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| 0:36 | Intro. [Recording date: March 8, 2010.] Past, then move to the present, then future. In the past, the music business was very different. Who made money and how did they make it? What did record labels provide that made them profitable? What record labels provide for the artist: not too much difference between what they do today and then. What's different is the structures of how they do it; that's changed dramatically. The old model, for years--came into the business in 1970 at Capitol Records, worked there 14 years before going to Universal's MCA Records, in 1983. Labels based on a model reliant solely on one or two things: either you had an established artist that was in the public light previously--literally from the 1950s Elvis Presley or Frank Sinatra--or everything was established via radio play. Radio really was the forefront and strategic partner; as radio grew, with the Top 40, and then later in the 1970s, when FM radio started playing albums, a second explosion. The model was based on securing radio play, marketing to the audience that was hearing records on the radio, and subsequent television as well. The distribution channels were very strong at retail. At that time, record chains--Tower Records, Warehouse Records, Licorice Pizza--great record stores people could walk in and buy music. Profitable till 1983, when the CD came around; and then it became even more profitable on the label side--more profit in CDs and people who had bought in vinyl, cassette, or 8-track cassette re-bought it in this new format. Labels could make a lot of money converting catalogs to digital without spending a lot of money on artists--reselling to the public a lot of the music they already had. As new artists broke, same plan was in effect--radio was in the vanguard. Now know that in the mid- to late 1990s everything started to change when a little website named Napster came along. |
| 4:17 | Stick with pre-digital world. Hard in some industries to predict success. With a new artist or new album, how accurate were the forecasts that the labels would make in predicting success? In movies, told that they are not very good at predicting what's going to be a blockbuster and what isn't. Effort obviously matters but is not decisive in that industry. In record industry? Sat down and had weekly meetings about new releases. Different marketing plan in effect for established artists. If you broke in an artist like Bob Seger when at Capitol, different plan than trying to break a brand new artist. Initial projections back then not that hard. Experience: an artist you looked at; went out and secured the talent. Pink Floyd: an album-based group; marketing plan completely different from for an artist who was a Top-40 mainstay group. Before they were a household word, did people know? Building process: when you signed an act--used to sign for 3-year deals, some longer depending on if from another label or in development already. Look at acts and say: if we sell 50,000 or 100,000, would have a base to go on to do a second act. There are always times when we under-projected or over-projected. Any pleasant surprises you remember? Picked all of Bob Seger's singles from Night Moves through 1983. Never really had a hit single, but toured relentlessly and built up a good album base. Didn't have that magic chance until 1976 with Night Moves. Went to management and said that was the cut that would work; need to get airplay outside of just Michigan. Became the first single; went top 5 nationally. Actual marketing process: after everybody agreed that Night Moves was the single, what did people do on the ground to get that music heard? From the promotion side, spiraled from going from station to station. Fortunate--had some major radio stations jump on the record very early in 5 or 6 major markets. From the minute that happened, we went into emergency mode, said: We need marketing. Had meetings subsequent to regular meetings. Made bombardier jackets that said Night Moves, with fur collars, and gave them out retail and to radio key programmers and general managers. Created posters for fans and general marketing. Did new radio spots. Marketing for whole tour; markets Bob was going to go and re-play; but now the venue was changing. Went into Defcon 4 status. When you get the nibble on a record like this, you are going to do everything necessary to bring the record in. You really don't know until you have weeks and weeks of sales; you hope you are going to reach that gold and platinum, even mult-platinum level. Once the record was a hit, on the radio for three months--12 weeks of airplay--already at platinum. Knew then from the album side what to pick for the second single. Now radio welcomed with open arms because they'd had a hit with the first single. Fortunate with that project--four singles. Doesn't always happen that way. Sometimes you get a single that is great radio but doesn't convey to album sales, or not proportionate. Ever have any singles that slogged and slogged and never made it? Yes; that's the one thing about the record business that nobody understands. Letters saying record labels only promote what they want, pick and choose. No record label cares where their hits come from. A hit is a hit. Would love every record they put out to sell. Every artist they sign gets some kind of advance. We could have some priorities; radio picked another record for their own reasons. |
| 13:30 | Profit margins in the business. CD came out; people were excited and wanted to recreate their own catalogs. Price went up or down? When CDs were first released, they were retailing for $19.99. Retailing in long, slim boxes. Hard to steal. Cardboard box. They sold. Michael Jackson's Thriller was one of the first CDs that ever went platinum just in CD sales--platinum is 1 million. Shortly after, long slim pack went away. Dealers gave feedback that that packaging wasn't working at all. Most of the labels co-opt the expense of converting all those record stores to bins that would work. Co-opt--mean paid for it? Yes, in advertising or gave an allowance. CD good for profit margins: most industries when you get an innovation like that, competition makes it stay the same price. Consumer gets the better deal. Was it cheaper to make CDs? Vinyl was cheaper then. Vinyl has come back as a huge niche market, but not many vinyl plants around, so it costs more to make vinyl today because there are not as many places that can make it. Back then, vinyl records cost only about a dollar to make; though some artists insisted on what we call "virgin vinyl," never been recycled; charged a dollar more for that at retail. Extraordinary royalty for some, like the Beatles, a dollar more for that. The CD varies based on royalties, negotiated for every artist. Company has to decide on distribution. Manufacturing cost for CDs was about $2.65-$3.00. Wish to get cost down; tried eco-path, with cardboard. Raw manufacturing; have to factor in the cost of the marketing, the promotion, and back then, when the CD happened, cost of making a video. Dealers were buying CDs for $6.99-$10.00, depending on whether it was a double CD or single CD; retailing for $15.99-$16.99, sometimes higher. As time went on, marketplace became more competitive. |
| 18:26 | A successful album--high end goal would be platinum, a million sales. First milestone would be gold--that's 500 units. Second, platinum. Each subsequent million is called multi-platinum. In the 1970s and 1980s, what would be a wildly successful CD? While at Capitol, from Bob Seeger, almost through 1983 almost all he did was a million plus. Pink Floyd, Dark Side of the Moon, over 10 million--not in four years. Thriller to date goes back and forth with the Eagles' Greatest Hits for being the number one best selling of all time; both about 30 million to date. Couple of others? Bruce Springsteen's Born in the U.S.A. did 10-15 million. Spice Girls. Now? Taylor Swift, two albums, 10 million plus. CDs, or digital? One of the biggest sellers now. A lot of people argue that you can't make any money today because everybody steals it. From the label side or from the artist? Both. Couple of hundred independent artists receive my newsletter; all say that if it weren't for the Internet, they couldn't make a living. What do they do? Market and tour relentlessly. None getting rich or have big hits; but all able to live. Internet has changed ability to make notoriety and generate revenues. Some complain that because of file sharing--Napster, Limewire and others--the Internet has helped them a lot. What about the more successful groups? Two different viewpoints; two sets of data supporting both. Report in 2009 by Forrester Research shows that the record industry in one decade, from 199-2009, went from $14.6 billion to $6.3 billion in revenues. Industry blames that on online piracy. On the other hand there are studies all over the world that have been done that have cited that those who download music illegally also happen to be the biggest consumers of legal music. There are studies backing that up. Difficult to measure accurately; prone to bias. Even without file-sharing, people were burning copies of CDs. Still going to be dark nets where people do this. From the artist side, if you look at the people who used the web to their success--one of the greatest examples would current be--before Lady Gaga released Bad Romance to radio, right before it went out, the single wasn't pushed at radio, almost simultaneously, overnight on YouTube almost 10 million views. Made no money from it? Might have; don't know arrangements with Universal, might be able to repackage it later. All media is a marketing tool. Some artists retain the rights to all their videos. Before the video was in the Top 10 it got up to 25 million views on YouTube. Knew record was destined to go to Number 1. Artists sometimes virally use the web--Wilco. Tremendous experience--went into label, wanted a better record. Took it back and offered it to all their fans. First downloaded album online. Band did it because they knew the money they were making from their record sales wasn't near what they were making from their live appearances. Worked; and Electro Records came to them--under the same Warner Music Group. Record still ended up sending 300-400,000 copies; probably gold. Next album sold more, and next sold more. Jeff Tweedy out there saying that the Internet is not my enemy. Great divide: labels versus aggressive or progressive artists. Labels never embrace the Internet; Steve Jobs. |
| 28:49 | Who is making money on iTunes? The revenue is split between iTunes and the labels, which break it down to the artist; and each artist has a different deal. Make less if you are selling a song for $1.99 than an album. Puzzle: record label revenue is way down, maybe half of what it was, and maybe falling--does that include iTunes? That's gross revenue, so it includes everything. So, normally, you'd think this is a change, it happens in markets; this new distribution channel is phenomenal. ITunes doesn't work so well as a gift; but it is easy and quick and lets you find new music. Why haven't they cut out the record label entirely? Why aren't they a label, letting the Internet filter out quality? If you are a new artist today, you submit your music to iTunes; write out the contract--they are not against signing new artists. They are hands down the number 1 online store all over the world. Incredible job of branding: Steve Jobs best innovator; plus he has an iPod to sell. iTunes is a store and an online store, but not a label, don't go out and secure talent. At what point does an artist say to a label, what are you doing for me? Steve Jobs has no vested interest in making CDs, strictly a digital market. Doesn't want to bother with the brick and mortar world, and doesn't need to. Cost of underwriting--everybody thinks all you have to do today is you make your record, and the label signs it and they just put it out and then if I'm lucky enough to get played, they just sell it and they keep all the money. That's just wrong. The label spends a fortune in marketing, promotion, videos. If you speak to an independent artist, they know how difficult that is because most of them are doing it on a local, regional level. Tremendous amount of money. Securing radio play today is harder than ever. New music first is being shared peer-to-peer and is going on YouTube. Artists first are developing themselves in front of radio play. Might already have sold 50,000-100,000 albums before radio play, and they know how to do it very well. |
| 34:23 | Is radio going to make it? Radio revenues are down; radio stocks are now below a dollar, penny stocks. If they want to make it, they've got to give a reason for people to be entertained. If you go into any market today, you hear the same 30-40 records. The argument from radio will be that that's the way it always was. But formerly you had personalities. If in Los Angeles and turned on KMET, knew I was in LA. If in NYC and turned on WABC, knew I was in NYC. Or WNEW. Today, all so cloned. Audio talent is minimal. Records 95-98% the same. The youth of today isn't waiting for radio. Online sharing files at age of 13-14. See something developing, can see the progress online. First question to ask when lecturing: How many of you listen to radio for new music? Maybe 1 or 2 hands go up. How many have iPods? online? Everybody. How many sharing files with friends--95%. How many buy music? Almost 70%. Still means 30% aren't; and how much? But this is the world that exists today. Cannot go back to the old model. ITunes is the number 1 branded store. Why hasn't every label created its own destination where they sell uniquely? Some have tried. Not just having a store where you click--store where you do something. The Beatles have--still not for sale digitally, and every day it's not people are stealing it--imagine what they could do by packaging it: if you buy this, you get this other thing. ITunes can't do that without the labels, because the labels have the content. |
| 38:34 | A lot of times industries have a sea change like this; obviously trouble adjusting. Why don't we see new labels springing up from scratch? Sounds like a profit opportunity. From this point forward, strategic alliances, Universal just did one with Bally's Fitness, sold 4.5 million for downloads. Encouraging people to join their clubs; going to get a free download from the Universal catalog. Starbucks' model? Didn't work. They have a whole lot of outlets: to a marketing person, first thought is there's 10,000 Starbucks; we'll put 5 albums in every one--that's 50,000--we put 10, it's 100,000. If you put them in China, that's a billion. Doesn't work that way. Why not put them in McDonald's? That might be the future. Eat the hamburger, chip in your brain, get a download. Starbucks thing didn't work. Worked with the Ray Charles album, but not with the Paul McCartney album. Critical element that's missing today is the great record store. People miss the emotional connection. Amoeba Records in Los Angeles--environment that was similar to what Tower Records was in its great days. People look and spend time there. Won't come back the way it was. Used to hang out in Tower Records. Do that at iTunes, too. Emotional connection different. |
| 42:55 | Shift gears: Quote from John Perry Barlow, lyricist for the Grateful Dead, recent article in The Atlantic: "What people today are beginning to realize is what became obvious to us back then--the important correlation is the one between familiarity and value, not scarcity and value. Adam Smith taught that the scarcer you make something, the more valuable it becomes. In the physical world, that works beautifully. But we couldn't regulate [taping at] our shows, and you can't online. The Internet doesn't behave that way. But here's the thing: if I give my song away to 20 people, and they give it to 20 people, pretty soon everybody knows me, and my value as a creator is dramatically enhanced. That was the value proposition with the Dead." Referring to the bootleg phenomenon, record and share with friends; and with the Dead, they encouraged it and tried to make it a profitable strategy of marketing. Quality not quite as high, but high enough that people enjoyed it. The Dead's idea was always that they were touring and that made a lot of money. Will touring continue that way? The amount of money that U-2 or Bruce Springsteen grossed from their concerts, after you take off their production costs, can still see that the net revenue to the artists is way higher than what it is from their record sales. If their albums sold a million and they made ten million touring, you have the answer. Then, licensing. Those artists who are able to deliver live--if Wilco's able to sell out those smaller halls, they don't have to sell x amount of dollars to try to sell those tickets. If their album is selling 400,000, and that's split among the band members and the record company, after that's split, the revenues are not going to be anywhere near what the touring and licensing and merchandising are. Is that new or has that always been true? Think probably--back in the 1970s and 1980s, Bruce Springsteen, in three or four years extraordinary--allowed him to play 30-50 markets or the Rose Bowl. In that one year his concerts outgrossed his record sales. The issue is, you are not touring every year. We don't have artists delivering album after album after album any more. Their catalogs--they are still getting royalty checks, making hits for the last 20-30 years. Ironic: extraordinary technology--digital music that lets people enjoy a better quality experience than a concert--different, but extraordinary fidelity; and then we turn the profit mechanism into standing live in front of 50-100,000. Wild thing. Used to be if you toured you sold the albums. Now, you are saying, if you tour you sell the albums. What U-2 did, they screened it on the Internet. Regardless of what everyone throws at me, glass half full not half empty. Opportunities online. If you are interested in keeping your CD in the marketplace for a longer period of time, lower your prices. Don't release albums with one or two good tracks. Not going to pay $10.00 for an album with one good song. |
| 50:08 | Never a better time in history. Ability to find music you once loved--don't have to go to NYC to find it in used CD market. Incredible feast. Worry is that that's now. Twenty years from now, as this generation pays less and less and feels more and more entitled to get it for free, the ability of that to generate returns that encourage people to go into the business isn't going to be there. May or may not be true. Factor we don't know: what will be developed in the future that will allow people to generate more revenue from online. People not in the habit today of purchasing music will have a hard time converting to it. On the other hand, see an artist like Susan Boyle in England, wins the x-factor and worldwide sells 10 million in 90 days. She sold 3 million in the United States alone. Record label will tell you it's an older demographic, they don't traditionally download, different audience. All of those things exist. But a lot of those people could have accessed it online; or having someone get it for them easier. Increasingly more difficult to generate the same kind of sales to give you a return on your investment. But the model that exists today in a year, two years, or three years, same as the labels will change. When I left in 1992, every record label had a full promotion staff of people who went to radio. They are gone. You don't need 30-40 people now because radio has changed. But retail has changed, too. Have friends selling a lot of music online. Friday Music, licenses music, sells new music, doing well, couldn't have done that previously--selling vinyl and selling CDs. Music as the big umbrella. Those models, 360 model--Live Nation signed Madonna to a hundred million dollar deal for 10 years. Guaranteed her 10 million dollars a year for 10 years; get her records, her tour revenue, her merchandising. Madonna signed that deal, think last year, age 50. They are not counting on her selling $50 million in records in the next ten years. They are counting on getting the revenue from all the other ancillary strains. Guarantee you that you will see Madonna music on commercials and in a myriad of other ways. |
| 55:19 | Susan Boyle example. Subtle point. Not a big TV watcher; in England, came in second on England's Got Talent. If just heard song I Dreamed a Dream on the radio--had a great voice; but thought about buying album because of emotional connection, clip on YouTube--staged? real?--wows the audience and judges. Not the same song as if you just heard it on the radio. Other aspects, glorious thing, Internet. TV as well. American Idol--like what they do or not, audience has emotional connection to the people for 6 months. What American Idol does is what radio doesn't do any more. Radio: If we like Sammy Hagar, we're going to play Sammy Hagar. Played the music because it was lifestyle-oriented music. That's what their audience wanted. The guys that programmed in those markets had huge numbers. Paralleled the biggest top-40 music station. We could take an artist and build it over to the hip singles side. That's gone now. No more album format. Radio isn't going to take somebody without having some reason to play it. Television making a connection every week. Journey song, Don't Stop Believing, Sopranos episode. Second life because of that, sold millions online in next few months; put the song on Glee and it sells again. Used to be able to browse and feel connection; whipping open the vinyl album and smelling that vinyl; don't get that sensory connection any more. "Your download is complete." |
| 59:45 | Had that connection with the DJs, too. WMET, WNEW--stable of disk jockeys. Hired by Capitol Records as "Regional Album Marketing Specialist"--in 1971, sent to NY, WNEW, WPLJ, and Long Island, WLIRFM, and down in D.C. and up in Boston, WBCN. Forerunners of what was happening. Allison Steele, etc. Personalities gone today. If you had that talent--you can't be a DJ today. The stations don't allow it any more. What are those people doing today? In the old days if you had a musical, 1600s-1700s, very limited. You could play for the King, for the Church. Today, as the profitability changes, some people aren't good at touring. Natural advantage that accrues to people who can't do that. One place that could accrue is movies. A lot of the most talented folks--thinking of Randy Newman--doesn't do that much any more, writes for Toy Story, Pixar, not writing for the King. Not writing symphonies or concertos or Sail Away. What other changes like that are coming? What happens with great music when coupled with great movies--Forrest Gump, sound track did great because of the movie, best from each decade. Song used at the end of an HBO series, Six Feet Under, song used in the last episode of that series. Had never heard it; immediately went online and found the song and got a hold of it--group called SIA [CEA? sp?], being used in brand new movie last night during the Oscars. That song, Austrialian artist, only known by some very progressive stations in the United States, Six Feet Under, spread virally. Nahin [sp?] Emotional connection--that's what film and television does. Article, TV show--Madmen--producers involved with the ¬Sopranos--inundated with artists who want to be on. American public has a voracious appetite for new entertainment. Flash Dance soundtrack, one of the first. Universal, largest TV soundtrack of all time, Beverly Hills Cop. |
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| 0:36 | Intro. [Recording date: March 2, 2010.] Public choice: application of economics to political science and the political process. Story, Garett Jones podcast, referencing letter to the editor by Don Boudreaux on death of John Murtha (Congressman, Democrat, Pennsylvania). Laudatory Washington Post obituary for Murtha: King of Pork--he did very good job bringing goodies, earmarks back to his constituents. Boudreaux point: If a person went around the country breaking into other people's houses stealing their money, breaking into banks, and then distributed the proceeds to one's buddies in one's hometown, they would be considered a thief, not a hero; but when a representative of the House of Representatives does it, he's considered a good politician, or successful politician. Shame that people aren't embarrassed to be that kind of politician rather than taking pride in it. A couple of footnotes: May have said in the Jones podcast that there may have been good old days; but that's naive. People have always tried to bring home goodies to their constituents. Just think there used to be less scope for it; maybe less prevalent. People have always tried to get army bases in their districts, dams built in their districts, all kinds of things that government can do to make a politician look good. Second point: some people get very upset that Russ was critical of democracy, part of the democratic process; inevitably quid pro quos in politics; to call it theft isn't productive to the enterprise of good government. Disagree; think it's really important to expose government as unproductive when it is unproductive; important to distinguish between democracy and various forms of democracy that happen in practice. Idea that the will of the people should have some influence on political outcomes beats tyranny. Idea of majority rule is a good idea--has some golden specialness to it--is dangerous. What makes the United States so successful historically is the fact that we are a constitutional republic. One of the roles of the Constitution is to stop government from doing things that are closer to theft and less like things that government ought to be doing. Russ: not an anarchist, not a romantic about the past roles of government--government may have been a little more effective in the past because it did less. |
| 4:35 | Certainly true that that is the way modern democracy works. But David Hume taught us, by exposing what he called the naturalistic fallacy, that just because something is doesn't mean that it ought to be. True, that's the way it works. Value judgment: An institution in which people are able to take resources from others, bring them back home for their own benefit and the benefit of their buddies--that is as blatant as the institution we have now. Pork-barrel politics--which is what John Murtha was very, very good at--allowed him to do exactly what thieves would do in the example given. The fact that it's common, typical, does not make it right. Makes it incumbent upon us to point out that that's the reality. Frank Charterow [sp.?], great writer, mid-20th century: You go to Washington and you see these beautiful buildings, marble columns, looks very majestic; pretty city, neoclassical architecture. That glorious facade hides a lot of really nefarious behavior. The fact that the people who commit that behavior are elected to office, have titles--that what they do is not legislated as criminal activity--does not mean it is good for society. Only hope for preventing those activities is if people understand what those activities are. One of the ways to reduce those opportunities is shame. Shame is an under-appreciated social force--applies also to Wall Street. Wall Street made a lot of money during the crisis, but they were just playing by the rules. If you had a chance to make a lot of money, why wouldn't you? Answer: if it's wrong and it's destructive and you are portraying your fiduciary responsibility, or worse, manipulating the rules--government controls the rules--it's not good. Would be good if Wall Street had a culture that said some of the things are moral, and we are not going to pursue them--better than making them illegal. Would be great if members of Congress actually meant the oath of office that they swore to uphold the Constitution. Better world. Huge part of morality--not everything that is legal is right; and not everything that is illegal is wrong. Legislative rules not a guide for morality. Don't want to be naive; but voting scoundrels out of office doesn't require shame. Problem: people in the district in which Representative Murtha was in office are benefiting. They are the beneficiaries of his skill. Many--not the majority of them. Some funded his campaigns. Some attempt now by some candidates to stake out territory, saying they are not in favor of pork. Having said all that, pork is not very big. The glass is half full. In the United States, through most of its history, the pork benefits have been small potatoes. Earmarks small. We get upset about them. Resource wastage terms; but the "benefit" of pork for people who want to build a better society is that it magnifies and brings into relief the larger, deeper problems. Most people understand that a multi-million dollar airport paid for with Federal funds in Murtha's rural district that has only about 2 flights a day, an average of 20 passengers, is not a good use of resources. Airport sports Murtha's name. When people see that resource waste exists and it is the result of constrained majoritarian government in the United States, they are led to ask: What else is going on? That airport may be small potatoes, but perhaps the larger programs are not as deserving of reverence. Pork is an unfortunate thing for the folks in power. It helps expose the true nature of what's going on in Washington. |
| 13:11 | Straw man that classical liberals have to answer: People say these free market types have some interesting ideas, but they are against government. Co-blog at Cafe Hayek, much on this topic; might think anarchists, but not. Philosophical non-stater. Anarchy means no law. Philosophically, how far can you push the privatization of collective action. We know from historical studies that it can be pushed pretty far. We know money can be supplied privately in a way that 50 years ago--because there was no research--in a way that even Hayek hadn't thought possible--though at the end of his life changed his mind based on that research and advocated the denationalization of money. Would not push the button today and get rid of all government. Social institutions and expectations couldn't withstand such a thing; we would descend into chaos, lawlessness. Question motivating Jim Buchanan, single greatest figure along with Gordon Tullock in public choice, always emphasize: compared to what? It's not the merits of the market compared to some ideally-performing government, or ideally-performing dictator--it's compared to government as it is likely to perform as the alternative to the market. Also wrong to hypothesize a perfectly working market and assume that's what's happening in reality. Popular mind celebrates democracy, and has a far-too-romantic view of democracy--incumbent upon us to show that government in general, and democracy in particular, has certain flaws that people are unaware of. Works of James Buchanan are online at the Library of Economics and Liberty. Still going strong at age 90; does not shy from philosophical thinking; very Smithian. Are you against democracy? No. To the extent that we have government, obviously it should be tied in some way to the choices and desires of the people governed. Regular, fair elections probably the best way; could debate more online balloting. Government should be in broadly defined way democratic, constitutionally restrained, have certain powers that are off limits to it. The way the 1787 Constitution does it--it enumerates and grants the powers to the government, with the stipulation in the 9th and 10th Amendment that the powers not granted to the government remain with the states and with the people. Against the romanticization of the State and of democracy. Kenneth Arrow, no free market radical, one of the first Americans to win the Nobel Prize in economics--his signature work, 1951, is showing that there is no system of collective choice, be it majoritarian voting, be it appointing a dictator, that generates outcomes are not arbitrary, somehow arbitrary, not somehow the produce not of the genuine preferences and choices of the voters, but instead are the result of the particular mechanisms whereby the collective choice process is carried out. Inevitably the mechanisms tend to determine the outcomes. Book in hand, Social Choice and Individual Values, very difficult to read, written in mathematics. Should have been the end of Welfare Economics--study of choices made collectively, in the absence of politics. Economics has done a great disservice to public policy by pointing obsessively to market failure--that is, that a perfect market doesn't exist--leading to the natural implication, widely held, that therefore the government should come in and solve the problem; oblivious to the question of whether there is an incentive for the powers that are to solve that problem are pernicious. Whole idea of efficiency in economics opens the door to justifications that are not borne out in practice--no more reliable than that markets are perfect. |
| 22:95 | Challenge earlier statement, nostalgia. Most people don't agree; most people prefer discretion to rules; want to go on a case-by-case basis; don't want to say this is a violation of this Constitutional principle. They want to say: this speech is bad. Recently Supreme Court ruled that corporations can fund, say, a documentary in advance of a political election. In a public poll, a large proportion disagree with that decision. Could debate the constitutionality, but not going to. Idea that we would want to overturn that decision because it goes against the will of the people, or ban certain types of speech because most people don't like it, whereas there is a Constitutional principle that the government should not be in the business of banning speech. Most people have trouble with that, would say they agree with the principle of freedom of speech, but in this case it doesn't apply. Evolution of American political life over the last 200 years--steady deterioration of the role of the U.S. Constitution in constraining political outcomes. Probably because most Americans don't think it's a good idea. The last 200 years have been generally glorious in American life on virtually every dimension. Slavery would be the big exception, but we got rid of it; trend is good. Many things were not great. One could argue that the move away from Constitutional constraints has been very beneficial. Answer to that? Fans of progress; has been a lot of progress. Answer is twofold. First, the Constitution has worked in many respects; not a dead letter. One of the most important parts of that document is the Commerce Clause. The Commerce Clause in effect gives the power to regulate inter-state commerce to Uncle Sam--takes it away from the states. The Framers didn't use the term "free trade zone," but that's exactly what they did--they created a free trade zone spanning a continent. That free trade that we have from Maine to Hawaii, from Florida to Alaska, allows a huge specialization of labor and hence prosperity. Property rights are relatively secure in the United States. How much that has to do with the Constitution, unsure. We have never had in this country a government that is so out of control and tyrannical that people arbitrarily feared for their lives. Some horrors, of course: slavery; internment of Japanese-Americans during WWII. High-trust society. Regular elections. Two houses of Congress; three branches of government. Not a dead letter. But some parts are dead letters: Article I, Section 8--specifies very limited powers granted to Uncle Sam--no way one can plausibly read Article I, Section 8 and conclude that Uncle Sam should be in the business of building airports in Murtha's home district or bridges to nowhere in Alaska. Legerdemain, play with words--clever lawyers and politicians do. Fair reading of the politician, mindset of James Madison and the Framers of the Constitution makes it clear that they did not envision a national government with vast powers, who could only be stopped from acting when you found a prohibition in the Constitution. They envisioned a government that would be stopped from acting always when it got beyond those powers enumerated. But they lived a long time ago. The claim would be that they were wrong. All these expansions of government--social welfare, social spending, Social Security, Medicare, Medicaid, the welfare state--most Americans generally support; the regulatory environment we live in, from the Food and Drug Administration (FDA) to the Environmental Protection Agency, most Americans would argue these are all good things. The fact that people support these things does not make them wise or good. The idea of a Constitution is to create a government that is not tightly tied every moment to majoritarian passions. Example: Medicare. Medicare is going bankrupt. Most Americans support it today--concept called rational ignorance--because they don't really know what the situation is. Medicare recipients are getting their payments. The future generations are being taxed to pay for those, and that bill is coming due. Even young people don't look 10, 20, 30 years into the future with any clarity. If you are 70 or 80 and someone tells you Medicare is going to be bankrupt in 2035 or whatever the year is, you might express horror but you don't really care that much. You want your check, your pharmaceuticals and doctor visits to be paid for. Same thing with Social Security. Much of what government does today gets enacted and stays enacted and even gets approval because the collective nature of what government does means that people don't know the full consequences of the nature of the programs that they support. |
| 31:37 | Rational ignorance. First, the term sounds weird. Surely ignorance is always irrational. All it means is that knowledge is a scarce good. It's not free. If it were free, each of us would be geniuses and fully informed of everything in the world. Huge amounts that we don't know. A few years ago went to the library, to the government documents section, and found the annual--2003, 2004--Code of Federal Regulations (CFRs). All the regulations promulgated by the Federal bureaucracy, most of which have the force of law. Measured the amount of library shelf space that the Federal regulation takes up: 26 feet of library shelf space. And that wasn't all of the regulations, since some of the regulations were confidential, top secret, national defense. Eight yards, almost a first down of regulations. Published every year; each annual set contains all of the past regulations that are still in effect. Printed on thin paper, many double-columned. Closed eyes, randomly grabbed a volume off the shelves, wanted to see if I knew what was in it. Turned out to be from the Department of Agriculture. Opened it at random, put finger on random page; regulation set up the Southwest Texas Lettuce Growers' Association. That's correcting a market failure--that's what government does. Government does so much it's impossible to know it all. Idea that when people go to the polls they are knowledgeable is ludicrous. Rational to not be informed: time is scarce. Gaining knowledge takes time. We need leisure from time to time, we have jobs to do, families. Romantic view is of people in togas sitting around in Greece or Rome. At the margin, most people do and should spend their time attending to those things that affect them most directly; you'd be a poor father if you spent your time learning about regulation. In private market, when you go to buy a gallon of milk, the decision is yours; you have an incentive to know for each market transaction to gather as much information that you think is requisite given the size and importance of the financial transaction. No voter will have a discernable effect on the outcome of an election. People want to believe that every vote counts. Journalists. Russ votes--Don doesn't--understands that outcome of one vote is immaterial. Journalists taking class laugh; then anger, something un-American about it. 2000 election; 1960 election--dozens or hundreds of votes determined election but even if you had stayed home that day it wouldn't have affected the question. But what if everybody had stayed home? They don't. Just asking the question: what is rational for you to do as an individual? Spend time reading to your kid or should you vote? Nothing is accomplished by an individual vote--percentage difference between the candidates not measurable by a hundredth of a decimal point. Just a fact. Can debate how it should affect your behavior; but it's a fact. Moral duty to vote? Scientific point remains. Could argue that in a small town, very small numbers, perhaps some election has been determined by one vote or a tie. Follows from that, that at the margin, no voter has strong enough incentives to gather information about the candidates as that voter would have if that voter truly believed him or herself to be the decisive factor. That's what is meant by rational ignorance. Don't have to like the fact that Don doesn't vote to agree with that point. There is a reason why in elections that the signs say very little. Blue background, name written in red with stars; another candidate's sign has a red background, name written in blue with stripes. May indicate whether the person is Democratic, Republican, or Independent. Voting is not at all analogous to choices made in markets. Not in a moral sense but in an analytic sense, it is a much more ir-response-ible act. It's a feedback loop. There is not that individual feedback loop in the voting process. If you have a family of three kids and you buy a sports car, you are going to find out that that was a bad choice. Most car buyers, unlike most voters, spend a lot of time reading a little bit, test-driving a car, not just the name of the car flashed on the screen; though there is brand name. |
| 42:10 | Feedback loops in market decisions, rational ignorance is undeniable. More fascinating: You get a phenomenon in politics you only have somewhat in markets. You buy the sports car and you then you brag about how great it's performing as a carpool car. You are oblivious; and you keep buying it. You can buy a cereal you don't like, you make lots of mistakes; but you usually stop buying cereal that makes you nauseous; you buy the flavor of ice cream you like. But in politics, you can keep buying the same flavor over and over again; it doesn't achieve its goals; it impoverishes the people you think it's helping, and you can be a proud supporter of that candidate forever. Even after they are dead. You can be oblivious, no incentive to look deeply into whether that was a wise choice. Part of your identity, your reputation, your self-esteem; very different process. One criticism that those who don't vote get is: you are not a good citizen; you are falling down on the job. But not falling down on the job; spend a lot of time most of it for free, blogging, contributing thoughts. Thoughts may be worthless, but certainly actively engaged. More productive if took the hour and half to cast a vote or thinking deeply and seriously about some issue and writing an op ed or blog piece about it? The latter. Might have some effect; more feedback, chance of being challenged. If you vote like a moron, there's no cost. Expect angry emails. Might be a personal feeling of guilt. You don't even know if you are a moron. If enough people vote moronically, will get moronic candidates. It is true, of course, that if a bad candidate is elected, and that bad candidate puts in place bad policies, those bad policies later will hurt those who voted for the candidate and also those who voted against that candidate. The point is: at the time of voting, that act--and it's the individual act of voting that we're talking about--there is no consequence to anyone of voting A, B, or not voting at all. Therefore, people are quite unconstrained in being able to express whatever fantasies, romantic notions, anger that they feel. Another underappreciated aspect of voting for candidates--understood by public choice scholars but underappreciated by the public--underappreciated because it's called the people's "choice"--we choose. By attaching the term "choose" or "choice" to candidates and the process of electing candidates we transfer to that choice process the same good feelings we have about choosing in a supermarket. Too much difference between those choices for the political process to have that good name. If I see you go into a supermarket, Safeway, and put into your basket a bottle of wine, a turkey, some paper towels, but not diapers, cleaning fluid, or bubble gum, I can be pretty sure that for that shopping trip you wanted the things you bought and not the other things. But each candidate is a bundle, a whole cart. Like walking into a supermarket and seeing two or three pre-filled grocery carts behind plexiglass. You get to look inside; Cart A has wine and turkey but not paper towels but has diapers; Carts B and C have some things you do want and others you don't want. Could only be half a roll when you get home. Suppose you choose Cart A. We can conclude you preferred Cart A to Carts B and C, but we cannot conclude anything about the individual components. Bundling problem. Each candidate has a position on taxes, environment, abortion, etc. If a majority of voters vote for candidate Smith over candidate Jones, no one really knows if the voters chose candidate Smith because of his position on taxes or in spite of his position on taxes. But candidate Smith will believe that every position he took in the campaign was wanted by the voters. |
| 50:43 | Worse than that. The cart's really big. You can't see a lot of the things in the cart. You are stuck with some of the stuff in the cart. Making it worse is that there is a lot of stuff in the bottom of the cart you didn't know about. The diaper manufacturers asked the grocery to put it in the cart. Rent-seeking. We might like the idea that there's a best way to teach kids how to read; but if the Federal level decides--a whole lot of people with No Child Left Behind just happened to be really good friends of the Bush administration. It's possible that was the best reading material, but suspect not. What you get home in the cart is not necessarily the stuff resulting from people sitting around asking what is really the best. Minimum wage legislation--the name makes people think everybody is guaranteed a minimum wage. But you are only guaranteed a minimum wage if you work. A lot of mislabeling; a lot of changing after the fact. The first George Bush said famously in campaign "Read my lips: No new taxes." A few years later he raised taxes. Taxes in your cart. Critique: This is a cheap shot at democracy. Any candidate has a wide range of views. Inevitable reality that it's an imperfect process. I get some stuff I like, you get some stuff you like. It's a straw man, like complaining about gravity because it makes cars burn too much fuel. Flaws are inherent in democracy. Two responses. First, too many people are not as aware of these flaws as they should be. Journalists' reactions. Pointing that out: it's good to know what's true. Second: the choice we face is increasing the size and scope of government a little more or decreasing it. Which direction should we head? If overly romantic view, bias. There are alternatives to government. We don't need the government to determine the size of our toilet tanks. Now that's a collective decision. We don't need the government to decide whether or not we can purchase goods imported from foreigners--but we turn it over to the State. Even with a core list, not going to be perfect; but the magnitude and ill-effects of the problems will be confined to a smaller space. |
| 57:44 | Another metaphor, heard ten years ago in talk by Don Boudreaux: What if we chose our cars the way we chose our politicians? Variant on the grocery cart example. We're all going to drive the same cars. Why is that a bad idea? We could have candidates. Get rid of the problem that candidates break their problems. Candidate A proposes a minivan; Candidate B proposes a sedan; Candidate C--usually aren't three viable--sports car. You are not allowed to drive the cars as the voters. You can listen to it honk it's horn, look at it from the outside. Can make a pretty good vote. With four kids, might vote for the minivan. Won't be the best minivan, but if my candidate wins, at least I'll get a minivan. With rent-seeking, hard to find out what the features will be. Don't want kids to watch TV in the car, but manufacturers might lobby for it. I might not win. Why such a horrible outcome? Making that decision collectively costs me. Yet we do that with education, with so many aspects of our lives. If we are doing it that way, there are things that are good about it. The central point is: Is this a decision that should be made that way? Government should do for us what we cannot do well for ourselves. Picking out a car isn't one of them; Cash-for-Clunkers isn't one of them. Can make an argument for them. People should understand how government really works rather than some romantic, rose-colored way. The rose-colored way is the dominant way government is viewed. Is that true? Most people have a very low opinion of Congress, of politicians: lying scoundrels. People blame the individual: Let's vote the scoundrels out. Congress selects for a certain type of person, as most occupations do. The problem, chief problem, isn't with the nature of the particular people in office. It's with the incentives voters face in electing them and the incentives the politicians face when in office. Voters focus on personalities. Voting celebrated as mystical collective experience, sacred act in people's lives. Nothing more sacred about voting for a Congressman than buying paper towels at Safeway. |
| 1:05:10 | How might we get there from here? Given that many people have this romantic vision? Viewpoint: If something isn't as good as we thought it should be, we ought to spend more money on it. We never do that in the private sector. Nobody says, if we want better cars we should write some donations to Honda and Ford--bad example. Everybody understands that that set of incentives is misaligned. But people say spending more money on public schools is good. Health care: people complaining. We have price controls on health care: the government already controls every aspect and price in health care. How do we get to a different outcome? Given that you don't vote? Work to build through the promulgation of ideas and by example: freedom and liberty. If that culture is built, it will be reflected in the political process. If people want to be led by the nose, they will be. May be that we can't get there from here. |
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| 0:36 | Intro. [Recording date: February 24, 2010.] Fieldwork and the sample. In the middle of the 1990s got interested in the lives of the working poor--so much of the research in the field on poverty focused on those who were part of the welfare system, which has never been popular even among those who are on welfare. Feeling was that sociologists and economists as well had ignored the large number of poor people in the United States that work for a living. Living on upper West Side of New York, on the edge of Harlem, evident that people in Harlem were going to work in large numbers. Statistical examination of central Harlem showed that at least 2/3 of the households in Harlem had at least one worker in them; but still very poor. Who are these people? what is the role of poverty in poverty? Studied a sample of people who worked for a large and to-be-unnamed fast food chain, service sector in Harlem. Followed 200 some odd people who had jobs there and another 100 who had applied for those jobs and failed to get them. First book, No Shame in My Game, made use of survey data, interviews, and very detailed studies that took more than a year to gather the data for--a handful of people emblematic of the study. Representative of people in the low-wage sector, primarily in the fast-food industry. By the time finished with book, welfare reform bill had passed in 1996; question of what would happen over the long run to the nation's working poor more vivid in people's minds. What happens to people in this kind of labor market over time animated the next book, Chutes and Ladders. Wanted to know if you entered the labor market in a job like this, was it true that it would be a dead end, or were there mobility possibilities? Could go down, too. Don't see a lot of 60-year old cashiers, so probably don't stay there forever. Stay there longer in Harlem than on Long Island. Labor turnover in high unemployment areas is much slower than in healthier labor markets. Second question: what would it mean if you had thousands and thousands of people coming off the welfare rolls coming into that market? Would the people working there to begin with be hurt by this flood of new entrants to the labor market? Second question similar to what people worry about with immigration, new, ongoing, or continuing group of what appears to be competitors--what's the impact? This is a related issue. |
| 6:04 | Book is very poignant, nice mix of narrative with fact. Try to summarize--though each person's different, charm and power of case study. Contrary to expectations at the time, most of the people in the study did very well. About 1/3 no longer poor at the time of the final followup, eight years after research began. Period intersected time of strongest labor market since WWII--late 1990s and right up to about 2001, record low unemployment, high growth, low inflation. Perfect weather, as opposed to the perfect storm. Almost uniquely good time; kind not only to those at the top end but for people at the bottom. Suggested that some of the dominant language of the time--that these people were damaged, didn't know how to seize opportunity, intended for the low wage labor market was incorrect. Purpose of first book was to describe the pathways. One pathway was when labor markets tightened, the firms they were in began to grow. Growing even in inner city neighborhoods. Fast food agencies were expanding, creating new shops, pulling employees off the floor and promoting them into managers as the firms grow. In a high-growth industry, opportunities open up even at the bottom. Even if those are short job chains, which is characteristic of service sector employment, if there are new establishments opening up there will be much more opportunity than there would otherwise be. Short job chains? Not very many rungs on the ladder above your head. Service sector industries tend to not have a lot of promotion possibilities relative to other industries; but if there are many establishments opening up, managers needed to monitor the labor force. That was one route to mobility. Another route--education or training--the route most economists rely on. Interesting: the range of skills, institutions they attended. Economists often think high school, college, graduate school; but there is a lot more educational opportunity out there for people with low skills. Example: one young man worked for the fast food firm for 3-4 years at least, during which time he attended a trade school where he got a certificate in refrigeration and air conditioning. Quite costly--around $3500 to get that credential. Once he got it, he could earn four times the hourly rate he'd been earning before. How did he afford it? Those workers fortunate enough to live in households where someone else could take care of a cost of living--roof, food--were creating a financial aid system out of their earnings. He lived with his aunt and uncle, who didn't charge him room and board; he could take all the money he earned and put it toward this certificate. The day he finished was the day he quit his fast food job; went to job fairs--field team did with him--and picked up job in refrigeration. Human capital route; firm expansion. Some of the workers were not actually doing better, but the composition of their households changed, so the mobility of their families was more positive than in the past. Can happen when workers marry, or when children get old enough to enter the labor force, when the ratio of workers to non-workers in the household changes. |
| 12:48 | Quote, F. Scott Fitzgerald [not Hemingway]--the rich are different--they have more money. On the surface, fact; having a lot more money has a lot of implications. The poor are different--they have less money. Huge part of their problem; but compounded by family issues, drugs, cultural challenges, racism--panoply of challenges and hurdles in book. Examples: One young woman in study had a son about 2 years old; didn't earn enough money to pay for childcare. Earning about $.25 more than the minimum wage at the time. Only way she could stay in the labor market was to get her mother, who had been on welfare for decades, to watch the child. She was able to get her mother to do that; mother expected to be paid something to do this, but a lot less than outside childcare would have been. Could stay in the labor market and create a steady work biography that is important to employers. Who will help you and who will not help you really make a difference in a low-wage economy. The woman ends up using her grandmother as a babysitter--who is cheaper. Moving around, looking for the best deals within her family circumstances. Other families have no money changing hands; other folks working literally 24 hours a day--8 hours on, 8 hours looking after someone else's child, 8 hours sleeping, and everybody transferring themselves around those requirements on a 24-hour basis. If you didn't have people who will help you, impossible for you to stay in the labor market. People who step out look very checkered to the next employer. Steadiness depends a lot on your family circumstances. One of the workers doesn't step out of the labor market a lot, but moves a lot from job to job, partly because he has trouble staying employed--anger issues, messes up--but always able to find another job, till end of story ending up with a radical move. If you are only on each job for 3 months, it doesn't look good. Talking about Jamal (not real name), who is an African American, about age 23 when first met. Had always worked since age 13, but didn't keep jobs for very long; had a temper; didn't like being put at the bottom; but almost never without a job. Defining characteristic of the working poor--rarely unemployed but didn't always have jobs or work patterns that were very stable. In the late 1990s when doing this study, it was quite possible for someone like Jamal to job hop. Much harder now. Economic conditions surrounding a job seeker or job holder make a different. In some parts of the country, Massachusetts for example, unemployment was down to around 2%--so low that employers were lining up at prisons, trying to get men coming out of prison on training courses when they were inside and hiring them as soon as they got out. |
| 19:09 | Right now very high unemployment relative to the 1990s, or even relative to the 1980s when things improved after a bad recession. Mild recession in early 1990s, mild one in 2001, and a bad one now. Right now the unemployment rate is very close to 10%--9.7% at this taping in February 2010. A lot of people believe that's understated because people have given up--you have to answer the question to be counted as unemployed. Pattern within that high unemployment rate--varies tremendously by education--and income, but that may be misleading. Education: if you have less than a high school diploma your unemployment rate is much higher than if you have an advanced degree. Sure that was true in 1996 or 1998. Even though the labor market was booming, growth; but among people who had little education, wasn't the unemployment rate--the measured unemployment rate--still fairly high? In book: Even in these good times, employers turn down 12 out of 13 candidates for the fictionally named Burger Barn. That figure comes from the period before the boom, the beginning of this study. In the beginning of this study, 1992-1994, unemployment was very high, particularly in Harlem--18% measured unemployment. By 1997-1998, record low unemployment rates, even for Harlem. Don't disagree that unemployment rates higher for lower education groups--always been the case even when very lower unemployment. There were people who would be regarded by employers at bad bets; but at this time even people coming out of jail were looked at, partly because the alternatives were moving up the ladder. Best of all possible worlds was being looked at. When started the followup, only looking at what would happen with regard to welfare reform. Nobody knew there would be an economic renaissance. Just landed on top of study. Interesting that study happened during a period of prosperity, though, because it reveals the limitations of a cultural argument that says the reason why people don't do well is because they are not motivated, uninterested, poorer skills, no experience, etc. They don't understand the work culture. That can't explain how it can be the case that almost overnight unemployment falls through rock bottom and you start to see young black males, who are usually the cultural end of the caboose--the cultural argument doesn't work very well to explain how such a dramatic change could happen almost overnight. Poignance of stories--Fitzerald/Hemingway thing. Presumably there are people who are worse off than the working poor, perhaps even worse off because they don't have the cultural savvy. Certainly are. Can't claim any expertise in this book about those who were out of work or looking for work. But, the proportion out of the labor force was so tiny, not worth wasting the paper to write a book. The groups that really do matter as social scientists or policy analysts, are people who are or have been part of the labor force, and that is about 98% of the adults in the country. For those who didn't do well--study half-empty/half-full--there were certainly people who did not do well. Three groups. High flyers: people who did very well, did better than they or Newman ever expected. Some making $50,000-$70,000 a year because they got that certificate or switched job to FedEx. Fourth route to upper mobility was to find a unionized job. Very important to these workers. Some found public sector jobs that were unionized, city or local labor force that was really the holy grail for many of them--civil service job. Others found jobs in unionized jobs or in shops that were competing with unionized shops for labor and had fairly good wages and benefits packages. But unions are declining steadily since about 1950 as a percentage of the labor force. Unions were important--critical for those who found those jobs, but going the way of the dinosaurs. Not common in 1997 either. Don't know which way causation runs in that story. How many--roughly--high flyers were in those union jobs? About a third. So, high flyers, then middle group: people who had made headway, ahead of inflation, but not much. Secure but not really secure. Better off, would have said they were better off; moved from fast food into retail, had jobs that were less dirty, less despised, more prestigious. But if they were doing better, it was probably because they married or found a partner. Had to be something else going on in their household because their wages didn't shift that much. Didn't fall behind, but weren't earning that much more; wouldn't be able to make a huge difference by themselves in their material standard of living. Then there was a group at the bottom that really was in trouble. Skidding along the bottom, often with depression issues, alcohol problems, often derailed by illness--health insurance issue becomes very poignant for them. Often derailed not by health for themselves but by someone who needed to be taken care of--a kid, a parent. Very fragile situation with regard to access to health care. In and out, in and out, in and out. Don't want to talk a lot about the high flyers--no one expected that. |
| 29:25 | Role of information. Some of the people are extremely savvy about how to take advantage opportunities in the welfare system. Medicaid extremely helpful to the poor. Did the folks who didn't take advantage of those opportunities not know about or not qualify for government aid? Second question: The guy who found the refrigeration opportunity--the people who don't to that, is it because they couldn't get the $3500 or because they didn't have time or the opportunity to find out about those opportunities? Good questions--a little of each. Being savvy is partly about having skills in gaining information and having networks to exercise those skills with. People vary in the quality and range of their networks. Mainstay in Sociology: weak ties really important. Strong ties--people you know very well, who occupy a niche in the world similar to your own--versus weak ties--more diverse, range outside of your social niche and have information you don't already know. Sociologist Mark Granovetter at Stanford: studied job search behavior and noticed those who have extensive weak ties did better than those who had mainly strong ties. His explanation: information travels better in weak networks if you can activate them. Like a portfolio--you need some diversity. Found that there were people in the study who had the kind of ties Granovetter was talking about, positioned in different industries in theory. But in practice, the ability to get someone to do something for you is very uneven. Sandra Smith, Berkeley, book: Lone Pursuit: what causes social parties to activate on behalf of their job-searching friends? Was grad student at the time. Workers are very doubtful or dubious about recommending someone for job openings unless they have enormous confidence. If they think that person is going to embarrass them or reflect poorly on them, or do a bad job and ruin the recommendation of the recommender, they won't do anything for them. Universal phenomenon. But it has a lot of profound consequences if your only options for job-finding run through networks; there isn't going to be anything else--no job bulletin that will help you or a career day on your campus. Uniquely reliant on your social network. Same thing applies to something like Medicaid. There are people who are very good at finding out information from their fellows; and Medicaid information tends to travel along these lines. One fellow in story, pregnant several times; got really sick during pregnancy, hadn't seen a doctor at all; finally her aunt pulled her aside and said "Listen, honey--you are going down to the Medicaid office right now because you need to go to a doctor." Combination of not knowing, not wanting to think about it, not wanting to be stigmatized that had led her to not do this on her own steam. In the end she did because she was so afraid of losing the baby and they were able to help her. Partly your aunt takes you aside and tells you how your mother in law knows something you don't know. Insertion of a network in between. Getting a certificate--lack of money or information--usually both. Money is a huge barrier. Huge barrier for going back to school. Surprised at how much more education the sample had received in the 8-year period studied--well over half beyond school age at the point of beginning the study. They got GEDs at a high rate; got college degrees even though it took them a long time. Couldn't go full time--went part time and work, or drop out of school and work; but they really wanted to be in school. Created their own financial aid system. If you take 15 years to finish your degree, you will reap benefits that really make a difference for every year; but lack of a diploma affects you for a very long time. |
| 37:26 | Turn to issue that runs through the book: Edmund Phelps podcast: nature of work in America, satisfaction we have from our jobs. In this time period, in the last 25 years in general, huge increase in knowledge workers, people using their minds in interesting ways. Opposite end: people punching in with pictures of a hamburger on it. Closest to Charlie Chaplin in "Modern Times." Not very stimulating. But even in that environment, talk about the nature of work--people talk about the pleasures and things they learn. We don't just care about the amount of money make--obviously it matters a lot, and at the low end you want to make a lot more rather than less, but one of the themes of the conversations is the role of pride, satisfaction, prestige. How important is that to the people you talk to? People talked about being autonomous on the job, make their own decisions instead of being constantly micromanaged, criticized by their boss. Being a worker--any kind of worker--is valued by society. Alternative is to be totally outside the status system in our society, to be completely devalued. No occupational identity end of social universe. Below them--and they know plenty below them--those people are despised. Above them, plenty of people who have jobs above them. Suspended between these two categories. Superior to those out of the labor force. Resent that they take their income and support a welfare system, including those in their own families watching over their children. Look up the system; they will not be a teacher or lawyer. Tense limbo between those two extremes. Just being in the labor force matters. Pride in having a job. At same time, cover over uniforms on hot day; commute incredibly long hours to take a job because they don't want to be seen working in this kind of job. Weird kind of pride mixed with embarrassment when you work at the bottom of the labor force. And one of the things about this kind of job is that you are heavily surveilled. Don't have a lot of autonomy. Nonetheless, people do take a lot of pleasure in the fellowship of the workplace; though sometimes horrible personality clashes of course. A lot of the people would socialize off the job with the people they were working with. Drawing away from the people in their neighborhoods. Instead spending almost all of their time with fellow workers. Argued in No Shame and My Game that that is an important element: glue into work world, away from the streets. |
| 43:30 | Distinction in book: people on welfare, who are draining cash, sometimes directly from the working poor; and people--underground economy, drug dealers, making a lot of money. Tension between that job--it is a job! just not on the books--and the fear people had of it because of association with whole set of pathologies. Most of these folks have siblings or neighbors in the drug trade. Basic view: This is scary; It exposes everyone around you to tremendous risk; Stay away. Don't know what the sociologists have studied and published about the drug trade--that the drug trade doesn't actually make very good money. They do think it's flashy. It is flashy for a tiny number of people. For most people in the drug trade, it's risky, it's dangerous, and you don't make much money. You die young. You die young or you are below the minimum wage. They mainly didn't know that. They mainly thought: This is too scary I don't want you coming around. But these folks do come around. Truth. Important to know those people--the people you really have to fear are strangers. Strangers have no obligations to you. But someone you've known all your life, even if they are doing drugs and you are not, will be more respectful of your safety. People in other parts of the informal economy are a different story. People move in and out of the fast food jobs they hold later on--unregulated, informal sector of unlicensed, skilled work. Examples? One young man taken under the wing by his dad, who taught him how to do electrical work, plumbing. Handyman stuff. In Harlem, you don't call a unionized plumber to fix your leaky sink! It's expensive. Whole cadre of people doing work off the books, but not illegal. Not licensed. Cash business; and some barter; but mainly a cash economy, but not a licensed one. A lot of men do car repair the same way. Repair work basically out their home. Fix radios. Shadow economy, but not illegal in the sense of the drug trade. In the formal sector, they would regard those folks as working. They have real jobs. Just not paying taxes. Often providing more than you can do and providing satisfying work. Very skilled. But in order to do that, someone has to train you. Will your Dad train you? Certificate like the refrigeration guy, or will someone show you how it's done? |
| 48:17 | Ideas from the book; bias. Social issues: short run problems, long run problems; short run solutions, long run solutions. Bottom up versus top down: agree or disagree, confirmation bias. Three policy conclusions: Importance of growth for the economy as a whole. Good years, American economy growing, great moderation, mid-1980s or so, good policy goal. Number two: making our schools better. Our school system is not very good, how to make better. Number three: access to capital credit: the guy who wants access to $3500 doesn't always have an uncle who can make that happen. Maybe not a bad idea like in Africa, Asia, for people to have access to small loans to be administered in some creative way, perhaps not by the banking system. All important points. First growth. Study took place in period when economy was growing so fast. Study at any other time wouldn't likely have found the kind of mobility. Really very little we could not do if we have full employment. Jobs critical for every aspect of life. Nobody seems to know how to do that right now. About schools: an amendment. These people know that school is important. They are putting effort into going back to school. They don't come from good schools. If they had the resources to go to good schools, they would, but they don't. Money matters here. Access to credit matters as much as access to financial aid. The faster you complete, the faster you reap the benefits. The quality of schools matters; but most of the people came out of some of the worst high schools in New York City. They still managed. If we wanted everyone to turn into a rocket scientist--but what they needed most of all were teachers who respected them, teachers who treated them like adults because they most often feel like adults before middle class students do, and often hold them to high standards; people who take them seriously; and taking them seriously. Mary Britain [sp?] from Harvard--run away from dangerous zone schools, street violence, in between their home and their school make it hard for them to go to school. Selection bias. Their original motivation isn't school quality--they just don't want to be knifed in the hallway. How is it that we permit and turn a blind eye to students? Safety, stability, and financing all of these things matter. In terms of access to capital and credit. Book: The Missing Class. People who use credit cards are usually not at the very bottom--usually one rung up. Not so good for them. The near poor--upwardly mobile; economy got better, or find themselves better. They find themselves working in better jobs and suddenly think they don't want to find themselves sitting on a couch with holes any more. But their wages aren't actually high enough to permit that, not on cash. Start using credit; get into terrible debt. Can permit them to stay in school, but tend to be averse to loans. A lot of economists trying to figure out why, but they tend to be averse to loans; afraid they won't be able to pay it back. Good thing to worry about. But they tend to drop out of school instead. Credit figures in their lives as credit cards. Don't understand how much it is costing them. Bankruptcy laws have changed in ways it makes the costs much greater. |
| 58:32 | Interviewed hundreds of people, used graduate students. You must have gotten to know these people. Book so rich! Do you stay in touch? Stayed in touch for 8 years. Panel study for income dynamics. After 8 years, have to finish sometimes. A couple of occasions, catching up on some things. Other things. |
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| 0:36 | Intro. [Recording date: February 19, 2010.] Why book title Bailout Nation and how does that relate to the financial crisis? Title coined by Bill Fleckenstein, did forward for book, author of Greenspan's Bubbles. Concept: we had turned from, at least the mythology of a nation that was very independent minded, pick yourself up by your bootstraps--a land where anybody clever who worked hard could make something of himself. Went from that to a group of overpaid bankers, coddled and rescued from their own folly by the government. Perfect fit for what was taking place. Not a nation that studies a lot of history; book traces that history. A lot of people think it started in 2008 with the rescue of Bear Stearns. Goes back longer. Look at universe of bailouts in two ways. One thing if you are an extreme skier and you go out into the back woods and get in trouble--you took on the risk yourself. Different from people walking down the street and a building falls down, earthquake. People in trouble through no fault of their own and those who elected to take a risk, to be aggressive, speculate and run into trouble. First real bailout, where government says you behaved in aggressive behavior and got into trouble, and if we were truly a capitalist nation you would suffer the consequences of your own folly, was Lockheed--1971. They knew their way around the government, around government defense contracting. They had tried to get into building private sector planes; overextended themselves; built a couple private-sector planes that weren't well regarded in marketplace. Found themselves in precarious liquidity positions, running out of money; yet they have all these big government contracts--during the time of the Vietnamese War. Went to the government and said if you don't give us a loan, we're going to go bankrupt and how is that going to help your war effort? Close debate. Might have been one where the Vice President had to break the tie. Recognized that it was not business as usual. William Proxmire, very conservative, coined the phrase "corporate welfare" to describe the idea. Unconscionable to think that a company in trouble would go to the government. One of the justifications was: It's only a loan. Expect to get it back. They did get it back; turned out to look like it was not a big deal. When you make law, policy, govern the nation, idea is to be broad and pass rules that cover everybody, not to carve out specific exceptions for connected companies whose management is close to some elected official. Why not loans to Grumman, Rockwell, Northrup, other competitors? Giving a strategic advantage and disadvantaging everybody else. Any time we look at government actions, government is essentially picking winning and losers. Great if you are in the winning pile--got a big tax rebate or mortgage modification. But if you are in the losing pile, who was practical and put 30% down, those people are in the losing pile. Best example: if you are a first-time home buyer and prices remain elevated because of all the government subsidies, you are the loser and the existing homeowners, who you overpaid, are the winners. Lockheed perfect example: they won, got low interest loan they wouldn't get from the private sector. Also create the incentive for rent-seeking--rather than trying to make better airplanes next time, might as well just go to Washington. Moral hazard: encourage more and more of them. |
| 7:12 | The next one--Chrysler. A couple of minor things in between. Continental Illinois--1984; not minor. Railroad issues took place in the 1970s. Chrysler was a sea change. You'll notice that these things tend to happen in election years. Lockheed was before the 1972 election; Chrysler was before the 1980 election. Not a coincidence it was a swing state, could have gone either way. End up with this icon of American industry that through a series of really bad decisions that go back to the 1950s--bad cars, bad design, bad union contracts that they had--Big 3, or "Big Two and a Half" as referred to by Barron's at the time, the half being Chrysler, signed contract after WWII, millions of GIs returning home from war. Instead of risking a strike or falling behind in production, GM, Ford, and Chrysler signed a very generous contract with the union giving strong health care and pension benefits, guaranteed jobs; never perceiving what would happen at the end of the baby boom. Took about 25 years before the effects were widespread. Combine that with the price of oil spiking in the 1970s and you have a recipe for, as Warren Buffett said: The tide goes out and you can see that no one is wearing a bathing suit. Of the Big 3, Chrysler had the worst cars, structure, balance sheet; teetering on the verge of collapse. Government didn't make the loan, but they guaranteed the loan. Again it got paid back. Russ started teaching in 1980; student did a pencil drawing of Lee Iacocca with legend "Our Hero"--sarcastic. Iacocca efforts to keep out Japanese cars. Continental Illinois decision--1984. Let's talk about Chrysler for one more minute. Counterfactuals: we don't have access to an alternative universe; have to hypothesize: ask what would the American auto industry look like today if instead of being rescued, Chrysler were forced to go through the difficult process of bankruptcy reorganization, perhaps even liquidation. Everybody stops and says, would have lost a couple hundred thousand jobs. Here's what we know happened. From 1980 till two or three years ago, the United Auto Workers Union (UAW) went from a million and a half members to, today, under 300,000; the Big 3 auto share went from greater than 75% of the U.S. market to now under 50%; ultimately GM and Chrysler had to file bankruptcy in 2009. Which we are still paying for. Counterfactual: If we would have said to Chrysler, you are doing a lousy job, and while we are concerned, what we should do--the most the government should do is say you are a significant player, you should reorganize; and if you liquidate and cannot find private sector financing, we'll match the private sector financing. Warren Buffett. Had Chrysler gone through that process, we know for a fact they would have gotten out from the onerous pension and health care obligations. We can imagine that it would have put the fear of God into the senior management of GM and Ford--though they might just have snickered at Chrysler. Perhaps might have made the UAW more interested in negotiating less of a Detroit- and more of a Silicon-Valley-type of contract with less guaranteed benefits and more stock options, so that the employees participated more in the upside, incentive to do a good job. Instead, just kicked the can down the road. |
| 14:10 | Continental Illinois, first large financial institution rescue. Highly leveraged bank making a lot of risky bets with other people's money. What a shocker. Observation: they didn't get bailed out per se. It's their creditors who got bailed out. In the United States, we bail out creditors. Sometimes we let the firm fail, but we almost never let the creditors go down. That encourages creditors to be riskier and less prudent in their loans. Continental Illinois goes down in 1984. Next: 1998 Long Term Capital Management (LTCM): how much weight? Background: Highly leveraged firm--meaning using other people's money, borrowed money, to make risky bets. Leverage: extremely leveraged; plus little air of mystery. Before quants were as well-understood as they are today, previous to black-box trading being as ubiquitous as it is today. Nobel Laureates with very clever model managed to find small anomalies, small inefficiencies, and arbitraged them away; made a lot of money in the beginning. Got credit at cheap terms; lenders hoped to be able to imitate that. Mean reversion--we there are these relationships with different asset classes, so when this relationship gets too far out of whack, we'll just take the other side of the bet. If you are doing it with leverage, you have to hope you are taking that bet just as the stretched rubber band comes back to position and not before it keeps stretching. They had deployed so much leverage and bought so much esoteric--Russian--bonds that were really small, tiny odd little things. Buy a 10 or 30 year Treasury note, very liquid. If you are going to buy a small, thinly traded note that there is not a buyer or seller for, when you go to liquidate that position you won't get anywhere near the bid price. Will go from $100 to $20. LTCM was an opportunity to send a message to the marketplace. Beanie Baby hedge fund syndrome: if you choose to not buy stocks, bonds, options, futures, commodities, things that are easy to trade, then we're not going to rescue you. Imagine a hedge fund set up to only buy Star Wars collectibles and Beanie Babies. That's what LTCM did. Why should the NY Fed stepped in to save them? Had they not done that, it wouldn't have been fatal; would have punished the companies that made bad bets. A billion here, a billion there, would have been painful knee-skinning. Two questions about LTCM. First, the firm that didn't get rescued. Idea: Moral hazard helped create the crisis, but then have to deal with two things, one related to LTCM and one related to Drexel Burnham, which does not get rescued. They went bankrupt; world didn't end. Unpleasant, skinned knee. Been suspected that the head, Joseph, was despised by Nicholas Brady, Secretary of the Treasury--claim of James Stewart. Weren't rescued, was a signal that some folks might not get rescued. LTCM wasn't exactly rescued. Fed orchestrated it: all who lent money to LTCM, rather than go bankrupt, figure out how to keep them afloat for awhile so there aren't big consequences, big collapse, perhaps not. The creditors themselves played the role in the rescue. The Fed orchestrated it, brought them to the table; weren't happy that LTCM might go under; not entirely voluntary. The firms that were involved did pay a price. Fair assessment; didn't pay much of a price. Distinction between LTCM and Drexel--criminal investigation into Drexel, Michael Milken, insider trading scandal. Drexel not perceived as a warning against speculation, but as if one of your senior guys gets caught doing something illegal, you are at risk. Not a publically traded company at the time; irony of Drexel is at the time they were the fifth largest investment bank, which is what Bear Stearns was. The difference between the two--no allegations that Bear Stearns was doing anything illegal. Company caught in huge scandal; trading partners said they didn't need this. Milken was the big rainmaker there. Look at it as a whole separate animal. Right that the bailouts primarily have served to rescue the creditors. Bear Stearns rescue: bondholders of Bear made 100% whole. Lehman becomes a weird exception. Insular chief executive who had the opportunity to rescue the firm and blew it. Warren Buffett made an offer: would give $2 billion, terms were better than what he ended up doing with Goldman Sachs and GE--by then the crisis was more dangerous. Not just from Buffett; would get more from others if Buffett gave them some. Bernanke, Paulson--view of Buffett's offer being turned down. Fly on the wall. What they then did wrong: let's do a controlled bankruptcy. Could have done something similar with Lehman. |
| 27:26 | Kind of tried with Lehman. Different theory: what the government did with Bear Stearns--we don't want them to go bankrupt, so to make them attractive to a suitor, guaranteed what ended up being $29 billion worth of assets that perhaps aren't worth very much, to make it easy for JP Morgan Chase to acquire them; and they did. With Lehman, tried to do the same thing, but wouldn't give that guarantee. Barclay's, regulator, Bank of England, isn't going to be happy about this; but weren't going to do it this time. Could be that Fuld (Lehman's CEO) is an idiot. Public story: had to draw the line somewhere. Proceed to never draw the line anywhere and pay 100 cents on the dollar. In book, biggest creditor of Bear Stearns was JP Morgan; they had a huge amount at stake if Bear Stearns went bankrupt. Very happy to acquire those assets. Who were Lehman's creditors? Most of their creditors seem to have been Asian banks, who didn't have a lot of pull in Washington. Also: when Bear Stearns was rescued, they didn't go bankrupt. "Controlled bankruptcy"--what does that mean for somebody who held credit default swaps (CDSs) on Bear Stearns, people who bought insurance against Bear Stearns's potential bankruptcy, versus people who held Lehman credit default swaps, who did go bankrupt, were now owed money because the government let them go bankrupt? Massive economic stake in both of those actions, winners and losers. When you look at what took place when Bear Stearns was in the process of collapse--people who bought credit default swaps not so much betting on their bankruptcy but betting on their credit worthiness also had positions in options and bet on the stock prices. Scuttlebutt: they didn't make as much money as they would have made had Bear Stearns's bonds gone to zero, but made enough on the equity side that we shouldn't get too bent out of shape. Don't buy that argument: the government steps in and back to making winners and losers. Whoever is on one side of that CDS trade that should have been paid off is now a loser instead of a winner. Some argument to be made that when you have systemic risks, one of the risks that is involved is that the government won't allow one of these companies to go belly up. After LTCM, anyone making that bet should have been aware that sometimes the government does come in. Regardless, close Super Bowl game; clock winding down, government steps in and decides to add 3 points, changing the outcome of the game. Kick the field goal. Decision-making process picking winners and losers. In housing: another billion and a half dollars coming in to prop up housing. When you prop up housing, you are punishing people who want to buy--renters, newlyweds saving to own; holding down interest rates punishes the elderly who are hoping to generate their income off of some bonds. Need to be more cognizant of picking winners and losers; very often rewarding the profligate and punishing the prudential. |
| 33:07 | Theme of book: Federal Reserve and monetary policy--going back as far as 1987 to Alan Greenspan's behavior, not bailing out the way Bernanke did or Paulson with a $700 billion dollar check, or taking over Fannie Mae and Freddie Mac's obligations--a trillion dollars on my balance sheet and yours instead of whoever lent them the money--but instead bailing out implicitly. Trying to manipulate interest rates and prop up asset markets. Greenspan didn't pay a price for it for a long time. Benjamin Disraeli quote: The one thing we learn from history is that we learn nothing from history. Watched this unfold as a trader and market watcher; go back and learn more details. Didn't realize between the 1980s and 1990s the Fed Chairman could cut interest rates on his own. Belongia podcast. Greenspan did it six times--wasn't secretive, made him look more authoritative. Note in the book, hubris on his part; one of the rate cuts; at the next meeting the FOMC took away the Fed Chairman's ability to do that. In 1987, new Fed chief, a little green, new, learning process. The 1987 crash, unique event. Stocks don't drop 20-30% because traders switch to decaf. For the most part, markets do a fairly decent job. Could spend months debating why it collapsed, speculation trying to uncover what might have caused it. Portfolio insurance, creaky infrastructure; book Black Monday, reasons why you couldn't get through to your brokerage firm; intemperate comments from the U.S. Treasury Secretary about the dollar; 23% one-day drop on top of 15% leading up to that point. Greenspan learned you could have a market crash and clean up afterwards, no broader effects in the larger economy. Take that one antidote and say, let's look at history and see if it's a one-off. It was the exception to the rule. Always been major repercussions. Great Depression followed the Crash of 1929. Japan, United States in 2000. Tulip bubble. Greenspan instead drew the conclusion it was easy to clean up. How did he clean up? Strongest tool the Fed has--cutting interest rates. We cut rates fairly aggressively after the 1987 crash. Caused a little boom in the real estate market; monthly costs lower; prices of housing. Not true that housing prices have never collapsed. Post Depression era housing prices collapsed; from 1989 to 1996, in major cities, mild price decline in housing prices. Happened in our lifetime--people just repeating what they'd heard and not looking at the data. |
| 40:47 | Greenspan and the stock market--started to recognize that he could more or less influence the outcome of the stock market by raising or lowering the price of interest rates. What was the mechanism? Broader context of what came before: huge spike of inflation during the 1970s; Volker taking interest rates very high; even when the back of inflation was broken, rates had come down but really were somewhat elevated compared to historical levels. In the mid-1980s had the economy recovering, stock market doing well, but Fed rates around 8%, mortgage rates in 7-9% range; still had room to take rates lower. Every time we ran into a minor recession--nothing to be feared. Famous quote: during recessions and bear markets money returns to its rightful owners--careful people make money. Every time there was a threat to the stock market, would see some rate cuts. Traders on Wall Street figured out that they just had to sell stocks and Greenspan would say they were seeing problems the Fed wasn't seeing, so let's head off a recession and cut interest rates. Whole other level; irony; Ayn Rand--pulling the levers constantly. Between him and his shrink. Once you have that wave of applause from traders--Greenspan got standing ovations--he kept the rally and the market going, criticized for not cutting rates sooner. Irony there. Belongia, former researcher in the St. Louis Fed--challenge, Fed has one lever, the discount rate--it can have loose money or tight money; trying to do at least four things: keep full employment, keep the economy growing, keep stable prices, involved in fighting poverty--community banking activity and oversight. Rehabilitation rules to overcome redlining. Minor factor in what took place. Really employment and fighting inflation, 95% of what the Fed does. The Fed has a lot of mission creep. Employs lots of economists. Supposed to keep the economy humming at a steady rate of growth, supposed to have a fight-poverty thing in the background; then add keeping asset prices stable. Emotional impact on Greenspan or any Chair responding to the adulation--making them winners--he's forgetting who is losing. He's the maestro. Mission creep: speech excerpted in book--psychology of traders--now the shrink-in-chief for traders? Used "confidence." Sometimes you want lack of confidence. If the building is on fire, you want to run. Not part of the Fed's job description. |
| 49:11 | In 2001; 2003-2004, he kept interest rates low. Now people agree it was a big mistake; but at the time, we'd faced 9/11, confidence was shattered, people were scared; tech bubble had just popped; had to make sure we didn't fall into a Japan-like deflation and horrible recession. Interest rate drops viewed as necessary. But that really wasn't the timing. September 11 happened; Ritholz's office in 2 World Trade but working in Long Island office that day. Not an abstract event, on cell phone with head trader; everybody had gotten out. Struck that the Fed cut didn't happen that day. The Fed cut rates an hour before the markets reopened the following Monday morning. September 11 had been the preceding Tuesday. The very name "Trade Center" reflected global capitalism. He waited; so the Fed was all about the stock market, not about the country. As if, if we could make the market well, everything would fall into place. Enormous change in policy. Ben Bernanke almost didn't get reconfirmed. |
| 52:29 | Perspective. Two parallel tracks of bailout. One is literal bailout--Fed or Treasury makes good for the creditors, who should have lost some if not all of their money. We did that many times in this last crisis, and before that as well. At the same time, we have a Fed manipulating interest rates in the hopes of keeping financial markets from never going down too much--the "Greenspan put." Two tracks which both encourage risk-taking, remove the loss from the profit-loss equation to some extent. Not entirely--Lehman went broke. Some people lost their money. But remarkable number of people made an enormous amount of money: Fuld of Lehman, Jimmy Cayne of Bear Stearns--had a lot of paper losses, but each left with $500 million of their own stock which they sold prudentially, not by playing recklessly with their own money. What was the psychological impact on the players in the market? Do you think they expected to be bailed out, thought there was a chance, or subconscious possibility that removed a fear? Which players are we talking about? A lot of stupid people made dumb decisions and lost all their money. But the savvy people, traders, senior management, didn't lose so much. Dividing line: senior management of the publically traded companies and the big non-public Wall Street partnerships. Historically, most of those partnerships--like law firms--were non-public; a decision was made to allow them to go public at some point. It's not a coincidence that every single company that got into trouble, there's a lot of OPM (Other People's Money) involved through a senior manager. The most you can lose is what you have in stock--stocks and options. If the company goes out of business, that goes to zero. The shareholders and taxpayers took a loss; but managers like Fuld were wisely, prudently investing their own shares all along. When Bear Stearns was trading at 172 and Jimmy Cayne was worth 1 point something billion, he couldn't cash that out. Gave him the cover to play recklessly with other people's money. Puzzle: why did those other people lend the money? Those stock prices were fraudulent--based on an artificial inflation of earnings based on sheer recklessness, sheer speculation--"mark to make-believe." Race course: If you set the record on the straightaway, you don't break the record--you are going too fast to slow down and make the turn and you hit the wall. That speed record shouldn't really count. That's pretty much what the investment companies did. How hard is it to sell stock at 150 if you don't care? Flat out, pedal to the metal. Number two--key psychology, difference--if you are in a publically traded company you have a limited amount of exposure to the amount you own in stocks and options. In partnerships, different legal standard. If a partnership did what Lehman did and loses $50 billion, first the assets of the partnership are exhausted by creditors. They take the building, the art on the walls. Once that's exhausted, you get to go after each and every partner--take the houses, cars, Monet's. None of the partnerships or the partnerships that went public late got anywhere near the problems. Neither did the hedge funds. If you are an invested in a hedge fund, limited liability partner; but if you are the hedge fund manager, they can take house, collection, everything else. We know of 380 small firms that went belly up--10-30 men shops that existed to sell loans to people on Wall Street. But of the 50-100 year old multi-billion firms--the partnerships managed to avoid this mess. Management in publicly traded firms were willing to take big risks with shareholder's money. |
| 1:02:16 | Pet causes of the crisis, one thing people point at: Change in structure in the industry. Miss the point that that's not a random event. If you look at the history, they go public in the 1980s, in the aftermath--could be a coincidence but maybe not--of the Continental Illinois bailout. It says to financial players, if you leverage, you might not pay a price for it; if you borrow a lot of money, you may be able to get it because those folks may be willing to take a greater risk than they used to because now they may get bailed out. You can build an investment model on 30:1 or sometimes more leverage and you're going to make an enormous amount of money along the way. It might not blow up, not a plan. We changed the risk environment they played in. Puzzle is why anybody stayed a partner; and most didn't. Senior manager from old European money, famous name, didn't care about going public--a few of them, happy running business, didn't feel the need to go public; happy to be a quiet little partnership. But few and far between. Vast bulk of publicly traded companies happy to go for the leverage. Hard-scrabble traders, reputation for not being Ivy League firms. Pop-psychology. Hyper-competitive, hyper-aggressive that you don't see in the old firms of Europe. Fine so long as you are not playing with my money. Wasn't about wanting more money--about who is winning. Money was just a score. |
| 1:06:37 | Book: span of stuff it tries to explain in accessible way--history, pieces of the puzzle, nontechnical coverage. Question: What have you learned? Nation hasn't learned enough; but what have you learned personally from living through this remarkable time? About book: six blind men describing an element--didn't want to just describe one aspect of this. Learned two lessons, sort of surprised. First, this country has more or less become ungovernable. Have not taken any steps to fix what was broken. Many errors leading up to this, no single factor, thirty or so people and things to blame, about half a dozen more important. Torches and pitchforks, people would rise up. Didn't expect the sudden death of Michael Jackson, close finale in American Idol--as long as the population is fed, they roll over and don't care; on to the next issue. Diffuse outrage. Half full view--when you almost don't confirm the Times Man of the Year as Fed Chairman, there's some optimism. Second thing: how human nature is never-changing. We've come through the crisis--buildings are still standing, feed kids and send them to school, economy marches on. Speaking to investors in the last 2-3 years, if you avoided the bloodshed, great; if you managed to jump back in in March, that's a good thing. People are already asking where they are going to get their 10% again. Handful of people rotated out of stocks and into housing and got caught; rotated into commodities and got hurt; what's the next bubble? The Onion is supposed to be a parody, but the headlines are true--one not too long ago, "America Demands Another Bubble to Invest In." Hope I've learned to jump out before the next bubble pops. Country ungovernable; and human nature never changes. |
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| 0:36 | Intro. [Recording date: February 16, 2010.] Garett is a macroeonomist, but uses Twitter, which is micro. Tweets on deep issues using tweets as a form of both entertainment and economics education. Career path and how got to George Mason? Undergraduate degree in history at Brigham Young U., minored in sociology, thought they were good ways to learn how societies worked. Noticed that in both, the most interesting explanations came from economics. Read some of Fogel's work on economics of slavery, Rodney Stark on economics of religion. George Stigler, economist, said, "There's only one social science and we're its practitioners." Decided to try to get a Ph.D. in political science. Took all the fun classes in one year. Learned a lot of great stuff. Ultimately realized econ was the way to go. Took a year off to take appropriate classes, math classes. During the year off, was lowly intern for Orrin Hatch of Utah in Washington, D.C. Tax policy. Making copies, licking envelopes. Advice: Always be willing to do more work, take more to do. Eventually got to the point of being able to draft speeches and op ed. After that, went to UC San Diego in economics--reputation for being very mathematical, very formal. Trying to get away from years of squooshiness, trying to find balance. Went to first academic job after dissertation that job market wasn't that excited about--on how the Federal Reserve controls interest rates on a day-to-day basis. Part was on intraday changes in the Federal Funds rate. Got to think about natural experiments, so common now in microeconomics. Thesis adviser was Jim Hamilton. What if Fed accidentally puts in or takes out a billion dollars too much? Hard for them to tell how much to put in or take out of the economy. Thinking about macro in micro terms. Toiled away in academia for a couple of years. A few weeks after 9/11, phone call from Senator Hatch's office--wanted a Ph.D. economist on staff, found him through Google at Southern Illinois University. Left academia for 15 months; economic policy adviser to Orrin Hatch--tax issues, labor issues. Year of the 2003 tax cuts, when taxes on dividends and capital gains were cut; a lot of the Bush rate cuts were sped up. Then back to academic life. During time in the Senate had decided it was fun but not as much fun as the free thought in academia; so if going back, had better find something to work on that was incredibly exciting. Otherwise, stick around a couple of years and then cash in as a lobbyist. All about the opportunity cost. Went to work on economic growth. |
| 7:01 | Working on a book in economic growth--relationship between IQ and economic growth--will do future podcast. For here, experience with Twitter and academic--real world--experience. Two unreal places--academic life and Congress. Twitter, in the abstract first. Russ on Twitter as EconTalker, questions for listeners, announcements of who is coming up, occasionally for short bloggings, but not a lot of "I'm having a pizza right now." Tyler Cowen podcast: older folks tend to look down on Twitter; but it's a form of communication. Just a short form of blogging if you don't do it on your cell phone. Twitter limited to 140 characters, including spaces; a lot of abbreviations are used. Somewhat like Haiku, there is an elegance that arises from the constraints of 140 characters. How does Tweeting relate to your Senate experience and public choice? Common when reading books or blogs to find great little short nuggets, short quotes. Whole books like Bartlett's Familiar Quotations consist of short quotes--guess that half are 140 characters or less. The best parts of books are often in that 140 character range. A lot of economics is distilling things to their essence. Political Science class--this week, we'll read this 1000 page book; we'll come in and talk about it next week. Ultimately you pull out maybe a little more than 140 characters, but not too much more. In academic economics, we often write 30-page articles that can say more--or less--than 1000 page books; a core insight. Twitter encourages focus on the basic idea. Hayek's "The Use of Knowledge in Society"--15 pages--read many times and worth rereading. Most we could ask for from Twitter is a tweet that is so provocative, so distilled that it would be worth rereading it many times. What are some? On Twitter with one "r" in "Garett"--GarettJones. One the other day, Tyler Cowen just linked to: If businesses say the tax cut doesn't help them, that's an argument for the tax cut. That's a puzzle. Tries when twittering to create a puzzle. If the tax cut doesn't help them, that seems to be an argument against them, since after all, the idea of a tax cut is to get the business to respond. Want a big response, big help. How can it be that it's an argument for the tax cut. Would seem to be an argument for the impotence of the tax cut, and therefore a bad argument, a case against it. Businesses love it when you cut their taxes on things they are already doing. That's what they get really excited about. Saw lobbyists coming in while on the Hill; companies do spend a modest amount on lobbying tax issues. A lot of business see taxes as a cost to be managed, not as a policy choice--if you cut taxes we'll respond this way: if you cut taxes on capital, we'll do a lot more investing. A way to get their rents lowered. Not interested in making the country better off; focused on their bottom line. The kind of tax cuts businesses would respond most to are ones where they are kind of indifferent between doing one activity versus another. Example: whether a business locates on the right or the left side of the street. Simple choice; we as voters might have a preference: A city council might decide they want a gas station on the right side of the street rather than the left. Could just turn around; so let's call it the East side versus the West side. Small tax, pennies, dollars, to encourage them to locate on the east side of the city or the intersection. If you want them on the east side, only a very small incentive is necessary to get them to do it. A lot of tax changes that get bandied about are really just paying businesses to tell them to do what they would have done anyway. In some cases, a lot of things tax lobbyists would come in and ask for were genuine simplifications--government would just have a lot of crazy rules, hoops for businesses to jump through. |
| 16:05 | Standpoint of the classroom: infra-marginal changes versus marginal changes. Inframarginal: stuff I'm already doing, so it will take a massive change in price or taxes to get me to do something different. Marginal meaning it's going to affect my behavior. A lot of people get confused because they have trouble keeping these things straight; people say: If we make it less lucrative to be a doctor, that's not going to change the number of people who becomes doctors because "no one goes into medicine to get rich--they do it to help people." For an economist, hard not to laugh. People go into medicine for lots of reasons--presumably because they like to help people, find it satisfying; presumably because it pays very well. There are many, many people who, if their wages were cut in half might still want to be in medicine. But there are millions more who would become lawyers, who are just willing to get their medical degree; so if you make it less lucrative, they are going to go do something else. It's not to say that people are motivated to become doctors solely for the money--it's just that money matters. To finish the tweet: flat supply and demand curves; what do relatively flat or elastic curves mean? A perfectly flat supply curve means that businesses are going to supply the amount of output at one particular price. If the price rose slightly, there would be an infinite amount supplied; if the price were cut slightly, there would be none supplied. Might be the equivalent of whether you open your gas station on the East side versus the West side. If just a little bit steep, not quite perfectly flat, then if the price rises just a little bit, you will get a huge quantity response. People will supply a lot more of that product. For example, might happen if you paid people more to be a specialist in medicine, ear, nose, and throat specialist. Pay a little more, a lot of people go into that specialty. What that means is that if the supply curve is relatively flat, there is not that much of what we call producer's surplus out there in the market. Not that much extra value being created that gets the producer excited. Producer surplus is basically the difference between what you'd have to pay a person to be willing to produce that unit of output, versus what they actually get paid. It's a little bit like profit. A relatively flat supply curve means it doesn't take a lot of extra money to draw me or my suppliers into the industry. The costs of me doing it, what I'm giving up by expanding or going into this industry, are relatively similar to what I'm already doing. We say in that case that there's very little economic profit; or that there is very little producer surplus in those industries where my next best alternative is almost as good. If something doesn't work out, I can just go ahead and do that other thing. In a setting like that, there isn't going to be a lot of extra value created if the price goes up a little bit. The producers are going to switch over from one market into another market, but it's not going to be the kind of thing they are going to get excited about enough to lobby about. The consumer might benefit tremendously, though, because the shape of the demand curve has nothing to do with the shape of the supply curve. If consumers are very eager to get this new product, relative to the old one, even if it doesn't cost a lot for the market to supply it they are going to get a huge bargain. So much of the production and innovation that goes on is by companies already in a line of work, deciding to just tweak slightly what they are doing in order to create a lot more value for people. The iPad is a great example of this. Everybody made fun of it the day after it came out--they said it's just a huge iPhone. But when you think about it, a huge iPhone might be great. So from Apple's point of view a small change. We'll see how that will work out. We don't know, and they don't either. Idea would be that if the business is saying this isn't going to help us, it could be a very good thing to encourage or discourage this activity because the consumer could benefit a lot. The fact that a business is asking for one tax cut or another shouldn't really get that much play in our political process. We need to think through the consequences. Sometimes what's good for General Motors (GM) is good for the country. Usually not. Especially right now--old quote, someone being appointed to a position in a Presidential administration who had helped run GM, about 50-60 years ago; different world now. |
| 22:45 | Another example: Pointed out on twitter the other day that the way to control spending is to create more earmarks. Strange idea; put "[sic]" as a reminder that it was not a typo. Everybody's against earmarks, though they are not popular. It's not my earmark, so it's a terrible thing; we've got to get rid of earmarks. The impolite way to say it is "pork"--driving us into debt. What could possibly be good about earmarks? They are one way for party leaders to control individual members. American politicians are really entrepreneurs. Every person is building his own brand. Not like in the British system, if you are in the Labour Party you have to do what the Labour Party says. Why is that, by the way? Not entirely sure. Much more party loyalty in the United Kingdom than in the United States. Well, what's so great about party brands? Parties last a long time. Parties are a brand. In the private sector, why do employees pay attention to the company brand reputation? Because there is this corporation saying let's pay attention to Toyota's reputation. Creating some bad cars, some trouble; Toyota cares about that name value. Executives at Toyota have an incentive to take care of the brand. Employee gets paid the same no matter what, does same job no matter what; doesn't care about the brand. That creates an incentive those who have a bigger stake in the brand to monitor, to encourage caring about the brand. IBM, Microsoft, even Ford have good brand value. Parties are one part of American politics that last for a long time--Republican party brand, Democrat party brand have some value. Go up and down--polls. Party brand on average may have a longer focus on the future than individual politicians would. Individual politicians might say they will be in office for 4, 6, 8 years, then cash in as a lobbyist or go back and run for Governor. The party brand might be focused on the long run. Donald Whitman's The Myth of Democratic Failure--there are market failures in political markets, but brands are one way to overcome that. Earmarks are one way to keep the underlings in line. It's a way of rewarding your friends and punishing your enemies. People at the top have some control over earmarks. The Majority Leader and Speaker of the House can tell someone they need your vote for something, and when the member says, what's in it for me? A new post office, a new interchange, a new four lane bridge instead of two lane bridge; and they get to brag about that back home. In the United States, both parties get to exercise their earmarks. Surprising how it's a bipartisan game. In the last Presidential election, John McCain came out boldly for getting rid of earmarks. Remember it as being a remarkably small amount of money--tens of billions, not even a hundred billion. Something like $20 billion. A drop in the bucket in the U.S. budget. Suggesting it is an incentive system within Congress to get stuff done that otherwise would not get done; we'd like to think that maybe would be better than the alternative because maybe some longer term incentives would be in play. At some point, this or the next decade, Congress is going to wrestle with entitlement spending. The options are pretty clear--will be some combination of raising taxes, cutting spending, or defaulting on the debt. Default might mean some inflation or just being a slow payer. When the time comes it's going to be parties that cut the deal. Both parties would like to brag about that to the voters, saying they didn't cut your benefit; but the parties both know it has to be done. Later rather than sooner. Having the ability to discipline members--which are such an inexpensive way to buy the votes of politicians--will work better than trying to appeal to their patriotism, for instance. The alternative: extra entitlement spending. Given choice between giving a Congressman a $2 million post office in his district versus a $2 billion dollar increase for his district in Medicare spending--say, because he's got an older population--it's cheaper with earmarks. |
| 31:22 | Digress: Rep. John Murtha passed away, recently. Washington Post obituary called him the King of Pork, master at getting stuff for his district. Don Boudreaux wrote a letter to the editor--don't know if it got published; email Russ if you want to get on his mailing list--similar to Twitter, has to be short--It's interesting if you are a Congressman and you manage to get millions of dollars for your constituents, you are considered a hero. You get re-elected and you brag about it. But if you went around the country breaking into homes and banks, took the money and gave it to your friends, you'd be called a thief. What's the difference? Russ: don't think there's a big difference; not a big fan of earmarks, at least not in the short term. But is it imaginable that part of our challenge as a body politic in the United States today stems from the fact that what was once considered honorable is now considered dishonorable and vice versa. Maybe there was a time in America when to bring home pork for your constituents was considered somewhat inappropriate. The mechanisms may not have been there. It's a cultural change. There are a handful of people in Congress who would say it is wrong. The more stuff you don't do because it's wrong, the better off you are. You don't want to rely on legislation as a way to stop. Consider it a form of redistribution from one part of the country to the other. Some are better at gaming the system because they have been at it a longer time or they know the rules better; are able to use that influence and knowledge and channel their influence to a small group of people known as their constituents. Why wouldn't you be ashamed of that? Surely there was a time where people might have been ashamed; now they are good politicians. Senator Nelson in Nebraska was embarrassed that he cut a deal for his constituents to get a deal on health care; Senator Landrieu of Louisiana had some embarrassment. But they've decided to live with it. Thoughts on those issues? Was in the Senate at the time when pork was king. Same size as normal pork projects. Many small, little tax breaks, can imagine they are designed to benefit small groups. Often in the range of tens of millions of dollars. Occasionally a billion dollars. Sense that this has gone on for a long time. Building canals in the 19th century; where railroads went was probably pretty politicized. It seems that it is a signal voters look to as a sign that their politician has some skill. If writing down a model of political economy, would model it that way. Voters can see a new bridge with a sign that says "Your tax dollars at work." Of course, it's other people's tax dollars; should say: "Your distant neighbor's tax dollars at work." In the Troubled Asset Relief Program (TARP) bill, which was a $700 billion bill, which failed the first time--the second time it passed. We were told we were on the edge of a cliff, apocalypse. Hidden away in that very long bill was a paragraph or two of green energy. Who is not in favor of green energy? Turned out it was a subsidy for cars that were using some form of electric power; and it just turned out that it only applied to one car--the Chevy Volt. The way they did that was to make it apply to a certain type of electric battery. More than one company working on electric batteries, but the Volt had its own unique battery, so that's what the subsidy was for. On Capital Hill, call that a "rifle shot." Targeted. Usually rifle shots are considered shameful. Some range to it, roughly $5000 per car, huge. That rifle shot was done quietly. Even though you can brag about it to your constituents, it's considered somewhat gauche to do it out in the open. Like steroids--kind of tolerated in the culture of baseball, before they were banned. Considered okay, but not exactly. They all hid it; wanted people to think their skills were natural. Earmarking and pork is something like that steroid debate. Try to do it quietly. |
| 40:22 | Productivity. A few tweets over last few months that mention organizational capital. Arnold Kling at EconLog has a theme on this. What is it? Organizational capital is basically the ideas and habits of work that people build at work. We know what physical capital is--the machines. Businesses also build cultures, R&D labs and trained people. A lot of what we are doing at work is building patterns, processes. When Arnold worked at Freddie Mac, he didn't spend his time processing loan applications. People spent their time building computer programs that would take care of the stuff automatically. At Citibank--another semi-private, quasi-private, faux-private enterprise in the United States. These folks build patterns--write or approve computer programs about which checks clear, loan approval. Engineers at an auto company--it doesn't take that many people to build a car; it takes a lot of people to design a car in advance. How much money will go into safety, how thick should be the sheet metal? The job of a corporation is to get the process moving. Thought of Russ in San Francisco over the weekend--video about a local fortune cookie factory which manages to crank out 10,000 fortune cookies a day with exactly two workers. Russ's The Price of Everything--how few people it takes to run an egg processing facility. Whole idea of people-free production--sounds like you are playing when you say there are not many people involved in making a car. After all, they are involved in design--so they are making the car. Yet it makes a difference. Car factory--should go. Can sometimes see some of the magic in an ad. In a Ford plant in Kansas City in the mid-1990s. If you stand in the right part of the factory, every 30 seconds a brand new car rolls off the line. For fans of "I, Pencil," think of the people who designed the robots. Extraordinary thing the way we have embodied knowledge within capital. There are factories that have no people. Don't have to have lights or heat; save more money. Wasn't true 50-100 years ago. Why relevant? Relevant for explaining the recession and the recovery. For this recession right now, we have seen that the productivity of workers is going up during recessions. For people on the streets, that makes sense--that's when the boss comes and says he's going to make you work harder. Certainly some of that going on. Even Marx made this point about the reserve army of the unemployed--the boss can always point to the unemployed on the streets so you better work harder. Puzzle is that it wasn't always this way. Before last few recessions it wasn't this way. There is a whole theory built around the idea that productivity tends to go up during booms and down during recessions--real business cycle theory--Ed Prescott and Finn Kydland got the Nobel Prize for inventing this model. Pro-cyclical productivity. They noticed the fact--which economists didn't really dispute--that productivity was higher during booms and lower during recessions. In the past. They came up with this model in the 1980s. They said: let's see if we can explain that by assuming or believing it's the productivity that is following its own path. There are times when productivity is high--say when we are having a lot of innovations or when government regulation is supportive--and maybe bad times when there is the opposite. Or maybe animal spirits; or maybe when oil prices are low it's really cheap to bring in inputs from overseas. What Kydland and Prescott did was show they could explain everything else that goes on the business cycle starting with that. Economy grows faster, more investment, unemployment goes down, etc. Boiling it down to an aphorism: You make hay when the sun shines. The reason you don't make hay when the sun doesn't shine is because it will be damp and mildewy, and the hay will rot. Better wait. Work more when productivity is high and less when it is low. Self-reinforcing. Were able to explain why wages and investment are high during booms and why productivity was procyclical. The problem was--the model was true until it wasn't. The last three recessions we've had the opposite happen. 1991, 2001, and the current one. We've returned to the land of common sense, where it looks like bosses make people work harder. Decades of commons sense being false; all of a sudden common sense is true. Unlikely that bosses have suddenly decided to be greedy and previously deciding to lay off workers--we don't want to work them too hard--in the old days. |
| 50:38 | So what could have changed? Goes to this idea of organizational capital. In layoffs, they might be laying off people involved in design. There is a lot of uncertainty about what is going to profitable or even legal in the future. Financial services industry. Now is not a good time to invest in new production processes. Keep around the people working on the line at Ford. That number will be relatively unresponsive to swings, is the claim. McDonald's probably be keeping the same number of people at the restaurants making hamburgers, but probably have fewer people at Hamburger University. Measured productivity. In everyday language we think productivity means how skilled are you. If I've gotten more productive, that means I can make more in a particular amount of time. But that isn't exactly what it is. it's An aggregate number gathered by looking at a measure of labor--number of workers, hours worked. If number of workers, the denominator can go down a lot without productivity going down a lot during a recession. Most of us sitting in cubicles making sure people get paid, taxes get done, writing computer programs. Can't do that in construction. If you are building half as many houses as before, you can't do that. In the past recession, large percentage of construction workers laid off. Tweet on this particular one: it's an old one. |
| 54:29 | Anything else, fun, for tweets? Supply siders pretty popular in some circles: people respond to tax changes. Models may be too optimistic, predicting that people respond a lot to tax changes. One prediction, if you were an honest-to-goodness supply-sider, would predict that 2010 would be a boom year, at least for America's rich, because taxes are going to be going through the roof in 2011 for people making over $100,000 or $200,000 a year. 2010 compared to 2011. Can look at this after the fact. People should make hay while the sun shines. Think they are going to be wrong. Chastening moment. Tax rates are important, but maybe not so important for labor supply. Empirical question. For podcast, talked about looking at whether there is a correlation between tax cuts and government spending. Milton Friedman said he never saw a tax cut he didn't like: the less money the government has to play with the less damage they'll do. Often goes by the name of Starve the Beast. Theory of politics--not economics--that there was a politically acceptable deficit they can run. They'll spend all the money they take in in taxes plus that deficit; that's total government spending. Tax cuts pull down the level of government spending. Distinction between tax rates and tax revenue. Assuming that cuts in tax rates lead to less tax revenue--usually the case, holding everything else constant, that we are not in the downward part of the Laffer curve. We've had decades of experience with this; you can look at the data yourself. A few have looked at it more formally--Christina Romer, before she took office as head of the Council of Economic Advisers, with David Romer, looked at it herself using one statistical method. Niskanen at Cato Institute used another method. Both came to roughly same conclusion--that tax cuts today may cause tax revenues to increase in the future. William Gale at Brookings: politicians have two ways of looking at the world--Puritan Mode or Partier Mode. Puritan mode: parties restrain each other, on a diet. Partier Mode: just let go. Seems to match the U.S. data. Time to revisit idea that tax cuts control government spending. May be encouraging Congress to party more. We haven't made much impact on the size of government. How to move in opposite direction? People are a little more worried than they used to be. Baby boomers moving toward retirement. We just saw a trillion dollars go out the window without politicians making too big of a deal about it. Get you thinking. We were supposed to be putting our fiscal house in order in the last ten years getting ready for the baby boomers. |
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| 0:36 | Intro. [Recording date: February 12, 2010.] 2006 Nobel Prize winner in economics, Edmund Phelps. Paul Samuelson's 1948 Foundations of Economic Analysis was beginning of formalization of economic theory into mathematical form--took it to a new level. Quote from Phelps's Nobel Prize lecture: Samuelson's project to correct, clarify and broaden the theory brought into focus its strengths; but also its limitations: It abstracted from the distinctive character of the modern economy--the endemic uncertainty, ambiguity, diversity of beliefs, specialization of knowledge and problem solving. As a result it could not capture, or endogenize, the observable phenomena that are endemic to the modern economy--innovation, waves of rapid growth, big swings in business activity, disequilibria, intense employee engagement and workers' intellectual development. The best and brightest of the neoclassicals saw these defects but lacked a micro-theory to address them.How did your work on unemployment began to address these problems? Not sure that it did in first year. Started trying to create abstract models cast in terms of equations had to make a zillion choices about what to assume and not assume. Very natural to reject the idea of perfect foresight about the future. Had done some work on that vein, but when working on unemployment starting in 1966, wanted to get more realistic. No breakthrough way of capturing how people thought about the future, but simply wasn't willing to impute to a knowledge of the consequences of their present decisions for the future. Became increasingly conscious from 1966-1970 that this was important; would hardly be able to talk about the major sources of business fluctuations if I were to put on the jacket of perfect foresight. Do you think the Rational Expectations approach was a dead end--a wrong way to go? In 1966 the term "rational expectations" didn't exist; we didn't have much in the way of mathematical models that look like statistics, with probabilities--some models like that. Didn't think of self as being some extraordinary deviant from rational expectations. Knew of Walras, Knut Wicksell, later Swedeish economist, Irving Fisher--knew there were important figures who had imputed knowledge of the future to economic models; but there were also people like Frank Knight at U. of Chicago who thought the future essentially uncertain and every businessman knows that; and Friedrich Hayek. If something is new, how could anybody know? John Maynard Keynes also emphasized that innovative projects depend on a person's animal spirits. Choice--could go with classical people or modernists; temperamentally attuned to the latter group. |
| 8:14 | There was a lot of other work going on at the same time. Rational expectations rage came toward the end of the second half of the 1960s. John Muth, first or almost first to talk about it explicitly. People of course don't know exactly the future, but they know the probability distribution that governs the future. They don't know which ball will be pulled out of the urn, but they know what's in that urn. In the 1970s, some of Phelps's work survived and was drawn upon, but some viewed as flawed as not having introduced rational expectations. Something close to perfect foresight. In the 1960s--irony--unemployment was very low; by the end of the 1970s it was very high. There was a belief that our models, certainly our equilibrium models of the labor market, were not performing in a very satisfactory way. What was different about your models? How do you look at labor market and unemployment? As economics became more and more mathematicized, it became more and more standard to think of each market as having a price that cleared the market. There was no excess demand and no excess supply. Differed from that--argued that companies have an incentive to set their wages above the market-clearing level--for their own self-interest. Didn't rationalize very well right away, but eventually saw what was going on. Equilibrium in the sense of no one being surprised by what others are doing is characterized by involuntary unemployment that comes from companies having a sense of self-interest in keeping their wages up and their quit-rates down. Wanted to give employees something to lose if company did badly. Hardly emphasized in succeeding literature. Brought unemployment back into the picture. Other thing in work in the 1960s--if people get fooled, if each firm doesn't realize that other firms have the same incentive, then wages will be less high than they would have been if the wage-setters knew what was going on; and employment would be lower than if they understood. Emphasizing stop talking about equilibrium so obsessively; we can be out of equilibrium; and if we are out of equilibrium then sooner or later the information will come out that shows people are wrong and they will react to that. So wages are going to pick up, rising faster; prices will rise faster; start to get clear inflation. Not trying to predict the 1970s, but did realize that the unemployment rate was extremely low in the last half of the 1960s; had to explain to self how this could be; answer was that people didn't know what was going on and out of equilibrium but inflation will turn up--just you wait. More complicated than that. Uncertainty not just in the future but in the present--not sure what's happening right now. Medieval economy you know all the people you are working with, see the transactions; in modern economy, knowledge is very costly. Spread out, geographically, physically. If everybody's working in the manor, self-sufficient. Once you get globalization or a national market with specialization then people have a hard time understanding what's going on. |
| 15:47 | How did those insights interact with the Keynesian idea of aggregate demand? Didn't start out to try to unseat Keynes. Trying to provide a microeconomic foundation for the basic idea of Keynesian economics. Trying to show if aggregate demand increased, the effect would not be simply a momentary increase of output and unemployment until people caught on, but rather there could be a prolonged period in which output and employment are elevated relative to the equilibrium path. Wasn't being anti-Keynesian; taking Keynes fully on board and trying to make sense of him. But a natural consequence of argument was if the monetary authorities tried to maintain output and employment at its elevated level, by pouring more and more money into the economy when money wages and prices were pushed up, then people will begin to anticipate when price and wage increases in the future in the economy; so that won't work. Attempt to kind-of legislate a disequilibrium on the part of the Central Bank won't work. Very upsetting to Keynesians. Probably not as hated as Milton Friedman, but might have been hated more because Friedman was never in the Keynesian camp, but Phelps was thought to have been a Keynesian. Friedman doing something similar with attack on the Phillips Curve and Central Banks. Thought he oversimplified. His strength and his weakness was that he oversimplified a lot. |
| 19:17 | Naive question, as a micro guy: strange schizophrenia between micro and macro. In micro we like to say markets clear; in macro, strange disequilibrium in the labor market. But in both micro and macro same disequilibrium--don't think of it as disequilibrium per se. If you go into a grocery store there is lots of stuff on the shelves when you leave, and cars on the lot at the auto dealer. We don't say this market is in disequilibrium because there is all this unsold stock. Why don't we just say they should lower their prices and sell everything? Inventories are there because future demand is uncertain. Disappointing a customer is really to be avoided. We don't expect those markets to clear in a textbook way; understand there is a richer story. Isn't that what is going on in the labor market, that it's costly? No. Why? Also want to make clear that a car that doesn't get sold doesn't have a family to feed, so there is a different social aspect. Not ready to put you in jail! The story is essentially a story about a kind of stochastic equilibrium. There are ups and downs in the volume of business from day to day. Some days end up with a smaller number of cars less in the lot than you would have guessed. Perfectly possible to build mathematical models in which there are probability distributions that govern whether somebody gets up in the morning and goes to a used car lot. Can build a model in which a precautionary stock of cars is kept in used car lots: if you don't have one there you can't sell one. Sense in which everyone would have liked to have sold more cars and nobody can predict the number of cars that are actually sold. That story in its usual version usually slip quickly into the thought that everybody knows these probability distributions and we are just looking at a stochastic process. Carry that over to the labor market--people lose their jobs, so they then go look for another one; there are some frictions, but you are always in a kind of stochastic equilibrium. Concede the grain of truth in that story; it's just not the kind of story I'm interested in. As a macroeconomist I'm interested in the story in which something happens to cause the whole industry to be off, to get it wrong. For example, there could be some kind of obscure monetary development that causes people to want to reduce their bank holdings and load up more on things for the refrigerator and so on. There are macro shocks that are not quickly identified that catch people having wrong expectations in the sense of not having probability distributions in their mind that are the right ones. Russ: I totally agree; let me ask the question a different way. In the current world, right now, where unemployment is about 10%, some recently unemployed, some for a long time, some receiving unemployment compensation which is not pleasant but beats having nothing. When you are unemployed, there are lots of jobs available, but what you don't know, which is like what the producer doesn't know what the price and wages offered by competitors are--if you are out of work and you are offered a job that pays less than what you were paid before, you don't know whether that's your best alternative or just a bad draw out of the urn. You wait, because there's a cost to quitting that new job, if it turns out you were wrong. Seems that that process is a massive part of why there is measured unemployment at all, but in particular why during a downturn unemployment persists. Wouldn't call that a disequilibrium. Everyone being rational. Don't think of anybody as being irrational. All doing the best they can. If the bottom drops out of the housing market and a lot of construction workers find themselves unemployed then even if there will be some sort of adjustment of prices and wages that will bring the economy back to the same level of activity, it's going to take a while for round pegs to find round holes and square pegs to find square holes. Absolutely fine. Non-Keynesian story about employment, unemployment, persistence, and so forth that wasn't addressed by Phelps's work in the 1960s. Was just addressing the prevailing view. Also more structuralist views that say when there's a shock it's not the same across the board for every company. Some companies are different from others; some industries have different experiences. Maybe downturn concentrated in construction industry. In last 20 years spent all my time on that! |
| 28:38 | Russ: Observation was not made as a criticism: Chicago-trained, Lucas student though dissertation in micro. But in recent years become more interested in Austrian approach, where imperfect information important and structural changes important. Can't just look at aggregates. In current downturn, 22.6% of jobs lost since beginning of recession in construction. If you are a construction worker, it's very hard to figure out if your job is coming back in six months, two years, or never. Smartest person in the world doesn't know the answer to that question, let alone the average construction worker. That Knightian uncertainty, inherent in Phelps's methodological approach. At the end of the 1980s, world didn't look very Keynesian any more. Tremendous depression in Europe, with unemployment rates of like 15% in the middle of the 1980s. Just hung up there. No deflation or disinflation. Wait a minute--we need to find a structuralist story to understand this kind of thing; worked on that from 1986-2000. Back up for a second: why did that lack of an inverse relationship between unemployment and prices--why was that a challenge to the Keynesian model? Keynes had left the whole behavior of money-wage rates something of a puzzle. Not that he didn't it some thought. Then Phillips came along with the Phillips Curve, which said not that when employment is high workers ask for a high level of the wage, but rather than when employment is high or unemployment is low, we see money wage rates rising faster than if employment is lower. The higher the level of employment, the faster money wage rates are rising. Keynesians embraced this as the solution to their problem of what to do about wages in their models. Phillips' paper in 1957 or so, there grew up a kind of Keynes--Phillips' model. Implied that you would have money wage rates rising a lot slower than before in Europe or even falling. But they weren't. This was a kind of downturn the Keynesian model had nothing to say about. Started working on modeling of determination of the natural unemployment rate itself, with an eye to trying to understand the European phenomenon in the 1980s. Wealth, real interest rates, and real exchange rates--variables you would have had in a non-monetary model--impact on the natural unemployment rate itself. Clue as to reasoning by recalling Milton Friedman. Friedman was more of a Keynesian than he ever wanted to admit. Sort of a half-Keynesian. He said something like this: If you have a decrease in demand--decrease of investment demand, decrease of export demand, whatever--in an open economy, then you could look to money wage rates to solve the problem. Or it might more or at least as convenient to look to the exchange rate to solve the problem. When investment or export demand weakens, that would lower interest rates; that would cause the currency to drop. Where will the currency hit bottom? Will keep on falling until demand is back up to where it was before, employment is back up to where it was before. Why? Because that's what has to happen for the interest rate to be back to where it was before. Interest rate in this country has to be the same as it is in the rest of the world. Keeps on falling until the economy has healed itself fully. Otherwise that market will be in disequilibrium, capital will flow across borders. There was Friedman using impeccable Keynesian reasoning but reaching a non-Keynesian answer. Yes, there is unemployment for a while, but the wage-price mechanism will operate to bring the world back to equilibrium. Implicitly supposing what so many Keynesians suppose: namely that the structure of demand doesn't matter. Just aggregates. In Phelps's models of the late 1980s, at least those that had exchange rates in them, that's not true. When the exchange rate falls, that's like an increase of tariffs. Domestic firms now protected against foreign competition. They will respond by raising markups. Prices will rise relative to wages, which is like lowering wages relative prices. New equilibrium is not where it was before. New equilibrium is lower than it was initially. Real exchange rate depreciation has this little negative in it that is always overlooked by the people who see real exchange rate depreciation as a salvation. Two sector stories sort of the same thing--when you have a real exchange rate depreciation, that's tantamount to a decrease in the relative price of nontradeables. Structure is not neutral. |
| 39:38 | Observation, then shift gears. Conversation reminds of how difficult macro is. Start off asking suppose demand decreases. For a particular thing. Investment demand, export demand, consumer demand. Nothing is exogenous. Have to ask: Why? Why did it decrease? Not just structural question of which. But you've got to start somewhere. Stuff happens! If you want to start with the premise that it's a deterministic world and everything is known, then nothing can happen except random disturbances. You can get a certain distance with that; have played around with that, not criticizing anybody. Making a different argument: we as outside observers don't know why demand fell. Really hard to do comparative statics--what are we holding constant? Something must have changed, might be random, but it's probably something we didn't observe or didn't understand that changed this. As a result our ability to predict this is very limited. Are you saying that, say, when investment demand changes, we better know why else our analysis is incomplete? Yes. Constant, hanging over so much of what we do, always one more step. But one step at a time. Methodological question, especially for nonacademic listeners--I put this in my model, Friedman put this in his model or left that out--what do you think our ability is to distinguish between good models and bad models and how should we do that as economists? "I never saw a model I didn't like." Don't believe in good models and bad models. Carry around a tremendous repertory of models--Austrian, Keynesian, Marshallian, Lucas, Sargent, Prescott--six or seven models of my own which I sometimes get tangled up. If you study the price of peas and the output of peas you might be able to get through your career with just a Marshallian model. You can't get anywhere in macroeconomics with just one model. Just doesn't work. Do we make any progress? Sure. New riches in the form of new models we didn't conceive of before. Almost a witness--student of economics in the autumn of 1952, only 16 years after Keynes's General Theory came out. Could go to the college library and read the debates between Keynes and Hayek, only 20 years earlier. Witness to that, and witness to American Keynesianism, which differed profoundly from Keynes because the Americans took the uncertainty out. Took the lack of knowledge out of Keynes. The math went a lot easier, was more beautiful. If you just took Keynes's marginal efficiency of capital, which was a subjective thing, and plopped it down, then it made it obvious there was something curious there. Americans didn't like that, so they got rid of it. Arrival of Phillips; participated in debate about Phillips Curve and permanence of shift in aggregate demand; built structuralist models in which the natural rate of unemployment is constantly moving around. Now having a revival of Austrian style models, financial crisis--not only do we all have imperfect knowledge but we have disagreements. Some people were bullish, some bearish. Some made money--not many--many lost money, wonder why. Macroeconomics has been a roller coaster of discovery and reappraisal and fights. |
| 47:19 | Russ: That's my question. When I was in grad school in the 1970s, we were taught, 1976-1980, at Chicago, so definite emphasis there, nobody took Keynes seriously, emphasis on real business cycles, what stochastic shocks or real shocks were causing the business cycle. Focus on rational expectations--that was the hot topic. Some problems developed with those models, but they looked kind of interesting and promising. Great Moderation. But now we are back to Square One. Not only didn't learn any Keynes, but didn't learn any Austrian theory. Nobody took that stuff seriously; could be back, not sure. More like a roller coaster than a slow steady accumulation of knowledge. Keynes is back too--in vogue. No--don't go back to exactly the same place. The Chinese say a man never crosses the river in the same way twice. We could never go back to the Keynes of 1936. We know too much, would be second-guessing. But it's an extraordinary book by an extraordinary mind, influential. To forbid it like Lady Chatterly's Lover is pretty ridiculous and atrocious. Rational expectations was a casualty. We know it was no good. Conference in 1981, Individual Expectations and Aggregate Outcomes: Rational Expectations Re-examined. Went through models where people disagreed or even think they disagreed. Had challenges to rational expectations, just as Oskar Morgenstern challenged the work on intertemporal equilibrium in the late 1920s by Hayek. Caused Hayek to have a change of heart. Rare for any academic. Didn't advertise it. |
| 51:25 | How do you evaluate good models or bad models? A lot of things are back in play. You may say the Keynes of 1936 dead, but his insights relevant; but a lot of what I hear from public intellectuals is that it's relevant. Reading the wrong newspaper! Could be. Pick up the Financial Times and you will see much more diversity of opinion than you will in some family newspapers. Real point: no matter how sophisticated or open-minded, with horse in the race, hard to evaluate each unique-each-time crisis. Not a lot of data points. Great Depression, current recession, a lot of little recessions. Hard to know. Any evidence that we are better? We've rejected some things. We have rising cumulative knowledge. Some of us remember Hayek I and Hayek II and Keynes and the American Keynesians and the Friedman/Phelps perspective and Rational Expectations revolution, and the structuralist stuff and the critique of rational expectations with Roman Friedman who has done some of it with me. I remember all those things, so I feel incredibly richer. Probably others don't. I actually wonder whether so-called Keynesians these days have actually read Keynes's General Theory. I think they haven't, otherwise they wouldn't say some of the things they say. Other point is that--this comes profoundly back to Hayek and imperfect knowledge, particularly of the future and uncertainty--every big crisis like this is not only out of the blue. They always are. Each one is in important ways quite different. The world has changed quite a bit. We're not just going through something like the Great Depression of the 1930s where this slump is different in important ways. On the other hand, probably the present slump is more different from the garden variety of recessions we had after WWII than it is different from the Great Depression of the 1930s. Now we are discovering more stuff about the financial sector, which has evolved enormously in the space of two or three decades. That's something different. Globalized economy in which the United States is producing only a quarter of the output, not something like almost half in the decade or two after WWII. And so much more freedom of goods, freedom of capital. The rules of the game have changed so much. Everything has to be re-thought. We never got consensus on the 1930s either! This sounds like a slam but it's not: a lot of what we tell is ex-post story-telling. What we are best at; in search of knowledge. A lot of things different now, so we can't just apply the models we had in the past. I hear you, but I think economists tell better stories than economic historians do. Economic historians, general public, very crude stories. We need stories to help us avoid making the same mistake twice. Other thing: We need economists who are gifted with a lot of insight and theoretical imagination to be involved in policy discussion. If we don't have that component, societies are going to be the poorer for it. Britain had Keynes, and he probably did more good than harm. Wasn't always clear; had to change his mind at some times; and that's okay. Intellectual caliber of his thought was generally better than what was coming from the others. We have to.... A lot of these public intellectuals you referred to are using slogans, like "Keynesian economics" like it's a slogan to mean one thing one week, another thing another week. Could mean a pro-active stance, could mean nothing more than that; or could mean a big public sector is better than a small public sector. For some people it means that. A lot of these public intellectuals are doing a lot of harm to the quality of the discourse. |
| 1:00:00 | Ironic that Keynes's most important insight wasn't listened to: Economic Consequences of the Peace. Treaty of Versailles. Insights into what you call the Good Life, the workplace, and what we understand about that. Have to resist the temptation that I invented it. Don't have much time to read any more, but like to ask myself what previous guys said and thought. Trying to put into my own words some thoughts about the good life in a lecture in Munich in 2003. By some accident had to give another version, 12 months later in New York. Realized at some point that distilling point of philosophers read in college. Didn't read Aristotle; had read Plato, had to scramble to go back. Had read David Hume, so great on knowledge and how tricky our knowledge is; need for imagination. Profound effect. Read Henri Bergson; didn't realize that Bergson was to some extent doing a version on Nietzsche; didn't read Nietzsche. Also read William James. Late 19th century headline thinkers had a lot to say about change, adventure, curiosity, and how we change in the process of all that. John Dewey on that same wavelength, Columbia 1920s-30s. People go to work to make a boat, got to have things to enlist their minds. Why talking about this good life? Idea in background was that this conception of the good life could maybe be justification for an entrepreneurial capitalism, such as we thought in the year 2003 in the United States, with still-fresh memories of the Internet revolution. Now it looks like there is a lot less innovation and entrepreneurial spirit than we thought there was. But in 2003 thought that it was important to celebrate the excitement, engagement, adventure; thought it was a new way of defending capitalism. Previous theorists had thought that well, it was a good way, good system for capital formation, building up the capital stock. Nice to get rich. But there are countries in Europe that don't have any of the innovativeness, the flair, the excitement of American capitalism, and they've got awfully high levels of wealth. Can't say that you have to have capitalism to be rich and comfortable. What's your thought now? Still optimistic about that entrepreneurial spirit? We've lost some of it, but we can get it back, and we'd better get it back because we want this good life. Also, further point: if you have an economy with a lot of dynamism--meaning opportunities come and go but if you are equipped for innovation you are better off--you want to be equipped to innovate when ideas strike for another reason: It's good for employment. And high employment is good. Earning your own way in life, not being a burden on the public trough; want children to grow up with parents who are role models of having careers. Society is healthier if employment is higher, particularly if economy offers challenging jobs. All intertwined. If you have an economy of that quality, also get side-benefits like high employment. |
| 1:09:04 | There's never been a society in human history like the United States today--even today with unemployment--there's never been a time when creative people could use their creativity in extraordinarily exuberant and satisfying ways. Incredible environment for that psychologically satisfying human experience. Worry about whether that's easy for me to say because I'm enjoying that, podcast, creative things in job. But people who are self-employed and doing things they love, creative things from health care to iPad, seems like all-time high. Worried about that almost from beginning of writings about this. Dirty, mindless, grimy, unrewarding jobs taken only for the money. Recognize that. But at the same time, reject idea that almost across the board except for this hard core of creative, imaginative people, that jobs are dreary. Radio debate one day on NPR; thought by self, carrying on work and importance of challenge. After break, another guest came on, Robert Reich, Clinton Administration. Said, "Most people in the United States hate their jobs." Staggered and annoyed. What he said is not borne out by the data. By far the majority are highly or fairly satisfied in their jobs. People love being in the thick of things, love being in a company that is aspirational. People want to have that involvement. Not everybody gets to invent the iPod. We can't all be Steve Jobs. But some is a trickle-down thing. Someone once said: In a highly entrepreneurial environment, even the waitresses show more hussle and are more interested--that becomes the culture. |
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| 0:36 | Intro. [Recording date: February 4, 2010.] No, guest today. Thoughts on trade. Thanks for request for feedback on experimental Mike Munger podcast. Read all email even if not enough time to respond to all. We are on Twitter at EconTalker. About 15 years ago, wrote book The Choice, in which David Ricardo comes back to life as a ghost to try to convince a television manufacturer that trade is good for Americans even though it will destroy his company and hurt his home town. Central is Ricardo's idea of comparative advantage. A few years ago, essays on Econlib. In last couple of thinking has changed: perhaps an even deeper insight and more important than Ricardo's which is in many classrooms. Ideas on trade have not changed so much as gotten richer. Insights come from conversations with Don Boudreaux; seminar with James Buchanan, podcast with Mike Munger on division of labor; podcast with Paul Romer on growth. Quote from article by Robert Frank, NYTimes: "For example, as a Peace Corps volunteer in Nepal long ago, I hired a cook..." Question is: Why does a spectacularly resourceful and intelligent person in Nepal earn spectacularly less than a lazy untalented American? Daughter, age 17, babysitting for 2-3 years; makes about $10 an hour, a lot more than anybody in Nepal makes who is incredibly talented. Her main talent is her ability to show up on time and not burn the house down. Patience helps; a few other skills, but not like thatching a roof or butchering a goat. Frank points out that relatively unskilled people in America make a lot more than people in Nepal. David Henderson EconLog blog post closer to the truth. Will try to answer why and impart insights. |
| 5:55 | The one-sentence answer comes from a quote from the book The Choice, and that is that "self-sufficiency is the road to poverty." Self-sufficiency in everyday language is a good thing--standing on your own two feet and not relying on others. In the context of economics and trade, realize quickly that standing on your own two feet if you mean it literally, you are going to be desperately poor and probably will not supply. PBS special, "Frontier House"--try to live in 1880s in Montana. None of the families made it: didn't generate enough output with just their own skills to have made it through the winter. One family that created a still, made liquor and swapped it was viewed as cheating by other families. Modern skills not well suited; but also if you only rely on yourself you are going to be very, very poor. Literally, couldn't use tools others made. Quick answer. Slightly longer answer, coming from David Ricardo, is that specialization and trade make us rich. The more America trades with Nepal, the better off both of us will be; trade is mutually beneficial; trade allows people with diverse skills, even if you are not as good at everything as someone else. Even if Russ is not as good at thatching a roof or butchering a goat, and even if you are better at all those things than Russ, both will be better off if you each specialize in one of those things and trades for the other things we want. The power of specialization in that setting isn't what we normally think of, which is learning by doing. It simply has to do with each devoting himself to what he is relatively good at; more can be produced than otherwise. Opponents of globalization want us to be more like Nepal. But deeper answer as to why Nepal suffers comes from insight by James Buchanan in a paper he wrote with Yong Yoon on increasing returns and Adam Smith. Example they use: You and I and a bunch of fellow human beings are part of a group of hunter-gatherers, close to subsistence living conditions. We get all of our food from hunting; basically one task; meat sustains us. Daughter and wife vegetarian, but in primitive society probably not that common. Primitive society of hunters. Sitting around at the end of a long day of hunting for deer; suppose tired of living on a very small amount of venison; would like to have more meat, more output, higher income. What are your choices? How could we move toward a higher level of prosperity? three options: can bang your neighbor on the head and take his meat; you can develop a technique that allows you to be a more successful hunter for every hour you spend hunting:--improve the knife you use, invent a bow and arrow, invent a gun or net, learn to track deer more successfully--generally called productivity. Theft, plunder; productivity. There is a third option which is trade. Banging people on the head: Walter Williams observation: that first option of banging people on the head has been the historical favorite for a long time. Only in the last few centuries have people done something else. Tend to think of theft as a zero-sum game--if I get richer by taking your venison, I'm better off and you are worse off. But it's important to remember that theft is a negative-sum game. If I know I might get banged on the head, my incentive to accumulate wealth is smaller. And I'll have to devote resources to keeping you from banging me on the head--lock meat up or hide it. Secure property rights are an important part of prosperity. The other two methods, productivity and trade, are not zero-sum; they are positive sum. They certainly make me better off without making someone else worse off--assume lots of deer and no congestion problems. A better way to kill deer or trading for it also makes you better off as well as me, certainly in the trade case. If I make a better knife and you see me coming home with more meat, you are going to wonder how I did that; might follow you around; I might share idea, sell it to you, or you might figure it out on your own. |
| 14:27 | When we think of trade--third technique--we think of David Ricardo. We think of specializing in some task full time and trading. In the Ricardo story, what drives trade is our differences, the fact that we are not the same. Jonathan Sacks, Chief Rabbi of the United Kingdom: Trade makes diversity a blessing. Often, diversity is a source of conflict and tension; but because of the opportunity to specialize with trade, trade encourages us to cooperate. But what if we are all identical? Ricardian incentive to trade goes away. If you are a teacher, you know that it isn't just a special case where we are literally identical; if you are twice as good as I am at two tasks, our incentive to trade disappears, or three times as good. What really matters is our differential ability in Task A versus Task B. If we are all equally good at all tasks, it looks like there isn't going to be any specialization; certainly isn't going to be Ricardian specialization. But it turns out--this is the Buchanan-Yoon point--that there is a possibility for specialization and trade even when we are all identical. Rather spectacular--didn't appreciate it, hadn't thought about it; important. Back to hunting scenario: only one task, hunting; but there are other tasks as well. We have to keep our tents or lean-to's thatched. Hunting is just the only way of gathering food. One thing we have to do before we go out into the woods is make sandwiches; no restaurants. Each of us takes some time to make a sandwich for breakfast and for lunch; takes away time from hunting. One of us decides to open a business with take-out lunch solution; pre-made sandwiches so the hunters don't have to do it for themselves. At first glance, this takeout solution cannot succeed. What's required for this to succeed is that for my business as the sandwich maker, you have to be willing to pay more for a sandwich than I give up by not being able to hunt. By making the sandwich for you, I'm going to lose time hunting; you're going to free up time. You as the buyer of the sandwich want to pay less than you normally have to spend in time--foregone hunting--to make the sandwich itself. So, if we are all identical, and it takes me just as long to make a sandwich as it takes you and we are equally productive as hunters, my making a sandwich for you is not a viable business opportunity. Cannot be profitable. It seems we need the Ricardian world. But what Buchanan and Yoon point out is that even when we are all identical, it is possible that the sandwich business can thrive. We are leaving out non-monetary factors--you might want to stay home and make sandwiches even if it means giving up meat production, you might want to sell the sandwiches cheaper than your foregone costs of going out into the field, because you hate hunting--it disgusts you or you hate the woods or you love cooking. So there are non-monetary factors which we are putting aside for now. Continuing with the example. |
| 20:30 | At first glance it appears there is no advantage to specializing and trading if we are all identical. But in fact if there are enough hunters, it can be productive for me to become a sandwich maker and make all of us better off. What it requires is the addition of technology to the sandwich-making process that makes sense when I am making 100 or 500 sandwiches but that doesn't make sense when I am making 1. Economies of scale: suddenly I can now produce a sandwich at a low enough cost to me--I can do it quickly enough--that my foregone time per sandwich is less than it would take you with your production of a single sandwich. Some obvious ways that might happen: facetious examples--if making one loaf of bread, small oven, might knead the dough myself, slice the meat and spread the mustard with my knife, grow the mustard in my mustard field--all those things are technology when making one sandwich. But if I'm making 500, I might have a special oven when baking bread; food processor or mix master for kneading the dough, power electric meat slicer; mustard field that is easier to cultivate enough for 500 sandwiches a day. Shocking--when making 500 sandwiches, the addition of those technologies, of adding capital, those technologies make the sandwich cheaper per sandwich in terms of foregone time, which allows me to make a profit, pricing it at a price that makes you want to buy it. You can't say that as the buyer of that sandwich, and here's what's interesting: 'Oh, I'll just do that myself; I'll get my own slicer.' But if you are making just one sandwich, a meat slicer makes a sandwich more expensive, not cheaper. One sandwich is not enough to amortize the cost of the meat slicer; you have to have a large volume to exploit the advantages of that technology. Puzzle sometimes why in primitive societies: why don't primitive societies today use the most up-to-date technologies available? It's not profitable. It's not productive to use a grain thresher when you have a plot of land that's 20 feet by 30 feet. You have to have a big farm. Important to notice that the scale of the operation has a huge impact on how much capital to employ. This was one of Adam Smith's most fundamental insights in The Wealth of Nations: the division of labor is limited by the extent of the market. Mike Munger podcast: not just that you divide the sandwich-making up into smaller and smaller pieces. That's part of it. Might have one person baking the bread, another person assembling the sandwich, someone who tears the aluminum foil. As volume expands, more and more specialization. But more important insight is the application of capital, technology, suddenly becomes profitable, wise to use. Then have an incentive to improve that technology. Leverage our potential as human beings. If you lift weights, you can be stronger and carry more books around with you. You don't need technology--you can do pushups. But you can add some technology--can add a backpack. But then you can kick it up a notch--you can add a Kindle. Then can have a thousand books. Can leverage your human abilities to carry stuff. If I'm producing enough sandwiches, it can be possible to add technology to make it profitable. A couple of points: First, the technology isn't sitting there. You have an incentive to invent a meat slicer. Somebody has to come up with a way to make the process worthwhile, and that's only sensible when you have lots of people around you. Might take a few million people, or tens of millions around you to make it worthwhile to produce an automobile instead of crafting something in a more artisanal way. Fifty people gathered in the wilderness--let's make them the most skillful Nepalese--they're going to be desperately poor. Self-sufficiency is the road to poverty because even fifty people can't maintain the modern standard of living we've become accustomed to. Have to be able to interact with tens of thousands, millions of people to attain the scale. |
| 30:01 | Question: Even if we are all identical we can have this potential for specialization. So, which one of us is going to become the sandwich maker? One answer is it doesn't matter. Any one of us could. Better answer, from a student--it's the first person to think of it. It's not obvious that there is the potential for profit from sandwich making. Not obvious that there are two jobs--hunting and sandwich making. Important insight. When we teach trade, we get stuck in this two-by-two matrix. But there aren't two tasks. There are n; and we don't know how big n is. The number of tasks emerges from our insights. There is no book; they have to be figured out by human creativity. In the real world we are not all identical. We are all different. Ricardo's question: If we are all different, which one of us becomes the sandwich maker? Who would do it best, who of our group would be the best person to assign to that task? Said that two different ways, don't really mean the same thing. What we mean by best is not literally the best, because what we are trying to do with that phrasing is to get at comparative advantage. Say it a little better, make the distinction: there is a person who is best at sandwich making and the best person for the job; may not be the same person. That was Ricardo's insight. Who will it be? It's tempting to say that the sandwich maker--could think of this as a competitive process, could be one person starts it and somebody else competes with him and drives him out of business, or a few of them might open up. Could also think about a cooperative process: there's fifty of us sitting around; which of the fifty of us should not be a hunter and should stay home every day? Either could come up with the right answer. Think about what appears to be the obvious answer and why it's wrong. Obvious answer is: let's have a competition. Everybody makes sandwiches; whoever can make sandwiches the quickest should be the sandwich maker. That's not true; will show in a minute. A second obvious but not true answer is: let's just take the worst hunter. The reason those answers are wrong was David Ricardo's great insight--you have to look at opportunity cost. Summary on website, Lauren Landsburg. What you give up is the true cost of making the sandwich. The cost of making a sandwich isn't money but the time you give up and what you can do with that time. Even though you're the best sandwich maker in the competition, you might be so good at hunting that it would be nuts to make you the sandwich maker; the market in a competitive process would never assign sandwich making to you because you give up too much coming out of the field. And even if you are the worst hunter, you could be so awful at sandwich making that you are better off staying a hunter. That was Ricardo's insight, that what you give up to do a particular task is really the determinant of who you assign to do a task. |
| 36:14 | Another way to think about Ricardo's insight also is that it matters who does what. You don't assign people randomly to tasks. If you want to make the pie of economic activity as large as possible, you don't just assign sandwich making to the best sandwich maker because that can be too costly. It could mean giving up a lot of venison if that guy is an extraordinary hunter. Which people do which thing is not obvious because you want to look at their relative abilities. One of the lessons here is--talking about economic output, maximizing the size of the pie; holding off non-monetary aspects, they do matter; if talking about the true size of the true pie we'd want to talk about those aspects as well. So, one of the lessons of the Ricardian insight and approach is: there are two ways to get venison. Direct way--you go out and be a hunter. Roundabout way--make sandwiches and swap them for venison. True for individuals or for nations. Trade is fundamentally in this Ricardian story--implicit cooperation where we leverage each other's skills. Important point in the Ricardian story: in a world where we are different, the pattern of trade that results is an illusion. The observed pattern of trade can fool us into thinking what the underlying cause of trade is. If you and I are in this primitive society and I become the sandwich maker; and after a few years have added fancy new breads and spices to the venison, improved the sandwiches a lot; an observer could look at it and would say it's obvious why he's the sandwich maker--he's terrible at hunting. And it would be true. After not hunting for five or ten years and running the sandwich shop, my hunting skills would probably atrophy. You in the kitchen would look inept trying to slice the meat or bake the bread. The pattern of skills is endogenous. It emerges. Depends on the technology that evolves. The person in Nepal who has to do all those things for himself, because there aren't enough people around him to specialize--Smith's point. By looking at the exterior, apparent skills, fooled. Self-sufficiency is the road to poverty. Nepal relatively cut off-tariffs, not a lot of good infrastructure. Spence podcast. To answer the question why the Nepalese person is so desperately poor and the American so rich: that Nepalese cook doesn't have as many people to exchange with; goods are more costly. Smithian because the more people you can exchange with, the more you can leverage the economies of scale; Ricardian because the more people you can exchange with, the more diverse they are likely to be and the more you can specialize. Ricardo story that there are differences is a different story in terms of timing than the Smith story. Ricardian story is about a point in time: at this point in time, given our skills and technology, it makes sense to specialize. The Smithian story is about the power of trade to change our technology in a much more dynamic way. Growth of innovation and technology, power of ideas and knowledge--Paul Romer point. |
| 44:28 | Question: We've said if there are enough people to trade with, and there could be some false starts, even if there are no differences in skills, then specialization and exchange--trade--makes us better off; and even if there is no difference, they make us better off. What is the difference between becoming a better hunter--making a better knife, creating a spear or a net--and having the opportunity to buy a sandwich on the way to the field? The answer is: there is no difference. It doesn't matter to me as a hunter whether I've got a better tool or can buy a sandwich--both allow me to become more productive. Both create time. Time is our most precious resource. That means there are only two ways to improve our standard of living. You can bang your neighbor over the head and take his stuff, or you can figure out ways to make your resources to be more productive. Steal or figure out ways to make your time, energy, skills to yield more. Two ways to be productive: add technology so that spear goes faster--fishing rod, better fishing rod, net, trawler--or specialization with trade, which allows us to use all of our skills. Theft or plunder, or increase our productivity. Two ways to be more productive: either increase our technology to be more productive, or specialize and trade more, taking advantage of technology. fundamentally all about technology, but one is direct and the other is roundabout. Over the last 300 years this has been the story of human enterprise. In the United States in the last century, an increase in our standard of about 10 times. More capital and most productive people based on their opportunity costs. But not everyone is better off every minute. A textile worker in North Carolina can have a lower standard of living today than a few years ago because of economic forces. Example: about 50 years ago, a typical North Carolina textile worker operated about five machines at once. Each capable of running a thread through a loom 100 times a minute. Today's machines are six times as quick--600 times a minute. That's the standard productivity change we think of. In addition, each machine itself is easier to oversee; so instead of overseeing 5 machines, each worker oversees 100 machines. Output per worker way up 20 times over; worker is 120 times more productive in total. Smith's point: maybe you should put the textile mill in China. But person in North Carolina may not find other work right away. The people who wear clothes benefit and have more resources to do other things, but the worker in North Carolina may suffer. Same true of farmers in 1900. This is how our standard of living improves. Overall our standard of living improves even though not everyone's situation improves at the same time. In about 1900, about 40% of our population was on the farm; today about 2% or a little under 3%. A farmer in 1900 told that would happen would assume people would starve to death and there would be riots in the street because people wouldn't have jobs. What happened was that new jobs came along. Economic change; Don Boudreaux podcast--everything we observe around us is the result of an enormous web of specialization and trade. Incredible blessing in United States--large country with open trade. We specialize a lot. Also true that even when economy is humming along there are going to be short-run challenges; but even when struggling they are doing better than people did hundreds of years ago. |
| 55:25 | More questions. This story about specialization and trade increasing our standard of living--Smith and Ricardo stories--what does that story have to do with borders between nations? If hunter is in Maine, and sandwich maker is a few feet away in Canada, does it change the conclusions about specialization and trade? Not at all. Borders have nothing to do with it. Both sides better off. What's the difference between Toyota figuring out a better way to make cars and Ford figuring that out? between finding ways to make your land more productive through fertilizer or better harvesting techniques and buying cheaper food through foreigners? They are the same. Obviously ups and downs. Question: in the real world we live in, David Ricardo's world, how do we decide who does what? Not just the 2x2 matrix of hunting and fishing. There isn't one. What steers people into different tasks are the wages, sending people into the most productive uses of their time. Suppose you believe you have a God-given obligation to use your skills and talents to serve mankind. How would you decide what to do? What is Roger Federer better at--tennis or fly fishing? Meaningless question. Surprising! Let's have him play tennis for a while and then let's have him fly-fish for a while. Maybe he's not just the best tennis player in the world but the best fly-fisherman in the world. Not obvious. It's the value of his playing tennis that matters, not his absolute aptitude. How good he is at fly fishing doesn't matter. Take Andy Roddick--one of the top 50 tennis players in the world--could be he's the best knot-tier in the world, so that's what he should do. It's the value of what your productivity produces relative to the other values of things you be doing. Enormous matrix; which as Friedrich Hayek pointed out would be an impossible problem to solve. You could never gather that information, much less use it to allocate people. The wages and prices steer people into their activities. Knot-tying doesn't pay. Once you put the value in, Roddick puts his energy into tennis. It could be that Federer is the best golfer in the world, even better than Tiger Woods; but he sticks with tennis because he loves tennis. That's okay too--that's the non-monetary aspect. You don't just take the job that pays the most money. You take the job that's most rewarding based on both the monetary and non-monetary aspects. You take the job that pays the most where the pay isn't just the monetary pay but also the satisfaction you get. Very few of us take the job that pays the most. Few of us take the job that takes the most. |
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| 0:36 | Intro. [Recording date: January 27, 2010.] Friedrich A. Hayek's view of the business cycle and money. Rap song, John Papola and Russ Roberts, at end of interview; video at EconStories.tv. Business cycle: What did Hayek see as the cause of the business, the booms and busts? Two scenarios. One: Central Bank independently decided to cheapen credit, expand the supply of loanable funds--Wicksellian phrase--ignite and investment boom. Second scenario more subtle: investors become more optimistic, new technology they want to invest in; come to banks and want to borrow more; instead of banks letting that drive the interest rate up, the Central Bank becomes involved by injecting enough credit to keep the interest rate from rising. So, first theory is the supply of loanable funds shifts first; second is that demand shifts first, but then the Central Bank shifts the supply to accommodate the demand. As the "real bills doctrine" used to put it: to supply the needs of trade. In either case, bad idea; drives the market interest rate below the equilibrium or natural rate and creates a disequilibrium between the plans of savers and investors. Investors are trying to invest more resources than are really available in the economy; consumers don't want to delay that much consumption. First scenario: Fed mistakenly or because of political pressure artificially lowers interest rates. That does what in the real economy that causes a problem? Think of investors having lots of investment plans on their shelf with different rates of return; interest rate serves as a rationing device, benchmark that an investment plan has to clear to make it worth it. As the interest rate goes down, more and more investment plans begin to look like they'll pay back enough to cover the cost. Plans come off the shelf, which increases the quantity of money. In particular, Hayek emphasizes: it's the most interest-sensitive plans that are going to take off in a low-interest environment; and those are the ones that involve a lot of time between the investment and the rewards being reaped--basic principle of finance. You discount your cash flows back to the present. If you can borrow just a little more cheaply, long term investment projects become more attractive. |
| 4:42 | Continue the story: Some projects get undertaken. Sounds good! More investment! What's wrong with that? There are only so many resources in the economy--only so many workers, equipment, raw materials; they get drawn away from more sustainable investment projects into these other projects that aren't appropriate for the state of demand in the economy, the time-preferences of consumers. Economy invests in roundabout production, early stages of long-term projects; other parts start to languish; shorter projects become starved for resources. Misallocation; which would mean that the pie is not as big as it could get. But that's not the end of the story. Projects that need a long time to come to fruition need continual investments; you don't usually investments at once and wait; you have to keep tending the tree. That's where the problem comes. As resources are expended to keep these projects going, they start to bid up the prices of labor, materials, and machines; other businesses find their costs of production going up. Input prices going up; not enough to go around. At some point it becomes clear that there aren't enough savings to bring all these projects to fruition and some have to be terminated--they aren't going to make a profit. Will lead to unemployment in those industries that made the wrong investment. In the last boom and bust, it was the housing industry that took off. Characteristic of the Hayekian process is where you see half-finished investment projects being abandoned because they will not be profitable. Half-built condominium projects on the outskirts of Las Vegas. But those were stopped because the interest rate changed; the funding changed. In the current situation--John Taylor's story--the artificially lower interest rates of the 2002-2004 period encouraged lots of borrowing and construction; but when raised by Greenspan in 2004-2005 they became unprofitable. In the Hayekian story, does it require the rise in interest rates? That's the usual symptom of their being more investment than savings. In the short run or intermediate run if the Federal Reserve is controlling interest rates, it comes through the news as the Central Bank decided that it needs to raise interest rates. They are bowing to the inevitable; scarcity of resources is pushing interest rates back up to equilibrium. |
| 9:35 | Wouldn't this also happen in any industry where there is innovation? Take the Fed out of it for the moment and talk about creative destruction--Schumpeter's term--the idea that innovation and new ideas come along, new business comes along; draws resources away from other areas. Price system tries to soften the transition; can't do it perfectly, imperfect information. As a new sector springs up--automotive industry at end of 19th century, internet industry at the end of the 20th century--people are drawn to these new opportunities; some will turn out to be failures. Not artificially induced by an artificially low interest rate. Amazon was unprofitable for a long time; profitable now. Took all kinds of resources that made it hard for other businesses to thrive. That's a healthy kind of growth; test is whether projects do become profitable. If because of new technology, economy has a new set of investment projects that promise higher payoffs in the future, people will be willing to save to provide investment for those projects. New demand for investable resources bids up the interest rate if the Central Bank allows it to happen. Hayek referred to this as the interest rate brake, preventing the economy from overinvesting. To bid the resources away from the current users, businesses have to pay a little more. Healthy, brings about economic growth. Problem comes in second scenario; if Central Bank decides interest rate ought not to rise and pumps in enough credit so that you get the new investments and the old investments, then you get the danger. Some will be profitable like amazon, but pet-dot-com didn't make it. Very often, an overinvestment or malinvestment boom piggybacks on an overinvestment boom. It's just allowed to go too far because the Central Bank is over-accommodating. What influence did the Austrian and Hayek theories have on real business cycle theory, the time-to-build work, Prescott, and others? Empirical puzzle for monetary malinvestment theories: Thought experiment: Central Bank changes policy, makes the interest rate low. We should see a burst of new investment starts. Hard thing to explain is why the change in investment persists even after the change becomes evident to everybody. That's what the time-to-build model attempts to explain: you don't just invest all at once; you have to make continuous investments. Mike Montgomery, U. of Maine, has written papers trying to apply the modeling technique of Kydland and Prescott to show that there's more mileage in the Austrian approach. Some have disrespected--not sure of verb looking for. Sometimes hear references to distress borrowing. |
| 16:31 | Role of expectations. When the Federal Reserve plays with the current interest rate, it goes down if we are talking about the current crisis, 2002-2004; low for an unusually long time, negative in real terms for a couple of years; most people expect those rates to go back up at some point. If I'm planning a long-term investment, say, with this time-to-build, delayed, ongoing investment--not so much building a house, but an amazon--will have to build warehouses, will have to advertise--will be pumping money in continually over a fairly long period of time. Why would I respond to low interest rates if I know they are only temporarily low--forget rational expectations--if I just reasonably expect that that's not going to persist? Wouldn't it be surprising if short-run changes in interest rates generate these long-term projects? Good question; has to be answered to make sense of Hayek's theory. If everybody had perfect expectations, perfect foresight about the path of interest rates, you wouldn't see this cycle. It doesn't require that everybody guess wrong. It just requires that too many people guess wrong about the path of interest rates, in order to get enough malinvestment to cause a problem. Piggybacked on sustainable investments. People are convinced now that it's a new era--This Time is Different, by Rogoff and Reinhart. Reinhart podcast. Sometimes Fed has encouraged this: Greenspan talked about the "new economy" in the midst of the dotcom boom. Supposed to be permanent, ever-higher productivity growth. Can get the problem. There's no doubt there's a wide distribution of savviness; uncertainty. Differences of opinion about how soon and how much; people want to make their money now and get out at the right time; uncertainty about how long the money is going to stay cheap. Political pressure to keep it cheap. Very, very low interest rates now; but artificially low; Fed trying to keep rates low for home-buying. Big spread now between short-term and long-term interest rates. Would avoid getting caught if you locked in for the long-term, but tempting to borrow at the low short-term rate and roll it over--and that's when people get caught out. U.S. Government doing that now. When U.S. Government borrows short-term, they have an incentive to promote inflation; can refinance their debt. |
| 20:54 | Economic history. Hayek's most important book on this subject--Prices and Production, 1931. Did he have a story to tell for what started the Great Depression? That was his story. His story was that the Federal Reserve and the Bank of England had injected credit during the 1920s and built up a credit bubble. Done it during a genuine period of high growth in the economy in order to keep the price level from falling--they were stabilizationists, inspired by keeping price level stable. Hayek argued said in 1933 that for several years he had been arguing against the stabilizationists. In an environment of growing output, it requires a continual injection of money to keep the price level from falling; and that injection of credit distorts the interest, and that causes the problem. Hayek criticized earlier economists who said that if the price level is flat, everything must be fine--that's not the indicator you want to look at. Argued that you want to look at relative prices, early vs. late stage investment, structure of production. Explanation for why the boom of 1920s couldn't last. Attracted a lot of followers. Something went wrong; by the 1940s, he was out of favor as a macroeconomist. Austrian business cycle theory neglected, almost forgotten by the economics profession. Why? Another guy came along--Keynes. Hayek was not the only guy troubled by Keynes's ascent--Schumpeter also was very resentful. Both are remembered fondly by other economists; but their work on microeconomics is well-respected, but it's their macro stuff that got put on the shelf. What happened? Events kept moving forward. Hayek had, arguably, a good explanation for the downturn. He didn't have such a good explanation for why the economy continued to deteriorate after 1931--continued to go down and stayed down for so long. He actually had a prescription for what to do about it. In Prices and Production--which we did at the time--he said that the Central Bank should try to stabilize the money stream--nominal GDP, or MV, money times the number of times it's turning over, V, velocity of money. If people are hoarding, inject more money. Also Milton Friedman's advice. But Hayek didn't say that based on his own advice, and later apologized for it: had fond wish that a little deflation would help break the rigidity of prices and wages and restore a more flexibly functioning economy--pipe dream. Did not call for Central Banks to do what his own theory called for--keep spending to continue from encouraging downward spiral. Other Austrians offered what advice for what they called a "secondary deflation." Kind of overkill, having economy going through this deflationary cycle. Hayek should have spoken out more against it; didn't do so. Viewed as having nothing useful to say about how to stop the cycle, even if he had been right about how it started. In that kind of environment, as Friedman has said, Hayek's picture of events was regarded as very gloomy--nothing we can do, had to let the economy purge the problems out of the system in the most painful way possible. When Keynes came along, it was regarded as a message of hope. Here's something we can do. We don't have to just sit by and linger in the depression; something active we can do. Same hopeful message a year ago with the stimulus package; hopeful message keeps selling. Idea that fiscal policy--playing around with government spending and taxes--has enjoyed a comeback. Thought it was dead; thought evidence showed it was too little too late or doesn't have any effect because offset by private spending. Reason may be view that the Fed is out of bullets--interest rates can't go any lower so they can't do anything. Think that's wrong. Some economists have rediscovered idea that monetary policy still is the thing that's ruling the behavior of the economy--if we'd prevented the shrinkage in nominal GDP, the recession would have been milder. Scott Sumner argument; podcast. Difficult to know whether that's right. Can't eliminate recessions that way. There were real malinvestments. When those are written down, real income has to decline. Resources are unemployed temporarily till they can find more sustainable uses. But you don't want to exacerbate it by making it hard for people to repay their debts because, say, nominal income is shrinking. |
| 29:06 | Money; what the Fed has done wrong. What should the Fed to get it right to avoid these booms and busts? What did Hayek say about what the Fed should be doing? Hayek had talked about the issue on various levels. When he took for granted that you should have a Central Bank issuing fiat money and asked what's the most neutral monetary policy they can pursue, what will do the least damage to the economy, he was always a strong opponent of inflation, against the idea that you could stimulate the economy in any useful way by cheap money. But he suggested early on trying to stabilize the spending flow in the economy--nominal GDP. In The Constitution of Liberty he later said that maybe a shorthand way of doing that would be to stabilize an index of wholesale prices. Still didn't want to stabilize consumer prices because of the problem he pointed to in the 1920s--you are injecting more credit when productivity is high, and that can cause a credit bubble. But instead focus on input prices. As the 1970s went on, and inflation got out of hand, he started thinking more fundamentally about the institutional arrangement: not what the Fed should do, but is there some institutional arrangement, some regime change, that would give us better performance than we are getting from Central Banks. Famously published a pamphlet in 1976 called Choice and Currency, where he said to protect ourselves against inflation, people ought to be free to use whatever currency in the world they find more stable. That would put a damper on the inflationary proclivities of any one Central Bank. Then he pushed it a little further and said why don't we let private firms into this competition; published a monograph: The Denationalization of Money--available on the web at IEA at no charge. Argues against the presumption that government has to provide money and imagines what would happen if private firms were providing money, and fiat-type money: money that is not based on gold or silver but based on the promises of these private banks that they would keep the value stable; might be more reliable than central banks have been. Easier to hold private firms to their promises than to hold central banks to their promises. Historical context: for those of us in our fifties living in the United States, the worst inflation of our lifetimes was in the 1970s, when inflation reached 13.3% in 1979. Scared a lot of people. In the last year or two, some question as to whether we've had deflation, if it was mild; but for somebody like Hayek, they had seen hyperinflation, not just in Zimbabwe, which we read about in the paper, but in many of the nations of Europe. In Germany, in the aftermath of WWI, hyperinflation led to political consequences, partly leading to the rise of Hitler. Fear of inflation must have been very different for that generation. Hayek in his correspondence with Keynes was very uneasy about the threat of inflation in the 1940s. Vigilant; this creature had to be contained. Under the institution of the gold standard, which prevailed for the early part of Hayek's life, there is no tendency toward a rising price level; some periods of mild deflation, even periods when output tends to grow a little faster than the price of gold. Anything about 0 in the price level is cause for concern. Hayek: need to look behind the scenes. Concerned about the consumer price index but also what was behind it, excess growth in Central Bank credit. In the 1970s, these inflation and consumer price index inflation in Great Britain was in the 20% range--much higher than the United States, very alarming. |
| 35:37 | Turn to The Denationalization of Money. If Hayek was proposing a private money supply, what would be the implications for his story of the interest rate as coordinating the plans of savers and investors? What would be the interest rate path, path of inflation, under a denationalized money in Hayek's view? Written about this: in The Denationalization of Money Hayek seems to switch toward favoring stability in the consumer price index, contrary to what he believed his entire career. It was his explanation for the crash of 1929. But in The Denationalization of Money he says private money issuers would most appeal to the public if they promised stable prices. Has a little footnote: Yes, yes, I'm among those who pointed out this could be a problem, but I no longer think it's a problem of much practical relevance. Trouble making sense of that. Think what he's saying is that when you are talking about Central Banks creating problems of 25% inflation, that's a much bigger practical problem than the malinvestment caused by trying to create a stable price level. Go back to 1931-1932 for a minute: talking about why Hayek's ideas fell out of favor. Gloomy story; waiting it out takes a long time. Others have argued that that long time wasn't Hayek's fault: there was regime uncertainty. Bob Higgs has argued that--Roosevelt frantically intervening in a lot of ways in the price system and the rules of the game, so private investment takes horrible tumble in the 1930s; could be for other reasons as well. Add in all these stories: Higgs: regime uncertainty; Friedman: money supply collapsing. Not just uncertainty about Roosevelt was going to do, but what Roosevelt actually did in the National Recovery Act and the Agricultural Adjustment Act. Organized agriculture to restrict output in the name of raising prices, in the name of restoring profits, and thereby prosperity. Non sequitur there: you can make one industry more profitable by cartelizing it and increasing its profits, but you can't do that for everybody because it only works by restricting output. If everybody restricts output, it's even worse. Industries restricting output are not going to be hiring more workers--they will be cutting back on all those things. Strange idea that still has some life of its own. |
| 40:09 | Piece of Keynes that is fruitfully tied into the story of Hayek: The role of animal spirits, psychology, fear of the future, uncertainty--reference in rap video we are about to hear. Believe Keynes was wrong that that was what causes business cycles, seems there is a part of what makes it difficult to cope with them. For example, equation of exchange, Irving Fisher: MV=PT. Amount of money times the number of times it turns over--that's total spending--equals the amount of economic activity time prices. People are holding onto money because they are anxious. So now people are a little more cautious. That's hard to measure. No handle on that; don't know how severe it is. Offsetting that with M is going to be an inherently difficult thing to do. That's why Milton Friedman said Central Banks have done a bad job of it and shouldn't even try. Should just target M, let it grow at a slow steady rate; fine as long as velocity is relatively stable. One argument would be that V is stable so long as the government doesn't mess around with M, so if M is stable, then V will be responding to whatever people are responding to normally, so pretty stable. Once the government starts messing with M, then V will be relatively unstable. Keynes: could stuck in 1933. Could not have a good answer, either as Hayek or Keynes. The one thing the government needs to do now is create confidence about the future; and that's the one thing that economists, psychologists, and government policy makers know very little about. New plan every week; which tends to undermine. Two problems: One is that people are trying to hang onto their money and not spend it because they don't know what's coming. More generally, investors are going to put off launching new projects until it becomes clear what the environment's going to be. Creating uncertainty in the tax environment just makes it worse. Once the Central Bank and the Treasury and whoever else has made the policy that has dug us into a deep hole, it's not easy to climb out. No magic bullet for doing that. Need to put stable policies in place to allow people to start planning for the future again. Argument for doing nothing; risky politically. Argument for the rule of law. But we have to do something--only if it makes it better--which seems to be the next part of that sentence. |
| 45:38 | White's ideas, arguments on money and the institutions that might lead to a better world. What do you think we ought to be doing with the money supply, and what is the role of the Fed, if any? What do you advocate? First best idea: not imagining will happen any time soon--monetary systems based on a gold or silver system in which banks compete to issue currency. Traditionally known as a free banking system. No Central Bank. All kinds of money supplied by private institutions. The private institutions discipline each other. Any bank that issues more money than its customers want to hold will find its money returning to it for redemption. It will be losing reserves to the other banks. Tradition based historically on gold and silver that the banks don't issue. Acts as a constraint; constraint made by banking system as a whole. Redemption: Would the redemption process be mandated by law or would it emerge through the competitive process? Part of the contract that banks have with their customers, so part of the competitive process. We have something like that today: your checking account is redeemable in Federal Reserve Notes. Your Federal Reserve Notes are the basic money. You can go to your bank and empty out your bank account. That's your deal with the bank. You wouldn't open a bank account at a bank that didn't promise to let you do that whenever you wanted. In the old days, people did that with bank accounts but the basic money was gold or silver coins, which banks had to promise to deliver whenever people wanted it. Mostly people open accounts so they can pay each other, so they can write checks; so banks have to make good at the clearing house on checks written to people at other banks. Checks come back: we just credited our customer with $50 because your customer said he needed to get it from you. That's the clearinghouse. Banks are always transferring reserves to each other; that's where this constraint is immediately felt. What would be the amount of the reserves that a bank would hold to engender my confidence in this world? The bank has to figure out what reserves it would have to hold in order to meet the redemption demands it has to meet at the end of the business day--at the clearing house. Empirically, banks have to figure this out. It's a practical problem. That's what bankers are good at. Historically banks, in the early days, when reserves were hard to replenish--it was hard to get a shipment of gold from somewhere else--banks would hold 30-40% reserves. As railroads were built, as banks became more sophisticated about managing their assets, gold and silver reserves sometimes went down to 2%. Those weren't the only resources banks had. They had very liquid assets any bank could sell. Any particular bank would have commercial paper or government bonds that it could sell very quickly to replenish its reserves. But banks were very vigilant about meeting all the redemption demands that came to them. But in those days--what period of time are we talking about? Most written about: Scotland, between 1720 and 1845. Very long time, trial. Canada had a fairly free banking system up to the Bank of Canada Act in 1935. Lots of historical experience with these kinds of systems. Kevin Dowd book collected experience in those times. But in those times, there were still runs on banks. What about the stability of the economy as a whole? Competition proponents confronted with "Well, before the Fed, established in 1914, we had all kinds of recessions, depressions, bank runs, problems, so even if you put the current crisis at the Fed's doorstep, and even the 1933, 1929 Great Depression--it wasn't all paradise before that. Free banking more or less stable than the current regime? Bank runs and financial panics were a problem in the United States in the late 19th century. Taken as the number 1 rationale for Central Banking and when Central Banking didn't solve the problem with deposit insurance in the 1930s. If you look around the world, don't just look at the United States, you find that bank runs and financial panics are actually pretty rare. Don't seem to be an inevitable consequence of having a fractional reserve banking system. Much more common in the United States than in Canada, where there are no financial panics; much more common in England than in Scotland. Begin to think: if you want a stable banking system, maybe it has to do with the way banks are regulated. The instability of banking in the United States is due to the peculiar regulations on U.S. banks. In particular, U.S. banks were not allowed to branch out; never across state lines and often not within states. That meant the banks were undercapitalized, under-diversified. Secondly, restrictions on banks' ability to meet shifts in the public's desire to hold currency rather than deposits. Known as the inelasticity of the currency. There was a ceiling on the amount of bank notes a bank could issue, set by the National Banking Acts. Panics have a history. They typically begin in the fall. What happens is farmers come to the bank and say "I need to pay my farm workers." They don't have bank accounts, so can't write checks. Banks would say "We're not allowed to issue more bank notes." Farmer says: but you still have to give me currency, have to let me redeem my deposits, so I'll take silver coins, or I'll take greenbacks--money issued by the government that served as reserves. A problem the banks could have solved by changing the form of their liabilities between deposits and notes turns into a reserve drain. The country banks start pulling reserves out of the cities; the cities then start pulling money out of New York, and then we've got a panic. In countries that didn't have these restrictions on banks, you didn't find those events. Created by our regulation; not a natural weakness. |
| 54:09 | Why do you think the Fed was created? Fed was created to solve these panic problems. But there was another way to do it. There were people in the United States who said: Hey, look at Canada--they don't have these problems. Why don't we look at Canada? That kind of reform was blocked by the small banking lobby. They said: Canada has nationwide branching of banks. If we allow that, my neighborhood is going to be invaded by banks that are better run than mine; I can't allow that. Of course, small banking lobby is hard to remember. Very powerful. It wasn't until 1995 that banks got to branch across state lines in the United States. In some states you couldn't branch within the state. Unit banking. Russ: graduate student in Chicago [1970s]: you were allowed to have two drive-up windows in Illinois within a certain radius of the main office. Illinoise, strange, anticompetitive. Texas also strange: two-thirds of the banks failed when the because they were not diversified outside Texas. Almost all their loans were oil-related industry or real estate. Part of the political problem: seeming unfairness of losing all your money in one bank. You put all your money in one basket; there's a run on that bank, maybe rare, but effect on you. Most of the time in American history, we let bad decisions yield bad consequences. You make a lousy car, your car company goes out of business. You may a lousy product, you lose your money. If you run your bank badly, normally we'd say you go out of business. But if it imposes a very large cost on a small group of identifiable individuals, the political demand for the Federal Deposit Insurance Corporation (FDIC) must have been part of the story as to why people wanted to get the government into the banking business. Surprising thing is how long it took to get Federal Deposit Insurances; and when it passed, it was by the thinnest of margins. Franklin Roosevelt (FDR) was actually against it--Governor of NY. Almost inevitably went broke, paying out too much money to failed banks. Not popular idea at the Federal level. But the FDIC has the backing of the Federal Reserve, and they can always print money. FDR letter to the Editor he wrote: FDIC, which he opposed, was a moral hazard. Deposits always guaranteed, so it will encourage bad investments. Argument he made and also made by large banks. Proponents of deposit insurance at the time were small banks: people think we are weak, but if we can look just as solid as the larger banks people will stop withdrawing their money from us and putting it into larger banks. Even the playing field. Triumph for the small bank lobby. If a problem arises from bank runs, there is a way for banks to anticipate and build in a a circuit-breaker into their contracts: Notice of withdrawal clause. Trust banks traditionally had this before Federal deposit insurance. What it said was: in the event we need to, you need to give us 60 or 90 days' notice before you withdraw your money. You wouldn't want the bank to invoke that on you; but you would if the alternative was everybody else in the bank empties it before you get there. You'd like them to invoke that clause on the other depositors. The 90 days gives the bank time to sell off some of its other assets, avoiding firesale losses. Historical research on bank runs indicates that the reason people run is run is not fear of people running. People typically ran when the bank was already insolvent. Healthy purpose of closing the bank before the bank lost even more money. True, the losses were unevenly distributed, depending on whether you got on the front of the line or the back of the line. In a way, that provides a useful incentive mechanism: monitor your bank and don't rely on other people to monitor it for you. |
| 1:00:29 | Just have the government monitor it. That way I can sleep at night. Unless the government monitoring system goes bad. Another contractual mechanism: extended liability for bank shareholders. In the Scottish free banking era, bank shareholders had unlimited liability--if the bank assets declined in value or had bad loans, a letter would go out to the shareholders saying you have to chip in. Banks did fail, but the depositors didn't end up losing any money. It was the shareholders. Scotland: great poetry, great fly-fishing, great single malt scotch, great model for how we ought to organize banking. Adam Smith; ironically now on Britain's 20-pound note. Competitive and innovative, training ground in the 19th century; spread throughout world; modern ideas on banking. Accidentally left haggis off the list of great Scottish contributions; swear on it, swear at it. Free banking politically unlike to be a starter right now. Never been a time in recent American history when people have been more hostile to a Central Bank. Remarkable. Ben Bernanke. Fix the Fed: get the right person in the job. Neglects the incentives the person faces in the job; changed for Bernanke from when he was an academic to when he was a Central Banker. Not going to talk about legislation. But pick the right person or tinker with the institution? Belongia podcast. Any politically viable small step we could make toward a free banking world without having to do it in one swoop? Open the door? Hard sell. Ben Bernanke's survival turns on the fact that he has critics on both the left and the right. Not going to agree on who should replace him; he will emerge as the compromise. Some incremental steps we can take; but don't expect free banking any time soon. Strong version of placing a binding rule on the Fed, path of particular economic policy. Haven't seen much willingness. Strong form--eliminate the Central Bank--unlike. But just as the U.S. postal system has become less relevant as private firms have been allowed to enter the market--overnight letters by UPS or FEDEx do not constitute an entrenchment on the U.S. monopoly on mail--less and less of a problem for consumers. Innovation in payments mechanisms will allow people easier access to other forms of money; might help constrain Central Banks. In the 1990s, Randy Crosner, competition between Central Banks losing market share and competition making them behave more responsibly. Offshore bank accounts, precious metals, more options; if the dollar becomes more iffy. Currently tax disadvantages to putting your money in precious metals--have to pay capital gains taxes if your gold holds its value while the dollar drops. You get taxed on that, even if you haven't made any real profit. Increase in money transfers since 9-11 even though we know the 9-11 hijackers got their money transferred through Western Union. Options we need to keep open. Chip cards, internet transfer. If I want you to build me a house: if I want to write a contract with you to pay you when it is finished, if I specify that payment in gold or Danish kroners or CPI-indexed--it's legal now. If the dollar and inflation got out of hand, the courts would enforce those contracts? Hugh McCulloch AER article said these contracts are now enforceable. Quietly been told that rules against commercial banks in the United States issuing currency have been repealed. Suppose no bank wants to stick its neck out and compete with the Fed. |
| 1:10:42 | Fear the Boom and Bust: Rap. Mono version. Stereo version available and video available at EconStories.tv |
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| 0:36 | Intro. [Recording date: January 18, 2010.] Commission on Growth and Development work, started in 2006. Background on mission and how it's unfolded. Mission had two parts: feeling on part of those who became part of the commission that the importance of growth is that it has been an enabler objectives, poverty reduction. Difficult problems in the developing world without the tailwind of growth. Never meant to be negative with respect to important achievements in health, education, other things. Complementary. Also, Washington Consensus that came together in the late 1980s-1990: experience accumulated in developing world: India, China; growth had turned up after a long hiatus in parts of the world, Africa, South America. Experience plus academic world; goal to assess what we still didn't know. Outlines of the Washington Consensus: put together put together principally by John Williamson with colleagues; attempt to try to understand what the key necessary had to be met in order for a developing country to grow and develop. Put together a list; even to this day sensible; list has been expanded over time. Problem wasn't the idea; it was the way it was interpreted. Interpreted as a set of policy actions by government, or a strategy that if you did that you were pretty much assured to grow. Turned out not to be true. Misuse of the Washington Consensus was that it was a kind of formula, necessary and sufficient conditions for growth. Now, most of us think of them as a close approximation to necessary conditions; sufficient conditions missing. Problem really was in the application; got turned into a prescription for a very limited role for government, including Latin America: the market will take care of most of it and if the government gets beyond a certain size it will start making things worse rather than better. That was not what was intended by the framers of the Washington Consensus. President Obama in inauguration speech: the issue isn't whether the government is big or small but whether it is effective at doing things that require collective action. Washington Consensus was an emphasis on markets, rule of law, private property; but also restraint on government spending because developing countries didn't spend their money wisely. Got interpreted to mean little or no government rather than wiser government. Wiser government tricky. Commissioners mostly policy leaders from the developing world; few exceptions: Bob Rubin--former Secretary of the Treasury--Bob Solow, modern growth theory and Nobel Laureate. Went in thinking it was fairly complex economics; came out thinking this is a lot about government and governance, not thought of as economics. 22 commissioners altogether, most from the "real world." Heads of central banks. Would have predicted in advance that it would be hard for politicians to be brutally honest; hard enough for academics. Was there a lot of political infighting? No. Harder in public forum; not speaking for one's country; output was the Commission's output. Their experience in their own thinking didn't always lead them to agree. Very controversial aspects. Decided to just say they didn't agree when they didn't agree. |
| 8:20 | Produced report about two years after the Commission was started in 2006. In 2008, Report came out. Sentence startling, might be first of the Overview: "Since 1950, 13 economies have grown at an average rate of 7% a year or more for 25 years or longer." Rule of 72: If you can grow at 7%, you double the size of your economy every decade. If you do that for 20 years, you quadruple the size. What was the secret? Learned two things; don't want to over-generalize from the successes; have to look at the failures and the also-rans if you want to get a complete picture. Understood that; used device to highlight some things. Openness of the global economy, by policy, wise policy on the part of the United States, European Union, advanced countries after WWII was the enabling factor. Two parts: huge markets for developing countries that can find a place in them; and a lot of knowledge they can import: technology, management capability. Increases productive potential much faster than you can do it on a standalone basis, or faster than the advanced countries can do it. Overwhelmingly the dominant factor, more than aid. Then a whole lot of things that go on inside an economy, some political, some economic that take advantage of that favorable environment. On economic side: very high saving and investment levels are critical, including on public sector side: infrastructure, education. Public sector under pressure in a poor country, so investing their 5-8% for the future rather than the present; have to have a supportive population. Takes leadership; people will make those sacrifices if they think their children and grandchildren will be better off than they are. People do that; but they have to believe two things: that it's possible and that their all in it together. Inclusive element that is essential. |
| 12:46 | Two aspects of public activity. Infrastructure in the United States: bridges, tunnels. In poorer countries, much more basic than that. Can't get the crop to the port; can't bring stuff from the port to the people; can't use a real truck. Educational part harder to understand. Lots of countries pour money into education but get no return; didn't get education but just spent money on it. Ironic for the father of signaling theory, which downplays education for its role in creating human capital and emphasizes its role as a signal to talk about its importance in developing countries. Inputs are more like requirements: if you have one without the other it tends to slow you down. Not surprising that economic development tends to start on the coast or around rivers; historically true, infrastructure already there. True in China case. Paul Collier: a lot of landlocked states in Africa. Infrastructure expensive; in a poor country tends to get pushed aside by immediate problems like disasters, famine. Not trivial things; crowding out effect dramatic on long-term growth. Most of these countries--Japan's an exception--were very poor when they started growing: China, Korea; Singapore was a poor fishing village. Big sacrifice, tough choice; requires inspired leadership. Education: academic studies using data and cross-section studies turn up a huge variety of results. Specification of the model complicated. It is true that there is a tendency to measure education by inputs to it--how much money is spent on it, how many kids are enrolled. When you measure the output, you get surprising and disappointing results; do not get good output in terms of development of young people; ubiquitous. True in the United States also. We often give it away, and people don't treat things they are given with the same care as things they earn. Subsidized education. Data support that. In many developing countries there is family commitment to education including financial commitment, in cases where it seems to be working well. In India, nobody monitors public employees. Resembles political machine from certain American cities; patronage system. In some cases young women don't get to go to school because when the family is under pressure, they are the ones who are pulled out. Complex challenge to up the quality. |
| 19:15 | Globalization: You don't want to just look at the winners. Any examples of countries that have cut themselves off from the global marketplace and have been successful? No; unable to find any. You can cut yourself off or try to partially cut yourself off and for a while lots of people thought that was a good idea. Runs out of gas; may look like it's working for a decade or so but not going to work for 25 years. You pay an increasing price in terms of cost or efficiency by taking that route. Examples even in advanced countries. Canada, Australia, and New Zealand all had very high tariffs, import substitution policy that developed their industrial sectors; have all abandoned them because the costs got too high. Can measure the costs: amount of protection you require to have an automobile in one of these countries; end up with tariffs that are effectively 80%; too expensive to support this strategy. Lose the economies of scale and lose that competitive edge. Runs out of gas: thinking of the United States and the big three auto makers. In a lot of industries, three competitors is plenty. But in the United States something happened in the 1950s-1970s that made the industry relatively cozy; something then happened in Japan that forced that the big three to work a lot harder and some of them couldn't do it. In a developing country, subtle aspect of policy: want to have the objective of being open and fostering competition, but it is possible to do it too fast. If you had relatively inefficient sectors and then expose them to global competition too fast, the Schumpeterian job destruction instead of job creation can get out ahead. Generally see countries that are succeeding going in the right direction but at a measured pace. Didn't make it easy for the automobile companies; many automobile companies elsewhere operate globally and build cars for countries where the price of gasoline is much higher. Managerial cultural dynamic. Get scale economics: Adam Smith, comparative advantage--what you are relatively good at and can compete in. Advantage you get from the global market. Seeing the potential for an enormously large pin factory that sells to the global market and thereby takes advantage of specialization and application of capital is the road to productivity. Also the road to vulnerability: dependent on the world economy; recent crisis. Lower variance if you are cut off from the global economy, but the mean is not very high. |
| 25:26 | Corruption. Challenge in these stories: government being the right size, enough to cover infrastructure. What role does governance play in success and failure? Important role. Wholesale corruption--grand theft--is devastating because there are just not that many resources in poorer countries. Banks in Switzerland and the Cayman Islands. Paul Collier. Major issue. When done well, effective leadership. Botswana: president came from the tribe where the diamonds were found, well-developed regional decision-making process at the tribal level; these belong to the country, off in the right direction. The other road is a pitched battle. Natural-resource-wealthy countries: competition to control the resources when cash flow is in a geographically limited place. In developed countries, resources relatively dispersed, in the brains of people. The most you can extract from it is via income tax, not like what people can do to oil and diamonds. Back to the 1950s: where in the developing were things predicted to go pretty well: Africa. Where major problems: they said Asia. Dead wrong. Underestimated the importance attached to human resources when developed. How were they going to make the single asset of people better. |
| 29:46 | Policy and how we might get more than 13 economies to grow at 7%. Collier and Easterly: Russ pessimistic about the ability of outside influences to do anything in the short run to help. No evidence we can help them; hope but no evidence. Optimism? Have tried aid. Other than opening our borders and trading is there anything the developed West can do for the less developed world? Can do a lot in humanitarian terms. Even countries that are going badly still think it is their business, so external influence, interference, not likely accepted even for poor countries. Humanitarian disaster, manmade or by forces of nature, situation changes. Palliative. Easterly and Spence don't agree on much agree on this; part company on how to think about the role of the state. Effective government, effective leadership an important input; so is the private sector dynamic. When they come together, powerful. Washington Consensus overreaction. Challenge is: selectivity bias. If you look at the successful states, their governments tend to be fairly well run. We don't know much about how to get from A to B. What are we going to do about that? Who is "we?" Not too pessimistic: demonstration effects have enormously large impact; lots of examples in that. China: Deng Hsiao Ping went to Singapore and then New York and it just opened his eyes with respect not only to what was possible but how you'd go about it; why the market was so important. India. A big neighbor, similar in size and population has a big influence. China now starting to have an impact on the developing world both in knowledge transfer and in using their resources. People worry about the international political economy. Nation, identity-building, adapting policies. Reasonable basis to hope we can return to that pattern in the post 2008 financial crisis period. In Brazil, grew rapidly till the mid-1970s, more or less stopped dead in its tracks for 25 years; now is growing very promisingly. Haven't listed those 13 countries. Cultural question: Japan, Korea, Singapore, China, all in Asia; India, close to Asia. How much is a good kind of contagion where the success of your neighbor puts pressure on you or you learn from your neighbors. Not a lot of success in Africa or Latin America to be copied. Any from those areas? Brazil and Botswana. Oman. Majority are in Asia. India and Vietnam about to join the club but haven't been at it long enough. We don't know; but it looks like the demonstration effects are more powerful regionally, so probably a cultural component to it. Hard to reach a definitive conclusion because there are other factors. One of the disadvantages the African countries have is that they are new. Conflict/tribal structure; not a lot of years in building national identity. When push comes to shove, do we all think we are in this together? Still building that identity. United States, China. Deeper questions about the politics and cohesiveness that turn out to be constraints on collective choice, policy, decision-making and investing. |
| 39:17 | What are the most exciting areas in research on this topic of growth that have the most promise? Work in political economy: incentives created by the economy and the effect of the political system on that and vice versa. Once you put the political system in the model and make it endogenous--rather than thinking of development as having exogenous government policy and the economy reacts, so the model is about the economy. The political economy research agenda is to make the politics part of the model. If you talk to policy-makers, they say it's like you're telling me you've got a model that's going to predict what to do tomorrow. Wonder about where are the levers. What's exogenous with this? Answers will turn out to be interesting. There are constraints on politicians. Creative part in developing country context has to do with sequencing things so you can get things done without too much political resistance. Recipe problem: you might know the ingredients--Washington Consensus--but don't know when to add what to what, don't know the process. Bob Solow used exactly those words. Recipes are country-specific. Nobody thinks that a country with a literacy rate of 40% is going to grow--certain things that everybody agrees on. Nobody thinks that a country where you have to take a horse and buggy to get inland is going to grow at high rates. |
| 42:54 | Practical aspects of the Commission. Two major reports. First report: requirements for growth, success. What are the prospects that people are going to listen to this? Does the nature of the Commissioners being non-academic help or hinder it? Helps. They are not anti-academic. Highly educated, came to work interactively with the best of the academic world. Conversely, the best of the academics benefit. Because of who the Commissioners are, the Report seems to have a life of its own in the developing world. Public attention. Growth rates of 10% are out of the range of the experience of the developed world. Most popular part of the report: idea of one of the Commissioners: fun, Bad Ideas. Smash hit. Email, newspapers: governments doing 18 of the 25. Good idea to put it in the negative. Anti-demonstration effect. |
| 45:55 | Haiti. Don't know how horrific it's going to be. Infrastructure: there's nothing there, not about buildings but about government, the normal channels you would go through in a developed country. Part due to so much being destroyed; part due to its not being a good system. Good opportunity to start over? Observation: very difficult to change things when they are not going well; but when they are going horrendously badly or there is a crisis, that's when you have a chance to change things. In a crisis the constraints that normally operate get removed. Lots of examples. Crisis doesn't always produce good results; does produce an opportunity. Make a massive humanitarian effort, and then keep going. Tall order. Have the resources; relatively small country; neighbors in North and South America; lots of relationships: Governor General of Canada is Haitian in origin. Reason to make a supremely large effort. As in every case, they are going to have to take it over. Let the Haitians move to the United States--if we had a different welfare system. Incredible challenge to deliver the aid. Could increase GDP worldwide overnight by 10% practically overnight--meaning in a decade--just by lightening up on immigration. Right, but a tough subject. Natural that some people would be opposed on personal grounds; others opposed on ignorance, assuming it would hurt us; others would be helped by having more folks here. Where young people are coming into job markets and the jobs don't match, enormous matching problem. Lots of countries where even the highest growth rates you can imagine wouldn't have the absorbing capacity for these people. Probably need supervision. In a country like the United States, people move to jobs and jobs move to people. In the global economy, jobs move to people, works pretty well. People are more constrained about moving to jobs. Not letting the pace of creative destruction get too far ahead of the labor market: crude understanding of the labor market. If you make it more expensive to hire and fire people, labor market more dynamic. But also risk, other things we haven't thought about. Right now, with 10% unemployment in the United States right now, it's still a dynamic place to be. In poor countries, creative destruction doesn't work the way it works here. Cultural, infrastructure, legal environment? Different thing. We don't understand it very well. Barriers in incremental employment creation are partially man-made. Relates to the political economy discussion. If you have a formal labor market and a huge informal labor market that is less skilled, less educated, you have a dual economy situation. If you try to work with the formal labor market, may not work very well. End up with barriers to the people who are not in the modern economy entering it. |
| 54:12 | Wanted to ask about second report; instead will put a link. Deals with financial crisis and global economic crisis. Instead: Spence, unusual career. Standard academic economist, innovative and sophisticated mathematical highest level stuff; became dean of a world-class business school--Dean of faculty of Arts and Sciences at Harvard first--narrow academic economist; academic administrator; changed gears to become dean of a business school, faculty who view themselves as largely self-employed, fund-raising; then win Nobel Prize; then chair international commission. What have you learned? Wiser than at age 25. Which experiences valuable, what relearned? Lucky to have these opportunities. Dean at Harvard and then at Stanford, viewed as leadership. Enjoyed getting to know the people; inside view of management as people were on boards. Commission: leaders in the political and policy area. Came to appreciate not only the people but how many different kinds of skills and capabilities and imaginations and intellects it takes to run a successful society and successful economy. Complex set of things that go into a productive, innovative, rewarding opportunity for society--have a sense of what that means. How can the rest of us understand that without following your career path? Everybody has brushes with this. Nobody ever has the complete picture. Society manages to run where nobody has the whole grasp. People's experience gives them a sense of this: institution they are in or their community gives them a chance to do something different from what they do at work. Young people are very creative; kind of have the advantage of narrowness of focus. Fixated on informational structure of markets and how that worked. As you get older--interview many people, contact with many people, tend to acquire managerial responsibilities--not just the direct experience. Maybe give up the innovative edge and acquire the broader view; sense of how important people and their values are in making things happen. Leadership from values, integrity. Focus: what people say about entrepreneurs; Adam Smith: grotesquely inaccurate assessment of their chances of success--which is a good thing because if they knew their real chances they'd give up. Narrowness of focus: in your 20s and 30s you think you know everything. Handicap, but advantage to it because you focus. Doing this program you learn how little you know. Not a bad system. Spence: Youngest daughter graduated from high school, gave graduation address; you need to understand that you are entering the period when you are most powerful and most creative. Later on you'll be wiser, more balanced. Natural cycle. Understand where you are in that and throw yourself into it. Interview with Commission is not meant to last. What next? Stay involved with things related to the global economy and the developing world; writing, research, teaching. Country level involvement. China, Latin America. Agenda bigger than time available. Indonesia, Commission member from there; switching jobs. Stay involved with the private sector, boards, investment. |
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| 0:36 | Intro. [Recording date: January 12, 2010.] Unusual format: solicited questions on Twitter (EconTalker) and Cafe Hayek; picked 10 most interesting, will try to get names right. Will do six minute answers; bell will go off, must finish sentence. |
| 1:44 | Craig Morgan: Story on National Public Radio about fresh water scarcity threatening mankind. Peak Water. Water is scarce and an important resource. Different from Peak Oil. We don't use up water, just make it temporarily icky or it evaporates. Good desalinization tool called the sun; brings water up out of the ocean and deposits it over land. Scarcity; separate two things: potable drinking water and storm runoff. All cities in the United States and Europe; heavy rain causes runoff and goes directly untreated into rivers. We can't manage all the runoff. We treat water as if it were garbage. Human feces is toxic waste; tiny amount can make a large quantity of water not only unusable but almost a bio-weapon. Take clean potable water and combine it with human feces and then spend billions trying to treat it. Rose George book, analyzes sanitation all over the world. Some cultures are fecal-philic and some are fecal-phobic. China and Southeast Asia use human feces for fertilizer; has a lot of nutrients, though it also contains e-coli and things that are deadly. India and the United States flush it away. Both wrong. The problem is not scarcity of water; the problem is we haven't dealt with the problem of human waste and keeping it separate. Pretty good job in the United States. We pour water into it! Our sanitation system works well, but our water system does not. We have shortages. Richard McKenzie podcast: southern California, not much rain, no shortage of Mercedes and Jaguars but they don't rain either. In poorer societies, struggle to deliver clean water through the public sector. Can the private sector do better? Should focus on sanitary handling of human waste; could deliver clean potable water. A public good would be getting rid of human waste--public sector could deliver that service. Water is a commodity; private systems could deliver that. Rose George book: talk about waste treatment. What mistake? Gold standard is a ceramic toilet inside your house that uses water-born sanitation. We try to approximate that. In China, a number of places are using dry biological systems that also produces a clean methane gas you can cook with. Never touches the water. Bell goes off. No reason to take it away from the house. Want to control odor and contact with germs. |
| 8:12 | Question 2, from Stephen and TX Sur [sp?]. Bubbles in our current economy. Can we identify bubbles? do something about them? Neoclassical economist. Adam Smith; correction, animal spirits talked about by John Maynard Keynes--group psychology. Used example: investing doesn't have much to do with fundamentals but more like a beauty contest where your objective was not to say which person was the most beautiful but which person everyone else thought was the most beautiful. Nothing about underlying fundamentals; just group psychology. Want to think that's just wrong, but it turns out that Vernon Smith and Charlie Plott, neither of whom would be associated with Keynes, have been able to replicate something like bubbles in laboratory experiments. Thousands of people who didn't know each other at computer terminals all over the world, supposed to buy and sell derivatives on an underlying asset which had a certain value and would fluctuate. They all knew that the value of this asset would go to zero at time 30--a month from now in the experiment. What would happen to the value of the option? For at least 5 or 6 periods after everyone knows the value of the asset has gone to 0, there is still trading in these options. Not surprising that people want to sell them; what's surprising is that people buy them. Why? Thought they could still make money and they were right until they were the last ones holding it. Ponzi scheme, chain letter. But Ponzi scheme seems like a fraud; in this experiment everybody knew the value of the asset was zero. Something like animal spirits might actually count in these kinds of bubbles. They play some role; we don't have a theory of animal spirits, though. For those who want to put bubbles at the center of investing, who want to get rid of the efficient markets hypothesis and bring behavioral economics and bubbles in as the default, pretty empty box. What an Austrian economist might call an asset inflation; wrong signal about the cost of funds, interest rates too low. Taylor Rule, podcast: Fed Funds rates were less than half that suggested by the Taylor Rule, sending a signal to investors that they could make a lot of money in housing; but it was artificial. At least as good an explanation as animal spirits. Way too much money in the housing stock, misallocation of resources. The Fed made it very cheap to borrow. It seems that everybody's really good at identifying a bubble after it's broken; not many people very good at identifying it before. Even the housing bubble--we artificially increased housing prices. Subjectivist with regard to pricing. Keynes's insight--price partly depends on what you think others will pay for it. Prices do seem to return to fundamentals. Bell. |
| 14:25 | Question 3. Agnostic asks: There has been an explosion in compassionate food--grass fed beef, free range eggs, pastured cows; little stories about treating animals nicely. Bottom up rather than top down regulation by the state. Arguments with vegetarians, who say it's exploitation of the animals. Better if animal had not been born. Cattle and chickens not so great as pets. Montana, mountain meadow, five beautiful cows and one extremely happy looking bull. Cow and bull heaven; somebody was paying for them to be there, designed it, because they want to sell them for profit. People might pay more for happy cattle, taste or health benefits. Or just don't want to be cruel. Peter Singer utilitarian argument--it's not obvious that it really is true that had those cows never been born that they'd be better off. Just the fact that at the end of their life they go into an abattoir--slaughterhouse for the SAT students--when they kill them cows, maybe they do it in a kosher way, allowing people to keep kosher. Paradox: if I am a vegetarian.... Suppose you really value the quality of life of animals, trying to decide whether to be a vegetarian or not. Have to say you favor a capitalist system that delivers meat to consumers because you care about animals. Nice that they are born and live their bovine life for a while. Couldn't live on their own; they would disappear quickly if there were no market for their meat. Strong opinions on this show; defend the vegetarian view: I'm not a utilitarian; all I'm saying is that I as a human being don't have the right to exploit animals. Totally happy with a world with fewer cows. Don't even have the right to bring them into the world to use them as an object for my pleasure. Have converted two utilitarians to eating free range meat. Have to look into the actual conditions; unnecessarily cruel. Why isn't there a middle ground--take cattles' lives with respect and then eat them. Temple Grandin, autistic woman self-described, developed ways to treat animals with more compassion as they enter the abattoir, with little or no increase in cost. Didn't answer the question: top down versus bottom up. Regulations would just raise costs. If what you did was, as an entrepreneur, find a way to appeal to more customers so they would pay more for better treatment. Some people find a difference in the taste because of reduced chemicals released in the frantic final minutes of a cow's life. Bell. Atlantic article about food and about Alice Waters, written by Caitlin Flanagan. |
| 21:27 | Question 4: Viking Vista [sp.] asks: What is the biggest deficiency in the study of economics today? More and more in a direction where they are studying economics instead of markets; more like a subfield of applied math. Adam Smith, when he wrote the Wealth of Nations, was interested in what causes wealth, but it was a subsidiary question. His earlier book The Theory of Moral Sentiments, was about when is it moral to act in your own self-interest? Under what circumstances can you build a society where people working in their own self-interest make other people better off is an important question; but modern economics doesn't look at either of them. Tends to look at the simplified invisible hand problem: can we show that with what economists call the first and second welfare theorems we actually come up with a competitive market at work. Assumptions we make in order to prove those theorems are absurd. Assumptions about competition, information, nonlinearity--decreasing returns to scale. Adam Smith--pin factory example: if you divide the tasks into 18 different tasks, you get a whole lot of pins; and you get trade and exchange. But that's increasing returns to scale. Economics should be about entrepreneurship, increasing returns to scale, and the way people go over the mountain and find ways to trade with their neighbors. Instead, economics now studies static situations. Old joke: guy comes out of a bar and sees someone on his hands and knees looking for something under a streetlight. Asks to help; guy looking for his keys. Asks where last seen; guy points over into the dark and says over there. So why not look there? The light is better here. Too painful. Economics looks in the place where the light is best, but markets are the place that's dark. Different question: Mike finished grad school, got job--what proportion of understanding gained post-graduate school? Lucky to be at a place that was Chicago-school-oriented. Advertising for eyeglasses and licensing restrictions. Read that literature, Alchian, Demsetz. Learned more, distrustful. First job at Federal Trade Commission; looked at airlines, trains. Like a post-doc. Learned, but because not an economist. For Russ, about 50% or more since grad school at Chicago; couldn't have understood then, not sure how to teach it in an undergraduate education. How do you teach people how to think like an economist, to understand the "and then what?" Mysterious. Bell. Biggest challenge in teaching undergraduates is that we have to give them a grade; hampers education. We only give out questions where we think we know the answers; otherwise hard to grade. Most interesting conversations with economists at lunch: why to sell cars is there such a strange price discrimination? CarMax pops up, different way of doing it. Both exist. We don't know the answer to that. |
| 28:21 | Question 5: David Williams. To what extent did Fannie Mae and other government-backed debt have in creating the financial crisis? Try to compare different costs. Crisis couldn't have happened without Fannie Mae and Freddie Mac--they were necessary but perhaps not sufficient. Government set a trap baited with three kinds of tasty cheese. We subsidized downpayment, terrible idea, reducing the skin in the game that people had in their own house and takes away the power of the signal about whether the person can manage finances in life. Second, artificially low interest rates. Third, guarantee of permanent price increases. Secretary Paulson in 2006 said that any decline in housing prices was a market failure and government would act--that's what government does--to prevent that. If you think housing prices are always going to go up--first rule of finance is that if anything is known to be going to happen, it's happened already. Fannie Mae and Freddie Mac, created 1938 and 1970 respectively; job called intermediation, find people who want to borrow money and get them together with people who want to loan money. Bigger packages. Problem with mortgages is they are illiquid--don't trade very well as assets. Risky to get the loan too far away from the house, so you have information about it. Big change between 1994 and 1997: definition of a "loan that was conforming." Conforming loan: one with 20% down and a 30-year ceiling on time for mortgage repayments. Dropped both of those: nothing down, 100% of your income could be devoted to your mortgage. Fannie Mae would still buy it at par value. Sisters of Mercy Orphanage could buy it as if it weren't a risky asset--government certified. Reason this happened: Housing and Urban Development (HUD) created mandates for Fannie and Freddie to give something back; they were making a lot of money. Wanted social justice; required them to devote a certain proportion of their business to those with low income. Started to raise that proportion between 1994 and 2006--Clinton administration initiative that the Bush administration embraced. Fannie and Freddie's lobbying effort respected as one of most powerful on Capitol Hill; making a lot of money from loans; government implicitly guaranteed the value of those securities. People kept pouring money into. At one point, $20 billion in new packages every quarter; even more than that. Housing had been a good hedge against inflation; bought a house, stayed in it for 30 years, and after it was paid off it appreciated at about the rate of inflation. American Dream. Once we started pouring all this money in, we destroyed affordable housing because the average price went up, just between 1997 and 2004--up from $150,000 to $250,000 in real terms. Looked like a bubble. Bell. Wasn't animal spirits, though animal spirits played a role because once prices start appreciating like that it can be rational to be exuberant about them; what stoked the fire was bad government policy. Trap. If we can get more people in houses they'll be better off--unless they default. |
| 35:12 | Question 6: John Strong. It has always seemed to me that a social order with free competition requires a high order of cooperation, much higher than a social order where competition is restricted. Makes you think about what is meant by cooperation. Two different kinds of cooperation. One is that I act in a way that advances your goals because of the way the system is set up. Get used to this tacit coordination or cooperation; still get what we want. Another kind of cooperation is where we have a meeting where we assign people tasks and all go out and do them because we care. Families cooperate that way--sometimes; tell son to mow the lawn and sometimes come back and he'll be gone. Mancur Olson, free rider problem. Two really different kinds of cooperation. Experimental literature: dictator games. Two of us; I go first. $100 on the table; I'll suggest a split--I get $60 and you get $40. You go second; you either veto or you accept. If you veto, we both get $0. If you accept, we get the deal I proposed. Rationally, should accept $40; should even accept $99/$1 rather than $0, and I know that. So the prediction for an economist is that everybody always proposes $99/$1 if they go first and everyone always accepts if they go second because $1 is bigger than $0. Lo and behold, that's not what you find. People will pay a price for fairness. Second person: will I pay $1 because the first person's being such a jerk? Will I pay $2? In Western Europe, United States, Canada, where people are used to markets--if you put them in an anonymous setting they propose 60-40 or 50-50, something close or an even split. If you go to a society that depends on that second sense of cooperation, families, clans, they always propose 99-1 and the other guy will always say no. Weird thing is, sometimes you see that three or four times. They both get zero and stay there because they are not used to impersonal cooperation. Impersonal cooperation is what markets are. Difficult to get into people's minds, but once it's there you get more cooperation. Other factors that may cause those results to differ. Digress: if you go to countries that did not have market-based systems like the former Soviet Union, hear a lot of stories of semi-market behavior where people don't have much trust. Guy plans conference in Soviet Union and right before it's about to start he's told he doesn't have as many rooms as promised. But I had a contract! So, sue me. In America that doesn't happen very often; people would feel like a jerk to be that opportunistic. In societies that are top down or corrupt, they struggle with that level of trust. Worry it's disappearing, especially in light of the bailouts. Play by the rules of the game and end up a sucker. Fragile. Rule of law isn't what sustains capitalism. Bell. Legal system is for last resorts. |
| 41:42 | Basic economics question, Question 7: Dave. Can you tax a business, or is it passed on to consumers? Complete answer was done by Alfred Marshall in his Principles of Economics. Simple answer: Depends on two things. If it's a tax on income--suppose we tax the profits of the business. Looks like it shouldn't have many distorting effects, like an excess profits tax. After the fact, we are just going to take a little slice. The more you make the more you take. You don't really deserve it; but you have enough incentives. But it encourages overcapitalized production in the sense that instead of declaring profits, the company is going to plow all its money back into robots, conference chairs for its executives, maybe overpaying its executives. So one of the reasons we have robots instead of workers is that the United States has relatively high taxes on corporations. So, who pays the tax on corporate income? Workers! It increases the wages of a few skilled workers, but it reduces employment. It drives companies overseas. Doesn't it make the workers who remain more productive? Yes; the few people who remain are better off, making higher wages; relatively skilled. Corporate income taxes hurt unskilled workers. Second kind of tax: ad valorem, or per unit, tax on the sale of products. Marshall: If a tax impinges on anything used by one set of persons in the production of goods, to be disposed of to other persons, the tax tends to check production--you can get less of it. Shifts a large part of the tax to consumers and a small part back to production. So, unless what is called perfectly competitive--for example, wheat. A tax on wheat would be entirely on consumers. If you put a tax on cigarettes, which is not perfectly elastic, some of that is going to be passed on to consumers. It's only the ones in between where the producer pays any of the tax at all. The distinction is between who pays the tax, who writes the check--the business writes the check--and who pays the check. Generally, it's paid by consumers or by labor. The incidence--the impact of the check--is rarely on business. Technically, it depends on the shapes of the supply and demand curves. One of the values of a formal education in economics. Russ's notes. Cheat and skip off this question: Russ has never seen American Idol; has seen the you-tube of Susan Boyle on the British version; has seen Simon Cowell; leaving the show, rumored that he makes $36 million. Wife thought he made about $600,000. Fascinating--no one seems outraged about that, but people are outraged about Wall Street bonuses, which are enjoying our taxpayer money. He's also enjoying our money--people who watch the show buy the products, which results in his higher income. Market process versus one that is rigged. Incidence question: we don't actually pay Cowell anything. We pay the producers of products, who buy advertising from television companies who buy shows from people like Cowell. The actual incidence of income is different from who pays. Just like for taxes: the person who writes the check--you don't really care who writes the check. Bell. |
| 47:56 | Question 8: Russell Wood. How would a free market economist advise his own child about the value of attending college? Mike: older son a sophomore, younger son a senior in high school. Three aspects: value added--education; signaling--this is the sort of person I am, I'm college educated; and the kind of college you go to sends a signal about that; third is connections--the people who are in your dorm that you are listening to, meet important people from your state at Harvard. Another thing in parentheses: people go to college to learn how not to become a jerk. Mike took longer than most people--went to college and then got Masters and Ph.D. Why people go to graduate school--takes them longer; nothing productive to give society. Germany has figured out it's cheaper to pay people to study than to pay them to go back to work. As long as they are in school, they are not unemployed; cheaper for the state. Colleges offer different mixes: do you care about the education, the signal, or the connections, and in what mix? There are a lot of ways to cut costs if you look at private colleges, very expensive; a lot of value as signals, lots of connections, people you want your son or daughter to hang out with. No single answer. Which is better, chocolate or vanilla? Part of it depends on taste, on objective. A free market economist would advise his child to think about what I want to get out of this; and how much do I want to pay for it? If you are constrained on money then taking AP courses or courses during the summer makes a huge difference. Can go to a top college; can get in and not spend very much money by trying to economize on the time spent there. Russ at George Mason, state school; Mike at Duke, private school. Russ attended North Carolina as an undergrad, public; Chicago as graduate school, private. Two things to add to list: more important what you study than where you go, some places really good for a particular subject, most okay for most things. Deeply important is the ability to write. Advice: communicating, written, verbally; even PowerPoint. Resume: being at a State school it's really easy to say it doesn't matter where you go; but true based on other experiences. Both compromised in answering this question. Paper: how little time students spend studying today compared to 40-50 years ago. Many better ways to spend your time if your goal is education? People are emphasizing the signaling and connections part. High school where you could take the equivalent of three years of college calculus. Bell. Guidance counselor then said to son: You don't have to take any math in college; you can do other things. Called and said he had pretty clear talents for math; why would you tell him that? Guidance counselor said I didn't take any math and I turned out okay. A lot of the people we have advising our students are not focused on engineering, science, creating new things; view of college as a finishing school, learn to play the piano and sing. Component called "fun"--does take up most of what has been liberated by the reduction in studying habits. Nature abhors a vacuum. |
| 55:21 | Question 9: Marina. Thoughtful email, gist of it was: There are many charities that collect money from donors to fund cures for diseases, problems, etc. They tend to focus on a particular strategy for curing a particular disease. If a maverick comes along who has a different approach--long shot, mavericks usually wrong, but occasionally right. Ulcers, originally thought to be caused by anxiety and worry; turns out there is a bacteria. Ridiculed, mocked--could be wrong, but could be a threat. Charities care about power and money like everybody else. Ironic: they are humans. One of the first insights of public choice: there is no moral transubstantiation just because someone leaves a market firm and goes to work for the government or a nonprofit. Says they care about people in their mission. Thomas Kuhn, Structure of Scientific Revolution--there's going to be a lot of resistance to new ideas. Some might just be that the existing ideology is a sunk cost, an asset. Human beings going to say they are not so sure about that. Marina in her question gives examples of people not just objecting but going on the attack, spreading rumors. Competing fund-raising source. New entry, private firm may have to be stuck with a competitor. Any relevance to University of East Anglia trove, that suggested that perhaps scientists involved in global warming studies were attacked--people who disagreed with the idea of global warming? Might be just from science, truthiness, truth that transcends mere science; they know that what they want is right; might be a little inconvenient for now. Big harm in public relations' sense; need to suppress facts. Difficult to explain why when the temperature should be going up, it is actually going down. Noted economist on you-tube video: his model suggested there wouldn't be a global crisis if the housing market tanked, not ready to give up on that yet. Digression: strange how cynical we have become. Culture so focused on cynicism, irony. Watch old newsreels and ads; changed. Parts of citizen that haven't grown yet. Cynical about government, but not their Senator. Cynical about business, but not science because romantic illusion about scientists. Have to have some inherent naive trust in some class of human beings. President Obama. Want to trust people. Interesting that we don't make more mistakes than we do. Bell. |
| 1:01:56 | Question 10: Russ asks Mike. Economy is not doing very well. Ten percent unemployment, falling labor false, so drop from 10.2% to 10% was because some people gave up and stopped looking. Lots of challenges on horizon--massive deficit, growing debt, promises for government entitlement programs, apparently dysfunctional political system, list goes on. Yet optimistic about the future. Will your children have a better life than you will, have a better standard of life than you? Is our future dark or bright? One thing that has made America successful is: what is the American Dream? Central creation myth, not the political one but the economic and family one: if I work hard and provide an education and a house for my children, they will be better off than I was. So the reason I am going to work hard and sacrifice, give time and read to them, is that they will be better off. The world over time gets better. Immigrants certainly believe in it. Do Americans believe in it? Many native-born Americans believe it, sacrifice, work two jobs, send kids to school, whereas they couldn't in their home countries. Evidence on social mobility: less upward social mobility than there was even 20-30 years ago. People are born to a particular class-income percentile; more than used to be stay in or fall from that same percentile. Change in education--people don't work as hard because they don't see the benefits. Suppose you live in Detroit, jobs you depended on either aren't there or disappeared when someone is 56. Shaking that optimism. Russ: data on mobility tricky. Relative versus absolute: may be stuck within same quartile, decile, or quintile, but all moving up. Russ: Shocked at how hard children work in high school relative to how hard I worked. Dumbing downs, but lots of homework. American Dream easier than ever if you graduate from high school and go on to something serious, you will thrive. Immigrants who do that move way up. Most of the mechanisms are still there. Interesting distinctions: in some ways easier than ever before to achieve something like the American Dream; if you work hard, so many opportunities. Computers, cars cheaper; better off than parents if you just work for it. But many young people don't work for it. Divide into two cultures. |
| 1:08:25 | Close with a different point. Email us if you like or don't like this format. What makes America special is not its success, but the extraordinary opportunity it gives people to pursue their dreams, whatever those dreams are, vegetarian, musical, entrepreneurial, loud, adventurous, quiet. Give people the opportunity to choose their path in life. Book, Price of Everything: there is no weaver of dreams. No one whose responsibility it is in a capitalist system to make sure everything fits together; yet in America it fits together harmoniously. Dreaming and creating. Rising role of government in deciding who wins and who loses; in America till recently much less privilege. Worry. Blame not government, but voters. Rule of law. Interesting: informal institutions, market, educational. We want to mess with it; that gets rid of its genius. Claim on other side is we have to mess with it because only the elites get their chance. Data suggest otherwise. The more regulation, the more likely to shunt people into positions they have already occupied. How do we get voters to be more interested? |
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| 0:36 | Intro. [Recording date: January 6, 2010.] Federal Reserve: What does the Fed do now? What is the range of activities. Responsibilities in three broad areas. Most attention given to its responsibility for monetary policy. Greater scrutiny now for its responsibilities for bank regulation and supervision. Least to third area: provision of bank services--check clearing and cash distribution. Twelve regional banks with oversight by Board in Washington. When we read about the Fed deciding to change or leave the Federal Funds range unchanged, what do the regional banks have to do with that? Input in policy meetings from the local offices; variety of opinions coming from the regional bank presidents, ease or tighten. To outside world, some difference of opinion. In practice, it depends on the strength of the Chairman and what the individual presidents wish to do. Chairman and Board staff tend to run the show. Appearances aside, regional bank presidents do not have all that much input into the making of policy. Two reasons for that: one: If the Chairman cannot get his way in policy, he doesn't stand as Chairman very long. True often in the Volker era--much scrutiny of key policy votes; speculation that the Chairman was not in charge and might be time to be replaced. Strange. In essay, observed when Greenspan was Chairman, at Federal Reserve Open Market Committee (FOMC) meetings, exercised control in duplicitous way. At FOMC meetings each of the 12 regional bank presidents and other 6 governors would take turns going around the table summarizing their idea of where the economy stood and whether current policy should be maintained or perhaps a move should be made on the funds rate. After everyone had spoken, Greenspan could get an idea, say, if he wanted to move on the funds rate, if he had the votes to make that move. If he didn't have the votes, he wouldn't propose a policy change. Committee would vote and announcement would be made. FOMC meeting on Tuesday. On Friday morning, the Board of Governors of the Federal Reserve--the 6 members--meets with the Chairman. Noted macroeconomists, bankers, appointed as political payoff: backgrounds vary. Greenspan comes into the room with a recommendation from one or two of the regional banks to change the discount rate and call for a vote--not the Federal Funds rate. Federal Funds rate is the rate banks charge each other for overnight loans; Fed intervenes to affect that rate by either injecting or taking out money to get that rate to move to the Federal Funds target. It's a competitive, market rate. What's the discount rate? Set administratively by the Fed--it's the rate at which member banks can borrow from the Fed's discount window. If a bank's reserves drop below its required reserves, it can get money from the Fed itself--direct borrowing from the Fed. Supposed to be used as a lender of last resort occasion, when member banks are solvent but temporarily illiquid. Not a market rate--Fed just sets it. At the time we're talking about it was below the Federal Funds rate. So, Greenspan would propose a change to the discount rate on Friday morning. To do that he has to have a proposal from one of the 12 regional banks; typically would be one bank. Vote would be in favor of changing the discount rate. Unanimous or one dissent; if no big majority, Chairman's authority would be brought into question. Board would vote with the Chairman. |
| 10:41 | What's the impact of that? When the discount rate would change, there would be wider spread between the discount rate and the Federal Funds rate--assuming goal is to ease policy without the consent of the FOMC. For "technical reasons" would do a corresponding pass-through change in the Federal Funds rate--so if moved 25 basis points on the discount rate, would instruct the desk that for technical reasons they should move the Federal Funds rate in the same direction and by the same amount. What you've done is divert the will of the FOMC. So Greenspan lowers the discount rate and then says to the open market desk that they'll want to move the Federal Funds rate by that amount, too. Not well known. None of the regional presidents every spoke up. Two bank presidents who were strong allies of Greenspan, would go along with anything he wanted; but this had gone on for a number of years. Trying to draw Greenspan out of the bushes--will we be sandbagged again? Nobody said anything. Now back at U. of Mississippi, but Belongia was there at the time. Information content of this ruse: the Press reports on the Federal Funds target that comes out of the Tuesday meeting; Greenspan made sure that was supported by the people in the room; but on Friday maneuvered differently. Is that reported? Can look at the record--about a half dozen or maybe more over a three-year period, between about 1989 and 1981. Not particularly sinister--not covered up. Wall Street Journal, NY Times would report it on the Friday. |
| 16:19 | In essay, suggestion that we don't need the regional banks, or we don't need as many. Begs the question of what you want the regional banks to do. In essay, point out that when Volker was Chairman, he vetoed the choices of two local Boards of Directors of who was to be the local bank president. Vetoed jerry Jordan at Atlanta and Lee Hoskins at St. Louis. Both well-known monetarists; both had well-established records of what they believed in. Reported in the press that Volker wanted the strongest dissenting voice to be silenced. Volker wanted research department shut down. Arthur Burns--more sinister way. Jordan had been director of research briefly at St. Louis, track record of monetarist tendencies. Could make the case that Volker didn't want people like that as regional bank papers. Either you want strong independent points of view, or get rid of them. Strange assessment of Volker's motivation: most of us think of Volker as a monetarist. He wrung inflation out of the system in the early 1980s, late 1970s; recognized role of money supply in creating inflation; raised the Federal Fund rate through open market operations. Interesting alternative: Alton Gilbert, long-time member of the St. Louis staff, had a paper censored by Volker around 1980 or 1981 that was subsequently published in the St. Louis Review about 1985. Used confidential data from the NY Fed's trading desk to demonstrate that at the time the Fed was allegedly doing monetary targeting, it was doing anything but that. Was set to give this paper at Karl Brunner's monetary conference when he was sent a memo ordering him to destroy all copies of the paper. Argument Volker gave was interesting. The paper only included means and variances of the data; but argument was that someone could possibly construct the individual trades from a table of means and variances. Two people walk into a room and average height is six feet tall; presumably from that you can construct their individual heights. The expressed reason is not really credible. What was the worry? The Fed was still fooling around with interest rates. Didn't they say that was what they were doing? Allegedly, after Oct. 6, 1979 famous Saturday emergency meeting they were adopting a policy of targeting the aggregates. Presumably continued that policy until October of 1982, when the misbehaving aggregates caused them to switch to something else. Fears of losing credibility or something else; paper was feared as being critical of what they'd done. |
| 22:58 | As a grad student, Russ was taught that the Fed controlled the money supply; as time passed, the Fed became focuser on the Federal Funds rate. In 2006 Friedman podcast, he said the Fed says they are targeting interest rates but what they really do is target the aggregates; if they do that the economy does well and if they don't the economy doesn't do well. What's your take on that? Paper in the 2007 issue of Public Choice--old argument, Allan Meltzer, Brunner, and Friedman have made it. Source of confusion about how the Fed falls into mistakes. The Fed has a single tool, open market operations, where it injects or removes reserves from the banking system. With that, it can try to hit an intermediate target--an interest rate or the quantity of money. What information do you glean from that intermediate target? For most of its history, the intermediate target the Fed has pursued has been an interest rate--precisely how they get into trouble. Why do they get in trouble? As a market-determined price, it can change because of changes in the supply of reserves or the demand for reserves, independently of the Fed's open market operations. The Fed believes every change is a result of their actions; do not make allowances for the possibility it can change because of a change in the public's demand for loans, which will in turn affect bank reserves. Consider what happens if we go into an economic downturn. The demand for loans will fall. In turn, the demand for bank reserves will fall, because reserves are an input to bank lending. The Fed will see a decline in the Federal Funds rate and mistakenly assume they have been overly expansionary in their provision of reserves to the banking system, and will tighten up, give an instruction to the desk: we've been too accommodative, so let's drain reserves, exacerbating the economy's decline. In the summer of 2008, everybody has been saying the Fed's been really easy; look how low the Funds rate was. Op ed piece, not accepted by the Wall Street Journal, pointing out that the 5-year growth rate of bank reserves had been slightly negative; Fed had been restrictive for a 5-year period. No wonder the economy was on the verge of a recession. Funds rate: signal was Fed had been easy. In reverse, get the same thing during an upturn; demand for loans rises, so demand for reserves rises, which pushes the Funds rate up; the Fed looks at it and thinks they have been too restrictive and start to loosen precisely as the economy is expanding. Scott Sumner podcast: we often mistakenly look at the funds rate. The Fed itself gets confused--confuses its proxy for the money supply, the target it wants to be manipulating. What a regional bank can do if it gets involved in the process. In 1976, Journal of Monetary Economics had a series of essays in honor of Homer Jones, director of St. Louis Fed between 1957-1971. He introduced many things that the modern Federal Reserve accepts as given, such as hiring economists to write scientific articles and holding conferences and publishing data. One of the essays, written by Jim Meigs, worked at St. Louis Fed while finishing his U. of Chicago dissertation, traces a number of things in the policy record, things the 1959-1961 St. Louis president was trying to introduce--ways that the Fed was operating, confusing being tight for being loose. Not much difference now from what was going on back then. How little things have changed in the way the Fed does policy, not operating as an academic research department trying to impress its professional colleagues but focusing on making a difference in the monetary process. Theme: The different regional Feds have economists who write on all kinds of things, like different economics departments at universities. Suggesting that they should write on monetary policy. They write on all kinds of things. It has become strange. Pressure from interest groups, pressure from boards of directors, vision of individual bank presidents, and also pressure from the Board of Governors. The Board of Governors would like nothing better than to have the 12 regional banks work on ice fishing--anything other than monetary policy. Economists who would like to write about ice fishing like it that they are pushed that way, but that's a small group. Other areas the Feds write on. People who work at the Fed enjoy the freedom to write on their topics of interest and don't want to just write on assessing the Fed, so they like that. Power. |
| 33:38 | Recommendations: makeover for the Fed. Making the Fed more accountable. Essay recommendations: shrink the regional banks since they are not doing the role of helping critique and measure the Fed's policy but merely cheerleading or doing something else with taxpayer money. Fewer? What else do you recommend to make the Fed more effective? The reason for shrinking the number of districts from 12 to 5 is motivated by a number of things. The price services function, check clearing and other things the Fed does has declined enormously. No reason today to have the volume of services that needs to be done. Fed's supervisory and regulatory function, advocated by Volker and possibly Greenspan: if you are going to provide a stable and sound payments mechanism, the Fed only needs to supervise the 100 largest holding companies. How many does it supervise now? It supervises Federal Reserve member banks--a lot of institutions, many small and don't have an integral role in the payments system. Could reduce, focus regulatory function on a small number of large institutions to keep the payments system sound. If you are going to keep bank presidents as voting members of the FOMC, some bank presidents now get a vote only every third year. Hard to take things seriously. Permanent voting members. Political economy weird: whatever incentive the Chair would have to pick those regional bank heads now, would really try to co-opt those folks if they could vote every time. Begs the question of who appoints them. Currently appointed by the Boards of Directors of those regional banks. Under the current structure, the Chairman has the option to veto. Prefer to see them appointed by the President and confirmed by the Senate as the Board of Governors are, to take that veto power away from the Chairman. Far too much meddling. |
| 38:11 | Going to more philosophical issue: as a body politic, comforting to voters to think there is a maestro at the Fed. Alan Greenspan Times Man of the Year in 2001--not quite as popular today or as respected. Today, new maestro--Ben Bernanke! He understands, pulled us back from the brink. Idea that there might be five independent, thoughtful folks who might disagree would pull the curtain back from this charade that the Fed is led by this all-seeing wizard of monetary policy. Hard to do. Not always clear what is the "right" Federal Funds rate. Problem, essay: things have been made a mess by Congress's insistence on a dual mandate for the Fed, which is something we know is impossible from basic economic theory. Tinbergen gave us the mathematical result: the Fed has one instrument--one lever--and with one instrument you can at most pursue one independent objective. Congress tells the Fed to pursue full employment--which you can couch in terms of full output--and price stability. Built into the system an impossible mandate for monetary policy. Mostly the bank presidents run around embracing this dual mandate like little schoolgirls: We have this dual mandate! Instead of saying to Congress, we can't do this; tell us to pursue something we can achieve, such as price stability. Most schoolboys. Embarrassing. Want to keep their jobs. Social mission, community development, distractions, politically what they have to do to stay in office. Jobs not that threatened. Don't know that any regional bank president has ever lost his job for saying this; haven't said it very often. Would at least serve one term, not in danger of being unemployable. Responsible to go out the promote the idea that this mandate can be embraced when it is something that cannot be achieved. |
| 42:48 | Taylor Rule? Two inputs: size of the economy and the change in inflation. Two goals; feedback loop. John Taylor argues that when the Fed is doing its job well, they can handle these two things; need to keep the economy on an even keel. Assessment? Don't buy any of that. Which Taylor rule? Brad deLong's site: John Taylor's rule or Glenn Rudebusch and others--completely different Taylor Rule. Two give wildly different answers. Can add to this mess the Taylor Rule as interpreted by the St. Louis Fed, plotted on p. 10 of Monetary Trends and show what it implies for different assumptions about the Fed's value for target inflation. We know how quickly the economics profession discarded the monetary aggregates in the 1980s when they so-called started to misbehave--M1, M2. If the profession started to apply the same impatience that they applied to the monetary aggregates to the Taylor Rule we'd have stopped talking about it a long time ago. Why so attached to the Taylor Rule? If you look at, in Monetary Trends, Fed was targeting very high inflation rates in the recent past; but does anyone believe that? No. But people are attached to it. Take on trying to achieve two goals; Scott Sumner. Nominal GDP targeting was popular in the early 1990s; Bob Perry president of the San Francisco Fed at the time; wanted to give his take. Sumner podcast: GDP rising in current dollars, want money supply to fall; if falling, be more loose. Change Federal Funds rate accordingly. Gets at notion of looking at prices and real output simultaneously. Bob Perry wanted to talk about nominal GDP targeting at the time and thought that a 6% growth in nominal GDP would make sense. Inflation at 3%, real output growth at 3%, so nominal growth would be 6%. Small meeting of Fed economists; San Francisco Fed; Milton Friedman at luncheon and said: "This is all nice, Bob, but tell me what you would do if you are at your nominal target of 6% but you have 7% on prices and -1% on real?" Awkward. Stagflation. High inflation, economy is growing negatively, recession. Doesn't take a great deal of imagination to envision we could be there a year from now--low employment, prices start to take off; housing overhang but real economy still not in good shape. What does Fed do--nip inflation or handle real economy? That's why Congress has given them two targets--Congress doesn't want them to focus on inflation in that world; they want them to get those people back to work. Right? Ignore one. Can't solve both at once. What most people have in mind is two goals, sometimes one is more important than the other, so focus on the important one. Dynamic inconsistency of optimal plan. Changes in tax rates; the only thing monetary policy can deal with is price stability. |
| 49:54 | How would you get there? Not the Taylor rule. How should the Fed achieve that goal of price stability? Fed get back to its business of constructing monetary data, which it is not currently doing. Indict the Fed on failing to collect and publish accurate data on money. Isn't that what the Fed does? What's wrong? They are publishing data on money, none of which is scientifically valid. The data it publishes comply with no economic or statistical standards that would be recognized by economists or the Bureau of Labor Statistics (BLS). Meaningless data. They publish M1, M2--why not statistically reliable? and what should they be collecting? Problems complicated by Sweeps programs. When you begin to pay interest on deposits--checking accounts, banking system--things should not be added together, but weighted differently, just as components of the CPI. Not just p_1 + p_2 +p_3. Don't want to weight sardine prices with heavy equipment. What happened within the Board of Governors' special studies section in the late 1970s was that work was done to figure out how you would create expenditure share weights for currency, checkable deposits that didn't pay interest, checkable deposits that did pay interest, as well as where you would draw the dividing lines. Not clear that M1--current definition--is the dividing line. Might be M1 plus some other things. Some work stalled; should be going on at the Board of Governors: weighted measure of money. Don't think that much of the consumer price index (CPI), so that's not so exciting as might be hoped. Casual, not technical. Weighted measure by expenditure shares, weighted by expenditures on monetary services. International data on this don't behave anything like the official accounting data; give you different inferences about testable hypotheses about future course of inflation, course of money in the cycle, etc. Fed reconstructed their index of industrial production in this manner; but have done nothing with money. Hide the truth or other things? If we had a good monetary series, what goal for the Chair of the Fed to do with those data? People advocate, small group at least: keeping the supply of reserves on a stable path that would keep the inflation rate low and stable so that people can make long-term planning decisions. Monetary policy can't influence real variables in the long run; can't fine-tune the business cycle; no evidence to support idea that monetary policy can do much more. By pretending it can do other things it introduces uncertainty into the world. Politics of the Fed, seems kind of dysfunctional. Get rid of it and have private money? Would impose lots of information costs. Chairman of Fed instead of being elected man of the year might simply be the most boring person in Washington. Ought to put him in the basement of a building with stereo system and food and not let him come out for a year, not talk to the Press. Bill Belichick school of monetary policy. Fed Chair gets praised for his crypticness, so put him in the basement and don't even let him be cryptic. Just let him be boring. Counterpoint: Greenspan running out and saying things about irrational exuberance, Fed's responsible. How does he know what the right value for the DOW is, and all of a sudden you have all of these ancillary targets that have absolutely nothing to do with anything. Should have been fired after that speech. Define a bubble; when was last time anyone was able to predict one in advance? And if you want to deflate one, what are the costs to other things going on in the economy? Exchange rate target--now up to four targets: keep dollar stable, inflation stable, employment stable, and no asset exuberance of the wrong kind. |
| 1:00:15 | Transparency and accountability. The Fed needs to be more accountable. The Fed now has more than $1 trillion in housing loans on its books. Bizarre: launched into this whole new area. Whole new area--got to keep mortgage rates stable and have everyone able to buy a house. What should be the political influence on the Fed? He's a political animal. Hard to hold him accountable right now when you have a dual mandate that is impossible. First thing you need to reconcile is by giving the Fed a mandate that is in fact achievable. Example: Central Bank of New Zealand reformed more than a decade ago: if you don't achieve, we will reduce your salary or remove you from office. First, set a mandate that makes sense: price level, rate of change for the price level that is very specific. Independence and accountability are at opposite ends of a continuum. The only way that the Fed should be independent is that once you give it a mandate, the Fed is free to pursue that mandate any way that it chooses. If the Fed's responsible for keeping the inflation rate between 0-2% it can do that by targeting the money supply, the Taylor Rule, or following a Ouija board. If they fail to achieve the result, penalties; accountability. Transparency: Fed now announces after each meeting what the new Fed Funds rate is--another censored Fed paper, topic for another day--no idea how they are arriving at anything that they do. Talk that they are following the Taylor Rule. Bear Sterns episode: abrogation of democracy. Where is the accountability? Why were they allowed to do that? What weight attached to employment versus inflation at any one point in time? No idea what they might attach to one objective versus another. None of this is transparent. Any ex post justification? No. As a practical matter, not much transparency at all. Would come forth if backed up by a practical mandate, explicit statement of how you would achieve it. Price stability: achieve by 2% reserve growth, with intermediate target for this variable and provide data the public could monitor to see if you are on that path, that would be transparency the public could monitor. |
| 1:06:03 | Thirst that people want the comfort that people want someone at the top of the economy running it. President; Chairman of the Fed. Why does it persist? Thirst; Ignorance; Inherent advantages that accrue to economists about what the Fed can do. Mission creep. Fed steering the economy; every once in a while disastrous mis-step. Who should be fired? Well, it was complicated. Without any data, how would have any accountability. Bootlegger and baptists story--we like the idea that the Fed can steer the economy. People at the top reap the benefits. Comment? Doctors or scientists or economists: all professions and individuals get into trouble when you oversell what you can do. The worst thing you can do when take your first job is over promise what you can do. Fed's problems self-inflicted. Retrench: this is what you can reasonably expect from us. Refine what it can do in bank regulation so that it has faith in the regulatory function; get back to monetary policy, what it can deliver. Wizard of Oz role--can't help but disappoint. "It needs to"--no "it" there. Next Chairman of the Fed has no incentive to say it should have a smaller role. Time Magazine from Roosevelt Administration in waiting room. Memorial for Tony Snow: so refreshing as the White House spokesman because he would say, "I don't know." Individuals who take office. Can't make Paul Volker or Alan Greenspan behave in a certain way; but can make rules. Ben Bernanke was first rate economist; now a first rate bureaucrat. Different incentives. Political pressure about who is in the job. From the inside, sometimes individuals do make a difference; heroic people do sometimes do heroic things. At the margins we can change incentives a little bit. |
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| 0:36 | Intro. [Recording date: December 30, 2009.] Smoot-Hawley tariff as cause of the Great Depression. First, Keynesian theory of business cycle and economic growth. In the Keynesian model, what is the cause of recessions and depressions? Lack of aggregate demand--total spending--usually arises from an increase in the demand to hold money. People start hoarding cash, don't spend; and in that model, spending is what creates income. Size of the real economy is determined by total demand from investors, consumers, government spending. Demand-driven model, often called an over-production, under-consumption model; Mercantilistic model. Pre-classical view of the world with more sophistication and algebra. Output of the economy is given; it's demand that is the defining limit for how big the economy is. Aggregate supply is just there. If we produce but don't consume it, then we enter a downturn. Everything in the Keynesian model is a spending model--spending is what drives the actual size of the real economy. Keynesian policy advocates that--stimulate consumers to spend, the government to spend. Making up the gap. In that hoarding of money, anxiety on the part of consumers, does Keynes or his followers talk about that? Keynes uses the phrase "animal spirits" to capture the uncertainty of people's feelings about the future. Is that just exogenous? Yes; the volatility of money demand drives the Keynesian system. People just become fearful, expectational fears of the future, fearful they might lose their job--they do lose their job--therefore they start holding back. Money accumulates and doesn't circulate in exchange. Price level in the Keynesian model is given, parametric. If prices don't adapt to this shift to aggregate demand then quantities have to adapt. Keynesian system is about quantities adapting, not prices adapting. Justified historically by Keynesians by prices or wages being sticky downwards; unemployment in labor market is a result. Important point: Keynesians have a view of money supply itself as an endogenous variable--money supply adapts to money demand. |
| 5:13 | Paradox of thrift. They Keynesian argument, brought up in The General Theory of Employment, Interest and Money: if people save, in the aggregate, that people are poorer. Classicals'--pre-Keynesians, up to around 1930--view was that if people save, and did not spend for current consumption, the money went into the banks, the banks loaned it out for productive investment, capital accumulation; this increased productivity and real wages; higher standard of living. Straightforward; savings beneficial to productivity; better off if we consumed less in the present and more in the future. Keynes turned the world on its end. Paradox of thrift: he argued that if we all try to save more, savings will leave the flow of spending; the money goes in the bank but the bank doesn't lend it back out. Like in a mattress--it leaves the circuit of transactions. Think of savings in the Keynesian model like a black hole--goes in and nothing comes back out. Puts pressure to contract the whole real economy. If people save it doesn't lead to capital accumulation; it leads to lower income because people are not spending. Real economy shrinks to that level of spending that is left. If we all save more, we are all poorer. The General Theory came out in 1936, a time when there wasn't a lot of investing. We are in a time right now when people put money in the bank and the banks are not so anxious to lend, and there aren't so many willing to take risks and borrow. So the standard classical model would say if there is this increase in savings, for whatever reason, interest rates will fall, which will make some investments more attractive that once were unattractive. That should cause equilibrating effect; more productive stuff. In the middle of a downturn, though, there are times when the money just sits in the bank; there are times when that Keynesian worry about savings could be correct? Can understand the logic of the Keynesian model if the price system is broken; and that's exactly what Keynes is doing, macro with no micro, no price system. Reality is that money going into the banks and consumers not spending it, investors spending it, is just shifting around who is doing the spending. The black hole argument that the money goes in and becomes excess reserves of the banks, borrowers not borrowing because they are fearful they can't repay it, is an empirical question. Interest rate emerges between borrowers and lenders, investors and savers--if we are arguing that that doesn't function, we have to ask the question why. |
| 9:55 | Intermediation: just a fancy word for the fact that when people are willing to postpone consumption--which we call savings--and there are other people who want to invest, and have access to more money--borrow--there is an information problem. Lender needs to find the folks who want to borrow. Munger podcast on middlemen--a bank is just a middleman, middle thing, intermediary that links the lenders to the borrowers, takes a cut for its comparative advantage in this brokering activity and for the risk it is taking. If someone says aren't doing their job, something might be wrong with the banking system, then that's what we ought to look at. Banks are the brokers, middlemen, coordinate savers and borrowers. Problem with the Keynesian model, the original way it is written, is that what Keynes is observing is institutional collapse, and not giving proper weight and criticism on the policies that structured those institutions. The price system doesn't have inherent flaws that make it fail. The laws of supply and demand and the competitive process--short of public goods and negative externality arguments--price system based on incentives, respond unless you are in institutional collapse. At higher rates of interest, savers are willing to save more. At higher interest rates, borrowers do not want to borrow as much; at lower interest rates they are encouraged to. If supply-demand for loanable funds through the bank are not responding in the way that incentives in a normally-functioning institution would operate under competitive forces, then we have to ask what are the policy questions. Keynes never does this; not an empiricist in this regard; pure theory without much evidence. Why do you call that institutional collapse? Taping end up 2009, to air the first week of 2010. If great idea for new business, this wouldn't be the week or month to want to borrow a lot and risk family's future; would wait. Totally rational. Wouldn't require institutional collapse. Don't care how cheap money is; just nervous. Real empirical question is the volatility of money demand under normal and abnormal circumstances. Keynes will think the abnormal circumstances are the normal conditions of life. Current monetary crisis we are in--financial institutional crisis; at the edge of institutional collapse. Public policy has encouraged them to lock up by absorbing enormous volumes of risk. |
| 15:14 | The Great Depression. Close parallels. Institutional collapse of the 1930s and Smoot-Hawley. Standard view of Smoot Hawley--a tariff act passed in 1930 which set off a round of reciprocal tariff increases by our trading partners. Discouraged economic trade between the United States and the rest of the world. On the surface it had an attractiveness to the general citizen--let's keep out their stuff and that way people will buy more of our stuff; and through a Keynesian argument of aggregate demand people this will keep our factories going. Standard view of Smoot Hawley: In 1930 trade wasn't nearly as important in percentage terms in the U.S. economy--about 5-7% of U.S. economy. If you pass a tariff and that number fell, it can't have the magnitude necessary to explain the contraction we saw in the 1930s--a 36% decline in the economy from 1930-1933. So, Smoot-Hawley has been dismissed as an important contributor to the Great Depression. Why argue with that? Many problems with the way we model that tariff today, partly because of that Keynesian influence. We model the as C+I+G+X-M (Consumption Spending + Investment Spending + Government Spending + Exports - Imports); when you add that up, that's 100% of total spending. Can take total spending and parse it amongst consumers, investors, government and net exports. Most modern economists basically argue that it was a negative policy, reduced the economy, but not near the magnitudes, sideshow; and they argue that free marketers have exaggerated the argument. The time it was passing, most of the world's economists argued it was vastly destructive. Why did the economics profession at the time have such a unified and loud voice to this, that it was central to the Great Depression; yet economists today with econometrics and modeling techniques argue it was a sideshow? We're smarter now. Or: in pre-Keynesian times, economists saw these things as more integrated, more effects than can be quantitatively measured in any macro model. Keynesians and New Classicals, e.g., Robert Lucas, alike argued it was not the main story. The main story today is predominantly the monetary story, which comes from Milton Friedman and Anna Schwartz. Most economic historians accept the monetary hypothesis: institutional collapse of 10,421 banks--40% of the banks--in three years; the money supply declined catastrophically. Don't dispute that. Tendency today to do one of two mistakes: macro dissipation effect or micro trivialization effect. If you look at the water in the Panama Canal, it's a very small amount of water compared to the Atlantic and Pacific Oceans. If you look at a broad map of the oceans, one might infer that the volume of world trade that occurs in the Panama Canal has to be small, because it's a relatively small amount of water. But we know that's not true--it's very critical water there. We are tempted with Smoot-Hawley to dissipate it into the background and say this is just a little small thing relative to all this other stuff. Conversely, when we do micro modeling of it and look at the Harberger triangles, deadweight losses for tariffs--losses of people artificially induced to buy the more expensive products and use more resources for steel than it needs to because of the tariff--we get into compartmentalization, where we hermetically seal off the effects of that tariff to other institutions. Hypothesis came from two monetary economists--Larry White and also Alan Meltzer, who in his article in 1976 Journal of Monetary Economics pointed out that Smoot Hawley may have had a very significant monetary effect. |
| 24:21 | Non-obvious channel. We usually think of trade as being a micro phenomenon or aggregate macro. Why would it have monetary implications? Book: monetary implosion, collapse of the banking system, financial disintermediation, etc. is the main culprit in why it was a catastrophic rather than normal downturn. But what caused that collapse? Authorities to cite: Friedman and Schwartz, in their Monetary History of the United States, were the first to point out that the proximate cause was the Federal Reserve and allowing a series of bank runs over four years. Fractional reserve system; only a fraction of the deposits are ever in the bank at any one time. Credit structure is based on that. Base money changes have massive effects throughout the entire economy. If the Fed behaves properly and wisely, shouldn't be a problem. Can have runaway inflation or deflation. People don't trust the banks and pull money out. Where were the first bank runs? We had the stock market crash in October 1929--precedes Smoot-Hawley. The legislative history of Smoot-Hawley: Herbert Hoover was elected on a promise to impose tariffs--to protect the farmers in America. But America at this time--about half of its export income came from the farm sector. We were the world's largest exporter of agricultural goods--as we still are today. So tariffs would hurt farmers, not help them. In March and April of 1929, right after inaugurated, tariff went through the House of Representatives; passed the House in fall of 1929. House very protectionist at this time; expanded tariff to virtually everything, very high rates. Senate at this time was more free trade; 16 free trade Senators blocking Smoot-Hawley in the Senate. On October 21, 1929, the 16 free trade Senators log-rolled; said they'd join in if you give tariffs for the industries in our states. The Senate then supported the Smoot Hawley bill. Tariff increases from 38%-60%--almost a doubling. Immediate ramifications. The day the 16 Senators switched, on October 21, is when the market began its slide; lost 1/3 of its value before the Crash on October 29, 1929. When you read the financial papers--Wall Street Journal, New York Times--they have front page stories on one side with markets decline and other side Smoot-Hawley passes; nobody connecting the dots. The reason they have something to do with each other--speculators are acquiring and processing information about the future. Hugely protectionist stand; traders around the world are seeing this and can anticipate; train coming right at them. Expect it to hit not only our export companies--automotive, radios--expect their prices to collapse; and expect commodities market, grains, also to collapse. Why? We put up tariffs to the rest of the world's goods. Any goods that come into the United States will have to have a higher price to absorb this tax that has to be paid by the importer. Foreign governments retaliated; in early 1929 when Smoot-Hawley was going through the House and the Senate, a lot of countries started preemptive strikes on us, e.g., Spain, and raised tariffs to American goods. Speculators around the world saw the impending tariff war; tariff wars have a tendency to proliferate, so not just Spain against America, but Spain against France, Britain, etc. Exactly what ended up unfolding. Foreign buyers that were buying about 30% of our wheat, corn, cotton, put up tariffs to our goods; buying corn, wheat, cotton from other places, like Canada. Farmers dependent on the export market were also hit. Not only get the capital market on all of our foreign products, electronics, steel, automotive industry to take a severe hit, stock market slide. But more important is the quantity side--less production. A lot less corn, cotton sold to the rest of the world. More available here, pushing price down; but total amount will shrink. |
| 33:29 | Interesting what happened after the stock market crash. Smoot-Hawley, Federal Reserve in fall of 1929 raised interest rates dramatically, started earlier, deliberately trying to squelch what they called stock market speculation--but market was not overvalued by any financial criteria. Same thing happening today. Monetary contraction in late 1928, early 1929, slows economy down. Depression actually started in July-August 1929. What happened after the stock market crash: Senate and House bills for Smoot-Hawley were different bills. Tried to reconcile them in November and December. Couldn't agree; looked like the bill was dead. NY Times even declared it was dead. Stock market, which had lost more than a third of its value gradually started to come back. Wasn't finally passed until June of 1930. Congress meets in January 1929 and starts on reconciliation; changes made in schedules to get the tariff to pass. Got back to 8% of where it had been at the beginning of 1929; but in spring of 1930, 36 countries lodged 59 formal protests with the State Department, start to get retaliation by countries. On May 5, 1930, 1,028 professors of economics, professional economists signed a petition to Hoover saying not to sign this bill. Made the point in that letter that it would have monetary effects. Today there are maybe 10,000-20,000 economists; back then many fewer, and they all agreed enough to sign the petition. In June the final bill went to Hoover, June 14; on the following Monday he signed the bill to keep his campaign promise. Stock market took a big hit. In first two weeks of June, stock market lost 20% of its value. Second-biggest drop in the history of the stock market. Stock market is just a barometer. People tend to think it has its own causal effects, and it has some; but this was as a barometer. Not just American stock markets. In 10 different countries, all of our trading partners, also massive collapse in their stock markets. England, Germany, Italy. Something worldwide going on. Economists at this time realized that trade had monetary effects. |
| 40:05 | Will be less efficient as an economy, less trade, everyone dealing with it, but 2-3% less. Missing something. If you have a 2% lose of Gross National Product, it sounds like everything moves down 2%. Reality is that if you have a 2% loss in your real economy but it's showing up in 5 or 10 states, that is catastrophic for those states. Modern modeling, tend to think everything is in unison, but everything is not in unison. There are distributional effects. When you take $2 or 3 billion out of 5 or 10 states at this time, catastrophic--10-15% drops in those states. What are those states? Where did those bank failures start to occur? Went back to Friedman and Schwartz, and they make the point that the first bank runs occur in November and December of 1930, and they occur in 6 Midwest farm states--agricultural export markets. Massive drop in farm income. Total of 600 banks failed in two months. Not 600/50, rounding number of states, which was 48 at the time--it was concentrated in those 6 states. One big bank that went down was the Bank of the United States in New York, sixth largest bank in America, own unique significance; all the rest of these banks started to fail in the Midwest. In the years 1920-1929 we had an average of 600 banks per year nationwide close their doors, small farm banks spread all across America. Now you get 600 in two months, plus one huge bank in NY. In 1931, more bank runs in spring, summer, and fall; hundreds more banks go down. 1300 banks go down in 1931. Primarily starting with the agricultural regions. 1931 catastrophic worldwide--a lot of bank failures in Europe. In the U.S. the bank runs start in the South and Midwest, migrate north and east; go from rural to cities. In Europe, same pattern. Domino effect. In 1929 in Austria, largest farm credit bank--government had been subsidizing farmers; in 1930, forced it to merge with the largest commercial bank; combined was bankrupt when it reopened its doors. Hungary general credit bank, Germany's 3rd largest bank went down; bank runs over this period moving from country to country. All tied to subsidies given to specific sectors on the world export market. The world tariff war--the loans made to special interest groups were not sustainable when the tariffs started to escalate. The farmers who had borrowed the money on the expectations of future profits--those profits disappeared when world trade collapsed; as a result they couldn't repay their loans in those regions; and as a result of that the banks didn't have the cash flow they expected; loss of confidence. Banks that had loans to businesses in the world export market failed when the world export market went down. |
| 48:34 | Question is: if those banks fail, what's the proper response? If those failures lead to contagion or general fear of the bank system collapsing--none of the European banks had deposit insurance; we didn't have deposit insurance. Most of the Europeans created central banks after 1920--after WWI. So, now, what does a central bank to do? Supposed to support the base money and the inverted credit pyramid. If people are pulling their money out of the banks out of fear they will lose their principal, then you have to inject liquidity to keep those banks open. If you don't, those banks come down, and that's what they did. European and our central banks both derelict in this. Flawed institutional financial structure; and the tariff, via international retaliation, put enormous pressure on the banking institutions. Why aren't the central banks responding? Discussion in free banking literature; they didn't see it coming. Right in the middle of the collapse they thought they had an easy money policy--at the same time the money supply is contracting. They didn't have the data we have today. Can think of this as a fleshing out of the Friedman and Schwartz story, to uncover the mechanism that led to the collapse of the banking system; and the subsequent contraction of the money supply. Inverted pyramid--small amount of base money held by the banks, supporting to the fractional reserve system and lots of loans. If loans fail, create an insolvency problem for those banks. Difference between illiquidity and insolvency. Illiquidity is what the Fed can prevent by having elastic currency, open market operations, being the lender of last resort. The problem was there wasn't a lender of last resort. In a central banking system on a fractional reserve, you absolutely have to have a lender of last resort. Entire concept of central banking structurally flawed. Nevertheless that's one of the institutions we have; but during the Great Depression, the Federal Reserve did everything wrong. In 1931 during the height of the bank runs, banks had gone down, money supply had already contracted in double digits, the Fed was selling assets through open market operations, pulling reserves out of the system. Alan Meltzer argues it was because they were wedded to the Real Bills Doctrine--credit should go along with the needs of trade. Very pro-cyclical: if the economy is in a downturn, there is less trade going on; therefore you need to supply less currency. Would magnify the downturn. Or: if the economy is picking up, you have more trade, you need more money; print more money--procyclical view of the world. Some truth to that. At the time the Federal Reserve Board--now the Board of Governors--you didn't have to be an economist or have any credentials in economics. Three had no training in economics--one a farmer, another a politician, another a "used-car salesman--I don't know what he was." No background. Didn't have the data. We still have that problem today--lags now, and the lags then were worse. |
| 53:45 | Full circle: implications. Two examples. Want to get back to opening question of institutional collapse. When you are in a world where banks are failing because of expectations of profit not being realized as the tariff rug is being pulled out from under them, you are going to have inability of these institutions to perform helping lenders and borrowers get together. Will get to that. Two examples. Farm and industrial activity. In the tariff war following Smoot-Hawley, we had a retaliation from Canada, our largest trading partner. Canada had a very different monetary system, much more free banking: no limits on branch banking. No bank failures during the Great Depression even though 1/3 of their GDP came from foreign trade. Took massive tariff hit but the monetary system didn't dive. It absorbed that hit. Their money supply only dropped 13% vs. ours dropping 29%. They had no bank failures; we had 10,421 bank failures. Their financial system didn't become an aggravating factor. Their downturn in real output was much smaller than ours. Lessons to be learned. We put up tariffs to a lot of Canadian goods. After 1930 they deliberately went after our iron and steel exports to Canada. We were exporting about $200 million a year in iron and steel to Canada. After Smoot-Hawley when the Canadian government retaliated--specifically iron and steel but also other items--our exports to Canada dropped to $29 million a year--an 85% drop. Looking at the 17 months between the tariff retaliation by Canada and the decline in exports of iron and steel to Canada, in first 17 months, $359 million less exports. Why 17 months? Seventeen months after Smoot-Hawley, something happens in a particular city: Pittsburgh, city of iron and steel. Eleven of Pittsburgh's banks go insolvent and have to shut their doors. Depositor losses of $69 million, main structure of the entire banking system. If we are going to take most of the iron and steel out of the Pittsburgh economy, this is a good reason why you might have so many losses in the banks that were shut down. Furthermore, if you look at the interregnum period between Roosevelt being elected in November 1932 and being inaugurated in March 1933 (when we did inaugurations at the time), what we find is the big collapse occurred--4000 banks went down in those four months--while Hoover was still President, but lame duck. The Detroit banks, the main banks the Reconstruction Finance Corporation was worried about--in February, the Reconstruction Finance Corporation examined the banks in Detroit directly tied to the auto industry and came up with a rescue plan, which would have required about $12 million to save all of the banks tied directly to the auto industry. They went to Henry Ford and asked for $7.5 million of his money to be subordinated deposits he wouldn't withdraw to give the cash to the banks; and then went to the other companies--Hudson Motors, Chrysler, General Motors, to come up with $4.5 million. For about $12 million they argued they could stabilize the banking system in Detroit. Look back at the auto industry following Smoot-Hawley, in book, auto industry our largest export, along with iron and steel--like planes today--and what we find is the three-year cumulative loss from the time of Smoot-Hawley's passage to the time of the Detroit banking crisis in January-February 1933, cumulative volume in dollars of auto exports declined $1.5 billion. Had we not had those tariffs and maintained our world exports, Detroit would have seen a billion and a half dollars flow right into it. They needed $12 million to save those banks. The entire Detroit system decimated by this law. Henry Ford backed out and withdrew $25 million of his own cash when the other companies wouldn't agree, and put it in his own personal vault; precipitates whole collapse. Notion that Smoot-Hawley was a little trivial sideshow is misleading. Have to start disaggregating, looking at the micro connections. All this inefficiency ultimately shows up in the financial system. All mistakes in investments, all investments that are not going to fulfill expectations, all end up in the insolvency of those banks. We did not have leaders of central banks that responded correctly, even though it was an insolvency problem that could have prevented the contagion. |
| 1:02:26 | Not surprisingly, people don't want to use that intermediary at that point in time. Keynes argument about savings. Keynes, in The General Theory, when he argues that people save not according to interest rates, but tradition: we have notions of tradition and inertia, we save because our fathers and mothers saved, not responding to price incentives--and we invest based on animal spirits, psychological factors, overconfidence or fear, nothing to do with that price or incentives--before 1933 and there's no deposit insurance, and the central bank is not acting like a lender of last resort, which would stabilize those bank runs; and you are on a fractional reserve and have a massive exogenous hit to regional economies: If I put $100 in the bank and the interest rate on my savings in 3% and someone says put it over in this bank at 7%, I have an incentive to put it there, but if I am worried about losing my principal there, the 7% doesn't matter to me. It's a matter of getting my principal back because there was no deposit insurance. Is the bank safe? Movie: It's a Wonderful Life--bank runs like that happened worldwide. "Your money's not here." Keynes's "broken joint" between savers and investors might make sense of a world of institutional collapse. Instead of Keynes's blaming government policy, he blames the price system. But prices are not just floating abstractions--they are connected to property, connected to ownership, connected to institutions. Keynes has no clue about institutions. Blames price system for the failings of government--the tariff, the central banking system; fractional reserves per se are not necessarily unstable but a monopoly on that is. But we had bank runs before the Federal Reserve system. How can you claim that the bank runs in the late 1920s and early 1930s were a function of the Federal Reserve? What's different here is we did have bank runs in the 1920s. Fed policy different. State banks, not part of the Federal Reserve system. Bank failures from 1929 tend to be small unit banks, farm banks; when you look at total depositor losses through the decade of the 1920s, yearly loss for depositors was $62 million per year on average nationwide. Failure of the Bank of the United States took down $200 million by itself. By the time you get to 1929--about 5000 bank failures in ten years; don't get the major runs. Last run before the creation of the Fed, 1907, was Knickerbocker Trust in NY, and JP Morgan saved that system. Created the Fed because we said we don't have to privately save the banking system. In the 1920s, main person at Fed was Benjamin Strong, never let the contagion happen. Money supply steadily growing about 5-6% a year; though there was deposit insurance at the state level and every deposit insurance system failed. Trying to challenge argument that Keynes blames the wrong culprit: failure of the bank as coordinator of savings and lending collapses during the Great Depression. Keynes blames that on animal spirits, the price system, etc. You are suggesting the bank system failed because the Fed--per Friedman and Schwartz--could have averted it. Deeper point: if we didn't have fractional reserve banking and monopoly supply money from the Federal Government, that that more competitive world would be a more stable world and wouldn't have to rely on these lender of last resort arguments. Challenge: in pre-Fed days, you still had instability in the banking system. In the 1920s understandable; but before the Fed we had all this instability. Difference between asking about the interest rate versus the institutional structure. In America, we only had one era close to free banking--end of the Second Bank of the United States up to the Civil War. Roughly 1827 for 30 years. Look at that era--not totally free banking. From Civil War onwards, two tracks--national banks under Federal regulation, State banks under State regulation. Most of those crises that we like to attribute to the banking system, can look at the policies. Not as if you had laissez faire. Wildcat era of free banking, but not free banking because of branching laws. Also have states that will put up unit banking laws--can't have a second one within a state. California unique--didn't have branching laws, survived better. Rolnick, Weber, Rockoff, and others. Era of free banking more stable, no major inflation, no catastrophic downturns. Huge spread of financial services. Small empirical window--could say that about the Great Moderation of the post WWII period. Difference: in American history, we had this experience. Look at depositor losses; 80% came in a handful of states, which had a requirement for anyone who opened a "free bank" that they had to have a certain percentage of their assets in State Bonds. Indiana, Michigan. You can open a bank, but part of your capital has to be that you have to purchase our bonds. Not a free bank. Those states defaulted on their bonds. In percentage terms, not even a fraction of a percent. Then you look at the Federal Reserve system, from its inception through 1933, vastly higher relative to deposits. Free banking vastly superior even with the distortions even then. Canada, other countries. Free trade matters; free banking matters; money matters. Brittle, rigid system with all the wrong incentives--deposit insurance, moral hazard, previous branching restrictions, unit banks, dual-track regulatory system with some banks in and others out of the Fed. |
| 11:15:44 | It's one thing to say Smoot Hawley's magnitude can't be important because its magnitude isn't important; can't just look at the volume of trade, have to look at the impact on the monetary system. Still a question of magnitude. In Pittsburgh, 17 months, Detroit 3 years. Confident that those banks' contraction can be pinned on Smoot Hawley? How about the contraction in the money supply? Agriculture for starting point--but not just Detroit or Pittsburgh. Nevada, minerals, copper. We know how much the state lost in income. Twelve banks, a fourth of the banks in the state went down. Boise, Toledo, Chicago; look around the world. A lot of banks failed. Interesting research question. Insolvency problem hits these banks. Insolvency crisis in agricultural and city banks--Smoot-Hawley has a big thing to play with. Insolvency creates illiquidity. Can't solve an insolvency problem with a liquidity solution--Anna Schwartz. Caldwell and Company Bank System--140 banks, Tennessee and Arkansas. What kind of reactions to your research? Boring book--detailed book. Review from John Allison--banker but not economic historian. Monetarists or any economic historians in the past who have been skeptical of Smoot-Hawley? Elgar criticism: not sure the tariff could have had that much effect; maybe worse than we can econometrically measure, have to dig in further. Maybe those 1028 economists who signed that petition saw something on the ground that we are not seeing here. Pattern, no one has disputed that pattern. Sure, there are other factors. Douglas Irwin made point that 2% job but tariff might have had monetary effects. |
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| 0:36 | Intro. [Recording date: December 18, 2009.] Most people hear the word "market failure" and think it means markets didn't do what I wanted them to do. They failed me. That's not what economists mean. Narrow definition. Textbook definition of market failure. Precise notion, focus on efficiency issues--the allocation of resources. Looking at situations where we get an equilibrium where it would be possible to make one person better off without making anybody worse off. Technical term for that--Pareto optimality. Can reallocate resources. Late 19th century economy Vilfredo Pareto. One measure: how would we know the world A is better than world B? Really we are talking about potential Pareto-improvements, because you usually have to actually compensate people to assure that they are no worse off, and somebody is better off. Notion of actual improvement is very rare--no policy maker would allow that to remain. Usually it involves a transfer of resources where you could at least compensate people and still have something left. Public finance and public welfare theory--increasingly uneasy with it. Policy changes that simply make the world more efficient are usually just making the pie bigger; but not going to worry about whether some of the people might actually be worse off so long as the gains to others are sufficiently great that they could compensate those who are worse off. Increasing the size of the pie has implications for distribution that are often presented as conflicts, but they need not be. If you are inside the frontier you can often get ways of expanding the pie and cut it up to redistribute. Want to know that we are getting the most out of the economy; if there are laws in place that are hampering that, or laws that could be put in place to improve it, might want to go in that direction. Major justification for government. Government is supposed to come up and institute policies, expanding the pie. Efficiency objective of government policy. Textbook claim; the way we teach students--markets don't always work perfectly, and government's supposed to step in in those cases on efficiency grounds. |
| 6:17 | Examples of market failure: Monopoly, abuse of market power leading to prices above marginal cost, leading to a deadweight loss. If the behavior that underlies it is anti-competitive, this is what Antitrust policy is intended to correct. Define deadweight loss: occurs in a situation where there is actually a loss of resources to society, in the course of maximizing their profits, the monopoly would reduce output. Even though there are cases where on the margin people would like to pay the cost of the output that is produced, they are not able to. The output is basically lose. There is a potential exchange that would make the monopolist and the buyer better off, but the monopolist would have to lower the cost of all the other units to do that, which would discourage the monopolist from doing that; so there is a foregone net benefit. Technological example, natural monopoly where the costs are minimized with one producer. Declining average cost could do it. Marginal cost below average cost and with competitive pricing people would be losing money; or one supplier. This is the justification for one utility regulation: allow one person to produce the output at least cost, but we'll do something about putting a cap on prices so you don't get exploited and have excessive prices. We have regulation, though, in cases where there is not a natural monopoly. Big example is externalities: consumption externalities, for a consumer, auto congestion, driving in peak period you delay other people, but you don't have to account for that in your decisions; impose a social cost and there should be something in the market that makes you take account of your decision but nothing makes the market do that. No one owns the roads. Well, the government owns the roads: is there something they could do that would make people account for the social costs in their decision. Production externalities: pollution, firm produces something and dumps something in the water; air pollution; climate change. What's the market doing explicitly to force firms to take account of what they are doing to the broader section of society? Information failures: people are not acting with full information or are even being deceived so the utility they expect to get from their goods is not what they wind up getting, so we have a variety of information policies. Austrian perspective: it's unrealistic to have perfect information be a goal; we need to get rid of friction. Straw man critique of economic activity. Public production: you have certain services that are socially desirable but they may not be privately profitable. Natural monopoly similar; or you could have capital requirements that make it hard for one firm to produce the interstate highway system. Orphan drugs. Argument is that the government has to get involved and be the provider of these goods or services even though they may even lose money. |
| 12:13 | Textbook says government needs to set the right tax, set the right subsidy, regulate, produce it themselves. Book: instead of asking whether the textbook is right, ask to see how government actually behaves. Theory; but also need to look at the evidence. Easy to theoretically point out these problems with markets; but who actually performs better? Do markets make efforts to correct these problems? Does government step in and actually do a better job? Intervention justified? Or do they come in and make things worse? So many of these issues come up time and time again, but the public policy debate always starts from square one. Start to assemble what we know and start accumulating evidence; don't just treat these things as though they've never happened before. Book is available free of charge online. What do we know? Government interventions have turned out to be remarkably disappointing across the board. It is certainly the case that markets do fail--we do have pollution, congestion; but there are other cases where it's hard to find evidence of the kind of market failure that would justify government intervention. More troubling is the lack of evidence of whether government interventions--justified or not--significantly turning things around. Not even saying we should use the benchmark of optimal government policy--just clearly producing benefits. Hard to find evidence that led to that conclusion. Focused on academic research, not on government reports--not many of those. Scientific assessment. Secondly, often public approaches these things as ideological--you can predict based on one's political affiliation where these things are going to come out. Had a representative sample across the board in terms of political persuasions; didn't limit search to particular scholars. Big qualification: there's a lot we don't know, room for more work. At this stage, a disturbing picture and big warning sign for expecting positive results for big government. Russ--love conclusion, but skeptical with empirical approaches. Law of large numbers--not all colluding. As n gets large, unless only talking about publication bias. Group think. Russ: will press on the nature of the empirical work. Sophisticated techniques with lots of assumptions along the way different from averages and facts, relatively transparent. Reality checks, simple descriptive data. Certainly economists are opportunistic; if they have a chance to come up with an article that says all the previous research is wrong, they're going to do it. Surprised by consensus that appears to emerge. Exchange on antitrust issues. |
| 19:20 | Turn to the evidence. A few broad categories. Broad strokes overview, then philosophical issues. Antitrust: What was interesting was the absence of positive evidence. Didn't find things that said that government investigations of collusion led to price increases per se; just didn't find evidence of significant price decreases. Anti-monopoly cases, Microsoft recent example, no cases that led to benefits for consumers. People now saying: What was the point of the Microsoft case? Could have said the same thing about the IBM case, the cereal case? Now we see the government is investigating Intel. Have accumulated evidence of lack of consumer benefit from prosecution of anti-monopoly behavior; should give one pause. Some evidence there is consumer harm. Wouldn't the interventionist claim that that's just because those are the cases that you observe? Could be that without this occasional foray into threatening action against collusion and mergers--there's a hidden benefit you don't see. Defense: You don't see the main point of anti-trust, which is deterrence; without this prices would break loose, collusion would be the rule of the day, mergers till we get monopoly. There have been efforts to address that, controls, international comparisons; strengths of antitrust laws between the United States and Canada, or between the United States and the United Kingdom. Even those studies don't seem to find anything productive in producing a more competitive economy with antitrust laws. Still an open question. Not a deep empirical understanding--gaps in knowledge. Lack of engagement with economists on this issue; people have very strong positions despite the evidence; a lot written either pro or con about the Bush Administration's position on antitrust, but no reconciliation with the evidence. Pervaded by religion. Another area where that's true--macroeconomics, strong set of prior beliefs. At least in macro there is a desire to generate evidence; with antitrust, not much concern. Hasn't struck a chord. Difficult to get data; but agencies who have economists could make things easier. Disappointing for both policy and the economics profession. Economists have a large personal stake financially in the antitrust wars--they consult; very lucrative. But they compete. Open question: micro/macro discussion--lack of broad overview of the social deadweight loss to the United States. Arnold Harberger worked on this, a long time ago, very crude, lots of assumptions; suggested a small one. Overview of how industries are performing. Subsequent investigations have not suggested that a big problem in the United States is high markups because of monopoly power. Reality check that would be powerful to pursue. Weakness of academic field of Industrial Organization (IO) is it's not given us enough hands on overview. |
| 27:38 | Contrarian take: Defense of the interventionist approach would be okay, the United States looks very competitive--Schumpetarian, competition everywhere, monopolists see competitors come out of the blue--sure there's not much monopoly, and what would be the big gain from throwing away all this apparatus? Let's get rid of all this antitrust stuff. Contrary view would say it's not that expensive and maybe the deterrence effect is important. Policy implications: first, one should focus on the most egregious cases. XM and Sirius. Ford and GM. Second: Don't want to encourage collusion. The harm is the policy is gamed. Microsoft's competitors had a lot to do with bringing this case; huge transactions costs, attention by management, considerable time and resources. Government isn't spending billions of dollars. Can create a culture where your managers spend more time gaming the government than producing better products. Regulated, even deregulated industries, grew up with the government and hard to cut the cord. Not the climate one wants: I'm having a problem with my competitor so it's time for me to start lobbying my Congressman and turn to the antitrust authorities. Destructiveness of rent-seeking; Munger and Don Boudreaux podcasts. Pervasive problem in all areas where government is involved; political. Any measures of the magnitude of that cost? Not really. Fun to do a case study at a corporate level--how many hours spent on these issues, how big the legal staff. |
| 32:03 | Safety reforms, social regulation. Deals with the externalities, safety being one. Workplace safety. Descriptive evidence of workplace accidents going down; but when you try to isolate the effects of the Occupational Safety and Health Administration (OSHA), supposed to be inspecting the safety of plants, people tend not to find statistically significant effect of the OSHA regulation. In the world, seems that things getting better; value of regression analysis, isolate the counterfactual--what can we attribute to the policy as opposed to other factors. More detailed study of how these regulations actually work in practice. Attraction of an eloquent speaker, like the President, is that one gets the idea that someone of his intelligence is carrying out and performing these regulations; but the President doesn't go to plants and inspect toys. Agency not particularly well-staffed, spread out--one toy tester for China. OSHA, similar kind of thing. General morale, difficulty of persisting in these investigations. Not to say that problems don't exist. Market provides huge incentives for providing safe workplaces--courts, liability system; and can be killed in the market if things are unsafe or even in the labor market--have to offer a compensating differential in wages. Imperfect information--workers don't know that, get exploited? Area of safety clear when an airplane crashes or a mine caves in or when people repeatedly have hand chopped off from a machine that doesn't work well. The word gets out. Economics profession--job market blogs, potential employers. Hard these days to hide the fact that working for a particular firm is safe when it's unsafe. Regulatory agencies, constraints on people. Regression analysis: always tricky to "hold other things constant." What's interesting about the safety issue--data pretty clear, overwhelmingly clear, that the overall long-term trend across every dimension of our lives, auto safety, workplace safety, has been getting better and better; and it's been going on for a hundred years, fifty years, as long as we have the data. Clear that safety is a "normal good"--correlated with income and prosperity. As we get more prosperous, we are willing to devote more resources to these issues; firms compete. Higher value of life, higher quality of life. When you look at the data and see that nothing is change because of OSHA, it doesn't prove that OSHA didn't make a difference. It's possible, could have been worse without them. But it puts the burden of proof is on OSHA defenders. Law says improvement, but data say no improvement. Laws versus the bottom-up emergence that have improved safety. Mechanism: deeper micro understanding abstracting away from the data. What exactly are these inspectors doing that's telling the plant how to become safer over time? Airlines: what exactly is it the Federal Aviation Administration (FAA) is going to tell manufacturers and airlines that they don't already know? If anything, they've taught the government something. Dreamliner just tested by Boeing, still has to be certified. The FAA is going to tell Boeing if they think the plane is safe enough to fly? Imagine the quality of the people who work for Boeing on that plane, their training and knowledge; going to ask the FAA if they know what they are doing? There can be mechanisms where one can point something out. Possible critical in the area of financial regulations; but tell me the mechanism. One has to go beyond the abstraction. What exactly it is they can do and what exactly they are going to do. Boeing example great because really highlights distinction between government failure and market failure. It's true that Boeing is not really eager to crash its planes. Not good for Boeing when plane crashes. Could argue that they'll cut a corner here and there because they want to make a profit. Economist's response is they care about both today and tomorrow; organization is ongoing with repeated to interactions; incentives will probably be aligned with desires of consumers. Okay, but not perfectly. So, what the government can do is just to make sure that they haven't cut a corner here and there just to make small profit. But then: fair enough; now tell me what the structure of the FAA would be that would in practice reduce that corner-cutting instead of just making life more difficult for Boeing or its competitors. Boeing itself could be cutting a corner that it doesn't know it is doing or isn't aware of the tradeoffs. Clear in some investigations of the FAA that the airlines realize they have not changed their configuration of putting a screw on to some part of the plane; still say they are going to fly these things, in line with procedure. But there's no way that this is going to compromise the flight of the plane. When they cut corners that have significant repercussions, liability, negligence issues that can also have criminal implications. Doesn't mean some of them won't take a chance; life-changing things going beyond just making money--people go to prison for this kind of stuff. People self-select to go into this line of work. Observed data: remarkably safe. Stress point by Sam Peltzman, podcast--market robustness. How people and markets themselves try to respond to externalities. Nice example is congestion: market response is the congestion you experience is under your control, endogenous. Where you choose to live, where you choose to work. If someone really dislikes driving in congested traffic, he will make choice to try to find place to live to reduce that congestion cost, albeit may be paying a little more for housing. Data in estimates of time--people who have the highest value of time have shorter commutes; people with low value of time have longer commutes--market's way of responding to an externality. Area of noise--people who don't like to live near runways or airports. In Boston, they've located the School of the Deaf right near the runway--the land is cheap and people not annoyed as much by the noise. Financial area--don't expect same types of mistakes, going to be learning. |
| 46:13 | Turn to classic case where government regulation may have improved matters: pollution. Private incentives to reduce pollution; pollution is foregone efficiency, natural long-term trend toward less waste because waste is costly. But always a temptation to dump that waste into somebody else's air, somebody else's water. Net effect of government pollution regulation? There are alternative ways we address pollution or externalities. Can use the price mechanism, in which you try to put a charge for somebody for doing this, or a quantity mechanism, saying there are certain technologies you have to use to abate the pollution. Government's preferred approach is usually what is called "command and control." Air pollution and automobile pollution have gone down; heavy hand by the government in pushing things too far back. At each point you can ask is the social cost exceeding the social benefit? What the evidence has shown has been yes, we've had benefit, but at very high cost. In case of the automobile increasing the cost of production. Most of the evidence: fairly balanced, what gains we have made in terms of pollution have been balanced by the higher production costs of doing so. Lessons and concerns with current climate debate: are we going to go ahead with a policy that is too heavy-handed, sacrifice too much of GDP? Goal to reduce pollution and not going to worry about the cost. We have limited resources. If at the same time we want to spend money on subsidizing somebody else in the social area we are not going to have the resources to do that. Goal, want to achieve particular level, pay little attention to the cost. What mechanisms could we have used to achieve those levels of air pollution reduction at lower cost? Pricing emissions. Could actually monitor the social cost of pollution; ways of doing this without intruding on drivers; could add actual price. Tax emissions. Similar example with airplane noise. Have command and control regulations--have to make plane engines that have certain decibel levels. Could have a noise tax to airplanes--if you go over this, here is what you have to pay. Decibel exposure down dramatically; but cost to plane is increased capital cost, planes obsolete, reduced value of capital stock; reflected in prices. Tradeoffs we often make. General engineering mentality that comes about with a lot of these policies, want to achieve the goal, ignore costs. Spills over into production. Want to build the extension out to Dulles Airport on the Metro line [in Washington, D.C.]; when all done, will be excited. But billions of dollars and cost overruns. Those kinds of cost/benefit tradeoffs are not central in public policy formation. General distribution of costs by the taxpayers enables it to move forward--individual taxpayer doesn't pay very much, benefits may be localized. We all benefit, but we also are all paying. Quibble with tax idea: seems that it's better to have a tax than the command and control mandate of particular technology--catalytic converter--for every unit of pollution put out above a certain amount pay a tax versus this is the technology you have to use. At the same time, Honda met the same standard of pollution that the catalytic converter produced in other cars, but they were required to have one anyway. Distortion for political reasons. Quibble: we could put a tax on the social cost. What we can measure is the pollution. Still a challenge to figure out the social cost, the harm those pollutions cause; and problem to set the level of tax. Role of the economist. Congestion tolls--use estimated value of time. As a practical matter, these things can become politicized quickly. Seeing that already--highway example. Intercounty connector toll schedule has been announced; seems very high to users or observers. Will be political pressure. |
| 55:52 | Philosophical questions: Accept findings, summary of what many people have studied, gloomy picture: government intervention often doesn't achieve what it was intended to do, or servers counter goals, or certainly not what textbooks describe. Two broad reasons for that. One would be incompetence: incentives, morale, technical challenges. Second more sinister: idea that that economists and political scientists have been writing about, regulatory capture--once a regulatory idea gets set up, the people who are regulated have the biggest incentive to make sure it serves them rather than a so-called public interest. Any evidence? Latter. Political economy driving a lot of these things, interest groups in general. Often not capture per se. America getting increasingly better at lobbying; returns from it are really high. Highway: not that people are being regulated but that they want the expenditures to benefit them. Answer to the question extremely important: where do we go from here? Policy conclusion has to derive from: What is the underlying problem? Interest groups. Calls for not the wishful thinking of more government; at a time when markets are suspect, more reliance on markets. Didn't talk much on natural monopoly; major examples are ones where we've had deregulation or partial deregulation. Learned about gains. Some of this stuff is on the horizon. Skeptic: Enron story in California shows the danger of deregulation. It was the market that outed Enron. Energy part of it: attempts of California. Something called deregulation that was so mismanaged and went in the face of what was trying to be accomplished. Mismanaged terribly. Chances for privatization: airport, metro system, highways; very important to run very carefully designed experiments to avoid the California problem. What kind of experiments? We have some on the book. We have examples of airports trying to become private airports. Chicago Midway first major one. Unfortunately during the crisis their funder wasn't able to come up with the money. Imagine a bus service contracted out, private provider taking it. Munger Chilean bus podcast. Thoughts on the feasibility of the politics? Easy to say we should move to more privatization; people worried now about private incentives, but coalitions big threat. Yandle, Bootlegger and Baptist. When actual safety regulation gets written, it's written by people who have a stake in it. How might the special interest be quieted? Ties in with the micro/macro question. With public policy reform, need some entrepreneur to sell it to the public. Broader vision: trucking regulation; inflation during the 1970s, think regulation will help fight inflation. Crisis provides us with an opportunity. Concerns: budgetary, we will have to pay a lot of this back, governments at all levels running huge deficits; want also to spur growth. Privatization: can help budgetary considerations. Also turn private sector loose and they may come up with innovations. Think more broadly about where it can help many people in the economy. |
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| 0:36 | Intro. [Recording date: December 15, 2009.] Federal government's budget deficit and what that might mean for the future. Recent Econbrowser post reacted to Paul Krugman's claim that the deficit not really worrisome. Seem a little worried about it. In agreement with Krugman that we don't need to balance the budget right away. A large deficit in 2009-2010 is desirable and necessary. Would be counterproductive to the point of infeasible to try to balance it right now. Concern is with what's going to happen a couple of years down the road, longer term trajectory. Paul's position is we can grow our way out, just as at the end of WWII we had a debt/GDP ratio for the United States that got above 100%. Worked our way down with economic growth. A number of other countries in the world have also had those kind of debt levels and have worked out of them through economic growth. Debt-to-GDP ratio: Debt is a stock and GDP is a flow--a stock is at a point in time and a flow occurs over time. If you make $50,000 per year in income, that's an amount per year. If you owe $50,000, a stock without a time component--that would be a 100% debt to GDP ratio. Some might think that if you owe 100% then you are bankrupt. But you are going to repay it over time; and if you grow your ability to finance both the principal and the interest are feasible. Key question is the service cost, which is a flow--what do you owe in interest on that per year? With a given interest rate you are basically talking about the same comparison. Take the $50,000 debt and, say, with 5% interest that's $2500 per year--that's something you want to compare with your income. Debt and GDP are in different units, but it is a natural way to think about the overall burden. Referring to the historical norms is relevant: if it gets far out of line with things we've seen, wonder what is going to stabilize this? Are we out of line in peacetime? Yes--nothing apart from WWII that is like what we are getting into right now. This is an unusual development. Deficits this year and next on the order of about 10% of GDP. Mechanics: This past week the Senate voted to lift the debt ceiling from $12.1 trillion to something closer to $14 trillion. There is a political game that goes on that is very separate from the economics. Politically, we have separate votes in the United States on the spending and tax questions, which determine the deficit; and on the total allowable ceiling for the debt. From an economic perspective strange to separate those two questions because there is no way you can run a bigger deficit without increasing the debt. Politicians can say they voted against the tax increase and are trying to do something about it, but when it comes to spending they are the ones that created the basic need to do the extra borrowing. Concerned about the grandstanding by politicians. |
| 5:46 | $14 trillion is a really big number, close to right above GDP now. Harder to do because there isn't a single interest rate; a lot of the debt was issued in the past at all different interest rates. Current rate that the Treasury has to offer to attract additional funds, very low. Practically free if you are looking at short term debt. Now we expect to borrow on the order of $1.5 trillion to finance the shortfall in the coming year of revenues to expenditures; but in addition, we have debt coming due because of the way the past debt was financed. So we have borrowing we have to do to pay off old debt and interest service costs. Change in the debt is equal to the deficit: have to roll over the old debt because you haven't done anything to pay it down, plus added new debt equal to this year's deficit. Another complication: who is holding the debt? A lot of that debt is not owed to the public. It's owed by one branch of the government to another branch of the government. Often net that out to talk about the net debt to the public, which is a little bit more modest number. How modest is it? Would be 60% of GDP instead of 100%. Sizeable sum. Federal Reserve owns a sizeable chunk of the government debt; and the Social Security Trust Fund is by far the biggest single holder. Money the government promises to pay to another entity of the government. Puzzle: the Fed is currently buying mortgages held by Fannie Mae and Freddie Mac--about $1 trillion on their books. Somebody said: that's nothing to worry about because they're guaranteed. Yes--but they are guaranteed by the government. How does that enter into the accounting? The mortgage-backed securities the Fed is buying are not so much owned outright by Fannie and Freddie as guaranteed by Fannie and Freddie; so the government is on the line for those. Conservatorship that Fannie and Freddie are operating under--their obligations have been assumed explicitly. There is potential liabilities on all kinds of fronts. Also Ginnie Mae, FHA, FDIC--huge numbers; future health care costs. Medicare. Money the government owes to itself, but it's money the government was going to make to the future retirees. Not part of that direct debt calculation, accounting identity; but they are part of what constitutes the solvency of the Federal government. But it's not necessarily generate the requirement for the Treasury to borrow in the coming year. Seductive aspect of these loan guarantees--totally off budget. Fannie and Freddie were collecting fees--relatively small fees--over the years for promising that they would make good on all these loans they were securitizing, but didn't have enough capital to do it. Still in that same business. Complex topic. According to the legislation there are certain promises on the books to retirees right now; also promises for medical care in the form of Medicare, under the current law. Assume that not all those promises are going to be kept--might turn out to be false. If the United States breaks those promises, changes the letter of the law, say with a later retirement age or an income means test, seems to be different than paying back the bondholders, Treasury Securities holders of last year, or the FHA mortgages. Totally different. United States has no legal obligation to have exactly the same retirement age or same health benefits it could cover 20 years from now as they are doing today; not going to be feasible. Project trends, nothing but trouble ahead. But if the United States were to default on its obligations to bondholders, that has dramatic repercussions in terms of our ability to borrow next time and the world financial system. Totally different, although you could say the government is in both instances reneging on something. Longer-run issue. |
| 13:58 | Short and medium term, short being 2-3 months from now; medium being 2010-2013. Not too long, not dealing with demographic issues that will occur later. Just read Washington Post article detailing the nuts and bolts of the $31 billion sale of Treasuries. Tried to find the article; Googled it and also pulled up Freddie Mac will ask for $31 billion from taxpayers and GM lost nearly $31 billion in 2008. Got a lot of uncertainty. Article: the $31 billion was a four-week Treasury loan. Interest rate might have been literally zero. Park your money and if there's deflation you'll be covered; if there's inflation in four weeks you'll lose a little bit. Basically said we'll borrow under a short term period because it's cheap. People aren't too worried about default four weeks from now. That's what the investment banks did that went broke, though: they borrowed on very short terms because they could get a low rate of interest. When people start worrying, it can suddenly stop and you can't finance the next $31 billion. Worried about that? Not over two- month horizon--sending a signal that we won't have that problem by January 2010. Yield curve does slope up; but even long term rates surprisingly low. Argument that Paul Krugman makes: low rates at various horizons, doesn't look like markets are worried. Markets are not worried today. Could things change? Things could. Nature of that scenario: thing that's going to help is economic growth. If we continue to see growth like we did in the third quarter of 2009, that will help for all of these things, not just bringing in more tax revenue but reducing the risk of the government having to pay out more on these implicit guarantees, great stability to the financial system. Would see interest rates rise as they do normally in an expansion. If we had another recurrence of serious financial problems--commercial real estate--or if economy were to sputter from here, or if the politics were to play out in a way that the people become much more concerned about these longer run issues will be resolved, then could be a day coming when the short term rates will change very quickly. Could happen in two years or medium term horizon. Key policy for addressing that is for the government to take a more responsible stand on these longer run issues. Demonstrate that we do have a path that makes sense going into the future and that people can believe. 2010 is about two weeks from now; sounds far away as "twenty-ten," like Buck Rogers. |
| 20:12 | Negative scenario for two-month thing. Russ a deficit dove in the past; would say that Milton Friedman's insight is not so much how you finance government spending--taxes today or taxes tomorrow--it's what you spend it on. If you finance it with taxes tomorrow it will cost you a little more so you want to be careful about what you spend it on; interest cost. No vague risk of default--just a luxury to run a deficit in the 1980s and 1990s. We're supposed to borrow about $3 trillion in the coming year. That magnitude borrowing and other things, like commercial real estate. Fannie and Freddie purchased about 600,000 mortgages in 2007 with less than 5% down. Those mortgages are probably not doing very well. Between 25-33% of mortgages today are under water. Some are adjustable rate mortgages that will reset in 2010, won't look so good. Combination plus magnitude of borrowing could be difficult to pull off. Conceivable the Chinese would say it doesn't look as safe as it used to. Would start with a rising interest rate. Is there a doomsday scenario like that that you can imagine and what would be the warning signs? Numbers: current baseline projection from the Congressional Budget Office (CBO) is for a total deficit for 2010 of under $1.4 trillion. For 2011, under $1 trillion. What growth rate are they assuming? Assuming continuing growth, don't know number. Markets don't seem to be expecting problem at the moment. Can't rule it out 100%. Low rates now reflect past responsible behavior with U.S. debt management. Tallest pygmy theory--the United States is struggling, but we are still a relatively safe place to park money, so we are the parking lot of choice. Fall of 2008--flight into dollars. Surprising because the United States was ground zero for the world's financial problems, yet people wanted to park their money in dollars. Even now despite concerns, short term borrowing rates are practically zero. Link between short and long run has to do with credibility; can't take for granted that we will always have that credibility as a nation. Possible to abuse the power. Details, specifics of where the recovery money got spent. Undermines the ability of the United States to weather a crisis. To the credit of the Administration, they have not proposed a second stimulus package of the same kind. What is the possibility that the debt will simply be monetized--that the Fed will simply print money? True by definition--what the government owes is dollars and could create as many dollars as it needs to fulfill those obligations. With a default we are not talking about failing to do that. Question is: can you do that without a dramatic deterioration in what the dollar can purchase? Doomsday scenario is joined with a currency crisis, collapse in the value of the dollar. Federal Reserve could defend the dollar by raising interest rates, letting the Treasury default; or could try to step into the gap. People within the Federal Reserve would be horrified by the presumption that they are going to bail out the Federal government and monetize the debt. Would be similar to what happened in the fall of 2008; Fed just decided somebody's got to solve the problem near term and we'll sort it out later; create reserves to whatever level we need; doubled the Fed's balance sheet, as a short run response to the crisis. Fed would be reluctant to knowingly go down that road. Could take a series of measures for auctions that would have a similar kind of effect. Standard problem with currency crises--no good option. Threats to real side of economic activity. Want to not get there in the first place. Snort not at analysis but that we find ourselves in it. |
| 30:43 | Clarifying point: in other sovereign defaults, impression is that the signals come very late and very suddenly. Things look great and all of a sudden it's over. Is that accurate summary? Talking not just about sovereign defaults but also about currency crises. Latter is the key model for the United States; we are fortunate to be able to borrow in dollars; so don't need to go all the way to default here. Variety of experiences in either category, mistake to lump them all together and say they all follow this pattern. Often it is the case that you have a country that was seeing real growth and acquiring a lot of debt as a result; things looked very good before they looked bad. Run-up in the public debt is an element you'd find in many of the other episodes; if you took the name "U.S." off the current numbers and replaced them with some small developing country, you'd say this is the kind of situation that could go that route. On other hand, would see some movement in short term interest rates in advance. Remarkable how extremely low the borrowing costs for the United States are; don't think you'd find an analogous situation in the other experiences of a country that went from that kind of borrowing advantage to suddenly the sort of crisis we are talking about in the space of months. Different country's name--why does that matter? Is it just that it's "unimaginable"? Is it the past good will we've earned, trust and expectation that ship will find its way to a safe harbor? Combination and also sheer size of the United States. If it did happen it would be not just on us but on the whole world. Initial flight to the dollar; if you don't trust the United States, who else do you trust? Tradition. History of responsible management of the debt. Chinese: made some worried noises about the possibility of inflation that would reduce the value of the resources we return to them for the money they've given us. What are they thinking? No actual "they"--more complicated. What strategy? Keeping the yuan from appreciating and obtaining an export market. Has worked fairly well for them so far. In addition to accumulating huge dollar holdings, they are also accumulating holdings of physical commodities--gold, copper, oil, anything you can store. If these events happen, they will take a loss on their dollar holdings but a gain on their commodity holdings. Not totally exposed. Different theory or playing a different game. Any other economic forces alarming in short or medium run? Haven't mentioned that if you look at Federal tax receipts as a percentage of GDP, historically for the United States always has been below about 21%. Very flat, long term stability. Trends for medical expenditures growing much faster than GDP, so something's got to give. One way it could give is the world figures out it's not good to lend to us any more. Another way would be a big increase in the taxes the Federal government collects; would sacrifice our long run growth potential. Experience of last decade--we haven't created jobs, have invested in housing and productive capacity at the government level, not in infrastructure but basically increasing transfer payments. Worry about longer run trajectory for the United States--are we trying to make the world a better place in the next 20 years or just passing the problems along to the next generation? Theme that shows up a lot of places. Lloyd Blankfein, CEO of Goldman Sachs, quote: Doing God's work because they were channeling capital to its highest-valued use. So between 2004 and 2006, channeled about $1.5 trillion into subprime mortgages, people buying homes they couldn't afford, second homes, third homes. Don't think that was its highest-valued use. |
| 40:22 | Oil prices. In the past decade, a long run-up in oil prices. Tend to bounce around a lot, but long, sustained trend. Debate over why. Focus on the last legs, from 2005-2008, saw real acceleration of that trend, which really goes back to 1997. World production of petroleum basically stagnated between 2005-2008, but in 2006-2007, world GDP increased by more than 10% in real terms. Would produce tremendous increase in demand for oil and other items. China increased its demand by a million barrels a day over that period. How can China be consuming another million barrels a day when the world isn't producing any more oil? The only way that can happen is for people in places like the United States and Europe and Japan to consume less. Could have drawn down inventories. Why do that? Not a temporary development. Did we consume less oil? Yes. Consumption of OECD countries was down about a million barrels a day. Takes a big increase in the price of oil for people to change consumption. It's highly inelastic in price over the short run, more so in 2005-2006 than historically, partly because the energy expenditures had become modest enough for a lot of Americans that you could just afford to ignore those initial price increases. Broader picture changing as well. Remarkable thing happening globally, with China being most dramatic example, but also newly industrialized countries--major change in standard of living within a generation. Those people want cars and other stuff that takes oil. Challenges world to increase production further. Complicated story. Bottom line is that it's not all that easy to keep increasing oil production year after year; challenge to try to keep up with the growing demand from the newly industrialized countries. Trend for next decade. Short run, other issues--world recession took a big bite out of world demand, and have been some adjustments to price increases. Still a lot of people in China, majority don't have cars yet; if their incomes keep growing more and more will want cars; so significant long-range challenge. Saudi Arabia: Supply and demand picture. Relatively vertical supply curve in the short run; relatively inelastic demand curve shifting out, will mainly be reflected in higher prices. Countries and individuals will respond differently; short and long run differences. More flexibility in the long run. Not quite a clean supply picture. One supplier, maybe more than one, that does have a massive inventory because their extraction costs are so low relative to the rest of the world, and that's Saudi Arabia. Is that still the right way to think about what complicates this picture? For years the Saudis were the world's swing producers in oil markets; had a lot of excess capacity and would change their production volumes on a monthly basis in response to market conditions. Would increase production when prices high, and vice versa. Claimed to have huge reserves and a lot of excess capacity. People assumed they would always play that role--which smoothes prices. As prices run up, they find it lucrative to respond with bigger production. Not doing that now? They did that up through about 2005; but then their production started to decline. Assumption had been that extra oil China wanted to consume would come from Saudi Arabia; but the facts were that it didn't. What explains those facts is more complicated issue. Do the Saudis have as much oil and capacity as they are claiming? Open question. May be that they perceived it wasn't in their interest to stabilize the price at a lower level; or may be that they found that they didn't. Even if they do have that kind of capacity--which they have never said that that's what they would do--it wouldn't take too many years of growth by China for that to get eaten up. Throw in India, too. And the oil-producing countries themselves are an important source of demand. Brazil will be a net exporter; another country in which there have been important new discoveries. New element in calculations: the pace of the growth in demand, and a lot of our traditional supplies are going into decline. In the United States, oil production has been declining for the last 40 years. Increased fraction coming from offshore. North Sea in decline now; Mexico in decline; Indonesia one of the original members of OPEC is now an oil importer because of declining production rates. There are some promising spots; Brazil, maybe Africa. But need a lot of extra production to keep up. |
| 50:31 | What about the role of speculation? Any kind of price increase gets tied into speculators. Barro podcast--not just oil price that was going up, but almost every commodity. Harder to tell that story--all correlated with incomes, demand more of everything. Decade-long trend: for those purposes, above-ground inventories not particularly relevant. Separate question for month-to-month or day-to-day price fluctuations. On a daily basis, entirely speculation, people making guesses where those prices might be. If you look at 2009, U.S. inventories of oil were consistently above their trend throughout the year, so there is a case to be made that speculation is one factor in what's going on, and in correlation of daily price changes. But don't want to confound longer run reality. Mistake to say that all of that price increase of $50 up was just speculation. Correlation: on daily basis, speculation could be part of it; but also some commonalities. China is not just buying oil--they are buying copper, corn, increasing meat consumption putting pressure on grain. Common aspect. Agricultural production--we should be able to increase that. In case of oil, definite limitations at least in some traditional producing areas. Besides China, we have an ethanol mandate in the United States that puts pressure on corn; as more land went into corn, went into land that wasn't quite as good as previous land, making price higher certainly in the short run. As land pulled away from other products, like soybeans, would make those prices higher. But it's not just agricultural products. In the past we've had immense amounts of economic growth and they don't tend to get associated with long term price increases; in fact things tend to go the other way. Things get cheaper as technology improves. Short run phenomenon? Interesting time. Change in character of the growth. We went four years from 2003-2007 with 5% real GDP growth--pretty big deal. Historical precedent for that? |
| 55:40 | Oil prices: What evidence do we have on oil prices causing the current recession? When oil prices were rising at the beginning of this decade, many said it would destroy the economy. Economy kept humming along. Got to 2001, tech boom collapsed, very short, didn't have a big impact on GDP or employment, started humming along again. What is the connection between oil price shocks--increases--and the economy? For much of that earlier period, increases in oil prices, but they came gradually. A few more cents on gas but income rising at the same time. Expenditure share had fallen from where it had been in 1980. Beginning in the fall of 2007-summer of 2008, big move-up in price of oil and at pump; now expenditure share significant, had to cut spending. Summer of 2008, 25% drop in purchases of SUVs and light trucks; same time purchases of lighter fuel efficient imports going up. Pretty strong case that what was happening to auto demand had a lot to do with sudden energy prices. Big deal for U.S. auto sector; lost jobs, lost income. Consumption spending generally slowed, in line with historical correlations between consumption spending and energy prices. One factor that were hitting some sector of the economy. At the same time we had housing, subtracting about 1% from real GDP growth during the first year of the recession, that and a little more the year before the recession. The energy price increases were the straw that broke the camel's back, tipped the scales into a recession. Fall of 2008, financial crisis; entirely new phase. Not directly caused by oil prices, but we were dealt a tougher hand by having gone through three quarters of a recession. Energy prices were a contributing factor to this and to a number of previous recessions. Default: transmission mechanism between financial markets and the real side of the economy. One view says that recession totally a result of financial issues; another view says it's more complicated. Hard to argue the latter because it started in December of 2007 by the official measure, so it would have to have some real side. Consequences for our lives if there were a serious Federal debt default? Any inherent real side implications for American life? If you don't trust your money being lent to the Federal government, how do you trust it being lent to the U.S. bank, U.S. firm, or U.S. consumer? If government is having trouble borrowing, the rest of us will. When credit dries up, sends economy into nose dive. Historical examples--joint with currency and overall banking/financial system. Historically United States was such a safe haven--what would replace that? Would be a global aspect. |
| 1:03:25 | Causation in economics generally. Rise in price of oil; Ed Leamer paper on housing prices being a driver of recessions; many believe monetary policy is sufficient; Keynesians look at other factors, animal spirits. Data? What is the state of our knowledge about business cycles? Not what we'd like it to be. Element of recessions is missed expectations. If you knew a recession was coming in six months, the Fed and businesses and individuals would have acted differently. For something to go this wrong, something must have been very different from what was expected. Different recessions start to look quite different. But there is some common element--once enough sectors are having problems at the same time, a lot of sectors tend to go into reverse. We are a long way from being able to say we are about to have to have one of these things six months from now. Maybe be inherent in the nature of the beast. Maybe can't predict recessions any more than we can't be able to predict stock prices. |
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| 0:36 | Intro. [Recording date: December 9, 2009.] Economics 2.0--what do you mean by that? Economics you don't hear about in the mainstream media or in undergraduate economics curriculum. Traditional economics is all about allocating a given amount of resources. Textbooks: people have unlimited wants, limited resources, and the economic problem is to allocate scarce resources among competing ends. Guns versus butter. Not in mainstream--makes it sound like this is a weird, rogue view; but of the ten economists interviewed in book, four won Nobel Prizes and the others highly prestigious. Prestigious view but not widely disseminated. Flip side of scarcity is abundance. In terms of measuring the standard of living and how it's changed over time, and in some sense it's changed very suddenly. Can argue that from the time when people first formed civilizations until around 1800 the standard of living changed relatively little. Dramatic improvements since then. If people lived on the equivalent of $150 a year until around 1500 or 1600; then from 1800 till now, people go from a couple hundred dollars a year to $8000 a year--on a worldwide average. In the United States it's more like $40,000 a year. Tremendous acceleration in growth in the standard of living, just as a fact. Where did that come from? Traditional economics says you've got these scarce resources; the only place that could come from is people forgoing consumption today to get consumption tomorrow by accumulating capital. Yet clearly we've been able to go way beyond what we could get just by accumulating capital. Intangible factors: ideas, innovations. |
| 4:32 | Some of that is produced by capital. Average undergraduate economics major has some idea that technology has something to do with our standard of living. But we don't teach our students much about the texture of that or where it comes from. Ideas--just someone's thinking, gets added to the pile of ideas. But it's more than that. Massive focused effort for some ideas, research and development, private sector and some from public sector as well. Economics 2.0 phrase: Trial and error. Think of the way pharmaceutical companies operate. They will just try a bunch of different molecules and see how they affect different symptoms in different tissues. If they find some they think are promising they might try them on animals; if they work and are safe, go on to human trials. True with entrepreneurship in general: dot com experience, all sorts of new companies formed to try many things. Some failures, like pets.com which was going to deliver pet food to your door. Couple of spectacular successes, like amazon. Hard to predict which would succeed because none were making money. Ex ante, trial and error process. Trial and error underrated and also difficult to model. Interview with Joel Mokyr in book; talks about because this is stuff that cannot be predicted, you cannot model it, cannot forecast the way economic growth will take place. Things happen that are not anticipated. |
| 8:05 | Early days of show, talked about growth and how it is talked about in economics. MIT, Robert Solow. How did economists think about growth in the 1960s and 1970s, and how has that changed? Even true now: daughter in college, had to grind through Solow models; capital accumulation, sacrifice consumption today. Solow himself found the most important problem which is that empirically, capital accumulation doesn't account for very much in the increase in the standard of living over time--maybe a quarter or less. Or the differences across countries. Report under the World Bank--growth accounting analysis of the standard of living in different countries and converted it into wealth terms. Instead of just saying what's the income of a country, they asked what's the wealth. In that measure the average citizen in a well-developed country has over $400,000 of wealth--lifetime income. Most is intangible. Not gold coins, not accounted for by the resources or the capital of the country. All intangible. Things like human capital--education--and odd phenomenon that for some countries, negative intangible wealth. How can you have negative intangible wealth? Their institutions are so harmful--e.g., North Korea--that the institutions cause so much harm that they actually produce less than what you'd think they'd be able to produce just based on their labor and capital. Institutions subtract output and wealth from the country. |
| 11:27 | Let's talk about capital, phrase that economists bandy about loosely. Standard view of a country's resources would be labor--people; raw materials--iron ore, gold, physical assets; and capital--produced goods that can be used to produce other goods, like factories, machine tools, office buildings, computers, equipment and plant used to produce other goods. In the Economics 2.0 approach, capital also includes knowledge, which can also be used to produce other goods. Embodied in human beings and in physical equipment. Knowledge drives a large amount of our productivity--includes know-how, not just facts. Knowledge: how to prevent dysentery, Paul Romer podcast. Sugar in water, prevent dysentery. Walmart knowing how to increase its logistic system has increased GDP--know-how. Companies constantly trying to learn, improve. Knowledge can be anything from scientific, abstract knowledge to workers figuring out how to do their jobs better. Strange that it has taken economics 200 years to figure out intangible assets; granted that it wasn't as important 200 years ago. Listener would say, "Well, duh!" For podcasts, physical capital like microphone, recording device, server; know-how--how to upload the file into the server; most of what we are producing in this podcast can only be measured in trivial ways such as how many hours spent preparing for the podcast. Input into the production function of this experience. People really will think about the economy differently once they concentrate and focus on this. George Mason economist Garrett Jones: Most workers today don't make widgets; they build organizational capital. Add to the capacity of the company to do something new or control risks; not actually assembling things by hand or making new output. Macroeconomics assumes everyone is homogeneous labor, L; and all capital is homogeneous K. Encourages you to think about differently the sources of economic prosperity. Political debate: We can't get rich doing each other's laundry. Idea was that we used to make stuff, but now we have a service economy and services are ultimately going to impoverish us. What is the answer via Economics 2.0? At consumer end, you are going to get better and better goods and services at lower and lower cost through innovation. Laundry: Economics 1.0 story--isn't it great that you can send your shirt out to be ironed by somebody else so you can use your comparative advantage to work on something else? Economics 2.0 answer--that's great that you can send your shirt out, but haven't you heard of permanent press, eliminates ironing shirts altogether. Creates abundance from consumer point of view. What kind of work are people going to do if you put them out of business by doing permanent press? Answer: they will learn to do these building-organizational-capital skills, new ideas, helping new products reach the market. Use their brains more. Risk of implying we will all end up being consultants. New version of permanent press--no iron, 100% cotton shirt. Permanent press was synthetic. |
| 19:03 | Home in on a little piece of this: The traditional worry about innovation is that people get replaced by machines; but people get replaced by ideas. Travel from D.C. to Boston; pay tolls; people are paid. They've been replaced by device you put on your window, Easy Pass. Misleading to say that Easy Pass transmitter put the person out of work. Really the extraordinary set of software behind that little gadget that is doing the work. Somebody had to come up with the concept that people could get through tollbooths faster; wouldn't it be great if we could use the same transponder here as in New York? Paul Romer's work: nonrivalrous aspect. We are producing EconTalk; eventually pressure on bandwidth but currently it can't be used up. Transponder, efficient. Hardware vs. software. Two people can't type on the same keyboard at the same time; but there is no reason why two people can't use spreadsheets software at the same time. Economics 2.0: stuff that operates like software, nonrivalrous, can be replicated cheaply. Better idea for running fast food restaurant--arranged food certain way, better contracts. Business process patent--Amazon wanted to patent the idea of being able to order with one click. Why should they be able to do that and no one else? Tension. Want them to have an incentive to think of it. Discussion in book about intellectual property. If you are thinking about intangible ideas more, you are going to be confronted with value that is not embedded just in hardware or physical stuff, but value embedded in ideas. No conclusive, one-size-fits-all answer for that. Some situations where clearly a lot of work goes into developing an idea, yet the idea can easily be copied. Pharmaceuticals: years of trial and error, come up with this molecule that works and you are ready to market it; somebody else can copy the work without doing the work. Something like one-click ordering--didn't take years and years of trial and error; probably something you could come up with in a couple of days, or an afternoon or five-minute brainstorming. Wouldn't want to give that years of copyright protection. |
| 25:01 | Hardware/software distinction--nonrivalrous part, issues of growth and poverty; bugs in the software; metaphor. Two parts: why is the standard of living so much higher than it was 200 years ago? Software part of that story is ideas. If ideas are easily copied, easily replicated, then that's our story--growth just takes off because ideas start building on each other, lots of growth without using up resources. But then other issue: it makes the differences in the standard of living across countries even more puzzling. Why is it that North Korea doesn't use the same ideas we use? Another aspect of software, analogous to the operating system: communism a different operating system than capitalism, Mugabe's dictatorship different from a more democratic society. Certain operating systems mess up the ability of the economy to operate--extremely buggy. Some of the bugs: things like poorly enforced property rights, |