An Economic History From 1998

My highlights from research on 1998 (with umpteen revisions tonight).

I was wondering whether the massive drop in oil prices that year was engineered in order to facilitate economic collapse in Russia, but having looked at this graph, it appears that such a scenario more likely could have happened in the late 1980s; if it occurred at all?

When were the impacts of the banking system's use of a new and unregulated form of 'high-power money' (in 1994) felt? I refer to money created through what has been referred to as "arcane procedures and instruments"; like 'zero-reserve sweeps'. These novel banking processes resulted in an enormous expansion of the money base that was largely concealed from public scrutiny. More on this topic here.

1998 – May 7th. Greenspan:

"We need an understanding if we are to minimize the chances that 'we' will experience a systematic disruption beyond our degree of comprehension or our ability to respond effectively..."

1998 – Global currency crisis associated with the the failure of Long term Capital Management. It was a currency trader. With the guidance of the US Fed all of the banks got together when it started to collapse and propped up the currency markets. Underscored is “the fact that

“deregulation” has created an economic monster which requires more and more tinkering from the stewards of the system.”[1]

1998 – August 31st. Russia’s economic problems helped sent the Dow Jones Industrial Average to its second biggest single-day drop ever, 512 points.

1998 US IP owners imposed draconian new US copyright regime.[2]

Late 1990s. The percentage of people belonging to the middle class in the “old industrial countries” began to decline from the late 1990s to the present (August 2008). Making up for the falling incomes of First World workers for some years after 2000 was an increase in consumer credit. In 2007 a “popular default” broke out in the US. [3]

1998 – Present (2007. China’s huge labor surpluses absorbed through debt-financed investments in huge mega-projects that dwarf the already huge Three Gorges Dam. [4]

1998 – Book: The Buying of the Congress: How Special Interests Have Stolen Your Right to Life, Liberty, and the Pursuit of Happiness. Today ... there is no leadership or protest against our subjugation to the powerful economic interests that have captured our Congress and our politics. We are tired, and there is no alternative but to protest. (An appendix lists 32 leading members of Congress, along with each of their top ten career patrons (corporations and lobbying PACs). It's a depressing picture.) [5]

1998 – Doug Nolan’s Credit Bubble Bulletin begins.

1998 Hugo Chavez elected President in Venezuela (loss of oil to US)

1998 – Economic Giantism hastens

1998 – February 4th. US House of Reps Sub Committee. On the Asian Financial Crisis

1998 – Greenspan quote:

"Nor should we require individual banks to hold capital in amounts sufficient to fully protect against those rare systemic events which, in any event, may render standard probability evaluation moot. The management of systemic risk is properly the job of the central banks. Individual banks should not be required to hold capital against the possibility of overall financial breakdown. Indeed, central banks, by their existence, appropriately offer a form of catastrophe insurance to banks against such events."[6]

Late 1990s – The economy was growing, unemployment was creeping downward. Wages were increasing only modestly. Greenspan kept interest rates low, knowing that the workers’ fear of unemployment would continue to keep wages in check. The low interest rates fuelled the dotcom bubble. [7]

1998 – George Shultz vetted Bush Jr for the job as US president and put together the team behind his presidency. [8]

1998 September 21st. US Fed Reserve and 16 major Wall Street investment banks meet to organise a financial bailout of the hedge fund that they had all lent money to – Long Term Capital Management. There was real fear that the bond market would seize up as creditors rushed for the exits. The US Federal Reserve pushed billions of dollars of liquidity into the markets.

The US Fed denies involvement in the LTCM bailout.

"Perhaps [Paul Volker's] highest profile stance since his Fed days was taken during the Long-Term Capital Management fiasco of 1998. Volcker questioned the "bailout" of LTCM by the consortium of investment banks.

"Why should the weight of the federal government be brought to bear to help out a private investor?" [9]

1998 – October 6th. IMF head, Michel Camdessus, warns of global systemic crisis.

"We are speaking not just of countries in crisis, but of a system in crisis, a system not yet sufficiently adapted to the opportunities and risks of globalisation."[10]

1998 – October. Former chairman of the US Federal Reserve Board Paul Volcker said in a [then] recent speech to the International Finance Institute, published in the Financial Times:

“The problems we see with such force today are systemic--they arise from within the ordinary workings of global financial capitalism. ... Consider the latest bit of evidence from the US itself; one unsupervised and unregulated financial institution--an institution boasting the most elaborate models of market behaviour and sophisticated advisors--carried the possibility, by testimony of the US Federal Reserve, of pulling down the financial tent." [11]

[Volcker was referring to the multi-billion dollar bailout of the Long Term Capital Management hedge fund.]

1998 – October. As President Bill Clinton was warning of the worst financial crisis in 50 years, and calling for strong global leadership, the war against his administration being waged by powerful sections of the American bourgeoisie was intensifying with the House judiciary committee recommending an unrestricted investigation as to whether ground existed for his impeachment.[12]

1998 – November. Failure by the Organization of Petroleum Exporting Countries (OPEC) to cut production at its meeting in November 1998 prompted prices to collapse to a 12-year low of $10.35 a barrel in New York the following month.

1998 – Robert Rubin (then US Treasury Secretary) and Alan Greenspan persuaded Congress to change banking laws to permit the merger of Travelers Insurance, Citibank and Citigroup

1998 – October 21st. Discussing the 1998, 1987 and 1929 crashes. (Select Committee of the US Treasury. Minutes of evidence). Mr Davies: “It seems to me that we are somewhere in between the 1987 episode and the 1929 episode—hopefully a great deal closer to the 1987 episode…. So the Fed lost control of interest rates and to some extent sadly that has happened in recent weeks, although nothing like to the same degree…. The other element of the perverse policy was that fiscal policy generally was far too tight, so a combination of those events led to ten years of depression…. the world economy is generally weaker going into this crash than was true in 1987. Therefore, rebound would be slower and the background is weaker, so we will not get the rebound that we saw in 1988. Professor Minford: “after a big crash like 1987, which was on the same scale if not rather bigger than the share market crash we have seen in the last couple of months, that it was easy to turn round. We overdid it in retrospect…. There is no lack of liquidity today. In fact, some people maintain there is too much. Money supply in the United States is clearly growing quite robustly at this moment. All this points to the fact that we do have the ability to respond to this; and all the evidence is that we are responding to it…”

[1]Rigging the Market: The Secret Maneuverings of the Plunge Protection
Team
Mike Whitney, Information Clearing House, 09/14/06
http://www.undollars.com/archives/arch_undollar.whitney_9_17_06.htm

[2] The Bear's Lair, by Martin Hutchinson
http://www.prudentbear.com/articles/show/2070
The decline of Western incomes. July 23, 2007

[3] The crisis of the global economy
A report of the Institute of Globalisation and Social Movements, Moscow
By Vasily Koltashov
Translated by Renfrey Clarke, Links – International Journal of Socialist Renewal
http://links.org.au/node/517

[4] THE NEW IMPERIALISM: ON SPATIO-TEMPORAL FIXES AND ACCUMULATION BY DISPOSSESSION, David Harvey -- http://titanus.roma1.infn.it/sito_pol/Global_emp/Harvey.htm

[5] Lewis, Charles and the Center for Public Integrity. The Buying of the Congress: How Special Interests Have Stolen Your Right to Life, Liberty, and the Pursuit of Happiness. New York: Avon Books, 1998. 416 pages. ISBN 0-380-97596-3
http://www.namebase.org/cgi-bin/nb01/fB

[6] Greenspan 1998
http://www.federalreserve.gov/boarddocs/Speeches/1998/19980226.htm

[7] Michael Perelman. Chapter 2 of his draft book ‘The Invisible Handcuffs’.
http://michaelperelman.wordpress.com/2008/07/22/second-chapter-of-the-invisible-handcuffs-of-capitalism-how-market-tyranny-stifles-the-economy-by-stunting-workers/

[8] George Pratt Shultz: Profile of a Hit Man
by Scott Thompson and Nancy Spannaus
This article appears in the December 10, 2004 issue of Executive Intelligence Review.
http://www.larouchepub.com/other/2004/site_packages/econ_hitmen/3148shultz1.html

[9] Paul Volker - Part 2. Brian Trumbore
President/Editor, StocksandNews.com
http://www.buyandhold.com/bh/en/education/history/2000/paul_volker2.html

[10] Tuesday, 6 October, 1998, 19:41 GMT 20:41 UK
IMF chief warns of world crisis
http://news.bbc.co.uk/2/hi/187695.stm

[11] Conflicts dominate Washington meeting
World leaders at International Monetary Fund conference
acknowledge global economic crisis
By Nick Beams
8 October, 1998
http://www.wsws.org/news/1998/oct1998/econ-o08.shtml

[12] Conflicts dominate Washington meeting
World leaders at International Monetary Fund conference
acknowledge global economic crisis
By Nick Beams
8 October, 1998
http://www.wsws.org/news/1998/oct1998/econ-o08.shtml

A Negatively Sloped Hicksian Labour Supply Curve?

by the Sandwichman

The report of French President Nicholaus Sarkozy's Commission on the Measurement of Economic Performance and Social Progress, issued Monday, contains 184 instances of the word 'leisure'. The following, though, is from the Reflections and Overview of the Commission's principals, Joseph Stiglitz, Amartya Sen and Jean-Paul Fitoussi:

Surely, if one society chooses to limit its consumption of material goods, enjoying more leisure, including time devoted to culture, the arts, and community engagement, it should not be counted against it. Citizens in such a society might be far happier than in one which works longer hours, spending less time both with the family and in the community. Citizens in the hardworking society complain that, while they are working hard for the family, they have no time left for the family. Yet, our conventional measures would attribute better economic performance to the harder-working and unhappier society: both incomes and growth would be higher. Furthermore, the increase in average working time may be itself the consequence of the society’s malfunctioning. If inequality becomes pervasive, the number of persons who have to work harder to ensure their living may greatly increase (there is a negatively sloped Hicksian labour supply curve): they may claim that they have no choice but to work harder (though of course they could, were they willing to accept a much lower standard of material consumption than other citizens). It would be questionable whether this evolution is welfare-enhancing, even if GDP increases as a consequence.

If leisure is a normal good... But, what if leisure isn't a normal good?

The canonical labor supply model treats leisure as a normal consumption good, which is questionable, to put it mildly. Below a culturally-determined income threshold, non-working time ceases to be available for use as leisure and instead becomes unemployment -- that is, a disutility rather than a utility. Likewise, for most occupations, there is an optimal length of working day and week in which the work itself enhances quality of life, aside from the income received from working. That optimum is likely to be rather dynamic and unstable. Indifference curves do not provide a suitable representation of these effects taken together.

At the end of their Reflections, the authors express the hope that their report will provide the impetus for a broader discussion of "societal values, for what we, as a society, care about, and whether we are really striving for what is important." This is a discussion, incidentally, that Sydney J. Chapman called for 100 years ago in the concluding paragraph of his "Hours of Labour":

Tangible things force themselves upon our attention as the more intangible do not, and some of us who have an economic bent of mind get into the way, in consequence, of thinking too much of the quantity of external wealth produced and too little of the balance between internal and external wealth. In ultimate terms, to those who care to put it that way, all wealth is life, as Ruskin insisted. There hardly appears to be any risk of a general underrating of external goods, but there is some risk of an underrating of the new needs of the life lived outside the hours devoted to production – which should themselves be, not a sacrifice to real living, but a part of it – and of an underrating of the dependence even of productive advance upon the widespread enjoyment and proper use of adequate leisure and an adequate income.

Sidney Chapman's theory of the hours of labour, published in September 1909 in The Economic Journal, was acknowledged as authoritative by the leading economists of the day. It provided important insights into the prospects for market rationality with respect to work time arrangements and hinted at a profound immanent critique of economists' excessive concern with external wealth. Chapman's theory was consigned to obscurity by mathematical analyses that reverted heedlessly to outdated and naïve assumptions about the connection between hours and output. The centenary of the theory's publication offers an occasion to reconsider what has been lost by economists' neglect of Chapman's theory.

Notre Dame To Dissolve Heterodox Economics Department

The link to the story in the Chronicle of Higher Education is http://chronicle.com/article/Notre-Dame-to-Dissolve/48460. The bad guy in this is the dean, who wanted to have a "highly ranked" graduate program in economics (there was already a conventional econ department in the business school, but that was under another dean). So, he took away the grad program from the famous and productive, but heterodox and book-publishing (many of them very influential and important, check out Phil Mirowski's work) department. They set up what orthodox economist Robert Solow warned would be a "third rate MIT department," which he said we did not need another of. Now the axe is falling, and the heterodox department is to be completely eliminated. Supposedly the remnant tenured faculty will be scattered among other departments where they will be allowed to teach their upper level courses, but no principles or intermediate theory ones.

The department contains a number of important economists. Mirowski is the author of Machine Dreams and More Heat than Light. David Ruccio is the editor of Rethinking Marxism. Amitava Dutt is a development economist who is the author of numerous books, and there are others. This is a sad day, especially in light of the discredit that economic orthodoxy is standing in now.

Minsky Punts, Part II

by the Sandwichman

"Employment is the bottom line of the current crisis. It is essential that governments focus on helping jobseekers in the months to come," stated Angel Gurria, Secretary General of the Organization for Economic Co-operation and Development yesterday at the launch of its Employment Outlook 2009. The OECD report anticipates that unemployment in the OECD countries could reach 57 million people and an unemployment rate of 10%. It points out that young people have been hardest hit by the jobs crisis.

Would a Minsky-inspired "job guarantee program" be an economically feasible response to that jobs crisis? Randal Wray is probably the best-known current advocate of such a program. In August, Wray posted a brief description of the idea along with some references for further reading. The Sandwichman's familiarity with the debate around the job guarantee idea comes largely from a discussion in Robert LaJeunesse's book, Work Time Regulation as Sustainable Full Employment Strategy, in which LaJeunesse sought to show why work time regulation would be superior to a jobs guarantee.

LaJeunesse's main objection to the job guarantee idea is that it expands work and consumption instead of questioning the compulsion for and ecological sustainability of perpetual, artificially-induced economic growth. Peter Victor's book, Managing without Growth, and the Sustainable Development Commission's report, Prosperity without Growth?, give persuasive evidence in support of such criticism.

While the Sandwichman agrees wholeheartedly with LaJeunesse's ecological critique, he also has microeconomic concerns about job guarantees. But first, before outlining those difficulties, more on the dimensions of the jobs crisis, and particularly the youth jobs crisis.

The official unemployment rate in August for 16-24 year olds was 18.2%. That's the seasonally adjusted "U3" number, using the narrow definition of unemployment. The BLS doesn't give "alternative measures of labor underutilization" by age categories. For the general population, the broadest measure if underemployment, U6, is 16.8% or about one and three-quarters times the official rate of 9.7%. Using the ratio of U6 to U3 to arrive at a conservative estimate of youth underemployment gives a total of 31.5% combined underemployment and unemployment.

Another way to gauge the real dimensions of the youth unemployment crisis is to look at the historical trend of the employment ratio. The current employment ratio of 46.6% is 8.5 percentage points lower than the 33 year-average. But even that average is skewed by the collapse of labor market participation that has occurred since 2001. Between January 2001 and December 2003, labor market participation of 16-24 year olds fell from 66% to 60.5%. But after that it remained virtually flat until January 2007 when it resumed its decline. In other words, although there was a modest recovery of three percentage points in the official unemployment rate the employment rate only regained about one percentage point from its 2001 recession low before heading downward again.

As the chart below shows, unemployment and under-participation leveled off at around 20% from 2003 to 2007 and then resumed their climb from near recession peak levels:


Scared yet? Returning now to Sandwichman's microeconomic objections to job guarantee schemes, there are three aspects that particularly trouble me. First is the historical precedent that explicitly "make work" jobs have always carried a stigma. This was true of the 19th century workhouse in Britain and of WPA jobs during the Great Depression.

Second, the necessity for some kind of administrative overhead -- managers, planners and staff -- must necessarily lead to the creation of a bureaucratic empire whose denizens will have a stake in the continuation and expansion of their institutional niche.

Finally, a job is not simply about the exchange of a certain amount of time and effort for a paycheck. Some kind of learning and social interaction goes on in the workplace. Not all of it is directly tied to the work. What kind of informal culture of "lifers" and "transients" is likely to emerge in buffer world of guaranteed jobs? What's to prevent the lifers (as well as the administrators) from devising schemes to divert the efforts of enrollees to their private interests?

Diminishing returns for each dollar of new debt

Or 'why the economic stumuli won't go very far'.

"According to Antal Fekete [1] if you take this chart further back, we used to get $3 of GDP for every $1 of debt. Sometime in the late '60s, the line crossed below $1, meaning every new Dollar of debt returned less than that in GDP. Antal thinks we actual went negative in 2006, but regardless of whether his data is the same as this chart, we are approaching that point. This is truly a point of no return. This means every new $1 borrowed reduces GDP."[2]

Hmmm... could consumers be on strike whilst they pay off their debt? Could wealthy investors be purchasing gold and hiding it under their mattresses instead of creating 'real' wealth in the community? Could indebted oil-producing nations be hiking up the price of oil so that they can pay down their sovereign debt? And I wonder how much extra money is now being spent to repair the damage from (what used to be avoidable) climate change. So many questions and so few dollars!


[1] I do not subscribe to all of the view expressed by Antal Fekete. In particular, I am not a fan of 'the gold standard' because the application of it would not guarantee the absence of a debt bubble and the hoarding of 'gold' does make for a prosperous and healthy economy.

[2] Why The Stimulus Won't Work: The Marginal Productivity of Debt
http://yelnick.typepad.com/politick/2009/04/why-the-stimulus-wont-work-the-marginal-productivity-of-debt.html

How high energy prices create new economic 'norms'

Henry CK Liu wrote an interesting article in 2005 in which he outlines the rather dire implications for the US and global economy from rising energy prices. He claims, by the way, that the then quite dramatic rise in the price for gasoline was not the result of peak oil. Rather, he appears to say in this case, it came from high refinery costs. Please correct me if I've misinterpreted that point (and others). It is conceivable that the high cost of debt experienced by the petroleum cartel could also (easily) be added to the price of oil.

I've summarised the ten points Mr Liu has made on the subject below:

Fact 1: Energy prices are so basic to the global economy that, when they rise, the same material quantity in transactions simply involves greater cash flow. Higher oil prices do not take money out of the global economy but shift the profit to different sectors. Foreign oil producers must then shift their dollars back into US Treasury bonds or other dollar assets as part of the rules of the game of US dollar hegemony. A rise in monetary value of assets adds to the monetary wealth of the economy.

Fact 2: High energy costs translates into reduced consumption in other sectors unless higher income can be generated from the increased cash flow. Wage rises have a long time lag behind price increases. Workers may be able to increase their income by working longer hours in the meantime. The latter does not necessarily translate into productivity increases.

Fact 3: As cash flow increases for the same amount of material activities, the GDP rises while the economy stagnates. Purchases and sales amount to the same (maybe less) at a higher price and profit margin and with slightly more employees at lower pay per unit of revenue. The inflation from rapidly rising energy costs resulted in businesses hedging to protect themselves in the expanding structured finance world.

Fact 4: The impact of the sharp rise in energy prices results in asset values – in fact the entire commodity price chain - being in a upward spiral. It becomes possible to carry more debt without affected the debt-to-equity ratio. In effect this gives substance to a debt bubble and represents a defacto depreciation of money that is misidentified as growth.

Fact 5: High energy prices threaten the economic viability of some commercial sectors.

Fact 6: No interest-rate policy from any central bank can contain energy-cost-related inflation. Central banks can and do create debt bubbles.

Fact 7: War is a gluttonous consumer of oil. Waging war will translate therefore into rising dollar interest rates due to a higher US federal budget deficit. This is recessionary for the globalised economy but an economic stimulant in the US as long as collateral damage from the war occurs somewhere else.

Fact 8: In a debt bubble, oil in the ground can be more valuable than oil above ground because it can serve as a monetizable asset through asset-backed securities (ABS) in the wild, wild world of structured finance (derivatives). Also gasoline prices will not come down because there is no economic incentive to fix the shortage of crude oil refinery capacity. Refineries are among the most capital-intensive investments and the return on new investment will need continued high gasoline prices to pay for it.

Fact 9: The reason the US imports oil is that importing is cheaper and cleaner than extracting domestic oil – not because the US has a shortage of proven oil reserves.

Fact 10: Fifty-dollar oil [+] will buy the US debt bubble a little more time. Despite all the grandstand warnings about the need to reduce the US trade deficit, a case can be made that the United States cannot drastically reduce its trade deficit without paying the price of a sharp recession that could trigger a global depression.

From:
The real problems with $50 oil
By Henry C K Liu May 26, 2005
http://www.atimes.com/atimes/Global_Economy/GE26Dj02.html

When Did The US Housing Bubble Begin?

In his most recent post on "Economics and its Discontents" on economic principals, David Warsh asserts that the US housing bubble occurred during 2003-06. In a thread following a post on this on Economist's View, I questioned this and said that it began in 1998, only to get a lot of criticism from others, with alternative beginning points being posed, including 2000 and 2001. I replied by noting that if one looks at the price-to-rent and price-to-income ratios for housing from both of the two indexes available (Case and Shiller and OFHEO, the latter having the bubble peaking in early 2007, while Case and Shiller say mid-2006) that showed these ratios taking off in 1998, although basically nobody noticed at the time because we were nearing the end of the dramatic dot.com bubble that crashed hard in early 2000. One can find a source for the OFHEO one here and for the Case and Shiller one here.

Now, part of what has people nonplussed I think is that both Kindleberger and Minsky used to argue that most bubbles start with some sort of identifiable "fundamentals displacement" that starts some price or prices on an upward path that then turns into a speculative bubble. But it is hard to identify such a displacement for housing in 1998. However, it seems that this is the case for some other of the really large bubbles of history, including the Mississippi one of 1719-20, the South Sea one of 1720, the 1920s stock market bubble, the 1980s one as well, and probably the dot.com bubble also. I wrote about this back in 1991 in my book, From Catastrophe to Chaos: A General Theory of Economic Discontinuities (repeated in second edition, 2000) on p. 61 as follows.

In all four of these cases the bubbles emerged after relatively long periods of general economic growth. Thus it may be that the trigger of these bubbles was a critical accumulation of general confidence and enthusiasm without any specific displacement of any fundamental being involved. It may well be that other episodes which have apparently begun with fundamental displacements may in fact have been "misspecified fundamentals" on the part of the participants. They mistakenly forecast that the initial displacement represented the future trend of the fundamental and the collapse of prices came when the illusion vanished. In this respect the lack of a clear initial displacement may be a way of identifying a pure speculative bubble. The pure bubble simply emerges from the swelling sea of boundless optimism, like Aphrodite from the froth.

Fiscal Stimulus Hits (Near To) Home

My oldest daughter, Meagan, who is about to turn 38 and is a single mother with a four and three quarters years old son, Charlie, works with disturbed teenagers in the Bay area in CA for an NGO that depends on public funds. Nearly a year ago her hours were cut back so that she lost her health insurance. She phoned me last night to tell me that thanks to an infusion of federal stimulus money, she will be put back on full time employment with her health insurance restored.

I also note that at James Madison University where I teach, the governor of the state mandated a 15% budget cut to us, which would have entailed layoffs. However, thanks to stimulus funds, it will be only about 8%, which although still entailing furloughs and plenty of cutting, will at least avoid any layoffs.

More on the Ways in Which Economics Fails to Conduct Itself Scientifically

Economics is only now beginning to come to terms with the external consistency demands posed by research in psychology, sociology and other related disciplines.

I’ve been thinking a bit more about science, pure and applied. My two criteria for “science-ness” thus far have been explanation (providing the causal mechanisms that generate outcomes) and giving priority to the minimization of Type I error. These have to do much more with pure science than applied, however. When a geologist assesses whether a site is stable enough to build on, she is concerned quite as much, if not more, with false negatives than false positives.

Where the two overlap, however, is in the role given to what can be called external consistency. Internal consistency is the property of logical coherence. Economists and others use math, for example, to test for it. An argument is externally consistent, however, if it does not contradict claims thought to be true made by other researchers, typically in adjacent fields. For instance, to be externally consistent a geological theory must adhere to the recognized results obtained in physics and chemistry.

The case for external consistency can be seen as a corollary to Type 1 error minimization: if your hypothesis butts up against arguments or evidence with enough credibility elsewhere, you are at heightened risk of being wrong. But what counts as enough credibility? There is no getting away from the fact that this is an elastic criterion. On one end we have the more-or-less indisputable results of real, fully tested sciences: if you violate any of them, you can’t be right. (I once had a student who proposed a project design for urban rainwater collection that would have violated the second law of thermodynamics. This was extreme.) On the other we have plausible results that have not yet been subjected to critical tests. How much credence we give them, and how we trade off this consideration against others, is a matter of judgment—one characteristic of the quality of a practitioner.

Economics is only now beginning to come to terms with the external consistency demands posed by research in psychology, sociology and other related disciplines. A good applied economist is someone who knows this work, can evaluate how compelling it is and how much impact it should have on the validity of economic models and methods.

Casualties of the Crisis

Just in case we are too caught up in the blame game to keep our sense of priorities, here’s the abstract of a recent World Bank working paper (my emphasis):

The human consequences of the current global financial crisis for the developing world are presumed to be severe yet few studies have quantified such impact. The authors estimate the additional number of infant deaths in sub-Saharan Africa likely due to the crisis and discuss possible mitigation strategies. They pool birth-level data as reported in female adult retrospective birth histories from all Demographic and Health Surveys collected in sub-Saharan Africa nations. This results in a data set of 639,000 births to 264,000 women in 30 countries. The authors use regression models with flexible controls for temporal trends to assess an infant’s likelihood of death as a function of fluctuations in national income. They then apply this estimated likelihood to expected growth shortfalls as a result of the crisis. At current growth projections, their estimates suggest there will be 30,000 - 50,000 excess infant deaths in sub-Saharan Africa. Most of these additional deaths are likely to be poorer children (born to women in rural areas and lower education levels) and are overwhelmingly female. If the crisis continues to worsen the number of deaths may grow much larger, especially those to girls. Policies that protect the income of poor households and that maintain critical health services during times of economic contraction should be considered. Interventions targeted at female infants and young girls may be particularly beneficial.

"Because health-care resources are assumed to be fixed..."

by the Sandwichman

From an op-ed by Rupert Darwall in the Wall Street Journal today:

"The case for ObamaCare, as with the NHS, rests on what might be termed the "lump of health care" fallacy."

How Seriously Wrong John Cochrane Is

I have stated here already that I have problems with Paul Krugman's analysis of what went wrong with macro, most notably his nearly total ignoring of the analysis made by many heterodox economists. However, the inflamed reply by John Cochrane has been a joke. He presents himself as speaking for "the economics profession" rather than just a narrow group of Chicago-based or inspired economists. He is the expert, and Krugman supposedly makes trivial technical errors such as not distinguishing CAPM from Black-Scholes, etc. So, I decided to see how wise Cochrane is by going back to look at his widely praised (including even by Robert Shiller: "impressive treatise of very high quality" and "can also serve as a textbook in an advanced finance course") 2001 book published by Princeton University Press, _Asset Pricing_. On what has happened in the last few years, it is utterly useless.

In the index I went to find the following words/phrases: "fat tails" "kurtosis" "leptokurtosis." They are not there, even though pretty much all practitioners and a large literature already existed discussing how to explain the ubiquity in practically all asset markets of exactly those phenomena. He has a big fat zero to say about them, nothing.

I did find "bubbles," which he discusses briefly near the end of the book (pp. 399-402). He seems to recognize that they might exist, but his discussion is strictly in terms of "rational bubbles" and cites Peter Garber ("Tulipmania" JPE, 1989) on how they are not econometrically identifiable (and later says they do not explain empirical variations of price/dividend ratios; oh, and Garber). The model of rational bubbles he discusses supposedly must go on forever, which he then sneers at because "Infinity is a long time...The solar system will end at some point." Somehow he ignores the Blanchard-Watson 1983 paper on stochastically crashing bubbles, which indeed crash in finite time after rising at an accelerating rate to provide a risk premium for the ever-rising probability of the inevitable crash. Ironically, this last model lies at the base of the forecasting model used by econophysicist Didier Sornette and his associates, whose not-too-bad recent forecasting record on crashes is ultimately based on estimating the moment that such a process (complicated by oscillations) blows to infinity.

Oh, and Peter Garber is also wrong, see "Complex bubble persistence in closed-end country funds," by Ehsan Ahmed, Roger Koppl, me, and Mark V. White, Journal of Economic Behavior and Organization, Jan. 1997, 32(1), 19-37, although the basic insight that one can identify the fundamental by the net asset value of a closed-end fund and thus can identify increases in price of the fund above its NAV as a bubble had been made by many others prior to us. So, it is simply ridiculous of Cochrane to have ignored this point as well (he does recognize on p. 408 that some such funds trade regularly at discounts but never mentions that some have shown massive increases in price above NAV or that this clearly shows the existence of a bubble).

Earthquakes, Financial and Geological

As Paul Krugman’s diagnosis of the state of economics bounces around the blogosphere, we are being treated once again to the old debate over whether economics can ever be as scientific as the “real” sciences, the hard ones that have big budgets for lab gear.

If you want to talk about hard sciences, talk about geology. They even have hardness tests, which I remember from my freshman course many long years ago. (I did pretty well in it, but would have done better if I could have ID’ed coal on a midterm exam.) Yet when it comes to a crucial task like predicting earthquakes, geologists are not much better than the pseudo-scientists who populate economics departments. They do even worse, actually, when you consider that their margins of error are hundreds of miles, hundreds of years, and an order of magnitude or two. This makes Alan Greenspan look like Nostradamus.

But of course, that’s not what does or does not qualify geology as a science. Rather, scientists are researchers who subject themselves to rigorous falsification testing that, in the long run, weeds out error. What’s important about the study of earthquakes, for instance, is not its predictive power but that it’s based on an understanding derived from plate tectonics. Yet this was not always the case. That freshman course I mentioned was taught by some of the last holdouts against plate theory; we learned about igneous intrusions and isostatic rebound, but not subduction faults.

You can’t take a course like that any more, because the reward system for geologists gives lots of points for devising critical tests and takes away even more for failure to pass them. Suppose there were a parallel universe in which geologists acted like economists. You might have a popular school of thought that holds that earthquakes are caused by the differential pressure exerted by topography; that’s why there are more quakes in California than Kansas. You could show that the coefficient on topographical variation is significant at a very low p-value in a pooled cross-section. You could calibrate a model showing how much variation is associated with how many earthquakes. Hell, you could generate hundreds of models with different functional forms and control variables and estimators and build whole careers around nuanced discussions of which one “performs” better.

But none of this has anything to do with science. In the universe we actually live in, geologists looked for critical tests: evidence that decisively discriminated between plate tectonics and competing theories.

If you want to tell me that people formulate lifetime spending plans based on the present value of their expected future stream of real after-tax income, and that because of this any dollar of additional government spending is a dollar less of private spending, fine. But don’t calibrate it or show me results “consistent” with it. Think of a critical test, a real-world situation in which we would get a particular result only if this story is correct, and then live or die by the result. Yes, I know this can be difficult in economics, just as it is in geology, but it’s even harder if you don’t try.

The 'medium' is what you actually do.

In 1970 Charles A Reich wrote his book 'The Greening of America' in praise of the cultural protest movement of the 1960s.. It was one of the most personally influential books I have read.

Over the years since Reich's publication the mainstream media have placed much emphasis on the relative affluence of the young people of '60s generation. Leading journalists and TV hosts often supposed that an unprecedented rise in material wealth was somehow causative of the rebellious spirit that was the hallmark of the youth at that time.

It is clear, however, that great waves of alienation with modern western society had already swelled in the hearts of many individuals that were born in a different time altogether. As much as many former hipsters would hate the thought, the real depths of dissent that shaped the events of the 1960s may have actually come from their parents' and earlier generations. A small, particularly articulate and thoughtful number of people such as the likes of Martin Luther King, Charles Reich (as above), John Kenneth Galbraith, C Wright Mills, John Fitzgerald Kennedy, Robert Kennedy, Lewis Mumford, Laurence J Peter, Barry Commoner, Karl Polanyi and others took the limelight and shaped the thoughts of many a draft-dodger and pot-smoking greenie.

What was new and potentially revolutionary was the new medium of television and the ubiquity of cheap books; these people mostly understood how to use these media to best advantage. They knew well the ways and means by which public consciousness was actively manipulated and sought to explain this predicament to their large audiences.

In 1970, for instance, Charles Reich drew upon the thinking of Marshall McLuhan to explain how the medium of our lives was the real message:

"....let us borrow some thinking frm Marshall McLuhan. A young boy asks his father, "What do you do, Daddy?". Here is how the father might answer:
"I struggle with crowds, traffic jams and parking problems for about an hour. I talk a great deal on the telephone to people I hardly know. I dictate to a secretary and then proof-read what she types. I have all sorts of meetings wtih people I don't know very well or like very much. I eat lunch in a big hurry and can't taste or remember what I've eaten. I hurry, hurry, hurry. I spend my time in very functional offices with very functional furniture, and I never look at the weather or sky or people passing by. I talk but I don't sing or dance or touch people. I spend the last hour, all alone, struggleing with crowds, traffic and parking."

More likely, the father would respond to his son by saying:

"I am a lawyer. I help people and businesses to solve their problems. I help everybody to know the rules that we all have to live by, and to get along according to these rules."

Reich moves his focus onto the trapped realm of the modern 'liberal-intellectual'. No matter how great their sophistication, he says, they still keep to such goals as excellence, approval of colleagues, recognition and achievement. They may have fewer myths or illusions, but their despairing view of life's possibilities bar their way to a new consciousness and their dependence on goals involving outside approval deprives them of courage to be themselves.

To profess freedom without a change in personal consciousness it seems to me is like wanting the thunder and lightening without the rain, to want the sun without the heat and the light.

“No creature can learn that which his heart has no shape to hold.”**

** 'All the Pretty Horses', McCarthy 1992

Why Japanese Health Care is Bad

Harden, Blaine. 2009. "Health Care in Japan: Low-Cost, for Now: Aging Population Could Strain System." Washington Post. (7 September).

Half a world away from the U.S. health-care debate, Japan has a system that costs half as much and often achieves better medical outcomes than its American counterpart. It does so by banning insurance company profits, limiting doctor fees and accepting shortcomings in care that many well-insured Americans would find intolerable.

But many health-care economists say Japan's low-cost system is probably not sustainable without significant change. Japan already has the world's oldest population; by 2050, 40 percent will be 65 or older. The disease mix is becoming more expensive to treat.

So, public intervention of the medical system is obviously bad. The problem is that the Japanese health system makes the mistake of failing to let enough people die. The article does admit that a healthy lifestyle is also a factor, but let's hope that the US does not follow Japan.