California still does not have a budget. The Republicans have taken a vow not to raise taxes. To pass a budget will require a few Republican votes, but whoever wavers will be severely punished by the Republicans. The Republicans are holding out to get existing rules trashed, put on permanent spending caps, and cut spending. Governor Arnold has a "compromise," which is bad, but the Republicans strongly reject it, holding out for a complete capitulation. Arnold also proposes to put almost all state workers on minimum wage. This brilliant idea is put on hold by a court challenge.
Schumpeter is of interest here:
Schumpeter, Joseph A. 1954. "The Economic Crisis of the Tax State." International Economic Papers, 4; reprinted in Schumpeter, Joseph A. 1991. The Economics and Sociology of Capitalism, ed. Richard Swedberg (Princeton: Princeton University Press): pp. 99-140.
101: "The spirit of a people, its cultural level, its social structure, the deeds its policy may prepare -- all this and more is written in its fiscal history. ... The public finances are one of the best starting points for an investigation of society."
Sunday, August 31, 2008
Theological Question
Didn't Pat Robertson explain that Hurricane was God's punishment for abortion and/or homosexuality? Would Gustav similarly be a reprimand for the sins of the Republicans?
Saturday, August 30, 2008
Stock Buybacks Again
I have written a couple times about the irrationality of stock buybacks from the standpoint of corporations using their money to manipulate stocks in expectation of higher bonuses. Today's Wall Street Journal offers another take on the subject. Besides providing a sense of the magnitude of stock buybacks, the article concentrates on the personal irrationality of corporate management, rather than the systemic irrationality of the capitalist system. In particular, the article suggests that corporations often squander money by purchasing stocks that turn out to be overpriced.
The article also offers examples of corporations purchasing unrelated corporations to make a quick buck, rather than developing their own productive capacities. My favorite example here was Exxon's entry into the typewriter business, suggesting that the management may be so inept that stock buybacks might not be so bad.
Zweig, Jason. 2008. "With Buybacks, Look Before You Leap: Repurchases Routinely Give Shares a Lift, But the Effect Could Be Ephemeral." Wall Street Journal (30 August): p. B 1
http://online.wsj.com/article/SB122005273251785043.html?mod=todays_us_money_and_investing
"Stocks regularly jump up 3% to 6% on the announcement of a buyback."
"Benjamin Graham pointed out a paradox: The better a company's executives are at managing its businesses, the worse they are likely to be at managing its cash."
"Three decades ago, with oil skyrocketing and profits gushing in, energy companies squandered billions of dollars on one bone-headed diversification after another. Mobil bought Montgomery Ward, the dying retailer. Arco acquired Anaconda Copper just before metal prices collapsed. Exxon even got the bright idea of manufacturing typewriters."
"So far in 2008, ConocoPhillips has spent $5 billion buying back stock; Chevron, $3.6 billion. From the end of 2004 through this June 30, says analyst Howard Silverblatt of Standard & Poor's, Exxon Mobil has soaked up an astounding $102.2 billion worth of its own shares."
"All told, the companies in the Standard & Poor's 500-stock index have bought back shares valued at more than a half-trillion dollars' worth of their shares in the past year."
"Every three months, Duke University economist John Graham surveys hundreds of chief financial officers. During the week of March 13, 2000, the absolute peak of the market bubble, 82% of finance chiefs said their shares were cheap, with only 3.4% saying their stock was "overvalued." More recently, buybacks hit their all-time quarterly high of $171.9 billion in September 2007, just before the Dow crested at 14000."
"Mistimed buybacks can be deadly. In 2006 and 2007, Washington Mutual spent $6.5 billion on buybacks. In January 2007, with the stock at 43.73 per share, chief executive Kerry Killinger called the repurchase program "a superior use of capital." Also in 2006 and 2007, Wachovia sank $5.7 billion into buybacks at an average price of more than 54. Citigroup spent $8.3 billion to repurchase stock in 2006 and 2007 at share prices of about 50. In April 2008, all three banks were so capital-starved that they had to raise cash by selling shares for a fraction of what they had recently paid for them -- WaMu at 8.75, Wachovia at 24, Citi at 25.27 a share."
The article also offers examples of corporations purchasing unrelated corporations to make a quick buck, rather than developing their own productive capacities. My favorite example here was Exxon's entry into the typewriter business, suggesting that the management may be so inept that stock buybacks might not be so bad.
Zweig, Jason. 2008. "With Buybacks, Look Before You Leap: Repurchases Routinely Give Shares a Lift, But the Effect Could Be Ephemeral." Wall Street Journal (30 August): p. B 1
http://online.wsj.com/article/SB122005273251785043.html?mod=todays_us_money_and_investing
"Stocks regularly jump up 3% to 6% on the announcement of a buyback."
"Benjamin Graham pointed out a paradox: The better a company's executives are at managing its businesses, the worse they are likely to be at managing its cash."
"Three decades ago, with oil skyrocketing and profits gushing in, energy companies squandered billions of dollars on one bone-headed diversification after another. Mobil bought Montgomery Ward, the dying retailer. Arco acquired Anaconda Copper just before metal prices collapsed. Exxon even got the bright idea of manufacturing typewriters."
"So far in 2008, ConocoPhillips has spent $5 billion buying back stock; Chevron, $3.6 billion. From the end of 2004 through this June 30, says analyst Howard Silverblatt of Standard & Poor's, Exxon Mobil has soaked up an astounding $102.2 billion worth of its own shares."
"All told, the companies in the Standard & Poor's 500-stock index have bought back shares valued at more than a half-trillion dollars' worth of their shares in the past year."
"Every three months, Duke University economist John Graham surveys hundreds of chief financial officers. During the week of March 13, 2000, the absolute peak of the market bubble, 82% of finance chiefs said their shares were cheap, with only 3.4% saying their stock was "overvalued." More recently, buybacks hit their all-time quarterly high of $171.9 billion in September 2007, just before the Dow crested at 14000."
"Mistimed buybacks can be deadly. In 2006 and 2007, Washington Mutual spent $6.5 billion on buybacks. In January 2007, with the stock at 43.73 per share, chief executive Kerry Killinger called the repurchase program "a superior use of capital." Also in 2006 and 2007, Wachovia sank $5.7 billion into buybacks at an average price of more than 54. Citigroup spent $8.3 billion to repurchase stock in 2006 and 2007 at share prices of about 50. In April 2008, all three banks were so capital-starved that they had to raise cash by selling shares for a fraction of what they had recently paid for them -- WaMu at 8.75, Wachovia at 24, Citi at 25.27 a share."
Friday, August 29, 2008
Happy Birthday: You May Have His Axe, But I Have His Ball Peen Hammer
Happy Birthday, Charlie Parker! I borrow the following from Garrison Keillor:
It's the birthday of jazz saxophonist Charlie Parker, born in Kansas City, Kansas (1920). He is considered one of the half-dozen greatest jazz musicians, right up there with Duke Ellington and Louis Armstrong. Early in his career, he received the nickname of "Yardbird," and he became known as "Bird."
Before Parker, jazz meant swing, melodies played at dance tempos by musicians in big orchestras who never got to take solos for very long. Late at night, after their big band jobs were over, Parker, Dizzy Gillespie, and other black musicians kept on playing, improvising long lines at blazing speed. Parker used a lot of flatted fifths, and jazz players used the word "bebop" to sing a flatted fifth, but Parker didn't like to use the word for the way he played. "Let's not call it bebop," he said. "Let's just call it music."
As a teenager, Parker became addicted to morphine while hospitalized after a car accident. He later became addicted to heroin, which contributed to his death at 34. The official cause was listed as pneumonia and a bleeding ulcer. The coroner made a mistake in estimating Parker's age to be between 50 and 60.
Parker said, "I realized by using the high notes of the chords as a melodic line, and by the right harmonic progression, I could play what I heard inside me. That's when I was born."
It's the birthday of jazz saxophonist Charlie Parker, born in Kansas City, Kansas (1920). He is considered one of the half-dozen greatest jazz musicians, right up there with Duke Ellington and Louis Armstrong. Early in his career, he received the nickname of "Yardbird," and he became known as "Bird."
Before Parker, jazz meant swing, melodies played at dance tempos by musicians in big orchestras who never got to take solos for very long. Late at night, after their big band jobs were over, Parker, Dizzy Gillespie, and other black musicians kept on playing, improvising long lines at blazing speed. Parker used a lot of flatted fifths, and jazz players used the word "bebop" to sing a flatted fifth, but Parker didn't like to use the word for the way he played. "Let's not call it bebop," he said. "Let's just call it music."
As a teenager, Parker became addicted to morphine while hospitalized after a car accident. He later became addicted to heroin, which contributed to his death at 34. The official cause was listed as pneumonia and a bleeding ulcer. The coroner made a mistake in estimating Parker's age to be between 50 and 60.
Parker said, "I realized by using the high notes of the chords as a melodic line, and by the right harmonic progression, I could play what I heard inside me. That's when I was born."
The EU: A Slow Learner
The EU is preparing make even more costly mistakes in its carbon emissions reduction program. Reuters reports that draft legislation will increase offsets to fully a fourth of (paper) reductions. If past experience is a guide, this means that the true cap has just been lifted again, and that billions more euros will be made in profits at the ultimate expense of consumers. (The difference between the increase in revenues companies get by charging more for carbon-intensive products and the cost of manufacturing an offset is the source of rents divvied up by buyers, sellers and financial packagers of offsets.) Will the US legislation we enact next year be equally corrupt and ineffectual?
Auto Da Fé
Who will get burned by the conjuncture of rising fuel prices and household debt deflation? The Frankfurter Allgemeine Zeitung reports that some corporate paper issued by GM is now trading at 50% of face.
The Beauty of Markets and Markets of Beauty
In looking through William Stanley Jevons' Principles of Economics, mostly a collection of unpublished fragments, Jevons concluded a section on negative value with a fascinating story from Herodotus on auctions in the Babylonian marriage market. The story speaks for itself and requires no commentary on my part.
137: "According to Herodotus the Babylonians managed to find husbands for all their young women. They collected together whatever maidens might be of marriageable years and sold them by auction, beginning with those esteemed the most beautiful. They gradually proceeded downwards in the scale of comeliness until some damsel equidistant between beauty and plainness had to be given away gratis. Then the plain and the ugly and the deformed were brought out by degrees, and the bidding went on; but in the other way, the premiums obtained for beauty being spent as dowries for the less favoured. All the women found husbands, and all the husbands found what they desired."
137: "According to Herodotus the Babylonians managed to find husbands for all their young women. They collected together whatever maidens might be of marriageable years and sold them by auction, beginning with those esteemed the most beautiful. They gradually proceeded downwards in the scale of comeliness until some damsel equidistant between beauty and plainness had to be given away gratis. Then the plain and the ugly and the deformed were brought out by degrees, and the bidding went on; but in the other way, the premiums obtained for beauty being spent as dowries for the less favoured. All the women found husbands, and all the husbands found what they desired."
Thursday, August 28, 2008
They're called the 'Unholy Trinity' – the IMF, the World Bank and the WTO. Part One.
Introduction.
The IMF and the World Bank were originally established in 1944 at the Bretton Woods conference between allied forces (essentially the US and Britain). It was a response to a wide range of international economic problems in relation to global trade that were experienced at the time and in the preceding decades. The most notable examples of such difficulties were exchange rate instability, ‘hot’ money flowing in and out of nations unpredictably, and the lack of a mechanism to adjust the balance of payments problems of countries, post-World War II debt and the need for the reconstruction and development of economies across the globe.
The IMF was designed to put in place a stable exchange rates regime with some scope for revaluation and convertibility of currencies when required. Short-term liquidity crises were to be managed by lending money to nations that experienced a temporary balance of payments crisis or by providing some form of orderly devaluation of the affected nation’s currency in times of more persistent BOP problems. It was hoped that these two latter processes would allow nations to reduce their deficits without resorting to protectionism or by experiencing deflation.
The International Bank for Reconstruction and Development (the World Bank) had the purpose of financing projects and infrastructure development in the war-torn European nations as well as to assist the industrialisation of post-colonial societies.
Under Bretton Woods the US dollar became the global reserve currency. This meant, amongst other things, that while every other national currency could devalue against the dollar, the US dollar could be devalued only against gold.
John Maynard Keynes and other negotiators at Bretton Woods had originally advocated a global reserve currency that was not, in fact, to be linked to any particular national currency. But the US held the hegemonic power at the time of these negotiations and its leaders designed the system to serve their priorities [1]. They wanted an up-dated gold standard to facilitate the liberalization of global trade and they wanted financial power concentrated in Washington and New York. US ‘negotiators’ won the day and lost the cause by doing so.
Because of the economic asymmetry between he United States and the rest of the world it soon began to experience a persistent balance of payments deficit. This situation arose under Bretton Woods because without the persistent US capital outflows the world experienced (for a number of reasons) a liquidity shortage. “In the early postwar years, the capital outflow consisted largely of foreign aid. By the end of the 1950s, private long-term investment abroad (mainly direct investment) exceeded military expenditures abroad and other official transfers (Eichengreen 199 1).” [2]
That Bretton Woods system crumbled after 1968 and ended with the closing by President Richard Nixon of the gold window on 15 August 1971. Prior to that at least one US presidential administration had used the nation’s economic hegemony to intervene and disrupt the operations of the Bretton Woods institutions. [3]
By the early 1970s the free market had become largely a historical relic in any case. “It [had] been transformed by three systemic forces over the [previous] 40 years: accelerating concentration of industry and banking, increasing intervention of government into the “private sector”, and…the spectacular rise of the intracorporate (nonmarket) economy of the global oligopolies.”[4]
For more on the background and history of the Bretton Woods system see: The Bretton International Monetary System: A Historical Overview, by Michael D. Bordo.
END OF PART ONE
[1] Keynes’ Achilles’ heel was his lack of political sense, according to his biographer Robert Skidelsky. “He never studied the sources of power nor how society is affected by social stratification or the forces of social control.’. Page 494 ‘John Maynard Keynes, Fighting for Freedom, 1937 – 1946’ by Robert Skidelsky.
[2] The Bretton International Monetary System: A Historical Overview, by Michael D. Bordo, professor of economics at Rutgers University.
www.nber.org/chapters/c6867.pdf
[3] Documents show that the Nixon administration engaged in an invisible economic blockade against the Allende government in Chile, intervening at the World Bank, IDB, and Export-Import bank to curtail or terminate credits and loans to Chile before Allende had been in office for a month. See: Department of State, Memorandum for Henry Kissinger on Chile, December 4, 1970:
http://www.gwu.edu/~nsarchiv/NSAEBB/NSAEBB8/ch20-01.htm
[4] ‘Global Reach – The Power of the Multinational Corporations’ by Richard J Barnet & Ronald E Muller. Simon and Schuster1974. SBN 671-22104-3 Paperback.
The IMF and the World Bank were originally established in 1944 at the Bretton Woods conference between allied forces (essentially the US and Britain). It was a response to a wide range of international economic problems in relation to global trade that were experienced at the time and in the preceding decades. The most notable examples of such difficulties were exchange rate instability, ‘hot’ money flowing in and out of nations unpredictably, and the lack of a mechanism to adjust the balance of payments problems of countries, post-World War II debt and the need for the reconstruction and development of economies across the globe.
The IMF was designed to put in place a stable exchange rates regime with some scope for revaluation and convertibility of currencies when required. Short-term liquidity crises were to be managed by lending money to nations that experienced a temporary balance of payments crisis or by providing some form of orderly devaluation of the affected nation’s currency in times of more persistent BOP problems. It was hoped that these two latter processes would allow nations to reduce their deficits without resorting to protectionism or by experiencing deflation.
The International Bank for Reconstruction and Development (the World Bank) had the purpose of financing projects and infrastructure development in the war-torn European nations as well as to assist the industrialisation of post-colonial societies.
Under Bretton Woods the US dollar became the global reserve currency. This meant, amongst other things, that while every other national currency could devalue against the dollar, the US dollar could be devalued only against gold.
John Maynard Keynes and other negotiators at Bretton Woods had originally advocated a global reserve currency that was not, in fact, to be linked to any particular national currency. But the US held the hegemonic power at the time of these negotiations and its leaders designed the system to serve their priorities [1]. They wanted an up-dated gold standard to facilitate the liberalization of global trade and they wanted financial power concentrated in Washington and New York. US ‘negotiators’ won the day and lost the cause by doing so.
Because of the economic asymmetry between he United States and the rest of the world it soon began to experience a persistent balance of payments deficit. This situation arose under Bretton Woods because without the persistent US capital outflows the world experienced (for a number of reasons) a liquidity shortage. “In the early postwar years, the capital outflow consisted largely of foreign aid. By the end of the 1950s, private long-term investment abroad (mainly direct investment) exceeded military expenditures abroad and other official transfers (Eichengreen 199 1).” [2]
That Bretton Woods system crumbled after 1968 and ended with the closing by President Richard Nixon of the gold window on 15 August 1971. Prior to that at least one US presidential administration had used the nation’s economic hegemony to intervene and disrupt the operations of the Bretton Woods institutions. [3]
By the early 1970s the free market had become largely a historical relic in any case. “It [had] been transformed by three systemic forces over the [previous] 40 years: accelerating concentration of industry and banking, increasing intervention of government into the “private sector”, and…the spectacular rise of the intracorporate (nonmarket) economy of the global oligopolies.”[4]
For more on the background and history of the Bretton Woods system see: The Bretton International Monetary System: A Historical Overview, by Michael D. Bordo.
END OF PART ONE
[1] Keynes’ Achilles’ heel was his lack of political sense, according to his biographer Robert Skidelsky. “He never studied the sources of power nor how society is affected by social stratification or the forces of social control.’. Page 494 ‘John Maynard Keynes, Fighting for Freedom, 1937 – 1946’ by Robert Skidelsky.
[2] The Bretton International Monetary System: A Historical Overview, by Michael D. Bordo, professor of economics at Rutgers University.
www.nber.org/chapters/c6867.pdf
[3] Documents show that the Nixon administration engaged in an invisible economic blockade against the Allende government in Chile, intervening at the World Bank, IDB, and Export-Import bank to curtail or terminate credits and loans to Chile before Allende had been in office for a month. See: Department of State, Memorandum for Henry Kissinger on Chile, December 4, 1970:
http://www.gwu.edu/~nsarchiv/NSAEBB/NSAEBB8/ch20-01.htm
[4] ‘Global Reach – The Power of the Multinational Corporations’ by Richard J Barnet & Ronald E Muller. Simon and Schuster1974. SBN 671-22104-3 Paperback.
Wednesday, August 27, 2008
Rubonomics for the People
Like many of you, I was a bit dismayed when Obama turned to Robert Rubin and his coterie for economic advice. I now admit that I was mistaken. According to Tuesday's Wall Street Journal, Citicorp has been paying Robert Rubin $17 million a year for a part-time job with no responsibility. Judging by the company's performance, the expectations placed on him might not be particularly high.
My full-time teaching job leaves me little spare time, but I think I could put aside a few hours each week in return for $17 million. I would be willing to take a pay cut in return for cutting back a few extra hours.
If you're like me, and think that you would want an opportunity like that, I would hope that Pres. Obama would enact policies that would give everybody an opportunity like Robert Rubin. With this in mind, I will put myself an unofficial adviser to the Obama campaign, suggesting the slogan: Rubinomics for the People.
Go Barak!
My full-time teaching job leaves me little spare time, but I think I could put aside a few hours each week in return for $17 million. I would be willing to take a pay cut in return for cutting back a few extra hours.
If you're like me, and think that you would want an opportunity like that, I would hope that Pres. Obama would enact policies that would give everybody an opportunity like Robert Rubin. With this in mind, I will put myself an unofficial adviser to the Obama campaign, suggesting the slogan: Rubinomics for the People.
Go Barak!
Tuesday, August 26, 2008
The Father of Rent Seeking Retires
I have just learned that the "father of rent seeking," 86-year-old Gordon Tullock, professor of economics and law at George Mason, suddenly decided a couple of weeks ago to retire, and has done so, moving to Arizona to live with his sister. Many readers and contributors to this blog probably do not think much of Tullock, given his quite strongly pro-free market orientation. However, he has been one of the more interesting characters in economics in recent years, who has arguably not received his proper due. In particular, James Buchanan received the Nobel Prize about 20 years ago for discovering/inventing public choice theory, with his 1960 book, _The Calculus of Consent_, being the source for this that was cited. There was a minor problem: Gordon Tullock was coauthor of that book and did not share the prize, although he was the founder and longtime editor of the journal Public Choice. (Rumor has it that the Nobel Committee had Richard Musgrave in mind to share it with Buchanan, but never gave it to him, and he is now dead, with Tullock somehow not even on their radar screen. Probably all three should have shared it, although many here probably think that neither Buchanan nor Tullock deserve(d) it).
Tullock may still get the prize, and has been high on some betting pools in recent years. He would get it for his discovery/invention of the concept of "rent seeking," although Anne Krueger invented the term some years later. Concern with corruption might lead to an award for this idea, that interest groups get governments to create artificial monopolies that create scarcity rents that can often get taken by those interest groups, often through bribery or corruption. Tullock's original paper on the matter was "The welfare costs of tariffs, monopolies, and theft," Western Economic Journal (now Economic Inquiry), 1967, 5: 224-232. I also note that some think he will not get the prize because he is very curmudgeonly, long showing his respect for somebody by insulting them. If he did not think much of someone, he simply ignores them.
Tullock may still get the prize, and has been high on some betting pools in recent years. He would get it for his discovery/invention of the concept of "rent seeking," although Anne Krueger invented the term some years later. Concern with corruption might lead to an award for this idea, that interest groups get governments to create artificial monopolies that create scarcity rents that can often get taken by those interest groups, often through bribery or corruption. Tullock's original paper on the matter was "The welfare costs of tariffs, monopolies, and theft," Western Economic Journal (now Economic Inquiry), 1967, 5: 224-232. I also note that some think he will not get the prize because he is very curmudgeonly, long showing his respect for somebody by insulting them. If he did not think much of someone, he simply ignores them.
The Mirage of Economic Efficiency
Almost 70 years ago, George Stigler introduced the concept of flexibility. A business might be highly efficient, but it may not have the flexibility to meet changing conditions. Stigler's point is largely ignored. I would prefer that other parts of his work were ignored, but I do not have much say in such matters.
Stigler, George. 1939. "Production and Distribution in the Short Run." Journal of Political Economy, 47 (June): pp. 304-27.
Stigler' point is fairly simple. Nuclear power plants are often used to explain what he meant. Assume, for the sake of argument only, that a nuclear power plant can produce electricity much cheaper than other forms of generation (by the way, I do not believe this assumption is correct). The problem is that demand shifts. The capacity to produce for peak demand might not be needed 90% of the time, making it an economical.
A coal fueled plant might be far less efficient, but it can be brought online relatively quickly when it is needed. Even though the engineering efficiency of the coal-fired plant might be low, it might be appropriate for handling peak loads.
Uncertainty makes Stigler's theory even more compelling. A biological example from my book, The Perverse Economy, might be appropriate.
"Biologists of all stripes acknowledge an amazing ability of various plants and animals to adapt to specialized niches. For example, scientists have recently discovered a new species, wholly unrelated to any previously known species, which survives on the lips of one particular type of lobster (Morris 1995). Although this form of evolution is remarkable, it also leaves the creatures vulnerable to even a slight change in the environment. The same specialization that made these creatures so dependent on the success of a relatively small group of lobsters makes them less adaptable to relatively small changes in the global environment. For example, this particular group of lobsters may decline or migrate to a less desirable location, threatening the existence of their tiny lip dwellers."
In the Perverse Economy, I used another example, regarding a glue shortage -- not glue in general, but a particular kind of glue. A computer chip is a silicon wafer, which is useless without the capacity to send and receive signals from a circuit board. A plastic package allows the chip to make the connection between the chip and the board. The industry uses specialized epoxy glue for fabricating these packages.
During the 1990s, a single Sumitomo Corporation plant manufactured the majority of the world's supply of the epoxy resin. About 60% of all memory modules depended on the product of this particular factory, when in July 1993 a fire destroyed this factory.
Ordinarily, an event like a fire in a glue factory not be of very much interest except for the people close to the event, but this fire ravaged the chip market. Dealers had been paying about $33 for a megabyte of memory before the fire. By the end of the month, the same memory commanded $95. The industry feared that prices would go even higher.
Bill Clinton's trade policy with Haiti illustrates a similar danger. Clinton forced Haiti open up its agricultural markets. Heavily subsidized US rice destroyed Haiti's capacity to produce rice. In terms of conventional economic theory, some economists might have seen Clinton's policy as efficient, following the laws of conventional economics (subsidies are ignored in this logic, especially the heavy water subsidies given to California rice growers). Relatively unproductive rice farmers would give up that activity to participate in the modernization of Haiti, presumably in some sweatshop.
Unfortunately, when agricultural prices began to soar, Haiti was unable to quickly resuscitate its previous capacity to grow rice. Food riots soon followed.
The recent sawdust shock is relevant here. Here is what the Wall Street Journal reported about sawdust:
"The price of sawdust has soared since 2006, up from about $25 a ton to more than $100 in some markets. Blame the housing slump: Fewer new homes mean fewer trees cut for use in construction, which leads to less sawdust and other wood waste, driving up the price."
"Farms use sawdust and wood shavings as cozy and clean bedding for horses and chickens. Particle-board makers devour it by the boxcar to fashion a cheap building material. Auto-parts manufacturers blend a finely pulverized sawdust called "wood flour" with plastic polymers to make a lightweight material to cover steering wheels and dashboards."
"Wineries use oak sawdust as a flavoring agent for some wines. Perdue Farms, which raises broiler chickens, goes through seven million cubic feet of wood shavings a year. Oil-rig operators in Wyoming and Colorado pour sawdust into the caverns they find deep inside rock formations as they hunt for pools of petroleum. Sawdust gives drill bits something to grind through."
"The housing slump has devastated sawmill production across the country."
Millman, Joel. 2008. "Sawdust Shock: A Shortage Looms As Economy Slows." Wall Street Journal (3 March): p. A 1.http://online.wsj.com/article/SB120451039119406735.html
Stigler, George. 1939. "Production and Distribution in the Short Run." Journal of Political Economy, 47 (June): pp. 304-27.
Stigler' point is fairly simple. Nuclear power plants are often used to explain what he meant. Assume, for the sake of argument only, that a nuclear power plant can produce electricity much cheaper than other forms of generation (by the way, I do not believe this assumption is correct). The problem is that demand shifts. The capacity to produce for peak demand might not be needed 90% of the time, making it an economical.
A coal fueled plant might be far less efficient, but it can be brought online relatively quickly when it is needed. Even though the engineering efficiency of the coal-fired plant might be low, it might be appropriate for handling peak loads.
Uncertainty makes Stigler's theory even more compelling. A biological example from my book, The Perverse Economy, might be appropriate.
"Biologists of all stripes acknowledge an amazing ability of various plants and animals to adapt to specialized niches. For example, scientists have recently discovered a new species, wholly unrelated to any previously known species, which survives on the lips of one particular type of lobster (Morris 1995). Although this form of evolution is remarkable, it also leaves the creatures vulnerable to even a slight change in the environment. The same specialization that made these creatures so dependent on the success of a relatively small group of lobsters makes them less adaptable to relatively small changes in the global environment. For example, this particular group of lobsters may decline or migrate to a less desirable location, threatening the existence of their tiny lip dwellers."
In the Perverse Economy, I used another example, regarding a glue shortage -- not glue in general, but a particular kind of glue. A computer chip is a silicon wafer, which is useless without the capacity to send and receive signals from a circuit board. A plastic package allows the chip to make the connection between the chip and the board. The industry uses specialized epoxy glue for fabricating these packages.
During the 1990s, a single Sumitomo Corporation plant manufactured the majority of the world's supply of the epoxy resin. About 60% of all memory modules depended on the product of this particular factory, when in July 1993 a fire destroyed this factory.
Ordinarily, an event like a fire in a glue factory not be of very much interest except for the people close to the event, but this fire ravaged the chip market. Dealers had been paying about $33 for a megabyte of memory before the fire. By the end of the month, the same memory commanded $95. The industry feared that prices would go even higher.
Bill Clinton's trade policy with Haiti illustrates a similar danger. Clinton forced Haiti open up its agricultural markets. Heavily subsidized US rice destroyed Haiti's capacity to produce rice. In terms of conventional economic theory, some economists might have seen Clinton's policy as efficient, following the laws of conventional economics (subsidies are ignored in this logic, especially the heavy water subsidies given to California rice growers). Relatively unproductive rice farmers would give up that activity to participate in the modernization of Haiti, presumably in some sweatshop.
Unfortunately, when agricultural prices began to soar, Haiti was unable to quickly resuscitate its previous capacity to grow rice. Food riots soon followed.
The recent sawdust shock is relevant here. Here is what the Wall Street Journal reported about sawdust:
"The price of sawdust has soared since 2006, up from about $25 a ton to more than $100 in some markets. Blame the housing slump: Fewer new homes mean fewer trees cut for use in construction, which leads to less sawdust and other wood waste, driving up the price."
"Farms use sawdust and wood shavings as cozy and clean bedding for horses and chickens. Particle-board makers devour it by the boxcar to fashion a cheap building material. Auto-parts manufacturers blend a finely pulverized sawdust called "wood flour" with plastic polymers to make a lightweight material to cover steering wheels and dashboards."
"Wineries use oak sawdust as a flavoring agent for some wines. Perdue Farms, which raises broiler chickens, goes through seven million cubic feet of wood shavings a year. Oil-rig operators in Wyoming and Colorado pour sawdust into the caverns they find deep inside rock formations as they hunt for pools of petroleum. Sawdust gives drill bits something to grind through."
"The housing slump has devastated sawmill production across the country."
Millman, Joel. 2008. "Sawdust Shock: A Shortage Looms As Economy Slows." Wall Street Journal (3 March): p. A 1.http://online.wsj.com/article/SB120451039119406735.html
Monday, August 25, 2008
Henri Cartan, RIP
Henri Cartan, the grand old man of French mathematics, has died at 104. He was the founder and leader of the "Bourbaki" movement in the 1930s, a group that tried to redo mathematics as a totally formalized and axiomatized system, following deep intellectual traditions in France of hyper-rationalism that go back to Descartes, if not all the way to Thomas Aquinas, and which in French socio-economics was associated with the social engineering idealism of Saint-Simon and the dirigiste tradition of French indicative central planning. The group operated, at least initially, anonymously, signing their papers with the name of a dead French general, Nicholas Bourbaki. They hoped to clarify mathematics and remove from it any mysticism or fuzzy thinking.
One of Cartan's most assiduous students in the immediate post-WW II period was the late Gerard Debreu, the more mathematical and austere half of Arrow and Debreu, who famously proved the existence of competitive general equilibrium in 1954, both of them eventually receiving the Nobel Prize in economics. Debreu was probably the most articulate and influential spokesman for axiomatizing economic theory, something now very much out of favor for many reasons. Indeed, as Roy Weintraub has noted in his book, _How Economics Became a Mathematical Science_, the trends of uses of math in economics tend to repeat trends in math itself, with the Bourbakist approach having fallen out of fashion within math itself some time ago. Simulation and many other approaches have picked up, and we see this in economics with agent-based modeling and more emphasis on empirics and induction from that now.
Even though Cartan and his allies dominated French mathematics for decades, two of the most interesting mathematicians to come out of France, Rene Thom, the founder of catastrophe theory, and Benoit Mandelbrot, the inventor/discoverer of fractals, were both very bad at proving theorems and following the Bourbakist approach. Indeed their great success, including with influence on economics, was perhaps a sign of the limits of Bourbakism more generally.
One of Cartan's most assiduous students in the immediate post-WW II period was the late Gerard Debreu, the more mathematical and austere half of Arrow and Debreu, who famously proved the existence of competitive general equilibrium in 1954, both of them eventually receiving the Nobel Prize in economics. Debreu was probably the most articulate and influential spokesman for axiomatizing economic theory, something now very much out of favor for many reasons. Indeed, as Roy Weintraub has noted in his book, _How Economics Became a Mathematical Science_, the trends of uses of math in economics tend to repeat trends in math itself, with the Bourbakist approach having fallen out of fashion within math itself some time ago. Simulation and many other approaches have picked up, and we see this in economics with agent-based modeling and more emphasis on empirics and induction from that now.
Even though Cartan and his allies dominated French mathematics for decades, two of the most interesting mathematicians to come out of France, Rene Thom, the founder of catastrophe theory, and Benoit Mandelbrot, the inventor/discoverer of fractals, were both very bad at proving theorems and following the Bourbakist approach. Indeed their great success, including with influence on economics, was perhaps a sign of the limits of Bourbakism more generally.
How the Gnome of Zurich Got It Wrong
Last week I was at a conference in Zurich, Switzerland, site of the HQs of all those Swiss banks. At Einstein's alma mater, the Swiss Federal University of Technology (ETH) there is a mathematics professor named Paul Embrechts whom I like to think of as being the actual Gnome of Zurich. About a decade ago he succeeded in convincing the leading Swiss banks to use the mathematical entity known as a copula as the basis for measuring risk. They did so, and from them it spread to become the most widely used method in the financial world, displacing the Black-Scholes formula, although one is hard pressed to find a definition of it in any financial economics textbooks. I will say that it is based on a stationary distribution that attempts to take into account more fully covariances among events. It also has the advantage of actually admitting that there are lots more extreme events than does the Gaussian normal that underlies Black-Scholes, which after the 1987 crash most of the practitioners knew was garbage. So, it admits the stylized fact that all asset markets exhibit "fat tails" or kurtosis, those more frequent extreme events.
However, it turns out that the copulas have not proved sufficient to deal with the events of the last year, with most funds and banks and whatnot still getting into trouble. One of the conference participants was an econophysicist colleague of Embrechts, Didier Sornette, who runs an "Observatory of Financial Crises." While he has made some not so accurate public forecasts himself (see my "Econophysics and Economic Complexity," available at http://cob.jmu.edu/rosserjb), Sornette described the problem with the copulas: they do not take into account how herding can happen. So, they can give the right probability that a 10% decline in a market can happen in one day, but will understate the probability that this might happen for three days in a row. This would suggest that Nassim Taleb with his black swans might be right, although anybody trying to follow his "barbell strategy" to make money on really big crashes would probably have lost money over most of the last several years, despite the big crashes that have been going on over the past year.
However, it turns out that the copulas have not proved sufficient to deal with the events of the last year, with most funds and banks and whatnot still getting into trouble. One of the conference participants was an econophysicist colleague of Embrechts, Didier Sornette, who runs an "Observatory of Financial Crises." While he has made some not so accurate public forecasts himself (see my "Econophysics and Economic Complexity," available at http://cob.jmu.edu/rosserjb), Sornette described the problem with the copulas: they do not take into account how herding can happen. So, they can give the right probability that a 10% decline in a market can happen in one day, but will understate the probability that this might happen for three days in a row. This would suggest that Nassim Taleb with his black swans might be right, although anybody trying to follow his "barbell strategy" to make money on really big crashes would probably have lost money over most of the last several years, despite the big crashes that have been going on over the past year.
TWO THINGS
by the Sandwichman
"'Two things,' he said, as we were standing outside the first-class bathroom. 'One, just because I think it really captures where I was going with the whole issue of balancing market sensibilities with moral sentiment. One of my favorite quotes is — you know that famous Robert F. Kennedy quote about the measure of our G.D.P.?'
"I didn’t, I said."
"'Well, I’ll send it to you, because it’s one of the most beautiful of his speeches,' Obama said.
"In it, Kennedy argues that a country’s health can’t be measured simply by its economic output. That output, he said, 'counts special locks for our doors and the jails for those who break them -- but not the health of our children, the quality of their education or the joy of their play.'"
"How did we get to this strange pass, where up is down and down is up? How did it happen that the nation’s economic hero is a terminal-cancer patient going through a costly divorce? How is it that Congress talks about stimulating 'the economy' when much that will actually be stimulated is the destruction of things it says it cares about on other days?
"How did the notion of economy become so totally uneconomic?
"The story begins in Ireland in the 1650s..."
"'Two things,' he said, as we were standing outside the first-class bathroom. 'One, just because I think it really captures where I was going with the whole issue of balancing market sensibilities with moral sentiment. One of my favorite quotes is — you know that famous Robert F. Kennedy quote about the measure of our G.D.P.?'
"I didn’t, I said."
"'Well, I’ll send it to you, because it’s one of the most beautiful of his speeches,' Obama said.
"In it, Kennedy argues that a country’s health can’t be measured simply by its economic output. That output, he said, 'counts special locks for our doors and the jails for those who break them -- but not the health of our children, the quality of their education or the joy of their play.'"
"How did we get to this strange pass, where up is down and down is up? How did it happen that the nation’s economic hero is a terminal-cancer patient going through a costly divorce? How is it that Congress talks about stimulating 'the economy' when much that will actually be stimulated is the destruction of things it says it cares about on other days?
"How did the notion of economy become so totally uneconomic?
"The story begins in Ireland in the 1650s..."
Saturday, August 23, 2008
Clothing for the 21st Century (the folly of mass production)
With the new clothing of the 21st century human labour will out-compete the machine because:
Human life and wellbeing will be safeguarded
** Ample land, water and other critical resources will be available for essential food production;
** People will not be poisoned by industrial processes;
** There'll be less superfluous consumption and production and therefore more leisure time;
** We'll be more satisfied with our products because we will design and make them;
** The monotony and drudgery of mass production will be reduced;
** Local production will result in the decentralisation of power and wealth in society.
** The imperative to condition us with advertising and 'education' will no longer exist.
Do you know who made this extravagant campaign promise?
"We in America today are nearer to the final triumph over poverty than ever before in the history of any land. The poor-house is vanishing from among us. We have not yet reached the goal, but, given a chance to go forward with the policies of the last eight years, we shall soon with the help of God be in sight of the day when poverty will be banished from this nation."
Hoover, Herbert. 1952. The Memoirs of Herbert Hoover: The Cabinet and the Presidency, 1920-1933 (New York: Macmillan): p. 184: while running for the Republican presidential nomination in 1928.
This, of course, compares with George Bush's promise of a humble foreign policy.
"We in America today are nearer to the final triumph over poverty than ever before in the history of any land. The poor-house is vanishing from among us. We have not yet reached the goal, but, given a chance to go forward with the policies of the last eight years, we shall soon with the help of God be in sight of the day when poverty will be banished from this nation."
Hoover, Herbert. 1952. The Memoirs of Herbert Hoover: The Cabinet and the Presidency, 1920-1933 (New York: Macmillan): p. 184: while running for the Republican presidential nomination in 1928.
This, of course, compares with George Bush's promise of a humble foreign policy.
Thursday, August 21, 2008
The Folly of Offshore Oil Drilling
The idea that the oil companies need to get permission to drill offshore is ridiculous. The majors are more intent in using their funds to buy back their stocks to raise the share price to help boost their bonuses. Here are my notes from an interesting study from the James A. Baker III Institute for Public Policy.
Jaffe, Amy Myers and Ronald Soligo. 2007. "The International Oil Companies." Working Paper #20. Study on the Role of National Oil Companies in International Energy Markets. James A. Baker III Institute for Public Policy, Rice University.
http://www.bakerinstitute.org/publications/NOC_IOCs_Jaffe-Soligo.pdf
The idea that the oil companies need to get permission to drill offshore is ridiculous. The majors are more intent in using their funds to buy back their stocks to raise the share price to help boost their bonuses. Here are my notes from an interesting study from the James A. Baker III Institute for Public Policy.
Jaffe, Amy Myers and Ronald Soligo. 2007. "The International Oil Companies." Working Paper #20. Study on the Role of National Oil Companies in International Energy Markets. James A. Baker III Institute for Public Policy, Rice University.
http://www.bakerinstitute.org/publications/NOC_IOCs_Jaffe-Soligo.pdf
This study looks at the outlays of the big five or companies, BP, Chevron, Conoco Phillips, Exxon Mobil, and Royal Dutch Shell, which had $120.8 billion in profits in 2006 with 9.7 million barrels a day of oil production. The next 20 largest firms had 31.2 billion in profits with 2.1 million barrels per day of production. In terms of operating cash flow, the big five registered $155 billion in 2006, compared to only 50 billion for the next 20 largest American oil firms.
"Cash flow is a better measure of the discretionary resources available to firms than profits. For the Big Five IOCs, operating cash flow, shown in Figure 2, was slightly more than two and a half times higher in 2006 than the average levels prevailing in the 1996-99 period, rising from roughly $60 billion in the late 1990s to $154.9 billion in 2005."
"But while prices, profits, and cash flow have risen dramatically, investment in exploration has not -- especially by the largest IOCs."
They look at outlays of the Big Five firms among the following categories: share buybacks, reserve acquisitions from other firms, exploration expenditures, development outlays, and dividend payments.
"Development expenditures reflect investments in fields that have already been discovered and are the easiest (most cost-effective) way to boost output in the short run. Nonetheless, it is investment in the exploration of new fields that will assure the long-term viability of these firms."
"Share buybacks (equity repurchases) have absorbed a growing share of these outlays, rising from only 1% in 1993 to 37.1% in 2006, while expenditures on exploration account for a decreasing proportion, declining from 13.8% in 1993 to only 5.8% in 2006. It is interesting to note that, despite an almost 50% increase in exploration expenditures from 2005 to 2006, these expenditures as a share of the total increased from 5.3% to only 5.8%."
"The data for the "next 20" firms reveals a pattern of expenditures that is quite different from that of the Big Five. Outlays for exploration have increased significantly in absolute terms, although not as a share of total outlays. Dividends account for a much smaller proportion of outlays while acquiring reserves from other firms is larger. Development expenditures have increased more than three-fold since 1999. However, as a percentage of these outlays, development expenditure has increased from 33.5 % to 47.3%."
"smaller firms are more aggressive in spending for reserves additions than the Big Five-through growing exploration outlays and through acquisitions from other firms."
"The gap [in absolute dollar terms" between the exploration expenditures of the Big Five and the smaller companies has closed, with the next top 20 firms now spending in absolute amounts roughly the same as the Big Five. This is especially telling when one considers the huge differences in operating cash flow between the two groups, where the Big Five registered $155 billion in 2006 against only $50 billion in operating cash flow for these next 20 oil independents."
"The Big Five are gradually depleting their reserves with an average replacement ratio of only 82% in the period since 1999, as compared with 147% for the next 20.8."
"To some extent the decline for the Big Five is attributable to the downward restatement of reserves, especially by Royal Dutch Shell."
"The oil production of the five largest oil companies has declined since the mid-1990s. Oil production for the five largest oil companies fell from 10.25 million b/d in 1996 to 9.45 million b/d in 2005 before rebounding to 9.7 million b/d in 2006. By contrast, for the next 20 U.S. independent oil firms, their oil production has risen since 1996, from 1.55 million b/d in 1996 to about 2.13 million b/d in 2005 and 2006."
"Increasingly, the IOCs have become more like general contractors, coordinating the operation of a number of suppliers who themselves are the ones who undertake seismic work, analyze data, provide drilling rigs and crews and a host of oil field services. The larger IOCs also serve the function of bankers, providing the vast amount of financial resources required to mount greenfield projects in increasingly unfavorable and difficult environments. They also provide the management, organizational skills, and oversight that these large projects require."
"The question is whether NOCs will find this role increasingly useful or whether they believe that such operational planning functions can either be performed by themselves or be farmed out to a service company under a fee-for-service structure. The fact that IOCs have had a poor record in recent years avoiding giant cost overruns on mega projects in Kazakhstan, the Sakhalin Islands, and the Middle East means that NOCs might be skeptical of the benefits being offered by IOCs. Moreover, investors are also questioning whether there is a continued role for the largest firms in a world where the average size of new finds is declining. Smaller E&P firms have lower costs than the large bureaucratic IOCs. They might have an advantage in finding and developing the remaining reserves that are available to private firms. Stock markets reflect these perceptions, with the shares of NOCs and American independents generally performing better than IOC shares."
Jaffe, Amy Myers and Ronald Soligo. 2007. "The International Oil Companies." Working Paper #20. Study on the Role of National Oil Companies in International Energy Markets. James A. Baker III Institute for Public Policy, Rice University.
http://www.bakerinstitute.org/publications/NOC_IOCs_Jaffe-Soligo.pdf
The idea that the oil companies need to get permission to drill offshore is ridiculous. The majors are more intent in using their funds to buy back their stocks to raise the share price to help boost their bonuses. Here are my notes from an interesting study from the James A. Baker III Institute for Public Policy.
Jaffe, Amy Myers and Ronald Soligo. 2007. "The International Oil Companies." Working Paper #20. Study on the Role of National Oil Companies in International Energy Markets. James A. Baker III Institute for Public Policy, Rice University.
http://www.bakerinstitute.org/publications/NOC_IOCs_Jaffe-Soligo.pdf
This study looks at the outlays of the big five or companies, BP, Chevron, Conoco Phillips, Exxon Mobil, and Royal Dutch Shell, which had $120.8 billion in profits in 2006 with 9.7 million barrels a day of oil production. The next 20 largest firms had 31.2 billion in profits with 2.1 million barrels per day of production. In terms of operating cash flow, the big five registered $155 billion in 2006, compared to only 50 billion for the next 20 largest American oil firms.
"Cash flow is a better measure of the discretionary resources available to firms than profits. For the Big Five IOCs, operating cash flow, shown in Figure 2, was slightly more than two and a half times higher in 2006 than the average levels prevailing in the 1996-99 period, rising from roughly $60 billion in the late 1990s to $154.9 billion in 2005."
"But while prices, profits, and cash flow have risen dramatically, investment in exploration has not -- especially by the largest IOCs."
They look at outlays of the Big Five firms among the following categories: share buybacks, reserve acquisitions from other firms, exploration expenditures, development outlays, and dividend payments.
"Development expenditures reflect investments in fields that have already been discovered and are the easiest (most cost-effective) way to boost output in the short run. Nonetheless, it is investment in the exploration of new fields that will assure the long-term viability of these firms."
"Share buybacks (equity repurchases) have absorbed a growing share of these outlays, rising from only 1% in 1993 to 37.1% in 2006, while expenditures on exploration account for a decreasing proportion, declining from 13.8% in 1993 to only 5.8% in 2006. It is interesting to note that, despite an almost 50% increase in exploration expenditures from 2005 to 2006, these expenditures as a share of the total increased from 5.3% to only 5.8%."
"The data for the "next 20" firms reveals a pattern of expenditures that is quite different from that of the Big Five. Outlays for exploration have increased significantly in absolute terms, although not as a share of total outlays. Dividends account for a much smaller proportion of outlays while acquiring reserves from other firms is larger. Development expenditures have increased more than three-fold since 1999. However, as a percentage of these outlays, development expenditure has increased from 33.5 % to 47.3%."
"smaller firms are more aggressive in spending for reserves additions than the Big Five-through growing exploration outlays and through acquisitions from other firms."
"The gap [in absolute dollar terms" between the exploration expenditures of the Big Five and the smaller companies has closed, with the next top 20 firms now spending in absolute amounts roughly the same as the Big Five. This is especially telling when one considers the huge differences in operating cash flow between the two groups, where the Big Five registered $155 billion in 2006 against only $50 billion in operating cash flow for these next 20 oil independents."
"The Big Five are gradually depleting their reserves with an average replacement ratio of only 82% in the period since 1999, as compared with 147% for the next 20.8."
"To some extent the decline for the Big Five is attributable to the downward restatement of reserves, especially by Royal Dutch Shell."
"The oil production of the five largest oil companies has declined since the mid-1990s. Oil production for the five largest oil companies fell from 10.25 million b/d in 1996 to 9.45 million b/d in 2005 before rebounding to 9.7 million b/d in 2006. By contrast, for the next 20 U.S. independent oil firms, their oil production has risen since 1996, from 1.55 million b/d in 1996 to about 2.13 million b/d in 2005 and 2006."
"Increasingly, the IOCs have become more like general contractors, coordinating the operation of a number of suppliers who themselves are the ones who undertake seismic work, analyze data, provide drilling rigs and crews and a host of oil field services. The larger IOCs also serve the function of bankers, providing the vast amount of financial resources required to mount greenfield projects in increasingly unfavorable and difficult environments. They also provide the management, organizational skills, and oversight that these large projects require."
"The question is whether NOCs will find this role increasingly useful or whether they believe that such operational planning functions can either be performed by themselves or be farmed out to a service company under a fee-for-service structure. The fact that IOCs have had a poor record in recent years avoiding giant cost overruns on mega projects in Kazakhstan, the Sakhalin Islands, and the Middle East means that NOCs might be skeptical of the benefits being offered by IOCs. Moreover, investors are also questioning whether there is a continued role for the largest firms in a world where the average size of new finds is declining. Smaller E&P firms have lower costs than the large bureaucratic IOCs. They might have an advantage in finding and developing the remaining reserves that are available to private firms. Stock markets reflect these perceptions, with the shares of NOCs and American independents generally performing better than IOC shares."
Tuesday, August 19, 2008
"Let the Games Be Doped"
In his recent (8/12/08) New York TIMES article titled "Let the Games Be Doped," John Tierney argues that we should let athletes take any drugs -- or use any artificial means they want -- in athletic contests. I was going to write a letter to the TIMES, but got lazy and/or busy. Now, in today's "Science" section, there are two particularly anemic letters criticizing Tierney's perspective. So I'm provoked to write.
Of course, there are obvious questions. If all artificial means are OK, why can't Olympic swimmers use flippers? or why not weapons? Take THAT, Michael Phelps!
But that's not my point (see also my Valentine's Day card on EconoSpeak this year at http://econospeak.blogspot.com/2008/02/next-steroids.html). Tierney comes at the issue from a "libertarian" angle, arguing essentially that it's up to the individual to decide on whether or not the costs of steroids (or whatever) outweigh benefits. The problem is (as is often ignored by so-called "libertarians") there are external costs. In this case, athlete A imposes costs on athlete B without the latter's consent.
In plainer prose, if athlete A uses steroids, that gives him a competitive advantage. So, if athlete B wants to win, she has to take them too (or compensate for her disadvantage in some other way). With a bunch of athletes in the same event, it's unlikely that the relative rankings will change a lot due to steroid use. The external costs would push them all to use steroids -- and they'll all end up pretty much where they started. Since steroids have bad side-effects, it's a kind of self-destructive competition.
Robert Frank and Philip Cook call for an "arms control" agreement in this situation. All of the athletes in an event are prevented from using steroids, then we prevent the self-destructive competition. That's what anti-doping rules are all about.
Further, the Olympics involve what Frank and Cook call a "winner-take-all" competition (in their book THE WINNER-TAKE-ALL SOCIETY). That means that if someone wins a gold medal (in a TV-popular event) it means big bucks, along with a lot of non-financial rewards. But if you win "only" a silver or a bronze medal, the rewards are nil. This creates a massive incentive to engage in self-destructive competition.
What to do? We could split athletics into two completely separate "tracks." On the one hand, there would be dope-free track, where athletes must voluntarily participate in drug tests. On the other, there would be the "Tierney track," where all artificial means are allowed. Saturday Night Live had a skit about Tierney's idea a long time ago, back when Dennis Miller was funny (see http://www.hulu.com/watch/4090/saturday-night-live-weekend-update-all-drug-olympics).
My guess is that the drug-free track would have much greater prestige. In terms of "libertarian" notions, I'd bet that it would pass the "market test" with flying colors. The Tierney track would go the way of the late unlamented XFL.
Note that I am not against new technology (cyborgs in athletic events, etc.) Go for it: if you want to abuse your body, it's your right as an American! (Why not heroin?) Nor am I saying that Big Brother should dictate to all athletes. But there should be a minimal-technology or "clean" track in athletics. If people don't want to participate, they don't have to.
On top of that, some effort should be made to get rid of the "winner-take-all" element. For example, take the money out of sports. This is less likely to happen. But I think we can all do something as individuals: shun "big league" sports and watch "minor league" or amateurs ones. Here in L.A., forget the Kings and watch the Long Beach Ice Dogs. Even better, instead of watching sports, participate in them. Among other things, it's actually good for one's health. And feel free to use advanced technology, like a Wii.
-- Jim Devine
Of course, there are obvious questions. If all artificial means are OK, why can't Olympic swimmers use flippers? or why not weapons? Take THAT, Michael Phelps!
But that's not my point (see also my Valentine's Day card on EconoSpeak this year at http://econospeak.blogspot.com/2008/02/next-steroids.html). Tierney comes at the issue from a "libertarian" angle, arguing essentially that it's up to the individual to decide on whether or not the costs of steroids (or whatever) outweigh benefits. The problem is (as is often ignored by so-called "libertarians") there are external costs. In this case, athlete A imposes costs on athlete B without the latter's consent.
In plainer prose, if athlete A uses steroids, that gives him a competitive advantage. So, if athlete B wants to win, she has to take them too (or compensate for her disadvantage in some other way). With a bunch of athletes in the same event, it's unlikely that the relative rankings will change a lot due to steroid use. The external costs would push them all to use steroids -- and they'll all end up pretty much where they started. Since steroids have bad side-effects, it's a kind of self-destructive competition.
Robert Frank and Philip Cook call for an "arms control" agreement in this situation. All of the athletes in an event are prevented from using steroids, then we prevent the self-destructive competition. That's what anti-doping rules are all about.
Further, the Olympics involve what Frank and Cook call a "winner-take-all" competition (in their book THE WINNER-TAKE-ALL SOCIETY). That means that if someone wins a gold medal (in a TV-popular event) it means big bucks, along with a lot of non-financial rewards. But if you win "only" a silver or a bronze medal, the rewards are nil. This creates a massive incentive to engage in self-destructive competition.
What to do? We could split athletics into two completely separate "tracks." On the one hand, there would be dope-free track, where athletes must voluntarily participate in drug tests. On the other, there would be the "Tierney track," where all artificial means are allowed. Saturday Night Live had a skit about Tierney's idea a long time ago, back when Dennis Miller was funny (see http://www.hulu.com/watch/4090/saturday-night-live-weekend-update-all-drug-olympics).
My guess is that the drug-free track would have much greater prestige. In terms of "libertarian" notions, I'd bet that it would pass the "market test" with flying colors. The Tierney track would go the way of the late unlamented XFL.
Note that I am not against new technology (cyborgs in athletic events, etc.) Go for it: if you want to abuse your body, it's your right as an American! (Why not heroin?) Nor am I saying that Big Brother should dictate to all athletes. But there should be a minimal-technology or "clean" track in athletics. If people don't want to participate, they don't have to.
On top of that, some effort should be made to get rid of the "winner-take-all" element. For example, take the money out of sports. This is less likely to happen. But I think we can all do something as individuals: shun "big league" sports and watch "minor league" or amateurs ones. Here in L.A., forget the Kings and watch the Long Beach Ice Dogs. Even better, instead of watching sports, participate in them. Among other things, it's actually good for one's health. And feel free to use advanced technology, like a Wii.
-- Jim Devine
Monday, August 18, 2008
Forecasting Crises: MBA Students and Skyscrapers
Economic models are notoriously poor at forecasting severe downturns. Here are some studies that identify the kind of behavior that suggest that a crisis might be around the corner.
Broughton, Philip Delves. 2008. Ahead of the Curve: Two Years at Harvard Business School (New York: Penguin Group).
272-3: "The job statistics for our class showed that 42% went into financial services, ranging from investment banking to private equity, venture capital, and commercial banking. 21% went into consulting. There was then a steep drop to technology and telecommunications, with 6%. Pharmaceuticals, consumer products, retail, and other manufacturing each drew less than 5%. Nonprofit and government accounted for less than 5%, half of whom were part of an HBS program to place students in nonprofit and government jobs and subsidize their salaries to bring them in range of the for-profit sector. 80% of the class took jobs in the United States. The total compensation for my class in its first year out was $138,125. Ray Soifer, a graduate of the class of 1965 and a banking analyst, had been keeping track of the relationship between the condition of the American equity market and the percentage of Harvard MBA graduates choosing careers in financial services. 10% or less was a long-term buy signal. 30% or more was a long-term sell. The choices of the class of 2006 told you the markets were soon to crash."
Michael Lewis seemed to have stumbled on the model earlier.
Lewis, Michael. 1989. Liar's Poker: Rising Through the Wreckage on Wall Street (NY: W.W. Norton).
24: "Forty percent of the thirteen hundred members of Yale's graduating class of 1986 applied to one investment bank, First Boston."
Poor, Meredith. 1998. "Twin Towers: Letter to the Editor." Scientific American (April).
The skyscrapers of the 1930s (the Chrysler Building and the Empire State Building) were built just as the Great Depression took hold of the U.S. economy. The World Trade Center and Sears Tower were also leading indicators of the economic malaise of the 1970s. And just as Malaysia completes its showpiece, the Petronas Twin Towers ["The World's Tallest Buildings," by Cesar Pelli, Charles Thornton and Leonard Joseph, December 1997], the economy of the region dives into disaster. In retrospect, this should be no surprise; during these periods, symbolism took great precedence over substance.
Soon picked up by Business Week
Koretz, Gene. 1999. "Do Towers Rise Before a Crash?" Business Week (17 May): p. 26.
Andrew Lawrence of Dresdner Kleinwort Bensen in Hong Kong found a close relationship between the construction of grandiose high rise buildings (reflecting excessive optimism) and subsequent crashes.
Broughton, Philip Delves. 2008. Ahead of the Curve: Two Years at Harvard Business School (New York: Penguin Group).
272-3: "The job statistics for our class showed that 42% went into financial services, ranging from investment banking to private equity, venture capital, and commercial banking. 21% went into consulting. There was then a steep drop to technology and telecommunications, with 6%. Pharmaceuticals, consumer products, retail, and other manufacturing each drew less than 5%. Nonprofit and government accounted for less than 5%, half of whom were part of an HBS program to place students in nonprofit and government jobs and subsidize their salaries to bring them in range of the for-profit sector. 80% of the class took jobs in the United States. The total compensation for my class in its first year out was $138,125. Ray Soifer, a graduate of the class of 1965 and a banking analyst, had been keeping track of the relationship between the condition of the American equity market and the percentage of Harvard MBA graduates choosing careers in financial services. 10% or less was a long-term buy signal. 30% or more was a long-term sell. The choices of the class of 2006 told you the markets were soon to crash."
Michael Lewis seemed to have stumbled on the model earlier.
Lewis, Michael. 1989. Liar's Poker: Rising Through the Wreckage on Wall Street (NY: W.W. Norton).
24: "Forty percent of the thirteen hundred members of Yale's graduating class of 1986 applied to one investment bank, First Boston."
Poor, Meredith. 1998. "Twin Towers: Letter to the Editor." Scientific American (April).
The skyscrapers of the 1930s (the Chrysler Building and the Empire State Building) were built just as the Great Depression took hold of the U.S. economy. The World Trade Center and Sears Tower were also leading indicators of the economic malaise of the 1970s. And just as Malaysia completes its showpiece, the Petronas Twin Towers ["The World's Tallest Buildings," by Cesar Pelli, Charles Thornton and Leonard Joseph, December 1997], the economy of the region dives into disaster. In retrospect, this should be no surprise; during these periods, symbolism took great precedence over substance.
Soon picked up by Business Week
Koretz, Gene. 1999. "Do Towers Rise Before a Crash?" Business Week (17 May): p. 26.
Andrew Lawrence of Dresdner Kleinwort Bensen in Hong Kong found a close relationship between the construction of grandiose high rise buildings (reflecting excessive optimism) and subsequent crashes.
A Speech for Obama on Energy Prices
My fellow Americans,
In the last year the price of energy, and especially gas at the pump, has gone way up. While it has come down a little in recent weeks, it is still much higher than before, and it is squeezing the budgets of families all across the country. This expense is all the more difficult to bear at a time when the economy is sputtering and paychecks are stagnating. People are looking for answers.
What I am going to say today will surprise you – but I will get to that later. First, I want to clear up the issue that everyone is talking about right now, offshore oil drilling. What’s my position on that?
If you listen to the energy experts, they all agree that drilling for more oil off our coasts will have little effect on the prices we pay for gasoline and other energy products. First, it will take many years before exploration uncovers productive oil fields, and more years to build the platforms and transportation systems to bring this oil to the market. So no matter what we do about this issue today, it will not have an effect on today’s prices. But the experts also say that the potential output of these fields, compared with global supply and demand, is simply not enough to move prices more than one or two percent. If we had another Saudi Arabia lying off our coast it would make a big difference, but we don’t. So, while I wish there were a simple decision we could take that would bring immediate and substantial relief to families struggling with energy costs, I don’t think offshore drilling is the answer.
But the issue won’t go away. This is an election year, and the polling companies are working overtime to tell us what the public thinks about every topic. And if we can believe their numbers, a large majority of Americans think that we should give offshore drilling a try anyway, on the principle that if you have a problem you should do everything you can.
We live in a democracy. If a substantial majority favors a policy, and if the policy does no harm, we should respect the will of the people. So, even though I’m not optimistic about what more drilling can do, I’m willing to reverse the ban we’ve had in recent decades.
Democrats in the House and Senate are preparing legislation along these lines. To keep to the requirement of “do no harm”, this legislation will see to it that any offshore oil production adheres to strict environmental standards, so that we don’t have oil spills fouling our beaches — the problem that led to the ban in the first place. We will also have controls on the ability of big oil companies to reap windfall profits from these finds: their oversized profits are part of the problem and cannot be part of the solution. Together, these stipulations will guarantee that a change in policy on offshore drilling, whatever its benefits, will not impose significant costs. If Republicans agree to a careful, responsible shift in regulation we can move forward quickly.
But as I said, whether we drill a little more or a little less will not have much impact on sky-high energy costs. If we are serious about addressing this issue, we must move beyond the debate over drilling and address the underlying causes. That is my real purpose today.
We should begin with a sobering fact: while energy prices will continue to fluctuate unpredictably, in the long run they are headed up, up, up. In part this is because the supply of scarce resources like petroleum is starting to reach its limit. Experts disagree about just when this peak supply will occur, but they agree that the day is not far off. In the meantime, the demand for oil and other energy products is rising quickly in countries like China and India. We are happy to see anyone anywhere move out of poverty and into a more comfortable lifestyle, but we should also recognize that this means they will be able to afford to buy more cars, heat their houses to a more comfortable temperature and in general use more energy. Between a plateau of supply and a rising curve of demand, we are facing a future of scarce and expensive energy.
But there is another side to energy prices. In previous speeches I have talked about the urgent necessity of weaning America from its dependence on oil and other fossil fuels. Avoiding conflict over oil supplies is central to our national security, whether it is about getting drawn into battles in oil-producing countries like Iraq and Iran, or finding a way to end warfare where oil fields and oil pipelines are at stake, as is now the case in the conflict between Russia and Georgia. The less reliant we are on these supplies, the more we can focus on the true threats to our security, like groups that would commit wanton acts of terror against our population. The fixation on oil is distorting our priorities and fomenting violence around the world.
Just as urgent is the demand to prevent catastrophic climate change. Already the concentration of carbon in the earth’s atmosphere is entering the danger zone, and every day our factories, power plants and automobiles are pushing that number up higher and higher. No one knows where the tipping point is, the level of greenhouse gases that can trigger a process of self-reinforcing climate change that we will be powerless to stop. We must drastically reduce our consumption of fossil fuels, and quickly, if we are to keep faith with future generations that will inherit whatever world we leave them. And there is little we can do as a country that would more restore our standing in the world than to shoulder our share of the burden in preserving a liveable planet.
For all these reasons, we have to kick the fossil fuel habit. And this will mean higher prices, much higher than today. So, not only are we unable to repeal the law of supply and demand to bring down these costs, in fact we need higher prices to achieve our core national objectives. What then can we do?
Here is where I will ask you to think outside the box. What I will propose to you today is that the problem is not the price of oil and other energy products as such, but where the money goes. When you pay four dollars or more at the pump for a gallon of gas, your hard-earned money is on its way to a foreign country or a fabulously profitable oil company. It’s gone: you will never see it again.
But suppose we did something different. Instead of paying high prices to far-off governments or oil profiteers, suppose we paid it to ourselves, so that we could actually get it back. This is what I’m going to suggest.
The way to do this is by actually raising the price of oil. You could do it through a tax. The way I’ve proposed, in my climate change plan, is to have a limited number of permits for bringing fossil fuels into the economy, and to make energy companies pay for every one of these permits. Of course, they will pass this cost along to you, the consumer. This is how a market economy works. It will lead to innovation, as businesses and households find new ways to conserve energy. But the bottom-line result is that, to kick the fossil fuel habit, we will be paying a lot more for whatever we continue to use.
Yet here is the key point: the extra cost you will pay will not go to a foreign government or an oil company. It will come right back to you. Specifically, I am proposing to put all of these revenues from higher energy prices into a big pot, and then pay out the money in equal amounts to every American citizen. This is the simplest and fairest solution. I want to be very clear: this money will not be kept by the government. It is yours. I promise, here and before all of you, that at least 95 cents of every dollar collected in selling fossil fuel permits will be given back to the people, quickly, efficiently, fairly. Economists who have studied this idea estimate that the amount each of us would receive would be something like $1000 per year. Any additional public programs for energy research or conservation would be financed out of tax revenues as they are, or more accurately as they should be, today. The extra money you pay for energy would be earmarked, virtually all of it, to return to you.
This plan has many benefits. It will do more for our national security than any other single step we can take. It will restore America’s leadership role in the fight against climate change. It will be an added benefit for the most vulnerable Americans, those who are at the bottom of the economic ladder and use the least energy already: they will get back much more than they pay. But what I want to emphasize is that this is the only meaningful long run solution to the problem of runaway energy costs. Energy costs will rise, and in some respects we even need them to rise. But the problem is that, under the current system, every dollar we pay for energy is a dollar lost. The solution is to change the system so that we get this money back, literally, every one of us. It is the responsibility of government to set up this system and then get out of the way, so that the money can return to the public in the simplest, fairest and most direct manner. On the international front, if we can convince enough other countries to take a similar stand, and I think we can, the overall effect will be to bring down global demand substantially, so that much less of our energy bill ends up in foreign or corporate hands.
Unlike offshore drilling, the proposal I’ve just outlined is not in the news. The pollsters aren’t asking you what your position is on it. But, also unlike offshore drilling, it gets to the heart of the problem. We can’t legislate energy prices down and we shouldn’t try. But we can protect the budgets of our families and our economic health as a nation by turning Americans into recipients of energy money as well as payers of it. So this is my answer to out-of-control energy costs: let’s get this money back. Let’s take control of our energy problems and protect our standard of living at the same time. Let’s have a future in which, when you read headlines about higher energy prices you think, “That’s more money in the bank, for me.” Let’s get the energy money back.
In the last year the price of energy, and especially gas at the pump, has gone way up. While it has come down a little in recent weeks, it is still much higher than before, and it is squeezing the budgets of families all across the country. This expense is all the more difficult to bear at a time when the economy is sputtering and paychecks are stagnating. People are looking for answers.
What I am going to say today will surprise you – but I will get to that later. First, I want to clear up the issue that everyone is talking about right now, offshore oil drilling. What’s my position on that?
If you listen to the energy experts, they all agree that drilling for more oil off our coasts will have little effect on the prices we pay for gasoline and other energy products. First, it will take many years before exploration uncovers productive oil fields, and more years to build the platforms and transportation systems to bring this oil to the market. So no matter what we do about this issue today, it will not have an effect on today’s prices. But the experts also say that the potential output of these fields, compared with global supply and demand, is simply not enough to move prices more than one or two percent. If we had another Saudi Arabia lying off our coast it would make a big difference, but we don’t. So, while I wish there were a simple decision we could take that would bring immediate and substantial relief to families struggling with energy costs, I don’t think offshore drilling is the answer.
But the issue won’t go away. This is an election year, and the polling companies are working overtime to tell us what the public thinks about every topic. And if we can believe their numbers, a large majority of Americans think that we should give offshore drilling a try anyway, on the principle that if you have a problem you should do everything you can.
We live in a democracy. If a substantial majority favors a policy, and if the policy does no harm, we should respect the will of the people. So, even though I’m not optimistic about what more drilling can do, I’m willing to reverse the ban we’ve had in recent decades.
Democrats in the House and Senate are preparing legislation along these lines. To keep to the requirement of “do no harm”, this legislation will see to it that any offshore oil production adheres to strict environmental standards, so that we don’t have oil spills fouling our beaches — the problem that led to the ban in the first place. We will also have controls on the ability of big oil companies to reap windfall profits from these finds: their oversized profits are part of the problem and cannot be part of the solution. Together, these stipulations will guarantee that a change in policy on offshore drilling, whatever its benefits, will not impose significant costs. If Republicans agree to a careful, responsible shift in regulation we can move forward quickly.
But as I said, whether we drill a little more or a little less will not have much impact on sky-high energy costs. If we are serious about addressing this issue, we must move beyond the debate over drilling and address the underlying causes. That is my real purpose today.
We should begin with a sobering fact: while energy prices will continue to fluctuate unpredictably, in the long run they are headed up, up, up. In part this is because the supply of scarce resources like petroleum is starting to reach its limit. Experts disagree about just when this peak supply will occur, but they agree that the day is not far off. In the meantime, the demand for oil and other energy products is rising quickly in countries like China and India. We are happy to see anyone anywhere move out of poverty and into a more comfortable lifestyle, but we should also recognize that this means they will be able to afford to buy more cars, heat their houses to a more comfortable temperature and in general use more energy. Between a plateau of supply and a rising curve of demand, we are facing a future of scarce and expensive energy.
But there is another side to energy prices. In previous speeches I have talked about the urgent necessity of weaning America from its dependence on oil and other fossil fuels. Avoiding conflict over oil supplies is central to our national security, whether it is about getting drawn into battles in oil-producing countries like Iraq and Iran, or finding a way to end warfare where oil fields and oil pipelines are at stake, as is now the case in the conflict between Russia and Georgia. The less reliant we are on these supplies, the more we can focus on the true threats to our security, like groups that would commit wanton acts of terror against our population. The fixation on oil is distorting our priorities and fomenting violence around the world.
Just as urgent is the demand to prevent catastrophic climate change. Already the concentration of carbon in the earth’s atmosphere is entering the danger zone, and every day our factories, power plants and automobiles are pushing that number up higher and higher. No one knows where the tipping point is, the level of greenhouse gases that can trigger a process of self-reinforcing climate change that we will be powerless to stop. We must drastically reduce our consumption of fossil fuels, and quickly, if we are to keep faith with future generations that will inherit whatever world we leave them. And there is little we can do as a country that would more restore our standing in the world than to shoulder our share of the burden in preserving a liveable planet.
For all these reasons, we have to kick the fossil fuel habit. And this will mean higher prices, much higher than today. So, not only are we unable to repeal the law of supply and demand to bring down these costs, in fact we need higher prices to achieve our core national objectives. What then can we do?
Here is where I will ask you to think outside the box. What I will propose to you today is that the problem is not the price of oil and other energy products as such, but where the money goes. When you pay four dollars or more at the pump for a gallon of gas, your hard-earned money is on its way to a foreign country or a fabulously profitable oil company. It’s gone: you will never see it again.
But suppose we did something different. Instead of paying high prices to far-off governments or oil profiteers, suppose we paid it to ourselves, so that we could actually get it back. This is what I’m going to suggest.
The way to do this is by actually raising the price of oil. You could do it through a tax. The way I’ve proposed, in my climate change plan, is to have a limited number of permits for bringing fossil fuels into the economy, and to make energy companies pay for every one of these permits. Of course, they will pass this cost along to you, the consumer. This is how a market economy works. It will lead to innovation, as businesses and households find new ways to conserve energy. But the bottom-line result is that, to kick the fossil fuel habit, we will be paying a lot more for whatever we continue to use.
Yet here is the key point: the extra cost you will pay will not go to a foreign government or an oil company. It will come right back to you. Specifically, I am proposing to put all of these revenues from higher energy prices into a big pot, and then pay out the money in equal amounts to every American citizen. This is the simplest and fairest solution. I want to be very clear: this money will not be kept by the government. It is yours. I promise, here and before all of you, that at least 95 cents of every dollar collected in selling fossil fuel permits will be given back to the people, quickly, efficiently, fairly. Economists who have studied this idea estimate that the amount each of us would receive would be something like $1000 per year. Any additional public programs for energy research or conservation would be financed out of tax revenues as they are, or more accurately as they should be, today. The extra money you pay for energy would be earmarked, virtually all of it, to return to you.
This plan has many benefits. It will do more for our national security than any other single step we can take. It will restore America’s leadership role in the fight against climate change. It will be an added benefit for the most vulnerable Americans, those who are at the bottom of the economic ladder and use the least energy already: they will get back much more than they pay. But what I want to emphasize is that this is the only meaningful long run solution to the problem of runaway energy costs. Energy costs will rise, and in some respects we even need them to rise. But the problem is that, under the current system, every dollar we pay for energy is a dollar lost. The solution is to change the system so that we get this money back, literally, every one of us. It is the responsibility of government to set up this system and then get out of the way, so that the money can return to the public in the simplest, fairest and most direct manner. On the international front, if we can convince enough other countries to take a similar stand, and I think we can, the overall effect will be to bring down global demand substantially, so that much less of our energy bill ends up in foreign or corporate hands.
Unlike offshore drilling, the proposal I’ve just outlined is not in the news. The pollsters aren’t asking you what your position is on it. But, also unlike offshore drilling, it gets to the heart of the problem. We can’t legislate energy prices down and we shouldn’t try. But we can protect the budgets of our families and our economic health as a nation by turning Americans into recipients of energy money as well as payers of it. So this is my answer to out-of-control energy costs: let’s get this money back. Let’s take control of our energy problems and protect our standard of living at the same time. Let’s have a future in which, when you read headlines about higher energy prices you think, “That’s more money in the bank, for me.” Let’s get the energy money back.
Saturday, August 16, 2008
Irrational Exuberance of Economists?
Stephen Mihm's article on Roubini said:
"A recent study looked at “consensus forecasts” (the predictions of large groups of economists) that were made in advance of 60 different national recessions that hit around the world in the ’90s: in 97 percent of the cases, the study found, the economists failed to predict the coming contraction a year in advance. On those rare occasions when economists did successfully predict recessions, they significantly underestimated the severity of the downturns. Worse, many of the economists failed to anticipate recessions that occurred as soon as two months later."
Does anybody know the reference for this study?
"A recent study looked at “consensus forecasts” (the predictions of large groups of economists) that were made in advance of 60 different national recessions that hit around the world in the ’90s: in 97 percent of the cases, the study found, the economists failed to predict the coming contraction a year in advance. On those rare occasions when economists did successfully predict recessions, they significantly underestimated the severity of the downturns. Worse, many of the economists failed to anticipate recessions that occurred as soon as two months later."
Does anybody know the reference for this study?
Friday, August 15, 2008
Away with Education!
Charles Murray has an incredible proposal in Wednesday's Wall Street Journal. He wants to do away with most undergraduate education. This idea seems quite popular at the time -- at least Murray's time. One of his colleagues, had a similar idea:
"Can there be any thing more ridiculous, than that a father should waste his own money, and his son's time, in setting him to learn the Roman language, when, at the same time, he designs him for a trade, wherein he, having no use of Latin, fails not to forget that little which he brought from school."
Locke, John. 1690. Some Thoughts Concerning Education in John Locke, The Works of John Locke in Ten Volumes (London): ix, pp. 1- 205, p. 153.
The core of Murray's idea is that the purpose of education is to compare people for the workplace. Employers would be better served if prospective employees would just take tests to prove their competency. Here is what Murray has to say:
"Outside a handful of majors -- engineering and some of the sciences -- a bachelor's degree tells an employer nothing except that the applicant has a certain amount of intellectual ability and perseverance. Even a degree in a vocational major like business administration can mean anything from a solid base of knowledge to four years of barely remembered gut courses."
"The solution is not better degrees, but no degrees. Young people entering the job market should have a known, trusted measure of their qualifications they can carry into job interviews. That measure should express what they know, not where they learned it or how long it took them. They need a certification, not a degree."
I agree with Murray than many people are in college to earn a credential, which will have few benefits on the job. Some people with this kind of motivation will not get much out of college, but some will. And in the process, they might become richer (not necessarily in an economic sense), fuller people.
John Locke was correct that in education just restricted to Latin and Greek doesn't make sense. Many people during in the decades that followed Locke were leery of giving education to people without proper backgrounds, who might get too high an opinion of themselves -- or even become dangerous.
I certainly agree with Murray that college education has many deficiencies, a good number of which have to do with making education into providing business with good employees. Murray would certainly not appreciate that particular critique.
One measure of a decent educational system would be that the majority of graduates with be able to act as informed citizens with the result that they would get a government that would serve people's real needs.
By the way, whatever happened about the conservative demands to teach students about Shakespeare and great American literature?
"Can there be any thing more ridiculous, than that a father should waste his own money, and his son's time, in setting him to learn the Roman language, when, at the same time, he designs him for a trade, wherein he, having no use of Latin, fails not to forget that little which he brought from school."
Locke, John. 1690. Some Thoughts Concerning Education in John Locke, The Works of John Locke in Ten Volumes (London): ix, pp. 1- 205, p. 153.
The core of Murray's idea is that the purpose of education is to compare people for the workplace. Employers would be better served if prospective employees would just take tests to prove their competency. Here is what Murray has to say:
"Outside a handful of majors -- engineering and some of the sciences -- a bachelor's degree tells an employer nothing except that the applicant has a certain amount of intellectual ability and perseverance. Even a degree in a vocational major like business administration can mean anything from a solid base of knowledge to four years of barely remembered gut courses."
"The solution is not better degrees, but no degrees. Young people entering the job market should have a known, trusted measure of their qualifications they can carry into job interviews. That measure should express what they know, not where they learned it or how long it took them. They need a certification, not a degree."
I agree with Murray than many people are in college to earn a credential, which will have few benefits on the job. Some people with this kind of motivation will not get much out of college, but some will. And in the process, they might become richer (not necessarily in an economic sense), fuller people.
John Locke was correct that in education just restricted to Latin and Greek doesn't make sense. Many people during in the decades that followed Locke were leery of giving education to people without proper backgrounds, who might get too high an opinion of themselves -- or even become dangerous.
I certainly agree with Murray that college education has many deficiencies, a good number of which have to do with making education into providing business with good employees. Murray would certainly not appreciate that particular critique.
One measure of a decent educational system would be that the majority of graduates with be able to act as informed citizens with the result that they would get a government that would serve people's real needs.
By the way, whatever happened about the conservative demands to teach students about Shakespeare and great American literature?
Traitors to the Cause
by the Sandwichman
The phrase, cited by Michael, "traitors to the cause of economics as a whole" has a farcical ring to it -- like "traitors to the cause of the phone company billing department" or "traitors to the noble cause of bureaucracy". No doubt the note of laconic derision was intentional on Card's part. But it captures the peculiarly regimental loyalty and zeal that clings to the latter-day proponents of price doctrine.
If the contemporary exorcism of labor from economics seems tragic, it needs to be remembered that it isn't the first time. Setting aside Marx as beyond-the-neoclassical-pale, there is the case of William Thomas Thornton's On Labour: it's wrongful claims and rightful dues its actual present and possible future. Thornton's critique of price doctrine hinged on the phenomenon of 'higgling' or what we might today call negotiation. As Michael V. White explained in "'That God-forgotten Thornton', Exorcising Higgling after On Labour." "With equilibrium thus assumed rather than explained, Thornton's critique was dissolved by exorcising higgling from the domain of the 'science of political economy'." (page 151)
Depending on one's theological vantage point (or cynicism), the liquidation of Thornton's critique looms as either the Original Sin or the Immaculate Conception of marginalist thought.
The phrase, cited by Michael, "traitors to the cause of economics as a whole" has a farcical ring to it -- like "traitors to the cause of the phone company billing department" or "traitors to the noble cause of bureaucracy". No doubt the note of laconic derision was intentional on Card's part. But it captures the peculiarly regimental loyalty and zeal that clings to the latter-day proponents of price doctrine.
If the contemporary exorcism of labor from economics seems tragic, it needs to be remembered that it isn't the first time. Setting aside Marx as beyond-the-neoclassical-pale, there is the case of William Thomas Thornton's On Labour: it's wrongful claims and rightful dues its actual present and possible future. Thornton's critique of price doctrine hinged on the phenomenon of 'higgling' or what we might today call negotiation. As Michael V. White explained in "'That God-forgotten Thornton', Exorcising Higgling after On Labour." "With equilibrium thus assumed rather than explained, Thornton's critique was dissolved by exorcising higgling from the domain of the 'science of political economy'." (page 151)
Depending on one's theological vantage point (or cynicism), the liquidation of Thornton's critique looms as either the Original Sin or the Immaculate Conception of marginalist thought.
Thursday, August 14, 2008
The Exclusion of Labor, cont.
Here is the last paragraph of what I posted earlier, plus some text that goes into more detail about the subject. Any suggestions would be appreciated.
Most economists are dismissive of any theory not built on what they consider to be solid micro-foundations -- economists' jargon for this patently unrealistic model. Mainstream economists feel threatened by the suggestion that work, workers, or working conditions could be a legitimate subject of economic inquiry. As a result, any challenges to their theoretical position get treated to a hostile reception.
In one famous case, in 1944 Richard Lester published an article questioning whether labor markets actually operated in the manner that mainstream economics suggested. Lester had extensive experience in industry after having recently served as chair of the Southern Textile Commission of the National War Labor Board. Using government data, as well as surveys of industry leaders, Lester found evidence at odds with the assumptions of mainstream economic theory (Lester 1944). For example, his results suggested that an increase in the minimum wage would have little or no effect on employment, a conclusion that infuriated major defenders of the faith, led by George Stigler, later a leader of the Chicago school of economics and a Nobel laureate (see Prasch 2007).
Exactly a half century later, using an entirely different approach, Alan Krueger of Princeton and David Card of the University of California, Berkeley walked back into the same hornet's nest (Card and Krueger 1994). As might be expected, they too met with hostile criticism from fellow economists, some sponsored by the fast food industry. Card and Krueger were both distinguished economists. In fact, Card had won the John Bates Clark award from the American Economic Association given to the outstanding economist under the age of 40. In the face of the controversy, Card eventually dropped this line of research because of the personal costs of challenging the discipline. He explained:
I've subsequently stayed away from the minimum wage literature for a number of reasons. First, it cost me a lot of friends. People that I had known for many years, for instance, some of the ones I met at my first job at the University of Chicago, became very angry or disappointed. They thought that in publishing our work we were being traitors to the cause of economics as a whole. [Clement 2006]
Lester and Card did not fail to convince their fellow economists because of errors in their work. Economists either ignored their results or, worse yet, rejected them out of hand because they conflicted with economists cherished beliefs. As Stigler's colleague, Milton Friedman, once wrote: "Nothing is harder than for men to face facts that threaten to undermine strongly held beliefs, to change views arrived at over a long period. And there are no such things as unambiguous facts" (Friedman 1968, p. 14; cited in Diesing 1985, p. 61).
Yet, Chicago economics is famous for rejecting empirical evidence. Dierdre McCloskey, a former Chicago faculty member, recounts how people who used data that called the theory into question would "be met by choruses of "I can't believe it" or "It doesn't make sense." Milton Friedman's own Money Workshop at Chicago in the late 1960s and the early 1970s was a case in point" (McCloskey 1985, p. 140).
Melvin Reder, another Chicago faculty member, offered further insight in the way that Chicago refuses to give ground in the face of evidence that calls the micro-foundations into question:
Chicago economists tend strongly to appraise their own research and that of others by a standard that requires [inter alia] that the findings of empirical research be consistent with the implications of standard price theory .... The major objective is to convert non economists to their way of thinking .... However imaginative, answers that violate any maintained hypothesis of the paradigm, are penalized as evincing failure to absorb training. [Reder 1982, pp. 13, 18, and 19]
Economists regard this stubborn resistance to be good science. Predictably, the troubling questions raised by Lester and Card had no effect. Economists' beloved micro-foundations and their faith in market efficiency remained invulnerable -- so much so that economists today rarely even bother to publish research about the core of economic theory. In this environment, economists can continue to use their transaction-based theory without the inconvenience of dealing with work, workers, or working conditions. But by removing work, workers, and working conditions from their theory, economists blind themselves to the kind of inefficiencies that this book shows, especially in Chapter 9.
Most economists are dismissive of any theory not built on what they consider to be solid micro-foundations -- economists' jargon for this patently unrealistic model. Mainstream economists feel threatened by the suggestion that work, workers, or working conditions could be a legitimate subject of economic inquiry. As a result, any challenges to their theoretical position get treated to a hostile reception.
In one famous case, in 1944 Richard Lester published an article questioning whether labor markets actually operated in the manner that mainstream economics suggested. Lester had extensive experience in industry after having recently served as chair of the Southern Textile Commission of the National War Labor Board. Using government data, as well as surveys of industry leaders, Lester found evidence at odds with the assumptions of mainstream economic theory (Lester 1944). For example, his results suggested that an increase in the minimum wage would have little or no effect on employment, a conclusion that infuriated major defenders of the faith, led by George Stigler, later a leader of the Chicago school of economics and a Nobel laureate (see Prasch 2007).
Exactly a half century later, using an entirely different approach, Alan Krueger of Princeton and David Card of the University of California, Berkeley walked back into the same hornet's nest (Card and Krueger 1994). As might be expected, they too met with hostile criticism from fellow economists, some sponsored by the fast food industry. Card and Krueger were both distinguished economists. In fact, Card had won the John Bates Clark award from the American Economic Association given to the outstanding economist under the age of 40. In the face of the controversy, Card eventually dropped this line of research because of the personal costs of challenging the discipline. He explained:
I've subsequently stayed away from the minimum wage literature for a number of reasons. First, it cost me a lot of friends. People that I had known for many years, for instance, some of the ones I met at my first job at the University of Chicago, became very angry or disappointed. They thought that in publishing our work we were being traitors to the cause of economics as a whole. [Clement 2006]
Lester and Card did not fail to convince their fellow economists because of errors in their work. Economists either ignored their results or, worse yet, rejected them out of hand because they conflicted with economists cherished beliefs. As Stigler's colleague, Milton Friedman, once wrote: "Nothing is harder than for men to face facts that threaten to undermine strongly held beliefs, to change views arrived at over a long period. And there are no such things as unambiguous facts" (Friedman 1968, p. 14; cited in Diesing 1985, p. 61).
Yet, Chicago economics is famous for rejecting empirical evidence. Dierdre McCloskey, a former Chicago faculty member, recounts how people who used data that called the theory into question would "be met by choruses of "I can't believe it" or "It doesn't make sense." Milton Friedman's own Money Workshop at Chicago in the late 1960s and the early 1970s was a case in point" (McCloskey 1985, p. 140).
Melvin Reder, another Chicago faculty member, offered further insight in the way that Chicago refuses to give ground in the face of evidence that calls the micro-foundations into question:
Chicago economists tend strongly to appraise their own research and that of others by a standard that requires [inter alia] that the findings of empirical research be consistent with the implications of standard price theory .... The major objective is to convert non economists to their way of thinking .... However imaginative, answers that violate any maintained hypothesis of the paradigm, are penalized as evincing failure to absorb training. [Reder 1982, pp. 13, 18, and 19]
Economists regard this stubborn resistance to be good science. Predictably, the troubling questions raised by Lester and Card had no effect. Economists' beloved micro-foundations and their faith in market efficiency remained invulnerable -- so much so that economists today rarely even bother to publish research about the core of economic theory. In this environment, economists can continue to use their transaction-based theory without the inconvenience of dealing with work, workers, or working conditions. But by removing work, workers, and working conditions from their theory, economists blind themselves to the kind of inefficiencies that this book shows, especially in Chapter 9.
Observations on Jena, former East Germany
So, last week I gave some lectures at the Max Planck Institute for Economics in Jena, a city in the Lander of Thuringia in the former East Germany. This city was touted in the latest Economist Country Survey of Germany as doing as well as any in this former nation. Its university is also very renowned. Founded in 1558, it had Goethe as an administrator and faculty that included Shiller, Hegel, Fichte, Herder, Haeckel, and Frege, with both Robert Schumann and Karl Marx as students. The major business in town (it is only about 90,000 population) is the Carl Zeiss Optical Works, which dates to the 19th century, and was one of the most successful of enterprises even during the period of socialist rule, and is doing well now, part of why The Economist could tout the place. Its unemployment rate is about the same as the German average, which is much better than most of the former East Germany, where some parts still have such rates exceeding 20%.
The city is a more extreme than usual example of mixing the old and the replacing bomb-damaged-new in Germany. The old Market Square, with its Rathaus dating to the 14th century survived bombing that hit the Eichplatz next to it. That area was rebuilt during the socialist period, partly with an open square, and partly with a tall and round skyscraper. This structure represented the "Kombinate" approach of the former East Germans, which involved lots of horizontal and vertical integration of activities, with, in this case. everything in Jena coming under a single administrative entity. This skyscraper effectively represented this approach, with much of the university on several of its floors in that era.
On the one hand life seems not too bad. Buildings look OK, and people do not look poor. Students seem to have adapted to the new regime, although they were completely unacquainted with Post Keynesian economics, which I lectured on in one of my talks. However, in talking to some of them, they do not see prospects as good there. Most plan to look for jobs in "the old states" (of the West) or even outside of Germany, these being economics grad students. I also observed very little construction going on, with some of what is going on still being fixups of WW II bomb damage.
A curious point is that while hard science faculty survived mostly the transition, all the social science faculties were purged at the time. The current economics profs are all from the West. None of them live in Jena permanently, having apartments there, but going back home to the West on the weekends, if not more frequently. One of them told me that he did move his family in the late 1990s to Weimar near Jena, but they moved back west after three years, there being too much hostility from the locals. However, the students say this is gradually dying out.
The city is a more extreme than usual example of mixing the old and the replacing bomb-damaged-new in Germany. The old Market Square, with its Rathaus dating to the 14th century survived bombing that hit the Eichplatz next to it. That area was rebuilt during the socialist period, partly with an open square, and partly with a tall and round skyscraper. This structure represented the "Kombinate" approach of the former East Germans, which involved lots of horizontal and vertical integration of activities, with, in this case. everything in Jena coming under a single administrative entity. This skyscraper effectively represented this approach, with much of the university on several of its floors in that era.
On the one hand life seems not too bad. Buildings look OK, and people do not look poor. Students seem to have adapted to the new regime, although they were completely unacquainted with Post Keynesian economics, which I lectured on in one of my talks. However, in talking to some of them, they do not see prospects as good there. Most plan to look for jobs in "the old states" (of the West) or even outside of Germany, these being economics grad students. I also observed very little construction going on, with some of what is going on still being fixups of WW II bomb damage.
A curious point is that while hard science faculty survived mostly the transition, all the social science faculties were purged at the time. The current economics profs are all from the West. None of them live in Jena permanently, having apartments there, but going back home to the West on the weekends, if not more frequently. One of them told me that he did move his family in the late 1990s to Weimar near Jena, but they moved back west after three years, there being too much hostility from the locals. However, the students say this is gradually dying out.
Wednesday, August 13, 2008
The US and the Former USSR Compared
In 1959 C Wright Mills wrote of the basic trend then apparent that was making the US and USSR increasingly alike. He mentioned quite a long list of observations to support his claim:
-- "each had amalgamated on a continental domain great varieties of peoples and cultures";
-- "both had expanded their territory and power significantly;"
-- the political order is enlarged and centralised (becoming less political and more bureuacratic). In neither are there any "nationally responsible parties" that "debate openly and clearly the issues which the world now so rigidly confronts. The two-party state is without programmatic focus and without organisational basis for it." Neither nation has a civil service independent of corporate interest (US) or party dictation (USSR). "The classic conditions of democracy and democratic institutions do not flourish" in their power structures. "History-making decisions and lack of decisions are virtually monopolised by elites."
-- the power of both depended on technological developments that had ben made into a "cultural and social fetish";
-- the organisation of all life is increasingly adapted to industrial technologies. (As it turns out life hasn't adapted that well after all!)
-- work is alienated from people and consumption is culturally exploitative;
-- education and religion tends to be shaped by major economic, military and political forces. "They do not originate. They adapt." Mass eduction has evolved to "educated illiteracy".
-- the media is one of mass distraction. "they do not often communicate; they do not connect public issues with private troubles...they trivialise issues.."
-- the goal of the "self-cultivating" person has declined. "It is the specialist who is ascendant in both Russia and America."
The list goes on. Perhaps the most telling line in Mill's essay is when he asks "to what extent [is] the continuation of freedom [in the US] due to the fact that it is not being exercised?"
I think that was answered about 10 years later when peaceful civil protest resulted in students being shot dead, the US Army began (and probably continues to) spy on its citizens, news reporters began to be jailed for failing to reveal their sources and numerous assassinations occurred against civilian leaders.
Not that things are (or were) that much different in Australia.
'The Decline of the Left'. Lecture on the British Broadcasting Company. 1959. From 'Power, Politics and People - the collected essays of C Wright Mills'. Edited by Irving Louis Horowitz. Oxford University Press. 1963.
-- "each had amalgamated on a continental domain great varieties of peoples and cultures";
-- "both had expanded their territory and power significantly;"
-- the political order is enlarged and centralised (becoming less political and more bureuacratic). In neither are there any "nationally responsible parties" that "debate openly and clearly the issues which the world now so rigidly confronts. The two-party state is without programmatic focus and without organisational basis for it." Neither nation has a civil service independent of corporate interest (US) or party dictation (USSR). "The classic conditions of democracy and democratic institutions do not flourish" in their power structures. "History-making decisions and lack of decisions are virtually monopolised by elites."
-- the power of both depended on technological developments that had ben made into a "cultural and social fetish";
-- the organisation of all life is increasingly adapted to industrial technologies. (As it turns out life hasn't adapted that well after all!)
-- work is alienated from people and consumption is culturally exploitative;
-- education and religion tends to be shaped by major economic, military and political forces. "They do not originate. They adapt." Mass eduction has evolved to "educated illiteracy".
-- the media is one of mass distraction. "they do not often communicate; they do not connect public issues with private troubles...they trivialise issues.."
-- the goal of the "self-cultivating" person has declined. "It is the specialist who is ascendant in both Russia and America."
The list goes on. Perhaps the most telling line in Mill's essay is when he asks "to what extent [is] the continuation of freedom [in the US] due to the fact that it is not being exercised?"
I think that was answered about 10 years later when peaceful civil protest resulted in students being shot dead, the US Army began (and probably continues to) spy on its citizens, news reporters began to be jailed for failing to reveal their sources and numerous assassinations occurred against civilian leaders.
Not that things are (or were) that much different in Australia.
'The Decline of the Left'. Lecture on the British Broadcasting Company. 1959. From 'Power, Politics and People - the collected essays of C Wright Mills'. Edited by Irving Louis Horowitz. Oxford University Press. 1963.
Tuesday, August 12, 2008
Is There a Middle Way Economic System: Janos Kornai Speaks
Among the things I did while out of town for the last two weeks was to interview the 80-year old, Janos Kornai, for a forthcoming book. For those who do not know who he is, he is probably the best known economist in Eastern Europe, and in my opinion deserves the Nobel Prize in economics, if for nothing else, for his development of the concept of the "soft budget constraint," originally to analyze the problems of market socialist economies, but which is clearly relevant to many economies, as the current problems of financial institutions and their relationships with governments in many countries during the past year indicate. Kornai has had a fascinating personal life as well as career, having barely survived the Nazi occupation of Hungary, then at least partly in reaction to that becoming a supporter of Stalinist socialism, which he turned against after Stalin's death as he learned of human rights abuses, then his involvement in the 1956 revolution and later turning to mathematical economics and linear programming, to become a critic of neoclassical economics in his book, Anti-Equilibrium from 1971, and then on to forecast the fall of socialism in Hungary with his later work and his broader analysis of the nature and history of the socialist economies. For those not wishing to wait for our interview to be published, his fascinating memoirs are available from MIT Press.
In any case, I wish to note an unresolved issue in our discussion. In the late 1980s Kornai argued that ultimately "there is no third way" between command socialism and market capitalism, that the soft budget constraint and related political issues would force every country either to go to a hard line command socialist position like North Korea's or move towards some form of market capitalism as did most of Eastern Europe eventually. During our discussion he brought up in a favorable way the late West German economist, Walter Eucken, who has been little translated into English. He was the inventor of the concept of the "social market economy," (sozialmarktwirtschaften), which has been the official ideology, more or less, of the Bundes Republik of Germany since the late 1940s, and which I think the social democracies of the Nordic countries are more or less examples of as well. Now it can be argued, and Kornai does, that these countries are all just special cases, if involving some "hybrid" elements, of market capitalism. And it is certainly true that they all have mostly private ownership of the means of production with little central planning. However, Sweden in particular has long advertised itself as representing a Middle Way, with its advanced welfare state and high environmental and other public goods concerns. I, for one, think that Kornai should be a bit more willing to grant such status to such economies.
In any case, I wish to note an unresolved issue in our discussion. In the late 1980s Kornai argued that ultimately "there is no third way" between command socialism and market capitalism, that the soft budget constraint and related political issues would force every country either to go to a hard line command socialist position like North Korea's or move towards some form of market capitalism as did most of Eastern Europe eventually. During our discussion he brought up in a favorable way the late West German economist, Walter Eucken, who has been little translated into English. He was the inventor of the concept of the "social market economy," (sozialmarktwirtschaften), which has been the official ideology, more or less, of the Bundes Republik of Germany since the late 1940s, and which I think the social democracies of the Nordic countries are more or less examples of as well. Now it can be argued, and Kornai does, that these countries are all just special cases, if involving some "hybrid" elements, of market capitalism. And it is certainly true that they all have mostly private ownership of the means of production with little central planning. However, Sweden in particular has long advertised itself as representing a Middle Way, with its advanced welfare state and high environmental and other public goods concerns. I, for one, think that Kornai should be a bit more willing to grant such status to such economies.
Monday, August 11, 2008
Speaking of Child Labor
If you want to hear what I have to say about child labor, here’s a link to Against the Grain, a KPFA (Berkeley) radio show that interviewed me today. CS, the show’s host, really does his homework; he’s great at cutting through the distractions and getting to the point. In another life I used to do what he does now (for WORT in Madison) and can appreciate what it takes to do it well.
Who Are the Ossetians?
The current war between Russia and Georgia is over South Ossetia, an autonomous region of Georgia that won de facto independence on the ground back in 1993, with some assistance from the Russians, who have had peacekeeper troops there since. There are some odd ironies to this war, including that one of the places most ferociously bombed in Georgia in the current campaign has been Gori, birthplace of Josef Dzhugashvilii, better known to the world as "Stalin." While he is usually thought of as being Georgian, and certainly mostly was, there has long been a rumor that he had Ossetian ancestry, even though during his rule, Osip Mandelstam was accused of "anti-Soviet slander" for mentioning this rumor (apparently initially spread by anti-Stalin Georgian nationalist emigres). The basis of it is that a paternal great grandfather apparently did come originally from a thoroughly Ossetian village, Geri. Of course it was Stalin who initially split Ossetia into two halves, making the northern part an autonomous region in the Republic of Russia and the southern one an autonomous region in the Republic of Georgia, within the broader Union of Soviet Socialist Republics.
Another matter of some controversy involves the origin and identify of the Ossetians, who would like to have their own country (and while Russia helps them in the south, there is now way that help will extend to the north). Their language is clearly of the Iranian branch of Indo-European, related to Farsi/Persian, as well as such languages as Kurdish, Peshto, and Tajik, among others. They are also clearly descended from the Alans, who ran a medieval kingdom in the region for several centuries, only coming to an end with the Mongol invasions of Chingiz Khan. The bigger controversy has to do with the origins of the Alans, with the official Soviet view being (and the most widely held one now) that they were either descended from or closely related to the ancient Scythians of the golden grave mounds. While this view became widely accepted after the beginning of the 19th century, it overturned a competing view that has had some recent advocates pushing for it that the Scythians were of Turkish origin. That view was originally expressed by Herodotus.
Another matter of some controversy involves the origin and identify of the Ossetians, who would like to have their own country (and while Russia helps them in the south, there is now way that help will extend to the north). Their language is clearly of the Iranian branch of Indo-European, related to Farsi/Persian, as well as such languages as Kurdish, Peshto, and Tajik, among others. They are also clearly descended from the Alans, who ran a medieval kingdom in the region for several centuries, only coming to an end with the Mongol invasions of Chingiz Khan. The bigger controversy has to do with the origins of the Alans, with the official Soviet view being (and the most widely held one now) that they were either descended from or closely related to the ancient Scythians of the golden grave mounds. While this view became widely accepted after the beginning of the 19th century, it overturned a competing view that has had some recent advocates pushing for it that the Scythians were of Turkish origin. That view was originally expressed by Herodotus.
Putin Shows Who is Boss in Russia
The Georgians made a bad mistake attempting to invade South Ossetia, given the clear interest of the Russians in it and especially on the eve of the Olympic games, a period traditionally when nations attempt to avoid fighting wars, or at least starting fresh ones. I can only hope that the US did not give them a "green light" given that we are not willing to support them, to busy trying to get Russia to help us out with Iran, although one never knows with this administration.
However, I must agree with the many who are upset with the over-the-top reaction by the Russians, continuing to bomb deep into Georgia proper even after the Georgians had retreated from South Ossetia. Although clearly there are various motives going on here, including consolidating in Abkhazia, scaring the Ukrainians, and messing with the Georgian oil pipeline, another would seem to be strictly an internal Russian political one. The Russian constitution currently says the Commander in Chief is the president, now Dmitri Medvedev. Stories have been coming out of Russia in recent weeks about Russian bureaucrats now knowing whose picture to hang on their office walls, with a trend to putting up ones that show both Putin and Medvedev side by side. So, Putin goes from Beijing, where he hugged with Bush, to Vladikavkaz, the capital of North Ossetia on the frontline (note: "Vladikavkaz" means "Victory in the Caucusus" in Russian), where he undoubtedly put into play this very strong reaction. I think the bottom line in Russia is that those pictures with both guys are going to come off the walls and the old ones with just Putin will be back in their places (and this means that Russia will now also be like Germany, Italy, and Israel with having a strong premier and a figurehead president).
However, I must agree with the many who are upset with the over-the-top reaction by the Russians, continuing to bomb deep into Georgia proper even after the Georgians had retreated from South Ossetia. Although clearly there are various motives going on here, including consolidating in Abkhazia, scaring the Ukrainians, and messing with the Georgian oil pipeline, another would seem to be strictly an internal Russian political one. The Russian constitution currently says the Commander in Chief is the president, now Dmitri Medvedev. Stories have been coming out of Russia in recent weeks about Russian bureaucrats now knowing whose picture to hang on their office walls, with a trend to putting up ones that show both Putin and Medvedev side by side. So, Putin goes from Beijing, where he hugged with Bush, to Vladikavkaz, the capital of North Ossetia on the frontline (note: "Vladikavkaz" means "Victory in the Caucusus" in Russian), where he undoubtedly put into play this very strong reaction. I think the bottom line in Russia is that those pictures with both guys are going to come off the walls and the old ones with just Putin will be back in their places (and this means that Russia will now also be like Germany, Italy, and Israel with having a strong premier and a figurehead president).
Sunday, August 10, 2008
NPR on Fighting Fair
I was listening in to NPR, hearing about what the powerful Russian airforce is doing to defenseless citizens in Georgia. What I did not hear was how similar Russian explanations for their actions and their tactics sound identical to those of the US military -- including taking out defense and communications facilities.
The Irrelevance of Workers In Economic Theory
Many of you know that I am finishing up a book manuscript regarding the exclusion of work, workers and working conditions from economic theory. This part jumps into the middle of a section. The meat of the post is really in the third and fourth paragraphs, where I do a JSTOR survey of the almost total exclusion from economics. Fans of Martin Feldstein may appreciate his contribution.
In short, the exclusion of work, workers, and working conditions was not simply an accidental oversight. First, it served an important purpose in defending the capitalism from the accusation of exploitation. Second, any analysis based on labor would call out for both impossible quantification and more difficult mathematics. Utility, however, seemed to permit economists to avoid the need for quantification, while seeming to simplify mathematical complexities. Finally, utility seemed to be capable of fitting in with the type of models that economists were using in their quest to emulate physics with its mathematics of maximization.
As Phil Mirowski noted, "Production, as conventionally understood, does not "fit" in neoclassical value theory" (Mirowski 1989, p. 284). In short, ideology, mathematical convenience, and scientific ambitions all combined to sweep work, workers, and working conditions under the rug.
The radical shift from labor to extreme subjectivity in which consumer's unmeasurable preferences became the center of economic analysis sealed labor's marginalization in the theoretical world of economic theory. Other fields, such as sociology, industrial relations, or psychology seriously explore questions of work, workers or working conditions, but economics does not.
An August 8, 2008 search of 73 economics journals collected electronically in the JSTOR database revealed how marginal work, workers, and working conditions has become in economic literature. Of the articles published since January 2004, the term "working conditions" appeared in only 12, not counting four more substantial articles in the Review of African Political Economy, a journal rarely cited by mainstream economists. Of the remaining articles, three concerned the problem of retention of teachers. Another had a footnote that observed that people can learn about working conditions from websites. One article noted that faculty members in colleges and universities join unions to improve working conditions. A book review considered whether globalization could improve working conditions. Two articles mentioned legislation that took working conditions into account. One article disputed that child labor abroad experienced hideous working conditions. Another cited a mid-nineteenth century British economist who said that factory working conditions were good.
My favorite entry was from Martin Feldstein, whose contempt for spiteful egalitarian was discussed earlier. This article was one of his many attacks on Social Security that proposed that good working conditions should be treated as taxable income (Feldstein 2005, p. 36). None of the articles offered any evidence of serious engagement with work, workers, or working conditions. In contrast, a search for sociologists' articles with the term "working conditions" that covered ten fewer journals, returned 107 articles.
At the same time as questions of labor were disappearing, economics began to elevate the status of investors' financial claims, insisting that owners of this form of property had rights equal to those of owners of real goods, such as land or factories. Even something as ephemeral as "good will" became recognized as property.
In short, the exclusion of work, workers, and working conditions was not simply an accidental oversight. First, it served an important purpose in defending the capitalism from the accusation of exploitation. Second, any analysis based on labor would call out for both impossible quantification and more difficult mathematics. Utility, however, seemed to permit economists to avoid the need for quantification, while seeming to simplify mathematical complexities. Finally, utility seemed to be capable of fitting in with the type of models that economists were using in their quest to emulate physics with its mathematics of maximization.
As Phil Mirowski noted, "Production, as conventionally understood, does not "fit" in neoclassical value theory" (Mirowski 1989, p. 284). In short, ideology, mathematical convenience, and scientific ambitions all combined to sweep work, workers, and working conditions under the rug.
The radical shift from labor to extreme subjectivity in which consumer's unmeasurable preferences became the center of economic analysis sealed labor's marginalization in the theoretical world of economic theory. Other fields, such as sociology, industrial relations, or psychology seriously explore questions of work, workers or working conditions, but economics does not.
An August 8, 2008 search of 73 economics journals collected electronically in the JSTOR database revealed how marginal work, workers, and working conditions has become in economic literature. Of the articles published since January 2004, the term "working conditions" appeared in only 12, not counting four more substantial articles in the Review of African Political Economy, a journal rarely cited by mainstream economists. Of the remaining articles, three concerned the problem of retention of teachers. Another had a footnote that observed that people can learn about working conditions from websites. One article noted that faculty members in colleges and universities join unions to improve working conditions. A book review considered whether globalization could improve working conditions. Two articles mentioned legislation that took working conditions into account. One article disputed that child labor abroad experienced hideous working conditions. Another cited a mid-nineteenth century British economist who said that factory working conditions were good.
My favorite entry was from Martin Feldstein, whose contempt for spiteful egalitarian was discussed earlier. This article was one of his many attacks on Social Security that proposed that good working conditions should be treated as taxable income (Feldstein 2005, p. 36). None of the articles offered any evidence of serious engagement with work, workers, or working conditions. In contrast, a search for sociologists' articles with the term "working conditions" that covered ten fewer journals, returned 107 articles.
At the same time as questions of labor were disappearing, economics began to elevate the status of investors' financial claims, insisting that owners of this form of property had rights equal to those of owners of real goods, such as land or factories. Even something as ephemeral as "good will" became recognized as property.
Friday, August 8, 2008
The Petro-Euro. Exchange Rate Warfare (continued)
I have been unable to post replies to blogs lately. I don't know why. So I continue the discussion on exchange rate warfare here.
YouNoSneaky has queried the very existence of an over-valued US dollar.
Discounting very recent declines, the US dollar has been over-valued for a long period of time. Probably (at least) since the early 1960s. That has got to do with the petro-dollar (1973) and global reserve currency (1948) arrangements.
"...At present, approximately two thirds of world trade is conducted in dollars and two thirds of central banks' currency reserves are held in the American currency which remains the sole currency used by international institutions such as the IMF. This confers on the US a major economic advantage: the ability to run a trade deficit year after year. It can do this because foreign countries need dollars to repay their debts to the IMF, to conduct international trade and to build up their currency reserves. The US provides the world with these dollars by buying goods and services produced by foreign countries, but since it does not have a corresponding need for foreign currency, it sells far fewer goods and services in return...." [1]
'Reason' correctly points out that Germany does not have a trade deficit. However Germany is the core of the Eurozone.
"...Getting a share of this economic free lunch has been one of the motivations, and perhaps the main motivation, behind setting up the euro2 . Were the euro to become a reserve currency equal to, or perhaps even instead of, the dollar, countries would reduce their dollar holdings while building up their euro savings. Another way of putting this would be to say that Eurozone countries would be able to reduce their subsidy to American consumption and would find that other countries were now subsidising Eurozone consumption instead...."[2]
The Eurozone does has a trade deficit.
World trade in today's context is dominated by (i) European and US multinational corporations (ii) these same multinationals enjoying monopoly market positions within nations and (ii) trading occuring within the same corporations (or networks of) across national boundaries. Given this, the question of global exchange rate wars between these two powerful camps - the Eurozone and the US - needs to be explored further.
Stefan Karlsson also points out that a net outflow of Foreign Direct Investment (FDI) from the US combined with a large inflow of foreign capital into the US is a very good deal for America [BR: or is it really for US multinatinals??], since this means that Americans can get money very cheaply from the Asian central banks and invest them in high-yielding investments in Asia. [This is] the mechanism behind the fact that America, despite the build-up of net foreign liabilities ..has had a surplus in net investment income of roughly $30 billion during 2004. The fact that foreigners have $11 trillion in U.S. assets versus U.S. holdings of only $8 trillion of assets outside America is thus more than compensated by the fact that U.S. investments offshore have a much higher average yield than foreign investments in America. It is not America who loses when the Asians lend money at low rates to Americans who can then invest it in high-yielding investments in Asia.”[3]
[1] 'Petrodollar or Petroeuro? A new source of global conflict.' By Cóilín Nunan. Accessed on 8th August 2008. http://www.feasta.org/documents/review2/nunan.htm
[2] 'Petrodollar or Petroeuro? A new source of global conflict.' By Cóilín Nunan. Accessed on 8th August 2008. http://www.feasta.org/documents/review2/nunan.htm
[3] What Are We to Make of the Trade Deficit?
Daily Article by Stefan Karlsson | Posted on 3/21/2005
http://mises.org/story/1762
YouNoSneaky has queried the very existence of an over-valued US dollar.
Discounting very recent declines, the US dollar has been over-valued for a long period of time. Probably (at least) since the early 1960s. That has got to do with the petro-dollar (1973) and global reserve currency (1948) arrangements.
"...At present, approximately two thirds of world trade is conducted in dollars and two thirds of central banks' currency reserves are held in the American currency which remains the sole currency used by international institutions such as the IMF. This confers on the US a major economic advantage: the ability to run a trade deficit year after year. It can do this because foreign countries need dollars to repay their debts to the IMF, to conduct international trade and to build up their currency reserves. The US provides the world with these dollars by buying goods and services produced by foreign countries, but since it does not have a corresponding need for foreign currency, it sells far fewer goods and services in return...." [1]
'Reason' correctly points out that Germany does not have a trade deficit. However Germany is the core of the Eurozone.
"...Getting a share of this economic free lunch has been one of the motivations, and perhaps the main motivation, behind setting up the euro2 . Were the euro to become a reserve currency equal to, or perhaps even instead of, the dollar, countries would reduce their dollar holdings while building up their euro savings. Another way of putting this would be to say that Eurozone countries would be able to reduce their subsidy to American consumption and would find that other countries were now subsidising Eurozone consumption instead...."[2]
The Eurozone does has a trade deficit.
World trade in today's context is dominated by (i) European and US multinational corporations (ii) these same multinationals enjoying monopoly market positions within nations and (ii) trading occuring within the same corporations (or networks of) across national boundaries. Given this, the question of global exchange rate wars between these two powerful camps - the Eurozone and the US - needs to be explored further.
Stefan Karlsson also points out that a net outflow of Foreign Direct Investment (FDI) from the US combined with a large inflow of foreign capital into the US is a very good deal for America [BR: or is it really for US multinatinals??], since this means that Americans can get money very cheaply from the Asian central banks and invest them in high-yielding investments in Asia. [This is] the mechanism behind the fact that America, despite the build-up of net foreign liabilities ..has had a surplus in net investment income of roughly $30 billion during 2004. The fact that foreigners have $11 trillion in U.S. assets versus U.S. holdings of only $8 trillion of assets outside America is thus more than compensated by the fact that U.S. investments offshore have a much higher average yield than foreign investments in America. It is not America who loses when the Asians lend money at low rates to Americans who can then invest it in high-yielding investments in Asia.”[3]
[1] 'Petrodollar or Petroeuro? A new source of global conflict.' By Cóilín Nunan. Accessed on 8th August 2008. http://www.feasta.org/documents/review2/nunan.htm
[2] 'Petrodollar or Petroeuro? A new source of global conflict.' By Cóilín Nunan. Accessed on 8th August 2008. http://www.feasta.org/documents/review2/nunan.htm
[3] What Are We to Make of the Trade Deficit?
Daily Article by Stefan Karlsson | Posted on 3/21/2005
http://mises.org/story/1762
Kvetching
I don't usually use the Internet to kvetch, but after 6 weeks of smoke that had me wearing a mask, I now am reduced to dialup. We lost on electricity on Tue. night because of the strongest thunderstorm I have ever witnessed. The walls on the house shook. Rapid lightening strikes eventually took out a transformer around the corner. I talked to some of the repairmen sitting in a truck. They could not do anything until someone came to tell them which transformer is out.
I told them that I could show it to them. It goes out frequently. 15 minutes later, they drove way. Finally, after continual promises that a fix was coming in 2 hours, we finally got electricity back on Wed. night, only to find out that our DSL was kaput.
AT&T has been giving us the same runaround as PG&E. One call promised that a technician would come by 8 tonight, but another said that we have our "appointment" between 8 am and 8 pm on Wed.
I told them that I could show it to them. It goes out frequently. 15 minutes later, they drove way. Finally, after continual promises that a fix was coming in 2 hours, we finally got electricity back on Wed. night, only to find out that our DSL was kaput.
AT&T has been giving us the same runaround as PG&E. One call promised that a technician would come by 8 tonight, but another said that we have our "appointment" between 8 am and 8 pm on Wed.
Exchange Rate Warfare
Perhaps readers may be able to help clarify the state of play for multinationals over the last few decades? I'm trying to piece together the jigsaw of international manoevres by the world's largest corporations.
It's interesting to observe that the nations with the largest deficits - the US, UK and Germany - are also the homes of the largest transnational corporations. Have their respective governments and reserve banks been:
(i) floating a lot of debt to these businesses at low interest rates;
(ii) maintaining artificially high exchange rates in order for their large MNCs to
(iii) accumulate assets relatively cheaply overseas and in order to facilitate
(iv) their cheap repayment of debt??
Now that these same corporations are caught in a recession with high levels of debt are we now seeing a taxpayer-funded bailout of these same MNCs?
It's interesting to observe that the nations with the largest deficits - the US, UK and Germany - are also the homes of the largest transnational corporations. Have their respective governments and reserve banks been:
(i) floating a lot of debt to these businesses at low interest rates;
(ii) maintaining artificially high exchange rates in order for their large MNCs to
(iii) accumulate assets relatively cheaply overseas and in order to facilitate
(iv) their cheap repayment of debt??
Now that these same corporations are caught in a recession with high levels of debt are we now seeing a taxpayer-funded bailout of these same MNCs?
Thursday, August 7, 2008
Feldstein on the Tax Rebate – Life-cycle Model Vindicated
When President Bush and some in Congress thought that their one-time tax rebate was just the right fiscal remedy for an economy about to enter a Keynesian slowdown, some of us wonder if Albert Ando and Franco Modigliani’s old life cycle model of consumption had it right – that people would save much of this one-time tax rebate. Martin Feldstein argues that they were correct:
That’s right – very little bang for the buck. Feldstein takes this evidence and then turns on one of Obama’s proposals:
If Obama’s proposal was solely to boost consumption demand – it is even worse than this as it is a transfer of income from one household to another with the likely effect on aggregate consumption being zero if the households had similar marginal propensities to consume. But a lack of consumption is not what ails the US economy. Furthermore, Obama’s proposal is more designed to address income inequality and less about Keynesian demand stimulus. The fiscal stimulus part of the Obama plan would be from accelerating certain forms of public investment.
Feldstein closes on what I consider heresy:
Feldstein is well aware that we have a long-term fiscal imbalance with the current level of taxes being far below the current and projected level of government spending. Ricardian Equivalence types would mock at the idea that recognizing those deferred taxes into current taxes might curb aggregate demand. And even if one rejects Ricardian Equivalence, how can any economists with a supply-side orientation dismiss fiscal responsibility. After all, Keynesian maladies tend to be short-run affairs but the crowding-out of investment is something that lowers long-term growth. Feldstein knows this and usually preaches this. What on earth got him to close his WSJ oped with such heresy?
Update: Mark Thoma is linking to several comments about this Feldstein oped including how Free Exchange has caught Feldstein criticizing something he once endorsed:
Tax rebates of $78 billion arrived in the second quarter of the year. The government's recent GDP figures show that the level of consumer outlays only rose by an extra $12 billion, or 15% of the lost revenue. The rest went into savings, including the paydown of debt.
That’s right – very little bang for the buck. Feldstein takes this evidence and then turns on one of Obama’s proposals:
These conclusions are significant for evaluating the likely impact of Barack Obama's recent proposal to distribute $1,000 rebate checks to low- and middle-income workers at an estimated cost of approximately $65 billion. His plan, to finance those rebates with an extra tax on oil companies, would reduce investment in refining and exploration, keeping oil prices higher than they would otherwise be … All of the evidence on one-time tax rebates implies that the Obama plan to send $1,000 rebate checks would do little to raise consumer spending and stop the decline in employment. If the past is an indicator of what would happen, the $65 billion he proposes to spend on this plan would raise consumer spending by only about $10 billion, or less than one-tenth of 1% of GDP.
If Obama’s proposal was solely to boost consumption demand – it is even worse than this as it is a transfer of income from one household to another with the likely effect on aggregate consumption being zero if the households had similar marginal propensities to consume. But a lack of consumption is not what ails the US economy. Furthermore, Obama’s proposal is more designed to address income inequality and less about Keynesian demand stimulus. The fiscal stimulus part of the Obama plan would be from accelerating certain forms of public investment.
Feldstein closes on what I consider heresy:
The distinction between one-time tax rebates and permanent changes in net income is also important for the debate about Mr. Obama's proposal to raise income and payroll taxes. Because those tax increases would be permanent, they would cause a substantial reduction in consumer spending and aggregate demand.
Feldstein is well aware that we have a long-term fiscal imbalance with the current level of taxes being far below the current and projected level of government spending. Ricardian Equivalence types would mock at the idea that recognizing those deferred taxes into current taxes might curb aggregate demand. And even if one rejects Ricardian Equivalence, how can any economists with a supply-side orientation dismiss fiscal responsibility. After all, Keynesian maladies tend to be short-run affairs but the crowding-out of investment is something that lowers long-term growth. Feldstein knows this and usually preaches this. What on earth got him to close his WSJ oped with such heresy?
Update: Mark Thoma is linking to several comments about this Feldstein oped including how Free Exchange has caught Feldstein criticizing something he once endorsed:
MARTIN FELDSTEIN wrote back in December of 2007 that a fiscal stimulus was needed, and that a good way to design said stimulus was in the form of uniform tax rebates. For once, Congress did just what an economist wanted it to do, introducing a tax rebate stimulus plan that sent cheques to millions of households in the second quarter of this year. Naturally Mr Feldstein is appreciative, no? No. In today's Wall Street Journal, Mr Feldstein writes that of course the stimulus didn't work, and what's more, any old fool should have known it wouldn't. I believe this is what is known as a flip-flop.
Tuesday, August 5, 2008
More Pension Ripoffs: Ellen Schultz Deserves an Award
Ellen Schulz deserves some sort of award for keeping on top of the pension ripoffs that the corporations pull off. Here she also discusses my old employer, Consolidated Freightways.
Basically, the companies, even when they are cutting benefits for ordinary workers, they get shift lush executive pensions into the tax-free pension fund, increasing profits and managerial benefits at the same time.
Here is the article. Read it and weep.
Wall Street Journal - August 4, 2008
Companies Tap Pension Plans
To Fund Executive Benefits
Little-Known Move
Uses Tax Break Meant
For Rank and File
By ELLEN E. SCHULTZ and THEO FRANCIS
At a time when scores of companies are freezing pensions for their workers, some are quietly converting their pension plans into resources to finance their executives' retirement benefits and pay.
In recent years, companies from Intel Corp. to CenturyTel Inc. collectively have moved hundreds of millions of dollars of obligations for executive benefits into rank-and-file pension plans. This lets companies capture tax breaks intended for pensions of regular workers and use them to pay for executives' supplemental benefits and compensation.
The practice has drawn scant notice. A close examination by The Wall Street Journal shows how it works and reveals that the maneuver, besides being a dubious use of tax law, risks harming regular workers. It can drain assets from pension plans and make them more likely to fail. Now, with the current bear market in stocks weakening many pension plans, this practice could put more in jeopardy.
How many is impossible to tell. Neither the Internal Revenue Service nor other agencies track this maneuver. Employers generally reveal little about it. Some benefits consultants have warned them not to, in order to forestall a backlash by regulators and lower-level workers.
The background: Federal law encourages employers to offer pensions by giving companies a tax deduction when they contribute cash to a pension plan, and by letting the money in the plan grow tax free. Executives, like anyone else, can participate in these plans.
But their benefits can't be disproportionately large. IRS rules say pension plans must not "discriminate in favor of highly compensated employees." If a company wants to give its executives larger pensions -- as most do -- it must provide "supplemental" executive pensions, which don't carry any tax advantages.
The trick is to find a way to move some of the obligations for supplemental pensions into the plan that qualifies for tax breaks. Benefits consultants market sophisticated techniques to help companies do just that, without running afoul of IRS rules against favoring the highly paid.
Now, when the executives get ready to collect their deferred salaries, Intel won't have to pay them out of cash; the pension plan will pay them.
Normally, companies can deduct the cost of deferred comp only when they actually pay it, often many years after the obligation is incurred. But Intel's contribution to the pension plan was deductible immediately. Its tax saving: $65 million in the first year. In other words, taxpayers helped finance Intel's executive compensation.
Meanwhile, the move is enabling Intel to book as much as an extra $136 million of profit over the 10 years that began in 2005. That reflects the investment return Intel assumes on the $187 million.
Fred Thiele, Intel's global retirement manager, said the benefit was probably somewhat lower, because if Intel hadn't contributed this $187 million to the pension plan, it would have invested the cash or used it in some other productive way.
The company said the move aided shareholders and didn't hurt lower-paid employees because most don't benefit from Intel's pension plan. Instead, they receive their retirement benefits mainly from a profit-sharing plan, with the pension plan serving as a backup in case profit-sharing falls short.
The result, though, is that a majority of the tax-advantaged assets in Intel's pension plan are dedicated not to providing pensions for the rank and file but to paying deferred compensation of the company's most highly paid employees, roughly 4% of the work force.
On the Hook
And taxpayers are on the hook in other ways. When deferred executive salaries and bonuses are part of a pension plan, they can be rolled over into an Individual Retirement Account -- another tax-advantaged vehicle.
Intel believes that its practices "feel consistent" with both the spirit and letter of the law that gives tax benefits for providing pensions.
Intel may be a model for what's to come. Many companies are phasing out their pension plans, typically by "freezing" them, i.e., ending workers' buildup of new benefits. This leaves more pension assets available to cover executives' compensation and supplemental benefits. A number of companies have shifted executive benefits into frozen pension plans.
Technically, a company makes this move by increasing an executive's benefit in the regular pension plan by X dollars and canceling X dollars of the executive's deferred comp or supplemental pension.
CenturyTel, for instance, in 2005 moved its IOU for the supplemental pensions of 18 top employees into its regular pension plan. Chief Executive Glen Post's benefits in the regular pension plan jumped to $110,000 a year from $12,000. A spokesman for the Monroe, La., company, which made more such transfers in 2006, was frank about its motive: to take advantage of tax breaks by paying executive benefits out of a tax-advantaged pension plan.
How They Do It
So how can companies boost regular pension benefits for select executives while still passing the IRS's nondiscrimination tests? Benefits consultants help them figure out how.
To prove they don't discriminate, companies are supposed to compare what low-paid and high-paid employees receive from the pension plan. They don't have to compare actual individuals; they can compare ratios of the benefits received by groups of highly paid vs. groups of lower-paid employees.
Such a measure creates the potential for gerrymandering -- carefully moving employees about, in various theoretical groupings, to achieve a desired outcome.
Another technique: Count Social Security as part of the pension. This effectively raises low-paid employees' overall retirement benefits by a greater percentage than it raises those of the highly paid -- enabling companies to then increase the pensions of higher-paid people.
Indeed, "it is actually these discrimination tests that give rise to Qserp in the first place!" said materials from one consulting firm, Watson Wyatt Worldwide. "Qserp" means "qualified supplemental executive retirement plan" -- an industry term for a supplemental executive pension that "qualifies" for tax breaks.
Watson Wyatt senior consultant Alan Glickstein said the firm's calculations tell employers exactly how much disparity they can achieve between the pensions of highly paid people and others. "At the end, when the game is over, when the computer is cooling off, you know whether you passed [the IRS nondiscrimination tests] or not," he said. At that point, companies can retrofit the benefits of select executives, feeding some into the pension plan.
They can do this even if they freeze the pension plan, because executives' supplemental benefits and deferred comp aren't based on the frozen pension formula.
Keeping Quiet
Generally, only the executives are aware this is being done. Benefits consultants have advised companies to keep quiet to avoid an employee backlash. In material prepared for employers, Robert Schmidt, a consulting actuary with Milliman Inc., said that to "minimize this problem" of employee relations, companies should draw up a memo describing the transfer of supplemental executive benefits to the pension plan and give it "only to employees who are eligible."
The IRS was also a concern for Mr. Schmidt. He advised employers that in "dealing with the IRS," they should ask it for an approval letter, because if the agency later cracks down, its restrictions probably won't be retroactive.
"At some point in the future, the IRS may well take the position" that supplemental executive pensions moved into a regular pension plan "violate the 'spirit' of the nondiscrimination rules," Mr. Schmidt wrote. In an interview, he confirmed his written comments.
Companies don't explicitly tell the IRS that an amendment is intended to shift supplements executive benefits obligations into the regular pension plan. "They hide it," a Treasury official said. "They include the amendment with other amendments, and don't make it obvious."
With too little staffing to check the dozens of pages of actuaries' calculations, the IRS generally accepts the companies' assurances that their pension plans pass the discrimination tests, the official said.
"Under existing rules, there's little we can do anyway. If Congress doesn't like it, it can change the rules." To halt the practice, Congress would have to end the flexibility that companies now have in meeting the IRS nondiscrimination tests.
A spokesman for the IRS said it has no idea how many such pension amendments it has approved or how much money is involved.
A Way to Pass
Sometimes, the only tipoff that a firm is moving executive benefits into the regular pension is that it provides small increases to some lower-paid groups in the plan, in order to pass the nondiscrimination tests.
Royal & SunAlliance, an insurer, sold a division and laid off its 228 employees in 1999. Just before doing so, it amended the division's pension plan to award larger benefits to eight departing officers and directors. One human-resources executive got an additional $5,270 a month for life.
But to do this and still pass the IRS's nondiscrimination tests, the company needed to give tiny pension increases to 100 lower-level workers, said the company's benefits consultant, PricewaterhouseCoopers. One got an increase of $1.92 a month.
Joseph Gromala, a middle manager who stood to get $8.87 more a month at age 65, wrote to the company seeking details about higher sums other people were receiving. A lawyer wrote back saying the company didn't have to show him the relevant pension-plan amendment.
Mr. Gromala then sued in federal court, claiming that administrators of the pension plan were breaching their duty to operate it in participants' best interests. The company replied that its move was a business decision, not a pension decision, so the fiduciary issue was moot. The Sixth U.S. Circuit Court of Appeals agreed.
PricewaterhouseCoopers declined to comment. A spokesman for Royal & SunAlliance's former U.S. operation, now called Arrowpoint Capital, said the pension plan "wasn't discriminatory." Royal & SunAlliance recently changed its name to RSA Insurance Group.
Pension-plan amendments like the documents Mr. Gromala sought must be filed with the IRS, but the agency normally won't disclose specifics such as who benefits. The IRS says it can't release details of the amendments because they reflect individuals' benefits.
Not So Safe
Employers sometimes tell executives that moving their supplemental pensions or deferred comp into the company pension plan will make them more secure. Normally, supplemental pensions or deferred comp are just unsecured promises; companies don't set aside cash for supplemental executive pensions and deferred comp because there's no tax break for doing so. But the promises will be backed by assets if the company can squeeze them into a tax-advantaged pension plan.
This supposed security can prove illusory, as executives at Consolidated Freightways found out.
The trucking firm moved most of its retirement IOUs for eight top officers into its pension plan in late 2001. It said this would protect most or all of their promised benefits, which ranged up to $139,000 a year.
This came as relief to Tom Paulsen, then chief operating officer, who says he knew the Vancouver, Wash., trucking company was on "thin ice."
But the pension plan was underfunded. And Consolidated didn't add more assets to it when the company gave the plan new obligations. Adding the executive IOUs thus made the plan weaker. It went from having about 96% of the assets needed to pay promised benefits to having just 79%.
Losing Benefits
Consolidated later filed for bankruptcy and handed its pension plan over to a government insurer, the Pension Benefit Guaranty Corp. The PBGC commits to paying pensions only up to certain limits. Mr. Paulsen said he and other executives have been told they won't get their supplemental pensions.
Some lower-level people will lose benefits, too. Chester Madison, a middle manager who retired in 2002 after 33 years, saw his pension fall to $20,400 a year from $49,200. Mr. Madison, 62, has taken a job selling flooring in Sacramento, Calif.
He faults those who made the pension decisions. "I look at it as greed and taking care of the top echelons," he says.
It's impossible to know how much the addition of executive pensions to the pension plan contributed to the plan's failure. But in this as in similar companies where a plan saddled with executive benefits failed -- such as at kitchenware maker Oneida Ltd. in upstate New York -- it's clear the move weakened the plans by adding liabilities but no assets.
A trustee for Consolidated's bankruptcy liquidation declined to discuss details of the company's pension plan.
Mr. Madison and five other ex-employees sued Towers Perrin, a consulting firm that had advised Consolidated on structuring its benefits. The suit, alleging professional negligence over this and other issues, was dismissed in late 2006 by a federal court in the Northern District of California. Towers Perrin declined to comment.
Some companies, after moving executives' supplemental benefits into a pension plan, now take steps to protect them. When Hartmarx Corp. added executive obligations to its pension plan last year, it set up a trust that automatically would be funded if the plan failed.
Glenn Morgan, the clothier's chief financial officer, said the trust benefits nine or 10 people. "The purpose is to pay them the benefit they've earned," he said.
Basically, the companies, even when they are cutting benefits for ordinary workers, they get shift lush executive pensions into the tax-free pension fund, increasing profits and managerial benefits at the same time.
Here is the article. Read it and weep.
Wall Street Journal - August 4, 2008
Companies Tap Pension Plans
To Fund Executive Benefits
Little-Known Move
Uses Tax Break Meant
For Rank and File
By ELLEN E. SCHULTZ and THEO FRANCIS
At a time when scores of companies are freezing pensions for their workers, some are quietly converting their pension plans into resources to finance their executives' retirement benefits and pay.
In recent years, companies from Intel Corp. to CenturyTel Inc. collectively have moved hundreds of millions of dollars of obligations for executive benefits into rank-and-file pension plans. This lets companies capture tax breaks intended for pensions of regular workers and use them to pay for executives' supplemental benefits and compensation.
The practice has drawn scant notice. A close examination by The Wall Street Journal shows how it works and reveals that the maneuver, besides being a dubious use of tax law, risks harming regular workers. It can drain assets from pension plans and make them more likely to fail. Now, with the current bear market in stocks weakening many pension plans, this practice could put more in jeopardy.
How many is impossible to tell. Neither the Internal Revenue Service nor other agencies track this maneuver. Employers generally reveal little about it. Some benefits consultants have warned them not to, in order to forestall a backlash by regulators and lower-level workers.
The background: Federal law encourages employers to offer pensions by giving companies a tax deduction when they contribute cash to a pension plan, and by letting the money in the plan grow tax free. Executives, like anyone else, can participate in these plans.
But their benefits can't be disproportionately large. IRS rules say pension plans must not "discriminate in favor of highly compensated employees." If a company wants to give its executives larger pensions -- as most do -- it must provide "supplemental" executive pensions, which don't carry any tax advantages.
The trick is to find a way to move some of the obligations for supplemental pensions into the plan that qualifies for tax breaks. Benefits consultants market sophisticated techniques to help companies do just that, without running afoul of IRS rules against favoring the highly paid.
Now, when the executives get ready to collect their deferred salaries, Intel won't have to pay them out of cash; the pension plan will pay them.
Normally, companies can deduct the cost of deferred comp only when they actually pay it, often many years after the obligation is incurred. But Intel's contribution to the pension plan was deductible immediately. Its tax saving: $65 million in the first year. In other words, taxpayers helped finance Intel's executive compensation.
Meanwhile, the move is enabling Intel to book as much as an extra $136 million of profit over the 10 years that began in 2005. That reflects the investment return Intel assumes on the $187 million.
Fred Thiele, Intel's global retirement manager, said the benefit was probably somewhat lower, because if Intel hadn't contributed this $187 million to the pension plan, it would have invested the cash or used it in some other productive way.
The company said the move aided shareholders and didn't hurt lower-paid employees because most don't benefit from Intel's pension plan. Instead, they receive their retirement benefits mainly from a profit-sharing plan, with the pension plan serving as a backup in case profit-sharing falls short.
The result, though, is that a majority of the tax-advantaged assets in Intel's pension plan are dedicated not to providing pensions for the rank and file but to paying deferred compensation of the company's most highly paid employees, roughly 4% of the work force.
On the Hook
And taxpayers are on the hook in other ways. When deferred executive salaries and bonuses are part of a pension plan, they can be rolled over into an Individual Retirement Account -- another tax-advantaged vehicle.
Intel believes that its practices "feel consistent" with both the spirit and letter of the law that gives tax benefits for providing pensions.
Intel may be a model for what's to come. Many companies are phasing out their pension plans, typically by "freezing" them, i.e., ending workers' buildup of new benefits. This leaves more pension assets available to cover executives' compensation and supplemental benefits. A number of companies have shifted executive benefits into frozen pension plans.
Technically, a company makes this move by increasing an executive's benefit in the regular pension plan by X dollars and canceling X dollars of the executive's deferred comp or supplemental pension.
CenturyTel, for instance, in 2005 moved its IOU for the supplemental pensions of 18 top employees into its regular pension plan. Chief Executive Glen Post's benefits in the regular pension plan jumped to $110,000 a year from $12,000. A spokesman for the Monroe, La., company, which made more such transfers in 2006, was frank about its motive: to take advantage of tax breaks by paying executive benefits out of a tax-advantaged pension plan.
How They Do It
So how can companies boost regular pension benefits for select executives while still passing the IRS's nondiscrimination tests? Benefits consultants help them figure out how.
To prove they don't discriminate, companies are supposed to compare what low-paid and high-paid employees receive from the pension plan. They don't have to compare actual individuals; they can compare ratios of the benefits received by groups of highly paid vs. groups of lower-paid employees.
Such a measure creates the potential for gerrymandering -- carefully moving employees about, in various theoretical groupings, to achieve a desired outcome.
Another technique: Count Social Security as part of the pension. This effectively raises low-paid employees' overall retirement benefits by a greater percentage than it raises those of the highly paid -- enabling companies to then increase the pensions of higher-paid people.
Indeed, "it is actually these discrimination tests that give rise to Qserp in the first place!" said materials from one consulting firm, Watson Wyatt Worldwide. "Qserp" means "qualified supplemental executive retirement plan" -- an industry term for a supplemental executive pension that "qualifies" for tax breaks.
Watson Wyatt senior consultant Alan Glickstein said the firm's calculations tell employers exactly how much disparity they can achieve between the pensions of highly paid people and others. "At the end, when the game is over, when the computer is cooling off, you know whether you passed [the IRS nondiscrimination tests] or not," he said. At that point, companies can retrofit the benefits of select executives, feeding some into the pension plan.
They can do this even if they freeze the pension plan, because executives' supplemental benefits and deferred comp aren't based on the frozen pension formula.
Keeping Quiet
Generally, only the executives are aware this is being done. Benefits consultants have advised companies to keep quiet to avoid an employee backlash. In material prepared for employers, Robert Schmidt, a consulting actuary with Milliman Inc., said that to "minimize this problem" of employee relations, companies should draw up a memo describing the transfer of supplemental executive benefits to the pension plan and give it "only to employees who are eligible."
The IRS was also a concern for Mr. Schmidt. He advised employers that in "dealing with the IRS," they should ask it for an approval letter, because if the agency later cracks down, its restrictions probably won't be retroactive.
"At some point in the future, the IRS may well take the position" that supplemental executive pensions moved into a regular pension plan "violate the 'spirit' of the nondiscrimination rules," Mr. Schmidt wrote. In an interview, he confirmed his written comments.
Companies don't explicitly tell the IRS that an amendment is intended to shift supplements executive benefits obligations into the regular pension plan. "They hide it," a Treasury official said. "They include the amendment with other amendments, and don't make it obvious."
With too little staffing to check the dozens of pages of actuaries' calculations, the IRS generally accepts the companies' assurances that their pension plans pass the discrimination tests, the official said.
"Under existing rules, there's little we can do anyway. If Congress doesn't like it, it can change the rules." To halt the practice, Congress would have to end the flexibility that companies now have in meeting the IRS nondiscrimination tests.
A spokesman for the IRS said it has no idea how many such pension amendments it has approved or how much money is involved.
A Way to Pass
Sometimes, the only tipoff that a firm is moving executive benefits into the regular pension is that it provides small increases to some lower-paid groups in the plan, in order to pass the nondiscrimination tests.
Royal & SunAlliance, an insurer, sold a division and laid off its 228 employees in 1999. Just before doing so, it amended the division's pension plan to award larger benefits to eight departing officers and directors. One human-resources executive got an additional $5,270 a month for life.
But to do this and still pass the IRS's nondiscrimination tests, the company needed to give tiny pension increases to 100 lower-level workers, said the company's benefits consultant, PricewaterhouseCoopers. One got an increase of $1.92 a month.
Joseph Gromala, a middle manager who stood to get $8.87 more a month at age 65, wrote to the company seeking details about higher sums other people were receiving. A lawyer wrote back saying the company didn't have to show him the relevant pension-plan amendment.
Mr. Gromala then sued in federal court, claiming that administrators of the pension plan were breaching their duty to operate it in participants' best interests. The company replied that its move was a business decision, not a pension decision, so the fiduciary issue was moot. The Sixth U.S. Circuit Court of Appeals agreed.
PricewaterhouseCoopers declined to comment. A spokesman for Royal & SunAlliance's former U.S. operation, now called Arrowpoint Capital, said the pension plan "wasn't discriminatory." Royal & SunAlliance recently changed its name to RSA Insurance Group.
Pension-plan amendments like the documents Mr. Gromala sought must be filed with the IRS, but the agency normally won't disclose specifics such as who benefits. The IRS says it can't release details of the amendments because they reflect individuals' benefits.
Not So Safe
Employers sometimes tell executives that moving their supplemental pensions or deferred comp into the company pension plan will make them more secure. Normally, supplemental pensions or deferred comp are just unsecured promises; companies don't set aside cash for supplemental executive pensions and deferred comp because there's no tax break for doing so. But the promises will be backed by assets if the company can squeeze them into a tax-advantaged pension plan.
This supposed security can prove illusory, as executives at Consolidated Freightways found out.
The trucking firm moved most of its retirement IOUs for eight top officers into its pension plan in late 2001. It said this would protect most or all of their promised benefits, which ranged up to $139,000 a year.
This came as relief to Tom Paulsen, then chief operating officer, who says he knew the Vancouver, Wash., trucking company was on "thin ice."
But the pension plan was underfunded. And Consolidated didn't add more assets to it when the company gave the plan new obligations. Adding the executive IOUs thus made the plan weaker. It went from having about 96% of the assets needed to pay promised benefits to having just 79%.
Losing Benefits
Consolidated later filed for bankruptcy and handed its pension plan over to a government insurer, the Pension Benefit Guaranty Corp. The PBGC commits to paying pensions only up to certain limits. Mr. Paulsen said he and other executives have been told they won't get their supplemental pensions.
Some lower-level people will lose benefits, too. Chester Madison, a middle manager who retired in 2002 after 33 years, saw his pension fall to $20,400 a year from $49,200. Mr. Madison, 62, has taken a job selling flooring in Sacramento, Calif.
He faults those who made the pension decisions. "I look at it as greed and taking care of the top echelons," he says.
It's impossible to know how much the addition of executive pensions to the pension plan contributed to the plan's failure. But in this as in similar companies where a plan saddled with executive benefits failed -- such as at kitchenware maker Oneida Ltd. in upstate New York -- it's clear the move weakened the plans by adding liabilities but no assets.
A trustee for Consolidated's bankruptcy liquidation declined to discuss details of the company's pension plan.
Mr. Madison and five other ex-employees sued Towers Perrin, a consulting firm that had advised Consolidated on structuring its benefits. The suit, alleging professional negligence over this and other issues, was dismissed in late 2006 by a federal court in the Northern District of California. Towers Perrin declined to comment.
Some companies, after moving executives' supplemental benefits into a pension plan, now take steps to protect them. When Hartmarx Corp. added executive obligations to its pension plan last year, it set up a trust that automatically would be funded if the plan failed.
Glenn Morgan, the clothier's chief financial officer, said the trust benefits nine or 10 people. "The purpose is to pay them the benefit they've earned," he said.
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