Slipping a Slurpee While the Economy is in a Ditch

No need to help me out the ditch, doing just fine on my own - by Michael PereckasThe U.S. economic recovery seems likely to stall yet again as it attempts to finally get out of the ditch.  In an economy at full employment 18,000 jobs added would be a bad jobs report (over 100,000 new jobs a month are necessary just to keep up with population growth), with 9%+ unemployment 18,000 new jobs is a disaster. 

Our best hope for a new recovery is in just how bad things are.  The U.S. housing market has been terrible for so long that very little new construction has taken place, and we don't have enough housing.  Eventually people will get tired of living with their parents and construction will have to pick up.  Right?

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Peter Boettke's Economic Meta-analysis

Termite cathedral = spontaneous orderFrom Peter Boettke at the Coordination Problem blog:

I often use a 2 x 2 matrix to communicate to students the different schools of thought in economics.  The rows reflect the problem situation we are find ourselves in (simple or complex), the columns reflect the outcome of our interactions (order or disorder).  Neoclassical economics is found in the simple/order cell; Keynesian and market failure theory is found in the complex/disorder cell; Marxism and critics of economics are found in the simple/disorder cell.  What does that leave?  The complex/order cell and that is the intellectual home of the Classical economists such as Smith-Say, the Austrian school from Menger to Mises to Kirzner, and the New Institutional school of Alchian, Buchanan, Coase, Demsetz, North, Olson, Ostrom, Smith, Tullock and Williamson, etc.

The Austrians occupy a central place in this cell because they emphasize not only the cognitive limitations of man, but also the complications of uncertainty, time, and I think importantly modifications to our core understanding of money and capital.  Money is non-neutral, and the capital structure in an economy consists of combination of heterogeneous capital goods that multiple-specific uses.  Once these propositions are included in the analysis, along with other messy aspects of the real world, our understanding of market theory and the price system shifts drastically.  Nothing can be treated as given.  Everything must fall out of the analysis of exchange and production.  Economic analysis is about economic forces at work, not the analysis of situations after those forces have done their job.

The traditional perfect market versus market failure debate is stale --- the perfect market folks don't tell us how the story of the market unfolds, and the imperfect market folks stop the story short right when it is getting interesting.  Journalist can understand this simple characterization of economic ideas, but economists should know better.  Back in the late 1940s, Kenneth Boulding (John Bates Clark Medal winner in 1949) actually raised this issue in his review of Samuelson's Foundations in the JPE.  Boulding wondered if the flawless precision of mathematical economics would prove impotent in terms of dealing with the real world in comparison with the literary vagueness of classical economics and economic sociology.  Not many listened to Boulding, and instead of doing messynomics in the sense of complex/order cell, we got a stale debate between simple/order and complex/disorder. And it still is going on today.

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Muddling Through

Unlike cocktails, the best economies aren't made by muddling. Image by TheogeoWe have grown accustomed to rival constituencies focusing on economic issues with special relevance to them: conservatives want lower taxes, libertarians want smaller government and liberals want better services.  The relative merits of each position wax and wane in the public eye and everyone wins or loses at the margin.  However, our current departure from "normal economic conditions" should remind everyone that these partisan concerns are of secondary importance: allowing greater human flourishing and the prevention of extreme human deprivation are the ultimate ends of all policy preferences.  Conservatives and libertarians favor lower taxes because they believe that low taxes spur growth and allow more people to better their lives.  That low taxes might be a good thing in and of themselves has eventually become ideological dogma, but only because we lacked a sufficiently compelling reason to raise taxes.  While it generally isn't expressed in such utilitarian terms, we all believe we have the best policies to create the most happiness.

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A (Too?) Simple Solution to Financial Illiteracy

image courtesy of the New YorkerIn an editorial for the New Yorker, James Surowiecki suggests that the new consumer-protection agency's plans to "review and streamline" financial education initiatives is not enough:

We really need something more like a financial equivalent of drivers’ ed. There’s evidence that just improving basic calculation skills and inculcating a few key concepts could make a significant difference. One study of the few states that have mandated financial education in schools found that it had a surprisingly large impact on savings rates. And the Center for American Progress has found that, across the country, education and counselling by nonprofit organizations, like the Massachusetts Affordable Housing Alliance, have helped low-income families buy and hold onto homes, even during the housing bubble. The point isn’t to turn the average American into Warren Buffett but to help people avoid disasters and day-to-day choices that eat away at their bank accounts. The difference between knowing a little about your finances and knowing nothing can amount to hundreds of thousands of dollars over a lifetime. And, as the past ten years have shown us, the cost to society can be far greater than that.

I agree with Mr. Surowiecki's premise, but "reviewing and streamlining financial education initiatives" sounds to me like hopeless wonkery, as though awareness of the existence of idiots is enough to end all our financial woes.  The simple solution I would offer is tough love in conjunction with access for the "worthy": contrary to the Bush Administration's noble goal to make everyone a home-owner, I suggest three things: (1) a focus on policy making it easier for more people to rent, because renting rules; (2) no home loans for morons; and (3) no more bank bailouts.

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A Response to Paul Krugman

Paul Krugman, looking left

Paul Krugman's existence in the popular consciousness, mostly through his New York Times column and blog, the Conscience of a Liberal, largely rests on ideological antagonism.  Krugman's famous September, 2009 straw-man New York Times Magazine editorial, "How Did Economists Get It So Wrong?", attacking University of Chicago economist John Cochrane and others, was the "Hit Em Up" of economic policy debate. 

Krugman's near-constant invocation of "saltwater" and "freshwater" economics suggests two irreconcilable and antagonistic schools corresponding to two irreconcilable and antagonistic political parties: one urbane and sophisticated, one backwoods and boorish.  In Krugman's world, neither heterodox economists nor heterodox politicians can work together to solve problems honestly.  This is hackery.  In reality, the economics discipline is a nuanced conglomeration of disparate ideas.  The unholy marriage of economics and politics which Krugman represents only threatens to undermine the credibility of economics as rational discourse on human behavior.

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Symptoms versus the Disease

The Patient is Cured! - by GastevMy grandfather, a epidemiologist and medical doctor, was suspicious of medicine that addressed the symptom rather than the underlying malady.  He didn't appreciate a treatment that made you feel better, even if it didn't cure you.  I don't share his fealty to purity in treatment.  If the symptoms are what makes life unbearable, then minimizing the symptoms is real progress, even if a magical cure would be the best of all worlds.  Unfortunately, it seems many commentators want to cure the economy rather than deal with its symptoms.  Unemployment is the excruciating pain of a bad economy and right now we've got two years of agony with no end in sight.  Yet, many focus on cutting the deficit- which would certainly have the effect of prolonging high unemployment since reduced government spending would come out of already reduced economic demand.

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Our Obese Economy

Panics do not destroy capital; they merely reveal the extent to which it has been destroyed by its betrayal into hopelessly unproductive works. - John Stuart Mill

David Leonhardt recently wrote a column for the New York Times in overwhelming praise of the stimulus.  Leonhardt goes to great lengths to castigate opponents as political opportunists, visceral reactionaries, or ideologues, but Leonhardt, and many other proponents of economic stimulus - including Paul Krugman - fundamentally misunderstands the nature behind the opposition; it's not about doubting the math or denying that government programs designed to create jobs create jobs.  Reasoned opposition relies on the idea of malinvestments contaminating the economy and the creation of moral hazard inevitably postponing a bigger collapse.

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Greek Tragedy of the Commons

The Eurozone faces its first big test this month as revelations of a Greek debt crisis have raised the possibility of an insolvent country within the Euro 16.  So far the rest of the E.U. has insisted that Greece take measures to immediately reduce its deficit to the mandated maximum allowable 3% of GDP by 2012, after it was revealed to have run deficits four times that large in 2009.  The richest countries in Europe, most of whom have passed debt financed economic stimulus plans themselves, forcing new taxes, entitlement cuts and payroll freezes on one of the relatively poorer countries is tough medicine to stomach; however, given that other Mediterrian countries, notably Spain and Italy, face their own debt problems, setting a tough precident is not just justified, but essential.

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Book Review: Bruce Bartlett - The New American Economy

Bruce Bartlett's conservative economic bona fides are apparent in his resume: he started as a member of Ron Paul and Jack Kemp's Congressional staff, then became Executive Director of the Joint Economic Committee during the Reagan administration and later served as Deputy Assistant Secretary of Economic Policy at the Treasury Department under H. W. Bush.  He literally wrote the book on supply-side economics, with Reaganomics: Supply-Side Economics in Action in 1981.  With such unimpeachable conservative economic credentials, Bartlett feels free to slaughter some of the right's sacred cows in his recent book, The New American Economy: The Failure of Reaganomics and the New Way Forward.  He rehabilitates John Maynard Keynes as a misunderstood conservative, calls for the victory celebration and subsequent retirement of supply-side economics and defends President Obama's stimulus plan as the only thing to do.

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A Final Note on a Softer Economic Policy

There is a famous joke about the tendency of economists to consider their chosen field akin to the natural sciences: a physicist, a chemist, and an economist are stuck on a desert island.  A can of beans washes up on the beach.  The physicist devises a mechanism using twigs and rocks to attempt to force open the can, but after several hours with no results, during which the economist sits and smugly smiles, the physicist gives up.  The chemist attempts to extract some sort of substance from plants on the island to melt the can.  The economist continues sitting and smiling arrogantly as the chemist also fails in his efforts.  “What?” the physicist and chemist say, “do you have a better plan?”  The economist stands and walks proudly towards the can on the beach: “Let’s assume we have a can-opener.”

This joke is often told by economists to economists at economic conventions or by economics professors to economics students during economics class, which was where I first heard the joke.  Yet the same economists who make this joke forget their own lack of hard science credentials when they make predictions; and non-economists seem to forget the incorrectness of the last prediction when they hear the next prediction.  In times of trouble, the poor track record of economists at predicting the future is never called into question, and political leaders often blindly surrender national sovereignty to “experts.”

I undoubtedly believe that central economic planners are capable of coordinating and herding hundreds of millions of people to some greater economic purpose by simply printing money and increasing government spending, but I also believe that the negative consequences of these policies usually outweigh their beneficial effects.

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Our Old, Misunderstood Friend: Inflation

Recently, Chris Carr wrote an article advocating allowing natural deflation instead of using expansive monetary policy from central banks to artificially maintain persistent inflation.  I disagree with several aspects of Mr. Carr’s analysis, including some of the data. For example he misrepresents the level of deflation in the economy since the financial crisis by only examining September of 2009 and ignoring that this deflation exists despite a huge monetary stimulus.  Most fundamentally, however, I believe that he dramatically underestimates how dangerous deflation can be, as even tiny amounts of deflation can increase trade deficits and consumption and leave the indebted particularly vulnerable.  Mr. Carr's proposal for less centralized money might apply to countries, like China, needing to boost domestic demand in the face of massive budget and trade surpluses, but it would amount to economic suicide for the United States which has record budget and trade deficits and far too much consumption in the economy.

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Deflation, Savings, and Where We Go Next

The Japanese media has recently been obsessed with defure, or deflation.  The September annualized rate of deflation for Japan was 2.24%, compared to September annualized deflation rates of 0.18% in the U.S. and 0.80% in China.  Canada, the U.K., Australia, and the European Union had very low rates of annualized inflation in September.  Why does the media panic about anomalous low-single-digit deflation while ignoring the well-documented effects of seventy-five years of chronic inflation?  The rationale for the panic is that deflation can lead to a liquidity crisis (government stimulus is rendered impotent) and/or a deflationary spiral (hyperdeflation); yet, blind to the lessons of history, inflation is considered a necessary evil, and the possibility of an inflationary spiral is underserved. 

First, an explanation of the relevant terms.  Originally, inflation meant an increase in the money supply, and deflation meant a decrease in the money supply.  However, modern understandings of the terms are more nuanced; now inflation and deflation are related more to purchasing power and price levels.  Because when there is more of something it becomes less valuable, inflation is now understood as a devaluation of currency.  Deflation is when a currency becomes more valuable.  Usually during economic booms, there is a robust rate of inflation as people move their collective wealth from cash-based resources into assets; there is more cash around, so people treat it with less respect and tend to spend frivolously.  During recessions, people tend to value security over potential profits, and attach more value to cash-in-hand; a dollar is worth more as a result.  Deflationary periods indicate increasing aversion to risk among the population, but not necessarily recession: in the late nineteenth century the U.S. experienced both persistent deflation in the absence of a central bank and high rates of economic growth.

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Pay Attention to the Number of Zeros

We've all heard the stories of primitive humans only possessing words to express "one", "two", and "many".  Yet most modern people still think of numbers in terms of these basic units.  When we visualize three of something, we think of one group of one and one group of two.  Four is two groups of two.  Five is two groups of two and one group of one, etc.  Certainly, for things like money, we have relative anchors to which we assign values.  For example, one dollar is roughly the amount of money that buys me one pack of M&Ms.  Ten dollars buys me a used Bloodsport DVD.  300 dollars buys me a Playstation 3 or pays for one-month's rent in a mediocre apartment.  7,000 dollars buys me a ten-year-old economy car in decent condition.  A 100,000 dollar loan puts me through business school.  If I'm lucky and work hard, in ten years, 200,000 dollars could be my annual salary.  If I make the right choices, use my money effectively, and save, I might even be able to buy my one million dollar dream house in twenty-five years.  This is the absolute limit for 95% of Americans.  Numbers above this limit often are simply assigned the value of "many".

So it's no surprise that people all over the country are getting all up-in-arms about stimulus scandals and banker bonuses.  But, to put it in perspective, here is a list of "many"s expressed in terms of dream houses:

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Let's Not Go Down this Path...

"Please cancel all my afternoon meetings."Throughout the infamous Lost Decade of the 1990's, the Japanese government tried to stimulate the economy by lowering the interest rate, federally subsidizing and mandating unwelcome contruction projects in rural areas, and creating new government busy work.  The results of this were as follows: (1) the interest rate was lowered repeatedly with no effect until it reached zero.  The Bank of Japan's hands were tied: it couldn't raise the interest rate without hurting the economy, so it effectively had used up all of its resources on that front and was rendered impotent; (2) rural areas were overwhelmed with gradiose tunnel systems and multi-purpose/non-purpose halls, which went unused and fell into decay.  In my city, Fukushima, the ruralist of the rural (When the Beverly Hillbillies was dubbed into Japanese, they gave the characters Fukushima accents to emphasize the fact that they were uneducated hicks.), there are several pedestrian tunnels built to go under one-way streets, as though people couldn't just use the crosswalks.  These go unused, and in general have become unofficial homeless shelters.  There are also walls built to prevent mudslides in uninhabited areas and, of course, tetrapods; (3) government positions have spiralled out-of-control.  There are so many government workers that they've become their own demographic that politicians try to sex up for votes. 

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Common Sense Considerations for Green Jobs

As someone who generally opposes government intervention in the economy, I am highly skeptical about the efficacy of green job creation.  I believe government economic policy should foster an atmosphere where the forces of the free market are allowed to choose winners and losers.  However, I also believe government economic policy must focus on solving externalities by weighting incentives via taxation or similar soft-touch means. 

Nevertheless, I recently read current American Enterprise Institute Director of Economic-Policy Studies and former George W. Bush and John McCain presidential campaign advisor Kevin Hassett's sensationalist, straw-man editorial on Bloomberg.com and, after cringing a bit and then vomiting in my mouth, felt the compeling need to distance myself from Hassett's argument.

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