July 1, 2015My Failed Gotcha
July 1, 2015Why I'm a supply and demand-sider
June 30, 2015The euro and the Greek blackmail
June 30, 2015Question for Jeff Zients on Ex-Im
June 30, 2015Macroeconomics in small economies
June 29, 2015Wolfgang Kasper on the Euro
Entries by author
Frequently Asked Questions
Bryan Caplan, David Henderson and Scott Sumner, with guest blogger Alberto Mingardi, blog on issues and insights in economics.
JULY 1, 2015
And remembering another failed gotcha in the past--and what I learned from it.
This morning I read an article about the Greek crisis by UC Berkeley economist Barry Eichengreen, who has been following the crisis. In it, he writes:
The implication is clear. Never underestimate the ability of politicians to do the wrong thing. I will try to remember next time.
Ah hah, I thought. I bet I can find many examples on the web of Eichengreen's underestimating the ability of politicians to do the wrong thing in the past. That wouldn't even technically be a gotcha because he himself implicitly admits that he has underestimated. Still, I thought, it's worth pursuing.
I recalled that he is one of the economists who is regularly asked to give his opinions on economic issues for something called the IGM Forum, based at the University of Chicago. Surely, I thought, if I went through how he voted and his reasoning on each, when he gave a reason, I would find lots of examples of his having too much confidence in politicians.
I was wrong. I was wrong for two reasons. First, my rough estimate is that about 80% of the issues on which he was asked to give his opinion were positive, not normative, issues about the economy. So, for example, here's the question from February 15, 2012:
Question A: Because of the American Recovery and Reinvestment Act of 2009, the U.S. unemployment rate was lower at the end of 2010 than it would have been without the stimulus bill.
One can think that the unemployment rate was lower than it would have been without having a lot of trust in politicians and without even thinking that the jobs produced by the ARRA were good jobs.
Or consider this one from May 12, 2015:
The 9% cumulative increase in real US median household income since 1980 substantially understates how much better off people in the median American household are now economically, compared with 35 years ago.
Again, that's a positive issue, at least if you can assume that what people can consume is a measure of their wellbeing.
So there's just not much room for figuring out an economist's views on the competence of government from his views on these kinds of issues.
But even on more-normative issues, I didn't see clearly that Eichengreen badly overstates the competence of government. Here are his votes and reasoning on the various issues.
Here's a clearcut normative issue, from May 6, 2015:
Considering both distributional effects and changes in efficiency, it is a good idea to let companies that send video or other content to consumers pay more to Internet service providers for the right to send that traffic using faster or higher quality service.
I would have liked an Agree. What he gave was an Uncertain. That's simply humility on his part, an underappreciated virtue.
Moreover, I often found myself agreeing with Eichengreen on issues that were posed as positive ones but that had a normative tone, such as this one from September 29, 2014:
Letting car services such as Uber or Lyft compete with taxi firms on equal footing regarding genuine safety and insurance requirements, but without restrictions on prices or routes, raises consumer welfare.
Eichengreen gave it a Strongly Agree. Granted that this was posed as a positive question, but it would be a rare duck who would say, "I strongly agree that this would raise consumer welfare and I'm against it."
Once I figured this out, I had a choice: scrub my planned blog post or write it up with my actual results. I chose the latter. We economists are all familiar with journals that reject articles, not because they're badly done, but because they don't find the result that the researchers were expecting (hoping?) to find but didn't. But it's a bad idea to reject such high-quality articles: those articles tell us something too.
I learned something from this research, and it's a lesson I also learned much earlier in my life but seem to have to relearn. Actually, two lessons. The first, which I first learned from reading Pride and Prejudice three times in high school, was not to assume but to pay attention and weigh evidence. The second, which I learned when I was a summer intern at the Council of Economic Advisers under Herb Stein in the Nixon White House, was how much agreement there is among economists about not restricting competition, not regulating prices, etc. One afternoon that summer of '73, when I was caught up on all my projects, I found some old files from the mid-1960s when Kenneth Arrow was a senior economist at the Council. In one of his memos, he made the case for deregulating natural gas prices.
What was my earlier failed gotcha that I mention at the top of this post? In 1984, when I was a senior economist at the Council, I read a Washington Post editorial that argued against the Securities and Exchange Commission regulating newsletters. The Post made the case based on the idea that even if financial newsletters were misleading, we should trust freedom of speech and not trust government to regulate. So I sat down to write a letter to the Post making the case that the Post editorial writers should follow their own reasoning more consistently. Of course, the best way to make that case would be to find another editorial in which the editors advocated more regulation and more trust in government. None of the other editorials that day were on such topics. So I checked the previous day and found two editorials on topic. The problem: both advocated deregulation. So I went back one more day and found another editorial on topic that advocated--deregulation. I wrote my letter and it was published, but it wasn't as strongly worded as I had planned at first. Again, I learned something: Don't assume and specifically don't assume that you don't have allies.
JULY 1, 2015
I first got into blogging in 2009 out of frustration over Fed policy. The US obviously had a huge demand shortfall, and the Fed wasn't doing enough to address the problem. Indeed I believe the Fed caused the huge demand shortfall.
So most people think I'm a demand-side economist. (Some even equate "demand-side" with "Keynesian," which would make Milton Friedman roll over in his grave.) But like Friedman, I'm also a supply-side economist. Indeed perhaps even more so than Friedman. Much of my academic work focused on the Great Depression, and I ended up convinced that both supply and demand shocks played a big role. The negative supply shocks were caused by counterproductive policies under Hoover and FDR, notably the NIRA.
Now I find people criticizing me for not advocating that Greece leave the euro to solve its unemployment problem. In one sense that's a fair criticism, as it seems to go against my earlier views on the Great Depression, where I praised FDR for leaving the gold standard. Perhaps Greece should leave the euro. But first a few words of caution:
1. I hear people say that 25% unemployment is a disaster, which was caused by the euro. That's partly true. But back in 1994, Spain had 24% unemployment and was not using the euro. Indeed unemployment in Spain exceeded 20% for about 5 years during the 1990s. Evidently not being on the euro is not a cure-all.
If Sunday's referendum had provided three options:
1. Continued rule by Syriza.
Then my choice would be easy---option three. But that option is not on the table. As it is I lean toward option two, because I'm very afraid of Greece being ruled by a party that despises capitalism. In the short run, demand shocks are the most important, but in the long run it is supply-side factors that matter most. Ten years from now, Greece's economic performance will depend on how many neoliberal reforms have been enacted, not on what they did with their exchange rate back in 2015.
Despite all that, I can see why people might disagree with me. The option of leaving the euro certainly seems tempting. But when you are both a supply and demand-sider, the choices don't look quite as easy. Obviously the Spanish government didn't believe that devaluation would solve all their problems in the 1990s, even though they could have easily done so, as they still had the peseta.
Update: Commenter dlr pointed out that Spain did devalue on several occasions during the early 1990s, and by a total of over 30%. That of course strengthens my point.
PS. I like this comment by Alberto Mingardi:
Tsipras has attempted to blackmail the creditors, by agitating the spectre of a Greek default as the Lehman Brothers of the European crisis. The European authorities have acted so far seconding their instincts: that is, muddling through. But when push came to shove, they couldn't just accept the Greek terms, because of their most likely political effects: that is, suggesting to the Portuguese and Spanish that a deal on any terms could be ultimately made, and thus voters could heedlessly vote for anti-austerity parties.If the EC gives in to Syriza, and gives them far better terms then they were willing to offer mainstream parties, then why wouldn't voters in other European countries also elect radical leftist parties?
JUNE 30, 2015
We're showered with information and comments on the Greek crisis, and rightly so. The Greek Prime minister Alexis Tsipras has called for a referendum on the terms offered by creditors to Greece. Then night talks between Mr Juncker and Mr Tsipras apparently triggered the hypothesis of a last minute deal - but it doesn't seem that that will happen. Certainly not the week before the referendum, which is to happen on Sunday, Greek banks and the stock exchange are going to stay closed. Europe and the world have looked with anxiety at people queuing in front of ATM machines in Athens.
It might be worth remembering that, when Tsipras won elections a few months ago, the Greek situation certainly wasn't all happy - but the IMF was estimating positive growth for this year. A few months of socialism and reckless blackmailing attempts by the European creditors have stripped Greece of any hope of returning to growth, however feebly, and have brought the country to the edge of disaster. One small point. Italian Finance Minister Piercarlo Padoan explained to Corriere della sera that the Greeks did not send "technical" personnel to do the bargaining with their official creditors until but a few weeks ago. They did plenty of political lecturing, but they abstained from dealing with the minutiae of possible agreements. Other top officials confirmed, at different stages, that the Greek government's was a quintessential political game: no technicians in the room. You can't manage a country like that.
My sense is now that Tsipras is basically hoping for his compatriots to vote "yes", so that he can re-enter the negotiating room while blaming "the people" for having made the tough decision. Not an example of luminous leadership.
I find two comments of particular interest. Here's Tyler Cowen's on possible contagion and here are Guntram Wolff's economic and legal observations on capital controls. Capital controls have been imposed in Greece now, as happened in Cyprus before. Of course this decision calls into question the very nature of a monetary union: but European authorities do not seem to be bothered, so far.
Tyler Cowen makes an important point: "If only for geopolitical and also humanitarian reasons, the EU cannot wash its hands of Greece." I think AEI's Dalibor Rohac said it very wisely in a tweet: now it is time to change the treaty, to make it possible for a country to stay in the EU even if it leaves the euro, which is currently impossible. This would help in dealing with the geopolitical concerns underlined by Cowen.
At the end of the day, the crux of the Greek problem is the lack of procedures for exiting the Euro club. Orderly procedures aren't there: so expect a disordered development of the crisis.
Tsipras has attempted to blackmail the creditors, by agitating the spectre of a Greek default as the Lehman Brothers of the European crisis. The European authorities have acted so far seconding their instincts: that is, muddling through. But when push came to shove, they couldn't just accept the Greek terms, because of their most likely political effects: that is, suggesting to the Portuguese and Spanish that a deal on any terms could be ultimately made, and thus voters could heedlessly vote for anti-austerity parties.
If the Euro could be exited without leaving the EU, at this stage things would be at least a bit easier. And yet the European leadership finds the perspective most frightening. "The Euro is irreversible" is one of their favourite sentences. But you can't force people to stay in a club they feel they don't belong to. This semi-religious Eurospeech is, I fear, as effective in reinforcing populist stances, as appeasing to the Greek blackmail would be.
CATEGORIES: Eurozone crisis
JUNE 30, 2015
While surfing the web this morning, I came across a mention, by Cato Institute economist Dan Ikenson, of a White House conference call on the Export-Import Bank. I thought, what the heck, the call is during my lunch break; I'll try to get on. I signed in, playing it straight and listing my affiliation with the Hoover Institution, fully expecting that someone would look at that and reject me. Wrong. Given how quickly I got my ID number for the conference call, it was clear that this was automatic and there was essentially no screening. It also suggested--it turns out correctly--that there would be little giving away of strategy.
So I called in at the appointed 11:30 PDT. Sure enough, it started 20 minutes late but I missed the first few minutes because I was at Trader Joe's getting my lunch salad.
President Obama made some brief opening remarks and then turned it over to Jeff Zients, his director of the National Economic Council, for more detail. Zients gave the boilerplate case, the kind of mercantilist case that would cause the current Don Boudreaux and the 1990s Paul Krugman to blow a fuse: we need it to boost exports, jobs are at stake, we need it for our international competitiveness, there are beneficiaries in every single state, etc.
Because I thought there would be a chance for questions (although I knew the probability of my being picked was low), I thought of a question, the TANSTAAFL Bastiat's "what is not seen" question. Here would have been the question: "It's true that you can identify gainers in every state. But what about what is not seen--the losers in every state, people who don't get financing because Ex-Im has allocated lending to exporters rather than to them?"
But then Zients gave me an idea for an even better question by pitching a slow ball right across the plate. He argued that it was false that Ex-Im costs the taxpayer money because it actually makes money. If I recall his number, it was that in the last year the Ex-Im made $600 million. That led me to think of the obvious question that almost anyone trying to husband tax money would think of regardless of one's other political and economic views. And it was this:
Since Ex-Im makes money and you're saying that not only did it make money this year but also it makes money on average, why not let Ex-Im be self-financing with no government subsidy and no government sponsorship of any kind?
Unfortunately, Zients ended the call well before the scheduled time and took zero questions. But Dan Ikenson tells me that it's a good question.
JUNE 30, 2015
Like many American economists, I've learned macroeconomics from an American perspective. But America is a very unusual country. For instance, US RGDP growth has averaged about 3% for the past 120 years, if not more. Most business cycles are fairly small, partly reflecting the fact that our economy is well diversified. If Nevada is in recession, Massachusetts may be growing, or vice versa.
Other economies don't seem to adhere as closely to a stable trend line. Japan did very poorly in the 1940s, then raced ahead for decades, and has seen little growth since the early 1990s. Even smaller economies such as Latvia, Estonia, Iceland and Greece have seen spectacular booms followed by huge busts.
In the following quotation, I believe Paul Krugman is wrongly applying American-style macro thinking to the Greek case:
But doesn't the ultimate cause lie in wild irresponsibility on the part of the Greek government? I've been looking back at the numbers, readily available from the IMF, and what strikes me is how relatively mild Greek fiscal problems looked on the eve of crisis.
America would be able to support a public debt equal to 100% of GDP. But unlike Krugman, I believe the Greek situation in 2007 was "wildly irresponsible." Greece needed to run budget surpluses during the boom years, so that it would have the resources to do fiscal stimulus during a depression. Instead they ran a very large budget deficit during the boom period.
By the way, notice that Krugman simply uses the actual budget deficit, not the cyclically adjusted (structural) deficit, which presumably was even worse. In contrast, when economies are depressed he tends to use the cyclical adjusted deficit, which makes policy look more contractionary than the raw figures would suggest. Here is his excuse:
Now, the IMF says that the structural deficit was much larger -- but this reflects its estimate that the Greek economy was operating 10 percent above capacity, which I don't believe for a minute. (The problem here is the way standard methods for estimating potential output cause any large slump to propagate back into a reinterpretation of history, interpreting the past as an unsustainable boom.)I would certainly not believe a 10% over capacity estimate for the US economy in 2007, but I don't find it all that implausible for Greece. Suppose your economy is sucking in lots of foreign workers for a real estate boom. The boom ends and the foreign workers leave. Now your "natural rate of output" is lower, as you have less labor. The outflow of Mexican labor after 2007 was not enough to cause a big drop in the US natural rate, but in a smaller economy like Greece, or Nevada, or Dubai, that sort of shock to capacity output could be much more significant.
In the 1999-2000 boom the US government did run a budget surplus, and I believe Krugman supported that policy. He once suggested that President Bush made a mistake by cutting taxes and putting us back into a structural deficit. I'd argue the same applies to Greece (and Iceland, Estonia, etc.). Countries with those sorts of wild swings between boom and bust need to run surpluses during the good years. Because Greece did not do so, it is now forced to beg for loans from others. Its creditors know that it is unlikely to be able to repay those loans, and not surprisingly are reluctant to grant even more loans without some pretty strict conditions attached.
I recall that Australia went into the Global Financial Crisis with a net debt of less than 10% of GDP. If Greece had done the same it would be far better off today. (Sometimes the VSPs worries about public debt are actually true.)
I do agree with Krugman's conclusion:
The euro straitjacket, plus inadequately expansionary monetary policy within the eurozone, are the obvious culprits. But that, surely, is the deep question here. If Europe as currently organized can turn medium-sized fiscal failings into this kind of nightmare, the system is fundamentally unworkable.Yes, but for better or worse the Europeans are strongly committed to the euro. Even the Greek public is strongly committed. So Europe needs to make the system work better. And that means radical reductions in debt, back to levels where there is room to do fiscal stimulus during deep downturns. And that also means a move towards much more neoliberal policies, to make labor markets more flexible. And that also means the ECB needs to switch to a policy that stabilizes aggregate demand for the entire eurozone, such as NGDP targeting. All of these things need to be done, and if they are done then the euro may be able to work tolerably well. But I'm not optimistic that these things will be done, which is why I still think the euro is a bad idea.
What about fiscal union? That would require political union, turning the eurozone into a single country. It's not likely to happen and I believe it would be unwise.
JUNE 29, 2015
In following the Greek economic crisis, I have very little to add that has not been said. But one economist who said it well three and a half years ago is Australian economist and German native Wolfgang Kasper. His Econlib Feature Article, "Nothing New on the Euro Front," is still well worth reading. An excerpt from his conclusion:
Over the long term, there is but one solution to the Euro crisis: Flexible shock absorbers must be built into the Euroland cart again, as the road ahead may well become bumpier. This could mean that the Germans and some of their Northern neighbors quit the Euro, which would be a noble solution on the part of the strong economic regions. Or it could mean that the Greeks and Italians are invited to take 'a holiday from the Euro,' while the French and Spanish governments rein in their expensive welfare policies for citizens, industry and agriculture in order to keep pace within a new Hard Euro.
But wouldn't such an exit be messy? Yes, says Kasper, but other countries have been there before:
Both solutions would create hairy legal problems for owners of monetary assets and partners in credit contracts. But such problems are not new. They have been solved before when monetary unions were dissolved. Maybe European central bankers should apply for instruction in Singapore and Kuala Lumpur about how the split-up of the Straits dollar into the Singapore dollar and the Malaysian ringgit was handled, or they might learn how Prague and Bratislava did it during the 'Velvet Divorce.' Meanwhile, loan contracts are already being designed that anticipate devaluations after the introduction of the Nea Drachma, and wealthy foreigners in Tuscany are scrambling to match the value of their holiday homes with mortgages from Italian banks, so that their losses after the slide of the Lira Dura are minimized.
And his suggested step forward:
The technical and administrative problems with an introduction of a New D-Mark could also be solved: The government can declare that to forestall an imminent crisis, it has, most regrettably, no other option but to withdraw legal tender status for all Euro banknotes that do not carry a German identifier (all banknotes show a national code). All other Euro notes and coins will be exchanged at a fixed rate within three months. Political leaders can, after all, explain that it is free travel, free trade, free capital and enterprise movements, and the freedom for young Europeans from different countries to marry that matter for European integration, prosperity and lasting peace, not the artificial bond of an imposed unitary currency.
CATEGORIES: International Macroeconomics: Exchange Rates, International Debt, etc. , Monetary Policy
JUNE 29, 2015
When Americans think about inequality, it is often linked to ethnic differences. Sometimes that's also true in Europe (as with the Roma), but more often the inequality is regional. Perhaps the starkest example lies in Italy, where even in 2007 the south lagged far behind the north. Since then, things have only gotten worse:
The country is, in effect, made up of two economies. Take that 2001-13 stagnation. In that period northern and central Italy grew by a slightly less miserable 2%. The economy of the south, meanwhile, atrophied by 7%.
In one important respect southern Italy is different from Greece. Like eastern Germany, southern Italy is part of a larger and more prosperous fiscal union. For many decades, Italy has been doing the things that American progressives would recommend, pouring lots of fiscal stimulus into the south, to build up the economy. But nothing seems to work. Indeed from Greece to Italy to southern Iberia, the entire southern tier of Europe is doing quite poorly. But why? And what can America learn from the failure of Italian policies aimed at boosting the mezzogiorno?
American progressives will sometimes argue that we have much to learn from the successful welfare states in northern Europe. Perhaps that's true. But I'd have a bit more confidence in that claim if they could explain what we have to learn from the failed welfare states in southern Europe. Indeed I'd have more confidence in progressive ideas if they even had an explanation for the failed welfare states of southern Europe. But I don't ever recall reading a progressive explanation. Indeed the only explanations I've ever read are conservative explanations, tied to cultural differences.
PS. The mezzogiorno has roughly 1/3 of Italy's 60 million people, making it almost twice as populous as Greece. In absolute terms, incomes there (17,200 euros GDP per person in 2014) are far lower than among American blacks or Hispanics. In contrast, GDP per person in northern Italy was about 31,500 euros in 2014. And while the gap between eastern and western Germany is narrowing, the gap in Italy is widening. Why?
JUNE 28, 2015
Andrew Oxlade writes:
He [Ian Spreadbury] declined to predict the exact trigger but said it was more likely to happen in the next five years rather than 10.
There's some pretty serious innumeracy going on here. I'm not sure if it's Spreadbury or Oxlade who's innumerate. Oxlade might be misreporting what Spreadbury said.
It reminds me of one of my favorite examples that Richard Thaler and Cass Sunstein use in their book Nudge. I use it when I teach numeracy in class. They write:
Again, biases can creep in when similarity and frequency diverge. The most famous demonstration of such biases involves the case of a hypothetical woman named Linda. In this experiment, subjects were told the following: "Linda is thirty-one years old, single, outspoken, and very bright. She majored in philosophy. As a student, she was deeply concerned with issues of discrimination and social justice and aIso participated in antinuclear demonstrations." Then people were asked to rank, in order of the probability of their occurrence, eight possible futures for Linda. The two crucial answers were "bank teller" and "bank teller and active in the feminist movement." Most people said that Linda was less likely to be a bank teller than to be a bank teller and active in the feminist movement.
Just as all feminist bank tellers are bank tellers, the next ten years includes the next five years.
CATEGORIES: Behavioral Economics and Rationality
JUNE 28, 2015
If you travel to other countries you might occasionally notice something that you wish the US had. The one I notice most often is good subways. This article caught my eye:
Stan Paul, who begins his morning ride to UCLA in Riverside, experimented a few times with public transit, but an hour-plus ride on a commuter train ends near downtown Los Angeles, and to get from there to his office would take at least another hour by subway, bus and foot.
In the US there is a debate over whether we should spend more on mass transit, or whether our cities are too spread out for a subway system to make sense. But what if there is a third option:
Chinese firms are building Tehran's metro, two harbours in Egypt and a high-speed railway between Saudi Arabia's holy cities of Mecca and Medina.The LA subway discussed above has already been in development for several decades, and it's still not clear if it will be finished by 2036. Meanwhile Chinese cities like Beijing and Shanghai open new subway lines about once a year. The authorities in Tehran wisely chose the Chinese to build their subway system.
The US media often likes to frame issues along a narrow ideological spectrum, without considering third options. Often the two options are aligned with the two political parties. One party may support more government, while the other wants to protect the interests of powerful special interest groups. But what if there is a third option?
1. Instead of debating whether to have the antitrust authorities crack down on the airlines, why not make it legal for foreign airlines to fly between US cities? Why not allow foreign ships to go between US ports?
2. Instead of debating whether to spend more money on fixing the FAA, why not privatize the organization, as many other countries have done?
3. Instead of debating whether to have the government or the private sector deliver extremely expensive health case, why not allow foreign health professionals to freely operate in the US, producing cheap health care.
4. Instead of debating whether or not to spend tens of billions on new subway systems, why not allow foreign firms to build them much more rapidly, and at dramatically lower cost?
5. Instead of debating whether to "allow" gays to get married, why not entirely remove the government from the issue of marriage, leaving it as a private arrangement?
6. These third options need not be libertarian. Instead of debating whether or not to raise the minimum wage, choose a third option---higher minimums but paid for with government wage subsidies.
You may or may not agree with any of my suggestions, but surely there is a need for all of us (especially the news media) to stop framing issues so narrowly and allow more "thinking outside the box."
PS. Although LA may not be densely populated enough to support a subway system, the specific line being discussed would go from downtown toward Santa Monica, paralleling the relatively densely developed Wilshire blvd. If any line could work, it would be that one.
PPS. I sometimes have a fantasy where either the liberals or the conservatives were given 100% control of the US for 20 years, so that each side could see that its ideas don't work, and that third options are needed.
JUNE 27, 2015
How can a practical case also be a moral case? Simple: if one's standard of value is human life, as Epstein says his is, then whatever enhances human life is moral. There are some problems around the edges of his argument, but in a big-picture sense it holds up.
This is an excerpt from "Ethics and Energy," my basically positive review of Alex Epstein's book, The Moral Case for Fossil Fuels. Co-blogger Bryan Caplan was the person who first piqued my interest in the book with his posts here, here, here, here, and here.
Another excerpt from my review:
He reminds us that we need to judge various energy sources by the cost of all the resources used to produce energy. Sure, rays from the sun are free, but the various materials used to convert those rays into a usable energy form are very expensive, requiring many other materials per unit of energy produced. Referencing a U.S. Department of Energy report, he notes that such materials "can include highly purified silicon, phosphorus, boron, and compounds like titanium dioxide, cadmium telluride, and copper indium gallium selenide." The story for wind power is similar. He points out that generating one megawatt of electricity with wind power requires 542.3 tons of iron and steel, compared to only 5.2 tons to get the same amount of electricity using coal.
I'll close on a positive note. Epstein's last chapter is his best and should have been his first chapter. In it, he tells how he paid famous environmentalist Bill McKibben $10,000 to debate him. That alone impressed me. Epstein tells the story in such a dramatic way that it almost gave me chills. I recommend reading it first; you will likely then be motivated to read the rest of the book.
JUNE 26, 2015
When I was the senior economist for health policy under Martin Feldstein, chairman of President Reagan's Council of Economic Advisers, one of his biggest criticisms of politicians was their innumeracy. I agree that that matters a lot, and it's not just politicians but also many pundits who are innumerate.
I started teaching a 45-minute segment on numeracy about 25 years ago in every class I teach at the Naval Postgraduate School. What caused me to do it was a comment I made in class one day that, if the students had had any idea of the U.S. population, should have caused them to gasp or, at least, raise their eyebrows. (I don't remember my comment.) When I saw basically zero reaction, I asked them to take a scrap of paper and, without putting their names on the paper, write down their estimate of the U.S. population. At the time, it was about 250 million.
The median answer was great and so was the mode--both within about 2% of the right answer. But the range? The low end was 1.5 million. The high end was 1 billion. I pointed out that if the low end were right, it would mean that everyone in the United States was in the U.S. military.
What caused me to think of this was this comment by Jonah Goldberg:
The Left's identity-politics game is a bit like the welfare states of Europe, which exist solely by living off borrowed capital and unrequited generosity. Europeans can only have their lavish entitlements because they benefit from our military might and our technological innovation. Left to their own devices, they'd have to live quite differently.
It's the "our military might" that grabbed my attention. I'm sure that Goldberg has in mind the fact that the U.S. government is spending a higher percent of U.S. GDP on the military than the welfare states of Europe do. But even if the welfare states raised their percent to equal the percent that the U.S. government spends, that would be an increase of about 2 percentage points of GDP. That's a substantial number and doing that would require either an increase in taxes or a reduction in, most likely, welfare state spending. But it wouldn't mean that they would have to live "quite differently," not when government spending in those countries is typically over 40 percent of GDP. Goldberg's innumeracy here is not nearly as bad as that of the outliers in my class. Still, though, it would be hard to make his case if one had the right numbers.
CATEGORIES: Political Economy
JUNE 26, 2015
Bob Murphy has a new post discussing the similarities between the fiscal policy of 2013 (often called 'austerity') and the fiscal policy of 1937, which some Keynesians believe helped cause the 1937-38 depression (which was relatively deep).
In fact, there are lots of similarities that Bob missed. Consider the following discussion of tax policy in 1937.
On the revenue side, it is apparent that revenues increased sharply in the first quarter of 1937. There are two main factors. The most important one is the increase in income tax revenue, which grew by 66 percent from 1936 to 1937. This was due to a significant increase in income tax rates in the Revenue Act passed in June 1936. The rates previously ranged from 4 percent (starting at $4,000) to 59 percent (above $1 million). They remained unchanged for income brackets below $50,000, but were increased above that threshold, to reach 75 percent on the top earners. As a result, the average marginal tax rate for incomes above $4,000 almost doubled, from 6.4 percent to 11.6 percent.
So two major tax increases occurred on January 1, 1937; the payroll tax rate rose by 2 percentage points (from 0% to 2%) and the income tax was raised, but only on the wealthy. On January 1, 2013, the payroll tax rose by 2 percentage points, and income taxes were raised, but only on the upper middle class and wealthy. (Note, the 2013 increase affected people making over $200,000, but in real terms that was much less than $50,000 in 1937. Also note that the income tax was a far less important source of revenue back then.)
In a recent post Paul Krugman pointed out that the cuts in government spending (the "sequester") were largely offset by increases in state and local spending (or more precisely, decreases in the rate at which spending was being cut.) Now look at this graph for the 1930s, from the same source:
What can we make of all of this? Unfortunately we can't get a clear answer, partly due to data limitations, and partly due to ambiguity in what the Keynesian model says is the right way to measure austerity. I'll try to summarize the pros and cons for arguing that 1937 and 2013 are similar.
1. In 1936 the fiscal year ran July 1 to June 30, now it runs October 1 to September 30. That makes things tricky, given that in both cases much of the austerity begins on January 1. Bob Murphy quite reasonably responds by looking at two-year changes in the budget deficit. His figures actually show a bit more austerity in 1936-38 than my figures (which are from the St Louis Fred. He finds the deficit fell by 5.3% of GDP; the St. Louis Fred says it fell by a bit under 5%. Either way that's a bit more contraction than in a two year period around 2013 (which is roughly 4.3% of GDP.)
2. There are additional factors, which cut either way. Many Keynesians would point to the change in the change in the deficit as determining the change in GDP growth rates. That is, it's not whether you are running a big or small deficit that matters, or even whether it is rising or falling, but rather whether it is rising or falling faster than in recent years. That approach makes 1937 look more austere, although if you use calendar 2013 instead of fiscal 2013, the drop-off in 2013 is a bit more dramatic than using fiscal years. Growth really should have slowed in 2013.
3. Bringing in state and local spending (which is unjustified in my view) would be roughly a wash, as it affects both periods in about the same way.
4. Keynesians believe in looking at the cyclically-adjusted deficit. And this point is something that goes against 1937 having more austerity. Real GDP growth in 1935-37 was very high, with the first half of 1937 showing a real GDP nearly 25% higher than in the first half of 1935 (Balke and Gordon estimates). That means the cyclically adjusted deficit shrinkage in 1937 was significantly smaller than the actual deficit shrinkage. But I'm not certain how much. You might be surprised by the fact that RGDP growth in 1937 was so strong, as the recession began in mid-year. But the severe recession only began in Q4, and the level of GDP in late 1936 and the first half of 1937 was extremely strong---the only "boom-like" 12 months of the entire 1930s. Yes, the official unemployment rate was still high, but that's partly because workers on government works projects were counted as unemployed. There's a reason both the FDR administration and the Fed thought contractionary policies were needed. They were wrong, but the economy really did seem to be recovering quite rapidly at that moment, and (WPI) inflation was rising sharply.
In contrast, RGDP growth has been slow in recent years, and hence the cyclically-adjusted deficit is not dramatically different from the actual deficit.
I've probably made a few mistakes here, but I think it's fair to say that the level of austerity in 1937 was probably a bit more than 2013 (due to the bonus phase-out), but in a qualitative sense the two fiscal austerity projects shared a number of striking similarities. If you take out the bonus payments then the fiscal contraction from 1935 to 1938 would have been fairly smooth, and very similar to 2011-14. One study estimated that the bonus payments boosted 1936 RGDP growth by 2 1/2% to 3%. But even without that boost, RGDP growth was very rapid brisk during the 1933-41 recovery (mostly 8% to 12%/year), and thus not repeating the bonus payments in 1937 obviously can't explain one of the most severe depressions of the 20th century, one year later.
Of course there's also the monetary offset problem. The Fed did some contractionary policies in late 1936 and early 1937 (reserve requirement increases, gold sterilization) precisely because inflation was rising sharply. Indeed there was perhaps even a sort of "fiscal offset", as the bonus payments were enacted over FDR's veto, and the administration immediately tightened fiscal policy. Nonetheless, I believe the bonus payments did provide a short-term boost to the economy in late 1936---the monetary offset kicked in a bit later.
None of this should be viewed as a critique of moderate Keynesianism. I recall that economic historians like Christina Romer argued that fiscal contraction played some role in the 1937 business cycle, but that monetary policy was the key driver of AD in the late 1930s. Rather I'm suggesting that people be careful drawing simple lessons from complex cases. Fiscal policy was probably modestly more contractionary in 1937 than 2013, but the differences were not large enough to draw radically different conclusions from the two episodes.
FWIW, in my research on the Depression I pointed to the big rise in real wages during 1937-38, which had two causes:
1. A big rise in nominal wages after a massive unionization drive, which doubled union membership between 1936 and 1938 (probably due to the Wagner Act.)
2. A sharp shift from gold dishoarding in 1936 and early 1937 (which was inflationary) to gold hoarding in late 1937 and early 1938 (which was deflationary.) The dollar was pegged to gold at $35/oz during the period, and the base tended to follow changes in the monetary gold stock. As prices fell sharply in late 1937 and early 1938, real wages soared.
It's actually far more complicated than that, and I have a book coming out in December that explains it all in more detail.
JUNE 25, 2015
JUNE 25, 2015
I was recently in Portugal for the "Estoril Political Forum", masterly organised by Joao Carlos Espada. This was an uplifting event: we listened to many interesting speeches, in a room packed with hundreds of Portuguese students in the social sciences.
I chaired an "Einaudi Lunch." The Forum has lunches and dinners named after great figures, such as George Washington, Winston Churchill, and Konrad Adenauer. Luigi Einaudi parted company with them; he was a lesser statesman, but he was also a scholar. In a way, Einaudi was the Italian Wilhelm Roepke and the Italian Konrad Adenauer in one man.
Luigi Einaudi was born in 1874, and died in 1961. Right after WWII, Einaudi was Governor of the Bank of Italy and later Minister of Finance. In these capacities, he laid the groundwork for the so-called Italian "economic miracle" by stabilizing the Italian economy and pursuing the necessary reforms to re-establish trust in market institutions.
His experience as a practical politician was brief, though. In 1948, in recognition of his international prestige, he was elected President of the newly-born Italian Republic (though he himself was a monarchist). Many believed he was kicked upstairs. In a way, one major difference between Italy and Germany is that Einaudi was virtually alone in his efforts. In Germany, the Ordo-liberals preached to the public when Erhard was transforming their ideas into policy (see David Henderson on the German economic miracle)
Einaudi's career as an intellectual was remarkably long and fruitful. He was Professor of public finance at the University of Turin from 1902. He was a gifted writer. He wrote in crystal-clear Italian and his writing style is still enjoyable today, showing just minor scratches of time.
He published numerous essays and monographs and had a lifelong love affair with journalism. He was for forty years the Italian correspondent for The Economist. He became kind of a household name, in a time when the newspapers were really the main arena for exchanging ideas. Between 1896 and 1925--when he stopped writing after the the fascist regime took power--Einaudi published about 400 columns in La Stampa and about 1,700 in the Corriere della Sera. On Einaudi's journalism. see this paper by Giovanni Pavanelli.
In his columns, Einaudi preached the importance of free trade and competition, as well as the virtues of frugality in public spending and fairness in taxation to cure the evils of the Italian economy and particularly the one great evil of the Italian society: corruption and cronyism. No wonder he himself considered most of his articles "useless sermons."
In 1922, Einaudi admonished Italians that "it is easier to hope to solve a complex problem with quick and energetic means, than to actually solve it." His caveat against the myth of all-effective, problem-solving "strong men" fell on deaf ears.
Einaudi is not very well known outside of Italy--and in Italy is less known as a thinker than as a public figure and as the father of a successful publisher. Palgrave has published a selection of his numerous essays. I highly commend to you his 1933 critique of Keynesian recipes, "My plan is not the one of Keynes."
CATEGORIES: Economic History
JUNE 24, 2015
Jose Romeu Robazzi recently left the following comment:
"IMHO the disagreement between keynesians and monetarists remain the same: both schools identify AD shortfall as a problem, and both schools recommend some sort of intervention (e.g. wealth transfers to sustain AD): monetarists suggest monetary policy (with its associated Cantillon and "hot potatoes" effects) and keynesians recommend outright government spending to make up for AD shortfall (maybe associated with some sort of wealth taxation and negative taxes for the poor)."I believe this is a fairly common view, but I also think it's wrong. Speaking for myself, I do not support intervention to address demand shortfalls. Rather, I prefer a mechanical rule that would peg the price of NGDP futures contracts.
Now I suppose one could argue that even my proposal is "interventionist", and in a sense that's true, but it doesn't become more interventionist when there is a recession. Here's an analogy. Consider the old gold standard, where central banks bought and sold gold on demand, at a fixed price. Was that policy interventionist? In one sense yes, the central bank (or treasury) intervened in the international gold market. But would anyone serious claim that under the pre-1914 gold standard most governments "intervened to address AD shortfalls"? No, they simply pegged the price of a particular asset, and let the chips fall where they may. In contrast, I propose pegging the price of a particular asset, and letting the chips fall where they may. Oh wait, that sounds kind of similar, doesn't it?
Again, people are free to use terms like "intervention" in any way they wish, but in my opinion these terms do more to obfuscate than enlighten. For instance, in my view the Fed's mistake in late 2007 and early 2008 was not its failure to "intervene" to prevent a recession, but rather that the Fed did intervene and caused a sharp slowdown in AD, triggering a recession. How did it intervene? By bringing the growth in the monetary base that had been occurring for many years to a sudden stop. You may define what happened differently, and that's fine. But "intervention" is simply not a useful part of the discussion.
And I'd say the same about Jose's comments on Keynesians. Lots of Keynesians do favor wealth redistribution, but there isn't any necessary linkage. As I point out in this post, it's perfectly possible to be a conservative Keynesian and favor small government. You can simply use tax cuts as your preferred form of fiscal stimulus.
PS. George Selgin argues that it's more accurate to say that a true gold standard defines the currency unit, rather than pegs the price of gold. So my comparison is with a gold standard that involves a central bank or treasury that buys and sells gold.
JUNE 24, 2015
Paul Krugman is clever. In a post, "Most of the Way with Obamacare," about the effects of Obamacare on the number of people with health insurance, he sneaks in two claims as if they are obvious and noncontroversial. The first claim is clearly wrong; the second is probably wrong.
Here's Krugman's first claim, and he leads the post with it:
As we wait for King v Burwell - just how far are Republicans on the court willing to destroy the institution's reputation on behalf of their party? -
You wouldn't know it from anything in this clause or anything in Krugman's post, but the people on the King side of the legal case are the ones suing to uphold the Affordable Care Act, aka Obamacare, and the people on the Burwell side are the ones seeking to have the Supreme Court say, in effect, "Well, we know what the law says and the law does not establish subsidies for the federal exchanges in the various states that have not set up their own exchanges, but come on--let's just assume that Congress got it wrong." Substituting its own judgment for what the law clearly says would "destroy" the Supreme Court's reputation?
Here's his second claim:
Finally, of course, a large number of states are refusing to expand Medicaid and in general trying to obstruct the law.
The first part is true. Many state governments have refused to expand Medicaid. The second part? I think it's false. I don't know of any state government that is "trying to obstruct the law." I am open to being told otherwise. I do know, though, of a government that is trying to obstruct the law. It's the federal government. That's what the case is about. See my discussion above on his first claim.
JUNE 23, 2015
Peter Suderman of Reason magazine has an excellent article in Politico on just how bad the Congressional Republicans have been at coming up with an alternative to ObamaCare. I won't recite all of his points because that would amount to repeating almost the whole article. But here's one nugget that conveys the flavor of the piece:
In March, Rep. Paul Ryan (R-Wisc.), the Republican Chairman of the House Ways and Means Committee, promised that he would have a bill ready and scored by the Congressional Budget Office by late June when the decision arrived. "We have to be prepared, by the time the ruling comes, to have something. Not months later," he said. Yet when Ryan finally unveiled the outlines of a plan last Wednesday, he provided few details, and no legislation or CBO score.
The Democrats, by contrast, regrouped after the failure of HillaryCare. Here's an excerpt on that:
Democrats, in contrast, used the time between the demise of the Clinton plan and the election of Barack Obama to regroup and rebuild, with a focus on overcoming the specific challenges that doomed the 1993 effort. The Congressional Budget Office (CBO) scored the Clinton plan as an increase in the near-term deficit, with health premiums counted as government spending, so Democrats, starting with Sen. Ron Wyden, worked with the CBO to craft legislation that the CBO could score as deficit neutral, and premiums kept off the government tabs. The Clinton plan was widely criticized for causing people to lose their doctors and health care plans, so Democrats worked out legislation that President Obama could plausibly--if not, it turns out, accurately--promise would allow anyone who wanted to keep their current plan to do so. The Clinton plan was assailed by a mountain of industry funded ads opposing the proposal, so one of the first orders of business in crafting Obamacare was to negotiate support from doctors, hospitals and health insurers.
There is one issue, though, on which I think Suderman is off-target: his view on a famous 1993 memo by William Kristol that set in motion the Republican steps to kill HillaryCare. Suderman is both too uncharitable and not critical enough.
What Republicans learned from the defeat of the Clinton plan was that they could win health care debates by refusing to provide an alternative. An enormously influential 1993 memo from Bill Kristol cautioned Republicans to avoid the temptation to "[help] the president 'do something'" on health care, which would only lend credence to the Democratic idea that the system was broken. Instead, Kristol advised Republicans to question reforms that would upset a system with which a majority of the middle class was already satisfied, and to concentrate on tweaking the system as it already existed.
That's accurate, but my take at the time, given the way Americans were feeling about health care, is that Kristol chose the right strategy. If you kill a bad idea for almost 20 years, you've done a lot. Suderman is right that the Republicans "learned" what he says they learned and that that was ultimately wrong. I'm not sure Kristol is to blame, though. The Republicans, once they won the majority in both the House and Senate in the November 1994 elections, should have undertaken health care reform by free-market principles. They didn't. That's bad for them--and, more important, bad for us. But Suderman does not confront what might be the truth: that Kristol made the best out of a bad situation.
And how is Suderman insufficiently critical of Kristol? By referring to his proposed reforms as "tweaks." Some of them were tweaks. One of them likely was not. In the 1993 memo, Kristol wrote:
Relatively simple changes to insurance regulation, for example, can eliminate the barriers to health insurance for people with pre-existing medical conditions.
It's not clear what kinds of "relatively simply changes to insurance regulation" Kristol had in mind. But if, as I think, he meant prohibiting insurance companies from pricing for risk, that's not a tweak: that destroys insurance as insurance.
JUNE 23, 2015
Russ Roberts did a recent post complaining about the way Paul Krugman uses data to support his arguments. Roberts pointed out that when things turn out as he expected, Krugman cites the events as proof of his (Keynesian) worldview. When they don't, he suggests that "other things" interfered, and that the model is still correct. Now Krugman has a new post that doesn't specifically mention Robert's post, but responds to this general criticism.
First let's think a bit more about fiscal policy and "other things." Suppose the authorities reduce federal spending on output. That's a contractionary fiscal policy. And suppose that GDP rises rather than falls. That seems inconsistent with the Keynesian model. Could this outcome have been due to other factors? Yes, it certainly would have been. By definition, either state and local spending rose, or investment spending rose, or consumption rose, or the trade balance improved. So yes, there definitely would have been "other factors." The question is how we think about the cause of these other factors.
Perhaps the most confusing of the other factors is state and local spending. Many economists wrongly assume that state and local (S&L) spending are a part of fiscal policy, because we attach the letter "G" to their output. But in the Keynesian model they are really no different from private investment. During recessions both private companies and state and local government are less likely to build things like new roads. These decisions are made by 1000s of entities, and should be viewed as endogenous in any model of federal spending as a tool of fiscal policy. For instance, if fiscal stimulus causes 100,000 new houses to be built in suburban Phoenix, then local governments in that area will endogenously add roads, sewer lines, schools, etc. Or as the economy improves revenues will rise, and states constrained by balanced budget rules will spend more.
In calendar 2013, fiscal policy in the US became dramatically more contractionary. This isn't even debatable. The budget deficit plunged by an astounding $500 billion in a single year. Now suppose your prediction of a slowdown doesn't turn out to be true. How would you try to minimize the amount of austerity that occurred in 2013? One technique would be to use fiscal years, as the big tax increases occurred on January 1st, not at the beginning of the fiscal year. Thus the fall in the budget deficit for fiscal 2013 was somewhat less than $500 billion, although still extremely large. (I have no evidence Krugman did this; his IMF data has no link.)
Another technique is to focus on government consumption, which is only one component of fiscal policy. This will make the changes look much smaller. For instance, in 2013 most of the austerity consisted of tax increases and cuts in transfer payments, not reductions in government consumption. And another technique would be to muddy the waters by citing figures for the change in both federal and S&L deficits.
In Krugman's posts he has two graphs of government consumption, which show that as federal consumption fell, state and local consumption rose. Interesting data, but it's not clear what it tells us about fiscal policy. Then he makes a different claim:
What we should have realized, but I didn't - at least not fully - was that the sequester just wasn't that big relative to the economy. The CBO put the first-year impact on the deficit at $68 billion, or 0.4 percent of GDP, in the first year with much smaller additional impacts thereafter - not trivial, but not huge either.The sequester included government consumption and transfers, but not the big increase in government taxes. Recall that back in early 2013 Keynesian economists were extremely concerned about the dramatic shift toward austerity. And it wasn't just Krugman, there was a letter signed by 350 Keynesians warning that the austerity could lead to a recession. I think these guys were exactly right about one thing; there really was a lot of austerity occurring in 2013. (Yes, we didn't get 100% of the feared "fiscal cliff", but the $500 reduction in the deficit was only slightly less than that worst case, according to the estimates I've seen.) The estimates I saw suggested that the total austerity package would have been expected to reduce GDP by 1.5% to 2%. Can someone confirm that?
While I don't agree with Krugman's revisionist view that there really wasn't much austerity, I'd like to accept it as a working assumption for the rest of this post. And I'd like to analyze its implications.
1. First of all, it's worth pointing out that the same sort of mistake seems to have been made in Britain, for unrelated reasons. (S&L is less important over there.) At roughly the same time as the US misjudgment, many Keynesian economists were warning that austerity in Britain was a disastrous policy that would slow the recovery. But then Britain suddenly started doing much better, especially in the employment area. (Recall that British productivity was weak, but the Keynesian model says more AD will create jobs, it does not include a magic wand to make those new jobs more productive.) Once the strength of the labor market became apparent, many Keynesian economists decided that the austerity was actually much less than they had been assuming. Including during the period when they were loudly complaining about austerity.
So let's say there was nothing disingenuous about all these flip-flops. I've made similar mistakes at various times in my life. Even so, doesn't this call into question the effectiveness of fiscal policy? It's already a pretty blunt instrument; requiring politicians of different stripes to come together in a timely fashion to set the appropriate cyclically adjusted budget balance. If we are now to believe that even in real time it's extremely hard for the world's leading Keynesian economists to tell whether policy is contractionary or not, then how likely is it that this tool will be used effectively?
2. And if we have not one but two major misdiagnosis of the stance of fiscal policy in key economies, in just the past few years, how many others have occurred that we don't know about? How many posts by Krugman can you find that say "I claimed fiscal austerity in country X would lead to recession, and recession did occur as I predicted? But new data shows that there really wasn't any fiscal austerity. I now think the recession was due to other stuff." Can someone point me to these posts? Indeed how likely is it that Paul Krugman would have done the post I am commenting on, if the US and Britain had fallen into a euro-style double-dip recession in 2013? "Oops, no austerity, my mistake." In other words, using a legal analogy, is Krugman more like an impartial judge, or an attorney that advocates for his client, and only feels a need to present evidence that supports his case?
Now before commenters start claiming that everyone does this, let me admit that this is normal behavior in the blogosphere (with a few exceptions such as Tyler Cowen.) So then are we just left with a "he said she said"? Just a series of anecdotes that are open to interpretation? I'd make a couple observations here:
1. We do have some systematic evidence. The early cross-sectional regressions supported the Keynesian model. Later work by Mark Sadowski and others found this result only applied to countries that lacked an independent monetary policy. (And I'd add that there are some tricky causality issues for even those countries.) As of this moment, I know of no systematic evidence for the effectiveness of
2. In a sense this entire debate is an artifact of a flawed stabilization policy regime, with unclear lines of authority. As I just indicated, fiscal policy would be effective (i.e. effect GDP) in certain types of clearly defined monetary regimes. And Paul Krugman has agreed that fiscal policy would not be effective if interest rates were above zero. Indeed he has advocated a 4% inflation target precisely because that would eliminate the need for fiscal stimulus. If the precise role of the Fed at the zero bound were made explicit, then this debate would go away.
There are very few debates in economics that could be resolved by Congress, but this is one of them. In this post I explain how.
JUNE 23, 2015
I have a longish review of Andro Linklater's "Owning the Earth" at the Library of Law and Liberty. Linklater's project was to offer a story of the development of land ownership in Western societies. Not the smallest of endeavours in itself. Land ownership is not an easy subject and requires extensive historical knowledge to be mastered. On top of that, Linklater plays with the history of political thought and, still not satisfied, finishes his book with a (rather unconvincing) chapter on the financial crisis.
Now, why do writers do this kind of thing? How come when you are writing a book you become willing to put down whatever thought you have in your mind, regardless of the subject you picked for yourself?
I suspect that, whenever we are playing with words, we'd do the world a better service if we cut all but 15% of what we have written ourselves. People tend to drag on when they're speaking and when they're writing. Excessive length makes an argument less focused, more repetitive, and ultimately less persuasive. All authors will tell you that: "cut unnecessary words!" And yet very few of us wordsmiths are capable of doing it with our own prose.
CATEGORIES: Books: Reviews and Suggested Readings
JUNE 22, 2015
Another interesting aspect of Arrow's article is his view of the economics of information. He writes, "The value of information is frequently not known in any meaningful sense to the buyer; if, indeed, he knew enough to measure the value of information, he would know the information itself." This quote reminded me of a similar insight from Austrian economist Israel Kirzner. This information problem, Arrow maintains, leads to market failure. He argues that we, as patients (buyers of medical care), don't know enough to judge the experts (doctors) who provide it. Interestingly, though, he does not jump to the conclusion that the solution to this market failure is entirely governmental. He writes that the government is "usually implicitly or explicitly held to function as the agency which substitutes for the market's failure." He continues: "I am arguing here that in some circumstances other social institutions will step into the optimality gap."
This is from my review of Moral Hazard in Health Insurance by Amy Finkelstein, with Kenneth J. Arrow, Jonathan Gruber, Joseph P. Newhouse, and Joseph E. Stiglitz. The review is the lead review in the Summer 2015 issue of Regulation.
An excerpt on Finkelstein's essay:
Finkelstein builds her lecture around this latter insight. In particular, she discusses the two most famous health insurance experiments in U.S. history: the mid-1970s RAND HIE and the Oregon Medicaid experiment of 2008. Finkelstein distinguishes between two kinds of moral hazard that health insurance can give rise to: ex ante moral hazard and ex post moral hazard. Ex ante moral hazard occurs if someone, knowing he is insured, takes worse care of himself by, say, smoking, drinking excessively, or not exercising. Ex post moral hazard occurs if someone, knowing he is insured, uses more medical care because he does not pay the full cost. Finkelstein's focus, like that of most other health economists who study the issue, is on the latter.
CATEGORIES: Economics of Health Care
Most Recent Entries
OUR REGULAR READING:
Tyler Cowen and Alex Tabarrok
Russell Roberts and Don Boudreaux
Matt Zwolinski, et al
Jason Kuznicki, Gene Healy
Daniel J. Mitchell, Ilya Shapiro, et al
Nathan Smith, et al
WE TRY TO KEEP UP WITH:
Stan Collender, Pete Davis, Andrew Samwick
Nicolai Foss, Peter Klein
Steven Levitt and Stephen Dubner
Mike Rappaport and Michael S. Greve
Wall Street Journal
A FEW MORE:
History News Network
(was Prestopundit) Greg Ransom
A Few Enduring EconLog Entries