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October 25, 2004

The Economists' Voice: Second Issue

We have gotten the second, October 2004, issue of The Economists' Voice closed up and out the door.

This is--not surprisingly, considering its date--a highly political issue. We have George Akerlof beginning with Barry Bosworth's observation that "Republican administrations have the advantage in that they tend to hire business people who are good administrators," but that the Bush administration is not a normal Republican administration: people whom Akerlof regards as good administrators--and he is a fan of Paul O'Neill, Colin Powell, Christine Todd Whitman, William Donaldson, and Jerry Bremer--were simply not allowed to do their jobs. We have Bill Gale and Peter Orszag saying that the current Bush deficits are knocking one- to two-tenths of a percent a year off of the growth of the American economy's potential output, and that that's the good news: our long-term fiscal situation is truly terrifying. On the other side, we have Michael Boskin saying (i) yes, our long-term fiscal situation is bad, but (ii) the medium-term deficits are a problem but not that big a problem, and (iii) in the short run the Bush tax cuts hit at exactly the right moment to serve as an effective fiscal stimulus when the Federal Reserve was out of ammunition.

Justin Wolfers and Eric Zitzewitz slice-and-dice some prediction market results from TradeSports to conclude that, if Tradesports' bettors have rational expectations (a big if), the successful capture of Osama bin Laden as an "October Surprise" would have been (would be?) a decisive event, and that issues outside the control of the campaign staffs--the state of the economy, and progress on the war on terror--are key to the election. Preston McAfee investigates how a couple of billion dollars of hidden losses could destroy an Enron with a $60 billion equity value. His answer would not have surprised J.P. Morgan, who once told a congressional committee that his most important business asset was his reputation for "character." That's what Enron lost by hiding losses in SPVs.

Finally, Michele Boldrin and David K. Levine implicitly accuse Richard Posner of confusing the producer surplus that Disney earns from Mickey Mouse (which is maximized in the short run by monopolization) with the social surplus, which is not. Posner's response is somewhat cryptic: I read it as saying that there are quality issues and information costs associated with the decision to watch a Mickey Mouse cartoon: one expects a Mickey-Mouse experience, after all, and in the absence of monopoly control Gresham's Law will swing into action, and sub-Mickey-Mouse experiences will drive out Mickey-Mouse experiences.

The gem of the issue, I think, is Wolfers and Zitzewitz: it tells us that Tradesports' bettors believe things about the susceptibility of the American electorate to recent news and about the month-by-month probability of Osama bin Laden's capture that are profoundly disturbing. Either Tradesports' bettors are paranoid wingnuts, or we live in an even scarier world than I had imagined.

Election 2004: Fiction vs. Reality: George Akerlof, University of California, Berkeley: In a campaign speech given in Iowa, George Akerlof argues that the Bush administration has hamstrung its good administrators and opted time and again for waving a magic wand to solve problems instead of facing reality. The problem may be most severe in the case of the deficits, where if we don't face up to reality, Akerlof argues, there will be profound consequences.

Experimental Political Betting Markets and the 2004 Election: Justin Wolfers, Wharton. U.Penn; Eric Zitzewitz, Stanford GSB: Betting on elections has been of interest to economists and political scientists for some time. We recently persuaded TradeSports to run experimental contingent betting markets, in which one bets on whether President Bush will be re-elected, conditional on other specified events occurring. Early results suggest that market participants strongly believe that Osama bin Laden’s capture would have a substantial effect on President Bush’s electoral fortunes, and interestingly that the chance of his capture peaks just before the election. More generally, these markets suggest that issues outside the campaign -– like the state of the economy, and progress on the war on terror -– are the key factors in the forthcoming election.

The Budget Outlook: Projections and Implications: William Gale, Brookings; Peter Orszag, Brookings: Under reasonable projections, the unified budget deficits over the next decade will average 3.5 percent of GDP. Compared to a balanced budget, the unified budget deficits will reduce annual national income a decade hence by 1 to 2 percent (or roughly $1,500 to $3,000 per household per year, on average), and raise average long-term interest rates over the next decade by 80 to 120 basis points. Looking out beyond the next decade, the budget outlook grows steadily worse. Over the next 75 years, if the tax cuts are made permanent, this nation’s fiscal gap amounts to about 7 percent of GDP. The main drivers of this long-term fiscal gap are, in order, the spending growth associated with Medicare and Medicaid, the revenue losses from the 2001 and 2003 tax cuts, and increases in Social Security costs. The nation has never before experienced such large long-term fiscal imbalances. They will gradually impair economic performance and living standards, and carry with them the risk of a severe fiscal crisis.

Sense and Nonsense About Federal Deficits and Debt: Michael Boskin, Stanford: The Bush tax cuts were one of the largest and best-timed uses of fiscal policy in history, helping to prevent a much worse downturn (but it would have been even better had rate cuts been immediate and delayed real spending controls been enacted simultaneously). In the medium run of five-to-ten years, we project a debt-GDP ratio that peaks at 40% and then stabilizes even as the tax cuts are made permanent if the post-1998 splurge in non-defense discretionary spending is ended. This is hardly a debt spiraling out of control. In the long run of decades, the deficits in Social Security and Medicare are very large, but standard projections may overstate the problem by assuming modest long-run growth, increases in health care outlays far in excess of GDP growth for the better part of a century, large benefit increases in Social Security, and continuous tax cuts to offset real bracket creep and the AMT. But even with less stark projections, there would still be large deficits and large tax increases looming. To avoid them, continuously rigorous spending control and major program reform is essential.

The Real Lesson of Enron's Implosion: Market Makers Are In the Trust Business: R. Preston McAfee, Caltech: How did Enron, a firm worth $60 billion, collapse over the discovery of a billion or so in hidden debt and fraudulent accounting? It didn't. Or, at least, not directly. Market makers like Enron and Ebay are in the "trust" business, just as banks and insurance companies are. Once trust was lost, the rest of Enron's value quickly disappeared. The maintenance of customer trust is an important, and frequently mismanaged, aspect of business strategy. The legislative response of Sarbanes-Oxley may do some good, but cannot really ensure trust.

Why Mickey Mouse is Not Subject to Congestion: A Letter on 'Eldred and Fair Use': Michele Boldrin, University of Minnesota; David K. Levine, UCLA: In “Eldred and Fair Use,” Posner comments that awarding a monopoly over Mickey Mouse avoids the congestion problem that occurs with open access highways. Is the public domain a commons like an open access highway? No, it is not.

Posner responds to "Why Mickey Mouse is Not Subject to Congestion," by Michele Boldrin and David Levine: Richard A. Posner, University of Chicago: The question is whether it is possible to have a congestion externality in intellectual property, such as the Mickey Mouse character. Literally, the answer is no. Figuratively, it is yes.

Posted by DeLong at October 25, 2004 02:48 PM