October 2006 Archives

Returning visitors will immediately recognize that this post was inspired by these comments. In The Wealth of Nations, Adam Smith has a lot to say about "rent". In fact, Smith spends the whole of Chapter 11 of Book I on the subject. This rent of which he writes is a term for the returns to a fixed factor. For example, mineral wealth taken out of the ground returns rent to the landowner. In economic parlance, rent is often synonymous with profit. While most of the time there is no confusion from this, economists (and non-economists) also use the term "rent seeking" to describe behavior that is wasteful and decreases social welfare. When speaking of "rent seeking", they are not talking about the normal types of profit maximization behavior. Nor are they referring to the division of labor so eloquently described by Adam Smith. Behavior that Adam Smith praised in The Wealth of Nations (prudence, self-betterment, etc.) is not identical to the rent seeking behavior described by scholars such as Tullock and Krueger. The fact that the word "rent" is used in both contexts is perhaps unfortunate, but too solidly entrenched in the literature and the minds of economists to ever change. I believe that most economists are careful about the difference. Outside the profession, however, I think there may be some confusion that ends up giving economics a bad reputation.

As I pointed out last year in an Econoblog with Russell Roberts,

"The Theory of Moral Sentiments," on the other hand, is a treatise on temperance. It is a study of propriety, sympathy, and justice. Sadly, many people don't even know the book exists or that it was written by the man who is sometimes called the "father of capitalism." Ignorance of Smith's other major work leads people to think that economics is only about greed, self-interest, and rational maximization. As a result, many intelligent people who would be quite capable of becoming economically literate are turned off to economics because they see it as promoting a "greed is good" mentality that doesn't square with their world view. Unfortunately, this perception is so well embedded in the pop culture view of economics and economists that it may be very difficult to reverse.

While it helps to read The Theory of Moral Sentiments to reinforce the fact that Adam Smith was no Gordon Gecko, it is not really necessary. Only a misreading of The Wealth of Nations would cause someone to think economics is about "greed." Greed and self-interest are not identical ideas. Greed is self-interest run amok--self-interest with no temperance.

Consider first what Smith said in comparing trade protection to monopoly. After all, giving trade protection increases the market power of the domestic firm.

To give the monopoly of the home-market to the produce of domestic industry, in any particular art or manufacture, is in some measure to direct private people in what manner they ought to employ their capitals, and must, in almost all cases, be either a useless or a hurtful regulation. (Book IV, Chapter 2, paragraph 11)

Since Smith lived 200 years before Tullock and Krueger, he did not frame the discussion in precisely the same terms, but the notion of rent seeking as a destructive influence is present in The Wealth of Nations. It is in one of my favorite passages in the entire text. The context is a discussion of barriers to trade. I was first introduced to this passage in my 2nd year of grad school, and it has been with me ever since. Combined with the previous passage, it shows that Smith took a dim view of what we would today call "rent seeking," but correctly saw that it would always be with us as a thorn in our side.

To expect, indeed, that the freedom of trade should ever be entirely restored in Great Britain is as absurd as to expect that an Oceana or Utopia should ever be established in it. Not only the prejudices of the public, but what is much more unconquerable, the private interests of many individuals, irresistibly oppose it. Were the officers of the army to oppose with the same zeal and unanimity any reduction in the numbers of forces with which master manufacturers set themselves against every law that is likely to increase the number of their rivals in the home-market; were the former to animate their soldiers in the same manner as the latter enflame their workmen to attack with violence and outrage the proposers of any such regulation, to attempt to reduce the army would be as dangerous as it has now become to attempt to diminish in any respect the monopoly which our manufacturers have obtained against us. This monopoly has so much increased the number of some particular tribes of them that, like an overgrown standing army, they have become formidable to the government, and upon many occasions intimidate the legislature. The Member of Parliament who supports every proposal for strengthening this monopoly is sure to acquire not only the reputation of understanding trade, but great popularity and influence with an order of men whose numbers and wealth render them of great importance. If he opposes them, on the contrary, and still more if he has authority enough to be able to thwart them, neither the most acknowledged probity, nor the highest rank, nor the greatest public services can protect him from the most infamous abuse and detraction, from personal insults, nor sometimes from real danger, arising from the insolent outrage of furious and disappointed monopolists. (Book IV, Chapter 2, paragraph 43)

As the last couple of paychecks of the year approach, many people get a temporary pay raise, as Ron Lieber of the Wall Street Journal explains:

By now, many of the 8.9 million Americans who earn more than $100,000 annually have already hit six figures; scores more will do so in the next few weeks. Here's what they may miss if they don't watch their paycheck carefully: A nice-sized raise that appears without warning, then vanishes just as quietly on Jan. 1.

Sound odd? It's a function of tax rules. Most workers have their paychecks docked 6.2% to fund Social Security. But they stop paying that tax on income above a certain level each year. This year, the threshold is $94,200. Next year, it is $97,500.

...

There's no excuse for frittering the funds away. Be deliberate, and start with the obvious checklist: If you haven't maxed out your 401(k), especially the portion that your employer matches, increase your withholding. (Then consider just leaving it there come January to see if you miss the money.) Pay off your credit-card debt, and if you can't get rid of all of it, at least pay down the higher-interest cards. Fund a Roth IRA if you're eligible, and take advantage of the tax-free earnings you'll be able to withdraw once you're older.

Sounds like an application of the permanent income hypothesis. However, since this comes at the end of the year, a lot of people probably do use it to cover their holiday bills. December always throws off my consumption smoothing plans a bit.

3rd quarter real GDP grew at a 1.6% annualized growth rate. King asks how bad this really is and says that it's pretty bad, but not as bad as some will make it out to be. Brad DeLong says, "Gork!" Nouriel Roubini pats himself on the back for an excellent forecast. And he goes on to say:

What do these Q3 growth figures imply for Q4 and 2007 GDP growth? Expect today the usual spin with the soft-landing optimists – who were altogether wrong on Q2 growth and even more wrong on Q3 growth – having already started to spin the fairy tale of a Q4 rebound. This Q4 rebound has, so far, no base or data behind it: residential investment will be falling at a faster rate in Q4 than in Q3 given recent data on building permits and housing starts; non-residential investment that was, until now, growing very fast will sharply decelerate in Q4 and much more in 2007: see the lead story in the WSJ today referring to a McGraw Hill Construction study forecasting a rapid fall in construction spending in 2007 (including non residential construction and specifically stores and shopping centers), the first decline of construction spending since 1991.

No spin here. I do admit to being more optimistic than Roubini, but even so I am open to letting incoming data refine my position. I do not predict a 4th quarter rebound. Even if this is something approximating a soft landing, we're not out of the woods yet. Looking at the contributions of the different components of GDP to the overall growth rate, I cannot see any reason to expect anything much over 2% for the 4th quarter even under the best of circumstances. I would not be surprised with a number between 0.5 and 1.5%. Less than 0.5% would surprise me but not shock me. Residential investment will continue to be a drag on GDP, no argument there. However on the plus side, retail sales are continuing at a decent pace. Inventories are basically unchanged suggesting that firms still have some pricing power and consumers haven't yet let the housing slump get them down. Unless something suggests that the bottom is in the process of dropping out as we speak, I don't see 4th quarter GDP to be markedly worse than the 3rd.

Tim Duy makes the following observation:

Also, there is a reasonable chance that investment spending is held back by the delayed launch of Windows Vista. And note this from Bloomberg:

Norfolk Southern Corp., the fourth-largest U.S. railroad, boosted freight rates, helping third-quarter profit increase 38 percent. Sales rose 11 percent.

''Overall, we don't see any drastic slowing of the entire economy,'' Norfolk Southern Chief Executive Officer Charles ``Wick'' Moorman said in an interview. ``We think that pricing power will stay with us for a while.''

I pay attention to what the rail barons say – they generally have a good sense of economic activity.

Indeed. So while an actual prediction of a recession may be a bit premature, there are still many uncertainties that cloud the picture as we move from winter into spring. I will be paying close attention to the holiday spending figures. But interpret the early numbers with caution. The day after Thanksgiving isn't what it once was. Internet shopping peaks in mid-December. Some internet shoppers have already been at work (propping up 3rd quarter consumption?). This article on the subject is a year old, but probably still a good guide to what to expect.

The bottom line is that we are probably in for two or three quarters of below average growth. The 1995 soft landing was harder than what we have experienced so far--a fact that hasn't been mentioned much. By no means would I predict a reversal of the current trend and a return to 3+% growth yet. This report probably didn't surprise anyone at the Fed, nor would a slightly worse report in the 4th quarter. These figures support the position that pausing when they did was probably the right thing to do, but do not give any clarification about what is to come next (i.e. which will come first, a cut or an increase in rates). Staying the course still seems like the best option.

In closing, I point out a report that I have not seen getting a lot of play yet. From Bloomberg:

Oct. 27 (Bloomberg) -- An unexpected increase in auto production last quarter was a statistical fluke that will be reversed, making current U.S. economic growth even weaker, according to a former Commerce Department economist.

Last quarter's annualized 26 percent increase in motor vehicle production shocked Joe Carson, now director of economic research at AllianceBernstein LP in New York. Without the gain, the economy would have grown at an annual rate of 0.9 percent, not the 1.6 percent the Commerce Department reported today.

The reported increase in output came despite cutbacks announced by General Motors Corp., Ford Motor Co. and others. A drop in the wholesale price of SUVs and light trucks as the automakers cleared leftover 2006 models made production look stronger than it actually was, said Carson. The economic fallout from the auto-industry cutbacks will instead come this quarter, he said.

``Last quarter was weak even with the benefit of this mismatch and the fourth quarter will now also be weak because it's going the other way,'' Carson said. ``Whatever output you have this quarter, which will probably be down, will be discounted by a likely rebound in prices.''

Carson stressed that there wasn't an error in procedure requiring a correction from the government. It's the way the Commerce Department always computes the data and doesn't mean the statisticians committed any mistakes, he said.

Adjusting For Prices

The mismatch can be explained by looking at how the government adjusts the figures for price changes.

Commerce Department economists use wholesale light truck prices, from the Labor Department's producer price report, to eliminate the influence of inflation on investment and inventories for that category. A 5.5 percent drop in price of SUVs and other light trucks last quarter made output look stronger when adjusted for inflation, Carson said.

Declines in shipments of vehicles and parts from the Commerce Department's durable goods report over the last three months and in the Federal Reserve's output numbers in its industrial production figures, reinforce forecasts that the fourth-quarter growth numbers will show the auto cutbacks, Carson said.

Read the whole thing. Chain weighting looks at the percentage changes in constant dollar GDP for adjacent periods. So if firms cut prices to get rid of inventories, it would show up as higher growth in GDP from the production period to the sales period than if prices didn't fall. The size of the influence on overall GDP growth is larger than I would have thought, but I'll take their numbers at face value. How much it affects the 4th quarter depends on the slowdown in production. We shall see. But it's just one more thing to keep in mind going forward.

Robert Frank considers the relation between economic growth and happiness in today's NY Times

Does money buy happiness? The rapidly expanding literature on what determines “subjective well-being” appears to suggest a negative answer to this timeless question. Studies consistently find, for example, that when the incomes of everyone in a community grow over time, conventional measures of well-being show little change.

Many critics of economic growth interpret this finding to imply that continued economic growth should no longer be a policy goal in developed countries. They argue that if money buys happiness, it is relative, not absolute, income that matters. As incomes grow, people quickly adapt to their new circumstances, showing no enduring gains in measured happiness. Growth makes the poor happier in low-income countries, critics concede, but not in developed countries, where those at the bottom continue to experience relative deprivation.

All true. But these statements do not imply that economic growth no longer matters in wealthy countries. The reason, in a nutshell, is that happiness and welfare, though related, are very different things. Growth enables us to expand medical research and other activities that clearly enhance human welfare but have little effect on measured happiness levels.

Interpersonal utility comparisons are tricky, to say the least. Later in the article...

Since life is a continuing competitive struggle, this is as it should be. Accident victims who can recover their psychological footing quickly will function more effectively in their new circumstances than those who dwell unhappily on their misfortune. Windfall recipients who quickly recover their hunger for more will compete more effectively than those who linger in complacent euphoria.

...

These observations highlight the weakness of subjective well-being as a metric of welfare. The fact that people adapt quickly to new circumstances, good or bad, is just a design feature of the brain’s motivational system. The fact that a paraplegic may continue to be happy does not imply that his condition has not reduced his welfare. Indeed, many well-adjusted paraplegics report that they would undergo surgery entailing substantial risk of death if doing so promised to restore their mobility. Similarly, the fact that people may adapt quickly to higher incomes says nothing about whether economic growth makes them better off.

Critics of economic growth cite its threat to the planet’s survival. Yet it is not growth per se that threatens, but rather certain kinds of growth. Driving more S.U.V.’s causes harm, but taking more piano lessons does not. Any country with a government not beholden to corporate interests could easily curb environmentally harmful activities through taxation and regulation, redirecting spending toward things that really matter. Across developed countries, higher growth rates are actually associated with cleaner environments, not dirtier ones. The United States is the world’s largest emitter of greenhouse gases not because of its wealth but in spite of it.

Frank is angling for membership in Greg Mankiw's Pigou Club.

But growth’s most compelling promise is continuing progress against premature death, perhaps the most devastating of life’s tragedies. American families with five children in 1800 often saw two or three of them die before the age of 10. That this no longer happens has been a landmark achievement.

Intelligently managed growth will hasten our quest to defeat diseases that continue to strike people down in the prime of life. The mere fact that rising incomes do not bolster self-assessed happiness levels is no reason to abandon this quest.

It certainly is true that progress against premature death is one of the most important results of modern economic growth. But I have to ask if that was a result of intelligently managed growth or just plain growth. Intelligently managed growth sounds a bit too much like social engineering for my tastes. Of course there are limits to what an author can do in one short op-ed column. However, I wish Frank was a little more forthcoming about what he means by "intelligently managed." I wouldn't exactly say that the present growth picture qualifies as intelligently managed. What is the scope of the policies that would make our future growth intelligently managed.

I enjoy Frank's writing, and I certainly am in his camp in praising modern economic growth for what it has done for human welfare even if it doesn't show up in happiness studies. But the end of this column is a little hard for me to swallow. Who will manage the growth? What social welfare function will they maximize? Pigouvian taxes to correct well-defined, measurable externalities are one thing. Intelligently managed growth that taxes some activities and subsidizes others without reference to a specific market failure is quite another.

Link to the statement:

The Federal Open Market Committee decided today to keep its target for the federal funds rate at 5-1/4 percent.

Economic growth has slowed over the course of the year, partly reflecting a cooling of the housing market. Going forward, the economy seems likely to expand at a moderate pace.

Readings on core inflation have been elevated, and the high level of resource utilization has the potential to sustain inflation pressures. However, inflation pressures seem likely to moderate over time, reflecting reduced impetus from energy prices, contained inflation expectations, and the cumulative effects of monetary policy actions and other factors restraining aggregate demand.

Nonetheless, the Committee judges that some inflation risks remain. The extent and timing of any additional firming that may be needed to address these risks will depend on the evolution of the outlook for both inflation and economic growth, as implied by incoming information.

Voting for the FOMC monetary policy action were: Ben S. Bernanke, Chairman; Timothy F. Geithner, Vice Chairman; Susan S. Bies; Donald L. Kohn; Randall S. Kroszner; Frederic S. Mishkin; Sandra Pianalto; William Poole; Kevin M. Warsh; and Janet L. Yellen. Voting against was Jeffrey M. Lacker, who preferred an increase of 25 basis points in the federal funds rate target at this meeting.

Differences between this statement and the last are actually very few, and do help clarify rather than obscure what the FOMC is and has been thinking.

Here is a link to the previous statement. Notice that the verb tense has changed in the paragraph on growth.

The moderation in economic growth appears to be continuing, partly reflecting a cooling of the housing market.

Previously it was stated that the moderation in growth appears to be continuing. Now they say that growth "has slowed" and add a forward looking statement that growth is likely to expand at a moderate pace.

Soft landing, anyone?

The paragraph on inflation is revised and is more clear than in the previous statement. In September it read,

Readings on core inflation have been elevated, and the high levels of resource utilization and of the prices of energy and other commodities have the potential to sustain inflation pressures. However, inflation pressures seem likely to moderate over time, reflecting reduced impetus from energy prices, contained inflation expectations, and the cumulative effects of monetary policy actions and other factors restraining aggregate demand.

When the previous statement came out, Tim Duy was not impressed. To me it looked like they were hedging on energy prices--not yet ready to let go of the line about energy prices adding to inflation pressures. That part is now gone. As a result, the statement is a lot crisper. That is really the only substantive change. The focus now is on the possibility that resource utilization is the main worry for any further inflation going forward.

The statement about inflation risks remaining is identical to what we have seen before. The fact that Mr. Lacker dissented again indicates that among those who think inflation is already too high nothing has fundamentally changed. This is not the kind of statement that makes you think that a rate cut is around the corner. On the contrary, if this is a soft landing, some futher firming of policy will probably be needed to bring inflation down from its current level.

Today's statement is clearer than the last, and that is a good thing. The debate over whether or not we are in the midst of experiencing a soft landing will continue.

You hear stories like this every now and then. It bears repeating. Commas were not meant to be sprinkled liberally into your writing. A misplaced comma can change the meaning of a sentence. When that sentence contains an escape clause for a contract, the consequences can be costly. The NY Times has the story.

The dispute between Rogers Communications of Toronto, Canada’s largest cable television provider, and a telephone company in Atlantic Canada, Bell Aliant, is over the phone company’s attempt to cancel a contract governing Rogers’ use of telephone poles. But the argument turns on a single comma in the 14-page contract. The answer is worth 1 million Canadian dollars ($888,000).

Citing the “rules of punctuation,” Canada’s telecommunications regulator recently ruled that the comma allowed Bell Aliant to end its five-year agreement with Rogers at any time with notice.

Rogers argues that pole contracts run for five years and automatically renew for another five years, unless a telephone company cancels the agreement before the start of the final 12 months.

The contract is a standard one for the use of utility poles, negotiated between a cable television trade association and an alliance of telephone companies. French and English versions were approved by a government regulator about six years ago.

The dispute is over this sentence: “This agreement shall be effective from the date it is made and shall continue in force for a period of five (5) years from the date it is made, and thereafter for successive five (5) year terms, unless and until terminated by one year prior notice in writing by either party.”

The regulator concluded that the second comma meant that the part of the sentence describing the one-year notice for cancellation applied to both the five-year term as well as its renewal. Therefore, the regulator found, the phone company could escape the contract after as little as one year.

“The meaning of the clause was clear and unambiguous,” the regulator wrote in a ruling in July.

But Kenneth G. Engelhart, vice president for regulatory affairs at Rogers, disagreed. “Why they feel that a comma should somehow overrule the plain meaning of the words is beyond me,” he said. “I don’t think it makes any sense.”

But Canada is bilingual. Was the comma there in the French version?

Rogers is also pointing to the official French version of the pole agreement, which has equal status under Canadian law. While differences between the languages will not settle the comma question, Mr. Engelhart said the phrasing removed any ambiguity about the contract’s life span.

“It becomes very clear once you read the French version,” he said.

Of course it does... to him. Unfortunately, the Times did not print the French version.

We'll come back to the price gouging discussion another time. But that episode does remind me that there are so many interesting questions involving basic economics that can generate a lot of interesting discussion.

One difficulty in writing for a general audience (including blogging) is that basic economic ideas tend to oversimplify reality. It's unavoidable really. But we should always remember that the basic textbook theories are useful as a starting point--a model, and not a literal description of reality. For example, a significantly higher minimum wage is sure to reduce employment in a ceteris paribus world. However, it will be nearly impossible to identify the winners and losers from a very small change in the minimum wage so it may not be worth getting too worked up about in a world where ceteris is not paribus. (Russ Nelson, however, would not be moved by this argument. On principle, I agree. But from a pragmatic policy perspective...)

Actually, any discussion in which we talk about "the wage" or "the labor market" is already oversimplified. But we do this anyway. The reason we do is that it can be difficult to go into the details in the length of an op-ed or blog post. We simply cannot possibly discuss a multitude of elasticities and other details. We use economic shorthand. The reader fills in the gaps, sometimes by making assumptions that were not intended. In blogging, at least the comments provide for discussion. Remember, just because the writer didn't say it doesn't mean it can't happen or that the writer didn't think about it or is dismissive of it. It just means that the writer wanted to emphasize something else. Occasionally it matters, but a lot of times it doesn't. Some of the best comment threads are where a commenter and I have agreed about most everything but disagreed about some finer point. Perhaps this post will generate some discussion about the assumptions we make, good or bad.

In the Financial Times, Tim Harford answers his "Dear Economist" mail.

How would an economist respond to the phrase “money is the root of all evil”?

Harford answers,

Economists always seem to talk in dollars and cents, yet few economic models contain any reference to the stuff.

The reason why economists will use strange phrases such as “the value of a kiss is $49” is not that they think money is particularly important, but simply that it is a convenient way to measure things. If a toffee apple is worth $7 then a kiss is as good as seven toffee apples; however if the toffee apples cost $6 and the kiss costs $50 then the toffee apples are a better buy.

I am, of course, reminded of this post from last year. In that post, I quote this article by Robert Frank, who poses a question:

"You won a free ticket to see an Eric Clapton concert (which has no resale value). Bob Dylan is performing on the same night and is your next-best alternative activity. Tickets to see Dylan cost $40. On any given day, you would be willing to pay up to $50 to see Dylan. Assume there are no other costs of seeing either performer. Based on this information, what is the opportunity cost of seeing Eric Clapton? (a) $0, (b) $10, (c) $40, or (d) $50."

I still get a bunch of hits from search terms "clapton dylan opportunity cost frank" and variations on that theme.

Harford is doing what Frank did in quantifying the concept of utility in terms of dollars so that comparisons can be made. Economists think like this all the time. Non-economists, not so much. The idea in both is "willingness to pay," which is one of the basic building blocks of economic thinking. It is not surprising to see the idea surface in Harford's column. It will undoubtedly come up again.

What do you think about this? Is this a simple abstract idea that has little application? How does reality complicate the story?

What about the concept of opportunity cost itself? How would you improve our textbook presentation of the idea?

UPDATE: No takers yet? Restating the question: Should opportunity cost be thought cost net of benefits or only what is literally given up with no regard to benefits? Does it matter?

Yes, I know that the original Dylan/Clapton question has been criticized for being poorly worded. Largely that is because it does not explicitly clue in the reader that it is asking for the net cost. One possible reason for confusion is that the textbook definition of opportunity cost is too trivial. Most textbook problems on opportuntity cost don't require any complex thought concerning net cost (e.g. the opportunity cost of 1 apple is 2 oranges or the opportunity cost of sleeping in is going to class). Even the old stand-by example that the opportunity cost of going to college is tuition paid plus foregone wages is stripped of all kinds of interesting details (like the life-changing benefits of socialization in a college atmosphere, etc.) because they are hard to quantify. But when opportunity cost is lurking (unstated) in the background of more complicated quantitative problems it helps to have thought about Harford's example or the Dylan/Clapton question. It is in bridging that gap that most principles texts are lacking.

Thoughts?

UPDATE 2: Gavin Kennedy reminds me that Harford's "Dear Economist" letter misquoted I Timothy 6:10 "The love of money is the root of all evil." I apologize for missing that. As such, Harford gives a terrible theological answer. I did not mean to suggest that his answer was appropriate to the question. I merely wanted to work his answer into this other discussion.

Comments are open to both aspects of the post. If there is sufficient interest, I'll split them off to a separate post.

In response to my last post, Spencer comments:

After disasters major corporations like Wal Mart, Home Depot, etc.., usually do a very good job of resuppling the damaged area with the suplies they need without a significant increase in prices.

Do you have any evidence that a bunch of "price gougers" in pick-up trucks would ever generate a significant increase in the supply of basics like gasoline, electricity, food, medicine and water. Or, is this just another example of assuming a can-opener.

The question got me thinking about those "price gougers in pick-up trucks". Because that is often how they are portrayed in the media. They swoop in with a load of water or chainsaws, charge a bundle, and they're gone. They tend to be from out of town, and the local politicians see it as their duty to keep such opportunists out.

Of course the very reason that price gougers often fit this profile is the fact that the state has made the act illegal. There is a risk to doing what they are doing. That alone contributes to the higher prices that they charge. It also means that it may attract people who are have less to lose, people who are willing to take a risk. The risk is not that the entrepreneurial venture might fail, but that the law might come after them. Established, reputable firms do not want to run afoul of the attorney general, and so you don't see them doing the price gouging. Reputable firms use the opportunity to create goodwill.

Case in point: Culligan donated five semi-truck loads of bottled water after Hurricane Katrina (see the list for a number of other corporate donations). Nice sentiment, and I'm sure the people who received it were grateful. But we wouldn't be having this conversation if a donation of five semi-truck loads was enough to satisfy the demand for water after the hurricane. I did not hear stories of Culligan increasing their sales of water in the area. A brief Google search doesn't turn up much either. But I do find multiple sites mentioning the five donated truckloads.

Consider Spencer's mention of Wal-Mart and Home Depot. Again, a lot of what they provide was donated. And while that is a wonderful thing, there is something a bit odd about the overall picture. What the large companies do in providing donations is good, but falls short of meeting the total demand for these items. Again, the fact that we are having this conversation suggests that in a perfect world these companies would do even more. Are they instead doing just enough to generate some goodwill, some TV ad copy, and a feeling among the residents that they care more than the price gougers in pick-up trucks?

It is also important to note the relevant time frame. The typical pattern as I have observed it reported in the media is that the price gouging tends to be worst in the immediate aftermath. As basic utilities are restored and transportation becomes easier, then the regular retail function of Wal-Mart, Home Depot, et al. can resume. And then price gouging (be it by big boxes or guys in trucks) becomes less of an issue.

Another possibility to consider is that the national chain stores could take a loss on bottled water for a short time in a localized area in the interest of goodwill with the community. That adds an insurance dimension to the problem. Remember that the increase in price after the disaster is associated with the cost of arbitrage across locations. That cost is likely to be smaller for a retailer with a national distribution network, and they might just eat all or part of that cost.

But as long as these disasters continue to lead prosecutors to start a "witch hunt" for anything even resembling a profit motive, reputable companies will not do enough to satisfy the demand. Sure, the token five truckloads of water will come, but that is, pardon the pun, a drop in the bucket. All you will see are guys in pick-ups, who make good targets for politicians wanting to score points with the voters.

There is that which is seen, and that which is unseen. What is unseen here is that Wal-Mart, et al. could possibly satisfy more of the excess demand if they weren't afraid of being punished for trying.

The fact that we treat bottled water in a disaster area in a manner that encourages reputable, national firms to make token donations rather than engage in the unseemly profiteering that might actually help more people should give us pause. The fact that this attitude in government also makes the actions of the less scrupulous profiteers more harmful by forcing them to take additional risks and fly under the radar should also give us pause.

So no, I don't have evidence that guys in pick-up trucks would do a better job. That's the wrong question. I do have a very strong reason to believe that large companies could do a much better job if they knew they wouldn't be excoriated by politicians and the media for making a modest amount of money from it. While I praise them for their generosity, I think you'd get more than five truckloads from Culligan if they could charge a modest amount for their trouble. The fact that there are still guys in pick-up trucks means the established, reputable companies are not doing enough.

The guys in pick-up trucks are a second-best solution to the problem. The first-best solution is for established, reputable firms to enter those areas and drive the high cost risk takers out of business. But that will only happen if the government eases ceases vilifying the notion of profit, even a modest amount, in these situations.

I do have evidence that the government does an absolutely lousy job of providing these goods and services. I don't think that the private sector would do this.

From Wilson Mixon at Division of Labour,

According to a report on NPR, "in a major disaster the government can spend $10-15 per gallon of water." (Link leads to a summary and an audio; LexisNexis has the transcript.)

Couldn't much of this water could be delivered at a fraction of this cost if price gougers were given free rein? Of course, the NPR report is hawking a gee-whiz technical fix, administered by FEMA, not a sensible market response.

It's worth it to listen to the audio. This is a really interesting idea. Basically, they've come up with a way to take water out of the air using a desiccant. An example of this would be those little packets of "silica gel" you find in various product packaging. The technological innovation described in the audio uses the same principle to generate around 1200 gallons of water per day for around 20 cents per gallon. (These numbers are mentioned in the audio.) The 20 cents per gallon is apparently the marginal cost for the fuel to run the machine. The machine itself costs $300,000. That is a lot of overhead. By my calculations, if the machine lasts 10 years and you run it 25 full days per year it will add about a dollar per gallon to the average cost of the water produced.

Even so, it is likely that the average cost from such a machine, if it is as successful as the report makes it sound, would be less than the $10-15 that the government sometimes pays to bring water to a disaster area. So it might be an improvement from the status quo. But what about Mixon's suggestion that letting "price gougers" take care of the problem by bringing water from outside the area and selling it at a higher price? Let us not forget that part of the reason that the prices the "gougers" charge are so high is that the government does a pretty effective job of discouraging them. If the government got out of the way, there would be more "gougers" and the price would be lower. The price differential should approach the transport cost. In such an environment, it may be the case that machines like the one in the NPR report would be considered too costly to implement. It would be interesting to do the detailed cost/benefit analysis on that one.

The fact that the government has taken such a stance to prevent "price gouging" actually helps to justify the purchase of the machine by the government and explains the incentive for private firms to look for this type of solution. All of this just goes to show that private individuals will try to capture the rents associated with various market interventions. One type of activity is praised and the other is vilified. Yet it is not immediately clear which activity yields greater benefits to society.

The NPR report also mentions that the military is interested in this technology. Now that actually makes sense. This could be a revolutionary way to provide water on the battlefield. Wouldn't it make sense to have National Guard units purchase these machines for deployment either in battle or in times of national disaster? Putting the machines in the hands of the National Guard would seem to have a much better cost/benefit calculus than putting them in the hands of FEMA. If allowing markets to work freely is asking too much, can we at least ask that the machines go where they will be used most efficiently?

Via Reuters:

The Labor Department said a seasonally adjusted 299,000 workers filed new claims for state unemployment insurance benefits in the week ended October 14, down from 309,000 claims a week earlier.

Economists polled by Reuters were expecting a slight increase in jobless claims to 312,000 from an original reading of 308,000 in the week ended October 7.

Separately, the Conference Board released its index of leading economic indicators today. From their website:

The Conference Board announced today that the U.S. leading index increased 0.1 percent, the coincident index remained unchanged and the lagging index increased 0.2 percent in September.

and...

The leading index has fallen 1.0 percent below its most recent high reached in January. At the same time, real GDP growth slowed to a 2.6 percent (annual) rate in the second quarter, following a 5.6 percent gain in the first quarter. The behavior of the leading index so far suggests that economic growth should continue at the slow rate in the near term.

According to the Wall Street Journal, analysts had expected a 0.3% increase in the leading economic indicators. So once again the news is mixed. Overall, it appears that the economy is slowing a bit. Growth for the remainder of the year will probably remain below average, but there is no indication yet of a full-blown recession.

Taken as a whole, this week's data releases leave us pretty much where we started. If there were only a couple pieces of conflicting evidence, it would be more puzzling. The preponderance of conflicting signals reinforces what most of us have been thinking for a while. For the past few months, indeed most of this year, the economy has been slowly inching toward a critical point where either growth will slow (perhaps briefly turning negative) or resume at a more normal pace. That's a good argument for not doing anything to rock the boat at the moment.

UPDATE: On Tuesday, I admitted that the mixed bag of data makes it impossible for me to be Harry Truman's "one-armed economist". Today, James Hamilton also cannot avoid saying "on the other hand."

I'm wondering though whether "no change" might be the least likely outcome at this point. If we start to see some serious financial repercussions develop in housing, I'd look for a rate cut, and wouldn't worry in that event about commodity prices, since I would expect to see commodities fall sharply on news of a big downturn in economic activity. On the other hand, if instead we have seen the bottom for housing and the core inflation numbers remain this high, I'd look for the Fed to tighten further.

That is the direction the data has been pushing me as well. Unlike Kash, who seems more convinced than I that we've reached a peak (though he does leave some room for doubt), I see the upside and downside risks as roughly equal.

It might be that the upcoming 3rd quarter GDP data could be the news that gives us a clue as to which way this will break. It probably won't be the overall growth rate (which is likely to be positive but below everage), but the different subcategories of consumption and investment that will tell the story. At least until that point, I'm prepared to use both hands when explaining where the economy seems to be going, and what direction interest rates might take in 2007.

UPDATE 2: David Altig finds himself in general agreement and is almost ready to take the next step--but not quite.

But, for reasons I'll detail in a later post, I'm beginning to wonder about the reach of developments in [the housing] sector. I'm not quite ready to take the anti-Roubini bet with the degree of confidence that Nouriel himself puts on his recession call. But I'm getting there.

Absent any additional negative shocks, I would agree. I'm not quite ready to call it a soft landing yet, but I too am getting there.

A couple of dynamics seem to be at work in the CPI numbers released today. Obviously the fall in gas prices decreased the headline number which was down by 0.5%. That was no surprise. Yet the core rate continues to come in above the Fed's comfort zone. This months increase in the core was at 0.2%, the same as last months increase. Combined with previous increases, the core CPI has increased by 2.9% from a year ago.

Owners equivalent rent (OER) continues to push the core upward. This is due to two factors--the improvement in the rental market as housing slows, and the fall in energy prices since OER is computed net of utilities costs. See macroblog for an excellent discussion. Of course OER held the core low during the housing boom. (Ironic, isn't it?) If the rental market continues to improve and energy prices continue to fall, this effect could be with us well into 2007. Does the fact that the rise in the core can be partly explained by the rise in OER make it less troubling? Perhaps slightly, but be careful not to discount it too much. In the last couple years when OER was holding the core down, the core rate was already at the top end of the Fed's comfort zone. If the current rise in OER is the most important change to affect the core in recent months, then not much has changed. The core was rising at slightly more than a 2% rate for most of last year. If the current trend in OER continues, the core inflation rate could top out above 3%. If a simple back-of-the-envelope calculation suggests that after adjusting for OER's effect the core inflation rate has been up around 2.5% or higher for all of that time, that would still be too much for most.

In short, these numbers don't inspire me to call for a rate cut right now. However, there is an interesting question of whether the FOMC's assessment of risks has changed since the last meeting. Aside from the OER component of core inflation (which we can reasonably expect to rise a bit more--and which is somewhat more predictable), it does appear that the risk of additional inflation may have diminished. But the fact remains that the current level of inflation remains too high in the eyes of many. Facing this fact, will the Fed hold rates at this level for an extended period of time or begin raising them again? Given the suggest of "opportunistic disinflation" a decade ago, it is reasonable to expect that they might try that strategy again and hold steady for a while.

Today's CPI figures do not totally clear up the fog of uncertainties. They reinforce the fact that this is still a critical time for the economy. Given the "wait-and-see" stance of the Fed currently, I think it will take more than this to move them off of that position. Will core inflation rates on the wrong side of 3% be enough to effect a change in policy? We may find out.

(Archived BLS press release of today's CPI report)

Harry Truman wanted a one-armed economist. He didn't like our tendency to say, "on the other hand...".

These numbers make it hard to be one-armed. Let's turn it over to Reuters...

WASHINGTON (Reuters) - U.S. producer prices fell more than twice as much as expected last month on a record drop in gasoline prices, but core prices jumped amid a rebound in autos that may vex the Federal Reserve as it weighs inflation risks.

The Labor Department said on Tuesday that producer prices declined 1.3 percent in September, the steepest drop since April 2003. This came with a 22.2 percent fall in gasoline prices that broke the previous record of a 22.1 percent drop, set in March 1986.

It should be obvious that the decline in gas prices is responsible for most of the decrease. So we look at the core PPI. Brace yourself...

The core producer price index, which strips out volatile food and energy costs, advanced 0.6 percent after a 3.5 percent rebound in light motor truck prices, the largest increase since October 1985, following a 3.4 percent dip the previous month.

Passenger cars rose 2.8 percent -- the largest gain in 16 years -- after falling 2.6 percent in August.

Stripping out those sharp rises in truck and car prices, core producer prices would have risen 0.1 percent, a Labor Department official said.

So now the picture is either murkier or clearer depending on the importance you put on the core and various components of the core.

U.S. stock futures and Treasury bond prices lost ground on news of the advance in core prices, while the dollar was little changed.

"It's mostly a rebound in motor vehicle prices that exaggerated the jump in the core," said Mark Vitner, senior economist at Wachovia Securities in Charlotte, North Carolina.

"The trend is still one of moderation and with economic growth slowing, we should inflation moderating further later this year. This doesn't mean that we are not going to see a troubling number from time to time," he said.

Wall Street economists had expected the report, which comes a week ahead of a Federal Reserve meeting on interest rates, to show overall producer prices declining 0.6 percent last month while core prices were forecast to rise 0.2 percent.

So they didn't see the change in auto prices coming.

Financial markets believe the U.S. central bank will hold interest rates steady not just at its October 24-25 meeting, but through the end of the year. But the mixed signals from producer prices underline the tricky task facing policy-makers.

"I think the Fed will be confused on the number but I think the market is looking at the 0.6 (percent rise in core prices) and saying the Fed is less likely to cut," said Robert Macintosh, chief economist at Eaton Vance Management in Boston.

Wasn't the probability of a cut almost zero already? (Was that a Freudian slip revealing his wishful thinking?) This doesn't change much, and it is not going to "confuse" the Fed. The fact that gas prices dropped last month--something that all of us watched happen and so knew would be reflected in the data--certainly will not make them more likely to cut. Core PPI rose more than expected because of autos but without factoring in autos the increase was much more subdued. But when you look at the increase in the core over the last two months, you see that because of the drop in core prices (again due to autos) of -0.4% in August the total increase in the last two months is about +0.2%. That is certainly tolerable.

Far from making the Fed "confused", I think this is a reassurance that last months drop was the anomaly. The core PPI data hasn't changed dramatically since mid-summer. If anything, maybe it is a bit better. Steady as she goes. I can't see how this report is enough to swing the policy recommendation either way. So the stock market is probably overreacting a bit. They'll figure it out soon enough. They usually do. Of course there might be a little latent anxiety in the market in advance of the CPI data tomorrow. We shall see if the headline number and the core go off in opposite directions again. Given the fall in gas prices, I think it's a safe bet. The numbers will be mixed. What else is new?

From Wired: The real story behind the iPod.

Exercise for those who teach principles of economics (especially micro): Come up with as many principles level lessons as you can from this. Here's one:

Apple's team knew it could solve most of the problems plagued by the Nomad. Its FireWire connector could quickly transfer songs from the computer to player -- an entire CD in a few seconds; a huge library of MP3s in minutes. And thanks to the rapidly growing cell phone industry, new batteries and displays were constantly coming to market.

Complementary goods in production Lower input cost per unit of quality--Better and cheaper cell phone batteries and displays lowered the cost and increased the quality of Apple's innovation. (UPDATE: Lower input costs would be a more direct answer, but here is what I was thinking. Smaller batteries and displays were complementary with the smaller sized hard drive and other features of the iPod. What good is the small hard drive if everything else is bulky? What good is it to be mobile if the battery doesn't last? The iPod's value came from the combination of innovations. Only when the size and power requirements on all of these complementary inputs are met does the iPod become viable. Substituting a bulkier battery greatly diminishes the value. That is the sense in which I meant them complementary. Not in the literal production process, but innovative, value-creating process.)

You could probably spend a couple weeks in class on the intellectual property rights issues if you were so inclined. You are invited to post iPod teaching suggestions in the comments.

UPDATE: I also like to use the iPod as an example of invention (small hard drive, battery, etc.), innovation (assembling the various inventions into a music player), and diffusion (network externalities with iTunes, marketing, and adoption by the masses).

Remember when you were a kid and you couldn't wait to see the odometer in the family car turn over to some multiple of 10,000. Of course in today's cars the odometers are digital, so it's about as exciting as seeing your digital watch tick past midnight. Those old odometers looked like they really had to work to turn that last digit.

And so it is with the U.S. population clock which, as I write this, stands at 299,998,288. You can check the current number for yourself by going to the Census Bureau web site. In the morning, the big three-oh-oh (million) will have been reached. The Census Bureau's clock, like my odometer, is digital. The addition, be it by birth or by immigration, will arrive seemingly effortlessly. I think that is a good analogy. We're not running out of room in this country by any stretch of the imagination. Our society and economy will absorb the 300,000,000th person as readily as the 299,999,999th. And by 2050, we'll be adding number 400,000,000--a fact which causes Joel Kotkin to opine in the Wall Street Journal:

Unless there is some sort of cultural revolution, most people, particularly families, are likely to continue migrating to places where they can acquire a spot of land and a little privacy. And despite the much ballyhooed "return to the city" by aging boomers, most experts suggest that most are either staying in the suburbs or moving to towns farther out in the hinterland. At least 30% of Americans, according to surveys by the National Association of Realtors and the Fannie Mae Foundation, express the desire to move to the country or a small environment, far more than live there now. The scale of this dispersion depends largely on urban governance. If cities cannot, due to economic or regulatory constraints, provide sufficient job opportunities, people and businesses naturally will flee elsewhere. Other factors, such as preserving family-friendly neighborhoods and stamping out a nascent resurgence in crime, will also be critical.

Yes, we will find room for number 400,000,000 too. There is room for a few of you out here. Sorry, no "for sale" signs on my block. The few that were available this summer have long since been sold. Unlike some places, the real estate market here seems to be approximately in equilibrium. Growth is proceeding sensibly. I still have to get used to the sight of a new apartment complex a mile or two south of us. More room for the next hundred million Americans.

So rejoice at this milestone. Malthus was wrong. We're not doomed by population growth. While a growing country has always presented certain challenges, it has been our innovative responses to those challenges that have made this country what it is. And it's a reason that people keep coming.

To the 300,000,000th American: Welcome! We're glad you're here.

The September PPI and CPI come out tomorrow and Wednesday, respectively. Housing starts and the MBI refinancing index also are released on Wednesday. Initial jobless claims and the Conference Board leading indicators come out on Thursday.

This is an important week for data out in front of the FOMC meeting taking place on October 24-25. Fed speak will quiet down as the data releases take center stage. St. Louis Fed President Poole indicates that he will be watching the data this week.

"If it looks like the numbers this week and other information suggest to us that the inflation rate is moving higher, or in danger of hanging here ... then I am certainly very much in the camp that would favor additional policy restraint," Poole said in answer to questions after a speech.

Via Reuters.

Kash Mansori has a new blog... The Street Light.

I've added it to my feed reader already.

BlogNetBiz is an interesting addition to the blogosphere. In addition to the usual aggregator function, the site keeps track of the most active blogs and most active comments sections. Sort of a real time ranking system. Check it out.

Hat tip: EclectEcon

Minutes of the September meeting are on the Federal Reserve website.

Highlights:

The decline in real state does not appear to be affecting spending, but it is still a concern.

Thus far, the drop in housing market activity appeared not to have spilled over significantly to other sectors of the economy. Indeed, consumer expenditures appeared to have been expanding moderately over the previous few months, buoyed by increases in employment, personal income, and household wealth. Contacts in some Districts reported that retail sales had picked up a little most recently. Meeting participants noted that consumer spending going forward would be supported by the higher levels of personal income indicated by recent revisions to the national income and product accounts, by further gains in employment, and by the decline in consumer energy prices over recent months. However, considerable uncertainty was expressed regarding the ultimate extent of the downturn in the housing sector and the degree to which the slowing in housing activity and the deceleration in home prices would affect consumption and other expenditures going forward.

Inflation seems to be weighing heavily on many of the FOMC members. Some even worry that the public could lose confidence in the Fed's commitment to fighting inflation if the core measure remains at current levels. This is a decidedly stronger statement than at the August meeting.

Many meeting participants emphasized that they continued to be quite concerned about the outlook for inflation. Recent rates of core inflation, if they persisted, were seen as higher than consistent with price stability, and participants underscored the importance of ensuring a moderation in inflation. To be sure, very recent data on inflation suggested some improvement from the situation in the late spring, partly reflecting slower increases in owners' equivalent rent. Also, the considerably lower level of energy prices of recent weeks, if sustained, would help reduce overall inflation and damp increases in core prices. Moreover, businesses would meet more resistance to attempts to pass through cost increases in the less robust economic circumstances that were likely to prevail at least for a time. However, energy prices remained quite sensitive to a wide range of forces, including geopolitical developments, and might well rebound. To date, the available evidence indicated that inflation expectations remained contained--indeed, expectations of price increases for the next few years had fallen some as energy prices declined. Nonetheless, several participants worried that inflation expectations could rise and the Federal Reserve's willingness to carry through on its intention to seek price stability could be called into question if cost and price pressures mounted or even if there was no moderation in core inflation. Looking forward, most participants thought that the most likely outcome was a reduction in inflation pressures, but the anticipated decline was only gradual and the uncertainties around that forecast were skewed toward higher rather than lower inflation rates.

Their decision in September was not as difficult as it was in August.

In the Committee's discussion of monetary policy for the intermeeting period, nearly all members favored keeping the target federal funds rate at 5-1/4 percent at this meeting. Members generally expected economic activity to expand at a pace below the rate of growth of potential output in the near term before strengthening some over time. Moreover, given the uncertainties in forecasting, significantly more sluggish performance than anticipated could not be entirely ruled out. Although the uncertainties were substantial, core inflation seemed most likely to ebb gradually from its elevated level, in part owing to the waning effects of past increases in energy prices. The anticipated expansion of economic activity at a pace slightly below the rate of growth of the economy's potential would likely also play a role by easing pressures on resources. Members noted that certain developments of late--appreciable declines in energy prices, some softer indicators of economic activity, and slightly lower readings on core inflation--pointed to a modestly better inflation outlook and hence made the policy decision today somewhat less difficult than it was in August, when it was seen as a particularly close call.

And yet they make it clear that inflation surprises will be dealt with.

In view of the most recent information on the economy, members agreed that it was appropriate for the post-meeting statement to characterize economic growth as apparently continuing to moderate. However, in view of still-high energy and other commodity prices and elevated rates of resource utilization as well as recent indications of a possible acceleration in labor costs, members continued to see a substantial risk that inflation would not decline as anticipated by the Committee. Consequently, the Committee agreed that the statement should again cite such risks to inflation and explicitly reference the possibility of additional policy firming.

Contrast this with the corresponding paragraph from the August minutes:

All members agreed that the statement to be released after the meeting should convey that inflation risks remained dominant and that consequently keeping policy unchanged at this meeting did not necessarily mark the end of the tightening cycle. They concurred that an indication that economic growth had moderated was appropriate, and a consensus favored citing the same reasons for that moderation as in the June statement. Members also agreed that the statement should both mention factors contributing to the likely moderation of inflation pressures over time and reiterate the forces that were seen as having the potential to sustain inflation pressures.

The last couple sentences of the are a little stronger in the current minutes than in the previous.

Mr. Lacker's reason for dissent remained essentially unchanged.

Mr. Lacker dissented because he believed that further tightening was needed to bring inflation down more rapidly than would be the case if the policy rate were kept unchanged. Recent data indicated that inflation remained above levels consistent with price stability. Moreover, the upswing in compensation and unit labor costs in the first half of the year indicated that inflation risks were tilted to the upside. Although real growth was likely to be moderate in coming quarters, in his view it was unlikely to be slow enough to bring core inflation down.

While it is somewhat ironic that some of the statements about inflation are stronger this time than six weeks ago, we must remember that the last minutes needed to make the case for changing the policy stance from tightening to neutral. Now that the Fed is in a more neutral stance, the communications groundwork needs to be laid for the more likely change in the policy stance. As such it would appear that the next meeting will likely yield no change, but if you were expecting a decrease in rates in the next few months you may be disappointed.

UPDATE: Wall Street Journal and Reuters have articles on the minutes. Reuters characterizes the minutes as hawkish.

UPDATE 2: The NY Times has a quote from Mr. Lacker:

In Washington today, Mr. Lacker expanded on the reasons for his dissent, saying in a speech to the District of Columbia Chamber of Commerce that he is worried that Americans will come to accept higher inflation as the rule rather than an exception, and would act accordingly, to ill effect on the economy.

“If the Fed were to allow inflation to remain above target for too long, inflation expectations could become centered around the higher rate,” he said. “We don’t have any perfect measures of inflation expectations, but what we do have suggests that market participants do not foresee a rapid fall in core inflation. That is why I have argued for further policy actions to convincingly restore price stability.”

His entire speech can be found here, and this is the whole paragraph from which the Times quotes:

Moreover, the longer inflation remains elevated, the more difficult it will be to bring it back down. As people observe actual core inflation of 2.5 percent, along with the FOMC’s reactions, they adjust expectations regarding future inflation, and those expectations become the basis for price setting in product and labor markets. (By the way, it was for his contributions to economic research on exactly this phenomenon that Professor Edmund Phelps was awarded the Nobel Prize in economics a few days ago.) If the Fed were to allow inflation to remain above target for too long, inflation expectations could become centered around the higher rate. Once that occurs, history tells us that strong and more costly policy actions would be needed to bring inflation and inflation expectations back down. We don’t have any perfect measures of inflation expectations, but what we do have suggests that market participants do not foresee a rapid fall in core inflation. This is why I have argued for further policy actions to convincingly restore price stability.

Edmund Phelps has an op-ed in today's Wall Street Journal in which he defends a dynamic form of capitalism. He contrasts this dynamic form of capitalism found in America with the Continental European system.

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.

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.

One minor quibble that I would have is that the three economies he holds up as representative of the dynamic form of capitalism are quite different even among themselves in terms of how dynamic (i.e. conducive to entrepreneurial activity) they are. Indeed, states and provinces themselves differ. But I digress. The real issue is still to come...

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.

...

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.

I think a lot of us have given a lecture in class something along those lines, haven't we? And we might even use it as a springboard to talk about social/economic justice. Phelps writes,

... 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.

Though this defense of capitalism probably will not satisfy the most adamant free-marketers (he takes a little jab at Hayek and Ayn Rand) it is a reasoned defense. It is a plea for justice for the entrepreneur. And yet, it is difficult within our political system to craft policies that encourage the entrepreneur without also aiding established wealth. "Corporatism" as a mutation of capitalism carries with it an ability to seek (and often obtain) rents from government (regardless of who is in power). To that extent, the street protesters have a point. Corporatism is not the dynamic capitalism that Phelps wants.

But we must rememeber that, as Phelps says in his concluding paragraph, that "Capitalism in its innovations plants the seeds of its own encrustation with entrenched power." Perhaps that means that while we must allow business to grow, we also need to prune it back once in a while for its own health. One of the most important policy debates will be how we can increase the dynamism of the U.S. economy without allowing corporatism to stifle it. This is both a macro and a micro question. On the macro side, how do we formulate tax policy that encourages small businesses when large corporations and their lobbies use the process to further their own objectives (which may run counter to broader social objectives)? On the micro side, how do you regulate intellectual property--the new wealth driver? How do we prevent firms from exercising their market power to pre-empt entrepreneurial entry into their markets? These are the big questions. These are the tough questions. Our record in dealing with them has been mixed. The consequences of failing to deal with them are dire. Economists are more likely than politicians or the mainstream media to bring up these questions. Perhaps it is where we are most useful. The lens of economics can bring these issues into sharp focus. Debate and disagreement is inevitable, but the alternative--ignorance of the economic consequences--is much worse.

UPDATE: Felix Salmon has a harder time overlooking the problems with the first couple paragraphs that I allude to above.

He starts off with a strong and almost certainly wrong assertion ("There are two economic systems in the West") – meaning the US, Canada, and the UK on the one hand, and continental Europe on the other. He never tries to show that his assertion is true, but he loves to ride it into weird wonderlands:

Yeah. The writing is not as sharp as what we have come to expect from Milton Friedman. But there is something worth taking away from it nonetheless.

UPDATE 2: The free link to the article is now provided, with a tip of the hat to Greg Mankiw.

A superb choice. Here is the official Nobel page for Edmund Phelps. Here is some information on his work that led to the prize. Here is a classic Wall Street Journal op-ed from 1996.

Tyler Cowen has the best blog entry that I read today.

Like Cowen, I find it hard to classify Phelps into a single category. Unlike fellow Laureates Friedman and Lucas, Phelps did not become the leader of a particular school of thought. Yet his ideas were picked up by a wide swath of the profession. In fact, New Keynesians and Neoclassicals alike can trace their lineage through Phelps' papers. Reading the titles of some of his papers from the '60s and '70s remind a person of just how far ahead of the curve he was.

Concerning the overall meaning of this prize, Cowen says it well.

Relevance and breadth triumph over narrow technical skill.

Busy weekend ahead, so I'll try to do justice to this next week. In the meantime, I refer you to Economonitor, SCSU Scholars, and Cafe Hayek for comment on the jobs data.

We may have been underestimating the number of jobs by over 800,000. That takes some of the sting out of this month's 51,000 jobs (analysts had expected more than twice that many). Barry Ritholtz again wins by going with the "under," but we may have to audit some of his previous predictions in light of what Felix Salmon calls the "mother of all revisions."

Gabriel Mihalache has a blog called Economic Investigations that you might want to check out. He is a self-confessed "neoclassical cowboy" who spent the summer reading David Romer's Advanced Macroeconomics and everything he could find by Robert Lucas. I think students might particularly like his blog because he comes at it from the point of view of someone who, well..., spent the summer reading Romer and Lucas. In other words, he's brimming with enthusiasm and ideas. Some of his posts would be good fodder for grad student discussions. Take a look!