As financial sectors grow, they generally get more robust and more efficient at allocating capital. This is a boon for economic development, which is why a vigorous, well-managed banking system is a key component of all modern capitalist economies. But can a financial sector get too big? That is, not just big enough that the returns to scale become small, but big enough that they actually become negative, hurting economic development? A paper published a few months ago by Jean-Louis Arcand, Enrico Berkes, and Ugo Panizza suggests the answer is yes:

Our results show that the marginal effect of financial development on output growth becomes negative when credit to the private sector surpasses 110% of GDP. This result is surprisingly consistent across different types of estimators (simple regressions and semi-parametric estimations) and data (country-level and industry-level). The threshold at which we find that financial development starts having a negative effect on growth is similar to the threshold at which Easterly et al. 2000 find that financial development starts increasing volatility. This finding is consistent with the literature on the relationship between volatility and growth (Ramey and Ramey 1995) and that on the persistence of negative output shocks (Cerra and Saxena 2008).

If their results are right, the financial sector in the United States is about twice as large as it should be. And it's not just us: they say that their findings suggest that "all the advanced economies that are now facing serious problems are located above our 'too much' finance threshold." The chart above shows the full set of countries that are above or, in some cases, way above their threshold.

Food for thought. The full paper is here. (Via Felix Salmon.)

Raise the Gas Tax!

No one in Congress wants to raise the gas tax even though our transportation infrastructure is crumbling and revenue from the tax has been falling. Brad Plumer rounds up some substitute ideas:

One idea is a vehicle-miles traveled tax, which would track driver habits via GPS and charge per mile driven....Another is to charge some sort of congestion fee on overclogged highways....Mica, for his part, has suggested extending the Build America Bonds program....A bipartisan team affiliated with the Carnegie Endowment has proposed an upstream tax on oil combined with a variable gas tax that shrinks when oil prices rise and expands when oil prices plummet.

Uh huh. Or we could, you know, just raise the gas tax. We are ruled by idiots.

From Paul Waldman, after noting Rick Perry's aggressively maintained more-Texas-than-thou persona:

It's true that voters in the Northeast, Midwest, and West may have an irrational, kneejerk reaction against his voice or even just his home state, without actually knowing whether that reaction is justified. But the truth is, in his case, it pretty much is.

For the record, I don't think Perry can win the Republican nomination, and I know that he can't beat Obama in a general election. I'd love to see him try, though.

So what's the latest in Europe? Here's the New York Times explaining their latest problems:

Now, another type of contagion is causing concern: the risk of problems spreading to big banks, especially in Italy and Spain....The banks own so many bonds issued by their home countries that they are being weakened as the value of those bonds falls, amid concerns that the cost of government borrowing could become too expensive for Italy and Spain to bear. Now there are signs that these concerns are, in turn, starting to make it harder and costlier for the banks to borrow money to finance their day-to-day operations, a troubling trend that, at the worst, could lead to liquidity problems.

Hmmm. Banks are having trouble funding themselves. Here's the Wall Street Journal:

In Italy, one of the country's biggest banks, UniCredit SpA, faced numerous questions from analysts about the bank's short-term loans and whether disruptions in the funding market pose a threat. Executives acknowledged the market turmoil was having an impact, but downplayed its severity. "Liquidity…is available in the market. It's very, very short [term], but available," one senior executive said.

"Very, very" short term funding is all that's available to UniCredit. When that happened to Lehman Brothers, it had about a week left to live. The overnight market can dry up — well, overnight if a bank's solvency comes into question. The Washington Post tries to put this all into perspective:

The deepening woes raised the prospect of a crisis that would be almost as calamitous for the global economy as the one just avoided in Washington.

No no no. Europe is facing the prospect of a crisis that could be much more calamitous than our little debt ceiling kerfuffle. It might not happen in a week, but it's sure starting to look like it might happen in a month or two. As usual, I hope I'm just being an underinformed worrywart, but one way or another, this shoe sure looks like it's going to drop in pretty short order. Buckle up.

For more details, the Journal article is the best of the bunch. However, the Post has the best quote about Italy's travails: "Berlusconi is more interested in his bunga-bunga parties than his bond market," said Louise Cooper, a markets analyst at BGC Partners in London. And the Times has the best overall advice: "I don't think anyone wants to be long European banks right now,” said Simon White, an analyst and partner at Variant Perception, a London-based research firm. Probably not.

Presidential Power

I apologize in advance for indulging in a wonky process post yet again today ("more boy talk," as Twitter follower Stella calls it), but I want to repeat a point that I haven't made for a while. It got kicked off by this tweet from Dave Roberts:

My answer: No, he just has the easiest job. McConnell's sole goal for the past two years has been obstruction, something that Senate rules make easy. And the debt ceiling deal was a dog's breakfast of ideas from various sources. McConnell took credit for its final form, but he could do that mainly because, unlike John Boehner, he didn't have to put up with a big tea party contingent and was able to compromise without fear of losing his job.

More broadly, though, is it true that Republicans are just more ruthless and better strategists than President Obama? Matt Yglesias, after noting that the House is refusing to adjourn in order to prevent Obama from making recess appointments (they'll hold a pro forma session every few days), goes there:

I find that my mood around this fluctuates. Mondays and Wednesdays I’m frustrated by lefties who seem to see the unprecedented Republican obstruction the President is dealing with as part of an 11-dimensional chess game through which Obama “really” wants his progressive initiatives to be frustrated at every [turn]. On Tuesdays and Thursdays I think this is the most damning critique of all. In the face of an opposition that’s been relentlessly innovative, the White House has been staggeringly uncreative. Rather than a game of tit-for-tat, the Republicans seem to be inside the administration’s decision loop, heading off their retaliatory options before the President has even exercised them.

Has the White House really been staggeringly uncreative compared to Republicans? We don't have to guess about this. We recently had a Republican president in office for eight years and we can see just what he did. Keep in mind that George Bush was a very partisan animal and was advised by Karl Rove, a man with a major-league reputation for political ruthlessness. So what did Bush do to whip Democrats in line when they opposed him? Let's roll the tape:

  • 2001 tax cuts: passed by reconciliation so no Democratic votes were needed.
  • No Child Left Behind: No arm twisting here. This was a bipartisan bill cosponsored by Ted Kennedy. Bush got Democratic votes by agreeing to give Kennedy a lot of what he wanted.
  • War resolution: No arm twisting here either. After 9/11 Democrats were gung ho to invade Afghanistan and kick some al-Qaeda butt.
  • PATRIOT Act: Ditto.
  • Sarbanes-Oxley: This was basically a Democratic bill. Not only was there no arm twisting, Bush signed it reluctantly.
  • McCain-Feingold: Ditto.
  • Iraq war resolution: No arm twisting again. Lots of Democrats favored this and so did the public.
  • Homeland Security Department: Let's see. Oh yeah, I remember: Bush got his way here by winning the 2002 election and regaining his majority in Congress.
  • 2003 tax cuts: Again, passed via reconciliation. No Democratic votes needed.
  • Medicare Part D: Lots of arm twisting here, but mainly by Tom DeLay against his fellow Republicans. Several Democrats voted for it in the Senate, but let's be honest about this: details aside, it got some Dem votes because it was a piece of liberal social welfare legislation of the kind that Dems have long favored.
  • Social Security privatization: This failed. Bush was unable to get support from his own party, let alone coerce any support from Democrats.
  • Immigration reform: Ditto, more or less.

Contrary to his reputation, Bush mostly succeeded by pressing a moderate, and sometimes even liberal, agenda. Tax cuts aside, which he passed solely primarily with Republican support, the only real ruthlessness he showed toward Democrats on behalf of a conservative priority was the campaign hardball he played to add a union-busting provision to the Homeland Security bill. That was about it for presidential toughness. Ironically, the biggest show of ruthlessness during the Bush years was in the appointment of judges, but the ruthlessness there was wielded by Orrin Hatch, who made it easier to confirm conservative judges by peremptorily changing the blue slip rule in a remarkably cynical display of naked power politics. Democrats responded by filibustering a bunch of judges, which was also pretty unprecedented, and the whole thing eventually got resolved by a group of centrist senators called the Gang of 12. In this case, both sides displayed some ruthlessness, but not President Bush. He was just about the only person not really involved.

I'm not trying to make it sound like presidents are powerless. They can set agendas, they have control of executive orders, they have a pretty free hand in foreign policy, they can sway public opinion, they can lead their own party, and they can bargain with the other party.1 But Richard Neustadt taught us a long time ago that, especially on domestic issues, presidential power is distinctly limited. There's just not that much in the way of ruthless arm-twisting that they can do these days, and while Obama may not be as creative on this score as he ought to be, neither was Bush. That's more a reflection of political reality than it is of the character of either one of them.

1On the specific issue of the debt ceiling, the obvious thing Obama could have done differently was to insist that it be included as part of the lame duck deal last year. But for all the grief he's gotten over this, it's worth keeping in mind that Obama got a helluva lot out of that deal. In the end, he got a food safety bill, passage of the START treaty, a stimulus package, repeal of Don't Ask Don't Tell, and a 9/11 first responders bill. Maybe it would have been worth risking all that over inclusion of a debt ceiling increase, but that's hardly an open-and-shut case.

What's more, Obama also won passage during his first two years of a stimulus bill, a landmark healthcare bill that Democrats had been trying to pass for the better part of a century, a financial reform bill, and much needed reform of student loans. And more: a firm end to the Bush torture regime, the Lily Ledbetter Fair Pay Act, a hate crimes bill, a successful rescue of the American car industry, and resuscitation of the NLRB. Oh, and he killed Osama bin Laden too.

Sure, we all could have wished for more. Everyone has different hot buttons, and I particularly wish that financial reform had been stronger and that Obama had somehow managed to get cap-and-trade across the finish line. I'm also unhappy with the extension of the Afghanistan war and Obama's Bush-like policies regarding national security and civil liberties. Still and all, in two years Obama has done more to enact a liberal agenda than George Bush did for the conservative agenda in eight. That's not bad, folks. All things considered, I'd say Obama is the most effective politician of the Obama era. And the Bush era too.

This is hardly the biggest deal in the world, but it caught my eye so I'm passing it along. It's a "Taxpayer's Statement" mailed to me by my congressman, John Bayard Taylor Campbell III, chairman of the Budget and Spending Task Force of the Republican Study Committee. Take a look at the highlighted lines:

Miscellaneous taxes sure are up! Or wait — the statement calls them "miscellaneous receipts." Hmmm. Let's look at the footnote:

This includes taxes from a variety of places including gaming activity fees, Dept. of Interior fees, Puerto Rico, and other sources.

"Other sources" may sound like it's part of "taxes from a variety of places," but it turns out it's a completely independent clause. The vast bulk of that number, about $75 billion, is profit from the Federal Reserve's investments that have been returned to the Treasury. But even if you read the footnote you wouldn't know that. It just looks like the gummint is sucking up ever more of your money.

In the great game of misleading people about taxes, this is a misdemeanor at most. Maybe a parking ticket. Still, Campbell sure has gone to some lengths to make sure that taxes look high (and growing) and profit from the evil Fed is kept safely out of sight.

Ryan Avent reviews some ancient history today. As we all know, the 2009 stimulus package was smaller than it should have been given what we knew at the time. But it was way smaller than it should have been if we'd only known what was really going on. The House passed an $800 billion stimulus bill on January 26th:

Two days after that, Americans received grim news about the economy: in the fourth quarter of 2008, GDP contracted at a 3.8% annual pace—the worst quarterly performance since the deep recession of 1982....Unfortunately, the situation was far more dire than anyone in the administration or in Congress supposed.

Output in the third and fourth quarters fell by 3.7% and 8.9%, respectively, not at 0.5% and 3.8% as believed at the time. Employment was also falling much faster than estimated. Some 820,000 jobs were lost in January, rather than the 598,000 then reported. In the three months prior to the passage of stimulus, the economy cut loose 2.2m workers, not 1.8m. In January, total employment was already 1m workers below the level shown in the official data.

So what would Obama have proposed if he'd known that GDP had just contracted by 8.9% instead of 3.8%? Beats me. But even as cautious as he is and as mainstream as his advisors were, surely a recession that was more than twice as bad as they thought would have produced a stimulus that was something on the order of twice as big. I've never thought that the difference between, say, an $800 billion stimulus and a $1 trillion stimulus was a very big deal, but the difference between an $800 billion stimulus and a $1.6 trillion stimulus sure would have been.

BEA has a long track record of not doing a good job on GDP figures when the economy is turning sharply. It's too late to cry over spilt milk now, but if there's a way to get better at this it might help us out next time.

From Mitch McConnell, crowing over the debt ceiling fight:

I think some of our members may have thought the default issue was a hostage you might take a chance at shooting. Most of us didn't think that. What we did learn is this — it's a hostage that's worth ransoming. And it focuses the Congress on something that must be done.

Fine. I have no problem with talk like this. And on the bright side, this means that the pearl clutchers at Fox News will stop hyperventilating about Democrats who called Republicans hostage takers. Right?

Mitch McConnell, the Republican leader in the Senate, has made it clear that he considers hostage taking over the debt ceiling to be the new normal. From now on, Republicans are going to use the threat of default as a routine legislative maneuver. Michael Shear thinks Democrats should reciprocate and do the same when a Republican is president, but Jon Chait isn't sure this will work:

As a practical matter, I doubt this. In order to hold the debt ceiling hostage, you need, at the very least, extremely high levels of party discipline (in the House and the Senate, lest the upper chamber openly break ranks and isolate your hostage-taking wing.) You also probably need a propaganda apparatus that can create its own empirical reality in which the experts who warn that failing to lift the debt ceiling would create dire consequences are all wrong. I don't think the Democratic Party has either of these.

I'd add one more thing to this: what, exactly, would Democrats be holding out for if they did this? Republicans have an ideal topic: in return for raising the debt ceiling, we need to work on reducing the national debt. To a lot of voters, regardless of whether they approve, this at least makes sense. It seems natural, not artificial.

But what would Democrats do? Hold up the debt ceiling unless Republicans agree to bring the troops home from Yemen (or wherever our troops are a few years from now)? Hold up the debt ceiling unless Republicans agree to pass an immigration bill? Hold up the debt ceiling unless Republicans agree to reduce carbon emissions? None of these things seem even remotely tied to the idea of debt, which makes them far more obviously artificial than what Republicans did. And that means less public support and less media support.

That's a drag, but it's reality. Partisan tactics don't always work in mirror image form. We need to have our own outrageous tactics, not necessarily the same outrageous tactics as Republicans.

(Though Jon does offer an interesting twist: next time, maybe Dems should hold up the debt ceiling until Republicans agree to abolish the debt ceiling entirely. I don't know if that would work either, but it's an idea.)

Yesterday I suggested that if we really had to have a Supercommittee tasked with closing the long-term deficit further, it ought to be focused on healthcare since that's where our long-term deficit problem lies. But I left it to healthcare experts to figure out just what the committee should do.

The first thing to keep in mind, of course, is that when it comes to Medicare about half of our future increases are due to an aging population. Unless you're a big Soylent Green fan there's just nothing we can do about that, so we should face reality and accept the need for a gradual increase in Medicare taxes (or some other funding source) to handle that.

But we can also save money by making Medicare more efficient. PPACA does some of this already, but what more could we do? Austin Frakt is an expert, and he has some ideas:

  • More competitive bidding.
  • Prescription drug formularies to reduce pharmaceutical costs to VA levels.
  • Support comparative effectiveness research.
  • Based on that research, insist on paying for only the cheapest effective treatments.
  • Get tougher on setting rates for all healthcare providers, as the most efficient systems in other countries do.
  • Etc.

There's more at the link. If you want to get a handle on what we could do if we were really serious about cutting Medicare costs without sacrificing quality of care, it's a good place to start.