State Children's Health Insurance

The best argument that something is possible, is that it already exists. The best argument that something can work, is that it is working. The State Children's Health Insurance Program (SCHIP) is a joint state-federal effort that subsidizes health coverage for 6.6 million people, mostly children, from families that earn too much to qualify for Medicaid but not enough to afford their own private coverage. A majority of Congress voted to extend coverage to another 4 million at a cost of $35 billion to be paid by raising the federal cigarette tax. Bush vetoed the bill arguing that it would “federalize health care,” read socialized medicine. One can argue about the extent of coverage, but Bush’s veto seems not concerned with specifics, but rather is based on simple ideological labels that seem to guide many of his decisions. The charge that some people who now buy private health insurance for their children would switch to the SCHIP does not mean the extension is not needed to help relatively low income people. Some of these people who are sacrificing a great deal to cover their children need help.

Internet Service Providers Tax Ban

Congress has voted to extend the ban on state taxes on internet service providers. This is hardly a fledgling industry that needs a tax advantage. Internet service providers say the price of Internet access could rise by as much as 17 percent if the moratorium on state taxes were allowed to expire. This is sheer hyperbole. What state would contemplate a 17 percent tax on anything?
The US Supreme Court has ruled that internet retail sellers may not be required to collect state sales taxes. This is hardly equal protection under the law, giving an advantage to out-of-state retailers. The following consequences are pointed out by http://www.newrules.com
 It subsidizes the growth of distant companies, which contribute little to a community's civic and economic vitality, by giving them a 6 to 8 percent price advantage over local stores.
 It undermines state and local governments by reducing tax revenue for schools, police, and other services, a revenue loss that will continue to grow as internet sales continue to displace in-store sales.
 It makes a regressive tax more regressive (only those with Internet access and credit cards are able to take advantage of the tax break).

Loss of Biodiversity

“Soccer moms are the enemy of natural history,” says Edward O. Wilson, Pulitizer Prize winning Harvard biologist. He is concerned about the loss of world biodiversity, and perhaps if children spent more time playing in the dirt and searching for bugs and worms, they would grow up with a greater interest and knowledge of life. He observes that we live on an unknown planet with only 1.8 million species named and partly understood. This may be only 10 percent of the total. We do not know what small organisms are out there that may be playing a vital role in our survival on earth. Loss of what we can’t readily see may be the end of us.
He suggests that a society is defined not only by what it creates, but by what it refuses to destroy. Surely, extinction of life forms has always occurred, but not at the rapid rate of today. Some of that destruction is caused by poor people putting great pressure on resources and habitat for their own survival. He believes that there is an ethical dimension to preserving biodiversity and that we must solve world poverty. More modest consumption by the rich would also help.

Lecture at Michigan State University, October 22, 2007

Mechanism Design: 2007 Nobel Prize

My campaign to reduce use of the mechanism metaphor in Economics has taken a hit with the awarding of the Nobel Prize to "mechanism design." The scientific background paper provided by the Swedish Academy drew a lot of "bunk" comments in the margin of my copy. On p. 1 it says, "Some markets are free of government intervention ...." Government and all markets form a nexus. The reference to Hayek and the aggregation of all relevant information is still questionable. p. 2, "The theory thus helps to justify financing of public goods through taxation." I thought the case was already made by Pigou. The assertion ignores the interests of what I call unwilling riders. p. 5, "private information precludes full efficiency." No Kidding!
p. 7 re: Groves and Clarke condition that "there are no income effects" makes the theory trivial. p. 8, the condition that agents be "expected utility maximizers is unreal. Economics must be the only field where prizes are given to people with conflicting views since Kahneman received the prize for showing expected utility to be false. The further conditions of "the set of possible allocations was unidimensional and the agents had quasi-linear references" is also unreal.
p. 9, "the probability of funding a public-goods project tends to zero as the number of agents increases." Conclusion: "classical Pareto-efficiency is incompatible with voluntary participation." Amazing what rigor produces! Every school child knows that the decision rule for most direct popular votes on public production/taxes are passed with majority votes. Some think this acceptable and others support politicians who promise to lower all taxes. The two sides are unlikely to alter their positions as a result of this rigorous analysis. If these results only "provide a rigorous foundation for Samuelson's (1954) negative conjecture about public goods" who needs it?
p. 19 with reference to social choice rules. Noting that indeterminate multiple equilibriums are to be expected, "The final outcome can then depend on negotiations and bargaining among the voters." Reference is then made to Schelling who observes that outcomes depend on "social and psychological factors." Heaven forbid that the world is explained by psychology and not mathematical deduction!
I can only conclude that the prize was given for rigor for rigor's sake and not for anything useful.

The Paper Economy: Credit Crunch of 2007

New inventions are not limited to physical things such as machines and electronics. Clever fellows in the financial world invent new forms of paper that give direction to the physical world of goods and services. The latest include zero down payment and adjustable rate mortgages (ARMs) and securitization of mortgages (mortgage bundles) called “collateralized debt obligations” (CDOs). Previously, home buyers obtained a mortgage from a local bank or mortgage company who evaluated the borrower’s ability to repay the loan and held the debt on the bank’s books. Now, these local firms resell the mortgages to brokers who package large numbers of loans to be sold to large national and international financial firms such as hedge funds and private equity buyout firms. In 2006, brokers accounted for 80 percent of all mortgage originations, more than twice the amount 10 years previously. The mortgage broker does not hold the debt, but is paid a commission. The more loans made, the higher the commission. This is an incentive for quantity, not quality. To obtain volume, home buyers with little savings and uncertain jobs were attracted to zero down payment ARMs. The institutional system of mortgage brokers and securitization is supposed to shift risk from local banks to those best able to evaluate and bear it. However, information is a problem. The risk of these mortgage bundles is evaluated by credit-rating firms who know that they will not get their fees if they are too critical.
Credit is at the heart of our paper economy. Hedge funds borrow money to buy these bundles of mortgages. Borrowed money is used to buy borrowed money. At the same time, borrowed money is behind a lot of the action in the stock market—private equity takeovers, leveraged buyouts and corporate stock buybacks.
One of the inventors of this new world of paper is Satyajit Das who estimates that one dollar of “real” capital supports $20 to $30 of loans. Derivatives (including CDOs) amounted to $485 trillion early this year, which is eight times the total global domestic product. In a period of rapid financial innovation and expansion, many firms profit from being highly leveraged, recently however, subprime loan default rates have doubled. Whole communities of non-maintained houses in receivership have appeared. In June, two hedge funds run by Bear Stearns went bankrupt with a loss of $20 billion. Countrywide Financial, the nation’s largest mortgage lender, is in trouble and its stock dropped 50%. Still, it makes little effort to restructure mortgages in default as it can make money on foreclosure fees.
The structure of incentives created by contemporary formal and informal institutions seems all wrong. Originators of mortgages have no incentive to seek quality, mortgage companies make money in foreclosures, and bond rating firms and real estate appraisers make fees by optimistic evaluations. Institutions structure the relationships among participants in the economy. New paper and new symbols organize production of goods and services. We know from past depressions and recessions that the physical components of the economy did not suddenly rust or freeze up causing massive unemployment and destitution. The problem lay in the institutional relationships. Institutional economists are skeptical of claims that markets automatically reach equilibrium. Rather they observe evolution and cycles. The contemporary practice of borrowed money being used to buy borrowed money is reminiscent of the stock market crash of 1929 when stock purchase on margin and purchase of the stock of holding companies was rampant. Satyajit Das sees hard times ahead as the economy deflates. I have no prediction. I certainly can’t claim to be better than Alan Greenspan who emphasizes that investment is based on expectations—a psychological phenomenon, not simply a matter of production functions. No one can really know when consumers and investors will lose confidence and withdraw. We only know that it can be quite sudden and tipped by unforeseen events of various kinds.
(Material and insights for this blog were collected from Charles Whalen, James Shaffer, Warren Samuels, Jon D. Markman, and David Ignatius.)

Paying for Iraq War

At the beginning of the Iraq war I wondered why, if the war were so important to American security, Bush did not ask us to sacrifice and raise taxes to support it. Instead, of course, he lowered taxes, especially on the rich. Bush knew that enthusiasm would be tempered if people were asked to pay at the outset. The following column by Thomas Friedman of the New York Times explains Bush’s logic?!

October 7, 2007
Charge It to My Kids
By THOMAS L. FRIEDMAN
Every so often a quote comes out of the Bush administration that leaves you asking: Am I crazy or are they? I had one of those moments last week when Dana Perino, the White House press secretary, was asked about a proposal by some Congressional Democrats to levy a surtax to pay for the Iraq war, and she responded, “We’ve always known that Democrats seem to revert to type, and they are willing to raise taxes on just about anything.”
Yes, those silly Democrats. They’ll raise taxes for anything, even — get this — to pay for a war!
And if we did raise taxes to pay for our war to bring a measure of democracy to the Arab world, “does anyone seriously believe that the Democrats are going to end these new taxes that they’re asking the American people to pay at a time when it’s not necessary to pay them?” added Ms. Perino. “I just think it’s completely fiscally irresponsible.”
Friends, we are through the looking glass. It is now “fiscally irresponsible” to want to pay for a war with a tax. These democrats just don’t understand: the tooth fairy pays for wars. Of course she does — the tooth fairy leaves the money at the end of every month under Treasury Secretary Hank Paulson’s pillow. And what a big pillow it is! My God, what will the Democrats come up with next? Taxes to rebuild bridges or schools or high-speed rail or our lagging broadband networks? No, no, the tooth fairy covers all that. She borrows the money from China and leaves it under Paulson’s pillow.