Econlib

Governing Least: A Litany of Insight, by Bryan Caplan

Dan Moller’s Governing Least is packed with random insights and philosophic wit.  Some highlights:

Why so much political philosophy sounds desperate:

Only those already unsympathetic to utilitarianism are likely to be swayed by Rawls’s brief observations. Those who begin their political philosophy by defending the morality of rights don’t so much preach to the choir as exorcize the elect.

Why so much political philosophy sounds so blind:

The reason France does not require aid is not because some external group took pity on the French, but that they were able to generate exponential economic growth themselves. This makes it puzzling that philosophers write long books about aid without mentioning economic growth, and generally seem to imply that the path to escaping poverty lies through individual altruism. Why ignore the only mechanism that has ever succeeded in lifting millions of people out of poverty when thinking about poverty?

Rate My Professors as Evidence for Education Signaling, by David Henderson

Often, when I get curious about an economist I hear about or who asks me to friend him (I’ll use “him” to stand for “him/her”) on Facebook, I do a Google search and his ratings on “Rate My Professor” show up. So I often go to the ratings to see what students say. I know I’m getting a biased sample for which the particular biases are unknown but, still, it’s some information.

Shoot to kill: Power, precision, sufficiency and the appropriate target, by Scott Sumner

Over at MoneyIllusion I have a new post advocating reforms that would boost the power of monetary policy. Here I’d like to put this in context, especially given that the Fed is planning to revisit its policy strategy this summer. A successful monetary policy has four elements:

1. An appropriate target: I favor NGDP level targeting, but the Fed’s current target (AD set at a level that leads to 2% PCE inflation and minimizes the employment/output gap) is not that bad, if done right.

2. Power: The Fed needs policy tools that they are comfortable using, and that are powerful enough to hit the target. There are many possible reforms, some of which I’ve discussed in other posts. In a technical sense, it’s an easy problem. The Fed needs to decide which among the many feasible options it prefers, to insure that it never runs out of ammunition. Options include a higher inflation target, level targeting, allowing the Fed to buy any asset, negative IOR, having the Treasury take over the Fed’s balance sheet, etc. At MoneyIllusion I offer another possible reform to give the Fed more power.

3. Precision: I’ve previously mentioned numerous possible reforms to boost precision. Within the current discretionary framework, you could have the fed funds target adjusted daily, set at the median vote of the FOMC. Changes would be to the nearest basis point, with no presumption as to direction of change.

The sad decline of American democracy, by Scott Sumner

The Constitution says that only the Congress has the power to declare war, and the last time they did so was 1941. ( Update: David Henderson informed me that 1942 was the last declaration of war by the US.)  But that wasn’t the last war time the US fought a war. Interestingly, at just about the time Congress stopped declaring war, the “Department of War” was relabeled as the “Department of Defense”.

Congress is supposed to approve treaties with foreign nations. But Congress never approved the nuclear deal with Iran.

Congress increasingly gives unelected regulators the power to legislate.

In 1930, President Hoover told the press it was Congress’s responsibility to determine what would be included in Smoot-Hawley. After WWII, presidents began negotiating trade deals, but always under the understanding that final approval from Congress was required. Now the Trump administration indicates that they will not even ask Congress to approve the new China trade deal.

The Democratic House and the Republican Senate recently voted to remove the US from involvement in the Yemen War, which is a humanitarian catastrophe comparable to the Iraq War. But the administration plans to ignore the will of Congress.

Congress refused to appropriate funds for a new border wall, but the Trump administration plans to ignore this vote and build the wall anyway.

These trends have been proceeding for decades, under both political parties. In recent years, the movement toward a more authoritarian form of government seems to be accelerating.

My conservative friends tell me that recent Supreme Court picks will uphold the original intent of the Constitution. I hope they are right, but I doubt it. I suspect they’ll uphold “conservative” forms of authoritarianism and reject liberal forms, and vice versa for liberal justices. Only voters can stop the slide toward authoritarianism, and voters actually seem to like what is happening.

PS. Which of the following four topics attracts the greatest amount of protest from millennials:

1. A 1984-style surveillance state being imposed on America.
2. Nearly 400,000 people unjustly imprisoned in the War on Drugs (mostly minorities.)
3. The horrific slaughter in Yemen, which we are contributing to.
4. The choice of Halloween costumes at Yale University.

PPS. Yes, lots of horrible things are also occurring in China, but Americans really do need to look in the mirror.

(20 COMMENTS)

Stephen Moore for the Fed?, by David Henderson

 

The nomination [of Stephen Moore for the Federal Reserve Board] has stirred a lot of controversy. Writing in the New York Times last week, Harvard economics professor N. Gregory Mankiw, who was chairman of the Council of Economic Advisers under President George W. Bush, accused Moore of being “a propagandist, pushing for conservative causes, often with flimsy arguments.” Democratic Senators are expected to vote against Moore’s nomination and even a few Republican Senators have expressed skepticism.

You might think that I, who often agree with Stephen Moore on economic policy, would favor his nomination. I don’t. Before you jump to conclusions, this has nothing to do with personal animus towards him. He and I spoke at the same event at Southern Methodist University in 2010 and got along quite well. I rather like the guy. Instead, it’s simply that I think he’s unqualified. But we shouldn’t overstate the case against him. The case against having Moore on the Fed does not depend on the idea, as Mankiw seems to believe, that the Fed is a great organization. It’s not. And there’s a strong case against having a central bank in the first place.

These are the second and third paragraphs of my latest article for the Hoover Institution’s “Defining Ideas.” The article is titled “Wrong for the Fed.” Writing it gave me the chance to do two things: (1) the one implied by the title–explain why Stephen Moore would not be a good fit at the Fed, and (2) lay out the Fed’s sorry record over its more than 100 years and explain that there’s a surprisingly (to most people) strong case against having a Fed.

Read the whole thing.

(3 COMMENTS)

Governing Least: What’s Really Wrong with Utilitarianism, by Bryan Caplan

One argument against utilitarianism is that no one actually follows it.  I call this the Argument from Hypocrisy.  A better objection, though, is that even highly scrupulous utilitarians don’t comply with their stated principles; I call this the Argument from Conscience.   In Governing Least, Moller powerfully develops a parallel objection: While utilitarians often urge self-sacrifice, they rarely preach other-sacrifice.  But given their principles, they totally should!  Moller’s explanation is so well-phrased that I decided to reproduce a complete section.

Challenges to living with utilitarianism tend to focus on what I called options— the option we think we normally have to flout the overall good when we rather sleep in, or buy a subwoofer instead of donating to charity. But what really cuts ice are constraints on our actions. Singer and others emphasize that they can accept that they do not, as utilitarians, have the option to loaf about when they could help others, however much they fall short. But what is really hard about living with utilitarianism isn’t self-sacrifice but other-sacrifice, paradoxically enough. This wouldn’t be so if we were purely self- interested, but we aren’t, and the prospect of exploiting others for the greater good thus terrifies us. Of course, it’s rare that harming innocents will produce much good, but it’s easy enough to come up with cases:

Grandma: Grandma is a kindly soul who has saved up tens of thousands of dollars in cash over the years. One fine day you see her stashing it away under her mattress, and come to think that with just a little nudge you could cause her to fall and most probably die. You could then take her money, which others don’t know about, and redistribute it to those more worthy, saving many lives in the process. No one will ever know. Left to her own devices, Grandma would probably live a few more years, and her money would be discovered by her unworthy heirs who would blow it on fancy cars and vacations. Liberated from primitive deontic impulses by a recent college philosophy course, you silently say your goodbyes and prepare to send Grandma into the beyond.

If this seems too outré to take seriously, we can try this instead:

Child: Your son earns a good living as a doctor but is careless with some of his finances. You sometimes help him out by organizing his receipts and invoices. One day you have the opportunity to divert 1,000 from his funds to a charity where the money will do more good; neither he nor anyone else will ever notice the difference, besides the beneficiaries. You decide to steal your child’s money and promote the overall good.

Recall that we’ve already set aside ecumenical views that side with deontic morality in practice. So it’s no use to protest that the true utilitarian theory has some esoteric feature that lets us ignore the case, say because we should only follow rules with good consequences, and killing those around us to reduce hunger would have terrible consequences overall. The only views left on the table at this point are precisely those that are willing to contemplate that, at least in some circumstances, rubbing out Grandma and stealing from our children is the right thing to do. The problem, then, is that most people don’t seem able to accept even that they ought to aspire to such behavior, let alone engage in it. Exploiting those we love isn’t an ideal we fail to attain, it’s the very antipode of the ideals themselves. Just consider contexts in which we are specifically seeking to articulate them, as when we instruct our children. Do revisionist utilitarians sit down their sons and daughters and implore them to steal from their friends when it is possible to do so undetected and to divert the money to famine relief? There are many books by revisionist utilitarians telling us that we ought to do more to live up to the demands of morality through self- sacrifice; the fact that there are so few urging us to engage in more other-sacrifice would be surprising if revisionists really could take their philosophy seriously in practice.

Notice, again, that Moller is not invoking the Argument from Hypocrisy.  “The problem, then, is that most people don’t seem able to accept even that they ought to aspire to such behavior, let alone engage in it. ”  In other words, utilitarians don’t preach other-sacrifice, but fail to practice what they preach.  They barely even preach it!  Suspicious, to say the least.

(17 COMMENTS)

China’s growth—what do we actually know?, by Scott Sumner

Tyler Cowen recently linked to a study of China’s economic growth, which suggests that official figures (roughly 8%) overstate the real GDP growth rate by about 1.8%/year between 2010 and 2016:

Using publicly available data, we provide revised estimates of local and national GDP by re-estimating output of industrial, construction, wholesale and retail firms using data on value-added taxes. We also use several local economic indicators that are less likely to be manipulated by local governments to estimate local and aggregate GDP. The estimates also suggest that the adjustments by the NBS were insufficient after 2008. Relative to the official numbers, we estimate that GDP growth from 2010-2016 is 1.8 percentage points lower and the investment and savings rate in 2016 is 7 percentage points lower.

That might be correct, but I suspect the errors are actually much smaller.  Here it’s useful to start with some data that we can have more confidence in, average yearly nominal wage rates (divide by about 6.5 to get the dollar equivalent):

This matches all sorts of information from a variety of non-governmental sources.  When I speak with people who live in China, I get the same impression of very fast rising nominal wages–both for professional jobs and low-skilled jobs like maids.  When I read articles in the western media about wages in China, they tell the same story—very fast rising wages leading to many low-skilled firms moving to countries such as Vietnam.  It’s much harder to fake nominal wage data than GDP data, because China’s a huge country and local citizens are quite willing to talk about their personal financial situation (unlike during the Maoist era when they would have been terrified to offer truthful information to reporters.)  To summarize, we can be almost certain that nominal Chinese wages have grown at explosive rates over the past decade, roughly 10%/year.

The second piece of evidence is China’s explosive growth in infrastructure, the sort of growth you’d normally see in a fast growing economy like South Korea during the 1970-2010 period, not a Brazil or Mexico.  Again, this is easily observed by visitors.

We also see explosive growth in various segments where western firms play a major role, such as auto production.  This would be hard to fake.  Ditto for China consuming a huge share of the world’s key commodities such as steel, coal, copper, cement, etc.

You might argue that the wage data is nominal and tells us nothing about real wages.  That’s true, but we also have very good data on the dollar/yuan exchange rate, which has not changed much since 2009.

And note that the dollar itself is currently quite strong.  If we combine the relatively reliable nominal wage data with the extremely reliable exchange rate data, we see that Chinese wages are also rising at very fast rates in US dollar terms.  In addition, Chinese wages have grown much faster that wages in other East Asian countries, economies that are also growing fairly fast.

The developing countries in Southeast Asia have recently tended to grow at rates closer to 5%/year, which is roughly the rate that China would have been growing if their official GDP growth rate was overstated by 1.8%/year.  But look at Chinese wages compared to those of other Asian economies. Does it seem plausible that China is growing at the same rate as Indonesia?

If China’s growth rate is consistently overstated, then China should be much poorer than what the official figures show.  But if we compare China’s official GDP/person data to places such as Thailand and Malaysia, then the wage data makes it seem like China’s growth has been understated.

Then there is casual empiricism.  If China’s growth were overstated, then visitors to China would be telling people, “Hmmm, this doesn’t seem like a country with a per capita GDP of 9600.”  But if visitors do offer that opinion, it’s usually because China seems much richer than that figure.  At one time one could point to the fact that most Chinese lived in poor villages, but now most live in the cities.  At one time one could argue that while the coastal cities were doing well, the interior remained poor.  But now interior cities like Chongqing look quite affluent, as evidenced by this excellent NYT story.

I visited Chongqing in 1994, and recall a muddy, drab city full of crumbling grey cement buildings, with lots of poor people carrying heavy loads on their backs.

Again, it’s likely that the Chinese growth numbers are at least somewhat flawed.  But when we look at all of the evidence, we cannot have confidence in the claim that Chinese growth has been greatly overstated.  There is plenty of evidence in both directions.

PS.  In my view, the Chinese boom has been caused by a huge shift of labor into the private sector, where the vast majority of workers are now employed.

PPS.  People sometimes cite the fact that a Chinese leader once “admitted” that China’s growth was overstated.  That’s not true.  He admitted that the provincial growth rates are overstated, a point on which everyone agrees.  The national statistical bureau scales back those local estimates before deriving a national growth rate.  The issue at hand is whether their downward adjustment is large enough.

(25 COMMENTS)

Dan Moller’s Governing Least, by Bryan Caplan

Michael Huemer’s The Problem of Political Authority is definitely my favorite work of libertarian political philosophy.  Dan Moller’s new Governing Least, however, is definitely now my second-favorite work of libertarian political philosophy.  The two books have much in common: Both use common-sense ethics to argue for libertarian politics.  Both are calm, logical, and ever-mindful of potential criticisms.  Both strive to persuade reasonable people who don’t already agree with them.  Both are packed with broader insights.  And despite these parallels, both are deeply original.

So what’s most original about Moller’s position?  Instead of focusing on the rights of the victims of coercion, Moller emphasizes the effrontery of the advocates of coercion:

[I]n my account libertarianism emerges from everyday moral beliefs we have about when we are permitted to shift our burdens onto others. In fact, my account intentionally downplays the role of rights, and is motivated by doubts about what we may demand of others, rather than outrage about what others demand of us.

The effrontery is most blatant when you speak in the first person:

Imagine calling a town hall meeting and delivering the following speech:

My dear assembled citizens: I know most of us are strangers, but of late I have fallen on hard times through no fault of my own, by sheer bad luck. My savings are low, and I don’t have friends or family to help. Now as you know, I’ve previously asked for help from you as private citizens, as a matter of charity. But unfortunately that hasn’t been sufficient. Thus, I’m here now to insist that you (yes you, Emma, and you, John) owe me assistance as a matter of justice. It is a deep violation if you don’t work additional hours, take fewer vacations if need be, live in a smaller house, or send your kids to a worse school, in order to help me. Failing to do so is no less an injustice than failing to pay your debts.

Moreover, calling this an injustice means that it’s not enough that you comply with your obligations by working on my behalf. No, I insist that you help me to force your fellow citizens to assist me. It doesn’t matter if these others say to you that they need the money for their own purposes, that they prefer worthier causes, or if they’re just hard-hearted and don’t care. To the extent you care about justice, you must help me to force these others to assist me whether they wish to or not, since that is what is owed me in light of my recent bad luck.

Could you bring yourself to make this speech?

The fundamental objection to Moller’s position, he thinks, is to claim that governments have “emergent moral powers.”  But Moller firmly denies this.  Governments are just groups of people, so they are morally obliged to follow the same moral principles as everyone else.  While this may seem like libertarian question-begging, there’s nothing uniquely libertarian about it:

It is notable that many who wish to block rights-based objections to state action are nevertheless eager to enter their own moral objections to what the state does. Many of those unsympathetic to attacks on taxation rooted in individual rights also portray the absence of welfare provisions or various immigration policies as “unconscionable.” There is nothing inconsistent about this; the one set of moral claims may be right and the other confused. But the objection then cannot be based on the emergent moral powers of the state. We cannot both reject appeals to individuals rights on the general grounds that morality has nothing to tell us about what may emerge from government institutions, and then do just that, substituting our own preferred brand of interpersonal morality. Once we notice this, support for emergence should shrink drastically, since it will only come from those who think there are no policies of the state that can be rejected on fundamental moral grounds. The non- emergence assumption per se has no particular ideological leanings.

But doesn’t common-sense morality admit that rights to person and property are not absolute?  Of course; exceptions abound.  Moller sternly emphasizes, however, that these exceptions come with supplemental moral burdens attached.  In his “Emergency” hypothetical, for example, you steal 1000 under duress.  What then?

I propose the following non-exhaustive list of residual obligations for cases like Emergency:

Restitution: although I didn’t do wrong, I must repay the 1,000 if possible, perhaps in reasonable installments.

Compensation: to the extent you are otherwise harmed by my actions, I should attempt to compensate you. For instance, if I smashed your windows getting in or forced you to incur some loss because you had to come home at short notice, I must compensate you at some reasonable rate.

Sympathy: it is incumbent on me to convey, if not an apology for my (permissible) actions, at least sympathy for the harm I have caused you. (“I’m very sorry I had to do that” would be the natural if slightly misleading phrase.) I cannot offer a Gallic shrug at your distress and announce, “I did nothing wrong— it’s your problem” as you survey the wreckage of your home. To do so would exhibit a serious character flaw.

Responsibility: my obligations are not just backward looking, but forward looking. If I can reasonably foresee that some action of mine will put me in the position of facing an emergency that will then render it permissible to harm you, I must take responsibility to avoid such actions if possible. I should not think that I have less reason to take responsibility because I can avoid harms by transferring them to you instead. And failing to take responsibility weakens my claim to impose costs on others when the time comes.

A related principle is worth mentioning as well:

Need: my warrant for harming you depends on how bad my situation is. I cannot harm you if I am doing fine already merely in order to improve my position still further. I may be permitted to take your 1,000 to avert a physical threat, but not in order to make a lucrative investment in order to get even richer.

The political implications are expansive, starting with:

A welfare state justified in virtue of overriding reasons to promote the good of the beneficiaries incurs these residual obligations. Flouting them amounts to unfair burden- shifting. What would it look like actually to satisfy them? For starters, if I were the beneficiary of some emergency medical procedure that a third party compelled others to contribute to— say a state agency— I would be obligated to repay those charged for my benefit, possibly with some compensatory surcharge. If unable to pay, I would be required to pay in installments, with the agency keeping track of my income and tax records to ensure that my repayment were in line with my means…

Moreover, in repaying, my attitude toward my fellow citizens ought to be one of gratitude for coming to my assistance, as opposed to viewing these services as entitlements due to me as a matter of citizenship. This may seem curious: by hypothesis, the services I received made it past the threshold, meaning that the wealth transfers involved were permissible, and since I am repaying, they won’t even be net transfers in the long run, barring misfortune. Depending on how badly I needed aid, aiding may even have been obligatory on a third party. Why should I express gratitude for others fulfilling their duties? Consider the Gallic shrug— that supreme expression of indifference at someone else’s misfortunes, while disclaiming all responsibility for rectifying them, frequently encountered in Parisian cafés. Why shouldn’t I shrug my Gallic shrug at the rich complaining about their tax bill, and point out I merely got what I was entitled to, as would they in a similar situation?

This complaint would be apt if appropriate moral responses were a function solely of whether our acts are required or permissible. But there are all kinds of inappropriate moral responses even when what we have done is permissible or when what the other has done was required. If we are to meet for lunch and an urgent business affair obtrudes itself, I may be permitted to skip our lunch, but I shouldn’t treat putting you out lightly. What makes a Gallic shrug a vice here is that beneath the outer layer of permissibility there remains an inner structure whereby you have been harmed for my sake, which ought to be a source of concern, leading to some appropriate expression of regret if I am a decent person.  And the same is true in the case of welfare services. This is easy to ignore because of the opaque veils of state bureaucracy. But behind the faceless agency lie people who are harmed for the sake of benefiting me.

Governing Least manages to be at once readable and dense.  And though you can’t tell from the passages I just quoted, Moller also repeatedly appeals to and grapples with cutting-edge social science.  What, for example, should philosophers think about Greg Clark’s work on the long-run heritability of social status?  Moller’s take will surprise many of you.

Last question: Why do I still prefer Huemer to Moller?  Intellectually, because Huemer’s appeal to individual rights is just more clear-cut than Moller’s objection to “burden-shifting.”  Furthermore, Huemer focuses on the broader case for libertarianism, while Moller self-consciously focuses on opposition to the welfare state.*  And while Moller’s book is beautifully written and well-organized, Huemer’s is stellar on both counts.

Thus, if you’re only going to read one book of libertarian political philosophy, I still say you should read The Problem of Political Authority.  If you’re willing to read two such books, however, read Governing Least.  I loved it.

* Moller: “I also ignore the many noneconomic causes that libertarians have sometimes taken up, like free speech, gay marriage, and drug legalization. This is the fun part of libertarianism and requires little heroism to defend. Many disagree with such policies, but few think their sponsors cruel or ungenerous, while resistance to the welfare state and programs intended to foster economic equality evoke precisely that response.”

 

(14 COMMENTS)

Cowen on Optimal Marginal Tax Rates on CEOs, by David Henderson

A week ago, I sent to my editor my review of Tyler Cowen’s latest book, Big Business: A Love Letter to an American Anti-Hero. The book is outstanding. There are valuable facts and/or bits of economic reasoning on virtually every page. To give you an idea of how much I liked the book, I titled my review “A Love Letter to Tyler Cowen.” I’m not sure the editor will use that title.

The consistently great content meant that I had to leave a lot out of my review.

Here’s one part I left out but found striking. It’s on page 50, in the chapter on whether CEOs are paid too much. (Tyler says they’re not.):

Another factor is that, on average, top CEO talent helps larger firms proportionally more than smaller firms, and high salaries can be useful as a means of allocating the best talent to their most important uses. If Mark Zuckerberg had been running a midsized financial services company rather than Facebook, that would have been a waste of his talents, and likely Facebook would not have taken off as it did. A study found that when we take such “matching” factors into account, the optimal highest marginal tax rate on CEOs probably should be in the range of 27 to 34 percent. If the tax is much higher, the returns on making the right CEO-to-firm match will be smaller and productivity will be lower, and some of the star performers will end up at insufficiently important firms.

 

The study he refers to above is Laurence Ales and Christopher Sleet, “Taxing Top CEO Incomes,” American Economic Review, Vol. 106 (11): 3331-3366.

That reminds me of a point I made in a special seminar for some hand-picked, up-and-coming U.S. Navy and Marine Corps officers about 15 years ago. I had been asked to comment on some of their thoughts. One of their questions was “How can we get the best people into the Navy and Marine Corps?” I said that I thought it would be a mistake to get the best people in the Navy and Marine Corps. I pointed out that if the Navy had managed to persuade Bill Gates to become an officer in the mid-to-late 1970s, the PC revolution would have probably slowed by at least a few months. “Think,” I said, “of the enormous loss of productivity and consumer surplus from even a few months’ loss.”

 

(9 COMMENTS)

As Notre-Dame-de-Paris Was Burning…, by Pierre Lemieux

From any pronouncement, one must discount emotions, purple prose, and metaphors. Language is complex. In non-mathematical languages, things often (if not always) don’t literally mean what they say. This is even truer for politician-speak.

As Notre-Dame-de-Paris was burning, French president Emmanuel Macron tweeted:

Like all of our compatriots, I am sad this evening to see this part of us burning.

His original tweet was of course in French, but he repeated it in English. The English version is as close as possible to the French original:

Comme tous nos compatriotes, je suis triste ce soir de voir brûler cette part de nous.

I have no problem believing that Mr. Macron was as sad as were many of “us”—people who share some of my and his aesthetic preferences and values. Many have strong memories from visiting the cathedral. I remember climbing the stairs of the bell tower and feeling the weight of history on the stone curved in by eight centuries of footsteps. And Notre-Dame-de-Paris is an important monument of Western civilization and French history.

Yet, borrowing the point of view of the French, Notre-Dame is not a “part of us” and it is very unlikely that “all” of Mr. Macron’s compatriots were sad. In a country of 67 million, some certainly did not care. Probably more than one was content, if only for the entertainment. It would not be the first time Notre-Dame did not make unanimity: during the French Revolution, the cathedral was looted with the support of the public authorities and was used for wine storage.

Macron’s is not the worst use of “us” in history. It is not the most dangerous nationalist or tribal appeal that we have heard. (Note that my use of “we” just now is purely rhetorical and refers to an indeterminate subject; in such cases, the French language allows the use of “on” instead of “nous.”) I would also opine that many who were not sad to see Notre-Dame burning are not among the finest specimen of mankind. Yet, the use of “us” remains fraught with danger. One should always be clear in his own mind about who is included in the “we” set.

Macron also tweeted that Notre-Dame-de-Paris would be restored through a “national subscription” also open to foreigners who love Notre-Dame-de-Paris. He could not avoid some we-talk and invoking the “French national destiny.” But thinking of a voluntary subscription to finance this public good is wise. Moreover, I am sure that the price of visiting the renovated monument will increase. (If I remember well, walking in the cathedral was free although there was a fee for visiting the tower.) Perfect public goods are rare.

(3 COMMENTS)

Jill Lepore on Nationalism, Populism, and the State of America

Historian and author Jill Lepore talks about nationalism, populism, and the state of America with EconTalk host Russ Roberts. Lepore argues that we need a new Americanism, a common story we share and tell ourselves. Along the way, topics in the conversation include populism, the rise of globalization, and the challenge of knowing what is […]

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Robin Feldman on Drugs, Money, and Secret Handshakes

Law professor and author Robin Feldman of UC Hastings College of the Law talks about her book Drugs, Money, and Secret Handshakes with EconTalk host Russ Roberts. Feldman argues that the legal and regulatory environment for drug companies encourages those companies to seek drugs that extend their monopoly through the patent system often with insufficient […]

Jacob Stegenga on Medical Nihilism

Philosopher and author Jacob Stegenga of the University of Cambridge talks about his book Medical Nihilism with EconTalk host Russ Roberts. Stegenga argues that many medical treatments either fail to achieve their intended goals or achieve those goals with many negative side effects. Stegenga argues that the approval process for pharmaceuticals, for example, exaggerates benefits […]

Daniel Hamermesh on Spending Time

Economist and author Daniel Hamermesh of Barnard College and the Institute for the Study of Labor talks about his latest book, Spending Time, with EconTalk host Russ Roberts. Hamermesh explores how we treat time relative to money, how much we work and how that has changed over time, and the ways economists look at time, work, and leisure.

Daniel Hamermesh on Spending Time

Economist and author Daniel Hamermesh of Barnard College and the Institute for the Study of Labor talks about his latest book, Spending Time, with EconTalk host Russ Roberts. Hamermesh explores how we treat time relative to money, how much we work and how that has changed over time, and the ways economists look at time, […]

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Amy Tuteur on Birth, Natural Parenting, and Push Back

Obstetrician gynecologist Amy Tuteur and author of Push Back, talks about the book with EconTalk host Russ Roberts. Tuteur argues that natural parenting–the encouragement to women to give birth without epidurals or caesarians and to breastfeed–is bad for women’s health and has little or no benefit for their children.

This week's guest:

• Amy Tuteur's Home page
• Amy Tuteur on Twitter.

This week's focus:

• Push Back: Guilt in the Age of Natural Parenting, by Amy Tuteur on Amazon.com.

Additional ideas and people mentioned in this podcast episode:

• "The Score: How childbirth went industrial," by Atul Gawande in The New Yorker. October 9, 2006.
• "Is breast truly best? Estimating the effects of breastfeeding on long-term child health and wellbeing in the United States using sibling comparisons," by Cynthia G. Colen and David M. Ramey. ScienceDirect.com, Social Science & Medicine, May 2014.
• Sebastian Junger on Tribe. EconTalk.
• "Maternal Mortality Rate in U.S. Rises, Defying Global Trend, Study Finds," by Sabrina Tavernise, New York Times, September 21, 2016.
• "Is the United States Maternal Mortality Rate Increasing? Disentangling trends from measurement issues," by Marian F. MacDorman, Eugene Declercq, Howard Cabral, and Christine Morton. Obstet Gynecol, September 1, 2016.
• "Has Maternal Mortality Really Doubled in the U.S.?" by Dina Fine Maron, Scientific American, June 8, 2016.
• Emily Oster, infant mortality
• Emily Oster on Infant Mortality. EconTalk, November 2014.
• Emily Oster on Pregnancy, Causation, and Expecting Better. EconTalk, October 2013.
• "Who Said Childbirth Is Natural? The Medical Mission of Grantly Dick Read," by Donald Caton. American Society of Anesthesiologists. April 1996.

A few more readings and background resources:

• Medical Colonialism, by Tim A Holt and Tony J Adams. Journal of Medical Ethics, 1987 Jun; 13(2): 102
• What is a Doula? Dona.org.
• American College of Obstetricians and Gynecologists.
• Baby-friendly Hospital Initiative. World Health Organization.
• La Leche League.
• Adelle Davis. Wikipedia.
• Lamaze.
• Epidural Anesthesia. AmericanPregnancy.org. What is an epidural?
• William Sears (physician)). Wikipedia.
• The Complete Book of Christian Parenting and Child Care: A Medical and Moral Guide to Raising Happy Healthy Children, by Martha Sears, William Sears. Amazon.com. 1997.
• "Do Not Open This Door" from Young Frankenstein. Youtube video clip.

A few more EconTalk podcast episodes:

• Angus Deaton on Health, Wealth, and Poverty. EconTalk.
• Gary Taubes on Fat, Sugar and Scientific Discovery. EconTalk.
• Adam Cifu on Ending Medical Reversal. EconTalk.
• Thomas Leonard on Race, Eugenics, and Illiberal Reformers. EconTalk, December 2016.
• Janet Golden on Babies Made Us Modern. EconTalk, June 2018.

Time Podcast Episode Highlights

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0:33

Intro. [Recording date: February 20, 2019.]

Russ Roberts: My guest is obstetrician and gynecologist, author and blogger, Amy Tuteur.... Her book, which is the subject of today's conversation, is Push Back: Guilt in the Age of Natural Parenting.... So, tell us about your background, as an observer of all these issues related to childbirth and parenting.

Amy Tuteur: So, I'm an obstetrician-gynecologist, as you mentioned. I'm also the mother of four children, now all adults. So, I had my children back in the 1980s and 1990s. But even then, the pressure on women to have a natural childbirth, to breastfeed, and to parent in certain ways was getting started. But, now, it is much worse. And I really feel very badly for a lot of young women who are struggling with the pressure--mostly because it's unnecessary. So many of the things that people are upset about--for example, when I used to be practicing, I used to visit a woman the day after her baby was born; and she would be very, very upset about the fact that she had an epidural--which she hadn't planned on. Or had a C-section [Caesarian Section] that she hadn't planned on. And no matter how much I tried to point out that the reason we were doing this was because she should have a healthy baby and she should be healthy herself, she would be inconsolable. And, I began to wonder why it is that new mothers feel that way; and who is making them feel that way; and what can we do to help them.

Russ Roberts: I want to talk about a different--we are going to go through the different aspects of what you call natural parenting--the pressure to not have a C-section, to have a vaginal birth; the pressure to breastfeed; the--and then the issue of what you write about as attachment parenting and how close the child, the infant, should be to the parent at all times versus independence.

Amy Tuteur: Right.

Russ Roberts: So, I want to go through those one by one. Let's start with the C-section. There is a large--there has been an increase in C-sections in the United States. And the rate--I think in your book you quote a number of, roughly a third of all births or C-section births. And, as a--we had four children. That's not the right pronoun. My wife gave birth to four children. But I was a participant. In, of course, many ways. And one of the ways was that we, neither of us wanted a C-section. And felt there was pressure from parents that we had talked to, from their doctors; sometimes from the nurses--that a C-section was often just an easy way to deal with it. And that mothers who wanted to try longer and to go through labor were often not listened to, at least we were in at the time. So, give us your thoughts on that. Talk about the rate of caesarian section, and why you think that we should be more open to C-sections than we are culturally.

Amy Tuteur: So, before we get into the attitude toward C-section, I feel like I need to say that when I was practicing, I had a 16% C-section rate. Which is really quite low. Although I acknowledge that where I am practicing now, it would probably be higher, because the changes in the rules about vaginal birth after C-section.

Russ Roberts: When you say "rules," do you mean legal restrictions? Or hospital-imposed rules? Or what?

Amy Tuteur: Well, there are legal and insurance restrictions. But they come about because we knew, right from the very beginning that vaginal birth after C-section had a increased risk, compared to vaginal birth in women who hadn't had a previous C-section. And that risk includes the rupture of the uterus and the potential death of the baby. And even the death of the mother. And although women signed consent forms saying that they understood that that could happen, when it began to happen, these women sued. And they won. They sued claiming that they--although they had been told that it could happen, they didn't really understand that it could happen. And, insurance companies paid out a lot of money. And as a result, they directed the doctors and the hospitals that they, um, that they covered, to have certain restrictions on vaginal birth after caesarian. And the American College of Obstetrician-Gynecologists codified some of these restrictions. And they included the ability to perform a C-section within 30 minutes. Which meant that the doctors involved--like, the obstetrician and the anesthesiologist--had to be in the hospital at the time that the woman was in labor. And a lot of community and rural hospitals don't have an anesthesiologist in the hospital 24 hours a day. And so, those hospitals stopped doing vaginal birth attempts after C-section, because they couldn't meet the standards.

6:22

Russ Roberts:

Russ Roberts: So, that's one of the reasons that C-section rates are higher for second, third births, that--etc.--that after an original C-section, now those were increasingly C-section also, is what you are saying.

Amy Tuteur: Correct. That's right. But I think it's important to go back a little to the history of the natural childbirth movement, to really situate the whole C-section issue within the movement itself. Now, most people don't realize that the natural childbirth movement was created in the 1930s and 1940s by Grantly Dick Read, who was a British obstetrician. He was also a eugenicist. And he was preoccupied--as were many eugenicists in the 1930s--with the problem of what he called 'white race suicide.' He bemoaned the fact that white women of the so-called 'better classes' were having fewer children, while women of color, of the lower classes, were having more children. And he felt that upper class white people would be drowned in a sea of their--what he felt--were their inferiors. And he--

Russ Roberts: He was a racist. He was a terrible racist. Got it.

Amy Tuteur: Yeah. He was a racist. He was a misogynist--

Russ Roberts: How does that tie into the Natural Birth, thing, though? The natural parenting?

Amy Tuteur: Well, so, he thought that the reason that women were not--women of the better classes--were not having enough children was that they were, first of all, too educated. They were what he referred to as overcivilized. And also that they were afraid of the pain. And, to fix that fear of the pain, it told them it was all in their head. He said that primitive women gave birth easily; had no complications; and had no pain. So, to the extent that women had pain or complications, it was because they were over-educated and over-civilized.

Russ Roberts: This is something you call in the book, which I phrase--I like quite a bit--paleo-fantasy. That romanticization of pre-history and our primitive ancestry.

Amy Tuteur: Right. But, he did it with a purpose. It wasn't that he didn't understand what childbirth had been like in nature. He wanted women to feel bad if they didn't give birth to children--a lot of them. And easily. And, that--the movement in the United Kingdom crossed to the United States in the 1950s where it got a somewhat different spin. And that was because medicine had become very paternalistic, both toward women and toward men. But women rebelled first. And, one of the things that they were unhappy about was that the only anaesthesia available was anaesthesia that put you to sleep. And, they wanted to be awake for the birth; and they were willing to accept the pain. And that's fine. You know--if that's what women wanted. And, the natural childbirth movement, as it crossed to the United States, it was responsible for a lot of important and valuable changes. Natural childbirth advocates asked, 'Why can't husbands and partners be in the delivery room?' And, doctors at first responded, 'Well, they can't.' And women said, 'Well, why not?' And doctors said, 'Well, actually we don't know. We always did it that way; but we don't know why we did it that way. We'll change.' And so, a lot of things changed, in the 1960s, 1970s, and 1980s. Also, what changed is the development of epidural anesthesia. And the improvement of safety of Caesarian sections. It is important for people to understand that up until the 1930s, C-sections were extremely dangerous. They were considered a bad thing. So, a lot of women would have vaginal births and their babies would die. After anaesthesia became better, and then definitely after introduction of spinal and epidural anaesthesia, C-sections became safe. And anesthesia became safe. So, there was no longer a medical reason to avoid c-sections. And, not surprisingly, the c-section rate grows. Because all the doctors wanted to save all the babies they possibility could.

Russ Roberts: But it does pose--impose a much different post partum, after-birth experience for the women involved, in terms of recovery and ability to be with the child. So, talk about that.

Amy Tuteur: Well, again, it all depends on how you frame it. It's certainly a much better recovery than if your baby dies. And that was the choice. Now, what also happened during that time period was the reemergence of midwifery as a profession. And, there have always been midwives; and they have always struggled to make birth safer. But, the reemergence of midwives had more to do with differentiating themselves from obstetricians. And so midwives began to promote what they could do as good and natural, and demonize what doctors could do as bad and harmful. And vaginal birth is a great thing, but it's not the right thing for everyone. There's actually a high rate of infant mortality and maternal mortality; and C-sections--in fact, Atul Gawande actually wrote about this--C-sections have saved more lives than almost any other surgical procedure. They've been an amazing success. Are there too many? Yes, there are potentially too many. But, of course, the problems with having too few are much bigger than the problems with having too many. And, you know, you don't want to have a C-section--it's surgery--that's fine, you don't want to have a C-section. But, you shouldn't feel bad if you do have a C-section. That's what's really changed. Not so much that women are disappointed, but they feel they've done something wrong. And they haven't done anything wrong. And they are told that they have missed out on a certain kind of experience. And they haven't really missed out. In the entire history of human existence, no woman said, 'What I really want is to have an agonizing, painful, near-death experience when I have a baby.'

Russ Roberts: And it puts my child at risk, on top of it.

Amy Tuteur: It definitely puts my child at risk. But what's happened, and it's kind of like what's happened with vaccines, is that neo-natal mortality and maternal mortality are now, fortunately, very rare. And so people have gotten the wrong idea--that childbirth is relatively safe. It's not inherently safe. Obstetrics has made it safe. C-sections have made it safe. Anaesthesia has made it safe. So, you can't really say what we want to do is go back to unhindered childbirth because it was awesome when it was unhindered childbirth. No: It was horrific when there was unhindered childbirth. And what we're looking for now is a balance: Are we at the right place? I don't think we're at the right place. But, we need practical solutions, not demonizing c-sections, and definitely not demonizing women who have c-sections.

14:31

Russ Roberts: Let me ask a question of you as a practitioner; and it's not an easy question to answer; but, certainly there are births you attended where a C-section was called for unequivocally to save the life of the child or the mother. There certainly were times when a C-section was a risk that was being endured to gain something that was very remote, that safety. And then there's the gray areas, the in-between cases where it's hard to know whether a C-section is the definitive response to the risk that the mother and child are facing. As a practitioner, how many times, or how often, or how agonizing was that middle situation where it wasn't clear what the right thing to do is? I ask this because, our first--'our,' again the wrong pronoun--my wife's first delivery of our daughter, our doctor was--it was in the middle of the night; he hadn't arrived yet. There was a monitor of the baby's heart rate, my daughter's heart rate. It was going to very low levels when contractions were occurring. And the attending nurse--it was either an attending nurse or an attending, very young, inexperienced doctor--said, 'I think we need a C-section. Sign these forms.' And, we, like you point out, we were emotionally, culturally against a C-section. Whether that was right or wrong. But there was a lot of pressure on us, and we were not sure what to do. And very shortly thereafter the doctor came, and said, 'Oh, that's just the contraction. Don't worry about that.' And my wife had a very painful, but a vaginal birth; and mother and daughter were fine. That kind of moment, where it's not clear what the right thing to do is: Is that common? Or, in other words: How much leeway is there in trying to decide? I mean, I assume, as an economist, it's not usually--it's usually not open and shut. To use a bad metaphor. It's hard to know what the right thing to do is at any one time. And I think the legal system encourages doctors toward--I worry that the legal system encourages doctors toward c-section. So, what are your thoughts?

Amy Tuteur: Well, the real issue is that we have a technical problem. We know that childbirth can be dangerous for babies, because every time the uterus contracts, the baby has to, figuratively, hold its breath. It cuts off the blood flow to the baby. That's not really a problem if the placenta is functioning well. But, you might imagine that, in a baby that isn't getting enough oxygen through the placenta between contractions, each contraction, it causes the baby to hold its breath and it doesn't have enough, for lack of a better term, enough breath to hold. It begins to suffer oxygen deprivation. We could eliminate a significant proportion of unnecessary C-sections if we could measure the baby's oxygen content. But, the baby is inaccessible to us. We really can't measure the baby's oxygen content. All we can do is listen to the baby's heartbeat. Now, imagine if you had a problem, a medical problem, and you went to your doctor; and the only thing your doctor could do was listen to your heartbeat. Obviously, if your heartbeat was really, really slow, your doctor would know that you were in terrible trouble. And if your heartbeat was normal, your doctor would be relatively safe in assuming that you were okay. But if it were somewhere in the middle, and there was nothing else the doctor could do to figure it out, both you and the doctor would be in a very difficult situation.

Russ Roberts: Yup.

Amy Tuteur: And that's the situation that we're in now, where we know some babies will be harmed by labor; we know what some of the signs are. But we don't know the thing we really want to know, which is: Is the baby getting enough oxygen? So, we have this very imperfect test, to measure the baby's heart rate. And the thing about that test is that it has a really high false-positive rate. In other words, it will show distress even when the baby is not in distress. But it also has a really low false-negative rate. So, if it shows that the baby is fine, the baby is definitely fine. So, then the question becomes: If it suggests that the baby is in trouble, what should you do if you can't actually figure it out? And, that is really a value judgment. And it depends on the patient's values and the doctor's experience. An experienced physician might be willing to wait and see what happens, reasoning that if things are going badly, they'll get worse; and they can intervene then. But, a lot of parents don't want to wait and see. They don't want to risk their baby's health or their baby's brain function. And they're--when they are told that the baby might be at risk, they say, 'You know what? I'd rather help[?] the baby. I'd rather have a baby who is completely intellectually intact.' And therefore, the number of c-sections has risen. Because, when you can't be sure, a lot of people feel it's better to over-treat, because the consequences of undertreating are so devastating.

20:48

Russ Roberts: So, your point, which I think is easily missed--you just sort of alluded to it briefly a few minutes ago, which I think is worth emphasizing, is that until, maybe, certainly it started at the beginning of the 20th century but certainly before the 20th century--childbirth was a terrible cause of death--of not just infant mortality of children that didn't survive or died before delivery, but of maternal mortality. And that transformation is one of the great achievements of human history.

Amy Tuteur: Absolutely.

Russ Roberts: It's just under-appreciated. Give us some feel for what the magnitudes used to be. Again, in semi-modern times. Not ancient times.

Amy Tuteur: Well, in terms of maternal mortality, which is still higher than we would like it, but much, much lower than it was: If maternal mortality were now at the same rate now that it was, say, in 1900, approximately 45,000 women would die each year in childbirth. And that's equivalent to the number of women who die each year of breast cancer. And we all recognize breast cancer as a terrible scourge. So--

Russ Roberts: How many women die now of, in maternal, in childbirth?

Amy Tuteur: In the United States, between 700 and 800 women a year. Which is more than we would like--

Russ Roberts: wish it were lower. Yeah.

Amy Tuteur: But that's a far cry from 45,000.

Russ Roberts: Now, I should just mention that: There's been a recent uptick--not small. The word, 'uptick,' is not the right word. A spike in maternal mortality in the United States. And, that, we could spend the whole rest of the time on that. Because it's complicated--to me, looking at it from the outside. It seems to me a change in how it's been measured--

Amy Tuteur: Absolutely--

Russ Roberts: and the way that states [nations?--Econlib Ed.] report maternal mortality. I don't think the United States has become more dangerous place for women to give birth. And one of the challenges of measuring maternal mortality is that a woman who dies 6 months after childbirth can be classified as an example of maternal mortality. Because of a coroner's decision and the way that was kept track as changed over time--

Amy Tuteur: Right--

Russ Roberts: So it's quite complicated. I just want to mention that for listeners. This is the kind of issue that we like to talk about here: how data can be, quite, a lot more complicated than it appears. The other issue is that, the United States has a very high rate of deliveries of women, 40 and 45 and older, which are more dangerous.

Amy Tuteur: Yeah. So, that seems to be less of an issue. It's certainly a problem. But, I think the important thing is to look at what women are dying of. So, the--the shape of the problem has changed dramatically. In 1900, women were dying primarily of hemorrhage. Of infection. And of pre-eclampsia. In 2019, women are dying primarily of cardio-vascular disease, including congenital heart disease. And, pre-existing chronic conditions, like kidney disease, diabetes, other things. And so, what you find is that women are dying of high-tech problems that require high-tech solutions. And, you think about how we lowered infant mortality: One of the things that we did is we developed a triage system: different levels of nurseries. We have Level 1, 2, and 3. And, we transfer babies to Level 3 Nurseries if they are very sick, because those nurseries have specialized care. And that's dramatically improved neo-natal mortality. We have nothing like that for mothers. And we should be putting together something like that for mothers. We should have more peri-natologists, more maternity ICUs [Intensive Care Units]. Because, those are the women who are dying. And they are dying from lack of technology. So, one of the things that I find very upsetting is that, although we can argue whether, um, childbirth has been medicalized too much, when it comes to the issue of maternal mortality, the women who are dying are dying because they lack access to that technology. And it's bizarre--and very unfortunate--to claim that we could reduce maternal mortality if we lowered the C-section rate. Or lowered the intervention rate. Because, those things have--are exactly the opposite of what is going on. And, that's a phenomenon that I have referred to, and others have referred to as 'Medical Colonialism,' in that we have been expropriating, or activists have been expropriating the tragedies of underserved women to advocate for what privileged women want. So, you find something like, New York State, promoting doulas, in response to the maternal mortality situation.

Russ Roberts: Explain what a doula is.

Amy Tuteur: A doula is--it comes from the Greek word for slave. And it's basically a woman who helps other women cope with childbirth. Who supports them through childbirth. Both by giving encouragement and also by, you know, cold washcloth for their brow, cheerleading when they are pushing. Things like that.

Russ Roberts: Counting, for their Lamaze breath.

Amy Tuteur: Right. Right. But the, the sad thing, the tragic thing, is that, while doulas are very good, and they can definitely improve the experience of childbirth, the women who are dying are not dying from bad experiences. They are dying from heart disease. They are dying from kidney disease. And, it seems perverse to offer these women who are suffering a amenity that privileged women would really enjoy.

Russ Roberts: Yeah. Um. Let's--I agree.

27:25

Russ Roberts: Let's move to the epidural issue. A lot of people believe--and I know you do not, so I want to hear your take--a lot of people believe that an epidural puts the baby at some risk. And therefore it's better to have a "natural childbirth." And that that pain relief is just unnecessary.

Amy Tuteur: Well, unnecessary for whom? You know, I happen to think, as a physician and as a human being, that treating pain is the cornerstone of what any person should do for any other person. If somebody wants to be in pain, that's okay. But, um, you know, all pain relief has risks. Why is this the only form of pain relief where anybody talks about the risks? And why is it that those risks are magnified? So, for example, the risk of--the risk of a baby being harmed by an epidural is purely theoretical. The risk of a baby being harmed by attempted vaginal birth after a Caesarian is both very real and orders of magnitude greater than any theoretical risk of epidurals. So, why are natural childbirth advocates promoting VBACs [Vaginal Birth After Cesareans], but demonizing epidurals? It doesn't make sense, if what they are really talking about is the risk.

Russ Roberts: A VBAC is a Vaginal Birth After a Cesarean.

Amy Tuteur: Correct.

Russ Roberts: So, what are your thoughts on the risk? You said it was theoretical? Or hypothetical?

Amy Tuteur: There's really no risk. I mean, you know, one of the things that I always find very interesting is that women obstetricians don't believe any of this stuff. Because it's nonsense. Women obstetricians have epidurals in droves. They have C-sections at much higher rate than average. They don't believe,and their experience tells them, that these things are not bad things. They are just choices. And, one of the reasons that they've been portrayed as bad things is, sadly, because of the reemergence of midwifery. Midwives can't give epidurals. Midwives can't do C-sections. And so they've demonized them. In the United Kingdom, where midwives can administer Nitrous Oxide--laughing gas--for pain relief in labor, they consider that perfectly compatible with a natural childbirth, even though that's a drug.

Russ Roberts: That's interesting.

30:09

Russ Roberts: Let's talk about breastfeeding, because that's another area where there's been a lot of emotional, cultural issues that interface with actual science to the best of our knowledge, which is, of course, imperfect. There's a lot of pressure on women, you suggest in your book, to breastfeed rather than to administer formula. Why is that a mistake?

Amy Tuteur: Well, I often say that the key thing to know about breastfeeding is that the moralization of breastfeeding parallels the monetization of breastfeeding. Sometimes it's an advantage to be old--like I am. I'm 60 years old. And I remember a time before formula--before breastfeeding was magical. When it was just a way that you could feed your baby. A good way, but it didn't have all these supposed benefits. And then came the profession of lactation consultants. Which are good things. They are very helpful to women who are trying to breastfeed. But, instead of concentrating on helping women who want to breastfeed to do so, they are constantly seeking to increase market share. They want every woman to breastfeed. And that's, honestly, none of their business, how another woman uses her body. If a woman wants to breastfeed--great. I mean, I breastfed my four children. I enjoyed it. They thrived. It was a great experience. But that doesn't me the ideal that other women should aspire to. Other women have different preferences, different life histories that may make them feel differently about breastfeeding. But we've crushed that under the notion that breastfeeding has such massive benefits that no good mother should avoid doing it. And, theoretically, it's possible that breastfeeding has all sorts of massive benefits. Certainly there were small studies that suggested it might. But we've already done the big study that shows that it doesn't have big benefits. You know, two entire, nearly entire generations of Americans were raised on formula. Nothing happened that was bad. And, if you look at, um, breastfeeding rates, they've gone up dramatically since the 1970s. In 1973 I think we bottomed out with a breastfeeding initiation rate of 24%. Now, over 80% of women are leaving the hospital claiming that they are going to exclusively breastfeed. And in that time, there's been absolutely no impact on the infant mortality of term babies, and no impact on major parameters of infant illness and hospitalization for term babies. The only proven benefit has been for premature babies who have immature digestive systems. So, at this point, honestly, we are just lying to women. In order to get them to breastfeed, we tell them it has benefits that it doesn't have.

Russ Roberts: And the benefits, we're told, are better immunity against disease, better nutrition, healthier--whatever.

Amy Tuteur: Right, but then you should be able to see it. It's not that it couldn't have those benefits. But if it did have those benefits then the breastfeeding rates should at least be related in some way to infant mortality and infant morbidity--which is sickness. And, look around the world: the countries with the highest breastfeeding rates have the highest infant mortality rates. And the countries with the lowest infant mortality rates have the lowest breastfeeding rates.

Russ Roberts: But as you would point out--and you do in the book--there are lots of other factors. And so, those kind of crude comparisons are not definitive. They are provocative--

Amy Tuteur: It's not that they are not definitive. It just shows that people have been deceiving women. Don't tell women--if you look at the Lancet papers on breastfeeding or the World Health Organization, they say 823,000 lives could be saved each year if more women breastfed. Well, in the first place, those are not in industrialized countries, so why that should matter to American women is an issue. And in the second place, it isn't even true. Because, babies don't die of lack of breastfeeding. They die of prematurity; they die of congenital anomalies; they die of dirty water. But, breastfeeding is not going to save that many lives. And it's wrong to keep insisting that it will.

Russ Roberts: Well, in the poorer countries that don't have access to clean water, breastfeeding--a crude switch, just simply nothing else changes but formula is used less and breastfeeding is used more--that could save lives because that water issue. But it wouldn't be the breastfeeding per se. It's that the water is the problem.

Amy Tuteur: Well, and not only that: It's all well and good to breastfeed your baby till two; and then the baby has to still drink the dirty water. And then the baby will die. So, if we really want to save lives in those countries, we should help them with water purification.

Russ Roberts: I agree with that.

36:05

Russ Roberts: You mentioned a study, and you talk about it in the book, of siblings. Obviously, as you point out, many studies that purported to show that the benefits of breastfeeding were flawed because the sample of people who chose to breastfeed in the past was not a perfect match--control--with the people who weren't breastfeeding--

Amy Tuteur: Correct--

Russ Roberts: Classic problem in economics and epidemiology and elsewhere. But, there was a study that was somewhat more controlled, which is of siblings. Can you talk about that?

Amy Tuteur: Yeah. The Colen study was published in 2014. And it was a very elegant study. And it looked at 10 years of data in New York State. And it looked at the difference between, within families, between children who were bottle fed and breast fed. And there was no difference. All the parameters that seemed to be different for, if you looked as a group, of all children who were breastfed compared to all children who were bottle fed, on 11 different measures, like asthma and IQ [Intelligence Quotient] and you name it--every single one of the advantages that supposedly accrued from breast feeding disappeared.

Russ Roberts: And not surprisingly, breast feeding advocates have suggested that study is flawed.

Amy Tuteur: Right. But, you know, I think that the important thing here--we can get into the weeds with the scientific evidence, but the important thing is: This is an issue of choice for women. This is not just about what is good for babies. And, the fact of the matter is that the benefits of breastfeeding are so trivial that you can't even measure them. I mean, we can't find them in any large population. And, if that's the case, why are we pressuring women to use their bodies in an approved way? Shouldn't it be up to women to weigh the risks and benefits? I mean, why do we have something like the Baby-friendly Hospital Initiative, which goes into hospitals and pressures women to breastfeed? That, to me, is completely unethical.

Russ Roberts: Well, you talk about the self-interest of lactation consultants--you mentioned a minute ago. The irony, of course, is the original claim, was that formula has been foisted on women by the profiteering of multinational corporations. And now, you are suggesting that that's being overwhelmed by the self-interest of licensed and trained lactation experts.

Amy Tuteur: Well, the fact of the matter is, formula was not foisted on people by formula companies. Formula companies met the need for--women were already not breastfeeding. They were feeding their children cow's milk and various other concoctions instead of breastfeeding. And those babies died at a massive rate. We found infant feeding bottles from ancient Egypt. There have always been women who can't or don't wish to breastfeed. Formula fills the need. Did formula companies do a terrible thing in Africa in the 1970s? Absolutely. They did. And formula companies should be demonized for that. But that doesn't mean we should demonize formula. And that doesn't mean that we should pressure women in 2019 to breastfeed to punish formula companies for what they did in 1970. Every woman should be able to make her own decision. You know, people--lactation consultants talk a lot about the benefits of breastfeeding. Well, what about the benefits of trusting mothers to do what they think is best for their babies? What about the benefits of not pressuring them? I don't understand why that doesn't end up on our radar somewhere.

Russ Roberts: Well, I just want to mention: At one point I think you talk about the claim that 'a single bottle of formula is harmful to a baby's health.' This just seems to go against common sense. It reminds me of--I may have mentioned this before, but I think it's a tragic story; I think it's informative of human nature. Adelle Davis, the nutrition advocate and expert, died of cancer. And when she got cancer, she attributed it to a bag of potato chips she had eaten as a child, or in her youth.

Amy Tuteur: Right. Right.

Russ Roberts: And, that just--I mean, that's human nature to find things that allow us to keep our narratives intact. But the idea that one bottle of formula is going to lead to a disaster--but that is the claim. Is that correct?

Amy Tuteur: Well, yes. And it's part of a larger effort. Lactation professionals are well aware that the benefits that they predicted for breastfeeding have not come to pass. So, now they are predicting ever-more arcane benefits. And the latest thing is that formula ruins the micro biome of the infant gut. And that formula somehow changes the genetics of babies--the epigenetics of babies. Those things are both unproven, but also they are acknowledgement that the other benefits that they've been touting all this time have not come to pass.

Russ Roberts: Yeah, and of course it's possible that, as you say, the rise in breastfeeding in the 1970s and 1980s and 1990s and into today will lead to children who will live much longer: 'All the problems of formula and breastfeeding are going to show up in old age.' It's conceivable. I think it's unlikely. And with you: I think you want to focus more on the infant morbidity and mortality. But, it's conceivable that these kind of benefits could be there. But, as you point out, finding evidence--there's no real reason to think it's the case.

Amy Tuteur: Right. And, in the meantime, we're just flattening women. We're just telling them, 'This is what you have to do, and if you don't do it, you're a bad mother.' And women are literally committing suicide over this, over these, essentially non-existent benefits. Because they are being pressured. And, you know, one of the things that I've come to wonder about, and animates all that I do now, is: Why do good mothers feel so badly about themselves? And the reason is because there is a whole bunch of people whose profession is to make them feel badly about themselves. You know, make them feel badly if they don't breastfeed. Make them feel bad if they had a C-section. Make them feel bad if they had an epidural. How on earth is this helpful to babies, let alone to mothers? I don't see it.

43:17

Russ Roberts: Well, there is another issue--it came up in our earlier episode with Emily Oster on how to deal with pregnancy and what's the evidence on the right behaviors during pregnancy. And I want to let listeners know: I expect to have Emily on in the next few months, on her new book, Cribsheet--good title--

Amy Tuteur: yeah--

Russ Roberts: which is what we know about the child-raising process, once the birth has happened. And one of the issues that came up with Emily before is that, there would be issues like, should women have a glass of wine while they are pregnant. Should they drink caffeine? One of the things that matters in the health of the baby is the mental wellbeing of the mother. And, driving perspective of moms, or moms after childbirth, is not the best thing. It comes with a cost. That's all I'll say. As an economist, it's--

Amy Tuteur: Well, it more than comes with a cost. It suggests that what's going on here is not what we see on the surface. I mean, most people don't realize that like natural childbirth, both breastfeeding and the attachment parenting movement, were started by people who were explicitly trying to force women back into the home. [?] began in the late 1950s and came out of a traditionalist Catholic mothers' group, where the women, in this suburb, were upset that some mothers of young children were going to work. And they reasoned that if they convinced women to breastfeed, they'd have to stay at home. And so, the history of lactivism has always been about getting women to stay home. And, over the years--what you told them had to change. Because our sensibilities had to change--

Russ Roberts: yeah--

Amy Tuteur: So, it used to be, well, breastfeeding is good. You should stay home and do it. Now it's: You better breastfeed, or your child will be mentally defective and [?] it may be penitentiary. But, again, it's an effort to manipulate women. And attachment parenting--which, in its most popular inception is, by Dr. Bob Sears--Bob Sears was the medical director--I mean, Bill Sears. Bob Sears is his son, the anti-vaccination person. Bill Sears was the Medical Director of LaLeche League. And he and his wife believed, and they wrote in their first book, which is something like The Christian Guide to Parenting and Childbirth--they said that attachment parenting was given to them by God. They prayed on it and they received it from God as the way that God wants the family to be ordered, with the husband as the head and wife solely occupied with caring for him and the children. And I don't think that you can really ignore that these things were created to control women, and that they still are attempting to control women. That's a bad thing, in my view.

Russ Roberts: Well, I want to come to attachment parenting next. But, before we do, it's important to mention for people who have never fathered or mothered a child, that not every woman can breastfeed. On a physical basis, to produce enough milk to sustain the health of the child--I think most people just assume that this just a question of convenience. If you are working, it's hard to breastfeed. You have to pump milk and store it, or bring your baby to work, or get home for lunch; or whatever. But this is not what we're talking about. It's relevant; but, what we're talking about is the fact that--

Amy Tuteur: Well, right. But the reason they assume that--they don't assume it. They were told that by the lactation profession. If you read official lactation literature, it says that the incidence of insufficient breast milk is rare. But it's not rare. It's common. Just like miscarriages are common, because pregnancy isn't perfect, insufficient breast milk is common because breastfeeding isn't perfect. And yet, there's no acknowledgement of that. And so that the women who were told that breastfeeding is natural and there's not going to be any problem so long as they were committed to it and loved their baby enough, when they find themselves with insufficient breast milk, they blame themselves. They consider themselves freaks. I mean, imagine if we told women, when they had a miscarriage, that it was their fault? There's enough grief that comes from having a miscarriage without blaming women for it. And, what we've done with breastfeeding, we've said that women who are having problems, it's their fault. It's lack of, insufficient--it's lack of devotion, and lack of concern, and laziness. And, honestly, I can't think of anything more cruel than that. Because, it's not true.

48:28

Russ Roberts: So, let's talk about that. And I agree with you. Let's talk about attachment parenting. And I want to mention that--I want to set this up with--just let you react to this. We had Sebastian Junger on late last year. And there were many interesting things that came out of his book, Tribe. But, one of the themes of that book is that it's cruel to make small children sleep in their own room, because we evolved, of course, probably, in situations where parents and children slept close to one another, because there was a lot of physical danger through most of human history. So, you wouldn't go put your kid out on a--15, 20, 30 yards away. You'd keep 'im close. Because otherwise they'd get eaten by a sabretooth tiger. So, his claim is that--and I found this very poignant, and I know you're a skeptic on some of this, so I want you to react to it--

Amy Tuteur: Oh, yes--

Russ Roberts: Hang on. So, I'm just going to finish this example, though, because it's juicy. His claim is that the attachment that children have for their teddy bear, their stuffed animal, is this desperate attempt by a small human being to find the source of comfort in a world where they've been shoved out of the family bed. So, the idea that kids should sleep in their own room because it's good for them, they'll get better sleep habits, he suggests is actually not true; and in particular he suggests that in most cultures in the world, the idea of making your kids sleep in their own room would be seen as a sign of cruelty. So, talk about attachment parenting generally; and then tell us why--

Amy Tuteur: Well, I want to address that, because I think it's nonsense. It's nonsense on a number of different levels. First of all, the idea that there was one universal culture in pre-history and that all people did the same thing, and parented the same way is just completely bizarre. And, you know, if there was anything I learned from practicing medicine, it was that people in different parts of the world--because when you practice medicine in a city like Boston where I am, you meet people from all over the world--that there are a zillion different ways to raise children. Just like there are a zillion different ways to conduct marriages, and whole bunch of different ways to relate to your parents--you know, your adult--when you are an adult to relate to your parents. There's all sorts of different ways. And, one is not better than the other. I saw people from other cultures parent their children in ways that I would never parent, who raised happy, healthy, well-adjusted people. And, it seemed to me that the key, in looking at all these different cultures, was that children need to be loved, and need to know that they are loved. And that, all the rest is just commentary.

Russ Roberts: Yeah--so, sending them off to their own room is like saying, 'I don't love you.'

Amy Tuteur: Well, that's ridiculous--

Russ Roberts: By the way: All my kids, most of my kids, slept in their own room. They did in the mornings, sometimes, crawl into bed with us. But we did put them in their own rooms. So, I'm just--just to get that on the record.

Amy Tuteur: Well, I mean--my husband and I had basically what you would call a family bed, because we let anybody crawl in who wanted to. That worked well for some children. For other children, they were disgusted that we took up too much room. And went back to their own beds. But, you know, that's another thing about this, that: Not only the idea that all ancient culture was homogeneous across the entire world and across 50,000 years of human pre-history. It's that all children need the same thing: That, you know, what's good for one child will be good for all children. And, one of the great things about having more than one child--and I don't know if you and your wife also felt this way--is that you learn that everything is not your fault. That, children are born with their own personalities, and their own needs; and that the challenge of parenting is meeting the need of the child in front of you. Not some theoretical child, and not some pre-historic child, but the actual child standing there who needs something specific from you. And that might be something very different from what his brother or sister needs from you.

Russ Roberts: So, you have four kids. We have four kids, also. All of ours, it turns out, are the same. Exactly the same personalities, needs. Actually, the only thing they have in common is that they don't listen to EconTalk with any regularity. So, I can actually talk about them as much as I want. But, our kids were--yeah. One of the blessings of having more than one child, and even more than two, is the variety of personality, [?] skills, gifts, shortcomings, challenges, handicaps. It's an incredible--and I think they all came from the same parents. I'm pretty sure. Not 100%; but of course, it can't be. But I'm pretty confident that they are still from the same urn of genes. But it just comes out differently.

Amy Tuteur: Right. And so, you know, this idea that there's some Ur-child that we're all parenting is ridiculous. And, I also encourage people to consider: Why is there natural mothering, but no natural fathering? Why aren't people saying, 'You know, what children really need is for their fathers to go out and hunt big animals with spears?' And--

Russ Roberts: Well, we've had some guests who hinted[?] that as being a healthy thing. I'm just going to leave that alone.

Amy Tuteur: Right. But, for example, you know, we--one of the things that we do nowadays is have fathers in the delivery room when children are born. No indigenous, or virtually no indigenous cultures have fathers involved in childbirth. They are--women are banished to some hut or room or something far away from the men so they won't contaminate the men with the blood. And, when they are healed, then they can come back. So, why is it that we're not seeking to re-emulate that and banish women to birthing huts, and yet we're supposed to be, you know, re-emulate the family bed?

Russ Roberts: I have to say--I think my favorite moment in your book is when you talk about the husband who is there in the delivery room to support his wife, and she's in terrible pain; and she demands and epidural; and the husband says--it reminds me of the scene in Young Frankenstein. This is two, a couple of episodes in the last few months with this, where Gene Wilder says, 'No matter what I do, no matter how hard I beg: Don't open that door.' Well, similarly, this couple had decided, in advance, when they had their faculties fully about them, that they would not get an epidural. And they--*ahem* the wrong pronoun--would have a natural childbirth. And then, when confronted with the actual experience--and I should mention my wife had four natural childbirths; very pleased with that--she is; it was her choice--but, many women choose not to. And this woman, in the throes of labor, decided she wanted an epidural. And her husband said, 'Well, honey, you know we just decided--when you were calm--that this was not a good idea. So, I'm just--we shouldn't do this.' And at some point, as this conversation continued--I think the quote is, the mother turned to the doctor and, speaking of the husband, said, 'Kill him.'

Amy Tuteur: Yes. Yes.

Russ Roberts: Which, a number of women have confessed to me that they have said things in the middle of labor that they regret. That might be one of them; might not be. I don't know. But the idea of the husband being there is different, yes. Not common.

Amy Tuteur: Well, and that kind of incident really encapsulates so much of what is wrong with these movements. I mean, where else in, you know, in higher breadth of human existence would somebody ask you to decide whether or not you needed pain medication before you experienced the pain? And yet, that's what we tell women to do. And, you know, you talk about your wife had four natural childbirths. Well, I had four children, two with epidurals, two without. And so I can speak to the difference. And the difference was, the pain.

Russ Roberts: Yeah.

Amy Tuteur: That was the difference.

Russ Roberts: That reminds me of when we would go to classes before our children were born, and they would teach Lamaze to my wife and I. And I, of course, was a participant, because I was going to be her coach and help her with her breathing. And, you know, I--she found a place during her births and deliveries to get through it. I don't know if Lamaze had anything to do with those at all. But I expressed skepticism beforehand, because I said, 'If you could really control pain by breathing, they'd teach it to soldiers.' Or other people. The fact that it's only taught for childbirth suggests that it probably doesn't work.

Amy Tuteur: Right. It doesn't work. It absolutely doesn't work. And, it's--frankly, I think it's encouraging women to torture themselves, and embracing them for doing it. I mean, if you need a fallback and you are afraid of an epidural--fine; don't have an epidural. But don't tell me that this is empowering women. Why is it that women are the only ones empowered by pain and not men?

58:50

Russ Roberts: One thing we didn't get to talk about, which I didn't want to miss--and I apologize to come back a little, circle back onto this--is that you suggest that this is not something I'm aware of--that there is a black market [i.e., an illicit market--Econlib Ed.]--in your book you mention this--that there is a black market in breast milk. Is this true?

Amy Tuteur: Oh, absolutely.

Russ Roberts: And how does that work?

Amy Tuteur: Well--

Russ Roberts: What's the price? Do you know? Do you have a feel on the street?

Amy Tuteur: Well, there's also exchanges of breast milk. I mean, what has happened is that we have made women so panicked that, if their children don't get breast milk, that they will somehow be harmed, that women are reaching out to other women--either people that they know online who will share breast milk with them, or a black market in breast milk. First of all, when you pay, it's incredibly expensive. There are milk banks--real milk banks--where the milk is pasteurized, in which, I think it's like 8 an ounce or more. I mean, it's extraordinarily expensive. But when you, when there's an exchange over the Internet--you know, disease can be passed in breast milk. HIV [Human Immunodeficiency Virus] can be passed--the virus that causes AIDS [Acquired Immune Deficiency Syndrome]--is passed in breast milk. And, also, when people have looked--they've done some studies about, they've bought breast milk off the Internet--most of it is not breast milk. A lot of it is adulterated cow's milk.

Russ Roberts: Is it illegal? Is it illegal to sell your breast milk?

Amy Tuteur: You know what? I don't know. I don't know. But I do think that it shows you where we are as a culture, where women are willing to spend a fortune to buy the bodily fluids of other women for fear that their children are being deprived of something. That's--you know, that, I think, tells us more about where we are on the issue of breastfeeding than anything else. Because, the fact is, breastfeeding is not a health issue. It's a lifestyle choice. I mean, I breastfed. My kids enjoyed it. I enjoyed it. I had no trouble doing it. But that doesn't change the fact that the health benefits are trivial. And we should stop torturing women by implying that if their children don't get breast milk, that they are ruined for life. 'You,' what I say to women when I talk to them is, 'You will ruin your children. And your children will tell you that you have ruined them. But it will not have anything to do with birth or breastfeeding or anything like that.' All the things that you are encouraged to worry about are entirely irrelevant.

(23 COMMENTS)

Amy Tuteur on Birth, Natural Parenting, and Push Back

Obstetrician gynecologist Amy Tuteur and author of Push Back, talks about the book with EconTalk host Russ Roberts. Tuteur argues that natural parenting–the encouragement to women to give birth without epidurals or caesarians and to breastfeed–is bad for women’s health and has little or no benefit for their children.

The post Amy Tuteur on Birth, Natural Parenting, and Push Back appeared first on Econlib.

Amy Webb on Artificial Intelligence, Humanity, and the Big Nine

Futurist and author Amy Webb talks about her book, The Big Nine, with EconTalk host Russ Roberts. Webb observes that artificial intelligence is currently evolving in a handful of companies in the United States and China. She worries that innovation in the United States may lead to social changes that we may not ultimately like; […]

The post Amy Webb on Artificial Intelligence, Humanity, and the Big Nine appeared first on Econlib.

Amy Webb on Artificial Intelligence, Humanity, and the Big Nine

Futurist and author Amy Webb talks about her book, The Big Nine, with EconTalk host Russ Roberts. Webb observes that artificial intelligence is currently evolving in a handful of companies in the United States and China. She worries that innovation in the United States may lead to social changes that we may not ultimately like; in China, innovation may end up serving the geopolitical goals of the Chinese government with some uncomfortable foreign policy implications. Webb’s book is a reminder that artificial intelligence does not evolve in a vacuum–research and progress takes place in an institutional context. This is a wide-ranging conversation about the implications and possible futures of a world where artificial intelligence is increasingly part of our lives.

This week's guest:

• Amy Webb's Home page
• The Future Today Institute.
• Amy Webb on Twitter.

This week's focus:

• The Big Nine: How the Tech Titans and Their Thinking Machines Could Warp Humanity, by Amy Webb on Amazon.com.

Additional ideas and people mentioned in this podcast episode:

• The Belt and Road Initiative in China. Hong Kong Trade Development Council.
• "China has started ranking citizens with a creepy 'social credit' system--here's what you can do wrong, and the embarrassing, demeaning ways they can punish you," by Alexandra Ma. Business Insider, October 29, 2018.
• "Facebook and Cambridge Analytica: What You Need to Know as Fallout Widens," by Kevin Granville. The New York Times. March 19, 2018.
• "Amazon's Alexa Microwave Is as Dumb as It Is Brilliant," by Bryan Menegus. Gizmodo.com. September 20, 2018.
• "Let's Compete with Facebook," by Arnold Kling. Hackernoon.com, April 11, 2018.

A few more readings and background resources:

• Ada Lovelace. Biography.com.
• Tim Berners-Lee. W3.org.
• Frau Blucher, from Young Frankenstein. Youtube video snippet.
• Tyranny of choice
• "The Tyranny of Choice", by Barry Schwartz. Scientific American, December 2004.
• "The Tyranny of Choice". The Economist, December 16, 2010.
• Deep Mind.
• Creative Destruction, by Richard Alm and W. Michael Cox. Concise Encyclopedia of Economics.
• Public Goods, by Tyler Cowen. Concise Encyclopedia of Economics.

A few more EconTalk podcast episodes:

• Michael Munger on Sharing, Transaction Costs, and Tomorrow 3.0. EconTalk.
• Frank Dikotter on Mao's Great Famine. EconTalk.
• Jerry Muller on the Tyranny of Metrics. EconTalk.
• Cathy O'Neil on Weapons of Math Destruction. EconTalk.
• Rodney Brooks on Artificial Intelligence. EconTalk.
• Nick Bostrom on Superintelligence. EconTalk.
• Robin Hanson on the Technological Singularity. EconTalk, January 2011.
• A few futurist podcast episodes
• Benedict Evans on the Future of Cars. EconTalk, August 2017.
• Helen Pluckrose and James Lindsay on the Enemies of Modernity. EconTalk, February 2018.
• Tim O'Reilly on What's the Future. EconTalk, October 2017.
• Gary Marcus on the Future of Artificial Intelligence and the Brain. EconTalk, December 2014.
• Kelly Weinersmith and Zach Weinersmith on Soonish. EconTalk, January 2018.
• David Autor on the Future of Work and Polanyi's Paradox. EconTalk, October 2014.
• Don Boudreaux on China, Currency Manipulation, and Trade Deficits. EconTalk, November 2010.
• Neil Monnery on Hong Kong and the Architect of Prosperity. EconTalk, October 2018.

Time Podcast Episode Highlights

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0:33

Intro. [Recording date: February 12, 2019.]

Russ Roberts: My guest is futurist and author Amy Webb.... Her latest book is The Big Nine: How the Tech Titans and Their Thinking Machines Could Warp Humanity.... Your book is a warning about the challenges we face, that we're going to face dealing with the rise of artificial intelligence. What is special about the book, at least in my experience reading about AI [Artificial Intelligence] and worries about artificial intelligence is that it doesn't talk about AI in the abstract but actually recognizes the reality that AI is mostly being developed within very specific institutional settings in the United States and in China. So, let's start with what you call the Big Nine. Who are they?

Amy Webb: Sure. So, what's important to note is that when it comes to AI, there's a tremendous amount of misplaced optimism and fear. And so, as you rightly point out, we tend to think in the abstract. In reality, there are 9 big tech giants who overwhelmingly are funding the research--building the open-source frameworks, developing the tools and the methodologies, building the data sets, doing the tests, and deploying AI at scale. Six of those companies are in the United States--I call them the G-Mafia for short. They are Google, Microsoft, Amazon, Facebook, IBM [International Business Machines], and Apple. And the other three are collectively known as the BAT. And they are based in China. That's Baidu, Alibaba, and Tencent. Together, those Big Nine tech companies are building the future of AI. And as a result, our helping to make serious plans and determinations, um, for I would argue the future of humanity.

Russ Roberts: And, just out of curiosity: I don't think you say very much in the book at all about Europe. Is there anything happening in Europe, in terms of research?

Amy Webb: Sure. So, the--you know, there's plenty of happening in France. Certainly in Canada. Montreal is one of the global hubs for what's known as Deep Learning. So this is not to say that there's not pockets of development and research elsewhere in the world. And it also isn't to say that there aren't additional large companies that are helping to grow the ecosystem. Certainly Salesforce and Uber are both contributing. However, when we look at the large systems, and the ecosystems and everything that plugs into them, overwhelming these are the 9 companies that we ought to be paying attention to.

3:18

Russ Roberts: So, I want to start with China. I had an episode with Mike Munger on the sharing economy and what he calls in his book Tomorrow 3.0. And, in the course of that conversation, we joked about people getting rated on their social skills and that those would be made public--how nice people were to each other. And we had a nice laugh about that. And I mentioned that I didn't think that that was an ideal situation--that people would be incentivized that way to be good people: despite my general love of incentives, that made me uneasy. And in response to that episode, some people mentioned an episode of Black Mirror[?]--the video series--and also some things that were happening in China. And I thought, 'Yeh, yeh, yeh, whatever.' But, what's happening in China--it's hard to believe. But, tell us about it.

Amy Webb: Sure. And, let me give you a quick example of one manifestation of this trend, and then sort of set that in the broader cultural context. So, there's a province in China where a new sort of global system is being rolled out. And it is continually mining and refining the data of the citizens who live in that area. So, as an example, if you cross the street when there's a red light and you are not able to safely cross the street at that point--if you choose to anyway, as to jay-walk--cameras that are embedded with smart recognition technology will automatically not just recognize that there's a person in the intersection when there's not supposed to be, but will actually recognize that person by name. So they'll use facial recognition technology along with technologies that are capable of recognizing posture and gait. It will recognize who that person is. Their image will be displayed on a nearby digital--not bulletin board; what do you call those--digital billboard. Where their name and other personal information will be displayed. And it will also trigger a social media mention on a network called Weibo. Which is one of the predominant social networks in China. And that person, probably, some of their family members, some of their friends, but also their employer, will know that they have--they have infracted--they have caused an infraction. So, they've crossed the street when they weren't supposed to. And, in some cases, that person may be publicly told--publicly shamed--and publicly told to show up at a nearby police precinct. Now, this is sort of important because it tells us something about the future of recognition technology and data. Which is very much tethered to the future of artificial intelligence. Now, better known as the Social Credit Score, China has been experimenting with this for quite a while; and they are not just tracking people as they cross the street. They are also looking at other ways that people behave in society, and that ranges from whether or not bills are paid on time, to how people perform in their social circles, to disciplinary actions that may be taken at work or at school, to what people are searching on--you know, on the Internet. And the idea is to generate some kind of a metric to show people definitively how well they are fitting in to Chinese society as Chinese people. This probably sounds, to the people listening to the show, like a horrible, Twilight Zone episode--

Russ Roberts: It sounds like 1984, is what it sounds like to me. It's not like, 'I wonder if that's a good idea.' It's more like, 'Are you kidding me?'

Amy Webb: Yeah. And so like, when I first heard about this, my initial response was not abject horror. I was curious. I was very curious.

Russ Roberts: [?]

Amy Webb: But like, here's what made me curious: Why bother? I mean, China has 1.4 billion people. And if the idea is to deploy something like this at scale, that is a tremendous amount of data. And you have to stop and say to yourself, 'Well, what's the point?' So, this is where some cultural context comes into play. So, I used to live in China. And I also used to live in Japan. And, they are very different cultures, very different countries. One distinctive feature of China is a community-reporting mechanism that is sort of embedded into society. And going back many thousands of years--you know, China is an enormous--it's a huge piece of land. And you've got people living throughout it; in fact, they are so spread apart, you have, you know, significantly different dialects being spoken. So, one way to sort of maintain control over vast masses of people spread out geographically was to develop a culture--sort of a tattle-tale culture. And so, throughout villages, if you were doing something untoward or breaking some kind of local custom or rule, that would get reported--you would get reported. Sort of in a gossipy way. But, you would get reported; and ultimately that person that heard the information would report that on up to maybe a precinct or a feudal manager of some kind, who would then report that up to whoever was in charge of the village or town; and then you would get into some kind of actual trouble. This was a way of maintaining social control. And so if you talk to people in China today, a lot of people are aware of monitoring. What I find so interesting is that at the moment, the outcry that we see outside of China does not match the outcry that I have observed--or actually to the lack of outcry--that I have observed in China. Now, there's one other piece of this really important: This is that using AI in this way ties in to China's Belt and Road Initiative [BRI]. And you might have heard about the BRI. This is sort of a master plan--it's a long-term strategy that helps China optimize what used to be the previous Silk Road--trading route. But it's sort of built around infrastructure. What's interesting is that there's also a digital version of this--the sort of digital BRI--where China is partnering with a lot of countries that are in situations where social stability is not a guarantee. And so, they are starting to export this technology into societies and places where there isn't that cultural context in place. And so, you have to stop and wonder and ask yourself, 'What does it mean for 58 pilot countries to have in their hands a technology capable of mining and refining and learning about all of their citizens, and reporting any infractions on up to authorities?' You know, in places like the Philippines, where free speech right now is questionable, this kind of technology, which does not make sense to us as Americans, may make slightly more sense to people in China, becomes a dangerous weapon in the hands of an authoritative, an authoritarian regime elsewhere in the world.

11:14

Russ Roberts: It reminds me, when you talk about the tattle-tale culture--of course, the Soviets did the same thing. They encouraged people to inform on--telltale sounds like a child reporting an insult. It's a monitoring mechanism by which authoritarian governments keep people in line. And you talk about the lack of outcry. Well, one reason is, is that you are worried that your social score is going to be low. Outcrying is probably not a good idea.

Amy Webb: That's right. That's right.

Russ Roberts: You should mention also, which I got from your book, that: It's not just like it's awkward, it's kind of embarrassing, you have a low score. These scores are going to be--going to be used, or being used?--to deal with people get credit, whether they can travel? Is that correct?

Amy Webb: Right. So, again. It's China. So, we can't be 100% of the information that's coming out, because it's a controlled-information ecosystem. But from what we've been able to gather, in all of the research that I've done, you know--I would suggest that it's already being used. It's certainly being used against ethnic minorities like the Uighurs. But we've seen instances of scoring systems being used to make determinations about school that kids are able to get into. You know, kids who, through no fault of their own may have parents that have run afoul, you know, in some way, and earned demotions and demerits on their social credit scores. So, it would appear as though this is already starting to affect people in China. And, again, my job is to quantify and assess future risk. So, as I was doing all of this research, my mind immediately went to: What are the longer term downstream implications? I think some of them are pretty obvious. Right? Like, some people in China are going to wind up having a miserable life as a result of the social credit score--the social credit score as it grows and is more widely adopted to some extent could lead to better social harmony, I guess; but it also leads to, you know, quashing individual ideas and certain freedoms and expressions of individual thinking. But, the flip side of this is: If it's the case that China has BRI--and it's investing in countries around the world not just in infrastructure but in digital infrastructure like fiber and 5G and communications networks and small cells and all the different technologies, in addition to AI and data, isn't it plausible that some time in the near future, our future trade wars aren't just rhetoric but could wind up in a retaliatory situation where people who don't have a credit score can't participate in the Chinese economy? Or, businesses that don't have credit scores can't do, can't trade. Or countries that don't have--if we think about like a Triple A Bond rating, you know, what happens if this credit scoring system evolves and China does business with, only with countries that have a high-enough score? We could quite literally get locked out of part of the global economy. It seems far-fetched, but I would argue that the signals are present now that point to something that could look like that in the near future.

15:03

Russ Roberts: Well, this is going to be a pretty paranoid show--episode--of EconTalk. So, I'm okay with that kind of fear-mongering, because it strikes me as quite worrisome. And I think we have to be, as you hinted at, you have to be open-minded that maybe this will make a better Chinese society, as defined by them. You know, the Soviets wanted to create a new Soviet man--and woman. They failed. But now, with these tools maybe there will be a new Chinese man and woman who will be harmoniously living with their neighbor, never jaywalking, and never gossiping, and smiling more often. Who knows? But, it's not my first, default thought about how this is going to turn out. I think that--

Amy Webb: No, but you kind of--you have to start with--I want to point out that I am not like a dystopian fiction writer. I'm a pragmatist. So, this--I am not studying all of this for the purpose of scaring people. What I would argue is, I have studied all of this, and used data, and modeled out plausible outcomes; and it is scary. It really is. Because you have to, again, connect the dots between all of this and other adjacent areas that are important to note. The CCP [Chinese Communist Party] in China is--

Russ Roberts: the Communist Party--

Amy Webb: yep--is facing some huge opportunities but also big problems. The Chinese economy may technically be slowing, but it's not a slow economy. There's plenty of growth ahead. And, if that holds--and there's no reason why at the moment it wouldn't--you know, Chinese society is about to go through social mobility at a scale never seen before in modern human history. And as that enormous group of people moves up, they are going to want to buy stuff. They are going to want to travel. So, you know, that potentially causes some problems, because the more wealth that is earned, the more agency people feel, the more opinions they start having about how the government ought to be run. And, you know, the CCP effectively made the current President of China, Xi Jinping, effectively President for life. And 2049--which seems far off but in the grand scheme of things isn't really that far into the future--is the 100th anniversary of the founding of the CCP. China is very good at long-term planning. Now, they've not always made good on fulfilling promises. But they are good at planning.

Russ Roberts: Yes, they are.

Amy Webb: Right? So, I don't see all of this as flashes in the pan, and 'AI's kind of a hot buzzy topic right now.' I'm looking at the much longer term and the much bigger picture. That's what makes me kind of concerned.

18:02

Russ Roberts: I think that's absolutely right. One other institutional detail to make clear for listeners is that the Chinese Internet is roped off, to some extent--to quite a large extent. They are developing their own tools and apps. And, talk about the three companies in China that are working on AI and how they work together in a way that American companies are not.

Amy Webb: So, here's another interesting facet of the Big Nine and AI is on a sort of a dual-developmental track. In China, Baidu, Alibaba, and Tencent were all formed sort of in the late 1990s, early 2000s; and their origin stories are not all that different from our big, modern tech giants like Amazon and Google and Apple. The key distinction is that our big tech companies were formed out for the most part in Seattle, Redmond, and Cupertino--California and San Francisco. Where, the ecosystem was able to blossom: there's plenty of competition. And there was plenty of talent. California has fairly lenient--in some ways--fairly lenient employer/employee laws which has made it very easy for talent to move between companies. And, if you are somebody who studies innovation, you know, the sort of lack of--the limited or lack of regulation, the ability for people to move around--

Russ Roberts: letting people make enormous amounts of money when they succeed and losing all of it when they fail--

Amy Webb: Right. Right. Right. But, the lack of safety net, the lack of a central, federal authority, if you will, is partly what enabled these companies to grow. And to grow fast. And to grow big. Which is why we also see a lot of overlap. So, Google, Microsoft, Amazon, and IBM [International Business Machines] own and maintain the world's largest cloud infrastructure. So, if you own a website or you are a business owner or you are making a phone call, at some point you are accessing one of their clouds. You know--we have competing, for the most part, we have competing operating systems for our mobile devices. For the most part, we still have competing email systems. And that's because without a central authority dictating one of the companies was going to do which thing, they all sort of did it. They went alone. When it went on their own and built their own things. So, now we have tremendous wealth concentrated among just a few companies who own the lion's share of patents; who are funding most of the research. And, for the most part, Silicon Valley and Washington, D.C. have an antagonistic relationship. That is not the case in China. So, in China, when the big tech companies were being formed there, you don't do anything in China without also in some way creating that business in concert with Beijing--with the government. You've got to pull patents--I'm sorry--you've got to pull permits. You have to abide by various regulations and laws. People are checking in on you. So, while Baidu, Alibaba, and Tencent may be independent financial organizations, in practical terms they are very much working in lockstep with Beijing. Alibaba, for those of you not familiar with the company, is very similar to Amazon. So, it's a retail operation. Tencent is very similar to our social media: so, sort of Twitter meets gaming and chat. And, I'm sorry--and Baidu is sort of search--is the sort of Google-esque company of the bunch. When China--when the Chinese government decided that AI was going to be a central part of its future plans--and this was decided years ago--it also decided that Tencent was going to focus on health; that Baidu was going to focus on cloud; and that Alibaba was going to focus on various different data aspects. I'm sorry; and Baidu was also going to focus on AI and transportation. So, it's not as though these companies came to these additional areas of research and work on their own. It was centrally coordinated. And that's a really, really important thing to keep in mind. If we've got a central government, a powerful government that is now--that has this long-term vision and is centrally coordinating, what's happening at a top level with the research and the movements of these companies, suddenly you have a streamlined system where you don't have arguments about regulation; you don't have the companies at each other's throats--like we've seen in the United States, Apple suddenly calling for sweeping privacy regulations because, to be fair, it's sort of--they are already far ahead and it gives them a competitive advantage. You don't see all that infighting in China. So, we have some fundamental differences. And the real challenge is that while we're trying to sort all this out in the United States, you have a streamlined central authority with three very powerful companies who are all now collaborating in some way on the future. In addition to a bunch of other top-level government initiatives to repatriate academics; to bring back top AI people; but also to do things like start educating kindergarteners about AI. There is a textbook that is going to roll out this year throughout China teaching kindergarteners the fundamentals of machine learning. I mean, you know--whereas in the United States, you know, some of our government officials, you know, up until very recently denied AI's capabilities; and only yesterday--so this is February 11th--President Trump issued an Executive Order to, I guess--I mean, there's a handful of bullet points on what AI ought to be, but it wasn't a policy paper. There's no funding. There's no government structure set up. There's not--I mean it--you see where I'm getting at?

25:07

Russ Roberts: Well, yeah--let me push back against that a little bit. You know, China is growing tremendously; as you point out, they are going to, presumably, they are already in one of the greatest transformations in human history from the countryside to the city, from a low standard of living to a much higher standard of living. And most of that's wonderful, and I'm happy about it. We don't know exactly what their ambitions will be or are outside of their own borders, and therefore what the repercussions are for us. As you suggest, they are doing a bunch of stuff. But the fact that they are top down and planning and organized, and we are chaotic and disorganized--so, just to take an example, you know, there's n companies in America, more than 4; I don't know how many there are--working on various aspects of driverless autonomous vehicles. There's Uber; there's Lyft; Apple; Google; there's Waymo. There's a lot going on here. And a lot of that will turn out. That's the nature of creative destruction; and capitalism. Some of those investments won't pan out. It will--the gambles will fail and lose, and people lose all their money. And, in general, historically, that chaotic soup of competition serves the average person and the people who are innovators quite well. The fact that China has, say, Baidu focusing on that and no one else having to worry about it, could be a bug, not a feature. I'm not convinced that China teaching kindergarteners machine learning is going to turn out well. Could be a mistake. Could be an enormous blunder. They are not allowing kind of experimentation, trial and error, that in my view is central to innovation. So, I think it remains to be seen how successful their walled garden with top-down gardening going on from the government's vision of what they want AI to serve, is going to work out. It might. It could. And it could be hard--the outcomes might be really bad for not just the Chinese but for other people. But it might just kind of fail. And, I'm not even convinced that their growth path is going to continue the way it has in the past. A lot of people just assume that because they have grown dramatically over the last 25 years they'll keep growing dramatically. There's a lot of ghost cities in China; there's a lot of overbuilding. I'm not so sure they have everything under control. So, I think you have to have that caveat as a footnote to those concerns.

Amy Webb: I completely agree with you. I would say that, for years, especially in the United States, we've been indoctrinated into thinking that China is a copy-paste culture rather than a culture that understands how to innovate, and to some extent I think that that is the result of that heavy-fisted, top-down approach to business. What I'm concerned about is not whether China succeeds financially. Here's what I'm concerned about. The challenge with artificial intelligence is that it's already here. It is not--there's no event horizon. There's no single thing that happens. It's already here. And it's been here for a while. And, in fact, it powers--you know, artificial [?] intelligence now powers our email; it powers the anti-lock brakes in our cars. You know. And essentially, this new Third Era of computing that we are in, if we assume that the First Era was tabulation--so that would have been Ada Lovelace in the late 1800s--and a Second Era was programmable systems, which would have been those early IBM mainframes on up to the, you know, desktop computers that we use today. This next Era is AI. And AI, while we've seen it anthropomorphized in movies like Her and on shows like Westworld, at its heart, AI is simply systems that make decisions on our behalf. And they do that using tools to optimize. So, the challenge is that, right now, systems are capable of making fairly narrow decisions. And the structures of those systems, and which data they were trained on, and how they make decisions and under what circumstances, those decisions were made by a relatively few number of people working at the BAT [Baidu, Alibaba, Tencent] in China and at the G-Mafia here in the United States. And the problem is that these systems aren't static. They continue to learn. And they--you know--they join, literally millions and millions of other algorithms that are all working in service of optimizing things on our behalf. Which is why I agree with you that if we are talking about a self-driving future, it's good to have competition, because--for all the usual reasons. Right? We get better form factors[?]; we get better vehicles; we get better price points. But when we are talking about systems that are continuing to evolve, that grow more and more powerful the more data they have access to and the more compute they are given--more computer power. And as we move into the more technical aspects, there are things like Generative Adversarial Networks, which are specifically designed to play tricks, to help systems learn more quickly. We are talking about slowly but surely ceding control over to systems to make these decisions on our behalf. And, that is what concerns me. What concerns me is that we do not have a singular set of guardrails that are global in nature. We don't have norms and standards. I'm not in favor of regulation. On the other hand, we don't have any kind of agreed-upon ideas for who and what to optimize for, under what circumstances. Or even what data sets to use. And China has a vastly different approach than we do in the United States, in part because China has a completely different viewpoint on what details of people's private lives should be mined, refined, and productized. And here in the United States, a lot of these companies have obfuscated when and how they are using our data. And, the challenge is that we all have to live with the repercussions.

32:10

Russ Roberts: Yeah, I'd agree with that. Up to a point. I want to give you a chance to talk about some scary examples. I think the--I'll just say, up front, that for me, underlying this whole problem--there are many different proximate causes and concerns. But there is, it seems to me, a very significant lack of competition. We can talk about how much competition there is in the United States relative to China. But certainly--the concern for me here in the United States is that the Big Six[Big Nine?] here in the United States will stay the Big Six[Big Nine?]. Which will give them leverage to do a bunch of things that you or I might not like. I do want to add that whatever we do to regulate or constrain them, via culture or whatever, allows for the possibility that they don't stay the Big Six[Big Nine?]. And I think one of the challenges of any way to deal with these problems is that, if you're not careful, you are going to end up creating a cartel that--it's de facto right now, but that can change. But if you make it de jure, you're going to end up with much worse outcomes than I think we're going to have. But, to concede your point about concern: I do think the Silicon Valley ethos of ask for forgiveness rather than permission--because right now there's no one you have to ask permission for, generally. Users are not paying much attention. There's very little regulation of how your private data is being used. Obviously something happened on January 1st, 2019 because I get a lot of annoying bars on my websites saying 'Will you accept cookies?' and I stupidly always click 'Yes,' like I'm sure most people do. And now they've complied with whatever required them to do that, and they're moving along. So, you know, I do think that there are some serious issues here. And you give some examples in the book of where these corporations--or China--have done things, and they really pay a price for it. They just keep going. The Facebook/Cambridge Analytica problem. The example you give of China pressuring Marriott the way their website was designed in terms of territorial recognition of China's sovereignty over various places that are somewhat up in the air. Those are serious issues, I think. And, more importantly, they are just the tip of the iceberg. So, talk about a couple of those things that you are worried about, that I think are alarming. And, normally, the marketplace would punish these folks; but not much does.

Amy Webb: So, I love what you just said, which is that the market--so it's curious, right? Why has the marketplace not punished the Big Nine? Or at least the G-Mafia, right? Or at least Facebook?

Russ Roberts: They've been punished a little bit. I think their users are down. I'm thinking about deleting my Facebook page. And I'm sure--and I've switched to DuckDuckGo for my searching. It's a really small step. But these are things that maybe people are starting to do in a little, slightly bigger, numbers.

Amy Webb: Maybe. But, again, like I don't have access to the whole world's data. Thank God. But--and you--let's just reveal our biases: like, you and I are digitally savvy people.

Russ Roberts: You're kind, Amy.

Amy Webb: Well, but you are. I think the fact that you even know what DuckDuckGo is, that you are somebody who is using it, I think is quite telling. But, for how long have we continued to hear--like, how many breaches have we heard about of our trust, right, over the past 12 months? And we continue to hear outcries, and people continue to be really upset. And we just don't see significant drops in numbers that would suggest the marketplace is punishing companies the way that they might in other circumstances. I think that's curious. And I think the reason is not because Google, Amazon, Apple, IBM, Facebook, and Microsoft make our lives a little bit better, but rather that our lives don't work without these companies. Now, it's possible--you could argue that maybe Facebook could maybe quietly go away, and for some organizations and companies that run part of their businesses using that platform it would be pretty annoying. But life would go on. We don't function--modern society in America literally does not function without Amazon, Google, and Microsoft. Huge parts of the business world do not function without IBM. And, if you look at mobile phone and personal device usage, like, most Americans are using, in some way, Apple. So, the problem is: We can get all angry--like, we can get as angry as we want. But we don't have a choice, which is--

Russ Roberts: But is that true? I've got to challenge that. Just for a second--

Amy Webb: Yeh--

Russ Roberts: Sorry for interrupting. I might give you an example. I just bought an Apple XR. I don't know how you pronounce it--10R--the phone. I love it. It's fantastic. When I bought it, I forgot, that, actually my ear buds that I like are not going to work with the new phone because it doesn't have a jack. So, when I was at the store, and I asked if they had an adaptor, they did. To my relief, it was under 10. I was expecting--Apple, in the old days, it was the kind of thing they charged 32 dollars for; and you'd go, 'I've got a habit, I'd just pay 32.' I was kind of thrilled: I think it was 7.95. I was shocked at how reasonable it was. But, of course, the other view was, 'You're are telling me they are going to force you to buy an adaptor? Because you can't use your old earbuds?' And the answer is, 'Yeah. They're going to do that.' And I was happy to pay the 7.95. In fact, you could argue for people that don't have earbuds or are just going to use the ones that Apple provides with the phone, they shouldn't have to pay the implicit 7.95. So, it's all okay. And most of us, most of the time, are happy with the deal. Right? We're happy with--we don't care. That's the problem for me. One of the problems, besides the competition. My problem with your claim is that, most of us, just: 'It's fine. Okay, it's not great. [?] ask occasionally, we card data.' But most of us just live with it. Like you, I'm increasingly alarmed--

Amy Webb: and--

Russ Roberts: but I think it's hard for the average person listening: 'What's all the fuss about? I like Facebook. I love Google. I love--' These are companies that we don't just, like, 'Yeah, it's pleasant.' They make our lives sing. And most of the time, we are happy. So, what's the worry?

Amy Webb: I hear you. And so this is honestly--this is not just about privacy. I would argue this is about future competition and choice. And that is one of the things that concerns me most. So, let me paint a picture for you. A couple of months ago Amazon had a big Press announcement. They were talking about Alexa, and the developer kid--they were making a bunch of highly technical announcements. And at the very, very tail end of this Press event, they, almost as a footnote, revealed a brand new product. And that was an Amazon Basics Microwave. Did you hear about this?

Russ Roberts: Only in your book. Keep going. I had not heard about it.

Amy Webb: Right. Well, because it didn't make news. And, the couple of places--like, it showed up on Gizmodo, and a couple of, like super tech blogs. And the big deal about the 60 Amazon Microwave was that it has Alexa. And so that you can talk to Alexa. And, for the most part, that elicited snark. Right?

Russ Roberts: Yeah. Who needs it?

Amy Webb: What--right. 'Typical Americans: we can't bring ourselves to push the buttons on our microwave to pop our popcorn. We are so lazy, we need to talk to it.' And again, this was one of those--this was one of those times when I said, 'But wait a minute. Why would they do that? Why go through the headache and the heartache?' I mean, it's hard to launch a product. It's hard to launch a product that exists already in the marketplace that has a fairly significant twist which is going to cause you to have to educate consumers? Like, 'Why bother?' Right? And here's where I arrived. If one of Amazon.com's core functions at the moment is selling us stuff--like popcorn, right--we've noticed that lately you can subscribe to all different types of things. Why would Amazon do that? Because people tend to run out of things, and this helps them not run out. However, it also ensures, if I am subscribing to popcorn, that I'm not going to buy it at my local grocery store. So, now let's think this through. If I'm somebody who buys microwave popcorn, and I pop that popcorn in my Amazon, Alexa-powered microwave, one of the pieces of data that I'm revealing to Amazon is not just that I am a subscriber to popcorn, but that I, you know--how much popcorn I popped. So that Amazon can track how many bags I've gone through. And rather than sending me a monthly box of popcorn, which may not be enough, or may be too much, depending on the month, this is a way for Amazon to mine and refine my data in order to optimize that popcorn delivery specifically for me. And how magical would it be if Amazon knew exactly the moment that I was about to run out of popcorn and sent me a replenishment? Now, again, this doesn't sound like a bad thing, on the face of it, right?

Russ Roberts: Sounds pretty good.

Amy Webb: Like, it would be pretty amazing, if Amazon knew when I was going to run out of all my stuff and it just showed up for me.

Russ Roberts: It's the end of suffering. We never have to go through that popcornless night at the movies on that big-screen TV at home.

Amy Webb: So, now let's connect some other dots. Amazon has entered into a joint venture with JP Morgan and Berkshire Hathaway. And, it's no secret that Amazon, and Google, and Apple also, as well as IBM, are all looking at health care. They are all somehow involved in the health space. So, isn't it plausible that some day in the future, with all of my Amazon devices, Amazon has looked at my FitBit or whatever fitness device I've been wearing--has been monitoring my caloric intake, has seen that I haven't gotten on my, you know, fancy bicycle--

Russ Roberts: Amazon Basics Bicycle--

Amy Webb: That's right. And I put that bag of popcorn in the microwave; and guess what? The microwave won't pop it. Because, it has determined that I don't get to eat that popcorn today. Again, that's the kind of thing where I really do think it's going to show up; it's going to sneak up on us. And, I don't think that Amazon is hell-bent on making sure that all Americans are thin and svelte. I don't think that's what this is about. I think, again, we've got small groups of people trying to optimize decisions on behalf of us all; and these are the kinds of things that don't get thought through in advance. They are the kinds of decisions that people make and then ask for forgiveness later on. And as long as we're on this topic: Currently, our voice-based systems, as well as some of these other AI systems, are not inter-operable to some extent, because they use different programming languages. To some extent because they are literally on different types of silicon and they are parts of different ecosystems. So, if you are somebody who currently has a house full of Google home-connected devices and you try to introduce an Amazon device, they don't necessarily talk to each other. Conversely, if you are an Amazon home with a bunch of Alexa devices which I now realize--if you are listening to this in your house, I've probably set off your devices 15 times in the past three minutes--

Russ Roberts:'Alexa,' 'Alexa,' 'Alexa'--

Amy Webb: I apologize. But, like, think this through. Isn't it plausible that in our lifetimes, in the very near future, because we didn't have some kind of forethought, we're going to wind up in Amazon homes? or Google homes? or, you'll be an Apple household, where all your devices are with just one of those ecosystems and our data are tethered to them. I mean, think of how much of a pain in the neck it is to change mobile operating systems: If you've ever tried to go from Android to Apple or vice versa, it's hard. Now we're talking about all this other data--the ambient data that's part of your daily life. All of it. Plus, we didn't even talk about health and diagnostics and all of these other things that are all tied into these systems. And if those data sets become heritable, you know, we're talking about a future situation in which your family could be an Apple family, or an Amazon family, or a Google family. And your children may decide they want to marry into other Google families, or other Apple families, because it's too much of a pain in the neck to swap otherwise. I know that sounds like science fiction, but it's very much within the realm of plausibility.

Russ Roberts: So, I just have to add--digress for a second here. Having said 'Alexa' a few times, I'm just going to mention Marty Feldman and 'Blucher,' for people who are Young Frankenstein fans; and if you want to look that up, folks at home--we'll probably put a link up to it, I guess; we'll deal with that.

46:19

Russ Roberts: So, I want to take your example seriously. It sounds comical, but I don't think it is. And I think it's actually quite important. I'm going to give you a version of it that you refer to in the book and see if you think it's of this nature. So, right now, I use Gmail--even though I use DuckDuckGo for search. I do use Gmail; and I use Google calendar, and I have said this before--I love that when I make a plane reservation, it puts it on my calendar automatically. I'm a sucker for that. Like talking to the microwave. I'm embarrassed, but I do like it. I think it's cool. And it's convenient. And it saves a little bit of time. The other thing that happens with Gmail that I happen to really like is it started adding these possible responses: 'Thanks so much!' 'No, I don't think so.' 'Oh, great!' And, about 1 out of 5, I just click the box that automates the response to an email; and I think, 'Well, that's pleasant. That's exactly what I would have said.' Sometimes I click the box and then I add a few words, or I take away the exclamation point or add the exclamation point. And, you know, sometimes I think, 'Well, that's not exactly what I want to say but I'm going to say it anyway. I'll just click the box.' And, I think this kind of--I would call it corporate nudging, which you reference in the book quite a bit--is what's--it's the slippery slope. So, it starts off: 'You sure you want popcorn today? You've had 3 bags this week.' And you're still able to hit 'Yes' and override it. But, is it possible that there would be a day where, because of my health care payments, and I've got a bargain on my health care insurance if I allow Google to cut me off from, or Amazon to cut me off from popcorn and pay an extra fee for that--there's all kinds of things there that strike at the heart of how we live our lives. So I definitely agree with you. Where I think I'm a little more optimistic than you is that I imagine our culture is going to change. Now, of course, it's going to change in ways that--it's already changed an enormous amount. I think young people feel very different about, say, privacy, than older people. They feel very differently about digital life, virtual life, relative to brick-and-mortar life, real life. So, it's already changing. A lot of these things that you and I might find alarming thinking about them, maybe people in the future will just go, 'Ehh. So they cut me off from my popcorn. It's for my own good.' Now, I look at that, and I think that's a diminution--reduction; I can't say the word, 'diminuition'?--diminution of human agency and life and choice. And I really don't want AI making my decisions about who to date and what career to take and how I ought to spend my weekend, right? So, right now they might say, 'Here's some restaurants you might like,' or, 'Here's a movie you might enjoy,' or 'Here's a book.' And most of those I love, because I find out about books and movies I didn't know about. But are we really going down a path where it controls what I do? You could argue, I guess, it already does.

Amy Webb: Well, so that's the--so again: How did we wind up at this point? Why would somebody think--this, see, constantly ask these questions. So, why would somebody have thought to make that? And you could argue that one of the things that the modern Internet brought us was tyranny of choice. Right? And we have access--you know, when I think of when I first moved to Japan in the '*ahem, ahem, ahem,*' mid-1990s, long time ago, you know, there was no Internet where you could buy stuff. There was an Internet; but e-commerce was very, very early. And if I wanted Crest toothpaste, I had to FAX my request to the foreign buyers' club and wait for a month. The fact that you can now order that on Amazon--you know, as well as like any other thing that you--

Russ Roberts: Express. You've got a lot of choices in some cities--

Amy Webb: Right. You could argue that using AI to make recommendations was simply an antidote to the tyranny of choice which we created for ourselves in the early days. And, one could certainly argue that that's not necessarily a bad thing. I mean, the big joke at Netflix now is that Netflix will literally green-light everything. Right? Which is why there's sooo much stuff on Netflix.

Russ Roberts: It looks that way.

Amy Webb: To the point now where--it's hard to know--if you compare Netflix 3 or 4 years ago, it's hard to find, to surface[?] great content. So, that's one side of the coin. The other side of the coin is: Nobody asked me what I wanted. And somebody somewhere made a decision that this nudging is best for me. And, let me give you a concrete example of how that manifests in my life, in the real world. I have not been in a car accident. I think I'm a pretty safe driver. I don't tend to break the rules. The car that I drive, when I back into my driveway, the sound automatically turns itself down. So, I have a--

Russ Roberts: On the radio--

Amy Webb: On the radio. So, I have a parking pad. I don't live on a busy street. I have a garage that's tucked pretty far away. And I always back in. And, somebody decided that it was best for me, as the driver, to automatically turn that radio down, regardless of what I'm listening to, regardless of what kind of driver I am--any time that I've got my car in reverse. There's no law saying--there's no Federal mandate or law requiring that. There's no statistic--as far as I know, there's not enough data saying that an accident will be prevented or some huge number of accidents will be--

Russ Roberts: [?]

Amy Webb: you know what I mean? So, like, just somebody thought that would be a good feature. And I can't override it. That may seems like--that may not seem very important. To me, this is like a paper cut. And, the challenge with paper cuts is that you get one or two, and you don't sort of notice them. Maybe they are annoying for 5 seconds, and then you kind of just learn to live with it? Right? And you don't kind of notice it any more? What we are talking about with AI and these systems built by relatively small groups of homogenous people who are making decisions intended to govern us all, working at 6 companies in the United States and 3 in China--the problem is that we are going to start experiencing paper cuts at a fairly rapid clip. You have one or two cuts, not a big deal. Suddenly your entire body is covered in paper cuts, and your life is very different. You know, you may still be alive; but, I mean, stop and like visualize and think about what that would feel like. Suddenly life is nothing like it was before. You are miserable. And you don't have any way to override those paper cuts, because they just keep coming back, seemingly out of nowhere. That's the kind of future that I'm hoping to prevent.

53:27

Russ Roberts: So, the normal way--I want to--I have two thoughts on that. And I'm not sure they are right. But two thoughts. One is, my thought about how culture changes. You know, if you put a, if you put my grandfather, born in 1898, into the modern world, he'd find it very difficult. There would be a lot of things he wouldn't recognize. There would be--in just a hundred years--20 years--when he was a young man of 20 in 1918, roughly a hundred years ago: Being 20 now is really different. It would be weird for him to watch people walking down the street looking at their phones all the time. He'd think they were probably mentally disturbed. Many of them would be talking while they are walking, with their earbuds. And it would be jarring. And, more than just jarring--you could explain some of it to him--just the things that gave him pleasure would be different. And maybe not available. Which is part of your point, right? The freedom to do all kinds of things. Some of them small, like listening to the music as you back into your driveway at the same volume. Some of them large, like you say: It's coming. There will be things coming. So, one of you says is that, 'If they come, maybe people aren't as bothered by it as we are,' in thinking about them. The second issue is, if you make a really bad decision--and a lot of your book echoes some of the concerns of Cathy O'Neil in her book, Weapons of Math Destruction; and she was a guest on EconTalk; we'll put a link up to that episode. As you say, it's a very homogenous group. Mostly white men designing these things. But if you don't--historically, in a capitalist system, if you don't design things well and take into account that people aren't like you, you don't do very well. Right? If you think everybody is like you and likes to sit and code all night in your room, you are going to be a lousy designer of products for people. What's scary to me--and the concern that I share with you--is that I'm not sure that the profit-and-loss motive is doing a really good job of constraining those choices. And I see it in lots of ways. Some of which you talk about in your book; some of which I see elsewhere. The freedom that Amazon and Google and Apple have to do things that are, just kind of, funky--I can't even describe them. The things that--normally a company couldn't do that, because they'd lose so much money, they'd go out of business. But there's an enormous cushion for these companies, in terms of their profitability. And so, let's turn--it's--I'll just tell listeners before we started this, Amy, that I said, 'We'll spend the first half on what the problem is, and the second half on what to do about it.' And we are now, oh, 55 minutes in. And so if we can go a little over an hour that would be great, talking about what to do about it. So, normally you wouldn't do anything about it. You'd say, the profit motive and competition will constrain these kind of ridiculous stakes, and forms of arrogance, and tribal weirdness that this culture has produced out of Silicon Valley and Redmond and elsewhere. But, I don't see it happening. So, what I naturally look to is: How do I inject a little more competition into the system? How do I change the incentives that these folks face to do a better job? Taking account of what I want, not what they want.

Amy Webb: Yeah. So this is where things get a little complicated. And, you know, I just want to be very clear: I don't think Big Tech is the enemy. I don't think that the G-Mafia are the villains. In fact, I think they are our best hope for the future. You know. And, introducing competition at this point may not elicit the same type of responses that you might see in other market sectors, in other industries. And I think part of the reason for that is that the technology that these companies build and maintain is the invisible infrastructure powering everyday life. It's not a single widget, or even a series of widgets--

Russ Roberts: Fair enough--

Amy Webb: And I think the challenge is that if you try to, for example, introduce competition in the Cloud Space, which might be the, you know--or even try to break up Amazon, a la Baby Bells, from years ago--

Russ Roberts: right--

Amy Webb: And I've actually heard that suggested before--you know, the challenge is that the technology that Amazon Web--like, the AWS [Amazon Web Services], the infrastructure and the technology that that entire system relies on and therefore--huge parts of the government and our largest businesses, that our customers--the challenge is that that technology bleeds over into other aspects of Amazon's core functions. There aren't solid walls. And so, if it's the case that at this point competition is not possible, then what are some other ways forward? You know, this March--so, very--I think it's March--pretty soon from now, is the 30th Anniversary of Tim Berners-Lee's, Tim Berner-Lee's [sic], seminal paper and suggestion to CERN [Conseil Européen pour la Recherche Nucléaire, European Organization for Nuclear Research] that sort of outlined the core premise of the Internet. And everybody--the idea--everybody at the time that saw that thought it was kind of a boring but interesting idea. And the challenge is that nobody thought that through--sort of, if the Internet becomes something beyond universities connecting to each other to share research, it becomes something else. And technology always becomes something else. Right? Then, how do we mitigate that? How do we prevent against plausible risk? Right? And, one way, I think, that I think that we could think about the future of AI, is to treat it, you know, similar to a public good, the way that we might treat air. Right? And I know that's a complicated--that's complicated, and I know it sends some shock waves into economists who would argue with me that I'm totally off base, and you can't possibly apply that. But, the public good concept I think works because it, first of all tells us that we all have a stake: that we are not just going with the flow. And it also then helps us think about global guardrails. And that, then--you know, I know it sounds like I'm angling for regulation. I'm not. I'm angling for widespread collaboration, with some very specific, agreed-upon tenets[?]. So, you know, principles that go beyond the obvious. Like, make sure that AI is safe. But that, you know, that everybody on the planet would agree to things like, whenever an investor invests money in AI for whatever reason, a part of that investment must be allocated to, um, making safety a priority. Or, cleaning up one of the training databases. Um, things like that. And having some kind of global body--again, I'm not usually in favor of huge government and big bureaucracies, but I think in this particular case, we can't just assume that these companies who have motivations that I don't think are always in line with what's best for humanity--we can't assume that they are going to take care of the stuff on their own. I'm sure your listeners know--like, a couple of weeks ago, Google had to assure, reassure investors, that enormous spend on R&D, was worthwhile. Like, people got spooked. You know, when we're talking about game-changing, huge, technologies, and research areas like AI--and we have no basic--we have no Federal funding. We have no basic funding research, or not anywhere near enough, in some of these areas, outside of military expenditures. Somebody has got to do it. And the challenges that investors expect, um--some kind of return on investment or some kind of shiny new widget that gets revealed, you know, on a quarterly basis, as though you can schedule big R&D breakthroughs--you know, we have to--so, if there was some global agency that acted a little bit more like the IAEA [International Atomic Energy Agency], with the caveat that I am not saying AI as a weapon--you know, then we would have some mechanism to think this through. We would need some kind of--you know, going back to those questions on tribalism and culture--I think we need to have some kind of global human culture or values atlas that is going to take time to build but describes and is not static. All--how we interpret things, culturally, how we relate to each other. Because, ultimately, these systems don't just live within the geographic boundaries of our countries. They travel. So, um, yeah: I think that there are a lot of solutions that are, you know, top down. But we individuals have to take some responsibility as well. Which means, we have to get smarter about what data we are shedding and when and how and where and why. We have to demand transparency. And I think it's possible for the big tech companies to be more transparent, without sacrificing IP [? Internet Protocol?]. You know? And our universities, I think, have to take more responsibility and shift their curricula to include difficult questions, not just any single ethics class, so that they weave questions and worldviews and, you know, other things into their core curricula. So this is like a--there is no single fix here. The good news is that there is something for all of us to do, and collectively if we can get it together, but to shift the developmental track of AI, I think the optimistic scenarios are possible. I really do. My concern is that everybody is going to say, 'I don't feel the pain all that much yet, so I'm cool waiting.'

1:04:04

Russ Roberts: Well, the first step is to pay attention. And I love your book for encouraging me to pay attention. And others, and anyone else who is listening, I think it does a great job of that. I think the solution--challenge, is quite--this is where it gets complicated: There's no--I can't think of a single example where this kind of global collaboration works out well. To me, it's like the United Nations. It's a really great idea; it's a beautiful idea, you have a nice quote from Isaiah, on the front of about beating your ploughs, your swords into plough-shares. And it just it--the distance between the ideal and how it works into practice is so vast that my view is probably better to not have to have it at all. But I can understand that you can debate that. But, I'm not optimistic that a "global collaborative effort" would work in any way that would make you happy at the end of the day. I want to try to suggest--well, maybe I'm wrong. But I want to try to suggest a different approach and see if you think there's anything to it. So, you said it's like a public good. You're talking to an economist. I don't have any problem with that language. I think what is certainly has public good aspects to it is the role of digital stuff in our lives. You can't say, 'Well, I want a digital world like mine,' and your digital world would be like yours. We kind of consume that one air that you are talking about; and I think that's very à propos about how to think about this. But is it possible, is it imaginable, that we could have a different way of interacting with each other digitally than the current way, that would allow a little more of what we might call a privatization? Or more choice? Or more options? So, right now, underlying all of this, is that this idea that some really bright people figured out some really clever ways to use knowledge about us to make money. And it's especially clever because it's free to us. On the surface. It's not literally free. It's not free in lots of ways, by the way. So, I used to--I used to say all the time, 'Well, Google's free. What's the big deal?' Well, it's not literally free in any sense. It's true I don't make a payment each time I do a search. But it turns out that of course Google uses the information that I use when I search, and access to me, in all kinds of ways, to charge people for access to me. And instead of me getting to charge access. And it's there pipe; so I kind of get it. So that's the way it's worked out. But we could imagine a different world--either through regulation--not my first choice either, obviously--but I think technologically--I want to come back to Arnold Kling said in a blog post recently. He said, 'You don't like Facebook, how they handle privacy? Make a better one.' And you could say, 'Well, that's really hard to do. It's almost impossible. Everybody's already locked in.' And network effects. And blah, blah, blah. But I think there--we have a lot of really smart people. And one way to get around these kind of scary, dystopian concerns is for people to say, 'I don't like the way the Internet is designed. I want a different one.' And, 'People smarter than me--I can't figure it out. People write about it occasionally that blockchain could be the basis for a different kind of Internet. I try to read the articles; they don't make sense to me. My fault.' But, I imagine that that could happen. And it seems to me that's the right way to fix this problem, and to build in a different relationship between me and these companies that create services for me that actually--they are exploiting.

Amy Webb: I think there is, for--if we are talking about the realm in which we as individuals have personal relationships with parts of the Big Nine, then yes. I think it is plausible, not impossible but certainly challenging, for somebody to develop an alternative to Facebook--you know, that promises initially to somehow get around a lot of the challenges that Facebook has had. At the end of the day, though, we are still humans. And, the parts of the digital infrastructure that we seem to complain about will follow us. This is the same reason why I don't think that colonizing--like everybody who wants to colonize Mars--it's like, 'That's terrific. It's a wonderful idea. It's not going to solve your problems.' The problems that you have on this planet are going to follow you to the next planet. Right? So, I think if we are talking about the realm of personal technology, sure. Some of these issues can be solved. Somebody can certainly start another Twitter. I would welcome somebody starting another Twitter that has a different approach to speech. So, that's fine. I'm actually concerned about these systems that mine our data in a much more broad sense. And not just our personal data, but our companies' data, our local traffic data. You know--all of these systems that are learning from us in real time. And, ultimately, these narrow artificial intelligence applications are beginning to gain some momentum. There are some terrifically interesting research out of a group called Deep Mind, which is a subset of Google. And, you know, I read one of their most recent papers. They've trained a system called AlphaGo--AlphaZero is the new version of the algorithm. Which is now capable of going from zero knowledge to learning how to play several games at once. And that may not seem all that thrilling to listeners. But, what it portends--and what's really, truly remarkable about this research--is that, without humans working hard to train systems, these systems are now capable of training themselves. And also creating child AIs to perform some of the tasks for them. And they are doing them in ways that defy our understanding. When we say 'artificial intelligence,' I think that that's actually a misnomer, because it assumes that the systems that we are building that are now propagating on their own remotely resemble the way that we think. We don't actually understand enough of our own human brains. What's probably a better term is 'alien intelligence,' not 'artificial intelligence.' And semantics matter. 'Artificial intelligence' makes us feel as though we still have some agency. My concern is that, as these systems propagate, they become more and more alien to us in ways that we don't understand. And at some point they start making more important decisions where the stakes are higher, on behalf of us all. And there is a God in that system; and that is the original group of people who created it. Upon which the foundation was built, and all the learning took place. So, if it's the case that we are in the midst of that transition at the moment, I'm hoping that enough people wake up: that we do not close our eyes just as the machines are gaining awareness. And that we ourselves wake up, and that we demand a change in the developmental track. And that doesn't mean that these companies can't make plenty of money. And it certainly doesn't mean that the companies are evil, or even that the people who work in these companies have some kind of nefarious plan. I believe--you know, Chinese, government withstanding--notwithstanding--I believe that the people who are in this, who are working on trying to solve humanity's grandest challenges. But they are doing so within ridiculous constraints that have to do with, um, the market, and the whims of investors, and what direction the wind is blowing in Washington, D.C. and who has decided maybe this is the year for regulation. That--those are my concerns. The personal relationship that we have to Facebook is of course a piece of this. But it's the bigger picture that ought to concern us all.

1:12:40

Russ Roberts: So, I think you and I--I assume--I know it's true for me; I assume it's true for you--we know a lot of these people. You know, I socialize with them occasionally when I'm out in California in the summer. And the people who work at the G-Mafia, they are wonderful people. But the incentives they face are what affect how they behave. And, in general, as listeners know, obviously listeners know--I like most of those incentives. But I do think--in this case, it seems to be a little bit different, potentially. I'll give you an example, and maybe we'll close on this; you can react to this. So, Facebook has had a bad run. They've had data breaches; they've had issues about whether they distorted what people saw in their timeline on political grounds--so, we haven't even talked about this: some of this is going to strike at democracy in a kinds of ways that we haven't even begun to think about or worry about. It's coming. It's going to be--I think it's going to get so much uglier than--we think it's ugly now; it's going to get immensely uglier. And I'm very, very concerned about that. And Mark Zuckerberg was dragged in front of Congress; and he did a few semi-mea culpas. But here's what he didn't do: What he didn't do was say, 'You know, a few years back, I was a really bright kid in a dorm room at a university with somebody; and we had an idea. And it turned into Frankenstein. It turned into something we certainly didn't plan, couldn't imagine; and now, we think we're steering it. It's kind of steering us.' The market, as you say, is going to make a certain amount of money. He's got investors who came on when the stock was already high. They don't want to be told that it's not going to go so well in the future. But, what he could have said, was--can't literally, but you could imagine a world where he would say, 'It's good enough. I like Facebook the way it is. It's a fabulous platform. And I'm not just going to run a bunch of ads,' like they did this summer that try to make us romanticize about Facebook and feel nostalgic about its early days--those cute, really nice ads to good music. 'I'm just going to give it up. I'm going to turn it over to a foundation and let the people run it without concern for whether it makes a lot of money. I'm going to turn it into what we could call a utility. But not one that needs to make money. That just serves people. And that foundation will be staffed by volunteers who love it and care about it, but who won't be driven to make money.' And this just sounds like the most heretical thing I've ever said on EconTalk. Because it sounds like I'm against making money; and we all--everyone who knows me knows I'm not against making money. But, in a world where there's not a lot of competition, that desire to make money is a nasty--can be a nasty thing. And, I don't see any signs that, that--as I said earlier, that Facebook--I mean, Zuckerberg's paid a social price. I'm sure some of his friends are embarrassed. But, it's a weird thing--that, you can't get off that horse. It's already gone public. It's not yours, any more. And, it seems to me we need to be thinking about ways to take knowledge, which is fundamentally what underlies these platforms--these brilliant, gorgeous, extraordinary ways that we interact with each other--and make them a little less about making money, a little more about doing something else. And, the people who created them lose control of them. And then they're stuck. But my joke is: I love Evernote. Evernote is fantastic. If it ever disappears, I'm going to be really lost. It's fine as it is! I don't need it to get better! I don't need it to get bigger! Keep it like it is. It's fine. It's great. Now, I understand it has to work with the new platforms, so maybe it's not as trivial a problem as it sounds, just to keep it as a sort of static, historical event. But, this idea that you need to just keep mining more and more stuff out of my life to sell it to other people that I don't know about, as you point out, is a little bit disturbing. I'm off of my soapbox now.

Amy Webb: No, no, no--how do you--listen, I was like virtually high-fiving you the whole time. But here's the--you know, how do we reconcile something that I think we all grok, like on some level, right? How do you reconcile what you just said with our market economy in the United States, where shareholders have been led to believe that Big Tech equals massive returns? I mean--

Russ Roberts: Well, you can't. You can't.

Amy Webb: Right. And the difference--so then what we're left with is China.

Russ Roberts: No! No! No. God forbid. No, no. There's a third way--

Amy Webb: But--

Russ Roberts: There is a third way. The third way is non-profit. It's a weird thing that we think that the opposite of government is business. The opposite of government is not top-down. And not top-down has two forms: Business, and non-profits--that's foundations, philanthropy, voluntary organizations. A bunch of really smart people, if they wanted to, could create an alternative to Facebook, soon, that would--you'd have to have a reason for it to exist. It wouldn't be enough that it would be called 'Nosebook.' That's my dad's name for it--it's a little inside joke for my dad, because he can't remember the name of it; he's 88. He actually does. He just likes to call it 'Nosebook.' It makes him laugh. But, you can't just say, 'We're going to create a Facebook that isn't Facebook.' You say, 'Here's a Facebook that isn't going to filter your news, isn't going to allow hate speech'--whatever it is--and let people gravitate toward that. Now, one of the challenges of this "solution" is you don't want a whole new tribe of people who are all getting together--like, I don't want Conservative Twitter, Liberal Twitter, Libertarian Twitter, Nazi Twitter--even though Twitter is a really ugly place at times, at least I get to see who is being ugly. Sort of. It's not--of course, it can be anonymous.

Amy Webb: Right. That's the consumer--so again, that's the consumer implementation. Those are people using the products that are built. The challenge is that if you turn--if you turn Nosebook into a nonprofit--Facebook becomes a nonprofit; they've got plenty of money--I don't know exactly how that would work. But let's say that's what happens. Then, where does the enormous sum of money come, to push forward and do all of the magical things, for example, that Facebook R&D is working on? Some of which may not need to exist--like Facebook Portal--that's their--

Russ Roberts: their [?]--

Amy Webb: right?--

Russ Roberts: I'm not letting that[?] in my house. Are you?

Amy Webb: Yeah. Yeah, exactly. But, there are plenty of other things. I mean, Google has pushed pretty far ahead on some--again, like, we cannot think of these exponential technologies in a silo. We have to think about the relationship between AI and genomic editing and CRISPR [Clusters of Regularly Interspaced Short Palindromic Repeats], for example. Or, AI--the relationship between AI and collaborative robotics and smart cities. The challenge is that our Federal government--we don't have a giant pool of money sitting around to fund the kinds of basic research that are going to not just propel our own economy, but do, like, like fulfill the promises a lot of us have been told about what our futures will look like once technology helps us out. This is the crux of the problem. And, again, why I keep coming back to--we have to allow these companies to keep making money. The only way forward--the only way forward, is if the G-Mafia can be the heroes to their shareholders, and if the shareholders can exercise some patience, and there is some courageous leadership somewhere in the investment community where somebody is willing to stand up and say, 'We're going to let these companies keep their heads down and work really hard; and it's cool if we don't earn huge margins over the next, like 16 quarters. We're going to be okay with that.'

Russ Roberts: Nyeeh: Won't happen.

Amy Webb: I know. But like, somebody, somewhere, is going to have to exercise some--

Russ Roberts: So, let me try a different story.

Amy Webb: Sure.

Russ Roberts: Let me try a different story. First of all, there's no free lunch. So, it would be great to have infinite innovation at no cost, always good for people. Doesn't happen. Technology always has these spillovers that are destructive. We cope with them, though. So, I think we have to have a little bit of faith in human adaptation. And I think part of your book is a warning that that's going to be a lot harder than you think--because that's going to be here before you know it in a way that you can't do anything about it. And I think that's a genuine concern. And I salute you for it. It's a real issue. I'm not suggesting that we are going to keep getting this innovation if we put these things in non-profit form. We won't. We're going to have to give up on some of those future miracles--that we are going to live to 140 or whatever the thing is. And the truth is, we human beings--we don't like giving up on that. We like making the world better in different ways. So that's not going to change, either. So, I'm left, at least for now, with the idea that: Culture changes. I don't think you are ever going to get a world where investors say, 'Eah, I don't care how much money I make.' Which you could get, though, as a world where people are ashamed to do things that are destructive of human flourishing and human agency and freedom. And maybe that'll help stem some of this tide.

Amy Webb: I'm heartened, at least, that you're willing to have this conversation and that people are willing to listen to the conversation. Because, I mean, I think as our spirited discussion points out right now there's no easy answer. So, I've come up with a handful of, I think, very pinpointed, practical ways forward. You know, you've got an interesting idea on a way forward. I think the key point here is: We need to think of a different way forward. Preserving the status quo gives China a strategic advantage that is going to become a problem for us the further along that we go. And, you know, the G-mafia, working on their own, competitively rather than collaboratively, I think also causes us problems and probably sets them up for a regulatory environment that will become problematic rather than helpful in any way--not just to them, but to everybody. So, we've got to--you know, we've got to stop fetishizing the future and talking as though AI was some distant off thing; and get real about the challenges that we are facing. And, in the middle of all of this, I am calling upon the brilliant women and men and, you know, gender-non-conforming people who live and work around these companies, to exercise some creative and courageous leadership to take us into the future. I don't know what more we can ask at this point.

Russ Roberts: My guest today has been Amy Webb. And what I didn't tell listeners is--I don't know, Amy, if you remember, but in the early, early days of EconTalk--I want to say 2006 or 2007--

Amy Webb: It was, yeah, a long time ago--

Russ Roberts: I brought you in to give me advice on how we could make EconTalk more successful. So, I'm giving you, well let's say half the credit, for our success of giving your suggestions; and I want to thank you for that and for a fascinating book and a great conversation.

Amy Webb: Thank you so much. It really was a--I learned a lot.

(41 COMMENTS)

Jacob Vigdor on the Seattle Minimum Wage

Jacob Vigdor of the University of Washington talks with EconTalk host Russ Roberts about the impact of Seattle’s minimum wage increases in recent years. Vigdor along with others from the Evans School of Public Policy and Governance have tried to measure the change in employment, hours worked, and wages for low-skilled workers in Seattle. He […]

The post Jacob Vigdor on the Seattle Minimum Wage appeared first on Econlib.

Jean Tirole

.jpg "Ecole polytechnique Université Paris-Saclay [CC BY-SA 2.0 (https://creativecommons.org/licenses/by-sa/2.0)], via Wikimedia Commons") 

In 2014, French economist Jean Tirole was awarded the Nobel Prize in Economic Sciences “for his analysis of market power and regulation.” His main research, in which he uses game theory, is in an area of economics called industrial organization. Economists studying industrial organization apply economic analysis to understanding the way firms behave and why certain industries are organized as they are.

From the late 1960s to the early 1980s, economists George Stigler, Harold Demsetz, Sam Peltzman, and Yale Brozen, among others, played a dominant role in the study of industrial organization. Their view was that even though most industries don’t fit the economists’ “perfect competition” model—a model in which no firm has the power to set a price—the real world was full of competition. Firms compete by cutting their prices, by innovating, by advertising, by cutting costs, and by providing service, just to name a few. Their understanding of competition led them to skepticism about much of antitrust law and most government regulation.

In the 1980s, Jean Tirole introduced game theory into the study of industrial organization, also known as IO. The key idea of game theory is that, unlike for price takers, firms with market power take account of how their rivals are likely to react when they change prices or product offerings. Although the earlier-mentioned economists recognized this, they did not rigorously use game theory to spell out some of the implications of this interdependence. Tirole did.

One issue on which Tirole and his co-author Jean-Jacques Laffont focused was “asymmetric information.” A regulator has less information than the firms it regulates. So, if the regulator guesses incorrectly about a regulated firm’s costs, which is highly likely, it could set prices too low or too high. Tirole and Laffont showed that a clever regulator could offset this asymmetry by constructing contracts and letting firms choose which contract to accept. If, for example, some firms can take measures to lower their costs and other firms cannot, the regulator cannot necessarily distinguish between the two types. The regulator, recognizing this fact, may offer the firms either a cost-plus contract or a fixed-price contract. The cost-plus contract will appeal to firms with high costs, while the fixed-price contract will appeal to firms that can lower their costs. In this way, the regulator maintains incentives to keep costs down.

Their insights are most directly applicable to government entities, such as the Department of Defense, in their negotiations with firms that provide highly specialized military equipment. Indeed, economist Tyler Cowen has argued that Tirole’s work is about principal-agent theory rather than about reining in big business per se. In the Department of Defense example, the Department is the principal and the defense contractor is the agent.

One of Tirole’s main contributions has been in the area of “two-sided markets.” Consider Google. It can offer its services at one price to users (one side) and offer its services at a different price to advertisers (the other side). The higher the price to users, the fewer users there will be and, therefore, the less money Google will make from advertising. Google has decided to set a zero price to users and charge for advertising. Tirole and co-author Jean-Charles Rochet showed that the decision about profit-maximizing pricing is complicated, and they use substantial math to compute such prices under various theoretical conditions. Although Tirole believes in antitrust laws to limit both monopoly power and the exercise of monopoly power, he argues that regulators must be cautious in bringing the law to bear against firms in two-sided markets. An example of a two-sided market is a manufacturer of videogame consoles. The two sides are game developers and game players. He notes that it is very common for companies in such markets to set low prices on one side of the market and high prices on the other. But, he writes, “A regulator who does not bear in mind the unusual nature of a two-sided market may incorrectly condemn low pricing as predatory or high pricing as excessive, even though these pricing structures are adopted even by the smallest platforms entering the market.”

Tirole has brought the same kind of skepticism to some other related regulatory issues. Many regulators, for example, have advocated government regulation of interchange fees (IFs) in payment card associations such as Visa and MasterCard. But in 2003, Rochet and Tirole wrote that “given the [economics] profession’s current state of knowledge, there is no reason to believe that the IFs chosen by an association are systematically too high or too low, as compared with socially optimal levels.”

After winning the Nobel Prize, Tirole wrote a book for a popular audience, Economics for the Common Good. In it, he applied economics to a wide range of policy issues, laying out, among other things, the advantages of free trade for most residents of a given country and why much legislation and regulation causes negative unintended consequences.

Like most economists, Tirole favors free trade. In Economics for the Common Good, he noted that French consumers gain from freer trade in two ways. First, free trade exposes French monopolies and oligopolies to competition. He argued that two major French auto companies, Renault and Peugeot-Citroen, “sharply increased their efficiency” in response to car imports from Japan. Second, free trade gives consumers access to cheaper goods from low-wage countries.

In that same book, Tirole considered the unintended consequences of a hypothetical, but realistic, case in which a non-governmental organization, wanting to discourage killing elephants for their tusks, “confiscates ivory from traffickers.” In this hypothetical example, the organization can destroy the ivory or sell it. Destroying the ivory, he reasoned, would drive up the price. The higher price could cause poachers to kill more elephants. Another example he gave is of the perverse effects of price ceilings. Not only do they cause shortages, but also, as a result of these shortages, people line up and waste time in queues. Their time spent in queues wipes out the financial gain to consumers from the lower price, while also hurting the suppliers. No one wins and wealth is destroyed.

Also in that book, Tirole criticized the French government’s labor policies, which make it difficult for employers to fire people. He noted that this difficulty makes employers less likely to hire people in the first place. As a result, the unemployment rate in France was above 7 percent for over 30 years. The effect on young people has been particularly pernicious. When he wrote this book, the unemployment rate for French residents between 15 and 24 years old was 24 percent, and only 28.6 percent of percent of those in that age group had jobs. This was much lower than the OECD average of 39.6 percent, Germany’s 46.8 percent, and the Netherlands’ 62.3 percent.

One unintended, but predictable, consequence of government regulations of firms, which Tirole pointed out in Economics for the Common Good, is to make firms artificially small. When a French firm with 49 employees hires one more employee, he noted, it is subject to 34 additional legal obligations. Not surprisingly, therefore, in a figure that shows the number of enterprises with various numbers of employees, a spike occurs at 47 to 49 employees.

In Economics for the Common Good, Tirole ranged widely over policy issues in France. In addressing the French university system, he criticized the system’s rejection of selective admission to university. He argued that such a system causes the least prepared students to drop out and concluded that “[O]n the whole, the French educational system is a vast insider-trading crime.”

Tirole is chairman of the Toulouse School of Economics and of the Institute for Advanced Study in Toulouse. A French citizen, he was born in Troyes, France and earned his Ph.D. in economics in 1981 from the Massachusetts Institute of Technology.

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Selected Works

 

1. . (Co-authored with Jean-Jacques Laffont).“Using Cost Observation to Regulate Firms”. Journal of Political Economy. 94:3 (Part I). June: 614-641.

2. . The Theory of Industrial Organization. MIT Press.

3. . (Co-authored with Drew Fudenberg).“Moral Hazard and Renegotiation in Agency Contracts”, Econometrica, 58:6. November: 1279-1319.

4. . (Co-authored with Jean-Jacques Laffont). A Theory of Incentives in Procurement and Regulation. MIT Press.

2003: (Co-authored with Jean-Charles Rochet). “An Economic Analysis of the Determination of Interchange Fees in Payment Card Systems.” Review of Network Economics. 2:2: 69-79.

1. . (Co-authored with Jean-Charles Rochet). “Two-Sided Markets: A Progress Report.” The RAND Journal of Economics. 37:3. Autumn: 645-667.

2017, Economics for the Common Good. Princeton University Press.

 

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The 2008 Financial Crisis

It was, according to accounts filtering out of the White House, an extraordinary scene. Hank Paulson, the U.S. treasury secretary and a man with a personal fortune estimated at 700m (380m), had got down on one knee before the most powerful woman in Congress, Nancy Pelosi, and begged her to save his plan to rescue Wall Street.

    The Guardian, September 26, 20081

The financial crisis of 2008 was a complex event that took most economists and market participants by surprise. Since then, there have been many attempts to arrive at a narrative to explain the crisis, but none has proven definitive. For example, a Congressionally-chartered ten-member Financial Crisis Inquiry Commission produced three separate narratives, one supported by the members appointed by the Democrats, one supported by four members appointed by the Republicans, and a third written by the fifth Republican member, Peter Wallison.2

It is important to appreciate that the financial system is complex, not merely complicated. A complicated system, such as a smartphone, has a fixed structure, so it behaves in ways that are predictable and controllable. A complex system has an evolving structure, so it can evolve in ways that no one anticipates. We will never have a proven understanding of what caused the financial crisis, just as we will never have a proven understanding of what caused the first World War.

There can be no single, definitive narrative of the crisis. This entry can cover only a small subset of the issues raised by the episode.

Metaphorically, we may think of the crisis as a fire. It started in the housing market, spread to the sub-prime mortgage market, then engulfed the entire mortgage securities market and, finally, swept through the inter-bank lending market and the market for asset-backed commercial paper.

Home sales began to slow in the latter part of 2006. This soon created problems for the sector of the mortgage market devoted to making risky loans, with several major lenders—including the largest, New Century Financial—declaring bankruptcy early in 2007. At the time, the problem was referred to as the “sub-prime mortgage crisis,” confined to a few marginal institutions.

But by the spring of 2008, trouble was apparent at some Wall Street investment banks that underwrote securities backed by sub-prime mortgages. On March 16, commercial bank JP Morgan Chase acquired one of these firms, Bear Stearns, with help from loan guarantees provided by the Federal Reserve, the central bank of the United States.

Trouble then began to surface at all the major institutions in the mortgage securities market. By late summer, many investors had lost confidence in Freddie Mac and Fannie Mae, and the interest rates that lenders demanded from them were higher than what they could pay and still remain afloat. On September 7, the U.S. Treasury took these two GSEs into “conservatorship.”

Finally, the crisis hit the short-term inter-bank collateralized lending markets, in which all of the world’s major financial institutions participate. This phase began after government officials’ unsuccessful attempts to arrange a merger of investment bank Lehman Brothers, which declared bankruptcy on September 15. This bankruptcy caused the Reserve Primary money market fund, which held a lot of short-term Lehman securities, to mark down the value of its shares below the standard value of one dollar each. That created jitters in all short-term lending markets, including the inter-bank lending market and the market for asset-backed commercial paper in general, and caused stress among major European banks.

The freeze-up in the interbank lending market was too much for leading public officials to bear. Under intense pressure to act, Treasury Secretary Henry Paulson proposed a 700 billion financial rescue program. Congress initially voted it down, leading to heavy losses in the stock market and causing Secretary Paulson to plead for its passage. On a second vote, the measure, known as the Troubled Assets Relief Program (TARP), was approved.

In hindsight, within each sector affected by the crisis, we can find moral hazard, cognitive failures, and policy failures. Moral hazard (in insurance company terminology) arises when individuals and firms face incentives to profit from taking risks without having to bear responsibility in the event of losses. Cognitive failures arise when individuals and firms base decisions on faulty assumptions about potential scenarios. Policy failures arise when regulators reinforce rather than counteract the moral hazard and cognitive failures of market participants.

The Housing Sector

From roughly 1990 to the middle of 2006, the housing market was characterized by the following:

• an environment of low interest rates, both in nominal and real (inflation-adjusted) terms. Low nominal rates create low monthly payments for borrowers. Low real rates raise the value of all durable assets, including housing.
• prices for houses rising as fast as or faster than the overall price level
• an increase in the share of households owning rather than renting
• loosening of mortgage underwriting standards, allowing households with weaker credit histories to qualify for mortgages.
• lower minimum requirements for down payments. A standard requirement of at least ten percent was reduced to three percent and, in some cases, zero. This resulted in a large increase in the share of home purchases made with down payments of five percent or less.
• an increase in the use of new types of mortgages with “negative amortization,” meaning that the outstanding principal balance rises over time.
• an increase in consumers’ borrowing against their houses to finance spending, using home equity loans, second mortgages, and refinancing of existing mortgages with new loans for larger amounts.
• an increase in the proportion of mortgages going to people who were not planning to live in the homes that they purchased. Instead, they were buying them to speculate. 3

These phenomena produced an increase in mortgage debt that far outpaced the rise in income over the same period. The trends accelerated in the three years just prior to the downturn in the second half of 2006.

The rise in mortgage debt relative to income was not a problem as long as home prices were rising. A borrower having difficulty finding the cash to make a mortgage payment on a house that had appreciated in value could either borrow more with the house as collateral or sell the house to pay off the debt.

But when house prices stopped rising late in 2006, households that had taken on too much debt began to default. This set in motion a reverse cycle: house foreclosures increased the supply of homes for sale; meanwhile, lenders became wary of extending credit, and this reduced demand. Prices fell further, leading to more defaults and spurring lenders to tighten credit still further.

During the boom, some people were speculating in non-owner-occupied homes, while others were buying their own homes with little or no money down. And other households were, in the vernacular of the time, “using their houses as ATMs,” taking on additional mortgage debt in order to finance consumption.

In most states in the United States, once a mortgage lender forecloses on a property, the borrower is not responsible for repayment, even if the house cannot be sold for enough to cover the loan. This creates moral hazard, particularly for property speculators, who can enjoy all of the profits if house prices rise but can stick lenders with some of the losses if prices fall.

One can see cognitive failure in the way that owners of houses expected home prices to keep rising at a ten percent rate indefinitely, even though overall inflation was less than half that amount.4Also, many house owners seemed unaware of the risks of mortgages with “negative amortization.”

Policy failure played a big role in the housing sector. All of the trends listed above were supported by public policy. Because they wanted to see increased home ownership, politicians urged lenders to loosen credit standards. With the Community Reinvestment Act for banks and Affordable Housing Goals for Freddie Mac and Fannie Mae, they spurred traditional mortgage lenders to increase their lending to minority and low-income borrowers. When the crisis hit, politicians blamed lenders for borrowers’ inability to repay, and political pressure exacerbated the credit tightening that subsequently took place

The Sub-prime Mortgage Sector

Until the late 1990s, few lenders were willing to give mortgages to borrowers with problematic credit histories. But sub-prime mortgage lenders emerged and grew rapidly in the decade leading up to the crisis. This growth was fueled by financial innovations, including the use of credit scoring to finely grade mortgage borrowers, and the use of structured mortgage securities (discussed in the next section) to make the sub-prime sector attractive to investors with a low tolerance for risk. Above all, it was fueled by rising home prices, which created a history of low default rates.

There was moral hazard in the sub-prime mortgage sector because the lenders were not holding on to the loans and, therefore, not exposing themselves to default risk. Instead, they packaged the mortgages into securities and sold them to investors, with the securities market allocating the risk.

Because they sold loans in the secondary market, profits at sub-prime lenders were driven by volume, regardless of the likelihood of default. Turning down a borrower meant getting no revenue. Approving a borrower meant earning a fee. These incentives were passed through to the staff responsible for finding potential borrowers and underwriting loans, so that personnel were compensated based on “production,” meaning the new loans they originated.

Although in theory the sub-prime lenders were passing on to others the risks that were embedded in the loans they were making, they were among the first institutions to go bankrupt during the financial crisis. This shows that there was cognitive failure in the management at these companies, as they did not foresee the house price slowdown or its impact on their firms.

Cognitive failure also played a role in the rise of mortgages that were underwritten without verification of the borrowers’ income, employment, or assets. Historical data showed that credit scores were sufficient for assessing borrower risk and that additional verification contributed little predictive value. However, it turned out that once lenders were willing to forgo these documents, they attracted a different set of borrowers, whose propensity to default was higher than their credit scores otherwise indicated.

There was policy failure in that abuses in the sub-prime mortgage sector were allowed to continue. Ironically, while the safety and soundness of Freddie Mac and Fannie Mae were regulated under the Department of Housing and Urban Development, which had an institutional mission to expand home ownership, consumer protection with regard to mortgages was regulated by the Federal Reserve Board, whose primary institutional missions were monetary policy and bank safety. Though mortgage lenders were setting up borrowers to fail, the Federal Reserve made little or no effort to intervene. Even those policy makers who were concerned about practices in the sub-prime sector believed that, on balance, sub-prime mortgage lending was helping a previously under-served set of households to attain home ownership.5

Mortagage Securities

A mortgage security consists of a pool of mortgage loans, the payments on which are passed through to pension funds, insurance companies, or other institutional investors looking for reliable returns with little risk. The market for mortgage securities was created by two government agencies, known as Ginnie Mae and Freddie Mac, established in 1968 and 1970, respectively.

Mortgage securitization expanded in the 1980s, when Fannie Mae, which previously had used debt to finance its mortgage purchases, began issuing its own mortgage-backed securities. At the same time, Freddie Mac was sold to shareholders, who encouraged Freddie to grow its market share. But even though Freddie and Fannie were shareholder-owned, investors treated their securities as if they were government-backed. This was known as an implicit government guarantee.

Attempts to create a market for private-label mortgage securities (PLMS) without any form of government guarantee were largely unsuccessful until the late 1990s. The innovations that finally got the PLMS market going were credit scoring and the collateralized debt obligation (CDO).

Before credit scoring was used in the mortgage market, there was no quantifiable difference between any two borrowers who were approved for loans. With credit scoring, the Wall Street firms assembling pools of mortgages could distinguish between a borrower with a very good score (750, as measured by the popular FICO system) and one with a more doubtful score (650).

Using CDOs, Wall Street firms were able to provide major institutional investors with insulation from default risk by concentrating that risk in other sub-securities (“tranches”) that were sold to investors who were more tolerant of risk. In fact, these basic CDOs were enhanced by other exotic mechanisms, such as credit default swaps, that reallocated mortgage default risk to institutions in which hardly any observer expected to find it, including AIG Insurance.

There was moral hazard in the mortgage securities market, as Freddie Mac and Fannie Mae sought profits and growth on behalf of shareholders, but investors in their securities expected (correctly, as it turned out) that the government would protect them against losses. Years before the crisis, critics grumbled that the mortgage giants exemplified privatized profits and socialized risks.6

There was cognitive failure in the assessment of default risk. Assembling CDOs and other exotic instruments required sophisticated statistical modeling. The most important driver of expectations for mortgage defaults is the path for house prices, and the steep, broad-based decline in home prices that took place in 2006-2009 was outside the range that some modelers allowed for.

Another source of cognitive failure is the “suits/geeks” divide. In many firms, the financial engineers (“geeks) understood the risks of mortgage-related securities fairly well, but their conclusions did not make their way to the senior management level (“suits”).

There was policy failure on the part of bank regulators. Their previous adverse experience was with the Savings and Loan Crisis, in which firms that originated and retained mortgages went bankrupt in large numbers. This caused bank regulators to believe that mortgage securitization, which took risk off the books of depository institutions, would be safer for the financial system. For the purpose of assessing capital requirements for banks, regulators assigned a weight of 100 percent to mortgages originated and held by the bank, but assigned a weight of only 20 percent to the bank’s holdings of mortgage securities issued by Freddie Mac, Fannie Mae, or Ginnie Mae. This meant that banks needed to hold much more capital to hold mortgages than to hold mortgage-related securities; that naturally steered them toward the latter.

In 2001, regulators broadened the low-risk umbrella to include AAA-rated and AA-rated tranches of private-label CDOs. This ruling helped to generate a flood of PLMS, many of them backed by sub-prime mortgage loans.7

By using bond ratings as a key determinant of capital requirements, the regulators effectively put the bond rating agencies at the center of the process of creating private-label CDOs. The rating agencies immediately became subject to both moral hazard and cognitive failure. The moral hazard came from the fact that the rating agencies were paid by the issuers of securities, who wanted the most generous ratings possible, rather than being paid by the regulators, who needed more rigorous ratings. The cognitive failure came from the fact that that models that the rating agencies used gave too little weight to potential scenarios of broad-based declines in house prices. Moreover, the banks that bought the securities were happy to see them rated AAA because the high ratings made the securities eligible for lower capital requirements on the part of the banks. Both sides, therefore, buyers and sellers, had bad incentives.

There was policy failure on the part of Congress. Officials in both the Clinton and Bush Administrations were unhappy with the risk that Freddie Mac and Fannie Mae represented to taxpayers. But Congress balked at any attempt to tighten regulation of the safety and soundness of those firms.8

The Inter-bank Lending Market

There are a number of mechanisms through which financial institutions make short-term loans to one another. In the United States, banks use the Federal Funds market to manage short-term fluctuations in reserves. Internationally, banks lend in what is known as the LIBOR market.

One of the least known and most important markets is for “repo,” which is short for “repurchase agreement.” As first developed, the repo market was used by government bond dealers to finance inventories of securities, just as an automobile dealer might finance an inventory of cars. A money-market fund might lend money for one day or one week to a bond dealer, with the loan collateralized by a low-risk long-term security.

In the years leading up to the crisis, some dealers were financing low-risk mortgage-related securities in the repo market. But when some of these securities turned out to be subject to price declines that took them out of the “low-risk” category, participants in the repo market began to worry about all repo collateral. Repo lending offers very low profit margins, and if an investor has to be very discriminating about the collateral backing a repo loan, it can seem preferable to back out of repo lending altogether. This, indeed, is what happened, in what economist Gary Gorton and others called a “run on repo.”9

Another element of institutional panic was “collateral calls” involving derivative financial instruments. Derivatives, such as credit default swaps, are like side bets. The buyer of a credit default swap is betting that a particular debt instrument will default. The seller of a credit default swap is betting the opposite.

In the case of mortgage-related securities, the probability of default seemed low prior to the crisis. Sometimes, buyers of credit default swaps were merely satisfying the technical requirements to record the underlying securities as AAA-rated. They could do this if they obtained a credit default swap from an institution that was itself AAA-rated. AIG was an insurance company that saw an opportunity to take advantage of its AAA rating to sell credit default swaps on mortgage-related securities. AIG collected fees, and its Financial Products division calculated that the probability of default was essentially zero. The fees earned on each transaction were low, but the overall profit was high because of the enormous volume. AIG’s credit default swaps were a major element in the expansion of shadow banking by non-bank financial institutions during the run-up to the crisis.

Late in 2005, AIG abruptly stopped writing credit default swaps, in part because its own rating had been downgraded below AAA earlier in the year for unrelated reasons. By the time AIG stopped selling credit default swaps on mortgage-related securities, it had outstanding obligations on 80 billion of underlying securities and was earning 1 billion a year in fees.10

Because AIG no longer had its AAA rating and because the underlying mortgage securities, while not in default, were increasingly shaky, provisions in the contracts that AIG had written allowed the buyers of credit default swaps to require AIG to provide protection in the form of low-risk securities posted as collateral. These “collateral calls” were like a margin call that a stock broker will make on an investor who has borrowed money to buy stock that subsequently declines in value. In effect, collateral calls were a run on AIG’s shadow bank.

These collateral calls were made when the crisis in the inter-bank lending market was near its height in the summer of 2008 and banks were hoarding low-risk securities. In fact, the shortage of low-risk securities may have motivated some of the collateral calls, as institutions like Deutsche Bank and Goldman Sachs sought ways to ease their own liquidity problems. In any event, AIG could not raise enough short-term funds to meet its collateral calls without trying to dump long-term securities into a market that had little depth to absorb them. It turned to Federal authorities for a bailout, which was arranged and creatively backed by the Federal Reserve, but at the cost of reducing the value of shares in AIG.

With repos and derivatives, there was moral hazard in that the traders and executives of the narrow units that engaged in exotic transactions were able to claim large bonuses on the basis of short-term profits. But the adverse long-term consequences were spread to the rest of the firm and, ultimately, to taxpayers.

There was cognitive failure in that the collateral calls were an unanticipated risk of the derivatives business. The financial engineers focused on the (remote) chances of default on the underlying securities, not on the intermediate stress that might emerge from collateral calls.

There was policy failure when Congress passed the Commodity Futures Modernization Act. This legislation specified that derivatives would not be regulated by either of the agencies with the staff most qualified to understand them. Rather than require oversight by the Securities and Exchange Commission or the Commodity Futures Trading Commission (which regulated market-traded derivatives), Congress decreed that the regulator responsible for overseeing each firm would evaluate its derivative position. The logic was that a bank that was using derivatives to hedge other transactions should have its derivative position evaluated in a larger context. But, as it happened, the insurance and bank regulators who ended up with this responsibility were not equipped to see the dangers at firms such as AIG.

There was also policy failure in that officials approved of securitization that transferred risk out of the regulated banking sector. While Federal Reserve Officials were praising the risk management of commercial banks,11risk was accumulating in the shadow banking sector (non-bank institutions in the financial system), including AIG insurance, money market funds, Wall Street firms such as Bear Stearns and Lehman Brothers, and major foreign banks. When problems in the shadow banking sector contributed to the freeze in inter-bank lending and in the market for asset-backed commercial paper, policy makers felt compelled to extend bailouts to satisfy the needs of these non-bank institutions for liquid assets.

Conclusion

In terms of the fire metaphor suggested earlier, in hindsight, we can see that the markets for housing, sub-prime mortgages, mortgage-related securities, and inter-bank lending were all highly flammable just prior to the crisis. Moral hazard, cognitive failures, and policy failures all contributed the combustible mix.

The crisis also reflects a failure of the economics profession. A few economists, most notably Robert Shiller,12warned that the housing market was inflated, as indicated by ratios of prices to rents that were high by historical standards. Also, when risk-based capital regulation was proposed in the wake of the Savings and Loan Crisis and the Latin American debt crisis, a group of economists known as the Shadow Regulatory Committee warned that these regulations could be manipulated. They recommended, instead, greater use of senior subordinated debt at regulated financial institutions.13Many economists warned about the incentives for risk-taking at Freddie Mac and Fannie Mae.14

But even these economists failed to anticipate the 2008 crisis, in large part because economists did not take note of the complex mortgage-related securities and derivative instruments that had been developed. Economists have a strong preference for parsimonious models, and they look at financial markets through a lens that includes only a few types of simple assets, such as government bonds and corporate stock. This approach ignores even the repo market, which has been important in the financial system for over 40 years, and, of course, it omits CDOs, credit default swaps and other, more recent innovations.

Financial intermediaries do not produce tangible output that can be measured and counted. Instead, they provide intangible benefits that economists have never clearly articulated. The economics profession has a long way to go to catch up with modern finance.

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About the Author

Arnold Kling was an economist with the Federal Reserve Board and with the Federal Home Loan Mortgage Corporation before launching one of the first Web-based businesses in 1994.  His most recent books areSpecialization and Trade and The Three Languages of Politics. He earned his Ph.D. in economics from the Massachusetts Institute of Technology.

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Footnotes

1

“A desperate plea – then race for a deal before ‘sucker goes down’” The Guardian, September 26, 2008. https://www.theguardian.com/business/2008/sep/27/wallstreet.useconomy1

 

2

The report and dissents of the Financial Crisis Inquiry Commission can be found at https://fcic.law.stanford.edu/

3

See Stefania Albanesi, Giacomo De Giorgi, and Jaromir Nosal 2017, “Credit Growth and the Financial Crisis: A New Narrative” NBER working paper no. 23740. http://www.nber.org/papers/w23740

 

4

Karl E. Case and Robert J. Shiller 2003, “Is there a Bubble in the Housing Market?” Cowles Foundation Paper 1089 http://www.econ.yale.edu/shiller/pubs/p1089.pdf

 

5

Edward M. Gramlich 2004, “Subprime Mortgage Lending: Benefits, Costs, and Challenges,” Federal Reserve Board speeches. https://www.federalreserve.gov/boarddocs/speeches/2004/20040521/

 

6

For example, in 1999, Treasury Secretary Lawrence Summers said in a speech, “Debates about systemic risk should also now include government-sponsored enterprises.” See Bethany McLean and Joe Nocera 2010, All the Devils are Here: The Hidden History of the Financial Crisis Portfolio/Penguin Press. The authors write that Federal Reserve Chairman Alan Greenspan was also, like Summers, disturbed by the moral hazard inherent in the GSEs.

 

7

Jeffrey Friedman and Wladimir Kraus 2013, Engineering the Financial Crisis: Systemic Risk and the Failure of Regulation, University of Pennsylvania Press.

 

8

See McLean and Nocera, All the Devils are Here

 

9

Gary Gorton, Toomas Laarits, and Andrew Metrick 2017, “The Run on Repo and the Fed’s Response,” Stanford working paper. https://www.gsb.stanford.edu/sites/gsb/files/fin_11_17_gorton.pdf

 

10

Talking Points Memo 2009, “The Rise and Fall of AIG’s Financial Products Unit” https://talkingpointsmemo.com/muckraker/the-rise-and-fall-of-aig-s-financial-products-unit

 

11

Chairman Ben S. Bernanke 2006, “Modern Risk Management and Banking Supervision,” Federal Reserve Board speeches. https://www.federalreserve.gov/newsevents/speech/bernanke20060612a.htm

 

12

National Public Radio 2005, “Yale Professor Predicts Housing ’Bubble’ Will Burst” https://www.npr.org/templates/story/story.php?storyId4679264

 

13

Shadow Financial Regulatory Committee 2001, “The Basel Committee’s Revised Capital Accord Proposal” https://www.bis.org/bcbs/ca/shfirect.pdf

14

See the discussion in Viral V. Acharya, Matthew Richardson, Stijn Van Nieuwerburgh and Lawrence J. White 2011, Guaranteed to Fail: Fannie Mae, Freddie Mac, and the Debacle of Mortgage Finance, Princeton University Press.

 

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Christopher Sims

Christopher Sims was awarded, along with Thomas Sargent, the 2011 Nobel Prize in Economic Sciences. The Nobel committee cited their “empirical research on cause and effect in the macroeconomy.” The economists who spoke at the press conference announcing the award emphasized Sargent’s and Sims’ analysis of role of people’s expectations.

One of Sims’s earliest famous contributions was his work on money-income causality, which was cited by the Nobel committee. Money and income move together, but which causes which? Milton Friedman argued that changes in the money supply caused changes in income, noting that the supply of money often rises before income rises. Keynesians such as James Tobin argued that changes in income caused changes in the amount of money. Money seems to move first, but causality, said Tobin and others, still goes the other way: people hold more money when they expect income to rise in the future.

Which view is true? In 1972 Sims applied Clive Granger’s econometric test of causality. On Granger’s definition one variable is said to cause another variable if knowledge of the past values of the possibly causal variable helps to forecast the effect variable over and above the knowledge of the history of the effect variable itself. Implementing a test of this incremental predictability, Sims concluded “[T]he hypothesis that causality is unidirectional from money to income [Friedman’s view] agrees with the postwar U.S. data, whereas the hypothesis that causality is unidirectional from income to money [Tobin’s view] is rejected.”

Sims’s influential article “Macroeconomics and Reality” was a criticism of both the usual econometric interpretation of large-scale Keynesian econometric models and ofRobert Lucas’s influential earlier criticism of these Keynesian models (the so-called Lucas critique). Keynesian econometricians had claimed that with sufficiently accurate theoretical assumptions about the structure of the economy, correlations among the macroeconomic variables could be used to measure the strengths of various structural connections in the economy. Sims argued that there was no basis for thinking that these theoretical assumptions were sufficiently accurate. Such so-called “identifying assumptions” were, Sims said, literally “incredible.” Lucas, on the other hand, had not rejected the idea of such identification. Rather he had pointed out that, if people held “rational expectations” – that is, expectations that, though possibly incorrect, did not deviate on average from what actually occurs in a correctable, systematic manner – then failing to account for them would undermine the stability of the econometric estimates and render the macromodels useless for policy analysis. Lucas and his New Classical followers argued that in forming their expectations people take account of the rules implicitly followed by monetary and fiscal policymakers; and, unless those rules were integrated into the econometric model, every time the policymakers adopted a new policy (i.e., new rules), the estimates would shift in unpredictable ways.

While rejecting the structural interpretation of large-scale macromodels, Sims did not reject the models themselves, writing: “[T]here is no immediate prospect that large-scale macromodels will disappear from the scene, and for good reason: they are useful tools in forecasting and policy analysis.” Sims conceded that the Lucas critique was correct in those cases in which policy regimes truly changed. But he argued that such regime changes were rare and that most economic policy was concerned with the implementation of a particular policy regime. For that purpose, the large-scale macromodels could be helpful, since what was needed for forecasting was a model that captured the complex interrelationships among variables and not one that revealed the deeper structural connections.

In the same article, Sims proposed an alternative to large-scale macroeconomic models, the vector autoregression (or VAR). In Sims’s view, the VAR had the advantages of the earlier macromodels, in that it could capture the complex interactions among a relatively large number of variables needed for policy analysis and yet did not rely on as many questionable theoretical assumptions. With subsequent developments by Sims and others, the VAR became a major tool of empirical macroeconomic analysis.

Sims has also suggested that sticky prices are caused by “rational inattention,” an idea imported from electronic communications. Just as computers do not access information on the Internet infinitely fast (but rather, in bits per second), individual actors in an economy have only a finite ability to process information. This delay produces some sluggishness and randomness, and allows for more accurate forecasts than conventional models, in which people are assumed to be highly averse to change.

Sims’s recent work has focused on the fiscal theory of the price level, the view that inflation in the end is determined by fiscal problems—the overall amount of debt relative to the government’s ability to repay it—rather than by the split in government debt between base money and bonds. In 1999, Sims suggested that the fiscal foundations of the European Monetary Union were “precarious” and that a fiscal crisis in one country “would likely breed contagion effects in other countries.” The Greek financial crisis about a decade later seemed to confirm his prediction.

Christopher Sims earned his B.A. in mathematics in 1963 and his Ph.D. in economics in 1968, both from Harvard University. He taught at Harvard from 1968 to 1970, at the University of Minnesota from 1970 to 1990, at Yale University from 1990 to 1999, and at Princeton University from 1999 to the present. He has been a Fellow of the Econometric Society since 1974, a member of the American Academy of Arts and Sciences since 1988, a member of the National Academy of Sciences since 1989, President of the Econometric Society (1995), and President of the American Economic Association (2012). He has been a Visiting Scholar for the Federal Reserve Banks of Atlanta, New York, and Philadelphia off and on since 1994.

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Selected Works

1. . “Money, Income, and Causality.” American Economic Review 62: 4 (September): 540-552.

2. . “Macroeconomics and Reality.” Econometrica 48: 1 (January): 1-48.

1990 (with James H. Stock and Mark W. Watson). “Inference in Linear Time Series Models with some Unit Roots.” Econometrica 58: 1 (January): 113-144.

1. . “The Precarious Fiscal Foundations of EMU.” De Economist 147:4 (December): 415-436.

2. . “Implications of Rational Inattention.” Journal of Monetary Economics 50: 3 (April): 665–690.

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Gordon Tullock

Gordon Tullock, along with his colleague James M. Buchanan, was a founder of the School of Public Choice. Among his contributions to public choice were his study of bureaucracy, his early insights on rent seeking, his study of political revolutions, his analysis of dictatorships, and his analysis of incentives and outcomes in foreign policy. Tullock also contributed to the study of optimal organization of research, was a strong critic of common law, and did work on evolutionary biology. He was arguably one of the ten or so most influential economists of the last half of the twentieth century. Many economists believe that Tullock deserved to share Buchanan’s 1986 Nobel Prize or even deserved a Nobel Prize on his own.

One of Tullock’s early contributions to public choice was The Calculus of Consent: Logical Foundations of Constitutional Democracy, co-authored with Buchanan in 1962. In that path-breaking book, the authors assume that people seek their own interests in the political system and then consider the results of various rules and political structures. One can think of their book as a political economist’s version of Montesquieu.

One of the most masterful sections of The Calculus of Consent is the chapter in which the authors, using a model formulated by Tullock, consider what good decision rules would be for agreeing to have someone in government make a decision for the collective. An individual realizes that if only one person’s consent is required, and he is not that person, he could have huge costs imposed on him. Requiring more people’s consent in order for government to take action reduces the probability that that individual will be hurt. But as the number of people required to agree rises, the decision costs rise. In the extreme, if unanimity is required, people can game the system and hold out for a disproportionate share of benefits before they give their consent. The authors show that the individual’s preferred rule would be one by which the costs imposed on him plus the decision costs are at a minimum. That preferred rule would vary from person to person. But, they note, it would be highly improbable that the optimal decision rule would be one that requires a simple majority. They write, “On balance, 51 percent of the voting population would not seem to be much preferable to 49 percent.” They suggest further that the optimal rule would depend on the issues at stake. Because, they note, legislative action may “produce severe capital losses or lucrative capital gains” for various groups, the rational person, not knowing his own future position, might well want strong restraints on the exercise of legislative power.

Tullock’s part of The Calculus of Consent was a natural outgrowth of an unpublished manuscript written in the 1950s that later became his 1965 book, The Politics of Bureaucracy. Buchanan, reminiscing about that book, summed up Tullock’s approach and the book’s significance:

The substantive contribution in the manuscript was centered on the hypothesis that, regardless of role, the individual bureaucrat responds to the rewards and punishments that he confronts. This straightforward, and now so simple, hypothesis turned the whole post-Weberian quasi-normative approach to bureaucracy on its head. . . . The economic theory of bureaucracy was born.1

Buchanan noted in his reminiscence that Tullock’s “fascinating analysis” was “almost totally buried in an irritating personal narrative account of Tullock’s nine-year experience in the foreign service hierarchy.” Buchanan continued: “Then, as now, Tullock’s work was marked by his apparent inability to separate analytical exposition from personal anecdote.” Translation: Tullock learned from his experiences. As a Foreign Service officer with the U.S. State Department for nine years Tullock learned, up close and “personal,” how dysfunctional bureaucracy can be. In a later reminiscence, Tullock concluded:

A 90 per cent cut-back on our Foreign Service would save money without really damaging our international relations or stature.2

Tullock made many other contributions in considering incentives within the political system. Particularly noteworthy was his work on political revolutions and on dictatorships.

Consider, first, political revolutions. Any one person’s decision to participate in a revolution, Tullock noted, does not much affect the probability that the revolution will succeed. Therefore, each person’s actions do not much affect his expected benefits from revolution. On the other hand, a ruthless head of government can individualize the costs by heavily punishing those who participate in a revolution. So anyone contemplating participating in a revolution will be comparing heavy individual costs with small benefits that are simply his pro rata share of the overall benefits. Therefore, argued Tullock, for people to participate, they must expect some large benefits that are tied to their own participation, such as a job in the new government. That would explain an empirical regularity that Tullock noted—namely that “in most revolutions, the people who overthrow the existing government were high officials in that government before the revolution.”

This thinking carried over to his work on autocracy. In Autocracy, Tullock pointed out that in most societies at most times, governments were not democratically elected but were autocracies: they were dictatorships or kingdoms. For that reason, he argued, analysts should do more to understand them. Tullock’s book was his attempt to get the discussion started. In a chapter titled “Coups and Their Prevention,” Tullock argued that one of the autocrat’s main challenges is to survive in office. He wrote: “The dictator lives continuously under the Sword of Damocles and equally continuously worries about the thickness of the thread.” Tullock pointed out that a dictator needs his countrymen to believe not that he is good, just, or ordained by God, but that those who try to overthrow him will fail.”

Among modern economists, Tullock was the earliest discoverer of the concept of “rent seeking,” although he did not call it that. Before his work, the usual measure of the deadweight loss from monopoly was the part of the loss in consumer surplus that did not increase producer surplus for the monopolist. Consumer surplus is the maximum amount that consumers are willing to pay minus the amount they actually pay; producer surplus, also called “economic rent,” is the amount that producers get minus the minimum amount for which they would be willing to produce. Harberger3 had estimated that for the U.S. economy in the 1950s, that loss was very low, on the order of 0.1 percent of Gross National Product. In “The Welfare Cost of Tariffs, Monopolies, and Theft,” Tullock argued that this method understated the loss from monopoly because it did not take account of the investment of the monopolist—and of others trying to be monopolists—in becoming monopolists. These investments in monopoly are a loss to the economy. Tullock also pointed out that those who seek tariffs invest in getting those tariffs, and so the standard measure of the loss from tariffs understated the loss. His analysis, as the tariff example illustrates, applies more to firms seeking special privileges from government than to private attempts to monopolize via the free market because private attempts often lead, as if by an invisible hand, to increased competition.”

One of Tullock’s most important insights in public choice was in a short article in 1975 titled “The Transitional Gains Trap.” He noted that even though rent seeking often leads to big gains for the rent seekers, those gains are capitalized in asset prices, which means that buyers of the assets make a normal return on the asset. So, for example, if the government requires the use of ethanol in gasoline, owners of land on which corn is grown will find that their land is worth more because of the regulatory requirement. (Ethanol in the United States is produced from corn.) They gain when the regulation is first imposed. But when they sell the land, the new owner pays a price equal to the present value of the stream of the net profits from the land. So the new owner doesn’t get a supra-normal rate of return from the land. In other words, the owner at the time that the regulation was imposed got “transitional gains,” but the new owner does not. This means that the new owner will suffer a capital loss if the regulation is removed and will fight hard to keep the regulation in place, arguing, correctly, that he paid for those gains. That makes repealing the regulation more difficult than otherwise. Tullock notes that, therefore, we should try hard to avoid getting into these traps because they are hard to get out of.

Tullock was one of the few public choice economists to apply his tools to foreign policy. In Open Secrets of American Foreign Policy, he takes a hard-headed look at U.S. foreign policy rather than the romantic “the United States is the good guys” view that so many Americans take. For example, he wrote of the U.S. government’s bombing of Serbia under President Bill Clinton:

[T]he bombing campaign was a clear-cut violation of the United Nations Charter and hence, should be regarded as a war crime. It involved the use of military forces without the sanction of the Security Council and without any colorable claim of self-defense. Of course, it was not a first—we [the U.S. government] had done the same thing in Vietnam, Grenada and Panama.

Possibly Tullock’s most underappreciated contributions were in the area of methodology and the economics of research. About a decade after spending six months with philosopher Karl Popper at the Center for Advanced Studies in Palo Alto, Tullock published The Organization of Inquiry. In it, he considered why scientific discovery in both the hard sciences and economics works so well without any central planner, and he argued that centralized funding by government would slow progress. After arguing that applied science is generally more valuable than pure science, Tullock wrote:

Nor is there any real justification for the general tendency to consider pure research as somehow higher and better than applied research. It is certainly more pleasant to engage in research in fields that strike you as interesting than to confine yourself to fields which are likely to be profitable, but there is no reason why the person choosing the more pleasant type of research should be considered more noble.4

In Tullock’s view, a system of prizes for important discoveries would be an efficient way of achieving important breakthroughs. He wrote:

As an extreme example, surely offering a reward of 1 billion for the first successful ICBM would have resulted in both a large saving of money for the government and much faster production of this weapon.5

Tullock was born in Rockford, Illinois and was an undergrad at the University of Chicago from 1940 to 1943. His time there was interrupted when he was drafted into the U.S. Army. During his time at Chicago, though, he completed a one-semester course in economics taught by Henry Simons. After the war, he returned to the University of Chicago Law School, where he completed the J.D. degree in 1947. He was briefly with a law firm in 1947 before going into the Foreign Service, where he worked for nine years. He was an economics professor at the University of South Carolina (1959-1962), the University of Virginia (1962-1967), Rice University (1968-1969), the Virginia Polytechnic Institute and State University (1968-1983), George Mason University (1983-1987), the University of Arizona (1987-1999), and again at George Mason University (1999-2008). In 1966, he started the journal Papers in Non-Market Decision Making, which, in 1969, was renamed Public Choice.

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Selected Works

 

1. . The Calculus of Consent. (Co-authored with James M. Buchanan.) Ann Arbor, Michigan: University of Michigan Press.

2. . The Politics of Bureaucracy. Public Affairs Press. Washington, D.C.: Public Affairs Press.

3. . The Organization of Inquiry. Durham, North Carolina: Duke University Press.

4. . “The Welfare Costs of Tariffs, Monopolies, and Theft,” Western Economic Journal, 5:3 (June): 224-232.

5. . Toward a Mathematics of Politics. Ann Arbor, Michigan: University of Michigan Press.

6. . “The Paradox of Revolution.” Public Choice. Vol. 11. Fall: 89-99.

1975: “The Transitional Gains Trap.” Bell Journal of Economics, 6:2 (Autumn): 671-678.

1987: Autocracy. Hingham, Massachusetts: Kluwer Academic Publishers.

1. . Open Secrets of American Foreign Policy. New Jersey: World Scientific Publishing Co.

 

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Footnotes

James M. Buchanan. 1987. The qualities of a natural economist. In Charles K. Rowley, (Ed.) (1987). Democracy and public choice. Oxford and New York: Basil Blackwell, 9-19.

 

Gordon Tullock. 2009. Memories of an unexciting life. Unfinished and unpublished manuscript. Tucson, 2009. Quoted in Charles K. Rowley and Daniel Houser. “The Life and Times of Gordon Tullock.” 2011. George Mason University. Department of Economics. Paper No. 11-56. December 20.

 

Arnold C. Harberger. 1954 “Monopoly and Resource Allocation.” American Economic Review. 44(2): 77-87.

 

Tullock. 1966. P. 14.

 

Tullock. 1966. P. 168.

 

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Division of Labor

Division of labor combines specialization and the partition of a complex production task into several, or many, sub-tasks. Its importance in economics lies in the fact that a given number of workers can produce far more output using division of labor compared to the same number of workers each working alone. Interestingly, this is true even if those working alone are expert artisans. The production increase has several causes. According to Adam Smith, these include increased dexterity from learning, innovations in tool design and use as the steps are defined more clearly, and savings in wasted motion changing from one task to another.

Though the scientific understanding of the importance of division of labor is comparatively recent, the effects can be seen in most of human history. It would seem that exchange can arise only from differences in taste or circumstance. But division of labor implies that this is not true. In fact, even a society of perfect clones would develop exchange, because specialization alone is enough to reward advances such as currency, accounting, and other features of market economies.

In the early 1800s, David Ricardo developed a theory of comparative advantage as an explanation for the origins of trade. And this explanation has substantial power, particularly in a pre-industrial world. Assume, for example, that England is suited to produce wool, while Portugal is suited to produce wine. If each nation specializes, then total consumption in the world, and in each nation, is expanded. Interestingly, this is still true if one nation is better at producing both commodities: even the less productive nation benefits from specialization and trade.

In a world with industrial production based on division of labor, however, comparative advantage based on weather and soil conditions becomes secondary. Ricardo himself recognized this in his broader discussion of trade, as Meoqui points out. The reason is that division of labor produces a cost advantage where none existed before—an advantage based simply on specialization. Consequently, even in a world without comparative advantage, division of labor would create incentives for specialization and exchange.

Origins

The Neolithic Revolution, with its move to fixed agriculture and greater population densities, fostered specialization in both production of consumer goods and military protection. As Plato put it:

A State [arises] out of the needs of mankind; no one is self-sufficing, but all of us have many wants… Then, as we have many wants, and many persons are needed to supply them, one takes a helper… and another… [W]hen these partners and helpers are gathered together in one habitation the body of inhabitants is termed a State… And they exchange with one another, and one gives, and another receives, under the idea that the exchange will be for their good. (The Republic, Book II)

This idea of the city-state, or polis, as a nexus of cooperation directed by the leaders of the city is a potent tool for the social theorist. It is easy to see that the extent of specialization was limited by the size of the city: a clan has one person who plays on a hollow log with sticks; a moderately sized city might have a string quartet; and a large city could support a symphony.

One of the earliest sociologists, Muslim scholar Ibn Khaldun (1332-1406), also emphasized what he called “cooperation” as a means of achieving the benefits of specialization:

The power of the individual human being is not sufficient for him to obtain (the food) he needs, and does not provide him with as much food as he requires to live. Even if we assume an absolute minimum of food –that is, food enough for one day, (a little) wheat, for instance – that amount of food could be obtained only after much preparation such as grinding, kneading, and baking. Each of these three operations requires utensils and tools that can be provided only with the help of several crafts, such as the crafts of the blacksmith, the carpenter, and the potter. Assuming that a man could eat unprepared grain, an even greater number of operations would be necessary in order to obtain the grain: sowing and reaping, and threshing to separate it from the husks of the ear. Each of these operations requires a number of tools and many more crafts than those just mentioned. It is beyond the power of one man alone to do all that, or (even) part of it, by himself. Thus, he cannot do without a combination of many powers from among his fellow beings, if he is to obtain food for himself and for them. Through cooperation, the needs of a number of persons, many times greater than their own (number), can be satisfied. [From Muqaddimah (Introduction), First Prefatory Discussion in chapter 1; parenthetical expression in original in Rosenthal translation]

This sociological interpretation of specialization as a consequence of direction, limited by the size of the city, later motivated scholars such as Emile Durkheim (1858-1917) to recognize the central importance of division of labor for human flourishing.

Smith’s Insight

It is common to say that Adam Smith “invented” or “advocated” division of labor. Such claims are simply mistaken, on several grounds (see, for a discussion, Kennedy 2008). Smith described how decentralized market exchange fosters division of labor among cities or across political units, rather than just within them as previous thinkers had done. Smith had two key insights: First, division of labor would be powerful even if all human beings were identical, because differences in productive capacity are learned. Smith’s parable of the “street porter and the philosopher” illustrates the depth of this insight. As Smith put it:

[T]he very different genius which appears to distinguish men of different professions, when grown up to maturity, is not upon many occasions so much the cause, as the effect of the division of labour. The difference between the most dissimilar characters, between a philosopher and a common street porter, for example, seems to arise not so much from nature, as from habit, custom, and education. (WoN, V. 1, Ch 2; emphasis in original.)

Second, the division of labor gives rise to market institutions and expands the extent of the market. Exchange relations relentlessly push against borders and expand the effective locus of cooperation. The benefit to the individual is that first dozens, then hundreds, and ultimately millions, of other people stand ready to work for each of us, in ways that are constantly being expanded into new activities and new products.

Smith gives an example—the pin factory—that has become one of the central archetypes of economic theory. As Munger (2007) notes, Smith divides pin-making into 18 operations. But that number is arbitrary: labor is divided into the number of operations that fit the extent of the market. In a small market, perhaps three workers, each performing several different operations, could be employed. In a city or small country, as Smith saw, 18 different workers might be employed. In an international market, the optimal number of workers (or their equivalent in automated steps) would be even larger.

The interesting point is that there would be constant pressure on the factory to (a) expand the number of operations even more, and to automate them through the use of tools and other capital; and to (b) expand the size of the market served with consequently lower-cost pins so that the expanded output could be sold. Smith recognized this dynamic pressure in the form of what can only be regarded today as a theorem, the title of Chapter 3 in Book I of the Wealth of Nations: “That the Division of Labor is Limited by the Extent of the Market.” George Stigler treated this claim as a testable theorem in his 1951 article, and developed its insights in the context of modern economics.

Still, the full importance of Smith’s insight was not recognized and developed until quite recently. James Buchanan presented the starkest description of the implications of Smith’s theory (James Buchanan and Yong Yoon, 2002). While the bases of trade and exchange can be differences in tastes or capacities, market institutions would develop even if such differences were negligible. The Smithian conception of the basis for trade and the rewards from developing market institutions is more general and more fundamental than the simple version implied by deterministic comparative advantage.

Division of labor is a hopeful doctrine. Nearly any nation, regardless of its endowment of natural resources, can prosper simply by developing a specialization. That specialization might be determined by comparative advantage, lying in climate or other factors, of course. But division of labor alone is sufficient to create trading opportunities and the beginnings of prosperity. By contrast, nations that refuse the opportunity to specialize, clinging to mercantilist notions of independence and economic self-sufficiency, doom themselves and their populations to needless poverty.

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About the Author

Michael Munger is the Director of the PPE Program at Duke University.

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Further Reading

Buchanan, James, and Yong Yoon. 2002. “Globalization as Framed by the Two Logics of Trade,” The Independent Review, 6(3): 399-405.

Durkheim, Emile, 1984. Division of Labor in Society. New York: MacMillan.

Kennedy, Gavin. 2008. “Basic Errors About the Role of Adam Smith.” April 2: http://adamsmithslostlegacy.blogspot.com/2008/04/basic-errors-about-role-of-adam-smith.html

Khaldun, Ibn. 1377. Muqaddimah (Introductory) http://www.muslimphilosophy.com/ik/Muqaddimah/

Morales Meoqui, Jorge , 2015. Ricardo’s numerical example versus Ricardian trade model: A comparison of two distinct notions of comparative advantage DOI: 10.13140/RG.2.1.2484.5527/1 Link: https://www.researchgate.net/publication/283206070_Ricardos_numerical_example_versus_Ricardian_trade_model_A_comparison_of_two_distinct_notions_of_comparative_advantage

Munger, Michael. 2007. “I’ll Stick With These: Some Sharp Observations on the Division of Labor.” Indianapolis, Liberty Fund. http://www.econlib.org/library/Columns/y2007/Mungerpins.html

Plato, n.d. The Republic. Translated by Benjamin Jowett. http://classics.mit.edu/Plato/republic.html

Roberts, Russell. 2006. “Treasure Island: The Power of Trade. Part II. How Trade Transforms Our Standard of Living.” Indianapolis, Liberty Fund. http://www.econlib.org/library/Columns/y2006/Robertsstandardofliving.html

Smith, Adam. 1759/1853. (Revised Edition). The Theory of Moral Sentiments, New Edition. With a biographical and critical Memoir of the Author, by Dugald Stewart (London: Henry G. Bohn, 1853). 7/27/2015. http://oll.libertyfund.org/titles/2620

Smith, Adam. 1776/1904. An Inquiry into the Nature and Causes of the Wealth of Nations by Adam Smith, edited with an Introduction, Notes, Marginal Summary and an Enlarged Index by Edwin Cannan (London: Methuen, 1904). Vol. 1. 7/27/2015. http://oll.libertyfund.org/titles/237

Stigler, George. 1951. “The Division of Labor is Limited by the Extent of the Market.” Journal of Political Economy. 59(3): 185-193

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Hoover’s Economic Policies

When it was all over, I once made a list of New Deal ventures begun during Hoover’s years as Secretary of Commerce and then as president. . . . The New Deal owed much to what he had begun.1 —FDR advisor Rexford G. Tugwell

Many historians, most of the general public, and even many economists think of Herbert Hoover, the president who preceded Franklin D. Roosevelt, as a defender of laissez-faire economic policy. According to this view, Hoover’s dogmatic commitment to small government led him to stand by and do nothing while the economy collapsed in the wake of the 1929 stock market crash. The reality is quite different. Far from being a bystander, Hoover actively intervened in the economy, advocating and implementing polices that were quite similar to those that Franklin Roosevelt later implemented. Moreover, many of Hoover’s interventions, like those of his successor, caused the great depression to be “great”—that is, to last a long time.

Hoover’s early career

Hoover, a very successful mining engineer, thought that the engineer’s focus on efficiency could enable government to play a larger and more constructive role in the economy. In 1917, he became head of the wartime Food Administration, working to reduce American food consumption. Many Democrats, including FDR, saw him as a potential presidential candidate for their party in the 1920s. For most of the 1920s, Hoover was Secretary of Commerce under Republican Presidents Harding and Coolidge. As Commerce Secretary during the 1920-21 recession, Hoover convened conferences between government officials and business leaders as a way to use government to generate “cooperation” rather than individualistic competition. He particularly liked using the “cooperation” that was seen during wartime as an example to follow during economic crises. In contrast to Harding’s more genuine commitment to laissez-faire, Hoover began one 1921 conference with a call to “do something” rather than nothing. That conference ended with a call for more government planning to avoid future depressions, as well as using public works as a solution once they started.2 Pulitzer-Prize winning historian David Kennedy summarized Hoover’s work in the 1920-21 recession this way: “No previous administration had moved so purposefully and so creatively in the face of an economic downturn. Hoover had definitively made the point that government should not stand by idly when confronted with economic difficulty.”3 Harding, and later Coolidge, rejected most of Hoover’s ideas. This may well explain why the 1920-21 recession, as steep as it was, was fairly short, lasting 18 months.

Interestingly, though, in his role as Commerce Secretary, Hoover created a new government program called “Own Your Own Home,” which was designed to increase the level of homeownership. Hoover jawboned lenders and the construction industry to devote more resources to homeownership, and he argued for new rules that would allow federally chartered banks to do more residential lending. In 1927, Congress complied, and with this government stamp of approval and the resources made available by Federal Reserve expansionary policies through the decade, mortgage lending boomed. Not surprisingly, this program became part of the disaster of the depression, as bank failures dried up sources of funds, preventing the frequent refinancing that was common at the time, and high unemployment rates made the government-encouraged mortgages unaffordable. The result was a large increase in foreclosures.4

The Hoover presidency

Hoover did not stand idly by after the depression began. To fight the rapidly worsening depression, Hoover extended the size and scope of the federal government in six major areas: (1) federal spending, (2) agriculture, (3) wage policy, (4) immigration, (5) international trade, and (6) tax policy.

Consider federal government spending. (See Fiscal Policy.) Federal spending in the 1929 budget that Hoover inherited was 3.1 billion. He increased spending to 3.3 billion in 1930, 3.6 billion in 1931, and 4.7 billion and 4.6 billion in 1932 and 1933, respectively, a 48% increase over his four years. Because this was a period of deflation, the real increase in government spending was even larger: The real size of government spending in 1933 was almost double that of 1929.5 The budget deficits of 1931 and 1932 were 52.5% and 43.3% of total federal expenditures. No year between 1933 and 1941 under Roosevelt had a deficit that large.6 In short, Hoover was no defender of “austerity” and “budget cutting.”

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Figure 1

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Shortly after the stock market crash in October 1929, Hoover extended federal control over agriculture by expanding the reach of the Federal Farm Board (FFB), which had been created a few months earlier.7 The idea behind the FFB was to make government-funded loans to farm cooperatives and create “stabilization corporations” to keep farm prices up and deal with surpluses. In other words, it was a cartel plan. That fall, Hoover pushed the FFB into full action, lending to farmers all over the country and otherwise subsidizing farming in an attempt to keep prices up. The plan failed miserably, as subsidies encouraged farmers to grow more, exacerbating surpluses and eventually driving prices way down. As more farms faced dire circumstances, Hoover proposed the further anti-market step of paying farmers not to grow.

On wages, Hoover revived the business-government conferences of his time at the Department of Commerce by summoning major business leaders to the White House several times that fall. He asked them to pledge not to reduce wages in the face of rising unemployment. Hoover believed, as did a number of intellectuals at the time, that high wages caused prosperity, even though the true causation is from capital accumulation to increased labor productivity to higher wages. He argued that if major firms cut wages, workers would not have the purchasing power they needed to buy the goods being produced. As most depressions involve falling prices, cutting wages to match falling prices would have kept purchasing power constant. What Hoover wanted amounted to an increase in real wages, as constant nominal wages would be able to purchase more goods at falling prices. Presumably out of fear of the White House or, perhaps, because it would keep the unions quiet, industrial leaders agreed to this proposal. The result was rapidly escalating unemployment, as firms quickly realized that they could not continue to employ as many workers when their output prices were falling and labor costs were constant.8

Of all of the government failures of the Hoover presidency—excluding the actions of the Federal Reserve between 1929 and 1932, over which he had little to no influence—his attempt to maintain wages was the most damaging. Had he truly believed in laissez-faire, Hoover would not have intervened in the private sector that way. Hoover’s high-wage policy was a clear example of his lack of confidence in the corrective forces of the market and his willingness to use governmental power to fight the depression.

Later in his presidency, Hoover did more than just jawbone to keep wages up. He signed two pieces of labor legislation that dramatically increased the role of government in propping up wages and giving monopoly protection to unions. In 1931, he signed the Davis-Bacon Act, which mandated that all federally funded or assisted construction projects pay the “prevailing wage” (i.e., the above market-clearing union wage). The result of this move was to close out non-union labor, especially immigrants and non-whites, and drive up costs to taxpayers. A year later, he signed the Norris-LaGuardia Act, whose five major provisions each enshrined special provisions for unions in the law, such as prohibiting judges from using injunctions to stop strikes and making union-free contracts unenforceable in federal courts.9 Hoover’s interventions into the labor market are further evidence of his rejection of laissez-faire.

Two other areas that Hoover intervened in aggressively were immigration and international trade. One of the lesser-known policy changes during his presidency was his near halt to immigration through an Executive Order in September 1930. His argument was that blocking immigration would preserve the jobs and wages of American citizens against competition from low-wage immigrants. Immigration fell to a mere 10 to 15% of the allowable quota of visas for the five-month period ending February 28, 1931. Once again, Hoover was unafraid to intervene in the economic decisions of the private sector by preventing the competitive forces of the global labor market from setting wages.10

Even those with only a casual knowledge of the Great Depression will be familiar with one of Hoover’s major policy mistakes—his promotion and signing of the Smoot-Hawley tariff in 1930. This law increased tariffs significantly on a wide variety of imported goods, creating the highest tariff rates in U.S. history. While economist Douglas Irwin has found that Smoot-Hawley’s effects were not as large as often thought, they still helped cause a decline in international trade, a decline that contributed to the worsening worldwide depression.

Most of these policies continued and many expanded throughout 1931, with the economy worsening each month. By the end of the year, Hoover decided that more drastic action was necessary, and on December 8, he addressed Congress and offered proposals that historian David Kennedy refers to as “Hoover’s second program, ” and that has also been called “The Hoover New Deal.”11 His proposals included:

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The Reconstruction Finance Corporation to lend tax dollars to banks, firms and others institutions in need.

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A Home Loan Bank to provide government help to the construction sector.

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Congressional legalization of Hoover’s executive order that had blocked immigration.

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Direct loans to state governments for spending on relief for the unemployed.

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More aid to Federal Land Banks.

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Creating a Public Works Administration that would both better coordinate Federal public works and expand them.

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More vigorous enforcement of antitrust laws to end “destructive competition” in a variety of industries, as well as supporting work-sharing programs that would supposedly reduce unemployment.

On top of these spending proposals, most of which were approved in one form or another, Hoover proposed, and Congress approved, the largest peacetime tax increase in U.S. history. The Revenue Act of 1932 increased personal income taxes dramatically, but also brought back a variety of excise taxes that had been used during World War I. The higher income taxes involved an increase of the standard rate from a range of 1.5 to 5% to a range of 4 to 8%. On top of that increase, the Act placed a large surtax on higher-income earners, leading to a total tax rate of anywhere from 25 to 63%. The Act also raised the corporate income tax along with several taxes on other forms of income and wealth.

Whether or not Hoover’s prescriptions were the right medicine—and the evidence suggests that they were not—his programs were a fairly aggressive use of government to address the problems of the depression.12 These programs were hardly what one would expect from a man devoted to “laissez-faire” and accused of doing nothing while the depression worsened.

The views of contemporaries and modern historians

The myth of Hoover as a defender of laissez-faire persists, despite the fact that his contemporaries clearly understood that he made aggressive use of government to fight the recession. Indeed, Hoover’s own statements made clear that he recognized his aggressive use of intervention. The myth also persists in spite of the widespread recognition by modern historians that the Hoover presidency was anything but an era of laissez-faire.

According to Hoover’s Secretary of State, Henry Stimson, Hoover argued that balancing the budget was a mistake: “The President likened it to war times. He said in war times no one dreamed of balancing the budget. Fortunately we can borrow.”13 Hoover himself summarized his administration’s approach to the depression during a campaign speech in 1932:

We might have done nothing. That would have been utter ruin. Instead, we met the situation with proposals to private business and the Congress of the most gigantic program of economic defense and counter attack ever evolved in the history of the Republic. These programs, unparalleled in the history of depressions of any country and in any time, to care for distress, to provide employment, to aid agriculture, to maintain the financial stability of the country, to safeguard the savings of the people, to protect their homes, are not in the past tense—they are in action. . . . No government in Washington has hitherto considered that it held so broad a responsibility for leadership in such time.14

Some might dismiss this as campaign rhetoric, but as the other evidence indicates, Hoover was giving an accurate portrayal of his presidency. Indeed, Hoover’s profligacy was so clear that Roosevelt attacked it during the 1932 Presidential campaign.

Roosevelt’s own advisors understood that much of what they created during the New Deal owed its origins to Hoover’s policies, going as far back as his time at the Commerce Department in the 1920s. Thus the quote at the start of this article by Rex Tugwell, one of the academics at the center of FDR’s “brains trust.” Another member of the brains trust, Raymond Moley, wrote of that period:

When we all burst into Washington . . . we found every essential idea [of the New Deal] enacted in the 100-day Congress in the Hoover administration itself. The essentials of the NRA [National Recovery Administration], the PWA [Public Works Administration], the emergency relief setup were all there. Even the AAA [Agricultural Adjustment Act] was known to the Department of Agriculture. Only the TVA [Tennessee Valley Authority] and the Securities Act was [sic] drawn from other sources. The RFC [Reconstruction Finance Corporation], probably the greatest recovery agency, was of course a Hoover measure, passed long before the inauguration.15

Decades later, Tugwell, writing to Moley, said of Hoover: “[W]e were too hard on a man who really invented most of the devices we used.”16 Members of Roosevelt’s inner circle would have every reason to disassociate themselves from the policies of their predecessor; yet these two men recognized Hoover’s role as the father of the New Deal quite clearly.

Nor is this point lost on contemporary historians. In his authoritative history of the Great Depression era, David Kennedy admiringly wrote that Hoover’s 1932 program of activist policies helped “lay the groundwork for a broader restructuring of government’s role in many other sectors of American life, a restructuring known as the New Deal.”17 In a later discussion of the beginning of the Roosevelt administration, Kennedy observed (emphasis added):

Roosevelt intended to preside over a government even more vigorously interventionist and directive than Hoover’s. . . . [I]f Roosevelt had a plan in early 1933 to effect economic recovery, it was difficult to distinguish from many of the measures that Hoover, even if sometimes grudgingly, had already adopted: aid for agriculture, promotion of industrial cooperation, support for the banks, and a balanced budget. Only the last was dubious. . . . FDR denounced Hoover’s budget deficits.18

Conclusion

Despite overwhelming evidence to the contrary, from Hoover’s own beliefs to his actions as president to the observations of his contemporaries and modern historians, the myth of Herbert Hoover’s presidency as an example of laissez-faire persists. Of all the presidents up to and including him, Herbert Hoover was one of the most active interveners in the economy.

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About the Author

Steven Horwitz is the Charles A. Dana Professor of Economics at St. Lawrence University

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Footnotes

*

This entry is adapted, with permission, from Steven Horwitz, “Herbert Hoover: Father of the New Deal,” Cato Institute Briefing Papers, No. 122, September 29, 2011, at: http://www.cato.org/publications/briefing-paper/herbert-hoover-father-new-deal

 

As quoted in Amity Shlaes, The Forgotten Man: A New History of the Great Depression. New York: Harper Collins, 2007, p. 149.

 

Murray N. Rothbard, America’s Great Depression (1963; Auburn, AL: Ludwig von Mises Institute, 2008), p. 192.

 

David M. Kennedy, Freedom From Fear: The American People in Depression and War, 1929-1945. New York: Oxford University Press, p. 48.

 

See Steven Malanga, “Obsessive Housing Disorder,” City Journal, 19 (2), Spring 2009.

 

Federal government spending data can be found at: http://www2.census.gov/prod2/statcomp/documents/CT1970p2-12.pdf

 

See the data and discussion in Jonathan Hughes and Louis P. Cain, American Economic History, 7th ed., Boston: Pearson, 2007, p. 487. Hughes and Cain also note of those deficits, “The expenditures were in large part the doing of the outgoing Hoover administration.”

 

See Kennedy op. cit., pp. 43-44; Rothbard op. cit., p. 228; and Gene Smiley, Rethinking the Great Depression, Chicago: Ivan R. Dee, 2002, p. 13.

 

See Lee Ohanian, “What – or Who – Started the Great Depression?” Journal of Economic Theory 144, 2009, pp. 2310-2335.

 

Chuck Baird, “Freeing Labor Markets by Reforming Union Laws,” June 2011, Downsizing DC, Cato Institute, available at http://www.downsizinggovernment.org/labor/reforming-labor-union-laws.

 

See “White House Statement on Government Policies To Reduce Immigration” March 26, 1931, available at http://www.presidency.ucsb.edu/ws/index.php?pid22581#axzz1V7klWwZu. That statement opens with an explicit link between the immigration policy and unemployment: “President Hoover, to protect American workingmen from further competition for positions by new alien immigration during the existing conditions of employment, initiated action last September looking to a material reduction in the number of aliens entering this country.”

 

Kennedy op. cit., p. 83. The phrase “Hoover’s New Deal” is from the title of chapter 11 in Rothbard, op. cit..

 

Hoover’s higher tax rates backfired, as they further depressed income-earning activity, reducing the tax base, which in turn led to a fall in tax revenues for 1932.

 

As cited in Kennedy op. cit., p. 79.

 

Herbert Hoover, “Address Accepting the Republican Presidential Nomination,” August 11, 1932.

 

Raymond Moley, “Reappraising Hoover,” Newsweek, June 14, 1948, p. 100.

 

Letter from Rexford G. Tugwell to Raymond Moley, January 29, 1965, Raymond Moley Papers, “Speeches and Writings,” Box 245-49, Hoover Institution on War, Revolution and Peace, Stanford University, Stanford, CA, as cited in Davis W. Houck, “Rhetoric as Currency: Herbert Hoover and the 1929 Stock Market Crash,” Rhetoric & Public Affairs 3, 2000, p. 174.

 

Kennedy, op. cit., p. 83.

 

Kennedy, op. cit., p. 118.

 

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Unemployment

Few economic indicators are of more concern to Americans than unemployment statistics. Reports that unemployment rates are dropping make us happy; reports to the contrary make us anxious. But just what do unemployment!---- figures tell us? Are they reliable measures? What influences joblessness?

How Is Unemployment Defined and Measured?

Each month, the federal government’s Bureau of Labor Statistics randomly surveys sixty thousand individuals around the nation. If respondents say they are both out of work and seeking employment, they are counted as unemployed members of the labor force. Jobless respondents who have chosen not to continue looking for work are considered out of the labor force and therefore are not counted as unemployed. Almost half of all unemployment spells end because people leave the labor force. Ironically, those who drop out of the labor force—because they are discouraged, have household responsibilities, or are sick—actually make unemployment rates look better; the unemployment rate includes only people within the labor force who are out of work.

Not all unemployment is the same. Unemployment can be long term or short term. It can be frictional, meaning someone is between jobs; or it may be structural, as when someone’s skills are no longer demanded because of a change in technology or an industry downturn.

Is Unemployment a Big Problem?

Some say there are reasons to think that unemployment in the United States is not a big problem. In June 2005, for example, 33.5 percent of all unemployed people were under the age of twenty-four, and presumably few of them were the main source of income for their families. One out of six of the unemployed are teenagers. Moreover, the average duration of a spell of unemployment is short. In June 2005 it was 16.3 weeks. And the median spell of unemployment is even shorter. In June 2005 it was 7.0 weeks, meaning that half of all spells last 7.0 weeks or less.

On the basis of numbers like the above, many economists have thought that unemployment is not a very large problem. A few weeks of unemployment seems to them like just enough time for people to move from one job to another. Yet these numbers, though accurate, are misleading. Much of the reason why unemployment spells appear short is that many workers drop out of the labor force at least temporarily because they cannot find attractive jobs. Often two short spells of unemployment mean a long spell of joblessness because the person was unemployed for a short time, withdrew from the labor force, and then reentered the labor force.

And even if most unemployment spells are short, most weeks of unemployment are experienced by people who are out of work for a long time. To see why, consider the following example. Suppose that each week, twenty spells of unemployment lasting 1 week begin, and only one begins that lasts 20 weeks. Then the average duration of a completed spell of unemployment would be only 1.05 weeks. But half of all unemployment (half of the total of 40 weeks that the twenty-one people are out of work) would be accounted for by spells lasting 20 weeks.

Something like this example applies in the real world. In June 2005, for example, 42.9 percent of the unemployed had been unemployed for less than five weeks, but 16.9 percent had been unemployed for six or more months.

What Causes Long-Term Unemployment?

To fully understand unemployment, we must consider the causes of recorded long-term unemployment. Empirical evidence shows that two causes are welfare payments and unemployment insurance. These government assistance programs contribute to long-term unemployment in two ways.

First, government assistance increases the measure of unemployment by prompting people who are not working to claim that they are looking for work even when they are not. The work-registration requirement for welfare recipients, for example, compels people who otherwise would not be considered part of the labor force to register as if they were a part of it. This requirement effectively increases the measure of unemployed in the labor force even though these people are better described as nonemployed—that is, not actively looking for work.

In a study using state data on registrants in Aid to Families with Dependent Children and food stamp programs, my colleague Kim Clark and I found that the work-registration requirement actually increased measured unemployment by about 0.5 to 0.8 percentage points. If this same relationship holds in 2005, this requirement increases the measure of unemployment by 750,000 to 1.2 million people. Without the condition that they look for work, many of these people would not be counted as unemployed. Similarly, unemployment insurance increases the measure of unemployment by inducing people to say that they are job hunting in order to collect benefits.

The second way government assistance programs contribute to long-term unemployment is by providing an incentive, and the means, not to work. Each unemployed person has a “reservation wage”—the minimum wage he or she insists on getting before accepting a job. Unemployment insurance and other social assistance programs increase that reservation wage, causing an unemployed person to remain unemployed longer.

Consider, for example, an unemployed person who is accustomed to making 15.00 an hour. On unemployment insurance this person receives about 55 percent of normal!---- earnings, or 8.25 per lost work hour. If that person is in a 15 percent federal tax bracket and a 3 percent state tax bracket, he or she pays 1.49 in taxes per hour not worked and nets 6.76 per hour after taxes as compensation for not working. If that person took a job that paid 15.00 per hour, governments would take 18 percent for income taxes and 7.65 percent for Social Security taxes, netting him or her 11.15 per hour of work. Comparing the two payments, this person may decide that an hour of leisure is worth more than the extra 4.39 the job would pay. If so, this means that the unemployment insurance raises the person’s reservation wage to above 15.00 per hour.

Unemployment, therefore, may not be as costly for the jobless person as previously imagined. But as Harvard economist Martin Feldstein pointed out in the 1970s, the costs of unemployment to taxpayers are very great indeed. Take the example above of the individual who could work for 15.00 an hour or collect unemployment insurance of 8.25 per hour. The cost of unemployment to this unemployed person was only 4.39 per hour, the difference between the net income from working and the net income from not working. And as compensation for this cost, the unemployed person gained leisure, whose value could well be above 4.39 per hour. But other taxpayers as a group paid 8.25 in unemployment benefits for every hour the person was unemployed, and got back in taxes only 1.49 on this benefit. Moreover, they gave up 3.85 in lost tax and Social Security revenue that this person would have paid per hour employed at a 15.00 wage. Net loss to other taxpayers: 10.61 (8.25 1.49 3.85) per hour. Multiply this by millions of people collecting unemployment, each missing hundreds of hours of work, and you get a cost to taxpayers in the billions.

Unemployment insurance also extends the time a person stays off the job. Clark and I estimated that the existence of unemployment insurance almost doubles the number of unemployment spells lasting more than three months. If unemployment insurance were eliminated, the unemployment rate would drop by more than half a percentage point, which means that the number of unemployed people would fall by about 750,000. This is all the more significant in light of the fact that less than half of the unemployed receive insurance benefits, largely because many have not worked enough to qualify.

Another cause of long-term unemployment is unionization. High union wages that exceed the competitive market rate are likely to cause job losses in the unionized sector of the economy. Also, those who lose high-wage union jobs are often reluctant to accept alternative low-wage employment. Between 1970 and 1985, for example, a state with a 20 percent unionization rate, approximately the average for the fifty states and the District of Columbia, experienced an unemployment rate that was 1.2 percentage points higher than that of a hypothetical state that had no unions. To put this in perspective, 1.2 percentage points is about 60 percent of the increase in normal unemployment between 1970 and 1985.

There is no question that some long-term unemployment is caused by government intervention and unions that interfere with the supply of labor. It is, however, a great mistake (made by some conservative economists) to attribute most unemployment to government interventions in the economy or to any lack of desire to work on the part of the unemployed. Unemployment was a serious economic problem in the late nineteenth and early twentieth centuries prior to the welfare state and widespread unionization. Unemployment then, as now, was closely linked to general macroeconomic conditions. The great depression, when unemployment in the United States reached 25 percent, is the classic example of the damage that collapses in credit can do. Since then, most economists have agreed that cyclical fluctuations in unemployment are caused by changes in the demand for labor, not by changes in workers’ desires to work, and that unemployment in recessions is involuntary.

Even leaving aside cyclical fluctuations, a large part of unemployment is due to demand factors rather than supply. High unemployment in New England in the early 1990s, for example, was due to declines in computer and other industries in which New England specialized. High unemployment in northern California in the early 2000s was caused by the dot-com bust. The process of adjustment following shocks is long and painful, and recent research suggests that even temporary declines in demand can have permanent effects on unemployment, as workers who lose jobs are unable to sell their labor due to a loss of skills or for other reasons. Therefore, most economists who study unemployment support an active government role in training and retraining workers and in maintaining stable demand for labor.

The Natural Rate of Unemployment

Long before Milton Friedman and Edmund Phelps advanced the notion of the natural rate of unemployment (the lowest rate of unemployment tolerable without pushing up inflation), policymakers had contented themselves with striving for low, not zero, unemployment. Just what constitutes an acceptably low level of unemployment has been redefined over the decades. In the early 1960s an unemployment rate of 4 percent was both desirable and achievable. Over time, the unemployment rate drifted upward and, for the most part, has hovered around 7 percent.!---- Lately, it has fallen to 5 percent. I suspect that some of the reduction in the apparent natural rate of unemployment in recent years has to do with reduced transitional unemployment, both because fewer people are between jobs and because they are between jobs for shorter periods. Union power has been eroded by domestic regulatory action and inaction, as well as by international competition. More generally, international competition has restrained wage increases in high-wage industries. Another factor making unemployment lower is a decline in the fraction of the unemployed who are supported by unemployment insurance.

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About the Author

Lawrence H. Summers is Charles W. Eliot University Professor at Harvard University. He was previously the president of Harvard University. Before that, he was secretary of the U.S. Treasury.

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Further Reading

Feldstein, Martin. “The Economics of the New Unemployment.” Public Interest 33 (Fall 1973): 3–42.

Feldstein, Martin. “Why Is Productivity Growing Faster?” NBER Working Paper no. 9530. National Bureau of Economic Research, Cambridge, Mass., 2003.

Friedman, Milton. “The Role of Monetary Policy.” American Economic Review 58 (March 1968): 1–17.

Hall, Robert. “Employment Fluctuations and Wage Rigidity.” Brookings Papers on Economic Activity 1 (1980): 91–141.

Summers, Lawrence H. Understanding Unemployment. Cambridge: MIT Press, 1990.

Summers, Lawrence H. “Why Is the Unemployment Rate So Very High Near Full Employment?” Brookings Papers on Economic Activity 2 (1986): 339–383.

Summers, Lawrence H., and Kim B. Clark. “Labor Market Dynamics and Unemployment: A Reconsideration.” Brookings Papers on Economic Activity 1 (1979): 13–60.

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Unintended Consequences

The law of unintended consequences, often cited but rarely defined, is that actions of people—and especially of government—always have effects that are unanticipated or unintended. Economists and other social scientists have heeded its power for centuries; for just as long, politicians and popular opinion have largely ignored it.

The concept of unintended consequences is one of the building blocks of economics. Adam Smith’s “invisible hand,” the most famous metaphor in social science, is an example of a positive unintended consequence. Smith maintained that each individual, seeking only his own gain, “is led by an invisible hand to promote an end which was no part of his intention,” that end being the public interest. “It is not from the benevolence of the butcher, or the baker, that we expect our dinner,” Smith wrote, “but from regard to their own self interest.”

Most often, however, the law of unintended consequences illuminates the perverse unanticipated effects of legislation and regulation. In 1692 the English philosopher John Locke, a forerunner of modern economists, urged the defeat of a parliamentary bill designed to cut the maximum permissible rate of interest from 6 percent to 4 percent. Locke argued that instead of benefiting borrowers, as intended, it would hurt them. People would find ways to circumvent the law, with the costs of circumvention borne by borrowers. To the extent the law was obeyed, Locke concluded, the chief results would be less available credit and a redistribution of income away from “widows, orphans and all those who have their estates in money.”

In the first half of the nineteenth century, the famous French economic journalist Frédéric Bastiat often distinguished in his writing between the “seen” and the “unseen.” The seen were the obvious visible consequences of an action or policy. The unseen were the less obvious, and often unintended, consequences. In his famous essay “What Is Seen and What Is Not Seen,” Bastiat wrote:

There is only one difference between a bad economist and a good one: the bad economist confines himself to the visible effect; the good economist takes into account both the effect that can be seen and those effects that must be foreseen.1

Bastiat applied his analysis to a wide range of issues, including trade barriers, taxes, and government spending.

The first and most complete analysis of the concept of unintended consequences was done in 1936 by the American sociologist Robert K. Merton. In an influential article titled “The Unanticipated Consequences of Purposive Social Action,” Merton identified five sources of unanticipated consequences. The first two—and the most pervasive—were “ignorance” and “error.”

Merton labeled the third source the “imperious immediacy of interest.” By that he was referring to instances in which someone wants the intended consequence of an action so much that he purposefully chooses to ignore any unintended effects. (That type of willful ignorance is very different from true ignorance.) The Food and Drug Administration, for example, creates enormously destructive unintended!---- consequences with its regulation of pharmaceutical drugs. By requiring that drugs be not only safe but efficacious for a particular use, as it has done since 1962, the FDA has slowed down by years the introduction of each drug. An unintended consequence is that many people die or suffer who would have been able to live or thrive. This consequence, however, has been so well documented that the regulators and legislators now foresee it but accept it.

“Basic values” was Merton’s fourth source of unintended consequences. The Protestant ethic of hard work and asceticism, he wrote, “paradoxically leads to its own decline through the accumulation of wealth and possessions.” His final case was the “self-defeating prediction.” Here he was referring to the instances when the public prediction of a social development proves false precisely because the prediction changes the course of history. For example, the warnings earlier in this century that population growth would lead to mass starvation helped spur scientific breakthroughs in agricultural productivity that have since made it unlikely that the gloomy prophecy will come true. Merton later developed the flip side of this idea, coining the phrase “the self-fulfilling prophecy.” In a footnote to the 1936 article, he vowed to write a book devoted to the history and analysis of unanticipated consequences. Although Merton worked on the book over the next sixty years, it remained uncompleted when he died in 2003 at age ninety-two.

The law of unintended consequences provides the basis for many criticisms of government programs. As the critics see it, unintended consequences can add so much to the costs of some programs that they make the programs unwise even if they achieve their stated goals. For instance, the U.S. government has imposed quotas on imports of steel in order to protect steel companies and steelworkers from lower-priced competition. The quotas do help steel companies. But they also make less of the cheap steel available to U.S. automakers. As a result, the automakers have to pay more for steel than their foreign competitors do. So a policy that protects one industry from foreign competition makes it harder for another industry to compete with imports.

Similarly, Social Security has helped alleviate poverty among senior citizens. Many economists argue, however, that it has carried a cost that goes beyond the payroll taxes levied on workers and employers. Martin Feldstein and others maintain that today’s workers save less for their old age because they know they will receive Social Security checks when they retire. If Feldstein and the others are correct, it means that less savings are available, less investment takes place, and the economy and wages grow more slowly than they would without Social Security.

The law of unintended consequences is at work always and everywhere. People outraged about high prices of plywood in areas devastated by hurricanes, for example, may advocate price controls to keep the prices closer to usual levels. An unintended consequence is that suppliers of plywood from outside the region, who would have been willing to supply plywood quickly at the higher market price, are less willing to do so at the government-controlled price. Thus results a shortage of a good where it is badly needed. Government licensing of electricians, to take another example, keeps the supply of electricians below what it would otherwise be, and thus keeps the price of electricians’ services higher than otherwise. One unintended consequence is that people sometimes do their own electrical work, and, occasionally, one of these amateurs is electrocuted.

One final sobering example is the case of the Exxon Valdez oil spill in 1989. Afterward, many coastal states enacted laws placing unlimited liability on tanker operators. As a result, the Royal Dutch/Shell group, one of the world’s biggest oil companies, began hiring independent ships to deliver oil to the United States instead of using its own forty-six-tanker fleet. Oil specialists fretted that other reputable shippers would flee as well rather than face such unquantifiable risk, leaving the field to fly-by-night tanker operators with leaky ships and iffy insurance. Thus, the probability of spills probably increased and the likelihood of collecting damages probably decreased as a consequence of the new laws.

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About the Author

Rob Norton is an author and consultant and was previously the economics editor of Fortune magazine.

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Further Reading

Bastiat, Frédéric. “What Is Seen and What Is Not Seen.” Online at: http://www.econlib.org/library/Bastiat/basEss1.html.

Hayek, Friedrich A. New Studies in Philosophy, Politics, Economics and the History of Ideas. Chicago: University of Chicago Press, 1978.

Merton, Robert K. Sociological Ambivalence and Other Essays. New York: Free Press, 1976.

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Footnotes

Online at: http://www.econlib.org/library/Bastiat/basEss1.html.

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Urban Transportation

The defining trait of urban areas is density: of people, activities, and structures. The defining trait of urban transportation is the ability to cope with this density while moving people and goods. Density creates challenges for urban transportation because of crowding and the expense of providing infrastructure in built-up areas. It also creates certain advantages because of economies of scale: some transportation activities are cheaper when carried out in large volumes. These characteristics mean that two of the most important phenomena in urban transportation are traffic congestion and mass transit.

Traffic congestion imposes large costs, primarily in terms of lost time. (Economists measure the value of this time by examining situations in which people can trade time for money, such as by choosing different means of travel.) Researchers at the Texas Transportation Institute regularly estimate the costs of urban congestion; their estimate of annual congestion costs per capita in 2001 for seventy-five large U.S. metropolitan areas was 520, representing twenty-six hours of delay and forty-two gallons of fuel. This totals nearly 70 billion.1

But is the cost of congestion too high? Density dictates that we cannot expect to provide unencumbered road space for every person who might like it at 5:00 p.m. on a weekday—any more than one would expect to build a dormitory with a shower for every resident who wants to use one in the morning. Just as an architect might decide how many showers to provide for the dormitory, economists, by knowing how much people value their time and how much it costs to save time by increasing road capacity, can estimate the optimal amount of roadway capacity and the resulting level of congestion.

Virtually all economists agree that congestion in cities around the world is greater than this optimum. They also agree on the reason: driving in the rush hour is priced far below its real social cost. The social cost is the driver’s cost to himself plus the congestion imposed on other drivers. People often drive, therefore, even when the social cost is more than the trip is worth to them because they do not bear the cost of the congestion they cause. Whereas this social cost varies by time of day and location, the individual’s trip price (consisting of operating costs, fuel taxes, and the occasional toll) is more uniform. Even if the price covers the costs of providing road infrastructure, which it probably does not in U.S. cities, it is not serving the purpose of allocating road capacity at peak hours to those who value it most.

These observations lead directly to the frequent recommendation for “congestion pricing”: a system of prices that vary by time and location, designed to reduce congestion by encouraging people to shift their travel to less socially costly means, places, or times of day. Singapore has had congestion pricing since 1975. London adopted an ambitious pricing system in 2003, initially requiring five pounds (about eight U.S. dollars) to drive in its central area during weekdays. Singapore’s tolls are now collected electronically, and London’s through various off-site means, in both cases with enforcement by video recordings of license plates. In its first year, the London scheme appeared to have increased speeds to and in the central area by 15–20 percent and to have eliminated or diverted 67,500 weekday automobile trips there, with half of these shifting to public transit and another quarter diverting to less congested routes.2

A partial form of congestion pricing has recently been adopted in several U.S. locations. Known as “value pricing,” it applies only to a set of “express lanes” that are adjacent to an unpriced roadway. This scheme has the advantage that paying the price is voluntary, but also the disadvantage that congestion is eliminated for only a fraction of travelers and is even greater for the others than would be the case if the express lanes were opened to everyone. Value pricing has been in place on State Route 91 in the Los Angeles region since late 1995 and on Interstate 15 near San Diego since late 1996.3 Proposals have emerged for a nationwide network of such express lanes to replace the present system of intermittent carpool lanes.4

Since examples of congestion pricing are so few, the consequences of underpricing congested highways are far-reaching. People and businesses have rearranged themselves and their activities in time and place to lessen the!---- impacts of congestion, probably leading to more spread-out land-use patterns (although the land-use impact cannot be precisely predicted from theory). Furthermore, public authorities have responded by building more roadway capacity, including very expensive, wide expressways designed to allow high speeds, even though peak-period users cannot maintain those speeds. The result is a more spread-out urban area with bigger roads than would evolve if congestion pricing were in place.

The effectiveness of building capacity to relieve urban congestion is limited not only by its high cost, but also by the phenomenon of “latent demand” or “induced demand.” Because many potential peak-hour trips are already deterred by the congestion itself, any success in reducing that congestion is partially undone by an influx of these previously latent trips from other routes, hours of the day, or travel modes. As a consequence, adding capacity may still provide considerable benefits by allowing more people to travel when and where they want to, but it will not necessarily reduce congestion. The same problem afflicts other anticongestion policies, such as employer carpooling incentives, mass transit improvements, and land-use controls; moreover, these policies usually provide only weak incentives to change travel behavior.

Now consider mass transit, where economies of scale are critical. Researchers who have compared the costs of serving passenger trips in a given travel corridor via various modes consistently find that automobiles are most economical at low passenger densities, bus transit at medium densities, and rail transit at very high densities. (There is some disagreement about exactly where these thresholds occur, but not about their existence.) As passenger density increases, it becomes worthwhile at some point to pay one driver to serve many passengers by carrying them in a single vehicle, and eventually to incur the high capital cost of building a rail line. However, many rail transit systems recently constructed in the United States are uneconomical because the passenger volumes they carry are too low.5 An attractive alternative in such cases is “bus rapid transit,” in which local bus transit is configured to offer rail-like service quality at costs between those typical of bus and rail. Bus rapid transit was pioneered in Brazil and also operates on selected corridors in Ottawa, Los Angeles, Seattle, Boston, and other cities.6

In addition to the transit agency’s costs, scale economies have another dimension—costs incurred by its users. People using mass transit first have to access a station or bus stop and wait for the vehicle to arrive. Even if they know the schedule, they have to adjust their plans to match it, which is a cost to them. The more transit lines there are in a given area and the more frequent the service, the lower is each user’s cost to reach the station and wait for a vehicle to arrive. Empirical evidence reveals that people care even more about avoiding time spent walking or waiting than about time spent inside a vehicle. So these access costs are quite significant, as are the scale economies that result when increased passenger density leads to greater route coverage and/or frequency of service.

Scale economies are behind proposals to use land-use regulation to bolster transit demand by creating areas of high-density residential, commercial, or industrial development. However, many analysts are skeptical about how effective a given measure would be and whether such “transit-oriented developments” can overcome the preferences for low-density living that accompany rising income levels.

Scale economies create a prima facie case for transit subsidies because the social cost of handling a passenger is lowered by the favorable effects on the average cost for everyone. Another argument for transit subsidies is to overcome the inefficiently low price on peak-hour highway travel, if congestion pricing is deemed infeasible. Countering these arguments is the well-documented tendency of transit subsidies to be partly absorbed in higher wages to transit workers, less efficient use of employees, and excessive capital expenditures. This problem could be alleviated by giving the subsidies in the form of fare discounts rather than as grants to transit agencies. If subsidies are justified because of economies of scale in transit, however, then they would be justified for the many other industries with scale economies: it is infeasible and probably unwise to subsidize them all.

Because of scale economies in mass transit, it makes sense to focus service on those few markets with potentially high passenger density, especially suburb-to-downtown commutes and local travel in densely populated low-income areas. Unfortunately, this dictum collides with the political balance typically achieved in metropolitan-wide transit systems, where every participating jurisdiction is eager to receive some service in return for its financial contribution.

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Scale economies might make a case for highway subsidies as well, but it is even less clear-cut. Scale economies exist in construction of a given highway, but somewhat less so in an entire network because the cost of intersections rises more than proportionally to their capacity. Furthermore, because highways occupy a significant fraction of scarce urban land, expanding them drives up land prices and/or requires expensive mitigation measures, offsetting any scale economies in constructing them. On balance, there is probably not a strong case for subsidizing urban highway travel.

Today, government provides most urban transportation services and facilities, but this is not necessary, nor was it historically always the norm. Privately built and financed canals, and later “turnpikes,” were important in the industrialization of Britain in the eighteenth century and of the United States in the nineteenth century. And today, innovative private transit providers supply highly valued jitney service or specialized taxi service—sometimes illegally—in many cities around the globe, especially—but not exclusively—in the Third World. Ubiquitous private taxi fleets also play an important role in urban travel, and deregulating entry would bring down taxi fares substantially.

Private enterprise is making something of a comeback in infrastructure provision. A private company is completing Paris’s A86 ring road via tunnels under Versailles, financed by tolls. A similar proposal may break a thirty-year impasse over completing the final link in the Long Beach Freeway near Los Angeles. London is undertaking a controversial privatization of its subway system. In 2004, Texas solicited proposals for private construction and operation of new toll roads, and in 2005 Chicago privatized operation of its Skyway, an important segment of Interstate 90 bringing traffic into the city from the east.7

Evidence suggests that the private sector can carry out transportation activities more cheaply than the public sector can. Many experiments with the private sector have been motivated by huge subsidy increases or evident inefficiency of public sector operations. During the 1980s, all of Britain’s urban bus services outside London were privatized and the markets opened to free entry, resulting in cost savings but also some competitive problems. In most instances, some sort of regulation is needed to offset the market power that can accompany privatization. Success depends on the specifics of the situation and the details of any accompanying regulatory or franchising arrangements.

Urban transportation has historically had a dramatic influence on land-use patterns. Upon the invention of horse-drawn and then electric streetcars, “streetcar suburbs” quickly arose along newly laid tracks. Following World War II, widespread construction of express highways had a similar but even stronger effect, especially in the United States, causing development to spread more ubiquitously because automobiles relaxed the need for proximity to a transit line. These developments provided many desired amenities to residents, but also created problems. Whatever one’s judgment about the wisdom of those past decisions, the longevity of buildings makes such trends virtually impossible to reverse. In particular, a dispersed land-use pattern undermines the market potential of mass transit, making it ineffective as a means to counter the automobile’s dominance, even if promoting mass transit might have been a better policy in the first place.

Urban transportation is a vital part of economic activity and responds to well-designed economic policies. Much can be accomplished to improve urban life by using our basic knowledge of economic incentives.

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About the Author

Kenneth A. Small, research professor and professor emeritus of economics at the University of California at Irvine, specializes in urban, transportation, and environmental economics—especially highway congestion, air pollution from motor vehicles, and travel demand. Professor Small was a coeditor of the international journal Urban Studies for five years and is now associate editor of Transportation Research B. He received the Distinguished Member Award of the Transportation and Public Utilities Group of the American Economic Association in 1999 and is a Fellow of the Regional Science Association International.

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Further Reading

Introductory

Altshuler, Alan, and David Luberoff. Mega-Projects: The Changing Politics of Urban Public Investment. Washington, D.C.: Brookings Institution Press, 2003. Insightful description and analysis of the political changes behind the extraordinary increase in costs of the large U.S. urban infrastructure projects that started around 1970.

Arnott, Richard, and Kenneth Small. “The Economics of Traffic Congestion.” American Scientist 82 (1994): 446–455. Explanation of traffic paradoxes including induced demand, for a scientifically but not economically literate audience.

Downs, Anthony. Still Stuck in Traffic: Coping with Peak-Hour Traffic Congestion. Washington D.C.: Brookings Institution, 2004. A comprehensive look at numerous anticongestion!---- policies and their effectiveness, concluding largely that the only ones that are effective are politically infeasible.

Klein, Daniel B., Adrian T. Moore, and Binyam Reja. Curb Rights: A Foundation for Free Enterprise in Urban Transit. Washington, D.C.: Brookings Institution Press, 1997. Policy-oriented analysis of how the public sector can establish property rights to encourage successful private transit.

Meyer, John R., and José A. Gómez-Ibáñez. Autos, Transit, and Cities. Cambridge: Harvard University Press, 1981. A thorough analysis of urban transportation policy for an educated lay audience.

National Research Council. Curbing Gridlock: Peak-Period Fees to Relieve Traffic Congestion. Washington D.C.: National Academy Press, 1994. Full report by a study panel on congestion pricing. Volume 1 is the report, aimed at a general audience; volume 2 is a collection of commissioned papers.

Pickrell, Don H. “Rising Deficits and the Uses of Transit Subsidies in the United States.” Journal of Transport Economics and Policy 19 (1985): 281–298. Decomposes the dramatic increase in U.S. transit deficits into its sources, finding that about three-fourths of new subsidies were absorbed in higher costs.

White, Peter. “Deregulation of Local Bus Service in Great Britain: An Introductory Review.” Transport Reviews 15 (1995): 185–209. Reviews results of British bus deregulation of 1980s.

Winston, Clifford. “Government Failure in Urban Transportaion.” Fiscal Studies 21 (2000): 403–425. A nontechnical summary of inefficiencies in U.S. urban transportation policy drawing on the UK privatization experiment for perspective.

Advanced

Gómez-Ibáñez, José A., William B. Tye, and Clifford Winston, eds. Essays in Transportation Economics and Policy: A Handbook in Honor of John R. Meyer. Washington, D.C.: Brookings Institution Press, 1999. Collection of essays, some technical, on analytical and issue-oriented topics. Can serve as introductory textbook.

Santos, Georgina, ed. Road Pricing: Theory and Evidence. Elsevier: Oxford, 2004. Collection of scholarly articles about congestion pricing and related topics.

Small, Kenneth A. Urban Transportation Economics. Reading, Pa.: Harwood Academic, 1992, 2d ed. 2005. Advanced textbook and reference book.

Small, Kenneth A., and José A. Gómez-Ibáñez. “Urban Transportation.” In Paul Cheshire and Edwin S. Mills, eds., Handbook of Regional and Urban Economics. Vol. 3. New York: North-Holland, 1999. Survey of selected topics, aimed at professional economists.

Winston, Clifford, and Chad Shirley. Alternate Route: Toward Efficient Urban Transportation. Washington, D.C.: Brookings Institution Press, 1998. Analysis of mass transit policy in the United States, with emphasis on quantifying the inefficiencies of transit and highway investment and pricing.

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Footnotes

See David Schrank and Tim Lomax, 2003 Urban Mobility Report, available online at: http://mobility.tamu.edu/ums/.

See the Singapore Land Transport Authority Web site on electronic road pricing at: http://www.lta.gov.sg/motoring_matters/index_motoring_erp; and the Transport for London Web site on congestion charging at: http://www.tfl.gov.uk/tfl/cclondon/cc_intro. For other examples around the world, see the University of Minnesota’s Value Pricing Homepage at: http://www.hhh.umn.edu/centers/slp/projects/conpric/.

See the operators’ Web sites at http://www.91expresslanes.com/ and http://sandag.cog.ca.us/index.asp?classrd29fuseactionhome.classhome.

Robert W. Poole Jr. and C. Kenneth Orski, “HOT Networks: A New Plan for Congestion Relief and Better Transit,” Reason Public Policy Institute, Policy Study 305, February 2003, available online at: http://www.rppi.org/ps305.pdf.

See “The Public Purpose” Web site (http://www.publicpurpose.com/) for unabashedly critical and informative evaluations of many rail projects and other topics.

See the Bus Rapid Transit Policy Center Web site at: http://www.gobrt.org/; also Aaron Golub, “Brazil’s Buses: Simply Successful,” Access (University of California Transportation Center, Berkeley) 24 (2004), available online at: http://www.uctc.net/access/access.asp.

On privatization initiatives, see the periodicals Public Works Financing, and the Reason Foundation’s Privatization Watch (http://www.reason.org/pw.shtml), especially “Urban Toll Tunnels Solve Tough Problems” by Robert W. Poole Jr. (http://www.rppi.org/urbantolltunnels.html).

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Welfare

The U.S. welfare system would be an unlikely model for anyone designing a welfare system from scratch. The dozens of programs that make up the “system” have different (sometimes competing) goals, inconsistent rules, and over-lapping groups of beneficiaries. Responsibility for administering the various programs is spread throughout the executive branch of the federal government and across many committees of the U.S. Congress. Responsibilities are also shared with state, county, and city governments, which actually deliver the services and contribute to funding.

The six programs most commonly associated with the “social safety net” include: (1) Temporary Assistance for Needy Families (TANF), (2) the Food Stamp Program (FSP), (3) Supplemental Security Income (SSI), (4) Medicaid, (5) housing assistance, and (6) the Earned Income Tax Credit (EITC). The federal government is the primary funder of all six, although TANF and Medicaid each require a 25–50 percent state funding match. The first five programs are administered locally (by the states, counties, or local federal agencies), whereas EITC operates as part of the regular federal tax system. Outside the six major programs are many smaller government-assistance programs (e.g., Special Supplemental Food Program for Women, Infants and Children [WIC]; general assistance [GA]; school-based food programs; and Low-Income Home Energy Assistance Program [LIHEAP]), which have extensive numbers of participants but pay quite modest benefits.

Welfare reform, brought about through the passage of the Personal Responsibility and Work Opportunity Reconciliation Act (PRWORA) of 1996, significantly altered the rules for delivering income support, but it was narrowly focused on one program. The 1996 law replaced Aid to Families with Dependent Children (AFDC) with TANF. SSI and food stamps were also affected, but to a much lesser extent.

Key Programs

The accompanying figures summarize trends in the coverage and expenses of the six major federal safety-net programs over the past three decades. Figure 1 shows the percentage of the American population receiving benefits from each program, and Figure 2 presents the share of federal expenditures spent on each program. The bars in Figure 1 also plot the percentage of Americans classified as being in poverty. In addition to highlighting the evolution of these U.S. welfare programs, the following discussion briefly describes the forms of benefits paid out by programs, along with eligibility criteria.

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Figure 1  Percentage of Population Receiving Program Benefits

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Temporary Assistance for Needy Families pays cash assistance to single-parent or unemployed two-parent families for a limited term. The program also significantly funds job training and child care as a means to discourage welfare dependency and encourage work.

The origins of TANF are in the Social Security Act of 1935, which established the Aid to Dependent Children (ADP) program. ADP enabled state governments to help single mothers who were widowed or abandoned by their husbands. It was originally designed to allow mothers to stay at home and take care of their children, providing cash benefits for the basic requirements of food, shelter, and clothing. The program was expanded in the 1950s and 1960s to provide cash assistance to needy children and families regardless of the reason for parental absence. This expansion coincided with renaming the program Aid to Families with Dependent Children. While AFDC was principally a federal program managed by the Department of Health and Human Services, it was administered through state-run welfare offices. Indeed, states were responsible for organizing the program, determining benefits, establishing income and resource limits, and setting actual benefit payments. With relatively little flexibility, an AFDC program in New York City looked a lot like its counterpart in Reno, Nevada, apart from differences in the maximum amount each state paid to a family for assistance. Funding for AFDC was shared between the federal and state governments, with the feds covering a higher portion of AFDC benefit costs in states with lower-than-average per capita income. As with many other welfare programs, AFDC’s costs were not capped because the program was an “entitlement”—meaning that qualified families could not be refused cash assistance.

By the early 1990s, many policymakers were seeking alternatives to AFDC. Although the average monthly benefit in 1995 was only 376.70 per family and 132.64 per recipient, 40 percent of applicants remained on welfare for two years or longer. In response to this dependency, in 1996, Congress passed and President Bill Clinton signed the Personal Responsibility and Work Opportunity Reconciliation Act, which replaced AFDC with TANF. Under the new program, the federal government eliminated the entitlement to cash welfare, placed limits on the length of time families could collect benefits, and introduced work requirements. By law, a family cannot receive TANF benefits for more than a lifetime limit of five years, cumulative across welfare spells. Regarding work requirements, TANF mandated that at least 50 percent of recipients participate in “work” activities by 2002, with activities including employment, on-the-job training, vocational education, job search, and community service. Together, these activities must account for thirty hours per week for a single parent. Recipients who refuse to participate in work activities must be sanctioned, resulting in a loss of cash benefits. Enforcement of sanctions could include immediately suspending all cash payments, stopping support only after multiple episodes of noncompliance, or only partially reducing grants to families who fail to cooperate. States could, and in fact did, introduce more stringent requirements for families to work or participate in educational activities to qualify for cash payments. TANF cemented the primary emphasis on getting welfare recipients into jobs.

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Figure 2  Program Spending as a Percentage of Federal Outlays

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Figures 1 and 2 reveal that growth in neither costs nor enrollments motivated the passage of welfare reform in 1996. Program expenditures have accounted for less than 3 percent of the federal budget since 1975. The caseload remained relatively stable until the mid-1990s. After welfare reform, however, the welfare caseload and welfare spending as a percentage of government spending dropped sharply.

The Food Stamp Program, authorized as a permanent program in 1964, provides benefits to low-income households to buy nutritional, low-cost food. After 1974, Congress required all states to offer the program. Recipients use coupons and electronic benefits transfer (EBT) cards to purchase food at authorized retail stores. There are limitations on what items can be purchased with food stamps (e.g., they cannot be used to purchase cigarettes or alcohol). Recipients pay no tax on items purchased with food stamps. The federal government is entirely responsible for the rules and the complete funding of FSP benefits under the auspices of the Department of Agriculture’s Food and Nutrition Service (FNS). State governments, through local welfare offices, have primary responsibility for administering the Food Stamp Program. They determine eligibility, calculate benefits, and issue food stamp allotments.

Welfare reform imposed work requirements on recipients and allowed states to streamline administrative procedures for determining eligibility and benefits. Childless recipients between the ages of eighteen and fifty became ineligible for food stamps if they received benefits for more than three months while not working. According to Figure 1, the FSP caseload has included between 6 and 10 percent of the U.S. population, following a cyclical pattern before welfare reform: during recessions, the caseload percentage was higher. Welfare reform caused a decline in the FSP caseload percentage.

Supplemental Security Income, authorized by the Social Security Act in 1974, pays monthly cash benefits to needy individuals whose ability to work is restricted by blindness or disability. Families can also receive payments to support disabled children. Survivor’s benefits for children are authorized under Title II of the Social Security Act, not Title XVI, and are, therefore, not part of the SSI program. Although one cannot receive SSI payments and TANF payments concurrently, one can receive SSI and Social Security simultaneously. (In 2003, 35 percent of all SSI recipients also received Social Security benefits, and 57 percent of aged SSI recipients were Social Security beneficiaries.) The average SSI recipient received almost 5,000 in annual payments in 2003, with the average monthly federal payment being 417, and many state governments supplemented the basic SSI benefits with their own funds.

Welfare reforms and related immigration legislation in 1996–1997 sought to address three areas of perceived abuse in the SSI program. First, the legislation set up procedures to help ensure that SSI payments are not made to prison inmates. Second, the legislation eliminated benefits to less-disabled children, particularly children with behavioral problems rather than physical disorders. Finally, new immigrants were deemed ineligible for benefits prior to becoming citizens.

Medicaid became law in 1965, under the Social Security Act, to assist state governments in providing medical care to eligible needy persons. Medicaid provides health-care services to more than 49.7 million low-income individuals who are in one or more of the following categories: aged, blind, disabled, members of families with dependent children, or certain other children and pregnant women. Medicaid is the largest government program providing medical and health-related services to the nation’s poorest people and the largest single funding source for nursing homes and institutions for mentally retarded people.

Within federal guidelines, each state government is responsible for designing and administering its own program. Individual states determine persons covered, types and scope of benefits offered, and amounts of payments for services. Federal law requires that a single state agency be responsible for the administration of the Medicaid program; generally it is the state welfare or health agency. The federal government shares costs with states by means of an annually adjusted variable matching formula.

The Medicaid program has more participants than any other major welfare program. More than 17 percent of the population received Medicaid benefits in 2002, up from about 10 percent in the 1970s and 1980s. Spending on Medicaid has risen steadily as a fraction of the federal budget, increasing from approximately 2 percent in 1975 to 13 percent in 2002. Total outlays for the Medicaid program in 2002 (federal and state) were 259 billion, and per capita expenditures on Medicaid beneficiaries averaged 4,291.

Housing assistance covers a broad range of efforts by federal and state governments to improve housing quality and to reduce housing costs for lower-income households. The Department of Housing and Urban Development (HUD) and the Federal Housing Administration (FHA) administer most federal housing programs. Under current programs, each resident pays approximately 30 percent of his or her income for rent.

In terms of welfare policy, there are two principal types of housing assistance for low-income families: subsidized rent and public housing. The federal government has provided rental subsidies since the mid-1930s and today funds the HUD Section 8 voucher program. Local governments commonly provide for subsidized housing through their building authority in that they require a portion of new construction to be made available to low-income families at below-market rents. Public housing (the actual provision of dwellings) is almost exclusively a federal program administered by local public housing agencies (PHAs), not private owner-managers. In contrast to the mid-1960s, public housing now accounts for a small fraction of overall housing assistance.

Earned Income Tax Credit, enacted in 1975, pays a refundable tax credit for working Americans with low earnings. The tax credit increases family income by supplementing earnings up to a fixed level. The program was initially designed to offset the impact of Social Security taxes on low-income individuals and to encourage individuals to seek employment rather than rely on welfare benefits. Because EITC is part of the regular federal income tax system, receiving benefits is private, unremarkable, and without stigma. In 2004, the EITC paid out 33.1 billion to approximately 18.6 million claimants—several billion dollars more than the amounts projected to be spent on other primary programs such as TANF and food stamps. EITC is one of the few programs that effectively reach the eligible population. Analysis of EITC claims in 1999 shows that 86 percent of eligible families with children received the credit. (In contrast, only 66 percent of eligible households with children received food stamp benefits in 1999.) Although the EITC is generally paid all at once as an annual refund, it can also be included with an employee’s weekly, biweekly, or monthly paycheck.

caption div style"background-color: #ffffff;" hr pspan class"title"br bTable 1/b Benefits, Taxes, and Disposable Income for a Family of Four/span/p /div /caption

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Program Payments Tax Costs Disposable Income Earnings() TANF Food Stamps SSI Sec. 8Housing Federal EITC Health Care Federal Payroll Taxes Federal Income Tax Taxes, EITC Taxes, EITC, TANF, FSP Taxes, EITC, TANF, FSP,Sec. 8 0 8,148 5,988 9,660 10,800 0 MNP 0 0 0 12,663 20,611 4,000 7,498 5,510 8,170 9,400 1,600 MNP 306 0 5,294 16,503 23,279 8,000 5,498 4,550 6,170 8,000 3,200 MNP 612 0 10,588 19,317 25,393 12,000 3,498 3,590 4,170 6,600 4,300 MNP 918 0 15,382 21,631 27,007 16,000 0 2,630 2,170 5,200 4,101 Child 6–19 1,224 0 18,877 21,507 26,707 20,000 0 1,670 170 3,800 3,261 Child 1–6 1,530 0 21,731 23,401 27,201 24,000 0 710 0 2,400 2,421 Child 1–6 1,836 190 24,395 25,105 27,505

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Level of Benefits and Impacts on Work Incentives

How much do the above safety-net programs pay in benefits? Table 1 presents the benefit levels provided to a qualifying family whose annual earnings equal the amounts listed in the first column of the table. Calculations in this table assume that the family includes a father, a mother, and two children below the age of eighteen, and that this family lives in California.1 According to the row in the table for a family that earns 8,000 a year, this family would be eligible to receive 5,498 from TANF, 4,550 from food stamps, 6,170 from SSI, 8,000 in housing benefits from the Section 8 program, and 3,200 from EITC, for a total of 27,418 in government assistance. Moreover, this family would qualify for Medicaid’s Medically Needy Program (MNP), wherein all family members would receive zero-price health care. On reaching 16,000 in earnings, the family would qualify for Medicaid’s Children Ages 6 to 19 Program (Child 6–19), which provides zero-price health care to all children in the family; and at 20,000 in earnings, the family would qualify for Medicaid’s Children Ages 1 to 6 Program (Child 1–6), which offers zero-price health care to all children ages six and below.

To determine the disposable income available to a family, one needs to add the family’s earnings and the payments it receives in program benefits and then subtract the amounts paid in taxes. Any family faces three categories of taxes: Social Security payroll taxes, federal income tax, and state income tax. The eighth and ninth columns of the table show the amounts a family of four must pay in payroll and federal income taxes for the various levels of earnings—the negative values in these columns indicate payments that subtract from income rather than add to income. The table does not include a column for state taxes because none are paid for any of the income values considered in the table. The last three columns of the table report a family’s disposable income for each level of earnings, assuming participation in the programs listed in the associated column. The family that earns 8,000 receives 10,588 in disposable income for the year when it chooses not to participate in any welfare program and obtains benefits only from EITC. This family’s disposable income grows to 19,317 if it decides to take TANF and food stamps and to 25,393 if it also chooses to obtain assistance for rent.2

Note, by looking at the “Taxes, EITC, TANF, FSP” column, that a family participating in these programs increases its disposable income by 5,294 when it raises its earnings from zero to 4,000. That means that, in this range of earnings, work is rewarded; the family actually increases its disposable income by more than 4,000. But if a family raises its earnings from 12,000 to 16,000, its government benefits fall so much that its disposable income literally declines by 124. This happens because program benefits fall as earnings rise. Families facing these latter circumstances (earning 12,000) clearly have no incentive to increase their work effort since they will see no enhancement of their spending power. If one alters the family’s situation and also has it participate in housing programs, then the last column shows that raising earning from 12,000 to 24,000 yields merely 498 more in disposable income. Such features of our welfare system sharply reduce the returns of work, and in doing so discourage families from increasing their work activities. The U.S. welfare system enhances work incentives at low levels of earnings, but discourages work thereafter. To counterbalance such work disincentives, welfare reform in the mid-1990s introduced work requirements that required families to work above specific thresholds in order to qualify for benefits.

Future Directions

Welfare reform was enacted to promote self-sufficiency and to improve flexibility in the design of income-maintenance programs. To a large extent, these goals have been achieved. TANF has brought about substantial increases in the work activities of low-income families and enhanced states’ flexibility to create welfare systems unique to their constituencies. States are using the monies they are allocated in a more efficient manner—focusing on job readiness, child care, education, and work placement.

What other policy trends characterize the evolution of welfare system in the United State today? Briefly, two key forces are changing the basic relationship between the government and welfare recipients in all programs.

First, welfare programs at all levels are being geared toward more work-related activities. Nearly every program gives priority to parents who show a willingness and commitment to work. At the same time, able-bodied adults who refuse to work now find themselves disqualified from many programs. The emphasis on work has gained strength only since 1996. Proposals for the reauthorization of welfare reform all generally push for stricter work requirements and a longer work week.

Second, there has been a movement from pure in-kind provision to voucher-based systems. In-kind provision represents government efforts to both fund and directly serve the poor. Voucher systems are being emphasized not only for shelter but also for provision of food, health care, job training, and child care, among others. A cash-equivalent voucher is provided directly to the person served, who then redeems the voucher at any qualified/authorized service provider. This approach brings some of the advantages of market-based economics to the provision of welfare. The recipient spends dollars on the things he or she wants most. A classic example is public housing. HUD provides the funding for most public housing, and local government housing authorities use it to buy or build publicly owned residential units. This inefficient use of funds segregates low-income families into common facilities that typically duplicate housing resources that are widely available in the private market. Over the past decade, HUD and other government providers have been opting to fund more voucher-based, Section 8-type housing to meet the needs of the poor, thus allowing recipients greater choice in where they live.

Although welfare reform has achieved success in a short amount of time, more reform is needed. Of the many government assistance programs, only one, TANF, has seen any significant reform. The remaining programs (food stamps, SSI, housing assistance, Medicaid, and EITC) are about as inflexible as ever and generally ignore what is going on in the rest of the system. Future policy initiatives are likely to alter these programs toward the direction set for TANF in the 1990s welfare reform, with the two above trends continuing to influence new reforms.

Does Welfare Help the Poor?

David Henderson

Economists believe that people tend to make decisions that benefit themselves, so the answer to the above question seems obvious. If welfare did not help the poor, then why would so many of them go on welfare? This self-interest among the poor could also explain a phenomenon noted by those who study welfare, namely that only about one-half to two-thirds of those who qualify for welfare programs are enrolled in them. Presumably, the others have decided that it is in their self-interest to refuse the money and keep the government from meddling in their lives.

So, while it seems clear that welfare helps the poor who accept welfare, that does not mean that welfare helps the poor generally. Two groups of poor people, not counted in the welfare statistics, are hurt by welfare. The first group consists of the future poor. Economists know that welfare is a disincentive to work, and, therefore, that its existence reduces an economy’s output. If even some of this output would have been used for research and development, and if this forgone R&D would have increased growth, then welfare hurts growth by reducing R&D. If the annual growth rate of GDP in the United States had been just one percentage point lower between 1885 and 2005, then the United States today would be no richer than Mexico. The main thing that helps all poor people in the long run is economic growth. Even though the 1920s are thought of as a decade of prosperity, by today’s standards almost all Americans in the 1920s were poor. Economic growth made almost all Americans richer than their counterparts of the 1920s. A reduction in economic growth, even a slight one, if compounded, causes more future poverty than would otherwise have been the case.

The second group hurt by U.S. welfare is poor foreigners. The welfare state acts as a magnet for poor immigrants to the United States. Because of this, there are various domestic pressures to limit immigration. Without the welfare state, the number of immigrants would likely rise substantially, meaning that many previously poor foreigners would become much richer. The welfare state limits this improvement.

Based on Tyler Cowen, “Does the Welfare State Help the Poor?” Social Philosophy and Policy 19, no.1 (2002) pp. 36–54.

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About the Authors

Thomas MaCurdy is the Dean Witter Senior Fellow at the Hoover Institution and a professor of economics at Stanford University. He is a member of standing committees that advise the Congressional Budget Office, the U.S. Bureau of Labor Statistics, and the U.S. Census. Jeffrey M. Jones is a research fellow at the Hoover Institution. He was previously executive director of Promised Land Employment Service.

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Further Reading

 

DeParle, Jason. American Dream: Three Women, Ten Kids, and a Nation’s Drive to End Welfare. New York: Viking Books, 2004.

Jones, Jeffrey, and Thomas MaCurdy. “How Not to Mess Up a Good Thing.” Hoover Digest, no. 2. Stanford, Calif.: Hoover Institution Press, 2003. Pp. 99–108. Online at: http://www.hooverdigest.org/032/jones.html.

MaCurdy, Thomas, and Frank McIntyre. Helping Working-Poor Families: Advantages of Wage-Based Tax Credits over the EITC and Minimum Wages. Washington, D.C.: Employment Policies Institute, 2004. Online at: http://www.epionline.org/studies/macurdy_04-2004.pdf.

Malanga, Steven. “The Myth of the Working Poor.” City Journal (Autumn 2004). New York: Manhattan Institute, 2004. Online at: http://www.city-journal.org/html/14_4_working_poor.html.

Murray, Charles. Losing Ground: American Social Policy 1950–1980. New York: Basic Books, 1984.

O’Neill, June, and M. Anne Hill. “Gaining Ground, Moving Up: The Change in the Economic Status of Single Mothers Under Welfare Reform.” Civic Report, no. 35 (March 2003). New York: Manhattan Institute, 2003. Online at: http://www.manhattan-institute.org/html/cr_35.htm.

Rector, Robert, and Patrick F. Fagan. “The Continuing Good News About Welfare Reform.” Backgrounder no. 1620. Washington, D.C.: Heritage Foundation, 2003. Online at: http://www.heritage.org/Research/Welfare/BG1620.cfm.

Tanner, Michael. The Poverty of Welfare: Fighting Poverty in Civil Society. Washington, D.C.: Cato Institute, 2003.

2004 Green Book. Washington, D.C.: Committee on Ways and Means, U.S. House of Representatives, 2004. Online at: http://waysandmeans.house.gov/Documents.asp?section813.

 

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Footnotes

To qualify for low-income assistance, the family must have less than two thousand dollars in financial and housing assets. For the calculation of housing benefits, Table 1 assumes that the family pays nine hundred dollars in rent per month. In some circumstances, eligible benefit levels may be affected by dual-enrollment restrictions (e.g., cannot receive TANF and SSI concurrently).

 

In the calculation of food stamps and housing benefits, payments from TANF count as income: this lowers payments below the amounts listed in the table for the program. The program benefits listed in the first set of columns assume that the family participates only in that particular program.

 

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Contemporary Society’s Crumbling Pillar

• Once we understand that community matters, then it becomes clear why it is not enough for a country to experience strong economic growth… How that growth is distributed across communities in the country matters immensely.

• What then is the source of today’s problems? In one word, imbalance! When the three pillars of society are appropriately balanced, society has the best chance of providing for the well-being of its people.

• —Raghuram Rajan, The Third Pillar, page xvii.1

In his recent book, economist Raghuram Rajan argues that a well-balanced society rests on three pillars. One pillar is competitive markets. Another pillar is an effective but limited state (by which he means central government). A third pillar is vibrant local communities. The thesis of The Third Pillar is that contemporary society suffers a weakness in the third pillar of community.

Who Was Adam Smith?

Born in Scotland in 1723, where he lived most of his life and where he also died in 1790, Adam Smith is a mythical figure who fathered the modern discipline of economics, embraced unbridled self-interest, and fought against the government to promote capitalism and the interest of business and the rich.

Jesse Norman’s goal in his recent biography, Adam Smith: Father of Economics,1 is to show that the mythical Adam Smith is, well… a myth. His tools are the availability of an immense body of scholarship and an awareness of current events.

But how it is possible? Adam Smith did coin the idea of “invisible hand” and claimed that we don’t get our dinner from the benevolence of the butcher, baker, and brewer, but from their self-interest.

Hayek, Mises, and the Methodology of the Social Sciences

The Fortunes of Liberalism1 collects a wide-ranging number of Friedrich. A. Hayek’s articles, reviews, addresses, and even obituaries—35 in total—spanning all seven decades of his scholarly career from the 1920s to the 1980s. To call this collection eclectic is an understatement, but the unifying theme is Hayek’s perspective on thinkers who have some connection to Austrian economics, to Hayek’s reconstruction of liberalism, or to both. As such, it includes pieces engaging with the lives and work of thinkers like Carl Menger, Friedrich von Wieser, Ludwig von Mises, Wilhelm Röpke, Joseph Schumpeter, Ludwig Wittgenstein, Bruno Leoni, Leonard Read, and Lord Acton. It also contains several documents that explain Hayek’s thought processes leading up to and including the foundation of the Mont Pelerin Society.

The editors of this volume of Hayek’s collected works, operating under the unfortunate circumstance of founding Editor William Bartley’s death, organized it into two main parts: one on Austrian economics and one on the titular fortunes of liberalism. Within each part, Hayek’s thoughts are divided into chapters by thinker or theme rather than including a separate chapter for each original piece. So, for instance, the chapter on Carl Menger includes both a biography of Menger and an essay on Menger’s Principles of Economics. Sometimes pieces are folded into chapters as “addenda” that are thematically related. Each section begins with a “prologue,” a particular essay that is meant to set the tone for that part. And the chapter on Wittgenstein is presented as a “Coda” to Part I. While it makes perfect sense that the editors sought to provide some thematic structure to the book, this organization is ultimately bewildering.

Fortunately, the volume includes an appendix that lists the contents by date, making clear what elements constitute each chapter and when they were written. This is how I would recommend interested readers approach the text. Interested readers could either simply read the entries most relevant to their own interests or proceed chronologically. I took the latter approach, and found the contents a fascinating window into Hayek’s intellectual evolution.

For more on these topics, see the EconTalk podcast episodes Angus Burgin on Hayek, Friedman, and the Great Persuasian and Bruce Caldwell on Hayek.

It is certainly possible to read these essays in order to learn about their respective subjects. Hayek was himself interested in the history of ideas, and paints fascinating pictures of the state of the economics profession in the 1920’s, Carl Menger’s life and work, and the intellectual climate of interwar Vienna. But it is difficult to separate Hayek’s reconstructions of others’ ideas from his own thoughts. The essays here say as much or more about Hayek as they do about their subjects. Since the collected pieces span the entirety of Hayek’s career, Fortunes serves as a valuable companion piece to intellectual biographies and overviews of Hayek’s thought such as Hayek’s Challenge by Bruce Caldwell or Peter Boettke’s recent F.A. Hayek: Economics, Political Economy, and Social Philosophy.

“How can economists and other social scientists generate knowledge about economic and other social phenomena?”

Fortunes touches on an incredible breadth of topics, and it is impossible to comment on all of them. Here I focus on one theme in particular that recurs throughout this collection: Hayek’s views on the methodology of the social sciences. How can economists and other social scientists generate knowledge about economic and other social phenomena?

The primary figure Hayek engages with in this particular volume is Ludwig von Mises. While he engages with many other thinkers throughout the text, his agreements and disagreements with Mises are spelled out in far more detail. When it comes to other thinkers, Hayek frequently glosses over disagreements—”in a short review… it would not be appropriate to say more about any minor faults” (on Schumpeter, page 162)—or treats them in a sort of totemic fashion, dubbing thinkers like Lord Acton and Alexis de Tocqueville “patron saint[s]” (page 247) of the movement he wishes to build. This is even true of Hayek’s own teacher, Friedrich Wieser. While Hayek’s obituary of Wieser is packed to the brim with admiration, he is (appropriately) coy about points of agreement or disagreement with his former mentor. He engages Mises on a much more substantive level.

The relationship between Mises and Hayek has been hotly debated among economists interested in their ideas. Editor Peter Klein’s introduction surveys some of these debates (pages 9-13). Hayek himself penned “Economics and Knowledge” partly as a critique of what he understood as Mises’s extreme belief that economics was strictly a priori and deductive rather than empirical. In “Economics and Knowledge” Hayek qualifies this view by claiming that part of economics—that part dealing with how knowledge is generated and transmitted by the economic systems—is necessarily empirical. But as Hayek notes, after reading this article, Mises never expressed any disagreement with it (pages 55-56). How did Hayek’s views evolve after 1937?

Hayek’s 1941 review of Nationalökonomiei, the German language predecessor to Human Action, coincides with a crossroads in Hayek’s thought, around the time that he began work on his “Abuse of Reason” project (c.f. Caldwell 2004, Ch. 11). His views on this book are mixed. He expresses dismay that, while Mises’s thought has evolved over the decades, it does not engage seriously enough with contemporary economic theory (page 150). He praises the book on two specific grounds. First, he claims that the central part of the text is not Mises’s ruminations on methodology, but his analysis of an exchange society in terms of what is later called comparative advantage. Second, he admires Mises’s foray outside of economics proper into broader social philosophy (page 151). This would become a theme in all of Hayek’s work from the 1940’s onward. Because Nationalökonomiei is “more like [the work] of an eighteenth-century philosopher than that of a modern specialist… one feels throughout much nearer to reality” (page 152). In line with his own thinking at the time, he sees engagement with law, politics, and philosophy as a virtue rather than a vice. Hayek sums up his feelings thus:

• Although the reviewer would put many things differently, he must confess, at the risk of being condemned with Professor Mises as holding views conflicting with the whole trend of modern scientific development, that on the main point Professor Mises’s lone voice seems to him considerably nearer the truth than the commonly accepted views. (page 152)

A 1956 tribute to Mises that Hayek delivered at the Foundation for Economic Education reiterates this appreciation for a broader approach to economics, in line with older thinkers like Adam Smith and Montesquieu (page 133). In a tribute to Wilhelm Röpke published a few years later, Hayek makes his esteem for ‘political economy’ of this sort even more explicit:

• One is often more realistic and in closer touch with reality in the social sciences when one does not limit oneself to those facts that are measurable and quantifiable. There is also an intermediate realm between ‘pure’ theory and questions of practical politics where systematic treatment is at least as useful as in pure theory. (page 197)

In March 1964, Hayek reviews an English translation of Mises’s Epistemological Problems of Economics. He defends the contemporary relevance of the book, claiming that “the sort of uncritical empiricism against which this book is mainly directed is today probably found more frequently and in a more naïve form among American social scientists than anywhere else” (page 147). Hayek then goes on to claim that Mises’s view only gives the appearance of being extreme, and that, “on examination, the difference between the views which Professor Mises has long held and the modern ‘hypothetico-deductive’ interpretation of theoretical science (e.g., as stated by Karl Popper in 1935) is comparatively small” (page 148). This claim will surprise those who are familiar with the common reading of Mises as an ‘extreme’ apriorist. But Hayek shares this reading of Mises with Fritz Machlup (1955), a reading that has recently been articulated and defended by Gabriel Zanotti and Nicolas Cachanosky (2015). Hayek in fact sees this view as common to Austrian economics generally, arguing that Menger’s approach to understanding social institutions also has empirical, falsifiable content rather than being merely theoretical (pages 102-103).

Hayek also mentions approvingly Mises’s argument that social science can also lean on our understanding (German Verstehen) of human intentionality (page 148). We understand human values and goals because we ourselves are human. This point is quite similar to Hayek’s own argument that the “facts of the social sciences” consist partly in what people think and believe. A dollar bill, for example, counts as money because we believe that it does.

For background information, see Austrian School of Economics, by Peter J. Boettke, in the Concise Encyclopedia of Economics.

But Hayek’s thoughts on the role of qualitative understanding, as opposed to a more mathematical approach to human behavior, are muddied by two later entries in Fortunes. In his 1978 chapter on the historical significance of Menger’s Principles of Economics, Hayek expresses sympathy for Menger’s reliance on Verstehen, but wonders whether later mathematical techniques—particularly indifference curve analysis—render this approach unnecessary for economic theory (pages 102-103). In an unfinished essay for the New Palgrave dictionary of economics from the early 1980s, Hayek states that indifference curve analysis as developed by John R. Hicks in the 1930s “may well be regarded as the ultimate statement of more than half a century’s discussion in the tradition of the Austrian school.” (page 54)

I raise these complications not because I think they are particularly important, but as a note of caution. It is tempting to read either too much coherence or too much incoherence into Hayek’s thought, especially when pulling from articles, book reviews, obituaries, and fragments that span seven decades. It is not always clear when Hayek is expressing ecumenical professional judgments independent of his agreement or disagreement, when he is understating his own views, or when he is simply being kind to those he discusses. It is especially unwise to develop a strong impression of Hayek’s views from only considering this volume. So the interpretation I offer here should be taken as leaning on a limited and inconsistent set of observations.

In 1978, Hayek pens the foreword to the Liberty Fund edition of what is his favorite book by Mises, Socialism. He credits this book with a fundamental change in his views. With the benefit of hindsight, Hayek recognizes that Mises’s theory of the market process differed substantially from that of other economists (pages 140-141). This meant that his argument that a socialist planner could not engage in economic calculation fell at least partly on deaf ears. The pushback against Mises in the broader economics profession is, I suspect, what ultimately led both Mises and Hayek to write so much on economic methodology in the ensuing decades. They did not understand why everyone else did not see the point as clearly as they did.

This foreword also includes the most direct critique of Mises in Fortunes. Hayek takes issue with Mises’s claim that liberalism comes from a rational recognition of the benefits of social cooperation (page 142). Rather, says Hayek, human beings stumbled into a liberal, market order largely by accident. We may have come to prefer living in this sort of society ex post, but we did not rationally design it. This claim of course echoes Hayek’s famous view that important social institutions often evolve spontaneously rather than intentionally, one that he associates in this volume primarily with Menger (page 103) and Smith (page 56). Hayek goes on to claim that Mises later “largely emancipated himself from that rationalist-constructivist starting point” (page 142), but does not cite any work in particular. Perhaps he has in mind Human Action, since it post-dates socialism. Without speculating on particular passages Hayek might be thinking of, this book has a number of statements such as “the evolution of reason, language, and cooperation is the outcome of the same process; they were inseparably and necessarily linked together” (1949, page 43). This view is similar to Hayek’s argument in Law, Legislation, and Liberty that reason is a product of social evolution (1973, Ch. 1).

The difference between Mises and Hayek is often portrayed as the difference between an arch-rationalist and a skeptical empiricist. The essays in Fortunes, while not speaking decisively to this view—and obviously not considering Mises’s own words—complicate this simplistic view. It is no accident that both Mises and Hayek wrote so widely on so many topics. For both, understanding the process of social cooperation requires attention to the institutional framework of economic activity. Economists need to interact with diverse disciplines such as law, history, politics, moral philosophy, and psychology. And economics is but one part of a broader social philosophy, a philosophy that both of them identify with liberalism.

In his later work, Hayek does not object to Mises’s methodology so much as his early social rationalism. Time and again Hayek casts Mises in a more nuanced light than either his critics or some of his more enthusiastic followers. Maybe he is wrong. But Hayek takes the work of his revered mentor not as settled doctrine but as a launching pad to develop new and better ways of understanding the world. This is the best any academic mentor can hope for. As Peter Klein quotes in his introduction, Margit von Mises [Mises’s wife] said that “Lu[dwig] met every new student hopeful that one of them might develop into a second Hayek” (page 9).

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Footnotes

[1] The Fortunes of Liberalism: Essays on Austrian Economics and the Ideal of Freedom, by F. A. Hayek. Edited by Peter G. Klein. Liberty Fund, Inc., December, 2008.

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*Adam Martin is Political Economy Research Fellow at the Free Market Institute and an assistant professor of agricultural and applied economics in the College of Agricultural Sciences and Natural Resources at Texas Tech University.

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Interpreting Modern Monetary Theory

Introduction

Modern Monetary Theory (MMT), a non-mainstream economic doctrine, has recently emerged from popular and academic obscurity to become a hot topic. Enthusiastically embraced by assorted progressive politicians, MMT allegedly demonstrates that such expansive government programs as the Green New Deal will not impose significant financial burdens on government. Economists critical of the theory range widely across the ideological spectrum, from George Selgin of the Cato Institute and Scott Sumner of the Mercatus Center all the way to New Keynesian Paul Krugman, and Post-Keynesian Thomas Palley, both of whom otherwise sympathize with progressive programs. Yet many have found the expositions and defenses of MMT to be unclear, obscure, and even evasive.

If we focus solely on MMT’s essential claims about money, distinct from any associated policy proposals, it is neither new nor modern. It simply justifies funding government expenditures by issuing fiat money, which, of course, all economists have long been aware is possible. MMT then attempts to downplay the potential inflationary impact of such financing with manipulations of the government and central-bank balance sheets. But it merely puts the standard analysis into different boxes. Indeed, sophisticated advocates of MMT recognize that inflation can result from substantial increases in government expenditures unless one of three conditions holds: (1) there is significant unemployment in the economy; (2) government uses its taxing power to control inflation; or (3) the banking system somehow counteracts the government’s monetary expansion. Yet as we will see, advocates of MMT are overly optimistic about the efficacy of these three potential constraints on inflation, either overlooking their limitations, being unclear about how exactly they would be implemented, or grounding them in dubious economic doctrines.

Significant Unemployment

With respect to the first constraint about unemployment, Selgin has pointed out that “reasonable people can disagree about whether we still have some way to go before achieving full employment,” but “it’s 2019, not 1933; and the (labor) unemployment rate now hovers around 4 percent, rather than above 20 percent.”1 This explains why MMT is usually coupled with advocacy of job training and guarantee programs in which the government becomes the employer of last resort. Supposedly the resulting increase in output from increasing the labor-force participation rate would dampen any price increase. Beyond this simplistic knife-edge, on-off view of inflation, with an almost stationary Phillips Curve trade-off with unemployment, advocates of this scheme have been cavalier about such details as how many who are currently not in the labor force actually want to take government jobs and how such an extensive government program might disrupt private labor markets.2

Using Taxation to Limit Inflation

The most unusual feature of MMT is the second possible constraint: the claim that government taxation can control inflation. As Jim Kavanagh, defending MMT in Counterpunch, asserts, “taxes are that portion of the money… which the government withdraws for reasons that have nothing to do with needing to collect money to spend. Economically, they are for controlling inflation.” One of the most prominent of MMT theoreticians, L. Randall Wray of the Levy Institute of Economic Research at Bard College, admits that he is “skeptical of use of discretionary tax hikes to fight inflation,” but then concedes that “if there were a prolonged stretch of inflation we would—of course—recommend pro-actively raising taxes and/or reducing spending.” 3

Yes, government can always use taxes as an alternative to issuing money for financing expenditures. But this does not seem to be what most MMT proponents have in mind. Instead, they appear to claim that after newly issued money has paid for a government program, the government can use its taxing power to pull the money out of the economy. But what MMT proponents are never entirely explicit about is that the government can keep the newly spent money out of the economy only if it doesn’t simply turn around and spend the money it collects. To understand how this might be possible, we need to the look at the relationship between the Federal Reserve System and the Treasury Department. Both are government agencies that not only receive and disburse money but also create it. The Treasury issues coins, whereas the Fed issues Federal Reserve notes and its near equivalent, bank reserves held on deposit at the Fed. These are the forms of government fiat money, constituting what economists call the monetary base.

These two government agencies also hold balances of each other’s money. When the Treasury collects money through taxes or fees, it deposits that money at an account it holds at the Fed.4 If the money then just sits there, reissued neither by the Treasury nor by the Fed, it is indeed out of circulation, effectively burned. After all, the Treasury and the Fed are just two agencies of the same government, so how much they hold of each other’s money is just an accounting convention. But in fact, the money rarely sits for long in the Treasury balances at the Fed. The Treasury manages its Fed bank account roughly the same way the general public handles its bank accounts. Money is constantly flowing in and out of Treasury balances at the Fed, disbursed though checks the Treasury writes against the Fed. The total size of this account usually fluctuates within some desired range, and currently is about 350 billion.

Only once has the Treasury let its balances at the Fed pile up without making expenditures. That was during the financial crisis of 2008, when the Treasury helped the Fed engage in quantitative easing by issuing securities to borrow money from the general public. Yet the money still went right back into circulation, because the Fed used the money from the growing Treasury deposit to purchase financial assets or make loans to financial institutions. In fact, the Fed, like private banks, normally reissues most of the money that has been deposited with it, including the amount regularly in Treasury balances. Thus if the Treasury were to allow increasing deposits at the Fed to lie entirely idle, making no additional expenditures itself, the Fed would likely still put the bulk of that money back into the economy.

Although the Fed makes loans to banks and other financial institutions, and during the crisis, bought mortgage-backed securities, it normally issues money by purchasing Treasury securities. But legally it can make those purchases only from private parties, not directly from the Treasury, so the money is still being injected into the economy. Even if the Fed gained the authority to purchase Treasury securities from the Treasury, the money would only end up in Treasury deposits at the Fed, to again be re-spent by either the Treasury or the Fed. Even taxes that generate government surpluses rarely decrease the monetary base. The last time this happened in the United States was after the Civil War, when surpluses were used to retire Greenback paper currency. On those few occasions in recent times that the U.S. Treasury has run a surplus, the resulting revenue was used to make the final payment on maturing Treasury securities or to buy back outstanding Treasury securities. Either way, the money went back into the hands of the public.

In short, the U.S. government for over a century has never employed taxes to reduce or regulate the size of the monetary base. Of course, the government could do so. If the Treasury increased tax revenues without increasing expenditures, the Fed could allow Treasury deposits to simply accumulate. This would permanently take base money out of the economy. But this increasing Fed liability would have to be offset somewhere on the Fed’s balance sheet. One way to offset is just to let any increase in the Fed’s Treasury liabilities reduce the Fed’s capital account, in which case the total size of balance sheet would remain constant. But reducing the size of the Fed’s capital account, currently only 40 billion, has limits, unless the Fed adopts the accounting fiction of a negative capital account.

An alternative is for the Fed to offset an increase in its liabilities with a newly invented asset, equal in amount to the increase in Treasury deposits, that it could label Treasury currency or Reserves. (In fact, the Fed already does this with an asset labeled “Coin” for the small amount of Treasury money that regularly circulates through its vaults.) Then the Fed’s balance sheet would increase on both sides by the amount of accumulating tax revenue. Either of these balance sheet expedients could permanently pull money out of circulation, reducing the monetary base through taxation. But proponents of MMT tend to dismiss these accounting intricacies as the government’s “self-imposed constraints” that could easily be swept away. They remain vague about what new institutional arrangements they have in mind.

MMT stresses that the private sector would have no fiat money to spend if government had not issued sufficient quantities in the first place. This is obviously true, but irrelevant: those injections occurred mostly in the past. Indeed, the clearest cases are early fiat moneys, such as the Continental currency of the American Revolution, the Confederacy’s paper money during the Civil War, and the Greenbacks issued by the Union during that conflict. These are cases in which governments printed large quantities of money and directly spent it, generating severe inflation. Most modern fiat money, in contrast, emerged through a more subtle evolution, in which the government’s central bank issued banknotes redeemable at a fixed rate for some commodity, typically gold, with both items serving as money until the government broke the link with the commodity. This method sometimes entailed a more restrained and drawn out growth of the monetary base, with any severe inflation offset by economic growth.

Devotees of MMT, who belabor the distinction between stocks and flows, should be especially conscious that the large existing stock of what they call “sovereign currency” has little relevance to the inflationary impact of a dramatic increase in its flow. Admittedly, the U.S. government has enlarged the monetary base over time and will probably continue to do so in the future. And as long as it does so gradually, inflation will be mild. Higher levels of taxation could even slightly increase the amount of money sitting inert in the Fed’s and Treasury’s balance sheets. But that factor alone will hardly neutralize the inflationary impact of the monetary expansions required to finance the massive government expenditures that some progressives are pushing. Only pulling the new money back out of economy will do the job, unless of course new taxes are substituting for money creation.

Another possible interpretation of the claim that taxes can control inflation might focus on money’s velocity rather than its quantity. If higher taxes somehow reduce the velocity of circulation, they would dampen inflation. One controversial but mainstream approach in which taxes affect velocity is the Fiscal Theory of the Price Level (FTPL), whose most prolific champion is John Cochrane of the Hoover Institution. This theory even shares MMT’s insistence on the idea that taxes anchor the purchasing power of fiat money. But the FTPL’s policy implications are polar opposites. It does have taxation reducing money’s velocity through anticipated future surpluses. Yet advocates of MMT are not fans of surpluses. Nor are their tax proposals likely to inadvertently generate surpluses. Moreover, for reasons explored below, their theory has no room for expectations about future taxes increasing the public’s cash balances and thus bringing down money’s velocity.

Taxation is not the only possibly way to take money out of circulation. Government also borrows money from the public through the issue of Treasury securities. But as we’ve seen, Treasury borrowing likewise ends up deposited at the Fed, requiring the same manipulations explained above to permanently withdraw the money from the economy. Moreover, by issuing securities, the government has committed itself to paying interest in the future. It conceivably might get around that “self-imposed constraint” by repudiating its debt, but so far no advocate of MMT wants to take that route for either controlling inflation or eliminating the national debt. Indeed they don’t think that a growing national debt is likely to be a problem.

Some MMT proponents, including Kavanagh and Bill Mitchell, have suggested eliminating the government’s debt by having the Fed buy up all Treasury securities.5 But this is probably just a rhetorical flourish on their part. The asset side of the Fed’s balance sheet currently has a little over 2 trillion of Treasury securities. If the Fed buys the remaining 14 trillion outstanding (not counting the government trust funds, which is money the government does owe itself), proponents are well aware that doing so merely converts the form of the debt from interest earning Treasury securities to interest earning bank reserves. The Treasury would then pay interest on the bonds to the Fed, most of which the Fed would in turn pay out as interest to banks, except for a small residual the Fed remits to the Treasury.

“Such a near quadrupling of the monetary base hardly seems a recipe for curbing inflation, unless the Treasury simultaneously pulled all the new money out of circulation with taxes confined exclusively to flooding its deposits at the Fed.”

More important, converting the entire national debt into bank reserves would cause an enormous increase in the monetary base, which, even at the peak of quantitative easing, reached only slightly over 4 trillion. Such a near quadrupling of the monetary base hardly seems a recipe for curbing inflation, unless the Treasury simultaneously pulled all the new money out of circulation with taxes confined exclusively to flooding its deposits at the Fed. And the surplus revenue such taxes would have to generate would have to almost equal the entire 14 trillion increase in the base. But a final proposition in the MMT canon is that increases in the monetary base, even without interest on reserves, do not necessarily generate inflation at all. This conclusion is based on peculiar views about how the banking system works; that brings us to their third posited constraint on inflation.

Using the Banking System to Limit Inflation

The claim that banks can constrain inflation is the most complex and convoluted of MMT’s arguments. What gives this view some credence is what happened when the Fed generated an unprecedented increase in the monetary base through its quantitative easing during the financial crisis. Inflation did not take off, as many predicted, but it was because the Fed simultaneously started paying interest on the reserves that banks held on deposit at the Fed. Advocates of MMT, to their credit, recognized that paying interest on reserves was a game changer.6 The interest rate on reserves, if high enough, can induce banks to hold reserves rather than make loans that would otherwise increase deposits. This indeed permits the Fed to expand the monetary base while limiting the impact on the total money supply. As a result, still today the aggregate reserve ratio for checking accounts is well over 100 percent, compared with around 10 percent prior to the crisis. Although many mainstream monetary economists are likewise aware of the profound implications of paying interest on reserves, that realization has not fully penetrated through to politicians, journalists, and the general public.

For background definitions, see Keynesian Economics, by Alan S. Blinder; New Keynesian Economics, by N. Gregory Mankiw; and Monetarism, by Bennett T. McCallum, in the Concise Encyclopedia of Economics.

MMT, however, goes further. It contends that, whether the Fed pays interest on reserves or not, the government’s management of the monetary base does not translate into control over broader monetary measures. MMT derives this claim from Post-Keynesian economics, a related and older heterodox school of thought. More interventionist than mainstream New Keynesians, Post-Keynesians are quite diverse in their views, and not all proponents of MMT accept Post-Keynesianism fully. But many accept one of the core Post-Keynesian tenets: that the total quantity of money circulating among the general public is almost completely endogenous. By “endogenous” they mean beyond the discretionary control of government, and the money supply they have in mind consists of currency in circulation and deposits held at private banks. Their conclusion hinges on the Post-Keynesian approach to interest rates.

Post-Keynesians reject the standard analysis of what determines interest rates. They, along with advocates of MMT, deny that a monetary economy has a natural real rate of interest whose equilibrium level is determined by the supply of savings and demand for investment in the loanable funds market. Stephanie Kelton, an economics professor at Stony Brook University who embraces MMT, writes: “evidence suggests that interest rates don’t matter much at all when it comes to private investment.” Instead, investment decisions are “forward-looking, heavily influenced by ‘animal spirits,’ and overwhelmingly dependent on the state of profit expectations.”7 Post-Keynesians hold that saving, on the other hand, is primarily a function of people’s income, and not much affected by interest rates either. In the jargon of economists, they claim that saving is interest-inelastic.

As a result, Post-Keynesians and MMT advocates conclude that the loan market utterly fails to equilibrate planned saving and planned investment. Notice how this diverges from even the views of New Keynesians, who hold that that the interest rate affects how much private saving will be invested versus how much will be simply hoarded in cash balances or bank reserves. MMT attaches little importance to the effect of interest rate changes on investment or spending more generally. As Wray puts it, “when liquidity preference is high, there may be no rate of interest that will induce investment in illiquid capital.”8 Using MMT terminology, the economy exhibits no “intertemporal coordination.” Current saving cannot be depended upon to bring about an increase in capital goods that will increase future income. Thus, if too little spending causes a recession, only government borrowing can extract money from the idle cash balances of the general public and thereby increase spending.

See, for example, MMT is wrong,, by Scott Sumner, EconLog, January 25, 2019; and Keynesianism, NeoFisherism, and MMT, by Scott Sumner, EconLog, February 26, 2019.

Moreover, MMT emphasizes that government deficits increase the net financial assets of the private sector. Financial assets that arise between parties within the private sector, by contrast, are exactly offset by financial liabilities and have no net effect on the public’s financial assets. Without deficits providing the public with Treasury securities, the only government liability held by the private sector would be fiat money. Thus deficits increase the public’s total financial wealth, which allegedly increases income and stimulates spending. Even if deficits crowd out financial claims between private parties (which MMT finds unlikely), this does not diminish the deficits’ contribution to total wealth, which in turn spurs spending and leads to greater real investment. This is how MMT arrives at its counterintuitive conclusion that deficits can actually lower interest rates, a conclusion that has baffled critics like Sumner and Krugman.9 In essence, MMT treats government debt and government money as very close substitutes, more or less interchangeable. Therefore expanding either of them can have roughly similar impacts on the economy.

Because exponents of MMT consider increased money and increased debt as complementary ways to increase aggregate demand, they see little need to worry about the size of the government debt. Given their insistence that the government has no budget constraint, they are oblivious to the possibility that expectations about increased future taxes can affect perceptions of wealth, either as proposed in the FTPL or through even a partial working of Ricardian Equivalence.10 “Bond illusion,” in which government debt is considered net wealth, reigns supreme. The only expectations that have a major role in MMT’s macroeconomic theory are expectations about future profits, which are erratic due to the fundamental uncertainty that plagues the economy. MMT even challenges the empirical significance of the Fisher effect, in which expectations about future inflation cause a divergence between nominal and real interest rates. Government policy, in their view, should therefore focus exclusively on nominal interest rates.

How do all these assumptions lead to an endogenous money supply? Well, if private investment is a slave to animal spirits, so is bank lending. Advocates of MMT argue that deposits are not the source of bank lending but the other way around: bank lending creates deposits. Thus, the supply of bank loans is entirely demand driven, and that demand determines the amount of money banks create in the form of deposits. The defenders of this view realize that banks do wish to hold some desired level of reserves for clearing purposes and to satisfy customer demand for cash. And this desired level can change. But reserves, they claim, place no limit on bank landing. Nor do increases in total reserves create any impetus for bank lending.11

Changes in total reserves will, therefore, not affect how much money banks create through deposits. If the central bank should create more reserves than banks wish to hold, the banks will attempt to lend the excess reserves to other banks in the overnight lending market, which, for the United States, is the Federal funds market. This drives the Federal funds rate below the Fed’s target. To keep that rate on target, the Fed will have to reduce reserves with open market sales of Treasury securities, which automatically reduces the monetary base. Similarly, if banks wish to hold more reserves, they will try to borrow them from other banks, raising the Federal funds rate and forcing the Fed to increase the monetary base. This assumed endogeneity of bank lending thus makes both the total money supply and the monetary base endogenous. As Wray puts it, “causation must run from loans to deposits and then to reserves.”12 If the government were to impose a 100-percent reserve requirement, essentially converting private bank deposits into indirect central bank deposits, that would merely remove one link in this inverted causation.

Every step in this reasoning relies on a belief that the underlying risk-free nominal interest rate is not a market phenomenon but is ultimately arbitrary. In a reply to Krugman, Kelton asserts that “the Fed can pursue any rate policy it desires.” Wray has even proposed that central banks should “set the overnight rate at zero, and keep it there.”13 This will either eliminate any interest on short-term government debt or make it negligible, bringing close to consummation the union of base money and government debt into near perfect substitutes.14 The distinction between monetary policy and fiscal policy will miraculously vanish. Although longer-term and less-liquid financial assets and also real assets will still enjoy positive returns, profits, expectations of future profits, and liquidity will solely determine the spreads between various financial and real assets. These “interest rates (and thus asset prices) adjust to ensure,” in Wray’s words, consistency with the public’s “portfolio preferences.”15

To be sure, MMT concedes that the ability of an endogenous money supply to constrain inflation has limits. Government spending can still run up against the scarcity of real resources. Although some progressives invoking MMT seem unaware of this, Wray readily acknowledges that “just because the government can afford to spend does not mean government ought to spend more.” Government “must weigh the consequences in terms of withdrawing resources from other (perhaps more desirable) uses, as well as possible impacts on prices and exchange rates.”16 This returns us full circle to the first MMT constraint on inflation: the size of the “buffer stock” (Wray’s term) of unemployed labor that can be put to work.

The Topsy-Turvy World of MMT

There you have the topsy-turvy world of MMT. With accounting games, advocates of MMT attempt to reverse the roles of the government treasury and the central bank. They believe that the Treasury should control inflation and the Fed should finance government expenses. One of the most emphatic assertions of MMT, to quote Wray, is “taxes are not needed to ‘pay for’ government spending.”17 Taxes are needed only to make sure people accept fiat money and, if necessary, to keep inflation in check. And because both the treasury and central bank are government institutions, there is some truth to the idea that both institutions have dual roles. But as many others have pointed out, MMT theorists have yet to address or even consider the enormous public-choice problems that could hinder how their desired role reversal might function in practice.18

Equally important, critical parts of MMT’s edifice are built on Post-Keynesian foundations. As Kelton and Wray, along with Scott Fullwiler proclaim: “We have never tried to separate our ‘MMT’ approach from the heterodox tradition we share with Post Keynesians, Institutionalists and others. We have tried to extend that tradition.”19 A comprehensive and extensive critique of the Post-Keynesian paradigm is beyond the scope of this article. But if you strip away Post-Keynesian precepts, much of MMT’s edifice collapses, taking down many of its policy proposals with it.

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Footnotes

[1] George Selgin, “The Modern New Deal That’s Too Good to be True,” Alt-M (February 8, 2019).

[2] One of the best critiques of MMT’s job-training agenda, from a sympathetic, self-styled leftist, is Doug Henwood, “Modern Monetary Theory Isn’t Helping,” Jacobin (February 21 2019).

[3] Jim Kavanagh, “Behind the Money Curtain: A Left Take on Taxes, Spending and Modern Monetary Theory,” Counterpunch (January 22, 2018); L. Randall Wray, “Response to Doug Henwood’s Trolling in Jacobin,” New Economic Perspectives ( February 25, 2018).

[4] I’ve omitted two complicating details that have little effect: (a) The Treasury holds a small amount of the revenue it collects in the form of actual Federal Reserve notes (currently about 300 million) rather than as deposits at the Fed. (b) Tax revenues are temporarily lodged in Treasury deposits at private banks, in what are called “Tax and Loan Accounts,” before being transferred to the “Treasury General Account” at the Fed. This adds only a rest stop, creating a short lag as tax revenues flow toward expenditures. For more on this aspect of government finance, see George Selgin, “On Empty Purses and MMT Rhetoric,” Alt-M (March 5, 2019).

[5] Kavanagh, “Behind the Money Curtain”; and Bill Mitchell, “The US Government Can Buy as Much of Its Own Debt as It Chooses,” Bill Mitchell—Modern Monetary Theory (August 22, 2013).

[6] I was among the first to point this out: Jeffrey Rogers Hummel, “Paradoxes of Paying Interest on Reserves,” Liberty & Power (December 2008).

[7] Stephanie Kelton, “Paul Krugman Asked Me About Modern Monetary Theory. Here Are 4 Answers,” Bloomberg Opinion (March 1, 2019).

[8] Wray, “The Endogenous Money Approach,” New Economic Perspectives (August 17, 2009).

[9] Scott Sumner, “More MMT Follies (Sympathy for Krugman),” EconLog (March 1, 2019); Paul Krugman, “Running on MMT (Wonkish),” New York Times Opinion (February 25, 2019).

[10] Ricardian Equivalence is the idea that when the government increases its debt, the country’s residents will anticipate higher future taxes to pay the interest on the debt and the principal, and, therefore, will increase their saving.

[11] One of the most persistent critics of the MMT view of bank behavior is Julien Noizet, “A Response to Scott Fullwiler on MMT banking theory,” Spontaneous Finance (January 14, 2014). See also the reprint of one his other posts and links to many more at Noizet, “The Problems with MMT-Derived Banking Theory,” Alt-M (March 15, 2019).

[12] Wray, “The Endogenous Money Approach.”

[13] Kelton, “Paul Krugman Asked Me About Modern Monetary Theory. Here Are 4 Answers”; Wray, “A Post Keynesian View of Central Bank Independence, Policy Targets, and the Rules Versus Discretion Debate,” Journal of Post Keynesian Economics, 30 (2007): 138. I have challenged the common belief that the Fed determines interest rates: Jeffrey Rogers Hummel, “The Myth of Federal Reserve Control Over Interest Rates,” Library of Economics and Liberty (October 7, 2913).

[14] It is interesting to note that at one time Milton Friedman, in “A Monetary and Fiscal Framework for Economic Stability,” American Economic Review, 38 (June 1948): 245-64, proposed something similar—eliminating all government borrowing and relying entirely on taxation or issuing money to finance government expenditures.

[15] L. Randall Wray, Modern Money Theory: A Primer on Macroeconomics for Sovereign Monetary Systems, 2nd ed. (Basingstoke, UK: Palgrave Macmillan, 2015), p. 112.

[16] Ibid., pp. 193, 195.

[17] Wray, “What are Taxes For? The MMT Approach,” New Economic Perspectives (May 15, 2014).

[18] See Stan Veuger, “Modern Monetary Theory and Policy,” AEI (January 8, 2019); Scott Sumner and Patrick Horan, “How Reliable Is Modern Monetary Theory as a Guide to Policy?” Mercatus Center Policy Briefs (March 11, 2019), PDF file.

[19] Scott Fullwiler, Stephanie Kelton, and L. Randall Wray, “Modern Monetary Theory: A Response to Critics,” SSRN (January 15, 2012).

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*Jeffrey Rogers Hummel is Professor of economics at San Jose State University and the author of Emancipating Slaves, Enslaving Free Men: A History of the American Civil War, the second edition of which was released in 2014.

For more articles by Jeffrey Rogers Hummel, see the Archive.

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What Should Economists Do? An Appreciation

I‘m thankful to my undergraduate mentor, Bill Field, for things too many to count. Among these is his introducing me during my junior year to public-choice scholarship. “Dr. Field” (as I then called him) did so by suggesting that I read James Buchanan’s and Richard Wagner’s 1978 monograph, published by the Institute of Economic Affairs (and with a contribution from John Burton), titled The Consequences of Mr Keynes.1 In this monograph’s main essay, Buchanan and Wagner use straightforward economic logic to expose with crystal clarity a core political flaw of Keynesian economics—namely, even if Keynesianism is fully correct as a matter of theoretical economics, in practice democratic governments have poor incentives to implement it.

The reason for this political failure is that politicians’ incentives to spend more than they bring in are dominant regardless of prevailing macroeconomic conditions. And so while democratic governments will eagerly heed Keynesians’ counsel to run budget deficits during economic slumps, these governments will, with equal eagerness, ignore Keynesians’ counsel to balance their budgets under conditions of full employment.

One consequence of Mr. Keynes, therefore, was to release governments from what was formerly the binding expectation that in times of peace they follow a rule of fiscal prudence by always at least attempting to balance their annual budgets. After Keynes, government budgeting came to be seen as a discretionary macroeconomic ‘tool,’ yet, as Buchanan and Wagner argued, a tool that a direct application of economics to politics reveals should not be entrusted to politicians.

This public-choice criticism of Keynesian economics struck the 20-year-old me, as it continues to strike the 60-year-old me, as being not only brilliant in its simplicity, but also indisputably correct and highly relevant. Reading this monograph so early on in my training as an economist taught me that the economic way of thinking is indispensable for understanding not just conventional markets but a wide range of human activities, including politics. It also instilled in me an appreciation for the reality that the state is no superhuman agency that looms above society and governs with godlike solicitude, wisdom, knowledge, foresight, and courage. Since first firmly grasping this reality, I’ve been unable to take seriously the many economists who, when they recommend government intervention to correct alleged market failures, ignore the possibility of government failures.

But not until I read, during my senior year, Buchanan’s What Should Economists Do?2 did I learn just how deep, profound, and pioneering are Jim Buchanan’s ideas. The man was far more than a co-initiator (along with Gordon Tullock) of the sub-discipline of public choice economics.

Edited by Geoffrey Brennan and Robert Tollison, What Should Economists Do? is a 1979 collection of 16 of Buchanan’s most philosophical papers, half of which were published in this Liberty Fund collection for the first time. More than once I’ve heard the papers collected in this volume described as ones that deal with methodology. But this description is inaccurate. Nowhere in this volume does Buchanan prescribe or proscribe any particular methods of doing economic or political-science analyses.

What Buchanan does do in most of the papers—and in different ways—is remind us economists what our subject matter is and what it is not.

What Economists’ Subject Matter Is Not

Buchanan’s identification of what economists’ proper subject-matter is not is, I believe, even more important than his identification of what this subject-matter is. According to Buchanan, economists’ proper subject matter is emphatically not resource allocation.

Buchanan’s rejection of resource allocation as the proper subject matter of economics strikes most economists as odd and certainly mistaken. For almost 90 years now we economists have been taught from our freshmen days that economics is the study of how to allocate scarce resources, each with multiple possible uses, in ways that satisfy as many human wants as possible. If using a particular patch of land in Bordeaux as a vineyard satisfies a larger quantum of human wants than would be satisfied by using this land in any of the many other ways that are possible, then this patch of land should be used as a vineyard. And therefore (boasts the typical economist) economic theory is all about (1) understanding how markets allocate scarce resources, (2) determining if the allocation achieved by markets is optimal, and (3) giving government officials the guidance necessary to correct any sub-optimal pattern of resource allocation.

Buchanan demurred. He did not deny the conceptual distinction between ‘optimal’ and ‘suboptimal’ patterns of resource allocation. He would not disagree that building, say, a Barbie-doll factory on land now used as vineyards by Chateau Latour would almost certainly cause that land to be ‘misallocated.’ But Buchanan did insist that the economist’s task is different and more important than studying resource allocation.

Determining the optimal pattern of resource allocation is a problem for engineers. Such a problem differs in no relevant ways from those that must be solved by, say, a Walmart executive in charge of finding the profit-maximizing manner of transporting inventory from Walmart’s warehouses to its many retail stores. Solving such problems is important for society; we’re all made wealthier the more fully and quickly such resource-allocation problems are solved. But, Buchanan argued, finding such solutions is not what economists, as such, “should” do.

What Economists’ Subject-matter Is

So what is economists’ proper subject matter? What should we economists do? Buchanan’s answer is that we should study the entire universe of voluntary exchange.

“Economists “should” want to understand society and the social processes that constitute it. And to gain this understanding requires careful study of the motives and the consequences—especially the unintended consequences—of exchange.”

One unique expression of our humanity is the ability of each of us to envision how our lives can be improved by exchanging—by trading—with others. This rational pursuit, by each individual, of improvement of his or her life by exchanging with others forms the foundation of society. Economists “should” want to understand society and the social processes that constitute it. And to gain this understanding requires careful study of the motives and the consequences—especially the unintended consequences—of exchange. To gain such an understanding requires an appreciation of, and analysis of, the full range of exchange possibilities. This range is much larger than the typical neoclassical economist realizes.

Exchange includes, of course, that which occurs in private-property markets for partitionable goods and services—markets as small as neighborhood garage sales to those as vast as the globe-spanning market for petroleum. But the arms-length exchanges that occur in such markets are only one of the many varieties of exchange that we humans employ in our attempts to improve our lives. Most significantly for Buchanan’s purposes, we often organize ourselves collectively to achieve outcomes that, for whatever reason, are not achieved by ordinary market arrangements.

In the title essay of this collection—”What Should Economists Do?” (his 1963 Presidential address to the Southern Economic Association)—Buchanan used the example of members of a community wishing to drain a nearby swamp in order to protect themselves from mosquitoes. Any freshman economics student with a passing grade can explain why, despite every member of the community placing high positive value on draining the swamp, no conventional market will arise to carry out this task. “When asked to help pay to drain the swamp,” the freshman explains, “each person will refuse because he hopes to free-ride on other people’s payments. But with everyone behaving in this way, the final result is that the swamp never gets drained.”

Most economists back then—and still today, 55 years later—would award this freshman an A for her response. “Market failure!” declare neoclassical economists. These economists then immediately proceed to insist that the only way the swamp will be drained is if the state coerces the community members into paying for the project. This conclusion appears to be the only one supported by objective, scientific analysis.

Buchanan again demurred. He did so because he took seriously Adam Smith’s emphasis on the human propensity to truck, barter, and exchange, and because he understood that Smith never meant his observation to be interpreted as narrowly as economists came to interpret it. Writing about the swamp-draining example, Buchanan explained that

[d]efined in the orthodox, narrow way, the “market” fails; bilateral behavior of buyers and sellers does not remove the nuisance. “Inefficiency” presumably results. This is, however, surely an overly restricted conception of market behavior. If the market institutions, defined so narrowly, will not work, they will not meet individual objectives. Individual citizens will be led, because of the same propensity [to truck, barter, and exchange], to search voluntarily for more inclusive trading or exchange arrangements. A more complex institution may emerge to drain the swamp. The task of the economist includes the study of all such cooperative trading arrangements which become merely extensions of markets as more restrictively defined.

The richness of Buchanan’s understanding of the role of (good) economists is immense.

When we economists do what Buchanan advises we should do, we naturally come to see economic activity as an on-going process of trial, of error, and—if incentives are correct—of improvement through time in economic arrangements and outcomes. Buchanan’s point of view here is quite close to that of Ludwig von Mises, Israel Kirzner, and other Austrian economists who see the central role that entrepreneurship plays in economic affairs.

These scholars understand that real-world markets at each moment are chock-full of outcomes that mainstream economists identify as “failures.” But unlike mainstream economists, Buchanan and the Austrians also understand at least two additional facts. First, these “market failures” are potential profit opportunities for entrepreneurial people who can figure out ways to correct the failures. Second, the ways that entrepreneurial people can and do devise to correct these “failures” are many. These ways are far more varied than the two polar extremes featured in textbooks: at one pole, conventional arms-length market exchange and, at the other pole, government regulation or taxation as recommended most famously by A.C. Pigou.

Buchanan especially pleaded with economists to recognize the many non-market ways that entrepreneurial people creatively devise to solve collective-action problems. Some of these ways are private, such as clubs and homeowners’ associations. But often, in Buchanan’s view, they are governments—organizations (in Buchanan’s view) voluntarily established and agreed to by people, and invested with circumscribed powers to coerce, for the purpose of doing tasks that cannot effectively be done by conventional markets or by other private arrangements.

Thus did Buchanan see politics, no less than he saw any conventional market, as an arena of exchange. It’s just that what is exchanged in political markets are agreements to abide by rules: I’ll agree to be governed by a popularly elected legislature that operates according to majority rule if you agree to keep from that legislature the power to regulate the press.

Buchanan’s work on a social-contract theory of the state proves that much insight can be drawn from this perspective. He insisted on modeling democratic states as products, not of force unilaterally imposed, but of complex exchange among all of the many people whom the states govern. Yet Buchanan’s adherence to this theory led him, ironically, to endorse a form of legal positivism—namely, his insistence that social order must ultimately be rooted in consciously designed constitutional rules—that I believe to be wholly at odds with his appreciation of the reality of emergent order.

In What Should Economists Do? Buchanan devotes little ink to his social-contract theory. This essay, therefore, is no place for me to rehearse my criticisms of this theory. But my passing mention of it here is warranted because Buchanan’s well-known attachment to the social-contract theory of the state is an understandable result of his insightful insistence that, because we humans are very clever and entrepreneurial at devising exchange arrangements that are far more complex than are the relatively simple ones that we use in conventional private-property markets—and because economists “should” study exchange in all of its many manifestations—economists’ natural subject matter includes political exchange no less than it includes commercial exchange.

We see here how Buchanan came naturally to extend his understanding of economics to the domain of politics. And we see also that, contrary to what has sometimes been said over the years about Buchanan by poorly informed scholars and pundits, Buchanan’s motivation was always to better understand politics rather than to portray it in an unfavorable light. Indeed, while analyzing politics realistically rather than romantically does scrub the luster off of dreamy schemes of using the state to engineer society, Buchanan’s exchange theory of politics clearly is no tool that libertarians can use to disassemble support for the state.

A Deeper Case for Liberty

My favorite chapter in What Should Economists Do? after I’d first read this collection decades ago remains my favorite today: the 1978 lecture “Natural and Artifactual Man.” As with all genuinely deep and pioneering ideas, those developed by Buchanan in this lecture, while not easily summarized, cry out to be shared.

Buchanan’s “natural man”—or, updating Buchanan’s language, “natural person”—is that person within each of us whose behavior is wholly predictable. If you accidentally put your hand on a hot stovetop, you immediately pull your hand away. If the price of a Honda Accord falls relative to the price of a Toyota Camry, you become less likely to buy a Camry.

Artifactual person, in contrast, is that part of each of us that each of us creates. If you are currently overweight and you choose to lose weight, you envision a future in which you are a somewhat different person from the person you are today. Not only is your choice to lose weight much less predictable than is your ‘choice’ to remove your hand from the hot stovetop, but also by choosing to lose weight you create tomorrow someone who doesn’t exist today. Your preferences and expectations tomorrow will differ in their details from those that guide you today. As such, when you choose to become a different person from the person you are today, you cannot really know what preferences and expectations the future you will have.

Your choice to become a different you requires a leap of faith that the future you will be a person whom you prefer to be than the current you. Also requiring a leap of faith is your hope that the future you will judge as worthwhile the ‘cost’ that you bear to bring about this transformation. But because the future you will have preferences different from the current you, the current you—the person who must now make the choice to ‘become’ the future you—cannot know for sure if the future you will judge the transformation to be worthwhile.

This choice setting differs fundamentally from the choice setting confronted by agents in economics textbooks. In textbooks, choices are mechanical and wholly predictable given that each person’s preferences are assumed to be fixed and fully known at least to each person who holds them. As Buchanan notes, these textbook choices are not really choices at all because the persons who make them cannot within the confines of the theory behave otherwise than how they behave. To “choose” in such models is nothing more than to solve an optimization problem.

Yet in reality—as Buchanan reasonably infers from introspection and observation—each of us does far more than merely mechanically optimize a utility function. What makes each of us distinctly human is our propensity to change the details of who we are and of what we want. In stark contrast, neither dogs nor dolphins seek to be dogs and dolphins that differ tomorrow from the dogs and dolphins that they are today. The same is true for chipmunks and cheetahs and you name the non-human creature.

From this insight that each of us is constantly creating a slightly different each of us Buchanan draws a crucial normative conclusion—namely, the case for individual liberty is not ultimately a case for government to leave us free to maximize our utility. Instead, in Buchanan’s memorable words, “Man wants liberty to become the man he wants to become. He does so precisely because he does not know what man he will want to become in time.”

Whenever the state obstructs our choices and actions, it blocks our ability to travel down paths that would lead us to becoming persons different from the persons we are today. If these state obstructions were limited to those that prevent each of us from privately obstructing the paths-of-becoming open to our fellow human beings, such regulation by the state would be acceptable.

But the state does far more than merely protect us from each other. Nanny-statism and the mountains of rent-seeking restrictions that today loom large are unjustified infringements on our liberty not because they keep most of us (as economists inelegantly say) on a lower utility surface. These are unjustified infringements of our liberty because they prevent each of us from becoming who we want to become. They are shackles on the exercise of what makes us distinctly human. And by shackling our humanity, these interventions not only treat us like animals, they make us more like animals—and less like humans—than we would otherwise be.

Conclusion

Reading What Should Economists Do? at so young an age spoiled me. This work represents all that is best in economics and scholarship. Encountering later in graduate school, and in the pages of professional journals, mostly a combination of dreary modeling of static relationships and pointless puzzle-solving, I often despaired—as I still despair—that so few of my fellow economists do what Jim Buchanan argued economists should do, for economics done in this way is economics at its very best.

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Footnotes

[1] The Consequences of Mr Keynes, by James Buchanan and Richard Wagner, with a contribution from John Burton. Institute of Economic Affairs, 1978. PDF file.

[2] What Should Economists Do? by James M. Buchanan. Preface by Geoffrey Brennan and Robert D. Tollison. Liberty Fund, Inc., November 1979. Sixteen of Buchanan’s essays collected in book format. Available through the Liberty Fund Book Catalog.

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*Donald J. Boudreaux is Professor of Economics at George Mason University and Senior Fellow with the F. A. Hayek Program for Advanced Study in Philosophy, Politics, and Economics at George Mason’s Mercatus Center. He blogs at Café Hayek (www.cafehayek.com).

For more articles by Donald J. Boudreaux, see the Archive.

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Tax Justice

Emmanuel Saez and Gabriel Zucman have promised us a book on “Tax Justice.” That’s great. Perhaps it will help us understand the op-ed1 they recently published in the New York Times.

It is not strange to see these two economists arguing for confiscatory marginal tax rates. Given their scholarly and popular writings on taxes and inequality, the surprise would be if they had written something different. What’s strange is what they don’t say. They make claims about all manner of things. Let’s consider those claims.

Consider, for example, the nostalgia they seem to feel for the period between 1951 and 1963, when marginal tax rates exceeded 90 percent. In an important recent paper,2 Pikkety, Saez and Zucman dig into the data and show that average tax rates on the top 1% of income earners haven’t changed much since the 1950s. Historically, at least, imposing high marginal rates on the rich hasn’t meant that the rich pay more in taxes. Why, then, consider raising rates? Well, they tell us, “[T]hat few people faced the 90 percent top tax rates was not a bug; it was the feature that caused sky-high incomes to largely disappear.”

Minerva: An Experiment in Centrally Planned Education

• We are unique, standing apart from traditional universities and other ways of learning. We believe there is a better way, and refuse to settle for the status quo.
• —Stephen M. Kosslyn and Ben Nelson (editors) Building the Intentional University: Minerva and the Future of Higher Education, page 3891

Faculty and administrators at American universities are tempted to feel smug. Our higher education system is reputed to be the best in the world. Demand for admission, particularly at elite institutions, is very high. Economic rewards for graduates are well demonstrated.

But American higher education also has its critics. As the authors of Building the Intentional University point out,

… higher education is facing four overarching problems… students are leaving college woefully unprepared for life after graduation… college is too expensive… more than half of students don’t graduate. And even when they do, they have often been intellectually absent during much of their time in college… many qualified students around the world do not have access to a first-rate college education. American universities, for example, typically have quotas on how many non-American students they will take.

DNA Determinism

"DNA is the only thing that makes a substantial difference, accounting for 50 per cent of the variance in psychological traits. The rest comes down to chance environmental experiences that do not have long-term effects."—Robert Plomin, Blueprint: How DNA Makes Us Who We Are

After decades of studying the heritability of psychological traits, Robert Plomin argues that analysis of DNA can help predict individual characteristics. By the same token, interventions in our environment, including parenting styles and variations in education, have little or no long-term effect.

Plomin’s ideas have the potential to disturb many standard political views. For example, conservatives argue that poverty can be cured by encouraging people to finish high school and get married before having children. Progressives argue that poverty can be alleviated by spending more on education. But if Plomin is correct, then attempts to use environmental interventions to influence behavior or ability are equally unlikely to prove successful.

Economists Know: Ask What Changed

When you try to understand change, whether in economics or in the rest of life, one good rule is to ask what other factor or factors changed. To explain a change in one variable, we have to point to another variable that changed, not to one that stayed the same.1

Asking what changed can lead us to reject some explanations and embrace others. Consider three examples: the recent California fires; cable television’s sudden decision to drop C-SPAN in the early 1990s; and the dramatic increase in heroin-related deaths.

California Fires

In 2017 and 2018, Californians experienced devastating forest fires. The 2018 Camp Fire alone—officially the most destructive in the state’s history—burned 240 square miles, destroyed 18,804 buildings, and killed 86 people in and around Paradise, California.

What caused these fires to be so extreme? Let’s look for what changed.

Can Capitalism Survive? Ben Rogge on Capitalism’s Future

How can someone publish a book asking if capitalism can survive, offer no hope that it can, and still become widely applauded as a strong advocate of capitalism? The most obvious way is to be a world-class economist named Joseph Alois Schumpeter. The next notable way is to be Benjamin Rogge (1920-1980), not a world-class economist, but a very good economist and a world-class communicator.1 In a landmark book, Schumpeter (1975 [1942]) introduced the term “creative destruction” by way of improving economists’ appreciation of entrepreneurs and their understanding of the dynamism of markets.2 In Part II of this book Schumpeter considers the question: Can capitalism survive? And concludes “No, I do not think it can.” (page 61) Ben Rogge was strongly influenced by Schumpeter and used Schumpeter’s provocative question as the title of his own book.3 Rogge’s book consists of a selection of his publications and speeches covering a wide range of economic issues, including Schumpeter’s question in his opening chapter.

Unlike the authors discussed in previous Liberty Classics, Rogge’s work did not break new theoretical ground or provide the basis for new and related research agendas. His contribution was communicating to non-specialists the scholarly work of others in interesting and accessible ways, which is what good teachers do. Few economists perform this function effectively enough, however, to become, solely on the basis of that performance, highly regarded by many of the most prestigious economic scholars of their day. Ben Rogge did. He knew that sharing with the general public existing economic knowledge, much of it going back to Adam Smith, is a more productive activity for most economists than trying to impress other economists with esoteric analysis to develop “new” economic knowledge.4

Many people have heard the term “creative destruction” and a few will know it was coined by Schumpeter to explain the productivity created by profit-seeking entrepreneurs and businessmen. But unless they are professional economists it is doubtful they will ever read Capitalism, Socialism and Democracy or know that Schumpeter thought businessmen were more likely to compromise with bureaucrats and politicians in support of anti-capitalist policies than to resist such policies.5 Indeed, it is unlikely that many economics professors today have read Schumpeter, and even less likely that their students will be exposed to his contributions or to those of other giants in the history of economic thought. Thank goodness there are still important exceptions to this statement!

More troubling is that few academics in the social sciences and humanities today are willing to defend capitalism, and too many of them are hostile to it. Rogge quotes Schumpeter suggesting one reason an academic is likely to be antagonistic to capitalism arises “from the fact that his main chance of asserting himself lies in his actual or potential nuisance value.” (page 28) This is not as flippant as some might think, given the spitefulness of many academics. This spite is likely the result of the aggravation of academics to the “widening gap between their own incomes and those of the businessmen,” (page 29) which they seem to believe is the result of the inherent fraud and unfairness of capitalism.6

Why is this opposition of any consequence given Rogge’s discussion of Schumpeter’s resounding ‘yes’ to the question of whether capitalism can survive? Hasn’t capitalism been successful at “producing over time continued improvement in the economic wellbeing of the masses?” That answer is illustrated with Schumpeter’s observation, quoted in Rogge that, “Queen Elizabeth owned silk stockings. The capitalist achievement does not typically consist of providing more silk stockings for queens but in bringing them in reach of factory girls in return for steadily decreasing amounts of effort.” (page 17)

If indeed the masses benefit so much from capitalism, the casual reader of Rogge’s book might conclude that the political influence of those masses in favor of capitalism would cancel out the antagonism of the relatively few businessmen, academics, and bureaucrats. If they keep reading, however, Rogge explains that “the masses of the people [lack] any real understanding of the system that has heaped riches upon them or any instinct to defend from attack the central figure in that system, the businessman.”7 Rogge also believed that the biggest problem in making the case for capitalism is not convincing the masses of the “efficiency of the free-market system in promoting economic growth, in raising levels of living… but rather [convincing them of] its consistency with certain fundamental moral principles of life itself.” (page 40; emphasis in original)

Further, as Rogge also points out, “the profit-directed activities of the businessman are [considered] antisocial” and probably immoral, by many. Yet, a complete case for capitalism cannot be made without explaining the importance of businessmen maximizing their profits within the law. So, as important as Rogge thought making a moral case for markets and business is, he spent little time attempting to do so. He does make a humorous, but modest, effort, however, with this statement (page154):

• I make no claims for the superior moral fiber of the businessman, but I will say this: A basically dishonest man can survive longer in the church or the classroom than he can in the grain exchange or the furniture business. The penalty system in the business world operates with some real precision and certainty, largely unencumbered by a mystique of occupational sanctification.

Making the case for capitalism on the ability of markets to promote economic growth and increased living standards may not be as important as making the moral case, but it is easier for economists to do, which is what Rogge did in his chapters on profits and labor markets.

“As Rogge puts it, ‘capitalism created the organization man—and the organization man is indifferent to capitalism.'”

But I want to return to the hostility to capitalism we can expect from businessmen and academics, respectively. Rogge tells us he takes no pleasure in reporting “that the course of events is lending ever greater credibility to the Schumpeter thesis.” (page 31) Following Schumpeter, Rogge argued that as firms became larger in response to efficiencies of scale, the importance of individual entrepreneurs is diminished relative to that of teams. Entrepreneurs become less heroic and more obscure figures, widely thought of, when thought of at all, as more interested in profits than people. Rogge asks, “when did you last see a businessman treated sympathetically in a novel or a play? Whose name is better known to the American people: Ralph Nader or the president of General Motors or General Electric?” (page 32) As Rogge puts it, “capitalism created the organization man—and the organization man is indifferent to capitalism.” (page 27) As government regulations and subsidies increase, the profitability (and possibly the survival) of large corporations becomes less dependent on satisfying the preferences of consumers and more on capturing the government benefits that undermine capitalism.

Regarding academics (or intellectuals8), Rogge asks:

• Do we, or do we not have a surplus9 of intellectuals? Are they or are they not, by and large, critical of the American businessman and of the system of which he is a part? Do they or do they not ‘nurse left wing and scowling minorities, sponsor doubtful or submarginal cases’ (such as the lettuce boycott)? Do not these critics of capitalism control the world of the academy? (pages 31-32)

To ask these questions was to answer them. Many of the problems Rogge saw with higher education were caused, or at least aggravated, by “below-cost pricing”. Briefly stated, he argued that increased reliance on tuition, along with private-sector loans, to finance colleges and universities would better ration admission to those most capable of benefiting from higher education and motivate them to take advantage of their capability once admitted. Related, by tying professors’ incomes closer to students’ fees, Rogge asserted their incentive to take their teaching seriously would increase, and they would spend less class time expounding ideological views unrelated to the subject matter being taught.10

Economic productivity has clearly increased since Rogge died in 1980, with consumers of American businesses and students in higher education benefiting from some of the resulting changes in these institutions. Unfortunately, not all those changes have benefited consumers and students, and many of them have further reduced the prospects of free-market capitalism. The business climate has become increasingly less favorable to maintaining capitalism because of the threats and opportunities businessmen face from an increasingly intrusive government. A clear threat comes from a minefield of uncertainty resulting from a host of complex, inconsistent, and arbitrarily enforced regulations (federal, state and local) that do even more today to distort and undermine market decisions than when Rogge was writing. Admittedly, many regulations are sought by businesses, particularly large businesses, which serve to protect them against the competition of smaller businesses, which reduces “creative destruction” and therefore the dynamic efficiency of capitalism. Tax breaks, import restrictions, export subsidies, and certain environmental regulations are examples of political opportunities for businesses to profit from rent-seeking activities that destroy wealth instead of engaging in capitalistic activities that increase wealth.

But it would be changes in higher education that would really give Rogge the educator a nasty jolt if he returned to a university campus today. He would be encouraged and pleasantly surprised when he saw how much tuition had increased. He would be even more surprised, but hardly encouraged, when he found out how much government is subsidizing colleges and universities despite the higher tuitions. Rogge’s enthusiasm would lift when told that most universities, including the most prestigious, are emphasizing the importance of diversity and the basic humanity of people from all over the world in an effort to reduce prejudice and promote international peace. He would assume that such a curriculum included the study of markets and capitalism as the most effective way of achieving those noble objectives. As Rogge, in another collection of his articles, wrote:

• The process of voluntary exchange tends to be “civilizing” in its social impact on the parties involved, including a greater awareness of each other’s basic humanity and a reduction in sheer uninformed prejudice. This civilizing influence, combined with economic interdependence created by trade, tends to reduce conflict between the parties involved and to make for more peaceful relationships, both within a country and between countries. (A Maverick’s Defense of Freedom, pages 373-374)

But again, he would be disappointed upon discovering that the dominant view of market capitalism by campus diversity advocates and many students is that it allows the powerful and privileged to maintain their underserved wealth and status by exploiting underprivileged minorities. Indeed, favorable statements about capitalism and the importance of bourgeois values are considered hate speech (or even acts of violence) by those dedicated to creating welcoming campus environments so underrepresented minorities will no longer have to live in fear on such threatening campuses as the University of Pennsylvania, Berkeley, UCLA, Yale, and many more.11

Rogge’s disappointment would be further deepened by finding out that recent polls show that more millennials, those born between 1982 and 2002, would prefer living in a socialist or communist country than in a capitalist one.12 But he might receive a slight lift when he visits an economics principles course and finds out that economists are not responsible for the poor understanding of economics by today’s students. This comfort is minimal though, since it is based on seeing that economics isn’t being taught any worse than it was forty years ago when he wrote, “College Economics: Is it Subversive of Capitalism?” (page 130) At that time, Rogge answered no it wasn’t, because the level of teaching in the introductory course “is generally of such poor quality that the students are neither subverted nor enlightened—primarily they are bored.”

For more on Benjamin Rogge, see Reminiscences of Rogge, by David R. Henderson, EconLog, March 2014.

This represents a tremendous opportunity wasted during Rogge’s day, and still today. Over one million American college students take an introductory economics course each year, which is the best opportunity most will ever have to understand how market capitalism makes it possible for billions of strangers to help each other obtain two essential ingredients to human flourishing—prosperity and freedom—by engaging in a mutually beneficial process of productive cooperation.13 This doesn’t mean college students aren’t hearing some interesting lectures on economics and capitalism. They are just not hearing them in economics courses. As Rogge points out, the student receives “the true economic nonsense of the left in his courses in literature, history, political science, social psychology, sociology (one of the worst offenders), and philosophy.” (page 131)

From all accounts, Rogge was a cheerful man, willing to enter the arena of intellectual combat even when the prospects for victory were bleak. He continued making his case for capitalism with a smile on his face and lots of humor until the very end, even though he agreed with Schumpeter that making the case for capitalism was an uphill, and likely futile, fight. It should be no surprise that Rogge quoted Schumpeter’s famous statement that “[t]he report that a given ship is sinking is not defeatist. Only the spirit in which this report is received can be defeatist: The crew can sit down and drink. But it can also rush to the pumps.” There is still a lot of pumping to do.

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References

Lee, Dwight R. (2016). “Teaching the first economics course as if it is the last,” Journal of Business and Management, Vol. 22, No. 2 (2016): 101-113. A Festschrift Volume on the Economics of Education in honor of James L. Doti and Lynne P. Doti.

Mac Donald, Heather (2018). The Diversity Delusion (New York: St. Martin’s Press).

Rogge, Benjamin A. (1979). Can Capitalism Survive. (Indianapolis: Liberty Fund, Inc.). Rogge, Benjamin A. (2010). A Maverick’s Defense of Freedom (ed.) Dwight R. Lee. (Indianapolis: Liberty Fund, Inc.).

Schumpeter, Joseph (1975 [1942]). Capitalism, Socialism and Democracy (New York: Harper Colophon).

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Footnotes

[1] Obviously, people can be recognized as strong advocates of something while explaining that it is subject to grave threats. But when they are, they typically suggest steps than can be taken to moderate the threats, if not eliminate them entirely. Neither Schumpeter nor Rogge provide such hope. Schumpeter (pages 424-425) states “Marx was wrong in his diagnosis of the manner in which capitalist society would break down; he was not wrong in the prediction that it would break down eventually.” Rogge (1979, page 40) admits “I do not expect to see such an economy [a market economy with a minimum government] in my lifetime or in anyone’s lifetime in the infinity of years ahead of us.” He does offer very cautious hope for limited progress from education in his last chapter.

[2] Joseph Alois Schumpeter. Capitalism, Socialism, and Democracy. Harper & Brothers, 1942.

[3] Benjamin A. Rogge. Can Capitalism Survive? Liberty Fund, Inc., 1979. Available online at: https://www.econlib.org/library/LFBooks/Rogge/rggCCS.html.

[4] I understand that these two activities can complement each other, but for most economists they don’t.

[5] Businessmen frequently seek such policies as a way to restrict the entry of competitors into their industry. Rogge (1979, page 32) hints at this by paraphrasing, without elaboration, Adam Smith’s comment about never knowing much good done by a businessman who affected to trade for the public good.

[6] From Rogge (1979, page 29) paraphrasing Schumpeter.

[7] This is consistent with a public choice explanation, but Rogge doesn’t expand the explanation by considering the lack of motivation for an individual consumer to exert political influence to protect widely dispersed benefits.

[8] Rogge points out that he uses the term intellectuals as defined by Schumpeter, which is broader than academics. But I am using it to refer to academics.

[9] Meaning, as you would expect of an economist, more than can get the jobs they were trained for and want at prevailing wages. While not true for all academic majors, this is clearly true for many social science and humanity majors.

[10] See Rogge (1979, Part VIII, Chapter 1) on “Financing Higher Education in the United States.

[11] If this sounds too bizarre to be true, see Mac Donald (2018, Chapter 12).

[12] See Bradford Richardson, “Millennials would rather live in a socialist or communist nation than under capitalism: Poll,” The Washington Times: November 4, 2017.

[13] For a detailed discussion of this wasted opportunity see Lee (2016).

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*Dwight R. Lee is the Emeritus Ramsey Chair of Private Enterprise in the University of Georgia’s economics department. He is a coauthor of Common Sense Economics: What Everyone Should Know about Wealth and Prosperity, 3rd edition (St. Martin’s Press, 2016), with James Gwartney, Richard Stroup, Tawni Ferrarini and Joseph Calhoun.

For more articles by Dwight R. Lee, see the Archive.

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