David Brooks

It's far to much work to write about everything David Brooks says, but one of his last columns was fairly irritating, as it continues the "behaviorist" trend he's been talking about a lot.

First, there is notion that somehow economics "doesn't explain" what's going on. Well, the decision of millions of Americans to stop saving and withdraw equity from this homes is a fairly rational response to the Greenspan put of record low interest rates and booming house prices. Actions by banks to leverage up and take advantage of these trends are also fairly predictable. The Austrians actually have a good story of the liquidity boom and collapse as well. If you actually care to understand financial collapse, there are a wealth of sources, from blogs to Krugman and Brunnermeir, that manage to describe ongoing events well enough. Many of these people were pessimistic several months ago. The models I use at work to describe trends in mortgage default rates work rather well especially if you stress them with house price decreases. The problem wasn't "modelling," but rather models that failed to take into account the underlying changes in the types of people getting mortgages.

Much of the behaviorist stuff, however, doesn't seem to me particularly well targeted at explaining ongoing events. Even if you buy Mandelbrot and Taleb that the tail ends of stock returns are fat, why should volatility increase now? The problem with a philosophy that people are just "stupid" is that it really lacks the ability to explain changes over time, or to explain ongoing events, or to predict future events. It works great for blaming people ex post, however, and makes for a good column. Even many of the Nudge policy prescriptions--improve information, set defaults correctly--seem exactly the neoclassical prescription as well.

For the behaviorists to get better at modeling actual economic problems of interest, they're probably going to have to move from a system that goes "people in general are stupid, as judged from undergraduates in labs" to "in certain conditions, more psychologically realistic assumptions yield better explanatory and predictive power."  That is, behavioral work would be really good at explaining heterogeneities in the population.  There is some good work heading in this area--that poor people have high time discount rates, for instance, but even there it's tough to separate a behaviorist from an economic approach.

Friedman's approach of using whatever assumptions are needed to explain the data probably isn't ideal either. Clearly the quality of the assumptions and the sanity of the model do matter, and most people do care about economic intuition. So there's nothing wrong with behavioral assumptions.

The big problem I have with this whole train of thought, however, is this implicit assumption that psychology is "better" than that abstract economics. Really? Every theory is wrong, so the power of the behaviorist critique ought to be judged by the quality of their insights and the strength of their competing model. And it's not like psychology doesn't have a host of problems of its own. First of all, it's entirely descriptive, rather than explanatory; an uncomfortable mix of "facts" that barely pass the p = .05 criteria of truth. When was the last time you saw an experimental study support the null hypothesis? Either these people have a fantastic record of picking hypotheses and running tests, or else experimental error is strife, or else they are suppressing all sorts of things. Their "biases" often extend in both directions, and often feel like things that good Bayesians should do anyway. It's not clear the extent to which biases  persist in outside of the lab, where social interactions are complex, or even to what degree they effect a given individual, after all of the potential moves in a direction are netted out.  For instance, the "Gambler's fallacy" says that people expect a coin to come out heads after many tails.  But the "hot hand" fallacy suggests that people should expect a run of tails to be followed by another tail.  Which result dominates?  It's not clear to me that the existence of human failings is an alternative, and better, explanation of ongoing events.

Brooks is, however, right about two things. For one, much of macroeconomics is rather bad at figuring out what's going on. What macroeconomic theory says the government should buy equity states in banks, or buy failing assets? Economists may support either position, but don't generally rely on macro to do so. The representative agent models don't capture the connections and risk that are driving a lot of systemic problems. One problem here seems to be, well, that the rational expectations movement has bound macro to microeconomic assumptions. Of course, the Sonnenschein-Mantel-Debreu theorem shows that microeconomic assumptions need not entail any macroeconomic consequences. People don't talk about this a lot. A reasonable conclusion seems to that people should do macro using whatever assumptions they please.

It's also true that the notion ownership hasn't worked out great. No one had a bigger incentive to make sure Iraq went well than the neoconservatives, yet it took a while for people to start caring.  Of course, as political actors, they had relatively lighter incentives to change their (fairly wrong) priors on the possibility of the spread of democracy.  Similarly, the bank executives had plenty of their own money at stake, yet continued to make outsize risks anyway. Many people did respond to ownership well, such as those hedge funds that correctly bet against the housing bubble or Goldman Sachs, but plenty did not. It's not clear what happened here.  It's much easier to justify taking the risks everyone else is taking, since you'll all fail at the same time.  But since your money it at stake too, shouldn't you care about the absolute return as well?  The loans that banks kept on their books failed as well as the loans they securitized and sold off to others.  What system of incentives, if any, could encourage people to actually do risk analysis?  This is not just a "suprime" problem; Emerging Market Debt was badly priced in Europe, while the rating agencies in general gave private firms too high marks relative to municipal governments.  Maybe people are just bad at analyzing risk, even with lots of their own money at stake.  

Get Angry

I don't like to link to stuff without much comment, but I couldn't agree more with this.

Tail Events

The financial crisis has gotten many people interested in the possibility of really bad, really low probability systemic risk. This is not a new idea; people like Nassim Taleb and Mandelbrot have discussed for some time the ways in which financial returns follow non-normal distributions, a fact which is difficult to determine from existing data.

Of course, volatility in equities has been driven by systemic risk in the financial sector. Brunnermeier, whose work I've talked a lot about, goes into some length in explaining how links between financial firms generate strong cycles and network effects. And of course connected networks are going to display the usual non-linear chaotic symptoms. This is not really new either; Friedman based his advocacy for strong government intervention in the financial sector in times of crisis exactly on such network arguments (of course, the argument also supported the claim that governments are 'bad,' which never really made sense; either the government is a malevolent actor and ought be eradicated, or else it is an imperfect one and should be made better).

My point is just that none of this is exclusive to stocks or finance generally. There are plenty of tail risks out there founded on network connections with enormous consequences. People have a really hard time grasping this cognitively--I know I do--and the urge to compartmentalize and reduce really prevents people from understanding or planning for these events. Nor does historical data help that much, especially since historical data is biased against existential risks.

I still don't understand that last point, but it's really big for considering the biggest such "unknown unknown"--nuclear war. So we've been really close to nuclear war on several occasions. Eisenhower's deputies tried to "normalize" the use of nuclear weapons, while of course there was Cuba (where tactical nukes were deployed by Russians with standing orders to retaliate against a military strike by the US, and standing orders for the US military at one point dictated an invasion). Other interesting events include Petrov, Arkhipov, at least one recorded case of near Soviet missile firing, and so forth. The possibility of bad signaling, faulty equipment, false signal, etc etc is disturbingly high. Nixon tried the "I'm an unpredictable actor" approach, but from the Soviet point of view (not the American) there were actually rational reasons for him to act scary. This is also all very systemic, as many bad things are likely to happen in unison. MAD works well enough in the long-run, but the tail risks are very bad. India-Pakistan is of course the same situation without response time. What is particularly scary about that is that at least some Pakistani military leadership believe they could genuinely come out ahead in a nuclear exchange.

The really bad thing about tail risks in this scenario is that they really are martingales, but the inevitable bad event is existential exhaustion. That is, the probability of total collapse multiplies across, so even if in every period there is a really low probability of a really bad event, that bad event will happen eventually. So most civilizations collapse eventually. But of course, before globalization, collapses had only local effects. Eventually, some collapse will take all of us down.

What such a record of near-misses should tell a Bayesian who believes in many-worlds is that "we" are the survivors of quantum suicide. The nature of quantum suicide is that if you risk your life, the universe "splits" into some in which you die and others in which you life, and of course you are sentient and alive only in certain universes. So, our status as alive, sentient beings is powerful information about the state of all worlds. That is, we live in a reasonably representative universe which has escaped the tail risk of nuclear holocaust, and are quickly heading towards the "miraculous" universe which escapes in the nick of time every time--at least, we are most likely to be conscious of that state of affairs. I like to think of this as the Golan Trevize universe.

Another way of saying this is that you should not be "surprised" that you live in a populous nation, in a populous country, and so forth, because likely you are a "representative" person in terms of where your sentience ends up. There are other statistical likelihoods you can deduce from this position. For one, it is unlikely that mankind will last much longer in present form or present population. After all, if we continue dodging tail risks, then presumably we will continue expanding as fact we can as organisms do. The sum total of humans who have ever lived will be really large; and the probability of us being born around now really small (of course, there are still plenty of people around now, and maybe we are exactly a low probability tail event). So our best probability estimates suggest that either the human population drops pretty rapidly from now (then we find ourselves near the mean population, historically distributed, where we expect to be) or else we are a type of consciousness that achieves a maximum around now. So our best estimes suggest a singularity or total extinction soonish.

I suppose it makes sense that I'm "reflecting" about all of this. How does age enter into this; should we expect to live more about as long as we have? That doesn't make a lot of sense, so either this is all wrong it's more proof of the "nowness" of now.

But a naive estimate of the total "intelligences" available across all universes has to be pretty large, right? Even a low-ball estimate for ET balloons pretty quickly, and the rare Earth hypothesis does not seem particularly likely given the total ease at which life spreads. After all, if life can thrive here, where can't it develop? So something seems wrong. Intelligence ought to be spread all over the universe, and intelligence should beget more and more intelligence through robotic means if nothing else. So, given that you must, by virtue of the fact that "you" are a being with experience and sentience, why this particular sentient being, given that sentience ought to be everywhere? Perhaps--again--we are a tail event. Or we are a type of sentience only found among certain intelligences. But the probability of being a type of intelligence is a probability like any other, and we ought to expect to be a representative intelligence. So--shouldn't we be that much smarter? Is this really the mean intelligence level out there? That's kind of sad--we've only really been thinking for a few centuries. Or maybe we are some of the "ants" of the intelligence world, and just really numerous, while the truly high intelligence folks hog a certain few states?

So I suspect that the tail events I've been discussing both make it extremely unlikely for intelligence to form--so we are very historically contingent--and also very quickly kill off (or else singularitize and make scarce) more advanced intelligences. Looking through Earth's history, there is no real fitness advantage to high g. Plenty of animals have succeeded with many strategies, but even bonobos are nearly extinct. Like a laser which depends on certain light particles escaping and then amplifying, I suspect that it's really, really hard to evolve intelligence; but once it comes up, it grows quickly. As it grows however, it rapidly develops for itself contagious, fat tailed risk and wipes itself out across most of the universes it occupies. Of course, I'm testing the joint hypothesis of extinction and singularity. Not that this could be "tested," except in a sufficiently advanced simulation.

But of course any advanced intelligence "should" develop such a simulation, and the total possible number of intelligence states is going to be far greater in the simulation than in the "original"--whatever that means. So we should expect to be in a simulation. And what is the distribution of the owners? Perhaps they are malevolent or nice, but most likely they are simply apathetic. Much the same way that "junk" DNA rapidly overtakes the rest, the efficiently copying and haphazard simulators ought to be the ones generating the most states of affairs (How well does the multiverse hold up in a simulation? Hopefully they are nice enough to keep the seed number for future reference or recurrence (in some meta-probablistic sense, don't we have to be recurrent? After all, recurrent events happen infinitely often, while non-recurrent ones only finitely, so we simply have to be recurrent for the same reason that you will never pick up the exact number one when drawing from a continuum distribution from zero to two)). If you want a clear policy takeaway, we could be more concerned about maintaining the robustness of human survival to inevitable extreme events. Asteroids and all of that.

Let me check in the morning if this makes any sense.

Malaise Theory

I've talked about this a lot but never really coherently.

The idea is that many times in history, you have a problem where a belief system becomes the established tradition but proves untenable given social changes.  Then you have a generation which only conceives of things in certain ways, while realizing that the foundations of their thought lack solid roots.

Pankaj Mishra offers a good overview of how this works in the context of Buddhism.  The Buddha was historically contingent, in that he needed to arise in some sort of rapidly changing cultural world.  The actual environment in India was one in which urban republics rose in power and the Brahminical elite was rapidly dispossessed in favor of roving bands of ascetic and a new merchant elite.  Lack of faith in the old morality, rising individualism and wealth, and social disconnect led to a growing intellectual dissatisfaction.  Buddhism's adoption of "dukkha" or the unsatisfactoriness of life as a key part of the doctrine was a natural choice given the social reality.  

Nietzche gets at a very similar phenomenon with the whole "God is dead" line.  The point being that the Christian myth--that life ought to be lived in accordance with an a system of absolute morals, while passions are denigrated and reason elevated--was increasingly at odds with the rise of science and secular culture.  I guess you could call this 'nihlism' broadly but it seems to me a more specific historical trend.

There are various possible responses.  Nietzche called attention to new "secular gods" and these really did become very popular.  Or you could just do drugs.  Being some sort of superman was Nietzche's suggested response, but it doesn't seem particularly feasible.  Generally, people seek validation in some larger system, and destroying one usually leads to a quick search for another.  The common response seems to be a version of utopianism.  On the left, there is this sense that if previous human arrangements universally result in human suffering, then somehow we can build a better society through the explicit rejection of all received wisdom and the adoption of a permanent revolution.  So you get this studious, affected distaste of just about everything, anger and grievance for the sake of it, combined with a hope in "change;" damn the actual need or path the change will take.

You see a response on the right too, especially among neoconservatives.  This ideology really came from a plea for a more humble and gradual approach for foreign and domestic policy, and was primarily motivated through a disappointment in liberal institutions, but somehow morphed into a paranoid style of politics.  From Cheney to Iraq, you have a well-chronicled story of disgust at liberals combined with relative ignorance and a limitless belief in the transformability of society (Iraqi or American) through partisan means.  Much as it pains me to say, something similar seems to happen with the free-market fundamentalists, especially once they get a bit of power in other countries.  This is not to say I'm a fan of Naomi Klein--you may know what I think of her--and many of the people involved are not conservatives.  

Heterogeneities

I'm aware of no economic theory that claims this, but it is case that countries and people do not grow, but rather certain areas and communities that shift into a capitalist mindset.  Most human societies can be characterized by sharp stratifications.  One group of course handles agriculture, others fight over wealth, and usually you have some group that does the trade.  These are the Jews of Europe, Chinese Hakka in Southeast Asia, Lebanese and Hausa in West Africa, Portuguese in Spanish America, Indian Gujaratis and Punjabis across the Indian Ocean, along with Parsis, Armenians, and many other groups.  The pattern for many of these groups is similar--you maintain an outsider status in another area while trading with them, combining knowledge of trade routes with local connections.  The advantage is that you get the trust and finance of a close-knit community essential for controlling risk and the potential for theft.  While a rich farmer is expected to redistribute his income to family and friends, a rich trader can loan that money out and hire his relations.  

This model of trade relies on a starkly pre-modern set of constraints due to the costs of abandoning openness and accessibility.  It really only makes sense for economies characterized by a complete lack of trust, third-party interactions, and liquidity, because really trade is one of the simplest forms of arbitrage and should happen frequently.  So it's interesting to see the success of this model through times of free trade and to the present day essentially due this system's ability to transmit certain values.

It's popular to complain about British colonialism of Asia as an outright plunder along Burke's lines, and there is much to that.  However as far as empires go, it was a relatively light one that encouraged free and open trade--certainly in contrast to intrusions after de Gama leading to the control of maritime chokepoints and a sharp reduction in inter-Asian trade conducted by Asians.  The evidence for British openness is given by the success of not only State-approved traders but third party merchants.  Be they Baghdadi Jews or Parsis or wandering Scotsmen, there was a lot of money to be made in this part of the world.  Beyond trade, you had a big rush towards offshoring manufacturing into these areas as well, including infrastructure and cotton mills.  The big question is why India and China didn't gain more from this growth, and why more communities didn't take part.  Odeg Galor's answer to the first is that the gains from trade led to greater income per capita in richer countries and greater aggregate population in poorer countries.  As far as the second goes, it's tough to say.  A regime of relatively open trade and commerce enriched some groups while others failed to take part.  Arguably, the inequality of economic power accruing to certain groups is inevitable in a free market and leads to violence when paired with democratic politics.  

Okay, both pre-modern economies and colonialist systems impose many constraints encouraging group identities, but the real suprise is that modern economies, if anything, amplify the advantages held by certain groups, largely because of the values these groups possess.  This is an amazing time to be alive, with a roughly meritocratic system and outsize opportunities for driven and educated people.  So it's amazing to find that people still fail to respond to these incentives.  On the other side of the distribution, former advisor to President Clinton William Galston says that you need to do three things to not be poor: finish high school, marry before having a child, and wait until age 20 to have a child.  8% of people who do these things are poor, while 79% of people who do not are poor.  Getting into family breakdowns gets into a world of unemployment, spatial mismatch of jobs, and deviant family structures.  Men really have no excuse, responding to the responsibilities of being primary bread-winner by falling behind academically and extending adolescence.  The media doesn't really provide any good role models here either.  

But the broader point is that there are people in a culture of success and other people who are not.  These build on long-existing differences in attitudes towards work and education held by different groups in society, and extend on an array of political, cultural, and arguably genetic grounds.  While economists like to assume that people are in some sense similar and respond to incentives equally, there is clearly some sort of culturally conditioned response to opportunity.  In many ways, the capitalist mindset is inhuman and difficult to adjust to as a whole group.  One consequence is that the demographic composition of a standard American elite college in no way mirrors that of the country as a whole, but these people comprise an elite class, and the admissions officers staffing the gates prefer to diversify on the basis of superfluous characteristics while blaming poor schools for colleges' inability to draw from large segments of the population.  The great thing about such a meritocratic system is that you co-opt exactly all of the people who would otherwise complain.  There has probably been too much hand-wringing about whether there is a "genetic" or "cultural" basis.  Cultural connections established at an early age seem rather as firm as those established by genes.  

I realize that this is not very original, but I don't see many other people talking about this.  This trend doesn't look like it's going away.   

More Regional Disparities

The point of talking about changing political competition is to explain the regional disparities that prop up in many places. So far there is the story of how that happened in the South--that the end of Democrat political dominance and the beginnings of economic growth are related--but I think this is broadly applicable in many places.

In India, you have the result that the Congress Party saw an close to their political monopoly in 1991 and many good things started around the same time. These are commonly seen as unrelated but my sense is that there is a relation. This appears to make that point, though a little dated, while this makes the argument with respect to human development indicators.

One interesting consequence of this idea is that wedge issues that break up an otherwise indifferent electorate really matter. The end of Democrat power in the South was fueled by such issues as abortion and Civil Rights, while several Indian states have seen the rise of regional parties that exploit various linguistic differences and petty concerns. The actual issues may be inconsequential, but they perhaps explain why southern Indian States--in which these issues were more salient, resulting in greater competition between the regional parties and Congress--generally developed more before 1991.

After 1991 you have the development of a plausibly national party of the Right as well as many other regional parties. It's tough to tease out the effects on the national level, but on the state level there were many differences coinciding with the growth of state-level disparities. The effects are not entirely positive, as in order to gain popularity the parties do all sorts of things such as incite violence, go for blatant populism, and so forth. The current Reddy-led Congress government in Andhra Pradesh is a great negative example of this--aside from bad populist schemes catered to every group, they went to far as to declare a cease-fire with Maoist rebels to allow them time to rearm, so now you have more violence than ever. And the anti-incumbency factor being what it is, many parties plunder as much as they wish while in office and rail against corruption once out of office.

But in a general climate of institutional decay, you do see some degree of improved state-level governance spurred by political competition within states and economic competition across states. To some degree this has happened across all parties: the current BJP governments in Gujarat, Madhya Pradesh, Rajasthan, Chhattisgarh, and Karnataka are all reasonably promising, while BJP-supported governments in Orissa and Bihar have upended both political dominance and bad governance. Bihar is a particularly good example, as former Chief Minister Lalu put together a populist majority and let the state wither away. New governance has improved conditions, while Lalu himself--pulled by the incentives of ascending to Prime Minister one day--has turned out an unexpectedly good manager of the Railway system. Meanwhile, Congress control of Delhi has turned out extremely well.

There's much, much more to this than just that. An excess of competition (this seems similar to the excess-entry argument in IO) in places such as Uttar Pradesh seems to simply make governing anarchic. When parties compete on grounds of solidarity or identity rather than issues or ideologies (no matter how apparently distant from actual conditions) there are fewer incentives for governments to perform well. The growth of the middle-class is really important as well, as parties begin to compete on the basis of their political values. There are many particular state-level dynamics--in Gujarat the BJP has simply dominated for some time and run a tight ship--that complicate issues. But the basic theme seems right to me, and also relatively unexplored in past studies.

Edit: It would be awesome if I knew the politics of more than two democratic countries.

More New South

Thanks to those of you (especially Chris) who had things to say about the South.  To the left is some data that gets at the point I'm trying to make.  You have a graph of per capita personal income growth relative to 1948--so this is measuring post-WWII regional disparities in growth.  The Southern states appear to be moving in unison faster than the other plotted "blue" states like California and Illinois.   

Obviously, some of this is catch-up, as the South was relatively undeveloped for a while and then various changes made it economical for companies to take advantage of the income differential.  But the development literature is also clear that convergence requires meeting certain hurdles.  Going back to 1948, armed with knowledge of future trends in services, manufacturing, and agriculture, I think you'd be hard pressed to imagine the South as a leading area of growth in the country, but that's in fact what has happened.

So then the question is why did this happen.  Here is a long list of potential explanations, implicating among others a big push in infrastructure, human capital development (the Rockefeller-funded hookworm and malaria eradication projects were also useful), climate, and of course AC.  I find these explanations slightly ad hoc and they really seem to beg the question, while also better at explaining the earlier takeoff rather than the current trajectory.  My suspicion is that within a country like the U.S., state-level institutional differences explain at least some of the difference.  

And there is in fact a political explanation which largely makes my point by arguing that the breakdown of the Democrat majority after 1960 spurred economic growth.  While I emphasized Republicans, the point is really more about the changing electoral dynamics and the growing political power of people who do not have quite the entrenched economic interests as people elsewhere in the country (though if I read the paper right, the Republicans do have a larger impact on growth).  So the argument is that the South grew because it got better political leadership which prioritized high-growth policies, though of course other things were involved.  

If you look at the right of the graph, you'll see that the growth gap appears large and growing (though blue states remain richer).  These are very partisan viewpoints, but they argue fairly convincingly that Southern states are doing well and Blue/Rust Belt states are not doing so well.  In some sense it's no surprise that the Chicago politician sees a bad economic climate and the Arizona senator sees good fundamentals.  Of course assigning causality is hard, but it's much easier on a state level--where governors can get legislation passed and attract businesses--than on a national level, where all one really has to do is not make too many mistakes and hope you get lucky.  

If you really believe these results, they point to a radically different American regional differentials.  This New Yorker article is an interesting view on Rust Belt/Appalachia and their future prospects.  They really don't look great, and I somehow doubt that Presidential politics--which was the focus of the piece--is really going to change that.  Of course, there are really two issues here.  One is the increasing regulatory and business advantage certain states hold, and the other is the continued breakdown of the American family.  The second is a lot more important--I know of no community in this country that doesn't prioritize stable families, education, and hard work that isn't doing pretty well for themselves--but the first is much more open to political change.  But again that comes from the grassroots, and the South was lucky in that it lacked the unions and pork and could jump ahead to the jucier bits of development.  It's hard to imagine this happening in many struggling states and cities, which seem to face single-party dominance and not much of a constitutency for change (more of the same?).  

The overall situation here seems to be a global trend, in which the world as a whole converges with substantial hetergeneity on political and cultural grounds.  India is a good comparison as a pluralist democracy with substantial political devolution of powers to states.  And you see the better run states getting better while other struggle.  Freer markets seem to accelerate this process; amplifying the gains while making it harder to deny people their rationalizable worth.  Many people see a "race to the bottom" but optimistically, the incentives are there for everyone to govern and produce better.

How to Bailout

I haven't done too much on recent market nonsense, as I don't really know what's going on anyway.  If that's the sort of thing you're into, there are many, many good places to look at that right now.  

I was impressed by this suggestion by Mankiw, however.  Everyone agrees that the deleveraging of financial institutions sparked by falling asset prices and rising counterparty risk has thrown financial institutions into a frenzy.  It's hard to get a loan these days, and uncertainty and panic are pretty widespread.  

The Paulson Plan attempts to combat the uncertainty through a massive government intervention to purchase illiquid assets.  This both injects liquidity into the system and helps set a market price for mortgage based assets.  The whole point of securitization was to better price certain risks and spread them to those best able to bear them; this plan would help price the prices of those assets which are now currently in a free-fall and place them in government control for a few years.

There has been a lot of criticism against the plan from the conservative, theoretical side.  Their complaint is that the goal of any financial rescue should be to identify the solvent and unsolvent institutions, and recapitalize the decent ones, rather than bailing out the firms which made the worst mistakes.  There are ways to coordinate firms raising capital on their own--eliminate dividends, borrow from the Fed--but the government could also take an equity stake in the bank.  The nice bit about giving banks cash is that every dollar of fresh capital can support $10 or so of debt, improving the capacity of banks to deal with liquidity concerns and bad assets.  The government also has a better up-side with their investment than in the garbage housing pile.  

The critique of that view is that equity positions deter private investors while giving governments undue power over banks.  Without going to much into further levels of arguments, here's Mankiw's plan:

Whenever any financial institution attracts new private capital in an arms-length transaction, it can access an equal amount of public capital. The taxpayer would get the same terms as the private investor. The only difference is that government’s shares would be nonvoting until the government sold the shares at a later date.

This is nice as you get the benefit of fresh capital injections into failing banks, without deterring other investors.  While it is difficult to separate the good banks from bad (and nearly impossible to figure out good mortgage assets from bad), this way you rely on the aggregate assessment of vulture investors.  Obviously the judgement of investors has not proved to be great, but it can be presumed to be better than that of a politically-motivated body.  This is great for private firms--which piggy-back on the government--while reducing search costs and the risk of capital impairment on the part of the government.  Traditional libertarians are of course against any measure that involves government spending, but I tend to be more concerned about the impact of government than its sticker cost, and this seems a great way to prevent total financial collapse without having the Treasury bear all of the costs and none of the gains.  Such a plan is also likely to make money over time, and the borrowing necessary for a deal is unlikely to have any impact given the massive demand for relatively safe T-bills.  I really have nothing against the government doing this far more often if it cuts my taxes.  There hasn't been any discussion of this idea; I'll be interesting to see if this gets any traction.

The New South

There is no guarantee that the following makes any sense.  

Many people are interested in the notion of economic convergence.  Economic theory predicts that in the long-run, all economies should move to the frontier of development.  So Japan meets the West, expands a lot, and now has has the same standard of living as other rich countries while growing at the same rate.  Obviously this doesn't happen everywhere, and the question is whether the sources of those differences lie in genetics, culture, institutions, policy, or something else.  

One such convergence situation is the post-WWII behavior of the American South.  The South had always lagged the North in development, but this was earlier a geographical issue as the Southern plains attracted the Barbados-based plantation elite while the North pursued trade and manufacturing.  This gap continued.  The geographical barrier to convergence disappeared with a higher level of technology, and the fact that the South and the North are in the same country mean that a lot of other barriers to convergence were not a big deal.  The main barriers to there being similar economies in the North and South became institutional and related to the quality of governance.  

My argument is that ultimately changing institutions created the "New South," and that this really started to change with the political dominance of a group of socially conservative Democrats and Republicans in the '60s with a constituency broadly in favor of different economic ideas.  The shape of this new ideology--Goldwater Republicanism--was formed by many things.  There was an influx of Northerners.  Broadly, there were push and pull dynamics creating essentially a new party.  On a more national level, this is covered negatively by people like Krugman, who sees a basically racist Southern strategy, and more positively by people like Brooks or Douthat.  

The push factors include the racial fallout of the Civil Rights movement, which both increased Democrat votes from black voters and shifted many white voters into the Republican Party.  Liberal judicial decisions were another factor, from busing (again, more racial stuff, but one that lead to more private schooling, which was Christian, and so led to more evangelicalism) to Roe v. Wade.  The growing Christian gap would become a larger factor later on.  There were pull factors as well, as the newly constituted Republican Party was better able to attract natural conservatives, with their focus on law and order issues, taxes, welfare, cultural topics, and so forth.  I can imagine tipping effects, in which more and more conservatives join the Republican Party, which markets itself as more Republican, and so forth.  It's easy to call this racism, but it seems to me a more basic consequence of a pluralist society.  Societies riveted by ethno-linguistic divisions display much less social trust as a whole, and tend to have less redistributionist institutions.  This is not necessarily linked to race, look at India, in which caste divisions behave politically much like ethnic rivalries, and really hamper coherent policies.  

The product of these forces was to yield a much more ideologically consistent and partisan set of political parties in the south.  With a median voter that's conservative in the South, you end up with rotating conservative Democrat and staunch Republican governance.  The traditional base of the new conservatives consisted exactly of the sort of people open to a more upwardly mobile, free enterprise system of government, so an economic conservative approach became a natural fit to this program.  

Of course, the development of the "New South" had to do with many things, among them the rising importance of service industries not linked to geography, technology, AC, highways, and the positive impacts of Civil Rights bills in desegregating the population.  But many of the proximate causes of the convergence between North and South needed to take place in a tolerable institutional environment, which was then supplied by the new Republican governors.  Low-tax regimes, opposition to union labor, State subsidies, spending on infrastructure, education, and research, and so forth attracted an array of manufacturing (car manufacturing) and service (banking, telecom) interest; even as many economic fundamentals were in long-term decline (textiles, furniture, cotton, agriculture).  

With the recent transformation of the Republican Party into the Party of the South, it's popular to talk about how the social hangups of Southerners have become the stuff of national cultural wars.  But it's interesting to see that the institutional barriers between North and South has largely revesed itself with the South in an arguably better position.  There have been some attempts to take on the old guard in blue areas--especially by moderate Republicans like Romney, Bloomberg, Giulianni, and Schwarzenegger, and some moderate Democrat responses like Daley, Spitzer, and Cory Booker (Are these attempts to be a Clinton Democrat on a more local level?).  But largely, Blue states continue to hemorrhage people and jobs to the Sun Belt.  This election continues in many ways that trend, with the choice between a Chicago politician who promises more regulation, higher taxes, and a host of industrial policy technocrat intitiatives to solve problems in health care, energy, and education and an Arizonan politician who combines sufficient deferrence to the socially conservative wing of the party with a support for lower taxes and less regulation.

The ultimate consequence of this state variation in development policies is the Housing Bubble.  In some sense, it's a myth that we had a "national Housing Bubble"; it remained in many ways a regional problem with certain areas like California, New York, Chicagoland, and (yes, somewhat counter to the point) Florida.  Tight land regulations in these areas artificially inflated the value of land, creating the actual housing "bubble" that encouraged poor lending tactics and eventually the securitization problem.  Places like Texas, Georgia, Arizona or othern Southern areas that don't have quite the zoning regimen had a flexible response to demand in housing and so never suffered quite the price movement up or down.  These places are really being spared the worst of the current problems, while continuing to attract more corporate headquarters and operations.  Another housing implication is that since Democrats generally run cities, and since Democrats generally favor regulations, you have city-level housing markets that are absolutely horrible, with the attending higher housing prices diminishing to a large extent the value of a College degree (since of course you don't attend a top-tier school and move to Nebraska).  

Of course, the old Democrat holdouts are still home to some of the most amazingly productive sectors of the economy (Sillicon Valley, New York) with the associated Universities and so forth.  So the combination of highly productive people with an increasingly pushed middle class yields greater inequality issues in Blue States, and then of course that's all they talk about.  You could probably make the case that what Blue States now need is Republican governance, and Red States some Democrat policies.  

One reason for the general success of the Republican method is that state-level government has many different spending priorities and issues than on the national level.  And since state governments can't hold a deficit; national-level Republicans have of course run up the national debt, while state-level Republicans have not.  So while the national level assessment of Republicans is mixed--they might have saved the economy from turning into Europe, but they also messed up a lot of stuff on spending--the state-level economic assessment tends more positive.  

I think the crucial point is not that the Republicans are smarter, but that the people who vote for them are generally social aspirers open to new business with little personal stake in bureaucratic pork, which leads to broader support of a certain free-enterprise economic agenda, combined with the fact that the Republican talent pool is incorporating business-minded people.  Look at the ranks of prominent Southern state-level Republican politicians, and you see both a bias for religion and business.  Bush fit this model rather well, what with his MBA and so forth.  Of course you still have the lawyers (in America and Britain, politicans are chosen from the stock of lawyers, while in Korea and Germany it tends to be engineers), but it still seems to me a contrast between the sorts of people who have run Democrat machines in other parts of the country.  Edwards, Hillary, and Obama were all of course lawyers (on the other side, you have Romney a businessman-turned-governor, Huckabee a rather effective preacher-turned-governor, and so forth) and the primary race at times really felt like a battle between the UNC-educated lawyer who specializes in court cases and the Ivy-trained lawyers who focus a bit more on the academic stuff.  Arguably, neither group is really set to run an economy.  Corruption seems like an inevitable outcome, but really no one cares about corruption paired with actual development. 

I guess one of the things this is a reaction to is the notion that economic conservatism is just a really bad idea that was pushed on the Americd toan people, with universal devastating consequences.  I hear this from a lot of people, who just can't imagine that the Regan/Bush gang were really anything but absolutely horrible.  I ten push a little against this idea.  

Update:  There is also the cultural change in the South where more people become evangelical Christian and that starts to matter.  Is that another factor?

I'd love feedback on this to figure out whether to actually pursue this idea.  

The Fundamentals

There's a good bit over at the Center for Global Development on taking the long view with respect to the economic consequences of the financial crisis.  At the end of this post are a bunch of graphs illustrating that point, containing actual and extrapolated GDP per capita for the U.S., Western Europe, China, and India on a logarithmic scale:

Looking at the actual data, it's interesting the extent to which the American real economy basically grows at a steady rate, without reference to bubbles, panics, wars, or economic and financial crises.  So despite this talk from Naomi Klein and others that we're facing a monumental crisis of faith in our economic organization, as far as the economy as a whole is concerned, we will probably just revert back to the hist

orical average.  That's not to say that there won't be distributional issues.  

Another interesting point from the historical data: Recent growth rates are higher for America 

than Europe.  Of course at least some of European growth after WWII reflects capital replacement, but it's still interesting to see that growth rate pivot somewhere in the '70s, while American growth rates continued to rise.  It's not shown here, but England shows no pivot while Ireland pivots up.  There's an argument out there that under conservative governance (but also going back to Kennedy's supply-side tax cuts and Carter's deregulation), England and America made the necessary but painful transition into a more free-market system and so enjoyed hig

her growth rates than their Continental peers.  It's certainly true that while there are many people out there calling for the demise of American economic hegemony, as the graph shows, America has kept its share of world GDP relatively constant over the last few decades while Europe and Japan have plunged and non-island Asia risen.  The American model of relatively free immigration and relatively free markets may lead to a financial crisis every ten years or so, but in the long run it's very good at generating wealth.

Looking at India and China, you really see the growth takeoff in recent years.  While China's pivot is located at the Deng political reforms, India's growth actually took off a bit before the 1991 liberalization.  This is well-known among Indian economists but tends to be overlooked by people elsewhere who prefer the reform narrative.  The growth that did happen in the '80s was unsustainable, related to hesitant reform, and fueled by currency depreciation and excessive government debt.  In fact India did face a balance of payment crisis in 1991, leading to the "shock capitalist" systemic reforms that did, of cour

se, lift millions out of poverty.  

As Easterly notes, the biggest consequences of economic shocks tend not to be in the economy itself--which recovers eventually--but on the world of ideas informing regulatory and economic structures.  So the worst economic consequences of the Great Depression are not actually felt in America--where the country is about as rich as it would be were there no Depression--but in the developing world, where the Depression served as a cautionary tale of the free markets previously dominant and encouraged cataclysmic failures in government planning worldwide.  Due to historical influence, these institutions persist till today and continue to impoverish.  I guess what I'm trying to say is that some sort of Sarkozian arrogant claim of necessity for changing the structure of the economy could end up very very badly.  

As far as the predictions go, I estimated a model and fudged the numbers from there.  In constant 1990 dollars, in the year 2030, I see Europe with a GDP of $29,000 per capita, America with about $45,000, China with $14,000 and India with $6,700.  The Europe/America gap is of course large.  Given the wealth of talent over there, I have to imagine 

that some degree of convergence will bring the two areas closer to each other as they have been historically; but maybe this will only happen for those parts of Europe that improve their institutions and maintain fertility? 

Overheard on 53rd Street

"Hey, you'll never guess who I just saw!"  

"Who?"

"Obama!  He was at Boston Market with the Secret Service and everything!"

I always knew he was an old fashioned Northeast liberal.

A Farewell to Alms

Gregory Clark's book is one the best I've read on why some countries are rich and others are poor. There is plenty of excellent data, though the discussions are not particularly satisfying. Very similar to Maddison, he argues that the roots of the economic growth explosion that began in Europe go deep, and were fueled not by machines, but rather a number of cultural and genetic changes which shaped labor productivity and views towards entrepreneurship

The discussion on institutions is a shaky. Clark portrays England as having a Washington Consensus level of institutional development, with property rights and the like, for much of its history. The failure of medieval institutions to foster growth is taken as evidence that institutions do not matter greatly, but are rather responsive to local conditions. This attacks a whole trend to see institutional differences (ie between East and West Germany) as the source of economic variation. Institutions, however, are more complicated than an checklist of rights to secure. Rodrik will point out the general failure of the Washington Consensus to establish the sorts of institutional arrangements that are critical to growth, and the importance of eliminating salient roadblocks to allow growth. The rule of William of Orange, for instance, was crucial to establishing Parliamentary control, and the subsequent interest rates on government bonds--a key measure of the development of society according to Clark--dropped dramatically afterwards.

Clark is most convincing when he argues that differences in labor productivity and the spread of values down classes are powerful explanations for growth. Though he links these changes to a genetic-cultural complex, it's not clear that cultural variations explain economic changes. If productivity in many economies was so bad in the past, how did it suddenly change recently in places such as East and South Asia? Broad changes in culture or genes are unlikely, while infrastructure and institutions changed drastically during that period. There is clearly something going on there though--the time since a group has first used agriculture seems to predict current wealth, which presumably reflects the extent to which thriving in modern society requires a shift in mentality. Clark is right in suggesting that there are basically two periods in history--before economic divergence, and after. There are too few people examining what caused the shift from one to the other.