Can You Say Sonnenschein?......I knew you could

What bothers me about the current discussion on the relative merits of micro-founded versus non-micro-founded macro is the crazy idea that RBC/DSGE models are micro-founded. These are representative agent models, people! They are micro-founded models of a macroeconomy consisting of one agent, and so we should by all means use them whenever we come across such an economy, and good luck with that. Unfortunately, the macroeconomy we'd like to understand has many agents. And any attempt to apply general equilibrium analysis to such an economy is faced with an insurmountable problem. Hugo Sonnenshein showed conclusively that aggregate excess demand functions, aggregated from "well-behaved" individual excess demand functions, can behave any way you like - arbitrarily. Just sayin'.

The Real Problem with Microfoundations

Suppose you lived in a world in which there were two branches of economics, micro and macro.  Microeconomics in this world is rigorous, precise, honed over many decades of increasingly sophisticated analysis, and confirmed in almost every empirical test.  It is axiomatic, its propositions invested with mathematic certainty.  It has proved its worth in one application after another.  Macroeconomics, alas, is everything micro isn’t.  The axiomatic structure is missing; much theoretical work is essentially ad hoc.  Data are thinner and models are at risk of failing the first out-of-sample challenge.  Even outright embarrassment is a continuing problem: leading macroeconomists often make predictions that are not simply wrong, but profoundly, cosmically wrong.  It’s a crap shoot.

If this were your world, wouldn’t you want to base your macro on micro to the fullest possible extent?  Bend and squeeze the good, rigorous stuff as far as you can, so you could minimize the use of the dubious macro ad hocery?

I think something like this is in the back of the minds of most macroeconomists.  Optimization models, general equilibrium----these are things we know to be right and true, so the more we can use them to generate macro models, the more solid our ground.  Arguments with more apparent technical content that are sometimes trotted out don’t really change the situation.  Take the Lucas Critique: we need to take into account how people’s behavioral patterns will change in response to changes in policy.  This is certainly true, but it is another matter entirely to put your faith in models of optimizing individuals (or clone armies) as the vehicle for understanding behavioral shifts.  Whatever the purpose, If I believed in micro they way most economists do, I would be for microfoundations too.

Here’s the rub, though: micro is just as squishy, in its own way, as macro.  The axiomatic architecture has nothing to do with science, elegant as it may appear to those who have devoted years of their life to mastering it.  Yes, micro is absolutely internally consistent.  So what?

Optimization is a formal technique, something you can do with a sufficiently specified utility mapping and choice set, but it is not descriptive of the actual behavior of individuals or organizations.  Equilibrium can be identified in models constructed by economists, but there are few real-world markets in which stationarity is observed for very long.  (Disequilibrium dynamics are observed, but adjustment is the ill-behaved child of microeconomics, the one who smashes the furniture and is sent to bed early so that proper equilibrium conditions can hold forth.)  General equilibrium theory in particular is a dead-end project, useful only for establishing the myriad ways real world economies are incapable of achieving such timeless bliss.  Their welfare properties do not even hold asymptotically: getting closer to a an equilibrium state (achieving equimarginal conditions in more markets) does not guarantee Pareto superiority over positions further away.  And of course, the convenient construct of a representative agent has no justification whatsoever in microeconomic analysis.

Textbook micro should not be a basis for pre-certifying real micro modeling and empirical work, much less macro.  In fact, economics does not offer any specifically “scientific” concept or method around which we should be compelled to standardize, which leaves us with no substitute for thinking through every significant problem from the ground up.  Consider this not a loss but a gain.  With less a priori baggage, macroeconomics might develop the habit of pruning in the face of disconfirmation, treating Type I error with the seriousness real scientific work demands.  Hell, there can even be lots of serviceable micro within macro, but it will be empirically grounded and institutionally specific—finance, corporate investment, markets in real estate and consumer durables, stuff like that, populated by humans and not rational cyborgs.

A Weak Defense of a Low Tax Rate on Carried Interest

Mark Thoma links to two articles that should be read at the same time. First up is Greg Mankiw:

WHAT is carried interest? And why does it get the tax treatment it does? … If we are going to tax capital gains at a lower rate, one question necessarily arises: What is a capital gain, and how can we distinguish it from ordinary income? The answer seems simple. If you have a job, the money you are paid for your work is ordinary income. If you buy an asset at one time and sell it later for a higher price, the profit you made from holding it is a capital gain. But is it really that easy? Consider five examples, and see if you can identify what is ordinary income and what is a capital gain:

His fourth example was:

Dan is a real estate investor and a carpenter, but he is short of capital. He approaches his friend, Ms. Moneybags, and they become partners. Together, they buy a dilapidated house for $800,000 and sell it later for $1 million. She puts up the money, and he spends his weekends fixing up the house. They divide the $200,000 profit equally.

In his defense of the current treatment of carried interest, he writes:

This brings us to Dan and his partnership with Ms. Moneybags. The tax law treats this partnership as exactly equivalent to Carl’s situation. In this case, however, the $200,000 capital gain is divided into halves: some of it goes to Ms. Moneybags, who provided the cash, and some goes to Dan, who provided the sweat equity. Once again, nothing is treated as ordinary income. In some ways, this treatment makes sense. After all, Dan is doing half of what Carl did, so why should he have to pay a higher tax rate than Carl did on that half of his income?

As I read this question, my first thought was – maybe we should raise the tax rate on capital income to equal the tax rate on ordinary income. David Cay Johnston provides an interesting discussion of whether the proposed reduction in the corporate profit tax rates is really a reduction in the taxation of capital income or is indirectly a reduction in the tax burden on wages with this gem:

On the face of it, the AEI argument suggests workers should be joining the calls for Congress to cut corporate income tax rates. But, if the argument is correct, then workers should also be calling for cuts in their own income taxes and an end to reduced rates on dividends and capital gains.

EXACTLY!

Ongoing Confused US Discussion Of Internal Iranian Politics

Tomorrow is the Iranian parliamentary election that I have suggested might lead to lowering of tensions with possible renewed talks on the nuclear issue and a possible drop in the price of oil. Maybe, but before the election I want to note how garbled and misleading discussion in the US media of internal Iranian politics is and has been pretty much consistently. This generally arises from a combination of ignorance and a desire to have simple stories told about good guys vs bad guys. This has been going on basically since 1979.

So, the discussion has always been put in terms of "moderates," supposedly the good guys likelier to be more amenable to US policy interests, and "hardliners," supposedly the bad guys less likely to be so. In the years immediately following 1979, the focus seemed to be on economic policy attitudes. So, the "moderates" were the supposedly more pro-free market types while the "hardliners" were the supposedly more socialist types. Funny thing was that for what probably mattered in terms of attitudes to the US, the free market types based in the bazaars were much more hardline on theological issues compared to the socialists. Indeed, when the social reforming Khatami was surprisingly elected in 2001 over Rafsanjani, he brought back some of the pro-socialist types into economic policymaking over the more pro-free market types that the more socially and theologically conservative Rafsanjani had in place.

Now we come to today's discussion. One reads that the current race is between two sets of "arch-conservatives." However, one is viewed as more "moderate," the other less so. The supposedly more moderate group is led by President Ahmadinejad, whose supporters are currently a minority in the Majlis. The majority "hard(er)liners" are supposedly the supporters of Supreme Leader Khamene'i. Frankly, I think this is junk fed to dumb western media types by Ahmadinejad supporters.

After all, it is Ahmadinejad who is a Holocaust denier, not Khamene'i. The latter has called for the Israeli government to disappear, but he has never called for "eliminating Israel" as claimed by many commentators. Ahmadinejad is regularly identified as being more willing to negotiate with the US about nuclear weapons, but it is Khamene'i who has issued the fatwa against nuclear weapons.

We all worry that factions of the Revolutionary Guards are for nuclear weapons and that one of their hotheads will initiate an attack on US naval forces in the Persian Gulf. But it is Ahmadinejad who came out of the Revolutionary Guards, not Khamene'i, so frankly, this entire discussion has been an embarrassingly muddled mess.

Free Trade Ad Absurdam

The last thing a defender of free trade should want is to find herself on the same side as Jagdish Bhagwati.  Exactly because the arguments against laissez-faire on the international front are so strong, we need someone to remind us what is at risk when we mess with trade.  Too bad Bhagwati isn’t the guy.  In Defense of Globalization in particular was a big disappointment.  We tried using it in class to provide some friction to the alter-globalization voices, but students just tore it apart.

His latest screed in defense of trade orthodoxy comes on with the force of a handful of packing peanuts flung angrily into space.  Let’s look at his arguments.

“The first misconception is that exports create jobs, while imports do not....”  His rebuttal is that exporters often use imported parts, and shippers create jobs when they ship imports.  But what is the counterfactual here?  If he is opposing the idea that we should simply stop imports at the border and suffer without them, then he has a point.  His argument says nothing, however, against policies designed to replace imports with domestically produced products.  Moreover, it is absolutely the case that an import constitutes a leakage from a national macroeconomy, while an export constitutes an injection.  That’s not mercantilism, it’s basic accounting.

“Second, the credo “Trade, not aid” has given way to the mistaken belief that trade matters less than foreign assistance.”   Huh?  The problem with trying to manage trade flows is that it leads to an excess of foreign aid?  Where did he come up with this?  In reality, (1) rich countries have flagrantly failed to meet the aid targets enshrined in the Millennium Development Goals, and (2) it is the poorest countries, where current account deficits are structural and persistent, that the need for trade policy is most acute.  (Specifically, these countries need strategic investments, stakeholder-oriented pubic and private sector governance reforms and industrial policies to achieve external sustainability.)

“Third, many believe that manufactures deserve preferential support.”   Here Bhagwati makes the error of conflating a specific preference, for manufacturing, with a general preference for achieving approximate balance between imports and exports, whatever the sectors.  But let’s give him the benefit of assuming that a belief in the importance of manufacturing is more interventionist than, say, an exaggerated attachment to intellectual property protection.  What is his case against singling out manufacturing?  Simply that lots of famous people say you shouldn’t do this.  I’m not kidding: read the original.  There isn’t a single substantive point in his missive that considers the pro-manufacturing position and rebuts it.  Actually, manufacturing is important, not only for potentially high-productivity jobs but also for the kind of innovation that depends on bringing abstract ideas and hands-on skills together.  I’m writing this from Germany, and I can guarantee that preferential support for manufacturing is gospel over here, and that it works.

“Finally, the financial sector has come to be viewed as the bane of morality....The quasi-Marxist view that our morality stems from our economic position overlooks the moralizing role of family, religion, culture, and art.”  And now we get the ethical case: reject quasi-Marxism and pay no attention to the extraordinary concentration of wealth in a few hands.  In passing, we should note that he gets the Marx part absolutely backwards: Marx claimed repeatedly that ethical systems are relative to historical period and social position, and that one could not deduce the desirability of socialism from the ethical superiority of workers over capitalists.  (Granted, he did make lots of snide remarks about the rich, but he also spread his cynicism around to other classes.)  The main point, however, is that the ethics of plutocracy is almost orthogonal to debates over trade policy.  One can stuff finance back into a little box, with modest pay and privileges, and leave trade alone, or one can be a trade hawk and a finance dove.  This final argument isn’t an argument at all.

Face it, Bhagwati isn’t even listening.  He has no idea what the arguments are of those who worry about trade and social standards, or trade and ecological sustainability, or trade imbalances, inequality and the volatility of global finance.  He has written many clever papers based on a set of implausible assumptions (like trade always balancing at the margin), and he has no clue how to respond to those who question those assumptions.  My students, who think his priors are bonkers, found only incoherent bluster.

Wealth and Antisocial Behavior: Reverse Causality?

There is quite a bit of buzz about this just-prepublished article in the Proceedings of the National Academy of Sciences.  Here is the abstract:

Seven studies using experimental and naturalistic methods reveal that upper-class individuals behave more unethically than lower-class individuals. In studies 1 and 2, upper-class individuals were more likely to break the law while driving, relative to lower-class individuals. In follow-up laboratory studies, upper-class individuals were more likely to exhibit unethical decision-making tendencies (study 3), take valued goods from others (study 4), lie in a negotiation (study 5), cheat to increase their chances of winning a prize (study 6), and endorse unethical behavior at work (study 7) than were lower-class individuals. Mediator and moderator data demonstrated that upper-class individuals’ unethical tendencies are accounted for, in part, by their more favorable attitudes toward greed.

The tone of the first wave of commentary, as far as I can tell, is that we knew it all along—rich people are nasty.  I would like to put in a word, however, for the other direction of causality, that dishonesty and putting one’s own interests ahead of others are conducive to wealth.  I certainly don’t mean this deterministically; there are lots of stone-broke cheats and chiselers out there.  Nevertheless, at many key moments of life people face a choice, whether to shade a bit and advance their own career, or remain honest and end up back in the pack.  Do you take credit for someone else’s work in order to get a promotion?  Do you leave out some information that would reduce the likelihood of a sale that would make you a tidy profit?  And if you find yourself in a zero-sum situation where your gain is someone else’s loss (or more gain for you means less gain for them), do you push your advantage as hard as you can?

The reason I bring this up is because there is a constant background murmur in our society that says that greater wealth has to be a reward for more talent, more effort or more contribution to society.  When Steve Jobs died, he was a poster child for this view.  Yeah, he was something of a jerk, but he gave us all those great gadgets, and that’s why he was so rich.  Could it be, however, that among all those whose intelligence, creativity and obsessive toil drives progress, what separates the Steve Jobs from the Unknown Nerd is the bundle of personal traits that add up to claiming for oneself alone the contribution of everyone else?  There are a lot of people who could never imagine raking in billions while those who do the physical work in China are driven to, or past, the brink of suicide.  They won’t get to be CEO.  Nor would the people taking in the super-bonuses at Citi, G-S, BoA and the rest be where they are if they put as much energy into making sure mortgage borrowers were treated legally and fairly as they do into squeezing a little more profit into the kitty.

Maybe the reason a lot of people are vulnerable in this economy is that they’re too damned decent.  Between, say, Tyler Cowen and Leo Durocher, who do you think has a better handle on how the world really works?

Might The Rush To War With Iran Slow Down After Friday?

Maybe. The reason is that Iran is having parliamentary elections this Friday, something barely noticed in most US media. This means that just as with our GOP candidates (all but one of them anyway) competing to see who can be more hawkish and promising war against Iran, so the Iranian political leaders have been hyping their standing up to the US and Israel and the various threats that have been made with various assertions and threats of their own, most prominently the one to close the Strait of Hormuz to oil exports, even though this would largely cut off their own exports, a seemingly completely irrational thing to do.

As it is, given that their election oversight bodies have ruled out almost all seriously anti-governmentment candidates from running, not much is going to come of this election, and reportedly the disaffected in urban areas are not likely to turn out to vote much, although not particularly in response to calls by some outside dissident groups to boycott the election. As it is, with this sort of apathy by those who would like a more secular regime, the election is largely between competing hardline theocrats who are playing an Iranian version of what the US GOP candidates are doing (that is, all but one of them), making as loud and aggressive noises as they can to out-Islamistize each other.

In any case, there is reason to believe that the rhetoric on the Iranian side may cool off somewhat after the election this Friday is over. There might even be some openings to talks. Maybe some slowdown of the rate of enriching uranium to 19.5% would do it (95% is what is needed for nuke bombs, and none is being enriched to that level). The latest hysterical reports had to do with their accelerating these activities beyond what is needed for their medical research reactor, and this has led some to speculate that their accelerated activity was being done precisely to pile it up in anticipation of talks that would lead to them cutting back on this activity. We shall see, but there may be hope for some cooling off, with an accompanying reduction of pressure on oil prices.

Life in Ohio

Toledo, Ohio, where I reside, is an old Rust Belt city with bragging rights over very little. Two exceptions are: this is the city that produced the greatest jazz pianist - hell the greatest pianist - who ever lived, Art Tatum. And we have been represented in Congress for ages by one of the best, Marci Kaptur. But the Republicans in the state-house have redrawn Kaptur's 9th district to make it run in a thin line from Toledo to Cleveland - some 150 miles - along the edge of Lake Erie, encroaching on Dennis Kucinich's old district and forcing the two into an elimination match in the Democratic primary. For me, this is no contest: Marci is much the better choice. I hope she prevails.

Are Rents Rising?

Dean Baker has a good put down of an article in the New York Times that tries to claim there is a shortage of rental housing. The one piece of economic data that the Times presented was:

rents have been rising, up 2.4 percent in January from a year earlier, according to recent data, not adjusted for inflation

A nominal price increase over one year doesn’t sound that convincing. How hard would it have been to present matters adjusted for inflation? Dean presents a graph that takes the increase in owner equivalent rent over the 1991 to current period. It appears that there was no nominal increase in the previous year. Compare this to the 2.9% increase in the consumer price index over the past 12 months and the 1.6% increase over the previous year and a some elementary arithmetic indicates real rents have fallen over the past couple of years. And yet the Times claims that rents have been rising due to some alleged shortage?

Detroit News Endorses Austerity

Actually, this op-ed endorsed Mitt Romney to be our next President. There was one paragraph that actually made sense:

We disagree with Romney on a point vital to Michigan — his opposition to the bailout of the domestic automobile industry. Romney advocated for a more traditional bankruptcy process, while we believe the bridge loans provided by the federal government in the fall of 2008 were absolutely essential to the survival of General Motors Corp. and Chrysler Corp. The issue isn't a differentiator in the GOP primary, since the entire field opposed the rescue effort.

Of course, this paragraph was omitted in the version of the op-ed that the Romney camp distributed. Too bad as the rest of the op-ed was the kind of GOP spin we’ve come to expect including a claim that Bain Capital was all about job creation and a clever way of making a virtue of how the architect of RomneyCare contradicts himself as he condemns ObamaCare. But it is its praise for austerity as an alleged cure of our unemployment problem that is the most laughable aspect of this silly op-ed.

Romney knows how government policies affect private sector decision making. He understands the consequences of actions that raise business costs. And he gets that business is not the problem in America — a bloated and wasteful government is. He knows how to encourage the former and deflate the latter. Romney has been criticized by his opponents for downsizing troubled companies and firing workers. He acknowledges that those are often wrenching decisions. But if America is to avoid financial catastrophe, the next president must be willing to downsize government, jettison some of its operations and slash a federal work force that has grown by 12 percent over the past four years. Romney is best equipped for that task.

Our graph shows employment by the Federal, state, and local governments from January 2007 to January 2012 hoping to make a few points. One is simply that the Federal government is not the only government employer. Local and state government employment was over 87% of total government employment as of January 2012. Mark Thoma provides us with What’s Wrong With This Picture showing how local and state government employment has been declining over the past few years.

The other thing about our graph is I don’t see this alleged explosion in Federal employment. It is true that employment by all sectors of the government was rising in 2007 (before the recession) and continued to rise a bit in 2008 (before Obama became President). But over the past four years, Federal employment has risen by only 3.4%. If one looks at the last three years, Federal employment has increased only 1.4%. Over this same three year period, total government employment has declined by 2.7 percent.

And Riding to the Defense of Developing Country Airline Companies Is…..

Martin Khor has made a career of fashioning progressive arguments in favor of developing country business interests. His latest tack is to denounce the intention of the EU to charge a carbon tax on flights to European airports. It’s a violation of national sovereignty, he says, practically a reimposition of colonialism. It forces people in the poor countries to pay for a problem that was caused by the rich. It will be much too expensive. Such an awful idea.

One complaint in particular struck me: the EU has no business imposing a carbon tax on flights over non-EU airspace. Presumably the solution is to monitor the flight path of each plane and prorate the tax on the basis of its route. Planes will be zigzagging to avoid the surcharge, of course, and who knows how international airspace will or won’t be treated.

I would be the last person to defend the halting, timid and largely captured EU carbon regime; nevertheless more carbon pricing in this and other spheres is surely better than less. I would ask those inclined to give Khor the benefit of the doubt to consider two propositions. First, not taxing carbon is subsidizing it, since the costs it imposes on current and future generations, not least the poorest and most vulnerable of us, is real. Second, in the absence of a strict global agreement, meaningful action against climate change is necessarily national and regional, and no jurisdiction will step forward unless measures are taken that neutralize the advantages that foreign businesses have if they are free from carbon constraints.

If Khor is really concerned about the well-being of people in the bottom billions, he should raise questions about where the carbon money is going, and who benefits from free permit allocations and dodgy offsets.

Economic Bias

Noah Smith has an excellent post on the political biases baked into conventional macroeconomic models, especially DSGE. His view that the principal source of bias comes from the assumptions needed to make the models tractable accords with my take on microeconomics, particularly the ideological significance of convenient second-order conditions. I think we agree that these assumptions are not made out of explicit political motivation, but simply because they make life easier. Still, the bottom line is the same: bias is bias. Perhaps where the politics comes in is in the inclination not to worry about it.

Playing With Fire With Oil And Iran

Juan Cole is listing 10 reasons why the US sanctions against Iran making money from exporting oil are not working at http://www.juancole.com/2012/02/top-ten-ways-iran-defying-us-oil-sanctions-and-how-you-are-paying-for-it-all.html . While indeed Iranian oil sales have fallen, the impact of this has been at least partly offset by the rising price of oil due to all the war talk associated with the sanctions, along with the failure of Saudi oil production to increase to fill the cutbacks, along with declines in oil production in Nigeria, Syria, and Sudan for various reasons, as well as the decisions by India, China, Japan, South Korea, and others to repudiate the US policy. All of this threatens Obama's reelection as gas prices are heading up and Republicans are claiming it is due to Obama blocking the Keystone pipeline project, even as they call for an even more hawkish policy against Iran (see Jim Hamilton for the latest analysis of the Keystone project at http://www.econbrowser.com/archives/2012/02/workarounds_for.html ).

I largely agree with Cole on most of his points, with some minor variations. He argues that it is the "Israeli lobby," particularly AIPAC, that is responsible for the sanctions policy, although I would think that the lobby is responding to the Israeli government rather than being an independent source for this policy push. Israeli political leaders are fearful of a possible Iranian nuclear bomb, and according to the NY Times today, are probably not able to actually bomb out fully the four sites involved in the Iranian nuclear program, which may be why they are pushing even harder on the US, despite Israeli military intel reportedly agreeing with US intel and DOD that Iran does not have an active nuclear weapons program.

The US and UK have reportedly urged Israel not to bomb Iran as this would be "destabilizing." They may not do so for the reason noted in the previous paragraph, but it strikes me that Netanyahu may not mind encouraging destabilization by engaging in war talk and pushing the sanctions that have Iran engaging in talk of blocking the Strait of Hormuz. Bibi does not like Obama and would be perfectly happy to see him lose an election due to a bad economy driven by high oil prices, and all that applause he got in the US Congress may make him think he can get away with this, and he probably can, although maybe the economic recovery is just too strong to be overcome by the negative effect of rising oil prices.

I note some caveats on Juan Cole's post. He says that "Iran is sitting pretty." Not so. While oil prices have indeed gone up with all the war talk, the Iranian rial has declined by something like 60% against the USD. This is not helping the standard of living in Iran for people used to relying on imports of many consumer goods.

OTOH, this decline in living standards, hoped by the US to put pressure on the Iranian regime, is backfiring, just as the economic embargo against Cuba has for a full half century now. Reportedly Iranian citizens are rallying to support the regime against the US actions against their economy.

This fits in with another delusion pandered about in Washington, that we could get Iran to "stop its nuclear weapons program" by more vigorously supporting the Green movement opposition. First of all, any action to openly support the opposition would simply discredit that movement. Second, the opposition has long made it clear that it supports the peaceful civilian nuclear program of Iran. Getting them into power might make Israel slightly less paranoid, but it will not alter the nuclear program itself one bit.

The key to the nuclear program remains as it has been for a long time, the position of Supreme Leader Ali Khamene'i, although an article yesterday in WaPo by Ray Takeh [sp?] argues that there is a new "war generation" led by Ahmadinejad that wants nuke weapons. It is true that these young guys will outlive him and could move the existing program into one that does lead to nuclear weapons, but he has repeatedly issued fatwas against nuclear weapons, and as Juan Cole has pointed out repeatedly, Iran has not attacked another nation since the 1700s. These minor facts, supported by official US intel reports, somehow get lost in all the hysteria and pushing of economically damaging sanctions programs. To the extent these sanctions programs are being put into place to keep the Israelis from bombing Iran, the report today in the NY Times may have removed even that half-baked rationale for this stupidity.

In Some Circles, Economics Is Anathema

A pattern I find disturbing is that much of the left, at least in the English-speaking world, regards economics simply as a source of intellectual and moral corruption. Those who take this view make sweeping pronouncements on economic topics, but they pride themselves in not polluting their understanding by consulting economists or reading what economists have written.

Want an example? Check out the Uneconomics initiative and its “exposé” of how banks create money. Who could have imagined: private banks actually create money out of thin air when they make loans, and this creates the potential for economic volatility due to over- and undersupply. These secrets, supposedly covered up by sneaky economists and other elitists, are revealed by radical social critics, and we should be shocked, shocked.

Banking is a system that runs on make-believe and survives on ignorance.

Does it matter that a significant swath of the left thinks that standard stuff in a money and banking course is a great discovery that will shake capitalism to its foundations? And if I complain, am I just defending my own privileges as a so-called expert? Funny, I thought the reason to spend years of my life learning an intellectual speciality was to be able to make a contribution. Sorry about that.

Stranger than Friction

Barry Schwartz argues in this morning’s New York Times that capitalism is all about efficiency, and the problem is that too much efficiency can be a bad thing.  A more profitable company, he says, is a more efficient one, and capitalists are right to pursue profit, but maybe we should slow them down a bit—add some friction to the process.

I am reminded of the students I have every year, and there are a lot of them, who just can’t accept the idea that “equilibrium” in a market does not necessarily imply “good”.  You can have equilibrium in a market for slaves, or for nuclear weapons, or simply for your ordinary neighborhood drone.  How markets work and whether we are better off because they work that way are two entirely different questions.

So also with profit.  A more profitable company is not necessarily more efficient in any sense other than better at making profit.  Transferring more of the value added from paychecks to dividends is not more efficient than the other way around, but it is more profitable.  To be more precise, to be sustainable a business has to be profitable, but a more profitable business does not necessarily contribute more to society than a less profitable one.  (Note: in a stakeholder economy the goal of business would be to maximize the probability of being profitable over a given time horizon, not to maximize profit per se.)

It is distressing that Schwartz can muse on the implications of the financial crisis for his notion of profit-seeking but never consider the concept of risk.  Higher profit purchased at greater risk is not always such a great bargain, especially in a world of limited liability, not to mention bailouts of the systemically hyperconnected.

How did it come to be that conventional wisdom, which was once skeptical of profit—maybe even too skeptical—has now embraced the assumption that more profit means more better?