I don’t wish to respond point-by-point to some of the writings in the blogosphere, but given the above, Ryan Avent also is not looking deeply enough. Both he and Brad Plumer did not see that the posts in question clearly distinguished between spending cuts and “austerity” (Brad did issue what is arguably a correction.) I admire both bloggers and read them regularly, but these two posts both fail; here are some comments from Veronique. I would say there is a dominant narrative, repeated many times in not always precise language, which people find it very hard to think outside of.
Most of the time “austerity” is a misleading word and more precise concepts — readily intelligible I might add — are available. There really are some times when we should relabel austerity as “mostly tax increases,” but many people are reluctant to do so.
Austerity Facts?
Russ Roberts wants the facts:
Which nations in Europe have slashed government spending? I suppose “slash” is an ambiguous term but when you write that the experiment has been tried, don’t you have to show that spending has at least been cut or reduced, right? Maybe some European states have slashed the growth rate in government spending? Is that what he means? If so, shouldn’t different words be used? And either way, should there be some facts on this “experiment.” The word implies something scientific. But it all appears to be going on in the mind of the writer rather than in the real world
I’d like some facts. I have seen many articles on austerity. I can’t remember seeing any that suggest that government spending in any European country has actually fallen. Yes, there is talk of spending cuts or cuts in growth rates. But I’d like to see the data that shows the cuts have actually been implemented.
Me too. Where should I look?
Music to My Ears
Roman Frydman and Michael Goldberg at the FT’s Economist’s Forum:
Behavioural economists have uncovered much evidence that market participants do not act like conventional economists would predict “rational individuals” to act. But, instead of jettisoning the bogus standard of rationality underlying those predictions, behavioral economists have clung to it. They interpret their empirical findings to mean that many market participants are irrational, prone to emotion, or ignore economic fundamentals for other reasons. Once these individuals dominate the “rational” participants, they push asset prices away from their “true” fundamental values.
I’ve been harping on this error for years, but it has seemed to me that economists generally don’t grok what the error is. It’s good to see economists who get it.
New at Cato Unbound: Scott Sumner on the Monetary Flubs that Caused the Crash
This month’s edition of Cato Unbound on “The Monetary Lessons of the Not-So-Great Depression” kicks off with a probing, provocative essay by headliner Scott Sumner, “The Real Problem Was Nominal.” He says things like this:
We cannot hope to understand what happened late last year without first recognizing that the proximate cause of the crash was not a financial crisis, but rather a steep decline in nominal spending. Like any other fall in aggregate demand, this represented a failure of monetary policy. Severe demand-side recessions are almost never the result of special interest politics — the losses are too great and too widespread — but instead represent an intellectual failure by well-meaning public servants and the academic economists who advise them.
And this:
The real problem was not a “real” problem at all. It was a nominal problem, and the severe intensification of the debt crisis was a symptom of an ordinary Humean nominal shock. Furthermore, monetary policy was not “easy” but rather was highly contractionary in the only sense that matters, that is, relative to the stance expected to hit the Fed’s implicit nominal targets.
On deck we’ve got James Hamilton, George Selgin, and Jeff Hummel.
Causes of the Crisis
Critical Review has started a new blog “Causes of the Crisis” featuring contributors to the journal’s stellar issue on the topic. The papers in CRs special issue add up to the best and most comprehensive autopsy of the financial collapse available anywhere. The blog looks terrific too. Some excerpts…
Using models within economics or within any other social science, is especially treacherous. That’s because social science involves a higher degree of complexity than the natural sciences. The reason why social science is so complex is that the basic unit in social science, which economists call agents, are strategic, whereas the basic unit of the natural sciences are not. Economics can be thought of the physics with strategic atoms, who keep trying to foil any efforts to understand them and bring them under control. Strategic agents complicate modeling enormously; they make it impossible to have a perfect model since they increase the number of calculations one would have to make in order to solve the model beyond the calculations the fastest computer one can hypothesize could process in a finite amount of time.
[…]
This recognition that the economy is complex is not a new discovery. Earlier economists, such as John Stuart Mill, recognized the economy’s complexity and were very modest in their claims about the usefulness of their models. They carefully presented their models as aids to a broader informed common sense. They built this modesty into their policy advice and told policy makers that the most we can expect from models is half-truths. To make sure that they did not claim too much for their scientific models, they divided the field of economics into two branches—one a scientific branch, which worked on formal models, and the other political economy, which was the branch of economics that addressed policy. Political economy was seen as an art which did not have the backing of science, but instead relied on the insights from models developed in the scientific branch supplemented by educated common sense to guide policy prescriptions.
In the early 1900s that two-part division broke down, and economists became a bit less modest in their claims for models, and more aggressive in their application of models directly to policy questions. The two branches were merged, and the result was a tragedy for both the science of economics and for the applied policy branch of economics.
Hayek made a similar charge [to Krugman’s in his long NYT piece] in his Nobel Lecture of December 11, 1974, The Pretence of Knowledge:
… the economists are at this moment called upon to say how to extricate the free world from the serious threat of accelerating inflation which, it must be admitted, has been brought about by policies which the majority of economists recommended and even urged governments to pursue. We have indeed at the moment little cause for pride: as a profession we have made a mess of things.
Although Hayek saw the problem as stemming from an inappropriate “scientistic” attitude, he explicitly wanted “…to avoid giving the impression that I generally reject the mathematical method in economics.” Rather, his main message was that
If man is not to do more harm than good in his efforts to improve the social order, he will have to learn that in this, as in all other fields where essential complexity of an organized kind prevails, he cannot acquire the full knowledge which would make mastery of the events possible…The recognition of the insuperable limits to his knowledge ought indeed to teach the student of society a lesson of humility which should guard him against becoming an accomplice in men’s fatal striving to control society – a striving which makes him not only a tyrant over his fellows, but which may well make him the destroyer of a civilization which no brain has designed but which has grown from the free efforts of millions of individuals.
Economic scientists have precious little understanding of this rule governed complex order, and how to keep it on its demonstrated long term path of growth and human betterment without suffering too irreparably from the kind of unpredictable reverses that we are now mired in. Less pretence and a commitment to learn from the new data being generated as I write, will be both humbling and informative, after the inevitable human political impulse to blame one’s long standing political adversaries has run its course.
I look forward to posts from the other contributors.
Flaws and Frictions
I was pretty impressed with much of Krugman’s NYT Magazine magnum opus. Macro is a mess. Now, this isn’t what Krugman was saying, but I think his account of the disagreements on fundamental questions exposes macro as a proto-science at best.
Economics, as a field, got in trouble because economists were seduced by the vision of a perfect, frictionless market system. If the profession is to redeem itself, it will have to reconcile itself to a less alluring vision — that of a market economy that has many virtues but that is also shot through with flaws and frictions. The good news is that we don’t have to start from scratch. Even during the heyday of perfect-market economics, there was a lot of work done on the ways in which the real economy deviated from the theoretical ideal. What’s probably going to happen now — in fact, it’s already happening — is that flaws-and-frictions economics will move from the periphery of economic analysis to its center.
There’s already a fairly well developed example of the kind of economics I have in mind: the school of thought known as behavioral finance.
One might have thought Krugman was going to do something like acknowledge the immensely important point, associated with economists such as Ronald Coase and Douglass North, that market institutions in which “frictions” or transactions costs are relatively low are the exception rather than the rule. Markets are not only not frictionless, frictions generally keep markets from getting off the ground at all. When frictions are managed sufficiently to get markets up and going, that’s because they are embodied in a complexly interlocking set of institutions and organizations which make this possible. A scientific economics might seek to explain how it is that embodied markets achieve otherwise impossible feats of social coordination.
The “flaw” part of “flaws and frictions” is a little loaded. It’s an annoying habit of economists to hold on to homo economicus as a standard for rationality even after they have conceded that homo economicus is a more or less useless over-idealization. That we don’t live up the standard of more or less useless over-idealizations obviously does not imply that we are somehow defective. Be that as it may, one might have thought the recognition that a useless over-idealization of rationality does not apply to us might lead one toward a more sophisticated idea of the way minds and markets work together. There are, for example, the profound Hayekian points that individuals are computationally bounded, that expertise is local, that markets enable coordination by conveying otherwise inaccessible information, that epistemic and practical norms are both cause and effect of institutional structure, etc. Maybe we could look at experimental work, such as Vernon Smith’s, that explores how real people operate in different kinds of market structures.
It’s not like Hayek, Coase, North, and Smith don’t have Nobel prizes! But Krugman ignores the best of existing “flaws and frictions” economics and jumps straight to “behavioral finance,” which I’m fairly sure is the same old shit Krugman is complaining about — elegant models of counterfactual worlds — with ad hoc emendations to improve fit with the history the actual world.
Krugman should go further, but he won’t. He should say that beginning without “flaws and frictions” — assuming at the start unbounded perfectly rational agents and zero transactions costs — has all the virtues of theft over honest labor. An economics based on those assumption is ipso facto unscientific. The same goes for ad hoc variations on these assumptions. What sciences do is explain. (Sorry Milton.) And scientific explanation is largely a matter of detailing the causal mechanisms underpinning observed regularities.
“Freshwater” economics is not a science. It is a sometimes illuminating exercise in modeling counterfactual worlds. Insofar as “saltwater” economics recognizes that the need for a better account of human psychology and transactions costs in embodied institutions, it is better. But, so far, it isn’t. So far, “behavioral” macro is mere aspiration. It’s not something anyone is actually doing in a systematic way.
Maybe the most important conclusion I drew from Krugman’s piece is the politics of the freshwater/saltwater divide is complete nonsense. To seriously acknowledge “flaws and frictions” is to acknowledge that some institutions create friction while others reduce it; that some institutions enhance the salience of certain “flaws” while others work around them; etc. Having recently read a bunch of “Keynes was right” pieces, it seems pretty clear that lots of left-leaning economists are mistaking flawlessness and frictionlessness as necessary premises in the argument for limited government intervention in market institutions. But the upshot of flaws and frictions could very well be that we shouldn’t expect very much from government intervention. It seems pretty clear to me that Keynes’ characterization of the role of not-exactly-rational “animal spirits” in recessions is a very small part of an adequate general account of the way the quirks of human psychology tend to scale up to the macro level. The inference from flaws and frictions to Keynesian technocracy tends to be embarrassingly hasty.
The fact is, macro isn’t close to resembling a real science. (“The economy,” nationalistically construed, isn’t even close to resembling a subject of scientific investigation!) But we can’t count on elite economists to admit it, since their claim to authority on matters of public policy stands or falls with their claim to scientific expertise.
The Trouble with Public Choice: Too Generous to Politicians
Matt Yglesias recently admitted in a blog post to increasing bafflement about “the high degree cynicism and immorality displayed in big-time politics.” Today Matt says some libertarians “responded to that post by deciding they should be condescending and give me a little less in Public Choice Economics 101. That, however, misunderstands what I’m trying to say about the subject.” Which is what?
The formal model of the self-interested legislator is very easy to understand. What I’m saying is hard to understand is the actual psychology of this kind of behavior. I think I now have a much better grasp than I once did of what’s going on inside the heads of people who have ideological beliefs I disagree with. But I find it very difficult to extend my powers of moral imagination to the kind of people who hold high political office in the United States.
I’m with Matt. I too find it hard to get inside the heads of politicians, and I don’t find rational choice assumptions very illuminating in this regard. By insisting that politicians are motivated by considerations no different than businessmen or anybody else, public choice economists have helped slay the pernicious myth that politicians are generally warmly other-regarding public servants. But the economist’s assumption of motivational uniformity fails to capture that politicians do in fact seem to be really odd people who don’t seem to be primarily motivated by the same considerations that motivate most of us most of the time. The incentives of the political process create a kind of filter that selects for individuals extraordinarily fixated on power and status and extraordinarily motivated to keep it. If this is right (anyone know of personality studies of politicans?), then the problem with standard public choice is that it gives too much credit to politicians by assuming they’re like everyone else and therefore it fails to capture just how exceptionally prone politicians are to narcissism, motivated cognition, self-deception, and brazen lying.
I find I almost always side with those defending empirically-informed motivational realism against a priorist rational choice/public choice types. (The dispute here between classic public choicers Mike Munger and Anthony de Jasay against empirically-informed political philosopher Jerry Gaus is illustrative. Jerry’s right, I think.) So I agree with Matt that politicians are probably odd, and in a bad way. But then I wonder what Matt takes the general lesson of that to be. Maybe if I thought about it longer, I could imagine a story in which this doesn’t tend to imply skepticism about the efficiency and justice of a system in which politicians are given a great deal of discretion to shape individual and public life, but I can’t think of one right now. So I’m curious what Matt takes to be the broader implications of the idea that “we’re fated to be ruled by the sort of people who are really desperate to cling to power.”
You Got Morals in My Economics!
Economics, qua social science, is not a normative field. But much of the drive to understand how social interaction works is to give advice about policy. However, giving advice implies a standard for determining what counts as good advice, some kind of value theory. This is inconvenient for economists, who want badly to make policy recommendations, but who tend not to be very sophisticated moral philosophers (though there are some notable exceptions). Bryan Caplan tries to find a way around the inconvenience:
In many cases, there is no need to state your moral premise, because (economics + almost any moral premise) will do.
Suppose legalizing the market in human organs would make sick people healthy and poor people rich. What moral premise would imply “don’t legalize”? Sheer malevolence? Blind adoration of the status quo? While these are coherent moral premises, they’re so rare that the cost of addressing them is a waste of time.
It seems that Bryan thinks most opposition to markets in organs is a function of either ignorance of the likely consequences or perverse and exotic moral premises. This makes me wonder if he has ever debated this issue with anyone? Lots of people understand the economics well enough but continue to believe that markets in organs ought to be illegal. Here’s rough sketch of the standard argument.
Human beings have a certain dignity that is central to the value of human life. That dignity ought to be respected, preserved, and protected. Allowing the sale of human body parts diminishes the dignity of those involved in the transaction and erodes respect for the dignity of human beings generally. Therefore, markets in body parts ought to be legally prohibited.
Is this a good argument? No. I think it’s lousy argument, even in its most sophisticated form. But the idea that the value and conditions of human dignity imply that some things shouldn’t be bought and sold is not at all rare. Indeed, I think this is likely the dominant moral stance of most people in most places at most times in human history. If one grants the benefits of legalizing markets in organs, which I certainly do, then addressing this argument is not only not a waste of time, but is of fundamental importance in removing one of the main barriers to great improvements in human health and well-being.
Which is just to say, no, you can’t get around defending your moral premises by claiming that once the facts are established, all moral premises worth taking seriously point in the same direction. It’s just not true that there are “many cases” in which all paths converge like this. And when there is such a case, the convergence is often counterintuitive, and thus needs to be demonstrated, not just asserted. Policy analysis is at least as much applied moral philosophy as applied economics. Without some normative standard, economics has no application at all. Moreover, public deliberation about policy requires taking other people’s moral beliefs seriously and you can’t do that by ignoring them.
Gregory Clark Uses Computer over Phone, Predicts "Economic Redundancy" of Working Class
Gregory Clark’s basic assumption would seem to be that some people are born idiots. His argument in this Washington Post op-ed goes something like this: real wages of idiots have not increased because the demand for idiot labor has fallen due to the rise of the machines. Soon, the machines will be able to do anything an idiot can do for less than it costs to pay idiot subsistence wages. So idiots will be left “socially needy but economically redundant.” What will we do?! “There is only one answer,” Clark says. “You tax the winners — those with the still uniquely human skills, and those owning the capital and land — to provide for the losers.”
What to say? Tim Worstall says a good deal of it. This diagnosis by Bruce Wilder in Mark Thoma’s discussion thread seems to me in about the right neighborhood:
[In his book Farewll to Alms] Clark could find few institutional differences between 12th century England and 20th century Britain. In his mind, Henry II laid down the law of equity securing property rights, and nothing else much mattered. If anything, he regards the 12th century, with its low tax rates, as much more amenable to economic growth and innovation than the burdensome 20th century welfare state. So, I’m not surprised that he doesn’t credit institutional changes for changes in income distribution over the last three decades.
So, the shape of his fears that machines will soon displace the near-cretins serving him hamburgers at McDonald’s form a unitary theme. He sees his class burdened by taxes to support the no-account lower classes, who are even more useless now than in centuries past, but, perhaps, can reconcile himself to it as his paternalistic obligation.
Here is what I said some time ago at Free Exchange about Clark’s baseless truculence toward institutional explanations in economics.
Here’s what I think about Clark’s op-ed.
First, technological innovation over the past two centuries has been incredibly rapid, and workers have been repeatedly displaced by technology only to move on to different kinds of jobs. Why hasn’t technological change so far created much higher rates of unemployment? Does Clark think this is a historical fluke? Why does he think this pattern is about to be broken? Why does he think technological change is finally reaching a tipping point? His failure to address this obvious point at all is glaring. Is this whole conjecture really built on his experience with an automated phone call to United Airlines?
Second, I think that Clark wrongly accepts that real wages toward the bottom of the distribution have not risen. This is, to my opinion, an artifact of mistaken measurement techniques. See Broda and Weinstein. There is no reason to believe that the market forces which have improved standards of living for the poor will not continue to do so. Indeed, Clark’s assumptions about the efficiency gains from future technology provide us reason to think the real prices of many goods will continue to decline.
Third, insofar as wages have stagnated toward the bottom, a decline in hours worked for low-skilled workers explains a good deal of it. Doesn’t this show Clark is right?! No. It shows that badly structured welfare policy has provided an incentive for many low-skilled workers to work fewer hours in order to qualify for transfer payments. Because experience (hours worked at a task) is a main determinant of skill level, and skill level is a main determinant of wage levels, an incentive to reduce hours worked is an incentive to remain at a lower level of skill and thus wages. See Deere and Welch ($$$).
Fourth, Clark’s theory of blood-born idiocy leads him to conclude that there are little or no gains to be had from improvements in education. Here’s what he says:
Others see education as a way out of this dystopia. The root problem is, after all, the widening of the income gap between the skilled and the unskilled. Can expanded education give the poorest the tools to resist the march of the machines? I’m skeptical. Already, much of the supposed improvement in high school and college graduation rates has come by asking less of graduates. We can certainly arrange to have everyone “graduate” from high school, but whether they will have the skills needed to make it is doubtful.
This is maddeningly dense. Clark apparently believes the only way to make graduation rates go up is to devalue diplomas by giving them to irremediable idiots. That is to say, idiots are idiots and education can’t do anything about that. A more plausible view is that so many young people graduate high school (or don’t) with such poor abilities because the American public education system has failed disastrously to provide a minimally acceptable level of training to children who grow up in poor, predominately minority neighborhoods. The best explanation for this failure is an institutional explanation. The political forces in control of public schools in low-income neighborhoods have strong incentives to resist almost every potentially effective reform. There are no competitive markets in educational services for low-income families because such markets are, in effect, against the law. Were low-income families to have access to a competitive market in educational services, there is every reason to believe the quality of training would rise, the real level of ability of high-school graduates would rise, and the portion of high-school graduates prepared to benefit from higher education would rise.
The fundamental bone of contention here is over the fixity or flexibility of the human capacity to gain and improve economically relevant skills. Here is Cato Unbound’s issue on IQ.
Fifth, the piece is short-sighted. If robots can crowd out all low-skilled workers, there is no reason they cannot also crowd out all high-skilled workers. See Hanson. Would this be bad? Growth would proceed so rapidly that the returns to even small amounts of capital should be outrageously high. The gap will be between those with income from capital gains and those with none. To prevent this, some version of Clark’s recommendation might be desirable. I’d recommend Charles Murray’s scheme for replacing the United States’ social insurance apparatus with basic income grants and mandatory retirement and medical savings accounts. In a world of doubling-every-fifteen-minutes Hansonian robot growth, the portion of GDP necessary to fund universal grants sufficient to ensure a modestly lavish level of consumption would be so trifling that no one would even notice. For now, we should try to hasten the arrival of this post-human economy, in which case we should try to optimize incentives to innovation and growth. Higher taxes and higher levels of welfare spending is about the opposite of that.
The Value of Savings
Riffing off my response to Chait, Free Exchange’s Washington-based blogger writes:
Suppose you made a million dollars and you put all but $50,000 of it in a shoebox. Now suppose that you never lose the box, never spend it, and leave it all to the dog when you die. What good did the $950,000 do you? If one derives pleasure from imagining consumption possibilities but never actually consumes anything, does that count as value derived from consumption? What if the wealth is public knowledge, and it generates an attitude of deference among those who respect the wealthy or hope to profit from association with them? What about the value of security? Does the presence of a large, cash barrier between you and financial disaster count as a gain derived from consumption (given that the barrier represents the ability to consume post-disaster)?
I don’t mean this as any kind of criticism of Mr Wilkinson, I’m just wondering to what extent it is true. How much do people enjoy having money just because they enjoy having money?
I’ve been thinking about this a good deal. One way to look at savings, as Free Exchange suggests, is to see it as just another kind of consumption. This would help make sense of misers who compulsively hoard. When you get a dollar, you can exchange it for something else to consume or keep it and consume the utility of having a dollar over and over and over. I suppose one might say that differences in savings at the same level of income reveals a difference in time preference or risk aversion or estimates of lifetime income or money fetishism or a mix of these. (How hard is it to tell which it is?)
I think all this makes sense, but it’s not very helpful. You can’t eat dollars, live in them, get an education or much entertainment from them, etc. I think the insurance value of savings is really significant. How do we estimate it? Measure the difference in concentration of stress hormones at different savings levels? I also thing that the status value of savings can be significant, too. But this seems likely to be lower than the status value of effectively signaling wealth, which is just as likely to correspond to huge debt.
I’d guess there’s a great deal of variety in peoples’ attitudes toward savings and debt. Both sides of the ledger are morally valenced for many people. I’m a weirdo who reads too much economics, so I see my accumulated human capital as serving much of the insurance function of money savings. So, despite the fact that I remain a net debtor in money terms (student loans!), I feel well in the black. Some people are ashamed of debt, because it’s debt, and hasten to wipe it out. Others act like credit is free money and run up debt until it explodes in their face. Then they go bankrupt. And then, later, they do it again. Some Spockish types will make minimum payments on debt indefinitely, as long as the interest rate on the debt is lower than the interest rate on investment or the value of present consumption. Some people require a cushion of savings for minimal peace of mind. Others are happy as long as their checking account doesn’t dip below zero before the next paycheck. Etc. So I think it’s probably hard to draw a really useful generalization about the intrinsic utility and disutility of savings and debt.
Since it remains that most savings is intended to finance future consumption (my account with the largest positive balance is a 401K retirement savings account, and I’d bet that’s pretty typical), it seems best to keep the concepts of savings and consumption separate for analytical purposes — even if some of the value flows of savings seems a bit like the value of consumption; even if some forms of consumption have, in addition to the direct value of consumption to the consumer, savings-like value. Here I’m thinking of money spent improving a skill that is fun but pays, or money spent on capital goods that are also a source of enjoyment, like my computer here, or money spent on assembling a meaningful collection that appreciates in real market value. It’s complicated! I think it’s enough to say that the value of consumption isn’t the only source of value in life, and that the value of consumption isn’t even the only source of economic value in life. Nevertheless, real lifetime consumption remains far and away the best proxy for lifetime economic welfare.