steal market share from their rivals with no intention of benefiting society. the end result would be competition would drive prices down, higher quality products would be introduced to appeal to rival firms and the consumers in front general would be the ultimate beneficiaries of that competitive process. they would get better products at prices just high enough to cover the price of production. it's a remarkable story but as i noted, adam smith himself didn't believe that it was a general description of what happens when selfish people go about their business. erntd ..

>> of course, oftentimes the trade that helps the individual also helps the speci to which the individual belongs. so if you take for example about a mutant gene that codes for

keener eyesight in the hawk, we all know the half who bears that gene gets a clear advantage. you can spot my stomach higher altitude soaring above the valley floor. you'll catch more mice. you will feed his can more fully and raised more offspring. if that gene spread throughout the hawk population, which has a tendency to do, so much better for all the other hawks. not any of the disadvantaged by having keener eyesight. so that's the invisible hand played out in a darwinian setting. but as darwin was well aware oftentimes the trade that benefits individuals don't play out at all to the benefit of the group. here i want to tell a simple narrative story. i have taken altering the way i give talks in the last several years because in recent years been studying the lack of effectiveness of introductory econics course.

i hesitate to reveal to you that there are now studies in which students who take our course, our traditional introductory economics course, are given tt designed to probe their knowledge of basic economic principles six months after the course is over. and though students don't score any higher on those tests and others who never took the course at all. it's an extraordinary shameful performance. in other fields, it would be the subject of malpractice lawsuits. you have to wonder why isn't it an economics. parents are paying $40000 a year tuition, why hasn't someone filed suit? you are spending all those hours with mike kids and charging me all that money and you're not teaching them anything. my hypothesis is that we haven't seen such a suit because mosd people out and we'll don't do any economics either. so not at all evidence that we are sending out who are poorly trained.

ben bernanke and i in our textbook at a hypothesis about why this is so, basically it's a simple conjecture that we tried to throw way too much stuff at students during a semester. thousands of ideas literally wrapped up in equations and graphs, many of them. really the humanind does not absorb information in that form and in that quantity very effectively. so in the end is not such a surprise that all goes by in a blur. it would be interesting if it did not. what learning theorists teach us ishe way to get infortion to the human brain most naturally is to wrap it up in a narrative. so if you can take the economic principle that do most of the heavy lifti, and the good news there's only about a half a dozen of them, and wrap them up in stories that seem to say what's going on in context familiar with people that information gets into the brain easy. it is a dredged up quite easily from memory. people can see an a lot to it as

they go about their business in the world. so it is a way more effective way to master new concepts. it is our claim really that you can learn the basics of economics and a semester without great difficulty, if just you will cache the information in the form in which it is most easily absorbed and then make sure comg back, drilling. here is a story. this story i will tell you is a darwinian story. and it illustrates an very simple terms the central theme of my talk. so stay awake through the story and then whe some asks you what was that about, you can say i did hear the whole thing but this is the gist of the talk as he explained at the outset. so darwin asked this question your why is it that the members of vertebrate species, most of them, are asymmetric male versus female? than males in general in such species are bigger than generally more colorful than the females. whis that?

darwin wanted to know. so for example the bull eant seal, e-mail of the species weighs upwards of 6000 pounds. that's as much as a lead-in that would cater waiter at the big sport utility vehicle. is it good for males to be big, and darwin pointed out to, not really. in fact it's quite burdensome for males to be big. they get more ailments at much younger agers they have to beat lots of food to maintain their body mass. worst of all they are not very good at being competitors. the great white shark catches a 6000 pounds to much more easily than if you know of the species. the female weighs eight to 1200 pounds. so why are male so big? darwin's answer is quite provocative, simple, logically sound. the answer he suggested was that because like most other

vertebrates, the elephant seals are polygamist. that means they take more than one mate if they can. i stress if they can part. in darwinian terms, that's the worst outce imaginable, the game is over for you. so naturally the males take very seriously the ta of finding a mate. and they fight for them. typically vertebrate species. and lo and behold if you are slightly larger than your rival that you are fighting what you have an advantage in a fight. and so if there was a mutant gene, that would tend to make the bear of the gene more likely to win the fights with other males. the bloody, horrible fights to behold to put it in the nature archives. they just pummel one another for four or five hours and then they are bloodied and exhausted. finally one of them goes away

unable to continue. the winner claims access to him from anywhere from 5200 cows, and the gene that made him a little bigger that hped him winhen shows up in the pubs of all those counter and in another mutation comes along and it builds on itself and the bulls get bigger and bigger, not without limit their fadeaway 100,000 pounds. they weigh 6000 pounds. but 6000 pounds for the bowl is just a bad number. if they could take a bow and say that the count of three pushed the green button, you will always 3000 pounds, they would jump at the chance to do that. they can't. so 6000 ounces where they end up. that's an example of a trait that serves the individual but isn't dreck conflict with the interests of the group. and there are many, many traits like that. they'll have this general collective action problem feature. so in stadiums, people stand up to see better. nobody sees any better than if

everybody remained seated and yet of course it's more burdensome to remain standing. so that's the basic theme i'm going to talk about, that if you turn individuals lose in the marketplace you don't get an optimal distribution of resources by any presumption that comes out of our best available theory of competition. sometimes you get outcomes. oftentimes you get positively dreadful inefficient outcomes here and where we are different from other animal species is that we have the capacity, far more than other animals do, to make rules to try to make the inefficiencies less severe. and i ll talk about some of them. okay. let me try to set the rest of my remarks inhe context of the current downturn and looking for to its aftermath. this is a really bad downturn. this is the worst when a professional economist, active today has ever seen, the one what active in the great depression in the '30s are no

longer alive or professionally active. it had the steepest decline in output and employment and opponent on record. the great depression didt see as deep a decline as we've seen at the outset of this downturned. maybe it will not get to be as bad as in the great depression. probably it will not be because now, unlike then, we have some idea of what to do about it herbert hoover was the president when the great depression began in 1929. he didn't have a clue as to what doohickey thought you needed to balance the budget. he had never read the book explaining what to do about the great depression because it hadn't been written to it would be written for another seven years. 1936 was the publication date. roosevelt seemed about some intuition about what to and a lot of it squared inside when it became unleashed or you will not remember this even if you took an economics course but i remind you that national income is the sum of several components,

consumption, investment, government spending, we would add net exports today but we wouldn't talk much about it in those days because it was such a small share. but those are the main components of spending, and when spending falls way short of the amount necessary to generate a job for everyone, it can remain at a low-level, equilibrium equilibrium, for quite some time we're in such a situation now consumption has fallen sharply because it was at unsustainably high level to begin at. people were borrowing money against home equity that was a really home equity. those were just either artificial high prices. >> private investors are spending way less than they normally do. why would anyone want to build a factory right now? people already have capacity enough to produce more than what people want to buy at the moment. it doesn't make any sense to add to your capacity now. so consumers are going to rescue the low-level equilibrium in its

current trap near the investors are going to rescue it. that leaves only one other actor onhe scene the capacity to do anything about it. and that his government. and government in that situation can really help solve the problem by increasing spending and massive quick averse to prime the pump in effect to get the economy going again. and so he couldn't resist saying that it would even be better to do nothing to hire people to do useless tasks. to one of his famous examples was we could hire people to dig holes and fill the back up. they would go to the grocery store and spend it, pay their landlord, by clothing with it you're the recipient of that income would in turn go and spend it on other things and you would get the now familiar, then the concept of the multiplier. it worked and the economy would

be pushed back on its trajectory that would be sustainable again. government is the only actor who can do that, keynes argued. and i said it's uncontroversial. all the living former members of the presidents council of economic advisers who served under democratic and republican presidents alike have all come out in some form of, in favor of some form of stimulusackage. there are some economists it is not a good idea. they are not as distinguished as the broad group that supports stem despicable to say it is essentially an uncontroversial position that the government should be borrowing money, printing money, taking money and getting activity getting the economy going again. but why spend money on having people dig holes and fill them up? what a dumb idea that is if there is any alternatives that

would be more useful than digging holes and filling them up. does anyone doubt that there are ample alternatives that would be way more useful? think about the bridge across the mississippi river on identify that collapse as people were driving into minneapolis a few years ago. people were not expecting the bridge regularly. if they had inspected it and saw that it was deficient, they would've said we will fix it but not now because we don't have the budget. a lot of people were killed when the bridge collapsed. ed rendell, the governor of pennsylvania who was saying he has 6000 bridges in his state like that. they are already to be fixed. just the lack of money that is preventing from starting to work today. there are several ready people able to move right into those tasks. and so there's a big inventory of stuff we can spend money on that will help get the pump imed and get the economy going again. so it's just something that we need to do. people are complaining about

deficits. we can't afford to do this because there will be a big deficit if weo and that will burden our children and grandchildren. that is wrong. if we don't do this, the economy will remain at low level of unemployment if there will be a lot of unemployment. tax receipts will be lower. the government will have to borrow more money just to carry out the basic services. you see this very vividly here in california in your current budget crisis. you've got 50 state governors acting as many herbert hoover's having to cut back the tax receipts and that's just exacerbating. so deficits be damned. borrow and spend right now. that is their. because if you don't borrow and spend right now the deficits are going to be even bigger. it's not good to have deficits in the long run. we want to pay the deficits down, but not now. now is the time to be spending. if you want to have a vibrant project of national renewal, you can't that with borrowed money going forward.

we are borrowing money from the chinese now. they are willing to lend it to us. that is good, but if we want to rebuild the nations infrastructure we have to come up with ways of spending our own money to do that. so the pundits are looking at had an saying well, things are looking forward, look pretty damn. for many years to come and say people are going to be unhappy their standard of living is going tolower. not only that we live in a tax phobic country and so we're not going to be able to raise the tax revenue needed to carry out an ambitious program of national investment and renewal. so we are going to go limping along with our current dysfunctional system just as we have for the past decades. that's a very bleak view, in my opinion, and i think it's a necessarily pessimistic. a cole of points. first of all, the pundits are right. consumption will remain below its peak for many years to come. that is true.

but that's not the end of the world. joe manchin i was a peace corps volunteer in rural nepal. my house had two rooms, no electricity, no plumbing. no one here would want to live in a house like that. your kids would be embarrassed if their friends saw where you live in a house like the one i lived in. so i never for a moment felt embarrassed about that house. it was a good house in the context of where i lived. d so if our consumption standard goes down, that is unpleasant but we had jt surprisingly quick today. think about you when you were a student. in all likelihood your income was much lower than. were you less happy? if so you are unlike most people. there is a standard. there is a context that is right for every situation. and if you are in the ballpark for that standard, that's basically the thing you need to achieve in order to not to be

way down in the permanently depressed state because of your economics or circumstances. on the tax side, i think that too is a way to pessimistic view. there is just a way to stream out there i would guess two to $3 trillion a year of money that could be harvested from the ste stream in the united states economy that would be more than enough to pay for universal health care, high speed trains, fixing bridges, catching the road on time. all the things we say we should do and haven't done, we could very easily do by shifting the mix of things that we tax. right now, our tax system focuses on activities that are generally beneficial activities. we tax savings, we tax savings we tax people's savings. we tax job creation to the payroll tax. there are many things that we tax right now that are positively useful. people thinks as a tax as a

device that generates revenue, and that is one of the true effect of a tax. but the second effect of the tax is to discoupage the activity that we levy a tax on. when we tax usefulctivities, that is bad. that makes the economy less efficient. if we would shift our tax syste to emphasize taxes on activities that cause harm to others, and i will describe examples of this, there are so many of them that we could tax, each one of those taxes would actually make the economy more efficient, not less efficient, and would free up resources to pay for all these other activities that would be much, much more useful than the things that are being spent on now. people are accustomed to hearing that government is the source of waste in the economy that we are about the $640 pentagon toilet seats. that is supposed to prove to you without any question that the government bureaucrats in washington think they know how to spend your money more wisely

than you, but in fact they spend it carelessly when we turnt over to the. that is not a very good example because the pentagon toilet seats that they bout for $640 was actually a space shuttle toilet seat. it had to satisfy. there are wasteful government projects to be sure. the bridge to nowhere, but the conspicuous example. it got stopped because it came to public attention but there are many wasteful government projects. they should be faired out and killed whenever and wherever we can trick eve president has promised to do that, the disappointing as that president haven't been good at doing that. when you try to ferret out government waste, it doesn't yield easily. at the problem is that government programs ha constituents. would go after waste what we end up cutting off is not the most wasteful programs, to boot, but the one who's constituents who scream most loudly. so think about some of the examples from the bush

administration. self-proclaimed enemies of government waste, they cut the nsf budget for basic research. at a time when we're losing capital shares worldwide. they cut medical rehabilitation expenditures on injured war veterans. they cut nutritional assistance programs for poor mothers of small chdren. all of dhose programs are going to bring back much more in return than they cost. it's not a good idea to cut them. my pet example, during the bush years, cut the energy department program for rounding up loose nuclear materials in the former soviet union. these are very dangerous materials, terrorists want them. they are poorly fortified facilities guarded by soldiers who drink too much, don't get paid regularly. we should be spending more on that program rather than less. the ment a terrorist gets his head on that material, it will be smuggled out to the soviet union, shifter and we don't want to think what next. so cutting government waste, we should do it but don't count on

getting any big extra stream of dollars from doing that. private waste, i am speaking contrary to the conventional wisdom here, i understand. private waste is vastly bigger than public waste. number one. number two, it's much, much easier to eliminate than public waste. this is actually good news, the current situation is grossly wasteful, but that fact means that we can harvest additional resources without forcing people to undergo painful sacrifices. so why is there so much private waste? it's not because people pay too much for a toilet seat. competition keeps prices right where they belong in relation to cost. the problem is that many of the goals we try to achieve cost more than a strictly necessary to achieve them because of the context of backs in spending. i'm not getting the message that you're trying to gimmicky to me.

right now on a low sheet and send it up here i will give you one example. aristotle on nasa's want a special yacht. he is the late billionaire shipping magnate and so he commissioned a 325-foot young law yacht. there was a mosaic tile floor installed in a swimming pool that a push of a button would rise from the bottom to become a dancer. the barstools in the bar of the christina had whale ivory foot rest. they were covered in the leather harvested from the sperm whale. incredibly expensive sought after exact skins. these were very high expenditures but they work because he was able to say truthfully he got a special yacht for his money. special is a relative concept. his rival, wanted a special yacht also.

and so he hired a naval architect and he gave specific instructions to build the atlantis to. has got to keep it longer than the christina. that was one of the lines of the contractor he did know how long the christina was. it was the architect's task to find out how long it was an build his job longer. another example of smart for one, dumb for all. you want something special? we all want something special and we would all stand to see better, we don't see any better than before. if we would all spend a little less, somebody would have gotten something special, even so and fewer resources would have been expended. we see this as well in the housing market. everybodyants to send his child to a good sool. what's a good school? a good school is one that is better than other schools. it is another relative concept. this just in. 50% of the children are going to end up in bottom half schools nomad what we deal.

everybody wants to send their chdren to good schools. the banks make loans available on their terms. that means either homeowner can bid more on a house in a good school district. will i want to do that? guess i will. that is one of the most important goals as a parent. bu you want to do that also so you bid more vigorously. you have access to the same liberal credit terms i do and so we all did more vigorously for housing and a good school district. what is the net result? we been up the prices in the best school district. no more kids go to good school diricts than before. this is a false trade in the same way that the seals size. if we uld all work fewer hours and spend less money bidding against one another for houses in the better school districts, it would be nice to have extra

time with family and friends. and we would still see the same schools serving the same children as before. it's like a military arms race. nations build more bombs because they don't want to be invaded and conquered by rivals. there is a tendency therefore arms races to siphon out resources from other categories of consumption that would be more beneficial for the population at large. would everybody build more bombs, that tends to be mutually offsetting. there is no gaino the population when everybody build more bombs, that just create a new balance of terror at a higher level. if we could make an agreement to make more bombs, and rivals to enter into such agreements. imagine if a libertarian to announce such an agreement by saying that iraq is the individual nations of their freedom to build as many bombs as they wanted to. well, yes, it does.

but that's the whole point of the agreements. if we know we are free to build as many bombs as we want, we will build too many. people will see advantage there too because indiduals, they don't coincide there also. it's not the exceptional case where a group interested deviate from individuals. attacks are quite common for that to be so. you want to have a special occasion. the economist richard laird wrote in a poor country man proves to his wife that he loves her by giving her a rose. in a rich country you must get a dozen roses people don't read that passage and say what you talking about? what could he possibly have in mind? that's just the way the world is. context matters. my 20th anniversary coming up in october. the gift, it's a special occasion. the gift i will will buy will have to signify that i understand that it is a special

occasion and i will spend considerably more, i assure you, and if i were still living in nepal. i don't buy moaned the back. that is just the way life is. that's not a particular wasteful thing to worry about, but many of our other spending patterns follow those same basic behavioral forces, and do lead to wasteful spending patterns that you want apecial occasion for your child coming of age party. how much do you have to spend? the answer is it depends on the frame of reference in which you exist. one ceo spent $10 million on his daughters coming of age party. that seems like a lot but is he a bad person? i don't know him. but he is not a bad person merely for wanting to have staged a special occasion. the fact that he staged a special gccasion though spilled over onto other pple. people just below the top now have to, you know, i don't seize it someone spending 10 minutes i have to spend more. he is out of my league. but there are people just below

his league where we went to the party, we better spend a little bit more on our kids party or we will seem like skinflints. and then it cascades down a step at a time. i was going to my office at nyu. i thought i'd get out of the car and go into one of the nyu faculty apartments. what a clown going in there i wondered. and then i realized that professors ten-year old had a birthd party and now i there is not a magician or a clown or some other professional entertainer, they feel like it wasn't a special occasion. so it cascades down. in every domain we see expenditure cascades like it or i will mention one other example. victoria's secret catalog feature has a bejeweled abroad that they offer in recent years there was a nice picre of a model that's all for $12.5 million. sapphires and diamond studded all over. i talked to the marketing director and learned that in the

10 years that they have been doing this promotion they had never sold any of the bras. the broth just sit there. they generate publicity. there a big photo shoot when they unvei the current year's model and people see them in the catalog and of course every harvest the jewels and recycle them. but people see this 12 and a half million dollar brought in the catalog and they say to themselves some chump is buydown. i'm going to buy the value of $350 raw for my girlfriend. so it shift the frame of reference in a subtle way and that is w the money has been going. the income gains have been going to the top of the income ladder for the past three decades. they have been spending the money at the topic that money has been going toward the usual cool things that everybody wants to have. that generates a cascade to the people all the way down the income ladder are spending more now. comedian neuhaus in the u.s., 50% larger than it was in 1970. not because the media earner

learned more than in 1970. it's because others are spending more. why are they spending more? because of this frame of reference shipped one step at a time. this is wasteful. it's not that it is purely wasteful. the big houses are nice. the gas grills are nice. the bejeweled bras are all nice things to all but there are other pressing things to spend money on, like the program to round up like fixing bridges. we have to ask ourselves are we spending our money and the ways that best serve our purposes. it's not a very good deal for a rich person to get a tax cut financed by money borrowed from the chinese and then build a bigger mansion and discover that everyone else in your income category also got a tax cut and build a bigger mansion and now the net effect is just that the bar has been raised that defines how big imagine you need.

where's the gain? there is no gain and happiness from that. in fact, if we could measure accurately, the prediction is people with a larger manon, if everyone had them, would be less happy. because it's a lot more trouble to keep track of th staff you need to recruit and train to maintain a bigger mansion. so this is money that could be diverted from those in spending patterns to pay for otherhings that would really make a difference in real people's lives. that's the claim. it sounds ke snake oil. money for nothing but there is no controversial assumption built for anywhere into the ardley. it is just based on the observation, which i attribute to charles darwin that reward depends on many situations on relative performance, not absolute performance. when we are in situations like that arms races that generate waste, are the norm. and they are very simple policies for short-circuiting

arms races and freeing u resources. i will just mention very quickly in conclusion a simple policy step that we might take to haest some of e resources. right now we have a progressive income tax. my proposal is tocrap the progressive income tax and adopt in its place a much more steeply progressive conmption tax. that's not a good marketing name. let's call it an unlimited savings allowance tax. here is how it would work if you would report her income to the irs the same as you do now. dendy would report how much you save now the way you document your 401(k) contribution. the difference between those two numbers, your income minus your savings is how much you spent this year. lets tax that nuer might is a big standard deduction and tax it as a low rate first and then let the rate go up and up and up the more you spend. think about how that would affect the decision of a wealthy family who currently spend $5 million a year and faces

just, for example, a top margin tax rate on consumption of 100%, that means that it wants to spend one more dollar, it's got to spend the dollar and then pay an extra dollar of tax on that dollar. so wants to put a $2 million a dish and onto its mansion. with this tax, the addition would cost 4 million. wow. that is a pretty big hit compared to what we were planning on. lets scaleback and build an additional only half as large, 1 million. and we'll pay the tax on that addition. it will be 2 million, the same as if we would spend under the current tax system. we won't get as big of an addition but it won't mte because everyone else will scaleback because of database the same incentives to save more and consume less as we do. the government gives 1 million of extra tax revenue. there is more savings, more investment, the economy grows faster. there is real resources created out of thin air byhat measure.

there are many other harmful activities we can tax. pollution of all kinds, transactions in the financial markets. just an endless list of activities. getting on a congested highway. there is an endless list of activities that people engage in that cause harm to others. taxing those activities makes economic pie bigger and when you do that it's always possible for everybody to get a larger slice than before. so again, my prediction, 100 years from n, we will think back and identify charles darwin as the father ofodern economics because i think by the time people will realize that there's no general general presumptiothat self interested action in the marketplace lead to generally to the best results for all. sometimes it does. often it doesn't. and when it doesn't there are often simple unobtrusive policy measures we can adopt that will bring us closer in line with what our real possibilities are. animals can do that.

we can do that. what a shame it would be to walk away from the possibility. again, i know incident is as good you have a full menu of other things you could have been doing tonight. thanks for taking time out to come and hear me speak and i know we have questioned that i see a lot of them here on the desk. [applause] >> at cornell university, new york times columnist and author of the new book the economic naturalist field guide. it's now time for our q&a period. and anxious to get started. i think a lot when i get ready to do this about proper way to frame a discussion period with our speakers. tonight q&a i thought it wld be appropriate to cover as many points as we can so that we can all gain a very good understanding of what,

professor, you are teaching is about acquiring a greater understanding of economics, psychological and sociological facts instead of how we can make the best decisions. so let's begin, you it ended to remarks on tax policy. i have several questions on tax policy. and several of them asked a question about taxing our sins, tobacco, alcohol and maybe as well. >> yes. there is a separate case you can make for taxing activity that people engage in even though they know they are bad for them. so these are not conflict between individual and group activities, but smoking for example at there are very clear data now shows that there are hardly any smokers who are glad they spoke for almt every

smoker wishes he didn't smoke. the logic of a tax on smoking is that you are less likely to start smoking if tax is heavy on smoking because most smokers start when they're teenagers. and if you think about the limited disposable income of a teenager, adding a couple of dollars to the pack of cigarettes makes it a much bigger hurdle for a teenager to start smoking. i think you can think about those taxes as being taxes on harm, not because the other, but harm that would cost to ourselves. and oftentimes we cause harm to ourselves so because we lack the self-discipline to avoid the currently tinting activities, the sweeter fast food, the excess drink, excess tobacco and consumption into one. by taxing those things in the popular current phrase people closer to the spot they want to be occupied. i think there's great potential there. >> let me ask another question

and follow up on the tax question issue. this is sort of a two-part question. number one, and u may not think additionally that it applies. do we have too many hedge fund managers? one. and in the second part of this is why does the internal revenue service tweak the 20% fee, you all know about, charged by many hedge fund managers as a capital tax at 50% and not as an ordinary income tax at 35%? is this just another example of greed with the power of lobbyists representing special interests? >> the first question are there too many hedge fund editors? answer, yes. there are several reasons for that. one is that it's kind of like a tragedy of the commons problem. there are too many boats to go out into the fishery because no individual fishermen takes account of the fact that the

fish he catches, many of them would've been caught by the boats that were already out there. so if you think about hedge fund managers that are like fissures. they are so many deals out there. when you get an extra hedge fund manager out there, he doesn't deal. i am using he because most of them are males. but many of those deals would have been done by the hedge fund managers that were already out there. so you have just as you see too many fishermen launch boats into the common fishery, you see too many people prospecting for these deal. too many real estate agent, too many hedge fund managers, too many private equity firms and so on. no offense to the people who are in the industry. you are not violating any law for having chosen that. it is perfectly rational for the individual to have chosen that way. it's just that as a conflict between individual logic and group logic. we don't have an interest in having that many. the 20% fee they get what you make all carried interest, and managed to get the tax

authorities to tax at 15 percent rather than the ordinary income rate of 14%. that is a pure boondoggle in my opinion. that has the look of ordinary income. i think it is ordinary income and ought to be taxed at the same rate as ordinary income. >> which is 35%. >> is going to 39% as soon as was tax cuts expire at the end of 2010. >> okay. is another two-part question. how could people operate contrary to their spending capacity? leading to large amounts of debt. is this an american phenomenon? and the second part is what are the most common misconception that people have about when to stand or wednesday? >> it was quite easy to take on more debt than was prudent. in recent years because of a change in the financial industry under which the people who once loaned you money and held on to your loan, had a real interest

in making sure that you are going to pay the loan bk. that gradually gave way to a different set of incentives windbags would iniate loans and then bundle them into a mortgage-backed security and sell it to someone else. then if someone defaulted on a loan that was their problem, not the issue of the loans problem. they got their commission when the transaction was over as far as they were concerned. that is a recipe for people trying to generate these for themselves by loading money to anybody who will borrow. and so you saw people wearing $35000 a year giving loans to buy $750,000 condominiums. no questions asked. liars loans they recall. financialegulation is the only way to prohibit that from happening. and i think we are on a patch implementing some regulations that will make things more like it was when i bought my first house that i had about 25% after there were no interest only loans or loans with a balloon

payments or a rns. ackley had to have some adequate in the house and that was a very powerful incentives not to default on your loan. >> is listening to a radio program, he is discussing how we can all make economic choices in troubled times. >> you have a second part i'm sorry to the question. people choosing between saving and consuming. i think suppose you are somebody who's only goal in life is to do as much as you can. that's probably not an interesting life goal to hold, but if that were your goal, the way to go about it would be to say that much of your income as you possiblyan at every moment. if you're not saving at least 20% of your income, or consumption over the course of your lifetime will be smaller than it would be if you could boost your savings rate up to that amount. why? because if you save a new experience the miracle of

compound interest. you get interest on the interest on the interest on the interest, and it is truly a miracle how fast your allens grows when you keep aing to it and leave the interest in there. that interest is part of your income and so if you consume 80% of your income rather than 100% of it, it's true your consumption will be small at first, but as your account grows and the interest on it grows, the income you will consume out of, include the interest on your account and so the 80% of that new higher income figure is going to be much larger than 100% of the spendthrifts lower income figure. so don't ever borrow money to buy something that you can possibly save and pay for in cash when the time comes. maybe your first house, that's the time to borrow money pick your first new car? well go buy a new car. if it's your first car, buy a used car. pay cash for a.

>>ou know when i rea your book, i had the same question and it was just handed to me, about your tax policy on progressive consumption. this is the way the audience, person, submitted the question. i understand where you're coming from and suggesting progressive consumption tax rather than a progressive income tax. given the downturn in the economy, couldn't this have the adverse effect of deterring spending at a time when, as you mentioned, we should be spending to stimulate the economy? >> that is a great question and the premise of the question is exactly correct. we do not want to tax consumption right now. absolutely not. as i said at the outset, the current imperative is to get people to spend more, not less. the nice thing about a progressive consumption tax, if it were adopted now, under the provision that would be phased inradually only after the economy reached 5% unemployment

again, it would kill two birds with o stone. people would see a consumption tax on the horizon, and those who could would think of themselves a, i better build a wing on the mansion right now to avoid the consumption tag that is coming down the road you get an immediate jewel to spending which is exactly what we need right now. once it begins to phase in, start shifting the future stream of expenditures away from consumption, gradually, not all at once, away from consumption so people put more money into their savings vehicles. to capital market allocates those extra dollars to the best investment projects that people bring applications for. and investment grows, capital stock grows in the country, and the country's productive capacity grows over time as a sult of that. so you would get exactly the right mix of incentives both short run and long when.

people asked me, is this a pie in the sky vision of consumption tax like this. no. i wrote about this back in 1997. and i got a very friend letter from the late friedman saying he didn't think the government needed more revenue, which was my argument if you want to really attend all tse problems. here is the way to raise revenue. but that if it did need more revenue, this would be the way to raise it and he s me a reprint of his own article published in 1943 in economic review where he had recommended progressive consumption tax as of the best way to pay for the wartime expenditure effort. so it is a tax that liberals can figure. it is a tax that conservatives can figure. it is a tax which ought to be talking about. it's not really an unrealistic pie in the sky thank. >> didn't dr. frieden also talk about the negative income tax? how does that differ? >> yes. i wro a column on his death a

couple of years ago a title submitted was but in friedman lee a bleeding heart? and the time to change the type of the always changing. sometimes they come up with better one-third the nice thing about being able to compile collection in my column was i got to put the titles i wanted on each one. so yes, he proposed a negative income tax. if you don't learn any money the government pays you rather than you pay the government. and in the more money you earn, we take it back some fraction of each dollar earned in the form of taxes and so yes, it was the precursor to the current income tax credit which is the most widely copied welfare program the u.s. has come up with countries around the world have begun adopting this. it is a way to make it more attractive to employers to hire additional low-wage workers. that is one effect of it. and also gives people higher incomes than they would earn just under wages alone. so it is really a great cause.

and milton friedman was the original designer of it. >> milton friedman i can't tell you how many times he has spoken at the commonwealth club, and one of the greatest thrills actually in moderating that i have had was doing a program within many, many years ago. in fact, one time he had his wife who was also a phd in ecomics. they were really interesting programs and he was quite a guy. i want to shift gears for a minute and talk about some individuals are actually that you talk about in your book under chapter, you refer to as trailblazers. before i get to some of the trailblazers i want to talk about some people currently that have the role and have had a role in our current economic crisis. can you compare the economic rescue methods of our last treasury secretary, hank paulson, and our current one, tim geithner? or are they really in a sense the same person?

>> you know, hank paulson was a former ceo of goldman sachs. tim geithner i think was offered a position at goldman shs. he didn't accept them but he also had close relationships at goldman sachs. that people have been critical of both men have been critical on the grounds that their policies have been, if anything, to friendly to the investment, banking community here there is a coherent set of questions that have been raised about that. i don't know that i see a huge broad policy difference. i mean they both have taken aggressive posture to the effect tat if we don't bail out the large institutions that are in financial difficulty, that will have broad negative effects on the economy as a whole. so i think they have been quite aggressive in trying to keep those institutions from having to go under. for that reason.

>> professor frank, you did talk about current fed chairman ben wernick as well. and you know him quite well. co-authored a book entitled "principles of economics" within. is under a lot of fire right now for his role in the bank of america merger with merrill lynch. his term also expires in january of 2010. do you think that he will be reappointed or more importantly, does he think that he will be reappointed? >> i don'tver call him. u know, i imagine he is sleeping man fewer hours a night that i. he has a very full plate so i wouldn't call him and ask him any question like that. i think there are some events to play out between now and 2010 when his term expires. we don't know how the economy will unfold between now and then. i think if things turn up sharply betwn now and then it would be very hard not to

reappoint ben bernanke. i think he has done a very aggressive job trying to lean against this negative wind that has been blown. i think there was almost no one i know of who could have been nearly as effective in generating monetary stimulus for the system as he has been. he has done some very sort of path breaking innovative things to get new money supply into the credit string. and i think his broad expertise as a scholar of the great depressn, his deep concern about the huge human cost of large-scale unemployment make him really the ideal candidate to have been appointed to the job in the first place. i don't know how events will play out but i think there is a good chance if things get better he will stay on. >> in her chapter on trailblazers, we really don't have enough time to go through a lot of these people. there are some really incredible economists to let me just ask a question or two.

milton friedman characterized gavras as not so much economics as it is sociology. was he correct? >> i think it galbreath had gone to berkeley in the last 10 years he would've couched his argument much differently. if yo look at the points galbreath argued for, he was a berkeley phd from the '30s. they didn't have gained three on the curriculum than. there was no sophisticated smart for one, dumb for all linux thinking available to people who were in the curriculum then. but he identified what were actually the problems that have proved to be the ones that have plagued the economy. the idea that we spend so much on what ends up being not very productive expenditure in the private sector. fancher good, bigger goods, better goods that don't seem to

yield lasting satisfaction. while at the same time we neglect the public sphere to a shocking degree really. that diagnoses has proved descriptive and incredibly pressing it as a portrait of what was goi to end up being america's big problem. i think he was much more than a sociologist who he would couched his arguments differently than if he was riding with the benefit of the modern regular but i think it is on an unfortunate that the committee never awarded the prize to galbreath. >> it's pretty hard to have a discussion on economics without mentioning a british economist john mader james. in this particular question, it is as follows. present obama seemso follow change in economic theory fairly close to. has the president lost in your opinion taken capitalism and the power and benefits of free markets. >> i don't think he has. in fact, present obama was on

the faculty of the chicago law school for many years before he went into politics. that is as i'm sure most of you kn a hot bed of free market theology the chicago economics department has one meaning no braille laureates including milton friedman. and the respect for markets that pervades many quarters. he is very market oriented you can be and still i believe that the invisible hand works in every situation. i think intuitively he seems to have grasped wt color is that selfish behavior on the part of individuals often leads to bad results. and can be improved upon by sensible regulation. so i think i am very comforted when i listen to him speak about the history of regulation and what the original goals audit were and where we ought to be moving in that domain. you talk like that in your book about your criticism of no bill

prize, he made the following statement. is within a new york times new york times article in may of 2006. you said nobel prize as are sometimes awardeto scholars who are wrong for the right reasons, but almost never to those who are right for the wrong reasons. >> i had galbreath in mind in a column. i think galbreath as i just mentioned had the right description of the fundamental imbalance in spending patterns in the u.s. economy. here's prescription about what to do about it made good sense. he didn't have a clear vision of the incentive problem that generated that in balance, and i think that is not surprising in light of his training. ink it's more important in economics often do have the right method and to come up with the right prescription. is an aspect of a profession that has not served us well in every instance.

>> you are listening to the commonwealth club of readers program and our speaker todays economist and author robert frank. discussing how we can all make the best economic choices in troubled times. professor frank, what arthe biggest economic fallacies that you believe that led to this recession. i think the deregulation of the financial industry that took place was a single event that contributed most to the downturn that we are in the midst of. if you allow financial institutions to create portfolios that are based mostly on borrowed money. so i put in $1 of mine, and i buy an asset and i borrow $50 to buy 50 times as much of the asset and it is the asset is going in price, just a little bit, i will get pretty rich in the process of doing that. that is very risky. but as long as the asset price goes up i see other people earning money and i think if you

really sensitive thow focused people are on relative rewards, it's totally unrealistic to imagine that people will watch their neighbors investing in mortgage-backed securities, highly leveraged portfolios, or in a bundle of money every year, you've got your ordinary safer investments. you are not earning so much. it is hard to remain on the sidelines under the circumstances. moran buffett counseled against tech stocks ricky bobby were overpriced turkey didn't understand the business model. well, they were going up in price so people deserted hedge fund and bought shares in cisco systems and levered up. they pay the price in and also. if you allow leverage at that degree, it's going to lead to a bubble every time and it will lead to a collapse every time. so the first step i think in new regulati will be to somehow put a limit on the amount of leverage that financial institutions can engage in. >> unfortunaly, we have reached the time in our program where there is time for just one

last question. there have been several questions on health care. and try to put them together, if i can, into one or do you think a new health care reform package will adequately cover the uninsured and the uninsurable, those with pre-existing conditions? >> will a new health care plan include affordability or is there a chance will reduce costs to the taxpayers? >> the first problems you mention, the fact at there are many people withouinsurance, the fact that injured is an affordable, those problems all stem from a single cause which is that we rely on private insurers to provide health insurance. that's a failed business model effectively for this and a price. the private insurance companies and parroted is to not sign up as clients people who need medical care. they want to find healthy people to ensure, people who will