Volume 1, Issue 2

Betting on elections has been of interest to economists and political scientists for some time. We recently persuaded TradeSports to run experimental contingent betting markets, in which one bets on whether President Bush will be re-elected, conditional on other specified events occurring. Early results suggest that market participants strongly believe that Osama bin Laden’s capture would have a substantial effect on President Bush’s electoral fortunes, and interestingly that the chance of his capture peaks just before the election. More generally, these markets suggest that issues outside the campaign -– like the state of the economy, and progress on the war on terror -– are the key factors in the forthcoming election.

How did Enron, a firm worth $60 billion, collapse over the discovery of a billion or so in hidden debt and fraudulent accounting? It didn't. Or, at least, not directly. Market makers like Enron and Ebay are in the "trust" business, just as banks and insurance companies are. Once trust was lost, the rest of Enron's value quickly disappeared. The maintenance of customer trust is an important, and frequently mismanaged, aspect of business strategy. The legislative response of Sarbanes-Oxley may do some good, but cannot really ensure trust.

In a campaign speech given in Iowa, George Akerlof argues that the Bush administration has hamstrung its good administrators and opted time and again for waving a magic wand to solve problems instead of facing reality. The problem may be most severe in the case of the deficits, where if we don't face up to reality, Akerlof argues, there will be profound consequences.

Under reasonable projections, the unified budget deficits over the next decade will average 3.5 percent of GDP. Compared to a balanced budget, the unified budget deficits will reduce annual national income a decade hence by 1 to 2 percent (or roughly $1,500 to $3,000 per household per year, on average), and raise average long-term interest rates over the next decade by 80 to 120 basis points. Looking out beyond the next decade, the budget outlook grows steadily worse. Over the next 75 years, if the tax cuts are made permanent, this nation’s fiscal gap amounts to about 7 percent of GDP. The main drivers of this long-term fiscal gap are, in order, the spending growth associated with Medicare and Medicaid, the revenue losses from the 2001 and 2003 tax cuts, and increases in Social Security costs. The nation has never before experienced such large long-term fiscal imbalances. They will gradually impair economic performance and living standards, and carry with them the risk of a severe fiscal crisis.

In the short run, the Bush tax cuts were one of the largest and best-timed uses of fiscal policy in history, helping to prevent a much worse downturn (but it would have been better still if the tax rate cuts had been immediate and real spending controls enacted simultaneously to take effect well into the economic expansion). In the medium run of five-to-ten years, the CBO projects gradually declining deficits and a debt-GDP ratio that rises slightly to peak at about 40% in two or three years, and then stabilizes for the rest of the decade through 2014 even as the tax cuts are made permanent, so long as the post-1998 splurge in non-defense discretionary spending is slowed substantially. This is hardly a debt spiraling out of control. The deficits will reduce domestic investment, but less than dollar-for-dollar. The effect is important, but hardly a cause for hysteria. Of course, President Bush’s tax cuts and Senator Kerry’s spending increases have ramifications well beyond the next decade, when fiscal pressures will become even more pronounced. In the long run of decades, the deficits in Social Security and Medicare are projected to be much larger than the unified deficit in the next ten years. Standard projections exceed fifty trillion dollars in present value, but may overstate the problem by assuming quite modest long-run annual growth, increases in health care outlays far in excess of GDP growth for the better part of a century (the only way that will happen is if the health benefits are sufficient for citizens to want to spend that much), large real benefit increases in Social Security, and continuous tax cuts to offset real bracket creep and the AMT. But even with less stark projections, there would still be large deficits and large tax increases looming. To avoid them, continuously rigorous spending control and major program reform is essential.

All candidates and Presidents make some statements that make economists cringe, often put into speeches by political advisors unconstrained by economic literacy. From its description of the state of the economy to its policy prescriptions, much of the Kerry-Edwards campaign’s pronouncements are at odds with economic reality and basic economic principles. While their first term was far from perfect (too much spending, steel tariffs), Bush-Cheney policies and proposals are much closer to textbook economics, both micro and macro. The article discusses several such areas: the description of the economy; countercyclical fiscal policy; and price regulation.

In “Eldred and Fair Use,” Posner comments that awarding a monopoly over Mickey Mouse avoids the congestion problem that occurs with open access highways. Is the public domain a commons like an open access highway? No, it is not.

The question is whether it is possible to have a congestion externality in intellectual property, such as the Mickey Mouse character. Literally, the answer is no. Figuratively, it is yes.