Wonkapalooza

President Obama sat down to chat with Ezra Klein of Vox in what he jokingly described as a sort of Wonkapalooza. They discussed the intricacies of the Affordable Care Act derisively nicknamed "Obamacare" by his opponents. He makes a striking comment directed at Republicans: that if they can provide a better approach, he would gladly endorse it.

The interview was quite revealing in a number of ways. Pres. Obama's ability to distill very complex policy issues down to their core essence, and his candid assessments of what worked, what didn't work so well and why, and how things could be improved, was impressive. This could be the last time we hear from an articulate president for a while.

As I pick up this pen...

It was November 2008 when I first took up blogging in this space, right after Sen. Barrack Obama's election as America's 44th president.

How times have changed.

We now are witnessing the dawn of a new era in America, and the world undoubtedly.

The election of Donald J. Trump to succeed Mr. Obama heralds a new direction for America.

From an outward-looking, open, diverse, collaborative, and multilateralist polity, to one that would have an inward-looking, isolationist, and competitive/winner-take-all mentality.

It comes on the heels of the Brexit vote in the UK and the rise of far-right parties in Western Europe. 

Having taken a break from blogging in the past two years, I feel the need to start writing again.

Now more than ever, the need to find new, better ideas to deal with complex, long-standing problems is emerging.

Redistributing Wealth and the US Election

In their book Innovation Economy, authors Robert D Atkinson and Stephen J Ezell talk about the competing ideologies with regard to the tax system and wealth redistribution between the Democratic and Republican parties that were clearly debating points in this closely fought US presidential election of 2012. They say that

Washington economic politics has become a redistributionist battleground between ...the Right, seeking to funnel resources to their Main Street members (small business), and ... the Left, seeking to funnel resources to their Main Street members (low- and moderate-income Americans).

Behind this tussle between the Left and the Right in America is a fundamental question about what grows the economy. The Democrats using the arguments of John Maynard Keynesian essentially believe that growth occurs by supporting demand from the middle class. The Republicans borrowing from the thinking of Robert Mundell and Arthur Laffer and supported by Milton Friedman believe that growth comes by supporting the supply side of the economy through entrepreneurs and small business.

Atkinson who also wrote the book Supply-side Follies has been arguing that this debate is the wrong one to have. Borrowing from the ideas of Joseph Shumpeter, Douglass North and Mancur Olson, he believes that the reason why the US economy has stagnated in recent years has been because of existing policy failures to encourage investments in technology and innovation.

Over time, he believes the US tax system has diminished the incentives for innovative activity. The problem was created by economic advisers of both parties who advocate for flatter tax rates with a broader base. In line with this, broad based tax cuts have been offered to corporations and small business owners in exchange for disallowing tax deductions for productivity enhancing measures.

As a result, much of the tax cuts aimed at the top income bracket have been wasted on businesses that don't trade with the rest of the world or invest in productivity enhancing innovation. Rather than squander these tax cuts on the wealthy, it would be better spent targeting future wealth-creators. This includes entrepreneurs that are forced to innovate in order to remain internationally competitive as well as universities and research institutions that prepare scientists and engineers to become innovators.

This targeted approach for spurring innovation through tax policy is what is missing from the current debate which has focused more on the justification for auto bailouts, renewable energy companies, and the loosening of business regulation. Not a lot of attention has been devoted to what really drives growth in the economy, structural as opposed to cyclical growth. And that is perhaps why the race is so dead even.

Prepare to be nudged

Improvements to the “magic of the market” formula for maximising societal welfare involve intelligent “choice architecture” to address human frailties

According to Franklin Foer and Noam Scheiber, a new theory of state is in its embryos. In a piece for The New Republic they state that

Obama has set out to synthesize the New Democratic faith in the utility of markets with the Old Democratic emphasis on reducing inequality. (Nudge-ocracy: Barack Obama's new theory of the state, May 06, 2009)

They trace the genealogy of this new theory from the 70s with the disilllusionment of the “Old Democrat” establishment figure Charles Schultze with the command and control apparatus of the New Deal/New Society to the reinvention of government and pro-market stances of the “New Democrats” led by David Osborne and Bob Rubin to the current one unfolding. They say

…there is…certainly a sensibility that reigns in Obamaland. Perhaps the easiest place to see it is in the administration's fondness for behavioral economics, the branch of the dismal science that recognizes that humans aren't utility-maximizing utomatons, but flawed creatures who often screw up simple calculations and struggle with self-control. The key behavioral insight is that the way we frame choices matters enormously.

Much of this ethos finds its inspiration from Nudge, a book by his former colleagues at the University of Chicago Richard Thaler and Cass Sunstein (the latter was appointed to head up a regulatory review directorate in the influential Office of Management and Budget).

Foer and Sheiber dissect key decisions of the first 100 days of Obama in office over policies ranging from the banking and housing rescue plans to healthcare, education and the environment in which a preference for market mechanisms to state intervention has been evident to the chagrin of Old Democrats who prefer robust intervention. This is a brief synthesis:

1. where Keynesians like Paul Krugman would have preferred nationalising the banks, Tim Geithner and Larry Summers offered incentives and “nudges” to entice public private partnering to help determine the price of toxic assets,


2. where forcibly rewriting home loan contracts would have been more direct, subsidies were offered to creditors to provide easier terms to borrowers most at risk of default,


3. where the unions preferred beefing up public health and education systems, public options involving competition from private providers were enshrined as a way forward,


4. where environmentalists would have preferred picking winners, a cap and trade system was espoused.

The intent of these policies is not to do away with market mechanisms, but rather to correct for human frailties by offering incentives a.k.a. “nudges” to prompt individuals in the right direction. Foer and Scheiber state that

(i)n the grand scheme of things, these "nudges" were minor tweaks designed to elicit more rational behavior … Not all of Obama's nudges fall out of behavioral economics, per se. Some involve changing incentives to encourage certain activities and discourage others. Some involve fostering competition to trigger innovation. But, as in the behavioral examples, the Obamanauts typically have an outcome they want to promote. And, like the behaviorists, they instinctively recoil from imposing it unilaterally. So, instead, they monkey around with the choices people face, seeking to influence decision-making rather than mandate decisions.

Of Voter’s Regret and Animal Spirits

Against the counsel of his “better angels” (the moderate Democrats in Congress) President Obama this week unveiled yet another blueprint for dealing with a section of the economy, amidst growing concerns that his agenda is getting overly ambitious under these difficult economic times. Here is just a sample of the views from various personalities:

David Brooks, columnist, moderate Republican: “…I fear that in trying to do everything at once, it (the Obama administration) will do nothing well.” (The Big Test, The New York Times, February 24, 2009)

Paul Krugman, Nobel Laureate, economist: “The Obama administration’s economic policy is already falling behind the curve, and there’s a real, growing danger that it will never catch up.” (Behind the Curve in Conscience of a Liberal, New York Times, March 9, 2009)

Warren Buffett, the “Oracle of Omaha”, investment guru: “we’ve had muddled messages (referring to government response to the crisis).” (Interviewed on Squawk Box, CNBC, March 10, 2009)

Andy Grove, Stanford professor, former Intel CEO: “I find myself wringing my hands, not over the goals President Obama has set but over the ineffectual ways the administration has pursued them.” (Mr. President, time to rein in the chaos, The Washington Post, March 11, 2009)

George F Will Op-ed columnist: “The president's confidence in his capacities is undermining confidence in his judgment.” (Paved with Magnificent Intentions, Washington Post, March 12, 2009)

An "Animal Spirits" Revival

With all this talk of a crisis in confidence, the release of Georg Akerlof and Robert Schiller's book, Animal Spirits: How Human Psychology Drives the Economy, and Why It Matters for Global Capitalism which they commenced writing in 2003, could not be more timely. Akerlof of “The Market for Lemons” fame made the term “asymmetries of information” popular in public economics parlance. Schiller co-developed the Case-Schiller Index, a gauge for the US housing market relied on for setting options and futures prices. In the book, they tackle the role that ideas, trust and sentiment play in the economy. It could be considered a reappraisal of the term made use of by Keynes.

The chief of OMB (the Office of Management and Budget), Peter Orszag, one of Obama's so-called "propeller heads" in the White House is reportedly getting himself engrossed with it.

The Bumpy Ride Has Arrived

This week marked another “defining moment” in Australia as the latest unemployment figures showed a steeper incline than expected. In the forecast made previously here back in November of 2008, we said that unemployment could reach 6 per cent by May of this year. The recently released data saw it jump from 4.8 in January to 5.2 in February (analysts were expecting it to hit just 5). The continuing fall of skilled and general vacancies suggests that we have truly entered into a bleak season.

Should this supply policymakers with a “teachable moment” that enables them to consider differing views on how to proceed from here on out? Again, here is just a pair of quotes from the week:

Tony Makin, Professor of Economics, Griffith University (formerly with the IMF): “Federal fiscal packages unveiled since October last year have aimed to boost consumption in the short term, in keeping with Treasury advice at the outset that the best fiscal response to the global financial crisis was to 'go early, go hard, go households'. However, an arguably sounder fiscal response would have been the exact opposite: go later, go easy, go firms.” (Follow the Kiwi Leader, not Obama, The Australian, March 11, 2009)

Michael Costa, former treasurer, NSW Government: “Confidence building may turn out to be the only effective role for government in directly responding to today's economic conditions.” (Hubris and vaudeville but little sound policy, The Australian, March 13, 2009)

Smart Intervention

With the conclusion of the American electoral cycle conducted amidst one of the most severe economic storms the globe has seen since the Great Depression, many are suggesting that the repudiation of the GOP at the polls in both the presidential and congressional races means that the era of bigger government intervention is back.

It was a combination of imprudent deregulation of financial markets on the one hand coupled with unwarranted government intervention in the housing market on the other that led to the collapse of such Wall Street icons as Lehman Brothers placing great clouds of uncertainty over the major economies of the world.

The most tired bit of analysis floating around with the ascension of the Democrats in Washington is that a new dawn has come heralding the end of economic fundamentalism (a term used by Warren Buffet), the neoliberal agenda with the ‘magic of the markets’ at its core. The economic philosophy espoused by Reagan and Thatcher has been the cornerstone of fiscal and economic policies of both Conservative and New Democrat/New Labor governments over the last thirty odd years. It is time to dust up John Maynard Keynes and consign Milton Friedman back into storage, so they say.

Joseph Stiglitz, a Nobel Prize recipient in economics for his work on the 'economics of information', former Chief Economist of the World Bank and former Chairman of the Council of Economic Advisors under Pres. Bill Clinton, has rightly pointed to the laxity of financial regulation in credit and derivatives markets under the Bush White House, coupled with monetary easing by the Federal Reserve in response to the post-911 and dot com collapse in the early part of the decade as foundations for the present sub-prime mortgage crisis.

This is only half the picture, which deflects a fair share of the blame that should be laid at the feet of the Democrats. The other half comes from the unintended consequences of well-meaning government policies in the housing market ratcheted up significantly by the Clinton administration but initiated as far back in Carter’s to promote greater home ownership by mandating the Federally-supported Fannie Mae and Freddie Mac to allocate a greater share of their lending to lower income groups, the so-called ninjas (no income, no job, and no assets).

The home mortgage meltdown was made up of two failures: a false-negative on the one hand (government failing to act when it should have) and a false-positive on the other (government acting when it should not have). This was a calamity caused not for a lack of public intervention, but by the inappropriate (non-)use of it.


Of course, in the heat of the campaign, a smart candidate like Barack Obama who has reportedly read his fellow University of Chicago professors’, Thaler and Sunstein’s book, Nudge (Yale, April 2008- see left) on this very issue (just as British Opposition Leader, David Cameron has) probably believes that government’s role is not necessarily to mandate things to individuals, but to ensure that they are primed to make intelligent choices, knew that to pose such a nuanced stance would only be self-defeating.

Yet, in his advocacy of tort reform as well as in his healthcare policy which had been opposed by constituents of his own party, trial lawyers in the case of the former, and rival Hillary Clinton in the case of the latter (for being too libertarian) he demonstrated the essence of what is being termed the ‘real third way’, paternal libertarianism: not quite the Keynesian model; one might think of it as the Chicago School of Law and Economics. This new school of thought is in essence a heterodox economic paradigm sprouting from the discoveries made in the budding fields of behavioral and neural economics.

By conducting experiments and studying the mental processes involved in decision-making, this new branch of economics has demonstrated how even highly rational individuals make foolish moves when facing complex, unfamiliar terrain. It demonstrates how our minds often get tricked by the manner in which problems are presented to us.

In order to optimize social benefits in these circumstances, it is not sufficient for policies to merely maximize choice by increasing competition through deregulation. Governments also need to ensure that choices made by consumers are more likely to serve their interests by creating regular feedback mechanisms with which they can evaluate their choices vis-à-vis other options in a timely fashion. This would counteract the inertia of sticking to a current yet less beneficial position or being swayed unnecessarily by the mentality of the herd into making a foolish one.

When laid out in plain English, as Obama did by calling it a policy based on common sense, he contrasted it with the prevailing dogma of neoliberalism. This presented a perfect counterfoil to the seeming blind adherence of the incumbent party to unbridled free markets as a way to allocate resources optimally in society. This soothed the wounded psyche suffered by the American electorate under the current adverse economic climate and appealed to their characteristic sense of pragmatism.

In contrast to the prognostics of most analysts appearing in the news media, the new dispensation is not necessarily going to mean greater intervention by the collective in the sphere of the individual, but smarter intervention. These sorts of intervention do not set out to limit choice, but are designed with better “choice architecture” in which options can be posed in a manner that intelligently spots and corrects for natural, irrational biases present in most humans (read: homo sapiens, not homo economicus).

Of course it remains to be seen whether this new principle can be put into practice by the incoming administration amid the euphoria and stratospheric expectations raised by ambivalent promises made during the campaign, but the kernel of a new idea has been planted, and given time its diffusion is going to be inevitable.