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Nobel laureate Robert Solow talks about his disputes with environmentalist doomsayers.

The one thing that really annoys me is amateurs making absurd statements about economics...doing amateur dynamics without a license, without a proper qualification. And they were doing it badly, so I got steamed up about that.

On the policy issue posed by global warming, Solow says

how do we deal with the poorer parts of the world? ...How are we going to tell them we developed economically by burning fossil fuels at a tremendous rate, by partially depleting reserves and by polluting the atmosphere, but then tell them not to?

The obvious case is China, which sits on a vast pile of coal. If they burn it and get to be an economy of a billion people living at a modern standard of living, then we really are in for a problem.

What do we do instead? Technology has to be the main part of the solution...

we should try to reduce the greenhouse gas intensity of our own technology and then be able to offer that technology to other people. Whether that can be done in time to make a big difference I don't know, but I see no reason to think it can't.

Discussion Question. Do you agree with Solow that better Western technology, transferred to poorer countries, represents the best solution for global warming?

Nobel laureate Robert Solow argues that market imperfections should not be assumed away.

There are asymmetries of information...There are substantial elements of monopoly in the modern world...And there are inflexibilities, rigidities in the price and wage mechanism.

I think it's foolish to think that these are imperfections you could hope in time to get rid of. I think those rigidities in wages and prices correspond to needs that social institutions are trying to meet

[note: my Ph.D dissertation, which Solow supervised, was entitled "Imperfect Information and Price Rigidity."]

On the theory that there is a "natural rate" of unemployment, Solow says,

It seems to me that what the profession [ends up saying is that] If the rate of inflation is increasing, then the current unemployment rate must be less than the natural rate of unemployment. If the current rate of inflation is decreasing, then the current unemployment rate must be above the natural unemployment rate. But that, of course, is a way of saying exactly nothing.

Discussion Question. Solow suggests that the Federal Budget process is too time-consuming to be used for macroeconomic stabilization. Therefore, he argues that automatic stabilizers ought to be strengthened. What sorts of tax or spending programs help counter the business cycle?

Nobel laureate Robert Solow makes a point about globalization.

The notion that the poor countries of the world can in any reasonable interval achieve rich-country incomes without trade and capital flows is utterly implausible. If the poor countries of the world have to depend upon themselves for the saving to finance the investment that they need, or have to develop by themselves the skills and technology they need to become rich by our standards, it's going to take forever.

However, he points out that those in poor countries who fear change may have good reason to do so.

In the United States and Europe, we've done very well in redistributing income. We're far from perfect, but we've done much better in making sure that nearly everybody profits from progress. But you could not say that about a lot of poor countries.

Discussion Question. In countries with low standards of living, do you think that it is the poor or the powerful who most resist change?

John S. Irons pointed out this interview with Nobel Laureate Robert Solow. There is material here for several posts. First, Solow continues to be skeptical about the role of computers in productivity.

from about 1995 until 2000 we had a period of much faster productivity growth. It is very tempting, it may even be plausible, but it's not a clear certainty, that some or all of that acceleration of productivity is the computer at last bearing fruit...

The best guesses—but they are merely best guesses—are that in approximately the next five to 10 years, we'll experience productivity growth nowhere near what we did toward the end of 1990s but maybe a half a percent to a percent a year faster than in the 1970s...Comparing the computer with electricity or the internal combustion engine just doesn't seem to me to be justified yet...

I always thought that the main difference the computer made in my office was that before the computer my secretary used to work for me, and afterward I worked for my secretary!

I am loathe to disagree with Professor Solow, but let me raise an alternative point of view. That is that in 1987, when Solow wrote his famous line that "we see the computer age everywhere but in the productivity statistics" we were still early in the life of Moore's Law, and the state-of-the-art Intel chip was the 386. To quote from one of my recent essays,

In fifteen years of progress from 1985 to 2000, the standard microprocessor went from the 386 with 275,000 transistors to the Pentium 4 with 42,000,000 transistors.

I find it plausible that somewhere along the way the computer went from being a tool that turned professionals into secretaries to being a tool that helped productivity. Thus, I would attribute the pattern of acceleration of productivity to the nonlinearity of Moore's Law rather than to luck. And what I see as the "best guess" about productivity going forward is Brad DeLong's optimistic oulook. But we'll know more in ten years.

Discussion Question. Think of the economy as having two sectors. The "normal" sector grows at 1.5 percent per year, and the computer sector grows at 20 percent per year. If the computer sector starts out at 0.5 percent of the economy, and the "normal" sector starts out at 99.5 percent of the economy, how long will it take for average economic growth to reach 2.0 percent per year?

Leaning way too hard on Keynes' "dentist" metaphor, Brad DeLong has the chutzpah to argue that even after Enron and the dotcom collapse, America's financial markets are the model to which East Asia should aspire.

the fact that we in the U.S. share the same problems does not mean that East Asia does not need to have financial regulators that can do a better job of monitoring and controlling the systemic risks its financial institutions' transactions create. It does not mean that East Asia does not need to rely more on public information dissemination and arms-length market transactions and less on long-term "relationships" in determining what and how operating companies get to use other people's money. The most powerful argument, I think, for attempting to move...toward an Anglo-American financial system is simply that the U.S. is the center of the world economy, that the ability to draw on New York-based finance is a very valuable social asset, and that will be hard to do if information is not presented and corporations are not governed and supervised in a way familiar to New York.

DeLong's entire discussion is worth reading, and probably he is right. But I would rather wait until the United States pulls out of its current macroeconomic malaise before I pronounce our financial institutions robust.

Discussion Question. In 1990, there was fear that the United States could not compete with Japan. Now, the roles are reversed. What are the chances of yet another reversal?

Paul Krugman revisits the California "energy crisis," and he finds that it was caused entirely by ruthless supply restrictions on the part of large energy companies.

this was the most spectacular abuse of market power since the days of the robber barons — and the feds did nothing to stop it...

So we ignore California's experience at our peril. It's all too likely to be the shape of things to come.

I believe that it is fair to say that most economists would predict that California's experience is not the shape of things to come. Even among those who believe that companies found it profitable to withhold energy (and by no means do all analysts hold this view), there is a consensus that the California regulatory regime had unique aspects which made it brittle when demand increased. For example, Lynne Kiesling points out that power disruptions were as often caused by overwhelmed system operators as they were by actual shortages. Moreover, the cost of selling power in California was high due to scarce emission permits and a risk premium associated with a fear of not getting paid (fears which in fact were realized when the main electric utility went bankrupt). Finally, to the extent that suppliers were able to exercise market power, she points says that

the dysfunctional California restructuring labyrinth gave the generators market power on a silver platter.

Discussion Question. In his last sentence Krugman evidently is predicting that there will be widespread electricity shortages, due to market manipulation by energy suppliers. Kiesling would argue that shortages can occur only when state regulatory regimes disconnect retail consumers from prices. How can we use future performance in energy markets to evaluate these conflicting viewpoints?

The economic history lesson provided the theme for this swansong for the music distribution industry.

What is happening in music is a tremendous increase in the productivity of music storage and distribution, which will benefit consumers and music creators. By the same token, record stores and CD manufacturers will be displaced by this new technology. However, rather than express their resentment as nostalgia for outmoded business practices, the industry incumbents couch the issue in terms of copyright and intellectual property.

Discussion Question. Why have CD prices not been slashed as the recording industry tries to compete with Internet music distribution?

Brad DeLong put together some talking points about the stock market. These are some basic, mainstream ideas, including the fact that historical price/earnings ratios tend to be low, indicating a risk premium that is higher than many economic models suggest is appropriate. (One exception is the "rational beliefs equilibrium" explanation given by Mordecai Kurz.)

One of DeLong's readers said that the fact that stock prices historically have not behaved as the models might predict is an indictment of the economics profession. However, I think this is another instance of the late Herbert Stein's observation that although economists know little, non-economists know even less.

Concerning the stock market, suppose that someone chooses to get into the stock market whenever it appears that the earnings/price ratio on stocks is above the long-term real interest rate and to get out of the market when the long-term real interest rate appears to be higher. That is suppose, that you invested as if the risk premium ought to be zero, instead of its historical values. This rule would have paid off extremely well. Throughout most of the past 100 years, it would have kept you in stocks, which earned a high rate of return. However, it would have caused you to sell well before the peak of stock prices two years ago, and it certainly would have kept you out of the Internet Bubble.

In contrast, the average investor (by definition) earned inferior returns by having too little invested in stocks for many years and then over-investing in stocks at their peak.

Economists, who have a reasonable model of the fair valuation of stock prices, do not know very much, in that we do not have a way to predict market sentiment. However, non-economists, who do not use rational valuation models, know even less.

Discussion Question. Do you think that, compared to the average investor, economists were more or less likely to buy Internet stocks in 1999?

Another valuable article in The Milken Institute Review this quarter is by David Levine on social security. He concludes,

[the] attempt to finesse the problem by banking on the stock market is almost certainly doomed to failure--quite possibly for both retirees and workers, but certainly for at least on of the groups...But sadly, the hollow promises of partial privatization continue to occupy center stage in the debate.

Of course, what Levine proposes is even more anathema to the Democrats and the AARP than stock market accounts.

By 2030...the ratio of covered workers to beneficiaries will have dropped to 2.1:1 and expenditures will exceed revenues by 32 percent. To close that gap, three options are available. We could raise the payroll tax rate from 21.4 percent to 16.4 percent, cut benefits by 24 percent, or reduce the number of beneficiaries by 18 percent (which would require an increase in the retirement age to approximately 70).

How painless! Simply by raising the retirement age in 2030 to 70, we solve the problem. I had never calculated the number, and I assumed it need to be much higher.

Discussion Question. Why is such a simple solution not endorsed by either major political party?

Also in the Milken Institute Review, Gavin Buckley says that Japan is wallowing in its banking crisis, rather than fixing it. In theory, its Resolution and Collection Corporation (RCC) should be liquidating the assets of failed institutions.

when the assets are depleted, the RCC would close up shop as the Resolution Trust Corporation did in the United States in 1995. However, neither the RCC's owner--the Japanese Government--nor its staff members wish that to happen.

For its staff the job of collecting income from assets (rather than disposing of them) means job security.

In the same issue, Joseph Stiglitz explains the advantage of a rapid bankruptcy resolution process.

Firms facing bankruptcy are in a state of limbo: it is not clear who really owns them, the current owners or creditors. But without clear owners, there is always a temptation for current management and the old owners to strip assets.

...in the United States, trustees are appointed by the courts to prevent this. But in Asia there were neither the legal frameworks nor the personnel to implement trusteeships.

Finally, in the same publication on a similar topic, Myron Scholes says

We are very much equity-based in the United States, while Europe is mainly bank-based.

European corporations are coddled by their banks...

Well-developed equity markets quickly punish failure and reward success, directing capital to the right investments. That is missing in Europe.

Discussion Question. In the United States, financial scandals and crises create a desire to resolve the issue and move on. Why is this healthier than dragging out the crisis?