Less regulation allows Texas to move forward in wind power

See How Texas became tops in wind power by Ryan Maye Handy of The San Antonio Express-News. Excerpts:

"Texas today is by far the nation’s wind energy leader, accounting for about a fourth of the nation’s installed wind power generating capacity."

"The study by the Southern Legislative Conference, a public policy forum for Southern states, suggests that Texas, in part, moved so rapidly into wind power because its grid is not connected to other states, so it does not come under the jurisdiction of the Federal Energy Regulatory Commission. That allowed transmission projects needed to bring power from remote wind farms to population centers to move ahead without going through the federal permitting process, opening markets for wind energy developers."

"wind is projected to provide nearly 7 percent of utility-scale power generation in the U.S. this year, up from 6.3 percent in 2017, according to the Energy Department."

"In Texas, meanwhile, wind-generating capacity has surpassed coal as new wind projects come online and coal plants shut down. The state’s grid manager, the Electric Reliability Council of Texas, said in November that coal-generating capacity had slipped to 19,800 megawatts, making wind the second-largest power source in the state after natural gas.

Texas’s own minimalist approach to regulation helped wind get there, according the report by the Southern Legislative Council. In Texas, state, county and local governments have no regulatory power over where a wind project is located — that is up the landowner and developer — which in turn speeds siting, the report said

The state also made smart policy decisions, according to the report. In 2005, Texas chose to get ahead of renewable energy development by creating Competitive Renewable Energy Zones, where transmission lines were extended to help support wind power development in isolated regions of the state."

Was Obama Wrong About More Drilling Bringing More Oil?

See Drilled, Baby, Drilled: A decade ago Barack Obama mocked Sarah Palin. Who was right? WSJ editorial. Excerpts:

"Readers of pre-millennial vintage may recall the 2008 presidential campaign when Republicans and especially Sarah Palin picked up the chant “drill, baby, drill” as a response to soaring oil prices. The theme was much derided, not least by Barack Obama, who as late as 2012 called it “a slogan, a gimmick, and a bumper sticker” but “not a strategy.” Ten years later, who was right?

The U.S. Energy Information Administration (EIA) reported Thursday that U.S. crude oil production exceeded 10 million barrels a day for the first time since 1970. That’s double the five million barrels produced in 2008, thanks to the boom in, well, drilling, baby.

The EIA summary puts it this way: “U.S. crude oil production has increased significantly over the past 10 years, driven mainly by production from tighter rock formations including shale and other fine-grained rock using horizontal drilling and hydraulic fracturing to improve efficiency.” This is the “fracking” boom our readers know well that has been driven by innovation in the private oil and gas industry.

The magnitude of the boom is remarkable. The gusher has pushed the U.S. close to overtaking Saudi Arabia and Russia as the world’s leading oil producer. In 2006 the U.S. imported 12.9 million barrels a day of crude and petroleum products. By last October that was down to 2.5 million a day. Some gimmick.

Also striking is how quickly the oil and gas industry has recovered from the oil price plunge of 2015-2016. Previous price declines led to multiple bankruptcies and bank failures. This time drillers adapted quickly, took the rig count down fast, and cut costs. America’s flexible private capital markets helped the companies ride out the price trough, and now producers, investors and lenders are reaping the benefits of the oil price rebound to $69 a barrel.

And don’t forget the fracking boom in natural gas. EIA says U.S. gas production increased by some 50% from January 2010 to November 2017, reducing carbon emissions and heating prices. Thanks to new export terminals, the U.S. is now selling liquefied natural gas around the world. This has the potential to compete with Russian gas so Western Europe doesn’t have to succumb to Vladimir Putin’s periodic energy blackmail. Unleashing U.S. energy is Donald Trump’s best Russia containment strategy.

It’s worth stressing some of the policy lessons in all this. The first is that the best response to energy shocks is to let the market adjust to the price signals. As oil prices soared in the latter half of the last decade, politicians panicked and rushed to ban certain light bulbs, and subsidize and mandate cellulosic ethanol and other energy fads. The media fed the panic and cheered the politicians on. We were back at “peak oil” and the end of fossil fuels.

Yet American ingenuity was already discovering the solution for high prices in the shale plays of North Dakota, Pennsylvania, Texas and elsewhere. These drillers could move fast because they had the support of private capital and could lease private land. The frackers were also largely regulated by the states, which meant even the Obama Administration couldn’t stop them."

Dan Griswold on Rodrik on Trade

From Don Boudreaux.

"My Mercatus Center colleague Dan Griswold has carefully read – and now reviewed – Dani Rodrik’s 2017 book, Straight Talk on Trade.  Dan is no fan of what he read.  (Dan said that one of his models for his review is the brilliant review, from 2004, by Doug Irwin of Ha-Joon Chang’s Kicking Away the Ladder.)

The importance of exposing the flaws in Rodrik’s arguments is especially high.  Rodrik is an economist, and one at Harvard, no less.  Rodrik’s opposition to free trade isn’t the standard, run-of-the-mill mercantilist shrieking that daily issues from the mouths of politicians and the pens of pundits.  It’s more sophisticated – in the original meaning of that term.  I urge you to read all of Dan’s review – which is titled “Anything-but-Straight Talk on Trade” – but I paste below some choice excerpts.

Straight out of the box, Rodrik stacks the deck with loaded terms to describe the people and ideas he opposes. He calls those who think the world needs more economic freedom and openness, not less, “globalization’s cheerleaders,” indicting their willingness to “parrot the wonders of comparative advantage and free trade.” He argues that these folks’ “obsession with hyperglobalization” and “reigning market fundamentalist ideology” blind them to “the danger of globalization running amok.” He accuses those who support free-trade agreements such as the Trans-Pacific Partnership of engaging in “propaganda” and “shading of research” in pursuit of “free-market nirvana.”
…..

Rodrik ignores or brushes aside inconvenient counter-examples such as Hong Kong, Singapore, and Chile — three spectacular economic success stories that did not rely on state intervention. Regarding Hong Kong, an example Milton Friedman often cited to show the power of markets to improve human well-being, Rodrik can only note that its government plays a large role in providing land for housing. That seems a minor point when set against its open economy and laissez-faire approach to industrial development and finance. If hyperglobalization is the reigning ideology anywhere, it is Hong Kong, and the results are enviable.
…..
he real aim of the book becomes more apparent when Rodrik complains about the austerity that has been imposed on Greece by its debtors. He doesn’t blame the profligacy of the Greek government, but the general forces of globalization for infringing on Greece’s “right as a nation to determine their own economic, social, and political path.” He ignores the fact that other nations should be able to exercise their own sovereignty over whether to transfer funds to bail out Greece, and under what conditions. Instead of austerity, he would prefer “some good old-fashioned Keynesianism.”
In fact, for Rodrik, the answer to every problem seems to be more government intervention and less personal freedom to engage in commerce, whether domestic or across borders. Among his more novel proposals would be the establishment of government-run investment funds in promising new technologies, with the dividends from the assumed profits distributed to the general citizenry so that the fruits of technological advancement can be more widely shared. This demonstrates not the slightest bit of skepticism about the ability of government officials to pick just the right start-up companies and technologies, while ignoring ample evidence that governments are ill-equipped and face the wrong incentives for such endeavors, and that politics often determine who gets funded.
…..
Despite critical words about President Trump at certain points in the book, Dani Rodrik seems to share many of the basic assumptions of our president when it comes to the global economy. It’s just that his arguments are more clever and less straightforward.

DBx: I especially detest being accused of believing that free trade, or the free market, produces “nirvana.”  No serious free-market scholar has ever argued that free markets produce earthly paradise.  Scarcity will alway bite; one of the benefits of free markets is that they encourage each decision-maker to take much-better account of relevant scarcities than typically occurs with protectionism and other interventions in place.  Indeed, one distinguishing mark of market-oriented scholars is their refusal ever to fall for any of the many proposals that are built on the implicit assumption that scarcity’s bite is escapable."

On Monopsony and Legal Surroundings

By Vincent Geloso.

"A few days ago, in reply to this December NBER study, David Henderson at EconLog questioned the idea that labor market monopsonies matter to explain sluggish wage growth and rising wage inequality. Like David, I am skeptical of this argument. However, I am skeptical for different reasons.
First, let’s point out that the reasoning behind this story is well established (see notably the work of Alan Manning). Firms with market power over a more or less homogeneous labor force which must assume a disproportionate amount of search costs have every incentive to depress wages. This can lead to reductions in growth as, notably, it discourages human capital formation (see these two papers here and here as examples). As such, I am not as skeptical of “monopsony” as an argument.

However, I am skeptical of “monopsony” as an argument. Well, what I mean is that I am skeptical of considering monopsony without any qualifications regarding institutions. The key condition to an effective monopsony is the existence of barriers (natural and/or legal to mobility). As soon as it is relatively easy to leave a small city for another city, then even a city with a single-employer will have little ability to exert his “market power” (Note: I really hate that word). If you think about it simply through these lenses, then all that matters is the ability to move. All you need to care about are the barriers (legal and/or natural) to mobility (i.e. the chance to defect).

And here’s the thing. I don’t think that natural barriers are a big deal. For example, Price Fishback found that the “company towns” im the 19th century were hardly monopsonies (see here, here, here and here). If natural barriers were not a big deal, they are certainly not a big deal today. As such, I think the action is largely legal. My favorite example is the set of laws adopted following the Emancipation of slaves in the United States which limited the mobility (by limiting the chances of Northerners hiring agents to come who would act as headhunters in the South). That is a legal barrier (see here and here). I am also making that argument regarding the institution of seigneurial tenure in Canada in a working paper that I am reorganizing (see here).

What about today? The best example are housing restrictions? Well, housing construction and zoning regulations basically make the supply of housing quite inelastic. The areas where these regulations are the most severe are also, incidentally, high productivity areas. This has two effects on mobility. The first is that low-productivity workers in low-productivity areas cannot easily afford to move to the high-productivity area. As such, you are reducing their options of defection and increasing the likelihood that they will not look. You are also reducing the pool of places to apply which means that, in order to find a more remunerative job, they must search longer and harder (i.e. you are increasing their search costs). The second effect is that you are also tying workers to the areas they are in. True, they gain because the productivity becomes capitalized in the potential rent from selling any property they own. However, they are in essence tied to the place. As such, they can be more easily mistreated by employers.

These are only examples. I am sure I could extend the list to reach the size of the fiscal code (well, maybe not that much). The point is that “monopsony” (to the extent that it exists) is merely a symptom of other policies that either increase search costs for workers or reduce the number of options for defections. And I do not care much for analyzing symptoms."

Here is the post from Henderson

"David R. Henderson, an economist at the conservative Hoover Institution, said the existence of additional options outside a worker's current occupation or city made him skeptical that concentration was having an effect on wages. Skilled workers, he said, can seek out opportunities in other cities. Less-skilled workers can change occupations relatively easily. "Because they're unskilled, they fit in many kinds of jobs, and so you have more employers at the local level," Mr. Henderson said.
Some manufacturing industries, like breakfast cereal and tobacco, are even more concentrated than farm equipment. But since many workers in those businesses are less skilled than farm-equipment mechanics, they may be more interchangeable with workers in other industries.
To the extent that less-urban areas have a problem, Mr. Henderson added, policymakers should make it easier for people to move to cities where there are more opportunities, perhaps by easing building restrictions that drive up housing prices. That suggestion was also raised in a report on employers' market power by President Barack Obama's Council of Economic Advisers.

This is from Noam Scheiber and Ben Casselman, "Why Is Pay Lagging? Maybe Too Many Mergers in the Heartland," New York Times, January 25, 2018. (Print edition is January 26.)

 Because of my 4-part series on monopsony in labor markets in October 2016 in which I dissected a report from President Obama's Council of Economic Advisers, Ben Casselman reached out to me to ask my thoughts on José Azar, Ioana Marinescu, and Marshall I. Steinbaum, "Labor Market Concentration," NBER, December 2017. The ungated version is here.

I took some time to read it and spoke to him the next day. I'm very pleased that he quoted me accurately.
.
Ben left out one major criticism (I'm not blaming him--as long as he quotes me accurately and doesn't take me out of context, it's good). To measure concentration, the authors used data from CareerBuilder.com. What's wrong with that? Here's the extreme example I gave Ben. Let's say that you have 1,000 employers of a particular kind of labor in one area. What if only 2 of them are hiring? Then the data from Azar et al will show a highly concentrated market. Ben told me that he had wondered about that too and had asked Azar. Azar had answered that that's not a problem because if only 2 firms are hiring, that's what's relevant to job seekers. I told him I didn't think that was a good answer: the worker has 998 more potential employers and the odds are that some of them, within a few months, will be hiring.

I've thought about it more since then. I think my point is even stronger. Let's say that none of them is hiring in the next few months. It's still the case that there's potential competition among employers for workers. It's hard to believe that the wage would be much lower because only 2 firms are hiring if there are 998 other employers of the same type of labor."

U. S. Could Lose 1.8 Million Jobs If We Leave NAFTA

See Leaving NAFTA would be a self-imposed economic disaster resulting in job losses for 1.8M US workers in every state by Mark Perry.

"Below is the Executive Summary of a new research study “Terminating NAFTA: The National and State-by-State Impacts on Jobs, Exports and Output” prepared by Trade Partnership Worldwide for the Business Roundtable.

Using a methodology that enables us to capture the full impacts (both positive and negative; direct and indirect) across the U.S. and international economies, we find that a termination of the North American Free Trade Agreement (NAFTA) would have significant net negative impacts on the U.S. economy and U.S. employment, particularly over the immediate years after termination. Termination would re-impose high costs of tariffs on U.S. exports and imports, which would reduce the competitiveness of U.S. businesses both domestically and abroad. U.S. exports would drop, both to Canada and Mexico and globally, as U.S. output becomes more expensive and therefore U.S. businesses would be less competitive in these markets. Foreign purchasers would shift away from U.S. goods and services in favor of lower-cost goods and services made in other international markets, particularly those made in Asia.
These efficiency losses and trade shifts would have an impact on U.S. production of both goods and services, and thus also on U.S. employment. We estimate that, if NAFTA is terminated and most-favored nation (MFN) duties are re-imposed for U.S. trade with Canada and Mexico, the level of U.S. real output would fall 0.6 percent below levels that would prevail if NAFTA were in effect in each of the first one to five years after termination. Lower output means less employment after all the gains and losses are tallied: on balance 1.8 million workers would immediately lose their jobs in the first year with full termination and the return of MFN tariffs (see map above of job losses by state and table of job losses by industry).
While the focus of our study is the short- to medium-term, we also examine the national impacts of terminating NAFTA over the longer term (i.e., 10 years and after). Terminating NAFTA would have negative impacts on jobs, exports and output even after new supply chains are formed. In this longer run, we estimate that U.S. GDP would remain depressed by over 0.2 percent, permanently.

And here’s the paper’s conclusion:

Terminating NAFTA would be expensive to the United States by any measure. When the impacts are assessed using a framework that considers all of the ways in which the U.S. economy interacts, both domestically and internationally, terminating NAFTA has negative consequences that ripple throughout the economy. Those costs would be especially large in the first one to five years after NAFTA is terminated. But even over the longer term, the costs remain high and are significant. In short, terminating NAFTA would permanently reduce U.S. economic output, exports and employment.
Terminating NAFTA would prove to be a “win” for leading trading partners outside the NAFTA region. As supply chains shift to take advantage of relatively lower-cost production opportunities in non-NAFTA countries, those economies would grow faster and, with that growth, expand employment.

And here’s a statement from Joshua Bolten, President and CEO of Business Roundtable:

Terminating NAFTA would permanently reduce U.S. employment, exports, and economic output, while benefiting our economic competitors at the expense of American workers and businesses. We urge the Administration to take into account the potential damage of withdrawing from NAFTA, and to focus instead on modernizing the agreement so that it remains a cornerstone of American prosperity.

Related: Dartmouth economist and Tuck School dean Matt Slaughter’s Wall Street Journal op-ed on Monday “Leaving Nafta Would Cost $50 Billion a Year” (see excerpt below) and his study “How Withdrawing from NAFTA Would Damage the U.S. Economy.”

NAFTA has helped America’s small businesses, too. In 2014, more than 125,000 small businesses exported $136 billion to Canada or Mexico. That is 25% of all U.S. small-business exports. Not only has NAFTA increased the size of American workers’ paychecks, it has helped them stretch those paychecks further. American consumers have saved $10.5 billion a year from lower tariffs under NAFTA, with most of the benefits going to households with annual incomes below $70,000."

Restrictionists Are Misleading You About Immigrant Crime Rates

Restrictionists are inflaming public opinion to justify a harsh crackdown

By Alex Nowrasteh of Cato.

"President Donald Trump never misses an opportunity to depict unauthorized immigrants—especially of the Hispanic variety—as "rapists and criminals." HeJOSE CABEZAS/REUTERS/Newscom did it again in his State of the Union address when he drew attention to two Long Island teenage girls killed by the El Salvadorian gang MS13. Those deaths are tragic, but they don't say much one way or the other about the propensity of these immigrants to commit crimes.

You wouldn't, however, know that from restrictionist pundits who are working overtime to sell the "illegal immigrants are criminals" narrative. A case in point is former US Civil Rights Commission member Peter Kirsanow's recent piece in National Review purporting to show that these immigrants are more likely to commit crimes than the native born. But Kirsanow uses incomplete and cherry-picked data—and makes rookie mistakes in interpreting it to boot—that eviscerate the credibility of his case.

Kirsanow is correct that most of the disagreements over the criminality of undocumented immigrants could be resolved by better data. But that doesn't absolve us from accurately reading the data we do have. Kirsanow, however, does not. His entire case is based on a gross misreading of the 2011 Government Accountability Office (GAO) report on the State Criminal Alien Assistance Program (SCAAP), a federal program that partially reimburses states and localities for the cost of incarcerating certain criminal aliens.

The SCAAP report shows that in 2009, there were 295,959 criminal aliens incarcerated in state and local prisons at any given time that year. From this number, he subtracts those in the country legally and assumes that the balance gives one the total number of illegal immigrants incarcerated that year. He compares that number with the population of illegals in various states to estimate their crime rates. Then he compares that rate with the crime rate of citizens to come up with a massively inflated "incarceration rate" of these aliens.

But here's the problem with his analysis:

Kirsanow assumed, as some others before him with only a passing familiarity with these databases, that the 295,959 figure refers to the number of individuals incarcerated. In fact, it is the total number of incarcerations. In other words, if a criminal alien was incarcerated for 10 short sentences, released after each one, and then re-incarcerated, then that single alien would account for 10 incarcerations under the SCAAP figure for that year. But Kirsnaow counts that as 10 individuals.

However, when it comes to estimating the incarceration rate of natives, Kirsanow compares the number of individuals incarcerated with their total population. This nonsensical apples-to-oranges comparison yields an exceedingly unfavorable "incarceration rate" for undocumented immigrants. Indeed, for the five states he examines, the undocumented incarceration rate is 10-100 points higher than the natives, when more credible studies show that the reality may be closer to the opposite.

Kirsanow failed to appreciate that the purpose of the GAO report was to estimate the reimbursement that Uncle Sam owes state and local governments for incarcerating criminal illegal immigrants. Thus, the agency was only interested in the total number of incarcerations over the course of a year. It didn't care to separate out the number of offenses from the number of offenders. That is why the GAO report is nearly worthless for any scholarly attempt to estimate illegal immigrant crime rates.

A quick look at American Community Survey (ACS) data further confirms just how out-of-line Kirsanow's estimate is. (The ACS is an annual mini-census that, among other things, gathers information about prisoners in adult correctional facilities. It doesn't report on the broad legal status of immigrants but does indicate whether they are American citizens and their country of birth, making it possible to separate immigrants from Americans.)

For 2008, the ACS reported that there were 156,329 non-citizens incarcerated in all three—federal, state, and local—adult correctional facilities. This is only half of the 296,959 incarcerations that SCAAP reports in just state and local prisons making it logically impossible for the 296,959 figure to be referring to the total number of criminal aliens incarcerated.

Kirsanow is merely an individual whose analysis can be discounted. But there is no discounting the Alien Incarceration Report jointly released by the Departments of Justice (DOJ) and Homeland Security (DHS) last December. It too misrepresented data when it estimated that "one-in-five of all persons in the [federal] Bureau of Prisons custody were foreign born, and that 94 percent of confirmed aliens in custody were unlawfully present." That seems shockingly high as illegal immigrants are, at most, about 4 percent of the population. But if this report were right, they would be 19 percent of all prisoners.

But the report had no solid basis for its conclusion because it did not have all the prison data. If you scroll down beyond the report's press release and Summary of Findings, it admits as much. It notes:

This report does not include data on the foreign-born or alien populations in state prisons and local jails because state and local facilities do not routinely provide DHS or DOJ with comprehensive information about their inmates and detainees. This limitation is noteworthy because state and local facilities account for approximately 90 percent of the total U.S. incarcerated population. DHS and DOJ are working to develop a reliable methodology for estimating the status of state and local incarcerated populations in future reports.
Of course that didn't stop Fox News and other similar outfits from using it to peddle their "illegal immigrants are hardened criminal" line.

It is really important to bear in mind that the federal prison population is not representative of the incarcerated populations in state and local prisons. That's because federal prisons house illegal immigrants who commit immigration offenses. The ones who commit more serious crimes tend to be housed in state adult correctional facilities.

Only 85 total people who were convicted of murder were sentenced to federal prison in 2016. But the total number of murder convictions nationwide that year was 17,785. Clearly, only a small fraction of a percent of all murderers are incarcerated in federal prisons so most undocumented immigrants in these facilities are not hardened criminals.

As Kirsanow acknowledged, the government doesn't keep good data on illegal immigrant incarcerations in state correctional facilities. But the data we do have suggests that they are actually much less crime-prone than native-born Americans.

The Texas Tribune reported, after examining data obtained from the Texas Department of Criminal Justice, that illegal immigrants are underrepresented in local jails. They are only 4.6 percent of Texas inmates while they make up 6.3 percent of that state's total population.

Some academic researchers have examined quasi-natural policy shifts to see how crime rates change due to more intense immigration enforcement. If illegal immigrants are more crime-prone, then more aggressive immigration enforcement in an area should lower crime rates. But they found no overall reduction. This suggests, at a minimum, that illegal immigrants' crime rate is no higher than that of the broader population.

More recent research conduced by Michelangelo Landgrave and me finds similar results. We applied a statistical technique that is used to figure out the employment, age, and occupations of immigrants in the census to the incarcerated population data in the American Community Survey. This allowed us to estimate the percentage of illegals among the incarcerated. We found that even if one includes in the mix those in detention facilities—most whom are there for immigration-related offenses—illegal immigrants are 44 percent less likely to be incarcerated than native-born Americans. Excluding those in immigration detention yields an incarceration rate that is almost identical to that of legal immigrants: A dramatic 69 percent lower than that of natives.

Restrictionists want the public to believe that undocumented immigrants are criminals in order to justify harsh enforcement policies and crackdowns. But before America goes down this draconian path, it is vital that it gets the facts straight. Taking amateur analyses or government spin at face value will hurt peaceful and hardworking immigrants without making Americans safer."

Why Did Canadian Banks Do Better In The Depression? American banks were heavily regulated, contrary to Canadian banks

See A Bad Solution to Very Real Problems by Pierre Lemieux at EconLog. 

"Before the creation of the Federal Reserve System, the American central bank, in 1913, America had been plagued by recurrent banking crises and suspensions of payments. But this cannot be the ultimate justification for the Fed, because Canada, which did not have a central bank until 1935, had very few such crises. Renée Haltom, an economist with the Federal Reserve Bank of Richmond, writes:

If you define "financial crisis" as a systemic banking panic--featuring widespread suspensions of deposit withdrawals, bank failures, or government bailouts--the United States has experienced 12 since 1840. ... That's an average of one every 14 and a half years. Canada has had zero in that period.

The Great Depression brought the failure of thousands of banks in the United States, and none in Canada. Comparing Canada and the United States suggests that there was something deeply wrong with the American banking system. But what was it? The short answer is that American banks were heavily regulated, contrary to Canadian banks.

In 19th-century America, so-called "free banks" (which were in fact not free at all) as well as the "national banks" were forbidden to issue notes except by guaranteeing them with government bonds. In Canada, on the contrary, each bank could freely issue its own currency up to the value of its capital until the early 20th century.

There are two keys to understanding real free banking, which includes the freedom to issue private banknotes. First, issuing banknotes is just like accepting deposits: both create a bank liability against a corresponding asset. Loans are usually the corresponding assets, whether the bank lends deposited money or newly issued banknotes. The second key is that private banks cannot overissue banknotes when the latter are rapidly returned for redemption in underlying money (such as gold or any legal-tender money like national currency), which any bank has an incentive to do. If a bank does issue more notes than it can redeem, it will be rapidly revealed bankrupt before it can do much damage. This system worked well in Scotland and in Canada.

Another problem in America lied in the branching limitations or prohibitions (depending on the state) during most of the 19th century (some were not completely eliminated until 1994). A large number of banks were "unit" banks, that is, they could not legally open any branch besides their headquarters. Canadian banks, by contrast, faced few limitations on branching, and none after 1867. Around 1890, Canada had only a few dozen banks, but with branches all over the country that soon reached into the thousands, compared with 30,000 separate banks, often unit banks, in the United States. In his 1894 report, economist L. Carroll Root explained (page 320):

Under our United States system, which leaves each bank so largely dependent upon the fortunes of its locality, and the business of each locality so entirely dependent upon its local banks, nothing is more common than to see mutual ruin of banks and business in numerous widely scattered localities, while the business of the country has been as a whole sound. Such results are inconceivable in Canada. The widely extended system of each of the great banks, with its branches in every part of the country, constitutes a practical financial Lloyd's insurance, by which each helps to guarantee the soundness of all.

A central bank per se was not an automatic solution to the problems of the American unit-banking system. During the Great Depression, the Fed was incapable of making up for these faults and preventing the banking panic of 1933. In their famous Monetary History of the United States, 1867-1960, Milton Friedman and Anna Schwartz write:

The central banking system, set up primarily to render impossible the restriction of payments by commercial banks, itself joined the commercial banks in a more widespread, complete, and economically disturbing restriction of payments than had ever been experienced in the history of the country.

Besides the problems caused by the overregulated and inefficient banking system, a second factor played in favor of the creation of the Fed: the climate of opinion in the Progressive Era was becoming less favorable to free enterprise, and more open to the role of government experts and European ideas. The main founders of the American Economic Association had studied in Germany with professors who rejected the free-market model. Richard T. Ely was one of them and, as the president of the Academy of Political Science, he helped popularize the work of the National Monetary Commission, chaired by Republican Senator Nelson Aldrich. Most European countries already had central banks, and Aldrich was apparently converted to central banking by a visit to Europe on behalf of his Commission. He became the main mover of the central bank project.

The relative role of ideas and interests in the creation of the Fed is debatable, but Wall Street bankers certainly played a major role, with the active help of their political crony, the same Nelson Aldrich. Wall Street banks liked the unit-banking system, which limited effective competition against them and insured that other banks in the country, unable to branch in New York, would continue to deposit much of their reserves with them. They also thought that a central bank would rescue them if necessary. Economic historian Elmus Wicker, wrote:

[Aldrich] and his associates argued that every precaution had been taken in the bill to keep the influence of Wall Street to a minimum and suggested that the fear of Wall Street control was groundless! No one knew that Wall Street drafted the bill! ...
One of the great anomalies of U.S. financial history is how Wall Street bankers managed to play the role they did while politicians and the public were decrying Wall Street domination and influence!

In a paper reviewing the history of the Fed's origins, "New York's Bank: The National Monetary Commission and the Founding of the Fed," George Selgin observes the capture of the central-bank project by Wall Street bankers:

Notwithstanding the appearance of decentralization and government control, control of the Fed had, in fact, been "captured" by Wall Street.

A crucial meeting between Aldrich and his banking cronies was held on Jekyll Island, Georgia, in November 1910. The five participants--three prominent Wall Street bankers and one Harvard economist besides Aldrich himself--"[a]ll agreed the central bank should be controlled by the bankers and not by the government," Wicker writes. The project was in many respects the same as later adopted under the new Democratic administration of Woodrow Wilson. (I learned much about the whole topic of this post at a Liberty Fund/Cato Institute conference directed by George Selgin and held in the same room as the historic 1910 meeting.)

One of the bankers at the Jekyll Island meeting, German-born Paul Warburg, was a good representative of the European influence and the Progressive Era's faith in government. Economic historian James Levingston writes that Warburg, in his arguments for a central bank,

... went out of his way to suggest that the notion of a "self-regulating" market, even as enclosed and underwritten by specific government policy or legislation, was inappropriate and inapplicable to modern conditions, particularly with respect to the money market. "No automaton--no tax or fixed regulation"--would do. Instead, "the best judgement of the best experts must indicate the policy to be pursued from time to time." The evolution of the economy could no longer be understood as external events that by their nature remained impervious to knowledge and purposeful action; if left untouched the market would destroy, not regulate, itself.

On the contrary, a more free-market, free-banking, Canadian-style reform would have created a much more efficient and reliable banking system in America. The Fed was a bad solution. To summarize, three reasons seem to explain why this bad solution was adopted. First, an over-regulated banking system was fueling regular crises. Second, domestic and international opinion favored government intervention (supporting an old populist suspicion of private banks in America). Third, Wall Street bankers welcomed a central bank as a protection for their dominant position."