MultipleExplanationsfor - Cato Institute...financial innovations, and outsourcing ... suggests that the average productivity of ... tion, and globalization—all demand-side

46 / Regulation / Winter 2016–2017

i n r E V i E W

Multiple Explanations fora Largely Invisible Crisis✒ Review by Dwight R. Lee

Like a lot of economists writing on political issues, Americanenterprise institute scholar nicholas eberstadt focuses atten-tion in his new book, Men Without Work, on what he believes is

an extremely serious but “largely invisible crisis,” and makes a case forgovernment action to confront the problem. Unlike most such calls,

Dw ight R . Lee is a senior fellow in the william J. O’NeilCenter for global Markets and Freedom, Cox School ofbusiness, Southern Methodist University. he is a coauthorwith James gwartney, Richard Stroup, tawni Ferrarini, andJoseph Calhoun of CommonSense Economics:What EveryoneShouldKnow aboutWealth andProsperity, 3rd ed. (St. Martin’sPress, 2016).

however, instead of wanting governmentto do more, eberstadt gently suggests thatit do less. But his gentle suggestions arenot gentle enough for two economists/policy analysts who respond to the argu-ments in the last part of his book.

the crisis that concerns eberstadt isthe relentless downward spiral of the laborforce participation rate (LFPr) of prime-age American males between 1965 and2015. He begins Chapter 1 by pointing outthat so far in the 21st century we have seenthree fundamental indicators of economichealth that typically move together—wealth, output, and employment—losetheir alignment. the growth in wealth asmeasured by net worth of U.S. householdsand nonprofit institutions has surged,almost doubling between early 2001 andlate 2015. Yet, real per-capita output wasbarely 3% higher in the first quarter of 2016than it was eight years earlier.

there are different explanations for thiscollapse in economic growth. A compelling(though partial) explanation is found inthe labor market despite a steady streamof cheerful reports of a decreasing unem-ployment rate. eberstadt points out, “ifour nation’s work rate today were backto its start-of-the-century highs, approxi-mately 10 million more Americans wouldcurrently have paying jobs.” the LFPr forprime-age males declined from 94.1% in

1948 to 84.1% in 2015, and almost all ofthat decline has taken place since 1965.the decline occurred as the LFPr forprime-age females more than doubledbetween 1948 and 2015.

interesting details / in his first three chap-ters, eberstadt expands on numerousdetails concerning the real and troublingflight from work by U.S. men. Chapter 4begins with the observation that as coun-tries become wealthier, theircitizens generally consumesome of their additionalwealth in leisure. the U.S.experience, however, differsfrom that in other modernWestern economies in “pecu-liar, if not anomalous” ways.Working Americans “spendmarkedly longer hours on thejob than their counterparts inaffluent european countriesand Japan.” Yet, in 2014 theUnited States ranked 22ndout of 23 countries in prime-age male LFPr, coming inahead of only italy.

Chapter 5 contrasts menwho are, and who are not,participating in the labor force. Prime-age men who are not in the labor forceare apparently paying little attention toinformation provided by labor markets onjob opportunities, since “fully two-thirdsof [them] who were not in the labor force(niLF) for any part of 2014 were out of itfor the entire year.” in terms of race,

By 1965, both prime-age work rates andLFPr were already substantially lowerfor black males than whites. they alsodropped far more steeply for blacksthan whites over the next 50 years. it isworth noting, however, that those rateswere higher for black men in 1965 thanthey are for white men today.

the data eberstadt uses are for non-insti-tutionalized populations. the more edu-cation a man has, the more likely he is tobe working. Also, being married or havingbeen married increases the chances that aman will have a job or be actively lookingfor one. Finally, regardless of ethnicity, for-eign-born men of prime-employment ageare more likely to be employed or lookingfor a job than their ethnic counterpartsborn in America. in addition, immigrantshave higher LFPr than native-born Amer-icans over all educational levels except forcollege graduates.

in Chapter 6, after making the tradi-tional distinction between leisure (which

refines and elevates) and idle-ness (which corrupts), eber-stadt considers how prime-age niLF men use theirtime. According to the Cen-sus Bureau’s Annual Socialand economic Survey, whenprime-age men who did nothave a paying job at all in 1994and 2014 were asked why theydidn’t work, only 16% and15%, respectively, answered,“the inability to find work.”even at the bottom of theGreat recession in 2009, only28% provided that answer.

So how are niLF menspending their day comparedto employed men? Making use

of the U.S. Department of Labor’s “Ameri-can time Use Survey,” eberstadt finds thatniLF men spend 1 hour and 16 minutesmore than the latter on daily personal care,including sleeping; 31 minutes more onhousehold care; the same amount of timeon caring for household members; 5 hoursand 54 minutes less on work—which means

Men without work:America’s invisibleCrisis

by Nicholas eberstadt

216 pp.; templetonPress, 2016

Winter 2016–2017 / Regulation / 47

they worked just 7 minutes a day; 2 minutes lesson eating and drinking; and 4 hours and11 minutes more on socializing, relaxing,and leisure—which surely involved drinkingnot included in the “eating and drinkingcategory. regarding the leisure-based activi-ties of prime-age niLF men, eberstadt tellsus that in 2014 they spent more time thanworking men and women or unemployedmen listening to radio, watching televi-sion, using tobacco and drugs, gambling,and (perhaps incongruously, according toeberstadt) engaging in hobbies involvingarts and crafts. this chapter clearly leavesthe impression that niLF men are not, as agroup, very productive.

demand-side or supply-side? / Chapter 7considers two types of explanations forthe men without work problem: demand-side and supply-side. eberstadt clearlyrecognizes the importance of both, butdoubts that demand-side factors, suchas international trade, technological andfinancial innovations, and outsourcingand temporary work dominate supply-side factors.

He cites from the 2016 Report of the Presi-dent’s Council of Economic Advisers:

A number of studies have identifieddeclining labor market opportunitiesfor low-skilled workers as the mostlikely explanation for the decline forprime-age male labor force participa-tion, at least for the period in the mid-to-late 1970s and 1980s.

He then discusses five qualifications sug-gesting demand-side explanations areless compelling than commonly believed.First, there has been a steady decline inLFPr males since 1965. Second, workrates for women have been less affectedby recessions than have the rates for men.third, work rates are not typically reducedmuch by slow growth in affluent moderneconomies. Fourth, the LFPr for someless-educated prime-age American males(in particular, foreign-born and lower-skilled males) have increased since 1994.And fifth, if demand-side influences werethe primary reasons for low male LFPr,

one would not expect the large regionaldifferences in those rates to be more per-sistent than they would be with normallabor mobility. Long-term and large dif-ferences in male LFPr, even in adjacentstates, indicate that workers are not mov-ing in response to labor market oppor-tunities. these qualifications suggestthat it is supply-side influences that arereducing the LFPr of lower-skilled males,with dependence on government transfersan important influence by reducing themales’ labor mobility.

Welfare and the underground economy /How dependent are prime-age niLF menon government transfers, and what aretheir living standards? the data eberstadtcites and discusses in Chapter 8 seem tosupport the view that these men havebecome increasingly dependent on gov-ernment transfers and they live in low-income households, which strengthensthe supply-side explanation for the declin-ing LFPr for men. there is no doubt thathe is correct that it has become easier formen to qualify for disability payments,with Social Security Disability insurancebeing the main source of these payments.the number of men taking advantage ofthese payments has significantly increasedover the last 50 years.

Without going into the details of thedata, let me consider an omission in hisdiscussion that could have importantimplications for the seriousness of theproblem he is considering. He fails to con-sider an important source of income avail-able to prime-age niLF men that could bereducing the social costs of men droppingout of the labor force.

recall from my discussion of Chapter 6that eberstadt cites data showing niLF menwork only 7 minutes a day on average. thisestimate seems to ignore the possibility thatmany men recorded as niLF are actuallyworking clandestinely in the undergroundeconomy (a possibility about which thereis—understandably—little solid evidence),which is estimated to be contributing $2trillion, or a little over 12%, to U.S. GDP.Most of that contribution is believed to

come from the poorest households, whichaccording to Chapter 8 are the householdscontaining most of the niLF men. thissuggests that the average productivity ofniLF men—though not as high as it couldbe if they were formally employed—is notas small as eberstadt indicates. this couldmean that the problem of men withoutwork is not as serious as he would have usbelieve, at least in terms of lost productiv-ity. to the extent this is true, however, itstrengthens his view that government sup-port payments motivate lower-skilled mento leave formal employment. the incomelost by doing so can be more than made upby earnings from less-productive employ-ment in the underground economy.

Furthermore, ignoring the productiv-ity that men classified as being “withoutwork” may be contributing in the under-ground economy does not necessarilymean that eberstadt has overstated thesocial loss from the decreased LFPr ofprime-age men. Consider that in Chapter9 on crime and the decline in work, hewants “to understand the impact of [theupsurge in arrests, felony convictions, andincarcerations] on male work patterns inmodern America.” And he presents strongevidence that criminal activity and incar-ceration correlate with men becoming lessemployable, though he is careful not tomake causal claims.

A plausible case can be made thatwelfare payments increase felony convic-tions and incarceration and thereforecause reductions in LFPr of prime-agemales. that case goes as follows: As pre-viously argued, the possibility of engag-ing in the underground economy adds tothe incentive created by public assistancefor less-educated men to drop out of theformal labor market. this likely increasesthe number of men who get involved incriminal behavior and end up doing timein prison, thus becoming a greater cost onsociety and less attractive as an employee.even if not a major factor in employmenttrends, this could still explain how welfareassistance causes a long-term decline inLFPr for men by interacting with crimeto generate that decline.

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Some solutions / in his closing chapter,eberstradt offers some brief policy rec-ommendations. While acknowledgingthat addressing the men without workproblem requires action on many differentfronts—and certainly not just governmentaction—he suggests devoting closer atten-tion to three broad objectives:

■ revitalize American business and itsjob-generating capacities.

■ reduce the immense and perverse dis-incentives against male work embed-ded in our social welfare programs.

■ Come to terms with the enormouschallenge of bringing convicts and fel-ons back into our economy and society.

taking appropriate government actionon these issues would require undoingmuch that government currently does. Forexample, eliminating a lot of governmentregulations and scaling back the govern-ment wars on poverty and drugs wouldgo a long way toward accomplishing eachof the three objectives (respectively). Giventhe prevalence of poor education amongniLF men, it is surprising that eberstadtdoesn’t mention the importance of undo-ing the barriers that currently protect pub-lic K–12 schools against competition.

addressing critics / Men Without Work endswith two dissenting points of view, fol-lowed by a response from eberstadt. thefirst dissenter is Henry Olsen, a seniorfellow at the ethics & Public Policy Cen-ter. Olsen recognizes the negative con-sequences of men dropping out of thelabor force, but believes eberstadt “over-estimates the causal effect of governmentsafety net programs … and underestimatesthe causal effect [of ] a changing labormarket.” Disappointingly, Olsen saysnothing about the government policiesthat restrict the ability of men to preparethemselves educationally for productiveemployment or about the barriers thatprevent them from getting entry-level jobsin which they could develop employmentskills. He does recognize the disincentivesof entitlements, but adds that “once menfeel they cannot reenter the workforce,

they need something to live on.”the second dissenter is Jared Bernstein,

formerly chief economist and adviser toVice President Joe Biden and now with theCenter on Budget and Policy Priorities. Heagrees that men without work is a seriousproblem, but disagrees with eberstadt thatit is underappreciated. Bernstein mentionsconcerns about automation, immigra-tion, and globalization—all demand-sideinfluences on the declining percentage ofprime-age men in the labor force.

His more important disagreement witheberstadt concerns the latter’s belief thatthe downward trend in men’s LFPr islargely a supply-side problem, which Ber-nstein considers a serious misdiagnosis.not surprisingly, his suggested solutionsare limited to policies he must believe willincrease the demand for workers otherwiselikely to leave the workforce. i admit tobeing mildly surprised when he listed—nodoubt with plenty of demand-side enthu-siasm—raising minimum wages. Obvi-ously, raising the wage floor is a toughway to address weak labor demand. i am

reminded of a man who responds to hisboat taking on water by drilling a hole inthe boat’s bottom to let the water run out.

ebersadt responds politely to these crit-ics, pointing out that, except for a few laboreconomists at think tanks and universities,“menwithoutwork”remains largely ignoredby almost everyone else in the country,including most policymakers in Washing-ton. He also points out that he doesn’t claimwelfare and disability programs “caused themale flight from work, but rather financed it”(emphasis in original). As indicated earlier,i think eberstadt is a little too reticent toassign causation, but his dissenters don’tthink he is reticent enough.

i strongly recommend Men WithoutWork. it is a well written and informativebook on an important issue. i also recom-mend a previous book of eberstadt’s, ANation of Takers (templeton Press, 2012).that book considers the broad economicand social effects of public assistance pro-grams. it exhibits less caution about causa-tion, as indicated by its subtitle, America’sEntitlement Epidemic.

Finding the Money✒ Review by gReg KAzA

Heather Boushey’s new book, Finding Time: The Economics ofWork–Life Conflict, is topical for one reason: presidential hope-fuls Hillary Clinton and Donald trump both supported

taxpayer-subsidized child care.

gR eg K A zA is executive director of the Arkansas PolicyFoundation.

Clinton proposed to make “preschooluniversal for every four-year-old in Amer-ica” by spending more tax dollars to pro-vide a “living wage” to “America’s child careworkforce.” Her goal was to “significantlyincrease” government expenditures, whichshe termed “investments,” so that “no fam-ily in America has to pay more than 10percent of its income to afford high-qualitychild care.”

trump called for “rewriting the taxcode to allow working parents to deduct

from their income taxes child care expensesfor up to four children and elderly depen-dents.” He would also “provide low-incomehouseholds an expanded earned incometax Credit—in the form of a childcarerebate—and a matching $500 contribu-tion for their savings accounts.”

Both wanted to expand the Family andMedical Leave Act of 1993, which requiresemployers with 50 or more employees toprovide 12 weeks of unpaid leave. trumpproposed six weeks of paid maternity leave;Clinton would have required employers topay for 12 weeks.

Boushey leads the Washington Center

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forequitableGrowth,a thinktankfoundedby John Podesta, Clinton’s campaign chair.Boushey was named chief economist ofClinton’s presidential transition team inAugust. Her book can be summarized inone sentence: taxpayer-subsidized childcare is a pressing economic issue.

She links taxpayer-subsidized child careto changes in the domestic economy. Sheargues:

American businesses used to havea silent partner. this partner nevershowed up at a board meeting to make ademand but was integral to profitability.that partner was the American Wife.

She goes on to note:

in 1960, two-thirds of children lived in afamily where their parents were marriedand only their father worked outside thehome. this kind of family was commonacross all income levels.

today, women’s greater labor force par-ticipation influences upper-, middle-,and lower-income household decisions,demanding “a rethinking of the socialcontract between governments, firms, andfamilies.”

Middle-class households, she con-tends, face lower expectations. “Mostmiddle-class children now grow up in adual-earner or a single-parent family,” shewrites, leading households to lower eco-nomic expectations, make “Mom the newBreadwinner,” or increase debt loads. Low-income households face a “lack of income-mobility,” their members confronted with“erratic and unpredictable schedules” thatforce them to turn to “extended kin net-works” for support. Professionals also facechallenges. For many of them, Bousheywrites, “maintaining their place in theeconomic hierarchy requires a great dealof time and effort.” this leads to “facetime” demands at work and disregard forlife outside the office. All three groups areaffected by American businesses’ loss oftheir silent partner.

She cites 1930s-era new Deal legisla-tion as precedent to advance her case forpolicy changes in 2016. Among those prec-

edents are the 1935 Social Security andnational Labor relations acts, and the1938 Fair Labor Standards Act. Clinton’spolicy agenda would have added taxpayer-subsidized child care as well as paid sickdays, short-term time off, and “paid familyand medical leave.” Boushey wants to addgreater scheduling predictability and a limiton what she calls “overwork.”“An option to telecommutemay not help a working par-ent whose home office hasbeen turned into a playroomor the receptionist and lineworkers who must physicallybe at work,” she writes. “Butbetter scheduling practicesmay be especially helpful to alltheseworkers.”Herargumentsadvance an ambitious agenda.

the most ambitious goalis universal child care. Shelinks “early childhood edu-cation and the quality ofcare” to economic growthand argues for free or low-cost universal access to pre-kindergarten for all 3- and4-year-olds. She notes approvingly thatthe U.S. Senate and House passed legisla-tion in 1971 that would have “establisheda network of nationally funded, locallyadministered, comprehensive child-carecenters.” President richard nixon vetoedthe measure, though today’s republicansmight embrace the idea if they can be con-vinced to view the issue through the lensof economic, not social, policy.

How to pay for these programs? Bousheyclaims that “my proposals will cost taxpay-ers—and businesses—very little.” elsewhere,though, she concedes that “there are someadded costs for businesses when imple-menting work-life policies,” though theyaren’t quantified. She argues that “flexibilitysaves firms money” and that the stock mar-ket tends to respond positively when firmsintroduce workplace flexibility. She tries topersuade business, citing a 700-firm studythat found employers consider adoption ofworkforce flexibility policies to be manage-rial common sense.

Some firms and the U.S. governmentprovide care onsite or have flexible workschedules. “About eight in ten firms allowsome employees some flexibility over whenthey start or end work.” the problem?it’s still “far from the norm in the work-place for all or even most.” Boushey citesreal-world examples: San Francisco and

Connecticut’s paid sick-daypolicy; Alaska and Minneso-ta’s prohibition on employ-ment discrimination forfamily responsibilities; andpaid family leave in Califor-nia, new Jersey, and rhodeisland (financed by a tax onemployees). Do these policiesboost family incomes? Datathrough a complete economiccycle are not presented.

Unfortunately, she doesnot discuss a host of otherimportant matters: firms’current economic incentiveto be flexible in schedulingto retain skilled labor; federaleconomic policies’ contribu-tion to the weak jobs growth

described in the book; the role of churches,service clubs, and other voluntary organi-zations in providing support to families;and robots as household labor savers.

interestingly, Arkansas—home of sev-eral real-world Clinton policy experimentsinvolving labor and families—is not dis-cussed.Arkansasper-capitapersonal incomewas stagnant from 1983 (when Clintonchaired the state’s educational StandardsCommittee) until a decade ago. in 1983,Arkansas’ per-capita personal income was75.4% of the nation’s, and it hovered in themid-70s through 2006, when it was 76.8%,according to the U.S. Bureau of economicAnalysis. in 2007, state lawmakers votedto reduce Arkansas’ regressive grocery tax.that appears to have helped; in the last fewyears Arkansas’ per-capita personal incomehas been around 80% of the nation’s. inter-estingly, Clinton’s husband raised that taxwhen he was Arkansas governor.

My wife and i read Boushey’s bookand were left with the impression that the

Finding time:the economics ofwork–Life Conflict

by heather boushey

360 pp.; harvardUniversity Press, 2016


i n r e v i e w

Banning Cash: ThisTime is Not Different✒ Review by PieRRe LeMieUx

Ken rogoff is a former chief economist at the international Mon-etary Fund and now professor of economics at Harvard Univer-sity. Just after the recent recession, he published with Carmen

reinhart a best-seller entitled This Time Is Different, an ironic and iconictitle pointing to the hubris of thinking that our times were different

PieR R e LeMieUx is an economist in the Departmentof Management Sciences of the Université du Québec enOutaouais. his last book isWhoNeeds Jobs? Spreading Povertyor IncreasingWelfare (Palgrave Macmillan, 2014).

and immune to financial crises.As we shall see, this general idea is not

unrelated to rogoff ’s latest book, TheCurse of Cash, in which he proposes noth-ing less than a government prohibition,or near-prohibition, of cash in order tocripple the underground economy andpromote monetary policy. He has beenmaking this argument for two decadesand has been joined by a few pundits,economists, and bankers.

the term “cash” has many meanings,all referring to liquid assets—that is, assetswhose values can be realized rapidly. in itsnarrowest sense, cash refers to paper cur-rency (dollar bills in the United States),which is what rogoff and other propo-nents of abolition are referring to. Coinsare typically not included in this definitionof cash, and their value would add a mere3% to paper currency anyway.

Paper currency makes up about 10%of the total stock of U.S. money (usingthe M2 measure of money). the rest isessentially electronic money representedby accounting entries in the computers ofbanks, transferable by check, debit cards,direct transfers, and similar means. if all

cash were abolished, only electronic money(and coins) would remain.

rogoff claims to take a moderatestance. He stresses that cash would bephased out over 10 or 15 years. the larg-est denominations would go first, startingwith $100 and $50 bills, and then the $20.Smaller denominations ($10 and lower)might be kept because they are useful forsmall transactions and for low-incomepeople who may not have bank accountsand debit cards. But those bills mightbe banned too, and replaced by “equiva-lent-denomination coins of substantialweight.” it’s more difficult to becomea criminal if you always have to push awheelbarrow of money before you.

During the phase-out period, the gov-ernment would replace paper currencywith interest-bearing bonds, which couldof course be cashed and converted to elec-tronic money. there would be no overtconfiscation, except for those who chosenot to turn in their money earned illegally.

Whether the ban would be total or near-total, rogoff’s argument is that cash is badbecause it facilitates crime and becauseit prevents monetary policy from push-ing interest rates much below zero. thetwo main parts of The Curse of Cash explainthese two reasons for considering cash a

author considers parents like us helpless tocraft voluntary solutions to the time con-straints we face balancing work and familylife. these solutions range from voluntarydecisions to reduce consumption in sup-port of increased education spending, to

the use of time-saving technologies thatincrease efficiency and productivity at thehousehold level. Parents seeking voluntarysolutions that fit their unique situationswill likely be disappointed by those impor-tant omissions.

curse to be eliminated.

Fighting crime / rogoff believes that reduc-ing crime is the major reason for banningcash. He argues that cash is mostly used incriminal activities. its advantage for crimi-nals is that it is anonymous and that largedenominations are relatively easy to trans-port and store.

Surveys suggest that American con-sumers hold less than 20% of the part ofU.S. currency that circulates domestically.Moreover, 80% of the value of U.S. cur-rency is made of $100 notes, which ordi-nary consumers do not often use. (“note”or “banknote” is the technical term for apaper currency bill.) it is inferred that alarge part of cash must therefore be usedin criminal activities: tax evasion (notablyin small, cash-intensive retail businesses),drug transactions, and other illegal trans-actions in the underground economy. thesame appears to be true in other countrieswith their own currencies.

reducing tax evasion, rogoff calculates,would produce government revenues thatwould more than compensate the loss ofseigniorage. Seigniorage is the differencebetween the government’s cost of printingdollar notes and their market value.

this argument underestimates theneed of a free society for institutionalconstraints on state power. that theseconstraints often benefit criminals is nota sufficient argument for depriving othersof that protection. Criminals are prob-ably more likely than blameless citizens toinvoke the Fifth Amendment against self-incrimination, or the Fourth Amendmentagainst “unreasonable searches and sei-zures.” the eighth Amendment, against“cruel and unusual punishments,” lookseven more tailor-made for criminals. Butlimiting government power is necessaryto protect the innocent. even the pro-hibition of cruel and unusual punish-ments does, because many innocentswould plead guilty to lesser charges ifthe alternative in the plea-bargain offerwere excruciating torture.

“it is no accident,” rogoff wrote in a WallStreet Journal op-ed previewing his book,

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the government is able to collect morerevenue from tax evaders, it will bein a position to collect less taxes fromeveryone else.” this common argumentassumes an angelic government thatdutifully raises the minimum amountof taxes necessary to produce the publicgoods that all individuals want. in thereal world described by public choicetheory, Leviathan always lurks behindgovernment; it will be tempted to maxi-mize its revenues, charging what themarket will bear, in order to benefit itselectoral clienteles and enlarge the powerand perks of politicians and bureaucrats.in this perspective, the built-in constraintof tax evasion prevents government fromgrabbing more money from all taxpayers.

We can extend this reasoning to theunderground economy, which exists inlarge part because of both taxes and regu-lation, including prohibitions. When taxesor regulations reach a certain level, peoplestart retreating into the undergroundeconomy, which provides a built-in brakeon state encroachment. Harold Demsetz,the famed University of California, LosAngeles economist, hypothesized that asgovernment expenditures reach 25% ofgross national product (a concept closelyrelated to gross domestic product), “thefeedback system of underground trans-actions starts to become significant.” Hecontinued, “the feedback becomes moreforceful as the government sector increasesbeyond 30%, making the size of that sectordifficult to push much beyond 45% of realGnP in a democracy.”

Writing in 1982, Demsetz may havebeen too optimistic about where exactlythe built-in constraints of tax evasion andthe underground economy stop the state’svoracity. But these constraints are certainlystronger in a freer country, and that is abenefit, not a cost.

negative interest rates / the second broadargument that rogoff invokes againstcash is that it prevents monetary policyfrom pushing interest rates far into nega-tive territory, which he thinks is some-times required. to understand this argu-

“that whenever there is a big-time drug bust, the authori-ties typically find wads ofcash.” i suspect they also findcars. Suppose a law mandatedthat cars had to be equippedwith factory-installed, non-removable GPS devices andairplane-like black boxes inorder to combat their involve-ment in organized crime. As aconsequence, criminals mightswitch to horses and theauthorities would find horsesat big-time drug busts. Couldone then argue that horses—that inconvenient relic of thepast, just like cash—should beprohibited for everybody?

At the margin, some cost-benefitguesses are unavoidable in legislation, butbanning neutral things and exercisingprior controls are generally shunned ina free society, and for very good reasons.For example, alcohol is involved in about athird of crimes (according to Departmentof Justice estimates), but that does not jus-tify a new Prohibition. A similar argumentcan be made for cars, guns, and many othergoods. twitter is used by terrorists. But ina free society, deterrence through punish-ment is preferred to general prohibitionsand prior controls.

legitimate demand / there is obviouslya legitimate demand for cash, which isused in some 60% of small purchases (upto $10). Many find cash convenient, andnot only for emergencies. even for largepurchases, some individuals may have alegitimate reason to protect their privacy.Ultimately, all preferences are subjective,and economic efficiency is defined interms of what individuals want accordingto their own preferences.

interestingly, cash is one of the fewgoods that government seems to be effi-cient at producing. Such has not alwaysbeen the case and it is not true in all cir-cumstances. rogoff documents severalhistorical cases when governments havedebased paper currency by running the

printing press too fast. intoday’s rich countries, gov-ernments have more sophisti-cated ways than the printingpress to debase money. Solet’s keep the focus on cash.

About one-half of U.S.paper currency circulates inforeign countries. in “dol-larized” countries such asPanama or ecuador, the U.S.dollar is the official currency.in other countries, peopleuse dollar notes illegally (inview of local laws) to pro-tect themselves against thedebasement of their nationalcurrency by their own gov-ernment. this happened in

Zimbabwe just a few years ago after thegovernment had printed so many Zim-babwean dollars as to render them nearlyworthless. Galloping inflation became sorapid that the reserve Bank of Zimbabwewas printing notes in denominations of100 trillion Zimbabwe dollars.

that the poor Zimbabweans had touse U.S. cash to protect themselves againsttheir government’s exactions reminds usthat not all crimes are created equal, evenin Western countries. there is certainly abig difference between terrorism (wherethe use of cash is only “a relatively minorfactor”) on the one hand, and tax evasionor hiring an illegal immigrant for cash inthe underground economy on the other.

On the benefit of a cash ban in fight-ing illegal immigration, rogoff wrote inhis Wall Street Journal piece that “it surebeats building walls.” i’m not so sure, ifonly because banning cash is a virtual wallthat would also capture citizens. At anyrate, the economist venturing into norma-tive matters would normally attach thesame weight to a foreigner’s welfare as toa national’s. this is what the individualistmethodology of economics suggests.

Built-in constraint / Furthermore, rogoffdoes not see that some actions legallydefined as crimes constitute useful con-straints on the state. He writes that “if

the Curse of Cash

by Kenneth S. Rogoff

296 pp.; PrincetonUniversity Press, 2016

i n r e v i e w


ment, a little detour into monetary theoryis necessary.

Keynesian-inspired macroeconomic the-ory holds that recessions or slow recoveries(like the current one) are due to a deficiencyof “aggregate demand.” Government hasto boost aggregate demand by either fiscalor monetary policy. Keynes preferred fiscalpolicy—increasing government spendingor reducing the tax burden—but monetarypolicy has been fashionable lately. Monetarypolicy is supposed to work through thecentral bank pushing down interest ratesand thus stimulating investment and con-sumption expenditures. (real and nomi-nal interest rates are the same if expectedinflation or deflation is zero; otherwise theydiffer. to simplify this brief summary ofthe argument for negative interest rates, iassume no expected inflation or deflation,except otherwise specified.)

Pushing down interest rates will notwork when they are already at zero. intheory, the central bank could continuebuying bonds for more than their priceat maturity, thereby pushing their yieldsinto negative territory. it could also chargea negative rate to the banks that depositmoney with it. But as interest rates gobelow zero, it becomes less onerous forsavers and banks to keep their money incash—that is, in dollar notes—because atleast then they don’t lose the negativeinterest. the existence of cash preventsthe central bank from pushing interest ratebelow the zero bound constraint.

in reality, the “zero bound” constraintis not at zero, but slightly below. Storingcash is risky: it can be stolen or destroyedby fire. Secure storage, including insur-ance, costs something, especially for largevolumes of cash—perhaps between 0.5%and 1% of the value stored. So interest ratescan be pushed down to –0.5% or –1%, butnot further.

A negative interest rate looks like astrange creature. it means that lend-ers (including holders of bank deposits)must pay to lend, and borrowers get paidto borrow. Lenders will accept this only ifthey think that their savings are otherwisethreatened with even larger depreciation.

note that real interest rates can be tem-porarily negative if nominal interest rates,although positive, are lower than the infla-tion rate; but inflation expectations wouldsoon push up nominal rates and correctthe situation. A negative nominal interestis a new phenomenon.

During the past few years, central bankshave run “quantitative easing” programswhereby they purchased bonds on theopen market, bidding up their prices andpushing down their yield. recently, theyhave pushed them slightly below zero insome european countries and Japan. thesenegative rates have not yet been passed onto bank depositors except for some largecorporate deposits. in America, short-terminterest rates are still positive but close tozero. if cash did not exist, the argument

goes, the central bank could decisivelypush interest rates below zero.

Hubristic risk / there are many argumentsagainst central banks pushing (or tryingto push) interest rates below zero.

For one thing, it overestimates thestate of economic knowledge. Our veryimperfect knowledge of the nature of thebusiness cycle is illustrated by the fact thateconomists still debate the causes of theGreat Depression and even of the 2008–2009 recession. Politicians and the generalpublic don’t know more. the power ofmonetary (or fiscal) policy to manipulateaggregate demand is limited. We don’treally know the consequences of monetarypolicies, especially unconventional oneslike negative interest rates—except thatthey don’t seem to show much success ineurope and Japan thus far. As The Economistobserves, “each new round of central-bankaction seems to bring less stimulus andmore side effects.”

the argument for a policy of negativeinterest rates may also overestimate theinfluence of central banks, which is debatedamong economists. Do central banks exerta determining influence on interest ratesor do they mainly follow broader markettrends? there is no agreement on whetherthe currently low interest rates are a con-tinuation of a downward market trend thatstarted in the 1980s, an effect of monetarypolicy, or a joint effect of both factors. itcan be argued that central banks are justaccentuating the downward trend. thereis much that we don’t understand.

rogoff underestimates the economicand political risk of negative interest rates.it would be too tempting for governmentto push rates further below zero and keepthem there for longer periods in order

to reduce its own bor-rowing costs. exporterswould exert pressure formore negative interestrates, as this should leadto a lower exchange rateand higher exports. (thelower interest rates are,the less foreign investors

will want the currency.) this way, the worldcould end up in a protectionist race tothe bottom. negative interest rates wouldprove detrimental to savers, future retirees,and insurance companies.

even if politicians and bureaucratsbecome saints and only manipulate inter-est rates in the public interest (assumingwe can agree on a definition of this elusiveconcept), they may unintentionally gener-ate bubbles in other markets such as com-mercial real estate or stocks.

rogoff recognizes these dangers, buthe has faith in government. He admitsthat monetary policy is plagued by igno-rance and uncertainty, but he thinks thatproceeding cautiously would be safe. Heseems to think that, in case of ignorance,government should intervene.

it is safer to assume that politiciansand bureaucrats will not become saints,so it’s wise to constrain their power inthe field of economic policy as in otherareas. Cash provides individuals with a

it would be tempting for government topush interest rates far below zero andkeep them there for long periods of timeto reduce government borrowing costs.


measure of protection against their owngovernments. if it becomes necessary, theycan move their money over borders in cashform. if cash can facilitate private crime, italso renders government crime (by confis-cation) more difficult.

regulatory state / As rogoff admits, a totalor partial ban on cash would necessarily beaccompanied by a new crop of regulationsand controls. As cash is being phased out,restrictions on the maximum size of cashpayments (like in some european coun-tries) could be required. Other measureswould be needed; for example, governmentwould have to subsidize the provision ofdebit cards to low-income people—orsupply them itself—in order for peoplewithout them to be able to use money.the spread of foreign cash would haveto be prevented. Cryptocurrencies, whichnow provide a refuge for anonymity andprivacy, would have to be regulated, per-haps with backdoors for regulators. Pre-paid cards would be “discouraged,” to userogoff’s mild term. Fees on withdrawalsand deposits of any remaining cash maybe required. With negative interest rates,prepayment of taxes would have to becontrolled and banks may need bail-outs.Many savers would no doubt ask for statehelp. Other regulations would be adoptedto close newly discovered loopholes.

Cash hoarders would be shamed andbullied. rogoff suggests that, after U.S.cash has been abolished, any business “thatcomes to the bank each week with a pile ofeuros might as well have ‘money launder-ing operation’ emblazoned on its statio-nery.” He praises a British police agencythat bullied banks into restricting the sup-ply of €500 notes. As he says, governmentalways wins anyway: “it is hard to stay ontop of the government indefinitely in agame where the latter can keep adjustingthe rules until he wins.” Many people getthe word: submit! And the rule of law ridesaway into the setting sun of liberty.

Welcome to the brave new world of theregulatory state. With due respect to rog-off, his plea smacks of a naive trust of thestate and a dangerous elitism or paternal-

ism toward ordinary people who want touse cash and escape the clutches of theregulatory state.

the real question is very different fromthe one rogoff considers. it is not whethergovernment should prohibit cash, but whyit supplies cash in the first place. Considerthis intriguing fact: government-suppliedcash helps individuals escape intrusive sur-veillance by government.

Supplying cash is a rather minor inter-vention provided that competition is notforbidden. in the United States and manyother countries, legal tender laws are dead-letter. individuals or corporations may intheory agree to deal in other currencies anduse other forms of cash, although i suspectthat a host of indirect regulations and bul-lying kill any competitive temptation. toparaphrase rogoff, the users of other cur-rencies would have a money launderingtarget painted on their backs.

Better alternative / A world where govern-ment does not supply cash and preventsanybody else from doing so—which isclose to what rogoff recommends—wouldbe as dangerous as a world where govern-ment supplies cash and forces everybodyto use it. But between these two extremes(cash ban or cash monopoly), there is athird alternative: economic freedom.

Let each individual choose whetherhe wants to use cash or not and in whichcurrency, and give suppliers the freedomto respond to this demand (short ofcounterfeiting somebody else’s currency),whether they be governments—foreignor domestic—or private suppliers, andwhether their offerings are fiat money orcommodity-based money (such as gold).Following Friedrich Hayek, an economicsnobel Prize winner, many contemporaryeconomists have presented cogent argu-ments for allowing competition in the fieldof money as in other areas of life.

One thing is sure: we need another pro-hibition like we need another Berlin Wall.

As rogoff would say in another context,this time is not different. Human nature hasnot changed, knowledge has not attainedperfection, politicians and bureaucrats have

not become angels, Leviathan is still lurk-ing, and public policies can wreak havoc.Abolishing cash would increase govern-ment power, undermine the rule of law,facilitate risky monetary policies, start acascade of new regulations, and negate indi-vidual choices and the legitimate demandfor cash. it would bring another brick to theconstruction of the police state.

Steve Ambler, a professor of economicsat the University of Québec in Montréal’sbusiness school, says about the proposal ofbanning cash, “i think that the proposal isstrongly tied to the desire to control, track,and tax any and all forms of expenditure.”(the recent cancellation of cash and con-fiscation of part of it by the indian govern-ment confirms such suspicions.)

Citizens would be well advised not totrust the state, but a state that claims tobe democratic should trust its citizens.Switzerland is one of the economicallyfreest countries in the world: in the latestranking of the economic Freedom of theWorld index, it comes in fourth (comparedto the United States’ 16th). it is probablysignificant that Switzerland has one of thelargest banknote denominations in theworld: 1,000 Swiss francs—equivalent toabout $1,000 at the time of this writing.That is a beacon of liberty.

The Curse of Cash is a well-argued bookand rogoff is a good economist. if it werepossible to prove that government shouldabolish cash, he would have done it. But hisdemonstration is not conclusive becausethis time is not different.

Readings■ Denationalization of Money, 2nd ed., by FriedrichHayek. institute of economic Affairs, 1978.

■ Economic, Legal, and Political Dimensions of Competi-tion, by Harold Demsetz. north Holland, 1982.

■ “the Fall in interest rates: Low Pressure.” TheEconomist, September 24, 2016.

■ “the Myth of Federal reserve Control overinterest rates,” by Jeffrey rogers Hummel. Library ofEconomics and Liberty, October 7, 2013.

■ “the Sinister Side of Cash,” by Kenneth S. rogoff.Wall Street Journal, August 25, 2016.

■ “Where is Private note issue Legal?” by WilliamMcBride and Kurt Schuler. Cato Journal, Vol. 32, no. 2(Spring/Summer 2012).

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Down the Memory Hole✒ Review by DAviD R. heNDeRSON

Ask any American born before 1960 for an example of corporategreed resulting in environmental disaster and the odds aregood that he or she will name Love Canal. Love Canal, for read-

ers who don’t know, is a neighborhood in the city of niagara Falls, n.Y.that was once a chemical waste dump. the dump became a major news

DAviD R. heNDeRSON is a research fellow with thehoover institution and professor of economics in thegraduate School of business and Public Policy at the NavalPostgraduate School in Monterey, Calif. he is the editor ofTheConcise Encyclopedia of Economics (Liberty Fund, 2008).

story in the late 1970s, including sensa-tional articles in the Niagara Falls Gazette byregistered nurse turned reporter MichaelBrown, who would later write the bookLaying Waste: The Poisoning of America byToxic Chemicals (Pantheon, 1980). the inci-dent led to passage of the so-called Super-fund legislation of 1980, which imposeda tax on petroleum and chemical compa-nies to generate revenue for government-directed cleanup of toxic chemical sites.

But the real story of Love Canal isn’t the“corporate guys: bad; government guys andcommunity activists: good” tale that manypeople believe. in its February 1981 issue,Reason magazine published an exhaustive,fact-filled, 13,000-word article on LoveCanal written by independent investiga-tive reporter eric Zuesse. the article dra-matically recast many of the characters inBrown’s reports, including Brown himself.i recently asked Reason’s longtime sciencewriter, ron Bailey, whether further infor-mation in subsequent years had led himto doubt any important factual claims inZuesse’s piece and he replied, “i am notaware that his article has been contradictedor found deficient in any important way.”

When i read about Love Canal, i doso with an eye on two topics: (1) Does thework discuss Zuesse’s version of the story?(2) Does it challenge his claims? thosequestions were on my mind as i read his-torian richard newman’s new book LoveCanal. newman does not mention Zuesse,but he does raise some of the issues thatZuesse did. Disappointingly, newman ulti-

for a school and threatened to use eminentdomain to gain the land. rather than fightthe action, Hooker offered to sell the prop-erty to the school board for $1. the schoolboard agreed, even though it was aware ofthe site’s history.

in the deed of sale, Hooker included thefollowing closing paragraph:

Prior to the delivery of this instrument ofconveyance, the grantee herein has beenadvised by the grantor that the premisesabove described have been filled, in wholeor in part, to the present grade levelthereof with waste products resultingfrom the manufacturing of chemicalsby the grantor at its plant in the City ofniagara Falls, new York, and the granteeassumes all risk and liability incident tothe use thereof. it is therefore under-stood and agreed that, as a part of theconsideration for this conveyance and asa condition thereof, no claim, suit, actionor demand of any nature whatsoevershall ever be made by the grantee, its suc-cessors or assigns, for injury to a personor persons, including death resultingtherefrom, or loss of or damage to prop-erty caused by, in connection with or byreason of the presence of said industrialwastes. it is further agreed as a conditionhereof that each subsequent conveyance

of the aforesaid lands shall bemade subject to the foregoingprovisions and conditions.

the new owner of the landautomatically became liablefor any damage done by toxicwaste on the land, makingsuch a clause legally unneces-sary. Why, then, did Hookerinsert the clause? Zuesse’sexplanation is that Hookerwanted to underscore thatthe chemicals could be dan-gerous and should not bedisturbed. Consider that inMarch 1952, a Hooker offi-cial escorted school boardofficials to the site and, withthem present, made test bor-ings into the protective clay

mately ignores those issues and adoptsmuch of the story that Brown presented.

Backstory / Before diving into the book,some backstory is needed. in the 1890s,an entrepreneur named William Loveproposed to build a canal bypassing thefalls on the niagara river, which wouldallow shipping between Lake erie andLake Ontario. As part of his vision, Loveproposed a planned community alongthe waterway. His project ultimately wasdashed by the Panic of 1893 and a con-gressional prohibition on diverting waterfrom the niagara river, resulting in theabandoning of the partially dug canal.However, some of the residential develop-ment Love envisioned did become reality.

Decades later, the unfinished canal,which had become filled with water,became a dumpsite for the city of niagaraFalls’ municipal waste. Dur-ing World War ii, a city–basedchemical company, Hookerelectrochemical Company(later Hooker Chemical)received permission to dis-pose of chemical waste inthe canal. Late in the decade,Hooker drained it, lined itwith clay, and began depos-iting drums of chemicals atthe site. Dumping contin-ued through the early 1950s,when Hooker capped the sitewith clay.

development / But the sitewas soon disturbed. theniagara Falls City SchoolDistrict wanted the property

Love Canal: A toxichistory from Colonialtimes to the Present

by Richard S. Newman

306 pp.; OxfordUniversity Press, 2016


cover to convince the school board officialsthat the potentially dangerous chemicalswere there. Yet, in August 1953, the schoolboard unanimously voted to remove 4,000cubic yards of fill from the waste site tocomplete the grading at another schoolsite. the school board then began build-ing the school on the Love Canal site, andthat school opened in February 1955.

in 1957, the school board consideredtrading part of the property to two devel-opers in exchange for other land and$11,000 in cash. Hooker executives, uponhearing about the proposal, sent companyattorney Arthur Chambers to attend theboard meeting where the proposal wasdiscussed. Chambers reminded the boardmembers that chemicals were buried underthe land’s surface and pleaded with themnot to let houses be built on the land. theboard deadlocked 4–4, with the result thatthe resolution to sell the land failed.

Unfortunately, at the same time, cityworkmen, while constructing a sewer,punctured the walls of the site and its claycover. they did this even though articlesin the local paper at the time regularlywarned that the construction was “danger-ous” and “injurious.”

in short, Hooker Chemical tried onseveral occasions to warn people aboutthe dangers of the buried chemicals, andthe irresponsible players in the drama weregovernment officials. two decades later,as groundwater tests began finding toxicchemicals and assertions were made thatthe chemicals were causing birth defects,Brown began writing his articles.

newman’s version / newman tells someof this story. But at some points, heundercuts it with doubts about Hooker’sactions. He writes, for example:

Hooker later claimed that developersremoved the [clay] cap when buildingnew homes and streets. But subse-quent investigations doubted that thecompany had actually capped the entiredump (perhaps only part of it). … inshort, the Love Canal dump may neverhave been completely contained.

Here’s the problem: in a 306-page bookwith 32 pages of footnotes, this veryimportant claim is not footnoted. Soeither newman has failed to back up acorrect claim, or he’s simply stating someunspecified person’s opinion. the way toplant credible doubt is to show, not justassert, that there is doubt.

newman quotes much-celebrated LoveCanal activist Lois Gibbs’ claim that “resi-dents of this blue-collar community havecome to see that corporate power and influ-ence are what dictated the actions at LoveCanal, not the health and welfare of its citi-zens.” Yet, if Zuesse’s version of the story iscorrect, then it was a major corporation thatwarned against various politicians’ plans tocut through the cover over the toxic dump.Perhaps Hooker Chemical was truly wor-

ried about “the health and welfare” of LoveCanal’s citizens. Perhaps it merely wantedto avoid adverse publicity and possible legalaction (despite the legal protections in thedeed). regardless, the problem was not cor-porate power and influence but corporateimpotence. the politicians had their narrowgoal—building a school over a potentiallytoxic dump—and they were not about to bestopped by a mere corporation. Of course,the quote is from Gibbs, not from new-man, but newman does not even attemptto gainsay her strong claim.

this failure is not just a careless slip.in one section, for example, newmanwrites, “it all came back to the conceptof justice, for Love Canal families feltthat they had been sacrificed on the altarof profit and power.” it seems far moreaccurate to say that they were sacrificedon the altar of the local school board’spower; the idea that for-profit Hookersacrificed them is hard to maintain inlight of Hooker’s warnings not to disturb

the site. Moreover, elsewhere in the book,newman refers to Hooker’s “newfoundconcern” in 1980 with the “public’s healthand safety.” newfound? As documentedabove, Hooker stated and, more impor-tant, acted on its concern in the 1950s.

And what were the chemicals’ healthconsequences for Love Canal residents?One would think that a 2016 book wouldat least partially answer that question.But even though newman refers to badhealth consequences, he is disturbinglyvague about their nature. He refers, forexample, to some blood tests of youngchildren living in the area without evengiving a hint about what those blood testsfound. elsewhere he refers to a “muchdebated genetic test showing that roughlyone-third of the thirty-six people sampled

may have suffered chro-mosome damage.” One-third is high. What, then,was debated? Only whenyou actually read a 1983New York Times article ref-erenced in the footnotedo you find the follow-ing: “residents and for-

mer residents at the Love Canal toxic-wastesite in niagara Falls, n.Y., are no morelikely to have suffered chromosomal dam-age than residents elsewhere in the city,a Government study concluded today.”the study was conducted by the Centersfor Disease Control. note the asymmetry:newman puts the horrific claim aboutgenetic tests in the body, references a NewYork Times study in a footnote, and doesn’teven hint in the footnote either what thestudy found or that it was conducted bythe Centers for Disease Control.

At one point, newman refers to reporterBrown’s being driven “by an old-fashionedsense of justice.” i beg to differ. Consider,for example, Brown’s claim, which Zuessehighlights: “At that time [1953], the com-pany issued no detailed warnings aboutthe chemicals; a brief paragraph in thequitclaim document disclaimed companyliability for any injuries or deaths thatmight occur at the site.” A brief paragraph?As Zuesse points out, this paragraph,

Hooker Chemical tried to warn peopleabout the dangers of the buried chemi-cals, while the irresponsible players inthe drama were government officials.


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quoted above, is the longest paragraphin the whole deed. newman’s idea of anold-fashioned sense of justice is certainlynot mine.

Conclusion / it’s usually a good idea torevisit important historical issues in lightof new information. Unfortunately, new-man’s revisit of the Love Canal story omitsmuch of what Zuesse discovered 35 years

earlier. People who read it will get many ofthe apparently false impressions producedby Brown’s original reports.

if you want to know the history of LoveCanal in the 19th century and first half ofthe 20th century, Part One of newman’sbook is for you. But if you want to reallyunderstand the key events from the early1950s to 1980, Zuesse’s 1981 article is theplace to look.

Restoring Checks and Balances✒ Review by geORge LeeF

America’s constitutional structure, too few people today under-stand, was crafted for a good purpose: to disperse govern-mental power. it was dispersed vertically (little allocated to

the national level and most to the states) and horizontally withinthe national government, where the three branches were assignedspecific areas of authority and expected tocheck and balance each other. the Found-ers had experienced life under the BritishCrown with its concentration of power inthe monarchy and so disliked it that theyrisked their lives in a rebellion against it.

the United States prospered under thatdispersion of power, but the system beganto break down a century ago. the Progres-sives and especially President WoodrowWilson believed that the nation would bebetter off if governmental authority wereconcentrated in Washington, D.C., primar-ily exercised by enlightened administratorsworking in the executive branch. ever sincethen, our constitutional structure has beenunder siege with the dispersion of powersteadily giving way. it isn’t an exaggerationto say that today’s presidency wields morepower than King George iii ever imagined.

Why and how all of that matters is thesubject of Liberty’s Nemesis, a superb col-lection of 26 essays exploring differentfacets of our increasing concentration ofpower. edited by Dean reuter (a seniorstaff member at the Federalist Society) andJohn Yoo (a law professor at the University

geORge LeeF is director of research for the John w. PopeCenter for higher education Policy.

of California, Berkeley), the essays coverthe range of federal action (and sometimesinaction) that is giving us, as the subtitlesays, the unchecked expansion of the state.

readers will probably be at least pass-ingly familiar with most of the topics cov-ered, including the legal wrangling overthe 2010 Affordable Care Act, the Obamaadministration’s efforts at preventingpeople from acquiring guns and ammuni-tion, the unprecedented aggression of thenational Labor relations Board in pushingunionism, Operation Choke Point’s illegalstrangling of lawful businesses throughabusive banking regulation, federal inter-ference in state voting laws, the internalrevenue Service’s targeting of groups thatoppose the president’s agenda, and muchmore. Seeing all of these perversions ofthe rule of law discussed in one place givesreaders a heightened sense of anxiety overthe nation’s future.

in his introduction, reuter maintainsthat we are “dangerously near a tippingpoint” in that the balance of power is soeroded in favor of the president that thevery concept of checks and balances maybe irretrievably lost. Preserving that con-cept, he writes, “requires a certain faith-

fulness by all.” the problem is that manypoliticians today do not act in good faithtoward the Constitution they are swornto uphold. the balance of power inhib-its them because it makes governing slowand deliberate, requiring compromise andthe willingness to take “no” for an answer.But they are impatient to get things doneand happy with the breezy idea expressedby Democratic consultant Paul Begala,“Stroke of the pen—law of the land. Kindof cool.” that, however, is not how ourgovernment is supposed to work.

abuses of power / it isn’t possible to dojustice to each of these meaty essays in ashort review, so i will concentrate on just afew that i think readers will find the mosttroubling.

Consider the much debated SecondAmendment. the political left loathes theidea that citizens have the right to keepand bear arms and has engaged in a fiercecampaign against it. in his contribution,former congressman Bob Barr detailsthe non-legislative, extra-legal meansemployed by the Obama administrationto undermine that right.

One of them was “Operation Fast andFurious,” a gambit undertaken by theDepartment of Justice to sell firearmsto Mexican drug cartel figures with theintention of demonstrating the supposedneed for a greater crackdown on armssales. Some of the weapons involved inthis rogue plan were used in a 2010 gunbattle that cost a border patrol agent hislife. But when Congress investigated andsought information about Fast and Furi-ous, then–attorney general eric Holderrefused to turn over documents and washeld in contempt of Congress.

Another abuse of power is OperationChoke Point, which targets legitimate busi-nesses that sell guns and ammunition (aswell as other activities deemed unsavory,such as payday lending and coin sales).the operation directs the Federal Depositinsurance Corporation to pressure banksinto refusing to continue to deal with thesekinds of businesses because they are “highrisk” as declared by the Obama administra-

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tion. no law authorizes this operation andwhen Congress attempted to investigate it,Attorney General Loretta Lynch dismis-sively promised to “look into it.”

Another instance where the executivebranch operated without congressionalsanction is the education Department’sdirective for how colleges and universi-ties are to handle allegations of sexualassault on campus. no statute gives thedepartment that authority, but underits “interpretation” of the law and a rulepromulgated without adhering to theAdministrative Procedure Act, departmentofficials decreed that colleges must followtheir dictates.

in their essay on this, GregLukianoff and SamanthaHarris of the Foundation forindividual rights in educa-tion show how the vague lan-guage of title iX of the edu-cation Amendments of 1972was twisted to mean not justthat schools receiving federalstudent aid money could notdiscriminate against women(the statute’s clear intention),but to give the educationDepartment carte blanche todictate every aspect of schoolpolicy having anything todo with sex. Under a 2011department “guidance letter,”colleges risk the loss of gov-ernment funds unless theydo their utmost to prevent and punish allconduct that could be deemed harassment.

this has First Amendment implica-tions, the authors note. “if a listener takesoffense to sex- or gender-related speech forany reason, no matter how irrationally orunreasonably, the speaker has engaged insexual harassment,” they explain. So wenow have college officials frantically moni-toring speech that might lead to an inves-tigation by federal bureaucrats. Moreover,a substantial number of male studentshave been punished or expelled as a resultof the blatantly one-sided, quasi-judicialprocedures demanded by the department.thus, both free speech and due process of

law have become victims of the educationDepartment’s overreaching officials.

neglect of law / not only does the executivebranch make up new laws on its own, butit also neglects to enforce laws it decidesdon’t fit with its agenda. Several essaysdeal with that problem, including theadministration’s decision not to defendthe Defense of Marriage Act when it waschallenged in court, its decision to ignorethe law on the deportation of illegal immi-grants, and its decision to ignore the lawrequiring states to clean up their voterlists. Since the first two examples are fairly

well known, i’ll discuss thethird.

in his essay, “UnilateralActions of President Obamain Voting and elections,”Heritage Foundation legalscholar Hans von Spakovskyexamines the various waysthe current administrationhas intervened to improvethe chances that Democraticcandidates will win elections.this has been accomplishedthrough litigation to blockstate efforts at making theirelections less prone to fraudand by ignoring existing lawswhen enforcing them wouldwork against Democraticprospects.

Particularly importanthere is the 1993 national Voter regis-tration Act, which requires the states toundertake “a reasonable effort to removethe names of ineligible voters from officiallists.” there is evidence that in many ifnot most states, the rolls are laden withthe names of people who have died ormoved away. inaccurate lists make votefraud much easier. But the Obama admin-istration chose to ignore this law, a JusticeDepartment official calling it “uncon-genial” because it did not fit in with thepolitical goal of increasing voter turnout.

Similarly, von Spakovsky charges, theObama administration was not interestedin pursuing cases of voter suppression

and intimidation that may have helpedits political allies, such as reports of BlackPanther Party toughs patrolling Philadel-phia precincts to frighten away voters.

Von Spakovsky sums up, writing:

What appears clear is that the adminis-tration has misused its authority undervarious federal voting rights laws toadvance its own ideological agenda, andto help ensure the election of candidatesof the president’s political party. this isan abuse of executive power delegatedto the president by the Constitution to“take Care that the Laws be faithfullyexecuted.” … this administration hasfailed that obligation.

indeed so. When a political leader decidesnot to enforce the laws impartially, butinstead to pick and choose which ones toenforce for partisan advantage, a crucialelement of democracy’s social contract hasbeen violated.

Yoo’s conclusion / Yoo ends the book witha sobering conclusion. the administrativestate that was supposed to make every-thing more efficient has merely “easedthe way for special interests” because theyneed only to capture the heads of federalagencies rather than the far more difficulttask for persuading majorities in both theHouse and Senate to adopt whatever poli-cies they desire. there is no consent of thegoverned when the laws are made by unac-countable bureaucrats.

What is to be done? Yoo argues thatit is time to “disable and hobble” theadministrative state. He would like to seethe courts resuscitate the old “non-delega-tion doctrine” that used to keep Congressfrom handing its authority over to agen-cies. He also wants the courts to abandontheir position of deference toward mostagency actions and their statutory “inter-pretations.” And he favors a conservativeoffensive to restore the old concepts ofindividual rights, going so far as to saythat the almost universally reviled decisionin Lochner v. New York (1905) was actuallycorrect in that it protected the worker’sfreedom to contract as he thinks best.

Liberty’s Nemesis:the Uncheckedexpansion of the State

edited by Dean Reuterand John yoo

584 pp.; encounterbooks, 2016


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that Yoo argues for such controls onexecutive power may seem ironic, giventhat some have charged him with help-ing to expand the chief executive’s powerwhile head of the Office of Legal Counselin the George W. Bush administration.nonetheless, the ideas he offers in thisessay are good ones. However, the judiciaryis mostly in the hands of people who seeonly good in the administrative state and

who often have disdain for claims of indi-vidual rights.

reading Liberty’s Nemesis is like goingto see your doctor over what you think isa minor problem, only to learn that youhave an aggressive, fast-spreading cancer.You might survive it, but the odds aren’tgood. the unchecked expansion of thestate has ruined many other nations andour case is advancing rapidly.

Centrally PlanningFuel Economy✒ Review by DAviD R. heNDeRSON

In the next few years, companies that sell cars and light trucks inthe United States will have to comply with increasingly stringentfederal regulations on fuel economy. the government’s regulations

call for a required average of 54.5 miles per gallon on new cars andtrucks by 2025. the requirement will vary with the size of the car or

DAv iD R . heNDeR SON is a research fellow with thehoover institution and professor of economics in thegraduate School of business and Public Policy at the NavalPostgraduate School in Monterey, Calif. he previously wasthe senior economist for energy policy with President Rea-gan’s Council of economic Advisers. he is the editor ofTheConcise Encyclopedia of Economics (Liberty Fund, 2008).

truck, so each company will face a differ-ent required fuel economy average thatvaries with the size-mix of its sales. thisis after the Obama administration hadalready raised the overall required averageto 34.1 mpg for 2016.

On its face, such mandates would seemunnecessary. Auto consumers have amplereason to want fuel economy (balancedagainst other desirable traits such as safety,performance, and comfort), and car mak-ers have ample reason to supply it. And,as Regulation has repeatedly documented,there is plenty of evidence that the marketoperates well in this regard. (See, e.g., “DoConsumers Value Fuel economy?” Winter2005–2006; “Working Papers: CAFe Stan-dards,” Winter 2015–2016.)

How did such a large increase inrequired fuel economy happen? MargoOge, former director of the Office oftransportation and Air Quality in the

U.S. environmental Protection Agency,tells the story in her book, Driving theFuture. Oge had a large role in design-ing these regulations and negotiating forthem within the Obama administrationand with the auto makers, both foreignand domestic. Her book helps readersunderstand how this extreme regulatoryrequirement came about.

She argues for the regulations, basingher case on the climate change that shefears would occur without a large reductionin the carbon footprint of cars and trucks.She takes for granted that there would becatastrophic global warming without suchregulations. She does not consider otherways that economists have conceived forreducing carbon dioxide emissions, suchas cap-and-trade or taxes on carbon use orCO2 emissions. She also ignores or fails tounderstand any unintended consequencesof the regulations she favors.

Climate change debate / Given how heavilyOge leans on climate science to make acase that the world is dangerously warm-ing, it would have been nice had she taken

the various criticisms of this view moreseriously. At one point she refers to “cli-mate change deniers,” although thereare a number of climatologists at gooduniversities, none of whom deny climatechange, but all of whom are skeptical ofcurrent professions of certain doom. Sheis having none of it, insisting that “thecause of these earth-changing deviationsshould no longer be subject to debate.”

But should there be some debate? Shehas so much trouble granting that theremight be a debate that at one point sherefers to former President George H.W.Bush’s chief of staff John Sununu’s “effortto undermine the credibility of climate sci-ence.” How did Sununu undermine it? Shewrites: “Sununu ran computer models thathe claimed showed uncertainties cloudingthe understanding of global warming.”What she misses is that undermining sci-entists’ conclusions with computer modelsis—unless the models are dishonestly orinappropriately programmed—part of thescientific method.

She also criticizes Sherwood idso, whomshe calls, correctly, “a respected scientist.”in his book Carbon Dioxide: Friend or Foe?idso argues that increased greenhouse gasemissions “would actually increase foodyield and provide other benefits.” Ogeadmits that this is “true for some parts ofthe planet for short periods of time.” Butshe writes that, overall, “idso’s argumentsgave a false impression of the future impactsthat climate change would have on agricul-ture.” Unfortunately, she doesn’t botherto explain precisely why this “impression”is false, instead dismissing idso’s book asbeing “popular and controversial” and,therefore, “exactly what industry interestswanted.” We can’t have that.

But let’s assume, as she does, thatwithout a large cut in CO2 emissions,global warming would continue. Whatwould the consequences be? there is alarge, serious economics literature on this,written by people who share her concerns.i have in mind people like Yale econo-mist William nordhaus. But she doesn’treference his work, settling instead for areport by three people who are neither

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economists nor climate scientists: formertreasury secretary Henry Paulson, formernew York mayor Michael Bloomberg, andwealthy investor tom Steyer. She cites aclaim from their study thatby 2050, if current trendscontinue, “up to $106 billionof the nation’s coastal prop-erty will likely be below sealevel.” Put aside the impor-tant hedges “up to” and“likely”; does Oge realize howrelatively small a $106 billionloss is? in 2013, accordingto the Federal reserve’s Flowof Funds data, the value ofall privately owned land andproperty in the United Stateswas about $21.6 trillion. it’salmost certainly higher now.that $106 billion loss, there-fore, though large in abso-lute value, would be less than0.5% of the total.

Misunderstanding markets / to her credit,Oge understands why it would be a badidea to require auto companies to use spe-cific methods for reaching the ambitiousregulatory mpg goals. She writes:

the ePA didn’t tell automakers whattechnology they had to use to makethe improvements [in fuel economy]. itdidn’t pick winners and losers. instead,the mandate created a huge market forwhatever new technology could get thejob done. Private industry would have tofigure out the rest.

implicit in this passage is the idea thatfirms given a mandate will figure out theleast-cost way of complying with the man-date. it’s good that she acknowledges this.

But once you understand why it wouldbe a bad idea to require a particular tech-nology, it’s pretty easy to see why it’s a badidea to require a particular fuel economyfor cars and trucks. remember that Oge’sand others’ ultimate goal is not better fueleconomy per se but, rather, lower CO2 emis-sions. the least-cost way to get lower emis-sions is not to single out a particular sector

of the economy—in this case, new cars andtrucks—and require a minimum numberof mpg. instead, it is to have people cut theuses of CO2 that have the least value for a

given amount of emission.How would government

do this? economists offertwo answers: a cap-and-tradesystem or a tax on CO2 emis-sions. i note parentheticallythat even economists havegone a little astray in talkingabout carbon taxes. if globalwarming is a real threat, thenthe enemy is not carbon butCO2. equating a tax on car-bon with a tax on CO2 implic-itly assumes that one couldnot use a given amount ofcarbon in a way that producesless CO2. (there might evenbe a cheaper way to deal withfuture CO2 emissions: geo-engineering. But Oge does

not consider this.)With a tax on CO2 or a cap-and-trade

system, everyone who uses carbon has anincentive to economize on emissions. Sonot only new car buyers, but also users ofold cars would economize. Outside theauto sector, barbecue users, people heatingtheir homes, manufacturers using fuel, andelectric utilities—to name just a few—wouldeconomize. Yet Oge does not consider theoption of cap-and-trade or a tax on CO2

emissions. this omission is quite strikinggiven how vocal economists have been inrecent years about a tax or cap-and-trade.

it’s not as if she had no discussions witheconomists; she did, in both the GeorgeW. Bush and Obama administrations. Shetells of one interaction with Michael Green-stone, chief economist on the Obama WhiteHouse’s Council of economic Advisers. inher telling, she had reported a finding thatthe higher price of the more fuel-efficientcar would be more than offset by the savingsin fuel expenditures. Greenstone challengedher. She quotes him as saying, “the con-sumer won’t fully value these fuel economybenefits, so we should discount them by 50to 80 percent.”

Oge doesn’t say why he believed this. Soi called him at the University of Chicago,where he is an economics professor, andasked him. He explained to me that if carbuyers were not already demanding carsthat had the fuel efficiency she was tryingto achieve, it must be because there wereother negatives besides the higher upfrontprice of the car. those negatives might bethe cars’ performance, esthetics, safety, orother features.

Oge writes, “Academics like Greenstonewould still worry that we are messing withthe magic of the market.” He explained tome that consumers know what they wantbetter than central planners do. Summa-rizing her interaction with Greenstone,Oge writes, “the idea that the marketfunctions perfectly is a powerful politicaland theoretical obstacle to fuel economyregulations.” the idea that economiststhink that the market functions perfectlyis a caricature that many non-economistsshare. You don’t have to think that marketsfunction perfectly—whatever that means—to think that they function well or, at least,better than government.

if one sentence crystallizes the prob-lems caused by Oge’s lack of understand-ing of economics, it is this one, writtenabout the then-freshly formed Obamaadministration: “there will be others, evenwithin the new administration, who areideologically opposed to the regulations—as is almost inevitable in any room filledwith Washington lawyers and academiceconomists.” She, in short, sees econo-mists—even ones in the Obama admin-istration—as being ideologically opposedto regulation rather than being opposedbecause of their understanding of bothmarkets and regulation.

Her lack of understanding of marketsalso leads her to miss a basic fact aboutthe 1973 Arab oil embargo on the UnitedStates. the embargo, by itself, had noeffect on the United States because oilis fungible. in a world market, selectiveembargoes against particular countriescannot work because buyers who getthe oil from the embargoing countriescan resell it. What hurt us and other oil-

Driving the Future:Combating ClimateChange with Cleaner,Smarter Cars

by Margo t. Oge

351 pp.; Arcade, 2015


i n r e v i e w

v eR N MCK iNLey is a visiting scholar at george washing-ton University Law School and author of Financing Failure: ACentury of Bailouts (independent institute: 2012).

consuming countries in 1973 was notthe embargo. At the time world demandwas growing but world production wasgrowing more slowly, pushing prices up.Oge attributes the gasoline lines of 1973to the embargo, but that is wrong. thevillain behind the gasoline lines was theone for whom she later worked: the U.S.government with its price controls on oiland gas. Countries whose governmentsavoided price controls, such as Switzer-land, also avoided gasoline lines.

She is not alone in this basic misun-derstanding. She tells of a conversationshe had in the summer of 2013 withJames Woolsey, a director of the Centralintelligence Agency during Bill Clinton’spresidency. in October 1973, when he was

general counsel for the Senate Armed Ser-vices Committee, he had planned to run acongressional hearing on the Yom KippurWar. instead, he “missed most of the hear-ing waiting in the long line at the pumps.”Oge quotes Woolsey, “i turned pretty hos-tile to oil then, and that was forty yearsago.” Wow! One wonders what importantdecisions he made because he lacked thisbasic understanding of microeconomics.

Oge seems to be someone who tried todo what she thought was the right thing.it’s too bad that she didn’t have moreunderstanding of economics. if she had,then we might not be contending in a fewyears with cars that get much higher fueleconomy but suffer on yet unknown otherdimensions.

The Ulysses/Punch BowlView of the Fed✒ Review by veRN MCKiNLey

Adecade or so ago the Federal reserve was riding high. in themidst of what was called the “Great Moderation,” a 20-year runduring which inflation was under control and two quite mild

recessions graced us with their fleeting presence, things were look-ing good for the Fed. the tables had been turned on the stagflationof the 1970s and the Fed was gettingmuch of the credit.

in a speech on this phenomenon titledwith the same moniker as the perioditself, then-governor Ben Bernanke of theFederal reserve extolled his colleagues,gushing that their conduct of monetarypolicy, in contrast to the bleak memoriesof the 1970s, “makes me optimistic forthe future.” Overall there was little pub-lic consideration or appetite for revisitingthe core idea of deference to the Fed onits management of the economy and thefinancial system.

What a difference a decade makes.The Power and Independence of the Federal

Reserve is a timely primer on how the Fed-eral reserve has evolved in its structureand functions in its century of existence.the book is timely because all mannerof commenters—some qualified, othersnot—have provided a range of views sincethe onset of the financial crisis on: (1) whythe Fed needs additional powers, or why itdoes not need to exist at all; (2) why the Fedneeds to reduce its dual mandate of pricestability and low unemployment to a singlemandate of price stability, or why it needsto expand its mandate to include financialstability; or (3) why the Fed needs to gothrough a regular policy audit of monetarypolicy by the Government AccountabilityOffice, or why it can get by with its cur-rent financial statement audit and otherdata releases.

Peter Conti-Brown is an assistant pro-fessor of legal studies and business eth-ics at the University of Pennsylvania’sWharton School. He has also held posi-tions as a fellow at Stanford Law and inthe history department at Princeton, aswell as at a law firm and as a law clerk.He has never worked at the Fed or one ofthe other financial agencies, or at a com-mercial bank for that matter. But he justseems genuinely fascinated with how thisstrange animal known as “the Fed” worksin practice and he has apparently dedicateda large portion of the last five years think-ing about how it has evolved over time andif it indeed works well overall. Conti-Brownhighlights the dearth of quality legal andhistorical scholarship on the Fed (beyondthe point of its creation) and he intendsto fill that void.

independence for whom and from what? /As implied by the title, the focus of Conti-Brown’s book is on how the Fed’s Byzan-tine structure affects its power and inde-pendence. He uses a generalized definitionof power to mean simple influence on theglobal financial system. He then cobblestogether, based on his review of the litera-ture, a very Fed-specific definition of inde-pendence as the “separation, by statute, ofthe central bankers (specifically the Fedchair) and the politicians (specifically thepresident) for purposes of maintaininglow inflation.”

Conti-Brown puts the definition ofindependence in the context of the blendedmetaphors of the “Ulysses/punch bowlview of Fed independence,” to which herefers often throughout the book. Ulyssesis a metaphor for a system where “we writecentral banking laws that lash us (and ourpoliticians) to the mast and stuff beeswaxin the ears of … technocratic central bank-ers [who] guide the ship of the economyto the land of prosperity and low infla-tion.” the punch bowl refers to the oft-toldquote of former Fed chairman WilliamMcChesney Martin of how central bank-ers are “in the position of chaperone whohas ordered the punch bowl removed justwhen the party was really warming up.”

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takes on case studies of theexpected comparisons ofmajor chairmen of the Fed:the Martins, the Volckersand the Greenspans that theman on the street is familiarwith. But it also scrutinizesthe tarullos, the Alvarezesand the Blinders, namesthat are mostly just familiarto hard-core, Fed-obsessedgeeks.■ “What major interac-tions does the Fed have out-side its walls?” scrutinizesthe Fed’s relationship withthe president as impliedby the Fed-specific defini-tion of independence, andalso Congress and bank-

ers (including international banksand central banks). this includesa thoughtful section on regulatorycapture at the Federal reserve Bank ofnew York.

What he gets wrong / near the end of thebook, Conti-Brown advances case studiesto apply his detailed framework for theFed. He turns to an assessment of twocurrent proposed legislative amendmentsto the Federal reserve Act: a policy auditof monetary policy (“Audit the Fed”) anda mandate for a rules-based methodol-ogy for monetary policy. Conti-Brownconcludes that both are unnecessary. Hestarts off by making an excellent caseto justify a policy audit, one that i haveadvanced myself:

the public audit part of the proposal isconsistent with an essential componentof this book’s argument, that we cannotunderstand what the Fed is, what itdoes, and who on the outside influencesFed behavior without knowing moreabout how the Fed operates.

So far so good. He then turns the discus-sion on its head and ultimately concludesthat the audit effort is “motivated by adesire to punish specific Fed actions” andtherefore is not a good idea. Where did

the valid concerns about making the Fedmore transparent go in this analysis? Hisargument is not convincing.

the second proposed legislative amend-ment that Conti-Brown assesses is the sim-ple idea of requiring the Fed to adopt a ruleto guide its implementation of monetarypolicy. this is as opposed to the currentpractice of vesting plenary discretion inthe Fed to conduct monetary policy as thevoting members see fit, unhinged from alogical, consistent monetary rule. Based onwhat i know about the legislative propos-als on Capitol Hill (primarily sponsoredby House Financial Services CommitteeChairman Jeb Hensarling), Conti-Brownmisstates the proposed legislation whenhe says that the “rule selected and writ-ten into the Federal reserve Act is the so-called taylor rule.” in fact, Hensarling inmultiple press releases has explained thatthere is no such mandate that the taylorrule be used, that the rule would be “ofthe Fed’s own choosing with the powerto amend it or deviate from it at the Fed’sown choosing.”

i should also point out that Conti-Brown makes a few factual mistakes inthe book—mostly mistakes your typicalpolicy reader would not catch. For exam-ple, he speaks of Continental illinois andthe unprecedented $3.6 billion bailoutprovided to it in 1984, then states, “itwasn’t enough; the bank failed anyway.”Advocates of bailouts called Continental“too big to fail” for a reason. the bailoutmeant it did not ultimately fail and it livedon to become part of Bank of Americain the early 1990s. Additionally, he statesthat the last decade’s financial crisis wasfocused in the “uninsured investmentbanks, insurance companies, money mar-ket funds, and other uninsured financialinstitutions” because they lacked depositinsurance, which mitigates such panics. Yethe fails to explain why massive Citibank—asubsidiary of Citigroup, which is a Fed-regulated entity—had a run on its deposits,notwithstanding the fact that it was a goodold-fashioned commercial bank with FDiCinsurance. But misstatements and omis-sions like these are few and far between

Conti-Brown claims that thiswidely held view of the Fedin fact “doesn’t work” andis actually “wrong,” whichleads into the substance of hisanalysis of the Fed’s structureand history. However, Conti-Brown tips his hand that hejudges that the Fed ultimately“did the right thing” duringthe last decade’s financial cri-sis when he states (withoutmuch supporting detail), “Aswe all saw in the 2008 finan-cial crisis, policy failures andtriumphs within the Fed-eral reserve stirred financialhavoc but likely spared usfrom financial cataclysm.”

Covering all the bases / Conti-Brown’s his-torical and legal analysis of the Fed largelybreaks down into four major questions(which by the way do not precisely cross-walk to the four parts of The Power andIndependence of the Federal Reserve):

■ “How is the Fed governed?” traces theevolution of the governance throughwhat he calls the “three foundings ofthe Federal reserve” in 1913 (Federalreserve Act), in 1935 (Banking Actof 1935), and 1951 (Fed-treasuryAccord). those developments evolvedthe Fed from the “institutional chaos”of its early days to its current positionof pursuing “institutionally separate”sets of economic and monetary poli-cies. He applies legal scrutiny to whathe calls the “unconstitutional” Federalreserve Banks.

■ “What functions does the Fedperform?” contemplates the strangebrew of technical functions the Fed isresponsible for from monetary policy,to lender, to supervisor and regulator.

■ “What people at the Fed have stoodout over time and influenced itsdevelopment?” delves not only into thespecialists who comprise the leader-ship, but also the economists, lawyers,and international specialists. it also

the Power andindependence of theFederal Reserve

by Peter Conti-brown



i n r e v i e w

and he mostly gets his facts right in thisdetailed analysis of Fed operations.

Conclusion / Despite these stumbles thatthis Fed critic latches onto, Conti-Brown’sbook provides a thorough history andlegal analysis. i agree with his character-ization that it fills a large void in the litera-ture. My favorite find that Conti-Brownmined as part of his research is a 1914quote from Sen. Carter Glass about howthe Fed would not issue “fiat money”:

Fiat money is an irredeemable papermoney with no specie basis, with nogold reserve, but the value of whichdepends solely upon the taxing powerof the Government emitting it. thisFederal reserve note has 40 percentgold reserve behind it, has 100 percentshort-term, gilt-edge commercial paperbehind it.

i think we know how Federal reserve notes“evolved” in the ensuing century.

Should WeWantMore Government?✒ Review by PhiL R. MURRAy

The title of this book, How Big Should Our Government Be? by JonBakija, Lane Kenworthy, Peter Lindert, and Jeff Madrick, raisesan interesting question. the authors’ goal is “to broaden the

nation’s understanding of how big government actually should beby presenting the best research on the subject.” they claim to shun

PhiL R. MURRAy is a professor of economics at webberinternational University.

“ideology and politics.” their question ingeneral is, “Will bigger government hurtthe economy?” they reason it will not.

Social transfers / Lindert, an economicsprofessor at the University of California,Davis, opens his contribution deftly withrhetorical support from Adam Smith. inSmith’s Lectures on Jurisprudence, Lindertreminds us, the founder of economicsrefers to the “many expences necessaryin a civilized country.” Lindert equatesthose necessary expenses to governmentspending on “infrastructure.” in hisWealth of Nations, Smith refers to “publickworks which are beneficial to the wholesociety” that may need to be financed by“the general contribution of the wholesociety.” Lindert’s take is that Smith“clearly understood that external ben-efits could justify tax-based social expen-diture.” He then moves from economicliterature to an empirical investigation

of how transfer payments affect macro-economic performance.

His first piece of evidence is a graphthat shows real gross domestic product percapita and “social transfers as a % of [grossdomestic product]” for “four of Smith’scivilized countries—the United Kingdom,the United States, Sweden, and Japan.”the graph shows that both real GDP percapita and social transfers as a percentageof GDP have increased over the long run.One interpretation is that standards of liv-ing in those four countries have increaseddespite more government spending onpublic pensions, health care, unemploy-ment benefits, etc. Another interpretationis that the welfare state is compatible witha high standard of living. Lindert prefersthe latter. He recognizes that reverse cau-sality might be at work: “Perhaps the pros-perity bred the wasteful social spending.”He responds, “Yet if the social spending isnothing but a rich country’s bad habit, likeobesity or recreational drugs, why don’t wesee any easy evidence of it dragging down

GDP per capita?” Perhaps observing justfour high-income countries isn’t enoughto respond to that question.

the next piece of evidence is a table thatshows correlations between transfer pay-ments and economic performance amonga greater number of countries in theOrganisation for economic Co-operationand Development over several decades.Lindert straightforwardly calculates a cor-relation coefficient between “initial shareof social transfers in GDP” with the growthrate of GDP per capita during each decadefor all the countries. it is unclear, though,exactly how he did this; did he use averageGDP per capita for each decade? neverthe-less, he concludes, “History again shows nosignificantly negative relationship betweenthe start-of-decade public social spendingshare and either the growth or the level ofGDP per capita.” At this point, he encour-ages neither advocates of the welfare statenor advocates of limited government.“From all the correlations,” he declares,“we cannot infer a positive causal influenceof social spending on economic growth, yetany claim of a negative historical relation-ship is easy to doubt.” He adds:

i have surveyed the econometric studiesavailable as of a decade ago. none hasfound a significant negative effect of thewhole welfare state package on GDP, atleast not any study that has used soundeconometric techniques and has madeits underlying data available to others.even the few that announced negativeeffects but hide their data have failedto show negative effects large enoughto imply the major economic damageclaimed by some theorists, journalists,and politicians.

And with that, Lindert vigorouslyadvocates for the welfare state. taxing andtransferring income will not, according tohim, reduce the standard of living or itsrate of growth. He invites us, moreover,to expect these bonuses from the welfarestate: less income inequality, reduced pov-erty, increased longevity, honest govern-ment officials, small budget deficits, andeven happier people.

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argue that generous welfare spending iscompatible with high standards of liv-ing and growth. Bakija, an economist atWilliams College, argues at length thatgovernment officials can purchase alarger share of all goods and services aswell as increase taxes, and there will beno decrease in economic well-being. Hisfirst piece of evidence is a graph showingthat “across all countries in the world forwhich data are available, there is a strongpositive correlation between taxes as a shareof GDP and real GDP per person.” Heacknowledges that higher real GDP perperson might be causing higher taxes asa share of GDP, but he does not concedethat this possibility refutes his finding.

His next piece of evidence is a group ofgraphs showing the evolution of real GDPper person and the size of government(specifically, government spending as a per-centage of GDP) for 12 successful econo-

mies over a 100-year period.each country has a biggergovernment today than itdid about a century ago, andeach has a higher standardof living. Bakija emphasizesthat “there is no evidence ofa slowdown in the long-runeconomic growth rate in theera of big government.” thecase is not closed, however.there is a possibility thatbigger government reducesthe standard of living with-out reducing its trend rateof growth. in order to seewhether this happens, theauthor charts the percent-age-point change in the ratioof government spending toGDP from 1913 to 2013 ver-

sus the average annual percentage changein real GDP per capita over that periodfor 13 countries. even if real GDP grew atthe same rate almost every year, say 1.75percent, occasional decreases in real GDPper person because of bigger governmentwill reduce the average annual growth rateover all the years. Bakija’s figure shows thatstandards of living evidently did not grow

at slower rates on average as governmentsgrew larger. But the case is still not closed,as he admits: “A potential confoundingfactor arises because economic theory sug-gests that countries starting at lower levelsof GDP per person might find it easier togrow quickly.” even when holding con-stant this effect of “catch-up growth,”there is “no significant association betweenincrease in size of government and eco-nomic growth, despite enormous differ-ences in the magnitude of changes in thesize of government.”

econometric methods might clarify ourunderstanding of the relationship betweensize of government, economic well-being,and the “many other confounding factors.”Bakija reviews the literature. these num-ber-crunching exercises appear thoroughand sophisticated. Although econometricstudies don’t resolve the debate over whathappens in the economy when the gov-ernment gets larger, they create what theauthor calls a “common ground.” Someresearchers accept Lindert’s point that effi-cacious government spending is sufficientto counteract the adverse effects of taxes.Some imply that policies consistent withgreater economic freedom—such as freetrade, low inflation, and the absence ofemployment protection laws—offset taxesand government spending. those econo-mists, according to Bakija, “are essentiallyarguing that the nordic countries couldhave even higher economic growth if theymaintained all their market-friendly poli-cies but scaled back on their taxes andsocial welfare policies.” He admits thatthis view is possible, even “plausible,” butnot “convincingly demonstrated.” He sug-gests that citizens in a democracy might bemore willing to accept the uncertainty thataccompanies global capitalism if they geta welfare state along with it.

Which programs and taxes? / Given theirevidence that bigger government does notreduce economic growth, Kenworthy andMadrick (the former a sociologist andpolitical scientist at the University of Ari-zona, the latter a senior fellow at the Cen-tury Foundation) call for increasing taxes

He knows that some readers will beskeptical, so he offers justification. Suc-cessful welfare states rely on “the broaderkinds of taxes that economists considermore efficient.” these include “broad con-sumption taxes and sin taxes on harmfuland addictive products such as tobacco,alcohol, and gasoline.” Bureaucrats thatadminister successful welfare states spendefficiently too: “Universalist public trans-fers and services, those to which every-body is entitled, are cheaper to administerbecause there is less bureaucratic need toinvestigate who should be excluded fromthe benefits.”

the efficacy of welfare state spendingon health care, “skills accumulation formothers,” and “social programs for chil-dren and those of working age” apparentlyovercomes any deleterious effect of thewelfare state on productive effort. that’swhy we don’t observe a negative correla-tion between welfare spendingand GDP. Lindert boldly pro-claims, “no welfare state hasbecome poor.” not even theexample of Greece contradictshis findings, according to him,because “Greece has never hada true welfare state and, com-pared to other rich nations, itdoes little for the poor.” Yetthe author defines a welfarestate as “any democratic coun-try for which public socialtransfers, and the taxes implic-itly paying for them, exceed 20percent of GDP.” the book’sFigure 2.6 shows “public socialexpenditure as a % of GDP”beyond 20 percent in Greece,which seems to satisfy his defi-nition of a welfare state. thesame figure also shows that Greece’s welfarestate exhibits “elderly bias,” which may bewhy Lindert rejects it as “true.” Perhaps wemay draw the lesson that the best intentionsof a welfare state may be thwarted by specialinterest groups in the political process.

Size of government / the authors of HowBig Should Our Government Be? do not only

how big Should Ourgovernment be?

by Jon bakija,Lane Kenworthy,Peter Lindert, andJeff Madrick

207 pp.; University ofCalifornia Press, 2016


i n r e v i e w

and government spending by 10 percent-age points of GDP. in general, they recom-mend spending on “infrastructure, eco-nomic security, equality of opportunity,and fairly shared prosperity.” in particu-lar, they propose: “universal health care,”“one-year paid parental leave,” “universalearly education,” and 13 more programs.the authors do not itch to regulate everyaspect of economic life. “indeed,” Ken-worthy and Madrick grant, “the countrywould be better off if the degree of gov-ernment intervention in some areas wereto shrink.” the areas they have in mindinclude patents on pharmaceutical drugs,occupational licenses, and land use.

in order to finance bigger government,Kenworthy and Madrick recommend afederal consumption tax, a higher “effec-tive income tax rate for the top 1 percentof households,” “a carbon tax and a smallfinancial transactions tax,” and a higher“earnings threshold for the payroll tax.”in the chapter he contributed, Bakija“dug a little deeper” into the question ofwhether higher taxes would diminish theincentive to work. the data show that asthe highest marginal income tax rate paidby “people in the top 0.1 percent of thedistribution of pre-tax income” fell from70 percent in 1960 to about 40 percent in2014, their share of the income zoomedover 200 percent. We may not, Bakija cau-tions, take this to mean that the supply oflabor is sensitive to the tax rate on income,and thereby fear that reduced work effortwould result from the authors’ plans toincrease taxes.

Bakija presents cross-country evi-dence over the long run that shows norelationship between reductions in mar-ginal income tax rates and growth ratesin real GDP per person. He gives reasonswhy countries do not experience acceler-ated growth rates in their standards ofliving along with lower marginal incometax rates. He wants to shed light on whatwill happen to the standard of living fol-lowing an increase in marginal tax rates.“the important point for our purposes,”he summarizes, “is that none of thealternative explanations—rent-seeking,

technological change and globalization,or shifting of reported income betweenpersonal and corporate tax bases—impliesthat increasing tax rates on high-incomepeople involves large costs in terms of eco-nomic efficiency.” expand government,increase taxes to pay for it, and expect, inthe authors’ words, a “free lunch.”

if, a century ago, a progressive proposedincreasing taxes and government spendingfrom around 10 percent of U.S. GDP toaround 40 percent today, an advocate oflimited government would have predictedeconomic stagnation. Such an expansionof government is now historical fact, andtoday’s advocate of limited governmentcannot deny that growth has occurred.He might argue that growth could havebeen brisker, but he probably boasts of thestandard of living we have today.

Yet Bakija, Kenworthy, Lindert, and

Madrick face their own paradox. Biggergovernment is what their intellectualancestors wanted, and it is what we havetoday, but the authors still want more gov-ernment. they thereby admit that today’ssize of government is inadequate to main-tain infrastructure and solve social prob-lems. How do they know that increasingtaxes and spending another 10 percentagepoints of GDP will upgrade infrastructureand relieve social problems? Would a big-ger American welfare state show outcomessimilar to nordic welfare states?

this book will challenge readers wary ofbig government. Both they and those whoembrace big government may look forwardto the next round of this debate in the newbook by Centre for Policy Studies researchfellow nima Sanandaji, Debunking Utopia:Exposing the Myth of Nordic Socialism (WnDBooks, 2016).

What You Always Wantedto Know about GDPBut Were Afraid to Ask✒ Review by PieRRe LeMieUx

Gross domestic product (GDP) pops up everywhere in the news.Last summer, for example, the news that ireland’s GDP hadincreased by 26.3% in 2005 (compared to 8.5% the previous

year) had people scratching their heads. the Sept. 3, 2016 issue ofThe Economist raised the perennial question of whether GDP figures

PieR R e LeMieUx is an economist affiliated with the De-partment of Management Sciences of the Université du Qué-bec en Outaouais. His latest book isWhoNeeds Jobs? SpreadingPoverty or IncreasingWelfare (Palgrave Macmillan, 2014).

released by the Chinese government arereliable. then Japan began revamping itsGDP calculations after some contradic-tions appeared in official statistics. thisis not counting the routine articles thatfollow the quarterly release of estimatesand the monthly revisions by the Bureauof economic Analysis (BeA), the federalagency that calculates U.S. GDP andother numbers contained in the nationalincome and Product Accounts (niPA).

GDP is a complicated concept thatraises many issues. Understanding themrequires a good grasp of the concept ofGDP, its methodology, and the economictheory behind it. As an illustration ofthese treacherous grounds, the irish GDPincreased so much in 2005 because the“domestic” in “gross domestic products”refers to the residents (including corporateentities) of the territory over which it ismeasured. in 2005, several multinationalcorporations relocated to ireland to avoidhigher taxes elsewhere, giving the emeraldisle an enormous one-year GDP boost.

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there is much to learn in order tounderstand the use and misuse of GDP.Princeton University Press’s recent releaseof two books on GDP gives us an opportu-nity to do this. Let’s start withsome basics, and then take alook at the books.

oranges, apples and hap-

piness / What is GDP? it isdefined as the market valueof final goods and servicesproduced in a given coun-try (or other area) during agiven period of time. GDP isintended to measure an econ-omy’s production. it incor-porates only the productionof final goods, which willnot be further transformedduring the period under con-sideration (usually one year).intermediate goods—goodsthat are to be inputs for othergoods—are excluded in orderto avoid double-counting.For example, only the valueof a finished loaf of bread iscounted; adding the valueof the flour that went intothe bread would be double-counting since it is alreadyaccounted for in the price ofthe bread.

Soviet planners, who didnot want to consider pricesbecause they smacked of capi-talism, aimed at measuringall production in physical vol-ume. One drawback is that,with this method, they couldnot produce a single numberthat measured the produc-tion of their economy; theyonly had the amounts of apples, oranges,or tanks produced. they did not accept theconcept of GDP. But then, without marketprices, it is unclear how Soviet plannerscould have meaningfully calculated GDP.

Prices determined on free markets andused to calculate the value of GDP arenot arbitrary. the free-market price of a

good equals the marginal utility of thatgood—all consumers will buy additionalunits up to the point where the utility ofthe last unit is equal to its price. (think

of “utility” as satisfaction orhappiness, although the tech-nical concept is more compli-cated. See “John Hicks andthe Beauty of Logic,” Winter2014–2015.) GDP thus sumsup production as valued bythe consumers themselves intheir quest to maximize theirutility. GDP is a measure ofeconomic efficiency.

One must tread very care-fully here. Saying that thefree-market prices used tocompute GDP represent thevalue that consumers attachto the last units consumedof all goods does not meanthat GDP measures the totalutility of consumers, called“social welfare.” A persongets more utility from whathe consumes than what hepays for it; economists callthis “consumer surplus.” SoGDP is worth more than itsmoney value.

Another reason why GDPdoes not measure social wel-fare is that utility can be dis-tributed differently amongindividuals and inter-indi-vidual comparisons of utilityare scientifically impossible.in a 1950 paper, “evaluationof real national income,”the future nobel economicsprizewinner Paul Samuelsonprovided definitive proofthat GDP computed from

prices and quantities cannot measuresocial welfare.

there are three equivalent ways to cal-culate GDP. On the expenditure side, it canbe calculated as the sum of final expendi-tures by consumers, governments, busi-nesses purchasing equipment, and foreignimporters. equivalently, it can be calcu-

lated as the sum of values added in allindustries: this is the value-added side of theledger. Finally, it can be calculated as thesum of incomes received—the income side.We thus have a triple-entry accounting sys-tem that makes it difficult to falsify GDPfigures. Production must generate incomesthat serve to purchase everything. (What isnot purchased is held in inventories, whichare defined as a sort of investment along-side machines, equipment, and buildings.)

AN AFFeCtiONAte view

GDP: A Brief but Affectionate History is ashort book by Diane Coyle, an economist,professor at the University of Manchester(United Kingdom), and former adviser tothe UK treasury. the book explains thebasic concepts and statistics behind GDPwhile reviewing its intellectual history.three economists who worked on GDP-related concepts ultimately earned nobeleconomics prizes: richard Stone (1913–1991), Simon Kuznets (1901–1995), andWassily Leontief (1906–1999), but therewere many other precursors. Coyle’sbook also broadly traces the history ofeconomic growth, which is measured byGDP per capita. the book constitutes adefense of GDP, affectionate perhaps butvery critical at times.

Coyle notes that “very few people …truly understand how the regularly pub-lished GDP figures are constructed.” Sheadds, “this excludes many of the econo-mists who comment on GDP,” but i sus-pect this is a typo: she must have meantto include many economic commenta-tors in her blame. Both conceptually andstatistically, GDP relies on a vast set ofassumptions. Coyle explains many issuesin GDP accounting and data collection,from “chained” GDP to purchasing powerparities and hedonic prices.

She also reviews many limitations ofGDP. Because of data collection problems,GDP excludes the underground economy(drugs, prostitution, illegal labor, andsuch). this is beginning to change, how-ever; european Union governments haverecently started to incorporate estimatesof their underground economy. Another

gDP: A brief butAffectionate history

by Diane Coyle


the Little big Num-ber: how gDP Cameto Rule the world andwhat to Do about it

by Dirk Philipsen



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limitation: GDP excludes non-market pro-duction such as household work (cooking,taking care of children, gardening, etc.).

Coyle notes that GDP does not mea-sure welfare or happiness, but at timesshe seems to forget it. She does note thatseveral other indexes that attempt to dothis, such as the Human Developmentindex, are strongly correlated with GDP.Money does not bring happiness, but itseems to help.

Some of Coyle’s criticisms of GDP arenot as convincing as others. For example,she claims that new digital services withzero price—think Google search—drive agrowing “wedge between what GDP mea-sures and aggregate economic welfare.”i am not sure this claim is correct, andnot only because GDP does not measurewelfare. Goods that are zero-priced forconsumers do carry a positive price forothers—advertisers in the case of Google.they generate new incomes and new valueadded. the advertisers make a profit andhelp Google make one. in the accountinglogic of GDP, nothing seems to be lost.

Coyle criticizes the special and convo-luted treatment of the financial sector inGDP. i am not totally sure she is right inher criticism of how the contribution offinance is calculated. She certainly is wrongwhen she questions “whether financeshould be included in GDP at all.” if amarket good or service is demanded bysome consumers, it should be included inGDP. except for extreme cases (like, say,murder contracts), GDP is not a moralconcept. Or, at least, we try to keep it frombecoming so.

Environment / environmentalists haveargued, and Coyle seems to agree, thatdepletion of natural resources or naturalcapital should be deducted from GDP,just as depreciation of physical capitalis deducted to give net Domestic Prod-uct (nDP). this environmentalist ideais not as useful as it may first appear. Assuggested by Kuznets in 1973, the vol-ume of resources available depends onhuman knowledge and technology, whichinfluence efficiency in the use of those

resources. Since the production of thissort of knowledge is not incorporated inGDP, why and how should natural capitaland its depreciation be calculated?

We can go a bit further with a norma-tive argument. the moral desirability ofdeducting depreciation of natural capitalfrom GDP assumes that future genera-tions—which, except for government fol-lies, should be wealthier and healthier thanwe are—have a claim on today’s resources.Will they not be at least as altruistic aswe are and wish we had enjoyed the bestpossible life? Or else, what monsters arewe breeding?

From a positive (as opposed to nor-mative) viewpoint, the pro-depreciationargument assumes that environmental andgovernmental apparatchiks are the bestcandidates to exercise the claims of futuregenerations (who don’t often demonstrateor riot in favor of social justice and againstglobalization). Why shouldn’t decisionsabout the use of current natural resourcesbe left to their private owners, who mayhave children or grandchildren to whomthey would want to leave their resources?

Private property rights on naturalresources partly solve the depletion anddepreciation issue. the owner of an oil-richpiece of land decides whether the rent hewould get is worth depleting his resourceas opposed to leaving it to his children or,indirectly, to the children of a potentialbuyer bidding up the land price. this way,the optimal time path of depletion is, atleast partly, reflected in GDP.

it is true that not all resources can beeasily privatized and priced on markets—pure air or perhaps glaciers potentiallyaffected by global warming are examples.But the first solution should be to try andbetter define and enforce private propertyrights. Shadow pricing of resources shouldonly be resorted to when a Coasian solu-tion does not work. (On ronald Coase’stheory, see “the Power of exchange,” Win-ter 2013–2014.)

Coyle explains how GDP and niPA aswe know them were offspring of the GreatDepression and WWii. in both cases, gov-ernments needed to measure the economy

in order to better control it. Keynesianmacroeconomics soon provided a theo-retical framework to justify governmentexpenditures: “By design,” writes Coyle (theemphasis is hers), “GDP would increasewhen those policy levers were operated, atleast in the short run.”

Government services / One major flaw ofGDP relates to the treatment of govern-ment services. What is the value of theseservices, which are not priced on the mar-ket? in the early 1940s, it was decided toinclude in GDP all government expendi-tures on goods and services (includinglabor services, but excluding pure moneytransfers like, say, Social Security), as ifgovernment services were pure “profit”or value added. in other words, govern-ment services are valued at cost, contraryto ordinary services.

it is difficult to value something that isnot sold on markets, but the main reasonfor overstating so blatantly government’scontribution to GDP was to valorize warexpenditures and hide how they reducedconsumption expenditures. Many econo-mists involved in the development of GDP,including Kuznets himself, disagreed withthis government decision. Coyle makes itclear that GDP and the niPA as we knowthem were developed mainly as a tool forgovernment.

i have other quibbles with Coyle’s bookand i am not the only one (see the long andinstructive review of the book by MosheSyrquin in the Journal of Economic Litera-ture). For example, i don’t know how shecan blame deregulation and “the creationof toxic financial instruments that multi-plied and focused risk” for the Great reces-sion without mentioning that mortgage-backed securities were created by a federalhousing agency, Ginnie Mae. Coyle oftenseems to show as much affection for gov-ernment as for GDP. Yet, her book remainsa useful introduction to the meaning andlimitations of GDP.

tOtALitARiAN gDP

Dirk Philipsen’s The Little Big Number isa very different animal. Despite lengthy


endnotes, this book looks more like thework of a political pamphleteer. theauthor, an economic historian at DukeUniversity, argues that GDP is a danger-ous number that forces an inappropriatefocus on economic growth, wasteful mate-rial goods, and unsustainable capitalism.

Against what he sees as a sort of GDPtotalitarianism, the author longs for a neweconomy based on “belonging” and “tight-knit communities that integrate all aspectsof life” and would lead to “rising access tofertile land for purposes of physical andsocial nourishment,” whatever that lastbit means. Many of his pronouncementsare more clichés or incantations than eco-nomic arguments: “people and nature areincreasingly reduced to commodities” andwe need to contribute “to a larger socialwhole,” etc.

Economics? / the reader may sometimesquestion Philipsen’s understanding ofeconomics, let alone GDP. the authorof The Little Big Number does not seem tograsp the nature of value and the func-tion of prices. He argues that there is norelation between price and value. “Fewpeople,” Philipsen writes, “would haveto think long when faced with a choicebetween either $10 million in cash or, say,oxygen. Which would they value more?”He is puzzled by the low price of oxygen.

He seems unaware that Adam Smithraised this very problem in The Wealth ofNations, using water and diamonds insteadof oxygen and cash. economists havereferred to this problem as the “water–diamond paradox,” and its solution wascompleted with the theory of marginalutility in the late 19th century. the solu-tion is that, for a normal individual, thetotal utility of water is higher than thetotal utility of diamonds, but the marginalutility of diamonds, which are relativelyscarce, is higher than the marginal util-ity of water, which is in large supply. Anindividual would prefer no diamond tono water but he would rather have anotherdiamond than another glass of water.

the author of The Little Big Numberapparently does not understand the func-

tion of property rights. He sees externali-ties everywhere and constantly calls on gov-ernment, which is both a knight in shiningarmor and a black box, to legislate andregulate. He cites Coase twice in footnotes,apparently and strangely invoking himagainst GDP.

Under Philipsen’s pen, finance is a dirtyword and a fuzzy concept. it is used asa synonym sometimes of money, some-times of physical capital. Another time,“financialized” is identified with “given aprice.” He does not seem to understandthat financial assets are claims on physicalcapital and that it is normal that capitalexceed annual GDP, just as a machine isworth more than the profits it generatesin one year.

Philipsen argues that society and theeconomy must be reinvented according to“intelligent political design.” He does notexplain how such constructivism works.He does not cite Friedrich Hayek even once.

Understanding GdP / it is not obviousthat Philipsen understands what GDPis. For example, he claims that “mod-ern governments … generate almost halfof GDP.” this is not correct. Althoughpublic expenditures including transfers areoften close to and sometimes above 50% ofGDP, government production (strangelymeasured by its purchases, as we saw) isaround 45% of public expenditures. inthe United States, where total govern-ment expenditures represent about 40%of GDP, government thus “generates”slightly more than 20% of GDP.

Philipsen also falls prey to FrédéricBastiat’s broken-window fallacy: he sees“robust GDP growth in the wake ofdisasters.” this makes sense only if therewas Keynesian unemployment when thecatastrophe hit; otherwise, resourcesfor repairs and reconstruction are justdiverted from what they would otherwisehave produced. the accounting of GDPis consistent with this criticism of thebroken window fallacy.

Some statistics reported in the book arequestionable or unfindable. Some state-ments are at best metaphorical. For an

example of the latter, we read in The LittleBig Number that “humans are the only spe-cies that tolerates in its midst things likepoverty and unemployment, despite anoverabundance of wealth.” i am not surethat all chimpanzees have access to the bestfood (and all males to the best females)and are employed full-time at twice theprimates’ minimum wage.

Petersen constantly attacks the “onepercent”—the top percentile of incomeearners—and suggests that income equal-ity is unacceptable both in the UnitedStates and in the world. But if inequality isunacceptable in the world, most Americansare on the wrong side of “social justice.”According to humanprogress.org (a projectof the Cato institute, publisher of Regula-tion), any American with a net income ofmore than $32,400 is among the top 1%of incomes in the world. Some back-of-envelope calculations with tax statisticssuggest that four in 10 American taxpay-ers are among these. Similarly, a personreceiving only the basic income entitle-ment that Philipsen proposes ($15,000per year) would rank among the top 10%of income earners on the planet.

anti-GdP elitism / What Philipsen funda-mentally does not like about GDP is thatthe measure represents, however imper-fectly, what consumers want. the pref-erences of most consumers do not cor-respond to his own preferences. He doesnot seem to like tobacco, fast food, guns,bottled water, “a sedentary life on stuffycouches,” Walmart, Facebook, or cars.He likes what the intelligentsia like, suchas education, walks in the woods, beau-tiful bathrooms, tasty food, poetry, and“tight-knit communities” (although, asa practical matter of revealed preferences,intelligentsia denizens often live in cos-mopolitan environments).

Philipsen proposes to redefine theeconomy around his own preferences, withthe possible help of “several internationalleaders of either the caliber or politicalunderstanding of … elizabeth Warren.”But “another scenario,” he tells us, couldgive the job to “enlightened bureaucrats


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and academic elites.” i suspect he is notopposed to his “reconstituted political andlegal enforcement agencies” having guns toenforce his preferences.

Philipsen would protest that it is notwhat he likes that must be produced, butwhat “we, as a society” want. He does notunderstand that individual preferencescannot easily (if at all) be aggregated intosocial preferences and expressed as collec-tive choices. He believes in methodologi-

cal unicorns like the “satisfaction of thesocial body.”

He does not see that no “democratic dia-logue” or “public conversation” can lead tounanimity, except perhaps at the level of anabstract constitutional contract à la JamesBuchanan. (Philipsen does not mentionBuchanan’s work.) He does not understandHayek’s point that each individual has hisown goals and that a free society cannotimpose a single goal on everyone.

Collective choices—“an economy thatworks for what we want”—imply that somewill impose their views and lifestyles onothers. to paraphrase H.L. Mencken, Phil-ipsen’s proposed political system is one inwhich common people don’t know whatthey want and will get it good and hard.

if you do read this book, which will bereleased in paperback this spring, it mayactually make you fall in love with GDP. itis an imperfect measure for sure, but one

AGlaringMisuse of GDP

Among the many forms of GDP misuse, one is obvious,frequent, and dazzling. it stems from an interpreta-tion error that officials of national statistical bureaus

readily recognize but apparently do not care to correct. (See“Are imports a Drag on the economy?” Fall 2015.)

One of the main accounting identities of niPA states thatGDP is equal to the sum of consumption, investment, govern-ment expenditures (excluding transfers), and exports. in otherwords, it is the sum of domestic production flows to domesticconsumers, domestic purchasers of investment goods, domesticgovernments, and foreign importers. in still other words, theproduction side of GDP is equal to its expenditure side: every-thing that is produced is purchased.

this is an accounting identity, which means that it is trueby definition and cannot be false. it is necessarily true becauseanything produced that is not purchased by domestic consum-ers, businesses, governments, and foreign importers will pileup in inventories, which is a form of (unintentional) businessinvestment. investment is defined as including (besides fixedcapital) whatever remains after intentional purchases. this ishow accounting identities are necessarily true in the real world:some residual adjusts as a matter of definition.

We could write our accounting identity as:

GDP = consumer expenditures + business investment +government expenditures + exports

provided that we took consumer expenditures, business invest-ment, and government expenditures as including only goodsand services produced domestically. As its name indicates, grossdomestic product is made of domestic production only.

in the statistics that are actually collected, however, con-sumer expenditures (normally represented by C ), businessinvestment (I), and government expenditures (G) includesome imported goods and services. the Chinese-made fish-ing rod you bought at Walmart was captured in C ; the print-ing press a newspaper company bought from Germany was

part of I; and the salary of the foreign consultant hired bythe government was included in G. Consequently, it wouldnot be correct to write our accounting identity as GDP = C+ I + G + X (where X represent exports), because imports arecaptured in the right side of the equation and should notbe included.

to solve this statistical problem, the accounting identityis written as:

GDP = C + I + G + X – M

the term – M cancels the imports that are hidden in C, I, andG, as any good macroeconomics textbook explains.

if one did not have a good textbook in his introductorymacroeconomics class or never took such a class, being misledis easy. the problem is compounded by the fact that X – Mis often grouped inside parentheses so that the accountingidentity is remembered as:

GDP = C + I + G + (X – M)

For the non-expert, the last equation can easily suggestthat (X – M) is the balance of trade. this interpretation error isfurther encouraged by experts who call (X – M) “net exports.”to repeat, it is only “net exports” if you forget that – M is usedonly to cancel the imports that, in the process of data collec-tion, were included in C, I, and G. in other words, the term – Mis a statistical trick.

imports are not deducted from GDP. they cannot reducethe statistical measure of GDP because, by definition, they arenot part it.

in its press releases, the BeA continues to write that imports“are a subtraction in the calculation of GDP” (see, for example,its release of August 26, 2016). this is not wrong when youknow, as BeA economists do, that imports are subtracted afterbeing added; but it is highly misleading. the typical journalistconcludes that imports reduce GDP and transmits this impres-sion to his readers, fueling protectionist sentiments.


that is not based on the personal prefer-ences of ivory-tower elitists. “‘no growth,’”notes Coyle in her book, “is for the rich.”

MixeD bAg

technically, as Samuelson demonstrated,more GDP is neither a sufficient nor anecessary condition for increased wel-fare. economist robert Higgs countersthat “if GDP is to make any sense at all, itmust do so in relation to some concept ofeconomic welfare” (emphasis in original).Otherwise, why would we be interestedin such a figure? But, Higgs argues, it isan “exceedingly poor” measure of welfare.However, it seems to me, a poor measureis not always useless. GDP statistics cansometimes provide useful information.For example, observing a large increase inGDP per capita over a long period of time,or a much higher GDP per capita in onecountry than in another, helps documentthe likelihood that welfare is higher formost people.

A related criticism is that GDP is mainly,in practice, a tool for state dirigisme. it isbound to be misused (see sidebar). this isa serious problem, and our evaluation ofGDP (and other niPA statistics) must bemixed. GDP is not useless, but it must beused with caution.

With a view to the long term, we may askif it should be government that producesthese statistics. Why not leave them to aca-demic research groups such as the nationalBureau of economic research (which wasa pioneer in the field)? the advance of BigData could lead to competing estimatesfrom various private institutes. Already,ADP research institute and Moody’s Ana-lytics, two private organizations, jointlyproduce monthly employment statisticsbased on payroll data collected by ADP,a payroll services company. the problemwith the Japanese GDP figures, which imentioned in the introduction, appears tostem partly from fewer people answeringgovernment surveys and censuses (Financial

Times, September 29, 2016), a problem thatBig Data analysis could potentially solve.

in the shorter term, we should try tominimize the dangers of GDP in at leasttwo ways. First, we should push for a meth-odological rethink of the contribution ofgovernment to GDP. Second, we shouldinsist that official statistical agencies donot use GDP figures to mislead journalistsand the general public.

Readings

Working Papers ✒ by PeteR vAN DOReNA SUMMArY OF reCent PAPerS tHAt MAY Be OF intereSt tO REGULATION’S reADerS.

Effects of Student Loans onTuition and Enrollment“The Incidence of Student Loan Subsidies,” by Mahyar Kargar and

William Mann. July 2016. SSRN #2814842.

In the Summer 2016 issue, robert Archibald and David Feld-man examined the effect of federal student loan programson the behavior of university “list” tuition and financial aid.

they argued that at most nonprofit universities, the (presumablywealthy) marginal student’s willingness to pay list tuition is notaffected by financial aid. But universities may “tax” federal finan-cial aid by reducing their own financial aid offered to students.

Mahyar Kargar and William Mann examined a differentfederal loan program in a setting in which the marginal stu-dent’s ability to pay was affected and hence tuition effects arelikely to be observed. Parent Loans for Undergraduate Students(PLUS) are unlimited up to the cost of attendance. Some 13%of parents of fulltime undergrads have PLUS loans, averaging$13,000 per year.

Prior to 2010, PLUS loans were available under two federal loanprograms: the Federal Family education Loan program (FFeL)

and the Direct Loan (DL) program. in 2010 the two programsmerged. As a result, credit history rules that had applied only toPLUS loans under FFeL were applied to all PLUS loans. the neteffect of this rule change was to increase PLUS loan denials. Priorto the change, PLUS loan denials were 42% under FFeL but only21% under DL.

the authors examine the effect of this unexpected reduction incredit availability on tuition at schools in which the marginal stu-dent’s decision to enroll is most likely to be affected by this reduc-tion in credit availability: schools with more credit-constrainedlow-income students and more use of PLUS loans. they constructtwo variables: the percentage of students who use PLUS loans andthe percentage of financial aid students whose family income is$30,000 or less. they take the product of these two variables anddivide schools into two groups based on above (treated) and below(untreated) median values of this variable.

Undergraduate charges for the two groups of schools grew ata similar rate prior to 2011. But after 2011, tuition charges grewmore slowly for the “treated” group of schools. enrollment alsodropped in the treated schools. treated schools experienced a5% tuition decrease and 2.5% enrollment decrease. the authorsconclude that a grant equal to 10% of tuition would expand enroll-ment by 10% and tuition by 7.5% at schools in the treated group.

■ “A review essay on GDP: A Brief but AffectionateHistory by Diane Coyle,” by Moshe Syrquin. Journal ofEconomic Literature, Vol. 54, no. 2 (2016).

■ “evaluation of real national income,” by Paul A.Samuelson. Oxford Economic Papers, January 1950.

■ “Gross Domestic Product: An index of economicWelfare or a Meaningless Metric?” by robert Higgs.Independent Review, Vol 20, no. 1 (Summer 2015).

■ Measuring the Economy: A Primer on GDP and theNational Income and Product Accounts, published by theBureau of economic Analysis. September 2007.

■ “U.S. national income and Product Accounting:Basic Definitions and Concepts,” by Liegh tesfatsion.iowa State University, undated.

PeteR vAN DOReN is editor ofRegulation and a senior fellow at the Cato institute.

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Corporate Accounting“Estimating the Compliance Costs of Securities Regulation:

A Bunching Analysis of Sarbanes-Oxley Section 404(b),” by

Dhammika Dharmapala. July 2016. SSRN #2817151.

The Sarbanes-Oxley Act of 2002 (SOX) was enacted afterthe bankruptcies and subsequent findings of question-able accounting practices at enron and WorldCom. Aca-

demic criticism of SOX was fairly intense in the years immediatelyafter its enactment. Yale law professor roberta romano deemedthe law “Quack Corporate Governance,” to quote the title of herarticle that appeared in this journal (Winter 2005–2006). But in apaper evaluating the first 10 years of the SOX regime, Harvard lawprofessor John Coates concluded that SOX’s costs and benefitsare roughly equal or net positive (Working Papers, Spring 2014).

Dhammika Dharmapala uses a different method to evaluatethe net costs and benefits of SOX: examining the distribution offirms that are near an important legal threshold requiring SOXcompliance. Most significant provisions of SOX apply to firmsthat have a “public float” (market value of shares held by othersthan firm insiders) of $75 million or more. the author collectspublic float information for firms from 1993 to 2015, allowing formany years of data before and after SOX. Given the legal thresh-old of $75 million, the author asks whether there is evidence of“bunching” of firms just above or below that threshold. Bunchingabove would be evidence of net benefits of SOX, while bunchingbelow would be evidence of net costs.

in the pre-SOX period (1993–2002) there is no evidence ofbunching. the frequency distribution of public float data showsno discontinuities around $75 million. But in the years 2003–2015,following the enactment of SOX, there were 257 more firm-yearsbelow the $75 million threshold than would be expected. And thosefirms reduced their public float by $1.7 million on average. Using theaverage relationship between public float and market capitalization,the market value reduction implied by a $1.7 million reduction inpublic float is about $6 million dollars or 4–5% of the typical firmnear the threshold. thus, small firms facing the prospect of SOXcompliance forgo $6 million to avoid SOX regulation.

Patent Trolls“Patent Trolls: Evidence from Targeted Firms,” by Lauren Cohen,

Umit G. Gurun, and Scott Duke Kominers. August 2016. SSRN

#2464303.

Non-practicing entities (nPes) are firms whose sole assetsare intellectual property rights that they have purchasedrather than developed themselves. Such firms’ main

activity is suing other companies for patent infringement. theyhave been criticized (see “the Private and Social Costs of Patenttrolls,” Winter 2011–2012, and Working Papers columns in Fall

and Winter 2013) as well as defended (see “the $83 Billion PatentLitigation Fallacy,” Spring 2016) in Regulation.

the current paper is a comprehensive analysis of all nPe law-suits (21,300) from 2005 through 2015. nPes appear to behaveopportunistically. nPes disproportionately sue cash-rich firms.A one–standard deviation increase in cash holdings results in anincrease in the probability of being sued from 8.6% for the averagefirm to 16% for the firm with more cash.

nPes even sue cash-rich firms whose cash isn’t from the businesssegments that allegedly engaged in infringing. in contrast, practicingentity firms, which develop intellectual property and then manufac-ture products based on that knowledge, do not disproportionatelysue cash-rich firms. nor, for that matter, do small inventors.

nPes also forum-shop, looking for courtrooms where theirsuits are more likely to succeed. nPes litigate 43% of their cases inthe eastern District of texas, which is considered “friendly” to suchcases. Only 7% of the cases brought by Pes are litigated in east texas.

“While none of our results alone proves opportunistic legalbehavior (patent trolling) on the part of nPes, the mass of theevidence to this point appears most consistent with nPes behav-ing as patent trolls,” write the authors.

nPe suits have consequences for spending on research anddevelopment. After nPe settlement, defendant firms reducer&D investment by more than 25%. Small inventors, the allegedbeneficiaries of nPes, do not appear to be getting much of thesettlements nor increasing invention activity.

MinimumWages“Minimum Wage and Real Wage Inequality: Evidence from

Pass-Through to Retail Prices,” by Justin Leung. September 2016.

SSRN #2786411.

Economic analyses of the minimum wage often focus onthe negative employment effects for low-skilled, youngworkers. Using scanner data from 35,000 retail stores

in the United States, this paper asks whether minimum wageincreases result in increased prices for some products.

the author concludes that a 10% increase in the minimumwage raises retail prices at grocery stores in poor counties (definedas those with ratios of minimum wage to average wage [the Kaitzindex] above the median for the country) by 0.7%. When countiesare divided into quartiles according to the Kaitz index, the poorerthe county the larger the pass-through effect on prices.

this result is not simply because of an increase in labor costs atgrocery stores in poor counties. the percentage of minimum wageworkers in grocery stores in poor counties is not higher relativeto rich counties. And the quantities purchased in grocery storesincrease rather than decrease when the minimum wage is increasedconsistent with the minimum wage augmenting demand.

A 10% increase in the minimum wage results in a wage increasefor workers in the 10th percentile of the wage distribution of about


1.6% relative to the median wage. But price increases in food storesreduce this increase by about 0.3–0.6% in poor counties.

Congressional RegulatoryMandates“Preventing a Regulatory Train Wreck: Mandated Regulation

and the Cautionary Tale of Positive Train Control,” by Jerry Ellig and

Michael Horney. August 2016. SSRN #2821113.

Regulatory agencies are often blamed for imposing costs onthe economy that result in few if any benefits. But muchof the blame should be directed at Congress. According

to Jerry ellig of the Mercatus Center, 49% of the economicallysignificant regulations (costs exceeding $100 million) proposedfrom 2008 through 2013 were required by law. that is, Congressspecifically instructed agencies or departments to issue the rule.the executive order that requires review of economically signifi-cant regulations to determine whether they create benefits thatexceed costs has little effect in such situations because the execu-tive branch does not have discretion over whether to implementcongressionally mandated regulations.

in 2008 Congress enacted legislation requiring the nationalHighway traffic Safety Administration to issue a rule by 2011 to

enhance rear view visibility for drivers. nHtSA did not issue therule until 2014. normally, such a delay would be an example ofbureaucratic ineptitude and waste. But in this case, nHtSA wasresponding to its own analysis that determined that driver error isthe major determinant of the effectiveness of backup assist technolo-gies such as cameras. in addition, nHtSA concluded that the costper life saved for the cameras ranged from about 1.5 to three timesthe $6.1 million value of a statistical life used by the Department oftransportation to evaluate the cost effectiveness of its regulations.Given those poor cost-benefit results, nHtSA delayed until thepossibility of intervention by the courts forced it to issue the rule.

this paper examines another such rule, the requirement thatrailroads install automated positive train control to prevent traincollisions and derailments. Health and safety regulations are oftenenacted after scandals or disasters, and this example follows that pat-tern. Congress required positive train control in October 2008 after aSeptember2008commuter traincrash inCaliforniakilled25people.

the Federal railroad Administration had conducted cost-benefit analyses of positive train control in 1994 and 2004. theestimated 20-year costs were $10–$13 billion while the safetybenefits from lives saved and damages prevented were only$440–$670 million. the railroads balked at the cost and Con-gress punted, extending the compliance deadline from the endof 2015 to the end of 2018.

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MultipleExplanationsfor - Cato Institute...financial innovations, and outsourcing ... suggests that the average productivity of ... tion, and globalization—all demand-side