Monthly Archives: March 2013

The Dynamic Stochastic General Equilibrium (DSGE) has received quite a bit of criticism since the onset of our financial crisis, from prominent economists such as the likes of Robert Solow and Greg Mankiw (indeed, criticism of mainstream economic models is hardly a point unique to the left):

New classical and new Keynesian research has had little impact on practical macroeconomists who are charged with the messy task of conducting actual monetary and fiscal policy. It has also had little impact on what teachers tell future voters about macroeconomic policy when they enter the undergraduate classroom. From the standpoint of macroeconomic engineering, the work of the past several decades looks like an unfortunate wrong turn.

Economists were reminded of this flaw recently by Larry Summers (via Brad DeLong):

I was tempted to blast off at DSGE. But what is it that wouldn’t be a DSGE? A SCPE model. It is hard to see how that would be an improvement. Is macro about–as it was thought before Keynes, and came to be thought of again–cyclical fluctuations about a trend determined somewhere else, or about tragic accidents with millions of people unemployed for years in ways avoidable by better policies. If we don’t think in the second way, we are missing our major opportunity to engage in human betterment. And inserting another friction in a DSGE model isn’t going to get us there. Now it is easier to criticize than to do. But multiple equilibria, fragile equilibria, and so forth have promise. A little bit of avoiding what’s happened over the past six years would have paid enormous dividends…

And Noah Smith has another fantastic takedown of the DSGE:

Imagine a huge supermarket isle a kilometer long, packed with a million different kinds of peanut butter. And imagine that all the peanut butter brands look very similar, with the differences relegated to the ingredients lists on the back, which are all things like “potassium benzoate”. Now imagine that 85% of the peanut butter brands are actually poisonous, and that only a sophisticated understanding of the chemistry of things like potassium benzoate will allow you to tell which are good and which are poisonous.

This scenario, I think, gives a good general description of the problem facing any policymaker who wants to take DSGE models at face value and use them to inform government policy.

He goes on to suggest:

Experiments, detailed studies of consumer behavior, detailed studies of firm behavior, etc. – basically, huge amounts of serious careful empirical work – to find out which set of microfoundations are approximately true, so that we can focus only on a very narrow class of models, instead of just building dozens and dozens of highly different DSGE models and saying “Well, maybe things work this way!” Second, I’d suggest incorporating these reliable microeconomic insights into large-scale simulations.

Now this is all fine and dandy, but let’s take a step back to see why the DSGE has such a grasp on modern economics. Part of it has to do with its application of “microfoundations” – the idea that sound macroeconomic models are but the aggregation of various, heterogenous, utility-maxomizing agents rather than the assumption of macroscopic relationships between national output and employment as a method of framing models. This is known as the Lucas Critique.

But here’s the problem with the DSGE, the “dynamic stochastic” part of the model is pretty weak. By this I mean that while, yes, you can keep adding “frictions” to make the model a more realistic map of the macroeconomy, the system gets awkward very, very quickly. This is because understanding human behavior through optimization and equilibrium (as all mainstream economics is) becomes ridiculously difficult to solve compute. As an example, determining Walrasian equilibrium (don’t even get me started on how unrealistic this even is) is, “NP Complete”. (This means if you find an efficient solution to this you, a) receive the Millennium prize and b) can break the RSA crypto system).

When programmers reach a problem they know to be impossible to solve in an efficient manner they either tolerate approximations or find robust heuristics. On the other hand, economists seem to think that they can somehow ignore the laws of computation altogether.

I was disappointed that neither Summers nor Smith really encouraged the study of agent-based modeling (ABM). – To be fair, Noah (on Twitter) seems to be fairly enthused..

The advent of ABM comes with the preponderance of cheap and powerful computing, modern algorithms, and the study of complexity and emergence. Some of the most fascinating work done in this field is Epstein and Axtell’s Sugarscape. (See more here). Epstein et al. imagined a world with two goods – sugars and spices – with randomly distributed “mounds” across society, riddled with agents that have heterogeneous preferences and skills.

From this remarkably simple set of frictions (indeed – so simple that even the DSGE could have handled it), Epstein et al. simulate an economy with very basic and realistic macroeconomic emergence. Most remarkably, the idea that trade creates wealth, but inequality.

With modern computers, it’s very easy to program agents to act in a local environment based on simple conditional predicates. The brilliance of ABM, however, is that a realistic set of preferences and frictions – both local and global – can be instituted within the program without hitting exponential time. Indeed, with sufficient research from physicists, computer scientists, economists, and behaviorists it might just be possible to model our economy this way.

This is actually exactly what the European Central Bank is doing. This is precisely the kind of thing America should be leading. We, by far, have the best immediate access to the skilled researchers in the fields needed for ABM – the best finance quants, physicists, and economists.

Economists are (usually) very eager when the government funds large-scale scientific research or training. Such progress is very much in the American spirit. However, economists’ approach to their own discipline is a little more confusing. On the mainstream left, Summers understands (much better than I do) the flaws of a DSGE. However, he still believes in the possible success of “multiple” and “fragile” equilibria. His mindset rests, rather firmly, in the idea of economics as a game of optimization.

It’s time for the Fed to sponsor a contest, much like the DARPA self-driving car, that rewards a team of scholars who program an ABM that best captures the macroeconomy. This would be under a larger imperative to study economics through computational techniques that are in polynomial time (i.e. doable) but still very realistic representations of the world.

The idea of ABMs was floated in Science and Technology hearings of Congress back in 2010, but seem to have made little headway outside of imaginative computer science departments since.

It’s time to, dare I say it, spend a lot more on economic research. The randomized control trials are great, but here’s to the day when the Fed buys a supercomputer… or ten.

That lower-income Americans don’t save is a widely-accepted problem. In general, liberals believe wealth inequality (a function of savings rate) can be mitigated with strong social insurance programs and cash transfers. Both liberals and conservatives believe in the value of “nudging” people into saving more via opt-out retirement programs. Only conservatives, however, seem to believe a simple sales tax* would help the poor save more. Liberals retort by (rightly) noting that a non-progressive consumption tax is, by definition, highly regressive. The burden of a sales tax falls on the poorest. (Note I’m talking about the famous FairTax not better systems like an X Tax, or a graduated levy on wages/business cash flow, which hardly get the political traction of simple sales taxes).

With a number of Republican-heavy states planning on taxing sales instead of income and Congress debating a national Internet sales tax, I find myself in the awkward position of agreeing with Grover Norquist. By citing that sales taxes are regressive, liberals fail to advance debate in a meaningful manner. The sad truth is that the GOP is largely interested in anti-progressive modes of taxation. Sales fits the bill.

But, based on a simplistic understanding of economic models, conservatives believe that a simple sales tax would somehow increase savings rate. Take this fairly well-argued article for a national VAT from 1996:

Perhaps the feature of consumption taxes that its proponents cite most often is that they are not imposed on income derived from savings and investment, making higher rates of saving and economic growth more likely

Now, keep this in mind, while I explain a very interesting phenomenon from developmental economics, the Giffen Good. (Feel free to skip the next section if you understand the dynamics thereof) Perhaps the most fundamental rule of economics is that, ceteris paribus, the quantity demanded of a certain good at a given point in time is inversely proportional to its price (did I get everything?) A handful of items defy this “law”. Veblen goods, are usually luxury items for which the price is itself part of the value, signaling class and exclusivity. For these goods, there are certain price levels at which the demand curve slopes upward.

A far more elusive such item is the “Giffen Good”. Think about what happens when the price of Coke increases: the relative (opportunity) cost of Pepsi falls increasing its demand. Simple, right? This is called the “substitution effect”. But there’s another force at play. In economics, the purchasing power of your unit of account is inversely proportional to the price level. As the price level increases, your relative income falls. Now, economists define “inferior goods” to be those goods for which increased income results in decreased demand. Think fast-food and Goodwill. Conversely, when income falls demand increases.

Putting this all together, there might (there actually are, a very interesting series of articles here, here, and here) be a good:

  • That is economically “inferior”
  • For which the income effect is greater than the substitution effect
  • For which the good represents a large portion of overall income

The classical example is rice in several Chinese provinces. Here, farmers substitute between rice and meat, where rice is inferior, but staple. An increase in the price of rice results in a greater outlay in meeting the necessary amount, without enough leftover to purchase meat, which is then redirected into increased consumption of rice.

I think there’s strong reason to believe consumption itself is a Giffen good, in other words increasing the cost of consumption (through a sales tax) will only further increase consumption. Let’s look at the evidence.

  • As far as allocating income there are two, and only two, options: consumption or saving/investment – let’s assume that a citizen rationally substitutes between the two.
  • Consumption is clearly an inferior good. As income increases the marginal propensity to consume falls, and the relative share of savings and investment are far more prominent at high income levels. (Note, I understand that total consumption increases with income, but as the object of concern is savings rate, it is the relative share that matters)
  • There are no alternatives to substitution between income and savings.
  • A certain level of consumption is necessary (to buy food, gas, clothing, shelter, etc.)

So think about the target family earning $30,000 about whose savings rate the conservatives are oh-so-concerned. Said family saves $1,000 a year, has a “staple” spending of $27,000 and a discretionary spending of $2,000 (note that this isn’t discretionary as in a vacation to the Alps Florida, but buying a few extra books or a movie).

If sales tax is increased by 10%, even if the family cuts all discretionary spending, there is still a shortage of $700 from taxes on the necessary consumption. This can only come from savings rate.

So, on this family, a 10% increase in consumption tax, counterintuitively, directs 2.3% of total income back to consumption from savings. Oh, and, remember – income tax cuts won’t help this mooching member of the “47%”.

So next time your friendly neighbor GOP governor tells you that a sales tax will somehow help the poor, ask him if he’s ever sold rice in rural China.

…So is the name of Jagdish Bhagwati and Arvind Panagariya’s book, subtitled Debunking myths that undermine progress and addressing new challenges. While it lives up to its subtitle well, this forceful argument for trade liberalization fails to match the watershed after which it is named, Jawaharlal Nehru’s famed speech. In many ways, Bhagwati and Panagariya deliver a nicely edited review of literature on India’s growth since its reforms. Even as someone fairly well-read on India’s economic history, the sheer collection of empirics in Bhagwati and Panagariya’s arsenal is baffling – enough to give serious pause to anyone skeptical of free trade.

What Bhagwati et al. deliver in evidence and reason, they lack in insight (the true measure of their fantastic scholarship can be found in the plethora of self-citations riddled throughout the book – while the rest of this review may be critical, I don’t kid, their work is rich and informative). There are precious few comments on the underlying idea of India, and its tryst with destiny. While the thorough treatment of liberalization and its positive effects is much needed in our political discourse, perhaps the American version has a more apt, and humble, title: Why Growth Matters.

The method in which Bhagwati et al. focus their argument also leaves much to be desired. Presumably to magnify the import of their claim, the text is saturated with a vast embellishment of what the Left actually believes. Further, Bhagwati et al. fall prey to the stereotypical liberals (in the Indian sense) who chant growth is good, with little appreciation for nuances or caveats. For example this book has not a mention of hugely depleted aquifers in North India, the condition of our rivers, and that of our skies.

Indeed, when in their favor, Bhagwati et al. readily accept that there are subtleties to every question:

Then again, the causes of suicides are many. This is so even in the case of farmer suicides. It is, therefore, unlikely that a single cause like BT seeds would emerge as the main factor.

I agree completely though, am left wondering, why the same doubt cannot apply to a hugely more complex phenomenon, India’s growth itself. But perhaps the most striking flaw in the book is the devious representation Bhagwati et al. make of economists on the Left. The reader is made to believe that Brad DeLong and Dani Rodrik were somehow content with the level of liberalization before 1991. They, further, claim that DeLong and Rodrik believed that the most important reforms happened during Rajiv Gandhi’s tenure:

Unfortunately, both the statistical assertion by DeLong about allegedly robust pre-1991 growth and its explanation by Rodrik are wrong.

However, in a 2001 paper, here is what DeLong has this to say:

What comes next for India? The governments that followed the Rao government–first the United Front and now the BJP-led coalition–have continued reform and liberalization, albeit not as rapidly as one might have hoped given the pace of economic reform in the first half of the 1990s. But the amount that is still left to be done is staggering. 

Whether Indian real economic growth continues at the rapid pace of the past decade even if reform slows down and government budget deficits continue will tell us much about the resiliency of the growth process.

If Indian real economic growth does continue to be rapid even in the face of erratic public-sector performance, that will suggest to us that the most important factors were those that changed in India in the 1980s. (Emphasis added)

DeLong clearly admits that India is a far cry from a liberal democracy. It’s interesting that Bhagwati et al. paint DeLong’s conditional, predicated on continued successful growth without further reform, as an assertion. Indeed, it is unfair to the reader who does not check the full extent and qualification of DeLong’s opinion.

There is another oddity in criticizing Rodrik and DeLong’s purported belief that the sea-change in liberalization happened during the 1980s, in no small part because Bhagwati et al. make this argument themselves. There are numerous instances in which the authors respond to “critics” that don’t believe growth in the past two decades can be attributed to liberalization, because of high growth rates during the second Gandhi’s tenure as prime minister. Their (correct) reply to this (false) claim is that reform had started silently in the ’80s itself, and the Narasimha Rao policies only deepened the change.

This sort of exaggeration is common throughout the book. For example, the authors claim that:

A common refrain of the left-wing critics is that the post-1991 ‘neo-liberal’ reforms have led to an exponential increase in corruption.

They cite, for this claim, an article from New Age Weekly – the loud-horn of India’s Communist Party. To ascribe a “common refrain” to “left-wing” critics from the most ideologically radical publication in the country is edging on absurd. There are very good reasons to distrust anything and everything Vandana Shiva has to say. There are very good reasons to be skeptical of anti-BT cotton activists. There is very little reason to equate all left-wing thinkers in this category.

A similar vein of disingenuous argument is littered throughout the book. The most striking example to this effect is a graph following the authors’ cliam that:

The difference is so huge between the measured farmer and non-farmer suicide rates that one may question the validity of the data.

Right beneath this claim is a figure depicting the vast difference in the total suicides among farmers and the total population. This would, of course, be expected noting that India is, well, not an entirely agrarian nation. Unfortunately, the placement of this graph would trick a reader merely skimming the book for ideas (as I initially did) – removing credence from their greater point that there is no connection between liberalization and agricultural suicide.

By quibbles with the rest of this book rest on dispute not with the method of their argument, but the argument itself. I am a firm believer in liberal trade policy and, as I’ve mentioned, I believe Bhagwati and Panagariya have done a great service in conveying the sheer absurdity of the argument against. We disagree in large part, however, regarding the role Indian government has to play in its growth. The authors’ divide India’s economic future among tandem tracks:

Track 1: Reforms aimed at accelerating and sustaining growth while making it even more inclusive.

Track 2: Reforms to make redistributive programs more effective as their scope widens.

From the way in which the authors interpret the above goals, Track 1 (labor market reform, land acquisition, infrastructure, and higher education) and Track 2 (direct transfers, public work provision, guaranteed employment, healthcare, nutrition, and elementary education) represent supply-side versus demand-side policies, respectively.

There is a clear, (expected), and understandable preference given to the former. However, the evidence and assumptions of their argument do not hold ground. For one, they believe that any real growth implicitly requires formalization of India’s workforce:

There are many indicators of the inefficiencies that constrict growth. For instance, according to a 2007 Government of India report, the high-productivity formal sector […] employed just 13.7 percent of the workers in 2004. Besides, employees who are in the formal sector are not just small in number but have hardly been growing.

For someone not familiar with the Indian context, let me explain what “formal” and “informal” entail. When I go to a mini-Walmart like grocery shop (think Nilgiris, Reliance Fresh, or Spencer’s), I’m confronted with “formal” workers with absolutely no idea how to use the fancy cash registers at their disposal. It’s not uncommon to wait 5-10 minutes for a simple checkout because of how unbelievably incompetent these workers are.

On the other hand, “informal” includes the roadside bookshop or chai-kadai – where one man is serving about ten people at once, with remarkable quality and efficiency. It includes bookkeepers who make the idiots at formal stores look like a joke – for they can manually search the stacks of novels at their disposal in a tenth of the time it takes a so-called “high-productivity” formal worker to access his computer and direct me to the necessary book.

That Bhagwati et al. so casually assume that the formal sector is superior is just, simply, false. As far as services are concerned, this is evident to anyone who’s spent much time in India. I’m no maudlin sob-story who yearns for the “good old days” or the way “things used to be”. I’m all for technology, liberalization, and modernity – but the evidence that formality somehow aids growth (as far as services are concerned) has yet to be demonstrated. And, if you don’t believe me, I invite you to deal with the useless nuts at your local Spencer’s as opposed to the vegetable cart next door.

In their criticism of the Indian labor market, Bhagwati et al. are eager to repeal even the most sensible laws, including:

  • “Benefits related to sickness, maternity, disability, dependents” for employees earning below Rs. 10,000 a month
  • The right for “trade unions to strike and represent their members in labour courts in disputes with the employer”
  • Limiting “work without a day of rest to ten days”
  • Requiring “Proper disposal of waste”
  • “Extensive provisions for worker safety, including fencing of machines and moving parts, use of goggles to protect against excessive light and infra-red and ultra-violet radiation; precautions against fire; and the weight permitted to be carried by women and young persons”.

While they agree that the real culprit of labor rigidity in India is the Industrial Disputes Act (IDA) which makes it well-nigh impossible for factories to fire workers (and, consequently, hire them) – they seem to have fallen the the supply-side myth that grasped most of the USA during the Reagan era that somehow dismantling every worker protection would lead to increased aggregate supply and, hence, economic growth.

Indeed, the very flippant manner in which they claim these crucial provisions increase the “marginal cost” of labor and hence cause unemployment is ridiculous. The theoretical economic argument against this claim is so obvious. Economists argue that few industries are perfectly competitive (the stock market being one, which explains why it’s so hard to “beat” the market). In imperfect markets, the firm earns significant economic rent. This means that even decreased profit will not cause a reallocation of associated factors of production. In other words, a slightly higher marginal cost of labor will have no effect on employment.

Indeed, the greater cost is not even marginal in nature, but rather fixed. Provision of toilets and flow of water are largely independent of the number of workers employed. Similarly, the basic premise on which Bhagwati et al. approach education is flawed:

In contrast to elementary education, which is also a predominantly social objective and for that reason belongs to the Track II policy agenda, higher education belongs to the Track I agenda.

In other words, better universities somehow have supply-side effects in a way that primary education does not. This is simply not the case. For this to be true, Indian universities would necessarily be bottlenecked due to the huge number of highly-qualified Indian high school graduates. However, there are many private universities that are ready to be filled, suggesting a more broken educational infrastructure than the authors assume. A higher education system that can work independent of a weak primary system would need the flow of skilled immigrants the United States sees. Short of this influx, India needs to fix education from the bottom-up to achieve any sizable supply-side effects the, it seems, holy grail of liberalization advocates.

Overall, India’s Tryst with Destiny is a highly worthwhile read. Bhagwati et al. stick to the point, rendering the book a very short (but informative) read. As the authors are acutely aware, myths and lies about India’s reforms abound, and not just among the intellectual Bengali cafes, but even liberals abroad. Bhagwati and Panagariya make a strong case for continued liberalization. I believe I have made a strong case for my ultimate criticism of the book. As a reader fairly in touch with the beliefs of India’s left-wing, I believe the authors unfairly, and to their disadvantage, exaggerated the claims against liberalization. Indeed, I believe they directly misrepresented the opinion of two very respected economists. As an Indian, there is also a little pang that Bhagwati and Panagariya copyrighted the natal utterance of India – it’s very heart and soul – in a book advocating the ultimate removal of labor protections and unions. Contrary to the authors’ belief, Jawaharlal Nehru would not be all to happy with the thrust of this book.

Alex Jutca has some thoughts on Obama’s nominee for Fed Chair next year:

There is one problem with [nominating Bernanke], and it’s a lesson best exemplified in finance. In choosing firms to manage money, investors often discuss the need to guard against key man risk, which is the risk that an institution has become over-reliant on one person to drive results. The Fed has institutionalized that risk now, and has for some time, stretching back to the Greenspan and Volcker eras. It could mitigate the risk by limiting the discretionary powers of the FOMC by adopting Nominal GDP Level Targeting as its new regime. Or, as John Hilsenrath pointed out during the most recent FOMC meeting’s Q&A session, it could limit the terms of the chairman to 8-year periods as the ECB and BoE do, to which […] To be clear, I view term limits as an inferior policy solution to the problem of key man risk. However, it is an issue that is worth contemplating for the POTUS. As much good as Bernanke has done, if there is a clear candidate to make the transition to the next generation of Fed chairmen, perhaps January 2014 is the time for change.

There might be many good reasons for a change of guard, not the least that much-needed fresh ideas often come from newcomers, but the idea that “key men” will somehow hurt the Fed just seems very, very far flung.

Key man risk is comes from corporations like Apple which were defined by Steve Jobs. The job of a chief executive was not only managing the company, but serving as its ambassador to the world, inspiring investors and consumers with glitzy conferences. This domineering role is often found in large corporations. Indeed, companies wherein one figure dominated public imagination often don’t last as long as their more mundane counterparts.

But this misses the role Bernanke (or his successor) will play. The Fed doesn’t need to sell its brand or inspire investors (except in a very literal sense, of course). The Fed doesn’t need glitz and charm to market its product. The defining characteristics of a good central banker are competence, insight, and prescience. 

Indeed, the key man risk doesn’t even apply to central bank insofar as the general public (tell me, how many people can put Volcker, Greenspan, and Bernanke to their face). Of course, one can argue that there may be a similar interplay between the investing community and the central bank but, again, there’s no product to sell. The only virtue of the Fed is derived from the efficacy of its policy, not the aura thereof.

Of course, a very qualified version of the key man risk vis-a-vis the Fed may be the institution of market expectations which prevent rapid change towards another policy. As Jutca notes, targeting NGDP is one way of mitigating this risk.

So long as we have more than one profoundly competent economist, there is no “key man risk”.

The blogosphere’s been abuzz with Google’s decision to terminate Reader services this July. Paul Krugman sees the end of private Internet utilities as we know it:

First, it’s a well-understood though not often mentioned point that even in a plain-vanilla market, a monopolist with high fixed costs and limited ability to price-discriminate may not be able to make a profit supplying a good even when the potential consumer gains from that good exceed the costs of production. Basically, if the monopolist tries to charge a price corresponding to the value intense users place on the good, it won’t attract enough low-intensity users to cover its fixed costs; if it charges a low price to bring in the low-intensity user, it fails to capture enough of the surplus of high-intensity users, and again can’t cover its fixed costs.

What Avent adds is network externalities, in which the value of the good to each individual user depends on how many others are using it […] they mean that if the monopolist still doesn’t find it worthwhile to provide the good, the consumer losses are substantially larger than in a conventional monopoly-pricing analysis.

So what’s the answer? As Avent says, historical examples with these characteristics — like urban transport networks — have been resolved through public provision. It seems hard at this point to envision search and related functions as public utilities, but that’s arguably where the logic will eventually lead us.

I’ve been meaning to blog about my opinions on the Facebook online privacy debate and this seems like a pretty good opportunity to bite. It’s also particularly interesting (for me) because rarely is it that I disagree with Krugman’s opinions. In less polarized times, I’m sure we would find far more space for dispute but, today, when most politicians seem mad and the path forward is clear, there is broad consensus among most (a nominal GDP targeting offering a fine example to this effect).

The import of Krugman’s argument is that Google Reader which, unlike the search itself, is used very intensely by a rather small group of people can’t price even nominal sums without driving away the mass, who will refuse to pay more than a nominal fee.

Krugman assumes pretty standard microeconomic theory wherein a monopolist has limited ability to segregate the market. The problem doesn’t arise as much from the fact that users are unwilling to pay a decent fee, but that users are unwilling to pay. This requires the assumption of irrational behavior that is entirely contrary to the analysis he uses.

The wonder, and preponderance, of most online services comes from the perceived freeness of the service. And, because we’ve grown very accustomed to the idea of free goods, the idea of paying for basic Internet services seems even more nonsensical. So the decision Google faces is “to charge or not to charge”.

Furthermore, the assumption that Google Reader is a monopoly is wrong. While it would be easy to think so, considering its widespread use and robust network effects, Google actually operates more under what I would call contestable markets, wherein firms cannot earn economic profit. According to Wikipedia, William Baumol describes such a firm for which “there exist markets served by a small number of firms, which are nevertheless characterized by competitive equilibria (and therefore desirable welfare outcomes) because of the existence of potential short-term entrants.”

In the Internet it would not take long for users to make the switch to another service (because of perceived irrationality and relatively low entry costs), therefore Google Reader operates under the threat of competition. This is a potent force for social welfare. Note that Facebook and Google Search are probably less “threatened” by outside competition because of huge brand names compounded with relatively larger costs to entry.

Much of the blogosphere has already moved to other alternatives, because they always existed, delivering a threat to Google’s market power.

This allows me to make a somewhat rough segue into an interesting topic: Facebook and data. Newspapers of such repute as the International Herald Tribune have run stories describing privacy as a justifiable concern, even reaching the possibility that Facebook pay an annual fee of $50 dollars to each user.

Actually, Facebook is just a perfect example of the erosion of economic frictions, and the benefits unlocked. For one, everyone knows which data they give to Facebook: the truly paranoid don’t use it. Facebook which provides a value of, say, $300 dollars a year to each user (which is my reservation price). By trading data I consider very irrelevant to my security, such as relationship status, birthdate, location, and number of friends I earn my reservation price in value.

Effectively, Facebook allows one easily trade data for money. This used to be much harder. Many online portals that allow users to watch free movies (aside from torrents, of course) require clients to fill out a “survey” for various organizations. After filling three surveys which took time to submit, were weathered with millions of disgusting pop-ups, the user was granted his wish: two hours of free TV.

Facebook offers a much cleaner and, dare I say, safer way to trade this information for value. We are all willing to give up a certain level of information. Until today, there was no efficient way to interface the information market. Facebook is that conduit. Indeed, users also benefit from tailored advertisements, if they pay attention at all.

Ultimately Krugman, in suggesting that the future of such utilities (as they really are) lies in the public sector ignores that both Google and Facebook are highly profitable. Yes, Reader by itself is not profitable, but the same network effects he uses to derive his argument drive remarkable margins from the search portal itself in form of targeted advertisements. Further, even if Reader were to shut down, it is just not a societally important service that requires government intervention. Google’s decision is strategic, not microeconomic. The financial costs in providing Reader are low though, conversely, the reputational cost of not providing it is very high!

Public utilities are monopolistic because the minimum efficient scale far exceeds the total demand in a community, presenting large barriers to entry and removing any room for threat. None of Krugman’s logic is wrong. The assumption that Reader is a monopoly is. Perhaps we’ve found a robust example of contestable markets.

What do I mean by at it? Oh… well… blowing a lot of hot air in service of a myth, presumably to create hype around her brand. Last time it was The End of America comparing the modern United States to Hitler’s Germany, Mussolini’s Italy, and Stalin’s Germany based on ten, arbitrarily defined “steps”. Even the loony liberals at Rotten Tomatoes couldn’t rate it more than a 6/10. Today, it’s Is Pornography Driving Men Crazy.

Let’s start with her argument, basically captured by this paragraph:

There is an increasing body of scientific evidence to support this idea. Six years ago, I wrote an essay called “The Porn Myth,” which pointed out that therapists and sexual counselors were anecdotally connecting the rise in pornography consumption among young men with an increase in impotence and premature ejaculation among the same population. These were healthy young men who had no organic or psychological pathology that would disrupt normal sexual function.

Okay, so, as a member of modern society, I presume Naomi has access to a tool near and dear to all of us, Google. And, after reading her claim to “evidence”, I can’t believe she spent more than a few minutes selectively searching for proof (based on my prior that she possesses a slightly above-average level of intelligence and Googling skills). I say “claim” because there isn’t a single link to the papers to which she refers, absurd for a Project Syndicate link. Indeed, her argument hides behind the veracity of said “researchers”.

So, I spent two minutes Googling terms like “porn cause no harm”, “porn good”, “porn research evidence” – testimony to my value as a groundbreaking researcher and found real evidence to this effect:

  • The New Scientist: Porn: Good for us? As would be expected of such a publication, this article is peppered with high-quality references, links, limitations, questions and, most importantly, doubt – a characteristic Naomi ignores with gay abandon…
  • In terms of the use of pornography by sex offenders, the police sometimes suggest that a high percentage of sex offenders are found to have used pornography. This is meaningless, since most men have at some time used pornography. Looking closer, Michael Goldstein and Harold Kant found that rapists were more likely than nonrapists in the prison population to have been punished for looking at pornography while a youngster, while other research has shown that incarcerated nonrapists had seen more pornography, and seen it at an earlier age, than rapists. What does correlate highly with sex offense is a strict, repressive religious upbringing. Richard Green too has reported that both rapists and child molesters use less pornography than a control group of “normal” males.

Okay, okay, I’ll stop – you get my point! I can use Google to my will to derive basically any result I want (which is basically all she did, there’s no new insight – positive or normative – in her piece). Unlike Naomi, however, I’ve taken the time to link my sources and, now, will take the time to express quite a bit of doubt regarding the message of the above studies. Indeed, I fully appreciate the suspicion of degrading pornography in the age of technology where rough sex is available at the click of my button. I’ve been far more aggressive about regulating aspects of pornography than many other liberals would be, and I do believe that traditional institutions of sex and marriage are probably for the better. No, I don’t think pornography “desensitizes men” and causes rape. But hey, don’t I live in Communist Russia, or something?

Overwhelming evidence not only from scientists, but also sociologists, feminists, and investigative journalists seems to vindicate this belief.

Even assuming everything Naomi says is true, her logic is… well… non-existent. Here’s how she starts:

It is hard to ignore how many highly visible men in recent years (indeed, months) have behaved in sexually self-destructive ways. Some powerful men have long been sexually voracious; unlike today, though, they were far more discreet and generally used much better judgment in order to cover their tracks […] so many of the men caught up in sex-tinged scandals of late have exposed themselves – sometimes literally – through their own willing embrace of text messages, Twitter, and other indiscreet media.

What is driving this weirdly disinhibited decision-making? Could the widespread availability and consumption of pornography in recent years actually be rewiring the male brain, affecting men’s judgment about sex and causing them to have more difficulty controlling their impulses?

Okay, so basically, Naomi is blames Anthony Weiner boxer’s on porn. Somehow, the degrading, sexual effects of pornography are manifest in the benign, if irresponsibly communicated, sexual practices of powerful men. Huh? Is she saying that irresponsible “sexting” is a phenomenon not from the preponderance of modern technology but the evil, dark, con of Man?

Has she even read the love letters between famous lovers in the pre-Internet era? The beautiful erotica that lines ancient Indian caves? The Kama Sutra which is probably far more “rough” than Naomi might expect… (warning: it has biting)

Her conclusion is a little more palatable, though not insightful:

This is not to say that they are not responsible for their behavior. But I would argue that it is a different kind of responsibility: the responsibility to understand the powerfully addictive potential of pornography use, and to seek counseling and medication if the addiction starts to affect one’s spouse, family, professional life, or judgment.

By now, there is an effective and detailed model for weaning porn-addicted men and restoring them to a more balanced mental state, one less at the mercy of their compulsions. Understanding how pornography affects the brain and wreaks havoc on male virility permits people to make better-informed choices – rather than engage in pointless self-loathing or reactive collective judgments – in a world that has become more and more addictively hardcore.

Marital sex therapy is already a huge industry, formally, in the West. And, I would venture, it’s a pretty big informal process among friends elsewhere. The titular claim ascribes a certain causality to pornography that is entirely irrelevant from her conclusion. That pornography is “powerfully addictive” is yet to be proven. That modern sexual practices are a result thereof, even more so.

Of course, as I mentioned earlier, I believe there is a lot of room for improvement in how we deal with the porn industry. That much of it is available free just seems blatantly unfair to the actresses porn stars. That only by referendum in 2013 were condoms required, too. Porn is an industry that is often-cited to be a “quick escape” for young girls in debt. Selling yourself should be a choice, not a necessity from poverty.

This is an argument for stronger social insurance and a more evolved attitude towards marginalized members of society. However, just as she did for The End of America, Naomi has shifted the sphere of debate from that which is actually important (Dick Cheney’s curtailment of civil liberties… marginalized, young, girls) to pure, senseless hype (America as Communist Russia… Weiner’s weiner on the World Wide Web a result of porn).

This does no justice to her compatriots who, too, want a better society without the evils of the Bush administration or exploited girls. But when our journalists derive all authority and profit from generating hype, what else can we expect?

Evan Soltas has a very interesting blog post about intergenerational inequality. The thrust of his argument is that inequality in educational attainment exists, even adjusting for differences in income. At some level, this is trivial – one would expect educated parents, wealthy or not, to spend more on academic pursuits for their children. The conclusion Evan draws, however, is quite fantastic that is, the effect of educating a kid today is geometrically valuable:

Here’s why that math is important. The high school dropout rate among people whose fathers were dropouts is 22.2 percent. The dropout rate with high-school-grad fathers is 2.9 percent. Let’s assume that the social value of a high school degree is $30,000 per graduate; that’s roughly the difference in average income between non-grads and grads. Public policy that supposes they are helping one person assesses the value of that degree at $30,000, obviously. Public policy that supposes they are helping an infinite succession of people assesses the value of that degree at $819,000.

He arrives at a whopping $819,000 as the difference in the net present value of fathers with and without high-school degrees in terms of the future earning potential of their kids. I would argue that the value of a high-school degree is somewhat less than $30,000 because a good amount of the delta is derived from the further division between college graduates and non-graduates. This wouldn’t change the situation if the deviation was randomly distributed (and college actually added value, a contestable claim), but there’s good reason to believe it’s not. (For example, there are definitely demographics in which it’s very likely a child graduates high school, but also very unlikely that he or she graduates a 4-year college).

That even basic jobs require a college degree nowadays would further diminish the value of a high school degree by itself. The $819,000 figure includes the increased chance of attending college, which is far more dubious in its actual value added. A more conservative, but not necessarily better, approach would be to estimate the value added by high school itself, assuming that college adds no value, or approximately $11,000, according to Pearson.

The geometric multiplier is about 26.15, yielding a present value of $298,615. This isn’t nearly as astonishing as Evan’s $819,000, and probably isn’t as close to the truth. However, it does compound an already compelling case for investing in high school education; that it’s worth it even if no one ends up at college. At a public school, the average cost per pupil is $10,652 or about $40,000 for a degree, or a 645% return on investment. This is a low-hanging fruit.

I think there’s one big flaw in the way Evan looks at things; it’s also important to note that the value of a high school education is hugely understated by the calculated figure, because it is the difference in annual income. The effect over a lifetime is many multiples of this. For this reason, the return on a high school degree, a net of 645%, doesn’t begin to approximate the real value of an education.

A final caveat, I have a pretty strong feeling that education by itself doesn’t explain the intergenerational inequality in education. As it happens, I came across this passage in a recent copy of the Economist:

The well-to-do [have] largely held to old-fashioned ideas about marriage. Among professionals, births within marriage are four times as common as births where the father is registered as absent from the household.

This is for Britain, but the gap is only worse in America. The figure below charts educational attainment of a child by family situation at age sixteen.


One can see an almost twofold increase in dropout rate between dual and single guardian households (the exception being families where neither of the guardian is directly related to the child). The geometric multiplier between a nuclear family and anything but is about 20. While this is less than that of a high school degree, the policy cost is also substantially less than $40,000.

Today, in many ways, we disincentivize marriage – as Nicholas Kristoff grimly notes – with poorly designed welfare programs (such as handouts to single mothers). As the Economist notes, I don’t believe the chain of causality is as strong between an educated parent inculcating similar values in his children as much as strong tendencies towards the nuclear family among the educated, which themselves engender stronger attitudes about education.

Regardless, any of these points are a damning indictment of the “American dream”. Policymakers need to acknowledge the importance of a high school education. We’ve spent billions in grants and subsidized student loans for college that implicitly benefit the lucky, that is those who already have a high-school education.

Further, it is far from established that college today adds economic value to society. The huge underemployment of recent graduates (which itself causes the unemployment of those without a college degree) should make each of us think twice while promoting the virtues of college.

Indeed, the advent of online courses further convinces me that college is but a licensing factory. For example, a University of Washington course in Financial Econometrics is provided on the Coursera platform, with the additional option of doing slightly more work and receiving slightly more attention, at a price tag of $4,000. This is absurd. The only value derived from the for-credit option is Washington’s official stamp of approval, a license.

By blindly subsidizing college education we’re implicitly encouraging rent-seeking behaviors that are damaging to society as a whole, especially those at the bottom. Evan’s point is clear: we need to stop acting like a high school degree is its present value, so long as inequality persists. Indeed, Evan hugely underestimates the value of his own claim by ignoring the lifetime effect of increased cash flow. For those of you interested in that figure, even discounting at 15%, it’s over $10 million.

Republicans love to say funny things like:

There are 47 percent of the people who will vote for the President no matter what…. There are 47 percent who are with him, who are dependent upon government…who believe that government has a responsibility to care for them, who believe that they’re entitled to health care, to food, to housing, you name it…. These are people who pay no income tax…. My job is not to worry about those people—I’ll never convince them that they should take personal responsibility and care for their lives…

They also like to explain why they lost with logic such as:

It’s a proven political strategy, which is give a bunch of money to a group and, guess what, they’ll vote for you.

And they also hate Obamacare. They love using their megaphone, known as Fox News, to reiterate this point with headlines such as:

Poll: Obamacare a Bigger Worry Than Sequester

(This is all under the presupposition that we, the Tyrannical Democrats, actually give a shit what people think). Of course, if anyone actually read the bottom print of the article, it would be clear that this poll is from a small town in Pennsylvania.

But okay, okay – too much digression from my main point. People hate Obamacare, here are some statistics:

  • Just over a third think it makes the country better off [1]
  • More than 60% of the country thinks we’re worse off or no different [1]
  • 45% of voters want their Governor to cooperate with HHS, and 11% are undecided [2]
  • 47% (hmm….) of Americans support a full repeal [3]

Alright, yes, I’m “cherry-picking” statistics here. But that doesn’t matter, I’m not trying to make a logical argument (I am trying to understand the Fox News mind, after all). These statistics come under headlines that demonize Obamacare and everything associated thereof.

Do the Republicans not understand that they’re logic is screwed up at a very, very fundamental level? Obamacare is, by far, the President’s largest “free handout” to the “takers”. It’s the most “anti-business” galling, socialist paradise that the 47% better love. Except they don’t. So here’s their argument:

  1. Obama won because he loves giving stuff away.
  2. A majority of the people want him to take his stuff back (again, whether the polls are unbiased etc. is irrelevant)
  3. And therefore, somehow, we conclude handouts are why the 47% voted for Obama.

My point is that, yes, Democrats probably have stronger priors with regard to social spending (though the size of our government declined most rapidly under Bill Clinton, by a whopping 3.9% of GDP). However, plain entitlements like healthcare are not the reason most of the country voted Obama.

They sensed a sense of hope, perhaps misplaced. The idea that maybe America is for everyone. The principles behind Obamacare – social justice, equal opportunity for children – is what they voted for.

So, Republicans, in the future, when you want to make a crappy argument, please don’t use its contradiction as proof thereof.

James Pethokoukis asks whether spending austerity is the path to prosperity in the US:

So this is my take: Spending cuts can be pro-growth, certainly over the longer term, all else equal. But neither party in Washington has offered a financially and politically realistic path to lower spending — certainly not low enough to balance the budget in a decade — that wouldn’t also, say, risk US defense and basic research capabilities.

Here’s the evidence he starts with:

Researchers tend to find a negative relationship between the size of government and economic growth in advanced economies. After surveying the literature […] it’s “fair to say than an increase in total government size of ten percentage points in tax revenue or expenditure as a share of GDP is […] associated with an annual lower growth rate of between one-half and one percentage point.”

For one, this ignores the fact that many of us who believe in fiscal stimulus today don’t necessarily have stronger priors about government spending, just that at a zero lower bound deficits can be self-financing. But more importantly, the whole, carefully placed, correlation can be rejected with the syllogism:

  1. Researchers tend to find that richer economies have bigger governments (because, you know, they do)
  2. Researchers tend to find that richer economies have slower growth rates (notice that “developed” isn’t a progressive verb)
  3. Therefore, bigger governments must be associated with slower growth rates.

You see, this whole argument is tautological: growth can’t be sustained forever. If the simplistic argument I presented is correct, and growth rates are the ultimate goal, we should move towards becoming India, or something. My argument is, of course, shoddy and, by extension, the idea that government spending is anemic to growth (especially in depressed conditions) is, as well. 

Pethokoukis further develops his argument with a blatantly incorrect op-ed from a former Romney advisor:

First, the lower level of future government spending avoids the necessity of sharply raising taxes. The expectation that tax rates won’t need to rise provides incentives for higher investment and employment today. Second, since the expectation of lower future taxes has the effect of raising people’s estimation of future disposable income, consumption increases today. Third, the new budget’s reduction in the growth of government spending is gradual. That allows private businesses to adjust efficiently without disruptions.

Noah Smith and Paul Krugman have already wrecked this argument, and I can’t do any better. 


Upshot: If you have no Zero Lower Bound, and if the Fed partially counteracts the demand-side effects of fiscal policy, and if people have forward-looking expectations, and if you don’t cut government purchases much, and if taxes are very distortionary, then austerity works. This is not really a new result, but it rarely gets shown so explicitly, so it’s good that John Taylor and his co-authors went ahead and did it.
That said, the result basically ignores the real Keynesian critique that has emerged since 2008, which is that the Zero Lower Bound matters a lot. It also probably assumes that taxes are a bit more distortionary than they really are. And it also probably overestimates the Republicans’ real willingness to cut transfers (entitlements are the “third rail”, after all), and underestimates their willingness to cut government purchases. In real life, spending cuts usually fall on the things that are politically most easy to cut, but are economically most valuable in both the short and long runs – infrastructure and research. Finally, Taylor’s plan ignores distributional concerns, but that’s pretty much par for the course.

Let’s think this through. If you take $200 billion a year from the poor and hand it to the rich, and people believe that this transfer is forever, permanent income theory says that consumption among the poor should fall by $200 billion while consumption among the rich rises by the same amount. There are, however, two reasons not to believe this.

One is that there is some evidence that permanent income doesn’t work all that well, that the rich persistently consume less of their income than the poor.

More to the point here, however, is that it’s very likely that people would view both savage spending cuts and the tax cuts they pay for as less than permanent, likely to provoke a backlash or at any rate a reversal at some point. And in that case the rich would not spend all of their tax cut.

Economists don’t talk about the moral importance of spending in a recession. Unemployment insurance and transfers are discussed in the scope of Keynesian stimulus, and basically all the debate is framed around this attractor. But in a recession, the poorest and most vulnerable loose their jobs. And, when growth resumes, most of the income returns to a vanishingly small percent of the population.

Basically, a financial recession is a redistribution of wealth, to the rich. Not only is the argument against economic stimulus wrong logically, it’s wrong morally. I believe in hard work and fair taxation as much as the next guy, if you don’t believe me, read about my admiration for American conservatism. (Also read Brad DeLong’s takedown of bad conservative ideas with good conservative ideas, notably Milton Friedman).

Unemployment insurance makes sure insures that unemployed parents can continue to buy books for their kids and put food on the table. Transfers help the poor recover from predatory practices (and, admittedly, their own stupidity for buying things they can’t afford – but not their kids’, who will ultimately pay for society’s apathy).

Maybe tax cuts pay for themselves. The argument Pethokoukis presents is unconvincing but, even if they do, the deficits we incur today to build our way out of this recession won’t matter. When the Republicans claim that we should offset any tax increases with spending cuts, I really scratch my head. Because, right now, they both suck for the economy. 


Edit: Brad Plumer has a piece making the same argument. It’s wrong for the same reasons. Also, I’ve heard an AD argument suggesting that an increase in oil-exports will cause inflation. This is wrong for the same reason every nut who claimed America’s deficits, or lack of austerity, will cause inflation. In fact, a little more inflation would probably be a good thing. No matter, as I note, the supply-side benefits of cheap oil probably outpace the effects of demand.

Another Edit: Altman and Plumer are right that resulting investment will cause an appreciation of the dollar, even in the counterfactual that the increased exports came from, say, Oman. This is because the infrastructure behind oil production need Omani labor, Omani land, and hence the Omani rial. The cost from demand of oil itself, though, is no different whether it’s flowing from Oman or the USA.

Daniel Altman has a piece in Foreign Policy, concerned about the effect increased oil exports  will have on the American economy, suggesting that Americans might be hit with the infamous “resource curse”:

To buy all that oil and gas, America’s new customers will need dollars — and that will begin to push up the currency’s value. It will rise further still if the oil and gas industries energize the U.S. economy enough to pull in new investment from abroad.

Though these shifts will be dramatic enough, the most profound effects will be on American workers and consumers. A stronger dollar is usually fine for Americans, as long as their purchasing power keeps up with the currency. Yet this is exactly where the problem will be. The new exchange rates will make it harder for non-petroleum industries — where many more Americans are employed — to export their products. At the same time, the strong dollar will make imports more affordable to American consumers. Some of the money generated by oil and gas will still filter through to other industries, but those dependent on exports or competing with imports could find themselves in a dire situation.

The news for consumers is not all good, either. With more income coming into the country, local prices will creep up as well. The United States might go the way of Norway and Australia, rich countries that have become two of the world’s most expensive places to visit and live, in large part because of their resource booms. The combination of higher prices for goods and services and falling wages in industries unable to compete at the new exchange rates will squeeze household budgets from both ends.

I share the same concern increasing prices will have on the median consumer, but think this argument is ultimately unfair. First of all, when it comes to oil, Altman seems to argue that there’s something particularly special about American oil exports. To the contrary, because oil is priced in dollars, American consumers are vulnerable to increased exports of oil whether the crude originates in Saudi Arabia or Texas. For this reason, the comparison to Australia is incorrect, because the rapid rise in Australia’s exports weren’t on the dollar standard.

Indeed, with a few basic assumptions, it is possible to argue that increased American exports will decrease international demand for dollars, and hence its value. I will assume the following:

  • Demand for oil is price-inelastic (this is a fairly defensible and data-driven belief, as indicated by this IMF report)
  • Oil will continue to be priced in dollars (so long as the Americans, and not the Chinese, are responsible for peace in the Middle East, this will continue to be the case)
  • The increase in oil production is exogenous (recent technological advances clearly support this theory).

Consider the international market for oil:

ImageThis rather simple graph illustrates why increased American exports won’t necessarily drive an increase in dollar value. R+ Rrepresents the initial demand for dollars, while R+ Rrepresents the demand for dollars after a positive supply shock. It’s clear that, due to price inelasticity, the demand for the dollar has fallen. A retrospective edit: I should note that I know the price of oil will continue to increase, certainly from rising demand but possibly also from supply-side factors like peak oil phenomenon. Under price-inelastic conditions, this would imply an increased demand for the dollar. However, this graph demonstrates the supply shock against the counterfactual in which America doesn’t export oil which, I think, vindicates my argument.

Oil isn’t like corn or steel. We run the oil market, and hence any exogenous increase in exports, whether from Saudi Arabia, Qatar, which means demand for dollars will increase, regardless. Again, the undertone of the article suggests that Altman feels it’s worse that the oil is coming from the US as opposed to the Arab-world, but the fact is that if dollars are going somewhere, they might as well go home.

It also seems odd to suggest that we might become the “United Petrostates of America”. Even as a nation that championed the idea of free, international trade in the 20th Century, imports and exports remain a relatively small portion of the American economy. “Petrostate” connotes the Saudi disaster that is an economy so drunk and dependent on state capitalism of oil that all institutions become extractive, failing to make the leap of human development required of a modern nation.

There’s another problem with Altman’s argument. Exports will increase, driving demand for the dollar, which will make imports cheap, increasing our deficit.  But this is how trade works! If there’s one concept we all remember from Econ 101, it’s that trade is ultimately self-correcting. Now, one may argue that frictions and controls across money markets won’t let this happen, but Altman – too – in his argument assumes a pretty mainstream interpretation of international trade, so I see no problem criticizing his conclusion on these premises.

We share a similar concern about the income derived from increased production. Unlike Altman, I do think the supply-side effect of oil will far exceed its impact on aggregate demand, resulting in cheaper energy and higher real incomes for all. The US should learn from Norway how to direct an oil boom to the well-being of all without concentrating all the benefits in a rent-seeking minority.

I don’t know whether the answer to this lies in high taxes; regardless, income from land should ultimately be shared by every American. Oil is a dirty good. We didn’t build our country on oil, but on ideas. It will be damning if this windfall impedes our efforts to move to cleaner sources of energy and, as Altman fears, crowds-out better investments.

In the end, if we can divorce ourself from the mess that is the Middle East, we will achieve a geopolitical landmark, allowing us to pursue policy that is truly for greater, visionary interests rather than the short-term need for oil. Arab dictators will no longer have an iron grip on international development and, perhaps, citizens thereof will be freed of the real resource curse.

In the mean time, we should ensure that the coming windfall in investments derived from energy will be directed towards clean energy, human capital, and greater equity. This is no different from any other export, and the relative cost to the US, unlike other exports, is nil because oil is, by standard, denominated in the dollar.