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I hope to have a more complete reply to Jim Manzi’s assessment, but I wanted to make a couple of remarks off the cuff.
One Manzi says
Economists will sometimes make explicit claims that “the economic science says X,” and will more frequently make implicit claims for scientific knowledge by flatly asserting the known truth of some predictive assertion. This is normally a statement made around some specific policy question – we should (or should not) execute the following stimulus program; we should (or should not) raise the minimum wage right now, etc.
. . . all we have is an informed opinion of the type we might have from an expert historian rendering an opinion about something the likelihood that Libya would revert to an authoritarian government within ten years if it overthrew Gaddafi
Its important to distinguish between economics as science and economics as a policy driver. Manzi is focusing on economic statements that are made as policy drivers and saying it is only informed opinion. Yet this informed opinion is what is being offered. Economic science is a different enterprise.
Saying that we should execute the following stimulus program is much different than saying that we have an established scientific principle that stimulus has such-and-such effect. Contrary to intuition the first statement is far, far weaker. This is why “economic science says” is heard less frequently than “we should.”
Even setting aside personal values, “we should” is, by its very nature, a statement about subjective probability distributions. It is saying I believe that the distribution of possible effects in the stimulus world is – by some metric – superior or inferior to the distribution of possible effects in the non-stimulus world.
This requires only that you have some evidence – any evidence – that the stimulus is more likely than not to do things that you judge to be good or bad.
As such, saying that “we should” do something does not make an implicit claim about factual knowledge. Moreover, no one advising the government acts as if it does. Hardcore proponents of democracy assert that “we should” follow the advice of a group of people on the grounds that they have all survived to the age of 18. This is hardly a claim to any sort of scientific knowledge.
Now, I know Manzi’s complaint will be that economists come waving models and multipliers as if their recommendations were based on well established science. However, this is not how economists have traditionally offered their evidence. Economists are famous for refusing to draw firm conclusions and offering loads of caveats. As Harry Truman famously said
Give me a one-handed economist! All my economics say, ”On the one hand… on the other.
That scarcely represents overselling policy recommendations as scientific knowledge. In recent years some economists, myself included, have responded to the near relentless pressure for clear concise statements with
Our model suggests . . .
I believe you will find this statement repeated over and over again in congressional testimony. No “there is”, “there will be”, “it is a scientific fact.”
Our model suggests, gives you one interpretation. Many economists would love to stand before legislatures and give an hours long lecture on all of the evidence and competing possibilities. However, you get 20 minutes and the audience will demand that your story have a moral.
At the end of a presentation, more than once, the very first question has been this exact phrase: That’s all very interesting professor, but are you saying we should do this or not?
It’s a joke among my friends and family that I begin the answer with “Well, . . . “ Again, no false mantle of scientific certainty.
Now, lets consider economists as pundits. Aren’t they asserting models as facts. Very rarely.
Take Paul Krugman.
Conservatives will no doubt have noticed that one of Krugman’s major themes is that their point of view is stupid. One might be inclined to think that this is a rude way of saying “you do not have access to the scientific knowledge that I do”
It is not. It is a statement about what he thinks of your intelligence and ability to draw well formed conclusions.
He is not saying, I have such a deep understanding into the nature of the economy that everyone should listen to me. He is quite literally saying that the statements of conservatives convey such a shallow and imbecilic understanding of the economy that no one should consider listening to them.
He is not claiming the mantle of science, he is claiming the mantle of not being a moron.
On the opposite side of the spectrum, go back and look at the public statements of Milton Friedman. How many times did he lean on the fact that economics had established scientific knowledge that shouldn’t be questioned.
He always began with very simple facts and then drew out a small, compelling story. At worst, he would say “look at the evidence” and then proceed to offer the type of simple statistics that wouldn’t be uncommon in an Op-Ed.
Again, no implicit claim to scientific knowledge, only an implicit claim that reasonable informed people would agree with him.
The public policy statements of economists aren’t assertions of scientific knowledge. They are informed argument and economists present them as such. There is no doubt that economists use their knowledge of economic science to inform their policy arguments. Yet, in making those arguments they are not claiming scientific knowledge that they do not possess.
What you can argue is that economists think that they are smarter than everyone else. Indeed, economists across the political spectrum have made precisely that point. From Greg Mankiw
Larry, Vindicated
“President Summers asked me, didn’t I agree that, in general, economists are smarter than political scientists, and political scientists are smarter than sociologists?” [former dean Peter] Ellison told the Globe.
Here (via Mark Perry, posted two days ago) are GRE scores by field. Economists rank number 4. Political scientists are number 17, and sociologists are number 23.
In short, Manzi’s true point shouldn’t be that economists falsely assert scientific knowledge were there is none. It should be that we are arrogant pricks. I think many economists would agree.
I posted a link to Bryan Caplan’s paper on Behavioral Economics and the Welfare State. Many of the comments I got from economists were predictable:
- Where is the formal model and existence proofs?
- Where is the data analysis?
- How is this a paper?
- Do you mean to tell me this is publishable?
I too was shocked initially by these features or lack thereof. However, that’s part of what made the paper compelling.
Some papers get a wonderful data set, perform magnificent identification and get a result that really changes your mind about something you care about. Most don’t.
Most are cases that are of very narrow interest or do a 90% good job at the ID but leave enough doors open that you are not really sure if the result is meaningful or not.
On the other hand, one could as Bryan and his co-author did, attack an important question, string together some non-obvious points and in my case leave the reader thinking about whether he or she should reexamine an import view.
The profession should rightly celebrate the first kind of paper. However, what about the relative worth of the second and the third?
I submit that bringing up arguments that use the economic way of thinking matter. This is true even if the argument is not definitive, has no mathematical proof behind it and marshals no data.
Let me give a more timely example. We are now engaged in a debate over the nature of recessions and how the government should respond. There are obviously lots of models and empirical studies, none of them perfect.
However, more than any other analysis the baby-sitting coop story made me a confident Keynesian. Before then I could parrot the New Keynesian models and understood that this was more or less what a smart economist was supposed to say.
However, I didn’t know how to counter the logic of Laizze Faire except to say, “well there are sticky prices and an Euler equation and so the household will adjust consumption . . . “ This is compelling to virtually no one – not even, on a deep level, to myself.
When it really came down to it, I would have been left with “Great Depression! Want it to happen again? No? Then we need to spend more money or cut taxes! Why? Because I am very smart and I have a whiteboard. Do you have a whiteboard?”
However, a simple story about baby-sitting and it all fell into place. Paul Krugman has retold the story many times. Its about a baby-sitting co-op that uses scrip to track how many times a couple has sat for other members of the co-op and thus how many times someone should sit for them.
Because of some mismanagement in the handling of scrip the co-op at one point went into recession. There weren’t any fewer people who could babysit and there weren’t any fewer opportunities for couples to go out. The real baby-sitting economy hadn’t changed.
Bad policies by the co-op leaders reduced the number of scrip per couple. And, for lack of scrip no one went out. And because no one went out, no one sat. And because no one sat, no one got any scrip. And, since no one got any scrip, no one could go out . . .
Excess demand for financial assets led to a collapse in the demand for real good and services. Something that seemed extremely complicated was elucidated by a simple story.
Years ago that story was printed in an economics journal. I read it in the Slate.com archives.
As I have mentioned before I started warning of a Japanese style scenario in early 2008, not because of a formal model, but because of that baby-sitting story.
You see, the investment banks were like a baby-sitting couple who by borrowing and lending script and carefully tracking dining out patterns with fancy computer models had assured everyone that any couple, at any time, could find a baby-sitter whether they had physical scrip or not. Just come to us, and we’ll make it happen. No scrip down as it were.
That system was about to collapse and when that happened the demand for physical scrip was going to skyrocket. If you believed the original baby-sitting story that meant a recession of epic proportions. We were going to need a lot more scrip and the Fed didn’t seem to get that.
Nor, I should mention, did may people familiar with mainstream macro-economics. Its not that you couldn’t have gotten that result out of the math models. Its that you wouldn’t have known where to look.
You would have thought about wealth effects and the distributional impact of housing. Willem Buiter, a very smart man, insisted there would be no recession because the decline in the price of houses made homeowners poorer but homebuyers richer. This does somewhere between little and nothing to the representative agents Euler equation. However, Buiter failed to consider the simple lesson of the baby-sitting economy.
Buiter, forgot about scrip.
One of the obvious areas where Tyler’s thesis will run into controversy is in Medicine. Medicine is the most obvious place to look for innovation outside of the information sector.
Its also where a big chunk of the middle America’s paycheck has gone. Its not much of a stretch to say that if you think medicine has done a lot of good then you think the last 30 years have been good for the average American. If not then not.
Here I tend to side with Tyler. I don’t think most medicine has done that much good and I am not optimistic about the usefulness of most future medical spending.
This is not to say I don’t think there will be important breakthroughs. I think there will and the next fifty years will be exciting on that front. Its just that along the way we will dump a bunch of GDP down the drain, paying for medicine that is not so good.
The question is why are we doing this?
I have struggled with this. Is it because medical breakthroughs are reaching diminishing marginal returns. That doesn’t seem right because quite frankly there weren’t that many breakthroughs in the past.
We have vaccines, antibiotics, sterilization and anesthesia. That’s about it for really big time breakthroughs.
The view I subscribe to currently is that most people don’t care that much about increasing their life expectancy, they care about being cared for and being cared about. They care about reassurance and they care about feeling like they are not alone.
We can see that people don’t care that much about maximizing their life expectancy because they place an enormous premium on their doctor’s bedside manner and a much smaller premium on his error rate. We can see that when objectively bad doctors who are nice rarely get sued for malpractice, while much better doctors ,who are assholes get sued all the time.
We can see that when we offer potential surgical patients stats on the number of fatalities at prospective hospitals and they refuse them. We can see that when message boards about doctors are filled with comments like “He really understood me.” “She took the time to stop and listen. “ “I knew they cared about whether I got better” “I was more than just a number.”
These are not comments about the skill of the medical provider but about the caring of the medical provider.
Now, when I present this stuff to my students they often say: but a doctor who cares will do a better job and so you are more likely to live longer.
Lets ignore the fact that if this were true it should be captured in the doctors’ stats. Suppose that it is true. Then why in the world are we investing all of this time an energy selecting really smart students and then putting them through years and years of training if the main thing that matters is how much the doc cares?
Dealing with this is a real puzzle. Though I am a free market person, I see the price system’s big advantage is that it conveys information. In medicine virtually no information is conveyed through price. People at all levels are confused about what they really want or what we should do.
For example, when I speak with doctors the issue of non-compliance often comes up. This is typically to explain why treatments that look good in clinical trials don’t work out as well in real life.
Non-compliance is the issue of getting patents to go along with some aspect of the treatment they don’t want to go along with. I argue that if the treatment only works if the patient does something that he or she isn’t going to do, then the treatment doesn’t work. Doesn’t matter what JAMA says. To the docs I say, you go to war with the patients you have, not the patients you wish you had.
To society at large, however, I say, we have to rethink what we are doing here. Ultimately, we want to make sure that we are spending money to make someone better off. If the doctor is complaining, the patient is complaining, and either the insurer or the government is getting a huge bill, then exactly who are we serving here?
Krugman blogs on demand-deniers, those who don’t believe that recessions are caused by a fall in Aggregate Demand.
Third, monetarists — old-style Friedman-type monetarists who focus on monetary aggregates, or the new style which says that the Fed can and should target nominal GDP — are, whether they realize it or not, part of the axis of monetary evil as far as the demand-deniers are concerned. They may believe that they can limit the scope of demand-side reasoning, making it a case for technocratic policy at the central bank but no more than that. But from the point of view of those who can’t see how demand can possibly matter, they’re essentially in the same camp as Keynesians. And you know, they are; once you’ve accepted the idea that inadequate demand is the problem, the role of fiscal as opposed to monetary policy is just a technical detail (albeit one of enormous practical importance).
At first I thought he meant those who focus on monetary policy were inadvertently pumping up the demand-deniers. A re-reading revealed that he meant that the monetarist were on the same side as Krugman – and thus evil in the minds of the demand-deniers.
In a recent email to a fellow economist, I pointed out that as soon as you accept that the Federal Reserve has control over the overnight interest rate almost all of the Aggregate Demand conclusions fall out as a matter of basic intertemporal optimization.
Said more explicitly:
If the Fed tries to increase interest rates by shrinking the money supply then folks will try to buy less and save more.
If the market functions smoothly and perfectly then buying less will drive prices down. Saving more will drive the interest rate back down and almost everything will go back to the way it was before the Fed did anything. The only difference will be lower prices.
Thus the Feds effort to raise interest rates would fail.
For the Fed to even be able to alter interest rates there has to be some frictions in the market.
Now you might think that the distortions involved in monkeying with the money supply are so bad is not worth it, but you are in the technocratic world now. You are debating the merits of various demand side policies – not whether or not they are logically possible.
More or less the same thing is true with deficit spending as well. You could believe that deficit spending today causes people to save more in anticipation of higher taxes tomorrow but it takes some pretty heroic assumptions to get all the way to the idea that deficits can’t possibly spur demand.
At the root, I agree, is the common tendency to deny that something is possible when what you mean is that it is undesirable. You might have a laundry list of reasons to think that deficit financed Aggregate Demand expansions are undesirable but that is different than saying that they are impossible.
Denialism, to be clear, does not market one as a crank or fool. Almost everyone does it. I have heard many people claim that violent crime, prostitution, drug abuse, etc could not be eliminated even if we removed all restraints on the state.
I’ve also heard people say that poverty could not be eliminated with a likewise abandonment of our basic principles of government.
All of these denials are almost certainly wrong.
I am tempted to describe the policies that I am confident would virtually eliminate crime and poverty but their draconian nature is so extreme that the description would cause people to recoil from my general case. Moreover, I adamantly profess that doing these things would make the world a much, much worse place.
And, that’s the point. If you don’t like deficits then you can and shouldmake the case that the ultimate price is too high. You should feel free even to make the moral case that these things shouldn’t be done even if they would improve the economy.
However, what we shouldn’t do is look away from the truth because the weighing of right and wrong is too painful.
Megan McArdle comments on the following questions
There’s a sort of fair question highlighted at Balloon Juice–why aren’t libertarians proposing solutions for the foreclosure crisis? There are serious paperwork issues, which banks seem to have tried to solve by throwing together some highly suspect legal documents. As Mistermix says, “Since the basis of libertarian philosophy is property rights, I would have expected a little more outrage from places like Reason about robo-signing”. ED Kain adds “In any case, I say mistermix’s critique is fair because it is – libertarians are not proposing meaningful solutions to the foreclosure problem as far as I can tell.”
I don’t know about the Reason guys but I can say that I was more or less hoping the whole thing would blow over and that in the wake of it we could get serious about electronic documents and get rid of the paper crap all together.
The reason I’m not more outraged is that I have seen little evidence that actual property rights were infringed. Property rights are often represented by pieces of paper but they are not created by pieces of paper. They are created by mutual consent and a meeting of minds. To my knowledge almost all of these cases involve people who believed that they were taking out a mortgage and banks who believed that they were providing a mortgage. That’s a solid transaction.
Now to the extent there were people who were tricked into certain deals, that is a problem whether the paperwork checks out or not. In those cases there was no meeting of the minds and the existence of a confirmed paper trail doesn’t change that.
Karl posted something that he should have titled “Stream of Consciousness” instead of “Unsubstantiated Claims” where he thought out loud. One of those thoughts landed on the Fisher effect.
My sloppy writing makes it sound as if I am saying Reihan should read up on the Fisher effect. What I mean to say is that Reihan brought up the fact that people fear inflation eroding savings. These fears are common. I have had many a Facebook debate over them. Indeed, Ron Paul has repeatedly pointed to this has his main reason for fearing debasement of the currency.
I believe that the Fisher effect is controversial among Austrians, and Keynes didn’t believe in the relationship at all, except under hyperinflation. Using price inflation in the Fisher equation makes a lot of things confusing, because the composition of output under recession circumstances (less than full employment — or a flat SRAS) is that raising inflation expectations to, say, 3% from 2% will likely cause an increase in real output, leaving inflation at it’s long-run target. Indeed, the Fed isn’t even interested in boosting inflation expectations past its set 2%, and has made that very clear. What the Fed wants is higher NGDP…but unfortunately it operates under a target for nominal interest rates.
Scott Sumner has a post about how inflation is, counterintuitively, good for savers. The thrust of it is that raising NGDP expectations will raise the Wicksellian real interest rate. People will spend more on investment (maybe not consumption, but probably), and we will get far more output, while trend inflation remains intact (and if it doesn’t, then the Fed can act as necessary). This is a boon to savers, as it raises not only the interest rate on savings accounts, CD’s, and the yield on bonds…it raises other asset prices as well, like stocks, real estate, commodities, etc. All are vehicles for saving, and a higher level of NGDP causes every type of investment to increase its yield.
This is the fundamental reason inflation is confusing. People think a lot about cash, but not many people save in cash (as in safes) under a normal positive trend inflation rate — criminals mostly. I think that price inflation is just muddying the debate here, and is completely useless.
A little late, I know, but Happy Thanksgiving everyone!
A couple days ago, Reihan Salam put forth the question of why the United States is so great. Which means how has the US economy performed so well over the last century? Karl answers with what he deemed a “conventional answer”, and FreeExchange grapples with the question, concluding a mix of market size and the influx of talent to America (read: immigration).
I agree that market size has a lot to do with the wealth that the US generates. The most important thing to note is that the US is a free trade area. Capital and labor are free to migrate easily and efficiently across the borders of states in the US. This advantage, the comparative advantage of trade, has allowed the US to innovate in ways that having trade barriers would not allow. The most striking example comes from (I believe) David Friedman, when he noted that there are two ways to make automobiles; you can erect a factory and build them with steel, or you can plant a field and build them with agriculture…or, presumably, you could erect a tower, and build them with finance. The easy with which this division of labor can manifest itself within the United States is definitely a key to the prosperity we enjoy. Although I believe that the advantage of market size has run its course, it has still been very important.
I want to touch on an element that fell out of favor among researchers in the 60’s, but has since seen a tepid renaissance. That is, culture matters.
Conveniently, that is the title of a book that was put out after a Harvard international studies conference headed by Lawrence Harrison and Samuel Huntington. To begin, I’d like to turn to Robert Putnam, from his book, Making Democracy Work, in which Putnam describes his visit to the government offices of the poor Puglia region of Italy:
In the dingy anteroom loll several indolent functionaries, though they are likely to be present on an hour or two each day and be unresponsive even then. The persistent visitor might discover that the offices beyond stand only ghostly rows of empty desks. One mayor, frustrated at his inability to get action from the region’s bureaucrats exploded to us, “They don’t answer the mail, they don’t even answer the telephone!”
Putnam then contrasts that experience with the experience of the government offices in the rich Emilia-Romangna region in the north:
Visiting the glass-walled regional headquarters is like entering a modern, high-tech firm. A brisk, courteous receptionist directs the visitors to the appropriate office, where as likely as not, the relevant official will call up a computerized database on regional problems and policies…A legislative pioneer in many fields, the Emilian government has progressed from words to deeds, its effectiveness measured by dozens of daycare centers and industrial parks, repertory theaters adn vocational training sites scattered throughout the region.
These two regions stand but 400 miles away from eachother, but they may well be worlds apart. The curious question is, why? They are both populated by Italian people who share the history of Italy. Putnam concludes that the source of this disparity is low trust leading to an inability to achieve large-scale cooperation. He argues that the differing histories is the source, tracing all the way back to medieval times. While the south was traditionally monarchist, hierarchical, closed, and dominated by the church; the north was more egalitarian, communal, and open to trade. Later, the north was influenced by the ideas of the enlightenment.
The idea is that while the south was discouraging networks from forming, as they presented challenges to the hierarchy (and especially the church), the north embraced the formation of social networks, which allowed it to form valuable human (and social) capital.
In their book, Harrison and Huntington present data regarding trust and economic performance (measured in PPP per capita GNP). Not surprisingly, there is a strong correlation between the percentage of people who “trust people in general”, and GNP per capita (sorry I don’t have a link, but if I find suitable data, I’ll reconstruct). The question is, why? Argentinean scholar Mariano Grondona has proposed typological rules. These rules fall into three broad categories.
- The first category are norms related to individual behavior. These include norms that support a strong work ethic, individual accountability, and a belief that you are the protagonist of your own life and not at the whim of mystical powers or “powerful leaders”.
- The second category are norms related to cooperative behavior. Foremost is a belief that life is a non-zero-sum game and that there are payoffs to cooperating in a larger group. Societies that believe in a fixed pie of wealth have a difficult time creating social capital, and are often characterized by looting and cheating.
- The third category are norms related to innovation. Cultures that look to rational scientific explanations of the world tend to be more innovative. It is also very important that a culture be tolerant of heresy and experimentation. Orthodoxy stifles innovation. It is also important that a culture welcome competition and celebrate achievement. Overly egalitarian societies reduce the incentives for risk-taking.
Not surprisingly, those cultural traits are also the key to well-functioning organizations, including businesses, charities, and governments. A final norm, and one that is possibly the most important, is how people view time.[1] As Eric Bienhocker states:
Cultures that live for today (or, conversely, are mired in the past) have problems across the board, ranging from low work ethic, to inability to engage in complex coordination and low levels of investment in innovation. Why work hard, and invest in cooperation and innovation if tomorrow doesn’t matter? In contrast, cultures that have an ethic of investing for tomorrow tend to value work, have high intergeneration savings rates, demonstrate a willingness to sacrifice short-term pleasures for long-term gain, and enjoy high levels of cooperation.
Trust also affects the intangible wealth of nations. Bryan Caplan is fond of touting the fact that poor immigrants are extremely productive, as long as they work in America. The amount of physical capital (A, k, L in Cobb-Douglas) in the US certainly tells part of the story, but as the World Bank has pointed out, it can’t come anywhere near telling the whole story. In fact, our institutions contribute 80% to the US’ capital stock. Contrast that with the poorest nation on earth, the Democratic Republic of Congo, whose intangible capital actually depresses the total wealth of the country.
William Easterly has pointed out that in the last half-century, the developed world has provided more than $1 trillion in economic assistance to the developing world. Yet poverty in places like Africa and South America still persists. Africa even regressed[2] (until recently). The lesson? It is important not to ignore the cultural basis of economic growth.
[1]The Origin of Wealth, Eric Bienhocker. I’d like to thank Bienhocker as well, for providing a guide to much of my analysis of culture.
[2]Just wanted to let you know that that is one of my very favorite TED speeches. It is incredibly inspiring.
Another chart to steal from Real Time Economics, this time provided by Justin Lahart.
The classic hydraulic macro story would imply that someone is hoarding cash. It would be really nice then if we could look around and see some cash being hoarded. Indeed, we do.
A point I want to make is that none of these pieces of evidence is in-and-of itself conclusive: The small business survey, the flow of funds, inflation expectations, etc.
There could be explanations for all of them that involve something other than the traditional liquidity demand story: that is that recessions are caused by excess demand in the market for cash/bonds/safety.
However, the liquidity demand story suggests that certain things should all be happening at the same time: a decline in the demand for labor, a decline in the purchase of durables, a decline in consumer prices and business’s pricing power, a decline in asset prices, a decline in inflation expectations, an increase in cash holdings, an increase in the ease of finding workers, etc.
And, all of those things are happening.
I like to focus on inflation because I think just about all of us have agreed that inflation is primarily controlled by actions at the Fed. Thus close patterns between inflation and other variables should suggest that they are also controlled by the Fed.
Here is fraction of income spent on durables and inflation.
Ed Leamer likes to say that its all durables and housing. I think there is more going on in housing than money creation but lets check the Leamer story versus inflation.
Looking at durables only suggests that inflation might flatten out soon. Looking at durables and new houses suggests that deflation will be upon us for sure. It will be interesting to see what happens.
Note, however, that this is not saying that a reduction in income spent on durables and housing will cause a decline in inflation. Its saying the Fed has already taken certain actions. The immediate result of those actions is a decline the fraction of income spent on durables and new houses. The future impact of those same actions will be a decline in inflation.
In other words the inflation decline is already baked in. What we have to ask ourselves now is whether we want to take actions that would raise inflation expectations for the medium future.
In an update to his popular post, which is causing some interesting commentary on Twitter, my co-blogger Karl Smith has this to say:
My argument is no, this isn’t just another bad experience. Its a failure of our most basic institutions and is leading to pure loss.
Indeed, I think that the wrong way to think about the problem of recessions is that there is a fundamental problem with market economies, or that recessions (no matter how deep) represent a market failure. To me, this recession (both the depth and length) is fairly clearly a monetary failure…and if you catch me on a bad day (or a good day, depending on your disposition I suppose), I’d even go as far as to claim that the type of money system we use makes our economies prone to the types of failures we have recently experienced. In fact, financial crises are not rare. The World Bank has identified 96 banking crises (large enough to cause economy-wie problems) and 176 monetary failures since the dismantling of the Bretton Woods in 1971.[1]
Even before the termination of gold convertibility, massive crashes were remarkably common the world over. From the Holland tulip mania to the Great Crash of 1929, these crashes have happened with frightening regularity. Being as these types of economic issues span countries, time periods, regulatory regimes, and degrees of economic development; I think that it is safe to say we should begin turning a inquiring eye toward the one system that permeates all of these societies throughout time and location.
That, of course, is the type of money we use, the characteristics of which have been replicated by nearly every society since the relinquishment of barter, and the dawn of what we would consider “modern money”. This recession is, of course, no different. An increase in the demand to hold safe assets (of which the medium of exchange is generally the safest, at least in developed economies) causes a disconnect between workers and factories. People and machines sit idle. Productive capacity dwindles, along with hours worked. Price and wage stickiness facilitates a real downward adjustment to market clearing rates to cause grinding deflation (or disinflation, which under a regime of positive trend inflation is similarly problematic).
Is there a bug inherent in the money system that is used the world over that causes these disconnects? I think that analyzing the dynamics of the flow of biomass through natural ecosystems can provide useful insights into how the money we use causes the economy (or sectors of the economy) to become brittle (too brittle to sustain?) and prone to failure.
Will make our lives less worth living until our eventual death anyway.
Paul Krugman complains that its not only the Austerity crowd but the Tight Money crowd that’s switching its tune on the bond markets
So will the OECD call for a drastic shift toward expansionary [monetary] policies, since the clear and present danger, at least according to the bond market, is disinflation (and possibly deflation)?
No, it won’t. The bond market only rules if it tells people what they want to hear.
The odd thing isn’t that people only hear what they want. Confirmation bias is ubiquitous. The odd thing is that so many in positions of authority only want to hear that which justifies greater indifference to human suffering.
Others will see more cynical causes but, my current explanation is that this is a transfer of logic from the way certain body tissues operate. Its clearly the case that skin, muscle and connective tissue respond to stress by growing: a process known as hypertrophy. This might also be the case with nervous tissue and some other, though importantly not all, tissues. This is an interesting and important phenomenon that details the power of highly complex evolutionary systems. Yet, it is a fool’s errand to apply this to the world writ large.
When you stress most things they don’t grow back stronger, they break. When you apply job losses to an economy people don’t become hardier, they become poorer. The idea that tough love will lead to a better economy in the long run is just wrong. Not mean. Not heartless. Not insensitive. Wrong.
Monetary policy doesn’t work that way. Fiscal stimulus doesn’t work that way.
More importantly, I want people to question whether or not you believe in economic toughness primarily because you are extrapolating from your experience with muscle fatigue. Human bias is elusive and works in mysterious ways. You may have learned from an early age that “no pain means no gain” and at a minimum that’s a good rule of thumb when dealing with sarcoplasm. However, this phenomenon is deeply dependent on the nature of sarcoplasm and the metabolic process generally. It does not carry over to the world or equilibrium systems on the whole. You will make deep logical errors if you believe that it does.
And getting the right answer matters. What’s important is not whether what you are saying “feels” true. Unlike Paul, I don’t doubt your sincerity. What matters is whether it is true. The world operates on objective facts and their relationships. The world does not operate on whether you subjectively feel like you did the right or responsible thing. We can talk more later about how responsibility – or compassion for that matter – are mental interpretations. Real world events are the result of the interaction of subatomic particles. Responsibility or irresponsibility can’t cause anything to happen they can only provide an interpretation of events that have actual physical causes. But, like I said more on that later.
The issue today is: what series of logical steps is telling you that we should listen to bond markets when they suggest tighter polices but not when they suggest loose ones?
A nail salon has made national headlines recently by charging an overweight customer an extra $5 because they were over the official weight limit of the pedicure chair, which can cost $2,400 to fix. This has been called price discrimination, and has been compared to the practice of dry cleaners to charge more to clean women’s clothes than men’s clothes even though the cost to the cleaner is the same. But in order for something to be price discrimination, the price differential has to be greater than is justified by different costs. In fact, if it costs more to serve an overweight person than a not overweight person, then charging them the same is price discrimination.
The FindLaw blog Free Enterprise does not appear convinced by the different underlying costs justification in this case, because:
…it is difficult to see how a $5 surcharge, unless charged hundreds of times each day, would help defer the over $2,000 dollar cost of fixing a broken chair. In the long run, the negative publicity the salon is receiving may end up costing much more.
But the negative publicity costs are probably why the charges aren’t higher for overweight customers. This constraint on the store’s price setting means underlying cost differences may be much larger than $5. The marginally higher prices for overweight customers will recover more of the underlying costs and are therefore less price discriminatory than when everyone is charged the same.
So is this type of differential pricing a “good” thing? I won’t weigh in on the morality of the issue, but at a first pass it does seem more efficient. However, if other customers value going to a salon that charges everyone the same regardless of weight, than they may find another salon to go to. This is the long-term PR cost to the firm. In this case, as in many other real life cases, otherwise efficient differential pricing based on personal characteristics may not be efficient when you consider that customers have preferences over these pricing issues aside from any direct monetary benefits or costs to them. This is why market outcomes can be “fair” without regulation despite the fact that narrowly defined self-interest may predict “unfair” outcomes. People value what they see as fair business practices, and they are willing to pay for it.
In a defense of stimulus skeptics, Jim Manzi offers this appeal to a non-consensus among economists on the issue:
…in a genuinely scientific field which has accepted a predictive rule as valid to the point that there is a true consensus—such that the only reason for refusal to accept it is crankery or, in Chait’s terms, “politics”—you don’t usually see: several full professors at the top two departments in the subject, when speaking directly in their area of research expertise, challenge it; 10 percent of all practitioners in the field refuse to accept it; and the two leading global general circulation publications in field running op-eds questioning it.
Specifically, he cites the fact that the University of Chicago’s Barro, Fama, and Mulligan are stimulus skeptics, and according a survey from Mankiw, so are 10% of all economists. But I don’t think 10% of economists and a handful of high-profile experts disagreeing is sufficient to say there is not a strong consensus.
For economics 90% agreement is a pretty high level of agreement, and I would be surprised to find a consensus much stronger on that on most issues. From a survey of economists by Whaples we can see that “only” 87.5% of economists agree that the U.S. should remove all remaining tariffs and trade barriers, 90.1% believe that employers should not be restricted from outsourcing jobs, 85% agree that subsidies to agriculture should be removed, and the same percent say it about sports subsidies as well. From another survey of economists, 87.5% agree that the U.S. trade deficit is not primarily due to other nations’ nontariff trade barriers, 83.5% agree or agree with provisos that tax policy can affect the long-run rate of capital formation, 93% agree that pollution taxes or tradeable permits are more efficient than emissions standards, 92.9% agree or agree with provisos that flexible exchange rates are effective, and 92.6% agree that tariffs or import quotes reduce the general welfare of society.
Despite the disagreement by 7% to 17% of economists on these issues I would argue that are all accurately characterized as representing as a strong consensus. Whaples calls the agreement in those examples a “consensus” and “an overwhelming majority”, and Fuller and Geide-Stevenson, the authors of the other paper, explicitly refer to those examples as representing a “strong consensus”.
Yet I’m certain that on each of these issues you could find experts at the top 10 economics departments that agree with the minority position. Stiglitz alone will probably disagree with more than half of them, and you won’t have to look hard to find a half a dozen other Ivy League dissenters.
My point is not to disagree with Manzi that a strong consensus means it is okay to call anyone who disagrees with the consensus a “crank” or “politically motivated”, but just to point out that the bar he’s set for a “true consensus” pretty much means that there’s is no “true consensus” on important issues in economics. Then again, he may very well agree with that point.
No, believe it or not this paper wasn’t written by Bryan Caplan or Robin Hanson. From the abstract:
In this paper, we analyze the extent to which market forces create an incentive for cloning human beings. We show that a market for cloning arises if a large enough fraction of the clone’s income can be appropriated by its model. Only people with the highest ability are cloned, while people at the bottom of the distribution of income specialize in surrogacy. In the short run, cloning reduces inequality. In the long run, it creates a perfectly egalitarian society where all workers have a top ability if fertility is uncorrelated with ability and if the distribution of ability among sexually produced children is the same as among their parents. In such a society, cloning has disappeared….
Unlike the normal, unpredictable, process of genetic heredity, cloners will be able to guarantee that their clones will be high-ability by cloning high-ability individuals. This paper looks at whether people will create clones for profit. Assuming that slavery will be continue to be illegal, the question is how could someone appropriate wealth from a clone they created? The authors offer three ways:
Negative bequest – this is when you borrow money in someone else’s name, e.g. adopt the baby clone and rack up debt in it’s name. Apparently, this is legal in Japan.
Informational retention – here you withhold information from the clone about where they came from, and who their “model” was unless they pay for it. A problem with this is that the clone has to wait until he’s older to pay for this (since child clones don’t have money, obviously) in which case you may have ruined a lot of potential, as they could have been investing in particular talents throughout childhood. For instance, the clone who learns on his 18th birthday that his model was Mozart, but he’s neglected to learn piano.
Gene ownership – if genetic codes are patentable in the future, then you could sell a clone his genome which contains information that could help them stay healthy or improve their labor market earnings.
Education – top tier schools could form a consortium to clone high-talented individuals to increase the demand for their products, and since top tier schools are not easily replicable this will drive up prices and increase rents.
The first one seems worst to me, since clones have no choice but to pay rents. Given the desirability of having these high-ability clones as citizens, I assume that some countries would pass laws to serve as sanctuaries from this type of debt.
I am curious as to what Bryan Caplan, who has previously argued for his right to clone, would say about whether these things methods of clone wealth appropriation should be legal?
An op-ed in the New York Times illustrates why those concerned about energy use and “sustainability” should not be concerned about farms and being locavores, but about households energy usage
Overall, transportation accounts for about 14 percent of the total energy consumed by the American food system.
Other favorite targets of sustainability advocates include the fertilizers and chemicals used in modern farming. But their share of the food system’s energy use is even lower, about 8 percent.
The real energy hog, it turns out, is not industrial agriculture at all, but you and me. Home preparation and storage account for 32 percent of all energy use in our food system, the largest component by far.
Driving to a nearby Walmart to buy factory foods may be more environmentally sound if it saves you a car trip because you’re going there anyway, or if it’s closer than wherever it is you buy local food. I don’t know if anyone has quantified the extent to which big boxes have helped the environment by allowing one-stop shopping, but it seems it would be significant.
And it sounds like foodies should be focusing on which ways to prepare food conserve the most energy. Is microwaving your food the most environmentally friendly thing you can do? Clearly, locavores and greens are focusing on the wrong part of the food production chain to wring energy savings out of. The urban farmer/locavore/foodie aesthetic is a high status one though; the Walmart shopper/microwaver is not.
The piece closes with this paragraph which I will second and should be repeated to urban farmers everywhere:
The best way to make the most of these truly precious resources of land, favorable climates and human labor is to grow lettuce, oranges, wheat, peppers, bananas, whatever, in the places where they grow best and with the most efficient technologies — and then pay the relatively tiny energy cost to get them to market, as we do with every other commodity in the economy. Sometimes that means growing vegetables in your backyard. Sometimes that means buying vegetables grown in California or Costa Rica.
Reading David Post and Matt Yglesias on copyright and artists has me thinking about the popular justification for copyright laws in contrast to the economic justification.
The economic justification is that free markets will not provide enough profit for artists to undertake some projects for which the social benefits of doing so outweigh the costs. Optimal copyrights will compensate artists just enough so that they are willing to create the works, anything above that is inefficient rents* (you hear that Metallica!).
The popular justification seems to be more about maintaining some “fair” balance between consumer surplus and producer surplus. The measure usually being that people who create things that generate a lot of social benefit (e.g. they write hits) deserve to get proportionally rich. Even after the artists are dead people feel that the benefits should flow to his children, wife, estate, etc. in proportion to the social benefits. This, I suspect, is simply the status quo bias. In this country artists who create very popular art have tended to get very rich from it, ergo we have come to see this as the “fair” outcome.
People seem much less concerned that the payment to roadworkers be in proportion to the benefit that society gets from that roads they created, and that the payments continue to flow long past when the work is done. The same is true of the designers of those roads.
Why should we be disproportionately concerned about artists ability to capture economic rents? Why should we be concerned about the ratio of producer to consumer surplus in the arts and not for other workers? Wouldn’t we be better off in a world full of middle class artists but more art?
This, to me, seems like yet another area for liberaltarian agreement.
*For more on this, see Alex Tabarrok’s “Patent Theory versus Patent Law”.
Is it surprising that conservatives don’t complain more about occupational licensing? On the one hand it’s not, because economists themselves don’t seem to think it’s much of a big deal. In their 2009 paper, Morris Kleiner and Alan Kreuger point out that since 2000 no articles on the issue had been written in what are considered some of the top economic journals: AER, JPE, QJE, Econometrica. In the leading labor economics journals, Industrial and Labor Relations Review and the Journal of Labor Economics, only one article on had appeared. In contrast, there were 16 articles on labor unions in just those labor journals. In a survey of five labor economics textbooks Stephenson and Wendt found that occupational licensing took up a combined total of 10 pages, whereas there were 7 chapters on unions. Clearly the profession is neglecting the issue, so why shouldn’t conservatives?
On the other hand, we have the following graph which shows unionization versus occupational licensing using data from Morris Kleiner*:
Over the last 70 years, occupational licensing come to dominate unionization as a labor market restriction, with growth in the former accelerating in recent years. The most recent estimates are that 30% of the labor force is required to have occupational licensing by a government agency, compare to around 13% that are unionized. Estimates of the impact of licensing on wages are about 10% to 15%, which is comparable to the typical estimates of the union wage premium.
So occupational licensing has the same affect on wages and is more pervasive than unionization; this tells me that conservatives should care a lot about. So why don’t they? One reason may be that they believe licensing increases quality. As I wrote yesterday, in my post on why liberals should care about occupational licensing, the evidence suggests this is not the case. But I don’t think this fact is generally appreciated.
One explanation is that, in contrast to unionism, licensing typically requires workers to jump through some impressive, expensive, and time consuming hoops, which certainly makes it seem like it should increase service quality. Also, one can certainly imagine that for many occupations there is some theoretically optimal non-zero level of licensing, but that public choice problems –highlighted here by Matt Yglesias– make that impossible.
Many conservatives may not grasp the public choice problem, and instead have too much trust in the institutions that set licensing standards. But these are mandatory government institutions, which conservatives should be skeptical of and instead favor free market, optional ones. At the very least they should favor mandatory testing, registration, and certification which allows people to work in an occupation even if they fail, but without the “Government Certified” stamp of approval.
Dean Baker’s hypothesis is that conservatives, journalists, and other professionals not complaining about occupational licensing is about class; specifically, the professional class. He argues that “free traders” only want free trade in low-skilled labor, and not high-skilled labor like doctors and other professionals. This is why they don’t complain when trade agreements come with restrictions on professional labor markets, like those on foreign doctors, but they do complain when they come with restrictions on low-skilled labor.
Even more puzzling, he argues, is that people are more concerned about restrictions on low-skilled trade between countries than on high-skilled trade between states:
The “free-trade” crew want to have a single set of standards for all forms of merchandise traded all over the world, but it has apparently escaped their attention that a lawyer from New York can’t practice across the river in New Jersey.
I don’t necessarily believe Dean’s diagnosis that free-traders really want is “cheap nannies”, and that their motivations are selfish. For one thing he frequently charges journalists with this, but are governmental barriers even among the top 10 things stopping a significant number of immigrants from putting journalists out of jobs? I do think that there is some sort of professionalism bias occurring, but it’s a bias towards believing that high-skilled labor market restrictions are for everyone’s benefit, not just their own.
In any case, whatever their motivations I think conservatives should care more about occupational licensing because it prevents free trade between the states, increases protectionism in professional services, and is a labor market restriction that is as expensive as and more pervasive than unions.
My final comment in this two-part post on occupational licensing is that I would like to see the ideologically diverse individuals and institutions who oppose occupational licensing to work together on this issue. This could be co-sponsoring papers, panels, or entire research programs. Dean Baker at the liberal CEPR, many at the libertarian Reason Foundation, and Matt Yglesias at the liberal Center for American Progress are on the same side and have written passionately about this issue. So why not a CEPR, CAP, Reason joint research program on occupational licensing? Just give me a call when you start handing out research grants.
Did you know that you can’t tell the future in Maryland? I’m not saying that you are physically (or psychically) unable to peer into the future and divine important information for residents of the Chesapeake Bay State, but that you are legally forbidden from doing it unless you have obtained a license to do so. Most licensing is not as frivolous as the fortune-teller example, yet as Karl recently argued, many commentators who are otherwise concerned with bad government policy tend to ignore it. This appears to be a problem with both the left and the right, so I want to offer arguments for both liberals and conservatives that occupational licensing is worse than they thought. Today I will attempt the harder case of persuading liberals, tomorrow conservatives.
I think the liberal tendency tend to ignore or even outright support occupational licensing comes from two motivating beliefs: they envision it as a way to generate upward mobility and create middle class jobs, and they believe it to be effective way to prevent people -especially poor people- from being ripped off, injured, or otherwise done harm.
The appeal of licensing as a way to create better jobs is obvious. Making it harder to do a job certainly restricts supply, and so as you would expect the evidence has shown licensing increases wages. The evidence shows that, while the impact varies by occupation, the average increase in wages from licensing is 10% to 15%. So if licensing helps barbers get a 15% increase in his wages, then that can appear to be a desirable wage subsidy.
The first problem with this is that every occupational license that affects wages does so by limiting supply. This means that for every increase in hairstylist wages from licensing, there are would-be hairstylists thwarted and pushed into a lower paying job. In his book “Licensing Occupations: Ensuring Quality or Restricting Competition?”, Morris Kleiner uses state-by-state variations in licensing to show that employment growth for a given occupation is 20% higher in states where they aren’t licensed.
Furthermore, given that 73% of licensed workers have a college degree, and 44% have more than a bachelors, these higher wages will frequently come from the pockets of individuals with lower-income than those who benefit. Studies on the impact on prices of licensing generally find effects ranging from 4% to 35%, so the amount is significant. Increasing the wages of inner city barbers may be a good thing ceteris paribus, but in reality this happens at the expense of other inner city residents.
Another problem is that occupational licensing is often a tool with which one occupation fends off competition from another, usually lower wage, occupation. For instance, many states have regulations preventing dental hygienists from practicing without the supervision of a dentist. Dentists have an average of six years more schooling than a hygienists, who on average have 2.6 years of post high-school education. In addition, dentists make on average $100 an hour, and are 80% male, whereas hygiensts are 97% female and make around $37 an hour. Kleiner and Park find that these regulations transfer $1.5 billion dollars a year from hygiensts to dentists. This is a highly regressive transfer to a male dominated, higher educated, higher paid job from a female dominated, lower educated, lower paid job. In a very similar vein with likely similar impacts, many states restrict the ability of nurses to practice without the supervision of doctors. In fact these regulations are currently growing as regulators rush to restrict the number nurses working in retail health clinics in a variety of ways to prevent them from competing with doctors.
Considering all of the above ways in which licensing tends to benefit relatively higher wage individuals who on average have a college degree or more, it strongly suggests the impact of licensing is regressive.
The second motivation of liberals in supporting occupational licensing is that they see it as an important regulatory tool with which to protect consumers. I think part of the problem is that liberals tend to envision the debate in terms of the most extreme examples. The number one response I get from liberals when I criticize occupational licensing whatsoever is to say “what, and you think anyone off the street should be allowed to do brain surgery? Typical libertarian extremism”. But this is framing the issue wrong in two ways.
First, it is wrong to assume that in the absence of licensing occupations, these jobs would be practiced by Joe Schmoe off the street. College professors, for instance, generally do not face licensing requirements, and yet we don’t suffer from a scourge of colleges hiring high school dropouts to teach physics.
Second, the options are not just occupational licensing or absolute laissez faire. It’s best to think of licensing as existing on a spectrum of occupational restrictions that range from very heavy, like the government defining who, what, and how very specifically, to exceedingly light, like optional registration. Liberals can support moving down this ladder without believing we need to get off it entirely.
For instance, instead of occupational licenses, governments could mandate testing, and offer certification for those who pass and have some set of qualifications. They could also allow private groups to offer alternative, competing certifications. Consider how much we have benefitted from the alternative certification process of Teach for America. In addition, there are variety of ways to have less restrictive occupational licensing, which the differences between states shows. After all, the empirical literature on this topic can exist because states vary greatly in the extent of licensing. Indiana has around 11% of it’s workforce licensed, while California has 30%. If all states moved towards regulatings more like Indiana it would be an improvement without requiring any sort of radical libertarian experiment.
Another problem with occupational licensing as a regulatory tool is that there is a lot of evidence that it does nothing to increase quality. One strain of research shows that malpractice insurance premiums aren’t lower in states with occupational licensing, which you would expect if licensing was increasing service quality. Other evidence comes from research into the effectiveness of nurses in providing primary care services, which has shown they do no worse than doctors. Still other research shows that licensing and certification for teachers does not increase outcomes. While the set of occupations which are licensed is broad, and the evidence for many jobs limited, the balance of the literature on licensing suggests it does not increases quality. Part of this is probably because, as discussed above, in areas where there is no licensing other mechanisms arise or be mandated to ensure quality can be monitored.
Not only does it licensing increase quality of services performed, but for many individuals it may price them out of the legal market and into black markets or performing the services themselves. This means people doing their own plumbing or, like Matt Yglesias, giving themselves haircuts, because licensing pushes prices higher than consumers are willing to pay. Potentially worse, low-income individuals may simply forego these services, causing more damage in the long-run… well, not for haircuts.
A great example this comes from underground dentists who operate in dirty basements using unclean equipment. Here is a description of what this looks like in New Jersey:
They set up their shingles in dingy basements, garages and spare rooms in apartment buildings across New Jersey.
The equipment includes seating ripped out of cars, rusty tools to probe inside mouths and soda bottles to dispose of spittle…
In Union City last summer, Luis Eduardo Gallo-Enriquez walked into a small office one floor below the waiting room of a licensed dentist, looking sweaty in muddied jeans, according to one of his patients. Gallo-Enriquez, a 45-year-old Ecuadorean native, was more than an hour late for an appointment but proceeded to charge the 25-year-old Secaucus woman $600 to apply her braces — using rusty tools and no X-rays or dental impressions — and put her on a monthly payment plan.
When she contacted him about a problem she was having with a chafing wire, he told her he had set off on a Caribbean vacation and advised her to trim the wire herself with a nail clipper, assuring her, “I tell this to people all the time,” she recounted.
Operations like this would be drummed out of business by other low-cost models if licensing were weakened. Think dentists in Walmart. Forcing transactions into the black market also prevents the other quality improving institutions, like credentialing, malpractice, and independent review organizations, from functioning. Word of mouth doesn’t even work as well when a service is illegal.
One last cost of licensing that will bother liberals is that by being issued at state, county, and even city levels, it decreases geographic mobility. A barber licensed in one county may have to jump through all sorts of hoops to practice in another, which will increase their cost of moving.
Overall I think that occupational licensing is something that liberals should care about, and that reducing it would particularly benefit low-income individuals. If more liberals were involved in criticizing licensing then the conversation would not so often end up with libertarians arguing for more extreme reforms like the removal of all legal requirements for doctors, and instead would focus on more pragmatic solutions like figuring out how we can all be more like states like Indiana, and how to encourage alternative credentialing institutions that allow more flexibility.
The post-housing-bubble narrative has been that the unsustainability of prices was obvious ex ante, and so we should be able to call them in the future. This to me seems to be a bit of hindsight bias, but it is always difficult to make a case that claims which turn out to be ex post false were nevertheless ex ante reasonable. Kristopher Gerardi, Christopher Foote, and Paul Willen have a new paper out that I’ve been waiting for someone to write. They go through pre-collapse claims of the housing pessimists, optimists, and agnostics, and evaluate not just who was write and wrong but which beliefs where obviously right and which were debatable. This is a fun and accessible paper starring a well-known cast of characters, with prominent roles for Paul Krugman, Dean Baker, and Robert Shiller, and a quick cameo by The Economist, Calculated Risk, and John Cassidy. I strongly recommend it.
Rereading the cases of the optimists and the agnostics should be a reminder to those who claim to have identified the bubble, and also argue for the identifiability of future bubbles, with a high degree of confidence. The burden of proof on those making those claims is to argue convincingly against, for instance, Himmelberg, Mayer, and Sinai who argue that you can’t just look at price to rent ratios, but must consider changes in the user-cost of housing.
Even more prominent than the housing optimists are the housing agnostics. Rosen and Haines argued that the academic consensus on the issue was that the relationship between prices and fundamentals was sound, and that overpriced markets, if they existed at all, were limited. The authors find that the beliefs of agnostics can be summarized in this quotation from Davis, Lenhart, and Martin:
If the rent-price ratio were to rise from its level at the end of 2006 up to about its historical average value of 5 percent by mid-2012, house prices might fall by 3 percent per year, depending on rent growth over the period.
There is a tendency to call anyone who bought a home during the late stages of the bubble “irrational”, because prices were obviously unsustainable. But as the authors point out, the consensus of economists gave no indication that this was the case, and so behaving as if it wasn’t was quite reasonable for non-experts. Of course, pointing out that current prices were justified by fundamentals does not rationalize a 120% LTV negative amortization mortgage.
To those who simply point to lower lending standards as sufficient proof for a bubble, the authors offer this:
Did lax lending standards shift out the demand curve for new homes and raise house prices, or did higher house prices reduce the chance of future loan losses, thereby encouraging lenders to relax their standards? Economists will debate this issue for some time. For our part, we simply point out that an in-depth study of lending standards would have been of little help to an economist trying to learn whether the early-to-mid 2000s increase in house prices was sustainable. If one economist argued that lax standards were fueling an unsustainable surge in house prices, another could have responded that reducing credit constraints generally brings asset prices closer to fundamental values, not farther away.
I believe the case for humility about the obviousness and knowability of bubbles is underappreciated. Many, I’m sure, will simply point to the pre-bubble agnostic consensus of economists as more evidence that economists are rational expectations obsessed, over-mathematized fools who don’t know what they’re doing. I think they would benefit from a close reading of this paper.
Here you can find the paper whose abstract contains this sentence:
“To overcome endogeneity, we draw on a quasi-natural experiment in German history and exploit the exogenous spatial distribution of baroque opera houses built as a part of rulers’ competition for prestigious cultural amenities.”
The title is “The Phantom of the Opera: Cultural Amenities, Human Capital, and Regional Economic Growth”.
It is a common and poor framing of the question to ask whether uncertainty is causing our current economic woes. Just as the path of GDP is more volatile and difficult to forecast than in stable growth years, the path of individual firm sales is similarly more volatile and uncertain. More uncertainty will make households and businesses save more and invest and spend less. There is nothing controversial here. The debate is about the cause of uncertainty, and here I see a troubling correlation between what people think the current villain is and what their non-recession bugaboos are. The narratives struggling to tie the current economic woes to long-run stagnating wages, an undereducated workforce, and anything Democrats do strike me as a tenuous stretch and reflect our tendency to need a compelling narrative when easy explanations do not present themselves.
I think a good test for yourself is to ask “what problems do you think are important today that you didn’t think were important in 2004, and what policies would you favor now that you would have opposed then?”. My answer is that low house prices are a problem today where I would previously said low prices are just transfers from sellers to buyers, and I would favor policies that prop them up when I would previously have opposed them. What are yours?
In response to Tyler Cowen’s semi-praise for job saving programs, Arnold Kling has this wisdom for us:
On the larger point, keep in mind that in an ordinary non-recession month 4 million jobs are destroyed and about 4.2 million jobs are created. Suppose that in a bad month of a recession, 4.0 million jobs are created and 4.5 million jobs are destroyed. Which of those 4.5 million jobs ought to be saved, because they might come back in a stronger economy? No one in Washington knows.
Modeled Behavior 