Known Unknowns


Welcome to Known Unknowns, a newsletter that sees the risk in unintended consequences from policies targeting problems that then become self-fulling prophesies.

Magical infrastructure thinking

Regular readers have probably noticed that I tend to favor market-based solutions to our problems. I think markets are amazing, and this is why I became an economist. The whole idea that there’s this force that brings people together in order to negotiate, create, and innovate is pretty amazing to me, even beautiful.

Though markets can always go wrong, there are externalities that people don’t price in, opaque information, incomplete markets for insurance—all of those things offer a scope of policy to improve markets. But the government can go too far, and it often does. Markets are like water—you can divert where they flow so much, but if you go too far, you can cause a lot of damage.

And now that we are in the midst of a very severe economic downturn caused by policy (even though it was justified for the sake of public health), the government's role to help us come out of it will be a hotly debated subject.

Like many New Yorkers, I watched many of Governor Cuomo’s news conferences over these past few months. And while this was mostly a satisfying experience, I must admit that he lost me when it came to economic policy. For example, there was little talk about helping small businesses and the rising unemployment rates. But he promised that the government could create demand with large infrastructure projects, such as gleaming airports in remote parts of New York state (and he would tell us this while sitting in front of a large bridge named after his father). The fact that the state is facing major budget shortfalls was not mentioned, but at one point, the governor suggested the can Fed should just print money to pay for it all. And that’s when I started to feel a little dizzy.

And the governor is not alone. Many people in both parties think that infrastructure spending is our way out. And who doesn’t want a train to LaGuardia? There’s evidence that good infrastructure promotes growth, and that we need better roads, highways, broadband, electricity, and dams.

But I get skeptical when we’re promised that any infrastructure will deliver higher growth. And I’m even more wary when people invoke the WPA programs from the Great Depression as evidence that this will all work. The works programs did help some, but they did not create sustained demand, and they may have even slowed job recovery in the private sector. And they’d be less effective now that construction requires more technical skills and requires inputs from abroad.

Again, I want that train to LaGuardia, too. But these projects need to actually be useful and necessary, and we also need a viable way to fund them. It’s wishful thinking that an out-of-work hotel concierge can build an airport in west New York, paid for by the printing press—and that anything good would actually come from that.

Fed policy

Thankfully, I haven’t heard any Fed official say that they are planning on printing money to pay for the Chris Cuomo Erie Airport, though if they keep buying muni bonds, they might. But so far, the Fed has stepped up, kept markets liquid, and ensured that many corporations and some medium-sized business could get capital. Corporate bond markets are doing record issues at record low rates, which is pretty incredible.

But I worry how this will go as we get into the next phase of this crisis. More businesses will go under, and there may be more shutdowns and uncertainty—which could mean more lay-offs and a negative demand shock. How much more can the Fed do? It’s one thing to keep the economy on life support, but a sustained downturn is another problem that requires a more deft policy. I’m grateful for an independent, competent Fed, even if I don’t always agree with everything that they do.

So, I’m distressed that the New York Times and the Washington Post (not as explicitly—but it’s still uncritical of the idea) are arguing that the Fed should adjust its mandate and specifically target Black unemployment. It’s a terrible idea, for many reasons. First of all, disparities in the labor market are a great injustice, caused by many complex problems like racism, lack of access to quality education, and housing policies. But the level of the Fed Funds rate doesn’t solve any of these problems, and pretending that it does avoids doing the necessary work to solve these very real problems. It’s another example of people passing off the buck to the Fed, even for things that it doesn’t have the tools to solve. Interest rates are a blunt tool that certainly have their downsides. Black Americans deserve better than this—they deserve actual change, and policies targeted specifically to their needs.

Never mind the fact that monetary targeting to one group of citizens obliterates any shred of Fed independence (why not target Native American unemployment, for example, which is even higher?), and never mind that it will lead to asset bubbles that will only worsen inequality and expose the Fed to even more scrutiny.

Rethinking the safety net

One of the things that I love about markets is the ways in which they change and evolve. This is progress. But the role of labor also changes. Once, we were serfs, then small-scale artisans and farmers, and then we eventually worked in factories. Then, we became knowledge workers and creative freelancers. But the problem is that institutions change slower than markets do, and this causes frictions, inequality, and people eventually falling through the safety net.

The Wall Street Journal tells us that many creative freelancers are struggling in California. They were among the first to lose their jobs, and many don’t know when they’ll be rehired. Curiously, there is no mention of AB5, which passed shortly before the pandemic, and which made it much more difficult and expensive to hire freelancers by trying to turn them into employees.

In any case, it shows how we need institutions to offer more support, and the CARES act did extend unemployment benefits to freelancers. But they need better options for healthcare, and possibly wage subsidies as well. Also, it shows why policies like AB5 are so destructive—you can’t just turn freelancers into regular workers with legislation. The market has changed, and so must the institutions that support it.

Risk assessment

Another argument for government intervention is that people can’t make good risk decisions because they are so riddled with behavioral biases, and a benevolent social planner has to take on all of the risk for them.

COVID-19 has been a case study in individual risk management that we’ll be discussing and debating for years. People must make risk assessments about what they’ll do and how much risk they’ll expose themselves to, as well as their families and their communities, too. And so far, people have been pretty lousy at it. Everyone I know appears to be overly cautious and will barely leave home (even if they are low-risk), or taking way too much risk—and sometimes it’s the same person. But is that really evidence of bias, or the result of lingering uncertainty? We are months into this thing, and we still don’t get consistent, clear information on what’s high-risk or low-risk behavior. News stories harp on tail cases and don’t tell us what the risk factors for complications actually are. You can’t expect people to make good risk decisions if they don’t have good data. No wonder people are either becoming totally agoraphobic or else crowding into already crowded bars.

The government does have a role to play in helping us make better risk choices, and this involves not allowing very risky activities that can cause harm to others while also educating us so that we can make informed trade-offs for the medium-level risks.

Until next time, Pension Geeks!