Great Questions of Economics
Arnold Kling
Applying Introductory Economics Every Day

Archive of posts 141-150 of GQE

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Another Oil Crisis?

Paul Krugman says that we may be headed into another energy crisis.

So I'm sorry to say that under current conditions, a third oil crisis could indeed happen. It doesn't have to happen: a diplomatic breakthrough could calm oil markets, and even if oil prices rise, the U.S. economy may be more robust than I fear. But it's easier to tell a downbeat, even scary, story than any of us would like.

Every energy crisis that Krugman cites--the 1973 oil embargo, the 1979 oil crisis, and the 2001 California energy crisis--took place in an environment of price controls. My prediction is that if we stay away from price controls, any disruption in energy markets will be short-lived and do little damage to the overall economy.

Discussion Question. Many economists would like to see a tax on gasoline or on imported oil as a way to encourage energy independence and to reduce the transfer of wealth to oil producers. Is there any way that this idea could be sold politically?

A Natural Experiment in Foreign Aid

"Natural experiment" is a vogue term among academic economists. It means a phenomenon that occurred accidentally but which has the effect of creating something like a controlled scientific experiment. John Weidner does not use the term, but in a very insightful post he describes the abundance of oil wealth in Arab countries as a natural experiment in foreign aid.

A select group of undeveloped countries has been showered with so much of our wealth that they have often been at a loss what to do with it. The money was given in exchange for petroleum, but since that was a commodity they were not using themselves, these countries were essentially just given trillions of dollars. Money enough to provide them with a standard of living comparable to the West.

...The truth is, though they have lots of money, they are as poor as ever. If the petro-dollars vanished, they would revert instantly to pauperhood.

Discussion Question. Weidner goes on to say that "Real wealth is in people and character, and no one can give to you." Is the natural experiment sufficient evidence to justify such a strong conclusion?

Economic Ignorance Patrol

There is a lot of really lousy economics that I do not have time to deal with, including email chain letters proposing gasoline boycotts and Paul Krugman's New York Times columns. Fortunately, Jane Galt, or Megan McArdle, or whoever she calls herself these days, is on the case.

On the idea of boycotting Exxon and Mobil because they are big:

So this boycott takes 30% of a commodity out of the market. What happens then, class? That's right; the price goes up.

On the CAFE approach to (supposedly) reduce gasoline demand by regulating fuel economy on cars.

But if we realize that the consumers are actually consuming mileage, not gas, then we can see that CAFE inevitably increases the mileage consumed.

On Social Security (after an excellent parable skewering Krugman and the Democratic Party's "solution" of paying down debt),

Still a better plan would be the Chilean radical surgery approach: guarantee current benefits for those over 55 and move everyone else towards defined-contribution plans.

She gives us a lot to read.

Discussion Question. At, the Long Now Foundation's web site to generate discussions of the long-term future, there is a bet that web logs will overtake the New York Times as a cited news source by 2007. If Jane Galt is already more worth citing than Paul Krugman, should we move up the date?

Dornbusch on Exchange Rates

Rudi Dornbusch has some thoughts about international macroeconomic equilibrium.

Two views about today's prevailing exchange rates exist: the dollar is overvalued dollar and the yen needs a deep depreciation. The implication of the two is an explosion upward for the Euro. But can Europe deal with such a shock, and what would happen to the US if that happened?

...A big appreciation in the euro is not on the cards. Europe's leading economies, like Germany, are a fiscal embarrassment. Their tardiness in reforming and hostility to capital creates an impression of eurosclerosis that won't attract capital.

I had a hard time following Dornbusch when I took his International Macroeconomics course at MIT, and I have a hard time following him now. He seems to be making a "tallest pygmy" argument that although the U.S. needs a weaker exchange rate in order to restore trade balance, Japan and Europe need weak exchange rates even more.

Discussion Question. Other economists, notably Brad DeLong, suggest that the world needs to "balance up," meaning that rather than have the U.S. undertake all of the international adjustment by cutting imports, other countries need to increase their domestic demand. How might this happen?

CEO's and Ballplayers

Alan B. Krueger's column in the New York Times business section discusses research on income inequality. Among many interesting findings, he mentions

After adjusting for inflation, salaries of chief executives grew about 6 percent a year in the 1980's and 90's, while those of basketball and baseball players grew more than 10 percent a year. Wage growth has been so strong at the high end that the top 1 percent of taxpayers have taken home 94 percent of the growth in total income since 1973.

I would make a couple of remarks about this. One is that this is part of a trend that I noted in 75 Percent Mental that knowledge is being rewarded more than ownership of physical capital.

The other remark is that we have a reasonable explanation for the increase in the wages of baseball and basketball players. That is, the "reserve clause" was struck down. As a result, wages which had been artificially held far below their competitive level now are rising toward a competitive equilibrium.

Discussion Question. Why has the pay of CEO's risen so rapidly?

McArdle Vs. Krugman

Megan McArdle takes on Paul Krugman on the Social Security issue.

I'm sure that 2041 sounds comfortably far off to Krugman; in all likelihood, he'll be dead. I, on the other hand, will be just entering my golden years when -- oops! -- there will only be enough money to pay 73% of current benefits.

She wins, even if you take points off for failing to cite This classic

Discussion Question. Krugman juxtaposes the tax cut against the future social security deficit. However, if the tax cuts were to increase economic growth, would it still have an adverse affect on our future ability to fund social security?

Economists Vs. Environmentalists II

My second TechCentralStation column is up.

The critics of Bjorn Lomborg accuse him of not having a background in environmental science. In effect, they are accusing him of practicing ecology without a license.

The way I read it, Lomborg is not disputing environmental biology or ecological modeling. He differs from ecologists primarily in the treatment of the economic aspects of the environment. Although he is not a professional economist, Lomborg uses mainstream analysis rather than the peculiar models of ecologists. (His analysis of global warming owes much to the work of Yale economist William Nordhaus.) If anything, his work rests on a better overall scientific foundation than that of his critics.

Lomborg is scheduled to speak on Monday, April 8, in Washington DC from 10:30-12:00. I would have to miss a class to get there, so I'm not planning on attending. But if others in the blogosphere plan to show up, let me know and I could get a substitute. arnold at arnoldkling dot com

Fattening the Obesity Statistics

According to a food industry spokesman, obesity has been redefined more than it has increased.

In 1998, the U.S. Government changed the standards by which body mass index is measured. As a result, close to 30 million Americans were shifted from a government-approved weight to the overweight and obese category, without gaining an ounce, Burrita said.

William Quick adds this analysis:

According to an American Medical Association report, 14.5 % of Americans in 1980 were obese, a total of 32,700,000 (based on a population of 226,000,000). If, as the above article states, the numbers of obese Americans have "doubled" in the past twenty years, this would mean there are now about 66 million of them. But thirty million of those fatties were created by a change in definition, so by the standards of 1980 [we would calculate an] obesity percentage of 12.85 percent, an actual decrease in obesity percentage since 1980.

Discussion Question. Obesity remains a health issue, even if it is not increasing. However, if obesity is not increasing, does that reduce its salience as a public policy issue?

Productivity Optimist

Brad DeLong has yet another interesting post, this time on the productivity outlook. (See his number 2002-03-30)

If it is indeed the case that uses of information technology are growing faster than their prices are declining--perhaps because this is one of the few waves of innovation that are true general-purpose technologies--than the late 1990s are likely to substantially underestimate what future productivity growth is likely to be.

DeLong breezes through several analytical models which all suggest that much of the boost to productivity growth from information technology may still be ahead of us.

Discussion Question. Economics used to be known as the Dismal Science, in part because of what is known as the Law of Diminishing Returns. Is there any reason to believe that we have reached a point of diminishing returns for information technology innovation?

Diversity in Government?

Larry White (for whom I worked one summer) argues that financial regulation benefits from diversity.

I am not arguing for the world to replicate the American system of 200-plus regulatory agencies. Far fewer will suffice for most countries. But the next time that someone advocates a single financial regulator and its simplicity, remember that there is another side to that coin: where are the safety valves? Where are the alternatives? What about errors? How will innovation occur? In government (as well as in the private sector) a golden rule is that more competition and less monopoly is likely to be beneficial.

This is similar to a point of view I head MIT biologist Eric Lander express about medical research. He felt that having research spread among a number of agencies, although messy on paper, helped keep the overall process more open and better able to mitigate individual mistakes.

Discussion Question. How does this argument for diversity of regulation relate to the argument over the benefits and costs of federalism?