Archive for February, 2012

Mankiw’s 10 Value-Laden Principles

The claim that economics is value free is a common one, and one of the many things Mankiw asserts in defence of his classes. I thought a good way to demonstrate that economics is not value free would be to highlight how many of his 10 principles are actually value-ridden. The 10 principles have been poked fun at elsewhere, and rightly so – they are simply a series of assertions about the nature of the economy. Real science sometimes starts with assertions, but the crucial difference is that those assertions are not contradicted by empirical evidence, anywhere, ever.

However, I digress. Here are the 10 principles – I have highlighted and discussed the values I deem to be implicit or explicit (please note that I do not necessarily disagree with these values; I’m merely showing they exist):

#1 People face tradeoffs#2 The cost of something is what you give up to get it#3 Rational people think at the margin, #4 People respond to incentives

These are all reflective of a view of how people value decisions; that they make decisions based on  costs and benefits. In reality, people respond to incentives based on a number of other criteria, such as the motives of the person rewarding or punishing them. These motives or ‘values’ are swept under the rug in economics, in favour of a mostly monetary/self interested view of human behaviour, where people value things based on outcomes.

#5 Trade can make everyone better off

The sentence itself is clearly a value judgement – trade increases value, so it is good for it to take place. Related is the ‘trade must be mutually beneficial otherwise people wouldn’t do it’ line of thinking, which effectively asserts that ‘market’ transactions are always beneficial. Whether this is true or not is up for debate, but it is certainly loaded with value judgements about what is desirable.

#6 Markets are usually a good way to organize economic activity & #7 Governments can sometimes improve market outcomes

‘Markets’ in this case meaning private property and contracts, and some hidden regulations like limited liability laws, with no thought as to the social relations and institutions required to sustain them, and no thought as to the historical context of those institutions. The government is somehow separate from these institutions, which we take as a given. That we choose not to judge these institutions based on their values is in and of itself a value judgement that they are desirable or natural.

#8 A country’s standard of living depends on its ability to produce goods and services

This equates material abundance with standard of living, and effectively amounts to a judgement that growth will always increase happiness*:

You may say I’m putting words in his mouth a bit here, as he is talking about objective standard of living. But what is objective standard of living? If people aren’t happier then does telling them that their stuff is shinier change that? This is exactly the kind of thing that instils an implicit value judgement in economists, leading them to assert that people should be happier with their lot despite stagnating median incomes, and that we should measure income as consumption. Consumption is higher, and our models say that should make you happier, so stop complaining!

#9 Prices Rise When the Government Prints Too Much Money & #10 Society Faces a Short-Run Tradeoff Between Inflation and Unemployment

Implicit here is that both inflation and unemployment are bad past a certain point, and in different situations one is desirable whilst the other is not. Again, a value judgement.

Economics is a study of how people behave and so by definition cannot be value free – it must contain judgements about people’s actions and the motivations for those actions, as well as judgements about what is or isn’t desirable for them. As Rod Hill and Tony Myatt highlight here and here, your average textbook is full of value judgements. This is inevitable, and would be fine if they were explicit. But the fact that academic economists continue to deny it is just another indictment of their discipline.

*Red = happiness, black = GDP per capita. Source: Scholarpedia

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The Poverty of Mainstream Debate, Part I: Stimulus, Deficits & Ricardian Equivalence

You may notice that I rarely comment on current affairs. Mainly, this is because mainstream debate appears to be regressing rather than moving forward, the result being that it is behind where it was in 1829, and whilst many far more respected people with far larger platforms than me have been winning the argument for a long time, progress is not being made.

To start, we have the supposedly most intelligent economists in the world seriously debating Ricardian Equivalence. This is the proposition that people will respond to government spending increases by scaling back their own spending in anticipation of future taxes (mention this to someone who isn’t interested in economics and prepare to be looked at very strangely indeed). Let’s first note what Ricardo said about his own theory:

But the people who paid the taxes never so estimate them, and therefore do not manage their private affairs accordingly. We are too apt to think that the war is burdensome only in proportion to what we are at the moment called to pay for it in taxes, without reflecting on the probable duration of such taxes. It would be difficult to convince a man possessed of £20,000, or any other sum, that a perpetual payment of £50 per annum was equally burdensome with a single tax of £1000.

Is it any surprises that there is absolutely zero empirical evidence for this effect? Then why is everybody talking about it?

Another meme about deficits/stimulus is defining the amount of stimulus as the deficit. Really, this is quite simple and was summed up well by a commenter on Marginal Revolution:

“A slightly more respectable argument is that the current deficit is slightly smaller than in 2010 (when it was 10.1% of GDP.) But that shouldn’t cause a recession.”

This would be a NET CHANGE that is CONTRACTIONARY. Going from a 10% deficit to an 8% deficit is easing off from the accelerator, so to speak. If you ease off on the accelerator while going up a hill… well you slow down.

Looking at net deficits tells us very little about the level of demand being created relative to what it was before the recession and to what would be needed to close the output gap.

As a final note on stimulus, the Obama stimulus is not a major point for anti-Keynesians, as it was largely offset by state and local contractionstoo small anyway and pretty poorly constructed. Having vampire squid banks that absorb much of the proceeds of growth surely doesn’t help, either. All in all, not a shining example in the history of fiscal expansion.

Now, none of what I’ve said is new or original – in fact, it’s incredibly old and has been repeated ad nauseum.  But this doesn’t stop everyone from everyday economists to ‘nobel’ prize winners trotting out the same tired lines about the money having to come from somewhere (never mind that applying similar logic an increase in private spending cannot increase employment either), how the New Deal failed (>10% growth is an obvious example of failure) and so forth.

But when your opponents are prepared to believe absolutely anything – from NDGP targeting to Austrian economics to Ricardian equivalence – just so that they can deny a positive role for the state, these things don’t seem to matter.

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How Natural is Capitalism, Exactly?

The standard libertarian narrative of capitalism goes something like this: once various feudal restrictions were lifted and property rights were fully defined, people indulged in their ‘natural propensity to truck, barter and exchange’ and economic freedom fuelled growth. Conditions were poor for workers, but were better than the alternative. To tamper with capitalism and the free market is to tamper with the nature of man.

It is first worth considering the existence of an entity called the ‘free market’. But the fact is that people simply see the ‘free market’ where they want to, ignoring certain rules and regulations. To start, the workings of an economy are massively affected by the definition of property; what types of property are deemed private, as well as the definition of fraud and the workings of the criminal justice system. Secondly, laws like limited liability, immigration restrictions and laws that protect shareholders are often swept under the rug.

I feel the idea of a ‘free market’ greatly skews the views of its proponents, as they see something as complicated as the transition in China as simply them ‘unleashing’ the free market, and also write catch-all sentences like this:

It is worth remembering that the epicentre of the 2008 disaster was American property, hardly a free market undistorted by government.

Which, to me, simply makes no sense. I mean, the crisis was undeniably focused on private institutions, and if you’re going to start blaming government laws then you’ll logically have to end up blaming ones like limited liability laws, laws that define corporations, and possibly even private property itself.

I believe some have tried to argue that the black market represents a type of free market, but I’m not sure how possible that is given the amount of customs and arbitrary rules you often find there, not to mention the considerable amount of force.

Furthermore, the idea that trade springs up wherever man is and money initially arose as a solution to the ‘spot trade’ problem created by mankind’s natural propensity to ‘barter, truck and exchange’  has been falsified spectacularly by the anthropologist David Graeber, who revealed that there are 0 examples of barter arising spontaneously; money first arose primarily as a form of debt, and ultimately was a social relation.

On top of this, the historical origins of capitalism, at least in places, are hardly as magical as its defenders would have you believe. The industrial revolution involved large amounts of collusion between landlords and capitalists, and produced a surge in game laws, designed to limit peasant’s ability to subsist and hence create a workforce dependent on wages. The emergence of capitalism and the wage system was also closely intertwined with slavery and colonialism, and the facilitation of trade has required strong political institutions, rather than simple property rights and contracts.

Not only this, but almost every developed country had to use protectionist policies to get rich. This has been extensively documented by many scholars – the only potential examples of countries that got rich without much protectionism are the Netherlands and Hong Kong (which is effectively the London of a country currently using highly protectionist policies, anyway). I have attempted to offer a theoretical grounding for this here, but whether or not my argument convinces you does not change the historical facts.

My inclination towards capitalism is still ‘the worst system except all others that have been tried’, but the fact is that capitalism is a highly planned system with a questionable history – there is nothing ‘natural’ about it. Now this doesn’t tell us much about whether we should accept it here and now, but it makes statements such as “Capitalism is what people do if you leave them alone” rather questionable.

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The Correct Way to Teach Economics

I have previously tried to emphasise that not everything taught on an economics course is worthless and needs to be abandoned. Here I’m going to take two examples of models/theories you are taught, one that is taught scientifically, and one that is taught, erm, economically. This may be slightly zzz for some but it is important, particularly for trying to get some mainstream economists on my side (assuming that’s possible).

The first, ‘good’ example is how income is related to consumption.

You are presented with a hypothesis: people do not consume all of their income (Y), which can be denoted the Marginal Propensity to Consume (MPC). You are also told that people have to spend some money to stay alive, which can be denoted autonomous consumption (Ca). So total consumption is equal to:

C = Ca + MPC*Y

You then look at the evidence, which suggests this is roughly accurate, but not entirely. You are told this must be explained somehow, and presented with the Permanent Income Hypothesis, which is incorporated into the equation thusly:

C = Ca +MPC*Yp

Where Yp = Permanent Income or Average Lifetime Income

This appears to explain the data better, but still not completely. So you must then incorporate inflation/money illusion, interest rates, credit availability and so forth. This continues as long as is practically feasible and until the models are satisfactorily accurate.

Contrast this with demand-supply, where the following methodology is used:

“Students, this is a market. When demand does x, y happens and when supply does z, w happens (P.S. Adam Smith).”

“There are some assumptions we have to use to get it, though. Here they are:

Perfect information

Perfect competition

Homogeneous products and preferences

Perfect mobility of goods/services

People are rational utility maximisers

(probably some more I’ve forgotten)”

This isn’t an exaggeration. Economists like to suggest that these assumptions are simplifying but students find it much easier to follow the first example than the second, for understandable reasons. I’m not exactly sure what would replace the demand supply diagram, and I do agree that it captures some obvious truths at its heart. But the above is simply not an acceptable way to teach science.

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Top 10 Economics Blog Posts of 2011

My views developed and changed substantially over the course of 2011, in no small part thanks to the blogosphere. I thought I’d highlight some of posts that influenced me most, by opening my eyes to previously unknown facts or ways of thinking. Naturally, this list is left-inclined, but I expect most will find the posts interesting.

10. Macroeconomics is not hard (Brad Delong)

Delong reveals that, following the crash of 1829, many of the classical economists often appealed to by the anti-Keynes crowd - including Jean-Baptiste Say and John Stuart Mill – came to a somewhat ‘Keynesian’ conclusion about the role of aggregate demand:

Yet Say changed his mind. By 1829, in his analysis of the British financial panic and recession of 1825-6, Jean-Baptiste Say was writing that there could indeed be such a thing as a general glut of commodities after all: “every type of merchandise had sunk below its costs of production, a multitude of workers were without work. Many bankruptcies were declared…”

Apparently the level of 19th century historical revisionism was pretty high.

9. Blacklisted Economics Professor Found Dead: NC Publishes His Last Letter (naked capitalism)

This is the first example I saw of how selective ‘free market’ proponents are with their logic, and was delivered in excellent satirical form:

Soon after receiving tenure, it occurred to me that we were being profoundly inconsistent. While we had correctly criticized the previous mainstream view that politics involved benevolent efforts to serve the common good, we had failed to apply the same rigor to the community of academic economists. As a result, we were modeling both economic and political actors as self-interested utility-maximizing agents, while continuing to see economics professors as idealistic pursuers of truth. I decided to correct this oversight by developing my theory of Academic Choice, in which economists are theorized as rational agents who continually seek to maximize their future earnings potential.

Economists have continued to ignore this theory, but a quick look at the financial crisis and some of the origins of the libertarian/’think tank‘ movement suggests that it may be worth exploring.

8. It’s the Political Economy, Stupid! (Econospeak)

Peter Dorman sums up how well the ruling class have shifted the intellectual narrative of the crisis, despite losing the battle of ideas:

But Keynes was wrong about the power of “academic scribblers”. Idea-smiths provide language, narratives and tools for those in control, but the broad contours of policy depend on who the controllers happen to be. We are not living through an epoch of intellectual failure, but one in which there is no available mechanism to oust a political-economic elite whose interests have become incompatible with ours.

(This is part of the reason I consider a large amount of public debate to be futile).

7. Canards about economists (Robert Vienneau)

Robert Vienneau notes 3 examples of where the conventional wisdom about ‘what economists said’ is completely off: Keynes & sticky wages/prices, the origin of the phrase ‘the dismal science’, and Adam Smith’s ‘invisible hand’. Short and sharp, but both interesting and important.

6. Ideas behind their time (Marginal Revolution)

We are all familiar with ideas said to be ahead of their time, Babbage’s analytical engine and da Vinci’s helicopter are classic examples.  We are also familiar with ideas “of their time,” ideas that were “in the air” and thus were often simultaneously discovered such as the telephone, calculus, evolution, and color photography.  What is less commented on is the third possibility, ideas that could have been discovered much earlier but which were not, ideas behind their time.

OK, this was late 2010, but let’s ignore that. This is possibly the most interesting question I have ever seen asked on a blog. I’d suggest that Marx was probably ahead of his time, Adam Smith and Keynes were ‘of their time’, but recently economics has seen an intellectual shift to ‘behind its time’.

5. Dude! Where’s My Recovery? (Steve Keen)

Steve Keen sums up exactly why neoclassical economists are wrong about debt, money and banking, and how it affects our current predicament. Enough evidence is provided that I’m not sure how anyone could conclude Keen is wrong.

4. Stephen Williamson gets intellectually pulpified (Noahpinion)

Stephen Williamson gives us a short review of John Quiggin’s Zombie Economics, in which he effectively throws his hands up in the air and declares DSGE and the EMH to be unfalsifiable. John Quiggin has a go, Noahpinion has a more comprehensive go, Paul Krugman notes it, Williamson gets uppity and confused. Later, Williamson writes another, longer review, in which he makes effectively the same mistake, but this time with rationality. The whole debacle is worth looking at, but Noahpinion’s post is the most comprehensive and is all you really need to know.

3. David Graeber’s response to Robert Murphy (naked capitalism)

David Graeber has managed to blow a significant hole in mainstream and Austrian economics by exposing the myth that barter spontaneously arose and that spot exchange is somehow ‘natural’ to man. Murphy, after reading merely two paragraphs of an interview, took exception to this and posted a response. Graeber’s rebuttal contains a paragraph that sums up my experience of many RW bloggers very succinctly:

However, in the blogsphere, the quality or even intention of an argument often doesn’t matter. I have to assume Murphy was aware that all he had to do was to write something—anything really—and claim it rebutted me, and the piece would be instantly snatched up by a right-wing echo chamber, mirrored on half a dozen websites and that followers of those websites would then dutifully begin appearing across the web declaring to everyone willing to listen that my work had been rebutted.

Yep.

2. With Notably Rare Exceptions (Crooked Timber)

If you were reading blogs at the time, this one should need no introduction. A demonstration of the poverty of mainstream thought and the implicit separation of ‘good’ from ‘bad’ or ‘shock’ times in economics. A few of the best:

With notably rare exceptions, Germany remained largely at peace with its neighbors during the 20th century.

With notably rare exceptions, Mrs. Lincoln enjoyed the play.

With notably rare exceptions, Achilles was invincible.

With notably rare exceptions, the Roman Empire’s crucifixion policy was successful in containing subversive religious movements among the hoi polloi.

With notably rare exceptions, all animals are equal.

With notably rare exceptions, when you wake up in the morning, you know for a fact that you will still be alive by the end of the day.

Hooray for CT commenters! One of whom, incidentally, is responsible for number 1:

1. A review of Tim Harford’s Adapt (Tom Slee)

All books are going to have their critics. But there’s criticism and then there’s criticism. Tom Slee’s review of Adapt - a book where Tim Harford praises trial and error as always and everywhere an appropriate method – is the latter. The problem:

Tetlock divided his experts into foxes (good at many things) and hedgehogs (good at one thing) and argued that hedgehogs are over-confident because they “reduce the problem to some core theoretical scheme’… and they used that theme over and over, like a template, to stamp out predictions”. And that’s exactly what Harford does here. He sees evolution as a fox-like strategy (trying many things and selecting a few) but doesn’t notice that at the level of individual species, evolution gives us both foxes and hedgehogs, and both do perfectly fine.

Maybe it’s just me, but the whole review seems to reflect an exceptionally high level of thinking – exactly the kind of thing we need in economics. I haven’t yet read Slee’s book, but based on his blog and the Amazon reviews, I certainly plan to.

Some runners up: Bryan Caplan and Scott Sumner both had thought provoking posts, but they’ve internalised too much of the conventional wisdom for me to put them in. David Malone’s comment on the narrative of the crisis was in close competition with Peter Dorman’s, whilst Chris Dillow is always interesting but it’s hard to find a post that stands head and shoulders above the rest. Mike Kimel’s work on his anti-laffer curve is worth a mention, too. Lastly, the D&D section of the SomethingAwful forums is fantastic for countering the standard, capitalism favouring narrative of history – if you go there, prepare to be pulled leftwards.

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Why Don’t We Redistribute to Poor Countries?

This is a long overdue post to counter the claim from those who oppose domestic redistribution that it is somehow nationalistic – that if we truly care about the poor, we should redistribute to poor countries, not our comparatively rich countrymen.

From a purely aesthetic perspective, the reason people vote for domestic redistribution is because that is the poverty they are most aware of, and where they can easily see the effects of redistribution. This is due to both availability bias and a general lack of capacity to process the amount of poverty in the world. Launching tirades against voters because of this is, therefore, akin to mocking people for behaving like real people rather than rational economic people.

However, this isn’t the main problem. Redistributing large amounts to developing countries is undesirable for two other reasons.

The first is a laffer-curve style argument: if we were to collect as much as possible in the short term and redistribute it, our economy would be heavily taxed and we wouldn’t even be spending it on public services. In other words, we’d bankrupt the public sector and the economy would grind to a halt, eliminating our capacity for long term redistribution. The long term aid maximising amount of redistribution is probably fairly low as  % of GDP, given that taxes cannot be so excessively high as to slow down growth, and enough of the tax revenue needs to be spent in the domestic economy to keep it going. Add political limitations to this and you’re looking at a level of redistribution not dissimilar to what we have now.

Secondly, and most importantly, is the false equivalence between domestic and international redistribution. This is best phrased as follows:

Economic growth is the cure for absolute poverty.

Redistribution is the cure for relative poverty.

The second statement is almost true by definition, whilst the first is clearly borne out by the facts (and I suspect, would not be opposed by those I am disagreeing with here). After all, is there a single example of a poor country developing due to aid? Sure, individual acts of redistribution may extend some lives in the short term, but in many cases it simply destroys industries and reduces the country’s capacity for development in the long term.

Similarly, there is not an example of a country that has grown its way out of relative poverty – the U.S. is the largest economy in the world, yet inequality is rife. Meanwhile, many Northern/Central European countries – though they do very well on growth too, incidentally – are effectively absent of relative poverty.

Now, we can discuss whether domestic redistribution is desirable or not, and whether relative poverty is ‘actually’ a problem or was just made up by Stalin, but for now, defending inequality on the grounds that people in developing countries are even poorer will not suffice.

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