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Scott Sumner  

Fifty years ago

Scott Sumner

Fifty years ago, the Red Guards were rampaging through the streets of Beijing. Chairman Mao issued weird, over-the-top statements about the evils of American capitalism. Free markets were seen as exploitation, as a sort of winner-take-all. Meanwhile, the US was trying to promote the ideology of open markets, emphasizing that trade is mutually beneficial.

So how about today? The FT quotes one of Trump's top advisors:

Steve Bannon, the brains behind Donald Trump's nationalist economic agenda, added to tensions roiling the White House by pouring scorn on his colleagues, rubbishing US policy on North Korea and pressing for the administration to be "maniacally focused" on "economic war with China". . . .

Mr Bannon said US defence and security officials were "wetting themselves" as they urged a softer line on China in order to secure its help in curbing Pyongyang's nuclear missile programme. North Korea was a "sideshow" in the context of a winner-takes-all competition between the world's two largest economies. . . .

Mr Bannon claimed he was working to place anti-China hawks in key positions at the defence and state departments.

"We're at economic war with China," Mr Bannon said. "One of us is going to be a hegemon in 25 or 30 years and it's gonna be them if we go down this path.

And here's how the Chinese responded:

China's foreign ministry responded by saying that the China-US economic relationship was "mutually beneficial" and there could be "no winner from a trade war". It added: "We hope that people will not use 19th- and 20th-century perspectives and measures to address 21st-century problems."

PS. In his later years, Mao became somewhat mentally unstable. His pragmatic advisors tried to moderate his policies, but his instincts were with the radical advice he was getting from the "Gang of Four".

PPS. This post is about rhetoric, not policy.

David R. Henderson  

Hummel on the Curse of Cash

David Henderson

In "Anti-Paper Prophet: Comments on The Curse of Cash." Jeff Hummel has written an excellent response to Ken Rogoff's response to Hummel's review of his book The Curse of Cash. The whole thing is well worth reading. Here are the parts I found most striking.

When Rogoff gets to bona fide predatory acts within the underground economy, such as extortion, human trafficking, and violence associated with the drug trade, he descends primarily into lurid anecdotes. He fails to give even crude quantitative estimates to buttress his claim that eliminating cash would curtail these activities. As for corruption and bribery, Rogoff admits that they are really serious only in poorer countries--precisely where he also concedes that a premature elimination of cash would have dire economic consequences. In his discussion of terrorism, he admits that eliminating cash would have at best trivial impacts.

Nor can Rogoff demonstrate any increased revenue for the U.S. government from phasing out large denomination notes. Relying on IRS estimates of the legally earned but unreported taxes in 2006 and extrapolating forward to 2015, he puts the potential gains to the national government at $50 billion annually (or less than 0.3 percent of GDP), along with approximately another $20 billion gain for state and local taxation. Yet his most comprehensive estimate of the seigniorage the government would lose from phasing out cash is $98 billion, or over 0.5 percent of GDP. Add to that the $32 billion annual cost of free electronic accounts for the poor, and Rogoff has failed to make a credible case that his proposal would create a net gain for the U.S. government, much less a net benefit for society overall.

Here's Jeff's accomplishment in affecting Rogoff's own views:
Rogoff's response to my review is quite respectful. He clearly wishes to encourage a civil dialogue on this question. Indeed, much of his response consists of amplifying details of his proposal. He does accuse me of "polemic exaggeration" because I titled my review "The War on Cash," but that hardly seems unwarranted given that the title of his book is The Curse of Cash. More important, Rogoff's response exhibits a shift in emphases [sic] in order to make his proposal appear still more tentative than in his book. Thus, he includes "many years of discussion and analysis" before any "advanced democracy is likely to start down the less cash-road." And he pushes the "ultimate move to coins only (which I throw out as a very long-run idea ...)" to "a time frame on the order of half a century or more."

Although I have only skimmed Rogoff's book, I have read a number of reviews and the distinct view I got was that Rogoff wanted substantial moves to coins in a decade or two rather than in 5 decades. That's a huge change.

Another insight from Hummel:

However these shifts introduce some additional tensions into Rogoff's case. By admitting that phasing out cash is less of a priority for the U.S. than for other countries, especially those with high levels of tax evasion, he in essence is saying that his scheme is least needed where it is least onerous to implement and most needed where it is premature or dangerous to impose.

And yet another great point:
By adding emphasis to how slowly he is willing to implement his proposal, Rogoff also undercuts the urgency he has attached to overcoming the zero lower bound, which in his book he characterized as having "essentially crippled monetary policy across the advanced world for much of the past 8 years" (p. 4). Indeed, if he is really willing to wait "at least a couple decades" for the phasing out of large denomination notes, why not just rely on market processes and technological innovations already in play to achieve a less coerced transition? Rogoff even predicts in his response that "the use of cash in the U.S. in legal tax-compliant transactions will be well under 5 percent ten years from now and probably only 1-2 percent twenty years from now, and that is assuming no change in government policy on cash [emphasis mine]."

CATEGORIES: Monetary Policy , Money

In recent years, the political situation in the US has become highly polarized. But I'm not convinced that this necessarily prevents the two sides from coming together on monetary policy. Consider:

1. The idea of NGDP targeting has considerable (and growing) support on both the left and the right.

2. David Beckworth recently interviewed Matt Yglesias (who might be described as center-left), and at one point David read from a piece Yglesias wrote in 2011:

Most important, for all the flaws in the right's current critique of the Fed, they're correct to point to the need for accountability. The idea of a central bank that's "independent" of day-to-day politics is a good one, but too often that's come to mean a central bank that's immune from criticism or meaningful supervision. The Federal Reserve System's current vague mandate needs to be replaced with a specific target, defined in law. The public and the politicians we elected need to be prepared to hold the system accountable for achieving the target, and Congress needs to accept responsibility for picking a target that leads to good outcomes. Most of all, progressives need to start caring about the Fed and engaging in the debate over what it does.
3. Later in the interview (after the 40 minute mark), Yglesias expressed some views on Fed accountability that are quite similar to what I've been advocating. He referred to the need for the Fed to "look back" and evaluate past decisions, suggesting the Fed needed to ask these questions:
OK, in 2015, did that go the way we [the Fed] wanted it to? Heading into the year, what did we think we were going to achieve? Did we achieve it? And if we keep failing to achieve our goals, do we need to change our strategy? (Approximate quotation)
I've made similar proposals for more Fed accountability, and when I talk to conservative policy types in DC, I sense there is a lot of interest in moving in that direction.

Bryan Caplan  

War Crimes and the Long Run

Bryan Caplan
Economists often sing the praises of credibility, also known as "time consistency."  When Kydland and Prescott won their Nobel Prizes in 2004, their citation gives this work pride of place:
Finn Kydland and Edward Prescott have been awarded the 2004 Bank of Sweden Prize
in Economic Sciences in Memory of Alfred Nobel for their fundamental contributions to
two closely related areas of macroeconomic research. The first concerns the design of
macroeconomic policy. Kydland and Prescott uncovered inherent imperfections-credibility
problems-in the ability of governments to implement desirable economic policies.
But what does credibility mean in practice?  One common objection to the Nuremberg trials was that they gave bad incentives to future war criminals.  If war criminals know they'll be tried and executed if they lose, self-interest urges them to fight to the bitter end.  From this perspective, the trials were short-sighted.  They satisfied the impulse for revenge, but extended the duration of future wars.

On reflection, however, that's only a medium-run view.  The apostle of credibility could easily retort, "Yes, the Nuremberg trials encourage future war criminals to fight to the bitter end.  But they also discourage future leaders from committing war crimes in the first place.  We should take a truly long-run view." 

In politics, the masses are highly impulsive.  They favor whatever feels good at the moment; medium- and long-run effects are usually too dull and remote to contemplate.  Elites, however, often want to claim the mantle of credibility - and deride their opponents' short-sightedness.  If you're paying attention, however, the real elite debate is rarely Credibility Versus the Easy Way Out.  Instead, it's Medium- Versus Long-Run Credibility.  Should the U.S. reach a new understanding the Russia?  In the short-run, it wounds U.S. pride.  In the medium-run, it helps resolve a bunch of pressing global issues, like the Syrian Civil War.  In the long-run, it encourages countries to act like Russia.

What's the prudent course?  Economists' rhetoric suggests that we put the long-run uber alles.  But a real answer requires a massive detour into the psychology of history.  How long do world leaders even know what other countries did in the past?  How long will they remember?  And how much does this knowledge affect their expectations?  Personally, I don't know - and I doubt many people who pontificate on the value of credibility know either.

David R. Henderson  

The Ethics of Charles Koch

David Henderson
Charles [Koch] is a true believer, whose free-market beliefs are unquestionably self-interested--but also undeniably sincere. His value system is apparent in all aspects of his company, including Koch's lobbying operation. Until the early 1990s, the company didn't have a Washington presence; this, one former Koch lobbyist said, reflected Charles's inherent distrust of politicians and his anti-government bent. Once it did open a Washington office, prompted by the wave of government investigations and the bad PR stirred up by Bill Koch, the company's lobbyists operated differently than the K street-hired guns that stalk the halls of Congress for their corporate clients.

Koch lobbyists don't shift their positions based on the political headwinds. According to one Senate Republican leadership aide, they won't be found pressing for subsidies in one bill and opposing them in another. "They're not rent seekers," he said. The overriding factor guiding the company's lobbying agenda is not whether a legislative proposal will be good or bad for Koch Industries, but whether it is consistent with Charles's libertarian beliefs.

Richard Fink, Charles's top advisor, enforces ideological consistency across the spectrum of Koch business units, and he frequently intercedes to prevent them from inadvertently transgressing Charles's free-market creed. Such was the case when one Koch business unit, which had developed an environmentally sensitive incinerator, sought permission to work with regulators to strengthen environmental rules. This might have improved the company's competitive position, but it went against Charles's overarching philosophy. Fink spiked the idea.

This is from Daniel Schulman, Sons of Wichita. I posted about it yesterday.

It speaks for itself.

I'm a footnote and endnote reader. When I read something interesting, I want to see the source. Unfortunately, in this heavily endnoted book, there are huge holes. There are lots of interesting stories and stated facts without any endnote telling the source.

David R. Henderson  

Sons of Wichita

David Henderson

On my vacation, which is coming to an end, the first book I read was Daniel Schulman's Sons of Wichita. It's subtitled "How the Koch Brothers Became America's Most Powerful and Private Dynasty." Written by an editor of Mother Jones, Sons of Wichita is, in my semi-informed opinion, largely fair.

I found this passage interesting:

"Koch has a pattern of delaying needed repairs and maintenance, often neglecting them entirely," Linda Eads, the former Texas deputy attorney general, noted in a 2001 affidavit. "One reason for this failure to operate safe pipelines comes from Koch's so-called Market-Based Management approach. For example, under this management philosophy, each section of the Koch pipeline must show a profit, and this profit must increase every quarter. Environmental and safety compliance does not pay off quarter by fiscal quarter, and thus employees are not rewarded or encouraged to strive for safety or compliance. Indeed, safety improvements are regularly delayed or ignored even when recommended by employees. Employees at Koch are told that every decision has to be judged by its economic effect and how the decision will affect the company's profitability."

I have 4 comments.

1. Eads showed herself to be a strong, to put it mildly, critic of Koch Industries. So we can't assume that hers is an unbiased and accurate commentary on the issue of applying Market-Based Management.

2. I read Charles Koch's book on market-based management several years ago and I didn't bring it with me on my vacation. But my recall is that it was too loose a guide to making actual decisions. So I could imagine someone interpreting it her way and I could imagine someone interpreting it some other way.

3. I'm not saying I'm sure she's wrong but it's hard for me to believe that, as she says, "this profit must increase every quarter." If you're striving to maximize the value of a company, you will have quarters in which profit decreases. I agree with her that if you strive to increase profit quarter by quarter, you will make some very bad decisions. If drug companies did that, for example, they would, quarter by quarter, reduce research and development. But would Charles understand economics so badly that he would have, as a goal, profit increasing every quarter.

4. Notice the last sentence in the quoted passage. She seems to treat "its economic effect" as if an action has one effect. But, as noted in #3 above, an action can reduce quarterly profits but increase long-term profitability. Certainly, the Danielle Smalley case that Schulman discusses, in which a jury awarded $296 million in a wrongful death suit against Koch Industries, suggests that their failure to maintain a pipeline was not profit-maximizing. Of course, no one could have known up front that Koch Industries would face such a large award. Even the plaintiff had asked for "only" $100 million. But the point is that Koch's management would know that it would face some probability of a wrongful death suit with a big payoff.

Lars Christensen and Alex Tabarrok have some interesting posts on the question of how the risk of nuclear war might impact the stock market. A few comments:

1. I basically agree with Alex's post, but would frame it slightly differently. I think what he's basically saying is that stock prices are relative prices. If there is an apocalypse that destroys everything, then it's not obvious why the price of one asset would change relative to another asset. Alex discusses the issue in terms of whether people would want to sell stocks. I don't like that framing because stocks don't move because they are sold, rather because people begin to value them differently relative to the way they value other assets such as cash. But again, this is merely aesthetic preference, i agree with the substance of Alex's post.

2. An action that creates a 0.1% risk of nuclear war (with 10 million deaths) within the next 12 months is an absolutely horrible event. Worse than 9/11 in terms of expected loss of life. Far worse if it's an all out nuclear war with hundreds of millions killed. But of course it is still very unlikely to happen, and thus stocks would probably move by less than 0.1%, which is just statistical noise in a market where daily moves are usually much bigger. You wouldn't even notice.

3. However, US stocks did seem to fall noticeably on the recent escalation of tensions with North Korea. East Asian stocks fell even more sharply. That may be because the risk is much higher than 0.1%, or perhaps more likely that the markets fear something else, a political crisis (just short of nuclear war) that severely damages the relationship between the US, Japan and China, hurting the global economy. One reason that uncertainty hurts equity markets is that dramatic events are more likely to be bad than good. If a crystal ball told you that something dramatic was likely to happen to your house in the next 12 hours, you'd expect something like a fire, not a random arrangement of atoms that miraculously came together to produce a new patio.

Some of these points may seem to conflict, so here's my takeaway:

A. Don't be reassured by small market reactions to risk of apocalypse. Even a small increase in risk of armageddon is a horrible thing. The world can take only so many of those small risks before the actual disaster occurs. If the Cuban Missile Crisis led to a 1% increase in the risk of nuclear war, then it was still one of the worst things to have happened in all of American history. We lucked out. So even if Lars is right about the Cuban Missile Crisis, the historians that claimed a nuclear war was "too close for comfort" might also have been right.

B. Market reactions to threat of nuclear war may be about something else---fear that the crisis could spiral into a new Cold War, which would badly hurt the global economy. No one killed, but a signficant decline in trade and living standards.

Screen Shot 2017-08-13 at 9.14.13 AM.png

It's puzzling to me that so many progressives view the term 'neoliberalism' with disdain. A new article by Cardiff Garcia shows that the world is becoming much more equal. And that trend is being spurred by less between country inequality---within country inequality has actually risen slightly:

Screen Shot 2017-08-12 at 7.57.20 AM.png
It seems likely that much of the reduction in between country inequality is caused by market reforms in places like China, India, and the ASEAN group.

Neoliberalism might just be the best thing that ever happened.

PS. Commenter PaulS raised an interesting point after my previous post:

And yet I think the [free market] approach would fail in the USA. A privatized NYC subway would act like the cable companies, which are monopolies and awful. US airlines are semi-competitive and manage to be awful too.

I think there is a tendency for people to look at an actual market outcome in the US and assume the results reflect market forces. Airlines are not a free market, indeed the US government bans foreign airlines from serving America routes, even though they often provide much better service. When US car companies started facing serious competition from foreign automakers, they dramatically improved the quality of US cars. Privatizing airports, air traffic control and airport security would also improve the flying experience.

I would add that my cable TV company in Boston (which faced competition from other cable companies), provided about 10 times better service than the NYC subway.

Scott Sumner  

More markets please

Scott Sumner

I've devoted much of the past ten years to advocating the creation of a highly liquid nominal GDP prediction market. I believe this sort of market would eventually revolutionize macroeconomics. Over time, people would stop thinking of the stance of monetary policy in terms of interest rates and begin focusing on what really matters, expected future NGDP. We could begin monitoring the efficacy of monetary policy in real time.

But NGDP is not the only area where we need more markets---there are hundreds of other areas crying out for reform. Legalizing markets in drugs, prostitution and gambling could radically reduce our prison population, save enormous sums of money, reduce violence in Latin America and reduce authoritarian tendencies in our own government. Markets for organ transplants could save tens of thousands of lives. (Why do progressives seem so upset by the health cost of repealing Obamacare, but not the ban on organ markets?)

In Europe, they are far ahead of America in many areas, with much more widespread privatization of airports, air traffic control, airport security, passenger rail service, postal delivery, toll roads and many other activities. Hong Kong has one of the world's best subway systems, and its privately run. Imagine what private enterprise could do with NYC's abysmal system.

Given the need for many more markets, I was surprised to see Noah Smith make this argument:

Taken to its ludicrous extreme, marketism would incur far too many transaction costs. Imagine having to pay a fee for the air you breathe, or to walk down the street where you live. Such a free-market paradise would feel more like a prison.

The late 20th century saw an expansion in the scope of human relations that take place in markets. But the early 21st century should be a time for rethinking this trend. The idea of markets in everything is bumping up against its natural limits.

If you expected the article to justify this claim with many horror stories about actual failed markets, you would be disappointed. Instead Smith points to some rather far-fetched examples of possible overreach, such as privatizing the air we breathe. Smith's right that markets are not appropriate in all areas of life, but I don't agree with his claim that we are bumping up against the natural limits of markets. In my view the neoliberal revolution of the late 20th century didn't go nearly far enough.

Smith refers to Coase's argument that some activities are better handled within firms than through markets:

Within companies, people often prize loyalty to coworkers or to an organization. That may explain the surprising yet common finding that direct monetary incentives often reduce work performance rather than increase it. Privatizing the army, tax collectors and prisons is a bad idea, because it ignores the crucial function that loyalty, dedication, idealism and commitment play among combat troops, bureaucrats and prison guards.
That's a good argument, but in the US combat troops and tax collectors are generally employed by the government. There are some private prisons, but I'm not sure there is any evidence that government prison guards have more idealism or loyalty than private sector prison guards. One part of San Francisco has a very successful private police force. Perhaps prisons should not be privatized, but that's an empirical issue that needs to be studied--appeals to loyalty, dedication, and idealism do not answer the question.

Again, markets are not appropriate everywhere, and I don't rule out the possibility that there has been overreach in a few areas. But overall, there is still a massive need for more markets, not to mention a need for more deregulation of existing markets in areas such as zoning, occupational licensing and many other activities.

Check out this CNN story on the HK subway, which earned a 2 billion dollar profit in 2014. It carries 5.2 million passengers a day, and has a 99.9% on time rate. (Hong Kong has only 7.4 million people.)

Screen Shot 2017-08-11 at 5.23.26 PM.png
Why can't we have nice things?

CATEGORIES: Free Markets

Alberto Mingardi  

Do criminals obey regulations?

Alberto Mingardi

regulated2.jpg Is deregulation helping terrorists? So thinks The Independent, which points out that "changes made in the Deregulation Act 2015 scrapped an obligation on sellers of dangerous substances" which made "it easier to buy dangerous acids that have been used in a spate of attacks in recent weeks".

Instead of having to register with their local council, sellers of "reportable substances" are merely required to tell authorities about anyone buying a substance "if the supplier has reasonable grounds for believing the transaction to be suspicious", such as if there is a suspicion the chemical is "intended for the illicit manufacture of explosives" or "any illicit use".

The law says reasons for such suspicions could be if the customer is vague or uncertain about how they will use the substance, wants to buy large quantities, is unwilling to provide proof of ID or insists on "unusual methods of payment".

If none of these take place, people are free to buy and sell powerful acids without any regulation, licensing or registration.

I find the argument to be astounding. For one, regulations impact law abiding citizens and businesses. You need to be committed to play by the rules, that is, for rules to influence your behaviour. If you decided to be an outlaw, you're very unlikely to be brought in another direction by controls on substances you can or you cannot legally buy.

Our experience with outright prohibition (not even "controls") of certain substances is that, if there is demand for them, people will find a way to get hold of them.

Of course, costs will increase - as it is in the case of drugs. But would that, higher costs in getting supplies, substantially hinder terrorists?

I think we may agree that if someone decides to participate in a terrorist attack (and even more so, in a suicidal terrorist attack) her mind is pretty much made up. No matter how crazy such a decision may look to us, it is one which will be hard to shake. Can regulation in selling acids really do so?

It seems to me this is hardly an argument: it is more an expression either of blind faith in over-regulation, or of a distrust of any kind of de-regulation, regardless of what has been deregulated and to what extent.

I understand the British left is witnessing an impressive growth of its own consensus, and on a pretty extreme platform, so it needs to grow it even more by denouncing the hypocrisies and incompetence of the Tories. But if a political movement is propelled by this kind of rather badly argued propaganda and demands more of it (like in the case of Grenfell Tower), what shall we expect out of it the day it reaches power?

CATEGORIES: Regulation

Alex Tabarrok has an interesting new post on trends in housing prices:

In 2005, I thought housing prices were rising above the fundamentals and I said so. In 2008, as the fall in housing prices was well under way, I wrote a blog post and later a NYTimes op-ed saying that the housing price bubble was not nearly as big as people thought. I wrote:
I think that housing prices went beyond the fundamentals sometime around 2004...but 2004 levels are still well above long run trend.

...Prices will probably drop some more but personally I don't expect to ever again see index values around 110. Do you? If we don't see the massive drop back to "normal" levels then the run up in prices should be described as a shift to a new equilibrium...[with some overshooting, rather than as a bubble.]

To put it mildly, not everyone agreed with my argument. I certainly got the timing wrong-I didn't think the recession would be as long or as deep as it was. Nevertheless, some people are coming round to my point of view. Karl Smith, for example, has a new post Was There Ever a Bubble in Housing Prices? which concludes more or less, as I did nearly ten years earlier, that the answer is no. What happened was greater liquidity which made housing prices gyrate more like stock prices but "the fundamental driver isn't irrational bubble behavior. It is competition over a scarce resource."

I have frequently argued that bubbles are a myth, or more precisely the "bubble" concept is generally not a very useful tool for understanding the world. In the comment section to Alex's post, Alan Goldhammer made this remark:

First of all there were some prescient folks who called the 'bubble' very early on including Dean Baker and the Calculated Risk duo of Bill McBride and the late Doris Dungy.
At first glance it would seem that an early prediction is better than a late prediction. But in a 2010 post I argued just the opposite---the earlier predictions were less accurate than later predictions, indeed not accurate at all.

When Dean Baker warned of a housing bubble in 2002 and Robert Shiller warned of "irrational exuberance" in the stock market in 1996, they weren't merely suggesting that bubble conditions might develop in the future, they were claiming that asset prices were already at excessive levels.

In retrospect, those claims don't seem particularly prescient. Tabarrok's post shows that housing prices are now above 2002 levels, even in real terms. And of course stocks are now far above 1996 levels. That doesn't mean they were necessarily wrong; perhaps housing and stocks are in a new bubble. But it does mean that one cannot simply point to these early predictions as being obviously correct bubble calls, as it is by no means obvious that prices were excessively inflated in those two cases.

Screen Shot 2017-08-07 at 12.54.29 PM.png
I often suggest that bubble claims will be increasingly popular during the 21st century. That's partly because recent bubbles are widely (and wrongly) viewed as having done great damage to the economy, and also because with the "new normal" of ultra low interest rates, asset values will often seem higher than justified by many of the usual metrics.

Following the valuable advice of co-blogger David Henderson, I've gotten my hands on Milton Friedman on Freedom, a new collection edited by the Hoover Institution. The book will surprise all of us who never properly appreciated the insights and wisdom of Friedman's political thinking. His own peculiar blend of classical liberalism comes out all the more as subtle and relevant.
Friedman on Freedom.jpg

Among the several chapters, I did particularly enjoy a 1974 interview with Reason magazine. Friedman was then interviewed by the editorial trio (Tibor Machan, Joe Cobb, Ralph Raico), who were challenging him from what they considered a more consistent libertarian position.

The interview is rich and interesting in many ways. Friedman defends a negative income tax and school vouchers as "devices for enabling the free market to play a larger role." He admits that the work of E.G. West made him revisit his own rationale for compulsory education (but not to abandon vouchers as a practical policy proposal), and he discusses inflation and the gold standard.

Friedman also speaks on a matter which has likewise been pondered by many of his contemporaries: why intellectuals oppose capitalism. To these questions, some have replied that the main reason is resentment (intellectuals expect more recognition from the market society than they actually get); some have pointed out that self-interest drives the phenomenon (intellectuals preach government controls and regulation because they'll be the controllers and regulators); some have taken the charitable view that intellectuals do not understand what the market really is about (as they cherish "projects" and the market is instead an unplanned order).

Friedman rejects the resentment view and proposes a version of the self-interest thesis by looking at the demand-side, so to speak. And it shows--behind the veil of his civility--very little consideration for the tastes of his fellow intellectuals for complex arguments, which seems to me quite a criticism.

Here's the passage:

REASON: Perhaps we can go back to your comment about intellectuals. What do you think of the thesis put forth by von Mises and Schoeck, that envy motivates many contemporary intellectuals' opposition to the free market?

FRIEDMAN: Well, I don't think we'll get very far by interpreting the intellectuals' motivation. Their critical attitudes might be attributed to personal resentment and envy but I would say that a more fruitful direction, or a more fundamental one, is that intellectuals are people with something to sell. So the question becomes, what is there a better market for? I think a major reason why intellectuals tend to move towards collectivism is that the collectivist answer is a simple one. If there's something wrong pass a law and do something about it. If there's something wrong it's because of some no-good bum, some devil, evil and wicked--that's a very simple story to tell. You don't have to be very smart to write it and you don't have to be very smart to accept it. On the other hand, the individualistic or libertarian argument is a sophisticated and subtle one. If there's something wrong with society, if there's a real social evil, maybe you will make better progress by letting people voluntarily try to eliminate the evil. Therefore, I think, there is in advance a tendency for intellectuals to be attracted to sell the collectivist idea.

REASON: It's paradoxical but people might then say that you are attributing to the collectivist intellectual a better feeling for the market.

FRIEDMAN: Of course. But while there's a bigger market for Fords than there is for American Motors products, there is a market for the American Motors products. In the same way, there's a bigger market for collectivist ideology than there is for individualist ideology. The thing that really baffles me is that the fraction of intellectuals who are collectivists is, I think, even larger than would be justified by the market.

Bryan Caplan  

What's in Your Bag?

Bryan Caplan
As a consumer, my experiences are exceedingly pleasant.  I don't just receive endless great products for reasonable prices.  I routinely receive gracious, flexible service with a smile.  Small snapshot: When I buy baked goods or produce at Wegmans, the cashiers don't even bother to look in the brown paper sack.  They simply ask me, "What's in your bag?" - and ring up whatever I declare.

How can profit-maximizing businesses treat me so well?  The easy answer is "competition" - if any one business offered worse terms, I'd take my business elsewhere.  That makes a lot of sense, but dodges the deeper question: Why is gracious, flexible service with a smile the market equilibrium in the first place?

The academically fashionable answer is probably just "trust."  If consumers are generally honest, stores don't need to verify what they say.  That answer, too, is sensible but superficial.  I live in a wealthy area, so consumers have far less motivation to lie to save a few dollars.  Perhaps more importantly, stores can - and almost certainly do - unofficially profile individual consumers to decide how to treat them.  I look like a middle-age, middle-class dad - and businesses treat me accordingly.

The obvious upshot is that my first-hand experiences are rather unrepresentative.  Business gives me the royal treatment, but that's because I frequent upscale areas and project a suitable image.  If you changed either of these conditions, I expect I'd see an uglier side of the market.  If you changed both, it might get downright ugly.  My beautiful Bubble is wonderful, but encompasses only a tiny corner of the business world.

The deeper lesson, though, is that consumers' experiences vary for totally forgivable reasons! Being nice in a rich area is cheap; being nice in a poor area is expensive.  The same goes for individuals: Being nice to mellow middle-age people is a lot cheaper than being nice to surly teens.  If you want to blame anyone for sub-excellent service, you should blame the consumers whose opportunistic behavior confirms negative stereotypes

The final lesson, of course, is that using regulation to mandate royal treatment for everyone would have dire side effects.  There'd be a cost spike throughout the economy; the less upscale the area and the consumers, the sharper the spike.  And as usual, trying to mask cost increases with price controls would provide cheap, high-quality products for some - and shortages for everyone else.  A world where business willingly provided excellent service to everyone would be a big improvement over the world of today.  But a world where business were legally required to provide excellent service to everyone would be much worse.

Moore's Law is optimistic and reflects the ability of humans to "chip" away at a problem, making sequential, cumulative advances. Much of technology fits this pattern. One glaring exception, tragically, is the drug development conducted by pharmaceutical companies. It is hugely expensive and has gotten more so each year. If costs continue to grow at 7.5 percent per year, real costs will more than double every 10 years. The pharmaceutical industry seems to be operating under a reverse-Moore's Law. I call it Hooper's Law. Here's the short version: Drug development costs double every decade. Why? Simple: the U.S. Food and Drug Administration is steadily increasing the cost per clinical trial participant and the number of required participants per clinical trial.
This is from Charles L. Hooper, "Hooper's Law of Drug Development," one of the two Econlib Feature Articles for August.

In the piece, Charley explains why this has happened.

After pegging the Swiss franc at 1.2 per euro for a period of about three years, the Swiss National Bank suddenly revalued the franc sharply higher in January 2015, in a surprise contractionary move. They also cut interest rates sharply, a near perfect (and very rare) example of NeoFisherism in action.

In the months leading up to the revaluation, the SNB had accumulated significant foreign reserves, as it sold francs to speculators who (correctly) anticipated that the Swiss would revalue. The SNB was worried about the risk associated with an excessively large balance sheet. What if all those euro and dollar assets fell in value? Might the SNB become insolvent?

At the time I warned the Swiss that they were making a mistake, although in fairness this is a mistake made by many people, even many economists. Here's the problem. In the short run, a revaluation takes the pressure off the franc. It's value moves closer to what speculators see as "equilibrium". But equilibrium also depends on future monetary policy. And a revaluation makes Swiss policy even tighter, reducing trend inflation in Switzerland to a level below that of other developed countries. This just makes the Swiss franc an even more attractive asset to hold. People like to hold Swiss francs because Switzerland has a near 50-year history of one currency revaluation after another. The revaluation in 2015 validated those expectations, and led investors to anticipate more of the same.

So who turned out to be right, me or the SNB? Based on this graph (and WSJ article) I'd say that I was right:

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Notice how the SNB balance sheet was fairly stable during much of the currency peg period, before rising in the months before the revaluation. It was that increase that triggered concern at the SNB, and led to the revaluation. But it didn't work, the balance sheet has expanded massively over the past 2 1/2 years, just the opposite of what they wanted, but exactly what I feared would occur.

At the time of the January 2015 Swiss revaluation, the Danish krone was under speculative pressure for similar reasons. Many thought they would be forced to revalue. I claimed that no central bank is ever forced to revalue, and Tyler Cowen suggested that the outcome in Denmark would provide evidence as to whether the Swiss were actually forced to revalue (as many claimed) or simply chose to revalue---as I claimed.

The results are in and the Danes did not give in to speculators---they continued to peg the krone to the euro at a fixed rate. But wouldn't they have to buy up lots of foreign assets to do this? For a brief period the answer is yes, but over the longer run they were able to buy far fewer assets than the Swiss. Look at the Danish central bank's balance sheet:

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Notice that the Danish central bank's assets rose sharply in early 2015, during the period of speculative fever, but then retuned to normal once the speculators were convinced the Danes were serious about maintaining the euro peg. That's what the Swiss should have done.

There are many broader lessons here. ECB head Trichet was critical of Bernanke's QE programs during the period around 2010 and 2011, and preferred a tighter monetary policy. But in the long run this led to slower NGDP growth, and the ECB has been forced to massively expand its balance sheet as a result.

Remember, the slower the trend rate of NGDP growth, the lower the level of nominal interest rates, and the lower the opportunity cost of holding base money. This means that conservative central banks will end up with really large balance sheets. I have called this the "socialism or inflation" dilemma for conservatives. The WSJ article mentions that the SNB already owns about $150 billion in equities, and that there is political pressure to move some of the other $600 billion into domestic investments.

David R. Henderson  

Good News on Employment

David Henderson


Ben Casselman of FiveThirtyEight writes:

Prime-age employment rate hits 78.7%, highest since September 2008.

Of course we still have a long way to go to get back to the peak of about 17 years ago.

CATEGORIES: Labor Market

The term 'natural' has multiple meanings and even more connotations. It often means something like free from human interference, and sometimes comes with a connotation of better or healthier.

When economists refer to a "natural rate of interest", however, those definitions don't work. Obviously no interest rate can be free of human interference. It might mean something like "free of government interference", but economists have given the term an entirely different meaning.

Economists define the natural rate of interest as the interest rate that is expected to deliver a level of aggregate demand which is conducive of macroeconomic stability. Wicksell thought of macro stability in terms of price stability, so he defined the natural rate as the interest rate likely to lead to price stability. But there are as many natural rates as there are theories of macroeconomic stability.

Thus the natural rate is not a single variable that is "out there", waiting to be discovered by humans, rather its a roundabout way of describing macro stability. In the mildly inflationary period around 1900-10, Wicksell might have said that prices were rising, or "the interest rate is below the natural rate". Those statements were essentially identical.

This post was prompted by a comment left by Cloud Yip, in a post where I suggested the natural rate of interest in Hong Kong was the US interest rate. Here's YiP:

For the HK part, I think you only mean the linked exchange rate is "perfect"in the sense that it established credibility and the monetary policy is rigid as intended right?

You don't mean that it is "perfect" in the sense that the interest rate in HK is very close to the natural rate in the region, I assume. Haven't really check it yet, but I suppose that the NGDP is quit volatile......

I think we in HK are staying very close to the natural rate of the US, and it is actually quite an interesting counter example to your main point in the article. I think the supposed deviation from the natural rate in HK (which I simply assumed without much proof) is pushing the economy overheat in here.

This is a valid criticism, for two reasons. First, I do view NGDP stability as the best criterion for judging the natural rate, not a stable exchange rate. And second, it's a stretch to view a stable exchange rate as "macroeconomic stability".

In my defense, I was trying to be a bit provocative to make a point. Just as some people view price stability as evidence of monetary stability and others look to NGDP, there are people who view a stable exchange rate as evidence of macro stability. Indeed that might well be the view of the authorities in Hong Kong. My point is that there is a natural rate of interest associated with each and every variable that one might view as the criterion for macro stability.

Some conservatives and/or libertarians might prefer a different definition of the natural rate of interest---based on the concept of a market interest rate determined completely free of government interference. I'm not entirely unsympathetic to that definition, as it's closer to the use of "natural" in other areas of life (as compared to the Wicksellian definition.) But it's also important to note that it's not the definition used by economists, so it can lead to people talking past each other.

Free market advocates might also prefer that definition because "natural" has a connotation of "good", as with "natural foods."

Screen Shot 2017-08-03 at 8.42.17 AM.png
However we cannot just assume that a completely laissez-faire monetary system would provide for price stability, NGDP stability, or any other plausible definition of the Wicksellian natural rate. It might, but we just don't know. (I'm skeptical, as macro stability seems like a public good to me.)

We are left with an unfortunate situation where almost everyone wants the interest rate to be at its natural level, but each person defines that term differently. Better to jettison all talk of interest rates, natural or otherwise, and speak directly to what sort of monetary policy you want to see---the Fed targeting the price level, the Fed targeting NGDP, or no Fed with free banking, etc.


Henderson with live bait.jpg

This is at a marina near my cottage at Minaki.

HT2 Mike Hammock for helping me rotate the picture.

CATEGORIES: Free Markets

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Conspiracy and Condemnation

Contributing Guest

Democracy in Chains.jpg by Art Carden

Democracy in Chains author Nancy MacLean and her defenders are promulgating the idea that critics of her book (like me) are part of a sinister conspiracy to discredit her book. It might make a good plot for an X-Files episode (or The Simpsons), but we're still firmly on this side of the looking glass.

Consider this less-conspiratorial and (in my experience, far more accurate alternative) to the "coordinated attack" hypothesis:

A lot of people who appreciate James M. Buchanan's work are part of the same social networks. We go to the same conferences and read the same journals. We're friends on Facebook, and we follow one another on Twitter. In short, it's exactly what you would expect from a community of scholars interested in similar topics and methods.

We also weather various "who is funding this?!" storms and assaults on our character when we try to hold a conference, start a center, host a speaker, etc. We see things like the faculty reaction to the Milton Friedman Institute at the University of Chicago in 2008 and this year's faculty-wide denunciation of an honorable scholar (James Otteson) at Wake Forest. We read books like The Shock Doctrine and articles like Jane Mayer's 2010 New Yorker piece that are...less than careful with the ideas we think are essential to a free and flourishing society and that boldly slander thinkers we respect. Suffice it to say we're a bit wary.

Word gets out that there are a few books in the pipeline, Democracy in Chains being one of them, that carry the "right wing conspiracy" torch. On learning the premise of Democracy in Chains, a lot of people get interested. I, for one, offer to review the book for Regulation, a publication of the Cato Institute, for which I have written several reviews.

I--and I assume, a lot of other people--think nothing further of it. Someone in our network starts reading it and puts up a couple of Facebook posts about some of the book's egregious errors. We bat some of these claims back and forth on social media. It becomes clear that there is something seriously wrong with the book. Instead of waiting for Viking to send me a review copy, I swallow hard and drop $15 or so for the Kindle version so I can go ahead and get the review off my desk. By this point, there's a decent amount of social media chatter about the book, and people are posting and sharing some of the biggest problems they find. More people decide they need to take a look.

People learn that Michael Munger is working on a review and decide not to go beyond social media with what they're learning by reading MacLean because we wanted to see what Professor Munger has to say first. There are a couple of reasons for this. First, Mike is known and loved in our circles, and he is the epitome of the careful and fair scholar we should all strive to be. Second, Mike is a colleague of MacLean's at Duke, and some of us (me, anyway) wanted to see how he was going to handle this. Third, I suspect a decent number of people were waiting for Mike's review so they could see whether the book was really as bad as they thought.

Professor Munger circulated his review, and it was consonant with what a lot of other people in our network had found. The floodgates opened and the discussion went from Facebook to the blogosphere. As I mentioned in an article for, "Munger's essay is remarkable in that it is utterly devastating to MacLean's thesis without being an exhaustive inventory of her mistakes"--mistakes which have been compiled by Jonathan Adler, David Bernstein, and Ilya Somin at the Washington Post's Volokh Conspiracy blog, Steven Horwitz at Bleeding Heart Libertarians, Phil W. Magness at his own blog and the History News Network, Russ Roberts on Medium, and myself at

And then something interesting happened. Instead of responding to the criticisms and defending her findings as one might at a seminar or academic conference or upon receiving a critical referee report, MacLean issued an appeal to her ideological fellow travelers claiming that she was being "smeared" by Koch operatives. Suddenly, there were boatloads of five-star reviews of her book on that hundreds of people were finding helpful--and that a analysis showed to be largely unreliable.

And all the while, she and her defenders are not actually responding to her critics--critics who are exercised about this book because of the amount of publicity it has gotten, the serious problems of interpretation it presents, and the fact that it has the potential to do real, serious harm to the humane studies by slandering an entire body of scholarship as, somehow, a racist reaction to Brown v. Board of Education.

Instead of explaining why MacLean, who to her credit admits that she is not a specialist, is correct in her interpretations of Buchanan while experts on Buchanan's work are wrong, she and her defenders are simply chanting "hocus pocus Charles Kochus" and hoping it suffices to discredit or refute her critics. One of her defenders pointed out that the book is "strongly footnoted." Indeed, it is, and the Norwegian Blue is a remarkable bird with beautiful plumage. A dead parrot with beautiful plumage is still a dead parrot, and a fundamentally flawed book with a lot of footnotes is still a fundamentally flawed book.

It saddens me that basically any action will be interpreted as evidence for a conspiracy. Buchanan's admirers and students come to his defense? Clearly proof of a coordinated conspiracy. What if Buchanan's admirers and students had ignored Democracy and Chains and gone on with their lives? We would stand condemned as it would be clear from our stunned silence that MacLean had uncovered the conspiracy and set us reeling. It really is tragic. Buchanan was a serious thinker and an insightful, subtle scholar. His legacy deserves better than this. Indeed, the entire academy deserves better than this.

Art Carden is Associate Professor of Economics at Samford University's Brock School of Business, and he is by his own admission as Koched up as they come: he has an award named for Charles G. Koch in his office, he does a lot of work for and is affiliated with an array of Koch-related organizations, and he has applied for and received money from the Charles Koch Foundation to host on-campus events.

Scott Sumner  

Which bus would you take?

Scott Sumner

Over at TheMoneyIllusion I did a post discussing the issue of whether central banks should be thought of as "controlling" interest rates. Here's one excerpt:

There are powerful cognitive illusions here. The day-to-day Fed "control" over rates creates the illusion of much more control than actually exists. Monetary policy is much more than a series of short run decisions on where to set the fed funds target. By analogy, a bus driver going through the Alps has very good short term "control" over the direction of the bus. He can nudge the bus left or right by turning the steering wheel. But over longer stretches of time the direction of the bus is "controlled" by a combination of the direction of the road (i.e. economy) combined with the bus driver's strong desire than he and his passengers don't hurl over the edge to a terrifying death (i.e. hyperinflation/hyperdeflation).
Let's take that analogy a bit further. You are about to take a bus from Zurich to Milan, right over the Alps. You have three buses to choose from:

1. Bus A is a self-driving machine, fitted with a rear-mounted camera and the latest automatic steering mechanism, designed by noted Swiss engineer Johan Taylor. When the camera sees that the bus has deviated too far to the right of the road, it automatically steers the bus to the left, and vice versa.

2. Bus B is driven by Johanna Yellen, widely regarded as one of Switzerland's best bus drivers.

3. Bus C is a complicated human/machine hybrid. It has forward looking cameras, that feed road images into a large building, in real time. About 10,000 bus drivers sit at the controls of a simulator, and steer the bus as they think is appropriate. The average of all of their steering decisions is fed back to the bus in real time, in order to adjust the steering mechanism. To motivate good steering decisions, the 10,000 bus drivers are rewarded according to whether their individual steering decisions would have led, ex post, to a smoother and safer drive than that produced by the consensus.

Which bus would you take?

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