1.Economic Development and Property By Walter E. Williams Wednesday, September 5, 2007
2. China's One-Child Mistake
*3. Calderónomics By MARY ANASTASIA O'GRADY WSJ September 17, 2007; Page A16
4. EU Court Rejects Microsoft Appeal Decision Has Implications For Further Cases Involving Microsoft and Other Firms
5. THE BIGGEST TAX HAVEN IN EUROPE
* 6. Microsoft Loss In Europe Raises American Fears
*7. Microsoft's Waterloo WSJ September 18, 2007
*8. Mortgages and Monetary Policy By ROBERT E. LUCAS, JR.  WSJ September 19, 2007; Page A20
*9. Sarkozy's Social Contract
10. World Economy in Flux As America Downshifts Huge Trade Gap NarrowsAs Dollar, Housing Slide; Exporting Lobster Traps
*11. Independent Women By ANN METTLER WSJ September 20, 2007
12. Aiding Trade
13. Americans Shifting to Zero-Income Tax states
*14. OECD Review Urges EU to Reduce Its Barriers
*15. Global capitalism saves the children By Rich Lowry
16. The global economy The turning point Sep 20th 2007 rom The Economist print edition
17. Climate Will the Developing World Risk Growth for Green?
18. Wanted: A Japanese Reformer
19. TRADE IS THE BEST AID FOR AFRICA
*20.Dynamic Capitalism  By EDMUND S. PHELPS WSJ October 10, 2006; Page A14
*21. Entrepreneurial Culture By EDMUND S. PHELPS wsj February 12, 2007; Page A15
22. World Bank Nears Rate Reduction Move Is Part of Compromise Navigated by Zoellick To Assist Poorest Nations
23. Why Not Let Belgium Disappear?
24. Democracy in retreat around the world By Daniel Dombey
25.Why Microsoft Was Wrong By NEELIE KROES
26. EUROPE'S LAGGING SERVICE SECTOR
27. European's Do Not Want American-Style Capitalism
28. Be Like Egypt
29. Egypt, Saudi Arabia Rise In World Bank Rankings
 30. Mexico's economy Braced for contagion
31. Fugitive returned
*32. CHILE'S DISABILITY SYSTEM
33. Corporations Shouldn't Be Democracies
34. Rupee Whiplash
35. What Made Chavez Possible?   Font Size:
36. IBD Celebrates the Global Flat Tax Revolution
37. The 4 Boneheaded Biases of Stupid Voters (And we're all stupid voters.) Bryan Caplan | October 2007 Print Edition Reason Magazine
38. Historic Surge In Grain Prices Roils Markets
*39. The Secrets of Intangible Wealth
40. Gavin Kennedy, Adam Smith, and Gregory Clark  by Arnold Kling
*41. The Great Moderation in Output
*42. What Really Buys Happiness? Not income equality, but mobility and opportunity Arthur C. Brooks
43. Three Cheers for the World Bank.
44. HONG KONG'S ECONOMIC FREEDOM
 
 
 
 
 

1.Economic Development and Property By Walter E. Williams Wednesday, September 5, 2007

Strong Property Rights Encourage Better Behavior. Walter Williams explains why property rights encourage people to make wise and moral choices:

http://www.townhall.com/columnists/WalterEWilliams/2007/09/05/economics_and_property_rights

Economic theory does not operate in a vacuum. Institutions, such as the property rights structure, determine how the theory manifests itself. Similarly, the law of gravity isn't repealed when a parachutist floats gently down to earth. The parachute simply affects how the law of gravity manifests itself.

Failure to recognize the effect of different property rights structures on outcomes leads to faulty analysis. Think about several questions. Which lake will yield larger, more mature fish -- a publicly owned or a privately owned lake? Why is it that herds of cows flourished and buffalos did not? Who will care for a house better -- a renter or owner?

The answer to each question has to do with the property rights structure. In a publicly owned lake, everyone has the right to the fish. In order to assert his right, the person has to catch the fish. This leads to overfishing because the person who tosses back an immature fish doesn't benefit himself. He benefits someone else who will keep the fish. It's a different story with a privately owned lake. The owner needn't catch a fish in order to assert his rights and can let the fish mature. It's the same principle with buffalo and other wildlife that's publicly owned. Through various rules and regulations, governments, though imperfectly, attempt to solve this property rights problem with licenses, fishing and hunting seasons and setting limits on catch and size.

Private property rights force the owner to take into account the effect of his current use of the property on its future value. A homeowner has a greater stake in what a house is worth 10 or 20 years from now than a renter. An owner would more likely make sacrifices and take the kind of care that lengthens the usable life of the house. But owners have methods to make renters share some of the interests of an owner through requiring security deposits against damage.

There's a completely ignored aspect of the effect of restrictions on private property rights and that's restrictions on profits. Pretend that you're an owner of a firm. There are two equally capable secretaries that you might hire. The pretty secretary demands $300 a week while the homely secretary is willing to work for $200. If you hired the homely secretary, your profits would be $100 greater. But what if there were a 50 percent profit tax? The profit tax reduces your rights to profit and reduces your cost of discriminating against the homely secretary. Instead of foregoing $100 without the profit tax, you'd forego only $50 by hiring the pretty secretary. The more the cost of doing something goes down, predictably, the more people will do of it. Wherever private property rights to profits are attenuated, we expect more choices to be made by noneconomic factors such as race and other physical attributes. That's especially the case in nonprofit entities like government and universities.

You say, "Hold it, Williams, government and universities have preferential hiring policies in favor of racial minorities; so you're wrong." No. When it was politically expedient, government and universities were the leaders in racial discrimination against racial minorities. Now that it's politically expedient to discriminate in favor of racial minorities, government and universities are in the forefront. For example, in 1936, there were only three black Ph.D. chemists employed by all of the white universities in the U.S., whereas 300 black chemists alone were employed by private industry. In government, blacks were only 1 percent of non-Postal Civil Service workers in 1930. By the way, where did blacks make their entry into white universities? If you said in sports, the moneymaking part of the university, go to the head of the class.

There are numerous issues and problems that are otherwise inexplicable unless we take into consideration the property rights structure.

Dr. Williams serves on the faculty of George Mason University as John M. Olin Distinguished Professor of Economics and is the author of More Liberty Means Less Government: Our Founders Knew This Well.

2. China's One-Child Mistake
By NICHOLAS EBERSTADT
WSJ September 17, 2007; Page A17

With a shrinking working-age population, who will take care of the country's retirees?

If China could take a single decision today to enhance the nation's long-term economic outlook, it would be to recognize that coercive population control has been a tragic and historic mistake -- and to abandon it, immediately.

Such a call might surprise the casual observer, for on its own terms, China's population program has been a superficial success. In the early 1970s, China's then-current childbearing patterns implied nearly five births per woman. At the start of the "one child policy" in 1979, China's total fertility rate was nearly three births per woman. Today, China's fertility rate is far below the "net reproduction rate" -- by many estimates, just 1.7 births per woman nationwide. In some major population centers -- Beijing, Shanghai and Tianjin among them -- the average number of births per woman today has fallen below one baby per lifetime.

This "success," however, comes with immense inadvertent costs and unintended consequences. Thanks to a decade and a half of sub-replacement fertility, China's working-age population is poised to peak in size, and then start to decline, more or less indefinitely, within less than a decade. A generation from now, China's potential labor force (ages 15-64) will be no larger than it is today, perhaps smaller. This presages a radical change in China's growth environment from the generation just completed, during which time (1980-2005) the country's working-age population expanded by over 55%.

"Composition effects" only make the picture worse. Until now, young people have been the life force raising the overall level of education and technical attainment in China's work force. But between 2005 and 2030, China's 15-24 age group is slated to slump in absolute size, with a projected decline of over 20% in store. In fact, the only part of the working-age population that stands to increase in size between now and 2030 is the over-50 cohort. Will they bring the dynamism we have come to expect from China in recent decades?

On current trajectories, China's total population will start to decline around 2030. Even so, China must expect a "population explosion" between then and now -- one entirely comprised of senior citizens. Between 2005 and 2030, China's 65-plus age cohort will likely more than double in size, to 235 million or more, from about 100 million now. And because of the fall-off in young people, China's age profile will "gray" in the decades ahead at a pace almost never before witnessed in human history. China is still a fairly youthful society today -- but by 2030, by such metrics as median population age, the country will be "grayer" than the United States -- "grayer," that is, than the U.S. of 2030, not the U.S. of today.

How will China's future senior citizens support themselves? China still has no official national pension system. Up to now, China's de facto national pension system has been the family -- but that social safety net is unraveling, and rapidly. Until very recently, thanks to relatively large Chinese families, almost every Chinese woman had given birth to at least one son -- under Confucian tradition, their first line of support. But just two decades from now, thanks to the "success" of the one-child policy, roughly a third of women entering their 60s will have no living son.

In such numbers, one can see the making of a slow-motion humanitarian tragedy. But the withering away of the Chinese family under population control has even more far-reaching implications.

In Beijing, Shanghai and other parts of China, extreme sub-replacement fertility has already been in effect for over a generation. If this continues for another generation, we will see the emergence of a new norm: a "4-2-1 family" composed of four grandparents, but only two children, and just one grandchild. The children in these new family structures will have no brothers or sisters, no uncles or aunts, and no cousins. Their only blood relatives will be their ancestors.

It is no secret that China is already a "low trust society": Personal and business transactions still rely heavily upon guanxi, the network of personal relations largely demarcated by family ties. What exactly will provide the "social capital" to undergird commercial and economic development in a future China where "families" are, increasingly, little more than atomized households and isolated individuals?

One final consequence of China's population-control program requires comment: the eerie, unnatural and increasingly extreme imbalance between baby boys and baby girls. Under normal circumstances, about 103 to 105 baby boys are born for every 100 baby girls. Shortly after the advent of the one-child policy, however, China began reporting biologically impossible disparities between boys and girls -- and the imbalance has only continued to rise. Today China reports 123 baby boys for every 100 girls.

Over the coming generation, those same little boys and girls will grow up to be prospective brides and grooms. One need not be a demographer to see from these numbers the massive imbalance in the "marriage market" in a generation, or less. How will China cope with the sudden and very rapid emergence of tens of millions of essentially unmarriageable young men?

All of these problems just described are directly associated with involuntary population control. Scrapping this restrictive birth-control policy would surely ease China's incipient aging crisis, its looming family-structure problems and its worrisome gender imbalances. Some in China's leadership may worry that the end of the one-child policy might mean the return to the five-child family -- but in reality, modern China is most unlikely to return to pre-industrial fertility norms.

In the final analysis, the wealth of nations in the modern world is not found in the ground, or the forests, or in other natural resources. The true wealth of modern countries resides in their people -- in human resources. China's people are not a curse -- they are a blessing. The Chinese people, like people elsewhere, are rational, calculating actors who seek to improve their own circumstances -- not heedless beasts who procreate without thought of the future.

Trusting China's people to act in their own self-interest -- not least of all, trusting their choices and preferences with respect to their own family size -- may very well prove to be the key to whether China ultimately succeeds in abolishing poverty and attaining mass affluence in the decades and generations ahead.

Mr. Eberstadt is a resident scholar at the American Enterprise Institute. This essay is excerpted from remarks delivered at the World Economic Forum's conference in Dalian, China earlier this month.
 

3. Calderónomics By MARY ANASTASIA O'GRADY WSJ September 17, 2007; Page A16

As young Mexicans have poured across the southern U.S. border in recent years, looking for work, a common American refrain has been to blame Mexican economic policy. Even many of us who welcome the new labor for the U.S. economy have also noted that the Mexican government's failure to deepen the economic restructuring begun some 20 years ago has spurred migration, imposing a heavy burden on Mexican society.

This reality has not been lost on President Felipe Calderón. He campaigned in the lead-up to last year's election on a platform that emphasized jobs, promising to deliver the policy changes that would bring them about. Unfortunately, Mr. Calderón's National Action Party (PAN) is only a minority in Congress, and judging by the "reforms" passed there last week, his vision of a modernized Mexico is still a long way off.

It's bad enough that the government's fiscal reform falls so far short of the pro-growth agenda Mr. Calderón promised. But to make matters worse, opposition parties made passing it contingent on a heavily politicized "electoral reform" and a no-strings-attached tax cut for the monopoly, state-owned oil company Pemex. If there is one lesson from this latest legislative struggle between modernizers and Mexico's old guard in the Institutional Revolutionary Party (PRI), it's that timidity when confronting dinosaurs doesn't pay.

Mr. Calderón has been carefully choosing his fights in his first year in office. His biggest achievement to date is the reform of the public-sector pension system, a measure that in the medium term will remove the obligations of the large entitlement program from the budget.

Having one win under his belt, Mr. Calderón moved this summer to introduce a fiscal reform designed to close revenue shortfalls. A better course of action, with oil topping $80 a barrel, would have been opening the oil market to private investment. But this would have challenged the theology that says that the inefficient state-owned oil monopoly Pemex is sacred. Mr. Calderón apparently has decided, for now, against questioning that taboo.

Instead, he chose to go after the productive private sector of the economy, where at least some large companies are known to take advantage of a complex, exemption-ridden regime to dodge tax payments. The choice has not been fruitful.

As I reported in my July 2 column, Hacienda Minister (Treasury Secretary) Agustin Carstens, formerly of the International Monetary Fund, chose not to seek growth through lower corporate tax rates and simplification. Instead, he crafted a plan to create a corporate alternative minimum tax. The proposal raised the cost of labor on some part of the work force and complicated the code.

An email I received from the Mexican office of a large multinational investment firm insisted that the plan was not biased against skilled labor. That conclusion implied that the Hacienda proposal was so complicated that even some Mexican experts couldn't figure it out. John A. McLees, tax partner at the law firm Baker McKenzie, collaborated with his Mexican counterpart in Tijuana on a study that argued convincingly that the proposal did indeed raise the cost of labor for salaries between approximately $15,000-$35,000, middle-range pay in Mexico. When workers cost more, companies hire fewer. For a president who ran on an employment platform, it was a disappointment.

If the AMT is intended, as some have speculated, to be an end run toward the goal of a single, low flat-tax, not many are buying it. Most businesses view it as a tax hike and few seem confident that a new tax, once adopted, would ever be abolished.

Thus the administration, normally considered market friendly, found itself without even its natural allies in negotiations with Congress. Meanwhile some of the worst elements of Mexico's corporatist past were preparing to extract a pound of flesh for their support.

The bill that finally passed last week sets the AMT at 16.5%, increasing it to 17.5% in three years. Those rates are lower than originally proposed and the burden on labor has been significantly reduced. The government forecasts a revenue increase of 100 billion pesos ($9 billion) to be used for infrastructure investment and social programs for the poor. But no one expects it to spur much growth. Hacienda forecasts that without the reform Mexico would have grown at 3.5% in 2008 and with the reform it will grow at 3.7%, still an anemic rate for a developing country.

What is yet unknown is how the tax changes might affect investment decisions. Some tax experts are already warning that for U.S. investors, paying the AMT could mean double taxation because it is not an income tax and the tax treaty with the U.S. only covers income taxes.

As part of the bargain in Congress, the PRI opposition forced the government to hand Pemex what amounts to an annual tax cut of 30 billion pesos, to grow to 60 billion pesos by 2010. A reform-minded negotiator might have asked for something in return. Pemex is highly inefficient and not likely to improve without competition. Since there is nothing in the Mexican constitution that gives Pemex the right to the monopoly it has in trading energy products like petrochemicals and gasoline, some competition could be introduced without a constitutional amendment. This was also an opportunity to force reform in Pemex's bankrupt pension plan.

The government also had to give up important ground in an electoral reform. It agreed to fire Luis Ugalde, the head of the supposedly independent Federal Electoral Institute (IFE), and the entire board. The hard-left Revolutionary Democratic Party wanted this in order to delegitimize Mr. Calderón's victory last summer. The PRI dinosaurs wanted it to extract revenge against political rivals who worked with former President Vicente Fox to name Mr. Ugalde. Now they have a say in putting their own nominees on the board. The bargain also tightens restrictions on the use of campaign TV and radio spots, outlawing "negative" advertising -- which the IFE will judge subjectively -- and prohibiting private-sector issue ads. In other words, free speech takes a hit in this reform and the IFE board is politicized. Now the only hope that this constitutional change might be defeated is if more than half of Mexican states refuse to approve it.

If not, Mr. Calderón will have won his watered-down fiscal reform but at a high cost. Mexicans have to hope that he starts to think bigger and bolder. This nibbling around the edges of reform is only going to get him eaten alive by the dinosaurs.

Write to O'Grady@wsj.com.
 

4. EU Court Rejects Microsoft Appeal Decision Has Implications For Further Cases Involving Microsoft and Other Firms
By CHARLES FORELLE
WSJ September 17, 2007 9:08 a.m.

BRUSSELS -- One of Europe's highest courts handed Microsoft Corp. a stinging defeat in its hard-fought antitrust case, dismissing nearly all of the company's appeal of a landmark 2004 decision by the European Union and upholding €497 million ($689.7 million) in fines.

The ruling by the European Court of First Instance endorsed in broad strokes the EU's power to regulate dominant companies abusing their market position.

Microsoft said it hasn't decided yet whether to appeal the ruling to Europe's highest tribunal, the European Court of Justice. "We just need to think about this. It's a serious and substantial decision and it deserves serious thought rather than an instantaneous decision," Brad Smith, the company's general counsel, told reporters in Brussels.

The latest ruling arms European antitrust authorities with strong tools to further pursue Microsoft, if it chooses to, as well as other dominant, high-tech players. The court, which sits in Luxembourg, brushed aside Microsoft's arguments that its intellectual property should provide protection from regulation and that high-tech industries, by their fast-moving nature, should be treated with a different hand.
[Microsoft] MORE COVERAGE

• Read the EU court decision and Microsoft's statement
• Timeline of key events.
FROM THE ARCHIVES

• Microsoft, Rivals Take 'Office' Politics Global
08/29/07
• Microsoft Responds to EU Antitrust Charges
04/23/07
• Microsoft Appeals EU's Antitrust Fine
10/02/06
• EU Fines Microsoft $358.3 Million
07/12/06
• Microsoft Rivals Launch New EU Complaint
02/22/06
• Microsoft to License Windows Code
01/25/06
• EU Imposes Record Fine on Microsoft
03/24/04
• EU Opens Antitrust Probe of Microsoft
08/03/00

The court's ruling also moves Europe's antitrust jurisprudence further away from that of the U.S., where regulators are less apt to view aggressive conduct by dominant companies as abusive.

EU antitrust commissioner Neelie Kroes said after the court's ruling that she won't "tolerate continued noncompliance" by Microsoft. Ms. Kroes said Microsoft's share of the software market is now "far too much" to give competitors a fair chance to compete, and said regulators want to see "a significant drop" in Microsoft's market share.

In Europe, abuse-of-dominance is forbidden by a section of the European treaty known as Article 82. But courts have had relatively few opportunities to outline Article 82's scope.

The Microsoft case represented a choice opportunity -- and the court took it, saying the EU's executive arm, the European Commission, had proceeded appropriately in drawing broad powers from Article 82 to move against the software giant.

The Microsoft case had two key components. The first was whether the Redmond, Wash. software giant abused its dominant position by bundling the Windows Media Player inside its Windows operating system. The EU argued the bundling was illegal under European antitrust law since it disadvantaged others who produced -- or might want to try -- a separate media player. RealNetworks Inc., the maker of an alternative player, joined that case but settled with Microsoft in 2005 for $761 million.

The bundling allegations resemble the crux of an earlier antitrust case brought by U.S. authorities against Microsoft, which was built around how the bundled Web browser was used against rival Netscape.

The case's other main component concerned protocols that allow other manufacturers' servers to communicate with Microsoft machines in a type of network known as a workgroup. These servers are commonly used for tasks such as maintaining a directory of users and controlling their access to the network, storing shared files and queuing documents for printers.

In 1998, Sun Microsystems Inc. complained to the EU that Microsoft had refused to share "interoperability" information it needed to let servers running its operating system work with Microsoft-based computers.

That complaint touched off the EU's investigation; six years later, it handed down its decision.

That landmark decision, more than 300 pages in length and the culmination of a six-year probe by EU officials, prescribed a harsh fine -- €497 million -- and ordered Microsoft to remove its media player from the Windows operating system and share communications protocols with rivals who wanted their machines to work with Windows computers.

The decision reflected years of frustration on both sides. Microsoft mounted a massive public-relations and legal campaign in Brussels; the EU pushed back. Microsoft chief Steve Ballmer flew to Brussels for settlement talks, but hopes of a settlement evaporated. Former Competition Commissioner Mario Monti said he wanted a clear decision from the EU to set a precedent in dealing with dominant high-tech firms.

Monday, the Court of First Instance upheld both the removal of media player and the requirement to disclose the protocols. It also left the €497 million fine in place. That suggests that further fines -- €281 million in 2006 for Microsoft's refusal to comply with the decision and a running levy of €3 million per day since August 2006 for excessive pricing -- will also remain in place, though they weren't the subject of Monday's litigation.

The court did reject a minor part of the EU's case, saying the antitrust regulator exceeded its authority when it created an outside trustee to monitor Microsoft. The court also said Microsoft didn't have to pay for the trustee.

The case -- so far -- means Europe has been more successful than the U.S. at bringing antitrust action against Microsoft. A years-long effort in the U.S. came close; in 2000 a federal judge, Thomas Penfield Jackson, called the company "untrustworthy" and ordered it broken up. But that decision was quickly overturned on appeal, and Judge Jackson was admonished for extrajudicial conversations with reporters.

The government eventually settled in 2001, winning little more than an agreement that would make it easier for computer makers to hide Microsoft's Internet programs if they wanted to use versions made by a competitor.

Microsoft today remains, by any assessment, a singularly dominant company in a vital industry -- estimates of its market share for PC operating systems runs as high as 95%.

In Europe, the Microsoft result could embolden regulators to pursue the software giant further. There is an outstanding investigation of a separate complaint involving Microsoft's dominant Office productivity software. In that case, a group backed by companies including International Business Machines Corp. alleges that Microsoft shut rivals out of the market with its tight control over the file formats used by Word, Excel and PowerPoint to encode documents.

Also, the EU launched this summer cases alleging abuses under Article 82 against two other high-tech companies, chip giant Intel Corp. and memory-chip maker Rambus Inc.

The alleged abuses are different in nature, and neither is directly related to Microsoft's troubles, though lawyers say the court's guidance is likely to steer how the EU proceeds in them. Intel is accused of dumping chips below cost and using rebates and marketing funds to compel computer makers not to buy from rival Advanced Micro Devices Inc; the EU says Rambus sprang a "patent ambush" on rivals by working with them to form industry standards for chip design, then later claiming it had patents on the designs and charging a high price for them.

Write to Charles Forelle at charles.forelle@wsj.com

5. THE BIGGEST TAX HAVEN IN EUROPE
------------------------------------------------------------------------

Under an obscure piece of British tax legislation, anyone who lives in
Britain but was not born there need only pay taxes on the small amount
of money they bring into the country every year, and not on their
worldwide earnings, according to Bloomberg News.
In effect, the tax status -- known as "non-domiciled" -- has
made London a tax haven for everyone from Russian oil tycoons to
international investment bankers.  According to figures compiled
by the British Treasury:
   o   There were about 112,000 people claiming non-domiciled status
       in the year through April 2005.
   o   Although they reported a total of £9.8 billion (about
       U.S. $19.9 billion) in earnings, their wealth from overseas
       income would be much more.
Some people are not happy about the situation. In a recent report the
Trades Union Congress, which represents 7 million workers in 66 unions,
argued that closing the loophole could help raise the £4 billion
(about U.S. $8.1 billion) the government needs to meet its pledge of
halving child poverty by 2010.

Source: Matthew Lynn, "The biggest tax haven in Europe is not what
you might expect," International Herald Tribune, September 13,
2007.

or text:
http://www.iht.com/articles/2007/09/13/bloomberg/BXlynn-web.php
For more on Taxes:
ttp://www.ncpa.org/sub/dpd/?Article_Category=20

Saturday, September 15, 2007 ~ 10:48 p.m., Dan Mitchell Wrote:
Mexico's Crazy Tax Plan. There are many things that Mexican politicians should do in order to boost the nation's anemic economy. Deregulation, privatization, property rights, rule-of-law, and trade liberalization are just a few steps that would increase economic efficiency and improve incentives for productive behavior. Unfortunately, those policies are not popular with politicians since they would reduce government power. So it is disappointing – but not surprising – to see that those politicians have decided that a huge tax increase is a tonic for Mexico's economy. USA Today reports on Mexico's shift toward even more statism:

      President Felipe Calderón is pushing an overhaul of Mexico's tax system, which he blames for the country's high poverty rate and creaking infrastructure. …"Only with stronger public finances can we confront the enormous challenge of ending the misery that millions of Mexicans live in," Calderón said in his State of the Union address this month. Caldero?n's goal is to increase Mexico's tax income by about a third, or roughly $35 billion a year. …"What this government needs is more income; it's as simple as that," said Rep. Susan Monreal, secretary of the budget committee in Mexico's Chamber of Deputies, the lower house of Congress. "We have 50 million people who are living in poverty and not seeing the fruits of this economy. That has to change." …To raise more money, the tax plan would: •Create a corporate income tax based on companies' revenue, rather than their profits. Companies would have to pay the higher of the two figures, making tax deductions irrelevant. •Require banks to deduct a 2% tax on deposits over a certain amount, probably $1,800 per month. The measure is aimed at catching people who are paid under the table.
      http://www.usatoday.com/news/world/2007-09-11-mexicotaxes_N.htm?loc= interstitialskip
 

 6. Microsoft Loss In Europe Raises American Fears
By CHARLES FORELLE
WSJ September 18, 2007

BRUSSELS -- Microsoft Corp.'s stinging defeat in a European courtroom rewrites the rules for competition in Europe, promising tighter scrutiny for dominant companies including several American giants.

The Luxembourg-based Court of First Instance said the European Commission acted properly in 2004 when it found that Microsoft had abused its near-monopoly position. The commission, taking a significantly tougher line than U.S. antitrust authorities have done recently, said Microsoft improperly bundled a media player with its Windows operating system and denied competitors information needed to make their computers work with Microsoft's software.

Microsoft's total bill in fines and penalties could reach €2 billion, or $2.77 billion. The company said it will quickly hand over the information to its rivals as the commission wanted.

In Europe, the case was followed with the attention normally paid to the travails of royals or the fate of national soccer teams. Lawyers for Microsoft, the European Commission and groups supporting both sides went to Luxembourg to hear it read from the bench. Reporters thronged the courtroom. EU officials praised the decision -- which asserted broad powers for the EU to regulate industry-dominating companies -- for protecting consumers.
[Microsoft] MORE COVERAGE

• Read the EU court decision and Microsoft's statement
• Timeline of key events
• BizTech: Risk to Microsoft Customers: Not Much
• Law Blog: EU Sets Sights on iTunes
FROM THE ARCHIVES

• Microsoft, Rivals Take 'Office' Politics Global
08/29/07
• Microsoft Responds to EU Antitrust Charges
04/23/07
• Microsoft Appeals EU's Antitrust Fine
10/02/06
• EU Fines Microsoft $358.3 Million
07/12/06
• Microsoft Rivals Launch New EU Complaint
02/22/06
• Microsoft to License Windows Code
01/25/06
• EU Imposes Record Fine on Microsoft
03/24/04
• EU Opens Antitrust Probe of Microsoft
08/03/00

Microsoft's backers said the ruling will stifle innovation by making it tougher to design products with new features. Some lawyers raised the specter of a regulatory nightmare as technology companies struggle to adapt to differing standards across the globe.

"If I were a leading company in any sector, I'd be really concerned about this," said Ted Henneberry, an antitrust lawyer at Heller Ehrman LLP in London who wasn't involved in the Microsoft case.

Chip makers Intel Corp. and Rambus Inc. are among the U.S. companies that may be affected as antitrust regulators in Brussels are emboldened by the ruling. The European Union brought a case against Intel in July, accusing it of using marketing incentives to deter customers from dealing with rival Advanced Micro Devices Inc. The EU is investigating Rambus over alleged manipulation of standard-setting bodies to assure itself of patent royalties.

Rep. Robert Wexler, a Florida Democrat who is chairman of the House Foreign Affairs Subcommittee on Europe, called yesterday's ruling a "dangerous precedent." He said he intends to call a hearing to review what he described as a "new form of protectionism" by the EU.

The U.S. Justice Department's chief, Thomas Barnett, contrasted Europe's approach with America's. He said that in the U.S., even dominant firms "are encouraged to compete vigorously," while Europe's stance may end up "harming consumers by chilling innovation."

European regulators hailed the court decision as a victory for consumers, who, in the words of Competition Commissioner Neelie Kroes, are "suffering at the hands of Microsoft." Ms. Kroes said she would like to see a "significant drop" in Microsoft's nearly 95% market share in operating-system software.
An EU court ruling backs the European Commission's decision that software giant Microsoft illegally used its power to crush competitors. Video courtesy of Reuters.

In the last big Europe antitrust case, the Luxembourg court found the commission employed shoddy legal reasoning when it blocked the planned merger of General Electric Co. and Honeywell International Inc. The two companies never did merge.

This time, the court seized the opportunity to outline a broad interpretation of the EU's power to regulate dominant companies. It brushed aside Microsoft's argument that traditional antitrust tools aren't appropriate for fast-moving technology industries.

The EU said Microsoft illegally bundled Windows Media Player inside its Windows operating system, hurting independent makers of media-player software. RealNetworks Inc., the maker of an alternative player, joined the case but settled with Microsoft in 2005 for $761 million. The bundling allegation resembled the crux of the U.S. antitrust case against Microsoft, settled in 2001, which was built around complaints about Microsoft's bundled Web browser.
[Neelie Kroes]

The second part of the EU's case involved protocols, or procedures for transferring data between computers. The EU alleged that Microsoft, by not disclosing its protocols, was making it too hard for servers running different software to communicate with certain Microsoft-based machines. These machines are used for tasks such as maintaining a directory of users and controlling their access to a network.

The ruling could hurt Microsoft's profitable business of software for servers, or big corporate computers, by forcing it to disclose the protocols at little or no cost. The information could help "open source" competitors such as the Linux operating system. Separately, the EU is reviewing complaints about Microsoft's Office software and concerns over how Microsoft bundled encryption and other features in its new Vista operating system.

The court's president, Bo Vesterdorf, first announced that the court had rejected the EU's appointment of a trustee to monitor Microsoft -- a minor aspect of the case. Then he said the court "dismisses the remainder of the application" -- Microsoft's appeal.

Brad Smith, Microsoft's general counsel, said Microsoft is weighing whether to appeal to Europe's highest tribunal, the Court of Justice. He said Microsoft has licenses to its protocols available to competitors, but it charges for them. The EU has suggested the information should be free.

The EU's case dates to 1998, when Sun Microsystems Inc. complained that Microsoft wasn't sharing some computer code needed to make computers running Sun's Solaris operating system talk to machines running Windows. The European Commission's investigation snowballed, and the commission rebuffed Microsoft chief Steve Ballmer when he flew to Brussels for settlement talks. Europe's competition commissioner at the time, Mario Monti, said he wanted a clear precedent defining the EU's powers in dealing with dominant high-tech companies.
[Microsoft]

In 2004, the commission called for a €497 million fine against Microsoft and ordered the company to disclose its server-protocol information. With additional fines including a €3 million-a-day penalty, the bill grew to about €2 billion. Microsoft, which has plenty of cash, has put much of the money in an escrow account, and it will be released to the EU once the case is concluded, unless the company wins an appeal. The EU would then distribute the money among member states.

Mrs. Kroes, who succeeded Mr. Monti, had close ties to the business community in her home country, the Netherlands, and was expected to be gentler on companies. But Microsoft stuck in her craw. Her staff expressed frustration that the company was snowing it under with documents instead of complying with the order -- even though Microsoft had lost a court bid to stay its implementation.

Microsoft did eventually remove Media Player from Windows in one version, but few people bought it because it was the same price as the version with Media Player. Emotions flared again last year when Microsoft said the commission's objections to Windows Vista would delay its release -- a tactic meant to bring customer pressure to bear on Mrs. Kroes's office.

In the months leading up to yesterday's ruling, the situation had mellowed some as the two sides came closer on the issue of the protocol disclosures.

Also, Microsoft gave ground to Google Inc. In a new version of its Internet Explorer software, Microsoft included a small window that directed computer users to Microsoft's Internet search service. Prior to the software's debut late last year, Google argued to regulators in the U.S. and Europe that the "toolbar" was anticompetitive. Before introducing the new browser, Microsoft made it easier to set the window to other search engines, including Google.

In advance of Monday's ruling, Court of Justice precedents suggested that a refusal to license copyrighted material is abusive if a dominant company seeks without justification to eliminate competition and if the competitor wants to make a new product, not just a copy.

Microsoft argued that Sun and other vendors wanted to make a replica of a Windows server to drop it into a network, and weren't developing anything novel. Microsoft presented the case as a battle over the sanctity of intellectual property and the right to profit from inventions. The commission said its expert determined the protocols were of such minor value that they would be given away free of charge in a normal market.

Marleen Van Kerckhove, a lawyer in Brussels for Arnold & Porter LLP, which has done work for Microsoft in other matters, said the court had taken a "big leap" by agreeing that the commission could order a compulsory license when a competitor had merely the "possibility of a new product." She added, "We are moving further away from the U.S."

"The refusal to deal and the refusal to supply is larger than the high-tech world," said David Anderson of law firm Berwin Leighton Paisner LLP. Dominant companies across the spectrum "need to be very careful," he said.

--Robert A. Guth and John R. Wilke contributed to this article.

Write to Charles Forelle at charles.forelle@wsj.com
 
 

7. Microsoft's Waterloo WSJ September 18, 2007

If Europe's judges can humble Microsoft, then no one is immune.
 

Lawyers are often the biggest winners in big court cases, and the climax of the EU-Microsoft saga proves the rule. Yesterday's appeals court decision against the U.S. software giant will open the way to a legal bonanza in Brussels. The European regulators and Microsoft's rivals who rushed to declare victory may rue the day they got what they wished for.

The ruling by the European Union's second most powerful court was a judicial slam dunk for Brussels. The court upheld the European Commission's 2004 judgment that Microsoft had abused the dominance of its Windows operating system. The company illegally "bundled" its Media Player program with Windows and refused to provide rivals with the information they needed to create software that worked with Microsoft programs. The court agreed with the Commission's argument that Microsoft limited competition and affirmed the record €497 million fine that Brussels levied on the company.

The decision was clear and emphatic, leaving global companies with little doubt about where the EU stands on policing the technology industry. We can't think of anything else good to say about this outcome.

In their campaign against Microsoft, European regulators have put technology companies on notice about daring to improve their products. Microsoft itself felt compelled to consult the Commission last year about add-ons to its new Vista program before bringing it to market. This hardly encourages innovation or benefits consumers. But then again that's not the point of EU antitrust law. Brussels' main concern is the well-being of Bill Gates's competitors.

Yesterday's legal rout will surely be felt, and closely studied, elsewhere along America's West Coast. If Europe can bring mighty Microsoft to heel, then no one's immune. The Brussels antitrust cops are already investigating Intel and might find good reasons in yesterday's decision to check in on those innovative folks at Google and Apple, too.

The EU's competition chief, Neelie Kroes, discounts "scare stories about the supposed negative consequences of this ruling for other companies." She also says that she is "not expecting a number of companies to come for coffee" and a chat about how their rival is hurting their business, though such firms would be "quite welcome."

All of which suggests this could get out of hand faster than the click of a mouse. Microsoft's general counsel, Brad Smith, points out that Apple's iPod dominates the MP3 player market, in which Microsoft's Zune is the underdog, and that Google's search engine has whipped Microsoft's MSN and all other comers. Not to mention the near-monopoly in some mainframe-computer markets held by IBM, which joined Sun Microsystems in pushing Brussels to take on Microsoft in 1998. Mr. Smith seems to be implying that two can play at this game of making "strategic complaints."

Firms that do so risk little of their own time, energy or money. Once it takes up a case, the Commission does the heavy lifting. The targeted companies incur huge costs to defend themselves. European regulators, and now judges, apparently believe that the proper venue for competition among technology companies is in the courtrooms rather than research labs. Everyone will be worse off, except, of course, lawyers.

The court yesterday concluded that Microsoft hadn't proved that sharing its technology with rivals would "have a significant negative effect on its incentives to innovate." The Commission may have followed the letter of the law here, though the way it was applied still seems questionable. In any case, the law is out of tune with today's high speed of technological innovation and should be changed. The U.S. Justice Department yesterday noted the outcome could "harm consumers by chilling innovation and discouraging competition."

The technology industry has shown itself able to regulate itself through competition. But the judges in Luxembourg yesterday put Brussels at the center of the action. The regulators and the industry may come to realize this news isn't worth cheering.
RELATED ARTICLES AND BLOGS
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•  Microsoft Ruling Will Put EU's Teeth to the Test
 

8. Mortgages and Monetary Policy By ROBERT E. LUCAS, JR.  WSJ September 19, 2007; Page A20

In the past 50 years, there have been two macroeconomic policy changes in the United States that have really mattered. One of these was the supply-side reduction in marginal tax rates, initiated after Ronald Reagan was elected president in 1980 and continued and extended during the current administration. The other was the advent of "inflation targeting," which is the term I prefer for a monetary policy focused on inflation-control to the exclusion of other objectives. As a result of these changes, steady GDP growth, low unemployment rates and low inflation rates -- once thought to be an impossible combination -- have been a reality in the U.S. for more than 20 years.

Both of these reforms work, in part, because they stabilize people's expectations about aspects of the future. The supply side tax cuts, in contrast to Keynesian on-again-off-again temporary tax cuts, are designed to be in place over the long run, and help to assure us that the returns to today's hard work and savings will not be taxed away tomorrow. Inflation targeting is a commitment that no matter what unpredictable shocks the economy is subjected to, the Fed will do what is needed to restore a fixed, target inflation rate and so maintain a "nominal anchor" to expectations.

This summer's subprime mortgage crisis puts the long-run emphasis of inflation targeting to a severe test. Something has to be done right now. What should it be?

There are two distinct aspects to this test, which deserve separate analysis.

There is an immediate risk of a payments crisis, a modern analogue to an old-fashioned bank run. Many institutions -- not just banks -- have payment obligations that are far in excess of the reserves to which they have immediate access. Against these obligations they hold short-term securities that they believed could be liquidated on short notice at little cost. If some of these securities turn out not to be liquid in this sense (and especially if no one is sure who holds them) then everyone wants to get into Treasury bonds. We have seen this very clearly recently in the widening yield spreads between Treasury bills and privately issued commercial paper.

In this process, some losses are incurred (and have been) but the more important risk is that a need to liquidate can force otherwise solid enterprises into failure. (I have to add that one of the papers that helped make Ben Bernanke's reputation as an economist was his 1983 article outlining the large, real costs of the demise of banking institutions during the 1930s.) There is no way to rule this possibility out based on market forces alone: If everyone else wants to cash out, then I want to be first in line. So we need a second commitment by the Fed, unrelated to inflation control, to stand ready to provide the liquidity if needed to serve as lender of last resort.

By reducing the discount rate and encouraging use of the discount window -- instead of reducing the funds rate until yesterday -- I think Mr. Bernanke was trying to separate the short-term problem of lender of last resort and the long-term problem of inflation targeting, and to show that we can and will deal forcefully with the liquidity crisis, if one should emerge, without weakening the commitment to price stability.

The need for a lender-of-last-resort function is one qualification to the discipline of inflation targeting, but it is a necessary one. There is a second line of argument that seems to me much less compelling. It starts with the fact that monetary policy necessarily affects future inflation rates, not the current rate: That has already been determined when the open market committee meets. We also know that whatever funds rate target is chosen, all kinds of others forces -- anything that happens to the real economy -- will affect next quarter's rate of inflation, or next year's. So we would like to forecast these other forces as well as possible and take them into account.

There is nothing wrong with this logic, but how useful it is depends on how good we are at forecasting the non-monetary determinants of prices. In fact, inflation forecasting is notoriously one of the squishiest areas of economic statistics. In this situation, it is all too easy for easy money advocates to see a recession coming and rationalize low interest rates. They could be right -- who really knows? -- and in any case we may not know enough to prove them wrong.

So I am skeptical about the argument that the subprime mortgage problem will contaminate the whole mortgage market, that housing construction will come to a halt, and that the economy will slip into a recession. Every step in this chain is questionable and none has been quantified. If we have learned anything from the past 20 years it is that there is a lot of stability built into the real economy.

To me, inflation targeting at its best is an application of Milton Friedman's maxim that "inflation is always and everywhere a monetary phenomenon," and its corollary that monetary policy should concentrate on the one thing it can do well -- control inflation. It can be hard to keep this in mind in financially chaotic times, but I think it is worth a try.

Mr. Lucas, professor of economics at the University of Chicago, received the 1995 Nobel Memorial Prize in Economic Sciences.
 

9. Sarkozy's Social Contract
WSJ September 19, 2007

Adieu to the welfare state.
 

In unveiling his domestic reform agenda in Paris yesterday, Nicolas Sarkozy called for "a new social contract" for France. His proposed revision of French socialist tradition going back to Jean-Jacques Rousseau is nothing short of revolutionary. His ability to deliver will make or break the Sarkozy presidency.

Mr. Sarkozy, true to character, came out swinging. The new President declared that those empty French political shibboleths -- "social dialogue" and "solidarity" -- "can't be an alibi for inaction." France's generous welfare support and special privileges for insiders is "unjust" and "financially untenable," "discourages work and job creation," and "fails to bring equal opportunity." The result: France's jobless rate in the euro zone's highest.

The President wants "a new social contract founded on work, merit and equal opportunity." He then promised to loosen restrictions on working hours and toughen up requirements to receive unemployment benefits, to ease hiring and firing rules and ease incentives to retire early. By the end of the year he plans to cut back the costly benefits enjoyed by public-sector workers.

Cautious optimism is in order. Over the summer, his new government moved gingerly. An autonomy plan for universities was watered down. A law assuring minimum transport services during strikes, intended to weaken the unions, was as well. On the plus side, wealth and income taxes were cut and the inheritance tax abolished. Fine. But considering his strong mandate and dominance of parliament, Mr. Sarkozy didn't overachieve.

The details of yesterday's proposals are sketchy but potentially provide a foundation to build on. Echoing a frequent promise, the President said the law mandating a work week of a maximum of 35 hours ought to be further relaxed to let the French -- perish the thought -- "choose work over leisure." His government has already made overtime tax-free. Inexplicably, Mr. Sarkozy refrained from pulling the plug on a law that's come to symbolize France's slothful ways.

The President showed more political courage in calling for an end to state-guaranteed job security at private firms. Such legal protections discourage companies from taking on new employees and spur outsourcing. By backing a new work contract, he sided with the almost 10% of the workforce out of a job -- the so-called "outsiders" -- against the majority of protected "insiders."

Upping the ante, Mr. Sarkozy took on the most coddled insiders of all, public-sector workers. State employees retire earlier with full and often better benefits than the rest of the population, which picks up the tab. Train conductors, for example, legally stop work at 50 thanks to a rule drawn up early in the 20th century when they shoveled coal into engines. French conductors who sit inside the air conditioned cabins of modern bullet trains don't face similar hazards.

Scaling back these benefits invites confrontation with the most powerful constituency against change in France, public-sector unions. In 1995, the last time a new President -- Jacques Chirac -- tried something similar, strikes brought the country to a standstill. But this isn't 1995, and unlike President Chirac, Mr. Sarkozy won an electoral mandate for change. In a Opinion Way/Ajis poll published yesterday, 51% of the French support Mr. Sarkozy's social policy, 38% oppose. As for the vaunted "French social model," a bare 9% wants to "preserve it as is."

One of the biggest threats to Mr. Sarkozy's revolution comes not from the unions, or the public at large. It's from Mr. Sarkozy. In his first four months in office, the President has revealed a populist streak. He browbeats the European Central Bank to lower interest rates and sticks his nose into big business. Such interventionism harks back to old-style French economic management and is out of tune with the approach outlined yesterday.

Mr. Sarkozy's long-awaited speech sets the stage for most important political battle in his first term. Whatever the President does in the next five years, he can't claim to have succeeded unless France breaks out of its economic slumber. His equally ambitious foreign policy depends on it, too. For if Mr. Sarkozy can't get domestic reform right, he won't have the credibility to lead on Iran or make up with the U.S.

The President's prescriptions for the ailing French welfare state are hard to argue with. Now if only Mr. Sarkozy bothers to apply them.
 

10. World Economy in Flux As America Downshifts Huge Trade Gap NarrowsAs Dollar, Housing Slide; Exporting Lobster Traps
By MICHAEL M. PHILLIPS
WSJ September 20, 2007

For years, economists have warned that the U.S. can't run up endless charges on the national credit card to cover its huge appetite for imported cars, oil, electronics and other goods. Someday, they said, the bill will come due.

It looks like someday may have finally arrived.

After 16 years during which the U.S. mainly borrowed and bought while much of the rest of the world lent and sold, the global economy appears to be undergoing a fundamental shift. American exporters are finding eager overseas markets for their products. U.S. consumers are beginning to temper their free-spending ways as the housing boom turns to bust. China, the Middle East, central Europe and Africa are absorbing more of the world's imports. The result: Instead of depending as heavily on the U.S. for demand, the world economy could become more evenly balanced.

In the background is a U.S. dollar that has grown weaker against the euro, British pound, and many other currencies. The euro hit $1.39 this month, the strongest it has been since its birth in 1999. A J.P. Morgan index comparing the dollar to a basket of 16 currencies weighted by their importance to U.S. trade is now hovering around a low not seen in more than 10 years, a decline given a shove by this week's Federal Reserve move to cut interest rates.
BALANCING ACT

•  What's New: The long-widening U.S. current-account deficit appears to have begun reversing course, as U.S. growth slows.
•  What's Next: A gradual change could correct longstanding imbalances in the global economy, but a rapid one could be painful to U.S. consumers.
•  What to Watch: How much do foreign investment in the U.S., the housing market and the dollar fall?

All of this could well add up to a major readjustment of the U.S. trade deficit, which began in 1991 and has ballooned to a level that would have seemed unimaginable not long ago. The broadest measure of the trade gap, known as the current-account deficit, at the end of 2005 hit an all-time record of 6.8% of the gross domestic product, the value of all goods and services produced in the U.S. During the second quarter of this year it was down to 5.5%. That might just be the start.

"We're definitely poised to have some significant rebalancing" of trade, says Harvard University economist Kenneth Rogoff, a former chief economist for the International Monetary Fund. He had been expecting the account deficit to shrink "by maybe half a percentage point of GDP over the next twelve months. Now it seems likely it will go down by 1.5 percentage points." And, he adds, "We could see something more rapid."

Something "more rapid" could be painful. Since Americans have financed their prosperity with borrowed money, reversing that habit means a period of living less opulently.

If foreign money turns scarce and the trade deficit narrows suddenly, Americans could face a tumbling dollar, soaring interest rates and an economic downturn. That could send shock waves back through Europe and Asia if their own consumers don't make up for lost demand from the U.S., the world's largest national economy.

If it happens more gradually, the recent run of American prosperity may continue, in a more subdued way. Much depends on the Fed and other central banks managing to loosen up tight credit markets without reigniting inflation. In any case, "we not only have to sell more to the rest of the world, but we have to tighten our belts here at home," says Joseph P. Quinlan, chief market strategist at Bank of America.
[Shrinking Deficit]

It's still an open question how much the U.S. trade gap will contract, or whether some new development might again turn it back to widening. "The real key is understanding whether this is a fundamental change in the trajectory or whether it's temporary," says Catherine L. Mann, an economist at Brandeis International Business School. Ms. Mann knows how hard it is to tell; she predicted in 1999 that the current account would max out at 4% of GDP by 2002 and begin to contract.

If the turnaround persists, the implications for the U.S. could be profound. The weak dollar makes imports more expensive and raises an inflation risk. Interest rates are also likely to be higher than they otherwise would, as Americans have to offer higher yields to induce foreigners to put their money in the U.S.

"We're going to feel a real impact as the current account shrinks," says Harvard's Mr. Rogoff. "The typical individual will see this as a part of a broader inflation cutting into wage gains and standards of living." His back-of-the-envelope calculation is that a 20% drop in the dollar's exchange value reduces Americans' income by 3%, adjusted for inflation.

The massive U.S. trade imbalance is the product of a tangle of causes and effects. It springs largely from foreign-exchange rates, the attractiveness of U.S. financial markets, the profligacy of U.S. consumers versus the thrift of consumers elsewhere and persistent differences in economic growth rates among countries.

Between 1999 and 2006, the U.S. economy grew an average of 2.9% per year, while Germany and Japan each limped along at 1.4% growth rates, according to the IMF. Faster growth means more imports. The richer Americans felt, the more they spent on Chinese toys, German motorcycles, Mauritian shirts or Japanese cars. The housing boom gave consumers a sense of well-being that led them to spend more freely than ever.

At the same time, the growth differential served as a lure for foreign investors. Generally speaking, it's easier to make money investing in stocks in a steadily growing economy than a more languid one. The temptation is especially strong when the financial markets are as deep and liquid as those in the U.S are.

The U.S. government compounded the effect by overspending its budget and issuing Treasury securities to cover its debts. The central banks of China and Japan, among others, have bought trillions of dollars in U.S. notes.

More foreign currency chasing fewer dollars made each dollar more valuable. The stronger dollar, in turn, reverberated through the economy again, making imports relatively cheaper and U.S. exports relatively pricier. The strengthening dollar made U.S. stocks, bonds and other investments even more attractive to foreigners because they were more valuable in euros, yen, pounds or other currencies when the investors cashed out.

For many years, the combination of those forces led the U.S. to buy far more from overseas than it sold abroad. In the second quarter of this year, the current-account deficit measured $191 billion, or more than $760 billion on an annualized basis. To pay for those imports, the U.S. has to attract $2.1 billion in foreign investments every day.

Conditions, however, have changed dramatically. These days, U.S. growth lags behind that of many of its overseas trading partners. The IMF is projecting 2% growth for the U.S. in 2007, and 2.6% growth for Germany and Japan. The 13 countries that share the euro are expected to grow 2.5% this year, according to Bank of America.

American consumers' endless confidence and insatiable appetite at the mall appear to have been jolted by falling house prices and, more recently, tight credit conditions. "The forces that had been supportive to excess consumption for a decade are now headed the other way, and the U.S. consumer just can't keep driving...America's current-account deficit to higher highs," says Stephen Roach, chairman of Morgan Stanley Asia in Hong Kong. Mr. Roach calls that "one of the key conditions...that could be critical in triggering a long-overdue rebalancing of the global economy."

Indeed, the slowing domestic economy already appears to be stifling growth in American demand for foreign goods. The U.S. share of global imports has fallen to 14.3%; the lowest since the recession of 1991-92, according to IMF data. In 2000, the U.S. soaked up 18.8% of world imports. By contrast, Brazil, South Africa, India and other developing countries now account for 40.1% of global imports, up from 28.4% in 1991. "We're not the sole market of last resort," says Mr. Quinlan, the Bank of America strategist.

The weak dollar and strong euro are taking a toll on European companies that try to tap U.S. markets, such as Wolfsburg, Germany-based Volkswagen AG.

Volkswagen has lost more than €2.5 billion, or about $3.5 billion, in North America over the past five years, partly as a result of the dollar's weakness. The company said this month that it is considering building cars in the U.S. again for the first time in nearly 20 years, as a way of reducing its exposure to currency fluctuations. By making cars in the U.S., where costs and revenue are in dollars, companies help to insulate themselves from unfavorable exchange-rate changes. Currently, Volkswagen's only North American factory is in Puebla, Mexico.

"The North American region remains by far our biggest challenge," Hans Dieter Pötsch, Volkswagen's chief financial officer, recently told journalists and industry analysts during a conference call. "We clearly need to change our strategy here."

At the same time, the recent panic sparked by the impact of falling house prices on the subprime mortgage market may have somewhat damped global enthusiasm for Wall Street. The data are too recent and limited to allow a definitive conclusion, but Treasury figures released this week showed that net long-term capital inflows into the U.S., often volatile, measured just $19 billion in July compared with $91 billion the previous month. Investors chose instead to put their money in shorter-term securities.
[Weaker Dollar, Stronger Export]

"At the margin, rates in Europe and Japan are going to look more attractive, given the whole subprime mess," says Mr. Rogoff. "But I'm not saying there's going to be a wholesale cut-and-run out of the United States."

The slowing economy and uncertainty about U.S. financial markets are feeding back into the currency markets. "I expect to see more and more weakening of the dollar in the coming months and years," predicts Princeton economist Alan Blinder, a former vice chairman of the Federal Reserve Board. Currency trends are notoriously hard to predict, though. Mr. Blinder confesses that he thought the dollar was embarking on the long march downwards in 2002, only to see it pick up again in 2004. The Japanese yen has not gained much ground on the dollar compared to 10 years ago.

The slipping dollar also makes it easier for American companies to compete against overseas firms -- a key to reducing the trade deficit.

For years, Riverdale Mills Corp., in Northbridge, Mass., held 90% of the $10 million-a-year market for plastic-coated wire used in lobster traps in New England and Canada. By 2000, when the euro was worth just $0.85, an Italian company had taken a big bite out of the company's market share. But now, with the euro resurgent, Riverdale's wire seems like a bargain again. "Foreign competition got us down to 60% of the market, and now we're creeping back" to about 70-75%, says James M. Knott Sr., the company's chief executive.

Kendig Kneen, owner of Al-jon Manufacturing LLC, has seen his exports of car crushers, bailers and compactors jump 10% to 15% in the past 18 months, driven by faster growth abroad and an exchange rate that helps him take on his German and Italian competitors.

Al-jon, an Ottumwa, Iowa, company with more than $50 million in annual sales, has opened markets in Australia, Ukraine, England and elsewhere. "I'd like to think it's on the strength of my products, but part of it is the strong world economy and part of it is the dollar," says Mr. Kneen, who recently doubled the size of his plant and boosted his work force by 50%, to 150 employees.

There are still obstacles to a smooth rebalancing of global trade flows, and China is one of the biggest. Beijing has been reluctant to allow its currency, the yuan, to rise much against the dollar, despite fierce pressure from U.S. lawmakers and business executives who say that the artificially weak currency gives Chinese companies an unfair edge over American firms. The yuan has appreciated about 10% against the dollar since Beijing first allowed it to move in July 2005, but U.S. manufacturers -- backed by Treasury Secretary Henry Paulson -- say that's not far enough or fast enough to allow even-handed competition.

While China and India are bigger markets for U.S. companies than they used to be, "there are nearly one billion workers in Asia who earn less than $2 per day," says Bank of America's Mr. Quinlan. "They can afford a Coke, but until they can afford a car and computer, global rebalancing will proceed slowly."

--Stephen Power contributed to this article.

Write to Michael M. Phillips at michael.phillips@wsj.com

11. Independent Women By ANN METTLER WSJ September 20, 2007

The knowledge-based economy empowers the fairer sex.

Despite the recent economic upswing, Europeans continue to feel uneasy about the rise of the service economy, which today accounts for 70% of the Continent's gross domestic product. Instead, we find deep-seated nostalgia for the post-World War II industrial economy. Be it the trente glorieuse in France or Germany's Rheinland Model, many Europeans to this day reminisce about what they considered a perfect economic system: a predictable, slow-moving society, neatly divided into labor and capital, in which the industrial male worker provided a good living for his family on a single income. The common wisdom is that these were Europe's heydays, never to return. Today's reforms are merely attempts, by this view, to preserve as much as possible of this heralded age.
[Business Europe]

Entirely overlooked in this romanticized ode to the past is that the industrial era was far from empowering for women. Female economic dependency on men was rampant and professional opportunities limited. The onset of the service- and knowledge-based economy has been a boon to the more than 50% of the population so routinely overlooked in a world in which economic power still overwhelmingly rests in male hands.

But quietly, and impressively, women have seized the opportunities that a new economic era based on services, knowledge and innovation has to offer. The rise of female employment, and increasing economic power that women yield in the 21st century, can only partly be explained by emancipation. Instead, women have been aided by an economic model that relies less on hard physical labor and plays to their innate strengths -- flexibility and endurance or service orientation and the ability to multi-task in diverse, professional environments. And these competencies are paying off as across the EU women hold the majority of "high-skilled nonmanual" jobs.

Education has been at the center of female advancement. Routinely outperforming their male counterparts, women today have a higher share of highly-skilled workers than men in 16 out of 25 European countries. Among some of Europe's economic top performers, there is a pronounced gender gap among the highly skilled -- in favor of women. In Finland, for instance, 32.7% of the female workforce is highly-skilled, compared to 24.3% of men, according to a European Commission study. In Ireland, the figures are 27.3% and 23.6% respectively, and in Sweden 30% compared to 21.8%. Contrary to widespread misconceptions, the percentage of employees with a college degree is greater in the service sector than in manufacturing. Particularly in Scandinavia, with its disproportionately high share of services, women have benefited from this trend. The rise of educational standards among women went hand in hand with a pronounced increase in female employment rates, which between 2000-2005 rose by more than 2.7% compared to only 0.4% for men.

To be sure, there is still a long way to go, with the overall female employment rate at 56.3%, compared to 71.3% for men. But the trend is clear, and it is unstoppable. Women will hold increasing economic power in the 21st century knowledge- and service-based economy. Female employment rates will rise, as will women's earnings and purchasing power.

A tale of things to come is the remarkable experience of the United States. A recent study by Andrew Beveridge, a demographer at Queens College, found that in New York and other large cities such as Chicago, Boston and Dallas, average wages for young, college-educated women in their 20s for the first time outstrip those of their male colleagues -- and by a significant margin. In Dallas, for instance, these young women now make on average 20% more than their male counterparts, reflecting their increased value in a more diverse labor market, which rewards their ambition, diligence and hard work.

It is not unreasonable to foresee a similar development in Europe, where more women graduate from universities than men. In an economy based on meritocracy, which is a prerequisite for innovation and sustained growth, such a development should be natural and welcomed.

Going forward, Europe needs to take account of these seismic changes in the economy and society. It must urgently rehabilitate the service sector and correct the false image of a low value-added, precarious part of the economy. The service sector is Europe's primary job engine. It has particularly benefited women, who account for almost two-thirds of the net rise in employment in services. Total employment in the EU has increased by over 8.3 million since 2000. That growth has been entirely driven by the creation of over 11.4 million jobs in the services sector. Industry and agriculture shed 1.6 million and 1.2 million jobs respectively during the same period.

Sabotaging or undermining the services sector is not only economically suicidal. It's also a disservice to women.

Europe needs to develop a new, more positive vision of its economic future. The implicit assumption that things can never be as good as they once were is not only depressing and counter-productive but plain wrong. Women today have opportunities that most of their mothers could not have dreamt of. It is in the enlightened self-interest of Europe's male-dominated centers of power to shed their nostalgia, and to take note of new realities. And the millions of women who have reaped the advantages of a new economic age should make their voices heard. Otherwise, Europe will have more memories than dreams, and more history than future.

Ms. Mettler is executive director of the Lisbon Council.
 
 

12. Aiding Trade
By PASCAL LAMY and HARUHIKO KURODA
WSJ September 20, 2007

We may be at the "make-or-break" moment for global free trade. Although bilateral trade deals are becoming more common, consensus on the multilateral Doha Round is still elusive. Many leaders have called for progress on Doha, but rallying political support at home for dramatic trade liberalization is always challenging.
[Aiding Trade]

So at this critical juncture, it is most important that we continue to give special attention to those economies that can actually benefit most from the Doha Round -- the least developed countries and smaller states. Opening markets and expanding trading opportunities stimulate economic growth and higher living standards. But for countries still isolated from the global trading system there are large adjustment costs to opening their markets. And that is why the new Aid-for-Trade initiative -- launched at the World Trade Organization Ministerial meeting in Hong Kong in 2005 -- is so important. The U.S., European Union and Japan pledged initial contributions of about $15 billion to kickstart the initiative through 2010.

Aid-for-Trade will help these least-developed and smallest countries benefit from new trading opportunities by building the necessary capacity to trade effectively and efficiently -- with donor support coordinated through multilateral partnerships with institutions like the WTO, the World Bank and regional development banks.

Each small and weak economy has its own specific needs. Some are isolated or landlocked, others are in a post-conflict environment, and still others enjoy limited raw materials or resource endowments. Aid-for-Trade will help these economies build the infrastructure to transport goods and to create new, viable and cost-effective tradable products. It will provide assistance for export promotion and trade finance, and fund training for customs officials and for trade negotiators to take advantage of free trade agreements. And it also will offer help in implementing market-oriented reforms and, yes, building the social safety nets needed for people to adjust to the changing economic environment.
Although Aid-for-Trade is designed to help weak economies and small states into the global trading network, it is the private sector that will ultimately drive the supply and demand for trade, as new products fit into existing or new production networks -- as raw materials for processing, intermediate goods for assembly elsewhere, or as final products.

Increased trade and investment -- particularly intraregional trade and foreign direct investment -- has been key in driving Asia's expansion. China's expansion continues at over 11%. India's economic growth is about 9%, and those countries most affected 10 years ago by the Asian financial crisis are now growing at about 6%. But for all the hype about the region's growing global economic power, there remain two distinct faces of Asia and the Pacific. One perspective emphasizes the advances made by newly-industrialized economies and the rapid expansion in China and India. This has led to a tripling in their share of world exports -- to nearly 21% from less than 7% in 1980 -- helping bring about rapid growth and higher living standards. The other perspective focuses on smaller developing nations in this region and their challenges. From Afghanistan to Vanuatu, there are some 37 developing economies in Asia and the Pacific -- least developed ones like Bangladesh and Cambodia; small states such as the Maldives or Marshall Islands, or the landlocked transition economies of the Kyrgyz Republic and Turkmenistan -- that today account for just 2.8% of world exports, nearly the same as in 1980.

The dichotomy between the region's success stories and those left behind boosts the argument for Aid-for-Trade. One of the goals of Aid-for-Trade in Asia and the Pacific is to galvanize support from the region's successful economies to help the small and weak economies within the region. Together with regional development banks in Africa, Asia and Latin America, we will see what is needed in each of these regions at this early stage of the initiative. The results will then be presented at a global Aid-for-Trade review meeting to be held at WTO headquarters in Geneva in late November.
Aid-for-Trade is about giving developing countries the tools to take advantage of market-opening opportunities, especially those that would result from the successful conclusion of the WTO Doha Round -- to better harness trade as an engine of economic growth and development. It is a necessary complement to the Doha Round, but not a substitute. A successful conclusion to the Doha Development Round is the most important contribution that we can make to accelerating economic growth, promoting development and contribute to reducing poverty.

Mr. Lamy is director-general of the World Trade Organization. Mr. Kuroda is president of the Asian Development Bank.
 
 

Wednesday, September 19, 2007 ~ 2:59 p.m., Dan Mitchell Wrote:
13. Americans Shifting to Zero-Income Tax states. A story in the Kansas City Star reveals that millions of Americans are moving to states without income taxes. Not surprisingly, politicians and revenue bureaucrats from high-tax states are engaging in police-state efforts to monitor escaping taxpayers:

      No-income-tax states such as Florida, Nevada and Texas are looking increasingly attractive to people getting ready for retirement. ...But before you move to a tax haven, it's important to pay attention to the fine print of how to move. It's easy to make seemingly minor mistakes that can trigger a painful audit — and a hefty bill — from the high-tax jurisdiction you thought you had left behind. ...Some relatively high-tax states are increasingly cracking down on individuals who claim to have moved out of state, but still maintain strong connections to their former homes. Massachusetts plans to hire additional tax examiners in the next few months, some of whom will be assigned to a special "domicile unit" as part of its tax-audit program. ... state income tax rates can run as high as 10.3 percent in California and 8.97 percent in New Jersey. Besides Florida, Nevada and Texas, other states with no state income tax for individuals include Washington, Alaska, South Dakota and Wyoming. New Hampshire and Tennessee don't have a broad wage-based income tax but do tax interest and dividends. ...from April 2000 through June 2006, there was a net migration of 2.3 million people moving from states with income taxes to states with no income taxes, an average of more than 1,000 people moving per day, says Richard Vedder, an economics professor at Ohio University in Athens, Ohio, based on an analysis of census data.
      http://www.kansascity.com/business/moneywise/story/265933.html
 
 
 

Tuesday, September 18, 2007 ~ 10:23 a.m., Dan Mitchell Wrote:
14. New Report Details World Bank Corruption. Kevin Hassett discusses the shocking new report on graft at the World Bank:

      ...corruption is worse than even the most strident Wolfowitz supporter could have dreamed. ...The facts detailed boggle the imagination. The report says, "more than 2,000 external cases of alleged fraud, corruption or misconduct have been investigated by the bank since 1999, and more than 330 companies and individuals have been publicly sanctioned." ...Dating back to a pioneering paper by Harvard economist Robert Barro, students of economic growth have known that corruption is a leading obstacle to economic growth. Advances in the rule of law, Barro found, have a powerful positive impact on the economic prospects of a country.
      http://www.aei.org/publications/filter.all,pubID.26813/pub_detail.asp
 
 

14. OECD Review Urges EU to Reduce Its Barriers
By PAUL HANNON
WSJ September 21, 2007

LONDON -- The European Union must reduce barriers to the across-border provision of services, make its energy markets more competitive, and aid the integration of retail banking if it is to close the income gap with the U.S. and other top performers, the Organization for Economic Cooperation and Development said.

In its first review of EU economic policy, the OECD said that while the performance of the 15 countries that were members of the bloc before it was enlarged in 2004 has improved, "there is no room for complacency."

"Average incomes in the EU15 are almost a third lower than in the best-performing OECD countries and more than a third of the working-age population remains inactive," the OECD said. The OECD also noted that most of the reforms that have boosted growth date back to the 1990s. "Progress has slowed down recently," it said.

The OECD identified the dominant services sector as a key source of weakness. Following years of debate, EU governments have agreed to a modest deregulation of the sector. But the OECD said trade in services among member states amounts to less than 5% of gross domestic product, with consumer protection and other regulations acting as barriers to the cross-border provision of services.

"They can be out of all proportion to their objective and have the effect of shielding local firms from competition," the OECD said.

The OECD said further liberalization of "network industries" such as electricity, gas, telecommunications, transport, ports and postal services is also a priority. It added that increased competition in those sectors could raise GDP by 1.5% to 2% annually.

The energy sector is a particular source of concern, the OECD said.

"Energy markets need to be linked together more tightly and opened up to competition," the OECD said. "This would lower prices for consumers and make energy supplies more secure."

The OECD said vertically integrated "energy giants" that control networks, generation and supply "can treat competitors unfairly and shut out potential entrants."

The Paris-based think tank for the world's most-developed economies said vertically integrated energy companies must be broken up "to prevent abuse of power and create a level playing field."

Write to Paul Hannon at paul.hannon@dowjones.com
 

15. Global capitalism saves the children By Rich Lowry
Thursday, September 20, 2007

http://www.townhall.com/columnists/RichLowry/2007/09/20/global_capitalism_saves_the_children

Global capitalism has long lacked for a ringing slogan like "workers of the world unite." It's never too late to find one, and a good candidate -- with apologies to the international charity of the same name -- might be "save the children."

The United Nations Children's Fund just announced that deaths of young children worldwide hit an all-time low, falling beneath 10 million annually. Better practices to protect against disease and to enhance nutrition -- more vaccinations and mosquito nets, more breast-feeding and vitamin A drops -- played a role, but the most important factor in this global good-news story is economic growth.

It is no coincidence that as UNICEF was reporting the drop in child mortality, the World Bank was reporting global poverty rates had fallen as part of an extraordinary worldwide economic boom. Treasury Secretary Henry Paulson calls it "far and away the strongest global economy I've seen in my business lifetime." The global economy is growing at a 5 percent clip, higher than the 3 percent of the period from 1960 to 1980 and the 4.7 percent from 1960 to 1980. As U.S. News & World Report points out, "Gross global product is three times as big as it was in 1970"; so the global economy is not only growing faster, but there's more to grow.

In a worldwide instance of trickle-down economics, the growth is diminishing the ranks of the poor. According to the World Bank, developing countries have averaged 3.9 percent growth since 2000, contributing "to rapidly falling poverty rates in all developing regions over the past few years." In 1990, 1.25 billion people lived on less than $1 a day. In 2004, less than a billion did, even though world population increased 20 percent in the interim.

When a developing country gets richer, it means that people living there are less likely to be malnourished and -- as infrastructure improves -- more likely to have access to clean water and to sanitation. This is a boon to health.

A recent article in the journal Lancet concluded that "undernutrition is the underlying cause of a substantial proportion of all child deaths." Malnutrition weakens a child's immune system and makes him more susceptible to diarrhea, malaria, pneumonia and other diseases. Lack of potable water and sanitation -- roughly 1 billion people lack clean water, and 2 billion lack sanitation -- also increases the risk of illness, obviously. Millions die every year from diseases associated with contaminated water and poor sanitation.

China and India have led the way in growth, with the fastest- and second-fastest-growing major economies in the world. Thus, what have been sinks of human misery on a vast scale for centuries are becoming more livable. China accounted for almost all the recent drop in people living on less than $1 a day, experiencing a decline of 300 million since 1990. India has seen its mortality rate for children under the age of 5 decline from 123 per 1,000 in 1990 to 74 in 2005.

Such growth in developing countries is the result of, according to the World Bank, "further integration into world markets, better functioning internal markets and rising demand for many commodities." In short: globalization and capitalism. When a goateed anarcho-syndicalist commits an act of vandalism at an anti-globalization protest, he might think that he's striking a blow against The Man, but he's really rallying against the chance some desperately poor little boy or girl has to live a healthier life.

Because we in the West have reached the sunny uplands of sustained economic development, we can worry about the deleterious second-order effects -- pollution, etc. -- of growth. In too many places around the world, however, economic growth is still a matter of life and death. Governments, philanthropists and activists have been pouring massive resources into fighting AIDS and other diseases in the Third World recently. This is all very commendable, but we can't ignore the main event.

By all means, let's save the world -- help it grow.

Rich Lowry is author of Legacy: Paying the Price for the Clinton Years .

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16. The global economy The turning point Sep 20th 2007 rom The Economist print edition
Does the latest financial crisis signal the end of a golden age of stable growth?
Illustration by James Fryer

IF ECONOMICS were a children's tale, a long period of rising incomes and improving living standards would always be followed by a big, bad recession. Rising unemployment, falling spending and contracting output—such is the inevitable reckoning for the good times of plentiful jobs and abundant earnings that went before. The hangover needs to be commensurate with the party.

No country has had it quite so good as America. For the past 20 years or more its economy has managed an enviable combination of steady growth and low inflation. To add to its good fortune, spending has routinely exceeded its income—leading to a persistent current-account deficit—without any apparent ill effects on the economy. The occasional setbacks have been remarkably small by historical standards. At the start of 1991, for instance, America's GDP fell for a second successive quarter (a common definition of a recession). But output soon recovered and by the end of the year had surpassed its previous peak. The next downturn, in 2001, was shallower still, with GDP dipping by less than half a percent.

More recently, other rich countries have enjoyed a similar improvement in economic stability. The ups and downs of economic life, known as the business cycle, have provided a much smoother ride than they once did. That is partly why there has been such a clamour for financial and housing assets, and why firms and households have been more willing to take on debt. A lot is now riding on this golden age of stability continuing.

But perceptions about risk are shifting. America's economy, for so long seemingly impregnable, has been growing rather meekly for the past year, weighed down by a slump in housebuilding. The ongoing crisis in credit markets threatens it with recession. Some observers, long mystified by America's ability to live beyond its means and postpone what they see as an unavoidable downturn, think that the world's biggest economy might finally have run out of luck.

Competing views about what lies ahead are themselves cyclical. When growth is steady, the belief that the business cycle can be tamed is understandably high. When recession threatens, that confidence can quickly vanish. On a pessimistic view the “Great Moderation”—the sharp drop in economic instability in America and other rich countries—will prove illusory. But an optimist would counter that the vast improvement in economic stability has been so marked that it will not just disappear overnight.

The world economy has reached a decisive point. If that magical combination of growth and stability was just luck, it is now due a long-postponed and painful correction. But if it was thanks to changes in the way the world works, does that mean the golden age will endure?
Luck or judgment?

Much of the focus—in good times past, as well as bad times present—has been on America, where fluctuations in economic growth have fallen by around half since the early 1980s (see chart 1). In upswings the economy's growth rate has varied by less from one quarter of the year to the next and from year to year. Recessions have been rarer, shorter and shallower.

The most visible symptom of this smoother trajectory is in the jobs market. Since the mid-1980s, America's unemployment rate has fluctuated far less than it did in earlier generations. Between 1961 and 1983, America's annual unemployment rate varied from 3.5% to 9.7%. Since 1984, it has stayed within the tighter bounds of 4% to 7.5%.

Much of America's good fortune has been repeated elsewhere. A study published last year by Stephen Cecchetti, of Brandeis University, Alfonso Flores-Lagunes, of the University of Arizona, and Stefan Krause, of Emory University, found that 16 out of 25 OECD economies, including Britain, Germany, Spain and Australia, had also seen a marked improvement in economic stability.

What lay behind that change? The sceptical view is that improved stability has no cause: it is mostly down to luck. Economic shocks—abrupt shifts in business conditions—have by chance been less powerful. The economy is no better at taking a hit; it is just that since the two oil-supply shocks of the 1970s the punches have not been so hard.

Yet the global economy has taken some big blows during the golden age. In the last decade the rich world has weathered the Asian financial crisis, Russia's debt default, the dotcom boom and bust, terrorist attacks on America, sharp increases in oil prices and the uncertainty that came with wars in Afghanistan and Iraq. Still, economic volatility has not picked up. It is true that the abrupt curtailment of energy supplies to a world that was highly dependent on oil was a unique and traumatic event. But economies were more hidebound then: job markets were less flexible and producers more stymied by regulation. The painful results cannot wholly be put down to energy dependency.
The flexible economy

The more likely explanation is that economies have become far better at absorbing shocks, because they are more flexible. There are many structural shifts that might have contributed to this, from globalisation to the decline of manufacturing in the rich world. The academic literature keeps returning to three: improvements in managing stocks of goods, the financial innovation that expanded credit markets, and wiser monetary policy.

For such a tiny part of GDP, the content of warehouses has had a surprisingly big effect on its volatility. When industries cut or add stocks according to demand, that adjustment magnifies the effect of the initial change in sales. Stock levels were once much larger relative to the size of the economy, so a small slip in demand could easily blow up into a recession. But thanks to improvements in technology, firms now have timelier and better information about buyers. Speedier market intelligence and production in smaller batches allows firms to match supply to changing conditions. This makes huge stocks unnecessary and minimises the lurches in inventories that were once so destabilising. The entire inventory of some lean-running companies now consists of whatever FedEx or UPS is shipping on their account.

Mr Cecchetti and his colleagues calculate that, on average, more than half the improvement in the stability of economic growth in the countries they studied is accounted for by diminished inventory cycles. That something so workaday as supply-chain management could have so marked an effect might seem a dull conclusion. But dullness is a virtue, because technological improvement is irreversible. This means the greater stability it provides is likely to be permanent.
The Wall Street shuffle

If better logistics is an unalloyed plus for the economy, the benefits of financial innovation may seem more doubtful—at least just now. Complex derivatives, such as collateralised debt obligations (CDOs), have created a truly nasty mess (see article). But if credit has perhaps been too easy to come by, that was itself a novelty. Credit was strictly rationed until a wave of deregulation and innovation during the 1980s and 1990s led to an expansion. That, in turn, gave a wider range of firms and consumers the means to plug temporary gaps in spending power.

Credit scoring and securitisation have attracted plenty of scrutiny in recent weeks. But the use of techniques to assess the risk of default, together with the repackaging of loans into marketable securities suitable for savers, has broadened access to borrowed funds and broken the rigid link between income and spending. No longer are investment plans tied to the vagaries of a firm's cash flow. And consumers can better match their spending to lifetime incomes. A bigger credit pool means transient declines in earning power need not trigger a downward spiral of falling demand and falling income. These are all valuable advances that smooth out the business cycle.

The third explanation for the moderation is that central banks, in getting to grips with inflation, have fostered more stable economic growth too. Indeed, so widespread is this assumption that the power of central banks is sometimes exaggerated. The rally in the world's stockmarkets over the past month has probably been driven by “faith in the Fed”: the belief that America's central bank will cut interest rates by enough to prevent recession.

In principle, controlling inflation helps steady the economy. High inflation tends to be volatile and research has shown that erratic inflation and large fluctuations in GDP growth tend to go hand in hand. That statistical link might be more than chance. High and variable inflation interferes with the smooth functioning of economies. It obscures the changes in relative prices that tell producers about how customer tastes are always changing. It also leads to variations in real interest rates and volatile patterns in spending.

Though the theory is compelling, empirical studies have struggled to pin down a strong link between better monetary policy and tamer cycles. Ben Bernanke, head of the Federal Reserve, has argued that “the policy explanation for the Great Moderation deserves more credit than it has received in the literature.” At the very least, central banks have stopped adding to economic volatility, even if they have not done so much to actively reduce it.
The shock-absorber that shocked

Although it is perverse to argue the golden age has not been tested, it would be foolish to rule out a shock (or combination of shocks) that might break the economy's resilience. Combine the present discord in credit markets with the seeming vulnerability of housing markets and it is all too easy to imagine the rich-world economies in trouble.

What makes today's turmoil so disturbing is that one of the mechanisms which helped stabilise growth has suddenly become a threat to it. Financial innovation is central to the Great Moderation, but its most recent creations allowed credit to be extended on too easy terms. The fallout is now poisoning the markets for short-term funding that are so essential to the economy's smooth functioning.

Because of rising arrears and defaults on American subprime mortgages, investors have lost faith in the securities backed by them. The impact has broadened to a more general revulsion against assets in which the income depends on repayments of consumer debt. As funding dried up, the resulting squeeze has put upward pressure on the money-market interest rates that determine the cost of borrowing for households and small businesses.

As long as credit markets stay impaired, the economy's normal self-regulation cannot fully be relied upon. A channel that for so long has helped smooth economic growth might now threaten it. A shock-absorber could turn into a shock-amplifier.

Indeed, the very stability of growth may have encouraged people to take on a debt burden that could prove troublesome. Strong credit growth is both cause and consequence of the golden age.

Belief that the business cycle has been tamed for good helps explain why property prices in many rich countries have risen so high and why there has been such a willingness to take on debt at large multiples of income. A less volatile economy makes income streams more reliable and, goes the argument, justifies higher prices for all assets, including housing. A reduced fear of job losses means homebuyers in America, Britain and elsewhere have been content to take out huge home loans.

But like all booms, the housing rush is dependent on ever-more risky borrowers to prop it up. Once credit conditions tighten, the marginal homebuyer is frozen out of the market. That is one likely consequence of the trouble at Northern Rock, a mortgage bank that was rescued this week by the British government (see article). Northern Rock was responsible for a huge share of mortgage lending earlier this year. But after a run on the bank its ability to write new business has vanished.

Britain has been growing steadily in the last year, but it has the same fault lines as America—an overvalued housing market, high consumer debt (see chart 2) and a huge trade deficit. Unlike other European countries, it has a big non-prime mortgage market too. Though less than 10% of recent loan growth has been in subprime, this rises to around 25% if you count borrowers who never had to prove how much they earn, according to David Miles, at Morgan Stanley.

Just as the germ carried from America's subprime mortgage market is now infecting money markets elsewhere, so the housing downturn itself could spread globally. As Alan Greenspan, the former Fed chief, reminded everyone this week, there have been housing booms in at least 40 different countries and “the US is by no means above the median”. If global house prices are as correlated on the way down as they were on the way up, the pain will not be confined to America. The cracks that have spread with the credit crisis could be the network through which the housing malaise travels.

As central banks try to mitigate these risks to growth, the danger is that they become complacent about inflation. There is a sorry story of how monetary laxity once undermined hopes for a more stable economy. In 1959 Arthur Burns, then chairman of the National Bureau of Economic Research (NBER), made a famous prediction that “the business cycle is unlikely to be as disturbing or troublesome to our children as it once was to our fathers.” For a decade that optimism seemed justified. But in the 1970s, on Burns's watch as Fed chairman, unemployment rose, inflation took off and a growing sense of economic crisis made a mockery of the idea that governments could control the business cycle. Attempts to fine-tune the economy through cheap money instead led to higher inflation and increased economic instability.

In his new book (see article), Mr Greenspan delivers a timely warning that progress in policymaking is always vulnerable to reversal. Looking to 2030, he fears that the burdens of an ageing population will eventually lead to upward pressure on inflation. And future Fed chairmen cannot rely on the deflationary effects of globalisation to tame prices, as Mr Greenspan could, as over time that impulse will fade.

Mr Greenspan questions the political will to enforce price stability. “Whether the Fed will be allowed to apply the hard-earned monetary policy lessons of the past four decades is a critical unknown. But the dysfunctional state of American politics does not give me great confidence in the short run.”

Once people sense inflation is slipping out of control, changes in expectations can quickly become self-fulfilling. Firms price higher and employees demand wages to match. If inflation expectations slip anchor, central banks will have to ratchet up real interest rates (or bond markets will do the job for them). Policy might again become the source of economic shocks.

Today the stakes are arguably higher. Highly leveraged economies rely on low nominal interest rates to keep debt-service costs manageable. A spike in bond yields would probably cause huge instability as interest costs ate into available spending. If wiser central bankers have indeed played a big role in the Great Moderation, it is sobering to think how easily the dangers of lax monetary policy might be forgotten.
Revising downwards

The prospect of a co-ordinated global housing slump is a very frightening one. For the moment, it remains a plausible risk. If house prices hold up, the credit-market disruption is still likely to harm growth in 2008. Even if money markets settle down—and there are the first signs of this happening (see article)—the loans that banks have been unable to sell as securities will instead sit on balance sheets, crimping their ability to lend. A more careful approach to credit means businesses and households will find it harder to borrow. That will hurt the world economy.
Banking on the Fed

Private-sector forecasts for developed-world growth are understandably being revised down. Revealingly, the biggest changes have been to expectations about interest rates. The likelihood of rate increases in Europe has been largely written off. And many projections for the Fed funds rate were decisively reduced ahead of the decision this week to cut (see article). In essence, the markets are betting the Fed can save the day. Stockmarkets, at least, do not appear to be priced for a recession—or anything like it.

On this they may be simply following the form book. If central bank actions are credited with mitigating previous downturns, then why not this one? The global economy has proved to be far more resilient than had often seemed likely. And it showed very few signs of trouble before the credit-market dislocations, mostly because growth outside the rich world has been strong.

In July the IMF revised down its projections for economic growth in America for this year, but still upgraded its global economic forecasts because of the strength of the emerging markets. These economies—a source of a big shock only a decade ago—could now prove to be a stabilising force for the world economy. Thanks to their handsomely cushioned foreign-exchange reserves, the fast-growing economies of Asia and the Middle East are now less dependent on capital markets to fuel their growth.

America remains the biggest risk. Even here, where the outlook is gloomiest, recession is not a forgone conclusion. Perhaps the best that can be hoped for—and maybe what policymakers are trying to engineer—is a continuation of the muddle-through growth of the past year or so. That would help contain pressures on inflation without causing excessive dislocation in the economy. But the risks to even this outcome are on the downside.

In the past year, America has become less central to global growth. But it is a big importer and a hard landing would affect other countries. Its fortunes over the next year will still have huge significance for other reasons too. America has been at the leading edge of the Great Moderation and has arguably pushed the boundaries of risk-taking furthest. If America falls hard now, it will be a harbinger for the rest of the rich world.
 

17. Climate Will the Developing World Risk Growth for Green?
By JEFFREY BALL
September 22, 2007; Page A2

Back-to-back, high-profile meetings on global warming this week are likely to produce a lot of hot air about whether the industrialized world should subject itself to tighter greenhouse-gas "caps."
[Week Ahead]

In New York on Monday, a United Nations session is likely to call for tighter emission mandates. In Washington on Thursday and Friday, a Bush administration conference is expected to talk up voluntary pledges.

But the debate over how to prod emission cuts by industrialized countries is fast being eclipsed by a more-practical question: how to create incentives for the cuts in the developing world.

Many industrialized countries that have promised emission reductions under the Kyoto Protocol, the existing climate-change treaty, are likely to miss their pledges. Even in ostensibly "green" Europe and Japan, politicians tend to flinch from rules their domestic industry protests are too onerous.

Meanwhile, the U.S., which refused to ratify Kyoto, is about to be eclipsed by China as the world's biggest greenhouse-gas emitter. The upshot: Even if, say, Spain met its target, and the U.S. signed up for one, the atmosphere wouldn't feel much benefit unless China and other developing nations followed suit.

Developing economies have made clear they aren't about to subject themselves to emission caps. The West enjoyed its fossil-fueled century of economic growth, they point out. Now it is their turn.

So the task facing the diplomats in New York and Washington this week, and in December at a bigger U.N. global-warming conference in Bali, Indonesia, is to come up with a system that makes cutting emissions worth the developing world's while.

More than a decade ago, when the Kyoto treaty was negotiated, diplomats tried to do this by creating an international "carbon market." It lets industrialized countries earn credits toward their Kyoto obligations by bankrolling emission-reducing projects in the developing world, where they're cheaper. That market -- essentially a capital shift from West to East -- is worth billions of dollars a year. Yet it still isn't significantly slowing emissions growth in developing nations. China continues to build new coal-fired power plants at a feverish pace.

Now, new ideas for green financial carrots are popping up. One involves trees.

Trees matter to the atmosphere because, through photosynthesis, they take in and store carbon dioxide, the greenhouse gas that's emitted when fossil fuels are burned. But cutting down trees is big business in many developing nations.

The Kyoto treaty tries to encourage tree-planting in the developing world by letting companies that do it peddle carbon credits -- an additional revenue stream. Some forest-rich developing nations want to be able to sell such credits not just for planting new trees, but for preserving existing ones that otherwise might be logged.

Kyoto's negotiators rejected that idea as too vulnerable to abuse. How, for example, to ensure that protecting one stand of forest wouldn't push loggers to another tract? But developing countries, backed by some environmental groups, now say forest-monitoring technology has improved to the point where the rules should be loosened.

In-the-weeds financial debates like this tree fight are likely to prove at least as telling an indicator of progress in addressing global warming as more rhetoric about carbon caps.

Write to Jeffrey Ball at jeffrey.ball@wsj.com
 
 
 
 
 

18. Wanted: A Japanese Reformer
By RICHARD KATZ
September 24, 2007

Now that we know Yasuo Fukuda will soon be Japan's new prime minister, attention is turning to what we don't know about him -- his economic plans. To judge by the consensus view in the media, the best economic reformers can hope for is stasis; the worst would be backtracking. Yet that's an oversimplification. Mr. Fukuda is indeed likely to avoid substantial new reforms. But previous reforms have taken on a life of their own and he cannot turn back the clock even if he wanted to do so. A host of economic and demographic problems will keep up the pressure for reform.

No one doubts that Mr. Fukuda is smart and competent. But he lacks any clear vision for Japan's economic future. He personally favors reform and was even former prime minister Junichiro Koizumi's chief cabinet secretary. However, Mr. Fukuda is by temperament an arbiter between conflicting views and interests, not a bold initiator like Mr. Koizumi.

Having been selected as the consensus candidate by the quarreling bosses of the many factions within the ruling Liberal Democratic Party (LDP), Mr. Fukuda will be hog-tied by them. He makes no secret that he cannot decide policy without consulting those who put him in power. Asked by a TV interviewer about his economic policies, Mr. Fukuda begged off on the grounds that he hadn't yet conferred with the faction heads. He has said he will continue with reform, perhaps more slowly, while simultaneously helping the perceived victims of reform. One can imagine positive ways to do this, but Mr. Fukuda's "split the difference" personality and his refusal to translate such sentiments into concrete policies stoke fears that he will straddle instead, thereby producing a hash.

Aggravating matters, many of the LDP barons to whom Mr. Fukuda feels beholden read -- or rather, misread -- the LDP's disastrous loss in the July Upper House election as primarily a rebellion by rural districts against Mr. Koizumi's reforms. Hence, they are pressing Mr. Fukuda to roll back some of these reforms, pump up rural public works, and avoid import-opening free trade agreements.

In practice, Mr. Fukuda's deference to such barons means that traditional vested interests will get their way more often. For example, the government is now selling a bankrupt regional bank that it took over in 2003. Of seven bidders, three were foreign investors. When it came time for the Financial Services Agency to winnow the list, it excluded the foreign bidders on Sept. 21. Reportedly, movers and shakers in the bank's home prefecture, Tochigi, pressed for this. This was partly a reaction to the unexpected loss of the local LDP incumbent in the July elections, which local party leaders attributed to voters' reservations about reform including foreign buyouts.

Fortunately these retrograde tendencies are only part of the story. Reform did not spring forth fully grown from the brow of Junichiro Koizumi. Mr. Koizumi was as much the product of the reform process as its instigator. And the Koizumi experience offers some hope.

Many of the reforms bearing fruit during Mr. Koizumi's tenure were actually initiated during the 1996-98 term of Ryutaro Hashimoto. The collapse of the 1980s bubble and the attendant economic and political shake-up compelled reform during the 1990s. Low growth left the LDP unable to meet the demands of some of its constituencies without hurting others.

The LDP needed growth. However, as Mr. Koizumi later put it, "No growth without reform." After a long delay, some Japanese leaders finally got the point. The results were such pre-Koizumi reforms as the financial "Big Bang"; an increase in the powers of the prime minister, which Mr. Koizumi would later wield to such great effect; and assorted changes in corporate laws that have both pressed companies to restructure and given them more tools to do so.

Those reforms are still in place, and they've built momentum. Better accounting rules make it harder for firms to hide money-losing operations in far-flung subsidiaries. Downsizing, spin-offs and revitalization by new management is increasingly the result, though unfortunately still at only a minority of firms. The non-performing loan crisis and its resolution made it much tougher for banks to keep "zombie companies" on artificial life support. A leap in manufactured imports and foreign direct investment keeps firms' feet to the fire. These reforms will not be reversed.

The pressure for further top-down action will also grow. All the changes undertaken so far are still not enough to create the productivity revolution Japan needs so badly. Consider the aging problem. Beginning with the budget to be presented late next year -- either months before or months after the Lower House election -- the government is legally obliged to pony up growing sums of money every year for social security. Yet the government is also required to keep retiree benefits at no less than 50% of the working population's average wage. Unless it dares to renege on this pledge, it will have to cut spending or hike taxes. Asked whether he would raise the unpopular consumption tax to finance increased social security expenses, Mr. Fukuda refused to be pinned down.

Or the government can strive for faster economic growth, both real and nominal. Higher returns to capital enabling private pension plans and life insurers to pay better annuities would also ease the LDP's dilemma. But better growth and returns to capital require new initiatives.

Meantime, earlier rounds of reform, coupled with reforms in Japan's neighbors, make it more difficult for the LDP to coddle the rural lobby. Resentment among Japan's urban voters will prevent Tokyo from returning to the pre-Koizumi days when paving river beds and building "bridges to nowhere" caused public works to average 7.5% of GDP (it's now 3.8%). South Korea's recent aggressive efforts to negotiate free trade agreements are creating an important constituency among Japan's giant exporters for similar pacts.

The LDP does still face the downside of Mr. Koizumi's reforms. His strategy reduced some of the growth-destroying means by which Japan had provided income equality and security -- such as rural public works and loans to zombies -- but without providing growth-harmonious replacements. Hence the backlash now being exaggerated and exploited by the opponents of reform.

Further -- and broader -- reforms that provide a better trade-off between growth and equality require leadership. Galvanizing the country was Mr. Koizumi's greatest achievement. So far, Mr. Fukuda shows no signs of similar leadership qualities. In the short run, that might not matter so much. But, further down the road the same rule will apply: no growth without even more reform.

Mr. Katz is editor of the monthly Oriental Economist Report.
 
 

19. TRADE IS THE BEST AID FOR AFRICA
------------------------------------------------------------------------

Throughout history trade has led to greater productivity and economic
growth.  Open markets allow countries, companies and regions to
specialize in the production of what they do best and import products
that can be made more efficiently elsewhere, says Christa Bieker, a
policy analyst with the National Center for Policy Analysis.

Unfortunately, the United States discourages freer international trade
through its policy of agricultural protection.  U.S. subsidies to
farmers have reached staggering levels:
   o   In 2006 alone, farm subsidies amounted to $19 billion.
   o   Attempts to limit subsidies -- begining with the Freedom to
       Farm Act of 1996 -- have not been successful; over the past 10
       years taxpayers have spent more than $150 billion on farm
       subsidies.
   o   From 1999 to 2005, U.S. cotton farmers received 86 cents in
       subsidies for every dollar they received from sales.

Since the 1990s, world cotton prices have fallen by half, much of which
is due to U.S. farm subsidies, according to the International Cotton
Advisory Committee.  Their estimates suggest that world cotton
prices would rise by 26 percent if the United States repealed cotton
subsidies.  This amounts to an increase of over $300 million per
year in income for African cotton farmers.

In many cases the negative economic impact of agricultural subsidies is
greater on African countries than the development aid they receive,
says Bieker.  For example, in 2002:
   o   Burkina Faso received $10 million in U.S. aid, yet lost $13.7
       million in export earnings due to depressed cotton prices.
   o   Chad received $5.7 million in U.S. aid but lost nearly the
       same amount in export earnings.

   o   Togo received $4 million in U.S. aid but lost $7.4 million in
       export earnings.

Source: Christa Bieker, "Trade Is the Best Aid for Africa,"
National Center for Policy Analysis, Brief Analysis No. 593, September
24, 2007.
For text:
http://www.ncpa.org/pub/ba/ba593/
For more on Trade Issues:
http://www.ncpa.org/sub/dpd/?Article_Category=42

20.Dynamic Capitalism  By EDMUND S. PHELPS WSJ October 10, 2006; Page A14

There are two economic systems in the West. Several nations -- including the U.S., Canada and the U.K. -- have a private-ownership system marked by great openness to the implementation of new commercial ideas coming from entrepreneurs, and by a pluralism of views among the financiers who select the ideas to nurture by providing the capital and incentives necessary for their development. Although much innovation comes from established companies, as in pharmaceuticals, much comes from start-ups, particularly the most novel innovations. This is free enterprise, a k a capitalism.
[Photo]
WTO protesters: Exaggerating the "downside."

The other system -- in Western Continental Europe -- though also based on private ownership, has been modified by the introduction of institutions aimed at protecting the interests of "stakeholders" and "social partners." The system's institutions include big employer confederations, big unions and monopolistic banks. Since World War II, a great deal of liberalization has taken place. But new corporatist institutions have sprung up: Co-determination (cogestion, or Mitbestimmung) has brought "worker councils" (Betriebsrat); and in Germany, a union representative sits on the investment committee of corporations. The system operates to discourage changes such as relocations and the entry of new firms, and its performance depends on established companies in cooperation with local and national banks. What it lacks in flexibility it tries to compensate for with technological sophistication. So different is this system that it has its own name: the "social market economy" in Germany, "social democracy" in France and "concertazione" in Italy.

Dynamism and Fertility

The American and Continental systems are not operationally equivalent, contrary to some neoclassical views. Let me use the word "dynamism" to mean the fertility of the economy in coming up with innovative ideas believed to be technologically feasible and profitable -- in short, the economy's talent at commercially successful innovating. In this terminology, the free enterprise system is structured in such a way that it facilitates and stimulates dynamism while the Continental system impedes and discourages it.

Wasn't the Continental system designed to stifle dynamism? When building the massive structures of corporatism in interwar Italy, theoreticians explained that their new system would be more dynamic than capitalism -- maybe not more fertile in little ideas, such as might come to petit-bourgeois entrepreneurs, but certainly in big ideas. Not having to fear fluid market conditions, an entrenched company could afford to develop radical innovation. And with industrial confederations and state mediation available, such companies could arrange to avoid costly duplication of their investments. The state and its instruments, the big banks, could intervene to settle conflicts about the economy's direction. Thus the corporatist economy was expected to usher in a new futurismo that was famously symbolized by Severini's paintings of fast trains. (What was important was that the train was rushing forward, not that it ran on time.)
PHELPS IN THE WSJ
 
Selected commentaries by Edmund S. Phelps in The Wall Street Journal.
• Dynamic Capitalism
10/10/06
 
• Remedies for New Orleans
10/10/05
 
• The Way We Live Now
12/28/04
 
• This Recovery Is No 'Dead Cat Bounce'
01/12/04
 
• Crash, Bang, Wallop
01/05/04
 
• False Hopes for the Economy
06/03/03
 
• Scapegoating The Natural Rate
08/06/96
 

Friedrich Hayek, in the late 1930s and early '40s, began the modern theory of how a capitalist system, if pure enough, would possess the greatest dynamism -- not socialism and not corporatism. First, virtually everyone right down to the humblest employees has "know-how," some of what Michael Polanyi called "personal knowledge" and some merely private knowledge, and out of that an idea may come that few others would have. In its openness to the ideas of all or most participants, the capitalist economy tends to generate a plethora of new ideas.

Second, the pluralism of experience that the financiers bring to bear in their decisions gives a wide range of entrepreneurial ideas a chance of insightful evaluation. And, importantly, the financier and the entrepreneur do not need the approval of the state or of social partners. Nor are they accountable later on to such social bodies if the project goes badly, not even to the financier's investors. So projects can be undertaken that would be too opaque and uncertain for the state or social partners to endorse. Lastly, the pluralism of knowledge and experience that managers and consumers bring to bear in deciding which innovations to try, and which to adopt, is crucial in giving a good chance to the most promising innovations launched. Where the Continental system convenes experts to set a product standard before any version is launched, capitalism gives market access to all versions.
* * *

The issues swirling around capitalism today concern the consequences of its dynamism. The main benefit of an innovative economy is commonly said to be a higher level of productivity -- and thus higher hourly wages and a higher quality of life. There is a huge element of truth in this belief, no matter how many tens of qualifications might be in order. Much of the huge rise of productivity since the 1920s can be traced to new commercial products and business methods developed and launched in the U.S. and kindred economies. (These include household appliances, sound movies, frozen food, pasteurized orange juice, television, semiconductor chips, the Internet browser, the redesign of cinemas and recent retailing methods.) There were often engineering tasks along the way, yet business entrepreneurs were the drivers.

There is one conceivable qualification that ought to be addressed. Is productivity not finally at the point, after 150 years of growth, that having yet another year's growth would be of negligible value? D.H. Lawrence spoke of America's "everlasting slog." Whatever the answer, it is important to note that advances in productivity, in generally pulling up wage rates, make it affordable for low-wage people to avoid work that is tedious or grueling or dangerous in favor of work that is more interesting and formative.

Of course, productivity levels in the smaller countries will always owe more to innovations developed abroad than to those they develop themselves. Some might suspect that the domestic market is so tiny in a country such as Iceland, for instance, that even in per capita terms only a very small number of homemade innovations would bring a satisfactory productivity gain -- and thus an adequate rate of return. In fact, most of the Continental economies, including the large ones, have been content to sail in the slipstream of a handful of economies that do the preponderance of the world's innovating. The late Harvard economist Zvi Griliches commented approvingly that in such a policy, the Europeans "are so smart."

I take a different view. For one thing, it is good business to be an innovative force in the "global economy." Globalization has diminished the importance of scale as well as distance. Tiny Denmark sets its sights on markets in the U.S., the EU and elsewhere. Iceland has entered into European banking and biogenetics. France has long done this -- and can do more of it. But it could do so more successfully if it did not insulate its innovational decisions so much from evaluations by financial markets -- including the stock market -- as Airbus does. The U.S. is already demonstrably in the global innovation business. To date, there is an adequate rate of return to be expected from "investing" in the conception, development and marketing of innovations for the global economy -- a return on a par with the return from investing in plant and equipment, software and other business capital. That is a better option for Americans than suffering diminished returns from investing solely in the classical avenue of fixed capital.
* * *

I would, however, stress a benefit of dynamism that I believe to be far more important. Instituting a high level of dynamism, so that the economy is fired by the new ideas of entrepreneurs, serves to transform the workplace -- in the firms developing an innovation and also in the firms dealing with the innovations. The challenges that arise in developing a new idea and in gaining its acceptance in the marketplace provide the workforce with high levels of mental stimulation, problem-solving, employee-engagement and, thus, personal growth. Note that an individual working alone cannot easily create the continual arrival of new challenges. It "takes a village," preferably the whole society.

The concept that people need problem-solving and intellectual development originates in Europe: There is the classical Aristotle, who writes of the "development of talents"; later the Renaissance figure Cellini, who jubilates in achievement; and Cervantes, who evokes vitality and challenge. In the 20th century, Alfred Marshall observed that the job is in the worker's thoughts for most of the day. And Gunnar Myrdal wrote in 1933 that the time will soon come when more satisfaction derives from the job than from consuming. The American application of this Aristotelian perspective is the thesis that most, if not all, of such self-realization in modern societies can come only from a career. Today we cannot go tilting at windmills, but we can take on the challenges of a career. If a challenging career is not the main hope for self-realization, what else could be? Even to be a good mother, it helps to have the experience of work outside the home.

I must mention a "derived" benefit from dynamism that flows from its effects on productivity and self-realization. A more innovative economy tends to devote more resources to investing of all kinds -- in new employees and customers as well as new office and factory space. And although this may come about through a shift of resources from the consumer-goods sector, it also comes through the recruitment of new participants to the labor force. Also, the resulting increase of employee-engagement serves to lower quit rates and, hence, to make possible a reduction of the "natural" unemployment rate. Thus, high dynamism tends to bring a pervasive prosperity to the economy on top of the productivity advances and all the self-realization going on. True, that may not be pronounced every month or year. Just as the creative artist does not create all the time, but rather in episodes and breaks, so the dynamic economy has heightened high-frequency volatility and may go through wide swings. Perhaps this volatility is not only normal but also productive from the point of view of creativity and, ultimately, achievement.

Ideals and Reality

I know I have drawn an idealized portrait of capitalism: The reality in the U.S. and elsewhere is much less impressive. But we can, nevertheless, ask whether there is any evidence in favor of these claims on behalf of dynamism. Do we find evidence of greater benefits of dynamism in the relatively capitalist economies than in the Continental economies as currently structured? In the Continent's Big Three, hourly labor productivity is lower than in the U.S. Labor-force participation is also generally lower. And here is new evidence: The World Values Survey indicates that the Continent's workers find less job satisfaction and derive less pride from the work they do in their job.

Dynamism does have its downside. The same capitalist dynamism that adds to the desirability of jobs also adds to their precariousness. The strong possibility of a general slump can cause anxiety. But we need some perspective. Even a market socialist economy might be unpredictable: In truth, the Continental economies are also susceptible to wide swings. In fact, it is the corporatist economies that have suffered the widest swings in recent decades. In the U.S. and the U.K., unemployment rates have been remarkably steady for 20 years. It may be that when the Continental economies are down, the paucity of their dynamism makes it harder for them to find something new on which to base a comeback.

The U.S. economy might be said to suffer from incomplete inclusion of the disadvantaged. But that is less a fault of capitalism than of electoral politics. The U.S. economy is not unambiguously worse than the Continental ones in this regard: Low-wage workers at least have access to jobs, which is of huge value to them in their efforts to be role models in their family and community. In any case, we can fix the problem.

Why, then, if the "downside" is so exaggerated, is capitalism so reviled in Western Continental Europe? It may be that elements of capitalism are seen by some in Europe as morally wrong in the same way that birth control or nuclear power or sweatshops are seen by some as simply wrong in spite of the consequences of barring them. And it appears that the recent street protesters associate business with established wealth; in their minds, giving greater latitude to businesses would increase the privileges of old wealth. By an "entrepreneur" they appear to mean a rich owner of a bank or factory, while for Schumpeter and Knight it meant a newcomer, a parvenu who is an outsider. A tremendous confusion is created by associating "capitalism" with entrenched wealth and power. The textbook capitalism of Schumpeter and Hayek means opening up the economy to new industries, opening industries to start-up companies, and opening existing companies to new owners and new managers. It is inseparable from an adequate degree of competition. Monopolies like Microsoft are a deviation from the model.

It would be unhistorical to say that capitalism in my textbook sense of the term does not and cannot exist. Tocqueville marveled at the relatively pure capitalism he found in America. The greater involvement of Americans in governing themselves, their broader education and their wider equality of opportunity, all encourage the emergence of the "man of action" with the "skill" to "grasp the chance of the moment."
* * *

I want to conclude by arguing that generating more dynamism through the injection of more capitalism does serve economic justice.

We all feel good to see people freed to pursue their dreams. Yet Hayek and Ayn Rand went too far in taking such freedom to be an absolute, the consequences be damned. In judging whether a nation's economic system is acceptable, its consequences for the prospects of the realization of people's dreams matter, too. Since the economy is a system in which people interact, the endeavors of some may damage the prospects of others. So a persuasive justification of well-functioning capitalism must be grounded on its all its consequences, not just those called freedoms.

To argue that the consequences of capitalism are just requires some conception of economic justice. I broadly subscribe to the conception of economic justice in the work by John Rawls. In any organization of the economy, the participants will score unequally in how far they manage to go in their personal growth. An organization that leaves the bottom score lower than it would be under another feasible organization is unjust. So a new organization that raised the scores of some, though at the expense of reducing scores at the bottom, would not be justified. Yet a high score is just if it does not hurt others. "Envy is the vice of mankind," said Kant, whom Rawls greatly admired.

The 'Least Advantaged'

What would be the consequence, from this Rawlsian point of view, of releasing entrepreneurs onto the economy? In the classic case to which Rawls devoted his attention, the lowest score is always that of workers with the lowest wage, whom he called the "least advantaged": Their self-realization lies mostly in marrying, raising children and participating in the community, and it will be greater the higher their wage. So if the increased dynamism created by liberating private entrepreneurs and financiers tends to raise productivity, as I argue -- and if that in turn pulls up those bottom wages, or at any rate does not lower them -- it is not unjust. Does anyone doubt that the past two centuries of commercial innovations have pulled up wage rates at the low end and everywhere else in the distribution?

Yet the tone here is wrong. As Kant also said, persons are not to be made instruments for the gain of others. Suppose the wage of the lowest- paid workers was foreseen to be reduced over the entire future by innovations conceived by entrepreneurs. Are those whose dream is to find personal development through a career as an entrepreneur not to be permitted to pursue their dream? To respond, we have to go outside Rawls's classical model, in which work is all about money. In an economy in which entrepreneurs are forbidden to pursue their self-realization, they have the bottom scores in self-realization -- no matter if they take paying jobs instead -- and that counts whether or not they were born the "least advantaged." So even if their activities did come at the expense of the lowest-paid workers, Rawlsian justice in this extended sense requires that entrepreneurs be accorded enough opportunity to raise their self-realization score up to the level of the lowest-paid workers -- and higher, of course, if workers are not damaged by support for entrepreneurship. In this case, too, then, the introduction of entrepreneurial dynamism serves to raise Rawls's bottom scores.

Actual capitalism departs from well-functioning capitalism -- monopolies too big to break up, undetected cartels, regulatory failures and political corruption. Capitalism in its innovations plants the seeds of its own encrustation with entrenched power. These departures weigh heavily on the rewards earned, particularly the wages of the least advantaged, and give a bad name to capitalism. But I must insist: It would be a non sequitur to give up on private entrepreneurs and financiers as the wellspring of dynamism merely because the fruits of their dynamism would likely be less than they could be in a less imperfect system. I conclude that capitalism is justified -- normally by the expectable benefits to the lowest-paid workers but, failing that, by the injustice of depriving entrepreneurial types (as well as other creative people) of opportunities for their self-expression.

Mr. Phelps, the McVickar Professor of Political Economy at Columbia, was yesterday awarded the 2006 Nobel Prize for economics.
 

21. Entrepreneurial Culture By EDMUND S. PHELPS wsj February 12, 2007; Page A15

The nations of Continental Western Europe, in the reforms they make to try to raise their economic performance, may prove to be a testing ground for the view that culture matters for a society's economic results.

As is increasingly admitted, the economic performance in nearly every Continental country is generally poor compared to the U.S. and a few other countries that share the U.S.'s
characteristics. Productivity in the Continental Big Three -- Germany, France and Italy -- stopped gaining ground on the U.S. in the early 1990s, then lost ground as a result of recent
slowdowns and the U.S. speed-up. Unemployment rates are generally far higher than those in the U.S., U.K., Canada and Ireland. And labor force participation rates have been lower for
decades. Relatedly, the employee engagement and job satisfaction reported in surveys are mostly lower, too.

It is reasonable to infer that the economic systems on the Continent are not well structured for high performance. In my view, the Continental economies began to be underperformers in
the interwar period, and have remained so -- with corrective steps here and further missteps there -- from the postwar decades onward. There was no sense of a structural deficiency
during the "glorious years" from the mid-'50s through the '70s when the low-hanging fruit of unexploited technologies overseas and Europeans' drive to regain the wealth they had lost in
the war powered rapid growth and high employment. Today, there is the sense that a problem exists.
[Entrepreneurial]

What could be the origins of such underperformance? It may be that the relatively poor job satisfaction and employee engagement on the Continent are a proximate cause -- though not
the underlying cause -- of the poorer participation and unemployment rates. And high unemployment could lead to a mismatch of worker to job, causing job dissatisfaction and employee
disengagement. The task is to find the underlying cause, or causes, of the entire syndrome of poorer employment, productivity, employee engagement and job satisfaction.

Many economists attribute the Continent's higher unemployment and lower participation, if not also its lower productivity, to the Continent's social model -- in particular, the plethora of
social insurance entitlements and the taxes to pay for them. The standard argument is fallacious, though. The consequent reduction of after-tax wage rates is unlikely to be an enduring
disincentive to work, for reduced earnings will bring reduced saving; and once private wealth has fallen to its former ratio to after-tax wages, people will be as motivated to work as
before.

An indictment of entitlements has to focus on the huge "social wealth" that the welfare state creates at the stroke of the pen. Yet statistical tests of the effects of welfare spending on
employment yield erratic results. In any case, it is hard to see that scaling down entitlements would be transformative for economic performance. (Indeed, some economists see increased
wealth, social plus private, as raising the population's willingness to weather market shocks and helping entrepreneurs to finance innovation. I am skeptical.)

In my thesis, the Continental economies' root problem is a dearth of economic dynamism -- loosely, the rate of commercially successful innovation. A country's dynamism, being slow to
change, is not measured by the growth rate over any short- or medium-length span. The level of dynamism is a matter of how fertile the country is in coming up with innovative ideas
having prospects of profitability, how adept it is at identifying and nourishing the ideas with the best prospects, and how prepared it is in evaluating and trying out the new products and
methods that are launched onto the market.

There is evidence of such a dearth. Germany, Italy and France appear to possess less dynamism than do the U.S. and the others. Far fewer firms break into the top ranks in the former, and
fewer employees are reported to have jobs with extensive freedom in decision-making -- which is essential at companies engaged in novel, and thus creative, activity.

Further, I argue that the cause of that dearth of dynamism lies in the sort of "economic model" found in most, if not all, of the Continental countries. A country's economic model
determines its economic dynamism. The dynamism that the economic model possesses is in turn a crucial determinant of the country's economic performance: Where there is more
entrepreneurial activity -- and thus more innovation, as well as all the financial and managerial activity it leads to -- there are more jobs to fill, and those added jobs are relatively engaging
and fulfilling. Participation rises accordingly and productivity climbs to a higher path. Thus I see the sort of economic model operating in the Continental countries to be a major cause --
perhaps the largest cause -- of their lackluster performance characteristics.

There are two dimensions to a country's economic model. One part consists of its economic institutions. These institutions on the Continent do not look to be good for dynamism. They
typically exhibit a Balkanized/segmented financial sector favoring insiders, myriad impediments and penalties placed before outsider entrepreneurs, a consumer sector not venturesome
about new products or short of the needed education, union voting (not just advice) in management decisions, and state interventionism. Some studies of mine on what attributes
determine which of the advanced economies are the least vibrant -- or the least responsive to the stimulus of a technological revolution -- pointed to the strength in the less vibrant
economies of inhibiting institutions such as employment protection legislation and red tape, and to the weakness of enabling institutions, such as a well-functioning stock market and
ample liberal-arts education.

The other part of the economic model consists of various elements of the country's economic culture. Some cultural attributes in a country may have direct effects on performance -- on
top of their indirect effects through the institutions they foster. Values and attitudes are analogous to institutions -- some impede, others enable. They are as much a part of the
"economy," and possibly as important for how well it functions, as the institutions are. Clearly, any study of the sources of poor performance on the Continent that omits that part of the
system can yield results only of unknown reliability.

Of course, people may at bottom all want the same things. Yet not all people may have the instinct to demand and seek the things that best serve their ultimate goals. There is evidence
from University of Michigan "values surveys" that working-age people in the Continent's Big Three differ somewhat from those in the U.S. and the other comparator countries in the
number of them expressing various "values" in the workplace.

The values that might impact dynamism are of special interest here. Relatively few in the Big Three report that they want jobs offering opportunities for achievement (42% in France and
54% in Italy, versus an average of 73% in Canada and the U.S.); chances for initiative in the job (38% in France and 47% in Italy, as against an average of 53% in Canada and the U.S.),
and even interesting work (59% in France and Italy, versus an average of 71.5% in Canada and the U.K). Relatively few are keen on taking responsibility, or freedom (57% in Germany and
58% in France as against 61% in the U.S. and 65% in Canada), and relatively few are happy about taking orders (Italy 1.03, of a possible 3.0, and Germany 1.13, as against 1.34 in Canada
and 1.47 in the U.S.).

Perhaps many would be willing to take it for granted that the spirit of stimulation, problem-solving, mastery and discovery has impacts on a country's dynamism and thus on its economic
performance. In countries where that spirit is weak, an entrepreneurial type contemplating a start-up might be scared off by the prospect of having employees with little zest for any of
those experiences. And there might be few entrepreneurial types to begin with. As luck would have it, a study of 18 advanced countries I conducted last summer found that inter-country
differences in each of the performance indicators are significantly explained by the intercountry differences in the above cultural values. (Nearly all those values have significant
influence on most of the indicators.)

The weakness of these values on the Continent is not the only impediment to a revival of dynamism there. There is the solidarist aim of protecting the "social partners" -- communities
and regions, business owners, organized labor and the professions -- from disruptive market forces. There is also the consensualist aim of blocking business initiatives that lack the
consent of the "stakeholders" -- those, such as employees, customers and rival companies, thought to have a stake besides the owners. There is an intellectual current elevating
community and society over individual engagement and personal growth, which springs from antimaterialist and egalitarian strains in Western culture. There is also the "scientism" that
holds that state-directed research is the key to higher productivity. Equally, there is the tradition of hierarchical organization in Continental countries. Lastly, there a strain of
anti-commercialism. "A German would rather say he had inherited his fortune than say he made it himself," the economist Hans-Werner Sinn once remarked to me.

In my earlier work, I had organized my thinking around some intellectual currents -- solidarism, consensualism, anti-commercialism and conformism -- that emerged as a reaction on the
Continent to the Enlightenment and to capitalism in the 19th century. It would be understandable if such a climate had a dispiriting effect on potential entrepreneurs. But to be candid, I
had not imagined that Continental Man might be less entrepreneurial. It did not occur to me that he had less need for mental challenge, problem-solving, initiative and responsibility.

It may be that the Continentals finding, over the 19th and early 20th century, that there was little opportunity or reward to exercise freedom and responsibility, learned not to care much
about those values. Similarly, it may be that Americans, having assimilated large doses of freedom and initiative for generations, take those things for granted. That appears to be what
Tocqueville thought: "The greater involvement of Americans in governing themselves, their relatively broad education and their wider equality of opportunity all encourage the
emergence of the 'man of action' with the 'skill' to 'grasp the chance of the moment.'"

The most basic point to carry away is that the empirical results related here lend support to the Enlightenment theme that a nation's culture ultimately makes a difference for the nation's
economic performance in all its aspects -- productivity, prosperity and personal growth.

It was a mistake of the Continental Europeans to think that they expressed the right values -- right for them. These values led them to evolve economic models bringing in train a level of
economic performance with which most working-age people are now discontented. Perhaps the way out -- to go from unsatisfactory performance to high performance -- will require not
only reform of institutions but also a cultural shift that returns Europe to the philosophical roots that put it on the map to begin with.

Mr. Phelps, a professor at Columbia University, is the 2006 Nobel Laureate in economics.

22. World Bank Nears Rate Reduction Move Is Part of Compromise Navigated by Zoellick To Assist Poorest Nations
By BOB DAVIS
WSJ September 25, 2007

WASHINGTON -- For the first time in nearly a decade, the World Bank is poised to make significant cuts in the interest rates it charges China, Brazil, Mexico and other big developing countries as part of a deal to boost aid for the world's poorest nations.

According to bank officials, as part of the compromise, the World Bank will contribute as much as $3.5 billion to the International Development Association, a World Bank unit that provides grants and no-interest loans to the world's 80 poorest nations.
[World Bank]

The deal has been negotiated over the past few months and shows the difficulty in bridging longstanding fissures in the World Bank among impoverished countries, rich countries and those in the middle such as China and Brazil, all of which are the bank's shareholders. The compromise was pushed hard by the World Bank's new president, Robert Zoellick, who has emerged as a pragmatic horse trader, unsympathetic to conservative critics who say the bank should cut off lending to countries that can borrow easily on private markets.

"He believes in linking up poor countries, rich countries and middle-income countries as way of [producing] a more inclusive form of globalization," said a senior World Bank official. Bank officials wouldn't be identified speaking on the subject because the compromise is still being refined and must be approved by the bank's board, which is expected to meet again on the issue later this week. The bank is pushing for a final deal in time for its annual meeting here Oct. 19.

The World Bank largely finances itself by borrowing on world markets at very favorable rates because it is backed by the world's governments, and then lending that money at a higher rate to developing countries. But the IDA unit is traditionally funded by contributions from governments since it goes to countries too poor to pay money back with interest.

Every three years, the World Bank raises new funds for IDA. The $3.5 billion World Bank contribution to IDA is meant to encourage rich countries to boost their commitments, too. It is now looking for donors to commit between $25 billion and $30 billion for the three years ending June 30, 2011, compared with about $18 billion for the three preceding years, to cover a big increase in debt relief and pay for development projects.

Following the 1997-98 Asian financial crisis, the World Bank increased the interest rates on loans to middle-income countries -- such as China, Mexico and Brazil -- by about 0.25 percentage point. Even though the global economy recovered, it hasn't reduced the rate, aside from occasional waivers. Currently, middle-income countries pay rates of about 0.3 percentage point above the London interbank offered rate, or Libor, at which banks lend to each other.

For years, middle-income countries complained that the rates should be lowered, but they were stymied in the bank's governing executive board by wealthy nations such as the U.S., which didn't want the World Bank competing with private markets. The world's poorest nations also opposed a rate reduction, fearing that it would give a leg up on their somewhat-wealthier competitors.

But now a breakthrough is in the works, with Mr. Zoellick revamping proposals by France, the U.S. and other wealthy nations, according to bank officials. In exchange for lowering interest rates to pre-Asian-crisis levels, Mr. Zoellick pressed Brazil, Mexico, China and other middle-income countries to support a substantial contribution to IDA by the International Finance Corp., a World Bank arm that lends to private companies, rather than governments. Middle-income countries have long opposed such IFC contributions because they wanted the IFC to continue to focus on companies in their countries.

Last year, for the first time, the IFC contributed $150 million to IDA earmarked for private-sector development in poor nations. As part of the compromise, the IFC is increasing its contribution to as much as $1.75 billion over four years, World Bank officials said.

Officials at the IFC also opposed the deal for months, arguing the plan would distort the agency's mission to lend to the private sector. But the IFC relented after conversations with Mr. Zoellick, who was backed by many of the World Bank's wealthiest nations. Middle-income countries -- whose construction companies, airlines and utilities and other firms depend on IFC lending -- dropped their opposition to using IFC money in exchange for the rate cut on loans, bank officials said.

The World Bank unit that makes loans to governments in middle-income countries, the International Bank for Reconstruction and Development, is also expected to earmark as much as $1.75 billion to IDA. That unit has long contributed to IDA.

The compromise still has its critics. Some smaller European countries and poor countries worry that the U.S. and other large lenders will use the IFC contributions to IDA as an excuse to cut their own commitments to the poor.

A former U.S. trade negotiator, Mr. Zoellick looked for a deal that would tie together the bank's various constituencies and personally lobbied the board's 24 directors. Mr. Zoellick, who worked for about two years at Goldman Sachs before taking the World Bank job, has dismissed concern that lower interest rates would put the World Bank in more direct competition with the private sector.

"In my time at Goldman Sachs, I never heard once of the World Bank as competitor," he has told World Bank officials.

Write to Bob Davis at bob.davis@wsj.com
 
 

Monday, September 24, 2007 ~ 10:54 a.m., Dan Mitchell Wrote:
23. Why Not Let Belgium Disappear? The International Herald Tribune reports on the growing hostility between French and Dutch regions of Belgium, which has manifested itself in a three-month failure to form a government. But why is this bad news? First, the absence of a government means that politicians are not concocting silly new ideas to waste money and over-regulate the economy (which is also why gridlock is a good thing in America). But more importantly, why not let the country divorce? Or, at the very least, engage in radical decentralization so that the two regions (maybe three if Brussels becomes a capital city akin to DC) have complete fiscal autonomy?

      ...more than three months after a general election, Belgium has failed to create a government, producing a crisis so profound that it has led to a flood of warnings, predictions, even promises that the country is about to disappear. ...Officials from the former government - including former Prime Minister Guy Verhofstadt, who is ethnically Flemish - report for work and collect salaries. The former government is allowed to pay bills, implement previously-decided polices and make urgent decisions on peace and security. ...there is deep resentment in Flanders that its much-healthier economy must subsidize the Francophone south, where unemployment is double that of the north. ...Belgium has suffered through previous political crises and threats of partition. But a number of political analysts say that this one is different. The turning point is widely believed to have been last December when RTBF, a Francophone public television channel, broadcast a hoax on the break-up of Belgium. The two-hour live television report showed images of cheering, flag-waving Flemish nationalists and crowds of French-speaking Walloons preparing to leave, while also reporting that the king had fled the country. Panicked viewers called the station, and the prime minister's office condemned the program as irresponsible and tasteless. But for the first time, in the public imagination, the possibility of a breakup seemed real.
      http://www.iht.com/articles/2007/09/20/news/belgium.php
 
 

 24. Democracy in retreat around the world By Daniel Dombey in Washington http://www.ft.com/cms/s/0/692acca6-6ad8-11dc-9410-0000779fd2ac.html

Published: September 24 2007 22:00 | Last updated: September 24 2007 22:00

Democracy and good governance are on the retreat in a number of countries around the world, a wide-ranging report says on Tuesday.

The report, compiled by Freedom House, a US government-supported campaigning organisation, concludes that human rights and governance have worsened in Russia and Iran, arguing that corruption in Iran has intensified in spite of the campaign promises of President Mahmoud Ahmadi-Nejad.

It also indicates that states across the world are attempting to follow the model of China and Russia by seeking to modernise parts of their economy while keeping a central grip on power.

Among the countries that have achieved economic success while maintaining or intensifying what the report identifies as political repression are Libya, Tunisia and Algeria. It adds that Egypt has been both economically unsuccessful and politically repressive and that democratic developments have been stopped in their tracks by coups in Thailand and Bangladesh.

The survey of 30 countries comes as President George W.Bush prepares to address the United Nations on his “freedom agenda” for the world on Tuesday.

On taking office for the second time, Mr Bush pledged that America would seek to end “tyranny in our world”, and he prides himself on being a “dissident president”.

The White House says that “interrelated aspects of human freedom” will be at the heart of the president’s efforts during his time at the UN – whether the issue is Darfur, governance in Africa more generally, or the Middle East peace process.

But in an introductory essay to its survey, Freedom House highlights what it calls “the durability of a 21st century authoritarian capitalist model” pioneered by China.

It argues that Russia has followed a similar path of exploiting economic growth to minimise pressure for political reform and claims that Russia “has come to resemble the autocratic regimes of central Asia more than the consolidated democracies of eastern Europe”.

For the past two years “Russia could no longer be considered a democracy at all according to most metrics”, and is less democratic today than it was in 2005.

It highlights the high threshold for parties to be elected to the Russian parliament, opacity in the award of broadcasting licences, corruption, the rareness of jury trials and uneven enforcement of property rights.

“Civil society has been a clear target of the Russian government over the past two years,” Freedom House says.

On Iran, the report says that corruption has increased – as highlighted by cut-rate privatisations for favoured buyers and a failure to deposit billions of dollars in oil revenues in the national treasury on schedule.

It adds that restrictions on freedom of expression have worsened since Mr Ahmadi-Nejad was elected president in 2005.

“Journalists, particularly younger and less well-known ones, have little protection from arbitrary arrest and detention,” it says, adding that academics and non- governmental organisations with foreign contacts have increasingly been accused of breaking the law by committing “political offences”.

Copyright The Financial Times Limited 2007
 
 
 
 
 

25.Why Microsoft Was Wrong By NEELIE KROES
WSJ September 26, 2007

BRUSSELS -- U.S. and EU antitrust laws agree on most things, not least the objective of benefiting consumers.

This is hardly surprising. When Jean Monnet, one of the European Union's founders, was working on antitrust rules in the draft treaties over 50 years ago, he was heavily influenced by his many U.S. friends, in particular Harvard law professor Robert Bowie. Since then, discussion among academics, practitioners and enforcers on both sides of the Atlantic has never stopped. Both in Europe and America the objective is to find the best solution for consumers, the best way to solve competition problems so as to increase consumer welfare.
[Trust in Antitrust]

EU antitrust law achieves this objective to the tune of billions of dollars each year. By breaking up international cartels, it saves European consumers at least $6 billion every year. It has pushed down the price of international telephone calls in Europe by more than 40%. It led to the European Commission's fining France Telecom for pricing broadband in such a way that competitors that were every bit as efficient as France Telecom would be squeezed off the market. The result is that competitors are investing in the provision of broadband services and more consumers are using broadband in France than ever before. Eighteen percent of EU homes now have broadband, a figure that continues to rise rapidly. The Commission has recently acted against Spain's Telefónica for similar abuses.

Antitrust law also led the debate in favor of proposals, adopted last week, for far-reaching reforms to the EU energy market with an effective breakup of companies' supply and distribution businesses. That separation will eliminate conflicts of interest and lead to more investment and stronger competition, and a better deal for individuals and businesses. Sound rules, rigorously applied, benefit European consumers every day, for competition usually induces companies to offer the best products at the lowest prices.

Consumers benefit from competitive markets. So do the companies that compete on those markets. As a result of EU enforcement action, Deutsche Post separated its commercial activities from its letter monopoly business, allowing competitors like UPS better access to German customers. And the European Commission has acted against the drug company AstraZeneca for misuse of the patent system and the drug authorization system, which delayed market entry by generic drug manufacturers.

Antitrust law opens markets and keeps them open for companies to compete; it does not choose who wins. Inevitably, however, when a monopolist's abusive behavior is stopped, chances are that its competitors will have a stronger position on the market afterward. So when differences of opinion emerge across the Atlantic as to what to do in a particular case, we need to move beyond the simplistic rhetoric of whether one side protects consumers or competitors. I have more faith in both the EU and the U.S. systems of antitrust than that. Both systems are looking to increase the welfare of consumers. In practice there are far more similarities than differences in our approaches.

We have similar views on the iniquity of cartels, on the circumstances when mergers between competitors bring risks to consumers, on the rarer circumstances when mergers between suppliers and customers also bring risks to end-consumers. Cooperation between agencies in furthering these views is common: We regularly coordinate action in the U.S. and Europe to break up global cartels; faced with the same merger filings, we often coordinate information gathering to reduce the regulatory burden on notifying parties. Coordination is only possible because we are tackling these issues using essentially the same approach.

The work that the EU and U.S. authorities do around the world, spreading the gospel of free markets, is testament to our common approach. Both EU and U.S. representatives delivered the same messages to China during the preparation of its now-adopted Anti-Monopoly Law, not just about the importance of competition rules, but also about what those rules should contain.

Even in the field of unilateral behavior by monopolists, we agree on a lot: Antitrust law should rarely limit unilateral action by companies, even when those companies are monopolists. When looking at such conduct, the legal tests set out in their respective Microsoft cases by the U.S. Court of Appeals in Washington, D.C., on the one hand, and the EU Court of First Instance on the other, are largely the same. Both require a type of rule of reason analysis, looking not just at whether the potential consumer benefits outweigh the harm in the short run, but whether incentives to innovate will be maintained in the long run.

Maintaining the incentive for companies to innovate is vital to ensure that product markets remain dynamic, changing as improved products and production processes are introduced. In the Microsoft case decided last week in the EU, the court noted that not even Microsoft had argued that its incentive to innovate had been undermined by its previous practice of disclosing Windows desktop interoperability information. It is worth remembering that, in common with industry practice, Microsoft voluntarily used to provide information permitting interoperability between servers and its Windows desktop. Of course this was before Microsoft wanted to push its own server software; then the provision stopped. Even after Microsoft was later forced to resume providing certain interoperability information -- as part of the settlement it reached with the U.S. Department of Justice -- Microsoft stated that its incentives to innovate had not been undermined.

So if the differences do not lie in the objectives of the antitrust laws, or in the tests that we apply, do differences exist? To answer that question, we have to look at the substance. Fortunately there are people on both sides of the Atlantic doing just that. Federal Trade Commissioner J. Thomas Rosch has recently suggested that U.S. and EU antitrust policies are based, respectively, on "Chicago school" and "post-Chicago school" economics. The Chicago school taught that markets are inherently efficient, and that there is nothing a monopolist can do to keep a good competitor down. Work done since then -- the post-Chicago school -- suggests that life may not be that simple.

There is some truth to Commissioner Rosch's description of the EU's approach. Having worked in business for many years before becoming competition commissioner, I have difficulty seeing the real cutthroat world of business in the theoretical models of the Chicago school. They remind me of Dr. Pangloss in Voltaire's "Candide," believing that we live in the best of all possible worlds and that all is for the best. In reality, businesses do engage in strategic behavior to undermine their rivals. Where a well-established monopolist exploits its position to colonize neighboring markets, this can scare investors from funding competitors, undermine the incentive and ability of those competitors to invest and innovate, and drive out competitors who are as efficient as the monopolist. And monopolists exploiting their strategic position to conquer new markets are less likely to innovate than companies forced to compete for customers on the basis of the merits of their products.

To most people, this is just common sense: a straightforward description of the real world of business. There cannot be many businesspeople who doubt that a monopolist can use its market power to squash even the most efficient rival producers of goods or services that interact with the monopolized product. There cannot be many venture capitalists who would invest in a company whose market can at any moment fall under the sway of an entrenched neighboring monopolist whose behavior was subject to no limits.

What I will do is continue to look hard at the actions of monopolists. I will use my practical business experience to help me understand the dynamics of markets. I will look for answers that maintain the incentives of everyone on the market to innovate, and not just the friendly neighborhood monopolist. Power has to be used responsibly, by the enforcement agencies and by the monopolists. I will not look for fights, but where interventions will make consumers better off, I will not shy away from them.

Ms. Kroes is the European commissioner for competition.
 

26. EUROPE'S LAGGING SERVICE SECTOR
------------------------------------------------------------------------

Europe's failure to develop a thriving service sector is the main
culprit behind the fact that over the last fifty years, hours worked in
Europe have declined by almost 45 percent compared to hours worked in
the United States, says Richard Rogerson, research associate at the
National Bureau of Economic Research.

According to Rogerson:
   o   Typically, as a modern economy develops, employment is
       concentrated first in agriculture, then it moves to
       manufacturing, and finally, to services.
   o   Europe seems to have made it through the first two phases but
       then fumbled the transition to the service sector.
   o   This lack of service sector maturation goes a long way toward
       explaining the deterioration of European labor markets where,
       for some time now, unemployment rates have far exceeded those
       for the United States.
This anemic service sector growth is a by-product of a European tax
rate that is 15 to 20 percent higher than that of the United States,
says Rogerson.  Consider:
  o   At the same time that changing technology creates an economic
       force leading to greater hours worked in the service sector,
       Europe raises taxes, thus creating an opposing force that
       encourages services to be provided outside the market
   o   In other words, while in the United States it's now the norm
       for people to pay professional providers for services such as
       child care, elder care, cooking, cleaning, home repairs, and
       yard maintenance, Europeans -- with taxes taking more of their
       disposable income -- are more likely to do these things for
       themselves.

Rogerson calls this "home work" as opposed to "market
work."  And, he notes that there is evidence that if one adds
up the hours Europeans spend doing "home work" (which in the
United States is more likely to be handled by service providers), it
significantly offsets the differences in market work.

Source: Matthew Davis, "Europe's Lagging Service Sector,"
NBER Digest, September/October 2007; based upon: Richard Rogerson,
"Structural Transformation and the Deterioration of European Labor
Market Outcomes," NBER Working Paper No. 12889, February 2007.

For text:
http://www.nber.org/digest/septoct07/w12889.html
For report:
http://www.nber.org/papers/w12889
For more on Taxes:
http://www.ncpa.org/sub/dpd/?Article_Category=20
 

Tuesday, September 25, 2007 ~ 10:51 a.m., Dan Mitchell Wrote:
http://www.freedomandprosperity.org/blog/blog.shtml
27. European's Do Not Want American-Style Capitalism. The Financial Times reports on a poll showing that Europeans generally want more government intervention and have little desire for an "American-style" capitalist system. At the same time, the Europeans have little faith that they can compete in the modern economy. It is unclear, though, whether they understand that their support for bigger government is a reason why Europe has trouble competing with the rest of the world:

      Europeans have little faith that their continent can compete economically with fast-growing Asian countries – but are even more convinced that it should not become more like the US. …multinational corporations are seen by Europeans as more powerful than governments, while those polled generally believed that regulations protecting workers' rights should be strengthened rather than relaxed. …When asked whether Europe's economy should be more like that of the US, the results were clear-cut. Those saying it should not, included 78 per cent of Germans, 73 per cent of the French, 58 per cent of the Spanish. In both Italy and the UK, 46 per cent opposed the US model. …Asked if a free-market, capitalist economy was the best system, Spanish and German respondents agreed overall, but the French and Italians did not. The British were less clear, although there was more support than opposition for a "capitalist" system.
      http://www.ft.com/cms/s/0/22a93b12-69ea-11dc-a571-0000779fd2ac.html
 
 

28. Be Like Egypt
WESJ September 28, 2007

Egypt has a lot of problems these days, but Cairo deserves kudos for getting one important thing right: economic reform. The North African country has just won top billing in a newly released list of the world's fastest cutters of business-thwarting red tape.

The good news comes in the "Doing Business 2008" report just out from the World Bank's International Finance Corporation. The annual study ranks countries on a variety of measures of ease of doing business, from time required to obtain a business license to severity of minimum capital requirements to ease of hiring and firing to bankruptcy laws, and a lot in between. Singapore tops the overall league table this year, and others in the top 10 include usual suspects like the U.S., Hong Kong, Australia and Ireland.

More interesting than the snapshot, though, are all the changes in this year's rankings compared to last year's. The report's authors count about 200 significant pro-business reforms enacted in 98 countries. Bulgaria cut corporate and labor taxes and improved transparency of building inspections. Result: It's ranked 46 this year, up from 54 last year. Thailand smoothed electronic processing of customs formalities at the border, and rose to 15 from 18 on the list. The Dominican Republic cut import processing times, went online with tax registration and cut property registration times to 60 days from 107. It rose to 99th place this year from 117th.

And then there are the big reformers. Egypt slashed the minimum capital requirement to 1,000 Egyptian pounds ($179) from 50,000 pounds. It sliced property registration fees and shaved seven days off the time for processing imports. It still has a long way to go -- it now ranks 126 in the rankings, up from 165 a year ago -- but it is the top reformer in this year's report. China's new property and bankruptcy laws, among other reforms, also earn it a place among the top 10 reformers and pull its overall ranking up to 83 from 93. Colombia's extension of port operating hours, rationalization of customs inspections and gradual reductions in corporate tax rates put it in 66th place this year, up from 79.

For all the progress, much more remains to be done to unleash the potential of many of the world's entrepreneurs. The report's authors note that while easing business formation is in vogue, only eight countries loosened their labor markets (and four made labor laws more rigid). Some countries -- including Venezuela and Bangladesh -- fell backward in the list thanks to new anti-business measures. Still, it's hard not to be optimistic overall after thumbing through this report. More and more governments are cottoning on to the virtues of liberalization, and more and more people are reaping the benefits. Change can't come fast enough for many, but it is coming.
RELATED ARTICLES AND BLOGS
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•  Egypt, Saudi Arabia Rise In World Bank Rankings
 

29. Egypt, Saudi Arabia Rise In World Bank Rankings
By BOB DAVIS
WSJ September 26, 2007; Page A6

WASHINGTON -- Egypt and Saudi Arabia, long considered bureaucratic mazes, changed their laws and regulations to make it substantially easier to start and run businesses, according to a yearly World Bank report that tracks business reforms globally.
[World Bank]

Among the top 10 "reformers" cited by the World Bank in its fifth-annual ranking were four countries from Central and Eastern Europe (Croatia, Macedonia, Georgia and Bulgaria); two from the Middle East (Egypt and Saudi Arabia); two from Africa (Ghana and Kenya); and China and Colombia.

The bank has regularly lauded the Eastern European countries, China and Colombia for reducing barriers to business; the emergence of Saudi Arabia and Egypt is new. Egypt was listed as the top reformer, having made improvements in five of 10 categories affecting business tracked by the World Bank.

Developing nations compete with one another to move up on the World Bank rankings of 178 nations, figuring a better ranking will mean additional investment and, ultimately, economic growth.

The report also becomes a way for the World Bank's private-sector unit, International Finance Corp., to encourage economic ministries to press ahead with market-friendly changes. A computer simulation model on a World Bank Web site, www.doingbusiness.org, lets officials see how changes in, say, their bankruptcy or tax rules would likely affect their standings.
[globe] MORE
 
• Click here for an interactive Google map with details on every country in the world (link is to an external site).
• Doing Business
www.doingbusiness.org

The World Bank guards the results of the overall rankings closely. Countries promote themselves in anticipation of better ratings. A week ago, a Kazakhstan economic official predicted his country would move up substantially from its 63rd slot because of the steps it had taken to make it easier for businesses to operate in the country. Instead, the country fell to No. 71 because the pace of overhaul in other countries was more rapid. The bank also added three countries to its rankings this year.

Among the 10 areas tracked by the World Bank are regulations involved in starting businesses, obtaining licenses, registering property, getting credit, paying taxes and closing businesses. Saudi Arabia, for instance, has been among the toughest places in the world to start a business. The country cut layers of bureaucracy and reduced the time to approve start-ups to 15 days from 39. Saudi Arabia jumped 15 places in the overall rankings to No. 23.

Egypt slashed the minimum capital requirement to start a business to 10,000 Egyptian pounds ($1,800) from 50,000 Egyptian pounds. Two years ago in Croatia, it took 956 days to register property; now it takes 174 days, the World Bank report found.

There is no clear link between a country's overall ranking and its economic well-being. China, the economic star of the past two decades, was in the middle of the pack this year at No. 83, while India, whose economy has taken off in the past few years, lagged behind at No. 120. Bank economists say a country's ranking is less important than its change over the past several years. Two years ago, China was No. 108, and India was No. 138; their rise in the ranking reflects the progress they have made.

Venezuela was the country that has dropped the farthest in the rankings. In search of what President Hugo Chávez calls "21st Century Socialism," Venezuela has nationalized industries and made it harder for companies to get export licenses and to fire workers, all of which discouraged investment outside the oil sector. Two years ago, the country was ranked No. 144; this year, it came in at No. 172.

Write to Bob Davis at bob.davis@wsj.com
 
 

 30. Mexico's economy Braced for contagion

Sep 27th 2007 | MEXICO CITY
From The Economist print edition
More resilient but still exposed

TIME was when the Mexican economy moved to the rhythm of the oil price. But since the signing of the North American Free-Trade Agreement in 1992, it is the pace of industrial production in the United States that sets the beat south of the border (see chart). When the American economy slowed in 2001, Mexico suffered two years of stagnation. As fears of an American recession deepen, will it be different for Mexico this time?

More than 70% of Mexico's exports go to the United States. Manufacturing in its northern states is bound to slow in line with its American counterpart. But many economists see grounds for hoping that the country can ride out a shallow recession across the border more successfully than it did in 2001.

Mexican consumers are spending more than they did in the past. And this time policymakers may not have to rein them in. Indeed, the government is better placed to stimulate the economy if that is needed. The government's finances are close to balance; most government debt is now long-term and denominated in pesos, rather than dollars. Mexico's still modest credit market has continued growing; bank lending rose by 26% in the year to July. Housebuilding, backed by government programmes, remains robust. Mexico's president, Felipe Calderón, this month gained approval for a tax reform which should pay for extra public investment in roads and other infrastructure.

Recently, much foreign direct investment has gone to services rather than manufacturing. That should continue, and would help to cover any current-account deficit. Officials think that tourism revenues will not drop much even if the American economy slows. Guillermo Güémez García, a deputy governor of the central bank, argues that although some Americans may stay at home, others will choose Mexico instead of more expensive and distant destinations. He also notes that because the peso has tracked the dollar, Mexican exporters may gain market share across the border at the expense of rivals battling with stronger currencies.

The finance ministry still reckons that Mexico's economy will grow by 3.7% in 2008. Héctor Chávez of Banco Santander, a Spanish-owned bank, says that if the American economy grows at 2%, Mexico can manage 3%. But the latest economic data from the United States make all these figures look optimistic. A sharper slowdown will strengthen the government's case that Mexico's state-owned oil industry, whose output is falling, needs reform and liberalisation. For once, a crisis—if it proves to be one—really could be an opportunity.

 Peru
31. Fugitive returned

Sep 27th 2007 | LIMA
From The Economist print edition
A landmark extradition sees Alberto Fujimori facing justice

Reuters

FOR much of his decade as president between 1990 and 2000, Peruvians saw Alberto Fujimori as a saviour. He conquered the hyperinflation bequeathed by his predecessor, Alan García, and restored growth. With Vladimiro Montesinos, his shadowy intelligence chief, he crushed the Maoist terrorists of the Shining Path and locked up their leader, Abimael Guzmán. Now the saviour has joined Messrs Montesinos and Guzmán behind bars.

There was always a dark side to Mr Fujimori. Though twice freely elected, he shut down his country's Congress in 1992 and used other strong-arm methods. He fled to Japan in 2000 after trying fraudulently to win a third, unconstitutional term. In November 2005 he flew to Chile, in an apparent bid to slip back into Peru and rally his supporters for last year's presidential election. There he was arrested at the Peruvian government's request.

In a decision hailed by human-rights campaigners, Chile's Supreme Court ruled on September 21st that Mr Fujimori should be extradited to Peru to face seven sets of charges. These include complicity in the actions of the Colina Group, an army death squad that killed 25 civilians in two separate incidents (one of them involved the slaughter of those attending a barbecue which the intelligence service believed was to raise funds for Shining Path). Most of the charges relate to corruption: the most sinister feature of Mr Fujimori's rule was the unlimited power granted to Mr Montesinos to bribe and extort on a scale that prosecutors say topped $1 billion.

Mr Fujimori claims not to have known the doings of his spy chief. But Mr Montesinos, who has already been found guilty on several charges and is serving a 20-year jail sentence, will be a key figure in his trials. Mr Montesinos and several members of the army are still being tried for the actions of the Colina group.

The Fujimori case had the potential to strain Peru's relations with Chile, which while much improved are easily inflamed by hurt from defeat in 19th-century wars. But Chile's Supreme Court stuck to the letter of the country's law. In approving extradition while rejecting six of the charges, it mainly based itself on Chile's own penal code rather than on international norms.

Nevertheless, some lawyers see the verdict as a wider turning point. The court followed the ruling of Britain's House of Lords in the case of Chile's former dictator, Augusto Pinochet, in dismissing defence arguments that Mr Fujimori, as a former head of state, enjoyed immunity from criminal prosecution.

José Miguel Vivanco of Human Rights Watch, a New York-based group, points out that the Fujimori case marks the first time that a court has extradited a former head of state for trial in his own country, rather than by an international tribunal. In doing so, Chile's Supreme Court, one of the more formalistic and conservative in Latin America, has up-ended the region's long tradition of granting political asylum to former rulers. Under that tradition, Panama shelters several disgraced presidents, including Haiti's Raoul Cédras.

Another former Haitian dictator, Jean-Claude Duvalier, this week asked forgiveness of his country. Mr Duvalier, in exile in France since 1986, is believed to want to return home after running out of money. But the country's president, René Préval, said his government would press ahead with efforts to recover money he believed was stolen during Mr Duvalier's rule.

Mr Fujimori's case will be a test for Peru's judges and for Mr García who, in an irony of history, is again its president. The judiciary was undermined when Mr Fujimori appointed pliant judges in the 1990s. It has since taken steps towards greater professionalism. The defendant enjoys certain privileges: as a former head of state, he will be tried by the Supreme Court, and under international law he can be tried only for those matters on which the Chilean judges approved his extradition.

In 1992 Mr García himself sought asylum in Colombia, fearing corruption charges from Mr Fujimori (they were eventually dropped). Since winning last year's election, having campaigned as a free-marketeer, he has relied for a legislative majority on the backing of Mr Fujimori's supporters. They are now led by Mr Fujimori's daughter, Keiko, who won 603,000 votes in Lima, three times more than any other congressional candidate.

That alliance is now under strain. Mr Fujimori is being held at a police base, rather than under house arrest as he hoped. Mr García says his former adversary's fate should be decided strictly according to the law. Ms Fujimori, who is likely to run for the presidency in 2011, calls her father the victim of a vendetta.

In trying to return to Peru, Mr Fujimori seemed to hope that he would again be greeted as a saviour. But Peru has moved on: in polls, a majority say they would never vote for him. Ms Fujimori has some of her father's political talents, and Peru's politics is notoriously unpredictable. But rather than the return to the presidential palace he dreamed of, it may be Mr Fujimori's fate to join Mr Montesinos and Mr Guzmán in the high-security jail he himself ordered built in a naval fortress.
 

32. CHILE'S DISABILITY SYSTEM
------------------------------------------------------------------------

Twenty-five years ago, Chile replaced its disability insurance system
with one in which workers contribute to accounts they individually
own.  The new disability system is very innovative and could be a
model for countries that rely on pay-as-you-go (PAYGO) systems, where
the taxes of today's workers fund the benefits of today's retirees, say
Estelle James, a consultant to the World Bank and other organizations,
and Augusto Iglesias, a senior partner of PrimAmérica
Consultores.

Features of Chile's disability system:

   o   Like the old age system, it is pre-funded, so each generation
       covers its own disability costs.
   o   Private pension funds and insurance companies participate in
       the process of assessing workers' disabilities and financially
       benefit from controlling costs.
   o   Disability rates and costs in the new system are lower than
       in the old system and lower than in most other countries.

Disabled workers who qualify are guaranteed a defined benefit for the
balance of their lives:  70 percent of their average wage (if
totally disabled) and 50 percent (if partially disabled).  The
benefit is funded in two ways:
   o   First, the money in the worker's retirement account is
       available in case of a disability.
   o   Secondly, if the amount in the account is insufficient to pay
       for a lifetime annuity at the specified level, the balance is
       funded by a group disability insurance policy purchased by
       each pension fund and paid for by its affiliated
       workers.
   o   Survivors' benefits for the spouse and minor children of a
       deceased worker are covered by the same group disability and
       survivors (D&S) insurance contract.
   o   Thus, at the point when a worker has been certified as
       permanently disabled, his entire lifetime defined benefit has
       been funded by a combination of his own retirement account and
       a top-up from the D&S insurance.
   o   This means that costs are not passed on to future
       generations.

Source: Estelle James and Augusto Iglesias, "Integrated Disability
and Retirement Systems in Chile," National Center for Policy
Analysis, Policy Report No. 302, September 2007.

For text:
http://www.ncpa.org/pub/st/st302/
For more on Social Security Issues:
http://www.ncpa.org/sub/dpd/?Article_Category=39
 
 

33. Corporations Shouldn't Be Democracies
By LYNN A. STOUT
WSJ September 27, 2007; Page A17

Securities and Exchange Commission Chairman Christopher Cox faces a critical decision. Oct. 2 is the deadline for comment on two different proposed SEC rules for governing director elections in U.S. corporations.

One "proxy access" rule, backed by the SEC's Democratic commissioners, would transform U.S. corporate law by requiring companies to pay the expenses of dissident shareholders seeking to replace the company's board or directors. The other, a "no access" rule backed by the agency's Republicans, preserves longstanding regulations that discourage shareholder activism by requiring that dissidents use their own funds to mount a proxy fight. The chairman holds the swing vote that will determine which rule is passed.

Mr. Cox should vote "no access." The proposed proxy access rule is driven by the emotional claim, unsupported by evidence, that American corporations benefit from "shareholder democracy."

Successful corporations are not, and never have been, democratic institutions. Since the public corporation first evolved over a century ago, U.S law has discouraged shareholders from taking an active role in corporate governance, and this "hands off" approach has proven a recipe for tremendous success.

According to the Economist, 13 of the world's 30 largest corporations are American. Japan (which is also famously unfriendly to shareholders) is runner-up with six of the largest firms, while Germany and France tie for third place with three each. No other nation on earth comes close in terms of nurturing great corporations.

Companies seem to succeed best when they are controlled by boards of directors, not by shareholders. Why? One obvious advantage of board control is more informed and efficient decision making. An even more important factor, however, is that board control "locks in" and protects corporate assets and investment capital.

Corporations typically pursue projects that require huge sunk-cost investments. In the 19th and 20th centuries, they built railroads, canals and factories. Today they design complex software and electronics, produce new drugs and medical treatments, and create valuable trademarks and brand names. Board control over corporate assets protects those assets and gives them time to work, allowing shareholders collectively to recoup the value of their initial investment (and then some) over the long haul.

Conversely, long-term investment becomes impossible if shareholders have the power to drain cash out of the firm at any time -- say, by threatening to remove directors who refuse to cut expenses or sell assets in order to pay shareholders a special dividend or fund a massive share repurchase program.

Whether out of ignorance, greed, or short-sightedness, these are exactly the sorts of threats that today's activist shareholders, usually at hedge funds, typically make. Consider Carl Icahn's demand this past spring that Motorola undertake a massive stock buyback program, at a time when the company desperately needed to invest in research and development to produce a successor product to its RAZR cellphone. By giving activists even greater leverage over boards, the SEC's proposed proxy access rule will undermine American corporations' ability to do exactly what investors, and the larger society, want them to do: pursue big, long-term, innovative business projects.

For evidence of this we need only compare the U.S. experience with that of our Anglo-Saxon corporate cousins across the Atlantic. American corporate law severely limits shareholders' rights. So does Japanese, German and French corporate law. In contrast, the United Kingdom seems a paradise for shareholders. In the U.K., shareholders can call a meeting to remove the board of directors at any time. They can pass resolutions telling boards to take certain actions, they are entitled to vote on dividends and CEO pay, and they can force a board to accept a hostile takeover bid the board would prefer to reject. (In the U.S., boards can "just say no.")

Yet the U.K. is headquarters to just one and a half of the world's 30 largest companies, BP and the "Royal" half of Royal Dutch Shell. Even the tiny Netherlands has nurtured more great corporations (2.5 to the U.K.'s 1.5).

If shareholder democracy were good for corporations and investors, the U.K. would be a corporate powerhouse. Instead, it's an also-ran in the global race for corporate competitiveness. The SEC shouldn't mess with U.S. corporate success. Shareholder democracy is a shallow idea based on a fundamental misunderstanding of what makes good companies tick. Chairman Cox, and the SEC, should reject it.

Ms. Stout is a law professor at UCLA and the principal investigator for the UCLA-Sloan Foundation Research Program on Business Organizations.
 
 
 
 
 
 
 

34. Rupee Whiplash
WSJ September 27, 2007

The Indian central bank is driving toward capital account convertibility.
 
 

Watch out for whiplash in Mumbai. Only a month after tinkering with capital controls, the Reserve Bank of India reversed course on Tuesday and liberalized a wide range of capital outflows. That's a far better road to take for the health of India's economy.

Tuesday's announcement doubled the maximum amount individuals can invest abroad to $200,000 a year, lifted the cap on mutual fund investments abroad, and boosted the amount that companies can invest overseas. The central bank is driving toward capital account convertibility.

For decades, India disadvantaged its companies and investors by controlling when and where they could invest. In an age of globalized markets, that strategy looks dated, not to mention foolhardy. Restricting investment options concentrates risk and lower returns.

The central bank has been untangling this mess at a leisurely pace -- until now. As foreign direct investment, portfolio flows, and other money pour into the country, the rupee has been heading skyward, stoking fears that India's exports could get dearer.

That put the bank in a bind. Without liberalizing the capital account, the central bank could only mop up the incoming flows (which is expensive) or impose capital controls. The RBI tried both this year, and the rupee only rose higher. So now it's moving to freer markets.

Tuesday's move may not ease the rupee appreciation; India's economy is hot, so many investors may keep their money at home. But every market has cycles. The more choices India's companies and investors have, the better they'll weather the ups and downs.
 
 
 
 
 

35. What Made Chavez Possible?   Font Size:
By Alvaro Vargas Llosa : BIO| 27 Sep 2007
  Discuss This Story! (12)   Email  |   Print |  Bookmark |  Save
 
What made Hugo Chavez possible? How does a country let a man whose credentials are those of a coup leader who tried to topple a legitimate government become the unbridled ruler of the nation? What kind of people applaud a president who would replace the republican institutions with a system -- socialism -- that was so discredited in the 20th century?

Some of the answers to these troubling questions can be found in a paper written by professor Hugo Faria and sponsored by the Institute of Superior Administration Studies and Monteavila University in Caracas -- "Hugo Chavez Against the Backdrop of Venezuelan Economic and Political History." This is not a purely academic exercise.

Latin America's history shows that populist strongmen keep appearing with astonishing frequency. Understanding why Chavez came to power almost a decade ago and is now poised through a constitutional amendment to become president-for-life is a necessary step in trying to halt the emergence of future populist strongmen.

In the first half of the 20th century, Venezuela had a relatively free economy even though its political system was undemocratic. Far from giving rise to a typical state-run economy dependent on its natural resources, the discovery of oil in 1918 gave impetus to a free-market system that led to impressive results. Manufacturing and services, in addition to oil, expanded at rates greater than the economy as a whole.

The Central Bank was autonomous, the marginal income tax rate was 12 percent, the public sector absorbed no more than one-fifth of the nation's production and the government ran surpluses every year. By 1960, the average Venezuela worker earned 84 cents for every dollar made by the average American worker.

But then something went wrong. It started under the dictatorial government of the 1950s and gathered pace when democracy came to Venezuela in 1958. Venezuelans went from being mostly self-relying entrepreneurs to depending on a government that began to grow -- and grow. Professor Faria thinks that economic success led to a desire for political participation -- i.e., democratic government, which in turn generated all sorts of pressures on a new political elite bent on pandering to the people's instincts for dependency rather than hard work.

"The inception of democracy," Faria says, "brought more redistributionist policies and a greater influence of rent-seeking groups that had the effect of undermining the economic freedoms." The results were high fiscal spending, limits on foreign investment, a wave of nationalizations and the politicization of the currency and the judiciary. Between 1960 and 1997, the year before Chavez gained power, Venezuela's real income per capita shrank by an average annual rate of 0.13 percent.

I would add another explanation to the one given by Faria for the move toward big government after the establishment of democracy in Venezuela -- the political culture of the Latin American elites. They were profoundly influenced by the nationalist ideas in vogue at the time -- that development was only possible by breaking away from the international centers of power and the creation of domestic markets through government protection. The policies associated with these ideas -- import substitution, nationalizations, currency manipulation, price controls -- were deeply ingrained in the political mind of Latin America.

By the time Chavez campaigned for an end to the "Punto Fijo" system -- the name by which the four decades of democratic rule between 1958 and 1998 are known in Venezuela -- the people had no faith in their republican institutions. They had no memory of the small-government days and they associated the Venezuelan economy with free-market exploitation because a few groups close to the state seemed to prosper at the expense of everyone else.

Tragically, Venezuelans inadvertently put their faith in a man who guaranteed that a system that had impoverished the country would be perpetuated. Nothing Chavez has done -- handouts, nationalizations, land expropriations, price controls, taxes -- is new. Under the governments of Romulo Betancourt, Raul Leoni, Rafael Caldera (twice), Carlos Andres Perez (twice), Luis Herrera and Jaime Lusinchi, those policies were also implemented in different degrees and mixes. The price of oil was not as high as it is today, so the shortcomings were less easily concealed than they are in present-day Venezuela.

The immense responsibility of previous democratic governments in Chavez's rise is one that Latin Americans should never forget. It was not liberal democracy as such but leaders acting under its mantle that made Chavez the man who is seeking "indefinite" re-election today. What a sad story.
 
 
 
 
 
 
 
 

hursday, September 27, 2007 ~ 12:30 p.m., Dan Mitchell Wrote:
36. IBD Celebrates the Global Flat Tax Revolution. The dramatic shift to low-rate tax systems gets a thumbs-up from Investor's Business Daily:

      Since 1994, Estonia's flax tax rate has decreased steadily from an original 26% to its current 22%. It applies to all personal and corporate income with no deductions. ...Nearby nations soon began getting their feet wet. First, Latvia and Lithuania, both at rates of about 25%. Then Russia in 2001 enacted a flat tax on personal income at 13%; revenues doubled there in less than three years. Serbia followed in 2003 with a 14% flat rate. Ukraine set its flat tax at 13% in 2004. Slovakia activated its 19% flat rate the same year. Romania's flat tax was pegged at 16% in 2005. Georgia outdid them all, passing a 12% flat tax into law on an overwhelming parliamentary vote just before Christmas 2004. Macedonia's flat tax rate, inaugurated this year, is also 12%. Global legal expert David Storobin considers the flat tax the mark of a New Europe. "Tax reforms in Eastern Europe are having a tremendous effect on Western European economies, as companies are bound to move to neighboring states to avoid paying the near-confiscatory taxation (especially when you combine the income tax with corporate, capital gains and dividend taxes) levied in the 'Old Europe' to support the Welfare State system," Storobin wrote... It is in the midst of this revolutionary fervor that Albania and Bulgaria will give the go-ahead to a 10% flat tax next year while the Czech Republic will begin enjoying a flat rate of 15% in 2008. Then there's the small nation of Montenegro, which actually plans a 9% flat tax in 2010. ...The results of the flat tax have been astounding. A former economic backwater like Slovakia has seen skyrocketing job growth, a 9% GDP rate last year, the unearthing of its underground economy, and billions in investment from the likes of Hyundai and Sony.
      http://www.ibdeditorials.com/IBDArticles.aspx?id=275524561948107

37. The 4 Boneheaded Biases of Stupid Voters (And we're all stupid voters.) Bryan Caplan | October 2007 Print Edition Reason Magazine

http://www.reason.com/news/show/122019.html

Almost all the “respectable” economic theories of politics begin by assuming that the typical citizen understands economics and votes accordingly—at least on average. By a “miracle of aggregation,” random errors are supposed to balance themselves out. But this works only if voters’ errors are random, not systematic.

The evidence—most notably, the results of the 1996 Survey of Americans and Economists on the Economy—shows that the general public’s views on economics not only are different from those of professional economists but are less accurate, and in predictable ways. The public really does generally hold, for starters, that prices are not governed by supply and demand, that protectionism helps the economy, that saving labor is a bad idea, and that living standards are falling. Economics journals regularly reject theoretical papers that explicitly recognize these biases. In a well-known piece in the Journal of Political Economy in 1995, the economists Stephen Coate and Stephen Morris worry that some of their colleagues are smuggling in the “unreasonable assumptions” that voters “have biased beliefs about the effects of policies” and “could be persistently fooled.” That’s the economist’s standard view of systematic voter bias: that it doesn’t exist.

Or at least, that’s what economists say as researchers. As teachers, curiously, most economists adopt a different approach. When the latest batch of freshmen shows up for Econ 1, textbook authors and instructors still try to separate students from their prejudices. In the words of the famed economist Paul Krugman, they try “to vaccinate the minds of our undergraduates against the misconceptions that are so predominant in educated discussion.”

Out of all the complaints that economists lodge against laymen, four families of beliefs stand out: the anti-market bias, the anti-foreign bias, the make-work bias, and the pessimistic bias.

Anti-Market Bias
I first learned about farm price supports in the produce section of the grocery store. I was in kindergarten. My mother explained that price supports seemed to make fruits and vegetables more expensive but assured me that this conclusion was simplistic. If the supports went away, so many farms would go out of business that prices would soon be higher than ever. I accepted what she told me and felt a lingering sense that price competition is bad for buyer and seller alike.

This was one of my first memorable encounters with anti-market bias, a tendency to underestimate the economic benefits of the market mechanism. The public has severe doubts about how much it can count on profit-seeking business to produce socially beneficial outcomes. People focus on the motives of business and neglect the discipline imposed by competition. While economists admit that profit maximization plus market imperfections can yield bad results, noneconomists tend to view successful greed as socially harmful per se.

Joseph Schumpeter, arguably the greatest historian of economic thought, matter-of-factly spoke of “the ineradicable prejudice that every action intended to serve the profit interest must be anti-social by this fact alone.” Anti-market bias, he implied, is not a temporary, culturally specific aberration. It is a deeply rooted pattern of human thinking that has frustrated economists for generations.

There are too many variations on anti-market bias to list them all. Probably the most common error of this sort is to equate market payments with transfers, ignoring their incentive properties. (A transfer, in economic jargon, is a no-strings-attached movement of wealth from one person to another.) All that matters, then, is how much you empathize with the transfer’s recipient compared to the transfer’s provider. People tend, for example, to see profits as a gift to the rich. So unless you perversely pity the rich more than the poor, limiting profits seems like common sense.

Yet profits are not a handout but a quid pro quo: If you want to get rich, you have to do something people will pay for. Profits give incentives to reduce production costs, move resources from less-valued to more-valued industries, and dream up new products. This is the central lesson of The Wealth of Nations: The “invisible hand” quietly persuades selfish businessmen to serve the public good. For modern economists, these are truisms, yet teachers of economics keep quoting and requoting this passage. Why? Because Adam Smith’s thesis was counterintuitive to his contemporaries, and it remains counterintuitive today.

A prejudice similar to the one against profit has dogged interest, from ancient Athens to modern Islamabad. Like profit, interest is not a gift but a quid pro quo: The lender earns interest in exchange for delaying his consumption. A government that successfully stamped out interest payments would be no friend to those in need of credit, since that policy would crush lending as well.

Anti-market biases lead people to misunderstand and reject even policies they should, given their preferences for end results, support. For example, the Princeton economist Alan Blinder blames opposition to tradable pollution permits on anti-market bias. Why let people “pay to pollute,” when we can force them to cease and desist?

The textbook answer is that tradable permits get you more pollution abatement for the same cost. The firms able to cut their emissions cheaply do so, selling their excess pollution quotas to less flexible polluters. End result: more abatement bang for your buck. But noneconomists, including relatively sophisticated policy insiders, disagree. In his 1987 book Hard Heads, Soft Hearts, Blinder discusses a fascinating survey of 63 environmentalists, congressional staffers, and industry lobbyists. Not one could explain economists’ standard rationale for tradable permits.

The second most prominent avatar of anti-market bias is monopoly theories of price. Economists acknowledge that monopolies exist. But the public habitually makes monopoly a scapegoat for scarcity. The idea that supply and demand usually control prices is hard to accept. Even in industries with many firms, noneconomists treat prices as a function of CEO intentions and conspiracies.

Historically, it has been especially common for the public to pick out middlemen as uniquely vicious “monopolists.” Look at these parasites: They buy products, “mark them up,” and then resell us the “exact same thing.” Economists have a standard response. Transportation, storage, and distribution are valuable services—a fact that becomes obvious whenever you need a cold drink in the middle of nowhere. Like most valuable services, they are not costless. The most that is reasonable to ask, then, is not that middlemen work for free, but that they face the daily test of competition.

One specific price, the price for labor, is often thought to be the result of conspiracy: capitalists joining forces to keep wages at the subsistence level. More literate defenders of this fallacy point out that Adam Smith himself worried about employer conspiracies, overlooking the fact that in Smith’s time high transportation and communication costs left workers with far fewer alternative employers.

In the Third World, of course, the number of employment options is often substantially lower than in developed countries. But if there really were a vast employer conspiracy to hold down wages, the Third World would be an especially profitable place to invest. Query: Does investing your life savings in poor countries seem like a painless way to get rich quick? If not, you at least tacitly accept economists’ sad-but-true theory of Third World poverty: Its workers earn low wages because their productivity is low, due partly to lower skill levels and partly to anti-growth public policies.

Collusion aside, the public’s implicit model of price determination is that businesses are monopolists of variable altruism. If a CEO feels greedy when he wakes up, he raises his price—or puts low-quality merchandise on the shelves. Nice guys charge fair prices for good products; greedy scoundrels gouge with impunity for junk. It is only a short step for market skeptics to add “…and nice guys finish last.”

Where does the public go wrong? For one thing, asking for more can get you less. Giving your boss the ultimatum “Double my pay or I quit” usually ends badly. The same holds in business: Raising prices and cutting quality often lead to lower profits, not higher. Many strategies that work as a one-shot scam backfire as routine policies. It is hard to make a profit if no one sets foot in your store twice. Intelligent greed militates against dishonesty and discourtesy because they damage the seller’s reputation.

An outsider who eavesdrops on economists’ discussions might get the impression that the benefits of markets remain controversial. But economists who debate certain issues about the perfection of markets are not debating, say, whether prices give incentives. Almost all economists recognize the core benefits of the market mechanism; they disagree only at the margin. Widespread bias against market mechanisms as reasonably efficient means of meeting human needs affects politicians’ incentives in almost every decision they make. It is perhaps most relevant today in the debate over whether the American health care system needs more markets and choice or more central control.

Anti-Foreign Bias
A shrewd businessman I know has long thought that everything wrong in the American economy could be solved with two expedients: 1) a naval blockade of Japan, and 2) a Berlin Wall at the Mexican border.

Like most noneconomists, he suffers from anti-foreign bias, a tendency to underestimate the economic benefits of interaction with foreigners. Popular metaphors equate international trade with racing and warfare, so you might say that anti-foreign views are embedded in our language. Perhaps foreigners are sneakier, craftier, or greedier. Whatever the reason, they supposedly have a special power to exploit us.

There is probably no other popular opinion that economists have found so enduringly objectionable. In The Wealth of Nations, Adam Smith admonishes his countrymen: “What is prudence in the conduct of every private family, can scarce be folly in a great kingdom. If a foreign country can supply us with a commodity cheaper than we ourselves can make it, better buy it of them with some part of the produce of our own industry.”

As far as his peers were concerned, Smith’s arguments won the day. More than a century later, Simon Newcomb could securely observe in the Quarterly Journal of Economics that “one of the most marked points of antagonism between the ideas of the economists since Adam Smith and those which governed the commercial policy of nations before his time is found in the case of foreign trade.” There was a little backsliding during the Great Depression, but economists’ pro-foreign views abide to this day.

Even theorists, such as Paul Krugman, who specialize in exceptions to the optimality of free trade frequently downplay their findings as abstract curiosities. As Krugman wrote in his 1996 book Pop Internationalism: “This innovative stuff is not a priority for today’s undergraduates. In the last decade of the 20th century, the essential things to teach students are still the insights of Hume and Ricardo. That is, we need to teach them that trade deficits are self-correcting and that the benefits of trade do not depend on a country having an absolute advantage over its rivals.”

Economics textbooks teach that total output increases if producers specialize and trade. On an individual level, who could deny it? Imagine how much time it would take to grow your own food, while a few hours’ wages spent at the grocery store can feed you for weeks. Analogies between individual and social behavior are at times misleading, but this is not one of those times. International trade is, as the economic writer Steven Landsburg explains in his 1993 book The Armchair Economist, a technology: “There are two technologies for producing automobiles in America. One is to manufacture them in Detroit, and the other is to grow them in Iowa. Everybody knows about the first technology; let me tell you about the second. First you plant seeds, which are the raw materials from which automobiles are constructed. You wait a few months until wheat appears. Then you harvest the wheat, load it onto ships, and sail the ships westward into the Pacific Ocean. After a few months, the ships reappear with Toyotas on them.”

How can anyone overlook trade’s remarkable benefits? Adam Smith, along with many 18th- and 19th-century economists, identifies the root error as misidentification of money and wealth: “A rich country, in the same manner as a rich man, is supposed to be a country abounding in money; and to heap up gold and silver in any country is supposed to be the best way to enrich it.” It follows that trade is zero sum, since the only way for a country to make its balance more favorable is to make another country’s balance less favorable.

Even in Smith’s day, however, his story was probably too clever by half. The root error behind 18th-century mercantilism was an unreasonable distrust of foreigners. Otherwise, why would people focus on money draining out of “the nation” but not “the region,” “the city,” “the village,” or “the family”? Anyone who consistently equated money with wealth would fear all outflows of precious metals. In practice, human beings then and now commit the balance of trade fallacy only when other countries enter the picture. No one loses sleep about the trade balance between California and Nevada, or me and iTunes. The fallacy is not treating all purchases as a cost but treating foreign purchases as a cost.

Anti-foreign bias is easier to spot nowadays. To take one prominent example, immigration is far more of an issue now than it was in Smith’s time. Economists are predictably quick to see the benefits of immigration. Trade in labor is roughly the same as trade in goods. Specialization and exchange raise output—for instance, by letting skilled American moms return to work by hiring Mexican nannies.

In terms of the balance of payments, immigration is a nonissue. If an immigrant moves from Mexico City to New York and spends all his earnings in his new homeland, the balance of trade does not change. Yet the public still looks on immigration as a bald misfortune: jobs lost, wages reduced, public services consumed. Many in the general public see immigration as a distinct danger, independent of, and more frightening than, an unfavorable balance of trade. People feel all the more vulnerable when they reflect that these foreigners are not just selling us their products. They live among us.

It is misleading to think of “foreignness” as a simple either/or. From the viewpoint of the typical American, Canadians are less foreign than the British, who are in turn less foreign than the Japanese. From 1983 to 1987, 28 percent of Americans in the National Opinion Research Center’s General Social Survey admitted they disliked Japan, but only 8 percent disliked England, and a scant 3 percent disliked Canada.

Objective measures like the volume of trade or the trade deficit are often secondary to physical, linguistic, and cultural similarity. Trade with Canada or Great Britain generates only mild alarm compared to trade with Mexico or Japan. U.S. imports from and trade deficits with Canada exceeded those with Mexico every year from 1985 to 2004. During the anti-Japan hysteria of the 1980s, British foreign direct investment in the U.S. always exceeded that of the Japanese by at least 50 percent. Foreigners who look like us and speak English are hardly foreign at all.

Calm reflection on the international economy reveals much to be thankful for and little to fear. On this point, economists past and present agree. But an important proviso lurks beneath the surface. Yes, there is little to fear about the international economy itself. But modern researchers rarely mention that attitudes about the international economy are another story. Paul Krugman hits the nail on the head: “The conflict among nations that so many policy intellectuals imagine prevails is an illusion; but it is an illusion that can destroy the reality of mutual gains from trade.” We can see this today most vividly in the absurdly overblown political reactions to the immigration issue, from walls to forcing illegal workers currently in America to leave before they can begin an onerous procedure to gain paper legality.

Make-Work Bias
I was an undergraduate when the Cold War ended. I still remember talking about military spending cuts with a conservative student. The whole idea made her nervous; she had no idea how a market economy would absorb the discharged soldiers. In her mind, to lay off 100,000 government employees was virtually equivalent to disemploying 100,000 people for life.

If a well-educated individual ideologically opposed to wasteful government spending thinks like this, it is hardly surprising that she is not alone. The public often literally believes that labor is better to use than conserve. Saving labor, producing more goods with fewer man-hours, is widely perceived not as progress but as a danger. I call this the make-work bias, a tendency to underestimate the economic benefits of conserving labor. Where noneconomists see the destruction of jobs, economists see the essence of economic growth: the production of more with less.

Economists have been at war with the make-work bias for centuries. The 19th-century economist Frederic Bastiat ridiculed the equation of prosperity with jobs as “Sisyphism,” after the mythological fully employed Greek who was eternally condemned to roll a boulder up a hill.

In the eyes of the public, he wrote, “effort itself constitutes and measures wealth. To progress is to increase the ratio of effort to result. Its ideal may be represented by the toil of Sisyphus, at once barren and eternal.” For the economist, by contrast, wealth “increases proportionately to the increase in the ratio of result to effort. Absolute perfection, whose archetype is God, consists [of] a situation in which no effort at all yields infinite results.”

Nineteenth-century economists believed they had diagnosed enduring economic confusions, not intellectual fads, and they were right. The crudest form of make-work bias is the Luddite fear of the machine. Common sense proclaims that machines make life easier for human beings. The public qualifies this “naive” position by noting that machines also throw people out of work. It forgets that technology also creates new jobs. Without the computer, to give one obvious example, there would be no jobs in computer programming or software development. But the fundamental defense of labor-saving technology is deeper than that. Employing more workers than you need wastes valuable labor.

After technology throws people out of work, they have an incentive to find a new use for their talents. The Dallas Fed economist W. Michael Cox and the journalist Richard Alm illustrate this process in their 1999 book Myths of Rich and Poor, citing history’s most striking example, the drastic decline in agricultural employment: “In 1800, it took nearly 95 of every 100 Americans to feed the country. In 1900, it took 40. Today, it takes just 3.…The workers no longer needed on farms have been put to use providing new homes, furniture, clothing, computers, pharmaceuticals, appliances, medical assistance, movies, financial advice, video games, gourmet meals, and an almost dizzying array of other goods and services.”

Many economists advocate government assistance to cushion the displaced workers’ transition to new jobs and to retain public support for a dynamic economy. Other economists disagree. But almost all economists grant that stopping those transitions has a grave cost.

Exasperating as the Luddite mentality is, countries rarely accede to public anxieties and turn back the clock of technology. But you cannot say the same about another controversy infused with make-work bias: hostility to downsizing.

Inside of a household, everyone understands what Cox and Alm call “the upside of downsizing.” You do not worry about how to spend the hours you save when you buy a washing machine. Make-work confusion can arise only in an exchange economy. If you receive a washing machine as a gift, the benefit is yours; you have more free time and the same income. If you get downsized, the benefit goes to other people; you have more free time, but your income temporarily falls. In both cases, though, society conserves valuable labor.

The danger of the make-work bias is easiest to see in Europe, where labor market regulation to “save jobs” has produced decades of high unemployment. But we can see it in the U.S. as well, especially in our massive employment lawsuit industry. The hard lesson to learn is that giving people “rights to their jobs” is a drain on productivity—and makes employers think twice about hiring people in the first place.

Pessimistic Bias
I first encountered anti-drug propaganda in second grade. It was called “drug education,” but it was mostly scary stories. I was told that kids around me were using drugs and that a pusher would soon offer me some too. Teachers warned that more and more kids would become addicts, and that by the time I was in junior high I would be surrounded by them. Authority figures would occasionally speculate about our adulthood, and wonder how a country could function with such a degenerate work force.

I am still waiting to be offered drugs. The junior high dystopia never materialized. By the time I reached adulthood, it was apparent that most people were not going to their jobs high on PCP. Generation X’s entry into the work force accompanied the marvels of the Internet age, not a stupor-induced decline in productivity and innovation.

My teachers’ predictions about America’s economic future fit nicely into a larger pattern. As a general rule, the public believes economic conditions are not as good as they really are. It sees a world going from bad to worse; the economy faces a long list of grim challenges, leaving little room for hope. We can call this the pessimistic bias, a tendency to overestimate the severity of economic problems and underestimate the economy’s performance in the recent past, the present, and the future.

Pessimism about the economy comes in two varieties. You may be pessimistic about symptoms, overblowing the severity of the effects of everything from the deficit to affirmative action. But you can also be pessimistic overall, seeing negative trends in living standards, wages, and inequality. Public opinion is marked by both forms of pessimism. Economists constantly advise the public not to lose sleep over the latest economic threat in the news, pointing out massive gains we’ve made during the last 100 years and now take for granted.

David Hume—economist, philosopher, and Adam Smith’s best friend—blamed popular pessimism on our psychology. “The humour of blaming the present, and admiring the past, is strongly rooted in human nature,” he wrote, “and has an influence even on persons endued with the profoundest judgment and most extensive learning.”

But 19th-century economists did little to develop the theme of pessimistic bias. Nineteenth-century socialists who predicted “immiseration” of the working class met intellectual resistance from economists. But the root of the socialists’ forecast was hostility to markets, not pessimism as such. Economists often ridiculed socialists for their wild optimism about the impending socialist utopia.

Pessimistic bias is widely thought to have grown worse in the modern era. In The Idea of Decline in Western History (1997), the historian Arthur Herman of the Smithsonian Institution maintains that it peaked soon after the end of World War I, when “talking about the end of Western civilization had become as natural as breathing. The only subject left to debate was not whether the modern West was doomed but why.”

How can high levels of pessimism coexist with constantly rising standards of living? Although pessimism has abated since World War I, the gap between objective conditions and subjective perceptions is arguably greater than ever. In The Progress Paradox (2003), the journalist Gregg Easterbrook ridicules the “abundance denial” of the developed world: “Our forebears, who worked and sacrificed tirelessly in the hopes their descendants would someday be free, comfortable, healthy, and educated, might be dismayed to observe how acidly we deny we now are these things.”

Not all professional economists are utter optimists about tomorrow. There is an ongoing debate among economists about growth slow-down. This is what relatively pessimistic economists like Paul Krugman mean when they say that “the U.S. economy is doing badly.” Other economists counter that standard numbers inadequately adjust for the rising quality and variety of the consumption basket and the changing composition of the work force. Either way, the worst-case scenario that GDP statistics permit—a lower speed of progress—is no disaster.

The intelligent pessimist’s favorite refuge is to argue that standard statistics such as GDP miss important components of our standard of living. The leading candidate is environmental quality. Pessimists often add that our failure to deal with environmental destruction will soon morph into economic disaster as well. If resources are rapidly vanishing as our numbers multiply, human beings are going to be poor and hungry, not just out of touch with Mother Earth.

A number of economists have met these challenges. The most wide-ranging is the late Julian Simon, who argued that popular “doom-and-gloom” views of resource depletion, overpopulation, and environmental quality are exaggerated and often the opposite of the truth. Past progress does not guarantee future progress, but as Simon explained in his 1995 book The State of Humanity, it does create a strong presumption: “Throughout the long sweep of history, forecasts of resource scarcity have always been heard, and—just as now—the doomsayers have always claimed that the past was no guide to the future because they stood at a turning point in history.”

Simon has been a lightning rod for controversy, but his main theses—that natural resources are getting cheaper, population density is not bad for growth, and air quality is improving—are now almost mainstream in environmental economics. Since the Harvard economist Michael Kremer’s seminal 1993 paper “Population Growth and Technological Change: One Million B.C. to 1990,” even Simon’s “extreme” view that population growth raises living standards has gained wide acceptance.

The UCLA geographer Jared Diamond’s immensely popular 1997 book Guns, Germs, and Steel links population and innovation in essentially the same way, albeit with little fanfare. The upshot: GDP may not be the best conceivable measurement of our well-being, but refining measures of economic welfare does not revive the case for pessimism. In fact, more inclusive measures cement the case for optimism, because life has also been getting better on the neglected dimensions.

This pessimistic bias is a general-interest prop to political demagoguery of all kinds. It creates a presumption that matters, left uncontrolled, are spiraling to destruction, and that something has to be done, no matter how costly or ultimately counterproductive to wealth or freedom. This mind-set plays a role in almost every modern political controversy, from downsizing to immigration to global warming.

Bias Against Bias
Economists have a love-hate relationship with systematic bias. As theorists, they deny its existence. But when they teach, address the public, or wonder what is wrong with the world, they dip into their own private stash of the stuff. On some level, economists not only recognize that systematically biased beliefs exist; they think they have discovered virulent strains in their own backyard.

You can hardly teach economics without bumping into these biases. Students of economics are not blank slates for their teachers to write on. They arrive with strong prejudices. They underestimate the benefits of markets. They underestimate the benefits of dealing with foreigners. They underestimate the benefits of conserving labor. They underestimate the performance of the economy. And in doing all that underestimating, they overestimate both the need for the government to solve these purported problems and the likely efficacy of its solutions.

Bryan Caplan, a professor of economics at George Mason University, is the author of The Myth of the Rational Voter: Why Democracies Choose Bad Policies (Princeton University Press), from which this article is excerpted. © Copyright 2007 by Princeton University Press.
 

 
38. Historic Surge In Grain Prices Roils Markets
By SCOTT KILMAN
WSJ ptember 28, 2007; Page A1

Rising prices and surging demand for the crops that supply half of the world's calories are producing the biggest changes in global food markets in 30 years, altering the economic landscape for everyone from consumers and farmers to corporate giants and the world's poor.
[Grain]

"The days of cheap grain are gone," says Dan Basse, president of AgResource Co., a Chicago commodity forecasting concern.

This year the prices of Illinois corn and soybeans are up 40% and 75%, respectively, from a year ago. Kansas wheat is up 70% or more. And a growing number of economists and agribusiness executives think the run-ups could last as long as a decade, raising the cost of all kinds of food.

In the past, such increases have been caused by temporary supply disruptions. Following a poor harvest, farmers would rush to capitalize on higher crop prices by planting more of that crop the next season, sending prices back down. But the current rally, which started a year ago in the corn-futures trading pit at the Chicago Board of Trade, is different.

Not only have prices remained high, but the rally has swept up other commodities such as barley, sorghum, eggs, cheese, oats, rice, peas, sunflower and lentils. In Georgia, the nation's No. 1 poultry-producing state, slaughterhouses are charging a record wholesale price for three-pound chickens, up 15% from a year ago.

What's changed is that powerful new sources of demand are emerging. In addition to U.S. government incentives that encourage businesses to turn corn and soybeans into motor fuel, the growing economies of Asia and Latin America are enabling hundreds of millions of people to spend more on food. A growing middle class in these regions is eating more meat and milk, which in turn is increasing demand for grain to feed livestock. In the U.S., a beef cow has to eat roughly six pounds of grain to put on a pound of weight, and a hog about four pounds.

The reversal of a long-term trend toward lower grain prices could have profound effects on the world's ability to feed its poor. Global grain stockpiles are being drawn down to their tightest levels in three decades, leaving the world vulnerable to shocks brought on by bad harvests. And it's far from clear how much more land could be brought into production or to what extent advances in biotechnology might increase crop yields in the future.

American families, which spend 9.9% of their disposable income on food, are facing the fastest-rising food prices in 17 years. The consumer's cost for everything from yogurt and popcorn to breakfast cereal and fast-food french fries is climbing. In U.S. cities last month, the average retail price of a pound loaf of whole-wheat bread was up 24% from a year ago, according to the Bureau of Labor Statistics. Whole milk hit $3.807 a gallon, up 26%.

Similar increases are showing up abroad. Italian shoppers are protesting soaring pasta prices, and Mexican authorities have capped the price of corn tortillas. Pakistan is curbing wheat exports to counter rising food-price inflation while Russian authorities, worried about rising bread prices, are considering a similar clampdown.

Food companies are struggling to figure out how to pass on higher costs to supermarkets and restaurant chains, which have gotten bigger and thus gained clout since the last prolonged rise in food prices in the 1970s.

"We're in uncharted territory," says Christopher Fraleigh, chief executive of the food and beverage division of Sara Lee Corp., which earlier this month raised its bread prices 5%.

The biggest winner is the U.S. Farm Belt, which is primed for an unusually long expansion, even as a nationwide housing slump damps the broader economy. The Agriculture Department expects U.S. net farm income to soar 48% this year to a record $87.1 billion.

"I sold wheat here just the other day for $7 [a bushel]. That's the first time I've ever done that," says Doyle Johannes, a fourth-generation grain farmer in Underwood, N.D. With prices so high, he bought his first new harvesting combine, a $250,000 Caterpillar decked out with computerized controls and a built-in cooler.

An expected spending spree by farmers is igniting the stocks of several farm suppliers. Shares of implement maker Deere & Co. are up about 76% from a year ago, while seed and herbicide giant Monsanto Co.'s stock is up 79%, and fertilizer maker Mosaic Co.'s shares have more than tripled.

The grain rally shows few signs of slowing even though U.S. corn farmers are expecting a record harvest. Futures traders are betting that the price of corn, used for everything from sweetening soda to putting the crunch in snack foods, will climb above $4 next March and stay above that level into 2010. In recent days, Iowa farmers have been selling corn for $3.25 a bushel.

Next year is shaping up to be the third in a row in which the world consumes more grain to make fuel, food and livestock feed than it harvests. The trend is helping reduce global grain stockpiles to their lowest point relative to consumption since the mid-1970s, when Asia struggled with chronic food shortages and the Soviet Union suddenly emerged as a big grain importer.

Part of the reason for the drawdown can be seen in China, where soaring demand for milk has increased the number of dairy cattle threefold so far this decade. Half of the world's hogs now live in China, which is importing about 13% of all the soybeans grown in the U.S. to help fatten its livestock. The Chinese government, caught off guard by a nearly 50% rise in retail pork prices, is throwing cash at farmers willing to produce more of the nation's most widely consumed meat.

The prospect for a long boom is riveting economists because the declining real price of grain has long been one of the unsung forces behind the development of the global economy. Thanks to steadily improving seeds, synthetic fertilizer and more powerful farm equipment, the productivity of farmers in the West and Asia has stayed so far ahead of population growth that prices of corn and wheat, adjusted for inflation, had dropped 75% and 69%, respectively, since 1974. Among other things, falling grain prices made food more affordable for the world's poor, helping shrink the percentage of the world's population that is malnourished.

The recent grain drain has stirred a new set of worries in the developing world. Developing nations used to complain their farmers were hurt by rich subsidies offered to producers in the U.S. and European Union, which encouraged price-depressing gluts. Now, their concern is shifting to how sharply high grain prices will erode the buying power of the world's hungry.

Humanitarian groups are cautioning that their budgets for food aid won't go nearly as far as they did in the past. Roughly 200 million of the 850 million malnourished people in the world's poorest nations receive some food assistance. "My major concern is that we will lose ground against hunger," says Josette Sheeran, executive director of the United Nations' World Food Program.

That outlook is increasing the urgency of nascent efforts to end foot shortages in sub-Saharan Africa, the one region in which hunger is worsening. "I think we are going to be facing a food crunch," says former U.N. Secretary-General Kofi Annan. "So we have to really take charge and begin to produce our own food," Mr. Annan, a Ghanaian, said during an interview at his Geneva office, where he heads a push by the Bill & Melinda Gates Foundation and Rockefeller Foundation to help bring to Africa the agricultural revolution that spread across Asia and Latin America decades ago.

U.S. farm exports, meanwhile, are climbing, dousing the fears of just a few years ago that the U.S. farm sector was on the verge of generating a trade deficit. Agriculture Department economists expect exports to hit a record $79 billion in the fiscal year ending Sept. 30, up 15% from last year.

For food-company executives, life is getting more complicated. "One year it's oil, the next it's grain," says General Mills Inc. Chief Executive Kendall Powell. "But it's all underpinned by one thing: strong global demand for those commodities." The Minneapolis food giant, which had sales of $12.4 billion in its latest fiscal year, expects raw-material costs in the fiscal year ending in May to jump $250 million, mostly due to costlier farm commodities.

To cope, General Mills is shrinking the size of its breakfast-cereal packages, effectively raising the price per ounce. At a Dominick's supermarket in suburban Chicago, a 15.6-ounce box of Wheaties recently cost $5.16, more per ounce than the round steak London broil at the meat counter. Grain typically has accounted for a small part of the cost of packaged products like bread and ready-to-eat cereals.

Fast-food chain Burger King Corp. is importing more grass-fed beef to make its U.S. hamburgers, and its Asian outlets are switching to french fries made from cheaper New Zealand potatoes rather than Washington state spuds.

So far, the burden of higher grain prices is falling heaviest on small businesses, which don't have the wiggle room that large companies do.

Hit by a 35% increase in wheat-flour costs since December, Michael Kalupa, owner of Kalupa's Bakery in Tampa, Fla., said he has put off plans to buy a new walk-in refrigerator. "Guys like us pretty much have to bite the bullet," said Mr. Kalupa, president of Retail Bakers of America, a bakers trade group.
 
 

   39. The Secrets of Intangible Wealth
By RONALD BAILEY
WSJ September 29, 2007

A Mexican migrant to the U.S. is five times more productive than one who stays home. Why is that?

The answer is not the obvious one: This country has more machinery or tools or natural resources. Instead, according to some remarkable but largely ignored research -- by the World Bank, of all places -- it is because the average American has access to over $418,000 in intangible wealth, while the stay-at-home Mexican's intangible wealth is just $34,000.

But what is intangible wealth, and how on earth is it measured? And what does it mean for the world's people -- poor and rich? That's where the story gets even more interesting.

Two years ago the World Bank's environmental economics department set out to assess the relative contributions of various kinds of capital to economic development. Its study, "Where is the Wealth of Nations?: Measuring Capital for the 21st Century," began by defining natural capital as the sum of nonrenewable resources (including oil, natural gas, coal and mineral resources), cropland, pasture land, forested areas and protected areas. Produced, or built, capital is what many of us think of when we think of capital: the sum of machinery, equipment, and structures (including infrastructure) and urban land.

But once the value of all these are added up, the economists found something big was still missing: the vast majority of world's wealth! If one simply adds up the current value of a country's natural resources and produced, or built, capital, there's no way that can account for that country's level of income.

The rest is the result of "intangible" factors -- such as the trust among people in a society, an efficient judicial system, clear property rights and effective government. All this intangible capital also boosts the productivity of labor and results in higher total wealth. In fact, the World Bank finds, "Human capital and the value of institutions (as measured by rule of law) constitute the largest share of wealth in virtually all countries."

Once one takes into account all of the world's natural resources and produced capital, 80% of the wealth of rich countries and 60% of the wealth of poor countries is of this intangible type. The bottom line: "Rich countries are largely rich because of the skills of their populations and the quality of the institutions supporting economic activity."

What the World Bank economists have brilliantly done is quantify the intangible value of education and social institutions. According to their regression analyses, for example, the rule of law explains 57% of countries' intangible capital. Education accounts for 36%.

The rule-of-law index was devised using several hundred individual variables measuring perceptions of governance, drawn from 25 separate data sources constructed by 18 different organizations. The latter include civil society groups (Freedom House), political and business risk-rating agencies (Economist Intelligence Unit) and think tanks (International Budget Project Open Budget Index).

Switzerland scores 99.5 out of 100 on the rule-of-law index and the U.S. hits 91.8. By contrast, Nigeria's score is a pitiful 5.8; Burundi's 4.3; and Ethiopia's 16.4. The members of the Organization for Economic Cooperation and Development -- 30 wealthy developed countries -- have an average score of 90, while sub-Saharan Africa's is a dismal 28.

The natural wealth in rich countries like the U.S. is a tiny proportion of their overall wealth -- typically 1% to 3% -- yet they derive more value from what they have. Cropland, pastures and forests are more valuable in rich countries because they can be combined with other capital like machinery and strong property rights to produce more value. Machinery, buildings, roads and so forth account for 17% of the rich countries' total wealth.

Overall, the average per capita wealth in the rich Organization for Economic Cooperation Development (OECD) countries is $440,000, consisting of $10,000 in natural capital, $76,000 in produced capital, and a whopping $354,000 in intangible capital. (Switzerland has the highest per capita wealth, at $648,000. The U.S. is fourth at $513,000.)

By comparison, the World Bank study finds that total wealth for the low income countries averages $7,216 per person. That consists of $2,075 in natural capital, $1,150 in produced capital and $3,991 in intangible capital. The countries with the lowest per capita wealth are Ethiopia ($1,965), Nigeria ($2,748), and Burundi ($2,859).

In fact, some countries are so badly run, that they actually have negative intangible capital. Through rampant corruption and failing school systems, Nigeria and the Democratic Republic of the Congo are destroying their intangible capital and ensuring that their people will be poorer in the future.

In the U.S., according to the World Bank study, natural capital is $15,000 per person, produced capital is $80,000 and intangible capital is $418,000. And thus, considering common measure used to compare countries, its annual purchasing power parity GDP per capita is $43,800. By contrast, oil-rich Mexico's total natural capital per person is $8,500 ($6,000 due to oil), produced capital is $19,000 and intangible capita is $34,500 -- a total of $62,000 per person. Yet its GDP per capita is $10,700. When a Mexican, or for that matter, a South Asian or African, walks across our border, they gain immediate access to intangible capital worth $418,000 per person. Who wouldn't walk across the border in such circumstances?

The World Bank study bolsters the deep insights of the late development economist Peter Bauer. In his brilliant 1972 book "Dissent on Development," Bauer wrote: "If all conditions for development other than capital are present, capital will soon be generated locally or will be available . . . from abroad. . . . If, however, the conditions for development are not present, then aid . . . will be necessarily unproductive and therefore ineffective. Thus, if the mainsprings of development are present, material progress will occur even without foreign aid. If they are absent, it will not occur even with aid."

The World Bank's pathbreaking "Where is the Wealth of Nations?" convincingly demonstrates that the "mainsprings of development" are the rule of law and a good school system. The big question that its researchers don't answer is: How can the people of the developing world rid themselves of the kleptocrats who loot their countries and keep them poor?

Mr. Bailey is Reason magazine's science correspondent.

From http://econlog.econlib.org/
 

40. Gavin Kennedy, Adam Smith, and Gregory Clark  by Arnold Kling

Kennedy writes,
 

    In the extreme, I have suggested that economic history of the last 10,000 years (and for long enough before that) the history of the poor is not the decisive factor in economic development: it is the history of the rich (all those above subsistence), plus the history of the politically powerful who diverted some proportion (from taxation, levies, duties, and oppression) of the annual production of wealth into stone built cities, infra-structure, cathedrals, harbours, canals, routes for trade, shipping, and the instruments of war.

    The growing commercial exchange economy below a society, gradually accumulating capital stock (Smithian growth), with all the associated knowledge, literature, natural and moral philosophy, science, invention, and technologies, prepared the ground for the eventual invention and application of power-driven machinery that constituted what some call the industrial revolution.
 

Read the whole thing.

Let me summarize various ideas to explain what we call the industrial revolution, and problems with them:

1. Gradual accumulation of capital. Then why such a sudden, sharp rise in the average standard of living?

2. Better institutions. Rather than accuse Adam Smith of taking this view, let me accuse Meir Kohn, who I recall giving a talk in which he said, in effect, you don't need anything special to get economic growth. You just need government to stop being predatory. The problem with this view, according to Clark, is that England's government (and perhaps that in other countries) could be described as not severely predatory long before the industrial revolution.

3. Better interaction between science and applied technology. I associate that view with Joel Mokyr. The problem with this view is that it is difficult to explain why the industrial revolution was so concentrated in England.

4. A more industrious work force. Clark's view is that harsh conditions killed off the less industrious people in England, leaving a race that was easier to train, educate, and discipline.

There is nothing about any one of these explanations that excludes the other. I like (3), because ideas have increasing returns. A story of capital accumulation alone runs into the problem that diminishing returns should cause growth to fizzle out at some point.

I like (2), because it is very hard to explain international differences without looking at institutions. Clark himself has pointed out that the same worker can have higher productivity by immigrating to the United States. Bryan and I have both argued that this implicitly suggests a role for institutions.

There is something to be said for (4), also. Clark makes a good point that it is remarkable that the cotton industry was organized so that raw cotton was shipped at great cost to England, turned into cloth, and then shipped at great cost back to India. If India's work force had been amenable to training and discipline, then presumably most of the manufacturing would have taken place in India.
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From a pointer found on the marginal revolution blog
http://economistsview.typepad.com/economistsview/2007/09/the-great-moder.html
September 28, 2007
41. The Great Moderation in Output

This work finds that The Great Moderation in output - the decline in the volatility of output in the mid 1980s - is due to declining variability in investment and consumer durables purchases, a result that suggests that better inventory management and financial innovation are at least part of the declining volatility story. It also finds that for understanding swings in GDP growth, "Tracking shifts in investment spending remains critical, but changes in household spending on nondurable goods are now more important than movements in consumer durables. Meanwhile, the fraction of jobs growth volatility attributable to firms in professional and business services has risen to the point where this sector has become the largest contributor to short-run swings in aggregate jobs growth.":

    The 'Great Moderation' in Output and Employment Volatility: An Update, by Evan F. Koenig and Nicole Ball , Economic Letter, FRB Dallas: Volatility can wreak havoc on economies. Sudden, sharp ups and downs in business activity can make it difficult for consumers to plan their spending, workers to feel secure in their jobs and companies to determine their future investments. Because of their impact on expectations and business and consumer confidence, swings in the economy can become self-reinforcing. Volatility can also spill over into real and financial asset markets, where severe price movements can produce seemingly arbitrary redistributions of wealth.

    It's good news, then, that the U.S. economy has become much more stable. On average, the five recessions from 1959 to 1983 were 47 months apart, lingered 12 months and were associated with a 2.17 percent peak-to-trough decline in real gross domestic product. By contrast, the 1990 downturn came after 92 months of expansion, lasted eight months and involved a 1.26 percent decline in GDP. The 2001 slump ended a record 120 months of uninterrupted growth, lasted eight months and entailed a GDP decline of only 0.35 percent. More generally, quarterly growth in both real GDP and jobs became markedly less volatile after 1983.[1]

    Explanations for this "Great Moderation," as it's called, include structural changes in the economy, improved monetary policy and simple good luck.

    Potentially important structural changes include the elimination of ceilings on deposit interest rates, broader access to credit markets through financial innovations like home equity loans, tighter inventory controls facilitated by technology, and the globalization of output and labor markets.

    By improved monetary policy, analysts typically have in mind central bank actions that respond more quickly and forcefully to emerging inflation pressures, so that medium- to long-term price expectations remain contained.

    As for good luck, analysts cite the reduced frequency of economic shocks comparable to the 1973 Arab oil embargo and 1979 oil price spike.[2]

    We've accumulated eight years of additional data since completion of the early work on the Great Moderation, and the U.S. economy has experienced another recession and recovery. The new data allow us to examine whether the moderation has continued and detect changes in different sectors' contributions to volatility.

    Our results are interesting because of the light they shed on the debate over the causes of the Great Moderation, but they're also useful in their own right. Breaking volatility down by sector, for example, can pinpoint which industries and expenditure categories are currently the most important sources of fluctuations in GDP and employment. It's in these areas that monitoring efforts ought to be focused.

    What we've found in studying the new data is that the reduced aggregate volatility that began in 1984 has continued into the new millennium. The economy's volatility hasn't, however, dropped much further. In the case of GDP growth, most of the initial volatility decline can be attributed to greater stability in investment and consumer durables expenditures. Volatility from consumer spending has fallen further in recent years, but this decline has been completely offset by increased volatility from international trade.

    In the case of jobs growth, most of the 1984 volatility decline can be attributed to manufacturing. The sector's volatility contribution has held steady since then, even though its employment share has continued to shrink. Meanwhile, jobs growth volatility originating in professional and business services has increased sharply.

    Sector Volatility
    How much any sector contributes to the U.S. economy's ups and downs depends on three factors: the sector's own volatility, its share of business activity, and its tendency to move with or against the overall economy. This cataloging is analogous to the familiar notion that any given stock contributes more to a portfolio's riskiness the more volatile its returns, the larger its portfolio share, and the greater the correlation between its return and returns on the portfolio's other stocks.[3]

    We traced various sectors' contributions to the volatility of quarterly growth in GDP and jobs over three periods: the 25 years starting in 1959 and running through 1983, the 12 years from 1984 through 1995 and the nearly 12 years from 1996 through the second quarter of 2007. Each of these intervals includes at least one economic expansion, recession and recovery.

    The most recent period is interesting because it was marked by rapid growth in international trade and financial flows and the spread of new, more flexible labor market arrangements. These are the kinds of structural changes that might be expected to affect the stability of economic growth. This period was also marked by large swings in the real price of oil.[4] Insofar as oil price shocks were responsible for some of the economy's pre-1984 instability, we might expect a return of some of that volatility.

    GDP Growth Volatility
    We can measure GDP growth's volatility by looking at the range within which growth has fallen 95 percent of the time. Between 1959 and 1983, for example, annualized GDP growth averaged 3.6 percent and strayed outside a –5.3 to 12.5 percent range only 5 percent of the time. The margin of error for GDP growth over this period was plus or minus 8.9 percentage points (Chart 1).

Chart 1: GDP growth volatility dropped off sharply in the mid 1980s

    Between 1984 and 1995, growth was 3.2 percent, plus or minus 4.3 points—a margin of error less than half of what it had been. Finally, from 1996 to 2007, GDP growth averaged 3.1 percent, plus or minus 4.1 points.

    By convention, analysts measure a series' volatility by its standard deviation, which is one-half the margin of error. In percentage points, the standard deviations for GDP growth are 4.47 for 1959–83, 2.14 for 1984–95 and 2.04 for 1996–2007.

    The big decline in GDP growth volatility occurred during the mid-1980s. Since then, it has stayed relatively constant. Sustaining this low volatility over the past 12 years is impressive, however, given the large swings in oil prices and business investment during that period. This suggests the economy's increased stability is due to more than good luck.

    So, if not purely good luck, then what? A sector-by-sector breakdown reveals expenditure categories whose volatility contributions fell most sharply from 1959–83 to 1984–95 (Table 1). Inventory investment's contribution declined from 1.82 to 0.69 percentage points, consumer durables' from 0.83 to 0.44 points, residential investment's from 0.57 to 0.25 points and nonresidential fixed investment's from 0.71 to 0.42 points.

 
Table 1
Contributions to Volatility in GDP Growth
(Percentage points)
 
1959–83
 
1984–95
 
1996–2007
Consumption
1.42
 
 
 
.82
 
 
 
.41
 
   Durables
.83
 
 
 
.44
 
 
 
.12
 
   Nondurables
.39
 
 
 
.24
 
 
 
.18
 
   Services
.20
 
 
 
.14
 
 
 
.11
 
Investment
3.10
 
 
 
1.36
 
 
 
1.34
 
   Nonresidential fixed
.71
 
 
 
.42
 
 
 
.51
 
   Residential
.57
 
 
 
.25
 
 
 
.17
 
   Inventory
1.82
 
 
 
.69
 
 
 
.66
 
Government
.22
 
 
 
.24
 
 
 
.17
 
Net exports
–.26
 
 
 
–.28
 
 
 
.12
 
   Total
4.47
 
 
 
2.14
 
 
 
2.04
 
NOTES: The total is the standard deviation of GDP growth. 2007 data are through the second quarter. Numbers may not add up due to rounding.
SOURCE: Bureau of Economic Analysis.

    These results suggest—but don't prove—that tighter inventory controls, consumers' improved access to credit and financial deregulation played important roles in the economy's greater stability.

    Although the decline in overall GDP growth volatility has been small since 1995, some shifts in sector contributions are significant. For example, consumption's contribution over the most recent 12 years is half what it was over the previous 12. Most of this decline can be attributed to consumer durables, but nondurables also show a drop.

    The recent reduction in consumption's volatility contribution is, however, offset by net exports' increased contribution. In 1959–83 and 1984–95, the trade sector subtracted about 0.3 percentage points from GDP volatility. This reflects net exports' historical tendency to act as an automatic stabilizer, rising when the U.S. economy is weak and falling when it's strong. Since 1995, though, the correlation between quarterly changes in net exports and GDP has turned slightly positive, and the category has added 0.1 point to aggregate volatility.

    Let's take a closer look at investment and consumer durables, which are primarily responsible for output's increased post-1983 stability. Changes in these sectors' relative size didn't contribute much to the decline in overall GDP volatility. Most of the impact came from reductions in their volatility and their correlation with the overall economy.

    For investment, the standard deviation of sector growth fell from 22.6 to 14.2 to 11.4 percentage points over the sample periods, and the correlation between sector and GDP growth declined from 0.85 to 0.64 before bouncing back up to 0.73 (Chart 2A).

Chart 2: investment, consumer spending on durables key to post-1983 GDP stability

    Meanwhile, investment's share of GDP held steady at about 0.16 (16 percent). The net result was a sharp decline in the sector's contribution to GDP growth volatility from 1959–83 to 1984–95 and very little change from 1984–95 to 1996–2007.

    For consumer durables, the standard deviation of sector growth fell from 15.0 to 12.1 to 9.4 percentage points, and the correlation between sector and GDP growth dropped from 0.66 to 0.44 to 0.15.

    At the same time, the sector share held steady at about 0.084 (8.4 percent). Consequently, consumer durables' contribution to the volatility of GDP growth fell substantially from sample period to sample period, up to and including 1996–2007 (Chart 2B).

    Before 1984, the key categories to watch in tracking GDP fluctuations were inventory investment, consumer durables spending and nonresidential fixed investment. Inventory and nonresidential fixed investment remain important sources of volatility today, but consumer durables ranks as an also-ran. Now tied for third in importance are consumer expenditures on nondurable goods, residential investment and government expenditures.[5]

    Jobs Growth Volatility
    When it comes to overall volatility, jobs growth exhibits a decline that's similar to the one we saw for GDP growth but smaller in magnitude (Chart 3). The margin of error needed to encompass 95 percent of jobs growth's variation narrows from 5.1 percentage points for 1959–83, to 3 points for 1984–95, to 2.7 points for 1996–2007. The standard deviation of jobs growth drops from 2.53 to 1.52 to 1.33 points in those periods.

Chart 3: job growth volatility declined markedly in the mid-1980s

    Average annual jobs growth has declined, too, going from 2.3 percent in 1959–83 to 2.1 percent in 1984–95 and 1.4 percent in 1996–2007.

    Manufacturing was mainly responsible for the sharp fall in jobs growth volatility after 1983. Its contribution dropped from 1.25 percentage points in 1959–83 to 0.32 points in 1984–95 and 0.34 in 1996–2007 (Table 2). Construction has caused less volatility in the past 12 years, but it's doubtful this decline will survive the current slowdown in residential building.

 
Table 2
Contributions to Volatility in Jobs Growth
(Percentage points)
 
1959–83
 
1984–95
 
1996–2007
Goods
1.54
 
 
 
.56
 
 
 
.46
 
    Resources
.04
 
 
 
.01
 
 
 
.00
 
    Construction
.25
 
 
 
.23
 
 
 
.12
 
    Manufacturing
1.25
 
 
 
.32
 
 
 
.34
 
Private services
.88
 
 
 
.89
 
 
 
.86
 
    Trade, transportation and utilities
.40
 
 
 
.40
 
 
 
.29
 
    Information
.10
 
 
 
.04
 
 
 
.10
 
    Financial
.04
 
 
 
.06
 
 
 
.03
 
    Professional and business
.13
 
 
 
.19
 
 
 
.37
 
    Education and health
.07
 
 
 
.01
 
 
 
–.03
 
    Leisure
.12
 
 
 
.13
 
 
 
.08
 
    Other
.03
 
 
 
.06
 
 
 
.01
 
Government
.11
 
 
 
.07
 
 
 
.01
 
    Total
2.53
 
 
 
1.52
 
 
 
1.33
 
NOTES: The total is the standard deviation of jobs growth. 2007 data are through the second quarter.
SOURCE: Bureau of Labor Statistics.

    Overall, private services' contribution to the economy's volatility hasn't changed much. Within services, however, we see a marked tendency for the volatility from the professional and business services sector to rise over the three periods—from 0.13 percentage points to 0.19 points to 0.37 points. The contribution from trade, transportation and utilities, on the other hand, has declined.

    What's going on in manufacturing and professional and business services, the two sectors with the most notable change in their contributions to overall volatility?

    Part of the story in manufacturing is foreign competition and productivity-enhancing technologies, which have combined to reduce the sector's share of total employment from 25 percent to 17 percent to 12 percent (Chart 4).

Chart 4: manufacturing much less important as source of jobs growth volatility

    The standard deviation of manufacturing's volatility growth rate is generally lower now, too. It fell sharply from 5.4 percentage points in 1959–83 to 2.2 points in 1984–95, before rising slightly—to 3 points—over the past 12 years. This lower jobs growth volatility probably reflects the more stable growth in investment and consumer goods expenditures we've already discussed.

    Finally, it's interesting that the correlation between total and manufacturing jobs growth has changed so little over the years, fluctuating from 0.95 to 0.86 to 0.91. Perhaps more flexible labor market practices have offset the weaker links between investment expenditures and GDP and between consumer goods expenditures and GDP.

    Manufacturing has traditionally been a source of economic instability, but volatility from a segment of the usually stable services sector may be something of a surprise. Professional and business services' increasing contribution to overall volatility has been driven mainly by two factors: the sector's growing relative size—its share of total jobs has gone from 8 to 10 to over 12 percent—and rising internal volatility—the standard deviation of its growth is up from 1.9 to 2.3 to 3.2 percentage points (Chart 5). The sector's correlation with aggregate jobs growth has held fairly steady.

Chart 5: professional and business services more important source of jobs growth volatility

    The expansion of professional and business services has been well documented. This sector includes business managers and knowledge-based employees like lawyers, accountants and computer-system designers, whose jobs are in increasing demand and relatively difficult to send overseas. The sector's rising volatility reflects the high-tech boom and bust of the late 1990s and early 2000s. The 2001 downturn was widely considered a white-collar recession. Unfortunately, the detailed subsector data we need to be able to say more are simply not available for before 1990.

    Factoring in all these changes, which were the most important sources of jobs growth variation before the Great Moderation and which are the most important now? Between 1959 and 1983, manufacturing; trade, transportation and utilities; and construction—in that order—were the main drivers of aggregate jobs growth fluctuations. Today, the big three are professional and business services; manufacturing; and trade, transportation and utilities. Given that service-sector developments increasingly drive the U.S. economy today, it's no surprise that two of the three most important sectors to monitor fall into the services category.[6]

    Summary and Conclusions
    GDP and jobs growth became more stable about 24 years ago. Most of the decline in output growth volatility is attributable to smaller swings in investment and consumer durables purchases, swings that are also less synchronized with fluctuations in the overall economy. The reduction in jobs growth volatility is due almost entirely to a shrunken and less variable manufacturing sector.

    Changes in GDP and jobs growth volatility since 1984 have been relatively modest. Beneath the surface, however, sector contributions have shifted. Consumer spending—especially on durable goods—accounts for an ever-smaller fraction of short-run variability in GDP growth. On the other hand, net exports have become less of a stabilizing influence.

    Two decades ago, keeping tabs on shifts in investment spending and consumer durables purchases was crucial for understanding swings in GDP growth. Tracking shifts in investment spending remains critical, but changes in household spending on nondurable goods are now more important than movements in consumer durables. Meanwhile, the fraction of jobs growth volatility attributable to firms in professional and business services has risen to the point where this sector has become the largest contributor to short-run swings in aggregate jobs growth.

    While the underlying causes of the economy's increased stability remain the subject of debate, the stability's persistence suggests that it's unlikely to be entirely the result of good luck. Improved monetary policy may well have played a role, but the timing of the volatility reduction and its sectoral composition also suggest other factors have been at work. They include improved inventory management, changes in the financial system that have made it easier for households to smooth out their spending over time, and the elimination of ceilings on bank deposit interest rates, which has helped reduce the construction sector's cyclicality.

    Notes

    The authors thank Christine Rowlette and Jessica Renier for research assistance.

       1. Among the earliest articles documenting the reduction in GDP volatility are "Has the U.S. Economy Become More Stable? A Bayesian Approach Based on a Markov-Switching Model of the Business Cycle," by Chang-Jin Kim and Charles Nelson, Review of Economics and Statistics, vol. 81, November 1999, pp. 608–16; "Output Fluctuations in the United States: What Has Changed Since the Early 1980's?" by Margaret M. McConnell and Gabriel Perez- Quiros, American Economic Review, vol. 90, December 2000, pp. 1464–76; and "The Long and Large Decline in U.S. Output Volatility," by Olivier Blanchard and John Simon, Brookings Papers on Economic Activity, no. 1, 2001, pp. 135–64. (Blanchard and Simon see the 1984 volatility reduction as part of a longer-term trend.)

          For evidence on jobs growth volatility, see "The Declining Volatility of U.S. Employment: Was Arthur Burns Right?" by M. V. Cacdac Warnock and Francis E. Warnock, Federal Reserve Board of Governors, International Finance Discussion Paper no. 677, August 2000.

          Inflation has been lower and more stable, too. However, we focus on real activity.
 
       2. Good summaries of the Great Moderation literature include "The Great Moderation," a speech by Federal Reserve Chairman Ben S. Bernanke at the meetings of the Eastern Economic Association, Feb. 20, 2004, and "Has the Business Cycle Changed? Evidence and Explanations," by James H. Stock and Mark W. Watson, a paper presented at the Federal Reserve Bank of Kansas City symposium "Monetary Policy and Uncertainty," Jackson Hole, Wyo., Aug. 28–30, 2003. Also, see "On the Causes of the Increased Stability of the U.S. Economy," by James A. Kahn, Margaret M. McConnell and Gabriel Perez-Quiros, Federal Reserve Bank of New York Economic Policy Review, May 2002, pp. 183–202; "New Economy, New Recession?" by Evan F. Koenig, Thomas F. Siems and Mark A. Wynne, Federal Reserve Bank of Dallas Southwest Economy, March/April 2002, pp. 11–16; and "Has Monetary Policy Become More Effective?" by Jean Boivin and Marc P. Giannoni, Review of Economics and Statistics, vol. 88, August 2006, pp. 445–62.
 
       3. Suppose that the random variable X is the weighted sum of n other random variables, Xi, for i = 1, 2, ...n: X = ??iXi, where the weights, ?i, are fixed. From the definition of the correlation coefficient, ?XXi , we know that Cov(X, Xi ) = ?XXi ?X ?Xi , where ?X and ?Xi are the standard deviations of X and Xi , respectively. Hence, ?²X = Cov(X, ??i Xi ) = ??i Cov(X, Xi ) = ??i ?XXi ?X ?Xi , and ?X = ??i ?XXi ?Xi. In practice, there is often small period-to-period variation in the ?i. Consequently, this formula is only approximately valid.
 
       4. The standard deviation of the four-quarter change in real oil prices was 36.3 percentage points over the 24 years from 1960 through 1983, 22.7 points over 1984–95 and 32.7 points over 1996–2007. Looking only at the standard deviation of oil price increases (some claim increases have a much bigger economic impact than decreases), the standard deviations are 52.5, 15.1 and 25.9 points over the three periods.
 
       5. An alternative ranking, based solely on correlations between sector and GDP growth, has consumer durables expenditures, nonresidential fixed investment and inventory investment in a virtual dead heat over 1959–83, with correlations of 0.66, 0.65 and 0.64. In today's economy, the top-ranking sectors by this criterion are nonresidential investment (0.56), inventory investment (0.46) and consumer expenditures on nondurable goods (0.46).
 
       6. A ranking based entirely on the correlation between sector and aggregate jobs growth puts manufacturing in first place over 1959–83, with a correlation of 0.95, followed by the professional and business services and trade, transportation and utilities sectors in a virtual tie, with correlations of 0.92 and 0.91, respectively. In today's economy, the tables are turned. Professional and business services and trade, transportation and utilities both have correlation coefficients of 0.95, while manufacturing has slipped to third, with a correlation coefficient of 0.91.

Posted by Mark Thoma on September 28, 2007 at 12:15 AM in Economics, Monetary Policy

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paine says...

famous last words

expenditures on residential structures
are trending less volatile

the greater flux of the knowledge sector
is no surprise eh ??

Posted by: paine | September 28, 2007 at 03:49 AM
spencer says...

But also note that the reduced volatility has also been accompanied by slower growth. From 1952 to 1982 trend per capita real GDP growth was 2.26%. But since 1982 it has been 1.99%. A 0.27 percentage point of over 10% may not seem like much, but over time it becomes significant.

If we were offered this trade-off would we accept it?

I used 1982 as the break point because I had that data handy, but using 1984 would not change the results.

Posted by: spencer | September 28, 2007 at 05:27 AM
reason says...

Spencer,
can you clarify. Knowing as I do that a fall of 5% followed by a rise of 5% leaves you down, does a lower average rate of growth actually mean you are worse off in the end if growth was more often negative? I've never done the maths to know - perhaps you have.

I don't think your question by the way is actually relevant, as I think there is inevitably a downward trend in potential GDP growth as an economy grows. (Note also absolute rather than per capita GDP is being measured). It is not clear to me that any trade-off is involved.

I also question whether the absolute levels of GDP are actually meaningful given all the measurement problems associated with GDP. Job growth seems to have been banded on the upside since the 80s. There is no convincing evidence that downward movements are any less severe. But annual employment growth rates of up to 8% during the 70s are hard to believe - obviously the transition of married women into the workforce allowed a dramatic expansion of the willing labour force when wages rose.

Posted by: reason | September 28, 2007 at 06:12 AM
spencer says...

I have never done the math either, so I can not answer your question.

But one of the interesting differences is that prior to 1984 actual real gdp was frequently higher then potential gdp. But since 1982 the only time actual gdp was significantly higher than potential gdp was in the late 1990s.

One factor in evaluating the great moderation is that it is partially a consequence of disinflationary monetary policy. One reason we had high inflation is that we kept the economy operating at full capacity and conversely one reason we have had lower inflation since 1980 is that we have kept the economy from overheating. If slower growth under the great moderation is a consequence of disinflationary monetary policy we are facing a trade-off between inflation and growth.

Also note I was using per capita gdp comparisons that partially but not completely negates your point about labor force growth.

You are raining valid points and that is the reason I posed my comments as a question.

Posted by: spencer | September 28, 2007 at 07:00 AM
kharris says...

reason/spencer,

I'm not sure this answers the 5% up/5% down issue raised, because one often needs to chew the fat with the one who raised the question to get it precicely. However, a logged GDP series takes care of the problem that a subsequent 5% up is less than the initial 5% down. In a logged series, they are the same. Running a handy-dandy Bloomberg regression line through a logged GDP series from 1959 to end-1983 and another from 1984 to 2007, sure enough the slope of the more recent line is flatter.

spencer raises a question that I think is really about what leads to what. If more moderate growth leads to less volatility, then the decline in volatility is a blessing. It makes economic management easier, reduces the variability in household income and employment and the like. If it is the other way around, if efforts at economic management (or some other thing) have reduced volatility at the cost of reduced growth, it is not clear that we are better off. Whether steadier performance makes up for slower growth is mostly, I think, a quetion of one's preferences.

Posted by: kharris | September 28, 2007 at 08:36 AM
spencer says...

My growth rate calculation were based on exponential regression trend lines.

Posted by: spencer | September 28, 2007 at 09:07 AM
Ed says...

fascinating discussion. is reduced volatility worth a 10% reduction in the rate of GDP growth? I believe it is because I think of it as an insurance policy. In a world of higher growth but higher volatility you never know whether you will be caught by chance during one of these below average growth periods.

Posted by: Ed | September 28, 2007 at 09:56 AM
richard says...

While not a big fan of Jim Grant, I believe that is the motif of his books on monetary history and interest rates: that the decrease of volatility has been bought by a decrease in growth. I think it's an interesting topic, but I don't know if it's at all testable -- which makes it a religious topic.

Posted by: richard | September 28, 2007 at 02:01 PM
spencer says...

I just calculated the growth in real PCE for durables and real fixed investment including both residential and nonresidential for the two era.

There was no difference. Real PCE for durables grew at a 5% rate from 1950 to 1984 and since 1984. Real fixed investment including both residential and nonresidential grew at a 4.4% trend growth rate in both era.

Moreover, since population growth slowed in the later era it implies that on a per capita basis these two most volatile eras actually grew faster after 1984. So the slow down in real per capita real gdp growth occurred in other segments of the economy. Of course this implies the the drop in volatility is not responsible for the slower growth in real per capita gdp growth.

This mean I have to look deeper into the data.

Posted by: spencer | September 28, 2007 at 02:58 PM
 
 

city journal
 
42. What Really Buys Happiness? Not income equality, but mobility and opportunity Arthur C. Brooks
Summer 2007

http://city-journal.org/html/17_3_economic_inequality.html

The United States is a rich nation getting richer. According to the U.S. Census, between 1993 and 2003 the average inflation-adjusted income in the top quintile of American earners increased 22 percent. But prosperity didn’t end with the top earners: those in the middle quintile saw their incomes rise 17 percent, on average, while the bottom quintile enjoyed a 13 percent increase. This isn’t a short-term phenomenon, either. In the 30 years leading up to 2003, top-quintile earners saw their real incomes increase by two-thirds, versus a quarter for those in the middle quintile and a fifth among the bottom earners.

Reason to celebrate? Not according to those who worry about rising income inequality—the fact that the rich are getting richer faster than the poor are getting richer. The National Opinion Research Center’s General Social Survey (GSS) indicates that in 1973, the average family in the top quintile earned about ten times what the average bottom-quintile family earned. By 2003, that difference had grown to almost 15 times.

Rising inequality makes for good political fodder. “When I graduated from college, the average corporate CEO made 20 times what the average worker did. Today, it’s nearly 400 times,” said Virginia senator James Webb in his response to President Bush’s State of the Union address this year. “In other words, it takes the average worker more than a year to make the money his or her boss makes in one day.” Former North Carolina senator John Edwards, who sought the Democratic presidential nomination in 2004 and is seeking it again in 2008, based his first campaign almost entirely on the contention that we are “two Americas, not one: one America that does the work, another America that reaps the reward.”

Edwards is one of a group of liberal politicians, policymakers, and social activists who want to reduce economic inequality through greater taxation and redistribution of wealth. And their plan draws inspiration from a particular academic theory: that inequality is socially destructive because it makes people miserable. As a scholar working in the field of public policy, I have long witnessed hand-wringing about the alleged connection between inequality and unhappiness. What first made me doubt this prevailing view was not some new scholarly study but rather that when I questioned actual human beings about it, few expressed any shock and outrage at the enormous wealth of software moguls and CEOs. On the contrary, they tended to hope that their kids might become the next Bill Gates.

Were these people somehow unrepresentative of America? Or was the academic consensus wrong? I set out to discover which it was. What I found was that economic inequality doesn’t frustrate Americans at all. It is, rather, the perceived lack of economic opportunity that makes us unhappy. To focus our policies on inequality, instead of opportunity, is to make a grave error—one that will worsen the very problem we seek to solve and make us generally unhappier to boot.

The egalitarians’ argument usually starts with the assertion that prosperity is all relative. So long as we are above the level of basic subsistence, they say, we care more about our financial position relative to others than about our absolute income. Experimental evidence, they continue, supports this claim. In one study, two-thirds of subjects said that they would be happier at a company where they earned $33,000 while their colleagues earned $30,000 than at one where they earned $35,000 while their colleagues earned $38,000. In another, 56 percent of participants chose a job paying $50,000 per year while everyone else earned $25,000, rather than a job paying $100,000 per year while others made $200,000—forgoing $50,000 per year simply to maintain a position of relative affluence. In a world of economic inequality, the egalitarians point out, some people have less than others—and as these studies seem to show, that very fact will make them unhappy, even if they are suffering no actual deprivation. The solution to their unhappiness is to impose greater economic equality.

Even though income inequality is rising, . . .

And the way to do that, of course, is to tax the haves and redistribute their income to the have-nots. Cornell economist Robert Frank, a major critic of income inequality, adds that such a move might not make the rich as unhappy as you’d think, since they tend to use their income on things they don’t really want or need. “We could spend roughly one-third less on consumption,” Frank writes, “and suffer no significant reduction in satisfaction.” Some egalitarians even make the astounding argument that we should tax the economically successful in order to discourage them from working, since their work will only make them richer and thus sadden the less successful. According to British economist Richard Layard, “If we make taxes commensurate to the damage that an individual does to others when he earns more”—the damage to others’ happiness, that is—“then he will only work harder if there is a true net benefit to society as a whole. It is efficient to discourage work effort that makes society worse off.” Work, according to this postmodern argument—contrary to millennia of moral teaching—is no different from a destructive vice like tobacco, which governments sometimes tax in order to discourage people from smoking.

One of the many problems with the egalitarians’ line of reasoning is that it misinterprets the experimental evidence. The two famous studies mentioned above don’t necessarily mean, as the egalitarians claim, that people would be happier in a world of total equality. Rather, they suggest that in a world of inequality, people like having more than others and dislike having less—even to the point of neglecting their financial interests. How people would react to a miraculously equal world is something that the studies don’t attempt to address.

But there is another, more fundamental, reason that the arguments linking economic inequality to unhappiness are mistaken. If the egalitarians are right, then average happiness levels should be falling. But they aren’t. The GSS shows that in 1972, 30 percent of the population said that they were “very happy” with their lives; in 1982, 31 percent; in 1993, 32 percent; in 2004, 31 percent. In other words, no significant change in reported happiness occurred—even as income inequality increased by nearly half. Happiness levels have certainly shown some fluctuations over the last three decades, but income inequality explains none of them.

The same result holds at the individual level. We can judge inequality by looking at the difference between our incomes and those of others in our “reference group”: people similar to us in such respects as age, sex, and education. The further we are from the typical reference-group income, the more inequality we will perceive. And if we measure inequality this way, the GSS reveals the startling fact that inequality has no relationship at all with our happiness.

But happiness does rise if people believe that their families have a chance of improving their standard of living. That belief is worth 12 percentage points in the likelihood of being “very happy.” The GSS asked respondents, “The way things are in America, people like me and my family have a good chance of improving our standard of living—do you agree or disagree?” Those who agreed were 44 percent more likely than those who disagreed to say that they were “very happy,” 40 percent less likely to say that they felt “no good at all” at times, and 20 percent less likely to say that they felt like failures. In other words, those who don’t believe in economic mobility—for themselves or for others—are not as happy as those who do.

This important fact is another reason that the two studies cited above don’t show what the egalitarians think they do: they posit a static universe, a fictional place where incomes don’t change. Perhaps in a world where you have no opportunity for advancement, the most important thing about your income really is how it measures up to other people’s. But in the real world, our attitude about the future matters a great deal. In the 1990s, economist Andrew Clark found that the happiness of British workers actually rose as their reference group’s average income rose relative to their own income—because they saw that rise as evidence of what they themselves could achieve. People take the average income in their group as a measure of their own potential. Rising inequality can even raise our happiness by demonstrating the success that our future may hold.

. . . people's happiness hasn't declined.

Believing in mobility helps make people happy, then. But does mobility actually exist in the United States? The Left doesn’t think so. Liberals, including rich liberals, are far less likely than conservatives to see a better future for people who work hard. Just 26 percent of liberals with incomes above the national average believe that there’s a lot of upward income mobility in America, versus 48 percent of conservatives with below-average incomes. And 90 percent of the poorer conservatives said that hard work and perseverance could overcome disadvantage, versus 65 percent of the richer liberals. If a liberal and a conservative are exactly identical in income, education, sex, family situation, and race, the liberal will still be 20 percentage points less likely than the conservative to say that hard work leads to success for the disadvantaged.

It is small wonder, then, that conservatives tend to be happier than liberals today. The 2004 GSS showed that 44 percent of people who identified themselves as “conservative” or “extremely conservative” were “very happy” about their lives; only 25 percent of self-identified liberals or extreme liberals gave that response. Conservatives believe that they live in a more promising country than liberals do, and that makes them happier.

But which side is right about economic mobility and opportunity? Liberals often cite research from past decades showing that some people face higher barriers to success than others. For example, in the early 1970s, a widely read book by Harvard’s Christopher Jencks asserted that schools couldn’t do much to fix income inequalities; deeper factors, such as discrimination or cultural problems, were largely to blame. If schools don’t bring the bottom up in America, isn’t opportunity a myth?

Despite the limitations of our school system in improving the lives of the underprivileged, however, more recent studies show robust economic mobility in America. The U.S. Census Bureau, the Urban Institute, and the Federal Reserve have all pointed out that, as a general rule, about a fifth of the people in the lowest income quintile will climb to a higher quintile within a year, and that about half will rise within a decade. True, a significant proportion of people will fall over the same period. But the studies nevertheless put paid to the claim that economic mobility is in any way unusual. Millions and millions of poor Americans climb out of the ranks of poverty every year.

And those left behind, it’s important to note, will almost certainly not become happier if we redistribute more income. Indeed, they will probably become less happy. Policies designed to lower economic inequality tend to change the incentives of both the haves and the have-nots in a way that particularly harms the have-nots. Reductions in the incentives to prosper mean fewer jobs created, less economic growth, less in tax revenues, and less charitable giving—all to the detriment of those left behind. And redistribution can, as the American welfare system has shown, turn beneficiaries into demoralized long-term dependents. As Irving Kristol put it three years before the federal welfare reform of 1996, “The problem with our current welfare programs is not that they are costly—which they are—but that they have such perverse consequences for people they are supposed to benefit.”

Further, policies to redress economic inequality hardly affect true inequality at all. Policymakers and economists rarely denounce the scandal of inequality in work effort, creativity, talent, or enthusiasm. We almost never hear about the outrage that is America’s inequality in leisure time, love, faith, or fun—even though these are things that most of us value more than money. To believe that we can redress inequality in our society by moving cash around is to have a materialistic, mechanistic, and totally unrealistic understanding of the resources that we truly care about.

Finally, arguments against inequality legitimize envy. Americans may indeed have strong concerns about their relative incomes and may seek status as reflected in their economic circumstances. But to base our policies on the anxieties of those at the back of the status race is to bow before Invidia. A deadly sin is not, in my view, a smart blueprint for policymaking.

A more accurate vision of America sees a land of both inequality and opportunity, in which hard work and perseverance are the keys to jumping from the ranks of the have-nots to those of the haves. If we can solve problems of absolute deprivation, such as hunger and homelessness, then rewarding hard work will continue to serve as a positive stimulant to achievement. Redistribution and taxation, beyond what’s necessary to pay for key services, weaken America’s willingness and ability to thrive.

This vision promotes policies focused not on wiping out economic inequality, but rather on enhancing economic mobility. They include improving educational opportunities, aggressively addressing cultural impediments to success, enhancing the fluidity of labor markets, searching for ways to include all citizens in America’s investing revolution, and protecting the climate of American entrepreneurship.

Placidity about income inequality, and opposition to income redistribution, are evidence of a light heart, not a hard one. If happiness is our goal, those who promote opportunity over economic equality have no apologies to make.
 

Friday, September 28, 2007 ~ 1:32 p.m., Dan Mitchell Wrote:
43. Three Cheers for the World Bank. I admit I'm committing an ideological sin, but the World Bank has released its 2008 "Doing Business" report (http://www.doingbusiness.org/documents/DB-2008-overview.pdf), which ranks 178 countries on regulatory impediments to entrepreneurship, and it is a first-rate publication. I realize the World Bank should not exist, and I'm quite aware that many of their activities in other areas hinder economic growth, but this report is very helpful in promoting regulatory competition among jurisdictions. I'll atone for my sin by coming up with a reason to criticize the international bureaucracy in the near future, but this EU Observer story shows how Doing Business creates pressure for regulatory liberalization:

      Thanks to regulatory reforms, Eastern Europe and Central Asia have surpassed East Asia for ease of doing business, a World Bank report says. The report, called "Doing Business" compares and ranks 178 economies and seven regions on the basis of ten indicators related to business regulations. ...Several of the region's countries have also overtaken some Western European economies. Estonia and Georgia for instance, the region's two top performers, have surpassed most EU members and both hold a spot in the top twenty
      http://euobserver.com/9/24851/?rk=1
 
 

 
44. HONG KONG'S ECONOMIC FREEDOM
------------------------------------------------------------------------

In the World Series of economic freedom, Hong Kong remains the
champion, says James A. Dorn, vice president for academic affairs at
the Cato Institute.
According to the Economic Freedom of the Word report by the Fraser
Institute:
   o   For the 11th consecutive year Hong Kong has been ranked No. 1
       with a score of 8.9 out of 10.
   o   Following Hong Kong are Singapore (8.8), New Zealand (8.5)
       and Switzerland (8.3).
   o   The United States, the United Kingdom and Canada (all tied
       for fifth place with 8.1).

At the opposite end of the spectrum:

   o   India -- the world's largest democracy -- ranked 69th, with a
       score of 6.6.
   o   China (6.3) ranked 86th; Vietnam (6.1) ranked 97th; Russia
       (5.8) ranked 112th.
   o   Zimbabwe, with its total disregard for economic freedom, came
       in last with a score of 2.9 (North Korea and Cuba were not
       included).
   o   Most African nations fared poorly, except for Botswana (7.2),
       which ranked 38th.

Hong Kong's ability to maintain its free-market system and its No. 1
ranking is testimony to its people's desire to expand their
opportunities by adhering to an open trading system, low taxes, sound
money, minimal government regulation, and the rule of law, says Dorn.
The key lesson from Hong Kong's "small government, big
market" model of development is that economic freedom is the best
path toward sustainable development, understood as increasing the range
of choices open to people.

Source: James A. Dorn, "Hong Kong's economic freedom,"
Washington Times, September 27, 2007.
For text:
http://www.washingtontimes.com/article/20070927/COMMENTARY/109270005/1012
For Fraser report:
http://www.fraserinstitute.ca/Commerce.Web/product_files/EFW2007BOOK2.pdf
For more on International Issues:
http://www.ncpa.org/sub/dpd/?Article_Category=26