Just crazy enough to work...

"When depression economics prevails, the usual rules of economic policy no longer apply: virtue becomes vice, caution is risky and prudence is folly."
Paul Krugman, Nobel Prize Winning Economist in a New York Times Op-Ed Piece

"What you see in FDR that I hope my team can emulate is not always getting it right, but projecting a sense of confidence, and a willingness to try things. And experiment in order to get people working again."
Barack Obama, President Elect in a interview on 60 Minutes

Auto Response

I must admit, I got scared when I watched this video. No, it's not one of those videos that you watch for a while before something pops into frame screaming. It's the GM-sponsored video that argues for the auto industry bailout. Currently, Congress is looking to give the Big 3 US automakers around $25 billion in low cost loans.

This would amount to spending $104,000 per job saved at those companies. Sounds like an awful deal when you put it like that and I'm betting GM knows it. That's why in the videos they expand their influence to all of the jobs in all of the sectors that they buy parts from (electronics, plastics, steel, etc). In order to keep jobs in those industries, the US auto industry needs your money now.

The worst thing is, is that it all seemed so reasonable. Even a dyed in the wool economist like me even got worried. So I started doing a little research. Here's what I found out:

The Big 3 pays its employees an average of $70 an hour or $140,000 per year. Japanese companies pay their employees $44 an hour or $88,000 a year. This is a result of the union control at these plants. It makes our companies extremely uncompetitive.

Also, the bailout money is being given with restrictions. Essentially, the money can only be spent to research more fuel efficient cars. That's not going to help most of the employees. They're still going to be fired while the industry waits to invent something the public will buy.

I also found out on the radio that this isn't the first time that the US auto industry has received low cost loans from the government. The problem is, the news is swamped with stuff on the current bailout, so I can't find out anything about it, but I have a conjecture. I bet it was probably around 1981. In 1981, the US and Japan reached a Voluntary Restraint of Trade agreement. The Japanese knew the government was going to put a tariff on imported cars and offered the restraint instead. I bet the reason the US government was considering the tariff was the original bailout. The government knew that raising the import tax on foreign-made cars would help the auto industry. The auto industry had to be propped up in order for the government to get its money back. The quota raised car prices by $1,600 (just like the tariff would have) and cost US consumers $7 billion dollars.

In the end, the government made money off of the deal, helped by the quota. I bet a current bailout would be accompanied by tariffs or quotas again. The government would hate to look like it invested money in people who couldn't pay us back*. The same thing is going to be true of the finance industry. The government is going to become majority share holders in some of those companies and will probably change the rules to make sure the industry is able to pay back those loans.

The whole thing makes me extremely nervous. I don't think the government can pick a winning company better than private investors can. I know things are tight in the credit market, but these companies have been hemorrhaging money for a long time now. Something has to be done to make these companies more efficient, and government money doesn't seem like the way to do it.

*Again

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Update: My guess was right. In 1979, Chrysler petitioned the government for $1.5 billion in low cost loans which were approved by President Carter in January of 1980. The loans were repaid in 1983-earlier than they had to be-and the government made a tidy $350 million. Clearly, the government knew it had a stake in auto industry and went out of its way to help it by hurting everyone else.

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Update 2: Economist, Robert Lawrence, talks about how the auto industry could fail in the future by doing what Congress forces it to do. Article here.

Simple Macro

I've been teaching the Macro part of 200 lately and I've used a post from Mankiw to illustrate a class example. Pretty simple stuff, but I think it describes what is happening to the economy today.

Uncertainty about the future has caused banks to stop lending and thus excess reserves have skyrocketed. This causes the money multiplier to fall creating a short run recession with deflation. The Fed is trying to counter the deflation by increasing the monetary base.

My prediction is that once banks get back to normal lending the money multiplier will rise. As a result, the money supply is going to rapidly increase due to all the money that the Fed put into the system. This will create an expansion and inflation. The Fed knows this is likely to happen and will try to counter it, but my guess is that they'll act too late and we'll still see significant inflation. By trying to stop the run-away inflation (which it created in the first place) the Fed will put the breaks on the economy causing some bubble that was created by the inflation to burst sending us into an other recession.

What should we look for to see if I'm right? The Fed will announce increases in the interest rate. Currently, the Fed's discount rate is around 1.75 (the lowest its been since November 2002; the end of the last recession). I predict that the Fed will raise rates up to around 5% or 6% within two years.

Not a very optimistic outlook, but I think its at least reasonable.

Hey Teachers...leave them kids alone!

A few days ago I went to a meeting sponsored by the club Think. The debate was on privatization. The whole issue with the collapse of many big companies and the subsequent bailout of those companies sparked this debate. Many people see the demise of these corporations and the troubles the financial system is facing as a damning critique of capitalism. Thus, the government needs to step in and help because it can do things better.

For specificity the debate ended up focusing on education and what the outcome of privatization would be. I enjoyed listening to everyone's opinions on the subject and came up with a few thoughts that I wanted to jot down about the subject.

The first idea I had was: What exactly are we hoping to accomplish with public education? I think for most people it boils down to three things. One, some parents may have smart kids that would benefit from an education but are unable to afford the cost of school. Two, some parents are lazy and irresponsible and would not send their kids to a good school or perhaps even to school at all. Three, we want the population to be well educated.

The second idea was: How do we fix these problems? Public education provides a nice base for all kids. It can avoid both the problem since poor parents have a free school for their kids and bad parents are legally obligated to send their kids.

In spite of the benefits of public schooling it does suffer from several problems. First of all, it doesn't do that great a job of educating. According to this article, the US is ranked 18th out of 24 developed countries in terms of K-12 education by UNICEF. I think this stems from the fact that public schools are set up to be little geographic monopolies. Even if you give the parents a choice between schools, they're set up so that they don't compete with each other*. Second, since the government is endorsing the curriculum, it has to pick something that is mildly satisfying for all parents. This means that the government has to pick abstinence only or safe sex, creationism or evolution, etc. No choice is going to make everyone happy. Thirdly, the government doesn't know when a course is valuable or not. At a university, if students are willing to pay for a class they'll provide it. Not so at a public middle school. Kids don't pay for a class so when it's time for budget cuts Arts and Music lose.

Public schools don't really get the feedback from the market like other businesses do and they perform badly because of it. A little competition would help get these schools behaving more like a company which means they'll fight to provide the best education they can at the lowest price. Think about it this way, everybody complains about the DVM but they don't have a choice but to go there. However, if you don't like Wal-Mart, you can go to Target and these companies know it.

And come to think of it, I've often thought about how cool it would be to open a school and in a conversation today someone echoed that desire. I know of plenty of good people who would be interested in opening schools who would be dedicated to the idea. None of them open schools because the public school system is a monopoly. On average, parent already pays around $8,000 to $10,000 in taxes per year to fund public education. For that parent to send their kid to a private school they would have to pay $16,000 (taxes plus the private school tuition) to get an education that is worth around $8,000. Not many people are willing to do that so few private school are ever opened.

I think a voucher system could introduce that competition nicely. It already seems to do well for higher education. Students can receive scholarships (vouchers) and pick the school they think offers the best education. If they want a better education, then they can spend some of their own money on top of the scholarship. Colleges have to compete to attract good students and so they have to provide a good education at a low cost. And as a nice bonus, no one has to agree on what they think a good education means. Some people prefer a conservative education, some prefer a liberal education. Some prefer to focus on math and science others on art and literature.

Vouchers also seem to solve the problem that poor parents can't afford to send their kids to a good school. Scholarships are already set up to give smart, low-income students an opportunity to go to the same schools they rich attend allowing them to get out of poverty based on merit. The taxes that fund the voucher system could be progressive so that the rich help fund the education of the poor**. So if you're worried that the rich will get richer and the poor will get poorer all you need to do is give the poor a scholarship for around what a rich person would pay for education (probably around $12,000 would do it).

Vouchers may even solve the bad parenting issue. I've heard many people argue that a bad parent will just send their kid to the nearest school and not take the time to investigate whether that school is very good. However, if a school is going to stay in business it will probably have to cater to more than just the small group of bad parents. Good parents will keep an eye on school quality and leave if the school starts doing poorly and it will have to close or improve. Thus the bad parents will free ride on the good parent's watchfulness. Bad parents are bad by definition so they could easily find some terrible shack where the teacher just beats the kids all day. I'm not sure that there are many parents that are that deliberately awful, but maybe. So I'd be willing to bend on my free market principles and OK some rating system like you find on restaurants. If a school doesn't meet some level of qualification it gets shut down.

All in all, I think privatization with a voucher system could be a really good thing for education in the country. Certainly, it is contingent on some political factors. Teacher's unions and county school boards would oppose this move and with anything that involves politics there isn't necessarily the incentive to structure the voucher system in way that won't cater to someone's special interests. But hey, even a cynical economist can hope right?


* For example, you never see two elementary school right next to each other even though you see grocery stores right next to each other all the time.

** If you're into that sort of thing.

Aren't People Crazy?

I hear this a lot, "People are crazy." It gets said in a lot of different ways, but the core is people are irrational. They make bad decisions and bad decisions are irrational. For instance, people heavily invest in stock of the company that they work for. A portfolio like that leaves them vulnerable to too much risk of loss. Basically, people think the company that they work for is a safer bet than it is (as the people who worked for Enron found out).

People mis-estimate risk. We are systematically wrong when guessing how risky some activity is due to what many claim are biological factors that were evolved when humans lived in pre-tribe groups. Two researchers, Kahneman and Tversky, won a Nobel prize for their work in demonstrating that people will take a risky bet when it's phased one way, but will reject the bet when it's phrased a little differently. They've also shown that people are consistently wrong when estimating how likely they are to die from various things, like car crashes for instance.

The November 2008 issue of Popular Science had a similar take on how irrational people are. They report that you are 40,000 times more likely to die in a car crash than on a roller coaster and "yet it's the amusement-park rides that scare people." We take things that seem like more immediate threats too seriously. We are afraid of flying but not pollution. There is a one in a million change that you will die in a plane crash but 40% of deaths are caused by pollution.

I think this is a little unfair though. You look at the risks (which are essentially the costs) and say that we should be doing less of the high cost activity. It's like saying, watching TV is cheaper than eating so you should really be watching TV and not eating. To say that a person should rationally be afraid of the risker/costlier activity ignores the relative benefits of the activities.

Going on a roller coaster gets you nothing but an adrenaline surge. Riding in a car allows you to see your family, get food, go to school and an array of other important activities. Even though the risks are higher the rewards are much greater. So we aren't afraid of getting in the car. The same is true of pollution versus planes. There are plenty of substitutes for long distance travel, but if you want to live a city (because of all the fun stuff there) you've got to be okay with the pollution.

Now, if only I could figure out why people are afraid of public speaking.

Revealed Prefereces

I was listening to the radio recently and heard a story about how Wal-mart made lots of contributions to Republican candidates and the Republican party. The story included the opinion that Wal-mart should instead be funding the Democrats because many of their workers rely on publicly funded health care. If more Democrats were elected, Wal-mart would be able to continue not giving its workers health care making it cheaper to hire them. Wal-mart (in all of its evil) must be acting irrationally.

Or is it...

Wal-mart can pay its workers less if it gives them health care. But if the health care it gives them is not worth the reduction in wages then the workers are going to be mad and go work somewhere else. So, if workers and Wal-mart have come to the decision to work together, the people who work at Wal-mart must be happier with the slightly higher wages and no health care than the lower wages and health care.

Wal-mart knows that it will likely to have to pay more in corporate taxes if a national health care system is created. The taxes it pays will be more than what it has to reduce wages by because it knows that its employees won't be willing to work for less. For example, Wal-mart would have to pay $1 million in taxes but since its employees have health care that it doesn't have to provide for them, people will be willing to work for less. The savings in wages would not add up to be $1 million meaning that the employees of Wal-mart do not in fact value the health care they will be getting at $1 million.

How do I know that the employees of Wal-mart do not value the health care more than the wages they would lose to get it? I know thanks to Wake-Up-Walmart.com. The site claims:

"Since the average full-time Wal-Mart employee earned $17,114 in 2005, he or she would have to spend between 7 and 25 percent of his or her income just to cover the premiums and medical deductibles, if electing for single coverage. [Wal-Mart 2006 Associate Guide and UFCW analysis.]."

The people who work for Wal-mart are so poor that they can not afford the health care. They would prefer to take the risk and keep the money. Clearly, that is an unfortunate decision for those people, but forcing Wal-mart to create a health care system does not improve their situation.

A law would only make both Wal-mart and its employees worse off. Whereas, passing laws that allow for Wal-mart to make its employees as producitve as possible actually would increase their wages allowing them to purchase health care when they thought it was better than the alternative.

A Pessimistic Forecast

I'm pretty much tired of politics.

Both parties claim that they're going to make things better for everyone. This is absolutely false. Why? Because there is no such thing as a free lunch.

Essentially, any government policy will have some costs and some benefits. Which means some people will be made better off at the expense of others. No government policy is going to be good for everyone.

If they were really honest with us, they'd be saying, "I promise the 51% of you who vote for me more stuff than I take from you." Look at the tax polices. Hidden in all of the claims and promises will be a different distribution of wealth than we have today. Both candidate are hoping you feel like it redistributes the pie in your favor.

We can only hope that some of the policies a president enacts are at least better for the people they help than they are bad for the people they hurt. Sounds easy enough, but in practice, it's very hard. If you try to give stuff to people they change their behavior so you have to give them more. If you try to take stuff from people then they make sure that they have less to take or spend valuable resources just making sure you can't get it.

Universal health care is great example. It has the capability to help some at the expense of a lot of people. Universal health insurance is not free because we give up all the good things that the market does for innovation in health care. Having universal health care sucks. Not having universal health care sucks.

No president is going to change that. They're just going to change who it sucks worse for.

I hate to burst your bubble on how great the next 4 years are going to be, but it ain't gonna be what you're hoping for. Improvements in just about everything worth having don't get made by governments, especially presidents.