Aaron Steelman

English

Research Papers in Economics

RF: Much of your work has focused on political
economy questions. Did your time at the CEA
affect your view of the policymaking process? 
Kroszner: It was interesting to be lobbied by
various interest groups. I had written about lob-
bying, but I actually got to be a participant in the
process, perhaps even becoming a data point for
one of my future papers. Virtually everyone
couches their private interest in a public interest
rationale. I don’t think that’s anything new or sur-
prising. But it’s interesting the way that everybody
is obligated to talk about the broader good. And
what’s also very interesting is that I think most
people really do believe that. If you gave most of
these lobbyists a lie-detector test, they would pass.
They really do believe what they are telling you,
even if as an economist I would say that what they
are arguing for would benefit only a very narrow
group. In addition, most of them were quite rea-
sonable about accepting and trying to answer the
questions I would pose. No one would just come
in and say, “Support this or lose our vote.” That’s
not how these things operate. They always try to
give substantive reasons for their positions.
When you spend much of your career working
in a certain industry, you begin to see more
nuances, you are more willing to give the benefit
of the doubt to arguments that to an outsider
might seem questionable. That may be why you
find so many people who, in general, are free-
market advocates but when it comes to their
industry, they are willing to say we need this reg-
ulation or barrier. And in some cases they may be
right—there may, in fact, be a market failure. But
the real question is: Should the government take
action? I don’t believe that markets work perfectly
all the time. Virtually all markets are imperfect in
some way. But what is the relevant alternative?
The alternative can be much, much worse. I am
a great believer in the power and importance of
free markets for advancing human good. But it’s
not because those markets work perfectly—it’s
because I can’t think of a better alternative.
RF: What role do you think the CEA can play
in formulating economic policy? 
Kroszner: I think the tradition at the CEAbasi-
cally has been to prevent bad policies from being
implemented. Often proposals can sound great
and very creative, but economists have a frame-
Editor’s Note: This is an abbreviated version of RF’s conversa-
tion with Randall Kroszner. For the full interview, go to our Web
site: www.rich.frb.org/pubs/regionfocus.
The Council of Economic Advisers (CEA), created in
1946, consists of three members who counsel the
President on a wide variety of economic issues. The
Council’s work is most visible on macroeconomic issues.
But its members and their staff also research microeco-
nomic issues, several of which have been prominent of
late, including corporate governance reform.
Randall Kroszner, professor of economics at the
University of Chicago’s Graduate School of Business,
joined the CEAin 2001. Much of his academic work has
focused on political economy questions, such as what
drives deregulation of select industries. His position on
the Council gave him an opportunity to witness the
give-and-take of the policy process that he had
researched from outside government. His time in
Washington also demonstrated why neoclassical eco-
nomics provides a powerful analytical framework for
examining new policy questions, such as those that
arose following the terrorist attacks of Sept. 11, 2001.
Kroszner recently left his position at the CEAto return
to the University of Chicago, where he edits the Journal
of Law & Economics. He has been a visiting scholar at
the Federal Reserve Board of Governors, the Interna-
tional Monetary Fund, and the U.S. Securities and
Exchange Commission. Aaron Steelman interviewed
Kroszner at the Cato Institute in Washington, D.C., 
on Sept. 23, 2003.
32 Region Focus • Winter 2004
INTERVIEW
Randall
KrosznerWinter 2004 • Region Focus 33
work to look at them and explain
their unintended consequences. 
In addition to trying to stamp
out bad policies, we also tried to
promote good policies. For instance,
many of the tax changes—particu-
larly the tax cuts on capital—were
things economists had been talking
about for decades. There wasn’t a
big constituency for such proposals,
but we said this is the right thing to
do if you want to get the most bang
for the buck. The President under-
stood this well and did a good job
of presenting it to the public.
In a crisis situation, you really get
to see the power of economics—
especially in Washington, where
most people derive their power
from having knowledge of the insti-
tutions. That was no longer very useful after Sept.
11, because we were in a different world. No one
had dealt with the type of issues we needed to
deal with after such an astonishing terrorist attack.
Do we need something like terrorism-risk insur-
ance? Do we need some sort of support for the
airline industry? As economists, we could say, “We
understand that demand curves slope down. We
understand that there are opportunity costs. We
understand people’s incentives.” That was very
important, because we could bring that frame-
work to a new situation and describe what’s most
likely to happen under a variety of different sce-
narios. In contrast, people who just had knowl-
edge of the institutions didn’t have that, because
they had no framework. And since the institutions
had changed and their applications were going to
be very different in a post-Sept. 11 world, econo-
mists got the upper hand and had much more
influence. It’s really nice to see the power of eco-
nomics to explain the situation and be very useful
as a tool for policy development.
RF: There was some expansion of the federal
financial safety net following Sept. 11, 2001 —
terrorism-risk insurance, for instance. What
were the major issues of debate and what do you
think of the legislation that actually emerged?
Kroszner: There was great concern immediately
following Sept. 11 that the insurance markets were
not going to be able to accommodate these new
risks quickly. I think we all believed that, even-
tually, the markets would be able to adjust, but it
would take a little time to figure out the calcula-
tion of risk and understand what appropriate
pricing for that would be. Also, with more time,
you have more data. With each passing day
without a terrorist event, you now have better
information about the likelihood of an event. Still,
in the immediate aftermath of Sept. 11, many
people believed that this was going to be a real
problem for property markets—to be able to go
ahead with projects that were underway or even
for existing buildings. So the policy question was:
Should there be some sort of role for the federal
government in providing a backstop with terror-
ism-risk insurance? We argued that there poten-
tially could be a temporary role the government
could play. With that in mind, we thought about
how to structure a program that would, in fact,
be temporary and not with us forever, like so many
other “temporary” government programs. We
designed a multiyear program that increased
private-sector risk-sharing over time, so that the
proportion of losses that the government would
cover would decline over time. The objective was
to build private-sector capacity, so that the gov-
ernment could eventually exit. When many tem-
porary programs are set to expire, people say, “We
can’t let that expire. The private sector can’t pick
up the slack.” Well, of course it can’t, because the
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I am a great believer
in the power and
importance of free
markets. But it’s not
because those markets
work perfectly—it’s
because I can’t think
of a better alternative.government has been handling the problem com-
pletely and given the private sector no incentive
to get involved. We wanted to avoid that trap.
There had been a concern among economists
that we weren’t charging explicit prices. It cer-
tainly would be natural to do that. But the
problem was, if we know how to price it, then the
private markets could easily do so and there would
be no reason for the government to be involved
in the first place. Also, I think there is an impor-
tant lesson here about bringing economics into
practice in Washington. If you were to collect pre-
miums over the life of the program, you would
have to set up a bureaucracy in order to process
those premiums and then there would be discus-
sions of what to do with that money. At the con-
clusion of the program, you have the bureaucratic
infrastructure and a source of revenue in place,
and I think it becomes much more difficult to
exit from the program. And since we thought it
was crucially important to make sure the program
is temporary, we thought it would be better to
avoid this possible problem. 
At first blush, of course, the simple economic
solution is always to charge for a good or service
that you are providing. But you then have to
think about the institutions and filter it through
the political economy of Washington. Did we
believe that the taxpayer will be better off by not
charging a premium
today but increasing the
likelihood of eliminating
this program and allow-
ing the private sector to
take over the risks? I
thought the answer was
yes, and we were able to
convince the President
of this. It was quite fun
to see the usefulness of
political economy—an
area I had worked on
quite a bit—in practice.
It is not a deviation
from the fundamentals
of economics. Certainly,
the first step is to always
think about using the
price system. But the
second step is determining whether there is an
additional cost in the government context that
is not there in the private sector context.
RF: What do you think were the root causes of
the recent corporate governance scandals? And
how well do you think the Sarbanes-Oxley Act
will address them?
Kroszner: When looking at the reasons for the
corporate governance scandals, people focus a lot
on expertise and the role of independent direc-
tors. But there is very little evidence in the case
of Enron, for example, that it was a lack of expert-
ise or independence that caused that firm’s diffi-
culties. It’s similar to Glass-Steagall in a sense:
People had a theory about the source of the
problem and how to solve it, but they left a lot of
pieces out. For example, there has been very little
focus on the role of institutional investors. Where
were the pension funds who owned 2 percent or
3 percent of these firms’ stock? Why weren’t they
looking at the management practices and asking
questions? I think part of the reason is there were
a lot of other regulatory rules that discouraged
active involvement by institutional investors. We
should have been looking at those types of issues
right from the start.
It’s much too early to tell what the conse-
quences of Sarbanes-Oxley are. I hear everything
from it’s just a minor cost, all the way to it’s the
death of the corporation. I think the answer is
somewhere in between. 
I should point out, though, that one of the big
benefits of the way Sarbanes-Oxley was written
is that most of the changes have to be imple-
mented by the Securities and Exchange Com-
mission (SEC). So where things may have gone a
bit too far, the SEC has generally done a good
job of trying to implement changes as reasonably
as possible. For instance, the Sarbanes-Oxley def-
inition of a financial “expert” would have per-
mitted extremely few people to qualify. The SEC
took a broader view of that, which made the law
more sensible. I don’t think that Congress had
intended to make the definition so narrow orig-
inally, but in the desire to do something quickly
it acted hastily.
One of the projects that I’m now starting on
with Phil Strahan is to try to document how
boards of directors have changed since 2000 and
really understand both the private market
responses to the scandals and also the responses
that have been driven by Sarbanes-Oxley. This is
an example of an issue that I worked on in Wash-
ington, where we had our theories of what the
consequences would be from a regulatory change,
and now coming back to academia I will have the
time to actually look at the evidence.
RF: For most of American history, the Democ-
ratic Party was known as the free-trade party,
while the Republicans tended to favor protec-
tionism. Since the 1940s, though, those roles
have largely shifted. What do you think accounts
for the change?
34 Region Focus • Winter 2004
In scholarly 
publishing, there is 
a very big tradeoff: 
You can either say
nothing precisely or
precisely nothing.Kroszner:The Reciprocal Trade Agreements Act
(RTAA) of 1934 fundamentally transformed both
the process and outcome of U.S. trade policy: Con-
gress delegated much of its authority over tariff-
setting to the President—a precursor of more
recent “fast-track” and “trade promotion author-
ity” legislation—and explicitly linked reductions
of tariffs abroad with reductions of tariffs at home.
This was the start of a sharp move towards trade
liberalization. The durability of this change in the
post-war United States was achieved only when
the Republicans, long-time supporters of high
tariffs who originally vowed to repeal the RTAA,
began to support this Democratic initiative in the
1940s. The key to the shift was the institutional
structure of the RTAAitself, which increased the
incentives for exporters to organize and lobby in
favor of trade liberalization, as well as the increase
in foreign trade following World War II. 
An important lesson from this episode is that
the organization and strength of interest groups
are not simply given but are shaped by incentives
embodied in the laws and regulations governing
different areas of economic activity. Policymakers
should take this type of response into account
when structuring or restructuring any type of eco-
nomic policy, not just in the trade arena.
RF: As editor of the Journal of Law & Eco-
nomics, are you concerned about the state of
academic publishing?
Kroszner:The typical trajectory for an academic
is to have a large stream of papers coming out, say,
three or four years after your first academic
appointment, and then after you have tenure you
turn to doing more book chapters and other
things that don’t require being bothered by ref-
erees. One of the major reasons that people don’t
want to submit papers to journals is the referee
process. The judgments that the referees make are
often seen as arbitrary and not particularly
thoughtful. I think part of that is because the ref-
erees don’t have much of a stake in what they are
doing. Their comments are anonymous and they
typically aren’t compensated. So at the Journal of
Law & Economics we pay referees for their work.
I’m not sure that is the best way to handle the
process. I have often thought that a Board of
Editors, who would take responsibility for the
decisions and not hide behind the referees, would
act much more responsibly. 
Also, at the Journal of Law & Economics I reject
about one-third of manuscripts out of hand, and
I think that saves everyone time and effort. In
those cases, I try to get back to people very
quickly and suggest an alternative venue. For
instance, some of the papers we receive would be
much more appropriate for a law journal. There
is no point in wasting referees’ time by sending
those papers out for comment. But the
question of how you get a better review
process is very important for people
involved with scholarly journals.
In scholarly publishing, there also is
a very big tradeoff: You can either say
nothing precisely or precisely nothing.
And, unfortunately, there is a lot of
emphasis on precision and getting
absolutely everything right. Getting
things right is important. But sometimes
people forget about trying to answer
important questions and taking a look
at the bigger picture. 
At the Journal of Law & Economics, we
have tried to take more chances on inter-
esting papers that may be a bit out of
the mainstream, because they are
attempting to tackle big issues and are
not simply making very incremental con-
tributions to the literature. Unfortu-
nately, it’s often hard to find those types
of papers. People aren’t willing to take
chances, because the profession places
so much emphasis on precision, often at
the expense of originality. At many
schools, publishing four or five papers
that discuss minor questions will be
enough to get tenure. But you really have
to take risks to move the discipline
ahead. It will generate a lot more
research to be wrong in an interesting
way than to be right in a boring way.
RF: Which economists have influ-
enced you the most?
Kroszner: In terms of people’s writ-
ings, I think Hayek was the greatest
influence. He had a very broad per-
spective and thought very much about
the fundamentals of equilibrium con-
cepts in economics. Another person whose work
has been of great influence and whom I have met
a number of times is Milton Friedman. He made
extremely important contributions to economic
science and also had a very good sense of how
to bring economics to bear on important prac-
tical questions. That is very much the Chicago
tradition. Economics is not just a set of analyt-
ical tools—economics is a way for us to under-
stand how people behave. It’s a framework for
looking at behavior individually, in the family, in
the firm, and in politics. RF
Winter 2004 • Region Focus 35
Randall Kroszner
➤ Present Position
Professor of Economics, Graduate
School of Business, University of
Chicago
➤ Previous Positions
Member of the President’s Council of
Economic Advisers (2001-2003);
Visiting Scholar, Federal Reserve Board
of Governors and the Federal Reserve
Banks of Chicago, Kansas City,
Minneapolis, New York, and St. Louis;
Visiting Scholar, International
Monetary Fund; Visiting Scholar, U.S.
Securities and Exchange Commission
➤ Education
B.S., Brown University (1984); Ph.D.,
Harvard University (1990)
➤ Selected Publications
Author or co-author of numerous
scholarly articles in such publications
as the American Economic Review,
Journal of Political Economy,
Quarterly Journal of Economics,
Journal of Monetary Economics, and
Journal of Law & Economics
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Interview : Randall Kroszner

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Interview : Randall Kroszner

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