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Politicizing the Economy:

Tyler Cowen has an important column in today's NYT. It begins:

FOR years now, many businesses and individuals in the United States have been relying on the power of government, rather than competition in the marketplace, to increase their wealth. This is politicization of the economy. It made the financial crisis much worse, and the trend is accelerating.

Well before the financial crisis erupted, policy makers treated homeowners as a protected political class and gave mortgage-backed securities privileged regulatory treatment. Furthermore, they allowed and encouraged high leverage and the expectation of bailouts for creditors, which had been practiced numerous times, including the precedent of Long-Term Capital Management in 1998. Without these mistakes, the economy would not have been so invested in leverage and real estate and the financial crisis would have been much milder.

But we are now injecting politics ever more deeply into the American economy, whether it be in finance or in sectors like health care. Not only have we failed to learn from our mistakes, but also we're repeating them on an ever-larger scale.

Read the whole thing.

MCM (mail):
A good column, even if I rolled my eyes at the Atlas Shrugged reference.
9.13.2009 10:26am
Richard Riley (mail):
Tyler Cowen's warning against politicization of the economny is a fair in a general sense. But isn't the course of the Great Depression a great honking counterexample? Currently, fingers crossed, the economy has at least reached the bottom of the abyss and it may be climbing back. That's about 21 months after the official start of the current recession, and 12 months after Lehman tipped the recession into a crisis. In contrast, during 1929 through 1933, an era when by any measure the government's involvement in the economy was much less, the economy stayed in virtual free fall for 3 1/2 years. If anything, wouldn't Cowen's argument mean that we should be in worse shape now than in, say, late 1931? And isn't that demonstrably untrue?

Yes, I know VC contributors among others have been among those claiming that both Hoover's and Roosevelt's response to the 1929 crash made the ensuing depression much worse. I don't see it, but leaving that larger argument aside, isn't it undeniable that, whatever Hoover did, it certainly involved enormously LESS government meddling in the economy than what we have now?

That seems so clear to me that arguments like Cowen's almost have to be driven by sentiment rather than facts.
9.13.2009 10:33am
PeteP:
Our current administration was elected on several main points ;

1 ) Hatred of George Bush
2 ) Along came this very unusual black man - young, clean-cut, well-dressed, well-educated, well-spoken, charismatic, making vague camelot-esque promises of 'Change'.

Once in - he has permeated his administration with more of the same - impressive clean-cut well-educated black Chicago-ites like himself. Valerie jareet, Eric Holder, Van Jones, et al.

Unfortunately, he ( and they ) happen to be extremist left-wing radicals, hateful of the very system that allowed them such impressive success as they have all enjoyed, determined to remake America in their own vision, modeled after of Social Democrat Eruope.

Unfortunately, the only thing our President has proven himself exceptionaly good at is winning elections. In fact, he's only lost one in his life - to Bobby Rush - a Founder of the Black Panthers, convicted felon ( illegal possesion of several handguns, among other charges ) who now sits in Congress and introduces legislation to ban handguns.

He follows people like Jeremiah Wright, Van Jones, Saul Alinsky, Bill Ayers, etc. He believes as they do.

But now, he does not follow them - he leads them. And us.

Straight off the cliff to our left. When anyone complains, they are called 'closet racists'.

The Republicans can not offer a viable alternative, because they have proven themselves equally as corrupt, immoral, fungible to the winds of personal profit and comfort, inept, and short-sighted.

From this basis, how is ANYTHING not going to be 'politicized '?
9.13.2009 11:02am
Daniel Chapman (mail):
I couldn't even get through the 3 paragraph summary without thinking of the line "Economy of Pull." I think Atlas Shrugged references will be getting less eye-rolls in the days to come.
9.13.2009 11:11am
Cornellian (mail):
Unfortunately, he ( and they ) happen to be extremist left-wing radicals, hateful of the very system that allowed them such impressive success as they have all enjoyed, determined to remake America in their own vision, modeled after of Social Democrat Eruope.

So some country like Norway or France is run by "extremist left-wing radicals?" Do you aspire to be taken seriously?
9.13.2009 11:16am
Kevin P. (mail):

Richard Riley:
In contrast, during 1929 through 1933, an era when by any measure the government's involvement in the economy was much less...


Before you state that the Great Depression was some magical period where the government helped the country out, you need to do a lot more reading. There is plenty of evidence that the New Deal made the Great Depression worse and last much longer.

Start with:
National Recovery Administration

FDR's policies prolonged Depression by 7 years, UCLA economists calculate
9.13.2009 11:19am
Kevin P. (mail):
Daniel Chapman, have you read Atlas Shrugged?
9.13.2009 11:20am
MarkField (mail):
Barry Ritholz comments on Cowen's column here.
9.13.2009 11:21am
Richard Riley (mail):
Kevin P., I'm saying nothing of the sort. You just assume I am shilling for the New Deal which is (a) incorrect and hence (b) annoying.

I'm not claiming that the Great Depression was "solved" by the New Deal or any other government action. What I AM saying is that if government action in the economy just makes things worse as Tyler Cowen claims, then isn't the Great Depression during 1929 through 1933 (that is, before FDR's election) at least an example that things can get pretty damn bad WITHOUT significant government action? Yes, I know Hoover tried a few half-hearted measures like the Reconstruction Finance Corporation, but by any measure the government's involvement in the economy during every point in the Hoover administration was much, much less than it is now.

So I WOULD ask you and Tyler Cowen, why didn't things get better quicker during 1929-1933 than during the current recession, if you're so insistent that government keeping its paws off the economy is always and everywhere the right policy?
9.13.2009 11:33am
James T:
i for one would welcome some more of those Hoover-villes. They had a rustic charm to them; much tastier than my bailout cheese wheel that I would get today.
9.13.2009 11:38am
David Welker (www):
My objection to Cowen is the following:


Furthermore, they allowed and encouraged high leverage and the expectation of bailouts for creditors, which had been practiced numerous times, including the precedent of Long-Term Capital Management in 1998. Without these mistakes, the economy would not have been so invested in leverage and real estate and the financial crisis would have been much milder.


Once again, we have an economist assuming that which must be proven. I do not think one can just automatically assume that moral hazard is going to be a huge issue. Also, people are certainly quite capable of making huge mistakes with their money even in the absence of moral hazard. The bottom-line is that I don't think it is acceptable to make this assertion without evidence.
9.13.2009 11:48am
Pro Natura (mail):
Richard Riley
isn't the Great Depression during 1929 through 1933 (that is, before FDR's election) at least an example that things can get pretty damn bad WITHOUT significant government action?
You seem to be unfamiliar with the Smoot-Hawley tariff and Milton Friedman's work relating ections of the Federal Reserve to the onset of the Great Depression. Both these are perfect examples of special interest groups getting "favorable" political outcomes that end up devastating the economy.

The Obamessiah and his Obamanuts are already following this familiar game plan with disastrous "bailouts" of politically powerful financial institutions, protective tariffs for the tire industry, and plans to impose "green house" tariffs on all sorts of goods. I'm unsure whether it was Sarkohzy or the Obamessiah who first mentioned this toxic idea, but both are now promoting it.
9.13.2009 11:55am
Allan Walstad (mail):

...whatever Hoover did, it certainly involved enormously LESS government meddling in the economy than what we have now?

Well, that's pretty scary. The story that Hoover fiddled while the economy burned, and FDR's idiotic meddling somehow fixed it all, is one of those debilitating myths that stand like a brick wall in the way of our learning from past mistakes and making better decisions now.

Cowen is right. Unfortunately, the country is hooked on government intervention much as an addict is hooked on a harmful drug. The worse things get, the more intense the need for another hit--which will make things worse.

By the way, the housing crisis is an interesting example of Austrian business cycle theory, in which inflationary policy causes an unsustainable boom by stimulating long-term capital investments that cannot be maintained. Buying a home plays the role of a long-term capital investment for individuals and families. When the Fed drove interests rates to near-zero levels, it made it appear that people could afford homes that they really could not. When interest rates recovered, those investments had to be liquidated. Fannie Mae and Freddie Mac also played their well-known roles, from the lenders' end, in making the loans appear safe. Government intervention to prevent the housing market from sorting out naturally can only cause further misallocation of resources and more trouble later on.
9.13.2009 11:56am
Brett Bellmore:
It's only a mistake, if the people making the decision don't want the end result. A smaller economy, but one where the political class have hugely more clout, and so rake in a much larger fraction of the smaller gross, is not self-evidently something political decision makers will find undesirable.
9.13.2009 11:57am
David Welker (www):
Another failure in the Cowen column:


Finance and health care are two separate issues, of course, but in both cases we're making the common mistake of digging in durable political protections for special interest groups.


As if durable political protections for special interest groups in healthcare don't already exist.

As if such protections won't always exist.

What Cowen needs to do is read the Federalist Papers #10 and realize the special interests aka factions, who have always sought and achieved more or less durable political protections, have always existed and will always exist.

Libertarian wisdom apparently consists of forgetting that which was well-known in the past and thinking that one has discovered an alarming new problem.
9.13.2009 11:59am
pot meet kettle (mail):

When anyone complains, they are called 'closet racists'.


I would never call you a closet racist.
9.13.2009 12:07pm
David Welker (www):
On the issue of whether the New Deal caused the Great Depression, anyone interested in intelligent analysis, as opposed to what we have seen in the comments on this topic thus far, check out this short blog post by Nobel-Prize winning economist Paul Krugman on that topic.
9.13.2009 12:10pm
Kevin P. (mail):
Dang, David Welker, your sense of irony is so subtle that it escapes even yourself. Intelligent analysis and Paul Krugman in the same sentence... And he's a Nobel-Prize winner, of course, thereby above reproach.
9.13.2009 12:14pm
Fraggle Rock (mail):
Well, he's no Yasser Arafat.....
9.13.2009 12:30pm
David M. Nieporent (www):
On the issue of whether the New Deal caused the Great Depression, anyone interested in intelligent analysis, as opposed to what we have seen in the comments on this topic thus far, check out this short blog post by Nobel-Prize winning economist Paul Krugman on that topic.
Of course, nobody claimed that the New Deal caused the Great Depression, since the Great Depression predated the New Deal; the claim was that the New Deal prolonged and/or worsened the Great Depression.

And that "short blog post" has nothing whatsoever to do with the cause of the Great Depression at all, but with whether the Great Society was Keynesian.
9.13.2009 12:33pm
ShelbyC:

...check out this short blog post by Nobel-Prize winning economist Paul Krugman on that topic.


Maybe after that we can look to some writings on peace in the middle east by Nobel Peace Prize winner Yasser Arafat.
9.13.2009 12:34pm
ShelbyC:
Whoops, sorry Fraggle.
9.13.2009 12:35pm
devil's advocate (mail):
MCM

even if I rolled my eyes at the Atlas Shrugged reference.


look, it might be melodramatic but nobody better captures the problem of government capture than Wesley Mouch. To cite Atlas Shrugged as an overall crystal ball foretelling us slouching into socialism might be a bit trite. And I think the philosphy of objectivism is ironically shot-through with hero worship, but in this context, the citation is most highly appropriate.


David Welker

Libertarian wisdom apparently consists of forgetting that which was well-known in the past and thinking that one has discovered an alarming new problem.


I don't view this column as saying this kind of thing has not existed in the past. He's talking about direction of change and extent. Just because the founders were inured too the constant problem of faction -- and it certainly operated at the state level back then, see Shay's rebellion -- doesn't mean they felt the republic need always be at its mercy, e.g.:



. . . the majority, having such coexistent passion or interest, must be rendered, by their number and local situation, unable to concert and carry into effect schemes of oppression. . .
publius



This they saw as the job of republican government. So for Cowan to put his intellectual oar in the water at this moment seems propitious if what he advocates he nonetheless admits is a tall order.

Brian
, one stop shopping for corporate hand outs.
9.13.2009 12:39pm
David Welker (www):
Here is the correct link to the relevant Krugman blog post.

And if it matters, David Nieporent is correct that the argument on the table is that the New Deal made the Great Depression worse, not that it caused it.

The point stands. For actual intelligent commentary on this issue, check out the Krugman blog post linked to above. The original link was incorrect.
9.13.2009 12:50pm
David Welker (www):

I don't view this column as saying this kind of thing has not existed in the past. He's talking about direction of change and extent.


Is he? Okay. So, lets see. The healthcare industry is going from having enormous vested interest in the status quo to having enormous vested interest in the status quo.

That sounds really different!

Your point about magnitude sounds reasonable. But when you think about it, its not a significant argument. The burden is on you to explain how the new durable political interests that arise as a result of reform are so much different and worse than the ones that currently exist.


Just because the founders were inured too the constant problem of faction -- and it certainly operated at the state level back then, see Shay's rebellion -- doesn't mean they felt the republic need always be at its mercy, e.g.:


Is Tyler Cowen's thesis is not that some extreme and absurd claim that reform will leave us at the mercy of special interests. His thesis is that special interests will achieve "durable political protections."

So, I agree that the founders did not expect to be at the mercy of special interests. But who cares. That isn't a concern either then nor now.

As far as "durable political protections" being written into the political process by special interests, one only need to think about the Constitution itself to see that special protections for factions were established from the very beginning.

Look, I am all for limiting "durable political protections" for special interests. But that has nothing to do with healthcare reform. A much more effective route to deal with that issue would be to focus on procedural matters. For example, eliminating the filibuster in the Senate would make "durable political protections" less durable.
9.13.2009 1:05pm
David Welker (www):

Dang, David Welker, your sense of irony is so subtle that it escapes even yourself. Intelligent analysis and Paul Krugman in the same sentence... And he's a Nobel-Prize winner, of course, thereby above reproach.


First, you say that you think Paul Krugman is not capable of intelligent analysis. That assertion, I think, is a sign that you are unable to recognize intelligent analysis.

Second, you assert, without evidence, that I said or implied that Paul Krugman was above reproach. I said no such thing. Although, given that the term "reproach" tends to be directed at individuals and not arguments, I would suggest that it may be more productive to focus relatively more attention on substantive arguments rather than absurdly attacking, as you do, Paul Krugman's ability to produce intelligent analysis.
9.13.2009 1:12pm
David Welker (www):

Maybe after that we can look to some writings on peace in the middle east by Nobel Peace Prize winner Yasser Arafat.


Obviously, Yasser Arafa wasn't awarded the Nobel Peace Prize for his intellectual accomplishments. Also, he shared this prize with negotiators on the Isreali side.

Nice job bringing up an intellectually irrelevant point out of pure emotion.
9.13.2009 1:19pm
Smith,A:
"Politicizing the Economy"

Given that political economy, has been around for four centuries, with Adam Smith as one of its leading lights, this redux seems rather shallow.
9.13.2009 1:38pm
Pon Raul's Son Pand Raul:
OK David Welker, I will take the bait. Krugman's argument is that 20% wage reductions across the board would not have increased employment because that would be 20% less cash flow. This argument is easily debunked because without fixed wages, not everyone would have a reduction. Some people would stay the same or decrease less or maybe even increase. This would mean that the marginal worker would be employed at wage X-2 because he could bring in X-1, where at a fixed wage of X, the worker would lose the employer 1. The fact that Krugman makes this argument shows that he either is 1) dishonest or 2) not really all that good at economics. My guess is that he is dishonest.
9.13.2009 1:44pm
David Welker (www):
Pon Raul's Son Pand Raul:

First, your ad hominen attack on Paul Krugman is unhelpful and lowers your credibiiity.

Second, feel free to elaborate on your point and exactly why you think it is so devestating to Krugman's argument. I don't see it.
9.13.2009 1:55pm
David Welker (www):

Given that political economy, has been around for four centuries, with Adam Smith as one of its leading lights, this redux seems rather shallow.


Yes, I think shallow is a very good word for this op-ed. I will give Cowen a little break, because of the word limits. But really, given those limits, he probably should try to make columns that have a limit more depth and less breadth.
9.13.2009 1:58pm
anonn:
Why hasn't anyone learned to just ignore Welker, so hopefully he'll go away.
9.13.2009 2:00pm
David Welker (www):

Why hasn't anyone learned to just ignore Welker, so hopefully he'll go away.


Awww... you poor thing. You can't stand someone with a different opinion, can you?
9.13.2009 2:03pm
juris_imprudent (mail):
Richard Riley

What I AM saying is that if government action in the economy just makes things worse as Tyler Cowen claims, then isn't the Great Depression during 1929 through 1933 (that is, before FDR's election) at least an example that things can get pretty damn bad WITHOUT significant government action?

Your error is in not looking at the govt actions PRIOR to the GD that caused and/or exacerbated it. Smoot-Hawley and gold fetishism, not to mention the terms of the Treaty of Versailles are all things that govt['s] did that brought on the world wide crisis. What the govt did AFTER is not the lesson here.
9.13.2009 2:03pm
juris_imprudent (mail):
First, you say that you think Paul Krugman is not capable of intelligent analysis.

The problem is you aren't citing the intelligent work that Krugman was recognized for with the Nobel. You are instead citing his idiocy that is supposedly credible because he once did some good [unrelated] work. Think of it like Pauling and his nonsense on vitamin C.
9.13.2009 2:10pm
Off Kilter (mail):
Tyler is clearly right. The problem is worsening and the speed at which it's worsening is increasing. Jeff Hummel's prediction of a federal debt default sometime between 2017 and 2037 sounds more and more likely. We're circling the drain, gentlemen, and the vortex moves faster as it gets closer to the center...
9.13.2009 2:23pm
Mark N. (www):
The problem is that it's not clear how to make finance have no politicization. For centuries there's been an implicit guarantee that in major financial crises, the government will do something to help out. This produces obvious moral hazard. It's also not clear how to even partially remove the implicit guarantee, even if explicit state involvement is removed.

As for what to do about it, The Economist has a decent high-level proposal.
9.13.2009 2:24pm
David Welker (www):

For centuries there's been an implicit guarantee that in major financial crises, the government will do something to help out. This produces obvious moral hazard.


Really?

Again, I am afraid that abstract concepts like "moral hazard" applied to hypothetical situations are no substitution for facts which exist in the real world.

For example, one of the institutions that was bailed out was Bear Stearns.

It's stock, which was once trading at more than $150 per share was ultimately bought by JP Morgan for $10 a share as a result of being bailed out. Is it really "obvious" that this is a major "moral hazard" issue where shareholders are going to ignore reckless behavior by management because bailouts do not impose enough costs? I think most investors would be somewhat unhappy with the value of something they own losing more than 90% of its value.

The more significant problem with financial institutions is probably not moral hazard. Shareholders suffer big time when they are "rescued." Often, bondholders also suffer in a big way.

No, the more significant issue is NOT moral hazard but rather the misalignment of incentives between management and other stakeholders and the long-term interest of financial and other firms.
9.13.2009 2:46pm
traveler496:
My gut feel is that much of Cowan's basic thesis is correct, but part of me is left wishing he had said more about the "too big to fail" issue. He says

We've created a class of politically protected "too big to fail" institutions, and the current proposals for regulatory reform further cement this notion.

Does Cowan believe that if government had avoided overly politicizing business, there would be no institutions so big and systemically interconnected that their failure would risk unacceptable impacts to the economy? That such institutions would exist, but wouldn't fail? That they would exist and sometimes fail, but that there are better, unstated, ways to manage the resulting impacts? That they would exist and sometimes fail with big impacts, but hey that's life and at least the impacts would be less than those we can expect w/ the current overly-politicized approach?
9.13.2009 3:07pm
Lee A. Arnold (mail) (www):
Many things MUST become "too big to fail." Politicization is an effect from this, not a primary cause of it.

The primary cause is that economic growth increasingly requires size, monopolistic competition and/or oligopoly. This is a basic lesson of modern growth theory. Economic growth requires increasing returns, and requires innovations in very complex technologies. These are frequently accomplished ONLY by oligopolies and by monopolistic competition. If you inhibit these, you are going to decelerate economic growth. In many cases, a very small number of firms is able to meet consumer demand MOST efficiently -- and also, ONLY these firms have enough market power to compete with overseas firms, if we intend to keep trade open.

This concentration makes "market discipline" problematic. Markets sometimes make adjustments in these only by bringing down the whole house of cards.

Finance: Without a financial bailout, the credit markets would have frozen up, bringing the economy to a screeching halt, no payrolls, no mortgages, people out on the street without a job.

Healthcare: Here, we require a monopsony. The cost is growing, due to demographics and innovation, but in fact the demand is not infinite, far from it: the demand is completely predictable, now and in the future.

We are arguing over how to pay for it. But individuals cannot pay for their own healthcare because the cost growth is outstripping the return on investment securities. So the idea of risk-sharing for the inevitable hospitalization of nearly everybody is a sham, it could never add up: and in reality the proposed mandate is a generational transfer, like Social Security. (Only with private insurers draining-off about 20% of the money.)

We should just nationalize it and give everybody what they need. You and I really don't care about making sure that we each have big screen TVs, but we feel it in our hearts when people don't get medical attention. That makes it a kind of public good. It won't hurt anything. The Defense Department hasn't stopped innovation in weapons.
9.13.2009 3:31pm
Soronel Haetir (mail):

That they would exist and sometimes fail with big impacts, but hey that's life and at least the impacts would be less than those we can expect w/ the current overly-politicized approach?


This is certainly what I would prefer. Eventually I see the current approach reaching a point where no more political fixes are possible. When that happens the reckoning is going to be incredibly painful. Much better to have regular smaller failures.
9.13.2009 3:33pm
Richard Riley (mail):
A couple of commenters above are right - the Tariff Act of 1930 (Smoot-Hawley) was certainly enacted during the Hoover administration, and represents government action that made the Depression worse worldwide.
9.13.2009 4:07pm
devil's advocate (mail):
David Welker


The healthcare industry is going from having enormous vested interest in the status quo to having enormous vested interest in the status quo.


It isn't their factional capture that's changing, the status quo is changing to give them millions more forced customers with government subsidies.

So the lefties figure the way to stop this corporate rent seeking is just to have government take it over. Whereas Cowen says don't mandate that people do business with these clowns.

Brian
9.13.2009 4:48pm
Ariel:
David Welker,

You can't rightly complain of an ad hominem to Paul Krugman when you bring his credentials as the main reason to believe he is right, as opposed to, say, Milton Friedman. While you're discussing Krugman's qualifications as a way to evaluate the credibility of what he says, it's perfectly relevant to bring up the lack of credibility of those qualifications. It's also relevant to bring up that Krugman is a former Enron adviser, to assist in evaluating his credibility.
9.13.2009 4:55pm
juris_imprudent (mail):
Lee Arnold, I hardly know where to begin, but first let me say that your economic illiteracy is indeed impressive.

This is a basic lesson of modern growth theory.

Really? According to whom?

But individuals cannot pay for their own healthcare

Uh, then who IS supposed to pay for it? I should pay for my routine stuff and have insurance against the risk of the exceptional. My health insurance shouldn't be tied to employment any more than my car or home insurance is. It is because of existing GOVT policy - not a dictate (or failure) of the market.

We should just nationalize it and give everybody what they need.

Yes, that is bound to work. Say, why haven't we tried that with food - it is certainly as essential as health care, no?

That makes it a kind of public good.

Nope, but it's nice you feel that way.
9.13.2009 6:10pm
Lee A. Arnold (mail) (www):
Juris_imprudent,

"According to whom?"

-- Solow, Arrow, Lucas, Paul Romer. Starts with Marshall and Schumpeter, of course.

"I should pay for my routine stuff and have insurance against the risk of the exceptional."

-- You mean you don't ALREADY? Or are you in the top quintile?

"why haven't we tried that with food"

-- Because the unit price of food products means we don't need to.

Public goods are non-rivalrous and non-excludable. That would fit the definition of the utility in individual knowledge that everyone is receiving adequate medical attention. And that would strictly fit the definition of a public good. But I knew you weren't economically literate at the modern growth theory question!
9.13.2009 6:37pm
ArthurKirkland:

FOR years now, many businesses and individuals in the United States have been relying on the power of government, rather than competition in the marketplace, to increase their wealth. This is politicization of the economy. It made the financial crisis much worse

I haven't read the entire column (or the comments), but if the author, as seems obvious, is decrying poorly overseen no-bid contracts funneling untold billions to politically connected insiders (Iraq, Afghanistan, District of New Jersey consent decrees), I believe we can safely say the crisis has passed.
9.13.2009 7:15pm
scattergood:
My reading of the article is that Tyler assumes that in ANY economic system there is a basis or mechanism for competition and the allocation of resources. In capitalism, the pure theoretical form, the basis of competition and resource allocation is the competitive ability of private firms and individual to create productive and useful products and services.

However, now, in Tyler's opinion, the competitive basis for the distribution and allocation of resources is and will continue to be political favoritism. He points to the growing size of the largest banks that have received significant political favors as an example. He theorizes that health care firms currently rely on political favoritism to protect their sales and distribution channels, and guarantee them customers, and that 'reform' of this industry only looks like more of the same.
9.13.2009 8:52pm
Bart (mail):
Politicization of the economy? Wasn't that formerly called socialism?
9.13.2009 9:08pm
ShelbyC:

Politicization of the economy? Wasn't that formerly called socialism?


Only when someone else does it.
9.13.2009 9:24pm
Ricardo (mail):
In contrast, during 1929 through 1933, an era when by any measure the government's involvement in the economy was much less, the economy stayed in virtual free fall for 3 1/2 years.

Whenever I see statements like this, it always brings up the question of how exactly to measure "government's involvement in the economy." What matters isn't some index of overall government intervention but rather the details of specific government policies.

Others have alluded to Friedman and Schwartz's work and that is a good starting point. There were several interventions at work in 1929 through 1933:

1. The Fed sharply increased the discount rate in 1931 in order to protect the dollar exchange rate when it should, in fact, have been aggressively cutting rates as the Fed did now.
2. The Fed was relatively new and inexperienced in this period and had replaced a system of clearinghouse banks, emergency currency issue and private lenders of last resort that served as a clunky but still potentially effective way to manage financial crises. That isn't to say we should abolish the Fed today: rather it's saying the Fed may have done worse in 1929-1933 than no Fed.
3. Restrictions on interstate branch banking made bank runs much worse. Many banks that failed in the Great Depression in fact had only one branch which meant they had no way to manage this risk. Bank runs were arguably what would have been a nasty recession into the Great Depression (see Ben Bernanke's academic work for more on this).
9.13.2009 10:06pm
Ricardo (mail):
No, the more significant issue is NOT moral hazard but rather the misalignment of incentives between management and other stakeholders and the long-term interest of financial and other firms.

David Welker, the "misalignment of incentives" you speak of often goes by the term "moral hazard" in the economics profession. There is still moral hazard but you are right that it is on the part of traders and managers rather than shareholders.
9.13.2009 10:15pm
Pon Raul's Son Pand Raul:
David Wanker,

That was not an ad hominen. It was a direct attack of his logic followed up with a conclusion that he is stupid and/or dishonest. That might be rude, but it is not an ad hominen. Maybe you should look things up before you write something that makes you look so completely dumb.
9.13.2009 11:40pm
http://volokh.com/?exclude=davidb :

Read the whole thing.

The bold (literally) exhortation to educate ourselves in a way you see fit -- well, it's just really annoying.
9.14.2009 12:18am
http://volokh.com/?exclude=davidb :
Sure hope I spelled "exhortation" right.
9.14.2009 12:18am
David Welker (www):
Ricardo,

While the phrase "moral hazard" always refers to a problem of of misaligned of incentives, not all misaligned incentives should be referred to using the phrase "moral hazard." Instead, I think the phrase is most applicable when the misalignment of incentives is caused by insurance, in whatever form.

So, people think of bailouts of firms "too big to fail" as a sort of insurance, and then worry that these firms will take greater risks than justified because they do not face the full consequences of failure. That is why the term moral hazard is usually used in this context.

Management has different incentives than shareholders not primarily because of insurance or bailouts, but because their compensation is not sufficiently tied to the long-term well-being of the companies they manage, and even more perversely is often tied to the short-term in such a way that it may make sense to sacrifice long-term company interests for short-term gains that increase compensation immediately. Since this misalignment of incentives is not caused by insurance, I would not use the phrase "moral hazard" to refer to it.

Ultimately, the important point is not whether we use the term "moral hazard" to refer to this particular misalignment of incentives between managers and shareholders or not. The important point is that this sort of misalignment of incentives is not caused by bailouts, but rather flawed compensation systems.
9.14.2009 12:28am
Leo Marvin (mail):
Pon Raul's Son Pand Raul:

David Wanker,

That was not an ad hominen. It was a direct attack of his logic [...]

I suppose "David Wanker" isn't an ad hominem because it's a direct attack on his wanking?
9.14.2009 12:34am
ShelbyC:

I haven't read the entire column (or the comments), but if the author, as seems obvious, is decrying poorly overseen no-bid contracts funneling untold billions to politically connected insiders (Iraq, Afghanistan, District of New Jersey consent decrees), I believe we can safely say the crisis has passed.


You're half right. This is a funny comment. The first half seems to be suggesting (correctly) that many folks are blind to the politicization of the economy when it's their guy that's doing it. The second half seems to be suggesting that you're one of them.
9.14.2009 12:53am
Ricardo (mail):
Ultimately, the important point is not whether we use the term "moral hazard" to refer to this particular misalignment of incentives between managers and shareholders or not. The important point is that this sort of misalignment of incentives is not caused by bailouts, but rather flawed compensation systems.

If we are going to use jargon terms, we might as well use them correctly. Insurance is the typical example used in discussions of moral hazard but the concept goes beyond insurance markets. See the literature on credit markets under incomplete information or the corporate governance literature, for instance.

In any case, though, as I scroll back, Tyler's original point was "Furthermore, they allowed and encouraged high leverage and the expectation of bailouts for creditors, which had been practiced numerous times, including the precedent of Long-Term Capital Management in 1998." So first, it's the combination of policies that allowed and encouraged high leverage and the expectation of bailouts for creditors, not just one of these in isolation. Second, government effectively bailed out LCTM's creditors in 1998 and then bailed out creditors in the current crisis using actual government money. These are facts. Do you believe that creditors were too dense to form this expectation of a bailout in their minds in advance? Or are you claiming they had this expectation but that it didn't affect the perceived credit risk or risk premium attached to their counterparties?
9.14.2009 1:22am
David Welker (www):

Do you believe that creditors were too dense to form this expectation of a bailout in their minds in advance? Or are you claiming they had this expectation but that it didn't affect the perceived credit risk or risk premium attached to their counterparties?


What I believe is that we need empirical evidence regarding investor beliefs to answer this question, not merely theory.

Creditors in Lehman Brother's found out in a very painful way that no bailout would occur. So, I think investors assuming that bondholders will never suffer in bailouts would be highly irrational. Also, lets not forget what happened to GM bondholders.

Furthermore, I simply don't think that we can realistically expect creditors, who are, after all, very busy people, to exercise perfect monitoring of financial and other institutions, especially when they take modern advice with respect to diversification.

Does it really make sense to worry about moral hazard in the context of creditors with diversified portfolios? The whole idea behind the strategy of diversification is to relieve an investor of having to know everything about the institutions that make use of their funds. Instead, there is a reliance on credit rating agencies and diversification.

It seems to me that the issue of moral hazard is less important in a context where investors in either stocks or bonds pursue a diversification strategy. Such investors--and diversification is an extremely common investment strategy--are not going to effectively monitor specific companies. Moral hazard or not.

I think a bigger issue is the corruption in the credit rating agencies which caused them to fail to reliably rate the risk of investments.

Overall, I think the excessive focus on the moral hazard caused by bailouts is an example of moving too far away from actual institutional contexts and too far away from an examination of actual investor behavior.
9.14.2009 2:14am
juris_imprudent (mail):
Solow, Arrow, Lucas, Paul Romer. Starts with Marshall and Schumpeter, of course.

Can't say that I've read every word that everyone of them has written, but I certainly do not recall any significant part of them saying that growth required monopoly or oligopoly as you assert. So, I still call bullshit.

You mean you don't ALREADY? Or are you in the top quintile?

No, it means I have a generous health 'insurance' plan through my employer, although I am in the top quintile thank you very much. That doesn't change that I think the system could be structured differently, just as you do - though in the opposite way.

Your assertion that nationalization and GIVING everyone what they need is the only workable solution is not addressed. Nor do you identify who will pay if not individuals, though you seem to imply that if the govt pays for it somehow we aren't.

Because the unit price of food products means we don't need to.

If health care is essential to our well being, how can food not be? How can the market be trusted to deliver the proper quantity of quality food to people without massive/total govt control? Unit price is irrelevant to the moral calculus you rely on.
9.14.2009 2:33am
Ricardo (mail):
David, I think the reason you are getting hung up on Tyler Cowen talking about moral hazard is that you read it as an argument against bailouts while I read it as an argument for better supervision and regulation of investment banks. Not to mention a warning against the government lavishing money or other favors on financial institutions upon hearing them cry uncle.

The most important creditors for investment banks (and hedge funds like LTCM) are not the bond-holding public but... other investment banks. You are right that there is an empirical question here -- since I haven't seen any actual evidence on the beliefs of investment bankers who made these credit decision, I fall back on the fact that creditors were bailed out in 1998 and then were mostly bailed out again in 2008. Tyler Cowen would hardly disagree that finance firms made stupid decisions for reasons other than future expectations of a bailout, though. Just that it is a factor along with inadequate supervision or oversight.
9.14.2009 3:10am
Ricardo (mail):
Can't say that I've read every word that everyone of them has written, but I certainly do not recall any significant part of them saying that growth required monopoly or oligopoly as you assert. So, I still call bullshit.

juris_imprudent, you should familiarize yourself at least with the basic Romer growth model (a staple of modern growth theory) before calling others economically illiterate. This model assumes that technology is what drives growth and that technology in turn comes from monopolistic firms who develop new technology with the guarantee that they will be able to exploit that technology for monopoly profits. Think of the drug companies: most innovation in pharmaceuticals comes from large firms that patent their innovations and exploit the patents for profits, making the innovation profitable in the first place. As the argument goes, without monopoly profits (via patents or some other institution) there is less innovation. Modern growth theory assumes the origin of economic growth is in innovation (rather than capital accumulation, as the simple Solow growth model has it).

This much is really not in dispute at the level of theory. You can disagree with the theory as it applies to reality and certainly disagree with Lee Arnold's use of the theory to reach his conclusions but not with what the theory plainly states as you can find in any economics textbook.
9.14.2009 3:19am
Lee A. Arnold (mail) (www):
Juris-imprudent, Please read more carefully. Growth requires increasing returns and innovations in complex technologies. If you have any -- ANY -- empirical evidence or theoretical proof that this doesn't lead to "monopolistic competition" or shouldn't have to lead to it, please bring it forward. I'm pretty sure we could get the economists to tune in.

Also explain why everyone in the quintiles under you doesn't have a health-plan like yours, and what they should do to get it! We're all ears.

I don't think nationalization is the only workable solution nor did I write that, either. In fact I would prefer a two-tier system like Australia, where everyone carries a tax-paid public coverage, and about half the population also chooses to buy additional private coverage.

Unit price may be irrelevant to the moral calculus YOU rely upon, but to me it determines how well the people at lower levels of the distribution of income can satisfy their necessary demand for medical care -- and if the unit prices of medical care were as low as that of food, we certainly wouldn't be having this discussion.
9.14.2009 11:55am
Lee A. Arnold (mail) (www):
Juris-imprudent, Please read more carefully. Growth requires increasing returns and innovations in complex technologies. If you have any -- ANY -- empirical evidence or theoretical proof that this doesn't lead to "monopolistic competition" or shouldn't have to lead to it, please bring it forward. I'm pretty sure we could get the economists to tune in.

Also explain why everyone in the quintiles under you doesn't have a health-plan like yours, and what they should do to get it! We're all ears.

I don't think nationalization is the only workable solution nor did I write that, either. In fact I would prefer a two-tier system like Australia, where everyone carries a tax-paid public coverage, and about half the population also chooses to buy additional private coverage.

Unit price may be irrelevant to the moral calculus YOU rely upon, but to me it determines how well the people at lower levels of the distribution of income can satisfy their necessary demand for medical care -- and if the unit prices of medical care were as low as that of food, we certainly wouldn't be having this discussion.
9.14.2009 11:55am
Brian G (mail) (www):
The economy has been subject to political influences as far back as the dark times of George Bush II. To reward his political benefactors, King George II wrecked the economy in order to make his fat cat pals at Haliburton and Big Oil filthy rich.

Obama, through the sheer force of his brilliance and endearing personality, will resuce the economy and us from the devestation wrought by King George II.
9.14.2009 3:26pm
liberty (mail) (www):
"whatever Hoover did, it certainly involved enormously LESS government meddling in the economy than what we have now?"

"more" and "less" are impossible to even define, let alone measure. Hoover fixed wages across much of the economy, and practically ended all foreign trade (which was a larger segment of the national income at the time), and he did this all very fast.

What we have today is a tanglework of regulations, but most of which we are used to, and few of which actually fix wages or prices by command (though many prop them up or press them down through subsidy or protection), and we allow trade, which provides flexibility as well.


"Growth requires increasing returns and innovations in complex technologies. If you have any -- ANY -- empirical evidence or theoretical proof that this doesn't lead to "monopolistic competition" or shouldn't have to lead to it, please bring it forward. I'm pretty sure we could get the economists to tune in. "

It depends upon what you mean by monopolistic competition--most economists working in organization theory and antitrust have long since abandoned any belief in perfect competition, or that these other forms are "imperfect" and need fixing or regulating by government, let alone nationalization.

This *was* the belief from about the 1930s through the 1960s, though. Also, you might look at some Galbraith from the 1960s, check out his predictions along these lines (also the Marxists from several decades earlier), you'll see that the only companies that exist today are U.S. Steel, Kraft, RCA, Coca-Cola, CBS and General Motors, because everything was conglomerating so much there would only be room for one company in each sector.

So far this has not occurred--but if you want it to, we could start nationalizing.
9.14.2009 3:41pm
Lee A. Arnold (mail) (www):
"It depends upon what you mean by monopolistic competition--most economists working in organization theory and antitrust have long since abandoned any belief in perfect competition, or that these other forms are "imperfect" and need fixing or regulating by government, let alone nationalization."

Except apparently every economist who depended upon perfect competition necessary to the efficient markets hypothesis in the financial markets, before the current debacle, and who are thinking about what to do about "too big to fail" now.
9.14.2009 6:19pm

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