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    Part 2: The Basics of a Shutdown

    Mar 1 • Government, Regulation • 489 Views

    On Friday, we might have a funding gap. With no up-to-date appropriations, agencies providing nonessential services from the federal government will have to stop. But what is “nonessential?”

    A recent congressional research paper says we can look back to 1995 for an answer. In the health category, the National Institutes of Health did not accept new patients for clinical research. Many application reviews, ranging from firearm requests to passports and visas were postponed. National parks and monuments were closed. Federal contractors might be unpaid.

    On the other hand, national security, benefits that are not annually funded, emergency medical care, disaster response, border protection…you see the basic idea…these continue.

    Finally, who is explicitly “excepted?” The list includes the President and members of Congress.

    And, we are prepared. Each year, federal agencies are asked to submit shutdown plans.

    The Economic Lesson

    The spending, taxing, and borrowing overseen by the President and the Congress is called fiscal policy.

    While a funding gap might be the immediate fiscal controversy, within weeks, the Congress will also have to raise the debt ceiling.

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    Part 1: The Basics of a Shutdown

    Feb 28 • Economic Debates, Government, Regulation • 517 Views

    Our story begins on October 1, 2010. With a fiscal year that starts on October 1 and ends on September 30, the first day in October is crucial. Because the President and the Congress had not yet agreed on the 2011 budget, in some way, they had to approve appropriations for agencies that get yearly funding.

    Why can’t agencies just keep spending until they get their appropriations? Article I, Section 9 of the Constitution is one reason. “No Money shall be drawn from the Treasury, but in Consequence of Appropriations made by Law.” Furthermore, Congress passed the Antideficiency Act that confirms the impact of a funding gap. Nonessential government activities have to stop.

    There is a temporary solution called a Continuing Resolution (CR) which perpetuates funding until a new CR, a specific funding act, or the budget is passed. The problem is that the existing CR expires March 4th. Currently, we have neither a budget agreement nor a new CR. This 10 page Congressional Research paper provides a clear explanation.

    What is nonessential? How are we affected by a shutdown?

    More tomorrow.

    The Economic Lesson

    The budget process formally starts when the President submits a budget to Congress. The process for the 2011 budget began during February 2010 when President Obama sent his 2011 budget to the Congress.  You can look at this Washington Post interactive for an overview of the budget process.

    Between 1977 and 2010, there were 17 funding gaps. However, since 1993, we had only 2. The most memorable one ended in 1996 during the Clinton administration. It lasted 21 days, from December 16, 1995 to January 6, 1996.

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    A Warren Buffett Story

    Feb 27 • Economic History, Financial Markets, Thinking Economically • 612 Views

    If you had purchased Berkshire Hathaway stock on December 6, 1976, you paid approximately $77. At yesterday’s closing price, one share of the same firm (BRK/A) was $127,550. (Looking at the BLS CPI inflation calculator, $77 in 1976 is equal to the buying power of $298.02 today.)

    Annually, Warren Buffett, the person responsible for the astronomical increase in Berkshire Hathaway’s share price, sends his letter to shareholders. 26 pages long, it is statistical, it is folksy, it expresses general investing acumen, specific performance information, and even a letter to his uncle from his grandfather about always having a financial reserve. I recommend reading it all. For now, though, I wanted to share one story from the letter. It reveals the secret to success.

    The story involves Mr. Buffett’s first contact with GEICO, a firm that Berkshire Hathaway owns. As a business student at Columbia, 60 years ago, Mr. Buffett’s idol was Ben Graham, the co-author of a classic investing “primer.” When Buffett discovered that Graham was the chairman of the Government Employees Insurance Co (now GEICO), he decided, one Saturday, to visit the company’s headquarters in Washington, D.C. When he arrived, the door was locked because the offices were closed on Saturday. Buffett’s response? To knock and shout until a janitor appeared. Asked if anyone was there, the janitor took him to the office of Lorimer Davidson, an executive who later became GEICO’s CEO. Davidson spoke with his young visitor for 4 hours.

    Fast forward to 1996 when Mr. Davidson made a video expressing his pleasure that his firm, GEICO, would “permanently reside” with Berkshire Hathaway. He also “playfully concluded” by saying, “Next time, Warren, please make an appointment.”

    The Economic Lesson

    Both Adam Smith and John Maynard Keynes wrote about the spirit exhibited by Warren Buffet as a student. Smith might have referred simply to the business activity generated by self-interest while Keynes could have taken us to the motivational role of “animal spirits.”

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    Ivy League Games

    Feb 26 • Businesses, Demand, Supply, and Markets • 813 Views

    Joining Harvard and the multitudes they hoped would follow, in 2006, Princeton eliminated its early admissions option. Now, with Harvard and the University of Virginia, Princeton has said it will return to early admissions because few followed.

    The Economic Lesson

    I wonder whether we can explain both decisions through game theory. First, let’s call the market structure within which Ivy League schools compete, an oligopoly. With few market participants on the supply side, a “price making” capability (admissions standards), and difficult entry and exit (colleges neither leave nor enter the Ivy League), schools typically wield considerable power.

    Also, as oligopolies, they engage in game theory. Here is how it works. The two firms (or schools) know that, to some extent, they are interdependent; one school’s decisions affect the other school. Consequently, each one tries to predict what the other will do.

    The result is a behavioral matrix called the prisoners’ dilemma. Imagine a square divided into quarters. For example, above the left quarter is Princeton/no early admission. Above the right quarter is Princeton/early admission. To the left of the upper quarter is Penn/no early admission. To the left of the lower quarter is Penn/early admission.

    You can fill in the matrix. Where Princeton/no early admission and Penn/no early admission converge, we could say that equal numbers of students apply. However, what happens when they converge with one school not doing it and the other proceeding? What if neither proceeds?

    As you can see here, the prisoners’ dilemma conveys the pros and cons of unilateral behavior and of collusion. The problem, as Princeton discovered, is that market participants cannot guarantee competitors’ behavior.

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    Innovative Challenges

    Feb 25 • Businesses, Economic Debates, Government, Innovation, Labor, Macroeconomic Measurement, Regulation, Thinking Economically • 540 Views

    Is it likely that, with each new discovery, innovation gets tougher?

    It might have been easier to identify an asteroid a century ago because the undiscovered ones were very big. It might have been simpler to find a new human organ; the last one, the parathyroid gland, was discovered in 1880. Similarly, developing plants with larger fruit gets to a point where incremental progress is smaller and smaller.  

    So, where does this take us?

    1. To teams. With discoveries becoming more complex, the “renaissance man” like Thomas Edison or Albert Einstein, no longer can know it all. Instead, scientists need to pool their expertise.

    2. To a knowledge plateau. According to economist Tyler Cowen, because the “low hanging” fruit has been picked, it is ever more difficult to make the scientific breakthroughs that spearhead growth.

    3. To a very busy patents office. With scientific teams submitting ever more complex research, it takes the patent office more expertise, more people, and more money to issue the patents that new firms frequently require.

    4. To a President with a challenge. Saying in his State of the Union address that innovation is the key to future economic growth, President Obama now needs to determine the governmental incentives that will accelerate innovation. Economist Mike Mandel has several policy suggestions

    The Economic Lesson

    With Article 1, Section 8, Clause 8 saying, “To promote the Progress of Science and useful Arts, by securing for limit Times to Authors and Inventors the exclusive Right to their respective Writings and Discoveries,” the US Constitution established the right to protect innovation.

    Interestingly, although Hamilton and Jefferson did not entirely agree, both were involved with the first Patent Act in 1790.


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