Diatribes of Jay

This is a blog of essays on public policy. It shuns ideology and applies facts, logic and math to economic, social and political problems. It has a subject-matter index, a list of recent posts, and permalinks at the ends of posts. Comments are moderated and may take time to appear. Note: Profile updated 4/7/12

25 December 2008

Think People, Not Ideas


One of life’s great lessons—which many learn too late—is that people matter more than ideas.

I learned that lesson early in adulthood. My work acquainted me with an extraordinary scientist at the beginning of the biotech revolution. He was (maybe still is; we lost touch) one of the smartest men I’d ever met. Besides accumulating a host of academic awards, he had picked up his kid’s Rubik’s Cube and solved it, by himself, methodically, in less than an hour.

But he had far more than analytical intelligence. He was a thoroughly honest, decent and approachable man, with common sense and people skills rare in academia. I observed his finer qualities as I watched him prepare to launch a business in his brave new field.

Neither I nor the people he dealt with understood much about that field or his ideas. But we all understood how exceptionally talented he was. So I scraped together everything I could afford and invested in his new company. I still remember rushing down to the bank with a cashier’s check just in time to subscribe to the limited partnership. About six years later, my investment had increased fourteen fold.

Those like me who teach and do research often love ideas more than people. So do many political pundits. People are so slippery and complex. They can turn on you or, like Blago, rot from within. Ideas, in contrast, seem steady and unchanging.

Academics and pundits love it when good ideas triumph. That’s why scientists love the story of French physicist Louis de Broglie. He discovered the numerical relationship between the energy of a photon and the frequency of its electromagnetic waves. Among many other things, his formulas explain why X-rays are much more potent than ordinary red light.

De Broglie wrote up his discovery in his doctoral thesis at the University of Paris. But his thesis was too short, only a few pages. So the University famously refused to award him the degree. Five years later, after experiments confirmed his theory, De Broglie won the Nobel Prize for his thesis. Then he got his degree.

Outside the halls of academe, life is seldom like that. It’s not easy to verify good social or business ideas with a few experiments. You have to risk political or financial capital, sometimes both. Sometimes you have to put your reputation—and others’ lives, fortunes and sacred honor— at risk for decades.

So in social and political life good ideas often go begging. Harry Truman recognized the need for universal health care, but we still don’t have it. Jimmy Carter warned us thirty years ago to wean ourselves from oil. He wore sweaters in the White House as a symbol of conservation, but the nation ridiculed him. After the Japanese auto “invasion” of the 1980s, anyone could see that better engineered, lighter, smaller, more fuel efficient cars were the auto industry’s future. But Detroit never took the hint. Instead it stayed on its glide path toward oil addiction and a handout from Washington.

Were these failures of ideology or failures of leadership? The right ideas were old; they still are. What was missing was people who could understand them and put them to work, avoiding obstacles and exploiting changed circumstances.

Ideas also can be treacherous. They are so malleable. People can twist and abuse them, willfully or by neglect.

In the hands of Dubya and his crew, the notion that free markets are powerful tools for social progress became “greed is good.” Thomas Jefferson’s idea that the natural state of Man is liberty became “let’s force it down the throats of alien people who never had it and don’t understand it.” After thousands of American deaths, tens of thousands of Iraqi deaths, millions displaced and trillions spent, that ill-advised corollary is still in doubt.

Dubya’s everlasting tragedy is that not all of his ideas were bad. We know now that invading Iraq and privatizing Social Security were bad ideas. But some of Dubya’s ideas were good. He won in 2004 in part because he had a grand vision, while John Kerry had none. The problem was that most of Dubya’s ideas were wildly unrealistic, and he and his team were incompetent to identify the good ones and carry them out.

A love of ideas may be why the mainstream media took so long to warm to Barack Obama. Only last week, as it made Obama its “Man of the Year,” did Time Magazine finally get it right. Obama’s most important characteristics are not his race, his funny name, his unusual family background, his brilliant speechmaking, his charisma, his coolness under fire, or any of the other things about which our media obsessed endlessly. They are his competence and businesslike, non-ideological approach to solving problems—his willingness to go wherever the facts and pragmatism lead him.

We’ve lacked leaders with those traits for so long that it took Obama’s spectacular electoral success for Time to see the light. A bit late for voters, wouldn’t you say?

In fact, it’s hard to pin any ideas on Obama. Change is not an idea; it’s a campaign slogan. In his first news conference, Obama wouldn’t even commit himself to raising taxes on the rich. Let’s “take a look at the data,” he said, and then decide what to do. To him, ideas are not ends in themselves; they are only tools to build a more perfect union. That edifice, not the tools used to build it, are his final end. As his extraordinary campaign has shown, he’s a good builder.

We are in good hands not because Obama has good ideas (which he does), but because he’s a good person: superbly educated, smart, thoughtful, careful, humble, and endowed with extraordinary judgment and managerial skill. Somehow, despite all the myth and rumors, the American electorate picked the best candidate: the best leader, the best manager.

Obama picked his Cabinet the same way. With few exceptions, they’re low-key, highly skilled, non-ideological people like him. He even balanced the few ideological and political picks with opposing forces elsewhere in his administration. With every selection and announcement, he was telling us “ideas don’t matter; people do.” Ideas often have to change with circumstances.

If we can accept this bit of his leadership and run with it, we just might pull ourselves out of our slump quicker than anyone now expects. Pick the best people, and good ideas will follow. The converse just isn’t so.

With that idea firmly in mind, we can look forward to a new year with better leadership. Happy New Year!

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20 December 2008

A Season for Workers?


We are sliding into the most depressing holiday season in memory. Millions have lost or are losing their jobs, their homes or both. Health care for many workers is still a dream. Every economic trend is down.

Our Masters of the Universe crippled our economy in an orgy of greed. Now our stalwart worker and consumer—battered, abused and confused—may be giving up. He and she may be abandoning the Race to Acquire Stuff, on which 70% of our economy depends. Their dropout might improve our abysmal national savings rate, but the price might be a decade or more of economic stagnation.

Whatever awaits us, the odd term “worker-consumer” holds the key to any hope.

Henry Ford understood. He made his cars cheap enough—and his workers’ salaries high enough—so they could afford to buy the cars they made. The textbooks credit him with inventing a new industrial tool, the assembly line. But the textbooks are wrong. What Ford really discovered was a new social order.

For most of human history, skilled workers had designed and built things for the rich and powerful. First they worked for nobles under a system of royal patronage. Then the corporation’s advent brought a class of nonhereditary private owners, and laborers worked at their beck and call.

But with Ford’s insight, workers began to make things for themselves. They were (and are!) far more numerous than owners. So they became the “market.” Through their collective buying decisions, they determined what to make. Then, under the supervision of their managers, they made it.

This change in the regime of human production was unimaginably consequential. Standardization of design, assembly-line production and mass markets led to economies of scale unheard of in human history. In one year our auto plants turned out more technologically advanced vehicles than all the Conestoga wagons ever made. And workers’ high salaries let them afford these advanced creations. Thus was a uniquely American prosperity born.

That uniquely American regime of industrial production helped win humanity’s greatest and most dangerous war. It began an era of unprecedented social cohesion and prosperity, which is only now ending. The only other great, democratic empire to achieve a similar feat was ancient Rome’s, nearly two millennia before.

So what has gone so wrong? Ford had a key economic insight. Giving workers a fair shake expands the market, builds productivity and prosperity, and makes owners richer. It’s a classic win-win-win. You might call it “trickle up.” Ford’s insight still has enormous resonance today, if anyone would heed it.

But no one ever solved the governance problem. Some one has to run things, including industrial companies. Our economic vehicle is in a ditch because greedy morons took the wheel. For them, Ford’s enlightened self-interest would be an enormous improvement.

Although a visionary, Ford himself remained an unconscionable autocrat. His most famous remark (apropos of his Model T) was “you can have any color you want, as long as it’s black.” He was willing to pay workers a fair wage only when it suited him. Despite his extraordinary insight into the real source of wealth and prosperity in industrial society, he never broke with his self-obsessed social class.

Our problem today is not who’s winning the class struggle. Most of the time, we’ve managed it better than most other countries in most of human history. We Americans understand that “Which Side Are You On” is a nice, stirring union song but no recipe for real social or political progress. We have to make the pie bigger, not fight over scraps.

The public did not elect Barack Obama by decisive margins—and does not now support him by even greater margins—just to restore the divisions of the sixties, let alone the last century’s thirties. Our problem is something else: a shortage of excellence and innovation, plus the loss of basic competence.

We could squeeze our auto workers to Asian levels of pay and benefits and beyond, and still our cars wouldn’t sell, although they’d be cheaper. We need better industrial leaders to make better decisions and take the right risks. We need market-leading innovation, not heavier weight, new body styles on old platforms, or incomprehensible financial instruments to support yet more credit.

How do we get good industrial leaders? That’s the $ 64 trillion question. The Russian revolution collectivized and politicized everything and failed spectacularly. China is leaving Russia in the dust after abandoning that rotten system earlier and more decisively. Germany has had some success with labor representatives on corporate boards of directors, but its system has made its industry less agile. Japan has been the most successful in heavy industry, with “quality circles” that get real ideas from real workers and give them real attention and real rewards (both psychic and monetary) in return. Not coincidentally, Japan has the “flattest” pay scale, i.e., the lowest ratio between CEO pay and worker pay in the industrialized world.

Despite Peter Drucker and his proselytizing for excellent companies, we’ve had no real revolution in industrial management in America since Henry Ford. We copied Japan’s kanban system of “just in time” supply, but we failed to adopt fully Japan’s quality circles and respectful treatment of workers’ ideas. Our car industry’s obsolete Detroit culture still operates under a modified system of owner autocracy established by Henry Ford.

So what do we do? Do we wage yet another class struggle? Do we sit around while our economy completes its self-destruction, waiting for a new, better incarnation of Henry Ford—a Barack Obama of industry?

What we should do is think hard about institutional changes to encourage innovation, maintain industrial agility and make better use of workers’ minds, as well as their hands. A flatter, more horizontal management structure is an obvious desideratum, but how to get it and whether politics can force it are not easy questions.

While thinking about these fundamental issues, we can do three things. First, we can restore specialization, i.e., the division of labor that came with the industrial age.

Conglomerate empire building has been a colossal failure. Everyone from the union hall to the boardroom and Congress now knows this. All should recognize this truth in every policy and deed.

GE is a prime example. One of our excellent industrial companies, it’s floundering because it caught high-finance fever. It makes the world’s best high-technology windmills, medical equipment, water purification equipment, gas turbines and jet engines. Why is it trying to compete with Wall Street ? Its finance arm is dragging it down even more than its century-old commodity light-bulb business, so it’s trying to sell both in a down market. Maybe Warren Buffet, with the leverage of his bridge investment, can help GE relearn how to stick to its knitting.

The auto industry is another case in point. As a condition of any bridge loan or bailout, the best thing the government could do would be to fire all current top management and split GM and Chrysler up.

If necessary, pass antitrust exemptions to allow economies of scale in purchasing and standard part design. But spin off every brand as a separate company. Force each to complete with the others and with rivals in the marketplace. That alone would make room for new industrial leaders unspoiled by stagnation and corruption.

Spun off, some GM brands might even attract private investment. Cadillac has lots of fans for its new, smaller, more agile cars. The Chevy Volt is the only American car enterprise in my lifetime to steal a march on Toyota. Spin it off, and I’ll not only buy a Volt. I’ll buy stock in the company, too. But neither I nor any other sane private investor will invest in GM the conglomerate.

The second thing we can do is find better ways to bring workers’ minds, as well as their hands, to bear on design and production. Who better knows how to improve a car than the man or woman who builds it every day and probably drives one as well?

We need better institutionalization of worker input. We need to do more than either German board representation or half-hearted American attempts to copy Japanese quality circles. Whatever we do, it must reflect American culture, and it must have a visionary and irrepressible champion. Without a champion, any effort to make progress on this politically fraught front will likely fail.

The quid pro quo for genuinely respectful treatment of workers’ minds and ideas is relaxation of counterproductive union work rules. It’s one thing for unions to demand a good wage, decent benefits, and unstressful and safe working conditions. It’s quite another for them to hobble automation and efficient factory management by refusing to allow inefficient plants to be closed, redundant workers to be reassigned or laid off, or whole categories of unnecessary work to be discontinued. Although understandably directed at preserving jobs, rigid work rules ultimately destroy jobs by making producers inefficient and inflexible and therefore uncompetitive. Collective bargaining agreements have to come down from book-length documents to short pacts that focus on the essential conditions that Ford understood: a living wage, decent benefits, and fair and humane working conditions.

Finally, as I’ve written before, we need to take the millstone of legacy costs from around our heavy industry’s neck. It’s no answer to have Big-Three workers take the same pay and benefits as their counterparts in Asian-owned American plants. Those Asian-owned plants aren’t paying for the retirement and health care of our Greatest Generation of workers, who built our prosperity after World War II. Our government has to step up to the plate and take on the social obligations that every other advanced government has willingly accepted. If it doesn’t, our remaining heavy industry will simply complete its flight overseas.

Maybe flight is inevitable when an economic empire like ours decays. But even Britain still has Rolls-Royce, which makes superb jet engines and industrial machinery, in addition to luxury cars. If we act quickly we might preserve even more of our great industrial base for future generations. I’d hate to see Boeing, Caterpillar, or GE go, too.

American workers don’t want handouts. They never have, and they never will. What they want is better institutions that better recognize and use their skills. What they need is better leadership, both industrial and political.

In two respects, time is on American workers’ side. First, as I’ve outlined in another post, scarcity of and inelasticity of supply and demand for energy are going to make intercontinental transport of heavy goods (like steel and cars) less economic. As oil reaches yet unseen prices (which it will as soon as the global economy recovers), the worldwide race for the bottom in worker treatment will cease, at least insofar as heavy industry is concerned. Increasing standards of living and worker aspirations in places like China, India and Vietnam will add political to economic pressure.

The result will be a cessation—or at least a dramatic reduction—in the global squeeze on workers. Unions that understand and exploit these long-term trends will do a better job of protecting their workers by focusing on what really matters: more productive partnerships with management and less pie-splitting. If the last two decades have taught us anything, it’s that workers do not improve their lot by making their employers inefficient or uncompetitive.

On January 20 we’ll have good political leadership. What we lack is industrial leadership of similar quality. Our auto industry is dying. GE is sick. Even Boeing is nearly a year behind on its “Dreamliner.”

So the best our political leadership can do is maximize the chances for good industrial leadership. It can begin by: (1) splitting up failing big firms and spinning off their parts to give industrial leaders more ways to grow and private money more reasons to invest, (2) encouraging new, cooperative relationships between owners and workers and new institutions to exploit their respective talents, and (3) at long last, sparing industry the enormous cost of social obligations that every other advanced society bears collectively.

If the Obama team hits the ground running and begins working toward these goals quickly, the American worker still has a chance. If not, our commanding lead in industry, which began so auspiciously with Henry Ford, may mimic an old soldier or decaying empire. It may just fade away, leaving both workers and owners sadder and poorer.

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16 December 2008

Energy Economics


Introduction
Scarcity
Inelasticity of Supply and Demand
Fixed Versus Marginal Cost
External Costs
Comparison Table and Conclusion


1. Introduction. Energy is the crying issue of our time, bar none. Even with oil prices down at $40 per barrel, we are still spending nearly half a billion dollars per day on imported oil, because we import ten million barrels a day.

Developed countries need energy to maintain their lifestyle and pace of innovation. Developing countries—especially the “BRIC” nations Brazil, Russia, India and China—need it to complete their process of orderly development and avoid social unrest. Least developing countries need it to overcome decades or centuries of poverty and avoid slipping further behind.

The era of cheap oil is coming to an end. Everyone knows it. Over the next several decades, humankind will have to make massive investments in new forms of energy to replace oil. The biggest question confronting us is in what sources to invest.

The alternatives are wind, solar, biofuels, nuclear and coal (including various forms of coal-derived “oil”). Natural gas may also provide an alternative, but the extent of natural gas reserves is still highly uncertain.

Which source(s) of energy we choose for our near-term investment will determine the health of our global economy, our people and our planet. There is no more consequential choice for the future of our species.

Fortunately, we do not have to choose in the dark. Economics may be a “dismal” science, but it’s still a science. Over the last several centuries it has developed some useful ideas that can help us make the choice. The most important are: (1) scarcity; (2) inelasticity of demand; (3) the difference between marginal cost and fixed costs; and (4) “external” or nonproduction costs of energy and fuel.

Among economists, all these ideas are well-established and non-controversial. Experts use them every day. Neither policy makers nor the public can understand the question, let alone find answers, without them.

2. Scarcity. Geologists disagree about whether we have reached “peak oil”—the point after which global oil production inexorably declines due to scarcity of untapped reserves. Some think we have; others think not. Some think (and many hope) that new technology will discover unlimited sources of new cheap oil. Part of the reason for the recent extreme volatility in oil prices is uncertainty over how scarce oil really is.

But economists and policy makers don’t have to worry about degrees of scarcity. You can make considerable progress in your thinking by defining “scarcity” much more simply. A commodity is “scarce” if its supply is limited over time scales of interest for current investment.

That is definitely true of oil. Investments in pipelines, refineries and drilling (especially the deep and undersea drilling now required to reach yet untapped oil), are designed to last several decades. Typically they are supposed to last thirty to forty years.

No one expects oil to act like an unlimited commodity over that time frame, especially not as BRIC countries double or triple their usage and global population expands by 50%. Geological processes take millions of years to produce new petroleum, and what we have on Earth now, wherever and however deep it may be, is what we’ve got. Oil is scarce in the sense of not being unlimited over reasonable investment time scales.

What about the alternatives? At the moment, the U.S., China, Australia and Eastern Europe all seem to have reserves of coal sufficient to last a century or more. That’s more than typical investment time, so coal is not scarce. The same can be said, with somewhat greater uncertainty, about natural gas.

Wind and solar power are even more unlimited. Based on then-current technology, with appropriate storage a set of solar thermal power arrays [see paragraph before heading “Replacing Oil”] equivalent to one twenty-ninth the land area of Texas could have supplied our entire national electrical power requirement for 2005-2006. Furthermore, both solar and wind power are in their infancy: wind power is just beginning to reach [search for “Global Wind Power”] its global exponential growth phase, and solar hasn’t yet seriously begun. For practical purposes of present investment, wind and solar power are unlimited, i.e., not scarce.

Nuclear and biofuels require more nuanced analysis. Properly designed “breeder” reactors can make their own nuclear fuel, forever. But for two reasons, no one is designing or building breeder reactors any more. First, the chief breeder fuel—plutonium—can make fissionable material for nuclear weapons, without expensive refinement or purification. Plutonium fuel is a proliferation nightmare.

Second, quite apart from its weapons potential, plutonium is one of the most dangerous substances known to humankind. As a heavy metal, it is highly toxic, much more so than lead. With its radioactivity, it is so poisonous that inhaling a single particle can cause lung cancer. Not for nothing is plutonium named for Pluto, i.e., Hades and Hell.

So current plans for expanding nuclear power rely on enriched uranium for fuel. Although toxic, too, it’s not nearly as bad as plutonium. And uranium enriched for power plants requires additional enrichment for nuclear weapons. So compared to plutonium, uranium is a much safer alternative.

Unfortunately, uranium is much like oil insofar as scarcity is concerned. We know that its quantity in the earth’s crust is limited, but we don’t yet know just how much there is. The deposits we know of are localized in certain countries, mostly outside the developed world, in places like Niger. So transportation cost and political risk add to the element of scarcity. Therefore nuclear power, practically speaking, is a scarce commodity, although probably not as scarce as oil.

Biofuels are also scarce, i.e., limited, because they require land, fresh water and energy to grow. The Earth’s land area is finite, and its arable land even more so. Most of the arable land is already spoken for; we use it to grow crops for food. In addition, biofuel crops take fresh water to grow. Even switchgrass, although it needs less water than corn, takes energy to plant, fertilize, irrigate, harvest, and pulp its cellulose, as well as to grow and handle the enzymes or genetically modified bugs that convert raw pulp to usable fuel. Like land and fresh water, most of these resources are limited.

This point is not just theory. Most economists believe that last summer’s anomalous global spike in food prices reflected futures markets digesting plans for diverting agricultural land from food to fuel production. Those markets’ anticipation had a predictable effect on food prices. No doubt they overshot, as they often do. But the effect was real and to be expected. Biofuels are scare in the sense of relying on limited resources—land, fresh water, and other fuels. In any foreseeable future scenario they will remain so: they will compete with scarce food for land, fresh water and agricultural investment and energy.

3. Inelasticity of supply and demand. The second fundamental concept that should guide our energy choices is inelasticity of supply and demand. A commodity is said to be “inelastic” if small changes in its supply or demand cause big changes in market prices. That happens when there are few or no substitutes for the commodity and consumers’ costs of switching to substitutes are high.

For demand, I’ve explained this concept in detail in another post. It’s actually quite simple. If you’ve spent $40,000 on a big SUV that runs only on gasoline, you have no choice. You can’t switch to substitutes like ethanol or diesel because they’ll ruin your engine and devalue your $40,000 investment.

You might take public transportation, but it is inconvenient and, in many parts of our country, unavailable. So you’ll pay whatever gas costs to get to work to earn a living. As gas prices rise, your only alternative is to write off your $40,000 investment and buy another form of transportation.

But you may have noticed that, except for the Prius, other forms of transportation are not exactly ubiquitous. So, at a very personal level, your demand is “inelastic.” You buy gas, whatever it costs, or you stop going to work and taking your kids to school, i.e., you stop living.

This sort of inelasticity is exactly what has yo-yoed prices of oil and gasoline over the last several years. The price of a barrel of oil has gone from $40 to nearly $150 and back again. That’s nearly a factor of four!

During that time, what changed? Human population certainly didn’t go up and down by a factor of four. Nor did the number of cars worldwide, which is slowly but steadily increasing.

What caused the rise was slow but steady increases in global automobile production and usage, with further increases expected. The percentage increases were in the low single digits. Yet they caused price to vary by a factor of four. That’s inelasticity!

Now that the global economy is slowing, futures prices have dropped dramatically. But actual demand for oil is only beginning to slow, so far by only one or two percent. Futures markets, which are predictive and often overshoot, are telling us the very same tale of inelasticity: little changes in demand produce big changes in price because demand is highly inelastic.

Supply is also inelastic because oil is scarce. Even if it weren’t scare, new sources of gasoline (oil wells, pipelines and refineries) take decades to bring on line. And there is also the ever-present factor of geopolitical risk, include war and terrorism in the Middle East.

Inelasticity relates intimately to substitution and scarcity. Your personal demand for gasoline is inelastic because your car won’t run on any other fuel. You have no substitutes. At the same time, the supply of gasoline is inelastic because oil is scarce. Even Saudi Arabia can’t ramp up production indefinitely or immediately, even to exploit oil prices near $150 per barrel. So you suffer and pay the price, economizing in other areas, even food. That’s inelasticity!

Now imagine that you had a “flex-fuel” car, which could run on either gas or ethanol. As the price of gas rose, the price of ethanol would constrain your cost of transportation. If a gallon of ethanol cost less than a gallon of gas, you could switch. But as we have seen, biofuels are also scarce, so in the long run that might not be much of an improvement.

Now suppose your car could run on electricity, by charging good batteries. Then you could run it on wind, the sun, hydroelectric power, coal, nuclear energy, natural gas, or even geothermal energy. Your options to satisfy your demand would be vastly increased, the more so because the supply of some of these sources (especially the wind and sun) is not scarce. And supply would be flexible, i.e., not inelastic, for the same reasons.

Whatever source of energy was cheaper, you could use. That in a nutshell is why the Chevy Volt could be a transformational product, which Congress should not just save, but expedite, at all costs.

4. Fixed versus marginal cost. The third fundamental concept of energy economics is the difference between fixed and marginal cost. These terms sound complex but are quite simple.

Let’s go back to that $40,000 SUV. If it’s your only car, $40,000 is your “fixed cost” of transportation. It’s a one-time, sunk investment—a lump sum, a done deal.

Fixed costs are not easy to reduce or reverse. You could sell your SUV used, but you’d take a big loss on the original purchase price. The equivalent on the supply side (although much more expensive) is a field full of oil wells, a pipeline or a refinery. Try to sell a used oil field that is running dry, and you’ll discover what the terms “fixed” and “sunk” costs mean. (For our purposes these terms are roughly equivalent.)

Your marginal (incremental) cost of transportation is (neglecting maintenance and insurance) what you pay for gas. Let’s say you now pay $ 2 per gallon and get 20 miles per gallon. Your marginal cost of transportation is 10 cents per mile. If gas prices go up to $ 3 per gallon again, so does your marginal cost; it goes up to 15 cents per mile.

The key difference between marginal and fixed cost is that marginal cost is optional. You can’t “unbuy” your SUV. But whatever the price of gas, you can save on marginal cost by driving less. You can even cut your marginal cost for gas entirely by taking public transportation and not driving at all. But in doing so you would devalue—and eventually have to write off—your $40,000 fixed-cost investment, less what you might sell your used SUV for.

The distinction between fixed and marginal cost is absolutely crucial for making intelligent energy choices. Why? Because marginal costs vary dramatically depending upon the source of energy we choose.

Here’s where wind and solar energy shine (pardon the expression). Their marginal cost is zero because the wind and sun are free.

Not only that: once society has incurred the fixed cost of building a grid to take wind and solar power to cities, the costs of transportation are free, too. Electrons glide to market on their own Coulomb forces; they don’t have to fill up their tanks with costly fuel. In contrast, oil, gasoline, natural gas, uranium—even biofuels—require effort, energy and transportation at every stage from extraction to use. Transportation of heavy liquids or volatile gases is a significant part of their marginal cost.

There are small costs for maintaining windmills, solar arrays and electric grid. But we can safely ignore them for first-order analysis. They are a drop in the bucket compared to the cost of extracting, processing, storing, safekeeping (especially nuclear fuel), transporting and marketing physical fuel. Because electrons don’t weigh anything and transport themselves, nothing can compare to electricity in minimizing marginal cost. And nothing can compare to means of generating electricity that, like wind and solar power, don’t require any fuel.

There are other “free” sources of electricity besides wind and sun. Hydroelectric, geothermal, and tidal power are among them. But unlike wind and sun, these sources are localized and limited geographically and therefore scarce. Wind and sun are ubiquitous and, at our current stage of human development, virtually unlimited.

In comparison, the marginal cost of fuel-based energy is much higher, whatever the fuel. Moreover, scarcity increases the financial and practical risk of fuel costs. As demand inevitably increases with population growth, scarcity (defined as limited supply) produces steadily increasing prices. Equally important, uncertainty of supply—including political risk and varying “guesstimates” of actual reserves—mean increasingly wild price fluctuations as futures markets guess at a continually changing global balance of supply and demand.

To some extent these points apply to every physical fuel: oil, natural gas, tar sands, uranium, biofuels—even coal. As human population increases 50% over the next four decades, and as demand for energy increases accordingly, the price of every fuel will increase dramatically. Those fuels for which supply estimates are uncertain or varying, including oil and uranium, will experience wild price gyrations, as did the price of oil over the last several years.

In contrast, the energy value of windmills and solar arrays will depend only on long-range predictions of weather patterns, i.e., warnings of dramatic, secular changes in wind and sun. They will not include political risk in foreign lands. And because the generators will be widely distributed geographically, they will dramatically reduce the risk of terrorism to energy infrastructure. (Biofuels also have this advantage of geographic dispersion, although their scarcity will likely make their prices more volatile than those of solar and wind energy.)

5. External costs. Over the last forty years, one of the most important developments in economics has been the notion of “external” costs. These are real costs that market prices do not reflect.

Coal provides the most extreme example. The market “price” of coal reflects only extractive costs, i.e., what it takes to dig the mines, bring up the coal, and prepare it for marketing. All other costs the market price excludes.

What are these other costs? There are many. First, there is the cost of transporting coal from mine to power plant. Second, there are the immediate environmental effects of mining, including displaced soil threatening mining towns, burying local streams, and polluting local aquifers, plus the cost of harm done by local air pollution produced directly by mining operations. Third, there are health effects on miners and their families, including injury, death, and things like “black lung” disease, which proper mining operation can reduce but never eliminate. Coal mining is still one of the most dangerous occupations in the civilized world.

Fourth, there is sulfur dioxide pollution (which forms sulfuric acid when combined with water, as in rain or fog). There are children’s asthma and its treatment, other respiratory diseases, and “acid rain” throughout our northeast, which federal regulation and interstate compacts are just beginning to get under control after decades of effort. Fifth, there is mercury pollution, which poisons our rivers, lakes and oceans. Coal-generated mercury already has required warnings against pregnant women eating too much tuna and anyone eating too much sushi. Sixth and most important, there is global warming, with all its implications for climate change: rising sea levels, increasing severity of storms, increasing drought, the relentless march of tropical diseases northward (or in the southern hemisphere southward), the loss of ice habitat for native people and animals in polar regions, the imminent loss of low-lying tropical land in the Maldives and South Pacific, and the possibility of mass human migration and war caused by the submergence of low-lying areas worldwide.

It’s hard to put a price on all these many consequences of burning coal. It’s even harder to put a price on millions’ loss of life’s enjoyment as pollution increases, mosquitoes and other disease-bearing pests move into densely inhabited temperate urban areas, and poverty and desperation increase worldwide while we lose low-lying arable land and coastal areas to a rising sea.

All these costs are real or imminent. Proposals for so-called “cap and trade” carbon credits or a “carbon tax” are designed to monetize them and include them in our market pricing system, so that the market prices of coal and other fossil fuels reflect all their costs, including societal and long-term costs.

Yet even these proposals don’t account for all external costs. A carbon credit or carbon tax, for example, would treat coal the same as oil or natural gas, despite that fact that burning oil or natural gas does not create significant sulfur dioxide or mercury pollution.

So far, complete estimates of various energy sources’ external costs are only educated guesses. But we can say three things about these costs. First, for coal and other fossil fuels, they are huge. Global warming, which threatens to remake the planet on which we evolved, are among them. Second, they are highly uncertain. Most current estimates are likely to be low because there are so many possible consequences and so few of them can be quantified. (Quantitative analysts tend to ignore things they can’t quantify, just as the derivatives ratings agencies ignored the risk that housing prices wouldn’t keep going up.)

Finally, while we cannot estimate external costs precisely, we can prioritize our energy alternatives in terms of descending external costs. Coal has by far the most deleterious and wide-ranging external costs. Other fossil fuels, which pollute less but still produce carbon dioxide, are second worst. Oil is worse than natural gas because it produces hydrocarbon smog while natural gas does not.

Nuclear power produces no air pollution or carbon dioxide, but it does produce a small amount of radioactive solid waste requiring transportation and careful disposal. Biofuels should produce little or no air pollution; they do not contribute to global warming because the carbon dioxide produced by this year’s burning is taken up in growing next year’s crop. Yet biofuels increase the prices of land and food as they usurp resources used for food agriculture. They also generate some incidental air pollution and carbon dioxide as they use fossil fuels for agriculture and transportation. That, too, is an external cost.

“Natural” means of producing electricity have by far the lowest external costs. They produce no pollution or carbon dioxide whatsoever. Hydropower may disturb riparian fish migration, as is happening with salmon in our Pacific Northwest. Geothermal energy may release subterranean sulfur dioxide and hydrogen sulfide. But wind and solar produce no pollution and disturb nothing except views of sagebrush and (absent simple precautions) maybe some particular paths of migratory birds. Thus wind and solar power “win” the external cost comparison hands down.

5. Comparison Table and Conclusion. We can now summarize this discussion in the following table:







SourceScarcity1Supply
Inelasticity
2
Marginal Cost3Uncertainty4External Costs5Reliability6
SolarLowLowZeroLowZeroHigh
WindLowLowZeroLowVery lowHigh
HydroHighHighZeroMediumVery lowHigh
BiofuelMediumLowMediumMediumLowHigh
Natural
Gas
MediumMediumMediumMediumMediumHigh
NuclearMedium7MediumMediumHigh8LowHigh
OilHighVery HighMediumVery HighMediumLow
CoalLowLowMediumLowHighestHigh

TABLE NOTES:
1.“Scarcity” means the extent to which supply is or will be limited in the relevant time frame for investment. Lower is better.
2.Solar and wind have low supply inelasticity because their power arrays are infinitely scalable and quick and cheap to site, permit and build. Biofuels have low inelasticity because there is always room to grow new crops. (Displacement of food crops is a factor in “Marginal Cost,” “Uncertainty“ and “Reliability.”) Lower is better.
3.Marginal cost of producing a unit of energy, including fuel (if any) and transportation and labor costs, but excluding the cost of maintaining plant and infrastructure. Lower is better.
4.Uncertainty in marginal cost, including temporal uncertainty, medium-term economic uncertainty and geopolitical risk. Lower is better.
5.Complete assessment of external costs, including all forms of pollution, health effects, global warming, and probability-discounted catastrophic effects, such as nuclear-plant terrorism or meltdown or radioactive storage leak. Lower is better.
6.Medium-term reliability of supply. Reflects similar factors to “uncertainty” but focuses on risk of severe supply disruption. Higher is better.
7.Assumes uranium-based fuel cycle; plutonium fuel cycle is deemed too risky for widespread use.
8.The primary factor here is not accidents, but the cost of uranium. It takes 15-20 years to design, site and build a nuclear power plant. No one knows what the price of uranium will be at the end of this long process. Changes in the global market could render an investment made fifteen years earlier uneconomic, before any power is generated.

* * *


As this table shows, wind and solar energy beat the other sources in almost every respect. They are so superior that you wonder why we aren’t already engaged in a massive program to exploit them.

The only disadvantage of wind and solar is that they are intermittent. Wind doesn’t blow all the time, and the sun doesn’t shine at night or every day.

But there are places in this country where the wind blows almost all the time, even at night. And there are also places in this country, including most of New Mexico and Texas, where the sun shines about three days out of four. We know where those places are, and we can build our windmill and solar arrays there. The only thing that might shut them down for extended periods is (God forbid) a nuclear winter.

As for routine intermittency, there is a simple answer. We are already using the worst possible fuel—coal—to make over half our electricity. Until wind and solar power reach that same fraction—half—of our power needs, we can simply use them, however intermittently, to replace coal. Every kilowatt-hour made by sun or wind is a kilowatt-hour for which we don’t have to burn coal (or even natural gas), with all its horrendous direct and indirect consequences, including asthma, acid rain, mercury pollution and global warming,

It will be a decade, at least, maybe two, before we get to the point where wind and solar replace coal and other fossil fuels, even just for electric power. We don’t have to worry about intermittency until we get near that point. By the time we do, we will probably have good batteries to solve the intermittency problem decisively. And as soon as we have good batteries in plug-in hybrids like the Chevy Volt, wind and solar power can start replacing oil as the energy source for transportation, too.

Millions of laptops, iPods and cell phones use nontoxic, nonpolluting lithium-ion batteries reliably right now, today. It is only a matter of time before we scale them up for commuting and household use. The nation that first does so will have a jump on what is likely to be one of the biggest markets of the twenty-first century.

A final advantage of wind and solar power—which does not appear in the table—is that investments in them are infinitely scalable. They can run from a single windmill or small solar array for a little town to a massive array for a city. Whatever their size, their low level of danger and environmental impact mean that siting them and assessing environmental effects will proceed quickly. In many cases the permitting process can take months, as compared to years for coal-fired power plants and decades for nuclear plants. Wind and solar are fine technologies for quick-start, geographically dispersed power generation.

So we have a clear glide path to energy independence with zero pollution, zero marginal cost (except maintenance), and the lowest external costs of any known energy source. Any rational business person, policy planner or economist would take that opportunity and run with it.

That’s why President-Elect Obama has emphasized wind and solar power throughout his campaign and does so now. (Whether his new energy man, Steve Chu, overemphasizes biofuels is another issue, which I’ll address soon.) Did I mention that Obama has strategic vision?

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12 December 2008

Our Global Paradigm Shift


[For a prescription for the holidays, click here.]

One reason why the current “recession” promises to be particularly severe is that two things are happening at once. We have a severe short-term problem, but our long-term challenge is even more serious.

The short-term problem is a burst asset bubble—in housing prices. That bubble coincided roughly with a commodities bubble, making it twice as dangerous. These two nearly simultaneous bubbles followed a high-tech bubble, which in turn followed bubbles of varying duration in Japan, Russia, the rest of Asia, and elsewhere.

Asset bubbles like these are older than the Dutch tulip craze of 1624. We can’t foresee an end to them. If two can burst simultaneously in twenty-first century America, despite a vibrant free press, universal literacy, and a presumably skeptical population, they can inflate and burst anywhere at any time.

Boys will be boys. Perhaps if women had a greater role in economic decisions, bubbles might occur less often or might inflate less grotesquely before bursting. That’s why the remarks that got Larry Summers fired as president of Harvard were so unfortunate. Women in positions of economic power might give unproven economic dogma less credence, show a little less raw greed, and maybe exercise more common sense. That approach is certainly worth a try.

But without the saving grace of as-yet-unexploited gender differences, asset bubbles may be part of the human condition. We may be stuck with them forever. We’ll get through these bursting as we have all the others—slowly, painfully and suitably chastened, until irrational exuberance strikes again.

What’s new is the long-term challenge. For the first time in human history, we are running out of planet to plunder.

By “we” I mean the human race. We simply can’t go on living as we have, and we know it. As I’ve explained at length in another post, the recent run-up in oil’s and other commodities’ prices is just a series of classic market signals warning that we are reaching our limits. (Don’t worry about the recent pseudo-“crash;” commodities’ prices will resurge as soon as there is any sign of economic recovery.)

Signs of dawning realization are everywhere. It’s not just Al Gore’s new status as prophet. Nor is it President-Elect Obama’s honest affirmation—after eight years of moronic denial—that global warming is “a matter of urgency and national security.” It’s everything from the “eat local” movement to the dramatic global explosion in wind energy. It’s the understanding—at least in our scientific community—that exploding destruction of native forest is ruining the global oxygen-carbon dioxide balance that not only keeps our climate cool but supports all animal life on Earth, including us.

Slowly we are beginning to understand that a lot of things we’ve done without thinking don’t make much sense. Things like burning coal and oil for heat and power provide short-term benefits but threaten our species’ long-term survival.

Even speaking of “long-term“ consequences may be a misnomer. The consequences of our collective folly are “long term” only to people accustomed to reading quarterly reports. In fact, absent a paradigm shift, dramatic consequences will appear in your grandchildren’s lifetimes, if not in your children’s. We Boomers are not just throwing the most reckless party in human history and leaving the bill to our kids. We also may be destroying the House we evolved in. What a party!

But look at the world outside the dance hall. If you do, you can easily spot three of the most destructive global trends. The first is burning coal, a folly in which China and India have overtaken us. The second is deforestation, especially in Southeast Asia and the Amazon Valley, where most of our pristine forest remains. The third is our own American auto industry—the most needlessly wasteful collective industrial endeavor in human history. (It is needlessly wasteful even as compared with coal plants in China and India because those nations have no other way to industrialize rapidly. Anyway both nations are working hard on converting to nuclear and renewable energy; China’s Three Gorges Dam and hydroelectric plants are one example.)

That’s why what happened last night in the Senate may not be such a bad thing. We have no direct control over China’s or India’s power plants, nor over what happens to forests in Indonesia, Borneo, or Brazil. But we do control our own auto industry.

By now it should be obvious to anyone who can read that our auto industry is clueless. Even with the hangman’s noose concentrating their minds, its leaders just don’t get it. The strongest of our Big Three (Ford) has a CEO who just can’t wait to exploit falling gas prices by selling big gas guzzlers again. As animator Ann Telnaes brilliantly illustrated, he and the cars he makes are dinosaurs begging for their meteoric coup de grace.

For all the wrong reasons, Congress gave it to them last night. Senate Republicans, who killed the bill, blamed the little guy: the worker. But the fault lies with the managers who ran the industry into the ground and the politicians who believed in and encouraged them. One of the many reasons our industry is failing is that it still follows the Henry Ford model of industrial autocracy. Our industry badly lags Japan’s and Germany’s in engaging workers’ minds and hearts as much as their limbs.

But our car industry’s imminent fate is just a small part of a much larger picture. We have to learn to live sustainably on the planet on which we evolved. If we don’t, we will suffer the common fate of every animal species that outgrows its habitat. We will suffer what ecologists euphemistically call “catastrophic population decline.” Ordinary folk call it war, famine and pestilence.

Our future needn’t be that bleak. We don’t have to waste energy extracting scarce fuels like oil or coal and transporting them thousands or hundreds of miles, only to burn them so as to poison our air and cook our planet. Instead, we can take as much energy as we need from the wind, sun, and water, essentially for free (in marginal cost). We can still have our busy lifestyle—even our individual vehicles—and intercontinental travel. All we need do is use our species’ chief evolutionary advantage, our intelligence, to make a paradigm shift.

This week alone, two of our best pundits highlighted separate aspects of that shift. Tom Friedman wrote of the coming trend in electric cars, charged at plug-in stations as ubiquitous as gas stations today and run on low-marginal-cost wind and solar power. He cited that trend as reason why no bailout can save our auto dinosaurs from extinction. Just the day before, David Brooks had written of the trend toward “localizing” suburban communities in centers of work and leisure, minimizing commuting and making life more sociable and livable. Both essays reflected a new world in which cheap fossil fuels are no longer the foundation of whole societies or the basis for city and regional planning.

Yet the consequences of the coming global paradigm shift go far beyond commuting. Among many other things, international trade will change beyond recognition.

For several hundred years (since the Hanseatic league), the global economic system has lived on free trade. We all accepted the dogma of “comparative advantage.” That dogma taught that some areas and people are better than others at growing or making certain things, and trade in what each produces better makes everybody better off.

During the halcyon days of international trade, that was a good assumption. Things like spices, pearls, gold and jewels were perfect objects for long-distance trade. They had high value-to-weight ratios, so their sellers could afford to transport them across the globe. Moreover, the sailing ships that brought these goods back to colonial powers ran on wind, which is free. Even accounting for piracy and inclement weather, the marginal cost of transporting these goods (as distinguished from the fixed cost of building the ships) was low compared to the value of the cargo.

As we became addicted to cheap coal and oil, we learned to ship more and heavier stuff. We now transport steel, cars, minerals, coal and oil itself thousands of miles. People in New York City eat New Zealand lamb and mussels. Men in Europe give ladies flowers from Africa. Companies make huge, heavy parts for aircraft in Europe and Japan and ship them to Boeing in Seattle for assembly. (The reasons for this intercontinental transport are more political than economic.) Insofar as trade is concerned, we live in a global village held together by cheap energy.

There are two problems with this paradigm. First, the dogma of comparative advantage is limited if not flawed. New York Times columnist and economist Paul Krugman recently won the Nobel Prize for explaining its flaws. It doesn’t always work in practice; that’s why the developed world does a brisk trade in cars although every part of it makes passable ones. (Even Detroit’s dinosaurs get you from Point A to Point B and last years.)

Second, and far more important, cheap oil is running out. Even if fully accurate in the abstract, which it is not, comparative advantage only works if transportation costs are low. Unless the difference in value between a lamb grown in New Zealand and one grown in upstate New York exceeds the intercontinental transportation cost of lamb meat, it makes no economic sense for New Yorkers to eat New Zealand lamb.

Up to now, cheap oil kept transportation costs low. But oil is no longer cheap. There are too many of us, creating too great a demand, for fossil-fuel prices to stay low. That’s why the mere possibility of an auto-industry bailout (and presumably an economic recovery to follow) sent oil futures up over ten percent.

As I’ve explained in another post, the inelasticity of demand for these basic commodities is the highest in the commercial world. That’s why their prices have dropped so rapidly during the current economic slowdown. That’s why their prices will skyrocket just as quickly as the global economy picks up again. And as our global population increases from 6.5 billion to nine billion (as predicted by 2050), the gas prices of last summer will look cheap by comparison. If we humans don’t change our ways, we could have gasoline at twenty or thirty dollars a gallon within thirty years. With oil prices like that, international trade in heavy commodities will become unsustainable.

The law of supply and demand is not the only thing making our current paradigm unworkable. There are also so-called “external” costs: the effect of burning fossil fuels on our environment and our planet.

Even if we could produce all the fossil fuels we needed, the cost of burning them, including pollution and global warming, would be astronomical. We can continue our low-transportation-cost “comparative advantage” paradigm only at the cost of losing our Eden, the planet on which we evolved.

So if we are smart, both trade and transportation will change radically as our paradigm shifts. We will trade ideas, written work and designs over the Internet. Light, compact, high-value products like computer chips, human organs, and antibodies will continue to move between continents. But most people and most heavy things will stay home.

This is the new awakening that we see all around us. It lies behind such diverse phenomena as electric cars, the “eat local” movement, attempts to save endangered species, the burgeoning extractive industries in the developing world (which are closer to their customers), our auto industry’s pleas for a bailout, and the cries of people from the Maldives and the South Pacific that they’d rather not live under water.

The Chinese word for “crisis” has two characters: “danger” and “opportunity.” Our new global paradigm shift offers both.

The danger is of large-scale social dislocation, even war—possibly even nuclear war. Lest we forget, the quest for scarce, localized energy and natural resources helped motivate the last century’s cataclysms. It is no accident that Japan and Germany, both of which came late to the colonial party, were instigators of humanity’s greatest self-induced catastrophe. Nor is it any accident that, once war began, Japan went straight for Southeast Asia’s rubber plantations and oil fields, and Germany went for the Caucasus’ oil fields, breaking its treaty with Stalin. Economically, World War II was the last, greatest spasm of exploitive military colonialism.

What restored international stability after the cataclysm was the present worldwide trading system. It gave Japan and Germany (and others) access to the same resources they had tried to conquer by force, through free markets, on an equal footing with the rest of the world. Now the fearsome Axis is at peace.

And therein lies the opportunity in the new global paradigm. Wind, sun and biofuels are neither scarce nor localized. They are ubiquitous and available to all. We need not fight over them. Nor need we fight over means to exploit them. We can trade in the means to exploit them or in better ideas for making those means. Blueprints for high-tech windmills, for example, can span the globe in seconds and for pennies, with agreed royalties to follow in exchange.

Now we can see what a stable world will look like in the long run. We will reserve irreplaceable fossil fuels for making plastics and medicines and for unavoidable uses like blast furnaces. Our “operating” energy will come from renewable wind, solar and hydroelectric power, supplemented by nuclear power and carbon-neutral biofuels like cane-derived ethanol. Every town and suburban district will have its own local generators, including windmills and solar cells. Good batteries will store power for later use. Air pollution will be minimal or non-existent, and people in cities will be much healthier. Global warming will be curbed.

For air transport we will use electricity-derived hydrogen or hydrogen-bearing fuel, generated by carbon-neutral means. As compared to today, air travel will be a relative luxury, reserved for high-social-value missions. Most intercontinental travel will revert to the sea, largely in stately sailing ships with computer-designed hydrodynamic hulls. But these ships won’t have sails. They’ll have high-strength polymer-fabric airfoils trimmed automatically by computers. They’ll make fifteen or twenty knots in a good wind (about what oil-fueled ocean liners now make), with zero fuel cost and no air pollution.

Business will neither slow down nor suffer from the change. Business people will meet instantaneously in cyberspace, in full-sized, full-motion, three-dimensional holographic images. Negotiators continents apart might even have electronic means to smell each others’ pheromones of greed and fear.

International business “travel” will take seconds, with no discomfort, jet lag or lost baggage. The only people to travel in the flesh will be those going for extended visits—mostly visiting artists, musicians, scholars, or scientists, plus millions of happy tourists. All will ride on the wind or renewable fuel.

Life in the fast lane will be a bit slower and more fun. Who wouldn’t prefer a stately sailing ship to a crowded 747 cabin, anyway?

But getting to this grand vision from here won’t be easy. Vested interests galore—including whole nations—will resist the change. Among them will be the Saudis, Russia, Iran, Venezuela, and our own coal, steel, oil and auto industries. Whole populations may feel the agony of transition. War, famine and pestilence may result. We will have to find international political mechanisms to share the pain and the benefit, just as the international free-trading system does today.

Where we’re going is not the problem. Except for the pheromone smelling, we have all the technology needed to implement this grand vision right now, today. We are working on the good batteries.

But everything depends upon the transition and how smoothly it goes. Preparing a gentle rest for our obsolete auto industry and saving its pieces that still have value (like the Chevy Volt) are just the beginning.


P.S.: Coming Soon: The Yin and Yang of Steve Chu, or How Obama’s Scientist and Engineer Might Promote the New Paradigm

P.P.S. Luffing Time

As every sailor knows, the maneuver called “coming about” has its critical moments. Its goal is to change the boat’s heading so the wind passes over the bow and begins to blow from the boat’s other side.

If the helmsman fails to act decisively, the boat can get stuck “in irons,” with its bow in the wind. Then the sails don’t work as designed. They “luff,” or flap loudly and uselessly. The boat goes nowhere, drifting backward aimlessly. The helm loses control for lack of headway.

That’s where we are now as a nation. We are caught in irons with our sails luffing.

We all thought we heard the order to come about on November 4. We expected the wind to cross from starboard to port, from ideology to evidence, from cronyism to competence. We were thrilled when a new crew, with high qualifications and even higher expectations, rushed on board.

Many of us wanted to throw the relieved captain overboard and begin anew. But our law doesn’t countenance mutiny. Old hands are still at the helm.

In the past two months, we have spent over half a trillion dollars. We have nothing to show for it but mistrusted experts’ assurances that things could be worse. We couldn’t decide to save our auto industry, although it asked for less than one-twentieth of what we already have spent on Wall Street—all with virtually no oversight or control. The reasons sounded much like what we’ve heard repeatedly over the last eight years: workers are at fault, and markets will cure themselves.

Getting out of irons takes patience and finesse. You can curse and thrash about all you want. But the bow won’t move until you gain enough headway—even moving backwards!—for the helm to respond.

Diagnosis suggests prescription. Our economy took years to get this bad. It won’t complete its self-destruction overnight. Perhaps we should all take an extended seasonal holiday while the new Congress takes the nation’s pulse and Obama’s transition team prepares to get us out of irons.

Maybe Treasury should disgorge enough money to keep GM and Chrysler afloat until the transition. Enough of the first $350 billion of TARP money remains for that purpose. But Treasury shouldn’t even ask for the second $350 billion. If it does, Congress should rescind its authority with alacrity.

We’ve all worked frenetically during the last eight years. During the last two months we’ve shared panic and taxpayers’ money with equal abandon. And we’re still headed towards multiple, highly visible reefs.

Yet at this precise moment we’re in no immediate danger. We’re caught in irons, aimlessly adrift.

So let’s take this luffing time and enjoy the winter holidays. Let firms losing money shut down for the holidays but lay no more workers off. Let’s all sit by our firesides and enjoy what really matters: our families, our friends, our hard-won freedom, and the promise of a new direction.

Let us all think hard about what made us great as a nation and can again. It wasn’t caution or timidity that brought the Pilgrims to our shores, won the West, built the transcontinental railways, or forged a new nation in a new land.

If our only goal is avoiding further risk, we will surely fail. We must decide what risks are worth taking, for what rewards, and prepare ourselves to take them come what may. Only bold action can cure a helmsman’s failure to act decisively. More drift cannot.

Then, on January 6, renewed by our rest, let us begin anew. Let the new Congress get us out of irons and chart a new course. If it can’t, then on January 20 our new Captain and his crew surely will. Having the old captain and crew flail about when they have utterly lost both the wind and the people’s confidence will only make things worse.

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10 December 2008

Darfur


The New York Times’ Judith Warner is a columnist to watch. Her “Domestic Disturbances” columns are ostensibly about children and parenting. She uses her own two children to suggest themes and provide examples.

As far as comments reveal, most of Warner’s readers are women. But her writing goes far beyond children and her gender. She may be as close as our dysfunctional media will ever come to the modern equivalent of Socrates. She gives us truth through the eyes of children.

I have noted [end of first post] how brilliantly she captured the spirit of joy, relief and catharsis that progressive people felt worldwide on Barack Obama’s election. Last Thursday evening she used children as a medium to explore a timeless moral dilemma: how to cope with evil.

The trigger for that column was the death of Jdimytai Damour, the Wal-Mart worker trampled by a crowd of early-morning shoppers on Black Friday. With hints of his death’s significance as a symbol of moral and cultural decay, Warner described how she wrestled with her five-year-old daughter’s effort to understand the event, including a YouTube video of a failed attempt to resuscitate the man.

From there Warner riffed to another timeless theme (especially among Jews): the Holocaust. She described her daughter’s need to know and her own effort to keep her child’s curiosity from straying into morbid obsession, fear, cynicism or apathy. Jewish and other parents have struggled with that dilemma for over sixty years.

With all the bad news surrounding us, it seemed odd to focus on the death of oxymoronically named Damour, the trampled Wall-Mart worker. No doubt he suffered for a few minutes before oblivion. But he hardly suffered more than the thousands of people who die weekly in traffic and domestic accidents. His death was more a potent symbol of societal decay than a reflection of widespread human suffering.

No so Darfur. For four years now, the world has stood idly by while tens of thousands are killed and mutilated, women raped, children terrorized and starved, villages burned, and hundreds of thousands killed or displaced and made homeless. And while Damour’s causa mortis was an insensate a mob, Darfur symbolizes deliberately planned genocide for the vilest of human motives: territorial conquest and racial bigotry.

As a Jew myself, I find it odd to devote so much energy and angst to the Holocaust, which is history and cannot be changed, and so little to Darfur—a genocide that is ongoing right now, in our time and on our watch.

If the truth be told, the Holocaust and the Genocide in Darfur have much in common. Just as dispersed Jews found themselves an unwelcome minority in a Europe carved up by centuries of inter-ethnic warfare having nothing to do with them, so the black Darfuris found themselves unwelcome guests in a majority-white Sudan created by long-absent colonial powers. Just as the Holocaust was motivated by ethnic animus, so is the Genocide in Darfur.

“Evil triumphs when good men do nothing.” Isn’t that the Holocaust’s unforgettable lesson? Yet here we are, in at least the fourth year of the Genocide, with little but ineffectual chatter to show for the lesson that six million European Jews died horribly to teach.

Eons ago, a tribe ruled by a cruel, stupid and selfish brute rebelled. Its members ambushed him in silent unity. They left him dead or crippled, and collective government was born.

From that ambush to modern law was only a matter of time. The Barons’ stand at Runnymede was but a step along the way. So is the International Criminal Court, which I hope President Obama will quickly have us join.

It will take a long struggle to establish the principle born of that primeval ambush globally. In these matters practicality is all. Our ancestors hiding in the trees to jump the tribal bully had to have unity and strength with them, lest they fail and only weaken their tribe. Miscalculation and division set the cause back, as they did in Iraq.

But Darfur would be so easy. A single squadron of advanced aircraft, with electronic weapons and countermeasures, would make short work of Sudan’s miserable air force and the Janjaweed’s camel-mounted genocidal assault teams, if it came to that. Yet no one acts.

Maybe help is on the way. Susan Rice, our newly designated U.N. Ambassador, is smart, articulate, smooth and tough as nails. She has been a consistent advocate of strong remedies in Darfur.

So, apparently, has been Samantha Power, a Harvard professor now on Obama’s State-Department transition team, who is an expert on genocide. She may get a position at State, and I hope she does.

Diplomacy is always preferable to military action, and skillful diplomacy backed by the credible threat of military force still might work. The Barons did not have to fight at Runnymede, after all. All they had to do was show up.

Darfur is not the most important morsel on our diplomatic plate. Maybe India, Pakistan, Afghanistan, Iran, Russia and North Korea come first. But I can think of nothing more salving to our national self image and more bracing for gender equality than to have three strong women—Hillary Clinton, Susan Rice, and Samantha Power—stop the Genocide at last.

I hope that every Jew, male or female, will support their effort. It is not enough to read about the Holocaust, to cry “Never forget!” and “Never again!” when something like a repeat performance is occurring right now, before the watchful but impotent lenses of our TV cameras. A genocide is no less a genocide because its victims are not Jews.

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06 December 2008

Saving the Big Three II: Accountability


[For a new index to my posts on the auto industry, click here.]

A previous post laid out why a bailout of our auto industry is likely to fail without a radical reduction in legacy costs, preferably by means of rational national health-care and pension programs. That, it appears, is not going to happen, at least not anytime soon. Instead, Congress appears ready to do whatever it can now to avoid the “sky is falling” syndrome that the Big Three’s CEOs have self-servingly predicted.

It’s not hard to understand why Congress, in the worst “recession” in three generations (dare I say “depression”?), wants to avoid losing millions more jobs in the already hardest-hit states. But if Congress is going to put taxpayers into the business of making cars, it should at least be as smart as a new graduate with a bachelor’s degree in business.

No one—not even our hypothetical newly-minted graduate—would invest in a business in our auto industry’s present shaky condition without taking a few minimum precautions. Stripped to their essence, they are: (1) a short leash, (2) new management, (3) new vision, and (4) accountability.

1. A short leash. The Big Three now say they want $34 billion, but they don’t need it all right away. To avoid wasting money, and to provide time for planning and reflection, Congress should give them only what they need for two months—until the new Congress convenes and the new administration takes office. Since Ford says it doesn’t need any cash right now, that probably boils down to about $ 4 billion each for GM and Chrysler. Congress should tell all three they won’t get more until they satisfy all of the following criteria.

2. New Management. It’s nice that all three CEOs agreed to reduce their enormous salaries to $1 per year, because that’s what they are worth. Not only are these the folks who drove their businesses into the ground. They also were dumb enough to fly to Washington from Detroit separately in private jets, and to demand bailouts for a failing industry, from a skeptical Congress, without business plans for recovery. They must have confused themselves with Wall Street banks, which make nothing but money and don’t encounter technological or market risk. If so, they were (as President-Elect Obama in his inimitable understatement might say) mistaken.

These are folks who have zero strategic vision for the future of their industry. Their idea of vision is to make big expensive cars while gas is cheap, and now to wait until gas gets cheaper so they can do it again. They didn’t get it then and don’t get it now.

In a colloquy with Gwen Ifill on the Lehrer News Hour, Alan Mullaly of Ford three times insisted that Ford would save itself by continuing to make small, medium and large cars. Apparently, with gas prices falling, he wants to continue to produce gas-guzzling dinosaurs like the Ford Expedition, which no one needs unless he runs a construction company or has six sons who play football. His “plan” for recovery is downsized business as usual, i.e., the same strategy that got the Big Three in this mess.

He and the other two should go. If there are no consequences for failure, at least it should not be repeated.

Congress need not micromanage their replacements. All it need do is require that the Big Three’s directors pick replacements committed to a radically new vision for the industry. It wouldn’t hurt if Congress required approval by a blue ribbon panel of independent industry analysts, economists, and labor experts. Several lower layers of management should go also, but new people at the top, if properly selected and motivated, probably will see to that.

3. New Vision. If the industry is to recover, it must do at least three things. First, it must make its domestic cars more like its foreign cars in size, fuel efficiency and quality. As my own personal experience attests, the cars that at least one of the Big Three (Ford) markets abroad aren’t bad. The cars that all three make here should be just as good.

Congress might require that each maker import a substantial percentage of its sales from its own foreign factories until it has had a chance to retool its domestic plants. Why any U.S. firm should produce quality products abroad and overpriced junk here at home is puzzling, to say the least. But Congress need not solve that mystery; it need only require that the trend be reversed.

Second, the industry must commit to radically better fuel economy. Dubya wants to give the industry previously allotted efficiency money with no strings attached, but that’s a recipe for extinction. Gas prices will not stay low if the economy recovers, and recovery is the whole point of the exercise. Congress should demand radical improvements in efficiency as a condition of continuing relief. The bar should be set higher, not lower, than current law requires.

Third, Congress should demand innovation. Before receiving the next installment of relief money, each firm should have concrete plans for: (1) plug-in hybrids, (2) cars that get more than 40 miles per gallon, (3) vehicles that run on compressed natural gas, and (4) alternative power sources such as fuel cells. Plans for all but (4) should be for production by a specified date, not mere prototypes or “concept cars.” Congress might also consider requiring flex-fuel cars that can burn 85% or higher ethanol blends, but only after repealing its ridiculous tariff on cane-derived foreign ethanol. (For the reasons, see posts 1 and 2).

As for GM, Congress should require it to produce the Chevy Volt in quantity by late summer of 2010, i.e, at the normal time for new-model introductions. Of all the products now in the pipeline, that is the one most likely to save the industry and promote energy independence. It is also the only product in half a century (other than gas-guzzling dinosaurs) with which our industry has been ready to beat Toyota to market. The Volt can be made to succeed with a little imagination.

4. Accountability. Finally, Congress should make one thing clear at the outset: no more money without accountability. That doesn’t mean congressional micromanagement. Far less does it mean having lawyers and lobbyists nitpick a detailed set of numerical milestones. Congress should set general milestones, like those in the vision above, and assess their satisfaction at public hearings, with the aid of a blue-ribbon panel of experts. If the experts’ thumbs go down, no new money. No excuses.

* * *


Although many smart people are skeptical, Congress is probably right to invest a little money in an attempt to save our domestic industry. Under current conditions, ten billion or so qualifies as a little money.

But Congress needn’t be stupid about it. It need not, and should not, invest billions just to delay the dinosaurs’ extinction by a few months. Congress should make an effort, with the aid of experts, to impose conditions that will significantly increase the Big Three’s chances of survival, notwithstanding residual legacy costs. Keeping current management in place does not meet that criterion.

Even with the best of plans, the industry will continue to hemorrhage jobs and money for some time. But perhaps Congress can reduce the job losses and encourage a leaner, better industry to emerge. It’s worth a try, but not without strict conditions stringently enforced. Holding most of the bailout money until late January will give Congress and the new administration time to formulate intelligent conditions.

Besides humanitarian concerns, there is a national-security rationale for a rescue plan. If some day we have to manufacture tanks to defend our country, we don’t want to have to ask Toyota to do so.

So the Big Three may be worth saving, but not with current management or their current “downsized business as usual” plans. We need bold new management with a bold new vision for the industry. Anything less is just kicking the bankruptcy can down the road.

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03 December 2008

Paulson’s Latest Egg


[For comment on what may be a waste of $350 billion in rescue money, click here.]

Today the Wall Street Journal reported [subscription required] the outlines of a new plan by Treasury chief Paulson to help stabilize the housing market. Under the plan, Treasury would buy securities that package “new home loans” guaranteed by Fannie and Freddie. The report did not estimate the amount of money potentially involved.

This plan (or at least the WSJ's report on it) has one ambiguity, two possible advantages, and seven decisive disadvantages.

The ambiguity lies in the words “new home loans.” Do these words mean: (1) any new loans for homes, including refinancings, (2) new loans for any new purchases, including those of existing homes, or (3) loans to purchase newly built homes only?

Resolution of this ambiguity will determine whether and how much (if at all) the plan would stimulate the general economy. Unless we want to continue spending trillions haphazardly, we must make sure that every expenditure does double duty. It must stimulate the general economy at the same time as it stabilizes our financial sector. With $2 trillion already spent and more than $ 7 trillion guaranteed, we don’t have enough trillions left to borrow to do one thing at a time.

Including refinancings in the new Paulson plan would be a bad idea. They generate no new economic activity outside the financial sector and so provide no general economic stimulus. Including resales of existing homes would be better, but not much. Resales directly promote economic activity (the loan itself and any subsequent securitization) only in our financial sector. They might promote some other economic activity incidentally, for example, by making it easier for workers to sell their homes and seek better jobs in new locales. But that’s not enough double duty to justify the program.

By far the best option would be to limit the program to newly built homes. Doing so would help our home-construction industry recover directly by rapidly clearing the huge inventory of unsold new homes.

Two possible advantages accrue to this plan, but only if it excludes refinancings. First, the program might help stabilize housing prices by making it easier (and perhaps cheaper) to buy and sell homes. Second, if limited to new construction, it might stimulate the home-construction industry, but not until after clearing most or all of the currently unsold inventory.

Against these possible advantages, the program as reported would have all seven disadvantages of the $800 billion new bailout plan that Paulson floated over the Thanksgiving holiday. First, it would contradict Paulson’s own recent experience, which led him to “inject capital” into failing financial institutions rather than buy complex toxic paper. Second, to the extent private institutions originated the loans to be securitized and bought with federal funds, the plan would leave the same people who brought us this mess in charge of the loans’ and securities’ terms. Third, in so doing, it would encourage (or at least not discourage), additional risky, stupid and predatory behavior, making moral hazard official government policy.

Fourth, Paulson’s new program is an invitation to step into the same pitfall that Paulson only recently avoided by not buying “troubled” paper under the TARP program. Packaged-loan securities and their derivatives are impossible to price accurately because their markets are completely opaque, with no relevant readily available data. Moreover, existing mathematical risk-assessment models are garbage: they assume away the most salient risks.

Fifth, the program would build our securitization/credit-swap/derivatives house of cards even higher, without additional regulation, even though every rational commentator has identified lack of regulation as what made those markets fail. It would be easier, simpler and safer to have Fannie and Freddie inject the money directly into mortgage loans and put the securitization-derivatives markets on hold until they can be rationalized and made safe and sound.

Sixth, the program assumes that tightness of credit, or its price, is the cause of the slowdown in housing, rather than the continuing free fall in housing prices and the natural caution induced by general economic conditions. There is no evidence, other than anecdotes, for that assumption. Finally, whatever money Paulson & Co. pumps into this program before January 20 will be unavailable for the incoming administration to use for its own economic recovery program.

The crux of the matter is Paulson’s fixation with post-loan financial markets, i.e., securities that package loans and their derivatives. These are the “products” of Wall Street. Lest we forget, they are also the products that caused our current financial meltdown because the markets in which they trade are completely opaque, unregulated and chaotic.

By continuing to rely on these failed markets with no new government supervision and no new regulation, Paulson threatens to throw good money after bad. Why anyone would want to pour more money into markets whose failure is the root cause of all our immediate problems is puzzling.

The new program might make more sense if Fannie and Freddie themselves set standard, sensible, nonpredatory terms for new mortgages, purchased them, and securitized them itself. But those precautions are not features of the program as reported. Evidently Paulson wants to have the (so far falsely) presumed advantages of derivatives markets in “recycling” loan capital without doing the hard work of stabilizing, rationalizing and regulating those markets, which might take years.

At this point, Paulson & Company seem like exhausted, punch-drunk knights in old movies of medieval jousting. They are so tired they can barely raise their lances. They are members of an administration that was out of useful ideas when it took office eight years ago. More important, their expertise is limited to the Wall Street branch of our financial sector―an important part, but only a small part, of our huge economy.

That expertise is far too narrow to fix our economy as a whole. We need industrialists and at least a few scientists on our recovery team, plus some plain old-fashioned bankers of the non-Wall-Street variety.

We need to recall that banking (the more so investment banking) is economic infrastructure, not the economy. And it’s our entire economy that, according to yesterday’s official report, has been in recession for a year.

But help is on the way. The Obama administration includes some of the best economic minds in the nation. It will have had two months―with no direct responsibility and no need to fight alligators―to take the measure of our economic swamp and chart a way out. It will also (I hope) include a few industrialists and scientists, so that real industry and basic research will not be neglected in the recovery plan. No plan can begin to fix our economy, or even do serious double duty, unless it addresses real industries that make real things.

The best thing that Paulson & Company can do now is stop trying to invent grand new initiatives and settle into a holding pattern until January 20. Their efforts to stabilize credit markets appear to have had some success. The Libor (London Interbank Offered Rate) has dropped from 4.5% at the height of the credit crisis to 2.2%. That’s progress.

Paulson & Company should take comfort in that fact and continue, as cheaply as possible, to do what appears essential to keep credit markets from refreezing. That’s where their expertise lies, and that’s the only respect in which they have had demonstrable success so far.

General economic recovery requires much more. It must involve housing, industry, infrastructure, education and basic science. And if our auto industry and remaining heavy industry are to have a ghost of a chance of long-term survival under American ownership, it must involve rapid reform of health care as well.

All these things are jobs for the next administration, which has no restrictive ideology, fresh horses, and much broader expertise. Most important of all, it has a new architect in chief, elected for his wide strategic vision. That is something the present administration doesn’t have and never had, however smart its Wall Street investment bankers may be within their narrow fields of expertise.

UPDATE: IS $350 BILLION BEING WASTED? In a story posted late today, the New York Times suggested that the loan-securities purchases by Treasury discussed above are part of the $800 billion bailout announced last week and criticized in my earlier post. According to today’s Times story, that bailout allotted $500 billion to purchases of mortgage-backed securities. Based on figures it reported for last week, almost 70% of the new loan money, or about $350 billion, would go for refinancings.

This information leads to three questions. First, what good will $350 billion of refinancings do for the real economy? People like me who have good credit will be able to reduce their monthly payments, but this money will do nothing to increase sales of homes, help homeowners in default or foreclosure, or encourage new home construction. Second, how can newspapers last week have reported $600 billion allotted to the mortgage industry, while a reputable paper like the Times now reports $500 billion? Was the difference just a reporter’s a typo, or is Treasury now so under stress and chaotic that it doesn't even notice an $100 billion discrepancy any more?

These questions suggest that Congress should call a halt to further bailout activity by Treasury until Treasury files a full report of expenditures so far and Congress has had time to digest that report. It would be hard to conceive of a less productive means of spending $350 billion in economic rescue money than allowing millions of people with good credit and no risk of default to refinance their homes. All that would do if shuffle paper and generate yet more opaque and risky mortgage-backed securities and their derivatives.

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