Why California is Losing Sustainability

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Joel Kotkin writes,

Desalinization, widely used in the even more arid Middle East, notably Israel, has been blocked by environmental interests but could tap a virtually unlimited supply of the wet stuff, and lies close to the state’s most densely populated areas. Essentially the state could build enough desalinization facilities, and the energy plants to run them, for less money than Brown wants to spend on his high-speed choo-choo to nowhere.

Pointer from Don Boudreaux, who recommends the entire essay.

My one criticism is that it not an essay written to convince people to change their minds. To me, the most interesting challenge is to find a way to explain to environmentalists that markets are a subtle, sophisticated calculation mechanism for sustainability. (Incidentally, I am not certain that desalinization is quite at the point where it meets the market test.) Of course, markets can and do come up with imperfect answers. But people who claim to have better answers often do not.

Do Unit Roots Ruin the Concept of Potential GDP?

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Roger Farmer re-litigates an old controversy about macroeconomic data, concluding

What do we learn from this? Much the same as we learn from the fact that unemployment has a unit root. Just as unemployment can remain persistently high, so GDP can remain persistently below trend. There is no evidence that the economy is self-correcting.

Pointer from Mark Thoma. My comments:

1. Although unemployment has a unit root, Ed Leamer finds that there is some persistence to changes in payroll employment. See his textbook. You might also Google Kling-Leamer-momentum-employment.

2. Unit roots in macro data cause a huge problem. If you don’t correct for them, you get spurious correlation. If you do correct for them, you tend to get noise. That is one reason I call macroeconometrics The Science of Hubris.

3. In stock market returns, econometricians have been able to identify long-term mean reversion even though the short run is a random walk. Can something similar be done with GDP data?

4. If real GDP truly is nonstationary, then how can we rescue the concept of potential GDP? If you think of the economy as ultimately self-correcting, then what it corrects to is potential GDP. If the economy is not self-correcting, then the concept of potential GDP can have no objective basis.

I come to this issue with a desire not to praise the concept of potential GDP, but to bury it. From a PSST perspective, there is no such thing as potential GDP. The patterns of specialization and trade that are sustainable now are the patterns that are sustainable now. There were other patterns that were sustainable in the past, and entrepreneurs will discover still other patterns sustainable in the future, but right now we cannot describe those alternative patterns as potential. Right now those alternative patterns are either not sustainable or yet to be discovered.

Exit, Voice, and Technocracy

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Tim Harford writes,

several economists suggested structures that would put decision making at arm’s length from politicians, delegating it to technocrats with the expertise and incentives to do what is right for Britain.

He reports on interviews he had with several mainstream economists. Pointer from Mark Thoma.

What this tells you is that mainstream economists distrust voice (the political process), as I do. However, for mainstream economists, the preferred alternative is fantasy despotism, with technocrats in the role of despots. For me, the preferred alternative is exit, with people given more opportunities to choose among different governing bodies. See the widely-unread Unchecked and Unbalanced.

Robert Solow on Sustainability

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A commenter points to a talk from 1991, in which Solow says,

Once you take the point of view that I have been urging on you in thinking about sustainability as a matter of distributional equity between the present and the future, you can see that it becomes a problem about saving and investment. It becomes a problem about the choice between current consumption and providing for the future.

The reader recommended the article for this quip:

It is very hard to be against sustainability. In fact, the less you know about it, the better it sounds.

I recommend the entire article to readers of this blog and indeed to any student of economics. In fact, I would like to hit every graduate school economics professor over the head with it and say, “This is what you should be aiming to enable your students to do when they get their Ph.Ds.”

Solow deals with the concept of sustainability not with a formal model but with a philosophical examination. It is this ability to think like a philosopher that was lost when MIT transformed economics. Ironically, Solow aided and abetted the transformation.

Solow was my dissertation adviser. Although we have grown apart ideologically, my macro memoir explains how I was drawn to him in the late 1970s:

Unlike many of my fellow students, I am not inspired by Dornbusch and Fischer. I do not see the benefit of writing down equations to solve long-term optimization problems as a way of understanding macroeconomics. To me, too much economic relevance is being sacrificed to the altars of mathematical rigor and rational-expectations dogma. That assessment puts me hopelessly out of step with where academic macroeconomics is headed. It binds me to Solow.

Brad DeLong on the Public Sector vs. the Private Sector

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He writes,

Now we know that as bad as market failures can be, government failures can be worse. We badly need new effective institutional forms. But the decreasing salience of “Smithian” commodities in the twenty-first century means that rational governance would expect the private-market sphere to shrink relative to the public.

Pointer from Tyler Cowen.

I think of Brad DeLong as a Jekyll-Hyde character. The bad Brad DeLong snarks and snarls. The good Brad DeLong is insightful. This post is the good Brad DeLong. Read the whole thing. I am only commenting on part of it now. I would like to comment more on his discussion of the risk premium, but I think I need to see a longer, less hurried version of it.

In the quoted passage, his point is that as the share of the economy that produces stuff decreases and the share that provides health care, education, and information increases, we will see more informational asymmetries and externalities. This might mean that we need an expansion of existing government. However, when I think of “new institutional forms,” I think of the organizations of civil society and entrepreneurs.

Recall that Tyler and Alex see informational asymmetry being conquered by the Internet and entrepreneurs who make use of it. Recall also my comments on reputation systems as regulators.

Recall also my catch-phrase: Markets fail. Use markets.

Self-Control and Unemployment

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Jason Collins passes along this not-surprising result from a study by Michael Daly and others.

Analyzing unemployment data from two nationally representative British cohorts (N = 16,780), we found that low self-control in childhood was associated with the emergence and persistence of unemployment across four decades. On average, a 1-SD increase in self-control was associated with a reduction in the probability of unemployment of 1.4 percentage points after adjustment for intelligence, social class, and gender. From labor-market entry to middle age, individuals with low self-control experienced 1.6 times as many months of unemployment as those with high self-control.

This is one reason that it will be difficult to disentangle the effect of single parenting on economic outcomes. If parents of out-of-wedlock children have less self-control than married parents, and if self-control is somewhat heritable, then one could observe poor outcomes for children of single-parent families even if the family environments are not a problem.

Four Forces Watch: Poor Children Have Smaller Brains

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The Washington Post did not put this story on page one.

>New research that shows poor children have smaller brains than affluent children has deepened the national debate about ways to narrow the achievement gap.

Most of the story goes with the assumption poverty causes smaller brain size. But amazingly enough, the story also includes this alternative interpretation:

But James Thompson, a psychologist at University College London, has a third theory.

“People who have less ability and marry people with less ability have children who, on balance, on average, have less ability,” he said. Thompson noted that there is a genetic component to intelligence that Noble and Sowell failed to consider.

“It makes my jaw drop that we’ve known for years intelligence is inheritable and scientists are beginning to track down exactly how it happens,” Thompson said. “The well-known genetic hypothesis has not even had a chance to enter the door in this discussion.”

The story also quotes Charles Murray.

“I would be astonished if children’s brain size were NOT correlated with parental income. How could it be otherwise?”

The politically correct presumption would be that the brain size of poor children can be increased using some government programs. Can we verify that by comparing brain sizes of identical children raised apart? Or by comparing brain sizes of children randomly chosen for pre-school programs with children from a control group?

Murray has more commentary here, including a historical scientific controversy over whether there even exists a relationship between brain size and intelligence among humans.

Do I Heart Elizabeth Warren?

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Simon Johnson writes,

Senator Warren puts forward two main sets of proposals. The first is to more strongly discourage the deception of customers. This is hard to argue against. Some parts of the financial sector are well-run, providing essential services at reasonable prices and with sound ethics throughout. Other parts of finance have drifted, frankly, into deceiving people – on fees, on risks, on terms and conditions – as a primary source of profits. We don’t allow this kind of cheating in the non-financial sector and we shouldn’t allow it in finance either.

…The second proposal is to end the greatest cheat of all – the implicit subsidies received by the largest financial institutions, structured so as to encourage excessive and irresponsible risk-taking. These consequences of these subsidies have already caused massive macroeconomic damage – this is why our crisis in 2008-09 was so severe and the recovery so slow. Yet we have made painfully little progress towards really ending the problems associated with some very large financial firms – and their debts – being viewed by markets and policymakers as being too big to fail.

Pointer from Mark Thoma.

It may seem surprising that I agree with Senator Warren on both of these points. However, I disagree that the Consumer Financial Protection Board is taking the best approach to solving the problem of skilled financial firms exploiting less-skilled consumers. As I wrote here,

Regulated industries are always ready to complain about the cost of complying with bright-line regulations. However, I have the opposite objection. Particularly when it comes to the financial sector, compliance with BLR is far too easy. The bankers are always able to outmaneuver the regulators, staying within the letter of the rules while mocking their spirit.

That essay is where I proposed principles-based regulation as an alternative.

The Case for Taxing College Endowments

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Jorge Klor de Alva and Mark Schneider make the argument.

many of the richest universities in the country–sitting on hundreds of millions, if not billions, of dollars in tax exempt endowments, and garnering tens of millions of dollars of tax deductible gifts every year–receive government subsidies through current tax laws that dwarf anything received by public colleges and universities, institutions that educate the majority of the nation’s low- and middle-class students. For example, we estimate that in 2013, Princeton University’s tax-exempt status generated more than $100,000 per full-time equivalent student in taxpayer subsidies, compared to around $12,000 per student at Rutgers
University (the state flagship)

However, the flaw is not that rich educational institutions benefit more than other educational institutions from tax exemptions. The flaw is that our tax system has designated certain institutions as morally superior to others because they claim non-profit status.

The essay that I wrote on this topic is one of my favorites.

Other tax issues might be moot if instead of taxing income or profits we shifted to a tax on the consumption of goods and services. Such a tax system would place profit-seeking firms and nonprofits on an equal footing. It would continue to exempt donations from tax, but it would equally exempt other forms of saving and investment.

The Fed as Shadow Bank

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What would you call an institution that holds a portfolio of mortgage-backed securities and government bonds, funded mostly by overnight borrowing at an annual interest rate of 0.25 percent?

If Goldman Sachs or Citadel (a hedge fund) did that, we would call it “shadow banking.” That is, the institution is engaging in maturity transformation without being regulated as a bank.

And that is the Fed as it operates today. It pays 0.25 percent interest on “reserves,” which is just a way of saying that the Fed is borrowing at 0.25 percent to fund its portfolio.

It may be worth spending some time thinking about the Fed as just another shadow bank. When other shadow banks do what the Fed does, we call it portfolio management or carry trading or riding the yield curve. We don’t use mumbo-jumbo like “monetary policy” or “inflation targeting” or “quantitative easing.”

The Fed’s role as a shadow bank was less obvious back in the days of textbook central banking, with the Fed’s liabilities consisting of non-interest-bearing reserves and currency, and its assets consisting of short-term T-bills. (Actually, the textbooks had it wrong. The assets were repo loans. The Fed has always been a big player in the Gary Gorton shadow-banking poster child known as the repo market.) Still, I think that if we had always thought about the Fed in terms of shadow banking we would have been on the right track.

Some people call the classic Fed liabilities “money” or “high-powered money.” But I do not find that so exciting. In my view, the market decides what to use as money.

I tend to think that shadow banking affects the economy. As with other forms of banking, when there is more of it, credit conditions are looser, and this makes it easier for businesses to keep experiments going. This can be a good thing–if enough experiments turn out well. It can be a bad thing–if the experiments include too many ideas that are not really sustainable.

However, banking and shadow banking that is centered around portfolios of government securities does nothing to help credit conditions for businesses. It just facilitates crowding out.

So what could be wrong with holding the view that the Fed has never been and never will be something other than just another shadow bank? Most economists would argue that the Fed did important things in the 1970s and 1980s. In the 1970s, it was too loose and we got inflation. In the early 1980s it tightened and inflation went away.

I would say that we could just as easily blame the rest of the shadow banks. Who was it that kept long-term interest rates below inflation in the 1970s? Who was it that made long-term rates shoot up in the early 1980s? I think that one can defend the notion that it was the rest of the shadow banks that did that, and the Fed just kind of followed along.