I recently visited Cuba for the first time, to participate in scholarly meetings.  For an American citizen this short voyage requires a leap through hyperspace.   It was my third attempt over ten years to get there.  Obstacles had included both the US government and the Cuban government.

     This was a trip back in time, to 1959.   For one thing, a majority of the (few) autos on the street in Havana are large American cars from the 1950s.  Most are beautiful.   One hears about the cars, but I had thought the reports must be exaggerated.   

     Cuba’s economic system is out of Alice in Wonderland.   It has one of the world’s longest lasting dual exchange rate systems.  Currently the cost of dollars in the market is 25 times higher than the official rate of one peso per one dollar.  This means that a worker in the hotel sector or restaurant sector who is able to keep dollar earnings has an income 25 times higher than one who must turn them in to the government.

      The island long ago developed an advantage in skilled services such as medicine and education.  But doctors and professors earn far less than those who join the fledgling private economy.  The latter features 178 possible approved jobs.  The possible choices on the list by design make no use of an educated person’s skills.   They include waiter, bathroom attendant, taxi driver, automobile battery repairman, mule driver, and wheel barrow operator.   Most people are still employed by the state, however.

      Perhaps American consumer society has too many goods available; but Cuba has far too few.  Most things that one would want — a toaster to make breakfast, leather to make shoes, tools for auto repair, software to upgrade a computer, spare parts to keep all those appliances from the 1950s running, …everything - is only available either by rationing, waiting in line, or going to the black market.  Many are not available at all.    

      How can such a system have persisted for so long?   Why doesn’t everyone see the folly?  

      Repression and fear don’t explain it.  The fact is that the advantages of the market system are not hard-wired into human brains — not anywhere, and especially not when they have been portrayed as the allies of selfishness and corruption, in opposition to such noble ideals as cooperation, fairness, and equality. 

     When the Soviet Union was collapsing, Robert Shiller and co-authors surveyed residents of Moscow and New York regarding their attitudes toward free markets.   Unsurprisingly, many of the Russians gave answers that strike an economist as failing to appreciate adequately the virtues of the marketplace as a mechanism to bring supply and demand into equality.  For example 66% of the Russian respondents thought it was unfair of flower-sellers to charge higher prices on holidays.  The surprising finding, however, was that just as high a percentage of Americans thought it was unfair of the flower-sellers to raise prices!  (Economists, of course, point out that  demand is much higher on holidays, and that without the higher prices flower-growers would have no incentive to increase the supply at such times.) 

      People in Eastern Europe eventually figured out that communism does not work and that the market system does.  If the United States of America did not exist, or if the embargo did not exist, Cubans could do likewise: infer that there is something fundamentally wrong with an economic system that involves so much time wasted and so many simple desires frustrated.  But in the case of Cuba, there is an alternative explanation right at hand.  Many of these goods would be imported from the United States, or produced at home with inputs from the United States.  Therefore it must be the US and its embargo that is to blame.  So it seems to many Cubans.

      When makers of foreign policy ”get tough” with another country, they often under-estimate the extent to which the opponent’s government can derive long-lasting legitimacy by pointing to the external threat to rally its people.   The citizens of the last two countries still clinging to communism, Cuba and North Korea, both vividly remember military conflict with the United States (the Bay of Pigs and the Korean War, respectively) and both countries have long been subject to American sanctions.   The first communist country to experiment with market reforms, Poland, was one that never came into military conflict with the West.    Lesson:  the US should end its obsolete embargo against Cuba.  Let those private-sector auto mechanics have their spare parts!

      Harvard’s Jorge Dominguez likens the Cuban reform path to an accordion that alternately goes in and out.  Liberalization took hold out of the desperate economic situation (”special period”) that followed the 1991 collapse of the Soviet Union, Cuba’s long-time benefactor.  The reform process was then slowed from 1996 to 2005 — even stopped altogether — in part because Venezuelan support made it less necessary.  

     Reforms have been renewed in recent years– now under “los lineamientos,” translated as “the guidelines.”  For example, the government announced in 2011 it would let people buy and sell houses. Farmers can sell directly to the market, to hotels and restaurants, rather than just to the government.  One explanation for the recent reforms is that the more pragmatic Raul Castro took over after his brother became ill in 2006.  But another explanation is that money from Venezuela has lately begun to level off and appears uncertain in the future.  (For one thing, Venezuela’s oil production has declined during a period when everyone else’s has boomed, due to mismanagement by Hugo Chavez of his own economy.)  

      Referring to the heavy economic dependence on the US that had ended abruptly after the 1959 revolution and to the heavy dependence on the Soviet Union that had ended abruptly after the 1989 fall of the Berlin Wall, Cuba’s Minister for Heavy Industry in 1995 vowed, “We will never let this happen to us for the third time.” (Jatar, 1999, p.38).  Yet that is what is now happening with respect to dependence on Venezuela.

      For now, Cuba is casting about for a model to follow.  The example of Sweden shows that it is possible to combine a strong social safety net with a strong private economy.  But what Cuba seeks is a model of transition out of communism.   

      The Chinese economic miracle is the obvious model, beginning with the reforms of Deng Xiaoping.  This judgment assumes that income equality is in reality not as important to Cuba as the requirements that the Communist Party maintain control and the country’s leaders never have to say they were wrong.  The Cuban slogan has long been “Socialism or death!” Cubans are proud, and mindful of their history of ill-treatment by larger powers.  In this they resemble the Chinese, who have converted to capitalism more energetically than the capitalists while yet leaving the giant picture of Chairman Mao up in Tiananmen Square.  

      But when the Chinese and Soviets split in the 1960s, Cuba went with the latter.  Only in some American college dorm rooms did posters of Mao and Che appear side-by-side.   So for now the model is Vietnam, rather than China.  (Unfortunately, the Vietnamese economy has been troubled of late.)

      Four things will happen soon, probably at approximately the same time:  the aging generation of Cuban émigrés who have dictated American policy on Cuba will give way to the next generation; the Castros will pass from the scene as well; American-Cuban relations will be normalized; and the world’s 2^nd-to-last museum of communism will spontaneously convert to a rapidly growing service-exporting economy.   Lineamientos and models will no longer seem so necessary. 

      I just hope that before the wave of American money and tourists arrives on its shores, the government of Cuba undertakes the appropriate regulatory intervention:  a zoning law that all car bodies in some designated part of Old Havana must date from 1959 or earlier.

 References 
•·   Jorge I. Dominguez “Hello from Havana,”  Harvard Magazine, July-August 2009.
•·   Dominguez, et al, eds., Cuban Economic and Social Development (Harvard University Press), 2012.
•·   Anna Julia Jatar-Hausmann, The Cuban Way (Kumarian Press), 1999.
•·   Robert Shiller, Maxim Boycko & Vladimir Korobov, “Popular Attitudes Towards Free Markets: The Soviet Union and the United States Compared,” American Economic Review 81, no.3, pp.385-400, June 1991.

[A shorter version of this column was published by Project Syndicate. Comments may be posted there.]

Politicians who advertise themselves as “fiscal conservatives” sometimes campaign on crowd-pleasing pledges to cut taxes and simultaneously reduce budget deficits.  These are difficult promises to deliver on in practice, since the budget deficit equals government spending minus tax revenue.

Aspiring fiscal conservatives may be interested in learning four innovative tricks that are commonly used by American politicians who like to promise what seems impossible.   Each of these feats has been perfected over three decades or more.  Indeed they first acquired their colorful names in the early years of the Ronald Reagan presidency:

1. The “Magic Asterisk”
2. “Rosy Scenario”
3. The Laffer hypothesis
4. The “Starve the Beast” hypothesis.

As shop-worn as these four conjuring tricks are, voters and journalists continue to fall for them. Thus they remain useful equipment in the repertoire of the fiscal conservative.

The first term was coined by Reagan’s Budget Director, David Stockman.  Originally it was an act of desperation, because the numbers in the 1981 budget plan didn’t add up.  “We invented the ‘magic asterisk’:  If we couldn’t find the savings in time - and we couldn’t-we would issue an IOU. We would call it ‘Future savings to be identified.’” [p.124]   Since that time the Magic Asterisk has become a familiar device in the American policy arena.   Recent examples include the recommendation of the Simpson-Bowles commission to cut real spending growth by precise amounts, without saying where.   US Presidential candidate Mitt Romney has done the same in his spending plan.    Another current application of the Magic Asterisk is Romney’s plan to eliminate enough tax expenditures to make up the revenue lost by cutting marginal tax rates by 20% (which is $5 trillion in revenue), while steadfastly refusing to say what tax expenditures he would eliminate.

As Election Day nears, the pressure on a candidate to get more specific grows.  The conjurer is thus forced to go to Trick Two:  since he can’t find enough tax loopholes to eliminate, he must claim that what he meant by closing the revenue gap was that stronger economic growth will bring in the added revenue.   The most popular magician’s assistant of all time makes her encore on the stage.  Murray Weidenbaum, Reagan’s first Council of Economic Advisers Chairman, deserves the credit for originally dreaming up Ms. Rosy Scenario, “perhaps my most lasting legacy” [p.57].  The Reagan Administration in its early years forecast 5% income growth (twice the long-run average), in order to imply in its projections a boost to revenues big enough to make up for its many tax cut measures [p.93-97].   Since then candidates of every party have made use of Rosy’s talents.

Indeed official growth forecasts are systematically overly optimistic in almost all of a sample of 33 countries, contributing to overly optimistic budget forecasts.   European governments are particularly biased.

In the Republican primaries last year, candidate Tim Pawlenty assumed a 5 per cent growth rate to make his own plan work.   He was all but laughed out of the race.  Mitt Romney probably can’t get away with this sleight-of-hand either.   The press asks, “Why should we believe that the growth rate will magically accelerate just because you become president?   Where will this GDP come from?   It sounds like pulling a rabbit out of a hat.”  Right on cue, it is time for Trick 3.

Trick 3 is the famous Laffer Hypothesis.   This is the proposition, identified with “supply side economics,” that reductions in tax rates are like magic beans:  they stimulate economic growth a lot — so much so that total tax revenue (the tax rate times income) goes up rather than down.   One might think that the Romney campaign would never resurrect such a hoary and discredited trick.  After all, two of his main economic advisers, Glenn Hubbard and Greg Mankiw, both have textbooks in which they say that the Laffer Hypothesis is incorrect as a description of US tax rates.  Mankiw’s book, in its first edition, even called its proponents “charlatans.”  But the historical record is that each Republican presidential candidate since Reagan has had good economic advisers who disavow the Laffer Hypothesis.  Yet time and again the president (or candidate), and his vice president (or running mate) and his political aides read from a script that relies on the Laffer logic (Appendix I). They are the ones who make the policy if the candidate wins, not the academic economist.   George W. Bush had these same two top economic advisers in his first term, Hubbard and Mankiw, when he cut taxes and transmogrified a record surplus into a record deficit.

Trick 4, “Starve the Beast,” typically comes later, if and when the president is elected, has enacted his tax cuts, and discovers that smoke and mirrors don’t work against hard fiscal reality. He can’t find enough spending to cut (Magic Asterisk has disappeared up the conjurer’s sleeve); the acceleration in GDP is nowhere to be seen (Rosy Scenario has vanished in thin air); and tax revenues have not grown (no rabbit in the Laffer hat).   The audience is now told that losing tax revenue and widening the budget deficit was the plan all along.  The performer explains that the deficit is all the fault of Congress for not cutting spending and that the only way to tame the beast is raise the budget deficit because “Congress can’t spend money it doesn’t have.”  This trick never works either, of course.  Congress can in fact spend money it doesn’t have, especially if the “conservative” president has been quietly sending it budgets every year that call for that.   “Starve the Beast” as a budget strategy, like the other three, dates back to the first Reagan Administration. (Bartlett, 2007, p.6-7.)

By the time the crowd realizes it has been had, the confidence man has pulled off the greatest trick of all:  yet another audience who came to see the deficit shrunk instead leaves the theater with the deficit bigger than when it came in.

References
Bruce Bartlett, 2007, “‘Starve the Beast’ Origins and Development of a Budgetary Metaphor,”The Independent Review, XII, 1, summer, 5-26.
Jeffrey Frankel, 2008, “Snake-Oil Tax Cuts,” Economic Policy Institute, Briefing Paper 221, September.
–2011, “Over-optimism in Forecasts by Official Budget Agencies and Its Implications,” Oxford Review of Economic Policy vol.27, no. 4, 536-562. NBER WP 17239; Summary in NBER Digest.
David Stockman, 1986, The Triumph of Politics: Why the Reagan Revolution Failed (Harper & Row).
Murray Weidenbaum, 2005, Advising Reagan: Making Economic Policy, 1981-82 (Washington Univ., St.Louis).

[A version of this column appeared earlier at Project Syndicate, which has the copyright.  Comments can be posted there.]

Every pundit agrees that President Obama did badly in the first debate.  But I can’t help wondering whether he (and VP Joe Biden) would have been able to come out swinging as freely as they have in the subsequent debates, if it were not for what happened in Denver.  Obama must have been afraid of sounding unpresidential.   But because his initial performance was so roundly criticized for passivity, he was licensed after that to argue aggressively:  “What you are saying is not true, Governor Romney.”  And it helps that he was right, each time.   (My morning-after talking-head comments can be viewed: “Re-cap of 1st Presidential Debate,” Oct.4; and “Re-cap” of 2nd Presidential Debate, Oct.17.)

Of all the areas where Romney’s assertions in the first debate were rebutted successfully in each of the subsequent debates, his tax “plan” is one of the most important.  The credibility of independent analysts and fact-checkers has helped here.   The main problem is not that Romney hasn’t announced a plan detailed enough to be worthy of the name.   The main problem is, rather, that no plan can achieve three simultaneous goals, each of which the Republican candidate has repeatedly promised:   (1) cutting tax rates 20%,  (2) avoiding loss of tax revenue by elimination of deductions, and yet  (3) preventing overall taxes from going up on those earning less than $200,000 a year.    Romney and Ryan have been conducting a shell game:  they show the public what is under two of the three shells, but not all three at any one time.  For example, Republicans will argue that the tax cut won’t raise the budget deficit by citing a study that cuts middle class benefits like the tax-deductibility of mortgage interest.  Then when reminded that they promised not to do that, they will cite a study that lets taxes go up on those earning $100,000-$200,000.

The 20% cut in tax rates would in itself cost $480 billion on revenue in 2015 or about $5 trillion over the next 10 years.  I don’t think there is disagreement about that.  (But Bruce Bartlett estimates $6 trillion:Tax Notes, 10/29/12, p.2.)   All the disagreement is whether Romney can make up the revenue by eliminating deductions as he claims.  Yet in the first debate, when Obama started to address this question, Romney tried to shut him down by saying that a $5 trillion tax cut wasn’t his complete plan, as if anyone had ever said it was.  Worse, in the Vice Presidential debate, Congressman Ryan claimed that the Obama deputy campaign manager had “stipulated” that they had been wrong, that the tax cut wasn’t really $5 trillion.  The media was fooled by this one, failing to note that she had only made the (accurate) statement that the question of controversy was not whether the overall loss of revenue would be the full $5 trillion, but whether Romney could make all of that up by eliminating deductions.  This is an elementary point and Obama was able to get it across effectively in the second and third debates, even to number-weary viewers.

Some pundits say that, if Romney’s weakness is that his budget numbers don’t add up, Obama’s weakness is that he hasn’t laid out a specific agenda for his second term.  (Either that, or that he didn’t get us out of the recession fast enough.)

What will happen after the election?   It is typical that fervently debated plans of the candidates become mostly irrelevant soon after the winner’s presidential term begins.  (My Oct.22 talking head comments on this are viewable, at the 26-min. mark.) They are overtaken by unexpected events, such as a market crash at home or an armed attack somewhere in the world.  In the present case, we have a good idea of the events that, soon after the election, will quickly replace the sound-bites of the campaign.   In economic policy, a renewed euro crisis within the next year is likely to have serious spillover effects.   But more urgent for the American president will be the Fiscal Cliff, which arrives January 2013.   Immediately after the election it will become the dominant question.  Yet neither candidate is talking about it.  The explanation for this silence is in part that no politician wants to talk about the specifics of budget-cutting pain; but it is also in part that the two candidates genuinely can’t know what they will do before they know how many supporters they would have in Congress to do it. By the way, I have a prediction regarding monetary policy.   If Romney were to be elected president, his position that monetary policy has been much too easy would turn around on a dime.   Like Nixon, Reagan and Bush before him, he would seek to push the Fed toward easing, not tightening.

Foreign policy was the focus of the third debate.  (Incidentally, why does Romney believe that Syria “is Iran’s path to the sea?”  That is a strange rendering of geography.  Four years ago, McCain thought that Afghanistan bordered Iraq.  GWB said that Africa was one nation.  Reagan mixed up Brazil and Bolivia. Anyone see a pattern? )

The pressing foreign policy issues for the next president will likely be the withdrawal from Afghanistan, the nuclear standoff with Iran, and territorial disputes over islands off the coast of Asia.  Instead of discussing realistically the sort of policy decisions that will need to be made, the candidates have been debating “who said what, when” after the killing of four American diplomats in Benghazi last month.   Despite that tragedy, Obama’s overall policy in Libya remains a success on net.  His actions helped remove Qaddafi, which is reminiscent to me of Bill Clinton’s interventions in Kosovo (helping remove Milosevic) and Haiti (Cédras).   Removing bad guys without US combat deaths.   Libya ranks behind two other major Obama foreign policy successes: withdrawal from Iraq and removal of bin Laden.   Contrast that to the 4,000 Americans who died in the Iraq war; the 3,000 in the World Trade Center; and the global damage done to American foreign policy more generally during those years.

         A survey of economists is published in the November 2012 issue of Foreign Policy.  One question was whether we thought that the US unemployment rate would dip below 8.0% before the election.   When the FP conducted the poll at the end of the summer, unemployment was 8.1-8.2%.  Now it’s 7.8%.  Only 8% of the respondents said “yes.”   (I was one.  I basically just extrapolated the trend of the last two years.)   

My fellow economists choose defense spending and agricultural subsidies as the two categories of US federal budget that they think the best to cut.  They rate the euro crisis as the greatest threat to the world economy now and are particularly worried about Spain.   

For a slideshow presentation of the results, see “The FP Survey: The Economy.”   Or in a magazine format:  “If we’re ever going to get out of this slump, what will it take?  We asked more than 60 leading economists to tell us.”   

        Also, here is a recent poll from The Economist, asking similar questions of NBER and NABE economists:   “Asking the Experts,” Oct. 6.

        Mitt Romney, presidential candidate, said in now-infamous comments that 47% of the American electorate is dependent on the federal government, that he will never be able to teach them to take personal responsibility for their lives, and that they are certain to vote for Barack Obama in November.   He continues a tradition in his party that goes back at least three decades:  building political campaigns around the proposition that folks in the heartland exhibit the American virtues of self sufficiency and personal responsibility and the implication that other, more urban, regions display decadent social values and dependency on government.

          It is a good general rule to judge individuals on their own merits and not on the supposed attributes of the racial, socioeconomic or geographic groups to which they belong. Cultural generalizations are dangerous.   But since questions have been raised, the fearless social scientist will not shrink from confronting them.  Are residents of “red states,” who tend to vote Republican, indeed more likely to take responsibility for their personal behavior than those who live in “blue states” and tend to vote Democratic?

       Inspired by the role that religion plays in the red-state view of the world, I will organize the investigation in terms of the Seven Deadly Sins:   Greed, Gluttony, Lust, Sloth, Wrath, and so on.  We will see that measures of these “sins,” state-by-state, bear a statistical relationship with voting patterns - but not the relationship that many assume.  (For data sources and econometric details, see the statistical appendix at my website.)    

1)      Greed  
 
    The red states receive more federal spending, relative to taxes, than the blue states, as I wrote in a 2010 blog post.  Updated data show that the pattern continues.  Those who claim to be fiscally conservative are the ones who in truth tend to feed the most voraciously at the federal trough. Alaskans are the most dependent on the federal government, receiving $7,448 in spending (net of taxes) per capita.  New England, the Mid-Atlantic States, Minnesota and Illinois are the biggest net givers.  Regarding Romney’s specific  ”47%” allegation: the states with high percentages of people who pay no income tax tend to vote Republican, not Democratic.

     Figure 1 shows on the horizontal axis each state’s receipt of spending by the federal government, net of tax payments, per capita.  The vertical axis shows the ratio of Democratic to Republican votes state by state, in the last three presidential elections.    The red states (low in the graph) tend to be on the receiving end (high spending).  The blue states (high in the graph) constitute a majority of the ones that foot the bill (positive contributions to the nationwide kitty).  The relationship is highly significant statistically.
  

Figure 1:  Federal Spending Received minus Taxes Paid, among Blue vs. Red States
(Average of votes in 2000, 2004 and 2008 presidential elections)  Click here for larger image.

2) Gluttony

     States where residents suffer more from obesity, in part because they have worse eating habits, tend to vote Republican, as I showed in a blog post last June.  To illustrate, a mere 1 percentage point decrease in a state’s obesity rate is associated on average with an estimated increase in the ratio of Democratic to Republican voters from 1.00 to 1.07.  The relationship is highly significant statistically.   (Figure 2.)

               
Fig.2: Obesity (% of population) Click for larger image     Fig.3: Fitness Index  Click for larger image  

3) Sloth

     States where residents get less physical exercise tend to vote Republican.  (Figure 10d in appendix.) The relationship is highly significant statistically.    Figure 3 combines physical exercise and lack of obesity into a single index of physical fitness.

      In his recent book, Coming Apart, Charles Murray argues that those who live in the “super-zip codes” - the areas with high education levels, like Belmont, Massachusetts  - have maintained traditional American values of hard work, while those who live elsewhere show “crashing” rates of industriousness.   He writes that those who live in areas with less education have been leaving the labor force for years, often falsely claiming disability. They “goof off,” “sleeping and watching television” (p.180-181).  Those that remain employed have reduced the length of their work-week and their dedication to their jobs, at the same time that those living in the super-zip codes have increased theirs (p.176-77).  Some academic researchers and news media fear accusations of liberal bias if they talk about such things.  AEI scholar Murray may be immune from this fear: he is well-known as a conservative/libertarian whose earlier book The Bell Curve dealt with black-white differences in test achievement.  (The statistics in his recent book look at whites alone, so as to control for race.)   

4) Lust

     Sex is interesting.  Red states residents buy more online adult entertainment, according to a 2009 study in the Journal of Economic Perspectives by Benjamin Edelman.   Notwithstanding proclamations about the importance of pre-marital chastity, evidence suggests that young people in red states do have sex before marriage.  It is less likely to be safe sex than among those in blue states.   States that vote Republican have higher birth rates among 15-17-year-old girls, as Figure 4 shows.   Again, the difference is highly significant statistically.    They also have higher rates of the sexually-transmitted disease Chlamydia .  (This difference, unlike the others, is not statistically significant at the aggregate state level; but it is when combined into an overall measure of unsafe sex.)

      Apparently the gap between what they say and what they do is particularly wide for teen-agers who describe themselves as evangelical Christians.  According to research by Mark Regnerus, a sociologist at the University of Texas, Austin, white evangelical adolescents usually state a belief in pre-marital abstinence — 74 per cent — but in fact are surprisingly active sexually, compared to mainline Protestants and Jews who do not tend to state such a belief.  When the evangelicals do engage in sex, they are less likely to use protection than others.  The gap between word and deed is strikingly high for the millions of teenagers who take a formal pledge to remain celibate until marriage, typically in a ring ceremony, according to a New Yorker article by Margaret Talbott (”Red Sex, Blue Sex“).  The majority of them, though holding out for awhile, “end up having sex before marriage, and not usually with their future spouse.”   Two other sociologists, Peter Bearman (Columbia University) and Hannah Bruckner (Yale) find a positive correlation between the abstinence pledge and Sexually Transmitted Disease (STD).  Pledgers are less likely to use a condom if and when they first have sex and overall are slightly more likely to contract a STD.  (Under George W. Bush, the federal government subsidized such abstinence pledge program despite their questionable effectiveness.)
              

                  
Fig.4: Teen pregnancy rates  Click for larger image         Fig.5: Firearms Assaults  Click for larger image

5) Wrath

     Nobody is surprised to hear that red states have higher rates of gun ownership than blue states.  But there is an important distinction between those who use guns responsibly and those who do not.   The data show that ¾ of the states with high rates of firearms assaults vote Republican.  (Figure 5.)   The regression is statistically significant.

6) Drunkenness  

     People who drink too much endanger themselves and endanger others as well.  You guessed it: States with high rates of fatal accidents from drunk driving tend to vote Republican (Figure 6).     Statistically significant. 

     
Fig.6: Drunk driving fatalities  Click for larger image       Fig.7: Smoking rates  Click for larger image   

7) Smoking

     Finally, states with high rates of smoking vote Republican too, as Figure 7 illustrates.   Again, the relationship is highly significant statistically.   

     Many of the Seven Deadly Sins can indeed be deadly.  It is particularly striking that the states where the most residents exhibit behavior that endangers their health and that of others - with many of these unhealthy people later free-riding on their fellow citizens when they show up uninsured in the hospital emergency room - are also the states where congressmen tended to vote against the Affordable Care Act (Obamacare) in 2010.  This risky behavior includes poor physical fitness (as measured by rates of obesity, lack of exercise, and poor diet), careless sexual behavior (as measured by rates of teen pregnancy and Chlamydia), smoking, drunk-driving (as reflected in fatalities) and irresponsible use of guns (as reflected in armed assaults). 

     Each obese American incurs medical costs 42%  higher than those of normal weight.  Often others are stuck with the bill, if the patient has not been able to get health insurance because of a weight problem.  These people are free-riders on the health care system even if they don’t want to be.   The individual mandate of Obamacare was designed to fix this free-riding problem and re-establish personal responsibility.  Yet congressmen in states with high rates of obesity or other health risk factors voted against the legislation.  (See my blogpost or an op-ed on Obamacare for the evidence.)   

     Utah is the most conspicuous outlier in most of these relationships.  It has a high population of Mormons. Apparently they follow the strictures of their religion more closely than those of other religious denominations.  (Could this be why evangelicals tend to resent Mormons so much, according to opinion polls?)   But Utah notwithstanding, the relationships hold on average.

     The five most “red” states are Wyoming, Oklahoma, Utah, Idaho, and Alaska.  The five most “blue” are New York, Massachusetts, Rhode Island, Vermont and Hawaii.   The average score of the five reddest states is worse in each category than the average score of the five bluest states: more obesity, smoking, Chlamydia, teenage pregnancy, drunk driving fatalities, and firearms assaults.  In the latter three of those measures, the “reckless” shares of the population are almost twice as high among the first five states as among the last five.  While we are at it, we might as well acknowledge that the red state populations also tend to be less educated and more prone to divorce. 

     There you have it, the surprising statistics.  ”Let he who is without sin cast the first stone.”

[This article draws in part on an op-ed concerning Obamacare in the Christian Science Monitor and another concerning Romney's "47%" remarks at Project Syndicate.    VoxEU also has a version.   Details on data and computations are available in a posted statistical appendix.]  

Once again this morning, the BLS employment release tells conflicting stories depending on whether one looks at the unemployment rate or job growth.   The U.S. unemployment rate fell from 8.3% in July to 8.1% in August, continuing the gradual three-year downward trend (from its 2009 peak at 10 %).     Political economy equations often say that the direction of movement of the unemployment rate in the period preceding a presidential election is the main economic determinant of whether the incumbent is re-elected.  

“Are we better off than we were four years ago?”   Yes.   If the criterion is to be a narrow unemployment comparison, and one counts from the month following the day Obama took the oath of office, then we are now at a lower unemployment rate.   But that is very simple-minded as a criterion.   (Look at GDP.  Better yet look at how the free-fall turned around  and the recession ended within his first 5 months.)

Employment growth is the more important statistic, to evaluate the progress of the economic recovery.  Here today’s BLS report was disappointing: only 96,000 jobs created.    The jobs number climbs into six digits if one looks at private sector employment growth.  

By the way, am I the only one who sees a general bias toward negativity in the media?   When the unemployment number looks bad and job creation looks good, like a month ago, the newspapers seem to headline the former.   When the unemployment rate looks good and employment disappoints, as this time around, they tend to focus on the latter.  The TV shows do the same (including those on which I appear).

In any case, as always, one should look at a longer run trend.   The fact is that private sector job growth has been running at an annual rate of 162,000 per month over the last two years.    This is far greater than the rate during the Bush Administration even if one looks only at the years in between the Bush recessions of 2001 and 2008  (83,000 per month, on average, from November 2001 to December 2007.)   It is not enough.  For example it is much less than the rate during the Clinton Administration, month in, month out (218,000 private sector jobs created per month, on average).  But it is a big improvement over where we were.

On the subject of Bill Clinton.  His speech to the Democratic Convention  Wednesday night again demonstrated his unique ability to explain wonkish policy details in a folksy way.    This included pointing out the statistics on private sector job creation under Democratic presidents since 1961 compared to Republican Presidents.   The rate has been just over twice as great.   Thus the current Obama-Bush comparison continues a half-century tradition.

The point about private sector job expansion looking better than overall employment growth is of course what Obama was trying to say in June when he made his unfortunately worded statement that “the private sector is doing fine.”   He quickly retracted that language, which was the right thing to do.  But the point still needs to be made.

Why look at private sector jobs, instead of total jobs?    I have a feeling that this is a Republican way of looking at things.  The Republicans don’t seem to believe there is anything amiss if a million public sector workers lose their jobs.  (Which is what has happened over the last year:  934,000.)    Teachers, firefighters, construction workers…   Apparently those don’t  count as real jobs because they are in the public sector.    That would explain the Republican congressional opposition to Obama’s initial fiscal stimulus in 2009 (the one that ended the recession) and their more successful subsequent attempts to block Obama’s job proposals.  

So maybe we should be looking at total employment after all, rather than private employment.  Or even focusing on the underemployed and discouraged workers.  But these are all reasons why we need to resume enacting the policies that Obama has been trying to enact.

     I have argued that the best way to think of “black swan” events is as developments that, even though low-probability, can in fact be contemplated ahead of time.  Even if they are the sort of thing that has never happened before within an analyst’s memory, similar things may have happened before in the distant past or in other countries.   

     What current possible shocks have probabilities that, even if fairly low, are high enough to warrant thinking about now?  Some have been discussed ad infinitum, others hardly at all.

• Most widely discussed is the danger of a break-up of the euro. Considered unthinkable a short time ago, the probability that one or more euro members will drop out is now well above 50%. Currency unions have disintegrated before.
• Another is the possibility of a hard landing in China, analogous to the crisis that hit Korea and other East Asian markets in 1997.
• An oil crisis in the Mideast is the classic black swan event. Each one catches us by surprise: 1956, 1973, 1979, and 1990 (among others). Oil prices can rise for lots of reasons, not just crises in the Mideast, and have done so in recent years. But the most likely crisis scenarios currently stem from either military conflict with Iran or instability in some Arab government. The threatened loss of supply to world markets typically shows up as a sharp increase in demand for oil inventories and thus in prices.
• The most worrisome financial threat is a crash of currently over-priced bond markets. In theory such a crash could be precipitated by inflation (particularly commodity-induced inflation as in 1973 or 1979). But this seems unlikely. More likely triggers are (i) a breakdown in the eurozone or (ii) political dysfunction in Washington. A default in Greece or some other Mediterranean country could trigger a global debt crisis any time. The evidence of extreme dysfunction in US politics is already there for all to see, in the attempts by some politicians to repeat the macroeconomic policy mistakes of 1937 and in the debt-ceiling show-down of August 2011 (which led S&P to downgrade US government credit rating from AAA to AA). The obvious crunch date comes after the American election, as the “fiscal cliff” approaches in the last two months of this year. In theory, fears of what will happen January 1 should lead investors to start dumping bonds now. But it is still considered a sign of sophistication in financial markets to opine that, precisely because the consequences of going over the cliff would be so bad, the politicians will again find a last-minute way to avoid it. In truth, the fact that we haven’t gone over the cliff before does not necessarily mean we won’t this time. Perhaps observers think that a clear result in the election, one way or the other, would help settle things. A true black swan in the mix would be a repeat in November of the disputed 2000 presidential election; there has been no reform in the meantime to assure people that their votes will be counted or that a disputed outcome would be resolved by independent institutions rather than by interested political appointees.
• Scariest on the list is a terrorist attack with weapons of mass destruction. When politicians have used the specter of a September 11 repeat to scare the American public into supporting unhelpful policy responses, the mistake has been in the unhelpful policy responses, not in the “scare” part. There is long-standing gap between the probability of a nuclear event as perceived by terrorism experts and the probability as perceived by the public. Admittedly the probability is lower now that Osama bin Laden is dead.
• Last on this list is an unprecedented climate disaster. Environmentalists sometimes underestimate the benefits of technological and economic progress when they reason that a finite supply of resources must of necessity be exhausted eventually. But the disbelievers are just as faulty in their reasoning that because a global climate disaster has not happened in the past it can’t happen in the future.

       Throughout history, big economic and political shocks have often occurred in August, when leaders had gone on vacation in the belief that world affairs were quiet.   Examples of geopolitical jolts that came in August include the outbreak of World War I, the Nazi-Soviet pact of 1939 and the Berlin Wall in 1961.  Subsequent examples of economic and other surprises in August have included the Nixon shock of 1971 (when the American president enacted wage-price controls, took the dollar off gold, and imposed trade controls), 1982 eruption in Mexico of the international debt crisis, Iraq’s invasion of Kuwait in 1990, the 1991 Soviet coup, 1992 crisis in the European Exchange Rate Mechanism, Hurricane Katrina in 2005, and US subprime mortgage crisis of 2007.   Many of these shocks constituted events that had previously not even appeared on most radar screens. They were considered unthinkable. 

The phrase “black swans” has come to be used to mean a very unlikely event of this sort.  Managers of Long Term Capital Management in 1998 or of most major banks in 2008 have suggested that they could not be expected to have allowed for a financial collapse such as the one that followed the default of Russia or the one that followed the bursting of the US housing bubble, because it was a “7-standard deviation event,” that is, an event of inconceivably tiny probability…in the realm of the probability that two major meteors hit the earth at the same time.   This is nonsense.  If the statistical model says the probability of a financial crisis is that low, it is the model that is wrong.  This is like the case when “hundred-year floods” turn up every few years.

A bit more enlightened are people who talk about Knightian uncertainty or “unknown unknowns.” Ignorance with humility is better than ignorance without it.    A still better interpretation is that statistical distributions have “fat tails,” in technical terms.  But it would be nice to get beyond the Jurassic Park lesson (”don’t be surprised if things go wrong”), to be able to say intelligent things about what causes tail events. 

       What does “black swan” really mean?   In my view, it should refer to an event that is considered virtually impossible by those whose frame of reference is limited in time span and geographical area, but that is well within the probability distribution for those whose data set includes other countries besides their own and other decades or centuries. 

      Consider five examples of mistakes made by those whose memory did not extend beyond a few years or decades of personal experience in a small number of countries.

1. “All swans are white.”  The origin of the black swan metaphor was the belief that all swans were white, a conclusion that might have been reached by a 19^th century Englishman based on a lifetime of personal observation and David Hume’s principle of induction.   But ornithologists already knew that there in fact existed black swans in Australia, having discovered them in 1697.  A 19^th-century Englishman encountering a black swan for the first time might have considered it an event of unthinkably low probability, even though the relevant information to the contrary had already been available in ornithology books.  It seems a waste of an excellent metaphor to use the term just to mean a highly unexpected event.  A better use of “black swan” would be to mean an event that would not have been quite so unexpected ex ante if forecasters had cast their data net over a broader set of countries and a longer time perspective.

 2. “Terrorists don’t blow up big office buildings.”   Before September 11, 2001, some terrorist experts warned that foreign terrorists might try to blow up tall American office buildings.   These warnings were not taken seriously by those in power at the time.   Many Americans did not know the history of terrorist events taking place in other countries and in other decades.  

 3. “Housing prices don’t fall.” Many Americans up to 2006 based their behavior on the assumption that nominal housing prices, even if they slowed down, would not fall.   After all, “they never had before,” which meant that they had not fallen in living memory in the United States.   They may not have been aware that housing prices had often fallen in other countries, and in the US before the 1940s.  Needless to say, many a decision would have been made very differently, whether by indebted homeowners or leveraged bank executives, if they had thought there was a non-negligible chance of an outright decline in prices.

 4. “Volatilities are low.”   During the years 2004-06, financial markets perceived market risk as very low.  This was most nakedly visible in the implicit volatilities in options prices such as the VIX.  But it was also manifest in junk bond spreads, sovereign spreads, and many other financial prices.  One of the reasons for this historic mis-pricing of risk is that traders were plugging into their Black-Scholes formulas estimates of variances that went back only a few years, or at most a few decades (the period of the late “Great Moderation”).  They should have gone back much farther - or better yet, formed judgments based on a more comprehensive assessment of what risks might lie in wait for the world economy.

 5. “Big banks don’t fail.”   ”Governments of advanced countries don’t default.”   ”European governments don’t default.”  Enough said.  Greece’s debt troubles, in particular, should not have caught anyone by surprise, least of all northern Europeans.   The perception was that euro countries were fundamentally different from emerging markets, that like Germany they were free of default risk.  Suddenly, in 2010, the Greek sovereign spread shot up, exceeding 800% by June. But even when the Greek crisis erupted, leaders in Brussels and Frankfurt seemed to view it as a black swan, instead of recognizing it as a close cousin of the Argentine crisis of ten years earlier, the Mexican crisis of 1994, and many others in history, including among European countries.

      My next blog post will list some of the shocks that, even though low-probability, have high enough probability that they should be treated as thinkable rather than unthinkable, they would have great consequences, and they therefore warrant some advance preparation.

The BLS this morning reported U.S. job gains of 163,000 in July, which is good news in the eyes of the financial markets.  The jobs data had been disappointing over the preceding three spring months.  Before that, during the winter months, employment growth was strong.

In terms of perceptions and politics, pundits will say that today’s report is good news for Obama’s re-election prospects, just as they said the spring jobs numbers were bad news for the President.  But my interest is in economics and reality, rather than perceptions and politics.   From a longer-term perspective, a few important facts have not been adequately discussed.

• 1. The rate of job growth over the last two years, 137,000 jobs per month, inadequate as it is, has actually been greater than the rate of job growth during the George W. Bush Administration (101,000 per month) even if one excludes the two Bush recessions that occurred in the first and last years of his administration, respectively.   The Obama Administration looks even better if one confines the numbers to private sector employment, since the government has been shedding jobs under Obama and was growing rapidly under Bush. Of course this is still nothing like the sort of progress we would ideally want to see - say, the 237,000 jobs that were created month in and month out on average during the 8 years of the Clinton Administration. And the number of long-term unemployed remains worryingly high. But the situation is a big improvement over the economy that Obama inherited three years ago.  

• 2. An unemployment rate of 8.3% shows that the economy is still in unsatisfactory shape.   (The July numbers show a rise from 8.21 to 8.25, which the BLS labelled “essentially unchanged” in the first sentence of its release.)   Unemployment remains higher than what the Obama Administration hoped we would have by now at the time it took office in January 2009.  Most of the difference can be explained by the fact that the level of economic activity in January 2009 - as a result of the free-fall in the last part of 2008 - was much worse than was realized at the time. The subsequent downward revision by the Commerce Department in the official statistic for the level of GDP at the start of 2009 can explain why the level of the economy is disappointing 3 ½ years later, more than the rate of growth over the intervening period. After all, those horrendous 2008 rates of decline in GDP and employment turned around during the six months immediately following the day Obama took office.  

• 3. Most private-sector and independent economists agree that the Obama fiscal stimulus made a positive difference; that - together with TARP and monetary easing by the Fed, unpopular as they are in some circles — it helps explain the mid-2009 economic turnaround; and that it helps explain the moderate growth that followed (2 ½ % growth p.a. in the 2nd half of 2009 plus 2010).   A good explanation for the disappointingly slow rate of growth in output and employment since the end of 2010 is that the fiscal stimulus has been withdrawn and the government sector has been contracting. (Since the November 2010 election, there have been enough Republicans in Congress to block the American Jobs Act and every other action that Obama proposes.)  One can see this in the composition of both GDP and employment. Today’s jobs report features another 9,000 jobs cut in state, local, and federal governments, continuing the pattern that has held throughout the recovery: jobs and output in manufacturing and the rest of the private sector have been expanding, partially offset by contraction in the public sector.

     My preceding post bemoaned the tendency for many US politicians to exhibit a procyclicalist pattern:    supporting tax cuts and spending increases when the economy is booming, which should be the time to save money for a rainy day, and then re-discovering the evils of budget deficits only in times of recession, thus supporting fiscal contraction at precisely the wrong time.  Procyclicalists exacerbate the magnitude of the swings in the business cycle.        This is not just an American problem.  A similar unfortunate cycle — large fiscal deficits when the economy is already expanding anyway, followed by fiscal contraction in response to a recession — has also been visible in the United Kingdom and euroland in recent years.   Greece and Portugal are the two most infamous examples. But the larger European countries, as well, failed to take advantage of the expansionary period 2003-07 to strengthen their public finances, and instead ran budget deficits in excess of the limits (3% of GDP) that they were supposed to obey under the Stability and Growth Pact. Then, over the last few years, politicians in both the UK and the continent have made their recessions worse by imposing aggressive fiscal austerity at precisely the wrong time.      Historically, developing countries used to be the ones where dysfunctional political systems produced procyclical fiscal policies.  Almost all of them showed a positive correlation between government spending and the business cycle during the period 1960-1999.  But things have changed.   Remarkably, during the decade 2000-2010, about a third of emerging market governments - in countries such as China, Chile, Malaysia, Korea, Botswana, and Indonesia - managed to reverse the historical correlation.  They took advantage of the boom years 2003-2007 to strengthen their budget positions, saving up for a rainy day.  They were thus in a good position to ease up when the global recession hit them in 2008-09.        In fact a majority of the governments that have followed countercyclical spending policies since 2000 are in emerging market or developing countries.   They figured out how to achieve countercyclicality during the last decade, precisely the decade when so many politicians in “advanced countries” forgot how to.