An ongoing review of politics and culture

Malinvestment and Recessions

Frequent commenter Pithlord asks a good question in the comments to my last post:

[M]arkets can be rational-but-wrong. But if that’s the case, and if the markets are revising their beliefs about future real productive capacity (as opposed to nominal demand), then there must have been some new piece of information in September 2008 that meant it was rational to revise expectations of future productive capacity downwards. A lot. I have trouble seeing what that piece of information would be.

That’s an extremely good question, and I’ll try to answer it as I see it. But first, I want to stress that I’m not an economist, and that I come at this with, basically, the instincts from my Wall Street career, as well as my strong inclination to believe that the people who run the Fed are not idiots. They may certainly be wrong – we’re very much in uncharted territory – but if the solution to our economic problems were obvious, and in their hands, then you need an explanation for why they are not pursuing that solution. They might be more willing to tolerate unemployment than someone else – they may have other priorities. But any dovish argument needs to grapple with those priorities. Simply asserting that there is no other side to the question – that it is obvious what is to be done, and it’s simply mysterious or evidence of malicious intent if the powers that be don’t do it – well, it’s just a poor mode of argumentation, it seems to me.

So, here’s how I look at it. I don’t believe the wealth effect is terribly significant. In general, people don’t spend (much) of rises in asset values, and they don’t save (much) more in response to asset price declines. That’s because most people don’t own much in the way of assets. Most people consume what they earn – or more. And the people who own assets don’t reallocate between savings and consumption that much in response to market fluctuations, even big ones. Markets fluctuate for all sorts of reasons; that’s why they say the stock market has predicted twelve of the last four recessions.

The kinds of market declines that presage recessions are ones related to the creation of large amounts of bad debt. When large amounts of debt go bad, it’s a problem in and of itself – money gets “stuck” cleaning up debt rather than being deployed more productively. But it’s also an indication that prior investment decisions – on a broad scale – were based on exceedingly faulty information about possible returns.

In the 2000s, we had reasonably good growth in consumption, and therefore reasonably good economic growth. But a huge percentage of this consumption was underwritten by rising housing values. The market behaved, for some time, as if either this would continue forever, or it would be eventually replaced by some other driver of consumption growth. When the housing market turned negative, the market initially treated this as a cyclical downturn – there would be less construction in the near future, so money would flow into other goods or services. But when the sheer scale of the bad debt became clear, that revealed two things. First, it revealed massive weaknesses in our financial system – which is what caused the financial panic. But it also caused a significant revision in expectations about how much consumption would grow in the future. The debt overhang was directly going to cause people to consume less as they saved to pay off their bad debts. But indirectly, it changed people’s expectations because the scale of the bad debt made people realize how much of the consumption growth of the 2000s was tied up in a rising housing market. Tied up, in other words, in an illusion, one that was not going to be repeated or easily replaced.

The mutual fund disclaimer says “past performance is not indicative of future results” but that’s all we have to go on in the real world. If past performance was good, we think future performance will be as well. If the past performance is revealed to have been not as good as previously thought, then future performance expectations will be revised sharply downward.

I actually saw this happen once before, on a much smaller scale, in the 2000 recession. I remember when the market’s perception changed from the notion that this was just a correction to the expectation that something was going to change in the real economy. We could have vaporized trillions on paper without any material consequence in the real world – as I say, I’m skeptical that the wealth effect is very large. But two high-profile bankruptcies changed the way the correction was perceived: Enron and Worldcom. Both were instances of fraudulent accounting. Even though both were large companies, their bankruptcies alone wouldn’t have been a big deal. But because their frauds were so longstanding, what the market understood was that these companies had not really been profitable for some time. Moreover, the market understood that other companies – their competitors – had invested heavily, with borrowed money, to copy these apparently moneymaking strategies that were now revealed to be fraudulent. All these other telecommunications and energy companies were now perceived to be at risk – projections for profit went out the window, and projections for bankruptcy replaced them. So, once again, what changed was expectations for how much return the economy was likely to produce. What had apparently been produced profitably in the past was revealed to be fraudulent – value-destroying rather than value-creating. That changed expectations for what might be produced in the future. On a much smaller scale, but a similar process.

The line between what I argued in my last post and what the inflation doves are arguing isn’t actually that sharp. I’m not denying that a rise in inflation would boost demand, all else being equal. I’m arguing that all else won’t be equal – that we need to worry about a rise in inflation resulting in a drop in real growth, via a variety of mechanisms. That would mean the boost to NGDP from an inflationary strategy would be lower than expected, which would lead to demand for more inflation. And the tradeoff gets worse the further down that road you go.

That’s why I’m biased toward a hard-money monetary policy – a policy that focuses on price stability (and yes, I think there’s a case for some degree of “catch up” given the deflation of 2009) rather than the dual mandate that the Fed formally operates under (though they don’t seem to be following it in practice, and haven’t been for some time) of achieving price stability and full employment. But the more important focuses should be twofold: on alleviating human misery by tackling unemployment directly, and on taking action on the supply side that would improve expectations regarding future growth. And I cannot stress enough that I believe there are lots of left-wing opportunities that properly should be classified as supply-side ones. For example: liquifying the housing market by some kind of debt cram-down.

We’re now actually overdue for a revival in construction. But it isn’t happening because the housing market has seized up due to bad mortgage debt. The amount of inflation it would take to solve that problem is terrifying – we don’t want to go there. But we could tackle the debt directly. I’d call that a supply-side action, government clearing away the dead wood so the economy can grow again – just like patents are a government-granted monopoly, the process of foreclosure is a creation of the legal system. The goal should be to get transactions happening again, and that requires cleaning up the mountain of bad debt, even if it means banks take another hit. Again: the focus should be on creating conditions that encourage wealth creation, not on preserving the position of incumbents. (Some people argue Japan couldn’t get out of its liquidity trap for years because it wouldn’t inflate the economy enough – I’m inclined to agree with those who argue that Japan couldn’t get out of its liquidity trap because it wasn’t willing to take on the incumbent banks, who would not write off their enormous portfolio of bad debt.)

Why Easier Money Is Not A Sufficient Answer to The Great Recession

I’ve been meaning to write something about this for some time. If I understand the case for monetary policy über alles, the argument runs roughly as follows. After the financial crisis of 2008, we saw a dramatic fall-off in consumer demand for goods and services, and a dramatic increase in demand for money – for safe stores of value. This produced the deep and long recession whose effects – particularly high unemployment – still plague us. The solution is to reduce demand for money by increasing expected inflation. If inflation expectations rise, people will be less willing to hold safe stores of value – because they will not be perceived as safe stores of value anymore. So, instead, they’ll spend their money on goods and services, or invest their money in ventures that produce a higher return. And either will produce a return to growth.

My problem with this story is it leaves out the why of the increase in demand for money. The implicit, unstated assumption behind the story is that there is some natural rate of real growth that everybody knows is achievable, and that therefore the sudden rise in demand for money reflects some kind of irrationality on the part of the participants in the economy. But I don’t think that’s the case. We don’t know what the “natural” rate of achievable real growth is. It seems to me that the story of the Great Recession is that people suddenly realized that the rise in consumption over the 2000s had been based on fantasy. Housing values would not go up forever, and people were consequently not as rich as they thought they were. More to the point: if the apparent increases in household wealth of the 2000s were revealed to be illusory, then expectations for future increases in wealth would have to be recalibrated as well. If we weren’t as rich as we thought we were in 2006, maybe we wouldn’t be as rich as we thought we’d be in 2016 either.

The recession, then, was caused by a rational drop in expectations for real growth. If real growth is projected to be poor, then it is rational to save more for rainy days, and to keep that savings in safe stores of value.

The problem, of course, is that this becomes a self-fulfilling prophecy. The question is whether the cycle can be broken merely by undermining faith in the safe store of value.

I don’t think so, because I think making money less safe will only encourage people to seek other sources of safety that appear money-like. These could, in fact, be highly risky – whether we’re talking about fake AAA securities or highly volatile commodities – but whether or not they prove to be as safe as hoped, a shift out of money and into these kinds of assets will not spur either aggregate demand or real growth. You might well get more inflation – indeed, I’d expect you would – but this would be offset by lower real growth.

Now, this might not be true for a smaller economy. A small economy can devalue its currency and thereby increase demand for other currencies without materially affecting the incentives for those currencies to devalue in turn. Such a small economy can, thereby, capture a greater share of global demand to offset the drop in domestic demand, and thereby prop up real growth at the cost of a one-time drop in everybody’s wealth. This is basically what Sweden did in the Great Recession. But a big economy like the United States can’t do this without creating enormous strains in other large economies. The likely result would be competitive devaluations that leave everyone basically where they were before – with higher inflation offset by lower real growth. And the strategy poses risks for smaller economies as well, if it becomes a habit. Countries that get a reputation for dealing with debt by repeated devaluations wind up paying very high interest rates even when times are good. These high rates, in turn, make robust real growth more difficult to achieve than in countries with better fiscal and monetary management. Pre-Euro Italy and pre-Lula Brazil are good examples.

That doesn’t mean that monetary policy has no role to play in keeping a major economy stable. It absolutely does. The role of sound monetary policy is to provide price stability. To keep inflation very low and positive. That’s precisely what the Fed has been trying to do – with considerable success – since Paul Volcker broke the back of double-digit inflation in the early 1980s. I’m not making the case against “fiat money” and for a gold standard – that would just mean yoking the economy to the vicissitudes of demand and supply in a random commodity, something that only has appeal in those circumstances where the monetary authorities stop doing their proper job. I’m making the case for doing that proper job: aiming for price stability.

In my view, therefore, the response to the short-term economic dislocation should be to focus on the long-term. Get long-term real growth expectations to rise, and the economy will recover as businesses react to take advantage of the opportunities afforded by that projected growth.

That’s not a right-wing view. It doesn’t mean that we should only respond by cutting marginal income tax rates, or even that we need to bring the deficit down. It means that we need to reorient our spending priorities around investments that will deliver for the long term – more investment in physical infrastructure and human capital, less investment in defense and current consumption. And it means we need to reorient our taxing priorities – eliminating economy-distorting tax expenditures, reducing taxes on employment, and increasing taxes on consumption. It may mean increasing government intervention in some areas – to restore confidence in the financial system, for example, or to liquify the housing market by getting rid of the burden of overhanging debt – and reducing it in others; patent and copyright reform, for example, should properly be understood as a species of deregulation, reducing the scope of government-granted monopolies. It means, in general, that we should be assessing changes in spending, taxes and regulation by what they will do to long-term expectations for real growth, and not what they’ll do for short-term demand.

The short-term focus, by contrast, should be on reducing human misery and preserving the value of human capital, while imposing the least drag on long-term economic performance. Since the Volcker recession, American employment recessions have been substantially longer-lived than recessions of comparable depth in the pre-Volcker period. This was true in 1990-1991, and again in 2000-2002, and again today. This may well be a side-effect of the successful efforts by the Fed to achieve price stability, and if so that’s still preferable to the pre-Volcker situation when unemployment and inflation both marched up in a saw-tooth pattern to successively higher peaks with each recession and recovery. But we don’t have to accept that situation as inevitable. We could tackle unemployment directly, whether through a German-style Kurzarbeit program or through Great Depression-style public employment schemes or through some other mechanism – or a combination thereof. The biggest initiative of the Obama Administration in this regard was the stimulus plan, which, by giving aid to the states, prevented massive public-sector layoffs. This was a good thing to do – but it wasn’t a fair thing to do, because it protected public employees but not the employees of private enterprises, and it provided that protection without any givebacks (on benefits or work rules, for example) that might have increased productivity in the public sector and thereby promoted long-term growth. And this, I believe, is the primary reason that the stimulus remains unpopular – not because people wanted teachers and firefighters laid off, but because people don’t like favoritism.

What I’m laying out is a case for what might be called hard-money paleo-liberalism: a state that invests in projects that are important to long-term growth (whether physical- or human-capital-related) but are too large or diffuse or uncertain to attract private sector investment, and that plays an important role in cushioning the effects of economic dislocation on those directly affected, but that pursues a monetary policy aimed at price stability rather than counter-cyclical stimulus.

The emerging conventional wisdom on the left is that the Obama Administration failed by not focusing more on short-term economic performance – getting more monetary stimulus (by packing the Fed with inflation doves) and/or more fiscal stimulus (by passing a larger or second stimulus bill of similar character to the first). Leaving aside whether the Administration could have achieved either posited goal, as well as whether the Administration could have known that more stimulus was necessary, my suggestion is that this is the wrong critique. The Obama Administration should be faulted – from the left – for not being sufficiently creative in tackling unemployment directly, for not leading an adequate reorientation of our national spending priorities, and for being insufficiently aggressive at tackling the structural problems in the housing and financial sectors that are holding back a resumption of growth. His policymaking has remained squarely within the neo-liberal consensus even as that consensus appears to have failed. But the one great achievement of the last 30 years was a monetary policy that worked. So it’s strange to see the continued support for that pillar be made the focus of what he’s done wrong.

Uncertainty and Investment

Matt Yglesias argues that regulatory uncertainty can deter investment.

Writing about a DC bar that had to close its doors because it couldn’t get a liquor license, he writes that this isn’t just bad because of the loss of economic activity from that one bar but also because it’s

a sign to would-be entrepreneurs everywhere that their potential investments are much riskier than a superficial read of market conditions would suggest.

Well, exactly.

I’ve been an entrepreneur, startup advisor and technology journalist, and I’ve always been surprised at how risk-averse venture capitalists seem. Isn’t the whole point of their job to take risks?

And yet most venture capitalists have very narrow sets of criteria under which they invest.

The answer is that risk isn’t unidimensional. Whenever you undertake something there are many factors that can go wrong. And it’s precisely by mitigating risks in most of these factors that you feel comfortable taking bigger risks along other factors.

So a VC will try to back a team that’s located in Silicon Valley, has the right pedigree, etc. and minimize all these other risks precisely because she’s taking a big risk on an untested product in an untested market.

To take another example, let’s say you’re a company that’s thinking about building and operating a bridge.

This type of investment typically entails spending a ton of money upfront, and then using money from toll fees and the like to recoup your investment over time. For these big types of projects, the time frame is generally measured in the decades. Usually these investments are leveraged: you borrow most of the money to build the bridge and then pay back interest out of the cashflow from the tolls.

That means you need to take into account not just how much it’ll cost to build the bridge and how many people will use it and how much you think they’ll pay (30 years from now!) but also things over which you have even less control like, say, interest rates and inflation.

Now let’s say you’re looking at two bridge projects, one in Germany and one in Argentina. Let’s say for the sake of argument that they are identical in terms of how much they’ll cost, how much you can expect to recoup (nominally), etc. What’s inflation going to be like in Argentina in 30 years? What about Germany?

Well, no one can say for sure. But one can guess. One can note that inflation has been pretty moderate in Germany for over 30 years. One can note that Germany’s political culture is hellbent on keeping inflation under control, even if this entails considerable other costs. One can note that Germany is in a region, Europe, that has had generally sound monetary policy and credible central banks.

Meanwhile, one can note that Argentina defaulted on its loans and dramatically devalued its currency a decade ago and that it hasn’t yet come to an agreement to the satisfaction of all its bondholders. One can note that not only is inflation rampant in Argentina right now but that the government is actively involved in denying the extent of the phenomenon, going so far as harassing analysts putting out inflation numbers that contradict the government’s figures.

Again, let’s say that on the “pure” business metrics, the two bridges are the same. Something tells me the bridge in Germany is going to get built, and the one in Argentina isn’t.

Of course, it’s possible that this is wrong. Maybe one day Germany decides to debase the euro to keep its exports competitive and hits onto an inflationary cycle that gets out of control. Maybe Argentina elects a former hard-left trade unionist who realizes that credibility with international investors will help regular people in Argentina and manages to keep Argentinian economic policy “orthodox.”

But right now, there’s just a lot more uncertainty associated with building a bridge in Argentina than in Germany, and this means that, ceteris paribus, Argentina will get less investment than Germany.

All of which is to say that, yes, regulatory uncertainty can and does indeed deter investment. And the key to grokking that is to understand that it’s precisely by making some criteria more certain that entrepreneurs and investors are freed to take more risks.

Certainly it doesn’t mean that there aren’t a lot of politicos BS-ing about this. It’s not an argument against all regulation (indeed in some cases good regulation is better than no regulation). And after taking the US federal government to the brink of default, the Republican Party is arguably the least well placed in talking about “certainty.”

But, “uncertainty” matters.

How France Must Save Itself And Thereby Save The World

At Business Insider, I put forward a plan for France to reform its economy, and thereby lead the Eurozone out of the doldrums and to the sunlit uplands of prosperity.

I encourage you to read it and share it.

Texas' policies attract people to move there but that doesn't mean the people who move there like Texas' policies

A puzzling post from Matt Yglesias.

Writing that Texas’ job growth is mainly due to population growth (it seems the picture is slightly more complex ), he writes:

A few people came up to me after the Cato event on Thursday night and said something like, you may be right but doesn’t the population boom show that people are voting with their feet for Texas-style public policy? … You can’t talk about revealed preferences without looking at prices. Notwithstanding the real estate crash, someone who bought a building in Williamsburg or Central Square or Logan Circle ten or fifteen years ago has done very well for himself. This would not be a million dollar house in Houston. In Brooklyn and Cambridge and DC we have “gentrification.” In Dallas they have population growth. There’s little net population increase in coastal states because THE RENT IS TOO DAMN HIGH (book forthcoming).

Right, but why is the rent too damn high in coastal states? As Ed Glaeser convincingly argues, and as I’m sure Matt knows, the rent is too damn high in coastal states because of policies enacted by these states that make construction hard, and thus reduce the housing supply, and thus drive up prices. Conversely, the rent is not too damn high in Texas because construction is relatively unregulated and so supply and demand match up (in both directions: Texas had a soft landing from the housing bubble).

Imagine, to take another Yglesias hobbyhorse, and I hope the subject of a forthcoming book from him, that all states except Massachusetts enacted very strict occupational licensing regimes for clowns. Plenty of clowns would presumably move to Massachusetts.

One person might say: “See? Massachusetts’ policies have enticed plenty of clowns to move there, which is good for consumer choice and the broader economy (and clowns).”

A second person might say: “Clowns didn’t move there because of policies, they moved there because it’s easier/cheaper to be a clown in Massachusetts.”

And the first person would say: “Well, exactly.”

Back before Deng’s reforms when plenty of communist Chinese tried to come to Hong Kong to make a better life, I’m pretty sure most of them weren’t readers of Hayek who had made an intellectual determination that central planning and collective ownership of the means of production was inferior to free markets and the rule of law. But it would still be fair to say that they were voting with their feet against communist policies.

Corporations are not people. They're persons.

There’s a bit of hoo-ha about Mitt Romney saying that “corporations are people.”

He was using shorthand to refer to the fact that taxes on corporations are ultimately borne by people (not just shareholders, by the way—workers and customers as well), which is absolutely correct.

Romney’s off the cuff statement has been used pretty unfairly to malign him.

This is because the phrase “corporations are people” has some political salience because of Supreme Court decisions that are purported to have granted special rights to corporations on the grounds that they are people.

There’s even a movement to amend the Constitution to say that corporations are not people.

This may just be the dumbest controversy EVER. It makes intelligent design look like the general theory of relativity. It’s like a controversy about whether the sun rises in the east.

Even the intelligent Jon Chait writes in defense of Romney “there is a controversy over whether corporations are people from the standpoint of law.” No there isn’t.

Understanding why corporations are not people, but persons, is easier with some grasp of law and history, but really, all it requires is knowledge of English and logic.

Corporations are persons.

What this means is that they’re recognized by the law as entities that can have a name, sue in court, be a party to contracts and have property.

Different types of persons have different types of rights, but these types of persons have only the rights that allow them to exist. Not the kind of “human rights” that fleshlings enjoy. (These non-people persons are referred to as “moral persons,” an even more misleading term, as opposed to “physical persons.”)

That’s it.

That’s it.

That corporations are persons does not mean that they are people, as a matter of law, language and logic. (Etymology, as often, helps: persona in Latin is the mask that actors would use in the ancient theater. Legal personality is thus the “mask” that either individual people or groups of people use to act in the legal arena. This is also why we have the word “persona” in English, which also refers figuratively to a mask.)

And if corporations are people, it means we’ve reinstated slavery, because corporations are bought, sold and even killed by their owners every day.

But there’s an even more profound reason why this non-controversy is stupid.

It’s not just that it’s an obvious fact that corporations are persons, not people, and that this, in itself, is utterly uncontroversial and of no notable policy consequence.

It’s that the doctrine of legal personality is one of the basic building blocks of civilization. It’s right up there with writing and indoor plumbing.

This is because without legal personality, it is not possible to have an institution that is distinct from the humans who make it up.

A state is a legal person. Without the concept of legal personality, any land and its inhabitants are the personal property of its ruler, as it was for much of human history. Even Robert Mugabe would not dare assert personal legal property over all of Zimbabwe.

It is quite simply one of the greatest achievements of civilization that we reached a level of sophistication high enough that we could not only conceive, but theorize and enforce the concept of an institution that is, actually, nothing but an abstract concept (there is no such thing as “Wal-Mart.” There are buildings and people and bank accounts, but “Wal-Mart” doesn’t exist. Except as a fiction. As a law professor of mine used to say “I’ve never had lunch with a corporation.”).

It’s not just a great achievement of civilization because it’s a beautiful concept. It’s a great achievement of civilization because without it all of civilization would collapse. Every collective human endeavor now includes the creation of non-people persons. Literally. Imagine what would happen if every corporation and state vanished overnight as a legal construct (but leaving all the buildings and stuff intact). Society. Would. Collapse.

Being opposed to the concept of corporations as persons, or not understanding why corporations are persons and why the fact that it is so is as problematic as the fact of the sun rising in the east, is frightening.

(Parenthetically: Why, then, the controversy around Supreme Court decisions? A few reasons.

(1. People are stupid.

(2. The omniscient and perfect Framers of the US Constitution neglected to distinguish in their text between the vulgar and legal meanings of the word “person”. For example, in the infamous Three-fifth Compromise, the “free persons” used for the purpose of the census do not include corporations. But in other stances of the use of “persons”, they might. But this is not a debate as to whether corporations are persons (they are) or people (they’re not), but a debate as to how to interpret the Framers’ sloppy English.)

Of Clouds and Silver Linings

I didn’t post anything about the manufactured debt-ceiling crisis because I thought the whole thing was political theater and that the best way to make our politicians stop this sort of nonsense would be to ignore them entirely.

But there is at least a bit of a silver lining: S&P has downgraded American sovereign debt to below AAA for the first time in, to all intents and purposes, forever.

Since the manifest culpability of the ratings agencies in the financial crisis obviously hasn’t done enough to dent their credibility, perhaps this ludicrous decision will be the straw that finally breaks the camel’s back.

Why ludicrous? Because the United States has the strongest credit in the world, as evidenced by the extraordinarily low rates of interest demanded for our debt and by the fact that when there is a financial crisis – even one caused by purported fears of an American default! – investors flee to the safety of . . . American government debt.

You say, apropos of the recent game of chicken between the GOP and the Democrats, that American political institutions have proven themselves to be significantly flawed, unable to deal with serious fiscal challenges. What, praytell, do you think of the vastly more significant game of chicken playing out across the pond between Germany and the more economically troubled members of the Euro zone (particularly Italy)? Why should Germany still be rated AAA when it doesn’t even borrow in its own currency, and faces the potential collapse of its entire banking system if an adequate solution to the Euro crisis is not found?

(Note that I don’t expect any such thing to happen. But I also don’t expect the United States ever to default on its debts. My point is that if I had to compare the likelihood of the collapse of the Euro versus the likelihood of an American default, why on earth – even in the wake of the recent absurdity – would I rate American default more likely?)

The practical consequences of the downgrade by a single agency are minimal, but should Moody’s follow suit we might see an additional silver lining: the collapse of the Basel II/III capital rules. These rules are organized around credit ratings: AAA-rated debt requires virtually no capital to hold. Since, as we learned in the financial crisis, AAA ratings can be manufactured, and since the ratings agencies have proven willing to let themselves be gamed in the manufacture of said ratings, a system like this creates an enormous incentive to pursue such games, and hide risk in the apparently risk-free portion of a bank’s portfolio (which is precisely how the major American banks nearly went under in 2008-2009). But if Treasuries do not get the most favorable capital treatment, then the whole system is obviously absurd. So, hopefully, purportedly risk-free instruments that are not backed by the full faith and credit of the United States government will, in the future, have a more substantial capital charge associated with them, which will reduce the incentive to hide risk in this fashion.

Finally, since nobody else is going to agree with me that the loss of our S&P AAA is a good thing because it discredits the AAA as such, this action by S&P is going to serve as a considerable constraint on future legislative action to increase the deficit (whether by extending tax cuts or enacting new spending programs), for fear that such action would lead to further downgrades. As such, since we are plainly headed towards a double-dip recession, we’re about to get a test of the monetary-policy-_uber-alles_ theories that have been floating around. Because a renewed recession will unquestionably balloon the deficit further. And if the central bank doesn’t take action in the face of both a renewed recession and the prospect of a sovereign downgrade, I think we can safely say that, whatever Chairman Bernanke may have written in his academic work, he doesn’t actually believe he can engineer a nominal GDP recovery.

The Fundamental Problems

This is going to be a fly-by-night post.

The thing that strikes me most about contemporary political debates is how much they arise because of an undiscussed underlying problem: GDP growth.

The main problems of contemporary Western economies is high debt (public and private) and unemployment. The best remedies for both are economic growth. Greece’s debt wouldn’t be a problem if it had high economic growth (or if investors believed it had that potential).

The disquieting rise of extremist politics in Europe would be much ameliorated if there were more jobs, and more growth. Etc.

And yet growth is very rarely discussed or, perhaps worse, only in the context of big government boondoggles like Barack Obama’s plan to boost US exports (what do exports have to do with growth?) or France’s “grand emprunt”.

Ok, so where does economic growth come from? Economics 101 says it comes from population growth and productivity growth. It’s almost a tautology: how much economic value you create comes from how many people you have and how many units of economic value each person create.

Population growth is underdiscussed because the debate about economic growth is dominated by economic policy folks who don’t like to talk about mushy things like that.

But I favor pro-family policies as outlined by e.g. Scene Archdukes Ross Douthat and Reihan Salam in their last book, as well as a “generous” immigration policy.

When it comes to productivity, I believe that the two single most important diagnoses of the problem are this National Affairs article by Scenester Jim Manzi and Tyler Cowen’s book The Great Stagnation (itself heavily inspired by Peter Thiel’s Optimistic Thought Experiment and subsequent pronouncements on the lack of breakthrough innovation).

Ok, so the West’s fundamental problem for the past 30 years has been low population and productivity growth. There are a couple things we can do for population. But productivity remains this mysterious thing.

Cowen/Thiel basically argue that low productivity growth comes from a lack of breakthrough innovation, which itself comes from, roughly, a lack of ambition and a lack of fundamental research.

I think that’s certainly part of it, but I have to say that when it comes to explanations for low productivity I turn to Matthew B. Crawford’s Shop Class As Soulcraft and Amar Bhidé’s Venturesome Economy.

Despite their seemingly very different subject matters, I believe those two actually are spotlights on different aspects of the same problem, which happens to be the key to higher productivity growth. And I would argue that the problem is a fundamental mismatch between raw ability and opportunity.

They both highlight the fundamental bankruptcy of the 30 year old Grand Strategy of the West in dealing with Globalization, which is the creation of a supposed Knowledge Economy of college-educated workers.

It turns out, this Knowledge Economy is really a 19th century industrial economy where physical widgets are replaced with “ideas.” The reason why the Grand Strategy is bankrupt is that most corporate white-collar work is actually more displaceable by outsourcing/technology than small-scale, global-reach entrepreneurship, whether it involves fixing motorcycles or building tables (Shop Class) or making yoga pants (Venturesome Economy).

We are taking raw material in the form of middle-class 18 year olds in Ohio, putting them in conveyor-belt colleges and conveyor-belt jobs like bank teller, travel agent, accountants, claims adjusters, “engineers” and so forth which can and will be done better, faster and cheaper by computers and/or eager Indians. The Knowledge Economy “works” (for how long?) for the Harvard-McKinsey conveyor belt who will, in any case, always land on their feet, whether through accumulated social capital or human capital. It does not, however, work for the Median Public University-Big Regional Company conveyor belt.

Peter Thiel’s venture capital firm Founders Fund is investing in breakthrough company SpaceX that wants to turn humanity into a spacefaring civilization. SpaceX is not doing this, however, by inventing breakthrough spaceship technology. It is doing this by using very well-understood, old technology — rockets — and making them much cheaper and usable. It is, in other words, not a scientific innovation company, but a process and business model innovation company. It is building Hondas in space , not The Phoenix . (And by the way, who is going to build the first useful flying car? A PhD in a lab coat or a passionate, shop-class type mechanic who will teach himself the requisite physics through Khan Academy (process innovation!) and fund himself through credit cards (financial innovation!)? I would bet on the latter.)

There is no lack of resources for fundamental research, which provides the open source toolkit for breakthrough innovation. But there is a serious mismatch between raw ability and skill and opportunity for building breakthrough innovation through process and business model and marketing innovation a la SpaceX.

So this is a roundabout way of saying that I think we would go a long way towards improving productivity growth by, first and foremost, building decentralized, talent-focused knowledge-signaling systems, and fostering an open, decentralized, entrepreneurial economy with more venturesome consumers and entrepreneurs, and more venturesome soulcrafters.

Of course it’s all easier said than done.

But I guess the crucial point here is that it’s too easy to believe we need a deus ex machina, like “breakthrough innovation” and flying cars to get ourselves from our rut. But the flying cars won’t come from a skygod, whether in the guise of Big Government, Big Science or Big John Galt.

We have the tools we need. The problem is that hundreds of millions of people have great latent talent which is not being recognized (even by themselves) and validated and met with opportunity. The problem, as always, is to let a thousand flowers bloom.

Objective Scarcity and the Paradox of Productivity

In general, if you care about equality, you ought to be passionate about scarcity. As long as there’s not enough of some valuable commodity to go around, then whoever’s richest is going to end up getting it even if the income distribution is relatively flat. By contrast, when you make some category of goods plentiful, you necessarily end up curbing inequities. These days all kinds of Americans can afford a good television. Tragically, though, many Americans can’t afford a house in a safe neighborhood with a decent school that’s within a convenient commute of the central business district of a major city.

That’s Matt Yglesias again, pointing out (correctly) that just because Americans have plenty of food and cheap entertainment relative to just about any period in the past, that doesn’t mean there’s no such thing as poverty.

His solution to the problem of scarcity of good schools and safe neighborhoods, though, is to make more slots available for both – build more housing in good neighborhoods and make good schools educate more children. And this implicitly assumes that opening up more slots won’t change the character of either the schools or the neighborhoods – an assumption that sounds wrong on its face and that many would argue has been disproven in practice repeatedly (most dramatically with the failure of busing).

Here’s the thing. You can improve performance at a single school by attracting a higher caliber of student and/or a higher caliber of teacher. Similarly, you can make one neighborhood safer by attracting a higher caliber of resident and/or improving policing. But the only way to make all schools better in aggregate is to improve the caliber of students and/or teachers generally. The only way to make neighborhoods safer in aggregate is to improve the caliber of residents and/or improving policing generally.

And increasing the number of available slots in good schools or safe neighborhoods can only do this indirectly if at all. The implicit assumption seems to be that new students and residents will acculturate to their new schools and neighborhoods. But it’s at least as likely that the schools and neighborhoods are what will change – for the worse. If you recognize this, then what you have to be arguing for is not simply increasing slots, but giving greater scope and authority to good institutions. Give management of a high-performing network of schools the opportunity to take over a failing school. Give the precinct commander who’s cleaned up a tough neighborhood the job of police chief in a small city. And so forth. But even as you do these obvious things, you’re going to discover that these highly-effective managers succeed in part by selecting good personnel, personnel they select from a larger pool. And if they do a better job of getting rid of lousy teachers or cops, those people go elsewhere. And some other school or precinct gets just a little bit worse.

Public policy has limited leverage over the overall caliber of the student body or the resident population (immigration policy is one of the few levers it does have). It obviously does have some leverage over the quality (and quantity) of teachers and police officers, but even this leverage is relatively limited, and not only by obstructive unions or whatever your particular bugaboo is. It’s limited because talent is the scarcest commodity there is. And the price of talent is driven, most fundamentally, by productivity.

The paradox alluded to in the title of this post is that the cheap television sets are, in a very real sense, the cause of objective scarcity in schools. Productivity growth in big swathes of the economy has made our society objectively richer. In many, many professions, a single individual can generate much more output per hour than he or she could a generation or two generations ago. Teaching and policing, though, have experienced much less productivity growth than the economy as a whole. As you would expect, competition for employees with more productive sectors of the economy has resulted in rising costs combined with declining quality.

We could improve the quality of the teaching and/or policing pool nationwide by the combination of higher spending and more intelligent recruitment, training and management techniques. The result would be an overall better pool for these occupations, which should improve the quality of the service. On the other side of the ledger, we’d experience a deterioration in personnel quality in some other sector in the economy – which might be a good tradeoff depending on what that sector was. But even that will only buy us time. Costs will rise inexorably, and the more concerned we are with maintaining the quality of the labor pool in these essential services, the faster they will rise.

There are only three ways to avoid this trap. One is to cease pursuit of, or even reverse, productivity gains elsewhere in the economy. If the economy as a whole became less productive, professions like teaching would become more attractive – even at relatively lower wages. (It is worth noting that the Soviet Union had a very highly regarded schools system.) On the other hand, productivity is the most important driver of increases in national wealth, and so long as other countries are pursuing national wealth, our national power depends very directly on successfully competing with them. (It is worth noting that the Soviet Union no longer exists.)

The second is to reduce the quantity of the service. Quality of live theater, for example, or of live orchestral music, has arguably remained high in spite of Baumol’s cost disease because there is simply less live theater and fewer orchestras around than there used to be, and they charge high enough prices to maintain high quality. Similarly, we could just teach fewer kids. Police fewer neighborhoods. To some extent, this is precisely what has occurred. This approach amounts to the secession of the more productive sectors of society from the rest of society, which will get progressively worse-educated and less personally secure. It is not an impossible outcome, but it is one that should be abhorrent to anyone with remotely progressive sentiments, or, really, any sense that we ought to have some degree of solidarity with our fellow citizens.

The third alternative is to pursue productivity gains in professions like teaching that have not experienced many such gains historically. There’s some low-hanging fruit here – better teaching and classroom-management techniques can increase the quality of instruction in a given period. Similarly, good collection and use of data can significantly improve the impact of policing by putting cops where they are most needed. But once that fruit is plucked, it’s not clear where you go for additional gains. Recall what productivity means: it means more output per hour. If we’re talking about teaching, that means getting more instruction out of each individual teacher/hour. This is much more difficult to do with teaching than with manufacturing – that’s why we haven’t done it. But that’s the question we have to be asking. (Yglesias has suggested in the past that smaller classes may make schools worse in aggregate because it means hiring more teachers which means, on average, worse teachers. But in the absence of productivity-enhancing innovations, there’s no reason to think that bigger classes would be better – rather, there’s some class size beyond which performance starts to deteriorate for any teacher.)

I’m on the board of a charter school. I believe that letting strong personalities create institutions, giving them scope to achieve their goals and holding them accountable if they don’t, is the way to grow strong institutions, and that strong institutions will deliver better services than weak ones. (And I believe that public policy has a variety of levers to make sure that these institutions genuinely serve everyone, as public institutions must, and should use those levers.) But I also recognize that “do more of what works” is a much, much more difficult mandate than boosters seem to realize.

Roll Over

Matt Yglesias points out correctly that Chinese ownership of American debt doesn’t give them the ability to repossess, thereby refuting a John Stewart joke.

But while massive foreign ownership of American debt doesn’t give foreign powers the “right” to take over the country (nor the ability), it does give them considerable leverage over the policies of the United States government.

That’s because the debt has to be rolled over. We’re not going to pay it off. We shouldn’t want to pay it off. (Ever.) So when it comes due, we’ll need to sell new debt to pay off the old principal. And that new debt will pay interest at then-prevailing rates. We need buyers of American debt in large numbers to exist in the future, or we won’t be able to roll the debt over at attractive rates (which means we’ll be paying more in taxes to service the debt).

Now, this would all be true whether the buyers of government debt are domestic or foreign. But if the buyers are domestic, then the whole “tax to pay interest” thing is a domestic redistribution question: who is to be taxed to pay interest to whom. There are a variety of ways to settle these kinds of questions, but none of them have direct foreign policy implications.

But if the debt is held substantially by foreign powers, then higher interest rates mean paying more taxes to those foreign powers.

Our dependence on foreign debt purchases is rather like our dependence on foreign oil. Because we consume so much oil, cannot easily switch to other fuels, and purchase so much of it abroad, we have an interest in places like Saudi Arabia. And these countries do have some ability to influence our foreign policy – more than they would have if we were an oil exporter or if we used nuclear fusion to meet our energy needs. Similarly, if China is the overwhelmingly dominant buyer of American federal debt, then China’s decisions about what the right price is for that debt – what interest to demand – will be the most important factor in determining what the price actually is. And that gives them leverage over the United States government.

Yglesias wonders all the time why we have such a pronounced policy preference for disinflation, across both parties, even when inflation has been below target and unemployment has been really high. There are a variety of reasons – the fact that the ECB is even more paranoid about inflation, for example; the fact that unemployment isn’t afflicting a true cross-section of the American public; the vastly expanded political influence of the financial sector – but I’ve long felt that one reason is that we have to keep the Chinese happy because we need them to keep buying our debt. Let’s put it this way: when was the last time you heard a Chinese official say that America needs to do more quantitative easing to spur growth, because they are worried that too much austerity will impair our ability to pay back the debt they own? Never? Correct. Because the odds of truly defaulting on our debt are virtually zero, never mind the current Washington shenanigans, whereas the odds of inflation eating away at the value of the debt owned by the Chinese are to some extent positive. Disinflation-above-all is the preferred policy for somebody who is a substantial creditor to the United States and in no sense an equity holder.

Yglesias thinks it would be better for the Chinese to buy less American debt. I agree, although the way I would put it is that it would be better for both the Chinese and the Americans for China to raise its level of domestic demand and lower its savings rate. But this would require Americans to generate more savings to compensate, otherwise interest rates would go up, making rolling our enormous debt more expensive. And raising savings rates is contractionary. There’s not a way around this. Many of the things we need to do for the long term health of the country – for example, reducing our dependence on fossil fuels and reducing our dependence on foreign credit – are contractionary in the short term. Goosing inflation expectations will lower domestic savings when we need to be raising it. Goosing demand will increase demand for imported oil when we need to be reducing it. What Yglesias thinks is the optimal policy response to the tragedy of persistently high unemployment – namely for the Fed to engineer higher inflation expectations to boost domestic demand – digs us further into our long-term hole. Higher domestic demand means lower domestic savings which means an increased dependence on Chinese purchases of domestic debt. Higher inflation expectations mean higher long-term interest rates (which means more of our taxes going to pay interest, and less to providing services to the American people) or, if interest rates remain low, that implies that higher inflation expectations are being offset by lower real growth expectations, and it’s real growth that makes us wealthier.

“I just stay in bed if no one calls me”

Yesterday’s Wall Street Journal had an uplift piece on using gee-whiz data analytics to improve Chicago’s public schools. I found it incredibly depressing. Here is how the article opens:

At 7:15 on a chilly May morning, Marshall Metro High School attendance clerk Karin Henry punched numbers into a telephone, her red nails clacking as she dialed.

“Good morning, Miss MeMe,” she said to Barbara “MeMe” Diamond, a 17-year-old junior with a habit of oversleeping. “This is Ms. Henry, your stalker.

The timing of the call was key. Earlier in the year, Ms. Henry and a co-worker were spending nearly two hours a day calling every student who hadn’t checked into school by 9:30 a.m. But weekly data tracked by their office found that only about 9% of those students ever arrived. So they changed tactics, zeroing in on habitual latecomers like MeMe, and delivering wake-up calls starting at 6:30. On that May morning, 19 of the 26 students called showed up.

“I just stay in bed if no one calls me,” MeMe said. “That 6:30 call be bugging me, but it gets me here.”

Here is how the article ends:

Sharief Raines, an 18-year-old senior with a toddler at home, took the challenge after missing every school day in December. In January, she showed up 12 of 19 days. Ms. Calhoun even watched the baby one afternoon while Sharief did homework. “I saw Dean Calhoun was trying to help me,” she said. “I didn’t want to let her down.”

Sharief graduated June 11.

The attendance clerk sounds like somebody getting into the office early to get her job done, and I assume that both MeMe Diamond and Sharief Raines have faced enormous obstacles in their lives. I say this without malice, but no school is going to solve the problems of many students like this. This school exists within a sea of dysfunction that it cannot fix.

The implicit frame of reference that is normally used for these kinds of stories is the history of the communities and families in question, or the “good” suburban schools around them. Mine is different.

Globalization has created trans-national labor pools through a mix of literal outsourcing, immigration and importing labor content via shipped manufactured goods. We move the people, the jobs or the merchandise; but either way, workers in Illinois must increasingly compete with workers who live in Eurasia or have immigrated here from Latin America and elsewhere. These are no longer poor people “out there somewhere” for whom we should feel pity and give foreign aid, but people with whom, one way or another, our hourly pay is being compared by those who will decide where new jobs go. Today there are probably hundreds of millions of people on one side of the relevant labor pool who have such a different orientation toward school that the worry is that they’re working too hard, and hundreds of millions of low-skill competitors on the other who are prepared to work for wages much lower than those of even very poor Americans.

Within less than one year, MeMe and Sharief will have to compete in that environment. There is no fixed lump of labor. By specializing in what we do best, and then trading with ever-larger numbers of others who can afford to buy our output, we can become wealthier. What will MeMe and Sharief specialize in? Who in an open market will pay enough for their time to create sufficient income to support them (and Sharief’s child) in a humane manner? (It’s easy to read this as scornful, but I really just feel sympathetic, in that if dealt the same hand of cards, I think I would be in pretty much the same place.)

By extension, where are large chunks of the American labor force are headed? How much dysfunction can the productive economy carry on its back as the level of global competition rises ever higher?

The answers to all of these questions are, in my opinion, very troubling.

I don’t have any great solutions, but then again, I don’t think anybody else does either. “The Answer” is probably not there to be found. I doubt there are any silver bullets, just lots and lots of scut work in many areas, each of which can make a small contribution.

“Data-driven schooling,” if done with this perspective in mind, can certainly make an incremental positive contribution. But it’s easy to do it in a way that actually makes things worse.. If focused on short-term carrots-and-sticks that ignore character effects; if divorced from the right incentives for the participants; and if not focused on careful evaluation of the actual success or failure of interventions against validated outputs, it’s likely to be a huge waste of scare time and money.

(Cross-posted to The Corner)

A U.S. Manufacturing Strategy, Part 2

This continues from the prior post, which argued that the U.S. government ought to care a whole lot about absolute and relative American productivity growth.

Proposition 2: Not all kinds of productivity growth are created equal

I’ll illustrate two different kinds of productivity growth with practical examples from my experience in the manufacturing industry. I once invented a new production planning algorithm (essentially, the decision rules for which products to make when, and in what sequence) that improved the output of a specific factory by about 5 percent. This is pure gravy: the same people show up at the same factory and work the same number of hours, the same raw materials are purchased and so on, but the world just gets 5 per cent more widgets out of the other end. This is normally the kind of thing most people picture when they use the term “productivity growth” in normal speech. On another occasion, I figured out the financing that made it profitable to shut down an entire factory, and sell the land to a property developer. This is normally the kind of thing that most people mean in normal speech by “the locusts of private equity.” I’ll call the first example an improvement in “operational efficiency” and the second example an improvement in “allocative efficiency.” In fact, both are necessary for ongoing improvements in productivity and wealth for an advanced economy.

Let me describe the decisions around these kinds of changes from the point of view of a business owner or executive. In somewhat simplified terms, if I’m doing stuff that earns returns below my cost of capital, or if I can get someone else to do it for me at lower cost than I’m doing it, it makes sense to cut out the activity. These cut activities will tend to be those with lower productivity. Cutting activities for shareholder value reasons will therefore strongly tend to cut low-productivity activities, and increase my firm’s average productivity through pure “high-grading.” But this ignores at least a couple of important questions. First, did I fail to uncover economically achievable improvements in operational efficiency that would have allowed me to conduct these activities at higher returns and cheaper than alternatives? Second, are the cut activities linked in some non-obvious way, and potentially only over time, to the other more profitable activities, such that I have fooled myself into putting the profitable parts of the business at risk?

A business culture that ignores these questions can tend to get into a death spiral of endless high-grading against an ever-rising tide of competition that eats the business one bite at a time. The fear of many critics of American business (or “Anglo-Saxon financial capitalism”) has for a long time been that this is what is happening to the American economy on a grand scale.

And further, at the level of the entire society, while a firm can get more productive by high-grading, if the alternative employment for the people who used to work at the closed factory is collecting unemployment checks, can’t this become a society with an ever-shrinking base of people with high-paying jobs? This is the nightmare scenario of an ever shrinking number wealthy financiers, who are increasingly detached from a broader society all around them living off a combination of table scraps and handouts.

There is something to this fear. But on the other hand, the failure to allocate capital and labor from kinds of activities where there are inherent limitations to how productive they can be to those where they have greater inherent productivity will also hurt productivity growth in the long run. The key word in that sentence is “inherent.” The more we can take what is currently viewed as inherent productivity by analysts, economists and others, and improve it by unanticipated innovations, the more we can have allocative efficiency without giving up as many manufacturing jobs.

Think of operational efficiency as getting better at playing a given game, and allocative efficiency as deciding what games to play. We need both. We want to have an economic regime such that the people working a specific line in a given plant work as hard and as smart as possible to get that line to be as productive as possible; such that the management of that plant is allocating resources among the production lines, and thinking hard about the overall production process such that they make that plant as productive as possible; such that the company is doing the same thing at a yet-higher level for its collection of factories, warehouses and sales offices; and such that the economy as a whole is allocating resources across firms intelligently.

In fact, when we move from the level of the individual firm to the economy as a whole, the nature of the process of resource allocation should change. If, following Coase, we very crudely define the boundaries of the firm as the maximum extent of activity for which central planning can work effectively, then we need to use markets to allocate resources across firms. The unique virtue of markets is not so much in their allocative efficiency, as in what Douglas North termed their “adaptive efficiency”: basically, discovering entirely new ways of organizing resources. If allocative efficiency is deciding what game to play, adaptive efficiency is inventing entirely new games. Adaptive efficiency is not nearly as important for an economy in catch-up mode, but for an advanced economy, it is essential for productivity growth.

We can think of a hierarchy of kinds of productivity growth, with operational efficiency at the foundation, then allocative efficiency next, and finally adaptive efficiency as the master-allocator of resources. We then need to think about manufacturing strategy in the context of the need for the combination of operational efficiency, allocative efficiency and adaptive efficiency that will create rapid, continuing productivity growth in the economy as a whole. In effect, adaptive efficiency – which, all else equal, is likely to continue to squeeze out manufacturing jobs – needs to be the evolutionary principle by which the economy creates productivity growth, but efforts to improve operational efficiency within manufacturing will change the set of “givens” (for example., the relative profitability of in-sourcing versus outsourcing) that this evolutionary process will confront.

The next post in this series will try to sketch out some ideas for what I think is most likely to help do this.

(Cross-posted to The Corner)

A U.S. Manufacturing Strategy, Part 1

There has been an interesting ongoing blogosphere dialogue on the role of manufacturing in creating high-wage jobs in America, involving Paul Krugman, Reihan Salam, David Leonhardt, Karl Smith and Michael Mandel, among others.

This topic has been a fixation of mine for a very long time. Here is how I opened an article a couple of years ago in National Review:

I still remember the first time I walked into a working factory. In the foreground, innumerable machines whirred and clacked away in precise, interlocking dances. A massive vat shaped like a 50-foot-tall Campbell’s soup can loomed in the background. It was encased in a protective sheath of refractory bricks that glowed dusky pink with trapped heat. A crane arm dumped heavy sand continuously into the top at (literally) industrial volumes. Steaming, liquid glass gushed out of the business end at the bottom in a matching stream. I couldn’t see the heating element, but it was in there somewhere, and it was working. …

I was looking at concretized human ingenuity. In the auto industry, “car guy” is a slang term for an executive who doesn’t just view the business of a car company as making money, but loves the cars themselves. I’m a factory guy.

I spent the first few years of my career in the 1980s as one small part of a self-conscious movement to rescue American manufacturing from its projected obsolescence. I’ve worked in glass plants, assembly plants, oil refineries, and textile plants from Florida to Canada, and many points in between. I’ve carried a union card and walked a picket line.

I’ll put forward several propositions as being as being relevant to this discussion. (This would be a very long blog post, so I’ll break them up into several posts.)

Proposition 1: Competitiveness is productivity

Professional economists often pooh-pooh the importance of national competitiveness. To quote Krugman:

The growing obsession in most advanced nations with international competitiveness should be seen, not as a well-founded concern, but as a view held in the face of overwhelming contrary evidence.

They will point out that we all gain from trade, and as people in other places get richer, so can we. Countries, they say, are not like corporations.

Maybe so, but it’s still the case that some societies are populated by lots of people with high wage jobs, nice houses and good schools, and other societies are populated by lots of people hustling for tips from vacationers from the first kind of society. Over time, people who spend their working hours generating goods or services that they can sell for a big margin versus the costs of the required inputs will tend to live in the first kind of society. Nothing is forever in this world, but I want America to remain in that camp for a very long time.

This doesn’t occur by immiserating other societies – international economic competition is not zero-sum in that sense. But there are many paths open to us for how we react to the rise of non-Western economies, some of which lead to us being much better off than others, both in an absolute sense, and also in a relative sense.

Relative productivity is likely to matter a lot, because it will materially influence future absolute wealth by affecting the flow of global technology and innovation. But relative productivity and wealth also matter in and of themselves. First, they will impact the global prestige and success of the Western idea of the open society which we value independently of its economic benefits. Second, maintenance of a very large GDP per capita gap between the West and the rest of the world will be essential to maintaining relative Western aggregate GDP, and therefore, long-run military power.

In sum, we want the rest of the world to get richer, but we want to stay much richer than they get.

This demands that we sustain rapid productivity growth over many decades. Unfortunately for us, this is much harder to do for an advanced economy than for those in catch-up mode, and is likely to continue to create very tough social strains in America. Perhaps we’re just not up to it. This, and not some lets-all-succeed-equally-together happy talk, is the real meaning of globalization for America in 2011.

(Cross-posted to The Corner)

Monetary Stimulus and Commodity Prices

Commodity prices continue to rise due to high demand from developing countries, particularly China and India, even though domestic demand is weak and core inflation numbers are both low now and projected to remain low. So what should developed-country central bankers do?

Low core inflation and weak demand sound like they call for additional monetary stimulus. But additional monetary stimulus would not be limited to the United States – it would spill over to other dollar-linked economies, such as China and Latin America, where it would not be welcome. Moreover, it would put pressure on the central banks of other weak industrialized economies – the Euro Zone and Japan – to provide their own monetary stimulus, lest their countries suffer a crippling rise in the value of their currencies relative to the dollar.

The likely end result of substantial additional monetary stimulus by the developed world central banks, then, would be a revaluation upward of the currencies of the major developing economies – China, India, Brazil, etc.

Now, this might look like a feature rather than a bug. A higher Yuan would make American products more competitive in China, which should stimulate employment. But think about the effect on commodity prices. China and India would continue to demand more and more oil. But oil, priced in dollars, would be cheaper in Yuan terms after a revaluation. Of course, this fact would drive up the price of oil, so that it became more expensive in dollar terms. The new equilibrium oil price should be higher than it was before revaluation in dollar terms, and lower than it was before revaluation in Yuan terms. And the same should be true, broadly speaking, for all commodities that are in demand on a global basis.

Demand for oil in particular is relatively inelastic. There aren’t good short-term substitutes for oil – if gas gets more expensive, you can cut down on discretionary driving, but that’s about it. So a spike in oil prices translates directly into a hit to domestic demand for other goods and services. Which, in turn, would require more monetary stimulus to offset.

I’m not suggesting you can’t get any bang for the monetary stimulus buck. I am suggesting that these kinds of feedback effects may mean that getting nominal GDP back to trend could result in much larger price rises for economically-sensitive commodities than people might realize. If getting core inflation temporarily up to 3-4% meant $200/barrel oil, does anyone think that this would be perceived as an economic success? Even if unemployment was dropping as well?

I am no monetary crank, but I have a lot more sympathy for the fears of the developed country central bankers, operating in uncharted territory, than the banks’ left-wing critics seem to have.

International Health-Care Comparisons: How About Them Apples

As long as we’re talking about health-care, a few thoughts about international comparisons.

The biggest knock against the United States’ health-care system isn’t that we spend so much, but that we appear to get so little value for money: based on aggregate numbers, Americans are less-healthy than many other major industrialized countries, in spite of spending lots more on health care.

Some of that is surely the combination of waste and free riding. America’s system provides fewer incentives to use the lowest-cost treatment than most other national health-care systems. That provides a greater incentive for pharmaceutical and device-makers to come up with new and expensive health-care products for the American market. Some of these products will be genuinely useful innovations and some will be copy-cat drugs and the like designed to extract IP-related rents without delivering much in the way of value. Other countries can then get the benefit of the useful innovations at much lower cost than Americans do, and avoid the wasteful copycat innovations.

A great deal of it is due to the fact that America’s health-care providers earn a lot more on average than those of other countries. But the big driver of this disparity is that America has vastly more specialists. And the big driver of that disparity is that everybody would like to see specialists more easily, and you can only do that if you have more specialists. And since America has fewer incentives for cost-containment, Americans get what they want (and pay for it), and people in other countries do more queuing. (And they do the most queuing in systems that employ health-care providers directly, which is exactly what you’d expect – when prices are driven down artificially by a monopsony buyer, supply dries up.) Measuring the value of being able to see a specialist more easily in America in terms of actual health-care outcomes isn’t going to capture everything that matters to the consumer. There’s some value, after all, to having the opportunity – and the coverage – to do everything you can to beat that cancer, even if the odds are, objectively, lousy. But it costs something – across a society, it costs a lot. This is exactly the kind of preference question that a diversity of insurance options – at different price points – should be able to resolve. Not necessarily at the lowest-cost point on the curve, mind you, but at a point that represents the aggregate preferences of consumers – provided those consumers are making decisions based on real prices, which would be the case in a functioning individual insurance market and is much less so today.

But some of it probably amounts to apples-to-oranges comparisons. It would be useful to look not merely at aggregate statistics but to break the statistics down demographically by race and by income. The United States has a much larger non-white population than the European countries to which we are usually compared; we also have a much higher percentage of the population living in poverty. I would expect that, if you compared poor Americans to poor French or German citizens, America’s health statistics would look pretty bad. I’m less sure how the comparison would look if you compared, say, the second income quintile of each country.

And then there are lifestyle questions. Obesity is rising across the globe, but it is a much bigger problem in the United States than it is in other industrialized countries. And obesity is a driver of a host of negative health outcomes that cannot really be ameliorated by the health-care system. Indeed, you would expect an epidemic of obesity simultaneously to be a drag on GDP (more people unable to work due to obesity-related health problems), a booster of health-care expenditures, and a driver of lousy aggregate health statistics such as low life expectancy. But is America’s obesity problem really caused by our health-care system? Not really, no – and our health-care system can’t really solve it either.

My strong suspicion is that demographic differences are a significant driver of the ways in which American health outcomes are inferior. Tackling the consequences of higher rates of poverty may require modifications to the structure of our health-care system – for example, it may well make sense for the government to provide directly on a “cheaper than free” basis certain basic services with large public health benefits, rather than merely providing subsidized or public insurance – but that’s not the same thing as blaming that overall structure for the disparities that exist. By contrast, I suspect that much of the higher cost of American healthcare reflects genuine consumer preferences; the question, though, is the degree to which those preferences are based on real prices. To the extent that they are not (and I think that’s to a very great extent), one solution would be to move in the direction of limiting the scope for consumer preferences – say, by eliminating private insurance. The other direction to go would be to move in the direction of making health-care consumers more aware of the prices they are paying when they buy insurance. That, to my mind, is the real center-left versus center-right divide on where to take the American healthcare system.

Putting Medicare On a Budget

Matt Yglesias making the case for government-run health care:

There should be no question that if you give 15 bureaucrats in Washington a budget with which to run Medicare, that they’ll deliver health care services inside the budget cap.

If it’s that simple, why aren’t we just doing that? Why are we talking about how to reduce the growth of Medicare spending? Just put Medicare on a budget – outlays cannot exceed revenue from the Medicare component of payroll taxes. Then let the bureaucrats figure out which procedures and treatments won’t be covered anymore, which are going to get a lower reimbursement rate, etc. Problem solved. Right?

Of course, as the deficit-reduction follies of the 1980s demonstrated – and every weapons system procurement continues to demonstrate – it’s not actually so easy to put government on a budget. There are powerful interests that can be brought to bear to make sure that budgetary discipline is not applied. It’s true that the bureaucrats can’t spend what isn’t appropriated, but the only discipline that can be brought to bear on the appropriators is the eternal vigilance of the bond market.

That goes for private businesses as well – they also can’t be forced not to borrow against future earnings, except by the vigilance of the bond market. We just expect the bond market to offer any given private business less rope with which to hang itself than we expect it to offer a government.

When criticizing proposals to voucherize Medicare, Yglesias – correctly – notes that these schemes “save” money by fiat: they just don’t let the vouchers grow in value as fast as health-care expenditures are expected to grow. But putting Medicare on a budget – strictly limiting spending to some number – would amount to exactly the same thing. The consequence would be some combination of less coverage and lower payments to providers, which in turn would have some impact on the quality of care and the pace of health-care innovation. Why is this a good thing when it’s a consequence of government budgeting, but a bad thing when it’s a consequence of private budgeting?

I can think of two reasons. The first is that the government, as a monopsony, can bargain more effectively than a private insurer can. The question is how large this effect is when you’re dealing with very large private actors. If you have thousands of insurance providers, there’s probably a huge difference. If four or five insurance carriers wind up dominating the national market, I wouldn’t expect the difference in bargaining power to be meaningful.

The second is that private insurers will simply refuse to provide adequate coverage for the price of the voucher. Affluent individuals will be able to buy supplemental coverage, but indigent or even middle-income individuals will be left out in the cold. But this objection, it seems to me, is amenable to regulatory solution – specifically, the kinds of regulations embedded in the health-care law passed in the last Congress. To qualify for the insurance exchanges, plans must provide coverage that meets certain criteria. To the extent that insurers have an incentive to meet the requirements of the exchanges – and if they don’t, then the whole concept of the Democratic health-care reform won’t work – they have to figure out how to drive down the cost of coverage. These are precisely the same incentives that the Medicare bureaucrats have in the strictly budgeted hypothetical – except that a given insurer could lose business if it gets a reputation of having a lousy network of doctors, or not covering certain popular drugs, etc., whereas if you have a single-payer insurer there’s no recourse to alternatives when and if the bureaucrats get something wrong.

Yglesias makes much of the graphs showing that the Untied States has more expensive healthcare than more statist systems, but I don’t see why we should assume expenditures would be linear with the degree of state involvement – nor, more to the point, am I entirely clear how you measure the degree of state involvement in the various hybrid systems out there. The United States has a system whereby private health expenditures are heavily subsidized by the state through the tax system, and where the government single-payer health insurance program for the elderly is not put on a proper budget. You would expect both of those aspects of the American health care system to drive up costs relative to other systems. In both cases, we’re talking about the interaction between state intervention and a free market, not a pure free market system.

The French, Swiss and Dutch systems are also hybrids. Those hybrids are structured with a better alignment of interests to reduce costs than the American system. I think that’s a better frame than “more” or “less” statist.

There is a legitimate question whether private insurers have any productive role to play in health care. I think they do – because I think that multiple competing insurers are more likely to effectively converge on coverage that suits most consumers, as well as to provide alternative forms of coverage for those who prefer it, than a single, government-run insurer is. Relatedly, I expect a system with multiple, competing private insurers to do a better job of encouraging productive medical innovation than a single, government-run insurer. I think those benefits are worth paying for by allowing private insurers to make a profit.

But private insurance can only work as a social matter if you get everybody into the risk pool together, otherwise insurers will compete to get a more-favorable risk pool rather than competing to provide a more compelling package of coverage. That was the promise of the ACA passed by the last Congress: that it would begin the process of slowly moving us away from employer-provided (and government-subsidized, through the tax system) health care toward a regulated private insurance market that everyone participated in individually. Voucherizing Medicare within such a scheme would be another step toward getting everybody into the same pool.

Neither government bureaucrats nor the bureaucrats inside large insurance companies have magic powers. If the goal is to reduce health-care costs, then somebody is going to have to impose budgetary discipline. The debate about the proper role for private insurance – if any – is really orthogonal to this.

The GM Bailout and Telepathic Dogs

Karl Smith at Modeled Behavior has a great reply to my post on the GM bailout that features “non-zero orthogonal information,” probability measures, and a hypothetical telepathic dog.

I think the essence of his first point is that no matter how strong one’s overall beliefs about government intervention in the market, that the results of the GM bailout still provide some information that should contribute to how he should see the world. I agree.

I further basically agree with Smith that “the real problem is that the information about GM qua GM is so low that there is a good chance that it is swamped by this bias.” The way I would put this is that we know only the state of the world as it actually exists in the presence of the GM bailout, but the “information” that I really care about is the causal attribution of effects to the bailout. Knowing these causal effects would require us to estimate what the counterfactual world without a GM bailout would look like. My argument is that since we are so poor at estimating this counterfactual world, therefore (to use Smith’s terms), the information is swamped by the bias. Or more precisely, that we are incapable of conducting analysis that should convince rational people who start with different biases to come to a common view of the effects of the bailout.

To be practical about this, Paul Krugman believes that “the auto industry…probably would have imploded if President Obama hadn’t stepped in to rescue General Motors and Chrysler.” I disagree. Until we agree even roughly about this counterfactual world, we can’t agree about the effects of the bailout. But there is no method of analysis that we both accept that can be used to even roughly estimate this counterfactual world, so we’re stuck just disagreeing.

Smith’s second point is that this recognition about of our ignorance calls for “dovishness”:

That is, it calls for being reluctant to accept near term harm for long term benefit. Things that are close up are easier to see. Entropy expands with the arrow of time.

This mediates in favor of being less hawkish on war, less hawkish on the deficit, less hawkish on climate, less hawkish on campaign finance reform, less hawkish on health care, etc.

I also agree with the basic thrust of this, though I would put it as “humility,” or in practical terms, hedging our bets whenever possible. And further, I think it is important to recognize that this applies only at the maximum level of the political hierarchy with which we identify. That is, I think the American government should hedge its bets whenever possible. But trial-and-error improvement within the American political economy calls for sub-entities (say, sates or individual companies) to commit to specific positions, sometimes without hedging.

His third and final point is that while recognizing our ignorance, we need to remember that there is no such thing as “no policy,” saying by example:

One cannot have no tax policy. Even a policy of zero taxes is a tax policy. Even the policy of zero change in taxes is a tax policy.

This is true, of course. What I think recognition of our ignorance leads to, however, is the resulting recognition that what economists and others often call “status quo bias” should more appropriately be called “rational status quo preference.”

If we believe that the current state of a society represents, in part, the current state of an evolutionary process in which functional forms will tend to survive, and further, that various parts of the social organization interact in ways that we do not understand, then both of these observations should lead us to be open-mindedly skeptical of change. This doesn’t mean that all change is bad. In fact, as long we believe that social evolution is eternal, we should accept that any attempt to maintain stasis would be deadly to the society. Some change is essential. But acceptance of our ignorance calls for the burden of proof to be placed on those who advocate any specific change.

To take Smith’s example of tax rates, there is something special about the current tax rate as opposed to all others – it is one part of an organic society that has survived so far, and we don’t really understand what it is about the society that creates this success. Obviously, it’s never really this simple – for example, is the relevant “current state” of society today’s tax rate; or is the specific procedure by which we establish tax rates, which could lead to any given rate; or is the process by which we establish procedures for setting tax rates, and so on up the ladder of abstraction? But at the level of generality of Smith’s reply, this is a rough principle which I think derives from a stance of epistemic humility.

(Cross-posted to The Corner)

Inescapable Economics

Just one quick point apropos of the last to posts on this site, one by me and one by Jim Manzi.

Suppose you started from the following goals:

- As a matter of fairness and equality of opportunity, I want to subsidize college (and graduate school) tuition for those who otherwise could not afford such an education.

- I want to minimize the economic and political distortions associated with my subsidy, and to minimize as well any costs to local and individual experimentation and choice.

Which would you prefer: providing grants to poor students to attend the university of their choice, or establishing a public university with free tuition?

I would assume that most people aiming to achieve the two goals articulated above would opt for the first option. Giving money to students who otherwise couldn’t afford tuition directly achieves goal #1. And it appears to achieve goal #2 because it doesn’t particularly interfere with individual consumer decisions.

But, per the argument of my post, this conclusion has embedded economic assumptions. Specifically, it assumed elastic supply of college spots. If, in an extreme example, there were a fixed number of spots for college, then the entire subsidy to poor students would be captured by incumbent institutions in the form of price increases. This, in turn, would make college unaffordable for a larger set of students, who would require a subsidy, and so on, rising tuition driving ever-higher levels of subsidy.

That doesn’t sound like it meets goal #2 at all. Whereas, in the same circumstances – completely inelastic supply – establishing a new, free tuition public university would have fewer negative collateral effects, either establishing a market where one did not previously exist (perhaps because no private institution could profitably serve this student population) or driving lower costs across the system. Poor students would have more choice, and the existing student population would not suffer.

On the other hand, if supply is completely elastic, the opposite would be true. A subsidy that went directly to students would increase supply without substantial negative externalities, and would preserve choice, while the creation of a public university with free tuition would drive marginal private universities out of business, resulting in reduced consumer choice. This drop in supply would, in turn, drive demand for more slots at the free university, which in turn would drive more private institutions out of business, resulting in ever-greater domination by the single, public provider.

So what should a public policymaker do?

One answer is to say: the public policymaker should not try to subsidize education for indigent students. It is impossible to know with sufficient certainty whether policy A (grants to poor students) or policy B (free tuition at a public university) would be optimal, and either one could have negative side effects that outweigh any benefit. Therefore, we should be epistemically humble, and abandon our goal of equal educational opportunity.

Abandoning goal #1, though, may not be political feasible – or we may simply consider abandoning it to be immoral. In either case, we cannot avoid trying to understand the possible implications of our policy choices, and evaluating them in light of the effects we observe.

My point is: we can’t tell from a description of the policy whether a policy will be “epistemically humble” or not. The policy that looks like the less-distorting one may only look less-distorting because you don’t investigate the economics of the situation. Once investigated, a credible argument may emerge that this policy is, in fact, the more distorting of the two available options. You cannot pick the more “humble” option without knowing the economics. It may appear that you can, but that’s an illusion. And if you’re convinced that the economics are also an illusion, then you simply cannot pick.

Eliminating economic arguments from the conversation because they are insufficiently scientific doesn’t make economics go away. Policies with still have economic effects, effects that may be very different from what folk wisdom would assume. We just won’t have any idea what they will be. That being the case, the epistemically humble thing to do is, in most cases, not to have a policy – that is to say, not to make any decisions that implicate large numbers of people in any way.

But if you have a scope to make policy, then everything – even the policy of doing nothing – is a policy. A policy of issuing currency backed by gold is a monetary policy, one that outsources questions of money supply to the gold mining industry. If you disclaim value to economic argument, you have no way of knowing whether it’s a good policy or a bad policy, but it’s still a policy, as is issuing a currency backed by nothing but a promise to manage the supply of currency “well” without any clear definition of what is meant by “well” (which is the policy of every industrialized country today). The only way not to make policy is to disclaim authority. If you don’t issue currency at all, then you have no monetary policy.

So the only way to avoid making decisions that implicate large numbers of people is not to have authority over large numbers of people – that is to say, not to have large states with the power to tax, spend, issue currency, etc.

Once you accept – or endorse – the existence of large states with significant involvement in the economy, you can’t avoid making policy with economic implications, and therefore you can’t avoid resort to economics as an input to decisionmaking. Epistemic humility, in such circumstances, has to involve some way of evaluating arguments within economics to assess relative levels of certainty, and some way of assigning weight to higher or lower levels of uncertainty within a policy calculus (very high variance in possible outcome might be worth it if the expected outcome is very positive, whereas very low variance might not be worth it if the expected outcome is very negative; this is a question of risk-tolerance).

That’s the way I see it, anyway.

Matt Yglesias Is Not A Left-Winger

Because if he were, he’d argue that the proper response to overpaid college professors is to drop tuition costs at public universities.

Here’s the argument in a nutshell:

- Competition in the higher education market is not driving down costs. Rather, elite schools compete to capture the most valuable segment of the market – the highest potential future donors – and do not compete on price but on quality of services. Prices escalate inexorably, and a big chunk of this is captured by employees – especially professors. Lower-tier institutions must raise their salaries to compete for talent, and so must raise their tuitions. All of this is what you would expect in a market with relatively inelastic supply and rising – indeed, subsidized, through Pell grants and such – demand.

- In such a market, a slashing of tuitions at public institutions of higher education, combined with a public subsidy of said institutions to offset the lost revenue, would change the price dynamic. Similar-quality private institutions would need to figure out how to compete at the lower price point. This could involve eliminating frills or cutting salaries or pushing for higher productivity from existing employees. However they got there, they’d have to drive costs down somehow. And this pressure to control costs would ripple through the system more generally, eventually reaching the elite institutions.

- Ergo, the solution to “overpaid” university employees is not to reduce public subsidies of universities, but to increase such subsidies, while demanding offsetting reductions in tuition (and, as well, to reduce or eliminate subsidies that go directly to students – if demand is outstripping inelastic supply, then subsidies to consumers only drive prices up).

That’s the argument, anyway. It’s premised, of course, on the notion that such cost-reductions are indeed available – particularly, that there are ways to increase productivity in the higher education sector. I don’t know if that’s the case. If it isn’t, then the result of lowering tuition at public universities would be to reduce supply, as marginal providers of higher education went out of business, unable to compete at the lower price point with public universities, and unable to compete on “quality” with higher-tier private academic institutions.

Although I’m sympathetic to the argument that, inasmuch as we are interested in making college affordable for the indigent, we should shift from subsidizing demand to subsidizing supply, I’m not really trying to argue that point. Rather, I just wanted to highlight that this position – provide the services directly if you want them to be cheaper – is an old-school left-wing position to take. Indeed, it’s the rationale behind the NHS, which, lo and behold, has lower costs than pretty much any other industrialized country’s health-care sector, and more supply bottlenecks – more queuing for tests and procedures – than its Dutch, French or American competitors as well.

UPDATE: I should have posted this link, a very good rundown of the above argument, tackling education subsidies but also wage subsidies, a topic of interest to various TAS alumni.

The Inherently Ideological Evaluation of the GM Bailout

Megan McArdle has done consistently excellent reported pieces on the GM bailout, and her recent evaluation of its net effect on the U.S. Treasury is no exception. Her bottom line is that the deal caused U.S. taxpayers to:

burn $10-20 billion in order to give the company another shot at life. To put that in perspective, GM had about 75,000 hourly workers before the bankruptcy. We could have given each of them a cool $250,000 and still come out well ahead compared to the ultimate cost of the bailout including the tax breaks

This is in line with the Obama administration’s $14 billion estimate of the net cost to the Treasury, as reported in the Wall Street Journal. If anything, I think this understates the case on the direct costs, because it does not consider other direct transfers of economic value like the government support for Delphi that inflated the value of the asset that GM sold to create a big chunk of their headline profits this past quarter, green car development subsidies, and uncompensated interest costs on the government investment.

But no matter what realistic direct bailout costs you estimate, the objection of bailout defenders is that it is dwarfed by the other receipts or avoided expenditures created by the bailout. According to the Wall Street Journal, this is exactly the defense offered by the Obama administration:

The White House report said the money invested in GM and Chrysler ultimately saved the government tens of billions of dollars in direct and indirect costs, including the cost of unemployment insurance and lost tax receipts that the government would have incurred had the big Detroit auto makers collapsed.

There is a lot to this point, but it’s not really so simple. You can’t compare all of these net tax receipts (or more broadly, economic activity) to what would happen in “the world as it is today, minus GM.”

First, in the event of a bankruptcy, you don’t burn down the factories, erase all the source code on all the hard disks, make it illegal to use the brand name Chevrolet, and execute all of the employees. Others take ownership of the assets, and the employees go on with their lives. Some of these assets will be put to use generating revenues, profits and taxes, and some of these former employees will get jobs or start businesses, and generate revenues, profits and taxes. In order to measure the effect of the bailout over, say, five or ten years, you have to compare the actual taxes collected to what would happened over this same period in the counterfactual case where the bankruptcy was allowed to proceed. What owners would have bought the factories and IP assets, and what would they have done with them? What businesses would the former employees have started? Who would have moved to Arizona and retired? What new industry clusters will evolve in Arizona because of this transfer of people?

Second. some of the profit GM makes today would have been made by other companies that picked up some of the slack if the company lost market share after a bankruptcy. They would pay taxes on these profits, and as far as government receipts are concerned, money is money. How would auto industry structure evolve over time given whatever changes happened to the assets currently owned by the legal entity GM, or the employees currently paid by it?

Anybody who tells you they can answer these question reliably is full of it.

And that doesn’t even start to get to the really long-run considerations of what effects this has on rule of law and moral hazard (or if you want to make the case for the bailout, social solidarity and degradation of the working class).

I hold the belief, quite strongly, that the net effect of the GM bailout will be negative. More precisely, I hold the belief that over a series of many such decisions, a mindset that would have been stringent enough not to have sanctioned the GM bailout is likely to lead to better overall economic outcomes for America. This belief is ideological – not in the sense that I just hold it for inexplicable reasons that cannot ever be changed by empirical analysis – but in the sense that I don’t believe that human beings currently have the capability to conduct the kind of analysis that should convince a rational observer to change his mind about the GM bailout in isolation from a more profound paradigm-shift-like change in his beliefs about the world.

The GM bailout is not an isolated case of this problem. And as I’ve argued many times, impressive-sounding empirical analysis is typically insufficient to measure the effect of important economic interventions like the stimulus program. If you can’t even measure what effect already-executed programs have had, how likely is it that you can predict the effects of future programs?

Acceptance of this degree of ignorance doesn’t cut equally against all ideological positions. It leads naturally to a call for decentralized decision-making, experiments, and entrepreneurial groping toward knowledge.

(Cross-posted to The Corner)