How does a recession end? The cliché story told about World War II is that there was exogenous sharp increase in demand and America’s factories went back to work to supply the needed war supplies.

In that case, the government sent clear signals concerning what it needed and in what quantity. In 2009’s recession, the signals are more murky. You don’t have to be a good game theorist to foresee a complicated signaling game. Each business, ranging from cars to banks, must ask itself; “what is the probability that we will get a government bailout? If we get one, how big will it be? Can we, and should we, take actions today to increase or at least not decrease the likelihood that we receive a government bailout/handout?”. So the "poison pill" defense in business is to hurt your business to make it less desirable as a takeover target, in this case I'm wondering whether a "poison pill" makes a firm more likely to receive a public bailout.

So in my "model", during a recession firms can engage in Keynesian government rent-seeking (seeking a bailout) or engage in productive re-organization. My claim is that many firms now believe that the former activity is more profitable than the second one and in aggregate this will hurt our economy's macro performance.


How would a business plan if it knew that the President was Milton Friedman and that he could credibly commit to bailout no one. In this case, during the 2009 recession the business would say to itself “we will sink or swim based on our own decisions”, such a firm would use the recession to reorganize and focus on future sectors of growth and perhaps even retool to get ready for the next boom.

These stark differences in the firm’s investment behavior crucially depend on the firm’s expectations of “who” is the government that it is playing a strategic game against.

While it is individually rational for each firm and at risk industry to sit still and act like a victim (each has an incentive to appear to be passive victims who do not control their destiny and to convey that innocent people will suffer if they are not protected ---- i.e their blue collar workers) as they await the Obama Team’s largess, in aggregate such actions prolong the recession as more time passes and real reorganization does not occur.

I have tried to read Keynes on several occasions. What I don’t see being discussed in the original text or by Paul Krugman is a clear statement concerning how diverse firms form expectations of the marginal benefits of hiring new workers and how such firms choose the capital stock such that the marginal benefit of hiring new workers (and retaining incumbent workers) remains high. After all, national employment rates will rise if labor demand increases. Implicitly, the Keynesian crew is arguing that a President who can engage in a massive “New Deal” can shift expectations and this will bring about new investment. This represents a massive “average treatment effect” of the form:

Expect Recession to Persist into 2011 = c + b*1(Engage in Big New Deal) + U

where 1() is the indicator function that equals one if a President starts an enormous public works campaign.

The empirical hypothesis is to test whether the coefficient "b" is less than zero.
Do Government stimulus programs shift expectations to raise hope and belief and reign in the crazed "animal spirits" such that prosperity will return?

It seems like behavioral economics (which started in micro-economics) now has merged again with macro-economics to give us a multiple equilibrium model such that the brave government is the only economic actor who can save us from dooming ourselves to chaos and revolution. This sounds a bit heroic to me.

I am arguing that the expectation of a “New Deal” may slow down and retard private investment, not due to crowding out due to higher interest rates, but due to rent seeking as industry seeks to look weak and needy.

In a world where firms recognize that investments in capital are sunk irreversible investments, facing uncertainty such firms always had an incentive to delay such investments. Now they have a second incentive to delay (namely hope for a bailout). In aggregate such choices add up.

Here is a blog I read; Glaeser on War

Dora Costa and I have a new book recently published by Princeton Press . The book focuses on the causes and consequences of social networks during the U.S Civil War. In the final chapter we discuss what is known about the "dark side" of social capital. Bernie Madoff represents an example of what we didn't talk about. In our chapter, we discuss examples such as the Ku Klux Klan and terrorist groups. Both groups are aided by the close social ties between their members.

What is my point about Bernie Madoff? The New York Times is running long articles making the point that because Bernie was jewish, lived in a nice part of New York City and attended the right social events and looked avuncular that rich jewish households trusted him and didn't ask any questions.

Trust crowds out investor effort as households didn't bother to ask the tough questions and do the basic "due diligence" before investing their $.

To repeat my point, suppose that New Yorkers don't like Republicans from Alaska --- based on Gary Becker's work on the economics of discrimination --- a Republican from Alaska would only be able to attract New Yorkers to invest in her funds if she did a fantastic job explaining every bit of her business plan; the burden of proof would be on her and she would need to be 150% above the bar for New Yorkers to invest in her.

In a world where effort is costly and people are lazy, we need less trust --- both trust in government bailouts (due to ex-post moral hazard) and ex-ante trust in the Madoffs in the world. In a dog eat dog world, each decision maker would need to do his own research before investing.

Are you a good data sleuth? here is a puzzle. Yes, California has a temperate climate that doesn't require much air conditioning but take a close look at this picture below. Note the "divergence big time" between California's per-capita electricity consumption relative to the rest of the nation. Who gets credit for this green progress? The de-industrialization of California? Effective energy policy? New capital investments by for profits minimizing expected PDV of electricity bills? All? Neither?




A new Stanford paper takes a look at this important issue. Jim Sweeney's Paper . Sudarshan and Sweeney give policy 20% of the credit. That appears to be smaller than the conventional wisdom.

Here is another picture that I like. I see the power of liberal ideology. From this graph you can't tell if this power is from a displacement effect such that energy intensive activity migrates away from these states or if environmentalist states are able to "treat" energy intensive activity to reduce its energy intensity.

My wife and I have owned a Los Angeles home for 6 months now. The UC is our lender. According to the paperwork we received today, at the rate that we are paying down our principal debt we will own this home outright in 100 years. I take a long term perspective. I don't believe that Bernie Madoff invested any of my money.

While the world looks to Washington for a bailout, I have my eyes set on San Francisco. The Annual Economics meetings are taking place in a city that I like. I don't attend the meetings when I don't like the city. It is true that for 90% of the nation's economists that a trip to SF is a production. But, it is a green city and it will be 55 degrees and foggy each day.

The Annual Meetings offer the opportunity to see old friends and to learn some economics. Dora will have the pleasure of participating in a lot of junior recruiting for UCLA. I will be talking and talking and talking and hanging out in the book area. Our Princeton Press book is now available and I'm hoping that Princeton will allow me to give them away for free.

While I am proud of this publishing success, I have also suffered great personal defeat. I was recently notified by the Association of Environmental and Resource Economists that I lost out to at least 2 candidates in a vote consisting of 4 candidates to be a Director of this Association. Like Ralph Nader, John Kerry, Al Gore, Jesse Jackson, McCain, I will have to live with this stinging defeat. I campaigned hard and spent roughly $40 million dollars in my attempt to win the election. Most of that money was spent on buying cable TV time where I read from my published papers. I also mailed out checks to voters who I thought were just at the margin of voting for me or not.

Fortunately, I can look forward to my winter 2009 Environmental Economics class where I will teach 140 students the joys of environmental economics. I hope that at least one of these talented young students can achieve what I could not. What textbook do I use for my course? Here is the whole thing .

More environmental economists should follow Scott Barrett's lead and work on the social science of geoengineering. Here is Scott's paper . What can economists add to this "science stuff"? We have studied choice under uncertainty and this appears to be classic example. You can talk about Knightian Uncertainty but the analysis will quickly return to what Marty Weitzman discusses here .

No quick or easy technological fix for climate change, researchers say

UCLA scientist sees many geoengineering plans as 'preposterous'


Stuart Wolpert, swolpert@support.ucla.edu


Global warming, some have argued, can be reversed with a large-scale "geoengineering" fix, such as having a giant blimp spray liquefied sulfur dioxide in the stratosphere or building tens of millions of chemical filter systems in the atmosphere to filter out carbon dioxide.


But Richard Turco, a professor in the UCLA Department of Atmospheric and Oceanic Sciences and a member and founding director of UCLA's Institute of the Environment, sees no evidence that such technological alterations of the climate system would be as quick or easy as their proponents claim and says many of them wouldn't work at all.

Turco will present his new research on geoengineering — conducted with colleague Fangqun Yu, a research professor at the State University of New York–Albany's atmospheric sciences research center — today and Thursday at the American Geophysical Union's annual meeting in San Francisco.



"We're talking about tinkering with the climate system that affects everybody on Earth," said Turco, an atmospheric chemist with expertise in the microphysics of fine particles suspended in the atmosphere. "Some of the ideas are extreme. There would certainly be winners and losers, but no one would know who until it's too late.



"If people are going to pursue geoengineering, they have to realize that it won't be quick, cheap or easy; indeed, suggestions that it might be are utter nonsense, and possibly irresponsible. Many of these ideas would require massive infrastructure and manpower commitments. For example, one concept to deliver reflective particles to the upper atmosphere on aircraft would require numerous airports, fleets of planes and a weather forecasting network dedicated only to this project. Its operation might be comparable to the world's entire commercial flight industry. And even after that massive investment, the climatic response would be highly uncertain."



Given the difficulties of reducing greenhouse gas emissions, the idea of a simple large-scale technological solution to climate change can seem very appealing.



"Global warming due to carbon dioxide emissions appears to be happening even faster than we expected," Turco said. "Carbon dioxide emissions are continuing to grow despite all of the warnings about climate change, despite all of the data showing such change is occurring and despite all of the efforts to control carbon emissions. The emissions are rising, in part, because China and India are using increasingly more energy and because fossil fuels still represent the cheapest source of energy.



"If we continue down this path, the climate is likely to change dramatically — major ice sheets could melt, sea levels could rise, it may evolve into a climate catastrophe. So it is tempting to seek an alternative response to climate change in case we can't get emissions under control. The result is that more and more geoengineering proposals are surfacing. Some of the people developing such proposals know what they're talking about; many don't."



Turco and Yu have been studying a particular geoengineering approach that involves the injection of nanoparticles, or their precursor gases — such as sulfur dioxide or hydrogen sulfide — into the stratosphere from aircraft or large balloons.



While our climate system normally involves a balance between incoming sunlight and outgoing heat radiation, excess atmospheric greenhouse gases trap additional heat and cause the Earth's temperature to rise, Turco noted. "One way to control the potential warming is to reduce the emissions of greenhouse gases," he said. "We haven't been able to get a handle on that. Another idea, instead of reducing emissions, is to somehow compensate for them."



The idea of injecting sulfur dioxide or other toxic gases into the stratosphere in gaseous or liquefied form would mean that planes or balloons would have to fly as high as 13 miles — higher than any commercial aircraft can reach. And the amounts involved range to many millions of tons.



"Some of these proposals are preposterous, mind-boggling," Turco said. "What happens, for example, when you spray liquefied sulfur dioxide into the stratosphere? Nobody knows."



In a study published earlier this year, Turco analyzed what happens when a stream of very small particles is injected into the atmosphere. He showed that when the particles are first emitted, they are highly concentrated, collide frequently and coagulate to much larger sizes than expected.



"To create the desired climate outcomes, you would need to insert roughly 10 million tons of optimally-sized particles into the stratosphere," he said. "You would have to disperse these particles very quickly over the entire stratosphere or they would coagulate into much larger sizes. At such enhanced sizes, the particles do not have the same effect; they're much less effective in forcing climate compensation. In the end, you would have to fly thousands of high-altitude jets every day to get enough particles into the atmosphere to achieve your goal. And this activity would have to be sustained for hundreds of years."



The basic idea behind stratospheric particle injections is that the Earth's temperature depends on the reflectivity of the atmosphere. About one-third of the energy from the sun hitting the Earth is reflected back into space. That fraction is called the "albedo." If the albedo increases, the average global temperature decreases because less energy is available to warm the planet. So if we can increase the albedo sufficiently, we can compensate for global warming.



"The size distribution of the particles is critical," Turco said. "If the particles are too large, that will actually create a warming effect, a greenhouse warming. Small particles are not useful because they don't reflect much radiation; you need something in between, and we have shown that is hard to achieve reliably."



Turco and Yu have simulated, for the first time, the actual injection processes that might be used, focusing on the early evolution of the injection plumes created from aircraft or balloon platforms. They used an advanced computer model developed by Yu to calculate the detailed microphysical processes that ensue when reactive, particle-forming vapors are emitted into the atmosphere. They also accounted for the photochemical reactions of the injected vapors, as well as the mixing and dilution of the injection plume.



"We found that schemes to emit precursor gases in large quantities would be extremely difficult to design and implement within the constraints of a narrow tolerance for error, and in addition, the outcomes would be very sensitive to variables over which we would have little control, such as the stability and mixing conditions that occur locally," Turco said.



"Advocates of geoengineering have tried to make climate engineering sound so simple," he added. "It's not simple at all. We now know that the properties and effects of a geoengineered particle layer in the stratosphere would be far more unpredictable, for example, than the physics of global warming associated with carbon dioxide emissions. Embarking on such a project could be foolhardy."



How can global warming be combated?



"We must reduce carbon emissions," Turco said. "We need to invest big-time in alternative energy sources with minimal carbon footprints."



The research is federally funded by the National Science Foundation.



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The New York Times Letter to the Editor are always funny. There is true competition to publish there and the cream of the crop usually are pretty good. This one gets an A+.

To the Editor:

It is amusing that Andrew M. Cuomo, who owes his whole career to his dad, may not get the Senate seat of Hillary Rodham Clinton (who owes her whole career to her husband) because David A. Paterson (who owes his whole career to his dad) may give it to Caroline Kennedy (who owes her whole career to her dad).

You would think a state as large as New York could find someone who deserves something on his or her own.

David Machlowitz
Westfield, N.J., Dec. 16, 2008

Nepotism and social networks may be part of the returns for going to elite schools. Whether a clever economist can quantify this remains an open question. What would be the right control group? People who go to Harvard classes but make no friends while there? (this might be a select sample).

Switching Subjects, there is an interesting debate going on here:
Mark Thoma's eloquent statement on crowding out in good times versus in recessions

One new thought;

Thoma appears to give little weight to the long run productivity effects of "creative destruction". In his model, there is an unemployed army of people doing nothing but watching TV at home. These individuals would love to work at their original wage but nobody will hire them at that wage so they are wasting time.

Think of Detroit today. Would the U.S economy as a whole be richer in 2015 if Detroit's workers recognize that the "Big 3 jobs aren't coming back" and these households move to more productive regions with newer capital and more pro-growth economic policies? Thoma's New Deal will slow down this out-migration from this slow growth region. (Similar to proping up Eastern Germany after German unification).

Consider the following dynamic game theoretic argument. If firms anticipate that real wages are declining, then they are more likely to make irreverible investments in factories and other capital that are complements of labor. So you are more likely to buy left shoes if right shoes become cheaper.

Workers are more likely to upgrade their human capital and skills when the opportunity cost is low.

So my point is that the Thoma focus on the very short run plays down the importance of a dynamic economy investing in new capital (both factories and skills) to get ready to be productive in the future.

Thoma might counter that an unemployed worker starts drinking booze and this degrades his skills in an economy with skill degradation (i.e duration dependence).

So, this debate hinges on whether recessions are the right time for economy wide re-organization and capital investment in worker skill upgrading? If so, does a Keynesian Green New Deal or regular New Deal actually slow down worker skill investment (as they take new post office jobs) and firm investment and re-organization (as General Motors keeps making cars that people don't want).

If productive firms (i.e google) anticipate that this costly New Deal will lead to future inflation and future higher taxes then does this retard their capital investments now?

I am a 1987 graduate of the LSE. I wasn't the only American walking around there. The joke was that LSE stood for Let's See Europe. I studied economic history and econometrics there. I don't believe that I was Dudley Baines or E.H Hunt's best student but I did learn a few things and I met some very smart people who helped push me to work harder and to not be so smug. The LSE continues to help me. For both of my books, they have been kind enough to spread the word to their vast network. Here is the new one; The LSE alumni booklist provides a short blurb on the Costa/Kahn book (look under k)

I now own 10 copies of the book and I must admit that it looks good. It is hard to believe that it actually exists. I hope somebody reads it!

Do you ever wonder what causes what? I know that my lectures cause my students to fall asleep but I'm not sure what else I know about causality. Robert Gordon asks a tight causal question in his new nber working paper; "Did Economics Cause World War II?"


Did Economics Cause World War II?

Robert J. Gordon

NBER Working Paper No. 14560
Issued in December 2008

---- Abstract -----

Historians have long recognized the role of economic resources and organization in determining the outcome of World War II: the Nazi economy lacked the economic resources and organization to oppose the combined might of the U.S., U.K., and U.S.S.R. A minority view is that the Germans were defeated not by economics, but by Hitler's many strategic and tactical mistakes, of which the most important was the invasion of the Soviet Union. Compared to this debate about the outcome of the war, there has been less attention to economics as the cause of World War II.


This is a review article of a new economic history of the Nazi economy by Adam Tooze which cuts through the debate between economics and Hitler's mistakes as fundamental causes of the outcome. Instead, Tooze argues that the invasion of the Soviet Union was the inevitable result of Hitler's paranoia about the land-starved backwardness of German agriculture as contrasted with the raw material and land resources of America's continent and Britain's empire. The American frontier expansion that obliterated the native Indians provided Hitler with a explicit precedent, which he often cited, for pushing aside the native populations in the east to provide land for German Aryan farmers.


Germany's agricultural weakness is summarized by its low land-labor ratio, but Poland and the Ukraine had even less land per person. Thus simply acquiring the land to the east could not solve Germany's problem of low agricultural productivity without removing the native farming populations. Far better than other histories of the Third Reich, Tooze reveals the shocking details of General Plan Ost, the uber-holocaust which would have removed, largely through murder, as many as 45 million people from eastern agricultural land. Tooze, like the Nazis before him, fails to emphasize that the solution to Germany's agricultural problem was not acquiring more land for the existing German farm population, but rather by raising the land-labor ratio by making the existing German land more efficient, mechanizing agriculture and encouraging rural-to-urban migration within Germany.

This paper is available as PDF (210 K) or via email.

http://papers.nber.org/papers/w14560

When I was a graduate student over 15 years ago now, my midwestern university didn't offer any courses in international trade or environmental economics. I have tried to overcome my upbringing by doing some work at the intersection of these fields. I will let you judge whether this empirical work is good. My new NBER paper (joint with Lucas Davis) on Trade and the Environment .

If you are a labor economist, I would encourage you to take a look at our paper. We breathe some new life into the canonical Roy Model, we assemble some very funky data sets, and we document that old durable goods whose lifespans are endogenous and depend on trading possibilities are important determinants of both local and global pollution levels.

In my humble opinion, this is a pretty subtle paper that explores a number of ideas while trying to keep the empirics relatively simple.

Our focus on consumer activity and in particular used vehicle purchases distinguishes this study from most empirical trade and the environment papers.

Here is an example of what I've done on pollution havens in the past:
Kahn 2003

Arik Levinson has a nice new paper revisiting these issues by taking a careful look at intermediate inputs in production.

Arik's 2007 NBER paper .

Switching subjects, as I've boasted the other day --- the Costa/Kahn book will be available starting this tuesday. If you are in Los Angeles, UCLA will be putting on a parade to celebrate this event.