Ev Ehrlich's Everyday Economics


But Some Are More Equal than Others

The Wall Street Journal reports that “Google has approached…companies that carry Internet traffic with a proposal to create a fast lane for its own content…”

Well, sure – if you were Google, wouldn’t you want that? What’s the big deal?

The big deal is this:

For several years, Google has led a coalition to “save the Internet” by creating a policy they call “net neutrality.” “Net neutrality” means that all traffic on the Internet would move at the same speed. Google argues that the Internet ought to work the way the phone system did fifty years ago, when all calls moved over the wires at the same speed. Specifically, Google would prohibit every website from going to Internet providers (such as Comcast, Verizon, or others) and paying for the right to reach Internet users with faster speeds and more reliable connections. There will be no Internet “fast lanes.” As in Orwell’s Animal Farm, all the animals will be created equal.

And like Animal Farm, “neutrality” sounds egalitarian, but it’s really a recipe for freezing the Internet and its current winners, starting with Google. The “one speed” phone system Google champions was part of a regulatory regime in which the phone company – Ma Bell, there was only one – provided this “one speed” condition in exchange for a monopoly franchise and profits that were guaranteed by regulation. The Internet of today – unlike the phone system of generations ago – isn’t brought to you by regulated fat-cats who are guaranteed a profit; it’s brought to you by companies that have invested tens of billions of their own dough and compete with each other daily. When Ma Bell provided one-speed “neutrality,” it was a great deal – for Ma Bell. But once we got rid of it, over twenty years ago, we suddenly got cheap phones, competitive rates, cell phones, text messaging, fixed-price plans, 3G, and phones that did the jobs of computers, cameras, bike messengers, radios, and just about everything else you have except your can opener.

But “neutral” sounds good, and Google ran with it, positioning themselves as the friend of competition and the stereotypic “little guy” on the Internet. If all traffic traveled at one “neutral” speed, they argued, the Internet would be “fair” – little companies could challenge the big ones because there would be no advantages. Innovation would flourish, and the full potential of the Internet would be realized.

The fact that this argument came from America’s 15th largest company (just a few notches below IBM and Coca-Cola) – one that has swallowed up innovative competitors such as YouTube for ten-figure sums – should have made some people suspicious, and rightly so. Because, as Orwell would have said, while Google wants all the animals to be equal, some are more equal than others. By prohibiting anybody from buying faster speeds and more reliable connections, Google wants to limit its future competition, because Google already has faster speeds and more reliable connections, and they don’t want anybody messing with their good thing.

Google got those advantages by doing exactly what the Wall Street Journal said they were doing – by buying expensive “caching” services that distribute their content all over the Internet. When you go to Google, its software figures out where you are and finds the “cache” of content nearest you. So while its competitors’ content travels at a “neutral” speed across the Internet’s maze of connections, Google’s material spends as little time in that maze as it can – instead, it travels through Hyperspace, magically appearing at a server near you while its competitors navigate the sidestreets. As Google said itself on its public policy blog: by cutting deals with the broadband providers, it can “improve page load times for videos and Web pages.” In other words, be faster. So Google isn’t in favor of a “one speed” Internet. But they are in favor of an Internet with one speed for everybody else.

But the danger posed by net “neutrality” is about more than preserving Google and other big sites’ current advantages. In the longer term, these arbitrary “one speed” rules could paralyze innovation on the Internet. Imagine real-time medical devices that communicate medical information over the Internet and let patients go home instead of staying in hospitals; or Voice Over Internet Phones that offer a range of different speeds, connection strengths, and prices and let customers exercise their choice; or real-time streaming of the highest definition first-run movies (and, one day, such over-the-top applications as 3-D or hologramic entertainment) directly into the home. None of that stuff can happen unless customers can be guaranteed the fastest downloads and uninterrupted service. That’s innovation! But Google’s vision of “neutrality” wants to make sure that all those applications travel at the same speed as a Facebook friend request or Dirty Joke websites. That’s the real meaning of “neutral” – an Internet stuck in neutral.

But now, Google’s shown its hand. It’s going to use its financial and engineering muscle to speed its content to users, while stopping smaller and newer competitors from using a cheaper, easier way to do the same. On Google’s Internet, all the animals will be created equal, but some will be more equal than others.


The Real Nitty Gritty

When you get right down to the real nitty-gritty, as Shirley Ellis used to sing, the “net neutrality” debate comes down to this – is the market for broadband dominated by a voracious, two-headed cable-telco duopoly monster that will dominate the Internet and expropriate its transformative value? That’s an important – if not the important question – because a competitive market would check the various abuses “neutrality” advocates claim to be just around the corner.

One sign that competition is working in the broadband market is that the price of connectivity is falling and its adoption spreading. A 1 mbps connection costs about XX today, $7 per month in 2006, $26 per month in 2002, and didn’t exist commercially eight years ago. And broadband is permeating the market as fast as or faster than PCs, DVDs, or any other electronic/data product in recent memory.

For some neutrality advocates, it’s not enough. “But there are only two of them!” is the essence of their rejoinder.

Look – there were only two guys in the ring for the Ali/Frazier fights, and they beat each other’s brains out! And that’s what’s happening in broadband today. There are plenty of reasons to think the “duopoly model” doesn’t apply to broadband – and here are five of them.

First, the point of a duopoly is to collude against the public by agreeing to set a price. But that’s because, in duopoly theory, the two producers are making a standard, static good. The only way they can compete is on price – there’s no quality competition, no competition to innovate.

But cable and telco companies in the so-called “duopoly” compete every day, regardless of what prices are – by offering leapfrogging speed and reliability. (JB: Need Link’s – or Jeff? - leapfrogging examples. What do we have?) Like Ali and Frazier, they are beating each daily in the race to provide faster and more reliable connections for customers.

A second key difference is fixed cost. About half the cost of a system such as FiOS or cable is fixed, including depreciation, the amortization of research and software, and shared system-aide operating costs. The cost of adding a new user to the system is very low once these up-front investments are made. So cutting prices to increase the system’s use allows the competitors to spread their massive investments over a large number of users. It’s the classic natural monopoly problem, but instead of lethargic regulation of one sanctioned producer, we have two producers – and maybe more – willing to battle it out. It is the very “ruinous” competition that the regulation of natural monopolies such as electric utilities sought to avoid.

Did I say “maybe more” than two producers? That’s the third point. The “third pipe” many analysts hope to see in the broadband market may not be a pipe at all – it might be wireless broadband. One-sixth of all households only use a mobile phone – no fixed line hook-up – and most of them are folks under 25. That’s not to say that young people are about to abandon their broadband hook-ups for their phones, but it is to say that once mobile broadband gets better, customers may flock to it just as they have flocked to mobile telephony. And that may not be that far away -- mobile systems in Australia offer speeds up to 10 mbps. Nielsen recently reported that three out of five mobile broadband users are considering swapping out the home ISP, and that Internet access is “the next frontier of wireless substitution.” So the potential for a large-scale flight to mobile broadband is there -- cable and telco may prove to be the “only” two producers of a product that the markets turns away from.

A fourth consideration is the changing face of the broadband market. Until very recently, a broadband customer was assuredly a dial-up customer being brought into a new world. Now, they’re often an existing broadband customer being brought into an even newer world. The vast pool of dial-up customers is becoming an Aral Sea – soon there will be none left, and cable and telcos will have to find new customers either from each other’s customer base or from users of their previous generations of projects. And at the same time, their users will be more knowledgeable, demanding, and sophisticated about broadband. Providers are going to have to work harder to keep up; the future of the industry is more competitive, not less.

Finally, there’s the dimension of competition that focuses on what’s perhaps most important of all – what the consumer wants. And paradoxically, this is precisely the kind of competition the “neutrality” advocates want to do away with. Their version of an Internet that is “open end to end” really means that nothing can be given priority over anything else, and they are certain that is what consumers want.

Really? Consumers don’t want the feed from a heart monitor to get priority over a song download, or an E-Trade transaction to go faster than a Facebook posting? They don’t want different Internet search or e-mail services to compete on the basis of speed of connection? They don’t want a broadband provider to think up creative new applications or special features, much as being connected to AT&T Mobile allows you to use an iPhone?

Who says, and who knows? The cable and telco providers are trying to find out, because whichever of them figures it out first is going to win the competition for customer allegiance – until consumers change their minds. But the “neutrality” crowd wants to prohibit this competition in a way that is, ultimately, uncompetitive.

No one doubts that the Internet is a Promethean phenomenon. But the fact that it is transformative doesn’t tell us the best way to bring it to fruition. “Neutrality” advocates want to shape the Internet in the image of their own assumptions, the most important of which is that the broadband market isn’t and won’t be competitive, which is why we have to guide it through regulation.

They’re wrong. When you get right down to the real nitty-gritty, there is competition for broadband, and as in any competitive market, the customers, not the advocates, are always right.


Cannot Sink But Will Not Swim

On August 1, the FCC issued a ruling that Comcast had endangered the “vibrant and open nature of the Internet” by slowing down customer use of BitTorrent and other peer-to-peer applications, and that it had misrepresented its practices to both its customers and the Commission.

The finding would appear decisive, but the Commission’s ruling has something for everybody. “Neutrality” proponents will claim that it justifies their vision of an “unimpeded” end-to-end Internet. Providers will note that the finding doesn’t rule out traffic management during times of congestions, just the clumsy way Comcast went about it. Consumer advocates will take pleasure in the Commission’s championship of transparency. Others will take heart in the Commission’s statement that blocking odious content such as child pornography or pirated intellectual property is still “consistent with Federal policy.” The ruling enunciates clear principles, even if peppered with interesting contradictions, and makes clear that the FCC can do whatever it needs to do without new legislation. So the Commission’s ruling does a great deal for a great many, but it still doesn’t do one thing.

The ruling doesn’t solve the fundamental problem confronting the Internet – what to do when it gets too crowded.

Let’s first take a moment to look at the background of the FCC’s ruling. Several independent groups, including the Associated Press, discovered that Comcast was slowing traffic that used peer-to-peer applications, principally BitTorrent, but others as well. At first Comcast denied it, but then admitted it was true, explaining that it did so only to manage periods of peak congestion. It then changed its story again, admitting that it regularly slows this kind of traffic regardless of the level of congestion.

As ever, it’s the cover-up, not the crime. I don’t understand why Comcast was slowing traffic when there weren’t congested conditions, although I can imagine doing so prevents congestion before the fact. And slowing down one type of application – peer-to-peer – sounds discriminatory, but you can see the argument for it. It’s like saying that you can’t water your lawn when there’s a drought and the reservoir is low – it may be arbitrary (some folks would rather give up bathing than stop watering the lawn), but at least it solves the problem.

Comcast’s putting the burden of limiting congestion by going after peer-to-peer networks has that quality. One reason they drew such fire for doing so is that when you say “peer to peer networks,” people think – piracy. But blaming peer-to-per networks for piracy is like blaming the ocean for pirates – being on the ocean doesn’t make you a pirate, but that’s where all the pirates work. Piracy isn’t Comcast’s concern, nor should it be – that would be like asking rhe airlines to search their passengers for contraband. File swapping increases the demand for bandwidth, and bandwidth is what Comcast sells.

What Comcast doesn’t sell much of over high-speed Internet connections is content, which leads to one of the oddest aspects of the Commission’s finding. It says that Comcast’s motive for reining it BitTorrent-type applications is that those applications “provide Internet users with the opportunity to view high-quality video that they might otherwise watch (and pay for) on cable television.” Yes, Comcast does sell cable-TV service, but the order doesn’t contain proof that Comcast was intervening due to BitTorrent’s competition with Comcast TV services. And would you give up cable TV for what you can get through the Internet? Or more accurately – have you?

No, peer-to-per networks and BitTorrent applications are the likely target for limitation during congested periods because they’re big, incredibly big. P2P does create congestion problems. The bandwidth used by YouTube, a multibillion dollar subsidiary of Google, itself the eleventh largest corporation in America, is greater than the bandwidth of the entire Internet eight years ago. If you want to cut back on bandwidth use, there’s an easy target. And, at first blush, it’s not a bad presumption that reining back peer-to-peer has lower social costs than, say, e-commerce, or school or government or health networks.

Is that unfair, or arbitrary? Well, that takes us back to the question I posed earlier -- what do we do when the Internet is crowded? And that’s what I’ll address later today.


So what do we do when the Internet is crowded? Anything that has a fixed level of capacity is vulnerable to too much demand. When there are too many cars on the road, there’s traffic and people sit and idle their engines. So Comcast’s solution was arbitrary (and inexpertly administered), but ultimately no more so than telling people they can’t water their lawn during a drought.

Was Comcast’s move the best solution? No, not by a long shot. The best solution is to let users and websites determine what speed and reliability are worth to them. Different websites will value speed differently, and for different reasons. A health clinic with real-time monitors or an on-line stock trader will think every increment of speed and reliability is worth it. A new competitor to Google might value speed highly to compete with the incumbent by being faster. So some sites are simply going to be willing to buy the right to priority for their site’s traffic when the Internet gets crowded. It would be like having HOV lanes that let some traffic pass more quickly.

The people who propose “net neutrality” oppose this vision of a competitive Internet. They argue that the Internet would lose its “open and vibrant” nature if this were allowed. But it’s hard to see how. For example, some people send their mail by priority overnight, some send it by second day delivery, and some with a regular stamp, but all the mail gets through. And some businesses have 24/7 live customer service lines, some only during office hours, and some respond to e-mail the next day – they decide what that level of service is worth and act accordingly … and so, too, do customers.

Why should the Internet be any different? Neutrality proponents point to the Internet’s epochal character and its potential to bring together all of humanity in a new and profound way. No one argues that. But the singularity of the Internet doesn’t tell us what to do to use it in a way that does the most good for the greatest number. And when it gets congested, the best answer probably isn’t the one “neutrality” proponents favor – everybody being slow together -- hey, at least it’s “neutral.” Besides, that’s not what happens now anyway. The big sites – Google, EBay, and so on – already have big speed advantages due to more and better equipment (including caching) that smaller guys can’t get. That’s why they’re the money behind “neutrality” – because “neutrality” preserves their advantages.

The FCC ruling has to be seen in this context. There is pressure on the FCC now to allow the principle that some websites can buy faster or more reliable service from Internet providers, even though such a principle would allow far greater competition and innovation on the Internet in the long run. And now, in this decision, the FCC suggests that it may want new rules regarding management of congestion. We don’t know that yet – the opinion, on the one hand, tells us that the problem isn’t rules per se, but that companies such as Comcast must apply rules in a non-discriminatory and transparent manner. But on the other hand, the FCC advisory suggests that there’s no way to do that, since techniques that would allow rules to be enforced (such as Deep Packet Inspection) would not be “acceptable.”

So where does the FCC leave us? The Internet does not have limitless capacity, so there are going to be times when it will get congested. One option is to let the market sort it out – a competitive Internet. “Neutrality” advocates don’t like that. Another is to allow broadband providers the ability to implement rules (when needed, and transparently, to be sure) to manage those periods. But “neutrality” advocates don’t like that solution either.

That leaves the third option – letting everyone tough it out and share the misery. It’s the option that gives us highway traffic that doesn’t move, airplanes that sit on tarmacs, and brown-outs during the summer heat. To some advocates, this solution may be in keeping with how they construe the egalitarian character of the Internet. But for users, it’s a blueprint for an Internet that cannot sink but will not swim.

In September 2008, Comcast responded to the FCC by announcing it was testing a program that would slow down those customers using the most bandwidth, regardless of the purposes or programs they were employing, when the system neared congestion. While this approach may be more to the FCC’s liking, it may not be different in practice from Comcast’s discredited approach.


Oh, That Reality

My 10th grade daughter came home the other night with a home work assignment – to write a speech about a controversial subject. The topic she chose was sex education in high school. She was for it. Her argument, with which many people disagree, was that sexual activity, like it or not, is frequent, if not the norm, and that basing a teenager’s defenses against contraception and disease on abstinence alone was akin to living in a world of illusion. It was wrong, she argued, to confuse what should be with what is.

Well, like I said, some people agree, some don’t. But as I listened to her practice her speech it occurred to me that the debate between principle and practicality – or, for some, expedience – isn’t limited to issues we regard as being moral, if not theological, ones. In fact, it underlies many of the economic policy debates we have today.

For example; file sharing, or piracy. Stealing something – anything – is wrong. But technology has made the potential for file sharing unstoppably enormous. Right or wrong, it’s here. Once the media business accepts reality as it is, it can move forward to new business models that turn file sharing an economic bonanza, not a death threat, just as Hollywood now makes more money off DVDs than theater tickets, or the Brooklyn Dodgers were the first Club to see radio as free advertising, not a threat to its box office. But piracy laws that try to legislate what should be, and ignore what is, or even more crucially, what can no longer be, are dangerous, particularly if they create toll booths and check points along the Internet that compromise its openness. Sure, prosecute egregious pirates, but insisting that piracy go away isn’t going to work.

And another example of the confusion between what should be and what is is immigration. Sure, one we decide an immigration law, it needs to be enforced. But burgeoning levels of immigration show that relying on enforcement alone isn’t working, and isn’t going to work. There is simply too much demand here for everything from programmers to dishwashers and too much supply that’s one plane ticket or one midnight mad dash away from it. Once we accept that enforcement, like piracy laws, or abstinence, isn’t going to solve the problem alone, we can move forward to thinking about new guest workers programs, expanded programs that allow employers to bring in specific needs, or other measures that manage immigration appropriately.

And these three issues share one more similarity – the assumption that one side is “moral” and the other “isn’t.” Abstinence has moral virtue, but so does preventing unwanted pregnancy or disease. Piracy is wrong, but cheap distribution of artistic works allows for more competition and, therefore, experience for consumers and opportunities for new producers. And pell-mell immigration may be bad, but not for the Americans who benefit from low-wage service work that might otherwise go undone, or for people trying to build a better life, much as previous generations in many of our own families did. You can have all the attitude you like, but the next time somebody empties your bedpan, you’ll thank an immigrant.

There’s something wonderfully wistful about a world in which teenagers chastely danced to records and Mom cleaned up after them, not a West African housekeeper. Whether it was a better world (or even existed) is not the issue – whether we should base policy on the goal of recreating it is.


From Alan to Ben

William McChesney Martin, who was Fed Chairman from Truman to Nixon, famously remarked that his job was to take away the punch bowl once the party got going.

He was referring, of course, to the Fed's role in the economy; when the economy gets too hot, and prices rise, the Fed's job is to tighten credit and cool it off. When the economy falters and people lose jobs, the Fed does the reverse. That's the job that Ben Bernanke is signing up to do -- the job Alan Greenspan signed up for in 1987.

But six months into Greenspan's tenure, the stock market crashed. Suddenly the danger confronting the economy wasn't inflation or unemployment next year, but a financial panic that afternoon. The companies that let people trade stocks on the New York Exchange were on the verge of going broke. Had Greenspan not stepped in to rescue them, stock trading and the financial system would have stopped cold.

Over the next 18 years, while Bernanke was building a career as a distinguished economics professor at Princeton, Greenspan was making his rep as a crisis manager. He worked with Treasury Secretary Robert Rubin to bail out Mexico in 1994. Four years later, he came to the rescue of world markets when Asia, Russia, and Brazil turned into falling financial dominoes. And when the dot.com bubble burst in 2001, he came to the rescue again, making credit cheap to undo the damage of falling stock prices. Whatever his failures - including his endorsement of the 2001 tax cuts - Greenspan knew how to manage the world's financial crises; he was good at letting the world's financial markets sleep soundly at night.

Bernanke might have to be even better. Our government now spends more on wars, hurricanes, and tax cuts than it brings in, and foreigners - in particular the governments of China and Japan - are lending us the money to do it. But no one lends forever. What happens when these foreign lenders decide they’re putting too many eggs in our basket? The result could be higher interest rates, falling stock and home prices, a recession, and perhaps the failure of some banks - the mother of all financial crises.

Right now, the talk is about Bernanke's theoretical writings on monetary policy. He's a leading exponent of the theory that the Fed should announce how much inflation it's willing to tolerate - say, two percent - and then put its policies on autopilot to reach that target. But the responsibilities of being Fed Chairman will turn the most devout theoretician into a pragmatist in short order - ask Alan Greenspan. A financial panic sometimes means raising rates, sometimes lowering them; sometimes cooperating with other countries, sometimes confronting them; and sometimes making up new rules for private banks or trading exchanges. The textbooks don't say much about that.

Bernanke's ability to live up to this challenge one day may well define his tenure as Fed Chairman. It's one thing to know when to take away the punch bowl. It's another to know what to do when the party breaks into a brawl.


His Two Cents, For What It’s Worth

The Washington Post, Washington, D.C. — Gen. Ulysses S. Grant, 18th president of the United States, submitted this exclusive piece to Outlook through Everett Ehrlich, author of the novel "Grant Speaks" (Warner, 2000) and a frequent commentator on National Public Radio.

The Treasury Department is printing up another new $50 bill with yet another new picture of me on it. This one has special colors hidden in it, and the ink changes its appearance depending on how you look at it -- just like a battlefield.

I've always found it odd that they put my face on money, since I never had a head for it. My prospects as a merchant were so poor that my father forced me into the U.S. Military Academy at West Point so that I might one day have an occupation.

When I was 8, the old man sent me to buy a neighbor's horse. When I got to the neighbor's house, I said: "Papa says I may offer you $20 for the colt, but if you won't take that, to offer you $22.50, and if you won't take that, to give you $25." You don't have to be Commodore Vanderbilt to figure out what I paid. After that, I quit negotiating and started demanding unconditional surrender instead.

I failed in every business I tried except slaughter. When I was stationed at Fort Vancouver during the Gold Rush, I had the idea of shipping ice to San Francisco, where a chronic ice shortage was compelling the citizenry to drink their whiskey neat. But our boat hit some bad winds in Puget Sound, and we delivered a cargo of water, which they already had in abundance.

I drank myself out of the service after that, and went home to farm the land my father-in-law gave me. All I managed to grow was children. By the summer of '57, the economy had crashed, and I was down to cutting wood and selling it on a street corner in St. Louis. I wore my overcoat from the Mexican War to solicit a little respect. Or, failing that, sympathy.

I was standing there one September's day when who should come along but Sherman. He had been three years ahead of me at West Point. It was Sherman who first saw my name on the roster of new students and nicknamed me "Sam," on account of my initials -- you know, Ulysses S., Uncle Sam. That was about 18 years before.

"Hello, Sam," he says, and he looks me over with those dark, deep- set eyes. "How's it going for you?"

"Well, I'm busy fighting poverty, Cump," I said, which is what we called him -- it was short for Tecumseh, his middle name. "How about you?" Sherman had quit the army in '50 and ended up in banking in California.

"I'm a dead cock in the pit, Sam," he said, shaking his twitchy, gaunt head. "The crash wiped us clean."

We stood there, avoiding each other's gazes as only failures can, until he walked on. Eight years later, with him at my side, I led the greatest army the world had ever known.

When I was president, money proved to be a problem. Fisk and Gould, the speculators, talked me into buying gold to make the dollar cheap. When I tried to break them on "Black Friday," in '69, they were out before the market turned, like kids winning a game of hot potato. Later in my presidency, there were incessant demands for "sound money." When the Northern Pacific railroad failed and the stock market crashed again, Commodore Vanderbilt and his banking friends said they needed some "sound money" to save themselves, and I told them they could have it. Then the farmers said they needed some of their own "sound money" to save their selves, and I told them that was inflationary. Let that be a lesson to other presidents: Money gets sounder the higher up the chain it goes.

After I retired, my boy, Buck, went into the brokerage business with a fellow named Ferdinand Ward. Buck proved as naive as I was -- Ward swindled us for all we had and skipped town. Once I had lost everything, I turned to the only capital I had left -- the story of my life. I took up writing my "Personal Memoirs" in order to leave Mrs. Grant some money. It sold 300,000 copies -- outpacing the Bible. Just like the Bible, it had a compelling leading character.

I suppose my picture is on the $50 bill to celebrate my victory over Bobby Lee, but I suspect there's another reason -- to remind you that having money, or even being on money, doesn't mean knowing what to do with it. Next time you hold a fifty, look me in the eye and think about it.


Are Mankiw and Dobbs Our Choices?

The economists have looked out upon the world and pronounced it good. Just last week, Gregory Mankiw, chair of the Council of Economics Advisors, told us that outsourcing and displacement are just another installment of the historical process of economics growth and betterment and we should stay our fears about them. Somehow, the American public failed to be assuaged.

In one way, Mankiw is absolutely right, and in another, he needs to get a clue. Sure, change and displacement have always been a part of growth—ask the farmers who became industrial workers a century ago. But if change is the price of growth, what is our obligation to those displaced in the process?

One answer, particularly within the business community, is to emphasize growth, as if there were people somewhere who were against it. This school emphasizes the need for a well educated population, a culture of entrepreneurship and innovation, and a commitment to research and development and technological progress. If we have those, they argue, our economy and our people will be so deft, so agile that they will readily keep their feet amid the economy’s tremors.

This answer, like Chairman Mankiw’s, is both absolutely right and completely misses the boat. The vague promise of school later does little to alleviate fear now. And it risks being perceived as part of a political con game, in which business groups champion good schools and helpful technology, leaving the Administration to announce that there’s no money to fund them, because all the money went to the smash-and-grab tax cuts the same business groups supported.

For all of Lou Dobbs’ nightly ridicule of corporate traitors on CNN, outsourcing to India and China aren’t the driving forces behind job loss. Productivity, structural change and bad economic policy are. But ultimately, it doesn’t matter. A current of fear and protectionism is gripping the economy. It is so strong that economic progress itself has become suspect. And it leads to the inescapable conclusion that if we want to have trade, innovation, and growth, we need to have an adjustment policy.

What does adjustment policy mean? It means allowing workers to insure themselves against wage loss when they lose jobs. It means allowing them to take their health care with them as well. It means changing the tax system to expand support for the incomes and retirement of the working poor, and to treat an investment in education the same way it treats an investment in a machine. It means finding the resources to pay for national K-12 education, even if it means raising taxes and limiting Social Security and healthcare for the long term. And it means a higher minimum wage, to keep the bottom of the labor force attached to the rest of us.

I believe wholeheartedly in free trade, but the trade debate misses the point. Look at the steel industry. When they were unprotected, steel workers lost their jobs. They were protected, and the companies consolidated and workers lost their jobs anyway. Counterproductive restrictions on trade and investment won’t help working people. Nor will sermons from economists or businesspeople. A conscious adjustment policy that serves workers’ interests will.


A Political Party on a Laptop

The Washington Post, Washington, D.C. — Back in 1937, an economist named Ronald Coase realized something that helped explain the rise of modern corporations -- and which just might explain the coming decline of the American two-party political system.

Coase's insight was this: The cost of gathering information determines the size of organizations.

It sounds abstract, but in the past it meant that complex tasks undertaken on vast scales required organizational behemoths. This was as true for the Democratic and Republican parties as it was for General Motors. Choosing and marketing candidates isn't so different from designing, manufacturing and selling automobiles.

But the Internet has changed all that in one crucial respect that wouldn't surprise Coase one bit. To an economist, the "trick" of the Internet is that it drives the cost of information down to virtually zero. So according to Coase's theory, smaller information-gathering costs mean smaller organizations. And that's why the Internet has made it easier for small folks, whether small firms or dark-horse candidates such as Howard Dean, to take on the big ones.

For all Dean's talk about wanting to represent the truly "Democratic wing of the Democratic Party," the paradox is that he is essentially a third-party candidate using modern technology to achieve a takeover of the Democratic Party. Other candidates -- John Kerry, John Edwards, Wesley Clark -- are competing to take control of the party's fundraising, organizational and media operations. But Dean is not interested in taking control of those depreciating assets. He is creating his own party, his own lists, his own money, his own organization. What he wants are the Democratic brand name and legacy, the party's last remaining assets of value, as part of his marketing strategy. Perhaps that's why former vice president Al Gore's endorsement of Dean last week felt so strange -- less like the traditional benediction of a fellow member of the party "club" than a senior executive welcoming the successful leveraged buyout specialist. And if Dean can do it this time around, so can others in future campaigns.

To understand it all better, let's go back to Coase and the world of business. Say you want to buy an appliance, or a vacation. You know there are bargains out there, but it takes time and energy to find them. That's what economists call the "transaction cost" of a purchase. This cost of acquiring information is everywhere: the time it takes to call a friend or to learn something in a newspaper. Or the time and resources it takes a company to find out where to find parts and to make sure they show up at an assembly line on time.

Back when it cost a great deal to learn and know things -- when transaction costs were very high -- big corporations had to solve the problem of coordinating information, such as what customers wanted to buy, what parts were being produced and shipped, how to make sure prices covered costs, and so on. The advent of mass production and similar "process" technologies let firms produce and sell things -- cars, steel, oil, chemicals, food -- on a much larger scale, so there was suddenly much more information to coordinate.

Companies solved this problem by creating massive bureaucratic pyramids; Alfred Sloane, chairman of General Motors, was famous for creating the multi-divisional firm. The job of these internal hierarchies is to gather, validate and store the information the company needed to coordinate all its activities. That's what "middle managers" in marketing, accounting and so on manage -- information.

Now, however, with internal communications networks and the speed of the Internet, you don't need a horde of people in a big pyramid to handle all that information. Firms have become "flatter" and "faster," and the "networked" or "virtual" company has come into being -- groups of firms that use shared networks to behave as if they were part of the same company. A generation ago, GM made all its own parts and IBM all its own chips. Not today. Now, specialized companies use networks to coordinate their activities with GM and IBM, and supply the needed components.

So the end result of the Internet revolution on companies has been exactly what Coase's theory predicted: Cheap information has allowed firms to shrink. Size is now less of an advantage in organizations, and that means more competition in the global marketplace. For companies, it's either reorganize or die. That's what Coase, who won the 1991 Nobel Prize in economics, was talking about.

Coase's ideas are no less true for political organizations, as Dean's success shows. He is the first candidate to use the Internet effectively as a political organizing device.

To put it in perspective, think about how political parties started. They began as a way of bringing like-minded people together to wield political influence, in the best and worst senses of the term. And they were a reflection of transaction costs, because that kind of large-scale, social organization was the most effective way to process political information.

Consider, for example, the first "modern" political campaign -- the Whig campaign for William Henry Harrison in 1840. Apart from some success as an Indian killer, Harrison had minimal credentials, but the Whigs figured out how to use the tremendous organizational apparatus of their party to promote him. They fabricated the image of Harrison as the "log cabin and hard cider" candidate, despite his more patrician roots, and used the party organization to enforce discipline around the fabrication -- to get everyone to say the same thing at the same time. In America's first political mass media stunt, they constructed a 10-foot-high ball of twine, wood and tin, covered it with Whig political slogans, and rolled it first from Cleveland to Columbus and then from town to town across the country (hence the expression "Keep the ball rolling").

It seems quaint now, but then it was an act of genius, because it capitalized on the Whigs' brilliant use of their party's primary asset -- the ability to coordinate information on a national scale. They got the entire party on message and then managed the activities of community supporters around the country to pull off the ball stunt. It was, a kind of primitive, analog blog. But in 1840, only a well-organized political organization could have done it.

No longer. Now anyone with a Web site and a server, a satellite transponder and about $100 million can have -- in a matter of months -- much of what the political parties have taken generations to build. Technology, of course, has changed politics before. Television changed the two parties, for example, but it didn't make the parties obsolete. In fact, in the day of Richard M. Nixon and John F. Kennedy, television strengthened the two-party duopoly (the economist's term for a shared monopoly), as only those two parties had the resources to use it competitively.

But the Internet doesn't reinforce the parties -- instead, it questions their very rationale. You don't need a political party to keep the ball rolling -- you can have a virtual party do it just as easily.

And that's what Howard Dean has done. Nor is Dean alone. The same forces make the evangelical right a powerful force in the Republican Party. With its TV stations, membership lists and money, it is a party waiting to happen. When Republicans of more moderate stripes express concerns about the evangelicals "taking a walk" on the party, they are recognizing that underlying reality.

The ability to have "virtual political parties" is the greatest challenge the two parties have ever faced. There are strategies available to them, of course -- deft positioning allows them to preempt competitors, as it does in every industry, and they can use the same technology, although Internet culture doesn't seem readily amenable to either Democrat.com or Republican.com. Being a Democrat or a Republican isn't enough of an advantage anymore -- there are simply too many other places where people can get political information and find political bedfellows in an age of low information costs.

The real question is whether -- really, how -- the two parties, like any other waning duopoly, will use non-market means to preserve their fading power -- by, for example, keeping third-party candidates out of televised debates, making it harder for other parties to get public funding or closing off "open" primaries that invite marauding forms of political organization.

But the challenge is unavoidable, and the future is coming on fast. Here are some predictions. First, if Dean loses the nomination, he will preserve his organizational advantage and reemerge as a third-party force four years from now. He has done with technology what Ross Perot could not do with money alone. Second, the evangelical right will become a separate political party in the near future, and will hold its own conventions and primaries. Like the Conservative Party in New York state, it will usually endorse Republican candidates. But evangelicals will use their inherent party-ness to make the Republican candidate stand in front of them and give a separate acceptance speech. And finally, in the next six or eight presidential elections, a third-party candidate will win the presidency. Issues -- most likely the coming fiscal debacle and the inescapable abrogation of promises made on Social Security and Medicare -- will give the third-party candidate an opening. But technology will give him, or her, the means.

Sooner or later, it's going to happen. And all because of what an economist named Ronald Coase understood 70 years ago.



In 1992, Singapore, a prosperous but somewhat up-tight city-state known for caning its criminals, decided there was too much gum on the sidewalk, so it outlawed gum. But, in response to pressure brought to bear by the U.S. government (after lobbying by the Wrigley Corporation) the Singaporeans will now let you buy sugarless gum over the counter to chew at will, hopefully with your mouth closed. This was actually part of our bilateral, free trade agreement with Singapore.

This is a troubling decision, for two reasons. First, the gum problem isn’t a trade problem. You couldn’t chew Wrigley gum in Singapore, or Singaporean gum, or any country’s gum. Sure, some people chewed gum anyway, but like it or not, the prohibition wasn’t about trade. It was about the law – the Singaporeans simply like their streets very clean. Economists have a term for this – it’s called a “cultural preference.”

Gum might seem like a trivial example of this, but how about whether genetically modified foods can be sold in Europe? Our producers say these modified foods are safe, and they might be right, but that’s not the point. The point is that, just like gum-hating Singaporeans, the Europeans don’t like anybody playing with their food, or at least their food’s chromosomes. You can’t buy American modified food, or European modified food, or anybody else’s modified food in Europe. It’s not like in Japan, where they once claimed that Japanese skis were uniquely able to ski across Japanese snow. We should save our belligerence for instances like that one, where American products are being unfairly handicapped, and not for countries that exercise their right to decide what they want to eat -- or what they want stuck to the bottom of their shoe.

But even more troubling; why are we wasting our time on Singaporean chewing gum in the first place? The world is now eighteen months into a series of global free trade negotiations that are on the brink of failure. But the U.S. is preoccupied by an endless series of bilateral trade agreements with such economic powerhouses as Singapore, Bahrain, and Morocco.

We’re doing that because we’re using access to the U.S. market as a whip to get other countries to toe the American line. Nations like Chile and Egypt are getting the message that they can have a trade deal with the U.S. only if they vote our way in the U.N., or support the U.S. in trade disputes with Europe.

That’s a bad policy. Forcing Singaporeans to allow our gum to be sold isn’t trade – it’s bullying. And forcing other nations to jump through American political hoops before they can sell their products will end up driving them into the arms of other trading partners. It’s time for the U.S. to use trade to bring the world together, not bring the world to heel.


Grasso and Landis

Forget how much Dick Grasso was paid. OK, ignore how much Dick Grasso was paid. The question it leaves behind is; just what is the chairman of the Stock Exchange supposed to do, anyway?

The answer is that the Chairman has two jobs. First, he’s supposed to represent the interests of the stock exchange’s owners – the traders who own the exchange’s 1,300 seats. That attracting foreign firms to the exchange, getting firms to jump from other exchanges, such as the NASDAQ, or attracting initial public offerings). In general, the more trading, the merrier those 1,300 seat owners will be.

But the second job is regulating those 1,300 traders to make sure they don’t rob, cheat, or steal. For example, a customer wants to by Megablob Corporation stock for 37 dollars and 50 cents. On the floor, somebody’s offering to sell it for 37 dollars and 40 cents. So the broker buys it for the lower price, and then sells it to his own client for the higher price, making a dime a share. I’m shocked! Well, it doesn’t happen as often as it might, because the chairman is supposed to take the people who do it aside and…well, it gets unpleasant.

Wait, that sounds familiar. A bunch of folks collectively own the pieces of an American institution. They hire a guy to run their affairs and help them make money. But that guy is also expected to regulate them, to take them aside when they get out of line.

The Chairman of the Stock Exchange? No! The Commissioner of Baseball!

Bud Selig has the same job Dick Grasso did – to represent the members of a group – instead of 1,300 traders, the 30 franchise owners -- and, at the same time, curb their excesses. And baseball often draws the same criticism as the stock exchange – that the head man is too interested in promoting the short-term interests of his owners, and not in making them shape up.

Some big investors think it’s time to give it up this model, and turn the regulation of the stock exchange over to some outside group, like the SEC, or an independent group of regulators. But there’s a better answer; the New York Stock Exchange needs a Judge Landis.

In 1919, gangsters had bribed players to throw the World Series and the public was up in arms. So the owners turned to a well-known federal judge named Kenesaw Mountain Landis to bail them out. Landis demanded the authority to regulate the owners’ actions and promised them a revitalized game in return. So they made Landis commissioners, and he delivered. (Although, on the downside, he was an arbitrary, anti-labor, autocrat who perpetuated baseball’s shameful apartheid system.)

The stock exchange doesn’t need a new structure. It needs a Judge Landis. It needs someone who understands that a well-regulated market is going to make more money for its traders in the long run, because they won’t suffer embarrassments such as this one. It took a scandal for baseball’s owners to see the light. Maybe the stock exchange’s owners are starting to get the picture.