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James Glassman takes a blame the victim position on Enron employees who had a lot of their savings tied up in company stock.

But let's not lose sight of the main lesson of the Enron disaster: Bad things happen to good investors, and diversification is the only protection. Companies should design plans that make diversification easier, but ultimately, the responsibility for wise investing must lie with the investor. Politicians who say it doesn't are only encouraging risky behavior.

In contrast, Ken Harney is sympathetic to the heirs of a wealthy widow, who discovered that she had taken out a reverse mortgage with a shared-appreciation feature. As a consequence, the mortgage company pocketed about $750,000 of the proceeds from the sale of her home for $2.2 million. However, Harney concludes by saying

The bottom line for seniors and their loved ones is simple: Borrower be on guard.

What we have in this country, in my opinion, is a large portion of the population making significant financial decisions without knowing basic math, much less the level of economics and finance that is required to make sound choices. Moreover, there is little or no quality control in the area of financial advice. If the average American needs surgery, chances are it will be performed by someone who meets reasonably high standards for ethics and training. If the average American needs a mortgage or stock market advice, chances are they will encounter someone who truly is suited to selling mattresses.

I think that the financial services industry needs better regulation. Regulators can help to ensure that ethical standards are upheld. They also can give average citizens a way to distiguish qualified financial advisers from quacks and salesmen. Perhaps the optimum regulation would be less onerous in some respects than financial regulations that exist today. Perhaps the best regulation can come from private boards and watchdog groups, and not from government. But I disagree with Glassman that the average citizen should learn financial lessons the hard way.

Discussion Question. Obviously, I think that many people receive bad financial advice. Why is that? Why don't market forces drive bad financial practitioners out of business?

It is interesting to read the analyses of Argentina by Martin Feldstein and Joseph Stiglitz side by side. Feldstein was a chief economic adviser in a Republican administration and Stiglitz was chief economic adviser in a Democratic administration.

They agree about the flaw of pegging the Argentinian peso to the dollar. Feldstein calls it a "bad idea" and Stiglitz calls it "highly risky."

They disagree on how to characterize the ratio of Argentina's foreign debt to its GDP.

• Stiglitz describes this ratio as "moderate, at around 45 per cent, lower than Japan's."
• Feldstein describes it as "excessive...eventually reached 50 percent of GDP...clear that Argentina could no longer borrow to roll over those debts and pay the interest"

They also disagree on the impact of the IMF's attempts to encourage Argentina to reduce its budget deficit.

• Stiglitz says that making these recommendations was "a fatal mistake."
• Feldstein says that the recommendations should have been enforced, but instead that "the multi-billion dollar loans that the IMF gave to Argentina permitted it to postpone dealing with its fundamental problems."

I would reiterate what I said in post #24, that the IMF stands for the "Impossible Mission Fund."

Brad DeLong's Macroeconomics textbook has this to say about economists who attack the IMF when a country experiences an increase in interest rates and a devaluation of the exchange rate as a result of a currency crisis:

both...were wrong...the fall in exchange rate confidence and the resulting decline in international investment must lead to a rise in domestic interest rates and...must also lead to a [currency depreciation] --p.206-207

DeLong then goes on to draw an analogy between those who expect the IMF to prevent these consequences and the legend of King Canute commanding the tides to stop.

Discussion Question. As the case of Argentina illustrates, it is not clear when the IMF is helping or hurting countries by lending to them. How can the IMF determine when its loans are helping countries by providing liquidity or hurting them by deepening insolvency?

My favorite magazine, The Atlantic Monthly, has an opinion piece in the February 2002 issue by Jack Beatty that makes the bleeding-heart liberal case for removing trade barriers. The Atlantic's web site lags the dead-trees version, so the article has not yet appeared on line. Beatty says,

Basically, the West has required the Rest to open their markets without reciprocating commensurately. Developing countries lose about $100 billion a year owing to Western export subsidies and trade barriers.

A free-trade conservative would just say that we should remove trade barriers and damn the consequences. The bleeding-heart position is that we should have some special government programs aimed at helping workers and farmers who would be displaced by imports from overseas. But neither the free-trade conservatives nor the bleeding-heart liberals have enough votes in Congress.

Discussion Question. The anti-globalization movement strongly opposes imports from poor countries. The argument is that developing countries do not give workers the pay and working conditions enjoyed by Americans. What impact do our trade barriers have on the pay and working conditions in developing countries?

Economists dream of bringing the underdeveloped world up to the living standards of the United States. Ecologists warn that this is a nightmare. In Scientific American, Edward O. Wilson carries on an imaginary dialog with an economist. Wilson writes,

the average amount of productive land and shallow sea appropriated by each person in bits and pieces from around the world for food, water, housing, energy, transportation, commerce, and waste absorption--is about one hectare (2.5 acres) in developing nations but about 9.6 hectares (24 acres) in the U.S. The footprint for the total human population is 2.1 hectares (5.2 acres). For every person in the world to reach present U.S. levels of consumption with existing technology would require four more planet Earths.

Wilson focuses on two resources. One resource is fresh water. As an economist, I expect that if fresh water is scarce, then its price will rise. This in turn will lead to conservation and to technologies that increase supply. If water suddenly became more scarce, then this would be good news for eastern Canadians and bad news for southern Californians. But markets should be able to sort it out.

The other resource is the atmosphere. Wilson is among those who believes that atmospheric pollution is a grave issue. If that view is correct, then we have a problem, because atmospheric pollution is a classic case of an externality. Left alone, the market will produce more pollution than is optimal.

Discussion Question. Do you think that markets will take care of the problem of fresh water? Are the necessary property rights and pricing mechanisms in place? In what ways might they be inadequate?

One of the poster children for the unintended consequences of government regulation is the specification of Corporate Average Fuel Economy (CAFE). In today's National Review Online, Ken Adelman writes,

Smaller cars means more death on the highways. Last summer, a National Academy of Sciences panel concluded that CAFE had contributed to between 1,300 and 2,600 traffic deaths each year, with ten times the number of serious injuries. Another authoritative source found similar results. The Harvard Center for Risk Analysis concluded that these regulations account for half of the weight reduction in new cars, which led to "2,200 to 3,900 additional fatalities to motorists per year."

In addition to forcing cars to be smaller, the original CAFE standards had a loophole. Sport-utility vehicles (SUV's) and their relatives were not included. Instead, they were classified as "light trucks."

One approach is to close the loophole for SUV's. However, a better approach would be to focus on the fundamental goal.

Overall, the goal is to reduce dependence on foreign oil. Making cars more fuel-efficient does not necessarily do this, because people do not hold their driving constant. Instead, they tend to take advantage of better fuel efficiency to drive more miles. Overall fuel consumption remains high.

To reduce fuel usage, we should increase the gasoline tax. To allow consumers and manufacturers time to adapt, we should phase in a gasoline tax increase, with a small increase (say, a nickel) in the near term cumulating to a larger increase (say, $1) after five years.

Of course, it is not popular to propose an increase in gasoline taxes (I'll bet that Adelman would attack such an idea). Politically, it is a lot easier to try to address the issue of energy independence by flailing at it with unproductive regulations such as CAFE.

In his New York Times column today, Hal Varian looks at one of the most fascinating issues about the information revolution. How will it affect the firm's choice between internal and external suppliers?.

Many gurus, such as the authors of Unleashing the Killer App, argue that large companies should be outsourcing heavily in order to take advantage of the Internet. However, Varian points out,

The real issue confronting a company trying to decide if some unit will be inside or spun off is what incentives the spinoff will have. If you spin off something critical to your business, you leave yourself open to extortion down the road. An internal monopoly supplier may be sluggish and inefficient, but its incentives are at least party aligned with the rest of the organization. An external monopoly can be much worse.

The example that occurs to the reader is the decision by IBM to outsource the development of the operating system for its personal computer in the early 1980's. It created an "external monopoly" for a start-up called Microsoft.

My opinion is that many organizations are erring on the side of trying to perform too many functions internally.

• Doctors' offices perform far too many adminstrative services, as I argued here.
• Financial institutions could take better advantage of external information technology services, as I argued here.
• Schools, law firms, and many small- and mid-sized companies could use external suppliers to meet all of their information technology needs. Instead, these organizations struggle to manage information technology staff that is underqualified and undependable.

I think that what goes on in these cases is that the bosses are risk-averse, and they fear a loss of control if they switch from internal suppliers. In fact, the internal suppliers sometimes go to great lengths to reinforce this fear.

Discussion Question. The head of information technology services within an organization would appear to have an incentive to argue against outsourcing IT. What can the organization do to arrive at an objective but informed decision?

The crisis in Argentina begs for a post-mortem. In particular, the role of a "currency board," in which Argentina pegged its exchange rate to the dollar, is controversial. In a letter to the editor of Financial Times, Columbia University economics professor Edmund Phelps writes,

Lenders and investors may have mistaken the construction of the currency board as a signal that a creative, vibrant capitalism was also under construction.

What Phelps is saying is that the currency board increased investor confidence in Argentina. Up to a point, this was a good thing. But investors became overconfident, and they allowed Argentina to borrow excessively. Because Argentina's economy had structural weaknesses, it became insolvent.

Conceptually, there are three types of crises that put pressure on a country's currency.

1. A liquidity crisis.

   In this case, a country simply needs a loan in order to fend off a speculative attack on its currency. In Brad DeLong's new macroeconomic textbook, he describes the crises of Mexico and Asia in the 1990's in a way that makes them sound like liquidity crises. The best solution in such cases is an international loan to the country suffering the speculative attack.

2. A balance of trade crisis.

   In this case, the problem is that the country's goods cost too much in world markets. The simplest, fastest way for a country to cut its prices is for its exchange rate to depreciate.

3. A solvency crisis.

   In this case, a country has borrowed more than it can hope to repay. Some of the debt has to be written off. The country's standard of living is bound to decline.

In any currency crisis, some criticisms are inevitable. The left always complains about any increase in interest rates, and the right always complains about any currency devaluation. However, as DeLong states forcefully in his textbook, these are consequences that are impossible to avoid.

Another favorite whipping boy is the International Monetary Fund. The IMF is designed to handle a liquidity crisis. However, in a solvency crisis, the initials IMF could stand for "Impossible Mission Fund." That is because critics blame the IMF for what is an inevitable decline in the standard of living in the insolvent country.

Discussion Question: If a borrower is illiquid but not insolvent, you should lend more to that borrower. If the borrower is insolvent, you should not lend to that borrower. Will borrowers tell you that they are insolvent? How can a lender make a determination of whether the borrower has the capacity to repay a loan, particularly when the borrower is a foreign government?

The local telephone companies control the "last mile" of phone lines. Under current legislation, they are supposed to act as wholesalers, meaning that a competing company would be allowed to provide DSL service over phone lines by paying a "fair price" to the local phone company.

As it stands, the local phone company that is setting the "fair price" is both a supplier to and a competitor with the companies that would use the phone lines for broadband. So far, the "fair price" has driven just about every competing DSL provider out of business.

On TechCentralStation, Duane Freese argues that this is stifling the growth of broadband.

A better answer that would promote more competition, less regulation and ultimately greater investment and opportunity would split each of the Bells into two arms - a retail firm dealing in competitive enterprises and a wholesale seller of its local loops to each of them.

A counter-argument is that breaking up the Bells in this way would raise the cost of capital for the Bells and thereby reduce their ability to expand broadband. Indeed, the Bells argue that the mere threat of a break-up has a chilling effect.

Another counter-argument is that the Bells do not have a complete monopoly on the "last mile." Cable companies can offer broadband Internet service as well.

Still, I am inclined to agree with Freese.

Discussion Question. Presumably the Bells would break up voluntarily if they thought that this would be good for their shareholders. Even supposing that the broadband market would be more efficient if the Bells were broken up, is it wrong for the government to destroy shareholder wealth by ordering such a breakup?

One of Glenn Reynolds' readers pointed out that Scott Adams in The Dilbert Future predicted the emergence of something like the phenomenon of free web logs.

This model depends on people being willing to take the time to put information on the Net without the benefit of payment. Why will people do that? They will do it because that's our most basic human nature...

Adams' thesis is that people naturally like to gossip, voice their opinions, etc.

On the other hand, one of my readers, Brad Hutchings, emailed me (and I'll add my reactions in italics):

I wonder what would happen if you started charging $12 for a yearly membership to your GQE blog...You'd have to find the appropriate balance between what you give away and what only members can see

I think that the way to get a subscription model to work would be for a bunch of web loggers to get together to form a club. Subscribers might get custom email notices geared to their preferences, special communication channels with authors, or other benefits.

I think you'd get more grief from other bloggers than from your readers. Like the Linux crowd, a lot of bloggers get pretty full of themselves with the service and sacrifice they offer their readers. I find with my trialware that the technical types get all bent out of shape on price. People like my Mom, who are the intended customers and just want stuff that works well, are more than happy to pay a premium price for good software. I imagine it's the same with intelligent entertainment.

The point about your Mom as opposed to the technical type is spot on. I think that a model of for-profit web logging would lead to Bloggers tuning their material for their readers, whereas now their goal is to impress other Bloggers. A for-profit model would empower readers or currupt the Bloggers, depending on your point of view. I agree with the analogy to open source software, which I once called The User Disenfranchisement Movement.

Discussion Question: Do you think that for web logs to be of high quality that a business model must be found? Without a business model, won't Bloggers lose motivation and let the quality of their web logs suffer?

Some web logs have a "donationware" revenue model. This leads some Bloggers to think in terms of micropayments.

It has been my experience that trying to turn one's avocation into a vocation is most often a bad idea...

Perhaps it's inevitable that things will go to a pay-per-page-view model, but I believe that when and if it does it'll change the nature of Blogging markedly. Perhaps for the better, perhaps not, but it won't be just a hobby one does for fun anymore and that will change how people approach it, view it, and what kinds of people engage in it, read it, and what their expectations are.

Myria draws an analogy with Linux. I think this is a good analogy. Programmers supply labor to the Linux project derive an indirect benefit in that their reputations are enhanced. This in turn can raise their value in other contexts. My approach to Blogging is based on that model. Maybe because of my Blog, I will be in more demand as a teacher or speaker. As John Perry Barlow puts it, you do not charge for bits, you charge for relationships.

Discussion Question: Myria says that Blogging would change if people saw it as an occupation rather than as a hobby. How might Blogging be improved by having an economic incentive to attract readers? What would be the down side?