A Double Irish Dutch Sandwich for EconoKash

Kash is back to blogging with a focus on transfer pricing:

Ireland has long been a favorite country for multinationals to set up shop in, thanks in part to its 12.5% corporate tax rate – one of the lowest in the world. A typical situation would be for a multinational based in the US or Asia to set up an Irish subsidiary as the principal entity from which to run its European business, thereby allowing it to legally record a significant portion of its European income in Ireland.

Actually 12.5% is far from being one of the lowest in the world but I’ve interrupted:

why does Germany treat Ireland so differently from Cyprus when it comes to providing financial assistance? One possible explanation is that the corporate tax rate in Cyprus, which had been set at 10%, was seen by Germany as being more egregious than Ireland’s rate.

But Cyprus may not be more egregious than Ireland as explained by Jesse Drucker:

Google cut its taxes by $3.1 billion in the last three years using a technique that moves most of its foreign profits through Ireland and the Netherlands to Bermuda. Google’s income shifting -- involving strategies known to lawyers as the “Double Irish” and the “Dutch Sandwich” -- helped reduce its overseas tax rate to 2.4 percent

The rest of this discussion is well worth the read. Look – international tax law can be challenging at times as effective rates can be much lower than statutory rates. A bigger challenge is why the national tax authorities allow transfer pricing mechanisms to shift so much income to places like Bermuda.

Two Types of Preferences and the Relevance of Cost-Benefit Analysis

Here is another in the string of posts inspired by my weekly class on cost-benefit analysis.  Last night’s topic was stated preference methods, like contingent valuation.  These are controversial because they are often used to put prices on things people don’t normally think of as having prices, like the “existence value” of whole species, pristine natural environments or the avoidance of risks to public health.

My view is that many of the confusions in economics can be traced to ambiguities in language.  We often use words to mean multiple things and then try to apply what works for one meaning to a different meaning, where it doesn’t.  Case in point: preferences.  I prefer A to B means I want state-of-the-world A to occur rather than state-of-the-world B, whether A and B are two pairs of shoes that could sit in my closet or two destinies for wild salmon along rivers that drain the Olympic mountains in northwestern Washington State.  They are similar in the sense that both pertain to my wanting something, but they are also different.

I propose two kinds of preferences based on different motivations.  One I will call normative; this reflects my judgments regarding what I deem to be right or wrong.  The other is experiential, what I want based on how I would personally benefit from it.  Economists sometimes say that ethical judgments are essentially experiential, since you derive pleasure from seeing right triumph over wrong, but I disagree.  Experiential preferences cause you to want A over B because A makes you happier or gives you more “utility”.  Normative preferences give you happiness or utility if a choice process selects A, and you believe A is ethically preferred to B.  These are clearly not the same thing.  In the first case utility is a cause, in the second an effect.

An example of a fundamentally normative preference is the one exercised by a jury deliberating a civil or criminal dispute.  It would be absurd to have verdicts determined by jurors expressing a willingness to pay to convict or acquit, and then adding up the totals to see which is greater.  This is because juries are supposed to deliberate based on a conception of justice, not on what’s in it for them, personally.  An example of a fundamentally experiential preference is the question of whether to publicly subsidize a sports stadium in a city.  Taxpayers’ preferences will be based on the degree to which the team that plays in the stadium gives them some sort of personal excitement, satisfaction or pride.  This could well be captured by a technique that measures their willingness to pay for the stadium.

Of course, preferences that are primarily normative can have a secondary experiential component, and vice versa.  In the stadium example, for instance, one effect of a subsidy is to transfer public money to private investors in professional sports teams.  This has an ethical aspect, which may play a role in how preferences are established.  In fact, in a society with glaring shortfalls in public programs for health, education and other essential services, like Brazil, the ethical component may become primary, as we saw in the protests over the World Cup.  Where public funds are not so constrained and the gaps not so severe, the decision turns on what the local population expects to derive, personally, from better facilities for professional sports, and questions of ethics are secondary.

Most existence values for environmental goods, I would argue, are essentially normative preferences.  They are about what people believe to be right or meritorious, not what gives them personal satisfaction.  Willingness to pay in these circumstances makes about as much sense as a decision tool as it does in jury trials.  We might be misled by elements of experiential preference that enter the mix, but our well-being as members of a society that makes choices of this kind is an effect, not a cause of what we wish to see happen.

If this analysis is correct, CBA can help us put numbers on the experiential aspects of a policy choice, recognizing that some other process is needed to assess its normative merits.

Plug and Play: The "New" Welfare Economics

Lionel Robbins (1929) "The economic effects of variations of hours of labour":

"The days are gone when it was necessary to combat the naïve assumption that the connection between hours and output is one of direct variation, that it is necessarily true that a lengthening of the working day increases output and a curtailment diminishes it."

Enrico Barone (1908)"The ministry of production in the collectivist state":

"It is convenient to suppose – it is a simple book-keeping artifice, so to speak – that each individual sells the services of all his capital and re-purchases afterwards the part he consumes directly. For example, A, for eight hours of work of a particular kind which he supplies, receives a certain remuneration at an hourly rate. It is a matter of indifference whether we enter A's receipts as the proceeds of eight hours' labour, or as the proceeds of twenty-four hours' labour less expenditure of sixteen hours consumed by leisure."

So much for combating naïve assumptions. Apparently all one had to do back in 1938 to avoid combat was "suppose" conveniently what in days gone by had been assumed naïvely and that was enough to ground the "New" Welfare Economics in mathematical tractability. None of which would have worked if the connection between hours and output was not one of direct variation. A simple book-keeping artifice, indeed!

Did it matter whether or not the theoretical ball bearings upon which Budget Circular A-47 rolled were round? Of course not. No one ever read Barone. They just plugged his handy-dandy formula into theirs. But, hey, no interpersonal comparisons of utility were made. Sometimes you have to take a big leap of faith for Science.

Economics, History and Economic History, Misread

My curmudgeonly moment today is devoted to the latest issue of The Nation, which has published a review article by Timothy Shenk on several recently released books on the history of capitalism.  A standard complaint is that the author you’re criticizing has managed to make so many errors in so few lines, but Shenk’s review is bloated and circles endlessly around very little substance, so perhaps his ratio is more commonplace.  Still, the errors were annoying.

Unless you have too much time on your hands you won’t want to read the original, so here’s a short synopsis.  According to Shenk, economists and historians used to be cut from the same cloth, but they diverged in the twentieth century as economics became more technical and history more cultural.  Historians abandoned economics, and economists were interested only in issues related to national policies and economic growth.  Now a new cohort of “historians of capitalism” are boldly defining a sphere in which historians can explore the grand issues that economics has abandoned.  But the historians have identified capitalism as economic growth.  This has helped them make sense of institutions like slavery that were formerly seen as outside the capitalist penumbra, but it is problematic in other respects.  Economists and ecologists now agree that rapid growth is over, perhaps growth itself, so the new direction these historians are taking is of little value for the future.

I often resort to lists in these posts because I don’t have time to craft a proper essay that knits everything together.  It’s the same today.

1. Economic history as a subfield of economics has been ill-treated by the profession, but it has continued unabated.  What about Douglass North?  Cliometrics?  Business history?  The current fascination with the longue durée in economic life?  The history of finance?  Economic history is a massive enterprise and has asked every sort of question, large and small.

2. And historians never stopped debating the origins and meaning of capitalism.  There has been a vigorous literature on how to explain the divergence of Europe from the less dynamic trajectories of India and China in the early modern era and intense disputes over the evolution of living standards during the industrial revolution.  A lot of environmental history is also transparently a history of capitalism.  So also the history of science and technology.  So where does this idea that historians dropped the study of capitalism come from?

3. According to Shenk, the 1960s gave history its radicals committed to bottom-up narratives and economics its Friedmanites.  Actually, economics got its radicals too but had little institutional space for them.  And the market fundamentalists surged in the 1970s and ‘80s for largely unrelated reasons.

4. Normal long run per capita economic growth under capitalism is a modest 1-2%.  There are temporary exceptions in miracle economies and miracle decades, but the point Piketty and others are making is that mature capitalist economies should expect to see slow rates of growth in the future, as they had in the past.  Secular stagnation adds slower technological change and demographic transition to the mix.  The first is supply-side and the second results from demand since, as a population ages, its rate of investment falls.

5. Secular stagnation has nothing to do with the Malthusian fantasies of some parts of the environmental movement.  One could be true and the other false, or maybe they are both false.  Shenk’s reference to the end of “unlimited” economic growth gives away his confusion: economic growth is always limited by a wide range of factors including the cost of material inputs.  I’ve gone after the degrowth thing elsewhere and won’t take it up now, but I do want to register a complaint about the notion that the expectation (and fear) on the part of some economists that future economic growth will be sluggish has some connection to environmental beliefs that growth and ecological responsibility are incompatible.  They stem from completely different concerns, and they view growth in completely different ways.

It’s a sign of the times in the US that a house organ like The Nation has so few articles by economists and prints long (and I do mean long) pieces like this one about economics with no apparent fact-checking.

Incidentally, I’m interested in the books under review and would love to read something that discusses what they have to say.

"There is no such thing as a secondary benefit"

Arthur Maass, "Benefit-Cost Analysis: Its Relevance to Public Investment Decisions" (1966):

There is no such thing as a secondary benefit. A secondary benefit, as the phrase has been used in the benefit-cost literature, is in fact a benefit in support of an objective other than efficiency. The word benefit (and the word cost, too) has no meaning by itself, but only in association with an objective; there are efficiency benefits, income redistribution benefits, and others. Thus, if the objective function for a public program involves more than economic efficiency — and it will in most cases — there is no legitimate reason for holding that the efficiency benefits are primary and should be included in the benefit-cost analysis whereas benefits in support of other objectives are secondary and should be mentioned, if at all, in separate subsidiary paragraphs of the survey report.
… 

The executive agencies have painted themselves into the efficiency box. In 1950 the Subcommittee on Benefits and Costs of the Federal Inter-Agency River Basin Committee gave overwhelming emphasis to the efficiency ranking function in its now well-known “Green Book” report. In 1952 the Bureau of the Budget, in a Budget Circular that neither required nor invited formal review and approval by the Congress, nailed this emphasis into national policy, adopting it as the standard by which the Bureau would review agency projects to determine their standing in the President’s program. And soon thereafter agency planning manuals were revised, where necessary, to reflect this Budget Circular. In this way benefits to all became virtually restricted to benefits that increase national product. 

The federal bureaucrats, it should be noted, were not acting in a vacuum; they were reflecting the doctrines of the new welfare economics which has focused entirely on economic efficiency.

Remedies Are Made of This... (cornmeal and potatoes edition)

"Mayor Wood of New York in 1857 suggested employing on public works everybody who would work, payment to be made one-quarter in cash and the balance in cornmeal and potatoes." -- Otto T. Mallery, "The Long Range Planning of Public Works," chapter XIV of Business Cycles and Unemployment, President's Conference on Unemployment, 1923.

Chapter XIX of John Maurice Clark's Studies in the Economics of Overhead Costs contains a section on "Remedies for the Business Cycle," in which Clark anticipated his later, much more extensive discussion in Planning for Public Works:

"For filling up the hollows [of the business cycle], the most positive and definite prescription is that government should plan an elastic schedule for public works of a postponable sort, and should save certain works to be prosecuted only in time of depression and unemployment, or prosecute the entire program more actively at such times."

Two years before Clark's book on overhead costs was published, President Warren G. Harding's Conference on Unemployment convened to consider how to relieve unemployment resulting from the 1921 depression. Commerce Secretary Herbert Hoover chaired the conference. Philadelphia playground pioneer Otto T. Mallery wrote the chapter on public works for the National Bureau of Economic Research's report to the conference.

After citing the opinion of the Minority Report of the 1909 Royal Commission on Poor Laws and Relief of Distress that "it is now administratively possible, if it is sincerely wished to do so, to remedy most of the evils of unemployment..." Mallery concluded his chapter with the observation that "flexible distribution of public works merits careful consideration as a factor in limiting the swing of the industrial pendulum and in lessening the shocks of unemployment." Thus was optimism kindled for combatting what John R Commons reckoned to be "the greatest defect of our capitalistic system, its inability to furnish security of the job."

Ninety-some odd years later and how are those "remedies for the business cycle" working out? This is not to suggest that the various remedies proposed in 1923 by the President's Conference -- unemployment insurance, counter-cyclical spending on public works, improved economic statistics, responsive monetary policy -- were inappropriate or ill-conceived. The conference report may even be viewed  as somewhat of a blueprint for the New Deal.

As time went by "various kinds of remedies" were replaced by aggregate demand management which was superseded by "real business cycle" focus on the supply side. Jean-Baptiste Say was rehabilitated. "If labour markets were allowed to function freely," the supply-side ideology claimed, "protracted unemployment would be cured automatically." In other words, the cure for unemployment is... unemployment.

Ninety-one years ago, Commons summed up the then prevailing interpretations of unemployment:

The older economists held that the elasticity of modern business was provided for in the rise and fall of prices through the law of supply and demand. But they assumed that everybody was employed all the time and that all commodities were on the markets and were being bought and sold all the time. If commodities in some directions were abundant then their prices would fall, which meant that the prices of other commodities would rise Then the disparity would equalize itself by capital and labor shifting from the low-priced and over-supplied industries to the high-priced and undersupplied industries. The rise and fall of prices through oscillations of demand and supply made the system elastic and harmonious. 

Seventy years ago Karl Marx came upon the scene with exactly the opposite interpretation. He rejected the law of demand and supply, with its oscillation of prices, and held that the elasticity of modem capitalism is found in the reserve army of the unemployed: Just as modern business must have a reserve fund in the banks and a reserve stock of goods on the shelves and in the warehouses, in order to provide for elasticity, so it must have a reserve army of that other commodity, labor, which it can draw upon in periods of prosperity and then throw upon its own resources in periods of adversity. 

It was seventy years ago, also, that modem trade-unionism started in England and America. It started on the same hypothesis of unemployment, but it retained the economist's doctrine of demand and supply. There is not enough work to go around [!], because the wage fund is limited, and therefore the workman must string out his job; must go slow; must restrict output; must limit apprenticeship, must shorten the hours, in order to take up the slack of the unemployed. 

This theory is not peculiar to labor unions. It is the common conviction of all wage-earners, burned into them by experience. Willing, ready and able to work, needing the work for themselves and families, there is no demand for their work. Trade unionists differ from unorganized labor in that they have power to put into effect what the others would do if they could. 

And who shall say that they are not right? Two years ago business men, newspapers, intellectuals, were calling upon the laborers to work harder; their efficiency had fallen off a third or a half; they were stringing out the jobs. Then suddenly several millions of them were laid off by the employers. They had produced too much. The employers now began to restrict output. Where labor restricted output in 1919 and 1920 in order to raise wages and prolong jobs, employers restrict output in 1921 in order to keep up prices and keep down wages.

The Marxian and trade-unionist critiques and prescriptions have been vanquished. Keynesian advocates of aggregate demand management are reduced to kibitzing from the sidelines. The "older economists" are back in the saddle. Everything old is new again. 

Or is it?

There's nothing you can do that can't be done
Nothing you can sing that can't be sung
Nothing you can say but you can learn how to play the game
It's easy

All you need is growth
All you need is growth
All you need is growth, growth
Growth is all you need

Is growth "all you need"? One hundred and five years ago, a Royal Commission minority surmised, "it is now administratively possible, if it is sincerely wished to do so, to remedy most of the evils of unemployment,.."

If it is sincerely wished to do so.

Those who insist there are no "limits to growth" seem to forget that the evils of unemployment have not been remedied -- even though it was believed by some, over a century ago, that it was administratively possible to do so. If, in more than one hundred years, unemployment could neither be remedied administratively nor "decoupled" from economic growth, what foundation does one have for faith that economic growth can be "decoupled" from carbon dioxide emissions or other natural resources and ecological impacts?

Or was that transition too sudden? What I am saying -- and have been saying all along -- is that there are not one but two couplings implicated in the environment/economy nexus. To say that GDP growth can be decoupled from natural resource consumption is to speculate about only one of those couplings. We have no data from the future that can confirm or deny such speculation.

We do, however, have data on the persistence of business cycle fluctuations that result in unemployment. Remedies for climate change face precisely the same political and ideological barriers as do remedies for the business cycle. There is no reason on earth that one would be given a free pass while the other is held hostage to rapacity.

Medical Device Excise Tax and Transfer Pricing

The Republicans ran on tax cuts for the rich – well the “job creators” even if getting tax breaks will not necessarily led to any new job creation. But it is time to reward the base:

First on the chopping block is likely the 2.3 percent tax on medical devices, such as hospital beds, MRIs, pacemakers or artificial joints. Soon-to-be Senate Majority Leader Mitch McConnell of Kentucky immediately targeted the tax in his victory speech Wednesday. The tax has been in place since 2013, and medical device lobbying groups have spent millions trying to gain support for repeal

Jane G. Gravelle and Sean Lowry of the Congressional Research Service just provided an economic analysis of the Medical Device Excise Tax (MDET), which may provide some ammunition for the proponents of repeal. Their report turns out to be a fairly balanced presentation of the issues. Page 8 points out something that needed further development:

A July 2014 report issued by the Treasury Inspector General for Tax Administration (TIGTA) found that the number of medical device excise tax filings and the amount of associated revenue reported are lower than estimated … The IRS estimated between 9,000 and 15,600 quarterly Form 720 tax returns with excise tax revenue of $1.2 billion for this same, two-quarter period. In other words, actual medical device tax collections were 76.1% of projected collections during this period.

Paul Jenks echoes this shortfall:

Through the first half of 2013, Treasury auditors estimate that the tax levy should have collected $1.2 billion in excise taxes, but the IRS has received $913 million.

Was the problem non-compliance by firms who did not realize they were covered or was there something else going on? What is missing is any discussion of the transfer pricing aspects. Richard Ainsworth, Andrew Shact, and Gail Wasylyshyn (ASW) provides a nice discussion of the constructive price issue:

Related party pricing - Will the traditional constructive price rules apply in the medical devices area, most notably the 75% valuation safe harbor rule under Revenue Ruling 80-273? Given the related party transactions typical in the medical device market and the probability that transactions may be structured among related parties to reduce exposure to the MDET, this issue could impact the revenue raised under this tax …The proposed regulations indicate that there should be a “… basic sales price [that] assume[s] that the manufacturer sells the taxable article in an arm’s length transaction (that is, in a transaction between two unrelated parties) to a wholesale distributor that then sells the taxable article to a retailer that resells to consumers.” The basic sales price presumes a traditional manufacturer-wholesaler-retailer-consumer marketplace. In cases where the basic sales price is not available, a constructive price will be determined, as an exception .. The medical device industry is exceedingly top-heavy. Although the Medical Device Manufacturers Association (MDMA) observes that 80% to 98% of the medical device manufacturers swept up in the MDET will be small businesses, 86% of the $20 billion the MDET is expected to generate over ten years will come from the ten largest firms. Thus, even though the MDET will be a considerable administrative burden for numerous companies, the government’s revenue will come primarily from the largest publicly traded multi-entity groups.

What does this all mean in terms of how much tax will be collected by MDET. Let’s assume a medical device manufacturer with $10 billion in U.S. sales per year. I’m thinking of this firm or the medical device division of this firm. MDET will not cost our firm $230 million at all. At most the tax bite would be only $172 million per year assuming these firms adopted the 75% safe harbor. But they are most likely paying less if not a lot less. I will argue shortly that the constructive price should more likely be only 65% of the end user sales price, which would mean our firm would be $150 million per year in MDET. The reality, however, is that they are only paying $69 million per year through a simple form of transfer pricing manipulation. The Big Four issued commentary on this issue similar to the following:

In the absence of further IRS guidance, taxpayers subject to the MDET who are concerned that the safe harbors set too high a constructive sales price or who have transaction patterns falling outside the safe harbors may decide to take approaches similar to those used elsewhere for U.S. federal income tax purposes to establish arm’s length prices. The taxpayer should first determine if it has any sales of a particular medical device at arm’s length at the same point in the distribution chain that can be used as a proxy to determine the constructive sale price for transactions with related parties involving such device. If not, taxpayers may be able to use certain transactional transfer pricing methods to support a more realistic constructive sale price for MDET purposes. The IRS has extensive guidance under the transfer pricing rules of section 482 on the “arm’s length principle” and permissible methods for establishing appropriate transfer pricing for U.S. federal income tax purposes. Very generally, the arm’s length principle of section 482 (including its various acceptable transfer pricing methodologies) is intended to produce a price that is consistent with the results of a transaction “if uncontrolled taxpayers had engaged in the same transaction under the same circumstances (arm’s length result).” Although the Treasury Department and the IRS made a curious comment in the preamble to the final MDET regulations suggesting that transfer pricing methods for section 482 purposes are not appropriate for MDET purposes, taxpayers may be skeptical about the statement’s significance given that constructive sales price rules and the transfer pricing rules generally have the same objective. Similar to the arm’s length principle articulated in section 482, the constructive sales price for purposes of a manufacturer’s excise tax (including the MDET) is “the price for which such articles are sold, in the ordinary course of trade, by manufacturers or producers thereof, as determined by the Secretary.”

That comment that section 482 principles are not appropriate for MDET purposes is indeed curious. I would argue that based on an appropriate application of the Resale Price Method that one could readily argue for a discount between 30% and 35%. The 30% argument comes from the observed gross margin of companies such as this one or this one. ASW also notes that if there is a service division as well as a sales division for a medical device manufacturer, their value-added should be excluded from the constructive price. Let’s assume these divisions combined operating expenses are 30% of sales and an appropriate operating margin is 5%. Then you get my 35% discount. So how would the medical device manufacturers pay only $69 million and not my $150 million? Because the Big Four accounting firms are arguing for discounts that are twice my answer. How on earth do they justify this extreme result? It is called the Cost Plus Method with production costs being 25% of sales and a contract manufacturer return equal to 5% of sales. Of course, the $3.5 billion difference between the Big Four answer and the 35% discount rate under the Resale Price Method represents the value of the product intangibles of the medical device manufacturer. Under arm’s length pricing, no manufacturer would fail to include this amount in their price to a distributor. So how are the Big Four writing these reports with a straight face? The answer is simple – they are advocacy reports based on the assumption that the IRS is stupid.

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Does not being authenticated mean I am a fake?

Neo-Fisherian Nonsense

Nick Rowe is drained by some weird new idea:

Figuring out the intuition behind John Cochrane's paper, to see what was really going on in his model, really drained me. Do I really have to wade through that Stephanie Schmidt-Grohe and Martin Uribe paper too, and reverse-engineer their result as well? I'm too old for this. Don't any of you young whippersnappers have an economic intuition? Do you all get snowed by every fancy-mathy paper that comes along?

If I’m wrong about this – let Stephen Williamson correct me but I thought he started down the neo-Fisherian train of thought because he realized that his (and others) prediction that Bernanke’s Quantitative Easing was not leading to hyperinflation. So when one’s model fails, turn to another model. And if one is somehow adverse to admitting Keynes got something right – come up with something that makes no sense. John Cochrane decides to weigh with a post I could spend all day making fun of:

At left is what we might call the pure neo-Fisherian view. Raise interest rates, and inflation will come. I guess there is a super-pure view which would say that expected inflation rises right away. But that's not necessary.

I’m sort of glad he laid this out and it makes my first take easier. This whole neo-Fisherian nonsense strikes me as turning Dornbusch overshooting on its head. Dornbusch would argue that an expansionary monetary policy pushed real interest rates down in the short-run with the excess aggregate demand slowly driving up inflation. The neo-Fisherites would have it raise real interest rates in the short-run. So how is this supposed to work? We get a reduction in aggregate demand which becomes inflationary? Nick isn’t the only one getting too old for this. To be fair to Cochrane, his later ramblings did include this:

In the standard view, a central bank would soon see inflation spiraling down, would quickly lower interest rates to push it back up again. Upside down, this might be a stylized view of the 1970s and 1980s.

My second – and more limited task – is to wonder whether Cochrane ever read Friedman and Schwartz:

This dog that did not bark has demolished a lot of macroeconomic beliefs: MV = PY. Sorry, we loved you. But when reserves go from $50 billion to $3 trillion and nothing at all happens to inflation -- or at most we're arguing about percentage points -- it has to go out the window.

Where to begin with this? Increases in the monetary base are not the same thing as an increase in the money supply – whether measured in terms of M1 or M2. Friedman and Schwartz noted that the Federal Reserve did increase the monetary base during the Great Depression but the money supply fell. Here the explosion in the monetary base during Quantitative Easing was met with a less than proportional rise in rise in the money supply. Taking the 7-year period from mid-2007 to mid-2014, nominal M2 rose by only 56.3%. OK – over the same period nominal GDP rose by a mere 20.36% with velocity falling from 1.99 to 1.54. But guess what – velocity fell during the Great Depression as well. Let’s take a few charts of this measure of velocity starting with the one provided by FRED. Does Cochrane see a stable velocity before the Great Recession? I don’t. John Mauldin apparently loves this Quantity Equation but notes:

let's look at the velocity of money for the last 108 years. Notice that the velocity of money fell during the Great Depression.

Velocity was 1.95 in 1918 but only 1.17 by 1932. Velocity’s variability over the Great Depression period was staggering. But once one realizes that velocity does not capture any agent’s behavior but is really nothing more than a silly definition, then why would any economist love it? Another observer of velocity during both the Great Recession and the Great Depression tried the following experiment:

Let's go back even further in time and look at another velocity of money using GDP and the annual St. Louis Adjusted Monetary Base ... instead of M2 …Notice that the drop in the velocity of money after the Great Recession is unprecedented....except, if you go all the way back to the Great Depression.

Call me an old fashion Keynesian if you will but I was never impressed with the Quantity Equation. And this neo-Fisherian nonsense strikes me as a waste of time.

Microeconomics, From Physical to Metaphysical

Here is another in my continuing series of snippets from my class in cost-benefit analysis.

The prices and quantities actually traded are visible or nearly so.

The price elasticity of demand at the current market price is one degree removed from immediate visibility; it requires only a pair price/quantity points that occur in what you’re willing to accept as the same market at the (nearly) same time.

The demand curve is not visible, despite how often you see these curves in textbooks.  It can be estimated from visible market data with some additional assumptions about functional form, or from surveys conditional on the extent to which they are thought to reflect real potential market behavior.  It can be validated ex post for prices actually offered in markets.

Utility is not visible, nor can imputations of it be validated in any conceivable way.  It can be contradicted (and is) by measured subjective well-being, but this just means that MSWB is not the same as utility.  Utility has the same scientific stature as the soul.

The Great Electoral Wipeout of 2014

Like everyone else I know, I've been trying to interpret the mass annihilation of Democrats in the elections that just took place.  I have no particular expertise to apply, and in any case the data we need to test our hypotheses aren't available yet.  Right now, it’s all speculation.

First, let’s agree on the facts.  (1) At the national level the Democrats got creamed.  Their losses in the senate, when this is all over, will prove to be even greater than their most pessimistic pollsters imagined.  Even their victories, like Warner’s squeaker in Virginia (if it holds up), were signs of collapse.  And they got further clobbered in the House.  (2) Governorships and state legislatures went decisively Republican, with few exceptions.  This was a red tide all the way down.  (3) Turnout was low, but even where it wasn't (Colorado), it didn't make a significant difference.

Now for some hypotheses.

1. This was the biggest-spending nonpresidential election the country has ever seen, and a large proportion of the total was anonymous and unaccountable to anyone except political strategists.  There was wall-to-wall TV advertising in October.  My browser was popping with political ads for a state senate race that wasn't even in my district.  (Hey, don’t these guys know about zip codes?)  The bulk of the money was Republican, but of course we don’t know how effective all this spending actually was.  While I’m sympathetic to this howl of outrage by Jeffery Sachs, I think it’s premature to conclude that money was a big factor.  Look for a wave of research (and “research”) conducted by and for political operatives trying to convince donors to pump in even bigger bucks the next time around.

2. It was also an election of fear.  Polls have shown an obsession with ISIS and Ebola that can only be described as paranoia.  I’m not saying that there aren't nasty paramilitary groups around the world or scary diseases, just that the current moment isn't actually scarier overall than others we've lived through, but a substantial portion of the public is convinced that we are staring at the face of  Armageddon.  This was perhaps the main theme of late-campaign advertising and messaging, no doubt driven by the widespread belief that fear activates mental processes favorable to conservatism.  Whether that was a meaningful factor in the rout remains to be determined, however.

3. It was a scream of anger directed at Barack Obama, personally.  The intensity of this hatred is in about the same range as we saw with Bush Junior during the late stages of his presidency, but the causes are different.  With Bush it was above all the catastrophe of the Iraq invasion and the nonchalant dishonesty with which it was peddled, as well as the perception that his ignorance and lack of interest in the hard work of governance was revealed in the botched response to Hurricane Katrina.  To put it bluntly, he came across as an overly entitled frat boy, an easy target as it turned out.  With Obama it’s a little more complicated.  To begin, we can’t overlook the fact that hatred of Obama is largely a white phenomenon.  White people hating a black guy has to have a racial element.  Here’s a very speculative reading: Obama is a professional talker.  He has given us years of smooth talk about making government work for us, supporting the middle class, and managing international conflicts prudently and professionally.  But the reality has been a steadily declining median income, a lack of visible success in government programs, and continuing global chaos.  In the case of ACA/Obamacare, first there was the disaster of the website meltdown, which John Judis, based on polling data, describes as Obama’s Katrina, and then, due to the complexity of the program, the delay (at best) in the impact on health care utilization.  (How many voters have benefited yet from ACA in the form of actually getting health care they needed, reducing their medical spending, and not being enslaved to health insurance benefits when deciding what job to take or stay in?  This might kick in over time, and perhaps ACA will be given some credit for the decline in health cost inflation, but we’re not there yet.)  What I’m getting to is this: there’s a big gap between Obama’s rhetoric and the results on the ground, and this plays into a racial stereotype, the jiving black guy.  The performance of Obama explains a general disillusionment with what his wing of the Democratic party has come to represent, but the racial element explains the hatred.  It’s interesting that Obama has gotten trapped in this bind; clearly much of his original appeal was based on his being able to convince voters that even though he was black he wasn't angry or militant or anything like that.  And that’s still the case.  But he waltzed into a different, but just as toxic, racial stereotype, and since it’s based on not believing anything the man says any more, there’s nothing he can say to defuse it.  Worse, it tarred the entire party in the eyes of many white voters, since they suspected all along that the Democrats had become the party of those people, and now they knew it for sure.  In this context, it’s interesting that a fourth of Republican voters voiced displeasure with their own party in the exit polls, but they hated Obama and the Democrats more.

4. There’s no sign that the electorate shifted to the right on substantive political issues.  In fact, the evidence from referenda around the country, on marijuana, guns, abortion, and the minimum wage, is that, if anything, the swing is moderately to the left.  This election played out on ideological and cultural stereotypes.

5. Blaming the election results on low turnout is a distraction: turnout is, as we like to say, endogenous.  The voters Democrats depend on, younger, lower-income, nonwhite, weren't motivated, as they often aren't.  I think it’s presumptive to claim that their lack of interest is a technical problem to be solved by better outreach and mobilization.  No doubt more accurate targeting and so on can play a role, but surely the biggest element is that, unlike the Republicans, the Democrats don’t stand for anything their base is likely to get motivated about.  Worse, in power Democrats do stand for principles (privatizing education and more liberal and lucrative finance, to mention just two) that are anathema to large parts of their base.  It is not an exaggeration to say, as Arun Gupta does, that “it’s time to rethink this notion that Democrats lack principles. They have a clear agenda and are actually more ideological than Republicans. Democrats like Obama are willing to lose power to carry out the neoliberal agenda.”

To repeat, all of this is simply speculation.  These are hypotheses that can and hopefully will be put to empirical tests.  I especially hope we will have some experimental evidence on the racial dimension of Obama-loathing, since we’d be a lot better off as a society if we could talk about this stuff openly and honestly.  Oh, and we need a programmatic political movement with a post-neoliberal vision and agenda.

Public Works, Economic Stabilization and Cost-Benefit Sophistry

I. Public Works and Economic Stabilization

This is where it all began. The National Resources Board's 1934 Report on National Planning and Public Works contained a radically different vision of the methods and purposes of conducting a cost benefit analysis than what has subsequently become the convention. This has profound conceptual (and possibly legal?) consequences for the supposed "economic optimization" of action to limit climate change.

John Maurice Clark was the NRB's economic consultant on the issue of "the use of public works as an economic stabilizing device." His findings provided the substantial basis for the report's Section II, Part 3 "Public Works and 'Economic Stabilization.'" A comprehensive report by Clark, Economics of Planning Public Works, was published in 1935 by the National Planning Board of the Federal Emergency Administration of Public\Works.

In Chapter Nine of his 1935 book, Clark introduced the (Kahn-) Keynesian multiplier into American economic discourse. This theoretical analysis provided a rationale for including the extended "secondary effects" of work relief in the calculation of project benefits. As the NRB report had noted: 

A second series of questions involves the relations of public works to economic stabilization and the emergency problem of work relief. What part can public works play in meeting the problem of business cycles and how far can these works be made an instrument for recovery?

This "second series of questions" was given a very high priority indeed by the Roosevelt administration in the context of the Great Depression. But for Clark the employment of labor that would otherwise have been idle was more than simply a secondary benefit of public works. It was the redress of a cost-shifting "externality" that resulted from the treatment of labor by employers as a variable cost that could be dispensed with during times of business slack. 

In his Studies in the Economics of Overhead Costs, Clark (1923) had argued that labor should be considered as an overhead cost of doing business rather than as a variable cost of the employing firm because the cost of maintaining the worker and his or her family "in good stead" has to be borne by someone whether or not that worker is employed:

If all industry were integrated and owned by workers, what would be the relation of constant to variable expense? ...it would be clear to worker-owners that the real cost of labor could not be materially reduced by unemployment.

One might argue that in a democracy, public works can be regarded as "integrated and owned by workers" and thus capable of restoring payment for the real cost of labor, if not by private employers then by the government -- which could then recover the outlay through taxation. Nor should it be assumed that Clark's attitude of reparation was not shared by the National Resources Board. The opening paragraphs of the report's foreword proclaimed in populist prose:

The natural resources of America are the heritage of the whole Nation and should be conserved and utilized for the benefit of all of our people. Our national democracy is built upon the principle that the gains of our civilization are essentially mass gains and should be administered for the benefit of the many rather than the few; our priceless resources of soil, water, minerals are for the service of the American people, for the promotion of the welfare and well-being of all citizens. The present study of our natural resources is carried through in this spirit and with a desire to make this principle a living fact in America. 

Unfortunately this principle has not always been followed even when declared; on the contrary, there has been tragic waste and loss of resources and human labor, and widespread spoliation and misuse of the natural wealth of the many by the few. [emphasis added]

The conservation movement begun a quarter of a century ago marked the beginning of an organized national effort to protect and develop these assets; and this national policy was aided in many instances by the individual States. To some extent the shameful waste of timber, oil, soil, and minerals has been halted, although with terrible exceptions where ignorance, inattention, or greed has devastated our heritage almost beyond belief.

So this, then, is the founding rationale for cost-benefit analysis, as different from today's market-appeasing conventions as chalk from cheese. And -- oh, yes -- it is THE LAW:

"...if the benefits to whomsoever they may accrue are in excess of the estimated costs, and if the lives and social security of people are otherwise adversely affected." --  Title 33 U.S. Code § 701a - Declaration of policy of the Flood Control Act of 1936

Refugees from the "1000-year flood" of the Mississippi River in 1937.

II. The Fallacy of Maximizing Net Returns

In the early 1950s, the mandate for giving prominent consideration to secondary benefits was effectively expurgated from federal government cost-benefit guidelines. The purge was carried out through two documents: the "Green Book," Proposed Practices for Economic Analysis of River Basin Projects, published in May 1950 and Budget Circular A-47 issued on December 31, 1952. Maynard Hufschmidt's (2000) chronicle of "Benefit-Cost Analysis 1933 - 1985" provides a useful overview of the sequence of events. Hufschmidt worked for the National Resources Planning Board, the Bureau of the Budget, and the Department of the Interior between 1941 and 1954.

Hufschmidt recounted that the Green Book's "treatment of the thorny issue of secondary benefits was at odds with the  practice of the Bureau of Reclamation" and it recommended that benefits "should be measured from the strict national economic efficiency point of view" rather than from the perspective of local or regional benefits. This controversial recommendation was not implemented by the concerned agencies.

John Maurice Clark was called upon again, along with two other economists, to adjudicate the issues in dispute between water resources agencies and the interagency subcommittee on benefits and costs. According to Hufschmidt, the panel of economists "recommended a cautious approach to including secondary benefits," which included separate reporting of primary and secondary benefits but did not rule out their use. [I have requested the Report of Panel of Consultants on Secondary or Indirect Benefits of Water-Use Projects through interlibrary loan and hope to elaborate on its analysis when I have had a chance to study it.]

The economic consultants' report was submitted at the end of June, 1952. Six months later it became a moot point as the federal Bureau of the Budget issued Budget Circular A-47, severely restricting the use of secondary benefits. Hufschmidt described A-47 as a "conservative document" that was regarded as imposing "severe restraint" on water projects:

The subject matter coverage was much the same as the Green Book; basically, it was a conservative document, which placed primary emphasis on economic efficiency-oriented primary benefits for project justification. The use of secondary benefits was severely restricted, an opportunity-cost concept of interest or discount rate, tied to the interest rate of long-term government bonds, was adopted, and a 50-year time horizon was established.  

Budget Circular A-47 was widely regarded by the water resources agencies and by the many proponents of water resources projects in Congress as a severe restraint on water projects. It served this purpose during the eight years of a relatively conservative Republican administration under President Eisenhower from 1952 to 1960, and was finally rescinded in 1962 in the early days of President Kennedy’s administration.

It doesn't need to be assumed that skepticism or caution regarding the evaluation of secondary benefits was unwarranted. Richard Hammond (1966) observed that the practices of the Bureau of Reclamation "brought benefit-cost analysis into disrepute in many quarters, particularly when agencies continued, in times of wartime boom and post-war 'full employment,' practices generated by the depression." On the other hand, the remedy pursued by the Green Book had its own problems, characterized by Hammond as "The Fallacy of Maximizing Net Returns" which the Green Book pursued as an "incontrovertible proposition":

The most effective use of economic resources is made if they are utilized in such a way that the amount by which benefits exceed costs is at a maximum rather than in such a way as to produce a maximum benefit-cost ratio or on some other basis... This criterion of maximising net benefits is a fundamental requirement for economic justification of a project. [emphasis added by Hammond]

"What seems to have happened," Hammond observed of the foregoing paragraph,"is that a familiar abstract proposition of economic theory, that rational conduct consists in balancing marginal cost against marginal gain, has been mistaken for a prescriptive rule of behavior applicable in any and all circumstances without qualification." Furthermore, he eventually explained, the maximizing mania ultimately boils down to substituting guesswork about one set of "opportunity cost" intangibles for other intangibles called "secondary benefit" and diminishing some of the speculative figures to an infinitesimal amount by the application of an arbitrary discount rate.

In defence of Clark's earlier formulations regarding secondary benefits, he was almost exasperating in his insistent qualification of cost and benefit estimates as judgemental and tentative. This contrasts with the maximalist language of pseudo-scientific precision exemplified by the Green Book's use of "words like measure, ascertain, and evaluate in contexts where estimate, expect, and guess would be more appropriate."

III. Kapp and Trade

In 2010 the U.S government's Interagency Working Group on Social Cost of Carbon (IAWG) presented its estimate of the social cost of carbon "to allow agencies to incorporate the social benefits of reducing carbon dioxide (CO2) emissions into cost-benefit analyses of regulatory actions that have small, or 'marginal,' impacts on cumulative global emissions." The IAWG's central estimate for the social cost of CO2 in 2010 was $21 in 2007 dollars, based on a 3% discount rate. One of the damages associated with an increased increment of carbon emissions in a given year is specified as "property damages from increased flood risk." Would the Flood Control Act of 1936 have any pertinence to their cost benefit analysis?

The Kaldor-Hicks compensation test constitutes a guiding principle for the selection of a discount rate for cost-benefit analysis, the IAWG report explains:

One theoretical foundation for the cost-benefit analyses in which the social cost of carbon will be used— the Kaldor-Hicks potential-compensation test—also suggests that market rates should be used to discount future benefits and costs, because it is the market interest rate that would govern the returns potentially set aside today to compensate future individuals for climate damages that they bear.

The Kaldor-Hicks test presumably allows the analyst to set equity considerations aside while evaluating the economic efficiency. Does it?

David Ellerman argues that the efficiency/equity distinction is simply an artifact of the choice of numeraire. In other words, the supposed efficiency of a policy outcome measured in dollars is an illusion created by the fact that efficiency is being measured with the "same yardstick" that was used to assign "value" to incommensurable things like human life, output of goods and services and damage to the environment. If one reverses the process and establishes human life or environmental damage as the unit of measurement, then the results of the analysis are also reversed.

Although simple, this is not an intuitively obvious argument, so Ellerman illustrates it with a very simple example in which John values apples at one dollar each, while Mary values them at 50 cents. Social wealth would be improved if Mary sells an apple to John for 75 cents. Under the Kaldor-Hicks criterion, social wealth would also be improved if Mary lost her apple and John found it, even though Mary receives no compensation. Kaldor-Hicks would deem this an efficiency gain because John could potentially compensate Mary by paying her 75 cents for the lost apple. Measured in apples, though, there has been no change in total wealth because Mary's lost apple exactly balances John found one..

But using apples as the unit of measurement changes everything. Since John values one apple at one dollar, he also values one dollar at one apple. Mary values a dollar at two apples.Measured in apples, social wealth would be improved if John lost a dollar -- worth only one apple to him -- and Mary, who values the dollar at two apples, found it. John's cost is smaller -- in apples -- than Mary's benefit. But since a dollar is a dollar, if the unit of measurement was dollars, the cost and the benefit would exactly balance leaving no net gain.

Ellerman's illustration may seem trivial but the "same yardstick" argument comes from Paul Samuelson who pointed out that, measured in money, the marginal utility of income is constant at unity. Bill Gates would value an extra $20 a week of income as much as a Walmart clerk would -- $20 dollars worth! It's a tautology.

Of course that's not the only problem with the IAWG's cost of carbon estimate. Moyer, Woolley, Glotter and Weisbach argued that the social cost of carbon estimates in the IAWG models are constrained by shared assumptions of persistent economic growth. Even a modest negative impact on productivity, they find, would increase social cost of carbon estimates by several orders of magnitude above the IAWG estimates.

Johnson and Hope found that assigning equity weights to damages in regions with lower incomes or using different discount rates generates social cost of carbon estimates two and a half to twelve times those of IAWG. Foley, Rezai and Taylor argued that the social cost of carbon and the relevant social discount rate are conditional on a specific policy scenario "the details of which must be made explicit for the estimate to be meaningful." There is also Martin Weitzman's analysis that the uncertainty about the prospect of catastrophic climate outcomes renders traditional cost-benefit analysis irrelevant.

Remember how we got to this analytical impasse, though? Clark's analysis of planning for public works and the National Resources Board report were concerned with the environment to be sure. But their sense of urgency was more particularly focused on the unemployment crisis. Controlling floods, reclaiming eroded agricultural land and replanting forests were viewed as ways to productively employ workers who would otherwise have to be given welfare or work at "leaf raking" make-work jobs. Public works were being considered as a way to smooth out the fluctuations of the business cycle and ameliorate the effects of cost-shifting due to employers accounting for workers as a variable, rather than a fixed overhead cost.

In February 2010, the U.S. official unemployment rate was 9.8%. The word "unemployment" doesn't appear in the 50-page IAWG report on the social cost of carbon. Nor do the words "recession," "jobs," "poverty" or "inequality" The word "labor" occurs several times but only in the context of an arcane footnote about "a method of estimating η using data on labor supply behavior." The "lives and social security of people" is given short shrift. "Growth," however, appears 34 times, about two-thirds of which refer to economic growth. In the IAWG report, one may conclude, economic growth is unrelated to employment of labor but closely correlated with "interest rate," which appears 20 times -- roughly the same frequency as "growth" in the economic context..

That's the problem right there.

In 1950, the same year the Green Book was curbing the use of secondary benefits in cost benefit analysis, Karl William Kapp's book The Social Cost of Private Enterprise was published, inspired by and elaborating on J. M. Clark's analysis of cost shifting. "As Kapp implied," remarked Joan Martinez-Alier, "from a business point of view, externalities are not so much market failures as cost-shifting successes." From that perspective, the IAWG's $21 a ton estimate of the social cost of carbon dioxide also may be better understood as an agenda-shifting success rather than a planning failure.

Eighty years ago, it may still have been possible to believe that those cost-shifting successes of business could be remedied through planning and public works conducted by a democratically-responsive government. Today, the role of government and the intention of cost benefit analysis is very different from what was professed in the foreword to the National Resources Board's 1934 report. How has that happened?

"Many difficult conceptual issues such as externalities, consumer surplus, opportunity costs, and secondary benefits that had troubled earlier practitioners were resolved and other unresolved issues, such as the discount rate, were at least clarified." -- Maynard M. Hufschmidt, "Benefit-Cost Analysis 1933-1985"

Just what are those "secondary benefits"? What are the "opportunity costs"? How did the difficult issues get resolved? And who cares?

What if I told you that "secondary benefits" was a cipher for "wages of labor," that "opportunity costs" was code for "return on capital investment" and that a significant portion of those supposedly sacrosanct financial "opportunities" result from cost-shifting? What if I pointed out that the "difficult issues" were "resolved" by declaring that wages were of little concern to public policy making but that profits were paramount?

Would you conclude with Hufschmidt that these difficult "conceptual" issues had been "resolved" or "at least clarified"? Or would you object that these are political, not conceptual, issues and that they have been suppressed and arrogated by the ideological framing and technocratic jargon of cost-benefit analysis? I leave the last word to John Maurice Clark:

"It comes down to this, that any use of labor that is worth anything at all is worth that much more than nothing. In that respect the socialist view of business depressions is correct and any rebuttal that attempts to explain away this fact by the reckonings of financial expenses is a bit of economic sophistry." Studies in the Economics of Overhead Costs (1923).

New Introductory Economics Textbooks

I haven’t used this blog to call attention to my new textbooks, Microeconomics: A Fresh Start and Macroeconomics: A Fresh Start, so let me do that now.  Where did they come from, what’s new about them, and who are they for?  In this post I will describe the concepts behind the books in a general way, and in future posts I’ll discuss particular things to look for in each of them.

1. Where did they come from?  They came from my own teaching, which has been intensive in introductory economics to an extent that I suspect few other teachers can match.  Because of my particular career history, virtually all my economics instruction has been at the intro level for the past 20 years.  For the past 16 years I’ve been at Evergreen, where most teaching is interdisciplinary and team-based.  I have taught introductory economics with natural scientists, philosophers, historians, sociologists, political scientists and cultural studies scholars.  Each time I have searched for different points of contact and tension between economics and these other fields.  In the process I’ve come to understand what makes economics distinctive, and to identify the assumptions and mental frameworks economists use that people with other backgrounds don’t.  Conveying what is specific to economics seems to me to be a big part of what introductory teaching should be about.

In addition, Evergreen’s pedagogy is steeped in critical thinking and inductive, problem-solving modes of learning.  Well before it was fashionable I was devising a wide range of workshops, labs, mini-projects and other activities for students to experience using economics and not just memorizing definitions and diagrams.  With this approach I simply couldn’t use any of the existing introductory economics texts.  They were all written in an authoritative voice: this is what you must believe.  They provided lots of models with sparse explanation; the expectation was obviously that the instructor would spend most of the available class time filling in the explanations the books left out.  They were based on the tabula rasa notion that students walk into the classroom with an empty head, waiting to have it filled up with “material”—rather than recognizing that students are people who come to education with a head already stocked with ideas, so that education has to be about new ideas meeting existing ones.

I had no choice but to begin writing my own book, slowly, a chapter at a time.

2. What’s different?  Basically, the differences fall into two categories.  First, as I’ve just described, the pedagogical model is entirely different.  Economics in these books is offered as an object of scrutiny, not a fount of unchallengeable wisdom.  Where economics differs in its assumptions and strategies of understanding, I simply put them beside the approaches of other disciplines and let students make up their own minds.  Evidence is presented not to demonstrate that some particular economic theories are “right”, but as a basis for critical thinking.  My premise is that the world economics tries to analyze is extremely complex, and no single theory will be right every time.  The best approach is case-based: identifying the kinds of situations where particular theories do a good job, as well as the ones were they tend to come up short.

Very important to the pedagogy is deep explanation.  I try to make every assumption explicit, every time.  This includes how the elements of a theory can (or can’t) be measured, why curves are drawn the way they are (and whether they could be drawn differently), and how you would know if the theory were wrong.  I talk about the history behind the various theories—when they were developed and what they were intended to accomplish.  I give extra examples.  My goal is to pack as much of the explanation as possible into the reading, so that more class time can be spent on activities, not lectures.

The explanation style also addresses itself to the ideas that, in my experience, students are likely to bring to the study of economics.  Where their experiences are relevant, I try to bring them in.  Where popularly-held economic ideas conflict with careful reasoning, I don’t hesitate to point it out.  Above all, I’m attentive to the problem of language, the way the same words may mean one thing in everyday conversation and another in a technical economics context.  You can see this, for instance, in words like “equilibrium” and “trade”.  It’s not that the student’s language is “wrong”, just that adjustments need to be made for the way words are used differently.

The other major difference is content, and here I have to describe the biggest, most consequential decision I made when writing these texts.  There have always been textbooks written to correct the “errors” of mainstream economics or to offer what their authors thought was a better theoretical framework.  I’m sympathetic to many of the ideas you can find in these books, and it’s stimulating to have a wide range of views, but in the end each such book has the same flaw: it’s my way or the highway.  These books replace the espousal of doctrine A by the mainstream books with the author’s preferred doctrine B.  They don’t invite a critical reading, and invariably you (the instructor) are going to find that there’s a lot of B that you just can’t buy into.  In any event, none of these books has really caused the profession as a whole to rethink how it approaches the introductory curriculum.

So I decided I would not try to fix economics.  These books do not represent my personal take on what’s wrong with economics as it is and how it ought to be reformed.  I simply don’t go there.  (Except on occasions when I can’t help it.)  Rather than the gap between my ideal economics and actually existing economics, I chose to focus on the gap between economics as it is currently practiced by economists and the way it is presented to introductory students.  That gap is huge, and it gives me a lot to work with.

Why is it so huge?  I think two factors have coincided.  On the one hand, economics has evolved considerably over the past two decades or so.  It has become much more empirical, more interested in institutions, and somewhat more realistic about human behavior.  There is also more willingness to entertain models with unconventional features, like multiple equilibria, speculative bubbles, increasing returns and imperfect competition.  The rate of change may be less than what some of us wanted, but it has been substantial all the same.  On the other hand, however, there is immense inertia in the textbook market.  Part of this is our fault: intro teachers want to recycle their notes, exercises and exams.  They want to teach more or less the same course this year they taught last year, with the occasional tweak to liven it up.  Of course, there are few incentives for most economists to knock themselves out reinventing the intro course.  But a lot of the blame also  has to be put on the textbook publishers.  A modern commercial textbook is a behemoth, the product of an immense army of editors, graphics people, marketers and other staff.  It’s a big bet in a big lottery.  And just like Hollywood, the publishers try to produce blockbusters by slightly varying the formula of last year’s blockbuster.  There’s a saying—I think attributable to David Colander—that intro texts have to abide by the 15% rule: no book can be more than 15% different from the others and still see the light of day.

This explains the title of my two books.  They are written from the ground up to reflect, as best as I am able, the state of economics today, as if no previous textbook had ever been written.  They are fresh starts.

3. Who are they for?  I think there are three potential audiences.  First, many economists may be feeling frustrated with the existing array of texts.  They are embarrassed by teaching subject matter that their discipline has largely moved on from, while not covering key concepts that underlie contemporary research.  Some may be swayed by high-profile student protests, demanding more relevance and a less doctrinaire attitude in undergraduate economics.  They may also be gravitating to the critical thinking–active learning paradigm in teaching as they see colleagues in other disciplines doing.  These economists may be willing to adopt a new kind of textbook in spite of the obvious costs in time and discarding prior investments.

The second group is heterodox economists.  If they are looking for a textbook that trumpets their particular brand of heterodoxy they will be disappointed.  But they may be content with a book they don’t have to teach against.

The third group is not necessarily academic at all.  It consists of people who are curious about what economics is up to in the post-2008 world and would like to read a literate, open-minded but comprehensive account.  I’ve tried to make these texts engaging—not in the disjointed manner of the collage-style products of the big commercial houses (which seem to be in a permanent state of fighting off boredom), but in the form of a narrative, the way a good science journalist presents science.  Maybe there are readers out there who are eager for a pair of books about contemporary economics that doesn’t shy away from the technicalities, but also looks at it from a broader cultural, political and historical perspective.

Science Communication

There’s an interesting article on Dan Kahan in today’s Chronicle of Higher Education.  Kahan, for those who don’t know, is the current guru of science communication.  His updating of the work of Mary Douglas is valuable; I always liked Douglas even though I found her politics unappealing.  There is some Douglas in my earlier writing on risk norms (for instance in Markets and Mortality).

In general, I think Kahan is right that tribal affiliation is a major impediment to communicating the science of climate change.  This is a problem for both sides—not only for denialists who see themselves fighting to save the free market against enviro-crypto-socialists but also the enviros who see the climate problem as a vindication of their disdain for economic growth and materialistic values.  Now how much the economy should be regulated and what sorts of values contribute to a good life are important questions and deserve all the attention and reflection we want to give to them, but the tribal identities people have developed around them can only get in the way of dealing with climate change in a rational fashion.

In other words, this isn’t just about anti-science Republicans or Koch-funded denialism (which do exist), but also environmentalists using the climate to act out their moralism.  Big cars are b-a-a-a-d.  TV is b-a-a-a-d.  Trying to make money is b-a-a-a-d.  Climate change is nature’s revenge on humans for all that badness.  (See more venting about green moralism here.)

It’s difficult to get green folks to stop doing this because they get reinforcement from their tribe (including their inner tribe) every time they denounce the moral turpitude of the other side.  But they should see that it’s not working and stop.

One other, more specific thought about science communication: scientists spend their life honing observation and measurement.  For them, science consists of devising and applying new methods for identifying, documenting and measuring our world.  When they think of communication, they have in mind explanations of what empirical results they’ve established and the methodological basis for them.  The assumption seems to be that public understanding of science takes the form of an unordered collation of facts about observations and methods.  We have ice cores!  Here are fluctuations in CO2 concentrations in the atmosphere over the past 150,000 years!  Here is the change over 50 years in the range of a beetle that damages spruce forests!  Here is our best estimate of the relationship between global temperatures, thermal expansion and sea level rise!

But that’s not really how people think themselves through complex issues.  Rather, they need stories, and science succeeds when it supplies a compelling story that provides a structure for individual facts.  The story doesn’t have to be perfectly correct in all its particulars, just true enough that it does the job.  You can qualify it as you go deeper.

This is why I cringed when I read the latest synthesis report from the IPCC.  Of course, there is nothing scientifically wrong about their brief distillations of research into the various aspects of greenhouse gas emissions, carbon response and the like.  But this is not a story.  What I tried to do here, here and here was a stab at a story.  I’m not a scientist (just an economist), and my presentation was radically simplified even by my standards, but something like this is what might reach people who do not do science for a living.

Opportunity Costs and Secondary Benefits

"Many difficult conceptual issues such as externalities, consumer surplus, opportunity costs, and secondary benefits that had troubled earlier practitioners were resolved and other unresolved issues, such as the discount rate, were at least clarified." -- Maynard M. Hufschmidt, "Benefit-Cost Analysis 1933-1985"

And they all lived happily ever after... (in the Cost-Benefit fairy tale, that is).

What are secondary benefits? What are opportunity costs? How did the difficult issues get resolved? And who cares?

What if I told you -- just for argument's sake, mind you -- that "secondary benefits" was a cipher for "wages of labor" and that "opportunity costs" was code for "return on investment"? What if I pointed out that the "difficult issues" were "resolved" by declaring that wages were of little concern to public policy making but that profits were paramount? Would you care about secondary benefits, opportunity costs and how those difficult issues were resolved?

Economists generally don't. At least not until now anyway.

The Sandwichman has scheduled an EconoSpeak blog post for Wednesday, November 5, titled "Unemployment, Interest and the Social Cost of Carbon" "Public Works, Economic Stabilization and Cost-Benefit Analysis" that doesn't quite go as far as the "what if" scenarios above. It explores highlights of the untold story of CBA from the New Deal to today's climate change policy "Integrated Assessment Models."

But keep those "what if" scenarios in mind. Cost-Benefit Analysis is about class struggle, the rules for conducting that struggle and which class makes the rules.