Semi-Daily Journal Archive

The Blogspot archive of the weblog of J. Bradford DeLong, Professor of Economics and Chair of the PEIS major at U.C. Berkeley, a Research Associate of the National Bureau of Economic Research, and former Deputy Assistant Secretary of the U.S. Treasury.

Saturday, October 28, 2006

America Swings Toward a Parliamentary System...

Michael Kinsley is the latest member of the chorus saying, "Vote the party, not the individual politician":

Guardian Unlimited | Comment is free | The electoral end of piety: In a remarkable editorial on Wednesday, the New York Times endorsed Diane Farrell for Congress from a district in Connecticut. Who is Diane Farrell? I have no idea, and the Times didn't seem to have much of one. After eight years as first selectman of Westport (a position similar to that of a mayor), the paper noted somewhat desperately, "she has a better understanding than most legislators of the impact of federal mandates and tax policy on local government". By contrast her opponent, Christopher Shays, has held the seat for almost 20 years and been endorsed by the Times "in every race in which he has faced a serious opponent" - until now.

Shays is a Republican, but not excessively so. He's moderate in policy and in temperament. In fact he's just the kind of Republican the Times ordinarily likes to dig up and endorse in order to prove that it's not blindly Democratic. Yet the Times decided to "strongly endorse" Shays's opponent entirely because she's a Democrat. Or rather because she is not a Republican: "Mr Shays has been a good congressman, but not good enough to overcome the fact that his re-election would help empower a party that is long overdue for a shakeup."

One of the axioms of democratic piety in the US is that you vote for the person, not the party. People love to say, "I evaluate each candidate on his or her own merits" - even when it's not true.... But this year does seem to be different. You hear people say - though rarely as forthrightly as the Times - that they are voting for the party, not the person. Well, more accurately, they say they are voting against the party, not the person... voting for the Democrat simply out of anger at or frustration with the Republican party.

The pious view is mistaken. There is nothing wrong with voting for the party, not the person. In other democracies, such as Britain, this person-not-the-party piety is unknown and would be hard to comprehend. A candidate for parliament runs on a party platform promising various things, and if that party wins a majority of seats it "forms a government". You would be silly to vote for the person and not the party. The party's views are what counts. The person's own views are almost irrelevant.

Even under the American arrangement there is nothing ignoble about voting the party line. It is an efficient way to minimise your information costs.... A candidate's party affiliation doesn't tell you everything you would like to know, but it tells you something. In fact it tells you a lot - enough so that it makes sense to vote for your party preference even when you know nothing else about a candidate. Or even to vote for a candidate that you actively dislike...

Greg Mankiw: For Higher Gas Taxes

Greg Mankiw goes on the offensive against the the letters the Wall Street Journal editorial page chooses to publish:

Greg Mankiw's Blog: Alternatives to the Pigou Club: Today's Wall Street Journal prints various letters in response to my oped on gas taxes.... [L]et me try to spell out more generally the alternatives from which we must choose.... [Y]ou most likely fit into one of these... categories.

  1. You deny the existence of these externalities [from pollution from auto emissions] as a type of market failure. Perhaps you think you live in a Coasian fantasy world where people bargain without transaction costs to reach efficient allocations. (Note: I am not suggesting that Coase himself thought we lived in such a world--he considered it only a useful thought experiment.)
  2. You recognize the externalities but you don't think the government should try to respond to them. You are such a believer in small government that you are willing to live with inferior economic outcomes, such as pollution and congestion.
  3. You recognize the externalities, think the government should try to correct them, but think the current low taxes we put on gasoline are sufficient. In this case, you have weighed and rejected the evidence, such as that of Parry and Small, that higher Pigovian would be optimal. (Parry and Small calculate an optimal tax of $1.01 for the United States in today's dollars. After my proposed phase-in of a $1 hike, the U.S. tax would be $1.40. Assuming 10 years of 3 percent inflation, the tax in real terms would approach almost exactly what Parry and Small recommend. By the way, the published version of Parry and Small was in the American Economic Review, September 2005.)
  4. You recognize the externalities but think the government should try to correct the market failure through regulations (such as CAFE standards) or through market-based solutions that do not raise government revenue (such as cap-and-trade systems). Perhaps you are concerned that government would waste the extra revenue on useless government programs.

Let me respond to group 4, because my guess is that this is the largest group of antipigovians.

The reason I am less concerned that the extra revenue will be spent is that it already has been spent. The federal government has promised benefits to the elderly far in excess of what it can pay. At some point the nation will have to reckon with the looming fiscal gap. The most likely political compromise will involve higher tax revenue. We should, therefore, be ready to increase revenue in a way that does the least damage--or, better yet, the most good. If not Pigovian taxes, then other taxes will be increased.

An optimistic libertarian might hope that we can deal with the looming fiscal gap without raising the ratio of taxes to GDP above its current level. I wish I could believe that this were possible. In a previous oped, I advocated increasing, slowly but substantially, the age of eligibility for Social Security and Medicare. But even if we could scale back government spending in such a radical way, Pigovian taxes would not lose their appeal. Let's use the extra revenue from Pigovian taxes to reduce distortionary taxes, such as income taxes. Politically unrealistic, you say? Surely, if a future government were so libertarian as to manage a radical reduction in entitlement promises to the elderly, it would have no trouble delivering equally radical cuts in income taxes. In fact, the tax cuts would be the easy part of the package....

Let me try to put the issue in terms of a flow chart.

Question: Do you believe consumption of gasoline is free of negative externalities leading to market inefficiency? If YES, you are part of group 1. If NO, continue.

Question: Do you believe that public policy should ignore these externalities? If YES, you are part of group 2. If NO, continue.

Question: Do you believe the current tax on gasoline sufficiently internalizes the negative externalities? If YES, you are part of group 3. If NO, continue.

Question: Do you believe the best remedy for the remaining externalities is a regulatory system rather than a higher tax? If YES, you are part of group 4. If NO, you are a member of the Pigou Club.

I think most most muembers of Group 4 believe that Greg Mankiw's Pigovian taxes on gasoline and other carbon emissions would be a good thing, but don't think that we can get there easily in today's political climate--especially with a Republican Party that doesn't care about balancing the budget at all but has a large fundamentalist wing opposed to all tax increases that might stabilize our fiscal situation and avoid running big risks of future disasters. CAFE is not a way of avoiding "taxing"--it's a way of getting the auto companies to collect the tax (and rebate the revenue to purchasers of fuel-efficient cars). It's an inefficient policy with little pollution-reduction bang for its excess-burden buck, but it is one that Mankiw's political masters might accept--you see, it isn't called a "tax." The same holds for tradeable permit schemes.

Most members of Group 4, I think, aren't opposed to taxing gasoline in a Pigovian way. What they are is opposed to calling the tax a tax, because they believe Republican politicians need a way to save face.


The Wall Street Journal editorial editors' choice of letters is pathetic: two from lobbyists (one of whom falsely and shamelessly claims to be a "policy wonk") who they decide deserve to run free ads, one dork from Carmel denying that demand for gasoline is not price-sensitive at all, one dork from Fort Worth calling Greg Mankiw(!!!) a socialist, and one confused person from Atlanta who doesn't seem to understand that Mankiw's gasoline tax is pro-growth (when growth is properly measured, that is):

October 26, 2006; Page A19

Higher Gas Taxes Will Never Make Americans Abandon Their Cars Missing from N. Gregory Mankiw's interesting proposal to raise the federal gasoline tax by $1 over the next 10 years ("Raise the Gas Tax," editorial page, Oct. 20) is any context or explanation of why the tax is collected in the first place. It generates dedicated revenue for the Highway Trust Fund that is used solely for transportation programs. The federal gas tax finances almost 45% of all public investments in road improvements each year.

Prof. Mankiw says boosting the gas tax would get people out of their cars and force them to live closer to where they work, thereby reducing road congestion. Yet there is no evidence to suggest this would happen based on the most current Census Bureau data. More than 80% of commuters drive to work alone. That trend will continue in the future.

To much fanfare, the U.S. population officially reached 300 million Oct. 17, and is expected to reach 400 million by 2043. America's highways, bridges and transit systems are now crumbling because of years of under-investment by all levels of government. Between now and 2043, based on current trends, highway capacity will grow only 9%, but traffic levels will swell by 135% to more than seven trillion vehicle miles traveled annually. The average motorist can expect to spend 160 hours stuck in traffic delays, or the equivalent of four weeks each year. It's a recipe for a gridlocked nation, absent any new highway and transit investment that adds major new capacity.

Providing and maintaining the transportation infrastructure is a core function of government. Let's increase the federal gasoline tax, but let's make sure it's used for its intended purpose -- maintaining and improving the highway and public transit systems so crucial to America's mobility, national security, economic strength and global competitiveness.

Matthew J. Jeanneret
Senior Vice President
Communications & Marketing
American Road & Transportation Builders Association
Washington

Whew! That was dizzying. Tax-cuts convert to the left of me, raise the gas tax to the right! Keep this up and I will need to start wearing a switchable eye patch to prevent vertigo. As regards the gas tax, did Prof. Mankiw see less traffic during the recent price run-up at the pumps? Concerning high fuel taxes in Europe, he would have plenty of time in traffic there to read The Guardian or Le Figaro. On the subject of efficiency, I can hardly wait to watch the Fed spend that tax windfall.

Charles Dusenbury
Carmel, Calif.

Count me in as a policy wonk who thinks Prof. Mankiw's self-described "wacky" idea of raising the gas tax is one that should stay on the dusty shelf of economic theory and not in the practical world of public policy. Giving politicians more gas tax revenues is like giving your car keys and a bottle of gin to a teenager.

Over the past 25 years, governments at all levels have collected twice as much in gas taxes ($1.34 trillion in today's dollars) as the domestic oil companies have earned collectively in profits ($643 billion). In only three of those years (1980, 1981 and 1982) did industry profits exceed government's annual tax take. Add on corporate income tax payments and government's total tax take from the industry rises to $2.2 trillion in today's dollars. Not only has this made no dent in the federal deficit, but it has given Washington the means to fund such boondoggles as the Bridge to Nowhere.

Moreover, our great national experiment of trying to use tax policy to dampen consumption is now the textbook definition of the law of unintended consequences. According to the Congressional Research Service, the 1980 windfall profits tax depressed the domestic production and extraction industry and furthered our dependence on foreign sources of oil. The French have some of the highest gas taxes in Europe yet remain 100% dependent on foreign oil.

As I'm sure Prof. Mankiw teaches his students, taxes should simply be a means of funding government programs, not a tool for advancing social, political or economic agendas.

Scott A. Hodge
President
Tax Foundation
Washington

Whenever I read an article or listen to someone crow about raising the gas tax, I am reminded of how far removed some people are from the rest of us who have to work for a living. Every point in Prof. Mankiw's commentary boils down to improperly using the tax code to force a certain behavior and enact social change, all in a quest to show us poor folks who have to drive to work, to the store or to pick up the kids that we're just not in line with the professor's progressive thinking. If being in traffic makes Prof. Mankiw wish the rest of us would drive less, reading socialist diatribes like his makes me wish people like him would write less.

Kevin C. Carpenter
Fort Worth, Texas

Prof. Mankiw suggests that federal taxes on gas should be raised to levels of half that of Britain in order to, among other reasons, grow the economy. While his logic of shifting the tax code's focus from punishing productivity to encouraging consumption is right-headed, I must point out that the U.K. is a country in which both consumption and productivity are taxed at high rates, to the detriment of the economy. It is no stretch of the imagination to see Congress imposing the same misguided policies in the U.S. Instead, the entire focus of our tax code should be shifted from punishing productivity to encouraging consumption. Ultimately, Congress and the people would be playing for the same team.

Simon Arpiarian
Atlanta

The Economist Gets a Base Hit

On the other hand, here is the Economist doing what the Economist does well:

Free exchange | Economist.com: IT IS HARD to contemplate the new US GDP figures without a mental image forming of Republican campaign strategists rolling around on the ground, gripping their bellies and moaning "It hurts! It hurts!" Second quarter GDP growth was a lacklustre 2.6% (annualised), well below economists expectations. This morning (this afternoon, here in London) the news came that America's economy had disappointed again, growing by just 1.6% in the third quarter, rather than the 2.2% that economists had been expecting. There has been a tepid attempt to bring up the Dow's record levels, but this has fallen rather flat: the record isn't a record if you adjust for inflation, and anyway, the Dow isn't a very good proxy for economic health, or even investor confidence. It has only thirty companies in it, and these are weighted by cost rather than market capitalisation, which means that it is easily blown about by outsized movements in the prices of a few stocks. The S&P 500, which is much more representative, is still well below its 2000 peak.

In the New York Times on Tuesday, Eduardo Porter wrote This Time, it's Not the Economy:

President Bush, in hopes of winning credit for his party’s stewardship of the economy, is spending two days this week campaigning on the theme that the economy is purring. “No question that a strong economy is going to help our candidates,” Mr. Bush said in a CNBC interview yesterday, “primarily because they have got something to run on, they can say our economy’s good because I voted for tax relief.”

But Republican candidates do not seem to be getting any traction from the glowing economic statistics with midterm elections just two weeks away...

We'd suggest that this is because the statistics, like GDP, are not actually glowing; in fact, they're barely emitting enough light to check your watch by. Even fantastic headline numbers, like 4.6% unemployment, disguise weak wage growth and sagging labour force participation. Perhaps even more problematically for the Republicans, what growth there is isn't being felt by the average voter. Companies are increasing compensation--but they're spending it on benefits like health insurance, which doesn't feel the same as a wage increase even if you're one of the unlucky few who gets a $100,000 cancer treatment out of it. And income growth is concentrated among the wealthy, who are too few to swing an election...

When We First Saw the Grizzly, It Was Half a Mile Away Across a Meadow...

Nouriel "Grizzly" Roubini (as Andrew Samwick calls him) looks back at his successful forecast of Q3 GDP growth:

RGE - Q3 GDP growth dismal at 1.6%; expect further slowdown in Q4 and recession by 2007: The first estimate of Q3 GDP growth is a dismal 1.6%, sharply lower than the 5.6% of Q1 and the 2.6% of Q2. In July - when I first predicted a US recession in 2007 - I forecasted that Q3 GDP growth would be 1.5% at the time when the market consensus was 3.1%. Given the onslaught of bad macro news in the fall professional forecasters started to cut their Q3 forecasts from 3.1% to 2.5%, down to 2.2% last week and 2% this morning. They were still wrong and overoptimistic as the actual first estimate came as 1.6%, only an epsilon higher than my July forecast of 1.5% (the same forecasters had gotten Q2 wrong too; my spring forecast for Q2 was 2.5% versus a consensus of 3.2%; the actual figure ended up being 2.6%).

The weakness in Q3 growth is widespread: real residential investment fell at an annualized rate of 17.4%, much worse than the 11.1% drop of Q2; the trade balance was a negative drag on growth as the trade deficit widened sharply in Q3 relative to Q2; inventory accumulation was slightly lower in Q3 than in Q2 thus being a small drag on growth as well; non durable consumption grew only at an annualized rate of 1.6%; and while durable consumption grew faster in Q3 than in Q2 you can expect significant slowdown in durable consumption in Q4 as the glut of autos and housing related durables consumption takes a hit on the economy. Even non-residential investment in structures that was growing at an annualized rate of 20.3% in Q2 slowed down its growth to 14% in Q3: you can expect a much sharper slowdown in such non-residential investment in Q4 and 2007 for reasons discussed below. Real investment in software and equipment – that had fallen in Q2 – recovered in Q3 to a 6.4% growth rate; but further weakness in the economy in Q4 and 2007 will lead to a significant slowdown in such investment in the quarters ahead.

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. This weakness in residential and non-residential construction will directly affect retail activity where employment has already started to fall. Expect in Q4 and 2007 actual fall in durable consumption (autos, housing related consumption such as furniture and home appliances and other big ticket items) as the housing slowdown, the fall in home prices and the negative wealth effects of falling prices and reset of ARMs take a toll on consumption, especially housing-related durable one. Given the ongoing sharp slowdown in the economy, real investment in software and equipment will be growing less in Q4 and 2007 than in Q3. And both inventories and trade are likely to remain a drag on growth in Q4 as inventory adjustment will continue (with demand growing less than production) while a strong dollar will further widen the trade deficit in spite of the economic slowdown.

The first leading indicator of economic activity for October – the Philly, Richmond and Chicago Fed reports – are all consistent with a further economic slowdown in Q4 relative to Q3. I thus keep my forecast that Q4 growth will be between 0% and 1% and that the economy will enter into an outright recession by Q1 of 2007 or, at the latest, Q2...

The New Republic Makes a Joke of Itself

It publishes Joseph Loconte:

Is liberalism synonymous with secularism? A TNR debate, Day 4: Contrary to the eccentric, embittered attack by ex-White House staffer David Kuo, the president's faith-based initiative has delivered on another Bush promise: to confront the government's animus against religious charities in providing social services. You can't measure the success of this initiative in federal dollars... the standard liberal fallacy...

A previous act of pollution of the stream of debate by Joseph Loconte:

Joseph Loconte on Iraq on National Review Online: There is a tenacity, a resolve, a certain moral seriousness about Nouri Al-Maliki, the Iraqi prime minister, that many politicians here must find unsettling. His determination was on full display Wednesday, when he addressed Congress to discuss the future of Iraq. In a 30-minute speech interrupted 27 times by applause, Al-Maliki poignantly described the existential terrorist threat facing his country...

If the White House has sometimes appeared naive about the “terrible” violence in Baghdad... its critics have an opposite problem: an unflappable fatalism.... We’ve seen this mood before. It is reminiscent of the cynicism of progressives in the 1930s, who viewed the struggle against Nazi Germany in the black light of the First World War....

Al-Maliki’s speech to Congress stands as a reproach to the debunkers of our own day. He was sober, yet not cynical, about America’s and the world’s failure to support Iraq’s stirrings toward freedom, particularly after the first Gulf War. “In 1991, when Iraqis tried to capitalize on the regime’s momentary weakness and rose up, we were alone again,” he said....

The heart of Al-Maliki’s message, though, was that Iraq is center stage in the fight against global terrorism. Here is a confrontation, he warned, that demands the engagement of “every liberal democracy that values freedom.” It is this message — delivered by a man trying to govern his nation at ground zero of the struggle — which offends liberal leaders and intellectuals.... A man who once carried a death sentence on his head and lived in exile for over 20 years, Al-Maliki is no utopian. He knows all about the sectarian divisions in his country, the threat of rogue militias, the security problems in Baghdad, the fears that drain away hope. “The journey has been perilous,” he told Congress, “and the future is not guaranteed.” Yet he remains resolved: “I will not allow terrorists to dictate to us our future.”

The cynics in his audience — the Ted Kennedy wing of the Democratic party — are not the ones to lead America into this future. They remain trapped in the past, it seems, an emotional quagmire of their own making.

That Frank Foer feels that this voice is a good one to put in his corner of the public sphere is a good reason to stay far away.

Why Oh Why Can't We Have a Better Press Corps? (Economist Edition) Why Oh Why Can't We Have a Better Press Corps? (Economist Edition)

The Economist blows yet another one:

Corporate crime | Jail time for Jeffrey | Economist.com : Is the sentence handed to Enron's ex-boss excessive?

The sentence of 24 years and four months handed to the former boss of Enron on October 23rd is slightly less than the record-breaking 25 years in prison being served by Bernie Ebbers, the former boss of WorldCom.... Skilling's lawyers had sought a sentence of just seven to ten years, citing his good works in the community and the fact that his convictions for fraud and insider trading, connected with the collapse of Enron in 2001, were his first....

[T]here are growing worries about the severity of America's white-collar sentences, which treat bosses more harshly than drug dealers and some murderers.... America also treats white-collar offenders more severely than other rich countries. Nick Leeson... who brought down Barings Bank, served just four years of a six-and-a-half-year sentence. And South Korea's courts sentenced Kim Woo Choong, a former boss of Daewoo, to ten years--despite his fleeing the country after the group collapsed.

That Mr Skilling's sentence was so much harsher than that of Andrew Fastow, the former chief financial officer whose role in Enron's collapse was far clearer, has also caused disquiet. Lawyers feel that Mr Fastow, who received a six-year sentence last month, was rewarded for co-operating with prosecutors, while Mr Skilling was punished simply for asserting his constitutional right to go to trial.

His conviction and lengthy sentence highlight America's growing "criminalisation of agency costs", says Larry Ribstein, a law professor at the University of Illinois. To get the benefits of diversified public ownership of firms, shareholders must delegate responsibility to managers, or agents. But agents do not always do the right thing by shareholders. Should such agency costs be handled by means other than criminal prosecutions and jail terms? Mr Ribstein thinks so. Civil litigation against managers and stricter corporate governance might be less costly and less likely to discourage legitimate risk-taking, he says...

What "legitimate risk taking" could possibly be discouraged by sending Mr. Skilling to jail? This makes sense only if telling your CFO to commit fraud in order to push losses off into future years is "legitimate risk taking."

Quality control, people. Quality control. The suggestion that fraud by managers be dealt with only by civil litigation is as stupid and short-sighted as the suggestion that theft and violence be dealt with only by civil litigation.

FT: Kate Burgess and Jeremy Grant on U.S. Corporate Governance

Flaws in the legal structure underlying U.S. corporate governance:

FT.com / Companies / Financial services: Investors "lack basic rights" on US boards By Kate Burgess in London and Jeremy Grant in Washington Published: October 27 2006 22:40 | Last updated: October 27 2006 22:40: Some of the world's largest investment managers have called on US regulators to give shareholders power to change the composition of US boards, claiming shareholders in US companies "lack basic rights which they take for granted in other developed countries%."

The call is a sign that one of the key tenets of US corporate governance -- limited shareholder access to company proxies for board elections -- is coming under attack from non-US investors as foreign ownership of US companies grows. In a letter to Christopher Cox, chairman of the Securities and Exchange Commission, the group calls on the regulator to allow investors to vote on the election of directors to "encourage more responsive and responsible boards" in the US. This might help to prevent recurrences of the "dismaying number of corporate scandals and board-level derelictions of duty in recent years" suffered by shareholders in US companies, it said....

Signatories of the letter... the group manages about $34,000bn in assets.

The move follows the delay this month of a key SEC meeting that was to address whether to allow shareholders more access to company proxies, one of the most sensitive issues on Mr Cox's agenda.The SEC was to have decided whether to let stand a recent US court ruling that had forced the regulator to reconsider its policy that blocked shareholder access to proxies where elections of board directors were concerned.

The issue has become a key battleground in US corporate governance. Shareholder rights activists have intensified efforts to get access to the proxy to have a say in the composition of company boards -- and therefore also in such matters as executive compensation...

Dan Bogart on Private vs. Public Ownership of Railroads Economics Faculty: Dan Bogart

A seminar last Monday, October 23, 2006, that I am sorry I missed (I was in a committee meeting). Dan Bogart from UC Irvine:

Dan Bogart (2006), "Private Ownership and the Development of Transport Systems: Cross-country Evidence from the Diffusion of Railroads in the 19th Century" http://orion.oac.uci.edu/~dbogart/bogart_railprivate_10_6_2006.pdf:

Railroads played a key role in 19th century economic growth, particularly in middle to low income countries. Despite their high benefits, there were large differences in railroad diffusion across countries. This paper investigates whether the degree of private ownership can explain the cross-country differences in railroad diffusion and investment. It uses a new data set on the number of track miles owned by private companies in over 40 countries, provinces, or colonies between 1840 and 1912. The initial results show that greater private ownership increased railroad miles per capita and railroad investment per capita after controlling for GDP per capita, political institutions, as well as country and year fixed effects. The findings address the historical and contemporary debate about the merits of public versus private ownership. Most countries in the 19th century faced a choice between direct funding through public ownership or private ownership with indirect funding through government subsidies. My findings suggest that countries which had greater private sector participation tended to have higher railroad diffusion and investment.

Daniel Gross on Dow 12000

Mark Thoma watches as journamalism in the interest of reprinting Republican talking points drives Daniel Gross into shrill unholy madness:

Economist's View: The Real Dow 12,000 Story: Daniel Gross on a new Republican talking point, "Dow 12,000":

How Now, Grown Dow?.... The Dow Jones industrial average first closed above 12,000 on Oct. 19, and has remained above that lofty benchmark ever since.... Dow 12,000 quickly became a Republican talking point.... So far, Republican candidates don't seem to be benefiting from the Dow record, which is less surprising than it seems. For starters, the Dow's success does not mean that stock-market investors in general are thriving, because the Dow... as an overall stock-market proxy and investment tool, it's an also-ran.... The S&P 500... is a much more accurate gauge.... [T]he claim that "the stock market" is at an all-time high simply doesn't match most investors' experiences.... 12,000 doesn't really even represent a record high for the Dow.... In real terms, the Dow is still nowhere near the peak it hit several years ago....

[S]ome of those who are trumpeting the high nominal value of the stock market are urging people to focus on the real, inflation-adjusted value of another asset that has been at record highs recently. Take a gander at George Will's absurd column last week.... Will celebrates the record nominal high in stock prices but urges readers to focus on the real price of oil. By mixing and matching real and nominal, Will could just as easily have argued that oil is more expensive than it has ever been, while the Dow is barely at the level it reached in 1999. If Democrats controlled the levers of power, he'd be making precisely that argument...

Greg Mankiw: For Higher Gas Taxes

Greg Mankiw goes on the offensive against the the letters the Wall Street Journal editorial page chooses to publish:

Greg Mankiw's Blog: Alternatives to the Pigou Club: Today's Wall Street Journal prints various letters in response to my oped on gas taxes.... [L]et me try to spell out more generally the alternatives from which we must choose.... [Y]ou most likely fit into one of these... categories.

  1. You deny the existence of these externalities [from pollution from auto emissions] as a type of market failure. Perhaps you think you live in a Coasian fantasy world where people bargain without transaction costs to reach efficient allocations. (Note: I am not suggesting that Coase himself thought we lived in such a world--he considered it only a useful thought experiment.)
  2. You recognize the externalities but you don't think the government should try to respond to them. You are such a believer in small government that you are willing to live with inferior economic outcomes, such as pollution and congestion.
  3. You recognize the externalities, think the government should try to correct them, but think the current low taxes we put on gasoline are sufficient. In this case, you have weighed and rejected the evidence, such as that of Parry and Small, that higher Pigovian would be optimal. (Parry and Small calculate an optimal tax of $1.01 for the United States in today's dollars. After my proposed phase-in of a $1 hike, the U.S. tax would be $1.40. Assuming 10 years of 3 percent inflation, the tax in real terms would approach almost exactly what Parry and Small recommend. By the way, the published version of Parry and Small was in the American Economic Review, September 2005.)
  4. You recognize the externalities but think the government should try to correct the market failure through regulations (such as CAFE standards) or through market-based solutions that do not raise government revenue (such as cap-and-trade systems). Perhaps you are concerned that government would waste the extra revenue on useless government programs.

Let me respond to group 4, because my guess is that this is the largest group of antipigovians.

The reason I am less concerned that the extra revenue will be spent is that it already has been spent. The federal government has promised benefits to the elderly far in excess of what it can pay. At some point the nation will have to reckon with the looming fiscal gap. The most likely political compromise will involve higher tax revenue. We should, therefore, be ready to increase revenue in a way that does the least damage--or, better yet, the most good. If not Pigovian taxes, then other taxes will be increased.

An optimistic libertarian might hope that we can deal with the looming fiscal gap without raising the ratio of taxes to GDP above its current level. I wish I could believe that this were possible. In a previous oped, I advocated increasing, slowly but substantially, the age of eligibility for Social Security and Medicare. But even if we could scale back government spending in such a radical way, Pigovian taxes would not lose their appeal. Let's use the extra revenue from Pigovian taxes to reduce distortionary taxes, such as income taxes. Politically unrealistic, you say? Surely, if a future government were so libertarian as to manage a radical reduction in entitlement promises to the elderly, it would have no trouble delivering equally radical cuts in income taxes. In fact, the tax cuts would be the easy part of the package....

Let me try to put the issue in terms of a flow chart.

Question: Do you believe consumption of gasoline is free of negative externalities leading to market inefficiency? If YES, you are part of group 1. If NO, continue.

Question: Do you believe that public policy should ignore these externalities? If YES, you are part of group 2. If NO, continue.

Question: Do you believe the current tax on gasoline sufficiently internalizes the negative externalities? If YES, you are part of group 3. If NO, continue.

Question: Do you believe the best remedy for the remaining externalities is a regulatory system rather than a higher tax? If YES, you are part of group 4. If NO, you are a member of the Pigou Club.

I think most most muembers of Group 4 believe that Greg Mankiw's Pigovian taxes on gasoline and other carbon emissions would be a good thing, but don't think that we can get there easily in today's political climate--especially with a Republican Party that doesn't care about balancing the budget at all but has a large fundamentalist wing opposed to all tax increases that might stabilize our fiscal situation and avoid running big risks of future disasters. CAFE is not a way of avoiding "taxing"--it's a way of getting the auto companies to collect the tax (and rebate the revenue to purchasers of fuel-efficient cars). It's an inefficient policy with little pollution-reduction bang for its excess-burden buck, but it is one that Mankiw's political masters might accept--you see, it isn't called a "tax." The same holds for tradeable permit schemes.

Most members of Group 4, I think, aren't opposed to taxing gasoline in a Pigovian way. What they are is opposed to calling the tax a tax, because they believe Republican politicians need a way to save face.


The Wall Street Journal editorial editors' choice of letters is pathetic: two from lobbyists (one of whom falsely and shamelessly claims to be a "policy wonk") who they decide deserve to run free ads, one dork from Carmel denying that demand for gasoline is not price-sensitive at all, one dork from Fort Worth calling Greg Mankiw(!!!) a socialist, and one confused person from Atlanta who doesn't seem to understand that Mankiw's gasoline tax is pro-growth (when growth is properly measured, that is):

October 26, 2006; Page A19

Higher Gas Taxes Will Never Make Americans Abandon Their Cars Missing from N. Gregory Mankiw's interesting proposal to raise the federal gasoline tax by $1 over the next 10 years ("Raise the Gas Tax," editorial page, Oct. 20) is any context or explanation of why the tax is collected in the first place. It generates dedicated revenue for the Highway Trust Fund that is used solely for transportation programs. The federal gas tax finances almost 45% of all public investments in road improvements each year.

Prof. Mankiw says boosting the gas tax would get people out of their cars and force them to live closer to where they work, thereby reducing road congestion. Yet there is no evidence to suggest this would happen based on the most current Census Bureau data. More than 80% of commuters drive to work alone. That trend will continue in the future.

To much fanfare, the U.S. population officially reached 300 million Oct. 17, and is expected to reach 400 million by 2043. America's highways, bridges and transit systems are now crumbling because of years of under-investment by all levels of government. Between now and 2043, based on current trends, highway capacity will grow only 9%, but traffic levels will swell by 135% to more than seven trillion vehicle miles traveled annually. The average motorist can expect to spend 160 hours stuck in traffic delays, or the equivalent of four weeks each year. It's a recipe for a gridlocked nation, absent any new highway and transit investment that adds major new capacity.

Providing and maintaining the transportation infrastructure is a core function of government. Let's increase the federal gasoline tax, but let's make sure it's used for its intended purpose -- maintaining and improving the highway and public transit systems so crucial to America's mobility, national security, economic strength and global competitiveness.

Matthew J. Jeanneret
Senior Vice President
Communications & Marketing
American Road & Transportation Builders Association
Washington

Whew! That was dizzying. Tax-cuts convert to the left of me, raise the gas tax to the right! Keep this up and I will need to start wearing a switchable eye patch to prevent vertigo. As regards the gas tax, did Prof. Mankiw see less traffic during the recent price run-up at the pumps? Concerning high fuel taxes in Europe, he would have plenty of time in traffic there to read The Guardian or Le Figaro. On the subject of efficiency, I can hardly wait to watch the Fed spend that tax windfall.

Charles Dusenbury
Carmel, Calif.

Count me in as a policy wonk who thinks Prof. Mankiw's self-described "wacky" idea of raising the gas tax is one that should stay on the dusty shelf of economic theory and not in the practical world of public policy. Giving politicians more gas tax revenues is like giving your car keys and a bottle of gin to a teenager.

Over the past 25 years, governments at all levels have collected twice as much in gas taxes ($1.34 trillion in today's dollars) as the domestic oil companies have earned collectively in profits ($643 billion). In only three of those years (1980, 1981 and 1982) did industry profits exceed government's annual tax take. Add on corporate income tax payments and government's total tax take from the industry rises to $2.2 trillion in today's dollars. Not only has this made no dent in the federal deficit, but it has given Washington the means to fund such boondoggles as the Bridge to Nowhere.

Moreover, our great national experiment of trying to use tax policy to dampen consumption is now the textbook definition of the law of unintended consequences. According to the Congressional Research Service, the 1980 windfall profits tax depressed the domestic production and extraction industry and furthered our dependence on foreign sources of oil. The French have some of the highest gas taxes in Europe yet remain 100% dependent on foreign oil.

As I'm sure Prof. Mankiw teaches his students, taxes should simply be a means of funding government programs, not a tool for advancing social, political or economic agendas.

Scott A. Hodge
President
Tax Foundation
Washington

Whenever I read an article or listen to someone crow about raising the gas tax, I am reminded of how far removed some people are from the rest of us who have to work for a living. Every point in Prof. Mankiw's commentary boils down to improperly using the tax code to force a certain behavior and enact social change, all in a quest to show us poor folks who have to drive to work, to the store or to pick up the kids that we're just not in line with the professor's progressive thinking. If being in traffic makes Prof. Mankiw wish the rest of us would drive less, reading socialist diatribes like his makes me wish people like him would write less.

Kevin C. Carpenter
Fort Worth, Texas

Prof. Mankiw suggests that federal taxes on gas should be raised to levels of half that of Britain in order to, among other reasons, grow the economy. While his logic of shifting the tax code's focus from punishing productivity to encouraging consumption is right-headed, I must point out that the U.K. is a country in which both consumption and productivity are taxed at high rates, to the detriment of the economy. It is no stretch of the imagination to see Congress imposing the same misguided policies in the U.S. Instead, the entire focus of our tax code should be shifted from punishing productivity to encouraging consumption. Ultimately, Congress and the people would be playing for the same team.

Simon Arpiarian
Atlanta

Mark Spiegel: Did Quantitative Easing by the Bank of Japan Work?

Mark Thoma sends us to Mark Spiegel on the channels of monetary policy:

Economist's View: FRBSF: Did Quantitative Easing by the Bank of Japan Work?: The San Francisco Fed has an Economic Letter assessing of the Bank of Japan's policy of quantitative easing from 2001 to 2006. Here's the introduction and conclusion to the study:

Did Quantitative Easing by the Bank of Japan "Work"?, by Mark M. Spiegel Vice, FRBSF Economic Letter: On March 19, 2001, the Bank of Japan (BOJ) embarked on an unprecedented monetary policy experiment, commonly referred to as "quantitative easing," in an attempt to stimulate the nation's stagnant economy.

Under this policy, the BOJ increased its target for "current account balances" of commercial banks at the BOJ far in excess of their required reserve levels. This had the expected impact of reducing the already low overnight call rate (which is roughly equivalent to ... the federal funds rate) effectively to zero. In addition, the BOJ committed to maintain the policy until the core consumer price index registered "stably" a 0% or a positive increase year on year. The policy was lifted five years later, in March 2006. At the launch of the program, many were skeptical that it would have any impact on the real economy, as overnight interest rates were already close to zero, so flooding Japanese commercial banks with excess reserves would only amount to a swap of two assets with close to zero yields.

Now that the program has been lifted, several studies have attempted to assess its impact through a number of channels. These include a direct effect of increases in current account balances, an impact on the expectations of market participants, increased central bank purchases of long-term Japanese government bonds (JGBs) that would reduce long-term interest rates, and an encouragement of greater risk-tolerance in the Japanese financial system....

Conclusion: The results ... are just now making their way into the literature, but several patterns already have emerged. First, the primary evidence for the real effects of quantitative easing appears to be associated with ... some measurable declines in longer-term interest rates. These have been associated with both changes in agents' expectations of future interest rate levels and with purchases of "nonstandard" assets, such as longer-term JGBs. As these policies often occurred simultaneously, it is difficult to discriminate between the two. Second, there appears to be evidence that the program aided weaker Japanese banks and generally encouraged greater risk-tolerance in the Japanese financial system.

While these outcomes appear to be consistent with the intentions of the program, the magnitudes of these impacts are still very uncertain. Moreover, in strengthening the performance of the weakest Japanese banks, quantitative easing may have had the undesired impact of delaying structural reform...

The idea that direct injections of liquidity into the economy may work to stimulate spending even without having effects on interest rates is an old one, and one that I have always viewed with skepticism. Somebody's behavior has to be changing in order for spending to go up. And it is hard to see how behavior can change without changing some financial market prices and interest rates somehow, somewhere.

The Soft Bigotry of Low Expectations

The soft bigotry of low expectations. Kevin Drum is excited at a Washington Post

The Washington Monthly: SLEAZY ADVERTISING....Michael Grunwald writes an honest piece today in the Washington Post about the wildly negative campaigning going on in the Republican camp this election cycle. He briefly suggests that "some Democrats are playing rough, too" -- and provides a couple of examples -- but immediately acknowledges that virtually all Democratic ads have focused on policies and performance. Not so on the other side:

The result has been a carnival of ugly, especially on the GOP side, where operatives are trying to counter what polls show is a hostile political environment by casting opponents as fatally flawed characters. The National Republican Campaign Committee is spending more than 90 percent of its advertising budget on negative ads, according to GOP operatives, and the rest of the party seems to be following suit.

See? It's not so hard to simply report the facts, is it?

Very sad.

Friday, October 27, 2006

The New Republic Makes a Joke of Itself

It publishes Joseph Loconte:

Is liberalism synonymous with secularism? A TNR debate, Day 4: Contrary to the eccentric, embittered attack by ex-White House staffer David Kuo, the president's faith-based initiative has delivered on another Bush promise: to confront the government's animus against religious charities in providing social services. You can't measure the success of this initiative in federal dollars... the standard liberal fallacy...

A previous act of pollution of the stream of debate by Joseph Loconte:

Joseph Loconte on Iraq on National Review Online: There is a tenacity, a resolve, a certain moral seriousness about Nouri Al-Maliki, the Iraqi prime minister, that many politicians here must find unsettling. His determination was on full display Wednesday, when he addressed Congress to discuss the future of Iraq. In a 30-minute speech interrupted 27 times by applause, Al-Maliki poignantly described the existential terrorist threat facing his country...

If the White House has sometimes appeared naive about the “terrible” violence in Baghdad... its critics have an opposite problem: an unflappable fatalism.... We’ve seen this mood before. It is reminiscent of the cynicism of progressives in the 1930s, who viewed the struggle against Nazi Germany in the black light of the First World War....

Al-Maliki’s speech to Congress stands as a reproach to the debunkers of our own day. He was sober, yet not cynical, about America’s and the world’s failure to support Iraq’s stirrings toward freedom, particularly after the first Gulf War. “In 1991, when Iraqis tried to capitalize on the regime’s momentary weakness and rose up, we were alone again,” he said....

The heart of Al-Maliki’s message, though, was that Iraq is center stage in the fight against global terrorism. Here is a confrontation, he warned, that demands the engagement of “every liberal democracy that values freedom.” It is this message — delivered by a man trying to govern his nation at ground zero of the struggle — which offends liberal leaders and intellectuals.... A man who once carried a death sentence on his head and lived in exile for over 20 years, Al-Maliki is no utopian. He knows all about the sectarian divisions in his country, the threat of rogue militias, the security problems in Baghdad, the fears that drain away hope. “The journey has been perilous,” he told Congress, “and the future is not guaranteed.” Yet he remains resolved: “I will not allow terrorists to dictate to us our future.”

The cynics in his audience — the Ted Kennedy wing of the Democratic party — are not the ones to lead America into this future. They remain trapped in the past, it seems, an emotional quagmire of their own making.

That Frank Foer feels that this voice is a good one to put in his corner of the public sphere is a good reason to stay far away.

When We First Saw the Grizzly, It Was Half a Mile Away Across a Meadow...

Nouriel "Grizzly" Roubini (as Andrew Samwick calls him) looks back at his successful forecast of Q3 GDP growth:

RGE - Q3 GDP growth dismal at 1.6%; expect further slowdown in Q4 and recession by 2007: The first estimate of Q3 GDP growth is a dismal 1.6%, sharply lower than the 5.6% of Q1 and the 2.6% of Q2. In July - when I first predicted a US recession in 2007 - I forecasted that Q3 GDP growth would be 1.5% at the time when the market consensus was 3.1%. Given the onslaught of bad macro news in the fall professional forecasters started to cut their Q3 forecasts from 3.1% to 2.5%, down to 2.2% last week and 2% this morning. They were still wrong and overoptimistic as the actual first estimate came as 1.6%, only an epsilon higher than my July forecast of 1.5% (the same forecasters had gotten Q2 wrong too; my spring forecast for Q2 was 2.5% versus a consensus of 3.2%; the actual figure ended up being 2.6%).

The weakness in Q3 growth is widespread: real residential investment fell at an annualized rate of 17.4%, much worse than the 11.1% drop of Q2; the trade balance was a negative drag on growth as the trade deficit widened sharply in Q3 relative to Q2; inventory accumulation was slightly lower in Q3 than in Q2 thus being a small drag on growth as well; non durable consumption grew only at an annualized rate of 1.6%; and while durable consumption grew faster in Q3 than in Q2 you can expect significant slowdown in durable consumption in Q4 as the glut of autos and housing related durables consumption takes a hit on the economy. Even non-residential investment in structures that was growing at an annualized rate of 20.3% in Q2 slowed down its growth to 14% in Q3: you can expect a much sharper slowdown in such non-residential investment in Q4 and 2007 for reasons discussed below. Real investment in software and equipment – that had fallen in Q2 – recovered in Q3 to a 6.4% growth rate; but further weakness in the economy in Q4 and 2007 will lead to a significant slowdown in such investment in the quarters ahead.

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. This weakness in residential and non-residential construction will directly affect retail activity where employment has already started to fall. Expect in Q4 and 2007 actual fall in durable consumption (autos, housing related consumption such as furniture and home appliances and other big ticket items) as the housing slowdown, the fall in home prices and the negative wealth effects of falling prices and reset of ARMs take a toll on consumption, especially housing-related durable one. Given the ongoing sharp slowdown in the economy, real investment in software and equipment will be growing less in Q4 and 2007 than in Q3. And both inventories and trade are likely to remain a drag on growth in Q4 as inventory adjustment will continue (with demand growing less than production) while a strong dollar will further widen the trade deficit in spite of the economic slowdown.

The first leading indicator of economic activity for October – the Philly, Richmond and Chicago Fed reports – are all consistent with a further economic slowdown in Q4 relative to Q3. I thus keep my forecast that Q4 growth will be between 0% and 1% and that the economy will enter into an outright recession by Q1 of 2007 or, at the latest, Q2...

Greg Mankiw: For Higher Gas Taxes

Greg Mankiw goes on the offensive against the the letters the Wall Street Journal editorial page chooses to publish:

Greg Mankiw's Blog: Alternatives to the Pigou Club: Today's Wall Street Journal prints various letters in response to my oped on gas taxes.... [L]et me try to spell out more generally the alternatives from which we must choose.... [Y]ou most likely fit into one of these... categories.

  1. You deny the existence of these externalities [from pollution from auto emissions] as a type of market failure. Perhaps you think you live in a Coasian fantasy world where people bargain without transaction costs to reach efficient allocations. (Note: I am not suggesting that Coase himself thought we lived in such a world--he considered it only a useful thought experiment.)
  2. You recognize the externalities but you don't think the government should try to respond to them. You are such a believer in small government that you are willing to live with inferior economic outcomes, such as pollution and congestion.
  3. You recognize the externalities, think the government should try to correct them, but think the current low taxes we put on gasoline are sufficient. In this case, you have weighed and rejected the evidence, such as that of Parry and Small, that higher Pigovian would be optimal. (Parry and Small calculate an optimal tax of $1.01 for the United States in today's dollars. After my proposed phase-in of a $1 hike, the U.S. tax would be $1.40. Assuming 10 years of 3 percent inflation, the tax in real terms would approach almost exactly what Parry and Small recommend. By the way, the published version of Parry and Small was in the American Economic Review, September 2005.)
  4. You recognize the externalities but think the government should try to correct the market failure through regulations (such as CAFE standards) or through market-based solutions that do not raise government revenue (such as cap-and-trade systems). Perhaps you are concerned that government would waste the extra revenue on useless government programs.

Let me respond to group 4, because my guess is that this is the largest group of antipigovians.

The reason I am less concerned that the extra revenue will be spent is that it already has been spent. The federal government has promised benefits to the elderly far in excess of what it can pay. At some point the nation will have to reckon with the looming fiscal gap. The most likely political compromise will involve higher tax revenue. We should, therefore, be ready to increase revenue in a way that does the least damage--or, better yet, the most good. If not Pigovian taxes, then other taxes will be increased.

An optimistic libertarian might hope that we can deal with the looming fiscal gap without raising the ratio of taxes to GDP above its current level. I wish I could believe that this were possible. In a previous oped, I advocated increasing, slowly but substantially, the age of eligibility for Social Security and Medicare. But even if we could scale back government spending in such a radical way, Pigovian taxes would not lose their appeal. Let's use the extra revenue from Pigovian taxes to reduce distortionary taxes, such as income taxes. Politically unrealistic, you say? Surely, if a future government were so libertarian as to manage a radical reduction in entitlement promises to the elderly, it would have no trouble delivering equally radical cuts in income taxes. In fact, the tax cuts would be the easy part of the package....

Let me try to put the issue in terms of a flow chart.

Question: Do you believe consumption of gasoline is free of negative externalities leading to market inefficiency? If YES, you are part of group 1. If NO, continue.

Question: Do you believe that public policy should ignore these externalities? If YES, you are part of group 2. If NO, continue.

Question: Do you believe the current tax on gasoline sufficiently internalizes the negative externalities? If YES, you are part of group 3. If NO, continue.

Question: Do you believe the best remedy for the remaining externalities is a regulatory system rather than a higher tax? If YES, you are part of group 4. If NO, you are a member of the Pigou Club.

I think most most muembers of Group 4 believe that Greg Mankiw's Pigovian taxes on gasoline and other carbon emissions would be a good thing, but don't think that we can get there easily in today's political climate--especially with a Republican Party that doesn't care about balancing the budget at all but has a large fundamentalist wing opposed to all tax increases that might stabilize our fiscal situation and avoid running big risks of future disasters. CAFE is not a way of avoiding "taxing"--it's a way of getting the auto companies to collect the tax (and rebate the revenue to purchasers of fuel-efficient cars). It's an inefficient policy with little pollution-reduction bang for its excess-burden buck, but it is one that Mankiw's political masters might accept--you see, it isn't called a "tax." The same holds for tradeable permit schemes.

Most members of Group 4, I think, aren't opposed to taxing gasoline in a Pigovian way. What they are is opposed to calling the tax a tax, because they believe Republican politicians need a way to save face.


The Wall Street Journal editorial editors' choice of letters is pathetic: two from lobbyists (one of whom falsely and shamelessly claims to be a "policy wonk") who they decide deserve to run free ads, one dork from Carmel denying that demand for gasoline is not price-sensitive at all, one dork from Fort Worth calling Greg Mankiw(!!!) a socialist, and one confused person from Atlanta who doesn't seem to understand that Mankiw's gasoline tax is pro-growth (when growth is properly measured, that is):

October 26, 2006; Page A19

Higher Gas Taxes Will Never Make Americans Abandon Their Cars Missing from N. Gregory Mankiw's interesting proposal to raise the federal gasoline tax by $1 over the next 10 years ("Raise the Gas Tax," editorial page, Oct. 20) is any context or explanation of why the tax is collected in the first place. It generates dedicated revenue for the Highway Trust Fund that is used solely for transportation programs. The federal gas tax finances almost 45% of all public investments in road improvements each year.

Prof. Mankiw says boosting the gas tax would get people out of their cars and force them to live closer to where they work, thereby reducing road congestion. Yet there is no evidence to suggest this would happen based on the most current Census Bureau data. More than 80% of commuters drive to work alone. That trend will continue in the future.

To much fanfare, the U.S. population officially reached 300 million Oct. 17, and is expected to reach 400 million by 2043. America's highways, bridges and transit systems are now crumbling because of years of under-investment by all levels of government. Between now and 2043, based on current trends, highway capacity will grow only 9%, but traffic levels will swell by 135% to more than seven trillion vehicle miles traveled annually. The average motorist can expect to spend 160 hours stuck in traffic delays, or the equivalent of four weeks each year. It's a recipe for a gridlocked nation, absent any new highway and transit investment that adds major new capacity.

Providing and maintaining the transportation infrastructure is a core function of government. Let's increase the federal gasoline tax, but let's make sure it's used for its intended purpose -- maintaining and improving the highway and public transit systems so crucial to America's mobility, national security, economic strength and global competitiveness.

Matthew J. Jeanneret
Senior Vice President
Communications & Marketing
American Road & Transportation Builders Association
Washington

Whew! That was dizzying. Tax-cuts convert to the left of me, raise the gas tax to the right! Keep this up and I will need to start wearing a switchable eye patch to prevent vertigo. As regards the gas tax, did Prof. Mankiw see less traffic during the recent price run-up at the pumps? Concerning high fuel taxes in Europe, he would have plenty of time in traffic there to read The Guardian or Le Figaro. On the subject of efficiency, I can hardly wait to watch the Fed spend that tax windfall.

Charles Dusenbury
Carmel, Calif.

Count me in as a policy wonk who thinks Prof. Mankiw's self-described "wacky" idea of raising the gas tax is one that should stay on the dusty shelf of economic theory and not in the practical world of public policy. Giving politicians more gas tax revenues is like giving your car keys and a bottle of gin to a teenager.

Over the past 25 years, governments at all levels have collected twice as much in gas taxes ($1.34 trillion in today's dollars) as the domestic oil companies have earned collectively in profits ($643 billion). In only three of those years (1980, 1981 and 1982) did industry profits exceed government's annual tax take. Add on corporate income tax payments and government's total tax take from the industry rises to $2.2 trillion in today's dollars. Not only has this made no dent in the federal deficit, but it has given Washington the means to fund such boondoggles as the Bridge to Nowhere.

Moreover, our great national experiment of trying to use tax policy to dampen consumption is now the textbook definition of the law of unintended consequences. According to the Congressional Research Service, the 1980 windfall profits tax depressed the domestic production and extraction industry and furthered our dependence on foreign sources of oil. The French have some of the highest gas taxes in Europe yet remain 100% dependent on foreign oil.

As I'm sure Prof. Mankiw teaches his students, taxes should simply be a means of funding government programs, not a tool for advancing social, political or economic agendas.

Scott A. Hodge
President
Tax Foundation
Washington

Whenever I read an article or listen to someone crow about raising the gas tax, I am reminded of how far removed some people are from the rest of us who have to work for a living. Every point in Prof. Mankiw's commentary boils down to improperly using the tax code to force a certain behavior and enact social change, all in a quest to show us poor folks who have to drive to work, to the store or to pick up the kids that we're just not in line with the professor's progressive thinking. If being in traffic makes Prof. Mankiw wish the rest of us would drive less, reading socialist diatribes like his makes me wish people like him would write less.

Kevin C. Carpenter
Fort Worth, Texas

Prof. Mankiw suggests that federal taxes on gas should be raised to levels of half that of Britain in order to, among other reasons, grow the economy. While his logic of shifting the tax code's focus from punishing productivity to encouraging consumption is right-headed, I must point out that the U.K. is a country in which both consumption and productivity are taxed at high rates, to the detriment of the economy. It is no stretch of the imagination to see Congress imposing the same misguided policies in the U.S. Instead, the entire focus of our tax code should be shifted from punishing productivity to encouraging consumption. Ultimately, Congress and the people would be playing for the same team.

Simon Arpiarian
Atlanta

The Economist Gets a Base Hit

On the other hand, here is the Economist doing what the Economist does well:

Free exchange | Economist.com: IT IS HARD to contemplate the new US GDP figures without a mental image forming of Republican campaign strategists rolling around on the ground, gripping their bellies and moaning "It hurts! It hurts!" Second quarter GDP growth was a lacklustre 2.6% (annualised), well below economists expectations. This morning (this afternoon, here in London) the news came that America's economy had disappointed again, growing by just 1.6% in the third quarter, rather than the 2.2% that economists had been expecting. There has been a tepid attempt to bring up the Dow's record levels, but this has fallen rather flat: the record isn't a record if you adjust for inflation, and anyway, the Dow isn't a very good proxy for economic health, or even investor confidence. It has only thirty companies in it, and these are weighted by cost rather than market capitalisation, which means that it is easily blown about by outsized movements in the prices of a few stocks. The S&P 500, which is much more representative, is still well below its 2000 peak.

In the New York Times on Tuesday, Eduardo Porter wrote This Time, it's Not the Economy:

President Bush, in hopes of winning credit for his party’s stewardship of the economy, is spending two days this week campaigning on the theme that the economy is purring. “No question that a strong economy is going to help our candidates,” Mr. Bush said in a CNBC interview yesterday, “primarily because they have got something to run on, they can say our economy’s good because I voted for tax relief.”

But Republican candidates do not seem to be getting any traction from the glowing economic statistics with midterm elections just two weeks away...

We'd suggest that this is because the statistics, like GDP, are not actually glowing; in fact, they're barely emitting enough light to check your watch by. Even fantastic headline numbers, like 4.6% unemployment, disguise weak wage growth and sagging labour force participation. Perhaps even more problematically for the Republicans, what growth there is isn't being felt by the average voter. Companies are increasing compensation--but they're spending it on benefits like health insurance, which doesn't feel the same as a wage increase even if you're one of the unlucky few who gets a $100,000 cancer treatment out of it. And income growth is concentrated among the wealthy, who are too few to swing an election...

Gork!

The BEA says:

GDP (Third Quarter 2006 (advance)): 1.6% [per year]

The odds of the Fed's cutting interest rates soon just went up.

More to follow...

The Soft Bigotry of Low Expectations

The soft bigotry of low expectations. Kevin Drum is excited at a Washington Post

The Washington Monthly: SLEAZY ADVERTISING....Michael Grunwald writes an honest piece today in the Washington Post about the wildly negative campaigning going on in the Republican camp this election cycle. He briefly suggests that "some Democrats are playing rough, too" -- and provides a couple of examples -- but immediately acknowledges that virtually all Democratic ads have focused on policies and performance. Not so on the other side:

The result has been a carnival of ugly, especially on the GOP side, where operatives are trying to counter what polls show is a hostile political environment by casting opponents as fatally flawed characters. The National Republican Campaign Committee is spending more than 90 percent of its advertising budget on negative ads, according to GOP operatives, and the rest of the party seems to be following suit.

See? It's not so hard to simply report the facts, is it?

Very sad.

Mark Spiegel: Did Quantitative Easing by the Bank of Japan Work?

Mark Thoma sends us to Mark Spiegel on the channels of monetary policy:

Economist's View: FRBSF: Did Quantitative Easing by the Bank of Japan Work?: The San Francisco Fed has an Economic Letter assessing of the Bank of Japan's policy of quantitative easing from 2001 to 2006. Here's the introduction and conclusion to the study:

Did Quantitative Easing by the Bank of Japan "Work"?, by Mark M. Spiegel Vice, FRBSF Economic Letter: On March 19, 2001, the Bank of Japan (BOJ) embarked on an unprecedented monetary policy experiment, commonly referred to as "quantitative easing," in an attempt to stimulate the nation's stagnant economy.

Under this policy, the BOJ increased its target for "current account balances" of commercial banks at the BOJ far in excess of their required reserve levels. This had the expected impact of reducing the already low overnight call rate (which is roughly equivalent to ... the federal funds rate) effectively to zero. In addition, the BOJ committed to maintain the policy until the core consumer price index registered "stably" a 0% or a positive increase year on year. The policy was lifted five years later, in March 2006. At the launch of the program, many were skeptical that it would have any impact on the real economy, as overnight interest rates were already close to zero, so flooding Japanese commercial banks with excess reserves would only amount to a swap of two assets with close to zero yields.

Now that the program has been lifted, several studies have attempted to assess its impact through a number of channels. These include a direct effect of increases in current account balances, an impact on the expectations of market participants, increased central bank purchases of long-term Japanese government bonds (JGBs) that would reduce long-term interest rates, and an encouragement of greater risk-tolerance in the Japanese financial system....

Conclusion: The results ... are just now making their way into the literature, but several patterns already have emerged. First, the primary evidence for the real effects of quantitative easing appears to be associated with ... some measurable declines in longer-term interest rates. These have been associated with both changes in agents' expectations of future interest rate levels and with purchases of "nonstandard" assets, such as longer-term JGBs. As these policies often occurred simultaneously, it is difficult to discriminate between the two. Second, there appears to be evidence that the program aided weaker Japanese banks and generally encouraged greater risk-tolerance in the Japanese financial system.

While these outcomes appear to be consistent with the intentions of the program, the magnitudes of these impacts are still very uncertain. Moreover, in strengthening the performance of the weakest Japanese banks, quantitative easing may have had the undesired impact of delaying structural reform...

The idea that direct injections of liquidity into the economy may work to stimulate spending even without having effects on interest rates is an old one, and one that I have always viewed with skepticism. Somebody's behavior has to be changing in order for spending to go up. And it is hard to see how behavior can change without changing some financial market prices and interest rates somehow, somewhere.

Daniel Gross on Dow 12000

Mark Thoma watches as journamalism in the interest of reprinting Republican talking points drives Daniel Gross into shrill unholy madness:

Economist's View: The Real Dow 12,000 Story: Daniel Gross on a new Republican talking point, "Dow 12,000":

How Now, Grown Dow?.... The Dow Jones industrial average first closed above 12,000 on Oct. 19, and has remained above that lofty benchmark ever since.... Dow 12,000 quickly became a Republican talking point.... So far, Republican candidates don't seem to be benefiting from the Dow record, which is less surprising than it seems. For starters, the Dow's success does not mean that stock-market investors in general are thriving, because the Dow... as an overall stock-market proxy and investment tool, it's an also-ran.... The S&P 500... is a much more accurate gauge.... [T]he claim that "the stock market" is at an all-time high simply doesn't match most investors' experiences.... 12,000 doesn't really even represent a record high for the Dow.... In real terms, the Dow is still nowhere near the peak it hit several years ago....

[S]ome of those who are trumpeting the high nominal value of the stock market are urging people to focus on the real, inflation-adjusted value of another asset that has been at record highs recently. Take a gander at George Will's absurd column last week.... Will celebrates the record nominal high in stock prices but urges readers to focus on the real price of oil. By mixing and matching real and nominal, Will could just as easily have argued that oil is more expensive than it has ever been, while the Dow is barely at the level it reached in 1999. If Democrats controlled the levers of power, he'd be making precisely that argument...

DELIVER US FROM EVIL

>[DELIVER US FROM EVIL](http://sfgate.com/eguide/arts/movies-55474.html): Deliver Us From Evil Documentary, 01:41 minutes, Rated NR This spellbinding documentary about a notorious pedophile priest deserves to be in the running for an Oscar. Filmmaker Amy Berg makes a strong case for a cover-up of Father Oliver O’Grady’s heinous acts by the Roman Catholic hierarchy in California. When she catches up with him in Ireland, where he was deported after his conviction for sexual abuse, he’s leading the life of Riley. He seems eerily removed from his wrongdoings, as if he were an actor playing a pedophile. -- R. Stein, SF Chronicle San Francisco County Lumiere [buy tickets] 2:00 - 4:30 - 7:00 - 9:35 Alameda County Shattuck Cinemas [buy tickets] 1:40 - 4:05 - 6:30 - 9:00 >[THE DEPARTED](http://sfgate.com/eguide/arts/movies-54582.html): The Departed Action/Adventure, 02:30 minutes, Rated R Full Review This is Martin Scorsese’s most enjoyable film in years, and his first in 15 years that isn’t a failed attempt at a masterpiece, but rather a fabulously successful attempt at a good movie. Matt Damon is a police mole, working for a gangster (Jack Nicholson), and Leonardo DiCaprio is a spy working for the police from within the gangster’s crew, in this complicated, irresistible and always entertaining picture. -- M. LaSalle, SF Chronicle >[THE LAST KING OF SCOTLAND](http://sfgate.com/eguide/arts/movies-52657.html): >[THE DEPARTED](http://sfgate.com/eguide/arts/movies-54582.html): The Last King of Scotland Drama, 02:03 minutes, Rated R Full Review An immediate contender for Oscar consideration and a spot on critics’ top 10 list, this startlingly original drama imagines a fictional relationship between Ugandan dictator Idi Amin and a young Scottish physician who becomes one of his closest confidants. Forest Whitaker gives the performance of his career as the strongman, playing him as a charming seducer who only occasionally shows sides of the madman within. James McAvoy is the doctor who finds the lure of power irresistible. >[THE SCIENCE OF SLEEP](http://sfgate.com/eguide/arts/movies-52867.html): The Science of Sleep Drama, 01:45 minutes, Rated R Full Review Flying solo for the first time as a screenwriter, French director Michel Gondry proves he has more of a sense of humor than was evident in “Human Nature” and “Eternal Sunshine of the Spotless Mind.” Gael García Bernal is both funny and edgy as an aspiring graphic artist in Paris who has trouble distinguishing between his dreams and waking life. This becomes particularly problematic when he falls for his neighbor, played by Charlotte Gainsbourg. The best way to enjoy this mind-bender is to not try to make sense of it. Just let it wash over you. -- R. Stein, SF Chronicle >[TIM BURTON'S THE NIGHTMARE BEFORE CHRISTMAS IN DISNEY DIGITAL 3D](http://sfgate.com/eguide/arts/movies-55487.html): Tim Burton's The Nightmare Before Christmas in Disney Digital 3D Animation, 01:16 minutes, Rated PG

Thursday, October 26, 2006

Oil is Rather Expensive

Brad Setser is skeptical:

RGE - Not so big worries for big oil -- even at $60 a barrel, oil is rather expensive: I would be the first to concede that $60 isn't $80. Or even $70, the average price for oil (at least the good sweet light easy to refine stuff) in the second and third quarter. US consumers - at least those in those parts of the income distribution that haven't seen big rises in their nominal-let-alone real wages -- were starting to feel really squeezed with oil at $80. Now, they can afford to fill up their tank and still buy at least a few things at the local Walmart.

But the premise behind Chip Cummins' A2 Wall Street Journal article still seemed a bit off. If you invested in a lot of oil fields that were expected to be profitable if oil averaged $20 a barrel, you will certainly make more money if oil is at $80 -- or even $70 -- than if oil is at $60. But I am pretty sure that you will be making money even if oil is hovering around $60 a barrel.

Equity markets are not my thing. But given the change in the trajectory of oil prices, I cannot imagine that anyone holding an oil companies' stock would expect oil companies to be able to sustain the kind of revenue growth they enjoyed when oil was steadily climbing up now that oil is falling. So, unlike Cummins, I would hardly define a slowdown in oil profits as a "big problem":

"With crude prices falling and oil-field costs on the rise, major oil companies have a big problem: sustaining their phenomenal profit growth."

Oil companies should make less money in q4 than in q3. So what? They will still be making a ton of money.... [I]f someone had told me two years ago that oil at $60 would be widely considered a positive for the US economy (and a negative for oil companies), I wouldn't have believed them.

Then again, if someone had told me two years ago that China could double its reserves, only partially sterilize the resulting reserve increase and still have (CPI) inflation of less than 2%, I wouldn't have believed them either...

Facing the Future with (at least) One Hand Tied

Menzie Chinn thinks about the Federal Reserve's position:

Econbrowser: The U.S. Macroeconomy: Facing the Future with (at least) One Hand Tied: What about monetary policy? It is an economic truism that you cannot hit two separate target variables with one instrument. With fiscal policy hamstrung, monetary policy needs to make tradeoffs in order to hit inflation and output targets. If energy prices continue their slide, it may be that monetary policymakers will have the leeway to drop the Fed Funds rate. But if, for instance, energy prices do not continue their fall, or a decline in the dollar's value leads to a rise in import prices, then the Fed will be forced to choose between inflation stabilization and output stabilization. With Ben Bernanke at the helm, I think I know on which side he would err.

In fact, the choice may be more painful than what I have suggested in this scenario. In the wake of the dot-com collapse, monetary policy was successful in spurring economic recovery by encouraging a massive boom in residential investment. With the stock of housing at the end of last year 45% larger than it was at the end of 2001, it is not clear that a repeat performance is possible.

What I see as one possibility for monetary policy to work is by way of facilitating the shift of labor and capital to the export and import-competing sectors (mostly manufacturing, and some services). Expansionary monetary policy could accelerate the dollar's decline, and lower interest rates might result in stimulating higher investment in plant and equipment in those sectors so that we avoid a recession. How a sharp descent in the dollar will affect economies abroad remains an open question.

Now, several studies have documented the fact that in the past, large current account imbalances in industrial countries have usually been unwound with few serious consequences to either output or asset prices. But I have to stress, these are uncharted territory. The textbook model I laid out above may not apply this time around. By virtue of the fiscal and monetary policies of the last five years, the U.S. is ever more dependent on foreign capital inflows to determine interest rates; and indeed the United States is as dependent as it has ever been (at least in the post-War era) on foreign official or quasi-state -- not private investor -- financing. How all the ties binding the world's single largest economy will be unwound is something nobody can be certain of. What we can be certain of is that the choices made by policy makers in the past five years have circumscribed our ability to manage a downturn.

Andrew Samwick Posts More on Executive Compensation

Andrew Samwick agrees with me. Smart guy:

Vox Baby: More on Executive Compensation: Mark Thoma and Brad DeLong have picked up the theme of this earlier post on executive compensation. Brad makes three points:

First, at-the-money options do not make CEOs "long" their company as much as long the volatility of their company. It's clear that direct ownership of stock--ideally, restricted stock--is a better mechanism for aligning managers' interests with shareholders.

I agree with Brad's conclusion--restricted stock is a better method of aligning the interests of managers and shareholders.

Second, when I looked at the data I thought I saw an important difference between entrepreneurial-CEO-owners (like Bill Gates, with stock) and manager-CEO-nonowners (with options). I think there is an important difference.

True as well--there is an important difference. My point in the original post is that there are very few examples one can find in which, through options, manager-CEO-nonowners accumulated ownership stakes that were large enough so that their compensation was meaningfully different from what Jensen and Murphy were describing in the data. My issue with Krugman's column was that he was implicating J&M in the option mess--I don't think that's warranted.

Third, we do have a big organizational problem here. We need diversity of ownership--both to raise capital on the scale required for modern business organizations and to spread risk. But once you have diversified ownership, monitoring and supervising managers becomes a public good from the shareholders' perspective, and it is very hard to get market or market-like or indeed voting political mechanisms to adequately supply public goods: the difficulties of collective action by dispersed owners of corporations has been one of the institutional flaws of modern capitalism for more than a century.

The fear today is that mechanisms of corporate control and governance that used to constrain the ability of top managers to raid the corporation have broken down even more than in the past. Why and how much and indeed whether this is true is a very hard question. To say that "corporate boards are failing" to do their job is true, but leaves the questions of why they are failing and whether they are failing any more than in the past unanswered.

True again. The problems resulting from the separation of ownership and control in large corporations are the central problem in corporate finance. I did not intend to raise the two questions posed at the end of Brad's post but only to assert that corporate boards are the last line of defense against problems of corporate governance. If the recent use of options is perceived as abusive, hold the Boards that were complicit or clueless to account.

Why Oh Why Can't We Have a Better Press Corps? (Yet Another Washington Post Edition)

Yes, it's Sebastian Mallaby being an idiot once again:

A Nadir of U.S. Power - washingtonpost.com: By Sebastian Mallaby: It's not exactly morning in America. In Iraq, things get ever uglier, and the old remedy of extra troops now seems tragically futile. The Bush team has recently tried putting thousands of additional soldiers into Baghdad, and the result after two months is that violence there has increased. Iraq is often seen as a special Rumsfeldian screw-up. But in Afghanistan, the Bush team quickly handed off to a model pro-Western leader backed by a broad NATO coalition. And what are the results there? The government is wobbling, warlords run drugs and the pro-al-Qaeda Taliban have 4,000 to 5,000 active fighters in the country.

It's not just military efforts that are faltering. Five years ago, President Bush launched an experiment in tough-talk diplomacy....

But traditional diplomacy is faring no better. In North Korea and Iran, the United States has tried every diplomatic trick to prevent nuclear proliferation, making common cause with Western Europe, Russia, China and Japan, and wielding both sticks and carrots. The result is failure: North Korea has tested a nuke and Iran still presses on with its enrichment program...

Ummm. No. Whatever you call what the Bush administration's policies, they have not tried "traditional diplomacy."

Mallaby continues:

Every honest politician knows that we need to quit gobbling carbon. But higher gas taxes are seen as a political non-starter on both sides of the political spectrum...

Seen as a non-starter by Al Gore?

And there is more:

[T]he right and left are pushing policies that are marginal to the country's problems. The right wants to make its tax cuts "permanent," even though the boomers' retirement ensures that taxes will have to go up. The left wants to raise the minimum wage, even though this can only help a minority of workers...

So only policies that help everyone are admissible?

Matthew Yglesias / proudly eponymous since 2002

Matthew Yglesias / proudly eponymous since 2002: VDH on the Brain: America's worst Thucydides scholar takes on twentieth century history:

I thought these who advocated such nonsense might at any second suggest that because Mussolini's fascists, Hitler's Nazis, and Tojo's militarists all had quite different agendas, separate racial ideologies, and particular aims in WWII, then, they could hardly be lumped together as the Axis that threatened Western republics and needed a generic anti-fascist response. All during the Vietnam War, we were lectured daily about the intricacies of Vietnamese, Russian, and Chinese Communists -- their rivalries, hatreds, and quite separate aims-as they combined to defeat the United States, and trumped their own tensions with an all-encompassing hatred of Western democratic capitalism.

Now then. Germany and Italy formed a formal military alliance and Germany and Japan had a looser, but similar arrangement. Nobody was "lumping" them together, they were actual allies. Meanwhile, this view of Vietnam is bizarre. The distinction-drawers were completely correct. Where Communist parties were seen as alien impositions of Moscow (Warsaw, Prague, Kabul, Budapest) you had one dynamic, but where they had authentic roots in local nationalism (as in, say, Vietnam) the situation was very different. Nixon seized advantage of the Sino-Soviet split to greatly enhance America's strategic situation. Does Hanson really deny this? How stupid is he?

CEO Compensation

Andrew Samwick wrestles with the problems of CEO compensation and with Paul Krugman:

Vox Baby: Mixed Reviews for Krugman Today: In "Incentives for the Dead" (reposted by Mark Thoma for those of you without TimesSelect), Paul Krugman addresses the social and economic aspects of option backdating and repricing. He gets some things right--this is accounting fraud, it is also tax evasion, and the perpetrators should be prosecuted fully. But he gets some of the economic aspects wrong. Consider:

[W]e need to go back to the original ideological justification for giant executive paychecks.In the 1960's... C.E.O.'s of the largest firms were paid... about 40 times as much as the average worker. But executives wanted more -- and professors at business schools provided a theory... a chief executive who expects to receive the same salary if his company is highly profitable that he will receive if it just muddles along won't be willing to take risks and make hard decisions. "Corporate America," declared an influential 1990 article by Michael Jensen of the Harvard Business School and Kevin Murphy of the University of Southern California, "pays its most important leaders like bureaucrats. Is it any wonder then that so many C.E.O.'s act like bureaucrats?"

Jensen and Murphy's article... provides a theory to justify higher pay-performance sensitivities....[O]bviously, nothing in Jensen and Murphy's paper justifies backdating or repricing--quite the contrary.

Krugman continues:

The claim, then, was that executives had to be given more of a stake in their companies' success. And so corporate boards began giving C.E.O.'s lots of stock options -- the right to purchase a share of the company's stocks at a fixed price, usually the market price on the day the option was issued. If the stock went up, these options would pay off.... [E]xecutives would have the incentive to do whatever it took to push the stock price up. In the 1990's, executive stock options proliferated -- and executive pay soared, rising to 367 times the average worker's pay by the early years of this decade. But the truth was that in many -- perhaps most -- cases, executive pay still had little to do with performance. For one thing, the great bull market of the 1990's meant that even companies that didn't do especially well saw their stock prices rise.

The last sentence continues to be something of a mystery in the economics literature--why don't we see more relative performance evaluation? Fair enough.... But the statement just prior to it is extremely misleading.... [T]he data suggest a more limited role for options in generating large pay-performance sensitivities.... Among CEOs, the median incentives received from options are roughly the same as the median incentives received from direct holdings of stock.... I think Krugman is overstating the link between Jensen and Murphy's paper--or any economic theory--and the particular way that options have been used in compensation contracts....

So my revision of Krugman's argument, at least as it pertains to the economics, is... that there was too little bait on the hook to begin with.... CEOs have been pushing their boards of directors to grant them pay increases, the tax code and accounting regulations have favored options as the easiest and most advantageous way to do that, and corporate boards have acquiesced.

Ultimately, all problems of corporate governance derive from inadequate monitoring of the managers by the shareholders. Corporate boards are supposed to do this. Some are obviously failing.

Three comments:

First, at-the-money options do not make CEOs "long" their company as much as long the volatility of their company. It's clear that direct ownership of stock--ideally, restricted stock--is a better mechanism for aligning managers' interests with shareholders.

Second, when I looked at the data I thought I saw an important difference between entrepreneurial-CEO-owners (like Bill Gates, with stock) and manager-CEO-nonowners (with options). I think there is an important difference.

Third, we do have a big organizational problem here. We need diversity of ownership--both to raise capital on the scale required for modern business organizations and to spread risk. But once you have diversified ownership, monitoring and supervising managers becomes a public good from the shareholders' perspective, and it is very hard to get market or market-like or indeed voting political mechanisms to adequately supply public goods: the difficulties of collective action by dispersed owners of corporations has been one of the institutional flaws of modern capitalism for more than a century.

The fear today is that mechanisms of corporate control and governance that used to constrain the ability of top managers to raid the corporation have broken down even more than in the past. Why and how much and indeed whether this is true is a very hard question. To say that "corporate boards are failing" to do their job is true, but leaves the questions of why they are failing and whether they are failing any more than in the past unanswered.