Tuesday, December 28, 2010

The essence of the matter

Have you wondered why economists seem so divided over on their interpretations of the current economic crisis? Here is my attempt to boil it down.

Keynesians and Classicals (of various kinds) agree on one key point; there is currently a serious lack of confidence in the economy that is inhibiting private business investment expenditures. What sharply divides them are views as to what caused this crisis of confidence and what needs to be done to fix it.

Keynesians think that the market failed because of lack of regulation in a dynamic innovative environment. Those with Classical inclinations believe that exactly the opposite is true; that it was ill-conceived regulatory initiatives like the concerted push to expand home ownership in America, underwritten by FANNIE MAE and FREDDIE MAC, and facilitated by easy money, that caused a housing bubble and runaway financial asset expansion. The latter was seriously aggravated by a cartel of rating agencies indirectly created by government licensing requirements and operating with serious conflicts of interest.

Keynesians think that more government-Fed-financed stimulus is needed, and that higher taxes don't matter. Those who believe in the market believe that permanent significant tax reductions (comprehensive tax reform) and a commitment to fiscal responsibility at the various levels of government is what is needed. This will entail credibly limiting the power of the Fed as well.

Tuesday, December 7, 2010

Look not to Israel, the Arab states or the U.S. for a solution - look to the United Nations!

See the pdf file at this link

click here

- an article from Commentary magazine, current issue, by Michael Bernstam.

I found this article amazing in its simplicity. It seems so obvious to me after reading it that I marvel that anyone carefully contemplating the Israel-Palestinian conflict could fail to consider the role of UNRWA. But you never hear a word about it.

If Bernstam is right, then UNRWA must stand as the most perniciously destructive and counterproductive of the agencies of the UN. The "achievements" of the UN in the world have been rightly criticized and even vilified. But this must be the worst of them. It is a case mostly of unintended harms, but that is no mitigation to those millions whose lives it has affected.

Those who rise to condemn Israel pointing to the injustice of the displacement in 1949 of the Arabs whose descendants became today's Palestinians, should read this article carefully and consider the balancing of evils over the years that have attended all of the many refugees from that awful period in history. Absent the dependency enabling (nay producing) role of UNRWA, the refugee status of the Palestinians would not have endured. In the meantime, UNRWA has evolved into a Palestinian controlled, terrorist sponsoring, paramilitary organization that is also an all-encompassing welfare state perpetuating refugeeism. Remember, this is an agency of the United Nations.! And, as such, it receives most of its financing from the taxpayers of the United States!

What this article tells me (and I do not discount the possibility that I am naïve about some of it) is that while we correctly report, analyze and condemn current injustices on both sides of the issue - being the predictable result of political opportunism and the racism of fundamentalists and ultra-nationalists - the foundationally pathological structure of the Palestinian situation is at the root of it. If this is not fixed the problem quite simply will never go away and will probably get steadily worse. Yet, if Bernstam is correct, the solution he offers, the abolition of UNRWA, is the obvious fix.

I highly recommend you read this article.

Sunday, December 5, 2010

Income inequality is NOT a bad thing.

In light of the current debate in the Congress about extending tax cuts for the "rich," I feel compelled to revisit the question of economic inequality.

Perhaps the most stubbornly persistent idea embraced by American "liberals" (statists) is the idea that the rich ought to pay more tax (meaning a higher proportion of their income) because income inequality is a bad thing. This idea is widespread. It has achieved the status of a self-evident truth. And yet when one examines it carefully one sees that the belief is not only illogical, it is also unworthy.

At the most practical level it is just silly - though dangerously so. There is no reason to believe that target-taxing people who earn more than $250,000 a year will help anyone at all. The argument is that government needs that revenue to prevent the deficit from getting any worse. And, after all, the "rich" can afford it. This kind of reasoning comes from economic ignorance (notwithstanding the fact that many of the people who are making it should know better). It comes from focusing on the short-term-direct effects of any policy and ignores the longer-term-widespread effects. The deficit is the result of a shortfall of tax-revenue against expenditure. But taxes affect behavior. A lower tax rate may actually boost revenue if it encourages economic activity. This is not just a theoretical possibility; there are many historical examples of this. So, if its just the deficit that is the problem, it is by no means clear that soaking the rich will help and may likely hurt. There is nothing that helps cure government deficits more than vigorous private-sector economic activity which generates lots of tax revenue, and low levels of taxation are crucial for this in the long term.

Of course the best way to reduce the deficit is to cut government expenditure - but that is a subject for another blog.

If, alternatively, the liberals are concerned about jobs (especially for the poor and for minorities) they should understand that it is only the rich who create jobs. Government jobs depend parasitically on value created in the private sector; government does not create much value itself. Its role is to create conditions that allow for the creation of value by productive, entrepreneurial activity. Without the rich there are no jobs. Without the rich there is no economic growth. If you tax the rich you tax the desire to become rich and create jobs.

So, at a practical level, the policy is ill-advised. Liberals reading this will roll their eyes. "We have heard this before from the likes of Ronald Reagan - it is 'trickle down' economics and it is nonsense. The rich don't spend their money on creating jobs, they save it and the money does not trickle down to the poor." Again, economic illiteracy. Those making that argument could not possibly really believe what they are saying. If they did why would they stop short of advocating the complete elimination of all income inequality? Why not raise income taxes on the rich sufficient to erase all income gaps? Contemplating that, they will realize that this would be disastrous, that it would most probably destroy the economy by killing golden egg-laying goose. But somehow mild income leveling has no bad effects on the goose? Listen guys, we know that 'trickle down' must work. Even if the rich save their income, that money comes back into the economy through the capital market (at least it will when it starts working again!). Its not really 'trickle down.' Its 'spread it around.' Taxes shrink the pie, tax-cuts expand it. Its not a zero-sum game and its not rocket science. You can't simply take taxes from the rich and give them to the poor (which rarely actually happens anyway) without destroying economic value.

Yet, having said all this, I suspect that deep down the intelligent liberal knows it already. I suspect that this is not what its really about. We have had upwards of forty years of the war on poverty and there is apparently no victory in sight. If you add up all of the money extracted by taxes for so-called poverty programs, and divide it by the number of people classified as "poor," there should not be any poor people left. Contributions are more than adequate to ensure no poverty. Why are the poor not getting "their" money? Why indeed? Poverty in America is actually less of a condition than an industry employing millions of parasitical bureaucrats with a vested interest in its perpetuation. [Many of them are sincere - they know not what they do.]

No, I suspect the real reason behind the desire to sock it to the rich with a big tax stick, is the powerful visceral appeal of the act of reducing income inequality. Inequality has taken on a life of its own as a bogey man. Its not really poverty that is the problem in liberal eyes, it is inequality. Sans poverty, inequality would still be problem for them. If somehow the poorest person in America earned a million dollars annually and the richest earned a billion, this would still be a problem for them. If the rich billionaires were small in number yet owned a large proportion of the wealth, and the millionaires were large in number yet owned a proportion less than their numbers in the population, this would still be a problem for them. I think they will admit this. Inequality, in and of itself, is a problem for them.

Now, why should this be so? Oh, they have ready answers. But, though they may dress it up in all manner of respectable rhetoric like "the dangers of relative deprivation," in the end it comes down to just two basic and very base emotions - resentment and envy! That is what it is really about. The liberal mind hates all inequalities. It cannot abide "gaps." Its policy motivations are all about the eradication of gaps. There is a deep-seated resentment of the acquisition of riches. There is a barely acknowledged envy of the rich. How much is resentment and how much envy, who knows? I suspect the intellectuals are more resentful and the liberals who are poor are more envious, it doesn't matter much. Both are equally unworthy.

Think about it. What are the values we try to inculcate in our children? Generosity, sharing, joy for the good-fortune of others. And what values do we condemn in them? Resentment, envy, and the inability to rejoice in (or at least respect) the achievements of others. Yet when it comes to the fashioning of economic and social policy we somehow think its ok to reverse these values and extol the benefits of enforced equality, elevating resentment and envy to national virtues. Echoing Adam Smith, how can what are vices of private behavior become virtues when practiced by government?

Poverty is bad. Income inequality is not. It is a necessary outcome of a free society in which people make different lifestyle choices and encounter different odds. To be sure, all free people should be equal in the eyes of the law, they should be equally subject to the rule of law, but they should not be made to be equal in results when they violate no law.

Monday, November 29, 2010

After Keynes: Rediscovering Hayek.

About two years ago in my blog I predicted that sooner or later the pendulum would swing back against the Keynesian resurgence as disillusionment with its policy failures mounted up. This is now happening - in Europe and elsewhere. The one glaring exception is the Board of Governors of the Federal Reserve System of the United States (aka. Ben Bernanke).

See this interesting article in Newsweek.

A Return to Economist Friedrich Hayek's Ideas - Newsweek


Friday, October 29, 2010

Considerations on market stability and the world of finance

David Prychitko has written a very interesting article, just published in the latest issue of the Review of Austrian Economics. It is a timely consideration of the ideas of a prominent Keynesian, Hyman Minsky, on the question of the alleged inherent instability of the financial system (actually all capitalist financial systems).

Minsky was a devoted Keynesian, but an imaginative one. He extends and deepens Keynes’s ideas, making them more plausible and intuitive. His main instrument is a very useful taxonomy of types of finance. There are three types, hedge finance, speculative finance and Ponzi finance. They escalate in degree of risk. When the revenue stream from an investment is confidently expected to pay all expenditure streams at every moment in the future we have hedge finance. With speculative finance there are some holes; near-term expenditures may exceed revenues, the hope being that in the longer term, revenues and capital gains will redress the balance. Ponzi finance is a situation in which in which interest on the debt actually exceeds revenue flows. (In passing we could note that this is a nice framework not only for analyzing the behavior of individuals, but also, even more relevantly, of the state.)

Minsky’s story uses this taxonomy to explain how a cycle is composed of the progression of economic agents from hedge finance to Ponzi finance before an inevitable collapse. He claims that the take off from hedge to speculative finance is inevitable, the Minsky-moment at which the start of the boom occurs. Prychitko, while giving us an appreciation of Minsky’s work, criticizes him for not providing an explanation of the genesis of this progression from tranquil business as usual to escalating speculative positions. Of course the Austrian explanation is the credit cycle ignited by what is so charmingly referred to today as “quantitative easing” by the central bank. For the rest you need to read this wonderful article which provides Austrians with a welcome window into the other world.

I would like to add a note on one aspect of this fundamental debate with the Keynesians. Prychitko claims that Minsky has no explanation of the Minsky-moment and implies, I think, that without such an explanation we are at a loss to understand how any cycle would occur. Why would entrepreneurs ever abandon their commitment to hedge finance? What provokes them to take on more risk to the point of financial meltdown? I think this is basically correct. But I want to guard against the possible conclusion that what is being claimed is that, absent governmental monetary mismanagement, no cycles would ever occur.

Of course Keynes’s explanation (surely implicit in Minsky) is rooted in casual social psychology. Entrepreneurs display “animal spirits” and are susceptible to waves of optimism and pessimism. There is “herding.” Asset values, being inherently subjective, very sensitive to projected future revenues, are subject to large, unpredictable, connected swings. So the explanation of the Minsky-moment is that eventually financial tranquility is bound to be disturbed by a contagion of unrealistic optimistic expectations. And the rest is history.

My own take on this is as follows: I think there is an element of truth in what Keynes says. I think, even in the absence of monetary mismanagement, there would be cycles. In fact, cycles are part of the experimental, evolutionary nature of the market process. All action is based on expectations. The epistemological basis of some expectations is more solid than others. In the realm of business investment, particularly in an environment of innovation and rapid change, the knowledge-base is quite tenuous. Entrepreneurs pit their conflicting expectations against each other. Most of them (and maybe all of them) will be wrong. Hence, where the investment environment invites imaginative visions (for example the late 1800’s and early 1900’s, the 1990s) we are bound to get a clustering of errors. It is inherent in the market process.

There are a number of reasons why the “people should know better” argument doesn’t work against this. Firstly, even though it may be perfectly clear that asset values are unrealistically high, and must eventually be corrected, investors do not know when this correction will come and are anxious to ride the boom as long as they can. There is a kind of brinkmanship. That this occurs is, I think, undeniable. Second, one could argue that memory is fatally selective. We remember the more recent past better than the more distant, especially when the latter belongs to previous generations. So, for example, the discrediting of Keynesian ideas is not remembered as well by the current generation as by those who lived through the 1970’s and early 1980’s. Third, there is the “each episode is unique” syndrome (a kind of pop “historicist” anti-Mengerian approach); this is a “new economy” in which the old rules don’t apply. And there may be other, similar arguments. I think it not implausible to suggest that the “dark forces of time and ignorance” do make for a world of unavoidable turbulence.

So what? Well the power of the Austrian argument derives not from asserting that without government mismanagement cycles could be avoided; it comes rather from the anti-utopian argument that this world is not perfect. It is extremely complex, it churns, it surges, and it progresses. The trick is to allow it to play out and not think you can achieve smooth sailing by interfering with it. Striving for the impossible produces highly exaggerated cycles and messes up the ability of the process to filter information, to sift the viable projects from the others. Absent government mismanagement, the boom comes to a natural end because the waves of optimistic investment put an increasing strain on the supply of loanable funds and push up interest rates. The most insane thing you can do is attempt to prolong the boom by trying to keep down the cost of increasingly scarce credit.

But this is the view of someone who believes that the market process is inherently stable. Cycles will occur, but the financial markets, if unencumbered, can accommodate them. Cycles are mitigated by the homeostatic properties of the market, which work fast enough to correct any run-away waves of optimism and pessimism, to prevent social dysfunction or collapse.

The Keynesians quite simply do not believe this. They believe that the market system is inherently unstable, that herding behaviors, if not checked by enlightened leadership, could result in financial and social collapse, in disaster and catastrophe.

[At least that is the story. It’s hard to know how sincere this is and to what extent it is just a pretext for the desire to engage in large scale Robin-Hood-type income distribution. In addition, it totally ignores the unrealism of assuming that government leadership has the ability (knowledge) to, and can be trusted to, do the job. That is, it ignores the incentive and knowledge problems that economic policy must face. It asserts market failure but ignores government failure.]

As a theoretical matter, the stability of the market system cannot be proved. Stability (and convergence) rests (among other things) on the speed with which the undeniable homeostatic forces (like price flexibility) work relative to the speed of other changes. We have no robust theory of behavior in disequilibrium and without one we cannot prove the stability of a system of interconnected markets. The confident assertion that the market system is not inherently unstable (which I do firmly believe) derives from a particular understanding of how markets work plus a particular reading of history. Theoretically the world need not work the way it does. It could be closer to the one envisioned by Keynes, but it isn’t.

The absence of a knock-down argument (theoretical or empirical – history does not speak with one voice) is the reason I even have to write something like this; it is the reason discredited ideas get recycled. It makes our jobs much more difficult. But I guess there is an upside to that.

Monday, October 25, 2010

Can Israel be Jewish and a Liberal Democracy?

The article linked below is not a very good defense of Israel as a Jewish state. I think it can be stated much more simply.

Is the idea of an official religion for a nation-state consistent with pure liberal democracy (libertarian values)?

I think the answer is definitely "no." (Of course, the whole idea of a nation-state may not be consistent with this ideal anyway. Libertarians don't like the idea of any collectives, like "nation." But they exist nevertheless.) Hence America, and some other liberal democracies, strive mightily to strike a neutral position on religion - making it a matter of private choice and practice as long as their adherents do not act coercively.

But this option is simply not on the table in the Middle East. Without exception every nation-state in the Middle East has an official religion, and except for Israel it is Islam. And, in every respect, without exception, Israel is closer to the liberal democratic ideal than any of its neighbors and enemies - the gap is enormous. To push a "peace-process" that results in a single, secular Israel-Palestinian state, is, as a practical matter, to place all of the Jews in Israel, (and many around the world) in grave danger.

There is ample evidence to indicate that this is no mere pretext. It is an essential part of Israel's character (as a nation, a set of institutional and cultural practices) that it has been, and continues to be, a safe-haven and a guardian for Jews everywhere. The vast majority of Jews now living in Israel came there, or descend from relatives who came there, from places where they were persecuted, often fleeing for their very lives. This is not a mere donning of the posture of victimhood, so common among other minorities, for political reasons. Israel asks for nothing except to be left alone in its tiny piece of real estate. It can fend for itself. It needs no "affirmative action."

Before we self-righteously push for a "peace-process" that results in a secular, Israel-Palestine, or even a secular Israel, we should demand the secularization and democratization of Egypt, Syria, Jordan, Lebanon, Saudi Arabia and the rest of them.

Douglas J. Feith: Can Israel Be Jewish and Democratic? - WSJ.com

In The Wall Street Journal, Douglas J. Feith of the Hudson Institute writes that many nations have laws and practices that recognize their majority group's history, language or religion while also protecting the rights of minorities.

Saturday, October 9, 2010

Israel-Palestine - the key is economic, the barrier is religious.

The Israeli-Palestinian talks seem destined to collapse. The ostensible reason for the collapse is Israel's refusal to block the resumption of construction of "settlements" on the West Bank and in east Jerusalem. But I seriously doubt that this is the case. This is not the essence of the differences between Israel and the Palestinians.

As I have stated many times, Israel did not create the Palestinian problem and Israel cannot solve it. The essence of the problem is the existence of a Jewish state in the heart of the Middle East. Israel is an affront, an unacceptable insult, to both Arab national aspirations/self esteem and religious precepts (it is a Muslim imperative that no infidel may rule land once ruled by a Muslim governmental authority). In the last few decades it is the latter that has become much more important. But both are really smokescreens in the service of realpolitik. The Arab dictators of the area, and Arab and Muslim dictators further afield, use the "Palestinian cause" to deflect attention away from their own corruption and despotic rule - for their failure to modernize and liberalize their economies. The Palestinians are pawns in the hands of outside rulers who are dictators, religious fanatics, or both. The Saudis top the list. A true peace with Israel would deprive them of this.

Of course, it does not help matters that Israel is so monumentally successful and a democracy to boot. For those convinced that Israel is the problem, this simply multiplies the insults by widening the economic and cultural-political gap. By a curious stretch of logic, if Israelis are doing so well it must be because the Palestinians are suffering so much.

But, not all Palestinians are so bitter or so naive. Many see in Israel a mirror of their own possibilities, and the West Bank economy is now growing rapidly, in part owing to employment supplied by the expanding settlements.

For the record: I condemn the use of public money for the construction of any private buildings or settlements wherever they may be - in Palestine or in New Jersey. And I condemn the religious fanaticism that claims land on the basis of a biblical promise and uses political power to divert funds to its cause. There should be no doubt where I stand on this. But, as I understand it, these are not the central objections to the settlements by those who blame Israel. Rather they see any Jewish settlement as a form of "occupation" and seem to think that if only the "occupation" could be ended, peace could be achieved. This view is as dangerous as it is wrong.

The settlements are a mixed bag. I don't know how much state funding lies behind them, but all-in-all the settlers constitute a population of about 300,000 - a tiny minority among the 2.5 million Palestinians. By all accounts they are industrious and productive. If they are financed by the Israeli taxpayer (or international Jewish donations) they are a gift to both the settlers and the Palestinians. In any future Palestinian state, a peaceful neighbor with Israel, the status of Jewish people living there will have to be determined. Will Jews be able to live as peacefully in Palestine as the million Arab Israelis do in Israel. If not, why not? And if not, then that is no real peace. Assuming they are, and depending where the borders are drawn, the settlements would indeed be valuable economic models for the new state. A rational approach to real peace would not be to walk out of peace talks on this account.

If there is any hope for real peace, I believe it will have to be based on shared economic interests. The Palestinians constitute a huge labor force and a huge potential local market for both Israel and future Palestinian industry. Israeli ingenuity and technology could prove invaluable. There is an unlimited potential for mutual advantage - a substantial "peace dividend." But for this to even have a chance, religious fanaticism on both sides will have to be controlled.

Economic prosperity depends largely on economic freedom. As China and the thriving economies of the UAE illustrate, a large measure of economic freedom can exist within a politically restrictive state. Private property, honoring of contracts, the absence of price controls and oppressive economic regulation, a stable financial system, etc. are all necessary for economic growth. Political freedom, though not necessary, is also helpful in this regard. Of course, freedom is an overriding end in itself. Economic growth is of little use if the options available to consumers are severely limited, if what they can read and say are restricted. And that is why oppressive states that experience economic growth also experience tremendous pressure for political liberalization. The prime example of this is Chile.

In fact economic growth does best in liberal democracies - economies that are "democratic" in the broader sense of that word - not just politically in the sense of being able to elect representatives, but democratic in the sense of being open, free societies whose citizens possess what we understand as civil liberties, among which the most important is freedom of speech. And these liberal democracies are also secular societies, where religion is a private matter and everyone is free to practice her/his religion as long as s/he does not attempt to forcibly impose it on anyone else. There is no official religion and religious precepts ideally do not govern public life - have no expression in law.

All of the states in the Middle East have official religions. The case of Israel is ambiguous. It is the freest society in the region (and one of the freest in the world) and it affords its citizens many civil liberties. But on the matter of religion, there are violations of basic individual freedoms. The law-of-return discriminates in favor of Jews in matters of citizenship, and certain civil functions are monopolized by religious authorities - owing to the power of the orthodox Jewish political parties in the proportional representation system of election. So, marriage and funeral ceremonies must be performed by the recognized religious authorities - in the case of Jews this is the orthodox Jewish establishment; and intermarriage is effectively ruled out - interfaith couples have to leave Israel to marry!

On its face this is unacceptable to anyone who believes in civil liberties - which includes most Jews worldwide. But the politics of the situation has proven to be an immovable barrier to its reform. Breaking the monopoly of the religious right-wing to make room for more liberal denominations and, importantly, to allow for civil marriages, has been impossible. This disturbs me, but I am even more worried about another trend and what it may portend.

Israeli demographics tracks world trends. The piously religious families are the ones having lots of babies, while the secular liberals have very few. This trend will, not so gradually, erode the secular liberal component of Israeli society. In addition the worldwide renaissance in fundamentalism has affected Israeli youth as well. Religious identification in Israel is at an all time high. And because of the right-wing religious monopoly this means right-wing religious affiliation. Israelis living abroad in North America often affiliate Conservative of Reform, but no such alternative exists in Israel (these movements are tiny in Israel).

The religious population in Israel has posed numerous challenges, most of which have been successfully met by palatable compromises. Most mundanely, the religious communities receive huge subsidies so that their young men may study in Yeshivot. They also receive exemption from army service - though it is true that more and more soldiers are in fact religiously observant - it is only the anti-Zionist branches of the religious right to whom this exemption mostly applies. Jewish religious holidays are national holidays - but for most Israelis this means a day at the beach or out with the family. There have been political initiatives to try to ban such activities, most especially the driving of cars during holy days, but to date Israeli law has has upheld the principle of individual civil liberty in this regard. With increasing political power going to the religious establishments who knows how this will play out in the future?

So, projecting both the demographic and cultural trends one sees an increasing right-wing religious influence that could prove inimical to both Israel's own economic development and to the prospects of a spontaneously developing peace. Leaving it to the religious fanatics on both sides, it is easy to see, would mean continual hostility as the conflicting claims of each in matters of belief and land are simply irreconcilable. The religious constituent in Israel is the most belligerent when it comes to foreign policy.

True, a Jewish theocracy is likely to be more tolerant than a Muslim one - but were I a Muslim I would prefer neither, and moderate Muslims clearly will not and should not accept either. Both Jews and Muslims have rich histories of pragmatic commercial achievement and it is this, rather than their respective religions, that holds the greatest hope for a spontaneous evolution of peaceful coexistence. Once substantial trade and economic interaction exists the official recognition will follow. But for that to happen religious fervor on both sides must be constrained.

I don't know how strong the current momentum for mutually advantageous economic development is, but this clearly should be a conscious component of any intelligent understanding of the situation and any sensible foreign policy toward it.

Sunday, September 26, 2010

Peter Lewin's thought for the day - remembering history

The reason why we (collectively) don't learn from history is that we don't live long enough to remember it.

Those alive today who are old enough to have actually experienced, as thinking adults, the Carter, Reagan,Thatcher administrations and the ascendancy of the ideas of Friederich Hayek and Milton Friedman - leading to the widespread discrediting of Keynesian economics - are in the ineffective minority. The knowledge that counts for economic policy is very much based on actual experience (you had to live through it); it is tacit in nature, very difficult to transmit to someone who did not share the experience. Written history is a pale substitute for the real thing, and it frequently distorts.

So, every generation seems doomed to find out for itself what it should not do by doing it again - just like every child in the process of growing up.