The fundamental question for whether the market can fix itself: "can it be arbitraged?"

Nick Rowe responds in the comment section of this post:

"Daniel: There is no "money market". When people talk about the "money market" they really mean the market in loans. Which is the bond market.

There is a market in which bonds are traded for money. That's the "bond market". The demand for bonds depends (inter alia) on the rate of interest.

There is a market in which goods are traded for money. That's the "goods market". The demand for goods depends (inter alia) on the rate of interest.

Liquidity preference theory says the rate of interest adjusts to clear the bond market.

Loanable funds theory says the rate of interest adjusts to clear the goods market.

Clearly it can't do both at once (except by fluke). Or rather, the only way it can do both at once is if some of those other things in the "inter alia" adjust too. And that would include the stock of money and the price of goods."

I think I may be closer to Nick than I had originally thought. To start with, though, I am somewhat confused about why he says that hte loanable funds theory says interest rates clear the goods market and liquidity preference theory says they clear the loanable funds market. I would have thought loanable funds theory says the interest rate clears the loanable funds market and liquidity preference says it clears the demand for and supply of liquidity - the decision whether to hold cash or not. I'm not sure what the goods market has to do with it (is this an intertemporal goods market point?), but I'm not sure that matters all that much.

The point is, there's no reason to think the interest rate satisfies both conditions simultaneously - and that is something I've always maintained. But other things like the stock of money, prices, and output can adjust so that it does satisfy both simultaneously (Hicks essentially forces this outcome - he doesn't allow any non-clearance in the loanable funds market or in the supply and demand for money). The point is, what is the nature of these "other adjustments"?

Nick makes the fair point on his blog that prices are probably rigid. We usually assume that the money supply is exogenously determined, so that leaves us with output. So let's say output takes the brunt of the adjustment and now the conditions of the loanable fund theory and the liquidity preference theory are satisfied. Fine. Now what about the depression in output?

This is where the contrast with the Walrasian system is important. In a Walrasian system excess supply of output in one corner of the system is offset by excess demand in some other part of the system (Brad DeLong would say excess demand for bonds, secure assets, etc.). That's the whack-a-mole world I was talking about earlier. Unless there are institutional frictions (zero lower bound, disrupted credit channels) that situation actually isn't all that worrisome. Why? Because we think market actors are good at arbitrage. Excess supply in one corner and excess demand in another corner is an opportunity for arbitrage.

But is that the case in this system that Nick and I have been describing? No, it's not. Before the dual constraints of the loanable funds theory and the liquidity preference theory weren't both satisfied. Taking after Keynes, let's say the supply and demand for cash/liquidity cleared but there was excess supply in the market for loanable funds. Income is then reduced to satisfy the loanable funds theory (so that both the loanable funds and liquidity preference theory are now satisfied). So now we have reduced income (deficient demand/excess supply in the goods market) but the loanable funds market is now cleared by the interest rate, as is supply and demand for cash. Unlike in the Walrasian system, we now have excess supply (deficient demand) in one corner of the system without any excess demand in another corner of the system.

Above, I said the Walrasian co-existence of excess supply and excess demand offered the opportunity for arbitrage and that we think people are good at arbitrage. In this situation, though (unlike in DeLong's original whack-a-mole glut with frictions) there is no opportunity to arbitrage because there is no excess demand to balance out the excess supply.

That's why the market can't fix itself. The market is an institution designed to arbitrage. If you can't arbitrage your way out of the situation, then you can't get out of it with a market, and that's why we say that you need government to increase demand (either through monetary or fiscal policy).

Steve Horwitz would counter that if you don't assume money supply is exogenous you get a new arbitrage opportunity... I have not sufficiently explored those arguments yet to comment on that one.

Nick Rowe, Brad DeLong, and Me on Whack-A-Mole General Gluts and Money

The other day I took some issue with the idea that general gluts are just excess demand for [bonds, money, secure assets] and excess supply of goods and services. The idea isn't absurd, of course. If there happens to be no excess demand for money but there is an excess demand for bonds and surplus of goods and services, that will sure feel like a recession to workers and look like a recession in the data. In that sense I don't think Brad DeLong's version of the story is wrong per se. In all likelihood we've had many downturns characterized by this sort of general glut. But there's something ultimately unsatisfying about this approach when you're going through a downturn that just doesn't bounce back - when you have a stable underemployment equilibrium. Why would this "whack-a-mole" general glut not work itself out? Brad provides several great reasons why not: disrupted credit channels, the zero lower bound, etc. All of these reasons are very good reasons for why a whack-a-mole general glut would lock in for a while. And perhaps that's all there is to it.

But I have my doubts that that's all there is to it, and so does Nick Rowe. However, Nick takes a somewhat different approach from me an in a lot of ways, my approach to why the whack-a-mole theory is incomplete is closer to Brad.

Nick starts with a review of some quantity-constraint material which is very good to look over. He was the one that first alerted me to how important Janos Kornai's work on socialist economies was for understanding market economies - because of these quantity constraints (supply constrained under socialism, demand constrained under the market).

Then Nick gets into the monetary stuff:

"If there are n goods, including one called "money", we do not have one big market where all n goods are traded with n excess demands whose values must sum to zero. We might call that good "money", but it wouldn't be money. It might be the medium of account, with a price set at one; but it is not the medium of exchange. All goods are means of payment in a world where all goods can be traded against all goods in one big centralised market. You can pay for anything with anything. In a monetary exchange economy, with n goods including money, there are n-1 markets. In each of those markets, there are two goods traded. Money is traded against one of the non-money goods. Each market has two excess demands. The value of the excess demand (supply) for the non-money good must equal the excess supply (demand) for money in that market. That's true for each individual (assuming no fat fingers) and must be true when we sum across individuals in a particular market. Summing across all n-1 markets, the sum of the values of the n-1 excess supplies of the non-money goods must equal the sum of the n-1 excess demands for money.

Walras' Law describes an economy with one market with n goods traded and n excess demands. In a monetary exchange economy there are n-1 markets with 2 goods traded and 2(n-1) excess demands.

OK. So can't we just re-state Walras' Law as saying that the sum of the values of the excess supplies (demands) for the n-1 non-money goods must equal the sum of the n-1 excess demands (supplies) for money?

The short answer is: "No, you can't". Or rather: "You can if you like, but it's a very different beast from the original Walras' Law, and is totally useless"."

I like to think in terms of a linear system, because when we worry about recessions we're worrying about slack, and with a linear system it's very easy to conceptualize exactly what the source of the slack is. So Nick talks about n-1 markets and n goods (one being money, which crucially has no market, and is instead traded in all markets). When he says "market" think of a linear system with a supply and demand schedule. So:

Qs=a+bP
Qd=c-dP

Putting this in equilibrium (Qs=Qd) and moving things around:

Q-bP=a
Q+dP=c

...and the solution is trivial. That system is a "market". There are n-1 goods out there and then Nick adds money which makes "n", but he says money isn't traded in a market, so that's n goods, n-1 prices, and 2(n-1) market relations (because you have a supply relation and a demand relation for each market). I think Nick is wrong here. Why? Let's go back to our system of equations - "money" gets a column because it's a good, right? Does it get a row? Nick implies no - because there are n-1 markets. But this seems wrong. It oughta get a vector of prices, right? That's what the "price level" is, after all - it's the inverse of the value of money. So while Nick tells us there are n-1 markets which have 2(n-1) market relations and n goods, and n-1 prices it seems to me there are n goods, n-1 prices, and the price level.

This, I think, is what Brad was thinking in this post where he took issue with my claim that the nature of the interest rate as one price operating in two markets implied an overidentification. Brad wrote: "In the language that Dan is talking, I think that the right thing to say is that if the price level is sticky then the Walrasian system is over-identified. If the price level is flexible then the Walrasian system is just identified--the thing that is supposed to move in order to eliminate the excess demand for financial assets is the price level, and it does not, or it does not move fast enough."

This thinking from Brad seems very close to what Nick is saying to me: n goods (including money), n-1 markets, and one "price level" producing a perfectly identified system. In this system, you need sticky prices to get slack, Brad is right on that.

But the problem is, we don't live in this system. And you know who drove this home for me? Brad DeLong.

Everything comes down to money and the interest rate, and everything comes back to Keynes. In this post, Brad explains why the interest rate is really one price functioning in two markets: the bond market and the money market. People want loanable funds and people want liquidity. Let's bring this back to our system of linear equations where Brad is an out-of-the-closet Walrasian (who is open about the fact that the price level squares the system of linear equations) and Nick is a still-in-the-closet Walrasian (who still insists we have n goods and n-1 markets even though it's clear that that n-th good - money - is related to all the other goods through the price level). What does the interest rate do to this system of equations?

It overidentifies the system, introducing the very real potential for slack. Before we had n-1 goods, n-1 prices, and money for a total of 2(n-1)+1 columns. We had 2(n-1) market relations (supply and demand in each of the n-1 markets) and the price level for a total of 2(n-1)+1 rows. This is a well-identified system where we can have whack-a-mole general gluts but no reason to think those gluts won't be arbitraged away eventually (by adjustments in the price level, a la Brad's point, if nothing else). But Keynes points out that we are missing one row - one market relation. We are missing the money market or the market for liquidity - that market that Nick says doesn't exist. This is the liquidity preference theory of the interest rate - the interest rate is determined by the desire to stay liquid. The problem is that while we add this market relation as a row in our linear system, we don't add another column so that the system remains identified. Why? Because we already have the interest rate as a column - because the interest rate is the inverse of the price of bonds (which are presumably already there as one of our n-1 goods and n-1 prices).

This is a major problem. Now we have 2n rows and 2(n-1)+1 columns. That introduces slack. Now, where that slack shows up isn't entirely clear. Keynes said investment was made based on the investment level that would equalize the marginal efficiency of capital and the interest rate. So he thought a lot of the slack would show up in investment. It's not a bad approach - we do see the sharpest drops during recessions in investment. Keynes was a sharp guy. Hicks took a slightly different approach that was perhaps better suited to the new wave of national accounts measurement. In his model, he forced the loanable funds market to actually clear at the same interest rate as the money market. This means no slack in the loanable funds market, so the slack would be felt in the prices or quantities of goods and services. Hicks strikes me as being a little more presumptuous than Keynes in this respect, so I somewhat prefer Keynes - who left the question open.

Anyway - hopefully this clarifies where I agree and where I differ with Brad and Nick. I think Nick's system is relatively Walrasian once you think about the role of the price level. I think Brad's unashamedly Walrasian system ignores his own prior writing about the interest rate. And I think the interest rate is key: it is one price operating in two markets. You can arbitrage your way out of whack-a-mole gluts. You cannot arbitrage your way out of an overdetermined system. You have to hack the system - you have to get the interest rate to a level that is consistent with full employment.

UPDATE: And this, I should add, is why despite Brad's quite justifiable praise of Say, Bastiat, Mill, Bagehot, Fisher, and Friedman - there is a very good reason why Skidelsky calls Keynes "the master", and why I write so much about him on here.

*****

The blogosphere can get heated when people disagree with each other. Let me nip that in the bud. Nick and Brad are quite simply the best bloggers that I follow right now. Most of this stuff I ultimately, at some point picked up from them anyway!

Was Keynes a Central Planner?

Barkley Rosser weighs in with a post that's getting a lot of attention.

Mark Thoma picks it up here. Arnold Kling cautiously agrees here (but says later Keynesians were more inclined to central planning). I find Kling's post a little incredible, but it depends on what time frame he has in mind. In the full 75 years since the General Theory most self-identified Keynesians have been more skeptical - not less skeptical - of government intervention than Keynes himself. Keynes anticipated this, of course. He said we need to try this out and let experience determine how far this is practicable. However, if Kling is thinking of the immediate post-war period he may have more of a point. A few prominent Keynesians, like Lawrence Klein and Abba Lerner, were quite enthusiastic about central planning. Still, they didn't get this from Keynes and while they themselves were fairly prominent I'm not sure they're representative.

My thoughts on Keynes as a central planner are here. I think Rosser gives a little too much ground, even. If you look at the broad sweep of what Keynes has written on the subject he's perfectly clear: central planning doesn't work, socialism doesn't work, state ownership is highly inappropriate, the best example of "socialization of investment" is private joint stock companies, the government has no advantage in allocating resources, etc. Some point to the German foreword, like the creator of the video himself, John Papola. I think Papola is very confused - this is my review of the German foreword.

#1,000

I couldn't resist stealing the 1,000th post.  The fact that I've done so little to contribute to the post count makes it that much more rewarding.


My brother is a blogging machine.  And a cowboy, apparently.

On this wedding thing, and royals

Christopher Hitchens, from 2000:

"This country for some reason does not have a name. Britain doesn't quite cover it (Ulster is part of the UK but not of Great Britain), England clearly doesn't cover it, and terms such as Albion or Britannia are part of the lost world of the Punch cartoon. Instead we have - like the recipient of some outmoded honour - a title: the United Kingdom of Great Britain and Northern Ireland. Other countries have titles which express ideas - "the United States of America" was proudly coined by that great English republican Thomas Paine, and at a time when there were fewer than 20 states - but ours is more a mode of address for a slightly iffy constitutional compromise that is now drawing peacefully towards its close.

And at the apex of this compromise is, fittingly enough, an absurdity. If it were not for the regal fog - the mist of state openings and birthday honours and Christmas broadcasts and fairytale weddings - we could have begun to confront this reality long before it was thrust upon us.

The argument of practicality - of the obvious need to evolve a secular constitution that separates church from state, replaces the hereditary principle and in other ways reflects the modern Euro-American world of human rights and civil society - ought not to be allowed to obscure the argument of principle. At bottom, the republican idea contains a different concept of citizenship itself. Not only does monarchy have a bad effect on our elite, it has a dire effect on our popular and public opinion.

...the monarchic principle constitutes an obstacle to precisely that sense of responsibility about which we hear so much. It can't be good for people to lead vicarious lives, made up partly of prurience and partly of deference, and fixated on the doings of an undistinguished and spoiled family.

In case I should seem snobbish about this, I can speak of the section of the public with which I am best acquainted: the humble drudges who bring out the nation's newspapers. The "royal" theme operates with the intensity of Gresham's law in this sector, encouraging laziness and sentimentality and salacity by making it too easy to fill page upon page with brainless twaddle, and encouraging contempt for the readership that makes itself such an easy target.

There have been times in our history - the stupid adulation of the loath some Edward VIII as "one of us" - when such manipulated populism was positively dangerous. But at no time is this conditioning of mild hysteria and personality cult a wholesome thing.

What one wants to propose, therefore, is not that we abolish monarchy but that we transcend it or, to put it in more old-fashioned terms, that we grow out of it. To remove the Windsors by the stroke of a legislative pen would be highly satisfying in one way, but disappointing in another. The infantilism and cretinism of the press, for example, can't be cured just by a fiat. What should now begin is the process of emancipating ourselves from the mental habits of royalism, and the many supports it provides to unthinking attitudes and dysfunctional practices.

The last-ditchers are right in one way: it would scarcely be progress if we scrapped the Windsors and then prostrated ourselves at the feet of an imperial presidency. But if the argument is rightly conducted then the attitudes required to see us through to a democratic republic - or federation of democratic republics - would be their own insurance. We even begin to think as democratic republicans, and culti vate and reward democratic republican virtues.

Those who really wanted to would not be prevented from idolising Prince William or from gurgling at the Queen Mum. There will be room for royalists and restorationists in a democratic republic, and there will no doubt be tabloids and glossies to gratify them. But the large and growing number of republicans and democrats will not have to witness this spectacle as if we were all a part of it, and it was all a part of us."

On Coordination Mechanisms and the Market

Jonathan Catalan responded extensively to "Lord Keynes"* and myself here, and then "Lord Keynes" put up a response back to Jonathan. I wanted to take issue with one thing in his response. "Lord Keynes" writes:

"...it is precisely that notion of a coordination mechanism in the market that Post Keynesians reject... Catalán might care to acknowledge that even some Austrians reject the notion of plan/pattern coordination in free markets, so even his own economic school is divided on that issue. Anyone who rejects the belief that the free market has a coordination mechanism will see that there is bound to be a waste of resources and involuntary unemployment in such a system."

Let's be very careful here, "Lord Keynes". The market does have a coordination mechanism and I don't think even Post Keynesians reject that. You have an effective demand schedule, do you not? You have a supply schedule, do you not? OK - you have market coordination. What you mean is that you don't always have a clearing market or an optimizing market. But you do have coordination. Investments aren't made and prices aren't set by throwing darts at a dart board. Prices coordinate.

This is an important distinction and it gets back to the distinction between central planning and demand management. What coordinates resources for Post Keynesians or any sort of Keynesians? Markets and the price mechanism. What are the aggregate properties of that coordination? Well that's where we Keynesians may depart from Austrians and others. But don't say there's no market coordination. Of course there is.

This bothers me about Joe Stiglitz a lot. He's very casual with phrases like "markets don't work". Well what do you mean by that? Don't work in what sense? Do they really "not work" or do they underperform in some systematic way. To say that market coordination does not guarantee full employment is very, very different from saying that there is no market coordination. The market still guarantees that positive net benefit transactions occur and negative net benefit transactions don't occur. That's coordination. No central planner could guarantee that. Whether that results in full employment is a different question entirely.

* - I don't know about anyone else, but this guy's screen name always strikes me as a little overfamiliar and presumptuous.

General Gluts, Unemployment Equilibrium, and the Whack-A-Mole Theory of the Business Cycle

Brad DeLong picked up my post commenting on Gene Callahan the other day. He writes: "Damned if I know why Lucas thinks that there can never be an excess demand for bonds the flip side of which by Walras's law is a deficient demand for goods and services, and which could be cured by getting the government to spend-and-borrow and thus issue bonds to soak up the planned excess demand. The logic is exactly parallel to the idea that when the money stock is too low there is an excess demand for liquidity the flip side of which by Walras's law is a deficient demand for goods and services. Or why Lucas thinks that disrupting the credit channel--which in this framework means that the private sector cannot create safe assets and so there is an excess demand for safety, etc.--cannot have an impact on production and employment, but he doesn't. Damned if I know what Hayek thought about anything macroeconomic. "His logic was not at its best," was what Milton Friedman once said to me--and Friedman had tried to teach."

So I think this is pretty good. General gluts - which are really gluts of goods and shortages of some kind of asset - emerge in the way that DeLong relates and ties back to Say, Mill, Friedman, etc. He also points out that institutional disruptions to market clearing (like disrupted credit channels) can make a general glut stick around for a while. This is also a good point.

But Nick Rowe raised a criticism in the comment section: "An excess demand for bonds cannot cause demand-deficient unemployment. Remember my three women? The hairdresser, manicurist, and masseuse? Suppose they all have an excess demand for bonds. They want to sell their services for bonds. But they can't, because none of them wants to sell bonds. So do they suffer deficient-demand unemployment? Not if they can barter their way back to full-employment. And Walras' Law is supposed to be true in all economies, whether barter or monetary.

Could an excess demand for unobtainium cause a deficient demand for actually existing goods and services? No. If it did, we would be in a permanent state of deficient demand. Because everybody wants more unobtainium. But we know we can't get more unobtainium, so we go back to spending our income on the stuff we can get more of.

If unobtainium sounds too science-fictiony: Does an excess demand for rent-controlled apartments in NYC cause deficient demand for goods and services? By Walras' Law it must.

Walras' Law is the biggest fallacy we are still teaching in economics.

An excess demand for money? Now we're talking about something that *can* cause deficient demand for goods and services.

The logic is not exactly parallel. It's non-existent in the case of bonds, and watertight in the case of money."

Nick leaves it there, and it's a little vague. What's different about money? Why would excess demand for money keep us in a stable position of underemployment when excess demand for other goods wouldn't (I'm not sure I agree with Nick entirely - bonds have qualities which introduce the same problems that money does - in that sense I agree with DeLong).

Money is really two products trading at the same price: it's a medium of exchange and it's a source of liquidity. The whack-a-mole theory of the business cycle that DeLong presents (i.e. - when demand for bonds/money/assets is high the demand for goods and services is low) isn't wrong, and it is characteristic of Say, Mill, and others in the 19th century. It's just somewhat incomplete. The whack-a-mole theory of the business cycle still maintains Walras' Law. The problem is that since money is essentially two goods trading at one price, there's no real reason to mainatin Walras' Law. Walras' system is over-identified. Deficient demand is a symptom and it's something which (because of the multiplier) aggravates and locks-in the problem. Deficient demand is proto-Keynesian (which is why DeLong can find so many 19th century writers propounding the whack-a-mole theory of the business cycle). It's good stuff but it's incomplete. What causes that to be a stable equilibrium? The liquidity preference theory of the interest rate which overidentifies Walras' system and creates slack. Keynes left the question of where that slack would express itself relatively open. Hicks - by forcing both the loanable funds market and the money market to clear - modeled it so that the slack would all show up in output. Those details aren't important. The point is, Walras' Law need not hold when the system is overidentified.

Keynes and the "Socialization of Investment"

Cold War paranoia really screwed over the United States in many ways - it generated a lot of pathologies. One is that it's hard to talk seriously about anything that Marx wrote around a large portion of the population. I can deal with that - I can do without Marx on a day to day basis - but it's still unfortunate. It's harder, though, to talk about other people who called themselves "socialists" explicitly or who talked about "socialization". This stuff always gets tied back to Marxism in people's minds, and that's unfortunate.

If only Keynes knew about what would happen in the 1950s and 1960s back in 1936. He might have thought of something to replace "socialization of investment" with. Commenters on this post are getting interested in that, so I thought I'd share some from one of my favorite books of Keynes - The End of Laissez Faire (1926).

"I believe that in many cases the ideal size for the unit of control and organisation lies somewhere between the individual and the modern State. I suggest, therefore, that progress lies in the growth and the recognition of semi-autonomous bodies within the State - bodies whose criterion of action within their own field is solely the public good as they understand it, and from whose deliberations motives of private advantage are excluded, though some place it may still be necessary to leave, until the ambit of men's altruism grows wider, to the separate advantage of particular groups, classes, or faculties - bodies which in the ordinary course of affairs are mainly autonomous within their prescribed limitations, but are subject in the last resort to the sovereignty of the democracy expressed through Parliament.

I propose a return, it may be said, towards medieval conceptions of separate autonomies. But, in England at any rate, corporations are a mode of government which has never ceased to be important and is sympathetic to our institutions. It is easy to give examples, from what already exists, of separate autonomies which have attained or are approaching the mode I designate - the universities, the Bank of England, the Port of London Authority, even perhaps the railway companies. In Germany there are doubtless analogous instances.

But more interesting than these is the trend of joint stock institutions, when they have reached a certain age and size, to approximate to the status of public corporations rather than that of individualistic private enterprise. One of the most interesting and unnoticed developments of recent decades has been the tendency of big enterprise to socialise itself. A point arrives in the growth of a big institution - particularly a big railway or big public utility enterprise, but also a big bank or a big insurance company - at which the owners of the capital, i.e. its shareholders, are almost entirely dissociated from the management, with the result that the direct personal interest of the latter in the making of great profit becomes quite secondary. When this stage is reached, the general stability and reputation of the institution are the more considered by the management than the maximum of profit for the shareholders. The shareholders must be satisfied by conventionally adequate dividends; but once this is secured, the direct interest of the management often consists in avoiding criticism from the public and from the customers of the concern. This is particularly the case if their great size or semi-monopolistic position renders them conspicuous in the public eye and vulnerable to public attack. The extreme instance, perhaps, of this tendency in the case of an institution, theoretically the unrestricted property of private persons, is the Bank of England. It is almost true to say that there is no class of persons in the kingdom of whom the Governor of the Bank of England thinks less when he decides on his policy than of his shareholders. Their rights, in excess of their conventional dividend, have already sunk to the neighbourhood of zero. But the same thing is partly true of many other big institutions. They are, as time goes on, socialising themselves.

Not that this is unmixed gain. The same causes promote conservatism and a waning of enterprise. In fact, we already have in these cases many of the faults as well as the advantages of State Socialism. Nevertheless, we see here, I think, a natural line of evolution. The battle of Socialism against unlimited private profit is being won in detail hour by hour. In these particular fields - it remains acute elsewhere - this is no longer the pressing problem. There is, for instance, no so-called important political question so really unimportant, so irrelevant to the reorganisation of the economic life of Great Britain, as the nationalisation of the railways."

I love that last sentence especially, and it's one of those cases where you wish Keynes had lived longer than he did. He simply had no use for the wave of nationalizations that washed over Britain in the mid-20th century - the nationalizations that disturbed Hayek so much. I wish more of this had made its way into the General Theory. The need for the socialization is clear in both. The doubts about central planning and the state are there in both. But people still think of state socialism when they read those passages of the General Theory because we've been hard-wired to associate "socialization" with "socialism". How depressing is that? Keynes can't talk about any sort of social action without people thinking of socialism - even when he denigrates state socialism in the very same passage. Anyway - in addition to denigrating state socialism I wish he talked more about joint stock companies in the General Theory as well. It would have helped to clear a lot of things up. Keynes also regularly notes that different solutions are appropriate to different societies - I imagine he would say that lot of the public corporations he personally found appropriate for Britain in the 1930s might not be appropriate for America or even for Britain in the 2010's. The point is clear on the socialization of investment, though - he is least enthusiastic about state ownership, most enthusiastic about complete private ownership by joint-stock companies, and willing to contemplate public corporations. Needless to say, that's not socialism and I personally think it's a stretch to call it corporatism (but perhaps that could apply).

I'll end with a passage a little further down that has some externality thinking to it:

"We must aim at separating those services which are technically social from those which are technically individual. The most important Agenda of the State relate not to those activities which private individuals are already fulfilling, but to those functions which fall outside the sphere of the individual, to those decisions which are made by no one if the State does not make them. The important thing for government is not to do things which individuals are doing already, and to do them a little better or a little worse; but to do those things which at present are not done at all."

Karl Smith and MattW agree on KvH2

My paraphrase of Smith: "I like that Hayek guy a lot, but I don't really recognize their Keynes - but I do know another guy named Keynes who, like Hayek, has some good ideas that are worth considering along with Hayek's."

MattW, a commenter on the Cafe Hayek post, writes: "I consider myself more Hayekian than Keynesian, but even I see that Keynes’ point of view is presented very poorly. This really bugs me in any arguments because it just makes my side look worse overall; setting up a weak version to argue against only works if you’re trying to convince people who don’t know anything about the argument."

I'm glad I'm not a complete voice in the wilderness on this one. I want to re-emphasize again - I love the video and am truly impressed with what John and Russ have put together. But if you call Keynes a central planner, you ought to expect a few "WTF!!!"s from across the aisle (not "win the future").

Why can't we all just get along?: My take on Callahan and DeLong's Macroeconomic History

Gene Callahan points us to an oldie-but-goodie from Brad DeLong on the history of economic thought. Gene writes:

"DeLong clarifies something that only became apparent to me last year: the deepest divide in macro is between those who believe that general overproduction is possible and those who think that only sectoral imbalances can occur. The list of adherents to the latter view is interesting here: "Think of Karl Marx, Friedrich Hayek, Ludwig von Mises, Andrew Mellon, Robert Lucas, et cetera."

That's right: Marx."

Gene has corrected me on Marx in the past - I do not know Marx in detail although I certainly think I've read overproductionism in him before. I'll have to re-check that. But the more fundamental point is that the "fight of the century" has really been over the general glut. In a lot of ways its an extension of the earlier fight that Adam Smith fought over zero-sum thinking on trade. The vulgar mercantilists (there were some good ones) lived in a zero-sum world and they did not think that you could grow the pie from specialization and exchange. In a similar way, the general glut deniers operate off of zero-sum game thinking on the economy. How many times have you heard someone say "every dollar the government spends is a dollar that the private sector can't spend"? We just recently heard Stephen Landsburg say that, did we not? Classical assertions that we can't fall below the production possibilities frontier are the mirror image of mercantilist assertions that we can't move the production possibilities frontier further out. This zero-sum economics is bad economics. Smithian, Malthusian, and Keynesian economics dispels this notion of the zero-sum game.

But my title - "why can't we all just get along" - laments this tendency to pit sectoral shifts against general gluts. I noticed a line in Papola's video that he has brought up in conversation with me a lot in the past - that because some sectors are worse than others there can't be a general glut (see 4:54). Why would anyone think this? At any point in time - boom or bust - some industries are doing well and some aren't. In the midst of these sectoral situations, all sectors together can be better off than they would have been or worse off than they would have been. There's nothing in the claim that the economy is generally worse off than it would be that excludes the prospect of sectoral downturns.

So why do John Papola and others seem to think these ideas contradict each other? Why is this the fight of the century? Can't we conceive of both sectoral and macroeconomic processes and figure out what's more relevant at any given time?

Nothing is stopping general glutters from accepting sectoral downturns. You will never, ever hear a Keynesian or any monetary disequilibrium theorist for that matter say "it's impossible to have downturns that hit some sectors worse than others". You'll never hear it. You will occasionally hear people say that general gluts can't happen. That's zero-sum economics, and it's been proven wrong empirically and theoretically time and time again. We need more Smithian and Keynesian economics, but I don't think that means we need less Hayek or Lucas. It simply means that this paradigm shift needs to be more completely integrated and we've got to stop this balkanization of the discipline that is always looking for grand ideological fights.

The Fight of the Century

John Papola and Russ Roberts' new Keynes v. Hayek video is up. It is very high quality and entertaining, like the last one. I have a few reservations about the content, though (also like the last one) - but it's still worth a watch.

First and foremost, is this really "the fight of the century"? The contrast between Keynes and Hayek just seems so artificial to me. I've always been a proponent of what's been called "Hayekian micro" and see no contradiction with Keynes on that front. In some ways, Hayekian micro is more consistent with Keynesianism than more traditional neoclassical micro. As for Hayekian macro, I've always thought there was something to that too (Keynes thought there was something to it as well), it just doesn't seem to provide a viable counter-argument to the liquidity preference theory of the interest rate, and therefore it doesn't displace Keynes. Keynes still provides the best view of the macroeconomy that we have, and I think Hayek provides a good treatment of a more specific process that probably also goes on. Of course, when we juxtapose Keynes and Hayek it's often a stand-in for the libertarian and non-libertarian strains of the classical liberal tradition. OK, fine. There is some conflict on that front. But they seem to be allies in the liberalism vs. fascism or liberalism vs. central planning fight. In economics itself their conflict doesn't really exist in any real way in micro (Keynes didn't weigh in there and there's nothing about Hayek's micro that contradicts Keynes), and their conflict in macro is fairly marginal compared to other macro fights (I know it doesn't seem this way from some corners of the blogosphere, but it really is).

Another issue with the video is that Keynes is referred to as "central planning", "top-down", "chessmen moved on a board at a whim", etc.. Oh please. If this is artistic license, then OK. As I said, I enjoyed the video and don't want readers here to get the impression that I'm disparaging it over what amounts to artistic license. The concern, though, is that people that are starting to get interested in these subjects and are relatively new to Keynes and Hayek are going to get a very skewed idea of Keynesianism.

A recurring problem in this video is that it distorts Keynesianism in much the same way that the first one did - namely, Keynesianism is reduced to "C+G+I=Y, so if we boost G we boost Y". This is exactly what you're supposed to learn that Keynes was not saying. John and Russ are confusing accounting identities with behavioral laws. They're confusing a static economy with a dynamic Keynesian economy. This is a very bad habit in economics. In the last video, we had the Austrian theory of the interest rate, but no Keynesian theory of the interest rate. In this video we have neither theory. So once again, John Papola gets hung up on this "you can spend on anything - it doesn't matter" issue. That sounds very strange if you think that Keynesianism is "if we boost G, we boost Y". It makes more sense when you realize it's about government note creation - Keynes's version of the helicopter drop.

Econometrics makes its way into this video as well, in some funny ways. First, I'm not sure why the Hayek character thinks that econometricians have a predisposition to Keynesianism. Any macroeconomic theory is going to have its cadre of econometricians and empirical evidence. Second, it's odd that Russ keeps making this claim about how unscientific this work is... we're still waiting for Russ's "Great Austerity Hoax" post about the Heritage analysis where two economists formerly affiliated with GMU use exactly the same models that stimulus advocates used!

Another thing that might be worth noting is that the Austrian inferiority complex comes out here, as in the last one. Hayek isn't recognized at the door again and gets a cavity search (the Hay-eksplosives line was great!), he loses in the end despite punching out Keynes, etc. This is all a little silly too. Hayek won a Nobel Prize. He's widely recognized as a towering figure in economics. He's not a marginal figure. Keynes is lionized too, of course - and for good reason. And he's not celebrated today despite being proven wrong. He's celebrated because most of what he predicted has been borne out by the data. We can note that you can squeeze Austrian theory into the data too if we are so inclined. Predictions about interest rates and inflation that Keynesians got right are a little embarassing for some Austrians, but you can make a case for them. But it's simply not true that Keynes has been knocked out here. John and Russ and many others want to ascribe Keynes's success to politicians - because apparently politicians love Keynes (you could have fooled me - I thought everyone's been trying to outdo each other on deficit reduction). Personally, I think it's more than a little condescending for John and Russ to keep repeating this sort of thing. Politicians get elected on promises to "rein in spending" - you don't see me going around saying that the only reason Hayek is having a revival is that politicians love him. I know that's condescending and I know that's simply not true, despite the apparent coincidence between what some politicians say and what Austrians say. That's not the reason why a large share of the profession is coming around to ideas they had rejected for decades in the case of Keynes or Hayek.

*****

So in summation, it's a great video. It's always tough to talk critically about this or the last one because I do think there's a degree of artistic license and I do thoroughly enjoy the videos. But you have to be careful with these as well. I think people could really enjoy this if they come at it knowing something about the economics of Keynes and the economics of Hayek. But for less informed viewers, a lot of these videos can be extremely misleading. And the "central planning" lines, etc. are very unfortunate - even from an artistic license perspective. It makes me less interested in taking part int he discussion if that's what "the other side" thinks of me, and I'm sure I'm not alone. If you want to fight with a central planner over the pretense of knowledge go find a central planner, and stop wasting your time with Keynesians.

*****

A few links that might be relevant:

- My first long post contrasting Keynesianism with consumptionism. My post taking Krugman to task for slipping into consumptionism. Taking Casey Mulligan to task for consumptionism (this is when I knew I was making an impression, because commenter Samuel Wonacott said he knew as soon as he read Mulligan's post that I would "jump all over it").

- This, I think, is an important post where I talk about why Keynesian "ditch digging" is more like Friedman's helicopter drop than it is like a public works program. This isn't to say public works are bad from a Keynesian perspective. We should just think of public works as "a helicopter drop where we get a bridge too" rather than "boosting G to boost Y". And this is just a fun post on helicopter drops.

- This is an old post on the prospect of a Keynesian-Austrian synthesis. Also here and here. I sketched out some of the math on this a couple weeks ago in response to a conversation at Coordination Problem where - again - commenters insisted on this false choice between Keynes and Hayek. I hope to finish that this fall. The posts above actually don't get into exactly what that entails - essentially I was working on an IS-LM models with a capital structure. Or, if you prefer, a capital structure model with a liquidity preference theory of the interest rate.

*****

What are people's thoughts on the video? I want to draw people's attention to my new comment policy - I'm not going to put up with drive-bys anymore.

UPDATE: One more point I meant to mention on the substantial WWII segment in the video. I think the episode is suggestive, and it's suggestive in clear favor of Keynes - but it's very hard to make much of it because as Hayek says in the video, it's just one datapoint. However, one of the things that bothers me about this talk about WWII is the idea that all wars are all waste. I am always stunned that people talking about WWII from a Bastiatian angle are so loathe to note that keeping fascists from dominating Europe was a very, very good thing. War is hell. It's not something to be excited about. It causes lower standard of living at home. It does all these things. But Nazis are more hellish, and I wish people would do less insinuating about how the draft tinkers with unemployment figures and be more explicit about the fact that those soldiers were fighting for a free world.

Two C-SPAN Videos of Note

Although neither are up yet - they should be soon.

- First, Harry Holzer - professor at Georgetown University and a labor economist here at the Urban Institute was on Washington Journal this morning. He had a good overview of employment and earnings during and before the recession. I have talked with Harry a lot here on various projects - he's provided comments and advice on things - although I've never worked on one of his projects directly.

- Second, Bernanke will hold the Fed's first press conference at 2:15 today. This will be very interesting to watch. The Bernanke Fed has been amazingly open - he's done a lot more interviews than his predecessor (I'm not sure Greenspan did any while he was in the office), he makes a regular effort to try to talk to the public rather than to bankers and policy makers. These press conferences are in the same vein. I wonder a little if the middle of a crisis is the best time to start, but better late than never. People scrutinize the Fed's words and markets will move on what is said in a way that they wouldn't necessarily move on any old slip of the tongue in a presidential press conference. Still, this is good to see. It will be tough for him. Nobody is entirely happy with him - some think he's done too much, and the rest think he hasn't done enough.

NASA vs. Ag Subsidies

Previously on here I've promoted a practical and hopefully widely appealing way to address externalities: ditch ag subsidies and double NASA's budget. Food is a product where virtually all the costs and benefits one can think of are internalized - particularly in today's day and age where it doesn't contribute all that much to macroeconomic volatility. Alternatively, there are lots of positive externalities associated with space exploration. The two budgets are roughly comparable, which makes this deficit-neutral budget plan convenient to think about.

Oddly enough, then, this post at the Space Politics blog directly ties NASA to agriculture subsidies!

In a lot of ways, they're absolutely right - and they hit on one of the many interesting externality/collective action questions swirling around NASA. I've talked about the positive externalities (the diffuse benefits and concentrated costs) of space exploration here before. But there are also concentrated benefits and diffuse costs to think about: namely that NASA is a boon to Florida, Texas, and Alabama. That's part of the reason why you have a Tea Party candidate from Florida backing manned space flight.

I think this poses more of a risk in terms of tying NASA to old ways of doing things that are associated with Cape Canaveral, Houston, and Huntsville. It doesn't seem to be presenting a huge risk of over-investment in space exploration.

Still, it's interesting. There are negative externalities wrapped within positive externalities. And the sorts of things NASA spends most of its time talking about in externalityish lingo - their "spin-offs" - aren't really externalities at all!

Assault of Thoughts - 5/27/2011

"Words ought to be a little wild, for they are the assault of thoughts on the unthinking" - JMK

- Marco Rubio, of all people, comes out in support of public manned spaceflight.

- John Quiggin and Henry Farrell have an article in Foreign Affairs on "Hard Keynesianism" in Europe.

On Reason

An excellent post on the evolutionary function of reasoning - it is to win arguments, rather than find truth.

- "However, for communication to be possible, listeners have to have ways to discriminate reliable, trustworthy information from potentially dangerous information—otherwise speakers would be wont to abuse them through lies and deception. One way listeners and speakers can improve the reliability of communication is through arguments. The speaker gives a reason to accept a given conclusion. The listener can then evaluate this reason to decide whether she should accept the conclusion." (Richard Rorty on reason as a "clever way of talking about things" - check)

- "When people reason alone, there will often be nothing to hold their confirmation bias in check. This might lead to distortions of their beliefs." (C.S. Peirce on knowledge generation as a social endeavor - check)

- "Proactively used reasoning also favors decisions that are easy to justify but not necessarily better. In all these instances traditionally described as failures or flaws, reasoning does exactly what can be expected of an argumentative device: Look for arguments that support a given conclusion, and, ceteris paribus, favor conclusions for which arguments can be found." (John Maynard Keynes on remorseless logicians ending up in Bedlam - check)

Why anyone would want to base either their epistemology or their methodology on reason is beyond me. At best reasoning is just an internally consistent language with no guarantee of correspondence with the real world. At worst it's not even internally consistent because we don't do it well enough. It's a tool and a useful one. Internally consistent and intelligible languages and grammars are important for thinking things through, after all. But it's not a foundation.

Keynes didn't have an "idle resources theory of the interest rate"

He had a "liquidity preference theory of the interest rate", and I think I typically try to talk about liquidity preference on here, rather than idle resources. Not a big deal in every day discussions about it, but it's an important distinction to keep in mind.

"Idle resources" have come up in online discussions of Landsburg's piece on taxes, and they have recently been highlighted by "Lord Keynes" in a critique of Jonathan's mises.org piece on government spending. "Lord Keynes" focuses on the idea that people don't want to work when they are unemployed - a point I agree with him on. He also highlights another particularly problematic statement of Jonathan's where he says that (1.) government is a disequilibrium force, and (2.) government pursues less preferred ends. Both of these could be true, but I don't think Jonathan has any warrant to suggest that they have to be true.

Anyway, what caught my attention was the use of these terms "idle resources". It gives us the image of machines that aren't being used or factories that are shuttered, or people that do not have jobs. These things are real problems, but it's important to remember that idleness need not be so dichotomous. Idleness of resources can emerge when the same resource is being used, but it is kept more liquid than it normally would. Let's say depositors at a bank shift their funds from two year CDs to six month CDs because they are concerned about the prospect of imminent job loss and want to keep some savings liquid. Those deposits are going to be more idle when the bank turns around to use them. Stuffing mattresses with bills and "hoarding" is how we talk about these idle resources, but of course "hoarding" is only the most extreme case of idle resources. Economic actors need not increase their cash on hand at all to have idleness. Keynes's key point was that it is on this margin between leaving resources relatively more or less liquid that the interest rate is determined. When firms make investment decisions they compare the marginal efficiency of capital - the discount rate that would be required for a project to provide net benefits - and determine whether the marginal efficiency of capital exceeds the interest rate or not. If the marginal efficiency of capital exceeds the interest rate, then all interest earnings from putting funds at interest would be discounted and the firm would make a net loss. If the interest rate exceeds the marginal efficiency of capital then more present value earnings are to be had in putting funds at interest, and investments are not made. The idleness of resources is determined by the interest rate and liquidity preference.

Non-stop Inertia... working under neoliberalism

My disciplinary home has a much greater leftist presence than Daniel's, which can make conversations interesting.  I've been thankful for my relationship with Daniel, which has pretty well inoculated me against some of the rather sophomoric economic critiques offered by humanists.  At the same time, from my inexpert political and economic position I wouldn't shy away from saying that leftist discourses of various sorts have very much rubbed off on me, and I don't feel any special allegiance to mainstream economic solutions from the libertarian to the progressive.  I'm not the poster boy for radicalism by a long stretch, but I'm just as open to these voices as I am to any others.

All that's just preface to this, since the work below comes from a somewhat different perspective than the readership of this blog.  It's a review for Non-Stop Inertia, a recent book about joblessness and temp work in neo-liberalism.  A few folks have been posting it in my orbit of the blogosphere and I thought some of you may find it interesting.

"Temporary to Permanent", The New Inquiry

 

A question to readers on 1920-21

Does anyone know of a good treatment of the 1920-21 depression in the United Kingdom?

I'm at it again.

Assault of Thoughts - 4/24/2011

"Words ought to be a little wild, for they are the assault of thoughts on the unthinking" - JMK

- Yglesias connects the Jetsons to Keynes's "Economic Possibilities for our Grandchildren", one of my favorite essays of his. Yglesias doesn't work the complete logic out, but he notes a reason why I think Keynes was ultimatey wrong about work hour predictions: leisure isn't always consumption-free. Modern leisure is very consumption-heavy. We'll have to work for that. Aside from questions of increased leisure and the role of consumption in the future, I don't think we're done investing, which is a more fundamental reason why Keynes was wrong! The previous post was about visiting and presumably eventually settling Mars. Once we actually have a nascent colony on Mars, do you think the the marginal efficiency of capital is going to be driven to zero? Ummm... no. Once we have a human footprint on Mars it will be several centuries until we see that again, I think. We will get wealthier which means more people will trade of labor for leisure. I have no doubt there will be some of the substitution, and there ought to be! That's the fruit of progress, which we ought to enjoy. But we aren't finished yet, and we never will be. There is plenty more investment to do. In the long run, we're simply on another frontier.

- Poetry from Gary.

- A new post from Evan.

- The new Review of Austrian Economics is out.

- An anonymous commenter shares this story about ridiculous pricing of some Amazon books. He ties it to very thin markets, which may play a role, but it also simply has to do with algorithmic trading, as Brad DeLong points out. That makes you really wonder about the old claims of market socialists that advances in computer technology could make socialism more viable!

On to Mars

Elon Musk announces that he will put human beings on Mars in 10 years as a best case scenario, and 15-20 years. This comes shortly after the announcement of SpaceX's Falcon Heavy rocket, which is supposed to be able to lift twice the payload of the shuttle.

I don't know if the details of the mission are available - the one I know in detail is Zubrin's "Mars Direct" plan. The way he tells it, that sort of plan is the only feasible way for doing it. Not being an astrophysicist, I can't evaluate that.

Another Elon Musk project is Tesla Motors - the electric car company. There are substantial externalities that cause us to underinvest in interplanetary exploration, just as there are externalities that make us overinvest in combustion engines and underinvest in cleaner cars. But just as in the case of his Mars plan, Musk seems to be addressing the externalities in the car industry that the government bungles.

In response, I think NASA needs to announce a two tiered prize fund: one for the first party to put a human on the surface of Mars, and one for the first party to put a human on Mars and bring him back safely to Earth. And then NASA should announce its own effort. If NASA achieves either task first, it will distribute the prize between all the competitors.

A fun Mars Youtube video from Symphony of Science:

Two Russian leaders making fools of themselves

First, Russian President Medvedev (short guy, second from the right in a gray suit) dancing:



And second, Russian Prime Minister (and former President... and likely future President) Vladimir Putin demonstrating how little he understands monetary policy. Folksy, "get off my lawn" crabbiness against the U.S. plays well in Russia, though.

Troy Camplin on Artists' Externalities

Troy Camplin, who blogs about the relationship between Austrian economics and literature, agrees with me that cultural production is closely associated with positive externalities. He writes:

"Richard Florida repeatedly argues that the presence of "bohemians," which of course includes artists and literary writers, positively correlated with the presence of the creative class that provides the driving force of most economic growth. The interactions among artists/writers and other creative people, ranging from programmers to advertisers, thus create the conditions for creative-based economic growth. Thus, the presence of artists/writers acts as a positive externality.

How might artists and writers gain a return on their contributions? Or are externalities inherently impossible to "cash in" on?"

Any thoughts on the question? My feeling is that (1.) if there was an easy solution to "cash in" there wouldn't be an externality, and (2.) to a large extent this misses the point - some things provide benefits that people don't want to monetize, and that's fine. Patronage and philanthropy of course are a major solution to these sorts of externalities: if a person gets utility from the utility of others that's a sure way to address externalities at least to a limited extent. Altruism internalizes costs and benefits.

Find the pet peeve

There are a few pet peeves I harp on here on a semi-regular basis. Let's try a few:

1. Find the empirical problem I would point out with this study by Palmer and Schloss on color preference.

2. Find the history of thought problem with this article by Don Boudreaux on Keynesianism.

3. Find the theoretical problem with this blog post by Steve Landsburg about taxes (not one I've seen DeLong or Krugman talk about... I'm somewhat amazed this post has been so controversial and I think the issues that most people have raised are fairly semantic).

Each case that I'm thinking about is an issue I've talked about on here before (although perhaps in another context).

Updates on me

- I just got Robert Shimer's new book in the mail and am very excited about it! With any luck this is going to be a major jumping off point for my dissertation.

- I got my articles for the Encyclopedia of American Populism back from the editor - very minor changes - they seemed to like them. I wrote articles on "technological unemployment", "the Quantity Theory of Money", "Coin's Financial School", "the National Monetary Commission", and "the International Monetary Conference". All late 19th/early 20th century monetary history stuff, except for the technological unemployment article. The encyclopedia is intended as an undergraduate reference volume, which is a nice change of pace. It's also a good economic history publication to add to the CV.

- I have a new collaboration project which I'll hopefully share more about in the future - still hashing out the details.

- I was at home all of yesterday recovering from some minor dental work and made major progress on my chapter on engineering labor supply - hopefully within the next couple weeks enough will be finished to get a draft up on SSRN to get some reactions to it.

Assault of Thoughts - 4/20/2011

"Words ought to be a little wild, for they are the assault of thoughts on the unthinking" - JMK

- Evan has a post on some creative use of old Border's space. He writes: "Both of these projects stretch the concept of the bookseller to include a mandate of contributing to the cultural engine. What is going on is not simply the presentation of books for consumption, but also a preferential option for the small publishers or for local work, and also for continued production of literature or other arts. Both are pointing social networking tools toward useful rather than gimmicky ends. I'm not sure what will come of either venture, but the energy behind them seems important in itself. People want to set up something like this, and it's encouraging to see some people go out on a limb and do it."

- "Lord Keynes" writes about a similarity between Hayek and Keynes on the parameterization of models. Unfortunately, I disagree with Keynes on this point.

- In this post, I discuss the suggestion that government causes externalities. There's a pretty obvious Pigovian solution to this, of course - if you think it's a problem. Poll taxes. Not exactly a solution a lot of people will reach for, of course. But it bears a resemblence to the sort of voluntary government that a lot of people propose, and it raises one of the major problems with that sort of voluntary scheme: the dependence of voice on the ability to pay.

New Comment Policy

I meant to mention this the other day, but forgot. I'm not going to be completely hands off about commenting anymore. I used to only remove comments that insulted other people in an ad hominem way, but I'm going to be more rigorous now. I'm exercising my free speech in this respect, not limiting yours. My blogging activity is going to go steadily down over the next several months and will be much lower in the fall and I want my blogging to be productive.

If you tell me that my ideology is immoral or that I want to shoot people to get my way (the comment that inspired this change of policy yesterday) or that my ideology demands mass imprisonment, I'm simply going to delete it. I don't want that clouding discussion. You clearly have no clue what you're talking about and I don't have the time to walk you back off that ledge.

If you don't like that, you can feel free to comment somewhere else.

Efficiency Problems vs. Externalities

Both Mattheus, in the comments here, and Don Boudreaux have recently talked about the government itself as an externality.

My initial reaction to Mattheus was to agree with him.

The more I think about it, though, I have a hard time talking about the government in these terms – not because there aren’t problems associated with government (I would be the last person to deny that), but because it confuses the definition of “externality” and that’s a very important concept that I’d prefer not to confuse.

An externality exists in a situation where some of the costs and benefits of a decision do not inform the decision making process because no rights adhere to those costs and benefits. The efficiency of that decision making process has no real bearing on whether something is an externality or not. We can imagine inefficient allocation mechanisms for goods with no particular externality (for example, monopolies or markets with considerable information asymmetries), and we can imagine efficient markets for a good that is potentially rife with externalities (such as gasoline).

So what is the situation with government? Well in liberal democracies government internalizes all costs and benefits. Everyone has standing in a liberal democracy and all preferences can legitimately inform the decision making process. If I am not a party to your transaction with the gas station, my disutility from your carbon usage can’t inform that transaction. But if I’m voting anything I am pissed off about or happy about is fair game. The problem with government, it seems to me, is that it’s not nearly as efficient in maximizing those benefits and minimizing those costs as the market is. This is why, of course, we like the market to make allocation decisions in the vast majority of cases. The government has loads of problems with it, but decisions that are systematically uninformed by subjective valuations of costs and benefits is not one of thoase problems.

So why do Mattheus and Don think it’s an externality? The more I think about it I’m not really sure. It seems like cargo cult economics to me. Externalities are all about people bearing costs that don’t seem like they should be bearing; externalities are a good way to get the attention of economists; ergo: let’s call the government a big negative externality!

I’m not so sure about this. Government internalizes all kinds of costs and benefits. That’s the whole point of classical liberal government, and that’s why it’s cited as a potential solution to externalities that pose particularly big problems. Is it inefficient and sometimes even abusive? Sure. But unless we’re talking about a case of substantial disenfranchisement, I’m not sure these problems have their source in externalities.

Also from Evan

Greg Alan Isakov's "The Stable Song" came up on Pandora yesterday - I liked it a lot and suspected Evan would, so I sent it to him. Turns out he already knows the guy. He provided me with this good live version of the song:

Assault of Thoughts - 4/19/2011

"Words ought to be a little wild, for they are the assault of thoughts on the unthinking" - JMK

-David Altig talks about the odd phenomena that sometimes the most anti-Keynesian people in the room are the New Keynesians.

-Gene Callahan talks about how crying wolf on state brutality can increase the brutality of the state.

-Evan points me to an article by Vivek Wadhwa on going into engineering vs. the liberal arts. Wadhwa is one of the more outspoken voices in the science and engineering workforce community, and usually he's very concerned about the brain drain and the sufficiency of the high skill workforce, so his perspective in this post was a bit of a surprise to me.

Mark Thoma on Empirical Macro

This is a really excellent post by Mark Thoma. This is how people need to approach empirical macro, and why history is so important for good macroeconomics.

Culture as an Externality

I mentioned to Prateek in the comment section of this post that I might write some about culture as an externality. I honestly haven't had the time to put much thought into it. But here's the basic idea: culture is a context that you find yourself in and, if you are cultured, that you participate in and engage with. But culture isn't like a loaf of bread or any normal good; the extent to which you benefit from culture depends substantially on the culture that others purchase and experience. The buyers of fine architectural specimens benefit from their purchase themselves, of course, but they also provide a positive externality for everyone else by contributing to the culture of the community. Private pieces of culture - rare or important books, private art, my wine rack, etc. - are somewhat harder to talk about in these terms because they are often kept private, but they (1.) produce more cultured people who go into the world and interact with others in an cultured way, an (2.) create a market for works of culture that would be weaker otherwise.

This relates to the earlier point about Russ Roberts' post insofar as markets themselves are positive externalities. My exchanges support the existence and persistence of producers. All markets, in this sense, are a collective action problem: they require a critical mass of demand to even emerge. This is why I hesitate to be too celebratory about places like Amazon or Wal-Mart. That they can provide goods at a low price is obviously something that I acknowledge and celebrate them for. But there is a real collective action problem associated with culture-producers and preservers like small book-sellers and farmers' markets. I have my own demand for niche books and farmers' market food, and the market will satisfy that demand the way the market always does. But when we think about culture, we realize that our demand doesn't stop there - what we derive utility from doesn't stop at the level of our own individual consumption. I derive utility from the presence of a bustling farmers' market. I derive utility from the existence of a variety of small and used bookstores and I derive utility from hearing about the positive experiences that friends have there. Now, I could pay friends to go to these venues, of course. That would be the market solution. But the very act of payment for that source of utility would destroy it as a source of utility. The point is, we derive utility (and disutility) from interactions that we have no control over, particularly the cultural milieu that we find ourselves in. That is the very definition of an externality, and because it's an externality we can't expect the market to provide for it on its own - other institutions may be more helpful.

Assault of Thoughts - 4/17/2011

"Words ought to be a little wild, for they are the assault of thoughts on the unthinking" - JMK

- Bryan Caplan bemoans the fact that the anti-war movement isn't more pacifist. I think it's to their credit that they're not. He also tries to make it a partisan issue... I think that case is somewhat weak, although I suppose it's understandable if you think all anti-war movements should be pacifist. I have a comment on the post.

- Arnold Kling makes a point I've often made on here: health reform should have had a much more substantial dose of federalism.

- Jonathan Levin wins the John Bates Clark Medal.

- A question - has anyone read Tullock's The Organization of Inquiry? What did you think?

Externalities everywhere

Every day I become more and more convinced about how central externalities are to modern human society. It should not be surprising, given the modern turn towards the individual, that social welfare would be less well served by modern institutions than individual welfare. This is not even a bad thing - the growth we've experienced since the individualist turn strongly suggests that there's something substantial to the idea of modern individualism that ought to be maintained vigorously! But that still means that modern institutions might not be well equipped to address the welfare of parties external to the interactions of individuals. I think of human progress as the fulfillment of the difference in welfare from what we are to what we could be in the future. Two social technologies - the market and modern science - are the best tools we have to maximize that progress. But each of these targets specific kinds of welfare improvements, so that modernity is something like a net that catches a lot of opportunities for progress but lets certain opportunities systematically slip through. Externalities are not "exceptions to the rule" - they're a natural and pervasive part of life. And one of the reasons why I hammer thinking about property so hard is that it's precisely our natural embrace of status quo property arrangements that makes us ambivalent towards externalities. If you see human progress as a positive (if ambiguous) thing, that strikes me as an odd position to hold.

I have two points on externalities.

First, Russ Roberts' recent podcast with Dani Rodrik has an interesting discussion of externalities that I've never thought of. On his blog, Russ writes of it:

"Along the way, Rodrik argued, to my surprise, that starting a new venture in a poor country has a positive externality that leads to market failure. He gave the example of a call center–suppose a country has a work force that would be good at working in call centers. An entrepreneur who starts a call center will thereby provide information to other entrepreneurs about the quality of the work force."

Pigou meets Kirzner. It would be a productive meeting, but I'm afraid there would be a lot of resistance, at least from modern proponents of Kirzner. Information asymmetries in hiring are very well understood - the step that I haven't heard anybody take that Rodrik takes here is to point out that because information is welfare-enhancing in labor markets with asymmetric information, entrepreneurs who hire in these markets (providing information on the wage and skill distributions of the population) generate positive externalities for other entrepreneurs.

My other point is to note that I've started writing a short article that I want to submit to a journal called Space Policy on the (mis)use of externalities to justify NASA. NASA's heart has been in the right place in their self-justification to the public. For a very long time they've touted their "spin-offs" - NASA technology that is useful in the private sector. They even have a regular publication dedicated exclusively to featuring these spin-offs, which has covered something like 1,600 spin-offs to date (and they note that this is not exhaustive). The effort is well-intended, but this is not really an externality - or if it is an externality ("information goods" like technology are so strange it's hard to think about them in the same way as non-information goods), it only scratches the surface of the externalities that NASA addresses. I plan on going over three more traditional externalities of public space exploration that NASA does not talk about as much as spin-offs, but should to provide what economists would consider a legitimate justification for public provision of space exploration. The articles in this journal are shorter than in others, so hopefully I'll be able to wrap it up in the next couple weeks (depending on other workloads). And sorry Evan - I know you'll be disappointed to learn its an Elsevier journal.

But for this morning - time to write more about the engineering labor market.

New Acquisition

I just ordered Rob Shimer's Labor Markets and Business Cycles (2010), and I may be reading it next (it might turn out a semester back in the swing of graduate level economics would help me digest it better, though). I expect Shimer's work to be a jumping off point for my dissertation, particularly the material on wage rigidity. Wage rigidity does not play a big role in my view of macroeconomic fluctuations, but (1.) maybe it should - particularly for the more typical downturns which I'm likely to see more of in my lifetime than more atypical downturn that we're going through now, (2.) even if I stay unconvinced of the importance of wage rigidity, I ought to work on it because this is a quite dominant perspective in the field right now. This may take me into using the sexy LEHD data that everybody loves but I'm concerned that (because it only provides earnings and not wage rates), the plain Jane CPS might end up being more useful for me. Anyway - I have a rough brain storm of the types of ideas I might look into, and reading and familiarizing myself with this book seems like an important start.

Two good quotes

"There is no possibility of balancing the budget except by increasing the national income, which is the same thing as increasing employment." - John Maynard Keynes, 1932

"The cave-dwellers' language of characteristics would not have suddenly become nonsensical: shadows are not forgeries" - Michael Oakeshott on Plato's cave

Why isn't Russ Roberts re-posting the hell out of this?

Menzie Chinn has a more detailed post on the Heritage IHS Global Insight model of the Ryan Plan, and this post focuses on precisely what I highlighted: the labor elasticities and the crowding out assumptions. Russ Roberts really needs to weigh in on this. It bothers me a great deal that a professional like him would accuse colleagues of promoting a "hoax" for using standard econometric practice. Critiques can always be raised. Do you disagree with their assumptions? Where do they get their assumptions? Ought we to invoke the Lucas Critique? etc. By all means, go over these points, but before you call it a "hoax" as Russ has, at least recognize the extent to which they've laid out all their assumptions and simply said "this is our best guide right now". If Russ isn't satisfied, fine - Russ isn't satisfied. But don't go around calling the position of those you disagree with a "hoax" and then stay dead silent when people more politically sympathetic to you use the exact same modeling strategy. He needs to be re-posting the hell out of these critiques of the Heritage analysis. If the sort of macro-modeling that CBO, Zandi, Romer, etc. did was a "hoax" and by its very nature illegitimate, then Russ needs to be a voice in the conservative/libertarian community asserting that the emperor has not clothes when it comes to the analysis of the Ryan budget too. I disagree with Russ. I think these analyses are useful, despite the fact that they obviously have limits and liabilities. I didn't critique them when they did it for the stimulus, and my only critique of the Heritage analysis is for their assumptions - not for their modeling strategy.

At Cafe Hayek they like to point out that they're against all politicians - they aren't Republican or Democrat. This is obviously true. I'm not a Republican or a Democrat either and what I write here is not informed by partisan politics, even if I may consider Democrats somewhat more palatable than Republicans. In the same way, they consider the Tea Party (i.e. - Republicans) somewhat more palatable than Democrats. That's fine. But if you're going to make the claim that your positions aren't informed by party, keep your analysis consistent no matter who you're dealing with. Critique this Heritage analysis - call it a hoax. Or retract that previous post. Don't call high multiplier estimates "ex post story telling" and deceptive econometrics (the Ed Leamer point they raise), and then favorably cite Barro's low multiplier estimates. Be consistent.

Brown, Spooner, and the Constitution

Is the Constitution just any other contract that is binding on signatories and no one else? Aaron Brown agrees with Lysander Spooner that it is in this post. I have a lot of comments on there that accept that it is just such a contract for the sake of argument, but I conclude with a hesitation. Simply put, if constitutions are reducible to contracts why does nobody treat them as such? That would seem to provide good reason to question whether they are contracts in the traditional sense. I'm not sure of any reason to think they are contracts except for a vague "it's a legal sort of document that discusses rights and obligations of people" argument. Fair enough, but the question remains - if it is a contract in the traditional sense why does nobody seem to think about it or treat it as a contract in the traditional sense? Common sense and conventional wisdom are not good bases for argument, but I have trouble jettisoning common sense and conventional wisdom for deduction from abstraction alone. This argument also seems based on the assumption that there is no such entity as "society" and that there are only individuals... another assumption I'm not entirely sure about.

A few more things on Rorty

Gary's claim in the comment section of the prior post yesterday that Rorty depended on "some sort of positive action by the state" for a credo of universal human rights both flustered and confused me. This confusion was reinforced by a later claim by Gary that I hold an ancient view of rights, which I apparently take to "depend on participation in the body politic by "the people"" (if you don't remember me ever being of this view, you're not alone - I can't manage to remember that either).

Regardless, it lead me to browsing more Rortian themes. I came across a few points of interest. First, when he died in 2007, he was memorialized by Greg Mankiw and Tyler Cowen. Cowen provides his understanding of Rorty's significance and Mankiw provides a story of his relationship with Rorty in class.

I also found this passage from a 1992 Virginia Law Review article interesting:

"The good kind of prophet thinks of herself as just someone who has a better idea, on an epistemological par with the people who claim to have a new gimmick for retreading tires, or programming computers, or redrawing the company's table of organization. Good prophets say that if we all got together and did such and such, we would probably like the results. They paint pictures of what this brighter future would look like, and write scenarios about how it might be brought about. When they've finished doing that, they have nothing more to offer, except to say "Let's try it!" (a phrase I prefer to "Just do it!").

This kind of prophet does not think that her views have "legitimacy" or "authority". The other, worse, type of prophet thinks of herself as a messenger from somebody (God) or something (Truth, Reason, History, Human Nature, Science, Philosophy, the Spirit of the Laws, The Working Class, the Blood and Soil of Germany, The Consciousness of hte Oppressed, Woman's Experience, Negritude, the Overman who is to come, the New Socialist Man who is to come) - somebody in whose name, or something in the name of which, they speak. Such prophets think of themselves as not just one more voice in the conversation, but as the representative of something that is somehow more than another such voice

."

The first paragraph made me think of Keynes's approach, and the second paragraph provides a window on the some of the voices he was up against; those who took the gold standard and other orthodoxies of either theory or policy as an independent authority for Britain to hew to, as well as socialists and other totalitarian philosophies that cited higher authorities for their counter-arguments. It also reminded me of the "reform liberals" or non-Keynesian New Dealers in America; those for whom the primary problem was "economic royalists" rather than "magneto trouble". Many of these sorts were really just well-meaning people with rhetoric instead of reasoned positions (the same can probably be said for many gold-bugs), and they were eventually brought into the Keynesian camp. You can also see the opponents of Keynesianism today reflected in that second paragraph - some higher moral priority like "fiscal responsibility" as an abstraction, or "sound money" as an abstraction and as a moral goal substitute for "this is my idea, this is how it works, let's give it a try". It doesn't matter if dedication to the abstraction works - "liberty" or "responsibility" or some other abstraction or tradition justify it. Functionality is a distraction.

This is not to say that a moral justification of sorts isn't important: it is. But it's not a substitute for (1.) humility when it comes to citing the authority with which you speak, and (2.) a good argument on why what you're proposing is functional in making the world better.