Frankenblog

Reversed Psychology: Tax Cuts and Work

by Bruce Webb

In comments to his last post A Response to Megan McArdle, Again Cactus put the following up as a summary of the Economic Right’s approach to tax cuts:
1. tax cuts mean people are encouraged to work harder
2. people work harder
3, growth

Another version of this was posted, without apparent irony, on a MY post on the soda tax. How to Think about Pubic Health Taxes (bolding mine but actually echoed when MY later quoted himself)

Think about the case for taxing income, via the income tax and FICA. Why do it? Well, to get the money. That’s how we finance Social Security, the Department of Defense, Medicare, interest payments on the national debt, Medicaid, federal aid to schools, veterans’ health care and benefits, the FBI, etc. Now what’s the case against taxing people’s income? Well, it’s that it discourages work and it discourages investment. And that’s bad for the economy. Now we go back and forth over whether any given expenditure has a value that outweighs the economic costs. Liberals, like me, tend to think that a relatively high level of expenditure is justified whereas folks on the right tend to disagree.

But that simply shows, and not for the first time that some of our progressive wunderkinden have simply internalized the central tenet of supply side voodoo, the idea that income taxes are a tax on work and capital gains taxes are a tax on investment, and that like proposed taxes on soda or existing taxes on liquor and gasoline the more you tax something the less people are inclined to expose themselves to that tax.

This I think is a profound misunderstanding of the psychology of work and investment. Those who care about why I would think that and those who are just dying to mock the whole idea can follow me below the fold.

Now there are some people who work just for the sake of work itself. In fact a lot of people will spend many hours on work that comes with no monetary compensation at all. We call these people ‘hobbyists’ and ‘unpaid volunteers’. And I suppose if you taxed these people directly on their time there would be some tendency to reduce that time, or at least the time reported to the tax man. But most people do not approach work as some sort of dispensable hobby, instead work is the means to some other desired end whether that end be subsistance, or fame, or fortune with its attendant material objects, or in some cases simple sociality (e.g. some people live to organize office birthday parties). Mostly though people are one way or another working for the paycheck.

But even the paycheck amount is not an end in itself, at least not for everybody, and particularly not for those people who work outside the hyper-competitive world of Wall Street, not every clerk dreams of being office supervisor, not every framer dreams of being site superintendent. some times what you have is good enough.

And when we examine history we can see that in most times and most places this is the norm, sure there are always strivers and always some measure of economic mobility but particularly in largely pre-industrialized societies people tend to end up at some equilibrium. And that equilibrium point is mostly established by a desired level of consumption.

I first came across a formalized version of this in Chayanov’s The Theory of Peasant Economy. I just now ran across a pretty good version of Chayanov’s overall thesis here Russian History Encyclopedia: Peasant Economy

Perhaps the greatest theorist of the peasant economy was a Russian economist named Alexander Chayanov, who lived from 1888 to 1939. Chayanov published a book entitled Peasant Farm Organization, which postulated a theory of peasant economy with application for peasant economies beyond Russia. He argued that the laws of classical economics do not fit the peasant economy; in other words, production in a household was not based upon the profit motive or the ownership of the means of production, but rather by calculations made by households as consumers and workers. In modern terminology, the family satisfied rather than maximized profit.

According to Chayanov, the basic principle for understanding the peasant economy was the balance between the household member as a laborer and as a consumer. Peasant households and their members could either increase the number of hours they worked, or work more intensively, or sometimes both. The calculation made by households whether to work more or not was subjective, based upon an estimate of how much production was needed for survival (consumption) and how much was desired for investment to increase the family’s productive potential. Those estimates were balanced against the unattractiveness of agricultural labor. Households sought to reach an equilibrium between production increases and the disutility of increased labor. In short, households increased their production as long as production gains outweighed the negative aspects of increased labor. This principle of labor production in the peasant economy led Chayanov to argue that the optimal size of the agricultural production unit varied according to the sector of production at a time the official policy of the Communist Party of the Soviet Union was pushing for large collective farms. As a result of this disagreement with Marxist economists and the Party line, Chayanov was arrested in 1930 and executed in 1939.

Chayanov came to his understanding not from a position of armchair theorist but by doing some serious data analysis of the surprisingly (to us) abundant documentation of peasant work life in Czarist Russia. And the result was that he found some very large divergences in work effort over the course of the standard peasant work-life with the peasant couple stepping up their work hours during some periods (for example while children are small and when setting up children with their own holdings) and then dialing it back.

Now even in the Peasant Economy there are strivers who undertake to raise their equilibrium point, your German ‘kleinbauer’ maybe wanting to rise to the status of ‘bauer’ and your ‘bauer’ to ‘grossbauer’, but equally the shift could go the other direction in any given generation, but the whole effort was not particularly driven by the profit motive but instead by the desired outcome.

Which is where supply siders get their psychology reversed. They see the income tax as a tax on work and as such a disincentive to work itself. Just as they see a tax on capital gains as a tax on capital and so a disincentive to invest. The historical reality generally shows the exact opposite, the higher the tax the more you have to work to achieve your desired consumption outcome, and similarly the same is true for investment, more tax means more intensification of investment activity. Now certainly there are limits to how far this process can go, if you tax labor output down to subsistence and sub-subsistence levels you risk your serfs and/or wage employees simply running away, and contrawise if you tax capital at rates up to 98% it is no wonder that the Beatles ran away from England as well. But there is no evidence that current levels of taxation are actually above the sweet spot where taxes mean more work and more capital investment rather than less.

Meaning we need to redraw that Laffer curve to include consumption equilbrium points for various income levels. If a person’s current income is above his own personal equilibrium point he might well react to a tax cut by reducing his hours of work. If instead a tax increase takes him from above equilibrium to below he might react by increasing hours. And the same is true for the investor. If as a group a society’s top 5% or top 1% are living large at current returns and rates, a tax cut might just lead to them commissioning artists or patronizing writers and scholars. Traditionally aristocracies have sought to reduce or eliminate their overall tax burdens, and it was not because they had a burning desire to spend every day working their fingers to the bone. Instead that tax exemption enabled them to maintain or even expand their consumption.

Supply side psychology treats ‘work’ and ‘investment’ as ends subject to direct incentives or disincentives from taxes. But historical reality shows they the are instead means to other ends that include such things as consumption and display. Calculating the impact on any given tax change on any given group requires some deeper understanding of the sociology involved among that group. History is full of instances where people scraped and scrapped behind the scenes simply to maintain appearances at Court or its socio-economic equivalent (think ‘Sunday Go to Meeting Clothes’ among the working classes).

How hard are you willing to work to keep that Bass Boat and the Lake Cabin even as the taxes on them are “killing you”? Are you really going to cut back your overtime in response to a tax increase if it means giving up your Season Ski Pass?

via, anonymous liberal :

One of the more fascinating sociological phenomenon is the tendency people have, in certain situations, to ignore what their own senses are telling them and instead buy into an elaborate fiction just because other people appear to be doing the same thing. The classic illustration of this phenomenon is Hans Christian Andersen’s story The Emperor’s New Clothes — where a couple of con men convince the Emperor that they’ve made him a new suit out of the finest cloth there is, but that only smart people can see it. Not wanting to look dumb, the Emperor and his ministers rave about how beautiful the suit is and organize a procession through town. The villagers, not wanting to admit they don’t understand what’s going on, also rave about the Emperor’s beautiful new suit as he marches naked through the town. It’s not until a child points out the obvious — that the Emperor has no clothes — that the entire fiction crumbles.

Sarah Palin’s manic, rambling, completely incoherent resignation speech the other day was just the latest of her many naked processions through town. Yet for reasons I can’t begin to fathom, a large number of people, in both Republican circles and the mainstream media, continue to insist that she’s wearing a beautiful new suit. For instance, Mark Halperin of TIME insists– despite all evidence and common sense to the contrary — that by quitting her only significant governmental job before serving out her first term, and doing so in a complete train wreck of a speech, Palin actually strengthened her 2012 prospects. And though many on the right are belatedly acknowledging that the Emperor has no clothes, many others continue to insist that Palin is a viable presidential candidate and that her decision to step down may have been a “shrewd” one.

As Josh Marshall so perfectly put it earlier today:

[A]ny pundit who thinks this is some risky but potentially brilliant strategic move is absolutely smoking crack. Hitting the crack pipe, or, just as likely, being witlessly contrarian to set themselves apart from the common herd of sane people.

Though I’m sympathetic to the crack-smoking theory, it’s probably the second sentence that most accurately describes why people like Halperin say the things they say, and have been doing so since last fall. Sarah Palin has gone out of her way over the last year to display for everyone who is willing to acknowledge what their senses are telling them just how totally and completely unsuited she is to hold high office. She is a complete mediocrity, quite possibly the most superficial, ignorant, joke of a politician ever to have achieved such political prominence.

It is nothing short of astonishing what Palin has been able to get away with while still being taken seriously. During the presidential campaign, she was kept completely away from the media for nearly a month after being selected–something that is completely unprecedented. When she was finally permitted to be interviewed, she flamed out in spectacular fashion, displaying a profound lack of policy knowledge and a near total inability to express her thoughts coherently or logically. Her stump speech was riddled with easily falsifiable claims about her record, claims that she continued to repeat even after they had been repeatedly and exhaustively debunked. She never held a press conference or appeared on any of the Sunday news shows. Toward the end of the campaign, polls were conclusively showing that she was a drag on the ticket and her own staff was trashing her in the media. Rather than send her to contested states, the McCain campaign began shipping her off to reliably red states, a clear acknowledgment that she was doing more harm than good in the states that mattered.

Yet despite all of this, many within the media continued to treat Palin as if she was a serious presidential candidate in her own right. They continued to pretend that the Emperor’s new suit was, if not spectacular, at least well-tailored.

But this past weekend, even those who continued to buy into this delusion should have been jolted back to reality. Palin announced that she is resigning as Governor of Alaska, just over halfway through her first term. In a hastily thrown together press conference, she gave one of the craziest speeches I’ve ever seen. It was manic from start to finish, a totally unintelligible hodge-podge of random and often contradictory quotes and metaphors that left you wondering whether she had completely lost her mind and provided no insight at all into why she was actually resigning from office, leaving even her defenders not knowing what to say.

The Emperor has no clothes, people. It’s well past time to put an end to this delusion. Sarah Palin is transparently, manifestly unqualified to be in any position of power and this is obvious to anyone who cares to look.

UPDATE: Ross Douthat weighs in on Palin and, thankfully, points out the obvious: that it is “delusional” to believe that Palin’s decision to resign the governship will help her presidential chances and that her “bizarre, rambling resignation speech should take her off the political map for the duration of the Obama era.”

Ross devotes the second half of his column, however, to spinning the tired narrative of Palin as victim of the cruel misogynist liberal media. Though Ross doesn’t seem to realize it, this meme is just as delusional. Does Ross really believe that the media would have been kinder to a male liberal politician who performed as disastrously as Palin did during the presidential campaign? Imagine Obama had picked Tim Kaine as his runningmate and Kaine then hid from the press for most of the campaign, lied repeatedly about his record in every speech, and gave interviews like the ones Palin gave to Charlie Gibson and Katie Couric. Let’s further suppose that this hypothetical Kaine became embroiled in a number of scandals, became an obvious drag on an ultimately losing ticket, and that his own staffers began viciously attacking him in the media before the campaign was even over. Would anyone be indulging in the fantasy that this hypothetical governor was a viable presidential candidate? Would anyone be claiming that he was a victim of the media? Of course not. Indeed, I’m virtually certain that the press treatment this hypothetical Democratic governor would have endured would have been far more brutal than anything Sarah Palin has endured. The truth is, the media has been far kinder to Sarah Palin than she deserves. They’ve continued to take her seriously long after she gave them any reason to. They’ve been delicate in pointing out her obvious inadequacies as a politician and gentle in rebutting her repeated bold-faced lies. They’ve continued to indulge in the delusion that Palin is a serious national candidate long after there was any reason to believe that was true.

This last line from Ross’s column also bothers me:

Sarah Palin is beloved by millions because her rise suggested, however temporarily, that the old American aphorism about how anyone can grow up to be president might actually be true.

This is a ridiculous statement. If you want evidence that anyone can grow up to be president, how about looking at the current President. It’s hard to imagine a more unlikely future president than the biracial son of a teenage mother in Hawaii who was given the name of his absentee Muslim father. But Obama did well in school, worked hard, impressed everyone he met with his intellect and managed to put himself in a position to become president.

Palin stands for a very different proposition, that if you have the right backers, anyone, no matter how unqualified or unsuited for the job, can potentially become president. That’s scary. While I very much want to believe that a smart kid who works hard and plays her cards right can become president someday, no matter where she comes from, I don’t want to believe that any random schmuck can become president. The president shouldn’t be an average person. The president should be someone who is most decidedly above average in most respects. Pedigree doesn’t matter to me, but capability does. And it should to all Americans.

Ed Whelan (National Review’s Bench Memos) writes:

In a May 2006 speech, Judge Sotomayor tells “a joke that [she thinks] aptly describes the difference between supreme court, circuit court, and district court judging”:

It involves three judges who go duck hunting. A duck flies overhead and the supreme court justice, before he picks up his shotgun, ponders about the policy implications of shooting the duck — how will the environment be affected, how will the duck hunting business be affected if he doesn’t shoot the duck, well by the time he finishes, the duck got away.

Another duck flies overhead, and the circuit judge goes through his five part test before pulling the trigger — 1) he lifts the shotgun to his shoulder, 3) [sic] he sights the duck, 3) he measures the velocity of the duck’s flight, 4) he aims, and 5) he shoots—and, he misses.

Finally, another duck flies by, the district judge picks up the shotgun and shoots. The duck lands and the district judge picks it up, swings it over his shoulder and decides that he will let the other two judges explain what he did over dinner.

So Sotomayor thinks an unobjectionable and apt description of the role of Supreme Court justices in making decisions involves “ponder[ing] about … policy implications.”

(The excerpt above is from the prepared text on pages 10-12 of the speech (emphasis added). Sotomayor handwrote some trivial changes.)

The trouble with this criticism, it seems to me — even if you take the joke seriously on this point — is that of course Supreme Court Justices routinely, and entirely properly, consider “policy implications” in the sense of consequences. Let me just offer a few examples:

1. In some cases, the Supreme Court acts as a common-law-making court, or something very close to it, and there is (and should be) very little controversy about this. Admiralty law is one example. The defenses to federal criminal charges are another. (Federal crimes are legislatively defined, but the defenses are not.) The law of many federal remedies is in some measure another — consider the preliminary injunction standard, which calls for considering the consequences of granting or denying the injunction, or consider the qualified immunity caselaw, which has largely been developed with an eye towards the consequences of providing more or less liability.

This is so even when there are statutes, but the statutes are either deliberately vague or specifically delegate authority to federal courts. Antitrust law, where the Court has for over a century interpreted the categorical ban on restraints of trade as an authorization to develop a law of which restraints are permissible and which aren’t, is another noted example. The fields of evidentiary privileges and copyright fair use, where the Congress expressly left the federal courts the task of developing the law further, offer more examples. In all these areas, the job of the federal courts, and in particular the Supreme Court, is to develop legal rules that they see as sensible “in the light of reason and experience,” and looking at consequences (”the policy implications”) is an important part of that.

Recall that most of American law (including property, tort, contract, evidence, and criminal law) was developed by the common-law courts. It has been in considerable measure codified by legislatures, but common-law courts continue to develop it. The scope of common law and common-law-like development by federal courts is narrower, but there are still considerable chunks in which it persists.

2. But I take it that Whelan is particularly considered about the interpretation of statutes — and let’s even focus on those statutes that don’t contain broadly recognized delegation of broad authority to judges — and of constitutional provisions (though Judge Sotomayor didn’t focus on those). Still, it’s pretty uncontroversial that even there judges should look at practical consequences. To my knowledge, all the Justices, including the strongest textualists and originalists on the Court (such as Justices Scalia and Thomas), routinely consider practical implications in interpreting statutes and constitutional provisions.

The cases that come before the Supreme Court are generally not ones in which the text provides one absolutely clear result. There are plenty of such cases in our legal system, but they tend to be resolved early, precisely because the result is clear. Rather, you often have several plausible readings. Figuring out the best reading often leads judges to ask whether one or another reading would have results that are ridiculous, or inconsistent with what was understood as the purpose of the provision, or unduly administratively burdensome.

Now one can certainly argue that courts should look first and foremost at the text and original meaning; but as I mentioned, I think nearly all Justices and judges would agree that the text and original meaning are often not dispositive. One can also ask that, within those boundaries, courts be attentive to precedent. But precedent itself has often been developed based on considerations of consequences (especially when the text and original meaning were ambiguous). And the decision whether to reverse precedent itself often involves consequentialist attention to “policy implications”; see for instance two recent reversals of precedent, Montejo v. Louisiana and Arizona v. Gant, in both of which Justices Scalia and Thomas were in the majority (and in one of which Chief Justice Roberts and Justice Alito were in the majority).

3. Finally, recall that many well-established constitutional tests, including ones that aren’t controversial among conservatives, liberals, or pretty much anyone else, specifically call for an evaluation of consequences. Even Justices Scalia and Thomas, who would read the Equal Protection Clause as being a nearly categorical ban on race classifications by the government, would recognize an exception for “those measures the State must take to provide a bulwark against anarchy, or to prevent violence” (such as prison riots or “imminent danger to life and limb). Likewise, speech restrictions may sometimes be constitutional if they are necessary to serve a sufficiently important government interest — and you can’t decide that without looking to the consequences of the decision.

* * *I mention all this because talk about how judges shouldn’t “make policy” has been commonplace now, especially on the Right. (Consider also the fuss about Judge Sotomayor’s “the court of appeals is where policy is made” line.) And I think criticisms of excessive judicial policymaking — and in particular, in the sense Judge Sotomayor uses the phrase in the joke quoted above, decisionmaking based on what seems to the judge to be likelier to produce good results — are often correct. Sometimes the text or original meaning of a binding legal command is clear, and courts should follow that.

But it’s a mistake, I think, to turn that important insight into a categorical assertion that judges shouldn’t “make policy,” or should just “follow the law” instead of “making the law.” First, judicial development of legal rules, with an eye towards their consequences, is a longstanding feature of American law, recognized and accepted from the Framers onwards. (Yes, I know that there was often talk about how the courts “discovered the law” rather than “made the law,” but the reality was that judges did indeed make important decisions based partly on the perceived consequences of those decisions, rather than just following unambiguous custom or the commands of abstract reason.) In the federal courts, the proper scope of the courts’ pure common-law-making powers is less, but it’s also supplemented by deliberate delegations by Congressional statutes.

Second, some judicial attention to consequences is inevitable given the ambiguity of the text and original meaning of most statutes and constitutional provisions. And third, the constitutional rules that courts have developed — with the support of even those Justices who care most about text and original meaning — expressly call for some degree of consequentialist reasoning in their application.

Any particular decision, or set of decisions, by a court or a judge can of course be faulted for unduly departing from the commands that one thinks should be legally binding. But a thoroughgoing condemnation of judicial attention to “policy implications” in the sense of a decision’s practical consequences strikes me as unsupportable, especially in the American legal system as it has been understood for centuries and as it continues to be understood today even by the judges that the Right most applauds.

Cross posted from Crooked Timber:

Refuted economic doctrines #8: the superiority of flexible labor markets

by John Quiggin on May 22, 2009

According to the latest data, the unemployment rate in the US was equal to that in the EU-15 in March, and is now likely to be higher. Writing in the NY Times, Floyd Norris refers to the conventional wisdom that flexibility inherent in the American system — it is easier to both hire and fire workers than in many European countries implies that unemployment should be lower (at any given point in the business cycle) in the US than in Europe.

Although this is the conventional wisdom, the research on which it was based (by Lazear and others) has long since been qualified or refuted. I looked at this in the context of the Australian debate about unfair dismissal laws a few years back. Although the early research supported the simple view that more flexibility = more jobs, later research yielded the conclusion that employment protection laws lower the variance of employment and unemployment but have no clear effect on the average levels.

When you look at the institutions involved, this is unsurprising. Although Norris refers to restrictions on hiring and firing, the reality is that restrictions on hiring are nowhere very important. Even in the extreme case of Spain, they amount to a few weeks of salary. The big differences are in costs of firing, and it is the anticipation of these costs that acts to constrain hiring in periods of expansion.

Advocates of the US system make much of the deterrent to hiring associated with employment protection laws, but they ignore the other side of the coin. When the economy is contract, employment protection laws do in fact protect employment (if they did not, they would have no adverse effect on hiring either).

On this basis there is nothing surprising in what we are seeing. EU unemployment rates should be higher in expansions and lower in contractions, which is exactly what is required for lower variance.

Which is better? The big problem with strong employment protection is that it tends to create an insider class of well-protected permanent employees and an outsider class who are either unemployed or assigned to some form of semi-permanent “temporary” status (see, for example, the tenure system in universities). But, comparing the EU and US as a whole, the opposite seems to be the case – there is a sharper class divide, and less social mobility in the US than in the EU.

More on this from the Center for Economic Policy Research (h/t Brad DeLong).

Having Little Money Often Means No Car, No Washing Machine, No Checking Account And No Break From Fees and High Prices

By DeNeen L. Brown
Washington Post Staff Writer
Monday, May 18, 2009

You have to be rich to be poor.

That’s what some people who have never lived below the poverty line don’t understand.

Put it another way: The poorer you are, the more things cost. More in money, time, hassle, exhaustion, menace. This is a fact of life that reality television and magazines don’t often explain.

So we’ll explain it here. Consider this a primer on the economics of poverty.

“The poor pay more for a gallon of milk; they pay more on a capital basis for inferior housing,” says Rep. Earl Blumenauer (D-Ore.). “The poor and 100 million who are struggling for the middle class actually end up paying more for transportation, for housing, for health care, for mortgages. They get steered to subprime lending. . . . The poor pay more for things middle-class America takes for granted.”

Poverty 101: We’ll start with the basics.

Like food: You don’t have a car to get to a supermarket, much less to Costco or Trader Joe’s, where the middle class goes to save money. You don’t have three hours to take the bus. So you buy groceries at the corner store, where a gallon of milk costs an extra dollar.

A loaf of bread there costs you $2.99 for white. For wheat, it’s $3.79. The clerk behind the counter tells you the gallon of leaking milk in the bottom of the back cooler is $4.99. She holds up four fingers to clarify. The milk is beneath the shelf that holds beef bologna for $3.79. A pound of butter sells for $4.49. In the back of the store are fruits and vegetables. The green peppers are shriveled, the bananas are more brown than yellow, the oranges are picked over.

(At a Safeway on Bradley Boulevard in Bethesda, the wheat bread costs $1.19, and white bread is on sale for $1. A gallon of milk costs $3.49 — $2.99 if you buy two gallons. A pound of butter is $2.49. Beef bologna is on sale, two packages for $5.)

Prices in urban corner stores are almost always higher, economists say. And sometimes, prices in supermarkets in poorer neighborhoods are higher. Many of these stores charge more because the cost of doing business in some neighborhoods is higher. “First, they are probably paying more on goods because they don’t get the low wholesale price that bigger stores get,” says Bradley R. Schiller, a professor emeritus at American University and the author of “The Economics of Poverty and Discrimination.”

“The real estate is higher. The fact that volume is low means fewer sales per worker. They make fewer dollars of revenue per square foot of space. They don’t end up making more money. Every corner grocery store wishes they had profits their customers think they have.”

According to the Census Bureau, more than 37 million people in the country live below the poverty line. The poor know these facts of life. These facts become their lives.

Time is money, they say, and the poor pay more in time, too.

When you are poor, you don’t have the luxury of throwing a load into the washing machine and then taking your morning jog while it cycles. You wait until Monday afternoon, when the laundromat is most likely to be empty, and you put all of that laundry from four kids into four heaps, bundle it in sheets, load a cart and drag it to the corner.

“If I had my choice, I would have a washer and a dryer,” says Nya Oti, 37, a food-service worker who lives in Brightwood. She stands on her toes to reach the top of a washer in the laundromat on Georgia Avenue NW and pours in detergent. The four loads of laundry will take her about two hours. A soap opera is playing loudly on the television hanging from the ceiling. A man comes in talking to himself. He drags his loads of dirty sheets and mattress pads and dumps them one by one into the machines next to Oti.

She does not seem to notice. She is talking about other costs of poverty. “My car broke down this weekend, and it took a lot of time getting on the bus, standing on the bus stop. It was a waste of a whole lot of times. Waiting. The transfer to the different bus.”

When she has her car, she drives to Maryland, where she shops for her groceries at Shoppers Food Warehouse or Save-A-Lot, where she says some items are cheaper and some are higher. “They have a way of getting you in there on a bargain. You go in for something cheap, but something else is more expensive.” She buys bags of oranges or apples, but not the organic kind. “Organic is too much,” she says.

“When you are poor, you substitute time for money,” says Randy Albelda, an economics professor at the University of Massachusetts at Boston. “You have to work a lot of hours and still not make a lot of money. You get squeezed, and your money is squeezed.”

The poor pay more in hassle: the calls from the bill collectors, the landlord, the utility company. So they spend money to avoid the hassle. The poor pay for caller identification because it gives them peace of mind to weed out calls from bill collectors.

The rich have direct deposit for their paychecks. The poor have check-cashing and payday loan joints, which cost time and money. Payday advance companies say they are providing an essential service to people who most need them. Their critics say they are preying on people who are the most “economically vulnerable.”

“As you’ve seen with the financial services industry, if people can cut a profit, they do it,” Blumenauer says. “The poor pay more for financial services. A lot of people who are ‘unbanked’ pay $3 for a money order to pay their electric bill. They pay a 2 percent check-cashing fee because they don’t have bank services. The reasons? Part of it is lack of education. But part of it is because people target them. There is evidence that credit-card mills have recently started trolling for the poor. They are targeting the recently bankrupt.”

Outside the ACE check-cashing office on Georgia Avenue in Petworth, Harrison Blakeney, 67, explains a hard financial lesson of poverty. He uses the check-cashing store to pay his telephone bill. The store charges 10 percent to take Blakeney’s money and send the payment to the phone company. That 10 percent becomes what it costs him to get his payment to the telephone company on time. Ten percent is more than the cost of a stamp. But, Blakeney says: “I don’t have time to mail it. You come here and get it done. Then you don’t get charged with the late fee.”

Blakeney, a retired auto mechanic who now lives on a fixed income, says: “We could send the payment ahead of time but sometimes you don’t have money ahead of time. That’s why you pay extra money to get them to send it.”

Blakeney, wearing a purple jacket, leans on his cane. He has no criticism for the check-cashing place. “That’s how they make their money,” he says. “I don’t care about the charge.”

Just then, Lenwood Brooks walks out of the check-cashing place. He is angry about how much it just cost him to cash a check. “They charged me $15 to cash a $300 check,” he says.

You ask him why he didn’t just go to a bank. But his story is as complicated as the various reasons people find themselves in poverty and in need of a check-cashing joint. He says he lost his driver’s license and now his regular bank “won’t recognize me as a human. That’s why I had to come here. It’s a rip-off, but it’s like a convenience store. You pay for the convenience.”

Then there’s credit. The poor don’t have it. What they had was a place like First Cash Advance in D.C.’s Manor Park neighborhood, where a neon sign once flashed “PAYDAY ADVANCE.” Through the bulletproof glass, a cashier in white eyeliner and long white nails explained what you needed to get an advance on your paycheck — a pay stub, a legitimate ID, a checkbook. This meant you’re doing well enough to have a checking account, but you’re still poor.

And if you qualify, the fee for borrowing $300 is $46.50.

That was not for a year — it’s for seven days, although the terms can vary. How much interest will this payday loan cost you? In simple terms, the company is charging a $15.50 fee for every $100 that you borrow. On your $300 payday loan — borrowed for a term of seven days — the effective annual percentage rate is 806 percent.

The cashier says that what you do is write First Cash Advance a check for $345.50 plus another $1 fee, and it will give you $300 in cash upfront. It holds the check until you get paid. Then you bring in $346.50 and it returns your check. Or it cashes the check and keeps your $346.50, or you have the option of extending the loan with additional fees. You’ll be out $46.50, which you’d rather have for the late fee on the rent you didn’t pay on time. Or the gas bill you swear you paid last month but the gas company swears it never got.

But now the payday advance place has closed, shuttered by metal doors. A sign in the front door says the business has moved. After the D.C. government passed a law requiring payday lenders to abide by a 24-percent limit on the annual percentage rate charged on a loan, many such stores in the District closed. Now advocates for the poor say they are concerned about other businesses that prey on poor people by extending loans in exchange for car titles. If a person does not pay back the loan, then the business becomes the owner of the car.

All these costs can lead the poor to a collective depression. Douglas J. Besharov, resident scholar at the American Enterprise Institute, says: “There are social costs of being poor, though it is not clear where the cause and effect is. We know for a fact that on certain measures, people who are poor are often more depressed than people who are not. I don’t know if poverty made them depressed or the depression made them poor. I think the cause and effect is an open question. Some people are so depressed they are not functional. ‘I live in a crummy neighborhood. My kids go to a crummy school.’ That is not the kind of scenario that would make them happy.” Another effect of all this, he says: “Would you want to hire someone like that?”

The poor suspect that prices are higher where they live, even the prices in major supermarkets. The suspicions sometimes spill over into frustration.

On a hot spring afternoon, Jacob Carter finds himself standing in a checkout line at the Giant on Alabama Avenue SE. Before the cashier finishes ringing up his items, he puts $43 on the conveyor belt. But his bill comes to $52.07. He has no more money, so he tells the clerk to start removing items.

The clerk suggests that he use his “bonus card” for savings.

Carter tells the clerk he has no such card.

He puts back the liter of soda. Puts back the paper towels. Sets aside $9 worth of hot fried chicken wings. He returns $13 worth of groceries. “Y’all got some high prices in this [expletive],” he says, standing in Aisle 4, blue shirt over work clothes.

The clerk suggests that he take his cash off the conveyor belt, because if she moves the belt the money will be carried into the machinery. Then the money will be gone.

Carter, a building engineer, snatches up the money, then gives it to the clerk. His final bill is $39.07.

He looks at the receipt and then announces without the slightest indication as to why: “Just give me all my [expletive] money back. It’s too high in this [expletive].” The clerk calls the supervisor, who comes over. The supervisor doesn’t argue with Carter. She just starts the process of giving him a refund.

“I want my money back. This [expletive] is too high. My grandmother told me about this store.”

The supervisor returns $39.07 in cash. “Sir,” she says, “have a blessed day.”

The food in this supermarket might be cheaper than the goods at a corner store. But Carter still feels frustrated by what he thinks is a mark-up on prices in supermarkets in poor neighborhoods. Carter walks out.

The poor pay in other ways, ways you might never imagine. Jeanette Reed, who is retired and lives on a fixed income, sold her blood when she needed money. “I had no other source to get money,” she says. “I went to the blood bank. And they gave me $30.

“I needed the money. I didn’t have the money and no source of getting money. No gas. No food. I have to go to a center that gives out boxes of food once a month. They give you cereal or vouchers for $10. They give you canned tuna and macaroni and cheese. Crackers and soup. They give you commodities like day-old bread.”

The poor know the special economics of their housing, too.

“You pay rent that might be more than a mortgage,” Reed says. “But you don’t have the credit or the down payment to buy a house. Apartments are not going down. They are going up. They say houses are better, cheaper. But how are you going to get in a house if you don’t have any money for a down payment?”

There is also an economic cost to living in low-income neighborhoods.

“The cheaper housing is in more-dangerous areas,” says Reed, who lives in Southeast Washington. “I moved out of my old apartment. I hate that area. They be walking up and down the street. Couldn’t take the dog out at night because strangers walking up and down the street. They will knock on your door. Either they rob you, kill or ask for money. If you’re not there, they will steal air conditioners and copper. They will sell your copper [pipes] for money.”

And then there is the particular unpleasantness when you make too much money to fall below the poverty line, but not enough to move up, up and away from it.

For our final guest lecturer on poverty we take you to the Thrift Store on Georgia Avenue and Marie Nicholas, 35, in an orange shirt, purple pants and thick black eyeliner. She is what economists call the working poor.

She is picking through the racks. The store is busy with customers on a Monday afternoon. There is the shrill sound of hangers sliding across racks under fluorescent lights. An old confirmation dress hangs from the ceiling. It has faded to yellow. It’s not far from the used silver pumps, size 9 1/2 , nearly new, on sale for $9.99.

“People working who don’t make a lot of money go to the system for help, and they deny them,” Nicholas says. “They say I make too much. It almost helps if you don’t work.”

She says she makes $15 an hour working as a certified nursing assistant. She pays $850 for rent for a one-bedroom that she shares with her boyfriend and child. She went looking for a two-bedroom unit recently and found it would cost her $1,400. She pays $300 a month for child care for her 11-year-old son, who is developmentally delayed. She tried to put him in a subsidized child-care facility, but was told she makes too much money. “My son was not chosen for Head Start because I wasn’t in a shelter or on welfare. People’s kids who do go don’t do nothing but sit at home.”

Money and time. “I ride the bus to get to work,” Nicholas says. It takes an hour. “If I could drive, it would take me 10 minutes. I have to catch two buses.” She gets to the bus stop at 6:30 a.m. The bus is supposed to come every 10 or 15 minutes. Sometimes, she says, it comes every 30 minutes.

What could you accomplish with the lost 20 minutes standing there in the rain? Waiting. That’s another cost of poverty. You wait in lines. You wait at bus stops. You wait on the bus as it makes it way up Georgia Avenue, hitting every stop. No sense in trying to hurry when you are poor.

When you are poor, you wait.

Via Glen Greenwald:

Top Senate Democrat: bankers “own” the U.S. Congress

Sen. Dick Durbin, on a local Chicago radio station this week, blurted out an obvious truth about Congress that, despite being blindingly obvious, is rarely spoken:  “And the banks — hard to believe in a time when we’re facing a banking crisis that many of the banks created — are still the most powerful lobby on Capitol Hill. And they frankly own the place.”  The blunt acknowledgment that the same banks that caused the financial crisis “own” the U.S. Congress — according to one of that institution’s most powerful members — demonstrates just how extreme this institutional corruption is.

The ownership of the federal government by banks and other large corporations is effectuated in literally countless ways, none more effective than the endless and increasingly sleazy overlap between government and corporate officials.  Here is just one random item this week announcing a couple of standard personnel moves:

Former Barney Frank staffer now top Goldman Sachs lobbyist

Goldman Sachs’ new top lobbyist was recently the top staffer to Rep. Barney Frank, D-Mass., on the House Financial Services Committee chaired by Frank.  Michael Paese, a registered lobbyist for the Securities Industries and Financial Markets Association since he left Frank’s committee in September, will join Goldman as director of government affairs, a role held last year by former Tom Daschle intimate, Mark Patterson, now the chief of staff at the Treasury Department. This is not Paese’s first swing through the Wall Street-Congress revolving door: he previously worked at JP Morgan and Mercantile Bankshares, and in between served as senior minority counsel at the Financial Services Committee.

So:  Paese went from Chairman Frank’s office to be the top lobbyist at Goldman, and shortly before that, Goldman dispatched Paese’s predecessor, close Tom Daschle associate Mark Patterson, to be Chief of Staff to Treasury Secretary Tim Geithner, himself a protege of former Goldman CEO Robert Rubin and a virtually wholly owned subsidiary of the banking industry.  That’s all part of what Desmond Lachman — American Enterprise Institute fellow, former chief emerging market strategist at Salomon Smith Barney and top IMF official (no socialist he) – recently described as “Goldman Sachs’s seeming lock on high-level U.S. Treasury jobs.”

Meanwhile, the above-linked Huffington Post article which reported on Durbin’s comments also notes Sen. Evan Bayh’s previously-reported central role on behalf of the bankers in blocking legislation, hated by the banking industry, to allow bankruptcy judges to alter the terms of mortgages so that families can stay in their homes.  Bayh is up for re-election in 2010, and here — according to the indispensable Open Secrets site — is Bayh’s top donor:

Goldman is also the top donor to Bayh over the course of his Congressional career, during which Bayh has received more than $4 million from the finance, insurance and real estate sectors:

In a totally unrelated coincidence — after the Government, as Matt Taibbi put it, enacted “a bailout program that has now figured three ways to funnel money to Goldman, Sachs”– this is what happened earlier this month:

Goldman reports $1.8 billion profit

Goldman Sachs reported a much stronger-than-expected first-quarter profit Monday, bouncing back from its worst quarter as a public company. . . .

In reporting its results a day earlier than expected, New York-based Goldman said it earned $1.81 billion, or $3.39 a share, for the quarter ended March 31. Analysts surveyed by Thomson Financial were looking for a profit of $1.64 a share.

Goldman shares, which have surged more than 70% during the past month, continued rising late Monday, gaining about 4.7% for the day.

Nobody even tries to hide this any longer.  The only way they could make it more blatant is if they hung a huge Goldman Sachs logo on the Capitol dome and then branded it onto the foreheads of leading members of Congress and executive branch officials.

Of course, ownership of the government is not confined to Goldman or even to bankers generally; legislation in virtually every area is written by the lobbyists dispatched by the corporations that demand it, and its passage then ensured by “representatives” whose pockets are stuffed with money from those same corporations.  Just as one example, as Jane Hamsher reported about Bayh:

Bayh’s little “lobbyist problem” is considered by many to be what tanked his Vice Presidential aspirations. His wife Susan earns about $837,000 a year serving on seven corporate boards, among them Wellpoint, a health insurance company for which Bayh helped secure a $24.7 million dollar grant. She’s on the board of ETrade, even as Bayh is on the Senate Finance Committee.

Bayh wants people to believe he’s a “moderate” who sits in the “center.”

Center of K Street, maybe.

Meanwhile, the only citizen protests relating to this mass robbery are driven by anger at the government for treating bankers too harshly and unfairly — one of the most classic manifestations of what Taibbi, in a separate piece, so aptly calls the “peasant mentality”:

After all, the reason the winger crowd can’t find a way to be coherently angry right now is because this country has no healthy avenues for genuine populist outrage. It never has. The setup always goes the other way: when the excesses of business interests and their political proteges in Washington leave the regular guy broke and screwed, the response is always for the lower and middle classes to split down the middle and find reasons to get pissed off not at their greedy bosses but at each other. That’s why even people like [Glenn] Beck’s audience, who I’d wager are mostly lower-income people, can’t imagine themselves protesting against the Wall Street barons who in actuality are the ones who fucked them over. . . .

Actual rich people can’t ever be the target. It’s a classic peasant mentality: going into fits of groveling and bowing whenever the master’s carriage rides by, then fuming against the Turks in Crimea or the Jews in the Pale or whoever after spending fifteen hard hours in the fields.  You know you’re a peasant when you worship the very people who are right now, this minute, conning you and taking your shit. Whatever the master does, you’re on board. When you get frisky, he sticks a big cross in the middle of your village, and you spend the rest of your life praying to it with big googly eyes. Or he puts out newspapers full of innuendo about this or that faraway group and you immediately salute and rush off to join the hate squad.  A good peasant is loyal, simpleminded, and full of misdirected anger.  And that’s what we’ve got now, a lot of misdirected anger searching around for a non-target to mis-punish . . . can’t be mad at AIG, can’t be mad at Citi or Goldman Sachs. The real villains have to be the anti-AIG protesters! After all, those people earned those bonuses! If ever there was a textbook case of peasant thinking, it’s struggling middle-class Americans burned up in defense of taxpayer-funded bonuses to millionaires. It’s really weird stuff.

One might think it would be a big news story for the second most-powerful member of the U.S. Senate to baldly state that the Congress is “owned” by the bankers who spawned the financial crisis and continue to dictate the government’s actions.  But it won’t be.  The leading members of the media work for the very corporations that benefit most from this process.  Establishment journalists are integral and well-rewarded members of the same system and thus cannot and will not see it as inherently corrupt (instead, as Newsweek’s Evan Thomas said, their role, as “members of the ruling class,” is to “prop up the existing order,” ”protect traditional institutions” and ”safeguard the status quo”).

That Congress is fully owned and controlled by a tiny sliver of narrow, oligarchical, deeply corrupted interests is simultaneously so obvious yet so demonized (only Unserious Shrill Fringe radicals, such as the IMF’s former chief economist, use that sort of language) that even Durbin’s explicit admission will be largely ignored.  Even that extreme of a confession (Durbin elaborated on it with Ed Schultz last night) hardly causes a ripple.

Enjoy!

This second part was also incredibly funny, this dude knows how to piss people off something fantastic.

So he gets this party notice under his door and decides to invite himself to the party ….

From: David Thorne
Date: Monday 8 Dec 2008 11.04am
To: Matthew Smythe
Subject: R.S.V.P.

Dear Matthew,
Thank you for the party invite. At first glance I thought it may be a child’s party what with it being vibrant and having balloons but I realise you probably did your best with what little tools were available. I wouldn’t miss it for the world. What time would you like me there?

Regards, David.

From: Matthew Smythe
Date: Monday 8 Dec 2008 3.48pm
To: David Thorne
Subject: Re: R.S.V.P.

Hi David
Sorry the note was just to let you know that we might be a bit loud that night. The house warming is really just for friends and family but you can drop past for a beer if you like.
Cheers Matthew

From: David Thorne
Date: Monday 8 Dec 2008 5.41pm
To: Matthew Smythe
Subject: Re: Re: R.S.V.P.

Thanks Matthew,
Including me in your list of friends and family means a lot. You and I don’t tend to have long discussions when we meet in the hallway and I plan to put a stop to that. Next time we bump into each other I intend to have a very long conversation with you and I am sure you are looking forward to that as much as I am. I have told my friend Ross that you are having a party and he is as excited as I am. Do you want us to bring anything or will everything be provided?

Regards, David.

From: Matthew Smythe
Date: Tuesday 9 Dec 2008 10.01am
To: David Thorne
Subject: Re: Re: Re: R.S.V.P.

Hi David
As I said, my housewarming is just for friends and family. There is not a lot of room so cant really have to many people come. Sorry about that mate.
Cheers Matthew

From: David Thorne
Date: Tuesday 9 Dec 2008 2.36pm
To: Matthew Smythe
Subject: Re: Re: Re: Re: R.S.V.P.

Dear Matthew,
I can appreciate that, our apartments are not very large are they? I myself like to go for a jog every night to keep fit but fear leaving the house so I have to jog on the spot taking very small steps with my arms straight down. I understand the problems of space restrictions all too well. If you would like to store some of your furniture at my place during the party you are quite welcome to - if we move your cane furniture into my spare room for the night and scatter cushions on the ground, that would provide a lot more seating and create a cozy atmosphere at the same time. I have a mirror ball that you can borrow. I have told Ross not to invite anyone else due to the space constraints so it will just be us two and my other friend Simon. When I told Simon that Ross and I were going to a party he became quite angry that I had not invited him as well so I really didn’t have any choice as he can become quite violent. Sometimes I am afraid to even be in the same room as him. So just myself Ross and Simon. Simon’s girlfriend has a work function on that night but might come along after that if she can get a lift with friends.

Regards, David.

From: Matthew Smythe
Date: Tuesday 9 Dec 2008 4.19pm
To: David Thorne
Subject: Re: Re: Re: Re: R.S.V.P.

Wtf? Nobody can come to the houswarming party it is just for friends and family. I dont even know these people. How do you know I have cane furniture? Are you the guy in apartment 1?

From: David Thorne
Date: Tuesday 9 Dec 2008 6.12pm
To: Matthew Smythe
Subject: Re: Re: Re: Re: Re: R.S.V.P.

Hi Matthew,
I understand it is an exclusive party and I appreciate you trusting my judgement on who to bring. I just assumed you have cane furniture, doesn’t everybody? Cane is possibly one of the most renewable natural resources we have after plastic, it is not only strong but lightweight and attractive. Every item in my apartment is made of cane, including my television. It looks like the one from Gilligan’s Island but is in colour of course. Do you remember that episode where a robot came to the island? That was the best one in my opinion. I always preferred Mary Anne to Ginger, same with Flintstones - I found Betty much more attractive than Wilma but then I am not really keen on redheads at all They have freckles all over their body did you know? It’s the ones on their back and shoulders that creep me out the most.

Anyway, Ross rang me today all excited about the party and asked me what the theme is, I told him that I don’t think there is a theme and we discussed it and feel that it should be an eighties themed party. I have a white suit and projector and am coming as Nik Kershaw. I have made a looping tape of ‘wouldn’t it be good’ to play as I am sure you will agree that this song rocks and has stood the test of time well. I am in the process of redesigning your invites appropriately and will get a few hundred of them printed off later today. I will have to ask you for the money for this as print cartridges for my Epson are pretty expensive. They stopped making this model a month after I bought it and I have to get the cartridges sent from China. Around $120 should cover it. You can just pop the money in my letter box if I don’t see you before tonight.

Regards, David.

From: Matthew Smythe
Date: Wednesday 10 Dec 2008 11.06pm
To: David Thorne
Subject: Re: Re: Re: Re: Re: Re: R.S.V.P.

What the fuck are you talking about? There is no theme for the party it is just a few friends and family. noone else can come IT IS ONLY FOR MY FRIENDS AND FAMILY do you understand? Do not print anything out because I am not paying for something I dont need and didnt ask you to do! look I am sorry but i am heaps busy and that night is not convenient. Are you in Apatrment1?

From: David Thorne
Date: Thursday 11 Dec 2008 9.15am
To: Matthew Smythe
Subject: Re: Re: Re: Re: Re: Re: Re: R.S.V.P.

Hello Matthew,
I agree that it is not very convenient and must admit that when I first received your invitation I was perplexed that it was on a Sunday night but who am I to judge. No, I am in apartment 3B. Our bedroom walls are touching so when we are sleeping our heads are only a few feet apart. If I put my ear to the wall I can hear you I also agree with you that having a particular theme for your party may not be the best choice, it makes more sense to leave it open as a generic fancy dress party, that way everyone can come dressed in whatever they want. Once, I went to a party in a bear outfit which worked out well as it was freezing and I was the only one warm. As it won’t be cold the night of your party, I have decided to come as a Ninja. I think it would be really good if you dressed as a ninja as well and we could perform a martial arts display for the other guests. I have real swords and will bring them. If you need help with your costume let me know, I have made mine by wrapping a black t-shirt around my face with a hooded jacket and cut finger holes in black socks for the gloves. I do not have any black pants so will spray paint my legs on the night.

It is a little hard to breath in the costume so I will need you to keep the window open during the party to provide good air circulation. Actually, I just had a thought, how awesome would it be if I arrived ‘through’ the window like a real ninja. We should definitely do that. I just measured the distance between our balconies and I should be able to jump it. I once leaped across a creek that was over five metres wide and almost made it.

Also, you mentioned in your invitation that if there was anything I needed, to let you know. My car is going in for a service next week and I was wondering, seeing as we are good friends now, if it would be ok to borrow yours on that day. I hate catching the bus as they are full of poor people who don’t own cars.

Regards, David.

From: Matthew Smythe
Date: Thursday 11 Dec 2008 3.02pm
To: David Thorne
Subject: Re: Re: Re: Re: Re: Re: Re: Re: R.S.V.P.

WTF? No you cant borrow my car and there is no fucking 3B. I reckon you are that guy from Apartment 1. You are not coming to my house warming and you are not bringing any of your friends What the fu*k is wrong with you??? The only people invited are friends and family I told you that. It is just drinks there is no fucking fancy dress and only people I know are coming! I dont want to be rude but jesus fucking christ man.

From: David Thorne
Date: Sunday 14 Dec 2008 2.04am
To: Matthew Smythe
Subject: Party

Hello Matthew,
I have been away since Thursday so have not been able to check my email from home. Flying back late today in time for the party and just wanted to say that we are really looking forward to it. Will probably get there around eleven or twelve, just when it starts to liven up. Simon’s girlfriend Cathy’s work function was cancelled so she can make it after all which is good news. She will probably have a few friends with her so they will take the mini van. Also, I have arranged a Piñata.

Can’t wait, see you tonight.

Regards, David.

A refocus on empiricism:

The Last Temptation of Risk

by Barry Eichengreen

THE GREAT Credit Crisis has cast into doubt much of what we thought we knew about economics. We thought that monetary policy had tamed the business cycle. We thought that because changes in central-bank policies had delivered low and stable inflation, the volatility of the pre-1985 years had been consigned to the dustbin of history; they had given way to the quaintly dubbed “Great Moderation.” We thought that financial institutions and markets had come to be self-regulating—that investors could be left largely if not wholly to their own devices. Above all we thought that we had learned how to prevent the kind of financial calamity that struck the world in 1929.

We now know that much of what we thought was true was not. The Great Moderation was an illusion. Monetary policies focusing on low inflation to the exclusion of other considerations (not least excesses in financial markets) can allow dangerous vulnerabilities to build up. Relying on institutional investors to self-regulate is the economic equivalent of letting children decide their own diets. As a result we are now in for an economic and financial downturn that will rival the Great Depression before it is over.

The question is how we could have been so misguided. One interpretation, understandably popular given our current plight, is that the basic economic theory informing the actions of central bankers and regulators was fatally flawed. The only course left is to throw it out and start over. But another view, considerably closer to the truth, is that the problem lay not so much with the poverty of the underlying theory as with selective reading of it—a selective reading shaped by the social milieu. That social milieu encouraged financial decision makers to cherry-pick the theories that supported excessive risk taking. It discouraged whistle-blowing, not just by risk-management officers in large financial institutions, but also by the economists whose scholarship provided intellectual justification for the financial institutions’ decisions. The consequence was that scholarship that warned of potential disaster was ignored. And the result was global economic calamity on a scale not seen for four generations.

SO WHERE were the intellectual agenda setters when the crisis was building? Why did they fail to see this train wreck coming? More than that, why did they consort actively with the financial sector in setting the stage for the collapse?

For economists in business schools the answer is straightforward. Business schools see themselves as suppliers of inputs to business. Just as General Motors provides its suppliers with specifications for the cold-rolled sheet it needs for fabricating auto bodies, J. P. Morgan makes clear the kind of financial engineers it requires, and business schools deem to provide. In the wake of the 1987 stock-market crash, Morgan’s chairman, Dennis Weatherstone, started calling for a daily “4:15 Report” summarizing how much his firm would lose if tomorrow turned out to be a bad day. His counterparts at other firms then adopted the practice. Soon after, business schools jumped to supply graduates to write those reports. Value at Risk, as that number and the process for calculating it came to be known, quickly gained a place in the business-school curriculum.

The desire for up-to-date information on the risks of doing business was admirable. Less admirable was the belief that those risks could be reduced to a single number which could then be estimated on the basis of a set of mathematical equations fitted to a few data points. Much as former–GM CEO Alfred Sloan once sought to transform automobile production from a craft to an engineering problem, Weatherstone and his colleagues encouraged the belief that risk and return could be reduced to a set of equations specified by an MBA and solved by a machine.

Getting the machine to spit out a headline number for Value at Risk was straightforward. But deciding what to put into the model was another matter. The art of gauging Value at Risk required imagining the severity of the shocks to which the portfolio might be subjected. It required knowing what new variables to add in response to financial innovation and unfolding events. Doing this right required a thoughtful and creative practitioner. Value at Risk, like dynamite, can be a powerful tool when in the right hands. Placed in the wrong hands—well, you know.

These simple models should have been regarded as no more than starting points for serious thinking. Instead, those responsible for making key decisions, institutional investors and their regulators alike, took them literally. This reflected the seductive appeal of elegant theory. Reducing risk to a single number encouraged the belief that it could be mastered. It also made it easier to leave early for that weekend in the Hamptons.

Now, of course, we know that the gulf between assumption and reality was too wide to be bridged. These models were worse than unrealistic. They were weapons of economic mass destruction.

For some years those who relied on these artificial constructs were not caught out. Episodes of high volatility, like the 1987 stock-market crash, still loomed large in the data set to which the model was fit. They served to highlight the potential for big shocks and cautioned against aggressive investment strategies. Since financial innovation was gradual, models estimated on historical data remained reasonable representations of the balance of risks.

WITH TIME, however, memories of the 1987 crash faded. In the data used by the financial engineers, the crash became only one observation among many generated in the course of the Great Moderation. There were echoes, like the all-but-failure of the hedge fund Long-Term Capital Management in 1998. (Over four months the company lost $4.6 billion and had to be saved through a bailout orchestrated by the Federal Reserve Bank of New York.) But these warning signs were muffled by comparison. This encouraged the misplaced belief that the same central-bank policies that had reduced the volatility of inflation had magically, perhaps through transference, also reduced the volatility of financial markets. It encouraged the belief that mastery of the remaining risk made more aggressive investment strategies permissible. It made it possible, for example, to employ more leverage—to make use of more borrowed money—without putting more value at risk.

Meanwhile, deregulation was on the march. Memories of the 1930s disaster that had prompted the adoption of restrictions like the Glass-Steagall Act, which separated commercial and investment banking, faded with the passage of time. This tilted the political balance toward those who, for ideological reasons, favored permissive regulation. Meanwhile, financial institutions, in principle prohibited from pursuing certain lines of business, found ways around those restrictions, encouraging the view that strict regulation was futile. With the elimination of regulatory ceilings on the interest rates that could be paid to depositors, commercial banks had to compete for funding by offering higher rates, which in turn pressured them to adopt riskier lending and investment policies in order to pay the bill. With the entry of low-cost brokerages and the elimination of fixed commissions on stock trades, broker-dealers like Bear Stearns, which had previously earned a comfy living off of such commissions, now felt compelled to enter riskier lines of business.

But where the accelerating pace of change should have prompted more caution, the routinization of risk management encouraged precisely the opposite. The idea that risk management had been reduced to a mere engineering problem seduced business in general, and financial businesses in particular, into believing that it was safe to use more leverage and to invest in more volatile assets.

Of course, risk officers could have pointed out that the models had been fit to data for a period of unprecedented low volatility. They could have pointed out that models designed to predict losses on securities backed by residential mortgages were estimated on data only for years when housing prices were rising and foreclosures were essentially unknown. They could have emphasized the high degree of uncertainty surrounding their estimates. But they knew on which side their bread was buttered. Senior management strongly preferred to take on additional risk, since if the dice came up seven they stood to receive megabonuses, whereas if they rolled snake eyes the worst they could expect was a golden parachute. If an investment strategy that promised high returns today threatened to jeopardize the viability of the enterprise tomorrow, then this was someone else’s problem. For a junior risk officer to warn the members of the investment committee that they were taking undue risk would have dimmed his chances of promotion. And so on up the ladder.

WHY CORPORATE risk officers did not sound the alarm bells is thus clear enough. But where were the business-school professors while these events were unfolding? Answer: they were writing textbooks about Value at Risk. (Truth in advertising requires me to acknowledge that the leading such book is by a professor at the University of California.) Business schools are rated by business publications and compete for students on the basis of their record of placing graduates. With banks hiring graduates educated in Value at Risk, business schools had an obvious incentive to supply the same.

But what of doctoral programs in economics (like the one in which I teach)? The top PhD-granting departments only rarely send their graduates to positions in banking or business—most go on to other universities. But their faculties do not object to the occasional high-paying consulting gig. They don’t mind serving as the entertainment at beachside and ski-slope retreats hosted by investment banks for their important clients.

Generous speaker’s fees were thus available to those prepared to drink the Kool-Aid. Not everyone indulged. But there was nonetheless a subconscious tendency to embrace the arguments of one’s more “successful” colleagues in a discipline where money, in this case earned through speaking engagements and consultancies, is the common denominator of success.

Those who predicted the housing slump eventually became famous, of course. Princeton University Press now takes out space ads in general-interest publications prominently displaying the sober visage of Yale University economics professor Robert Shiller, the maven of the housing crash. Not every academic scribbler can expect this kind of attention from his publisher. But such fame comes only after the fact. The more housing prices rose and the longer predictions of their decline looked to be wrong, the lonelier the intellectual nonconformists became. Sociologists may be more familiar than economists with the psychic costs of nonconformity. But because there is a strong external demand for economists’ services, they may experience even-stronger economic incentives than their colleagues in other disciplines to conform to the industry-held view. They can thus incur even-greater costs—economic and also psychic—from falling out of step.

WHY BELABOR these points? Because it was not that economic theory had nothing to say about the kinds of structural weaknesses and conflicts of interest that paved the way to our current catastrophe. In fact, large swaths of modern economic theory focus squarely on the kind of generic problems that created our current mess. The problem was not an inability to imagine that conflicts of interest, self-dealing and herd behavior could arise, but a peculiar failure to apply those insights to the real world.

Take for example agency theory, whose point of departure is the observation that shareholders find it difficult to monitor managers, who have an incentive to make decisions that translate into large end-of-current-year bonuses but not necessarily into the long-term health of the enterprise. Risk taking that produces handsome returns today but ends in bankruptcy tomorrow may be perfectly congenial to CEOs who receive generous bonuses and severance packages but not to shareholders who end up holding worthless paper. This work had long pointed to compensation practices in the financial sector as encouraging short-termism and excessive risk taking and heightening conflicts of interest. The failure to heed such warnings is all the more striking given that agency theory is hardly an obscure corner of economics. A Nobel Prize for work on this topic was awarded to Leonid Hurwicz, Eric Maskin and Roger Myerson in 2007. (So much for the idea that it is only the financial engineers who are recognized by the Nobel Committee.)

Then there is information economics. It is a fact of life that borrowers know more than lenders about their willingness and capacity to repay. Who could know better what motivation lurks in the mind of the borrower and what opportunities he truly possesses? Taking this observation as its starting point, research in information economics has long emphasized the existence of adverse selection in financial markets—when interest rates rise, only borrowers with high-risk projects offering some chance of generating the high returns needed to service and repay loans will be willing to borrow. Indeed, if higher interest rates mean riskier borrowers, there may be no interest rate high enough to compensate the lender for the risk that the borrower may default. In that case lending and borrowing may collapse.

These models also show how borrowers have an incentive to take on more risk when using other people’s money or if they expect to be bailed out when things go wrong. In the wake of recent financial rescues, the name for this problem, “moral hazard,” will be familiar to even the casual newspaper reader. Again this is hardly an obscure corner of economics: George Akerlof, Michael Spence and Joseph Stiglitz were awarded the Nobel Prize for their work on it in 2001. Here again the potential problems of an inadequately regulated financial system would have been quite clear had anyone bothered to look.

Finally there is behavioral economics and its applications, including behavioral finance. Behavioral economics focuses on how cognition, emotion, and other psychological and social factors affect economic and financial decision making. Behavioral economists depart from the simpleminded benchmark that all investors take optimal decisions on the basis of all available information. Instead they acknowledge that decision making is not easy. They acknowledge that many decisions are taken using rules of thumb, which are often formed on the basis of social convention. They analyze how, to pick an example not entirely at random, decision making can be affected by the psychic costs of nonconformity.

It is easy to see how this small step in the direction of realism can transform one’s view of financial markets. It can explain herd behavior, where everyone follows the crowd, giving rise to bubbles, panics and crashes. Economists have succeeded in building elegant mathematical models of decision making under these conditions and in showing how such behavior can give rise to extreme instability. It should not be a surprise that people like the aforementioned George Akerlof and Robert Shiller are among the leaders in this field.

Moreover, what is true of investors can also be true of regulators, for whom information is similarly costly to acquire and who will similarly be tempted to follow convention—even when that convention allows excessive risk taking by the regulated. Indeed, these theories suggest that the attitudes of regulators may be infected not merely by the practices and attitudes of their fellow regulators, but also by those of the regulated. Economists now even have a name for this particular version of the intellectual fox-in-the-henhouse syndrome: cognitive regulatory capture.

And what is true of investors and regulators, introspection suggests, can also be true of academics. When it is costly to acquire and assimilate information about how reality diverges from the assumptions underlying popular economic models, it will be tempting to ignore those divergences. When convention within the discipline is to assume efficient markets, there will be psychic costs if one attempts to buck the trend. Scholars, in other words, are no more immune than regulators to the problem of cognitive capture.

What got us into this mess, in other words, were not the limits of scholarly imagination. It was not the failure or inability of economists to model conflicts of interest, incentives to take excessive risk and information problems that can give rise to bubbles, panics and crises. It was not that economists failed to recognize the role of social and psychological factors in decision making or that they lacked the tools needed to draw out the implications. In fact, these observations and others had been imaginatively elaborated by contributors to the literatures on agency theory, information economics and behavioral finance. Rather, the problem was a partial and blinkered reading of that literature. The consumers of economic theory, not surprisingly, tended to pick and choose those elements of that rich literature that best supported their self-serving actions. Equally reprehensibly, the producers of that theory, benefiting in ways both pecuniary and psychic, showed disturbingly little tendency to object. It is in this light that we must understand how it was that the vast majority of the economics profession remained so blissfully silent and indeed unaware of the risk of financial disaster.

WITH THE pressure of social conformity being so powerful, are we economists doomed to repeat past mistakes? Will we forever follow the latest intellectual fad and fashion, swinging wildly—much like investors whose behavior we seek to model—from irrational exuberance to excessive despair about the operation of markets? Isn’t our outlook simply too erratic and advice therefore too unreliable to be trusted as a guide for policy?

Maybe so. But amid the pervading sense of gloom and doom, there is at least one reason for hope. The last ten years have seen a quiet revolution in the practice of economics. For years theorists held the intellectual high ground. With their mastery of sophisticated mathematics, they were the high-prestige members of the profession. The methods of empirical economists seeking to analyze real data were rudimentary by comparison. As recently as the 1970s, doing a statistical analysis meant entering data on punch cards, submitting them at the university computing center, going out for dinner and returning some hours later to see if the program had successfully run. (I speak from experience.) The typical empirical analysis in economics utilized a few dozen, or at most a few hundred, observations transcribed by hand. It is not surprising that the theoretically inclined looked down, fondly if a bit condescendingly, on their more empirically oriented colleagues or that the theorists ruled the intellectual roost.

But the IT revolution has altered the lay of the intellectual land. Now every graduate student has a laptop computer with more memory than that decades-old university computing center. And she knows what to do with it. Just like the typical twelve-year-old knows more than her parents about how to download data from the internet, for graduate students in economics, unlike their instructors, importing data from cyberspace is second nature. They can grab data on grocery-store spending generated by the club cards issued by supermarket chains and combine it with information on temperature by zip code to see how the weather affects sales of beer. Their next step, of course, is to download securities prices from Bloomberg and see how blue skies and rain affect the behavior of financial markets. Finding that stock markets are more likely to rise on sunny days is not exactly reassuring for believers in the efficient-markets hypothesis.

The data sets used in empirical economics today are enormous, with observations running into the millions. Some of this work is admittedly self-indulgent, with researchers seeking to top one another in applying the largest data set to the smallest problem. But now it is on the empirical side where the capacity to do high-quality research is expanding most dramatically, be the topic beer sales or asset pricing. And, revealingly, it is now empirically oriented graduate students who are the hot property when top doctoral programs seek to hire new faculty.

Not surprisingly, the best students have responded. The top young economists are, increasingly, empirically oriented. They are concerned not with theoretical flights of fancy but with the facts on the ground. To the extent that their work is rooted concretely in observation of the real world, it is less likely to sway with the latest fad and fashion. Or so one hopes.

The late twentieth century was the heyday of deductive economics. Talented and facile theorists set the intellectual agenda. Their very facility enabled them to build models with virtually any implication, which meant that policy makers could pick and choose at their convenience. Theory turned out to be too malleable, in other words, to provide reliable guidance for policy.

In contrast, the twenty-first century will be the age of inductive economics, when empiricists hold sway and advice is grounded in concrete observation of markets and their inhabitants. Work in economics, including the abstract model building in which theorists engage, will be guided more powerfully by this real-world observation. It is about time.

Should this reassure us that we can avoid another crisis? Alas, there is no such certainty. The only way of being certain that one will not fall down the stairs is to not get out of bed. But at least economists, having observed the history of accidents, will no longer recommend removing the handrail.

Before Tea, Thank Your Lucky Stars, by Robert Frank, Commentary, NY Times: The link between success and luck is stronger than many people think. Analysis of this connection provides a useful framework for weighing … recent “tea parties,” where orators … bemoaned their “crippling” tax burdens. …

Contrary to what many parents tell their children, talent and hard work are neither necessary nor sufficient for economic success…, some people enjoy spectacular success despite having neither attribute. (Lip-synching members of boy bands?…)

Far more numerous are talented people who work very hard, only to achieve modest earnings. There are hundreds of them for every skilled, perseverant person who strikes it rich — disparities that often stem from random events. …

Malcolm Gladwell reports that a disproportionate number of pro hockey players owe their success to the accident of having been born in January, which made them the oldest, most experienced players in every youth league growing up. For that reason alone, they were more likely to make all-star teams, receive special coaching and eventually become professionals.

Although people are often quick to ascribe their own success to skill and hard work, even those qualities entail heavy elements of luck. … People born with good genes and raised in nurturing families can claim little moral credit for their talent and industriousness. They were just lucky. …

Even in markets where luck plays no role, minuscule differences in performance often translate into enormous differences in salaries. … In law, consulting, investment banking, corporate management and a host of other occupations, the ablest performers are often paid hundreds or even thousands of times as much as others who perform nearly as well.

Another important message of recent research is that a person’s salary depends far more on where she is born than on her talent and effort.

For example, as a Peace Corps volunteer in Nepal long ago, I hired a cook who had no formal education but was spectacularly intelligent and resourceful. … Yet his total lifetime earnings were less than even a very lazy, untalented American might earn in a single year. Well-paid Americans owe an enormous, if rarely acknowledged, debt to the social investments that supported their success.

The president’s proposal is modest: raising the top marginal tax rate from 35 percent to 39.5 percent, its level when Bill Clinton left office and well below the corresponding level in most other industrial countries. There has never been a shortage of talented people willing to work hard for success… And the president’s proposal would not cause such a shortage…

It would, however, promote more efficient provision of public services… For example,… when government levies higher tax rates on the wealthy, we can provide public services that the wealthy and others greatly value but that would otherwise be beyond reach. Under such a tax system, the heavier tax bill becomes payable only if we’re lucky enough to end up among life’s biggest winners.

Financially successful tax protesters seem blissfully unaware of how incredibly fortunate they are. To borrow from the late Ann Richards and her description of the first President Bush, they were born on third base and thought they’d hit a triple.