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June 8, 2008
David Warsh, Proprietor


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Voices in the Air

Expositions of Obamanomics have begun to appear.  In The New York Review of Books, John Cassidy asks, “If Obama isn’t an old-school Keynesian, what is he?” One answer, writes Cassidy, is a behavioralist – “the term economists use to describe those who subscribe to the tenets of behavioral economics, an increasingly popular discipline that seeks to marry the insights of psychology to the rigor of economics.”

 

Cassidy was reviewing a book, Nudge: Improving Decisions about Health, Wealth and Happiness, by Richard Thaler, of the Graduate School of Business of the University of Chicago, and Cass Sunstein, of Harvard Law School, in which the authors advocate the practice of “choice architecture” in the name of an overarching political doctrine they call libertarian paternalism.  The basic idea, eminently sensible though not often consensible (meaning sufficiently persuasive to create a broad consensus), is for government to adopt measures to move people in directions that will make their lives better – automatic opt-in to savings plans, nutrition labels on packaged foods, disclosure requirements in financial transactions, no-call lists, airbags,  and so on.

 

Cassidy’s deeper purpose is to delineate what he sees as a new approach to public policy, occupying a middle ground between libertarians (“Friedmanites”) and Keynesians, “whose intellectual jousting dominated economics for most of the twentieth century.”  The antecedents he traces to the work of Daniel Kahnemann and Amos Tversky, who began exploring systematic cognitive biases nearly forty years ago with a view to building into economics a more realistic view of human limitations. Present-day leaders of the behavioral movement, he says, include David Laibson and Andrei Shleifer, both of Harvard University; Mathew Rabin, of the University of California, Berkeley; Colin Camerer, of Caltech; and Thaler, who for many years wrote a column (“Anomalies”) for the Journal of Economic Perspectives. Cassidy hopes that behavioral economics will prove to be less a “middle way” than a vindication, “another convincing rationale” for the kind of Keynesian and regulatory policies that prevailed in the forty years after World War II, a period, Cassidy writes, “not coincidentally, in which working people saw their living standards improve at an unprecedented clip.”

 

It may be time to dust off the adage, attributed to one of Franklin Delano Roosevelt’s political aides. When asked about the economic advisers to the campaign, he pointed to his suit coat and said, before replying, “Do you see these buttons on my sleeve?  They don’t do a damn thing, but fashion says I’ve got to have them, so I do.”

 

Granted, we’ve come a long way from the first real “brains trust” in 1933 – the unofficial team of experts gathered to advise Roosevelt, including Adolph Berle, Rexford G. Tugwell, Raymond Moley, Felix Frankfurter, Thomas Corcoran and others, that gave currency to a term that had been used occasionally at least since 1901. Congress established a three-member Council of Economic Advisers to the President in 1946. President Eisenhower flirted briefly in 1953 with not filling the jobs when the Republican Congress threatened to withhold an appropriation. After Council economists acted too independently in early 1980s, a layer of insulation was established within the Executive Office of the President in 1993 in the form of the National Economic Council (first director, Robert Rubin). Today you can’t run anything without taking economics into consideration.  Intimations of an incipient revolution in economics have been a standard prop in recent presidential campaigns. Reagan had his supply-side economists, Mondale his strategic traders, Clinton his communitarians.

 

One of the most reassuring things about Obama is that Austan Goolsbee, of the Graduate School of Business of the University of Chicago, has been with him since his Senate campaign in 2004. A 1991 graduate of Yale College, Goolsbee received his PhD from the Massachusetts Institute of Technology in 1995 and went straight to Chicago to teach MBAs. A specialist in public finance, he has published a good deal on Internet taxation, and some recently on industrial organization. He has been a prolific communicator of professional views as well, writing first for Slate, then as a rotating columnist for The New York Times.

 

Probably the single most striking paper in Goolsbee’s portfolio is Evidence on the High-Income Laffer Curve from Six Decades of Tax Reform, published in Brookings Papers on Economic Activity in 1999. After the cartoon version of the Laffer Curve (tax cuts automatically pay for themselves) was convincingly impugned by experience – deficits exploded after the tax cuts of the 1980s and vanished after the tax increases of the 1990s — econometricians, especially Martin Feldstein and Lawrence Lindsey, devised methods to test more sophisticated versions of the proposition that high marginal tax rates had been counterproductive in the 1980s. It was not that high earners worked less, but rather that they shifted their compensation out of taxable forms (wages, salaries, bonuses) and into untaxed forms of compensation, notably capital income and various lavish  perks.

 

But Goolsbee applied these tax-responsiveness methods to six other major tax reforms since 1922 and found that “The lowest estimates of the elasticity [of taxable income with respect to the marginal rate] based on the 1980s data exceed even the highest estimates from data on any previous tax change.”  The vast majority of the changes in taxable income in the 90s had come from temporary shifts, mostly variations in the timing of option exercises, income that eventually would be subject to taxation. In other words, Goolsbee wrote, the evidence of “new” literature on tax responsiveness was no more compelling than the old. “It seems that, for now at least,” he concluded, “we will have to keep paying for our tax cuts the old fashioned way” – either by cutting expenditures, or, just possibly, dispensing with them altogether.

 

Moreover, Goolsbee is under no illusions that he is an expert on monetary or international economics. He has routinely turned for advice during the campaign to David and Christina Romer, macroeconomist and economic historian, respectively, both of Berkeley; and to David Cutler, of Harvard University, on matters of health care reform. (An unofficial list of others is here.) Earlier this spring, Goolsbee told Loretta Fulton, of the Abilene (Tex.) Reporter News (he spent his summers at his grandparents’ ranch in nearby View), that his job resembles that of a mechanic, who climbs over the wall during pit stops in a NASCAR race, tinkers with the car as needs be, then climbs back out of the way. “[Obama]’s definitely the guy driving the 500 laps,” Goolsbee said.

 

Since Keynes, the conventional wisdom has been that politicians are on the receiving end of a one-way conveyor belt of ideas from economists – from smart live ones if they are lucky, dumb dead ones if they are not. It doesn’t take a professional skeptic to recognize that this view is highly favorable to economists.  Indeed, it is probably downright misleading.  Bold politicians often take the lead in practice and economists must scramble to catch up. For politicians, at least the best of them, possess a wisdom about how to get things done that is superior to the understanding that any economics textbook can confer. Tax reform ordinarily has been the preserve of experts – the rare exceptions were the populist tax cuts of Ronald Reagan and George W. Bush. But anyone who knows the history of Social Security, or Medicaid, or the Prescription Drug Benefit Act of 2003 will recognize that such programs spring from the minds of political leaders, not from their technocratic counselors, eager to lobby for the Next New Thing.

 

Between now and November, mainstream journalists will probe, profile, and delineate the differences between the economics advisers and the policy staffs of each campaign. Not until the first big speech after the election will we know with any certainty how the next president intends to proceed. But I can say right now, with considerable confidence, what the election will be about.

 

The questions that finally will be at the heart of the 2008 election campaign were framed up with memorable clarity and depth by health economist Victor Fuchs, in a conference that he organized at Stanford University in the wake of the health care fiasco of 1994. He published the results two years later as Individual and Social Responsibility: Child Care, Education, Medical Care and Long Term Care.

 In his introduction, Fuchs wrote that a general, systemic failure was common to all the policies that plague the provision of such services. It stemmed from “our unwillingness and inability to discuss and resolve value issues that form the foundation of any society.” He continued, 

At the root of most of our major choices about social problems are choices about values. What kind of people are we? What kind of life to we want to lead? What is our vision of the good society? How much weight do we want to give to individual freedom? How much to equality? How much to security? How much to material progress? If we emphasize only individual responsibility, we come close to recreating “the jungle,” with all the freedom and all the insecurity and inequality that prevails in the jungle. On the other hand, if we ignore individual responsibility and rely entirely on social responsibility, the best we can hope for is the security of a well-run “zoo.”

Short-term, rapidly-shifting matters of policy aside – the business cycle, the war in Iraq – the 2008 election has been framed by Barack Obama precisely as a wide-ranging discussion of the various tensions between individual and social responsibility.  This is a man who has spent his adult life at the epicenter of a pair of powerful movements with their headquarters on the south side of Chicago, first as a community organizer for the Saul Alinsky-inspired Calumet Community Religious Conference, then as a lecturer on constitutional law at the Milton-Friedman/Aaron Director/Ronald Coase/George Stigler-inspired University of Chicago Law School.

You thought it was a big deal when the first Chicago economist took a seat on the Council of Economic Advisers (William Niskanen in 1981)? The chances are that the United States is about to get a president from Chicago’s Hyde Park – and learn something in the process about the difference between a liberal and a libertarian.

                                           *****

Covering economics from Boston is one thing.  Covering hedge fund compensation is quite another. I received a vivid lesson in the latter last week from Felix Salmon, the peripatetic online “Market Movers” columnist of Portfolio magazine.

 

Having published the Web version of “A Normal Professor” last week, I went to bed worrying that, in accepting a figure bruited about the University of Chicago, I had overestimated Andrei Shleifer’s net worth.  I woke up to a jaunty note from Salmon asking if perhaps the appropriate figure might be closer to $40 million in yearly income rather than total wealth. He had performed the rough calculations of fees on assets under management that I had been reluctant to attempt myself and came up with a much bigger number.

He wrote, “[M]y guess is that the Shleifer-Zimmerman family has a net worth of vastly more than $40 million, and quite possibly something in the billion dollar range.” Does that seem implausible? Not if you read Salomon’s brief. Is it authoritative?  Far from it — but it is a better guesstimate than mine. Still more persuasive appraisals will emerge in time.

That night I went to bed feeling a little like Doctor Evil, who in the Austin Powers movies was frozen in the ’60s and reawakened in the ’90s, thinking that one million dollars was a lot of money.

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