Economist Channel

Tim Kroencke at the University of Basel wrote a nice follow up on non-voting shares (previous posts here and here) , which I share with permission. Some of the controversy was whether companies would issue shares and whether investors would by them. It turns out, yes, and he sends a gorgeous example in which control rights and cash flow rights are priced differently and react to different events:

....

In Germany, it is quite common for large companies to issue voting shares (Stammaktien) and non-voting shares (Vorzugsaktien) and one can make nice case studies. Here is one I did a while ago,  that I have updated today, and I want to share with you:

In 2005, Porsche started to buy Volkswagen shares. In 2008, it became obvious that Porsche tried to overtake Volkswagen and the price of voting shares, and only the voting shares, skyrocked. Volkswagen became the world’s biggest company…  well, for a couple of days.

Some figures to give perspective: first, the share price of non-voting vs voting Volkswagen shares traded in Frankfurt:


The dividend yield:

 And here is how prices and yields add up to total returns:



Some observations:

First, the voting component of a share price can diverge substantially from its cash-flow related value. What is small most of the time does not need to be small all of the time. This should really worry any passive investor who simply wants to earn a factor premium. The typical broad index investor wants to earn the market premium. I really doubt that such an investor wants to be involved in the house of cards of the Wiedekings and Piëchs. There is a reason for hedge fund investors being around.

Second, voting and non-voting shares nicely move together - in the long-run. After all, they pay out a very similar cash-flow stream, as you write and as one would expect if the law is set up in a sensible way.

Third, non-voting shares outperformed the voting shares by roughly 100% over 18 years. This is the long-run picture, difference in cumulated returns come from differences in dividend yields. Cumulated over time, the premium for voting can be quite big!  Sure, this does not have to be the case in general. (For example, in 2011, die dividend yield of voting shares was slightly higher.) After all, we are looking at a failed takeover and this is just an example. However, I think one can safely make the point that non-voting shares are likely to better track the value of the cash-flow value of a company and are indeed well-suited for passive long-run investors.

Comment:

I was initially puzzled by the rate of return difference. If you start and end at the same price, but pay the same dividend, how do you achieve a different return? I think the answer is reinvestment. Dividends paid to the voting shares during the spike are reinvested at a time of terribly high prices, and so lose.

Ed Glaeser has a thoughtful essay at City Journal, "The War on Work -- and How to End It.''

It is interesting that our political class says it wants more Americans to work. Yet there are few activities as hit by disincentives and regulatory barriers than the simple act of paying another person to do something for you.

With wide range and long historical perspective, Ed points out the slow decline in the fraction of the population working, especially prime-age men.

From 1945 to 1968, only 5 percent of men between the ages of 25 and 54—prime-age males—were out of work. ...As of December 2016, 15.2 percent of prime-age men were jobless  

These are "out of the labor force," not looking for work. We are arguably at a business cycle peak, with a low unemployment rate -- defined as those looking for work.

Joblessness is disproportionately a condition of the poorly educated. While 72 percent of college graduates over age 25 have jobs, only 41 percent of high school dropouts are working. 

Why? I'm not going to restate the whole thoughtful essay but the disincentives caused by safety net programs are a big part of the story:

...Social Security and unemployment insurance,  National disability insurance,  Medicaid and food stamps, housing vouchers... 

These various programs make joblessness more bearable, at least materially; they also reduce the incentives to find work. ... After 1984, though, millions went on the disability rolls. And since disability payments vanish if the disabled person starts earning more than $1,170 per month, the disabled tend to stay disabled. The economists David Autor and Mark Duggan found that the share of adults aged 25–64 receiving disability insurance increased from 2.2 percent in 1985 to 4.1 percent 20 years later.... 

Other social-welfare programs operate in a similar way. Unemployment insurance stops completely when someone gets a job, which may explain why economist Bruce Meyer found that the unemployed tend to find jobs just as their insurance payments run out. Food-stamp and housing-voucher payments drop 30 percent when a recipient’s income rises past a set threshold by just $1. Elementary economics tells us that paying people to be or stay jobless will increase joblessness.

The excellent "Panhandling in Downtown Manhattan: A Preliminary Analysis"  by Gwendolyn Dordick and Brendan O’Flaherty (HT Marginal Revolution) gives a particularly vivid example, Eli the panhandler:

Eli is severely disabled and confined to a wheelchair. He is a slight African-American man in his mid to late forties. He is unable to speak clearly. His uncontrollable twisting movements undermine his ability to maintain eye, but they do little to stop him from trying to let people see his somewhat toothless smile.

Eli is not homeless; he rents a small place uptown. Eli collects Supplemental Security Income (SSI) and Medicaid. Rent, food, utilities and transportation leave him little money for anything else, such as helping out his daughters every now and then, and making monthly payments for his cell phone(1) . [1 Eli bragged that since he switched carriers that he chopped close to $90.00 off his monthly bill.] 

Eli held regular employment in the past; he worked in a mailroom for two hours a day, but his hours are constrained by government regulated income limits. The more income Eli has, the less his SSI benefit will be. Furthermore, if his "countable’ income exceeds the allowable limit, he will lose his SSI benefits.(2)   [2 Countable income includes earned income from wages, from self–employment; unearned income, such as Social Security benefits, pensions, State disability payments, unemployment benefits, interest income, and cash from friends and relatives; in-kind income, for food or shelter; and deemed income from a relative (http://www.ssa.gov/ssi/text-report-ussi.htm).]

Some of the highest marginal tax rates in the US apply to people  like Eli. Wouldn't we rather see Eli working in the mailroom?
Back to Glaeser, an important point

Scholars Olivier Blanchard and Justin Wolfers have explained Europe’s persistent unemployment, which they called “hysteresis,” by the interaction of adverse economic shocks and extremely generous welfare states.

The fact that food stamps and disability have huge implied marginal tax rates does not affect people how have a job. Their disincentives kick in when people lose jobs, use the programs, and find it very hard to kick the habit.

Glaeser also mentions occupational licensing and other barriers to employment.

Glaeser mentions housing subsidies, but not their disincentive effects. I hope, as a top real estate economist, he comes back to this topic. Much of our safety net is tied to location. One reason people don't move to follow better jobs is that safety net programs don't follow them or family members well.

Housing subsidies are among the worst offenders. If you win an "affordable housing" lottery in one part of town, you can't afford to move across town or to another town to follow a better job. Or any job. Our government's subsidy of highly leveraged owner occupied houses has impoverished a generation of people who need to leave the factory town when the factory closes.

This is a tough nut. We want our government to target money to people who really need it. But we don't have infinite money. The answer has been to means-test programs, phasing out benefits as people get more income. The answer also has been to make programs somewhat of a pain in the butt, and not so portable. That discourages people who "don't really need it." Many Federal programs have take up rates in the single digit percentages. State and local administration of programs also discourages portability. Once you've gotten on Medicaid and found a doctor who will actually see you, moving once again gets harder.

The answer, I think is perhaps to spend more in order to spend less, and to limit benefits by time not by income; to focus on the incentives of programs not the amounts they spend. If there is less income phase out, the marginal tax rate is lower. The static cost seems larger, but if more people can move out of needing benefits, it may not be larger in the long run. If disability for back pain, say, was for 3 years only, integrated with health care for back pain, has no income limit, is transferable to a new place, we might see a lot more work -- people figuring out new occupations that don't hurt their backs too, more mobility, and in the end less expense.  Benefits need to be much  more portable, we need to let builders build apartments where people want to go.

More deeply, our government is quickly creating a legal class system based on income. You are a "low income person," for life, apparently, much as you once were a serf, tied to place, occupation and status. No. In America "income" should be, as it is, a temporary part of your life, low at times of misfortune, high at times of good fortune, and always beckoning. We are not a class society, but we are fast creating one by legislation.

The disincentive to work comes from the sum of all programs, not each one in isolation. The fragmentation of our programs makes the disincentives harder to see. Glaeser:

Consolidating social policies would be a crucial step. Struggling families now receive food stamps, housing vouchers, Temporary Aid to Needy Families, and other assistance—all of which punish work. If the various programs were combined into a single cash benefit, that benefit could be designed so that the tax on earnings never went above 30 percent. We could follow the lead of Norway on unemployment and disability insurance, allowing the disabled to keep, say, 50 percent of their benefit above the $1,170 threshold, while tightening the requirements for being designated as disabled. [Or, as I suggest, limiting the time] Unemployment insurance could be structured so that payments were no longer contingent upon staying completely out of work.

Reforming the incentives of social programs could be a bipartisan effort (if anything can be a bipartisan effort these days). We spend less, we help people more.

Reform is not impossible.

Twenty years ago, the more economically successful European nations, such as Sweden, Germany, and the Netherlands, reorganized their welfare states to emphasize work and witnessed positive results. Others, including France, Italy, and Spain, did not, and they have struggled. In a sense, the eurozone financial crisis of the past half-decade is the legacy of southern European countries that wouldn’t fix their failing welfare systems. The U.S. needs to decide if it wants to follow the path of Germany or of Spain.

"Socialist" Sweden turned out to be remarkably hard nosed about incentives. If they can do it, so can we.

Todd Henderson and Dorothy Shapiro wrote me a thoughtful response to my post on non-voting shares. Todd and Dorothy:

Response to Cochrane

We are grateful for Cochrane’s thoughtful response to our op-ed in the Wall Street Journal. Space limitations prevent us from giving the necessary treatment to our ideas, but he is right to push us to be careful in our analysis, no matter the limits. We look forward to addressing his concerns and others in a forthcoming article.

In the meantime, here is a quick response to the thrust of Cochrane’s critique.

There is a logical inconsistency in Cochrane’s post—his “modest proposal” would require more legal change to accomplish than ours. (And we are the ones with a vested interest in more law!) For one, it’s not clear that companies would willingly issue non-voting stock in addition to voting stock (and in the right amounts)—this occurs very rarely in practice, if ever.

Second, even if the shares existed, Cochrane assumes that index funds would willingly buy them, although there’s no evidence to suggest that this would occur.

The hostile reaction from large passive institutional investors, including BlackRock and Vanguard, to the Snapchat IPO and other recent dual class stock offerings make it clear that passive funds wouldn’t buy non-voting stock willingly—institutional investors participated in those offerings under protest and have since been advocating for reforms that would prevent future non-voting offerings, even going so far as to lobby Russel FTSE to delist companies that have dual class shares.

It’s also unlikely that non-voting stock would be much cheaper than voting stock—empirical evidence has demonstrated that often, non-voting stock doesn’t trade at any discount to voting stock (such as when there's a controlling shareholder or the company is well run).

Even if passive funds could purchase non-voting shares at a small discount, it’s not obvious that they would have any incentive to do so. Index funds have the sole goal of replicating the performance of an index. Why would they want to get a different product for a lower price? This is especially true when doing so would cause them to give up power and influence over some of the companies that they invest in (for a small benefit that investors are unlikely to recognize).

So, under Cochrane’s proposal, the law would have to not only require companies to issue non-voting shares, it would also need to require index funds to buy them. Talk about a lot of law! (Read: coercion.) Not only would this be a more dramatic change than the one that we propose, it would surely lead to a worse world. As an example, there could be liquidity concerns—if passive funds wanted to sell en masse (as can happen when funds are tracking the same index), there would be no buyers. And, if passive funds instead wanted to buy, there would be no sellers (and in this situation, it's unlikely that the non-voting shares would really trade at a discount).

By contrast, our solution--encouraging (but not requiring) passive funds to abstain from voting—is much less intrusive. Rather than mandating the creation of a new market of non-voting shares, we advocate a voluntary legal change that would permit natural correctives to any corner solution. The concern seems to be that if index funds abstain, too much power will be vested in the hands of activists, not all of whom will be interested in long-term shareholder value. But if index funds are merely encouraged to abstain unless they have no strong interest in the outcome, then there is a natural, market-based corrective to this problem. If activists go overboard, then index funds will have a strong interest, and reenter the voting market at that time. In a sense, Cochrane’s critique is ironic: we are calling for less law. We want law to get out of the way, by letting index funds act naturally—to not vote when they have no interest in doing so, and where they have no comparative advantage in the process. (Our other alternative, a legal duty to vote in an informed matter, and not just blindly follow ISS and other proxy advisors, is a clear second best.)

***

A little response-response clarification:

I do not envision any coercion!  So I  deny "under Cochrane’s proposal, the law would have to not only require companies to issue non-voting shares, it would also need to require index funds to buy them."

Index funds need to wake up and ask for non-voting shares, and then companies will issue them. The funds get a discount and absolution from legal trouble. Or companies need to wake up and offer non-voting shares to index funds. The companies get a new source of financing.

The non-voting shares I have in mind need do need a lot of smart lawyering and contract writing by people like Todd and Dorothy.  I accept the point that current non-voting shares are not as protected as they should be, that the promise ``you get exactly as much money as the voting shares, and you can sue as bondholders do if you don't'' needs teeth.

Indeed, the market is hostile to non-voting shares because current non-voting shares are designed to concentrate control with insiders, not to create a vibrant outside market for corporate control. That's the last thing insiders want, and a reason that companies will be slow to offer such shares unless funds start demanding them.

Sometimes the world hasn't arrived by itself at the optimum, just because nobody thought of it, not because there is a market failure, and not because law has not compelled it. We live in a time of legal and financial innovation, not just gadget innovation.

And index funds not voting aggressively is not a screaming problem that can't take some time to sort out.

(How to start a fight in a libertarian bar -- "You're advocating government intervention! No, you're advocating government intervention! I probably should have left that out of the original, and there is not much need to spend time on it in further discussion. Laws and contracts and courts are all on the menu at the libertarian bar.)

***

Update:

This is a good point. Perhaps we just need some good intermediation/financial engineering for index funds to routinely lend out their shares around votes.

Update 2 here

Todd Henderson and Dorothy Shapiro Lund have an interesting OpEd in the Wall Street Journal, "Index funds are great for investors, risky for corporate governance." In brief, index funds don't participate heavily in monitoring companies, finding information about companies, or corporate control contests.

This point echoes larger complaints that with the spread of index funds there won't be enough active money to make markets efficient, and especially to make efficient the market for corporate control. One of the most important functions of a public market is, if you think that a company is mismanaged, you can buy up a lot of shares, vote out the management, and run it better. This is an imperfect system, to be sure, but note how many nonprofits (universities) and privately held companies, immune from this pressure, are run even more inefficiently than public companies.

Todd and Dorothy, law professors, after very nicely reviewing how funds currently deal with voting issues, seem to favor more law.

So how can the law ensure that these institutions make informed decisions about corporate governance? ... The first is to encourage them to rely on third-party corporate governance experts. It may be necessary... for the law to create incentives for institutional investors ...option three: encouraging passive institutional investors to abstain from voting altogether.   

Hmmm. When "the law," not a person or people, is the subject of a sentence, I get cautious. When the law wants "to encourage" people, my hackles rise.  The law "encourages" and "creates incentives" pretty bluntly. One example, though discarded, is a bit chilling,

 This could be accomplished by providing a legal cause of action to shareholders that are harmed by uninformed or conflicted voting decisions. But this would be a blunt tool for curbing abuse. 

Indeed it would.

But this is forgiveable. They are lawyers, so more law is the answer. We are economists, and law a necessary evil when contracts and markets fail. Is there not an economic solution, a Coasean way to slice the knot?

I think so. Companies should issue, and index funds should want to buy, non-voting shares.  Non-voting shares seem to be regarded as a little infamy of internet companies, used to keep control in the hands of founders. But a split between voting and non-voting shares seems ideally suited to a mass of indexing investors, and a few active, information-based traders and active corporate control investors. In this vision, most of those voting shares are in public hands, unlike the internet companies.  In fact, most corporate stock grants and options to insiders should be in the form of non-voting shares.

Non-voting shares are treated exactly the same for all cash flow purposes. They receive the same dividends, same rights in repurchase, same treatment in any reorganization. They just do not allow the right to vote.

Since index funds don't value the option to vote, they should want non-voting shares.


Would such shares trade at a discount? Yes, likely so. And that's a benefit, not a cost, a feature not a bug. Index funds could buy the same cash flow, which is what they want, cheaper, by giving up the value of their votes, which they're not interested in. Buying the same cashflow cheaper gives you a better return.

Todd  and Dorothy actually advocate a form of this idea, that the index funds voluntarily refuse to vote.  But then the index funds pay the cost of an option they do not use. By purchasing non-voting shares they do the same thing, and reap a financial reward.

This separation between voting and non-voting shares would make the market for corporate control more efficient. It is easier for someone who wants to buy the voting rights to buy them from other active investors than from passive mutual funds. It also separates the stock market price into guesses about cash flows and guesses about corporate control events. As a long-term investor I'm interested in the former and less in the latter.

Non-voting shares become a sort of state-contingent long term debt. Rather than guarantee payment by its fixed value, as in debt, payment is guaranteed by its equality with whatever other shareholders are paid, and similar rights in court as debt-holders have to enforce their right to be paid ahead of voting shareholders.

I've asked a few of my corporate finance colleagues about this idea, and their general reaction is that it won't work, because sooner or later the investors with voting shares find ways to screw the non-voting shares out of money, not just out of votes. The ability to vote is the ultimate guarantor of payment.

I'm still not totally convinced.  (I admit I did not follow all of the shenanigans they suggested to accomplish stealing money from voting shares.) If we're bringing in law here, and if we're designing a security, it seems not impossible to create a class of non-voting shares whose equal treatment in all cashflow related events is the same as those of voting shares, and who have strong rights to sue to guarantee those rights. Long-term debt works, after all, as the voting shares don't find a way to escape interest and principal payments. The contract design for that right seems easier than the legal means to "encourage" behavior that Todd and Dorothy imagine.

Update: See Todd and Dororthy's response and more discussion.

Anthony Diercks has a very useful review of the the academic literature on the question, what is the optimal inflation rate? He includes 150 papers, ordered from low to high inflation.


Broadly speaking, we start with the Friedman result that the optimal nominal interest rate is zero, so the optimal inflation rate is the negative of the real rate of interest. The optimal nominal interest rate is zero, so people feel no incentive to economize on money holdings, or devote effort to cash management, paying bills late and collecting early. Many sticky price models suggest an optimal inflation rate of zero, so you don't have to change sticky prices. Then,

Most all of the studies that have found a positive optimal inflation rate have been written in the last ten years. The increase in the number of studies with a positive optimal inflation rate can be explained predominantly by the rise of two modelling features: (1) inclusion of the zero lower bound and (2) financial frictions.  

The zero bound means the Fed may want some headroom, a higher nominal rate in normal times. (More on that issue in an earlier post here).

Then, economists get creative. Anthony provides a nice list of additional ingredients that have appeared in the literature:

Previous studies have outlined a deviation from strict inflation stabilization for some of the following reasons: 

• Money (opportunity cost of positive interest rate)
• Distortionary taxes (inflation can be shock absorber to reduce tax volatility)
• Govt. transfers (represent pure rents that inflation can conscate)
• Sticky wages (stabilize wages rather than inflation)
• Price and wage markup shocks (cost push shocks)
• Zero lower bound (inflation reduces chances of reaching ZLB)
• Capital accumulation (composition of demand between investment and consumption matters)
• Flexible prices (no costs associated with inflation)
• Foreigners demand for domestic currency (inflation generates seignorage)
• Price indexation (reduces costs of inflation)
• Collateral constraints (prevents borrowers from smoothing the way savers do)
• Endogenous firm entry (higher entry costs reduce number of firms but increase desired markups, inflation lowers markup and discourages welfare-inefficient entry)

This is a hot topic, as you can see. The Fed is thinking how to adapt to lower real interest rates. The blogosphere and commentariat are echoing more calls for the Fed to raise the inflation target. Some of this seems to reflect a resurgence of belief in the 1960s era static Phillips curve, that a higher target would lead to a permanent stimulus. Discredited economic ideas never seem to really die.

Anthony closes with

Overall, the goal of this survey is to act as a definitive resource that policymakers around the world can use to evaluate their inflation targets going forward. Furthermore, it will provide the general public with a justification and understanding of the 2% inflation target.

The former is laudable. The latter seems wishful, though necessary given Anthony works for the Fed. I think this survey has the opposite effect: it makes clear just how thin the scientific understanding behind the 2% mantra is, just how much our central banks pulled 2% out of a hat and then repeated it over and over again until it seemed carved in to stone. The Fed's mandate is "price stability," not "2% inflation." It is also a nice reminder of the difference between academic and policy writing. A good academic paper focuses on one mechanism and really understands it. Policy makers have to find an optimal inflation rate that balances 150 different mechanisms. And counting.

But do not take that as criticism. The optimal inflation target is likely whatever the inflation target is. Most of the function of a target is to be a rock of stability. 0%, 2%, or 4% would each likely work as well as the other, but constant rethinking of any target would not. The point of a target is to "anchor expectations." The "justification and understanding" should not be that 2.000% is precisely optimal. The justification and understanding is that the Fed picks one number and sticks to it. My main complaint about many people who want a higher target, or a price level target conveniently backdated to the pre-2007 trend, is the sneaking suspicion that this is just about current stimulus and they will want a lower target or to abandon the price level commitment later. (Where were you when the price level or NGDP target said to lower inflation?) The inflation target should not respond to current policy concerns. Inflation targets are like constitutions -- change them infrequently,  and only for very good reasons.

If you think Anthony is missing an important and relevant paper, put the citation in the comments. This paper is special for its attempt to be comprehensive. But keep it relevant -- the paper should have a qualitative answer to "what is the right long-run inflation target?"

Ricardo Reis has an excellent essay on the state of macroeconomics. "Is something really wrong with macroeconomics?"

In substantive debates about actual economic policies, it is frustrating to have good economic thinking on macro topics being dismissed with a four-letter insult: it is a DSGE. It is worrying to see the practice of rigorously stating logic in precise mathematical terms described as a flaw instead of a virtue. It is perplexing to read arguments being boxed into macroeconomic theory (bad) as opposed to microeconomic empirical work (good), as if there was such a strong distinction. It is dangerous to see public grant awards become strictly tied to some methodological directions to deal with the crisis in macroeconomics.

There have been lots of essays lately bemoaning the state of macroeconomics. Most of these essays are written by people not actively involved in research, or by older members of the profession who seem tired when faced with the difficulty of understanding what the young whippersnappers are up to, or by economic journalists who don't really understand the models they are criticizing. I am old enough to feel this temptation and have to fight it.

Many bemoan the simplifications of economic models, not recognizing that good economic models are quantiative parables. Models are best when they isolate a specific mechanism in a transparent way.

Critics usually conclude that we need to add the author's favorite ingredients -- psychology, sociology, autonomous agent models, heterogeneity, learning behavior, irrational expectations, and on and on -- stir the big pot, and somehow great insights will surely come. This is the standard third-year PhD student approach to writing a thesis, and explains why it takes five years to get a PhD.


I'm a bit guilty too -- with "Discount Rates" and "Macro Finance" full of my ideas on how to stir the pot and maybe get somewhere that I can't quite work out yet. Ricardo captures the feeling well:

 In turn, it would have been easy to share my thoughts on how macroeconomic research should change, which is, unsurprisingly, in the direction of my own research.

But at least I didn't argue that everyone else is wrong or bad or stuck, just these are my hunches on good things to try!

Others bemoan "too much math" in economics, a feeling that seldom comes from people who understand the math. The fact is, we have too little math in economics. There are so many phenomena we'd like to capture, so many frictions and real-world complications we would like to add and understand, but just don't have the tools to do it. Especially in finance, policy discussions go on and on about channels that we have very little clue to model.

Good economics is about answers, not questions; it's about finding the few simple ingredients that work. Economic models are so sensitive to ingredients that if you just pour and stir, you get garbage. Economics remains quite different from physics in that way. The underlying ingredients of (say) a climate or aircraft design model are very well understood, so you can make complex models that work. The underlying ingredients of economic models are not so well understood -- how much more will people work if their wages rise, how do they interpret statements by government officials, how do companies change their prices, and so on -- that small changes in the little ingredients make big differences in the economy-wide outcomes. Hence, good models are clear quantiative parables, not stone-soup melanges of popular ingredients.

Ricardo starts by evaluating current macroeconomics, empirically, by what active reasearchers are actually doing

... accurate measures of the state of macroeconomics are what the journals have recently published, or what the recent hires of top departments are working on.

After summarizing the research of 8 recent star new macroeconomics PhDs,

...this is all exciting work, connected to relevant applied questions, and that takes data and models seriously. In contrast, in the caricatures of the state of macroeconomics, there are only models with representative agents, perfect foresight, no role or care for inequality, and a cavalier disregard for financial markets, mortgage contracts, housing, or banks. Supposedly, macroeconomic research ignores identification and does not take advantage of plentiful microeconomic data to test its models, which anyway are too divorced from reality to be useful for any real world question. 

Compare this caricature with the research that I just described: the contrast is striking. Not a single one of these bright young minds that are the future of macroeconomics writes the papers that the critics claim are what all of macroeconomic research is like today. Instead, what they actually do is to mix theory and evidence, time-series aggregate data and micro data, methodological innovations and applied policy questions, with no clear patterns of ideology driven by geography.

After summarizing some other critiques, more data

Table 3 reports the articles published in the latest issue of the top journal in macroeconomics, the Journal of Monetary Economics...These include: theoretical papers on sovereign debt crises and capital controls, applied papers on the interrelation between financial indicators and macroeconomic aggregates, papers looking at extreme events like catastrophes and liquidity traps, and even purely empirical papers on measuring uncertainty in micro data and on forecasting time series in the macro data. There is originality and plurality, and a significant distance from the critics’ portrayal of research.

...Yet, according to De Grauwe (2009) “The science of macroeconomics is in deep trouble.” while Skidelsky (2009) thinks that there has already been a “...discrediting of mainstream macroeconomics”. These opinions express feelings more than facts, so it is hard to debate them.

Critics who bemoan rational expectations, DSGE, representative agent modeling, are largely complaining about what the young turks of the 1980s were doing, upsetting the Cambridge ISLM consensus of the 1970s. If you go to macroeconomics seminars today it's almost painful that every single paper has heterogeneous agents, some irrational expectations, and financial frictions galore. I actually long for the simplicity and transparency of the single agent rational expectations benchmark.

How about the charge that macroeconomic policy advice has been a failure?

Ricardo correctly points out that we are not nearly as influential as we think we are. (And policy makers are just as deaf to microeconomists, for example on free trade!)

macroeconomists are very far from running the world....Most macroeconomists support countercyclical fiscal policy, where public deficits rise in recessions, both in order to smooth tax rates over time and to provide some stimulus to aggregate demand. Looking at fiscal policy across the OECD countries over the last 30 years, it is hard to see too much of this advice being taken. Rather, policy is best described as deficits almost all the time, which does not match normative macroeconomics....Critics that blame the underperformance of the economy on economists vastly overstate the influence that economists actually have on economic policy.

I would double this observation for finance and the financial crisis. There is a trope in the media that efficient markets finance caused the crisis. This shows appalling ignorance. If you listen to efficient market finance, it says to invest passively in the market index, not risky tranches of mortgage backed securities pools, or the hedge funds that buy them.  And no academic told our regulators to set up the preoposterous system of mortgage subsidy and too big to fail bailouts.

One area where macroeconomists have perhaps more of an influence is in monetary policy. ...Looking at the major changes in the monetary policy landscape of the last few decades —central bank independence, inflation targeting, financial stability—they all followed long academic literatures. ...In the small sub-field of monetary economics, one can at least partially assess its successes and failures in the real world by judging how central banks have done over the past few decades....Every central bank that I know of in the developed world is in charge of keeping inflation low and stable.

Everyone loves to complain about the Fed. But their mandate is price level stability, now interpreted as less than 2% inflation, maximum employment, at least as much as money can affect it, and low interest rates. Check, check, check. I'm not sure how they did it, but it's hard to get too excited.

Mostly, by learning the lessons of history and not screwing up:

following the collapse of Lehman or the Greek default, news reports were dominated by non-economists claiming that capitalism was about to end and all that we knew was no longer valid, while economists used their analytical tools to make sense of events and suggest policies. In the United States in 2007-08, the Federal Reserve, led by the certified academic macroeconomist Ben Bernanke, acted swiftly and decisively.... While the recession was deep, it was nowhere as devastating as a depression. The economic profession had spent decades studying the Great Depression, and documenting the policy mistakes that contributed to its severity; these mistakes were all avoided in 2008-10.

A separate criticism of macroeconomic policy advice accuses it of being politically biased....Yet, labor economics also has a history of heated debates and strong ideological priors, as well as continuous re-examination of truths previously held as obvious, such as the effects of the minimum wage on employment or of immigration on wages.  ..Macroeconomics does not stand out from labor and public economics in the features that the critics point out as the source of its crisis...macroeconomics is not all that special relative to the other fields. Economists across all fields were in part surprised by the crisis, but also eager to study it and analyze it.

...one could teach a macroeconomics class where the baseline model has (i) finite lives with overlapping generations, (ii) preferences over non-durables and housing, (iii) naive hyperbolic discounting, (iv) sticky information in forming expectations, (v) incomplete markets for individual income risk with maximally tight borrowing constraints, (vi) monopolistic competition and firm entry with fixed costs, (viii) nominal rigidities, (viii) simple banks with a net worth constraint (ix) distortionary taxes and government spending, and (x) a desire for liquidity for exchanges in decentralized markets.

Current macroeconomic research is not mindless DSGE modeling filled with ridiculous assumptions and oblivious of data. Rather, young macroeconomists are doing vibrant, varied, and exciting work, getting jobs, and being published. Macroeconomics informs economic policy only moderately and not more nor all that differently than other fields in economics. Monetary policy has benefitted significantly from this advice in keeping inflation under control and preventing a new Great Depression. Macroeconomic forecasts perform poorly in absolute terms and given the size of the challenge probably always will. But relative to the level of aggregation, the time horizon, and the amount of funding, they are not so obviously worst than those in other fields. What is most wrong with macroeconomics today is perhaps that there is too little discussion of which models to teach and too little investment in graduate-level textbooks.  

As part of the development of our new group in Dublin, we will be updating the blog over the next few months and I hope to post a lot more. We will launch our new research cluster on September 8th with Professor Peter John as keynote (Details here). Currently, we are in the process of recruiting postdocs and PhD students, and we are starting a new MSc in September. I hope that Dublin will be seen as a vibrant place for the emerging behavioural public policy field.

1. BIT are hiring.

Charlie Plosser makes the case that the Federal Reserve should hold only Treasuries in its asset portfolio, at Hoover's "Defining Ideas"

Background: The Fed is essentially a giant money-market fund. Its liabilities are cash and bank reserves. Its assets are .. well, they used to be entirely short term Treasury securities, but now include mortgage-backed securities. In the crisis, the Fed bought a lot of other securities. Other central banks buy stocks, and it's pretty clear if there were a recession tomorrow, after interest rates hit zero the next day, the Fed would go on a buying binge. The Fed is a government agency, but it is "independent," enjoying a lot of freedom to do what it wants no matter what Congress or the Administration want it to do.

Plosser's proposal,

 1.        The Federal Reserve should be required to maintain a Treasuries-only policy as it pertains to the conduct of monetary policy. 

2.         The Federal Reserve should be prohibited from purchasing non-Treasury securities, private sector securities or lending against private collateral except through traditional discount window operations with depository institutions. 

3.         Emergency lending under Section 13(3) of the FRA should be eliminated and replaced with a new Fed-Treasury accord...

The Fed may buy other securities, but basically has to swap them back to the Treasury or sell them within 60 days. If the government is going to subsidize credit to various industries, voters, and constituencies, then the politically accountable Treasury should do it, not the independent Federal Reserve. Charlie allows here that the Fed may be able to move faster in a crisis.

Why only Treasuries? Why should the Fed not always have greater power to guide the economy more forcefully by buying whatever assets it thinks need propping up? Because,

 ...in a democracy, independence must come with limitations on the central bank’s authorities and discretionary powers. Otherwise, central bankers can use their powers to venture into policy realms unrelated to monetary policy, especially fiscal policy, which more appropriately rests with elected officials. ...Engaging in such actions also undermines the central bank’s legitimacy and the case for independence

A central bank that hands out money to voters, or denies such money when it wants to prick bubbles, cannot stay independent for long. That central bank then becomes a piggy bank for legislators and presidents.

More troubling was the lending under Section 13(3) of the Federal Reserve Act (FRA), which included support of the creditors of Bear Stearns and AIG. The Fed also funded other lending programs designed to support the purchase of commercial paper and other types of asset-backed securities.... Regardless of the rationale, the Fed sold Treasury securities from its portfolio and used the proceeds to purchase risky private sector securities. These actions amounted to debt-financed fiscal policy but without the explicit authorization of Congress. Given the distributional effects of such interventions, it is not surprising they proved controversial.

...The discretion to engage in credit allocation represents an open invitation to politicians and interest groups to pressure the central bank to use its authority to manage its assets to further some other agenda. Maybe the Fed should invest in green energy companies, in domestic manufacturers who pledge not to ship jobs overseas, or infrastructure bonds issued by state or municipal authorities. This may seem far-fetched, but Congress asked the Fed to invest in the automobile companies in 2008. After all, it had already supported Bear Stearns and AIG, and weren’t the big four auto companies as important to the economy and employment as these financial firms? Fortunately, the Fed said no, but the discretionary authority to engage in credit allocation could prove to be a threat to Fed independence. 

My first reaction, a few years ago when I started talking to Charlie about these things was, this is a tempest in a tea pot. The Fed and Treasury have one consolidated budget constraint. If the Fed loses money, it comes out of the Treasury eventually. This is like arguing whether you should pay restaurant bills from the cash in your left pocket or the cash in your right pocket.

Both Charlie and quite a few conversations inside the beltway convince me this is wrong. The average legislator does not see things this way at all, the Fed balance sheet really does look like a piggy bank.

Charlie cuts the gordian knot cleverly, I think. The Fed does move faster in a crisis. But buying securities is not the same as holding securities.

Actually, I would think the Fed would want such a deal. Right now, as I understand the legalities, the Fed is not allowed to swap securities with the Treasury. This is one of the brilliant legal constraints our ancestors put in against inflationary finance. They didn't want the Treasury to force the Fed to buy securities at inflated prices. But for the Fed, the ability to buy what it wants but not have to hold the risks, or political fallout, forever should be very attractive.

If there is a contrary view, I think it must be that there really is nothing left to monetary policy. Now that reserves pay interest, all Charlie's Fed will do is to act as a giant Treasuries only money market fund, to undo the curiosity that the Treasury itself cannot figure out how to issue true floating-rate debt directly, and to figure out what rate to offer.

Take the view then, that the Fed's central role is to interfere with -- sorry, to "supervise," "regulate" and "stabilize" -- financial markets, perhaps in crises only, or perhaps because you view markets as inherently unstable and behavioral and the Fed somehow able to offer super-rational financial dirigisme. If the independent Fed is going to be running "macro prudential" policy and scrutinizing banks credit policies, telling banks who to lend to, then it might as well interfere directly in the same markets, and even start buying and selling stocks to offset "herd" mentality in markets or whatever. Charlie doesn't talk about it, but the Fed's regulatory arm is already allocating credit.

This is, I think, where we are and are heading. But I think Charlie's point applies. This Fed as Great Financial Director cannot, in a democracy, stay as independent as has evolved for a Fed whose power is limited to old-fashioned monetary policy implemented by buying Treasury securities and managing a vanishing stock of money. And while it's fun for economists to write papers about just how rational we are and if someone put one of us in charge we could spot those bubbles and herds, I think we all agree politicians, handed another set of excuses to start handing out credit here and there, are not going to do a great job of it.

The tension remains. If the Fed is going to be deeply involved in directing the financial system, either it must be powerful, but then subject to the usual sort of political accountability as Treasury, and therefore subject to all the political craziness of the rest of government financial and credit allocation policy, or it must be severely limited in what financial levers it can push with great independence.

Research Assistant Needed for Behavioural Science Research

Applications are invited for an hourly paid role as a Research Assistant located within the UCD Geary Institute. The successful candidate will be offered a part-time role on an hourly basis for 6-8 weeks at 35 hours a week to commence with immediate effect.

The researcher will be based at the Geary Institute and will provide research support, deliverables and project work to Prof Liam Delaney in developing the behavioural science and public policy programme at UCD Geary Institute.

Pay: €10.55 per hour

Please send a cover letter outlining your skills and interest in the area and CV to Emma Barron, emma.barron@ucd.ie
Closing Date: Friday, 30th June 2017 at 17:00.

One of the core problems of financial reform is how to "resolve," AKA bankrupt, a big bank -- how can equity holders be wiped out, and debt holders carve up the remaining assets. Big banks are supposed to craft “living wills,” really living vivisection guides, but that effort is clearly in trouble. This blog post expands on a different idea for bank resolution; let’s call it “living trusts” by a similar analogy to estates.


Here's the idea: Let a bank fund its risky investments 100% by issuing equity. The bank then simply cannot fail — it cannot go bankrupt, it cannot suffer a run.  As I've argued elsewhere, I think this is entirely practical.

But suppose it really is important for some reason to carve up bank liabilities into a small amount of highly leveraged equity and a large amount of run-prone short-term debt. Suppose it really is important for banks to "create money," and to take deposits, and to funnel those into risky, illiquid, and otherwise hard-to-resolve assets. Suppose that equity holders really demand highly leveraged high return high risk bank equity, not super-safe low return low risk bank equity, that the return on equity not its Sharpe ratio is a constant of nature.

OK. For $100 of assets, and $100 of bank equity, let, say, $10 of that equity be traded — enough to establish a liquid market. Then, let $90 of that equity is held by a downstream entity or entities— a fund, special purpose vehicle, holding company or other money bucket. I’ll call it a holding company, and return to legal structures below. The holding company, in turn, issues $10 of holding company equity and $80 of debt.

There you have it — $100 of bank assets are “transformed” into $10 of very safe bank equity, $10 of risky and high return holding-company equity, and $80 of short-term debt.

Now if the bank loses money, the value of the bank equity falls. But the bank is failure-proof and run-proof. Shareholders get mad, may throw out management, may even break up the company. But they cannot run, demand their money now, and force bankruptcy.

The holding company can fail however! Suppose he bank loses $20. The holding company owes $80 of short term debt. Its assets are worth .9 x $80 = $72. It’s insolvent. It fails. Holding-company equity holders are wiped out. Holding-company creditors get the assets, common stock in the original bank, worth $72/$80 = 90 cents on their original dollar.

It need not be that drastic. Its likely the previous short-term debt holders don’t want stock, and would want to sell it in a hurry. Dumping 90 shares on the market might be tough.

The holding company could do a 5-minute recapitalization instead. Holders of the $80 of debt get $60 of debt and $12 of new holding-company equity. The holding company is recapitalized by the flip of a switch.

The key: this resolution/recapitalization can happen in about 5 minutes.


It takes no lawyers, no bankruptcy court, no resolution authority, no FDIC, no deep pocketed buyer, no deal sweeteners and toxic asset subsidies from the Fed, no months in court trying to find rehypothecated securities in foreign branches.  The bank itself keeps humming along. There is no interruption in lending activity, no risk that the ATM machines go dark. There is no run by depositors, brokerage clients, derivatives counterparties. There is no destruction of bank human capital.

The holding company assets—common stock in the bank — are completely transparent. They are liquid, and marked to market instantaneously. They can be handed to creditors at the flip of a switch. There is no tension between "illiquidity" and "insolvency," no "impaired assets." We know what the holding company is worth on a millisecond basis.  There is no "contagion," in which failure of one bank holding company leads people to question another, because everyone knows what the holding company is worth at all times. We don't need any regulators or accountants to flip any switches -- the second the market value of holding company equity falls below a given threshold, the failure or recapitalization happens instantly. Electronically.

As a reminder, here is how banks are organized now. In the event of bankruptcy or a run, the large amount of debt has a direct claim on the bank's assets. To realize that claim, though, they have to go through bankruptcy court or the resolution authority, and then sell actual assets. Assets are illiquid, hard to sell, especially in a crisis. This takes years and a lot of lawyer fees. Meanwhile the bank operations are often frozen, and its ability to serve customers and make loans is impaired, so the economy suffers.

Current regulation includes “living wills” that are supposed to make it easy to tear up a bank quickly, but there is a lot of doubt that will work. The Dodd- Frank "Resolution authority" is supposed to step in as the FDIC does, to quickly force a resolution before too much value is lost. But the idea that a few government officials can do over a weekend what bankruptcy court cannot accomplish in months seems weak, at best.
The living will idea has not been a huge success, with the Fed flunking several banks’ proposals. More deeply, the idea that in the midst of the next crisis — imagine early October 2008 — our government really will step in to a troubled big bank — Citi, say — and force big losses on the other creditors, each screaming their own "systemic importance" seems questionable.
I won't here belabor the options, but there are lots of ways to organize the same basic idea. I originally thought of the holding company as a mutual fund, exchange traded fund, or special purpose vehicle, to emphasize how mechanical the whole thing is. Now, I like the idea of a holding company a bit better, as equity also has voting and control rights. But this post is about finance and not law, and I'm not that good at corporate finance or law anyway. So fill the box any way you'd like.

"Holding company" is attractive though because many banks are already organized around a large holding company which effectively owns shares in multiple banks. So really all we're doing here is cleaning up the relationship between holding company and banks, and who has rights to what claims on either.

The central point: Debt, and especially short term debt, is a liability of the holding company not a liability of the original bank. Its rights are limited to recovering common stock of the bank. As stockholders, its owners can choose to liquidate the company if they choose. But they do not have the right to seize bank assets directly.

Clearly, having gone this far, the holding company could be diversified, and perhaps interleaved -- one holding company holds shares in several banks, and each bank could issue equity to multiple holding companies -- or leveraged bank-stock ETFs, which is what they become. Such diversification would make the debt even safer.

The idea has some parallel with cocos -- convertible bonds. The idea there is to issue bonds that trigger conversion to equity under certain conditions. The trouble is just what are those conditions. You need accountants or regulators to peer into notoriously obscure bank balance sheets and decide to trigger the conversion. With the holding company structure, the market price of bank shares does that for you.

What objections remain? Yes, the deposits and short term debt I describe are not perfectly risk free. Diversified holding companies would help. Capital ratios on holding companies would help. Partial funding with long-term debt, as with current banks, would help. But the current structure is not risk free either (!), absent a government guarantee.  In fact, the risk is a good deal smaller, even at the same capital ratios, because this system pretty much eliminates runs and crises. There is no uncertainty about the holding company's status.

The other possibility is that short term debt, with a bankruptcy court claim on assets, is somehow deeply tied to the bank's investment or loan origination activity. Lots of people make such a claim, perhaps that run-prone debt is needed to discipline bank managers in a way that closely-held equity cannot do. If there is such a tie, however, it is severed by government deposit insurance, guarantees, and resolution, so we're not making progress as things are.

(Some of these thoughts are prompted by "Bank Resolution and the Structure of Global Banks" by  Patrick Bolton Martin Oehmke, which Martin recently presented at Stanford. They study a similar issue of where and how regulators restructure banks.)

My little foray here into the blogosphere sometimes leaves me in slack-jawed amazement at the leaps of illogic in the commentariat.

In a recent blog post, Hoover Institute senior fellow John Cochrane likens single-payer health care to single-payer food:
...
by drawing an equivalence between health care and food, Cochrane is ignoring the long history of economic research showing that the health-care market is very different from others.  

Here I am left scratching my head. I did not, in fact, "liken single payer-heath care to single-payer food." I didn't mention health care at all. How can a post about food stamps "ignore" research on health economics? And if you spend 10 seconds googling you will find I have addressed all these arguments in other writing that is actually on this topic. You might not agree with my answers, but I don't "ignore" them.

A bit of advice to Noah: OK, you can't be bothered to do any real research before mounting a personal attack on  Bloomberg.com. But try to make it all the way through a blog post before writing a takedown.

(Or, back in the old days, before writing that "Cochrane is ignoring" something, basic journalistic ethics would demand that you contact Cochrane for comment, at which point Cochrane could point out that no, he is quite aware of Ken Arrow's work and has responded to it in detail, especially when actually writing about health care, not food. Or an editor or fact checker would require that. Some news media still practice this kind of basic journalistic ethics. Bloomberg, we see, does not.)

***

However completely unrelated to the subject at hand, though, Noah does bring up some interesting issues regarding health care. I'm grateful for the opportunity to rebut, because, as a matter of fact, I have written about health care,  and the attack gives me an opportunity to recycle some great old prose to prove that point.

The issue at hand: Can markets work for health care and health insurance? Noah:

There are so many problems with the health-insurance and health-care markets that it’s little wonder that they operate differently from the markets for food or cell phones. 

That's a misleading comparison. Health care is a complex personal service. The right comparison is lawyers, accountants, tax preparers, contractors, car repair shops, architects, gardeners, interior designers, bankers, brokers. These are all cases in which people deliver a complex service, and they know a lot more than we do. We hire their expertise as much as a product.

Health insurance is insurance. The right comparison is car insurance, home insurance, personal liability insurance, life insurance, disability insurance, and more complex insurance associated with businesses, such as director liability insurance, product liability insurance, freight insurance, and so forth.

All of these we generally leave to somewhat free markets. Nobody thinks there needs to be a single-payer contractor. (Well, maybe Noah does. I can't wait to see what kinds of bathroom tiles ContractorCare will pay for.) Just what is it about health care and insurance that have an essential market failure, and these do not?

Noah summarizes a 1963 Ken Arrow essay about health care, which Noah cites as research showing that markets cannot possibly work. The objections:

.. the importance of moral norms.  People have all kinds of moral considerations associated with health care. They expect doctors to act honestly and selflessly, and not just seek profit

Any time economists start telling you to pass complex regulations to enforce morality, run in the opposite direction. The Obama administration had something with the idea of "science-based" policy. At least let's get the cause and effect science right before we start making moral claims.

Let's read economists about economics:

...incomplete markets. Can people really know all of the possible health conditions they might get, including how much they would pay to cure or treat each one? ... The answer is certainly no. 

...uncertainty -- in health care, people don’t know what they’re buying until it’s already too late to make a different choice. Unlike food, which you buy over and over, open-heart surgery tends to only happen once.  

...adverse selection. People with health problems are more likely to try to buy health insurance; and since insurance companies know this, they have to charge everyone more. 

....moral hazard. After you’ve paid for insurance, the insurance company has every incentive to deny as many claims as it can get away with denying

These are all the standard objections to markets. They are all theoretical possibilities, echoed in every econ 101 textbook. But are they true of health care and insurance? And so much so that the evident pathologies of a government run system is better? (Remember, the free market case is not that markets are perfect. It is the long and sorry experience that governments are worse.) And are they so much more true than they are of all the above listed complex personal services, that the latter can be left to markets but a vast government bureaucracy must not only provide for all but outlaw the private option?

As it turns out, I have written about these things, in "After the ACA" easily available on my website and rather relentlessly promoted on this blog, especially p. 184ff,

B. The Straw Man 

...Critics adduce a hypothetical situation in which one person might be ill served by a straw- man completely unregulated market, with no charity or other care (which we have had for over eight hundred years, long before any government involvement at all), which nobody is advocating. They conclude that the hypothetical justifies the thousands of pages of the ACA, tens of thousands of pages of subsidiary regulation, and the mass of additional federal, state, and local regulation applying to every single person in the country.

How is it that we accept this deeply illogical argument, or that anyone making it expects it to be taken seriously? Will not one person fall through the cracks or be ill served by the highly regulated system? If I find one Canadian grandma denied a hip replacement or one elderly person who cannot get a doctor to take her as a Medicare patient, why do I not get to conclude that all regulation is hopeless and that only an absolutely free market can function? Both straw men are ludicrous, but somehow smart people make the first one, in print, and everyone nods wisely


C. Adverse Selection

We all took that economics course in which the professor shows how asymmetric information makes insurance markets impossible due to adverse selection. Sick people sign up in greater numbers, so premiums rise and the healthy go without. George Akerlof’s justly famous “The Market for Lemons” proved that used cars cannot be sold because sellers know more than buyers.

Yet CarMax thrives. Life, property, and auto insurance markets at least exist, and function reasonably well despite the similar theoretical possibility of asymmetric information. Life insurance is also “guaranteed renewable,” meaning you are not dropped if you get sick.

Is the story even true? Do most people, with knowledge of aches and pains, really know so much more about likely cost than an insurance company armed with a full set of computerized health records, actuaries, health economists, and whatever battery of tests it wants to run? Or is asymmetric information market failure in health insurance just a myth passed from generation to generation, despite functioning markets in front of our eyes?

Now the real world does see a big “adverse selection” phenomenon. Sick people are more likely to buy insurance, and healthy people forego it. But the insurance company does not charge people the same rate because it can’t tell who is sick or likely to cost more— the fundamental, technological, and intractable information asymmetry posited in your economics class. The insurance company charges the same rate because law and regulation force it to do so. The insurance company is barred from using all the information it has.

Regulation seems to feel that we have the opposite information problem; insurers know too much. The centerpiece of the ACA, after all, is banning the use of information, that is, preexisting conditions, not a great regret that insurers cannot tell who has preexisting conditions in order to charge them more.

 [Like many others Noah took both sides of this. People know more than doctors so the is adverse selection. Doctors know more than people so there are incomplete markets, and people can't shop.]

This source of adverse selection is the legal and regulatory problem, not the information problem of economic theory, and easily solved. If insurance were freely rated, nobody would be denied. Sick people would pay more, but “health status” insurance or guaranteed renewability solve that problem and eliminate the preexisting conditions problem.

Adverse selection due to fundamental information asymmetry in an unregulated market is, as far as I can tell, a cocktail-party market failure. It is a nice story, but does not quantitatively account for the real world. Furthermore, the ACA is not a minimally crafted regulation to solve the problem that people know more than their insurance companies can know about their health. Once again we are subject to the logical fallacy of accepting the entire regulatory structure because of one alleged failure
of a hypothetical free market.

D. Shopping Paternalism

Defenders of regulation reiterate the view that markets can’t possibly work for health decisions:

“A guy on his way to the hospital with a heart attack is in no position to negotiate the bill.”

“One point I cannot agree with is that competition can work in healthcare, at least as it does in other markets. I cannot fathom how people faced with serious illness will ever make cost- based decisions.”

“What about those who currently don’t have the background and/or the economic circumstances to consume healthcare, (e.g. take anti-hypertensive medicine instead of [buying] an iPhone)?”

Ezra Klein trying to understand why healthcare prices are so high and so obscure, writes:

"Health care is an unusual product in that it is difficult, and sometimes impossible, for the customer to say “no.” In certain cases, the customer is passed out, or otherwise incapable of making decisions about her care, and the decisions are made by providers whose mandate is, correctly, to save lives rather than money. In other cases, there is more time for loved ones to consider costs, but little emotional space to do so— no one wants to think there was something more they could have done to save their parent or child. It is not like buying a television, where you can easily comparison shop and walk out of the store, and even forgo the purchase if it’s too expensive. And imagine what you would pay for a television if the salesmen at Best Buy knew that you couldn’t leave without making a purchase." 

 [Noah is also not being particularly original!]

New York Times columnist Bill Keller put it clearly, in “Five Obamacare Myths:”

"[Myth:] The unfettered marketplace is a better solution. To the extent there is a profound difference of principle anywhere in this debate, it lies here. Conservatives contend that if you give consumers a voucher or a tax credit and set them loose in the marketplace they will do a better job than government at finding the services—schools, retirement portfolios, or in this case health insurance policies— that fit their needs.

I’m a pretty devout capitalist, and I see that in some cases individual responsibility helps contain wasteful spending on health care. If you have to share the cost of that extra M.R.I. or elective surgery, you’ll think hard about whether you really need it. But I’m deeply suspicious of the claim that a health care system dominated by powerful vested interests and mystifying in its complexity can be tamed by consumers who are strapped for time, often poor, sometimes uneducated, confused and afraid."

“Ten percent of the population accounts for 60 percent of the health outlays,” said Davis [Karen Davis, president of the Commonwealth Fund]. “They are the very sick, and they are not really in a position to make cost- conscious choices.”

Now, “dominated by powerful vested interests and mystifying in its complexity” is a good point, which I also just made. But why is it so? Answer: because law and regulation have created that complexity and protected powerful interests from competition. And is the ACA really creating a simple clear system that will not be “dominated by powerful vested interests?” Or is it creating an absurdly complex system that will be, completely and intentionally, dominated by powerful vested interests?

But the core issue is these consumers who are “passed out, or otherwise incapable of making decisions about [their] care,” “strapped for time, often poor, sometimes uneducated, confused and afraid,” and “not really in a position to make cost-conscious choices.”

Yes, a guy in the ambulance on his way to the hospital with a heart attack is not in a good position to negotiate. But what fraction of healthcare and its expense is caused by people with sudden, unexpected, debilitating conditions requiring immediate treatment? How many patients are literally passed out?

Answer: next to none. What does this story mean about treatment for, say, an obese person with diabetes and multiple complications, needing decades of treatment? For a cancer patient, facing years of choices over multiple experimental treatments? For a family, choosing long- term care options for a grandmother with dementia?

Most of the expense and problem in our healthcare system involves treatment of chronic conditions or (what turns out to be) end-of-life care, and involve many difficult decisions involving course of treatment, extent of treatment, method of delivery, and so on. These people can shop. Our healthcare system actually does a pretty decent job with heart attacks.

And even then . . . have they no families? If I’m on the way to the hospital, I call my wife. She is a heck of a negotiator. Moreover, healthcare is not a spot market, which people think about once, at fifty-five, when they get a heart attack. It is a long-term relationship. When your car breaks down at the side of the road, you’re in a poor position to negotiate with the tow-truck driver. That is why you join AAA. If you, by virtue of being human, might someday need treatment for a heart attack, might you not purchase health insurance, or at least shop ahead of time for a long-term relationship to your doctor, who will help to arrange hospital care?

And what choices really need to be made here? Why are we even talking about “negotiation?” Look at any functional, competitive business. As a matter of fact, roadside car repair and gas stations on interstates are remarkably honest, even though most of their customers meet them once. In a competitive, transparent market, a hospital that routinely overcharged cash customers with heart attacks would be creamed by Yelp.com reviews, to say nothing of lawsuits from angry patients. Life is not a one-shot game. Competition leads to clear posted prices, and businesses anxious to give a reputation for honest and efficient service.

So this is not even a realistic situation. To be sure, some conditions really are unexpected and incapacitating. Not everyone has a family. There will be people who are so obtuse they would not get around to thinking about these things even if we were a society that let people die in the gutter, which we are not, and maybe some hospital somewhere would pad someone’s bill a bit. (As if they do not now!) But now we are back to the straw man fallacy. Once again, the idea that ACA is a thoughtful, minimally designed intervention to solve the remaining problem of poor negotiating ability by people with sudden unexpected and debilitating health crises is ludicrous. As is the argument that we should accept the entire ACA because of this issue. 

Take a closer look at Keller and Davis’s statement: “strapped for time, often poor, sometimes uneducated, confused and afraid,” and “not really in a position to make cost- conscious choices.” We are talking about average Joe and Jane here, sorting through the forms on the insurance offerings to see which one offers better treatment for their multiple sclerosis or diabetes-related complications. If Joe and Jane cannot be trusted to sort through this, how in the world can they be trusted to figure out whether they want a fixed or variable mortgage? Which cell phone or cable plan to buy? To deal with auto mechanics, contractors, lawyers, and financial planners? How can they be trusted to
sign marriage or divorce documents, drive, or . . . vote?

We have a name for this state of mind: legal incompetence. Keller, Davis, and company are saying that the majority of Americans, together with their families, are legally incompetent to manage the purchase of health insurance or healthcare. And, by implication, much of anything else.

Yes, there are some people who are legally incompetent. But—straw man again—Keller and Davis are not advocating social services for the incompetent. They are defending the ACA, which applies to all of us. So they must think the vast majority of us are incompetent.

If not blatant illogic, this is a breathtaking aristocratic paternalism. Noblesse oblige. The poor little peasants cannot possibly be trusted to take care of themselves. We, the bien-pensants who administer the state, must make these decisions for them.

Let me ask any of you who still agree, does this mean you? When you are faced with cancer, do you really want to place your trust in the government health panel, because they will make better decisions than you, with your doctor and family? Or is this just for the benighted lower classes, and you and I, of course, know how to find a good doctor and work the system? 

Choice is always between alternatives. Sure, some people make awful decisions. The question is, can the ACA bureaucracy and insurance companies really do better? Yet you would not trust them to buy your shirts? And once again does the entire gargantuan bureaucratic apparatus of the ACA follow, not from the proposition that there is some fundamental economic market failure, but because . . Americans are no good at shopping?

No. Health is not too important to be left to the market. Health is so important—and so varied, so personal, and so subjective— that it must be left to the market. If you do not trust the vast majority of people to make the most important decisions of their lives, and a government bureaucracy can make better decisions on their behalf, you are a devout patrician, not a devout capitalist.

Well, that was fun, wasn't it? You may or may not agree. You may think I go on too long. But you can't possibly write that I "ignore" Noah's arguments.

By the way, if we're going to get huffy about "ignoring" classic writings of Nobel Prize winners on health care, Noah really shouldn't ignore this classic by Milton Friedman

Noah also starts with a logical whopper:

Americans, in general, support government-provided universal health care. A Pew Research Center survey taken in January found that 60 percent say that it’s the responsibility of the federal government to make sure that all Americans have health coverage. 

This should be on the SAT reading comprehension test. "Does the evidence support the proposition?" No. "responsibility... to make sure that all Americans have health coverage" is not "support government-provided universal health care." I support the former, and  not the latter. There are lots of ways, including involving extensive deregulation combined with robust charity care, to deliver "health coverage" without "government-provided universal health care."

So this ends up, really, being another post about language and rhetoric. What is going on with Noah, and with Bloomberg, and their fellow travelers, that such gaping holes of basic logic pass muster? That you can write a personal attack without making it through a blog post, let alone doing 10 seconds of googling to find if your allegations have any basis at all? I'll leave it to you to fill out the names and analogies for the rhetorical strategy. I guess if they think so little of American's shopping competence, they think equally little of their critical reading capacity.

Update: Thanks to a correspondent who pointed it out, we can now add Brad DeLong to the list of people who can't even be bothered to link to an article they want to "smackdown," let alone show any sign of reading it. This is, however, not news.

A revised draft of "Michelson-Morley, Fisher, and Occam" is now on my webpage (Yes, new title.)

This paper argues that the long quiet zero bound is an important experiment. The zero bound or an interest rate peg can be stable, and determinate. Longstanding contrary doctrines are simply wrong -- the doctrine that interest rate pegs must be unstable, starting with Milton Friedman, or the new-Keynesian view that the zero bound will lead to sunspot volatility.

I struggle hard with the implication that raising interest rates will eventually raise inflation. I've posted the paper before, but if any of you are following it this is a big revision.

What happens to inflation at the zero bound, and with a huge expansion of reserves? The big surprise: Nothing. This dog did not bark.