a loser. And, as a result, you’re just not willing to be part of the group.

…we have lower social trust, lower faith in the institutions, lower sense of collectivity.

And those are deep social trends that have been building for decades, but it just makes it much harder to sustain this kind of big legislation.

Shields agrees:

The we-ness of our society, the we, that we’re all in it together, has really been diminished.

To be charitable, this narrative could be correct. That is, it could be that the wonks who designed Obamacare had the right idea, and that the American people are too selfish and too unwilling to trust government to allow it to be implemented honestly and properly.

However, I see things differently.

Start by asking why it is that Healthcare.gov is not as good as Amazon.com or Kayak.com. One answer is that the government is not good enough at deploying information technology. However, I think that is only a shallow answer.

The deeper answer is that when we look at Kayak and Amazon, we are seeing the survivors that emerged from an intense tournament. In this tournament, thousands of competing firms fell by the wayside. Competitors tried many different business models, web site designs, business cultures, and so on.

Healthcare.gov did not emerge from this sort of competition. It came about because Congress passed a law.

Central to my approach to economics, and that of other economists who are variously called Austrians or market-oriented economists or Smith-Hayek economists or what have you, is the respect that we have for the evolutionary process by which markets produce innovation and excellence. My sense is that what divides us from pundits like Brooks and Shields, and even from most economists, is the credit that we assign to market evolution rather than elite expertise as a process for solving problems.

Bimodal Salaries, Unimodal tuition?

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Peter Turchin writes,

the left peak has hardly advanced and is currently (as of 2011) located at $50K. Given that the debt burden of an average law school graduate is twice that (over $100K), it means that for all practical purposes the individuals in the ‘loser’ category will never be able to repay their loans. In other words, the group of elite aspirants who have gone to the law school since 2001 have been sorted into two completely separate categories: those who succeeded in entering the top ranks of the elites and those who have failed utterly, with very few people in between.

Read the whole thing. Pointer from Tyler Cowen.

It appears that there are two markets, one for elite lawyers and one for ordinary lawyers. However, law school tuition is relatively homogeneous. At some point, I would expect to law school tuition fall sharply at all but the elite institutions.

Will They FUBAR Mortgage Finance, Too?

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James Stock said,

It is hard to see how a private guarantor could credibly provide full insurance because of its inability to diversify against severe common, or macro, risk. The presence of a government guarantee, as opposed to a private guarantee, resolves the credit risk asymmetric information problem associated with MBSs that do not yet have their constituent mortgages fully specified. With this asymmetric information problem resolved, the TBA market provides liquidity, hedging, and price discovery to the mortgage market.

Thanks to Nick Timiraos for the pointer.

What Stock is advocating, and what seems to have the support of the Obama Administration and many in Congress, is a completely new business process in the mortgage industry, with a government guarantee of mortgage securities as the critical element. As you read this, I am appearing on a panel of experts who take a different point of view.

In my contribution two years ago to a Mercatus center collection of alternative proposals, I stressed the danger of trying to stand up a completely new set of institutional arrangements in the mortgage industry. I was worried that implementation could prove troublesome. That argument might not have seemed so powerful then, but maybe in light of healthcare.gov it might get more attention now.

In my presentation to the panel, I will say that a government mortgage guarantee is like the ethanol mandate. Whatever the alleged public policy justification, it is really a special-interest handout. See Your Mortgage, Their Rent. Of course, just as with the ethanol mandate, it will be very hard to stop and, once in place, impossible to kill.

I am so pessimistic about the politics of housing finance reform that I think that the best hope would be to try to create a restrictive charter for the new government guarantee agency. Make it illegal for the agency to guarantee cash-out refinances, second mortgages, investor loans, home-equity loans, negative-amortization loans, and ARMs. Limit the agency to owner-occupied mortgages, for purchase or rate-lowering refis, with fixed rates for 15 or 30 years. Getting that would be a huge victory, and it would not detract from any legitimate public policy goals, but I doubt that it is achievable. Wall Street and the housing lobby are going to have their way with the public, and we’re going to end up having to bend over and submit.

The graduate/undergraduate dichotomy

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Nick Rowe writes,

What should the government do, if there is an increased desire to save, and the central bank is unable or unwilling to cut real interest rates enough to offset it? The answer is that the government should cut the growth rate of government spending, to shift the IS curve left, which raises the natural rate of interest (i.e. prevents it falling), because the IS curve slopes up when we have the growth rate of transitory income on the axis…

Fiscal policy in Old and New Keynesian models is even more different than John Cochrane thinks it is. And understanding why is hard.

Read the whole thing. It is graduate-school macro, which is harder than undergraduate macro.

I will just toss in a wrinkle, which is that in these sorts of models, sometimes the way to cut the growth rate of something is to increase its level immediately. So “cutting the growth rate of government spending” can mean immediately jumping to a high rate of government spending, from which you then have a slower growth rate.

There are various dichotomies in macro. The classical dichotomy separates nominal from real. The money supply only affects nominal variables (the price level) while leaving real variables (real wages, real GDP) unaffected. The crude Keynesian dichotomy is between prices and quantities. Instead of intersecting supply and demand curves, you have quantities affecting quantities. Spending creates jobs, and jobs create spending. Prices adjust to wages, and wages adjust to prices, but neither adjusts to employment or output.

Another dichotomy is between undergraduate and graduate macro. In undergraduate macro, fiscal policy works the way old Keynesian intuition says it works–by injecting spending into the economy. In graduate macro, fiscal policy works in these weird ways of twisting the path of desired consumption.

In communicating with other academics, a Keynesian economist will manipulate these dynamic optimization equations and derive a result that says that “fiscal policy works.” But when the economist communicates with undergraduates and other ordinary mortals, they hear a completely different story–basically Old Keynesian.

For the record, I think both stories have serious problems. The problem with the Old Keynesian story is that it rules out by assumption the operation of the adjustment mechanisms that we ordinarily take for granted, in which prices respond to excess supply and demand, and resources shift in response to profits and losses. However, I will still respect you in the morning if you say you are an Old Keynesian who believes that those adjustment mechanisms operate only very slowly in the real world. You can get from there to my PSST view by simply adding the proposition that throwing more M or G at the economy does nothing to speed up this adjustment process.

I have less respect for New Keynesians. (1) Although in a charitable mood I can try to pass a Turing test as a defender of the need for “microfoundations,” in my heart of hearts I believe that these representative-agent, dynamic optimization models are a useless exercise in mathematical masturbation. (2) In policy discussions, New Keynesians seem to gloss over how their models work, wave their hands, and deliver that Old-time Keynesian religion, hoping that nobody will call them out on it. Unfortunately for them, John Cochrane and Nick Rowe are around to try to keep them honest.

You should also read Brad DeLong and Paul Krugman on this topic. My sense is that they regard New Keynesians as useful idiots. But I think that they actually prefer something closer to Old Keynesianism. I would if I were them.

It’s Implementation, Stupid

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The Washington Post is troubled by President Obama’s “keep your plan” fix, but for the wrong reason.

Insurers who decided to act would try to hold onto their healthiest customers — those who don’t make many claims, if any. But the Obamacare marketplaces need those relatively healthy customers.

The threat of “adverse selection” in health insurance is over-rated and always has been.

The problems with implementation are under-rated and always have been. The Obama Administration has spent 3 years bulldozing the individual market in health insurance. Now, they expect the health insurance companies to rebuild it in 30 days.

The folks who have to implement the new Presidential edict are not pleased. From the state health insurance regulators:

The National Association of Insurance Commissioners (NAIC) suggested Thursday that the plan to allow insurance companies to offer non-compliant health plans into 2014 is not logistically feasible.

From the health insurance companies:

They have warned legislation in both chambers of Congress would provoke an administrative fiasco and could have serious implications for the new marketplace’s risk pool, premium prices and the cost of the law to the federal government.

From a WaPo blog story:

Here’s how Robert Laszewksi, an insurance consultant, put it in a note to clients earlier this morning:
“This means that the insurance companies have 32 days to reprogram their computer systems for policies, rates, and eligibility, send notices to the policyholders via US Mail, send a very complex letter that describes just what the differences are between specific policies and Obamacare compliant plans, ask the consumer for their decision — and give them a reasonable time to make that decision — and then enter those decisions back into their systems without creating massive billing, claim payment, and provider eligibility list mistakes.”

If I were the CEO of a health insurance company, I would engage in civil disobedience. I would design policies that are attractive to consumers, regardless of whether I offered those policies before and regardless of whether they satisfy regulatory mandates. I would then sell those policies to any customers who want them and defy the regulators to come in and take them away. I think in today’s environment, I could get away with that.

Thoughts on Secession

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Alberto Mingardi writes,

We are sometimes vote-intoxicated: we live in countries that consider voting the legitimate means for collecting [sic] decision making for everything but the extent and the boundaries of the very political community that is supposed to make decisions by voting. The bureaucratic apparatus is happy to have people decide democratically on other peoples’ money and lives, but not to the ultimate question of the survival of a nation state in its current geographical form. Too often secessionist movements are kicked out of the “respectable” public debate by quasi-religious appeal to the apparently immortal value of “national unity”.

I think you will find in general that the political class supports “reforms” that strengthen incumbents institutions and people in power, and that it opposes reforms that strengthen ordinary individuals. Making secession and “foot-voting” easier are examples of the latter.