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Peter Dorman
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In my intro micro textbook (econ 101-ism!) I have a discussion of price-gouging in the context of a hurricane. I give the argument for price-gouging, but then I point out that, in practice, volunteerism plays a crucial role in relief and recovery. Market incentives undermine the incentive for volunteer effort: why do something for free if others are cashing in on it?
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I too have been railing for years against the abuse of using accounting identities for the purpose of attributing causation: see, for instance, http://econospeak.blogspot.com/2016/12/the-identity-equals-causation-fallacy.html. The worst offender, in my opinion, is the claim that the components of net national savings “determine” the current account balance. It’s beyond weird. One small step toward sanity I’ve advocated on my own blogsite is actually using three parallel lines to indicate identity rather than the two for equality. It should function as a mnemonic device to remind us that when we have an identity we lack the necessary degree of freedom for making a causal argument. (To say A causes B makes sense only if there is at least a logical possibility that B could be other than what A makes it be.) As for the national income accounting identity and sheep/wolves, wolf predation plays the role that crowding out might play in fiscal policy. We have to channel our inner Farley Mowat and investigate how carnivorous these wolves actually are: do they decimate the poor sheep or just pick off the weak outlier now and then? It quickly gets empirical. My recommendation when faced with an accounting identity is to recognize that we are describing a single entity, however we choose to slice it. Change the entity and the components will change such that the identity continues to hold. At most we can identify more “active” components in the sense that the forces operating to alter the system work most immediately through those components—but they are still just conduits for causal forces operating externally, and there is no temporal or causal relationship between changes in these components and changes in the other ones. This is what I argued for current account balances in the article I wrote for Challenge many years ago. (I concluded that, based on the empirical evidence available at that time, the primary determinants of changes in the current account-net national savings system came from the trade side. But that doesn’t mean the trade account “causes” net national savings! See https://www.jstor.org/stable/i40032476) As to why economists are so prone to this logical error, I suspect it has something to do with political or ideological proclivities. Economists often become attached to a particular policy or narrative and their misuse of accounting identities feels right to them because it reinforces their priors. I definitely think the near-universal misuse of the net national savings-current account identity fits that mold. As soon as you endogenize the macro aggregates the simple comparative advantage world of trade theory has to be qualified. Economists don’t want to do that, so they interpret the identity as saying that net national savings, as a separate entity, “determines” the current account, and by implication trade, account, returning us to that nice, tidy comparative advantage world. (FWIW, I gravitate toward an IPE understanding of international economic relations. Countries are structurally inclined toward chronic surpluses or deficits due to deeply embedded traits that operate on both components of the identity. Detailed knowledge of how they work is necessary to explain/forecast changes in the surplus/deficit and net national savings position, which are the same thing.)
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I confess I’m at something of a loss in understanding the intensity of this exchange. It seems as though the two of you are both striving for an account framed in terms of “ideas” and “interests” as unitary terms, but surely there are very important distinctions we would want to make. First, let’s distinguish between ideas about what is in our interest from other ideas about what is right, advisable or entailed apart from our personal interest. If I believe it is in my personal interest to cheat you financially, we wouldn’t want to conflate my idea about this interest with my idea about the rightness or advisability of carrying out the action, would we? Second, the theory of ideology directs us to distinctions among ideas along a spectrum (or even multiple dimensions) of interest-impactedness. Even when people are acting, or claim to be acting, according to ideas other than those of their personal interests, they may be doing so indirectly to the extent they are attracted to these noble notions due to their interestedness. This is a complex, tangled topic, so I won’t go further except to put in a reminder that the theory of ideology is about belief, not truth value. (Contemporary standpoint theory is utterly muddled about this.) What about Germany? German political figures, pundits, the majority of the Council of Economic Experts, etc. generally justify their economic policies on the basis of ideas of the general good, not just what’s good for Germany. In that sense, they pass the first filter: their ostensible motivating ideas are not narrowly ideas of their own national self-interest. The important question is whether they pass the second: to what extent is the current embrace of ordoliberalism reflective of the national interest of Germany given its reliance on current account surpluses and its position in the Eurozone? That’s an important question, ultimately one that has to be explored empirically. My own hypothesis, for what it’s worth, is that structurally surplus countries generally display ideological predispositions for economic theories that stress saving and fiscal restraint. That’s part of what it means to be a structurally surplus country.
I agree with all your points. And there are two potential advantages to using a cap. (I prefer to call these permit systems.) (1) The Weitzman model of quantity vs price regulation makes it clear that the choice depends on which uncertainty comes with higher cost, uncertainty about carbon emissions (from a tax approach) or uncertainty about carbon prices (from a permit/cap approach). Enviros who have stared potential catastrophic carbon feedback mechanisms in the eye should opt to reduce uncertainty around emissions. (But you could always set a limit to price uncertainty with a collar.) (2) Instituting a policy is not a one-time operation. Any tax or cap will need to be revised repeatedly in the future as new data and understanding emerge. So what discourse do you want to have for debating possible tightening or loosening of the controls? A discourse around taxes and how high they should be, or one around emissions and how much they should be limited? Economists ignore politics at their peril.
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You are right to call out this trail of dishonesty, but I think there are two other factors. First, Keynes does (esp in his later writings) advocate the promotion of spending in various forms to counteract shortfalls in income. From an economic viewpoint this should be self-evident, but it challenges the the cultural biases that many conservatives harbor. Keynes was perfectly clear in including investment in that spending imperative, but he also saw moral as well as intellectual worth in pure consumption. From a political standpoint, the flashpoint is savings, which loses its intrinsic virtue in a world where I (largely) determines S rather than the other way around. The second issue is that the theory wars of the 1970s led to a partition in the 1980s: Keynesians were given the short run (when prices were sticky and money illusion ruled) and classicals the long run. From this arrangement, which has little to do with the thought of Keynes himself (representing him as if he were a proponent of the Treasury View), many people read backward and assumed it stemmed from JMK's short run fixation. In fact, the problem of time horizons is perhaps greater than ever before. Climate change is all about this, and at the same time our flexibilized economy is in a permanent short run. Right issue, wrong theory.
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This may be complicated. The initiative is being opposed by a large coalition of community, environmental and labor groups -- not because they are against carbon taxes, but because they want the government to keep most of the revenues and spend them on, well, community, environmental and labor programs. This coalition plans to introduce a future carbon tax proposal and is calling on the public to vote against the current one. The situation is really a mess. I think it's likely to replicate itself at the national level if the political preconditions for action are ever in place. It would be great if research can help us understand the dynamics of this conflict so we can navigate ourselves past it in the future.
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Completely agreed, Bob, and if comparative advantage would be presented in this way I wouldn't face any dilemmas at all.
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Bob, of course, on one level you're absolutely right, but it's also a matter of context. To take one example dear to my heart, in my macro text I begin with a general discussion of liberal approaches to international political economy (as exemplified by Smith) and contrast it with nationalist approaches (Hamilton and List) that focus on changes in comparative advantage. In that context, comparative advantage theory is a basis for understanding different traditions in this field. Later I bring in and develop the notion of persistent surplus and deficit countries and how this interacts with typical macro dynamics, but again it's not framed as a matter of absolute advantage, since both high productivity and low productivity countries, for instance, can be in the deficit camp and vice versa. My point might be summed up as, understanding comparative advantage is necessary but not sufficient for understanding the main patterns of international economic relations. My gripe is that people with a strong liberal bent (including a lot of economists) treat skepticism toward market liberalism as a result of insufficient education -- even though there actually is a problem with insufficient education! It's a dilemma.
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I find myself caught in an in-between zone on this issue. Half of me completely agrees with Nick, that it’s important for the logic of comparative advantage to be conveyed as a core idea in economics. It’s not logically trivial, and understanding it is a big step forward in thinking about how markets function. As someone who thinks markets, including those spilling over national borders, need smart regulation, I get really frustrated when people supposedly on my side (e.g. critics of undesirable trade agreements) make elementary mistakes in reasoning, of which failure to comprehend comparative advantage is an example. (Another example: the claim that trade theory is silent on the question of capital mobility.) They are providing more data points to those who claim that trade skepticism is based on ignorance, and, more important, by clinging to false reasons they are precluding a careful analysis of what the real problems are and what should be done about them. Grrrrr! But there is also a sanctimoniousness to the call for everyone (within our speaking range) to learn about comparative advantage (and similar entry-level how-markets-work concepts). People who don’t know anything about trade theory but have a general awareness of the world around them may worry about trade deficits or the effects of competition with workers in low-wage countries or regulatory arbitrage. These are real problems, and they are not “solved” simply by invoking comparative advantage. There is a whole world of reasoned economic debate about open economy macro, international political economy, labor market policy, etc. that recognizes Ricardian (and Stolper-Samuelsonian) logic but goes further and deeper. What I often see is something like this: 1. Average citizen worries about trade deficits and wage competition. 2. Economist says, this is because you don’t understand comparative advantage. If you did, you wouldn't worry about these things. I’m torn because I agree that people should know about comparative advantage, but I also think it’s intellectually wrong as well as arrogant to assume that the lack of this knowledge is the cause of the political concerns. (Nick, I’m not accusing you of this, just noting how common it is in general.)
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So as not to repeat myself, here is the link to a post from three years ago that addresses the issue of whether labor markets correctly “price” bad working conditions like physical risk, alienation and harassment: http://econospeak.blogspot.com/2012/07/pay-for-oppression-do-workers-in-fairer.html
My recollection is that the term neoliberalism entered English from Latin America in the 1980s or so. [Sadly, no: coined in English around 1976, by Charles Peters, as an antithesis to (domestic) neoconservatism. See, among many others: http://www.washingtonmonthly.com/features/2007/0705.klein.html. In German, "neoliberalism" was used earlier, as a synonym for Freiberg School "ordoliberalism"...] I understood it to mean "liberal in economics" and authoritarian everywhere else -- especially because that was the only way economic liberalism could be constructed (then and there).
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Secular stagnation? The US has been running systematic trade deficits, and this is a drag on domestic demand; it also entails higher levels of net domestic debt. I explored this six years ago in http://econospeak.blogspot.com/2007/09/bubblicious.html. The problem with sec-stag is that it's a closed economy concept. I'll believe the world is experiencing sec-stag when I see evidence of aggregate demand shortfalls at a global level. Until then, I'll assume this is the problem of a chronic deficit country with an unlimited ability to borrow in its own currency.
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Regarding alienation, I think that most of it can be summed up as extrinsic vs intrinsic motivation. The more you are extrinsically motivated, the more alienated you are. Of course, for reasons you allude to it is not possible or desirable to run an economy on intrinsic motivation alone.
Toggle Commented Oct 6, 2013 on Complexity & alienation at Stumbling and Mumbling
Frances, this is an excellent post, and I largely agree except for two demurrals. First, while it is true that the profession has swung dramatically in the direction of empiricism and that this is a cause for cheer, it should be born in mind that a lot of empirical work in economics is essentially calibration. You can see this most clearly in macro, but it is also true in micro. For instance, I’ve done a lot of work on child labor, and quite a few of the papers one finds in the professional literature (less the practitioner literature) take the form of specifying a household utility function and then estimating the parameters the model establishes as causal for household behavior. If you are already quite sure that the theory behind the model is correct this is not a problem, but I would not go so far as to say that this “tests” the theory to any great extent. Second, while I agree that much more theoretical diversity enters into professional work in bits and pieces, this is usually grafted on to a core model that is right out of the principles course (with more math). Thus: let us assume a perfectly competitive economy populated by rational, self-interested consumers and profit-maximizing firms, blah blah blah, but with the exception that people/firms are also motivated by x. And, yes, x can be all sorts of interesting things. Nevertheless, it is the very untouchable-ness of the core model that permits the experimentation with wrinkles and allows the final product to get published. The profession is long overdue for a new core that is conscious of the diversity of work economists have done in recent decades and allows space for these innovations to expand as the evidence warrants.
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Once you remove the mechanistic references to "correct" deficit and debt to GDP ratios, this article has nothing to say. There is simply no there there. The irony is that Germany does face potential risks, but they have to do with its banking system (even the public banks I have praised elsewhere). A rapid deflation of their assets could leave German authorities few options. It's important to remember that, without a printing press (sorry to use German swear words) at any level, national or zone-wide, and with the ECB balance sheet nearly tapped out, there is no way to support the financial system except fiscally. OK, better to be German than Dutch in that scenario, but still...
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Germany is an outlier. On the one hand, it is the only core country where finance does *not* rule. Remember that the majority of German finance is intermediated by public and cooperative institutions. Good old fashioned real economy interests rule there. On the other, virtually the entire political spectrum is immersed in a hyper-orthodox fiscal ideology in which saving is virtuous, borrowing is wicked, and monetary authorities must be eternally vigilant against the inflationary schemes of the borrowers. Imagine a bizarro William Jennings Bryan. (You shall not crucify the savers on a cross of eurobonds....) So I am not at all surprised that Schäuble would take progressive positions on reining in the financial sector (not only the FTT but bigger haircuts, tougher regs, etc.), while also mouthing idiocy about how the crisis is due to fiscal deficits, which must be immediately reduced everywhere.
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That blonde on the beach got it right, Mark. Unions are powerful around the world, including just north of where I'm sitting, in Canada. In Germany, the world's foremost exporter among the industrialized countries, unions and works councils still play an enormous role. All indications are that unions will be more important for China in the future, not less. The US story is about the US. It's about bad choices made by the labor movement during the long sleep (1950s - 90s), the rise of a well-funded, well-organized business lobby, the impact of racial politics on political alignment, and many other factors, nearly all of them US-specific. I'm not saying that the rest of the world is all OK, just that Americans need to get out more if they want to understand what ails them.
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Nick, there must be something I'm missing here. As I understand it, RBC models (and, as you say, most GE models) do specify a process, and they demonstrate that real world outcomes could have been generated by it ("the data are consistent with"), but what they don't do is show that the process actually occurred, or that the fingerprints show that the process occurred with a high degree of probability. Am I right here? As I understand it, if, for instance, you had a productivity shock-driven model of the business cycle, and you wanted to say it explained a particular instance, wouldn't you (according to my definition of "explain") need to provide the kind of detail I specified in my previous comment? I haven't seen this in the RBC literature, but I can't say I follow it religiously, and it's very possible there are such articles and haven't seen them.
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David: It's possible you have a different understanding of the word "explanation" than I do. Saying that you have a model that would correctly predict a subsequent outcome on the basis of prior data is not explaining by my book. I mean the term in the way it is used by my science colleagues: you show explicitly the process by which the outcome is arrived at. In that respect, I would disagree with Temin's review: it would be an important contribution to an explanation of the Depression to show how changes in TFP resulted in changes in aggregate output, even if TFP shocks were taken as exogenous. (We might find, of course, that they are ultimately endogenous, but putting a piece of the story in place is a step toward telling the whole story.) But do the contributors to this volume reveal actual mechanisms? Do we see specific productivity shocks working their way through specific markets to, for instance, invalidate specific investment plans? That would be an explanation as I understand it.
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There's a tendency for economists to refer to physics when they want to compare themselves to "real" scientists. This makes sense, since there is some overlap between the two populations: a strong orientation to math, a desire to locate laws that reduce the dimensionality of the perceived universe (in economics, with an error term). There is historical borrowing and all the rest. Nevertheless, the explananda in economics far more closely resemble what biologists and geologists have to cope with. I think a lot could be learned by observing the day to day work of practitioners in these fields. There are moments when a particular theory is hot, and reputations are made by people who add a crucial piece to a model, but most work is object-of-study-driven, and theories are tools. (OK, ambitious researchers dress up essentially descriptive work with hints that their results will alter how theories are understood or what their field of application can be, but this is mostly about merchandising. One of my jobs has been teaching grad students in ecology how to do this.)
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David: Can you provide an example or two of specific economic episodes for which RBC (in any flavor) supplied an important part of the explanation? I'm thinking of a particular macroeconomic event which researchers sought to understand, and where RBC was part of the "aha" moment. As a well-known exemplar, I offer the late-30s dip in US output, which is generally seen as reflective of a Keynesian fiscal mechanism. Needless to say, "explanation" is a rather higher bar than "is consistent with". I don't mean this rhetorically. I think economics suffers from insufficient tools of explanation, and if RBC can do the job in some contexts, fine. Also, I don't mean to be getting off on the what-do-you-think-about-RBC tangent. My question is intended to be in the spirit of this thread. That is, are people working on RBC primarily because there are a lot of publishing opportunities in tweaking the model, because of ideological motives (they want to rehabilitate noninterventionist macro), or because they are motivated to actually provide convincing explanations for economic phenomena?
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This is a great discussion, and I think it is a pretty accurate description of the way career incentives play out in economic research. Nevertheless, I also think it is symptomatic of a deeper problem with economics relative to the "real" sciences. In most fields of science, researchers want to explain things. They are looking for the mechanisms by which observed outcomes arise. A theory can be largely "figured out" but still contribute mightily to research as more and more observed phenomena are subjected to it. Very few biologists, for instance, see themselves as "working on theory", although (of course) biological theory continues to be developed. The bulk of the work is explaining how things work, and there are a lot of things out there (or in there if you happen to be a biologist). The fetish with prediction, the notion that a "good" theory is one that generates a single, falsifiable prediction in a given context, shifts the balance of theory work in directions that have little to do with the research most scientists do. (This sort-of-Popperian approach makes sense in adjudicating rival theories, but such adjudication is not the main activity in most sciences.) The result is that you get the pattern Nick describes in economics, but what governs the use of theories in the scientific literature is how successful they are in generating explanations. The second big problem is the lack of serious concern for Type I error. Most protocols in empirical economics are conditional: if my model is correct, and if we can make some additional assumptions that people like me have been willing to swallow, I can test for whether I can reject the null hypothesis that my prediction is totally false. Even worse is calibration: the test is whether I can find a set a parameters under which my model can survive an encounter with a data set. This approach has almost nothing to do with rooting out Type I error as most scientists understand it. Theories with a high probability of being false can survive decade after decade in economics, because the protocols are so intrinsically weak. Only now, with the rise of experimental and quasi-experimental methods, is there the appearance of a critical test from time to time, and even so most economists do not recognize the difference between such tests and their normal empirical work. I don't want to romanticize science. Theories do blow hot and cold in most disciplines for careerist reasons, and there is a lot of dubious stuff that gets published in the first efflorescence of a new research program, but the process is constrained by a serious commitment to minimizing Type I error over time. People who say something is true when it is later shown to be false suffer large career consequences in the scientific world. Can you say this about economics?
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Hi Nick. I have a question about your model. It seems to me that the baker is uncertain about the demand curve. In that case, isn't the question whether he/she raises the price slightly at the margin and also produces an extra loaf (possible high demand curve) or remains at the status quo? You have the baker contemplating a reduction in the price in order to sell another loaf, but this, of course, is the decision the monopolistic competitor (or monopolist) faces vis-a-vis a known demand curve. Why bake the extra odd loaf, in case the demand curve turns out to be higher, and not add the extra odd cents to the price? Aside from the technicalities, I still think there is a problem with the prediction inherent in your model. If you are right, as markets approach perfect competition (more competitors), we should expect to see something closer to neutrality in producer expectations of demand: ex post excess demand should arise about as often as ex post excess supply. My hunch, however, is that it is the opposite: in competitive markets excess supply is most severe and the consumer is king, while in monopolistic markets S and D are more balanced (at the higher monopoly prices) and the consumer is dirt. I like, though, how Canadian discussions of this problem quickly get into doughnuts at Tim Horton....
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The key to Lucas' bogus empiricism is the phrase "formulate explicit theories that fit the facts". The set of theories that can be calibrated to a data set is much larger than those that would survive a critical test that discriminates between their implications and those of other competing theories. Most econometrics on the macro side (and too much micro too, alas) is pseudo-science.
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