Saturday, January 31, 2009

"From 2002 to 2008, the five biggest Wall Street securities firms [Bear Stearns, Goldman Sachs, Lehman Brothers, Merrill Lynch, and Morgan Stanley] paid an estimated $190 billion in bonuses. Those companies churned out $76 billion in combined profits during the same period. Last year, the companies had a combined net loss of $25.3 billion, yet paid bonuses of roughly $26 billion."

Lucchetti, Aaron and Matthew Karnitschnig. 2009. "On Street, New Reality on Pay Sets In: Financial Firms Race to Reset Compensation Policies as U.S. Government Aims to Set Some Limits." Wall Street Journal (31 January): p. B 1.

Marx before Minsky

Previously, I made the case that the financial meltdown was basically a delayed response to the severe neglect of investment in plant, equipment, and infrastructure. I also explained the cause of this neglect.

Here, I'm going to discuss the financial side of the crisis, which, while secondary, is still important.

This crisis has been nicely described as a Minsky moment, but it may just as well be described as a Marx moment. Marx's term fictitious capital and the more conventional discounted present value are not entirely different, but Marx's expression emphasizes the fact that the future is both unknown and unknowable.

As Keynes explained very well, the future takes on an appearance of being known, but this knowledge is not knowledge at all. It is merely an extrapolation of the past.

There was a time when the returns from holding General Motors stock would have seemed very predictable, almost as much as an investment with Bernie Madoff.

Anticipating Hyman Minsky, Marx realized that over time people would become less risk averse and the risk-corrected discounted present values would start to rise. Extrapolating, this trend would be expected to continue.

What I did, many years ago, in Karl Marx's Crises Theory: Labor, Scarcity and Fictitious Capital (New York: Praeger, 1987) was to explain that this psychological phenomenon would tend to delink prices from underlying values. Expensive corporate headquarters would be built into the overhead costs of business. At the same time, as such capital values accumulate, measures of invested capital will increase, pulling down the rate of profit. Hunting for yields to maintain profit rates will set off bubbles, further promoting an even more speculative environment. Over time, this speculative psychology will eliminate the limited coordinating powers of the market and set the stage for a future crisis.

When the crisis comes, much of the fictitious capital will disappear, bringing prices more in line with underlying values.

In a sense, this part of Marx's crisis theory is not that far from Hayek's, but I think that Hayek may have taken this from Marx without attribution.

All this sounds very Minskyian. Of course, Minsky knew his Marx, just as he knew his Keynes. And Keynes, though never really studied Marx by his own confession, was surrounded by people who did.

Does Protection Have No Impact on Aggregate Demand?

Nick Rowe makes an argument against the “Buy American” provisions that I have made in the past:

Most (all?) economists agree that in a global recession, when each country wants to boost demand for the goods it produces, policies which steer demand to domestically-produced goods are individually rational (provided other countries don't retaliate), but collectively irrational when all countries do the same. I think most economists are wrong. It's not just collectively irrational, but individually irrational as well, at least for countries with flexible exchange rates ... In normal times, outside of a liquidity trap, an expansionary fiscal policy will put upward pressure on interest rates as the demand for money increases with higher income. Or the central bank raises interest rates to offset the increased demand to keep inflation on target. An increase in domestic interest rates will cause a capital account inflow, which causes the exchange rate to appreciate. The exchange rate appreciation will cause net exports to fall. The fall in net exports offsets the expansionary fiscal policy. Under imperfect capital mobility the offset will be partial. Under perfect capital mobility there will be full offset, for a small open economy. So in normal times, part or all of the increased demand from an expansionary fiscal policy will be lost due to a decline in net exports. Some or all of the extra demand just leaks out to foreign countries.

Nick then admits that if we are in a liquidity trap, the interest rate to capital account channel is cut off so a fiscal stimulus does not necessarily crowd-out net exports but then he writes:

A "buy domestic" policy will not shift demand towards domestic goods. If it did, so that imports fell and net exports increased, the current account surplus would merely cause the exchange rate to appreciate so that net exports fell to their original level. The current account must stay the same, because the capital account stays the same, because the interest rate differential stays the same, because interest rates stay the same.

Dani Rodrik, however, takes another view:

Yes it does. And not just in theory, but also in practice. The evidence comes from the 1930s, and from the work of Ben Bernanke himself (along with other scholars like Barry Eichengreen). The important finding is that countries that devalued their currencies by getting off the gold standard were able to recover more quickly, thanks in part to an increase in their net exports relative to countries that stayed on gold. Note that a currency depreciation amounts to a policy of combining import tariffs with export subsidies--hence the mercantilist intent and effect.

Dani also notes:

How much of a boost to economic activity will a fiscal stimulus provide? For those who believe that we have entered a Keynesian world of shortage of aggregate demand--me included--the answer depends on the Keynesian multiplier. The size of this multiplier depends in turn on three things in particular, the marginal propensity to consume (c), the marginal tax rate (t), and the marginal propensity to import (m). If c = 0.8, t = 0.2, and m = 0.2, the Keynesian multiplier is 1.8 (=1/(1-c(1-t)+m)). A $1 trillion fiscal stimulus would increase GDP by $1.8 trillion. Now suppose that we had a way to raise the multiplier by more than half, from 1.8 to 2.8. The same fiscal stimulus would now produce an increase in GDP of $2.8 trillion--quite a difference. Nice deal if you can get it. In fact you can. It is pretty easy to increase the multiplier; just raise import tariffs by enough so that the marginal propensity to import out of income is reduced substantially (to zero if you want the multiplier to go all the way to 2.8). Yes, yes, import protection is inefficient and not a very neighborly thing to do--but should we really care if the alternative is significantly lower growth and higher unemployment? More to the point, will Obama and his advisers care?

I guess Nick can come back and say Dani was assuming fixed exchange rates. So how is this all supposed to work out under fixed interest rates but floating exchange rates?

Our model is essentially:

Y = D(Y) + X(Y, e)

where Y = real GDP, D = domestic demand, X = net exports, and e is the real exchange rate. Let’s consider a hypothetical economy known as Obamia that has a domestic marginal propensity to spend = 0.8 and a marginal propensity to import = 0.2 and wants to increase real GDP by $1000 (think of America as one billion times the size of Obamia). Under fixed exchange rates and no trade protection, the multiplier is 2.5 so government purchases would have to be raised by $400 if no other policy tool was used. As real GDP rose increased by $1000, imports would increase by $200.

But suppose that the conservative part of Obamia balks at a large fiscal stimulus and its leaders reach some bipartisan compromise of having government purchases rise by only $200. Dani’s point is that if we adopt a mercantilist policy to increase the net export schedule by $200, then we can still achieve the real GDP goal.

Nick’s floating exchange rate version of the model, however, has the exchange rate automatically adjust such that the ultimate change in net exports is zero. In this case, the multiplier for fiscal policy is 5 and the multiplier for mercantilist policy is zero. In other words, a $200 increase in government purchases still achieves the goal of increasing real GDP by $1000. Lesson learned – floating exchange rates can achieve the same goal as Dani’s mercantilism. There is one difference, however, between the two approaches. Mercantilism often works by protecting the import competing sector. Under floating exchange rates, we are more likely to see increased employment in the export sector.

The House's Modern-Day Hoovers

Time to turn the microphone over to Colbert I. King:

The pain of this recession was apparently lost on Boehner and his House Republicans. Their public fretting over the future impact of deficits on today's children and grandchildren is disingenuous. In truth, what really gets them hot and bothered is the thought of government taking on more responsibility to fight this deepening recession, and the huge amount of public spending it will take to pull the economy out of the doldrums. It so happened that the Republican standard-bearer in the 1920s, Herbert Hoover, felt that way, too. Hoover's distaste for government, and his belief that business was the answer to the country's economic tailspin, got Democrat Franklin Delano Roosevelt elected president in 1932. In their slavish devotion to Hooverism, today's Republicans are repeating the mistakes that banished their party to the political wilderness in the '30s.

Friday, January 30, 2009

The Disastrous Toll of Fictitious Value

The world of fictitious value mesmerizes itself by using a strange language. Financial operations refer to their "shop," as if they were standing over a workbench shaping metal or wood. Then they talk about "value creation."

What does that mean? Suppose I start a private equity company. People give me money to create value. I can create this value by taking over a company with very little of my own money. I need a banking accomplice to give me a bridge loan and a compliant company management. Then I can "unlock" the firm's value.

Once source of untapped value is a pension fund. Workers can be granted stock in the company as compensation. I can take over the firm, then use the pension fund to pay for some of the money I own. I can load the firm up with debt and charge it exorbitant fees. Now I have begun to "unlock" value.

Next, I can fire lots of workers, including those whose pension fund financed my takeover. By doing so, I can show that I am creating efficiencies. Once I cook the books to make the firm look profitable and sell it to a unsuspecting public.

Should anyone be surprised that many of these companies have been going bankrupt? And the workers whose pensions were central to the process? Well, they have some pretty paper.

Ain't capital wonderful?

(Harrisonburg, Pay Attention) The Wonders of City Bike Systems

There is now a nice, green policy that is being followed in as many as 21 European cities that is not yet being followed in a single US one that I am aware of, having just googled a bunch on the matter. It is a city bike system, also sometimes generically called a "Velib" system after the very popular and famous one in Paris that began in 2007. However, while it is doing very well (see the Wikipedia entry for "Velib" about it), it has some oddities that may make it less desirable for cities in the US thinking of adopting such a system, it being run by a private company for the city.

Probably the oldest running, since the 1970s, and the best run is the one in Copenhagen, where nearly 40% of trips are now done by city bike. The city (actually through a non-profit organization) owns bikes that are kept in parking stands. In Paris they make you pay a subscription, and then you can access the bikes, which are locked up in their stands. In both the stands are all over the city, but in Copenhagen they are free. You just pull one out and ride it to another stand. Reduces traffic, improves health, reduces pollution, and any city in the US would look very cool and progressive and innovative if it were the first one in the country to do it. The bikes tend to be three speed and pretty tough with a good-sized basket in front. The biggest problems have been with car traffic, and in Copenhagen, with cars turning right and not paying attention to bikes coming up. Anyway, a nice link about the Copenhagen system.

Draft Submission to the White House Task Force on Working Families

by the Sandwichman

White House press release:
President Barack Obama today announced the creation of a White House Task Force on Middle Class Working Families to be chaired by Vice President Joe Biden. The Task Force is a major initiative targeted at raising the living standards of middle-class, working families in America. It is comprised of top-level administration policy makers, and in addition to regular meetings, it will conduct outreach sessions with representatives of labor, business, and the advocacy communities.
In response to the White House announcement, the Sandwichman is posting his Draft Submission to the White House Task Force on Working Families on EconoSpeak. This submission specifically addresses four of the major objectives for the Task Force, as elaborated in statements by President Obama and Vice President Biden, and in the theme for the first meeting of the Task Force on February 27, 2009 in Philadelphia, Pennsylvania:

· ensuring that the benefits of economic growth reach middle-class, working families;
· improving work and family balance;
· restoring labor standards;
· focusing on "green jobs" that "use renewable energy resources, reduce pollution, conserve energy and natural resources and reconstitute waste."

The underlying argument of this submission is that it is time to reconsider and rehabilitate the "surprisingly apposite" founding philosophy of the American labor movement. "Sharing the work and sparing the planet" comprehensively addresses the issues of green jobs, labor standards, work and family balance and fairness in the distribution of the benefits of economic growth.

Real GDP and Its Components: 2008QIV versus 2007QIII

BEA released its advanced estimate for the last quarter of 2008 and the news was awful:

Real gross domestic product -- the output of goods and services produced by labor and property located in the United States -- decreased at an annual rate of 3.8 percent in the fourth quarter of 2008, (that is, from the third quarter to the fourth quarter), according to advance estimates released by the Bureau of Economic Analysis. In the third quarter, real GDP decreased 0.5 percent.

While real GDP rose somewhat during the first two quarters of 2008, real GDP fell a bit during the last quarter of 2007. Real GDP was running at an annualized clip of $11,625.7 billion as of 2007QIII but real GDP for 2008QIV was reported to be only $11,599.4 billion.

I guess the silver lining was that both government purchases and net exports continued to improve. The improvement in real exports was tiny but imports fell – likely as a result of a weaker economy. Consumption demand fell by more than $90 billion – while investment demand fell by more than $190 billion. Maybe this will wake up a few Republicans in the Senate that we have indeed entered into a deep recession.

About Hedge Funds

· ‘Survivorship bias’
Hedge funds that die are not included in the index, and since the mortality rate among hedge funds is higher than among mutual funds, it produces a greater gap between the returns reported in the indices versus those earned by a typical investor. There are about 9000 funds. Half of them have a life span of three years. About one out of ten goes bust.

· Distortion of returns reported to hedge funds versus the typical investor
– associated with the higher mortality rate of hedge funds. Also the reporting for hedge funds is voluntary and they tend not to report bad results.

· Lack of auditing.
They represent a relatively small share of total financial assets but their relative share has increased significantly.

· Substantial leverage
Hedge funds have the ability to take on substantial leverage.

· Large potential impact on financial market conditions
The substantial leverage of hedge funds magnifies the potential impact on financial market conditions.

· Hedge funds play a large (inappropriate) role as an insurer for regulated institutions
"Hedge funds have become an important source of protection to regulated institutions by being large sellers of credit insurance in the rapidly growing market for credit default swaps . But highly-leveraged and unregulated hedge funds are not the ideal type of insurer!"

· Hedge funds are receiving money from Australian superannuation funds.
Because of the current great doubt experienced by the two major political parties about the virtues of the fiduciary habits of ordinary workers, they feel compelled to take their savings away. The money is placed in pension funds for their old age. Workers are not allowed to withdraw this money and especially they are not permitted any control over the way in which these dollars are invested. (Meanwhile we'll continue to tout the virtues of a 'free market' system).

..Superannuation fund trustees have traditionally not invested in hedge funds both because of the infancy of the hedge fund market in Australia and because of the legal obligations described above. Rather,superannuation trustees have tended to prefer to invest in fixed interest investments, cash, government bonds and property investment trusts.

Hedge funds have not been favoured areas of investment principally because of perceptions concerning:
• the volatility of returns;
• level of regulation;
• the perceived lack of transparency of hedge funds ;
• levels of management fees; and
• additional risks associated with the use of derivatives by hedge fund managers.

In order to make such investments, superannuation trustees need to give careful consideration to the legal restrictions imposed in the form of general trustee duties and the investment parameters imposed by their trust deed, investment plan and the SIS Act.

However, despite this traditional reluctance to invest in hedge funds, superannuation trustees in Australia are now starting to use hedge funds to diversify their investments. Hedge fund investment is providing superannuation trustees with a way of counter-balancing the decline in returns on investments in traditional products. Those trustees are also attracted by the relative low correlation between the performance of some hedge funds and that of the equity markets more generally. There is also a considerable degree of liquidity with hedge funds, something that real estate or other structured assets may not offer. Finally, the introduction of hedge funds for retail investors has made the product apparently more mainstream and therefore, for trustees, possibly less likely to result in fund member concern..."
Australia: Some Legal Issues relating to Superannuation Trustees as Hedge Fund Investors
By Tessa Hoser and Katherine Henzell, Blake Dawson Waldron
1 December 2002.

· One third of hedge fund capital comes from pension funds
One third of hedge fund capital comes from pension funds. “Pension funds reusing hedge fund investment to diversify their own risks, but a situation where almost one-third of the capital for institutions on the cutting edge of financial risks comes from institutions whose first priority is safe investments certainly bears watching”.
Rodrigo Rato, IMF Managing Director

· The insurance provided by hedge funds lacks integrity.

1. How can you collect on an insurance contract when no-one can agree on the amount of the losses??

2. Both the buyer and seller of CDS may trade their obligation in the OTC market. There is nothing to prevent the insurer from offloading his obligation to an unqualified or unreliable party, in the process irreparably damaging the value of the insurance originally purchased.

I would be interested to learn if anyone can shed light on a potential problem in financial markets larger by at least an order of magnitude greater than subprime + CDO s sold to the SIV s and other institutions that hold them. Dr. Roubini has put numbers on subprime and alt-A plus CDO s, of about 1.5 trillion, and we don't have good estimates yet for auto loan and credit card securitized debt. Dwarfing these numbers is the 30 to 40 trillion dollar (or more) value of credit default swaps (CDS) outstanding. These swaps are essentially insurance policies between 2 parties. The FIRST buyer, presumably, is one with an asset (bond or securitized debt) to hedge. The FIRST seller, presumably, is a party known to the buyer who is financially able to provide the contracted protection in the event being insured (default) in return for the fee collected. But if both sides of this equation may TRADE their obligation in the OTC market, what is to prevent the INSURER from offloading his obligation to an UNQUALIFIED party, damaging irreparably the value of insurance originally purchased. If the insured has no control over the assignment to a third party of the obligation, of what value is the insurance. You may recall that in the DELPHI automotive bankruptcy, with 2 billion in bonds outstanding, there were over 20 billion in CDS outstanding. If the presumed solvency of unregulated insurance providers has enabled careless debt instrument purchases, watch out.
Written by RHK on 2007-11-06 08:01:26

3. The Over the Counter (OTC) trade is opaque and allows for the creation of fictionalised capital.

· There’s been a dramatic acceleration in number and type of derivative instruments.
(But current accounting and regulatory practice – as of December 2007 - allow for the creation of huge amounts of imaginary capital that is opaque and not subject to appropriate credit ratings. With the possibility of firms upping their trade in derivatives to hide the day of reckoning that comes with insolvency. See the linked article on credit default swaps.)

Hedge funds (holding Russian corporate bonds with ‘put options’) are demanding either full payment of debt or much higher interest rates; up to 16% during 2008.

· The total number of hedge funds has grown dramatically.
In 2007 there existed about 9000 funds. Half of them have a life span of three years. About one out of ten goes bust.

· Hedge funds are ‘Program Trading outfits’. They make money by buying large baskets of stocks.
A hedge fund, like investment banks, are referred to as ‘Program Trading outfits’. They make money by buying large baskets of stocks and then will blow out of those positions when their computers are programmed to sell.

· The range of hedge fund returns is large and unprecedented.

· Hedge fund managers’ earnings are astronomical. are determined by the gains of their own capital in their funds and their share of their firm’s management and performance fees. Most funds charge a 5% management fee and a 44% performance fee)

Of the 200-plus funds that Permal invests in, the poorest performer in the year to date – from January through to November 15 – had reported a loss of 7 per cent, and the top performer had returned 70 per cent. [unsourced]

“…Combined, the top 50 hedge fund managers last year earned $29 billion. That figure represents the managers’ own pay and excludes the compensation of their employees. Five of the top 10, including Mr. Simons and Mr. Soros, were also at the top of the list for 2006….”
Wall Street Winners Get Billion-Dollar Paydays
Published: April 16, 2008

“Hedge fund managers, those masters of a secretive, sometimes volatile financial universe, are making money on a scale that once seemed unimaginable, even in Wall Street's rarefied realms. One manager, John Paulson, made $3.7 billion last year. He reaped that bounty, probably the richest in Wall Street history, by betting against certain mortgages and complex financial products that held them. Paulson, the founder of Paulson & Company, was not the only big winner. The hedge fund managers James Simons and George Soros each earned almost $3 billion last year, according to an annual ranking of top hedge fund earners by Institutional Investor's Alpha magazine, which comes out Wednesday. Hedge fund managers have redefined notions of wealth in recent years. And the richest among them are redefining those notions once again. Their unprecedented and growing affluence underscores the gaping inequality between the millions of Americans facing stagnating wages and rising home foreclosures and an agile financial elite that seems to thrive in good times and bad. Such profits may also prompt more calls for regulation of the industry…”
Hedge fund managers get billion-dollar paydays
By Jenny Anderson
Wednesday, April 16, 2008

· G8 finance ministers meet on the issues relating to hedge funds but fail to address the issues.

G8 finance ministers met on the issue of the lack of supervision of hedge funds but they failed to address the issue. (When?, Source?)

Wall Street Bonuses in 2008 – Disappointing or Shameful?

When I first heard that bonuses paid to Wall Street types dropped from around $33 billion in 2007 to only $18.4 billion, the Manhattan resident in me thought – “ouch, that’s going to hurt the already sagging aggregate demand around here”. Call me a Keynesian. The President had a different thought:

President Obama branded Wall Street bankers “shameful” on Thursday for giving themselves nearly $20 billion in bonuses as the economy was deteriorating and the government was spending billions to bail out some of the nation’s most prominent financial institutions. “There will be time for them to make profits, and there will be time for them to get bonuses”

OK – we don’t reward incompetence and we don’t give income assistance during hard times to the very wealthy. I’m with you Mr. President!

Update: Rudy Guiliani goes Keynesian on this story too:

Bonuses for Wall Street fat cats are easy political fodder in uncertain economic times, but former New York Mayor Rudy Giuliani said Friday cutting corporate bonuses means slashing jobs in the Big Apple. "If you somehow take that bonus out of the economy, it really will create unemployment," he said on CNN's "American Morning." "It means less spending in restaurants, less spending in department stores, so everything has an impact."

Memo to self – in the future, check out what Josh Marshall has to say before blogging on these types of issues:

As a resident of New York City, I think it's probably true that those dollars do do a decent amount for New York City economy, in the form of tax dollars and supporting local businesses -- though I would question its relative efficiency in stimulus terms. (And that's in large part because it's a lot of money in a fairly restricted geographic area.) But the government support that keeps these firms afloat doesn't just come from New York City, does it? This is the definition of trickle down -- give huge amounts of money to a small number of individuals, most of which will be socked away but a relatively small percentage of which will be spent on luxury goods. Amazing that this goof was once the GOP frontrunner for president.

Thursday, January 29, 2009

Stimulus Pork

Senator Max Baucus got $26 billion for private equity companies -- the vultures that buy companies, load them up with debt, collect exorbitant fees, and then try to sell them to the unsuspecting public.

Senator Robert Byrd is getting $4.6 billion for clean coal. "Clean, carbon-neutral coal can be a 'green' energy," Byrd said.

What the hell other crap is out there?

Drucker, Jesse and Peter Lattman. 2009. "Senate Provision Would Let Buyout Firms Defer Taxes on Canceled Debt." Wall Street Journal (28 January).

"Senate Finance Committee Chairman Max Baucus included language in the tax portion of the proposed stimulus package that would allow companies to defer income taxes triggered when they repurchase their own troubled debt at a discount. That would benefit a wide array of companies and industries, but would be a particular windfall to private-equity firms, which acquire companies using piles of debt in hopes of producing large profits for their investors. Amid the economic downturn, many of these deals have run into trouble and the firms are seeking to refinance them."

"The Joint Committee on Taxation estimates the proposal would cost the government roughly $26 billion over the next three years."

"A study by Boston Consulting Group found that, of 328 private-equity portfolio companies, roughly 60% had debt trading at levels considered "distressed"."

"To stave off default, private-equity executives have made reduction of their companies' debt a top priority. The companies are asking investors to swap their bonds for ones with lower values and longer maturities and also seeking to settle debt with cash. However, reducing debt levels can result in a big tax bill. For example, if a company issues $1 billion in debt, but later runs into trouble and exchanges it for new debt worth $600 million -- or buys it back for $600 million -- the remaining $400 million in cash is taxable income."

Stimulus Debate: Flakey Economics

Jeff Flake had a novel argument against increasing at least one form of additional government spending as Josh Marshall notes and rebuts:

Now he's explaining how capital spending on AMTRAK is also not stimulus because AMTRAK doesn't run a profit. Again, total non-sequitur. I think rail is something we should be spending a lot more on. But you can certainly disagree with that on policy terms. But you can't claim that that capital spending on rail stock and rail upgrades doesn't provide jobs. Of course it provides jobs. And whether Amtrak is profitable or not is completely beside the point.

Net income for both Ford and GM has recently been negative so does Congressman Flake think that if the American automobile manufacturers are somehow encouraged to hire more workers that this fails to constitute stimulus? In fact, a lot of companies currently have negative net income. According to Flake’s “logic”, the prospect for a recovery is really dismal!

Wednesday, January 28, 2009

Do House Republicans Understand Tax Policy and Consumption Demand?

I submit that Congressman Jeff Flake does not:

Rep. Flake (R) was just on CSPAN moments ago talking about tax cuts in the Stimulus Bill. And he just made the argument that a lot of tax cuts in the bill go to 'people who don't pay income taxes', i.e., they're tax rebates … There's a decent case that one-off tax rebates aren't as potent as spending in terms of pumping money back into the economy. The one from last year didn't seem to have much of a punch. But whether the money goes into the hands of people who do or do not pay income taxes is a completely irrelevant point in itself. It's only relevant to whether you can focus tax breaks on wealthier people -- a political point. What's more, since people who 'don't pay income taxes' are overwhelmingly people with low incomes, those people by definition spend more than those with higher incomes, if only because they have no choice. It's just a straight-up nonsensical statement.

While I have been noting that Ricardian Equivalence would argue for the proposition that tax cuts do not increase aggregate demand while increases in government purchases would stimulate aggregate demand, we should recognize the role of borrowing constraints:

If “strapped consumers” means those facing borrowing constraints, it is precisely these households that are more likely to consume rather than save a tax cut.

Flake seems to be arguing that households that do not face borrowing constraints would be more likely to consume a tax “cut” than those that do face borrowing constraints. This proposition is precisely the opposite of what economic theory would tell us. Then again – economic theory tells us that increases in tax cuts (especially tax cuts for rich households) have less bang for the buck than increases in government purchases. Are these House Republicans hoping for the lowest bang for the buck or are they really this stupid?

World Growth Collapses

Econbrowser provides a link to a just-released IMF survey that reports that in November, 2008, world industrial production went from growing at a positive amount to an annual rate of -15%, and world merchandise trade went from growing at a positive rate to nearly a -45% rate, a total collapse probably more dramatic than even during the Great Depression. The IMF has lowered its projection for aggregate world economic growth in 2009 from 2.4% to 0.5%, which if it comes to pass would be the lowest rate of world GDP growth since WW II. We are indeed in a massive world economic crisis of the first order.

More Less

Pass the stimulus - then help shorten the work week

New York Daily News

By Dean Baker

Wednesday, January 28th 2009, 4:00 AM

As job losses hemorrhage, the American economy is in desperate need of a stimulus. It is becoming increasingly clear that Congress must work rapidly to approve some version of President Obama's plan.

Then, Obama and the Congress should very quickly turn to taking a second, temporary step to create more jobs: creating incentives for companies to reduce the workweek and work year for many Americans.

The idea is not as radical as it sounds - and could prove very productive indeed for the American worker....

Do We Really Import Microsoft Software from Ireland?

John Ensign - Republican Policy Committee Chairman – claims we do:

You know, we have the second highest corporate tax rate in the industrialized world. Microsoft, which is a great American company, has zero exports from the United States. They have a lot of exports from Ireland, because, guess what, Ireland has a 12.5 percent corporate tax rate; we have a 35 percent corporate tax rate.

Microsoft does not manufacture products in Ireland to sell to the U.S. It designs all sorts of software that we can place on our personal computers. While you might argue that Microsoft has to manufacture things like the Xbox – such manufacturing is contracted to third parties. During fiscal year ended December 31, 2008, Microsoft incurred $8.2 billion in R&D expenditures according to its 10-K filing. This R&D is in part performed in Ireland but it also occurs in the U.S., Canada, China, Denmark, India, Israel and the UK.

Microsoft has used the provision of the U.S. transfer pricing regulation under section 1.482 to have whatever is developed by their R&D personal around the world to be jointly owned by the U.S. parent and its Irish subsidiary – even if most of the R&D occurs in the U.S. They do so under a series of contract R&D and Cost Sharing arrangements where the Irish subsidiary had to at one point compensate the U.S. parent for any pre-existing intangible assets. In the usual game, the multinational corporation hires some transfer pricing “expert” to write a “valuation” that supports a really low compensation. The IRS then has the right to challenge this valuation as to whether the compensation is truly arm’s length or fair market value. Often, it is below fair market value which would give the appearance that much of the value is being created by the Irish entity even if much of the value is truly being created within the U.S. To use the actual accounting when intercompany prices are not consistent with arm’s length prices to make the kind of inferences made by John Ensign is really silly.

Tuesday, January 27, 2009

Ricardian Equivalence Does Not Imply That Obama’s Fiscal Stimulus Will Be Ineffective

Kevin Quinn noted that the Wikipedia discussion of Ricardian Equivalence had the following error:

Ricardian equivalence states that a deficit-financed increase in government spending will not lead to an increase in aggregate demand. If consumers are 'Ricardian' they will save more now to compensate for the higher taxes they expect to face in the future, as the government has to pay back its debts. The increased government spending is exactly offset by decreased consumption on the part of the public, so aggregate demand does not change.

As noted here, John Cochrane made the same error. I would hope the Myron S. Scholes Professor of Finance at the University of Chicago Booth School of Business does not rely upon Wikipedia for his economic research. Alas, in an otherwise excellent post on fiscal policy, Menzie Chinn sort of falls into this trap as well:

Case 5 (government debts will have to be paid off in its entirety the future): When budget constraints hold with certainty intertemporally, and there is no way to default even partially on government debt (say via unexpected inflation), then increases in government debt due to tax cuts (for instance) induce no change in current consumption because households fully internalize the present value of the future tax liability

Menzie is right about transitional changes in tax policy not being able to change consumption in this Barro-Ricardo model, which is why GOP calls for using tax cuts to stimulate demand are likely not going to be the most effective policy tool. But what about transitional changes in government purchases? It is interesting that Wikipedia noted Ricardo’s 1820 Essay on the Funding System:

Ricardo studied whether it makes a difference to finance a war with the £20 million in current taxes or to issue government bonds with infinite maturity and annual interest payment of £1 million in all following years financed by future taxes. At the assumed interest rate of 5%, Ricardo concluded that "In point of economy there is no real difference in either of the modes, for 20 millions in one payment, 1 million per annum for ever ... are precisely of the same value".

Let’s modernize this example. Suppose we decide to have an additional $100 billion in public investment in 2009. In Ricardo’s example, permanent taxes will increase by $5 billion per year which would have a very modest offsetting reduction in consumption. So if government purchases rise by $100 billion and consumption falls by $5 billion, then isn’t the direct impact on aggregate demand closer to $95 billion for the year rather than zero?

Update: Republicans will oppose more government spending as they prefer tax cuts:

Hours before a meeting with President Barack Obama, House Republican leaders sought to rally opposition Tuesday to a White House-backed economic stimulus measure with an $825 billion price tag. Several officials said that Reps. John Boehner of Ohio, the GOP leader, and Eric Cantor of Virginia, his second-in-command, delivered the appeal at a closed-door meeting of the Republican rank and file. Both men said the legislation contains too much wasteful spending that will not help the economy recover from its worst nosedive since the Great Depression, the officials added ... Senate Republican Leader Mitch McConnell, R-Ky., said in a televised interview that Obama was having problems with Democrats, whom he said favor spending over tax cuts as a remedy for the economic crisis.

If Ricardian Equivalence holds, the GOP is opposing fiscal stimulus that will impact aggregate demand preferring tax cuts that will not increase aggregate demand. Go figure!

Monday, January 26, 2009

When Less is More

Dean Baker in the Guardian today:
Shortening the workweek would create jobs and stimulate the US economy – and give workers the benefits other countries provide.

What amuses the Sandwichman is the predictable bullying froth from opponents of shorter working time. A study in social pathology.

Cochrane’s Fiscal Fallacies

Greg Mankiw has found another critic of fiscal stimulus with this one being even more silly than the predecessors. John Cochrane claims the proponents of fiscal stimulus rest their case on three fallacies. The first is that Fama crowding-out by identity canard:

First, if money is not going to be printed, it has to come from somewhere. If the government borrows a dollar from you, that is a dollar that you do not spend, or that you do not lend to a company to spend on new investment. Every dollar of increased government spending must correspond to one less dollar of private spending. Jobs created by stimulus spending are offset by jobs lost from the decline in private spending. We can build roads instead of factories, but fiscal stimulus can’t help us to build more of both. This is just accounting, and does not need a complex argument about “crowding out.”

Calling Brad DeLong:

Now the NIPA savings-investment identity holds in all models--it is, after all, an identity, true by definition and construction. And every single model that has been built in which there is a possibility of high unemployment and idle resources is a model in which fiscal policy works because increases in government spending lead to unexpected declines in inventories and unexpected declines in inventories lead to firms to expand production, which leads to increases in income and saving. I would, therefore, say that Fama's claim is "wrong". Not only does it not hold in all models in the class, it does not hold in any models in the class.

His second “fallacy” is just strange:

Second, investment is “spending” every bit as much as consumption. Fiscal stimulus advocates want money spent on consumption, not saved. They evaluate past stimulus programs by whether people who got stimulus money spent it on consumption goods rather save it. But the economy overall does not care if you buy a car, or if you lend money to a company that buys a forklift.

Any reading of the General Theory by Lord Keynes would also say that advocates of fiscal stimulus would assign as high a multiplier to increasing investment demand as we assign to increasing consumption. Has Cochrane not noticed that the Obama fiscal policy wants to increase public investment rather than stimulate consumption?

He closes by showing he does not understand Ricardian Equivalence:

Third, people must ignore the fact that the government will raise future taxes to pay back the debt. If you know your taxes will go up in the future, the right thing to do with a stimulus check is to buy government bonds so you can pay those higher taxes. Now the net effect of fiscal stimulus is exactly zero, except to raise future tax distortions. The classic arguments for fiscal stimulus presume that the government can systematically fool people.

Oh good grief! If we were talking about temporary reductions in taxes – which would have to later be followed by tax surcharges – then Ricardian Equivalence predicts no increase in aggregate demand. But if we are talking about temporary increases in government purchases then rational households would realize that the increase in their lifetime tax bills would be quite modest, which would imply a small reduction in consumption demand relative to the large increase in government purchases.

I have to wonder John Cochrane could even pass the macroeconomic class offered at Greg Mankiw’s college! I also have to wonder why Greg Mankiw keeps posting without comment such incredibly silly arguments against fiscal stimulus.

Liquidity Traps, Credit Crunches, the Past Two Recessions, and Interest Rates on Long-Term BBB Debt

Jack Healy and Vikas Bajaj tell us that the cost of borrowing has zoomed up:

But with the credit markets still tight, corporations are being forced to pay much higher interest rates than they did a few years ago, putting more strain on balance sheets already hammered by falling profits and a grinding recession.

For those of you who have heard we are in a liquidity trap, remember that this refers to short-term interest rates on government debt whereas Healy and Bajaj are talking about long-term corporate debt. Interest rates on 20-year Federal bonds aren’t that high but credit spreads are:

Even companies with strong credit ratings are paying about 5 percentage points more than the federal government to borrow money, according to Standard & Poor’s. That is more than double the premium they paid last January. Companies with so-called junk credit ratings are paying a 15 percent premium. “That’s an extraordinary spread,” said Diane Vazza, head of global fixed-income research at Standard & Poor’s. “That’s unprecedented in the speculative-grade market.”

Sloped Curve takes these market rates to suggest that Paul Krugman is wrong about the liquidity trap argument:

Professor Krugman is also discussing only one side of the issue when it comes to where the economy is today. Professor Krugman is taking the fact that the US is in a liquidity trap for granted, and that the US is wrestling with the zero-lower-bound for interest rates, even though there are obvious reasons for why you would argue that the US is not in or near a liquidity trap ... the economic actors are not exposed to 0% interest rates. No final loans to private individuals or companies are made at or near a 0% interest rate ... There is another phenomenon, that is not a liquidity trap, but that can also create disinflation and even short-lived deflation. The phenomenon is a credit crunch. In a credit crunch credit becomes hard and/or expensive to come by, and this dampens the willingness to borrow, spend and invest. The difference between a liquidity trap and a credit crunch is that in a liquidity trap people have ample access to cheap credit and still choose to not borrow money, while in a credit crunch people do not borrow money either because they can't or because they view borrowing as too expensive. The basic attributes of these two phenomena are such that they are mutually exclusive. In a credit crunch you have limited access to cheap credit, in a liquidity trap you have ample access to nearly free credit; you can't have both.

I would beg to differ that one cannot have both as we are talking not only about interest rates are very different types of financial instruments but also about very different aspects of monetary policy. Our graphs are based on the monthly averages of interest rates on 20-year government bonds, AAA corporate bond rates, and BBB from January 1994 to December 2008. If we go back to 2001, it is interesting to note that the interest rate on BBB debt as of October 2001 was about the same as the interest rate as of January 2001 despite the fact that both AAA rates and rates on 20-year Federal bonds fell slightly. You may recall that this was the period where short-term rates fell dramatically but longer-term rates fell more modestly. But the big story was the climb in credit spreads – especially the BBB spread (BBB-s) which began in 2000 and continued through 2002. During the current recession, long-term Federal bond rates have fallen more dramatically but interest rates for companies with credit ratings of BBB or lower have increased as credit spreads have skyrocketed.

Traditional monetary policy can lower risk-free interest rates but recessions are also often associated with rising default risk. This recession in particular seems to have one of its underlying causes being increases in default risk and the associated troubles facing our financial institutions. Maybe this is why Ben Bernanke is frustrated with certain politicians not getting the need to release the remaining TARP funds:

This may be as close as we’re going to get to a Fed chairman labeling some in Congress as irresponsible. Sure, Federal Reserve Chairman Ben S. Bernanke was typically careful with his wording in a Jan. 13 speech in London. “The public in many countries” is “understandably concerned” that government is spending money to rescue the financial industry, “when other industries receive little or no assistance,” Bernanke said. After explaining how the world economy “is critically dependent on the free flow of credit,” Bernanke issued his challenge: “Responsible policy makers must therefore do what they can to communicate to their constituencies why financial stabilization is essential for economic recovery and is therefore in the broader public interest.” Three days after that speech, 33 of 39 Republican senators ignored Bernanke’s warning and voted against releasing the remaining $350 billion in Troubled Asset Relief Program money. (So did eight Democrats, mostly liberals, plus independent Bernie Sanders of Vermont.) Fortunately, that left enough supporters, mostly Democrats, to clear the release of the much-needed money. Too many senators shrugged their shoulders at Bernanke’s wise words.

As one of the fiscal stimulus critics that Greg Mankiw loves to cite, Gary Becker writes:

It is relevant in answering this question that the origins of this recession were in the financial sector, and especially in the excessive mortgage credit to sub prime and other borrowers. The widespread collapse of the financial sector, and the wholesale retreat from risky assets, clearly has called for a highly pro-active Fed. But it is not obvious why this should lead to greater confidence in the power of government spending stimulus packages. Of course, perhaps the prior emphasis on crowding out, and skepticism toward the stimulating effects of government spending, were wrong, or that recessions were too short and mild after the 1981-82 recession to call for Keynesian-type stimulus packages.

Becker has already been criticized for failing to note that interest rates were very high in 1982 but are nearly zero now. But he may indeed be right for the type of non-traditional monetary policy being advocated by our FED chairman today. Alas, many in the Republican Party are against both fiscal stimulus and this non-traditional monetary policy. I just don’t get it!

Update: Paul Krugman is kind enough to link to my post and then writes:

Well, my definition of a liquidity trap is, purely and simply, a situation in which conventional monetary policy — open-market purchases of short-term government debt — has lost effectiveness. Period. End of story. Now, if you prefer a different definition of a liquidity trap, OK; call our current situation a banana, instead. But changing the name does not change the essential fact — namely, conventional monetary policy has lost effectiveness. Yes, there are other things the Fed could do — and it’s doing them, on an awesome scale. But they’re controversial, precisely because, unlike conventional monetary policy, they involve picking and choosing among potentially risky investments. And there’s a much stronger case for fiscal policy than in normal times, because we don’t know how well these unconventional measures will work.

Might I add that I agree with Paul 100%!

The Fed as Financial Regulator

The Washington Post reports about a move afoot to give the Federal Reserve more regulatory power over the financial system.

Considering that the Federal Reserve is supposed to be independent of the government, it would seem that getting such powers to the Fed would be ill-advised.

In addition, considering that the Fed's posture in the bailout makes the Treasury Department looks like a paragon of transparency, giving such powers to the Fed seems even more questionable.

When the Democrats promised change, I thought they meant change for the better. Maybe I was wrong.

Sunday, January 25, 2009

Observations on China

I'm just now getting my energy back after my trip to China and a bout of food poisoning that I brought back. I hope I can be more attentive to the blog.

Just as an experiment, I tried to record a 15 minute discussion about my observations of China. I have to warn you that you should not expect any deep insights from fairly quick trip in which I spent most of my time in the corridors of various universities.

The First Fleet Whores on Australia’s Invasion Day

Today is Australia Day, though the vast majority of Australian aboriginal people would understandably prefer to call it ‘invasion day’. At least in these times Aboriginal grievances in relation to this awkward day get some mainstream media airing. The plight of my white female ancestors still doesn’t. They were the unwilling and much-abused first immigrants to this country.

“The First Fleet consisted of 1,480 people more than half of whom were convicts. There were 586 male and 192 female convicts as well as a large number of seamen, marines, servants and officials. Only a tiny fraction of these were accompanied by their wives and children.”

“…Within the penal colony, women were assigned only one main function – they were there primarily as objects of sexual gratification. The main difficulty, as far as the British authorities were concerned, was to find a sufficient number of women convicts, and to do this they had to impose preponderantly harsher sentences on women.….

The sexual abuse of female convicts began on the ships. Although after 1811 the women traveled on separate ships from the male convicts, they had the crews to contend with. WHR Brown told the Select Committee on the State of Gaols in 1819 that:

“These women informed me, as well as others of their shipmates, that they were subject to every insult from the master of the ship and sailors; that the master stript several and publickly whipped them; and that one young woman, from ill treatment, threw herself into the sea and perished, that the master beat one of the women that lived with me with a rope with his own hands till she was much bruised in her arms, breasts, and other parts of her body. I am certain, from her general good conduct, she could not have merited any cruelty from him.” [1]

My great, great grandmother was Mary O’Neill born in Maitland in New South Wales in 1843. On the genealogical history now finally revealed it is possible that she was related to another Mary O’Neill. A woman that is referred to in the journal of William Elyard, a surgeon superintendent on the "John Bull" which sailed from Cork on 25 July 1821 via St. Jago, to arrive in Sydney on 18 December 1821. Mary is described as one of “an aggressive pair” of women. Mary O'Neill and another woman, Ellen Nolan, were “identified as assaulting one of the men while cleaning” on this “troublesome voyage” of the convict ship taking the women to the Paramatta Factory. [2] The latter “operated as a prison, a maternity home, a marriage bureau, an employment exchange and a hostel or refuge for women in transit between jobs. All its inmates, however, were strictly speaking prisoners...’ What a comment on the common status of all females of the lower classes!” [3]

So cheers to our Mary O’Neills and our damned whores. May we continue to break the handle of many a hammer in our go-slow rebellions against enslavement and worse.

…..the damned whores the moment that the[y] got below fel a fighting amongst one another and Capt Meredith order the Sergt. Not to part them but to let them fight it out…..
- Lt Ralph Clark of the First Fleet, ‘The Journals and Letters of Lt Ralph Clark 1787-1792.

[1] In CMH Clark, ‘Select Documents in Australian History 1788-1850, Angus & Robertson, Sydney, 1965, p48. As quoted in ‘Damned Whores and God’s Police’ by Anne Summers.

[2] Will Elyard’s Journal.

[3] ‘The most outrageous conduct’ Convict rebellions in colonial Australia

The Fiscal Policy Debate Today on the Sunday Talkies – Who Listens to Economists?

While the Republicans are complain that the Democrats are not considering their ideas, Nancy Pelosi says that good ideas will be considered:

Appearing on ABC's This Week, Nancy Pelosi said that Republicans have had the opportunity to be included in crafting the stimulus bill -- even if not many of their ideas have been adopted. "Well, we will take some," said Pelosi. "We will judge them by their ability to create jobs, to -- to help turn the economy around, to stabilize the economy, and to see how much they cost."

John McCain appeared on Faux News and said:

In an appearance on Fox News Sunday, John McCain said he won't vote for President Obama's stimulus package as it stands now. McCain said there need to be more tax cuts for businesses, payroll tax cuts, and for existing tax cuts to be made permanent: " Well, the plan was written by the majority in -- a Democrat majority in the House, primarily. And so, yeah, I think there has to be major rewrites if we want to stimulate the economy."

Mark Thoma brings us a piece by Larry Mishel that basically says McCain and his Republicans colleagues are clueless.

"Not a Cure All, But..."

by the Sandwichman

From the Globe and Mail Report on Business, yesterday:
Yes you can: Save jobs by sacrificing your time and money.

As employers and employees confront the spectre of mass layoffs, creative measures are coming to the fore, including individual workers cutting their workweek to four days, with a proportional cut in pay.

The idea gained currency this week in U.S. President Barack Obama's call-to-duty inauguration speech. America's recovery, he said, in part will rely on "the selflessness of workers who would rather cut their hours than see a friend lose their job."
The Sandwichman points out the potential pitfall of the "proportional cut in pay" line. If workers are expected to handle the same workload in four days, it's just a speed-up with a pay cut. And what does that do to consumer spending? Here's where government needs to step in to make up the difference in pay as part of its economic stimulus package. More on that angle from Dean Baker in Monday's Guardian.

Saturday, January 24, 2009

Charlton Heston: Gun Nut or Sandwich Man?

Sandwichman thinks he may have discovered a way to build traffic to the site. For the record, Sandwichman wonders, "what's the fuss?" One the one hand, I feel more threatened by SUV drivers talking on cel phones than I do by goons carrying guns. On the other hand, how come there isn't a second amendment right to bring your own damn water or toothpaste onto an airliner? I mean, "airport security" is so obviously about conditioning people to follow orders and not question authority.

Thursday, January 22, 2009

Galbraith Part 2 on "Can Obamanomics Solve the Crisis?"

James K. Galbraith has a second part to his interview with Paul Jay on the real news. He goes on greater length about how it would be unwise to cut social security or medicare. He worries that Obama may be listening to those who want this, including conservative Democrats, but also notes that his public statements so far have not specifically said what to do about social security. "Wait and see," says Galbraith. He also addresses several other issues including the status of the dollar and the need for aid to those in danger of home foreclosures.

The link.

A Grammar of the Multiplier

by the Sandwichman

Paolo Virno's A Grammar of the Multitude is a short book, but it casts a very long shadow. Behind it looms the entire history of the labor movement and its heretical wing, Italian "workerism" (operaismo), which rethought Marxism in light of the struggles of the 1960s and 1970s....

6.5. Thesis 4

For the post-Fordist multitude every qualitative difference between labor time and non-labor time falls short...

The concept of "full employment" is obviously essential to any consideration of the Keynesian "multiplier". Yet the very distinction between employment and unemployment is what, according to Virno, is at stake in Post-Fordist society.

The Sandwichman can do little more here than simply to note the existence of the operaismo analysis. I have my reservations about the degree of abstraction of that analysis and it's exclusive historical contextualization in a brief and recent expanse of European history. Nevertheless, the very term, "Post-Fordist," calls into question glib manipulation of Keynesian terminology.
If we can say that Fordism incorporated, and rewrote in its own way, some aspects of the socialist experience, then post-Fordism has fundamentally dismissed both Keynesianism and socialism. Post-Fordism, hinging as it does upon the general intellect and the multitude, puts forth, in its own way, typical demands of communism (abolition of work, dissolution of the State, etc.). Post-Fordism is the communism of capital.
James Callaghan, in 1976:
We used to think that you could spend your way out of a recession and increase employment by cutting taxes and boosting government spending. I tell you in all candour that that option no longer exists, and in so far as it ever did exist, it only worked on each occasion since the war by injecting a bigger dose of inflation into the economy, followed by a higher level of unemployment as the next step.

Barro on the Fiscal Policy Multiplier: Does He Understand the Full Employment Constraint?

Robert Barro writes an op-ed critiquing the Obama fiscal policy proposal that is far below his intellectual standards. He starts off well:

Team Obama is reportedly using a number around 1.5. To think about what this means, first assume that the multiplier was 1.0. In this case, an increase by one unit in government purchases and, thereby, in the aggregate demand for goods would lead to an increase by one unit in real gross domestic product (GDP). Thus, the added public goods are essentially free to society. If the government buys another airplane or bridge, the economy's total output expands by enough to create the airplane or bridge without requiring a cut in anyone's consumption or investment. The explanation for this magic is that idle resources -- unemployed labor and capital -- are put to work to produce the added goods and services. If the multiplier is greater than 1.0, as is apparently assumed by Team Obama, the process is even more wonderful. In this case, real GDP rises by more than the increase in government purchases. Thus, in addition to the free airplane or bridge, we also have more goods and services left over to raise private consumption or investment.

In other words, Barro understands that the Keynesian multiplier theory rests on the proposition that the economy is below full employment – which seems like a plausible characterization of today’s economy. But then Barro pulls some empirical research from a period where we were likely near full employment:

A much more plausible starting point is a multiplier of zero. In this case, the GDP is given, and a rise in government purchases requires an equal fall in the total of other parts of GDP -- consumption, investment and net exports. In other words, the social cost of one unit of additional government purchases is one … What do the data show about multipliers? Because it is not easy to separate movements in government purchases from overall business fluctuations, the best evidence comes from large changes in military purchases that are driven by shifts in war and peace. A particularly good experiment is the massive expansion of U.S. defense expenditures during World War II … I have estimated that World War II raised U.S. defense expenditures by $540 billion (1996 dollars) per year at the peak in 1943-44, amounting to 44% of real GDP. I also estimated that the war raised real GDP by $430 billion per year in 1943-44. Thus, the multiplier was 0.8 (430/540). The other way to put this is that the war lowered components of GDP aside from military purchases. The main declines were in private investment, nonmilitary parts of government purchases, and net exports -- personal consumer expenditure changed little. Wartime production siphoned off resources from other economic uses -- there was a dampener, rather than a multiplier.

After saying “good grief”, I turn the microphone over to Paul Krugman:

Consumer goods were rationed; people were urged to restrain their spending to make resources available for the war effort. Oh, and the economy was at full employment — and then some. Rosie the Riveter, anyone? I can’t quite imagine the mindset that leads someone to forget all this, and think that you can use World War II to estimate the multiplier that might prevail in an underemployed, rationing-free economy.

Wednesday, January 21, 2009

Mainstream Media Fights for the Little Guy in the Spirit of the Muckrackers

This article shows the ridiculous lengths that economists can go in defending the indefensible:

I. J. ALEXANDER DYCK, University of Toronto - Joseph L. Rotman School of Management
DAVID A. MOSS, Harvard Business School - Business, Government and the International Economy Unit

LUIGI ZINGALES, University of Chicago, National Bureau of Economic Research (NBER), Centre for Economic Policy Research (CEPR), University of Chicago - Polsky Center for Entrepreneurship, Graduate School of Business, European Corporate Governance Institute (ECGI)

We argue that profit-maximizing media help overcome the problem of "rational ignorance" highlighted by Downs (1957) and in so doing make elected representatives more sensitive to the interests of general voters. By collecting news and combining it with entertainment, media are able to inform passive voters on politically relevant issues. To show the impact this information has on legislative outcomes, we document the effect "muckraking" magazines had on the voting patterns of U.S. representatives and senators in the early part of the 20th century. We also show under what conditions profit-maximizing media will cater to general (less affluent) voters in their coverage, providing a counterbalance to special interests.

Galbraith on "Can Obamanomics Solve the Crisis?"

The answer is, maybe not. The crisis is deep and more direct intervention will be needed in both banking and shoring up purchasing power, according to James K. Galbraith in an interview on the real news, accessible here.

He especially worries about the shift I have posted on here in a worried manner that Obama seems to have drunk the social security kool-aid and may be looking at long term cutbacks in benefits. Instead of my "stand pat" and do nothing to/with social security, he actually calls for increasing social security benefits.

BTW, the tux he is wearing in the clip was apparently for going to some bipartisan inaugural ball in honor of John McCain. Go figure.

BIG in Japan... Work Sharing

by the Sandwichman

This is how it begins. With baby steps. Experience with these kinds of programs in the past is that people learn they actually like the extra free time.
In the deep south of Japan sits the tiny island of Himeshima. Farmers cultivate delicious prawns, the rare chestnut tiger butterfly flitters around the beach and 2,400 islanders wallow in total job security.

It has been so on Himeshima for 40 years and suddenly, faced with the most alarming economic downturn since the Second World War, everyone from the central Government in Tokyo to the country's biggest industrial conglomerates is desperate to copy its secret: work sharing...

Tactics for hard times as Japanese turn to job-sharing

Business groups split over work sharing

Helping Employers Cut Hours, Not Jobs

Business bigwig suggests work-sharing schemes to cope with tough times

"the selflessness of workers who would rather cut their hours than see a friend lose their job..."

President Obama

As we consider the road that unfolds before us, we remember with humble gratitude those brave Americans who, at this very hour, patrol far-off deserts and distant mountains. They have something to tell us, just as the fallen heroes who lie in Arlington whisper through the ages. We honor them not only because they are guardians of our liberty, but because they embody the spirit of service; a willingness to find meaning in something greater than themselves. And yet, at this moment — a moment that will define a generation — it is precisely this spirit that must inhabit us all.

For as much as government can do and must do, it is ultimately the faith and determination of the American people upon which this nation relies. It is the kindness to take in a stranger when the levees break, the selflessness of workers who would rather cut their hours than see a friend lose their job which sees us through our darkest hours. It is the firefighter's courage to storm a stairway filled with smoke, but also a parent's willingness to nurture a child, that finally decides our fate.

Our challenges may be new. The instruments with which we meet them may be new. But those values upon which our success depends — hard work and honesty, courage and fair play, tolerance and curiosity, loyalty and patriotism — these things are old. These things are true. They have been the quiet force of progress throughout our history. What is demanded then is a return to these truths. What is required of us now is a new era of responsibility — a recognition, on the part of every American, that we have duties to ourselves, our nation, and the world, duties that we do not grudgingly accept but rather seize gladly, firm in the knowledge that there is nothing so satisfying to the spirit, so defining of our character, than giving our all to a difficult task.
America, this is one of those moments.

I believe that as hard as it will be, the change we need is coming. Because I’ve seen it. Because I’ve lived it. I’ve seen it in Illinois, when we provided health care to more children and moved more families from welfare to work. I’ve seen it in Washington, when we worked across party lines to open up government and hold lobbyists more accountable, to give better care for our veterans and keep nuclear weapons out of terrorist hands.

And I’ve seen it in this campaign. In the young people who voted for the first time, and in those who got involved again after a very long time. In the Republicans who never thought they’d pick up a Democratic ballot, but did. I’ve seen it in the workers who would rather cut their hours back a day than see their friends lose their jobs, in the soldiers who re-enlist after losing a limb, in the good neighbors who take a stranger in when a hurricane strikes and the floodwaters rise.

This country of ours has more wealth than any nation, but that’s not what makes us rich. We have the most powerful military on Earth, but that’s not what makes us strong. Our universities and our culture are the envy of the world, but that’s not what keeps the world coming to our shores.

Instead, it is that American spirit – that American promise – that pushes us forward even when the path is uncertain; that binds us together in spite of our differences; that makes us fix our eye not on what is seen, but what is unseen, that better place around the bend.

Tuesday, January 20, 2009

Gun Nuts Exposed at Distorting Data and Results

In the latest Econ Journal Watch, just out, Ian Ayres and John J. Donohue III have a paper, "Yet another refutation of the more guns, less crime hypothesis - with some help from Moody and Marvell" accessible (hopefully) at

Besides recounting how the major study by John Lott and Mustard has lots of data problems and cut off just before the post-1992 crime decline, they focus on a paper by Moody and Marvell that claims that a study of 24 states showed a reduction in crime for increasing access to guns. It turns out that in this study 23 of the 24 states had the opposite result, and the aggregate result was solely due to Florida. However, the data in Florida is all messed up and also probably caught a general crime wave decline due to a regression to the mean after the Mariel boat landings from Cuba in the early 1980s. I am not doing their paper justice, but the media discussion is often dominated by Lott and his allies who are now pushing for loosened gun laws in Virginia, and are counting on Dems laying low and not challenging their incessantly repeated claims that such gun law relaxations reduce crime. They should not lay low. The claims are baloney and lies, based on distorted date and misrepresentations of results from ones with better data.

Communists at the Inaugural Concert!

I was happy to see Pete Seeger at he Inaugural Concert (with the Boss in tow), singing all of the verses of This Land is Your Land, including the rarely sung:

As I was walkin'
Right there in front of me
Was a great big sign,
Said "Private Property"
But on the other side
It didn't say nothin'
'Cause this land was made for you and me.

Oh and speaking of Paul Samuelson, as Barkley has been, he has to be one of the funniest of all economists - a low bar I know. For example, his "algorithm" for solving the Transformation Problem: "Write down Values. Erase. Write down Prices." I think this was the same article where he called Marx "a minor Post-Ricardian." I have to admit, though, when I first read the article, I wasn't laughing. Spitting, more like. Ah, youth!

Monday, January 19, 2009

Britain needs a shorter-hours culture

by the Sandwichman

David Spencer in the Guardian
this morning echoes two of the Sandwichman's favorite talking points:
In a letter to the poet TS Eliot in 1945, he [Keynes] suggested that unemployment could be lowered by the reduction in working time. Indeed for Keynes this was the "ultimate solution" to the unemployment problem. Reducing work time not only extended the time during which workers could spend income and hence generate employment, but it also allowed jobs to be spread out more evenly across the available workforce, thereby reducing unemployment.
Orthodox economic theory teaches that those who argue for shorter working time succumb to the "lump of labour fallacy". This is the idea that there is a fixed amount of work to be done in society, so any reduction in work hours must increase the number of available jobs. It is argued by orthodox economists that the amount of work is not fixed and that reductions in work time will simply add to firms' costs. But the above fallacy is not wholly persuasive. If reduced hours encourage people to work more efficiently, then the effect may be to lower prices and to increase the demand for goods and services and in turn the demand for labour.

UK Government Adopts Nationalization of Troubled Banks

Bloomberg reports that Gordon Brown has been listening to economists:

Prime Minister Gordon Brown’s government tightened its grip on Britain’s financial system, guaranteeing toxic assets and giving the Bank of England unprecedented power to buy securities. The plan will increase the cost of bailing out the nation’s banks by at least 100 billion pounds ($147 billion), the Treasury said in a statement today. The government raised its stake in Royal Bank of Scotland Group Plc to 70 percent and said it would use Northern Rock Plc to spur mortgage lending. “This is aiming to once and for all underpin faith in the banking system,” said Alan Clarke, an economist at BNP Paribas SA in London. “We’re breaking all conventions. The availability of credit is going down and the economic outlook is getting worse, so the government is having to throw more and more at it.” The new measures are the biggest steps by Brown to get banks lending again as Britain slides deeper into a recession that may be the worst since the aftermath of World War II. The government will require aid recipients to sign “specific and quantified” agreements to lend, reflecting Brown’s frustration at the failure of an October rescue to unlock credit markets.

Felix Salmon looks at the troubles at Bank of America and Citigroup and recommends we adopt nationalization:

Citi and BofA aren't suffering from liquidity problems. They have all the liquidity they need, thanks to the Fed. The problem is one of solvency: the equity markets simply don't believe that the banks' assets are worth more than their liabilities. I can't see a solution to this problem short of nationalizing both Citi and BofA, and summarily firing the hapless Vikram Pandit along with the overambitious Ken Lewis.

But it seems that we Americans are heading down a different route, which Paul Krugman doesn’t like:

On paper, Gotham has $2 trillion in assets and $1.9 trillion in liabilities, so that it has a net worth of $100 billion. But a substantial fraction of its assets — say, $400 billion worth — are mortgage-backed securities and other toxic waste. If the bank tried to sell these assets, it would get no more than $200 billion. So Gotham is a zombie bank: it’s still operating, but the reality is that it has already gone bust. Its stock isn’t totally worthless — it still has a market capitalization of $20 billion — but that value is entirely based on the hope that shareholders will be rescued by a government bailout ... Well, the government could simply give Gotham a couple of hundred billion dollars, enough to make it solvent again. But this would, of course, be a huge gift to Gotham’s current shareholders — and it would also encourage excessive risk-taking in the future. Still, the possibility of such a gift is what’s now supporting Gotham’s stock price. A better approach would be to do what the government did with zombie savings and loans at the end of the 1980s: it seized the defunct banks, cleaning out the shareholders. Then it transferred their bad assets to a special institution, the Resolution Trust Corporation; paid off enough of the banks’ debts to make them solvent; and sold the fixed-up banks to new owners. The current buzz suggests, however, that policy makers aren’t willing to take either of these approaches. Instead, they’re reportedly gravitating toward a compromise approach: moving toxic waste from private banks’ balance sheets to a publicly owned “bad bank” or “aggregator bank” that would resemble the Resolution Trust Corporation, but without seizing the banks first.

Paul notes the American fear of the word nationalization and our willingness to give the troubled banks a gift by buying toxic assets at a “fair” price that exceeds the market value. In my view, this American way is just sheer insanity. We should watch and learn from the actions of the UK government.

Samuelson on Hayek, A Comment on Comments

Paul A. Samuelson has published "A few personal reminiscences of Friedrich von Hayek" in Journal of Economic Behavior and Organization, January 2009, vol. 69, issue 1, pp. 1-4, which I happen to edit, with an accompanying paper pp. 5-16 by Andrew Farrant and Edward MacPhail, entitled "Hayek, Samuelson, and the logic of the mixed economy?" One can link to Samuelson's paper at where Mark Thoma has it as one of his links for 2009-01-18 (easier than listing the whole url). In the last two days there have also been full blown postings on The Austrian Economists, Marginal Revolution, and Brad DeLong, with lots of furious commentary on the first two about it. While Samuelson praises Hayek's economics of information, saying he was the real winner of the socialist calculation debate and deserved his Nobel, PAS also criticizes his macroeconomic theory in comparison with Keynes's, argues his Road to Serfdom was wrong in forecasting that allowing for various forms of state intervention would lead to the road to serfdom, and dismisses Hayek's own criticisms of him on this matter, with Farrant and MacPhail examining the letter exchanges between them on this issue, and largely agreeing with PAS. The paper also has a long footnote highlighted by both Tyler Cowen at MR and Brad DeLong in which he reprises Melvin Reder's discussion of anti-Semitism by Keynes, Schumpeter, and Hayek, concluding that Keynes was the worst on this and Hayek the best of these three.

The comments on AE and MR have been mostly perfervidly livid at PAS over this article, going on about many points. However, I wish to address one in particular that has been brought up a bunch, one that was already mashed over in a posting and comments on Marginal Revolution by Tyler Cowen on 11/20/08. Responding to a nasty quote by PAS in Spiegel that "libertarians are emotional cripples," he linked to p. 416 of Mark Skousen's The Making of Modern Economics, who quoted the 13th edition of Samuelson and Nordhaus Economics from 1989, p. 387: "The Soviet economy is proof that, contrary to what many skeptics had earlier believed [a reference to Mises and Hayek](bracketed remark by Skousen) a socialist command economy can function and even thrive." Cowen and others have jumped on this as proof that Samuelson is "incompetent" and a lot worse, even though he cited CIA data for his claims, and also of course these commentators claiming the superiority of Hayek and how dare Samuelson say all those bad things about him.

Well, some of the language in Samuelson's paper (which I edited), is a bit strong, but I agree with the substance of most of it. Furthermore, while Hayek argued that centrally planned socialism would be inefficient, an argument PAS agrees with, Hayek no more forecast the moment of the Soviet collapse than did PAS or the CIA or pretty much anybody other than a French sociologist named Revel in 1976. Also, the severe economic decline in the Soviet bloc largely came after the political collapse of the bloc. It is not at all clear such a collapse would have happened without the political collapse, if the Soviet leaders in 1989 had cracked down on the independence demonstraters in Lithuania, the people fleeing across the Hungarian border into Austria, and of course supported the Honecker regime in East Germany in preventing the Berlin Wall from falling. After all, the upshot of the Chinese crushing the demonstrations in Tienanman Square was continued economic growth with a gradual transition to its current peculiar mixed economy that has grown very rapidly. And for all the carrying on many make about the Soviet economy, while it may have been inaccurate to describe it in 1989 as "thriving," and it was falling behind the US in growth, technical innovation, and quality of goods, it was functioning, and the population was not starving or homeless or without clothing or education or medical care, although it was politically repressed. But it had provided the industrial expansion that allowed it to build a military capacity that defeated Hitler's military at Stalingrad and Kursk. In short, this dumping all over PAS for these statements is fairly ridiculous, whatever one thinks of Samuelson's ultimate or broader influence on economics as the godfather of its mainstream neoclassical form in the last half of the 20th century.

The comments at The Austrian Economists can be found at and the ones at Marginal Revolution are at

Sunday, January 18, 2009

Sandwichman Reads the Footnotes (so you don't have to)

by the Sandwichman

The title of my last post was a composite allusion to The Rise and Fall of Economic Growth by H.W. Arndt (1978)and to chapter nine of Fred Hirsch's Social Limits to Growth (1976): "Political Keynesianism and the Managed Market." In his Managing Without Growth, Peter Victor cited Arndt's book extensively in his retelling of the short history of economic growth as prime policy objective.

Arndt concluded his book with a somewhat optimistic, albeit qualified, assessment of growth -- "the realistic question to ask is not whether further economic growth is possible or desirable, or even how rapid it should be, but what kind of growth we should aim at." In discussion "the right kind of economic growth," he footnoted Hirsch's book, "While this present book was in press, the implications for economic growth as a policy objective of 'positional competition' have been spelled out much more fully in an important and exciting book..." (which would have been clearer if he had stated it as "...the implications of 'positional competition' for economic growth as a policy objective have been spelled out...").

Admittedly, there is some discussion going on of what kind of spending is desirable in a stimulus package. But this is neither a secondary question nor a transitory one. It is, as Arndt termed it, the realistic question. When the question becomes "what kind of growth" instead of "how much growth," then some things that have in the past been growing may come to be excluded from the calculus as kinds of growth we don't actually want because they don't benefit society and they impose unacceptable costs on the environment, sociability, etc. It could even be that the sum total of those expendable kinds of growth results in a decline in Gross Domestic Product, which at any rate is not a good measure of social welfare.

Hitherto the "weapon of mass destruction" in defense of economic growth has always been the assumption that only through continued and fairly brisk growth could full employment be attained. That assumption is not tenable for two reasons. One, the political linkage between growth and full employment has been broken... and it has been broken by proponents of growth. Two, the claim to exclusivity relies on the reactionary political assertion that work-time reduction cannot play a positive role in maintaining full employment. That assertion is groundless.