Semi-Daily Journal

Strangeness-Squared

I just got home from a Berkeley administrative meeting that seemed very strange to me. And I have just realized why it seemed strange.

Let me back up. The Berkeley administration has asked for a proposal to hire six new faculty and create a teaching-and-research program-center-committee-group engaged in the study of "New Media." And they asked me--along with a bunch of other people--to go to an organizational meeting to try to decide what sort of proposal to write.

I talked about how a huge honking new-media studio would have allowed my cousin Philip to try out alternative ways of creating and then distributing animation. A music professor talked about how new media interacted with old media--about "Switched-on Bach" and how often one of the first things you did with new instruments was to try to make them sound like old instruments. One of the Information Management School people talked about how new media would flourish only if it could be built on top of viable revenue models.

And those were--in fifty minutes of conversation--I swear I am not making this up--the only points made in the discussion that even touched on actual new-media concepts or examples. People talked about how the word media had been already captured by perhaps inappropriate referents, and instead of "new media" we should speak of "mediation." People talked about how "digitization" should not be a defining concept for "new media." People talked about how "new media" could mean any of a number of different things--but somehow never managed to give a definition or even an example of even one of them. People talked about how studio work in architecture was not the end product--that the architecture school wasn't in the business of teaching people the skills they needed to build models and make drawings--but that the end product was a higher mode of understanding of built form, or how there were already too many new media studios staffed by people who were too much technologists and too much male.

But the one thing people did not talk about was "new media": no discussion of video-on-demand, or interactive educational programs, or computer games, or the use of the Director's Cut as an addition to sell DVDs, or mp3 files, or new internet-based modes of distribution that bypass conglomerates, or how a CRT or LCD-based palette of light is different from the reflective palette of pigments, or any of the host of other things--from weblogs to societal-scale information systems to pop-up advertisements on your computer--that occupy the "new media" space today.

And then I understood why the conversation had seemed so strange. It was simply that it was totally flat.

When I talk about "new media" I get excited. I tend to talk about how they have come close to transforming how we experience the world. I ask my audience to drop back into the last decade of the nineteenth century to one of the best-selling--and worst-written--books of that decade, Edward Bellamy’s Looking Backward. The narrator of the book is thrown forward in time from 1895 to the Utopia of 2000, where he examines Utopia and reflects on the civilization of his own time that he has left. One of Bellamy’s set pieces in the book is his description of the technological marvels of the start of the twenty-first century. The set piece begins with his hostess in 2000 asking him: "Would you like to hear some music?" Bellamy’s protagonist expects his hostess to play the piano. Instead, Bellamy’s protagonist is stupefied to find his host "merely touched one or two screws," and immediately the room was "filled with music; filled, not flooded, for, by some means, the volume of melody had been perfectly graduated to the size of the apartment. 'Grand!' I cried. 'Bach must be at the keys of that organ; but where is the organ?'" He learns that his hostess has called the orchestra on the telephone: the prime technological marvel of Bellamy's utopia you can dial up a live orchestra, and then put it on the speakerphone. You even have a choice of orchestras.

Bellamy's protagonist then says that: "if we [in the nineteenth century] could have devised an arrangement for providing everybody with music in their homes, perfect in quality, unlimited in quantity, suited to every mood, and beginning and ceasing at will, we should have considered the limit of human felicity already attained..."

The limit of human felicity. That's what our new media do for us, or, rather, what past generations thought they would do for us. Yet we today do not think of our recorded-entertainment industry as an especially remarkable or even an exceptionally notable part of our economy. We do not genuflect daily in front of our CD collections–or most of us don’t, anyway. We do not reflect that they have brought us to the limit of human felicity. We just take them very much for granted. As far as material prosperity is concerned, we are well enough off to be blissfully unaware of portions of our life that would have struck previous centuries as trans-Utopian. We don't think of how magical are the wearable CD player and the CD with Placido Domingo singing the part of Il Principe Ignoto in "Turandot" that fits into it.

Yet there were no sparks of excitement was visible at the meeting this afternoon. If the people there--most of them, at least--thought new media were magical or wonderful or transformative or beautiful, they seemed to hide it very well.

How do people get so ground down?...

No!!!!!!

Deflation Nation - Could falling prices send the U.S. into a Japanese-style recession? By Robert Shapiro: "...Now, mainstream economists like MIT's Paul Krugman and Stanford's Bradford DeLong..."

Nooo!!!! Stanford? Berkeley! Berkeley!! BERKELEY!!!!! BERKELEY!!!!!!!! BERKELEY!!!!!!!!!!

Alan Murray on IPO Underpricing

Alan Murray wrestles with the problem of IPO--Initial Public Offering--underpricing. On the one hand, why should the rest of us care if entrepreneurs wish to sell 10 percent of their companies at a half-off discount to the friends and clients of their investment bankers when their firms go public? Entrepreneurs are giving a rather large present to those on the IPO list, but if they did not wish to do so they could always use Hambrecht and Quist and run a true auction to sell off the initial tranche of shares. And they get benefits--a bunch of people who will have made money by investing in their stock, and who are likely to hold onto it and talk it up.

Murray comes down on the side of the--highly plausible--theory that IPO underpricing is a way that investment banks get their going-public client corporations to bribe those from whom they want to be thrown other prices of investment banking business.

WSJ.com - Article ...When the price of a stock jumps to $20 from $10 in the first day of trading, reaping instant profits for the lucky few who have been allocated shares, the investment bankers celebrate a "hot" offering. They ought to have their bonuses rescinded, for doing a poor job of pricing. Apologists say pricing a new issue is more "art" than "science." That might have been true 20 years ago; today, it is hogwash. As William Hambrecht, CEO of WR Hambrecht & Co. has demonstrated, today's technology makes it perfectly possible to use auctions to find the market price of a new issue.

Wall Street veterans whose views I respect (and who have asked that their names not be used in my rant) argue there are subtle benefits from the current IPO system. Much of their argument centers around marketing. Greasing the palms of "distinguished" investors such as Mr. Ebbers, and creating a "buzz" around a "hot" stock, may help companies going public for the first time get attention they desperately need.

Moreover, these veterans note, there seems to be no pressure from the companies issuing IPOs to do it differently. These companies, after all, are the ones being short-changed by the process. If their shares double in a day, that is money they have left on the table. But taking a company public is a big, one-time decision, fraught with uncertainty. As a result, issuers haven't been inclined to shake up the system. Mr. Hambrecht's efforts to persuade companies to issue IPO shares by Dutch auction have had only modest results. "It hasn't been easy," he confesses. Says investor advocate Nell Minow: "If you are 25 years old and operating out of your garage and somebody offers you tens of millions of dollars, are you going to quibble?"

So if the people being shafted by the current system don't care, why should I? Because it encourages corruption. For the last decade, U.S. government officials have been preaching the virtues of free markets to countries emerging from behind the Iron Curtain. The sermon has gone something like this: When you have controlled prices, you can't prevent corruption. When you allocate credit, people bribe loan officers. When you have import quotas, people bribe customs officials. The best antidote for corruption is free markets, with the market clearing prices.

Wall Street needs the same lecture. The Ebbers revelation has prompted a review of IPO allocation rules at investment banks. But that doesn't go far enough. The question isn't just how financial firms allocate hot shares; it is why they allocate them. That is what markets are for -- to find the right price and assure that supply equals demand so you don't have to ration. Why can't the capitalists embrace capitalism?...

The Rationing of IPOs
Encourages Corruption

A Platonic Dialogue on Eldred v. Ashcroft

A Platonic Dialogue on Eldred v. Ashcroft

Ignoramus Inquisitivus: I have a question. Why did the Supreme Court grant cert. [that is, agree to hear and decide] in Eldred v. Ashcroft [the case arguing that the most recent copyright extension act was unconstitutional because Article 1, Section 8, Clause 8 of the Constitution gives Congress the power to grant copyrights only for limited times, and only to promote the useful arts--and since the extension act was not intended to promote the useful arts Congress did not have the power to lawfully enact it]? One natural way to decide would be to say, "The Commerce Clause gives ample power for Congress to do whatever it wants as far as economic regulation is concerned. I§8¶8 covers patents and copyrights and should be read in a way consistent with the overall Commerce Clause to give the Congress effective plenary power..." A second way would be to say, "Congress has granted patents and copyrights for limited times, 100 years is a 'limited' time, 1000 years would be a 'limited' time, so what is the problem?"

Realisticus: But this is not a Supreme Court that accepts cases simply to affirm the Appeals Court decision, and strengthen the legal principle that the Commerce Clause is Godzilla. It is not a Supreme Court that accepts cases simply to affirm relatively boring Appeals Court decisions. Some justices accepted it because they wanted to say something...

Ignoramus Inquisitivus: Could the Supremes be seriously planning to give Larry Lessig and company [the lawyers arguing for the Eldred side of the case, arguing that the copyright extension is unconstitutional] a victory? Declare the copyright extension unconstitutional, and thus serve notice that they have fired up their chainsaws and are beginning to use them on all federal government power to regulate the economy? That power--exercised mostly through the Commerce Clause--has grown very large...

Sapientia: It's possible, but very unlikely. This isn't a "Texas Chainsaw Massacre" type of Supreme Court. These guys take small steps. This would be a big step. Congress might react. They don't want to get into an institutional fight with Congress.

Ignoramus Inquisitivus: But if they're not going to overturn the copyright extension, why did they take the case? And if they are going to overturn the copyright extension, how can they? I.§8¶8 is a grant of power, not a restriction. Can a grant of power to Congress cast a shadow that hobbles what is now an extraordinary broad Congressional power to regulate the economy however it wants?

Realisticus: How can a limited power to regulate interstate commerce be read to give the federal government the power to enforce formal racial equality nationwide? How can a limited power to regulate interstate commerce give the federal government the power to force people to buy health insurance? I.§8.¶8 can be read as a restriction and not a grant if five justices decide to read it as a restriction and not a grant of power, and if there is no resulting political uproar big enough to make the Supremes back down.

Experienticus: But it is harder to get five justices to do something that goes against the plain language of the document. And that's a powerful reason that Lessig and company should have taken into account. Were I arguing the case--were I in the position of wanting the Supremes to make new law curbing Congressional power--I would grab not for a section of the Constitution that gives Congress power, but one that takes it away. I would reach not for Article I but for Amendment V--the takings clause. Say that the copyright extension is a taking of private property--the right of access to things in the public domain--for public purpose. Say that such takings have to be done with compensation. And say that the hurdle is especially great when the "public purpose" for which the taking of intellectual property out of the public domain is being done is to extend and enhance the profits of one's Hollywood campaign contributors. I really don't understand why Lessig didn't make the "takings" argument. It is, I think, in the long run a much stronger argument if the Supremes' ultimate agenda really is the rollback of the Commerce Clause...

Sapientia: But there is a Lockeian counter to the "takings" argument: we extend copyright--we remove your public domain rights of access--just to increase the rate of progress of the useful arts and sciences. As in Lockeian "original appropriation," your rights aren't really harmed as long as there is "enough, and as good"--and faster progress means that there is more and better.

Realisticus: That none of the founders would have dreamed of the growth of the Commerce Clause is not decisive. The world changes. How people think changes. The fact that the founders did not foresee how large interstate commerce would become, and thus how powerful the power to regulate it would become does not bind us. It does not obligate us to read "interstate commerce" narrowly. That they would have seen Copyright and Commerce as somewhat independent activities doesn't mean that we can't see Copyright as wholly subsumed within Commerce.

Ignoramus Inquisitivus: But wouldn't it have been better to pass amendments? A New Deal Amendment to allow federal control of the economy, and a Civil Rights Amendment, rather than simply relying on an expanded and hypertrophied Commerce Clause? Change the Constitution according to constitutional procedures, rather than changing the rules of interpreting it according to whoever yells loudest wins?

Realisticus: You are forgetting that we already passed the real Civil Rights Amendments. We passed them in the 1860s. But then came a bad "constitutional moment" that changed the rules of interpretation, and eviscerated them: for a century the Civil Rights Amendment protected not the rights of freedmen but the rights of corporations. Bruce Ackerman is right: there are "constitutional moments" throughout American history, and the right-wing original-intent "shocked, shocked" at the expansion of the Commerce Clause has as much credibility as Claude Rains's "shocked, shocked" at gambling in Casablanca.

Ignoramus Inquisitivus: But...

Experienticus: And you mustn't forget the greatest and largest movement in judge-made law in American history: the Bork-Posner-Easterbrook rewrite--largely a good thing--of the entire antitrust and consumer-protection areas. There's nothing the law and economics movement would fear more than a return to the "original intent" of the authors of the Clayton Act.

Sapientia: Bruce Ackerman is a figure of fun to many, but it's not because of his positive theory of "constitutional moments"--and that cases before the last such "constitutional moment" aren't valid precedents. That positive part of his theory is unassailable. It's his normative claims that are mocked...

Ignoramus Inquisitivus: But there's a bigger problem. Who decides...

Sapientia: Yes. Rehnquist, C.J. [Chief Justice] could stand up and say, "Counsel, your argument that these long-ago precedents came before what Bruce Ackerman calls the latest 'constitutional moment' is surely correct and is well-taken. But I want you to stop talking and sit down, because the other more recent precedents on which you rely are now irrelevant. Nino [Scalia] and I have been talking, and we have decided--and we want you to go tell Bruce so he can come down and study it--that we are going to have our own constitutional moment right now..."

[Pause]

Sapientia: But none of us has answered your question, have we? You want me to tell you what the Eldred v. Ashcroft decision will be. I can't tell you what it will say--that depends on how smart and brave the law clerk who writes it is. But I think I can tell you what it will mean. The court won't overturn the copyright extension. They won't use the chainsaw. But they will take the chainsaw out of the garage and make sure its fuel tank is full. Its opinion will mean, "Congress, there are some limits, somewhere, to your copyright power." It will mean, "Disney, you've bought your last copyright extension." It will mean, "Congress, next time find someone more serious than Sonny Bono to lead the issue." It will mean, "We're not going to tell you where the line is exactly--that would be dicta, and we hate dicta, except when we don't--but we are telling you that if you move to extend copyright again, you first need to ask yourselves the Clint Eastwood question: 'Do you feel lucky?'"

Why So Many Things Went Right with the Internet

From Dan Gillmor's Sunday column in the San Jose Mercury News:

10 choices that were critical to the Net's success

By Dan Gillmor
Mercury News Technology Columnist

In our modern, corporate culture, the rise of the Internet is a happy accident. In its roots and growth, says Scott Bradner, the Net never had a business model.

How did technologists, government officials and a host of other early players turn something with no obvious business model into a system that has become so intrinsic to the new century? A series of decisions proved critical -- choices that helped turn data transport into a commodity business and put the power in users' hands, not in the centralized telecommunications companies' controlling grasp.

At a telecom conference in Massachusetts last week, Bradner, senior technical consultant at Harvard University and a longtime leader in the formation of Internet standards, listed 10 crucial decisions along the way. (You may have other candidates; send them to me and I'll list them on my Web page). Here are Bradner's picks:

1) Make it all work on top of existing networks. Designers deliberately didn't try to build a single, new über-data network -- it was about ``networks, not a network,'' Bradner observes. This meant supporting multiple network types by putting a simple set of rules, now called the Internet protocols, on top. This added layer was wide open for innovation, not controlled by a few players.

2) Use packets, not circuits. Telephone networks open a circuit from one phone to another, keeping the connection open until the call is ended. The Internet splits messages into little packages called packets, which are sent to their destination by various routes and at various times. This was a radical idea at the time, but it has been one of the qualities that makes the Internet so basically reliable and resilient under stress.

3) Create a ``routing'' function. Stand-alone boxes along the way from point to point make instant decisions on what route to send each packet by, reacting to failures in the networks. Again, this was a decentralizing function that enhanced reliability.

4) Split the Transmission Control Protocol (TCP) and Internet Protocol (IP), which are generally used together in much of what we do on the Net and are called TCP/IP. Originally they were meant to be tied together in a single service designed to guarantee that the stream of data would get to its destination complete and in perfect order. To do this, however, would have given network services far less flexibility. IP by itself offers an unreliable but still enormously valuable service, simply sending the packets through the network without checking to see if they all get there.

TCP makes sure, among other things, that they actually do get there. So an application can use TCP if it cares most about reliability, while another application can use IP (and other protocols) if it's more concerned with timeliness -- such as an Internet phone call -- where losing a few packets matters much less than getting most of the data there on time.

5) The National Science Foundation (NSF) funds the University of California-Berkeley, to put TCP/IP into the Unix operating system originally developed by AT&T. Berkeley thereby created a full but low-cost network operating system, along with a full suite of network applications, that computer start-up companies flocked to use in their boxes. It was, says Bradner, ``a way to get into the networking game without spending a lot of money.'' So it spread fast.

6) CSNET, an early network used by universities, connects with the ARPANET, the Internet precursor network operated by the Pentagon's Advanced Research Projects Agency. ARPA funded much of the early technical work on what later became the Net. ARPANET use had been restricted solely to government-funded individuals. The connection was for e-mail only, but it led to much more university research on networks and a more general understanding among students, faculty and staff of the value of internetworking. When students graduated, they sought employers that had the technology.

7) The NSF requires users of the NSFNET to use TCP/IP, not competing protocols. This decision about the NSFNET, which was originally created to connect supercomputer centers, forced wider availability of the TCP/IP protocol, and helped prevent a wasteful ``proliferation of miscellaneous transport protocols for the Internet,'' Bradner says.

8) International telecommunications standards bodies reject TCP/IP, then create a separate standard called OSI. TCP/IP, remember, was designed as a low layer on top of which other applications, such as e-mail, would be created. OSI was carrier-centric, a suite of protocols that included things like e-mail. Had TCP/IP been accepted and then co-opted by the international groups and telecom companies, things we now take for granted might not have appeared, or might have been under central control. One the fundamentals of the Net is we can create new protocols on top of IP, as Tim Berners-Lee did to create the World Wide Web, says Bradner -- ``and we don't have to have permission of the carriers to do that.

9) The NSF creates an ``Acceptable Use Policy'' restricting NSFNET use to noncommercial activities. Although this rule grew blurry, it was largely heeded despite fierce criticism. The result was an incentive to create commercial network providers. The commercial providers created a huge business of long-haul ``backbone'' and local carriers upon which the Internet relies today.

10) Once things start to build, government stays mostly out of the way. If the Internet suffered from a lack of regulation, Bradner says, it was ``a good suffering'' for all of us.

Stephen Roach on "The Great Failure of Central Banking"

I don't agree with Stephen Roach that the Federal Reserve should have made interest rates higher and tried to make unemployment higher in the late 1990s in order to diminish investment spending and collapse the stock market bubble. In my view, the time to deal with any problems created by the bubble's collapse is when the bubble collapses--not before. Relative to a lower-stock prices, lower-investment, one-percentage-point-of-unemployment-higher bubble-popping path for the U.S. economy in the late 1990s, the actual path that we took gave us an extra $1 trillion of real production.

You can complain about how that $1 trillion was distributed. You can regret that a large chunk of it--$200 billion?--was spent on investments that have much lower social value looking forward than their social cost. You can fear the damaging consequences of banruptcy and fraud on the economy. But you have to argue that these drawbacks from the fallout are quantitatively very large for the cost-benefit analysis to go Stephen Roach's way.

Nevertheless, he makes his case more strongly than anybody else does:

Morgan Stanley: ... Yet out of this glorious disinflation a new inflation was borne -- asset inflation. And central bankers didn’t have a clue how to deal with it.

They still don’t. The Bank of Japan was the first victim of the new inflation. Asset bubbles in equity and property markets in the late 1980s created enormous excesses in Japan’s real economy and in its financial system. The history of Japan’s pre- and post-bubble period tells us that the BOJ was late in recognizing the perils of what was to come. Its monetary policy stance was too accommodative in the late 1980s, thereby nurturing the build-up of the bubble. And it was too restrictive in the early 1990s, failing to appreciate the deflationary risks that always get unleashed in the aftermath of a popped asset bubble. Some 13 years after its bubble crested in 1989, Japan is still picking up the pieces. An alternative approach by the BOJ could have made a real difference.

It’s different in America -- I guess it always is. But the similarities with Japan should not be ignored. America’s asset bubble created its own set of distortions in the real economy. Capital spending went to excess as Corporate America became convinced it could acquire Nasdaq-like multiples through open-ended investment in new information technologies. Remember the e-based IT spending frenzies associated with B2B and B2C? The Y2K panic was the icing on this rapidly rising cake. Consumers also got lured into the bubble, increasingly viewing outsized equity returns as permanent substitutes for saving the old-fashioned way -- out of their paychecks. By the end, the very fabric of the US economy had been transformed -- the bubble had become the heart of the New Economy.

Like the BOJ, the Fed did nothing to stop it. Sure, there was the December 1996 musing by Alan Greenspan over "irrational exuberance." There was even a 25 bp tightening some three and a half months later, presumably aimed at addressing those concerns. But that assault on the bubble -- if you want to call it that -- was short-lived. Facing a torrent of political criticism for tampering with the democracy of the markets, the so-called independent US central bank did an about-face. Any further tightening was shelved, and the bubble took on a life of its own...

Cory Doctorow on DRM-in-Practice

The principal serious objection to tight control over content by IP rights holders is made by those who argue that by so doing they destroy most of the utility--and most of the consumer surplus--of the technology. Here Cory Doctorow makes this argument, with details, as applied to Toshiba's new clone of Apple's iPod:

Boing Boing: A Directory of Wonderful Things: ...Toshiba's new digital music player shows us more evidence that (consumer electronics) (digital rights management) = a**. The DRM vendor's mantra is, "DRM needs to be invisible, it needs to get out of the way of legitimate activity and only crop up when the user tries to infringe on copyright." A good sentiment, but it's more wishful thinking than design specification, as the new Tosh Mobilphone demonstrates.

The Mobilphone is an iPod clone with a 5GB drive and a USB 2.0 interface. The iPod, of course, rules for a number of reasons, but one of the biggies is that by using FireWire to synch MP3s with your computer, the iPod is capable of filling itself up with music in a matter of minutes. USB 2.0 leapfrogs FireWire and delivers even greater speed. So far, so good.

But for "security" reasons, the Mobilphone will only play music that has been encrypted with Toshiba's proprietary cipher. The encryption happens when you use Toshiba's software to synch your Mobilphone with your PC. Now, leave aside for the moment that this means that without (illegally, under the DMCA) reverse-engineering the crypto, no vendor except Toshiba and its licensees will ever be able to deliver a client for the Mobilphone (so forget about Linux, BSD, Mac or device-to-device apps), and that if Toshiba's fly-sized attention-span wanders away from the device, you'll be stuck holding a 5GB boat anchor.

Yes, leave that aside, because there's an immediate, non-hypothetical reason that Toshiba's brainless crypto-scheme is a stupid, anti-customer idea. The encryption of your music happens on the fly, as you synch your Mobilphone with your PC. That encryption process is CPU-intensive, so much so that it slows the USB 2.0 interface to USB 1.1 speeds. In other words, despite the presence of some truly azz-kicking, bleeding-edge interface technology, the Mobilphone synchs no faster than it would have if it had a poky old 1.1 bus.

Practically speaking this means that synching ten albums takes eight minutes instead of fifty seconds. I have an iTunes "Advanced Playlist" that grabs 5GB of random, high-rated music from my pool of 20GB of MP3s and synchs them every time I plug my iPod in -- it takes a minute or two. With the Mobilphone, it'd take all afternoon. Rip. Mix. Wait. Link Discuss (via Gizmodo)

Six Degrees of Paul Krugman

Peter Passell writes about his twelve favorite economics websites. From the Milken Review that he edits:

paul krugman | www.wws.princeton.edu/~pkrugman/ | Unofficial site:www.pkarchive.org/

Everyone, it seems, either loves Paul Krugman, or loves to hate him. One reason is that he gets amazing exposure through his Op-Ed column in The New York Times. Another is that he writes better than any economist since Keynes. Yet a third is that he doesn’t suffer fools (or knaves) easily – which often makes his opinion pieces a gas to read. His own Web site contains a sampling of his work, including some striking analytic pieces. But his unofficial site, run by Krugman groupies, is a whole lot more complete, and a whole lot more fun. It includes a lot of material about Krugman as well as stuff by him.

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xavier sala-i-martin | www.columbia.edu/~xs23/home.html

Some economists are smart. A few are funny. A very few, including Columbia University’s Xavier Sala-i-Martin are smart and funny. Who else, after all, would grace his home page with a picture of Miss Piggy in her pigs-in-space getup, and a pair of floating eyeballs that follow your cursor around the site? Check out the picture of his favorite supermodel. Or his link to a live webcam shot of downtown Barcelona (Sala-i-Martin is a Catalan). Then use the site to browse macroeconomist Sala-i-Martin’s distinguished and extensive research.

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richard freeman | www.nber.org/~freeman/

I’ll confess there is nothing special about Richard Freeman’s Web site – it’s just a well organized site containing a fine sampling of this Harvard University labor economist’s research. But I was happy to have the excuse to advertise Freeman’s work. He’s an interesting scholar and an able defender of left-center views in a world that has drifted to the right.

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rudi dornbusch | web.mit.edu/rudi/www/ | Alas, Rudi died at the end of July.

Rudi Dornbusch has been teaching macroeconomics and international finance at MIT since Gerry Ford was in the White House. But his views on public policy are as fresh – and as edgy – as ever. Don’t mistake his skepticism for conservatism just because he has a PhD from the University of Chicago; he really belongs to the take-no-prisoners school of economics. The site includes a lot of his more accessible opinion pieces, plus some excellent reading lists prepared for his graduate courses.

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robert shiller | aida.econ.yale.edu/~shiller/

Robert Shiller of Yale University caught the zeitgeist with Irrational Exuberance (Princeton University Press), his book about the psychological underpinnings of the stock market. A sample chapter is on his Web site, along with chapters from his other books and pretty much everything technical he’s written in the last decade. I like his statistics section, which provides a ton of data used in testing hypotheses about what drives the markets.

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bert ely | www.ely-co.com/default.asp

Bert Ely runs his own private consulting firm specializing in financial policy and banking. Ely’s a very public character, though, who’s bursting with interesting ideas about everything from inflation to bank deposit insurance to mortgage credit risk. And just about everything he’s ever written is available on his well-organized Web site.

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joel slemrod | taxpolicyresearch.umich.edu/

Joel Slemrod, an expert’s expert on the economics of taxation, directs the University of Michigan Business School’s Offfce of Tax Policy Research. Strictly speaking, this Web site is the Office’s, not Slemrod’s. But this marvelous source of info on tax policy is obviously Slemrod’s baby. Use it to keep up with current events in tax policy, or mine the ambitious World Tax Database that includes numbers on localities ranging from Alabama to Zimbabwe.

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ray fair | fairmodel.econ.yale.edu/

Macroeconomic forecasting has long been out of fashion in academia. Most of the macro computer models used today are maintained by private forecasting businesses and government agencies. Ray Fair of Yale University is the exception – a rigorous academic who takes forecasting seriously.What’s more, he’s a natural born teacher, maintaining a unique Web site that allows visitors to plug their own assumptions into his sophisticated computer models of the U.S. economy and the global economy, and grind out do-it-yourself forecasts. The process takes some knowledge of economics and a bit of hard work to learn. But it’s just a fab resource for those who want to understand what lies beneath the numbers.

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stephen roach | www.morganstanley.com/about/gef/team.html#ssr

Wall Street economists don’t get no respect. And understandably so: they are all too often shills for whatever lines their employers are peddling. But there are exceptions, and Stephen Roach, the chief economist at Morgan Stanley Dean Witter, is a big one. He heads a solid analytical team, which puts out a daily commentary on economic policy and events called the “Global Economic Forum.” It’s an excellent site for those interested in macroeconomics – one that bridges the gap between academic and business economists.

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brad delong | www.j-bradford-delong.net/

You may remember Brad DeLong as a former Deputy Assistant Secretary of the Treasury in the Clinton administration, or as Larry Summers’s sometime alter ego. Since 1997, he has been on the faculty at the University of California (Berkeley), where he struts his stuff both as a first-rate scholar with eclectic interests and as an evangelist for post-liberal economic policy. His Web site is just chock-full of ideas, including most of his recent writing, sample chapters from his macroeconomics textbook, revealing graphs,weird links, and even semi-weekly musings in his personal journal.

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nouriel roubini| www.stern.nyu.edu/globalmacro/

Roubini,who teaches at New York University’s Stern School of Business,may not qualify as a famous economist. But he certainly knows his way around policy circles, having spent time at the IMF, World Bank, U.S. Treasury and the White House. He maintains a wonderful Web site that serves as a clearinghouse for news, data and analysis of international financial issues. Indeed, it would make a nice home page/portal for those who work in international economics. The neatest part: an indepth bibliography on the Asian financial crisis.

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Peter Passell: Six Degrees of Paul Krugman

Bemusement and Relativity

John Quiggin believes that I shouldn't be bemused at how Einstein's special theory of relativity replaces the absolute ideas of 'past', 'present', and 'future' with the ideas of 'past light cone', 'future light cone', and 'outside the light cone' that are different for each observer at each different point and moving at each possible velocity. (It is a theory of relativity, after all.)

John Quiggin: ...It's only surprising in the 'isn't science amazing' way that a microwave oven is surprising the first time you see it. I wouldn't have thought you could boil water while not heating the cup containing the water, but now I don't give it a second thought.

Well, let me put it on the record right now that I find my microwave oven pretty damn amazing every single time I turn it on. Hell, I even find a spinning bicycle wheel suspended from a rope attached to one end of its axle amazing...

Ball and Mankiw on the "Natural Rate" of Unemployment

Larry Ball and Greg Mankiw have a very nice paper on the unemployment rate at which inflation is stable--the so-called NAIRU. The most fascinating part of the paper deals with the question of why the U.S. NAIRU fell so far and so fast in the 1990s. Ball and Mankiw find that they lean toward the hypothesis that the NAIRU is actually closely linked to the trend rate of productivity growth.

The NAIRU in Theory and Practice: NAIRU stands for the nonaccelerating inflation rate of unemployment. It is beyond dispute that this acronym is an ugly addition to the English language. There are, however, two issues that fail to command consensus among economists, which we address in this essay.

The first issue is whether the concept of NAIRU is a useful piece of business cycle theory. We believe it is, and we begin this paper by attempting to explain why. In our view, the NAIRU is approximately a synonym for the natural rate of unemployment. This concept follows naturally from any theory that says that changes in monetary policy, and aggregate demand more generally, push inflation and unemployment in opposite directions in the short run. Once this short-run tradeoff is admitted, there must be some level of unemployment consistent with stable inflation.

The second issue is why the NAIRU changes over time and, in particular, why it fell in the second half of the 1990s. This question is more difficult, and the answer is open to debate. Most likely, various factors are at work, including demographics and government policies. Yet one hypothesis stands out as particularly promising: fluctuations in the NAIRU appear related to fluctuations in productivity. In the 1970s, the NAIRU rose when productivity growth slowed. In the 1990s, the NAIRU fell when productivity growth sped up...

Coverage of Mugabe

Andrew Sullivan slimes New York Times bureau chief Rachel Swarns:

www.AndrewSullivan.com - Daily Dish: ...It seems the brutal tyrant in Zimbabwe, Robert Mugabe, has lost his head p.r. guy. Never mind. With puff-pieces like this one, who needs p.r.? "A Hero To Many!" Whoever Rachel Swarns is, she's clearly a Rainesian.... "Criticized in the West." This is a man who jails his opponents, rigs elections and is fomenting a famine in his country by brutal evictions of the only productive farmers. He's viciously homophobic and reviled by any serious African analyst as a menace to any democratic trends in the region. But the Times sees his good side. Of course they do.

Ted Barlow spends five minutes on the web and comes up with a list of articles on Mugabe Rachel Swarns has written:

August 17, 2002
Zimbabwe Starts Arresting White Farmers Defying Eviction
August 14, 2002
World Briefing | Africa: Zimbabwe: A Pledge To Withdraw From Congo
August 13, 2002
Mugabe Remains Unyielding On Eviction of White Farmers
August 12, 2002
Thousands of Whites Defying Zimbabwe Over Farm Evictions
August 9, 2002
World Briefing | Africa: Zimbabwe: Eviction Deadline
August 4, 2002
For Zimbabwe White Farmers, Time to Move On
June 18, 2002
World Briefing | Africa: Zimbabwe: Opposition Members Arrested
June 5, 2002
World Briefing | Africa: Zimbabwe: Leading Lawyer Arrested
June 1, 2002
Government and Media Spar in Zimbabwe
June 1, 2002
World Briefing | Africa: Zimbabwe: Mugabe Tells Rival To Accept Defeat
May 17, 2002
World Briefing | Africa: Zimbabwe: Black Squatters Face Eviction
May 9, 2002
World Briefing | Africa: Zimbabwe: Another Journalist Arrested
May 2, 2002
World Briefing | Africa: Zimbabwe: Three Journalists Arrested
April 24, 2002
World Briefing | Africa: Zimbabwe: Police Thwart Protest
March 29, 2002
World Briefing: Africa; ZIMBABWE: JOURNALIST'S ARREST CONDEMNED
March 22, 2002
World Briefing | Africa: Zimbabwe: Workers Ignore Strike Call
March 21, 2002
An Isolated Zimbabwe Tightens Strictures on Opposition Leader
March 20, 2002
Mugabe's Opponent Hints At Possible Reconciliation
March 19, 2002
Presidents Rush to Zimbabwe To Plead for Political Unity
March 17, 2002
The World; An Election, Yes. But Free and Fair?
March 14, 2002
Mugabe's Aides Declare Him Winner of Zimbabwe Vote
March 12, 2002
Official Arrested as Zimbabwe Election Ends
March 7, 2002
New Rules In Zimbabwe Likely to Aid Mugabe's Side
February 28, 2002
World Briefing | Africa: Zimbabwe: Court Doesn't Faze Government
February 26, 2002
Zimbabwe Candidate Charged With Treason
February 24, 2002
Desperation Drives a Zimbabwean Exodus South

And comments:

You know, to read those titles all together like that, you'd almost think that Rachel Swarns has been a tireless critic of Mugabe. You'd almost think that the Times has done a great public service, publishing highly critical stories about his murderous regime several times a week. (And this is just from one journalist, mind you.) You'd almost think that Andrew Sullivan owes somebody a big apology... his media criticism is formulaic (open Times, insult Times, rinse, repeat), it's dishonest, and it's boring.

Japan's Recession

The Japanese data revisions are in, and they are even worse than anyone--or at least than I--had feared, even fearing that they were worse than we hard feared. The second quarter of 2001 saw real GDP shrink at an 8 percent annual rate. The first quarter of 2002--which had supposedly seen GDP grow at 6 percent per year--was completely flat.

All this leaves Japanese real GDP today some 2.5 percent below its level in the fourth quarter of 20002.

Economist.com: Earlier this year, optimists could at least take solace from signs that the economy was rebounding in the first quarter, from a dismally deflationary 2001. It now turns out, however, that all of that growth was illusory. After revising the way it tots up the figures, the government announced at the end of August that GDP growth had been zero in the first quarter, not the 5.7% annual rate that was announced earlier. The second quarter was better, but not especially reassuring, with GDP rising at an annual rate of 1.9%. Industrial production rose sharply in April and May, but it tailed off again in June and July. Domestic demand refuses to show a convincing bounce, leaving the economy desperately dependent on those exports and overseas earnings...

ONCE again, Japan is paying the price for waiting. A combination of weak demand at home and bad economic news from America raised fresh doubts this week about whether its recent pick-up in output is here to stay. After putting off reforms, fiddling with the stockmarket and holding their breath at the end of the financial year in March, Japan's policymakers find themselves not far from where they were six months ago. Only now they are a little deeper in debt, have more countries rated above them in the international-bond tables, and have fewer ways to disguise their bad decisions.

Following signs of stagnant demand from America, investors sold off shares in exporters such as Sony, Toyota and Honda. Since a handful of such firms have supplied most of Japan's good news this year, shares in other domestic firms suffered as well, helping this week to drive the main Nikkei share index briefly below 9,000, where it last was in 1983. Because banks must report interim results at the end of this month, and must add losses on all those shares to their already weak balance sheets, confidence in the financial system is more than usually shaky.

This familiar cycle does not appear, despite a lower stockmarket, to be jangling nerves the way it did six months ago, when a weak yen and the looming repeal of insurance on some bank deposits raised the stakes. But in other respects, the situation has grown less encouraging. Earlier this year, optimists could at least take solace from signs that the economy was rebounding in the first quarter, from a dismally deflationary 2001. It now turns out, however, that all of that growth was illusory. After revising the way it tots up the figures, the government announced at the end of August that GDP growth had been zero in the first quarter, not the 5.7% annual rate that was announced earlier.

The second quarter was better, but not especially reassuring, with GDP rising at an annual rate of 1.9%. Industrial production rose sharply in April and May, but it tailed off again in June and July. Domestic demand refuses to show a convincing bounce, leaving the economy desperately dependent on those exports and overseas earnings. Even as Honda and Toyota have racked up profits in America, for example, domestic car sales have fallen year on year for the 12th straight month.

Things may yet turn around a bit. Surveys of small firms have shown rising confidence recently. Richard Jerram, chief economist at ING Barings in Tokyo, points to recent consumer surveys, which have been a good leading indicator and which suggest that deflationary pressures may soon ease up a little as well. And there is always luck: demand from overseas may perk up again. None of this will mean much, however, if domestic demand does not strengthen, with at least a mild uptick in capital investment. Otherwise, another white-knuckle March, when the financial year comes round again, may not be too far off.

Death Knights!

"Oooh!" the twelve-year-old whispered, clearly excited. "Death Knights!"

We were watching the movie The Fellowship of the Ring. The Nazgul, the Ringwraiths, the Dark Riders, the terrible servants of the Dark Lord Sauron had just appeared on the screen for the first time. I am transported to Tolkien's Middle-Earth. But the twelve-year-old saw The Lord of the Rings as a knock-off copy of the computer game Warcraft, itself a descendant of Dungeons and Dragons, itself a descendant of Tolkien's universe. I looked over at the twelve-year-old. He was clearly loving it--but the "it" wasas much what he sees as a renaming and a translation to the screen of the battles between the Horde and the remnants of Azeroth and Loredan that he has fought on the computer, as much as the raw power of the vision of Tolkien's fevered brain. He sees the Ringwraiths as the anti-paladins of the Horde from Warcraft.

Afterwards there was much discussion of whether a ranger like Strider could "really"--with the canons of reality set by the "rangers" in Warcraft--be as competent and as powerful as he is in the movie.

I wondered: is he being cheated? It's supposed to be hard for people to appreciate Kurosawa's "The Seven Samurai" today because so many of his narrative devices and visual set-pieces have been copied in innumerable, worse movies. On the other hand, the themes and stories are damned powerful--that's why they resonate, that's why they have been copied so often.

Traffic Engineer Sadism

I grew up in Washington DC. We lived here for a few years in the early nineties. But this morning is the first time I have driven in Washington DC since we moved to California in 1995. And, by California standards, DC traffic patterns and engineering are very strange indeed.

I didn't have any problems--I did, after all, grow up here. I simply drove from my father's house to the airport now known as Ronald Reagan George Washington National Airport and back. But I could not help noticing that:

• The signage was terrible.
• In addition to the signage being terrible, every crucial exit sign was hidden--save for its wordless, green bottom-left corner--behind a tree in full leaf.
• There were always either zero or two left-turn lanes.
• There was never any guidance in the intersection as to which of the two left-turn lanes fed into which of the cross-street lanes, so everyone turning left slowed to a crawl.

The coup-de-grace, however, came when coming back I arrived at the intersection of Canal Road and Foxhall Road at the western edge of Georgetown. There was a small sign saying "Maryland--Interstate 495" and it pointed to the right, telling everyone on Canal Road that to get to Maryland, or to Interstate 495, you turn right off of Canal Road onto Foxhall Road.

Now it is true that during the morning rush Canal Road is one way going southeast--that you can't continue northwest on Canal Road at all. But at all other times, if you want to get to Maryland or Interstate 495, you go straight out Canal Road. You do not turn onto Foxhall--not under any circumstances. During the morning rush, you want to turn around, cross key bridge, and head out to 495 using the Virginia-side George Washington Parkway. The only Maryland destinations I can think of that one would ever take Foxhall Road toward is the Friendship Heights shopping center, the Defense Mapping Agency, or the former Glen Echo Amusement Park.

So why do they do this? Why not start pruning trees? Why the eagerness to route people heading for Interstate 495 onto Foxhall and MacArthur Boulevards, through residential neighborhoods, and even over a one-lane bridge, rather than onto the (fast-moving) George Washington Parkway?

It's traffic engineering sadism, that's what it is.

Blaming the Victim

Ah. A fine example of blaming the victim. The NEA tried to avoid the first and worst mistake people make when they get slimed, and tried to avoid having their own statements serve as vehicles for distributing the libel. And the NEA gets blamed for not mounting a specific enough defense! And then gets attacked--via the implication that there must have been some sinister reason for their failure!

Instapundit.com: ...SPINSANITY AGREES with Cathy Young and others that the NEA is getting a bum rap. I'm persuaded now, but I can't help observing that the NEA hurt its case by acting guilty. As SpinSanity itself says:

After repeated attempts to contain the controversy, the NEA issued an indirectly worded statement on Aug. 27. Rather than directly refuting the charges, it vaguely asserts that critics "have taken the material out of context" and are "using this national tragedy to attempt to score political points," giving little indication that the entire controversy has essentially been fabricated. It also at some point apparently removed links to Lippincott's lesson.

Now that doesn't make misrepresentations of its views any less misleading, but on the other hand, people watch an organization's behavior for cues as to whether to take charges against it seriously. If NEA had said "this is a made-up controversy" and "we never said that" people would have been less inclined to believe the critics. So why didn't it?

Now consider the art in the paragraph above. One would expect a paragraph that begins "Now that doesn't make misrepesentations of its views any less misleading..." to continue with at least some mention of the offenders: Ellen Sorokin and the editors of the Washington Times, the TV commentators who picked up the Washington Times's story, online instant pundits who know damned well how unreliable the Washington Times is, and yet blithely rely on it without lifting a finger to check, say, what the NEA website says.

But that's not the paragraph we see. After the initial head-fake of the first "Now..." clause, it comes close to tripping over its feet in its haste to start blaming the victim...

Think Analytically!

Think Analytically!

I remember one day during the first Clinton Administration when Joe Stiglitz came into the room to chair a meeting, looked around, noticed that--so far--only economists had shown up, and announced that nobody who did not have a Ph.D. in economics would be allowed to speak at the meeting. (Do I need to point out that that Joe was making a joke?)

He was. All of us got it. All of us cheered and applauded.

We did so not because we Clinton-era economists all agreed on all the issues--anybody with half an ear to the ground would know that we did not. We did so because we had found that it was possible to make intellectual and policy progress in discussions with economists because we had all been trained to think analytically: to break the issue down into background assumptions about the world, beliefs about the principal causal mechanisms, and claims about the likely effects of different policies on those chains of cause-and-effect. When we disagreed--as we often did--we could quickly ascertain where and why, and then agree on how to go hunting for pieces of information that would help resolve the disagreement. This was in striking contrast with our collective experience with lawyers or media types, who would be vague about cause and effect, or shift premises in the middle of a meeting when they saw that making different background claims about the world would provide a smoother road to their desired conclusion.

I am thinking about this now because I am reading an article by Noam Scheiber in the September 9, 2002 New Republic. He has a bone to pick with me and my belief that the Federal Reserve should be following a lower interest rate more expansionary policy. But he does not think analytically. So I cannot figure out what his beef is.

The title of the article--"Less than Zero: Why Deflation Isn't a Problem"--tells me that his complaint is that more expansionary policy is unnecessary: I think it would be good because I think deflation might become a problem in a year or two, but if deflation isn't a problem, I am wrong. So far, so good. But before the end of the second paragraph, I am told that "deflation may be a concern" but "lowering interest rates... won't do much." So which is it?

I think that it is the title that is the misstep--that Scheiber thinks that deflation is a potential problem, but also thinks that lower interest rates won't do much to help prevent or stop it. Why not? I think the answer is that Scheiber believes that lowering interest rates won't do much to stimulate business spending on investment: in Scheiber's view, depressed conditions in many key industries--autos, audio equipment, semiconductor equipment, and sporting goods--mean that no CEO who is not an idiot would boost his company's spending on investment no matter how low the interest rate. So by the end of paragraph eight, Scheiber seems to be arguing that: (a) deflation may be a threat, (b) a good way to neutralize this potential threat is to boost business investment spending, (c) in normal times lowering interest rates is a good way to boost business investment spending, but (d) demand is already so low relative to supply in key industries that the normal interest rate medicine won't work.

But is this an argument that the Federal Reserve shouldn't have lowered interest rates? It seems not. Scheiber's is an argument that the Federal Reserve should have lowered interest rates more last year. Scheiber's is an argument that the Federal Reserve's lowering interest rates in the future will be ineffective. It is an argument that returning the economy to full employment will require fiscal policy--spending increases or tax cuts not targeted on the low-marginal-propensity-to-consume rich. But it is not an argument that lowering interest rates is a bad thing, or an argument that deflation is not a threat. The main thrust of the column simply does not connect up to Scheiber's claim that the Federal Reserve shouldn't have lowered--and shouldn't lower--interest rates.

So is there any reason to think that lowering interest rates would be a bad thing? There is a hint in one single sentence:

Meanwhile, in an industry like telecom, where there is too much capacity... lowering interest rates could exacerbate the situation by keeping marginal companies afloat and delaying... restructuring.

But let's think analytically--let's break this sentence up into the implicit chain of reasoning beneath it: (a) when the Federal Reserve cuts interest rates on short-term government bonds, it lowers borrowing costs for everyone; (b) there are a lot of marginal telecom firms that will go bankrupt rapidly unless their borrowing costs fall substantially; (c) the economy's long-term health depends on a rapid process of bankruptcy-and-workout in the telecom sector; hence (d) lowering interest rates harms the economy.

Laid out this way, we can see the gap in the logic. Marginal telecom firms teetering on the brink of bankruptcy do not borrow at the Federal Funds rate. The rates at which they can borrow incorporate huge risk and default premiums--they are on the edge of bankruptcy, after all. The general level of interest rates has only a trivial impact on their borrowing costs, and thus on whether teetering telecoms live or die. Only if you were certain that investment spending was completely unresponsive to interest rates could the effect of overall borrowing costs on the forthcoming telecom workout become a factor worth considering.

Nobody has any business claiming such a degree of certainty. It might be that business investment today is insensitive to interest rates (though I think it unlikely): stranger things have happened, and we have known since Paul Samuelson was a young man that business profits and expected demand relative to capacity--the factors making up the "accelerator"--are at least as important as interest rates as a determinant of business investment. But Scheiber might not be right (I would say, "is unlikely to be right").

Figures of Speech

Figures of Speech

"It's amazing how many dead figures of speech become alive and fresh again when you get a dog," said Ann Marie. The dog was lying on the floor, as if it were (a) completely boneless, and (b) lacking the energy to move a single muscle.

"Like?" I said.

"Well, the obvious--dog-tired," said Ann Marie, pointing at the dog. The dog eyed her, got up, walked over and began licking her feet. "Bootlicking," she said. "'Wolfing' your food"; "all bark and no bite"; "showing your belly."

The dog rolled over, and showed her belly to be scratched. She has a good rule for her life: if you don't understand what's going on, be sure to show that you are submissive.

Today during the conference Bill Nordhaus began talking about how Gross Domestic Income is a "mongrel statistic."

High-Tech Investment

High-Tech Investment

If you read your business pages, you might well think that business purchases of computers are way down. Guess what? They're not. This year it looks like America's businesses are going to buy 13% more in the way of quality-adjusted computers and peripherals than in any previous year. In 2001--the only year in which real investment in computers and peripherals fell--quality-adjusted purchases fell by only 3%. Spending on computers and peripherals has indeed fallen. But that's because computers have become cheaper--a lot cheaper--not because American business is installing less computer power this year than in the past.

Things look less bright if you aggregate up all high-tech investment--not just real investment in computers, but also software and "other": real investment in this broader category this year will be 4 percent below its year-2000 peak--but still higher than in any year other than 2000. Why the different pattern? The falloff in telecom investment. We are no longer spending a fortune digging holes and stuffing large quantities of fiber optic cables down them.

American Labor Productivity Growth Trends

Labor Productivity Growth Trends

Bill Nordhaus just gave a paper on U.S. productivity growth. One problem with the subject is that the year-to-year data are so noisy: errors in measuring output this year, errors in measuring output last year, errors in measuring hours worked this year, and errors in measuring hours worked last year all disturb the numbers reported for any given year. As a result, such papers almost always divide the time period up into a few chunks--1977-1989; 1989-1995; 1995-2001--and simply compare averages over those chunks.

But the time series is considerably richer. So while Bill was talking, I found myself (a) taking the annual data, (b) adjusting productivity growth for the business cycle (for productivity growth jumps by 0.39 percent for each percentage point increase in this year's unemployment rate, and falls by 0.77 percent for each percentage point increase in last year's unemployment rate), and (c) taking a centered five-year moving average (using our current forecasts for 2002, and taking a truncated four-year not-centered moving average for 2001). The resulting series--the "actual" and the "trend"--are plotted as the green and the red line in the figure below:

As a measure of the underlying pace of potential economic progress, it shows an interesting picture...

The Economist Joins the Pile on Alan Greenspan

This week's "Economics Focus" in the Economist joins the pack piling on to Alan Greenspan for not deflating America's stock market bubble earlier:

Economist.com: ...There may be no painless way to deflate bubbles. Yet the correct test is not whether a bubble can be deflated without some loss of output. Rather, it is whether the early pricking of a bubble causes less pain than letting it grow only to burst later. The longer a bubble is allowed to inflate, the more it encourages the build-up of other imbalances, such as too much borrowing and investment, which have the power to turn a mild downturn into something nastier. If the Fed had let some air out of the bubble earlier, America's economy might now be better placed for future growth...

Admittedly, for the Fed to justify an increase in interest rates when inflation was low would have been hard—but not impossible. It could, for instance, have argued that raising rates and so containing financial imbalances would avoid future economic instability and hence a large undershoot in future inflation.

Central bankers do not have a political mandate to respond to asset prices. Even so, Mr Greenspan could still have done more to warn investors about their irrational exuberance (which he talked of as long ago as December 1996). At least he could have refrained from talking up share prices, if unintentionally, through his enthusiasm for the new economy. Mr Greenspan repeatedly expressed confidence that America's productivity growth had risen significantly, encouraging investors to form unrealistic profit expectations. Estimates of productivity growth have since been cut. Goldman Sachs has shaved its estimate of trend productivity growth to 2%. Two years ago, most economists had their sights on 3% or more...

The first thing that must be said in Greenspan's defense is something that he knows well, but that the Economist has forgotten. Raising interest rates to prick an asset market bubble--reducing demand, causing unemployment, and throwing people out of work when there is no reason to think that the current state of the labor market is inconsistent with price stability--is not a policy to be entered into unadvisedly or lightly; but only reverently, discreetly, advisedly, soberly, and in the fear of God. "Sufficient unto the day is the evil thereof"--in short, deal with the bubble when the serious problems it threatens to cause are visible and approaching, not simply because there might be serious problems in the future.

The second thing to say is that Greenspan did warn of the dangers of "irrational exuberance," received considerable political flack when he did so, and found that such warnings had little effect. Taken in total, without selecting sentences on one side or the other, Greenspan's beliefs that on the one hand the market might be suffering from irrational exuberance but on the other hand look at these remarkable productivity growth numbers still seem well-founded.

The third thing to say is that Alan Greenspan's judgment is not perfect, but it is a damned sight better than mine. I can think of a number of times that I thought that Greenspan had made a significant monetary policy mistake:

• Not lowering interest rates more in the aftermath of the 1987 one-day stock market crash.
• Lowering interest rates too much in 1990-1991 to try to offset the Gulf War recession.
• Keeping interest rates too low--and thus risking accelerating inflation--in 1993.
• Raising interest rates too rapidly in 1994.
• Not raising interest rates enough, and allowing unemployment to drift down, in 1996-1997.
• Not lowering interest rates in the last three-quarters of 2000.
• Not lowering interest rates this year.

By my count, the first five times Greenspan was right: I was wrong. The sixth time I was right. And, although the jury is still out on the seventh, I think I am right. Nevertheless, the score is still Greenspan 5, DeLong 2. That's an impressive record, which we should not lose sight of. He knows things about how to make good monetary policy that I clearly do not.

EVERY August central bankers and economists gather in the Rocky Mountain resort of Jackson Hole, Wyoming, for the annual symposium of the Federal Reserve Bank of Kansas City. This year Alan Greenspan, chairman of the Federal Reserve Board, used the opportunity to give his fullest defence yet against charges that he should have raised interest rates in the late 1990s enough to prick the stockmarket bubble before it got too big. The Fed, like other central banks, takes account of rising asset prices (shares or property) to the extent that they boost spending and hence future inflation. Yet a financial bubble can inflate even when inflation in goods and services remains low. And when a bubble bursts, it may cause severe balance-sheet strains—of the kind now showing in America.

Mr Greenspan offers two defences for failing to respond to the bubble. First, he argues that it was impossible to be certain that the rise in share prices in the late 1990s really was a bubble until after it had burst. Second, even if a central bank can detect a bubble, it is not clear what it can do. A small rise in interest rates might not work; by increasing confidence in the central bank's powers, it might even boost share prices further. On the other hand, a sharp increase in rates could trigger a recession—the very outcome central bankers would be seeking to avoid, says Mr Greenspan.

Detecting and pricking bubbles are both difficult, but that is not a justification for doing nothing. Monetary policy always deals with uncertainty. Judging whether a rise in share prices is justified by an increase in productivity growth is surely not that different from deciding whether the potential rate of growth has increased or decreased. Central banks have to do that to estimate the gap between actual and potential output—itself an important input for forecasting inflation. A central bank does not need to be completely certain to act. Unrealistic profit expectations built into share prices in the late 1990s pointed to the strong probability of a bubble.

Supporters of Mr Greenspan argue that central bankers are unlikely to have more information or to make better judgments about share prices than markets do. Yet central bankers have longer time horizons and different incentives from the private sector. In other words, in many circumstances they may respond differently to the same information.

What of Mr Greenspan's second claim, that a small rise in interest rates might prove counterproductive? He cites three years—1989, 1994 and 1999—when share prices continued to rise even as the Federal Reserve raised rates. All the same, the impact of higher rates might be different if the Fed were actually to state that its aim was to cool the stockmarket.

There may be no painless way to deflate bubbles. Yet the correct test is not whether a bubble can be deflated without some loss of output. Rather, it is whether the early pricking of a bubble causes less pain than letting it grow only to burst later. The longer a bubble is allowed to inflate, the more it encourages the build-up of other imbalances, such as too much borrowing and investment, which have the power to turn a mild downturn into something nastier. If the Fed had let some air out of the bubble earlier, America's economy might now be better placed for future growth.

A recent paper* by Claudio Borio and Philip Lowe at the Bank for International Settlements addresses the problem of identifying bubbles. The authors argue that the focus on asset-price bubbles alone is wrong. It is only when a boom in share prices or house prices is combined with a big increase in debt and overinvestment by firms that economic and financial stability is threatened. From a study of 34 countries since 1960, Mr Borio and Mr Lowe conclude that a simultaneous surge in both credit and asset prices gives a pretty reliable warning of financial problems ahead. The case for a rise in interest rates is therefore stronger when asset-price rises go hand-in-hand with rapid growth in credit—as in America in the late 1990s.

Admittedly, for the Fed to justify an increase in interest rates when inflation was low would have been hard—but not impossible. It could, for instance, have argued that raising rates and so containing financial imbalances would avoid future economic instability and hence a large undershoot in future inflation.

Central bankers do not have a political mandate to respond to asset prices. Even so, Mr Greenspan could still have done more to warn investors about their irrational exuberance (which he talked of as long ago as December 1996). At least he could have refrained from talking up share prices, if unintentionally, through his enthusiasm for the new economy. Mr Greenspan repeatedly expressed confidence that America's productivity growth had risen significantly, encouraging investors to form unrealistic profit expectations. Estimates of productivity growth have since been cut. Goldman Sachs has shaved its estimate of trend productivity growth to 2%. Two years ago, most economists had their sights on 3% or more.

One positive sign: in his speech Mr Greenspan did at least accept that the Fed should try to identify bubbles and to incorporate them into economic models. But for the moment he doubts that central banks can do anything about them.

If the American economy recovers fast, then Mr Greenspan's policies will be vindicated—if bubbles left to burst of their own accord result only in a mild recession, central banks do not need to prick them. If America suffers several years of slow growth as its financial imbalances unwind, however, the verdict must be that the Fed got it wrong.

BLS August Report

The Bureau of Labor Statistics reports that businesses employed 39,000 more people in August than they did in July (on a seasonally adjusted basis). The BLS also reports that its survey of households produces an estimate of 429,000 more Americans at work in August than in July.

Which is more reliable? I have always trusted the business employment survey rather than the household survey as a more reliable business cycle indicator. This month, it is the one that is more pessimistic about the state of the economy.

Employment Report

Technical information:

  Household data:  (202) 691-6378   USDL 02-509

          http://www.bls.gov/cps/



  Establishment data:    691-6555   Transmission of material in this release is

          http://www.bls.gov/ces/   embargoed until 8:30 A.M. (EDT),

Media contact:           691-5902   Friday, September 6, 2002.

                                     

                                     

                  THE EMPLOYMENT SITUATION:  AUGUST 2002





   Both payroll employment and the unemployment rate were little changed in

August, the Bureau of Labor Statistics of the U.S. Department of Labor

reported today.  Job gains in services, government, and construction were

largely offset by losses in manufacturing and retail trade.

   

Unemployment (Household Survey Data)

   

   Both the unemployment rate, 5.7 percent, and the number of unemployed

persons, 8.1 million, were little changed over the month.  The jobless

rates for the major worker groups--adult men (5.2 percent), adult women

(4.9 percent), teenagers (17.2 percent), whites (5.1 percent), blacks 

(9.6 percent), and Hispanics (7.5 percent)--showed little or no change.  

(See tables A-1 and A-2.)

   

   The number of persons unemployed 15 weeks or more was 2.8 million in

August, down from the recent high of 3.1 million in June.  (See table A-6.)



Total Employment and the Labor Force (Household Survey Data)

   

   Total employment rose by 429,000 to 134.5 million in August, after seasonal 

adjustment.  The employment-population ratio was up by 0.2 percentage point to 

62.8 percent.  The civilian labor force (142.6 million) and the labor force 

participation rate (66.6 percent) were essentially unchanged over the month.  

(See table A-1.)

   

   About 6.8 million persons (not seasonally adjusted) held more than one

job in August.  These multiple jobholders represented 5.0 percent of the

total employed.  (See table A-10.)

   

Persons Not in the Labor Force (Household Survey Data)

   

   About 1.4 million persons (not seasonally adjusted) were marginally

attached to the labor force in August, essentially the same as a year

earlier.  These individuals reported that they wanted and were available

for work and had looked for a job sometime in the prior 12 months.  They

were not counted as unemployed, however, because they had not actively

searched for work in the 4 weeks preceding the survey.  The number of

discouraged workers was 372,000 in August.  Discouraged workers, a subset

of the marginally attached, were not currently looking for work 

specifically because they believed no jobs were available for them.  

(See table A-10.)



                                  - 2 -



Table A.  Major indicators of labor market activity, seasonally adjusted

(Numbers in thousands)

___________________________________________________________________________

                      |    Quarterly    |                          |

                      |    averages     |       Monthly data       |

                      |_________________|__________________________| July-

      Category        |       2002      |           2002           | Aug.

                      |_________________|__________________________|change

                      |   I    |   II   |  June  |  July  |  Aug.  |

______________________|________|________|________|________|________|_______

    HOUSEHOLD DATA    |                 Labor force status

                      |____________________________________________________

Civilian labor force..| 141,868| 142,605| 142,476| 142,390| 142,616|    226

  Employment..........| 133,894| 134,149| 134,053| 134,045| 134,474|    429

  Unemployment........|   7,975|   8,456|   8,424|   8,345|   8,142|   -203

Not in labor force....|  71,342|  71,059|  71,366|  71,633|  71,609|    -24

                      |________|________|________|________|________|_______

                      |                 Unemployment rates

                      |____________________________________________________

All workers...........|     5.6|     5.9|     5.9|     5.9|     5.7|   -0.2

  Adult men...........|     5.1|     5.3|     5.4|     5.2|     5.2|     .0

  Adult women.........|     4.9|     5.2|     5.1|     5.2|     4.9|    -.3

  Teenagers...........|    16.0|    17.1|    17.6|    17.7|    17.2|    -.5

  White...............|     5.0|     5.2|     5.2|     5.3|     5.1|    -.2

  Black...............|    10.1|    10.7|    10.7|     9.9|     9.6|    -.3

  Hispanic origin.....|     7.5|     7.4|     7.4|     7.6|     7.5|    -.1

                      |________|________|________|________|________|_______

 ESTABLISHMENT DATA   |                     Employment

                      |____________________________________________________

Nonfarm employment....| 130,759| 130,706| 130,736|p130,803|p130,842|    p39

  Goods-producing 1/..|  24,049|  23,879|  23,861| p23,820| p23,787|   p-33

    Construction......|   6,602|   6,544|   6,549|  p6,519|  p6,553|    p34

    Manufacturing.....|  16,883|  16,776|  16,757| p16,750| p16,682|   p-68

  Service-producing 1/| 106,711| 106,827| 106,875|p106,983|p107,055|    p72

    Retail trade......|  23,353|  23,327|  23,308| p23,341| p23,286|   p-55

    Services..........|  40,924|  41,090|  41,152| p41,212| p41,312|   p100

    Government........|  21,165|  21,201|  21,211| p21,231| p21,272|    p41

                      |________|________|________|________|________|_______

                      |                  Hours of work 2/

                      |____________________________________________________

Total private.........|    34.2|    34.2|    34.3|   p34.0|   p34.1|   p0.1

  Manufacturing.......|    40.8|    41.0|    41.1|   p40.7|   p40.8|    p.1

    Overtime..........|     4.0|     4.2|     4.3|    p4.0|    p4.2|    p.2

                      |________|________|________|________|________|_______

                      |    Indexes of aggregate weekly hours (1982=100) 2/

                      |____________________________________________________

Total private.........|   148.2|   148.3|   148.6|  p147.5|  p147.9|   p0.4

                      |________|________|________|________|________|_______

                      |                      Earnings 2/

                      |____________________________________________________

Avg. hourly earnings, |        |        |        |        |        |

  total private.......|  $14.62|  $14.71|  $14.75| p$14.78| p$14.82| p$0.04

Avg. weekly earnings, |        |        |        |        |        |

  total private.......|  499.52|  503.58|  505.93| p502.52| p505.36|  p2.84

______________________|________|________|________|________|________|_______

   1/  Includes other industries, not shown separately.

   2/  Data relate to private production or nonsupervisory workers.

   p=preliminary.

   

                                  - 3 -



Industry Payroll Employment (Establishment Survey Data)



   Total nonfarm payroll employment was little changed (+39,000) in August

at 130.8 million.  Since its recent low in April, payroll employment has

edged up by 162,000.  (See table B-1.)

   

   The services industry added 100,000 jobs in August.  Employment in this

industry has risen by 411,000 since February.  Employment in health services 

rose by 26,000 in August, in line with the average monthly increase over the 

prior 12 months.  The help supply industry, which provides workers to other 

businesses, added 51,000 jobs over the month, following a decline of 30,000 

in July.  Since its recent low point in February of this year, employment in 

help supply services has risen by 165,000.

   

   Government employment rose by 41,000 over the month.  The federal

government added 20,000 jobs, mostly reflecting an increase in the number

of federal security personnel at airports.  Employment in local government

grew by 34,000 in August, due largely to a gain in local education.  State

education employment fell by 20,000, after increasing by the same amount in

July.

   

   Employment in construction increased by 34,000 in August.  Despite this

one-month increase, the level of construction employment in August was

essentially the same as in April.



   Manufacturing employment declined by 68,000 in August; this compares

with losses in the prior 4 months that averaged 18,000.  In August, job

losses were widespread, including substantial declines in electronic and

other electrical equipment (-18,000) and industrial machinery and equipment

(-13,000).  After remaining fairly steady from January through July,

employment in fabricated metal products decreased by 10,000 in August.

Rubber and plastics manufacturing lost 7,000 jobs, offsetting the previous

month?s increase.

   

   Retail trade, which had shown little change on balance since February,

lost 55,000 jobs in August.  A decline in department store employment 

(-41,000) accounted for most of the drop.

   

                                  - 4 -



Weekly Hours (Establishment Survey Data)

   

   The average workweek for production or nonsupervisory workers on private

nonfarm payrolls edged up by 0.1 hour in August to 34.1 hours, seasonally

adjusted.  This follows a decline of 0.3 hour in July.  The manufacturing

workweek also was up by 0.1 hour over the month to 40.8 hours.



   Manufacturing overtime rose by 0.2 hour to 4.2 hours.  Both measures had

declined in July.  (See table B-2.)

   

   The index of aggregate weekly hours of production or nonsupervisory

workers on private nonfarm payrolls rose by 0.3 percent in August to 147.9

(1982=100).  The manufacturing index was down by 0.2 percent over the

month.  (See table B-5.)



Hourly and Weekly Earnings (Establishment Survey Data)

   

   Average hourly earnings of production or nonsupervisory workers on

private nonfarm payrolls increased by 4 cents in August to $14.82,

seasonally adjusted.  Average weekly earnings increased by 0.6 percent 

over the month to $505.36.  Over the year, both average hourly earnings 

and average weekly earnings grew by 3.1 percent.  (See table B-3.)

   

                      ______________________________

   

   

   The Employment Situation for September 2002 is scheduled to be released

on Friday, October 4, at 8:30 A.M. (EDT).

   

                                  - 5 - 

A Correction From John Quiggin

John Quiggin corrects this morning's Paul Krugman column about the rhetoric surrounding Social Security privatization. Of course, doing so makes Krugman's basic point twice as strong...

John Quiggin: ...Paul Krugman is usually right up to the minute. But the main point of his latest piece, namely, that the US Republicans have backed away from using the term "privatization" to describe their plans for Social Security individual accounts, was in Salon's Spinsanity back in June. And the kicker for his column is this para: "And what's the name of the Cato project to promote personal accounts? Why, the Project on Social Security Privatization, of course." In fact, as was reported in this blog, back in July, the Cato Institute has followed the Republican party line, and changed the name to Project on Social Security Choice. Of course, it will be a bit embarrassing for them to write in with a correction, since it simply underlines the main point...

Who Controls the Past Controls the Future. Who Controls the Present Controls the Past

I used to think that Paul Krugman was being too shrill when he described the Bush Administration's tactics as "Orwellian." I hereby confess: I was wrong. He was right.

The Bully's Pulpit: ...Ari Fleischer's insistence that Mr. Powell and Mr. Cheney have no differences over Iraq seems to have pushed some journalists into facing up, at least briefly, to the obvious.... "The Bush team has always had a credibility problem with some reporters because of their insistence on saying 'up is down' and 'black is white.'" But... if history is any guide, many reporters will... the next time the administration insists that chocolate is vanilla... won't report that the stuff is actually brown; at best they'll report that some Democrats claim that it's brown.

The Bush team's Orwellian propensities have long been apparent to anyone following its pronouncements on economics. Even during campaign 2000 these pronouncements relied on doublethink.... George W. Bush's plan to partially privatize Social Security always depended on the assertion that 2-1=4 — that we can divert payroll taxes into high-yielding personal accounts, yet still use the same money to pay benefits to retirees.

...Republican political consultants have found that in an era of plunging stocks and corporate scandal the word "privatization" has taken on negative connotations. The answer? Deny that personal accounts constitute privatization, and bully the press into going along....

Is it inaccurate to say that personal accounts equal privatization? We could argue on the merits. Under the Bush plan, a worker's personal account reflects any gains or losses on the stocks it represents. When risks and rewards accrue entirely to the individual, isn't that privatization?

But wait, we can do better. The push to convert Social Security into a system of personal accounts has been led by the Cato Institute. The Bush plan emerged directly from Cato's project on the subject, several members of Mr. Bush's commission on Social Security reform had close Cato ties, and much of the commission's staff came straight from Cato. You can read all about Cato's role on the special Web site the institute set up, socialsecurity.org.

And what's the name of the Cato project to promote personal accounts? Why, the Project on Social Security Privatization, of course.... The R.N.C.C. doesn't really think it can convince people that privatization isn't privatization. But that's not the goal. The memo doesn't talk about how to communicate with the public; it's a list of demands to place on journalists...

The Bully's Pulpit

ar is peace. Freedom is slavery. Ignorance is strength. Colin Powell and Dick Cheney are in perfect agreement. And the Bush administration won't privatize Social Security.

Ari Fleischer's insistence that Mr. Powell and Mr. Cheney have no differences over Iraq seems to have pushed some journalists into facing up, at least briefly, to the obvious. ABC's weblog The Note described it as a "chocolate-is-vanilla" claim, admitting that "The Bush team has always had a credibility problem with some reporters because of their insistence on saying 'up is down' and 'black is white.' "

But the administration needn't worry; if history is any guide, many reporters will soon return to their usual cringe. The next time the administration insists that chocolate is vanilla, much of the media — fearing accusations of liberal bias, trying to create the appearance of "balance" — won't report that the stuff is actually brown; at best they'll report that some Democrats claim that it's brown.

The Bush team's Orwellian propensities have long been apparent to anyone following its pronouncements on economics. Even during campaign 2000 these pronouncements relied on doublethink, the ability to believe two contradictory things at the same time. For example, George W. Bush's plan to partially privatize Social Security always depended on the assertion that 2-1=4 — that we can divert payroll taxes into high-yielding personal accounts, yet still use the same money to pay benefits to retirees.

The Orwellian tactics don't stop with doublethink; they also include newspeak, the redefinition of words to rule out disloyal thoughts. Again, Social Security is a perfect example. Republican political consultants have found that in an era of plunging stocks and corporate scandal the word "privatization" has taken on negative connotations. The answer? Deny that personal accounts constitute privatization, and bully the press into going along. A Republican National Campaign Committee memo lays out the new strategy: "It is very important that we not allow reporters to shill for Democrat demagoguery by inaccurately characterizing 'personal accounts' and 'privatization' as one and the same."

Is it inaccurate to say that personal accounts equal privatization? We could argue on the merits. Under the Bush plan, a worker's personal account reflects any gains or losses on the stocks it represents. When risks and rewards accrue entirely to the individual, isn't that privatization?

But wait, we can do better. The push to convert Social Security into a system of personal accounts has been led by the Cato Institute. The Bush plan emerged directly from Cato's project on the subject, several members of Mr. Bush's commission on Social Security reform had close Cato ties, and much of the commission's staff came straight from Cato. You can read all about Cato's role on the special Web site the institute set up, socialsecurity.org.

And what's the name of the Cato project to promote personal accounts? Why, the Project on Social Security Privatization, of course.

Which brings us back to the issue of intimidation. The R.N.C.C. doesn't really think it can convince people that privatization isn't privatization. But that's not the goal. The memo doesn't talk about how to communicate with the public; it's a list of demands to place on journalists. As Joshua Marshall put it at talkingpointsmemo.com, the goal is to "mau-mau reporters out of using the word 'privatization' in this context."

And the intimidation will probably succeed. Indeed, it's already working. As Mr. Marshall notes, in a recent interview of the House minority leader, Richard Gephardt, Judy Woodruff of CNN duly echoed the R.N.C.C.'s memo.

Unfortunately, this isn't just a question of Social Security policy. Once an administration believes that it can get away with insisting that black is white and up is down — and everything in this administration's history suggests that it believes just that — it's hard to see where the process stops. A habit of ignoring inconvenient reality, and presuming that the docile media will go along, soon infects all aspects of policy. And yes, that includes matters of war and peace.

The trouble is that eventually reality has a way of asserting itself. And in case you are wondering, ignorance isn't strength.

Hearts and Minds

Jim Henley explains how Yasser Arafat and company permanently and totally lost their battle for the hearts and minds of him, me, and I would bet most Americans in the summer of 1972. Some of my schoolmates were on the airplanes flown to Jordan and blown up in 1970, so Palestinian terrorism seemed very real as we watched the Munich Olympics Massacre on TV...

Unqualified Offerings: ...I was twelve years old at the time of the Munich Olympics and I saw the whole, awful thing, and the experience never left me. Enthusiasts for the Palestinian cause, however defined, might profit from pondering why that is. It was obvious to me, watching the masked gunmen on the balconies, and later the garish, uninformative spotlights on the runway, what I was seeing: a crime. I was watching bad guys. My first sustained exposure to "the plight of the Palestinians" was to villains acting in their name.... Then came the "discourse." Draw attention to the cause! I'd type more catch-phrases, but it's not worth the disgust. The 1970s were the high-water mark of Fanonist mendacity. It dumbfounded me then that anyone could believe such things, that people like George Habash were allowed to sit for interviews and go unmolested by local police anywhere on earth. Even then, Europe accepted such arguments in a way most Americans instinctively rejected them. To me, Yasser Arafat and the PLO were simply the masterminds of a loathsome criminal act. Weightlifters. That'll show 'em.

I think I'm far from the only American that Munich made a lasting impression on, and to the Palestinian's detriment. Later there was Entebbe and Khartoum and Leon Klinghoffer to reinforce the impression, but it was the sheer squalid cruelty of Munich that set the tone. Even after Oslo, the part of me that hoped for peace warred with the part that couldn't accept that Yasser Arafat should be allowed to live comfortably as a free man. It was not just the crimes, it was justifying the crimes.

The Palestinians have always had a case. Whether their case was particularly egregious in a global-historical sense is a matter for debate, but you can't blame the Palestinians themselves for a certain lack of detachment in the matter. You can blame their leaders for indulging in a decades-long orgy of apocalyptic gesture, though. And you can note that in their smug self-justification for turning crime into politics, they lost for decades the sympathy of the one country on earth that could bring them something like surcease and recompense: my country.

Readers of this blog know that I am pretty hard on Israel. I believe that many of its remaining security problems are substantially, though not entirely, of its own making. I believe that, at bottom, a critical mass of its political elite would rather have the West Bank than peace. I believe that the founding of Israel in 1948 represented many, many instances of what the Fifth Amendment refers to as a "taking" and that the individual property-holders affected should be compensated financially. I believe that, so long as Israel maintains a distinction between subjects in the West Bank and Gaza and citizens in Israel proper, that there is an occupation, and it is illegitimate. I believe that if Israel can't survive without continued US aid, that Zionism has failed at its stated purpose of ensuring a refuge for the Jews. These are intellectual positions. Since the proportion of Americans polled who say the US needs to pressure Israel to do more for peace grows ever closer to the proportion who think the US needs to pressure the Palestinian Authority, I'd wager that these are increasingly common beliefs. But at least on my part, they come with no particular emotional attachment to the situation of the Palestinians themselves. This is an ascription of collective responsibility for the crimes of a few, and the apologetics of more than a few. It is my failing.

That failing is thirty years old tonight.

Lord of the Rings

The Lord of the Rings

The nine-year-old is reading the Lord of the Rings. "Dad?"

"Yes?"

"I'm on page 168, and very little has happened. They're just meeting Strider!"

"I agree. The pace is quite slow at the beginning."

"Why?"

"I'm not sure. Perhaps Tolkien didn't have sufficient control over his book. Perhaps he was more interested in describing the world the hobbits lived in than he was in advancing the plot."

"It's a good book. But it's so big. I think it must only be for fast readers."

Tenth Avenue Freeze-Out

Tenth Avenue Freeze-Out

You cannot read Eric Alterman's weblog for very long without getting out your Springsteen CDs and putting them on. And I cannot listen to Springsteen CDs for very long without going out and buying another one--in this case, a three-CD collection of Bruce Springsteen and the E-Street Band live from 1975-1985.

The music is wonderful.

The CDs also include a lot of stories--Bruce Springsteen tells stories before, in the middle of, and after songs. The stories are mostly about growing up, and about fighting with his father as he grew up. Back at the start of the 1980s, when I was 20 or so listening to concerts in the old Boston Garden, my sympathies were all with Bruce Springtsteen--wanting to make his career with his "god-damned guitar" in the face of a father who wanted him to become a lawyer, get a little something for himself, and stop being such a hippy freak.

This time, however, I'm not 21: I'm 42. I'm not terribly interested in stories of people establishing boundaries vis-a-vis their parents and shaping their own lives. Frankly, I'm now on the other side. My heart goes out to the elder Mr. Springsteen, clearly keenly aware of how small the chances that his son would become a successful musician were, and desperate to keep his son's life from crashing into the ground. You can't not react when you see your kid taking a chance where the odds are 1000 to 1 against.

We want them to fly high. We are desperately eager for them to try their wings and learn to soar. And we are terrified that they are too young, too stupid, too inexperienced, too short-sighted to understand how to make their own way and achieve their own brand of success in the world.

The Cyclically-Adjusted Deficit

John Irons find and links to the Congressional Budget Office's estimates of the deficit adjusted for the state of the business cycle:

ArgMax Blog: The Cyclically Adjusted Deficit: ..."By those measures, roughly one-third of the projected decline in the total surplus between 2000 and 2003 results from "automatic stabilizers" the automatic response of the budget to the business cycle. Most of the remaining two-thirds is attributable to legislative action: primarily EGTRRA [2001 tax cuts], JCWAA, and increases in discretionary spending (including emergency appropriations enacted in response to the terrorist attacks of September 11)."...

Messrs. Lorentz and FitzGerald

Uncertain Principles if you start to get close to light speed, you need Special Relativity to describe what really happens...

*Sigh.* This is what happens when you read weblogs by real physicists--especially those who have been part of a team making Bose-Einstein condensates in their laboratory. (Kids! Don't try this at home!) My spreadsheet on the effects of product and income-side estimates of total output on our conception of the economic boom of the 1990s is now filled with Lorentz-FitzGerald contraction formulas...

Consider a person standing on the surface of the earth, and consider an event--the birth of a child, say--at that exact same time (in his frame of reference) on the other side of the galaxy--100,000 light years, or 9 x 10^20 meters away.

Now consider a second person walking past that first person at that exact same moment (when in the first person's reference frame the child is born), in the direction of the point 100,000 light years away. If you asked that second person whether the child on the other side of the galaxy had been born yet, and if so how old was she, you would get a different answer.

According to my calculations, the second person has a velocity relative to the first of approximately 3 x 10^-6 times the speed of light, and so in her frame of reference the distance to the event is not 100,000 light years--the Lorentz-FitzGerald contraction changes distances in the direction of motion by a factor of gamma = (1/(1 - 5 x 10^-12)). So the event is not 100,000 light years distant, but 100,000 light years plus 3 million miles distant.

Moreover, the second person says that the event does not take place at the same time he passes the first. If I have managed to multiply my vector by my matrix competently, the second person says that the birth of the child took place a million seconds--twelve days--in the past.

And the entire point of special relativity is that both observers are accurate, in their respective inertial frames of reference, and that neither frame of reference is any better (or any worse) for any purpose than the other.

All this is Heavy Magic, and--once one has seen enough bubble-chamber tracks of extraordinarily short-lived atomic particles for which time has been slowed by the Lorentz-FitzGerald contraction to believe in it--wreaks havoc with your (OK, my) intuitive belief that the "past" has a different ontological status than the "present" has a different ontological status than the "future"...

How Stands the Federal Republic of Germany?

How Stands the Federal Republic?

The New German Problem

By Brad DeLong

As Germany prepares to elect its next Chancellor, the two main candidates, Gerhard Schroeder and Edmund Stoiber, agree on one thing: unemployment must be reduced. Over the past two decades, high unemployment has transformed Europe in general and Germany in particular into a sociological time bomb. What will the unemployed, especially the long-term unemployed with only dim memories of integration into the world of work, do with themselves and their time? What will happen to confidence in governments that can not solve the unemployment problem?

We all try hard to forget that little more than 50 years ago Europe was and had for half a century been the world's most violent continent. Europeans had slaughtered each other on a scale unprecedented in human history. Against this backdrop, Western Europe after 1950 has been remarkably peaceful and stable, even taking into account the fall of the French Fourth Republic and the transitions from dictatorship to democracy in Portugal, Spain, and Greece. The most remarkable transformation of all was that of the Federal Republic of Germany. Anyone familiar with German history since 1800 is still astonished at the enthusiasm with which the nation that emerged from total defeat in 1945 embraced what many in previous generations would have called "unsuitable Anglo French political and economic models. Without the peace and stability that this assured in Germany, the largest linguistic nation west of Russia, it is difficult to imagine today's peace and stability in western Europe as a whole.

Germany owes its transformation in part to a combination of three factors: a backlog of unexploited technological opportunities to fuel rapid income growth, nearly full employment, and a state that shared the benefits of growth widely through public programs (rather than serving one class or interest as a weapon to concentrate wealth and power). Other factors--the memory of the Nazi catastrophe, the example of life east of the Iron Curtain, the potential threat posed by Stalin and his heirs--almost surely played a more important role. But the fact that the political-economic system worked for almost everyone weighed heavily in the balance, and was the final buttress holding up the cathedral.

To everyone's relief, political democracy and mixed market economies proved highly resilient against the oil price shocks of the 1970s. Incomes stagnated, but the institutional order endured. The institutional order has also endured the subsequent emergence and persistence of high unemployment. Within the Federal Republic, where unemployment remains near its early-1980s peak, the failure to address the unemployment problem was offset by other successes. The early 1990s witnessed the reunification of Germany, and the elimination of even moderate inflation risks. The late 1990s delivered deeper European integration, culminating in European Monetary Union.

In short, lack of progress on reducing unemployment could be excused in the past: other problems and opportunities were or at least could be presented as more urgent and important. But what more urgent problem or attractive opportunity exists today? Inflation no longer threatens anyone's savings. Germany is unified. Monetary union has been accomplished. Whoever leads the next German government must tackle unemployment, both for the sake of the economically most vulnerable and to ensure public confidence in the current system.

Unfortunately, whoever wins the election, Schroeder or Stoiber, will be nearly helpless in the medium term to address unemployment problems. Germany's Hartz Employment Commission has called for sweeping labor-market and social-welfare reforms, but it will be very difficult for any government to implement them. Without increased private-sector demand, the removal of supply-side restrictions that have fuelled high classical unemployment in the past are likely to simply result in high Keynesian unemployment in the future. European integration was supposed to take care of this deficient demand problem by driving decades of rapid economic growth as companies realized continent-wide economies of scale. But where is the demand to drive this growth? The European Central Bank (ECB) seems more interested in keeping interest rates high enough to force insolvent firms into bankruptcy than in promoting higher employment.

With private-sector demand stalling, the Hartz Employment Commission wants the government to serve as employer of last resort. But the Maastricht Treaty's Stability and Growth Pact limits fiscal deficits to 3% of GDP, a ceiling that Germany is already hitting. Unless a future government is bold enough to violate the pact with abandon, its only alternative will be to increase taxes, which might well prolong the very downturn in private-sector demand that has kept unemployment high. Were it not for the Stability and Growth Pact, a Keynesian spending-led program could provide the demand needed to reduce unemployment.

The problem could also be solved once and for all if the ECB were willing to risk a grand bargain with governments: if you liberalize product markets and make labor markets flexible, we will reduce interest rates and permit higher spending to fulfill the promise of near-full employment. But the ECB and the Stability and Growth Pact being what they are, both German parties are what they are: a sculptor who has promised to carve a marble statue overnight but has lost his chisel.

There may be little cause for immediate worry. The sociological time bomb may simply keep ticking. As Adam Smith put it, we should not despair when only one disaster strikes, for "there is a lot of ruin in a nation." But while Western Europe's post-war institutional order has worked miraculously well in historical perspective, voters have narrower views and focus on more private concerns. They are more likely to judge a party, a regime, or an institutional order by asking, "What have you done for me lately?"

With the great tasks of reunification and European integration behind it, future German governments are increasingly likely to be forced to answer, "Not much."

Globalization Will Continue

The always-smart Martin Wolf, writing in the Financial Times, produces a neo-Marxist analysis rejecting the belief that globalization has seen its high tide. Because the anti-globalization movement does not represent any powerful, unified, material interest group, its influence will be limited. It seems to me that he's almost surely right...

FT.com Home US: ...The terrorists who attacked the US on September 11 were mortal enemies of the US. But the US is not just a country, it is also a set of ideas. Among the ideas it has stood for over more than half a century is a liberal world economy. One of the questions raised by September 11 was whether it marked the end of a second era of global economic integration during the past 150 years. The answer, I suggest, remains no.We do not know our future. But we do know the past. In the late 19th century and early 20th century, the world economy achieved a high degree of integration. Yet this integration went into reverse between 1914 and 1945. That breakdown was the consequence of the combined force of ideas, interests, economic instability and calamitous international relations. The question is whether these same four horsemen will return.

First, the 20th-century collapse coincided with the rise of anti- liberal ideas: militarism, imperialism, nationalism, communism and fascism were embraced with enthusiasm. There are faint parallels in what David Henderson, former chief economist of the Organisation for Economic Co-operation and Development, has called "New Millennium Collectivists". But, for all their sound and fury, the anti-liberals of today are very different from those of a century ago.

They are rooted in no powerful social force, such as the organised working class. They do not seek power but largely reject organised politics. They offer no alternative way of running an economy. As John Lloyd makes clear in an illuminating recent pamphlet*, they have a multitude of often-contradictory objectives. Some of what protesters say - notably on the hypocrisy of the advanced countries and the plight of the poor - is valid. But one cannot beat something with nothing. Protest alone is unlikely to triumph...

A free world

By Martin Wolf | September 3, 2002 | Financial Times

The terrorists who attacked the US on September 11 were mortal enemies of the US. But the US is not just a country, it is also a set of ideas. Among the ideas it has stood for over more than half a century is a liberal world economy. One of the questions raised by September 11 was whether it marked the end of a second era of global economic integration during the past 150 years. The answer, I suggest, remains no.

We do not know our future. But we do know the past. In the late 19th century and early 20th century, the world economy achieved a high degree of integration. Yet this integration went into reverse between 1914 and 1945. That breakdown was the consequence of the combined force of ideas, interests, economic instability and calamitous international relations. The question is whether these same four horsemen will return.

First, the 20th-century collapse coincided with the rise of anti- liberal ideas: militarism, imperialism, nationalism, communism and fascism were embraced with enthusiasm. There are faint parallels in what David Henderson, former chief economist of the Organisation for Economic Co-operation and Development, has called "New Millennium Collectivists". But, for all their sound and fury, the anti-liberals of today are very different from those of a century ago.

They are rooted in no powerful social force, such as the organised working class. They do not seek power but largely reject organised politics. They offer no alternative way of running an economy. As John Lloyd makes clear in an illuminating recent pamphlet*, they have a multitude of often-contradictory objectives. Some of what protesters say - notably on the hypocrisy of the advanced countries and the plight of the poor - is valid. But one cannot beat something with nothing. Protest alone is unlikely to triumph.

Meanwhile, the ideas of economists remain strongly in favour of integration. Some, such as Dani Rodrik of Harvard University and Joseph Stiglitz, former chief economist of the World Bank, express doubts over how and how far integration should proceed. But no significant economist argues that closing off an economy makes sense. Doubts are strongest over the management of capital flows. Yet a high level of integration on the real side of the economy, through trade and direct investment, is perfectly compatible with some controls over capital movement.

The second force causing the disintegration of the earlier globalisation was protectionist interests, notably in the US, which culminated in the calamitous Smoot-Hawley tariff of 1930. Happily, contemporary economic developments have largely tamed these interests.

It is no accident that protectionist interests are strongest in predominantly nationally owned and operated industries, such as steel and agriculture. The rise of the internationally integrated multinational company has reduced the ability (and willingness) of many producers to wrap themselves in national flags. Is a Toyota factory in the US less or more American than a General Motors factory in China? How can one answer such a question?

Modern companies have global interests. This is what many protesters hate about them. The same is also true of many of their most valued employees. A consequence of investment around the world and the concomitant flows of intra-company trade is the breakdown in the ability and willingness of companies to collaborate with trade unions in the demand for protection. Similarly, inward direct investment and intra-industry and intra- company trade have weakened traditional protectionist interests in developing countries.

The decline in employment in manufacturing and the rise in the portion of the electorate in retirement have reduced the share of the population whose jobs are directly vulnerable to import competition. Consumers have also become accustomed to a variety of foreign products. They may complain, as workers, about imports. But they love the products of foreign companies.

Concern about the decline in relative wages and employment opportunities of the unskilled is widespread in high-income countries. But the political power of this group of people is modest, particularly since they have become a falling proportion of an increasingly educated population. Moreover, the general consensus of analysts is that this decline in opportunities for the unskilled reflects changes in technology far more than trade.

In addition, multilateral institutions and a web of international commitments makes it far more difficult for protectionist interests to capture legislatures. China has joined the World Trade Organisation. Even the Bush administration, wedded to unilateralism, has never said the US should simply ignore its obligations under the WTO.

Economic instability was the third source of the earlier breakdown. The decisive events in the collapse of the integrated economy of the late 19th and early 20th centuries were the series of financial and exchange-rate crises that rolled across the world in the 1930s, ably described by the Princeton university historian Harold James.**

Financial crises have come with depressing frequency over the past two decades. A report from the World Bank published last year wrote of "112 episodes of systemic banking crises in 93 countries since the late 1970s". Japan is still struggling with the aftermath of its "bubble economy". The US has suffered its bubble as well, which is now painfully deflating, revealing a sizeable amount of fraud and deception as it shrinks.

All these are signs of stress. Yet the outcome will not be another 1930s. Japan has avoided a depression. The US will surely succeed in that as well, even if a period of disappointing growth lies ahead. The move to floating exchange rates has reduced the risk of exchange-rate-cum- banking crises in emerging market economies (though, as Brazil shows, old-fashioned fiscal crises can still occur). The woes inflicted upon Argentina by the collapse of its currency board might better be viewed as the end of an era than as the beginning of a new one. It is also striking that, despite such crises, no significant country has reversed the commitment to liberal trade or even to freedom from exchange controls.

The fourth cause of the breakdown of the last liberal world order was rivalries among great powers. Today, however, the world has an undisputed hegemon. There is little chance of a war among great powers in the near future, except perhaps between the US and China. Yet China is not now a strategic rival of the US.

All great powers have abandoned the atavistic notion that prosperity derives from territorial gains plus plunder, rather than internal economic development plus peaceful exchange. In today's battle against terrorism, all the world's great powers are also on the same side.

Some fear that terrorist outrages on the scale of September 11 - or still worse ones - will end the commitment to open borders. Related fears concern weapons of mass destruction in the hands of hostile despotic regimes.

These are valid worries. If countries had to be sure of the safety of every shipment or person that crossed their borders, much of today's economic exchange and movement of people would become impossible. Yet that would hand the victory to terrorists and their sponsors.

At present, it does not appear that the world's response is to close borders. The decision to proceed with the Doha round of multilateral trade talks was an encouraging sign of that wise determination. Global co-operation against terrorists is a more appropriate and effective route.

September 11 was an attack on modernity by Islamic fascists. Safety will not now be achieved, in response, solely by applying force abroad and building fortresses at home. The task, instead, is to combine the search for security with a wider diffusion of the prosperity and hope offered only by a dynamic global market economy. This may be hard to achieve. It remains the only sane course.

* The Protest Ethic: How the anti-globalisation movement challenges social democracy (London: Demos, 2001)

** The End of Globalization: Lessons from The Great Depression (Harvard University Press, 2001)

Contact:  Martin Wolf

Failure of the Suspension of Disbelief

"I am sorry," says Ann Marie. "I can't find this movie credible."

We are watching The Shawshank Redemption.

"These people are in prison in Maine, right? Maine. M-A-I-N-E. Does a single one of them talk like anyone from Maine? No. They all talk like they're from LA, or New York, or Alabama. If you want me to believe a movie is set in Maine, have people talk like people do in Maine."

She has a point. Why does nobody ever do a true down-east accent in this movie? Do they just not care? Is it too hard?

"I haven't seen anything like this since they cast Julia Roberts as a second-generation Portuguese-American from an immigrant family in Mystic Pizza."

More From Civilization: Democracy Is Way Too Hard!

"Dad?"

"Yes?"

"Democracy is way too hard!"

"Yeah! Democracy is way too hard!" It is the twelve-year-old and the nine-year-old, speaking in chorus from the back seat.

"In democracy, when you move one military unit out of its home city two people become unhappy," says the nine-year-old.

"And if you don't spend a complete and total fortune on entertainment and luxuries, your people riot," says twelve-year-old.

"It's impossible to wage an aggressive campaign of conquest," says the nine-year-old. "They force you to make peace prematurely."

"But aren't your people much more productive? Aren't people richer? isn't scientific progress faster? Isn't total production much, much higher?" I ask.

"Yes. But what good is that if I want to conquer the world?" asks the nine-year-old.

"Remember. Civilization is not just a war game. It's a peace game too. You can win by creating a great and peaceful civilization," I say.

"Not if another civilization on earth happens to be led by Genghis Khan and possesses nuclear weapons," says the twelve-year-old.

"You're looking at it from the wrong perspective," I say, changing the subject, hoping to distract my children from the moral question--unsuitable for Berkeley--of whether it is possible for a preemptive war waged with nuclear weapons to be a "just cause." (Answer: when faced with the version of Genghis Khan inside the Civilization program, yes.)

"What do you mean?" says the nine-year-old.

"You're thinking that the people exist to serve the government--especially if the government wants to engage in world conquest. But the founders of America thought--especially Thomas Jefferson thought--Thomas Jefferson thought it was so true as to need no argument, to be self-evident." I pause.

"Thought what was true, Dad?" says the twelve-year-old.

"That all people are endowed with rights that no government can take away and that they cannot give away, rights to life, liberty, and the pursuit of happiness. That governments are instituted to secure these rights. And that governments are legitimate only as long as they serve the people by protecting these rights, and only as long as the people think the government is doing a good job. And if the government doesn't--if it drafts all the young men and sends them out to die half a continent away for a war waged for no purpose other than to make the ruler happy that he has conquered another province--then what do you think Jefferson believed the people had a right to do?"

"Aaargh!! Crash!! Chomp!! Arrghh! Riot!! Civil disorder!! Down with the Consul!! Aaarghh" says the nine-year-old.

Well, Jefferson was somewhat more eloquent. But you've got the idea," I said.

"'That whenever any Form of Government becomes destructive of these ends, it is the Right of the People to alter or to abolish it, and to institute new Government, laying its foundation on such principles and organizing its powers in such form, as to them shall seem most likely to effect their Safety and Happiness. Prudence, indeed, will dictate that Governments long established should not be changed for light and transient causes; and accordingly all experience hath shewn, that mankind are more disposed to suffer, while evils are sufferable, than to right themselves by abolishing the forms to which they are accustomed. But when a long train of abuses and usurpations, pursuing invariably the same Object evinces a design to reduce them under absolute Despotism, it is their right, it is their duty, to throw off such Government, and to provide new Guards for their future security.'"

"Dad?" says the twelve-year-old.

"Yes?"

"The Declaration of Independence was written with those strange s's that look like f's, right?"

"Yes."

"So shouldn't you say, '...purfuing invariably the fame Object evinces a defign to reduce them under abfolute Defpotifm...'?"

Really Scary

It's hard to know if this is a fair picture of what went on--and of how ignorant the typical large-corporation board member is. But if it is a fair picture, it's really scary.

Back to School, but This One Is for Top Corporate Officials

September 3, 2002

By ANDREW ROSS SORKIN

HICAGO — The class was not faring well. On its accounting exam the average score was 32 percent. The teacher was particularly exasperated that so many students had missed a multiple-choice question on the meaning of retained earnings.

"Don't tell me that you're on the audit committee and can't tell me what retained earnings are," Roman L. Weil, an accounting professor at the University of Chicago Graduate School of Business, said to the class.

These were no first-year M.B.A. students. They were top executives and board members of some of the nation's largest corporations, at a novel post- Enron boot camp.

About 80 officers and directors from companies including Pfizer, McDonald's, Motorola and Dow Chemical sat through three days of lectures to understand how to do their jobs at a time when far more people are watching them.

Many students came away daunted and frustrated by the overwhelming message in almost every lecture: that the legal landscape is constantly shifting and the liabilities for directors are greater than ever.

"We've got so many unknowns; there are no answers," James Boyd, chairman of Arch Coal Inc., lamented on the last day of class. "And the risk has changed. They are going to hold us to a much higher standard."

The program — the Directors' Consortium — was developed by the Wharton School at the University of Pennsylvania, Stanford Law School and the University of Chicago Graduate School of Business. It focuses on everything from whether notes should be destroyed after board meetings (the answer: usually, but not always), to who qualifies as a financial expert on a board's audit committee under the strict new legislation approved by Congress. (The class members decided that most of them would not qualify, but happily determined that Warren E. Buffett would not either.)

"As I look around the room I'm not sure if this is an executive education program or a support group," said Joseph A. Grundfest, a professor of law at Stanford University who is a former commissioner of the Securities and Exchange Commission and is on the board of the Oracle Corporation. "I feel your pain."

A class on directors' fiduciary duties and legal liabilities focused on the very basic question of whether board members' main responsibility is to shareholders, to all stakeholders or to the chief executive. "To whom do you owe the duty?" asked Richard A. Epstein, a law professor at the University of Chicago. (The class was divided on the answer.)

He told the class to always think about the answer this way: "Who can sue whom for what?"

"The board is like an insurance policy," Mr. Epstein said. "When things are good, you take your money and go to the beach. When there's a crisis, you're working overtime and massively underpaid."

With executives now constantly in the firing line, in front of judges and Congress, part of one class explored how to prepare for a deposition.

"You don't want to volunteer anything," Mr. Epstein said. "You have to have a personality vasectomy." Mr. Grundfest added: "Think slowly. Don't pull a Bill Clinton and ask what the definition of is is."

Henry J. McKinnell Jr., chairman and chief executive of Pfizer, told the class at lunch that at a deposition recently he was asked whether the board minutes, which were purposely kept vague, were accurate. "I had to tell them the truth," he said. "I said, `No. The minutes are not a complete reflection of what went on there.' Our lawyer was going crazy."

At one point, the conversation turned to how to pick an outside lawyer. "The real risk is that if you hire a criminal lawyer, you look guilty," Mr. Grundfest said.

Most of the lectures were about why it is so important to avoid a lawsuit in the first place. Of Arthur Andersen, Mr. Grundfest said: "As soon as it was indicted it lost. They were de facto dead."

Board members were advised to create clear corporate governance policies and always to make decisions collectively to avoid serious liability. "If you want to get in real trouble, make a decision by yourself," Mr. Epstein said. "This kind of misery loves company."

And the professors stressed over and over again to tell the truth.

"If there are ways people in this room go to jail, it's probably through crimes of upholstery — the cover-up will kill you," Mr. Grundfest told the class. He brought up the case in which Martha Stewart is being investigated for insider trading. "She might go to jail because she lied even though she might not have committed insider trading."

Given the greater liability now faced and the greater time commitment required of board members, some students who are members of several boards — while also serving as officials at their own companies — said they expected that they might have to resign from one or two boards. Mr. McKinnell of Pfizer said board members at his company put in about 200 hours of work a year.

David F. Larcker, a professor at Wharton, began his lecture on compensation committees by acknowledging: "Once the public gets finished pointing fingers at the audit committee, the compensation committee is next. This kind of stuff is a public relations nightmare."

He discussed how boards should arrange compensation packages among salary, stock options, restricted stock, benefits and perquisites and other items like severance agreements. Despite dozens of seemingly outlandish compensation arrangements for chief executives, which he displayed on a slide, Mr. Larcker told the class that compensation in corporate America is "nowhere near how out of whack as it is made out to be."

Still, he reminded the class that when interviewing job candidates: "If the first question they ask is `How many country club memberships do I get,' that's probably not the best candidate."

Steven N. Kaplan, a finance and management professor at the University of Chicago School of Business and a board member of Morningstar, and Steven Koch, a vice chairman at Credit Suisse First Boston who conceived the program, taught a class on finance using Enron's balance sheet as a study of bad oversight.

"Look at this," Mr. Kaplan said, pointing to a line on Enron's cash flow statement showing that "changes in components of working capital" shifted from negative $1 billion to positive $1.7 billion in a year. "If you're a board member, there has to be a disconnect."

Mr. Koch also warned the group of tricks bankers use to justify bad deals. "When someone walks in the room and starts yakking about strategic value, you have to ask, `What the heck does that mean?' " Mr. Koch said. "This is a frequent repository for games."

For some students, the three-day program was more than enough. But others, like Terry L. Savage, a board member of McDonald's and Pennzoil, wanted even more. At the end of the accounting class, she raced up to Mr. Weil, the professor, and asked whether she could take his accounting class on Monday evenings to brush up. "After 11 years on the compensation committee and now going on the audit committee, I decided to make it a major project to become informed about the issues and the mathematics," she said.

Perhaps some other students should have shown her enthusiasm. While the average score for the accounting test was 32 percent, that question on retained earnings — undistributed earnings that have not been paid out to stockholders or transferred to a surplus account — was answered correctly by fewer than 20 percent.

The Trackback List Keeps Growing

The whole point of this entry is to provide a trackback ping for this weblog.

Europe's Economic Policy Dilemmas

Here Morgan Stanley's Eric Chaney gives his take on western Europe's current fiscal policy dilemma. Given that the European economies are on the edge of recession, it makes neither economic nor political sense for them to cut their short-run budget deficits. But neither the "Stability and Growth Pact" nor the discourse about European fiscal policy allows one to try what the Clinton administration wanted to try in 1993--a larger deficit now coupled with lots of planned reduction in the deficit in the future.

Morgan Stanley: Euroland: The Arithmetic and Politics of Fiscal Policies - Part I

The European Monetary Union is going through its first real time crisis earlier than we had expected.  As catastrophic floods continue to ravage and take a heavy human toll in Germany  --but also in the Czech Republic and Russia-- the governments of several EMU countries are sandwiched between high budget deficits, tax receipt shortfalls, the need to find money for relief funds, and the Maastricht Treaty requirements.  In Germany, France and Italy, the tax cut programs previously scheduled for 2003 are discussed, if not already jeopardized.  The relevance of the Stability Pact is questioned, openly in France and Italy, more implicitly in Germany  --through proposals such as spending Bundesbank's profits on relief and reconstruction.

The conjunction of the global economic slowdown resulting from the burst of the technology bubble and of a large-scale natural disaster will force European leaders to take painful decisions, I think.  For the time being, most of them are trying to buy time, but with the imminent opening of the budget season, this option will soon be debarred.  In this forum, we review the current fiscal position of EMU countries and assess the risk of seeing one of the 'Big Three' crossing the forbidden line, i.e. showing a deficit higher than 3% of GDP. We find that this risk is not negligible.  Then, in a second part to come later, we will try to figure out how EMU policy makers could solve their fiscal puzzle, if economic growth were to disappoint again next year.

Fiscal lenience in fat years, headaches in scanty ones

EMU countries now in trouble, Portugal, Germany, France and Italy, would not be in such tight a corner if they had trimmed public spending during the fat years that started in 1997, once the uncertainties surrounding the launch of the euro were lifted, and culminated in 2000, when Europe was carried away by the great technology bubble.  Over the 1998-2000 period GDP growth cruised at 3.0% per year on average, one full point above the 1991-2000 average.  Government balances improved, of course, as a by-product of above trend growth in national income and thus in tax revenues.  Using a simple rule of thumb, based on a widely accepted budget balance sensitivity to the cycle (0.5), it appears that the positive effect of the business cycle reduced aggregate government deficit of EMU countries by 1.1% of GDP over the 1998-2001 period.  This happens to be exactly the actual reduction of deficits, no more, no less .  Clearly, cyclical improvements were not sufficient to cope with the next slowdown, however unexpected it was.  Two years of sub-par growth  --GDP was up only 1.2% on average over 2001 and 2002-- pushed deficits close to the 3% red line in each of the Big Three.

Is there a risk of a large country crossing the line this year?

Where do we go from there?  The arithmetic of fiscal balances is relatively simple, on a qualitative basis at least: if GDP grows below trend, then government balances would deteriorate, other things being equal.  Our in house fiscal policy expert Vincenzo Guzzo has computed that a delayed recovery that would limit EMU growth to 0.7% this year (our current estimate being 0.9%) would force governments to cut spending and/or raise taxes in order to contain deficits within the 3% cap .  But the occurrence of a natural disaster was not discounted in Vincenzo's calculations.  According to some German experts, the total cost of repairing the damages of the floods could be as high as 15 bn euros or 0.75% of GDP.  Of course, these enormous sums will not be spent over the next few months, and will be spread over quarters, if not years.  Even so, my colleague Elga Bartsch tells me that it will be difficult to keep the German deficit safely below 3% of GDP this year.  I fully concur with Elga's analysis, which stresses the importance of financial stability for the German public, and concludes that the current government is ready to take the boldest decisions in order to keep the deficit below the water line.  The fact that, according to opinion polls, Germans backed Chancellor Schroeder when he announced that the tax cuts scheduled for 2003 would be postponed to help finance the relief fund shows the correctness of my colleague's views.  That said, if Bavarian PM Stoiber becomes the next German chancellor and finds that government's coffers are empty, he might be less inclined to close 2002 books with a shortfall not exceeding 'Drei Komma Null', to quote a famous word from the inventor of the Stability pact, Theo Waigel.

Turning to Italy, Vincenzo Guzzo is definitely more pessimistic than the Italian government and also the street consensus regarding this year shortfall.  On Vincenzo's careful estimates, the Italian deficit will rise to at least 2.2% of GDP, with risks as high as 2.6%, if tax collection figures do not improve significantly later this year.  In France, where PM Raffarin just announced that the 2003 budget will not be disclosed before September the 25th -the very extreme limit allowed for by the Constitution-- Christel Rendu de Lint considers that the 2.7% of GDP estimate resulting from the audit on public finances ordered by the government in the aftermath of May-June elections is still a fair estimate.  However, as Christel pointed out recently ('Walking on the Edge', 30 August, 2002), downside risks to our short-term business cycle are tilted on the downside, and so are tax revenues estimates.

Cutting the 3% line in 2002: a possibility, not (yet) a probability

On balance, I think that the risk of seeing one of the three large countries breaching the 3.0% line this year has become significant, Germany being the main risk factor, at this stage.  A few months ago, Vincenzo and I had the opportunity to meet with one of the key budget ministers of the euro zone.  Showing a refreshing candor during our meeting, probably because of his strong academic background, this gentleman told us in essence that he felt comfortable about his budget forecasts, but that the uncertainty surrounding budget figures was higher than most people thought.  Just as GDP data are subject to considerable revisions over time, preliminary budget figures are fragile, because of the large number of institutions included in the 'general government' perimeter.  With each one of the Big Three walking dangerously close to the red line, these words of wisdom now sound like warnings.

Keep this in mind: even if end-of-year figures look fine, it remains possible that, later on, typically in April-May, more detailed data show that they were not.  Without knowing it, we might well be already on track for a breach of the sacrosanct 3% line.

In the second part of this forum, we will investigate what could happen to the European fiscal landscape if the global and European recoveries were delayed. In particular, we will survey the fiscal policy options left to governments of the Big Three.

In the Shadow of the Grand Tetons

Richard Berner from Morgan Stanley gives his take on the conversation at last weekend's Federal Reserve Jackson Hole symposium (sponsored by the Federal Reserve Bank of Kansas City).

From my perspective, the strangest and most worrisome thing about his report of the conversation is the "European" belief that interest rates have to stay high to promote the "liquidation" of potentially bankrupt enterprises.

This is not a strong current of thought in America (save, perhaps, for the pages of the New Republic):

...Few U.S. monetary policymakers fret that low interest rates will forestall corporate downsizing, because they believe that U.S. financial markets are appropriately denying capital to those sectors where gluts are biggest, or giving it to new management who will clean house. On the contrary, some officials worry that Corporate America is hesitant to hire. So while they are guardedly optimistic, they seemed more open-minded about the need for additional stimulus than recent press commentary had suggested. All agreed that the U.S. economy's resilience in the face of financial shocks was comforting, but no guarantee that it would persist.... With oil prices meaningfully higher than we forecast, I share their concern that fourth-quarter growth could zigzag back toward 2%. Such a sluggish pace might not prevent growing economic slack, dropping inflation another notch, and thus raising real short-term interest rates, a development the Fed wants to avoid. As a result, and despite the oft-expressed notion that the Fed is running out of basis points, further ease is certainly possible before year end...

But elsewhere:

...The contrast between the U.S. views and those of Japanese and European policymakers could not have been starker.... [D]espite obvious signs of a faltering European economy, many European central bankers suggested that inflation was too high to permit further monetary ease. Both are worried that too easy a monetary policy will keep 'zombie' firms in business or slow the pace of restructuring and thus ironically promote deflation. In other words, while American policymakers want to make sure real short-term rates are low enough to sustain a recovery in demand, their Japanese and European counterparts want to make sure that low real short-term rates do not sustain excessive supply...

The argument--a subclass of the Hayekian 'overinvestment' argument--seems to go as follows: The big thing wrong with the first-world economies today is that there are a lot of businesses that are pursuing fatally-flawed business plans. These businesses are fundamentally bankrupt. They need to be 'liquidated' so that the workers and the equipment and the buildings they use can be redeployed to value-adding rather than value-subtracting activities. The sooner they are liquidated, the better. And low interest rates that allow them to borrow cheaply give them extra months or years of life.

Better (according to this theory) to keep interest rates relatively high and force bankruptcy early, so that the process of redeployment can commence.

This argument has always seemed totally screw-loose to me. Yes, the market for corporate control needs to work to push businesses out of value-subtracting and into value-adding activities. But if your bankers are half-competent, they won't lend to companies that need to be 'liquidated'. If your bond buyers are half-competent, they won't buy the bonds of companies that are bad long-term bets. In a well-functioning financial market, what chokes off capital to sectors where it would be harmful isn't a high overall level of interest rates, but high industry premia, risk premia, default premia, management-incompetence premia--things that make interest rates high enough that it isn't worth it for companies that want to gamble for resurrection by borrowing to do so. In cases where there is a government guarantee out there (savings and loans, anyone?) things are more complicated. But corporate restructuring is enforced by bond market and bank loan premia over the government borrowing rates, not by a high government borrowing rate.

So it seems to me that the "European" case makes no sense at all--unless what the European central bankers are saying is that their bond buyers and their bank loan officers are, as a group, totally and completely incompetent at their jobs.

Morgan Stanley

United States: The Message from Jackson Hole

Richard Berner (New York)

The Grand Tetons' majestic beauty once again seemed to overwhelm concerns about monetary policy or the state of the global economy at the Kansas City Federal Reserve's annual Monetary Policy Symposium this weekend in Jackson Hole, Wyoming.  This venue unfailingly provides a relaxed backdrop in which to debate and reflect on characteristically sweeping issues like "Rethinking Stabilization Policy," this year's timely topic.

At issue in the formal discussion was the extent to which officials should use macroeconomic policies to smooth the business cycle.  Unlike recent years, when financial crises or the global economic slump dominated headlines, no immediate crisis stalked the proceedings this time.  But discussions over meals, in the halls and on the mountains always came back to the nagging uncertainty surrounding the sluggish global backdrop and what to do about it.  The issue was not whether to use counter-cyclical policy but how aggressively, and whether monetary and fiscal stimulus might be ineffective in a post-bubble, low-inflation world.  In my view, no one had the answer.  Importantly, despite enjoying better economic performance, U.S. policymakers ironically seemed to be more alert to the asymmetric nature of today's downside risks than were their overseas counterparts.

Fed Chairman Greenspan's introductory remarks at the conference are widely and correctly seen as a defense of the Fed's inaction in the 1990s in the face of rising concerns about a stock market bubble.  As my colleague David Greenlaw noted last week, Greenspan does not think that monetary policy is an effective tool to combat a bubble.  He offers two reasons for this.  First, bubbles are difficult, if not impossible, to "definitively" recognize until after the fact. Second, even if policymakers could effectively identify bubbles, there is no way to deflate them without inducing a "substantial contraction in economic activity."  Greenspan points out that through the course of the 1990's, Fed tightening was often associated with rising stock prices.  Policymakers would have had to raise rates much more aggressively to pop the bubble and this could, in itself, trigger precisely the type of negative impact on the economy that the Fed was trying to avoid.

Far from silencing his critics, the Chairman's defense has spurred a new torrent of invective, not least because his own testimony in July 1999 clearly outlined the risks of allowing a bubble to proceed.  But for me, it is time to move on, and Greenspan's remarks further underscored the dilemmas and difficult choices policymakers around the world now face in offsetting the fallout from the bubble's demise.

One is the mirror image of Greenspan's uncertainty about how high rates would have to rise to preempt a bubble: By how much should rates fall and will they be effective to offset the economic headwinds resulting from the bubble's collapse in a low-inflation world?  Among the headwinds: Negative wealth effects, the disincentives to invest, and aftershocks such as investor uncertainty over corporate governance and financial reporting.  Another, related to the first, is what I call Feldman's dilemma, after my colleague Robert Feldman: Will easy money prolong needed corporate downsizing and thus intensify dis- or de-flationary forces fostered by a bubble-induced investment boom (see "The Fed's Wrong Lessons From Japan," Global Economic Forum, August 8, 2002)?  The discussion unmasked worlds of difference between the views of U.S. and overseas participants on these issues and on economic risks.

Few U.S. monetary policymakers fret that low interest rates will forestall corporate downsizing, because they believe that U.S. financial markets are appropriately denying capital to those sectors where gluts are biggest, or giving it to new management who will clean house.  On the contrary, some officials worry that Corporate America is hesitant to hire.  So while they are guardedly optimistic, they seemed more open-minded about the need for additional stimulus than recent press commentary had suggested.  All agreed that the U.S. economy's resilience in the face of financial shocks was comforting, but no guarantee that it would persist.  Incoming data also were reassuring: We estimate that the July surge in consumer spending and the rebound in durable goods orders and deliveries likely will lift third-quarter growth above 3%.

However, some officials believe that without follow-through from job growth, the July pickup may be short-lived.  With oil prices meaningfully higher than we forecast, I share their concern that fourth-quarter growth could zigzag back toward 2%.  Such a sluggish pace might not prevent growing economic slack, dropping inflation another notch, and thus raising real short-term interest rates, a development the Fed wants to avoid.  As a result, and despite the oft-expressed notion that the Fed is running out of basis points, further ease is certainly possible before year end.

The contrast between the U.S. views and those of Japanese and European policymakers could not have been starker.  For their part, Japanese policymakers suffered a new barrage of criticism and advice, but seemed resigned to persistent deflation.  For example, Bank of Japan Deputy Governor Yamaguchi said "We've practically used up all our options" for conventional instruments of monetary policy, although he was willing to consider 'unconventional' tools.  And despite obvious signs of a faltering European economy, many European central bankers suggested that inflation was too high to permit further monetary ease.  Both are worried that too easy a monetary policy will keep 'zombie' firms in business or slow the pace of restructuring and thus ironically promote deflation.  In other words, while American policymakers want to make sure real short-term rates are low enough to sustain a recovery in demand, their Japanese and European counterparts want to make sure that low real short-term rates do not sustain excessive supply.

These radically different views of the world could reflect, perhaps appropriately, differences in the functioning of the U.S., Japanese and European economies.  More likely, they reflect big differences between policymakers here and abroad about the commitment required to combat this highly unusual business cycle, one for which Fed Chairman Greenspan said "only history books and musty archives gave us clues to the appropriate stance for policy."

In that context, one paper presented at the conference may have been the most thought-provoking about the real lessons from past business cycle experience.  Christina and David Romer argued that policy mistakes in the 1970s resulted from uncertainty over how the economy then worked.  In my view, how the fiscal and oil shocks of the 1960s and 1970s changed that understanding and how to respond to those shocks were also a big part of those mistakes.  Likewise, the bubble of the 1990s changed the functioning of different regions in the global economy and the interplay among them in ways policymakers and investors are only now coming to understand.  Just as in the 1970s, therefore, the scope for policy mistakes now is high.  Whether policymakers are vigilant in responding to further aftershocks from the bubble's demise will likely determine whether consumers, businesses and investors regain faith in recovery or become even more resigned to subpar economic and financial performance.  To the extent that European and Japanese policymakers are more cautious than their American counterparts in this setting, the U.S.-overseas performance gap could widen for some time to come.

Fareed Zakaria Thinks the Islamic Fundamentalist Moment Has Passed

Fareed Zakaria argues that the Islamic Fundamentalists' moment has passed--that people recognize that "Islamic fundamentalism has no real answers to the problems of the modern world; it has only fantasies." But he also thinks that "the new generation is just as angry, rebellious and bitter" as "he youth of the 1970s and 1980s, who came from villages into cities and took up Islam as a security blanket."

This, however, does not necessarily seem to me to be good news. If they are "angry, rebellious, and bitter," what do they think that they should do?

washingtonpost.com: The Extremists Are Losing: ...Compare the landscape a decade ago. In Algeria, Islamic fundamentalists, having won an election, were poised to take control of the country. In Turkey, an Islamist political party was soon to come to power. In Egypt, Hosni Mubarak's regime was terrorized by groups that had effectively shut down the country to foreign tourists. In Pakistan, the mullahs had scared Parliament into enacting blasphemy laws. Only a few years earlier, Iran's Ayatollah Khomeini had issued his fatwa against the novelist Salman Rushdie, who was still living under armed guard in a secret location.

Throughout the Arab world, much of the talk was about political Islam -- how to set up an Islamic state, implement Islamic law and practice Islamic banking. Look at these countries now. In Iran, the mullahs still reign but are despised. The governments of Algeria, Egypt, Turkey and (to a lesser extent) Pakistan have all crushed their Islamic groups. Many feared that, as a result, the fundamentalists would become martyrs. In fact, they have had to scramble to survive. In Turkey, the Islamists are now liberals who want to move the country into the European Union. In Algeria, Egypt and elsewhere they are a diminished lot, many of them reexamining their strategy of terror. If the governments bring them into the system, they will go from being mystical figures to local politicians.

Many Islamic groups are lying low; many will still attempt terrorism. But how can a political movement achieve its goals if none dares speak its name? A revolution, especially a transnational one, needs ideologues, pamphlets and party lines to articulate its message to the world. It needs politicians willing to embrace its cause. The Islamic radicals are quiet about their cause for a simple reason. Fewer and fewer people are buying it.

Don't get me wrong. This doesn't mean that people in the Middle East are happy with their regimes or approve of American foreign policy, or that they have come to accept Israel. All these tensions remain strong. But people have stopped looking at Islamic fundamentalism as their salvation. The youth of the 1970s and 1980s, who came from villages into cities and took up Islam as a security blanket, are passing into middle age. The new generation is just as angry, rebellious and bitter. But today's youth grew up in cities and towns, watch Western television shows, buy consumer products and have relatives living in the West. The Taliban holds no allure for them. Most ordinary people have realized that Islamic fundamentalism has no real answers to the problems of the modern world; it has only fantasies...

The Extremists Are Losing

By Fareed Zakaria

Tuesday, September 3, 2002; Page A17

In one of his legendary moments of brilliance, Sherlock Holmes pointed the attention of the police to the curious behavior of a dog on the night of the murder. The baffled police inspector pointed out that the dog had been silent during the night. "That was the curious incident," explained Holmes. Looking back over the past year, I am reminded of that story because the most important event that has taken place has been a non-event. Ever since that terrible day in September 2001, we have all been watching, waiting and listening for the angry voice of Islamic fundamentalism to rip through the Arab and Islamic world. But instead there has been . . . silence. The dog has not barked.

The health of al Qaeda is a separate matter. Osama bin Laden's organization may be in trouble, but -- more likely -- it may be lying low, plotting in the shadows. In the past it has waited for several years after an operation before staging the next one. Al Qaeda, however, is a band of fanatics, numbering in the thousands. It seeks a much broader following. That, after all, was the point of the attacks of Sept. 11. Bin Laden had hoped that by these spectacular feats of terror he would energize radical movements across the Islamic world. But in the past year it has been difficult to find a major Muslim politician or party or publication that has championed his ideas. In fact, the heated protests over Israel's recent military offensives and American "unilateralism" have obscured the fact that over the past year the fundamentalists have been quiet and in retreat. Radical political Islam -- which had grown in force and fury ever since the Iranian revolution of 1979 -- has peaked.

Compare the landscape a decade ago. In Algeria, Islamic fundamentalists, having won an election, were poised to take control of the country. In Turkey, an Islamist political party was soon to come to power. In Egypt, Hosni Mubarak's regime was terrorized by groups that had effectively shut down the country to foreign tourists. In Pakistan, the mullahs had scared Parliament into enacting blasphemy laws. Only a few years earlier, Iran's Ayatollah Khomeini had issued his fatwa against the novelist Salman Rushdie, who was still living under armed guard in a secret location. Throughout the Arab world, much of the talk was about political Islam -- how to set up an Islamic state, implement Islamic law and practice Islamic banking.

Look at these countries now. In Iran, the mullahs still reign but are despised. The governments of Algeria, Egypt, Turkey and (to a lesser extent) Pakistan have all crushed their Islamic groups. Many feared that, as a result, the fundamentalists would become martyrs. In fact, they have had to scramble to survive. In Turkey, the Islamists are now liberals who want to move the country into the European Union. In Algeria, Egypt and elsewhere they are a diminished lot, many of them reexamining their strategy of terror. If the governments bring them into the system, they will go from being mystical figures to local politicians.

Many Islamic groups are lying low; many will still attempt terrorism. But how can a political movement achieve its goals if none dares speak its name? A revolution, especially a transnational one, needs ideologues, pamphlets and party lines to articulate its message to the world. It needs politicians willing to embrace its cause. The Islamic radicals are quiet about their cause for a simple reason. Fewer and fewer people are buying it.

Don't get me wrong. This doesn't mean that people in the Middle East are happy with their regimes or approve of American foreign policy, or that they have come to accept Israel. All these tensions remain strong. But people have stopped looking at Islamic fundamentalism as their salvation. The youth of the 1970s and 1980s, who came from villages into cities and took up Islam as a security blanket, are passing into middle age. The new generation is just as angry, rebellious and bitter. But today's youth grew up in cities and towns, watch Western television shows, buy consumer products and have relatives living in the West. The Taliban holds no allure for them. Most ordinary people have realized that Islamic fundamentalism has no real answers to the problems of the modern world; it has only fantasies. They don't want to replace Western modernity; they want to combine it with Islam.

Alas, none of this will mean the end of our troubles. The Arab world remains a region on the boil. Its demographic, political, economic and social problems are immense and will probably bubble over. Outside the Middle East, in places like Indonesia, the fundamentalists are not yet stale. But you need a compelling ideology to turn frustration into sustained, effective action. After all, Africa has many problems. Yet it is not a mortal threat to the West.

Nor does it mean, alas, the end of terrorism. As they lose political appeal, revolutionary movements often turn more violent. The French scholar Gilles Kepel, who documents the failure of political Islam in his excellent book "Jihad," makes a comparison to communism. It was in the 1960s, after communism had lost any possible appeal to ordinary people -- after the revelations about Stalin's brutality, after the invasion of Hungary, as its economic model was decaying -- that communist radicals turned to terror. They became members of the Red Brigades, the Stern Gang, the Naxalites, the Shining Path. Having given up on winning the hearts of people, they hoped that violence would intimidate people into fearing them. That is where radical political Islam is today.

For America this means that there is no reason to be gloomy. History is not on the side of the mullahs. If the terrorists are defeated and the fundamentalists are challenged, they will wither. The West must do its part, but above all, moderate Muslims must do theirs. It also means that the cause of reforming the Arab world is not as hopeless as it looks today. We do not confront a region with a powerful alternative to Western ideas, just a place riddled with problems. If these problems are addressed -- if its regimes become less repressive, if they reform their economies -- the region will, over time, stop breeding terrorists and fanatics. The Japanese once practiced suicide bombing. Now they make computer games.

It might be difficult to see the light from where we are now, still deep in a war against terrorists, with new cells cropping up, new forms of terror multiplying and new methods to spread venomous doctrines. But at his core, the enemy is deadly ill. "This is not the end," as Winston Churchill said in 1942. "It is not even the beginning of the end. But it is the end of the beginning."

The writer is editor of Newsweek International and a columnist for Newsweek.

The Post-Canine Condition

The Register: Bark twice for bear - hunting dogs get mobile phones. By John LetticePosted: 22/08/2002 at 09:59 GMT.

Some while back, when the times were still good, Nokia was happily predicting that the reason mobile phone sales would continue to grow was because people would have several apiece. You know, the cool one for clubbing, the chunkier one for email, the waterproof one for scuba-diving... Well that all turns out to be far too unimaginative - why the blazes stop at people?

The fiendish Fins (who else) at Benefon have developed mobile phones for dogs, and aparently convinced at least one vertical market that there's a compelling use for them. It's part of a co-development effort with Pointer, which makes tracking devices for hunting dogs, and it combines GSM and GPS, so you know where your dog is. But um, why are you phoning it?

Well, you're telling it what to do, for starters, and (we really find this bit difficult to believe, but it's August) you can tell what kind of animal the hound's onto by its bark. We presume that if the dog's phoned you, then the phone has to be woof-activated. Big sales for it in September, when the Fins start going after elk.

We can't seem to find any English language data on this at the Benefon site, and although it appears to us this story was first broken by AP, we can't find an English version of that either. But over at Yahoo! you'll find a German version, and the magpies over at the Press Association have an English version here...

Ari Fleischer: Chocolate Is Vanilla

ABC News's The Note says that the press is getting tired of being told that black-is-white and chocolate-is-vanilla by Ari Fleischer. I'm not sure that the general press is, but it's clear that The Note is getting tired of it:

ABCNEWS.com : Political News Summary: Home Stretch (September 3, 2002): The sidebar story on this topic today is Ari Fleischer's chocolate-is-vanilla insistence yesterday that the Vice President and the Secretary of State are of a like mind on Iraq. This goes right to the credibility of the administration. The Bush team has always had a credibility problem with some reporters because of their insistence on saying "up is down" and "black is white." While the public doesn't necessarily see or pay attention to all of this, there has been a corrosive effect on the filter through which media and political elites view Administration statements and actions. The Brent Bozells of the world would like to see this as simply liberal media bias, but there are plenty of people on the right who will at least quietly agree they share this view, based on past Bush decisions such as steel tariffs...

The Care and Feeding of Redwoods

"Look." says Ann Marie. "Those redwoods have a huge amount of brown on them too."

We are in Tilden Park, just east of Berkeley, just over the first range of hills separating us from the Pacific Ocean. And the redwood trees do, indeed, have a lot of brown--a lot of dead branches--maybe one in ten branches is dead.

We worry about this because the builder and previous owner of our house planted some twenty-five redwood trees on the property about eighteen years ago. Some of these guys are now huge--seventy feet tall. On is dead: it grew to twenty feet and then joined the choir invisible. The rest are of varying heights (but fifty feet is a good guess as an average).

The problem is that this isn't redwood tree habitat: the last redwood tree grew here at least twelve thousand years ago. It gets very dry: it doesn't rain at all from May to November, our creek dries up by the end of June, and the spring at the northeast end of our property is now turning into a patch of damp mud, and will stay that way until the winter rains come.

And so, in the summer, large parts of our redwoods turn brown. Should we water them? I've been told that a full-grown redwood sucks up and respires 50 gallons of water a day.

What Ann Marie is telling me is that this is a common disease of Bay Area redwoods in the summer. It's true that these trees aren't healthy--and in a full-fledged Darwinian contest they probably wouldn't do too well. But we've put our thumbs on the scale because we like the way they look. Hence the extension of the coast redwood range to places like Tilden Park, and my front yard.

Mozambique's Cashew Exports

Margaret McMillan, Dani Rodrik, and Karen Horn Welch take a look at trade cause celebre of the 1990s: Mozambique's cashew exports. This is important because they are trustworthy--and virtually no one else with a loud opinion on this is.

Unfortunately, I haven't been able to do anything other than skim it yet, but here's the abstract and the introduction:

When Economic Reform Goes Wrong: Cashews in Mozambique

by Margaret McMillan, Dani Rodrik, Karen Horn Welch. NBER Working Paper No. w9117. Issued in August 2002

Abstract:

Mozambique liberalized its cashew sector in the early 1990s in response to pressure from the World Bank. Opponents of the reform have argued that the policy did little to benefit poor cashew farmers while bankrupting factories in urban areas. Using a welfare-theoretic framework, we analyze the available evidence and provide an accounting of the distributional and efficiency consequences of the reform. We estimate that the direct benefits from reducing restrictions on raw cashew exports were of the order $6.6 million annually, or about 0.14% of Mozambique GDP. However, these benefits were largely offset by the costs of unemployment in the urban areas. The net gain to farmers was probably no greater than $5.3 million, or $5.30 per year for the average cashew-growing household. Inadequate attention to economic structure and to political economy seems to account for these disappointing outcomes...

INTRODUCTION

In a case that has become a cause celebre for the anti-globalization movement, the World Bank prevailed on Mozambique’s government in the early 1990s to liberalize the cashew sector and to remove restrictions on exports of raw cashews. The Bank hoped that resources would be allocated more efficiently and the incomes of cashew farmers would be boosted. The policy was met with fierce opposition from the domestic cashew-processing industry, which ironically had just been privatized. After a decade of political strife, international controversy, and ongoing if hesitant reform, the consequences remain hotly contested. Each side in the debate has its favorite statistics: the World Bank points to the rise in farmgate prices, while its opponents point to the processing plants in urban areas which have been shut down and the thousands of workers that remain unemployed.

Historically, the cashew sector has constituted a significant part of Mozambique’s economy, providing income to several million individuals across the country. In the 1960s, Mozambique produced as much as half of the world’s total. The sector went into a long decline thereafter, as a combination of adverse policies and civil war (1982-1992) brought new tree plantings to a halt. Following independence in 1975, the government had banned the export of raw cashew nuts to stimulate domestic processing. Mozambique became the first African country to process cashews on a large scale. By 1980, the country had 14 processing factories. Following World Bank advice, the government began to loosen restrictions on raw cashew production in the late 1980s. The ban on exporting raw cashews was lifted in 1991/92 and replaced with an export quota and export tax. The quota was subsequently removed, and the export tax on raw nuts came down from 60% in 1991/92 to 14% in 1998/99.

From the vantage point of textbook economics, the analysis of the export restriction and its removal is a straightforward exercise. A ban (or tax) on exports depresses the domestic price of raw cashews, effectively subsidizing the domestic processors for whom raw cashews is the chief input. The policy results in an inefficient allocation of resources: raw cashew production is discouraged, and labor and capital are pulled into cashew processing where, absent externalities, their social value marginal product is lower than in other activities. The relaxation of the restrictions is therefore expected to create a double benefit. First, an efficiency gain, arising from the reversal of the adverse resource pulls mentioned above. And second, a distributional gain, resulting from the rise in farmgate prices for the poorest households in Mozambique. This is the sort of analysis that underlies, for example, Paul Krugman’s (2000) New York Times column on the subject, which took the anti-World Bank crowd to task for overlooking the propoor bias of the export liberalization.

As we shall show in this paper, many of the textbook implications of export liberalization were indeed realized. Farmgate prices rose, raw cashew exports increased, and resources were pulled out of cashew processing. However, even under the most favorable assumptions, the magnitude of the benefits generated by these effects were quite small—both in economic terms and in relation to the amount of time and energy that Mozambique’s government spent on this question over the years. We estimate that the efficiency gains generated by the removal of the export restrictions could not have amounted to more than $6.6 million annually, or about 0.14% of Mozambique GDP. The additional income accruing to the farmers was probably no greater than $5.3 million, or $5.30 per year for the average cashew-growing household. These are puny amounts for a policy that was a key plank in the World Bank’s reform agenda, and that became a serious bone of contention between the Bank and Mozambique, requiring the personal attention of both of their presidents.

Moreover, small as they are, these numbers overstate the benefits involved. The standard gains from the liberalization have to be set against the efficiency losses that have resulted from the idling of processing plants. In theory, the workers employed in these plants should have found alternative sources of employment after a reasonable time, perhaps suffering some wage losses in the process. In reality, a large number seems to have remained unemployed, perhaps because of the expectation that the liberalization would be eventually reversed. One account claims that 90% of the sector’s 11,000 workers were unemployed in 2001. Even if we take a fraction of this number, the loss in real output (equivalently, loss of real income of workers) that is involved is of the order of $6.1 million, or 0.12% of GDP. Note that this amount is roughly equivalent to the direct efficiency gain generated by the liberalization (as noted above). In all likelihood, therefore, the aggregate static gains produced by the liberalization were a wash. These disappointing outcomes are due in part to wrinkles that the textbook analysis sets aside. First, there are complications that arise from imperfect market structures. We highlight two of those in the analysis below. Domestically, there are several layers of intermediaries that separate cashew farmers from the export trade, creating a situation analogous to doublemarginalization in the analysis of vertical relationships in industrial organization. The chief implication of this is that we cannot expect increases in export prices to be passed one-for-one on to the farmers. The pass-through coefficient is much smaller than unity—more of the order of 40-50%--reducing the gains that accrue to the poorest households. In other words, traders capture much of the benefits from the liberalization. Externally, we have the complication that the world market for raw cashew is significantly less competitive than that for processed cashew. In effect, India is a monopsony buyer of raw cashew from Mozambique. Mozambique’s transformation from an exporter of processed cashews to an exporter of raw cashews can be expected therefore to produce a terms-of-trade loss for the country, which diminishes both the efficiency and distributional gains from liberalization.

The real hope for the liberalization strategy might, and should, have been placed on the dynamic effects. We emphasize two dynamic consequences in particular. First, the liberalization could have reinvigorated the rural sector over the medium- and long-run by reversing the dramatic collapse in cashew tree planting. Second, in the urban sector it could have heralded a restructuring of production by promoting a more rational investment pattern. The key in both instances was a credible commitment to a new pricing regime—possibly complemented with compensatory programs—that would have made it worthwhile for farmers, entrepreneurs, and workers to undertake investments that would be at least in part irreversible. The main failing of the cashew liberalization policy, in our view, was that it did not send sufficiently credible signals about the pricing regime. The result was that farmers refused to plant trees, cashew processors refused to take their resources elsewhere, and urban workers refused to look for other jobs. Had these adjustments taken place instead, the static losses would have been minimized, while the efficiency gains would have grown over time.

The Mozambique cashew story illustrates several themes that have become increasingly central in the analysis of reform. One theme has to do with the importance of credibility and the need for expectations management. The supply responses that will make reform successful are likely to be forthcoming only when there is sufficient credibility attached to the change in the policy regime. That in turn requires creative thinking on credibility enhancing mechanisms as an integral part of reform. The second theme is that reform is a “political” problem as well as a “technical” one. Had the political opposition of the urban groups been anticipated, or factored in, compensatory mechanisms and side bargains could have been worked out beforehand. Third, policy reform via conditionality is rarely conducive to desirable outcomes. The credibility problems noted above were created in part because the liberalization of the cashew sector was viewed as a “World Bank policy”—something that the government was doing not because it was a priority but because it was required to qualify for World Bank (and IMF) lending. Not having full ownership of the reform, the government was poor at selling it.

There are also implications for the acrimonious turn that the debate on globalization has taken of late. We have little doubt that most of the activists that have attacked the World Bank over its handling of the Mozambique cashew issue have their hearts in the right place. But few have carefully scrutinized the question that one would think they would have been most interested in: are the poorest farmers getting a better price for their product, and are they better off as a result? But the economists are not without blame either. They have relied on a priori generalizations and textbook expositions instead of figuring out what has really transpired on the ground.

Beyond Mozambique are there also implications for the rest of Sub-Saharan Africa (SSA), where 75% of the labor force still depends entirely on agriculture for its livelihood? Recent evidence suggests that—as in Mozambique—the supply response to price liberalization throughout most of SSA has been disappointing (UNCTAD, 1998). Over-reliance on price reforms is likely to be one reason for this. Most policymakers would agree that price and nonprice incentives are both important determinants of supply. In practice however, it is price reforms that have been carried out most often. It is far easier to stop regulating producer prices than it is to remove structural constraints like poor roads, lack of access to credit, or monopsony power on the part of domestic traders. The problem with price reforms is that they can be also reversed with the stroke of a pen. As our analysis of Mozambique suggests, a significant supply response is unlikely unless there is a sharp break in farmers' expectations about the future. Since non-price reforms are harder to reverse, they may be more effective in increasing the expected profitability of investment from the farmers' point of view, thus eliciting the elusive supply response.

The plan of the paper is as follows. Section 2 provides a capsule history of the cashew industry and of recent developments. Section 3 presents an analytical framework and a decomposition of the welfare effects of cashew liberalization into various channels. In section 4, we provide quantitative estimates of the efficiency and distributional implications of the liberalization. Sections 5 and 6 deal with domestic and international market structure complications, respectively. Section 7 focuses on the domestic processing industry and presents estimates of the unemployment loss. Section 8 speculates on the reasons behind the disappointing supply response. Section 9 concludes. A synopsis of the debate surrounding the case is presented in Appendix A.

Science Labs

The Nine-Year-Old and I spent a considerable amount of time yesterday with a Science Kit Minilabs Electric Motor kit. It was harder to assemble than I had thought, largely due to the large size of my fingers coupled with an armature assembly that is only one inch in diameter. The Nine-Year-Old wandered off several times during the 150-fold wrapping of the wire around the armature assembly--a time-consuming and boring part of the assembly of the motor.

But--and here's the remarkable thing--it worked, and worked well, the first time: the D-battery drove the (unloaded) motor at some 600 rpm. The Twelve-Year-Old was impressed. The Nine-Year-Old wondered why so much energy was being dissipated in vibration and noise, and couldn't this energy be trapped and used for something?

I worry, periodically, about the kids and science. The things they deal with are--in so many ways--so far removed from basic scientific principles. You could build an AM crystal radio back when I was a kid. You can't build a DVD player. You could fix a car--change the spark plugs, look at the distributor cap, monkey with the carburetor--when I was a kid. You can't today. I thought it was really neat the first time I used a language like Fortran to have a computer sum up the numbers from 1 to 100. But their experiences with computers are much, much further from the bare metal.

Of course, people 100 years ago were probably complaining that the modern young know nothing about how to gauge the process of steelmaking by the color of the metal and the smell of the slag...

Consequences of European Monetary Union

Back in the years between when the Maastricht Treaty was negotiated and when it was implemented, I would occasionally find an international economist and ask them why European Monetary Union was thought to be a good thing--"For," I would say, "it's hard to think that western Europe is an optimum currency area, in Robert Mundell's sense."

Now comes the Economist with one of its focuses. What is the point of the focus? That western Europe is not an optimum currency area, and that as a result the macroeconomic policy problems of its governments now that EMU is a reality are knotty and difficult--and made more difficult by the fiscal "Stability and Growth Pact."

The Csae for Co-Operating: ...Christopher Allsopp and David Vines of Oxford University, together with Warwick McKibbin of the Australian National University, argue against going it alone. Budget cuts are never painless, but within a monetary union individual cuts can be excruciating. A country with an autonomous monetary policy can offset tighter fiscal policy by expanding credit and devaluing the exchange rate. But in a monetary union, where an individual country can no longer cut interest rates, nothing cushions the blow.

The authors asked what would happen if France were to cut its budget deficit unilaterally, by 2% of GDP. According to their simulation, French output would fall by more than 2%. Prices would fall a bit in France, but across the euro area as a whole they would barely change. So the ECB would have little cause to cut nominal interest rates. As a result, the real rate of interest--nominal rates adjusted for inflation--would actually rise in France. Output would eventually recover, but not before a recession of up to three years.

What if France agreed with the other member states to cut deficits together? Surely, a synchronised contraction would be even more damaging, as each country's recession spilled over into its neighbours' economies. Possibly, the authors acknowledge. Yet, while the ECB might not respond to a slowdown in one country, fiscal austerity in all 12 euro countries would probably force it to cut rates, so bolstering private spending even as government spending falls. A rate cut would also weaken the euro, boosting exports...

AS THE River Elbe burst its banks this month, the German government's budget deficit threatened to breach the limits of the euro area's “stability and growth pact”. The pact prohibits fiscal deficits above 3% of GDP. Except in severe recessions, they can attract a fine of up to 0.5% of GDP. Germany now has a deficit of 2.8%. This week, Gerhard Schröder, Germany's chancellor, delayed popular tax cuts in order to be able to dispense flood aid without violating the pact. With an election coming up, this is a political embarrassment. Portugal, which admits to a fiscal deficit in 2001 of over 4%, already faces the prospect of punishment. Conceivably, France and Italy may also test the limits of the pact before long.

A decade ago, the pact's architects, most of them German, feared that the euro's credibility might be undermined by fiscal laxity among its members. If a government's borrowing becomes unsustainable, its central bank might be forced to bail it out, inflating away the real value of its debts. Such bail-outs are expressly forbidden in the euro area, while the European Central Bank (ECB) enjoys a forbiddingly strong position relative to national-level fiscal authorities.

Prudent or not, the euro area's 12 finance ministers remain accountable for their fiscal choices. If they court insolvency, financial markets will apply a risk premium to the government's bonds, or refuse to lend to them altogether. Why should the European Commission try to police sovereign borrowing when the markets already do so? If anything, monetary union calls for granting more fiscal discretion to national governments, not less. Having ceded monetary policy to the centre, member nations have greater need of fiscal flexibility to cope with problems that afflict them at home.

Germany is a case in point. If it were still in a position to conduct its own monetary policy, interest rates would now almost certainly be lower. Meanwhile, a weak German economy probably needs precisely the kind of tax cuts that Mr Schröder was forced to shelve this week. In other words, the pact's “excessive deficit procedure” looms large at precisely the moment it will do most harm. Germany may yet escape fines, by invoking a special exemption for events beyond its control—observing the letter, if not the spirit of the pact.

The pact may be flawed, but the euro area still has fiscal problems which its members need to address. Between 1990 and 1996, the future euro-area members ran an average deficit of well over 4% of GDP. Stronger economic growth, along with the tough rules of the stability pact, have since forced that figure down, to 1.5% on average. But now that “Maastricht fatigue” may be setting in, those deficits may widen again. Euro-area government debt stands at 72% of GDP, a deal higher than the 60% figure the Maastricht treaty deemed sustainable. Many European governments face hefty pension liabilities in the near future. If Europeans are serious about putting their budgets in order, they will need to undertake long-term fiscal reforms. Is it better that they do so singly, as and when the pact forces them to, or together, as part of a collective effort?

Christopher Allsopp and David Vines of Oxford University, together with Warwick McKibbin of the Australian National University, argue against going it alone*. Budget cuts are never painless, but within a monetary union individual cuts can be excruciating. A country with an autonomous monetary policy can offset tighter fiscal policy by expanding credit and devaluing the exchange rate. But in a monetary union, where an individual country can no longer cut interest rates, nothing cushions the blow.

The authors asked what would happen if France were to cut its budget deficit unilaterally, by 2% of GDP. According to their simulation, French output would fall by more than 2%. Prices would fall a bit in France, but across the euro area as a whole they would barely change. So the ECB would have little cause to cut nominal interest rates. As a result, the real rate of interest—nominal rates adjusted for inflation—would actually rise in France. Output would eventually recover, but not before a recession of up to three years.

What if France agreed with the other member states to cut deficits together? Surely, a synchronised contraction would be even more damaging, as each country's recession spilled over into its neighbours' economies. Possibly, the authors acknowledge. Yet, while the ECB might not respond to a slowdown in one country, fiscal austerity in all 12 euro countries would probably force it to cut rates, so bolstering private spending even as government spending falls. A rate cut would also weaken the euro, boosting exports.

Investors might provide another cushion. Collectively, the euro area accounts for a big share of the demand for global savings. As they reduced their claims on these savings, Europe's governments would take pressure off the world's long-term real interest rates, boosting share prices and “crowding in” private-sector investment.

If fiscal reforms are undertaken jointly, the short-term sacrifices may be surprisingly light, and the long-term benefits may arrive surprisingly early. Such a happy outcome hangs upon pursuing reforms that are both credible and co-operative. It is a pity, then, that Europe's stability and growth pact, as it stands, is neither.

So Where Did the Volume Go?

"Gene Healy's another smart person at Cato," an acquaintance said. "He's making powerful arguments that the Bush Administration must acknowledge Congress's power over war and peace in foreign affairs."

So I went to read what Gene Healy had written. I was expecting considerable volume: I had read a short piece by him on the "executive arrogance" of the Clinton years, calling Clinton's foreign policy:

...shameful... brazen... abuse of executive authority... contempt for constitutional limits ... Nixonian... the cluster-bomb humanitarianism of the war on Serbia...

But the volume turned out to be extremely muted. After all, if Healy really does believe that Clinton's conduct of foreign affairs in Bosnia, Kosovo, Haiti, and Afghanistan was "...shameful... brazen... abuse... contempt," what words must have come to Healy's mind to apply to many aspects of the Bush Administration's conduct of the campaign against terror? Yet somehow none of these words make it into Healy's discourse, which seems rather... milquetoast... by comparison. His arguments may be right--but if it was so important to express them so... forcefully in judging the Clinton Administration, isn't it even more important to express them forcefully today?

War with Iraq: Who Decides?

February 26, 2002

by Gene Healy

Gene Healy is senior editor at the Cato Institute.

With even the usually cautious Secretary of State Colin Powell calling for "regime change" in Baghdad, it's become increasingly clear that Iraq is the next target in the war on terror. According to press accounts, administration officials are drawing up plans for the president's review, examining whether massive U.S. ground forces will be needed, or if instead the Iraqi National Congress can take the place of the Northern Alliance and do most of the fighting on the ground.

It's nice that President Bush is looking at all the military options. But where is it written that one man, the president, gets to decide whether the United States goes to war with Iraq? Not in the Constitution, certainly. The Constitution gives the war power to Congress. In this case Congress has not authorized military action against Iraq. Unless and until Congress does, President Bush must not take such action.

The suggestion that the president should have unilateral power to make war was decisively rejected at the Constitutional Convention of 1787. As delegate Elbridge Gerry of Massachusetts put it, he "never expected to hear in a republic a motion to empower the executive alone to make war." Instead, the Framers agreed that Congress would have the power to declare war.

It's true that the Constitution makes the president the "Commander in Chief" of the US Army and Navy. But as Alexander Hamilton noted in Federalist No. 69, this does no more than make the president the "first General" of America 's armed forces. And generals don't get to decide which countries we go to war with.

In the case of Iraq, Congress has not passed a formal declaration of war, or authorized any military action whatsoever. Even the sweeping Use of Force resolution approved by Congress three days after the attack on the World Trade Center falls short of authorizing military action against Iraq. That resolution would sanction war with Iraq only if it is determined that the Iraqi government "aided" the commission of the terrorist attacks of Sept. 11. The evidence for that proposition seems far weaker than it did in October, when Czech government officials announced that hijacker Mohammed Atta had met with an Iraqi intelligence agent in Prague last April. Recent reports in the New York Times, the Chicago Tribune, and the Czech press have cast doubts on whether that meeting ever occurred.

Others have pointed to the anthrax mailings that alarmed the public in the months following Sept. 11 as a justification for war with Iraq. But despite intense investigation, the U.S. government has not found any evidence linking Iraq to the anthrax attacks. As Director of Homeland Security Tom Ridge put it recently, "based on the investigative work of many agencies, we 're all more inclined to think that the perpetrator is domestic."

Moreover, even if the government unearths evidence that Saddam Hussein supplied the anthrax, Congress would still need to authorize action against Iraq. By its terms, the current Use of Force resolution only approves military action against those nations, organizations or persons involved in "the terrorist attacks that occurred on September 11, 2001." Thus, Congress has not yet authorized a military response to any subsequent terrorist attacks.

Nonetheless, anyone following news accounts of the current debate on Iraq could be forgiven for thinking that President Bush has all the authority he needs to wage war on that country. Our elected representatives certainly seem to think so. Senatorial hawks, such as Joseph Lieberman (D.-Conn.), John McCain (R.-Ariz.), and Trent Lott (R.-Miss.) have been reduced to pleading their case via the U.S. mail. In a Dec. 5 letter to the president, Sen. Lieberman, et. al., wrote, "we believe we must directly confront Saddam, sooner rather than later." Even Sen. Daschle (D.-S. Dak.), initially reluctant to endorse military action, now merely bleats that Congress would like to be "included, consulted, and [wants] to work with the administration" -- not that the president lacks the authority unilaterally to wage war on Iraq.

But if the president can take us into war with Iraq without so much as a by-your-leave to Congress, then Congress' power to declare war isn't worth the parchment it's written on. Congressional hawks and doves alike have the power -- and the responsibility -- to vote on the question. And for his part, President Bush ought to acknowledge that until Congress votes him the authority to attack Iraq, the Constitution stays his hand.

January 20, 2001

Clinton's Legacy: Another Imperial Presidency

by Gene Healy

As President Clinton's tenure ends, pundits are trying to define the "Clinton Legacy." Many have focused on the Lewinsky scandal and impeachment, but Clinton may find his legacy in a less sordid but no less shameful aspect of his presidency: his abuse of executive authority in foreign affairs.

Undeclared wars and contempt for constitutional limits on presidential power mark Clinton's foreign policy. Future historians may well remember Clinton as the man who ensured that the "Imperial Presidency" would not vanish with the end of the Cold War.

In his 1973 book coining that phrase, historian Arthur Schlesinger Jr. warned that America's rise to Cold War leadership had transformed America's chief executive into a sort of elected emperor. As Schlesinger explained, though the framers had assigned the power to declare war to Congress, a succession of presidents through the latter half of the 20th Century had arrogated that power to themselves.

Despite his antiwar background, Clinton adopted a Nixonian view of presidential power. From the threatened invasion of Haiti in 1994 to the cluster-bomb humanitarianism of the war on Serbia in 1999, Clinton treated the constitutional command that Congress alone can declare war with less respect than the Imperial Presidents that preceded him. President Reagan's attack on Grenada and President Bush's invasion of Panama were undeclared wars, but they had the constitutional fig leaf of the need for surprise. Clinton's conduct has been more brazen.

With 1994's Haiti intervention, Clinton stood ready to launch a 20,000-troop invasion, while asserting that he did not need congressional authorization to do so. In Serbia, the air war from March to June 1999 represented the largest commitment of American military personnel and materiel since the Persian Gulf War.

Nonetheless, Clinton refused to go to Congress for a declaration of war. Indeed, administration officials would not admit that the bombing campaign over Serbia was a war. White House spokesman Joe Lockhart made that clear in an April 1999 exchange with a reporter:

Q: Is the President ready to call this a low-grade war?
Lockhart: No. Next question.

Q: Why not?
Lockhart: Because we view it as a conflict.

Q: How can you say that it's not war?
Lockhart: Because it doesn't meet the definition as we define it.

Apparently, it depends on what your definition of "war" is.

And then there were the attacks known as the "Wag the Dog" bombings. The first came in the August 1998 missile strikes on Sudan and Afghanistan, three days after Clinton's grand jury testimony and in the midst of a media firestorm over his televised non-apology for the Lewinsky affair. The administration has refused to release the evidence it claims to have relied on for its assertions that the Sudanese pharmaceutical plant made nerve gas and that its owner was linked to terrorist Osama Bin Laden.

The second "Wag the Dog" bombing occurred on the eve of the House impeachment debate when the president ordered air strikes on Iraq. Attempting to explain the curious timing of the attack, Clinton asserted that "we had to act and act now [because] without a strong inspections system, Iraq would be free to retain and begin to rebuild its chemical, biological, and nuclear weapons programs—in months, not years." As a result of the president's action, we've since gone two years without any weapons inspections.

The timing of Clinton's actions gave rise to suspicion that he was applying a chillingly literal version of Clausewitz's dictum that war is politics by other means. That sort of suspicion was by no means alien to our Constitution's framers. As Madison put it, if the power to declare war had been vested in the president rather than Congress, "the trust and the temptation would be too great for any one man."

Indeed, no one man should be entrusted with the power to lead the nation into war. The Constitution rightly vests Congress with the power to declare war. The Clinton years have made clear how important it is for Congress to reclaim that power.

The New German Problem

As Germany prepares to elect its next Chancellor, the two main candidates, Gerhard Schroeder and Edmund Stoiber, agree on one thing: unemployment must be reduced. Over the past two decades, high unemployment has transformed Europe in general and Germany in particular into a sociological time bomb. What will the unemployed - especially the long-term unemployed with only dim memories of integration into the world of work - do with themselves and their time? What will happen to confidence in governments that can not solve the problem?

It is easy to forget that little more than 50 years ago, Europe was the world's most violent continent. Europeans spent the previous forty years slaughtering each other on a scale unprecedented in human history. Against this backdrop, Western Europe after 1950 was remarkably peaceful and stable, even taking into account the fall of the French Fourth Republic and the transitions from dictatorship to democracy in Portugal, Spain, and Greece.

The most remarkable transformation of all was that of the Federal Republic of Germany. Anyone familiar with German history since 1800 is still astonished at the enthusiasm with which the nation that emerged from total defeat in 1945 embraced what many in previous generations would have called "unsuitable" Anglo-French political and economic models. Without the peace and stability that this assured in Germany - the largest linguistic nation west of Russia - it is difficult to imagine today's peace and stability in Europe as a whole.

Germany owes its transformation in part to a combination of three factors: a backlog of unexploited technological opportunities to fuel rapid income growth, nearly full employment, and a state that shared the benefits of growth widely through public programs (rather than serving one class or interest as a weapon to concentrate wealth and power). Other factors - the memory of the Nazi catastrophe, the example of life east of the Iron Curtain, the potential threat posed by Stalin and his heirs - also clearly played an important role. But the fact that the system worked for almost everyone was the final buttress holding up the cathedral.

To everyone's relief, political democracy and mixed market economies proved highly resilient against the oil price shocks of the 1970s. Incomes stagnated, but the institutional order endured. And it has also endured the subsequent emergence and persistence of high unemployment. Within the Federal Republic, where unemployment remains near its early-1980s peak, the failure to address the problem was offset by other successes. The early 1990s witnessed the reunification of Germany, and the elimination of even moderate inflation risks. The late 1990s delivered deeper European integration, culminating in European Monetary Union.

In short, lack of progress on reducing unemployment could be excused in the past: Europe faced more urgent problems and opportunities. But what more urgent problem or attractive opportunity exists today? Inflation no longer threatens anyone's savings. Germany is unified. Monetary union has been accomplished. Whoever leads the next German government must tackle unemployment, both for the sake of the economically most vulnerable and to ensure public confidence in the current system.

Unfortunately, whoever wins the election - Schroeder or Stoiber - will be helpless in the medium term to address the problem. Germany's Employment Commission has called for sweeping labor-market and social-welfare reforms, but it will be very difficult for any government to implement them. Without increased private-sector demand, the removal of supply-side restrictions that fuelled high "classical" unemployment will simply result in high "Keynesian" unemployment in the future.

European integration was supposed to take care of this by driving decades of rapid economic growth as companies realize continent-wide economies of scale. So where is this demand-driven growth? The European Central Bank (ECB) seems more interested in keeping interest rates high enough to force insolvent firms into bankruptcy than in promoting higher employment.

With private-sector demand stalling, the Employment Commission wants the government to serve as employer of last resort. But the Maastricht Treaty's Stability and Growth Pact limits fiscal deficits to 3% of GDP - a ceiling that Germany is already hitting. Unless a future government is bold enough to violate the pact with abandon, its only alternative will be to increase taxes, which would merely prolong the very downturn in private-sector demand that has kept unemployment high.

Were it not for the Stability and Growth Pact, a Keynesian spending-led program could provide the demand needed to reduce unemployment. The problem could be solved once and for all if the ECB were willing to risk the following bargain with governments: if you liberalize product markets and make labor markets flexible, we will reduce interest rates and permit higher spending to fulfill the promise of near-full employment. But the ECB and the Stability and Growth Pact being what they are, both German parties are what they are: a sculptor who has promised to carve a marble statue overnight but has lost his chisel.

There may be little cause for immediate worry. The sociological time bomb may simply continue ticking. As Adam Smith put it, "There is a lot of ruin in a nation." But while Western Europe's post-war institutional order has worked almost miraculously well in historical terms, voters have narrower views and focus on more private concerns. They are more likely to judge a party, a regime, or an institutional order by asking, "What have you done for me lately?" With the great tasks of reunification and European integration behind it, future German governments are increasingly likely to be forced to answer, "Not much."