Four great statements

Emphases are all mine.

"The question is not whether the EMH is “true,” how could it be? Almost no economic model is precisely true. The question is whether it is useful. I find the EMH useful, and anti-EMH models to be almost completely worthless. I’m still looking for the model that will tell me how to beat the stock market. Just when I was starting to warm up to Shiller’s model, he missed the huge bull market of 2009-11." - Scott Sumner

"Problems of capitalism are not justification for post-capitalist utopia.And problems of government are not justification for any anarchist worker's paradise." - Prateek Sanjay

"This is a great division between academics and--let's call them journamalists. Academics think that their arguments are stronger and thus that they are stronger and more persuasive when they cite and link. Journamalists think that if they give their readers a whisper that there are other, perhaps better sources of information, then--OH NOES!! THE REEDRS GO READ SOMETHING ELSE!! TEHRE GOEZ R ADVERTIZING REVENUE!! This makes academics think that journamalists are immoral, mannerless cads--the type of people who you invite to dinner who then urinate on your bedspread. Journamalists, by contrast, are puzzled: "What's the big deal?" they ask. "Everybody does it."" - Brad DeLong


And perhaps the wisest thing I've read in the last twenty-four hours:


"I decided to expand my “library”" - Jonathan Catalan

Who said it?

"Showing that one institutional arrangement leads to suboptimal performance is not equivalent, however, to showing that another institutional arrangement will perform better."

In case you're not sure what to get your sweetie in two weeks...

(HT Evan)

New Critical Review

Thanks to Warren for pointing out that a new issue of Critical Review is out. My copy hasn't come yet, which is good - because it will distract me from some work I need to do!

I'm glad to live in a county that makes public investments

Today made me appreciate Arlington County a little more - we had a carbon monoxide alarm go off in the apartment and Arlington County Fire Department came over and provided some great assistance. Everything is good now. It's good to live in a civilized society where we pay taxes and then get together to decide what we want to do with that money to make the community better. And it is better for having ACFD.

This also provides a great example of the emergence of government institutions. We used to have an all volunteer, independent fire department. As the county grew citizens decided it was appropriate to pay career firefighters to help the independent department out, and now that's evolved into a fully public department. Different societies at different points need different institutions, and when free people are allowed to make those decisions you usually get the best institutions. Maybe one day we'll re-privatize it if that's appropriate (like the post office - it seems like it doesn't make all that much sense to keep that public anymore). Who knows.

Also, for those who are curious, ACFD was the first on the scene and led the fire-fighting at the Pentagon (which is in Arlington).

A very interesting looking article on Cambridge Public Choice Theory

People who tell you that mainstream economists don't think about the nature of public decision making or the prospect of government failure are either trying to mislead you or simply not aware of the literature. All of the major market failure papers note this sort of thing - and it seems to me the point is obvious and implicit for those that don't. We've all known about this since Adam Smith and well before. And here's one more piece of evidence from the Cambridge Journal of Economics:

"Economists and the analysis of government failure: fallacies in the Chicago and Virginia interpretations of Cambridge welfare economics"

By Roger E. Backhouse and Steven G. Medema*

The theory of government failure was developed as a reaction against Pigovian welfare economics and the Cambridge approach to economic policy analysis generally, which ostensibly lacked a theory of governmental behaviour. We argue that the Cambridge tradition—as reflected in the writings of Henry Sidgwick, Alfred Marshall and A.C. Pigou—evidences a clear sense of the potential limitations and inefficiencies of the political process that were later developed, albeit in a more systematic fashion, in the government failure literature and at the same time bring out the ways in which the Cambridge and contemporary government failure approaches diverge, in spite of their strong similarities.

Government in science: the synthetic rubber case

"The rubber research program was a wartime emergency effort that became a peacetime research program. The wartime effort achieved most of its goals; the peacetime program was markedly less successful. During the war, patriotism and the desire not to let down the boys at the front acted as powerful stimuli. Once the war was over, such psychological motivation was considerably reduced. The rubber companies once again gave priority to profits, technological advantage, and market osition. There was no advantage (even a positive disadvantage) in making technical breakthroughs that would have to be shared with competitors. The universities began to see the research program as an easy means of funding their research and graduate students. While they clearly tried to produce worthwhile results, in order to create a rationale to prolong the research program, the academic groups nevertheless selected topics whcih reflected their own research interests.

Commercial competition probably provides the best spur to innovation in peacetime... The marketplace can be replaced by the peer-review system used by pure science or by mission-directed research. Neither method was adequately employed by the postwar research program."

- Peter Morris, "The American Synthetic Rubber Research Program", University of Pennsylvania Press, 1989 (p. 50-51).

A wise Austrian economist on mainstream understandings of preferences and the utility functions that represent them

"It should immediately be clear from this definition of “represent” that if one function, U(· ), represents the preference ordering, then any positive monotonic (i.e. rank order-respecting) transformation of U(· ) will also represent the ordering. The reason neoclassicals stress this seemingly trivial mathematical detail is that it (should) prevent any possible significance from being assigned to a “util.” For example, if U(a) = 20, while U(b) = 10, we can conclude is that a @ b, i.e. that the individual considers bundle a to be at least as good as bundle b [Bob used the symbol "@" to indicate the preference relation in this piece]. But we may not conclude that bundle a offers ten more “utils,” nor can we say that bundle a is “twice as good” as bundle b. Why not? Because our representation theorem tells us that the function V(· ), defined, say, as the square of the function U(· ), will also represent the preference relation. So if we used this monotonic transformation, we would have V(a) = 400 and V(b) = 100. It’s still true that the number assigned to the first bundle is higher, and thus we still conclude that bundle a is (ordinally) preferred by the individual. But now the utility assigned to the first bundle exceeds by three hundred that assigned to the second bundle, and it is no longer double the quantity."

- Bob Murphy, 2000

Note to commenters...

...because there's been cases of this towards me and now other commenters. If you are just here to insult other people, you're going to have your comments removed.

If you are making a substantive point that you've just gotten worked up about, that'll probably be OK. But if you're just here to be a jerk, you're not going to be allowed to stay here.

Also try to remember not to comment anonymously. Pseudonyms are just peachy.

Do these idiots even think before they say these things?

OK - so I'm listining to C-SPAN in the grocery store, and they're replaying one of this morning's network shows. They're talking to some guy involved with one of the campaigns - I think Newt's - and he was discussing some new poll of Hispanic voters in Florida who were not too keen on the GOP.

This guy argues that Hispanics are going to warm up to the Republicans because family values are very important to them.

Now - maybe this is just a rally-the-base kind of comment. But what the hell is this supposed to mean? Are Democrats not supportive of family values? Or for that matter, are Hispanics supposed to be uniquely supportive of family values? Has he ever considered that they aren't supporting Republicans precisely because of how they approach family values?

And a lot of Republicans actually think like this, I think. They think that half the country just doesn't care about family and ethics.

And I hate to bring Ron Paul into this again, but he makes insanely idiotic comments like this too. "People are going to support me because they love liberty". Dog whistles are a staple for politicians seeking high office, but this sort of thing firmly convinces me that (1.) these people don't really understand a lot of the American people, (2.) they haven't really thought carefully about liberty - only their own reelection, and (3.) they haven't really thought carefully about family - only their own reelection.

I like it better - for example - when Newt Gingrich comes out and just says "Obama is pro-food stamps and I don't like them". That's clear. That's a demarcation. I think food stamps are a good program, so I know I side with Obama on this. When they muck it up with comments that are more vague like "Obama is pro-food stamps so he wants people to be dependent on government" they sound like idiots or opportunists. On Ron Paul - don't tell me you support liberty. I support liberty too, and I don't like you much. Tell me what you actually think and let me decide if you're the president for me.

The grandest of generalizations

F.Y. Edgeworth, in defending the early marginalists' work on neoclassical microeconomics, talked about how the work was meant to "satisfy the soul of the philosopher with the grandest of generalizations". It's in this sense that I'm personally "satisfied" by the use of cardinal utility functions - something that's been discussed by stickman, the comment section of unlearningecon's blog, and Robert Vienneau.

My view is actually close to Mattheus's on what is actually true (preferences are ordinal, utility functions are made up, and interpersonal utility comparisons don't have a positive basis yet [that I know of - if a neuroscientist studying dopamine levels and human perception wants to challenge that I'm all ears]). But my views are quite far from Mattheus's on (1.) what it is mainstream economists think about these things, and (2.) how we should do microeconomics. With respect to those points, I can agree with Vienneau, stickman, and unlearningecon that a huge portion of Austrians have no clue what they are talking about.

So let's start at the beginning. On two separate points I think you really have to distinguish between two very different things:

1. You have to distinguish between "what mainstream economists think" and "what mainstream economists may or may not teach their undergraduate students"

2. You have to distinguish between "preferences" and "utility".

On point #1, I'm only going to concern myself with what mainstream economists think, because what they teach their students is a pedagogical issue and while I have my own thoughts on teaching undergrads, that doesn't really concern the discussion we're having.

Mainstream economists all agree that preferences are fundamentally ordinal relations. Indeed, that's how they're defined. It's a "preference relation" - it's not some preference scale. Everyone agrees that we can say "X is preferred to Y", or in some cases "X is indifferent to Y", but the sentence "X is twice as preferred as Y" doesn't make any sense because the preference relation is a binary relation. Now, we want to do something with that relation. So we usually assume certain things about preference relations. We say that agents are "rational". Now - a lot of critics of mainstream economics who don't know any better load a lot of junk onto that word "rational". But to say that someone has "rational preferences" is quite simple. It's just saying that (1.) the preference relations are complete, (2.) the preference relations are transitive. That's all.

The important question is - can rational agents settle on a maximal bundle given a set of constraints (typically a budget constraint) with these ordinal preferences.

Mainstream economists say "yes". I think different people learn a different answer to this question. I was taught the answer using Walker's Theorem (1977), because my professor thought it was particularly elegant. I understand there are other ways to show this, but learning Walker's Theorem was a bitch, so I've exerted exactly zero effort in learning any other method. This insight is the heart of mainstream micro. It's so important that we had to write the proof on our midterm and on our final. I think it was something like 1/8th of the points on our midterm and 1/5th of the points on our final. And since that was all of our grade except for 10% for homework, you can see how critical this point is. Ordinal preference relations can be maximized by a rational agent for any budget constraint. Please stop telling me mainstream economists don't think this.

OK, so this is settled. Now this is where Edgeworth's "grandest of generalizations" comes in.

We want to construct theories about the way the economy works motivated by action on the basis of these ordinal preference relations. But it's hard to do that with a collection of binary relations (X>Y, Y>Z, W>P, L>Q, etc.). So we ask ourselves: "can I think of a functional relation that represents these ordinal preference relations, which I can then analyze and use to theorize different things?". The key word here is "represents" - and this is also a point stressed by mainstream economists. What you want is a (cardinal) functional relation that will give you the same answer that you would get from a plausible set of ordinal preference relations. You want that because you can do calculus on a functional relation, but not on a set of binary relations.

Thus, we make up utility functions. We want utility functions that assign values to bundles that duplicate ordinal preference relations. If X is preferred to Y, we want U(X) > U(Y) for all X and Y under consideration. We also want to make sure we're talking about rational preference relations, so the function has to obey those rules as well. That's all that matters.

This gets to a point that stickman raised in some of the comment sections about monotonic transformations of utility functions. If U=x represents a preference relation, then U=ln(x) represents the same preference relation equally well. Indeed, there are lots of problems where you make that exact monotonic transformation because it's easier to solve U=ln(x) than U=x.

The point is, utility functions are meant to represent ordinal preference relations. They are not intended to give you information about the intensity of preferences. This is part of the reason that I'm somewhat skeptical of welfare analysis. It walks a dangerous line. Sometimes it's OK as a way of translating preferences into dollars. That doesn't cross the line of telling you how much more you enjoy something than another thing - it simply monetizes a preference relation. You don't know how much more you enjoy something unless you have a money-to-utils conversion, which of course is a conversion that doesn't exist (or at least that we don't have access to).

*****

A lot of these discussions go wrong when people take what they think they were taught in undergraduate microeconomics and start assuming that's what mainstream economics is. Things are always simplified. The problems you spend a lot of time on as an undergraduate are very different from the problems you spend time on as a graduate student, and it's the latter that's somewhat closer to what economists actually spend time on. Undergraduates spend very little time on working with ordinal preference relations. Graduate students do. They work a lot with that because it's the underpinning of all the subsequent functional relations that we work with.

Critics need to stop and take a second to consider that maybe undergraduate economics doesn't spend much time articulating the step from ordinal preference relations to cardinal utility functions because that step - while necessary - is not important to get the fundamental insights of economics. If instructional time is scarce - and it is, because many don't continue on in economics - you disseminate more knowledge by expecting your students to trust you on the step between ordinal preference and cardinal utility. With scarce instructional time you are also probably better off finessing the difference between a utility function that is useful for theoretical applications and a preference relation that is what is actually motivating human action.

Anyway - trust me - this is not some incredible insight of the internet Austrians. We know this. We spend a considerable amount of time on it.

...and if you all are mean to me in the comment section my next post will be a proof of Walker's Theorem.

Do the poor "deserve" their poverty?

Noahpinion has some good thoughts on this question that Bryan Caplan and Karl Smith are going to debate soon. Some of it waxes utilitarian: "When I witness the urban blight, violence, drug abuse, and other social ills that poverty may be causing, as a non-poor person I have an interest in preventing these social ills from affecting me, regardless of whether the ills are "deserved."".

This is a good point too: "That said, I think the Caplan definition of "deserve" is not as "uncontroversial" a moral premise as Caplan declares. The reason is that it is a partial-equilibrium definition, not a general-equilibrium one. If we live in a society in which X percent of the populace must be poor, then no matter what set of actions is taken by the population, some people will wind up in poverty. To see this, imagine that we lived in a society in which the hardest-working 50% of people get to be spectacularly rich, and the other 50% are forced to live in squalid poverty. In this society, if everyone raises their effort by 1000%, the number of people in poverty stays exactly the same. I doubt that most people would say that the lower half of the population "deserved" to stay in poverty after raising their effort by 1000%! But that is exactly what Caplan's definition implies."

Persistent underutilization of the factors of production - among them labor - is usually considered to be a macroeconomic question requiring macroeconomic answers. For some reason, though, a lot of poverty gets discussed in microeconomic terms. I've never been quite sure why.

One concern of mine about this talking about "deserving" poverty is that whatever decisions people make that put them in poverty aren't made in a vacuum. When you're a kid you are crucially dependent on the investments that society makes in you and that your parents make in you. If there are youth populations that parents and society systematically underinvest in, those populations are going to end up with higher poverty rates. Now, we probably could trace that to decisions they make in almost every case. Even factors out of their control can ultimately ascribed to their own decisions. Depressed local labor markets? Why didn't you just set out on your own - why didn't you move? But that seems to miss the point. Would anyone else, put in the same circumstances growing up, have made different decisions on average? Probably not. There's plenty of variation in human behavior and that variation does affect outcomes - but it's still constrained by these circumstances.

This distinction between "equality of opportunity" and "equality of outcomes" is largely made up. If you give a poor black kid and a middle class white kid a "color blind" college admissions test or a "color blind" employment test, you can't call that "equality of opportunity". Opportunity goes considerably deeper than the immediate circumstances of any given choice. Opportunity is something that builds up over years of investment (or lack of investment) in a kid.

Sometimes doing the right thing can be a real pain...

...not that "the right thing" here has any moral implications at all - just finally realizing that I really just need to drop this BLS data, use quarterly LED data with sex and education by industry instead, and add three more years of data that have managed to pile up since I first started working on this harebrained idea. Still, this is going to be a good paper, I think.

Gaaahhh.

I also think my department should trust that I would have done well in classes and just let me work on my own stuff.

Census humor

I've only ever used the SF-3 myself. Randall Munroe studied physics, so I'm impressed with his familiarity with social science datasets.

Fun fact I did not know until today - Munroe graduated from Christopher Newport University the same year I graduated from William and Mary. CNU is just a few miles down the road from W&M. My cousin went there, and Kate did a lot of joint stuff with the school's sister chapter of her sorority (Phi Mu).

Assault of Thoughts - 1/27/2012

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

- Noahpinion rightly praises Tabarrok's call for a more innovative economy. He's also right to explicitly raise the issue of public goods (although I'd rather call it "externalities" - a lot of these things aren't really public goods, they're private goods with crucial externalities). However, I'm not sure Tabarrok would be on the same page with him on that point. For me, this is an "all of the above" point. Noahpinion is exactly right that there are lots of things where simply increasing spending would be a very, very good idea. But Tabarrok is exactly right that this is about so much more than that - that a lot of it is about an environment that fosters entrepreneurialism and innovation. Previously, I've raised some concerns about the way Tabarrok talks about high skill immigration.

- Ron Paul proof-read and approved all the newsletters. Not exactly a surprise or a revelation. The guy vehemently defended them until the political winds turned. If this isn't enough to dissuade libertarians, I can understand that. But don't pretend this isn't something that we who are bothered by this should just brush off. And just admit how bad it all is like Steve Horwitz and Nick Gillespie. If the modern libertarian movement is nothing more than a Ron Paul lovefest it's hard to see how it differs from any other political personality cult with an idealistic ideology behind it.

- Troy Camplin claims that we ostracize and sneer at the commercial class. I call that bunk, and explain my position in the comment section. What do you all think? UPDATE: [More from Troy. He writes in response "I do think they are ostracized and sneered at in our literature and by many of our academics, who in turn teach college students to think of businessmen as inherently corrupt." I cannot think of a single professor I've had in my seven and half years of higher education that has said that businessmen are inherently corrupt (and I've had a couple humanities professors and a bunch of sociologists). But perhaps my case is still atypical. What about you all? Has anyone ever taught you that businessmen are inherently corrupt? He goes on: "One of the consequences is that those who go to college then go into business think that one has to be corrupt to be successful" I knew a lot of business majors (who often doubled-majored with economics at W&M), including two roommates. None of them thought this. I've never met anybody who went "into business" and thought this. But again - my case may be atypical. Can anyone confirm Troy's assertions here?]

- Happy EITC Day! Sometimes I feel like the people who whine about welfare and act as if government isn't an emergent order itself don't really understand the important landmarks in the history of our social democracy. U.S. government is a decentralized system with plenty of opportunity for information feedback and evolution. That makes for good government, and the evolution of the welfare state is an excellent example of that. Hooray for the EITC!

Unlearningecon with some thoughts on Austrian economics

Here.

Well now I'm actually conflicted!!!!

This isn't something you'd hear out of Ron Paul.

Good Genes + Persistent Libido = A Prolific Presidential Legacy

Apparently two of President John Tyler's grandchildren are still alive today (HT - Jenn Sykes). That's what continuing to have kids into your sixties (President Tyler), and your seventies (his son Lyon Gardiner Tyler) will get you! This is of personal interest because Lyon Gardiner Tyler is closely related to William and Mary - he was its seventeenth president and has lots of stuff named after him there. President Tyler was an alum as well.

More thoughts on Lastrapes, Selgin, and White

I've mentioned a few times now on the blog - including the last post - my concern about the fact that their paper is essentially a pre-post test. That's fine descriptively (Christina Romer has done a lot of work like this), but it's not as good for policy analysis.

So what might be different between the pre- and post-1913 period that might justify a difference-in-differences approach? I can think of a few things:

1. The move from extensive to intensive growth. I've referred to this previously as "the closing of the frontier" in the Cafe Hayek comment section, at which point George Selgin rather unceremoniously dismissed my views. But intensive growth and extensive growth certainly shouldn't be so controversial.

2. The move from very little of the labor force working for wages to a lot of the labor force working for wages.

3. The increased financialization of the economy (this is perhaps one of the most important points).

We could also think about the gold standard - is there a case for differentiating between the gold standard Fed and the post-gold standard Fed? The paper may have addressed this point - it's been several months since I've read it.

Can anyone think of anything else?

The paper is coming out in the Journal of Macroeconomics. If anyone has the time or inclination to run a difference-in-differences, perhaps with Great Britain or some other country as the counterfactual, I think that would be a valuable contribution. Macroeconometrics can learn a lot from microeconometrics.

Vulnerability to rent-seeking means you're not as robust as you could be

Steve Horwitz has a great comment on this post, and I would restrict my response to that thread, except there are two really important points I want to make - which I think merits a new post. First, he agrees the burden of proof is on free bankers. On the institutional robustness point, I think this is definitely right, simply because they've proven less robust. I take more issue with his second and third point. He writes:

"...the increased role played by government in money production, whether in the form of NBS type regulation or true central banks, were the result not of failures of free banking but of rent-seeking by private interests and/or the desire of government actors to have access to revenue through money creation. I'm quite confident that the cases where pretty free systems became central banks fit this pattern."

This is an odd point to raise, I think. if you're vulnerable to rent-seeking in this way it means you're not a very robust institution! Communists often complain that totalitarian-minded rent-seekers spoiled the worker's paradise. We usually don't take this to be a good argument supporting the institutional robustness of Communism! If you need angels to get a system of free-banking to work, then you're out of luck - because men aren't angels.

Next Steve writes that free bankers should:

"Do what White, Selgin, and Lastrapes have done and demonstrate that generally accepted macro outcomes have been worse under central banking than more free systems. Again, I think a real preponderance of the evidence is on the side of free banking here."

White, Selgin, and Lastrapes do have an interesting paper, but coming from the world of labor market program evaluation it's always been hard for me to know what to make of it. It's essentially a pre-post test, which would never get any creedance elsewhere. What you really want is some way to identify the counter-factual, because there are lots of reasons to believe that the twentieth century was very different from the nineteenth century, and had different requirements of its monetary and financial system.

One solution I've noodled over before is reproducing the White, Selgin, and Lastrapes analysis but with Great Britain as a paired economy in a difference-in-differences analysis, a common approach in labor economics and virtually the only viable counterfactual I can think of for the sort of policy analysis they're attempting. Details on difference-in-differences estimators can be found here. The idea is that Britain had a central bank through this whole period, so if you difference out the difference between the British economy post-1913 and the British economy pre-1913, you can identify the impact of the Fed. Maybe. It's still a dicey proposition.

More agreement on something that doesn't get us anywhere

Arnold Kling links to David Colander writing: "Not only are economists as a group not humble enough, what lay people are presented as economist's policy recommendations are often the policy recommendations of the least humble economist. In summary, my argument is that lack of humility in conveying the limitations of their results is the most serious ethical problem facing economists; it played a much larger role in causing the recent financial crisis than did the type of payments highlighted by Inside Job. Thus, and any new code of ethics for economists should deal with that humility problem."

I strongly agree with this - it's very similar to some of the points made by Robert Johnson in my link below.

The problem, once again, is that we all have different culprits in mind when we read something like this. When I read this, I immediately think of the mostly libertarian economists who want to radically alter and re-engineer the society that has naturally emerged and evolved in the United States by dismantling the social democracy that we have.

I highly doubt this is who Arnold Kling is thinking of as he reads this passage.

In fact, the very people that seem completely lacking in humility to me probably seem like poster children of humility to him.

I'm not sure where this gets us... probably nowhere.

Steve Horwtiz on Free Banking - a question about institutional robustness

In the comment thread of this post, Steve Horwtiz writes (in response to another commenter - not my initial post):

"There was no central bank in the 1890s, but that doesn't indict "free markets" because the US money supply process was still very much affected by the federal regulations of the National Banking System that made it difficult for national banks to respond to increased in the demand for money, especially those associated with harvest season or sectoral problems (e.g. the railroads in 1893). The panics of 1893 and 1907 were classic examples of government intervention (and in the name of financing the Civil War no less) gone bad."

I don't want to endorse his history because I'm no expert on the history of this period, and I don't want to "indict free markets" because of course I am a free market economist. But if we take this to be a reference to free banking, I do want to raise a question about institutional robustness. Since we only seem to be able to point to scattered, fleeting references to free banking, can you blame us non-free-bankers for raising concerns about how robust such a system would be? It's a bit like Communists who are never happy with the totalitarian systems that always seem to result from any attempt at making Communism a reality. There are lots of reasons to criticize Communism, but one quite natural criticism is that the only Communist society they've ever really been happy with survived for a grand total of two months.

I don't think - and have never claimed - central banking is perfect, but I think it works well enough to do the institutional job that we want it to do. We know central bankers learn from their mistakes and adapt the institution over time (just look at the history of the Fed). And we know these institutions are actually stable - we're coming up on the 100 year anniversary of the Fed, and the Bank of England has been going strong for centuries.

Steve is right in this comment - the 1890s were not a free banking era as free bankers understand the term. It's hard to find such an era, actually.

Those of us who care about institutional robustness and the actual functioning of our theoretical ideas in the real world should care about that, I think.

Facts are stubborn things

Well this is depressing.

I've always looked at those "fact checking" sites as being similar to Wikipedia anyway - good starting points. Still, this one is unfortunate.

Be careful reasoning from MPC

I have not jumped into the recent stimulus debate. To be honest I've been pretty put off by the mudslinging, particularly from Cochrane's corner. But this was an interesting post from David Glasner on it. He makes the point that if you want to translate Lucas and Cochrane into a Keynesian model, we're talking about an MPC of zero, so that consumption is entirely determined by lifetime income.

This is all fine, but it's important not to reason an actual multiplier from a given MPC. Yes, we can get something that's been labeled "the multiplier", but what we actually care about (and what we estimate) is the change in national income in response to a change in government spending. That is generally smaller than the multiplier you get from a given MPC. Why? Because government spending can crowd out investment spending.

With crowding out, you don't even need an MPC of zero to get Cochrane's result.

Right now, of course, we're more likely to see crowding in than crowding out. I'm also not personally convinced by an MPC of zero.

Fixing Economics

Robert Johnson has a few suggestions, below (HT - Mark Thoma). Regular readers know I think some of the sob stories about the "state of economics" are overblown. The two examples that Johnson leads with in the article (the Queen asking why economists "didn't see it" and the Mankiw walkout) are particularly irrelevant points. The Queen shouldn't expect anyone to be able to forecast a complex system, and the Mankiw students were being very naive.

Nevertheless, there's some really good stuff in here. I think the third point is probably already inculcated by the discipline, but the others - particularly the first - are very good.

One of the problems is that reading the first suggestion, I know different people will have different culprits in mind.

*****

"First, economists should resist overstating what they actually know. The quest for certainty, as philosopher John Dewey called it in 1929, is a dangerous temptress. In anxious times like the present, experts can gain great favor in society by offering a false resolution of uncertainty. Of course when the falseness is later unmasked as snake oil, the heroic reputation of the expert is shattered. But that tends to happen only after the damage is done.

Second, economists have to recognize the shortcomings of high-powered mathematical models, which are not substitutes for vigilant observation. Nobel laureate Kenneth Arrow saw this danger years ago when he exclaimed, “The math takes on a life of its own because the mathematics pushed toward a tendency to prove theories of mathematical, rather than scientific, interest.”

Financial-market models, for instance, tend to be constructed with building blocks that assume stable and anchored expectations. But the long history of financial crises over the past 200 years belies that notion. As far back as 1921, Frank Knight of the University of Chicago made the useful distinction between measurable risk and “unknown unknowns,” which he called radical uncertainty. Knight’s point was that in a period of radical uncertainty, expectations couldn’t be anchored because they have nothing to latch onto. Financial theories and regulatory designs that hinge on the assumption of stable and anchored expectations are not resilient enough to meet the challenges presented by real financial markets in radically uncertain times. [See Keynes on unknown unknowns as well]

The third remedy for repairing economics is to reintroduce context. More research on economic history and evidence-based studies are needed to understand the economy and overcome the mechanistic bare-bones models the students at Harvard objected to being taught.
But the economic orthodoxy continues its romance with the Enlightenment tradition of Cartesian “universal laws.” This began after the Thirty Years’ War, when society demanded both a method of investigation that did not antagonize religious factions and universal abstract laws and principles that could be objectively proven. Lost to the traumas of religious and social turmoil were the humble and pragmatic humanistic approaches of Francis Bacon and Michel de Montaigne and the suppleness of William Shakespeare. Reorienting economics away from the Enlightenment glamour of high theory and returning it to focusing on real problems, in the same way a clinical physician does, would make economics more relevant.

The profession needs to realign the incentives for doing reputable research in order to protect its integrity as a whole, as is done in medicine. Recent policies announced by the American Economic Association on disclosing conflicts of interest are a step in a healthy direction. Faculty members should also be forced to step down from consulting at the time they receive tenure.
Fourth, we must acknowledge the intimate, inseparable relationship between politics and economics. Modern debates about who caused the financial crisis—­government or the private financial sector—are almost ­nonsensical. We are living in an era of money politics and large powerful interests that influence the laws and regulations and their enforcement. In order to catalyze the evolution of economics, research teams would benefit from multidisciplinary interaction with politics, psychology, anthropology, sociology and history.

Such interdisciplinary communication would also benefit another neglected area of economics: the study of macroeconomic systems. Psychologists mock what economists call the micro­foundations of consumer behavior—a set of assumptions based on the idea that isolated individuals behave with clear knowledge of the future. That this framework is suitable for aggregate systems in a globalized economy simply because the tribe called economics has agreed to adhere to these ad hoc assumptions makes no sense. Increased interactions with disciplines that economists have often mocked as unscientific would greatly improve economists’ understanding of the real world and would be more truly scientific."

Bob on 1920-1921

I'm running out now, but please see Bob Murphy on the Krugman post. He's absolutely right about the way I interpret his Freeman article - I'm going to check out the process of getting that corrected. RAE article should be free of this (thanks again to some careful review by Bob).

A somewhat stunted understanding of what free people ought to be free to do collectively

Readers know I think externalities are a very important concept, and probably also know that I prefer talking about externalities to talking about public/private goods (because true public goods are quite rare, public goods can be provided privately, and there are important externalities associated with private goods... so the public/private thing just seems less helpful). But most people treat them similarly.

Public goods/externality arguments have always been an important part of the argument for free government, going at least as far back as Adam Smith. It's an important argument, but is it the only argument?

I was reading Coyne and Lemke's new article on polycentricity and disaster relief (HT Peter Boettke on the new issue of SIEO - Ostrom's work on polycentricity has interested me for a while, which is what piqued my interest in this article), and they seemed entirely focused on these efficiency/welfare maximization/incentive/calculation questions in talking about government and disaster relief. Take this passage for example:

"To date, those writing in the political economy tradition have focused on three categories of arguments related to the government provision of disaster relief. The first is how relief fails to fulfill the traditional defining characteristics of a public good. The traditional theory of public goods requires that a good be non-rivalrous in consumption and non-excludable in order to be considered public. If the good meets these criteria the market ‗fails‘ to supply the optimal amount of the good due to issues of pricing and free riding. In order to correct this market failure, it is argued that government intervention must intervene to increase production to move closer to the optimal level of output.

However, as argued by Shughart (2011), disaster relief fails to meet the necessary criteria because many components of disaster relief are scarce and, as such, rivalrous. The teams and tools needed to rescue survivors are in limited supply, and emergency provisions, such as drinking water and medical care, are also only available in finite quantities. These same goods are also easily excludable, which means that whole swaths of disaster relief efforts immediately fail to meet both criteria for being considered public goods (Shughart 2011). One particularly memorable example from Katrina is the purchase of trailers as substitute residences. Trailers are both non-excludable [sic] and non-rivalrous [sic], positioning them soundly as private rather than public goods."

There's more in the paper about knowledge and incentive problems too, but that all also falls under standard microeconomic conceptions of the role of government.

What was surprising to me about reading their paper was that I would have never even thought to justify federal disaster relief on the basis of an externality/public goods point, in the same way that I don't think I'd justify welfare on that basis (well - I may talk some in that case about the externalities imposed on children growing up in poor families against their will).

Think about what you're saying when you point out that goods and services needed in a disaster are private goods (they are - I agree on that), and therefore should be provided by the market. People who get goods in the market are those with the willingness and ability to pay the market price. Normally we think those two things are a pretty good indicator of where the good should be allocated, right? We want people to have the good who have the highest opportunity cost of not having the good.

But in a disaster situation (particularly in poor areas) you have major constraints on the ability to pay the market price, particularly if supplies are limited and there's a lot of income inequality. It's not clear at all that traditional market allocation is ideal in these situations. Maybe until things settle down everyone should have (1.) dry clothes, (2.) food, (3.) water, (4.) medical attention, and (5.) some kind of shelter regardless of their willingness and ability to pay a market price. If that's the case, it's unclear what the fact that these are private goods has to do with anything. They are private goods, but the market won't allocate them in the way that we probably think is best in these situations.

*****

Two other points:

1. Obviously that doesn't mean you shut down markets. That should go without saying, but in case someone thinks I'm advocating shutting down markets I want to clarify this point. Nobody who knows their economics should get upset at "price gouging" in a disaster. But there's also no reason to act like the government and the market are any more in contradiction with each other than charities and the market are. When government and charities have distributed all the supplies they have on a non-market, equitable basis that source of egalitarian supply is unlikely to have fulfilled everyone's demand. So you don't want to outlaw price gouging or anything like that - the market offers another avenue for fulfilling people's needs. Liberal governments, liberal private organizations, and liberal markets are complements to each other.

2. I haven't really gotten into the polycentricity discussion of the article (which is what I was really reading the article for), but that point is important too. One of the great strengths of the United States is that government and governance here are decentralized. We could have more of that. In addition, we have a lot of non-profit, humanitarian, NGO, and other organizations with overlapping missions and capacities. That polycentric response makes disaster relief a lot more robust than it otherwise would be.

*****

In summary - what could possibly justify limiting our view of government to such a weak concept as "public goods"? That just seems strange to me. You could argue that national defense is a public good, but personal and local security certainly isn't. We don't provide that because it's a "public good" or because it can't be provided on the market. We provide that because we believe that all men and women should have secure lives and property. There's lots of things that the government does besides providing public goods. It's very risky to let welfare economics dictate your political philosophy.

Some details on how our non-Keynesian president thinks about space policy...

...at a time when we need big public investments. From the Space Politics blog:

"The [New Yorker] article notes that as a candidate for president in 2008, Obama “had promised a bold space program”, a reference to his space policy white paper the campaign released in August 2008. However, according to the New Yorker article, those plans foundered on projections of growing budget deficits. “Especially in light of our new fiscal context, it is not possible to achieve the inspiring space program goals discussed during the campaign,” a November 2009 memo (authorship unstated) advised the president. That sentence, the article noted, was in bold and underlined for particular emphasis. The result:

'Obama was told that he should cancel NASA’s Bush-era Constellation program, along with its support projects, like the Ares launch vehicles, which were designed to return astronauts to the moon by 2020. The program was behind schedule, over budget, and “unachievable.” He agreed to end it. During the stimulus debate, Obama’s metaphorical moon-shot idea—the smart grid—was struck down as unworkable. Now the Administration’s actual moon-shot program was dead, too.'

Later, the article notes the president received a letter dated February 2, 2010—one day after the release of the 2011 budget proposal that announced plans to cancel Constellation, as Obama was advised the previous November—from a Virginia woman whose husband was working on the program. “I voted for you. I supported you. But I am very disappointed in you. You are not the President I thought you were going to be,” the woman, identified only as “Ginger”, wrote, after criticizing the president for cancelling Constellation while continuing to fund wars in Iraq and Afghanistan.

Obama’s response to his staff: “can I get a sense of how Ares fit in with our long term NASA strategy to effectively respond”. A few days later he got that information and then instructed an aide to “Draft a short letter for Ginger, answering her primary concern—her husband’s career—for me to send.” What the president was told, and how he decided to respond, aren’t disclosed."

Need not be from the Onion (but it is)

"He's not afraid to give Americans no-nonsense straight talk about his completely delusional fantasy world. That's why I'm part of the highly unlikely Ron Paul revolution."

Paul fans will like the last line too.

Good discussion of 1920-1921

In the comment section of this post.

One of the things they bring up that I haven't explored much is how the banking system fared. I'll have to make a mental note to look into that.

Plus there are several very kind references to me. Always nice.

Note that the three pieces that Zywicki links to as forming his own background on the depression are exactly the three pieces (which are actually quite different from each other - something I have to thank Bob Murphy for impressing upon me) that I respond to in my RAE article.

Warren Harding is A-OK with me

Another thing on the 1920-1921 stuff.

A lot of this inevitably turns into "Warren Harding was great" or "they don't like Harding". As a non-Harding scholar but as someone who is modestly conversant in the economic events of 1920-1921, I want to make clear that I think Harding was a fine president, for the brief time that he served. Labor unrest played a major role in the downturn, and he could have cracked down on that, but I know of no particularly draconian action from the Harding administration. Harding released Debs from the jail that Wilson threw him in on inexcusable, trumped up charges. Harding wisely cut taxes which, while not some depression-curing elixir, was the right move. Harding was a "return to normalcy" and a long-term growth president. He was a good president.

The one stain (which I don't know much about) is the Teapot Dome Scandal. I'm told he didn't have direct involvement in that. That's good, but not great. Presidents ought to know what goes on in their administration. So that's not ideal, but overall I don't judge Harding to be a "bad president" or anything like that. The caveat - as I said above - is that I'm certainly no Harding scholar.

UPDATE: Oh! And I almost forgot! Harding established the OMB which was an extremely wise move that was probably long overdue.

Krugman on 1920-21

Yesterday, Paul Krugman had another quick post on Harding and the 1920-1921 depression. It's been odd how the timing on his posts has worked - last time he commented on it, my RAE article just came out, so I sent it to him and he linked to it. This time, too, he posted shortly after my CJE article came out, so I sent that to him as well, and then I got another link!

I suggested if he was short on time he scroll down to the figure - I thought he'd like that.

I do want to clarify something on the passage he cites. It makes it sound like I may even think that post-war austerity caused the 1920-21 depression. That was certainly something you heard at the time (and a big part of the reason why a few people thought there might be a depression after WWII). I don't actually think it's quite that simple, myself - and I don't want people to be thrown by the passage Krugman cited. In my opinion Christina Romer (1988) has amply demonstrated that demand shocks had little to do with the 1920-21 depression. I agree. What I think is reasonable to say is that the sort of demand shock implicit in the rapid demobilization might have made things a little worse than they would have been to boot. That was really the intention of that passage.

Certainly if fiscal austerity was an important determinant of recovery, as some claim, the deep cuts of the Wilson administration should have prevented us from ever falling into the 1920-21 depression in the first place!

An odd sentence about Gingrich

Andrew Sullivan has a post up spelling out the appeal of a Gingrich v. Obama race. This last sentence seemed strange to me: "Say what you like about the man [Gingrich], but he has ideas, says arresting things, and most of all, would make the clearest possible contrast with Barack Obama in the general election."

The idea is that Romney would say anything to get elected, and Gingrich would just be Gingrich.

I don't see why people think this about politicians. I think we've seen ample evidence that every one of these candidates would say anything to achieve their ultimate goal of being elected. But the Gingrich point about the "clearest possible contrast" with Obama was especially surprising. Gingrich has been going around saying that Obama wants more people supported by the government while he wants more people supported by their own jobs. Since the election is going to be largely about the economy, we're going to hear more of that. How can anyone call that "the clearest possible contrast"? It's a compeltely fabricated contrast and it muddies the actual differences between them.

Cool Alaska population animation

I'm essentially done with the NBER chapter on new supply to the engineering labor force, and starting to contribute more to the other one on petroleum engineers - and as a result I'm reading more about trends in the Alaskan economy, including following the Alaska Department of Labor blog. This was a cool graphic they had featured - demonstrating the shift from a male-dominated territory to a more balanced population.



UPDATE: And apparently it's not animated on this post, but if you click on the picture it will open and animate.

Not a bad paragraph, for a Marxist

"Science, in content, form, and purpose, is fundamentally social, collective. It is invariably, in its every branch, the sum of knowledge attained by many different people, by past generations and by contemporaries. It is the composite product of collective labours. The facts and conclusions which it comprises are expressed in the form of concepts, definitions, and formulae; they are recorded in writing or in print. The purpose of all this is to facilitate the communication of knowledge to other people, to one's class, one's state, to humanity as a whole. Finally, and this is most important, science is a powerful instrument helping to disclose new productive forces in nature and new means of production. It gives man the means of struggle and of defence. Therefore, science comes into being and develops simultaneously with the rise and development of society, as an inevitable consequence and at the same time an indispensable condition for this development."

- S.I. Vavilov, 1948

Andrew Sullivan shares some of Louis C.K.'s political philosophy (which seems like a lose label for what he talks about)

Here. Whatever you want to call it, it's very good. Particularly the very last line. If you had to put a label on it, I'd call it Pragmatism.

Furthermore, I think the few issues he talks about on where he's a conservative and where he's a liberal - as well as more things from Louis, if you're familiar with some of his other discussions - show very nicely how "populism" and "libertarianism" aren't the only two things you can get when you mix some "liberal" views and some "conservative" views. People can take that Nolan chart way too seriously sometimes.

Steve Horwitz is exactly right about thinking about labor market discrimination

He provides a defense of his youtube video here. These arguments are very similar to the ones I made on Martin Luther King day about racial disparities - a literature I'm more familiar with than the gender disparities literature.

The point is, late stage discrimination is the tip of the iceberg when it comes to disparities, although it's often the most trumpeted. Steve and I do make slightly different points. Mine emphasizes the fact that when we define the problem as "the portion of the disparity that is not accounted for by legitimate observable variables, like education, intelligence, etc.", we miss the fact that inequality in those "legitimate observable variables" is often not acceptable either - often because of earlier-stage discrimination or inequality that we would not approve of. So only focusing on the "unexplained" variation at the later stages downplays the problem of racial disparities.

Steve's video's point is more highlighting the fact that the problematic disparities we do see are - for lack of a better term - "compounded" inequalities that occur well before the employer, rather than "discrimination" by the employer. Steve's post's point is that in saying what he did in the video, he did not mean to imply there aren't problems further upstream (the problems I spent time discussing in my post the other day).

An excellent source on this kind of compounding of inequality is Charles Tilly's book Durable Inequality, as is Oliver and Shapiro's book, Black Wealth/White Wealth. I read both in an economic sociology course I took with Deirdre Royster at William and Mary, and to this day are very important for how I think about inequality and racial disparities.

More libertarian labeling puzzlement

There are times that it seems to me the only difference between a liberal calling themselves a libertarian and a liberal not calling themselves a libertarian is that they like the ethos of one or the other group. Or perhaps they have friends that thought similarly and called themselves libertarians. I don't know - but analytically I find the term to be very undistinctive in a lot of cases. I've talked several times on here about Mark Pennington's defense of libertarianism which to me sounds like a defense of the liberal tradition in general - anyone in the liberal tradition.

I had the same feeling reading this description of John Tomasi's new book, linked to by Don Boudreaux. Like Don, I agree it sounds like an interesting read.

Unlike Don, the description makes me feel like I'm a "libertarian" by Tomasi's standards and Tomasi's argument about the relationship between liberty, property, fairness, justice, etc.. Here it is:

"Can libertarians care about social justice? In Free Market Fairness, John Tomasi argues that they can and should. Drawing simultaneously on moral insights from defenders of economic liberty such as F. A. Hayek and advocates of social justice such as John Rawls, Tomasi presents a new theory of liberal justice. This theory, free market fairness, is committed to both limited government and the material betterment of the poor. Unlike traditional libertarians, Tomasi argues that property rights are best defended not in terms of self-ownership or economic efficiency but as requirements of democratic legitimacy. At the same time, he encourages egalitarians concerned about social justice to listen more sympathetically to the claims ordinary citizens make about the importance of private economic liberty in their daily lives. In place of the familiar social democratic interpretations of social justice, Tomasi offers a "market democratic" conception of social justice: free market fairness. Tomasi argues that free market fairness, with its twin commitment to economic liberty and a fair distribution of goods and opportunities, is a morally superior account of liberal justice. Free market fairness is also a distinctively American ideal. It extends the notion, prominent in America's founding period, that protection of property and promotion of real opportunity are indivisible goals. Indeed, according to Tomasi, free market fairness is social justice, American style."

A lot of people don't think much of this "defining libertarianism" thing. What really interests me about it is that it's a window on how people view others. So when a libertarian offers a definition of "libertarian" that describes particular views on liberty, the market, government, etc. - and they consider someone like me to not be a libertarian, the implication is they think I don't agree with those views of liberty, the market, and government.

It's fascinating to me, then, that in so many cases not only do my views coincide with these definitions of "libertarian" - they coincide quite strongly.

What is it about the way humans think about ideology that this is possible?

I think that's why some of these discussions interest me - because it' offers some insights into a broader class of human behavior and understanding. It's more than just a definition.

Two good links

- Krugman, going back to the public debt issue. Maybe this one clarifies his position a little? I still think he said what I always thought he said, and I still think that (1.) Nick and Bob highlighted excellent points - even points that I hadn't thought about before seeing the modeling, but (2.) they still were not challenging or contradicting Krugman's argument. Neither was Don. Steve and Gene were right to come to Krugman's defense. This is actually a very good thing, people. It's OK if six professional economists choose to emphasize different aspects of a problem because they think different aspects are more important. It's more disconcerting if six professional economists come to wildly different conclusions on the same point. I don't think that is what happened.

- Andrew Sullivan shares some good points on the intergenerational obligations of government. This relates to things I've said in the past about temporal autarky and intertemporal externalities. Paine and Jefferson would heartily agree. I am less sure than I used to be about this "compact" language. It's probably safer to just say that government is an institution that emerges to solve many of these problems, it has characteristics similar to compact, but it's not exactly a compact - and leave it at that.

Rampell on Science and Engineering Education and Workers

Rampell discusses the NSF's new Science and Engineering Indicators, here. There are a few lines in her post I don't like, but there's good discussion of academic major choice.

Isaac Newton: Proponent of Theocratic Police States

"Enlightenment" is such a nice word. It's important to remember that it took time for the various strands of the enlightenment to coalesce. Case in point:

“Every good Prince ought by Gods commandment to punish even by death all such as do seek to seduce the people of God from his true worship.”

- Isaac Newton, c. 1688

However, as the blog post linked above notes, Newton's real target and intent is not entirely straightforward. It's an interesting read.

A dream class to teach

I've been working on the NBER chapter all this morning - thinking about a lot of things, including the issues raised in this post - and a really interesting course idea came to mind: Economics for Natural Science Majors. I think Economics for Non-Majors courses are fairly common (just as the "for non-majors" courses are common in many disciplines). In economics, usually these sorts of courses draw in public policy, government, and other social science people.

What would be interesting is to teach and economics course tailored to natural science majors. It would do two things:

1. Go over (in a more general way) material on the economics of science: occupational choice, labor market adjustment, compensating differentials, human capital investment, public goods nature of R&D, endogenous growth theory, etc.

2. Go over basic economic concepts as applied to science. You can teach things like the price mechanism and opportunity cost and how they relate to peak oil fears, discounting and thinking about climate change, etc.

At schools with some sort of social science general education requirement I think you could get a real critical mass for a class like this. Does anyone know if such a class exists? I think it would be a blast to teach.

Paul Romer on Regulation

Here (HT Tyler Cowen).

Experimentation, evolution, responsibility, and robustness in thinking about regulation. All absolutely essential. Romer's work on the science and engineering labor market has always bothered me, but everything else of his I've come across is quite good.

Predicting the future of complex systems is hard

Even when you've got a sample of millions to draw on. This article describes how doctors are essentially making educated guesses when they offer prognoses, particularly as their ability to treat illnesses has improved. Doctors have a lot of data to work with, and a lot of variation in the data to extract estimates from. But it's still hard for them.

Macroeconomists, on the other hand, are working with very small samples which makes prediction harder and makes inaccurate predictions more glaring (everyone's only looking at one time series after all). None of this is surprising - we're dealing with complex systems in both cases. This isn't planetary motion, people.

And yet for some reason these experts are often judged by their predictions. But we shouldn't ever turn to experts on complex systems for prediction. Expertise isn't about prediction, it's about explanation. A doctor may be bad at prognosis, but they are quite good at explanation (and thus figuring out workable solutions). That's why we should keep them around. Not because we expect them to have a crystal ball.

Virginia wineries, doing what we do best - absolute advantage can be better than comparative advantage

Barboursville Vineyards won best in class for their 2008 Cabernet Franc Reserve at the San Francisco Chronicle Wine Competition, which is apparently the largest competition for American wines. Barboursville also won best Cab Franc and best Viognier at a San Diego competition.

This is nice to see because Cabernet Franc and Viognier are recognized as being excellent grapes to grow in Virginia. That's all well and good, but sometimes I think we as Virginia wine enthusiasts wonder if that's just a relative claim. These grapes grow strongest here, but are we still trounced by California in all cases? In other words - as economists would say - do we have a comparative or an absolute advantage?

These prizes are at least one piece of evidence in favor of "absolute advantage", which is nice.

Kate and I have visisted Barboursville Vineyards once. It's a little outside of Charlottesville. We went there after visiting the newly refurbished Montpelier - home of James Madison. I don't remember being particularly impressed by the winery, although the wines were nice enough. The problem was, it was a mob scene. Lots of people, so not as pleasant of a tasting environment.

I do, however, highly recommend Montpelier if you are ever in that part of the state.

Good sentences on externalities from Mike Kimel

Here:

"This issue of other people using one's property rights has long existed with physical property. If you're neighbor doesn't wish to keep the music or odor or pollution he produces on his property, which is usually the case, he exports onto other people's property. Causing an earthquake on someone else's property [a reference to recent events surrounding fracking] is not an issue of bargaining over conflicting property rights, its taking someone else's property rights away. Ditto placing toxic fumes on other people's land. Because the party producing those fumes only has the property rights to its own property, not to someone else's. If the music one neighbor produces crosses the boundary onto property someone else is paying for, the producer of that music is trespassing. Sure, to some degree, everyone produces externalities, but the question is, how big can the externalities be before they must be regulated?"

As I said in previous posts, questions of externalities are always questions about standing. Everyone has subjective values. What we identify as externalities and how we solve those externalities revolves around determination of which subjective values "count".

This is one of many reasons why I always feel like barfing every time I hear "free market economist" used as a synonym for "libertarian economist". It's quite easy to make the case that the "free market" solution to pollution would be to outlaw any and all actitivies that pollute, because they all violate property rights. Property rights should be sacrosanct in a market economy, so anyone that isn't in support of outlawing all pollution as a violation of property rights is really thumbing their nose at the market economy. Almost all of us choose to abandon "free market economics" interpreted this way. Instead, we like having states that give monopoly priveleges that allow polluters to impose some costs on other citizens. Libertarians love trampling over these rights, along with a lot of non-libertarians like me. Nobody is a "free market economist". At least in that interpretation of "rights" (which logically speaking is not all that crazy of an interpretation, despite its problems on a pragmatic level).

The point: (1.) all these things are crucially dependent on underlying understandings about rights and standing, and (2.) stop using the term "free market economist".

The Fable of the Bees

This is a really great piece of research that I'm going to try to digest more tomorrow. From the blog post anouncing it: "If you were to rely on media reports alone, you might be inclined to believe that honeybees and honey are now in short supply. Based on the recent documentaries about Colony Collapse Disorder, you might believe that crops are at risk of going unpollinated and that we are heading towards a different “silent spring”—one in which the familiar springtime buzzing of the bee is no more. Yet, somehow, the honey is in the cupboard and farmers across the country are still able to supply food to stock our shelves, all with little or no economic impact from CCD. How can this be? As two prominent agricultural economists, Walter Thurman and Randal Rucker, discuss in a new PERC Policy Series, the market response of beekeepers provided a solution to the problem. Despite early predictions that CCD would cause billions of dollars of direct loss in crop production, beekeepers reacted so swiftly that virtually no changes were detected by consumers. While overcoming the difficulties of CCD has been no easy matter, beekeepers have proven themselves adept at navigating such changing market conditions."

I've been thinking of writing up something for a while about how we really bear a big cost when natural scientists don't accept social science as an important science to consult. Social science is a crucial scientific enterprise. We are studying the social behavior of a highly evolved, highly intelligent primate species that has a tremendous impact on the planet. We ignore it or dismiss it as something wishy washy or not "hard science" at our peril.

This is one good example about how understanding both bees and humans would have been very helpful - much more helpful than just relying on knowledge of bees.

Other examples include, of course, climate change. Someone like Lomborg, Mankiw, Nordhaus, Krugman, or friend of F&OST stickman (an environmental econ blogger) who know how our particular branch of the primate family tree reacts to adversity, can often provide much better commentary about what to expect from climate change than Al Gore or a climate scientist.

Another example I like a lot is nuclear weapons. At the dawn of the nuclear age lots of physicists got very concerned and got deeply involved in the anti-nuke movement. But prominent economists came up with the antithesis of the anti-nuke movement: the strategic concept of mutually assured destruction. Credible threats. Game theory. Instead of ridiculously imbuing an inanimate object like a nuclear weapon with moral content, these economists used what they knew about the human species to figure out a system that was most conducive to a lasting peace (or at least freedom from nuclear war).

There are likely many other examples - I'm interested in hearing any that you have.

A quick clarification on the externality thing...

...because there's some interesting conversation going on here.

First, commenter Mark was wondering about some of the things I said about subjective value in response to this sentence in Don's post: "This is not science; it is metaphysics: value judgments and political goals will enter into the determination of whether externalities occur in our world." When I concurred with this, noting that we're dealing with subjective value (i.e. - peoples' value judgements) I didn't mean that it's debatable or subjective whether there are externalities. There absolutely are. But those externalities are introduces by individual subjective valuation - value judgements - and these alone don't make externalities "unscientific" any more than anything else in economics is unscientific.

One tricky thing about the way that subjective valuations impact externalities is that there are really two layers of value judgements: first, peoples' own subjective valuations of externalized costs and benefits, and second - our decision as a society whether we want to recognize or give standing to those subjective values. For example - thieves like to take money from people. OK, that's their subjective value. As a society, we say "tough shit" to thieves. We don't really care about that subjective value and we give it no standing whatsoever. That seems like a silly example, right? It's actually quite relevant to these arguments that economists have over whether markets or government solves externalities more effectively. One "market" solution is to have the two parties bargain - people can pay to have polluters reduce pollution. Sounds fine, and if you draw it out the model, it looks fine. But this is still entirely contingent on a social value judgement. Think of it this way - why don't we say to people "well, you can pay the thief not to steal your money". We don't accept this. We give standing to polluters to impose costs, but not to thieves.

"Crime" is just the word we use to describe the actions that impose externalized costs that we consider it unreasonable to expect people to make a Coasean bargain over. We are OK talking to students about swimmers paying polluters not to pollute. We generally don't like to talk to students about paying a murderer not to kill you. Another way of saying this is that ransoms are just a type of Cosean bargain.

These are all value judgements, so coming out and saying "the market does better than the government" or "the government does better than the market" is not a question you can answer unless you can clarify what you mean by "better".

The other thing about this whole bargaining issue (which is central to the question of governments vs. markets in externalities) is that a lot of externalities involve public goods (and bads). Cleaner air is non-excludable, for example. So when we think about bargaining over this stuff we have to think about public goods issues too.

I do agree with some of Mark's points about just figuring out an objective measure of these things. We do that all the time. There's a ton of literature over the discount rate (as Current alluded to in his comment), and over the value of a human life. People estimate all sorts of demand elasticities precisely for this reason - to get a rough estimate of what these costs and benefits might look like.

That's all pragmatic application of the economics, and in my opinion it's much better than flying blind.

But it's important to recognize that these are rough estimates. It's not a measure of "utility" it's a measure of willingness and ability to pay. We need to be careful about two things when we do this: (1.) make sure we always recognize we're not really measuring subjective value - we're just trying to get better acquainted with the costs and benefits, and (2.) make sure we understand that we still have to bring value judgements about who has standing and who doesn't!

An assist on a DeLong smackdown over mercantilism

OK - I am wording this very carefully, so make sure you read it very carefully. Because I'm doing two dangerous things: offering a mild defense of mercantilism, and assisting Noah Smith in a "DeLong smackdown".

Noah Smith pushes back on a claim by DeLong and Don Boudreaux from a couple years ago that mercantilism could be a sound economic policy. In a casual conversation, I would be on DeLong and Boudreaux's side. Free trade is so crucial that you don't want to muddy the waters on a question like that.

But we're all people interested in the nitty-gritty here, and we're talking about scientific explanations of reality not dogmatism, so I think you can all handle my limited defense of mercantilism.

- First, one crucially has to ask exactly what the object of economic policy is. Cutting yourself off from specialization and exchange bears a very real cost, but if for any reason you think it's legitimate to maximize your relative position there may be some justification for a mercantilist position. This is essentially [somewhat sorta tangentially related to] the point that Noah Smith makes in answering Boudreaux's question about why we constitutionally disallow mercantilism between states. The reason seems obvious to me: we are negatively disposed towards a policy of relative deprivation between states (much less an escalating tariff war) in a way that we may not be negatively disposed towards relative deprivation between other countries. This is particularly true when it's a developing country defending a nascent industry (it seems less justified of developed countries). Maybe Don and Brad think that's insufficiently cosmopolitan, and I'd tend to agree with them. But that's a value judgement "bad policy" depends on how you make those value judgements about what is "bad".

- Second, as Noah points out, new trade theory (which is fundamentally Smithian, I'll remind everyone right now) provides a limited defense of limited protectionism. But Paul Krugman has always attached important cautions to these findings. Predicting the advantages of this sort of industrial policy gaming can be very hard. But it seems intellectually dishonest to say that it's always a bad policy. When you look at the really disastrous economic policies its really limited to socialism and actual planning. You have lots of anecdotal evidence for well-played mercantilism that speeds up the industrialization process and entrepreneurial activity. Anecdotal evidence is limited and what new trade theory tells us is that success is always going to be highly circumstantial. This makes it harder to demonstrate the case for mercantilism with standard empirical methods; randomly or quasi-randomly assigning a trade barrier isn't going to get you the right answer to your question because new trade theory's version of mercantilism also predicts that randomly assigned trade barriers are going to be bad policy. What we're interested in is strategic trade policy, and I have no clue how to think about randomly assigning strategic trade policy.

- Third, is that I think we need to clarify when in history we are talking about this. One important reason why mercantilism could be considered a "right" answer in the context of seventeenth and sixteenth century England but a "wrong" answer in twentieth century America is that mercantilism played an important role in maintaining the money supply (or NGDP for those of you that swing that way). Obviously that concern doesn't apply after the late seventeenth century. Again, we find these arguments have to be circumstantial.

I am not a "mercantilist" and if you gave me one of those surveys of what economists think I would check the free trade box. But we're grown-ups here and we can handle Alfred Marshall's wise words: "Nature's action is complex, and nothing is gained in the long run by pretending that it is simple, and trying to describe it in a series of elementary propositions".

Anthony Gregory on Ron Paul and foreign policy as a campaign plank

Bob Murphy brings my attention to a post by Anthony Gregory on the question of whether the handful of issues libertarians always talk about when promoting Ron Paul should be enough to earn a vote for him.

I'm not sure what Gregory feels about Nader - perhaps he's like Gene and would vote for him. I hope so - someone like that would be consistent. Unfortunately, I would wager that only a small minority of libertarians would vote for Nader on these grounds (and the ones that would would be either hard-core anarchists that have suspicions about Ron Paul in the first place, or those on the fringe of the movement).

It's an interesting read either way.

This line jumped out at me: "Ron Paul, from a genuine antiwar leftist perspective, shouldn't be considered good on 10% of the issues — but closer to 90% of the issues. Anyone who would prefer federal genocide and slavery to curbing the EPA and cutting taxes on the wealthy has some twisted priorities."

The first sentence is striking because it seems like we're talking about two different groups of people. If you're going after the "antiwar left", good luck with that - you'll probably get a fair amount of them - but that group is really, really small. People talk about how the antiwar movement hasn't been against Obama. It's bogus. The antiwar movement has been every bit as much against Obama as they were against Bush, because like Bush, Obama prosecutes wars. Code Pink has been plenty angry with him. The thing is, they haven't been able to attract as big crowds to their events because most of the people who came to the antiwar events under Bush weren't antiwar - they were anti-Bush's version of war. I went to protest events and teach-ins organized by pacifist groups, for example - but I never claimed to be a pacifist. So we have thinning crowds at these events, but that's because the actual antiwar left is fairly small. Most people left of center don't particularly like war but do not have a blanket disapproval of it. They are willing to accept a certain amount of civilian casualties as a consequence of war. They are comfortable treating prisoners of war differently than convicted criminals. They do not think there is any inherent problem in building and maintaining extremely lethal machines and training young men to use them against other young men. Or better yet - build lethal machines that don't require our young men to be put in harm's way.

But these sorts of people are not indiscriminantly comfortable with war. Not at all. We want it done in a certain way. And most of us that were in the protests in the 2000s but not as much now are not and never were antiwar. We also see a difference between Bush and Obama and Obama and Paul and think Obama's approach makes more sense than either Bush or Paul.

So if Gregory wants to convince the "genuine antiwar left", he should go for it. But I think that constituency is a lot smaller than he thinks, and a fair number of them are already positively disposed towards Paul.

Now, the second sentence of that quote is striking to me because of how condescending it is. And people say this sort of thing a lot. Paul says this sort of thing a lot. Somehow he gets treated like he's a "nice guy" but this sort of thing sounds more like "condescending asshole" than "nice guy" to me. These are big issues, though. So even though that's my reaction, I try not to be quite so blunt when I read things like this. But when you say things like that, just remember - we could shoot it right back at you and say that you're supporting slavery and genocide for not supporting judicious military engagement. That's why I'm not a pacifist, after all. Because I am opposed to slavery and genocide and I think pacifism will lead to slavery and genocide. That's what motivates me, but you don't see me calling pacifists promoters of slavery and genocide. Why don't you see me calling them that? Because I know that just because that's how I see the world, that's not how they see the world. They actually do care about slavery and genocide, and it would be wrong of me to act like they don't. Just something to keep in mind when you find yourself saying something like that. And perhaps also something to keep in mind when you scoff at those troglodyte Republicans booing Ron Paul - because Ron Paul has said stuff like that too. Maybe they're booing because they feel like Ron Paul has a history of being condescending to them.

Don Boudreaux is largely right about externalities

I'm shocked he's posted something on this topic that I agree with so much, so I ought to link it.

Don quotes Carl Dahlman who writes:

"This is not science; it is metaphysics: value judgments and political goals will enter into the determination of whether externalities occur in our world. You cannot show analytically that the government, in principle and in all cases, handles externalities better than the market; nor can you prove the opposite: it all depends on what point of reference you choose. And that is not a question of positive economics…. It is doubtful whether the term “externality” has any meaningful interpretation, except as an indicator of the political beliefs and value judgments of the person who uses (or avoids using) the term."

The only thing I disagree with is the first sentence that it's not science - it's metaphysics. This was my comment on the post, which should explain what I mean:

"Exactly right - I'm shocked you've posted something I agree with on this topic! Although I'm not sure this means it's "metaphysics". It means its subjective - and all values in economics are subjective.

In a market transaction, each person acknowledges the standing of the other person in dealing with these subjective values. That's the strength of market transactions. But of course not all actions occur in the market, and when it doesn't occur in a market there are very real questions about a person's standing.

Do I have standing when it comes to the way I subjectively value pollution? That's a much tougher question that people disagree on. It's not metaphysics. Nobody can contest that I bear a subjective value about those things any more than you can contest that I bear a subjective value about the market transactions I make. The question is, what do we do about my subjective values regarding these externalities. But that was never a positive question anyway - that was always a normative question."

Last weekend I read an article by Pete Leeson on the theory of clubs and public choice - but it touched on externalities and dismissed them. The article was good as a whole, but I thought he did a really atrocious job handling the externality question. That and Don's post really make me want to write more about this now.

Assault of thoughts - 1/18/2012

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

- Brad DeLong reposts an excellent obituary he wrote for Milton Friedman. It especially highlights Friedman's push for an all-volunteer military. It's a literature I knew about from school, but really got familiar with when preparing a proposal on recruitment for the Army Research Institute. Friedman did some excellent work on that, and it's shaped my view of the intersection of public economics and labor economics - particularly a lot of my thoughts on the science and engineering labor market. Unlike Bob Murphy, I do think we should tax to stop an asteroid and I also think a draft in a truly existential crisis is a different matter. But that's a pretty specific situation. Also, for those of you who are not aware, there's a relatively new Milton Friedman institute at the University of Chicago which Evan has been keeping me abreast of (and which actually appears to have been renamed the Becker Friedman Institute). I haven't been keeping up with it, but they can certainly be expected to have quality work there.

- Margaret Simms, my colleague at the Urban Institute, has two recent media pieces. First there's a quick interview about the economic circumstances of blacks here. Also interviewed in that one is William Rodgers, who used to be at my alma mater, William and Mary, and is now a colleague of Hal Salzman, my co-author for the engineering labor market work, at the Heidrich Center at Rutgers. Margaret also has a column on inequality that makes similar points to the Krugman column I posted on Monday.

- Paul Krugman has a good post on the dissemination of research in economics, and the role of the blogosophere. He's made many of these points before.

- It's official now, so I wanted to note that I will be authoring a chapter in a book on a basic income guarantee that Guinevere Liberty Nell has just gotten approved from Palgrave. I'm actually not currently a proponent of the basic income guarantee, mostly because of it's labor supply effects. But I will be writing a "pro-" chapter, or at least a chapter highlighting some salutary qualities of a basic income guarantee as a monetary policy tool. The theme of the book is to present the basic income guarantee as an alternative to the welfare state that market socialists and Austrian economists can both support. As you all know, I don't fall into either of those categories but I'm addressing my chapter mainly to monetary disequilibrium Austrian economists (although as I learn more about market socialism, I think I can work some of that in as well).