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The big event of this week in the U.S. will be the Supreme Court discussion of the Affordable Care Act aka “ObamaCare”, a supposedly derogatory nickname now embraced by the Obama campaign. At the heart of the fight is the so-called individual mandate which requires everyone to purchase health insurance. A related and important argument is that additional provisions, such as requiring coverage for individuals with preexisting conditions, become prohibitively expensive without the individual mandate. This is because, without the mandate, healthy individuals will not buy insurance till they become sick and this drives up costs of insurance companies. So, if the individual mandate is struck down, the argument goes, the court should also strike down the requirement that insurance companies cover individuals with pre-existing conditions.

I am not a lawyer but the main argument for canceling the individual mandate turns on whether the federal government has the right to penalize an individual if they do NOT take a certain action. There is plenty of precedent for taxing “action” but can the federal government tax “inaction”? Many amicus briefs have been filed but there are two key ones by economists.

David Cutler, who worked in the Obama administration, has filed one with many co-signatories (including Akerlof, Arrow, Maskin, Diamond, Gruber, Athey, Goldin, Katz, Rabin, Skinner etc.). They say there is no such thing as inaction. A conscious decision to forego healthcare is an action and hence under the purview of existing law. Foregoing insurance also affects outcomes largely by shifting costs to others and hence is not a neutral decision.

The other side of the argument is filed by Doug Holtz-Eakin with co-signatories inclusing Prescott, Smith, Cochrane, Jensen, Anne Krueger, Meltzer etc.) First, they argue that if an individual does not want to buy converage it must be because the costs outweigh the benefits. Second, they argue about the numbers, claming the costs imposed by the uninsured on the insured (“cost-shifting”) are far below the $43 billion estimated by the Government Economists and are more like $13 billion.

The first part of the Holtz-Eakin argument is, to me at least, odd. Uninsured individuals can get healthcare for free in the emergency room. Hence, they can get the benefits of healthcare  -or at least healthcare in extreme circumstances – without the costs. So, of course for them the benefits are outweighed by the costs because they get the benefits anyway. The argument by Holtz-Eakin presumes that the individuals are not free-riding and so their private decisions fully reflect the costs and benefits but they do not. Then, the second part of the argument which admits there is cost-shifting going on basically makes the point I am making – if there is cost-shifting, there is free-riding and then individual’s decisions do not fully internalize costs and benefits.

There has to be a better argument against the individual mandate than this. I looked at Senator Rand Paul’s brief. The precedent for this case is a 1942 case involving an Ohio farmer who was exceeding his quota of wheat production. Footnote 6 caught my eye:

So infamous is the case, it has been set to music, to the
1970s tune of “Convoy”:
“His name was farmer Filburn, we looked in
on his wheat sales. We caught him exceeding
his quota. A criminal hard as nails. He said,
“I don’t sell none interstate.” I said, “That
don’t mean cow flop.” We think you’re
affecting commerce. And I set fire to his crop,
HOT DAMN! Cause we got interstate
commerce. Ain’t no where to run! We gone
regulate you. That’s how we have fun.”

Will this convince Justice Kennedy or is it cow flop?

Find all briefs here.

In the past few weeks Romney has dropped from 70% to under 50% and Gingrich has rocketed to 40% on the prediction markets.  And in this time Obama for President has barely budged from its 50% perch.  As someone pointed out on Twitter (I forget who, sorry) this is hard to understand.

For example if you think that in this time there has been no change in the conditional probabilities that either Gingrich or Romney beats Obama in the general election, then these numbers imply that the market thinks that those conditional probabilities are the same.  Conversely, If you think that Gingrich has risen because his perceived odds of beating Obama have risen over the same period, then it must be that Romney’s have dropped in precisely the proportion to keep the total probability of a GOP president constant.

It’s hard to think of any public information that could have these perfectly offsetting effects.  Here’s the only theory I could come up with that is consistent with the data.  No matter who the Republican candidate is, he has a 50% chance of beating Obama.  This is just a Downsian prediction.  The GOP machine will move whoever it is to a median point in the policy space.  But, and here’s the model, this doesn’t imply that the GOP is indifferent between Gingrich and Romney.

While any candidate, no matter what his baggage, can be repositioned to the Downsian sweet spot, the cost of that repositioning depends on the candidate, the opposition, and the political climate.  The swing from Romney to Gingrich reflects new information about these that alters the relative cost of marketing the two candidates.  Gingrich has for some reason gotten relatively cheaper.

I didn’t say it was a good theory.

Update:  Rajiv Sethi reminded me that the tweet was from Richard Thaler. (And see Rajiv’s comment below.)

Auctions on eBay have a deadline and aggressive bidding occurs just before the auctions ends.  This is called “sniping” (see this excellent paper for a discussion along with the study of many other interesting issues).  One reason offered for this behavior is that bids might not come in as the auction ends so if your low bid gets in and my high bid does not, you win anyway (I seem to remember a paper by Al Roth along these lines).  A similar effect arises in the debt limit negotiations.

Assume for now the deadline is August 2 – if the debt limit is not raised by then all hell breaks loose.  If the House has a proposal on the table later today, this gives the Senate the change to reject it and table their own proposal.  But if the House gets their proposal in on August 1, there is too little time left for the Senate to respond with their own bill.  If they reject the House proposal, all hell breaks loose. And if the President vetoes the bill, all hell breaks loose. So, there is distinct advantage to the House from delaying the vote. Symmetrically, there is similar advantage to the Senate from delaying the vote.  But if both delay the vote, there is also a huge risk that neither proposal makes it through either chamber because both Reid and Boehner are having hard time drumming up enough votes.  So, as both parties delay the vote, there is a huge chance of hell breaking loose….

What if the August 2 deadline is not hard?  Then, I think I need a model to sort things out but my intuition is that there is bigger incentive to accept an early agreement (after August 1)- if you reject it, there is chance your counter proposal does not make it through as all hell breaks loose because the government runs out of money.  But if early agreements might be accepted, there is a bigger incentive to move early and get your bid in…..

Liberal commentators bemoan the demise of the old John McCain they thought they knew and loved.  Joe Klein wonders what happened to the guy who originally sponsored the Dream Act to allow children of illegal immigrants to become citizens. Think Progress points out that he is now supporting the tax cuts to the rich he vilified in 2000-2004.  What has happened to John McCain? Have his preferences changed?

There is one obvious theory that seems to make his positions consistent: McCain had to run to the right to beat off a primary challenger in Arizona.  But, as Joe Klein points out, “he recently won reelection and doesn’t have to pretend to be a troglodyte anymore.”  So this theory is flawed.

There is another obvious theory.  In this one, you have to identify an outcome a person supports or opposes not just by the policy itself but also by the the other person who supports it.  So you have outcomes like “tax policy opposed by Obama,” “tax policy supported by Bush,” “tax policy supported by Obama,” “tax policy opposed by Bush” etc.  Then, it is quite consistent for McCain to support a 35% tax on the rich when Bush opposes it but to oppose a 35% tax on the rich when Obama proposes it. Essentially, if McCain loses to someone in a Presidential election or primary he opposes their policies whatever they are.

A sophisticated model along these lines is offered by Gul and Pesendorfer.  It allows one person’s preferences to depend on the “type” of the other person, e.g. is the opponent selfish or generous? In principle, this model allows us to determine whether a person is spiteful using choice data.  McCain certainly has some behavior that is consistent with spitefulness.  Is he ever generous?  We would need to know his choices when facing someone he beat in a contest or someone he has never played.  Or is he just plain mean?  Joe Klein leans towards spite based on the available data:

“He’s a bitter man now, who can barely tolerate the fact that he lost to Barack Obama. But he lost for an obvious reason: his campaign proved him to be puerile and feckless, a politician who panicked when the heat was on during the financial collapse, a trigger-happy gambler who chose an incompetent for his vice president. He has made quite a show ever since of demonstrating his petulance and lack of grace.

What a guy.”

If choice with interdependent preferences can be utilized in empirical/experimental analyses, we can investigate the soul of homo economicus using the revealed preference paradigm.

Fresh from their rout of the Democrats, the G.O.P. are promising to repeal President Obama’s healthcare reform.  There are lots of things that can be improved in the law but there are also some features that will be popular with voters. To think about the risks of repeal, I find it useful to recall my favorite Rumsfeld quote:

“[A]s we know, there are known knowns; there are things we know we know. We also know there are known unknowns; that is to say we know there are some things we do not know. But there are also unknown unknowns — the ones we don’t know we don’t know.”

In the minds on most voters, the healthcare law in an unknown unknown – most of its provisions have not gone into effect and non-experts (and even experts?) have not read the bill fully.  There was never a really serious discussion of the law in the main stream media so citizens just know various buzz words (“death panels”).  The huge uncertainty made the law unpopular with voters and it gave Republicans an electoral advantage.

If the Republicans clamor to repeal the law, the Democrats can point to he features of the law that will be popular with voters  (no denial of coverage for pre-existing conditions, kids can stay on their parents’ policies till they are twenty six..).  The law will go from being an unknown unknown into known unknown/known known territory.  There is only upside for Democrats from this change – uncertainty-averse voters can’t have a worse impression of the healthcare reform than they already have.  They are judging the unknown unknown in its worst possible light.  The risk for Republicans is that if voters find some parts of the law appealing, their assessment actually improves and the Republicans’ electoral advantage diminishes.  Better to keep the details hidden.

There is a “middle of the road” strategy – repeal unpopular bits and keep the popular ones.  I’m not sure if this is really viable either.  It forces a serious discussion of the law.  For example, if Republicans try to repeal the requirement to buy insurance coverage, there will be some discussion of the subsidies offered and the costs of getting rid of the provision (some people will not buy insurance and then free-ride on emergency care pushing up costs for everyone else).  Even if the discussion is a mess, it can’t be worse than the shallow discussion we sat through last year.

My guess is that the usual promise of tax cuts seems to dominate healthcare repeal as a strategy for Republicans.

Obama has an interesting strategic decision to make about how to engage the Tea Party.  If there is one power that the President has, even when he has lost momentum policy-wise, it is to control attention.  How should he use this power in relation to the Tea Party?

Right now the Tea Party has few leaders, and none with any real power. Obama can essentially anoint a leader by picking him/her out of the crowd and engaging directly.  For example, by personally responding in a press conference to some attack and addressing the Tea Partier by name.  As the Tea Party tries to internally organize, a well-targeted salvo could throw a wrench in the works. On the other hand, it could backfire and provide them with a much-needed lightning rod.

He could frame the upcoming election as “sane, albeit perhaps incompetent Democrats” versus “nutty Tea Partiers.”  By doing so he would raise the stakes for the Tea Party higher than they might want to make them.  In its infancy, the Tea Party may not be ready for an up-or-out test.

Obama could be wisely waiting until after this election to make any move like this.  It may even be that he and the Tea Party have a mutual interest in keeping their profile low for now.  Because making this election out to be a test of the Tea Party’s fitness can only really have consequences in the event they fail to make a good showing.  In that case, the Tea Party disappears and Obama loses a potentially valuable third-party threat in 2012.

Instead, if they tacitly agree to view the Tea Party as too young to be a big contender this November, they both keep their hopes alive in the event of defeat.  Which of course means that the mainstream Republicans should have exactly the opposite incentive.

Now I am trying to figure out how this fits in with the story.

Obama has two focal options in Afghanistan, “Stay the Course” or “Cut and Run”.  Stay the Course means continuing the current counterinsurgency (COIN) strategy of “winning hearts and minds” of Afghan civilians.  Cut and Run means getting out as soon as possible and leaving the Afghans to deal with their own mess.  In either scenario it is optimal to sack McCrystal.

McCrystal is a strong believer in COIN so if you want to Cut and Run, it s better to replace him with someone else, a true believer in Cut and Run.  If Obama wants to Stay the Course, McCrystal is a possible candidate.  But there is a reputational cost, looking weak, to Obama of retaining McCrystal.  Replacing him carries the risk that the COIN strategy fails.  But Petraeus is the author of COIN so this risk is minimized if Petraeus replaces McCrystal.  So, even if you want to Stay the Course, it is optimal to sack McCrystal.

Pretty simple?

You are an ambitious, young Presidential-wannabe.  This makes you a trifle immodest and you decide to write an autobiography, Volume 1.  It’s going to set the stage for your Presidential bid.   Some may say you have yet to do anything so said volume may not sell too well, even though you have an exotic cocktail of a family background and were President of Harvard Law Review.   They may be right so you are not willing to pay a lump sum fee to employ an agent to sell your manuscript: not only might your book not work out, you would be stuck with a bill from an agent to add to your law school debts.

Luckily for you, pretty much every guy who writes a book is in the same position as you: immodest enough to write a book and yet knowing that it might not sell.  So, there is a standard contract that is signed with a book agent:  they work for you to get you a contract and if the book actually sells they get 15%.  This way you share the risk: if the book fails, at least you do not also lose the amount you paid the agent; in return, if it succeeds, you do not get to keep all the benefits.  The 15% contract gives you a form of insurance. Plus, it gives the agent the incentive to work hard, helping to alleviate the moral hazard problem.

Miracle of miracles, the book does actually sell eventually.  It lies ignored but you become kind of famous anyway and then people buy it.  Now you’re ready for Volume 2.  Is the old book agent contract still the best option for you?

Well, Volume 2 is almost certainly going to fly off the shelves.  You do not need to share the risk.  All you care about is the getting the best price and you don’t need protection in case of failure as it ain’t going to fail.  Best just to go with a great negotiator.  In fact, a well-connected Washington lawyer might be just the thing.  You just pay him upfront and he calls his contacts.  And he’s done it before.  It’s expensive if your book fails and you don’t get the rest of your advance or even have to give back the chunk they gave you.  But Volume 2 is your road to the Presidency, Volume 1 was just laying the foundation.  Everyone will read it as you’re intriguing and you’ll get to keep your advance and even get royalties.  Now, you can afford to be President as your law school debts are paid and you can even send your kids to a spiffy private school.

Obama’s Nuclear Posture Review has been revealed.  The main changes:

(1) We promise not to use nuclear weapons on nations that are in conflict with the U.S. even if they use biological and chemical weapons against us;

(2) Nuclear response is on the table against countries that are nuclear, in violation of the N.P.T., or are trying to acquire nuclear weapons.

This is an attempt to use a carrot and stick strategy to incentivize countries not to pursue nuclear weapons.  But is it any different from the old strategy of “ambiguity” where all options are left on the table and nothing is clarified?  Elementary game theory suggests the answer is “No”.

First, the Nuclear Posture Review is “Cheap Talk”, the game theoretic interpretation of the name of our blog.  We can always ignore the stated policy, go nuclear on nuclear states or non-nuclear on nuclear states – whatever is optimal at the time of decision.  Plenty of people within the government and outside it are going to push the optimal policy so it’s going to be hard to resist it. Then, the words of the review are just that – words.  Contracts we write for private exchange are enforced by the legal system.  For example a carrot and stick contract between an employer and employee, rewarding the employee for high output and punishing him for low output, cannot be violated without legal consequences.  But there is no world government to enforce the Nuclear Posture Review so it is Cheap Talk.

If our targets know our preferences, they can forecast our actions whatever we say or do not say, so-called backward induction.  So, there is no difference between the ambiguous regime and the clear regime.

What if our targets do not know our preferences?  Do they learn anything about our preferences by the posture we have adopted? Perhaps they learn we are “nice guys”?  But even bad guys have an incentive to pretend they are nice guys before they get you.  Hitler hid his ambitions behind the facade of friendliness while he advanced his agenda.  So, whether you are a good guy or bad guy, you are going to send the same message, the message that minimizes the probability that your opponent is aggressive.  This is a more sophisticated version of backward induction. So, your target is not going to believe your silver-tongued oratory.

We are left with the conclusion that a game theoretic analysis of the Nuclear Posture Review says it seems little different from the old policy of ambiguity.

President Obama has used the Congressional recess to appoint Paul Krugman as Vice Chairman of the Federal Reserve system.

Obama spent the first year in office wooing centrists like Olympia Snowe.  That strategy slowed down his reform agenda and did not pay off.  The President had to rely on old hardball Chicago politics to pass healthcare reform.  He has realized his hope of appealing to the center of the political spectrum is futile.  And in any case, it’s the diehard party faithful that decide midterm elections.  What better way to energize the base than by appointing their hero, the self-styled conscience of liberalism and economics Nobel Prize winner, Paul Krugman, to the Federal Reserve?

Krugman stands no chance of getting the 60 votes required to survive the usual Senate confirmation process.  As his appointment has no direct impact on the budget, the arcane procedure known as “reconciliation”, that requires only a simple majority, cannot be used to give him an up and down confirmation vote. Ironically, Krugman will have a huge impact on the budget as he favors expansionary monetary and fiscal policy in recessions.  A perpetually gloomy forecaster, Krugman almost always believes a recession is round the corner and for all practical purposes favors large budget deficits all the time.  Even if reconciliation could be used, with moderate Democrats against him, it is not clear that Krugman could draw 50 votes.  So,  a recess appointment was the only possible strategy for Obama.

This is obviously a dangerous move for the President.   He is used to hiding his liberal agenda behind the fig-leaf of bipartisanship.  With the leaf removed, he feels naked and vulnerable.  Obama has gambled that the extreme left must be brought out to retain the Democrats’ hold on Congress.  With the Krugman appointment as a flashpoint, Obama risks losing moderates and perversely provoking the extreme right to turn out and vote.

The benefits and risks for Obama are clear but what’s in it for Krugman?  He has long wanted to get his hands on the levers of economic policy.  But at what cost?  He will have to step down from his sinecure as a Times’ columnist.  He will have to mothball his textbook, as Ben Bernanke did before him.  Most of all, he may regret the demise of the speaking engagements that have helped to bankroll his many houses and apartments in America and beyond.  A favorite of the Hollywood glitterati – Ben Affleck is a close friend – Krugman will now have to give up the organic-chicken-and-chardonnay circuit and attend regular Fed meetings in Washington D.C. A dream for a regular economist but perhaps a letdown for a media star like Krugman.  Of course as a recess appointee, Krugman can only serve until the next Congress is seated – maybe that is just the right amount of time for him to substitute Ben Bernanke for Ben Affleck in his speed dial.

All in all, an intriguing appointment for all parties concerned.

Karen Tumulty at the Time blog Swampland perceptively writes:

“the easiest choice for endangered Democrats in swing districts is to vote against the bill–but only if it passes. That’s because they need two things to happen to get re-elected this fall. They need to win independent voters (who in most recent polls, such as this one by Ipsos/McClatchy, are deeply divided on the bill). But they also need the Democratic base in their districts to be energized enough to turn out in force–something that is far less likely to happen if Barack Obama’s signature domestic initiative goes down in flames.”

Tumulty compares the scenario to an earlier vote in 1993 on the Clinton economic plan:

“It was the night of August 5, 1993, and Bill Clinton was one vote short of what he needed to get his economic plan through the House–a vote he got, when freshman Marjorie Margolies-Mezvinsky switched hers. The other side of the Chamber seemed to explode. Republicans pulled out their hankies and started waving them at her, chanting: “Bye-bye, Margie.”

Margolies-Mezvinsky learned the hard way that they were right. Her Main Line Philadelphia district was the most Republican-leaning of any represented by a Democrat in Congress. She had sealed her fate:

During her campaign, she had promised not to raise taxes, and the budget proposed a hike in federal taxes, including a gasoline tax. On the day of the vote, she appeared on television and told her constituents that she was against the budget. Minutes before the vote, however, on August 5, 1993, President Clinton called to ask Margolies-Mezvinsky to support the measure. She told him that only if it was the deciding vote—in this case, the 218th yea—would she support the measure. “I wasn’t going to do it at 217. I wasn’t going to do it at 219. Only at 218, or I was voting against it,” she recalled.11 She also extracted a promise from Clinton that if she did have to vote for the budget package, that he would attend a conference in her district dedicated to reducing the budget deficit. He agreed (and later fulfilled the pledge). Nevertheless, Margolies-Mezvinsky told Clinton “I think I’m falling on a political sword on this one.”

Tumulty suggests the underlying game is the Prisoner’s Dilemma.  Some of her commenters suggest the game is similar to the free-rider problem in provision of public goods.  The free-rider problem is very similar to a Prisoner’s Dilemma so really the commenters are echoing her interpretation though they may not realize it.

I claim the interesting version of the game for Democratic Representatives in conservative districts is Chicken.  Two cars race towards each other on a road.  Each driver can swerve out of the way or drive straight.  If one swerves while the other does not, the former loses and the latter wins.  If neither swerves, there is a terrible crash.  If both swerve, both lose. A variant on this game is immortalized in the James Dean movie  “Rebel without a Cause”.

According to Tumulty, Democratic Representatives in conservative districts want to have their cake and eat it: they need healthcare reform to pass to get Democratic turnout but they want to vote against it to keep independents happy.  The strategic incentives are easy to figure out in two scenarios.  First, suppose the bill is going down however the Rep votes as it does not have enough votes.  Then, this Rep should vote against it – at least they get the independents in their district.  Second, suppose the bill is going to pass however the Rep votes – they should vote against via the Tumulty logic.

The third scenario is ambiguous.  Suppose a Rep’s vote is pivotal so the reform passes if and only if she votes for it.  At the present count with retiring Reps, Pelosi needs 216 votes to pass the Senate bill in the House so a Rep is pivotal if there are 215 votes and her vote is the only way the bill will pass. Margie M-M was in this position in 1993.  There are two possibilities in the third scenario.  In the first, the Rep wants to vote against the bill even when she is pivotal as she is focused on the independent vote.  This means she has a dominant strategy to vote against it the bill.

This case is strategically uninteresting and, as in the Margie case, it is implausible for all the undecideds to have a dominant strategy of this form.  So let’s turn to the second possibility – many undecideds Rep wants to vote for the bill if they are pivotal.  This generates Chicken.  If none of the conservative Democratic Reps vote for it, the bill goes down and its a disaster as Democratic voters do not turn out.  This is like cars crashing into each other in Chicken. Your ideal though is if someone else votes for it (i.e swerves) in the pivotal scenario and you can sit on the sidelines and vote against it (drive straight).  There is a “free-rider” problem in this game as in the Prisoner’s Dilemma.  But there is a coördination element too – if you are the pivotal voter you do want to vote for the bill.

Chicken has asymmetric equilibria where one player always swerves and the other drives straight. This corresponds to the case where the conservative Democrats know which of them will fall on their swords and vote for the bill and the rest of them can then vote against it.  This is the best equilibrium for Obama as the Senate Bill definitely passes the House.  But there is a symmetric equilibrium where each conservative Rep’s strategy is uncertain.  They might vote for it, they might not.  There is no implicit or explicit coördination among the voters in this equilibrium. This equilibrium is bad for Obama.  Sometimes lots of people vote for the bill and it passes with excess votes.  But sometimes it fails.

There is lots of strategy involved in trying to influence which equilibrium is played.  And there’s lots of strategy among the Reps themselves to generate coordination.  If you can commit not to vote for the bill, Obama and Pelosi are not going to twist your arm and they’ll focus on the lower-hanging fruit.  Commitment is hard.  You can make speeches in your district saying you’ll never vote for the bill.  Margie M-M did this but a call from the President persuaded her to flip anyway.  Republicans are going to emphasize the size of the independent vote to convince the undecideds that they have a dominant strategy to vote against the bill.  And the President is going to hint he’s not going to help you in your re-election campaign if you vote against the bill.  Etc., etc.

So, if the Senate bill is finally voted on, as we creep up to 200 votes or so, we’ll see Chicken played in the House.  We’ll see who lays an egg.

Harold Pollack at the New Republic blog The Treatment has an interesting comparative historical analysis of the current push to include the “public option” in the health bill via reconciliation and a famous vote in 1956 on a House bill to extend federal aid to states to build schools:

The bill would have provided federal aid to the states to build schools. Democrats sponsored the bill, which was popular ten years into the baby boom. For familiar pre-election reasons, Republicans wanted HR7535 to die. They got lucky when Harlem Congressman Adam Clayton Powell dropped a hand grenade into the process by proposed an amendment mandating that grants could only be used by states with schools “open to all children without regard to race in conformity with the requirements of the United States Supreme Court decisions.” Urban liberals could hardly oppose this amendment. Yet its inclusion would doom the final bill by driving away critical southern Democratic votes.

The inclusion of the Powell amendment killed the whole bill.  Pollack thinks that the inclusion of the public option would kill the health bill and hence Rockefeller and Obama do not want it included in the reconciliation process.  There are many theories for why Powell offered his amendment.  He could see that it would cause the collapse of the bill. In the process, it would reveal the hypocrisy of the Democratic leadership of the House and that, to him, was a greater goal than building more schools in the short run.  There is no greater goal, like civil rights, at stake in the current health reform so Pollack has a point in suggesting the progressives’ strategy is short-sighted not far-sighted.

Government organizations often compete not cooperate.  They compete for funding from the central government and if say the C.I.A. succeeds in some task and the N.C.T.C. does not, money, status, access etc. might move naturally towards the former from the latter.  If the N.C.T.C. helps the C.I.A. catch a terrorist, ironically, their own hard work is punished.  On the other hand, competition helps to give the bureaucracies the incentive to work hard.  That is, the positive effect that must be counterbalanced against the negative effect on incentives to cooperate.  What is the optimal incentive scheme?

This seems like a pretty important question and someone has studied an important part of it.  The classic paper is Hideshi Itoh’s Incentives to help in Multi-Agent Situations.

Suppose the marginal cost of helping is zero at zero effort of helping.  Then, if one agent’s help reduces the other’s marginal cost of effort at his main task, it is optimal to incentivize teamwork.  How do you do that?  One agent has to be paid when the other succeeds.  The assumptions that efforts are complements and that the marginal cost of help is zero at zero do not seem to be a big stretch in the present circumstances.  The benefits of greater competition, lower resource costs, must be traded off against the costs, less cooperation and hence more chance of a successful terrorist attack if “dots are not connected” across organizations.

Itoh also shows that if the marginal cost of helping is positive at zero help, the optimal scheme either involves total specialization or,  more surprisingly, substantial teamwork.  This is because giving agents the incentive to help each other just a little is very costly, given the cost condition.  So, if you are going to incentivize teamwork at all,  it is optimal incentivize large chunks of it.   If the benefits of catching terrorists is large, this logic also pushes the optimal scheme towards teamwork.

With much information classified, it is impossible to know how much intra-bureaucracy competition contributed to intelligence failure.  But whether it did not or not, it is worth ensuring that good mechanisms for cooperation are in place.

Whatever the merits of the claims made about Fox News by Obama’s communications team, it can be good strategy to pick a fight with your critics.  To the very long list of reasons, add this one.  If you can make them so angry that they lose the will to say anything at all nice about you, then you have won a major victory. For then they will have lost all (remaining) credibility.

But I am somebody who is very anxious to have the Afghan government and the Pakistani government have the capacity to ensure that those safe havens don’t exist. And so it, I think, will be an important reminder that we have no territorial ambitions in Afghanistan; we don’t have an interest in exploiting the resources of Afghanistan. What we want is simply that people aren’t hanging out in Afghanistan who are plotting to bomb the United States.

Obama said this in an interview with NPR (transcript.)  He actually says “hangin’ out” but the transcriber apparently wanted to maintain an air of formality and wrote “hanging.”  You can hear it here, around the 12:30 mark.  He chuckles a bit when he says it.

These are conspicuoulsy different ways for a President to talk, especially about something as serious as terrorism.  It says something about the man himself and it also draws a sharp contrast with Bush, whose standard catch phrase at these moments would be “rout out the terrorists.”

Previous installment in the series.

Jeff already wrote an interesting blog about Specter switching parties.  Specter seems to have switched because he stands a better chance winning in re-election as a Democrat than a Republican, Jeff’s point 4.  The Democrats seem ecstatic and I’m trying to deduce why this is the case.

If Specter had not been accepted into the Democratic fold, he would have lost in the Republican primary.  The Republican candidate, presumably someone very right wing, would then face a Democratic challenger.  This Democrat would be someone other than Specter as Specter would have tried to run as a Republican.  Maybe Specter would run as an Independent in this scenario – though I’m not sure if Pennsylvania allows this.  If the Democrats think that having Specter run as a Democrat means a higher probability of a Democratic win than this messy scenario, I can see some rationale for their happiness.

Their payoff is affected by the quality of Specter as a Democrat as well as his probability of winning.   Specter was pretty independent as a Republican and, for example, voted for the stimulus bill.   So, he is a net gain to the Democrats if he is more likely to vote Democrat than Republican with a “D” label attached to him rather than a “R”.  But he has just shown his lack of loyalty to party by switching sides and was always independent anyway.  His move is very much a rational move made by a calculating politician.  Hence, I believe he is only of use till he is re-elected (or not) in 2010.  Obama has promised to campaign with him and help him raise money.  This is useful till 2010.  After that, Specter will go his own way.    Obama has to get as much Specter-friendly legislation as possible passed in the next two years.  I’m not sure where Specter stands on healthcare reform.  He had cancer and is emotional about health issues.  Maybe this is a point of common value.

Continuing to make bold moves in the first 100 days of his administration, Obama will announce this week two blockbuster appointments to senior positions at the Department of Treasury.

Freakonomist

Sure to raise eyebrows will be the appointment of University of Chicago economist Steve Levitt to Tim Geithner’s team. Rarely venturing into the realm of policy,  the author of Freakonomics is better known –and often derided– for research focusing more on cute trivialities like cheating by Sumo wrestlers.

Ironically, his foray into Sumo-economics appears to be exactly why he is getting the call.  As readers of Freakonomics know, Levitt made headlines when he used the same statistical analysis to expose widespread cheating by teachers in the Chicago Public Schools.  How does this help the Department of Treasury you ask?  Stress Tests.  The big headline of Geithner’s first announcement as Treasury Secretary was the promise  to screen out banks doomed to fail.  Strangely, Treasury has since been mum on the results from the stress tests. Now we know the reason:  it turns out all the banks are getting passing marks and the suspicious Treasury Secretary is calling on Levitt to bring his Sumo-scrutiny to bear on the banks.

Colleagues at the University of Chicago economics department are cheering the move.  “I could not think of a better choice than Steve Levitt to move to Washington and help the Obama team” says Nobel Laureate James Heckman, adding that he expects the job to occupy Levitt for two full Obama administration terms. “We will miss him, but he has an important job to do.”

When we finally reached Levitt, he was at McDonalds headquarters at Oak Brook, IL.  Some of their franchises have been cheating by hiding Big Mac revenues that they have to share with McDonalds.  Levitt has found a way to benchmark performance that can reveal suspiciously underperforming locations.  “This is what economists call ‘moral hazard,’ ” Levitt said over a carton of Chicken McNuggets. “Look, economics is not rocket science.  Think of the US Government as like McDonalds, a bank and a toxic asset are just like a franchisee and a Big Mac.  Once you see it that way, its simple.”

Former Bushie

Joe Lieberman supported John McCain during the election, made a speech at the Republican Convention and said Obama was not ready for the Presidency.  And yet Obama later forgave him because he knew Lieberman’s vote was going to be crucial in the Senate.

Now, Obama has shown the same pragmatic streak in inviting Greg Mankiw to join his administration.  Mankiw was the head of Bush II’s Council of Economic Advisors.  He has so far played a role on the sidelines, an informal referee of the contest between Obama and his right-wing critics.  Mankiw is often skeptical of Obama’s plans but at the same time he does not fully endorse their antithesis.  This ambiguity has suited Mankiw well, as he has been courted by both sides of the political spectrum.  Finally, he has chosen his prom date and decided to join the Obama administration.  He will serve alongside his old Harvard colleague Larry Summers as Co-Director of the National Economic Council.

Why did Obama choose Mankiw for this post?

Mankiw said, “Well, in all modesty, I must point out that I proposed something like the Geithner plan – of course, I call it the Mankiw plan (!) – last October.  There are some differences in the details but the principles are the same.  I’m looking forward to improving the plan and being involved in its implementation.  Whenever you are asked to serve your country, I think you should do it, even if there are  ideological differences with some of the people involved.”

The additional intellectual heft of having Mankiw on board will certainly help in the coming months.  Mankiw is also quite familiar with the rump of the Republican party that is still left standing in Congress.  He is one of the rare individuals who has a good relationship with both John Boehner and Mitch McConnell.  McConnell and Mankiw were bridge partners and they have the camaraderie and preternatural ability to wordlessly communicate that comes from expertize at that genteel but vicious game.  But Mankiw can also be a populist and is a great expositor of complex ideas, a fact that Obama hopes will help in persuading at least some House Republicans to occasionally vote for some of his economic plans.

There is another factor at play.  True to predictions, Larry Summers has proved hard to control within the West Wing.  Orzag and Geithner have not been able to do it.   In any case, they are fantastically busy trying to implement Obama’s healthcare policies and manage the financial crisis.  Furman and Goolsbee , who were both students in Cambridge, are in awe of their former teacher and find it hard to contradict him.  Summers and Mankiw respect each other, or at least Mankiw respects Summers!  Obama has watched Biden and Clinton argue over Afghanistan policy.  As a lawyer, Obama has always favored the “team of rivals” approach and wants to replicate it in economic policy.

Only one thing stands in the way.  Mankiw has amassed a huge fortune by selling economics textbooks all over the world.  He is incorporated in Switzerland as a Verein for tax purposes. A verein is an association of independent businesses and each international textook is an independent “firm” within the Mankiw Verein.  This has several tax advantages and seems to be all quite legal. But with the current furor over AIG bonuses the administration wants to tread carefully.

Jeff and Sandeep

(I have taken to titling my posts in the style of an Alinea dish.)

I was reading one recent morning to my 2 year old boy a story from Frog and Toad.  In this story, Toad is grumpy about Winter but Frog talks him into coming for a sleigh ride.  Once the sleigh gets going really fast, Toad begins to forget all of his complaints and enjoy the ride.  Unbeknownst to Toad, Frog is knocked off the back of the sleigh as the sleigh starts to hurtle faster and faster down the hill.  Despite the sleigh being without a driver and completely out of control, Toad begins to feel more and more secure and at peace with the Winter.

Of course, something is going to happen to bring it all crashing down on Toad.  In fact, what happens is not that the sled crashes into a tree, at least not yet.  What happens is a crow flies by and upon hearing Toad describe what a wonderful ride he and Frog are having, points out to Toad that Frog is not behind him anymore.  Its only after learning that there is nobody at the wheel does Toad panic and cause the sleigh to crash.

This is a recurrent theme in children’s literature.  I think the quintessential expression of it is from the cartoons, especially the roadrunner/coyote cartoons.  Here is the image.  Coyote is chasing roadrunner through some rugged canyonland along a steep ridge and the chase brings Coyote to a cliff.  He is so focussed on finally nabbing the roadrunner that he does not notice that he has run off the cliff.  He keeps running.  In mid-air.  But then at some point he looks down and notices that there is no ground beneath his feet and at that moment that he falls to back to Earth.  (At which point he turns to the next page in his ACME catalog and the chase is on again…)

If you run off a cliff you should make sure you are running fast and that the opposing cliff is not too far.  It also helps to be like the roadunner: looking down is not in his nature and he always makes it to the other side.

I think of Obama’s first 100 days as running off a cliff.  We have a pretty good running start.  So far we are not looking down.  I hope we get to the other side before somebody does.  And please, pay no attention to the crows.

I admit defeat.

St. Patrick’s Day is approaching and I claim credit for the first to make this lame pun.  I won’t be the last.

Obama gave an interview yesterday on TV where he was asked about nationalizing banks.  His response is an interesting look into the way the administration thinks about things, comparing the US to Japan and Sweden.  You can read a transcript here.

What caught my eye was his use of the word “like” in the following excerpt (second sentence.)

So you’d think looking at it, Sweden looks like a good model. Here’s the problem; Sweden had like five banks.

This is the so-cal “like.” It stands for “about” or in this case “not many more than.” It lends an informality to the sentence which adds to its comical and therefore rhetorical punch.  On top of that it brings the President further down to Earth even when talking about something esoteric like bank nationalization.

I like it.  Is this the first occurence of the so-cal “like” in Presidential prose?

Be wary though, this mild version is the gateway “like” to more serious transgressions such as “We were discussing TARP and Geithner is like, ‘No way Larry, I am the Treasury Secretary and I say no caps on executive pay’ and then, like, Summers is all ‘Whatever.’ “

here are my two simple ways of thinking about fiscal stimulus.

from the perspective of the stimulee:  the federal government is right now the cheapest source of capital.  in fact capital has never been cheaper.  the treasury can borrow at record low interest rates. unfortunately the banking system is not doing its job as an intermediary channeling this credit to the bridge-builders.  so the bridge-builders effectively borrow directly from the source by accepting stimulus dollars and promising to pay them back in the future with taxes.

(of course there is a wedge between the amount i receive in stimulus ($X) and the amount I pay in taxes ($X/N) and this makes me inefficiently eager to accept it.  this is why stimulus should focus on public projects where the benefits are dispersed equally.)

from the perspective of government.  we accept that there are things government should be producing, in particular public projects where the benefits are dispersed equally.  the government has flexibility in the timing of these investments.  since the investment requires coupling labor with the government’s capital, the optimal timing is during times of (otherwise) unemployment when labor is relatively cheap.

so we don’t have to think about multipliers and we don’t have to think about Keynesian effective demand.  The government acting optimally to smooth expenditures should spend a lot now.  Yes, it means spending must be correspondingly reduced in the future and critics would worry that this won’t happen.  But there will come a time when interest rates are higher and it is more costly for the government to borrow and under pretty much any theory you have of how spending is determined, at the margin at least, that will have the effect of reducing spending.

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