A Heartbeat Away

On the face of it, one of the stronger arguments against McCain/Palin is that McCain is older than dirt and will likely keel over any second now, and that Palin is too inexperienced to take over when that happens.

So what is the likelihood that McCain does indeed shuffle off this mortal coil shortly after being elected? I'm surprised that I haven't seen this probability published in any of the dozens of articles that I've read that have made the above argument.

I looked up the relevant probabilities in the Social Security Administrations Actuarial Life Table. I don't think there is any information regarding McCain that would allow us to do better than these tables. Yes, he's had skin cancer and his ancestors have died somewhat younger than average. On the other hand, he looks reasonably fit, healthy, and vibrant, and I think that pushes him back towards having typical life expectancy. Maybe not, but it's still an interesting exercise to consider life expectancies for typical men of McCain's age.

From the tables, McCain has close to 97% probability of surviving the first year and better than 85% chance of surviving all four years. So no, he's not all that likely to kick the bucket during the next presidential term.

Another way of looking at it is this. If experience is critically important, and you consider McCain to be adequately experienced, but Obama only to be 80% likely to be adequately experienced for situations that might come up in the next four years, you'd be better off voting for McCain, even if you think that Palin certainly does not have adequate experience.

Everything Else Palin' by Comparison

Wow!

I'm finding the buzz around McCain's VP pick astounding. I've seen more email and blog traffic on this subject than on anything other topic for months. I've gotten emails from left wing friends that I haven't heard from in eons (they hate her, of course). A fairly left wing egroup that I subscribe to (another group of friends) had dozens of posts regarding Palin (yes, they hate her too, but there was no way they were going to vote for McCain anyway). Compare this to the complete lack of interest in Joe Biden.

She's not my type (for example, she thinks Creationism should be taught in schools, which is a bit beyond the palin for me), but there's no doubt in my mind that McCain's campaign is getting huge publicity from his surprising pick, and as a result, I think it was an impressively good roll-of-the-dice. It may not work in the end, but hey, it's worth the shot.

The power of beliefs and ideas

Beliefs are a powerful motivator of human action. We are at the core moral believing animals. Our beliefs shape the culture and the culture shapes our beliefs. People will believe in something, sometimes anything. Bret Stephen offers us this :

None of this seems to trouble Mr. Gore. He thinks that simply by declaring an emergency he can help achieve Stakhanovite results. He might recall what the Stakhanovite myth (about the man who mined 14 times his quota of coal in six hours) actually did to the Soviet economy.

A more interesting question is why Mr. Gore remains believable. Perhaps people think that facts ought not to count against a man whose task is to raise our sights, or play Cassandra to unbelieving mortals.

Or maybe he is believed simply because people want something in which to believe. "The readiness for self-sacrifice," wrote Eric Hoffer in "The True Believer," "is contingent on an imperviousness to the realities of life. . . . All active mass movements strive, therefore, to interpose a fact-proof screen between the faithful and the realities of the world. They do this by claiming that the ultimate and absolute truth is already embodied in their doctrine and that there is no truth nor certitude outside it. . . . To rely on the evidence of the senses and of reason is heresy and treason. It is startling to realize how much unbelief is necessary to make belief possible."

Sometimes reconsidered ideas and notions allow us to adjust our beliefs as suggested in this :

Of the farm's whole New Age mission, Tim remarks: "The error was, I think, imagining that there was somewhere new to go, someone new to be. It became increasingly clear that a closed system of myth did not jibe with the world as it really was." Looking later at the outside world, Tim saw "a system formed less from malice than from a kind of natural order, less from inordinate greed than from longings much like our own for privacy, comfort, individual freedom, and one's familiar or chosen way of life."

A nice insight that would be helpful to many people!

Herb Meyer reminds us that sometimes the distortions provided by existing notions and beliefs totally disable our ability to perceive things realistically:

Now, imagine that half of you were looking at me through a prism - one of those long, triangular bars of glass. A prism refracts and disperses light, so everything you see through a prism is distorted. Those of you looking at me through a prism might see a tall man with purple skin. My sports jacket might look green instead of brown, and my shirt might look red instead of white. In short, if you're looking at me through a prism you'll get everything wrong.

Well, just as there are real prisms -- those long, triangular bars of glass - there are intellectual prisms, in our minds. And if you're looking at the world through an intellectual prism, you'll also get everything wrong.

He applies this idea to an observation:

Let me put this as starkly as I can: What's going on today in our country isn't normal politics. In normal politics honorable people will disagree, sometimes fiercely, about how best to deal with the issues that confront us - national security, border control, healthcare, education, energy, the environment, and all the rest. What's going on today is a kind of domestic Cold War -- a seemingly endless standoff, with the occasional hard skirmish -- between those of us who see the US for what it really is, and those of us who are seeing the US through a prism. And remember, unlike real prisms these intellectual prisms -- or, if you prefer, these political prisms -- are invisible. If you're looking at the US through a political prism, you don't know you're seeing through a prism and you won't believe anyone who tries to tell you that you are.

This is why Americans who see our country and the world through a prism are impervious to facts.

Although some people wish otherwise

Illya Somin, Assistant Professor of Law at George Mason University answers the question, is Hayek still relevant?

To very briefly summarize Hayek's two most important ideas, he argued that socialism can't work as an effective system for producing and distributing goods because it has no way of aggregating the necessary information about people's wants and needs. By contrast, the price system of the market is a very effective method for collecting and using information about people's preferences and the relative value of different goods. Hayek's 1945 article "The Use of Knowledge in Society" is the best short statement of this argument. Hayek also argued that government control of the economy under socialism necessarily leads to the destruction of democracy and personal freedom. The central planners' control of the economy enables them to crush potential opposition and strangle civil society. This, of course, was the main argument of Hayek's most famous book, The Road to Serfdom (1944).

Today's advocates of government planning are more modest in their ambitions than the mid-twentieth century socialists whom Hayek criticized. But they are not modest enough to make his arguments irrelevant.

I don't claim that Hayek was right about everything or that he perfectly foresaw our situation today. To the contrary, he made his share of mistakes. But his most important arguments haven't lost their relevance.

It is clear from what he has written that Mr. Somin has read Hayek rather extensively and to good effect. There is plenty more worth reading in his original post.

By coincidence I recently found this interview with Bruce Caldwell author of an intellectual biography titled Hayek's Challenge, also cited here. Here they are discussing The Road to Serfdom.

Kokai: This book is still influential more than 60 years after its publication. Do you think it is still going to have some influence 60 years from now?

Caldwell: I don’t think the basic human desire to control social phenomena, control society through social policy, is ever going to dissipate. And, in fact, I think it is a noble desire. I think that Hayek, though, points out certain problems that people encounter when they try to plan a society. So I think that message is one that we would forget only at our peril. I’ll just put it that way.

And so the disagreements between advocates of some form of ordered liberty and those advocating some form of statism go on and on and on!

The Accountant and the Ditch Digger

Who bears the costs of government spending?

This is an important question because there is a very widespread misconception that those who pay the taxes bear the costs. By very widespread I mean that I've recently discovered that virtually everybody except my co-blogger (Howard) and a few other economically savvy persons seem to have this misconception.

As a simplification, consider an economy with only two types of jobs: relatively lower income ditch diggers and relatively higher income accountants. Let's say that income tax rates are raised for the accountants but not the ditch diggers. The misconception is this change in the tax rates would have no adverse effect on the ditch diggers since only the accountants pay more. Unfortunately, that's not true.

One general rule of economics is that if you tax something, you get less of it. Yes, there are exceptions, but those exceptions aren't applicable here. In this case the tax is on accounting labor so there will be less accounting labor. The mechanisms for the reduction in accounting labor include accountants working less overtime (or working part-time) and accountants retiring earlier. In addition, fewer people will put in the effort to become accountants so over time there will be fewer accountants and more ditch diggers. Fewer accounting hours and more ditch digger hours means that accounting hours get more expensive relative to ditch digger hours (in other words, the price mechanism is used to allocate the remaining scarce accounting hours to those persons and business that need them). As a result, the ratio of the after tax incomes of accountants and ditch diggers doesn't change all that much when the tax rates are increased for accountants.

The following chart illustrates the concept fairly clearly. Changing the top tax rate on the rich has had remarkably little impact on overall tax revenues. I readily admit that there are some distortions that are amplified by the way the data for the chart has been chosen, but the underlying concept is still true: changing tax rates on the rich have remarkably little effect on total tax receipts.
In addition, the remaining accountants (those who haven't retired or left the profession) are now charging businesses more for their services (because they can). Those businesses pass on these costs in their goods and services to the consumer. So the ditch digger, who is now making less (since there are now more ditch diggers), is faced with higher prices for the goods and services he consumes. Sure, the accountant is also faced with these higher prices, but since accountants make many times what the ditch digger does, the higher prices have a smaller impact on the accountant's household budget.

The bottom line is that progressive earned income tax rates end up not really being all that progressive when you consider who ultimately bears the cost. The cost of government spending is borne by all and because they have less resources, the poor suffer from those costs more than the rich. No matter what.

Taxing the rich will get you fewer rich, but it won't make the poor better off.

Social Order

Culture matters, sometimes in a big way. See here:

Compared with students from developed Western nations, students from less democratic countries like Saudi Arabia, Oman and Belarus tended to punish not only free-loaders, but also cooperative players, with the result that cooperation in their groups plummeted.

When players had the option to punish, the groups tended to display more cooperation, which is consistent with past research showing that the ability to punish can help foster cooperative behaviour. However, in some countries, 'selfish' players also punished cooperative players, perhaps as a means of revenge for punishments they had suffered, or maybe as a way of punishing do-gooders for showing them up. The researchers called this 'anti-social punishment', and the groups where this occurred tended to cooperate less.

Anti-social punishment occurred more in those countries, including Belarus and Saudi Arabia, shown by surveys to have less faith in the rule of law and less belief in civic cooperation. In a commentary on the findings, published in the same journal, Herbert Gintis of the Sante Fe Institute, said the results challenge the way people have tended to view capitalist democracies. "The success of democratic market societies may depend critically upon moral virtues as well as material interests, so the depiction of civil society as the sphere of 'naked self-interest' is radically incorrect," he wrote.

Man existed as a social and political creature long before there was anything like a modern economy. Cultures in which the individual learns to compete and cooperate while possessing a moral compass based upon something like the golden rule are at a distinct advantage. They can gain from more of the positives and fewer of the negatives in a free market system compared with other cultures. Institutions are a reflection and reinforcement of a societys' culture and beliefs. That this matters and that a free a moral people will fare better than people in a culture of envy or a collectivist society is my idea of social justice.

Lawrence Reed on The Great Depression

see Great Depression Myths (extended excerpts) and full article:

The Great Depression was not the country’s first depression, though it proved to be the longest. Several others preceded it. The calamity that began in 1929 lasted at least three times longer than any of the country’s previous depressions because the government compounded its initial errors with a series of additional and harmful interventions.

The central bank took further deflationary action by aggressively selling government securities for months after the stock market crashed. For the next three years, the money supply shrank by 30 percent. As prices then tumbled throughout the economy, the Fed’s higher interest rate policy boosted real (inflation-adjusted) rates dra­matically.

Though modern myth claims that the free market “self-destructed' in 1929, government policy was the debacle’s principal culprit. If this crash had been like previous ones, the hard times would have ended in two or three years at the most, and likely sooner than that. But unprecedented political bungling instead prolonged the misery for over 10 years.

Smoot-Hawley by itself should lay to rest the myth that Hoover was a free market practitioner, but there is even more to the story of his administration’s interventionist mistakes. Within a month of the stock market crash, he convened conferences of business leaders for the purpose of jawboning them into keeping wages artificially high even though both profits and prices were falling. As economist Richard Ebeling notes, “The ‘high‑wage 'policy of the Hoover administration and the trade unions ... succeeded only in pricing workers out of the labor market, generating an increasing circle of unemploy­ment.”

Commenting decades later on Hoover’s admin­istration, Rexford Guy Tugwell, one of the architects of Franklin Roosevelt’s policies of the 1930s, explained, “We didn’t admit it at the time, but practically the whole New Deal was extrapolated from programs that Hoover started.”

Though Hoover at first did lower taxes for the poorest of Americans, Larry Schweikart and Michael Allen in their sweeping A Patriot’s History of the United States: From Columbus’s Great Discovery to the War on Terror stress that he “of­fered no incentives to the wealthy to invest in new plants to stimulate hiring.” He even taxed bank checks, “which accelerated the decline in the availability of money by penalizing people for writing checks."

Compounding the error of high tariffs, huge subsidies, and defla­tionary monetary policy, Congress then passed and Hoover signed the Revenue Act of 1932. The largest tax increase in peacetime history, it doubled the income tax. The top bracket actually more than doubled, soaring from 24 percent to 63 percent.

Can any serious scholar observe the Hoover administration’s mas­sive economic intervention and, with a straight face, pronounce the inevitably deleterious effects as the fault of free markets?

Economist Jim Powell ... points out that “Almost all the failed banks were in states with unit bank­ing laws” — laws that prohibited banks from opening branches and thereby diversifying their portfo­lios and reducing their risks. Pow­ell writes: “Although the United States, with its unit banking laws, had thousands of bank failures, Canada, which permitted branch banking, didn’t have a single failure ...” Strangely, critics of capitalism who love to blame the market for the Depression never mention that fact.

Roosevelt secured passage of the Agricultural Adjustment Act, which levied a new tax on agri­cultural processors and used the revenue to supervise the wholesale destruction of valuable crops and cattle. Federal agents oversaw the ugly spectacle of perfectly good fields of cotton, wheat, and corn be­ing plowed under (the mules had to be convinced to trample the crops; they had been trained, of course, to walk between the rows). Healthy cattle, sheep, and pigs were slaugh­tered and buried in mass graves. Secretary of Agriculture Henry Wallace personally gave the order to slaughter six million baby pigs before they grew to full size. The administration also paid farmers for the first time for not working at all.

Benjamin M. Anderson writes, “NRA was not a revival measure. It was an antirevival measure. ... Through the whole of the NRA pe­riod industrial production did not rise as high as it had been in July 1933, before NRA came in.”

Roosevelt next signed into law steep income tax increases on the higher brackets and introduced a five-percent withholding tax on corporate dividends. He secured another tax increase in 1934. In fact, tax hikes became a favorite policy of Roosevelt for the next ten years, culminating in a top income tax rate of 90 percent. Senator Ar­thur Vandenberg of Michigan, who opposed much of the New Deal, lambasted Roosevelt’s massive tax increases. A sound economy would not be restored, he said, by following the socialist notion that America could “lift the lower one-third up” by pulling “the upper two-thirds down.”

Columnist Walter Lippmann wrote in March 1938 that “with almost no important exception every measure he [Roosevelt] has been interested in for the past five months has been to reduce or discourage the production of wealth.”

As pointed out earlier in this essay, Herbert Hoover’s own version of a “New Deal” had hiked the top mar­ginal income tax rate from 24 to 63 percent in 1932. But he was a piker compared to his tax-happy succes­sor. Under Roosevelt, the top rate was raised at first to 79 percent and then later to 90 percent. Economic historian Burton Folsom notes that in 1941 Roosevelt even proposed a whopping 99.5-percent marginal rate on all incomes over $100,000. “Why not?” he said when an advi­sor questioned the idea.

After that confiscatory proposal failed, Roosevelt issued an executive order to tax all income over $25,000 at the astonishing rate of 100 percent. He also promoted the lowering of the personal exemption to only $600, a tactic that pushed most American families into pay­ing at least some income tax for the first time. Shortly thereafter, Con­gress rescinded the executive order but went along with the reduction of the personal exemption.

The relent­less assaults of the Roosevelt ad­ministration — in both word and deed — against business, property, and free enterprise guaranteed that the capital needed to jump-start the economy was either taxed away or forced into hiding. Not until both Roosevelt and the war were gone did investors feel confident enough to “set in motion the postwar investment boom that powered the economy’s return to sustained prosperity.”

Those who can survey the events of the 1920s and 1930s and blame free-market capitalism for the economic calamity have their eyes, ears, and minds firmly closed to the facts. Changing the wrong-headed thinking that constitutes much of today’s conventional wisdom about this sordid historical episode is vital to reviving faith in free markets and preserving our liberties.

Note: If you read the full article, I disagree with the authors' characterization of the state of social security. A minor adjustment to retirement age buys substantial time to complete a fix.

Gene Smiley on The Great Depression

A review of the Gene Smiley book is here:

...the 1920s had been a period of dramatic economic growth and technological innovation that was lowering the costs of manufacturing and increasing the supplies of a wide variety of goods and services supplied to the consuming public.

Only agriculture remained to a great degree in the doldrums. With the end of the First World War, the global demand for American farm products had declined and the farming community had failed to adjust to the new international market situation. Once the Great Depression began, unemployment kept rising until it reached about 25 percent of the work force in late 1932. Both manufacturing output and construction decreased significantly, and international trade experienced a major decline.

He sees a primary source of the problem in the return to the gold standard by countries such as Great Britain at a rate of exchange that was too high relative to the domestic level of prices and wages that had been created by the wartime inflation. The problem was that the British trade unions had become too strong and wouldn’t accept cuts in money wages, and the British government was not willing to devalue the pound. Hence, Britain went into the Great Depression already in a severe recession.

...in 1927 and 1928 the Federal Reserve had increased the money supply to keep the stock market and construction booms going. Then the Fed brought the monetary expansion to a halt in late 1928 and 1929. That set the stage for the stock-market crash.

The economic policies of the Hoover administration were an unmitigated disaster. Taxes were raised and the government set up subsidy programs to prop up both unprofitable industries and wasteful agricultural production. Congress passed the Hawley-Smoot tariff that raised import taxes to a historical high, which set off an international trade war that ruined import and export markets around the world.

Anti-competitive price and wage rigidities were the primary reason the Depression grew in intensity as the early 1930s progressed, Smiley emphasizes.

The growing circle of unprofitable businesses in the face of these price and wage rigidities undermined the banking system, as an increasing number of enterprises could not pay off their loans. Bank-depositor panics broke out that led to bank runs. The financial sector of the American economy, as a result, went into a tailspin. The banking crisis was at its worst in the period between the November presidential election of 1932 and Franklin D. Roosevelt’s inauguration in March 1933.

Smiley persuasively shows with a thorough and detailed analysis of the facts that, contrary to many popular impressions, Roosevelt’s New Deal did not end the Great Depression. Instead, it prolonged the imbalances and distortions and indeed in many cases made them worse.

Economic improvement began only after the U.S. Supreme Court declared most of the New Deal systems of planning and controls to be unconstitutional in 1935 and 1936. To the extent that the private sector was freed from the heavy hand of direct government supervision, industries slowly began to adjust and expand output and add to their labor forces. But Smiley explains that Roosevelt undermined this recovery in 1936 and 1937. Angry that the Supreme Court had thrown out most of the central features of his New Deal, he went on an anti-business crusade that weakened business confidence in the political and economic future.

Then, in 1937-38, the American economy experienced a new depression within the Great Depression, owing to the Federal Reserve’s raising reserve requirements on commercial banks, which induced a monetary contraction and a decline in investment lending. Durable-goods manufacturing fell by 67 percent between May 1937 and May 1938.

Smiley calculates that during both the 1930s and the war years of the 1940s, the American economy experienced periods of capital consumption, when capital equipment and other durable production assets were not replaced as they were worn out.

The enduring legacy of the Great Depression, Smiley concludes, has been a total misunderstanding of this period: it was government mismanagement and intervention that created this economic crisis. And furthermore, what the government did during the decade of the 1930s left us with the institutional burden of the regulated economy and the welfare state. “What failed in the 1930s were governments, in their eagerness to direct activity to achieve political ends,” Smiley says at the end of this insightful and valuable work. “It has taken us a long time to begin to understand these costly lessons of the 1930s.”

Tim Worstall on The Great Depression

Tim Worstall shares some thoughts on current circumstances and The Great Depression here:

Betting upon a second Great Depression, or are you like me and thinking that yes, we've got some tough times coming, but the only people that can create disaster are the politicians? Sadly, that last isn't quite as comforting as it could be for it was the politicians and bank regulation itself that created the first depression: as long as we don't make the same mistakes again (or newer and even more inventive ones) the disaster, although perhaps not a recession, can be avoided.

Yes, irrational exuberance in the 20s, then the Great Crash, then recession. So far, so very like our own times. But what took it from a crash to a depression, that's the part we want to know, so that we can avoid doing that.

I don't think tariffs were the real problem. No, I think the blame should be on three things. The first is that the Fed refused to cut interest rates. The second was a large tax rise so as to cut the budget deficit (alarming as it may seem, Keynes was right in part, deficit spending does mitigate recessions, it's the cutting of the spending in the good times that governments have so much problem with). The third was the then extant system of bank regulation.

U.S. banking then was based on the single branch model: banks did not have widely diversified portfolios of risks, either geographically or by industry sector. Rather, all of their exposure was concentrated in the immediate hinterlands of their one deposit taking branch. This led to a certain fragility: it's worth noting that in Canada no banks went bust, while 8,000 did in the US. Canadian banks were allowed to operate countrywide, thus providing them with that diversification. It's that mass bankruptcy of banks which turned the shrinking of the credit markets into a rout.

Which brings us back to today: we see people arguing for some of the same things, but let's try not to make those same mistakes again, shall we? The first and most obvious is that we should ignore those siren calls for tax hikes, whether they're from deficit hawks or from those insistent that “the rich” should pay more. No, in an economy with contracting credit deficit spending is a rather good idea. Bernanke and his boys are most certainly not leaving interest rates too high, so that's one thing we don't need to worry about. Which leaves us, domestically, with just one thing—bank regulation.

Yes, we do have successive financial crises, that's in the nature of a market system that people will try new things and some of them will be stupid (making a loss is the market's way of telling you that you are indeed doing something stupid), but they're not all caused by the same things. Limits upon the mortgage markets and syndication are simply unneccessary: no one is going to make that mistake again, as they're not going to overinvest in telecoms companies with “interesting” accounting techniques, nor internet stocks, nor emerging nations, to give just a flavor of what has caused previous problems. Lessons learned at the cost of hundreds of billions of dollars tend to stay learned.

The second revolves around that very diversification which we would rather like banks to get themselves involved in. Christian Noyer, the governor of the French Central Bank (in reality, he's the provincial manager of the French branch of the European Central Bank) makes the point that the sub-prime crisis isn't going to topple European banks precisely because “their model of universal banking allows them to mitigate the consequences of a crisis in one segment of their activity.“ UBS may have been hit with vastly larger losses than Bear Sterns, but it didn't go bust because it has other business lines and resources to draw upon.

More good points in the article... I think trade might have been more important than he thinks because of the corresponding capital flows and investment stemming therefrom. Also, as for lessons learned, new mistakes will be made unlike the old ones but limits on leverage are appropriate for review to guard against systemic risk.

Intellectual Shift

Many of the posts on this blog are written with the idea of countering arguments in support of the great tide of statism that rolled across the globe in the past century. Personally, I wish to avoid traveling along The Road to Serfdom.

As described in The Industrial Counterrevolution :

In the wake of the Industrial Revolution and the arrival of mechanized mass production, a powerful new idea began to take hold and remake the world in its image. That idea, reduced to its bare essence, was that the economic revolution of industrialization both enabled and required a revolution in social organization: the eclipse, partial or total, of markets and competition by centralized, top-down control. The intellectual and political movements spawned by this idea emerged in the last quarter of the 19th century and utterly dominated the first three-quarters of the 20th.

In analytical terms, the common intellectual thread that runs through all of these movements -- namely, the rejection or demotion of market competition in favor of top-down control -- represents a direct assault on the principles of social order that gave rise to industrialization and are truest to its full promise.

According to Deepak Lal in Reviving the Invisible Hand (p.65):

There had been some extension of government intervention in the late nineteenth century with the passage of antitrust legislation following populist attacks against the “robber barons.” But it was Roosevelt’s New Deal which led to “an ideological shift – from widespread skepticism about the ability of the central government to improve the functioning of the economy to widespread faith in the competence of government.”

Rockoff argues that the Depression in itself could not have been responsible for this shift, as there were earlier crises in the 1830s and 1890s, with severely depressed incomes and high unemployment which did not lead to a dirigiste response. He argues that a change in the dominant ideology among intellectuals and opinion-makers was responsible. As George Stigler was first to point out, this change in opinion was not based upon any hard empirical evidence. The European move to dirigisme, their construction of the welfare state, and the supposed success of Stalinist planning in transforming an underdeveloped Russia, were the dominant factors in the change of opinion. This process was aided by the development of Keynesian economics and welfare economics, which, as Myint noted, with its: “emphasis on market failures, externalities, and the divergences between social and private costs, has for many decades been a powerful intellectual force behind interventionist policies.”

Not till the stagflation of the 1970s did opinion shift toward the more skeptical view of government of the nineteenth century. This had been presaged by the growing recognition that, because of problems related to information and incentives, planning and Keynesianism were not the touted panaceas, while the “new” political economy showed how most welfare programs would be capture by the “middle classes.”

Many intellectuals are still denouncing the more recent movement towards greater economic freedom in the world. I wish to counter their peddling of defective ideas.

The Role of Profit

Here are a few different takes:

At least when a society has the appropriate institutions and government policies, the overwhelming majority of the firms that make huge profits are doing a huge service to the population. In a society with the right institutions and public policies, the prevailing prices will approximate the true values and costs of marginal quantities of the goods and productive inputs. A great excess of revenues over costs means that the enterprise is almost certainly putting more value into the society than it is taking out.

Mancur Olson (scroll down at link)

What intellectuals steeped in constructivist presuppositions find most objectionable in the market order, in trade, in money and the institutions of finance, is that producers, traders, and financiers are not concerned with concrete needs of known people but with abstract calculation of costs and profit. But they forget, or have not learned, the arguments that we have just rehearsed. Concern for profit is just what makes possible the more effective use of resources. It makes the most productive use of the variety of potential support that can be enlisted from other business undertakings. The high-minded socialist slogan, 'Production for use, not for profit', which we find in one form or another from Aristotle to Bertrand Russell, from Albert Einstein to Archbishop Camara of Brazil (and often, since Aristotle, with the addition that these profits are made `at the expense of others'), betrays ignorance of how productive capacity is multiplied by different individuals obtaining access to different knowledge whose total exceeds what any single one of them could muster. The entrepreneur must in his activities probe beyond known uses and ends if he is to provide means for producing yet other means which in turn serve still others, and so on – that is, if he is to serve a multiplicity of ultimate ends. Prices and profit are all that most producers need to be able to serve more effectively the needs of men they do not know. They are a tool for searching – just as, for the soldier or hunter, the seaman or air pilot, the telescope extends the range of vision. The market process gives most people the material and information resources that they need in order to obtain what they want. Hence few things are more irresponsible than the derision of concern with costs by intellectuals who, commonly, do not know how to go about finding out how particular results are to be achieved at the least sacrifice of other ends. These intellectuals are blinded by indignation about that essential chance of very large gains that seem disproportionate to the effort required in a particular case, but that alone makes this kind of experimentation practicable.

It is hence hard to believe that anyone accurately informed about the market can honestly condemn the search for profit. The disdain of profit is due to ignorance, and to an attitude that we may if we wish admire in the ascetic who has chosen to be content with a small share of the riches of this world, but which, when actualised in the form of restrictions on profits of others, is selfish to the extent that it imposes asceticism, and indeed deprivations of all sorts, on others.

Hayek on profit (from The Fatal Conceit)...


I had been contemplating writing a short post about the role of profit for some time. Fortunately, Professor Steven Horwitz did such a nice job.

One of the more common complaints of critics of the market is that “the profit motive” works at cross-purposes with people and firms doing “the right thing.” The overarching problem with blaming a “motive” is that it ignores the distinction between intentions and results. That is, it ignores the possibility of unintended consequences, both beneficial and harmful.

What we care about is whether the goods get delivered, not the motives of those who provide them. Smith led economists to think about why it is that, or under what circumstances, self-interest leads to beneficial unintended consequences. It is perhaps human nature to assume that intentions equal results, or that self-interest means an absence of social benefit, as was often the case in the small, simple societies in which humanity evolved. However, in the more complex, anonymous world of what Hayek called “the Great Society,” the simple equation of intentions and results does not hold.

As Smith recognized, what determines whether the profit motive leads to good results are the institutions through which human action is mediated. Institutions, laws, and policies affect which activities are profitable and which are not. A good economic system is one in which those institutions, laws, and policies are such that the self-interested behavior of producers leads to socially beneficial outcomes. In mixed economies like that of the United States, the institutional framework often rewards profit-seeking behavior that does not produce social benefit or, conversely, prevents profit-seeking behavior that could produce such benefits. For example, if agricultural policy pays farmers not to grow, then the profit motive will lead to lower food supplies.

Labeling the profit motive as the source of the problem enables the critics to ignore the really difficult questions about how institutions, policies, and laws affect the profit-seeking incentives of producers and how that profit-seeking behavior translates into outcomes. Placing the blame on the profit motive without qualification simply overlooks the Smithian question of whether better institutions would enable the profit motive to generate better results and whether current policies or regulations are the source of the problem because they guide the profit motive in ways that produce the very problems the critics identify.

Placing blame for social problems on the profit motive is also easy if critics offer no alternative. What should be the basis for determining how resources are allocated if not in terms of profit-seeking behavior under the right set of institutions? How should people be motivated if not by profit? Often this question is just ignored, as critics are merely interested in casting blame. When it is not ignored, the answers can vary, but they mostly invoke a significant role for government. The implicit assumption, of course, is that the government personnel will not be motivated by profits or self-interest in the same way as the private-sector producers are.

How realistic this assumption is remains highly questionable. Why should we assume that government officials are any less self-interested than private individuals, especially when the door between the two sectors is constantly revolving? And if government officials do act in their self-interest and are motivated by the political analogs of profits (for example, votes, power, budgets), will they produce results that are any better than the private sector’s?

To blame the profit motive without asking whether an alternative will better solve the problems supposedly caused by the profit motive is to bias the case against the private sector.

Even this argument, however, does not go far enough. We are still, after all, focused on intentions and motivation. What critics of the profit motive almost never ask is how, in the absence of prices, profits, and other market institutions, producers will be able to know what to produce and how to produce it. The profit motive is a crucial part of a broader system that enables producers and consumers to share knowledge in ways that other systems do not.

For many critics of the profit motive, the problem is solved because public-spirited politicians and bureaucrats have replaced profit-seeking firms. Well, not so fast. By what method exactly will the officials know how to allocate resources?

In markets with good institutions, profit-seeking producers can get answers to these questions by observing prices and their own profits and losses in order to determine which uses of resources are more or less valuable to consumers. Rather than having one solution imposed on all producers, based on the best guesses of political officials, an industry populated by profit seekers can try out alternative solutions and learn which ones work most effectively. Competition for profit is a process of learning and discovery.

Thus the real problem with focusing on the profit motive is that it assumes that the primary role of profits is to motivate (or in contemporary language “incentivize”) producers. If one takes that view, it might seem relatively easy to find other ways to motivate them or to design a new system where production is taken over by the state. However, if the more important role of profits is to communicate knowledge about the efficiency of resource use and enable producers to learn what they are doing well or poorly, the argument becomes much more complicated. Now the critics must explain what in the absence of profits will tell producers what they should and should not do. Eliminating profit-seeking from an industry doesn’t just require that a new incentive be found but that a new way of learning be developed as well. Profit is not just a motive; it is also integral to the irreplaceable social learning process of the market.

Regardless of which explanation resonates best with you, it is vital to grasp the role of profit in order to better understand the functioning of a free market system.

Update: Liberty Lover weighs in:

...government managers have different incentives then private sector managers. They manage for the approval of politicians and other government employees rather than for profit and customers. For another thing, they have distorted information about what to produce, how much, which people should do what, and which resources should be allocated. Price controls hide these signals. Prices indicate the relative scarcity, demand, and supply of things.

Public Choice Theory and Taxation

I noticed this column in the WSJ the other day:

"People say all the time: 'We can't pick winners and losers.' Well then fine. Take every single dollar of subsidy out of the federal tax code. Get rid of it all. . . . Let's have a real level playing field where nobody gets a penny in subsidy."
– Hillary Clinton, quoted in USA Today, April 5, 2008

Now, there's a capital idea – and just in time for April 15. The simplest, fairest and most economically efficient tax code would end all special interest tax advantages and flatten tax rates. Except Mrs. Clinton was ridiculing this idea. She went on to say that if subsidies vanish from the tax code, we'd "hear the squeals of protest from Wall Street to Houston to Silicon Valley."

Her philosophy certainly fits with that of the current Congress, which is becoming a tax loophole production factory for the powerful.
...
This giveaway came only a few weeks after the National Association of Home Builders threatened to suspend their PAC contributions to Congress "until further notice" – meaning until they saw more return on their political investments. Congratulations. That gambit paid off big time. Other winners include the large Wall Street banks that have lost money in the subprime mortgage meltdown, including Citigroup, Merrill Lynch and Morgan Stanley, which also qualify for rebates to offset current losses.

With this loophole factory open for business on Capitol Hill again, business lobbies are spending more money than ever to curry Congressional favor.

At least this exercise is making clear what Democrats really mean by tax "fairness." It means raising tax rates so they can then sell tax breaks to the highest corporate bidder. We have certainly come a long way from 1986, when a Democratic Congress joined with Ronald Reagan to strip the tax code of most tax deductions and lower tax rates to a high of 28%. That reform spirit is dead on Capitol Hill.

When people in great numbers profess to want tax simplification or the elimination of subsidies of various kinds and yet politicians ignore this it is often fruitful to examine the matter from a public choice theory perspective. Who better to turn to in such matters than James Buchanan.

I am reminded of this, reviewed here:

The editor of the Journal of Economic Perspectives, Joseph Stiglitz, asked me to write a piece assessing the 1986 act from a public-choice perspective. I wrote an article that was pub­lished in 1987 in the Journal of Economic Perspectives (Bu­chanan 1987). I am very glad I am on record with that piece because all of my predictions turned out to be precisely on target. Because I predicted from a public-choice perspective that Congress had exhausted the rents that it could get from selling loopholes. Therefore if it could sweep them all clear and cut the rates, it would then have the chance to raise more revenue by immediately starting raising rates again with a wider base, which is what Congress did. Second and more important, once Congress had wiped out all those rents, it could then start reselling the rents. And of course that is exactly what happened. The act was hardly cool off the presses when Congress started putting in new loopholes, new changes. It did that in the 1990 schemes, and it did that again in the 1992 schemes, and, of course, Clinton is doing that with abandon now. When they talk about targeted taxes and targeted programs, which is nothing more than selling loopholes for these rents. I am unhappy, as Richard Mus­grave surely is, with what has happened since the 1986 act, but that is predictable, necessarily predictable, given the way we make tax policy. And I think if you come at this from a public-choice constitutionalist perspective, you do in fact get a totally different view on the whole fiscal state or fiscal structure.

The members of the sausage factory known as Congress are very adept at acquiring campaign contribution or other things they are desirous of in return for various tax breaks, subsidies or protection from onerous regulation (wait that last one is a good thing) . This is one reason why changes with very broad support are often difficult to realize.

Plasticity

I thought that this post at the blog of John Rutledge was worthwhile.

Plasticity is a property of a system that allows it to improve its efficiency by adapting to changes in its environment by altering its structure. Columbia's Eric Kandel won a Nobel Prize for showing that repeated environmental stimuli (electric shocks, etc.) lead to physical growth of neurons that dramatically alter the number of synapses, or contact points, between neighboring neurons.

This dynamic co-evolution of an organism and its environment--called epigenesis--is very important. In particular, Bruce Wexler's Brain and Culture: Neurobiology, Ideology, and Social Change details research showing that children's brains exhibit a high degree of plasticity up until about 1 years old but a dramatic loss of plasticity after that.

Essentially, children re-wire their brains to fit comfortably in the environment they see (which is why we all want to go back to our childhoods). If the environment does not change much, they will function efficiently. But if the environment changes to a dramatically different one after they lose plasticity, they experience cognitive dissonance, a permanently fearful and anxious state. Adults in this condition are not easy to get along with. They also violently resist seeing their children morph to fit the new environment. The result is conflict.

The rapid change brought on by improvements in communications technology and globalization has placed many people in this state. Fundamentalism, terrorism, genocide, protectionism, immigration, and outsourcing battles all reflect its cost. But attempts to stop change are futile. The answer is finding ways to reduce its cost by reducing the frictions that transform rapid change to turbulence.

There are two primary points I wish to emphasize in relation to this material. First, progress would be greatly aided by finding effective approaches that help people cope with the disorienting aspects of rapid change. Of course they may wish to resist all change. Second, the extended order of human cooperation is like a highly plastic brain. Multitudes of new connections can be made, old connections can persist or fade rapidly as in creative destuction, but unlike a brain, the stucture of such a network is infinitely exspansible and gives rise to emergent new powers.

Celepanic...

... or is that panibrate?

My company won two very important contracts in the last five days that more or less double the company's revenue for the coming year and lay the foundation for large future growth. We had been working on getting these contracts for several years.

So celebration is in order!

But I'm having a little trouble celebrating because I'm also very close to full scale panic. Where on earth am I going to be able to hire all the high quality people I need starting tomorrow? Unemployment ticked up and some people say we're in a recession, but I can tell you the number of available highly skilled roboticists in the San Diego area is very, very small.

In addition to the recruiting nightmare, I have oodles of system engineering to do for these new projects while keeping the current projects going as well.

This almost certainly signals a significant blogging break. Hopefully my co-blogger will pick of the slack...

The Industrial Counterrevolution

In an earlier post I referenced a very fine book mentioned here authored by Brink Lindsey. Drawing upon a more limited portion of the material therein he wrote an article available here. Excerpts follow:

How nationalism, protectionism, and collectivism spawned a century of dictatorship and war.

Globalization, by any other name, was in full swing a century ago. Indeed, it was remarkably advanced, even by contemporary standards.

In 1913, merchandise trade as a percentage of gross output was about 12 percent for the industrialized countries. They did not match that level of export performance again until the 1970s. The volume of international capital flows relative to total output reached heights in the early 20th century that have not been approached since.

The first world economy was made possible by the staggering technological breakthroughs of the Industrial Revolution. Most obviously, new forms of transportation toppled the age-old tyranny of distance. For inland transport, the significance of the railroad is difficult to overestimate.

The railroads knitted countries into truly integrated national markets and facilitated the penetration of foreign goods from port cities into the interior.

Meanwhile, another technology was uniting those national markets into a global whole. Although the steamship was first developed early in the 19th century, further innovations in subsequent decades -- the screw propeller, steel hulls, the compound engine -- transformed what had been primarily a river vessel into cheap and reliable ocean transport. The effect on freight costs was nothing short of spectacular: An index of freight rates along Atlantic export routes fell by 70 percent in real terms between 1840 and 1910.

The Industrial Revolution's burst of technological creativity thus demolished the natural barriers to trade posed by geography. At the same time, it created entirely new possibilities for beneficial international exchange.

So arose the initial grand bargain on which the first global division of labor was based: The core specialized in manufacturing, while the periphery specialized in primary products. For Great Britain, the first industrial power, manufactured goods constituted roughly three-quarters of its exports. The sprawling United States, on the other hand, straddled both core and periphery.

While far-flung foreign trade is as old as human history, this was something new. No longer was such commerce a marginal matter, limited to a few high-value luxuries. Now, for the first time, specialization of production on a worldwide scale was a central element of economic life in all the countries that participated.

But it was not to last. The global economic order that arose and flourished in the waning years of the 19th century was swept away by the great catastrophes of the 20th: world wars, the Great Depression, and totalitarian dictatorships. Only in the past couple of decades has a truly global division of labor been able to reemerge.

According to contemporary critics of global trade, the sad fate of that earlier epoch reveals the inherent dangers of unregulated markets. Then as now, they argue, economic forces had slipped all proper constraints; then as now, the ideology of laissez-faire ran roughshod over social needs.

These arguments are an almost perfect inversion of the truth. The tragedies of the 20th century stemmed, not from an over-reliance on markets, but from a pervasive loss of faith in them. In the wake of the Industrial Revolution and the arrival of mechanized mass production, a powerful new idea began to take hold and remake the world in its image. That idea, reduced to its bare essence, was that the economic revolution of industrialization both enabled and required a revolution in social organization: the eclipse, partial or total, of markets and competition by centralized, top-down control. The intellectual and political movements spawned by this idea emerged in the last quarter of the 19th century and utterly dominated the first three-quarters of the 20th. This 100-year historical episode, though composed of diverse and widely varying elements, possesses enough coherence to merit a name, and the one I suggest is the Industrial Counterrevolution.

In analytical terms, the common intellectual thread that runs through all of these movements -- namely, the rejection or demotion of market competition in favor of top-down control -- represents a direct assault on the principles of social order that gave rise to industrialization and are truest to its full promise.

It is impossible to understand the collapse of the first world economy, or the rise of the present one, except in relation to the Counterrevolution's centralizing impulses. For the story of globalization and the story of the Industrial Counterrevolution are mirror images of one another: In the early decades of the 20th century, the rise of collectivism spelled the demise of the global economy; in the past couple of decades, the loss of faith in the collectivist dream has allowed globalization to resume its course.

It is clear enough that the final breakdown of international economic integration during the calamitous 1930s was an extended consequence of the Great War. What is less well known is how the collectivist delusion helped to lead the world toward that awful conflict -- and thus toward all the horrors that followed in its wake.

At the midpoint of the 19th century, a very different future appeared to be on the horizon. The liberal creed of cosmopolitanism, free trade, and peace promised to define the shape of things to come.

The liberal champions of free trade did not view their cause solely or even primarily as a commercial matter. In their view, free trade carried profound implications for the whole field of international relations.

The free traders' sunny cosmopolitanism all too quickly gave way to a very different vision of the international scene. As the Industrial Counterrevolution began to gather momentum, the prospect of a world at peace started to recede. A new prospect, dark and menacing, came in its stead to the fore -- one of rival nations, rival races, pitted in fundamental and irresolvable conflict, engaged in a grim and merciless struggle for supremacy or submission. This radical and ruinous shift of perspective did not merely coincide with the spreading enthusiasm for centralization and top-down control; rather, the two developments were interconnected and mutually reinforcing.

The momentum of the Industrial Counterrevolution pushed inexorably toward expanding the power of the national state.

Many other emerging centralizing movements embraced an expanded national state from the outset. Edward Bellamy, American author of the utopian fantasy Looking Backward and a major influence on subsequent Progressive and New Deal intellectuals, called his philosophy "nationalism" to distinguish it from Marxist-style socialism. In Great Britain, the Fabians advocated incremental reform and a political strategy of "permeation," or working through established political parties. And in Germany, the conservative, Bismarckian "state socialists" were unabashed in their devotion to the national state. Characteristic in this regard was the economist Gustav Schmoller, who proclaimed the state to be "the most sublime ethical institution in history."

Furthermore, the growing enthusiasm for national economic planning was fundamentally at odds with the new international division of labor. After all, if centralized decision making is more efficient than markets, why allow international markets to persist?

A new collectivist case for protectionism thus began to emerge. If a nation's economic life is to come under central control, that control must extend to the nation's connections with the outside world.

It is true that many partisans of centralization, especially on the Left, resisted the protectionist logic of their position. Free trade appealed to their internationalist sympathies; also, a low-tariff policy was generally associated with cheap bread and thus was widely considered favorable to the working class. (How times have changed!) The momentum of centralization, though, generally prevailed over tradition and class interests. In the end, the fortunes of collectivism and protectionism rose together. In the middle of the 19th century, enlightened opinion was almost uniformly in favor of free trade; by the end of the century, protectionism had once again become intellectually respectable.

Protectionist measures did slow the pace of globalization (and blocked it for certain regions and sectors), but did not stop it. Despite increasing obstacles, the internationalization of economic life flourished in the decades before World War I.

Nevertheless, the drift toward protectionism did contribute to a new international atmosphere of conflict and tension. In Bellamy's utopia, national planners could somehow control their imports and exports without so much as a cross word from abroad. But in reality, restrictions on trade inevitably set nations against each other.

The implications of trade barriers for international relations are thus enormous. In a world of free trade, citizens of one country can exploit the benefits of a broader division of labor through peaceful commerce. But in a world where severe trade restrictions are endemic, such benefits can be attained only through warfare -- through defeat of the foreign sovereignty that blocks access to the desired products or markets. Free trade makes war economically irrational; protectionism, carried far enough, makes it pay.

The drive toward centralization had thus transformed the legacy of the industrial revolution from that of world peace to one of a world at war. It is indeed fitting to call this transformation an Industrial Counterrevolution in international affairs.

The result was that collectivism and militarism became mutually reinforcing. Aggressive nationalism was needed to secure and safeguard the full blessings of collectivism; at the same time, collectivization was needed to render the nation fit for military conflict. From this basic feedback loop issued the great tragedies of dictatorship and total war.

It is customary to view World War I as a tragic accident. But at a deeper level, the war was no accident. It was a product of the ideas of the Industrial Counterrevolution: ideas of centralization that merged into statism, ideas of statism that merged into aggressive nationalism, ideas of nationalism that merged into plans for military conquest.

The Russian Revolution and the rise of fascism were direct outgrowths of the Great War. Less obviously, so was the Great Depression. Postwar efforts to reconstitute the old international economic system, in particular the gold standard, were enacted under the badly distorted and volatile conditions of the time, leading ultimately to disastrously deflationary monetary policy in the United States and Europe. In the 1930s, the combination of economic catastrophe and predatory totalitarianism -- both aftershocks of the Great War -- spelled the end of the first global economy and precipitated a second global war. So ended the descent into fire and chaos that began with the guns of August.

When critics of global trade claim that the phenomenon's first, failed episode should be seen as a warning against reckless faith in markets, they are standing history on its head. In truth, the first global economy was destroyed by the antithesis of economic liberalism -- namely, the misbegotten dream of central planning and social engineering that inspired the Industrial Counterrevolution in all its variants. The collectivist delusion was flatly incompatible with an international division of labor: When the former was ascendant, the latter could not survive. For collectivism invariably attached itself to the ready means of the nation-state, and once so ensconced, it helped to stoke aggressive, beggar-thy-neighbor nationalism. In a world of centralized and increasingly regimented states whose interests could not help but clash, conflict was inevitable. And when war came, its terrible fury hatched new monsters: ruinous economic disruption and barbaric totalitarianism. The gossamer bonds of trust and mutuality that sustain a global marketplace had no chance against such an onslaught.

Only in the past couple of decades has the counterrevolutionary momentum exhausted itself in disillusionment and failure. And as overweening state control has receded -- with the opening of China, the fall of the Soviet empire, and many Third World countries' abandonment of state-dominated models of development -- market connections have been reestablished. The death of the dream of centralized control has marked the rebirth of globalization.

But the collectivist past continues to cast long shadows. The move toward more liberal policies has occurred amidst the ruins of the old order, and so has had to contend with grossly deformed conditions. The transition, as a consequence, has been wrenching and often brutally painful. And that transition is far from complete. The world economy is littered still with the wreckage of discredited systems, constraining the present and obscuring the future. Life has left the old regime, but the dead hand of its accumulated institutions, mindsets, and vested interests continues to weigh heavily upon the world. Against that dead hand -- which includes, among other things, the ideologically distorted misunderstanding of globalization's past -- the cause of freedom must contend for many decades to come.

While one can offer alternate narratives, I think this perspective has substantial validity. In some sense this period could be thought of as an exploration of alternative arrangement in political economy. In a starker light, it could be viewed as political failure on a global scale.

The Fed - just get over it!

Jerry Bowyer makes some relevant points:

During the panic of 1907, J. P. Morgan stepped in and created a consortium of investors, and by so doing ended the panic and saved the banking system. Yet instead of showing gratitude to a great financier who put his own capital at risk in a time of panic, the chattering classes of the day reacted with bitterness. “Isn’t this too much power for one man to have?” they asked. “Shouldn’t the people themselves have an institution that can step in to be the lender of last resort?” “Wouldn’t a public entity more fully serve the public interest?”

And so the Fed was born. Yes, conspiracy mongers, some Wall Street players participated in its creation, but that was more in the cause of minimizing the damage. The Fed was much more the brainchild of academic scribblers and progressive dreamers than of the debits-and-credits crowd. The bankers had to be sold on the idea. Yes, they would have to submit to more regulation. But as compensation they would get a true lender of last resort in a time of need.

That’s why I don’t get socialist Sen. Bernie Sanders. (That’s no right-wing epithet; he really is a socialist.) And that’s why I don’t get complaints about a “bailout for big banks” coming from the left. The liberals wanted a Fed and they got one. And as the chart above illustrates, it’s doing exactly what they created it to do: step in temporarily in times of turmoil.

Reasonable men can differ as to the utility of a central bank. Hamilton was for it; Jefferson against it. I tend to agree with Hamilton, but who am I to judge between such giants? The Jeffersonians among us, such as Ron Paul, have a point to make. A central bank is a very powerful institution, and power is dangerous. The Hamiltonians among us have a point, too. Panics also are dangerous, and we need institutions to minimize them.

There are pros and cons to having a central bank. We have one, so let them do their job.

See also video of Don Luskin on liquidity, bank runs and "the moral hazard state" and another video of the recent reduction of systemic risk from fed action. I think that market conditions have improved, but until credit spreads actually show further improvement, it is wise to be a little cautious.

Hoovernomics

This piece appeared in the WSJ the other day. It touches on some points sometimes overlooked in discussions of that era:

Around our offices, we're still recovering from the fact that Hoover was the last Presidential candidate we've endorsed. We've been trashing Hoovernomics ever since. The issue this year, however, is who is really pursuing the Hoover model.

To hear Mr. Schumer and his fellow-traveling columnists tell it, Hoover's great policy blunder was to do nothing, all the while insisting that everything was fine. But the problem with Hoover's economic policy isn't that it was passive but that it was actively destructive.

In 1930, he signed the Smoot-Hawley Tariff Act, setting off a wave of protectionist retaliation that undid the globalization of the preceding decades and did far more harm to the world economy than the stock-market crash ever did. Two years later, amid a bad recession, he undid the Calvin Coolidge-Andrew Mellon tax cuts, raising the top marginal income-tax rate to 63% from 25%. The recession became a Depression.

Note that although Smoot-Hawley was signed in 1930, contemporaneous accounts show that ideas about the likelihood of passage shifted dramatically towards the affirmative in October of 1929, just before the stock market crash. Make of it what you will. Also, dramatically raising marginal tax rates with a contracting economy, in a desperate attempt to balance the budget, is not exactly a pro-growth policy. When I first learned of that step, many years ago, I nearly fell out of my chair.

There you go again

Historically, natural resources have been subject to long periods of chronic scarcity or abundance with prices rising and then falling back towards their cost of production for extended periods of time. The bullish phases have typically lasted 15 to 25 years until supply finally overtakes demand again. This adjustment usually entails some combination of greater production, more efficient usage and/or creation of a substitute. Countries which are large net exporters of natural resources will seem to have an economic wind at their backs during the bullish phase (think Russia, Brazil and Australia) and more of an economic headwind during the bearish phase. Note also that the magnitude of the price swings and the difficulty of adjustment can be exacerbated by bad economic policy.

This Malthusian redux appeared recently, although in fairness, the authors are not quite full-blown apocaholics.

Now and then across the centuries, powerful voices have warned that human activity would overwhelm the earth's resources. The Cassandras always proved wrong. Each time, there were new resources to discover, new technologies to propel grow.

Today the old fears are back.

Although a Malthusian catastrophe is not at hand, the resource constraints foreseen by the Club of Rome are more evident today than at any time since the 1972 publication of the think tank's famous book, "The Limits of Growth." Steady increases in the prices for oil, wheat, copper and other commodities -- some of which have set record highs this month -- are signs of a lasting shift in demand as yet unmatched by rising supply.

As the world grows more populous -- the United Nations projects eight billion people by 2025, up from 6.6 billion today -- it also is growing more prosperous. The average person is consuming more food, water, metal and power. Growing numbers of China's 1.3 billion people and India's 1.1 billion are stepping up to the middle class, adopting the high-protein diets, gasoline-fueled transport and electric gadgets that developed nations enjoy.

The result is that demand for resources has soared. If supplies don't keep pace, prices are likely to climb further, economic growth in rich and poor nations alike could suffer, and some fear violent conflicts could ensue.

In the past, economic forces spurred solutions. Scarcity of resource led to higher prices, and higher prices eventually led to conservation and innovation. Whale oil was a popular source of lighting in the 19th century. Prices soared in the middle of the century, and people sought other ways to fuel lamps. In 1846, Abraham Gesner began developing kerosene, a cleaner-burning alternative. By the end of the century, whale oil cost less than it did in 1831.

A similar pattern could unfold again. But economic forces alone may not be able to fix the problems this time around. Societies as different as the U.S. and China face stiff political resistance to boosting water prices to encourage efficient use, particularly from farmers. When resources such as water are shared across borders, establishing a pricing framework can be thorny. And in many developing nations, food-subsidy programs make it less likely that rising prices will spur change.

Indeed, the true lesson of Thomas Malthus, an English economist who died in 1834, isn't that the world is doomed, but that preservation of human life requires analysis and then tough action. Given the history of England, with its plagues and famines, Malthus had good cause to wonder if society was "condemned to a perpetual oscillation between happiness and misery." That he was able to analyze that "perpetual oscillation" set him and his time apart from England's past. And that capacity to understand and respond meant that the world was less Malthusian thereafter.

Political responses can alter rules and institutional arrangements so as to facilitate the adjustment by consumers and producers or they can make things worse, particularly by trying to choose the solutions. (Think ethanol from corn...)

I suspect that many people haven't met The Doomslayer.

This is the litany : Our resources are running out. The air is bad, the water worse. The planet's species are dying off - more exactly, we're killing them -at the staggering rate of 100,000 per year, a figure that works out to almost 2,000 species per week, 300 per day, 10 per hour, another dead species every six minutes.We're trashing the planet, washing away the topsoil, paving over our farmlands, systematically deforesting our wildernesses, decimating the biota, and ultimately killing ourselves.

The world is getting progressively poorer, and it's all because of population, or more precisely, overpopulation. There's a finite store of resources on our pale blue dot, spaceship Earth, our small and fragile tiny planet, and we're fast approaching its ultimate carrying capacity. The limits to growth are finally upon us, and we're living on borrowed time. The laws of population growth are inexorable. Unless we act decisively, the final result is written in stone: mass poverty, famine, starvation, and death.

Time is short, and we have to act now.

That's the standard and canonical litany. It's been drilled into our heads so far and so forcefully that to hear it yet once more is ... well, it's almost reassuring. It's comforting, oddly consoling - at least we're face to face with the enemies: consumption, population, mindless growth. And we know the solution: cut back, contract, make do with less. "Live simply so that others may simply live."

There's just one problem with The Litany, just one slight little wee imperfection: every item in that dim and dreary recitation, each and every last claim, is false. Incorrect. At variance with the truth.

"Our species is better off in just about every measurable material way," he says. "Just about every important long-run measure of human material welfare shows improvement over the decades and centuries, in the United States and the rest of the world. Raw materials - all of them - have become less scarce rather than more. The air in the US and in other rich countries is irrefutably safer to breathe. Water cleanliness has improved. The environment is increasingly healthy, with every prospect that this trend will continue.

Julian Simon: The facts are fundamental.

Garrett Hardin: The facts are not fundamental. The theory is fundamental. - from a 1982 debate with the UC Santa Barbara biologist The doomslayer-doomsayer debate, Simon thinks, is an opposition between fact and bad theory, a case of empirical reality versus abstract principles that purport to define the way things work but don't.

"It's the difference," he says, "between a speculative analysis of what must happen versus my empirical analysis of what has happened over the long sweep of history."

The paradox is that those abstract principles and speculative analyses seem so very logical and believable, whereas the facts themselves, the story of what has happened, appear wholly illogical and impossible to explain. After all, people are fruitful and they multiply but the stores of raw materials in the earth's crust certainly don't, so how can it be possible that, as the world's population doubles, the price of raw materials is cut in half?

It makes no sense. Yet it has happened. So there must be an explanation.

And there is: resources, for the most part, don't grow on trees. People produce them, they create them, whether it be food, factories, machines, new technologies, or stockpiles of mined, refined, and purified raw materials.

"Resources come out of people's minds more than out of the ground or air," says Simon. "Minds matter economically as much as or more than hands or mouths. Human beings create more than they use, on average. It had to be so, or we would be an extinct species."

The defect of the Malthusian models, superficially plausible but invariably wrong, is that they leave the human mind out of the equation. "These models simply do not comprehend key elements of people - the imaginative and creative."

As for the future, "This is my long-run forecast in brief," says Simon. "The material conditions of life will continue to get better for most people, in most countries, most of the time, indefinitely. Within a century or two, all nations and most of humanity will be at or above today's Western living standards.

"I also speculate, however, that many people will continue to think and say that the conditions of life are getting worse."

Eventually the current bullish phase for natural resources will end, although not without more predictions of doom, and those familiar with the ideas of the doomslayer will smile.

See also videos of Julian Simon.

The Ultimate Resource

Alex Tabarrok sounding like Julian Simon:

(from Forbes via The Club For Growth):

Forget the talk of recession. The world is about to enter a new era in which miracle drugs will conquer cancer and other killer diseases and technological and scientific advances will trigger unprecedented economic growth and global prosperity.

Pie in the sky optimism? Perhaps. But there are reasons to be optimistic, and they rest not on science fiction but within the badly misnamed "dismal science," economics.

To understand why economics triggers such optimism, imagine that there are two deadly diseases. One disease is relatively rare, the other common. If you had to choose, would you rather be afflicted with the rare or the common disease?

If you don't want to die, it's much better to have the common disease. The reason? The cost of developing drugs for rare and common diseases are about the same, but the revenues aren't. Pharmaceutical companies concentrate on drugs with larger markets because larger markets mean more profits.

As a result, there are more drugs to treat diseases with a lot of patients than to treat rare diseases, and more drugs means greater life expectancy. Patients diagnosed with rare diseases--those ranked at the bottom quarter in terms of how frequently they are diagnosed--are 45% more likely to die before age 55 than are patients diagnosed with more common diseases.

So imagine this: If China and India were as wealthy as the U.S., the market for cancer drugs would be eight times larger than it is today.

Of course, China and India are not yet as wealthy as the U.S., but their economies are growing rapidly, and with them, the market for new drugs. Cancer is now China's leading killer, with spending on treatment increasing by 17% per year. To be close to the Chinese market, AstraZeneca and Novartis are building major research facilities in China, which will benefit patients everywhere.

Like pharmaceuticals, new computer chips, software and chemicals also require large research and development (R&D) expenditures. As India, China and other countries become wealthier, companies will increase their worldwide R&D investments. Most importantly, as markets expand, companies and countries will put to work the greatest asset of all for the betterment of mankind: brain power.

Amazingly, there are only about 6 million scientists and engineers in the entire world, nearly a quarter of whom are in the U.S. Poverty means that millions of potentially world-class scientists today spend their lives trying to eke out a subsistence living, rather than leading mankind's charge into the future. But if the world as a whole were as wealthy as the U.S. and were devoting the same share of population to research and development, there would be more than five times as many scientists and engineers worldwide.

People used to think that more population was bad for growth. In this view, people are stomachs--they eat, leaving less for everyone else. But once we realize the importance of ideas in the economy, people become brains--they innovate, creating more for everyone else.

New ideas mean more growth, and even small changes in economic growth rates produce large economic and social benefits. At current income levels, with an inflation-adjusted growth rate of 3% per year, America's real per capita gross domestic product would exceed $1 million per year in just over 100 years, more than 22 times higher than it is today. Growth like that could solve many problems.

In the 20th century, two world wars diverted the energy of two generations from production to destruction. When the horrors ended, the world was left hobbled and split. Communism isolated much of the world, reducing trade in goods and ideas--to everyone's detriment. World poverty meant that the U.S. and a few other countries shouldered the burdens of advancing knowledge nearly alone.

The battles of the 20th century were not fought in vain. Trade, development and the free flow of people and ideas are uniting all of humanity, maximizing the incentives and the means to produce new ideas. This gives us reason to be highly optimistic about the future.

Whatever problems we will struggle with in the short term, there is indeed reason to be optimistic. It is also good to understand that although globalization means more competition, more trade and more people working on new innovations is very much a positive sum game.

People, even better when they are free, are the ultimate resource!

Drunken Debauchery of the Past

Reading Throwing out the baby and keeping the bathwater at Thought Mesh reminded me of a blues song I wrote in the 70's called Wellesley which chronicles the drunken debauchery of those around me (Note that it's not about me; it's about a frat brother). I didn't actually get around to recording the song till much later, but it still captures the essence of some behaviors from thirty years ago. This song is actually a man-bites-dog story in that, unusually and surprisingly, the drunken encounter didn't actually end with sex.

The amazing thing about being alive a long time is that you see that human nature and behavior changes very, very, very slowly, if at all.