Barack Obama sounded a number of themes in his 2012 State of the Union Address this week, all underpinned by the proposition that socioeconomic ills can be solved by interventionist government in general and his administration in particular.

Indiana governor Mitch Daniels, giving the Republican rebuttal, effectively replied to the main claims. He pointed to the failure of  the President’s “grand experiment in trickle-down government.” Programs spend borrowed money in attempts to boost the middle class. “In fact, it works the other way: a government as big and bossy as this one is maintained on the backs of the middle class,” Mr. Daniels said.

Mr. Obama’s points about regulation drew less attention.  Acknowledging that “some rules are outdated, unnecessary, or too costly,” the President said he approved fewer regulations than his Republican predecessor did in his first three years and ordered every federal agency to eliminate rules that don’t make sense.

Truth, regulatory expansion in the age of Obama has been massive in healthcare and finance, with hugely expensive new requirements imposed on large numbers of individuals and businesses. But in broad terms he is right that regulatory expansion went on unabated under the second George Bush, indeed as it has under many US presidents since the 1930s.

From that perspective, the sprawling healthcare and Dodd-Frank financial regulation laws are additional links in the chain of government controls that bind American society ever tighter in almost every area. Certainly the trend is not new.

The issue Mr. Obama did not address is that much regulation is not just outdated, unnecessary, or too costly; it simply does not work. Case in point is the Financial Crimes Unit he proposes to create. Consider the mission of this new bureaucracy, in Mr. Obama’s words: “to crack down on large-scale fraud and protect people’s investments.” As if there were no law and officialdom that does this until now.

Fraud has always been subject to criminal law. The Justice Department, the FBI, state and local police forces are responsible for apprehending perpetrators and handing them over to the courts for punishment. Besides criminal prosecution, since the early 20^th century the US developed an elaborate body of law and regulation meant to prevent financial fraud. There came to be numerous civil bureaucracies to enforce the rules and investigate violations. These range from the Securities and Exchange Commission to the specialized overseer of Fannie Mae and Freddie Mac, the government-backed mortgage finance giants.

Close regulatory oversight did not prevent accounting shenanigans at Fannie and Freddie, let alone stop them from playing the role of enabler to the housing bubble, subsequently  in effect becoming insolvent. They remain dependent on Congressional handouts of taxpayer money.

Then there are the astounding failures of the Securities and Exchange Commission to intervene when alerted by whistleblowers to the giant Ponzi schemes of Bernard Madoff and Allen Stanford.

Mr. Obama wants to establish a new bureaucracy because the existing ones failed to do what they were supposed to do. Were the existing agencies private entities, they would have gone out of business and been replaced by better functioning firms (if warranted by market conditions). But since they’re part of the government, they don’t disappear. At most they change their names and get re-organized, as happened to the Fannie supervisor.

New ones are set up to compensate for the dysfunction of the old ones—a pattern public choice economics pioneer Gordon Tullock described in his book, The Politics of Bureaucracy.  Adding an extra bureau is the stock response to regulatory failure. Hence Mr. Obama’s proposed Financial Crimes Unit.

But this is futile. Tullock pointed out that after a few years new bureaucracies become like old bureaucracies in that they mainly look after themselves while pretending to carry out their supposed tasks. Nothing is achieved, while taxpayers and consumers pay for offices, salaries and other expenses. When failures show up, yet another bureaucracy is created.

Tullock called the resulting system of pullulating government organizations the emerging bureaucratic order. That was in 1965. It is no longer emerging, it is already here and Mr. Obama is adding to it.

One of the very good things about the blogosphere is that academics have been uploading their syllabuses for various courses. For the past couple of years, I have been teaching a graduate course taking a detailed and critical look at modern behavioral economics, including its normative and policy aspects.

More and more, I am thinking about this area in terms of the normative vision of the world it presupposes. Most amazingly, behavioral economists tend to accept the normative stance of neoclassical or standard economics (that is, the axioms of rationality). They “simply” do not believe that people behave in accordance with these axioms. Thus they find decisionmaking failure (akin to market failure). All sorts of state interventions may be warranted to correct for the suboptimalities that defective or biased decisions imply.

There are many issues here. (1) What is the status of neoclassical rationality as a normative standard? I think the technical idea of rationality gains acceptance to the extent that it is viewed as the instantiation of a broader rationality — or simply the instantiation of sensible decisionmaking. This is a not very defensible point. (2) Even assuming that is defensible, is “rationality” where economists ought to begin or where perhaps they should end up? Economists such as Philip Wicksteed argued, in effect, that irrationalities were disequilibrium phenomena that would tend to dissappear or be reduced under the pressure of the costs of bearing the consequences of irrationality. (3) Even assuming the empirical stubborness of biases or irrationality, is it possible or feasible to discover what unbiased behavior would be, especially in a world of multiple biases and differential degrees of these biases accross individuals and contexts?

Behavioral economics is one of the many areas of economics that could benefit with a little more fundamental thinking even at the expense of  yet another experiment or psychological study or “innovative” model. Let’s slow down and take a breather.

Here is my syllabus. Behavioral Economics Syllabus 2012

Jamie Dimon, the chief executive of JP Morgan Chase, says regulatory policy is working against economic recovery and as such is contradictory. His complaint is about the new bank rules, but in fact government actions in myriad areas are at odds with each other.

Consistency does not appear to be an object in policymaking. For many years subsidies for tobacco growers co-existed with anti-smoking measures. A couple of months ago NYU law professor Richard  Epstein wrote about regulatory and legal over-reach in the anti-smoking fight.  One of his conclusions: “There are other steps the government could take. The United States should promptly cut to zero the near $200 million in tobacco subsidies that it shelled out in 2010.”

The US is not alone in this. The EU also subsidized tobacco farmers.  Eventually the European Parliament cut most of the tobacco subsidy, but recently there was a report about subsidies to cigarette factories.  Meanwhile the EU runs anti-smoking ads.

Regarding financial regulation, Mr. Dimon says higher bank capital requirements may be reasonable in the future but are not reasonable now, in the midst of the European debt crisis. New capital rules discourage short-term lending to other banks and purchases of risky bank assets, getting in the way of stabilizing the financial system. This is not good for creating jobs and is making recovery slower and more painful, he argued.

A simple explanation for seemingly incompatible policies is that different government entities have different goals and do not coordinate their efforts. Thus Mr. Dimon suggested that policymakers should talk to each other.

Bureaucracies typically resist working with other bureaucracies for fear that their own power and budget might decline as a result. If high-ranking politicians wanted to, they could insist on coordinated policymaking. But they don’t, because coordinating does not matter to them. The ultimate goal for a politician running for office is to get elected. From that vantage point,  politicians tend to consistently push for policies that will bring them votes, funds or both. Anti-smoking gestures and agricultural subsidies are consistent with politicians’ self interest.

As for creating jobs, this is a means to getting elected but not the only means and not the most effective one, because it is uncertain. Government actions supposed to create jobs in reality often don’t. Raising money is probably more important because it allows for greater propaganda in which you can claim to be creating jobs, a more straightforward way to influence public opinion than attempting the real thing. Regulations that threaten the interests of large potential donors like banks are good for getting funds – the threatened businesses pay protection money – while also getting votes via the populist theme of attacking fat cat banks.

If policies were few and transparent, job creation, a goal desired by most of the population, would be more likely to be pursued consistently. Or at least, there would be fewer actions that go against it. That’s another argument for limited government. As things now stand, there are interventions for each objective and also for its opposite, all benefitting the political class.

Many economists are criticized for being unable to communicate their ideas in am intelligible and non-boring way. How many people, for example, jump to listen about a debate about the Austrian theory of the business cycle? It turns out quite a lot. John Papola and Russ Roberts demonstrated to the world that lots people will actually listen to an economics discussion if presented in an interesting way.  Their videos recently surpassed 4.5. million views. They did an amazing job especially with their good casting decisions for the reporter at the end of the second video.

This year I decided to run a video contest for students to create music videos that help illustrate the laws of supply and demand. The entries are in and many of them are quite funny. Over the next few weeks we will be picking the winners and one of the factors judges will consider is viewership and votes on Youtube and Facebook.

Here are a couple entries:

Check out the 15 finalists here http://hackleychair.blogspot.com/ and vote on Facebook. Who do you think should win?

(*Hackley Endowed Professor for the Study of Capitalism and Free Enterprise)

Gripes about capitalism go back 150 years and more. In the Communist Manifesto of 1848 Marx and Engels thundered that the specter of revolution haunted Europe, that the periodic reappearance of commercial crises “put on its trial, each time more threateningly, the existence of the entire bourgeois society.” They were not the first to assail the system and were followed by numerous others spanning the political spectrum.

Thus the Financial Times recently started a series on  “The Crisis of Capitalism.”  Europe suffers from a sovereign debt crisis due to over-spending by governments—why is that the crisis of capitalism? But one should not quibble. It is an old tradition. In the 1998 turmoil brought on by Russia’s default on its bonds and the failure of a large hedge fund, commentaries appeared bearing titles such as The Crisis in Global Capitalism, Global Capitalism RIP, Collapse of Capitalism, Who Lost Capitalism? and The Free Market’s Crisis of Faith.

I’ve taken those titles from a response by Michael Boskin, “Capitalism and its Discontents,” a classic that rings true 14 years later and merits re-reading.  It makes one realize how very persistent and impervious the attacks are. No matter how well the case is made for capitalism on economic and moral grounds, no matter how clearly the argument is presented (Boskin makes an eminently persuasive and readable case), as soon as a problem arises many voices will condemn the system.

Of course it was communism that in fact collapsed in the late 20^th century, but because humans beings are fallible, all political-economic systems are apt to run into some problem, and so pundits continue to write tombstone epitaphs for capitalism.

Boskin’s 1998 speech contains an anecdote illustrating a certain mindset. In 1989 President George H.W. Bush sent Boskin, then Chairman of the Council of Economic Advisers, to Moscow to help Gorbachev with Soviet economic reform. There he met, among others, the head of Gosplan, the government planning agency. The man asked: “Who sets the prices in your economy?” Boskin explained that most prices arise from the decisions of buyers and sellers.

The Gosplan chief asked again: “So who sets the prices in your economy?” Again Boskin explained. No effect. The stolid Soviet bureaucrat took out a giant computer printout containing the official prices of all products in the Soviet Union. Unable to conceive of markets working without government price setting, he may have thought of “reform” as central planners using a different technique for determining prices, perhaps a different computer model that Americans could provide.

I imagine Gosplan honchos’ education did not include reading Hayek, who explained why no central planning technique can work—some half-century before the frustrating meeting in Moscow. Today’s protestors do not call for central planning but do favor more government, whether in the form of greater regulation or measures to equalize income distribution. There is little evidence that these work any better than central planning; interventions like welfare programs are notable for their bad unintended consequences.

Nevertheless, like the Soviet planner Western statists can’t conceive of the possibility that non-intervention is better in most areas. There is a powerful myth that if some government is good, more government is even better and by intervening in everything that we don’t like, we’ll achieve egalitarian Nirvana with no crises.

Meanwhile we’ve been very fortunate. Despite a variety of destructive public policies and the limits to individuals’ wisdom whether in market or government,  capitalism has brought about an immense growth in income and numerous innovations that make life easier and more enjoyable. As a result we’re all better off than the authors of the Communist Manifesto 164 years ago.

Engels was a rich industrialist and supported Marx, who wasted a small fortune inherited from his family. They were obviously members of the bourgeois class they condemned, but compared to us their entire bourgeoisie was worse off. We have more food and clothing and better housing, are healthier and live longer. There is no alternative to capitalism because nothing else has worked as well, crises and all.

That’s the reality but we keep hoping we’ll find some government intervention that will take us to Nirvana.

In 1930, John Maynard Keynes dashed off an amazing prophecy. Extrapolating from the productivity gains of the past centuries, he came to the bold conclusion that the fundamental economic problem of scarcity would fade away in 100 years or so. Thanks to technological innovation and the accumulation of capital, the ancient condition of limited resources to satisfy competing wants would give way to a new age of plenty. Human beings would then face a very different quandary, namely what to do with themselves once they no longer have to work in order to survive.

Eighty-one years into the timeline Keynes suggested in his article, “Economic Possibilities for Our Grandchildren,” scarcity shows no sign of disappearing. Where did he go wrong?

He did hedge his bet by making it conditional on there being no important wars and no major increase in population. One reason we continue to experience a dearth of means to pursue the ends we desire is that wars absorb immense resources. Thus the $1 trillion spent on the Iraq war could have instead been used to satisfy myriad needs.

But aside from that, Keynes made a mistake in his reasoning. He argued that some high level of output be sufficient to meet needs because these will not grow as much as the ability to produce. He thought a point may soon be reached where what he called absolute needs – in contrast to relative needs or conspicuous consumption – will all be satisfied.

This notion of “absolute need” comes from a limited view of technological change as improving productivity while preferences for goods and services remain relatively stable. But in fact technology creates new products and tastes, working on the demand side as well as the supply side. It is not the case that there is a fixed basket of wants. We now want MRIs and smart phones; in the past there was no such need since we had no conception of these things.

That Keynes postulated less long-term growth in demand compared to supply fits in with his later theory that deficiency in aggregate demand causes recessions. Hence his argument that government spending can alleviate the down part of the business cycle by creating demand—the main rationale for large-scale stimulus programs, including the Obama administration’s questionable projects.

In a sense Keynesian policies reduce the possibility of the age of plenty that the man himself foresaw. Besides the question of the effectiveness of such programs – click for one of the posts on the subject by Mario Rizzo –  there is the matter of runaway government spending.  Keynes himself favored budget surpluses in good times to balance deficit spending in recessions.  Over the cycle surpluses would make up for deficits. But that is not the way it worked in reality.

A recent piece by Steven Horwitz in the Freeman reminds us of the seminal 1977 critique by James Buchanan and Richard Wagner, who pointed out that Keynes and the Keynesians removed institutional and moral impediments to deficit spending, thereby freeing politicians to spend without limit and rack up debt. No matter how huge the resources, the black hole of government spending can absorb it all.

Hence the current European debt crisis, brought on by various governments’ improvident spending.  Austerity is the word that dominates European policy discussions, the belt tightening necessary to counter past profligacy.  So Keynes provided governments with the excuse to run deficits with consequences that now threaten to create painful scarcity.

Almost certainly he would not have liked this unintended result. The end to the economic problem looks further off than ever.

‘Tis the season for predictions. Pundits offer conjectures on every conceivable subject, though accumulating evidence in recent years has established, as much as anything can be established, that you might as well examine tea leaves to divine the future. Yet one could learn from prophesies; a few are thought provoking and some may even be true.

My favorite is a little gem attributed to J.P. Morgan, the man who gave his name to the bank. I’ve heard this quote from financial industry people but don’t know the source.  Asked how markets will do, J.P. Morgan is said to have replied: Expect markets to fluctuate.

As a supposed insight, this appears to be worthless. What can you do with it? Had he instead said, “Expect company X to go up 20%,” well, you could buy company X. Except that there would be no point—he could just as well be wrong and, more importantly, by the time you see the prediction in the news, it would already be factored into the price of company X. Information has to be exclusive to make money.

Hence our august Congress is careful with a proposed stock trading rule for its members, casting the net sufficiently narrow so as to allow members to continue trading on non-public information that arises in Congress.  Jonathan Macey, a law professor at Yale, writes in the Wall Street Journal about this bill: “On closer examination, it appears that what Congress really wants is to keep making the big bucks that come from trading on inside information but to trick those outside of the Beltway into believing they are doing something about this corruption.” By contrast, hedge fund managers and others face lengthy prison terms for trading on corporate information.

Going back to J.P. Morgan’s maxim, it tells us that markets don’t stand still. This is perfectly correct. Stock prices may move a little or a lot, but they do fluctuate. The saying contains another lesson—if everybody knows that a statement about the future is correct, then it is not useful. That the sun will rise every morning in the coming year is a most uninteresting prediction.

But if we don’t know whether a forecast is correct, then it is dangerous to act on it. Either way, trying to gaze into a metaphorical crystal ball must be a waste of time. Then again, there are exceptions.

A seminal work in the debunking of futurists is Philip Tetlock’s 2005 book, Expert Political Judgment: How Good Is It? How Can We Know? Tetlock studied hundreds of experts’ opinions on economic and political events and found that a “a dart-throwing chimpanzee” would have done better.

On the other hand, short-term weather forecasts turn out to be mostly accurate. It makes sense to take an umbrella when the forecast is rain. Moreover, weather forecasts have improved over time. The other hopeful sign is that we’re learning not to trust expert opinion outside certain areas like the weather. It is a good guess we will learn more in 2012.

There has been a lot of talk this year, and especially during the holiday season, about the inequities in the distribution of wealth and income. But most of what has been written is quite simple-minded, if the writers mean to convey something more than their own personal preferences for a different distribution.

I have no objection to passive expressions of preference. But I do have objection when people attempt to bolster their case for intervention by the state under the banner of distributive justice, morality, religion or whatever is supposed to evoke some objectivity.

I also have no objection to those who want to give efficacy to their views (mistaken or not) by giving away their own money – much like Jesus urged the rich man to do and then to follow him.

It is obvious that I cannot engage in a full-length treatment of this issue here. But I can list some of the questions and issues that serious people ought to consider.

1. There seems to be very little concern, in the popular press, for the causes of unequal distribution. This includes, especially, the causes of the increasing unequal distribution over the past few decades. (However, recessions seem to be good for reducing income at the top.) Reformers should always consider causes before advising cures.
2. There is a confounding of the results of a process that produces a distribution with the process itself. If person A steals money from person B, I object to the process (theft) first and foremost, and not to the resultant distribution of wealth. I really don’t care if it results in a more equal or less equal distribution.
3. If there is something wrong with the rules-of-the-game, that is, the process that generates wealth and income distribution, let us attend to that. For example, if people are getting rich because of the warfare state or because the institutions they work for are bailed out by taxpayer money, let us address those issues.
4. What exactly constitutes a more just distribution? The economist Paul Samuelson (and other amateur “moral philosophers”) used to equate, in his textbook, equity with greater income equality. (He famously, but ignorantly, said that the Soviet Union “chose” greater equity at the expense of efficiently – but nevertheless they would surpass us in wealth soon, anyway.)
5. Justice does not simply imply equality. Sometimes it implies equality and sometimes inequality (as when the criminal gets his punishment, but the rest of us do not).
6. Is it important that the positive entitlement to resources must be bought with the effort of others who might believe they have better uses for their money?
7. Why should the hierarchy of values that emerges out a political system — based on favors, special interests, power-plays, (rationally) ignorant voters, self-interested politicians, and people much less moral than you and me – dominate  over my and your moral judgments?
8. Do the putative moral claims of the “poor” stop at the water’ edge? Given that the poor of the US are rich by world standards, what kind of objective morality of distributive justice allows that “our” poor get preference over, say, North Korea’s poor? Do we have a tribal morality?
9. To what extent are the commentators (law professors and economists especially included) trying to publicly signal their “goodness” by using their technical skills to come up with schemes that pander to unthought-out popular prejudices. After all, how much respect from the general public can academics get by coming up with some theorem on the quasi-transitivity of preferences, or what not?
10. Last, but not least, do the redistributioners have any idea how the so-called welfare state works in practice? Do they know how the state uses one hand to make the poor poorer (unseen) and uses the other hand to help them out (seen)? Do they see the coming bankruptcy of the welfare state?

I wish people would perform the following intellectual experiment. Find out how much in federal taxes you have paid in the past year. Don’t worry about making any distinctions between the various payroll taxes and the income tax. It all goes into the same pot in the final analysis.

Now assume that this amount is in an account and that you are not allowed to spend any of it on yourself or your immediate family. Nevertheless, you are given a choice about how to spend it. What would you spend it on? Now compare that with what the federal government spends on. How do they match up?

How many of us would spend this money on:

1. The Iraq War
2. The War in Afghanistan
3. Subsidization of other people’s mortgages (Fannie and Freddie)
4. Prohibiting adults from smoking or otherwise ingesting marijuana
5. Subsidizing agricultural businesses
6. Sending arms to the Egyptian military
7. The state budget of Israel
8. Paying for the retirement incomes of people you have never met and know little about
9. The budget of the Palestinian Authority
10.  The abortions of the fetuses of strangers
11. The imprisonment of non-violent drug offenders?

You can make your own list. The key to the experiment is to get away from the thought that this is the government’s money and really think of it as yours.

Now it is true that the experiment “evades” various collective action problems. But let’s us imagine that your allocation would provide a significant portion of whatever public good may be at issue.

What I am getting at is this. To what extend does government spending really reflect what you actually care about? Wouldn’t your allocations be more concerned with the people and conditions around you? Would they be devoted to problems, causes or people you really know something about?