Economic Navel Gazing...

PAUL KRUGMAN has a new piece up on the NYTimes website on new debates within the Economic community springing from the economic meltdown.

Krugman can be tough to take -- in fact some members of the Commission find his smug certainty that he is always right, and significantly smarter than everyone else in the room almost intolerable -- but this piece is definitely worth reading.

There are a number of telling points in the article dealing with the fact that most economists never even saw the possibility of the current recession...

stocks and other assets were always priced just right. There was nothing in the prevailing models suggesting the possibility of the kind of collapse that happened last year.

As a result of this failure, Krugman sees Economics returning to Keynesian thinking - which of course coincides nicely with his increasing support for Government intervention in the economy...

Krugman uses as an example a true story of a babysitting co-op in Washington DC:

This co-op, whose problems were recounted in a 1977 article in The Journal of Money, Credit and Banking, was an association of about 150 young couples who agreed to help one another by baby-sitting for one another’s children when parents wanted a night out. To ensure that every couple did its fair share of baby-sitting, the co-op introduced a form of scrip: coupons made out of heavy pieces of paper, each entitling the bearer to one half-hour of sitting time. Initially, members received 20 coupons on joining and were required to return the same amount on departing the group.

Unfortunately, it turned out that the co-op’s members, on average, wanted to hold a reserve of more than 20 coupons, perhaps, in case they should want to go out several times in a row. As a result, relatively few people wanted to spend their scrip and go out, while many wanted to baby-sit so they could add to their hoard. But since baby-sitting opportunities arise only when someone goes out for the night, this meant that baby-sitting jobs were hard to find, which made members of the co-op even more reluctant to go out, making baby-sitting jobs even scarcer. . . .

In short, the co-op fell into a recession.

What Krugman ignores by using this story is that the co-op members self selected to join the group, and therefore had common characteristics that made it a structurally inefficient economy. Babysitting is not generally an occupation that parents would choose to do, and the fixed exchange rate of the currency does not create enough value to overcome the inherent challenges in getting parents to do additional babysitting in trade for future babysitting.

While the Commission is happy to see Economist begin to appreciate that not all markets are perfect, and not all individuals make "rational" decisions, it is is not excited by calls to return to pure Kaynesian thought. In the Commissions view, Keynesian thought discounts the Externalities caused by government intervention in the economy, and those externalities played a big (but almost universally ignored) part in the lead up to the economic collapse.

While the Commission does not agree with neo-classical economists that unemployment is driven by people making a conscious choice to work less.... it does recognize that government policy has created some of the joblessness...

By relentlessly advocating increased home ownership and failing to encourage citizens to understand the trade-offs that come with owning a home, it played a large part in causing the bubble... Government policy ignores the fact that owning a home makes it much harder to move to find a new job. In fact, through action at the local, state and federal level, government encourages people to think that they have a pre-ordained right to have a job in the community of their choice. Through advocacy, government has created an entire cadre of irrational consumers, as well as fundamentally irrational markets in employment and housing...

Mr. Krugman would ignore that fact, and advocate for increased government action.

Guilt and Shame in Child Rearing...

Joshua Gans (author of Parentonomics) over at his Game Theorist blog points out a good article in the New York Times on the value of Guilt in child rearing.

Here is the link: http://www.nytimes.com/2009/08/25/science/25tier.htm

Unlike Shame -- something that should definitely be avoided in raising kids -- recent studies (including the somewhat cruel one detailed in the article) seem to indicate that a good sense of guilt is positively correlated with good behavior.

So apparently the Commission's mother(s) were on the right track after all...

Cap and Trade vs a Carbon Tax...

Gregory Mankiw had a great article in the New York Times this weekend on Climate Change and the proposed Cap and Trade program that is making its way through congress -- you can read it yourself, here.

Whether you are a believer in global warming or not (and the commission knows that some of you are not convinced), this article does a good job of highlighting the differences in the Cap and Trade program that President Obama campaigned on, and the one proposed by Congress.

Basic economics teaches us that if we want to actively reduce the carbon emitted as part of economic activity a Carbon Tax would be the most effective way to do so. Even those who do not believe in global warming would agree. The higher cost of releasing carbon as a byproduct of production would drive increasing efficiency and the search for new methods of production that did not reduce carbon. At the same time, prices for those products would increase. The revenue from the Carbon tax would be used to offset these higher prices through tax reductions.

Despite the fact that it would be the most efficient, a Carbon Tax is not politically viable. That leaves Cap and Trade. What Mr. Mankiw points out so effectively in his piece is that the Cap and Trade legislation is substantially less efficient than that proposed by President Obama when he was running.

The numbers involved are not trivial. From Congressional Budget Office estimates, one can calculate that if all the allowances were auctioned, the government could raise $989 billion in proceeds over 10 years. But in the bill as written, the auction proceeds are only $276 billion.

The issue is by lowering the proceeds to $276 billion -- that reduces the possible taxes to be offset -- which will mean higher prices in the rest of the economy.

As Mr. Mankiw explains:

The hard question is whether, on net, such a policy is good or bad. Here you can find policy wonks on both sides. To those who view climate change as an impending catastrophe and the distorting effects of the tax system as a mere annoyance, an imperfect bill is better than none at all. To those not fully convinced of the enormity of global warming but deeply worried about the adverse effects of high current and prospective tax rates, the bill is a step in the wrong direction.

The Commission feels that if we are going to try and do something about global warming, we should do it in the most efficient way possible. Unfortunately, Congress is hardly the place to go for efficiency...

The battle over Credit Card fees begins to heat up...

The New York Times has an article today on the brewing battle between Retailers and Credit Card issuers.

Card Fees Pit Retailers Against Banks -- NYTimes.com

At issue are the fees paid by retailers on every single credit card transaction they process. Some folks don't realize it, but when you pay for an item with a credit card, the retailer is making 2%-3% less then they would if you paid with cash or a check. Retailers would like to have this rate reduced, while issuing banks are adamant that the fees should not go down.

The Times appears to be approaching this story from the Retailer's perspective, and in doing so, glosses over the reasons credit cards exist in their current form.

Yes, banks make significant fees from processing these transactions, these fees help provide the incentive for these firms to continue to offer consumer credit, and along with their interest income, offset the risks inherent in the business.

But the banks aren't the only ones who benefit --retailers benefit too.

Imagine for a moment, a world without bank issued credit cards... Retailers would have to accept far more cash tranactions. Additionally, in order to increase sales, they would likely develop independent credit facilities -- i.e. store credit accounts -- and accept a large number of checks.

Sound familiar? That pretty much describes the world before Credit Cards. Granted, it was a simpler time, but what about the drawbacks?

Retailers had far more physical cash on hand. More cash on hand sounds like a good thing, but in reality, it forced more banking transactions, required more on-site cash management, and significantly increased security needs -- all at additional cost to the retailer.

Issuing store credit sounds great, but it moves all default risk to the retailer. It doesn't take many defaults to start adding up to a lot of money. It also requires retailers to have active credit departments -- with all the inherent staffing costs that entails.

Accepting more checks, also increases the number of banking transactions, and puts the retailer at risk of accepting checks that bounce.

These issues are a large part of what drove the market for modern credit cards, with banks taking on these risks.

The question really comes down to this -- do those potentially increased costs total up to more than 2%-3% of each CC sale. They sure did -- that is why we have seen an explosion in CC acceptance over the past 30 years.

See a brief history of credit cards (according to Wikipedia).

Whether those rates are still appropriate, or have become too high is a market discussion, and one in which the government should play no part. If the rates are too high, and the costs to retailers is too much for the market to bear, then the market will resolve the issue independently. Among the options:

1) Retailers start to discourage CC use, and the CC issuers, seeing a decline in business reduce their fees to an equilibrium rate.

2) Seeing an opportunity created by the high processing fees, a new player enters the market with competitive rates and the market reacts.

3) Retailers develop their own Credit processing network and compete directly with issuers.

I am sure that readers can think of many more.

The government's only role should be making sure that they are not interfering with the market's response to this issue. New competitors should be allowed to enter the market and earn the same regulatory acceptance that current players now enjoy, without undue bureaucratic hurdles placed in their way.

Don't Believe the Hype -- Job Retraining Edition...

For years, the 108Warren Commission has been skeptical of "Job Retraining" programs.

The programs are funded by state and federal tax dollars and are designed to help educate folks who have spent the bulk of their career in jobs that are no longer economically viable so that they can move on to a new career. On its face, this sounds like a great idea, and one that most taxpayers would be reasonably comfortable paying for.

Skeptics on the other hand, have pointed out that the employees most commonly displaced are those with the least education, and those least likely to be successful in developing new skills. While some have college degrees, most have not seen the inside of a classroom since they graduated from High School 20 years earlier. Even discounting the likelihood of potential age discrimination, the challenges facing "retrained" members of the workforce are not easy to overcome.

Now, in a bit of a surprise, the New York Times is pointing out the pitfalls of "Job Retraining." In an article on July 6th, Job Retraining May Fall Short of High Hopes, Times reporter Michael Luo points out the challenges faced by a group of Michigan residents who are going through, or have already completed "Job Retraining."

As an added bonus, Mr. Luo's article also pointed out a "little-noticed" study by the department of Labor that highlighted the same issues. For a link to this study, please CLICK HERE. Be warned, the factual conclusions are not highlighted in the Executive Summary -- in fact, the Summary appears to be cherry picking positive statements somewhat out of context.

As a concept, helping employees in displaced industries develop new skills so that they have improved odds in the job market is a good thing, but it is not a panacea. The reality is that the best thing we can do for employees in industries that are being displaced is to begin to train them for new opportunities while they are still working, and for that, the workers have to take the lead themselves.

As in most things, employees taking personal responsibility for their careers will be able to set themselves up with more options than those who don't.

Hat Tip to Marginal Revolution for the link.