Friday, April 30, 2010

NOVA's Disservice to Science

I couldn't contain my dismay while watching the latest NOVA episode titled "Mind Over Money." The subtitle of the program, "can markets be rational when humans aren't?", is the kind of statement that you would normally file under "drivel by some ignorant antiscience lunatic." It's however a statement made by a show that is supposed to be the "highest rated science series on television."

Just think about it: if humans are really as irrational as NOVA says they are, why should we limit the effects of irrationality to the domain of economics and markets? Why pretend that political behavior is less irrational (when it's exactly the opposite) and that government is the solution to the problem? Is NOVA implying that those supposedly irrational humans shouldn't be allowed to engage in demanding rational tasks such as to vote in a democracy?

I'm not alone in this negative assessment of the show. Nancy Dewolf Smith does an excellent job describing how bad this NOVA episode is in this WSJ article, how it's filled with intellectual dishonesty and grocery counter magazine sensationalism. She says:

... It's disappointing, part-way into "Mind Over Money," to see the show staggering toward a pit of ancient dung about an alleged struggle between economists who believe in efficient markets and study price signals, and behaviorists who study examples of seemingly nonrational economic behavior, such as "present bias." The "NOVA" episode even trots out the likes of the University of Chicago's Gary Becker for the efficient marketeers and Chicago's behavioral economist Richard Thaler for the other team. Journalists have been trying to whip up a war between these two groups for what feels like decades. But the dogs won't fight because their paths toward finding explanations for market outcomes usually run parallel, not at cross purposes.

As it turns out, "Mind Over Money" isn't really on either of those paths anyway. Like many in Washington these days, producer, writer and director Malcolm Clark appears to believe that the free market shouldn't really be free. But he's not out to skewer Wall Street. Instead, he pounces on us, the fragile humans who can't be trusted to look after ourselves and every century or so do stupid things like pay too much for tulips.

In the world according to "NOVA," the story of what's wrong today goes like this: For the past 50 years, our economy has been driven by disciples of a guy named Adam Smith, who believed that human beings always seek to act in their own best economic interest, and can detect and serve that interest best in markets free from government interference. A few decades ago, the potted historical narrative continues, some free marketeers developed a giant mathematical equation which has been used to run the economy ever since.

But the recent crash in housing prices and subsequent crises proved that the formula was wrong because it did not predict that people can be crazy and panic and do dumb things with their money. Actually, we're told, many years ago, a wise man named John Maynard Keynes did figure all this out, but he didn't have a giant equation so nobody listened to him. But fortunately there are other brilliant seers among us now, including Yale's Robert Shiller...

It's really sad stuff. Obviously, NOVA totally ignored experiments that show how markets can be extremely efficient, like the ones that I run in my classes, and that, I suppose, are also run by thousands of other professors of economics around the world every semester.

The lack of intellectual integrity and the ideological bias of this show is absolutely shocking. If NOVA can misrepresent an entire field of science so blatantly, what does it tells us about the scientific standards that they apply to every other show they produce?

Thursday, April 29, 2010

Laying the Path to Fiscal Responsibility - Really?

Here's a paragraph from a White House OMB announcement by Orszag regarding the National Commission on Fiscal Responsibility and Reform, which came out yesterday:
Recognizing the fiscal future that we face, the Administration has taken major steps to restore fiscal responsibility. The President’s Budget includes more deficit reduction than proposed by a President in any budget in over a decade; by 2015, it would cut the deficit from 5 percent of GDP to 4 percent of GDP.
Should I be impressed? It will only take eight years for the federal debt held by the public to balloon to 100% of the GDP with a 4% deficit!

From 1947 to 2008, the US federal deficit was higher than 4% (and not by much) only in 7 years: 1976, 1983, 1984, 1985, 1986, 1991 and 1992. It was equal to 9.91% in 2009 and is projected to be equal to 10.64% in 2010.

Anyone knows of a trusty rocketship leaving to a colony in Mars?

Monday, April 26, 2010

The Bailout Bill

The American has a good article by Phillip Swagel on how bailouts are about to become the law with the administration's financial regulation bill (HT Mankiw):

Markets participants will understand that the Senate financial regulation bill allows for bailouts, and this will give rise to riskier behavior that in turn makes future bailouts more likely. ...

A particularly misleading claim from the administration is that the bill is not a bailout because any losses would be recouped through taxes on banks after the fact. The intervention itself is the essence of the bailout, not whether there are losses to the government. Imagine if the Troubled Asset Relief Program was to end up with a profit—not just recouping the money put into firms over the past two years but actually making a return for taxpayers. No one would suggest that the TARP is then somehow not a bailout. Recouping funds after the fact might be a good way to protect taxpayers, but it is preposterous to claim that this makes the Dodd bill anything other than a bailout. The ability of the government to put money into a failing firm and make payments to counterparties at its discretion is what makes the Dodd proposal a permanent bailout authority, not the issue of who pays after the fact.

Sunday, April 25, 2010

Ostrom on Free Riding

Yes! Magazine has an interesting interview with latest Nobel Prize in Economics winner Elinor Ostrom (HT Selva Brasilis). Here's what she has to say about free riding:

Fran: But what about the “free-rider” problem—where some people abide by the rules and some people don’t? Won’t the whole thing fall apart?

Elinor: Well if the people don’t communicate and get some shared norms and rules, that’s right, you’ll have that problem. But if they get together and say, “Hey folks, this is a project that we’re all going to have to contribute to. Now, let’s figure it out,” they can make it work. For example, if it’s a community garden, they might say, “Do we agree every Saturday morning we’re all going to go down to the community garden, and we’re going to take roll and we’re going to put the roll up on a bulletin board?” A lot of communities have figured out subtle ways of making everyone contribute, because if they don’t, those people are noticeable.

Friday, April 23, 2010

Regulatory Power - To Fail?

What they've been watching wasn't the screen on the right: SEC officers caught using pornography at the workplace. Would there be a better example of government failure? (HT Selva Brasilis) According to the Washington Post:
Dozens of Securities and Exchange Commission staffers used government computers to access and download explicit images and many of the incidents have occurred since the global financial meltdown began, according to a new watchdog investigation.
The lesson from this episode is that good regulation should never rely on the infallibility of regulators.

Wednesday, April 21, 2010

Captain Kirk and Opportunistic Kantianism

My latest OrdemLivre.org article (in Portuguese) is about Kirk's opportunistic Kantianism, Spock's utilitarianism, and some implications for libertarian thinking. Here's a translated extract:
Given the importance of Hume, Bentham and Mill, among other utilitarians, in libertarian thinking, it surprises me sometimes that many libertarians express notions about freedom and private property that are formulated as if they are Kantian categorical imperatives. When libertarians say that freedom is an end on itself, they are making an absolute moral statement, and rejecting the utilitarian calculation. For me this is a good example of opportunistic Kantianism, since these same libertarians probably reject the majority of the teachings of Kant and his disciples. When libertarians use categorical imperatives, I see Kirk's justification for endangering the lives of his subordinates, even of members of his family, in a risky undertaking that has the salvation of good friend Spock as its ultimate goal. In other words, I see in libertarianism the same elements of opportunistic arbitrariness that are so common in other political philosophies.

Sunday, April 18, 2010

Cowen on the Necessity of Spending Cuts

Here's the summary of a NYT article by Tyler Cowen on the looming US fiscal disaster:

AMERICA’S long-run fiscal outlook is bleak, mostly because of an aging population and rising health care costs. To close the gap between expenditures and revenue, we’ll likely see a combination of revenue increases and spending cuts. And we’ll need to focus especially on reducing spending, largely because that taxes on the wealthy can be raised only so high. ...

The macroeconomic evidence also suggests the wisdom of emphasizing spending cuts. In a recent paper, Alberto Alesina and Silvia Ardagna, economics professors at Harvard, found that in developed countries, spending cuts were the key to successful fiscal adjustments — and were generally better for the economy than tax increases. Their conclusion was based on data since 1970 from the Organization for Economic Cooperation and Development.

The received wisdom in the United States is that deep spending cuts are politically impossible. But a number of economically advanced countries, including Sweden, Finland, Canada and, most recently, Ireland, have cut their government budgets when needed. ...

Right now there is plenty of concern about debt and deficits, but little consensus on which expenditures should be cut or reined in. Sooner or later, we’ll have to reconsider virtually every segment of the federal budget.

The issue of fiscal responsibility isn’t going away. So the question is now this: How deeply will we dig ourselves in before we create a more mature and more forward-looking political culture?

Saturday, April 17, 2010

Educators in Need of Public Finance Education

I found this passage on taxes in the National Education Association's Advocate of April 2010:
The share of taxes paid by corporations as a percentage of their profits has declined 50 percent over the last 20 years. Big business gets tax subsidies - without any accountability or regard for their impact on schools and on school-age children.
The NEA doesn't appear to be aware of what public finance educators have to say on the subject. Rosen and Gayer's Public Finance textbook for example explains that:
By drawing a sharp distinction between "corporations" and "people," the statement reflects a common fallacy - that businesses have an independent ability to bear a tax. True, the US legal system treats certain institutions such as corporations as if they were people. Although for many purposes this is a convenient fiction, it sometimes creates confusion. From an economist's point of view, people - stockholders, workers, landlords, consumers - bear taxes. A corporation cannot.
Since the NEA analysis doesn't distinguish between statutory and economic incidence of taxes, its policy proposals could easily have effects that are the opposite of their goals. If the NEA cannot get even such a simple, textbook level, introductory public finance concept right, what to think of their policy proposals on issues that are much more complex than this one?

The Communist Solution to Heterogeneous Preferences

Brought to us by Division of Labour's Art Carden:

A communist revolutionary is giving a speech.

Communist Revolutionary: "After the revolution, the land will flow with milk and honey!"

Audience Member: "But I don't like milk and honey."

Communist Revolutionary: (pause) "Comrade, after the revolution, you will like milk and honey!"

Tuesday, April 13, 2010

Baker on the American Way of Tax

Rosen & Gayer's Public Finance textbook, which I use in my classes, has a box with a classic Russell Baker text that originally appeared in the International Herald Tribune in 1977. It's more relevant than ever. Here's a segment:

“Figg,” he said, “you have made me sore wroth with your way of life. Therefore, I am going to soak you for more federal income taxes.” And he squeezed Figg until beads of blood popped out along the seams of Figg’s wallet.

“Mercy, good tax man,” Figg gasped. “Tell me how to live so that I may please my government, and I shall obey.”

The tax man told Figg to quit renting and buy a house. The government wanted everyone to accept large mortgage loans from bankers. If Figg complied, it would cut his taxes.

Figg bought a house, which he did not want, in a suburb where he did not want to live, and he invited his friends and relatives to attend a party celebrating his surrender to a way of life that pleased his government.

The tax man was so furious that he showed up and the party with bloodshot eyes. “I have had enough of this, Figg,” he declared. “Your government doesn’t want you entertaining friends and relatives. This will cost you plenty.”

Figg immediately threw out all his friends and relatives, then asked the tax man what sort of people his government wished him to entertain. “Business associates,” said the tax man. “Entertain plenty of business associates, and I shall cut your taxes.”

Read the rest here.

Monday, April 12, 2010

The European Advantage

Fiscally conservative economists in the US and other non-European countries tend to have a negative view of the European Union, and particularly of its European Commission in Brussels, as a bureaucratic behemoth that exemplifies the evils of centralized governance. Up to a certain extent the reputation is well deserved: Europe suffers from economic sclerosis for sure, and Brussels has too many times made the problem worse.

But the European countries appear to have an advantage over other countries: they have shown again and again during the last decade that they are more capable of publicly recognizing when their governments engage in fiscally irresponsible behavior. Even though this public understanding doesn't necessarily translate into action, this is better than the preferred political approach in most other countries, including the US: denial and obfuscation.

An example is given by this Financial Times article on the European Commission's realistic and pragmatic warnings to European countries regarding their excessive budget deficits:

The European Commission has warned the eurozone's four biggest countries - Germany, France, Italy and Spain - that their growth forecasts for the next three years are too optimistic, endangering their ability to cut deficits in line with European Union rules.

The Commission had asked the four, and others including Austria, Belgium, Ireland and the Netherlands, to spell out how they intended to meet medium-term deficit reduction targets to 3 per cent or less of gross domestic product - the EU's ceiling in normal economic times.

Contrast the ability of the European governments to openly debate such an important issue with the unquestioned, unrestrained and irresponsible fiscal stances that have been the norm during the last and current administrations in the US.

The Greek crisis for example, which has been cited by many as a sign of European weakness, is in my interpretation instead a sign of strength: government irresponsibility has been clearly more constrained by markets in Europe than in the US and in BRIC countries. Due to some curious and probably unplanned institutional constraints, governments in Europe find themselves forced to face their economic stringent realities much earlier than in the US and in BRIC countries, and for me this is evidence that their fiscal institutions are probably better positioned to face the fiscal challenges to come.

Saturday, April 10, 2010

The Coming US Fiscal Wreck

Everybody likes to talk about sustainability these days, so maybe they should be focusing on the main, real, and certain sustainability problem of most nations: their rotten fiscal realities, in particular, the easily predictable coming US fiscal wreck. Here is Williams and Altshuler on the topic (HT Mankiw):

Washington spends more than it takes in through tax revenues, resulting in a projected budget deficit of almost $1.35 trillion in 2010, or 9 percent of GDP, according to the Congressional Budget Office. Couldn't we get rid of the deficit by raising taxes?

No. A study we conducted at the Tax Policy Center found that Washington would have to raise taxes by almost 40 percent to reduce -- not eliminate, just reduce -- the deficit to 3 percent of our GDP, the 2015 goal the Obama administration set in its 2011 budget. That tax boost would mean the lowest income tax rate would jump from 10 to nearly 14 percent, and the top rate from 35 to 48 percent.

What if we raised taxes only on families with couples making more than $250,000 a year and on individuals making more than $200,000? The top two income tax rates would have to more than double, with the top rate hitting almost 77 percent, to get the deficit down to 3 percent of GDP. Such dramatic tax increases are politically untenable and still wouldn't come close to eliminating the deficit.

Friday, April 9, 2010

Vernon Smith on Asperger's Syndrome

Below an interview with Nobel Prize in Economic Sciences winner Vernon Smith on having being diagnosed with Asperger's Syndrome. HBO has been broadcasting an interesting documentary on the subject titled "A Mother's Courage: Talking Back to Autism."

Wednesday, April 7, 2010

High Interest Rates in Brazil: A Portrait of the Governing Party Ineptitude

This is the subject of my last OrdemLivre.org article (in Portuguese). Here's a translation of my accusatory main point:

The Lula da Silva administration in Brazil did nothing in two mandates to stimulate competition in the Brazilian banking sector and to modernize the archaic legal framework of the Brazilian financial system. ...

High interest rates in Brazil are not ... a technical problem, but a political problem, and the Lula da Silva administration lacks the courage, technical skills and intellectual honesty to face it.

Monday, April 5, 2010

Bailey on How Markets Make People Fairer

In this Reason.com article Ronald Bailey discusses the scientific evidence on how market economies make people develop their sense of fairness:

Are people innately fair-minded or is it learned behavior? A fascinating new study, "Markets, Religion, Community Size, and the Evolution of Fairness and Punishment," that is a big step toward resolving this question is being published today in the journal Science. The researchers find strong evidence that market institutions cause people to treat each other, especially, strangers more fairly. ...

This is exactly the sort of argument that libertarian thinker and economics Nobelist Friedrich Hayek made, especially in his last book, The Fatal Conceit: The Errors of Socialism. Successful societies are those that adopt market norms and they tend over time to outcompete societies organized in more primitive top-down ways. The upshot is that efforts to extract people from markets (e.g., communism, socialism, fascism) encourage them to revert to the innate savagery of dealing fairly only with kin and fellow tribespeople.

Sunday, April 4, 2010

7th Art: Double Indemnity (1944)

"You're not smarter, Walter... you're just a little taller." Great lines like this set the mood for Billy Wilder's "Double Indemnity" (1944), a classic that stands the test of time. It's a film noir about love, greed and crime, based on the novel by James M. Cain, with a magnificent musical score by Miklós Rózsa.

The movie has many eye candies for someone looking back today at life during the late 30s in Los Angeles. From the risqué depiction of adultery to the constant drinking and smoking, including a car stop at a beer-serving drive-thru around 4:00 PM, it's one of those movies that reflects societal changes very intensely. In some odd sense, you get confirmation through the lens of Wilder that social norms didn't become necessarily freer or less puritan during the last 70 years.

The most interesting aspects of the story however are related to economics. While the foundations of the economics of information asymmetry were established during the 70s, and their main authors only received a Nobel in 2001, you will clearly see the same arguments made by Cain and Wilder in the movie almost 40 years before economists stated them. There you will find examples of adverse selection, moral hazard, and principal-agent problems, all laid out in an almost academic fashion. If you know economic theory, make sure that you watch this movie with an eye on its great microeconomic and insurance finance insights.
Enjoy the trailer!