Free lunches always leave a bad taste

by Tim Harford

It may seem easy to give things away, but it is not. The more attractive the gift, the more damage people will do to themselves, and each other, trying to get hold of it.
If that idea seems counterintuitive, it is nevertheless true, as the managers of Ikea, the furniture giant, can testify. They opened a new London store recently, offering opening night discounts of nearly 90 per cent on a limited number of leather sofas. The store closed 40 minutes later after 6,000 people tried to force their way through the doors; several had to be taken to hospital.
The press immediately blamed either the boorish stupidity of the British public or the hypnotic influence of the wily Swedes. But the ill-tempered scenes are not unique to Britain: at the grand opening of Jeddah’s Ikea last summer, two people died in the crowds queuing to get hold of $150 vouchers. Nor are these incidents the result of some quasi-religious shopping frenzy. The curse of the free lunch is at work.
If I were to announce that next Tuesday I would stand in Times Square handing out $100 notes, the result would be pure social waste, even if New Yorkers inexplicably decided to form an orderly queue. That queue would get longer and longer until latecomers decided that it was not worth camping out all night to get $100.
The man at the back of the queue would be spending $99 worth of his time to get hold of $100. In other words, it would cost me $100 to give this man a net gain of $1 – and on top of that I would have to worry about potential casualties. If instead I were to hand out $200 to each expectant New Yorker instead, the problem would get worse, not better.
This scenario may seem far-fetched, but the world is full of attempts to give money away. For obvious reasons, the generous donors are usually not companies such as Ikea, but governments.
Many of us are involved in a situation analogous to the queue in Times Square twice a day, when we commute. Almost everywhere, governments have decided that roads should be free or heavily subsidised – much like a leather sofa on opening night at Ikea. Since everybody gets to use a valuable product for free, the resulting congestion and road rage should hardly come as a surprise. The “free” roads of the big cities of every developed country in the world are choked with cars, and bumper-to-bumper traffic is already a problem in many cities in the developing world.
London is a partial exception, after Transport for London, the government agency in charge, decided to stop the free lunches. With rather more wisdom than the management of Ikea, it levied a “congestion charge” of £5 on any driver wishing to cross central London. In doing so, TfL demonstrated the inefficiency of road use up to that point: although traffic levels only fell by 15 per cent, delays caused by congestion decreased by nearly one-third.
Motorists are not the only ones suffering from the curse of the free lunch. It also torments parents trying to place their children in the limited number of high-quality “free” schools. They pay for the right to attend those particular schools not by having to queue, but through the housing market: the better the local school, the higher the property values. At least these payments, unlike the cost of queues or traffic congestion, are transfers from buyer to seller rather than pure waste. Yet it would be more sensible if the money were spent on better schools instead.
Government policies to subsidise important services such as roads and education usually make no more sense than Ikea inadvertently organising an opening-night riot. Sometimes the benefits are dispersed by overcrowding, as happens in the case of the roads. In other cases, as with education, the benefits are simply misdirected, going not to poor parents but to homeowners selling property close to good schools.
This is not to say that subsidies must be abolished. With real political leadership, it is possible to direct them fairly accurately at the poor. In many instances, the right way to do this would be for the government to let competing companies charge what the market will bear, and give cash or vouchers only to those who cannot afford the fees. Such schemes are transparent and trust the poor to make their own decisions; political elites therefore view them with suspicion. The free lunch remains popular, partly because it can be aimed at favoured constituencies, and partly because queues are simply seen as a sign that we need more subsidies for more roads and more schools, not fewer. It is time we started paying our own bills.

Is unemployment benefit a good thing after all?

By Tim Harford

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In balancing these two effects, it’s hardly surprising that different societies have adopted very different systems. According to the Organisation for Economic Co-operation and Development, member governments spent an average of 0.75 per cent of gross domestic product on unemployment benefits in 2006. France spent nearly twice this sum, and Germany almost three times as much, while the US spent a third of the average, and the UK just over a quarter. Germany spent more than 10 times as much as the UK, relative to GDP.

Paying people to stay out of work is an example of that increasingly familiar phenomenon, “moral hazard”, but moral hazard can be more fearsome in the theorist’s imagination than it is in reality. Does unemployment benefit really encourage people to duck work? Unfortunately, the evidence suggests that it does: increases in benefits have repeatedly been linked with longer periods between jobs.

But new research from Raj Chetty, a young Berkeley economist, suggests that moral hazard may not be why more generous benefits seem to lead to more unemployment. Chetty realised that unemployment benefit does not merely pay people to stay out of work; it also protects them from having to rush into an unsuitable job. It is nothing to celebrate if unemployed engineers cannot afford to spend three months finding a job for which they are qualified, but are forced to work as estate agents to put food on the table. A longer gap between jobs is sometimes preferable.

This is an interesting theory, but distinguishing between moral hazard and the effect of having some cash to hand is tough. Chetty looked at sharp breaks in the unemployment insurance rules in the US, comparing one state’s rules with another’s, or examining moments when the rules changed. One suggestive finding is that when unemployment insurance becomes more generous, not everybody lingers on benefits. The median job-loser in the US has $200 when he loses his job and is unlikely to be able to borrow much, but some people have plenty of money in the bank when they find themselves unemployed. Chetty found that those with savings do not take any longer to find a job when paid more generous benefits, while those with little in the kitty when they lose their jobs do. This suggests that those without their own cash reserves are using unemployment benefits to buy themselves time to find the right job.

Of course, there may be many differences between people with savings and those without, so this merely suggests that Chetty is on to something. But there are other clues – for instance, Chetty and two colleagues looked at the system in Austria, where severance pay is due to anyone employed for more than three years. By looking at – for example – a factory closure in which lots of staff are fired simultaneously, they could treat severance pay almost as a randomised experiment. Those lucky enough to get severance pay spent more time looking for a new job, despite the fact that severance pay provides no direct incentive to stay out of work.

Unemployment benefit does encourage unemployment in the short term; but that may be no bad thing.

Daddy, Where Do Jobs Come From?

Jobs, it seems is becoming a very important issue as we seemed to have shed 5 million of them recently and are on the precipice of the worst recession since 1929. But fear not, for our president elect has a plan and it’s quite simple;

“More jobs.”

Yes, that’s about it, we’ll just “create” more jobs.

Now 3rd grade logic would tell you something is wrong. You can’t put your finger on it. Maybe you can’t full explain it. But you have this twingling sensation in the back of your head that you know something just ain’t right. That it ain’t as simple as;

“Just creating more jobs.”

It’s the same kind of twingling sensation you got back in school when you said, “Well why don’t we just print off more money.”

You intuitively knew something had to be wrong with that solution, but you perhaps couldn’t explain why. And thus it’s the same thing with Barack’s plan to create new jobs.

His idea for this massive infrastructure (and Keynesian) investment gives us all the same twingling sensation in the back of our heads. Why, if it was that simple, to just build roads, bridges and splurge more on education, what were we getting all worried about in the first place? Why are the stock markets so low? Why don’t we create jobs right now today? And so, since we all intuitively know it can’t be that simple, let me explain why. Let me explain to you where jobs come from.

Jobs come from one thing; demand.

Demand for goods and services currently existing or yet to exist. For example I demand food, a good that already exists. I also demand a hovercar and a clone of Jennifer Anitson, a good and service that have yet to exist. Regardless, if the product or service exists or can be created, and there is demand for it, then there is the potential for jobs to be created.

But demand must be met with supply and here is where the actual jobs are created. In order to supply these goods and services an entrepreneur or a company must hire people to help provide those goods and services. This includes everybody from the head of the company managing the firm to the suppliers, vendors, laborers, admins, marketers, accountants and anybody else required to bring these services to reality. However, there is a key element to make this all happen and that is profit.

Oh yes, that “evil” profit.

For you see, no entrepreneur, nor company, nor corporation is even going to bother going through the trouble of setting up the venture in the first place unless they are actually paid for it. And before you start berating these “evil capitalists” to have the temerity to demand recompense so that they may earn a living, you might want to look at yourselves in the mirror because no laborer (let alone you) is going to work unless they are compensated too. So just accept the fact we’re all financial whores, not out of evil or greed, but because it’s necessary for us to live and survive.

Regardless, immediately we see a problem with, not so much Obama’s infrastructure plan, but his fiscal policy in that he is going to raise taxes on not only the rich who employ the majority of people, but also corporations. Envy them and hate them all you want, increasing taxes on them will lower the incentive for them to invest, let alone start a new venture in the first place. And with the rapidly integrating global economy, if they really do have a great idea, why would they set up shop here in the first place? Ireland has a 12.5% corporate tax rate. Dubai has 0%. Russia has a flat tax. And “communist” China has a 20% corporate tax rate.
The good ol’ US o’ A has a 39% corporate tax.

So even though we haven’t addressed Obama’s specific infrastructure jobs creation plan, it’s quite possible other parts of his fiscal policy will impair it or destroy more jobs than it creates, simply because it destroys the incentive to create jobs in the first place; profit.

As for the specific plan itself, it’s not an issue of whether it will create jobs as much as it is a question at what cost.

Understand that to finance this infrastructure plan Obama has two choices; taxation or borrowing. And both options are going to cost jobs as well as efficiency.

In taxing people (no matter how “rich” they are) that takes money that would have been invested or spent anyway which would have created jobs as well. So if you tax the “rich jewelry dealer” an extra $50,000 so 2 employees in Obama’s Civilian Conservation Corps can pour concrete for a bridge, that’s all fine and dandy except for the fact the jewelry dealer now had to lay off his assistant and his admin to compensate for the cut. Congratulations, you created a big fat zero net new jobs.

Borrowing is no better in that the money borrowed by the government to finance the infrastructure jobs creation plan could have been borrowed by a company, an entrepreneur or even an individual to be used to create a new company, expand a factory or just plain spent, all of which would have created jobs too. Congratulations. You not only borrowed money and destroyed as many jobs as you created, but you’ve managed to increase interest rates as well! Thanks!

But the real cost is this, and is often the forgotten about or never-thought about aspect of economics, and that is efficiency. Specifically, as it relates to production.

If the money was left in the hands of the people, the people could then spend or invest that money as they saw fit and to their best benefit. Allowing people to make their own decisions as to how to expend their resources is the best way to make sure the goods and services produced in the economy are those that most benefit the people and increase standards of living the most. Of course, people make mistakes. The sickening, gluttonous binge of using one’s home equity as an ATM machine which has brought upon this financial crisis in the first place is a perfect example where the people will make mistakes. However, for all their flaws, recessions and depressions, free markets, ie- the people have historically been proven to be the best determinants of what to be produced.

Governments have not. And herein lies the flaw in Obama’s advisor’s plan; taking massive amounts of resources either through taxation or borrowing, takes money out of the hands of individuals and puts it in the hands of government. People now no longer get to decide what to spend their now dwindling resources on, and are instead forced to spend it on roads, infrastructure, and schools they may not need.

Now people may rightfully point out that things like roads, bridges, infrastructure, etc., are hardly foolish investments, and they’re right. But again the question is at what cost? Who would be better judges of how to spend this money and who would do more to help the economy out of recession;

A handful of bureaucrats and former Fannie Mae and Freddie Mac advisors now consulting a no-real-world-experience-president-elect determining what the best use of your money is?

Or

300 million Americans who are intricately familiar with their own personal financial situation and the problems/opportunities they face?

This is where the real costs come in that what determines our standards of living is whether we use our resources efficiently to produce the goods and services we NEED. We just promised $700 billion (more like $2 trillion) to bailout those same Harvard ef-ups who ran Wall Street and the government into the ground. Could the people not have used a $700 billion tax cut? Would that not have solved our little economic growth problem? No, we’re stupid, we don’t know what we’re talking about, now shut up and give us the money.

Obama’s infrastructure plan is no different (although, I will admit spending the money on bridges and roads is infinitely wiser than bailing out Ivy League deadbeats). We don’t know what’s best for us. You don’t need that money. Give it to us and we’ll build shinny new roads and bridges. Just what you wanted. No, not that new icky gross Pontiac Solstice that would ACTUALLY HELP OUT DETROIT WITHOUT A TAXPAYER BAILOUT. No Captain, that’s not what you want. You want an addition to the elementary school named after Barack Obama where a newly hired teacher will brainwash…errr….I mean “educate” the children about the evils of capitalism…errr…I mean “global warming.” That’s what you want.

It is this that is the true cost to this Keynesian nightmare. The loss of productivity and efficiency causing American’s standards of living to go down. Not because of a loss of jobs (for I’m optimistically assuming this infrastructure plan will ONLY destroy one job for each one it “creates”) but because the stuff we’re producing with it is not what the American people optimally want.

And finally, permit me a third point.

I know building bridges, though not optimal, is not a waste of money.

I know roads, albeit not optimal, are not a waste of money.

But notice how education was thrown in there?

Please. Please, just stop with the “we don’t spend enough on education.”

It’s a sickening lie and you’re not fooling anyone. By every measure, every stretch of the imagination we spend WAY TOO MUCH on education and the fact education is part of Obama’s jobs creation plan shows me just how inefficient this plan will be. Bridges, fine. Roads, fine. But more money for education would be on par with bailing out the losers of Wall Street and sub prime deadbeats.

Alas, appetizing as new roads and bridges are, it was the inclusion of education, above all else, that made me supremely confident the stork will not be bringing any new jobs to Obama with his little infrastructure plan.

Wall Street Bail-out and Economic Development

Read more! With the recent financial crisis in the United States, most of the debate we hear currently entails whether or not the government should be involved in some sort of bail-out. While this would be a major intervention, William Easterly, in a today’s op-ed in the Wall Street Journal, says that the U.S. will still remain largely capitalistic and the domestic effect is not the largest worry. To Dr. Easterly, the issue at hand is what message this policy choice sends to developing countries’ governments. While we may be choosing between some or more intervention, he contends that developing nations are choosing between free markets and government planning for economic growth.

For better or worse, our actions and beliefs today will affect the policies for many years to come of these countries. The point Easterly makes is an important one, and echos that of F.A. Hayek in “The Intellectuals and Socialism”. Whether you agree or disagree with government intervention, it is difficult to ignore the importance of the role our policy decisions play in steering developing governments’ future actions.

If any of you feel inspired by this issue or any development issues, there will be an opportunity for you to share your ideas to other students and non-profit organizations in an upcoming conference at Mason. A private consulting firm Midego Inc. from Fairfax, Virginia will be co-hosting the conference with the student group Global Health Students Beyond Borders in February. Here is more info:

“The conference is entitled “Breaking with Business As Usual” and the purpose of the conference is to bring together students and professionals from all disciplines to discuss and develop strategies to reach the Millennium Development Goals.

If you are not familiar with the MDGs, they are a set of 8 health, welfare and environmental sustainability goals set by the United Nations in the year 2000 and are aimed at improving the lives of the world’s poorest by improving issues related to education, poverty, public health and environmental degradation. Most of the worlds’ governments have pledged to supporting these goals, but are falling short in delivering on that promise. In order to move towards them innovative strategies must be developed.

We are calling for student poster or oral presentations – abstracts are due November 30th – see the attached guidlines. This is a 250 word abstract for either a poster or 10-minute presentation. Your ideas do not have to be tested and proven, we’re looking for new, innovative strategies. Take a look at the list of the MDG and their targets and I think you’ll see a lot that economic students would be interested in. Ideas I can think of off hand are providing micro-loans for small businesses, balancing economic growth with environmental conservation,and dealing with debt problems in developing nations. “

I know that many of you could offer new thinking on these topics, and I plan to propose a talk for the conference as well. If any of you have any questions about this conference or wish to get the application, you can email the Econ Society at gmueconsociety@gmail.com or email Midego Inc at sara@midego.com .

How to Recapitalize the Financial System

How to Recapitalize the Financial System

GREG MANKIW

There is broad agreement among economists that what the financial system needs right now is not only an injection of liquidity but also a recapitalization. The essence of the current financial crisis is that many firms bet that housing prices would not fall; the prices fell nonetheless; and now these firms have too little capital to perform the crucial function of financial intermediation.

(As an aside, one might ask, why did these firms make such bad bets? Essentially, it was a result of poor judgment among various private decisionmakers, encouraged by equally poor judgment of various public policymakers, many of whom were more interested in promoting homeownership among questionable borrowers than in the preserving the safety and soundness of the financial system. But this is not the time for recriminations. We have to face up to the problem sitting in our laps.)

The question for the moment is, How can we get capital back into the financial system? Ideally, it would be great if more Warren Buffetts would step up to the plate and recapitalize financial firms with private money. Unfortunately, that might not happen fast enough to prevent a major economic downturn.

Some economists have proposed forcing these firms to go raise more capital from private sources. But how exactly can the government do that? It is not entirely clear how, as a legal matter, that can be accomplished. Perhaps regulators can twist the arms of the financial institutions. Call it the Tony Soprano approach. “Nice bank you have here. I wouldn’t want anything bad to happen to it.”

Other economists have suggested that the government inject capital itself. That raises several questions. First, which firms? The government does not want to put taxpayer money into “zombie” firms that are in fact deeply insolvent but have not yet recognized it. Second, at what price should the government buy in? Third, isn’t this, kind of, like socialism? That is, do we really want the government to start playing a large, continuing role running Wall Street and allocating capital resources? I certainly don’t.

Here is an idea that might deal with these problems: The government can stand ready to be a silent partner to future Warren Buffetts.

It could work as follows. Whenever any financial institution attracts new private capital in an arms-length transaction, it can access an equal amount of public capital. The taxpayer would get the same terms as the private investor. The only difference is that government’s shares would be nonvoting until the government sold the shares at a later date.

This plan would solve the three problems. The private sector rather than the government would weed out the zombie firms. The private sector rather than the government would set the price. And the private sector rather than the government would exercise corporate control.

Why would an undercapitalized financial firm take advantage of this offer? Because it would need to raise only half as much capital from private sources, that financing should be easier to come by. With Warren Buffetts in scarce supply, the government can in effect replicate them, by pigging backing on what they do.

I believe that Treasury has the discretion to use some of the $700 billion recently approved by Congress to make these equity injections. I would recommend that the Treasury announce an upper limit, say, $300 billion, allocated on a first-come, first-served basis. The limit would encourage financial institutions to act quickly to get in before the door closed. Given how fast matters are deteriorating, the sooner capital gets back into the financial system, the better.

Conservatives Unite Against Bailouts


Written by Robert Romano
Yesterday, Americans for Limited Government President Bill Wilson, along with seventeen other conservative, limited government, and free market leaders, delivered an unyielding message to members Congress. It is an imperative message, and one that must become the clarion call of the opposition party during the next presidential administration: No more bailouts—especially not for the Big Three.

The fact is that it is time for some tough medicine for American businesses. This a recession, which so far as the history of economics goes, is not remarkable. During downturns, businesses will fail. In fact, it is during hard times that companies are often tested, and weaker brands will by virtue of marketplace dictates be forced to fold, or be sold. And it is no different with the Big Three. Should they fail, it will not mean the end of the American economy. It would simply mean the end of three businesses whose own indulgent behavior presaged their demise.

Lost in the public debate over bailing out the Big Three automakers is that these companies could be recapitalized with private investment. If only they were allowed under the lawfully-provided protection Chapter 11 bankruptcy offers to develop new business models that both adapt to current economic conditions and remove excesses, including the exorbitant union benefits the UAW has extracted from failed management of the companies.

In short, as the conservative leaders’ letter states, the bailout represents “an unfair imposition upon the American people who are in no way responsible for, and should not face the consequences of, the profligate behavior of Big Three corporate and UAW union management.”

And it is this principle that the conservative movement, and in extension the Republican Party, must stand for, and draw a line in the sand over: The American taxpayer cannot afford to perpetually finance failure. Whether it be failed government policies or business models, adding to the national debt in order to finance loans today for programs and companies that might fail by year’s end is simply asking too much.

Instead it is the interests of the American people to have an economy that can handle and absorb failure, because it is far outweighed by the innovation and ingenuity of the American entrepreneur. The same entrepreneur who invented the light bulb, the assembly line, the telephone, and television. And the same entrepreneur who, given the opportunity, can innovate the American auto industry and again make it competitive.

This formula for eventual success is quite simple: Congress only needs to do nothing. No more bailouts: It is time for Congress to let businesses know that they are on their own. Only then will they make decisions based upon their own survival, and not seek to perpetuate their own excesses at taxpayer expense.

Foggy Crystal Ball
China’s corrupt model produces toxic-baby formula but spic-and-span finances?

By Jonah Goldberg

These are humbling times for champions of the free market and American-style capitalism. The CEOs of the Big Three car companies are kneeling before Uncle Sam like Henry in the snows of Canossa. The stock market volatility these days is looking more and more like a death rattle. No one wants to check their 401(k) for fear of their face melting like that Gestapo guy in Raiders of the Lost Ark when he peeked inside the Ark of the Covenant.

But while we cheerleaders for economic liberty need to take our lumps and spend some time thinking about where things went wrong, it would be nice if the Chicken Littles spent a wee bit of time doing likewise.

Exhibit A: China. You can’t pick up a copy of Newsweek without reading something by Fareed Zakaria about how China will only get larger and larger in our rearview mirror. Five years ago, Goldman Sachs predicted that China’s GDP would overtake America’s by 2041. Now it thinks that China will reach us in 2027. (Of course, with a much bigger population, China’s per-capita wealth would be much lower than ours.) The National Intelligence Council’s new report, “Global Trends 2025: A Transformed World,” echoes these concerns.

Heck, maybe they’re all right. Maybe not. The simple fact is that no one knows.

But I’d bet against it.

First of all, there’s a long record of very smart people making very bad predictions. Just Google “bad predictions” and you’ll see what I mean. In 1943, the chairman of IBM said, “I think there is a world market for maybe five computers.” Legend has it the head of the U.S. Patent Office said in 1899, “Everything that can be invented has been invented.” Neville Chamberlain prophesied “peace in our time.”

And roughly two decades ago, the best and brightest were telling us that “Japan Inc.” was going to overtake America any day now.

“Future historians,” warned Harvard’s Ezra Vogel in 1986, “may well mark the mid-1980s as the time when Japan surpassed the United States to become the world’s dominant economic power.” Yale’s Paul Kennedy wrote a blockbuster of a book concluding that American policies should be designed to manage our decline “so that the relative erosion of the United States’ position takes place slowly and smoothly.” When Jacques Attali was head of the European Bank for Reconstruction and Development in 1991, he observed that America was becoming akin to “Japan’s granary, like Poland was for Flanders in the seventeenth century.”

Journalist James Fallows, political scientist Chalmers Johnson, and economist Lester Thurow were fawned over for their supposedly incontrovertible conclusion that Japan was the future. “The Cold War is over,” Johnson wrote, “and Japan won.”

Then, as you may have heard, the Japanese economy went kablooey.

The Japan example not only demonstrates that smart people can be wrong and that the elite chattering classes are prone to groupthink, but it helps illuminate why they are so prone to this sort of thing.

For more than a century, countless American intellectuals and business leaders have looked enviously at how foreign countries “planned” and “managed” their economies. Woodrow Wilson and the Progressives drooled over Otto von Bismarck, and today every self-proclaimed “global strategist” gazes at China’s managed capitalism like a kid with his nose pressed against a candy-store window.

Of course, China has made enormous progress since it decided that markets are a more desirable means of improving the lot of its citizens than organized mass murder. But China’s fans still have an enormous blind spot.

Ask yourself this: Why are we in this financial crisis?

Any short list of reasons would include a lack of transparency in markets and regulatory rule-making; collusion between business and government; the politicization of lending practices (including the socialization of risk and the privatization of profit through giant governmental entities like Fannie Mae); and, of course, simple greed.

Does anyone honestly think China doesn’t have these problems ten times over? It has no free press, no democratic accountability, and no truly independent regulators.

After every Chinese earthquake, we discover that safety inspectors couldn’t be trusted to oversee the construction of schools and hospitals. And we’re supposed to believe that China’s corrupt model produces toxic baby formula but spic-and-span finances?

There’s an honest debate about how much blame institutions like Fannie Mae and laws like the Community Reinvestment Act deserve for the financial crisis, but few honest observers dispute that they played some kind of deleterious role. Well, China’s entire economy is one big Fannie Mae, its laws one big Community Reinvestment Act.

I’m willing to bet that the bill for that comes due long, long, long before China catches up with the United States of America.

— Jonah Goldberg is the author of Liberal Fascism: The Secret History of the American Left from Mussolini to the Politics of Meaning.

Massive riots cripple Greece’s main cities

ATHENS, Greece (AP) – Greece’s interior minister says the massive protest riots in cities across the country are “unacceptable” but insists that police are doing all they can to protect people’s lives and property.Thousands of youths are rampaging through Athens, the northern city of Thessaloniki and several other cities in the third day of riots Monday after police shot and killed a teenager on Saturday.

Minister Prokopis Pavlopoulos spoke after the Greek government held an emergency meeting Monday night.

In the center of the Greek capital, hooded and masked protesters are throwing Molotov cocktails at riot police, who are responding with tear gas. Dozens of shops have been burned or smashed and looted.

THIS IS A BREAKING NEWS UPDATE. Check back soon for further information. AP’s earlier story is below.

ATHENS, Greece (AP)—Gangs of youths smashed their way through central Athens and Thessaloniki on Monday, torching stores and buildings after the fatal police shooting of a teenager sparked Greece’s worst rioting in decades.

Dozens of shops, banks and even luxury hotels had their windows smashed and burned in a night of lawlessness as youths fought running battles with riot police. Black smoke rose above the city center, mingling with clouds of tear gas.

Prime Minister Costas Karamanlis, whose increasingly unpopular government has already faced a growing number of sometimes violent demonstrations in recent months, called an emergency Cabinet meeting Monday night.

In Athens, rioters torched the capital’s massive Christmas tree in central Syntagma Square. As the hooded youths moved on, some protesters posed for photos in front of the blaze, and others sang the Greek version of “O Christmas Tree.”

The windows of two of Athens’ luxury hotels, the Athens Plaza and the Grande Bretagne on Syntagma Square, were smashed. A hotel guard at the Athens Plaza said its guests had been evacuated.

A lone man with a bucket of water struggled to extinguish a fire in the ground floor of the Foreign Ministry, opposite Parliament. Fires were also reported in the building of an airline and a Greek bank, as well as in tens of other stores in most of Athens’ major central streets.

Rioters, meanwhile, set up burning barricades across downtown streets.

Scenes of destruction also unfolded in Thessaloniki, where hundreds of masked and hooded youths hurled rocks and molotov cocktails at storefronts and riot police, who responded with tear gas.

The fire departments of both cities rushed to respond to the widespread destruction. In Athens, rioters surrounded one small fire truck as it tried to extinguish a blaze, smashing the truck’s windows before setting it alight.

Elsewhere, rioters looted a store selling hunting weapons and swords.

Greek media also reported fires and destruction in the central city of Larissa.

Massive riots first erupted Saturday across the country, from Thessaloniki in the north to the island of Crete in the south, after 15-year-old Alexandros Grigoropoulos was fatally shot by a police officer in Athens’ often volatile Exarchia district.

The circumstances surrounding the shooting are unclear, but the two officers involved have been arrested; one has been charged with murder and the other as an accomplice. A coroner’s report shows the boy was shot in the chest.

Schools were to shut Tuesday in mourning, while staff at universities declared a three-day strike.

The Police Officers’ Association has apologized to the boy’s family, and President Karolos Papoulias sent a telegram to his parents expressing his condolences.

“All the dangerous and unacceptable events that occurred because of the emotions that followed the tragic incident cannot and will not be tolerated,” Karamanlis said in a live televised address Monday morning. “The state will protect society.”

But his calls for calm went unheeded and the scenes of destruction are likely to further dent the government’s popularity.

In an outpouring of rage, high school and university students join self-styled anarchists in throwing everything from fruit and coins to rocks and Molotov cocktails at police and attacked police stations throughout the day.

“Cops! Pigs! Murderers!” protesters screamed at riot police.

Abroad, demonstrators raised banners at the Greek Embassy in London and the black-and-red anarchist flag at the Greek consulate in Berlin.

Separately, about 10,000 protesters from the Communist Party of Greece and another left-wing party marched through the center of Athens.

With the global financial crisis hitting Greek consumers, shop owners worried the violence would hurt consumer confidence.

“It comes at a time when we have been trying so hard to establish a Christmas spirit in the market,” said Vassilis Krokidis, head of the Piraeus Traders’ Association. “Our challenge remains getting through the economic crisis and saving the jobs of those who work in regular businesses.”

One assistant at a china shop watched in fear as rioters attacked her store.

“Nobody seems to care about the employees at the burnt shops, what will their fate be now over the Christmas season?” said the woman, who gave her name only as Eleni.

Although there is little public support for street violence or wanton destruction of property, there is a deep well of tolerance for demonstrations in Greece, where the right to protest is held dear.

Violence often breaks out between riot police and anarchists during demonstrations. Anarchist groups are also blamed for late-night firebombings of targets such as banks and diplomatic vehicles. The attacks rarely cause injuries.

The self-styled anarchist movement partly traces its roots in the resistance to Greece’s 1967-74 military dictatorship. The youths tend to espouse general anti-capitalist and antiestablishment principles, and have long-running animosity toward the police.

Illinois Gov. Blagojevich, chief of staff, arrested

Read about the latest developments

Blagojevich responds

Gov. Rod Blagojevich arrives at the Tribune Tower on Monday for an interview at CNN’s Chicago office. (Tribune photo by Nancy Stone / December 8, 2008)

UPDATE: Gov. Rod Blagojevich and his chief of staff, John Harris, were arrested by FBI agents on federal corruption charges Tuesday morning.

Blagojevich and Harris were arrested simultaneously at their homes at about 6:15 a.m., according to Frank Bochte of the FBI. Both were transported to FBI headquarters in Chicago.

In one charge related to the appointment of a senator to replace Barack Obama, prosecutors allege that Blagojevich sought appointment for himself as secretary of Health and Human Services in the new Obama administration, or a lucrative job with a union, in exchange for appointing a union-preferred candidate.

Another charge alleges Blagojevich and Harris conspired to demand the firing of Chicago Tribune editorial board members responsible for editorials critical of him in exchange for state help with the sale of Wrigley Field, the Chicago Cubs baseball stadium owned by Tribune Co.

Blagojevich and Harris, along with others, obtained and sought to gain financial benefits for the governor, members of his family and his campaign fund in exchange for appointments to state boards and commissions, state jobs and state contracts, according to the charges.

“The breadth of corruption laid out in these charges is staggering,” U.S. Attorney Patrick Fitzgerald said in a statement.

“They allege that Blagojevich put a ‘for sale’ sign on the naming of a United States senator; involved himself personally in pay-to-play schemes with the urgency of a salesman meeting his annual sales target; and corruptly used his office in an effort to trample editorial voices of criticism.”

Blagojevich is scheduled to appear before U.S. Magistrate Judge Nan Nolan later today, according to Randall Samborn of the U.S. attorney’s office.

Click here for the latest updates from the Breaking News Center

FROM TUESDAY MORNING’S CHICAGO TRIBUNE

A three-year federal corruption investigation of pay-to-play politics in Gov. Rod Blagojevich‘s administration has expanded to include his impending selection of a new U.S. senator to succeed President-elect Barack Obama, the Tribune has learned.

Federal authorities got approval from a judge before the November general election to secretly record the governor, sources told the Tribune, and among their concerns was whether the selection process might be tainted. That possibility has become a focus in an intensifying investigation that has included recordings of the governor and the cooperation of one of his closest friends.

The governor has not been accused of any wrongdoing. The specific contents of the recent recordings have not been disclosed. Blagojevich has said the appointment of a Senate successor, which is his choice alone, could come in a matter of weeks.

Speaking to reporters Monday for the first time since the Tribune revealed federal investigators had recorded him and others as part of their corruption probe, Blagojevich said his discussions were “always lawful.” He also defended close confidant John Wyma, whose cooperation with federal agents helped lead to the recordings, as “an honest person who’s conducted himself in an honest way.”

“I should say if anybody wants to tape my conversations, go right ahead, feel free to do it,” he said. “I appreciate anybody who wants to tape me openly and notoriously, and those who feel like they want to sneakily, and wear taping devices, I would remind them that it kind of smells like Nixon and Watergate.”

Unlike the recordings that the federal government has of Blagojevich, the tapes that led to President Richard Nixon‘s 1974 resignation over the burglary of Democratic offices at the Watergate complex and the ensuing coverup were made by Nixon himself.

Regardless of “whether you tape me privately or publicly, I can tell you that whatever I say is always lawful and the things I’m interested in are always lawful,” Blagojevich said. “And if there are any things out there like that, what you’ll hear is a governor who tirelessly and endlessly figures out ways to help average, ordinary working people.”

Blagojevich’s comments came amid increasing concern by Democrats that the governor’s pending appointment of a Senate successor may become politically tainted as a result of the investigations surrounding his administration. Federal investigators have been looking into allegations of corruption regarding state jobs, appointments and contracts in connection with Blagojevich’s prolific fundraising.

Blagojevich has not been charged with any wrongdoing and contended that if federal investigators areƒs “going to those lengths and extents [of obtaining recordings], if in fact that’s true, that would suggest all the past has been pretty good.”

“I don’t believe there’s any cloud that hangs over me. I think there’s nothing but sunshine hanging over me,” the governor said.

Blagojevich made the remarks at a Monday morning visit to laid-off workers staging a sit-in at the Republic Windows & Doors plant on Goose Island.

Later Monday, he met for 90 minutes with Rep. Jesse Jackson Jr., the South Side and southwest suburban congressman who has been the most visibly active campaigner for the appointment to replace Obama. Jackson, who was among the last high-profile Senate successor candidates to speak with Blagojevich, has had disagreements with the governor and is not close to him.

Blagojevich issued a strong defense of Wyma and accused the Tribune of publishing misinformation and possibly defamatory material.

“To begin with, they didn’t get it right,” he said. “John Wyma’s lawyer put out a statement. The Tribune was wrong and very well may have defamed him.”

But the statement from Wyma’s lawyer did not directly address the Tribune story and instead appeared directed at media outlets and others who reported Wyma wore a wire.

The Tribune noted that Wyma’s cooperation with federal investigators helped lead to recordings of Blagojevich but did not report that he wore a wire.

Wyma’s lawyer also did not respond to the Tribune’s report that Wyma was cooperating with investigators. “John Wyma is a friend of mine, he was my chief of staff, and I’m sure whatever he does, he does ethically and follows the rules,” the governor said.

Blagojevich said he would not remove Wyma from his inner circle of advisers. He also told the Tribune that Wyma was not involved in the deliberations over an Obama successor. “No, I consider him a friend. and I don’t consider him as anything but a friend. And to someone who, as I’ve known him, always has been an honest person who’s conducted himself in an honest way,” Blagojevich said of Wyma. “That’s the John Wyma I know and it’s the John Wyma that [Obama’s incoming chief of staff, Rep.] Rahm Emanuel knows and a lot of other people know.”

Blagojevich said he had last spoken to Wyma the day before Thanksgiving, when he offered holiday wishes and “talked a little bit about the plight of the Detroit Lions. He’s from Michigan.”

And the governor indicated he was not concerned about Wyma cooperating with federal investigators. “Look, I believe everybody should just tell the truth and pursue the truth and be truthful and then you do that and everything’s fine,” he said.

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