STELLA!

It’s interesting to find out that “hydraulic Keynesianism” was once really hydraulic, in the form of a Phillips water machine.  I recommend that, if you are interested in this kind of modeling and don’t want to deal with real water and its tendency to squirt through loose valves, you can get the same effect through the use of STELLA, a software package that provides simple, intuitive modeling of dynamic systems.  I’ve played around with it and can say that it’s wonderful fun.  You could actually build an economics course around it—has anyone tried?

UPDATE: I guess the leaky valves are not a problem if, underneath, you have an effective liquidity trap....

Microeconomics, Depedestalled

There has been a debate recently over whether and why macroeconomics is less scientific than its micro cousin.  I will leave macro aside for now and say, as clearly as possible, that micro is about as counter-scientific as one can get.  The problem is that utility theory, the idea that agents’ well-being can be measured by how much utility they have and that they go through life maximizing this ineffable U, is contrary to logic, evidence and the well-grounded findings of social sciences that actually study human decision-making close up.

Sen nailed the logic part decades ago.  Behavioral economics refutes the empirical presumptions.  Psychology, including its social and evolutionary branches, offers much more credible models.

Take away this utility maximization stuff and what’s left of micro?  There’s lots of excellent econometric technique, of course, and much of the aggregate theory (at the level of markets) still stands, but the agent stuff is at best a distraction and welfare economics is a zombie.  Conventional micro is propped upright only by the collective interest of its practitioners in preserving the value of their arcane skill set, and by ideological conviction.

Science it ain’t.

Who created the ideology of a 'natural' market?

The ideology of a 'natural' market within large modern industrial 'economies' was the central project of the Neoliberal movement.  

Neoliberalism (according to one economic historian, at least) was launched in Paris in August 1938.  At a colloquium to discuss the work of Walter Lippmann.  "It was a movement against planning as a method of concentrating and deploying expert knowledge. neoliberalism proposed an alternative ordering of knowledge, expertise, and political technology that it named “the market.”... Its political challenge to the Keynesian consensus got underway … with the founding of a think tank called the Institute of Economic Affairs in London in 1955..."

See:  http://cmes.hmdc.harvard.edu/files/Mitchell%20Paper.pdf

since the first time was such a smashing success...

Let's elect another MBA President!!!

The assumption that markets are 'natural'

I've just begun to browse the pages of David Graeber's  2011 book entitled 'Debt - The First 5,000 Years'.  Graeber is an anthropologist who makes no bones about the historical errors made by many economists on the evolution of markets and the use and nature of money.

On pages 44-45 Graeber writes:
"People continue to argue about whether an unfettered free market really will produced the results that [Adam] Smith said it would; but no one questions whether "the market" naturally exists....we simply assume that when valuable objects do change hands, it will normally be because two individuals have both decided they would gain a material advantage by swapping them.  One interesting corollary is that, as a result, economists have come to see the very question of the presence or absence of money as not especially important, since money is just a commodity, chosen to facilitate exchange, and which we use to measure the value of other commodities.  Otherwise it has no special qualities.

"....Call this the final apotheosis of economics as common sense.  Money is unimportant.  Economies - "real economies" - are really vast barter systems.  The problem is that history shows that without money, such vast barter systems do not occur....It's money that had made it possible for us to imagine ourselves in the way economists encourage us to do:  as a collection of individuals and nations whose main business is swapping things.  It's also clear that the mere existence of money, in itself, is not enough to allow us to see the world this way. ...

"The missing element is in fact...the role of government policy..."

Graeber goes on to explain how government foster 'the market'.  Laws, police, monetary policy, pegging the value of currency to precious metals, altering the amount of coins in circulation, regulating banks etc.

On page 49 Graeber asks a key question: "...what exactly was the point of extracting the gold, stamping one's picture on it, causing it to circulate among one's subjects - and then demanding that those same subjects give it back again?"

"This does seem a bit of a puzzle.  But if money and markets do not emerge spontaneously, it actually makes perfect sense.  Because this is the simplest and most efficient way to bring markets into being."

Money brings markets into being.  Not the other way around, as most economists would have it.  If this is true then Graeber's concluding thought has some authenticity:  "Perhaps the world really does owe you a living."

Well-Meaning, But Entirely Missing the Point About Stuxnet and Flame

Mischa Glenny warns that the US is entering dangerous waters by conducting cyberwarfare against Iran.  What if the tables are turned, and these weapons are used against the US?

Technical superiority is not written in stone, and the United States is arguably more dependent on networked computer systems than any other country in the world. Washington must halt the spiral toward an arms race, which, in the long term, it is not guaranteed to win.

The reality, however, is that the US never worries about being the victims of its own weapons.  When the US mined the harbors of Nicaragua during the Contra war, did it worry about explosives in San Francisco Bay?  Today, when drones are launched to assassinate men who make the mistake of getting together in a house in Afghanistan or Yemen, whether to plan violence or celebrate a wedding, are there fears of retaliatory attacks on Super Bowl parties in Atlanta or Las Vegas?  Trying to explain that US military hegemony means that we don’t have to think about what it would mean for others to do to us as we do to them is like trying to explain water to a fish.

And just to be clear: if Iran launches a cyberweapon as damaging to US security as our viruses were to them, we’ll kill a few thousand of them to show who’s boss.  But there’s no need to even talk about it: they won’t and we won’t.  It’s the sea we all swim in.

The Reflexive Libertarianism of Mainstream Economists, as Applied to the Analysis of Conditional Cash Transfers

I haven’t been blogging at all in the last few weeks, and I shouldn’t be now, because I am racing deadlines to complete work on a forthcoming report on child labor for the ILO (International Labor Organization).  In doing this, though, I’ve repeatedly come across the sort of economists’ tics that drive me crazy—and explain why I would never be at home in a mainstream economics program.

Consider the logic of conditional cash transfer (CCT) programs, which pay money to households in return for their agreement to make sure their kids attend school or receive health checkups.  These have been roaring successes in just about every country that has adopted them: they reduce poverty, increase education and raise the living standards and future prospects of children.  They are not without problems, of course, and I will discuss the shadows as well as the light in my report.

But back to the logic.  If you are an economist, your first question is, why the conditionality?  Why compel households to change the education and health decisions they make for their kids?  Why not just give them the money and let them do whatever they want with it?  You know the diagram: just giving away money has an income effect, allowing the households to migrate to a higher indifference curve, but imposing conditionality forces them to adhere to a particular threshold for education or health “goods” (substitution effect), which pushes them off their welfare-maximizing tangency and on to a low indifference curve.  Economists go through many years of schooling in order to think this way reflexively.

If you are still an economist, you look for two kinds of answers.  One is that there must a market failure somewhere.  Maybe households are ill-informed.  Maybe they don’t take into account the utility of children.  Maybe there are spillover benefits to education and health not captured at the household level.  Of course, if you are thinking along these lines, you will want evidence and not just speculation: show me the market failures.  Quantify them.

The other answer is culture.  Maybe the society in question is paternalistic toward poor people because it sees them as inferior, not capable of making their own decisions.  Hence conditionality is either an expression of this prejudice or a sop to those who have it.  When your core outlook is libertarian, every restriction on free choice looks like this.

Now suppose you aren’t an economist, or if you are you are an outlier.  You don’t think the utility maximization model is remotely descriptive of how most people make most decisions, and you don’t think it is helpful to view education as essentially a consumer good.  If you are like me, you think that most behavior is normative: people follow their crowd and largely do what the others do.  Of course, on the margin you might do a bit more of this or less of that, but the general pattern is not something you decide on.  You send kids to school not because you’ve given the matter thought and have decided that the present value of their future, educated earnings is greater than today’s opportunity cost, but because you and your kid are immersed in a sea of expectations about how much schooling is appropriate and how it reflects on both of you.  (Even home-schoolers do not act in isolation; they are nearly always part of a subculture in which this is a normative option, and the way they go about it reflects these social influences.)  Thinking this way makes you a strange economist, but a rather mainstream sociologist, social psychologist or historian.

The non-reflexive-libertarian view does not require a market failure or a taste for paternalism.  It sees CCTs as policy initiatives to shift cultural norms regarding education and health.  (And, no, trying to shift norms is no more paternalistic than choosing to not shift them.  Welcome to the inevitability of politics.)  Recipients of transfers can reasonably be asked to meet education and health conditions because child-rearing is recognized as socially necessary work, and it is equitable to pay people for it provided it is done in a way that meets societal expectations.

These things are much, much easier to understand if you don’t “think like an economist”.

Hume The Inimitable

Do you know Hume's argument for an Established Church? It is quoted in Smith's Wealth of Nations and it is too good not to share. It is Hume at his most impish.

Hume notes that diligence on the part of a worker of any sort depends on, as we would now say, his pay varying with performance. A flat wage not tied to performance leads to an “indolent” worker. An established religion where the clergy are paid a fixed salary by the state will then produce an indolent clergy. And this, for Hume, is a good reason for state establishment, since “this interested diligence of the clergy is what every wise legislator will study to prevent”!

 The result of free competition among clergy whose pay depends on the extent and devotion of their congregation, by contrast, will be that:“each ghostly practitioner, in order to render himself more precious and sacred in the eyes of retainers, will inspire them with the most violent abhorrence of all other sects...no regard will be paid to truth, morals or decency in the doctrines cultivated. Every tenet will be adopted that best suits the disorderly affections of the human frame. Customers will be drawn to each conventicle
by new industry and address in practicing on the passions and credulity of the populace.”

Will A Thousand CEOs Save The Planet? Report From Rio

Just back from presenting paper at International Society for Ecological Economics (ISEE) conference in Rio that preceded the main UN Sustainable Development conference that has started today there, the Rio + 20 show.  What is going on there is much more than the UN part, which will probably amount to a lot of fine resolutions signifying very little.  Demos are going on; we saw a bunch of landless marching, an "Occupa" group in tents protesting an arrest in Uruguay, and in the local paper feminists marching topless and a fancily made up Indian blocking traffic with his bow and arrow.

But the real show is all the other stuff, not just ISEE, but 500 side conferences.  I saw a claim that 60,000 people are in Rio for all this, with 1000 of those being CEOs, yes, CEOs.  Indeed, in our hotel I saw all kinds of business people, all dressed up and going to conferences.  The weirdest were Russian oil men from Siberia.  Now that has got to lead to green capitalism!   Another guy in a suit was attending a list of alphabet soup I did not recognize, although he did say he works for International Business Phones, whoever they are.  Saw a sign for something called ISGIE (could not track down on google who they are), but they were all in suits, and there was a big sign welcoming the Thai delegation for that one.  Indeed, for the main event, supposedly there are reps from over 130 countries.

I suspect the vast majority of these are wannabe rent seekers, out to get government subsidies for this that or the other thing.  I do not know.  Many I am sure have little real interest in improving the environment (see Russian oil men above).  OTOH, it does occur to me that when the green movement gets real, it is when one really gets business people doing stuff about it and making money from it.  Will any of those there seeking to make money out of all this actually accomplish anything worthwhile?  I really do not know.   I suspect the vast majority will not, but maybe some of them actually will, and I suspect that they will be the participants there not making any headlines.

As for ISEE, it is an uber green outfit also notable for taking heterodox positions regarding economic analysis, at least its founders and leaders.  One of the plenary speakers was the Prime Minister of Bhutan, the place where they first started saying they want to emphasize happiness over GDP.  Some of the papers and sessions were simply awful, the sort of thing that I suspect is going on at many other of the 500 side events (and maybe the main one as well), people going on about meta-analysis of how to implement the format for assessing how to discuss sustainability. I am not kidding. 

But then there were papers on very specific things going on in very specific places that gave me some hope, such as the efforts to provide credits for reforestation in developing countries through the Reducing Emissions from Deforestation and Desertification (REDD) UN project.  Unsurprisingly the bottom line often gets down to details.  Seems to be working in Kenya, mixed bag in Senegal (depends on which trees are planted), not doing so well in Nicaragua because central government grabs 3/4 of the credits, and in West Bengal the better off peasants in upper castes are doing much better out of the program than the poorer scheduled castes and scheduled tribal groups.  Messy reality out there, but worthwhile things are actually happening on the ground in some places, even if Nature journal is right that overall humanity deserves Fs on climate change, biodiversity, and income inequality since the last Rio conference 20 years ago.

Blurbs for Economic Classics That Might Have Been

Hayek, The Foetal Conceit

The book asks whether life begins at Concepcion and answers that if you are Chilean or Paraguayan, it very well may have!

Veblen,  Theory of The Business Class
 This curmudgeon knows his air travel like nobody's business!

Smith, The Wealth of Martians
18th Century Science Fiction at its very best!

Mankiw, Mackereleconomics
The definitive text for natural resource economics. 

Eurozone crisis originated in North America

"This crisis was not originated in Europe … seeing as you mention North America, this crisis originated in North America and much of our financial sector was contaminated by, how can I put it, unorthodox practices, from some sectors of the financial market."  José Manuel Barroso at the G20 summit in Mexico, 19th June 2012

Well, how did $34 trillion dollars suddenly appear in global capital markets between 2000 and 2007?

The globalisation crisis – looking at Greece

Greece’s elections are now over with the winners vowing to stay in the Eurozone and thus stabilizing global financial markets in the short term.  No one believes the crisis is over in Europe, however. 

Greece’s four biggest banks have recently received an 18 billion-euro injection of funds “but may need a lot more” [1].

In Greece, as it is around the globe today, private banks possess superior status and receive preference over ordinary private companies. A moral hazard of always being saved by governments has set in for the larger financial entities.  Governments then present the bank bailout bill to their taxpaying citizens.  The obvious question is why are they not allowed to simply fail?  Why aren’t these private institutions being nationalized? But these questions seem never to be explored in current mainstream media coverage. 

Isn’t it clear that the problem in Greece is that of globalization itself?  Financial institutions operating in individual nations are now a part of a much larger global network.  Therefore any process of nationalization and any measures to limit the mobility of capital (to avoid dangerous and unpredictable capital flight) go completely counter to the interests of the world’s financial actors – not just those of Europe and Greece.

We can see now that the predictable and catastrophic results of passing on these enormous bailout costs to the general public are playing out. Business is simply not managing in Greece. With 400 - 425 million Euros a day disappearing from Greece’s banks (during the last 2 weeks) even healthy business units in Greece cannot guarantee their working capital.  Any goods being brought into Greece have to be prepaid for.

Solutions are being proposed such as implementing ‘the right tax policy’ and even further deregulation for business and the general reduction of ‘bureaucracy’. [2] Solutions that don’t address the actual cause of the crisis are very unlikely to work.

Greece is also left vulnerable because it is no longer a ‘production-based economy’.  48% of Greece’s food comes from elsewhere for instance.  Who will guarantee continued supply if Greece’s financial credentials are destroyed?

It’s been a long time of not thinking about the wrongness of abandoning many local methods of resilience and productivity.  As Thomas Paine noted in the late 18^th Century  [3] the longer the social habit of not thinking about a wrong “gives it a superficial appearance of being right.”  Time, rather than reason, has made many of us converts to the ideology of globalization.  Formerly prosperous middle class families in Greece go hungry tonight while they finally have more time to ponder on the validity of ancient strategies for basic survival. 

REFERENCES:

[1]  Bailout of Greek banks is good, but not enough

02/06/2012

With an 18 billion-euro bailout, Greek banks are now staying afloat. But losses and political instability could easily sink the ship.

By Andy Dabilis for Southeast European Times in Athens -- 02/06/12

http://setimes.com/cocoon/setimes/xhtml/en_GB/features/setimes/features/2012/06/02/feature-01

 

[2]  Lateline, ABC TV.  Monday 18^th June 2012. 11:25pm

[3]  Thomas Paine, Common Sense (1776)

Niall Ferguson Exposes Two Problems with Balanced Budget Amendments

Niall Ferguson intended to make the case for austerity measures including a balanced budget amendment. Dean Baker read this before going to bed last night and started the critique of this tiresome BBC op-ed:

Hmmmm, $200 trillion at the federal level and $38 trillion at the state and local level? Can we get a source for this? Is there a date there for when the Martians will attack Planet Earth? In fairness, there are nutty projections that assume that per capita health care costs in the United States will be four or five times as high as in all other wealthy countries. If this proves true, over an infinite horizon we will have a very bad deficit problem. Of course, these health care costs would wreck our economy regardless of what we do with public sector health care programs. These projections would cause serious people to talk about the need to fix the health care system. But this is national economic policy that we are talking about. But this piece suggests an easy route for dealing with the deficit. Clearly there is a big market for deficit hawks.

Dean’s clever solution would be to spend money training college grads to write more gibberish like what the BBC should published. This would employ resources currently being left idle and hopefully generate more tax revenue via the traditional Keynesian mechanisms. Niall, however, suggests we pass a balanced budget amendment (which BTW does not tell us which tax rates we need to raise or which expenditures we need to reduce). As he does so, he does note:

The trouble is that the experience of the financial crisis has substantially strengthened the case for using the government deficit as a tool to stimulate the economy in times of recession.

Well – yea! Isn’t that the classic problem with balanced budget amendments – they turn fiscal policy into a pro-cyclical disaster. But let’s move onto the other problem by quoting Neill:

The present system is, to put it bluntly, fraudulent. There are no regularly published and accurate official balance sheets. Huge liabilities are simply hidden from view. Not even the current income and expenditure statements can be relied upon in some countries. No legitimate business could possible carry on in this fashion.

In other words, the way we normally measure deficits – current spending minus current taxes – does not capture those allegedly large present value shortfalls. Here is where Dean’s call for a course and his quip about the date that the Martians will attack Earth comes in. Niall’s alleged $238 trillion shortfall relies on some discounted cash flow calculation that he doesn’t even specify. What is the discount rate? What are projected expenditures over an infinite horizon? What are projected taxes over an infinite horizon? Such calculations require a host of assumptions. We are supposed to put all of this into a Constitutional Amendment?

The Cost of Volcker’s Disinflation and 1978-Era Macroeconomics

Paul Krugman has an interesting post on two counts. One count is his link to an intriguing discussion of macroeconomics by Robert J. Gordon. Gordon traces through the development of DSGE models and compares to them to how Keynesian models had evolved (1978-era macro) before the modern macroeconomics started to just ignore them. Gordon argues that 1978-era macroeconomics have a lot to say about how current situation and how we got here. The second count was the main reason for Paul’s post:

And one of the things they tend to bring up is the hoary old myth that the 80s success in taming inflation was somehow a terrible shock and surprise to Keynesians, who had no explanation. This is, as it happens, completely wrong: what actually happened in the 80s was, quite literally, a confirmation of the validity of textbook Keynesian economics. OK, first the facts: the 80s were marked first by a simultaneous surge in unemployment and plunge in inflation. Then unemployment came down but inflation stayed low(ish) … Inflation rate = -α(u – NAIRU) + Lagged inflation rate where u was the unemployment rate and the NAIRU was the non-accelerating-inflation rate of unemployment. And what did this approach predict about disinflation? It said that if policy makers were willing to impose a period of very high unemployment, they could bring inflation down — and that even if unemployment then fell back to the NAIRU, inflation would stay down.

Paul’s graph shows the unemployment rate over the 1979 to 1988, while our graph shows the GDP gap (using the CBO definition of potential GDP) over the same period. Notice we had a sizeable gap during the last two years of the Carter Administration followed by an enormous gap right after Reagan took office. The gap narrowed over the next few years but was still around 1 percent of GDP as Reagan’s second term started. Much of the movement in the GDP gap both up and down should be attributed to Volcker’s monetary policy. I agree with Paul’s assertion that it required a sustained period of often significant excess supply to achieve this disinflation. Some critics of this view, however, note how quickly inflation fell during the second bout of Volcker’s tight monetary policy (1982 recession). Gordon’s paper, however, also includes the following:

Instead this paper revives the supply‐side invented in the mid‐1970s that recognizes the co‐existence of flexible auction‐market prices for commodities like oil and sticky prices for the remaining non‐oil economy. Adverse supply shocks coming not just from oil prices but also, as in the early 1970s from auction‐market price shocks in food and exchange rates, boosted the expenditure share of commodities and forced nominal spending on non‐shocked products to contract.

Adverse supply shocks were partially for the run-up in inflation that the Volcker FED inherited. I would add that the U.S. economy had a series of favorable supply shocks, which were part of the reason why inflation fell so quickly. The oil price hikes during OPEC II were partially offset by oil price decreases while the dollar appreciation (due to the tug of war between Reagan’s fiscal stimulus and Volcker’s second bout of monetary contraction) lowered the dollar price of imports. This dollar appreciation had to later be reversed, which is why inflation stopped declining even as the GDP gap remained positive. Viewed over the entire 1979 to 1988 period, we did have to endure an awful lot of cumulative pain to get the inflation rate down to the lower levels enjoyed during the Great Moderation.

First Stab at a New Book: The Matrix: The Conjunction of War, Economic Theory, and the Economy

Vincent Portillo, a colleague, will join me in putting a new book


together. We only have 10 paragraphs to show for our effort, but any

comments will be very much appreciated. Getting an introduction down

is important, not only for communicating with readers, but for sorting

out our own ideas. Thanks.



This book is an exploration of the complex and fascinating

interactions between war, the economy, and economic thinking. Whether

you realize it or not, a complex Matrix resulting from the

interactions of war, economics, and economic thinking creates a

powerful force field that affects almost everything you do. This

force field, not unlike gravity, is both pervasive and invisible.

However, the effects of the Matrix are unpredictable. In a world

vulnerable to the possibility of serious destruction as the result of

both military and economic miscalculations, taking account of this

Matrix is imperative.



The effects of the Matrix are far more complex than those of gravity.

Obviously, an engineer designing an airplane must take into account

the force of gravity to avoid future calamities. Complete command of

the necessary scientific knowledge and care in the building of the

plane is insufficient to guarantee future safety. The human interface

creates an ever-present risk once pilots, mechanics, and air traffic

controllers take over responsibilities for the plane.

A far more intricate network of human behaviors interacting with the

Matrix leads to pervasive uncertainty, making the challenges of

responding to the Matrix are far more daunting than the

straightforward responsibilities of those who are responsible for the

plane's safety. The Matrix presents another dimension of

complications. If a pilot flies into a mountain, the immediacy of the

consequences makes interpretation of the event fairly simple.



In the case of the Matrix, choices today may set off a chain of events

that may have important consequences years or decades in the future.

Looking back to identify a single -- or even a small set of events as

the cause is very difficult. After all, events occurring in previous

millennia still remain the subject of ongoing debates among

historians. To make matters even more complex, the Matrix can cause

contradictory outcomes.



Here again, the human element comes into play. Any attempt at

identifying causality comes up again the tendency to understand the

sequence of events in light of pre-existing ideas or ideology.

Consequently, one must exercise extreme caution in any attempt to

manipulate the Matrix. Nonetheless, the risks of doing nothing are

even more dangerous, considering the potential dangers or perhaps even

likelihood of environmental, economic, or military disaster. Actions

to prevent cataclysmic outcomes require great care, backed up with a

relatively holistic perspective.



Economics occupies a special place in this intricate Matrix with

economics serving as a bridge between the other two principals of the

Matrix: war and the economy. Almost unintentionally, in the

seventeenth century, modern economics developed to a large extent in

response to questions raised by the needs and the consequences of

warfare.



More at



http://michaelperelman.wordpress.com/2012/06/15/first-stab-at-a-new-book-the-matrix-the-conjunction-of-war-economic-theory-and-the-economy/