Healthcare, Curing the Disease not the Symptoms; Pt. 1: Crunching the Numbers

It seems as if these days politics has become a competition in fear. Rather than who can come up with the best and most comprehensive solutions, it is about which side can scare the public enough into believing that they need to somehow be protected from the other side. This strategy is very effective as a distraction from the causes of what it is we are meant to fear as well as what the proposed solutions are.

Darwin vs. Smith

From Economist's View:

"Trumped by Darwin?"

Robert Frank returns to the point he made in Alpha Markets, i.e. that Charles Darwin provides the "true intellectual foundation" for economics. Though the example this time is male elk rather than bull elephant seals, the central point - and it's one worth giving more thought to - is that "Individual and group interests are almost always in conflict when rewards to individuals depend on relative performance." In these situations, which occur frequently in economic and social relationships, the assumption in neoclassical economic models that the maximization of self-interest is consistent with the maximization of social interest does not hold, and failure to recognize this has " undermined regulatory efforts ... causing considerable harm to us all":

The Invisible Hand, Trumped by Darwin?, by Robert Frank, Commentary, NY Times: If asked to identify the intellectual founder of their discipline, most economists today would probably cite Adam Smith. But that will change. ... Charles Darwin ... tracks economic reality much more closely. ...

Smith’s basic idea was that business owners ... have powerful incentives to introduce improved product designs and cost-saving innovations. These moves bolster innovators’ profits in the short term. But rivals respond by adopting the same innovations, and the resulting competition gradually drives down prices and profits. In the end, Smith argued, consumers reap all the gains.

The central theme of Darwin’s narrative was that competition favors traits and behavior according to how they affect the success of individuals, not species or other groups. As in Smith’s account, traits that enhance individual fitness sometimes promote group interests. For example, a mutation for keener eyesight in hawks benefits not only any individual hawk that bears it, but also makes hawks more likely to prosper as a species.

In other cases, however, traits that help individuals are harmful to larger groups. For instance, a mutation for larger antlers served the reproductive interests of an individual male elk, because it helped him prevail in battles ... for access to mates. But as this mutation spread, it started an arms race that made life more hazardous for male elk over all. The antlers of male elk can now span five feet or more. And despite their utility in battle, they often become a fatal handicap when predators pursue males into dense woods.

In Darwin’s framework, then,... [c]ompetition, to be sure, sometimes guides individual behavior in ways that benefit society as a whole. But not always.

Individual and group interests are almost always in conflict when rewards to individuals depend on relative performance, as in the antlers arms race. In the marketplace, such reward structures are the rule, not the exception. The income of investment managers, for example, depends mainly on the amount of money they manage, which in turn depends largely on their funds’ relative performance. Relative performance affects many other rewards in contemporary life. ...

In cases like these, relative incentive structures undermine the invisible hand. To make their funds more attractive to investors, money managers create complex securities that impose serious, if often well-camouflaged, risks on society. But when all managers take such steps, they are mutually offsetting. No one benefits, yet the risk of financial crises rises sharply. ...

It’s the same with athletes who take anabolic steroids. ...

If male elk could vote to scale back their antlers by half, they would have compelling reasons for doing so, because only relative antler size matters. Of course, they have no means to enact such regulations.

But humans can and do. ... Darwin has identified the rationale for much of the regulation we observe in modern societies — including steroid bans in sports, safety and hours regulation in the workplace, product safety standards and the myriad restrictions typically imposed on the financial sector.

Ideas have consequences. The uncritical celebration of the invisible hand by Smith’s disciples has undermined regulatory efforts to reconcile conflicts between individual and collective interests in recent decades, causing considerable harm to us all. ...

[And, again, for those who might be interested, see also Paul Krugman's: What Economists Can Learn from Evolutionary Theorists Synopsis.]

The first thing that comes to mind when reading this is the game theory behind the mutual scaling back of antler size by the elk. If they could all decide together to scale back the size of their antlers, they would choose to do so. However, there would also be incentive for some to cheat because then you still have small enough antlers to avoid predators but you also have bigger antlers which benefits finding a mate. This compares directly the discussion of cartels where firms decide to scale back production together in order to raise the price, but there is incentive to cheat and produce more to increase the benefits of the higher price.

The second thing is how this may or may not refute the invisible hand. It seems to me that following the theory of evolution, the size of the elk's antlers probably has reached a happy medium or at least is along the path towards that, two of the elk's primary evolutionary goals being survival and to mate. If the size of the elk's antlers became to large to be able to run away from predators, the ones with the smaller antlers would be those that survive and go on to mate, thus "regulating" antler size.

Thus it should happen in the economic world. There is a balance that needs to be made between maximizing profits and survival. As we've seen, the incentive structure in the financial world was severely misaligned, and so now we're seeing the correction. Those that are able to properly evolve in this environment will be better and stronger companies as we come out of the recession. Along the same metaphor of evolution, when recently reading White Fang the allusion of a recession to a famine stuck out to me. In the wild, during a famine, those animals that are strongest and best equipped to survive difficult times are the one's that live on to reproduce and continue on the species. Sometimes there's luck involved and sometimes animals that maybe shouldn't have died, die. But overall, it is the strongest of the species that live on. The problem that we're seeing now is that the government is keeping alive even the very weakest of the companies, making the god-like decision of who is deserving to carry on the species (whether it be bank, car, small business, etc...).

And if it was a faulty incentive structure that was the downfall of the banking industry, what incentive structure can the government be expected to be held by?

Health Care Commentary

The health care issue has always been something that has puzzled me, as I've never seemed to really feel as if the issues have been properly highlighted nor solutions put forward. Whenever I do read about, the issue is always so highly politicized and partisan. This is an interesting commentary by Richard Posner on his blog, www.becker-posner-blog.com. I don't think it quite gets at the issue, but he raises an interesting point that some of the issues could be cultural and that maybe the extra costs represent more of an American preference to a type of health care and life style that costs more.

This is the conclusion to the post, which can be found in its entirety here:
http://www.becker-posner-blog.com/archives/2009/06/the_administrat.html

"To return to the initial puzzle of why our peer nations are able to provide what seems, judging by outcomes, a level of health equal or superior to that of Americans at far lower cost, the only convincing answer is that the health-care providers in those nations limit treatment. I am not sure of the explanation, but the possibilities include: the professional model is more tenacious in societies less committed to free markets and a commercial culture than the United States; more of their hospitals are public and more of their doctors are public employees, who are therefore salaried rather than entrepreneurial; and Americans, being less fatalistic than most other peoples, have a more intense demand for life-extending procedures. These are reasons why a national health plan modeled, as the Administration's appears to be, on the health plans of peer nations with much lower aggregate health costs is unlikely to work well, or at least to generate net cost savings.

Of course if people value extension of life very highly--and there is evidence that, in the United States at least, most people do--a very costly health care system may be cost-justified, in the sense that the benefits exceed the costs. Yet the benefits seem rather illusory, since the extra money we spend on health care does not seem to produce better outcomes. But international comparisons of health that are limited as they largely are to differences in longevity are crude. They ignore health benefits unrelated to longevity, such as the benefits conferred by cosmetic surgery and the possibility that the additional costs of health care in the United States enable people to live more dangerous, strenuous, or self-indulgent lives and by doing so confer utility."

Some interesting GM facts from Carpe Diem

From Professor Mark Perry's Carpe Diem Blog:


"In Michigan there are 193,301 GM retirees and 46,467 active manufacturing workers, which is a ratio of more than 4 retirees per active worker. For Ohio, the ratio is more than 6 retirees per active worker, and in Indiana there are 8.6 retirees per active worker!

As someone said recently, "GM has become a health care benefits management firm that sells cars for a loss as a side venture.""

He also points out: "To put the decline in the number of GM manufacturing workers in perspective, consider that there are currently about 80,000 GM manufacturing workers in the entire U.S. In the 1970s, GM employed almost 85,000 workers in just one U.S. city: Flint, Michigan, "Vehicle City.""

Although this could be a little skewed seeing as how he's not taking account for the additional value added per worker, i.e. due to technological improvements and better education, each worker becoming more efficient, and as time goes by each worker can produce more.

And a quote found on Carpe Diem:
http://mjperry.blogspot.com/2009/06/government-motors-quotes-of-day.html

The government that runs Amtrak (which has lost $23 billion, in today's dollars, just since 1990) vows to make GM efficient. But one reason Amtrak runs on red ink is that legislators treat it as their toy train set, preventing it from cutting egregiously unprofitable routes.

~George Will

Bailouts and the Free Market

Mark Thoma responds to Edward L. Glaeser of the Boston Globe:
http://economistsview.typepad.com/economistsview/2009/06/the-problem-with-bailouts.html

"The Problem with Bailouts"

Ed Glaeser doesn't like the auto bailout:

The problem with bailouts, by Edward L. Glaeser, Commentary, Boston Globe: Recessions can ... reveal weakness in seemingly invulnerable businesses, like Citibank and Toyota. But diagnosing the nature of corporate ill health may be difficult. Some firms suffer from a fatal disease; others have a temporary virus. ...

The distinction between permanent and transitory troubles appears across industries, companies, and cities. The metropolitan areas of San Jose and Detroit are both suffering from double-digit unemployment rates... Despite California's political mismanagement, San Jose has a superb base of tech-savvy entrepreneurs and a terrific climate. Silicon Valley will rise again, but the prognosis for Detroit is less rosy. Overdependence on one not very competitive industry, a shortage of college graduates, and a cold climate have led the city of Detroit to lose more than 50 percent of its population since 1950. ...

When investment is private, professional investors determine which companies are doomed and which are salvageable. In the current situation, however, the government has decided that a large number of firms are too big to fail and so our elected leaders are deciding which firms to save and which to let go.

The right answer is not "save everybody." Human and physical capital should move out of declining industries and into more productive areas, unless America wants to be a permanent, industrial underperformer. But public-sector intervention usually errs on the side of the status quo. Politicians respond to the workers in an existing firm who are ... rallying to keep their jobs. The customers and employees of the new firms that will rise from a collapse have no seat at the table.

Since the collapse of Lehman Brothers, the public sector has spent billions saving the banks. While these decisions are certainly debatable, they are understandable. The US financial industry misbehaved badly,... but it is still a sector with a future. ... After all, every other sector in the economy depends on banks for their financing.

But what about cars? ... Does anyone, other than GM's management, believe that this company can come back? The current treatment, cash infusion and a reduction in corporate liabilities, provides a solution for a company that is broke, not for one that is broken.

The great cost of saving GM as a single company is that ... America's car industry ... might be better served with a number of smaller, nimbler firms. Across metropolitan areas and across sectors within areas, there is a strong link between small firms and economic success. Detroit was, a century ago, among the most entrepreneurial places on the planet, and it achieved automotive miracles, the scale of which ultimately turned the city into a model of big-firm stagnation.

If General Motors becomes a permanent employee-owned, state-sanctioned enterprise, the firm will lose its chance to split up and become entrepreneurial once more. This could be the great price, even greater than the tax costs, of treating a permanently plagued company like one with a temporary cash shortfall. As flawed as the free market may be, it is hard to be enthusiastic when politicians start playing financier with our tax dollars.

I don't think anyone is planning on "a permanent employee-owned, state-sanctioned enterprise." I don't disagree that the auto industry needs to change. However, there is a maximum rate at which the economy can transform itself, a maximum rate at which the economy can create new industry and absorb displaced and unemployed labor, and presently there's not much more the economy can do. Putting people out of work only to have to spend money in other ways to support those very same people through social insurance programs, losing tax revenues because of their lost income, and so on, is not wise. The transition needs to happen, and a break-up into smaller firms might very well be part of it, but it needs to happen at an acceptable rate.

When the bathtub is already draining as fast as it possibly can, dumping more water into it does not make the tub empty any faster, it only raises the water level. Similarly, right now the pool of unemployed is draining as fast as it can, and dumping more people into it will simply make the problem worse, the transformation of the economy won't happen any faster. Yes the car companies need to change, and yes, the government support needs to end as fast as possible. But the change can only happen so fast, and trying to push it faster doesn't do any good.

There will come a time once recovery is under way to make changes such as those discussed above. I know I don't want a permanent state-run or state-backed enterprise, and there will come a time when the companies must stand or fall on their own. But I also don't want to put people out of work during a recession based upon the notion that the industry must transform itself through private sector initiative when there's very little chance of that happening until things improve.


It seems to me that the two of them agree. Glaeser doesn't really focus on whether it is necessary or not for the bailout but seems more to be warning against any permanent state and employee run institutions as detrimental to productivity and growth. He says "If General Motors becomes a permanent employee-owned, state-sanctioned enterprise," the most important word being "if." I think his fear is that it's hard once the habit is started to break government dependence. As Glaeser points out: "But public-sector intervention usually errs on the side of the status quo. Politicians respond to the workers in an existing firm who are ... rallying to keep their jobs. The customers and employees of the new firms that will rise from a collapse have no seat at the table." So once recovery is underway and a proper restructering becomes timely, it will be hard to break the status quo. That is the difficulty of government intervention, easy to implement, difficult to reverse.

It's ok to make money!

From Bronte Capital:

Rortybomb is a blog where I find myself entirely agreeing with the mathematics and totally disagreeing with the conclusion. I have added it to the blog roll – and intend on taking a few shots at it. I consider Rortybomb as providing an illustration of all the things you can do to abuse mathematics in economics.

Mike (the blogger) posts empirical research suggesting the obvious – that big banks selling loans that can’t be securitised tend to have fatter margins. When they sell loans that can be securitised they tend to have thinner margins.

He then concludes that we should have smaller banks and more access to securitisation. Felix Salmon agrees with him and wants smaller banks and more securitisation.

No objection to the empirical fact that oligopolistic banks without securitisation competition are profitable. I see it in many places. And I see it today. Securitisation is being removed and bank margins are going up. Pre-provision, pre-trading loss profit of banks is rising.

My objection to Rortybomb is to the conclusion. Fat margins for banks are a good thing. They lead to the absence of financial crises. Thin margins lead banks to take more risk – and when they fail they have huge collateral damage.

Having a few fat rich banks is a small price to pay if you don’t trigger great depressions.

In the olden days banks used to give out toasters to anyone who would open an account. Why? Because new customers were frightfully profitable. Why didn't the banks compete with lower prices? Because they were not allowed to. Bank regulators actually regulated the value of the gifts (then known as "premiums") that banks could give their customers. They wanted to ensure that the toasters did not cost too much. Essentially they wanted to guarantee bank profitability. Krugman wants to go back to the toaster days. I just want to go back to days when banks were consistently very profitable over a cycle.

Big banks with no securitisation will be sufficiently profitable.

Rortybomb makes precisely my argument for big banks. That they rip us off. And that is a good thing.

The Temptation of Protectionism

I think that the really scary thing is that even though we've been through this before (although the article makes the point that it was in a different form) we seem to be making the same mistakes, in this case most specifically the Buy America provisions in the stimulus. There doesn't really seem to be a point if we can't learn from our mistakes. It seems coordination is the real problem here, as it is difficult to consolidate the different political pressures of various countries, which is the problem that the EU is facing in finding a solution for this crisis.

The protectionist temptation: Lessons from the Great Depression for today, by Barry Eichengreen and Douglas Irwin, Vox EU

TARP alternative. Why continue spending trillions?

I've found myself interested in hearing the alternative solutions that are put forward, particularly since defenders of programs such as TARP and more frequently the Stimulus argue that the other side simply hasn't put forward any solutions so these are our best options by default. This is an interesting proposal by Larry Kudlow, a bit technical but a clear description, that uses an upward sloping treasury yield curve and a mark-to-market reform. I particularly like this one point that Kudlow makes:

You could even have a two-tiered disclosure process: Accounting purists could be satisfied with a full mark-to-market disclosure, while regulators could forbear capital-standard rules that shouldn’t apply during this period of severe distress. As a result, banks would be in better shape to pass the Treasury’s new stress test and wouldn’t need new TARP capital-injections that further extend taxpayer liabilities.

This is nice because, as he points out, it satisfies both parties as there is still, if not more, transparency. So if the mark-to-market evaluation makes a company look less attractive than another, investors can choose to stay out.

A Shotgun-Marriage Proposal by Larry Kudlow

Banks opting out of bailout money

From the NYT:
Some Banks, Citing Strings, Want to Return Federal Aid

In depth analysis of Fiscal Stimulus

This is an interesting (a bit long) and thorough analysis by John H. Cochrane of the University of Chicago Booth School of Business discussing fiscal stimulus both in general but more specifically relating to the current situation and how the argument for a general fiscal stimulus (without much of a commentary on the specifics of the Obama team's plan) applies to the credit crisis. Although I would be interested to see a Keynesian's rebuttal to some of Cochrane's points, specifically on the points of the merit of the multiplier argument for fiscal stimulus, he provides some good insight and also a very interesting solution of his own. I specifically liked the points he made at the end of the paper where he points out, "Others say that we should have a fiscal stimulus to “give people confidence,” even if we have neither theory nor evidence that it will work. This impressively paternalistic argument was tried once with the TARP. Nobody could say how it would work in any way that made sense, but it was supposed to be important do to something grand to give people “confidence.” You see how that worked out. Public prayer would work better and cost a lot less." This rang true with something that bothered me with Obama's strategy of rushing a 1000 page long bill through congress. Basically, there may not be anything wrong with what he his proposing, but with so much money at stake, it is worth a closer look to make sure it will do what he says it will do.

Fiscal Stimulus, Fiscal Inflation, or Fiscal Fallacies?
By John H. Cochrane.

America could take some lessons in capitalism... from China

China Goes on a Smart Shopping Spree, Time Magazine:

The world might be sinking into its worst recession in generations, but China is on a wild shopping spree. Sitting some $2 trillion of cash reserves, Beijing is taking advantage of the woes of others to cement its grip on new sources of commodities ranging from olive oil to crude oil —often at fire-sale prices.

China's growth rate may be slowing in concert with the world economy, but even at that slower rate, its economy continues to expand, requiring a steady increase in supplies of oil, copper, aluminum and other minerals. And laying in sources of supply for those commodities also helps it prepare for the next boom. As economies across the world shrink, Chinese officials have told reporters in Beijing in recent weeks that they see a rare chance to expand its sources for primary commodities. "There are editorials in the Chinese press saying that this is a one-in-one hundred-year's opportunity," says Erika Downs, China energy fellow at the Brookings Institution in Washington. "There is a sense that this is a moment to be seized, that with competition lower they can get a good deal."

Recent deals with Brazil and China highlight Beijing's ability to use loans a means of securing energy supplies. In mid-February, Beijing negotiated a $10-billion loan to Brazil's state-owned oil company Perobras, as well as a $25-billion loan to Russia's state-run oil company Rosneft. Both companies' revenues have plummeted in recent months as crude oil prices fell by more than two-thirds. China offered large cash amounts in a tight credit market, but rather than require that the loans be serviced and repaid in cash, Brazil and Russia will repay the loans in crude oil supplies to China over the next two decades. Russia will ship eastern Siberian oil, while in Brazil, China hopes to get a share of major offshore fields which have recently been discovered. So, no matter what happens to the global economy, China is assured steady oil supplies over the next 20 years from two major oil-producing countries, in regions which are far more politically stable than China's suppliers in Africa.

But China's shopping spree has gone far beyond oil. The Australian government is examining a bid by the Aluminum Corp. of China or Chinalco to buy an 18% stake of the heavily indebted minerals giant Rio Tinto, for about $19.5 billion. It is also considering a bid by the Beijing trading company Minmetals to buy Australia's mining company Oz Minerals for about $1.7 billion — enough to wipe out that company's debt. Meanwhile, Chinese president Hu Jintao made a five-country swing around Africa in early February, signing deals in Tanzania and Madagascar on agriculture and telecommunications, and promising debt relief to the poorest continent.

China's appetites are good news for manufacturers in demand-depressed Europe. Last Wednesday, Beijing's Commerce Minister Chen Deming arrived in Germany with executives from about 90 Chinese companies, on a multi-billion-dollar shopping trip around Europe. The delegates signed more than $10 billion worth of deals in Germany alone, and another $400,000 worth of deals on a brief stop in Switzerland. Next stop was Spain, where the Chinese party bought about $320 million worth of goods ranging from auto parts to olive oil. Finally, in Britain they signed deals worth about $2 billion, including ordering 13,000 Jaguar cars. And while thousands of German auto workers marched in protest at layoffs in the country's debt-ridden auto industry, the Chinese delegates signed a deal to buy $2.2. billion worth of BMWs and Daimlers. Germany's new Economy Minister Karl-Theodor zu Guttenberg told reporters in Berlin that the Chinese visit had "come at the right time."

The shopping spree serves China's purposes, too, helping to head off possible retaliation from Western countries against the huge trade surpluses maintained by Beijing. An unnamed European diplomat in Beijing told the Financial Times on Wednesday that China's "biggest nightmare" is being ordered by the U.S. and Europe to raise the value of their currency by 30% or face a 30% rise in tariffs. The pressure to revalue the Chinese currency could come as early as April 2, when the Group of 20 richest countries in the world meet in London, and where President Obama is scheduled to meet Chinese president Hu Jiantao for the first time. In the run-up to that crucial meeting China's buying spree is aimed at soothing Western anger about the country's economic policies. "This is a smart diplomatic move," says Damien Ma, China analyst at the Eurasia Group in Washington. "China is seen as whittling down its trade surpluses."

China's buying spree has, however, been selective. The United States was conspicuously absent from its global shopping itinerary. The last major Chinese bid to buy a U.S. company ended in diplomatic disaster, when the China National Offshore Oil Corp. or CNOOC offered to buy the California oil company Unocal in 2005, in a deal worth about $18.5 billion, and a backlash in Congress prompted the angry Chinese to withdraw the offer. Unocal was finally sold to Chevron. More recent Chinese investments in the U.S. have also fared badly: Beijing has lost billions in recent months from investments in Morgan Stanley and the Blackstone Group, and Chinese officials who approved those investments have now come under fire in Beijing. "People are saying, 'Why did you invest in that?'," says Downs of the Brookings Institution. "They feel they have been burned in the U.S. and they don't want to be burned again."

Still, for many in Europe, Asia and Latin America, the Chinese offer welcome relief. And it's not as if there are any rival suitors right now.

By Vivienne Walt

A Republican Road to Economic Recovery (WSJ Op-Ed)

Another WSJ Op-Ed piece:

Inheriting countless challenges, Congress and the Obama administration have moved quickly on many fronts to implement their economic agenda. After two months of drastic interventions, has hope replaced fear, and confidence pushed aside uncertainty? Hardly.

David Gothard

The budget the president released last week, however, does provide some certainty about where we are headed: higher taxes on small businesses, work and capital investment.

Add to this the costly burdens of a cap-and-trade carbon emissions scheme and an effective nationalization of health care, and it is clear that the government is going to grow while the economy will shrink. In a nutshell, the president's budget seemingly seeks to replace the American political idea of equalizing opportunity with the European notion of equalizing results.

A constructive opposition party should be willing to call out the majority when it falls short. More important, Republicans must offer alternatives. In this spirit, here is what I would do differently:

- A pro-growth tax policy. Rather than raise the top marginal income tax rate to 39.6%, it should be dropped to 25%. The lower tax brackets should be collapsed to one 10% rate on the first $100,000 for couples. And the top corporate tax rate should be lowered to 25%. This modest reform would put American companies' tax liability more in line with the prevailing rates of our competitors.

We've seen 10 years of growth in our equity markets wiped out in recent months, while 401(k)s, IRAs and college savings plans are down by an average of 40%. The administration and congressional Democrats want to raise capital gains tax rates by a third. Instead, we should eliminate the capital gains tax. It supplies about 4% of federal revenues, yet it places a substantial drag on economic growth. Individuals already pay taxes on income when they earn it. They should not be socked again when they are saving and investing for their retirement and their children's education.

Capital gains taxes are a needless burden on investment, savings and risk-taking, activities in short supply these days. Getting rid of this tax could help establish a floor on stock prices and stem the decline in the value of retirement plans by increasing the after-tax rate of return on capital.

Democrats oppose this, playing on emotions of fear and envy. But while class warfare may make good short-term politics, it produces terrible economics.

- Guarantee sound money. For the last decade, the Federal Reserve's easy-money policy has helped fuel the housing bubble that precipitated our current crisis. We need to return to a sound money policy. That would end uncertainty, help keep interest rates down, and increase the confidence entrepreneurs and investors need to take the risks required for future growth.

I believe the best way to guarantee sound money is to use an explicit, market-based price guide, such as a basket of commodities, in setting monetary policy. A more politically realistic path to price stability would be for the Fed to explicitly embrace inflation targeting.

Transcripts from recent meetings of the Federal Open Market Committee meetings suggest that the Fed may already be moving in this direction. This would be an improvement over the status quo: It could help combat near-term deflation concerns while also calming the market's longer-term inflation fears.

- Fix the financial sector. A durable economic recovery requires a solution to the banking crisis. There are no easy or painless solutions, but the most damaging solution over the long term would be to nationalize our financial system. Once we put politicians in charge of allocating credit and resources in our economy, it is hard to imagine them letting go.

The underlying structural problem at our financial institutions is the toxic assets infecting their balance sheets and impairing their operations. In order to help purge these assets from the system, we need a government-sponsored, comprehensive solution, but one that is transparent and temporary, and which leverages -- rather than chases away -- private-sector capital.

The general idea is to establish an entity or fund to purchase troubled assets from financial institutions and then hold them until they could be sold once the market has recovered. The Treasury has announced its intention to use capital from the Troubled Asset Relief Program, along with financing from the Fed's soon-to-be operational Term Asset-Backed Securities Loan Facility, to set up such an entity. It will be a tall task to get all the details and incentives right, but the administration's general strategy appears to be sound.

A good model for this government-sponsored entity is the Resolution Trust Corporation (RTC), which helped clean up bank failures in the wake of the savings-and-loan crisis in the late 1980s and early 1990s by absorbing and selling off bad bank assets. The circumstances of today's financial sector are different, but the goals of our current efforts should mirror the general merits of an RTC-like entity. We should aim to recoup a portion of our initial expenditures, and we should leave only a fleeting government footprint on the financial sector and the economy.

- Get a grip on entitlements. With $56 trillion in unfunded liabilities and our social insurance programs set to implode, we must tackle the entitlement crisis. President Barack Obama deserves credit for his recent efforts to build a bipartisan consensus on entitlement reform. But we can't solve the entitlement problem unless we acknowledge why the costs are exploding, and then take action.

I have proposed legislation, called "A Roadmap for America's Future," that would bring permanent solvency to Medicare, Medicaid and Social Security. By transforming these open-ended entitlements into a system with a defined benefit safety net for the low-income and chronically ill, in conjunction with an individually owned, defined contribution system for health and retirement, we can reach the goal of these programs without bankrupting the next generation. It would also show the world and the credit markets that we are serious about our debt and unfunded liabilities.

Republicans can help Washington become part of the solution, not part of the problem. We can do this by pushing to enact tax policies that boost incentives for economic growth and job creation, focus the Fed on price stability, fix our banking system to get credit flowing again, stop reckless spending, and reform our entitlement programs.

Our economy is begging for clear leadership that inspires confidence and hope that the entrepreneurial spirit will flourish again. Our goal must be to offer Americans that leadership.

Mr. Ryan, from Wisconsin, is ranking Republican on the House Budget Committee and also serves on Ways and Means.

The 5 governors saying no to stimulus money

This, from the Wall Street Journal opinion section, seems to be a nice twist to the Keynesian argument in favor of stimulus/infrastructure/deficit spending in that running a deficit now in favor of future, sustained, long-term growth. I see the benefits in temporarily inflating the budget in favor of investing in infrastructure and investment in technologies such as alternative energies. These can provide jobs now and will also lay a strong foundation for future growth without need of the heavy hand of a continued and increased government presence. However other types of spending that only create a situation requiring continued government involvement, though may not all be bad, should be looked at separately and not lumped into a stimulus bill supposedly aimed at infrastructure. It seems incredibly misleading of President Obama to say on the one hand that the stimulus bill will be focused on infrastructure and technological development and on the other hand use the excuse that “No plan is. I can’t tell you for sure that everything in this plan will work exactly as we hope, but I can tell you with complete confidence that a failure to act will only deepen this crisis” in order to pass legislation that deviates from his originally stated goals. It seems that with such an argument, it wouldn't be too hard to sneak spending that deviates from the more traditional Keynesian spending programs into a bill that is 1073 pages long. Of course we could just pay the unemployed to dig ditches and fill them back in again until the recession passes as Keynes himself suggested...

From the Wall Street Journal:
Governors v. Congress

Debt-laden state governments were supposed to be the big winners from the $787 billion economic stimulus bill. But at least five Republican Governors are saying thanks but no thanks to some of the $150 billion of "free" money doled out to states, because it could make their budget headaches much worse down the line. And they're right.

These Governors -- Haley Barbour of Mississippi, Bobby Jindal of Louisiana, Butch Otter of Idaho, Rick Perry of Texas and Mark Sanford of South Carolina -- all have the same objection: The tens of billions of dollars of aid for health care, welfare and education will disappear in two years and leave states with no way to finance the expanded programs. Mr. Perry sent a letter to President Obama last week warning that Texas may refuse certain stimulus funds. "If this money expands entitlements, we will not accept it. This is exactly how addicts get hooked on drugs," he says.

Consider South Carolina. Its annual budget is roughly $7 billion and the stimulus will send about $2.8 billion to the state over two years. But to spend the hundreds of millions of dollars allocated to the likes of Head Start, child care subsidies and special education, the state will have to enroll thousands of new families into the programs. "There's no way politically we're going to be able to push people out of the program in two years when the federal money runs out," Mr. Sanford says.

The Medicaid money for states is also a fiscal time bomb. The stimulus bill temporarily increases the share of state Medicaid bills reimbursed by the federal government by two or three percentage points. High-income states now pay about half the Medicaid costs, and in low-income states the feds pay about 70%. Much of the stimulus money will cover health-care costs for unemployed workers and single workers without kids. But in 2011 almost all the $80 billion of extra federal Medicaid money vanishes. Does Congress really expect states to dump one million people or more from Medicaid at that stage?

The alternative, as we've warned, is that Congress will simply extend these transfer payments indefinitely. Pete Stark, David Obey and Nancy Pelosi no doubt intend exactly this, which could triple the stimulus price tag to as much as $3 trillion in additional spending and debt service over 10 years. But the states would still have to pick up their share of this tab for these new entitlements in perpetuity. Thanks, Washington.

Governors are protesting loudest over the $7 billion for unemployment insurance (UI) expansions. Under the law, states will increase UI benefits by $25 a week. The law also encourages states to cover part-time workers for the first time. The UI program is partly paid for by state payroll taxes imposed on employers of between 0.5% and 1% of each worker's pay. Mr. Barbour says that in Mississippi "we will absolutely have to raise our payroll tax on employers to keep benefits running after the federal dollars run out. This will cost our state jobs, so we'd rather not have these dollars in the first place."

The problem for these Governors is that they may be forced to spend the federal money whether they want it or not. Representative James Clyburn of South Carolina slipped a little-noticed provision into the stimulus bill giving state legislatures the power to overrule Governors and spend the money "by means of the adoption of a concurrent resolution." Most state legislatures are versions of Congress; they can't say no to new spending.

These five Governors deserve credit for blowing the whistle on the federal trap that Washington has set for their budgets. They stand in contrast to most of the other Governors, who are praising the stimulus as a way to paper over their fiscal holes through 2010. But money from Congress is never as free as it looks, as the banks can attest. Don't be surprised if two years from now states are still facing mountainous deficits. They will have their Uncle Sam to thank.

A look at China's currency manipulation

China Bashing Once Again from The Becker-Posner Blog:

During his confirmation hearing before the United States Senate toward the end of January, Secretary of the Treasury Timothy Geithner accused China of "manipulating" its currency. This is not a statement that helps to further China-US cooperation on trying to stimulate the depressed world economy and on other issues- Secretary of State Hillary Clinton is now in China trying to mend some fences. Yet Geithner's statement is a correct evaluation of the Chinese policy of keeping the value of its currency, the yuan, low relative to the dollar and other currencies. It is far less clear, however, whether this and related Chinese policies harm the US and other countries.

By keeping its currency cheap, China encourages greater exports since that policy makes Chinese goods cheaper on world markets. This policy also discourages imports by Chinese consumers and producers since it raises the cost of foreign goods in terms of the yuan. Partly due to its manipulation of the value of the yuan, China has run large surpluses on its current account in recent years because the value of its exports has been significantly above the value of its imports. China has accumulated over $2 trillion of reserves. The world recession has sharply reduced China's exports, but surprisingly the recession has reduced China's imports by much more, so that its foreign trade surpluses have grown greatly during recent months.

Some American producers have had trouble competing with cheap Chinese imports, and have either gone out of business, or shifted production overseas, mainly to China itself. Since China mainly exports goods produced with low priced labor that is not available in richer countries, their exports have not had a major impact on production in the richer countries. Far more significant to developed countries are the reductions in the cost of imported clothing and many other goods from China. Consumers, especially low income consumers, now take for granted their ability to buy cheaply many everyday goods that would cost perhaps five times as much were they made in the US, Western Europe, or Japan.

The Chinese government holds most of its more than $2 trillion in official reserves in US Treasury securities. China gets a bad deal from selling goods made by Chinese labor and capital in exchange for large amount of paper assets that yield low returns. China has accumulated far more reserves in the form of these assets than can be justified as a buffer against fluctuations in its imports and exports, or than is wise given its low standard of living. The US seems to have made the better bargain by exchanging low interest paper assets for a rich variety of consumer and producer goods.

Does China's ownership of large quantities of US government bonds give China the opportunity to "blackmail" the United States into more favorable policies toward China through threats to flood the international capital market with these assets? China has not made such threats, perhaps mainly because they would not be credible. Since China owns only a rather small fraction of US Treasury obligations, and an even smaller fraction of total liquid assets traded on world capital markets, a threat to sell their US governments would give China only a little leverage on world interest rates, including those paid by the United States government. Moreover, China, along with other governments, holds US Treasury assets because they are considered among the safest of all assets, especially during these turbulent times. By selling their US Treasury bonds, China would have to take on riskier assets at a time when China is trying to cut its exposure to risk.

To be sure, the high savings rates of China and other Asian countries during the past decade are partly responsible for the low world interest rates that contributed to the housing bubbles in the United States and other countries. To that degree, China bears some indirect responsibility for the financial crisis that is afflicting much of the world. However, China too is being badly hurt by the world recession. Moreover, excessive bank lending and borrowing, and government encouragement of sub prime loans, were much more important culprits in generating excesses in the housing market.

The extensive protectionist policies practiced by the Chinese government do hurt the United States and other countries, including China itself. Chinese protectionism is especially common in the financial sector; while foreign banks are being allowed greater access to China markets, they are still subject to considerable discrimination. The general trend in China (and other nations) toward less protectionism has been set back by the global recession, as China has recently introduced various "buy China" programs in its steel and other industries.

China bashing during past decade is reminiscent of the Japan bashing that occurred during the 1980s. It turned out that Japan's substantial export surplus with the US, its extensive accumulation of US Treasury bonds, and its purchases of assets in teh US did not hurt the United States, but were for the most part foolish actions on the part of the Japanese government and businesses. I believe that similar conclusions will be reached about the parallel Chinese practices.

Bernanke's Feb. 18th Speech on the balance sheet and credit easing

I found this transcript through Economist's View. I thought it gave some nice insight into what the Fed has been doing as well as another perspective on the Financial Crisis. He covers the steps that the Fed has been taking to resolve the crisis as well as what those implications are for both the Federal Reserve and the taxpayer.

Speech Transcript.

Putting the Recession into Perspective

From CNBC.com:

By: Albert Bozzo, Senior Features Editor | 13 Feb 2009 | 10:59 AM ET

If you think this recession is the worst since World War II, chances are you weren't born or working during the downturns of the 1970s and '80s, you're listening to President Obama too much or you're a white-collar worker in financial services.

If all three are true, you may even think we’re on the verge of another Great Depression.

At this point, the only thing that may be true is your age and employment status.

“The current situation has nothing in common with the Great Depression,” says economist Steve Hanke of the Cato Institute and Johns Hopkins University. “The sooner they [in Washington] stop spinning the bad news story and say nothing, the sooner we’ll be more confident.”

Hanke is not alone in dismissing what appears to be a potent cocktail of misinformation and doom and gloom, wherein the current recession—now in its 13th month—is already considered worse than the 16-month ones of 1973-1975 and 1980-1982.

“We were pretty scared in ’82; things looked horrible for awhile," says Bob Stovall of Wood Asset management and a 55-year veteran of the securities business. “I don’t think you can say it’s worse than then; its different. You have changed the landscape but you did that in the Midwest when you forced a lot of rust-belt companies to the wall."

“This time it's financial firms going out of business, instead of manufacturing ones, and the jobs are going with them," explains Stovall.

“I do think that's part of it,” says Robert Brusca, chief economist at Fact & Opinion Economics, saying that. “They’re the ones making the pronouncements. People in the financial sector are getting crushed.”

They’re not the only ones selling doom and gloom, though.

“I don’t remember a president talking down the economy as much as President Obama,” says economist Chris Rupkey of Bank of Tokyo-Mitsubishi. “The economy is very psychological. There’s a herd instinct.”

That herd instinct kicked into overdrive after the sudden collapse of Lehman Brothers, when many say the economy fell off a cliff and a classical cyclical downturn merged with a nasty one-of-kind credit crunch. So yes, economists agree things are bad, but they need to be put into perspective.

Employment

At this point, the current recession is worse than those of the '70s and '80s by only one statistical yardstick, and that’s the unusually quick ascent in the jobless rate—from 4.4 percent in March 2007 to 7.6 percent in January 2008.

“People are reacting so adversely to this is because the job market has become so weak,” explains Brusca.

But even though the sharp decline in payrolls over the past three months has been stunning, it is not as bad on a percentage basis as one period in 1974-1975, according to David Resler, chief economist at Nomura International. Resler says the economy would have to lose some 767,000 jobs a month over a three-month period from the current employment level to match that miserable performance.

During the 1973-1975 and 1980-1982 periods the unemployment rate almost doubled (4.6-9.0 percent, 5.6-10.8 percent, respectively), which means a peak of about 8.6-8.8 percent this time around. In further contrast, during a ten-month stretch in 1983-1983, the jobless rate was above 10-percent.

Nevertheless, that’s nothing compared to the Great Depression when the unemployment rate went from 3 percent to almost 25 percent in four years and national income was halved, notes Hanke in a recent column.

Growth

Thought it may be little consolation for the millions of unemployed, GDP is considered by economists to be the best and broadest gauge of a recession.

That may seem also peculiar since the economy actually grew in the first two quarters of this recession, but some of that had to do with the Federal Reserve's early and aggressive interest rate cutting and the federal government’s first stimulus plan which quickly put money into people’s pockets.

Given that backdrop, GDP contraction thus far has been modest. It’s down 1.1 percent vs. 3.1 percent in the 1970s period, says Chris Rupkey.

And though the economy shrunk at a 3.8 percent annualized rate in the fourth quarter of 2008 and is expected to decline another 4.0-6.0 percent in the first quarter of 2009, imagine the reaction today to the 7.8 percent plunge in the second quarter of 1980 or consecutive swoons of 4.9 percent and 6.4 percent in 1981-1982.

"Half of the workforce until now hadn't seen more than 16 months of recession—total," quips Resler. The past two short (eight months) and relatively shallow.

During the 1990-1991 recession, the deepest quarterly GDP decline was 3.0 percent; in the 2000-2001 one it was 1.4 percent.

“GDP hasn’t been that weak because the productivity increase is one of the best,” says Brusca. “You get a quarter or two that really knocks the level down,” he adds, and it looks like we’re at that stage now.

This time other fundamental factors are playing a bigger role than the past.

“Consumer spending will be bad,” says Resler. “We haven’t three consecutive quarterly declines in consumer spending since the 1950s.” He’s definitely expecting a repeat of that.

It’s Still Bad

Comparisons aside, no one is saying the current recession isn’t a painful one, and some see very little reason for optimism.

“I can't identify anything than looks good,” says Dean Baker, co-director of the Center for Economic Policy And Research, adding that business investment—which appeared to be holding up—posted its sharpest decline in 50 years in the final quarter of 2008.

“I'd be shocked if we have growth this year,” says Baker, even though he expects the Obama administration’s stimulus plan to have a sizable economic positive impact.

So may the words of the President and his advisors, say economists.

“It’s not surprising that politicians exaggerate this,” says Resler, who predicts “The tone of the message is going to start changing immediately; now that we have the stimulus in hand, you enhance it by saying positive things.”

Tunnel Thinking

For all the comparisons with other recessions, exaggerated or not, the most meaningful one may be its duration. It is also the toughest.

• Economy: Full Coverage

The consensus is this recession will end sometime between the second half of 2009 and the beginning of 2010. The pessimists say wait till next year—period.

David Jones, CEO of DMJ Advisors, is among those who see “hints of stability.” By that he means, the rate of decline in areas like retail appear to be slowing.

“We'll see the same thing happening on the housing side in the next couple months,” says Jones.

“I'm just waiting for the shift in people’s expectations,” adds Rupkey.

© 2009 CNBC.com

Wal-Mart's not the Enemy

From the Carpe Diem blog:

I recently posted about Charles Platt (pictured above), former senior writer for Wired magazine who took a job at an Arizona Wal-Mart and blogged about it here. He now has a longer article in yesterday's NY Post titled "Fly on the Wal: Undercover at Wal-Mart, The Heartland Superstore That May Save the Economy." Here are some excerpts:

Some people, usually community activists, loath Wal-Mart. Others, like the family of four struggling to make ends meet, are in love with the chain. I, meanwhile, am in awe of it.

The company is rebuked and reviled by anyone claiming a social conscience, and is lambasted by legislators as if its bad behavior places it somewhere between investment bankers and the Taliban.

Considering this is a company that is helping families ride out the economic downturn, which is providing jobs and stimulus while Congress bickers, which had sales growth of 2% this last quarter while other companies struggled, you have to wonder why. At least, I wondered why. And in that spirit of curiosity, I applied for an entry-level position at my local Wal-Mart.

Getting hired turned out to be a challenge. The personnel manager told me she had received more than 100 applications during that month alone, chasing just a handful of jobs. Thus the mystery deepened. If Wal-Mart was such an exploiter of the working poor, why were the working poor so eager to be exploited? And after they were hired, why did they seem so happy to be there? Anytime I shopped at the store, blue-clad Walmartians encouraged me to "Have a nice day" with the sincerity of the pope issuing a benediction.

Despite its huge size, the corporation turned out to have an eerie resemblance to a Silicon Valley startup. There was the same gung-ho spirit, same lack of dogma, same lax dress code, same informality - and same interest in owning a piece of the company. All of my coworkers accepted the offer to buy Wal-Mart stock by setting aside $2 of every paycheck.

Almost all the employee rules devolved to the sacred principle of never, ever offending a customer - or "guest," in Wal-Mart terminology. The reason was clearly articulated. On average, anyone walking into Wal-Mart is likely to spend more than $200,000 at the store during the rest of his life. Therefore, any clueless employee who alienates that customer will cost the store around a quarter-million dollars. "If we don't remember that our customers are in charge," our trainer warned us, "we turn into Kmart." She made that sound like devolving into some lesser being - a toad, maybe, or an ameba.

Coworkers assured me that the nearest Target paid its hourly full-timers less than Wal-Mart, while fast-food franchises were at the bottom of everyone's list.

I found myself reaching an inescapable conclusion. Low wages are not a Wal-Mart problem. They are an industry-wide problem, afflicting all unskilled entry-level jobs, and the reason should be obvious. In our free-enterprise system, employees are valued largely in terms of what they can do. This is why teenagers fresh out of high school often go to vocational training institutes to become auto mechanics or electricians. They understand a basic principle that seems to elude social commentators, politicians and union organizers. If you want better pay, you need to learn skills that are in demand.

The blunt tools of legislation or union power can force a corporation to pay higher wages, but if employees don't create an equal amount of additional value, there's no net gain. All other factors remaining equal, the store will have to charge higher prices for its merchandise, and its competitive position will suffer.

This is Economics 101, but no one wants to believe it, because it tells us that a legislative or unionized quick-fix is not going to work in the long term. If you want people to be wealthier, they have to create additional wealth.

To my mind, the real scandal is not that a large corporation doesn't pay people more. The scandal is that so many people have so little economic value. Despite (or because of) a free public school system, millions of teenagers enter the work force without marketable skills. So why would anyone expect them to be well paid?

You have to wonder, then, why the store has such a terrible reputation, and I have to tell you that so far as I can determine, trade unions have done most of the mudslinging. Web sites that serve as a source for negative stories are often affiliated with unions.

Do your part for the economy: stay home, do not spend

Families in debt must face up to financial reality: they are in a debt danger zone and should ignore politicians and businesses urging them to go and spend in order to boost the faltering economy. They should spend a bit less, save a bit more, and pay down some old debt.

This message comes from a Canadian economist, Roger Sauvé. He recently released a report entitled "The Current State of Canadian Family Finances," an annual review he has written for the Ottawa-based Vanier Institute of the Family for the past 10 years.

Among its key findings:

Average Canadian household debt rose to $90,700 in 2008. Total household debt now amounts to 140 per cent of disposable income. That ratio is at a record high. In 1990, before the last recession, the figure was 91 per cent.

Consumer and mortgage debt last year equalled 127 per cent of disposable income in the average family. This is about the same as the U.S. rate in 2006 "just before the bubble burst," the report notes. "The recession will likely push many more Canadians over the edge."

Spending and debt have risen much faster than incomes. Between 1990 and 2008, average household income rose 11.6 per cent, while spending increased 24 per cent and debt grew sixfold. At the same time, annual savings shrank to 3 per cent of disposable income, down sharply from 13 per cent in 1990.

Average net worth (wealth), which had been on the rise, fell in 2008 as a result of plunging stock markets and housing prices and the accompanying rise in debt.

Year-over-year consumer insolvencies (including bankruptcies and proposals) jumped almost 25 percent in October. Of particular concern, he adds, is the gradual climb for those age 55 and older, who are traditionally among the least debt-laden.

Laurie Campbell, executive director of Toronto credit counselling agency Credit Canada, said families should heed Sauvé's warnings and ignore pleas to help the economy by buying.
In theory, encouraging people to spend during a recession makes sense if they have the means to do it, she said. But not this time. "When we have savings at all-time lows and debt levels at record highs, there is absolutely no wiggle room."

How a US Housing Slump spreads the pain to Canada

Today Canadian Transport Minister John Baird, whose responsibilities include federal infrastructure, announced a planned $7 billion in infrastructure spending over the next two years, with emphasis on job-rich public works projects that can be started this year.

The $7-billion in new infrastructure funding also includes a $2-billion fund to support repairs and maintenance and accelerated construction at colleges and universities across Canada, and a $1-billion Green Infrastructure Fund.

The past week has seen an unprecedented series of budget previews, beginning last week when Harper's office indicated the country will run deficits totalling $64-billion over two years. And yesterday the Human Resources Minister Diane Finley announced that the budget will include $1.5-billion in training funds for laid-off workers.

In the wake of a coalition threat to topple the minority Conservative party last November, efforts at openness have taken place within the federal government. Individual provinces have put forward hundreds of ideas over the past few months for how to spend the multibillions the government plans to make available for roads, bridges, water-treatment plants, broadband initiatives and the like. The premiers also met with the Prime Minister and made suggestions on how to reform Employment Insurance and spend money on retraining.

It was a far cry from last year when Mr. Flaherty advised international investors that Ontario was one of the worst places in the world to invest.

But whether the Prime Minister can rebuild trust quickly is still a question. The government reconvenes today and the budget is presented tomorrow. Liberal leader Michael Ignatieff has said he will meet with his advisors after learning the contents of the budget and make a decision whether to support it or not within 24 hours.

Excerpts from an article in the Globe and Mail:

Looking through the blizzard of economic statistics, one stands above all else as a reliable barometer of where the Canadian economy is headed.

And it isn't even Canadian - it's U.S. housing starts.

When a backhoe digs into the ground in Phoenix or Peoria, starting work on a new home, it sets off a chain reaction of purchases that ripples through the North American economy.
Each new home generates hundreds of thousands of dollars in purchases ranging from labour, cement and lumber all the way to chandeliers and big-screen TVs.

Unfortunately for Canada, this great economic engine is still gearing down. At the height of the housing boom in 2005 and 2006, Americans were breaking ground on new homes at a rate of more than two million a year. In December, housing starts fell to a new postwar annual low of 550,000, according to figures released yesterday.

Recessions have little regard for national boundaries - least of all the 49th parallel.
"Canada can't insulate itself," said Craig Alexander, deputy chief economist at Toronto-Dominion Bank. "It's going to go along for the ride."

It all starts with Canada's heavy reliance on exports to its southern neighbour. The percentage has slipped over the past decade, but nearly 80 per cent of Canadian goods exported still go to a single foreign customer: the United States. And those exports contributed roughly 22 per cent of economic activity. Add in services, and the U.S.-centric orbit of the Canadian economy is even more pronounced.

Americans aren't just buying fewer homes: it's cars, computer software, potash and a whole lot else.

U.S. businesses are retrenching at an alarming rate, buying less and demanding lower prices.

Exports aren't the only conduit for the radiating U.S. economic pain. As the world's largest consumer, the United States helps set the price of the major commodities that Canada depends on for much of its wealth: oil, forest products, minerals and agricultural products.

The price of oil has plummeted to roughly $40 (U.S.) a barrel from more than $147 as recently as six months ago. Other commodity prices have also fallen, though not as sharply.

With the eastern part of the country already in recession, the commodity price collapse brought down the West, according to TD's Mr. Alexander. This year, the economy is expected to shrink in every province, except Saskatchewan.

"We didn't feel the effect of what was going on in the U.S.," said Stéfane Marion, chief economist at National Bank Financial Inc. in Montreal.

The root problem is that U.S. banks and their consumer customers took on too much debt, Mr. Marion explained. That isn't the case in Canada, but it's still our problem.

"We are in the second phase of the recession," Mr. Marion said. "The second wave is coming from the auto industry and the drop in commodity prices."

The U.S. problems have also migrated northward through the credit markets, upon which companies on both sides of the border rely to finance their operations. Tighter credit in the U.S. quickly led to the same in Canada.

"To a large extent, the Canadian economy is integrated north-south, not east-west," Mr. Alexander said. "The Canadian economy gets hit from all of these channels."

If you look back over recent decades, the correlation between U.S. and Canadian economic cycles, it's a virtual perfect match, said BMO Nesbitt Burns economist Sal Guatieri.
"It's almost impossible to avoid the U.S. fate," he said.

Canada suffered more than the United States during the recessions of the early 1980s and 1990s, weighed down by higher interest rates and government deficits.

The good news now is that economists don't expect Canada's slump to be as bad.

"The Canadian recession will be half as bad and half as long as the U.S. recession," Mr. Guatieri predicted.

Another bonus for Canada is that it's about to get what amounts to a double dose of economic stimulus.

There's Mr. Harper's plan, and then there's Mr. Obama's $800-billion-plus (U.S.) package.
It hardly matters how all the money is spent because the same channels that spread this made-in-USA recession to Canada will eventually carry the next economic expansion northward.

The lag of Government spending

From Carpe Diem:

WASHINGTON POST -- Less than half the money dedicated to highways, school construction and other infrastructure projects in a massive economic stimulus package unveiled by House Democrats is likely to be spent within the next two years, according to congressional budget analysts, meaning most of the spending would come too late to lift the nation out of recession.

A report by the Congressional Budget Office found that only about $136 billion of the $355 billion that House leaders want to allocate to infrastructure and other so-called discretionary programs would be spent by Oct. 1, 2010. The rest would come in future years, long after the CBO and other economists predict the recession will have ended.

For example, of $30 billion in highway spending, less than $4 billion would occur over the next two years. Of $18.5 billion proposed for renewable energy, less than $3 billion would be spent by 2011. And of $14 billion for school construction, less than $7 billion would be spent in the first two years.

From Bruce Bartlett's Wall Street Journal article "If It Ain't Broke, Don't Fix It" (12/2/1992):

This follows the pattern of postwar countercyclical programs: All were enacted well after the end of the recession. They exacerbated inflation, raised interest rates and made the next recession worse.

Bartlett documents the fiscal stimulus plans that were passed in response to the recessions 1948-49, 1957-58, 1960-91, 1969-70, 1973-75, and 1981-82, and shows that: a) in each of the six recessions, the fiscal stimulus legislation wasn't even signed into law until the end of the recession at the earliest, and in some cases wasn't passed until a year after the recession ended, and b) in all cases the fiscal stimulus plans took effect well after the recessions had ended.

MP: There has been a lot of debate lately about the effectiveness of stimulus plans, and the size of the multipliers, etc., and most of that debate probably assumes that the timing of the stimulus is perfect. But what if the timing isn't perfect, due to the long legislative lags designing the policy and the long lags before the policies actually take effect? In that case, even if some of the multiplier effects work as intended, it's still possible the policy will fail, and will actually destabilize an economy that has already recovered from a recession.

In other words, unless fiscal stimulus is timed perfectly, it will fail to stimulate the economy. Given the reality of legislative and effectiveness lags, perfect timing is impossible. Given that reality, fiscal stimulus policy won't work due to the problem of lags, regardless of any multiplier effects.

See Greg Mankiw's related post about fiscal policy lags here.