Friday, July 25, 2008

Economic Hard Times and the Role of Government

You might as well settle back. This could be a long post. But it should offer some tools for those of you who teach American History as well as economics.

The seeds of this post were planted last weekend. As usual, I was the first one up (not counting the cat) and I went to the kitchen to make the coffee and await the arrival of the Saturday morning newspapers. When they arrived, I quickly perused the local paper and then opened The Wall Street Journal. Inside I found this piece by James Grant. Titled "Why No Outrage?", it seeks to answer a question. In a nation with a long history of populist rage against the moneyed interests, why was there not a more vocal grass-roots movement to 'turn the rascals out' - the rascals being the heads of Wall Street firms, mortgage lenders, as well as central bankers, regulators and other denizens of the world of high finance?.

The article was by James Grant, author of a favorite book of mine, Money of the Mind. (It's a history of the democratization of credit from pre-Civil War era to the junk bond days of Michael Milken.)

In the WSJ article, Grant suggests linkages between Wall Street and both ends of Pennsylvania Avenue as a possible reason. But I think the truth in that is related to an earlier portion of the article when suggests that the link between Wall Street and Main Street may be part of the answer.

Grant takes us on a historical examination of the many ways the populist movement changed the nature of the economy as a whole and the financial system within it. (Indeed, in this I think he is drawing a parallel to his work in Money of the Mind.) The periods of economic and financial upheaval the U.S. experienced in the 19th and 20th century, helped shape the rules and agencies that police the financial market - and, if I may point out, that indirectly drive innovation. For as rules are promulgated and agencies incarnated (witness the proposed establishment of a new Federal Housing Finance Agency to oversee Fannie Mae, Freddie Mac, and the Federal Home Loan Banks - all creations of government), the market develops new ideas and products not covered by those rules and agencies. And many of the folks on Main Street take advantage of those new ideas as depositors, investors and borrowers.

Now, let us open today's issue of The Wall Street Journal. On the front page of section one, we see an article on how the "Economy Spurs Government to Grab Bigger Oversight Role". This article, by a number of Journal reporters, also provides historical insights linking the expansion of government to financial upheaval, although not restricted to that industry. (They mention a desire by many in the food industry for increased oversight.) And again, the connection to Main Street is clear. Individuals, citizens, consumers are looking to Washington to solve problems. Those same people are, by their activism, determining the size and scope of the role of government in the economy. And regardless of where you stand on that question, the connection is one that students need to understand.

As members of society, the economy and the policy, our students will make choices. They (and we) can choose to increase the size and scope of government. That will reduce the number of choices (freedoms) they have to make, and will increase the costs of government. They can also choose to decrease the size and scope of government. That will reduce the costs of government, but it means they will increasingly have to bear the risk and direct cost of those choices. After all, as we say here at the Powell Center, "There ain't no such thing as a free lunch." Furthermore, they need to understand that choosing not to choose means they are wiling to accept whatever happens - with size and cost of government and with their personal decisions.

I think the articles can provide a history teacher with additional information and an interesting way to tie the lessons of history to current events in the economy. I think the articles can help the economics teacher who is trying to help students understand the role of government in an economic system, and the ways that rules and agencies (institutions) impact decisions with that system.

I'd be curious to hear your thoughts on this.

11 comments:

rdan said...

Hi Tim...Thanks for visiting Angry Bear.

I came by to say hello. I notice that your links to economic blogs appear to reflect a definite bias of economists you prefer.

I assume it is intentional. It does raise concerns about your point of view around the topic of your blog...scope of government.

Do you use old Mankiw (90's) or new (2003 on)? Bill Polley e-mails cactus at AB, Arnold Kling at EconLog is good, where is Bruce Bartlett?

But where is the diversity of opinion?

Tim Schilling said...

rdan,

Thank you for visiting. I do tend to be pro-market. Although I try to be apolitical (I don't trust politicians - period. Different incentive structure.) The topic of my blog is meant to be economics in the classroom, and to that end I try to focus on ideas for the classroom teacher.

I don't use either Mankiw textbook. Not familiar w/Bruce Bartlett. I'll look him up.

As to diversity of opinion, like many others I hope to get some response and counterpoint from commenters. Not much luck there.

JD said...

I hope that you continue with finding ideas to be used and discussed in the economics classroom. My personal opinion is that I hope that people in your position (as an economics blogger) discuss ideas that interest you. Any bias you have is fine because I can offset your bias with other blogs and materials.

I want to teach my students to detect bias and then do their own thinking on the subject using a variety of different sources. If every blogger had diversity of opinion as their number one goal, this process would be become bland in a hurry.

I encourage you to continue to continue to provoke thought with the passion that you have shown this entire year. I look forward to your posts.

By the way, one of the reasons that we don't comment as often as we should to your posts is because of the excellent materials you put in front of us. By the time I'm done reading the linked information I am off to the classroom with enthusiasm and I forget to post.

rdan said...

Tim said:"That will reduce the number of choices (freedoms) they have to make, and will increase the costs of government. They can also choose to decrease the size and scope of government. That will reduce the costs of government, but it means they will increasingly have to bear the risk and direct cost of those choices. "

This is where trouble begins and the power of words is seductive. Government may or may not limit choices by regulation, or cost of regulation, or as in FDA example big pharma is the one to limit choices, not the government.

# choices and freedoms are NOT synonyms.

In the MA frameworks, the use of the term free trade is actually used in several goals. Many find this acceptable...in econ classes. That is a problem and suggests too much use of tertiary sources.

rdan said...

jd,

Diversity of opinion by a blogger, if the goal, can be bland, but I suggest kindly that if you are too busy making lesson plans from one source to try another source then you are trapped in the bias itself without knowing.

Good curriculum takes time to develop, and economics today is the slave of politics in the media, which is a very difficult bias to overcome.

What is pro-market? Compared to whom? Who is a good economist compared to an influential economist? How is policy a reflection of economic thought, if at all because of the distortions involved?

History has the same dilemma without the influence. When you teach the standard textbook on the American Revolution according to our frameworks you are automaticly inaccurate. What a dilemma!

BTW Tim,
I will figure out a way to link to Angry Bear for the k-12 group, to which I will belong Aug. 21. William Polley sends his best.

rdan said...

Tim,
Watch out for the simple regulation/innovation argument. Capture theory can describe how the current K street influence made for the Fannae Mae fiasco very easily.

I would also suggest thet the "shadow" banking system of 'innovation' was quite predictable in its results and not a surprise at all since 2004/05.

One could argue that the 'risk' is being socialized by this administration, even though the market had charged the premium of better returns already. Think about it...

Tim Schilling said...

rdan said,

"This is where trouble begins and the power of words is seductive. Government may or may not limit choices by regulation, or cost of regulation, or as in FDA example big pharma is the one to limit choices, not the government. # choices and freedoms are NOT synonyms. In the MA frameworks, the use of the term free trade is actually used in several goals. Many find this acceptable...in econ classes. That is a problem and suggests too much use of tertiary sources."

Can you provide a situation where government regulation does not limit choice? I'd be interested because every regulation I can think of tends to be restrictive (you may not...) or proscriptive (you must...). Either way choices are made by someone else.

And why I do not favor an abandonment of regulation, what I do say in many other posts is that people need to be careful in putting regulations in place. Too often regulations are put in place for perfectly laudable reasons, only to result in "unintended consequences". And once the regulation is in place, it's hard to remove - even if it proves harmful.

To your point about capture theory, you are right. Much of the current Fannie/Freddie fiasco can go back to K street. Ditto your earlier comment about the FDA and big pharma. But weren't these agencies originally attempts to "regulate" the market? In my mind, the question for our students to study is "does the establishment of a regulatory agency make the capture easier or harder?"

I go back to my earlier point. I don't object to regulation, per se. But regulation always has costs. Those costs (whether in terms of funds or efforts at influence) take resources which could be otherwise used.

The question, in my mind, comes down to opportunity cost. I don't object to the opportunity cost of regulation. I only ask that people spend a little more time examining what the opportunity cost may be in various circumstances.

The economy, I'm sure you'll agree, evolves. Often the regulations or restrictions don't keep up as well as we might hope. Does that mean "don't regulate"? I don't think it does. Does it mean "change and adapt regulation to circumstances? Perhaps, but get rid of the old regulations and make sure the costs (marginal, opportunity) are given some thought.

I love the dialogue because it will bring more opportunities for the students to think critically and examine what their choices are and what their opportunity costs are.

(BTW, don't restrictions on my choice limit my ability to use my resources as I see fit? Again, I'd welcome a further explanation.)

rdan said...

Yes...

What you say is true, however.... If my toohpaste has antifreeze in it to extend the product, is that freedom to choose? Is my freedom to choose exercised only after I am sick?

One forgets that regulations were not put in place because government likes to make regulations...regulations were put in place because people died, got sick, or were hurt in some way, even if only financially.

Do regs adapt quickly enough? No, mostly not. People become settled and complacent, forget, and it takes new hurt to change things. This is a human thing.

OR....

The FDA had 2000 inspectors fifteen years ago, now has about 700 with an increase in foreign trade x ten. The head of the FDA said the agency did not need more staff to Congress right before the poisonings of pets, and the deaths from toothpaste in Panama. Blame bad government for not coping was the response by some. Is that accurate?

MA econ frameworks uses the term free trade. Ouch?! Another post.

Opportunity costs can be factored in, except it has to be done by industry. The money spent on the highway system drained a lot out of the private sector...but the service aided growth.

Without gov. help the price of locating poles for telephone lines, cable, and cell would be huge...ATT and Verizon did not pay for access to everyone's back yard...they got it free, basically..not every gov. function is federal.

Capturing a market or an agency is why students need to learn...they will have the same issues in different form, some of their classmates as predators, some as victims, and some as just regular folk. I would posit an agency is usually set up to counter an imbalance of harm in the market...an individual has only the government sometimes to counter the collective of a company.

rdan said...

I would like to visit more often if okay with you.

BTW, I may take a position I may not personally believe without caveats, but can make for a reasonable and plausible case.

Another issue for me is the lack of math in our evaluations.

rdan said...

Re-framing for teachers first, then try the student. For me in a conference, avoid eye contact to not be called on. :)

Is there a difference between a private corporation with a natural monopoly and a government in terms of innovation and efficiency?

What is market clearing in relation to the short term for the above?
-----------------------------------
Do tax cuts and increased spending create opportunity costs that are damaging and dead weight to the economy? Does it slow an economy and lose revenue? Who pays the costs?...(hint, second graders.)
-----------------------------------

rdan said...

LOL. Angry Bear is like trying to herd a bunch of border collies...definite opinions.