Tag Archives: philosophy

Economics and liberal philosophy intersect on the question of liberty. The economist might argue that minimum wage laws reduce welfare by banning Pareto dominant transactions between two agents that would make each better off without leaving anyone else for the worse. The philosopher might argue that it is our freedom to work for whichever wage rate we command: surely volunteerism should not be banned?

A similar and more resonant argument emerges in the market for sex: banning it is not just illiberal, but destroys value created in a transaction that makes both solicitor and prostitute the worse off without bettering anyone else, so long as the activity is private and unseen. This is an overwhelmingly popular argument among intellectuals, left and right, but faces severe limits. Indeed, much of the argument falls prey to what we might call the fallacy of marginalism or confusing marginal benefit with average benefit.

I am not arguing that prostitution should be illegal, per se, but want to provide a framework that will be more amenable to modern liberals and libertarians than the moralistic nonsense offered by social conservatives and can hopefully extend that reasoning to more salient topics like minimum wage, immigration control, and other illiberal regulation.

First, let’s state the philosophical argument, or what Kaushik Basu calls the “principle of free contract”,

which asserts that when two or more consenting adults agree to a contract or an exchange that has no negative externalities on uninvolved individuals, then government has no reason to intervene and prohibit such a transaction. This principle is the product of two more fundamental ideas: the Pareto principle and consumer sovereignty. The Pareto principle asserts that if a change is such that at least one party is better off and others are no worse off, then that change is desirable. Consumer sovereignty asserts that each (adult) individual is the arbiter of that individual’s own welfare.

(I have not read this particular Basu paper, but enjoy his phrase and definition of free contract from his book Beyond the Invisible Hand – a book I read a long time ago, which inspired my love for economics.)

Therefore, if we aggregate over all such transactions, welfare and social good is maximized if and only if humans are free to contract. For this reason, economists are far less critical of moneylending at obscene – “usurious” – interest rates. But once we consider social norms the principle of free contract (PFC) is on substantially weaker footing.

Let’s use an example of prostitution to see how. Using a story from a TV favorite, The West Wing, imagine a young women paying her law school tuition through weekend prostitution. There is nothing morally repulsive about this scenario by itself, and it is a commendably efficient way to earn good money on a law student’s (presumably) busy schedule. To make the logical structure of the argument a little more transparent, let’s suppose Laurie – the prostitute – was actually using the money not to get through law school, but for LSAT prep to get into law school. This is not structurally different, but more intuitively forceful.

Laurie is now better off and ready to crack any exam and interview thrown at her as a result of elite prep classes affordable only to the few. However, seats at the top law schools are effectively zero sum: Laurie’s acceptance translates almost directly into her colleague’s rejection. This makes the application pool just a little more competitive on the margin. Now imagine a girl who just barely made it into law school without prep classes and, like Laurie, can neither afford to pay for elite classes or work in a normal job to finance resulting loans.

This girl, and everyone like her, will now be rejected because they only just made it. They would each all make it were they to also engage in a low time, high reward activity like prostitution. This argument continues: in the real world only several times because markets are not perfect, but theoretically ad infinitum.

Eventually, everything would be okay if all concerned were morally okay with prostitution. But Laurie is, let’s say, atheist – all of her compatriots that are practicing Catholics, Muslims, or just were morally uncertain about prostitution would be left behind. We know that within a capitalist system that those who do not work hard are left behind, and that is its greatest strength. But the assumption that contracts do not carry externalities is violated when others – to maintain the same standard of living – are compelled to do something that is against their moral code.

This argument can be terribly abused. I can stipulate it is against my moral code to work more than ten hours a week, and hence the government should ban everyone from doing so. That would be dumb, economically and morally, because most people do not hold this view.

But this is a more tenuous argument relative to prostitution. How many parents would say they are okay with their children participating in sex markets – with full and total consent – so that everyone else is better off, as liberal economic theory stipulates. My guess would be very few.

The side effect of free contract is forced homogeneity of the most aggressive principles.

In the sense of a “Protestant work ethic” that can be good, even great, by making once lazy and poor countries rich and prosperous – to summarize the nuances of economic history in five words!

The macroeconomist might say that both marginal and average welfare increase under free contract. Certainly if, between two convenience stores, the one owned by a hardworking immigrant stays open twenty-four hours, and the other closes at eight, competition will buoy per capita GDP, providing an illusion of a richer society. In reality, the microeconomist will reply, total utility – which is the cause of contention – is a tradeoff between work (dollars) and leisure. The higher GDP of the harder working country may not reflect a similarly higher utility if the value of leisure is high.

In fact, working hours are the clearest example of capitalism homogenizing the aggressive behaviors of hard work. This is most evident in the comparison of two similar economic structures – the United States and Europe – where the former is far richer by per capita GDP and works far harder whereas the latter is riddled with required vacations and regulated work hours. The United States being the more capitalist if the two, work ethic diffuses more rapidly from those innately or morally predisposed to such and those compelled into such through competition. But GDP does not account for the value of reading Shakespeare alone or watching NFL with your friends.

We can make this argument within the neoclassical structure as well by reconsidering the definition of “free”. If we no longer assume that the existence of choice implies the void of compulsion, it becomes clear that most contracts may not be free. For example, if I am providing my family a lifestyle commensurate with an income of $50,000 a year, and an immigrant moves and undercuts my prices, I can either choose to work the same hours for less income. But social commitments and a responsibility to family will encourage me to sacrifice leisure instead. Then, we may say, externalities exist to every contract making the idea of aggregated free contract a red herring in the case for liberalism.

Undercutting my personal wage rate is formally the same as working harder: indeed, if I choose to work for $4 instead of $8, hourly, I must spend twice as much time to maintain the same lifestyle.

This line of argument not only challenges the economic assumption that free contract is everywhere and always superior but also redefines the frame of a philosopher’s case for liberty. That is, under social obligations, am I really free to work less in the face of competition?

Ultimately, it is unlikely this argument can – or even should – change the mind of economists for most things. I, myself, am not convinced, but rather outlining what started out as a Devil’s Advocate case against prostitution or drug legality. In any case, for issues of social importance like prostitution, it bears (I think) significantly on the idea of externalities from the economic and social, rather than physical, outcomes of a contract. By definition, these are largely removed from standard economic analysis, but still follow similar principles of welfare and utility maximization.

I have touched, but not discussed, some philosophical pondering for another day. For one, what exactly constitutes “freedom”? This question has compelling implications, particularly so in markets for organs, surrogate mothers, and even plain, old, work.

Philosophical Problems with Prediction

August 28, 2013

the Economy: Home and the World

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Alex Rosenberg and Tyler Curtain recently wrote an essay criticizing the idea that economics is a science. While I am skeptical of any joint undertaking between Duke and UNC – where Rosenberg and Curtain teach, respectively – it’s important to dismiss, or severely injure, the notion that economics can – at a philosophical level – predict the business cycle.

An oft-lodged complaint of neoclassical macroeconomics was its inability to foresee the recent financial crisis and recession that followed. Many critics – left, right; idiotic, and lauded – complain that if economics wasn’t so tied up in senseless assumptions and adopted a “more scientific” approach to its methods its predictive capacity could be expanded.

Of course, critics admonish economists to become “more scientific” without explaining what exactly that means, but the vacuity of this claim is far deeper. The business cycle cannot be predicted by a credible model.

First, let’s distinguish logical predictions, from random frets of fury that are eventually vindicated. The former derive legitimacy from logical assumptions that are substantiated by reality, and hence are expected to hold true for the future. The latter comes from one man’s “intuition” (perhaps that credit booms will cause a crash) without an accompanying model – and describes most “correct” predictions about the recent crash.

The only point of predicting a recession from a correct logical model is for it to remain credible among society. There’s no point in having a right model that no body believes (and if it’s right for long enough, people by definition of Bayesian revision, will come to believe this is true – so this distinction is an artifact).

Let’s say I’m a brilliant economist that finally got rid of those dumb assumptions. Agents are no longer rational, and I’ve even measured how irrational each of Earth’s seven billion inhabitants are so that I can fine tune heterogeneous tastes and preferences perfectly. And because, let’s say, P = NP I can tractably compute even the most complicated world’s to predict the economy. I have a perfect model founded on the most scientific and empirical of observations. Everyone has complete faith in my brilliance.

And let’s say one morning I forebodingly write in the Wall Street Journal that in six months it is 75% likely the United States economy will contract (YoY) by ten whopping percent. But until then it will continue to grow, or stagnate. Even my beautiful model is not invincible against what happens next.

Since my model can logically predict the recession, all firms expect consumer demand to crash in six months. To maximize expected profit, firms lay off workers and curtail all but the longest term of investments. (If I’m building something that is expected to generate profits in two hundred years, the near term horizon will not affect this decision).

Suddenly, regardless of what my model predicted would happen today, the economy tricks itself into a recession. This has nothing to do with the kind of model I write, the assumptions I make, the math I use, the abstractions I allow, the realities I ignore, or the ideology to which I subscribe. Any and every model, will definitionally fall prey to fickle human expectations. No amount of devotion to the scientific method can fix this.

At this point, maybe the critics retreat and say, but then why can’t economics tell us that fiscal expansion works (does not work). For one, there’s no conclusive proof that it doesn’t (does). But more importantly, let’s say a completely trustable model tells us that deficit spending in recessions is magical and brings the economy roaring back. When the government, following economists’ advice, expands its budget drastically, expectations will drive the economy into a boom. The model, its merits aside, becomes a self-fulfilling prophecy.

A lot of this is common sense to anyone whose taken more than five seconds to think about what’s wrong with the economics profession. It’s foolish to expect models to be founded on the same, rigorously true assumptions – or adhere to the same scientific method – of physics and economics.

It is easy to appeal to human nature – to which economics is ultimately connected – as a cop out of the scientific method. But even in the most mundane of senses, an economist does not have the luxury of a model that is forever and always correct. Self observation produces confusing – even paradoxical results – which economists can never overcome. Sure, they can add frictions representing momentum of human expectations, but once we learn (formally) of this addition there will be yet another meta level expectational conflict.

This logic can be taken to an extreme. Not everyone believes a model and business decisions aren’t formed on economic theory. But ultimately it illustrates an important distinction between economics and every natural science.

Asking economists to follow the stylistic and epistemological guidelines of physicists and chemists is not the best way to improve the profession. In fact, it is impossible.

Is an Economics without Math like a Physics in Iambic Pentameter?

August 22, 2013

the Economy: Home and the World

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My question: since neoclassical economics atomizes the representative agent, wouldn’t a modern theory without hardcore math be like a particle physics in English? There are a few posts about the (over) use of abstruse math in economics. I don’t want to comment too much: this conversation is well above my intellectual pay grade. I have a hard time getting through an economics paper (sometimes I manage, and I do actually try to go through the whole paper). I’m pretty good at math. Just not that good. (Disclaimer: I’m writing this for my own benefit, and have no deep understanding in this part of economics).

I sympathize both with both sides, and I think Paul Krugman is right in emphasizing math as a way of preventing sloppy thinking. This is especially true for a subject like economics where there are only relative, not absolute, microfoundations. Economists get to choose what’s endogenous and what is not in a way that illuminates a particular point. Caplan’s says math doesn’t reveal anything that’s not already obvious. That’s because economists, unlike any other scientists, create their own world. If I assume a world without gravity, than I won’t be surprised to mathematically prove my ability to fly.

Economics jumps several logical levels in its use of math. Normally, in a reductionist framework, the farther you get away from small microfoundations, the less mathematical a subject becomes. It is possible, a hypothetically extreme reductionist might say, to reduce macroeconomics to microeconomics to psychology to neurobiology to biochemistry to physical chemistry to atomic physics to quantum physics. As the level of abstraction increases, the use of math falls – to the point where psychologists use math almost solely for empirical examination. But economics is an outlier: the principal charge of neoclassical econ is atomizing the individual. But in doing so, we loose the foundations from “lower” disciplines, and hence must assume our own. Economists, in other words, may create the world.

In that sense, asking a neoclassical to get beyond the math is like asking a physicist to talk in English. Bryan Caplan – who genuinely believes in modern insights – cannot ignore the math any more than he can abandon the “neo” in “neoclassical”.

Math is important for the same reason it (can be) useless. Since economics starts from scratch in a way no other science other than physics does, math tells us precisely what assumptions are made to reach a certain conclusion. Normally we think assumptions first, conclusion later, but let’s say I make a statement like:

Deficit spending can never be expansionary.

By itself, this means nothing. It might be an axiom for all I know. But let’s say it’s not, and we’re talking about a model with representative, rational agents. With math, you can “fill in” all the “holes” (find all necessary assumptions) to reach this conclusion. In that sense, it helps us backward engineer what a model specifically dictates.

You know this conclusion is true when we consider immortal agents which maximize intertemporal consumption. And given a more complex setup, there are many ways in which this particular conclusion may be reached.

You can explain this in English after the fact. This is slightly different from Paul Krugman’s point, which is working from the assumptions to a conclusion. The importance of math comes in seeing all the assumptions necessary for a conclusion. I don’t see how English does this. It’s not all about explanation.

Perhaps my confusion is reconciling Caplan’s comments on math with his comments on neoclassical economics:

Here are a few of the best new ideas to come out of academic economics since 1949:

Human capital theory

Rational expectations macroeconomics

The random walk view of financial markets

Signaling models

Public choice theory

Natural rate models of unemployment

Time consistency

The Prisoners’ Dilemma, coordination games, and hawk-dove games

The Ricardian equivalence argument for debt-neutrality

Contestable markets

This can all easily be explained in English. But in the process of reaching a conclusion, we can trip over our own English, unless the world has no frictions. But once it does, math is like a gutter rail to crazy thinking.

In some ways, mathematics philosophically echoes rational agent economics itself: there are many ways one can be irrational (or wrong), but only one in which he can be rational (or right).

Caplan the blogger or teacher can be aghast with some of the math he sees. But Caplan the neoclassical surely agrees that an economics without math would be like physics written in Iambic Pentameter?

P.S. Caplan challenges Krugman to identify a subject in economics where the insights cannot be explained in English to someone not brainwashed by math-econ. I wonder if he can describe to me a full, neoclassical model with all the best things about modern economics, without any complicated math. I would be grateful, since I’m not good enough to understand some of the papers I’d like too.

The Infinite Marketplace of Ideas

June 14, 2013

the Economy: Home and the World

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Matt Yglesias reminds us that “an awful lot of capital [income] today is actually rent”. It’s a point he’s been making for a while, but it’s unfortunately treated as a bygone conclusion rather than an engineered reality. Here’s he is:

Land is just scarce because it’s scarce, and as returns to Manhattan land ownership increase the size of the island doesn’t expand. Intellectual property is deliberate government-created scarcity out of concern that were it not possible for Bill Gates to become so wealthy nobody would write word processing programs (don’t tell these guys).

I’m of a mixed-mind about patents, but before we consider Yglesias’ point, we need to define our terms, specifically “property”. The real classical liberals go for something called the “labor theory of property” which was proposed by John Locke in his Second Treatise on Government which supposes that property comes about by “the exertion of labor upon natural resources”. I’m not of this view, but it offers rich insight into how we consider intellectual property, which I’ll get to.

The competing, and dominant, theory comes from Jeremy Bentham that property is not prior to government:

Property and law are born together, and die together. Before laws were made there was no property; take away laws, and property ceases.

Furthermore, in this view, property is not absolute. My favorite example is a la carte vs. buffets at a given restaurant. In the former, you own the right to eat your meal, but also give it to your friend and take it home. In the latter, the restaurant has only given you the right to eat the food, they reserve the right of all further distribution. Or take your own home. (In Texas) you have the right to shoot trespassers thereupon, but may not inject cocaine within. The law has not ceded you that right.

Now, the idea of “rent” is closely connected with property rights. As long back as the 18th century, David Ricardo noted that rents – loosely “unfair income” – comes from property misallocation:

It was from this difference in costs [between productive and unproductive land] that rent springs. For if the demand is high enough to warrant tilling the soil on the less productive farm, it will certainly be profitable to raise grain on the more productive farm. The greater the difference, the greater the rent.

Therefore, I think Yglesias’ point that intellectual property is “deliberate government engineered scarcity” is a truism at best. Property exists because of government, and to the extent that any property is scarce, it is “government engineered”. You may not like the nuts and bolts of the broken patent system, but the idea itself is not so alien.

Ultimately, I agree that intellectual property earns a fancy rent, but it’s not nearly so simple. I think about “intellectual property” in a very similar way as physical land. That is, when it comes to physical capital, I believe someone truly creates something. When it comes to intellectual property, I think that all the world’s intellectual pursuits already exist, but they only remain to be discovered. And just as the price of land falls as supply increases, so too does that of a broadly defined “intellectual property”. Of course, most of us don’t “buy” this property, but the “IP share” per good, if you will, falls.

However, this isn’t always the case. Just like some land is fertile or valuable, some intellectual landscapes are more productive and useful. In the intellectual world, until the industrial revolution, we were walking on barren deserts of no value. The first industrial revolution was like finding soil, the second like finding the rich riverbanks on the ancient Nile. The technology revolution was like finding Alaska, Qatar, Norway, and Texas altogether.

In the meantime, we’ve found barren land and cheap soil in such abundance that we ignore formal property in total and revert to a communal ownership thereof. Books on Project Gutenberg and the quadratic formula fall under this purview. But the new intellectual land is so fertile and rich, that Ricardo’s principle of rent is perfectly applicable and because this is owned by so few, rent-derived inequality is of critical importance.

But there is one big difference between land and intellectual property. What are your priors that – by and large – we have discovered all the minerals and inhabitable land in the world? Until intergalactic travel becomes a real possibility, my priors are high. Therefore, incredible land value taxes are a brilliant way of financing redistribution without distortion.

And what then is your prior that we have discovered all the profitable intellectual land god created? Perhaps it is similarly high. Oh how wrong you will be. See the brilliant Lord Kelvin at the turn of the last century:

The future truths of physical science are to be looked for in the sixth place of decimals.

Or Albert Michelson, famous for disproving luminiferous ether:

The more important fundamental laws and facts of physical science have all been discovered, and these are so firmly established that the possibility of their ever being supplanted in consequence of new discoveries is exceedingly remote.

This is a question of philosophy, but more a question of defining one’s terms. If you believe men create intellectual designs, then we can treat such property in similar vain to physical capital. However, if you believe in an infinite (or unobservable) landscape of profit-delivering discoveries, the only way to incentivize explorers is like from an era bygone: gold and silver.

There are two ways to achieve this. Many support crippling the patent system and supporting researchers and entrepreneurs with government tax credits instead. But relative to intellectual property, this suffers from adverse selection arising from asymmetric information. Given a set of researchers and a central funding authority, each researcher has a hidden prior on how good he believes his work will be. He will do his best to prove to the government agency that this prior is high. The government has some test T to check his application, but the test compromises precision for tractability (bureaucrats are limited in time, brains, and money).

On the other hand, a patent is obtained – broadly – after the researcher/entrepreneur discovers the idea for his device. Only those with truly (and not demonstrably) high priors will actually take the capital risk in pursuing this idea. In similar fashion, the kings of yore did not always pay explorers to go on grand voyages, but promised them ownership of wealth thereupon to accommodate for informational asymmetries.

I am no fan of inequality and hence I support socially-owned patents. The government should finance large-scale research projects, and all patents thereof are owned by the American society itself. For this to work in practice, there needs to be a strong and credible independence between patent authorities and the government research apparatus. Private researchers cannot believe that government will prefer itself in competing applications. At the end of each year, the government must auction each patent on an electronic marketplace for five years. This creates a rich source of revenue for social redistribution, but also ensures that intellectual property finds itself in the hands of the firm that will use it most productively. Every five years, the patent will be re-auctioned until the value drops below a certain inflation-indexed value and will fall into communal ownership.

The implicit assumption here is the labor theory of property. If intellectual ideas already exist, property is allocated to he who cultivates it thereof: like the scientist who discovers dry ice, or the programmer who creates Microsoft Office. It strikes me that a libertarian should be most accommodating of this argument.

And, ultimately, rents earned from intellectual property are ultimately spent on natural resources (land, oil, beachfront property, and fancy restaurants in Manhattan). If we tax that, we will be taxing the extractive uses of intellectual capital. That seems like the smarter way.

On the Generational Discount Rate (and Zero Lower Bounds)

June 4, 2013

the Economy: Home and the World

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Wikipedia defines the social discount rate as “a measure used to help guide choices about the value of diverting funds to social projects. It is defined as “the appropriate value of r to use in computing present discount value for social investments.” Determining this rate is not always easy and can be the subject of discrepancies in the true net benefit to certain projects, plans and policies.”

The social discount rate often stars in discussions about climate change. Take the forceful argument against a carbon tax, from Jim Manzi:

Nordhaus offers a thought experiment to demonstrate just how unrealistic [such a low discount rate] is: Imagine a scenario in which global warming would lead to zero costs between now and the year 2200, at which point global economic growth would be permanently reduced by 0.1 percent — in other words, that economic output starting in 2200 would be 99.9 percent of what it would have been had there been no global warming. Under this scenario, how much should we be willing to pay today as a lump sum to avoid this cost? Using the assumptions of the Stern Review, Nordhaus points out, we would pay about $30 trillion, which is more than half of the world’s entire annual economic output. Thanks, but no thanks.

As it happens, I find it hard to square my (relatively) utilitarian bias with anything but negative inverse (back in time) social discount rates. However, I disagree with Manzi’s argument for several reasons. Most obviously, it falls flat once we note that tax has to be collected somehow and each dollar from pollution is better than one from income (why Manzi, a conservative, ignores this is beyond me). Climate disaster also poses a tail risk that can’t easily be imported into a standard discounting model. I also happen to care about the wildlife and natural cost of a solvable problem.

Many liberals – and perhaps the “we’re burdening our children with debt” conservatives – will jump at the idea of a high social (or negative inverse) discount rate. That, after all, means we shouldn’t invest in schools or roads, that we shouldn’t fix our power grid and build libraries. But that’s not what I’m arguing at all. In fact, I’m not arguing anything that has direct relevance to policy itself. I think it’s first important to design a more lenient intellectual framework for this discussion.

I’ll call it the generational discount rate: that is, how do we discount one unit of utility for a discretely antecedent generation from our own. (). Defining “generation” is difficult, especially with the rich web of relationships and obligations in the modern world. However, I’m making what will become a historical argument, so we can take the long view. So note “generation” as: the discrete time step at which the last person alive today dies. The next generation would begin sometime around 2130 (incidentally when the really calamitous effects of global warming will begin to emerge).

Of course, you’ll note, the “generational sequence” is path dependent, which results in an almost infinite number of “paths” back in time to a previous generation. Where you “start” tracing time is crucial in the discrete breaks between one generation and the next. However, this friction is largely an inconvenience that doesn’t alter the point I’m about to make.

Important to note is that the social discount rate is usually concerned with the rather tangible measure of “consumption”, whereas the generational discounting pertains to the the more metaphysical idea of utility. Ultimately, the philosophical idea behind consumption and utility are not too different: to what extent will we defer happiness today for even greater happiness tomorrow, an introductory finance book might ask.

Indeed, the idea of social discounting is intimately connected with that of redistribution. By ordaining a high social discount rate, other things equal, we’re bringing future consumption into the present. Similarly, someone could quite naturally define a “kinship discount rate” which measures the extent to which someone will be willing to help a friend or family member based on “steps removed”. This framework also – at the broadest level – captures modern redistribution. Americans pay lots into social security to help their own, and a little into USAID to help Ugandan peanut farmers.

Discounting, in some abstract sense, is therefore the key to understanding means of redistribution. The word normally concerns space (tax dollars from Beverly Hills to the Bronx; from America to Africa), but is of equal relevance to distribution through time.

Indeed, inequality through time is far deeper than that across space. Of America’s total output – ever – imagine the disproportional accrual to those by total luck living between 1975 and 2025. The incredible utility from modern American medicine, transportation, communication, and entertainment: freely available to all? That is the reason for against a positive generational discount rate (which values equal utility in generation t more than generation t-1). A low generational discount rate then suggests that, ideally, we should take some percent of our current utility and send it back in time. Not just to the first American; but to the first man.

(As an example, the total economic income earned by someone between 1950 and 2050 is far less than what I will earn ipso facto between 1995 and 2095. It is then incumbent on me to tolerate higher taxes in the future to equalize our income to the extent possible. That 25% of America’s elderly fall below the poverty line is sign that we should be expanding benefits in any “reform”).

From standard utilitarian creed, in which I fall, it is of unimpeachable ethic that I should sacrifice just a little bit of my happiness to help those slave to a Malthusian world. Here it becomes very clear, for physical and not economical, reasons why backward redistribution of utility (though impossible) – and not income – is the lowest common denominator. Were we to redistribute income, denizens of history would invest more and we ourselves would be richer. This derives from basic principles of time travel and spacetime to which neoclassical economics is immune. Therefore, I prefer to mull within a framework of utility which is, after all, the charge of a utilitarian.

But the generation discount rate can’t, even if it is welfare efficient, fall below zero! This is the most damning zero lower bound, of them all: liquidity traps pale in comparison to the almighty generational discount trap! But, unlike the European Central Bank, when market conditions dictate you bring rates below zero, you should at least bring it to zero. And our current policy does not reflect this thinking, at all. The whole “debt is hurting our children” argument is crap because:

It’s only hurting American children. Chinese kids will do great from American interest outflow, thank you very much.
Our kids our going to be richer than us anyway, because of technology we invented, because of economic growth, and because of a million other things. We should do as much as we can to borrow from them!

Of course, not everyone can think like this. We’re not actually borrowing from our kids. America just has a low generational discount rate whereas China’s is quite high: it all has to balance out (it would be genius if we could all figure out how to borrow from our kids, but this would break the global zero lower bound).

But I told you, I’m not arguing against investment in research, education, and infrastructure. After all, I wouldn’t want all the generations to be “equally poor”. However, the next time we hear on the TV that the social security retirees are taking everything away from our youth, remember we are rich as we are today because of that generation. They gave us Microsoft and Apple, Netscape and Mosaic. Economic growth is path dependent, and if the previous generation were a bunch of bozos, we the millennials would be the poorer for it.

The answer to the tension between redistributing utility forward in time (until the zero lower bound, at least) and the need for economic growth can be realized from both a low generational and social discount rate (remember, one is backward and the other is forward in time – so it’s really the opposite). Here the length of one “generation” matters a lot, but that’s why I like my Randian definition: it concerns “we the living”. A low social discount rate means we build the roads for our kids and even grandchildren, it means we give them the education they need to prosper.

But a low – even zero – generational discount rate means we want to do our best to redistribute utility back in time. (Remember, in this little philosophical game, that means our future kids give us utility as well). That means, social security and Medicare are not in fact unethical. It means consumption for this generation, is what the driving policy ought to be.

The normative tension arises primarily from the definition of “generation”. Mine is rather long, and hence not dangerous. Thomas Jefferson thought a “generation” was 19 years, and that would be disastrously myopic under this framework. This is a subjective question for moral philosophers. But I will personally no longer bemoan the principle of “borrowing from our kids”. At 18, I am sure I and my friends will be largely responsible for repaying any deficits incurred towards elderly entitlements, but that redistribution is one utilitarians shall be thrilled to commit.

Think not just space, but time.

P.S. It really doesn’t matter whether you think “forward” or “backward” in time. A forward generational discounting (like the normal social discount rate) would result in a “one upper bound”, if you will.

Normative questions belong to economists too

March 6, 2013

the Economy: Home and the World

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@DavidA on Twitter points us to an old post by Joe Seydl arguing that economists are no longer allowed to speak about normative social problems, like inequality or climate change:

I propose a new rule: economists are no longer allowed to speak about normative social problems, such as rising inequality or climate change. Let’s leave the discussion of such problems to the philosophers.

The justification for this rule comes from the fact that solutions to normative social problems require selfless thinking. And there is ample evidence to suggest that economists behave in more self-interested ways than do noneconomists.[1]

Consider rising inequality. The philosophical justification for rising inequality can be found in John Rawls’ philosophy. In “A Theory of Justice,” Rawls argues that it is just to increase inequality up to the point where any further increase would leave the position of the least-well-off member of society unchanged. In other words, any increase in inequality that is worth bearing, according to Rawls, must benefit the worst-off members of society in some discernible way. This is known as Rawls’ Difference Principle.

A starting point for Rawls’ Difference Principle, however, requires that one at least has concern for the least-well-off members of society. Economists clearly don’t meet this criterion, because the distribution of efficiency gains rarely matters to them; why else would the majority of economists support a whole host of free-trade agreements that put manufacturing workers in direction competition with workers overseas, while at the same time protecting highly paid professionals, such as doctors and lawyers, from the same competition? The answer, of course, is that economists do not care about the well-being of manufacturing workers.

[…] Or consider climate change. It is all well and good if resources are allocated in such a way that leads to high productivity growth and rising living standards in the near term, but what about the longer term? Efficiency gains are “worth it,” according to the philosophers, if the gains are sustainable; and, importantly, if the gains are sustainable over many generations. If rising living standards over the next few decades come at the expense of more frequent droughts, floods, and devastating heat waves for future generations, then the near-term gains are probably not be worth pursuing.

Economists are incapable of thinking about sustainable development, because sustainable development requires a concern for the well-being of future generations. The rational-choice model that dominates neoclassical economics assumes that individuals are always in pursuit of their own material self-interests, saying nothing about the interests of future generations.

The rational-choice model may or may not be an accurate description of human behavior; there is evidence to suggest that humans often act irrationally, especially when it comes to their evaluation of sunk costs or charitable givings.[2] But it doesn’t matter, because so long as exposure to the rational-choice model increases the likelihood of selfish behavior, the implication is that economists will be in an increasingly poor position to evaluate normative social problems.

Economics wasn’t always this way. For example, in the 1940s, 1950s, and 1960s, Paul Samuelson wrote a great deal about the mixed-economy model, which stressed the importance of development on three fronts: efficiency, fairness, and sustainability.[3] (The latter two requiring selfless thinking.) But it’s unlikely that the profession will ever adopt a more outward stance on human behavior, as the standard rational-choice model can be thought of as a relentless force that only grows stronger with time.

For this reason, it makes sense to limit what economists are allowed to speak about, rather than sit around wondering whether economists will one day incorporate selflessness into their behavior models. If economists would like to speak about profit maximization in a particular market or how economies of scale differ across markets, then fine. But, please, let’s leave the normative questions to the philosophers.

Anyone who’s fully content with the way modern economics works needs to wake up. Even pretty ardent supporters of the EMH (like Larry Summers or Alan Greenspan) accept this. The recent financial crisis gives full life to this concern. However, the concern voiced in this quote is misguided in theory, and can be dangerous in practice.

Consider the Rawls’ Difference Principle. Without economic reasoning and analysis, how exactly is one supposed to figure out “the point where any further increase [in inequality] would leave the position of the least-well-off member of society unchanged” ? More importantly, what way to philosophers have to determine the “right” philosophy (at least economists are getting to the point where their convictions are either justified or falsified by data).

A radical philosopher (I’m thinking his name starts with an ‘M’ and ends with an ‘X’) might suggest that any level of concentrated capital ownership breaches this principle. In ideality, we would have an equally poor society, and in reality we would get Josef Stalin. Full disclosure, I think Marx was a terrible economist, but a pretty fantastic sociologist, ahead of his time.

This post also ignores that there are plenty of philosophers who are okay with an entirely self-interested society. Conversely, many economists are in favor of a kind and caring society. Indeed, the father of classical economics, Adam Smith, was himself believed that charity and trust ought to underpin any capitalistic society. Note the normative claim.

On the other hand, we have philosophers like Ayn Rand who believed love and marriage were for idiots, and atheistic selfishness was the way of the future.

The idea that economists can’t handle climate change is equally dubious. Indeed, I think global warming can be solved, entirely, in the hands of modified neoclassical thinking. The problem with simple economic models is the consideration of oil, gas, and coal as cash flow rather than capital stock while treating a sustainable environment as a public good rather than eroding resource. This is an idea embraced by E.F. Schumacher in Small is Beautiful. Though, unlike me, he prefers a Gandhian-agrarian society to capitalism. It was also this idea that compelled one of history’s most brilliant men, Buckminster Fuller, to suggest that the natural cost of oil is over a million dollars per barrel.

Within neoclassical models, were these assumptions of measure to be changed, we would very quickly move towards rapid carbon taxation and renewable energy. Further, it requires science and calculation to solve this problem, not the normative whims of an armchair philosopher. Indeed, it is the social philosopher within the economist that averts a wider cry for high carbon taxes.

Even conservative mainstream of economists, like Professor Mankiw, believe in an economic solution to our environmental problem. However, it is the the knowledge that a rapid decarbonization will corrode our society and political institutions that prevents a move towards this tax.

If we’re going to talk about mistakes economists have made why not John Locke’s idiotic defense of slavery. Indeed, it’s quite a bit easier to contrive philosophy towards a defense of slavery than it is any form of economics, which would argue that the abridgment of individual agency in commerce would broke a society. An economist’s argument; but a right argument.

The rational-choice model is widely criticized, at least in its simplistic form, even within the economics community. Not because it doesn’t yield the fair outcome, but because in our modern society it makes inane assumptions (no, I don’t consider my potential income in the year 2050 and raising interest rates against my utility function for a given tomato in making my purchase). That doesn’t mean the economics mindset is wrong, it means it has to change.

This post further assumes all economists would fall under the narrow realm of ‘mainstream’ economists. Plenty, have argued for a more equal society. What makes a philosopher more suited to judge “what is just”. Or, a more potent question, what makes a philosopher?

Youth Unemployment, a case for decreased regulation

January 27, 2013

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Jacque Lipchitz noted that “Cubism is like standing at a certain point on a mountain and looking around. If you go higher, things will look different; if you go lower, again they will look different. It is a point of view.”

Youth unemployment is an excellent example of how government regulations are but a point of view on this grand mountain of Economica. In the West we take pride in our minimum wage laws. We read chilling stories of boys in Bihar laboring for less than a dollar a day. We feel our system, our democracy – unequal as it may be – vindicated by the guarantee that our sons and daughters are paid a fair share for their hard work.

However, as we traverse that mountain we see that the very institutions protecting our youth are tearing society at the seams. There are effectively two ways to decrease unemployment: by encouraging employers to hire more workers (through stimulus, economic growth, etc.) or by decreasing the size of our labor force.

For the economy as a whole, the latter is undesirable. It might signal an increase in discouraged workers as has been noticed on both sides of the Atlantic over the past few years. It might signal a workforce that is unskilled in the context of modern demands. It might signal, especially scary for conservatives, a workforce simply unwilling to work. In a purely neoclassical model, a contraction in labor supply would also result in cost-push inflation. However, in the context of youth unemployment, a smaller workforce might be a good sign.

It means that more of our youth are investing in their future by going to college. It might mean that fewer students feel the economic pressure to work, fulfilling extracurricular pursuits such as sport and family-time, both activities any modern and wealthy economy ought to encourage.

Therefore the first way to decrease youth unemployment is to contract the labor force in a beneficial way – incentivize college education and ensure that families are able to make end’s meet without forcing children to work.

This still leaves a pretty big hole left to be filled. What about young students uninterested in pursuing further education? What about the many that want to work at Carrefour for the plain pleasure of it? This is where our perspective ought to change vis-a-vis minimum wage.

While implemented with noble intentions, preventing the economic reality of wage depression in a relentlessly free market, the minimum wage is one of the key culprits of youth unemployment. It is no accident that in Western countries teenage unemployment is almost twice as high as general unemployment; no accident that, historically, increases in minimum wage result in a sharp increase in youth, and not general, unemployment.

The reality is that the marginal revenue product of labor from hiring a young student is less than that of hiring a seasoned worker (even if unskilled). Our youth are more distractible with other commitments, some more important like a secondary education and others less so like drinking at the pub with friends. While the minimum wage might prevent income depression for the general workforce, compelling employers to pay at a rate of five pounds rather than four-and-a-half, it will most certainly not make up for the difference between what hiring a youth is worth and what it actually costs.

As Milton Friedman said, employers are not in the business of charity. Minimum wages, merited as they might be, are one of the most regressive laws when it comes to youth unemployment. The beneficiaries of such a law are more likely the children of the educated class who are more likely to present themselves in an employable manner in terms of dress, vocabulary, and overall disposition. They are also more likely to have direct contacts for employment, even for relatively unskilled jobs.

Youth unemployment has corrosive social effects. Unemployment results in youth with nothing better to do taking to the streets, resulting in crime either for money or out of boredom. Youth unemployment also results in a more contracted general labor force in the future. As young citizens who need employment are left to rot, they stand far more vulnerable to becoming discouraged in the future and hence becoming entirely unemployable, resulting in increased government entitlement outlays and a decreased national income.

Again, it’s not important that youth employment in the absolute be increased. By removing the minimum wage laws for young citizens it is likely that a few who do not need the extra money or want the reduced wages spend more time with their family or studying. The marginal value of an educated student in the aggregate results in a more robust economy, more ready for the skilled jobs necessary in the coming century.

We need to abandon the myth that minimum wage laws prevent exploitation of children. Today, with the information revolution abuse of young workers will take to the social media in a matter of minutes, destroying the name of any employer who dare pay less than competitive wages. On the other hand we need to make it as easy as possible to hire youth – perhaps offer employers tax credits per hire, decreased red-tape, and a sharp decrease in any tax regulation that would make employers unwilling to hire.

Proposals that suggest we need to train our youth miss the fundamental point that most of our youth need unskilled jobs. We’re not talking about the next mathematicians. The relentless free- market certainly ought to be regulated and protected, as is done in OEDC countries today, but not in a way that it cripples that whom it claims to protect.

Even as a fierce liberal I stand that minimum wage laws are among the most regressive and anti-poor legislation. Let’s move around the mountain and realize that the orthodoxy of regulation and protection will be its own undoing, let’s protect liberalism from itself.

Justice by Michael Sandel – Rewarding if not riveting

January 3, 2013

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Though it fails to answer its titular question, “what’s the right thing to do”, Michael Sandel’s Justice is a highly worthwhile read. Sandel illustrates questions of moral agency with rich examples relevant to anyone who reads a newspaper. Ultimately, however, its success comes from an eminently accessible read that will enlighten all but the most educated not from presenting a novel way of thought, as suggested by some reviewers.

In a time of rife unrest about the so-called “one percent”, Sandel offers a book for the rest of us. He makes accessible ideas otherwise locked to students of expensive courses or to those with the time to actually understand dense translations of Aristotle’s Greek. Sandel’s ability to make his both book readable and relevant speaks volumes about his role as a modern day political theorist.

Though we learn of his neo-Aristotelian sympathies late in the book, his description of Kantian and Rawlsian philosophies are hardly biased, offering an unobscured snapshot of their respective theories of justice.

The most irritating flaw was the very cursory consideration of the “trolley problem”, introduced in his discussion of utilitarianism. While Sandel gives a detailed explanation of this age-old puzzle, as well as a historical parallel in R v Dudley and Stephens the resulting discussion is rather staid, predictable, and lacks the animation found in his lectures.

Well, obviously we find it harder to push the fat man off a bridge – but Sandel leaves the question as a simple check on Bentham’s utilitarianism rather than a powerful question of ethical agency that is relevant in almost every political and legal discussion. While this beautiful puzzle is an excellent way to catch the mind of an uninterested reader, Sandel does not do justice to the rest of his book by considering this question as a teaser rather than as a culminating feature of the book, as it ought to have been.

I also found his discussion of Kantian and Rawlsian flaws to be rather vague. While it would be nearly-impossible to address completely every flaw of a political theory in a book as accessible as Justice, there was a glaring flaw in each theory which I sorely wish Sandel mentioned. I am sure I am not the only one.

When Sandel noted Kant’s dislike of sex outside of marriage, prostitutes, etc. as such unholy institutions undermined our autonomy, representing base instincts rather than a higher purpose, I couldn’t help but wonder, who decides that which is ‘higher purpose’. Kant seems to give us a few vague tools to gauge our autonomy (i.e. would we give to charity even if ripped of all human emotion?) but nothing worthwhile. I feel I am doing great disservice to a thinker like Kant, but I can hardly help but wonder if he was just another man that preached what he considered to be morally virtuous and defended it with contrived reason to maintain an illusion of secularism.

I liked Rawls much more, but I wish Sandel had spent more time discussing the “veil of ignorance”. My greatest qualm – one I am sure many share – is its impossible nature. Rawls wants those who craft the world, behind this veil, to be devoid of any human emotion (such as a predilection for risk), any knowledge of race, sex, sexuality, etc. Yet, by virtue of having the gift of thought (as someone crafting our world ought to have), by virtue of having the ability to philosophize about tax laws, about regulations one must have an opinion. One must have a bias. Even in the hypothetical world so romantic to political philosophers, I find it unbelievable to conceive a so called veil of ignorance that has un-opinionated men, entirely clueless of their station in life, someone able to create law and institute a government. I am sure Rawlsian thinkers would beg to differ, but I would have at least liked a greater discussion of this point.

Towards the end, it becomes clear that Sandel is racing towards Aristotle, who dominates the last one hundred pages. By virtue of length, Sandel provides a great glimpse into both the triumphs as well as flaws of Aristotelian thinking. He does an excellent job of advocating for what seems like a limiting and highly moralistic ideology. I was left wondering, however, who determines the purpose of an object? The maker? The patrons? The market? Ultimately it seems Aristotelian thinking, through the lens in which it is viewed, can be used to defend each of the previously studied philosophers. Its versatility makes it strong, but fails, then, to answer the guiding question “what’s the right thing to do?”

While the absence of eastern philosophers seems to be a common thread of complaint among reviewers of philosophy books, I thought Justice was already somewhat overambitious in its mission. However, in a failed attempt to answer so grand a question, Sandel provides a solid and entertaining journey through moral philosophy.

It would be very difficult to find a better way to spend the three to four hours required to read this rich if not riveting book.