Joel Kotkin on Average is Over

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in California

The swelling number of billionaires in the state, particularly in Silicon Valley, has enhanced power that is emerging into something like the old aristocratic French second estate. Through public advocacy and philanthropy, the oligarchs have tended to embrace California’s “green” agenda, with a very negative impact on traditional industries such as manufacturing, agriculture, energy, and construction. Like the aristocrats who saw all value in land, and dismissed other commerce as unworthy, they believe all value belongs to those who own the increasingly abstracted information revolution than has made them so fabulously rich.

… In neo-feudalist California, the biggest losers tend to be the old private sector middle class. This includes largely small business owners, professionals, and skilled workers in traditional industries most targeted by regulatory shifts and higher taxes.

If nothing else, the era of Average is Over produces a lot of intense rhetoric. Although, I have to say, Kotkin’s rhetoric is not too far removed from my jobs speech (which has an Average is Over theme to it).

Suits, Geeks, and Health-care Exchanges

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Megan McArdle writes,

I predicted in December 2012 that the exchanges would not be up and running on time with minimal knowledge of how the contracts and budgeting were being run, because the administration was being pretty closed-mouthed about those things. Was I prophetic? Hardly. I just didn’t see how the administration could make things work in the allotted time frame. The development cycle was just too aggressive, even with what my boss used to call a “Shake and Bake” system (take something out of the box, add a few of your own ingredients and roll it out). I thought about the software-implementation projects I’d worked on (not in development but on the server side) back in the days when I was an IT consultant. This seemed a lot faster than anything that any company I’d ever worked with would commit to, even if it had already designed some of the underlying architecture.

Michael Malone writes,

Anyone who has ever worked on or, worse, bought a big software application – and this is one of the biggest in history — could have told HHS that the final result would be buggy, late, unsatisfying to users, unable to live up to its billing, and most of all, resistant to upgrades, much less wholesale changes. In the real world, you can’t just order “Make it so!”

I, too, have some experience with software development. This sounds to me like a case of suits saying one thing and geeks saying another. The suits are talking about “glitches” and “too much demand.” The geeks are making it sound like the system might be FUBAR.

1. I have been reading that the process of interacting with databases in order to deal with user identity and security issues is cumbersome, and that is causing the problems, even at small scale. If so, then this cannot be solved by adding servers or by patching a few lines of code. It may be closer to “we need to rip the guts out of the segment of the system that manages data transfer and re-architect it.”

2. My instinct at this point would be to try to separate the functions involved with sign-up from the functions involved with “tire-kicking.” I would think that it would be easier to set up a “tire-kicking” site where people can find out what the plans are and approximately what they will cost given their personal situations. However, because you could not actually sign up, the system would not store personal information or access so much data. Meanwhile, you straighten out the system that lets people actually sign up. If it takes 6 more months to build a robust sign-up system, that is a PR issue that can be managed, as long as the tire-kicking” system would enable consumers to satisfy themselves about what Obamacare means to them personally.

3. There has always been a high failure rate in big software projects. This is true in the private sector as well as in government. In this case, I think a lot depends on how easy it is to take out one part of the system and fix it without affecting other parts of the system. If the internal interdependencies are too large and complex, trying to patch the system can turn out to be a bigger challenge than starting over by creating a simpler architecture.

Money, Finance, and Nominal GDP

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Scott Sumner writes, among other things,

there is utterly no reason to presume that “the financial markets will evolve ways to insulate the economy from what the Fed does.” Indeed so far as I know no economist has ever even proposed a model where this is true. And that’s because it would have to be a very strange model.

This puts me in an awkward position. Either I say that this is my own model, in which case I think I am taking more credit than I should. Or I say that it is implicit in the writings of some other economists, in which case Scott is going to argue that I am misinterpreting them. When in doubt, I will commit the first error.

However, I am not totally daft. Jeffrey Rogers Hummel has just posted an excellent tour of monetary theory. It serves as a very useful reference. Read the whole thing. He concludes,

As I conceded at the outset, central banks can affect interest rates somewhat. What is incorrect is the now-common but simplistic belief that the liquidity effect is so powerful that it allows the Fed to put interest rates wherever it wants, irrespective of underlying real demands and supplies in the economy. Nor do I deny that central banks have other far-reaching economic repercussions, often detrimental. But in a globalized world of open economies, the tight control of central banks over interest rates is a mirage. Central banks remain important enough players in the loan market that they can push short-term rates up or down a little. But in the final analysis, the market, not central banks, determines real interest rates.

If you take Hummel’s tour, pay attention to the McCloskey-Fama challenge. Also, pay attention to this point:

As the Fed increased bank reserves and currency in circulation by $2.5 trillion over the five years since, it also was, for the first time, paying banks interest on their reserves deposited at the Fed. Although the 0.25 percent rate it pays is quite low, it has consistently exceeded the yield on Treasury bills, one of the primary securities in the Fed’s balance sheet. Thus, at least $2 trillion of the base explosion represents interest-bearing money that, in substance, is government or private debt merely intermediated by the Fed…The Fed can have no more impact on market rates through pure intermediation—borrowing with interest-earning deposits in order to purchase other financial assets—than can Fannie Mae or Freddie Mac. The remaining $500 billion increase in non-interest-bearing money (what economists call “outside money”) represents only a slightly more rapid increase than in the decade before the crisis, and nearly all of that has been in the form of currency in the hands of the public.

In some sense, quantitative easing consists of the Fed borrowing at 0.25 percent to buy Treasury securities. It is engaged in debt management, converting the long-term obligations of the Treasury into short-term obligations of the Fed/Treasury. As other economists have pointed out, the Treasury could cut out the middle man by buying back long-term obligations and borrowing more at the short end of the market.

Hummel does not depart from the standard theoretical assumption that there is an equilibrium “real” money supply, which ultimately ties the price level to the supply of money. That means that when the Fed raises the money supply, eventually the economy must adjust with higher prices. If you take that view, then the question of whether or not the Fed can affect interest rates may not matter. If the Fed can force prices higher, then it can raise nominal GDP, and we have something.

However, I take the view that the McCloskey-Fama challenge means that in fact that the Fed cannot force prices higher, because there is little adjustment needed in the economy when the Fed does something. The Fed is dipping its little cup in and out of a sea of financial assets. Right near the cup, you can observe water move, but viewed from overhead, the sea seems to have its own tides and storms.* As Fischer Black wrote in “Noise,” this leads to the upsetting and heretical conclusion that there is no equilibrium “real” money supply that ties down the price level. Instead, prices evolve higgledy-piggledy, based on habits and expectations.

*If the Fed used a really huge pitcher, big enough to raise the sea level by several meters, then I think we would see an effect. I only think that will happen if we run into a government debt crisis and the option of sudden monetization is adopted.

Expressing Libertarian Frustration

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Clyde Wayne Crews, Jr. writes,

here we are in the 21st Century with Obamacare’s futility characterized as “glitches” and “hiccups” by the Washington Post and NPR.

Those aren’t “glitches.”

They are, as one title by the great Ludwig von Mises put it, an inevitable manifestation of the impossibility of Economic Calculation In the Socialist Commonwealth.

In modern America, this abomination should never have even been suggested, let alone enacted.

The entire essay expresses frustration. If you are in the minority in a majority-rules environment, how can you be anything but frustrated?

A Voice of Social Conservatives

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I review Robert P. George’s Conscience and Its Enemies. My conclusion:

I think that libertarians will find George’s book to be well-reasoned. He usually anticipates the sorts of arguments and concerns that libertarians would raise about his positions as a social conservative. On the whole I think that libertarians will continue to disagree with his views on some of the central issues. However, his book has made me aware that the more aggressive moves by the Left in the culture war are putting liberty of conscience at risk.

The Age-Earnings Profile

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It’s changing, as Timothy Taylor reports.

In 2012, the typical workers [did not] reach the median level of earnings until age 30–four years later than their counterparts in 1980. And in 2012, while wages still drop off when people reach their early 60s, the decline is not as rapid or as far.

He cites a study by Anthony P. Carnevale, Andrew R. Hanson, and Artem Gulish.

From a PSST perspective, it makes sense that as the economy grows more complex it takes more time for young people to arrive at their comparative advantage. But there are no doubt other things going on as well.

Three Axes Meets Average is Over

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William Galston sees things along the oppressor-oppressed axis.

There’s nothing we can do, says Mr. Cowen, to avert a future in which 10% to 15% of Americans enjoy fantastically wealthy and interesting lives while the rest slog along without hope of a better life, tranquilized by free Internet and canned beans…He seems not to have considered the possibility that his depiction of our future might fill [us] with justified revulsion.

Patrick J. Deneen chimes in along the civilization-barbarism axis.

Thus, a philosophy that places in the forefront a theory of human liberty arrives at the conclusion that certain historical, technological, and economic forces are inevitable, and it is futile to resist them. One might bother to ask the Amish if this is true, but they didn’t go to Harvard. Clearly, they don’t value human freedom, since they are not on the historical merry-go-round to inevitable human liberty—and degradation.

Pointer from Tyler Cowen.

Contemporary Money and Banking

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In a comment on this post, the DeLong who is still attached to his hinges left me with quite a reading list.

1. Barkley Rosser writes,

Prior to 1984, there was a clear correlation between reserves, loans, and M2. After then, while loans and M2 continued to go along in a pretty close lockstep, reserves simply have flopped around all over the place.

Rosser cites Seth Carpenter and Selva Demilrap, who write

For better or worse, most economists think of M2 as the measure of money. M2 is defined as the sum of currency, checking deposits, savings deposits, retail money market mutual funds, and small time deposits. Since 1992, the only deposits on depository institutions’ balance sheets that had reserve requirements have been transaction deposits, which are essentially checking deposits. As noted above, the majority of M2 is not reservable and money market mutual funds are not liabilities of depository institutions. Nevertheless, it is the link between money and reserves that drives the theoretical money multiplier relationship. As a result, the standard multiplier cannot be an important part of the transmission mechanism because reserves are not linked to most of M2.

After reading these and other papers on his list, Mr. DeLong writes,

All this leaves me befuddled as to what the FRB and the econ profession are using as a model of the money machine.

I think that the popular saying among monetary economists these days is that attention has shifted from the Fed’s liabilities to the Fed’s assets. The old story was that the Fed’s liabilities were currency and bank reserves, and the banks lent out a predictable multiple of their reserves. The new story is that banks hold a ton of excess reserves. Also, if you include retail money market mutual funds in M2 (when did that happen? I’m so out of it, I thought that M2 was still, you know M2), then Carpenter and Demilrap are right that the money multiplier was never so reliable, anyway.

Anyway, back to the Fed’s assets. When the Fed buys long-term Treasuries, this takes them out of the hands of private investors, who then have to find something else to buy. They bid up the prices of other bonds and drive down interest rates, or so the theory goes.

My own view is that in an enormous world capital market, the Fed is not driving long-term interest rates. I am willing to be wrong. But my null hypothesis is that the Fed is always in an asset substitutability trap. Financial markets work to create substitutability. As a result, you have Goodhart’s Law: if the Fed can control the supply of an asset class (or definition of money), then that asset class will not have much effect on the economy; if an asset class correlates strongly with economic activity, the Fed will not be able to control it.

Another way to put this is that monetary and financial arrangements are endogenous with respect to Fed procedures. The financial markets will evolve ways to insulate the economy from what the Fed does.

PSST, Youth Unemployment, and Internships

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From the book-in-progress, a draft of a dialogue in which a character representing my views is speaking.

In the Schumpeterian story, jobs are always being created and destroyed. Sometimes, though, new opportunities appear before old firms realize that they are in trouble. Lots of people try to come up with new ways to deliver news on the Internet, but old-fashioned newspapers are slow to close down. That is Schumpeter’s model of a boom.

Eventually, the obsolete firms get the memo. Perhaps they get it during a financial crisis, when it becomes clear that they are no longer viable. As a result, a lot of workers are let go at the same time.

Now the entrepreneurs have to figure out what to do with these unemployed workers. The challenge is that these are likely to be the workers whose skills have the least value in the contemporary workplace. They are not likely to be computer programmers, or effective project managers, or persuasive salespeople.

Moderator: But in today’s economy, the people that seem to be having the hardest time finding a job are younger workers. You would think that if technological obsolescence is the problem, it should be the older workers having problems, and young people should be doing okay.

Schumpeterian Adjustment: That is a bit of a puzzle. One factor at work is that a lot of older people work in occupations that are protected in one way or another. In government, they are not going to fire a 50-year-old in order to hire a 25-year-old, even if the younger worker has better computer skills and requires lower compensation.

Something like one-third of the labor force is working in occupations that require licenses, and one thing that people in those fields can do is make it harder to get a license. They require a new entrant to obtain a doctorate (this happened several years ago in Maryland in physical therapy), but existing practitioners are grandfathered in.

However, I think that the biggest reason that young people tend to have lower rates of employment than older workers is that young people have not been able to settle on their comparative advantage. Young people today do not go to trade school. Most of them get general degrees, and they have very little experience in actual work environments, so they do not know the best way to use their talents. Neither do employers.

We are seeing an economy with fewer well-defined jobs. If it’s well-defined, it can be automated. Instead, businesses have projects to try to create new capabilities or solve problems. It is harder to fit inexperienced workers into that framework. You cannot just give them a couple days of training and have them be productive. Overall, the up-front cost of bringing on a new worker has been going up, particularly for young people with no work experience.

Moderator: Shouldn’t the wage rate take care of that? Young workers will have to accept lower wages.

Schumpeterian Adjustment: In fact, what we are seeing is a different path for young workers into the workplace. Consider the phenomenon of internships, many of which are unpaid. I think that internships are a response to the high fixed cost associated with hiring a new worker. You have to put so much effort into training and acclimating a new hire before the person becomes productive that it does not work just to pay a low wage or to hire people that you will have to fire later. Instead, the internship works as a sort of trial period. By creating an internship path into the business, the firm cuts down on its up-front hiring costs. The intern bears more of those costs.

The Fiscal Brouhaha

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First, some reality:

At the close of business on Jan. 20, 2009, the day Obama was inaugurated, the U.S. government debt held by the public was $6,307,311,000,000, according to the Daily Treasury Statement for that day.

At the close of business on Sept. 30, 2013—the last day of fiscal 2013—the Daily Treasury Statement said the U.S. government debt held by the public was $11,976,279,000,000.

I think that it is fair to attribute a lot of this debt increase to policies and economic conditions created under President Bush. Still, I find it ironic that President Obama would tell Wall Street that investors should be concerned about a potential default.

My views of the current situation:

1. Our politicians are like a family with a huge credit card debt. The Republicans are threatening not to make the minimum payment, and that is clearly a case of brinkmanship. However, the Democrats have no plan to keep the debt from growing out of control, and that in its own way is brinkmanship.

2. It is almost as if our political system and the news media are designed to conjure up short-term symbolic conflicts to distract attention from long-term problems.

3. A good rule of thumb in politics is that fiscal conservatives make noise, but spenders win in the end.