Friday, April 29, 2011

Is Academic Economics Adapting?

Brad DeLong has a great post that is really worth thinking about for economists and non-economists alike. Although the financial crisis and the subsequent recession should have been a gigantic signal to economics departments that they have to adapt, DeLong sees little evidence that they are actually doing so. As a result, academic economists may deservedly lose influence, or as Brad DeLong puts it:
Perhaps academic economics departments will lose mindshare and influence to others – from business schools and public-policy programs to political science, psychology, and sociology departments. As university chancellors and students demand relevance and utility, perhaps these colleagues will take over teaching how the economy works and leave academic economists in a rump discipline that merely teaches the theory of logical choice.
For economists, this is worth thinking about. Is the stunted view of the economic world that one gets as one looks at the economy more and more exclusively from the perspective of economic models and theory good enough? Or do economic models and theory need to be supplemented by more robust thinking "outside the box" in order to enable better insight into the economic world and how it actually works? Do academic economists have a strong enough understanding of the history of their own discipline?

For non-economists, this is very much worth thinking about as well. It seems that economics has gone astray. That much of the work that economists have done recently has turned out to be irrelevant, or worse, actually harmful. If academic economists are handcuffed by narrow methodologies that render them less and less relevant, it suggests that other academics from business schools, sociology, anthropology, and psychology will need to step into the vacuum so that policy makers are able to understand how the real world economy actually works. Economics may have the term "economy" in the very name of the discipline. That does not mean that the real world economy is what economists are actually studying in all instances.

On the other hand, maybe Brad DeLong is incorrect in his thinking that economics needs to adapt. As Avanish Dixit has suggested, maybe the problem is that academic economists have not been listened to enough by "practical men who believed they had conquered risk."

I am inclined to think that the problem is not so much economic theory, which can be useful when used with appropriate caution, as much as not doing enough to combine and temper economic theory with facts on the ground as well as with markets themselves which are prone to being dominated by "practical men" who, motivated by fear or greed, overreact to the transitory trends of the moment. To criticize academic economics is not to criticize theorists exclusively, but merely to point out that academic theorists need to grapple with the problem of why "practical men" don't listen to them. That is why are "practical men" so irrational, unlike the homo economicus that is assumed in standard economic models. (Though it should be pointed out that this important question is starting to be addressed with the rise of behavioral economics.)

Whatever one ultimately thinks, Brad DeLong's post is worth thinking about.

Wednesday, April 13, 2011

The President's Budget Speech

You have to give President Obama credit. He did give a very good speech on the budget. It was very good to see President Obama unequivocally say that he would not allow the Bush tax cuts to be renewed for those making over $250,000 again. I don't see how we can say we are going to make massive spending cuts harming the poor and the middle class, but at the same time we can afford to continue to pay for financially reckless tax cuts for those at the top of the income ladder. It is good that Obama finally drew a line in the sand. One of this White House's weaknesses in terms of communication is sometimes playing its cards way too close. By drawing a few lines in the sand, the White House reassures his base that not everything is up for negotiation.

I am also glad to see Obama come out and say that Representative Paul Ryan's plan is simply not serious.

I also think the idea of looking carefully at tax expenditures and further simplifying the tax code along the way is a great one.

Now, I do not agree with everything in the President's speech. In particular, I disagree with this part:
Others will say that we shouldn’t even talk about cutting spending until the economy is fully recovered.  These are mostly folks in my party.  I’m sympathetic to this view -- which is one of the reasons I supported the payroll tax cuts we passed in December.  It’s also why we have to use a scalpel and not a machete to reduce the deficit, so that we can keep making the investments that create jobs.  But doing nothing on the deficit is just not an option.  Our debt has grown so large that we could do real damage to the economy if we don’t begin a process now to get our fiscal house in order.
I will admit to being one of those who thinks that deficit reduction should wait until the economy has fully recovered. It really is difficult to see what exactly has to be done before we even know what revenues are likely to look like. For example, if unemployment settles down at a long-term trend of 6% instead of 5%, this would imply a much different sort of budget situation. If economic growth after the economy has recovered is higher or lower than expected, this would imply a much different sort of budget situation. Finally, I think there is a real risk that budget cuts now could really slow down the economy and delay recovery. I think the longer term impacts on growth of a an unnecessarily delayed recovery could be significant, given the impacts on people's skill sets of long term unemployment. So, I still don't think this is the time to address budget deficits. However, if I did think this was the time, there is much to like in Obama's approach.

A final point. If Obama wants greater support from his base and independents going into the next election, he will need to learn how to be a more aggressive negotiator going forward. No one wants a President who does not seem like he knows what he wants and who doesn't know how to lead. Unfortunately, that is the impression that President Obama has sometimes given. So, it is important for the President to get out there and be more publicly involved in these sorts of negotiations going forward and emphasize that although he is flexible, there are some lines in the sand that he will not allow to be crossed. I understand that President Obama wants to appeal to independents as well as to his base. One thing he should keep in mind is that independents appreciate strong leadership too; what they do not like is extremism. There is no reason that President Obama cannot cultivate an image as a stronger leader which would be pleasing to both his base and independents while also cultivating an image of reasonableness. These are not mutually exclusive.

Overall, the President gave a really good speech. We will see how he follows through.

Monday, April 11, 2011

How Markets Fail: Snooki Versus the Nobel Laureate

One of the most major flaws markets sometimes exhibit is their failure to value things properly. Market incentives sometimes make it more lucrative to invest in trivial goods such as expensive "designer" bags that can sometimes cost tens of thousands or hundreds of thousands of dollars rather than make investments that are truly worthwhile, for example, reducing worldwide malaria deaths or dealing with the problem of homelessness. Basically, markets can sometimes cause society to misallocate huge amounts of resources to trivial things while real human needs are not met.

An example is Rutgers University paying more for the trivial reality star Snooki to appear on campus than they are paying for a Nobel Laureate. As Catherine Rampell explains, paying Snooki vast amounts of money to talk about her hair at Rutgers University may make some sort of economic sense. But doesn't this just go to show that the way that markets allocate resources is often anything but sensible?

Remember, the next time an economist tells you markets allocate resources more efficiently, that using their incomplete definition of efficiency. Under that definition, it makes more sense to pay tens of thousands of dollars to bring Snooki onto the campus of a public university or into a night club than to use those scarce resources for, I don't know, a scholarship or actual education or for something that actually matters! This should tell you that there is something deeply incomplete with the definition of efficiency used by most economists.