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Monthly Archives: April 2013

Noah Smith has a post about why macroeconomics doesn’t work (well):

1.  There are a number […] “heterodox” schools of thought, [which] claim that macro’s relative uselessness is based on an obviously faulty theoretical framework, and that all we have to do to get better macro is to use different kinds of theories – philosophical “praxeology”, or chaotic systems of nonlinear ODEs, etc. I’m not saying those theories are wrong, but you should realize that they are all just alternative theories, not alternative empirics. The weakness of macro empirics means that we’re going to be just as unable to pick between these funky alternatives as we are now unable to pick between various neoclassical DSGE models.



2. Macroeconomists should try to stop overselling their results. Just matching some of the moments of aggregate time series is way too low of a bar. [It is important] when models are rejected by statistical tests […] When models have low out-of-sample forecasting power, that is important. These things should be noted and reported. Plausibility is not good enough. We need to fight against the urge to pretend we understand things that we don’t understand.



3. To get better macro we need better micro. The fact that we haven’t fond any “laws of macroeconomics” need not deter us; as many others have noted, with good understanding of the behavior of individual agents, we can simulate hypothetical macroeconomies and try to do economic “weather forecasting”. We can also discard a whole slew of macro theories and models whose assumptions don’t fit the facts of microeconomics. This itself is a very difficult project, but there are a lot of smart decision theorists, game theorists, and experimentalists working on this, so I’m hopeful that we can make some real progress there. (But again, beware of people saying “All we need to do is agent-based modeling.” Without microfoundations we can believe in, any aggregation mechanism will just be garbage-in, garbage-out.)

This led to a very interesting Twitter discussion:

Ashok Rao ‏Personally, I’d frame it that modern theory is fundamentally deductive in nature whereas the marcoeconomy is inductive/Bayesian.

Noah Smith ‏I think that’s a wrong way of seeing things. Real science involves an iterative process of induction and deduction.

Ashok Rao ‏But your claim also assumes there’s something “fundamental” about the economy in the sense of a real science. Is there?

Noah Smith Maybe. There’s real science in earthquakes but we can’t predict them at all. 

Ashok Rao ‏Hm. So there are systemic laws. But can these not be “understood” only through induction? As in the economy as machine learning.

Noah Smith Maybe!

Ashok Rao As long as we agree that there is a lot of doubt! 🙂

This conversation is at the very heart of my discomfort with much of modern economics, and I’ve been wanting to blog about this for a while, so now is as good a time as ever to dive right into it. Before I go on, I want to clarify that it seems like Noah and I have a very different understanding of what inductive is (or at least should be):

Ashok Rao ‏Yes but the 3 ‘main’ equlibria frameworks (general, classical game theory, and rational expectations) are all deductive. Right?

Noah Smith ‏No, you can easily make a Walrasian equilibrium happen in a lab, it’s very robust under certain conditions!

Of course, to the extent that empirical creations in the lab or double auctions are inductive Noah is right. But the macroeconomics behind this is principally deductive. By this I mean mathematicians economists have employed mathematics (the major premise) to a set of assumptions (the minor premises) to infer a conclusion. Ultimately, the theory is a grand syllogism, and highly deductive in nature. Further, the comparison to earthquakes doesn’t sit well with me. Physicists have very good microfoundations about how the earth works, and they’re not in perpetual motion. Scientists might fail at the aggregation of these bits of knowledge, but economics has a much more inherent flaw.

This is precisely the reason classical game theoretic approaches work only in “small lab settings” and that the Walrasian equilibrium holds only under “certain conditions”. That they do granted the right assumptions is tautological. Indeed, mathematics is internally consistent and hence in a concocted economy (the double auction) specific deductive models have to hold.

But by induction, I don’t mean experimental confirmation tempered by statistical reasoning. W. Brian Arthur at the PARC puts it better than anyone else:

This ongoing materialization of exploratory actions causes an always-present Brownian motion within the economy. The economy is permanently in disruptive motion as agents explore, learn, and adapt. These disruptions, as we will see, can get magnified into larger phenomena. 

If economists want to import one idea from physics, it should be Brownian motion:

One way to model this is to suppose economic agents form individual beliefs (possibly several) or hypotheses—internal models—about the situation they are in and continually update these, which means they constantly adapt or discard and replace the actions or strategies based on these as they explore. They proceed in other words by induction  

The best way I can imagine this idea is a “Bayesian machine”, if you will. While classical game theory, rational expectations, and competitive (Walrasian) theory might have inductive verification, Arthur is suggesting that the economy is inherently inductive.

The catch here is that for something that is at its heart inductive, there is not deductive verification. This is why many such as myself are skeptical of the mathematical models that dominate economics as they cannot either explain or verify anything. Often criticized, is the unrealistic nature of rational expectations. But in a real economy, I not only know that I’m not rational, but I also know that fellow agents are irrational too. This means I have subjective preferences, but also have subjective preferences about other people’s subjective preferences. These two degrees of subjectivity make many economic assumptions not just wrong, but impossible. (Think the epistemological difference between is not and can not be). 

This is why I disagree with Noah. While in  specific circumstances – equilibrium is a sub-class of non-equilibrium, after all – deductive engines work, macroeconomics has failed because the economy is inductive. At every moment in time there is a constant ferment, a change in attitude and belief. Standard economics holds that we all have one, perfectly rational prior. Induction holds that we all have pretty crappy priors that are constantly updated not only by economic outcomes, but also political and institutional motion.

Talk to goldbugs (actually, avoid it if you can). They’ll tell you about how they fear a government-Jewish orchestrated New World Order meant to line the pockets of rich bankers at the cost of the worker, by debasing our currency. Every economic indicator tells you they are wrong.

In a deductive model, it is impossible to accommodate for such people. If we modify a standard DSGE to tolerate such granularity it becomes intractable. A computer scientist would think about this as a machine learning problem. While there are a handful for which analytical solutions might work, the driving theme behind modern data mining and machine learning projects, even as simple as classification problems, is the flexibility of statistical computer science.

But the problem with induction is that, well, it’s not deduction. A well-formed syllogism guarantees its inference. Very much like the sum of two and two has to be four. On the other hand, induction is fuzzy and unclear. You can’t prove any sweeping laws and ideas with inductive reasoning, as Karl Popper has brilliantly argued. Indeed, inductive thinking is fragile against “black swan” events.

These aren’t real limitations, though. In the economists’ imagination theory trumps empirics. For the same reason, running large simulations on supercomputers is hardly as appealing as theorizing Walrasian economists. Proving things is really fun (if you’re smart enough).

But just as natural evolution doesn’t lend itself to equilibrium analysis, economists cannot believe that the fundamental structure of the economy is static. It is constantly reborn in updated preferences, political upheaval, and institutional ferment. Human minds and mathematics can never model this. But a supercomputer might help.

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Every now and then, economists come up with ideas that are too radical and cool not to try. Kaushik Basu asking India to legalize paying bribes is one:

The paper puts forward a small but novel idea of how we can cut down the incidence of bribery. There are different kinds of bribes and what this paper is concerned […] harassment bribes [which] is widespread in India and it plays a large role in breeding inefficiency and has a corrosive effect on civil society. The central message of this paper is that we should declare the act of giving a bribe in all such cases as legitimate activity. In other words the giver of a harassment bribe should have full immunity from any punitive action by the state.

The Theory and Experiment

In the spirit of Basu’s best writing, the idea behind this proposal is game theoretic in nature. India is famous for its corrupt political culture. Of course, foreigners sense this from the carefully coordinated heists like the 2G Scam. But most bribery isn’t that sexy, nor is it coordinated. It’s the undignified bribes a commoner must pay to the police officer, or water man. The gift to expedite regulatory approval. (In my case the bribe to bring our American-born Dachshund, Lego, into India without the murder of a quarantine India requires).  Basu’s argument is as follows:

  1. In a “harassment” situation, the bribe giver is humiliated and is eager to bring the taker to justice.
  2. Under today’s punitive laws he, too, is a criminal and hence must keep quiet. The taker knows this to be the case and hence does not fear punishment – especially as this information is restricted to the two involved parties.
  3. If the government were to a) legalize the act of giving a bribe and b) incentivize citizens to report illicit activity the dominant strategy for the citizen would be to report the bribe regardless.

Here’s what the payoff matrix might look like with symmetric liability:

Citizen/Corrupt Official Accept Don’t Accept
Give and Report (-5, -5) (0, 0)
Give and Don’t Report (5, 10) (0, 0)

In reality, (Give and Report, Don’t Accept) might be a Pareto-efficient situation, but (Give and report), in this matrix, is not subgame perfect. This means a given citizen cannot credibly threaten to report, and the official knows this. Basu’s insight was noting that it’s not difficult for the government to make (Given and Report) a credible threat. This would force officials to accept transactions without a bribe because they will be penalized if no transactions are processed. (The bribe is just a way of extracting surplus from the citizen)

Citizen/Corrupt Official Accept Don’t Accept
Give and Report (15, -5) (0, -2)
Give and Don’t Report (5, 10) (0, -2)
Don’t Give (10, 0) (0, -2)

It can be seen that (Don’t Give, Accept) becomes a subgame-perfect Nash equilibrium. (Note, I omitted the Don’t Give option in the first game because it is strictly dominated by the given matrix and hence may be iteratively removed).

The beauty of Basu’s theory is that it’s vindicated not only by matrices, but also empirics. Klaus Abbink, Lata Gangadharan, Utteeyo Dasgupta, and Tarun Jain conducted an experiment in Hyderabad that verifies this theory. The sample (students in major universities around the city) was fairly representative of India’s middle-class as a whole. 55% reported having paid a bribe, and over 60% declared some familiarity with India’s labyrinthine corruptions laws. Participants had the chance of real earnings to the tune of almost $10, ensuring that they took the experiment seriously. For the average Indian student, this is definitely not a trivial sum of money: we should be confident that they played selfishly.

The experiment played a citizen against a corrupt official, as I noted above, with the same moves. Unlike my simpler matrix, they assume a 40% chance of successful prosecution if the bribe is reported, but a 5% chance if it is not, perhaps through a third agent. Citizens and officials are made aware of the potential gains from reporting and taking bribes, but also the risk of fines from a prosecution.

Three games are played. A control where both agents are at risk of prosecution, Basu’s proposal where only the official may be punished. Abbink et al. also consider a third option where the angry official threatens to take revenge on the citizen if he reports the bribe. The results are striking:

We found strong evidence that Basu’s proposal works. Twenty five percent of citizens reported bribe demands in the symmetric case, which increased to 59% in the asymmetric case. In the case of officials, while 38% asked for bribes in the symmetric treatment, this fell to 24% with asymmetric liability as officials feared the impact of greater reporting by citizens. Interestingly, the moral “refusal to pay” did not change significantly as we switched between the two versions (17 versus 19%), suggesting that the law is not a strong guide to moral behaviour.

But:

We find that the impact of asymmetric punishment is reduced considerably when retaliation enters the formulation. Only 42% of citizens report bribe demands and 37% of officials demand bribes, which is close to bribe demands with symmetric liability.

So Basu is correct, unless the official has the capacity to threaten citizens (perhaps with prolonged water shortage, delay, etc.)

My Thoughts

While the results of this experiment is a victory for behavioral economics and “out of the box” thinking, one sobering thought caught my eye:

Retaliation takes costly effort, but does not offer the official any explicit rewards. Thus, in our formulation, retaliation is never an optimal strategy and instead hangs as a threat that can be used by a vengeful official.

This is to say that revenge by the official is not a credible threat. Because it’s a costly process to antagonize a citizen, both parties are the worse off. In a world with symmetric information and rational actors, there should be no discernible effect in adding the option of retaliation. To the extent this sample is representative of middle-class, urban India – the game is settled outside of a subgame perfect equilibrium.

This is not to say the government shouldn’t experiment with Basu’s proposal. The idea that fairly petty officials (drunk police officers, etc.) have any long-term rationality is unlikely. Indeed, the only benefit from the non-credible threat of retaliation comes from possible deterrence and I suppose it’s unlikely many such agents have studied the Cold War.

This study decisively rebukes P. Sainath’s scathing critique  of Basu’s idea:

The Chief Economic Adviser dresses up these arguments for middle classes forced to make payoffs. For instance when a person allotted subsidised government land “goes to get her paperwork done … she is asked to pay a hefty bribe.” Yet, his law will in no way curb bribery where scarcity exists. For instance putting a child into school where seats are hard to get. Or even getting that flat or the land he speaks of, allotted. Raising the stakes Dr. Basu’s way could mean the victims face heavier demands. After all, the bribe taker needs to be compensated for the higher risk he now runs. And there is no focus at all on government failures that lead to scarcity. Nor on priorities that gift the corporate sector over $103 billion in write-offs in just this budget. Nor on spending policies that cut food subsidies and punish the poor.

If anything it suggests that behavioral game theory can soundly inform empirical study. A country like India, where the center is starved of national mandate, can only rely on the small “nudges” to fix its most damning problems. Basu offers a cheap, brilliant, and neat idea that seems to be defended by experimental study. It is time for the government to pilot similar projects at an increasing scale. Perhaps in cooperation with various municipal governments, the Centre can offer avenues for reporting petty bribes. This also gives India a great chance to work with endeavors such as Janaagraha’s I Paid a Bribe, to catalog the little bribes that dot urban India.

The marriage of technology, behavior, and design (TBD conferences anyone?) might offer India an escape from wasting institutions.

That South India is more developed than the Hindi-speaking North is a common refrain. Literacy rates and per capita income generally bear this out. Indeed, we worry of the barren villages in Bihar, not fertile landscapes across Tamil Nadu. As per the Human Development Indices across India, the South is just over 25% ahead of the All-India average.

And yet, the story is false. Or so is my conclusion after running into a few “Data Stories” of India (looks like Tyler Cowen is interested, too). While the maps give breathtaking life to the real depth of poverty across India, there are fairly rigorous analytics to vindicate my point. While the commonly-used GINI measure of inequality is very intuitive, it’s handcuffed by its inability to decompose the inequality with certain subgroups. A more appropriate measure is the Theil Index, which I talk about in a recent blog post:

The math behind the measure (between 0 and 1) requires a fair understanding of information theory but the idea is lower index implies a higher economic “entropy”.

Your physics teacher might tell you that this is a bad thing but, economically, it’s a little more complex. As Boltzmann showed, entropy increases as predictability of an event decreases. This means the entropy of a fair coin is higher than a biased one. Similarly, in a very equal economy it is very difficult to distinguish between two earners based only on their income. Indeed in a perfectly equal society this is impossible. However, as society stratifies itself, knowledge of ones income conveys far more information (redundancy), thereby decreasing entropy.

Within a system, Theil makes it easy for econometricians to understand the amount of total inequality due to within-group inequality and across-group inequality. If this is a little hard to grasp, think about it this way. If the total differences in economic output remained constant between countries (that is, India is still poor and Norway rich) but income was equally distributed within each country the residual inequality would be the “across-country” inequality. The residual from the converse, where all countries remain as unequal as they were, but world economic output is distributed equally to countries (not people), represents the “within-country” inequality.

And the same reasoning can be scaled-down to consider inequality within and across Indian states. And this is just what a few researchers from the University of Texas did. Before we discuss this, it’s worth considering what high” decomposed, across-state inequality is. A good benchmark is definitely America. While the Northeast and California are generally considered to be richer than the rest, the real turmoil of inequality – at least the public’s eye – is definitely between individuals and not states. Further, the economic relationship between various American regions has been highly volatile, with some sign that growth is picking up most rapidly (in no small part due to extractive oil and gas industries) across “middle America”. Here is a decomposed map of inequality in the United States:

Image

A few accounting points notes here – while the overall measure can never be negative (greyish or black, in the above figure) individual agents can. A below-zero value here indicates that the given county is actually decreasing overall inequality of the country as a whole. The signal, here, is that American states are, broadly, equal. The real inequality stems from the difference between the rich and poor in Manhattan, not between the New Yorker and Iowan.

So back to Galbraith, Chowdhury, and Shrivastava at Texas, we find that across-State inequality in India is pretty low:

Image

The dynamics of this graph are fascinating. For one, the purple line (within state inequality) is far more cyclical with overall inequality than the green line (between state inequality). While both do a fair job signalling inflections, the former represents approximately 90% of the change. Indeed, the contribution of between state inequality has been in relative decline since the 1980s.

While this chart is too fuzzy to derive any grand conclusions, it’s interesting that the correlation across between state and within state inequalities diminished significantly since the piecemeal reforms of the 1980s. While data isn’t available as far back as the ’50s, I suspect liberalization shifted the onus from the state onto the individual. Further, central bureaucrats weren’t able to throttle State growth in the same uneven manner as the years of Fabian regulation.

Of course, this is just mere conjecture. Here’s a graph from the Data Stories:

Image

It’s surprising how relatively rich Bangalore (the blue oasis straight up from the Southern tip) is. Generally, though, almost all of India is as deprived of all the assets indicated above. Now, some might say this isn’t a good depiction of wealth inequality across India because most of the inequality doesn’t stem from the upper-middle class that owns said assets, but among the poor. However, it’s important noting that in terms of total assets, the 5% that owns these assets controls most of Indian wealth. Division of what’s leftover barely moves overall inequality.

On the other hand, in terms of overall standard of living, the South might actually be significantly better:

Image

The big exception is that a good chunk of the North does as well if not better than the South. The cow-belt of India (it’s heartland) does remarkably badly. While this is commonly parsed as the relative wealth of the South, I think it’s the far more equitable distribution of the little that’s leftover after the 5% have taken their share. The above graph depicts what we may call the “poorest of the poor”. To that end, let’s reference this image against the Theil contributions of various states to overall inequality, again from Galbraith et al.:

Image

It should not be hard to see that there’s a fair overlap between the states listed on here (various incarnations of Maharashtra, West Bengal, Bihar, Madhya Pradesh, and Orissa) are the darkest on the map.

This has some important implications for policy making across India. Indians all over (especially in the anxious time before an election) hear of the Gujarat or Bihar “growth models”. Panagariya and Bhagwati in India’s Tryst with Destiny (which I critically review, here) talk about the importance of pro-growth policies. They fairly argue that redistribution alone cannot better the lives of India’s poor.

And while on a national stage this is definitely true, the data above clearly show that the more habitable states (in the economic sense) are not so because of rapid growth rates, but a more equitable distribution of income between the poor and the not-so-poor-but-not-rich. There are a few future research projects, in America, India, and the world that would be very interesting. The Theil Index is, econometrically, a far more robust measure capable of fantastic insight. It would be fascinating to see a study that decomposes a country not into States, but income percentiles to gauge the extent to which each contributes to overall inequality.

I’m guessing, within the United States, there has been an overwhelming shift in the past thirty years away from general inequality to that between the top 5%. In some sense, policy should be targeted to curing not just inequality, but also inequality of inequality.

 

Economists are often conflicted about the relationship between their discipline and human nature. Standard theory is stuffed with assumptions that rival those of a geocentric universe. Indeed, analytic rigor still remains a deeply ingrained tradition of modern economics. Hopeful researchers are warned not to snub mathematical courses. And correctly so, it’s difficult to read through many a paper without a sound understanding of calculus and linear algebra.

Yet, Tyler Cowen writes in the New York Times that economics has a deeply egalitarian, even human, tradition. But no consensus here, Brad DeLong comments that morality and economics are inherently split, and Paul Krugman agrees. And there’s so much more where this comes from. Noah Smith has a string of blog posts lambasting the dynamic stochastic general equilibrium and utility curves, crowned with a prod at Cowen: Markets in Almost Nothing.

But there’s one statistic that is so human it removes any doubt that economists are deeply concerned about the human essence of growth. GDP might be the king on the chessboard, but unemployment rate is queen. We have to wonder why this statistic matters at all. As we know, production is the function of labor, capital, and land. During a recession, disemployment effects hurt all three, as workers are laid off, factories shut down, and land untended. In standard models, there’s little qualitatively different between the three.

But imagine talking about the unemployment rate of capital. Given five factories, ten screwdrivers, and fifteen tractors, if one of each is put in disuse do we face a 10% unemployment rate? Laughably, perhaps. But a screwdriver isn’t nearly as valuable as a tractor, let alone a factory. In labor market unemployment, however, we treat the unemployment of a farmer interchangeably with that of an engineer.

The real measure of recession and economic conversation should be the output gap. It accepts that not all men are created equal. But, economists everywhere worry about the unemployment effects of minimum wage (wrongly so, perhaps) and austerity (rightly so?). Theoretically, unemployment should be measured in value – this would even remove the need to consider underemployment. But it’s not, and economists are responsible.

And, because unemployment rate is designed atop of human constructs, economists should also be careful to let it serve as a key indicator within a model. Certain economists often speak of the non-accelerating inflation rate of unemployment (NAIRU), which posits that below a certain level of unemployment price levels will become too unstable to tolerate. This fundamentally assumes there’s something special about the number of people unemployed, rather than the total value of that employment. (The Phillips Curve, similarly, can’t convey any real truths about our economy. Its continued irrelevance due to falling labor share of GDP reflects its greatest flaw, unemployment rate doesn’t mean much).

We rarely hear these economists talk about the over-employment of capital in similar terms. (A 10% unemployment of capital by unit not value, anyone?) This also means that, at least without a minimum wage, there is no such thing as natural unemployment. We take it a priori that a human employed is better than a machine employed and, to the extent that capital can be replaced with labor, during periods of human unemployment the same wages paid on capital can be used to employ humans (granted, this might be peanuts).

This is a highly contrived example but does serve the point that there can’t be a magical rate of unemployment at which inflation suddenly takes off. This little ramble of a post, I hope, shows the very human side of economics. It’s surprising that a discipline so sterile of analytical models is as profoundly infected with egalitarian spirit as suggested by the prevalence of unemployment rate. We would know that economics was really the clammy, divorced subject so many make it out to be if headlines were crammed with talk of the output gap.

For now, we’re safe.

Edit: When the Paul duo associates itself with the neo-Confederates at the Ludwig von Mises Institute, it’s hard not to accuse them of racism. But I don’t think this interview is an instance as such, and that’s the point of this post.

Brad DeLong takes us to Ian Millhiser on Rand Paul’s recent interview. The interview is seething with a dedication to states’ rights and “localism” but is not, ultimately, racist as Millhiser suggests with this picture:

Image

The thrust of Paul argument is captured in the sentiment of private property rights:

You had to ask me the “but.” I don’t like the idea of telling private business owners—I abhor racism. I think it’s a bad business decision to exclude anybody from your restaurant—but, at the same time, I do believe in private ownership. But I absolutely think there should be no discrimination in anything that gets any public funding, and that’s most of what I think the Civil Rights Act was about in my mind.

Or:

This is the hard part about believing in freedom—is, if you believe in the First Amendment, for example—you have too, for example, most good defenders of the First Amendment will believe in abhorrent groups standing up and saying awful things […] It’s the same way with other behaviors. In a free society, we will tolerate boorish people, who have abhorrent behavior.

Surprisingly, I think Paul is correct about everything. Except the distinction between private and public property. The State has the same right to proscribe certain practices – such as discrimination or cruelty – as it does to levy any form of taxation. An Obama soundbite, “you didn’t build that”, understanding the sentiment that every business can succeed only through a melange of government support and subsidy: of education, of law and, maybe most importantly, of contract.

Oh and the network is so much more complicated than that. Local businesses (and Coke) receive greater demand through government transfers for the poor. Tax breaks for small companies realign incentives to their benefit. I can name a million reasons why a local shop exists because of, and only because of, a government.

And this doesn’t mean, literally, that “you didn’t build it”. It doesn’t undermine private enterprise. Indeed, at its best, it only kindles such entrepreneurial spirits. But that’s a different story. When Rand Paul cedes that public resources have no place in discriminating against black or white, he must tacitly cede whichever position he holds on local, privately “owned”, entities.

“Owned” because property is derived from the State. This is a controversial logic for the libertarians who see private property antecedent to the State which is (in its only legitimate form) a collective action of the holders thereof. This is similar to the classically liberal attitude towards property, John Locke:

believed that ownership of property is created by the application of labour. In addition, he believed property precedes government and government cannot “dispose of the estates of the subjects arbitrarily.

However, for Rand Paul’s beliefs on abortion to be internally consistent, he must accept a Benthamite interpretation of property rights. Only when private property is delegated by the State, and exists solely under its existence thereof, can pro-life policy exist. The right of full agency on a women’s womb is retained by the State.

This further compounds his confusion regarding the Civil Rights Act. Since property rights are ultimately mediated through the State, it would be improper for a free society to grant the right of cruelty and discrimination to property “owners”. In this sense, by holding the deed to a restaurant, I have many rights. I have the right to block involuntary seizure or unwarranted search by the State. I have the right to bake pizzas. These are my rights as a citizen of the United States. But until unless the government condones discrimination itself, I do not have the right to discriminate unfairly.

Because Republicans are so fond of slippery-slope arguments (remember? if you legalize same-sex marriage men are going to get married to pigs, or something), I’m going to make one here. The strong form of Rand Paul’s argument suggests that I have the ultimate right to do what I will on my property. (In other words, he mistakenly applies Lockean values of liberalism). This would mean owners could kill, maim, torture, and steal those who enter their property.

Of course, the libertarian argument might go that if the market learned of such cruel acts, the shop would be snubbed until it modified its practices. In the mean time, I’m happy to live in post-1964 America, run by Kenyan, anti-market, socialist (has anyone heard of Chained CPI?), Muslims.

So Rand Paul isn’t racist, just wrong. If he had a more open approach to abortion, he could even have an internally consistent ideology supporting a crippled version of the Civil Rights Act. Millhiser doesn’t seem to think Paul’s ideology is compatible with a free society. It is, just not our free society.

Matt Yglesias has some thoughts on the (complicated) virtues of a consumption tax:

The great egalitarian political philosopher John Rawls wrote that he preferred the idea of a consumption tax to an income tax “since it imposes a levy according to how much a person takes out of the common store of goods and not according to how much he contributes.”

The idea of a consumption tax sounds beautiful and, on the surface, it’s moral virtues are clear. The economic argument rests on the belief that such a tax promotes saving and investment which is, in the long-run, better.

Granted this is true, the argument behind such a tax still requires some work. And this is also assuming that the tax is implemented in a progressive fashion. Otherwise, there might be perverse consequences. Let’s think of value in a closed economy (or the world as whole). Economic output is, of course: Consumption (C) + Investment (I) + Government Purchases (G).

Let’s further divide this as: C + I + Government Consumption (GC) + Government Investment (GI). The lines here really aren’t clear, especially with things like education. When government subsidizes education there’s both consumption (“an end in and of itself”) as well as investment (“as a means to an end”).

There’s nothing inherently valuable about education, except its promise of increased future consumption. Consumption is the only activity from which we derive any value, we just hope that with solid investment our future consumption would compound exponentially against the nominal amount deferred. But herein lies the problem.

Rawls, in his argument of a consumption tax, thinks “it imposes a levy according to how much a person takes out of the common store of goods and not according to how much he contributes.” He makes the mistake of believing there is something ipso facto valuable about “contribution”. This is wrong. The value of production is predicated on consumption. There’s an artistic (if Marxist) sense in which there’s dignity and value in the process of contribution itself. (anyway, I would, impersonally, argue that this is a form of consumption).

Regardless, we measure contribution in terms of its dollar value, not by unit. Ten light-bulbs are not as valuable as two MacBooks. If I’m giving to society a useless good, I’m contributing nothing at all. Therefore, there’s nothing specifically “better” – in the moral sense he argues – about taxing outflow over inflow. Of course, the way his words are framed, one pictures a common pot from which people freely take, but any such consumption is financed only by earned value from previous contribution. So there’s also a cyclical sense in which the distinction between production and consumption is vague.

Scott Sumner has some nice remarks on this column here, but this bit caught by eye:

I absolutely do not assume the economy is at full employment when advocating consumption taxes.  And “financial saving” is a meaningless term, so I won’t comment on that.  Saving is saving; it is defined in all the textbooks as the funds that go into investment.

If you buy my argument that there’s nothing by the fact better about investment (only that it can increase future consumption more than the amount by which it defers present value, or that there are positive returns) then this will be tough to accept, without qualification. Vanishingly low interest rates imply that investors don’t believe there are many worthwhile interest rates. Which is why companies and rich people are sitting on piles of cash. If the rate of return is low, it would be better to employ the resources to finance present consumption, especially for the needy. Indeed, smart spending on roads or education would both direct these funds toward future returns, but also serve as valuable consumption today.

Taxing capital might serve a bad precedent (but why, then, are some people okay with inflation – just an implicit tax), but I think it could be valuable if constitutionally capped to a certain proportion of government revenue. Any serious disincentives to save would be mitigated by ensuring the tax only applies to extremely large levels of cash.

This would also incentivize corporations like Apple to find productive venues of investment, as savings would earn a negative return (above a very, very high level). This is inefficient in the classical sense that Apple is not investing because there are no good investments to make. But in times of recession, which is usually when individuals or corporations find themselves sitting on cash, it might be an effective way to spur employment. Edit: Sumner notes that I haven’t defined my terms very clearly. And because income equals output, savings and investment really are the same thing. When I talk about taxing capital I mean highly liquid assets, as are many corporate cash piles, incentivizing investment in riskier and less-liquid projects. Like a factory. Or huge R&D endeavor.

And, really, this is no different than the Fed aggressively using government mandate to keep interest rates down.

Don’t get me wrong, I think a consumption/payroll tax is a much better system than what we have today. America needs to save more, and not just in the economic sense. Larger savings provides a sense of security which would better allow us to tolerate frictional unemployment. It also has the huge benefit of being ridiculously simple. The real immorality of our income taxation, as anyone who’s met a tax lawyer knows, is its complexity.

Noah Smith has some thoughts about a “world without macroeconomists” – a spin-off from a Twitter discussion a few days ago:

So does this mean that macro research is useless for policymaking? No! Not at all!! Because here’s an interesting thing about policymaking: No matter who advises the policymakers, policy is going to get made. That includes economic policy. So if there were no academic and Fed macroeconomists around to advise policymakers, who would policymakers listen to on economic matters?

This is the key point from his post, economists exist because they fill a critical gap in human knowledge. I should note that I don’t, in the least, qualify his definition of an economist:

Of course, the definition of “economist” is fuzzy; if you make a chart of past GDP growth rates on your home computer just for fun, does that make you an “economist”? So I’ll assume that “economist” means “academic economists, or economists working at government research institutes.” In other words, paid econ researchers.

I’m much closer to the dork that plugs in GDP data on my home computer, but I’ll give a shot at my thoughts anyway. For one (it’s just “Turtles all the way down”, skip below if you’re not interested), I don’t believe a “world without” conversations have much salience. Everything exists for a reason – some underlying cause within our worldview. An economist might say that I believe their profession is endogenous to our world. It’s like asking what the world would exist without Christianity. People act like it came from the Heavens and was exogenous to human events. However, a particular thread of action, however complex brought rise to these events.

We can’t hope to understand what these were but the discussion we’re about to have is entirely unreasonable. Consider Christianity:

  1. Say a particular world “State”, A, gives rise to Christian foundations.
  2. Say A is biconditional with the origins of Christianity
  3. To assume a world without Christianity would be to assume a world that never hit state A.
  4. But we know state existed. So the tenor of our question is ultimately reduced to “Imagine a world that never achieved state A”. 
  5. But we know that, because A did, indeed, occur – some other arbitrary State S gave rise to A.
  6. You can see where this is going. As Stephen Hawking might say, it’s turtles all the way down.

 

This is a really verbose way of saying that there was some intellectual gap that necessitated the formation of economics as an academic discipline. This gap, considering the preponderance of mainstream economics across academia, still exists today. So rather than answering the question a “world without economists”, it might be easier to wonder what would happen if all living economists suddenly died. Sad, I know.

Let’s consider why rich central banks were granted powerful independence in the postwar era. Fairly long-sighted governments understood that they would propagate boom-and-bust cycles coincident with national elections knowing full-well that budgets would not be passed on economic virtue but political necessity. This would emphasize increased spending and decreased taxes.

While neither of the above sound so bad in our austerity-saturated world today, economists know that aggregate supply isn’t always flat, and such stimulus can overheat an economy creating all kinds of problems. The drive to divorce central banking from politics is at the heart of why economics “deserves to be”, if you will.

Think about administering the United States of America: a set of over 300 million people earning about $50,000 a head. That’s $15 trillion, an unimaginable sum of money. A few people might say that we should let the pure and hot “free market” allocate capital in an efficient way. (Most) economists will tell us this isn’t particularly bright.

This leaves some need for central allocation of goods. Sure, not to the same extent a Marx would have imagined, but certainly a far cry from purely classical liberalism. This necessitates a bureaucracy responsible for economic administration. This entity can either be dictated by political whims or guided, if fallibly, by those who “understand” the allocation of scarce resources. (In some sense, all economists believe in central allocation, without which their profession is useless).

Naysayers will be quick to harp that we don’t need “economists” for this job. Smart lawyers and scientists could do the trick. But Richard Feynman’s thoughts on physics apply to economics, too: “If you think you understand quantum mechanics, you don’t”.

Just like quantum mechanists tell us it might be possible to build a computer that solves intractable problems in polynomial time, or transport photons economics has taught us that some very unintuitive principles are true:

  1. Currency does not (and should not) need to be “backed” by anything. The gold and silver standards were highly intuitive to humans, brilliant scientists and technocrats included. Currency as only paper sounds, to anyone before the past century of economic innovation, ridiculous.
  2. Deficits are not a bad thing. This is, again, a very counterintuitive notion.
  3. Nominal shocks can have real effects. (Just printing more money today can increase economic output).
  4. No honest man can beat the market. 

Try telling a Roman that replacing his bullion-backed currency with fiat money would actually help his economy. The idea that printing paper can, in certain circumstances, make us live better is beautifully counterintuitive.

Indeed, some annoying goldbugs are known to criticize Krugman or Bernanke by saying something nutty like “Ask a three year old how printing paper can make us richer. We need to get back to first principles”. Good economics does not have easily perceptible principles.

This is why Keynes’ General Theory was such a landmark work. It destroyed any semblance of intuitive understanding in economics, thereby converting it into a mature discipline.

We also take too much economic data for granted. The silent, apolitical, econometricians that staff the American government have collected such rich and high-quality data of economic trends across the world. Just browse through the wealth of information our FRED database contains.

Imagine the intellectual and bureaucratic infrastructure needed to calculate gross output, employment, or capital investment? The marriage of economics and statistics has generated some of the most valuable data in the world. Available for free. These are silent economists telling us what is. While the normative dominates op-eds in time of crisis, it is the positive that makes the economics discipline profound.

Estimating the entrepreneurial activity of 7 billion people is tantamount of measuring grand physical constants like the mass of this Earth or Newton’s Gravitational Constant. Economics is very much a science, in this sense. We commentators take this huge collection of macro-level data on an unimaginable scale to be granted. But the machine behind this is just about as intricate as any scientific endeavor.

And all this is ignoring the intellectual fertility economics has provided for philosophy, politics, and law. From Locke’s Two Treatises to Smith’s Wealth of Nations economics has underpinned political thought. The advent of sophisticated economic thinking is coincident with some of the richest works of political value including, yes, the Declaration of Independence itself.

And this doesn’t even begin to touch the kind of work done by the likes of Esther Duflo who tells us which policies, specifically, work in the direst of areas.

All this makes me sound like a cheerleader for the discipline. That I am certainly not. Recent computational advances have made me hopeful that economics of my generation will be far more effective at making the world a better place than the useless analytical models of the past.

I don’t think the sterile mathematics of analytic economics has added any value. (Finance is a different story, underpinned by probability and statistics: far more effective tools than the rigid models found in its parent discipline of economics). I don’t think we’re any the better for having a “dynamic stochastic general equilibrium”. I think utility curves are nonsense. I think the idea of perfectly transitive ordered preferences equally ridiculous.

I also don’t like Noah’s comparison with the past history of “other” scientific disciplines:

However, here’s an interesting thing about research, and about science: Past discovery is no guide to future discovery. Chemists were basically a joke for centuries before they stumbled on a few key principles, and rapidly turned into the most reliable discovery-factories in all of science. Biologists had an even longer history of uselessness before they became incredibly useful thanks to new technologies. So someday, macroeconomists might learn how to forecast the economy extremely well. We really just don’t know. A breakthrough in forecasting power would yield huge payoffs to society.

For one, he doesn’t include physicists. Either because he was trained as one (?) or because they were just too damn good. More importantly, just because “past discovery” (or, in this case, lack thereof) doesn’t mean anything about what might happen in the future. This is his point, but using his logic we might also justify homeopathy and astrology for having some “future” breakthrough. But even chemists and biologists don’t deserve to be included in the intellectual mess that is so much of economics. Economists disguise their work under the pretense of some “scientific method” that is “falsifiable”. But if something goes wrong they point to flawed agents in the real world, as Unlearning Economics points out:

I’m actually not entirely happy with this argument, because it implies that the economy would behave ‘well’ if everyone behaved according to economist’s ideals. All too often this can mean economists end up disparaging real people for not conforming to their theories, as Giles Saint-Paul did in his defence of economics post-crisis. The fact is that even if the world did behave according to the (impossible) neoclassical ‘ideal’, there would still be problems, such as business cycles, due to emergent properties of individually optimal behaviour. In any case, economists should be wary of the as if argument even without accepting my crazy heterodox position.

Sometimes arguing against a mainstream economist is like arguing god doesn’t exist. You can’t prove them wrong because their assumptions aren’t testable. (Except with modern behavioral empirics which disproves so much previously believed crap).

All said and done, we might think economists are nuts. But just think about all the crap people thought about money and finance before they came around. It’s just about as ridiculous as believing the world is flat. As I’ve said before, I’m all for expensive computational projects that would save the discipline from its mathematico-analytical backwash, to real, high-quality science.