by Jerry O’Driscoll  

In today’s Wall Street Journal, there is an article titled “Returning Workers Face Steep Pay Cuts.”  The article cites research by Kenneth Couch of the University of Connecticut that returning workers are taking on average a 40% pay cut from their old jobs.  This is first and foremost a personal tragedy for those affected.  The question we must ask as economists is why?  

Econometricians will still be picking over the data a decade from now. (And of course, they will be looking at revised data, rather than the data we are viewing today. But that is a subject for another post.)  One factor that must not be overlooked is that capital has been destroyed in the prior boom.  The so-called bust or crisis is the revelation of those losses.  Capital is heterogeneous.  The capital embodied in all those unoccupied homes in Las Vegas cannot be deployed to build goods and employ workers in the manufacturing sector. 

Many analysts, myself included, argue that economic recovery will involve a switch to a lower consumption path.  In the process, proportionately more resources will be devoted to production of goods for rest of the world.  New savings will be needed to finance that transition.  But much accumulated savings have been lost due to capital misallocation. In order to be competitive in the global economy, the U.S. must become a country of lower wages. And we are witnessing that painful adjustment in real time. 

The reflationists (whether monetary or fiscal) conflate cause and effect.  Falling wages rates are the consequence of prior bad policies and decisions.  They are not the cause of current problems.  Moreover, fiscal and monetary stimulus cannot restore the lost capital.  Printing money or redistributing income does not create real wealth.  

Falling real wages and declining living standards put flesh on the skeleton of macroeconomic policy debates.  They are the real-world consequences of bad macroeconomic policy: easy money, politically directed investment and regulatory capture.  All those bad policies are being continued or enhanced.  Only further misery will flow from them.

by Mario Rizzo 

I have taken a quick look at some of the provisions of the recently-passed House healthcare bill. What I want to do here is determine how it will affect me and others in a similar situation. I do not think my own situation is exceptional. I urge others to determine how it will affect them.  

My situation: My health insurance is provided by New York University. They offer a number of plans each with distinctive features, coverage and monthly premiums. I have chosen a point-of-service plan with very good in-network coverage. (I don’t like HMOs because of all the permissions I have to obtain before seeing specialists as well as other rigidities and limitations.) It also has an out-of-network aspect that enables me to see doctors outside of the United Healthcare network. I like this feature because if I ever want a specific good doctor I can still have coverage regardless of the network he or she is in. 

This feature of the plan does not offer very good coverage, however. For out-of-network doctors and facilities, in 2010, it will cover only 60% of customary and reasonable charges (usually less than many specialists charge in NYC) — with a yearly deductible of $2,500.  

Now this is where the House bill comes in. In order to collect more taxes from “the rich” it will limit the amount I can put in a flexible spending healthcare account (my own pre-tax dollars) to $2,500. “Why should I have all of these untaxed dollars to spend on my healthcare?” they are thinking. Are they also thinking that I am rich?  Many middle-class people have flexible spending accounts.  

The effect of the limitation is this. Going outside of my network will become much more expensive. My choice of doctors, labs and hospitals will be more limited than before. 

Previously, I was spending my own money and had some incentive to spend it prudently. (I would have greater incentive if the money did not disappear at the end of the year.) I could also use it for medical expenses not covered by insurance. (Dental insurance is normally not that good.)  

I would now be basically stuck with in-network providers. 

Does the House bill mandate better out-of-network coverage? I do not know the answer. (The full definition of what constitutes a “qualified plan” will not be determined until after the bill is passed!) But there are only two possibilities. First, it does not. In that case my healthcare coverage is worse than before – my choices are effectively more limited.  

Second, it does mandate better coverage out-of-network. If my employer must continue to provide this option it will be more expensive and my premiums will rise. Of course, my employer could have given me a better plan at greater cost before. It didn’t need the House of Representatives to do that. 

My employer might not continue this out-of-network coverage, however, since it must pay at least 72.5% of the higher premiums. It may not be willing to do that. Then my choices become completely limited to in-network providers.   

Thus the effect of this one provision alone is either to limit my choice of doctors or raise the cost of my insurance. 

There are many, many other provisions. I can understand neither most of the bill’s language nor how it will affect my situation in respects other than the above.  Look at the thing!!!   

In my own case, looking through the bill has made me feel small and powerless. Can we avoid becoming incompetent dependents looking to the State for our well-being? Oh I forgot: We have already become that. But I do hope we can avoid even more of the same. 

Addendum: I understand the argument that to allow me to use pre-tax dollars on healthcare does not create optimal incentives vis a vis other uses of my income. It will encourage too much use of healthcare from a social perspective. But if we continue to allow the use of pretax dollars to pay for insurance premiums the market is already distorted. Any reform that tries to make up for lower flex spending by increasing the extent and cost of insurance coverage doesn’t solve that problem. Things get moved from one distorted payment method to another, arguably more distorted, method.  

And then there is the major problem. The healthcare industry is already so filled with distortions caused by every kind of government intervention imaginable, that we are clearly in a second-third best world. So I have no idea what the humble flexible spending account does to the Optimality God.

by Mario Rizzo

Our first post was on November 11, 2008.  We are one year old and going strong.

My motivation in founding ThinkMarkets was to address the issues regarding the financial crisis and subsequent recession. We have had many posts on many topics since that day.

Thanks go to all of our contributors as well as to those who have made comments on the posts. We are on our way to saving the world.

by Mario Rizzo

I am deeply impressed by Henry Kaufman’s opinion piece in today’s Wall Street Journal. I think he makes a very good case for  breaking up financial institutions deemed too-big-to-fail as opposed to the regulatory alternatives being contemplated. As much as it pains me to think about the government regulating the size of any firm, this may be an option that is far, far better than the politically feasible alternatives.  You can imagine the horrors that are out there being proposed.

Many of my readers will disagree but I am very willing to be persuaded otherwise.

by Gene Callahan

I happened to be reading R. G. Collingwood’s famous essay (at least famous in my circles!) with the above title. While similar in some ways to Mises’s philosophical analysis of the concept of action, there are some quite significant differences present as well, and I thought that Think Markets readers might enjoy a brief discussion of one of them.

Perhaps the most notable difference between Mises and Collingwood is that the latter denies the possibility of interpersonal exchange! Exchange, he contends, is always with one’s self. His analysis proceeds as follows: Let’s say you have a slab of bacon and I have a loaf of bread, and apparently what is going on is that we are exchanging the two items. But, Collingwood notes, what I am really giving up is not a loaf of bread, but my eating of the loaf of bread. And what I really want is not a slab of bacon, but my eating of the slab of bacon. (Consider how little I would value inedible bacon!) But I cannot possibly give you my eating of the bread, and you cannot give me my eating of the bacon. No, in this event, each person exchanges with himself — I exchange my eating the bread for my eating the bacon, and you do the reverse — and each of us, in terms of these intrapersonal exchanges, acts as a facilitator — by my dropping my claim to be the rightful eater of the bread, you are allowed to “pick it up,” and vice versa.

Now, this may seem like a verbal quibble, until you see where Collingwood goes next. Since, as he believes he has demonstrated, all exchange is really with oneself, and is always trying to exchange more for less — that is what makes the action economic — then the idea of a ‘just price’ other than the market price is logically vacuous — when one complains that a price one is offered is “too high,” one is complaining that someone else is doing the same thing one is one’s self — exchanging with himself in the most advantageous way possible.

Any comments on Collingwood’s analysis?

by Chidem Kurdas

As Fannie Mae goes for its next withdrawal from the $200 billion kitty the US Treasury graciously made available to this government-created and -sustained mortgage financer, it may be useful to look beyond the current housing slump and consider what it augers for the future.

Having made yet another loss, the government-sponsored enterprise needs more money. A report Fannie filed with the Securities and Exchange Commission attributes the $19 billion third-quarter loss to the housing slump and mortgage defaults.  “We do not expect to operate profitably in the foreseeable future,” says  the company.

I always thought it was a great triumph of government public relations to come up with the sweet-sounding Fannie Mae moniker for an entity officially called the Federal National Mortgage Association.  Now I understand what the nickname really means—a pain in the taxpayers’ backside for the foreseeable future.

The business has been adversely affected by helping delinquent or imminently-in-default borrowers to modify their mortgages so as to reduce their monthly payments. As the economy recovers, defaults will decline, and presumably this aid will no longer be needed. But it is not clear when – or even if – the subsidy program will end.

In fact, it may be extended.  Fannie “may recommend supplementing the program with other initiatives that would allow us, pursuant to our mission, to assist more homeowners.”

By conventional wisdom, it is better for everybody and the economy at large that people not default on their mortgages. On that basis, the bailout of shaky homeowners via Fannie is good policy. It is certainly good politics. In view of the bailouts of investment banks, you might say it is only fair for families to get help with their mortgages.

Of course, the people getting this help are those that have mortgages in the first place. Those who do not own property or who were careful not to borrow too much do not get the defaulters’ subsidy. They’ll have to pay the taxes to prop up Fannie and get penalized for being frugal or poor. This is an income re-distribution program that is anything but fair.

More importantly, it sets a precedent. Housing will go down and go up, but whenever foreclosures start rising, the same politics will come to play. You’ve bailed out selected  mortgage defaulters today; why not bail out defaulters in the future?

Fannie is indefinitely dependent on government support. The report says, “we believe that continued federal government support of our business and the financial markets, as well as our status as a GSE, are essential to maintaining our access to debt funding. Changes or perceived changes in the government’s support of us or the markets could lead to an increase in our debt roll-over risk in future periods and have a material adverse effect on our ability to fund our operations.”

The defaulters’ welfare program will encourage new rounds of reckless borrowing, creating a vicious cycle of mortgage subsidies, government-sponsored enterprise losses and a federally mandated transfer of wealth. The transfer will be from people who don’t own their house (and who typically have lower incomes) to homeowners, and from those who do not over-extend themselves to those who get into a financial pickle.

Last year Arnold Kling  argued in a Cato Institute paper that the solution is to freeze the mortgage activities of Fannie and its cousin Freddie Mac.  As long as housing remains in the doldrums, that’s not going to happen. When the market recovers, it will be essential to push for the dismantling of GSEs.

by Glen Whitman

New paternalists often rely on the phenomenon of “hyperbolic discounting” to justify their policies. Hyperbolic discounting is difficult to define in a non-mathematical way. It is sometimes summarized as excessive impatience, but that’s an over-simplification. A person with a high-but-consistent rate of time discounting would not be a hyperbolic discounter. What hyperbolic discounting really means is having inconsistent rates of time-discounting. One consequence is that a hyperbolic discounter may exhibit “time inconsistency,” a tendency to make choices and then reverse them. After explaining hyperbolic discounting (in more technical terms that I have here), Mario and I explain how paternalists have made unjustified leaps in their use of the concept (pp. 699-700):

In short, hyperbolic discounting means that people at first make long-term plans for saving or dieting but then, when the time comes to implement these plans, they succumb to the desire for short-term gratification. For the new paternalists, this type of behavior suggests an opening for paternalist intervention or correction. Examples include the previously mentioned proposal to automatically enroll people in savings plans, and to impose a sin tax (on unhealthy foods, cigarettes, and so forth) to provide additional incentive for impatient people to resist their temptations.

New paternalists claim that they are evaluating the observed behavior of the individual in terms of his own normative standard. This appears attractive until we realize that the individual has no unambiguous standard for the appropriate level of time discounting. The analytical “opening” for paternalist policy is created by the existence of an internal inconsistency of choice. But although an inconsistency does create a quandary for traditional rational-choice theory—which assumes that people have internally consistent preferences—it does not provide any grounds for choosing between the inconsistent preferences. The inconsistency of a hyperbolic discounter could be “fixed” by making him uniformly more patient …, but it could also be “fixed” by making him uniformly less patient…

To craft new paternalist policies, it is necessary to decide the appropriate normative rate of time discounting. This matters because policies must specify the amount of money an individual is automatically signed up to save, the magnitude of a fat tax, etc. Which rate of discount is the correct one? Theory provides no answer, but the new paternalists have not hesitated to side with the more patient one. O’Donoghue and Rabin define “optimal behavior” as “that [which] maximizes long-run well-being,” where long-run well-being is associated with the more patient rate of discount. Gruber and Köszegi “take the agent’s long-run preferences as those relevant for social welfare maximization.”

To put the point slightly differently: the existence of an inconsistency does not give the new paternalists license to resolve that inconsistency however they please.

Hyperbolic discounting is difficult to work with mathematically. For that reason, behavioral economists have often used quasi-hyperbolic discounting instead. While hyperbolic discounting means a person has many (perhaps infinitely many) different rates of time discounting, quasi-hyperbolic discounting means a person has only two: one that applies when comparing any two periods in the future, and one that applies when comparing a present and future period. Once we recognize that real people tend to have a range of time discount rates, the slippery-slope potential becomes clear (p. 702):

Quasi-hyperbolic discounting makes it deceptively simple to choose the “correct” rate of discount, since there appear to be only two options. If real people actually engage in hyperbolic discounting, this implies a gradient or continuum of discount rates over time. If we assume, notwithstanding our earlier objections, that the immediate discount rate is impulsive or ill-considered, which of the longer-term rates is normatively preferable? There is nothing in the logic of new paternalism or behavioral economics that can provide an answer. We are faced with a continuum of normative possibilities. These arguments impel us to the conclusion that among the discount rates revealed in choice or planning behavior, none has a clear claim to normative superiority. Thus, the new paternalist is in a conceptual fog because his underlying standard of evaluation is unspecified. The notion of “excessive impatience” is both theoretically and empirically vague, and that means we have a gradient of possibilities. There is no clear line to resist the gradual creep of higher savings requirements, higher fat taxes, and the like.

Note the connection here to our earlier point, that gradients increase the slippery-slope risk. (As usual, full citations are available in the paper.)

Cross-posted at Agoraphilia.

by Andreas Hoffmann and Gunther Schnabl*

With central bank balance sheets and government debt levels exploding, discomfort about future inflation arises. A discussion about the appropriate exit strategy from low-interest rate policies has started. The standpoints of central banks are different. The ECB seems more decisively in favour of an early exit. The Federal Reserve discusses the technical aspects rather than an early timing (see Mario’s earlier blog entry). The Bank of Japan is said not to exit earlier than in five years. What situation are we facing? A return to monetary policies that are neutral to inflation and bubbles is unlikely for four reasons:

(1) Policy markers in industrial countries tend to use monetary policies asymmetrically. This asymmetry started in the 1980s in Japan. To promote growth of the export-led economy the Bank of Japan lowered interest rates in periods of appreciation, but did not raise them proportionally when the yen depreciated (for more). Finally interest rates fell to zero in the aftermath of the 1997/98 Asian crisis. Greenspan and Bernanke have followed a similar pattern with respect to stock markets (more). While they cut interest rates decisively during crisis, they hesitantly raised them in boom periods. Thus, the US interest rate level fell towards zero in the current crisis. In Europe as well, the interest rate reached a historical low in the latest slump.

(2) Even though it makes sense that central banks “give increased accommodation and extend thereby their circulation in order to prevent panics” (Hayek 1967: 108), the described structural fall of the interest rate level lowers the marginal productivity of investment (see Mario’s entry) and depresses growth. Thus lifting interest rates becomes difficult, as bad investment would be dismantled and/or bubbles burst (more).

(3) As long as interest rates can be lowered, the state budget remains stable. However, as soon as the zero-interest rate bound is reached, fiscal stimulus is intensified and government debt may skyrocket, as in Japan since the late 1990s. The higher the level of government debt, the higher will be the pressure on the central bank to keep the interest rate low. Japan is a „good“ example. As gross government debt has increased to more than 200 percent of GDP, the interest rate has to remain close to zero to keep the debt service under control.  

(4) This raises the question of whether the institutional independence of central banks can resist the pressure of governments to monetize the debt. The Bank of Japan has been de facto downgraded to a branch of the government since the 1990s. In the US fiscal and monetary policies are coordinated. The personal mobility between central bank, financial markets and government seems to blur the institutional separation. Also in Europe, an appreciation pressure on the euro will make it difficult to defend a restrictive course in monetary policy.

Thus, the political will is at the core for a decisive exit from easy monies and structural distortions. But both voters and politicians seem reluctant. They may rather prefer to laminate reforms with expansionary fiscal and monetary policies. From this perspective inflationary tendencies and new bubbles seem likely, while long-term growth will further slow down.

*Gunther Schnabl is professor of economic policy and  international economics at Leipzig University (Germany). Andreas  Hoffmann is a doctoral candidate at his chair and currently visiting New York University.

For more see: Hoffmann, A. and Schnabl, G. 2009: A Vicious Cycle of Manias, Crashes and Asymmetric Policy Responses – An Overinvestment View.

by Glen Whitman

A key conclusion of the literature on slippery slopes is that they are especially likely in the presence of gradients — meaning situations in which there is a relatively smooth continuum from one policy to another, and in which it is difficult to draw sharp distinctions. Gradients don’t guarantee slippery slope events, but they increase their probability in the presence of other slope processes.

In “Little Brother,” Mario and I review the literature on gradients and slippery slopes, and then we consider how the new paternalists deliberately frame policy choice in terms of gradients (pp. 693-694):

The new paternalist paradigm, as presented by its leading advocates, relies on discarding sharp distinctions in favor of gradients. Specifically, they reject standard distinctions between choice and coercion and between public and private action. Cass Sunstein and Richard Thaler minimize the importance of the distinction between paternalism in the private and in the public sectors. In explaining their concept of “libertarian paternalism,” they say that the distinction between libertarian and non-libertarian paternalism “is not simple and rigid.” Moreover, they explicitly state that libertarian and non-libertarian paternalism lie on a continuum: “The libertarian paternalist insists on preserving choice, whereas the non-libertarian paternalist is willing to foreclose choice. But in all cases, a real question is the cost of exercising choice, and here there is a continuum rather than a sharp dichotomy . . . .”

Sunstein and Thaler thus present us with a gradient on which choice is characterized by low costs of escaping the prescribed course of action, while coercion corresponds to higher costs of escape. Who imposes the costs of escape and how these costs are imposed are regarded as unimportant questions.

In the pages that follow, we summarize the many and sundry policies that S & T regard as falling on the libertarian paternalist spectrum. Many of these are policies they never mention in their public defenses of libertarian paternalism. But they do appear in their academic work, and reading the list makes it apparent just how un-libertarian libertarian paternalism can be. We conclude (pp. 697-698):

At the far end of the continuum lies an outright ban on certain activities. Sunstein and Thaler embrace this conclusion: “Almost all of the time, even the non-libertarian paternalist will allow choosers, at some cost, to reject the proposed course of action. Those who are required to wear motorcycle helmets can decide to risk the relevant penalty, and to pay it if need be.”

Notice that the same argument would place outright prohibition of alcohol, drugs, or anything else on the same spectrum. You are free to use any drug you want, says the argument, if you are willing to incur the cost of potential imprisonment. At this end of the continuum, we find, lies genuine hard paternalism. In Sunstein and Thaler’s words:

A libertarian paternalist who is especially enthusiastic about free choice would be inclined to make it relatively costless for people to obtain their preferred outcomes. (Call this a libertarian paternalist.) By contrast, a libertarian paternalist who is especially confident of his welfare judgments would be willing to impose real costs on workers and consumers who seek to do what, in the paternalist’s view, would not be in their best interests. (Call this a libertarian paternalist.)

Movement along a paternalist continuum should come as no surprise when the two ends of the continuum depend on which word is italicized, as well as on the subjective confidence of the policymaker in his welfare judgments.

It bears emphasis that the sequence of steps we have outlined—from nudging (changing the order of cafeteria items) to pushing (imposing costs on those who deviate from the state’s preferred terms of contract) to shoving (ruling out some terms entirely) to controlling (banning some activities altogether)—is not our creation. Sunstein and Thaler present the same proposals in approximately the same order, to demonstrate the existence of a continuum.

A bit later (pp. 698-699) we respond to a natural objection: that the new paternalism is not to blame for the existence of a gradient that already exists.

Some may object that the existence of a gradient from soft to hard paternalism is just a fact, and that the new paternalists cannot be faulted for pointing it out. But the gradient in fact results from the conceptual framework that the new paternalists have adopted and urge the rest of us to adopt. The main problem with the framework, in our view, is that it defines freedom of choice (and libertarianism) in terms of costs of exit, without any attention to who imposes the costs and how. An alternative framework, one that is more consistent with the typical usage of words like coercion and choice, would focus on whether rights of person and property are abridged by a given policy. On this approach, a restaurateur’s decision about dessert placement and a government’s decision about whether to allow helmetless motorcycle riding simply would not be on the same continuum. The former is private and non-coercive, the latter public and coercive. This is the sort of framework that the new paternalists encourage us to reject in favor of theirs.

To put it another way, the new paternalists often say that people are subject to “framing effects” that alter their choices. Indeed, they say that such framing effects are evidence of irrationality. Yet they are exploiting a framing effect in their advocacy of new paternalism. They encourage us to adopt a conceptual frame that relies on gradients, rather than a conceptual frame that highlights important distinctions. We will revisit this point later. (As usual, footnotes have been omitted, but are available in the full paper.)

Cross-posted at Agoraphilia.

by Jerry O’Driscoll  

In today’s Wall Street Journal, hedge-fund founder Mark Spitznagel celebrates Ludwig von Mises as “The Man Who Predicted the Depression.”  Spitznagel opens by observing that “Ludwig von Mises was snubbed by economists world-wide as he warned of a credit crisis in the 1920s.  We ignore the great Austrian at our peril today.”  

Spitznagel deals with The Theory of Money and Credit and does a good job presenting its principal arguments.  What I found most interesting, however, is the author’s argument that the book is a warning today.  There is a lively exchange over at The Austrian Economists, led by Pete Boettke, on whether monetary policy is too tight or too loose.  Spitznagel obviously thinks policy is too loose. So do I. 

Right now there are disinflationary forces still at work in the near term.  Many malinvestments have still not been liquidated. Bad commercial real-estate loans sit on the books of many banks.  All of this maintains downward pressure on asset prices.  

Meanwhile, the dollar has replaced the Yen as the currency of choice for a carry trade that is financing a real-estate boom in Asia, high gold prices and buoyant commodity markets. The Fed is promising near-zero overnight interest rates out as far as the eye can see.  The effects of the easy money have not yet manifested themselves in US consumer prices.  The asset boom will eventually spill over into final demand, though perhaps last in the US.  

In short, the seeds of the next boom and then bust have already been sown.  Spitznagel quotes Mises as saying to his fiancée in mid-1929, “A great crash is coming and I don’t want my name in any way connected with it.”  Words for our time.