A Conjecture on Equilibrium Selection

An interesting question is posed in the latest post by Rajiv Sethi on growth prospects for Sub-Saharan Africa. The core issue is whether, in a world characterized by multiple equilibria, it is historical inertia (transmitting local equilibria from one period to the next) or expectations (converging airlessly on new, possibly distant equilibria) that perform the selection. Sethi pulls out an old paper by Paul Krugman that zeroes in on the question.

The Krugman paper, as described by Sethi (I haven’t read the original) uses increasing returns in a two-good model to construct a two-equilibrium result, and the history-expectations dichotomy is resolved by the assumption that expectations will be decisive if the initial conditions are consistent with the attainment of either equilibrium.

My conjecture: this result, which is to say the assumption that convergent expectations can generate a leap from one local equilibrium to another provided either is feasible, depends on the number of potential equilibria and the complexity of the processes that generate them. Of course, if an economy’s structure is perfectly known to agents, complexity is not a problem, but it is safe to say that this knowledge is unattainable. (I’ve been trying, and it’s unattainable to me.) What we have, then, is a constraint on the role of expectations derived from the likelihood that they can converge on a multi-dimensional outcome complexly different from that inherited from the past.

Krugman’s model, if it is described properly, obscures this by proposing an extremely simple and transparent equilibrium selection choice. No doubt there are cases where such an assumption is warranted. But, as I argued long ago, the problem of multiple equilibria becomes far more general and complex when one incorporates interaction effects compared to increasing returns. (In technical terms, if you are looking at a matrix of send-order partial derivatives, increasing returns show up on the principle diagonal, while interaction effects are non-zero terms off the diagonal.) The factors that cause multiple equilibria entailing good x may be lodged in non-x sectors, interacting with x only through derived demands. Indeed, the processes may be so ramified that they resist any realistic strategy to disentangle them, such as would be required for a selection process based on expectations.

This is why, in the end, I think history plays by far the largest role in equilibrium selection. (It is also why I think that equilibrium methods are ill-suited to economic analysis.)

My Second Streaming Video, Tuesday, 6 PM Pacific Standard Time

I am planning on doing a second streaming video. I want to briefly answer a few questions raised about the first talk. Then I will take up where I left off and discuss the question of capital replacement, which I believe to be a key element of the current crisis.
go to:

http://www.ustream.tv/channel/unsettling-economics

Peter Diamond for the Fed

I would assume that he would be fairly uncontroversial. Why is he being held up?

Social Security Doing Just Fine

After several months delay, the Social Security Trustees have finally issued their report, which has received little MSM attention, with some outfits like the Washington Times putting out canned reports that do not reflect the contents of the report at all. For all the moaning and wailing and gnashing of teeth and shrieks of hysteria over the state of social security coming out of the deficit commission, the new report shows almost no change in any of the projected dates of any matters of interest. There is no immediate crisis, and the supposed dates of various shortfalls are barely changed. On top of which, the future of medicare actually looks much improved.

Although others have the story, the best coverage as usual of both the details of the report as well as the surrounding (lack of) media coverage is due to Bruce Webb over at angry bear (thanks again, Bruce, for your excellent efforts!). http://www.angrybearblog.com/search/label/social%20security.

Did President Reagan Increase Government Spending or Reduce It?

Daniel Mitchell who only pretends to be an economist writes more spin on the wonders of Reaganomics:

Both Ronald Reagan and Barack Obama entered office during periods of economic misery. But they adopted dramatically different solutions. Reagan reduced the burden of government and Obama increased the burden of government. So which approach worked best? In his Washington Times column, Richard Rahn compares the economy’s “recovery” performance under both Presidents. As you can see, Reaganomics is much better than Obamanomics.

I’m scratching my head here as I thought the standard pseudo-supply-side line was that the deficit exploded in the 1980’s because government spending exploded. OK, the truth is that the ratio of Federal spending to GDP neither increased nor decreased during this period. Real tax revenues per capita fell which is why the deficit rose but this notion that the burden of government fell is not factually based.

As far as the business cycle, Ezra Klein and Paul Krugman have already debunked Mitchell’s spin.

url to watch my lecture on-line

http://www.ustream.tv/recorded/8702391

Dresden: The Simulacrum City

I’ve just returned from several very enjoyable days in Dresden: a lot of museums, some music, and plenty of superb Saxon wine, which you can hardly find anywhere else. Nevertheless, I am obsessed with what this city has to say about the nature of reality.

Dresden was one of the great baroque capitals of Europe. It was made wealthy by mining, and its rulers were adept at avoiding war, so the wealth accumulated. Over several generations a series of spectacular buildings was erected along the banks of the Elbe, culminating in the construction frenzy of August der Starke – August the Strong, although the sculptures and portraits suggest that his muscle tone left something to be desired. A particular marvel is the Zwinger complex, a large open courtyard surrounded by arcades, parapets, towers and domes.

As you probably know, all of this, down to a few blasted wall segments, was destroyed during the bombing raids of February, 1945. Where there had been baroque splendor, now there was only rubble.

After the war, Dresden found itself in the German Democratic Republic, the “People’s State” that emerged from the Soviet zone. Slowly and not very efficiently, the authorities began to rebuild the ancient palaces and churches according to the original plans. After 1989 the process was accelerated, culminating in the completion of the Frauenkirche in 2005.

So now it’s all back, every vaulted arch and sculptured ornamentation. The effect is enormous. Dresden is once again a tourist mecca: I heard every European language family along with several Asian ones as I walked the streets of the Altstadt – and, of course, Dresden attracted me.

But what is this? The guidebooks talk about the buildings as though they are the same as those built centuries ago, but each one is a reconstruction. Dresden looks old, but it is newer than Las Vegas. It is an elegant, extremely sophisticated Euro Disneyland. The palaces were not built by kings to proclaim their wealth and power; they were built by modern construction firms to give tourists, and even the local population, the illusion of continuity, that the great erasure of 1945 could be undone.

Ah, but the artwork is original, you say. Those spectacular paintings, the Raphael Madonna with the bored cherubs at the bottom, the dynamic images of Rubens, the landscapes by Caspar David Friedrich that are almost archetypal for German romanticism – there is no make-believe here. These are the real items, the actual canvases that felt the brush of these artists.

Probably, but let’s do a thought experiment. These paintings survived because they were transported out of the city during the war. Some were returned immediately. Others, such as those seized by the invading armies (especially the Red Army), were returned later. Some were never returned and may never be seen again. But what if the canvas that hangs in the gallery today is not the original, but an excellent copy executed during the years when the work was passed from hand to hand? Maybe someone thought, I’d like to keep the original work and pass off a copy. If I can’t tell the difference, if I enjoy the copy while imagining that I am viewing the actual brush strokes of Raphael or Friedrich, how is this different from the pleasure I get from the ersatz palace the painting is housed in?

Is all of this an argument against the rebuilding of Dresden? No. I’m glad it was done. Like I said, I had a great time. Nevertheless, it does raise difficult questions concerning the meaning of authenticity in a world that expects to see the past within the present. I wonder what Walter Benjamin would have thought of this.

UPDATE: Before anyone posts a comment about this, I should mention that there is a fascinating coda to the Dresden story. The rebuilt city was declared a "World Heritage Site" by UNESCO, but this honor was revoked when the decision was made to build a new bridge across the Elbe that would alter the historic view. Except, of course, that the "old" bridges were also new, postwar reconstructions. It's all a hopeless tangle.

UPDATE No. 2: I've corrected a couple of spelling errors.

Bernanke Says Rising Wages Will Lift Spending

The New York Times Headline Says It all. This beats Greenspan some of Greenspan's worst predictions.

LINK

If anyone watched my video tonight, I would appreciate your comments

http://www.ustream.tv/channel/unsettling-economics

Reminder of My Streaming Experiment, 6:00 PM tonight

I am trying to see if I can figure out how you can send me text messages during the talk

http://www.ustream.tv/channel/unsettling-economics

To The Barricades!

I saw an open letter from economists advocating more fiscal stimulus. Obviously the Republicans and their Blue-Dog Demo allies make this a lost cause. What about an open letter to Bernanke asking the Fed to take its collective Head out of Its A**? A March on the Fed?

As Krugman notes in his column today, people who don't give damn about the unemployed are making noise about an increase in the natural rate as an excuse for inaction.

RAISE THE TARGET INFLATION RATE
MORE -OR AT LEAST NO LESS - QUANTITATIVE EASING
OBEY THE HUMPHREY-HAWKINS LAW: PUT PEOPLE BACK TO WORK

Streaming My First Economics Lecture Tuesday 6:00 PM PST

You can watch it streaming or, I hope, afterwards it should be available at

http://www.ustream.tv/channel/unsettling-economics

I hope you might find this a useful approach to economics, first using capital investment, and then production in general, as the focal point.

I have never tried anything like this before. No guarantees.

Cobol Is My Hero -- A Reverse Luddism

The Sacramento Bee reported that some people in California are wearing T-shirts bearing the cryptic words, "Cobol Is My Hero."

People outside of California might not be aware that our governor, Arnold Schwarzenegger, attempted to have state workers paid the minimum wage until the Legislature presents him with acceptable budget. Since the budget cannot be passed without a two thirds majority and the Republicans, who are unanimously committed to holding firm on their pledge to not raise taxes, have enough votes to veto any budget that does not suit them.

Already, in previous years, the Democrats have capitulated and agreed to horrendous cuts to education and, even worse, any program that threatened to give any help whatsoever to the poor. The Democrats went one step further, agreeing to additional tax cuts, which can only make the budget worse.

The state comptroller, John Chiang, refused to comply with the governor's demands, explaining that revamping the state computer system to change the wage structure in a short period of time would be impossible. To do so would be especially difficult because the system is programmed in an obsolete language, Cobol.

Cobol was last in the news in the run-up to the Y2K panic. Companies need to upgrade their computer systems, but lacked people trained in obsolete computer languages. In desperation, they turned to Indian companies, which was instrumental in accelerating the growth of outsourcing computer work to India.

Shortly before this rush to reprogram computers in anticipation of the Y2K disaster, Paul Strassmann, former CIO at General Foods and Kraft, wrote a book, which took the position that the churning of computer systems by means of excessively frequent upgrades cost a great deal more than any potential savings. The manpower required to reprogram everything, along with the inevitable glitches were not worth as much as the cost of upgrades.

Strassmann, Paul A. 1997. The Squandered Computer: Evaluating the Business Alignment of Information Technologies (Information Economics Press).

Strassmann's position was not particularly popular for obvious reasons. I have not followed the literature enough to know if he was proven correct or not, but workers in California have reason to applaud the obsolescence of Cobol -- a kind of reverse Luddism.

Economics without Equilibrium

There’s a nice post today (or yesterday, depending on what time zone your brain is in) by Rajiv Sethi on the effort to bring back non-equilibrium approaches to macroeconomics. It looks at the argument made by Tobin in the 1970s, Minsky’s oscillating financial instability model, as well as his own work.

I think the simplest way to put the question is to ask, what sciences should economics, given its subject matter, most resemble? Physics, with its immutable laws and extraordinarily precise measurement apparatuses? Not likely. How about biology, ecology and geology, with their messy, variegated objects of study, one-off cases, and path-dependence? This is where I would turn.

So how much equilibrium analysis do we find in these fields? The answer is, a little, but not much. Mostly there is a painstaking identification of discrete causal processes, each a challenge that can occupy a whole career, with little expectation that all of them will ever be fitted neatly into a single, all-explaining model. Economics would do well to follow this path.

For more detail on my take, look here.

The Ultimate Death Blow for Notre Dame Heterodoxy

Notre Dame exiled its heterodox economists to a separate department. Now it is about to execute a death sentence for the department. Apparently, mainstream economists have offered such excellent guidance that questions about their dogma no longer serve any purpose.

http://chronicle.com/article/Notre-Dame-to-Dissolve/48460/