Government – Page 94 – artdiamondblog.com

Confidence in Market Is Undermined by Economist-Backed Interventions

(p. A17) This year will be remembered not just for one of the worst financial crises in American history, but also as the moment when economists abandoned their principles. There used to be a consensus that selective intervention in the economy was bad. In the last 12 months this belief has been shattered.

Practically every day the government launches a massively expensive new initiative to solve the problems that the last day’s initiative did not. It is hard to discern any principles behind these actions. The lack of a coherent strategy has increased uncertainty and undermined the public’s perception of the government’s competence and trustworthiness.

The Obama administration, with its highly able team of economists, has a golden opportunity to put the country on a better path. We believe that the way forward is for the government to adopt two key principles. The first is that it should intervene only when there is a clearly identified market failure. The second is that government intervention should be carried out at minimum cost to taxpayers.

For the full commentary, see:
OLIVER HART and LUIGI ZINGALES. “Economists Have Abandoned Principle.” Wall Street Journal (Weds., DECEMBER 3, 2008): A17.

Global Warming Benefits Democracy in Greenland

Source of captionless photo: online version of the NYT article quoted and cited below.

(p. 20) . . . for the residents of the frozen island, the early stages of climate change promise more good, in at least one important sense, than bad. A Danish protectorate since 1721, Greenland has long sought to cut its ties with its colonizer. But while proponents of complete independence face little opposition at home or in Copenhagen, they haven’t been able to overcome one crucial calculation: the country depends on Danish assistance for more than 40 percent of its gross domestic product. “The independence wish has always been there,” says Aleqa Hammond, Greenland’s minister for finance and foreign affairs. “The reason we have never realized it is because of the economics.”
. . .
But the real promise lies in what may be found under the ice. Near the town of Uummannaq, about halfway up Greenland’s coast, retreating glaciers have uncovered pockets of lead and zinc. Gold and diamond prospectors have flooded the island’s south. Alcoa is preparing to build a large aluminum smelter. The island’s minerals are becoming more accessible even as global commodity prices are soaring. And with more than 80 percent of the land currently iced over, the hope is that the island has just begun to reveal its riches.
. . .
In November, Greenlanders will vote on a referendum that would leverage global warming into a path to independence. The island’s 56,000 predominantly Inuit residents have enjoyed limited home rule since 1978. The proposed plan for self-rule, drafted in partnership with Copenhagen, is expected to pass overwhelmingly.

For the full story, see:
STEPHAN FARIS. “Phenomenon; Ice Free; Will Global Warming Give Greenland Its Independence?” The New York Times, Magazine Section (Sun., July 27, 2008): 20.
(Note: ellipses added.)

Uncertainty About Government Actions Slows Recovery

In the commentary quoted below, Tyler Cowen makes the important point that recovery from the current economic crisis is being slowed by uncertainty about what the government will do next. While the uncertainty lasts, consumers will consume less, and investors will invest less.
Amity Shlaes has made a similar point about the Great Depression. Uncertainty about what policies FDR would try next, kept investors from risking their money in new entrepreneurial ventures.

(p. 5) The financial crisis is a result of many bad decisions, but one of them hasn’t received enough attention: the 1998 bailout of the Long-Term Capital Management hedge fund. If regulators had been less concerned with protecting the fund’s creditors, our current problems might not be quite so bad.
. . .
. . . Today, . . . , that ad hoc intervention by the government no longer looks so wise. With the Long-Term Capital bailout as a precedent, creditors came to believe that their loans to unsound financial institutions would be made good by the Fed — as long as the collapse of those institutions would threaten the global credit system. Bolstered by this sense of security, bad loans mushroomed.
. . .
While there are some advantages to leaving discretion in regulators’ hands, this hasn’t worked out very well. It has become increasingly apparent that the market doesn’t know what to expect and that many financial institutions are sitting on the sidelines, waiting to see what regulators will do next. Regulatory uncertainty is stifling the ability of financial markets to engineer at least a partial recovery.

For the full commentary, see:
TYLER COWEN. “Economic View; Bailout of Long-Term Capital: A Bad Precedent?” The New York Times, SundayBusiness Section (Sun., December 26, 2008): 5.
(Note: ellipses added.)

For the Amity Shlaes book mentioned above, see:
Shlaes, Amity. The Forgotten Man: A New History of the Great Depression. New York: HarperCollins, 2007.

Only Permanent Tax Cuts Provide Effective Stimulus

Source of graph: online version of the WSJ commentary quoted and cited below.

(p. A15) The incoming Obama administration and congressional Democrats are now considering a second fiscal stimulus package, estimated at more than $500 billion, to follow the Economic Stimulus Act of 2008. As they do, much can be learned by examining the first.

The major part of the first stimulus package was the $115 billion, temporary rebate payment program targeted to individuals and families that phased out as incomes rose. Most of the rebate checks were mailed or directly deposited during May, June and July.

The argument in favor of these temporary rebate payments was that they would increase consumption, stimulate aggregate demand, and thereby get the economy growing again. What were the results? The chart nearby reveals the answer.

The upper line shows disposable personal income through September. Disposable personal income is what households have left after paying taxes and receiving transfers from the government. The big blip is due to the rebate payments in May through July.

The lower line shows personal consumption expenditures by households. Observe that consumption shows no noticeable increase at the time of the rebate. Hence, by this simple measure, the rebate did little or nothing to stimulate consumption, overall aggregate demand, or the economy.

These results may seem surprising, but they are not. They correspond very closely to what basic economic theory tells us. According to the permanent-income theory of Milton Friedman, or the life-cycle theory of Franco Modigliani, temporary increases in income will not lead to significant increases in consumption. However, if increases are longer-term, as in the case of permanent tax cut, then consumption is increased, and by a significant amount.

For the full commentary, see:
JOHN B. TAYLOR. “Why Permanent Tax Cuts Are the Best Stimulus.” Wall Street Journal (Tues., NOVEMBER 25, 2008): A15.

Gains in Productivity Due to “Bipartisan Removal of Regulations that Stifle Competition and Innovation”

In the Clinton administration, Martin Neil Baily was the Chair of the Council of Economic Advisers. He is one of those Democratic economists, along with Brad DeLong and Larry Summers, who appreciates the importance of innovation through the process of creative destruction, in making our lives better.

(p. A15) The economic attention of U.S. government and business leaders is fixed squarely on the downturn and financial crisis. Whether or not bailouts are proper short-term medicine, economists agree that the long-run solution for restoring economic growth lies in raising productivity.

The single best measure of a country’s average standard of living is productivity: the value of output of goods and services a country produces per worker. The more workers produce, the more income they receive, and the more they can consume. Higher productivity results in higher standards of living.

So how has U.S. productivity grown recently? Unfortunately, very slowly. After averaging 2.7% productivity growth from 1995 through 2002, annual growth of productivity in the nonfarming business sector has slowed dramatically — to just 1.7% in 2005, 1.0% in 2006, and 1.4% in 2007. At this new average rate of under 1.4%, it would take nearly 52 years for average U.S. living standards to double — versus just 26 years at the earlier average. Signs of this slowdown are apparent, particularly in the waning competitiveness of U.S. sectors like automobiles, financial services and information technology.

On Monday, we are issuing a new report that details a set of policies the government could implement to boost U.S. productivity growth. Time is of the essence in addressing this challenge because the economy-wide impacts of structural policies tend to appear only gradually, in part because of many-year corporate planning horizons. It is also because faster productivity growth will ease the burden of massive U.S. fiscal deficits now projected for the coming years.

A central theme of this report is the critical role that competitive product markets play in spurring productivity growth and boosting standards of living. One of the great U.S. policy successes of recent decades has been the bipartisan removal of regulations that stifle competition and innovation in product markets. U.S. industries that face strong competitive intensity are more productive than highly regulated or otherwise sheltered industries. This competition, in turn, yields higher incomes and greater choices for consumers.

Maintaining the productivity benefits of product market competition requires sound choices in areas including trade and investment, regulation and infrastructure.

For the full commentary, see:
MARTIN NEIL BAILY and MATTHEW J. SLAUGHTER. “What’s Behind the Recent Productivity Slowdown.” The Wall Street Journal (Sat., DECEMBER 13, 2008): A15.

Government Pressure Led Fannie Mae and Freddie Mac to Increase Their Subprime Loans

“Former heads of Fannie Mae and Freddie Mac testified in the House Tuesday: left to right, Richard Syron, Daniel Mudd, Leland Brendsel and Franklin Raines.” Source of caption and photo: online version of the NYT article quoted and cited below.

(p. B3) Fannie Mae and Freddie Mac engaged in “an orgy of junk mortgage development” that turned the two mortgage-finance giants into vast repositories of subprime and similarly risky loans, a former Fannie executive testified on Tuesday.
. . .
And in March 2006, Enrico Dallavecchia, Fannie Mae’s chief risk officer, wrote to Mr. Mudd to say, “Dan, I have a serious problem with the control process around subprime limits.”
Despite the concerns, Fannie Mae further increased its purchases of subprime loans, according to a January 2007 internal presentation.
Freddie Mac’s senior executives ignored similar warnings. Donald J. Bisenius, a senior vice president, wrote in April 2004 to a colleague that “we did no-doc lending before, took inordinate losses and generated significant fraud cases.”
“I’m not sure what makes us think we’re so much smarter this time around,” he wrote.
Housing analysts say that the former heads of Fannie Mae and Freddie Mac increased their nonprime business because they felt pressure from the government and advocacy groups to meet goals for affordable housing as well as pressure to compete with Wall Street.

For the full story, see:
LYNNLEY BROWNING. “Ex-Executive Faults Fannie and Freddie for Nonprime Loans.” The New York Times (Weds., December 10, 2008): B3.
(Note: ellipsis added.)

Mackerel Money: “If a Dog Eats It, It’s Dog Food”

Mackerel on left; Larry Levine on right. Source of photo and image: online version of the WSJ article quoted and cited below.

In discussing the nature of money, my Wabash College economics professor, Ben Rogge, used to say “if a dog eats it, it’s dog food.” (The moral being that, if people use it as money, it’s money.)
There are many examples of unusual money: large stones, cigarettes, and now mackerel (see the article quoted below).
P.S. In an earlier entry, I worried that Rupert Murdoch would kill the WSJ‘s quirky trademark front-page article. Score one for Rupert’s ability to change his mind for the better, when it matters.

(p. A1) When Larry Levine helped prepare divorce papers for a client a few years ago, he got paid in mackerel. Once the case ended, he says, “I had a stack of macks.”

Mr. Levine and his client were prisoners in California’s Lompoc Federal Correctional Complex. Like other federal inmates around the country, they found a can of mackerel — the “mack” in prison lingo — was the standard currency.
“It’s the coin of the realm,” says Mark Bailey, who paid Mr. Levine in fish. Mr. Bailey was serving a two-year tax-fraud sentence in connection with a chain of strip clubs he owned. Mr. Levine was serving a nine-year term for drug dealing. Mr. Levine says he used his macks to get his beard trimmed, his clothes pressed and his shoes shined by other prisoners. “A haircut is two macks,” he says, as an expected tip for inmates who work in the prison barber shop.
There’s been a mackerel economy in federal prisons since about 2004, former inmates and some prison consultants say. That’s when federal prisons prohibited smoking and, by default, the cigarette pack, which was the earlier gold standard.
Prisoners need a proxy for the dollar because they’re not allowed to possess cash. Money they get from prison jobs (which pay a maximum of 40 cents an hour, according to the Federal Bureau of Prisons) or family members goes into commissary accounts that let them buy things such as food and toiletries. After (p. A16) the smokes disappeared, inmates turned to other items on the commissary menu to use as currency.
. . .
Mr. Muntz says he sold more than $1 million of mackerel for federal prison commissaries last year. It accounted for about half his commissary sales, he says, outstripping the canned tuna, crab, chicken and oysters he offers.
Unlike those more expensive delicacies, former prisoners say, the mack is a good stand-in for the greenback because each can (or pouch) costs about $1 and few — other than weight-lifters craving protein — want to eat it.
So inmates stash macks in lockers provided by the prison and use them to buy goods, including illicit ones such as stolen food and home-brewed “prison hooch,” as well as services, such as shoeshines and cell cleaning.
The Bureau of Prisons views any bartering among prisoners as fishy. “We are aware that inmates attempt to trade amongst themselves items that are purchased from the commissary,” says bureau spokeswoman Felicia Ponce in an email. She says guards respond by limiting the amount of goods prisoners can stockpile. Those who are caught bartering can end up in the “Special Housing Unit” — an isolation area also known as the “hole” — and could lose credit they get for good behavior.

For the full story, see:
JUSTIN SCHECK. “Mackerel Economics in Prison Leads to Appreciation for Oily Fillets; Packs of Fish Catch On as Currency, Former Inmates Say; Officials Carp.” The Wall Street Journal (Thurs., OCTOBER 2, 2008): A1 & A16.
(Note: ellipsis added.)

The classic article on cigarette money, is:
Radford, R.A. “The Economic Organization of a P.O.W. Camp.” Economica, New Series 12, no. 48 (Nov. 1945): 189-201.

Economist Arrested for Speaking the Truth

Detained Latvian economist Dmitrijs Smirnovs. Source of image: online version of the WSJ article quoted and cited below.

(p. A1) RIGA, Latvia — Hammered by economic woe, this former Soviet republic recently took a novel step to contain the crisis. Its counterespionage agency busted an economist for being too downbeat.

“All I did was say what everyone knows,” says Dmitrijs Smirnovs, a 32-year-old university lecturer detained by Latvia’s Security Police. The force is responsible for hunting down spies, terrorists and other threats to this Baltic nation of 2.3 million people and 26 banks.
Now free after two days of questioning, Mr. Smirnovs hasn’t been charged. But he is still under investigation for bad-mouthing the stability of Latvia’s banks and the national currency, the lat. Investigators suspect him of spreading “untruthful information.” They’ve ordered him not to leave the country and seized his computer.
Finance is a highly touchy subject in Latvia, one that the state tries, with unusual zeal, to shield from loose tongues. It is a criminal offense here to spread “untrue data or information” about the country’s financial system. Undermining it is outlawed as subversion.
So, when the global financial system began to buckle this autumn, Latvia’s Security Police mobilized to combat destabilizing chatter about banks and exchange rates. Agents directed their attention to Inter-(p. A19)net chat rooms, newspaper articles, cellphone text messages and even rock concerts. A popular musician was taken in for questioning after he cracked a joke about unstable Latvian banks at a performance.
Just one problem: Much of the speculative buzz now turns out to ring true.
. . .
In Latvia’s Soviet past, officials routinely blamed their problems on saboteurs or other scapegoats. “This is part of our political culture,” says Sergei Kruks, a media-studies lecturer. “If the state doesn’t have a solution, it has to find someone to blame.”

For the full story, see:
ANDREW HIGGINS. “How to Combat a Banking Crisis: First, Round Up the Pessimists; Latvian Agents Detain a Gloomy Economist; ‘It Is a Form of Deterrence’.” The Wall Street Journal (Mon., DECEMBER 1, 2008): A1 & A19.
(Note: ellipsis added.)

European Commission Now Lets Consumers Buy Ugly Vegetables

(p. A6) BRUSSELS — Misshapen fruit and vegetables won a reprieve on Wednesday from the European Union as it scrapped rules banning overly curved, extra knobbly or oddly shaped produce from supermarket shelves.

Ending regulations on the size and shape of 26 types of fruit and vegetables, the European authorities killed off restrictions that had become synonymous with bureaucratic meddling.
The rising cost of commodities also persuaded the European Commission that there was no point in throwing away food just because it looked strange.
As of July, when the changes go into force, these standards for the 26 products, as varied as peas and plums, will disappear. European shoppers will then be able to choose their produce whatever its appearance.

For the full story, see:
STEPHEN CASTLE. “Europe Relaxes Rules on Sale of Ugly Fruits and Vegetables.” The New York Times (Thurs., November 13, 2008): A6.

Eastman Was a Self-Financed Entrepreneur

Mark Casson has argued that the more original the entrepreneur’s innovation, the more likely he will need to finance all, or a large part, of it himself. To the extent that this is true, it represents an important argument for allowing the accumulation of wealth (and thereby an argument against substantial personal income, and inheritance, taxes.)
Here is an example, consistent with Casson’s argument, of a self-financed entrepreneur:

(p. 36) The idea of loading film into a camera, snapping the picture and then sending the film to a store to be processed was the brainchild of an American from Rochester, New York, called George Eastman. One day in 1879, at the bank where he had worked since leaving school at the age of fourteen, he didn’t get the promotion he was expecting. So he left and used his savings to set himself up as a “Maker and Dealer in Photographic Supplies.” At this time, picture taking was a messy, cumbersome and expensive business, involving glass-late negatives, buckets of chemicals an monster wooden cameras. When Eastman had finished his experiments with the process, his slogan promised, “You press the button. We do the rest.”

Source:
Burke, James. The Pinball Effect: How Renaissance Water Gardens Made the Carburetor Possible – and Other Journeys. Boston: Back Bay Books, 1997.