Deep insight from Eugene White in this paper (HT: Scott Sumner)

The fantastically costly failures of banks and other financial intermediaries are a consequence of appallingly bad choices made by managers. To gain unseemly executive compensation, managers had incentives to exploit conflicts of interests, increase leverage, and choose risky trades, instruments and portfolios. Reacting to these disastrous choices, policy makers have recommended splitting up the banks to make them smaller or limiting the scope of their activities. Elaborate efforts are being expended to ensure that leverage is controlled by raising capital and by gauging its exposure to the individual banks’ risks and systemic risk. Lastly, there have been calls for caps on executive compensation to reduce the rewards from risk-taking. These are very strong measures, but history suggests that they will not be lasting checks on risk. Previous reforms focused on regulating choices ultimately led to new institutions and instruments that circumvented the rules to take more risk.

Part of the recent crisis’ origins may be found in steady erosion of incentives that induced management to control risk. The problems of moral hazard from deposit insurance, “Too-Bigto-Fail,” and the “Greenspan Put” are well-known, though their magnitude is difficult to measure. In addition, the increasing ability of management to control the boards of directors has insulated them from efforts of rebellious shareholders to appoint new directors. Perhaps, the most important but least heralded change in the ten years prior to the 2008 crisis was the shift by most major investment banks from partnerships to limited liability corporations.

What is notable about contemporary reform is that there is little effort to change the incentives that caused bank executives to take the big risks and a huge emphasis on regulating their choices. The implicit assumption seems to be that incentives and the assignment of liability plays only a small role so that choices must be regulated—that is, the market cannot be made to adequately discipline banks. Could such a market-based system be devised? In this paper, I offer evidence from the American National Banking Era (1864-1913) for the ability of incentives to successfully limit losses from bank failures.

(Title up the post has been updated. HT to Paul Ramer.)

… is from pages 8-9 of Mark Pennington’s 2011 book Robust Political Economy:

Moreover, insofar as market failure theorists are right to focus on ‘incentive compatibility’, they fail to appy this analysis to their favoured institutional alternatives.  A consistent analysis of collective action and asymmetric information problems reveals that these are often more pronounced in a public sector environment than they are in a regime of ‘imperfect markets’.

Here’s a letter to the Wall Street Journal:

Lobbyist Scott Paul details the bounty that American tire producers now reap from the Obama administration’s tariff on Americans who buy Chinese tires (Letters, Jan. 26).  He then asserts that these gains prove the tariff’s merit.

Bull.

The argument against tariffs is not that they fail to yield benefits to protected industries; rather, it’s that these benefits come at the greater expense of the public at large.  Mr. Paul’s letter is evidence of the truth of Albert Venn Dicey’s observation that “Every man feels or thinks that protection would benefit his own business, and it is difficult to realize that what may be a benefit for any man taken alone, may be of no benefit to a body of men looked at collectively.”*

Mr. Paul’s false assumption that the gains to tire manufacturers are gains to Americans at large proves not the merit of the tire tariff but, instead, the narrowness of the tunnel vision of a rent-seeking lobbyist and of the rapacious corporations that he serves.

Sincerely,
Donald J. Boudreaux
Professor of Economics
George Mason University
Fairfax, VA  22030

* Albert Venn Dicey, Lectures on the Relation Between Law & Public Opinion in England During the Nineteenth Century (London: Macmillan and Co., 1905), p. 24.

Here is Dan Klein talking about his new book, Knowledge and Coordination:

His EconTalk episode on the book is here.

… is from page 63 of John Mueller’s outstanding 1999 book Capitalism, Democracy, and Ralph’s Pretty Good Grocery:

From the perspective of the intellectual, then, people in business may appear small-minded, crass, menial, and even stupid – though typically they will understand their business in greater depth and finer nuance than the average intellectual will ever understand anything.

Yep – although it’s wise to add that to understand one’s business is not (contrary to much popular misconception) simultaneously to understand adequately the workings or the logic of the larger economy of which that business is a part.  The average intellectual, alas, understands neither the complex of details and trade-offs regularly involved in running businesses (or even in the making of everyday household decisions by families other than his or her own) nor the workings or the logic of the larger economy.

Here’s a letter to the Wall Street Journal:

Having now read Pres. Obama’s 2012 State of the Union address (I cannot tolerate watching the kitschy display that is the actual delivery of a State of the Union address), I can say only that Thomas Babington Macaulay’s long-ago description of Robert Southey applies perfectly to Barack Obama:

“He conceives that the business of the magistrate is not merely to see that the persons and property of the people are secure from attack, but that he ought to be a jack-of-all-trades, architect, engineer, schoolmaster, merchant, theologian, a Lady Bountiful in every parish, a Paul Pry in every house, spying, eavesdropping, relieving, admonishing, spending our money for us.  His principle is, if we understand it rightly, that no man can do anything so well for himself as his rulers, be they who they may, can do it for him, and that a government approaches nearer and nearer to perfection in proportion as it interferes more and more with the habits and notions of individuals.”*

Sincerely,
Donald J. Boudreaux
Professor of Economics
George Mason University
Fairfax, VA  22030

* T.B. Macaulay, “Southey’s Colloquies on Society” (1830).

Unlike most people in my line of work (and I’m somewhat embarrassed to admit this fact), I cannot bear to watch politicians speak – and I especially cannot tolerate watching any President of the United States deliver the so-called “State of the Union” address.  That address is invariably a series of statements that are often downright false and always insulting to the intelligence of people with I.Q.s higher than that of sea slugs.  And beyond all that, all State of the Union addresses grate like fingernails on a chalkboard to anyone who has no desire to be a happy cog in the Great Collective as it is portrayed and lauded by our Leaders.  Fortunately, my friends at the Cato Institute have stomachs stronger than mine; they watched Mr. Obama’s address last night and corrected the record in the most important cases.  (HT Caleb Brown)

And here’s Greg Mankiw’s helpful response to Mr. Obama’s talk.  (Unlike Mankiw, though, I’m not in the least surprised by Mr. Obama’s xenophobia-laced trade-policy pronouncements: the President thinks that such will win him votes by energizing his economically uninformed “Progressive” base while also pleasing a good number of conservatives.  Case closed.)

Peter Suderman also responds to Mr. Obama’s speech.  (I especially like the title of Suderman’s post.)

In my most recent column in the Pittsburgh Tribune-Review, I continue to press Jim Buchanan’s case that public debt that ‘we owe to ourselves’ is not an insignificant burden on us.

The Independent Institute just announced its line-up of summer 2012 student seminars.

Bryan Caplan spies two blind spots in Charles Murray’s new book.

Here’s Walter Olson on some stupid notions that too many smart people have about job creation.

There was actually a news-worthy moment in Mitch Daniels response to President Obama’s State of the Union address. He said:

Decades ago, for instance, we could afford to send millionaires pension checks and pay medical bills for even the wealthiest among us.  Now, we can’t, so the dollars we have should be devoted to those who need them most.

The mortal enemies of Social Security and Medicare are those who, in contempt of the plain arithmetic, continue to mislead Americans that we should change nothing.  Listening to them much longer will mean that these proud programs implode, and take the American economy with them.  It will mean that coming generations are denied the jobs they need in their youth and the protection they deserve in their later years.

I would prefer to slowly dismember Social Security and Medicare and instead let us re-learn how to take care of ourselves and our neighbors without going through Washington. But if the goal is to save the system in some form akin to its current state, making the welfare component of Social Security and Medicare is a good place to start. Why should your children be taxed to pay for my retirement when I am capable of taking care of myself? The usual answer is that I paid into the system and I deserve “my” benefits. But I also paid into Food Stamps. I don’t expect my food stamp tax payments to come back. The government has deceived the American people for years, making them think that their payroll tax “contributions” are set aside for  their future benefit. But it’s not true. So let’s just admit it’s a welfare program. And if it’s a welfare program, why do rich people get benefits? Means-testing Social Security and Medicare would allow much lower tax rates in the future and be a more honest way to structure government-financed retirement and health plans.

… is from page 201 of my colleague Richard Wagner’s valuable 1987 essay “Liability Rules, Fiscal Institutions and Debt,” which is chapter 11 in the important 1987 collection Deficits (James M. Buchanan, Charles K. Rowley, & Robert D. Tollison, eds):

The claims of Keynesian macroeconomic theory and policy may or may not be correct; I for one think they are quite false.  But political survivability may be quite different from such matters of truth or falsity.  Even if the Keynesian presuppositions about economics were true, and so the economy were unstable and government could alter its budgetary policy to offset private sources of instability, it does not follow that those policy outcomes would dominate alternative policies within existing democratic regimes.  Moreover, even if those presuppositions were false, policy prescriptions based on those presuppositions could nonetheless have survival value within existing democratic institutions.

From this reality I conclude that it’s professional malpractice for a social scientist who pays little attention to the realities of how how collective-choice and government-decision-making processes actually work – namely, by carefully studying public choice – to advocate that government implement his or her theories.  Policy advocacy under such circumstances is professional malpractice regardless of the strength of the conviction with which the social scientist holds his or her theories to be true (and, indeed, regardless of the actual validity of those theories within their own theoretical domains).

Policy advocacy by persons insufficiently familiar with public-choice research is akin to, say, an automotive engineer designing an automobile with all sorts of (what are at least believed to be) internally consistent working parts, all of which conform well to known laws of physics, but none of which was designed with much knowledge at all of the actual features of the likely human beings who will drive the car – features such as people’s size, vision, the number of limbs they possess, and the purposes for which they likely are to use the car.

The title of this post is my new summary of the top two Republican candidates. You can pronounce it in two ways and both capture my lack of enthusiasm for them.

Here is George Will on Mitt and Newt. There are many fine passages. Here’s one on Newt:

Gingrich thinks South Carolina has catapulted him toward irresistible victory. There remain, however, 53 more delegate-selection processes — in 47 states, the District of Columbia, Puerto Rico and some possessions. Busy as an intellectual beaver having big ideas by the bushel, Gingrich has neglected some mundane matters, such as getting on the Virginia and Missouri ballots.

Should Prometheus have to sweat such tiresome details? Yes, because the nominating process in this complex continental nation usefully foreshadows the challenges of governing such a nation.

And here is an excerpt on Mitt:

The first presidential candidate from the economy’s now deeply unpopular financial sector, Romney is suffering because this sector’s arcane practices and instruments seem to many people, as indecipherable things often do, sinister. His tax returns perhaps testify to no more than sophisticated exploitation of the baroque tax code’s opportunities for — even encouragement of — tactics to minimize liabilities. This, however, may exacerbate the impression many Republicans seem to have of his slipperiness. And this attribute is related to the suspicion that there is something synthetic about him. This may be unfair, but so is life.

Life has been good to Romney, who now must quickly demonstrate authenticity, even if he needs to synthesize it. Actually, he does not need to. He speaks well, which is to say with infectious passion, about the dangers of the other party’s dependency agenda and the entitlement mentality it cultivates. But if Romney says even one more time “I believe in America” — a bromide worthy of Tom (“Your future is still ahead of you”) Dewey — voters may decide he is a human Oakland, that (as Gertrude Stein said of the city) there is no there there.

Read the whole thing.

So I’m skimming the e-mail version of the UVA Law alumni newsletter when I see this item: it’s about someone I don’t know: Jeffrey Kerr, ’87 graduate of the law school.  Mr. Kerr is now General Counsel for People for the Ethical Treatment of Animals (PETA).

What a marvelous world we inhabit today!  Regardless of your opinion of PETA and its preferred policies (most of which I am either indifferent to or downright oppose), you can’t help but smile admiringly at the fact that we have here a hugely well-educated, obviously very intelligent, and clearly hard-working modern American devoting his specialized talents to protecting creatures that, in pre-industrial times, would (had these creatures been alive at all) have been accorded absolutely no consideration by human beings.  And in the process of devoting his talents to helping animals, Mr. Kerr is, no doubt, handsomely compensated.  (Not compensated, I’m sure, as well as are the likes of IP attorneys and cardiovascular surgeons – but compensated well enough to allow him and his family to live what is at least a comfortable modern middle-class American life-style.)

It is only because modern Americans have in fact raised nearly every human being in our society far above the level of desperate poverty that was the norm everywhere on earth until just a few generations ago that we can – and are willing to – devote substantial resources to making the lives of animals better.

If you’re like me, you find talk of captive killer whales being “enslaved” and of possessing constitutionally protected rights to be ludicrous.  But if you’re like me you also celebrate the reality that we live in a world that permits, legally and – much more importantly – economically, such discussions to occur, as well permits the possibility for those discussions to bear fruit.  Mind you, I do not wish PETA well in the great majority of its endeavors.  But I’m pleased to be a denizen of a society so incredibly prosperous that we can survive the successful pursuit of even of such policies without the bulk of us suffering any noticeable decline in our living standards.

Via Todd Henderson, here’s Richard Epstein’s response to Jeffrey Sachs’s misrepresentations of libertarianism.

Arnold Kling rightly laments the state of business reporting.

What happens to measures of income “inequality” when the value of health-care benefits is taken into account?

Shikha Dalmia shares the troubling truth about India’s caste system.

Here’s Thomas Sowell on Newt Gingrich.  And here’s George Will.  I side with Will regarding Gingrich.  Four more years of Obama in the Oval Office would be better, in my view, than four years of Gingrich there: each man is mad for power; each man’s Promethean opinion of himself is quite the opposite of what a realistic self-opinion would be; each man is a font of economic idiocy; and each man’s principles are such that each would – recalling Mencken’s description of FDR – fatten up a crew of missionaries on the White House lawn for slaughter if he thought that endorsing cannibalism would get him more votes.  Yet the countless nutty and destructive policies that Pres. Gingrich would likely implement would inevitably be described by our crack mainstream press as “laissez faire” – thus creating more public misunderstanding.  (Of course, four more years of Obama in the White House might also be better than four years of Romney there….)

Here’s a new symposium on some recent work by my GMU Econ colleague Richard Wagner (HT Pete Boettke)

Bryan Caplan asks why should we restrict immigration.

Here’s a letter to the Weekly Standard (HT Roger Ream):

Angry at China for allegedly selling goods to Americans at artificially low prices, Irwin Stelzer unsheaths a mighty sword to rip the case for unilateral free trade: Book IV Chapter II of The Wealth of Nations (“Tariffs not Tax Breaks,” Jan. 30).  But only by reading selectively can Stelzer conclude that “Adam Smith does not counsel sitting idly by while his nation’s tradable goods industries are devastated by a predatory competitor.”

Smith, of course, understood that it’s sometimes theoretically possible for a government to retaliate against protectionist foreign governments in ways that generate positive results for citizens of the home country.  (No serious economist has ever denied this fact.)  Contrary to the impression left by Stelzer, however, Smith was highly skeptical of the practicability of such retaliation.

For example, Stelzer is correct to note that Smith recognized that “The job of doing all of this [retaliation] requires ‘the skill of that insidious and crafty animal, vulgarly called a statesman or politician.’”  But what curiously derisory terms Smith uses here to describe officials allegedly to be entrusted to practice socially beneficial retaliatory protectionism!  And sure enough, as we read on we discover that the lesson Smith drew from this political reality is the opposite of that drawn by Stelzer.

For Smith, entrusting “insidious and crafty” officials to impose retaliatory tariffs is to invite special-interest-group mischief.  In the second half of the paragraph [#39] in which he calls politicians “insidious and crafty,” Smith describes how retaliatory tariffs in practice are, indeed, poorly used.  And he closes that paragraph with this lament about the unavoidable influence of politically powerful producers: “Those workmen, however, who suffered by our neighbours prohibition will not be benefited by ours.  On the contrary, they and almost all the other classes of our citizens will thereby be obliged to pay dearer than before for certain goods.  Every such law, therefore, imposes a real tax upon the whole country, not in favour of that particular class of workmen who were injured by our neighbours prohibition, but of some other class.”

Your readers would do well to read Smith directly rather than to rely upon Stelzer’s misleading interpretation.

Sincerely,
Donald J. Boudreaux
Professor of Economics
George Mason University
Fairfax, VA  22030

… is from page 167 of James Ted McDonald’s, Casey Warman’s, and Christopher Worswick’s paper “Earnings, Occupations, and Schooling Decisions of Immigrants with Medical Degrees: Evidence for Canada and the United States,” which is Chapter 6 of High-Skilled Immigration in a Global Labor Market, Barry R. Chiswick, ed. (Washington: American Enterprise Institute, 2011), pp. 165-198:

In a recent paper, Phillips and others (2007)* examine administrative data from the American Medical Association, the Canadian Medical Association, and other sources to document the extent to which Canadian-educated physicians are working in the United States and U.S.-educated physicians are working in Canada.  They find that while only 408 U.S.-educated physicians were working in direct patient care in Canada in 2004, 8,162 Canadian-educated physicians were working in direct patient care in the United States in 2006, and close to 70 percent of these physicians were specialists.  Canadian-educated specialists in the United States represent 19 percent of the Canadian specialist workforce, while Canadian-educated primary-care physicians in the United States represent 8 percent of the Canadian general-practitioner workforce.  Overall, one in nine Canadian-educated physicians are practicing in the United States; after excluding U.S.-born physicians educated in Canada, still one in twelve are practicing in the United States.  They conclude that physician emigration to the United States is in fact an important contributing factor to the shortage of physicians in Canada.

*Robert L. Phillips, Jr., Stephen Petterson, George E. Fryer, Jr., and Walter Rosser, “The Canadian contribution to the US physician workforce, Canadian Medical Association Journal, Vol. 8, pp. 1083-87.

One lesson: people respond predictably to prices, even when those prices are dictated by a well-intentioned government and even when those prices are of health-care resources.

Here’s a letter to the Wall Street Journal:

I feel as though I’m twirling in the Twilight Zone when I read Karen Davenport, debating Michael Cannon, praise Obamacare for “requiring insurers to price premiums without regard to health status” – and then to insist that this regulation, combined with Uncle Sam’s mandate that everyone purchase such insurance, will increase the availability of health insurance (“Should Everyone Be Required to Have Health Insurance?” Jan. 23).

Does Prof. Davenport advocate this model also for other businesses – say, restaurants?  Does she think that restaurant customers would be better served if government required restaurants to price meals without regard to ‘hunger status,’ so that the bill paid by a diner who orders three lobsters, two filets, and a bottle of ’61 Chateau Latour be the same as the bill paid by a diner who orders only a single cup of soup?  Does she think that whatever problems might arise from such a regulation will be solved if government also forces every American to buy a minimum number of restaurant meals?  After all, food – even more so than health-care – is necessary for life.

If Prof. Davenport doesn’t advocate this regulatory model for restaurants, why doesn’t she?  (Please, Prof. Davenport, no protests that the health-care market is ‘unique.’  Of course it’s unique; every market is unique.  But is the health-care market unique in ways that prompt people consistently to act against their financial self-interest, as you apparently expect insurance companies to do?)

Sincerely,
Donald J. Boudreaux
Professor of Economics
George Mason University
Fairfax, VA  22030

This week’s EconTalk is David Rose talking about his book, The Moral Foundations of Economic Behavior. David asks the question–what moral values would best serve a group of people who want to be able to trust strangers not to act opportunistically which would in turn allow people to specialize, trade with strangers and so on.

The best economics article of the year. (HT: Chris Jones) Well, the year’s early, but it’s awfully good. You will learn a lot about how the world works. It’s a look at what has happened to manufacturing employment in the US and why it has happened. Superb.

… is from page 322 of the 1951 Augustus M. Kelly reissue of Frank Knight‘s 1935 collection The Ethics of Competition; specifically, it’s from Knight’s 1934 essay entitled “Economic Theory and Nationalism” (original emphasis; footnote omitted):

And this is what nationalism seems to mean.  The individual gives up the effort to treat the world, material or human, as his oyster, and tries to put himself in mystical unity with his group, meaning the more or less racial, cultural “nation” which is already the object of his strongest political allegiance.  Along with this growth in a kind of sentimental gregariousness, he swings from an active to a passive attitude toward society, and from a reflective to an emotional, impulsive attitude toward the world at large.  He swings from “rationalism” to “romanticism.”  In particular, the individual reacts from the notion of reaching validity by general discussion – which he has seen degenerate into a contest in “selling” – to a faith in “strong” individual leadership, which also represents a reaction from moral and intellectual equalitarianism to hero worship.  The movement also involves a shift from the actor interest to the spectator interest in society, and in part to a merging of the two in an experience of mystical participation.  Men want action, but by the group, i.e., the government or its outstanding personalities.  They do not want to act.

Here’s another letter to the New York Times:

Reporting on Apple’s alleged failure to create adequate numbers of jobs in America, you quote Betsey Stevenson, until recently former chief economist at the Labor Department, lamenting that “Companies once felt an obligation to support American workers, even when it wasn’t the best financial choice.  That’s disappeared.  Profits and efficiency have trumped generosity” (“How U.S. Lost Out on iPhone Work,” Jan. 22).

Forget Dr. Stevenson’s dubious history.  I’m curious to know if your reporters, in response, asked her the following sorts of questions: “Is your home, Dr. Stevenson, without an automatic washer and dryer so that you can better exercise your generosity by hiring washerwomen to launder your family’s clothes by hand?  When you cut your finger or get a stuffy nose, do you treat these ailments with inexpensive over-the-counter medications, or do you instead spend the extra money required to visit your physician in order to generously increase the demand for health-care workers?  And when a light bulb in your home burns out, do you avoid the ‘best financial choice’ of changing it yourself by generously hiring a handyman to change it for you?”

Unless Dr. Stevenson can answer honestly that she often spends her own money for no reason other than to ‘create jobs’ for strangers, she has no business complaining about other people behaving exactly as she does.

Sincerely,
Donald J. Boudreaux
Professor of Economics
George Mason University
Fairfax, VA  22030