Tuesday, December 21, 2010

An Innovative System to Combat Homelessness

Over at the New York Times Opinionator blog, David Bornstein has a post describing an innovative system to provide "permanent supportive housing" to chronically homeless individuals who are most at risk. Of note is that certain chronic homeless people are much more likely to die in their 40s and 50s due to problems related to their homelessness, such as having their medicine lost or stolen, lack of refrigeration for insulin for their diabetes, or the inability of doctors to follow up for cancer patients.

In response to such issues, an organization known as Common Ground has developed a "vulnerability index" using an algorithm that ranks homeless people by risk of death. The ranking is then used to prioritize the allocation of "permanent supportive housing."

One interesting thing noted by the article is how previous approaches to allocating permanent housing to homeless people only if they were "housing ready," meaning that they were drug and alcohol free. If you think about this, this is a completely ridiculous approach. It is nearly as though under previous approaches someone really needed to have to be perfect and have their act completely together (in a way that many non-homeless people do not; how many non-homeless people have issues with alcohol or drugs, for example?) before they can get access to a stable environment. But really, what is the probability that someone would be homeless in the first place if they didn't have difficult life issues? And why would anyone possibly think that someone will be better able to overcome problems with alcohol and drugs in an unstable environment than a stable environment? If life is unstable and harsh, as it is for homeless people, wouldn't this make the refuge of alcohol and drugs as a temporary respite more difficult to resist? It seems to me that the idea that people must be drug free and alcohol free before being offered the stability of permanent housing isn't actually based on pragmatic considerations of what is likely to work, but rather more of a morality play. In fact, this is approaching things from the wrong direction; for someone to have a higher probability of overcoming a drug or alcohol problem, they need to live in a stable environment.

Regardless, it is good to see innovative data-intensive approaches to the longstanding problem of homelessness.

Tuesday, December 14, 2010

The Tax Cut and Future Prospects for Deficit Reduction

Ross Douthat has an excellent post explaining why the tax deals has created incentives on both side that make any deals on deficit reduction less likely. I think he is basically right. Obama has to worry about his base, while Republicans are unlikely to be in the mood to accept any serious compromises given their perceptions that they caused Obama and Democrats to "cave" with the tax cut deal.

Knowledge and the Declining Marginal Utility of Wealth

Stephen Bainbridge writes:
Put less forcefully, the argument is plagued by the inherent problem that interpersonal comparisons of utility are difficult if not impossible. Hence, there is no way to know how rapidly a given individual's utility declines. A progressive tax system is thus, at best, a guess about average utility across society. And how exactly is that "fair"?
This is a pretty nonsensical objection. It is also impossible to calculate with exact precision the optimal number of miles of roads or aircraft carriers that the government should build. Are we to conclude, therefore, that it isn't "fair" for the government to build roads for transportation or aircraft carriers for national defense?

This argument doesn't even make sense. I think it is pretty obvious that basic necessities provide more benefit than extreme luxuries. For example, I think it is plainly obvious that there is more benefit to providing basic nutrition to what would otherwise be a malnourished child than providing a $1.9 million Hermes Birkin bag to a particularly vain man or woman. (Link: http://hubpages.com/hub/Top-Ten-Most-Expensive-Womens-Handbags) This is true, even though providing basic nutrition is much less expensive than the bag. Stephen Bainbridge's ludicrous response: "If you can't calculate with precision exactly how much more beneficial such an allocation is, it just isn't 'fair.'"

If we buy into this concept of fairness (fairness requires precise calculation), then it follows that it is not "fair" for the government to build roads or provide national defense. I am still not sure what the "optimal" number of roads or aircraft carriers is and do not believe that there is any purely objective way to make such a determination.

Maybe instead of unrealistic standards, some basic pragmatic sensibility is in order here?

Just as there is lack of pragmatic sensibility in the claim that redistribution should occur until everyone has exactly equal wealth, it is completely nonsensical and contrary to what everyone knows to be true to assert that the consumption of extravagant luxuries is as beneficial as the provision of basic necessities.

Or is the basic concept of "necessity" versus "luxury" just too difficult, because lines cannot be drawn with perfect precision? I would assert that a fetish with a utopian world with absolute perfection in line drawing is itself a luxury. One that is both impossible and which we could not possible afford.

I am perfectly glad to concede exceptions. Just as economists concede that, contrary to the expectation of the "law of demand" the demand for Veblen or Giffin goods actually increases with an increase in price, at least up to a point, even while emphasizing that this is an exception not the rule. In general, I don't think that the existence of declining marginal utility of wealth can seriously be doubted by anyone who does not have an ideological agenda to deny that which is plainly true.

It is also true that you cannot prove with absolute certainty that you are not actually nothing more than a brain in a vat being experimented on by mad scientists. It may be "impossible" to do interpersonal comparisons of utility in the same sense that it is "impossible" to prove that you are not actually a brain in a vat. As in all things, to some degree we just have to accept pragmatic sensibility as a guide rather than unreasonably expect the sort of absolute proof which doesn't actually exist for anything.

For example, using pragmatic sensibility, one can see that there is more value in providing basic nutrition to what would be otherwise malnourished children than an alternative of providing prostitutes to perfectly healthy middle aged men going through a mid-life crisis and cheating on their wives. I may not be able to "prove" that the prostitution provides less utility for these cheaters than basic nutrition does for what would otherwise be malnourished children to those who insist on a fantasy world with perfect line drawing, but I am nonetheless perfectly comfortable asserting it.

This reminds me of my earlier post with the quote by Bertrand Russel:
If a man is offered a fact which goes against his instincts, he will scrutinize it closely, and unless the evidence is overwhelming, he will refuse to believe it.
Why does Professor Bainbridge create an impossible standard of proof for the plainly correct observation that increases in wealth tend to have a diminishing marginal utility? I would suggest that the answer has something to do with ideology rather than truth.

Michael Dorf On Judge Hudson's Poor Reasoning

Over at Dorf on the Law, Cornell Constitutional Law Professor Micheal Dorf slams Judge Henry E. Hudson's shoddy reasoning in Virginia v. Sebelius, describing Hudson's reasoning as not merely mistaken, but "profoundly mistaken." As Professor Dorf describes it, instead of even attempting to provide some "functional explanation why regulation of economic inactivity is beyond the scope of Congressional power" Hudson instead relies "on the language of the earlier cases taken out of context."


Does the Constitution Protect the Smallpox Virus?

That is a question that Northwestern University Constitutional Law Professor Andrew Koppelman asks in criticizing Judge Henry Hudson's very poorly reasoned decision to overturn the individual mandate provision of the Affordable Care Act in a decision that Koppelman notes not only implicitly overturns McCulloch v. Maryland, a famous Marshall court decision that is nearly 200 years old, but also reads the Necessary and Proper clause out of the Constitution.

And Alexander Hamilton said in the Federalist Papers that the judiciary was the least dangerous branch....

Saturday, December 11, 2010

Why Thirteen Month Extension of Unemployment Benefits?

One curious thing is the length of the extensions of unemployment benefits. Right now, extended benefits were awkwardly scheduled to expire on November 30, right before the Christmas Holiday. But with the new deal, it sounds as though the future benefits will expire next year at the end of December, after Christmas.

I wonder who proposed that the extension should be 13-months instead of just a year. If you think about it, it could be either side. Republicans who really would like to see the benefits expire in the future probably wouldn't want to be in a situation of causing that expiration right before Christmas. On the other hand, the current expiration right before Christmas probably put a lot of pressure on Obama as well.

Economics and Groupthink

Arnold Kling has a very interesting and somewhat sad post on how he did not ever get tenure track position in an academic economics department because his research was not on the latest fad in macroeconomics, namely "rational expectations."

This is really pathetic. And I will say it. The academics who perpetuated and enforced this sort of conformity in thinking in their hiring practices were simply anti-intellectual. We don't want everyone doing research on the same theory. We want intellectual diversity and we want people who sharply question the latest academic fads. Insight into the truth is not fostered by groupthink... Far from it.

No wonder Paul Krugman argues in an excellent article that macroeconomics went through a "dark age." Imagine how much farther we might be in having some actual insight about how to more quickly get out our current economic mess had progress in the field of macroeconomics not been so stymied by these fads and groupthink.

Something has to change.

Smart People With Impractical Ideas

Here is a great example of an otherwise smart person saying something really silly, by Arnold Kling, who got his Ph.D. in economics from the Massachusetts Institute of Technology:
I think it will be a great day when government has to hold a bake sale to achieve any purpose whatsoever. That is, I would like to see most public goods funded by private donations rather than forced taxes. 
Lets think about this for a moment. There are two things to think about. (1) What is motivating this desire for taxes to be voluntary and (2) how practical would such a system be.

Lets talk about motives first. Basically, the motivation is a dream of living in a utopian world where autonomy is maximized. We have no duties to society; we only do as we please. In this sense, this idea is based on an extremely self-centered vision. Basically, there is a desire to free ride at the expense of society. We expect that society will protect our life, liberty, and property using coercion against private parties who would kill us, enslave us, or steal from us. But we do not think we have and duties to society in exchange for these basic protections.

As far as practicality, I don't think it needs to be discussed. If our government were funded through voluntary donations, it would have been overthrown long ago. And we would be living under another government that was not so foolish as to depend on voluntary donations. That Kling does not recognize how utterly impractical his idea is shows just how much he takes for granted.

So, the argument overall has two things going against it. First, the motivation is to avoid basic duties to society and instead act as a free rider. Second, even if the motivation were perfect, the idea is entirely impractical. No government that made taxation voluntary could survive.

Senators Spend 20-25% of Their Time Fundraising and Campaigning

According to an estimate by retiring Senator George Voinovich.

One question that I have about Citizens United, the decision that allows corporations to spend unlimited amounts of money influencing political campaigns, is whether it will decrease or increase that amount of time. Paradoxically, it is possible that the Citizens United will decrease the amount of time that Senators and Representatives have to fundraise and campaign due to the diminishing marginal effectiveness of spending on the outcome of a political campaign. (At some, more political commercials annoy more than help.) On the other hand, it could be that politicians are going to try to raise as much as possible, given the difficulty of measuring the effectiveness of campaign spending and the sense that more spending is the "safe" bet.

Great Post by Jack Goldsmith on Wikileaks

Over at Law Fare, Harvard Law Professor Jack Goldsmith has a few thoughts on Wikileaks. Highly recommended.

The Tea Party in Power

As the New York Times reports, the Tea Party-backed Nassau County Executive Edward P. Mangano has pulled a play from the Bush administration and managed to cut taxes without making sufficient budget cuts to make up for the lost revenue. This has created a severe fiscal crisis and it appears that the Nassau Interim Finance Authority may have to take over the finances of the county.

Is this what the Tea Party stands for?

Never Learning From Our Mistakes

When he took office, one of the first things George W. Bush did was turn the surplus he inherited from Bill Clinton and turn it into a deficit. When economic times are relatively good, there is a tendency to believe that economic troubles are unlikely to return. As Avinash Dixit puts it for a recent article in Finance and Development:

We shouldn’t think [economic crisis] have been abolished. Thinking that we have abolished them is an illusion and perhaps a dangerous illusion, because if you think you have abolished crises, your policymakers, business people, consumers, et cetera, will behave in more reckless ways and thereby make crises more likely. The lesson that really should be learned, and I’m afraid will never be learned, is that the time for fiscal prudence is when times are good. That’s when governments should be running substantial surpluses, so that when crises or a recession hit, they can spend freely without worrying about debt. Unfortunately, the reason the lesson will never be learned is that good economic times are especially conducive to the illusion that bad times will never return. (Bold added.)
The idea that we will never learn from our mistakes may sound pessimistic, but it may very well be true. Why don't we learn that reaching a surplus in good times is a good reason to pay down debt and even set aside some of the surplus, instead of thinking that it is very important to turn that surplus into a large deficit as soon as possible?

It is too really unfortunate that the business cycle is more severe than it needs to be, simply because people refuse to face reality and learn from the mistakes of the past.

Economic Theorist Avinash Dixit: Theory Versus Policy

Finance and Development, a publication of the International Monetary Fund, has a great profile article on Princeton economic theorist Avinash Dixit. It appear that Dixit combines both great theoretical work with great teaching ability; not only has he had a big impact on economic theorists, including some who went on to win the Nobel Prize in Economics, he has also been a great teacher. Dani Rodrik at the Harvard Kennedy School of Government has called Dixit "the best teacher I ever had" and his work has had a wide influence. 

One thing he asserts is that "economic theory came out of [the economic crisis] rather better than policy practice did." He goes on to suggest that the problem isn't theorists so much as those who tried to apply it in the political and business world without understanding its caveats:
But the real fault was not so much in economic theory as, if you like, in the political and business world, where people actually swallowed some of the simplistic views about the wonder of markets too much without recognizing the hundreds of qualifications that Adam Smith and a number of others have told us about, and we should all have known about.
This quote sounds great as a way for economic theorists to get off the hook: The problem isn't theorists; the problem is policy makers in business and politics who forget the many qualifications mentioned by economic theorists from Adam Smith onward. Except I think Dixit lets economic theorists off way too easily. If politicians and business leaders are simplifying the lessons that can be learned from economic theory in a problematic way, it should be the duty of economic theorists like Dixit to set them straight. Economic theorists have a duty to see that their work is not misused by those who misunderstand their findings. After all, if they allow policymakers in business to misuse their theories, then they are part of the problem. Policymakers who convince the constituencies that their policies are backed by economic theory but who are forgetting the important qualifications nonetheless gain false credibility. I just don't see how it is acceptable for economic theorists who are in an ideal position to set such policymakers straight to sit back in an ivory tower while Rome burns.

So contrary to Avinash Dixit, even if his assertions that "economic theory came out of [the economic crisis] rather better than policy practice" is correct, I would suggest that economic theorists still have some serious soul-searching to do. Even if the problem isn't with economic theories per se, but rather with the way those theories have been misapplied, doesn't that suggest that something must change in the way that economic theorists interact (or choose not to interact) with policymakers and those who make use of their work??

Monday, December 6, 2010

Graphing Life Expectancy and Wealth: This is How Graphs Should be Done

Don't Release Chrome OS Before It's Done

Chrome OS
According to TechCrunch, there are some indications that Google may be looking to release the Chrome OS this year, despite the existence of major bugs. This would be a really bad idea. Software is judged by the user experience, and users who have difficulty with an initial buggy version will lose confidence in the product and the company and tell all of their friends. For example, when Microsoft released Windows Vista with a myriad of problems, it damaged the reputation of Windows Vista severely. When later releases of Windows Vista fixed many of those problems, the earlier reputation tended to stick. Also, Windows Vista hurt the reputation of Microsoft overall. Google would be very wise to avoid making the same mistake. Especially since the consequences for Chrome OS are likely to be much more severe than for Windows. Given its position of dominance, it is much easier for Microsoft Windows to make a comeback with a subsequent release. It would be much more difficult for a product like Chrome OS, which does not have an established user base of hundreds of millions of customers, to recover from such a mistake.

Saturday, December 4, 2010


There really is nothing more exciting in the world than technological advance, as things that people once thought were science fiction become reality. A great example, as reported on by the New York Times, are holograms which seem so real that people consistently try to reach out and touch them. Imagine the applications for this technology as it advances. People will be able to have meetings that feel like they are in person, with holographic projections communicated over the internet. The applications from video games or even perhaps interactive movies are stunning. (Although logistical issues concerning space seem as though they are something of a concern for the latter idea.)

Economists and Philosophers

In a recent post, Harvard economist Greg Mankiw makes a list of pros and cons of unemployment benefits:
The pros are that it reduces households' income uncertainty and that it props up aggregate demand when the economy goes into a downturn.  The cons are that it has a budgetary cost (and thus, other things equal, means higher tax rates now or later) and that it reduces the job search efforts of the unemployed.
He then explains how he is unsure about an unemployment insurance extension, because he has not done a quantitative analysis of these pros and cons. Then he talks about other economists who have advocated an unemployment extension, and says the following:
I suspect, therefore, that the foundation of their support comes not from having weighed the specific pros and cons of UI per se, but rather from a more general desire to "spread the wealth around."  That issue is, as I tell my students, more a matter of political philosophy than it is of economics. (Bold added.)
I don't think this makes much sense.

Either "spreading the wealth around" is a pro or a con. You can't complete a cost-benefit analysis without saying which and giving it some sort of weight or justify giving it no weight. That is, you cannot have a valid opinion without being something more than an economist. Even the "neutral" decision to give distributional issues zero weight is still a choice with consequences that has to be explained and justified. If Greg Mankiw is "correct" about what economics is (and I don't think there is an objective answer to the question of what economics is) then it logically follows that economists cannot have a valid opinion about UI benefits arising solely from the study of economics.

What I am saying is that, even if an economist had studied everything on Greg Mankiw's pro and con list, they still wouldn't be in a position to offer any policy conclusions. Because Mankiw's pro and con list does not account for a distributional issues, but UI benefits definitely undoubtedly have important distributional effects in reality that have to be accounted for somehow.

If this is so, wouldn't it be better for economists who do voice a policy conclusion to explain how they used "non-economic thinking" to account for the "spreading the wealth around" effect, which is a reality that has to be accounted for one way or another? Or maybe economists should just stay out of the policy conclusion business altogether, since nearly any policy is going to have important effects on the distribution of income and wealth, and economists, according to Greg Mankiw, have nothing to say about that.

In other words, if we accept Greg Mankiw's definition of the divide between economists and political philosophy, then only economists who are also political philosophers can arrive at conclusions about policy.

Friday, December 3, 2010

Constitutional Hardball

Professor Jack Balkin has a very interesting proposal regarding how President Obama could play "constitutional hardball" with Republicans, who are already playing "constitutional hardball" themselves by misusing the filibuster.

A Weak Proposal For Reforming the Filibuster

Over at Balkinization, Professor Gerard N. Magliocca makes a rather weak proposal to "reform" the filibuster by limiting delay to "only" one year.

I don't see what is supposedly accomplished by thwarting the will of a majority of the Senate for such a long period of time. First of all, our founders really did not want political parties, but we now have political parties that behave in a manner very similar to a parliamentary system rather than exercising much independent judgment. In such an environment where political parties oppose for the sake of opposing, all that Professor Magliocca's proposal would accomplish is unnecessary delay. Worse, the proposal is unprincipled, in that it actually accepts the principle that the will of a majority in the Senate should be thwarted by a minority, contrary to the design of the Senate. Also, the proposal would have the affect of making legislation supported by a majority but not a supermajority impossible to pass within a year of an election, narrowing the window of opportunity to get anything significant done to only one year after an election.

It really is an unfortunate proposal, and one that is not much of an improvement over the status quo.

Will the Economy Have to Get Worse Before It Gets Better?

Assume the following facts are true. First, the economy is not going to just get better on its own, at least not in a reasonable time period. Second, even if the economy worsens to a large degree over time, there will not be sufficient political support to do anything about the economy as long as that worsening is gradual. Finally, if unemployment simply stays around 10%, there will be no political support for action to change the situation, especially since the pain of unemployment is concentrated among lower income workers who do not vote.

If these facts are true, it follows that Democrats should not worry too much about the expiration of tax cuts for everyone or whether unemployment benefits are extended. Going back to the point of the previous post, in fact such events might even be positive, in that it would create pressure for action to actually change the situation. Our political system is currently in a dysfunctional state where there is insufficient pressure for action in the form of fiscal stimulus to get the economy going again. What is needed is a shock to the system; as long as unemployment remains steady and primarily impacts lower income workers (along with a few unlucky others) perpetually persistent high unemployment will seem to be politically acceptable.

Trading High Income Tax Cuts For Unemployment Benefits

There has been a lot of talk lately about Democrats trading tax cuts for those who make over a million dollars a year in exchange for Republican agreement to extend unemployment benefits. This is a bad deal and should be rejected. Here is why.

The first thing to recognize is that half-measures are not actually worth that much. Extending unemployment benefits will not do much to keep unemployment low. According to a new White House Council of Economic Advisers report, failure to extend unemployment benefits will cost an additional 600,000 jobs as unemployed people cut back on spending. That sounds bad; but what is actually really bad is that we already have 15.1 million people who are unemployed and can't find jobs and we are not doing anything about it. And there is no reason to think that these people will get back to work anytime soon in the absence of fiscal stimulus. Counter-intuitively, unemployment may have to get worse before it will get better. Only a further worsening of the economic situation will create the political conditions necessary in order to get Republicans to agree to do something about the economic situation.

So, I say let Republicans show their true colors. Let them cut of unemployment benefits for 7.1 million people right before the Holidays if that is what they think is the right thing to do. I don't see why Democrats should bribe them with an extension of high income tax cuts for people making over a million dollars a year in order to induce them to do the right thing. I say, let Republicans refuse to extend the benefits and then face the consequences of their choice.

Second, it has been mentioned that tax cuts are a form of fiscal stimulus. That is, failure to cut taxes is a failure to provide the economy with a form of fiscal stimulus. The likely result of not providing this fiscal stimulus is a worsening of economic conditions. However, it should be noted that tax cuts, especially for those who are already very well off, simply are not a cost effective form of stimulus. The economy is likely to worsen in any case and ultimately we need much more fiscal stimulus that is much larger and in a much more effective form. The sooner we come to that realization, the better. Letting the economy take a hit sooner is better than letting things drag out. It is like the apocryphal story about the frog that stays in water that is slowly brought to a boil, whereas it would have jumped out (taken action to change its situation) if simply dropped in hot water. One can imagine the voting public becoming more and more comfortable with worsening economic conditions, especially as the negative effects  are concentrated on lower income people who do not vote. In contrast, the voting public would be more likely to support action in the face of more sharply negative economic news.

Unemployment Increases and the Politics of Fiscal Stimulus

It looks like the unemployment rate has increased again, moving from 9.6% to 9.8%. One wonders exactly how bad it has to get before Republicans relent on fiscal stimulus. Would 15% unemployment be enough to make them reconsider their position? What if unemployment is still near 10% next year. Would that be enough to make them reconsider?

I believe the answer is probably no. I just do not think the facts matter when it comes to the Republican position on fiscal stimulus. Perhaps I am wrong about that, but as Paul Krugman points out, incorrect economic theories have a way of surviving in the face of contrary evidence.

On the upside, I think that if unemployment rate continues to get worse, the preferred Republican policy of "doing nothing" will start to become increasingly politically unpopular. On the other hand, if the unemployment rate stays at about 10%, then I think it is possible that people get used to that as the "new normal" and see inaction as a perfectly acceptable policy response.

Tuesday, November 30, 2010

The Rise of Ideologically Homogeneous Political Parties

Yale Law Professor Jack Balkin has an excellent post explaining how the decreasing ideological diversity of the two political parties is making our system dysfunctional. Not surprisingly, Professor Balkin notes that getting rid of the filibuster is a key step we can take to make our system work reasonably well, given the trend towards ideologically more homogeneous parties.

Apache versus Oracle

TechRepublic has a great blog post on the topic of Oracle's Java strategy and Apache's resistance to it. It will be interesting to see how things turn out...

Great Quote by Bertrand Russell

"If a man is offered a fact which goes against his instincts, he will scrutinize it closely, and unless the evidence is overwhelming, he will refuse to believe it. If, on the other hand, he is offered something which affords a reason for acting in accordance to his instincts, he will accept it even on the slightest evidence."

(H/T Ezra Klein)

Monday, November 29, 2010

So Much For the Rule of Law

From Orin Kerr over at the Volokh Conspiracy:
But the word “Reinhardt” is radioactive at 1 First Street. Reinhardt writes like there is no Supreme Court, and as a result his opinions have a remarkable ability to annoy the Justices. In return, the Supreme Court loves to reverse Reinhardt. They love to reverse opinions he signs, and they love to reverse opinions he participates in. So the fact that he’ll likely be involved in the panel decision probably hurts opponents of Prop 8 in the long run.
I suppose it is too much to expect the Supreme Court to actually rule on the merits of the case and nothing but the merits of the case while setting aside any negative feelings about a particular Court of Appeals judge. But lets face it, not even former Supreme Court clerks like Orin Kerr believe this.

Sunday, November 28, 2010

Structural Versus Cyclical Unemployment

What is the difference? Basically, certain people take structural unemployment as a reason to do absolutely nothing about the problem of unemployment. In contrast, if unemployment is cyclical, then it is possible to use fiscal and monetary policy to counteract it.

The "do nothing caucus" has been declaring that unemployment is structural for quite a while now, in an attempt to justify doing absolutely nothing to solve our current dire employment situation. As Paul Krugman and others have noted, evidence is not on the side of the "do nothing caucus" given that the classic signs of structural unemployment are not present: "there are no large groups of workers with rising wages, there are no large parts of the labor force at full employment, there are no full-employment states aside from Nebraska and the Dakotas, inflation is falling, not rising." The main motivation for the arguments of the "do nothing caucus" is apparently not evidence, but an ideological belief that government should not intervene to lower the unemployment rate. Basically, the "do nothing caucus" goes from the desired policy result, namely, government inaction to lower unemployment, to the argument that would bolster that policy result, namely, that unemployment is structural rather than cyclical. Forget about the facts.

Ironically, if unemployment is allowed to remain high for an extended period of time, it will change from being cyclical (relatively temporary) to structural (relatively permanent), as job skills erode and workers find it increasingly difficult to readjust to the workforce. So, saying that unemployment is structural is a self-fulfilling prophecy. If you do not do anything to reverse temporary cyclical unemployment, then those workers will become more permanently unemployed as structural unemployment sets in. This is one of the biggest arguments for taking urgent action to fight unemployment. Alas, it is an argument that has been mostly ignored and is likely to continue to be ignored and at our peril.

Freedom, Justice, and Luxury

These are the themes of a new book I have started reading, The Classical World by Robin Lane Fox. It is often said, correctly I believe, that to understand the present, one must first understand the past. I first started studying and fell in love with Greek and Roman mythology in elementary school. Naturally, that study of mythology also included some study of history. However, now that I am an adult, I want to return to this subject in order to gain a more sophisticated understanding.

This particular book covers 900-years of history. As such, it is rather broad. After finishing it, I want to delve back into particular primary sources such as The Histories of Herodotus as well as some of the works of the famous Greek philosophers such as Plato and Aristotle.

After that, I am especially interested in studying the history of the Roman empire, especially its decline and fall. This strikes me as especially relevant at present, as there is a sense (hopefully false) that America has reached an apex and is in decline itself. Our political system is dysfunctional and seems incapable of responding effectively to the challenges facing us. While much of our current focus is budgetary (and that is important) I feel that the more important topic of fostering greater education, greater equity, and a greater degree of technological innovation are being neglected as incessant partisan bickering and squabbling hinder more effective action in making the critical investments in the future that we will need. Balancing the budget at the expense of making critical investments in the future may be penny wise, but it is pound foolish. On the other hand, I am a natural optimist. If America is wise, we, unlike the Roman empire, will succeed. But we may need to look to some degree to the past in order to consider the best course to chart for the future.

Anyway, I digress.

After studying the rise and fall of the Roman empire, with a special focus on Roman law, I plan to look at the history of Europe more broadly before shifting focus to the history of England. There, I want to understand better the origins of English law in context before shifting to a deeper study of American history and law. My ultimate goal is to study and understand the history of American law, with a special focus on constitutional law and its relation to our political system.

Now, back to the theme of this first book in this course of study that I am about to undertake. It is very interesting to me how early historians, such as those from early Greece and Rome, took a different approach to history than is common for modern historians. They were less theoretical, but nonetheless Robin Fox has identified some broad themes surrounding the concepts of freedom, justice, and luxury that used to occupy them. And if you think about it, those very same themes are still the object of ferocious political debate today and in some way largely motivate the law. So, by looking back at how previous civilizations dealt with those concepts, we can become more insightful concerning modern day political and legal dilemmas.

Saturday, November 27, 2010

The Politicization of the Chevrolet Volt

 Motor Trend has named the Chevrolet Volt the 2011 Car of the Year. Nonetheless, that hasn't kept "expert" conservative commentators like George Will from criticizing the car, although they haven't themselves driven it. Interestingly, George Will ignorantly calls the Volt a "government brainstorm" even though the car has been in development at least since 2006. But never mind, this seems to be the typical pattern with certain pundits; with such great rhetoric, there is no need to get your facts straight.

At $41,000, the Chevrolet Volt is a little expensive at this point, even after taking into consideration the $7,500 tax credit that purchasers will receive. But that is a familiar pattern with all technological innovation. The first model is always more expensive; typically, as the technology advances, manufacturers find ways to deliver the same or better technology at lower prices. This pattern is especially evident in computers.

Whether the Volt is successful or not, General Motors should be applauded for bringing a new innovation to market. It is only through experimenting with new products that technology advances at all. For example, many people doubted the usefulness of a tablet when Apple announced the iPad, but it has since taken off in a spectacular way. This is in contrast by earlier attempts to build tablets by other computer manufacturers. Sometimes it takes some time to get a product right. The only thing that is certain is that you will never succeed if you don't try.

Conservatives used to be known for having an optimistic "can do" attitude as exemplified by Ronald Reagan. Apparently, for some conservative pundits, those days are long gone. Instead of having an optimistic belief in doing great things in America, for example, high speed rail, we have political pundits that explain why such innovations are bound to fail here even while they succeed in China. If America is a country in decline, the culprit is a political system that has turned away from doing what is necessary for America to compete and win.

Well, as far as whether the Volt is any good, I think I will go with Motor Trend reviewers, who are more than capable of explaining their point of view,  any day of the week over the like of political pundits like George Will, who do not even bother to get their facts straight. Motor Trend knows cars, and what is more, they have actually had their hands on an actual Volt and driven it. That actually means something.

The Instability of Economics

In my previous post, I mentioned how political rhetoric is often divorced from reality using an article by an economist to illustrate. But as this excellent post by Paul Krugman illustrates, economics itself can be divorced from reality, especially due to the tendency by economists to assume away critical aspects of reality.

As Paul Krugman notes and under a system that he prefers, microeconomics and macroeconomics proceed using very different approaches. Basically, microeconomics starts from the false assumption that people are rational and is very much grounded in the idea that exchange is beneficial despite the evident self-interest of the bread maker who provides you with bread. Microeconomics is very much an academic discipline that takes Adam Smith's "invisible hand" as a mostly unquestioned starting point. In sharp contrast, macroeconomics traditionally has not had the luxury of assuming that people are collectively rational; one cannot explain an erratic business cycle, especially as exemplified by the Great Depression, in purely rational terms. For this reason, discussions of macroeconomics often proceed with discussions of ideas, like "confidence," that are not only difficult to quantify and but where the origins of the problem itself are difficult to ascertain. That is, even if you agree that the problem is one of "confidence," one's political biases are often likely to lead one to gravitate towards certain narratives concerning how problems of confidence arise. For example, the story that conservatives gravitate towards is that the problem is "uncertainty" concerning current political policy. According to the conservative narrative, apparently, we did not have to worry about the "uncertainty" caused by wars in Afghanistan and Iraq, regulatory failure to stop a housing bubble, and the second Bush administration's transformation of large surpluses inherited from the Clinton administration into staggering deficits, but we apparently have to worry deeply about moderate reforms to the health care system and regulation intended to make a financial crisis like the one we have recently experienced less likely. While I prefer the simpler narrative that the "confidence" problems are more related to the concerns of businesses and that sufficient buyers for their products will fail to materialize due to a poor economy and the concerns of consumers that their job may not be as secure as they thought, the claim that problems of confidence are actually caused by political policy is not one that is cleanly disprovable. It is, like claims that there must be sacrifices to the gods lest we incur their wrath, more a matter of religion than science. One can understand then how economists, with their desire to make economics "more scientific" would gravitate towards simplifying assumptions that (however unrealistic) make economics feel as though it is on a firmer foundation than it really is. If we assume that people are just "rational" (whatever that means), then we do not have to have psychological discussions concerning such slippery concepts such as "confidence." In a word, the understandable desire for more certainty and a firmer foundation is probably the strongest motivator for the movement to establish micro foundations for macroeconomics.

The psychological desire of economists to grasp onto the illusion of greater certainty, even the perhaps hubristic desire to transform economics into a "real science" may be quite understandable. But what economists need to ask themselves is not just what is desirable, but what is possible. Since people are not in fact "rational" but instead subject to systematic biases, is assuming they are a good starting point for microeconomics, much less macroeconomics? The downsides are evident, especially when economists not only fail to produce recommendations tending towards good policy, but are also behind recommendations leading to bad policy, as in the urge to deregulate the financial sector or the advice of certain economists to ignore the housing bubble or even deny that there was such a bubble. (And isn't saying that high prices constitute a "bubble" just another one of those slippery concepts, like "confidence," that a mindset that gravitates towards certainty might have difficult tackling?)

I ultimately think that Paul Krugman is right. A policy divide where microeconomics and macroeconomics are sharply divided in their methodology is ultimately probably an unstable one. While Krugman finds such a divide to be ideal, I disagree. I have never thought it was healthy for analysis in microeconomics to proceed in a manner dependent on the assumption of a rigidly defined rationality. However, instead of finding micro foundations for macroeconomics, I think the direction will be to find, as it were, macro foundations in microeconomics. This is best illustrated by the rise of behavioral economics, a rising field dedicated to putting microeconomics on more realistic and secure psychological foundations, but in the process of doing so, perhaps robbing economists of a false sense of security and certainty.

Monday, November 22, 2010

Great Article by Greg Mankiw

As Harvard professor of economic Greg Mankiw argues in his New York Times article, despite political rhetoric, there isn't necessarily much that is different between spending and tax expenditures. Republicans, in principle, should not object to "raising taxes" when that means eliminating tax expenditures that benefit particular and narrow interests. Similarly, Democrats should not object to all spending cuts; the question is always whether what we are spending money on worth the price we are paying.

Unfortunately, political rhetoric occupies its own domain which is often divorced from reality.

Economists, Handwaving, and the Culture of Economic Modeling

One of the most typical form of hand-waving you will see by some economists is when they insist that one policy is more efficient than others is the assertion that policy X should be adopted, even though it results in a distribution of income that disadvantages a large group of people who are less affluent on average to benefit a smaller group of people who are much more affluent on average. Many times, economists will point out that policy X is optimal, because you could theoretically tax a percentage of the increased profit flowing to winners in the more affluent group and transfer those resources to the losers in the less affluent group and the overall result would be more income for everyone. A good example is this blog post by University of Chicago economist Gary Becker, where he argues that the Russian policy of adopting an export ban on wheat that would effectively result in higher real incomes for those who do not own farms is a mistake, since it prevents farmers from enjoying windfall profits due to unexpectedly high prices for wheat on international markets. The argument goes that "Russia would be better off if it allowed farmers access to world prices, and it could give income transfers to urban families that offset at least some of the resulting higher cost to them of wheat and other foods."

Unfortunately, this sort of thinking, which could be taken directly from an Economics 101 textbook and does not consider any of the particularities of the Russian situation as being important, is very inadequate in terms of determining the best policy going forward. One wishes that economists like Becker would remember the old economic saying that "there is no such thing as a free lunch". An elementary error that Becker makes is his basic failure to account for the costs of redistributing income (or the costs of failing to do so.) What Becker fails to consider is that it not "free" to redistribute income.

First of all, those who earn extra income from accessing higher prices on international markets are very likely to fiercely resist redistribution on a political level. Those who oppose such redistribution are generally likely to succeed. Politically, it is much easier to adopt policies that result in more favorable distributions of income (even if there are some economic inefficiencies) than it is to redistribute income after it has been earned.

One might ask whether it should matter if there is a successful redistribution. Why should it matter whether the gains are distributed to a only a few? Isn't a $1,000,000 allocated to one person as good as $1,000 dollars allocated to a thousand people? Shouldn't Russia be indifferent between these two outcomes? And the answer is, of course not, due to the diminishing marginal utility of a dollar. That is, one person is not likely to derive as much utility out of a million dollars as a thousand people would out of a thousand dollars. Clearly, dollars that are spent on basic needs provide the most utility; only when one has enough quality food to eat and adequate shelter and adequate access to the other basic necessities, does one look to derive pleasure from luxury goods. One can much more easily do without a luxury good than one can do without a necessity. So, to the extent that the political failure to redistribute income would have the effect of depriving people of basic necessities, there would be a significant loss to Russian society.

Second, even if it is politically possible to redistribute income, government programs to redistribute income are potentially vulnerable to corruption. That is, there will be a temptation by those in charge of such redistribution to redirect wealth to themselves or to favored groups. Such corruption may not defeat a program to redistribute gains entirely, but their cost may in fact exceed the costs of the export ban that Becker is criticizing.

Third and finally, even if a program of redistribution is undertaken with minimal corruption, there is still administrative overhead involved with establishing a bureaucracy to oversee the redistribution, determining eligibility for redistribution, and prosecuting instances of fraud by those who falsely claim eligibility for benefits or attempt to claim benefits more than once. Perhaps such costs can be minimized by carefully structuring the government bureaucracy in charge of redistribution, but the challenges of doing so, both politically and logistically, should not be discounted. Also, newly established bureaucracies can sometimes be very difficult to disband politically when they have served their purpose.

Maybe Becker's conclusion that the Russian export ban on wheat is bad policy is right. But that would be more a matter of sheer luck than sound analysis. The universe of policy possibilities facing can be divided into three categories.

(1) Impose an export ban on wheat. This has enforcement costs as well as the increased income for farmers that is foregone by accessing international markets.

(2) Allow the export of wheat, but do not make any attempt to redistribute any of the windfall profits accruing to farmers due to unexpectedly high prices in international markets. This option has significant costs due to the diminishing marginal utility of a dollar and the fact that food is a basic necessity rather than a luxury item.

(3) Allow the export of wheat, but set up a bureaucracy to redistribute a portion of the windfall profits accruing to farmers. This option has significant costs in terms administrative expense, possible corruption, the establishment of new bureaucracy, and the political resistance of new bureaucracies to being disbanded when they have served their purpose.

So, what Becker has failed to do is try to compare these options and estimate the costs of the various choices. Implicitly, Becker waives his hand and says that the losers from the decision to allow the export of wheat can be more than compensated by the gains of the winners and everyone will be better off. But he fails to consider the costs of such transfer programs and whether it is even politically feasible. Basically, Becker's analysis proceeds as if the cost of transfer would be zero, when this is far from likely to be the case.

Finally, it should be noted that to actually do this analysis correctly, one would have to be very knowledgeable on the particulars of the Russian situation. In this case at least, an analysis based on nothing more than the abstract principles gleaned from an Economics 101 textbook is woefully incomplete. You have to know something about the political situation in Russia to determine whether a transfer of income to compensate the losers is even politically feasible and you have to know something about the corruption situation to estimate the likely costs of administering such a program. It may very well be that a temporary export ban is in fact the best policy for maximizing the welfare of the Russian people, when one does a full analysis that takes into account the costs of alternative policies. It is impossible to know for sure without doing the full analysis.

What is amazing to me though, is that professional economists like Gary Becker could make such elementary errors. If I were to guess about the origins of this mistake, I would chalk it to what I will call a "culture of economic modeling" where economists get so comfortable making simplifying assumptions for their models, that they make elementary analytical errors when it comes to policy analysis. Here, Gary Becker is doing nothing more than assuming that the costs of a transfer to compensate the losers are zero or de minimus. It is very natural for economists in particular to make such assumptions, since they are always making simplifying assumptions when it comes to creating economic models. But, when you consider the complications of the real world, in this case the simplifying assumption seems to be extremely dubious. At the very least, serious analysis of the political feasibility and the costs of doing transfers is worthy of serious analysis before assuming that such costs are insignificant.  I think this goes to show that it is very important for economists to carefully consider the applicability of their simplifying assumptions when doing real world policy analysis. I think the habits of mind that are useful for creating abstract academic economic models with no urgent need for real world applicability may need to be carefully adjusted for real world policy analysis.

Sunday, November 21, 2010

Ben Bernanke Speaks Out on Fiscal Stimulus

Is Federal Reserve Chairman Ben Bernanke too late in recommending economic stimulus? Perhaps being attacked by conservatives for quantitative easing has made Bernanke think the risks to the Federal Reserve's independence for making recommendations on fiscal policy are not very high after all. Apparently, monetary policy and the Federal Reserve's independence is now going to be under attack by conservative politicians and monetary policy "experts" such as Sarah Palin regardless of whether Bernanke comments on fiscal policy or not. In any case, there is a precedent for such commentary on fiscal policy, since Alan Greenspan also commented on fiscal policy. Unfortunately, as Paul Krugman laments, such recommendations are probably a little too late. Are Republicans willing to listen to a Republican Federal Reserve Chairman appointed by George W. Bush? Unfortunately, probably not.

Monday, November 15, 2010

Partisanship and Opportunistic Explanations of Reality

It seems that in explaining our current economic difficulties, certain individuals are opportunistically choosing explanations with implications favorable to their preexisting policy preferences and biases. For example, a lot of Republicans and conservative economists gravitate towards "uncertainty about government policy" as the number one reason that the economy is not recovering faster and downplay the issue of aggregate demand.

This is unfortunate. You would think that educated people would be able to overcome their prejudices and be able to consider things dispassionately based on evidence. The argument that "uncertainty" about political policy is holding the economy back just doesn't make much sense.

First of all, in a democracy, there is always policy uncertainty. The only way to eliminate it would be to replace democracy with dictatorship. Given the pervasiveness of uncertainty, on what basis do we say that uncertainty is higher now than earlier? I think the majority of reasonable investors knew that the housing market was overvalued and that there was a bubble that would eventually pop. The issue was when. Despite this massive uncertainty that should have given investors pause long ago, the housing bubble continued to grow for years. If the level of certainty is so important, why didn't the much more significant risk and uncertainty of the housing bubble bursting than the much smaller political uncertainties that now exist cause an economic slowdown?

Second, Republicans grandstanding on issues like extending unemployment insurance create a lot more economic uncertainty than either healthcare reform or financial reform, both of which are modest. But such uncertainty (which greatly affects aggregate demand and thus the economic climate facing small business) is usually never mentioned by those who gravitate towards uncertainty.

Third, the level of policy uncertainty has never really been that high. Obama campaigned on health care reform; it is not exactly shocking that it would be pursued after a successful election. Modest financial reform was inevitable after the aftermaths of the financial crisis and actually financial reform decreases uncertainty by making a future financial crisis marginally less likely and providing more predictable resolution authority if (and when) one does occur again.

Third, health care reform has already happened and so has financial reform. Of course, there are important questions surrounding implementation, but there is certainly much more political uncertainty surrounding Republican efforts to repeal or defund these policies than there is any residual uncertainty regarding implementation of policies whose broad outlines are already set. Yet those pointing to uncertainty as the "thing" holding back recovery never suggest that Republicans should back off attempts to repeal or defund healthcare reform or financial reform.

Fourth, as this brilliant post by Ezra Klein shows, there was more political uncertainty than surrounding health care reform and taxes during the Clinton administration, yet the unemployment rate actually fell and the economic growth accelerated. Strangely, those who assert that our current problems are caused by political uncertainty never mention the many cases where political uncertainty is higher than now, but economic growth quite robust. What does this show? That the argument that the problem is "policy uncertainty" has absolutely no grounding in history.

Unfortunately, the people who make the argument that it is all about uncertainty, whether they have Ph.D.s in economics or not, are not basing choosing their preferred explanations based on evidence and fact, but rather that which concurs better with their preexisting political preferences.

I think this is deeply unfortunate. One would wish that if an education could do one thing, it would be to cause all of us to look at evidence and facts first, and ideological preferences second. Unfortunately, education is not THAT powerful. If someone is determined to believe something for ideological reasons (and many people are), education is usually no match. First comes the ideological opinion (for conservatives, the opinion is that government is almost always the problem), then comes a highly selective and biased rendition of facts to support the opinion.

Monday, November 8, 2010

Thoughts on Income Inequality

I was reading this interesting post by Dartmouth College economics professor Andrew Samick at Capital Games and Gains concerning income inequality. Here are my thoughts in response:

I am in agreement with Andrew Samwick in theory. It seems what is most important to me is that the well-being of the everyday citizens is good in terms of food, shelter, clothing, education, medical care, leisure, and other things that improve well-being. Companies like Wal-Mart and Apple clearly make life better for most people to the extent that they deliver good products at lower prices or innovate and invent product categories that never existed before. There should be some reward for these activities.

I mean, certainly there are reasons to object to inequality. It is possible, for example, that someone who is wealthy can harm someone who is less so by driving up the prices of goods so that the person with average income could not afford them. But happily, for most goods, this isn't too much of a problem. Wealthy people do not consume unlimited numbers of tooth brushes or iPads or computers. They are generally satiated after buying a few of these goods. Thus, their consumption does not drive up the price. There are some problems with gentrification, of course, as when people find that they are no longer able to live in neighborhoods where their parents lived, as richer neighbors move in. So, there are certainly some negative stories with inequality, but for most goods and services, the consumption of the rich do not make people worse off.

I suppose it should be mentioned that there are also psychological aspects to inequality that shouldn't be entirely discounted either. We should certainly take critiques of accumulation, which perhaps originated with Veblen, seriously as well. When you have, as in modern America, all of this marketing and a commercial culture that glorifies wealth, many people seem to become unhappy because they do not have "things" that they really do not need and probably would not desire except in a social context. Corporate America spends countless dollars bombarding people with commercials that convince many people that they need things that they really do not, and I think a considerable amount of unhappiness results. I have seen this happen. I think we all have. So, there may be something to be said for a culture that glorifies people for their unique qualities more and for what they happen to own or possess less. I think such a cultural change could be facilitated, perhaps, by higher tax rates which would discourage accumulation beyond a certain level.

Now, acknowledging that there are some harms to inequality, is it worth combatting them? I certainly would not want to do anything that would discourage Steve Jobs from innovating, for example. But, is your average high-income CEO really a Steve Jobs? I happen to think that the truly innovative people are driven by passion, not merely money. Especially since I am quite sure that Steve Jobs would not even know how to begin to spend his money on personal consumption. Steve Jobs is driven by a passion for computing and innovating and seeing his creations turned into reality. It is much more than money that motivates him. So, we shouldn't necessarily assume that the costs in terms of innovation of curtailing inequality to some degree would be overwhelming. Indeed, it seems likely that if we took tax revenue used from taxing "conspicuous consumption" and used it to finance research and development, we could have more innovation on net.

All that said, if these were the only risks arising from inequality, I would agree with Andrew Samwick. I think people need to try to put their more superficial and usually unrealistic desires for ever more "things" in check and learn to pursue excellence using their own special talents. Maybe I and Andrew Samwick are holding people to an unrealistic standard when we expect them to not be unhappy because they cannot indulge in the conspicuous consumption that they see others indulging in... Not everyone has my personality, people are social animals, and corporations spend countless millions glorifying conspicuous consumption. But still, at least for now, this is the standard we should hope that people strive too. Of course, there may be some serious negative externalities when people fail in this. When people buy more house than they can really afford, doesn't this contribute to financial crises that affects those who do have the inclination and/or self-discipline to consume beyond our incomes?

Anyway, the case is not a complete slam dunk, but I am in agreement. We should all pursue our own lives and interests and not worry so much about what other people have or do not have. It is true that people who desire more than they can afford and spend accordingly cause negative externalities (i.e. by bidding up the price of housing and contributing to a housing bubble for example) or when they go bankrupt or fail to pay their debt, which increases the price of credit for those more responsible with their credit to some degree. But, I am frankly not sure we should  accommodate such imperfections. Not being able to control your desires, even if such desires are in part created by our commercial culture which constantly barrages us with images making conspicuous consumption seem desirable and identity affirming, is a sort of flaw. People would be better off if they learned to simply resist such imagery. Should the unhappiness that people experience because they are flawed "count" for policy purposes? I am not sure.

But here is my real argument against what I infer to be Andrew Samwick's position that we should be concerned only with absolute measures of income rather than relative measures. I believe that those with wealth naturally tend to buy influence in our political system. I guess when it comes to our civic system, I think we should all be considered "equal." We do not give people more votes just because they have more income or wealth. We used to have minimum property requirements for voting or holding office, but we have long ago abandoned such distinctions between citizens. A rich person and an average citizen each get just one vote. The ideal, I think, is that the interests of the average citizen in our civic system is just as important as the interests of the wealthy citizen. But this ideal seems to be violated on a regular basis as those with more wealth have more influence in our political life, just as they have more power to get what they want from our market economy.

But, obviously, much worse is rent-seeking. That is, when someone has a stream of income somehow tied to government policy, and those people then take a portion of that income to protect that income stream. For example, companies who lobby for wasteful agricultural subsidies that distort our markets. Or companies that try to extend copyrights to unreasonable periods in order to protect Mickey Mouse. I could go on. I think instances of rent-seeking are legion, and their are constituencies on both the left and the right. I think that Andrew Samwick and I would agree that rent-seeking is the much more pernicious problem than the wealthy having a somewhat disproportionate influence. It seems to me that there are wealthy people on both the left and right side of aisle, and they tend to cancel each other out to some degree. But, when a company or industry has an iron grip on an unjustified stream of income at public expense, there is often no countervailing force. The interests of the "special interest" are concentrated; the interest of the general public is diluted. The special interest has the incentive, the money, and the time to monitor political developments concerning their rent-seeking. The general public does not have the time or money to effectively monitor such nitty gritty political developments.

While Andrew Samwick also sees rent-seeking as pernicious, I think he hasn't considered the ultimate motive. The ultimate motive often is "conspicuous consumption." Why would those who control an industry insist on trying to corrupt the system in order to extract rents? These people are not poor. They would not generally live in poverty if they lost their income from rent-seeking. This sort of rent-seeking has a lot to do with the people in control of these industries and companies trying to construct their identity around earning as much money as possible. If you raised marginal tax rates on such people, they would have less incentive to engage in rent-seeking.

Overall, I think a lot of what motivates people in their economic lives is disconnected from anything remotely necessary for survival. It is always wanting more. One does not feel adequate, except as measured by stuff that they do not really need. I am not sure that curtailing this through higher tax rates would be a bad thing. I suspect that the truly passionate and dedicated (like Steve Jobs) are not really in it for the money. I don't think the truly best people in any field are in it primarily for the money. I therefore think that the horrors that are predicated by higher marginal tax rates are overstated.

Also, when we have out-sized rewards for certain professions, we have graduates flocking to those graduates even if this is not the socially most valuable place for them to be. For example, a huge percentage of Harvard graduates have majored in economics with the intention of going to Wall Street in order to get rich. But to what extent is what happens on Wall Street productive? Are these very smart people with tons of intellectual potential making the best use of their talents working in such positions, or would we be socially better off if they used their talents as engineers or teachers or social workers or cancer researchers? It seems to me that another high cost of status competitions based on conspicuous consumption is the potential of a "brain drain" from more valuable but less profitable activities to activities that are perhaps less valuable but more profitable. It seems that higher marginal tax rates on higher incomes would dampen some of this status competition and cause people to consider their profession more on their own ability to contribute and less on the financial awards. Of course, I suppose the thought that a Harvard graduate with crazy good math skills might make a more valuable contribution as a cancer researcher than a Wall Street executive is somewhat speculative. How do you measure relative contributions from the two career paths? Still, my sense is that the incomes on Wall Street are quite inflated relative to the social contribution of those earning those incomes.

Here is what makes me think twice about this. It seems that there are a lot of rich people who devote themselves to doing things that governments do not do nearly as well. I am thinking of the Gates Foundation, as an example. I am certainly glad that Bill Gates has made every dollar he has made, but that is because he has decided to do something truly worthy with it and because I believe that he is likely to be much more effective than any government would be, given that a government is likely to be tied down by bureaucracy.

The bottom-line is that with increased inequality, we may get a lot of wasted energy wasted in pointless and zero sum status games associated with conspicuous consumption. But then we also get those who, like Bill Gates, have moved beyond conspicuous consumption and who direct their resources in a public-spirited manner more efficiently and effectively than any government would probably do. (I am not saying that government cannot do these missions; only that given the way we tend to smother our governments with red tape, it is very difficult for people working for these institutions to be as effective as they could be, dollar for dollar.)

So, I guess my bottom-line position is actually ultimately the same as Andrew Samwick's position. But I think the case is much more complicated and contingent. I think there is a reason to be concerned about increased economic inequality. I also think that the idea that you can really take many steps to lessen influence peddling without tackling the problem of economic inequality and the associated culture of conspicuous consumption is very questionable.

Saturday, July 10, 2010

Problems with Mankiw's List of Ten "Principles" of Economics

Greg Mankiw is a Harvard professor of economics who writes a very popular introductory economics textbook called Principles of Economics. It is no doubt a very popular introductory economics textbook that is well written, although I certainly would prefer Paul Krugman's Economics. Also, Mankiw has a decent although infrequently updated blog here. Anyway, appropriately enough given the name of his textbook, Mankiw has devised a list of ten economics principles. There is only one problem I have with the list; many of the principles that he lists are not principles, but instead are either definitions, heuristics, or mere possibilities and also involve normative judgments. I therefore would assert that the word "principles" actually constitutes a sort of false advertising.

First, lets start with the definition of principles I am using. Consider this definition of principle from Merriam-Webster (available here):
1 a : a comprehensive and fundamental law, doctrine, or assumption b (1) : a rule or code of conduct (2) : habitual devotion to right principles  c : the laws or facts of nature underlying the working of an artificial device
Now, when I look at the first definition, the two adjectives that strike me in the definition of principle are comprehensive and fundamental. If something is not comprehensive but is instead merely a tendency or a rule of thumb, it should be called a heuristic rather than a principle. A principle should either be comprehensive or at least have a very strong tendency towards being comprehensive. 

Thus, if someone asked me whether a heuristic can rightly be called a principle, I would be inclined to say no. A real principle should have a much stronger tendency towards being comprehensive (i.e. like the law of gravity) than a mere heuristic. The word heuristic seems to be in tension against the attribute of being comprehensive. After all, as soon as you label something a heuristic, you have already conceded a more humble position for the thing than a principle. You have conceded that it is not comprehensive.

This makes me wonder about the whole decision to produce ten “principles” of economics. Why not just call them “principles, heuristics, possibilities, and definitions” or something more accurate? Let's have a look. Are the "principles" of economics that Mankiw identifies in his introductory textbook really principles or is Mankiw engaged in a sort of false advertising?

Here is the list of "principles" with commentary:
(1) People Face Tradeoffs. To get one thing, you have to give up something else. Making decisions requires trading off one goal against another.
This is the closest item in the list that actually comes closest to being a principle. Maybe. People usually face tradeoffs, although one can imagine situations where there is only one decision that one could make with any desirable attributes whatsoever. On the other hand, the further statement that “making decisions requires trading off one goal against another” is simply false when interpreted as a statement about the actual prerequisites to making decisions. Often people make decisions without really considering alternatives much less calculating the costs and benefits of the alternatives even tentatively much less comprehensively. One could say that taking action (not making decisions) often requires trading off one goal against another, whether or not one is consciously aware of that fact (and assuming that the person in question has “goals” other than satisfying a momentary inclination).
(2) The Cost of Something is What You Give Up to Get It. Decision-makers have to consider both the obvious and implicit costs of their actions. 
This isn’t a principle. This is merely a definition. If I say that the cost of something is the amount of damage you impose upon the environment to get it or the cost of something is what everyone gives up for you to get it (this would factor in both externalities and internalities) these would be equally valid definitions in different contexts.

Second, the statement that “Decision-makers have to consider both the obvious and implicit costs of their actions” is clearly a normative statement disguised as a statement of fact. What if decision-makers do not consider such costs? It is possible for them to not consider such costs. What is clearly meant is “Decision-makers should consider both the obvious and implicit costs of their actions.” Even then, we can quibble, because information about costs in the real world often are far from free.
(3) Rational People Think at the Margin. A rational decision-maker takes action if and only if the marginal benefit of the action exceeds the marginal cost.
Once again, this isn’t a principle. It is a (perhaps non-comprehensive) definition of “rational” that I would venture to say that majority of people in the real world do not meet. Once again, I could reasonably come up with a different definition of rational. I would also say that there is a normative judgment lurking here. Since the Enlightenment, a major theme has been that we should aspire to be “rational” while the legal profession pushes us to be “reasonable.” Personally, if I met someone who was actually “rational” according to this definition, I do not think I would associate with them very closely. Attributes like loyalty often require that one commit to another person without constant calculation of costs and benefits. In the end, if one is wise in their selection of close friends, things tend to work out fairly well (though not always — few things are more disappointing than misplaced loyalty) without bringing in calculations of marginal costs and benefits into the picture, which would have a tendency to ruin the friendship.
(4) People Respond to Incentives. Behavior changes when costs or benefits change.
Except when they don’t. This is a heuristic more than a principle. I would say that if you really want to understand how someone is going to respond, you need to put yourself in their shoes and try to understand things from their perspective. Admittedly, this is much more difficult than merely assessing the incentives that they face, as measured in a conventional manner.
(5) Trade Can Make Everyone Better Off. Trade allows each person to specialize in the activities he or she does best. By trading with others, people can buy a greater variety of goods or services.
This is clearly true, at least if interpreted broadly (to be completely accurate, we might say that "trade sometimes can make everyone better off"). Overall, this is humbly phrased as a possibility, not even a heuristic. It is not even an argument that trade usually makes everyone better off, only that there is a possibility that it might. Is the principle here that such a possibility usually exists? In what context? This is extremely vague.
(6) Markets Are Usually a Good Way to Organize Economic Activity. Households and firms that interact in market economies act as if they are guided by an “invisible hand” that leads the market to allocate resources efficiently. The opposite of this is economic activity that is organized by a central planner within the government.
This is self-consciously phrased as a heuristic (not a principle) and it is clearly normative. Are we to believe that the “invisible hand” leads the market to allocate resources efficiently? That depends on our definition of efficiency. Efficiency is not an objective concept. It always depends on a goal. If X and Y are goals in conflict, relatively efficiency in reaching X may imply inefficiency in reaching Y. (This is what economists call trade-offs). So, to say that markets allocate resources efficiently, there is an unstated assumption about a shared underlying goal by which efficiency is measured and also a subjective judgment that a certain level of efficiency is “good enough” to be called “efficient.”

Perhaps Professor Mankiw should actually read the “Wealth of Nations.” The “invisible hand” in that book is clearly referenced in an explicitly religious context. But, shouldn’t “rational” humans evaluate the efficiency of outcomes based on facts and not faith? It is interesting that people often talk about having “faith” in the market; I think references by economists to the religious metaphor of the “invisible hand” encourage such attitudes. And these are the same people who are always talking about what “rational” people do! I would think a rational person would eschew “faith” in the “invisible hand” for an actual inquiry into the facts.

Finally, to say that markets and central planning are opposites fails to consider public-private partnerships where markets and planning are mixed together. Also, that the efficient operation of markets are supported by government and without that foundation would crumble.
(7) Governments Can Sometimes Improve Market Outcomes. When a market fails to allocate resources efficiently, the government can change the outcome through public policy. Examples are regulations against monopolies and pollution.
Again, this is a heuristic and not a principle and is clearly normative (who decides that an intervention is an improvement?). Again, talking about failing to allocate resources efficiently assumes shared goals by which outcomes are measured. Again, there is a subjective conception of a point by which we judge there to be a transition from inefficient to efficient on whatever measure of efficiency is agreed upon. 
(8) A Country’s Standard of Living Depends on Its Ability to Produce Goods and Services. Countries whose workers produce a large quantity of goods and services per unit of time enjoy a high standard of living. Similarly, as a nation’s productivity grows, so does its average income.
Again, is a definition (of what standard of living means) rather than a principle. Again, alternative definitions that are just as valid come to mind. It would be perfectly reasonable to think that a country’s standard of living should be measured not only based on quantity of goods and services, but also by the quantity and quality of leisure time (which may or may not involve market transactions) and also the quality of one’s family life, friendships, and community life. Should standard of living be measured solely by GDP?
(9) Prices Rise When the Government Prints Too Much Money. When a government creates large quantities of the nation’s money, the value of the money falls. As a result, prices increase, requiring more of the same money to buy goods and services.
Obviously, this item requires the assumption ceretis parabis but seems less objectionable than most items on the list. Notice that there are already normative judgments embedded into this item (the amount of money printed is “too much”). But many respectable economists think that a small non-negative amount of inflation is desirable; but the larger point that prices rise when the value of money decreases due to an increase in quantity seems unobjectionable. This would be a reasonable “principle,” although we probably should leave the normative judgment (“too much money”) out of it.
(10) Society Faces a Short-Run Tradeoff Between Inflation and Unemployment. Reducing inflation often causes a temporary rise in unemployment. This tradeoff is crucial for understanding the short-run effects of changes in taxes, government spending and monetary policy.
This is again stated as a heuristic (“often causes”) rather than a principle. The heuristic nature of this statement aside, this is probably one of the best items on the list, as it is free from normative judgments.
Overall, there are a few things that might be argued to be genuine principles in this list, the overall list seems to be falsely labeled. What we have here instead of a list of principles is instead a list of definitions, heuristics, normative judgments, and (maybe) a few principles. (Can a heuristic be a principle? Maybe the existence of the heuristic or a possibility can be a principle, but the object of the heuristic or possibility would not be.)