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Ken Rogoff, of the International Monetary Fund, explains why countries that receive IMF loans often suffer austerity.

More often than not, the country has over-extended itself financially through some combination of imprudence and bad luck. Countries come to the IMF precisely because they know that it will lend to them when no one else will...IMF loans thus relieve austerity: they help governments limit the amount of budgetary belt-tightening required in a crisis...

saying that it causes austerity is like saying that doctors cause plagues.

Discussion Question. Argentina recently defaulted on an IMF loan. Will this reduce the austerity that Argentina will have to suffer?

Economists who believe that a stable currency and open economy are good for growth have to address the exception of Argentina. Brad DeLong writes,

In the 1990s Argentina implemented perhaps 80% of the neoliberal economic policy agenda. It opened up its economy to world trade and international capital; it sought to guarantee low inflation and sound money. It strove to improve its legal system so that decisions would accord with general rules and foster confidence that contracts would be enforced--whether or not a bribe had been paid.

It failed.

DeLong goes on to provide a plausible analysis that Argentina's failure was in spite of, not because of, its neoliberal policies. Still, it provides a cautionary tale.

Discussion Question. With China growing strongly and Argentina in collapse, are economists' views on free markets misguided?

In the dead-trees version of Atlantic Monthly for December, Jonathan Rauch writes about the new public policy concern with obesity.

It seems to me that the only honest and effective way to confront this issue is to tax not fattening foods or fattening companies, but fat people. It is they, after all, who drive up the government's health-care costs, so it is they who sould pay. What I propose, then, is to tax people by the pound.

Although the essay is tongue-in-cheek, the economic analysis is valid. If government regulates the fat content of, say, fast food, people will find fat elsewhere. Moreover, it could be that for some people the most efficient way to lose weight is not to change their diet but to exercise more. Just as the most efficient way to reduce fuel consumption is to tax gasoline, the most efficient way to reduce obesity is to enact the fat tax.

Discussion Question. Do you think that the goal of the anti-fat crusade is to improve health or to paint corporations as villains?

Has China found a way to mix authoritarian politics with a free-market system? According to Red Herring (insert pun here), China's venture capital market is hot.

If any doubt remained about how far China would go to embrace Western-style capitalism, it was dispelled in July when a group of investment firms founded the China Venture Capital Association. With 50 firms, representing a total of $40 billion under management...

On the other hand, this Washington Post article on the pressures faced by a Chinese bank tells a different story.

The Kunming Department Store, a six-story retail world crowned by a 32-story office building, lost $17.8 million last year. It cannot pay the $6 million annual interest on its $113 million in debt. Even so, this year, the Bank of China -- one of the nation's four largest -- gave the company's real estate subsidiary a fresh $1.8 million loan. The choice came down to adding one more bad bank loan to the crushing national inventory, or refusing credit and perhaps forcing the shutdown of a government-owned company that employs more than 5,000 people.

...The deal also highlights the deep-seated difficulties of ridding China's banks of as much as $500 billion in bad loans, perhaps the gravest threat to the economic future of the world's most populous country.

Of course, banks in non-Communist Japan also seem to be unable to shed their bad loans.

Discussion Question. Is China a candidate for long-term growth, or is its economic and political system still too rigid?

Alan B. Krueger summarizes various studies of economic mobility. Among the findings,

New studies by Bhashkar Mazumder of the Federal Reserve Bank of Chicago suggest that the similarity in income is even greater. Using Social Security records, he averaged fathers' earnings over 16 years (1970 through 1985) and sons' earnings over four years (1995 through 1998), and found that around 65 percent of the earnings advantage of fathers was transmitted to sons.

Krueger points out that if the correlation between fathers and sons is only .15 (as one early study found), then at two generations apart income is nearly uncorrelated. However, if the correlation is as high as .65, then it takes five generations for the influence of the first generation's income to dissipate.

I think that it is somewhat brave to take a correlation estimated in this way and extrapolate it across several generations. I have no way of knowing my great-great-great grandfather's income. As for my grandfather, he went bankrupt during the Depression. But I am confident that my income is highly dependent on the fact that he fled the Cossacks during the Russian Revolution to come to America.

Discussion Question. Studies that look at a single generation tend to show more economic mobility over a lifetime than do these cross-generational studies. One factor that may account for this is that cross-generational studies are limited to long-term U.S. citizens, whose income mobility tends to be less than that of immigrants. What other factors may account for the differences in apparent results between the two approaches?

The Heritage Foundation measures economic freedom in different countries. The average income per capita in the eleven countries classified as "free" is close to $27,000. The average in countries classified as "mostly free" is slightly less than half of that. The average in countries classified as "mostly unfree" or "repressed" is about $3500.

Discussion Question. The factors in the index of economic freedom include trade restrictions, flexibility of wages and prices, extent of government regulation, openness to foreign investment, and other components. Are these fair measures, or are they biased to favor countries that are successful without necessarily having freedom?

Steve Roach sounds the alarm over global imbalance.

At the end of 2001, according to IMF calculations, foreigners owned 18.3% of the total market value of US long-term securities. By way of comparison, the pre-bubble reading at the end of 1994 was a mere 11.0%. In other words, the bubble-induced excesses that unfolded on the demand side of the US macro equation in the latter half of the 1990s were financed largely by the "kindness of strangers." Foreign ownership is especially high for marketable US Treasuries, hitting 41.9% at the end of 2001, more than double the 20.2% share at the end of 1994.

Roach writes as if this were a "demand-pull" phenomenon, with the United States trying to absorb world savings. Another view is that asset markets drive the international disequilibrium. Foreigners want our assets, and that leads to their increase in U.S. asset holdings, which in turn leads to our enormous trade deficits.

What happens when foreigners stop wanting to add to their portfolios of U.S. investments? To balance the change in asset flows, there will have to be expenditure switching--our imports should fall, and domestic long-term investment should fall. Other countries will need to switch from export-based demand to their domestic demand. It all sounds simple in theory, but in practice there is a lot of friction in the process, and presumably a lot of unemployment along the way.

Discussion Question. Should policymakers be trying to reduce imbalances now, in order to minimize the subsequent adjustment?

Robert Reich says that Democrats should favor expansionary fiscal policy to fight the recession.

Here's where the Democrats' message should be crystal clear. If monetary policy isn't up to the task, the federal government has to do its part to stimulate use of America's productive capacity, even if that means running deficits.

Reich is suggesting that instead of blaming the Bush Administration for the current deficit, Democrats should support larger deficits in the near term. His argument is straight out of Keynes.

Specifically, Reich proposes a two-year exemption for Social Security taxes on the first $15,000 to $20,000 of income. I think that this is a wonderful idea. However, on paper it would add to the future problems of the Social Security trust fund, so my guess is that it is a political non-starter.

Discussion Question. Reich's proposal would reduce the tax on labor. However, once the exemption starts to phase out at $15,000, the marginal tax rate on labor would rise. How would a supply-sider evaluate the proposal?

Insurance companies always make money in the end, as this Washington Post article on homeowners' insurance reminds me.

It's a game in which actually tapping into the insurance protection they think they've paid for may toss the insured out of the game, and many homeowners are finding out about the new rules the hard way.

As an economist giving advice on personal finance, I recommend buying the least insurance practical. Moreover, never make small claims.

For life insurance, buy only term insurance, and only if you have clear dependents. For health insurance, get only catastrophic coverage (high deductible, high limit). For car insurance, do not buy collision coverage, because making a claim will cost you more in future insurance rates than paying for repairs yourself. Never pay for an "extended warranty."

Daniel Kahneman, who shared this year's Nobel Prize in economics, found that people suffer from "loss aversion." What this suggests is that you will tend to pay too much to avoid a loss. Loss-averse behavior tends to take money out of your pockets and put it into the pockets of insurance companies.

Discussion Question. If you take out extended warranties on every product that you buy, the chances are that you will be able to use at least one of them. Should this reinforce your decision to buy extended warranties?

In the wake of the Republicans' electoral success, all that Paul Krugman can think of is his political economy of income distribution. He sees hope "If the Democratic Party takes a clear stand for the middle class and against the plutocracy."

In contrast, Ted Halstead offers these specifics.

push for a temporary cut in the payroll tax, financed by redirecting the president's tax cut... enabling all Americans to divert part of their payroll taxes into personal retirement accounts, with matching sums provided by the government on a progressive basis...embracing school choice on the condition that it is paired with national equalization of funding on a per-pupil basis...mandatory [health] insurance for all Americans--just as we now have mandatory car insurance--with the understanding that government those who cannot afford to shoulder the full burden...

Each of Halstead's ideas would tend to help people at the bottom of the economic ladder. Each of his ideas has some merit from the standpoint of economic efficiency. Whether they are suited to the Democratic Party is less clear.

Discussion Question. Which constituencies would be energized by Halstead's program, and which constituencies would be energized against it?