View From Down Under

When I defend the various economic stimulus programs used to fight the latest recession, the typical response from my right wing friends is that government is not the answer to our problems.  The private sector is always better at producing cost effective outcomes, and the less government interference there is, the better.

This is the common understanding of supply side economics.  Lower taxes and less regulation equals higher output, higher government revenue, and better living for all.*

But are the two incompatible?  Does a belief in supply side mean you have to believe the stimulus packages actually made things worse?

The data on economic stimulus is quite clear.  Most economists agree that the US stimulus package has kept the recession from being much worse than it was  – the only argument is by how much.

Recessions are often associated (at their front end) with financial crises and flight from risk.  During good times, investors typically take more risks than they understand (chasing last year’s gains).  They buy equity in highly leveraged businesses which themselves own risky assets (CMOs, Russian bonds, dotcom startups), and often use margin loans to do it.  When things start to unwind, investors flee risky assets.  The resulting collapse in asset values creates uncertainty among both businesses and consumers, who pull back on their own spending and investment plans.  As a result, GDP contracts and recession ensues.

The appropriate government response is to buy risky assets to provide liquidity to the system and prevent financial meltdown (TARP), and to stimulate demand through a combination of lower interest rates and direct government spending  (stimulus).  The 1930s taught us what happens when you do something else.  The fact that the first part of these programs was agreed by President Bush, Barack Obama, and John McCain testifies to the logic.

Only the government is in a position to provide liquidity and stimulus in times of recession.  Not only is it appropriate for the government to do so, it is imperative.

This does not mean government is the answer to everything, or that government should try to ‘micro-manage’ demand over the cycles.  As Bob McTeer, former President of the Federal Reserve Bank of Dallas, writes:  “I don’t get why we can’t be supply-siders in normal times and yet accept that Keynes is relevant for depressions and deep recessions.  Both supply and demand are important.  Why must each side ridicule the other?”

The data I’ve seen supports this view.  In general, less government intervention is better (in economic terms), but there are times when government intervention is appropriate.  I believe government intervention is appropriate where externalities are not properly priced (pollution control); where free riders thwart effective outcomes – otherwise known as ‘public goods’ (fire fighting, street lights, health care); and when economic cycles turn down.  In other (much more eloquent) words:  to establish justice, insure domestic tranquillity, and promote the general welfare.

*This is not actually my understanding of supply side economics.  My understanding of the Laffer curve is that lower taxes only equals higher government revenue if marginal tax rates are greater than t*.  The reduced income tax receipts after the Bush tax cuts suggest the US is somewhere below t*.

Popularity: 93% [?]

The Senate finally passed a health care bill.  Next step is reconciliation with the House bill, but given the vote in the Senate (60-39) and the fact that the Senate is no longer majority rule but requires 60 votes to pass legislation, the final bill is likely to look very much like the Senate bill.  It’s also looking quite likely that a health care bill will be passed before Easter.

The bills have been watered down with compromises so much that much of the real reform the President wanted has been lost.  However, there is some substantial insurance reform: Extending coverage to millions of uninsured; restrictions on denying coverage; etc.

Perhaps the more important reforms longer term are the efforts in the Senate bill to control costs with provisions like pilot programs and bundled payments, and authorising the HHS secretary to implement reforms that will reduce costs longer term (without requiring legislation).  One major piece of cost control missing in the legislation is malpractice reform.  I believe the Republicans missed a golden opportunity for serious reform of medical malpractice.  A single Republican senator willing to back the plan if it included malpractice reform would have marginalized Joe Lieberman and Ben Nelson, and delivered a much stronger bill.

The view from down under is that the US health care system has committed itself to continue to be the world’s most expensive health care system, but the Senate attempts to ‘bend the curve’ are admirable.

Popularity: 71% [?]

The agreement reached in Copenhagen falls far short of the goal of a binding treaty limiting greenhouse gas emissions.  It is a ‘statement of intent’ to try to limit global warming to no more than 2°C, and a plan to help developing nations deal with climate change over the next 10 years.

Despite the President’s assertion that this is a step towards a legally binding treaty, it is more a recognition that a binding treaty to limit emissions is politically impossible – and likely always will be.

A binding treaty has a number of difficulties, not the least of which is that it is impossible to have a global binding treaty without global enforcement, and most governments are reluctant to relinquish any part of their sovereignty (just ask Chinese Premier Win Jiabao).

There are also some complex economic issues with developed vs developing countries.  How much should developed countries pay to developing countries to make up for the greenhouse gases they (developed countries) have already emitted?  How much will reducing emissions restrict economic development?  How can the US or Europe ask to limit new power plants in other countries when their own power production is emitting so heavily?  Should developed countries ‘share’ green technology with developing countries?  Because any compromise will be a political negotiation, it is certain to allocate these costs unfairly.  Even if fairness is somehow achieved, it will be perceived as unfair.  It is very difficult to ask Americans to send money or technology to India or Indonesia so that they can effectively become more competitive in the world economy.

But even a ‘binding’ treaty will be less than binding.  There will continue to be incentives to cheat, and the political reality is that many countries will do so if it is in their interest.  In that environment, a ‘statement of intent’ is a good outcome.

So it looks as though global warming will continue, and probably accelerate, for at least the next decade.

There is hope that things will change.  Europe, the US, and even China are putting large chunks of R&D investment into clean energy technologies.  Over time, it is likely that some of these will become cost competitive, particularly if carbon emissions are taxed or regulated to account for the externality of global warming.

The biggest emitters are China, USA, EU, Russia, India, Japan, and Brazil.  Concerted efforts by this group to reduce emissions is likely – all of them are publicly proclaiming this commitment.  If the rhetoric is indeed followed by reality, I am optimistic that we will see a reduction in emissions in the next ten years.

Whether it is enough to limit warming to another 2° remains to be seen.

Popularity: 61% [?]

There is little doubt that inadequate regulation contributed to the financial meltdown of 2008.  Financial institutions were using government guaranteed funds to purchase ‘innovative’ financial products whose risks were poorly understood.  Investment banks were creating these new products with little or no oversight, generating billions in fees for reallocating risk from those who owned it to those who thought they weren’t buying it.  Governments around the world were forced to intervene to prevent catastrophic failure of the global financial system.  A major revamp of US financial regulation is an appropriate response.

Ideally, the government should review existing regulation, understand where it fell short in the last financial crisis, and develop ways to fill those gaps.

Unfortunately, the US political system does not work that way.  The House passed legislation last week that focuses on punishing the banks, inserting Congress into the decision making of the Federal Reserve, and shifting consumer credit regulation from the Fed to a new agency.

The Consumer Financial Protection Agency is Barney Frank’s reaction to the subprime lending crisis.  Democrats in the House apparently believe the subprime crisis was a failure of consumer protection.  If the new agency is to have the effect of preventing another subprime crisis, it should be charged with restricting lending to consumers who should not borrow.  But of course, it is not.  The objectives of the agency are to ensure that: consumers have the information they need to make responsible decisions; consumers are protected from abuse, unfairness, and discrimination; markets for consumer financial products operate fairly and efficiently; and traditionally underserved consumers and communities have equal access to responsible financial services.

Barney Frank does not seem to understand that the financial crisis was caused by an explosion of innovative financial products, sold to investors who did not understand the risks, underwritten by insurers who did not understand the risk, and aggressively leveraged by lenders who did not understand the risks.  A large number of consumers were caught in this process, consumers who should not have qualified for loans in the first place.  But nothing I’ve seen in the house bill addresses the fundamental breakdown in financial regulation prior to the crash, and more consumer protection (as noble as it sounds) will not prevent another financial crisis.

Popularity: 100% [?]

John Sides at the Monkey Cage on how few reporters seem to understand the political process and the restrictions on presidential power.  “Understanding policymaking means taking Congress seriously and treating legislators as autonomous. It means acknowledging (repeatedly) the multiple veto points that are built into the system. Policy change is not solely a matter of presidential will or skill…”

Atul Gawande on the surprising likelihood that the small scale experiments in the health care bill may offer the best strategy for long term cost control.  “Where we crave sweeping transformation, however, all the current bill offers is those pilot programs, a battery of small-scale experiments. The strategy seems hopelessly inadequate to solve a problem of this magnitude. And yet—here’s the interesting thing—history suggests otherwise.”

Brad DeLong on how the economy can’t be improved without also benefitting the ‘fat cat’ bankers.  “In a crisis like the present, if you avoid the nationalization and extravagant deficit-spending route, and you still succeed in avoiding persistent mass unemployment, you will have done so by a process that boosts asset prices and enriches fat-cat bankers.”

Popularity: 45% [?]

Over that last few years the percentage of Americans who believe in human caused global warming has shrunk, even as the evidence for it has grown.  If the heat and noise of the debate has got you questioning, here is a small sample of the evidence.

First, the things we can know with certainty.

The global climate system has warmed over the last 100 years.  This is unequivocal, and supported by increases in global air and water temperatures, widespread melting of snow and ice, and rising global average sea level.  Yes there are yearly variations around the trend line, and some years are cooler than the previous year, but the trend is real.  (This data comes from NASA Goddard Institute)

The levels of CO2, methane, and nitrous oxide have increased dramatically in the last 100 years.  CO2 levels have increased roughly 35% over the last 50 years.  Methane has increased 48%, and nitrous oxide has increased 18%.  All of these are substantially above the natural range over the last 650,000 years as determined by ice core analysis.

These increases are due primarily to human activity.  Use of fossil fuels, agriculture, and change in land use are the primary contributors to the increase.

The levels of greenhouse gases are highly correlated with increasing global temperatures – and have been for millennia.  The data below comes from analysis of Antarctic ice cores.

These are facts regardless of whether you or I believe them to be facts.

There are other things we can know with a very high degree of certainty.

Climate models have been around for nearly 50 years, and are continuously getting more accurate as more data arrives.  These models are developed both independently and collaboratively by scientists in many countries.  None of these models are able to predict the current increase in global temperatures and sea levels without taking into account the man-made increases in greenhouse gases.  There is a very high degree of certainty that global warming is the result of human activity.

The big unknown is how much more the climate will change in the future.  As you can imagine, this will depend on the level of greenhouse gases we emit.  Estimates for temperature change by the end of this century range from alarming (1.8°C assuming global population peaks mid century and a rapid shift to clean technologies) to catastrophic (4.0°C if economic growth continues to be driven primarily by fossil fuels).

Despite all the certainty surrounding global warming,  the impact of continued climate change on human endeavours is unknown.  Scientists can estimate impacts on sea levels, precipitation, surface temperatures, and more, but calculating the cost of global warming in economic, social, or environmental terms has so far proven to be very difficult.  As has estimating the cost of avoiding further climate change.

But there is no doubt that global warming is real and will continue for some time.

Popularity: 75% [?]

Is smoking a leading cause of lung disease?  Do El Nino episodes cause weather changes?  Did widespread use of DDT cause major reduction of bird and fish populations in affected areas?

If a survey asked these questions today, the results would show an overwhelming majority of people in agreement.  Among scientists, there would be almost no doubters.  However, each of these propositions was initially met with strong, vocal, and emotional reactions from skeptics – many of whom owed their livelihoods and reputations to denying them.

Today, there is virtual unanimity among scientists about global warming.  The National Academy of Sciences, American Chemical Society, Crop Science Society, and many other scientific organizations have issued public statements confirming that global warming is occurring and is the result of human activity.

In spite of this, a recent survey by the Pew Research Center shows the number of Americans who believe there is solid evidence of global warming has actually dropped in the last three years.  A majority of Americans simply do not believe the scientific organizations.

Here is the data by political affiliation.  Belief in global warming has declined across the board, but the decline has been dramatic among Republicans.  Nearly half of the Republicans who in 2006 believed the earth was warming no longer believe so.

Just shows what can happen when a scientific issue becomes a political and emotional one.  It is clear there are a number of highly effective communicators in the US whose livelihood and reputation depend on debunking global warming.  As Upton Sinclair wrote:  ”It is difficult to get a man to understand something, when his salary depends upon his not understanding it”.

In the midst of the Copenhagen climate change meetings, I’ll be posting a few thoughts on climate change.  Next post will be fairly heavy on data.  In the meantime, I encourage you to look at some data yourself.  A couple of good places to start are the IPCC Summary and the National Academy of Sciences climate change report.

Popularity: 72% [?]

Employment figures released Friday were a pleasant surprise.  The unemployment rate declined slightly from 10.2% to 10.0%.  Seasonally adjusted job losses for November were 11,000 – this is a drop of 0.0084% of total employed and therefore the Department of Labor characterised employment as “essentially unchanged”.  The consensus forecast of economists for November was a loss of 125,000 jobs, so the flat result was a big surprise.

Hours worked also increased slightly, from 33.0 in October to 33.2 in November.  This is a necessary precursor to stronger hiring, as businesses will typically use any spare capacity from their existing employees before adding new ones.  However, hours worked has been fairly stable for some months, and is still a fair way below the average of 33.8 for the three years prior to the recession.

Many of the jobs created were temporary in nature.  This is not necessarily a bad thing, as temporary hiring typically precedes permanent hiring in a recovery.  Businesses are usually reluctant to commit to permanent hires until they are confident the requirement is permanent.

In other encouraging news, job losses from September and October were both positively revised.  The September reported loss of 219,000 jobs was revised to 139,000.  The October reported loss of 190,000 was revised down to 111,000.  In the past, the direction of these revisions has served as a pretty good leading indicator.

Of course, this report is a snapshot and subject to normal margins of error.  The figures are preliminary and likely to be revised in the future.  The reality is there are 7 million more Americans unemployed today than two years ago.  The US has serious issues with long term unemployed and discouraged workers.  For the unemployed, the recession is not over.

But the unemployment figures have some of the classic signs of end of recession data.  Before the unemployment rate can drop in a sustained manner, several things need to happen:

• Job losses must stop.  While it’s not entirely clear that losses have stopped for good, it is absolutely clear that the rate of job loss has slowed, and slowed dramatically.
• Hours worked must increase, absorbing excess labor capacity.  Again, a ways to go, but the signs are now encouraging.
• Temporary hiring needs to pick up.  As business activity requires more employees, but managers are still stuck with either hiring freezes or uncertainty, the typical path is to hire temp workers first, then permanent.

The best news from the Department of Labor yesterday is that these indicators are all apparently moving in the right direction.

Popularity: 62% [?]