 I guess we're ready to go. I wanted to welcome you. I'm Sheryl Sweniger director of the economic growth program Here at the new America Foundation. I want to welcome those in the audience and those who are Watching via the internet and in the web This I believe is a very important discussion We're about ready to have with Jim Fowles and Woody Brock about Woody's New book American gridlock Common sense 101 solutions to the economic crisis Jim Fowles hardly needs an introduction since he was the founding chairman of New America Foundation's board of directors Has distinguished himself for many years as a national and international Correspondent at the Atlantic author of many books and many of my most favorite books But the author of a forthcoming new book, which I think will be very important China Airborne Which addresses the important question of whether China will make be able to make the next leap in its economic growth and development to a more Advanced middle middle-income economy without all the breakdowns that usually accompanies such a path But our but our main guest and main speaker and It'll be a conversation is H. Woody Brock a president and founder of the strategic economic Decisions a consulting group that provides economic and financial market analysis. I'd like to think of Woody is probably the smartest Most insightful Economist and financial analyst that Washington really doesn't fully know or has totally undervalued in the in its experience. I had the pleasure and privilege of Hearing Woody talk about his book at the New York Nicobocker Club a few months ago And they're in an audience of financial Titans Including on the left of center Felix Roatton and on the on the right of center Byron wean formerly of Morgan Stanley I saw Woody wow people With his Intellectual analysis is brilliant deductive thinking about our present crisis and what to do about it What we are about to have is a conversation between One of the most distinguished National correspondents in Washington journalism International journalism and one of the most brilliant economists that I've met H. Woody Brock So I think it will be a very fruitful and and hopefully engage in discussion and Jim's going to take over from here and Central format is that they're going to have a a dialogue or conversation for 40 to 45 minutes We'll have time for 20 to 25 minutes from additional questions and discussions from the audience We'll have a little bit of Reception and refreshments if you want to stay beyond that and I'm sure a few additional people will be drifting in this It's in Washington DC custom. So Jim. I'll let you take it from here. Thank you very much Cheryl Thank you all for coming. Thanks to my friend Woody Brock for For honoring at New America and Washington DC with his presence This is a delight for me in many ways partly as Cheryl says it's because New America was a place that I knew in its infancy when it Occupied you know one one hundredth of its current its current footprint here physically and also in terms of Policy and intellectual stimulation. So it's been great to see the kinds of sessions It has frequently and now Woody is joining us for also having known Woody for quite a while since the late 1980s in Japan when I was living with my family and what he was doing his work there I've turned to him for advice a lot Here is an oddity or an unusual circumstance. Those of you in the Washington law-growing industry will understand Often blurbs for books are not fully sincere or precise But I actually did a blurb for Woody's book that exactly expresses why I have found it so valuable to listen to him So I'd like to read to you from my own three-sentence blurb in behalf of Woody's book Which is a will suffice for my introduction for decades Woody Brock has enlightened a select audience with his logically rigorous Factually impeccable analyses of past developments and future trends time and again. I've seen his insights prove true Especially in cases where he has challenged the prevailing wisdom of that era Now for the first time he addresses for a general readership He addresses a general readership with a comprehensive assessment of how to cope with the most intractable public problems of our time I don't agree with every one of his prescriptions Which is why I am all the more sincere in recommending the thoroughness and the rigor of his logic Woody Brock as you know as the founder and principal of strategic economic decisions in Palo Alto Palo Alto, right? It's it's it's beyond Geographical location, it's it's of the cloud he has is a his BA is MS and his MBA from Harvard is ma and his PhD from Princeton And I will say no more just because You will you will be exposed soon to the quality of his thought analysis. Let me start by asking you Woody essentially Why did you feel compelled to write this kind of book different from the very the the presentations you've done before and What mainly are you hoping people will take from your presentation? Thank you everybody. It's great to be here I'm not known in Washington at all And I've got this character and Greg Craig and these two guys as old friends and unfortunately that's about it But it's great to be here. You know, I never wanted to write this book. Oh, I was ordered to I got a call from a senior editor John Whiting and they said they've been on a fishing expedition trying to find somebody who was really deep Who was like an organ player who had pulled the different stops because in fact, I'm not an economist I've got the reason the mathematical foundations of Political and moral theory international relations history business school and God knows what economics. I find you know I have to do it But economics as I will argue later without politics without ethics in other words without the moral try-pass Is almost meaningless and that's something which Adam Smith would certainly agree with and make crystal clear at his time This book I was asked to write First refused and I said maybe I really do have a message So let me just say what the books trying to do three things number one is trying to identify Some areas some problems some substantive issues where we have to solve the problems. That's true for the chapters They range from everything like rethinking fair shares and an ideal state Which is chapter 6 the whole notion of the moral try-pass in what society would we all most like to live in? That's the most philosophical To much more pragmatic things like what do we do about this lost decade? We're recovering our 2% recovery isn't nearly enough to create the jobs. What do we do to do it? Next what do we do about health care what I mean is the 18% of GDP that goes to health care double most any other nation is by some studies do to go to 30 to 35 percent by big but by mid-century and Doesn't answer whereby you can actually have better health care and much more of it and cut the bill in half It's quite remarkable. I do want to talk about that. I Started thinking about things other issues. How do you prevent perfect financial storms? And what I found was using advanced logic, and that's what's different using the economics of uncertainty Using game theory John Nash was one of my teachers Using other things. That's just called a more advanced deductive logics. You could figure out answers To these big challenges that had the unusual property That they were win-win and did not involve the left and the right at all So the subtitle of the book is American gridlock why both the left and the right are wrong It's not that they're wrong. It's that by thinking bigger and better We were cross arguing and it turns out there win-win answers that I think my dog would approve of The reason this is true is the kind of thinking as you'll see specifically if we talk about it in the case of the Medicare solution Literally, I like Euclid. I put down three axioms that we all would agree to you'll agree with all of them and It implied that there's one on only one overall solution to the Medicare problem Now you may find that astounding, but you'll actually see a proof But the point about it is if you don't like the answer because it's deductive in nature You have to go back to the axioms Because you can't disagree with the conclusion. This is very unusual in public policy to do this But that was my training. I was trained by people to think that way So the point of the book is to say Cheer up. There are answers. They're not answers where the left must either gore the right or the right the left Everybody can win the arguments transcend Left right and thus it becomes possible to break gridlock which is all about Left versus right. So that's really the main goal Better thinking pays And on the assumption that not all of you have yet read the entire book Unlike me, I'll say that that's something that you'll find rewarding when you read it The leitmotif will come back to later is what he's very rigorous insistence on the difference between your deductive principles and the way you You think other people are going about their work Including a critique which we'll get to of big data what you think can be misleading as a way to but we'll say that for a moment What I like to do next woody is to contrast You've ticked off a number of of issues that are often discussed here in dc Contrast the analysis and prescription you're offering with the conventional wisdom of life here For example the lost decade. Yes, that's a good one. Yes, and then you know if that's discussed in dc It's what we're having recovery, but we're worried about this sort of permanently unemployed and their structural dislocation What is this dc dialogue missing on the lost decade question? Or how should we think about the lost decade and avoiding it? I'm just trying to think is if the president said Mr. Brock What can we do to fix the decade the way I would say it? Well, mr. President Let's make a laundry list of what we want to accomplish Faster growth particularly job creative growth, which is not necessarily the case. We want jobs job jobs. We want faster growth. Yes Oh, we don't want to irritate the bond market because we're getting close to that level As Italy is showing where rates don't go from 3.1 to 3.2 But from 3.1 to 7 and then you have major problems. So we don't want to upset the bond market deficits upset the bond market, correct We're all deficit foes except for paul krugman deficits are bad That's part of the washington story. So one thing mr. President. We cannot do Is stimulate using the deficit. We've done that. We're naughty. That can't be done Now in my book, I make a very serious point And it's a non debatable point the word deficit has no meaning No This is not my point the most important book Since canes ever written in macroeconomics By kenneth arrow the genius economic theorist and mordecai curts with whom I work with closely Did the definitive analysis of this for the president back in 1970 the book is called some after gathering Optimal fiscal policy rates of return and public investment In this you learn that there is no such thing as a deficit. There are two deficits good And bad the deficit that's good the bond market loves you and you stimulate the economy with it The deficit that's bad Upsets the bond market because basically you're just putting more debt on the shoulders of the kids Who may one day say hell no We won't pay Precisely as they brought down two Presidents by saying hell no we won't go So the bond market gets jittery and rates go from four to eight percent into twelve and you're broke So the point is i'm just going to outline if I could yep that mr. President once you understand The arrow curts distinction That the word deficit has no meaning Unless you qualify it Then mr. President you can have your cake and eat it to two Don't upset the bond market fix the infrastructure raise productivity Put the kids to work have massive job creation accelerators and multipliers going on Have it all okay. This is what I mean by a non left wing right wing. Let's let's have it all So what you do is you just understand the following very simple point and any businessman will understand this Incidentally the problem with the arrow curts book Which is without question The only other book other than canes that put the they put the whole thing together the unified four fields The problem was it was very heavy mathematics So Obviously it just never touched the public unfortunately My job is like being a boswell for johnson to try to put it into english because this to me is just common sense so country a has a deficit of A trillion dollars I don't think this is slide. I don't know think of country a The government spends four trillion The tax receipts are three In this country the fed can't do anything about that the treasury has to issue bonds and bills So now there's more debt whether the fed wishes to buy them in is a different issue. There is more debt The bond markets get concerned Deficits are bad. We must cut a deficit now country b Using government accounting familiar from washington is identical It spends four trillion and has tax receipts of three trillion But it has no deficit that's because of the four trillion spending The three trillion go to things like interest payments the military transfer payments and stuff like that Note that that spending which is not productive Is fully matched by the three trillion tax receipts the extra trillion Goes to I don't like the word infrastructure But per the arrow curts theory it goes to public investment done through private corporations with the property that you only invest if a new completely Independent bank Which appraises all these possible infrastructure project electric rills electric rids. I don't mean potholes really big thinking infrastructure It appraises the rate of return on capital on these And you don't talk about 18 bullet trains. It doesn't matter how powerful. Nancy Pelosi may be Her train won't get built from la to san francisco because a minus four percent rate of return on capital unlike the interstate highway system Which we think was 12 to 13 percent measured correctly not to mention the louisiana purchase Which was made manhattan look expensive And so You spend the money on Not infrastructure, but profitable Now the good news from america Unlike say switzerland japan they keep putting new roofs in the house every year. We haven't put a new roof in the house for 50 years The more leaky the roof is the higher the arrow curts rate of return on capital is and remember what makes this difficult Is that the returns from public investment? Unlike jim and i opening an ice cream stand where my dog can figure out, you know, how much money we're making With public investment what makes it difficult is the spillover effects The interstate highway system had a high rate of return You could never get that by charging tolls Amtrak has a high rate of return properly measured You laugh at that But woody amtrak raises prices and doesn't pay for it's not supposed to It makes it possible for many many minions to get to work in 40 minutes Not four hours ask the indians about the value of that the gdp is not baked on train platforms The gdp is baked in offices. You've got to get to working back So properly measuring these things i estimated we really literally could have a marshal planned Literally with a trillion dollars a year up to that Easily justifiable on stuff we haven't fixed or done Or ever created in the past 50 years england isn't our shoes Switzerland and japan couldn't avail themselves of this because there isn't much that would have a high rate of return So the point here is you're borrowing Conservatives like the fact that private companies are doing the work But at the broadest level and then i'll end with this and this is a bit of a tricky question That's why i'm being a little long-winded the most important point about the arrow curts book Which unified everything is basically in my words it said Stop thinking about the words private and public You rotate between states of the world Where for example right now the rate of return on mac mansions is what higher low Low negative just don't put your money there. I didn't hear the word public and private But the rate of return on good infrastructure that gets things going where we leave our kids the infrastructure of equality We inherited many years ago Is high at other times coming back from the war everybody needed a house So private investment was big the private sector ran a big deficit. Yes bad word The public sector didn't Other times the rate of return if it's high on public investment and not on private Means you want to have deficits for that and the private sector like right now has a huge Surplus all you want is arrow told me is every night when you go to bed You want all the nation's capital optimally invested No, is that capitalist in the extreme, but i'm the left-wing guy here saying krugeman's right for the wrong reasons that we need spending Paul krugeman never makes this distinction So he feeds the right-wing with fears of bad deficits We need good deficits and they're very possible for this country. So that's the main idea So before going on to some of these other points, I know that your purpose is not to engage Washington rhetoric on its own terms that that would that would be a waste. I can do it, but it's not Let's go beyond yes, so i'm going to ask you to do it for a moment Because I think that if president obama or his economic advisors were here They'd be saying The case you've made is the case they have tried to make two its last two state of the unions have been saying Public and private together build our highways build our space program Etc etc and they would point out to you that for the past say two years The reigning panic in political life has been debt panic deficit panic So so what practical guidance would you get the problem in the debate as I see it Is that no one is making these distinctions? Let me be more precise about that You go to the conservatives or to the public and you say look, we're just being good businessmen here We're no longer going to call Investment spending and productive high return spending. We're not going to call that deficits anymore. We're going to have a capital account So this is just not and never was deficits any business person knows that They have operating expenses and they have investments South Africa did that some governments peruded it but we don't do it for some reason. That's terribly misleading Secondly, I don't think they have ever made this point that there are bad deficits Now it may be difficult in washington to say the transfer payments are bad But transfer payments do keep four of us at our jobs in california But they don't create jobs. The point I missed is the following If I borrow from the kids a trillion dollars and just pay people to keep their jobs There of course, there's no net new job creation none If you borrow and he's the sergeant at arms and you get a trillion dollar check To fix 14 types of infrastructure and we don't mean roads at all but waving on that and incidentally The case for this is even stronger because there's a non-linearity our infrastructure problems are going critical We believe in the next 10 years. That means not one bridge a year I should say a decade falls into the mississippi river minnesota about 10 and people will really wake up The point is When you raise money and give it to this guy, he's going to hire 128 contractors Each of them will in turn hire 49 subcontractors and everybody can take but to work The resources are idle and sitting there right now What matters is that the projects be certified as having a high expected rate of return Oh woody Oh How can we prove they're all going to be profitable? Well, after the head of johnson and johnson how you prove which r&d projects are profitable The point is there's ways to do this. We're on average. You make a high rate of return. We do it all the time. It's doable So i'm an optimist we can have our cake you need it to the point is That if that you tell the conservatives who don't like deficits that you also don't like bad deficits at all You want good ones, but you want jobs for the kids Transfer payments won't do it. You need multiplayer effects. This is common sense. Yes Yes, and so i'm going to to cover a range of topics I'm going to move now to a next one without exhausting all this health care I would characterize the dc debate on health care The republicans say anything the government does to be involved in it is destructive wasteful And the democrats are sort of resigned to its endless escalation and cost and so both of them are despairing What are they both missing? well This is where i'm going to ask you if you could look aggressive And you're going to have to go a little bit back in time back to the future to remind yourselves of a supply and demand curve in x101 i'm going to ask you to do that It's pretty easy. He's a brutal task master, but we can all try the point is that the health care debate Because of the complexity of the whole subject and health care is infinitely complex Primarily for all the reasons pointed out in the definitive article ever written on it Which i think was 1967 again, Kenneth arrows famous essay on it where he got the whole thing What makes it hard is the nature of the good being produced and consumed It's externalities the fact that you have to have risk pooling because we'll risk a verse None of us can afford to get ill anymore. So we've got to pool our risk This just changes the kind of economics and you have to use the economics of uncertainty To understand that which he also invented 10 years before So the point is what i'm going to do is just make I'm going to start from scratch And i'm going to lay down three axioms By that i mean basic assumptions and this is the way i was trained And they're going to be things i want out of the health care system And i hope you'll join me in that you will want them to and your laboratory retrievers as well Right they got to be easy And then i'm going to simply tell you there's one and only one way to have your cake and eat it too And they're astounding The first axiom is i want a lot of people to have coverage i'm a socialist i want a university a university coverage I'm not saying that people will reach and pay higher premiums i'm just saying I don't think it's right in the society that's rich for people not to be able to afford health care Now you're going to say well woody that would be nice but you can never afford it Stop the axiom is only saying i would like lots more people to become all right Obama couldn't agree more Gosh woody you're left-wing next i want to make sure There's no rationing If there's a lot more demand there has to be a lot more supply A tricky word as you'll see in a minute, but yes When people have more access to use that awful washington term When people have more access meaning more of us have insurance policies as you know from our pet pieces That since i wrote this ahead of harvard medical school whatever More and more phones of doctors won't answer So it's a pyrrhic victory to have insurance when no one's going to see you like my friends in canada They point to buffalo and say that's where we go, but we got to pay it Rich people go to buffalo they point to buffalo. They say great health care 10 hospitals apparently have been built for canadiens I don't know it's crazy. That's rationing The obama care bill which is in detail reviewed and appendix a of the book Was supply light No teeth were given to more supply lots of teeth were given the fact if you're a small businessman And you don't provide coverage you pay big fines, right? We get teeth to demand But hope and sort of let's hope that more doctors approve to the supply centers already suggesting an imbalance now I want More people covered. I want the phones to answer And I want the cost of this whole thing what you can imagine if given a and b my god the cost is going to explode I want the cost cut at least in half to the nation There is one and only one way mr. President to have it all You can do both You can cut the cost hugely Have far more people not only have access, but get access anyone here not like that Now In appendix b This is proven as a general theorem. It's five pages of mathematics The editors of john wiley Said to me mr. Brock. We can't put equations in your book looking at an airport No one's gonna buy After the new science and national science foundation study has been completed No, we'll buy a book with equations because the problem is that it has been discovered that at least in the case of men Math and sex uniquely terrify men because both basically Precipitate performance anxiety. You can't fake the outcome No faking for men, right? so They tucked it in the back they put it in there, but I have a little picture that makes it easy What you're gonna see is quite extraordinary when I first thought of this. I just assumed it had been proven a hundred times Actually, it hadn't and I don't understand it So i'm assuming it has been but I just haven't had time to find it The point however is public policy. I want you to just go to figure 3.4 supply and demand graph Everybody with me That's on page number five And just want you this is real simple everyone sees this think of coca-cola price Quantity of coax, okay You may remember the downward sloping line d all that means is demand As you lower the price There's more demand so a slope stands everyone see that Lower the price out you go in the quantity axis. We've got the price and F. I'll bring prices Something like that supplies the reverse The higher the price goes The more Billy and I will get together and produce more widgets sound simple They cross that's your supply and demand balance see the price and quantity That's what everybody here knows Price will set demand equals small Paul samuels and the great economist Ken arrows brother And incidentally both those two great economists are the blood uncles of larry summers It's known as an unfair genetic advantage The the Point here is That most Time that I or anyone else Studies anything like this you're interested in how those lines move because that's the way to understand price changes Everybody see this see here's the problem intuitively. I want to say supplies going to go Woody if supply goes up demand goes up because supply always equals demand That's the paradox samuels and used to say for 10 minutes in our lives We actually understand the fundamental point of economics, which is it is not about numbers It's about curves these lines moving. What's it mean for the demand? Curve to move out all it means is at every different price There's more demand than before That's all it means the whole line moves out and you see when you model that notice what happens to the crisscross points You get a change in price and quantity everyone see that that's how we use these diagrams with fancy models No matter that's the basic point it turns out That there's another way to think about this which for some reason hasn't been used very much because it wasn't needed But in health care it is my starting point What the president really wants Is to control the explosion of costs as all the woodies get old The problem is the word cost control like the word Deficit has no meaning It's a partial equilibrium concept to use the fancy word You can impose cost controls and pay doctors 30% less But the nation can end up spending more on health care because an awful lot of doctors when that happens with their $400,000 of debt will migrate from the fields where we need them into the now brand new No government interference field in medicine The hot new field to go into if you're a burgeoning doctor And boy does it lucrative is sex change therapy Okay, so I don't think we want too much of that right so watch my hand I want you to look at this I want you to watch I want you to compute the product Here the area of the square So an equilibrium E I see a price of four and I see what how many I have an eye of it four times four is how much How much did the nation spend say 16 billion dollars on coal right so far so good I'm concerned with expenditure not cause because the it's as obama says it's the 18 plus percent going to 30 Which we're you know, we have no pentagon. We're broke basically We've got he wants to slow that growth. I want it to go way down Boy is that ambitious. What are you smoking? Here is the theorem If every year s the s line goes out faster than the d line And what I've done here is give you a sort of 20 year snapshot D goes out because all the woodies are getting old But I want s to go out more every year, which is easy to do if you think about it, which we never think about it So over time there's a big gap. Does everybody see that d doesn't go to s goes out more Please note the new equilibrium watch it carefully. You see my finger Could someone tell me how much we're spending Oh, is that down 25 percent? Wait a minute. Are there more doctors or less? Let's look on the quantity axis. What you're kidding. Gee, that's a 50 percent increase in the supply So your phone gets answered What's interesting is it doesn't matter what the slopes are this property is always true Putting it most simply what you see in appendix speed total expenditure If you let s go out faster and the ways to do it It's all in the book is a parabola it goes up and then it goes down to zero I know you may find that odd. I want you to do an experiment Think in 1980 of all the phone calls you made And the amount of money you spent per minute just freeze it Scale it up by the amount which population has grown between 1980 and today Take how much that expenditure on phone calls for all of us was in 1980 is a share of GDP then What do you think it is as a share of GDP today? Could someone give me a guess more Or less Did you hear 90 percent less? That's the point In-came competition You the cozy cartel of ma belt changed you had the baby bells So i'm not going to go on about this the point about this. It's a simple point But it's remarkable that as you go out and out and out this rectangle down here gets flatter and thinner and thinner It goes to zero That is another way of saying it is the fundamental theorem of progress progress means S goes out faster than d so we all end up spending less on cope So jim and i can now go take a trip or buy an ipod and this goes on for hundreds of years and health care And k-12 education are amongst the only fields i know of Where the reverse of this is true and you have an effect a kind of negative product So i'm sorry to be but that's no this is fascinating I'm going to say something i'm going to ask a question which i don't want you to answer Because we'll save this for discussion later to move it, but you know this kind of curve which we're all familiar with from economics assumes Decreasing marginal cost which that's been the difference between health care and education, right? But it fits into that. Okay, fine theorem does not it's generally that's the point We'll assume that for a minute or just shapes. Yes, okay Here another topic you that i think is very very different from the prevailing dc view is your rigorous insistence on deduction versus induction and your and your Your hostility to big data. Yes So it's given that this organization is now chaired by my successor eric schmitt of google who is uh The incarnation of big data and its benefits make the case against big data and it's misleading. Yes I will it's chapter one of the book and i used to think no one would be interested in this But it turns out people rather like it. It's sort of genuine interesting It is an extraordinary fact That if you look through this new book on the 20 great equations of history, which is to say not just physics But all sorts of things nasher theory of bargaining That virtually anything you can think of for example shannon who invented the concept of information and axiomatically proved What we mean by information made the computer possible. He was mit in the late thirties von Neumann the great genius who invented game theory Mathematized quantum theory and physics, which he never studied Invented the computer the self-stored computer formerly known of princeton Where he ran the institute for advanced study of the von Neumann machine He made the point if you look back Nothing important Newton arrow in economics nash game theory harsani game theory To each according to his needs very ethical. What would mother Teresa do? I axiomatized that says seven years ago to each according to his Contribution John Nash's roommate axiomatized that In 1953 it appeared in the annals of mathematics studies and this is smart people Everything came from deduction for example In the barge, I'm sorry to me politics is all about bargaining In economics, there is none in adam smith pure market fake prices is given and no wheat farmer can gang up with the neat We farm there's no bargaining no threats But in bargaining the question is basically who does the dishes how many times a week after dinner Or labor management or who gets how much of the pie Using axioms Nash came up with proof in 1950. There's one and only one solution function to any bargaining game was a formula The only variable that mattered In determining who gets how much of the pie was a non observable variable Year relative risk aversion compared to mine in the process of gambling The ratio of risk versions, all right Now if you had trolled the data for a thousand years You never would have found that risk aversion would matter to the bargaining problem You could set up experiment after experiment without von Neumann You couldn't even measure risk aversion no actually arrow showed how to do that and Nash came to an answer data comes in as it did to einstein in confirming What these geniuses end up with But the people themselves used axioms and deductions from first principles The nice thing being if you don't agree with the outcome go back and fix the principles But if they're real smart guys, you'll find their axioms are watertight This is the essence of genius the highest form is to prove that given reasonable axioms There's one and only one solution so to speak that satisfies them. That's the hope hard to do Often you can prove there's no solution Right arrow did that and trying to find an ideal voting scheme. So long story short We're living in a world Where whereas in 1900 there were as many streets Named after euclid as there were named after washington and jefferson remembering cleveland euclid avenue was the only one Euclid invented the axiomatic method 300 years before christ You all remember geometry the fact that You find a triangle In the angle some 280 degrees you call it a left-wing triangle. No, it isn't idiot Burn triangles it shut up next topic, right? It just follows But you have to invent the method to show this you sit there and you agree with those five axioms or whatever I can't remember how many so that's the point I'm making here You need the data to confirm it the most amazing example of this in the history of the world Is einstein the general theory of relativity this whole theory of curved spacetime published by him in 1916 He never used data none of them do newton didn't newton boasted that he derived in 20 minutes kepler's laws What kepler did? Induce using data so einstein comes up with this wacky theory It makes a prediction that light would be bent by a heavy object and then the eclipse of the sun In 1919 sir arthur eddington who held newton's terran mathematics at cambridge went and tested it with large photographic plates And it worked his telegram overnight made einstein the most important person on earth for a hundred years Which he deserved to be He offered to send a ship with the heavy plates to berlin for einstein to examine it And famously einstein said sir arthur and letter that hangs in the royal society. You are most generous People are starving that the world war one was just over. I have absolutely no need to see them You see sir arthur the theory is generally covariant a very important axiom. It had to be right This is what i'm talking about My point is the kids today don't even know who youkla is No one thinks that we're given a spreadsheet. We're given a spreadsheet and told the boss wants results at 505 in the afternoon or you're fired Now it's bad enough to use induction, which is the the reverse where you look through the data and hope to find the truth In public policy, especially in washington, we don't use induction. We use bastardized induction You on the left Find your think tank to give you more facts to fit your view you in the right find facts to fit your view It's a dialogue of the depth. It is a deafening the dialogue of the deaf So that's yes I'm going back to simplicity. I like axioms My dog does too. So here's an axiom I would share with you too as as we are gentlemen who reach our mature years I I try to avoid ever having a sentence with the words kids today and You're asking for trouble Kids they do x y and z but let me ask you one other thing about the Primacy of deduction if we assume that the greatest minds in human history have been right in their ability to produce these axioms What about everybody else and just operating from the gut? Isn't it better to have a bias in favor of fact? In general, I don't think gut in fact are the same. I think What is actually gut Is it once someone says to you? That on a flat plane for every point a and b there's only one straight line between them That's an axiom. It's it's a fact too. There's a link between them and data suggests axioms But the point is it's like a lever and a pulley But the axiomatic method does is it's a lever and a pulley you get so much more out of it than you otherwise I'm expressing myself poorly what I meant is for most people if they heard your dismissal of big data They would be then be reduced to their own prejudices and uninformed spasms No, I think the problem with that is that the big data itself May lead them astray. Do you see what I mean? They're not astray on either way But for most people in life who the hell needs axioms and deductions Most people go through their life and it doesn't really matter But most people voting If they've heard an issue debated only in terms of deficits are all terrible deficits are good Then they suffer from that But the arrow thing does in the case of deficits is they deduce from first principles If you want maximum happiness Make sure that you have the right investments in everything everywhere and that it's all about profit So it's it's it's left-wing because you're concerned with the greatest go to the greatest number It's right-wing in that. I'm a real capitalist. I want every penny public and private optimally invested and so I think do you So we promise to allow our crowd to ask questions within a few minutes from now I'm going to Suggest two or three topics You can address any of them or any combination there of in a couple of minutes because the other points that I very interested in your book About volatility, which is the curse of our modern life Whether how your approach would deal with the curse of volatility Your prescription in chapter six for the good society How that might enter a political discussion And also your symmetry your argument. There's a symmetrical failure between left and right. That's something I I am skeptical about somewhat myself, but but any any one earth one two or three of those subjects I don't have much to say about the last one. Good. I'm not sure if I said anything that it's right I may have screwed up, but I mean, I just don't remember so kind of been big I don't know so volatility or the good yeah, let me say something because in both these cases There are major advances and I happen to like ideas and I think you like ideas Incidentally if you haven't noticed it, I'm known for something very unusual very risky. I talk up to an audience If I think it's important to know about deductive logic, I tell people that's not fashionable when you're a public speaker Everyone's stupid. You're supposed to talk down. I couldn't disagree more I also agree with bill clinton. What matters is whether or not the people serving coffee in the back of the room are listening That's the beginning Right. So here we go. I don't want to spend long in the volatility story. There has been a revolution at stanford The work of mordecai curts again. This is the man that's that held arrow's chair He's just retired and also wrote the book with arrow on fiscal policy He also worked in game three But in the last 15 years, he was so fed up with standard efficient market economies He don't reject it. You don't reject it newton didn't work. I'm sorry. Einstein didn't reject newton In true science you arrive at a new better theory that includes the earlier theory as a special limiting case Got it Einstein's 10 equations if you just take simple things where there are no black holes and we're throwing a basketball around this room It reduces to what we call flat space time sort of normal stuff When you do that Of those 10 Einstein complicated equations the coefficients of nine of them go to zero Which is to say they're out of the picture and all you're left with is newton's potential function So really smart people really smart people don't expect to overturn something else They generalize it. So here we go the efficient market theory is to me very analogous in economics To what gallileo did with physics Gallileo was brilliant. He understood to understand and to test His concept that mass and gravity were independent He used a bell jar in which there was no air and it's true a feather falls at the rate of a lead ball In a bell jar mass and gravity One of the great findings in history He was not so stupid Is to take this very limited story And apply it in the real world on the thunderstorm where feathers go up and lead balls go down, correct? yes efficient market theory Properly understood which is not by finance professors largely made the assumption That no one would make mistakes in their probability forecast I'm going to call this mistakes free economics like friction free physics. I mean Newton added the friction and lagrange later on By this I mean the following what they were assuming Was that the data that's being generated to build your economic models was generated by a Random process Which is known as ergodically stationary in mathematics all it means is the following You may have this seasons bull and bear markets. You can have things change Got it, but the way they change can never and never does change There's no global warming which changes how the seasons change. There's no Gutenberg press There's no arrow inventing derivatives on a footnote There's no rise of china no advent of opec in 1973 But of course in the real world it's precisely the structural change which are fascinating So in the standard classical model of efficient markets, here's what happens We all crunched the data and as the Nobel prize winner last year Tom Sargent Who was the creator of this? Said in the new york times the day after he got the prize He said yes, we assume that using historical data Everybody would arrive at the same forecast the same betting odds and they would be gods He laughs now But try formulating it without such as This very simplifying assumption led to a complete testable theory, which is a great accomplishment Known as efficient market theory rational expectations Schiller tested this in 81 against the data and it could only explain unfortunately about 18 of the volatility of the markets That's not very good But he didn't know there was mistakes tree because this point is just rarely ever made so What curse did is to say wait a minute Maybe it's mistakes, but you have to be wrong about because you just don't know about global warming And maybe mistakes are the true source of volatility. So here we go I want you to think of something half this room is 20 percent higher reality you guys in your bet Your mean probability is to say 20 percent higher than what the truth will be You all are 20 percent below Got it the truth emerges notice The quantity of trades will explode Because you're all wrong. So you'll change your portfolios, correct? Price won't move Because every one of you had a symmetric mistake to somebody else So you change what you have But the impact on price is zero. So price volatility was zero hint hint Suppose like in the biggest such gamble in modern times our bets on our house prices. We're all wrong in the same direction Now Price is really going to drop Wait If I were teaching a course on this what I call the fundamental new theorem of risk and curts did all of this mathematically Brilliantly is the following. Let's suppose number one. There's a big Carly mistake. We're all wrong in the same direction. That's not good for price, correct? Oh, I forgot let the banks and the households be the most leveraged in history Two plus two equals minus 64 Free let all those idealized arrow hedging work. It's not work For let's assume you can't hedge most important things in life 90% Schiller says of the big risks which in the arrow classical theory we could all hedge Through what are now called rivers aren't hedgeable But if you want a mess in your hands, you don't have hedges You were colossally wrong in your bet. You were massively levered. This is a perfect storm Okay, but what this is saying is the following the current debate about this. I'm blaming james for being a dumb regulator You're a dumb consumer to buy that house And I don't know you're a banker and you're just evil Ad hominem criticism endless op-ed pieces the problem with this is that any engineer knows These are known as state variables. You can't change You're always going to have dumb regulators Go ask who wrote about this is I don't know who were the emperors of Byzantium I forget just in the in a theodora Railed about the bureaucrats and their stupidity greedy households. Gee joined the crowd bankers that are greedy The idea that you're more greedy than you were before is more no more absurd than saying kids are more horny Than they used to be get used to it The point is you can't change these things as king canute so lose courtiers Don't try to stop the waves Breaking in the coast of Denmark build a seawall And the seawall In this case is leveraged the only mentioned variable. I mentioned that you can change Is leverage so in august 58 my dad was awarded that bought he bought these things, you know stocks and everyone did Smith Barney he had to put down 45 percent margin On the stocks. Yes But then there was a bubble three months later as it's in my book. It was 90 The authority saw daddy was getting drunk. They said mr. Brock your neighbor. It were putting on your seat belt This time In the name of deregulation of a form that adam smith would not turn in this grave, but gyrate This time we take off the seat belt and require zero down payments the higher prices go This is the most crazy thing that ever happened. It has nothing to do with left wing right wing It's just common and I show in my book with as much deeper level why this is wrong. So that's point number one We've made a huge understanding Of risk by incorporating mistakes. It's the fundamental propagator of risk amplified non linearly hugely by the role of leverage being jointly wrong and massively levered is disaster I want a czar of leverage. It has nothing to do with the fed the fed funds rate that can affect cherry tomorrow Prices I want a leverage czar Okay, number two the last point with the the good society and then we'll stop and take questions here I have a diagram. I'd like to give you this has been my main life's interest Only now it's becoming relevant. I can talk about it before I had to shut up because no one was interested If you get So which page we're on page eight. Okay I'm sorry. That's the wrong. That's what I just gave you a minute ago. It's just you know Oh, look, look everybody. Yeah, look everybody page nine. Look at page nine everybody See, this was dad 58. Do you see how the marginal carpet went in three months from 45 to 90? And look at the reserve requirement. China changes, you know every what every month they govern leverage Look at ours. It looks like a dead patient on the soap opera screen All right, it just doesn't move markets no best They do in certain cases certainly not in finance, which has nothing to do with economics proper Right, here we go. I want to just look at the last slide here on page 14 I personally think this is the most interesting stuff Now this is something new i've done since the book which I think is better and should have been in the book, but that's all right Everybody's now asking if you read foreign affairs you read these 50 articles since january the first in the financial times called capitalism and crisis read frances fukiyama's new stuff the future of history everywhere So even the harvard business for you and fortune makes it it's all about what system do we want to live under? No fukiyama in 89 said basically capitalism one no pun intended zero In his new piece published in foreign affairs in january. He says he was right He says even the kids on the occupy wall street Nobody wants communism back and it's true with good reason We now know theoretically as well that the incentives in a communist system are such that you get an ever smaller pie But he said what he didn't know Is that a great debate would be between liberal western capitalism versus Statist authoritarianism Capitalism of brazil russia china, whatever. This is the big new debate So I just want to talk a little bit about this because really the mistake we make is to Compare gdp growth. I mean the nepalese are right. It's a lot more than that in shanghai two months ago I asked an audience of 150 people. Please raise your hand If you would not give up two percent growth For a bill of rights I think three hands 20 years ago, I suspect a lot of hands You get rich. You don't want to be carted away in the middle of the night. You want habeas corpus, correct? You want to build rights? You bet roll the same? I don't care what your skin color is. I'm a total democrat So what happens is what we really want to know and talk about an optimal system Or the system I'd like to live under is I want to know what's the right economy polity, which means government and constitution And by looking at this quickly you get an insight As to whether or not the asian model is better than ours First thing you have to do is go back to what rostow His book the three stages of economic growth published at mit In which he was very famous book. He showed that all countries can grow at the percent upfront. Is this starting from nothing No country's ever grown that fast once it develops. You just doesn't happen So to compare china and the us in that sense is silly What you want to do is ask what is the fate of both systems going forward And what I have found in this new stuff Is that both capitalism As we know it and as they know it in statist models suffer from a common problem Both contain the seeds of their own destruction The good news is that in our system, it's easy to fix Particularly by this overlap area b Where politics intrudes into the constitution and permits a modification of it Let me be very blunt and quick. The great crisis of the west Diagnosed by economists Is poorly diagnosed The great crisis of the decline of the west Has huge economic consequences But its origins are strictly political philosophical We invented a system and we're going to change it Or by if i'm running For a reelection against you and you for me for both of us It is rational To buy the votes of insecure voters by promising more benefits than the holy ghost can pay for Our room and we you're all shaking your head. You all agree. I mean, this is basic I remember the new york times when our unfunded liabilities hit a trillion It's not 52 trillion. You're probably all better than i am at the numbers. They change all the time. It's absurd It's it's it's going to be a disaster. I don't care if it's sacramento or greece. It's all the same story Australia Holland and switzerland have done the most to fix it if you want to move somewhere that's going to be maybe better But it's not the point We can fix that And 1800 our ancestors weren't worried about slavery. It was part of life We learned it's bad. We learned women are as good as men. We changed the constitution. We improved it That's the social learning process that Kenneth bolding used to talk about Well, I want a constitutional amendment right now As swistlin just passed whereby we aren't ever again allowed to mortgage the future of the children period I want us I want a second constitutional amendment The kids in this country if you want to know about downsizing hollowing out and so forth and so on Let me tell you don't listen to people who say it's due to globalization. That does nothing but add growth and trade No, that's not it Don't listen to people who say it's about technology the new technologies. Don't create jobs. This is not true Listen to someone who says i'm satan and i'm going to show you how to wreck the living standards of the middle class As biceps go out of favor and skills come in, which is what's been going on for 50 years I'm going to design an educational system With negative productivity for k-12. So you end up with a bunch of doofuses who can't do anything unlike germany Where your apprentice to the age 14 and 15 and you have a job and there was no youth unemployment in germany In this country kids can't get on i rate About the hosing of the young and i want a constitutional requirement That kids have positive productivity educational system period Anyway, so here the point is The area a is how government intrudes into the economy The theorem is the less it intrudes the better if you want growth But it has to provide public goods And it has to deal with externalities. Adam Smith would agree with both I'm a capitalist. I don't want government. Yes, you do without courts of law idiot You can't get your property rights enforced. I mean, this is ridiculous as far as fair taxes go since capitalism requires public goods You have to deal with how to pay for them fairly or outcome of the pitchforks I'm a capitalist. I don't want to talk about distributive justice. That's mother Teresa. No, it isn't idiot. It's you So i'm not left-wing or right-wing. This is common sense, right? b b is our ability To change the constitution in a communist system or in this Stasis system the problem is the area b is c His crabgrass takes over. There is no constitution. It's just a rubber stamp. They can ignore it. Do what they want I don't like that a Grows and grows under the stasis system because state-owned enterprises buy that very incentive structure Make sure there never can be a steven jobs Right, this is all the news stuff Our system has plenty of good going for it because that doesn't necessarily happen We can keep this the problem with our system is what i've already said This business of giving if we didn't have an entitlement crisis in this country And we didn't have the school problems that we have basically 90 of what we're all upset about would go away I want a constitutional amendment. We've learnt slavery is bad. We've learnt this situation is bad I want to text don't say it can't happen. It will the bond markets will make it happen the problem with the authoritarian model is A and b grow in a way that slows down growth a lot The real problem is and this is the difference to fix themselves Requires that more and more monopolistic single party powers give up their own power to fix society Now how likely is it that the people with all the power and the influence are going to give it up? That's I think a long run now. You've probably been much better about this in your book, but I worry about this I have a parallel argument in a slightly different style, but it's a worry. Yeah the incentive structure So anyway, the point about this is I'm going to make one last point And that's it, but it is I think important We all know on page 15. What's a good economy? Okay In English you've got four quarts of blueberries two pounds of flour Some shortening sugar water You have the ingredients the inputs We now have eight kinds of economies think of them as toaster oven sitting in front of you capitalism Fabian socials think of them all the best economy meaning the most efficient Produces the biggest pie Who wants a system? When you get less pie than we could have so that's evidence Economies also should be stable like yellow jello. They come back to where they were when they're shocked I don't see any boarded up windows here and broken windows and burnout buildings. Do I oh, they are elsewhere In 1955 again her which an arrow proved That adamsmith economies had an intrinsic stability I want freedom and privacy in the sense of I don't want people having to know what I'm having for dinner When I buy my chicken in the supermarket, and I don't want to get a permission slip like in dr. Javago who wants the movie Justice lump summary distribution the great theorems of economics at the highest level prove it and adamsmith perfect competition Economy alone will satisfy this laundry list. My dog barks twice. We all want this. This is apple pie and motherhood It's not left wing and right wing to want stability. Whatever. What's a good polity. This is what's new a good government What is government government is not what the books write That somehow in washington, they're supposed to maximize the public happiness Government is not about that government is that you are a california rancher He's your senator. I am a farmer in colorado You're my senator. I want those two to bargain and reach a compromise about how much water each of us gets You aren't as john nash first pointed out. You're not maximizing anything You're reaching an optimal compromise Don't forget the most important comment on that before nash in history the duke de telleron Leaving vienna in 1815 said what a great treaty we have signed which lasted to win 99 years it was the best treaty. He said this was a really good treaty. Everyone's leaving furious In 1919 at Versailles the french were thrilled at how they screwed the germans and you all know what happened, right? The notion of a good bargaining and we don't have time today. I have shown you haven't have an efficient Fair and an unbiased There are the three norms that the standards the yardsticks for how good is the government each is an interesting story But not for today The point i'm making is we all have known a good economy is measured by how efficient and non-wasteful it is We can now start talking using game theory about a good government Being judged by the nature of the bargaining compromises, but the problem with that is Bargaining could end up putting me in jail or enslaving me and you So the constitution kicks in and that's the fundamentally is jefferson said an ethical doctrine Don't forget adam smith was not an economist and i'm not He held the chair of moral sciences, right? Notice all the constitution does is look at the bill of rights. It's symmetries. You're equal to me. She's equal to him Yes We all have equal rights. This has nothing to do with bargaining power. This prevents the day to day washington bargaining From screwing us and carting us away in the middle of the night the asian system. You don't have that If prime minister lee whom i love doesn't like it. You don't write about that topic in your phd thesis Or you never get a job Secondly, I believe a constitution must deal with the fact That which is now you can prove it formally because of advances. These are all advances You have to deal with the fact of distributive justice as every kid now knows You can now show that you must have a progressive tax system It satisfies all sorts of axioms the rich should pay a larger share That's not to say they should pay 80 percent or anything And it also doesn't mean that people in the lower half of california should pay nothing the whole thing today is screwed up But it's absolutely true that That tax You can't justify at all the simplest version is the pain Of 10 percent of an income of a thousand years killing to a family whereas if you have a million a year It's much less But there's many other ways of proving this and everybody accepts the buffet type of concept But anyway, all i'm then saying is that we're making huge Progress in understanding what a good economy is you want a good polity You want a good constitution and you want a good economy and you want those areas a and b have overlapped to be Correct. I'm very excited that finally we're able to talk about these things. So I think we're finished Thank and we have time for one or two questions for our uh, our and so we take the microphone How about here a gentleman in the with a no jacket and this is hand up? Yes, and would you identify yourself place? Yes, I'm basil scarless. I've recently retired from the foreign service and I've lived abroad And I have a question regarding health care policy. Yes How would you specifically how would you expand supply? What would be an efficient way to do it in our society and secondly? What's your view of evidence based medicine? The second i'm not going to talk about because I don't know much All right The first one is interesting. It's a very good question. There's three Basic ways you shove the supply curve outward. The first is known as factor stuffing You tell harvard medical school You haven't changed the number of doctors that you're graduating. I don't know the numbers but overall it's terrible We the federal government having monopsony power In 10 years, you're going to triple the number of people Especially since 30 percent of physicians are about to retire Which is another point made in the book. The doctors want more doctors. They're not against it. They know what we face So you could increase the number of factors where they're needed, but that's minor league the real story Is walmartization or atmization? You have you you increase productivity huge Which has happened in every other sector except this And basically one thing I have proposed is you have expert systems 90 percent of the reasons we all go to doctors are what? Ordinary just basic things. You know the deal You go in you wait 30 minutes for the nurse. She takes you in the office Then the doctor comes in and stands in front of the degrees My appointment for my sore throat was five dollars at five 75 park avenue when I was young now it's 500 I'm business christmas eve all right Not good productivity. So the point is The kinds of things that most of us go to the doctors for are so basic monthly low IQ The freshman MIT can program a system today whereby when I go in for five dollars in the morning at 4 30 to cvs There's a booth. Oh, it's not just it's a booth. They take my blood Stuff happens to me. I'm talking not to an ordinary intern. They get the best interns to make the wisdom I'm being looked at tested. It's checking for all the anomalies that suggest that maybe I have a cancer or something like that Outcomes the prescription of what you should do and if something's wrong Outcomes the phone number of the zip code and the addresses of the doctors you have to see for your problem This is all done using the best of thinking it's delivered in a cheap new manner. It's gonna happen We're just so late with this. It's like saying the ATM machine could have happened 30 years earlier But we kept it from happening. Well, it did happen. So I think that innovation Productivity growth as well as more factors Are the ways in which you shift supply curves out and any one thing that this is not important. It's huge in history We live 30 times better today than in 1700 that is it would take one 30th of our time today Then it took to spend the whole year for the living standard then Prior to 1700 we've never known of a single thousand-year period when living standards more than doubled Not one In 300 years, they've risen 30 percent because of basically free market incentive-based I hate to say capitalism. I don't like the word but basically so I hope that's a partial answer Three ways to shove it out. Yes up here in the front. Good There is a phenomenon Yes This is a problem when you get a physician A physician will have as you just said a war story. Yours is all about the cleavage model. Yours is about torture reform There's nothing wrong with what you're saying. What I'm trying to do is transcend that whole thing The Answer I'm trying to think of the best answer to show For what you're saying here the theorem deals with slopes of any kind as long as demand is downward sloping A proper medical assistant arrow showed this in 67 and will always make you pay a front To go to the doctor. So you may want more But you're not going to waste it Conversely Everybody will have catastrophic insurance this fall is right out of arrow series risk version repeat Nobody would ever run the risk of having their house taken away from them because they're in the hospital and sick Nobody Right. So one very important thing for your point about the elasticity is you should pay upfront for some of it All right, that does a lot in that sense But the point I'm trying to make is maybe best indicated by taking an example you didn't make Let's say we're arguing about tort reform. Okay How does that affect what I mean? It has nothing to do with what I'm saying wrong tort reform Will push the demand curve for tests backwards Because now we don't have to cover our butt By giving tests about everything the incentive has changed. I'm no longer paying a million dollars premium The supply curve of doctors will notice that's a different market will shift outwards Because the doctors who can't stand The risks of lawsuits now won't have that so they won't get out of business retire early whatever and it's been shown I mean, obviously if you can push one demand curve backwards and another supply curve outward You're on the way to a big victory So you can take any single aspect of the health care crisis and filter it through this general law What to do to the two lines? Anything will affect it And what you want is like a constitutional requirement Everybody reform is judged by what to do to the two curves. That's the way the nation Can bring this huge bill way way down So I don't know if that's a good answer I'm happy to take more. So so one more question. Yes. So do you have a question? Yes Okay, we have a quick time for a question and answer. Then we have a reception. All right I'm page identify yourself. I'm mark ruin burger. I ran a new service here in washington On page 13 your third point. Let's take it out of theory and add the practical answer Politics is about multilateral bargaining between interest groups Or to hold on. Okay. This is going to be page 13 point number three point three, right? Okay, good government achieves a good bargaining compromise. We clarify what that means. Yes, what happens When one side and it doesn't matter which side? Yes refuses to bargain Well, that's just redefining the thing. I mean here is how john nash would answer that He would be his because he's a lot better than I am believe me I think he would say the following take the basic pie division problem The way he defined it was we got to reach a compromise at the pie. I mean god damn it. I want it all Screw you. What do you I want it all and we end up with 60 40 70 30 50 50 whatever The national solution shows in any case what that will be sometimes 80 20 sometimes 50 50 The point is that the rules of the game are if you don't bargain and compromise you both go away with zero Now who's going to want to go away with nothing and throw the pie down the drain That I think is maybe the best answer the incentive structure of the game Means that just as is true in real life. We all do bargain We may be furious like those guys at the treaty of vienna But is that a decent answer? Yeah, yes I think the mark of a good answer and a good discussion is that it resolves some questions and opens others So I think by that standard we need we owe woody a great vote of thanks so So I urge you all to Buy and read woody's book I urge you to have in the back of your mind a book for next week And so and we have a reception here, but again, thanks for coming and thanks to woody for this excellent presentation Thank you Jim