Monthly Archives: March 2009

Hey Kids! Transactions Costs!

Posted on by

In this macro-brutalizing post, William Buiter lays down many passages I agree with. I don’t believe it was offered in this spirit, but I think Buiter does a servicable job of explaining why my fave econ gurus — F.A. Hayek, James M. Buchanan, Douglass North, and Vernon Smith — will make you smarter than your local macro textbook. Buiter:

[M]ost of the New Classical and New Keynesian macroeconomics assumes away the problem of contract enforcement.  This problem is especially acute in trade over time or intertemporal trade, where the net value to each party to a contract of fulfilling the terms of the contract varies over time and can change sign.  In a world with selfish, rational, opportunistic agents, able and willing to lie and deceive, only a small set of voluntary transactions will ever be observed, relative to the universe of all potentially feasible transactions.

The first set of voluntary exchange-based transactions we are likely to see are self-enforcing contracts – those based on long-term relationships, repeated interactions and trust.  There are some of those, but not too many.  The second are those voluntarily-entered-into contracts that are not self-enforcing (say because interactions between the same sets of agents are infrequent and market participants have a degree of anonymity that prevents the use of reputation as a self-enforcement mechanism) but are instead enforced by some external agent or third party, often the state, sometimes the Mafia (sometimes it’s hard to tell who is who).  Third party enforcement of contracts is again often complex and costly, which is why it covers relatively few contracts.  It requires that the terms of the contract and the contingencies it contains be third-party observable and verifiable.  Again, only a limited set of exchanges can be supported this way.

The conclusion, boys and girls, should be that trade – voluntary exchange – is the exception rather than the rule and that markets are inherently and hopelessly incomplete.  Live with it and start from that fact.  The benchmark is no trade – pre-Friday Robinson Crusoe autarky.  For every good, service or financial instrument that plays a role in your ‘model of the world’, you should explain why a market for it exists – why it is traded at all. Perhaps we shall get somewhere this time.

[...]

The future surely belongs to behavioural approaches relying on empirical studies on how market participants learn, form views about the future and change these views in response to changes in their environment, peer group effects etc. 

Yeah! Do some real science, economists!

Let me point out that Buiter badly oversteps his line of reasoning when he says that voluntary exchange, as such, is the exception rather than the rule, because trade is in fact a ubiquitous feature of human society. The baseline is not “no trade” but the far from negligible level of exchange in hunter-gatherer societies. What Buiter might have said had he not himself wasted so much time with macroeconomics textbooks is this: There are transactions costs. These limit the trades it makes sense to make. But a vastly greater number of trades can be made (and vastly greater gains from exchange realized) when transactions costs — such as the costs of enforcing complex contracts — fall. The complex order of spatially and temporally extended impersonal exchange is the exception, not the rule. And that’s why almost all of humanity has been poor for almost forever.

But the main idea here is right, and it’s good to see a central banker grasp it: economics that leaves out transactions costs simply assumes what humanity has only rarely managed to approximate. Modern economies are weird, pulsing, unsteady achievements of ongoing cultural evolution. Economies certainly aren’t machines governed by physics-like regularities. Nor is “an economy” the creature of specious nationalist bookkeeping studied in textbooks. There are lots of things we need to grasp if we are to “get somewhere this time.”

What Policy Can Do for Growth and What Politics Won't

Posted on by

Yglesias’ valiant attempt to show how Obama’s big schemes are all connected by the thread of economic growth works mainly as an illuminating exercise in free association. The thread that in fact holds them together is that there are major constituencies within the Democratic Party that want them. Most of the time, that’s how politics works and Matt often displays a fine appreciation of that fact when it comes to Republican policy initiatives. Anyway, I’d like to comment on this bit of Matt’s post:

[P]erhaps the most important things policy can do to impact the capacity for sustainable growth—i.e., growth that’s not based on asset price bubbles—is to increase the availability of high-quality human capital and the availability and quality of public sector physical capital. Which is to say education and infrastructure.

I agree that human capital and physical infrastructure are crucial to growth. I’m even happy to agree that government investment in education has more than paid for itself over the years in added growth. But I also think the evidence points to the idea that returns to public investment in the status quo system of education have diminished to basically nothing. No Democrat is going to do anything to run afoul of their party’s most powerful client in order to promote the deep structural changes needed in primary education to actually improve the quantity and quality of American human capital. So instead we get free money for college, which is Obama’s way of saying “thank you” to the loyal, powerful bloc of Democrats who make their living pouring valuable human capital into nineteen-year-olds by making them pretend to have read Plato and Beloved. 

As for energy infrastructure, we really could use a “smart grid” that allowed for real-time pricing of energy based on demand. (See Lynne Kiesling on the “transactive” potential of the smart grid.) Markets are known to be the best mechanism available for efficiently allocating resources, and putting in place an infrastructure for pricing energy would be good for growth and the environment. Just before the bit quoted above, Matt allows that:

There are a lot of factors behind growth including, of course, old fashioned human ingenuity at coming up with new products to offer and new ways to offer old products.

But Matt evidently thinks policy can’t do much about this. One thing policy can do is to make markets possible, so that there are rewards to ingenuity. That can mean making an illegal market legal, or making a legal market worth investing in by lowering the burden of regulation. Another thing it can do is to restructure intellectual property law to encourage rather than discourage invention. Another thing it can do is not crowd out private investment in innovation, which is the opposite of what Obama plans to do in education, energy, and health care. When I talked to Nobel Prize-winner Edmund Phelps, an expert in failed European attempts to spur growth by subsidizing technological advance and no right-winger, he seemed pretty worried that a lot of new infrastructure spending (much of which will be flat-out unecessary and unproductive) and targeted government spending on “green” technology would in fact adversely affect incentives to innovate. I don’t think he’s wrong to be worried. Matt thinks entrepreneurship is an empty business buzzword, but it is in fact the foundation of economic growth. 

I will rejoice the day either Republicans or Democrats find that their interests align with the general good and plump for a serious set of pro-growth initiatives. Until then, I’ll expect the usual constituency service.

Interconnected Crises? Independently Urgent Emergencies? Whatever It Takes!

Posted on by

David Brooks says Obama is trying to do too much at once. (I agree.) Matt Yglesias says, no, because all these “crises” are interconnected, you see. Ezra Klein chimes in:

I’d make the argument on grounds of simple urgency: If a patient has cancer and heart disease, her doctor doesn’t have the luxury of treating only one or the other. 

The “stricken with multiple potentially fatal diseases” metaphor has the virtue of not turning on Matt’s weak case for the specific interconnections that would make Obama’s gallimaufry of Democratic desirables seem like some kind of coherent, farseeing package. Back in our salad days, the likes of Matt and Ezra mocked this very metaphor when it was rolled out to compare the immense fiscal imbalance of Social Security to the even immenser imbalance of Medicare because Social Security was just fine, and so didn’t even count as a scratch. Of course, now we have imminently terminal cancer and heart disease and rickets and gout and apparently also Alzheimers.

The Crisis of Conservative Incoherence

Posted on by

Reflecting on Limbaugh’s CPAC bloviations, IOZ offers this treat:

Conservatives are for opportunity, but not equality of outcomes, but we are born equal, but we succeed or fail on our own merits, but conservatives will try to stop you from failing, but if you do, that’s too bad, and we need everyone to succeed as an individual for the country to succeed, except for those who don’t, because it’s their fault, and the fault of the war on poverty, or . . . some such. The Donk is deluded by the allure of technocracy, by the notion of scientific government; the Gopster is a set of cultural phobias, affected regular-guy affinities, and catch phrases. It’s probably appropriate that they draw their inspiration and spokespeople from the ever-more-irrelevant and anachronistic medium of radio.

The Donk complains that the Republicans are crass obstructionists. Would that it were true. The contemporary GOP wears the guise of obstructionism but lacks the wherewithal to oppose effectively. Superjesus Black Reagan rules the airwaves, and the supposed opposition is sequestered away in a chintzy hotel ballroom listening to C-list newsmedia celebrities extemporize around the posthumous legacy of Romulus and Remus Ronald Reagan. If there is anything we need right now, it’s a cranky minority party that reacts with zealous incredulity at the vast outpouring of expenditure and views with innate suspicion the claims of managerial liberalism. Instead we get awkward governors mumbling anathemas at the US Geologic Survey and talk-radio hosts giving recursive stemwinders to the choir. The Donk spent eight years under George Bush getting along by going along, but as polite acquiescence seems to have been bred out of the rightward faction of national politics, they’ll endeavor to continue the trend by creating the most thunderously loud irrelevance the world has ever known.

Perfect.

Also, I believe IOZ deserves a prize for “Superjesus Black Reagan.” Could Mencken have done better?

The Permanent State vs. Democratic Government

Posted on by

This WSJ piece nicely illustrates the difference between the permanent apparatus of the state and the impermanent apparatus of elected government. It also illustrates nicely the problem of legitimacy in the context of a large state. The legitimacy of government coercion and redistribution, according to most contemporary liberal theorists, flows from decisions having passed through fair democratic procedures. But much de facto government comes from the unelected state, even under normal conditions. 

Much of the planning required to give out the funds is being done by career bureaucrats, because top political appointees at many agencies have yet to be nominated, much less confirmed.

At the Interior Department, an eight-person task force is mostly made up of career employees who have been named acting bureau chiefs.

Longtime employees also have been running the show at the Commerce Department, which remains without a secretary after the Obama administration’s first two candidates dropped out, and the third, former Washington Gov. Gary Locke, awaits confirmation. It took a week for the agency to provide any information about its stimulus plans. The agency has almost $8 billion to give out, including $3.9 billion for broadband grants.

All the so-called liberal democracies have a permanent civil service or bureacracy. I don’t see how they could function without them. But I also don’t understand how this fits into contemporary liberal accounts of the democratic legitimacy. Is this a problem?

[Note: Just in case... let me say that is a post about political theory, not anything about the Obama government in particular.]

Shrum's Dream of Obama

Posted on by

Bob Shrum’s newThe Week column nicely portrays how a Democratic stategist would like Obama’s budget to be seen: a Rooseveltian, Reaganesque revolution in American politics that would establishes state control over the energy economy and politically irreversible new entitlements under the guise of “rights”:

Obama’s new America will be very American, a reach for enduring values of equality, opportunity and economic justice. But it will also be very different.

[...]

The big change, however, is that America will not only move from laggard to leader on climate change, Obama is proposing to leave behind the entrenched carbon-based economy and rely on American ingenuity—yes, Newt, financed by your disdained public sector—to create a cleaner, more self-sufficient economy and the “green” jobs of the 21st Century.

[...]

The 60 votes in the Senate will be found—or gotten around. And after 60 years of struggle, health care will finally be a right, not a privilege in America.

[...]

The Pell Grant program, which offers scholarships to poor and middle class students, will no longer be an annual appropriation, subject to cuts; it will be an entitlement on the order of Social Security, with more than $5000 a year guaranteed to every eligible student. In all but name, this establishes a right to higher education.

So, to summarize, the pillars of the Obama revolution are: government control of the (green!) economy, socialized health care, and checks for young voters.

Check Out the Graphs on Andrew Gelman

Posted on by

Or, I should say, the graphs on “Income, Religion, and Voting” Andrew Gelman posted on 538.com. I like this one:

 

No matter how churchy, really poor people strongly favor Democrats. No matter how rich, people who don’t go to church VERY strongly favor Democrats. Generally, the higher the income, the more church attendance matters to votes, which as Andrew points out suggests that people care more about “social issues” the richer they get. But the relevant “social issues” is very different for religious and non-religious people.  But what’s going on toward the top of the income scale? At all levels of church attendance, having more money increases the chances of a Republican vote until you hit a relatively high level of income — looks like something near the border of the upper-middle and lower-upper class — at which point additional income starts to make a Republican vote a bit less likely. This is true even for very frequent chruch attenders. Superrich very-frequent churchgoers are evidently pretty damn Republican, but less so than almost-rich very-frequent churchgoers, and that’s interesting. 

What do you suppose explains that?

The Lump of Liberalism Fallacy

Posted on by

That’s what I’m going to call the error I sense lurking beneath a lot of resistance to moderate libertarianism. The fallacy is based on an implicit denial of the fluidity of ideology and political identity. The bounds of “right” and “left” have shifted immensely over the past two generations. Yet political conversation at any time tends to proceed as if the ideological inclinations and cultural assumptions of the “left” and “right” are natural, essential, and fixed. So, just to pick an example out of the air, the argument that the considerable intellectual, cultural, and psychological overlap between moderate classical liberals and market-friendly modern liberals ought to be given more coherence as a political philosophy and political identity is invariably met with the claim that this is compltely pointless because these groups have traditionally been part of different partisan coalitions, and these coalitions are essentially this or that way. So in order to make something liberaltarianism a going concern, you’ve basically got to find enough libertarians and natural Democrats both willing to sell out everything they believe in and good luck with that. It’s basically the same reasoning that says it is impossible to introduce to market a successful new brand of cereal because all the preexisting cereals brands already have 100 percent of the market share. But there’s something pretty obviously wrong with that way of thinking. I’m a big fan of Kashi U. 

Meanwhile, see Matt Welch’s puzzling piece on “The Liberaltarian Jackelope.” Matt’s argument seems to be that he’s totally a liberaltarian, that it once looked as though some Western Democrats might make some electoral headway by taking on a bit more libertarian flavor, and this excited him. But it turned out that Democrats aren’t even interested in following the Republicans in using fake libertarian rhetoric for political gain. So liberaltarianism is doomed.

The Obama Budget

Posted on by

Clive Crook’s gloss is right-on:

Take this budget at face value, and when Mr Obama talks about “a new era of responsibility” he does not mean: “We are all in this together.” He means: “The rich are responsible for this mess and it is payback time.” Leftist Democrats are thrilled, and rightly so. The budget has three themes: healthcare reform, public investment and unflinching redistribution. This is indeed a new social contract: we get, they pay. 

This is, in fact, one of the reasons I am increasingly optimistic about liberaltarianism. I predict Obama’s unabashed embrace of throwback, dirigiste, soak-the-rich “liberalism” will not prove popular with generally pro-market, well-to-do voters who crossed over for the first time to pull the lever for a Democratic president. Yet the not-very-religious remain repelled by social conservatism all the same. As I’ve said, it doesn’t matter to me whether the Republicans become more liberal on “values” issues or whether Democrats adopt more sensibly market-oriented social and economic policy. Either way, by signaling the desire of contemporary Democrats to move even further left than is feasible in the U.S., Obama draws attention to the unoccupied space in American politics.

Let's Not Follow the Japanese Example, Okay?

Posted on by

Masaru Tamamoto’s NYT op-ed is brutal:

There can be no justification for all those mostly unused airports. Or for roads that lead nowhere. Or for the finance minister who appeared to be drunk at the Group of 7 meeting this month in Rome. Our problem is so deep that it sometimes seems that no political party can tame the bureaucracy and put in place a coherent national agenda.

But what most people don’t recognize is that our crisis is not political, but psychological. After our aggression — and subsequent defeat — in World War II, safety and predictability became society’s goals. Bureaucrats rose to control the details of everyday life. We became a nation with lifetime employment, a corporate system based on stable cross-holdings of shares, and a large middle-class population in which people are equal and alike.

Conservative pundits here like to speak of this equality and sameness as being cornerstones of “Japanese” tradition. Nonsense. Throughout much of its history, Japan has had social stratification and great inequality of wealth and privilege. The “egalitarian” Japan was a creature of the 1970s, with its progressive taxation, redistribution of wealth, subsidies and the dampening of competition through regulation. This all seemed to work just fine until our asset-price bubble popped in the 1990s. Today, the hemmed-in Japanese seem satisfied with the knowledge that everyone around them is equally unhappy.

[...]

Japan desperately needs change, and this will require risk. Risk-taking is not common among the bureaucratically controlled. You won’t find many signs on Japanese beaches saying, “Swim at your own risk. No lifeguard on duty.” If that sign were to appear, many Japanese would likely ask the authorities to tell them if it is safe to swim. This same risk aversion translates into protectionism and insularity.

My greatest worry is that as we have become wealthier, we have also become more risk-averse, and that, basically, the U.S. will end up like this.