Why everyone should know pre-calculus

I overheard someone today talking about how much better one thing was than another. "It's logarithmically better", the person said. Of course he meant "exponentially better". We can see the difference graphically. Logarithmic increases look like this:

and exponential increases look like this:

Maybe he meant that it was getting better at a smaller and smaller rate. Probably not, though.

Taking on the Oligarchs

As the former chief economist at the International Monetary Fund, Simon Johnson has seen his share of crony capitalism in places like Russia and Indonesia. So when he starts warning about the unchecked influence of the financial lobby on the US government, we should all listen.

Given the mistakes made on Wall Street and the sheer size of the financial losses, one would think that Congress would take a tough line on the banks: wipeout shareholders, remove incompetent management and close down the zombies. But as Paul Krugman laments, this is not what the government is doing:

"...what they’re actually doing is underestimating the problem, doing too little too late, and not being open and honest in trying to assess the true cost. The actual plan seems to be to keep the banks semi-alive by implicitly guaranteeing their liabilities and dribbling in money as necessary, all the while proclaiming that they’re adequately capitalized — and hope that things turn up. It’s Japan all over again.

And the result will probably be a deeper, long-lasting crisis."

I don't think there's some vast conspiracy of financial managers seeking to control the government. Rather, the influence of the financial industry on the government is more of an emergent phenomenon, the result of the frequent exchange of talent from Wall Street to Capital Hill and back. I don't think Tim Geithner or anyone else is being insincere in their plans for fixing the banks; unfortunately, that doesn't mitigate the result.

Ed Glaeser, sacred cow-slayer

In the wake of $6 trillion of lost American housing wealth, now is certainly a good time for smart ideas on housing policy. One idea, courtesy of Harvard's Ed Glaeser, is getting rid of the mortgage interest deduction. It won't be easy, though. As Glaeser notes, this policy is a political "sacred cow".

With respect to the current crisis, the mortgage interest deduction encouraged Americans to leverage their houses as much as possible:

"Subsidizing interest payments encourages people to leverage themselves to the hilt to bet on housing markets. The size of the tax benefit is proportional to your debt. The deduction essentially encourages us to make leveraged bets on the swings of the housing market. That leverage means that housing price swings can easily wipe people out. We are currently experiencing the consequences of subsidizing gambles on housing."

But outside of the current situation, there are plenty of reasons to get rid of this deduction. The most important in my mind is that it is "wildly regressive", yielding proportionally greater savings for higher income earners than for lower income earners.

Glaeser advocates phasing out the mortgage deduction as part of his larger "libertarian progrssive" view: the view that large government is often used to privilege the privileged. The mortgage interest deduction is only available to people who itemize their taxes, virtually all of whom are well off. Indeed if you did want to support home ownership among the poor, a tax credit would be much more useful. This is probably a better use of taxpayer money than subsidizing million dollar houses for upper-middle class professionals.

I knew it all along!

Virtually every American college student has played "beer pong" or one of its many variants. The marriage of inebriation, boredom and impaired hand-eye coordination was seemingly made in Heaven. But can beer pong kill? No, but it can make you sick.

If you miss one of your opponents' cups, the ball falls on the floor and rolls behind a couch. And don't give me that nonsense about cleaning the ball in the cup of water; it's a cesspool!

28 Business Days Later*

NPR has a good primer on the term "zombie banks", which are banks that are essentially insolvent, but wonder the financial world living off the flesh--er, guarantee--of the government.

These banks represent a huge threat to our financial system, but it's unclear what to do about them. As one of the commentators says, "there's no cure for zombeism".

*Alternate titles:
Night of the Living Banks
Dawn of the TED
Resident Financial
Weekend at Bernie Madoff's (not really a zombie movie, but who cares?)

Change of heart

Add Alan Greenspan to the list of economists favoring some form of temporary bank nationalization. Greenspan was once a disciple of Ayn Rand, Goddess of individualism and libertarianism. Desperate times, I suppose.

(HT: Paul Krugman)

Semantics we can believe in

You know things are bad when a libertarian economist like Alex Tabarrok is warming to the idea of large-scale government intervention into the banking sector. Just one thing: don't call it "nationalization":

"Notice how the term nationalization confuses the issue. First, it suggests government ownership of the banks, which would indeed be a disaster. People in favor of free markets will rightly want to avoid any such outcome but ironically it's the current situation of "wait and see," and "protect the banker," which is likely to lead to an anemic recovery and eventual government ownership. Second, it confuses people on the left who think that nationalization is a way to insure that taxpayers get something on the upside. That idea is a joke - there is no upside. Taxpayers are going to have to pay through the nose but the critical point is that the taxpayers must pay the depositors whom they have guaranteed not the banks.

The debate so far has been framed between a "bailout" and "nationalization." But the public rightly sees the bailout as a way to protect bankers and thus we get pressure for government ownership, which has already happened in part through government control over banker wages. Bankruptcy in contrast is a normal free market procedure, it emphasizes that the firm has failed and current management should be removed. Framing the issue in this way, for example, makes it clear that only the depositors should be protected and under reorganization there should be no control over wages on future management (wages are going to have to be high to get anyone to take on the task). Finally the idea of bankruptcy makes it clear that the goal is to get banks solvent, under new management, and back under private control as quickly as possible."

Like Tabarrok, I generally oppose nationalization efforts in which government operates specific industries. If you think the government could run a car company, for example, try driving around in this:


But what Tabarrok is describing is very different. Since the government already has a stake in the banking sector (through the FDIC, it is the main bank insurer), government-facilitated bankruptcy is much more "free-market" than keeping insolvent, but politically connected banks on life-support. Tabarrok explains:

"What would a private insurance firm do in this situation? Would it pander to the current bank management and carry the zombie banks on its books, hoping and waiting for a miracle? Or would it step in, remove current management, pay off the depositors, reorganize and then sell the banks to recoup its losses? I believe a private insurer would follow the second path, the fact that the government is not yet ready to do this indicates how powerful bankers are in Washington. Thus, given deposit insurance the procedure most consistent with free market principles is bankruptcy, preferably a speed bankruptcy procedure under the auspices of the FDIC which has significant expertise in this field."

Despite the soon to be signed $800 billion stimulus package, the economy will not recover without a functioning banking sector. Bankruptcy won't be pretty, but it's better than being overrun by zombies.

If you want guys* to be romantic, make them a graph

*Guys like me, that is.

Courtesy of Flowing Data, the terrific blog on data visualization, the following chart shows what kind of gift you should get your wife/girlfriend/friend-with-benefits/chick whose bed you woke up in for Valentine's Day:

I fall under the "You've been fishing with her Dad" and "Barista/Assistant Regional Manager" categories, so I'm on the hook for a Tiffany bracelet. I got my fiancee an iPod, so I guess that will do.

"Buy American" debate

Over at the New York Times "Room for Debate" blog, a number of commentators take up the "Buy American" provision in the stimulus. There are some interesting points on both sides:

• Jagdish Bhagwati: "The buy-American provisions unravel previous trade agreements unilaterally and in violation to the concessions we made."
  
  
• Ha-Joon Chang: "Some people worry that this will lead to a 1930s-style all-out trade war. But in the short run, there is actually no danger of that. Now we have the World Trade Organization, the European Union and many other regional trade agreements that limit protectionism. Of course, in the longer run, if veiled protectionism continues, we run the risk of making a mockery of these agreements and destroying the global trading system....the solution to this problem should not be an adherence to the principle of free trade, which is not workable in practice anyway, but instead to establish a new international agreement that allows a transparent, forward-looking and time-bound protectionism as well as more infant-industry protection for developing countries. In other words, by allowing more protectionism now in a controlled way, we will be able to preserve the international trading system better in the longer run."

• Anne Krueger: "The buy-American measure in the stimulus package would do little, in part because few imports are used in construction projects. But the signal that it would send to other countries would invite protective measures to the detriment of American exports and employment. Once protectionist measures are adopted, they are difficult to remove. In the long run, choking off through protection the integration of the world economy reduces productivity and prospects for future growth of all economies. It does not make any sense to sacrifice longer term growth prospects for measures that, even in the short run, offer very little prospect except for the very few at the cost of many others."
  

• Robert E. Scott: "When the government buys steel for a bridge, for example, it has several objectives. Minimizing costs is one, but when the economy is in recession, there is added incentive to stimulate domestic employment. And when steel is purchased from a domestic producer the workers’ wages generate further spending, which supports yet more jobs in the domestic economy."

Bhagwati and Kreuger are ardent free trade supporters, while Chang and Scott support selective protectionism, particularly for developing countries.

I agree with Kreuger that this won't have a huge economic impact and I agree with Chang that this probably won't cause a trade war, given our international institutional structure. Chang is also right about the dangers of "veiled protectionism", but I disagree that infant industry protection is the right solution.

Scott's argument breaks down if there's a big difference between domestic and foreign components. As I've said before, if we pay a lot more for inputs to construction projects, we can't do as many projects and can't hire as many workers. My feeling is that this is a gift to domestic steel producers. It could ultimately end up costing jobs and impeding the stimulus.

Be careful what you wish for

In his column in the New York Times, Harvard economist Gregory Mankiw points out that China's accused currency manipulation is more complicated than our new Treasury Secretary has made it seem:

"Just before his confirmation as Treasury secretary, Timothy F. Geithner turned up the heat on the Chinese regarding the dollar-yuan exchange rate. President Obama, he said, 'believes that China is manipulating its currency. Countries like China cannot continue to get a free pass for undermining fair-trade principles'...

Critics of China say it is keeping the yuan undervalued to gain an advantage in the international marketplace. A cheaper yuan makes Chinese goods less expensive in the United States and American goods more expensive in China. As a result, American producers find it harder to compete with Chinese imports in the United States and to sell their own exports in China.

There is, however, another side to the story. The loss to American producers comes with a gain to the many millions of American consumers who prefer to pay less for the goods they buy...

Mr. Geithner and other China critics might also want to ponder how the Chinese keep the yuan undervalued. The essence of the policy is supplying yuan and demanding dollars on foreign-exchange markets. The dollars that China accumulates in these transactions are then invested in United States Treasury securities.

So when the Treasury secretary complains about the undervalued yuan, his message to the Chinese boils down to this: Stop lending us money."

The stimulus package just passed by the Senate will cost a lot of money; money that will be raised through the sale of Treasury bills to, among others, the Chinese government. A sudden change of heart by our foreign creditors could cause a currency crisis larger than any we've seen in the past. Antagonizing the Chinese is good politics, but bad economics.

If we're really interested in raising the value of the Chinese currency relative to ours, we might want to consider cutting our debt so we don't need so many countries buying our dollars. Until we do that, we might want to get off our high horse.

The long road down

The January jobs report was released this week. As David Leonhardt explains, it's not filled with good news:

The government said that 385,000 more jobs were lost last year than it had initially estimated. That brings the total loss since December 2007 to 3.6 million jobs. To put that in some perspective, here are the worst employment losses, as a share of the work force, over the last 40 years:

1981-82: 3.1 percent
1974-75: 2.8 percent
Current (2007-09): 2.6 percent

Keep in mind that the numbers for those earlier recessions describe the absolute low point of the job market. The losses in this recession aren’t yet over — and may, in fact, be a long way from over.

That last part is important. Right now, we're still doing better than in the early 1980s (and much better than the 1930s), but the real question is: where are we going? Many economists think we've got a long way to go.

Things certainly have changed over the past 16 years:

(HT: Paul Krugman)

Capping corporate compensation: cathartic, but not efficient

Former Merrill Lynch CEO John Thain probably isn't getting invited to too many parties these days. While his company collapsed and was ultimately bought out by Bank of American a few months ago, Thain contended that he deserved a bonus--a $10 million bonus, that is. Yes, after public outcry he withdrew his request. But his grandiose sense of entitlement has rubbed a recession-addled economy the wrong way.

Executive pay is a hot topic now. With so many people losing their jobs and seeing their savings melt away, the salaries of corporate heads (especially those in the financial industry) seem obscene; so much so, that President Obama has advocated capping executive pay for companies receiving bailout money, and has generally decried the level of corporate compensation.

It's hard to argue with the emotional appeal of corporate salary cuts. Do people really deserve to make tens (or hundreds) of millions of dollars a year? But the economic case for these cuts are not so straight forward. Reed Hastings, CEO of NetFlix, advocates a "tax, not shame policy" towards executive compensation:

"The reality is that the boards of public companies hate overpaying for anything, including executives. But picking the wrong chief executive is an enormous disaster, so boards are willing to pay an arm and a leg for already proven talent. Putting limits on the salaries at public companies, or trying to shame them into coming down, won’t stop this costly competition for talent.

Of course, it’s galling when a chief executive fails and is still handsomely rewarded. But with the concept of “tax, not shame,” a shocking $20 million severance package would generate $10 million for the government. That’s a far better solution than what we have today, not least because it works with the market rather than against it."

Economists generally favor taxes over price caps on the basis of efficiency. Surely some CEO's are worth a lot of money and companies should be allowed to spend extra to attract them. In fact, there is evidence that CEO salaries are tied to improvements in their company's market capitalization, implying that companies (at least sometimes) are getting what they're paying for. This, however, does not explain why US managers do so well relative to their European and Japanese counterparts.

But the larger fallacy in the pay cap argument is that the distribution of gains is between CEOs and shareholders, not CEOs and workers. Capping management salaries will simply put more money in the hands of the corporate board. This may be desierable in and of itself; but it won't do much for the average worker.

The "tax, not shame" policy would certianly do more for the budget deficit than a cap on pay. According to E.J. McMahon, a senior fellow at the (admittedly conservative) Manhattan Institute:

"From a New York perspective, it’s ironic that the Obama administration chose to reveal its bailout compensation cap on the same day that Sheldon Silver, the speaker of our state Assembly, moved closer to endorsing a bigger new “millionaire tax” to help close Albany’s $13 billion budget gap.

If New York’s weakest financial institutions (and who knows what future bailout recipients in other industries) are forced to hold pay to $500,000, Mr. Silver and his colleagues will have fewer million-dollar incomes to tax. This is the sort of unintended consequence that could almost persuade a free-market conservative to embrace the president’s policy. Almost."

As I've written before, the second fundamental welfare theorem says we can use lump-sum transfers (e.g. progressive taxation) to reach a desirable allocation of income. It's a lot less galling to think these gigantic salaries are funding "our soldiers, schools and security".

Statistics Humor

For anyone who thinks it can't be done:


(HT: Andrew Gelman)

Lawrence Lindsey on the Daily Show

Lawrence Lindsey, former Chief of the President's Council of Economic Advisers, stopped by the Daily Show last night to talk about the stimulus package:

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Lawrence Lindsey

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Lindsey brings up several interesting points during this interview. First, he warns against grandstanding politicians harping on symbolic, but ultimately minor points. We all might cringe at the sight of the CEOs from the Big Three traveling to Washington via private jets to ask for a handout; but as an economic issue, it's minor and a waste for Congress to focus so intently on it at the expense of actual issues facing the economy.

Second, Lindsey advocates for providing tax relief via the payroll tax, a policy that is gaining support among economists. While not everyone pays income tax, all workers pay payroll taxes. According to Lindsey, we can temporarily cut this tax and put $1,500 in every working American's pocket over the next year.

The new Fab Four

Famed photographer Annie Leibovitz photographs the Obama team in the March 2009 issue of Vanity Fair. Here's her shot of the people charged with averting economic disaster:

(Left to Right: Lawrence Summers, director, National Economic Council; Peter Orszag, director, Office of Management and Budget; Timothy Geithner, Secretary of the Treasury; Christina Romer, chair, Council of Economic Advisers)

Let's hope that they, too, are bigger than Jesus.

The case for protectionism (sort of)

Paul Krugman adds some nuance to our recent discussion on protectionism and the stimulus:

"...one part of the problem facing the world is that there are major policy externalities. My fiscal stimulus helps your economy, by increasing your exports — but you don’t share in my addition to government debt. As I explained a while back, this means that the bang per buck on stimulus for any one country is less than it is for the world as a whole.

And this in turn means that if macro policy isn’t coordinated internationally — and it isn’t — we’ll tend to end up with too little fiscal stimulus, everywhere.

Now ask, how would this change if each country adopted protectionist measures that “contained” the effects of fiscal expansion within its domestic economy? Then everyone would adopt a more expansionary policy — and the world would get closer to full employment than it would have otherwise. Yes, trade would be more distorted, which is a cost; but the distortion caused by a severely underemployed world economy would be reduced. And as the late James Tobin liked to say, it takes a lot of Harberger triangles to fill an Okun gap."

Krugman is quick to point out that this is not an argument in favor of long-term protectionism or even that protectionism is the best possible policy. The crux of his argument is the last sentence of the quote: the negative effect of a tax (like an import quota) is smaller than the negative effect of unemployment due to reduced total output.

Do some countries free ride on the fiscal stimulus of their partners? Probably. So in that sense, anything that encourages coordinated stimulus is a good thing. The clear downside is the risk of a trade war. Hopefully, we now have the global regulatory structure in place (such as the WTO) to prevent things from devolving into a situation like we saw in the 1930s.

I'm more pessimistic than Krugman about the potential for a trade war; but then again, he just won a Nobel Prize for his work on trade theory.

Getting more bang for the buck

Following up on the "Buy American" provisions in the stimulus package, Douglas Irwin points out of the pitfalls of lacing stimulus with protectionism:

"In rebuilding the San Francisco-Oakland Bay Bridge in the 1990s, the California transit authority complied with state rules mandating the use of domestic steel unless it was at least 25 percent more expensive than imported steel. A domestic bid came in at 23 percent above the foreign bid, and so the more expensive American steel had to be used. Because of the large amount of steel used in the project, California taxpayers had to pay a whopping $400 million more for the bridge. While this is a windfall for a lucky steel company, steel production is capital intensive, and the rule makes less money available for other construction projects that can employ many more workers."

The more money we pay for inputs, the less money we have for infrastructure projects that will hopefully create jobs, and lay the foundation for future growth, to steal a phrase from the President. We can't do that if the steel industry (or any other industry for that matter) uses the stimulus bill to buffer their profits to the detriment of American welfare. 

A lot of Americans are employed using steel. But if the price of steel goes up, fewer of these people will keep their jobs. It's that simple.

More meat less sex?

A sexy PETA ad featuring scantily-clad models fondling crudites was banned from the Super Bowl by NBC:

'Veggie Love': PETA's Banned Super Bowl Ad

While this may seem like a defeat for pro-vegetarian groups, Freakonomics suspects that, at $30 million for a 30-second Super Bowl ad spot, PETA got exactly what it wanted:

"Maybe G.M. should try the same ad strategy as People for the Ethical Treatment of Animals (PETA): get your commercial banned from the Super Bowl. PETA made a sexually explicit commercial that NBC wasn’t comfortable with — one that, just maybe, PETA knew NBC wouldn’t be comfortable with? — and got lots of press without having to actually run the ad."

But what about PETA's central claim, that vegetarians have better sex? New York Magazine looks at some of the evidence:

"Beyond the overenthusiastic veggie love and flagrant sexism in the banned PETA Super Bowl ad, we were also dubious of the notion that vegetarians have better sex. Slate allays our fears with facts: “Vegetarian diets tend to correlate with higher rates of zinc deficiency, which is closely associated with lower testosterone levels and depressed sex drives. Vegetarian women are also more likely to develop amenorrhea (loss of periods), a condition that's usually accompanied by low testosterone, vaginal dryness, and poor libido.” Not so sexy. The cornerstone of PETA’s argument is that eating meat makes you “fat, sick,” and therefore “boring in bed.” There’s some truth to vegetarians weighing less, on average, but the “journal Obstetrics & Gynecology shows that overweight women might, in fact, be slightly more [sexually] active,” Slate notes. If PETA is claiming that vegetarians make better sex partners because they're hotter than meat-eaters, we’d like to point out that Victoria's Secret models like Gisele enjoy a little meat. According to Churrascaria waiter Marcio Lorenzi, they're partial to chicken hearts."

I guess that's one theory we can put to bed.

Who's going to spend the money?

As I've written before, one of the big debates in the stimulus is whether tax cuts or government spending are more effective for boosting short-term demand. Paul Krugman weighs in:

"...one way to explain why government spending is better than tax cuts as a stimulus is to say that temporary tax cuts aren’t effective at increasing demand, but temporary spending increases are.

Here’s the logic (which follows directly from Milton Friedman’s permanent income hypothesis, by the way): suppose that the government introduces a new program that will cause it to spend $100 billion a year every year from now on. To pay for this, it will have to raise taxes by $100 billion a year, permanently — and if consumers take this into account, they might well cut their spending enough to offset the increase in government purchases.

But suppose the government introduces a one-time, $100 billion program to repair bridges over the next year. The government will have to issue debt to pay for this, and will have to service that debt, requiring higher taxes — say, $5 billion a year. That’s a much smaller impact on consumers’ future after-tax income than the permanent program. So much less of the spending rise will be offset by a fall in consumer demand. (I’m not considering the effect of the spending in raising income, which would probably cause consumer demand to rise rather than fall.)

So economic theory — Milton Friedman’s theory! — says that spending is a more effective form of stimulus than tax cuts."

According to Friedman's "Permanent Income Hypothesis" spending decisions are not based on transitory income gains (windfalls, such as tax rebates), but by a person's real wealth. This is why tax rebates tend to get put in the bank, rather than spent.

Tax rebates were ineffective as fiscal stimulus in 2007 for exactly the reasons Friedman's theory would have predicted. Of course Friedman would not have been in favor of large government spending, either. But it's interesting to consider the full implications of a theory.