Matt Zeitlin

I generally do want to be in a situation where I’m disagreeing with Matthew Yglesias and Matthew Rognlie — someone who blogs way too little for how smart he is (he’s going to MIT in the fall to start his economics PhD) — and I do not know if I disagree with them in their argument for why it might be OK for employers to look at credit reports when they hire people (for the opposing view, check out Kevin Drum), but there’s a slight wrinkle to this debate that I do not think the illustrious Matts are considering.

Aside from the general point that liberals ought not to spend their time regulating business aside from dealing with externalities, Rognlie argues that there might be a good reason that employers would want to get a look at the credit history of prospective employers. So, we should generally trust employers to know whether or not it’s true that someone with worse credit will be a worse employee, and that if we find out that this is a totally baseless idea, then regulatory action can be considered. This sounds reasonable enough, but I don’t think it reckons with the possibility that a worse credit score, could be meaningful and it would be wrong for an employer to look at it. Let’s look at another fact about someone that employers have used as a proxy for other qualities they are looking for in an employee: race.

As we all know, labor market discrimination by race is both immoral and illegal, but it happens, and it doesn’t just happen because people are evil, but because there is an empirical element. Tim Harford had a great piece from a while back in Forbes where he talks about taste-based and statistical discrimination. The former is when employers just don’t like ethnic minorities and are straight-forward bigots and the latter is discrimination that happens because certain racial and ethnic identities are used as markers for other traits that matter to employers. Both, of course, are morally wrong and illegal, but the latter is hard to root out because, absent regulatory or legal pressure, employers will benefit from statistical discrimination, or at least they won’t suffer from it. From the perspective of the qualified black guy who can’t a job, there’s no difference between the two types of discrimination:  he’s still being judged based on his group identity as opposed to his individual qualities.

So, when we talk about what type of information employers should either have access to or should make employment decisions based on, we can’t just talk about what information correlates with more valid and appropriate qualities of a prospective employee.

I think Drum might be on to something when he says that we should not let employers look at credit history, just as we don’t allow employers to use race to evaluate prospective employees on race (although, of course, we can’t stop them from observing it). But the reasons for not allowing credit history have to be extra-economic, because we know that statistical discrimination can both be rational and wrong. The reasons for protecting credit history are both that it’s information that is traditionally private and protected — I don’t think Rognlie or Yglesias agree that anyone should have access to the credit history of their neighbors, friends and acquaintances – and that it can create a situation where the poor who are more likely to have a spotty credit history can not get jobs because of their spotty credit history and their credit situation gets worse and then can’t get a job, and so on and so forth. Sometimes, considerations of justice need to outweigh the short-term justification for the powerful in labor markets. Much the same situation exists in hiring ex-cons. Surely it’s a case where statistical discrimination makes some sense, but as a society, we are worse off when ex-cons have a very hard time entering the labor market because it both extends their punishment past the one handed down by a judge and, when convicts can’t get jobs, they are more likely to commit crime.

This is not to say that any and all statistical discrimination is something the government should try to prevent or that mucking around in labor markets is the right thing to do, but everyone accepts that such mucking around is OK in some circumstances, and those reasons might justify doing so in other cases.

*Yikes, just after writing this post, I realized that Rognlie wrote another post incorporating a response to the kind of points I made. But I just spit out hundreds of words on this, so I’ll just link to Rognlie’s follow-up.

*For more great Rognlie stuff, here’s his defense of Fahrenheit and “Preference Functions That Score Rankings and Maximum Likelihood Estimation“

Yesterday, DealBook had a solid story on corporate boards and executive pay. One of the standard explanations for the rise in executive compensation goes like this: executive stock boards with friends, other executives and people who are generally inclined to signing off on high compensation packages and are not the fiercest advocates for shareholders. A new study, the one repord on in DealBook adds another wrinkle to this story. Boards will use peer companies to see what they should pay their executives. This seems sensible, but here’s the twist: “companies usually benchmark their executive pay with peers in their industry group, but that they also choose peers that pay more than others.” So, companies tend to look at the highest paid peer-executives, which then sets new-benchmarks for executive pay, leading to an upward spiral as the higher paid peers become ever higher paid.

This is a distressing situation for shareholders obviously, put I think that we have a system where nearly everyone knows that the ever increasing pay of many executives in publicly held companies is only tangentially related to merit should shed some light on the idea, now resurgent on the right, that our debates about economic policy are actually cultural. By this they mean that conservatives generally support the idea that business should be allowed to fail, that economic success should not be tied to good relations with the government and that excessive social support saps certain values: thrift, independence, prudence etc, that are key to society-wide economic success. As I’ve written before, the huge increase in inequality in the last 40 years, much of which is due partially to finance salaries exploding and also to CEO pay increasing without a great underlying reason seems to indicate that this thesis might not be correct, that there are other forces subverting merit and earned success besides liberal regulatory policies and social programs. And yet, you don’t see conservative get up in arms about executive compensation. Curious, that.

Derek Thompson at the Atlantic posted this chart showing long-term unemployment being not only at a locally unprecedented high due to the recession, but also at a scary level even compared to other recessions. Or as he put it, the median duration of unemployment is more than double than at any point since 1965. Obviously we are in the midst of a recession induced depressed labor market that is noteworthy for just how bad at is in terms of gross number of unemployed, people dropped out of the labor force and the mismatch between job-opening and the unemployed which is leading to such a long median durations of unemployment.

But this question of the scary labor market now is only part of a more long term story of how the labor market has been deteriorating for a while, even before the recession. Just eyeballing the graph, with the exception of the Federal Reserve stoked disinflating recession, the second highest median unemployment peak was the one following the early 00s recession and the peak before that follows the early 90s recession.

A paper published in July 2005 by the Federal Reserve Bank of Boston detailed how “Measured relative to the business cycle peak in March 2001, labor force participation rates almost four years later have not recovered as much as usual, and the discrepancies are large.” And because this paper focuses on the lack of recovery in labor force participation, it turns out that the decrease in unemployment following the last recover was actually understated, “because participation declined fairly consistently from 2001 on, the rise in unemployment during the recession also understated the severity of the slowdown.”

So, what to do about seemingly structural problems that are making the labor market less robust and about our current problem of an incredibly weak, recession-battered labor market? Well, for the latter, we should probably be trying for growth-inducing policies without many worries about inflation. But more generally, we have a long-term problem of education, human capital and job training. The usual way of looking at this problem is to bemoan our relatively poor educational system, but another way of looking at it is to examine that, despite our relatively open labor market compared to some other developed countries, we spend a relative pittance on “active labor market policies”: things like job training, employment subsidies, placement services, and job counseling for the unemployed. According to The Economics of Imperfect Labor Markets,  in 2006, the U.S. spent about .13% of GDP on these programs, the lowest of any OECD besides Korea,  while Denmark spent 1.74%.

If we are going to continue to have recessions with weak recoveries in the labor market, it is because of a wide range of policy failings besides sub-par growth and it’s not something we are really talking about enough.

So Treasury has been doing a big media push — with big pieces in the Atlantic, the New Yorker and chats with bloggers — trying to portray Tim Geithner as a technically competent public servant who is overwhelmingly and singularly focused on restoring economic stability and putting the U.S. on the path of growth. Naturally, the two big magazine profiles are very positive and do almost-too-much to make Geithner look like a great Treasury Secretary whose only problem is a lack of P.R. skill.

But one detail that is overwhelmingly positive is his commitment to public service.  Since working as a researcher at Kissinger Associates in the 1980s, Geithner has spent his entire career in public service, mostly as a career Treasury bureaucrat. As President of the New York Fed, he basically impressed every banker he came into contact with and, according to Josh Green in the Atlantic, was offered the CEO job at Citigroup.

Obviously, he turned it down. And one imagines that at many points of his impressive career at Treasury, he could have gotten any number of good jobs at all sorts of financial institutions. But he didn’t. Now, it’s not like Geithner is eating mud-cakes because of his career choices — Politico estimates his net worth to be between $740,000 and $1.7 million and he’s pulling down $191,300 per year in salary — but  he could making many multiples of that just serving on the boards of some banks, let alone working for one of them.

But plenty of people still seem to think that he’s too close to banks, despite never having worked for one (unlike, say, Robert Rubin or Larry Summers). I think this is mostly due to the fact that Geithner’s primary job as head of the New York Fed and as Treasury Secretary has been making sure banks don’t fail which necessarily means in engaging in bank-friendly activity. It’s not like he’s someone who’s committed to seeing the financial sector as large and under-regulated as possible; he just seems like a well-intentioned public servant who has had to make incredibly unpopular choices because that’s what he thought was the right thing to do.

Now, who knows, maybe he’ll serve out Obama’s first term and become the chairman of Goldman in 2013 in part of some quid pro pro for their enormous profitability while Geithner was New York Fed President and Treasury Secretary, but that wouldn’t be keeping in with any choices Geithner has made in his career.

So it seems like Bernanke renomination might be in trouble. The ire that lawmakers seem to have for Bernanke is, of course, hypocritical. Basically, everyone agreed that banks needed to be shoveled money lest the economy melt down, but no one wanted to take responsibility for it. So, the Fed, which had both the tools to do this and the necessary political insulation, shoveled tons of money to banks and now Bernanke is taking heat for it. And while this is unfair and silly, it makes sense.

What’s depressing about this situation is that there is a case to be made against Bernanke’s nomination and it seems like no one (in the Senate) is making it. Bernanke is not just the technical wizard in charge of value-neutral central banking policy, he’s probably the most important economic policy maker in the country. And, he has the policy preferences of, not surprisingly, the moderate-to-conservative Republican that he is. Which means that he’s quite concerned about inflation and has rejected expansionary, unemployment-lowering policies which he can implement because of inflation concerns.

Instead, both supporters and opponents of Bernanke seem to be mired in the past. The best positive case for Bernanke is that he did a good job when shit hit the fan. Which is true, but sort of irrelevant. The question is whether or not he should continue to be Fed chairman, not whether he should get a merit badge for his actions during the crisis. On the other hand, the idea that Bernanke should be punished for lack of regulatory action seems kind of silly. Following Megan McArdle, it seems unlikely that anyone would have done anything that useful in the time that Bernanke was Fed chairman. Also, it was hardly like the type of people who would be Fed chairman instead of Bernanke were super prescient on this issue.

But we’re stuck in a weird situation. Because Obama decided to renominate Bernanke, Chris Dodd is probably right that sinking the nomination now would be  ”the worst signal to the markets right now.” But if people just thought that the Fed chairmanship was another political/policymaking job that requires a certain level of expertise and that presidents get to appoint Fed chairmans whose political outlook is similar to ours, no one would have freaked out if Obama had just nominated Larry Summers or Janet Yellen. It’s not like they don’t have the technical chops for the job and it’s not like a slightly looser policy will turn back the clock to the late 1970s. But because we don’t seem to think of the Fed chairmanship this way, we’re stuck in the decidedly suboptimal situation where we have a less-than-ideal Fed Chairman pursuing less-than-ideal policies but it also being the case that it would be worse for everyone to not have him in the job.

It’s safe to say that the conservative movement has confused normative ideas about what policies should be implemented or not implemented. But of course I would say that; I’m a liberal. But it’s also noteworthy how the conservative movement has seriously confused positive ideas about pretty basic policy issues. There is, of course, the widespread belief among movement conservative types (and politicians) that reductions in marginal income tax rates will increase revenue. This, obviously, is not true and doesn’t have a scintilla of empirical evidence to support and not even any good argument for why this could be true when income tax rates are the lowest they have ever been.

But another argument that conservatives seem to take for granted is that, despite our abnormal-for-the-industrialized-world inequality, we have more intergenerational mobility, that the economic and social status for a given person is less influenced by their parents economic and social status than it is in other countries. Marco Rubio, profiled in today’s New York Times Magazine, believes this wholeheartedly:

He jackhammers his message about America’s exceptional status in the world. “This is the only society in history where your future is not determined by where you were born,” he said. “I believe that the United States of America is the greatest society in the history of humanity.”

This, intuitively, seems unlikely; if the income distribution is more spread out, it would seem harder to advance along it. But even when you just measure gross income gains, Marco Rubio, “The First Senator From the Tea Party?” is pretty wrong. Here are just a smorgaboard of papers and reports that all conclude that the US has less intergenerational income mobility than comparable countries. And, most damningly for hardcore economic conservatives, Scandinavian social democracies have higher levels of intergenerational income mobility.

Bhashkar Mazumder, an economist at the Federal Reserve Bank of Chicago, has a paper which says that “Using administrative data containing the earnings histories of parents and children,the IGE is estimated to be around 0.6. This suggests that the United States is substantially less mobile than previous research indicated.” And, “estimates of intergenerational mobility are significantly lower for families with little or no wealth.”

Or, from Markus Jantti of Abo Akademi University:

The United States, Italy, and France all have high persistence, at 0.45, 0.44, and 0.42, respectively, which with a 12-fold income advantage in the parental generation would translate to roughly three times higher incomes among the children of the richest fifth compared to those of the poorest. Denmark has the lowest persistence at 0.12, and most other countries are quite close to 0.25. These numbers translate to 1.35 and 1.86 times higher incomes among the richest fifth offspring, holding constant the parental income advantage

In summary, “Intergenerational income persistence in the United States is quite high compared to other countries, and that persistence.”

Now, conservatives could argue that all this talk of mobility doesn’t matter and that it’s aggregate growth that’s important. But when there is so much inequality, this type of argument isn’t likely to find much purchase in the electorate. And, even more damningly, there is a ton of research that suggests the best way to increase intergenerational mobility, especially among the very poor, is intensive, expensive investments in early childhood education and health care. Of course, the only conservative education policy is to make it easier to fire teachers, privatize as much as possible and just hope shit works out. Which I guess explains why they hold such contrary-to-reality views about intergenerational mobility.

Liberals are all too often raked over the coals by centrist and right wing pundits for their supposed “economic illiteracy.” This griping often comes in the form of overinflated fears that even the most symbolic protectionist moves will lead to trade wars or that any increase in the minimum wage necessarily means vast unemployment for the poor and young. And while in the case of protectionism there is a germ of a point — most protectionist moves run the spectrum from marginally harmful and stupid to inconsequential — liberals hardly have a monopoly on not following the dictates of introductory economic textbooks.

Take, for instance, the attitude that Sarah Palin and many prominent conservatives have towards government activity in a recession. This, again, is from Jonathan Raban’s excellent New York Review of Books essay:

For Palin, it’s simple. The national economy is a straightforward macrocosm of the domestic economy of the average god-fearing family of four. What’s good for the family is good for the nation, and vice versa; and the idea that the family should spend its way out of recession is an affront to common sense, conservative or otherwise. On December 3, she tweeted: “Baffling/nonsensical: Obama’s talk of yet another debt-ridden ‘stimulus’ pkg. Fight this 1, America, bc after last 1 unemployment rose, debt grew.” Five days later, while Obama was speaking at the Brookings Institution about the economy, Palin wrote, “Quik msg b4 book event: Prez pls pay down massive, obscene U.S debt &/or give ‘stimulus’ $ back to Americans b4 propose spending more of our $”

Palin’s general economic theory, so snugly adapted to Twitter’s 140- character limit, carries great weight. At a time when everyone should be clipping coupons, tightening belts, and buying generic peanut butter, Obama (Columbia and Harvard), Larry Summers (MIT and Harvard), Tim Geithner (Dartmouth and Johns Hopkins), and Peter Orszag (Princeton and London School of Economics) are out on a spending spree that is “baffling,” “nonsensical,” and “obscene.” But then what did we expect of the East Coast elites?

Of course, every introductory economics textbook takes as assumed wisdom that governments can help stimulate the economy to get out of a recession by increasing spending, cutting taxes in the short term and running deficits. This is just about as basic as the case for free trade raising living standards or price ceilings causing shortages. But it just so happens that it doesn’t accord with “common sense” that a government behavior’s in a recession ought to be the opposite of a household’s, but then again, common sense wouldn’t tell us that cheap foreign goods which displace native producers make the entire country more well off.

But we don’t see the types who are so quick to lambaste liberals for their stupidity following any inkling of protectionism (like the folks who write “leaders” for the Economist) taking the same haughty, dismissive attitude towards conservatives who oppose stimulus, even though the very textbooks that are the purported basis for their thought unequivocally say that her opinions are totally daft.

There is a lot of griping about material contained in your standard introductory economics textbook. For instance, Krugman’s textbook says all sorts of mean things about unions and the minimum wage; namely, that they are responsible for structural unemployment because they push wages past their equilibrium level. Of course, the empirical evidence for both propositions is quite murky and Krugman, in his blog and columns, obviously doesn’t think the minimum wage is such a bad thing.

On one point, however, introductory textbooks are unified and plainly correct: real-life socialism, where the government expropriates private industry, seizes the means of production and tries to direct the production of goods is really, really dumb.

Look, for example, at the Venezuelan auto industry and what Hugo Chavez wants to do with a Toyota plant:

CARACAS—Venezuelan President Hugo Chavez has threatened to expropriate Toyota MotorCorp.’s local assembly plant if it doesn’t produce more vehicles designed for rural areas and increase technology transfer.

Mr. Chavez said late Wednesday the Japanese auto maker needs to transfer more new technologies and manufacturing methods from headquarters to its local unit in Venezuela.

While Mr. Chavez directed most of his criticism at Toyota, he said other auto assemblers, including Fiat SpA and General Motors, are also guilty of not sharing technology from abroad with their Venezuelan units.

Mr. Chavez said his socialist government is going to apply strict quotas regarding the number and types of vehicles auto makers can produce. The president also ordered his trade minister, Eduardo Saman, to inspect the Toyota plant, saying it may not be making enough “rustic vehicles,” a style of all-terrain vehicle that is much-needed in Venezuela’s countryside, where they are often converted into minibuses.

So, we have one element of socialist stupidity: not giving deference to market outcomes of what goods are being produced and thinking that a better way to maximize consumer surplus and welfare is to have the government take over the commanding heights of an industry and make the production decisions.

But it gets even better (or worse):

As a result of low productivity, demand for automobiles far outstrips supply in Venezuela. Demand is also enhanced by subsidized gasoline in this oil-rich nation that makes a gallon of gasoline cost about seven cents.

Eduardo Blanco, who manages a Toyota dealership in the Los Palos Grandes neighborhood of Caracas, said last week that he has 600 people on a waiting list for vehicles, and that only a half a dozen cars arrive at his lot each month.

A classic case of the result of a price ceiling, a shortage! Sometimes Economics 101 (or in my case, Economics 201 taught by the esteemed and very liberal Robert Gordon) is just right.

To get this beyond just making fun of Hugo Chavez’s incompetent economic management, I think it’s important to locate and criticize real examples of command-and-control socialism, just so that when conservatives gripe and moan about mild industrial policy, bank bailouts in crisis or government subsidies to purchase health insurance, we can see how silly they’re being.

The WSJ has an excerpt from David Wessel’s new book, In Fed We Trust: Ben Bernanke’s War on the Great Panic,  which documents, well, Ben Bernanke actions in the great panic. The entire piece is interesting, but this one paragraph jumped out at me:

When the search for a successor to the then-venerated Mr. Greenspan began in the spring of 2005, Mr. Bernanke’s proximity to President Bush heightened the public speculation that he would be among the finalists, and he was. Others were Harvard’s Greg Mankiw and Martin Feldstein, Stanford’s John Taylor and a dark horse whose name never surfaced in the press: Stephen Friedman, a former Goldman Sachs chief executive and White House economic-policy coordinator. Each man was interviewed by a small search committee in Vice President Dick Cheney’s office for about 90 minutes.

It was bad enough for the credibility of the government’s response to the financial crisis that a former CEO of Goldman Sachs was running the Treasury Department, but the shitstorm that would have resulted from both Treasury and the Federal Reserve being run by two CEOs of the same investment bank would have been orders of magnitude worse. Now, I imagine that progressive critics of the Bush-Obama-Paulson-Bernanke-Geithner response to the financial crisis think that having Friedman at the Fed — or anyone else who came up in right wing policy and economic circles — wouldn’t have made that much of a substantive difference in the actual policy decisions, but I think everyone can agree that some sort of emergency, large-scale action by the Fed was necessary, and having someone with as solid a reputation as Bernanke at the helm was probably for the good.

I think, when all is said and done, the appointments of Gates and Bernanke will be seen as Bush’s best moves.

Dave Brockington at Lawyers, Guns and Money has an oldie but goodie complaint that you hear from anyone who thinks about tax and budget policies in a serious manner — that taxpayer funded stadiums are giant scams. Specifically, Jerry Jones has claimed that the new Cowboy stadium, which the city of Arlington contributed $325 million of the total $1.12 billion cost, will “be its own stimulus package that will help “the country and this world” dig out of the recession.”

And while the explicit subsidies cities give teams and their corporate sponsors for the construction of new stadiums is quite egregious, the far more common subsidy is exempting business or stadiums from paying taxes. Brockington points out that cities and states routininely exempt business from paying taxes in an effort to lure them into their jurisdiction. Everrett, Washington, for example, ‘”afforded Boeing large subsidies” to assemble the 787 there.

Now, of course, this is a very thorny problem because of its collective nature. While everyone would be better off if cities didn’t compete by slashing taxes (and thus their revenues) to attract businesses, it will generally be rational for a single city or county or state to do so. The real solution would be a total federalization of the tax code, which could only real happen if we had a federalization of budget and policy making, which for a variety of reasons, isn’t going to happen anytime soon.

Chris Hayes has a good essay in TAP on the oddly resurgent view that recessions, and even depressions, are not just normal parts of the business cycle, but are even morally beneficial.

As his modern example of this school, he focuses on Robert Samuelson, who constantly gripes about too-high social spending, and wrote The Great Inflation and Its Aftermath, which is a history of how economic planners in the 60s and 70s believed that there was an inverse relationship between inflation and unemployment, and thus promoted inlfationary monetary policy for essentially political reasons. There was then the horrible wage-price spiral, bracket-creep and stagflation, which helped pave the way for the election of Ronald Reagan and Paul Volcker heroically plunging the economy into recession in the early 1980s to purge inflation out of the system.

That’s at least the mainstream center-left to center-right narrative. Here’s Hayes’ version of the story, which, since it’s Chris Hayes, is the smartest possible leftist/social democratic version of those events:

It’s unclear however, whether the persistent inflation of the time was the result of the nature of the social contract, or a confluence of factors: a very long debt-financed war in Vietnam, combined with a loose monetary policy. And it is almost certainly true (and hardly controversial) that stable prices, while necessary for strong economic growth, are certainly not sufficient: George W Bush presided over one of the lowest average inflation rates of any post-war American president, yet his term left average wage earners worse off while precipitating the worst financial crisis in 80 years.

But for Samuelson, inflation is enemy number one, so much so that wringing it out of a system makes recessions look not so bad. “Recessions also have often-overlooked benefits,” he wrote in his Newsweek column last year, echoing, in an albeit softer tone, Mellon and Schumpeter. “They dampen inflation. In weak markets, companies can’t easily raise prices or workers’ wages. Similarly, recessions punish reckless financial speculation and poor corporate investments. Bad bets don’t pay off.”

With the unemployment sword of Damocles hanging over their heads, workers will think twice about asking for a raise, and all of this will lead to a robust kind of capitalism for the capitalists: one with low inflation, low interest rates and very high return to capital. If that sounds familiar, it’s an apt description of the economy of at least the last two decades, a kind of capitalism recently proven far less stable than it may have appeared, but one for which Samuelson is an unapologetic partisan: “The new economic order,” Samuelson writes, “is indeed inferior to the imagined and romanticized version of the old order. But it’s superior to the old order as it actually operated.”

Chris’ larger point, at the end of the essay, is that economies require some sort of political management, and that the Chicago School/Mellonist account of depressions and recessions as natural parts of the business cycle is one that A. is simply incorrect and B. not coincidentally tends towards favoring those policies which benefit the wealthy, lending and poweful. I largely agree with him — and Paul Krugman, whose work on recessions he cites — but I think the episode Samuelson recounts is a truely exceptional case.

That’s because the recession of 1981 was, unlike the recessions and depressions that business cycle theorists and Mellonists occasionally laud, was deliberately engineered by Volcker to break the inflation that was crippling the economy. He intentionally drove interest rates up so that prices would finally fall, even if it meant a decrease in growth.  Unlike other recessions, which aren’t good for the economy and simply lead to a lot of wasted capacity and unnecessary human suffereing, the 81-82 recession was specfically designed to achieve some long-term positive results for the national economy. Most recessions, needless to say, aren’t deliberately managed by financial wizards like Paul Volcker.

While Hayes is right to say that the inflation had more causes besides the obsession with keeping unemployment down, there is no denying that acertain ignorance of the micro-foundations of macro movements in the economy played a large part in the horrible mismanagement of the economy during that time. Of course, those seeking to explain everything in the macro economy by reference to micro-foundations haven’t been very sucessful, but the case of stagflation and the Phillips Curve wasn’t only a general vindication of this approach, but a very specific example of what happens when policymakers just look at historical relationships and totally ignore how individual participants in a market will respond to their policies.

Back to Hayes more general point — that “economies need management and policy to maintain some kind of equilibrium” and moreover “it will be politics, not technical expertise, which provides the principles and rules that regulate” — I think that the early 80s are probably the best example of this. Reagan’s inflation crushing had a whole lot to do with this overall political agenda, and Volcker was only able to pursue his monetary agenda because the political circumstances favored it.

So, there was a big econblogosphere throwdown when Obama said that he was wary of a provision in Waxman-Markey which would require the President, in 2020, to  tariffs on some goods from countries that didn’t have caps on carbon emissions.

As Paul Krugman and Eric Posner point out, this kind of policy makes total sense on purely economic grounds. The point of putting a cap on carbon is to raise the price of goods whose production involves carbon emissions to something approximating the negative externality that is all this carbon warming the planet. So, a tariff which incorporates this cost would seem to make a lot of sense. Otherwise, production of carbon intensive goods will shift from the US to foreign countries that don’t cap emissions and we’ll have gotten approximately nowhere.

On the other hand, starting a trade war with China over this would be A. economically damaging and B. wouldn’t help anyone reduce emissions. Moreover, even if we do manage to pass and implement the fairly weak Waxman-Markey bill, we’ll still have next to know  There are also all sorts of other practical objections to actually implementing this policy.

Even if we manage to pass and implement this fairly weak Waxman-Markey bill, we’ll still have next to no moral capital in 2020 to browbeat countries that are still poor and have low per-capita carbon emissions into doing something about warming.

The best case scenario is that the tariff provision acts like the EPA claiming authority to regulate carbon dioxide. During the House debate on Waxman Markey, some Democrats justified their support for the bill on the grounds that EPA regulation of carbon would be too horrible to bear. As John Dingell put it, “”If you want something to shudder about, take a look at that.” Hopefully the possibility of tariffs will act in a similar way — as a harsh, unilateral and unappealing way of dealing with a problem that will be rendered unnecessary if the parties just get their act together.

And much of this debate is academic. Obama can sign a bill with the tariffs and says he opposes them, which would cool down any countries that are worried about protectionism from his administration. His opposition would be pure signalling because the tariffs wouldn’t go into effect until four years after he left office.

Development economics is a weird discipline.  People have a good idea of what causes economic growth in developed economies, but have a poor understanding of what causes underdeveloped countries to become developed one. For example, few people think that what happened in East Asia in the 60s and 70s constitutes a model that other underdeveloped countries can follow. There are disagreements over what causes poverty, whether it’s bad governments, bad geography or the aftereffects of broad historical events. And yet, poverty, in terms of net social cost is by far the most important issue in the world.

Much of his doubt about development economics has lead to some, like William Easterly and Dambisa Mayo, to totally reject the aid enterprise and advocate that we basically just stop any top-down developmental aid to Africa. Others, like Jeffrey Sachs, thinks that all of Africa’s problems are due to its poverty and that this  poverty can be eliminated through better designed aid programs.

The truth lies in the middle, but in a strange way. Easterly and those in his camp are right about one thing, the record of rich country intervention in increasing the growth rate or measurable wealth or income of poor countries, especially in Africa, is very low. We’ve been giving tons of aid, and income has gone nowhere. On the other hand, we have a very good record in public health interventions. Smallpox, for example, was eliminated through a top-down effort by the World Health Organization.

This is all just a big wind up to Charles Kenney’s new book, or at least its free online introduction. Kenney makes the important argument that despite the depressing “economic” (i.e. income) news coming out of Africa, there has been good news on public health, well being and quality of life. More importantly, economists should do a better job of recognizing that improvements in public health, even if they don’t come with increased incomes or economic growth, are still very, very important:

As suggested by the global reach of improvements in the quality of life, income growth has not been a requirement for improvements in health or education or civil rights. Even most countries that have seen per capita income decline over the past thirty years have seen health, education and civil rights observance considerably improve. This is the greatest success of development. The last century has seen a dramatic (and literal) decline in the cost of living.

…The fact that income appears to be a poor proxy for overall changes in the quality of life suggests the need for a broad focus –a broad definition of development—for policymakers. Given that it is not clear exactly which policies at which times will promote growth, and the tenuous nature of the connection between income growth and quality of life, the first rule for economic policymaking should be ‘do no harm.’ The grail of economic growth does not justify the degradation of health, education or civil rights.Regarding support for improvements in the broader quality of life, policies might include aiding the spread of ideas through approaches that increase demand for good health and education. Communications programs and payments for school attendance or clinic visits have a role here. In addition, with the quality of service provision increasingly important to outcomes, reform of the institutions of health and education should also be a central concern.

Of course, Martha Nussbaum and Amartya Sen have been saying some version of this for decades, but considering how development and aid policy has had a relative revival of popularity and relevance, it’s worth remembering that it’s not all about income and growth.

One of the more popular deep explanations of the global financial crisis is that one of its roots is the global savings glut, especially in Asia. The way this story goes — and its one that Paul Krugman, among others, tells with conviction –is that in the late 1990s, Asia and other oil exporting countries became huge savers, and thus, net lenders in the world economy. What’s weird, however, is that in China for example, savings went up faster than domestic investment. This money needed somewhere to go, and there weren”t enough places to put in China. Along with this increase in saving, there was a period of very low long-term real interest rates, making investment attractive, especially in the United States and some European countries. So, all this money floods into the U.S., it has to go somewhere, and ends up bidding up the prices of securitized home mortgages. The values of these investment vehicles crash, and the financial system nearly collapses.

But wait, isn’t the story here seem to say that high rates of saving are bad and that they lead to too much investment? Most economic theory seems to suggest that saving is generally very good, and moreover, a lot of economists and policy types are always recommending that we tax consumption so as to encourage saving. If that’s true, then Matt Rognlie is certainly right to say, what’s wrong here, the global savings glut theory of the crisis or lots of economic theory? And how should this affect our views about saving?

I don’t think this two views are very much in conflict. For one, the global saving glut types are saying that problem isn’t too much saving, but that some countries (America) save far too little and other countries (China) save far too much. So, all those questions about tax policy towards saving and consumption don’t seem all that relevant when discussing a global savings glut.

Also, Rognlie says:

….you could make an argument that funneling excess savings into inflated property prices is the essence of a destructive “savings glut,” while “excess” savings don’t do the same damage when placed in other kinds of investments. But this is both question-begging and unlikely to provide useful lessons about policy. We’re not going to have the exact same kind of bubble repeat itself in the next couple decades, and if only real estate is capable of transforming savings into an economically destructive force, this entire line of reasoning has little relevance for the coming years.

But the way Bernanke tells the story is that this global savings glut was real and actually led to a decrease in long term interest rates.

The combined effect of these developments, I argued, raised desired saving relative to desired investment in the emerging markets, which in turn led to current account surpluses in those countries. But for the world as a whole, total saving must equal investment, and the sum of national current account balances must be zero. Accordingly, in the industrial economies, realized saving rates had to fall relative to investment, and current account deficits had to emerge as counterparts to the developing countries’ surpluses. This adjustment could be achieved only by declines in real interest rates (as well as increases in asset prices), as we observed. The effects were particularly large in the United States, perhaps because high productivity growth and deep capital markets in that country were particularly attractive to foreign capital. The global saving glut hypothesis is thus consistent with the three key facts I noted earlier.

And while Bernanke, who was giving this talk in September 2007, doesn’t connect the glut to the crisis, plenty of other people have done so and are perfectly reasonable. This is not to say that savings and low interest rates always means asset bubbles and subsequent crashes, but just it’s worth watching out for when high savings and one part of the world leads to massive overinvestment in another.

Alain de Botton, writing in City Journal, has an interesting piece trying to resuscitate the importance of pessimism:

It’s time to recognize how odd and counterproductive is the optimism on which we have grown up. For the last 200 years, despite occasional shocks, the Western world has been dominated by a belief in progress, based on its extraordinary scientific and entrepreneurial achievements. But from a broader historical perspective, this optimism is an anomaly. Humans have spent the greater part of their existence drawing a curious comfort from expecting the worst. In the West, lessons in pessimism derive from two sources: Roman Stoic philosophy and Christianity. It may be time to remind ourselves of a few of their lessons—not to add to our misery but to alleviate our injured surprise and sorrow.’

While I think that our currently troubled economic times should remind us that things aren’t necessarily always going to get better, it’s worth pointing out that Seneca, or anyone living before the Industrial Revolution, was living in a vastly different world than ours. It’s almost too telling that Botton brackets the last 200 years as a time when the human psyche took a turn for the optimistic. If you look at any measure of well being — let’s say life expectancy — optimism seems like the natural reaction. Let’s look at these two charts:

As the first chart vividly shows, the world before the Industrial Revolution was vastly different from the world after it in a way that we can’t really appreciate. Greg Clark’s evocation of this transition is in Farewell to Alms is especially useful.

Before industrialization, any technological or sanitary advance that led to higher population and increased life expectancy just resutled in a malthusian “crunch” where the extra people would consume any surplus and the population would go back down as people died of hunger or disease. This brutal state of affairs, which of course inspired Malthus, would have an obvious effect on whether or not intellectuals counseled optimism or pessimism as the best default stance for evaluating the present and predicting the future.

Now, all of this is not to say that the tonic of someone like Seneca (or Keynes, or Minksy, or Marx) is useful in response to those who claim that just because things have been going well for a long time means they are going to indefinitely in the future. But notice how I reference three post-industrial economists as useful cautioners. I think what Botton is doing here, while intersting, actually shows the silliness of those like, say, Leon Kass, who insist that all the knowledge one needs to be a properly adjusted human being comes from humanistic study of classic texts.

When Botton evokes Seneca — a thinker who really is, in the grand scheme of things, quite obscure  — to come to the conclusion that “Because we are hurt most by what we do not expect, and because we must expect everything…we must…keep in mind at all times the possibility of dire events” I wonder why he had to go to 1st century Rome to think of something that smart people have been saying for as long as smart people have been saying things.

Especially because he’s talking about a financial crisis that isn’t all that inexplicable if one looked at modern economic history or read the work of economists and economic historians who discuss the problems of instability and asset bubbles. If everyone were more familiar with the work of Minsky, or read Paul Krugman’s columns about the housing crisis, or listened to Nouriel Roubini or, if you want to get all Great Books-y, read Marx, of all people, about the inherent instability of capitalism, and you’d have a much more useful diagnosis of the problem of over optimism thinking about financial markets than if you read Seneca. Another example of this tendency would be if you cited Burke’s work as an explanation for the invasion of Iraq would be a failure, as opposed to say, citing past American invasions/occupations or past invasions or Iraq. Sure, a telling citation of Burke will get you to the general conclusion that cultures can’t be remade overnight, but a look at the British experience in Iraq or America’s time in Vietnam would be much more useful in evaluating the specific question.

As far as I can tell, in the context of debates about policy – really anything, but especially police – the main advantage that familiarity with great works gives you is the ability to cite a wide range of thinkers that people instinctively respect but aren’t that familiar with to support a position that you already have.

Both graphs taken from Brad Delong, who gives proper credit here.

Despite the fact that I’m not an undergraduate there, I really do love UC Berkeley. Both my parents went there, I’ve been to a bunch of their football games, I live close to it and so on and so forth. Also, I’m an egalitarian liberal, so I’m double excited that Emmanuel Saez has won the John Bates Clark medal for being the best American economist under 40. The J.B.C.  medal is the second most prestigious award in economics, and is a very good predictor of future Nobel winners. Around 40% of the Clark winners have gone on to win Nobels. Also, unlike the Nobel, it’s only awarded every two years.

Saez is famous for his research on inequality. Basically, whenever you see a chart or graph or table tracking American income inequality, it’s based on research Saez did with his French college Thomas Piketty. As inequality has exploded since the late 70s, and especially in the past eight years, so has the relevance of Saez’s work. He’s certainly earned the honor.

It’s also a nice nod to UC Berkeley’s economics department. Academic economics is generally considered to be the domain of two institutions in Cambridge: M.I.T. and Harvard. Because of their prestige and proximity to the National Bureau of Economic Research, these two institutions get the vast majority of the best graduate students (nearly every academic economist you’ve heard of got their PhD at M.I.T. or Harvard) and a whole lot of the most prestigious economists end up at one of those two places. Berkeley, being the greatest public university in the world, also has a stellar economics department with some real world class talent (David Card, George Akerlof  and Christina Romer before she departed for D.C.), so it’s pretty cool that they’re getting some attention.

Econoblogging superstar Brad Delong, of course, is another sweet Cal economist.

I feel like, aside Eric Cantor’s dreams of being Newt Gingrich and a standing policy-preference for more corporate and capital gains tax cuts, there are a few conceptual problems that the entirety of the Republican leadership, and much of the conservative commentariat, have about our current economic crisis.

1. Unemployment is, aside from other economic problems (low growth, the financial crisis), is really bad for the welfare of people. This central fact can be elided by models of recessions which assume an average level of income and take a 100% welfare loss to one person being the same as a 1% loss to 100 people (Matt Rognlie has a better, more technical explanation here) and by the fact that, even if the income and modelable effects of unemployment aren’t huge, the happiness effects are very strong. Now, because unemployment is such a big deal politically and too individuals, we can expect the Republicans to get immediate political comeuppance if they can be effectively portrayed as anti-stimulus, and therefore anti-job.But, on the other hand, if unemployment remains too high, then expect Democrats to get pummeled in 2010 and 2012.

2. We really do need stimulus. Republicans and conservatives have had a variety of strategies to avoid confronting this essential fact. One is to adopt the absurd argument, most prominently promulugated by Eugen Fama of U Chicago, that because of the NIPA savings-investment accounting identity (basically, that private sector investment is equal to private savings, corporate savings and the likely-to-be-negative government deficit) means that stimulus can’t work to increase growth or decrease unemployment, in the long term.

The other bad, and equally silly, argument is the one spread by Michael Steele that the government can’t create jobs. This ignores the fact that actually the government creates plenty of real jobs but also that just getting people to work and getting money in their pockets may not be ideal, but as far as closing the output gap, stimuluating spending and increases general welfare, it’s a fine strategy.

There’s also the lack of recognition of the fact that monetary policy has failed and that, unless we want to just wallow in low growth and unemployment, we need to think of some way to close the output gap and stoke consumption. Becuase of this total ignorance about the need for fiscal policy to stimuluate the economy, we generally haven’t heard the good, constructive conservative stimulus proposals like this one sketched out by Greg Mankiw or this one by Bruce Bartlett. And because Republicans have become such No-Nothings, they weren’t able to constructively criticize the Obama stimulus plan. As Noam Scheiber argued, this should have been an engineering debate, not a poltical one. So, the GOP could have agitated to put in more payroll tax cuts or to reinstate the Investment Tax Credit or criticized genuinely non-stimulative spending. Instead, they made their baseline position an opposition to stimulus spending at all and 36/41 on the senate voted for the insane Jim Demint tax cut proposal. And where the centrists did go after the bill, they took out of the most stimulative parts.

But the main things one and two the Republicans understand all lead up to the big number three.

3. This recession really is different from past one. Not only are the drops in employment, growth and projected length exceed both the post WWII average, but they are probably only matched by the Great Depression, but there is no mechanism for us to naturally climb out the hole. As opposed to other recessions, where we eventually climbed out “naturally” (more or less), this recession, because it’s driven by a total crisis/freeze in the financial sector, could last indefinitely. Just look at Japan, which after 20 years of unimpressive growth, has had a one quarter GDP drop of 3.3 percent, with more bad times likely to come. As Matt Yglesias points out, Japan still hasn’t really fixed the problems that lead to the lost decade, and was able to climb out of the hole due to American-lead consumption of their exports.

But an export-lead recovery obviously isn’t an option if the entire world economy is tanking. So, we can’t just sit on our hands and pray for a reversion for the mean. In a depression, or a really large recession, or a finance-driven deep recession or whatever you want to call it, you can either wait a really, really long time and have the entire world face declining living standards for that entire time or you can try to take aggressive, quick action to get things back into shape. Now, obviously, there is no guarantee that whatever government action, be it stimulus or some sort of shock-fix to the financial sector. As far as I can tell, congressional Republicans and some commentators simply don’t understand the gravity of the crisis, or in Rush Limbaugh’s case, hope that Democrats fail anyway.

Free Exchange has an interesting post on the boom in finance salaries, discussing a recent Times article about research showing that “finance salaries display bubble characteristics that inflate when new innovation comes along. The bubble occurs when innovation is financed by debt or equity rather than existing capital. That creates demand for financial services, inflating paychecks and attracting skilled labour. The presence of skilled labour begets financial innovation, further inflating the bubble.” This makes sense a whole lot of sense. So, what’s our response to his bubble of a bubble behavior that results in massive inequality and eventually screws us all? Well, the research Norris, the author of the Times article, cites says that finance innovators will, in response to low salaries, go into government where they will become regulators.

This seems like a salutary development. The authors of the study, Thomas Philippon and Ariel Reshef, say that in the two times where sky-high pay in the financial sector immediately preceded a financial collapse, “regulators did not have the human capital to keep up with the financial industry, and to understand it well enough to be able to exert effective regulation. Given the wage premia that we document, it was impossible for regulators to attract and retain highly skilled financial workers.” So, now, better people will go into the regulatory profession and all will be well. The only problem is that more regulation (which is certainly needed) isn’t necessarily smart regualation. The problem Philippon and Reshef document is wasteful or superfluous financial innovation that, due to being debt financed, can expand to the point where it takes down the entire economy. So, if we get a bunch of new regulations that just result in similar chicanery and regulatory arbitrage, we won’t have gotten anywhere. Instead, Free Exchange argues, we need “smart” regulation. This is a rather banal answer, of course we need smart regulation that doesn’t result in wasteful regulatory arbitrage!

But how likely are we to get the regulatory balance just right? It seems like we shouldn’t put all our faith in financial regulation and instead adopt simpler policies to prevent these bubbles. So, along with higher capital requirements and trying to push back against bank consolidation (so we don’t get so many too-big-to-fail situations), I feel like increased marginal tax rates on the super-rich, along with more brackets for those at the pinnacle of the income distribution will do a lot to discourage this high-reward, socially non-optimal financial behavior without trying to outsmart the finance industry. 

And for all you who are thinking “Zeitlin, why are you writing about finance at 8 on Valentine’s Day?” let me say that I’ve already been out to dinner with a friend and I’m going to a play soon, so stop your crowing!

It’s pretty weird that the Democratic congress, and more specifically the Senate, is moving sharply to Obama’s left and put in provisions greatly restricting executive bay in their version of the stimulus bill. This is weird because it shows how misplaced, or if not misplaced, how oddly aligned the leftism is in the Congress. So, the Senate Democrats could have pushed for a bill without an AMT patch and with more money shifted towards infrastructure and transit spending, which would have moved their position to the left without being openly antagonistic towards the president. Instead, they inserted these pay provisions.

But let’s talk about the pay provisons. The Times says that they would “would prohibit cash bonuses and almost all other incentive compensation for the five most senior officers and the 20 highest-paid executives at large companies that receive money under the Treasury’s Troubled Asset Relief Program, or TARP.” Clearly, there are going to be two reactions from Wall Street. One is ceaseless complaining about the provisions. And so we see in the Post story on the provisions, the financial services industry’s cheap lobbyist crowing about how these provisions “undermine the current incentive structure.” The more sophisticated response would be to simply rearrange compensation for executive around the new restrictions. For example, the awards of restricted stock or other bonuses, under the Dodd Amendment, are limited to “one-third of their [executives] annual pay.” The other way around the restrictions is to give back the TARP money (or never receive it) and get a different job.

And so we have the dilemma, both in the short term and the long term. Clearly, we don’t want executives at banks which only exists due to incredibly generous taxpayer support to be taking huge bonuses and pulling down large salaries. But more important than just restricting salaries in general is to try to reform the institutional set-up of financial institutions that encourages relatively little money paid in salary and instead has  most compensation be paid in large, performance based bonuses.

The problem, and this has been known for a while, is that big bonuses encourage excessive risk taking. And while one would hope that some people who overleveraged on bad bets would get out of the game or not get bonuses, thus encouraging people to be more conservative, the facts of the last 6 or so years of the housing bubble clearly refute that. The problem is that, for reasons of human psychology and due to the general nature of finance, bubbles form and so it basically always makes sense to get a bunch of people to give you money, leverage it, and make bets on assets whose price you think are going to go up indefinitely.

And once so much of your pay is tied to performance, you realize that the ones taking the bigger, more leveraged and riskier bets are getting even bigger bonuses. In fact, the guy working at the next office may not have any skepticism about whatever bubble you’re both investing in and is thus making better returns than you are. You may even be at risk for losing your job, so you start making similar big bets. Expand this dynamic out to an entire industry with trillions of dollars are their disposal, and you get our current crisis.

Now, I don’t know how to reform the bonus-incentive structure in the long term. After the government no longer has the excuse of only restricting those receiving government money, real, harsh pay restrictions will be impossible to pass.

And while one consequence of any restriction on income is that it discourages income seeking behavior, I can’t help but suspect that somehow discouraging the best and the brightest from going into finance wouldn’t be a good thing. Do we really need such a large finance sector, if it has shown itself to be incompetent at the one thing of social value it provides: the spreading around of risk?

Of course, there’s a backdoor way of changing the incentives for people going into finance. Just raise marginal income rates on rich people, or better yet, create more brackets at the tippity top of the income scale. It is by no means guaranteed that, once (and if) the crisis is over, we will have the same income distribution that we had before. But it’s worth remembering that much of the growth in inequality, and specifically the assent of the hyper rich (the .1,.01,.001 percentiles) was attributed to people making a lot of money in the financial sector. So, if we had made it so that those risk-fed, bubble-based bonuses based on work that had little social value were highly taxed, maybe we would have gotten the double social benefit of more generously funding government programs that people use while discouraging this bad risk taking.

Gary Becker and Kevin Murphy, two conservative economists at U Chicago have one of the better sensible, economically grounded attacks on the stimulus plan in the Wall Street Journal. They make a bunch of points, but their main one is that due to the nature of the specific spending, which they contend is likely to be permanent (with the obvious exception of the state funding stopgap, this seems pretty true) the expected multiplier will be lower over time. The other long term concern is that, eventually, taxes will have to go up to pay for the permanent new spending, which will have negative effects on growth, and, in their estimation, should be counted against any immediate, stimulus related GDP gains:

The increased federal debt caused by this stimulus package has to be paid for eventually by higher taxes on households and businesses. Higher income and business taxes generally discourage effort and investments, and result in a larger social burden than the actual level of the tax revenue needed to finance the greater debt. The burden from higher taxes down the road has to be deducted both from any short-term stimulus provided by the spending program, and from its long-run effects on the economy.

We believe that it is incumbent on both supporters and opponents of the bill to thoughtfully evaluate each of these four factors. We recognize that how individuals will come out in their own evaluation of these factors will determine their attitude toward the stimulus package, and that there is considerable ground for reasonable differences of opinion.

Our own view is that the short-term stimulus from the legislation before Congress will be smaller per dollar spent than is expected by many others because the package tries to combine short-term stimulus with long-term benefits to the economy. Unfortunately, short-term and long-term gains are in considerable conflict with each other. Moreover, it is very hard to spend wisely large sums in short periods of time. Nor can one ever forget that spending is not free, and ultimately it has to be financed by higher taxes.

Look, these are reasonable concerns, and while I’d argue with them over their specific estimation of the value of the spending programs and the likely multiplier, they’re at least making sense. But the one thing that counts against their analysis is a big underestimation of just how big the crisis we’re in is. I’m sure you’ve all seen the super scary unemployment graphs and, just anecdotally, we’ve generally underestimated just how bad it’s been and with all the uncertainty in the financial markets, things could certainly get worse. I guess what I’m trying to say is that Becker and Murphy don’t seem to be grappling with the weird paradoxes of what Krugman calls Depression Economics.

As Krugman puts it (and let me note that he came to all these conclusions when he was just an universally respected mainstream economist), depression economics are weird, and overwhelming, radical and quick action is what called for. The possibility of ending up with a lost decade of high unemployment and low growth is just too devastating and so policy makers should do just about everything to avoid it.

So, sure, we should keep in mind that our stimulus spending should be as well targeted as possible and that we’re gonna have to pay it all back eventually, but this kind of dithering has the serious possibility of preventing the type of massive actions required to prop up consumption, demand and employment.