Ev Ehrlich's Everyday Economics

Robot Insurance

The State of New Jersey is about to take a giant step into the 21^st century – on Monday, their State Senate will vote (and, I expect, pass) a bill that will eliminate the regulation of phone service that was born in the day of hand-cranked handset – the State Assembly has already moved the bill forward with a 66-7 vote and a chorus of kumbaya.

In a last stand, however, the opponents of deregulation have commissioned an analysis to support their view that it’s regulation, and not punishing competition, that keeps telephone prices where they are in New Jersey.   And that’s worth some discussion. The landline phone systems in most places around the country were built during an age of rate-base regulation.  That is, there was a time when our view was there was really only room for one phone company, and that in exchange for that company being given a monopoly franchise, it would receive a “fair” – meaning not too high and more-or-less guaranteed – return.

But, of course, that was then.  Today, rather than being a monopoly entrusted to one group of rapscallions, local phone service is a brutally competitive business that involves the legacy phone companies, cable companies, VOIP (voice over internet protocol), and, of course wireless.

Wireless!  It’s somewhere between amazing and sad that over a year before this hatchet-job pro-regulation study was released, the Center for Disease Control and Prevention issued a report showing that fully one quarter of U.S. households has cut the cord – taken the landline out of their house and gone completely wireless.  That’s more than double the share that did so five years ago, and that was over a year ago!  Moreover, one in seven, according to the same study, receives most of their calls by cell phone regardless, leaving their landline phone as an afterthought.

That’s 40 percent of the market that couldn’t give a fig for the legacy, Ma Bell phone that regulation affects.  Well, no, that’s wrong, because that “landline” phone might or might not be a legacy phone line.  For example, it might be a line delivered to the house over a cable television system.  Or it could be VoIP – for the love of gosh, you can buy VoIP for 30 bucks a year that includes caller ID, three-way calling, call forwarding, call waiting, enhanced 911, voicemail, 411 directory assistance, and live technical support.

Now, the opponents of deregulation know that mobile phones exist, or that VoIP exists, to be sure.  What do they have to say about them?  First, wireless:

Wireless plans are much more expensive than wireline services, so they do not provide a pricing constraint on landline services. Wireless coverage varies based on terrain, foliage and building structure and cannot guarantee calls made indoors.

The price of wireless doesn’t affect the use of landline?  Let’s start with this – if wireless were free, would more people leave their wireline phone for wireless?  I agree, so we’re only discussing the degree to which they compete.  To that point, let’s go back to the CDC study above – 25 percent of households have wireless but not landline.  What’s the percentage of households that don’t have wireless?  The answer is 15 percent, that’s it.  Six out of ten households have both, side by side.  How can they not compete?

And are wireless plans – as the report’s authors imply -- an expensive plaything for the bourgeoisie that has the time and inclination to fiddle with these infernal gadgets?  In fact, the CDC report says that people living in poverty or near poverty are more likely to use only wireless phones.  One-third of adults living in poverty are mobile-only, compared to 19 percent of high-income families and 20 percent of homes with a college graduate.  If regulation is helping the poor keep their landline phone, it’s not evident in the data.

Well, then, what about VoIP?  Have the pro-regulation analysts been watching those Vonage and Magic Jack television commercials?   Again, maybe not:

VoIP services provided over broadband services are not a cost-effective alternative for consumers dependent on landline services. Additionally, since VoIP services require electricity, they do not guarantee service during power outages that the legacy phone services do.

Forget buying a year’s worth of VoIP for a month’s worth of phone bill – what if there’s a black-out?  Is that the rationale for the regulatory regime – that the landline system works when the power goes off, so we have to specify prices for it?

In fact, while it gets this stuff wrong, the pro-regulation report emphasizes two important points.  The first is that New Jersey ranks number one among the states with 100 percent – not 99.9 percent – of its population having access to broadband speeds equal to or greater than 3 mps.  But if they do have that kind of access, then you’d imagine that they have both the ability and the sophistication to shop for telephony among competing alternatives, including VoIP.

And the second impressive finding was that New Jersey was, again, number one in the country with 74.4 percent of its households having access to three or more wireline service providers.  That sounds like a prima facie case of competition to me, being number one in the country and all, but it’s even more important because the report’s authors make a great deal out of how telephone prices rose in California when that state passed a deregulation five years ago.  Now I don’t know much about what happened in California, but I do know that if I keep going down the list of states with the greatest access to wireline providers that these authors provide, I’ll see that California is 35^th among the states with regard to the same measure – only one in ten Californians has access to the same three or more wireline service providers that three-quarters of Jerseyans do.  In fact, Jersey is perfectly situated to have a competitive market – it’s the most competitive market in the country by this measure, in contrast to California.  So what does one experience have to do with the other?

I think there are two embedded points in the undue and misleading noise the opposition to this phone deregulation bill has generated.  The first is that the report’s authors, and many on the sidelines, still see household telephone as a product unto itself, with its own, isolated market.  It’s not.  Your phone call is just one component of the flow of information in and out of your house, no different from an e-mail from Grandma, or a downloaded video, or an episode of Glee, or the traffic in and out of a home office.  Regulation or deregulation has almost nothing to do with the price of a landline phone.  Instead, for the companies like Comcast or Cox or ATT or Verizon, phone is an entrée into the household that allows the company to try to sell them television and broadband access.  And there are plenty of companies selling television – telcos, cable companies, Dish and DirecTV, and so on.  And there are plenty of companies trying to sell you broadband, from the telcos and cable companies to the wireless providers who are now knocking each other over to get 4G to the consumer.  The household phone is almost an afterthought – the interesting thing about it isn’t the phone, it’s the household.  The companies selling local phone into the household aren’t going to price themselves out of the relationship.  In fact, one important aspect of the Jersey deregulation bill is that it releases the phone companies from filling out forms and jumping through hoops that cable, or wireless, or VoIP competitors don’t have to mess with; for example, only phone companies have to tell the State how they addressed each service quality complaint they received.  In this environment – with 2 out of every five households viewing landline phones as either incidental or irrelevant -- what’s the rationale for that?  All it does is take hold one competitor back in this larger competition to bring information services and applications to the household.

And, last, who’s behind this report?  I don’t know who paid for it, but it was released by the AARP.  Look, I’m an old guy – I’ve been eligible for AARP membership for over a decade, but I don’t have the card yet, for fear that my wife will see it and find out I’m not as young as I told her I was.  But this kind of scare tactic reminds me of a Saturday Night Live routine I once saw about an insurance company that sold old people insurance against robot attack.  (“And when they grab you with those metals claws, you can’t break free, because they’re made of metal, and robots are strong.”)  It’s pure and simple a scare tactic. 

My old man was like that.  When medical emergencies forced him out of his apartment – he was 89, this was in 1999 – I went there to close the place up, and found he was still renting his rotary phone for two dollars a month -- he’d have bought robot insurance if they let him.  It wasn’t NYNEX’s best moment.  But now the shoe’s on the other foot.  If AARP really wants to help seniors (if that’s what I, an AARP-eligible person, am), it would help them get educated about their options in a competitive market for their business, one that offers them any and all levels of service and any and all price points, and quit trying to scare them about robots.

Letter to the Editors (2)

The old saw – first attributed, to my recollection, to Howard Dean – goes like this; Democrats love jobs but hate the people who create them.     For many Democrats, it’s true.  But an editorial in this week’s New York Times confirms a close corollary – liberals (certainly more than Democrats) love the Internet, but hate the people who built it. 

The Times editorial decries a suit filed by Verizon and Metro PCS that challenges the Federal Communications Commission’s right to impose “net neutrality” rules on the Internet.  Once again, “net neutrality” is the proposition that everything that travels the Internet must do at the same speed and on the same terms.  Nothing else on Earth works that way, of course, because individual needs and circumstances are always different consumers everywhere else are allowed – encouraged – to match up price and quality.  But the Times seems to buy the garbles logic of the neutrality crowd, particularly in remarks like these:

The suits could potentially free Internet service providers from regulation — allowing them to treat their own content better than that of rivals, and block content that they didn’t like or competed with. Verizon and AT&T have about 60 percent of wireless subscribers. And 80 percent of Americans live in areas with only two wireline broadband providers.

You get this often – now that it owns NBC, Comcast will stop you from watching Modern Family or Glee on your cable-based broadband, or that cable and telcos like Verizon will block content like Hulu or Slingbox, the current vehicles for Over-the-Top television that threaten cable-type operations.  Or that they won’t let you see either Keith Olbermann, or Glenn Beck or, ideally, both.

The idea that consumers would tolerate this kind of nonsense seems firmly embedded in the Times editorial board’s mind, but not in the reality of markets as we know them.  Yes, most people live in areas with two wire-based broadband options.  And yes, Verizon and ATT have a combined market share of 60 percent of wireless.  But with 4G penetrating the market, we are quickly approaching a state in which the vast majority of households have access to two wired and four wireless broadband providers.  And, unlike almost every other nation, the U.S. market has competition among platforms – among large, fixed cost systems that have to drive use and yield to recoup their massive investments.  That’s entirely different from places where the several broadband “competitors” all rent space from the national phone company, as happened in the U.S. during the DSL era, when no one invested and the entire wave of “competitors” disappeared in an instant.

Think about where you get your broadband from right now.  What if they decided to stop your access to any type of content, or any competing service?  Would you keep doing business with them, or would you find alternatives?  My guess is the latter, and when you put it that way, competition seems more formidable than the Times makes it out.

Or try this – let’s say Facebook (brief aside: I’ve seen the movie and yes, the guy who played Larry Summers did a better job than my choice for the role – Jon Lovitz.  But they shouldn’t have let Jesse Eisenberg be Zuckerburg; they should have given the part to the guy who plays Abed on Community    I mean, isn’t he the real deal?  Otherwise, the movie wasn’t as interesting as, say, whether Harvard beats Princeton in basketball on Saturday night and goes to the Dance for the firsttime since nineteen thirty seventeen or something… OK, brief aside over, continue sentence) decided to offer you a special network card that picked up a ubiquitous, proprietary national wireless network that allowed you to see “special” Facebook content  -- don’t ask me what it is – it’s so special I can’t tell you.  But you get the “Facecard” and you get lots of other stuff with it, including mail, a series of cloud applications, and all sorts of other stuff, but not everything – certainly not other social networks, maybe not even Google stuff, since Google and Facebook is the Ali-Frazier fight of the digital future – sooner or later these two guys – both legitimate champions -- are going to slug it out for who gets to be the organizing framework for the entire Internet experience.   But Facebook gives you all sorts of “extra” stuff in exchange for being on their network. 

Is that anti-competitive?  Would the Times oppose it?  it’s extra stuff and if you don’t want it, you can cruise down the street.   But it violates the Times’ dictum that you can’t have a provider pick and choose what you get to see, so I guess they’d oppose it.   It’s open because that’s how consumers want it.  So some things can be other than "open" and still pro-competitive.  "Competitive" often means open, no doubt about it, but more importantly, it means responsive to consumers.  And that's the real meaning of the "facecard" example -- the  Internet isn't open because regulators demand it.  It's open because that's what consumers want.

Let me use a second excerpt from the Times editorial to make this point.  Here we go:

                The choice for American consumers is between the open broadband they have come to expect — in which they can view any content from sources big and small — and a walled garden somewhat like cable TV, where providers can decide what we can see, and at what price.

This is a deft piece of writing on the Times’ part.  Industry types regularly talk about “a walled garden” as a metaphor for a system that has a policed boundary, but they usually use that phrase about the mobile telephony network.  So why did the Times switch the conventional usage and go, instead, to cable television as an example of such a system?  My guess is because they – or the advocates they’re talking to – know that consumers like having their mobile phones be a “walled garden.”  Do you get endless marketing calls on your mobile phone?  Robocalls?   Solicitations?  No, and the reason why is because that’s how consumers want it.  “Open” – meaning no boundaries – works on the Internet, but doesn’t work on mobile phones, and no one complains.  Moreover, as phones become the Internet – a point the Times seems to have lost on the way to the linotype machine – they’re going to have to keep customers happy on both sides of the equation – an open Internet and “walled garden” phone co-existing in the same device.   And that’s exactly the point – consumers are getting what they want, including the level of openness in the system.

Two last points: if net neutrality were to be dispensed with, broadband providers would, in essence, be operating in a “two sided market,” like credit card companies (which balance charging merchants and charging you) or…give me a minute…wait, I know!  The New York Times, which charges advertisers to put “premium content” in the newspaper and then charges crossword puzzle junkies like me to read it.  Isn’t that it?  If I want my heart monitor to travel across the Internet faster than a video of a cat playing the xylophone, then someone’s got to pay.  Or if Netflix wants to dump all the movies ever made since The Great Train Robbery on the net, meaning everyone else’s traffic has to slow down, then they’ll have to pay, too.  Stopping my cardiac monitor or allowing Netflix to clog up the system doesn’t make things “fair” – making them “fair” means posting the prices for these services on the wall so that we all know then and whomever wants to pay them has the chance.  Just like the price of a newspaper and the price of a full-page ad.  For the love of Pete, if advertising in the Times – paying for premium content – was “unfair,” then Bloomingdale’s would be the greatest perpetrator of injustice in civilization.

And the last last point goes to this in the Times editorial – a lament over “a swirl of antiregulatory fervor among Republicans on Capitol Hill.”  Whether or not Phillip Corbett thinks this is good writing http://topics.blogs.nytimes.com/author/philip-b-corbett/ is one thing, but it’s poor thinking to lump the debate over “net neutrality” together with the obstructionists who are either in denial over climate change or the pocket of the financial institutions who think Dodd-Frank would be a good thing not to implement.  Our planet’s carrying capacity is changing rapidly and the public is still being held hostage by financial institutions that are too big to fail.  What exactly about the Internet poses a similar danger?  I can’t think of it, either.

The Sorcerer’s Apprentice

The Bureau of Labor Statistics announced on Friday that the economy added 192,000 jobs, which is only modestly above the level needed to keep job growth over the growth rate of the working population, but still the largest monthly number since the “false dawn” of February through April of last year.  Back then, the economy suddenly produced over 300,000 jobs a month, but then promptly ran four job-losing months in a row, partly because the initial gain included the hiring of Census workers who left those jobs after the Spring count, and partly because the crisis in the Eurozone sent a new wave of fear into financial markets.  So while most economists – or at least the ones I agree with -- expected the employment number to be higher, at least the direction is right – up.

With all that said, and mindful of my role earlier in life as Defender of the Statistical System (when, as Undersecretary of Commerce, the statistical system was my bailiwick), I don’t believe the number.  The economy has to be generating more jobs than these numbers suggest.  And there are a bunch of reasons to think so.

The first is simply that, going back to September, the initial estimate of new jobs created has been revised upwards in each of the two following months.  (An “initial” estimate of the number of jobs created in any month, like last Friday’s estimate for February, is revised in each of the next two monthly reports, whereupon it sits for the better part of a year, when it is given a final revision as part of an annual review.)  September, 2010, saw job losses of 95,000 when first reported in early October – early December BLS took this loss down to 24,000.  October started at 151,000 new jobs and ended up at 210,000: November went from 39,000 to 93,000; December from 103,000 to 152,000.  And given that errors usually move in the direction of the trend, there’s every reason to believe that the next annual revision will move the numbers yet higher from where they started.

This doesn’t mean that BLS is half-assed or sloppy.  They understand this pattern of revision and report it candidly.  But their job is not to guess what employment did – it’s to report what employers tell them it was, and then let opinionated blowhards offer their views about why BLS is wrong.

So why are they wrong?  There’s always a little error in the data – that’s why they call them “data.”  BLS surveys over 100,000 business each month to get a basis for estimating job growth.  Sometimes the businesses don’t report on time, sometimes they change their internal numbers, and so on.  But the real catch has to do with how BLS knows that a business exists – how does BLS know whether to put a business on the list from which it draws this sample of 100,000+ companies (which represents over 400,000 “establishments,” meaning an individual factory or store). 

The answer is that they learn of a business’s existence when that company pays state unemployment taxes or otherwise reports itself to the government.  In some cases, that lag can be short, in others, it might go on for a while.  For example, my son Nick is a personal trainer and boxing instructor in Baltimore.  He draws no salary – he’s paid by clients or by gyms or other facilities that want him to attract clients for them.   The government “learns” of his employment at the end of the year, when he files a Schedule C on his tax return.  That’s one reason why there are after-the-fact annual revisions – because there are millions of “proprietors” who work that way. 

That’s an extreme example of the problem.  When the economy grows, new businesses are formed, and it takes the system a while to learn that they’re there.  BLS understands that and, using past experience, derives a statistical correction to the employment report for new businesses that they think are out there but haven’t reported yet, but I think they’re undercounting that.  For example, ADP – the largest company that processes payrolls for companies - using their own data, think that companies with 49 or fewer employees have added 600,000 jobs over the last year, from February 2010 to February 2011.  Half of that total occurred in the first nine months and the other total in the last three.  So there’s good evidence that the pace of job creation by small businesses is accelerating, and those are the ones BLS’s process has the hardest time capturing.

Moreover, like ADP’s, other measures of employment are showing bigger gains than BLS’s survey of establishments.  The most important of these is the Current Population Survey, which the Census Bureau undertakes on behalf of BLS in order to measure the unemployment rate.

You can’t estimate the unemployment rate except by asking people if they’re unemployed.  You can track the number of people filing unemployment claims, but not all unemployed people do – some aren’t eligible, some have benefits that have run out, and so on.  Many critics point to people who decide the-heck-with-it and stop looking for work (“discouraged workers”) but, once again, BLS’s job is not to guess what these folks would do if a job suddenly jumped out of a tree and bit them on the neck – it’s to report how many of them there are and let the opinionated blowhards do the rest.

So BLS hires the Census Bureau to interview 60,000 families every month, from which it estimates the unemployment rate.  In some ways, it’s a little dicier an estimate, because 400,000 business establishments is a bigger and better chunk of all the economy’s business establishments than 60,000 families is a chunk of all the nation’s families.  So the sampling errors are larger for the survey of households.  Moreover, just as with businesses, new households are harder to catch – for example, a young person or family leaves their parents’ house and goes out or their own, or immigrants arrive, or people move.  But young families usually split off when they have a job, and people move to go to new jobs, so it’s possible the survey undercounts the employed.  On the other hand, if my trainer son (wait, that doesn’t sound right…) were to be in the “household survey,” he’d be counted as employed, as opposed to not being included in the “establishment survey.”

Regardless, over the past three months – that is, from November 2010 to February 2011 – the survey of business establishments says the economy’s added slightly over 400,000 new jobs.  But the survey of households reports that it’s added 1,000,000 in the same three months.  The ADP survey is closer to 600,000, but also north of the BLS establishment survey.

And other economic evidence, however, circumstantial, support a higher number.  Initial claims for unemployment insurance are dropping and are about 25 percent lower than a year ago.  Retail sales continue to grow, and new orders and shipments of manufactured goods are 9 percent and 8 percent, respectively, over their levels of last June, the nadir following the Spring, 2010 “false dawn.”

The economy faces serious headwinds, among them the fiscal retrenchment of the states and the rising (although, in my view, temporary) price of oil.  And there’s the risk of federal budget cuts at level above the economy’s ability to withstand their impact.  But right now the economy is beginning to grow and employment isn’t tracking it.  The numbers we’re seeing, then, suggest that output is being produced the way Mickey Mouse produced brooms in The Sorcerer’s Apprentice segment of Fantasia.    I don’t buy it.  We’re going to find out soon that there’s more employment in the economy than we now think.

Cut the Crap

President Obama had a pretty good night on Tuesday.  His policy details were fine, and he’s awfully well-spoken.  But the President floated past the emotional tone of this moment in America, neither co-opting nor confronting  it.  There’s a stunning difference between feeding on the rage in the country today, on the one hand, and understanding it and taking it somewhere, and the President is not there yet. 

Sure, much of the Tea Party/Fox fantasy-industrial complex is as batty as it superficially appears.  But it feeds off a mélange of strong emotions – despair, disenfranchisement, and outrage.  Perhaps the President hears these frequencies, perhaps not.  But the bottom line is this; the President needs to superimpose over his policy specifics something that recognizes the strong feelings in the country today.  And, specifically, he needs to incorporate into his presentation the message that most Americans want their President to deliver:

Cut the crap.

That’s basically it.  The President is doing a fine job of projecting his openness to a bipartisan dialogue.  But he also needs to take the nation through a reality check, partly because Americans perceive, correctly, that the needles on the bullshit meters are all the way to the right, and partly because, once pushed, the vast bulk of Americans see the Tea/Fox segment of the spectrum as a self-reinforcing cocoon that talks to itself in its own language, much as the New Left of 40 years ago did.   Like the Left of 40 years ago, the New Right is now a true “counterculture,” one that is floating away from the mainstream, complete with their own response to the President’s speech.  Reality is their weakness, and the President has yet to hit them with it full bore. 

To his credit, the President finally got around to defining his view of the future, an aspect of any “transformational” Presidency, but an errand Obama hasn’t gotten to until halfway through his term; perhaps his Herculean cleaning of the fouled stables he inherited distracted him from thinking about what was next.  Moreover, I get the feeling that Obama’s intention is to embody Ghandiesquely the change he wishes to see – that is, to endow the political system with his own intelligence, composure, and open-mindedness (as opposed to brain-deadedness).

But that is sadly not enough.  The President is good on God, but short on Mammon – he’s great when he’s addressing the spiritual world of race, tragedy, and human hope, frailty, and impulses.  He looks out of place to me when discussing the economy and the realm of physical things.  His message of investing in ourselves – consciously preferring the future over the present – is substantively correct, but its emotional context is wrong.  He presents it as a choice that reflects his own thoughtfulness and intelligence.  Instead, it needs to be placed in a harder-edged context, one that reflects the harder-edged emotions of the moment. 

The American people see this and, more importantly, they feel it.  They see a system out of control, and they are shopping for leadership that provides a way out of the woods while empathizing with their sense of rage and powerlessness.  But they didn’t get it at the State of the Union.  Instead, they got a passionless vision of how we can make the future a better one, even if it was a vision with a great deal of substantive appeal.

But they didn’t get cut the crap.  In fact, if we got that level of connectedness, the policies we (as a supporter of the Administration) support would have a better chance of succeeding.   Let me show why that’s true by making three substantive points could be added to the “future first” message -- regarding climate and environment, government delivery systems, and, to begin with, budget.

We say that “everything must be on the table” in fixing the federal budget.  It’s easy to say, but until the President says straight-out that we need to fix Medicare and Medicaid, and to a lesser extent Social Security, and then rethink the tax system (as opposed to rationalizing the corporate income tax), the bullshit meters are going right, not left.  I’m sure that many his supporters don’t want the President to be the guy who puts entitlements “in play” in a significant way.  After all, his opponents would be happy to stop government from helping people, since they want the sate to go away.  But not being brutally honest about the most popular programs is absurd – they are already in play, not talking about them straight-on is like not wanting to be the first to talk about a tsunami heading for shore, or a fire that’s burning down the house.

Right now, Paul Ryan is ahead of the Administration on budgetary cut the crap.  But the President is well-situated to flank him and take the budget debate to the next level.  The American people need to be taken to a point of emotional acceptance about fixing the deficit, one that builds on the outrage they feel about being bankrupted by the choices made by others.  We’ve been kidding ourselves that we can fight wars, cut taxes, take care of everybody, and still fit ten pounds of potatoes in a five-pound bag.  We’ve been kidding ourselves about what it takes to maintain our standard of living.  And we’ve been stealing left and right from future generations, only to find that they will soon be us and our kids.  

So the budget message has to evolve into something so stripped of coyness as to be unavoidably true.  Everything the government does now – both the money it spends and the taxes it foregoes – is there because doing it made someone happy.  Fixing the problem means making people unhappy, and to say otherwise is to deny the truth.  (27 years later, Mondale was right!)  Let’s cut the crap and get to it.

The second area is the environment, specifically, planetary climate change.  Am I the only person who looks at the deniers in the climate debate and thinks about the first scene in Superman, where Jor-El’s father tells the Elders of Krypton about how their planet’s doomed, and in response they snicker at him?   At least he had his integrity.  But Obama’s given up on the “Jor-El lecture.”  The Administration’s approach is no longer to tell the Council of Kryptonians “our shit is deep” but that building rockets to take us to Earth will create good jobs!

This kind of bait-and-switch is bad politics and bad policy, and sets the bullshit meters off again.  As a policy matter, you can play with research and demonstration projects and mandate that there be a million electric vehicles on the road by a date certain – excuse me, a million such vehicles other than on golf courses – and all the other stuff that creates “the green jobs of the future,” but you will not put a dent in the climate problem until you price carbon out of the system.  In fact, our approach is a feeble attempt to mimic everything the system would do if you did price carbon correctly.  It has everything except what works.  You have to start there.

Right now, the Administration is living in fear of the deniers, and by so doing, makes them stronger.  Instead, it needs to start with a cut the crap line-drawing that emphasizes the extraordinary risks we’re up against and moves the debate to the same plane of generational fairness the Administration’s opponents justifiably bring to the budget debate.  So long as we run and hide from the message that there is undeniable danger, the opponents are right – we’re proposing big programs and taxes.  As in the budget debate, “not talking about” the full implications of reality makes it impossible to address the reality.  Instead, a cut the crap approach would isolate the deniers and their friends at the Department of Creation Science at Treefrog Bible College and reframe the debate.  The purveyors of cautious instincts inside the Administration should ask Presidents Clinton and Gore if they regret not being more courageous on this score.

And a third – and perhaps most important -- arena in which the President’s program needs to find the emotional tone of cut the crap is that of government itself.  Nice joke about salmon.  But here we are talking about devoting much-needed resources to education and infrastructure, and not a mention about the profound problems plaguing both delivery systems. 

Infrastructure first.  The way to get more resources into infrastructure is to confront the reality that the political system thinks they’re a kind of bakshish.  If you’re willing to outlaw earmarks, then it’s a small but productive pivot to attack “Bridges to Nowhere” and water projects that favor barge operators over the people of New Orleans.  I have argued elsewhere, together with my co-author Felix Rohatyn, that we need to replace these money-chewing programs with a consolidated Infrastructure Bank that makes rational investment decisions among competing projects and project modes.  The President endorsed such a concept in his 2008 campaign.  But pitiful little has been done to fix the modal infrastructure programs – instead, most of the emotional energy in the area has gone into a panic over the falling collections of the Highway Trust Fund, a trough at which state legislatures and the asphalt and concrete crowd meet for lunch.  The time has never been better for an argument that we need to reform the process and deprive the political system of its toys in order to make the investments we need.  You can ignore these problems, but if you propose to expand the programs without talking about these problems, you’re going to end up hearing about the problems before too long anyway.

And it’s an order of magnitude more true when discussing schools.  As in infrastructure, we are underfunding our schools, but without a better framework, we’ll never know by how much and how to go about getting it right.  The first line of education policy is not “we need to educate our kids for the future” – that’s not a direction.  It is we have to have a very difficult but very important conversation about what’s happening in our schools.  And at the heart of that conversation is the role of the teacher.  Everything about the way we hire, fire, and compensate them comes from another era, one in which the area was a ghetto for women who had few opportunities elsewhere.  It’s a profession that you enter, absent an all-consuming desire, because it employs you for life, pays you for seniority and not talent (and therefore underpays the young and often overpays the old), disallows moving resources into where they’re needed or in short-supply (for example, into math and science or poor neighborhoods), and supports an overly-centralized administrative system in which a principal can’t order toilet paper without a permit slip from the Count Seat.  It’s as if teaching were a monastic island unconnected to the labor market. 

To talk about education policy without making the problems clear undercuts the good message the Administration brings to the table.  Race To The Top was an important policy and did much good.  But it can only be understood in the context of a wholesale break with illusion and denial – cut the crap.  It’s a particularly hard conversation because of teacher unions, which deservedly feel that they’re under the gun; not only are schools underperforming, but states and localities are going broke and public sector unions are going to be on the firing live.  But are they better off if the reforms needed come as a punishment, or as a platform for more resources and popular support? 

So, as in the budget or climate, denial is the enemy.  The President has a good agenda, and it may be the case that many of the issues raised here – the need to rein in Medicare and Medicaid, the need to price carbon correctly, the need to fix the delivery mechanisms for such vital public sector services as infrastructure and education – would reach positive conclusions anyway, and that we’re best not talking about the difficult underlying realities until they’re ripe in the process.  But that’s an illusion – they’re ripe now.  The President needs to cast himself as the person unafraid to recognize and confront these realities, not only because they’re the best disciplining measure for the policy process, but because they’re his best response to the “populist” fantasy/industrial complex that opposes him.

There’s always an instinct in any raging centrist policy wonk – like me – to argue that you can do well by doing good.  Perhaps that’s in the mix.  But the rage and frustration in the country today reflects a feeling that institutions are perpetuating themselves without regard to what happens to the rest of us – the bullshit meters are twitching in the red.  The President needs to show that he gets it, and that it’s time to have an honest debate over what to do, and cut the crap.

The Future Lies Ahead

There’s a thin – and sometimes imaginary – line between giving your view – a view based on a lifetime of evolving judgment, thoughtful reflection, and sober experience – and being a big-mouthed Herkimer who does his Steve Allen reads the Daily News impression and today I’m going to straddle it.

There are opinions I don’t share(the Second Amendment gives you the right to own an assault weapon, the corporate and personal income tax should be separate systems), and then there are matters about which I generally don’t want to hear opinions.  And one of the latter is “what the President ought to say.”  I cringe when I hear somebody start a conversation  out that way – “You know, the President ought to get up and say…”, or even worse, “Why doesn’t the President just say…?”, usually followed by something about how the Congressional Republicans ought to be hanged like horse thieves (if I can say that without violating the New Civility).  A bus buddy of mine, whom I won’t identify by name insofar as I have, by implication, just disparaged him, is a master at this craft –he’s been architecting the President’s message from Day One from behind his newspaper in the mornings.

My tolerance for this kind of armchair messaging is low because people have the same misunderstanding about being President that they do, for example, about being a baseball player.  It just lookstoo easy – ballplayers seem to hang around a lot (often chewing stuff) and fail to get on base two out of three times.  Same thing with being President – you just stand there and say stuff, isn’t that it?  The idea that speaking is the 10 percent of the iceberg of being President that you can see, or that the President is obliged to speak in a very precise, disciplined way – as opposed to saying things that are satisfying to say – doesn’t seem to enter into this kind of advice.  Nor does the idea that what you’re saying has to resonate with an intricate plan for how to lead the country, how to control the terms of the political debate, and the priorities for action you have at the moment.  So much of the “President should say this” we get has elements of how he should accuse his opponents of being liars, dolts, doodyheads, or something similar, but worse.

Today, I prove myself no better.  Because next Tuesday is the first day of the rest of the President’s life, his State of the Union address, and like Bill Clinton, who declared that “the era of big government is over”  in 1995, President Obama gets one clean shot at reframing the post-shellacking debate. 

So, however irksome the question, it’s time to start thinking about what he ought to say next week.  To frame the question, let’s review.  The President’s programs have had one big success – they averted an economic disaster akin to the Depression.  Aside from some peripheral carping from both the far left and right, that’s more or less accepted.  He’s done some other things, as well.  One is a reregulation of the health insurance industry (mischaracterized as health care reform) that has some costs and benefits but that is neither the “job killer” its enemies claim nor the “big fucking deal” for which the Vice-President congratulated the President – if it was really that big a deal, then why is health care still linked to your job, and why do we still have a health care system that takes up twice the share of GDP that other countries spend to get the same result, and a ticking Medicare/Medicaid fiscal time bomb?  A second accomplishment of some note would be Dodd-Frank, which is to commended for taking a balanced approach to regulating capital markets (largely by incorporating the “Volcker Rule”), even if the law relies on the future effort of regulators to decide on the particulars.  I don’t want to sound dismissive, particularly given the agony of getting that much done, but that’s where we’re at.

But the ground has now shifted, and in ways other than the mid-term election.  The bill for avoiding an economic disaster is now coming due.  Granted, the entirety, or even the majority, of the fiscal mess isn’t of Obama’s making – The 2001 tax cuts – a response to a “long-term surplus” that proved a falsehood as damaging as “weapons of mass destruction” – and the Iraq War get some credit, but if we’re going to lay out who’s responsible for the fiscal deficit, we’re going to find more culprits than the final scene in Murder on the Oriental Express – (spoiler alert!) everyone did it.  Imposing austerity is not an attractive backdrop for a Presidency, but there’s no avoiding it – if the President fails to square up to the problem, he cedes the center to his opponents.  The question facing him, and his opponents, is this: what principles or rules will guide us through the retrenchment that we all know is coming?  His opponents have an answer: Leviathan Government that threatens our liberty, and so on.   Their answer – slay the beast.   It’s catchy and you can dance to it.

This is the President’s challenge, and opportunity.  Politics is about the future, and specifically, why the future is going to be better.  If you can’t explain why the future is going to be better, then find another line of work.   The vivid example of this was the 1996 election – President Clinton talked about a “bridge to the 21^st century” (for the life of me, I still have no idea what the hell that meant, it’s almost felonious metaphor abuse) while Bob Dole talked about how he remembered a better time in the past.  It was over before it began.  Even when Don’t Tread On Me types express their reverence for a distant, idealized national origin story, they’re talking about where they want to go.  For better and worse, Americans aren’t that interested in what just happened – they elected Obama because (in my view) they were sick to death of his predecessor or anything that reminded them of him.  But once Obama became President, they were uninterested in hearing about his predecessor.

The President’s good fortune is that, to date, he was embodiedthe future more than articulated a view of it.  He often speaks, I am told, about being a “transformative” President, but I can’t imagine that any President wants to be anything else.  But reading the President’s books, listening to him, watching him these past two years, the transformation he seeks seems to be about behavior and attitude – it comes from the meticulousness with which he’s conducted himself all his life and it’s about how we all need to be more thoughtful, considerate, and reasonable.  He was Civil before it was cool.

So on the question of “what does the future look like?,” the President has kept his powder dry.  That’s the great opportunity the State of the Union provides – we have a chance to hear the President’s view of the future in terms other than the usual, bipartisan platitudes about how great our country and its people are.  And we have a chance to hear it in the context of hard choices about retrenchment.

It won’t be about taxes – the President has already won on that score.  His compromise with Congressional Republicans, to my thinking, was the sharpest moment in his tenure.  It made a variety of good changes – keeping the estate tax on life support, a two-year partial respite on regressive Social Security taxes – and while it preserved the top rates of the Bush cuts, it kicked the issue of “should the rich pay more?” squarely into the 2012 election cycle.  I’m not saying the public will rise from their seats and speak as one to tax the rich (and, their subset, the dead rich), but if the President can’t win that argument in a national election, he should (and will!) go home and write more books.

Instead, the vision has to go to what kinds of spending should we cut and what should we protect.  And here is the opportunity to grab the future with both hands and hold on to it for dear life.  The message is we have to favor the future over the present.

Cuts to Social Security, and restructurings of Medicare, along with cuts in a variety of other programs – some highway cost-sharing grants, commodity support programs, defense (perhaps following Secretary Gates’ recommendations) -- are long overdue.  But the baby that will go out with the bathwater is spending that constitutes rational investment in the future.  It includes an improved approach to building infrastructure, support for research and development (particularly in areas with social contexts, such as environmental preservation or health), (again, carefully devised) education and training incentives, expansion of the broadband Internet across the “digital divide,” and other programs.  It’s an argument that the President needs to make not just to guide the retrenchment process, but to get past the “all spending by the Leviathan is evil” view that will hold the center ground until he explains to the contrary. 

There’s an element of wishful thinking in this.  I doubt there’s an economist drawing breath today who would disagree with the premise that (leaving aside some definitional issues) we should favor investment over consumption in the federal budget.  But the idea that we should favor the future over the present has currency that it never did before: as a cornerstone of the President’s identity; as a rule for thinking about retrenchment; and as a defense against the blanket anti-statist view of the President’s opponents.  There’s a reason why the classic parody of a platitudinous speech starts with the future lies ahead.  That’s because it does.  The President will explain to us next week how it’s all going to work.

Facebook at 50

We learned this week that Facebook has turned 50 – certainly not 50 years old – I wonder if Zuckerberg’s parents are 50 years old – but worth $50 billion, or at least that’s the value implied by the sale of a portion of its (privately held) stock to Goldman Sachs, which will own $450 million worth of the company, and a Russian company, Digital Sky, which added $50 million to the $700 million it owns in Facebook already.

If there was ever a time to sell a piece of Facebook, it’s now.  Zuckerberg was just made Time’s Person of the Year – which prompted by new favorite satirist, Andy Borowitz, to applaud Time’s controversial decision that Zuckerberg was, indeed, a person – and the movie is going great guns, even if I’ve never seen it (although I’m told the novice actor given the part really nails Larry Summers – I thought the part really belonged to Gary Shandling).  And we only recently learned that Facebook has now surpassed Google as the most visited site on the American Internet – about 9 percent of all site visits in the U.S. go there, although Google would account for 10 percent of you added in Google’s e-mail and YouTube affiliations.  So Facebook is the Flavor of the Month, and if you think having money makes you immune to that kind of faddishness, I have mortgages to sell you.

Is Facebook really worth $50 billion?  I don’t mean that in the cosmic shake-your-head-and-bemoan-man’s-fate sense, but in the down-to-earth context of whether this valuation is for real.  The answer is more yes than you’d think. 

The first perspective on this question is – who are the investors in question?.  And when you think about Goldman and the Russians, it’s not an open-and-shut case.  Digital Sky added incrementally to its already existing holding, so they have some incentive to create a demonstration effect that makes their existing stake in the company look more attractive.  And since Facebook is not traded public in markets and therefore subject to the information disclosure requirements and open trading procedures the stocks you own are, it’s easier to try to manipulate its value.  That’s not to say it would work, but you could try – Facebook’s limited number of existing shares are traded in a private market in which former employees and angel investors can buy and sell, and that means there’s limited liquidity and nebulous price revelation, as we economists like to say, which means you can’t really be sure what the hell it’s worth.

As for Goldman, I’ll pick that up in a moment.  To get there, though, start here:

One issue raised by the Facebook valuation is whether the company will go public.  Some analysts see this sale as a teaser to goose the market and get the public ready for an offering in the near future.  Others take Zuckerberg at his word – or his mumble – that he’s not interested in ceding that much control, and see this sale as proof that he can raise enough money to finance whatever plans he has without a public offering.  The reasons not to be become a public company boil down to the transparency it requires – you have to reveal your financial information and tolerate a distracting debate among investors, analysts, journalists, and idiots such as myself as to the extent to which you can differentiate your rear end from a hole in the ground.  And while the regulation of securities has been proved by history to be an essential part of a well-functioning capital market, it’s no picnic for the regulated.

The reason to go public is to raise money, a problem Facebook obviously doesn’t have.  Moreover, it’s possible that Facebook and Goldman are showing us the first inklings an alternative to the public markets for raising large sums of capital.  To wit: the Securities and Exchange Commission will allow stock in a company such as Facebook to be traded privately – that is, without the disclosure, governance, and other requirements made of public companies through laws such as Sarbanes-Oxley – so long as they have 499 or fewer shareholders.  That’s a pretty tight limit.  But Goldman is said to be considering a new investment structure in which it would buy Facebook’s private stock and then allow investors to buy shares of something like a “Goldman-Sachs Facebook Trust” or some such with a minimum participation of $2 million per investor.

That gets me back to Goldman and the valuation.  I think Goldman sees itself as a competitor, down the line, to the New York stock Exchange – not for schleps such as, say you and me, but as a market-maker for big block institutional traders.  It’s already in that business in a big way.  And if it were to do so, the line between public and private companies would blur, since both would be traded behind Goldman’s closed doors, instead of in the more regulated environment of the NYSE.  Regardless, Goldman’s interested in both private and public issues, and the idea of a Facebook structure in which it “owns” the stock and that it passes along all the goodness and badness of ownership to customers who don’t actually take title to the stock, has to be an intriguing one to a company with that kind of aspiration – it’s like a little Facebook stock exchange.  Moreover, for Facebook, it’s a way to create liquidity without having to comply with regulations that require it to be forthright about its circumstances, which is its right unless it wants to come to public markets.  As for whether I’d feel as protected in that arrangement as I do in a regulated, public exchange – well, I wouldn’t.   But that doesn’t mean it wouldn’t fly.  And Goldman’s buying into the company could be a step towards that kind of arrangement, or at least Facebook’s participation in it.  So Goldman’s buying Facebook at a $50 billion valuation could be like the Nationals giving Jayson Werth seven years – OK, there’s a risk we overpaid, but it gets us closer to a strategic goal, so what-the-hey.

But there’s then the question of Facebook’s intrinsic worth.  An interesting piece by an analyst named Andy Zaky, last August, made the case for a $50 billion Facebook, months before it actually traded at that implied valuation.    His argument, if I may distill it, is this.  Right now, Facebook doesn’t bring in much money, certainly in proportion to its user base; Zaky used the number 500 million users, but that was last August.  It’s closer to 600 million now.  And Facebook now has roughly the same number of visits as does Google, and Google’s worth $200 billion (in a public market).  So if Facebook gets better at monetizing itself – primarily through advertising – there’s no reason why it can’t get close to valuations like Google’s.

I see one strong and one weak argument buried in this chain of reasoning and, one argument that Zaky’s analysis misses, or at least seems to from what I read into it.  The strong argument is that Google became a dominant site through innovation, while Facebook became one through…well, what’s the technical term for bullshit?  Ah yes…network effects.  A product has network effects if its value increases the more people have it.  Like the phone system, Facebook is more valuable to me, the individual user, if more people join me in using it.  Sure, it’s more inviting looking than competitors such as MySpace (which was the most visited site in America as recently as 2007 -- Hey!  How’s MySpace doing now?),  but the real driver is reaching the network-based critical mass that generates the value to the individual user.  Google, in contrast, got where they are by doing something very well, there’s no network effect behind it.  Its value as a search engine has nothing to do with how many other people are using it.  There are a myriad of questions about Google’s algorithm, about whether Google’s conflicted in its role as an “impartial” search algorithm and, at the same time, a purveyor of other services for which people search, and there are privacy issues(which  they share, in some respects, with Facebook).  But it’s possible to imagine that Google might one day face competition from someone who out-Googles them, that is, does the search job better.  If Facebook is somehow out-competed, it will be because hundreds of millions of people were so pissed off at them for whatever reason that they switched to another, comparable service.  Absent an ergotistic spore breaking out in Facebook’s headquarters, that’s harder to imagine.  Google sits on top of a network; Facebook is a network.  So that’s the strong argument for why Facebook out-survives Google.

The weaker argument, as it pertains to Zaky’s analysis, is that advertising is about selling people things, and Google’s clientele are people looking for things, as opposed to Facebook’s users, who are looking for each other.  Advertising is relevant in the extreme to the value Google creates for its users, but only incidental to what Facebook’s users want.  I can’t imagine that Facebook qua Facebook is going to be worth as much – in terms of ability to generate revenue per user or per visit from its core service – as is Google. 

But Google’s valuation, to my thinking, isn’t completely, or really, about their value as a search engine.  It’s about their value as a gateway into the tangled maze of value created on the Internet.  Google is a search engine, but it’s already failed as an equipment manufacturer, succeeded as an e-mail provider and originator of operating systems for equipment,  and could end up being everything from a travel agency to a television station to a carriage provider, a wistful vision to which it occasionally purports to subscribe.  Facebook hasn’t added this kind of dimensionality, but it’s going to – yes, I said, will – because something to which so many people feel allegiance and are involved with daily cannot help but evolve in that direction.  It will own a generation of users in a way Google cannot, even though Google, their monopolistic hearts, does something. 

That’s the issue I have with the Zaky analysis, the argument he misses, as does any other valuation that focuses on advertising revenue per view.  Just what market are Google and Facebook in?  They’re monopolists in their own bailiwicks, but the spaces they occupy are only islands in a larger archipelago of value on the Internet.  They might be “service” or “software” companies, but that misses the point.  If it turns out that Facebook can truly cement the attentions of a generation of (self-absorbed, to be sure) users, then they can dominate the decisions about what equipment gets used, what broadband providers area selected, what other services enter the Internet space.  Is Facebook something you “get” on your mobile or broadband provider?  Or is your mobile or broadband provider someone that lets you “get” Facebook?  The difference comes down to who will capture the lion’s share of the value you realize by having the entire package – access, device, services, applications, the whole “stack.”

That’s why it’s possible to talk about Facebook’s being worth $50 billion – because it might end up, with all its gruesome banality (who gets to light the pyres that reward the villains who gave us Farmville or Mafia Wars?), the gateway to the broadband world.  There’s some chance that one day, all broadband access, service, and device providers will have to dance to their tune.

Today, 500 million users.  Tomorrow, the world.

Kabletown

Among the many myths and misimpressions on which the doctrine of “net neutrality” rests is that the Internet is a series of “dumb pipes,” a set of hollow vessels that carry messages the way the pneumatic tubes did on a vintage submarine in a black and white picture from the 1950s.   In fact, it was the spectacularly out-of-touch Senator Ted Stevens who called the Internet exactly that – a bunch of tubes – and remarkably, without ever acknowledging it, the neutrality crowd is in full agreement with him.  After all, that’s the essence of their argument – since the Internet is a set of “dumb pipes” – some kind of message-bearing plumbing -- there’s no reason why “everything should not be the same” as it is flushed to its final destination.

The fallacy of this premise, and the problems that arise when otherwise knowledgeable people tacitly endorse it, is most recently evident in a business tiff between Comcast and a private network company called Level 3.

Level three has been for some while one of the companies that make up the Internet backbone.  In fact, rather than a dumb plumbing system, the Internet itself is a labyrinth of these pipes.  That’s what the idea of “neutrality” doesn’t get – internet messages arrive at this labyrinth, are dispersed through the wormwood in “packets,” and then meet up once again at your computer, where they form a line in their original order and let you see or hear them.  That’s why things freeze up – because the packets sometimes don’t get in line fast enough – and that’s why some services want to be able to pay to let their packets move together, so they don’t freeze up, like a live entertainment transmission, telemedicine, uninterruptible Dick Tracy wrist videophones, or an important financial transaction.

Websites -- content originators -- take stuff to one of the many big “backbone” networks, which in turn take that content and those messages to the local networks that ship them to the people in your neighborhood, the people that you meet each day.  Or, sometimes, they hire a “Content Delivery Networks” o do the job for them; CDNs are companies that takes content from one place and deliver it to the entry way to the local networks that get them to your machine. 

There are many of these backbone providers and they coexist, by and large, through a system called “peering.”  Peering is a system that lets the backbone providers swap throughput so it gets to where it wants to go with the least cost, congestion, and aggravation.  For example, Orange and BT are two of these backbone companies.  If they billed each other every time a message jumped from one of their cables to the other’s, they’d go nuts processing the transactions.  So, instead, they set up a peering relationship, which says that they will trade data – let messages go from one to the other – so long as the volume moving both ways is “roughly” in balance.  In practice, “roughly” means that the volumes should differ by no more than a factor of two.  If for some reason they fall out of balance, they’ll settle up with each other in cash, a process known as “settlements” – I love business lingo.

OK, those are the basics.  Level 3 and Comcast, both having networks that are part of this labyrinth, had such a “peering” relationship.  But recently, Level 3 signed a deal with Netflix stipulating that Netflix would pay Level 3 to carry its movies to the backbone so they could find their way to you.  Netflix, remember, taught you how to get movies in your mailbox, but the pressures of competition and innovation have made that once-revolutionary premise passé.  Now, they want to stream movies to your home, and God bless them for it.  So they cut a deal with Level 3 to bring their films to the Internet, where they would find their way to movie-hungry customers.

So Level 3 showed up at the ports of Comcast’s Internet backbone – not their local networks, the one that brings phone and film and fun to the coaxial cable on your block, mind you, but the big hog cables that make up the digital Interstate – and said, “Hey!  I’ve got some movies to pass through.”  After all, they’ve got peering with Comcast, so there’s an environment of “trust but verify” between them.  Well, sure, that’s how it works, but when Level 3 backed up the truck, the movies they loaded up weren’t a few selected matinees, but the entire Netflix library.  And once they did, the balance of traffic between the two became decidedly one sided, by a ratio of about 5 to 1. 

So Comcast, understandably, told Level 3 their peering relationship  didn’t cover this kind of traffic, and Level 3 would have to buy more ports to Comcast’s network if they wanted to get Netflix’ movies to the movie-hungry final customer.  After all, the point of “peering” on the Internet is to handle each other’s traffic when that’s the least-cost way to do it – it isn’t “you deliver my goods for me, thanks.”

Now, reasonable business practice at this point would be to sit down and work out some kind of arrangement – after all, Level 3 has just signed on to be the docking end of a movie fire hose; what were they thinking when they signed the deal with Netflix?  That they’d simply show up at the door of Comcast or some other backbone provider and thank them for providing carriage as a community service?

Apparently yes, they did.  In essence, they decided to use their status as a backbone “peer” network to get a cheapo foothold into the world of content distribution.  Because rather than negotiate an arrangement, they yelped to the Federal Communications Commission that Comcast’s refusal to carry their goods for them was a violation of an “open” Internet and of the FCC’s oft-stated principle of “net neutrality.” 

Remember, “neutrality” means that nobody can pay for preferred treatment on the Internet.  Even if somebody’s doing robotic surgery on a patient in Ice Station Zebra, the signal carrying an image of Rock Hudson’s ruptured aorta will have to wait until Jimbo the teenager is done downloading a video of a cat playing the xylophone (“That is so cool!”).  Nothing on Earth works that way – no priorities, no rules, everything just “works out.” 

(Actually, I take that back.  When I was a graduate student in Ann Arbor in the early ‘70s  – Go Blue, one year we’ll give OSU a run for their money – there was a seven-street Intersection just before the Broadway bridge that led off into Ward One that had not a single traffic sign.  I remember a guy named Rolf telling me his political science professor citing that intersection as the only working example of “pure communism” – seven streams of traffic intersecting with no rules as to what should happen when they do.  Rolf’s professor was an idiot – I don’t see how that intersection in any way reflected worker control of the means of production, but it did have an idealistic communitarian air to it, which might lead the brainless to confuse it with worker Soviets running factories, but whatever.  On my last visit to friends in A2 a few years ago, I went through the intersection and noticed there were now stop signs on each of the seven corners.  So much for the last recorded instance of  economic neutrality on the planet.)

Level 3’s complaint to the FCC speaks volumes of the misrepresentations that lie beneath the doctrine of “neutrality.”  Does Comcast’s insistence that Level 3 pay for service provided make the Internet less “open?”  In fact, imagine how their other backbone customers, who are either “peering” or “settling,” would feel if they found out that all the movies Netflix was streaming to its million-member customer base were travelling without financial consideration.  Is their demand for payment somehow a form of “prioritization,” or pay for incremental service?  Only in the sense that buying a loaf of bread is preferential, conditional on payment.

I don’t where the FCC will end up here – they know better than to mischaracterize the way business is done among the Internet’s backbone providers, and they can surely see that Level 3 is trying to turn itself into a CDN while maintaining the benefit of being a peering backbone provider.  It reminds me of a cartoon I once saw with two naked guys with paper bags over their heads talking to Noah on the gangplanks of the Ark – “Let us on, we’re monkeys.”   But the FCC (or at least some of it) and its neutrality cheerleaders made such a to-do over the words “open” and “neutral” and “prioritization” that they may feel backed into a corner. 

Moreover, poor Comcast – or as they’re know on television’s funniest program, Kabletown – is trying to buy NBC (for reasons that make little sense to me, but that’s a tale for another day), and the FCC has the chance to make their lives miserable, Jack Donaghy’s efforts to elect Steve Austin to the Congress notwithstanding.

But wait a minute – let’s review what’s come up in this posting – Netflix, movies, videos of cats playing the xylophone.  It’s all about video streaming – or as we called it in Jackson heights during Saturday double features at the Boulevard theater, movies.  Video is coming to dominate the Internet, which bring us to this, a posting by Dan Rayburn, a representative of the streaming media industry.  In his post, whether willfully or not, he misrepresents the situation:

Comcast was for the first time demanding, "a recurring fee from Level 3 to transmit Internet online movies and other content to Comcast’s customers who request such content."

This statement is not true.  Comcast is not asking for a “fee” – that is, a price – for access to its customers.  It’s asking for reimbursement for access to its backbone.  In fact, Rayburn goes on to note that Comcast is not asking for an exorbitant price, or that before Level 3 showed up with an 18-wheeler full of data, peering between the two companies worked.

It’s the principle of the thing, Rayburn argues.  Comcast, in his view, is setting up a situation in which they can charge video content for being carried to the user:

 the real explosion of traffic on the Internet is from video, so while Comcast is not specifically calling out video related content from Netflix or anyone else, that's really what we we're talking about.

The key to unlocking Rayburn’s view is to remember that he’s a representative of the streaming video industry.  Streaming video is the fastest growing  traffic on the Internet, and unlike e-mail from your Aunt May or looking up last night’s NBA scores, it takes a lot of bandwidth.  It eats it up, much like trucks on the road cause much more wear and tear to the road surface and much more congestion to other motorists than do families in their Ford Escorts.  But the streaming video guys don’t want to pay for the bandwidth they use, just like the other Big Websites who thought up “net neutrality” aren’t interested in paying for the congestion they cause of the bandwidth they suck up.

Rayburn – like Level 3 -- is looking for a free ride, dressed up with platitudes about “neutral” and “open” and so on and so forth.  And underlying his scam is the idea that the Internet is a bunch of plumbing-type pipes that flush data to your doorstep.  It’s not.  It’s a complex, dynamic, network of networks, and it has to be run to reflect those realities.  And the burgeoning role of video makes it all the more important that we get past simplistic metaphors and provocative vocabulary and build a competitive, responsive broadband Internet.

The Fed Under Seige

The ongoing saga of the recovery that wasn’t took a new turn this week when a group conservative politicians and economists – some of them often rational, at least in my book -- launched a coordinated assault on the Federal Reserve and its (Republican) Chairman, Ben Bernanke, for displaying the audacity to act in line with the Fed’s oft-repeated and uncontroversial mandate to provide full employment with price stability – the quantitative easing (QE2) program.

Faced with a situation in which inflation was less than the Fed’s (again) oft-repeated and uncontroversial target of 2 percent inflation, and with unemployment significantly less than the “non-accelerating inflation rate of unemployment,” as we economists have decided to call “all the employment the economy can handle,” the Fed has announced its intention to do what you would do if you read its owners’ manual – lower interest rates by printing money and using it to buy bonds, meaning more money gets into circulation and, hopefully, it sticks somewhere.  But since short-term interest rates are already pretty low, the Fed announced that this time it would march further out the “yield curve,” meaning it would be buying bonds of 5 or 10 years duration, to establish that money was not only going to be cheap, but be cheap for a while.

The best argument for the soundness of this policy may be the voices against it.  Liberal icons Joe Stiglitz and Paul Krugman have both questioned the policy on the grounds that more fiscal stimulus is needed instead.  That’s swell, guys, but since more fiscal stimulus isn’t forthcoming, what’s Plan B?  Apparently, it’s whining about how we didn’t do Plan A.  Gene McCarthy  once said that “the function of liberal Republicans is to shoot the wounded after battle.”  That appears to be Joe’s and Krugman’s function as well.

But the real stars of the show are a group of conservative economists, like my friend – really -- Doug Holtz-Eakin, the well-regarded and very droll senior economic advisor to the McCain campaign, and right-wing fellow travelers like Weekly Standard’s William Kristol or my good friend (and, again, I’m not kidding) and crackpot Amity Schlaes, who recently devoted an entire book to the remarkable? whacky? idea that Roosevelt’s Depression-Era policies were a big mistake that only hurt working people (here’s the link, which opens with a George Will quote about reappraising the New Deal, which is like asking the Mongoose for a review of a book reappraising the Road Runner). 

This new group has run an ad in the Wall Street Journal (from whence it will trickle down to the masses)   in the form of an open letter to Bernanke.  The letter says his plan will “…risk currency debasement and inflation, and we do not think …(will promote)… employment.”  Instead, perhaps like Stiglitz and Krugman, they offer “…improvements in tax, spending and regulatory policies must take precedence in a national growth program, not further monetary stimulus.”  But what they mean here is permanent extension of the Bush tax cuts, including cuts for the top of the income ziggurat, maintaining the distinction between wages and salaries on the one hand and (less-taxed) capital gains on the other, and better treatment for the rich dead through elimination of the estate tax, coupled with unspecified spending cuts and deregulation, which I suspect means repealing the new health care law.

How this will lead to sustained growth in employment is beyond me.  After all, the tax cuts have already happened – what they mean by improving tax policy is not raising taxes on the rich.  And spending cuts (as part of a deficit-reduction plan) are going to be sorely needed once the economy starts growing, but cutting spending in order to induce growth is like dowsing a campfire before dinner’s cooked in the name of forest safety.

And how this is going to lead to inflation is also hard to imagine.  Capacity is ample and the economy has plenty of slack.  Hundreds of millions of people around the world are entering the tradable economy and are prepared to send us an ever-increasing slate of products for next-to-nothing.  Astonishing technological progress is fueling productivity growth.  See anybody striking for higher wages recently?  Me, either.

Let me reiterate what I discussed last week; the Fed’s policy is the best option we have right now.  Like Joe and Krugman, I’d rather a new round of stimulus, but since that’s not going to happen, I’m for Plan B.  Specifically, I think the missing element of economic policy right now is a drive to refinance the stock of mortgage debt, which would give people lower payments and therefore more income, keep foreclosures down and therefore keep more houses off the market, firm up the price of housing a bit, and give consumers a reason to get up in the morning.  Too bad the Congress won’t do that – actually, too bad the Administration won’t do that – but the Fed can take us close to it by making 5-10 year money so cheap that it does.

The dissent of the conservative economists has the veneer of a polite debate over monetary policy.  There’s always been such a debate.  Back in the 1970s, when the Fed, under Nixon, Ford, and Carter, under such lesser lights as Arthur Burns and William Miller, either turned a blind eye to or tacitly encouraged rising inflation, a similar group of conservative economists formed what they called the Shadow Open Market Committee, which advocated a tougher line on monetary expansion.  In essence, they won the argument, since Paul Volcker became Fed Chairman soon thereafter and implemented the austerity the Shadows had long supported in order to squeeze inflation out of the system.  (The Shadows, however, proceeded to fight the war after they’d already won it, and continued to complain about unduly lax monetary policy even after the economy began to grow again, even though inflation had disappeared, thus rendering them a bit less prescient than you would have thought.)

The Shadow Committee was openly and avowedly for austerity, and anti-growth.  That’s not unfair in the least – their view was that if it took a recession to squeeze inflation out of the system, then so be it.  And Volcker had the guts to do it.  At the time, I was horrified – horrified – that we’d choose to have 10 percent unemployment.  Now, liberals like me see Volcker as the only guy who gets what’s going on in financial markets and, by the way, he did get rid of inflation.  So much for our objections.

But here’s the problem.  The new group of anti-Fed conservatives appears to be just as anti-growth as their Shadow predecessors, just less honest about it.  The vague discussion of tax, spending, and regulatory policies is the same melange of stuff that Congressional Republicans now favor but are yet to spell out.  Is extending tax cuts for people with incomes over $250,000 (or now, as Senator Schumer appeared to suggest over the weekend, incomes over $1 million, graciously taking me out of the mix) and repealing health care (actually, to my thinking, insurance regulatory) reform going to trigger a new round of growth and employment?  Or what – letting GM go broke?  Can I have some of what you’re smoking?

Or perhaps what’s really going on is that this new group of dissenting economists are riding the wave of interest and glory set off by Senator Mitch McConnell, whose avowed single most important thing to achieve is for President Obama to be a one-term president.  Not growth, not jobs – just defeat the president.  OK, that’s politics, it’s in that odd intersection between repugnant and fine – that’s how he rolls, he said it, I get it, I hope he doesn’t get what he wants, in fact, go fu--, well, at least we all know where we are.

My concern is that this attack on the Fed, born and coordinated over a sea bass dinner at the University of Pennsylvania Club (isn’t that an endangered species?), is really a new front in the political siege of the Obama Administration, and that the real problem with the Fed’s policy is that it might work.  Let’s return to Doug Holtz-Eakin, this time from this weekend’s Washington Post.

After the failure of the stimulus, the Obama Administration has turned to a new export strategy to generate growth. Unfortunately, export-led growth is already the policy of choice for China, Japan, Germany, Brazil and a host of other key economies. It is inconsistent for every country to simultaneously count on net exports to generate growth.

What Doug means by “a new export strategy” is that the QE2 monetary policy is likely to reduce the dollar’s value, which helps exports.  But that’s not the point of the policy.  If the Administration wanted to devalue the dollar, there are far more effective, direct ways of doing it.  And wait – this is the Fed’s policy, not Obama’s – why the sleight of hand, the bait and switch that lumps them together? 

Besides, if anybody has a right to a cheaper currency it’s us, since we have a big trade deficit.  The countries Doug cites all run trade surpluses – they should be happy when their currencies appreciate it, because now their people can buy more foreign stuff for the same amount of money.  If McCain were President, Doug, wouldn’t he favor China’s currency rising?  This criticism of QE2 is exactly what the Germans and Chinese said when they learned about it – that they didn’t want the US to export more.  Man, I get so tired of these right-wing economists who sign on to the arguments made by our competitors and blame America first.

Holtz-Eakin goes on:

The Fed (and President Obama, who curiously decided to violate the "Fed is independent" rule and weigh in on the topic) sees this as domestic monetary policy, but to the world it is a competitive devaluation of the dollar.

Well, there we go again – “the world” thinks such and such.  The world also thinks that the death penalty is barbarous, that climate change is scary as hell, and we all should get six weeks paid vacation, not to mention cradle-to-grave, government sponsored health care.  Are we good with that, too?  And what’s with this new rule about how Presidents shouldn’t comment on what the Fed does?  When did that start?   And that’s before we consider then-Fed Chairman Alan Greenspan dancing like a trained bear for tax cuts a decade ago.  Somebody send these guys the memo about the rule again.

He continues:

The Administration's approach has been to set quantitative targets for external balances - essentially "quotas" for shares of the global economic pie. It would never work and has been rejected.

I salute with grim admiration Doug’s ability to slip the word “quotas” into the mix, but what Tim Geithner really said was that if countries are running trade surpluses at really high levels, they should be under some obligation to cut them, meaning stimulating domestic demand and easing any trade barriers, pro-growth stuff.  And if it was rejected, it was rejected by the same list of trade surplus countries – China, Germany, Brazil – who actually do have the “export first” mentality Doug accuses Obama of having.

All of this suggests to me that the dissenting conservative economists –particularly given their overtly political so-signers -- are being guided by the McConnell Agenda, not a pro-growth one.  Cutting taxes for the rich, repealing health-care reform, and supporting any and all spending cuts except those that might happen (with the exception of Representative Paul Ryan, the new chairman of the House Budget Committee, who is perhaps the only Member of either party willing to enumerate what spending he’d cut) are not the makings of a program to restore output and employment growth – they’re modern day Hooverism.

And people who are good and thoughtful economists who signed this dissent – Holtz-Eakin, John Taylor, Niall Ferguson – need to think about what lies down this road – an populist attack on the Fed led by Sarah Palin and Ron Paul, folks who seem to lack the first idea of what the Fed does and why there’s more to monetary policy than a parable about gold coins.  If the Fed intends to do something that might help the economy while this Administration is in power, then off with its elitist head. 

Yes, the Wall Street Journal dissent is putatively above-board, but the board is surfing a very troublesome wave.  It’s a stalking horse – to some – for an attack on the Fed, for reasons ranging from ignorance to an anti-elitist Cultural Revolution.  The more responsible Fed critics should proceed with caution.

At Ease

Alright, let’s start with the World Series.  As I recall, I picked Texas in 7, asserting that Lee would win two games and the Texas line-up would find a way to win 2 more.  All of these prognostications had one central, shared characteristic – they were all wrong.  (I’m reminded of Alan Arkin playing “The Detective” in one of the greatest movies ever made, Little Murders – “What do these 345 homicides have in common?  They have in common three things.  One, they have nothing in common…”.)    As Ron Washington, Texas’ manager, said after the event, “They beat us soundly.”  Hell yes.  They gave you some broth without any bread, Ron.

The theme of being wrong segues gracefully to the economic issue of the moment, the Fed’s new Quantitative Easing announcement or, as economists call it, QE2.  (The “2” recognizes that the Fed did this in 2009, so it’s the second time.  And it makes the whole thing much more droll.) 

First, the background paragraph.  The Fed usually influences the economy by pegging the interest rate at which banks can borrow from it and manipulating the “Fed funds” rate, the rate at which you can borrow the least risky money for the shortest period of time – every other interest rate is a departure from that one, either by being riskier or by having longer duration.  But short-term interest rates today are pretty damn low, so if you want to goose the economy, you’ve got to come up with something else, and that’s QE2.  The Fed, under this policy, will buy longer-term assets, like 5 and 10 year government bonds, and start taking their rates down, too.  It’s a strong message – not only are we keeping rates low today, but we’re going to keep them low for a long, long time.

I support this policy – in fact, the picture shown here is an actual sign I carried to the March to Restore Sanity, one that provoked confused (and pitying) stares from most people and an occasional squeal of glee for kids who excitedly told me they were economics majors and could they take their picture with my sign.  It was as good a response as you could hope for, although I did better with one my other signs – like the guy who used to sit on the third base sided of Shea in the 1960s,  I brought several , including my show-stopping “This sign makes an Important Point.”  God, I love mass irony!

Like many of QE2’s supporters, I’m for it even though it’s not the right (or most right) thing to do.  The right thing to do is to stimulate the economy on the spending side, and to stabilize the housing market, so that families feel confident that their home is going to keep some of its value and they don’t have to live in fear of another shoe – or perhaps another shoe rack – dropping.  You do that by setting up a mortgage refinancing facility that mortgage writers can borrow from cheaply.  In fact, this kind of socialist, freedom-denying chicanery was recently proposed by Bolshevik-in-training Glenn Hubbard, who was the Council of Economic Advisors chair under President Bush II.  In my variant, which is very close to his, we’d allow everyone who hasn’t missed a mortgage payment for the last eighteen months refinance their entire mortgage – whether it’s underwater or not – at a rate that reflects the government’s low borrowing costs – 4 percent would work.  The Fed would then buy these mortgages and hold them, at least until the storm had passed. 

That’s a great idea.  Families who haven’t missed a payment after the last 18 months of hell are, prima facie, good credit risks, and letting them refinance their entire mortgage, even if their house has dropped in value, keeps them in their house, which supports housing prices and neighborhoods.  And there’s the rewarding-the-virtuous aspect of it; maybe even Rick Santelli would approve.  And it does so while freeing up families’ disposable income, which helps other consumption.

The only problem with that idea is that it’s not going to happen – pigs will fly to daylight before Washington producers that result.  It’s got everything – stimulus, socialism, a whiff of moral hazard.  The probability of the new Congress passing such a proposal is -5.

But, on the other hand, most economists near the center of the spectrum – in terms of both ideology and awareness – understand that something needs to be done, because the economy is too listless, wastefully so.  Yet all we stand to get from the new configuration in Washington is more of the same – lectures about the perils of long-term debt followed by extensions of tax cuts we can’t afford.  The policy favored by most of the electorate, or so their choices reveal, is “do nothing,” the classic, Hoover-esque prescription dressed up as setting the stage for a torrent of liberating entrepreneurial heroism.   Why the nation’s entrepreneurial spirit would be dashed by a stimulus or a wave of expedited mortgage refinancings is not clear to me, nor is what’s keeping it from cutting loose at the moment, but it shows you what I know.  Regardless, that’s one of the important takeaways of the Fed’s decision – it represents a judgment by the Fed that the political system is irretrievably broken, and that it has the choice of sitting idly by or taking its best shot.

A second point that can be made about QE2 is that, in some respects, its opponents think it will work more than its supporters think it will work.  I’m a supporter, and I’m not sure.  It will put more money into the economy and, specifically, lower interest rates over the medium and long terms.   That means it will be easier to write cheap mortgages, which goes back to the need to get the household sector of the economy and its real estate problem squared away.   A direct approach – like Hubbard’s -- would work better, but maybe this more roundabout tack will get the job done.  And more generally, there’s already a lot of money sloshing around there – we need to use stimulus to set it loose more than adding to the slosh.

But the program’s opponents think that the program is going to work so well that it’s going to lead to ruinous inflation, both in goods and in assets, like the prices of stocks.  Maybe they don’t think they think that, but ultimately they do.  Because if the program does lead to higher general inflation or a new stock bubble, it’s likely because economic growth has been rekindled.

That’s certainly the case for inflation in general.  There probably are still some diehard monetarists who believe that once you introduce more money into the system, inflation has to follow.  But we’ve learned enough about how the economy operates to relegate that to the realm of superstition.  The effect of money on the price level depends on a host of real world considerations.  Are banks lending it as fast as they can get it? Are people saving it or spending it?  Is the economy’s productive capacity booked to the brim, or does it have slack resources ready to be applied to the task of production?  And there are also the real-world considerations of the moment, such as, are there hundreds of millions of Asians, Eastern Europeans, and others around the world prepared to offer us whatever we want for, as they say, “a fraction of the price?”  The relationship between money and inflation is not like the relationship between a seed and a tree – you don’t plant money and come back at the end of the growing season to reap inflation.

So expecting a surge of inflation means expecting some positive response in the real economy.  Inflation – once it’s above the background noise level – isn’t a good thing.  But it would be a symptom of good things elsewhere.

There’s then a different inflation argument – that all this new cash swirling around will end up going into bidding up the price of stocks and other assets to irrational levels.  After all, we’re being promised that the Fed is going to keep the interest you earn on bonds very, very low for a long time.  So if you’ve got money and want to earn a reasonable return on it, you have to put your money in other assets – most obviously, riskier bonds (the below-investment grade stuff issued by more tenuous companies) or stocks.  It’s not surprising that the stock market had a big day yesterday, the day after the announcement was made. 

But what goes up usually comes down.  The Fed could be setting the stock market up for another bubble, another boom-bust cycle that will start heading south once the economy starts to recover more substantially and the need to keep these interest rates very low is no longer the paramount concern.  That’s a reasonable concern but, again, I think it’s a more theoretical danger than a real one.  If the economy does start to grow, earnings will make stocks more valuable even as higher rates make them less so.  And the Fed can use its ability to comment on the passing scene to shape investors’ expectations and, to use a word we once found appropriate in such a situation, “exuberance.”  Moreover, the newly-created systemic risk regulator created in the Seize The Means of Production Act of 2010 – excuse me, I meant Dodd-Frank – will also be on the beat.  It can use such devices as margin requirements to dial down any prospective bubble.  That’s why we created them in the first place.

I still believe in new stimulus – as I’ve said before, a payroll tax holiday, using the Fed’s balance sheet to buy new small business loans (with loss protections), a National Infrastructure Bank.  A program to accelerate mortgage refinancings and reward people who have hung tough is entirely in order as part of such a stimulus.  In fact, I could be a good segue to a long-overdue policy regarding the break-up and privatization of Fannie Mae.

The problem with QE2 is not the policy itself.  It’s that the political system appears incapable of making any kind of competent economic policy on its own.  That’s largely the doing of the Administration’s obstructionist opposition, but it was the Administration’s job to manage them and it couldn’t do it.  So we’re left with the Fed doing what it can in the government’s absence.  Ultimately, to my mind, the risk is not that the Fed fails, but that the Administration’s opponents in the new Congress decide that the Fed is a fair political target (see Ron and Rand Paul, but not my favorite Paul, Les), and truly damage the country by putting it in play.  Just when you think it couldn’t get scarier…

Texas Over San Francisco. And more.

Two things today.  The first is comments from last week’s discussion of Malcolm Gladwell’s article in the New Yorker.  Go figure.  You can say all sorts of stuff and people read it and shrug, but start talking about Malcolm Gladwell – or Robert Frank – and the phones start lighting up.  My point is not to keep this issue alive – I’m happy to, of course, but why bother you with it? – but to give people of good faith and reason an honest response.

Then we can move on to item two – the World Series.  Anybody who would rather read an extended discussion of scale building in the service industries than speculation about who’s going to win the World Series is invited to…well, we start with the mailbag.

Someone named CJ Alexander writes:

I wish CEO pay would stop getting lumped in with “Talent” like that of athletes and entertainers. Absurd CEO pay is largely an American phenomenon perpetuated and protected by rank cronyism rather than market forces.

There is a comedian in Seattle named CJ Alexander, and I am hoping this is from him.  A comedian is reading my stuff and making coherent comments?  How much better can it get?    

CJ, best to your namesake, C. J. Wilson, who’ll be throwing Game Three for the Rangers..oh, I’m getting ahead of myself.  And I’m impressed that we’re at a point where we wish our CEOs had the abilities of, say, athletes such as Tim Linceum and Cliff Lee.  But CEOs are paid a great deal in large part because a great deal is bet on them, and because their opportunities to create (or destroy) shareholder value grow exponentially as the economy becomes more complex and contested.

What do CEOs do?  The first one I worked for was Mike Blumenthal, an interesting if high-handed guy, and he once told me the CEO had two jobs – to provide a vision for the company and to make sure the resources were there to execute it.  I would add, as a corollary perhaps (but not Ehrlich’s Corollary, please), that the CEO has to explain the vision and the strategy to achieve it to both internal and external stakeholders.  This sounds like story telling, and it is, but it is the frame that allows the organization’s progress to be measured.

So I think there’s an objective, economic reason why CEO pay is so high, particularly in the U.S., where equity markets are deeper, more volatile, and where the market for corporate control more competitive.  If I wanted stability, I’d go be a CEO in Europe or Japan, where the forces acting on you are different.  Do cronyism and back-scratching play a role?  Yup.  But there’s a Darwinian thing to them – the stockholders that allow them end up the losers for it.

Jesse Fahnestock writes:

Ehrlich’s Rule about the fundamentals of human behavior being the same at large sale is really the Economist’s rule, and could be fairly restated as “Cultural factors Are Not Really Relevant.”  I think it would be worth looking at those factors on their own terms as well.

Man, here I am, pushing 60, still talking about Gramsci!  (as opposed to Gramscii, which is a programming language)!

I think I’m reminding people that economic rules are important, too.  But I think we might be conflating two different arguments.  The economist’s rule, as economists are taught it, is that the commonality of the human race is their homo economicus instinct – to maximize, optimize, calculate, and act with economic rationality (transitivity, consistency, and so on).  That’s so far-fetched that they’re now giving Nobel prizes to the people who show that people act differently.  If you think that view of humanity substitutes for the reality of human longing for relatedness and, ultimately self-actualization and fulfillment, you’re off by a wide mark.

But there’s a second level, in which different societies have different economic rules or conditions, and those rules have more pervasive effects than we let on.  I’m finessing trump here, a little, because you can argue that those rules – a consensus-driven corporate control culture in Japan, a co-determined one in continental Europe, a fiercely competitive one in the U.S. – in turn reflect underlying culture and some historical legacy.  Culture counts, to be sure.  But my point in writing the piece was that those who see pay and the distribution of income from a cultural or anthropological perspective ought to consider economics.

Then someone named MQ says:

Robert Frank made this point many years ago – the whole economic theory of “winner take all” is precisely about technologically enabled economies of scale in service provision.

Well, yes and no.  Here’s a good statement by Frank that shows that MQ – my old buddy Mollie Quasebarth?  The Modern Jazz Quarter dropping their middle name? – has a point: 

Winner-take-all has long been a feature of markets in entertainment and sports. But in recent years, many other fields have adopted the winner-take-all payoff structure. There are two reasons for its proliferation: developments in communications, manufacturing technology, and transportation costs that have enabled the most talented performers to serve ever broader markets, which has increased the value of their services; and changes in implicit and explicit rules that have led to much more open competition for top performers, which has made it more likely that they will be paid their economic "value" as determined by the marketplace.   

That’s pretty close to economies of scale, so MQ’s right.  And, in fact, I chose this cite (from a book review, not the book itself) because it makes the second point I made last week – that “changes in the …rules” have allowed more open competition for top performers – that’s another way of saying that Marvin Miller and a unified, multipolar, national market for baseball both were needed to get salaries to rise.

But I think there’s a disconnect in Frank.  I view services scale building as the driver of these rising salaries, but I don’t see Frank’s objection, which I might paraphrase, is 1) “this is bad for the income distribution” and 2) “kids see ARod or Lebron James make this money and waste their time trying to be them.”  These are important issues, but I’m still going to treat them cavalierly – 1) this is a less troubling aspect of the income distribution than many others, and 2) if they’re wasting their time, it’s because they’re rational and have few alternatives.

Let me let it stop there.  Frank and I area pretty close and we’re both distant from Gladwell.  MQ, good point.

Simon writes:

Your “Rule” has no basis in empirical evidence.

True dat, Simon.  Maybe I should have called it my Hypothesis, or better yet, Ehrlich’s Razor – it worked for Occam.  Empirical evidence is a pretty high standard, but at least you can derive, for example, Hotelling’s Rule or Tinbergen’s Rule, even if they aren’t obeyed in life.

Finally, Minot – I presume not the town in South Dakota – points out:

Henry Ford passed in 1947 so Ford was not run by an anti-Semite when it made IPO via Goldman.  You are the right track.

Yes, but I stayed on the train one generation too late.  My apologies to the late Henry Ford II for the confusion – no, wait, he’s dead, too.  And he wasn’t an anti-Semite, but he did give us the Edsel.

I wish CEO pay would stop getting lumped in with that of “Talent” like athletes and entertainers. Absurd escalation of CEO pay is largely an Ameican phenomenon, perpetrated and protected by rank cronyism rather than market forces. Except in very rare outlier cases, it has little or nothing to do with performance.

Stepping back and looking at the respective bottom-line contributions of each makes the difference pretty obvious. The “talent” is both the production labor as well as the work product itself; the CEO is a manager of those things. In consumer terms, the it’s the difference between “thing we pay for and care about” versus “bureaucratic overhead.”

And now, the World Series.

Here’s a comment made by Dave Shenin in today’s Washington Post about Cliff Lee, who has a lifetime post-season record of 7-0 and an ERA of 1.26;

among pitchers who have made at least five post-season starts, only Sandy Koufax (0.95) and Christy Mathewson (1.06) have lower ERAs.

Wow, that’s a lot to handle at breakfast.  But first, you have to love the idea that we’re comparing Lee to a guy who not only pitched a hundred years ago, but died almost a hundred years ago.  (Well, 85 – I’m being literary.)  Mathewson, The Big Six, put on the greatest week of pitching ever, (sorry, Johnny Vander Meer), when he pitched three shutouts in one World Series – in 1905.  In fact, Matty’s incredible effort – three shutouts in six days, 14 hits allowed in 27 innings, 13 Ks – saved the World Series as we know it. 

That’s true because…The first Series was in 1903, and the upstart Boston Americans (perhaps the Red Sox should think about changing their name back) stunned the world by beating the Pittsburgh Pirates (who featured Honus Wagner, the Flying Dutchman, best position player of his day) only two years into the upstart American League’s existence.  It was Namath and the Jets, just as astonishing, 66 years before. 

So in 1904, when John McGraw’s Giants won the senior circuit’s pennant, they announced it was beneath them to play Boston, which had won the American League pennant again.  So there was no World Series, owing entirely to McGraw’s arrogance.  It was the only Series that didn’t happen come hell, high water, war, Depression, and everything else until Bud Selig and a few other radicals decided that baseball could not exist without a salary cap – let me repeat that – would cease to exist without a salary cap – unless they broke the players’ union and cancelled the World Series so, motivated by their desire to save baseball, they let the Series go down.

Selig to date has never admitted he was wrong, but John McGraw won his pennant again in 1905 and ­–as a bigger man than they -- agreed to play the Philadelphia-Kansas City-Oakland-Santa Clara?/Las Vegas? Athletics.  It was a transcendental match-up – every game was a shutout and Mathewson pitched three of them.  “Iron Man” McGinnity, Chief Bender, and Eddie Plank also pitched in that Series – all four (with Matty) are in the hall of Fame.  The public was galvanized – think Ripken and McGuire after the 1994 debacle – and the Series as an institution was saved.  Mathewson.  McGinnity.  Bender.  Plank.  There were Giants in the Earth in those days, boys and girls, and Athletics, too.  When you see that little elephant patch on the uniform of the Oakland A’s, remember that Bender and Plank and God’s own abandoned child, Rube Waddell, wore it 100-plus years ago, just like Cahill and Ziegler and Breslow do today.  That’s got to count for something.

But there’s another aspect to the comparison of Lee to Matty and Koufax, and that’s this – how dare they?  There are all sorts of baseball fans who read that comparison and say, hold on a second.  Lee’s pitching against wild card teams, in three rounds of playoffs, how can you compare him to guys like Matty and Sandy, who only pitched in the Series?

I admit to reacting that way a bit, but reality has to intercede.  First, there were 16 Clubs in their day, and thirty today, so the idea that the teams aren’t as good is, by that standard, only half true.  But more importantly, Matty played in the apartheid league (to his credit, I think Bud’s apologized for that one), and Sandy – in the Series – against an American League that was slow to integrate (Elston Howard and whom?).  Neither played against a field that was international in scope – no Ichiros, few Pujolses.  And, more importantly, today’s ballplayer trains all year, knows the technique of playing far better than their predecessors of past eras (watch how many guys in newsreels are hitting off their front foot), and in a league in which the strategy of playing has evolved dramatically – bullpens, platooning, statistics, and so on.

Please – are you going to tell me that Ty Cobb was really a better ballplayer than Ricky Henderson?  That a guy with Ricky’s (as he’d call himself) ability wouldn’t have eaten up baseball 100 years ago?   Babe Ruth, great, great player, changed baseball.  Would he hit 60 home runs against 6-inning starters are specialized relievers throwing the slider and the cutter?  Get real.  You are watching the best baseball that was ever played, right now.

Was I writing about the World Series?  Oh yeah.  In the last ten years, there have been 13 different Clubs going – that’s almost half of baseball’s 30 Clubs that have been to the World Series in the past ten years.  Texas and San Francisco both emerged from the middle of the baseball pack, dethroned the sitting champs, and are quirky Clubs.  San Francisco has good pitching, a bullpen capable of greatness, and a great line-up of other (foolish) peoples’ cast-offs – Burrell from Philly and Tampa, Ross from Florida, Huff from lots of places, but Texas might have the ultimate cast-off – their catcher, Bengie Molina, whom they obtained from  San Francisco itself – man, I wouldn’t want to play a Club that had a guy who was, up to memorial Day, my catcher! A catcher is the guy who knows everything!  He’s got the keys to the kingdom, the formula for Coca-Cola!  Texas also has 1,2,3, here comes Mr. Lee, the underappreciated , free-swinging Vlady Guerrero, who now has the chance to put a capstone on a great career, and the amazing player, person, and narrative of Josh Hamilton, who lost years to dope and drink and reclaimed himself with faith, the real Roy Hobbs – the film version, mind you, not the book.   

So here it is:  Texas wins in 7.  Lee is the real deal, and while he’s up against one of my favorite players, Tim Lincecum, The Freak, who resembles the knitcapped punk on The Simpsons and has an incredibly delivery to the plate, he’s going to win twice, and the Texas line-up is good enough to find two more wins, Matt Cain, the Giants’ number two, and Brian Wilson, their overpowering and ironic closer, notwithstanding.  And my theory of the Series is that “good” teams beat “hot” teams, although you’ve got to be a little of both to be there.  Philly over Tampa in 2008, Sox over Rockies in 2007, Cardinals over Tigers in 2005.  (Exception: Florida over New York, 2003.) 

Either way, it’s the best week in sports.  Hey, how’d LeBron do last night?   Really?  Wake me in April.