Big Government to Prevent Bigger Government

I recently posted Tyler Cowen's thoughts on income inequality, but the article linked was originally sent to me by Justin because of Cowen's positive thoughts on the bailouts (which I don't support):

How about a world with no bailouts? Why don’t we simply eliminate the safety net for clueless or unlucky risk-takers so that losses equal gains overall? That’s a good idea in principle, but it is hard to put into practice. Once a financial crisis arrives, politicians will seek to limit the damage, and that means they will bail out major financial institutions. Had we not passed TARP and related policies, the United States probably would have faced unemployment rates of 25 percent of higher, as in the Great Depression. The political consequences would not have been pretty. Bank bailouts may sound quite interventionist, and indeed they are, but in relative terms they probably were the most libertarian policy we had on tap. It meant big one-time expenses, but, for the most part, it kept government out of the real economy (the General Motors bailout aside).

I actually agree. In fact, in my history classes I describe the intervention of FDR's New Deal as effective. Not because it fixed the Great Depression, but because it was the moderate choice in a time of extreme global chaos. Hitler, Mussolini, and Franco were taking over nations as the extreme right. Stalin and the communists were taking over as the extreme left. Even in America leftist critics like Governor Huey Long were writing books like Share Our Wealth. In fact, 1930's socialist Norman Thomas wrote that the "Mr. Roosevelt did not carry out the Socialist platform, unless he carried it out on a stretcher". Perhaps FDR's huge expansion of the government was the least government could do without forcing a revolution.

Politics Without a Leading Political Party

As usual David Brooks from the New York Times articulates perfectly what is going on:

In 1951, Samuel Lubell invented the concept of the political solar system. At any moment, he wrote, there is a Sun Party (the majority party, which drives the agenda) and a Moon Party (the minority party, which shines by reflecting the solar rays).

In 2004 it looked like one of the parties were about to take control:

But something strange happened. No party took the lead. According to data today, both parties have become minority parties simultaneously. We are living in the era of two moons and no sun.

Here's why this is bad:

In policy terms, the era of the two moons is an era of stagnation. Each party is too weak to push its own agenda and too encased by its own cocoon to agree to a hybrid.

Like I said after watching a Tyler Cowen Q & A last year:

In the past I've specifically voted for divided government. Historically this has been the best way to limit the growth of bad government. However, now that our country is on an unsustainable growth in spending, gridlock will bankrupt us.

I must admit, my political concern about the European/American debt crisis has increased. I told my US History students recently that the current debt issue is a lot like the slavery issue during the mid 1800's. It is so lose-lose that no politician will touch it. Which meant from Andrew Jackson to Abraham Lincoln we have almost no meaningful presidents who would be willing to deal with issue issue appropriately.

Greenville, My New Home

I'm officially back in the country, less homeless, and ready to get back on the blogging train. There's no where better to start than NPR's recent spotlight on the success of my new home Greenville, SC. Here's the intro:

During the worst of the recession, new development ground to a halt and small businesses closed their doors on many Main Streets throughout the country.

That wasn't the case in Greenville, S.C. And while it seems improbable that a city would thrive during the recession, Greenville's mayor credits a mix of good luck and good fundamentals.

The Unseen Costs of Easy Money

For several years now the Federal Reserve has been printing money (quantitative easing) and lowering interests (through the discount window) in attempt to improve the US economy . Here's why that's not that great of a great idea:

More than any other policy action, monetary policy suffers from the sense that there is a free lunch to be had. Yet the interest rate is a price for the savings that are transferred to spenders. To the extent that the Fed manages to push this price down (and some economists will dispute its ability to push any meaningful interest rate down), it taxes the producers of savings and subsidizes the spenders of savings. Clearly, no government considers pushing down the price of any real good an effective way to stimulate the economy – any gain to consumers is a loss to producers, and the loss typically will outweigh the gain if the market price is a fair one.

Do we really want to be discouraging saving and encouraging debt?

Economics of Skirts

Good times equal small skirts:

Urban legend has it that the hemline is correlated with the economy. In times of decline, the hemline moves towards the floor (decreases), and when the economy is booming, skirts get shorter and the hemline increases. We collected monthly data on the hemline, for 1921-2009, and evaluate these against the NBER chronology of the economic cycle. The main finding is that the urban legend holds true but with a time lag of about three years. Hence, the current economic crisis predicts ankle length shirts around 2011 and 2012.

Via Barking up the wrong tree.

Economics of Weight Gain

From research on American teenagers:

I found statistically significant estimates, indicating that females gain weight in weaker economic periods and males gain weight in stronger economic periods.

Perhaps male wieght gain is something to be earned and female weight gain is a stress response. Anyone got any other possible explanations?

A World Without Economic Growth

Here's something absent from every single thing I've ever read about predicting the future of our economy: Even if economic growth ends right now (which it most certainly will not), we still be as rich as we are right now.

Why Employment is Low and Profits are High

The story runs as follows. Before the financial crash, there were lots of not-so-useful workers holding not-so-useful jobs. Employers didn't so much bother to figure out who they were. Demand was high and revenue was booming, so rooting out the less productive workers would have involved a lot of time and trouble -- plus it would have involved some morale costs with the more productive workers, who don't like being measured and spied on. So firms simply let the problem lie.

Then came the 2008 recession, and it was no longer possible to keep so many people on payroll. A lot of businesses were then forced to face the music: Bosses had to make tough calls about who could be let go and who was worth saving. (Note that unemployment is low for workers with a college degree, only 5 percent compared with 16 percent for less educated workers with no high school degree. This is consistent with the reality that less-productive individuals, who tend to have less education, have been laid off.)

In essence, we have seen the rise of a large class of "zero marginal product workers," to coin a term. Their productivity may not be literally zero, but it is lower than the cost of training, employing, and insuring them. That is why labor is hurting but capital is doing fine; dumping these employees is tough for the workers themselves -- and arguably bad for society at large -- but it simply doesn't damage profits much.

That's from Tyler Cowen in Foreign Policy Magazine.

Worthwhile Sentences on Political Commentary

From moderate David Brooks: "Democratic victories are always ascribed to hope; Republican ones to rage."

From the Economic Logician: "Many see the Great Recession, as it is now called, as a dual crisis: an economic crisis and a crisis of economics, and more specifically macroeconomics."

From Professor of Shakespeare Peter Saccio: "Shakespeare and Sarah Palin have two things in common. One, they both tend to make up words. Two, half the country can't understand what the other half of the country thinks is so great about them."

From the Seattle Times: "There are no small-government disciples in massive oil spills."

From New York Magazine: "If you can't beat it, the thinking goes, yell at it."

Yet Another Look at Government Stimulus

I know I've belabored this issue to death, but with the costs so large I think it's worth at least one more look. Over two and a half years ago I first predicted that the stimulus packages would not work. Later I posted that the stimuluses probably didn't work in the past (especially the New Deal) and that at best we'll never know if the cost was worth it. I eventually concluded that stimulus as a temporal tax progressive tax is the best and least used argument in favor.

The most famous example of government stimulus is World War II. And it with Ben Bernanke's recent announcement to print an extra $600 billion in a process called quantitative easing (aka increase the money supply), it seems the Federal Reserve's faith in government stimulus has not waned. However, a recent paper published by David Henderson suggest that World War II is a great study on stimulus, except that it proves the opposite of what you might think. First, here's the traditional thought process:

We often hear that big cuts in government spending over a short time are a bad idea. The case against big cuts, typically made by Keynesian economists, is twofold. First, large cuts in government spending, with no offsetting tax cuts, would lead to a large drop in aggregate demand for goods and services, thus causing a recession or even a depression. Second, with a major shift in demand (fewer government goods and services and more private ones), the economy will experience a wrenching readjustment, during which people will be unemployed and the economy will slow.

Now's here's the reality:

Yet, this scenario has already occurred in the United States, and the result was an astonishing boom. In the four years from peak World War II spending in 1944 to 1948, the U.S. government cut spending by $72 billion—a 75-percent reduction. It brought federal spending down from a peak of 44 percent of gross national product (GNP) in 1944 to only 8.9 percent in 1948, a drop of over 35 percentage points of GNP.

While government spending fell like a stone, federal tax revenues fell only a little, from a peak of $44.4 billion in 1945 to $39.7 billion in 1947 and $41.4 billion in 1948. In other words, from peak to trough, tax revenues fell by only $4.7 billion, or 10.6 percent. Yet, the economy boomed. The unemployment rate, which was artificially low at the end of the war because many millions of workers had been drafted into the U.S. armed services, did increase. But during the years from 1945 to 1948, it reached its peak at only 3.9 percent in 1946, and, for the months from September 1945 to December 1948, the average unemployment rate was only 3.5 percent.

Inequality and the Economy

Every time I teach the reasons for the Great Depression, one possibility often mentioned in textbooks is income inequality. Here it is in Wikipedia's reasons for the Depression. The link I just shared and what I've read before all point to an over-investment (or what I'd call a mis-investment) of resources. Perhaps the mistakes of a few can have a large ripple effect, but there's no reason to think the wealthy would be so much worse at investment than the average person. The inequality explanation never seemed to have legs, until I read this article:

The rich have been spending more simply because they have so much extra money. Their spending shifts the frame of reference that shapes the demands of those just below them, who travel in overlapping social circles. So this second group, too, spends more, which shifts the frame of reference for the group just below it, and so on, all the way down the income ladder. These cascades have made it substantially more expensive for middle-class families to achieve basic financial goals.

In a recent working paper based on census data for the 100 most populous counties in the United States, Adam Seth Levine (a postdoctoral researcher in political science at Vanderbilt University), Oege Dijk (an economics Ph.D. student at the European University Institute) and I found that the counties where income inequality grew fastest also showed the biggest increases in symptoms of financial distress.

This helps explain consumers buying houses they can't afford, a main cause of the most recent recession. It's difficult for economists to put a value on fairness, but we know there is one and now we see it has an important measurable impact.

Increase Quantity of Labor by Decreasing Price

Here's something I've been thinking about, but could never articulate so clearly:

This shouldn't be big news. In economics, prices fall with demand. Demand is down. The price for work -- wages -- should be down, too. But wages have a tendency to flat-line, not fall, in recessions. Workers refuse to work at lower pay and employers are afraid to lose good workers by demanding pay cuts. So instead of falling wages, you get falling employment.

Pearlstein suggests we all "look for creative new wage structures" to get the economy rolling again. That means "look for ways employers can pay employees less money." There are a couple ways to do this. Some we've tried, and some we haven't. We have tried hiring more part-time workers, off-shoring more jobs, and adding cheap positions. We haven't tried "job-sharing," the German plan where government and employers split the check for workers to keep more people in their old jobs even when demand for their product falls.

This "stickiness" helps explain why unemployment is a slow measure of an improving economy.

Restorcession Continues

It's all over the news. The recession is over, but people are still feeling it's effects. There are even polls, especially on local news, asking people whether they think the recession is over or not. The only problem is, it's not an opinion, it's a fact. But that doesn't change 10% unemployment and less than 0.5% economic growth. The economy isn't recessing, but it isn't growing much either. For most people, whether we are technically in a recession or not matters very little. What really matters is when the economy comes back to it's regular growth rate, around 3%. So what I propose is another name for economic declines, not a recession, but a restorcession. It's not over until the economy is fully restored to it's predecline state.

The Economic Stimulus Package, Last Part

Two years ago I posted on why I didn't think the stimulus package would work, why I didn't think the very very first worked, and why I might consider it as a "temporal progressive tax". But since the Federal Reserve recently predicted the recovery is slowing down, it's worth one last look. In this NPR podcast (via Justin) one of my favorite economists Tyler Cowen puts it like this: there has never been a very good test of Keynesian stimulus and in fact, this last stimulus package has probably the best chance to test it. A year and half ago he predicted it wouldn't help, and that it wasn't worth the risk to spend a trillion dollars on an untested idea.

But here's the worst part, because the macro-economy is so large and so unwieldy, even though this stimulus hasn't ended the recession in the predicted amount of time, it proves nothing. Supporters can reasonably say it would have been worse without it. Although I can't say with completely certainty the stimulus package has done more harm than good, the opposite can't be proven either. And it seems the burden of proof should be on the party wanting to spend a billion dollars.

Morality During Hard Times

I just finished watching the movies The Book of Eli and The Road. Both take place in a post-apocalyptic world where people are desperately trying to stay alive. Even the heroes are forced to do things we might find morally reprehensible. However, the sobering reality is that these fictional movies aren't fiction for much of the world. Until the Industrial Revolution, man was always on the verge of starvation. There are also countless people in world today forced to make lose lose choices. Whether it's the Dark Ages, Darfur, or hurricane battered New Orleans, it seems our view of right and wrong become more liberal during hard times. The more desperate, the moral gray the lines become.

I assumed this was exclusively a bad thing, that is until I read this post about some governmental changes during the Great Recession. I've posted about the positives of this recession before, but didn't mention these. The federal government recently overturned a ban on internet gambling. California, marijuana is becoming increasingly legal and taxed. There are even some local airports loosening the alcohol restrictions in airports to make money. Maybe just the right amount of hardship can shift cultural norms closer to my preference.

Emptying the Bottle: Late-July '10 Links

Here is a list of the worthwhile sites I've Bookmarked recently:

• Apple's control issues could hurt it in the long run, again.
• 151 positive traits of ADHD (earlier).
• Social benefit of the Sabbath (this is important).
• Ten ways movies get you into a fantasy world.
• Man chases disc golfers with a chainsaw at my alma mater.
• Watch this video of a Hallmark card, then watch the NAACP's reaction.
• Relationship between loving ourselves and loving others [graph].
• Number of birds killed by BP compared to cars, cats, and wind farms.
• When your opinion is not respected, focus on asking good questions.
• Feeling okay about being a consumer Christian, at least for now.
• Review of modern recession economics (highly recommended).

To follow live and to see comments, subscribe via Google Reader.

Costs of the Financial Crisis

Are not as much as you might think:

Are financial crises costly? To answer this question, one should not look at the cost of a bailout, a drop in GDP or missing tax revenue, but at what people care about: consumption. In this regard, the current crisis is too young to be analyzed, but other ones are available. Two recent papers look at this for Japan and Norway.

Yasuyuki Sawada, Kazumitsu Nawata, Masako Ii and Mark Lee use panel data from Japan that spans over the 1997 banking crisis and estimate Euler equation that allow for credit constraints. While in normal times, 7.82% of households are credit constraint, this increases only to 8.44% during the credit crunch. In other words, the ability for households to smooth out consumption was only negligibly affected.

Eilev Jansen studies Norway, but prefers a VAR approach linking current wealth and income to consumption, which appears to work better than Euler equation approaches for the recent years. But again, the impact of the crisis on consumption is negligible: the elasticity of equity income on consumption is 2%.

Like Bernie Madoff scandal, perhaps financial crises may be more about transferring or delaying wealth than an actual destruction of wealth. There's even some evidence that recessions are good for filtering out inefficient businesses and growing those that survive.

Why Economists Outweigh Historians

Teaching history has given me an appreciation for the importance of historical study. Yet we hear very little about historians in everyday life. Here's a pretty good explanation:

One answer I offered was that economists had managed a remarkable balancing act between making the guts of their work totally incomprehensible — and thus forbiddingly impressive — to the outside world while continuing to offer reasonably straightforward conclusions. The basic form of an academic economics paper is a couple of comprehensible paragraphs at the beginning and a couple of comprehensible paragraphs at the end, with a bunch of really-hard-to-follow math or statistical analysis in the middle. An academic history paper, on the other hand, is often an uninterrupted cascade of semi-comprehensible jargon that neither impresses a lay reader nor offers any clear conclusions.

The one economist in the audience had another suggestion. Most economic work was aimed at prediction, and the world is always hungry for predictions.He added that most macroeconomic predictions are worthless (he was a microeconomist), but that doesn't seem to have damped the demand for them.

Hopefully this recession has shown us the promises and limitations of economics.

Emptying the Bottle: Early-April '10 Links

Here is a list of the worthwhile sites I've Bookmarked recently:

• One benefit of the recession, we rest more (earlier).
• Retirement is lethal.
• Obama's victory in health care could help US foreign policy.
• Blog by a man who decided to give $10 to a stranger every day.
• Socialization against sex is correlates with income because it's costly.
• Keeping violent people occupied with violent movies. Is this why prisons have TVs?
• Social Security is probably not Constitutional.
• Global slum population decreases.
• Maybe global warming will bring world peace.
• Phones and computers make you happy, television makes you sad.
• Years ago libertarians said universal health insurance was better than the alternative.
• What would the world look like if economists were in charge? [highly recommended audio]
• Paying the unemployed makes more unemployed.
• Mean population center of the United States [map].
• Men do cry [graphic].

If you'd like to follow my shared items live, subscribe.

Future Impact of the Great Recession

Registration for next year's classes began last week and my AP Microeconomics class, which got canceled due to budget cuts last year, was on the list and it couldn't come at a better time:

individuals growing up during recessions tend to believe that success in life depends more on luck than on effort, support more government redistribution, but are less confident in public institutions. Moreover, we find that recessions have a long-lasting effect on individuals’ beliefs.