Peak Oil

Peak Oil is the theory that the world has already used (or soon will) all the oil that we are endowed with. Michael Lynch debunks the theory in the NYTimes.

Like many Malthusian beliefs, peak oil theory has been promoted by a motivated group of scientists and laymen who base their conclusions on poor analyses of data and misinterpretations of technical material. But because the news media and prominent figures like James Schlesinger, a former secretary of energy, and the oilman T. Boone Pickens have taken peak oil seriously, the public is understandably alarmed.

A careful examination of the facts shows that most arguments about peak oil are based on anecdotal information, vague references and ignorance of how the oil industry goes about finding fields and extracting petroleum. And this has been demonstrated over and over again: the founder of the Association for the Study of Peak Oil first claimed in 1989 that the peak had already been reached, and Mr. Schlesinger argued a decade earlier that production was unlikely to ever go much higher.

There are two big problems with the theory. First, it ignores improvements in technology which lowers the cost of recovering oil that was previously thought uneconomic. Second, it ignores the effect of rising prices on the search for new oil.

Stimulus Again

Robert Frank has a nice article that disusses the impact of state balanced budget rules. These are leading to cuts that will offset the benefits of the stimulus package.

The more than $15 billion excised from California’s budget last month was just a small fraction of recently announced cuts. Although some people object to the federal stimulus program on grounds that government spending is inherently inefficient, most recent state cuts have been for services widely viewed as essential. These cuts were mandated by laws meant to stop politicians from spending beyond their means. While such measures may be beneficial on balance, sharply reduced government spending is exactly what the economy doesn’t need right now.

The problem is that these cuts are a negative stimulus program. The federal government ought to be transferring funds to states that maintain expenditure and do not raise taxes. But this is rational, so I doubt it will happen.

Government Death Panels

The argument that health care reform will create death panels is clearly pretty absurd. Health care is always rationed. Sometimes by price, sometimes in other ways. But what is totall absurd is to argue that the political branches will cut services for the voting public. The government cannot end Saturday postal delivery or cut routes of Amtrak.

Sometimes, the government is critical in extending care. This article in the Washington Post shows how Medicare was instrumental in extending dialysis treatment.

Population Distribution by Age

Calculated Risk has some really cool graphs that show the US population distribution by age group. There is also some useful health expenditure graphs.

Doctored Statistics

Argentina has been playing with its statistical data to produce inflation numbers that understate the true value, according to this article in the Washington Post:

Workers at the government's National Institute of Statistics call it crass manipulation: Their agency, under pressure from above, altered socioeconomic data to reflect numbers palatable to the presidency. Inflation and poverty miraculously dropped, they said in interviews, and the economy boomed.

At least officially.

"They just erased the real numbers," said Luciano Belforte, an 18-year veteran at the institute. "Reality did not matter."

The basic method was to cease including data on goods whose prices were rising too fast:

Statisticians, mathematicians and survey-takers who still work at the INDEC described how managers stopped surveying products that had recorded steep price hikes. "If something went up more than 15 percent, they'd take it off the list," said Marcela Almeida, a mathematician and one of several workers deposed by prosecutors.

Almeida said managers would obsess about certain products, such as bread, urging surveyors to come back to the INDEC office with prices that remained low. If they were not low enough, Almeida said, "the person who received their forms would change this price."

This reminds me of "hidden inflation" in the Soviet Union. Prices were centrally fixed. If costs went up enterprises were not allowed to raise prices. So they instead got their goods classified as new goods. These new goods were not included in the price indices, so inflation would remain non-existent under socialism. Thus the inflation was hidden (as opposed to repressed inflation which occurs when prices are controlled and excess demand spills over into the black markets.)

Meanwhile, the Soviet statistical compendiums would cease to report indices that made the economy look bad.

So Argentina learns by example. But it is interesting because it is a democracy. And because many debt payments the government makes depends on these statistics.

By underreporting inflation figures, economists say, Argentina is cheating investors of proper compensation on nearly $50 billion in debt benchmarked to inflation.

"The way these bonds work is that every month, or every six months, the principal adjusts for inflation," said Robert Shapiro, co-chair of the American Task Force Argentina, a Washington group lobbying for Argentina to pay its debt to American investors. "So if inflation is actually 30 percent, and they're only adjusting 10 percent, that's a huge loss."

This no doubt is going to have serious repercussions on capital flows.

British Health Care

My friend and colleague Mark Harrison has written an open letter to Americans about the British National Health Service. It is a very clear and carefully organized explanation responding to the hysteria we hear in the US.

Can this change the views of Americans who cannot figure out whether the Old Testament came before or after the New Testament? As Bill Maher notes:

I'm the bad guy for saying it's a stupid country, yet polls show that a majority of Americans cannot name a single branch of government, or explain what the Bill of Rights is. 24% could not name the country America fought in the Revolutionary War. More than two-thirds of Americans don't know what's in Roe v. Wade. Two-thirds don't know what the Food and Drug Administration does. Some of this stuff you should be able to pick up simply by being alive. You know, like the way the Slumdog kid knew about cricket.

Not here. Nearly half of Americans don't know that states have two senators and more than half can't name their congressman. And among Republican governors, only 30% got their wife's name right on the first try.

Sarah Palin says she would never apologize for America. Even though a Gallup poll says 18% of Americans think the sun revolves around the earth. No, they're not stupid. They're interplanetary mavericks. A third of Republicans believe Obama is not a citizen, and a third of Democrats believe that George Bush had prior knowledge of the 9/11 attacks, which is an absurd sentence because it contains the words "Bush" and "knowledge."

People bitch and moan about taxes and spending, but they have no idea what their government spends money on. The average voter thinks foreign aid consumes 24% of our federal budget. It's actually less than 1%. And don't even ask about cabinet members: seven in ten think Napolitano is a kind of three-flavored ice cream. And last election, a full one-third of voters forgot why they were in the booth, handed out their pants, and asked, "Do you have these in a relaxed-fit?"

And I haven't even brought up America's religious beliefs. But here's one fun fact you can take away: did you know only about half of Americans are aware that Judaism is an older religion than Christianity? That's right, half of America looks at books called the Old Testament and the New Testament and cannot figure out which one came first.

And these are the idiots we want to weigh in on the minutia of health care policy?

Public Option

Richard Thaler discusses the public option in health care and says most of what I would want to say.

Posner on Lucas

Posner has an excellent post rebutting Lucas's article in the Economist. It is particularly interesting for his rebuttal of Lucas's revisionist history.

Lucas says in his article in the Economist that the Federal Reserve saved the day by pumping cash into the banking system and persuading the Treasury Department to do likewise. He does not mention the other measures taken by government. He praises Ben Bernanke, the chairman of the Fed, for having "formulated contingency plans ready for use when unforeseeable shocks occurred." In fact the Fed had no contingency plans for the housing and stock market shocks that rocked the economy. Its response when the shocks hit with full force last September was prompt, but also improvised and spasmodic--hence the failure to bail out Lehman Brothers, a failure that deepened the financial crisis by seizing up the commercial paper market.

The more important criticism that Posner makes is that Lucas, and Fama, so discounted the likelihood of asset bubbles that they ignored the consequences that they could have. The leap from efficient markets to no bubbles is a big leap.

The reason for the surprise was that leading macroeconomists and financial economists had believed until last September that there could never be another depression, that asset bubbles are a myth, that a recession can be more or less effortlessly averted by the Fed's reducing the federal funds rate, that the international banking industry was robust, and that our huge national debt was nothing to worry about, nor our very low personal savings rate. All these beliefs have turned out to be mistaken, along with extreme versions of the rational expectations hypothesis, the efficient-markets theory, and real business cycle theory.

The whole post is worth reading, as is Posner's book, A Failure of Capitalism, which I will comment on soon.

Technology and Taxes

Gregory Clark writes that in the future the economic problem will be

the ineluctable increase in the number of people with no marketable skills, and technology's role not as the antidote to social conflict, but as its instigator.

Unlike the period between the start of the Industrial Revolution and the mid 1950's, the gains from technological progress no longer accrue to the unskilled. So the future will be one with sharper and sharper income differences. Perhaps we can accept this regarding restaurants and homes, Clark writes, but regarding health care it is politically unacceptable. The critical question is then:

So, how do we operate a society in which a large share of the population is socially needy but economically redundant? There is only one answer. You tax the winners -- those with the still uniquely human skills, and those owning the capital and land -- to provide for the losers.

The future will see higher taxes. The question is how to set them in a politically acceptable way.

The last great hope may be to design a more efficient tax system. .. A more efficient system would tax only where there is a need for some specific public good or a transfer to the poor.

Unfortunately, such measures are only stopgaps. In the end, we may be forced to learn to live in a United States where, by stealth, "from each according to his ability, to each according to his need" becomes the guiding principle of government -- or else confront growing, unattended poverty.

Efficient Markets Again

Paul Krugman reviews several books in the New York Times, especially Justin Fox's book, The Myth of the Rational Market. But I wonder if Krugman actually read his own article. He reviews the development of modern finance theory, and especially emphasizes efficient markets (EMH) and the capital asset pricing model, CAPM. He then argues that this is what created the financial crisis.

Wall Street bought the ideas of the efficient-market theorists, in many cases literally: professors were lavishly paid to design complex financial strategies. And these strategies played a crucial role in the catastrophe that has now overtaken the world economy.

Doesn't this seem strange? If Wall Street bought the ideas of the efficient markets hypothesis why would invest so much in complex trading strategies? If they believed CAPM, they would know that they could only earn more return by taking on more risk. Isn't it more correct to argue that they did not believe in the EMH and the CAPM?

P.S. Today, Falkenstein likes Krugmans review no more than I, and is much harsher.

French Health Care

An interesting article on French health care and the fiscal problems they are facing. The irony:

As Congress fights over whether America should be more like France, the French government is trying to borrow U.S. tactics.

And more irony:

Ironically, France is actually in the midst of shifting to a fee-for-service system for its state-run hospitals. The hope is that it will be easier for the government to track if the money is being spent efficiently, compared with the old system of simply giving hospitals an annual lump-sum payment.

Economics Attacked and Defended

Lord Robert Skidelsky attacks the dismal science in the Financial Times and Nobel Laureate Robert Lucas defends it in the Economist.

Skidelsky attacks economists for not predicting the financial crisis, an accusation that Lucas deals with pretty well. Skidelsky wants to rebuild economics, but his attack is based on faulty premises and misunderstandings of what economists do.

For example, according to Skidelsky economics assumes an environment in which

uncertainty disappears to be replaced by calculable risk. Shocks and mistakes may occur but these will cancel each other out, so that, on average, people get what they expect. An important implication of this view is that shares are always correctly priced. This is the basis of the so-called efficient market hypothesis that has dominated financial economics. It led bankers into blind faith in their mathematical forecasting models. It led governments and regulators to discount the possibility that financial markets could implode.

The Efficient Markets Hypothesis does not, however, predict that asset prices are always correct. Only, that all available public information is incorporated in them. This is very different from assuming the price is correct. It is possible to have rational bubbles in asset prices, and if Skidelsky looked at mainstream economics journals he would see plenty of articles analyzing them.

Skidelksy continues

The efficient market hypothesis is simply an application of the recently triumphant New Classical school, which preaches that a decentralised market system is always at full employment. In their obsession with getting government out of economic life, Chicago economists claimed that any consistent set of policies will be learnt and anticipated by a population, and will therefore be ineffective.

Is this just the creation of a straw man or complete ignorance of the last twenty years of macroeconomics? Very hard to tell. But even the most hard-line new classical economists never argued that the economy was at full employment at all times. Their argument was that systematic monetary policy could not permanently reduce unemployment below some natural rate consistent with frictions and structural change. And they certainly did not argue that tax policies could not change the level of unemployment. And the new classical types were only half of the profession anyway.

Skidelsky is making a straw man parody of the most hard-line new classical types and he even gets that wrong. In the last 20 years or so the differences between salt-water and fresh-water macro has decreased. Everybody deals with models with frictions and where policies can have effects.

This leads Skidelsky to the conclusion that economics must be rebuilt. His prescription sure goes opposite to where our profession is going:

Beyond this, the postgraduate study of macroeconomics might with advantage be separated from that of microeconomics. Courses in microeconomics should concern themselves, as at present, with the building and testing of models based on a narrow set of assumptions. Their field of applicability lies in those areas where we have reliable views of the future. Macroeconomics, though, is an essential part of the art of government, and should always be taught in conjunction with subjects bearing on this.

The obvious aim of such a reconstruction is to protect macroeconomics from the encroachment of the methods and habits of the mathematician. Only through some such broadening can we hope to provide a proper education for those whose usefulness to society will lie as much in their philosophical and political literacy as in their mathematical efficiency.

In the past I have sometimes thought that the obsession to provide microfoundations for macroeconomics may have gone too far. Perhaps there are some areas where it is better to build models with aggregates and worry about microfoundations later. But after reading Skidelsky's plea I think I will try to drive that thought from my mind. What would Skidelsky macroeconomists do?

Instead I am going to work out how to restructure postgraduate education in history.

Clunker Policy

Cars for Clunkers removes old cars from the road and replaces them with more efficient cars. This saves gasoline and thus means less CO2 emissions. But new cars are produced using CO2. So how much is saved? Obviously it depends on the net improvement in mileage and the amount driven. This article in Slate goes over the figures.

Assume that 250,000 cars have been replaced with an average fuel efficiency gain of 69% (about what happens if we replace a car with 16 mpg with one that gets 27 mpg). Further assume no net increase in miles driven (a big if) so that stays at 12,000 per year. Then these cars cut overall fuel consumption by about 76 million gallons a year and CO2 emissions by about 737,200 tons annually.

What about producing the new cars?

According to William Chameides, dean of Duke University's Nicholas School for the Environment, making a new car produces 3.5 to 12.4 tons of carbon dioxide, with an average of 6.7 tons per vehicle. The average new car would therefore need to save about 700 gallons of gas to offset the carbon costs of its manufacturing.

If we use the 6.7 ton figure for 250,000 cars we estimate about 1.7 million tons for the new cars. Thus it would take more than two years of driving to achieve any net savings.

How to assess the total cost of the program? Compare it to the cost of a ton of CO2 in the marketplace:

Was spending $1 billion a particularly cost-effective way to achieve those CO₂ reductions? Probably not. Assuming the above calculations are correct and that each consumer keeps his or her car for 10 years, then the total savings should be a little less than 5.7 million tons of carbon dioxide. That means each ton of carbon dioxide would be worth about $175.53 to the U.S. government. As the Washington Policy Center pointed out on its blog in June, a ton of CO₂ currently goes for about $17.50 on the European Climate Exchange.

I guess we can conclude that, however, successful an auto stimulus program this is, it is not much of an environmental winner.

Born Again Keynesians

Posner has an interesting post on his blog criticizing born-again Keynesians, like Paul Krugman for ignoring their Keynes. The point is that uncertainty causes businessmen to hoard, which reduces investment and prevents recovery. His point is that the Obama health care plan, which Krugman, endorses, will create more uncertainty.

Posner quotes Keynes:

Keynes warned President Roosevelt in an open letter of December 31, 1933, about trying to combine far-reaching reform with recovery from an economic depression. He wote that

even wise and necessary Reform may, in some respects, impede and complicate Recovery. For it will upset the confidence of the business world and weaken their existing motives to action, before you have had time to put other motives in their place...And it will confuse the thought and aim of yourself and your administration by giving you too much to think about all at once.

The passage that I have italicized deserves particular emphasis (though Keynes's warning that "it will confuse the thought and aim of yourself and your administration by giving you too much to think about all at once" is equally timely) because of the strange turn that the debate over health reform has taken in recent days.

Posner, if you read his book on Failure of Capitalism, is more of Keynesian than most liberal Keynesians.

Killer App for Clunkers

The Wall Street Journal reports on the boom in the market for sodium silicate, the chemical used to kill clunkers under the government's cash program. The chemical turns into liquid glass and solidifies all the moving parts of the car.

There seems to be a chorus line of support for this program (but for a good post, see here). But if you take 250,000 cars off the road who gets hurt? Must be the people who buy these cars, and they must be the poor. So if we take another 500,000 off (if the additional $2 billion is appropriated) then the price of used cars for the poorest households must rise. Hardly seems progressive to me.

Wouldn't it be better to give a subsidy for new car purchases financed by a gasoline tax? The latter deals with the environmental cost, the former is the subsidy to the auto industry which is the real intent of the program.

What happens when all the clunkers run out?