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In a previous blog posting, I suggested that there is no case for capital adequacy regulation in an unregulated banking system.  In this ‘first-best’ environment, a bank’s capital policy would be just another aspect of its business model, comparable to its lending or reserving policies, say.  Banks’ capital adequacy standards would then be determined by competition and banks with inadequate capital would be driven out of business.

Nonetheless, it does not follow that there is no case for capital adequacy regulation in a ‘second-best’ world in which pre-existing state interventions — such as deposit insurance, the lender of last resort and Too-Big-to-Fail — create incentives for banks to take excessive risks.  By excessive risks, I refer to the risks that banks take but would not take if they had to bear the downsides of those risks themselves.

My point is that in this ‘second-best’ world there is a ‘second-best’ case for capital adequacy regulation to offset the incentives toward excessive risk-taking created by deposit insurance and so forth.  This posting examines what form such capital adequacy regulation might take.

At the heart of any system of capital adequacy regulation is a set of minimum required capital ratios, which were traditionally taken to be the ratios of core capital[1] to some measure of bank assets.

Under the international Basel capital regime, the centerpiece capital ratios involve a denominator measure known as Risk-Weighted Assets (RWAs).  The RWA approach gives each asset an arbitrary fixed weight between 0 percent and 100 percent, with OECD government debt given a weight of a zero.  The RWA measure itself is then the sum of the individual risk-weighted assets on a bank’s balance sheet.

The incentives created by the RWA approach turned Basel into a game in which the banks loaded up on low risk-weighted assets and most of the risks they took became invisible to the Basel risk measurement system.

The unreliability of the RWA measure is apparent from the following chart due to Andy Haldane:

Figure 1: Average Risk Weights and Leverage

This chart shows average Basel risk weights and leverage for a sample of international banks over the period 1994–2011.  Over this period, average risk weights show a clear downward trend, falling from just over 70 percent to about 40 percent.  Over the same period, bank leverage or assets divided by capital — a simple measure of bank riskiness — moved in the opposite direction, rising from about 20 to well over 30 at the start of the crisis.  The only difference is that while the latter then reversed itself, the average risk weight continued to fall during the crisis, continuing its earlier trend.  “While the risk traffic lights were flashing bright red for leverage [as the crisis approached], for risk weights they were signaling ever-deeper green,” as Haldane put it: the risk weights were a contrarian indicator for risk, indicating that risk was falling when it was, in fact, increasing sharply.[2]  The implication is that the RWA is a highly unreliable risk measure.[3]

Long before Basel, the preferred capital ratio was core capital to total assets, with no adjustment in the denominator for any risk-weights.  The inverse of this ratio, the bank leverage measure mentioned earlier, was regarded as the best available indicator of bank riskiness: the higher the leverage, the riskier the bank.

These older metrics then went out of fashion.  Over 30 years ago, it became fashionable to base regulatory capital ratios on RWAs because of their supposedly greater ‘risk sensitivity.’  Later the risk models came along, which were believed to provide even greater risk sensitivity.  The old capital/assets ratio was now passé, dismissed as primitive because of its risk insensitivity.  However, as RWAs and risk models have themselves become discredited, this risk insensitivity is no longer the disadvantage it once seemed to be.

On the contrary.

The old capital to assets ratio is making a comeback under a new name, the leverage ratio:[4] what is old is new again.  The introduction of a minimum leverage ratio is one of the key principles of the Basel III international capital regime.  Under this regime, there is to be a minimum required leverage ratio of 3 percent to supplement the various RWA-based capital requirements that are, unfortunately, its centerpieces.

The banking lobby hate the leverage ratio because it is less easy to game than RWA-based or model-based capital rules.  They and their Basel allies then argue that we all know that the RWA measure is flawed, but we shouldn’t throw out the baby with the bathwater.  (What baby? I ask. RWA is a pretend number and it’s as simple as that.)  They then assert that the leverage ratio is also flawed and conclude that we need the RWA to offset the flaws in the leverage ratio.

The flaw they now emphasize is the following: a minimum required leverage ratio would encourage banks to load up on the riskiest assets because the leverage ratio ignores the riskiness of individual assets.  This argument is commonly made and one could give many examples.  To give just one, a Financial Times editorial — ironically entitled “In praise of bank leverage ratios” — published on July 10, 2013 stated flatly:

Leverage ratios …  encourage lenders to load up on the riskiest assets available, which offer higher returns for the same capital.

Hold on right there!  Those who make such claims should think them through: if the banks were to load up on the riskiest assets, we first need to consider who would bear those higher risks.

The FT statement is not true as a general proposition and it is false in the circumstances that matter, i.e., where what is being proposed is a high minimum leverage ratio that would internalize the consequences of bank risk-taking.  And it is false in those circumstances precisely because it would internalize such risk-taking.

Consider the following cases:

In the first, imagine a bank with an infinitesimal capital ratio.  This bank benefits from the upside of its risk-taking but does not bear the downside.  If the risks pay off, it gets the profit; but if it makes a loss, it goes bankrupt and the loss is passed to its creditors.  Because the bank does not bear the downside, it has an incentive to load up on the riskiest assets available in order to maximize its expected profit.  In this case, the FT statement is correct.

In the second case, imagine a bank with a high capital-to-assets ratio.  This bank benefits from the upside of its risk-taking but also bears the downside if it makes a loss.  Because the bank bears the downside, it no longer has an incentive to load up on the riskiest assets.  Instead, it would select a mix of low-risk and high-risk assets that reflected its own risk appetite, i.e., its preferred trade-off between risk and expected return.  In this case, the FT statement is false.

My point is that the impact of a minimum required leverage ratio on bank risk-taking depends on the leverage ratio itself, and that it is only in the case of a very low leverage ratio that banks will load up on the riskiest assets.  However, if a bank is very thinly capitalized then it shouldn’t operate at all.  In a free-banking system, such a bank would lose creditors’ confidence and be run out of business.  Even in the contemporary United States, such a bank would fall foul of the Prompt Corrective Action statutes and the relevant authorities would be required to close it down.

In short, far from encouraging excessive risk-taking as is widely believed, a high minimum leverage ratio would internalize risk-taking incentives and lead to healthy rather than excessive risk-taking.

Then there is the question of how high ‘high’ should be.  There is of course no single magic number, but there is a remarkable degree of expert consensus on the broad order of magnitude involved.  For example, in an important 2010 letter to the Financial Times drafted by Anat Admati, she and 19 other renowned experts suggested a minimum required leverage ratio of at least 15 percent — at least five times greater than under Basel III — and some advocate much higher minima.  Independently, John Allison, Martin Hutchinson, Allan Meltzer and yours truly have also advocated minimum leverage ratios of at least 15 percent.  By a curious coincidence, 15 percent is about the average leverage ratio of U.S. banks at the time the Fed was founded.

There is one further and much under-appreciated benefit from a leverage ratio.  Suppose we had a leverage ratio whose denominator was not total assets or some similar measure.  Suppose instead that its denominator was the total amount at risk: one would take each position, establish the potential maximum loss on that position, and take the denominator to be the sum of these potential losses.  A leverage-ratio capital requirement based on a total-amount-at-risk denominator would give each position a capital requirement that was proportional to its riskiness, where its riskiness would be measured by its potential maximum loss.

Now consider any two positions with the same fair value.  With a total asset denominator, they would attract the same capital requirement, independently of their riskiness.  But now suppose that one position is a conventional bank asset such as a commercial loan, where the most that could be lost is the value of the loan itself.  The other position is a long position in a Credit Default Swap (i.e., a position in which the bank sells credit insurance).  If the reference credit in the CDS should sharply deteriorate, the long position could lose much more than its current value.  Remember AIG! Therefore, the CDS position is much riskier and would attract a much greater capital requirement under a total-amount-at-risk denominator.

The really toxic positions would be revealed to be the capital-hungry monsters that they are.  Their higher capital requirements would make many of them unattractive once the banks themselves were to made to bear the risks involved.  Much of the toxicity in banks’ positions would soon disappear.

The trick here is to get the denominator right.  Instead of measuring positions by their accounting fair values as under, e.g., U.S. Generally Accepted Accounting Principles, one should measure those positions by how much they might lose.

Nonetheless, even the best-designed leverage ratio regime can only ever be a second-best reform: it is not a panacea for all the ills that afflict the banking system.  Nor is it even clear that it would be the best ‘second-best’ reform: re-establishing some form of unlimited liability might be a better choice.

However, short of free banking, under which no capital regulation would be required in the first place, a high minimum leverage ratio would be a step in the right direction.

_____________

[1] By core capital, I refer the ‘fire-resistant’ capital available to support the bank in the heat of a crisis.  Core capital would include, e.g., tangible common equity and some retained earnings and disclosed reserves.  Core capital would exclude certain ‘softer’ capital items that cannot be relied upon in a crisis.  An example of the latter would be Deferred Tax Assets (DTAs).  DTAs allow a bank to claim back tax on previously incurred losses in the event it subsequently returns to profitability, but are useless to a bank in a solvency crisis.

[2] A. G. Haldane, “Constraining discretion in bank regulation.” Paper given at the Federal Reserve Bank of Atlanta Conference on ‘Maintaining Financial Stability: Holding a Tiger by the Tail(s)’, Federal Reserve Bank of Atlanta 9 April 2013, p. 10.

[3] The unreliability of the RWA measure is confirmed by a number of other studies.  These include, e.g.: A. Demirgüç-Kunt, E. Detragiache, and O. Merrouche, “Bank Capital: Lessons from the Financial Crisis,” World Bank Policy Research Working Paper Series No. 5473 2010); A. N. Berger and C. H. S. Bouwman, “How Does Capital Affect Bank Performance during Financial Crises?” Journal of Financial Economics 109 (2013): 146–76; A. Blundell-Wignall and C. Roulet, “Business Models of Banks, Leverage and the Distance-to-Default,” OECD Journal: Financial Market Trends 2012, no. 2 (2014); T. L. Hogan, N. Meredith and X. Pan, “Evaluating Risk-Based Capital Regulation,” Mercatus Center Working Paper Series No. 13-02 (2013); and V. V. Acharya and S. Steffen, “Falling short of expectation — stress testing the Eurozone banking system,” CEPS Policy Brief No. 315, January 2014.

[4] Strictly speaking, Basel III does not give the old capital-to-assets ratio a new name.  Instead, it creates a new leverage ratio measure in which the old denominator, total assets, is replaced by a new denominator measure called the leverage exposure.  The leverage exposure is meant to take account of the off-balance-sheet positions that the total assets measure fails to include.  However, in practice, the leverage exposure is not much different from the total assets measure, and for present purposes one can ignore the difference between the two denominators.  See Basel Committee on Banking Supervision, “Basel III: A global regulatory framework for more resilient banks and banking systems.”  Basel: Bank for International Settlements, June 2011, pp. 62-63.

[Cross-posted from Alt-M.org]

There are a great many reasons to support educational choice: maximizing freedomrespecting pluralism, reducing social conflict, empowering the poor, and so on. One reason is simply this: it works.

This week, researchers Patrick J. Wolf, M. Danish Shakeel, and Kaitlin P. Anderson of the University of Arkansas released the results of their painstaking meta-analysis of the international, gold-standard research on school choice programs, which concluded that, on average, such programs have a statistically significant positive impact on student performance on reading and math tests. Moreover, the magnitude of the positive impact increased the longer students participated in the program.

As Wolf observed in a blog post explaining the findings, the “clarity of the results… contrasts with the fog of dispute that often surrounds discussions of the effectiveness of private school choice.”

That’s So Meta

One of the main advantages of a meta-analysis is that it can overcome the limitations of individual studies (e.g., small samples sizes) by pooling the results of numerous studies. This meta-analysis is especially important because it includes all random-assignment studies on school choice programs (the gold standard for social science research), while excluding studies that employed less rigorous methods. The analysis included 19 studies on 11 school choice programs (including government-funded voucher programs as well as privately funded scholarship programs) in Colombia, Indiana, and the United States. Each study compared the performance of students who had applied for and randomly won a voucher to a “control group” of students who had applied for a voucher but randomly did not receive one. As Wolf explained, previous meta-analyses and research reviews omitted some gold-standard studies and/or included less rigorous research:

The most commonly cited school choice review, by economists Cecilia Rouse and Lisa Barrow, declares that it will focus on the evidence from existing experimental studies but then leaves out four such studies (three of which reported positive choice effects) and includes one study that was non-experimental (and found no significant effect of choice).  A more recent summary, by Epple, Romano, and Urquiola, selectively included only 48% of the empirical private school choice studies available in the research literature.  Greg Forster’s Win-Win report from 2013 is a welcome exception and gets the award for the school choice review closest to covering all of the studies that fit his inclusion criteria – 93.3%.

Survey Says: School Choice Improves Student Performance

The meta-analysis found that, on average, participating in a school choice program improves student test scores by about 0.27 standard deviations in reading and 0.15 standard deviations in math. In laymen’s terms, these are “highly statistically significant, educationally meaningful achievement gains of several months of additional learning from school choice.”

Interestingly, the positive results appeared to be larger for the programs in developing countries rather than the United States, especially in reading. That might stem from a larger gap in quality between government-run and private schools in the developing world. In addition, American students who lost the voucher lotteries “often found other ways to access school choices.” For example, in Washington, D.C., 12% of students who lost the voucher lottery still managed to enroll in a private school, and 35% enrolled in a charter school, meaning barely more than half of the “control group” attended their assigned district school.

The meta-analysis also found larger positive results from publicly funded rather than privately funded programs. The authors note that public finding “could be a proxy for the voucher amount” because the publicly funded vouchers were worth significantly more, on average, than the privately funded scholarships. The authors suggest that parents who are “relieved of an additional financial burden… might therefore be more likely to keep their chid enrolled in a private school long enough to realize the larger academic benefits that emerge after three or more years of private schooling.” Moreover, the higher-value vouchers are more likely to “motivate a higher-quality population of private schools to participate in the voucher program.” The authors also note that differences in accountability regulations may play a role.

The Benefits of Choice and Competition

The benefits of school choice are not limited to participating students. Last month, Wolf and Anna J. Egalite of North Carolina State University released a review of the research on the impact of competition on district schools. Although it is impossible to conduct a random-assignment study on the effects of competition (as much as some researchers would love to force different states to randomly adopt different policies in order to measure the difference in effects, neither the voters nor their elected representatives are so keen on the idea), there have been dozens of high-quality studies addressing this question, and a significant majority find that increased competition has a positive impact on district school performance: 

Thirty of the 42 evaluations of the effects of school-choice competition on the performance of affected public schools report that the test scores of all or some public school students increase when schools are faced with competition. Improvement in the performance of district schools appear to be especially large when competition spikes but otherwise, is quite modest in scale.

In other words, the evidence suggests that when district schools know that their students have other options, they take steps to improve. This is exactly what economic theory would predict. Monopolists are slow to change while organizations operating in a competitive environment must learn to adapt or they will perish.

On Designing School Choice Policies

Of course, not all school choice programs are created equal. Wolf and Egalite offer several wise suggestions to policymakers based on their research. Policymakers should “encourage innovative and thematically diverse schools” by crafting legislation that is “flexible and thoughtful enough to facilitate new models of schooling that have not been widely implemented yet.” We don’t know what education will look like in the future, so our laws should be platforms for innovations rather than constraints molded to the current system.

That means policymakers should resist the urge to over-regulate. The authors argue that private schools “should be allowed to maintain a reasonable degree of autonomy over instructional practices, pedagogy, and general day-to-day operations” and that, beyond a background check, “school leaders should be the ones determining teacher qualifications in line with their mission. We don’t know the “one best way” to teach students, and it’s likely that no “one best way” even exists. For that matter, we have not yet figured out a way to determine in advance whether a would-be teacher will be effective or not. Indeed, as this Brookings Institute chart shows (see page 8), there is practically no difference in effectiveness between traditionally certified teachers and their alternatively certified or even uncertified peers:

In other words, if in the name of “quality control,” the government mandated that voucher-accepting schools only hire traditionally certified teachers, not only would such a regulation fail to prevent the hiring of less-effective teachers, it would also prevent private schools from hiring lots of effective teachers. Sadly, too many policymakers never tire of crafting new ways to “ensure quality” that fall flat or even have the opposite impact.

School choice policies benefit both participating and nonparticipating students. Students who use vouchers or tax-credit scholarships to attend the school of their choice benefit by gaining access to schools that better fit their needs. Students who do not avail themselves of those options still benefit because the very access to alternatives spurs district schools to improve. These are great reasons to expand educational choice, but policymakers should be careful not to undermine the market mechanisms that foster competition and innovation.

For more on the impact of regulations on school choice policies, watch our recent Cato Institute event: “School Choice Regulations: Friend or Foe?”

 

Fresh off his resounding victory in the West Virginia primary, Senator Bernie Sanders has intimated that he has no intent of dropping out of the race any time soon, even though he trails his rival Hillary Clinton significantly in pledged delegates. One of the cornerstones of the Sanders campaign has been his health care plan, which would replace the entirety of the current health care system with a more generous version of Medicare. His campaign has claimed the plan would cost a little more than $13.8 trillion over the next decade, and he has proposed to fund these new expenditures with a clutch of tax increases, many of them levied on higher-income households. At the time, analysts at Cato and elsewhere expressed skepticism that the cost estimates touted by the campaign accurately accounted for all the increases in federal health expenditures the plan would require, and incorporated costs savings estimates that were overly optimistic. Now, a new study from the left-leaning Urban Institute corroborates many of these concerns, finding that Berniecare would cost twice as much as the $13.8 trillion price tag touted by the Sanders campaign.

The authors from the Urban Institute estimate that Berniecare would increase federal expenditures by $32 trillion, 233 percent, over the next decade. The $15 trillion in additional taxes proposed by Sanders would fail to even cover half of the health care proposal’s price tag, leaving a funding gap of $16.6 trillion. In the first year, federal spending would increase by $2.34 trillion. To give some context, total national health expenditures in the United States were $3 trillion in 2014.

Sanders was initially able to restrict most of the tax increases needed to higher-income households through income-based premiums, significantly increasing taxes on capital gains and dividends, and hiking marginal tax rates on high earners. Sanders cannot squeeze blood from the same stone twice, and there’s likely not much more he could do to propose higher taxes on these households, which means if he were to actually have to find ways to finance Berniecare, he’d have to turn to large tax increases on the middle class.

There are different reasons Berniecare would increase federal health spending so significantly. The most straightforward is that it would replace all other forms of health care, from employer sponsored insurance to state and local programs, with one federal program. The second factor is that the actual program would be significantly more generous than Medicare (and the European health systems Sanders so often praises), while also removing even cursory cost-sharing requirements. In addition, this proposal would add new benefits, like a comprehensive long-term services and support (LTSS) component that the Urban Institute estimates would cost $308 billion in its first year and $4.14 trillion over the next decade. These estimates focus on annual cash flows over a relatively short time period, so the study doesn’t delve into the longer-term sustainability issues that might develop from this new component, although they do note that “after this 10-year window, we would anticipate that costs would grow faster than in previous years as baby boomers reach age 80 and older, when rates of severe disability and LTSS use are much higher. Revenues would correspondingly need to grow rapidly over the ensuing 20 years.”

Even at twice the initial price tag claimed by the Sanders campaign, these cost estimates from the Urban Institute might actually underestimate the total costs. As they point out, the authors do not incorporate estimates for the higher utilization of health care services that would almost certainly occur when people move from the current system to the generous, first-dollar coverage in the more generous version of Medicare they would have under this proposal. They also chose not to incorporate higher provider payment rates for acute care services that might be necessary, and include “assumptions about reductions in drug prices [that] are particularly aggressive and may fall well short of political feasibility.”

Berniecare would increase federal government spending by $32 trillion over the next decade, more than twice as much as the revenue from the trillions in taxes Sanders has proposed. And this might not be underselling the actual price tag, and only considers the cash flow issues in the short-term. There could be even greater sustainability problems over a longer time horizon. One thing is for certain the plan would require even more trillions in additional tax hikes.

Economists certainly don’t speak with one voice, but there’s a general consensus on two principles of public finance that will lead to a more competitive and prosperous economy.

To be sure, some economists will say that high tax rates and more double taxation are nonetheless okay because they believe there is an “equity vs. efficiency” tradeoff and they are willing to sacrifice some prosperity in hopes of achieving more equality.

I disagree, mostly because there’s compelling evidence that this approach ultimately leads to less income for the poor, but this is a fair and honest debate. Both sides agree that lower rates and less double taxation will produce more growth (though they’ll disagree on how much growth) and both sides agree that a low-tax/faster-growth economy will produce more inequality (though they’ll disagree on whether the goal is to reduce inequality or reduce poverty).

Since I’m on the low-tax/faster-growth side of the debate, this is one of the reasons why I’m a big fan of tax competition and tax havens.

Simply stated, when politicians have to worry that jobs and investment can cross borders, they are less likely to impose higher tax rates and punitive levels of double taxation. Interestingly, even the statist bureaucrats at the Organization for Economic Cooperation and Development agree with me, writing that tax havens “may hamper the application of progressive tax rates.” They think that’s a bad thing, of course, but we both agree that tax competition means lower rates.

And look at what has happened to tax rates in the past few years. Now that politicians have undermined tax competition and weakened tax havens, tax rates are climbing.

So I was very surprised to see some economists signed a letter saying that so-called tax havens “serve no useful economic purpose.” Here are some excerpts.

The existence of tax havens does not add to overall global wealth or well-being; they serve no useful economic purpose. …these jurisdictions…increase inequality…and undermine…countries’ ability to collect their fair share of taxes. …There is no economic justification for allowing the continuation of tax havens.

You probably won’t be surprised by some of the economists who signed the letter. Thomas Piketty was on the list, which is hardly a surprise. Along with Jeffrey Sachs, who also has a track record of favoring more statism. Another predictable signatory is Olivier Blanchard, the former top economist at the pro-tax International Monetary Fund.

But if that’s an effective “appeal to authority,” there’s a big list of Nobel Prize winners who recognize the economic consensus outlined at the beginning of this post and who understand a one-size-fits-all approach would undermine progress.

In other words, there is a very strong “economic purpose” and “economic justification” for tax havens and tax competition.

Simply stated, they curtail the greed of the political class.

Philip Booth of the Institute of Economic Affairs in London opined on this issue. Here’s some of what he wrote for City A.M.

…the statement that tax havens “have no useful purpose” is demonstrably wrong and most of the other claims in the letter are incredible. Offshore centres allow companies and investment funds to operate internationally without having to abide by several different sets of rules and, often, pay more tax than ought to be due. …Investors who use tax havens can avoid being taxed twice on their investments and can avoid being taxed at a higher rate than that which prevails in the country in which they live, but they do not avoid all tax. …tax havens also allow the honest to shelter their money from corrupt and oppressive politicians. …one of the advantages of tax havens is that they help hold governments to account. They make it possible for businesses to avoid the worst excesses of government largesse and crazy tax systems – including the 39 per cent US corporation tax rate. They have other functions too: it is simply wrong to say that they have no useful purpose. It is also wrong to argue that, if only corrupt governments had more tax revenue, their people would be better served.

Amen. I especially like his final point in that excerpt, which is similar to Marian Tupy’s explanation that tax planning and tax havens are good for Africa’s growth.

Last but not least, Philip makes a key point about whether tax havens are bad because they are sometimes utilized by bad people.

…burglars operate where there is property. However, we would not abolish property because of burglars. We should not abolish tax havens either.

When talking to reporters, politicians, and others, I make a similar point, arguing that we shouldn’t ban cars simply because they are sometimes used as getaway vehicles from bank robberies.

The bottom line, as Professor Booth notes, is that we need tax havens and tax competition if we want reasonable fiscal systems.

But this isn’t simply an issue of wanting better tax policy in order to achieve more prosperity. In part because of demographic changes, tax havens and tax competition are necessary if we want to discourage politicians from creating “goldfish government” by taxing and spending nations into economic ruin.

P.S. Here’s my video on the economic case for tax havens.

P.P.S. Let’s not forget that the Paris-based Organization for Economic Cooperation and Development is the international bureaucracy most active in the fight to destroy tax competition. The is especially outrageous because American tax dollars subsidize the OECD.

In several states around the country, legislators are working to pass legislation that would move their states toward compliance with the REAL ID Act, the U.S. national ID law. Oklahoma state senator David Holt (R), for example, has touted his plan as giving Oklahomans the “liberty” to choose which of two ID types they’ll get. Either one feeds their data into a nationwide system of databases.

If you want a sense of what these legislators are getting their states into, take a look at the eight-page notice the Department of Homeland Security published in the Federal Register today. It’s an entirely ordinary bureaucratic document, which walks through the processes states have to go through to certify themselves as compliant. Its few pages represent hundreds of hours of paperwork that state employees will have to put in complying with federal mandates.

Among them is the requirement that the top official of the DMV and the state Attorney General confirm that their state jumps through all the hoops in federal law. Maybe Oklahoma’s Attorney General, Scott Pruitt (R), thinks his office’s time is well spent on pushing paper for the federal government, but it’s more likely that he wants to be enforcing Oklahoma laws that protect Oklahomans.

REAL ID-compliant states have to recertify to the DHS every three years that they meet DHS’s standards. DHS can and will change these standards, of course. DHS officials get to inspect state facilities and interview state employees and contractors. DHS can issue corrective demands and require the states to follow them before recertification.

It’s all unremarkable—if you’re sanguine about taxpayer dollars burned on bureaucracy, and if you think that states are just administrative arms of the federal government. But if you think of states as constitutionally independent sovereigns, you recognize that this document is out of whack. States do not exist to play second fiddle in bureaucrat-on-bureaucrat bureaucracy.

Whether or not we have a national ID matters. The constitutional design of government matters, including, one hopes, to people in Oklahoma and other states across that land. State officials who are conscious of these things should reject this paperwork and these mandates. If the federal government wants a national ID, the federal government should implement it itself.

Global Science Report is a feature from the Center for the Study of Science, where we highlight one or two important new items in the scientific literature or the popular media. For broader and more technical perspectives, consult our monthly “Current Wisdom.”

Although it’s a favorite headline as people shiver during the coldest parts of the winter, global warming is almost assuredly not behind your suffering (the “warming” part of global warming should have clued you in on this).

But, some folks steadfastly prefer the point of view that all bad weather is caused by climate change.

Consider White House Office of Science and Technology Policy (OSTP) head John Holdren. During the depth of the January 2014 cold outbreak (and the height of the misery) that made “polar vortex” a household name, OSTP released a video featuring Holdren telling us that “the kind of extreme cold being experienced by much of the United States as we speak, is a pattern that we can expect to see with increasing frequency as global warming continues.” 

At the time we said “not so fast,” pointing out that there were as many (if not more) findings in the scientific literature that suggested that either a) no relationship exists between global warming and the weather patterns giving rise to mid-latitude cold outbreaks, or b) the opposite is the case (global warming should lead to fewer and milder cold air outbreaks).

The Competitive Enterprise Institute even went as far as to request a formal correction from the White House. The White House responded by saying that the video represented only Holdren’s “personal opinion” and thus no correction was necessary. CEI filed a FOIA request, and after some hemming and hawing, the White House OSTP finally, after a half-hearted search, produced some documents. Unhappy with this outcome, CEI challenged the effort and just this past Monday, a federal court, questioning whether the OSTP acted in “good faith,” granted CEI’s request for discovery.

In the meantime, the scientific literature on this issue continues to accumulate. When a study finds a link between human-caused global warming and winter misery, it makes headlines somewhere. When it doesn’t, that somewhere is usually reduced to here.

Case in point: Last week, Washington Post’s Capital Weather Gang published a piece by Jason Samenow that highlighted a pair of new findings that suggested that global warming was leading to more blizzards along the East Coast. The mechanism, favored by the global-warming-is-making-cold/blizzards-worse crowd is that Arctic warming, enhanced by melting sea ice there, is causing the curves (i.e., ridges and troughs) in the jet stream to become bigger, and thus slower. This “locks in” a particular weather pattern and can allow cold air to drop further southward as well as set up condition necessary for big snow storms. To us, this seemed more a case of natural variability than global warming, but we suppose beauty is in the eye of the beholder.

But what you haven’t read in the Washington Post (or anywhere else for that matter), is that an even newer paper has just been published by scientists (including Martin Hoerling) at NOAA’s Earth System Research Laboratory  that basically demonstrates that global warming and Arctic sea ice loss should, according to climate models, lead to warmer winter temperatures, less temperature variability, and milder cold air outbreaks. This is basically the opposite conclusion from the one preferred and disseminated by Holdren et al.

From the paper’s abstract:

The emergence of rapid Arctic warming in recent decades has coincided with unusually cold winters over Northern Hemisphere continents. It has been speculated that this “Warm Arctic, Cold Continents” trend pattern is due to sea ice loss. Here we use multiple models to examine whether such a pattern is indeed forced by sea ice loss specifically, and by anthropogenic forcing in general. While we show much of Arctic amplification in surface warming to result from sea ice loss, we find that neither sea ice loss nor anthropogenic forcing overall to yield trends toward colder continental temperatures. An alternate explanation of the cooling is that it represents a strong articulation of internal atmospheric variability, evidence for which is derived from model data, and physical considerations. Sea ice loss impact on weather variability over the high latitude continents is found, however, characterized by reduced daily temperature variability and fewer cold extremes.

They were even more direct in paper’s conclusion:

We…showed that sea ice loss impact on daily weather variability over the high latitude continents consists of reduced daily temperature variability and fewer cold extremes indicating that the enhanced occurrences of cold spells during recent winters (e.g., Cohen et al. 2014) are not caused by sea ice loss.

This is pretty emphatic. Global warming results in warmer, less variable winters in North America (Figure 1).

 

Figure 1. Modeled change in winter mean temperature (left), daily temperature variability (middle), and temperature on the coldest 10 percent of the days (right) as a result of decline in Arctic sea ice. (source: Sun et al., 2016).

Now, if only our government’s “top scientist” were paying attention.

Reference:

Sun, L., J. Perlwitz, and M. Hoerling, 2016. What Caused the Recent “Warm Arctic, Cold Continents” Trend Pattern in Winter Temperatures? Geophysical Research Letters, doi: 10.1002/2016GL069024.

Yesterday the Center for Immigration Studies (CIS) published a report authored by Jason Richwine on the welfare cost of immigration. The CIS headline result, that immigrant-headed households consume more welfare than natives, lacks any kind of reasonable statistical controls.  To CIS’s credit, they do include tables with proper controls buried in their report and its appendix.  Those tables with proper controls undermine many of their headline findings.  In the first section, I will discuss how CIS’ buried results undermine their own headline findings.  In the next section, I will explain some of the other problems with their results and headline findings. 

CIS’s Other Results

The extended tables in the CIS report paint a far more nuanced picture of immigrant welfare use than they advertised.  To sum up the more detailed findings:

“In the no-control scenario, immigrant households cost $1,803 more than native households, which is consistent with Table 2 above. The second row shows that the immigrant-native difference becomes larger — up to $2,323 — when we control for the presence of a worker in the household. The difference then becomes gradually smaller as controls are added for education and number of children. The fourth row shows that immigrant households with the same worker status, education, and number of children as native households cost just $309 more, which is a statistically insignificant difference. The fifth row shows that immigrants use fewer welfare dollars when they are compared to natives of the same race as well as worker status, education, and number of children.” [emphasis added]

All of the tables I reference below are located in CIS’s report.   

Table 5 shows that households headed by an immigrant with less than a high school education consume less welfare than native households with the same education level.  For every other level of education, immigrant-headed households consume more than natives in the same education bracket. 

Table 6 controls for the number of children in native and immigrant households.  Immigrant households with one child, two children, and three or more children all consume fewer welfare benefits that the same sized native households. The only exception is that immigrant households without any children consume more. 

Table 7 has more mixed results. It shows that Hispanic and black immigrant-headed households consume less welfare than Hispanic and black native-headed households.  Immigrant white and Asian immigrants consume more welfare than native households headed by whites and Asians.  Table 8 breaks down their results with numerous different controls.  When controlled for a worker in the household, the number of children, the education of the head of household, and race, immigrant households consume less welfare.        

Table A3 shows that immigrant households with the youngest heads, 29 years old and under, impose a much lower cost than households headed by natives of the same age.  Table A4 shows that immigrants impose the greatest welfare costs in their first five years of residency but it decreases afterward and never again rises to that high initial level.  Table A5 shows that immigrant-headed working households with less than a high school degree consume less welfare than their native household counterparts.  For all other educational groups, the immigrant-headed households consume more than the comparable native-headed household. 

Table A6 shows immigrant headed households with children by race. Households headed by Hispanic, black, and Asian immigrants all consume less welfare than their native counterparts.  Households headed by white immigrants consume more welfare than white natives. 

Table A7 controls for poverty and race.  Overall, immigrant households in poverty consume less welfare than native households in poverty.  Hispanic and black immigrant households both massively under consume compared to native Hispanics and blacks.  White and Asian immigrant-headed households, on the other hand, consume more welfare than native households headed by members of the same race.

Many of the report’s detailed tables that use proper controls undermine their main conclusion. Excluding the bullet points at the beginning, this is a much more careful report than CIS has issued in the past. As a result, the report does come to a more nuanced conclusion than the headlines about it indicate.

Broader Issues

Below I will describe in detail some methodological and other issues with the CIS analysis – some of which expand on CIS’s controlled results that were not headlined. 

Individual Welfare Use or Head of Household

The CIS report compared all immigrant households and all of their inhabitants, including millions of native-born citizen children and U.S.-born spouses, with all households headed by native-born Americans. Richwine admits that the larger family size of immigrant households accounts for much (not all) of their greater welfare use because those born in the United States are eligible for all means-tested welfare benefits – even though Table 6 shows that immigrant households controlled for children consume a lower level of benefits.  A household level analysis does not reveal who receives the benefits, leaving the impression that the immigrants are the intended legal beneficiaries when they are often legally excluded from these programs. 

The CIS report should have compared immigrant individuals to native-born individuals for three reasons.  First, the number of people in an individual does not vary but the number of people in a household can vary tremendously.  The greater number of children in the immigrant household, rather than any different level of individual welfare use, is what largely drove the report’s results. 

Second, Medicaid and SSI benefit levels and eligibility are determined on an individual basis, not a household one.  Many immigrants are legally ineligible for those programs but their U.S.-born spouses and children do have access.  Thus, CIS counts the benefits received by the U.S.-born children even though the immigrants themselves are often ineligible.  This gives an inflated picture of immigrant welfare use. 

Third, it’s a lot easier and more accurate to compute the immigrant and native welfare costs when they are individuals than it is to work backward from the Survey of Income and Program Participation (SIPP), budgetary data, and imputations of program costs necessary due to a household analysis.   

Cato published an analysis of poor immigrant welfare use that compares individuals.  As a result, we can see the immigration or citizenship status, within limits, of the actual welfare users and the amount they consume.  The immigrants themselves are almost always less likely to use welfare and consume a lower dollar value of benefits than similar natives – as CIS corroborates in Table A7 of their report. 

The immigrant-headed household unit of analysis used in the CIS report presents other problems.  As a unit, it is just not as meaningful as it once was.  Professor Leighton Ku, director of the Center for Health Policy Research at George Washington University and a nationally recognized expert on these issues, wrote:

“Another problem is the ambiguous nature of what it means to be an ‘immigrant-headed household.’ In the CPS, a head of household is often assigned by the parent who is completing the survey: it could be the husband or wife. Consider an example of a five-person household, consisting of an immigrant male, a native-born wife, two native-born children, and a native-born unrelated person (such as someone renting a room). If the male has been deemed the head of household, this is an immigrant-headed household despite the fact that only one of five members is an immigrant and one (the renter) is not financially dependent on the immigrant. But if the wife was deemed the head of household, this would be a native-headed household, even though one member is an immigrant. Given that many families today have dual incomes and that the wife’s income often exceeds the husband’s, it is not clear if being assigned the ‘head of household’ in the Census form has much social meaning.”

The CIS report included the welfare cost of all the people living in the immigrant-headed household.  They make the defensible case that those U.S.-born children should be included because they would not exist in the United States and, therefore, would not consume welfare without the immigrant being here.  That’s a fair point, but it also leads to the defensible claim that the welfare consumed by the grandchildren, great-grandchildren, and every subsequent generation of an immigrant should also be included in the welfare calculation.  After all, without the initial immigrant, those subsequent welfare consuming native-born Americans wouldn’t be here either. 

The choice of researchers is to count just the immigrants and their welfare usage or to count the welfare consumed by the immigrants and all of their subsequent descendants.  Influenced by the Texas Office of the Comptroller, Cato decided to measure the welfare consumption of the immigrants themselves and excluded all of the subsequent generations.  CIS just counted the immigrants and their U.S.-born children and excluded their subsequent descendants (there are many grandchildren and great-grandchildren of immigrants alive today consuming welfare).     

Medicaid and Obamacare 

Differing Medicaid use rates and consumption levels account for over two-thirds of the entire gap between native and immigrant households in their headline results (table 2 of the CIS report).  That result is an artifact of the welfare system prior to the implementation of Obamacare’s Medicaid expansion. This difference will shrink or reverse when native enrollment and use rates rise in response to Obamacare’s mandated 2014 Medicaid expansion and rollout of exchange subsidies.

Reform Welfare or Restrict Legal Immigration – Which is Easier?

CIS seeks to use immigrant welfare use as an argument for cutting legal immigration.  Cato, on the other hand, has sought to build a wall around the welfare state and restrict non-citizen access rather than to more strictly regulate the international labor market.  When I suggested that CIS concentrate on reforming welfare over further restricting immigration, Richwine said, “[welfare reform is] not a policy change likely to occur in the near future.”  That may be true, but legally restricting legal immigration to the United States is even less likely to occur. 

Richwine’s explanation for focusing on immigration cuts rather than welfare reform doesn’t stand to scrutiny.  Congress has continually increased legal immigration levels since 1965. Congress considered a more restrictive immigration reform in 1996–and it was defeated handily.  In the mid-1990s, a high of 65 percent of Americans wanted to decrease immigration and Congress still couldn’t pass such a reform.  By mid-2015, only 34 percent of Americans wanted to decrease immigration.  The last time the anti-immigration opinion was this unpopular was in 1965 – on the eve of a transformative liberalization.   

Welfare, on the other hand, was reformed and restricted in 1996.  Furthermore, the public wants more reforms that limit welfare access and place more restrictions on welfare users. Historical trends and public opinion indicate that welfare reform is more likely and more popular than a severe reduction in legal immigration.  Regardless, CIS should join Cato and focus its efforts on restricting immigrant access to welfare rather than spin its wheels in a quixotic quest for a more restrictive immigration policy. 

Excluding the Big Welfare Programs

The CIS report only includes some means-tested welfare programs but excludes the rest of the welfare state.  Their report includes all immigrants and natives divided by households so it should include all of the welfare state – including the largest portions of Social Security and Medicare.  Immigrants pay large surpluses into Medicare and Social Security.  Richwine might object to including these programs because age and work history determine eligibility for the programs, so he might want to control for those factors.  That is a defensible argument, but it appears CIS thought that such a correction was not appropriate for the report’s headline results because they do not control for the eligibility of the programs.  Tables with proper controls are buried later in the paper and the appendix. CIS should at least add Medicare and Social Security to the tables in its appendix.  

One of the explanations Richwine gave for this report was “[w]ith the nation facing a long-term budgetary deficit, this study helps illuminate immigration’s impact on that problem.”  As the OECD makes clear in its fiscal analysis, it makes little sense to exclude immigrant consumption and contribution to the old-age entitlement programs that are actually driving the long-term debt.  If CIS wishes to grapple with the fiscal issues surrounding immigration, there is vast empirical literature on the topic that they should consult.   

As a final point, CIS’s headline result should have compared poor immigrant welfare use to poor American welfare use instead of comparing all American households to all native households.  The welfare benefit programs analyzed here are all intended for the poor.  It adds little to include Americans and immigrants who are too wealthy to receive much welfare. 

Net Fiscal Effects

Richwine includes a section in this CIS report where he attempts to defend his 2013 Heritage Foundation fiscal cost estimate that was roundly criticized by economists on the left and right.  He makes a lot of confused statements concerning how to measure the fiscal impact of immigration.  Instead of rehashing those arguments, here’s one small criticism of his 2013 Heritage paper: It was a 50-year fiscal cost analysis without a discount rate.             

Conclusion

When they use appropriate controls in the later parts of their paper and their appendix, CIS reaches much less negative and sometimes even positive results than their messaging indicates. Many of the issues raised in this post may be too wonky for general consumption, but they are important for producing excellent research. Cato has published two working papers, a bulletin, a policy analysis, and a book chapter on immigrant welfare use and the broader fiscal effects in which we explain our methods and defend them against criticisms.  We even include a literature survey on the topic that discusses the different results from the National Research Council.  I invite anybody more interested in these issues to read them.      

Special thanks to Charles Hughes for his excellent comments and suggestions on an earlier draft of this blog post.

In the Food and Drug Administration’s crackdown on what is now a thriving market for vaping products (nicotine and flavorings delivered without tobacco through a vaporizing device), Trevor Burrus has identified one group that is likely to emerge as winners from the regulations, namely large tobacco companies, which have lost many smoking customers to the vaping market without being notably successful at playing in it themselves. Another set of winners? Governments whose treasuries are enriched by conventional cigarette sales. Under the 1998 tobacco settlement, which I and others at Cato have criticized at length, a large chunk of revenue from these conventional sales goes to state governments. But this revenue source has been eroded badly as smokers switch to vaping, a trend the new rules are well calculated to slow or reverse.

As often happens with bad regulations, the winners will not be nearly so numerous as the losers, some of which I identify in a new piece at Ricochet. Not to be forgotten are thousands of small businesses; independent vaping shops and small vaping suppliers have both become common in recent years, and face ruin. But the real target of restrictions on consumer choice are consumers, and in this case what is at risk is not flavors and gimmicks but lives and health. While the FDA (and its sister Centers for Disease Control under Obama appointee Thomas Frieden) are dismissive of the benefits of vaping as harm reduction for established smokers, many others in the public health field take it seriously. An evidence review published last year by Public Health England found that “the current best estimate is that e-cigarettes are around 95% less harmful than smoking,” and that while there was plenty of evidence that the vaping option had led to a lot of successful switching away from cigarettes, there was “no evidence so far” to bolster counter-fears that vaping posed a countervailing menace as a gateway for novices destined to graduate into cigarette smoking.  I conclude my piece

If Congress chooses, it can do something about this. An amendment approved by the House Appropriations Committee last month would grandfather in products now available, applying the prohibitive rules only to products introduced in the future. Whether Washington acts on this sensible idea will depend in part on whether it is listening to the voices of ex-smokers and young consumers around the country who feel competent to run their own lives and make their own choices.

As I note at Overlawyered, the FDA at the same time announced stringent regulations restricting the sale of cigars, which former Catoite Jacob Grier writes about here (““The market for cigars is about to become a lot less diverse and a lot more boring.”) 

A few years ago President Barack Obama urged members of the European Union to admit Turkey. Now he wants the United Kingdom to stay in the EU. Even when the U.S. isn’t a member of the club the president has an opinion on who should be included

Should the British people vote for or against the EU? But Britons might learn from America’s experience.

What began as the Common Market was a clear positive for European peoples. It created what the name implied, a large free trade zone, promoting commerce among its members. Unfortunately, however, in recent years the EU has become more concerned about regulating than expanding commerce.

We see much the same process in America. The surge in the regulatory Leviathan has been particularly marked under the Obama administration. Moreover, the EU exacerbated the problem by creating the Euro, which unified monetary systems without a common continental budget. The UK stayed out, but most EU members joined the currency union.

At the same time, European policymakers have been pressing for greater EU political control over national budgets. Britain’s Westminster, the fount of parliamentary democracy worldwide for centuries, would end up subservient to a largely unaccountable continental bureaucracy across the British Channel. In fact, what thoughtful observers have call the “democratic deficit”—the European Parliament is even more disconnected from voters than the U.S. Congress—has helped spawn populist parties across the continent, including the United Kingdom Independence Party.

Britons today face a similar dilemma to that which divided Federalists and Anti-Federalists debating the U.S. Constitution. As I argued in American Conservative: “Unity enlarges an economic market and creates a stronger state to resist foreign dangers. But unity also creates domestic threats against liberty and community. At its worst an engorged state absorbs all beneath it.”

In America the Federalists were better organized and made the more effective public case. In retrospect the Anti-Federalists appear to have been more correct in their predictions of the ultimate impact on Americans’ lives and liberties. This lesson, not President Obama’s preferences, is what the British should take from the U.S. when considering how to vote on the EU.

The decision is up to the British people alone. They should peer across the Atlantic and ponder if they like what has developed.

Few people would, I think, take exception to the claim that, in a well-functioning monetary system, the quantity of money supplied should seldom differ, and should never differ very much, from the quantity demanded.  What’s controversial isn’t that claim itself, but the suggestion that it supplies a reason for preferring some path of money supply adjustments over others, or some monetary arrangements over others.

Why the controversy?  As we saw in the last installment, the demand for money ultimately consists, not of a demand for any particular number of money units, but of a demand for a particular amount of monetary purchasing power.  Whatever amount of purchasing X units of money might accomplish, when the general level of prices given by P, ½X units might accomplish equally well, were the level of prices ½P.  It follows that changes in the general level of prices might, in theory at least, serve just as well as changes in the available quantity of money units as a means for keeping the quantity of money supplied in line with the quantity demanded.

But then it follows as well that, if our world is one in which prices are “perfectly flexible,” meaning that they always adjust instantly to a level that eliminates any monetary shortage or surplus, any pattern of money supply changes will avoid money supply-demand discrepancies, or “monetary disequilibrium,” as well as any other.  The goal of avoiding bouts of monetary disequilibrium would in that case supply no grounds for preferring one monetary system or policy over another, or for preferring a stable level of spending over an unstable level.  Any such preference would instead have to be justified on other grounds.

So, a decision: we can either adopt the view that prices are indeed perfectly flexible, and proceed to ponder why, despite that view, we might prefer some monetary arrangements to others; or we can subscribe to the view that prices are generally not perfectly flexible, and then proceed to assess alternative monetary arrangements according to their capacity to avoid a non-trivial risk of monetary disequilibrium.

Your guide does not hesitate for a moment to recommend the latter course.  For while some prices do indeed appear to be quite flexible, even adjusting almost continually, at least during business hours (prices of goods and financial assets traded on organized exchanges come immediately to mind), in order for the general level of prices to instantly accommodate changes to either the quantity of money supplied or the quantity demanded, it must be the case, not merely that some or many prices are quite flexible, but that all of them are.  If, for example, the nominal stock of money were to double arbitrarily and independently of any change in demand, prices would generally have to double in order for equilibrium to be restored.  (Recall: twice as many units of money will command the same purchasing power as the original amount only when each unit commands half as much purchasing power as before.)  It follows that, so long as any prices are slow to adjust, the price level must be slow to adjust as well.  Put another way, an economy’s price level is only as flexible as its least flexible prices.

And only a purblind observer can fail to notice that some prices are far from fully flexible. The reason for this isn’t hard to grasp: changing prices is sometimes costly; and when it is, sellers have reason to avoid doing it often.  Economists use the expression “menu costs” to refer generally to the costs of changing prices, conjuring up thereby the image of a restaurateur paying a printer for a batch of new menus, for the sake of accommodating the rising costs of beef, fish, vegetables, wait staff, cooks, and so forth, or the restaurants’ growing popularity, or both.  In fact both the restaurants’ operating costs and the demand for its output change constantly.  Nevertheless it usually wouldn’t make sense to have new menus printed every day, let alone several times a day, to reflect all these fluctuations!  Electronic menus would help, of course, and now it is easy to conceive of them (though it wasn’t not long ago).  But those are costly as well, which is why (or one reason why) most restaurants don’t use them.

The cost of printing menus is, however, trivial compared to that of changing many other prices. The prices paid for workers, whether wage or salaried, are notoriously difficult to change, except perhaps according to a prearranged schedule, which can’t itself accommodate unexpected change.  Renegotiating wages or salaries can be an extremely costly business, as well as a time-consuming one.

“Menu costs” can account for prices being sticky even when the nature of underlying changes in supply or demand conditions is well understood.  Suppose, for example, that a restaurant’s popularity is growing at a steady and known rate.  That fact still wouldn’t justify having new menus printed every day, or every hour, or perhaps even every week.  But add the possibility that a perceived increase in demand may not last, and the restaurateur has that much more reason to delay ordering new menus: after all, if demand subsides again, the new menus may cost more than turning a few customers away would have.  (The menus might also annoy customers who would dislike not being able to anticipate what their meal will cost.)  Now imagine an employer asking his workers to take a wage rate cut because business was slack last quarter.  Get the idea?  If not, there’s a vast body of writings you can refer to for more examples and evidence.

These days it is common for economists who insist on the “stickiness” of the price level to be referred to, or to refer to themselves, as “New Keynesians.”  But the label is misleading.  Although John Maynard Keynes had plenty of innovative ideas, the idea that prices aren’t perfectly flexible wasn’t one of them.  Instead, by 1936, when Keynes published his General Theory, the idea that prices aren’t fully flexible was old-hat: no economists worth his or her salt thought otherwise.[1]  The assumption that prices are fully flexible, or “continuously market clearing,” is in contrast a relatively recent innovation, having first become prominent in the 1980s with the rise of the “New Classical” school of economists, who subscribe to it, not on empirical grounds, but because they confuse the economists’ construct of an all-knowing central auctioneer, who adjusts prices costlessly and continually to their market-clearing levels, with the means by which prices are determined and changed in real economies.

Let New Classical economists ruminate on the challenge of justifying any particular monetary regime in a world of perfectly flexible prices.  The rest of us needn’t bother.  Instead, we can accept the reality of “sticky” prices, and let that reality inform our conclusions concerning which sorts of monetary regimes are more likely, and which ones less likely, to avoid temporary surpluses and shortages of money and their harmful consequences.

What consequences are those?  The question is best answered by first recognizing the crucial economic insight that a shortage of money must have as its counterpart a surplus of goods and services and vice versa.  When money, the means of exchange, is in short supply, exchange itself, meaning spending of all sorts, suffers, leaving sellers disappointed.  In contrast, when money is superabundant, spending grows excessively, depleting inventories and creating shortages.  Yet these are only the most obvious consequences of monetary disequilibrium.  Other consequences follow from the fact that, owing to different prices’ varying degrees of stickiness, the process of moving from a defunct level of equilibrium prices to a new one necessarily involves some temporary distortion of relative price signals, and associated economic waste.  A price system has work enough to do in coming to grips with ongoing changes in consumer tastes and technology, among many other non-monetary factors that influence supply and demand for particular goods and services, without also having to reckon with monetary disturbances that call for scaling all prices up or down.  The more it must cope with the need to re-scale prices, the less capable it becomes at fine-tuning them to reflect changing conditions within particular markets.

Hyperinflations offer an extreme case in point, for during them sellers often resort to “indexing” local-currency prices to the local currency’s exchange rate with respect to some relatively stable foreign currency.  That is, they cease referring altogether to the specific conditions in the markets for particular goods, and settle instead for keeping their prices roughly consistent with rapidly changing monetary conditions.  In light of this tendency it’s hardly surprising that hyperinflations lead to all sorts of waste, if not to the utter collapse of the economies they afflict.  If relative prices can become so distorted during hyperinflations as to cease entirely to be meaningful indicators of goods’ and services’ relative scarcity, it’s also true that the usefulness of price signals in promoting the efficient use of scarce resources declines to a more modest extent during less severe bouts of  monetary disequilibrium.

What sort of monetary policy or regime best avoids the costs of having too much or too little money?  In an earlier post, I’ve suggested that keeping the supply of money in line with the demand for it, without depending on help in the shape of adjustments to the price level,  is mainly a matter of achieving a steady and predictable overall flow of spending.  But why spending?  Why not maintain a stable price level, or a stable and predictable rate of inflation?  If, as I’ve claimed, changes in the general level of prices are an economy’s way of coping, however imperfectly, with monetary shortages and surpluses, then surely an economy in which the price level remains constant, or roughly so, must be one in which such surpluses and shortages aren’t occurring.  Right?

No, actually.  Despite everything I’ve said here, monetary order, instead of going hand-in-hand with a stable level of prices or rate of inflation, is sometimes best achieved by tolerating price level or inflation rate changes.  A paradox?  Not really.  But as this post is already too long, I must put off explaining why until next time.
______________________
[1] For details see Leland Yeager’s essay, “New Keynesians and Old Monetarists,” reprinted in The Fluttering Veil.

[Cross-posted from Alt-M.org]

The ridesharing companies Uber and Lyft have withdrawn from Austin, Texas after voters there failed to pass Proposition 1, which would have repealed regulations requiring Uber and Lyft to include fingerprints as part of their driver background checks. This is a disappointing result, especially given that fingerprinting is, despite its sexy portrayal in forensic TV shows, not a perfect background check process and needlessly burdens rideshare companies.

Austin’s ordinances require rideshare companies to implement fingerprints as part of their background check system by February 2017. Under the rules the fingerprints would be submitted to the Texas Department of Public Safety, which would then send the records to the Federal Bureau of Investigation (FBI). As I pointed out in my Cato paper on ridesharing safety, the FBI fingerprint data are hardly comprehensive: 

Some have faulted Uber and Lyft for not including fingerprint scans as part of their background checks. However, fingerprint databases do not contain a full case history of the individual being investigated, and in some instances an FBI fingerprint check may unfairly prevent a qualified taxicab driver applicant from being approved. The FBI fingerprint database relies on reporting from police departments, and other local sources, as well as other federal departments and is not a complete collection of fingerprints in the United States.

Critics of the FBI fingerprint database point to its incomplete or inaccurate information. In July 2013 the National Employment Law Project (NELP) released a study on the FBI’s employment background checks and found that “FBI records are routinely flawed.” Also, while law enforcement agencies are diligent when it comes to adding fingerprint data of arrested or detained persons to the federal data, they are “far less vigilant about submitting the follow-up information on the disposition or final outcome of the arrest.”

This lack of vigilance is significant because, as the NELP study goes on to point out, “About one-third of felony arrests never lead to a conviction. Furthermore, of those initially charged with a felony offense and later convicted, nearly 30 percent were convicted of a different offense than the one for which they were originally charged, often a lesser misdemeanor conviction. In addition to cases where individuals are initially overcharged and later convicted of lesser offenses, other cases are overturned on appeal, expunged, or otherwise resolved in favor of the worker without ever being reflected on the FBI rap sheet.”

A Wall Street Journal article from 2014 made similar findings:

Many people who have never faced charges, or have had charges dropped, find that a lingering arrest record can ruin their chance to secure employment, loans and housing. Even in cases of a mistaken arrest, the damaging documents aren’t automatically removed. In other instances, arrest information is forwarded to the FBI but not necessarily updated there when a case is thrown out locally. Only half of the records with the FBI have fully up-to-date information.

“There is a myth that if you are arrested and cleared that it has no impact,” says Paul Butler, professor of law at Georgetown Law. “It’s not like the arrest never happened.”

Relying on fingerprints to paint an accurate picture of a driver applicant’s criminal history is misguided. Uber and Lyft do carry out background checks via third parties that look at court records and sex offender registries in order to determine whether a driver applicant meets their criminal background requirements, which are often stricter than those that govern taxi driver applicants. In fact, Austin is one of the cities where Uber’s and Lyft’s safety requirements are more stringent than those imposed on taxi drivers.

As R Street Institute’s Josiah Neeley has explained, Austin doesn’t prohibit taxi driver applicants who have been convicted of “a criminal homicide offense; fraud or theft; unauthorized use of a motor vehicle; prostitution or promotion of prostitution; sexual assault; sexual abuse or indecency; state or federal law regulating firearms; violence to a person; use, sale or possession of drugs; or driving while intoxicated” to work as taxi drivers provided that they have “maintained a record of good conduct and steady employment since release.” 

In contrast, Uber and Lyft disqualify driver applicants if they have been convicted of a felony in the last seven years. Uber and Lyft also include features that make drivers and passengers safer than they would be in traditional taxis.

Rideshare transactions are cashless. This removes an incentive for thieves to target rideshare drivers. Taxi drivers, who make a living out of picking up strangers, on the other hand can be more reliably assumed to be carrying cash than rideshare drivers. 

In addition, both the rideshare driver and passenger have profiles and ratings. The rating system provides an incentive for riders and passengers to be on their best behavior, and the profiles make it comparatively easy for investigators to determine who was at the scene of an alleged crime in a rideshare vehicle. It would be very stupid for an Uber passenger to try and get away with robbing an Uber driver, just as it would be unwise for an Uber driver to assault an Uber passenger. This, of course, doesn’t mean that rideshare background checks and safety features will deter all criminals, but they do compare very favorably to the safety procedures in place for taxis.

Perhaps too many Austin residents have watched CSI:Crime Scene Investigation and exhibited something similar to the “CSI effect” in the voting booth last weekend. The FBI fingerprint database may sound like a sensible resource to use for background checks, but it is not up-to-date and could result in otherwise qualified driver applicants being denied the opportunity to use Uber or Lyft.

North Carolina governor Pat McCrory (R) has just responded to the federal government’s threat to punish the state over its law prohibiting local governments from allowing transgendered people to choose their bathrooms: We’re suing!

Central to the nation’s bathroom war – which is one among sundry, seemingly endless culture wars – are the public schools. They are mentioned specifically in the Tar Heel State’s embattled law, and schools have been the sites of several lawsuits across the country over who gets to decide where students go to the bathroom or change their clothes. Of course, as Cato’s Public Schooling Battle Map reveals in stark detail, just like the nation, our schools are constant battlegrounds in the culture wars, and our children are essentially innocent civilians with political, social, and cultural bombs going off all around them.

At issue in North Carolina are really two things directly applicable to education: level of public school control, and private rights.

The immediate issue is whether a state should be able to make its own laws without the federal government overruling them. The feds have a legitimate claim, under the Fourteenth Amendment, to do what they are doing – attempting to prevent discrimination by state or local governments – but there is also a good case to be made that there are competing rights at stake – privacy versus nondiscrimination – and perhaps neither should take clear-cut precedence. Moreover, even if it has the authority to intervene, it may be best if Washington allowed social evolution to occur gradually rather than imposing it as people deal with what is, it seems, a pretty new idea: a person should choose which restroom or locker room to use. Of course, North Carolina’s law applies one rule to all municipalities, also potentially curbing natural societal evolution.

Private action versus government rule is also in play, but probably should not be. While government-imposed discrimination cannot be escaped, far less compelling is prohibiting private choice of policies or practices. If a public school has discriminatory policies you are stuck. If a private school does, in a school-choice program you can seek out something else without leaving all your tax dollars behind.

As important, if not more so, is that allowing private entities to choose their own policies is consistent with individual liberty, including freedom of association and religion, while it is much better suited to enabling people with competing values to peacefully co-exist. There is no zero-sum contest: Those who want an open bathroom policy could choose schools in which all the staff and families also embraced it, while those feeling more comfortable with bathrooms and locker rooms restricted by biological sex could go to schools with like-minded people.

Perhaps the best examples of educational choice helping to bring peace and balance rights have been in many European countries, where religious conflicts in schools abated as governments decided to fund choices of Protestant, Catholic, nonsectarian, or other institutions. Getting to the place of greater peace requires something difficult – accepting that all people should be able to live as they want as long as they do not force themselves on others, and even if we do not like the choices they make – but living and letting live is the foundation of a free society.

Want peace in North Carolina? Allowing state and local decision making may help. But letting people freely choose is the ultimate key.

The rise of new business models in online platforms and the sharing economy have inevitably been met with calls for more regulations. In his most recent budget, President Obama proposed to expand funding for efforts to “crac[k] down on the illegal misclassification of some employees as independent contractors.” Policymakers at the state and local levels have also called for more stringent regulations on these new business models.

Over the weekend, voters in Austin failed to overturn the city council’s ordinance that would impose a series of new regulations on ride-hailing companies operating in the city, from requiring drivers to go through fingerprint-based background checks, to restrictions detailing where drivers can stop for drop-offs and pickups. In response, Uber and Lyft announced that they had suspended operations in the city. In light of this rush to regulate, it is important to consider the people who rely on the opportunities made available by the new online platform economy. People utilize these platforms in different ways. Some participants offset fluctuations in traditional income to maintain their standard of living, while others use the platforms to rent out assets to supplement earnings from their traditional jobs. People from every age cohort and across the income distribution earn money through these new business models. New regulations that obstruct the development of the online platform economy could harm the many different people who choose to utilize those opportunities.

In one report from the JPMorgan Chase Institute, the authors analyzed anonymized data from 260,000 customers with earnings from any of 30 established online platforms and found that a growing number of people are participating, but that their reliance on these platforms has not increased. In other words, more people are using these new models, but not as full-time jobs. Earnings represented 33 percent of monthly income in labor platforms, in which participants are connected directly to customers, like Uber or Lyft. In the capital platforms where participants rent or sell to customers, like Airbnb, earnings represented only 20 percent of monthly income. So in neither component are most participants relying on earnings from these platforms as the majority of their income, for most people these aren’t full-time jobs.

Participating in the labor platform allows people to weather variations in their monthly income, as they can choose to work more hours to offset dips in other earnings. In months participants actively used the labor platform, those earnings accounted for an additional 15 percent of income, offsetting the 14 percent shortfall in non-platform income in those same months. As the authors note, this is in most cases a more attractive option than the old ones: look for a supplemental traditional job, reduce spending, or take on more credit. The capital platform is slightly different, in that those earnings tended to supplement traditional income, rather than replace it. So participants generally used the capital platform to try to increase their monthly income and raise their standard of living by utilizing the assets available to them. 

In a related report released last week, the authors find that while the percentage of adults with earnings from the online platform economy is fairly consistent across income quintiles, participants in the lower income quintiles are more reliant on these earnings, at least in the labor platform. Labor platform earnings account for more than 28 percent of total annual income for participants in the lowest quintile, compared to roughly 20 percent in the highest. Capital platform earnings, on the other hand, represent between 10.5 and 11 percent of annual total income across all quintiles.  

Percentage of Annual Income Earned Through Open Platform Economy, by Income Quintile and Type of Platform

Source: JPMorgan Chase Institute

Somewhat surprisingly, the authors find that while young people 18-24 were most likely to participate (5.2 percent), participants 55 and older are actually the group that derived the largest share of total income from these earnings. This suggests that workers in or near retirement could also be turning to these new business models as a supplemental source of income in lieu of continuing traditional work.

People of all ages and across the income distribution participate in the online platform economy. These business models have given these people new options and opportunities: some people use these platforms to replace unexpected reductions in other income that could otherwise cause serious problems. Older participants are turning to these platforms as a way to supplement their earnings and maintain their standard of living as they transition out of the workforce. Imposing more regulations on the online platform economy could limit or take away these opportunities.

 

America’s international position is distinguished by its alliance networks. Presidential candidates fear today’s dangerous world, but the United States is allied with every major industrialized power, save China and Russia. It is a position that Washington’s few potential adversaries must envy.

Yet as I pointed out in National Interest: “littering the globe with security commitments is costly. The U.S. must create a much bigger military to project force abroad to protect countries that often matter little for this nation’s security. Moreover, while policymakers hope to prevent war with treaty guarantees, the resulting tripwires ensure involvement if deterrence fails.”

Equally important, America’s involvement tends to turn friends and allies into dependents. The principle is the same as domestic welfare: Why should they do for themselves if they can get someone else to do so?

In his recent interview in the Atlantic, President Barack Obama complained: “Free-riders aggravate me.” Unfortunately, Washington has created a world filled with free- or at least cheap-riders.

The president recently visited one of the targets of his ire: Saudi Arabia. The royals long ago assumed the U.S. military would act as their de facto bodyguard. The first Gulf War was more about the Kingdom of Saudi Arabia than Kuwait. More recently, the “alliance” has dragged the U.S. into the KSA’s war in Yemen, which has gone from local civil war to regional sectarian conflict.

Content to spend barely one percent of its GDP on the military throughout the Cold War while facing the Soviet Union and Maoist China, Japan has started to do a bit more. It appears Tokyo is worried that Washington might not go to war with Beijing over the Senkakyu/Diaoyu Islands. Japan only recently passed legislation allowing its military to aid U.S. forces under attack. For decades, Japan’s only responsibility as an ally was to be defended.

Since the Korean War, the Republic of Korea has raced ahead of the North, with an economy as much as 40 times as large, a population twice as big, and a dramatic lead in technological prowess, international influence, and most every other measure of national power. Yet the ROK, facing a supposed existential threat, spends a lower percent of its GDP on the military than does America.

Then there are the Europeans. Foreign policy should be based on circumstances. After World War II, Western Europe was prostrate and Eastern Europe had been swallowed by the Soviet Union. Today the Europeans not only vastly outmatch Russia, their only potential antagonist, but they possess a larger economy and population than America.

Yet Washington’s desperate, even humiliating pleas for its allies to do more continue to fall on deaf ears. In fact, in all of these cases, the United States has variously insisted, demanded, and requested that its friends do more. When they did not, it often turned to begging and whining, with no greater success.

One could at least argue during the Cold War that it was in America’s interest to defend countries even if they would not protect themselves. No longer.

Yet the alliances commit America to go to war in defense of other nations’ interests. At the same time, such guarantees dissuade friendly states from doing more on their own behalf. If deterrence fails, as it often has throughout history, the good times will come to a dramatic and bloody end.

Washington has tolerated allied free-riding for far too long. It’s time for America to engage in burden-shedding rather than hope for burden-sharing. In its quest to maximize its number of allies, the United States has needlessly created a gaggle of dependents.

Should a federal court in Washington be guessing what common-law property rights a person has in New York, when there is a procedure in place that allows the federal court to ask the state’s highest court what the state law actually is? In Romanoff Equities v. United States, that’s exactly what the Court of Federal Claims (CFC, a special court that deals with monetary claims against the federal government) did, a “guess” that was subsequently affirmed on appeal.

The Romanoff family, as predecessors-in-title to a 1932 common-law right-of-way easement, had granted New York Central Railroad the right to “construct, operate and maintain” an elevated viaduct for the purpose of removing trains from pedestrian traffic in New York City. By the 1980s, however, the railroad no longer maintained the structure and, under the terms of the easement, the land and title were to revert to the Romanoff family. But the City of New York—wanting to convert the abandoned railroad viaduct into a recreational area (the High Line) that now includes taco trucks, salsa dancing, stargazing, retail shops, and other activities entirely unrelated to operating a railroad—asked the federal government to invoke the National Trails System Act and convert the easement into a public park.

The federal government granted the request, so the Romanoffs filed a lawsuit, arguing that converting the railroad right-of-way into a public park is a compensable taking under the Fifth Amendment. The Justice Department argued, and the CFC agreed, that the government’s conversion of the easement was not a taking because New York property law recognizes an “easement for anything” (!), allowing the City to use the property however it liked in perpetuity.

The Romanoffs took their case to the U.S. Court of Appeals for the Federal Circuit—a court of national jurisdiction that handles certain special appeals, including from the CFC—asking for “certification” to the New York Court of Appeals (the state’s highest court) for a proper interpretation of the easement. They argued that New York courts have never recognized an “easement for anything” and federal courts shouldn’t be inferring one. The Federal Circuit’s three-judge panel ignored the Romanoffs’ request that the court send the question to the state judiciary and instead upheld the CFC’s guess as to how a New York court would construe the easement.

The Romanoffs have now petitioned the Federal Circuit to hear the case en banc (all the judges on the court). In an amicus brief supporting that petition, Cato argues that novel or unsettled questions of state law, as in this case, should indeed be sent to a state’s highest court. When the Federal Circuit refused to certify the legal issue here, it made new law for the state of New York, violating principles of judicial federalism.

This case also has enormous consequences for property owners who have to litigate their constitutional claims in the CFC, a court of national jurisdiction. There are vast differences in how individual states treat property rights. Federal judges in Washington—who (understandably) have little familiarity with this varied jurisprudence—should not be fashioning state law with no basis in state-court precedent.  

Thanks to legal intern (soon to be legal associate) Frank Garrison for help with this blogpost, and our brief in the case.

[Reprinted with permission from Alan Reynolds, “What Do We Know about the Great Crash?National Review, November 9, 1979]

 Many scholars have long agreed that the Smoot-Hawley tariff had disastrous economic effects, but most of them have  felt  that  it could  not have caused the stock market collapse of  October  1929, since the tariff was not signed into law  until the following June. Today we know that market participants do not wait for a major law to pass, but instead try to anticipate whether or not it will pass and what its effects will be.

 Consider the following sequence of events:

 The Smoot-Hawley tariff passes the House on May   28, 1929.  Stock prices in New   York   (1926=100) drop   from 196 in March to 191   in June.   On June   19, Republicans   on the Senate Finance Committee   meet   to   rewrite   the   bill. Hoping for improvement, the market rallies,  but  industrial production  ( 1967 = 100)  peaks  in  July,  and  dips  very  slightly through  September.  Stocks  rise  to  216  by  September,  hit­ting their peak on  the  third  of  the  month.  The  full  Senate Finance Committee goes to   work  on  the  tariff  the  following day,  moving  it  to  the  Senate  floor  later  in  the   month.

 On October 21, the Senate rejects, 64 to 10, a move to limit tariff increases to agriculture. “A weakening of the Democratic-Progressive Coalition was evidenced on October 23,” notes the Commercial and Financial Chronicle. In this first test vote, 16 members of the anti-tariff coalition switch sides and vote to double the tariff on calcium carbide from Canada. Stocks collapse in the last hour of trading; the following morning is christened Black Thursday.   On  October 28,  a  delegation   of   senators   appeals   to   President   Hoover to help push a tariff  bill  through  quickly  (which  he  does  on the 31st). The Chronicle  headlines  news  about  broker  loans on  the  same  day:  “Recall  of  Foreign  Money  Grows  Heavier-All Europe  Withdrawing  Capital.” The following day is stalemate. Stocks begin to rally after November 14, rising steadily from 145 in November to 171 in April. Industrial production stops falling and hovers around the December level through March.

On March 24, 1930, the Senate passes the Smoot-Hawley tariff, 222 to 153. Debate now centers on whether or not President Hoover will veto. Still, stocks drop 11 points, to 160, in May. On June 17, 1930, despite the vigorous protests of a thousand economists, Hoover signs the bill into law, noting that it fulfills a campaign promise he had made, and stocks drop to 140 in July.

 The Commercial and Financial Chronicle dated June 21, 1930 led off  with  the major  events  of  the  week –”the signing by the President of  the  Smoot-Hawley  tariff  bill” and “a renewed violent collapse of the stock market.” Without ever quite linking the two events, the Chronicle did observe that “if the foreigner cannot sell his goods to us he cannot obtain the wherewithal to buy our goods.” Other sections noted  that  international  stocks  were  particularly hard hit, that 35 nations had vigorously  protested  the tariff and threatened retaliation, and that Canada and other  nations had already hiked their own tariffs “in view of the likelihood of such legislation in the United States.”

 It may be hard to realize how international trade could have so much impact on the domestic economy.  For years, in explaining income movements in the Thirties, attention has instead been focused on federal spending and deficits. Yet on the face of it, trade was far more important: exports fell from $7 billion in 1929 to $2.5 billion in 1932; federal spending was only $2.6 billion in 1929 and $3.2 billion in 1932. In 1929, exports accounted for nearly seven percent of our national production, and a much larger share of the production of goods (as opposed to services). Trade also accounted for 15 to 17 percent of farm income in 1926-29, and farm exports were slashed to a third of their 1929 level by 1933.

 Even these numbers, however, understate the significance of trade. Critical portions of the U.S. production process can be crippled by a high tax on imported materials. Other key industries are heavily dependent on exports.  Disruptions in trade patterns then ripple throughout the economy.  A tariff on linseed oil hurt the U.S. paint industry, a tariff on tungsten hurt steel, a tariff on casein hurt paper, a tariff on mica hurt electrical equipment, and so on. Over eight hundred things used in making automobiles were taxed by Smoot-Hawley. There were five hundred U.S. plants employing sixty thousand people to make cheap clothing out of imported wool rags; the tariff on wool rags rose by 140 per cent.

 Foreign countries were flattened by higher U.S. tariffs on things like olive oil (Italy), sugar and cigars (Cuba), silk (Japan), wheat and butter (Canada).  The impoverishment of foreign producers reduced their purchases of, say, U.S. cotton, thus bankrupting both farmers and the farmers’ banks.

It should be obvious that an effective limit on imports also reduces exports. Without the dollars obtained by selling here, foreign countries could not afford to buy our goods (or to repay their debts). From 1929 to 1932, U.S. imports from Germany fell by $181 million; U.S. exports to Germany fell by $277 million. Americans also had little use for foreign currency, since foreign goods were subject to prohibitive tariffs, so the dollar was artificially costly in terms of other currencies. That too depressed our exports, which turned out to be particularly devastating to farmers-the group that was supposed to benefit from the tariffs.

 There had already been some damage done (particularly to farm exports) by the tariff legislation of 1921 and 1922. As Princeton historian Arthur Link points out, however, “its only important changes were increased protection for aluminum, chemical products, and agricultural commodities.” Smoot-Hawley broadened the list to include 3,218 items (including sauerkraut), and 887 tariffs were sharply in­creased, on everything from Brazil nuts to strychnine. Clocks had faced a tariff of 45 percent; Smoot-Hawley raised that to 55 percent, plus up to $4.50 apiece. Tariffs on corn, butter, and unimproved wools were roughly doubled. A shrinking list of tariff-free goods no longer included “junk,” though leeches and skeletons were still exempt.

 A crucial consideration is that many tariffs were a specific amount of money per unit rather than a percentage of the price. As prices of many traded goods fell by half (or more) from 1929 to 1933, the effective rate of tariff doubled. If imported  felt  hats  sold  for  $5,  including  a tariff  of  $2.50, a fall in  price to $2.50 would confiscate the entire revenue from selling in the U.S. market. Without the dollars from selling in the U.S. market, the foreign hat manufacturer couldn’t buy anything here.

A number of seemingly separate explanations of the Great Crash fit together quite well once the importance of anticipated tariffs is acknowledged.  Charles  Kindleberger, in Manias,  Panics,  and  Crashes,  describes  some  structural collapse in the financial system: “Lending on  import,  for example, seems to have come to a  complete  stop.” But refusal to finance imports makes perfect sense if lenders were correctly anticipating steep tariffs ahead. There were early cancellations of import orders in 1929 that likewise reflected rational expectations, and import prices were among the first to fall.

A lot of stock was being bought on margin-that is, the buyer put up 25 to 50 per cent of the price and his broker went to the bank to borrow enough to cover the rest temporarily. The chairman of the Federal Reserve Board had warned the banks to curb these broker or “call” loans as early as February 1929, and the Fed nearly doubled the discount rate from 1927 to August 1929, partly in the hope of curbing stock market “speculation.” Most of the  broker loans in  1928-29 were not from the banks themselves,  how- ever, but were instead re-lent to brokers  on  behalf  of  domestic business and  foreign  banks,  businesses,  and  individuals.

 The massive withdrawal of foreign lenders from the broker-loan market in early October probably   reflected the correctly anticipated decline in the value of the collateral for those loans (stocks), and the fear among foreign capitalists that they would have to liquidate such assets to stay solvent in a world of high tariffs.  The process contributed to the crash as both cause and effect. There was a scramble for liquidity by both the lenders and the owners of stocks. As stock prices fell, brokers required that their customers put up more money to meet the margin requirement. If stockholders couldn’t come up with the cash, brokers could sell the securities to raise the money.  Either way, owners and brokers were pressed to unload stocks, thus perhaps accelerating (but not causing) the stock market decline.

The market suffered continual policy assaults after 1930. In early April of 1932, the Commercial  and  Financial Chronicle  reports  “the  market  fell  into  a complete  collapse . .  .  owing  to  the  approval  by  the  House  of  Representatives of an increased tax on stock  sales.”  The  Dow  bottomed  on July 8, when (as  the  Chronicle  of  the  following  day  reported)  there  had  been  some  good   news –the  Tariff   Commission  had  trimmed  18   tariffs,   and   a   House   subcommittee was looking into ways to cut  taxes  by  eliminating  duplication with states.  On  Tuesday,  September  19,  candidate Roosevelt  called   the  tariff  “the  road   to  ruin”  and  pledged to negotiate reductions in tariffs  as  soon  as  he  took  office. The following Saturday, the Chronicle was   astounded  that the “market again sharply reversed its course, and on Wednesday prices suddenly surged upward in a most sensational fashion.”

 

 

 

 

“A deeper reason for the failure of progressives to unite ideologically in the 1920’s was what might be called a substantial paralysis of the progressive mind… .[They] fought so hard all through the 1920’s against Andrew Mellon’s proposals to abolish the inheritance tax and to make drastic reductions in the taxes on large incomes. [Yet] the progressives were hard pressed to justify the continuation of nearly confiscatory tax levels.”

–Arthur S. Link, “What Happened to the Progressive Movement in the 1920s?” American Historical Review 64 (1959): 851-883. http://www.jstor.org/stable/1905118

You Ought to Have a Look is a feature from the Center for the Study of Science posted by Patrick J. Michaels and Paul C. (“Chip”) Knappenberger.  While this section will feature all of the areas of interest that we are emphasizing, the prominence of the climate issue is driving a tremendous amount of web traffic.  Here we post a few of the best in recent days, along with our color commentary.

We sign in this week with a look at how this year’s global temperature is evolving as the big Pacific El Niño begins to wane. The temporary rise in global temperature that accompanies El Niño events is timed differently at the surface than it is in the lower atmosphere. Thus, while El Niño-boosted warmth led to a record high value in the 2015 global average surface temperature record, it did not fully manifest itself in the lower atmosphere (where the 2015 temperatures remained well below record levels).

But now that warmth is being fully felt aloft. The figure below is the satellite-measured global average temperature history of the lower atmosphere as compiled from the University of Alabama-Huntsville (UAH). The El Niño-spiked temperatures are clearly obvious in the first four months of 2016 (the rightmost points in the graph).

Figure 1. Global average satellite-based temperatures of the lower atmosphere from January 1979 through April 2016, as compiled by researchers at the University of Alabama-Huntsville.

Dr. Roy Spencer, who along with Dr. John Christy, curates the UAH satellite temperature record, has this to say on his blog regarding what to expect for the rest of the year and how the 2016 annual temperatures may ultimately rank:

I expect average cooling to continue throughout the year as El Nino weakens and is replaced with La Nina, now expected by mid-summer or early fall. Nevertheless, 2016 could still end up as a record warm year in the satellite record…it all depends upon how fast the warmth from the El Nino dissipates and La Nina sets in.

Early indications are also that global average surface temperature are continuing to feel the effect of the big, but dying, El Niño, and remain elevated into record territory.

So, it won’t be too surprising to be reading headlines the end of the year screaming “2016 Hottest Year Ever”—but it’s probably too much to hope that the authors of the underlying story correctly attribute the cause. But, we’re sure their memory will be jogged, and they’ll be full of excuses, when the La Nina cooling sets in and post-El Nino temperatures drop below record levels in 2017 (and likely many years thereafter).

Next up is a quick look at the updated numbers from the United Nations in regards to just how much global greenhouse gas emissions will be impacted if all nations of the world abide by the emissions reductions scheduled promised in their Intended Nationally Determined Contributions (INDC) that they submitted under the Paris Climate Agreement. There is only a slim possibility that these schedules will be adhered to—for instance, in the U.S., all indications are that we overpromised. Unkept promises aside, the U.N. reports that total global emissions of greenhouse gases will be 55.0 Gt (Metric gigatons) CO2eq (equivalent emissions scaling all greenhouse gas absorption to the value for carbon dioxide) in 2025 and 56.2 GtCO2eq in 2030. 

In the figure below, we superimpose those expectations on the U.N.’s Intergovernmental Panel on Climate Change (IPCC) depictions of business-as-usual (“baseline”) projections described by the IPCC as “projections of GHG [greenhouse gas] emissions and their key drivers as they might evolve in a future in which no explicit actions are taken to reduce GHG emissions.” It should be clear from this graph, that, as we have been fond of saying all along, the sum total of all the INDCs under the Paris Climate Agreement amounts to little more than business-as-usual expectations. But now, to make it look like everyone is “doing something” about climate change, the expected evolution of economic systems is being rebranded as “climate action.” Maybe that makes everyone feel better.  In reality, only the US and the EU have proposed significant (and significantly expensive) reductions.

Figure 2. Greenhouse gas emissions expected under the Paris Climate Agreement (red) superimposed upon IPCC business-as-usual expectations.

 

Next we turn to an enlightening piece by a team of analysts at the Mercatus Center at George Mason University examining the cumulative cost of government regulations—and it isn’t pretty. They calculate that that federal regulations retard economic growth in the U.S. by about 0.8% per year—or to the tune of a GDP that is $4 trillion less in 2012 than it would have been absent new regulation imposed since 1980, adding that “[i]f the cost of regulatory accumulation were a country, it could have the 4th largest GDP in the world.” Here is an excerpt from the summary: 

Using a 22-industry dataset that covers 1977 through 2012, the study finds that regulation—by distorting the investment choices that lead to innovation—has created a considerable drag on the economy, amounting to an average reduction in the annual growth rate of the US gross domestic product (GDP) of 0.8 percent.

Federal regulations have accumulated over many decades, piling up over time. When regulators add more rules to the pile, analysts often consider the likely benefits and compliance costs of the additional rules.

But regulations have a greater effect on the economy than analysis of a single rule in isolation can convey. The buildup of regulations over time leads to duplicative, obsolete, conflicting, and even contradictory rules, and the multiplicity of regulatory constraints complicates and distorts the decision-making processes of firms operating in the economy. Firms respond to both individual regulations and regulatory accumulation by altering their plans for research and development, for expansion, and for updating equipment and processes. Because of the important role innovation and productivity growth play in an economy, these distortions have consequences for the growth of the economy in the long run.

Economic growth in the United States has, on average, been slowed by 0.8 percent per year since 1980 owing to the cumulative effects of regulation:

● If regulation had been held constant at levels observed in 1980, the US economy would have been about 25 percent larger than it actually was as of 2012.

● This means that in 2012, the economy was $4 trillion smaller than it would have been in the absence of regulatory growth since 1980.

● This amounts to a loss of approximately $13,000 per capita, a significant amount of money for most American workers.

The gory details are provided in the full report authored by Bentley Coffey, Patrick A. McLaughlin, and Pietro Peretto.

And, finally, before signing off, we want to make sure that if you are looking for rational looks at the allegations of climate change-driven catastrophes in the news this week, you’ll know where to find them. Here is a good story from the A Chemist in Langley blog that throws water on the claims that anthropogenic climate change is behind Canada’s Ft. McMurray fire, and here’s some good background from the New Orleans Geological Society on the myriad of non-climate forces behind the drowning Isle de Jean Charles (telling the story that the New York Times didn’t).

You ought to have a look!

It’s legacy-polishing season for the Obama administration, with the president making himself available for “articles that will allow [him] to showcase his major achievements,” the New York Times reports. Over at Time.com, I have a piece on what I think will turn out to be Obama’s lasting legacy: the evisceration of virtually any remaining legal limits on the president’s power to wage war abroad.

As I note in the column, it’s unlikely that “history” will judge our 44th president harshly because of that. After all, “when it comes to presidential legacies, ‘history’ has lousy judgment.”

More specifically, the academics charged with evaluating presidential legacies have lousy judgment. A look at the presidential rankings reveals that the scholars who fill out the scorecards hardly subscribe to the historian-as-“hanging-judge” theory. Bill Kauffman’s arch description of the rankings is more accurate: “polls by which court historians reward warmarkers and punish the peaceful.” The odious Woodrow Wilson is a perennial top 10 favorite, while his normalcy-securing successor, Warren Harding, is nearly always dead last. Say what you will about Wilson’s brutality and contempt for civil liberties at home, his senseless waste of life abroad–at least the man dreamed big! Teapot Dome, however? Unforgivable. 

During the last presidential election cycle, CNN asked some leading presidential historians to opine on the theme “What is ‘presidential greatness’?” Their answers reveal a perverse favoritism toward activist, warrior presidents.

 

  • “In good times or bad, a president is expected to do something!” says presidential biographer Richard Reeves: sometimes, as with the Cuban Missile Crisis, “he does the right thing and becomes great for it.” The “right thing” in this case, apparently, was bringing the world to the brink of thermonuclear war over a missile deployment that Kennedy knew had no strategic consequence, but would have made him look bad politically.

 

  • Aida Donald, author of Lion in the White House: A Life of Theodore Roosevelt, informs us that “Harry Truman was also a great president, because he was commander in chief in a great war.” That would be Truman’s “police action” in Korea, launched without congressional authorization, in which over 33,000 U.S. servicemen died.

 

  • And historian H.W. Brands, while noting that “being a good president” should be “good enough,” squelches that sensible point with another atrocious example: “James Polk broke the impasse over expansion to the Pacific.” Polk did that by “unnecessarily and unconstitutionally” launching a war—as a young congressman named Abraham Lincoln pointed out—to steal land from Mexico.

 

Presidential scholars tend to wax messianic when they mull “presidential greatness.” In their book on the subject, the scholars Marc Landy and Sidney Milkis write that the great ones demonstrate the wherewithal “to engage the nation in a struggle for its constitutional soul.” 

The president described in the Federalist Papers is a humbler figure, possessing “no particle of spiritual jurisdiction.” His actual job description, contained in Article II’s oath of office, is to “preserve, protect and defend” the nation’s fundamental law.

If historians used that metric, Obama would have reason to worry about his legacy. As it stands, though, he’ll probably do just fine. 

Writing for FT.com’s “The Exchange” blog, economists Diane Coyle and Jonathan Haskel suggestthat Britain’s regulators — namely, the Competition and Markets Authority and the Bank of England — have got it wrong on competition in banking.  The authors argue that “the CMA and the BoE” have overlooked “the ruinous effect on competition of the ‘too big to fail’ subsidy” in their recent reports and policy announcements, and that, if anything, it is becoming “harder than ever for new entrants to gain a foothold” in the banking market.

In my view, Coyle and Haskel are right, but their argument doesn’t go far enough.

Let’s start with the basics: what is the too-big-to-fail subsidy, and how does it affect competition in banking?  The fundamental idea is that the bigger a bank is, the more likely it is to be bailed out if it runs into trouble.  The events of the 2008 financial crisis seem to confirm this, as do the assumptions of government assistance that some rating agencies build into their “support” ratings.  And as the 2011 report of Britain’s Independent Commission on Banking points out:

If one bank is seen as more likely to receive government support than another this will give it an unwarranted competitive advantage.  As creditors are assumed to be less likely to take losses, the bank will be able to fund itself more cheaply and so will have a lower cost base than its rival for a reason nothing to do with superior underlying efficiency.

The result is that small banks struggle to compete against larger rivals, while market entrants have difficulty establishing themselves against privileged incumbents.  All of this makes the banking sector less dynamic — and more comprehensively dominated by large, established firms — than it might otherwise be.

As Coyle and Haskel see it, however, Britain’s CMA thinks the problem has already been solved: that the competitive playing field has been leveled by the Bank of England’s proposed “systemic risk buffer,” according to which larger banks must hold more equity capital against their risk-weighted assets than smaller competitors.  In consequence, the CMA’s October 2015 provisional report on Britain’s retail banking market mostly ignored the too-big-to-fail problem, focusing instead on the rather more mundane question of how consumers can be encouraged to switch bank accounts more often.

Yet the CMA’s position is mistaken, say Coyle and Haskel, for three reasons.  First, switching bank accounts doesn’t always make sense for consumers: in the UK, at least, one bank account is pretty much the same as another, so consumers’ status quo bias is often quite rational.  Second, the level of additional capital big banks must hold as a systemic risk buffer is not high enough to outweigh the funding benefits that accrue from being too-big-to-fail.  Third, the stepped schedule of systemic risk buffer requirements outlined by the Bank of England might make big banks less likely to compete with each other, by effectively creating high marginal tax rates when banks move from one “systemic risk buffer” tier to another.  As Coyle and Haskel say, “This might restrain the emergence of gargantuan banks, but the purpose of competition is to promote rivalry, not hold up expansion at arbitrary regulator-determined thresholds.”

So far, so good.  But there’s a bigger picture here that Coyle and Haskel don’t see, or at least fail to mention.  For one thing, it isn’t just lower funding costs that make too-big-to-fail such an anti-competitive doctrine.  In fact, the very act of bailing out a failing institution itself constitutes a powerful strike against market competition.  As Europe Economics’ Andrew Lilico has put it, “company failure is an essential and ineliminable part of the competition process.  One of the most important obstacles to new entry in the banking sector, impeding competition, is that failing banks are saved by the government.”  If you want smaller banks to grow, and new banks to prosper, in other words, you can’t keep saving their bigger rivals from the consequences of bad investments.

More important still are the grounds upon which banks compete.  And it’s here that our financial regulatory authorities have the most to answer for.  Yes—of course—banks should compete with one another to provide the best possible service at the best possible price.  In an ideal world, however, banks would compete on something else as well: namely, their safety, stability, and reliability.  That banks do not tend to compete on these grounds today is testament to the fact that their depositors, bondholders, and shareholders do not see the need to pay attention to such things.  “Regulatory badging,” that illusory sense that banks must be safe because they are subject to regulators’ oversight, means that people seldom ask how highly-leveraged their banks really are.  Deposit insurance means they might not care about the answer, even if they ask the question.  And too-big-to-fail compounds the problem: if your bank is going to be bailed out, why worry about its risk profile?  No amount of regulatory oversight can compensate for this loss of competitive market discipline.

Ultimately, then, Coyle and Haskel are right to stress the importance of competition: if financial stability is the goal, then competition must be central to any banking reform agenda worthy of the name.  But before regulators can be part of the solution, they must understand the ways in which they are part of the problem.  And that, alas, has yet to happen.

[Cross-posted from Alt-M.org]

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