How Is Economics Different?

I’ve just read, with morbid fascination, “The Superiority of Economics” by Marion Fourcade, Etienne Ollion, and Yann Algan, which will appear in a forthcoming issue of the Journal of Economic Perspectives.  No surprise that it is such a fine bit of work: I was very impressed by Fourcade’s Economists and Societies: Discipline and Profession in the United States, Britain, and France, 1890s to 1990s, which came out a few years ago.

My reactions might be interesting because, while my training is in economics, I never managed to get into the profession and have not taught in an economics department in any capacity in over 20 years.  This has its pluses and minuses.  I think I was better placed to write my economics textbooks as someone who could refer to economists in the third person (good for critical thinking), while I realize that, being completely out of the loop, I’m susceptible to serious gaps in understanding and errors in interpretation.  But there’s no perfect vantage point, right?

Anyway, here are some thoughts about “Superiority”.  You should read the original article first to see what I’m reacting to.

1. I’m surprised by the data that suggests that economists are not collaborating more across disciplinary boundaries than they used to.  It might be that the focus on top journals and citations, understandable from a data availability perspective, obscures the actual trend, or maybe not.  One possible source of omitted evidence is that their list of external disciplines does not include psychology or biology, two fields where it seems to me that collaboration has been most fruitful.  (See Figure 3, Extra-disciplinary citation in five top journals.)

2. The authors cite a bit of evidence for the view that economists think they are smarter than other social scientists.  (Tyler Cowen thinks economists really are smarter.)  My experience is that this attitude is in fact widespread and is a source of friction in academia: many faculty in other fields feel disrespected by economists and get a surge of schadenfreude when economics gets taken down a peg, as happened in the immediate wake of the financial crisis.  At the same time, the notion that there is something genuinely superior about economics or economists is absurd, when you think about it.  Write down your own list of the ten books or authors that you think have contributed most to our understanding of the modern world—how many are based in economics?  If you have more than, oh, two on your list you need to read more widely.

3. In my opinion, the inferiority of economics is revealed in topic areas where disciplines overlap—where economists and noneconomists study the same phenomena.  In nearly each case, I think you would learn more and better by paying greater attention to the nonecons.  This includes management, law, economic sociology, international political economy and social psychology.  I’m not saying economics isn’t valuable and even essential, just that there’s more illumination coming from other lamp posts.

4. The treatment of organizational structure focuses entirely on the American Economic Association in relation to the professional organizations for American political scientists and sociologists.  This material was quite interesting, but aren’t they leaving out something important?  I’m thinking of the National Bureau of Economic Research (NBER), which provides support and especially networking for “core” researchers in economics.  From where I stand, many rungs beneath, this looks like a nomenklatura for the profession.  Perhaps this is the sort of misinterpretation I warned against earlier.  But if not, we ought to document how members of NBER are recruited and what the career consequences are for inclusion versus exclusion.

5. Much is made of citation and authorship data drawn from a small number of select journals in economics and other social sciences.  This is the main value added provided by the paper, in fact, compared to earlier work.  I wonder, however, whether we should think of the patterns uncovered in these journals as primarily facts about journal publication or as proxy indicators of some deeper underlying process.  My reason for wondering is that, for the purposes of disseminating new research, working papers have almost entirely eclipsed published articles.  If, for instance, we care about the fact that most authors in the top econ journals come from the top five graduate departments because we think that these journals constitute a critical channel of research communication—well, we can care less now.  On the other hand, the relative concentration of authorship in economics compared to other fields revealed by Fourcade et al. may be important for what it says about the nature of the economics star system (and its tight institutional embeddedness in a few departments), and this may persist even after the journals have lost their earlier role.  If I were a reviewer of this article, I would have posed this question.

6. Towards the end the authors toss off in passing what they regard as the key points of intellectual unity that distinguish economists from, say, sociologists.  They don’t try to back this up with references, and perhaps it’s really the sort of thing different people will see differently.  In that spirit, here’s my short list.  (I make no attempt to justify or explain, but you’ll find most of this amplified somewhere or other in previous blog posts.)

a. Causation as prediction rather than process.  The goal of econometric work is to fulfill certain criteria for predicting the effect of independent variables on dependent variables, rather than to locate and describe causal mechanisms or processes.

b. Homogeneity and average effects.  Economic models incorporate entities (agents, goods) that are homogeneous in most respects or differ according to a few indexable criteria, and empirical methods search for discernible average effects.  In other disciplines the uniqueness of entities plays a greater role—one reason for more reliance on case studies.

c. Positive/normative convergence.  Perhaps the single most far-reaching intellectual commitment of economists is to the assumptions necessary for positive models (which can be tested or calibrated with real world data) to yield normative conclusions.  Utility theory, whose longevity is otherwise difficult to explain, is central to this.  Positive/normative convergence, of course, is what allows economics to evaluate policy in a dispositive manner and is attractive to people who, for varying reasons, distrust political and bureaucratic mechanisms.

d. Decision theory.  Economics has practically defined itself as a branch of decision theory, or perhaps as decision theory itself.  One characteristic of this theory is that it is forward-looking, comparing the results of some possible course of action to the continuation of the status quo (not taking the action).  As such, it discounts the historical roots of the status quo or indeed any source of judgment or evaluation external to the comparison between different decision outcomes.

7. For the most part, this article tries to understand the economics profession according to its internal characteristics: its professional structure and norms, the beliefs of its practitioners, and their interactions with academics from other disciplines.  It reveals a lot.  But little is said about the external factors, how economics is affected by the broader structures of power, interest, and beliefs in society at large.  This is the realm of ideological analysis.  I would be the first to defend the notion that internal factors are very important, and that it would be a mistake to think of economics as simply a functional element within, say, a capitalist framework or some other model of how the world works.  But surely these larger interests have to matter.  It can’t be incidental, for instance, that economics, whose main subject matter is central to accumulation of wealth, has the most tunneled vision of all the social sciences.  Of course, loose impressionistic claims about ideology have little value; this is an area for research and hypothesis-testing just like any other.  We need an internal account, among other reasons, to discipline critiques based on external reward or control, but we also need to bring in external factors in order to avoid attributing too much independent importance to professional selection, the bylaws of the AEA or other such matters.

Is 1921 A Role Model For Modern Macroeconomic Policy?

I am going to join in the piling on of Robert J. Samuelson that Dean Baker and now a few minutes ago my Econospeak colleague, pgl, have been engaging in.  But I want to take this a bit further.

So, the regrettable RJS in today's WaPo has fallen all over himself praising the new book by Jame Grant, _The Forgotten Depression_, which was also recently the subject of much praise at a Cato  Institute Symposium.  A number of economists have pushed Grant's line previously, among them Steve Horwitz, Larry White, and Lee Ohanian, with White participating in the Cato Institute hagiographic orgy, although a bit more on that in a minute.  RJS is completely suckered in, as noted by Baker and pgl.  Even though the non-farm unemployment rate hit 15.3% in 1921, after sharp falls in wages and prices, there was a rapid bounceback, in contrast to the Great Depression and the Great Recession.  Therefore all the claims that the Great Depression was due to trying to adhere to the gold standard are clearly wrong, and modern economists clearly have a "fragile grasp of reality."  If only we had let wages and prices crash in 2009, we would be la la land right now.

Let me look at the bigger picture on all this by comparing more closely the 1920-21 episode with the events immediately following WW II, as well as the Reagan recession of 1982 and our more recent experience.  I would suggest  as a good check on Grant's account, "Three Great American Disinflations," by Michael Bordo, Christopher Erceg, Andrew Levin, and Ryan Michaels, 2007, published by the Board of Governors of the Fed. I shall use numbers and accounts from it.

So, what happened back then?  We were  dealing with a regime shift from a no-gold standard period during WW I to a reimposition of it after the its end, basically a postwar adjustment. The most important actor here is one not mentioned at all in Samuelson's article, and pushed to the remote sidelines by Grant, who is all about wages and prices here, even though usually he is all about interest rates, with his newsletter, Grant's Interest Rate Observer, the basis for RJS calling "a respected financial commentator," (unlike RJS himself, but, hey, Grant does get on TV a lot). 

In any case, the Fed held its discount rate at 4% through 1919, while fiscal policy contracted, but a major  inflation broke out into double digits.  At the end of that year the Fed began to tighten, partly in accord with the reimposition of  the gold standard, and gold had been flowing out of the US quite heavily during 1919.  The discount rate was pushed from 4 to 6 percent, with the commercial paper rate about a point above it moving in tandem roughly.  The response was the deflation (20% decline in overall price level, with wages also falling substantially), along with a 30% decline in industrial production, and the rise of unemployment to 15.3% (funny, but aren't wage declines supposed to obviate laying off workers?).

When all this was hitting the fan hard in 1921, the Fed reversed course and lowered the discount rate back down to 4%.  The economy then went into its rapid rebound.  I note that in his remarks at Cato, at least Larry White did note this point as a caveat on all the proceedings.  Bordo et al also note that both Irving Fisher and also Friedman and Schwartz pinpointed the role of the Fed in all this and declared it to have behaved very irresponsibly in the entire episode.  But for Grant and Samuelson, the Fed barely even existed then.

So, what about these other episodes?  I  shall stay away from the GD, leaving its explanation to be what it long has been, overly strong adherence to the gold standard, with the Fed failing at the most crucial moment in Sept. 1931 as the global financial crash hit the US, pushing the unemployment rate up from 8% at the beginning of the year to a 1921 level of 15% by the end of the year. Of course, reimposing the gold standard was the trigger for the crash of 1921, if not its rebound. In any case, let us look at the other three episodes.

I  think we get a nice test of Grant's argument here.  In none of these, 1945-46, 1982-83, or 2007-10, did we see either deflation or wage declines.  However, in one of them there was only a very brief downturn, one quarter at the end of  WW II; one of them there was a pattern that resembled 1921, a sharp fall in output with sharply rising unemployment, followed by a rapid rebound, the Reagan recession, and then the deep fall followed by the slow recovery in the most recent episode.  What differentiates these?  Well, monetary policy.

At the end of WW II, in contrast to the end of WW I, there was no tightening of monetary policy.  Interest rates remained low through the immediate postwar fiscal contraction.  There was a brief dip, but it went nowhere, and the economy became the postwar boom. We must note that in both of these episodes we are dealing with massive regime shifts with huge changes in expectations.  It was only in 1951 with the Fed-Treasury Accord that we finally observe noticeable interest rate increases.

In the Reagan recession, this clearly was brought on by the extremely tight monetary policy of Volcker that had been put in place to crack entrenched inflation.  Interest rates were well into double digits.  So, when the economy plunged in 1982, pushing the unemployment rate over 10%, there was ample room for the Fed to respond, as it did in late 1982, with substantial cuts in interest rates, which it delivered after Mexico threatened to default on its debts and Reagan held back further rounds of his tax cuts.  The economy indeed rebounded sharply in 1983, giving Reagan his "Morning in America" for taking 49 states in his 1984 reelection. 

But, let us be clear.  This did not happen due to Reagan (or Volcker) allowing any deflation or wage cuts.  This was overwhelmingly a story like 1921 in that the recession was largely brought on by tight monetary policy and ended because of a loosening of that policy.  Neither Grant nor Samuelson provide a whisper of recognition of  this.

Finally, why the slow recent recovery? Well, I think there is more going on, but some of it has indeed been the inability of the Fed to provide much stimulus.  It had lowered interest rates in 2003-04 to help Bush get reelected (oh, and supposedly to avoid falling into a Japanese style deflation), with these being raised a bit a few years later, which contributed to the ending of the housing bubble.  But as that bubble declined they lowered rates prior to the full collapse of the financial sector in September 2008.  When the Minsky Moment arrived, they had had little regular  ammo available and had to resort to extraordinary measures to keep 2009 from becoming 1931, which they succeeded in doing.  But, once those extraordinary measures were removed, there we were, basically stuck at the ZLB, with them unable to provide much further stimulus.

This is a situation not remotely comparable to  1921, and those seriously posing it as an alternative are seriously misguided and misguiding.

Barkley Rosser

Was Robert Samuelson Referring to Keynes or the New Classicals?

Robert (no relationship to Paul) Samuelson draws another well deserved rebuke from Dean Baker. Samuelson seems to be impressed with more musings from James Grant where Grant alleges that all we need to avoid prolonged recessions is faith in the free market system. Samuelson summarizes:

Grant argues, for example, that the downward rigidity of wages in the 1930s prolonged and deepened the Great Depression, contrasting unfavorably with the 1920-1921 depression. He concedes that his laissez-faire approach might result in harsher recessions but also suggests that it would produce stronger recoveries. Grant disputes the conventional wisdom that falling wages and prices would doom the economy to a prolonged collapse by reducing incomes and making debts harder to repay. To the contrary: Lower prices might encourage spending and lower wages might encourage hiring.

I guess Samuelson has never heard of the debt deflation theory – in particular Tobin’s 1975 AER paper. But it is his closing paragraph that has irked Dean:

The recent financial crisis and the (unpredicted) weak recovery have exposed economists’ fragile grasp of reality. There has been a massive destruction of intellectual capital: Old ideas of how the economy functions and can be improved have been found wanting. Since the Great Depression, governments are expected to react to economic slumps with countercyclical policies that reverse the downturn and relieve personal suffering. These understandable impulses may compromise the economy’s recuperative rhythms. That’s a troubling possibility that echoes from the 1920s.

Dean notes:

Robert Samuelson apparently didn't know that all sorts of good Keynesian types, starting with Paul Krugman, predicted that the recovery would be weak due to inadequate stimulus … Apparently Samuelson is unaware of this history. He pushes his idea of leaving everything to the free market telling readers, harkening back to the recovery to the downturn following World War I

But can we return to this line from Samuelson?

There has been a massive destruction of intellectual capital

There was a massive destruction of intellectual capital but Samuelson has this all backwards. The New Classical revolution in macroeconomics that dominated the profession for the 30 years preceding the Great Recession tossed out Keynesian economics replacing it with the kind of faith in free markets that Grant and Samuelson seem to want to hold onto. Robert Samuelson indeed is so unaware of the history of macroeconomics that he missed the New Classical revolution as well. And he still gets to write a column for the Washington Post? Update: James Grant and Robert Samuelson really needed to read Daniel Kuehn:

A series of recent reviews of the depression of 1920–1921 by Austrian School and libertarian economists have argued that the downturn demonstrates the poverty of Keynesian policy recommendations. However, these writers misrepresent important characteristics of the 1920–1921 downturn, understating the actions of the Federal Reserve and overestimating the relevance of the Harding administration’s fiscal policy. They also engage a caricatured version of Keynesian theory and policy, which ignores Keynes’s views on the efficacy of nominal wage reductions and the preconditions for monetary and fiscal intervention. This paper argues that the government’s response to the 1920–1921 depression was consistent with Keynesian recommendations. It offers suggestions for when Austrian School and Keynesian economics share common ground and argues that the two schools come into conflict primarily in downturns where nominal interest rates are low and demand is depressed. Neither of these conditions held true in the 1920–1921 depression.

I learned about this from Paul Krugman who was writing about the 1921 recession back in April 1921.

Why We Might Need an Agency Agency

Chris Blattman has an interesting post in which he ruminates on a recent study in Ethiopia: people shown movies about personal success stories were later more likely to engage in future-oriented behavior than a placebo group shown entertainment movies or a control group shown no movies at all.  He goes on to reference other research coming to similar results.

My epiphany occurred when I was walking through Addis Ababa.  There is a beautiful, functional city there, buried beneath a ubiquitous layer of rubble that makes the roads almost unusable.  My first reaction was to think about organizational structures for clearing the rubble.  I had a chat with a transportation planner who assured me that just about everything has been tried, but the rubble remains.

Then I thought about Europe in the immediate aftermath of WWII, when there was also rubble everywhere, devastated infrastructure, agricultural collapse—just about every catastrophe societies could be subject to.  In Germany the “rubble women”, many of them widows, ventured forth, clearing the debris by brute force to begin the process of recovery.  What was the difference between the women of Dresden, Berlin or Hamburg in 1945 and those of Addis today?  It wasn’t education, since nothing you learn in school helps you deal with clearing away acres of brick and concrete.  It wasn’t political or social organization either, both of which had been pulverized, like the cities, by the twin disasters of the Third Reich and its utter defeat.  I know there are some who will say “social capital”, but for me this is more a label than an explanation.

My hypothesis is that the advantage of the rubble women was that they knew what their cities had looked like, and how it had been to live in them, before the chaos of war and air raids.  They could easily visualize what the coming years of focused effort would bring them, and from this image they could draw a sense of agency.  The residents of Addis can’t close their eyes and see the better Addis of tomorrow; for them, the extra work of hauling rubble is just that, extra work.  And even if you had the vision yourself, it wouldn’t do much good unless it were widely shared, so that you could count on others to keep going until the end.

If I’m right, agency is the core issue in development.  Without it, outside interventions will have only temporary benefits, and interventions themselves need to be examined for the effects they are likely to have on beneficiaries’ sense of agency.  Of course, agency is also an intensely political phenomenon, having everything to do with whether people think that they can claim and keep the fruits of their labor.

How A "Giant Welfare State" Does Not Cover All Its Citizens For Health Insurance

WaPo's Robert J. Samuelson is at it again here on Black Friday, berating us all  for not making "unpopular choices" regarding "who deserves benefits, how much and why?" without for once mentioning that a bunch of Americans do not have health insurance, making it the only OECD nation not to do so, even as he reveals that the US is the second biggest "welfare state" in the OECD, behind only France.  Yes, for direct government social spending US is 23rd at 19% of GDP, behind the OECD average of 22%.  But, take into account indirect support through the private sector, especially tax breaks for employer-provided health insurance, well, then we are at 30% of GDP for our hybrid system, behind only the 32% of France, oh horror or horrors!

So, anybody thinking about it more than RJS will understand that a major reason we spend so much is the high cost of our health care, gobbling 18% of GDP, compared to 12% for France and less for most other OECD nations.  So, we can spend all this much and still be the only OECD nation not providing health insurance for everybody, but this is not a problem for RJS.  Obviously we need to cut benefits from current recipients.  Not a word about further efforts to cut health care costs through such things that Dean Baker proposes, such as scaling back drug patents or opening up immigration for physicians.  What a joke, but not a surprise from the gang at the WaPo ed page and particularly that non-economist  economist, Robert J. Samuelson.

Barkley Rosser

Macroeconomics at George Mason University

I realize that Tyler Cowen is not the only economist who teaches macroeconomics at GWU but I don’t know the other professors. I am worried about what the students are learning at GWU after reading two of Tyler’s recent blog posts. His comments about Keynesian economics struck me as almost asserting that we Keynesians believe that only fiscal policy matters – which of course no one has ever asserted. But Simon Wren-Lewis has already set this matter straight:

Let me single out three Keynesian propositions. 1) Aggregate demand matters, at least in the short term and in some circumstances (see 2) maybe longer. 2) There is such a thing as a liquidity trap, or equivalently the fact that there is a zero lower bound to nominal interest rates matters 3) At least some forms of fiscal policy changes will impact on aggregate demand, and therefore (given 1), on output and employment. Because the liquidity trap matters, when interest rates are at their zero lower bound we should use fiscal policy as a stimulus tool, and we should not embark on fiscal austerity unless we have no other choice. If propositions (1) and (2) strike you as self evidently correct, you might accuse me of drawing the lines in this debate in a biased way … This suggests (3) is at the heart of the dispute. However my reason for including (1) and (2) is that if you accept these two points, point (3) follows pretty automatically.

But it is this post that has me worried:

“Ghost cities” lined with empty apartment blocks, abandoned highways and mothballed steel mills sprawl across China’s landscape – the outcome of government stimulus measures and hyperactive construction that have generated $6.8tn in wasted investment since 2009, according to a report by government researchers.

Tyler is referring to a report from Xu Ce of the National Development and Reform Commission which is noted here. Maybe there is some waste but Xu Ce has assuredly overestimated it for reasons ably noted by Paul Krugman:

What the paper does is look at the ratio of capital added to economic growth — the so-called incremental capital output ratio. It finds that the ICOR has been lower in recent years than it was in the past, and attributes all of the shortfall to waste. But what if there were no waste at all? What if China were simply engaged in capital deepening? What would we expect to see in that case? The answer is, exactly what we do see. The ICOR data say nothing at all about waste.

Paul walks us through a standard presentation of the production function used in the typical Solow growth theory model. This is all very basic stuff. I would hope the graduate students at GWU are learning this when they take growth theory.

For the Euthanasia of Kaldor-Hicks/Cost-Benefit Pseudo-Science

J. R. Hicks "The Foundations of Welfare Economics" 1939:

"Positive economics can be, and ought to be, the same for all men; one's welfare economics will inevitably be different according as one is a liberal or a socialist, a nationalist or an internationalist, a christian or a pagan. 

"It cannot be denied that this latter view is in fact widely accepted. If it is intellectually valid, then of course it ought to be accepted; and I must admit that I should have subscribed to it myself not so long ago. But it is rather a dreadful thing to have to accept. No one will question the activity of some of our 'positivists' in the criticism of current institutions; but it can hardly be denied that their authority to advance such criticism qua economists is diminished by their abnegation, so that in other hands economic positivism might easily become an excuse for the shirking of live issues, very conducive to the euthanasia of our science. 

"Fortunately there is no need for us to accept it. The way is open for a theory of economic policy which is immune from the objections brought against previously existing theories..."

Just a small sample of the objections Kaldor-Hicks has been immune to over the years:

"...judged in relation to its basic objective of enabling economists to make welfare prescriptions without having to make value judgments and, in particular, interpersonal comparisons of utility, the New Welfare Economics must be considered a failure." 

"Pareto is sometimes credited with an early formulation of the ill-fated Hicks or Kaldor principles of hypothetical compensation." 

"The ethical appeal of this [compensation criterion] argument, however, is weak."  

"It turns out then that Mr. Kaldor's criterion in its most general sense has not eliminated the problem of interpersonal comparison of utility. It has only subjected utility to the measuring rod of money, a measuring rod which bends, stretches, and ultimately falls to pieces in our hands."

"...implicit assumptions about the numéraire good in the Kaldor–Hicks efficiency–equity analysis involve a 'same-yardstick' fallacy..."

"For sustainability science, the Kaldor–Hicks rule runs counter to both intra- and inter-generational concerns."

"Only later would it be realized that one did not know -- indeed, one could not know -- the value of production independent of the distribution of income and the associated price vector that provided the weights to the various physical quantities being produced."

"...in all of this prodigious elegance, rarely is there recognition that the Pareto test remains what it has always been -- an analytical construct (inconsistent and incoherent at that) with no special claim to legitimacy beyond the tautological domain out of which it arose." 

"When the unweighted sum of net benefits from a project are used as a criterion of project evaluation, cost-benefit analysis may be sensitive to the choice of  numéraire . This is one reason, among others, why this criterion should not be used."

And yet:

"The Kaldor-Hicks criterion — a test of whether total social benefits exceed total social costs — is the theoretical foundation for the use of the analytical device known as benefit-cost (or net present value) analysis."

Not bad for an inconsistent, incoherent, ethically-weak, ill-fated tautological failure of a fallacy that should not be used!

Hicks was right. The Kaldor-Hicks theory is indeed "immune from objections."

DeLong on Hobson’s Choice v. Cochrane’s Bernie Madoff Economics

I want to highlight two interesting discussions relevant to the fiscal policy debate. First up is Brad DeLong:

The original argument was John A. Hobson’s, in his 1902 book Imperialism. The poor have to spend their incomes in order to buy their necessities. The middle class have to spend their incomes to buy their necessities and the conveniences they need in order to ensure themselves that they are not among the poor. The rich can spend their incomes or not. Hence the more unequal distribution of income, the more the potential for slack aggregate demand. With monetary policy constrained by the rules of the game that was the gold standard, Full employment in an unequal society required either unusually optimistic financiers and industrialists or something else.

Brad continues by noting that this something else could be monetary policy unless we fell into a liquidity trap. Peter Coy has a nice discussion on why Keynes’s views on fiscal policy is relevant today but alas he does have to cite something from John Cochrane:

If you believe the Keynesian argument for stimulus, you should think Bernie Madoff is a hero. He took money from people who were saving it, and gave it to people who most assuredly were going to spend it. Each dollar so transferred, in Krugman’s world, generates an additional dollar and a half of national income. The analogy is even closer. Madoff didn’t just take money from his savers, he essentially borrowed it from them, giving them phony accounts with promises of great profits to come. This looks a lot like government debt. If you believe the Keynesian argument for stimulus, you don’t care how the money is spent. All this puffery about “infrastructure,” monitoring, wise investment, jobs “created” and so on is pointless. Keynes thought the government should pay people to dig ditches and fill them up. If you believe in Keynesian stimulus, you don’t even care if the government spending money is stolen. Actually, that would be better. Thieves have notoriously high propensities to consume.

This weird tirade is just part of a very long tirade where Cochrane attacks the writings of Paul Krugman. Cochrane invokes Ricardian Equivalence as part of his case against the use of fiscal stimulus. Alas, he clearly does not understood Ricardian Equivalence or what the recent fiscal policy debate was about. First of all – the government is quite open about its finances so any suggestion that there is a Ponzi Scheme should alert the reader that Cochrane was on a silly rant. But he does admit that attempts to use fiscal stimulus amount to deficit financing. Ricardian Equivalence alerts us to the fact that the present value of all future taxes must match the present value of all future government spending as well as the current level of government debt. If no household is borrowing constrained, then the timing of taxes has no current effect on consumption demand. Brad’s post, however, should be seen as suggesting that some households are borrowing constrained. But it is this line that shows how clueless Cochrane is:

If you believe the Keynesian argument for stimulus, you don’t care how the money is spent.

Actually most Keynesians do care as we would prefer the stimulus in the form of infrastructure investment and not Hobson’ imperialism. This is also where Cochrane’s invocation of Ricardian Equivalence is most silly. Accelerating infrastructure is not a permanent increase in government spending and hence would not raise the present value of future taxes all that much. As such, any reduction in consumption would be very modest relative to the rise in government investment. And with this simple realism, Cochrane’s Bernie Madoff rant loses all relevance.

#NUM!éraire, Shmoo-méraire: Nature doesn't truck and barter

The commodity in terms of which the prices of all the others are expressed is the numéraire. -- Leon Walras, Elements of Pure Economics.

But the numéraire is a purely technical device, introduced simply for the purpose of making exchange values explicit. In no way does the introduction of a standard of value alter the fundamental nature of the economy in question. It remains a barter economy, since goods are exchanged solely for other goods. André Orléan, The Empire of Value.

In a previous post, Public Works, Economic Stabilization and Cost-Benefit Sophistry, the Sandwichman introduced David Ellerman's argument that the supposed efficiency/equity distinction underlying the Kaldor-Hicks compensation criterion is a "same-yardstick" illusion created by the tautological use of a numéraire (or "standard commodity") to evaluate its own value. One oyster is worth exactly one oyster in oysters. Ellerman demonstrated that simply switching the numeraire could have the effect of reversing which outcome is held to be efficient.

This discrepancy is not some curious foible of arcane economic theory. The Kaldor-Hicks compensation criterion is "the theoretical foundation for the use of the analytical device known as benefit-cost (or net present value) analysis" (emphasis added, Stavins 2007)

Ellerman documented the numéraire illusion (or fallacy) in a working paper dated ten years ago. Since then, he has presented several versions of his refutation of Kaldor-Hicks. According to Google Scholar, there has been one non-self citation -- in a 2014 Masters thesis -- of the five versions listed in Google Scholar.

There is a long and futile history of pointing out flaws in Kaldor-Hicks. In their 1978 review of the Kaldor-Hicks inspired "New Welfare Economics," Chipman and Moore declared it a failure, "...judged in relation to its basic objective of enabling economists to make welfare prescriptions without having to make value judgments and, in particular, interpersonal comparisons of utility." They concluded their review with the following assessment:

After 35 years of technical discussions, we are forced to come back to Robbins' 1932 position. We cannot make policy recommendations except on the basis of value judgments, and these value judgments should be made explicit... When all is said and done, the New Welfare Economics has succeeded in replacing the utilitarian smoke-screen [of technical jargon] by a still thicker and more terrifying smoke-screen of its own.

Thirty-six years on, that thicker, more terrifying smoke-screen prevails.

In a paper published in 1997. Kjell Arne Brekke presented an analysis that highlighted a different aspect of the importance to the outcome of cost-benefit analysis of the choice of numéraire. Brekke showed that, when public goods are involved, the sign (plus or minus) of the sum of net benefits is not independent of the choice of numéraire.

Brekke's discussion is marred by the peculiar conclusion that "[t]he choice of money as numéraire is systematically favourable to those who value money the least, relative to alternative numéraire." "Why do money and not environmental units as numéraire favour the environmentalist?" Brekke asked. His answer confuses the result of incoherent calculations with actual outcomes:

The net benefits of the project is positive for the environmentalist. If this net benefit is expressed in money terms, then it becomes a large number because money is of low value to the environmentalist. However, if the net benefit is expressed in environmental quality units, then the net benefit would be a small number, since environmental quality is important to the environmentalist.

Contrary to what Brekke argued, the choice of numéraire makes no difference to the net benefits from a project -- it only changes how those benefits are represented. In fact, by (mis)representing an environmentally-harmful project as unduly financially-beneficial, such "positive" results would support a decision that is less favourable to the environmentalist. Brekke also crucially misstated the Kaldor-Hicks compensation criterion as "the winners should compensate the losers."

In a commentary on Brekke's article, Jean Drèze acknowledged that "Brekke’s interpretation of his own result is indeed somewhat misleading" but argued none-the-less that these lapses shouldn't detract from the important insight that, "[w]hen the unweighted sum of net benefits from a project are used as a criterion of project evaluation, cost-benefit analysis may be sensitive to the choice of numéraire." With regard to the ethical status of the [Kaldor-Hicks] compensation criterion, Drèze observed that "[i]f compensation is only hypothetical, it is irrelevant. If it is actual, it should be counted as part of the project, which becomes a Pareto-improving project so that its desirability is not an issue." In a passage, Drèze speculated on the reasons for the persistence of the ethically vacuous, analytically incoherent "aggregate benefit criterion" (ABC) touted by the compensation criterion:

In short, Brekke’s analysis does highlight a major problem with the ABC criterion, which adds to its other theoretical flaws. In the light of these flaws, it may be asked why the ABC criterion is so widely used in practice. Several possible reasons come to mind. First, the practitioners may not appreciate these flaws. Second, they may be aware of them, but use the ABC criterion for convenience. Third, they may be reluctant to contemplate the value judgments involved in choosing distributional weights. Fourth, they may hold the normative view that marginal social utilities are equal in terms of their chosen numéraire. Fifth, they may simply be siding with the rich.

Drèze missed a sixth possible reason: acknowledging these iatrogenic flaws in the aggregate benefit criterion may have profound implications for the theoretical foundations of neoclassical economics that can't be papered over with distributional weights, as Drèze seems to think, or by reversion to an "actual" Pareto-improving standard instead of a hypothetical one. To put it bluntly, all the stuff and nonsense about numéraires proceeds from the a priori assumption of a barter economy -- that "goods are exchanged solely for other goods."

As Orléan puts it, Leon Walras's numéraire "is a purely technical device..." What "counts" is not money but some presumably intrinsic value that is held to inhere in the goods themselves -- "behind the veil of money," so to speak. "Real money," Orlean continues, "money that 'not only supplies a unit of account but also actually circulates and in addition functions as ‘a store of value'—does not exist." The incoherence of the aggregate benefit criterion and its corollary of hypothetical compensation is a symptom of the fundamental incoherence of the barter metaphor. "The most serious challenge that the existence of money poses to the theorist," according to Hahn (1982), "is this":

...the best developed model of the economy cannot find room for it. The best developed model is, of course, the Arrow-Debreu version of Walrasian general equilibrium. A world in which all conceivable contingent future contracts are possible neither needs nor wants intrinsically worthless money.

One has to wonder, though, just what is "best developed" about a model of the economy that can't find room for the existence of money. In his review of Hahn, Minsky referred to that model more bluntly as "rubbish that prevents the flowering of new theory."

Of Sealing Wax and Cell Phones...

Arguing against perfect foresight is as embarrassing as it is futile. To borrow Robert Solow's image, it's like debating cavalry tactics at the Battle of Austerlitz with a lunatic who thinks he's Napoleon Bonaparte. But the hypothetical prescience of the numéraire is both fundamental and lethal to the Kaldor-Hicks compensation criterion. The mix of commodities available in the future will be radically different than the commodities available today, just as today's commodities are radically different from those of fifty or a hundred years ago. 

Without perfect foresight (and without money -- real money) prices in a barter economy existing sometime in the future would be incommensurable with prices in a barter economy today. There could be no "standard commodity," no numéraire. The question of the choice of numéraire would be moot because there are no candidates to choose from. 

With perfect foresight, however, market actors would know whether or not compensation is/was/will be paid to the losers in a "potential" Pareto improvement. In other words, the addition of the word "potential" makes the phrase an oxymoron that violates the model's specifications.

No doubt Cost-Benefit Analysis gets around this dilemma by smuggling in a "common-sense" notion that money is nevertheless performing its magic in spite of the value theoretical "rigor" that has banished that supposedly illusory veil. With such a hybrid of theoretical abstraction and absent-minded distraction, neoclassical value theory gets to barter off its cake and eat it too.

Try not to think of an elephant. Money is essential to a market economy. "Market economies based on barter are inconceivable..." André Orléan argues in "Money: Instrument of Exchange or Social Institution of Value?" That "inconceivable" must be taken literally. The attempt to conceive of a market economy based on barter flounders on the shoals of cognitive dissonance. "Don't think of money," the theory commands. But you think of money. As Hyman Minsky wrote 30 years ago, "the Emperor of today's theory, the Arrow-Debreu version of Walrasian general equilibrium, has no clothes." 

The Kaldor-Hicks compensation criterion proclaims that we can all get richer by laundering the Emperor's invisible new clothes.

*****

In 1952 the Bureau of the Budget, in a Budget Circular [A-47] 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.

***** 

When all is said and done, the New Welfare Economics has succeeded in replacing the utilitarian smoke-screen by a still thicker and more terrifying smoke-screen of its own.

LA MONNAIE RÉALITÉ SOCIALE

Why is there no English translation of this important work by François Simiand?

Protect the Free Market from those Anarchists!

Whew!  Here's Robert Anton Wilson trying to get people into a state of generalized agnosticism, not agnosticism about God .... but agnosticism about the everything; even the free market!

"“Privilege implies exclusion from privilege, just as advantage implies disadvantage," Celine went on. "In the same mathematically reciprocal way, profit implies loss. If you and I exchange equal goods, that is trade: neither of us profits and neither of us loses. But if we exchange unequal goods, one of us profits and the other loses. Mathematically. Certainly. Now, such mathematically unequal exchanges will always occur because some traders will be shrewder than others. But in total freedom—in anarchy—such unequal exchanges will be sporadic and irregular. A phenomenon of unpredictable periodicity, mathematically speaking. Now look about you, professor—raise your nose from your great books and survey the actual world as it is—and you will not observe such unpredictable functions. You will observe, instead, a mathematically smooth function, a steady profit accruing to one group and an equally steady loss accumulating for all others. Why is this, professor? Because the system is not free or random, any mathematician would tell you a priori. Well, then, where is the determining function, the factor that controls the other variables? You have named it yourself, or Mr. Adler has: the Great Tradition. Privilege, I prefer to call it. When A meets B in the marketplace, they do not bargain as equals. A bargains from a position of privilege; hence, he always profits and B always loses. There is no more Free Market here than there is on the other side of the Iron Curtain. The privileges, or Private Laws—the rules of the game, as promulgated by the Politburo and the General Congress of the Communist Party on that side and by the U.S. government and the Federal Reserve Board on this side—are slightly different; that's all. And it is this that is threatened by anarchists, and by the repressed anarchist in each of us," he concluded, strongly emphasizing the last clause, staring at Drake, not at the professor.” 
― Robert Anton Wilson, The Golden Apple

The Ultimate Irrelevance of Grubergate

So, many people have gone hysterical over the publicity surrounding revelations of embarrassing quotations and video clips from Jon Gruber talking about aspects of Obamacare.  SCOTUS is taking on a case that might remove federal subsidies from individuals on state exchange insurance plans that are not linked to the federal system thanks to some publicized remarks by Gruber, even though he has never been a member of Congress, and numerous commentators are carrying on about how Obamacare would never never never have passed Congress if people had known what Gruber said about how those fines are really taxes just like SCOTUS later said, not to mention how much he looks like the epitome of pompous arrogance when he declared that "voters  are stupid."  Hot stuff.

So, if SCOTUS decides that those subsidies won't get paid if the state exchanges do not hook up with the federal one, well, there is apparently some easy way to do this without changing how the state's system works.  Of course, there may be some states with exchanges run by tea party GOPsters who may just take advantage of this to actually let insurance premia from their state exchanges go up sharply for their citizens just to show how anti-Obamacare they are.  Of course, it is harder to raise such premia on people with insurance than simply refusing to extend coverage to people who do not have it as is going on in lots of those states where local anti-Obamacarers are refusing to accept money from the federal government to extend Medicaid to their poorer citizens who do not have any, which option would not even be happening if SCOTUS had not broken precedent to let states opt out of this Medicaid expansion.

As for  this matter of how revealing that those fines are really taxes way back when would have killed the possibility of passing Obamacare, one should keep in mind that it had been revealed by opponents that Obamacare would give us death panels, would never work because nobody would sign up for it, and it would cause insurance premia to soar to infinity, not to mention that the medical profession would probably not take any patients with such plans. This probably explains why all along polls have shown that when asked, most Americans say they oppose "Obamacare," even as they say they support all of its individual provisions. And, hey, if it had been known that the fines were taxes, all those Republican congressional representatives and senators who voted for Obamacare because Obama had granted their requests for changes in the law would not have done so, thereby tanking it, given how we know that Republicans are so against tax increases (just kidding, folks, for anybody who thinks that I thought there were any Republicans who did vote for it... )..

 Barkley Rosser

Wrath of the Yurt

I like a lot of what John Quiggin has to say. That's why I find it disturbing when he lapses into an unprovoked ad hominem swipe at people living in yurts. Not only is it disturbing but distinctly peculiar.

Of course we're all supposed to understand that Quiggin isn't really talking about yurt dwellers when he refers to yurt dwellers. It's code. The label of yurt dweller is supposed to allude to some undefined fringe of political-economic non-conformists.

I have a problem with that. It is holding people up to ridicule, not for what they believe but for a mocking image of their (presumably) idiosyncratic personal attributes that is arbitrarily substituted for their opinions. This is what we used to refer to as stereotyping.

Exactly who is being ridiculed is left ambiguous. By a process of elimination, it is not the climate-change deniers on the right nor is it the "sensible" ecological modernizers in the center who Quiggin is mocking. That leaves the tree-hugging enviros on the left metaphorically dwelling in those patchouli-infested yurts. Like Naomi Klein. Or Herman Daly. Or Tim Jackson. Or Duncan Foley.

The trouble with the yurt dweller label is that it is infinitely expandable. To Senator Inhofe, people who accept the scientific consensus on climate change are yurt dwellers. Nicholas Stern, John Quiggin, William Nordhaus, Al Gore, the IPCC. Yurt dwellers all.

A Reverse Milgram

No, it’s not a wrestling move.  I’m wondering if anyone else has noticed that the collaboration of a portion of the psychology profession with state-sponsored torture during the Bush Jr. years is like the famous Stanley Milgram experiments, except that the psychologists are the ones turning the dials.

It’s an interesting question I suppose, if you put aside the fact that this torture, unlike Milgram’s, was real, whether the guys in the white coats are as susceptible to violating fundamental human rights if those in authority tell them to.  And the results of this experiment confirm and extend Milgram’s original findings.

Professional psychologists were brought in to assist the Bush administration’s torture program, and there was apparently no shortage of willing participants.  But the American Psychological Association has a code of ethics that would seem to make torture a form of professional misconduct.  To address this problem, the APA amended its code in 2002 to say that whenever ethics come into conflict with legally issued instructions, psychologists could just follow orders.  The sorry tale is summarized in this important article in the New York Times by James Risen, who has played a large role in uncovering the dark side of the “war on terror”.

A modern Milgram experiment would never pass an institutional review board, but we can now have this natural quasi-experiment with real subjects and real torture.

Daesh/ISIL/ISIS Calls For Terror Attacks On Saudi Arabia And Plans To Mint Money

Juan Cole has reported on a just released recording that may be by recently wounded Ibrahim al-Samarra'i, more widely known as Abu-Bakr al-Baghdadi, although apparently reverting to "Irahim" since he declared himself Caliph (Khalifa) of the Islamic State (Ibrahim is the Arabic version of Abraham).  He calls for terror attacks to be made on Saudi Arabia, for Shi'a to be specifically attacked both in Saudi Arabia and also in Yemen where the Houthi Zaydi Shi'a have seized control of Sana'a, the capital of Yemen, and also their plans to "mint money" to save the Islamic state from the "infidel finance" imposed on "Muslims by the West." It has not been verified that the recording is by him, but at least probably reflects his thinking, and also does seem to be his response to being wounded in the US attack near Mosul, which Daesh now recognizes happened.

One remark on this is that Saudi Arabia is arguably the fountainhead of the particular brand of Islam that al-Samarra'i espouses, Wah'habism.  I have posted here previously on the close relationship between it and Salafism, which is regularly muddled in most ignorant western commentary.  They overlap, but have some differences and origins, and while Daesh is clearly influenced by both, it looks like the Saudi Wah'habism is more important.  So, Saudi Arabia's alliance with the US makes them the "head of the snake" according to this message that must be "cut off."

On the matter of minting money, there are two aspects of this.  Of course, strict Islamists support interest-free banking, so-called Islamic banking,which in fact exists in many countries, including the US.  It is well established, although only a handful of countries impose it as the only allowed form.

The other aspect is probably bullionism, which is found in the Qur'an.  Money should only be gold and silver.  Indeed, the very strict Saudis have silver threads in their paper money to obey this, and the late Nelson Bunker Hunt got current Saudi King Abdullah to lose a few billion in the great silver bubble and crash of the early 80s on a claim that the world was going to go on a silver standard.  I do not know what form this Islamic State money will take, but I suspect they may imitate what the Saudis do and adhere to bullionism.

Barkley Rosser