More evidence on what government is.

In this post some commenters wish I provided more evidence for my assertions that government is an institution that is used to solve externalities and seek rents and prey on others.

Come on people, this shouldn't be that hard.

What are some things government produces or purchases to provide to the public?:
- National security (qualities of a public good)
- Interstate highways (network good - positive externality)
- Information for consumers (information asymmetry - negative externality)
- Basic research (positive externality)
- WIC (principal agent problem - negative externality of sorts)
- Medicare/Medicaid (lots of market "failures" that are reviewed here)
- Postal service (network good - positive externality - and now that it is less of a positive externality there are quite sensible calls to get rid of the Post Office)
- Education (positive externality, principal agent problem)
- Police protection (qualities of a public good)
- Macroeconomic stabilization (collective action problem/public good)
- Environmental regulation (negative externality)
- Deposit insurance (negative externality)
- The administration of justice (qualities of a public good)

What doesn't the government play any real role in producing?:
- Bread
- Furniture
- Laptops
- Appliances
- Cars
- Alcohol
- Books
- Music
- Herb gardens

You see a pattern here? I just thought through some major, obvious government goods and they all have obvious externalities or public goods qualities associated with them. I thought through some obvious normal goods that we come across on a regular basis with no widely remarked on externalities associated with them, and by and large these don't seem to be produced by the government.

Why?

Humans are not dumb. I know you all have this idea in your head that Keynesians think the common man is an idiot, but you're simply wrong when you say that (and more than a little condescending when you accuse us of it). I firmly believe that humans are not dumb and that thousands of years of interaction between humans has lead to the emergence and evolution of institutions that solve human problems. Humans know the market works. Humans know what the market is less capable of accomplishing, and they understand what things require more collective action to produce more optimally. There are lots of ways to act collectively. The state is one of many.

The apparatus of the state, over the entire course of its emergence, is obviously tempting to people. People can earn rents by bending the state to their own purposes. The state's use of coercion can be (and has been) used against innocent populations and citizens. The predation of the predation of the state has to be an essential element of any theory of government.

But clearly some states are more predatory than others. So what makes a particular political economy/state/non-state governing institution, etc. "robust"? Lot's of things. Normative regulation of the governing order (see Elinor Ostrom), clear residual rights contracting (see Oliver Hart), shifts in rhetorical treatment and understandings of certain actions (see Deirdre McCloskey), and meta-rulemaking or constitution writing (see James Buchanan). Each of these things are accomplished with a wide range of success. Successful institutions survive and succeed, unsuccessful institutions either die or they weaken themselves by preying on the market and other non-state institutions (the church, the family). The United States has been relatively successful in balancing these things for a number of reasons. Please note that the fact that the United States isn't some idealized form or perfect example doesn't invalidate any of this because I'm not talking about idealized forms - I'm talking about tendencies and roles of the state that all observed cases provide imperfect examples of.

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I have one addendum that was not incorporated into my initial theory of the state: inequality. A big part of what the state does is address inequality. This isn't entirely an externality issue (although there are major reasons why we should think externalities exascerbate inequality). It also isn't entirely a predation issue, although it has similar elements to that as well. But it's a very strange kind of predation. The weak prey on the strong. Or - in a lot of cases - the strong weaken themselves to strengthen the weak. This is a major function of the state and of other non-state, non-market institutions (think soup kitchens, churches, charities, etc.). An easy way of addressing this now is just to say "the state tries to ameliorate inequality too", but that seems like a somewhat incomplete theory of this element of the state. I imagine it's worth thinking through some evolutionary biology too - it's my understanding that in other species a certain degree of egalitarianism is evolutionarily fit. If you have issues with egalitarianism on a philosophical or ethical level, please don't raise them here. That's another conversation entirely. My point here is to try to present a theory of the state. An adequate theory of what the state is seems like it has to be broader than (although still inclusive of) rent-seeking and predation.

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This paper by Daron Acemoglu looks quite relevant. I seem to remember reading soem Theda Skocpol writing on these themes: Politics and Economics in Weak and Strong States.

Two good posts from Krugman and Vienneau

First, Paul Krugman reflects on what's been coming out of the INET Bretton Woods meeting and the revival of "the oldies" (Bagehot, Kindelberger, Keynes, etc.). In this portion, he ties the problem with the last couple decades back to the microfoundations push:

"Bagehot wrote of panics in which the collective desire to shed risky assets and debt produced a downward spiral; Keynes of situations in which the collective desire to save but not invest led to mass unemployment. And in both cases these arguments suggested a case for government intervention to undo or limit the bad macro consequences of reasonable individual behavior.

But notice that I’ve framed this in terms of “reasonable” behavior; it’s a lot harder to tell these stories in terms of perfectly rational, maximizing behavior.

One response — a pretty good response — is, “So?” After all, maximization isn’t a fact about human behavior, it’s a gadget — an assumption we use to cut through the complexities of psychology and all that, one that can be very useful if it clarifies your thought, but by no means an axiom or a law of nature.

But maximizing models have a special appeal for modern academic economists: they require solving equations! They’re rigorous! They make it easy to show that you’re doing “real research”. And so maximization tends to acquire a bigger importance in economic thought than it deserves."

The point isn't that microfoundations are inherently bad. The point is simply that we need to be intelligent about how we talk about microfoundations. In an earlier post I gave the example of physicists grappling with making quantum mechanics and relativity consistent. It would be weird (wouldn't it?) if physicists said "well relativity really needs microfoundations, so lets try to derive relativity from quantum mechanics and if relativity ends up popping out the other end, that's great - but if it doesn't we just have to abandon relativity." Would that make sense? Of course not. First, we need to really interogate this claim "relativity needs microfoundations". Why? Are microfoundations some sort of scientific pre-requisite? Nope. Nevertheless, consistency is good even if there's not a necessity for microfoundations. But that just leaves open the question - why derive macroprocesses from microfoundations? Why not derive microprocesses from macrofoundations? One is at risk of the ecological fallacy and the other is at risk of the fallacy of composition, but neither is a bad approach in and of itself. You all know my take on this - the Krugman post is very good.

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Robert Vienneau has a great review of Nozick up. There are a few things I especially like, starting with his assertion that "libertarians" are better called "propertarians". I would actually suggest that "paleo-propertarians" is better, because not only is libertarianism essentially a philosophy that enshrines property rights - it often offers preferential status to existing or status quo property arrangements. This distinction is important because it's precisely the assignment of rights that determines whether a social order is one of "liberty" or not. This is not something a lot of libertarian seem to appreciate. I did a double take recently when I read Bryan Caplan write: "boosting libertarians' Total Fertility Rate to 3 is the most realistic long-run path to liberty", and as far as I can tell he meant it seriously. Libertarians identify their philosophy with a philosophy of liberty, which is odd for other liberals. It's actually a very specific sort of philosophy of property, and it's not at all clear that a society arranged along libertarian lines would have more liberty. The fact that libertarians identify libertarianism with "liberty" makes engaging with them hard, because they actually do believe this. Convincing yourself of this sort of equivalence is powerful rhetorically; one need look no farther than the Bush administration for evidence of this. It's akin to equating ideas with the will of God - you obviate the need to really probe the idea when you equate it with the will of God. The modern Western world is a world of secular liberalism, and liberty is the new "will of God". If you proclaim your philosophy as being equivalent to liberty ("the will of God") as a matter of definition, you render unintelligible the counterarguments that offer different perspectives on exactly what we mean by liberty ("the will of God") and the implications of a specific philosophy for liberty. Just like with older fundamentalists, when I argue against libertarianism I am perceived as arguing against liberty.

Vienneau has other great points too - including Nozick's begging of the question on how to define "property rights" (a point I raise here a lot). He also presents Nozick's three propositions for the just distribution of property. What caught my eye here is that the third proposition: "Whatever injustices may nevertheless have arisen in original acquisition or transfer must be rectified justly" is usually defined circularly by libertarians - and it is defined on the basis of the very property rights that we're trying to rectify!

More Economic Science/Natural Science Analogizing: Two Thoughts

IS-LM as Ptolemaic Economics?!?!

Here, Mark Thoma paraphrases Larry Summers as saying "Larry Summers just said DSGE models played no role at all in WH policy response to crisis. It was all IS-LM augmented by liquidity trap... Summers says Ptolomy model outperformed Copernicun model for 50 years after discovered. Same for IS-LM vs. DSGE" at the INET Bretton Woods meeting that's going on right now.

Does this really make sense? I don't think so, although it's a turn of phrase that a lot of people are going to love to latch on to and repeat. So what does he mean that the Ptolemaic system worked better than Copernicus at first? Well, Copernicus had some bugs to work out at first - both empirical and theoretical. Empirically, the Copernican system implied that the other planets should have phases, which nobody had observed - leaving many in the Ptolemaic camp. Later, as telescopes were developed that did observe these phases, more people sided with Copernicus. Copernican predictions also weren't even as accurate until Kepler introduced elliptical orbits, and even Kepler's orbits had no solid justification until Newton! But is IS-LM Keynesianism really Ptolemaic relative to DSGE New Keynesianism? I'd say it's more accurate to say that IS-LM plays Copernicus to DSGE's Kepler or Newton. DSGE has a New Keynesian IS curve, after all, and the Taylor Rule and various other monetary policy rules do the same work that the LM curve does as well. IS-LM is still in New Keynesianism, it has just been filled out and modernized. Ptolemy was fundamentally different from Copernicus. Newton didn't throw out Copernicus - he developed him. IS-LM hasn't been thrown out either - the old IS-LM is just a first step toward more complicated models. I personally think in terms of IS-LM because even though I've had graduate macroeconomics and DSGE type models, I haven't had enough of it to really soak in yet. But there's not the fundamental break that Summers implies. I do think Keynes represented a paradigm shift, and I think Classical economics is more analgous to Ptolemy. Nobody except politicians and a few hold-out economists use Classical economics anymore. Even that's probably too harsh, though. Even Classical economics isn't as radically different from IS-LM and AD/AS economics as Ptolemy was from Copernicus. Still, I think there's a good case that Keynes marked a paradigm shift.

In What Way is Economics "Right"?

Here, Phil Plait discusses that kid that has some new ideas about Einstein and likes to do integration by parts on his window. He writes:

"Barnett may very well be a genius, and may very well rewrite a lot of physics… as, no doubt, future generations of genius scientists will. But one thing they won’t do is prove relativity wrong.

Bold statement? Not really. We know relativity is right. It may be incomplete, but it’s not wrong.

What I mean by this isn’t too hard to understand. In science (ideally, if you’ll pardon the pun), an idea becomes a hypothesis, a testable statement. If it passes the test, it can be expanded upon, broadened, tested and retested. Eventually, as it grows and becomes more solid, it becomes a theory — I know, in the general jargon that word means "guess", but to a scientist a theory is an explanation of phenomena so profoundly certain that a layperson would call it a law.

Relativity is just such a theory. It has passed essentially every single test to which it has been put for the past century. It is literally tested millions of times a day in particle accelerators, for example.

So I don’t think anyone, young Jacob Barnett or otherwise, will ever prove relativity to be wrong. What they might do, what I think and hope someone eventually will do, is show how it’s incomplete."

So how does economics stack up? What can we say, like this? Clearly we are different from relativity, but it's not like we're just making things up either. Later on in the post he lists evolution as being with relativity as one of those theories that we know to be "right", and that will never be proven wrong. I think laws in economics are "proven" in much the same way that evolution is (which shouldn't be surprising, since economics is a very, very specialized form of the biology of highly evolved primates). Relativity is "right" insofar as we know precise relations and formulas hold up consistently. Economics isn't "right" in that way. We don't have a supply curve that is the "right" supply curve. It sounds strange even to talk about it in those terms.

What we have, like evolutionary biology, is a mechanism that we know functions in the way we think it functions, broadly speaking. We know without a doubt that organisms evolved by natural selection, just as we know without a doubt that the price mechanism optimizes resource allocation (with "optimize" having a specific definition in this case, just as "selection" has a very specific definition in biology). We know the process is incontrovertibly true, but the way that process plays itself out is very contextual and historically contingent. When did humans evolve certain features or move to certain regions or emerge as a distinct species? These are natural history sorts of questions that are informed by the theory of evolution. These specific questions are analagous to questions like "how elastic was labor demand a decade ago?" or "what drove the inflation rate in the 1970s". The scientific law of supply and demand and market efficiency informs how we answer these questions both theoretically and empirically, but there is a lot more natural history to it than there is with relativity. Astrophysics has its own natural history, of course. People that try to answer questions about the origin of the moon or the asteroid belt set themselves to answer questions that are just as messy as the ones that biologists or economists deal with on a more regular basis.

Scientific theories are "right" in a lot of different ways, and people that are down on economics as a science should put aside their physics envy and just recognize we aren't "right" like relativity is "right". We're more "right" in the way that evolution is "right". We know that we have an accurate understanding of a broad mechanism or process that is central to answering the questions of economics, just like evolution is a broad mechanism or process that is central to answering all sorts of questions in biology.

Two conference in the DC area... in case anyone is in the DC area

First, the Association for Public Policy Analysis and Management has a call for papers up for their Nov. 3-5th conference. I've never been to this one, but it's the major public policy conference. Lot's of Urban Institute people always went to it.

Second, the Southern Economic Association has a call for papers up for their Nov. 19-21 conference. I have presented here a couple times before, and have always enjoyed it.

I wasn't sure at first if I would submit anything, but I think I will. I've had an analysis of Georgia's job creation tax credit on the back burner for a while now - I think submitting that will be a good way for me to get back on it, and it will provide good feedback that can hopefully help submitting it somewhere.

Aliens and Trade

Krugman suggests extra-terrestrial life would be good for trade. I imagine (if we survive the encounter) the bigger boost will be from technological development, but still a good point.

The same would be true, of course, for a human colony on Mars - division of labor is the foundation of civilized life.

But the trade would be very different - we'd probably be trading actual goods to Mars, but I doubt we would get goods back. The ones we would send would have to be absolutely essential, too, because of the cost of the trip.

So what would we trade? Knowledge. I imagine the early Martian colonists will do three things, for the most part: farm, build, and produce knowledge (maybe mining too if it turns out there's anything worthwhile up there). Knowledge is cheaper to send back to Earth than anything else, so it will likely play an important role in interplanetary trade a century or two from now (if we don't at least have a consistently manned outpost there before I die I'm going to be extremely disappointed).

Lovecraft talked some about extra-terrestrial exchange (not always voluntary, of course) when he wrote his alien stories. What was traded with the Yithians? With the Mi-Go? Knowledge.

Hans Hoppe on the Economics of the Nazis, and a Couple Other Thoughts

I think a lot about the economics of the interwar period - usually of the early twenties. I'm working on a short comment right now on the Hoover administration, which has had me thinking more about the early Depression than usual. And then this morning my post about Mein Kampf got me thinking about the economics of Nazism.

There are a lot of interesting things to be said about economics and Nazism. A lot of drama and good history going on with the war debts and the havoc that that wreaked on monetary policy. The fundamentally Keynesian employment program of the Nazis raises stimulating questions. A third, more gruesome issue I've been interested in is the economic logic of the doctrine of Lebensraum to maintain the agrarian character of German society, and put off the concentration and proletarianization of the population. The analysis - as I understand it - is quite similar to Jefferson's attitude toward the western frontier. Obviously the execution and the racial beliefs underlying the Lebensraum idea are more macabre and offensive, but the logic - and the logic of overproductionism - is quite similar. Given the popularity of this sort of overproductionist thinking in the interwar period, I've always found that intriguing and have been a little curious about where Hitler derived those ideas.

Anyway, so I put a little thought into these ideas again, and came across this fascinating talk on Nazi economics by Hans Hoppe. He's impressively objective given his subject matter, and even draws a few parallels between Hitler's economics and Austrian economics. Enjoy the ever-intriguing (if no always embracable) Hans Hoppe*:

*Jonathan has a critique of Hoppe's views on an entirely different issue here. I largely agree with him and have actually blogged about it in the past - see my comment on Jonathan's post for that link.

The Supreme Court and Climate Change

Discover's blog notes that the Supreme Court has agreed to hear a public nuisance suit brought against six power companies by eight states for damages caused by greenhouse gas emissions. To a certain extent, this is very good news, because it's a defeat for the use of coercive force on the part of polluters who impose costs with impunity on people who, because of history and practicality, don't have property rights to the air they consume.

I am a little concerned about it, though. While some people see the legal system and tort law as a viable way to arbitrate these things, I'm skeptical. I come at this as an economist - the problem is that a cost-bearer and a benefit-enjoyer can't meet to negotiate the terms of the cost and the benefit imposition (or if they want any cost or benefit imposition in the first place). The crux of the issue is that the cost-bearer has no legal claim on which to base a contract.

A legal solution drawing on public nuisance law at least allows ex post compensation that may or may not be appropriate. That's better than the previous situation, but it still allows benefit-enjoyers to impose the costs of pollution without the agreement of the cost-bearer. In other words, there is no "double-coincidence of wants" that guarantees that we have gains from trade: there is a "single incidence of want" with ad hoc, ex post, legally determined compensation. Even if the courts could adequately assess damages (which nobody who knows anything about the socialist calculation debate should expect), they still can't guarantee welfare maximization because they can only guarantee that cost=benefit, not that marginal cost=marginal benefit. Not only can they only guarantee that cost=benefit for compensated cost-bearers (if that), but that is all they are tasked with doing.

I think the better route would be to say "the air is collectively owned and it oughta be collectively managed", and have the court order the state to fix the problem, much as they did with desegregation. With desegregation, the rights structure that was the status quo was unjust, but rather than telling whites to compensate blacks and letting the rights structure work itself out, the courts ordered the government to rectify the arrangement of rights in public schools and in voting. Ad hoc, ex post compensation is not the price mechanism and we shouldn't expect it to achieve optimal results. State action is not the price mechanism either, but it would be much closer to the price mechanism if we had an institution acting as the agent of the people (who, under the status quo, suffer from an incomplete property rights regime).

If Biology Had Schools of Thought Like Economics Does

In this post I discuss how silly arguing from the perspective of "schools of thought" is in economics. Let me clarify, I don't think all economists do this. It's most problematic among macroeconomists, and particularly among macroeconomists that can't distinguish between their politics and their economics. This isn't an issue at all among microeconomists. Microeconomists differ over specific findings, but there are no great over-arching "schools of thought".

Anyway, by means of illustration I wanted to sketch out how silly it would be for evolutionary biologists to do what macroeconomists do. Imagine these schools of thought:

The Foodians: The Foodians strongly maintain that evolution is primarily driven by access to food sources. When climate changes, the kinds of food growing in an area changes and organisms who are best suited to survive eating the new collection of food available are the ones that survive and propagate successfully. Food drives evolution.

The Climatists: The climatists regularly accuse the Foodians of ignoring underlying causes (despite regular references in Foodian articles to things like changing climates). Climatists argue that it's wrong to say that food supply drives evolution - ultimately changes in the climate cause evolution. Organisms that are more prepared to survive in colder weather, or wetter climates, or what have you are going to survive and propagate successfully. Climate drives evolution.

The Dispersionists: The Dispersionists, on the other hand, think that both the Foodians and the Climatists are barking up the wrong tree. Evolution depends on the availability of lots of genetic variation in a population and this is going to depend on how dispersed or concentrated, large or small the population of a species is. If there are just a bunch of small colonies of an organism scattered widely across the planet with little contact between each other, genetic variation is not going to be as wide as if a lot of organisms of the same species congregated together and could easily travel through the population and mate with each other. Population dispersion is what drives evolution. Moreover, the other schools have a fatal flaw: they consider population variation to be homogeneous! They aggregate too much! Despite the regular mention of variations in the preparedness of organisms to eat certain foods or deal with certain climates, the Dispersionists still accuse Foodians and Climatists of genetic aggregationism... no one quite understands why they accuse them of this. Presumably its because Dispersionists are smitten with the way they talk about genetic disaggregation and like to feel special.

The Asteroidists: The Asteroidists argue that the biggest episode that life has to deal with on a planet is surviving being hit by an asteroid or other incoming rock. Large rocks flying into Earth drive evolution because the impact is so violent and the resulting climatic changes are so all-encompassing that only organisms designed to deal with the extreme cold after the impact blocks out the sun, or those who can burrow deep underground, or even those who are simply lucky enough not to live directly in the impact zone can survive. Impact events drive evolution.

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Can you imagine how goofy that would be? The disagreements I outlined above are largely based on caricatures of the other positions. There's very little that is obviously mutually exclusive in any of this, and whatever is mutually exclusive can be explained by acknowledging "yes, X is a process that operates sometimes and excludes the prospect of Y process occuring, but at other times Y may occur without X occuring".

The reason why economists do this is probably mostly because of politics and ideology, but it's allowed to perpetuate itself because we also have a very weak commitment to the idea that (1.) we are scientists - primatologists, in fact, and (2.) we are studying a complex phenomenon that involves multiple simultaneously operating processes.

I think it would be legitimate to say "I study this particular extinction episode a lot, which was caused by an asteroid strike so I emphasize the role of asteroids in my own research but I recognize all the other forces". That's fine. It is also legitimate to have a preference for what explains a large portion of the subject at hand in general, without thinking of other forces as illegitimate or mutually exclusive. What's wrong is to pretend that what we're dealing with should be treated as warring schools of thought. This isn't to say there can never be warring schools of thought. I'm not sure what a good example in biology would be - punctuated equilibrium vs. gradualism? That seems like it might fit the bill. But they should not be as common as they are in economics.

The Equation of Exchange and the Metaphysics of Commerce

"The Balance of trade is the metaphysics of commerce, which few understand and which serves no other purpose than to disturb the imagination" - Thomas Fitzsimmons, 1785

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What would you all think if I wrote "By definition Y=C+I+G, so if you increase G you increase Y". You probably wouldn't take me very seriously. Even when I make a case for fiscal policy, it's never that case. Freshmen learn what's wrong with that argument. Would it improve things at all if instead I said "By definition Y=C+I+G, so if you increase G holding everything else constant you increase Y"? This version is at least logically coherent, but would your opinion of me change all that much? Probably not. Let me put it this way - I should hope you would still think I was talking nonsense. It's true that Y=C+I+G; that is trivially true. But when you change government spending, you can't expect other things in the equation to stay the same. So the first, unqualified statement that I made is logically wrong because nothing constrains C and I to stay the same, allowing me to conclude that we can increase G ad infinitum to achieve permanent growth. The second version of my statement was logically sound, but meaningless and demonstrative of a very poor understanding of economics. The lack of understanding is evident not in my manipulation of the equation itself, but in my understanding of the meaning and use of the equation.

Unfortunately, Don Boudreaux recently made precisely the same mistake with another famous economic law, the equation of exchange, MV=PQ. Don writes:

"In today’s Wall Street Journal, U.S Treasury Secretary Timothy Geithner, Singapore Finance Minister Tharman Shanmugaratnam, and Australia Treasurer Wayne Swan worry aloud that, in emerging economies, “rapid growth” increases “the risk of domestic inflation.” Baloney. Inflation is the result of too much money chasing too few goods. So by increasing the flow of goods (and services) produced in an economy, rapid growth decreases the risk of domestic inflation. That the finance ministers of three major world governments do not understand this fundamental fact is appalling." (emphasis is mine)

Don is quite wrong here, and the various finance ministers he cites are correct*. The key to understanding how to think about the quantity theory is that it's simply a balancing of the books. Alone, it tells you nothing about the causal relationship between any of these variables. I want to emphasize that because a lot of people from all sides of the aisle treat it like it's a causal law (Exhibit A being the regular testimony in the banking committee of the politician that every libertarian wants to pretend isn't just another politician).

Don is discussing the role that rapid growth (and increase in Q) plays in inflation. Taking the naive view of the equation of exchange, he reasons that since P = MV/Q, when Q increases P (the general price level) must decrease. He doesn't even say "holding everything else constant", and so his claim is logically wrong. But even if he had said "holding everything else constant", that just begs the question - why would you ever claim to hold everything else constant? Don certainly wouldn't let me get away with "holding everything else constant" in the national income identity. So how does Q grow in Don's example? Well for the answer to that question we have to turn to some method of determining output - Q. For this, of course, economists traditionally turn to supply and demand. Profit maximizers and utility maximizers come together in a market and set their respective marginal benefits and marginal costs equal to each other and come to agreement on a Q and a P**. So that gives us two of the four variables in the quantity theory - not bad. How does Q and P change in a supply and demand model? Well, the supply schedule can shift, the demand schedule can shift, or both can shift simultaneously. These supply and demand curves, unlike the equation of exchange, are actual behavioral claims made by economists. If you have a given set of preferences, and you have certain rational and informational prerequisites, and you face a particular suite of prices you will purchase Q goods for P dollars each in the market. This is claimed to be causal and it does describe behavioral relationships. It is not an accounting identity like MV=PQ or Y=C+I+G. So what happens if demand for goods and services increases? We would expect to see Q and P both increase. What happens if the supply schedule shifts to the right? We would expect to see Q increase and P decrease.

Now, to make another trivially true statement, we can say that if M and V are held fixed, these supply and demand dynamics will be reflected in observed values. On this point alone - even at this "trivially true"/"ceteris paribus" stage in the game, and after adding one supply curve and one demand curve to give some actual behavioral traction to our equation of exchange, Don is clearly wrong. Output growth can occur for at least two reasons - a supply shift (i.e. - increased productivity) or a demand shift, and a shift in demand will cause prices to increase at the same time that quantity increases***.

But presumably we aren't satisfied with a "trivially true" refuation of Don's point. When supply or demand shift, things happen to M and V too. When demand for goods and services increases, more transactions occur and people increase the rate at which they spend a given stock of money. In other words, the velocity of money, V, increases. Another way of saying this is that the desire to hold on to cash decreases if your demand for goods and services increases and your income stays the same. That cash did not circulate before, and now it is put into circulation. This is a standard impact of an increase in demand, and its inverse is why Keynesians associate low demand with an increase in the desire to hold cash or other liquid, idle assets. So if we have demand-lead growth, we would expect V to go up as well (which is another reason why when Q goes up in the equation of exchange you can't simply assume P goes down - that increase in Q may be a part of a process that simultaneously increases V).

What happens with the money stock? Well, of course that depends on how you define money. If you're thinking in terms of a very narrow definition of money, you can safely assume that that stays fixed and the explanation provided above of P, Q, and V gives you what you need. I don't know too much about this end of the theory, but clearly there are definitions of M with varying breadth. Nominal credit creation in response to an increase in demand can also be said to increase the money supply, and would also create inflationary pressure. Would you have nominal credit creation in response to a productivity (i.e. - supply schedule) increase? I don't really see why you would expect that. People need less exchange media to conduct the same amount of commerce, so it's probably less sensitive to supply-lead growth. Then again, if the aggregate demand schedule is highly elastic, maybe you would need more. These are the kinds of issues you have to think through - the equation of exchange doesn't provide you the answer to any of these relationships.

So be careful when you use these. Don't get caught saying "when we print more money it creates inflation" or "when output grows, it lowers prices". These are abuses of the quantity theory.

*George Selgin has some comments in the comment section of this post that are worth reviewing. I think Selgin is basically right and understands precisely what I'm saying here. Unfortunately he was clearly indulging Don's misunderstanding of the issue when he was taking issue with my comments, and trying to paper over a pretty egregious Cafe Hayek post.

**You could of course raise some market process objections to this story, but the basic supply and demand relationship has been experimentally verified (by other George Mason professors, in fact), so whatever non-auctioneer market process is going on is clearly giving us about the same results, which should not be surprising to anyone.

***In the article that Don discusses, the authors mainly point to demand-lead growth in emerging economies as the inflation risk for emerging economies only. They specifically cite demand for exports, growing domestic demand, and rising commodity prices (which have been demand-driven, not supply-driven).

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Quantity theory links:

- I started a thread on this issue in Jonathan's forum here.

- This recent post by Brad DeLong doesn't explicitly mention the quantity theory, but he does bring up the problems with a Monetarist approach to the crisis. His critique is based on the interpretation of Monetarism as a misuse of the quantity theory... or at least a misuse given the very special circumstances we're going through now.

- Stephen Williamson replies to Mark Thoma and writes: "This is why I'm not an old-fashioned quantity theorist. What has to be going on here is a large increase in the world demand for US currency during the financial crisis. All the more reason to be worried about inflation, as the crisis-driven demand [for US currency] goes away." I'm not sure if Williamson is saying that "old-fashioned quantity theorists" misuse the equation of exchange, but this doesn't seem quite right as a critique of the quantity theory itself. If there is an increase in world demand for US currency that you expect to be temporary, then that's the same as saying there is a decrease in V that you expect to be temporary. If you expect it to be temporary, then you'd expect an increase in V in the future. If, following the processes I outlined above, you think that increase in V is going to be paired with an increase in demand and thus P and Q, then Williamson's worry about inflation in the future is perfectly justified and perfectly consistent with the quantity theory. It's simply not on the top of my list of things to worry about right now. When we actually see that inflation, it means we're probably out of the slump.

- Bill Mitchell, of the Modern Monetary Theory school, has a weekly quiz. The second question of a recent quiz is on the quantity theory. Mitchell sets up a straw man of what quantity theorists believe (essentially attributing Don Boudreaux-type views to them), and then credits Keynes with fixing all that. This is a little much - many users of the quantity theory long before Keynes used the quantity theory without making these mistakes, and Keynes certainly embraced the quantity theory - and he used it correctly and to great effect. So Mitchell's analysis here is correct - but his history is a little self-serving.

- Jonathan reposts some thoughts by Richard Ebeling on Hayek and the quantity theory here.

- And of course, a lot of this emerges from our discussion of Hayek's Prices and Production. You'll find my post on the first lecture, in which I deal with some of these questions, here. I think Hayek does much the same thing that Mitchell does with his treatment - he provides a reasonably accurate analysis of the quantity theory, but a fairly self-serving history of the idea. He also has a weird "this isn't important and in fact it's misleading" reaction to it by the end.

- Keynes has a suberb discussion of the use and misuse of the quantity theory in the Tract on Monetary Reform (it actually is the same discussion where he says "in the long run we're all dead"). I'll hopefully get a chance to quote it at length this weekend, but if I don't please look it up yourselves

Happy Halloween!

Here's a classic:

This Halloween should be fun - we moved this summer and are in an apartment complex with lots more kids than in the last one - so we should have trick-or-treaters. I plan on watching Tim Burton's Sleepy Hollow, which I've always loved for the atmosphere.

- My supervisor from GWU shares this link explaining taxes to children using Halloween. Pretty funny - even covers lock-box myths and Social Security taxes.

- This also reminds me of another sign I saw at the rally: "Burn Witches, not Korans"

- David Henderson reflects on the over-sensitivity to safety and Halloween. Of course I agree with him on this, but I have to say - part of the fun of Halloween was flaunting parental safety measures - staying out later than we were supposed to, wandering much farther than we were supposed to. Not that that's a reason for being absurd about the night's festivities, but from a kid's perspective the "rules were meant to be broken" attitude enhanced things.

- Here are some old links of mine: Poe on economics and Lovecraft on the nature of human fear.

And speaking of Poe, here's one of my favorite renditions of The Raven (by Christopher Walken):

And the winner is...

Dale Mortenson, Peter Diamond, and Christopher Pissarides! Wow - that was my wish list (with Peter Diamond thrown in for good measure).

They were awarded the prize for their analysis of markets with search frictions. This is very closely related to what I'm proposing doing doctoral work on. Congratulations!

UPDATE: Now here's some rich irony for you... one of the guys that just won a Nobel for matching frictions in the labor market is having his nomination for a Federal Reserve Board of Governors seat held up by Congress!

Yglesias on what "counts" as wealth and output

Matt Yglesias hits the nail on the head:

"I think it’s unquestionably true that one strength of the United States vis-a-vis Europe is that our setup is friendly to a certain kind of startup firm and this is why we’re world leaders in much of the high tech industry. But this kind of rhetoric is annoying and inaccurate:

[Google CEO Eric] Schmidt said that in parts of Europe the venture capital industry was being held back. “It takes a very long time to get a proper venture capital industry going. And in Europe there are many countries where the failure of venture capital is in fact seen as criminal, Germany, for example.” [...]

“Jobs are created by the private sector not by the public sector. Wealth is created by the private sector not by the public sector. If you are going to have great companies you have to be willing to support and encourage the creation of real wealth-generating capitalists. That means you have to put up with them.”

You would think the CEO of an Internet firm wouldn’t be totally dismissive of the idea that CERN and DARPA are contributing to wealth creation. And of course education is important to wealth-creation, and much of it is state-financed. And transportation infrastructure—typically state-financed—creates wealth. Of course even if the state completely removed itself from education finance, it’s not like nobody would go to school. Presumably the private sector would step in to fill some of the void. But conversely in places where the state steps beyond what we’d consider appropriate in the United States it still creates wealth. State-owned firms like Areva are generating value.

I raise these points not to make the case for a bigger or smaller public sector (I would say bigger than the US but smaller than France is ideal, but both are clearly workable) but simply to underscore the point that the performance of public agencies matters a lot."

This is the Robert Higgs school of GDP, of course: just don't count the public sector. The reassuring thing is that when they redefine the very definition of words like "wealth" you know they're desperate - the problem is that I think they actually believe this stuff. It's one thing to say that the government in most spheres of economic activity is less efficient at wealth production than the private sector. That is unambiguously true and completely uncontroversial. But in certain fields they are better (that's why there are a few fields where we regularly see governments: evolutionary pressures practically dictate we will see these sorts of efficiencies capitalized on by successful societies). And even where they're not better you don't just pretend they don't exist.

Anyway - this is a pet peeve of mine too. Similarly, it bugs me when people only think of "crowding out" as public activity crowding out private activity. Clearly that is a problem and it exists (again - unambiguous and uncontroversial), but you never hear anyone talk about private activity crowding out public activity. They simply define it out of the discussion. They assume it away. This is what an externality is though, if you think about it: private activity crowding out social activity. That's one way to look at it at least.

Econ Journal Watch reply is up!

Several weeks ago, I and several other bloggers were asked to draft a response to Buturovic and Klein's (2010) widely reported study concluding that libertarians and conservatives are more "economically enlightened" than moderates and liberals. Four bloggers (myself included) submitted replies, and they are now posted.

The original article is here - needless to say I think it leaves a lot to be desired and probably could never have been published in any other venue. I know that sounds harsh, but well - it is what it is. I think the authors know that too.

My reply is here. My approach was to focus on the most glaring and damning oversight of the article: their identification strategy. To put it plainly, their evidence supported multiple (contradictory) conclusions and they had no way to isolate the explanation they chose to report - and yet they reported it anyway. I also got the chance to quote Keynes and suggest that Bastiat's wisdom is often ignored by libertarians: both things I enjoy doing. All in all, I think it was a successful response.

The next best response (IMO) was by Rod Hill and it is here. Rod's was good, but he went down a road I deliberately avoided: getting into the weeds of the specific questions that Buturovic and Klein (2010) posed. It's not that that critique isn't valid - it certainly is and I stated in no uncertain terms in my piece that it was not an impressive or thoughtful survey instrument. But in such a short reply (they gave us up to 1,000 words), I didn't feel like I could adequately address each of the questions. And even then, the problem often wasn't with the "enlightened" answer that they identified per se - it was more the designation of other answers as unenlightened, as well as the general vagueness and poor wording of the questions. I'm glad Rod took up this angle - I did not in anticipation that others would, freeing me up to address the authors' identification strategy (or lack thereof), which I felt was more pressing anyway.

E.D. Kain's response is quite weak in my opinion. Kain alternately suggests that the survey was vague, subjective, but then goes on to say he agrees with the authors. Later he appeals to the idea that the economy is more complex than Buturovic and Klein (2010) present it (this is clearly true), and that Americans in general could be more enlightened when it comes to economics. The piece was diluted and directionless overall - not much to see here.

David Ruccio took an interesting, but I think ultimately limited approach in his critique. He reminded me of my sociology days - lots of talk of dominant discourses, hegemony, the marginalization of Marxian perspectives, and the exclusivity of neoclassicism dressed in the authority of "science". I can appreciate taking the concept of a "discursive framework" out for a drive every once in a while, but ultimately I'm one that takes the "science" in "social science" seriously. These are complicated questions, and perhaps even questions that are so complicated that we can't provide anything but a heavily caveated answer to - but they are still scientific questions for which there is a positive answer. Ultimately, Ruccio to me comes out as mired in ideology as Buturovic and Klein. He's somewhat more thoughtful than Kain, but still not a serious critique of the original article.

Buturovic and Klein will respond in the next issue, which I believe is set to come out in January of 2011. I'll of course share that when it comes out.

Enjoy!

And remember - pay attention to your identification strategy!

Craigslist and Prostitution

The Washington Post reports that Craigslist has stopped offering links to "adult services"ads. The change has only applied to U.S. users. Critics of course contend that Craigslist ads are a tool for prostitution and human trafficking. I've never seen one of these ads before - I assume they're nominally for dancers or escorts. Prostitution is always an interesting question for economists. Many conclude that there is no good economic reason for restricting consensual transactions for sex - any restrictions on prostitution have to find their basis elsewhere (which is sort of a useless point to make, I suppose - lawmakers don't generally turn to economists to comment on vice laws in the first place).

Anyway - this story reminded me of a paper that was presented at the First Annual IZA Conference on the Economics of Risky Behaviors, which I presented at last Spring. The paper, by Scott Cunningham (Baylor) and Todd Kendall (Compass Lexecon), was one of the best of the conference I thought. They looked at the relationship between internet prostitution and street-walking prostitution, and of course a discussion of these Craigslist ads featured prominently. Here is the abstract of the draft from last spring:

The increased proliferation of Internet and other technologies has profoundly changed the market for prostitution in the United States. We argue that the Internet lowers client search costs through the expediency of the search technology, allowing clients to learn about prostitutes in an area (including making comparisons), and thus mirroring the function of the street market. The Internet also reduces the cost structure of the prostitution supply function by both reducing the fixed costs and the variable costs of producing commercial sex through its negative effect on the probability of detection and the probability of arrest. On the one hand, such reductions in the fixed costs of production suggest that the marginal escort may be shifting towards younger women for whom the opportunity cost of detection is higher or who are more risk averse. On the other hand, thin market externalities in niche markets are overcome with Internet technology, which predicts a wider variety of worker characteristics as thin market externalities are solved via the Internet. We explore this conjecture empirically using a variety of data sources. First, we present evidence from a panel fixed effects model relating state-level prostitution arrests to the proportion of families in the state who have Internet access at home to show that Internet penetration predicts a decline in street prostitution. This negative correlation is robust to controls, but does not predict declines in other non-sex-related crimes. Second, we analyze 1998-2005 National Incident-Based Reporting System data (NIBRS). This data has to date not been used to learn about prostitution. We focus on both the cross-ORI and within-ORI changes in streetwalking offenses to learn more about the changes in jurisdictions happening to the kinds of women working in different locations. We present evidence showing that a majority of women caught by law enforcement are streetwalkers. Thirdly, we analyze data from an online clearinghouse called TheEroticReview to learn more about the change in the kinds of women working as prostitutes over time. And finally, we present data from a new dataset being fielded by the authors called the Survey for Adult Service Providers to analyze the characteristics of women currently concentrating their activities in the Internet-based, underground prostitution market. Policy implications are discussed.

I familiarized myself with the NIBRS this summer for our Summer Academy at the Urban Institute - a dozen minority undergraduates come for two months to be mentored and work on a research project, and my mentee (this is the second year I've participated) used the NIBRS for her work on changing Latino arrest rates resulting from new immigration enforcement policies. It's a fascinating dataset - detailed, individual level arrest records for the entire country going back years, and it's all public-use. If anyone is interested in any issues involving crime you should check it out.

Anyway - I digress. I haven't really thought about this paper for the conference until I saw this article in the post today, but it was a memorable one - great, thorough work with some innovative datasets. I didn't really ask any questions of this presenter because he went shortly before I did (and I was furiously looking over my notes), but now that I have a little time to look at this again, the obvious counter-argument to his conclusion is of course internet pornography. It may not be the case at all that internet prostitution is a well functioning market - it may simply be that with the availability of pornography potential Johns don't feel the need to seek out prostitutes. It's not an airtight alternative - it's not like pornographic videos weren't available before the internet - but it's plausible that videos weren't as readily accessible as, say, a magazine subscription, and what is being substituted for street-walkers is actually internet porn rather than internet hookers.

The other alternative is simply an interaction of internet porn and sex addiction. Let's say videos were readily and easily available before the internet - juts as accessible as magazines, for example. I am not a customer, so I wouldn't know. I still imagine if you're a sex addict watching the same videos (or reading the same magazines) over and over again gets boring. So pre-internet porn users who have sex addictions, for that reason, might engage the services of prostitutes. Then comes the internet - suddenly you have substantially more video available such that even a sex addict wouldn't necessarily get bored. Again, it's not necessarily internet prostitution that is being substituted for street-walking, but internet porn. I know internet prostitution is a major phenomenon - I'm not saying it isn't substituting for some of the street walking. But it's not necessarily the primary substitute. Since the authors only look at internet penetration into a community, it doesn't seem entirely clear what the primary substitute is. If it is internet porn, rather than internet prostitution, this could actually be a good thing for the safety of the women involved in the industry. They could get paid for performing in pornos with professional co-stars, rather than working the streets. Granted, I would imagine the pay isn't as good for a porn-star as for a prostitute, but in the Youtube age where you don't need a producer or publisher for that sort of thing (i.e. - lower entry barriers), the trade-off between safety and pay for these women might actually encourage many to cross over. That can't be a bad thing.

EJW Testimonial Puzzle

My reply to Buturovic and Klein is coming out any day now at Econ Journal Watch, so I've been checking the website fairly regularly in anticipation of the new issue. One thing they have on the right side of the screen is a series of what they call "testimonials". Basically readers gushing about Dan Klein and EJW. This one stood out as a little odd to me:

"David Hume once said “Truth springs from argument among friends.” For too long economics has been without serious challenge from without and within. Econ Journal Watch is important because it provides a mechanism for open and honest debate. Without serious debate, serious science is simply not possible."

— David C. Rose, Professor and Chair, Department of Economics, University of Missouri-St. Louis

Really? Are we thinking of the same discipline? I think of economics as being notoriously argumentative. One thing it does not suffer from is a lack of introspection (or external critique for that matter). I think EJW represents an attempt to elevate critiques that other economists don't see as particularly in need of raising - and that is all well and good. But to say that "for too long economics has been without serious challenge from without and within" seems quite divorced from the reality of the discipline.

I'm still chewing on what I think of EJW. It has some decent points to make, but then I read articles like Buturovic and Klein and it strikes me that EJW is not at the cutting edge of good economics at all. I don't think there's any need to sugar coat it - I don't think Buturovic and Klein could have been accepted to any journal that the author himself wasn't an editor for. Also in that issue there was an article with some pretty base, easily addressed, and quite thinly veiled Krugman bashing like what you'd read on any number of libertarian blogs.

There are good articles too, though, which makes thinking about it tough. There are some fantastic methodological critiques. There are good retrospectives on things like the euro. I'm still forming my opinion on it - I would not provide the gushing testimonials that some people do. But this one struck me as particularly odd-ball.

"Thinking like an economist" on climate change

Bjorn Lomborg, a famous "climate change skeptic", is publishing a new book where he identifies climate change as one of the biggest problems facing the human race, which should be addressed by a carbon tax and billions invested in addressing the problem (HT - Tyler Cowen). All very shocking stuff, right? This pronouncement by Lomborg is going to electrify the environmentalist community and it will be presented as a major coup.

The problem is, as far as I can tell Lomborg isn't really saying anything new. He's always asserted that climate change is real and a problem, and he has always (like a huge portion of economists) identified a carbon tax as the solution.

I think the public's view of economists is driven by the weird way that economists think and interact (relative to everyone else at least). For example, economists are very good at compartmentalizing different parts of a problem, and they are also good at thinking speculatively. Thus, in Superfreakonomics, you have the authors speculating about the relationship between time preference and the mitigation of climate change. They set aside the question of whether we should do anything about the problem (let's say, for the sake of argument, that we should) and ask "what should we do?". It may be more efficient to wait until climate change is actually a problem and cheaply pump sulfur aerosols into the atmosphere to cool down the Earth, compared to the impoverishing impact of reducing our carbon consumption. Like it or not, this is a serious thing to consider: do we do painful remedies now when we are relatively technologically unadvanced, or do we do cheap remedies later when we'll have greater technical know-how anyway. Normal people don't think in terms of these time preferences and trade-offs... but economists are not normal people.

Lomborg is the same way - he's severely criticized Al Gore and other alarmists for hyping extreme scenarios and misleading the public about the reality of climate change. Normal people assume this means that Lomborg is somehow unconcerned about climate change. After all, Al Gore seems to have good intentions. Anyone criticizing Al Gore must not take climate change seriously. This is not the case at all.

Generally speaking, natural scientists approach natural science objectively and social issues subjectively and emotionally. The general public often approaches both natural and social science issues somewhat subjectively and emotionally. Economists tend to approach social questions quite objectively. You can't assume that because an economist opposes cap-and-trade he is unconcerned about climate change. You can't assume that because an economist opposes the minimum wage he is unconcerned about low-income families. You can't assume that because an economist supports large budget deficits they are unconcerned about fiscal responsibility. They may be unconcerned about those things, but not necessarily. They view these questions objectively, as scientific questions, whereas the general public sees them as moral questions. If you come out against any proposed climate change policy it is assumed that you don't care about climate change. If you come out against any policy purported by elected officials to help the poor or to bring responsibility to Washington, it is assumed that you don't care about those things.

Of course, part of "thinking like an economists" is laughing it off when people assume you're a monster... in retrospect this probably isn't very conducive to straightening things out.

Another important element of "thinking like an economists" is amicable arguing. Criticism among economists is famously vicious, but professional. This catches a lot of non-economists off guard, which is why I think Lomborg has been branded as an opponent of dealing with climate change (and actually - Lomborg is not an economist, although he is a social scientist and he does "think like an economist"). I've run into concern about this "amicable arguing" at Cafe Hayek a lot. People there have accused me of "disrespecting" Don Boudreaux and Russ Roberts. That's because most people argue with people they don't like and try to smooth out disagreements with people they like. Economists aren't like that, as anyone who has been to an academic workshop in economics can tell you. This is what I tried on several occasions to tell people commenting on Cafe Hayek - I'm just raising what I see as concerns with Don and Russ's argument. Patting them on the back for good points seems unnecessary and unproductive. Beyond a shadow of a doubt, Don and Russ both get the same kind of scrutiny in their own workshops at GMU (just take a look at the Youtube debate between Bryan Caplan and Peter Boettke - amicable argument is the norm within economics departments).

Normal people don't generally act like this. Vigorous disagreement and disputation are taken as signs of opposition. Normal people try to cushion criticisms of friends, and let themselves go in criticisms of enemies. I've never seen that tendancy in economists. You don't do your friends any favors by indulging inaccuracy, and as Keynes said "There is no harm in being sometimes wrong- especially if one is promptly found out".

When you add all these things together: an eagerness to speculate, an ability to compartmentalize, objectivity on questions of social import (we can also think of this as a well tuned ability to distinguish between "is" and "ought" or positive and normative points), and an argumentative nature (even with friends), what you get is a group of people who can easily be mistaken as supporting something they actually oppose or opposing something they actually support. But that's not because we're being unclear about it - it's because you normal people are.

Peter Boettke on Economics and Sociology

Peter Boettke has a new post on economic sociology, providing lots of links and his thoughts. As I've mentioned on here before (probably sharing many of these same points), I've also got a warm spot in my heart for economic sociology, which I studied with Deirdre Royster at William and Mary. A lot of Boettke's important influences - Weber, Granovetter, Berger - are quite important to my thinking too.

Boettke highlights a relatively new book by Swedberg on Tocqueville's Political Economy, which looks interesting.

He mentions Granovetter with respect to embeddedness, but doesn't really get into his work on networks. Smithian division of labor is something that is often appealed to but isn't really central to a lot of modern economics of any school, except for some institutionalists and Coasians. I think any serious modern exposition of the division of labor has to be along the lines of Granovetter and network economies.

Other economic sociologists that have influenced me have been Tilly, Evans, and Skocpol.

Boettke also recommends Alex Preda's Information, Knowledge, and Economic Life: An Introduction to the Sociology of Markets.

Economics (and blogging) that matters

"The difficulty lies, not in the new ideas, but in escaping from the old ones, which ramify, for those brought up as most of us have been, into every corner of our minds." - JMK

Peter Boettke has a great post up on what he sees as a major problem of modern Austrian economics: the pursuit of Austrian economics as a secondary literature. I think this can really be a problem with any economist that enjoys the history of economic thought. Peter writes:

"Let me confess something as I begin this post, I am a historian of economic thought. It is one of my main areas of professional specialization. It has been listed on my CV since the 1980s and I have taught courses in the field, published in the journals in the field, and attended the professional meetings in the field just as long. I am a contributor to the "secondary literature" on Mises, on Hayek, on Kirzner, on Buchanan, on Boulding, on the Ostroms, etc. I obviously view history of economic thought as a worthy professional endeavor.

But I also think this is the #1 problem with modern Austrian economics --- both internal and external perspectives on it. Those working in the area view their work as part of a secondary literature providing commentary on the works of Menger, Mises, Hayek, Rothbard, Kirzner, Lachmann, etc. The question that should be raised is, Did Mises think of himself as part of a secondary literature on the works of Menger and Bohm-Bawerk? The answer is clear; No, he did not. Mises saw himself as part of a primary literature on economics. How about Murray Rothbard? Didn't he start his career off by trying to straighten people out on what Mises said? Again the answer is clear; Yes, but he also saw himself as contributing to the primary literature in economics (and politics, and philosophy, and history)."

It's hard to strike out and break new ground, particularly when you've had a taste of really classic economics (and not just a textbook restatement of it). But reading and restating the classics I think is important for at least two reasons:

1. The classics are often caricatured, and all these guys were brilliant so its never a bad idea to revisit them and rescue them from the caricature because it's likely in many cases you'll contribute more by rescuing the insights of genius from caricature than you will from your own contribution. A good example I think is the pains I go through in my 1920-21 article to demonstrate that Keynes did think that nominal wage adjustments could clear the labor market and that he did not always oppose deflation. I suppose my interpretation of the history was original to a certain extent - but rescuing those old insights from Keynes and bringing it to the attention of three scholars who bought into a cartoon version of Keynes and modern Keynesians was worthwhile. There's also simply the act of salvaging forgotten ideas. There's Ricardian Equivalence (maybe not the best idea, but it reinvigorated the public finance debate), or Krugman's citation of Marshall and von Thunen in his work on agglomeration economies.

2. The classics gave us an excellent starting point and a fairly good body of theory, and presumably we want to move forward by fixing what they got wrong or undertheorized, not by starting from scratch. I'm very interested in working on the connection between output and employment in Keynesian models, specifically considering corporate liquidity preference not as a determinant of output (Keynes did that) but as a determinant of what he called the employment function. That was a section of Keynes that was glossed over. The body of theory works, but that's where it could be improved. The other area of course comes from the contracting literature (and I suppose is also consistent with my Austrian friends) - asset and labor specificity and heterogeneity. It's definitely in the General Theory but it's not given too much treatment. I can't blame Keynes - he had bigger points to lay out at the time - but it's something that could always be worked on more. So knowing the classic works gives us a starting point for figuring out where to add.

I think blogging risks being a "secondary literature" endeavor too. Often it's simply reposting what other people have posted, perhaps with brief comment. That's not bad in and of itself. I bring a lot of things together here that you wouldn't normally find together, but which interest me. People know they can read my blog to read those sorts of things (history of economic thought, for example - you won't find too many bloggers that do history of economic thought and give both Keynesian and Austrian schools a fair amount of treatment). The re-posting and aggregating function of blogs is good, but it would be nice if blogging could make original contributions as well.

I've tried to do that on at least a couple themes:

- Differentiating between calculation problems and incentive problems, and therefore providing another way to look at the Socialist Calculation Debate that I think clarifies a few questions.

- Pointing out the macroeconomic role of state budgets, which are often ignored.

- Highlighting the importance of externalities to economic life outside of the pollution examples you always hear (granted I talk about pollution too), and

- I feel like I've tried to post several times on the importance of corporate liquidity preference for depressions and hiring in contrast with general consumer liquidity preference (the function of which is much better understood), and

- promoting the idea of a "necessary but not sufficient" view of macroeconomic theory that doesn't see most macroeconomic theories as exhaustive or inconsistent - but simply describing different economic processes that all occur simultaneously.

These aren't necessarily original to me, but they're common themes that I blog on and try to post new material on (in addition, of course, to all my aggregation and reposting of other material). I think blogs that can do this - that can make new contributions and continue to build on a set of points - are more useful than blogs that are simply "secondary literature", as Peter Boettke puts it.


What about readers? What are your new ideas or what are areas where you would like to produce new ideas, rather than just regurgitating old ones? And what are your views on the appropriate way to interact with classic works?

Two econ posts...

Greg Mankiw criticizes "extreme Keynesians" - basically people who he says think that aggregate demand explains everything. I couldn't agree more. Indeed, this is the argument I make in my paper on the 1920-21 depression. Although there I critique Powell (2009), Woods (2009), and Murphy (2009) for acting like this "extreme Keynesianism" is "Keynesianism" and for pretending that a Keynesian's response to every downturn is fiscal and monetary stimulus (it's quite clearly not but that didn't get through to them).

So from a theoretical/rhetorical perspective I agree with Mankiw completely. From a nuts-and-bolts perspective I think there are some problems with what he uses to critique the demand-side view in this recession. He writes:

"University of Chicago economist Casey Mulligan offers a challenge to that view. Casey points out that there is a regular surge in teenage employment during the summer months because more teenagers are available to work (that is, the supply of their labor has increased). That is no surprise: It is normal supply and demand in action. But if aggregate demand were the main constraint on employment, this increase in supply should not translate into higher employment during deep recessions such as this one. But it does!"

I'm not sure Mulligan was really reading Eggerston's point about the "paradox of toil" very closely. What is the mechanism through which increased labor supply negatively impacts unemployment? Eggerston says that: "Higher short-run supply may create deflationary expectations and increase the real interest rate. This lowers aggregate demand, since aggregate demand depends on the real interest rate." Isn't that precisely what we've seen this summer - the return of deflation risks? The impact of that higher [real] interest rate on demand and employment will unfold in the coming months. This whole "paradox of toil" thing, which I honestly haven't looked into that closely, doesn't say that supply and demand don't work anymore. An increase in the supply of labor still impacts employment like it always has, it just sets in motion mechanisms that might also counter-act that increase. But you have to consider these mechanisms carefully. How would we expect the specific mechanism Eggerston identifies to effect employment? We would (1.) not expect it to do anything to normal supply-and-demand relationships, but (2.) set in motion a reduction of demand for labor with some sort of lag.

So anyway - click through the links to look at the stuff yourself, but I don't see how Mulligan really proves what he sets out to prove unless he completely misunderstands what Eggerston and Krugman have been saying on this. I should note that Greg Mankiw indicates he thinks Mulligan's claims are too strong as well.

Anyway, this gets me to a post by Peter Boettke on the Higgsian uncertainty point. It's all good, but I would make the same critique of Boettke that Mankiw makes of unnamed "extreme Keynesians". How do you attribute the weight that you do to policy regime uncertainty? Your logic is impeccable - I buy the logic. How important is that logic to the functioning of the economy right now? This is my beef with a lot of macroeconomics. Some people try to frame macroeconomics as "ex post story telling" with lots of theories floating around, and that it's unscientific because it has lots of theories floating around. The problem is, very few of these theories contradict each other. There is no reason to think that we aren't going through an industrial restructuring (a la Kling), a rebalancing of malinvestments (a la the Austrians), a deficiency of demand (a la Keynes), and some important supply shocks (a la RBCT). All these things can happen at the same time. I could throw in Jonathan Catalan's recent post contrasting Kling and the Austrians here too.

Mankiw ends with a really great anecdote that I can identify with:

"I am reminded of a response I once gave to a reporter who asked whether I was a supply-sider or a Keynesian. "I am neither a supply-side economist nor a demand-side economist," I said. "I am a supply-and-demand economist.""

I think we all should be supply-and-demand economists. Isn't that kind of what you learn on day one? Understanding all these theories and trying to figure out how they work together would go a long way towards making us less ridiculous when we fight over stuff that isn't even mutually exclusive. Or put it this way - if it is mutually exclusive it's because we've unnecessarily defined it that way when what we should be doing is identifying processes that describe the way the world works.

UPDATE: Now that I think about it, a funny irony is that many of the economists who only tell demand stories are the same economists that can't seem to get through their heads what the impact of a demand shock like a mandate will do!

Jonathan Catalan on the Liquidity Trap

Jonathan's long awaited article on Krugman and the liquidity trap is now up at mises.org. Rather than skim it furiously now, I'm going to wait to read it more carefully and then perhaps share any thoughts I have. I'm seeing lots of familiar citations in the list of references, which is good! The liquidity trap has a long and circuitous theoretical history that is only complicated by the fact that we haven't seen many of them in practice. I imagine there are more theoretical versions of the liquidity trap than there are historical instances of it, in fact! A lot of people gloss over this and provide inappropriate analysis of the problem in the process - it looks like Jonathan is avoiding that.

I like his first footnote especially: "While Paul Krugman is a Keynesian, not all Keynesians agree with Paul Krugman. As such, any Keynesian reader who takes offense at the criticism aimed at Krugman and equivocated with general Keynesian theory should recognize that this characterization is meant for the sake of simplicity."

I have to wonder - was he thinking of me? Anticipating criticism, clarifying, and qualifying is always very good practice. In other words: always make sure you cover your ass.