Archives: October, 2008

Congratulations Paul Krugman

Today, the Royal Swedish Academy of Sciences awarded Princeton University economist and New York Times columnist Paul Krugman the Nobel Memorial Prize in Economic Sciences “for his analysis of trade patterns and location of economic activity.”  

I recently debated Krugman on whether it’s a good idea for government to guarantee universal health insurance coverage.  But today I have nothing but congratulations for him.

On Krugman’s Nobel

The Swedish Academy of Sciences has awarded the 2008 Nobel Memorial Prize in Economic Sciences to Paul Krugman, in recognition of his contribution to trade theory and specifically for his work on the effect of economies of scale in international trade.

Although Prof. Krugman is perhaps better known these days for his columns in the New York Times and his strong criticism of the Bush administration, trade wonks are well aware of his scholarly contributions, which number in the hundreds of scholarly journal articles and tens of books (including, jointly with Maurice Obstfeld, my undergraduate trade textbook). He won the John Bates Clark medal in economics in 1991, an arguably tougher prize to win than the Nobel.

I have my concerns with Prof. Krugman’s later work and his tendency to allow his political views to trump economic good sense. As the Economist [$] wrote in 2003 “A glance through his past columns reveals a growing tendency to attribute all the world’s ills to George Bush…Even his economics is sometimes stretched…” He is generally considered to be a big-government liberal. But the prize was not awarded for his NYT columns or his opinions on economic or foreign policy.

The Nobel is much deserved, even if Prof. Krugman’s rants have led him to stray far from his admirable trade-theory roots.

Missile Defense and the Banks

Many argue that the demand for public goods justifies government spending and taxing.  Defense spending is a classic public good. The New Times offers an interesting case study of how the federal government actually spends money on defense.

The story recounts the activities of Michael Cantrell, a Defense Department employee who turned into a lobbyist for various projects connected to the missile defense program. According to the story, Cantrell “extracted nearly $350 million for projects the Pentagon did not want, wasting taxpayer money on what would become dead-end ventures.”

Cantrell is awaiting sentencing on corruption charges related to taking kickbacks for defense contractors. But his violations of the law did not start until 2000. Much of the $350 million wasted on defense projects happened before he started taking a cut of the action.

Read the whole story. Here is my summary: Pentagon officials did not want the projects Cantrell pushed, but powerful members of Congress did support such outlays. DOD had missile ranges around the world, but Ted Stevens thought another one was needed in Alaska. Acoustics research might have been conducted many places, but Trent Lott preferred the work done by the University of Mississippi in Oxford and a Huntsville defense contractor that had a branch office in Oxford. And so on.

In other words, members were directing the DOD budget to benefit their constituents in exchange for votes on election day. “Vote for me and I will give you $1,000” is not limited to presidential elections.

Gordon Tullock once wrote of campaign finance:

It should of course be kept in mind that [campaign contributions] are not actually for the purpose of buying votes. The votes are bought by the bills passed by Congress, or the Legislature, which benefit voters. But the campaign money is used to inform the voters about what their congressman has done. Since the voters pay little attention, concentrating the message on a narrow scope and repeating it again and again is necessary even though it annoys intellectuals. On the whole it is the actual things done for the voters by the votes of their and other congressmen, which attract voters to elect those congressmen.

The Cantrell story confirms Tullock’s insight. The reporter mentions campaign finance contributions by defense contractors, but by and large, the story is one of constituent service (that is, the creation and maintenance of vote purchase schemes).

There are several interesting questions here. Can Congress actually provide public goods efficiently? Isn’t Cantrell’s story one of earmarking without the earmarks? If so, won’t the practice of earmarking continue even if Congress gets rid of earmarks? The story shows Congress in a poor light, but don’t we want the legislature to control its agents (like the Pentagon) instead of simply delegating authority to spend to them?

One final lesson. The Cantrell story shows what happens when Congress has money to spend on national defense. In coming days, the federal government may come into ownership of many banks. How do you think Congress will spend the capital of those banks?

Do Economists Count?

Jonathan Chait, a journalist who frequently attacks supply-side economics, derides Peter Robinson of National Review for making a big deal out of a statement by 100 economists (or maybe it’s only 90) warning about the dangers of Barack Obama’s plans to raise taxes and restrict international trade. Robinson may have gone a bit far in calling the statement “The Booming of the Big Guns.” As Chait says, 100 economists isn’t all that many. After all, 200 economists warned against the Wall Street bailout, and you see how much good that did.

But Chait also sneers at the quality of the economists who signed this statement opposing new burdens on production and trade. “The list certainly does not suggest excessive discrimination about credentials. It’s heavily larded with GOP apparatchiks now residing in the right-wing think tank world.” Actually, it’s not. There are maybe half a dozen who list think-tank affiliations, including people like Eric Hanushek of the Hoover Institution, who–perhaps Chait does not know–holds a Ph.D. from MIT and taught for years at the highly regarded University of Rochester econ department. And then there are five Nobel Laureates–Gary Becker, James Buchanan, Robert Mundell, Edward Prescott, and Vernon Smith.

After his snipe at “GOP apparatchiks now residing in the right-wing think tank world,” Chait says “(my favorite is “economist” George Schultz of the Hoover Institution).” OK, let’s think about that. First, it’s Shultz, not Schultz. And just who is this “GOP apparatchik George Schultz”? Well, Chait probably thinks that seven successful years as Secretary of State doesn’t qualify you as an expert on taxes and international trade. Maybe not. But Shultz also has a Ph.D. from MIT. And he taught economics for 20 years at MIT and the University of Chicago. He then served as director of OMB and Secretary of the Treasury. Qualified to comment on U.S. economic policy? I’d say so.

But if you insist on academic credentials–and 20 years at MIT and Chicago in the past doesn’t count–that still leaves you five Nobel laureates. And lots more economists of substantial accomplishment and reputation, including some who just might get a Nobel Prize one of these days, people like Robert Barro, Mike Jensen, John Taylor, Michael Boskin, Martin Feldstein, Anne Krueger, Glenn Hubbard, Burton Malkiel, Kevin Murphy, and Cato’s own Bill Niskanen. The fact is, I’ve seen a lot of petitions from economists, and this one is more top-heavy with academic credentials than most.   

It’s intriguing to note that the statement does not endorse McCain’s economic proposals, it just criticizes Obama’s. Perhaps they couldn’t get five Nobel laureates and the other accomplished economists on the list to do that.

The National Republican Trust PAC Is Wrong

I support the right of the National Republican Trust PAC to advocate any issue it wants in any way it wants. It shouldn’t even have to file reports with the government. It’s the job of the public to distinguish messages it should believe and messages it shouldn’t.

So let me help you with that now: An email being circulated by the National Republican Trust PAC is despicable and wrong.

“Obama’s Plan: Mohamed Atta Gets His Driver’s License,” it blares. [I’ve been able to find no online version to link to.] The email reads:

Did you know that Mohamed Atta, the 9/11 ring leader, had a valid Florida driver’s license?

Did you know 13 of the 19 hijackers had obtained valid driver’s licenses? Armed with these licenses, eight of the hijackers even registered to vote!

Here is the shocking fact: Obama strongly supports giving illegal aliens in America driver’s licenses.

He said as much during two Democratic debates earlier this year.

This is terror-pandering of the highest order. While it’s true that several 9/11 hijackers got driver’s licenses and other documents, this has the same relationship to the success of their attacks as the brand of shoes they wore. They could have used their Saudi passports to board flights that day, and the same people in the same circumstances could get on planes today. Even if the REAL ID Act were implemented and we all carried a national ID, terrorists would not be prevented from boarding U.S. flights.

Yet there is no reason to fear. Our protection against a subsequent 9/11-style attack is the direct security of hardened cockpit doors and the awareness and vigilance of airline crews and passengers.

If it’s true that Obama would allow illegal aliens to get driver’s licenses — by the way, it wouldn’t be his decision because driver’s licenses are issued by states — it wouldn’t affect our security against terrorism.

By all appearances, this message looks like it is designed as much to raise money for the National Republican Trust PAC as to discredit Obama. Certainly, it doesn’t bring credit to Senator John McCain. In fact, it hurts him. To folks who don’t know campaign finance law, it looks like a desperate and venal grasp by McCain for an issue against Obama.

Hyping terror threats damages our country by provoking overreeactions that can be more damaging than direct attacks themselves. This message from the National Republican Trust PAC is offensive.

The Blame Game

In the now-heated effort of D.C. policymakers and pundits to afix blame for the current financial mess, some fingers are being pointed at the Federal Reserve. The criticism: the Fed kept interest rates too low in the early 2000s, resulting in a lot of easy money. That money, in turn, created the housing bubble and subsequent collapse, ushering in the financial crisis.

Is this criticism sound?

Figure 1 shows the three-month Treasury Bill rate and the Federal funds rate over the past several years. It indicates that, yes, money was easy in the early 2000s, but not because of the Fed. The Fed was forced to reduce and maintain a low Fed funds rate in response to the market’s high price (and corresponding low interest rate) for short-maturity securities such as 3-month T-Bills.

So why were market rates so low?

Chairman Bernanke has suggested that foreign capital inflows were the true cause of easy money earlier this decade. Figure 2 shows that net international capital inflows surged beginning in 1998 and remained high thereafter. Superficially, the interest rate vs. international capital inflows correlation is not strong enough to clinch his argument. Critics could ask why interest rates did not fall until January 2001. Perhaps the answer would be that a strong U.S. economy and stock market during the late 1990s held up interest rates for a time. But then why did asset markets tank in January 2000, followed by the economy in January 2001? Some folks might respond that the Fed funds rate was unsustainably high during 2000. But we don’t really know the answer as yet.

Another question is why did market short-term interest rates increase after mid-2004 despite strong capital inflows? I don’t think anyone has a good answer for that, either.

But let’s return to the fact that the Fed had to cut its funds rate earlier this decade in order to keep pace with declining short-term market interest rates. So long as the Fed’s objective is to maintain the amount of bank reserves in circulation at a level that is just enough to achieve its non-inflationary growth objective and to do so through an interest rate targeting operation, it has no choice but to set the Fed funds rate as close as possible to short-term market interest rates. Otherwise, the Fed would risk injecting too much (or too little) liquidity into the economy — precisely what it’s now being incorrectly blamed for.

This brings us to the question of what, in light of the current crisis, the Fed should do to achieve its sometimes-conflicting objectives of maximizing non-inflationary growth and also ensuring systemic stability — that is, to avoid widespread failures among large financial institutions of the kind we have witnessed this year. The Fed appears to have no systematic approach or tools to achieve its second objective.

One possible method is stricter imposition of regulatory constraints, to prevent home price inflation from incentivizing excess and risky mortgage lending. But that approach was rejected by Fed and Treasury officials (see yesterday’s NYT). And they did that, possibly, for good short-term reasons: a buoyant asset sector returns political dividends, but the systemic problems happen on someone else’s watch. Or, more charitably, Fed officials may have genuinely believed that financial innovations (such as dynamic hedging) meant that the risks were spread so broadly that they didn’t matter anymore.

Another possibility is for the Fed to incorporate asset prices in its measure(s) of price stability — that is, include home and stock prices instead of just consumer goods when trying to determine if inflation is occurring. Doing so could lead the Fed to implement pre-emptive monetary strikes against perceived systemic risks in order to avoid an asset inflation party. That would be consistent with the definition of the Fed’s role (take away the punch-bowl just before the party really gets going), but it may not be any less “socialist.” Fed officials have now acknowledged that they are studying this issue and the jury is still out on it.

However, now we are paying the price for the lack of a proper market-oriented governance framework for dealing with systemic instability — by gravitating toward direct socialist control of the financial sector in an unproductively panicked manner.