What I want you to learn

One of our colleagues from another department was asking what we try to teach students in our core courses. Here is what I told him I want students to take away from econ 151:

Long-term economic growth is the consequence of division of labor, specialization, and exchange.

Just because both parties benefit from a transaction, they don't necessarily benefit equally. The distribution of the benefits of specialization and exchange depends on the relative power of the parties.

People's behavior is the consequence of both their preferences and their constraints. If you don't understand another's behavior, don't be too quick to attribute it to preferences or values. Look also at the choices they have. On the other side, don't attribute all behavior to economic incentives. Incentives matter, but values and preferences matter too--sometimes more.

Economic efficiency is desirable, but it is not the only thing we're looking for. We also want distributive justice, ecological sustainability, and caring relationships within the economy. Sometimes there are tradeoffs among these different goals. However, it is good also to look for ways to achieve more than one of them simultaneously.

When people disagree about public policy, it is usually not because they want to achieve different goals. More often they disagree about the analysis: that is, what policies will bring about the effects they desire. But these theoretical disagreements often have value judgments at bottom: What is a good theory? What drives human behavior? Can other people be trusted? It is here that "worldviews" matter.

Too long an answer, but as some great writer said, I don't have enough time to give you a short one.

No more executive bonuses!

I very much like the article in today's Wall Street Journal by Henry Mintzberg. I think he has the right idea. He sees the business firm as a community of people, and executives as leaders and members of that community. He also argues that the success or failure of a business can not be attributed to one or a few individuals with exalted titles. Under these conditions, bonuses can not be justified as in any sense deserved. Bonuses send the wrong message to employees, namely that their contributions to the firm don't matter. And bonuses create incentives for excessive risk-taking and short-term decision-making. It's better to loot the firm's intangible assets for short-term profit gains than to tend the business for a sustainable future.

Economists have a lot to answer for here, too. Once we began teaching that workers were interchangeable parts like machines, and just as replaceable, we opened the way for the idea that there is really only one person who counts in a business, and that's the CEO. While it may be a convenient way to model labor markets for some purposes, the unintended effects on business behavior, especially compensation practices, have been devastating. Not only the growing inequality of the American income distribution and American society, but also the modern wave of business scandals and the financial collapse of 2008 have their roots in this type of thinking. We need more people to say it out loud, as Prof. Mintzberg has.

I liked David Brook's framing of the health care debate as "The Values Question." He sums up the dilemma succinctly:

The bottom line is that we face a brutal choice.

Reform would make us a more decent society, but also a less vibrant one. It would ease the anxiety of millions at the cost of future growth. It would heal a wound in the social fabric while piling another expensive and untouchable promise on top of the many such promises we’ve already made. America would be a less youthful, ragged and unforgiving nation, and a more middle-aged, civilized and sedate one. [emphasis added]

I agree (mostly). He makes a strong assumption concerning the disastrous level of costs and drag on the economy from a revised health care approach. That may actually be the case, or it may turn out to be overstated. However, have we not also overestimated the boost to the economy of supply-side economics, and for that matter, underestimated the drag on the economy from the disparity in income and opportunity (e.g. lost H.C.)? I wonder, since we have erred on the side of allocation for so long, might it be time to err on the side of distribution and see what that might do for the well-being, and even productivity, of the nation? Is the choice between decency and vibrancy truly a zero-sum game?

A Dialogue on James K.A. Smith’s Account of Markets and Christian Desire

After reading James K.A. Smith's latest book: Desiring the Kingdom: Worship, Worldview, and Cultural Formation
I made some favorable comments about Jamie's argument that market participation may shape a set of desires which are contrary to, and in competition with, the desire for God. As is often the case, John was able to help me think through some of the issues, in the ensuing exchange (posted here with permission).

First, a summary of Smiths argument: modern consumer capitalism, by providing a set of practices, routines (or even liturgies) and images of an ideal life, is able to shape people's ultimate desires in harmful ways. People devote a large part of their life engaged in market activity at work and at the mall, and thus spend hours practicing consumption and profit maximization. Moreover, the most powerful media messages are ones focused creating the desire for a set of consumption goods that are necessary to achieve a certain lifestyle. In the end, this lifestyle, with all of the profiting and consuming that goes with it, becomes the ultimate vision of the good life that people adopt.

Now, John's comment:

My view on this radical orthodox approach to markets, values, and Christianity is that they have a mistaken understanding of how people operate in markets. They believe that people learn to maximize utility or profits or standard of living or something similar in the economy, and then bring that home. My view is that people have a set of beliefs that is their functional religion, and they operate out of that in all areas of their life. In my view, most businesses do not maximize profits. Many of them these days have a mission statement in which they describe a whole set of values that they try to fulfill. Same with individuals. We have plenty of evidence from behavioral economics that people are not "rational" in their economic behavior. You can find me advocating this position as early as "Stories Economists Tell" in 1988. It is also in my review essay on the Wealth, Poverty, and Human Destiny book that appeared in Faith and Economics: http://www.gordon.edu/ace/pdf/noelEtAlF04.pdf . (It starts around p. 67.)

My response:

I had read essay you linked to here about a year ago, but I had not connected those arguments to Jamie's work. I think that your response to this line of argument provides a nice dose of reality to a theory that over-simplifies the human condition. In my reading of Jamie's book, I kept thinking "this does not sound quite right" but could not put my finger on it. For that I thank you.

I do think that his argument might have merit in the following way: I do buy that the market system, and specifically the wealth of consumption options available to us today, makes a certain form of consumption-based idolatry especially easy to adopt. This, I think, is Jamie's main argument when he states that the market (or the mall) is the primary competitor with the church today for people's hearts. Part of what makes this type of idolatry easy to adopt is that consumption and shopping are increasingly a form of entertainment, but also because modern marketing really is pretty good at shaping people's desires.

One open question in my mind is whether all of this amounts to a re-shaping of people's "ultimate desires" or if we are simply moving around people's preferences for one set of goods/services over another. Jamie claims the former, if the latter is true, then modern consumer capitalism is much less pernicious.

John's response:

I used to be a follower of Galbraith on the issue of the effects of advertising, thinking that it really did shape preferences. Now I'm more inclined to think that the bulk of our purchases follow from a few very basic "lifestyle" decisions, and that advertising mainly influences teenagers who have a lot of discretionary income and are unduly sensitive to what is "cool." There's so much advertising now, especially on TV, that I don't even understand. It's not aimed at folks my age.

 

The CBO and Preventative Care

The Congressional Budget Office has a way of ruining a good party. Today they came out with the depressing argument that:

the evidence suggests that for most preventive services, expanded utilization leads to higher, not lower, medical spending overall.

My understanding of the history of the NHS in the UK backs this argument up. I believe that the cost of the service ended up being far higher than they anticipated due to increased demand swamping the benefits of preventative care. I could be wrong though.

That said, we need to figure out how to provide care for everyone, and it may be the spending more on preventative care is still the right thing to do. After all, if you can avoid ever getting sick, that is worth paying for, but if they are right, we will have to think more carefully about the financing of a public health plan.

More on health care

Several other reasons for high health care costs: *Consumers have limited information about prices charged by different providers, and about quality of different providers. *There is high concentration in some of these markets, particularly hospital care, insurance, and in some cases physician services (especially for specialties). The result is non-price competition which drives up costs. *Consumers receive their info about costs and benefits from providers, who often have an incentive to provide more procedures and visits. *Providers are required to provide uncompensated care, the costs of which are shifted onto paying customers. *The incentives are for uninsured individuals to skimp on preventative care and wait until they need high-cost catastrophic care. *The industry has been slow to adopt advances in information technology that have increased productivity everywhere else they have been applied. I think this has less to do with lack of cost-consciousness than with problems small providers have raising capital. I think the reform is aimed at addressing many of these problems. Some are directly addressed by, e.g., subsidizing info tech for providers, and doing more effectiveness research. But by getting everybody insured, the problems of uncompensated care and lack of prevention are reduced. My instincts are that this is a cost-saver, but as Steve says, it's an open question. I think you can buy a lot of generic statin for what a coronary-artery bypass costs. A universal mandate with limited community rating means much reduced administrative costs, which are ongoing. Competition is encouraged among insurers, who in turn use their market power to deal with the providers. We know this stuff works in other countries. We have by far the world's worst health care system, measured by cost-effectiveness. The only thing that prevents reform is our pride in refusing to learn from others who do it better. John Tiemstra

Health Care Costs and Reform

Here is my attempt to organize my thoughts about this health care reform debate.

As far as I can tell, the following are the main arguments for why health care prices are at current high levels. I am not certain each of them is true. Though all five arguments explain why the standard market forces that would normally exert downward pressure on prices do work as well in this context.

1. 1) Most consumers are insulated from the cost, true of those in most traditional insurance plans and government insurance.
   
2. 2) Consumers are unable to discern small variations in quality, so prices do not reflect marginal benefit.
   
3. 3) Due to lack of price-consciousness R&D is new-product focused not efficiency focused.
   
4. 4) Due to the lifecycle of medical procedures and drugs, a large portion of the best medical treatments are under patent, and thus subject to monopoly pricing.
   
5. 5) The government is unwilling to use its monopoly power in some market segments (medicare) to substantially limit prices. This is probably due to politics, the two main parties interested in medicare are health care providers and patients, providers care a lot about prices, patients do not care, because of #1.
   

Are there other major reasons for high prices that I have missed?

Total health care expenditures are a function of both price and quantity. Here are some reasons why quantity may be higher than optimal:

1. 6) We are rich, health care is a normal good.
   
2. 7) Americans are relatively unhealthy.
   
3. 8) Consumers are unable to discern small variations in quality, so they over-buy.
   
4. 9) Primary buyers (insurance companies) are not able to make choices about which treatments to pay for. I am not sure whether this is the result of regulation, competitive pressure, or some combination.
   
5. 10) The government is unwilling to use its monopoly power in some market segments (medicare) to substantially limit procedures. Again, this is due to politics, both providers and patients prefer that the government is less discerning.
   

The current major health care reform proposal has provisions to address #10 and #5, which is supposed to substitute for a solution to #8 and #2, by giving some government body (medicare advisory council) a mandate to make tough choices about care, and give them a tool called "comparative effectiveness review." It is not clear if this will change #9. If public and private insurance are supposed to compete, and it is competitive pressure that keeps private insurance from making tough choices, I suspect that the government's mandate to do so will only hinder its competitiveness, leaving us with rationing only for those in the Gov. insurance plan who cannot get private insurance.

Another argument is that providing care for everyone will result in healthier people, thus fixing #7 through preventative care. I suspect that the increase in cheap preventative care will be larger than the care that is prevented. This is an open question though.

Finally, there is hope that a government plan will be more efficient than a privately run plan because they don't waste money turning people away. I have seen a lot of debate go back and forth on this one and don't know what to think.

Bottom line: administrative cost savings may be a one-time decrease in expenses, and so this plan places all of our hopes for cheaper health care in the ability of the government to effectively ration treatment. It does nothing to address many of the root causes of the price increases.

The Case for Industrial Farming?

Blake Hurst, a farmer from Missouri, has written an interesting response to critics of industrial farming techniques. Michael Pollen's The Omnivore's Dillemma receives most of his criticism, and in the process he defends the farming practices, both for livestock and plants, that are widely condemned in a slew of recent books. I am not quite ready to give up on organic food altogether, but his arguments are good enough to make me highly uncertain – which, for me, is familiar territory.

Rationality and markets

I've now had a chance to read the article that Steve referred to in his post of June 24. I am not convinced by the claim that their evidence indicates that rationality is not required for market efficiency. The experiment on which this claim is based does not require the participants to access their own preferences or assess their own economic welfare. They are given reservation prices for a good that has no value to them at all (deliberately defaced baseball cards), and paid for making deals. They only way they could act "irrationally" in such circumstances is if they did not understand the instructions. The "equilibrium" that is reached is indeed the one the experimenters constructed, but it does not correspond to an efficient competitive market because information is limited (transaction prices are not publicly reported), and the law of one price does not hold. This experiment does not get at the psychological mechanisms that cause choices to depart from preferences, and preferences to depart from welfare. No conclusion about "efficiency" is warranted.

They use a separate but related experiment to determine if this "market experience" makes their subjects more rational, and conclude it does. The evidence seems to confirm this, but the effect is so small that I doubt it can be consistently replicated.

The canonical theory of consumer choice is a wonderfully flexible thing. It can be interpreted in such a way that it covers any conceivable behavior. The problem is that these interpretations empty it of content. It becomes a mere tautology, explaining nothing. I'm afraid that this paper is in the spirit of these tautological constructions of economics.

Love in Truth Part II: On Development

In the second section of Caritas In Veritate (Love in Truth) Benedict gives three requirements for true development: freedom, truth, and charity. This section forces the reader to think well beyond the notions of development that reign in economics and public policy.

First, his eloquent defense of freedom in development:

Integral human development presupposes the responsible freedom of the individual and of peoples: no structure can guarantee this development over and above human responsibility. The "types of messianism which give promises but create illusions"[38] always build their case on a denial of the transcendent dimension of development, in the conviction that it lies entirely at their disposal. This false security becomes a weakness, because it involves reducing man to subservience, to a mere means for development, while the humility of those who accept a vocation is transformed into true autonomy, because it sets them free. 

Here Benedict seems to be critiquing theories of development that are overly technocratic. It is probably not a stretch to say that China's experiment with forced communal agriculture falls under this category. It might also be fair to say that uncompromising capitalist reforms imposed on a population could also fall prey to this critique, if in the process people's freedom to preserve important traditions is sacrificed on the altar of lowering transaction costs.

Benedict's second requirement for development is respect for the truth of our vocation (to pursue development). This he explains in the following way:

the Christian vision has the particular characteristic of asserting and justifying the unconditional value of the human person and the meaning of his growth. The Christian vocation to development helps to promote the advancement of all men and of the whole man.

We cannot limit development to the traditional economic domain of increasing wealth and opportunity, nor can we be content to improve the lot of many at the expense of the few. Thus we cannot pursue development separate from a strong commitment to the value of each person, in their entirety, as God intended them to be.

The last requirement for development, charity, ties this discussion back to the previous section. Here he gives us the most beautiful passage thus far:

Underdevelopment has an even more important cause than lack of deep thought: it is "the lack of brotherhood among individuals and peoples"[52]. Will it ever be possible to obtain this brotherhood by human effort alone? As society becomes ever more globalized, it makes us neighbours but does not make us brothers. Reason, by itself, is capable of grasping the equality between men and of giving stability to their civic coexistence, but it cannot establish fraternity.

Benedict is calling us to fully engage both our heads and our hearts in our vocation, because our goal is not only to improve the material well-being of our fellow human beings, but to restore relationships.

This understanding of development is wonderful in its completeness and compassion, though the term "development" as it is commonly used in economics is much more limited. It may be fair to say that all of economics (or at least all of the interesting parts) fall under this definition of development, and this vision could provide a nice broad framework for Christian activity in economics.

Love in Truth Part I

I have started working through Pope Benedict's recent encyclical Caritas In Veritate (Love in Truth). He starts the letter with an introduction that meditates on the necessity of Charity and Truth in combination. One good quote:

A Christianity of charity without truth would be more or less interchangeable with a pool of good sentiments, helpful for social cohesion, but of little relevance.

This could be a mantra for Christian economists.

One of the themes of this introduction is to enlarge Christians' sphere of charity. Benedict states the problem as follows:

The risk for our time is that the de facto interdependence of people and nations is not matched by ethical interaction of consciences and minds that would give rise to truly human development.

Thus the problem is one of international social justice. He builds his case for social justice on the notion of "the common good:"

To take a stand for the common good is on the one hand to be solicitous for, and on the other hand to avail oneself of, that complex of institutions that give structure to the life of society, juridically, civilly, politically and culturally, making it the pólis, or "city". The more we strive to secure a common good corresponding to the real needs of our neighbours, the more effectively we love them.

And this common good is rooted in his definition of Charity:

It [charity] gives real substance to the personal relationship with God and with neighbour; it is the principle not only of micro-relationships (with friends, with family members or within small groups) but also of macro-relationships (social, economic and political ones).

The point here is that he will not allow an escape into personal-but-not-social virtue. We cannot settle for individual justice and not also justice in institutions:

This is the institutional path — we might also call it the political path — of charity, no less excellent and effective than the kind of charity which encounters the neighbour directly, outside the institutional mediation of the pólis.

So far so good. But to what degree are we justified in using the coercive force of the state as a means to be charitable and love our neighbor? He explicitly endorses the "political path" of charity, but does not justify the using the means of the state to make the overall system more just even when individuals are not willing to do so on their own. This is where things get messy. Perhaps this will come in the next section, perhaps someone will provide said justification in the comments section.

Working Paper: The Impact of Homework on Academic Achievement

I am nearing the point of submitting my job market paper for publication, and have a new draft of the paper. I also am testing out Academia.edu – a social networking site that links academics by institution, field, etc, and allows you to post papers. You can view/download my paper here.

New Experimental Evidence About Markets and Rationality

The paper that won the 2008 Arrow prize for senior economists looked pretty interesting, especially in light of John's arguments about the standard neo-classical assumptions. The article is available online here, though Calvin does not have access to the journal (which is a shame) but I have the article from inter-library loan if anyone is interested.

Here is the abstract:

Assumptions of individual rationality and preference stability provide the foundation for a convenient and tractable modeling approach. While both of these assumptions have come under scrutiny in distinct literatures, the two lines of research remain disjointed. This study begins by explicitly linking the two literatures while providing insights into whether market experience mitigates one specific form of individual rationality—consistent preferences. Using field experimental data gathered from more than 800 experimental subjects, we find evidence that the market is a catalyst for this type of rationality. The study then focuses on aggregate market outcomes by examining empirically whether individual rationality of this sort is a prerequisite for market efficiency. Using a complementary field experiment, we gathered data from more than 380 subjects of age 6-18 in multi-lateral bargaining markets at a shopping mall. We find that our chosen market institution is a filter of irrationality: even when markets are populated solely by irrational buyers, aggregate market outcomes converge to the intersection of the supply and demand functions.

The BofA-Merrill merger

Last night's installment of Frontline was designed to give Ken Lewis's point of view on the forced merger between Bank of America and Merrill Lynch. The point seemed to be that Lewis did what the government (Paulson and Bernanke) wanted him to do, even though he didn't like it, because it didn't look to him like it was in the best interest of BofA's shareholders. They even suggested (or had Maria Bartiromo suggest) that John Thain did the right thing by getting a good price for Merrill's shareholders. Lewis feels like he was punished for his good deeds--taking the TARP money and rescuing Merrill.

I find it hard to be sympathetic to either of these guys. As the story points out, toward the end of the negotiations, Thain was more concerned about lining his own and his buddies' pockets than anything else. And he was either willfully ignorant or deliberately deceptive about the depth of Merrill's problems. It seems to me that Lewis has no cause for complaint if he went into this knowing that the reason he was doing this was to save the financial system, and that he really had no idea how bad Merrill's balance sheet was. Lewis also knew that the Treasury stood ready to rescue his bank if the losses were large enough and, after all, he did have that TARP money. Nor is much said about the Treasury's efforts to find another buyer. I'm disappointed in Frontline. When are we going to get a documentary that takes a public-interest point of view?

Incentives for saving electricity

It is well-known that by far the cheapest way to save carbon emissions is energy conservation in homes. Yesterday's WSJ cites figures from McKinsey consultants suggesting that moving to energy-efficient home appliances saves about $108 for every ton of carbon emissions eliminated. This is what Frank Ackerman, in his new book Can We Afford the Future?, calls a "no regrets" option for reducing greenhouse gasses (pp. 56-60). So why isn't it being done? Ackerman points to the usual suspects: lack of information, lack of access to financing, and the effects of housing tenure. What it is not is lack of incentives. So as reported in the Journal, the approach of Rep. Peter Welch (D, VT) of offering tax rebates for homeowners and businesses to invest in efficiency is unlikely to have much effect. A serious communications and marketing program has a better chance of working. This is a case where behavioral economics has more to teach us than the standard model.

All of this raises questions for me about the "environmental Kuznets curve," the idea that as people get richer, they will spend more on environmental quality. Spending on the environment is what we used to call a "regrettable expenditure,"  like health care and security. It doesn't make us happier, just less unhappy. While we may be willing to pay more for such goods if the expenditures are collective (government spending or insurance), it is hard to part with this money on an individual basis. Nobody gets excited about buying a new water heater or changing to CFL or LED lighting, even if it saves money in the long run and reduces climate change as well. It doesn't make everyday life any nicer. The process has to involve changing people's values so that they can get really geeked about energy saving. I have discovered that on digital cable we have a whole channel devoted to this (grouped in there with HGTV, DIY, Create, and several other of my wife's favorites). Now if I could bring myself to watch it more....

Speaking of GM...

In the argument over who ruined GM, and whether it can be saved, I tend to view management as the key. Stuck in my mind I have a TV documentary I saw a long time ago. I don't remember who the executive was, or which company he worked for, but I remember his words. "The trouble with small cars is that you take out value faster than you take out cost." There you have it: a management philosophy that claims that to make a car smaller and more efficient, you have to "take out value." The opposite of the Toyota/Honda philosophy of putting as much value as possible into efficient cars. No wonder car buyers passed up Detroit offerings that screamed "CHEAP" and instead paid premium prices for Accords and Corollas.

Yes, Americans have a century-long love affair with the big, powerful, luxurious land yachts of the sort made by the Detroit Three. We also have a love affair with trains like the Century Limited and the Phoebe Snow, planes like the Lockheed Constellation and the DC-3, and luxury ocean liners like the Queen Elizabeth and the Titanic. You can still rent a horse-drawn carriage for an hour and take a romantic ride around downtown GR. But that doesn't mean that we prefer them to modern, efficient transportation for everyday use. When Detroit learns that, they'll be OK.

Is the canonical model "useful"?

At the ACE anniversary conference in April, I delivered a plenary address in which I argued that the standard, canonical model in economics is discredited, has been effectively abandoned for research purposes, and needs to be abandoned for teaching and prescriptive purposes too. My interlocutors made the claim that the model should be kept because it is "useful." For some, this seemed to mean that it is useful the way a map is useful, using abstract symbols to present a model of reality accurate enough to give directions to reach a goal. If you want to get from Waco to Houston, it will get you there. This seems to echo the famous statement of Robert Solow: "All theory depends on assumptions which are not quite true. That is what makes it theory." (QJE, Feb. 1956) Others claimed that without a general model that connected different phenomena together in a common causal framework, we would have no way to get a handle on what we know, and no framework for conducting research. Gabriel Martinez even made the remarkable claim that having a false framework is better than having no framework at all.

In that famous paper, Solow went on to say, "(I)t is important that the crucial assumptions be reasonably realistic," which he did not think was true of the Harrod-Domar model. A map is not useful if it puts the freeway exits in the wrong places, so that you think you are in Houston when in fact you got off in Galveston. The canonical model assumes perfect competition, which is a crucial assumption, and is not realistic. It answers questions (as Martinez said), but it gets the answers wrong. So the model predicts there will be equilibrium in labor markets, when in fact there is unemployment. It predicts the law of one price will hold, when it hardly ever does. It predicts that financial markets will be efficient, when in fact they periodically collapse. And it doesn't answer questions about some extremely important issues, like the size distribution of income or the optimal scale of the economy for ecological sustainability. It ignores the complexity of human decision-making, and the reality of economic power. This is not useful, but pernicious.

In my talk, I made some proposals about basic principles that a new economics should be founded on. But the frustration expressed with heterodoxy (by Robbie Mochrie and others at the conference) is that it doesn't offer a general, all-encompassing model. My claim is that we don't need one. Post-modern methodology suggests that they are dangerous anyway, but our research in economics is being guided by new questions, new techniques, and new basic principles that don't issue in a comprehensive mathematical construct, and we are still learning more every day. There is no shortcut to truth. Often you have to dig for it with your bare hands. The principles we need come from a basic biblical understanding of the nature of human beings, our relationship with God, and God's will for our relationships with each other. That will tell us where to dig.

The cost of the stimulus

There's been a lot of talk about how much the stimulus will add to the national debt, and how much it will cost the economy in the long run. It reminds me of something I read once in an old textbook. Who actually paid for WWII? Was it those of us who paid taxes to service the national debt in the succeeding decades? Well, if you really believe in the concept of opportunity cost, the war was paid for by the people at the time who did without cream for their coffee, gas and rubber for their cars (and new cars), nylon for their stockings, and so on. Did the war crowd out private investment that would have contributed to growth later on? Not really. The government built new plants that were given to private companies (e.g. Alcoa), and the twenty-year postwar boom is hardly evidence of crowding out during the war.

And what will be the opportunity cost of the current stimulus plan? If it works the way it should, nothing. The resources to be used would have been idle anyway. More investment is likely to be crowded in than crowded out—construction companies buying new cranes to work on those highways and schools. It's not like interest rates are going to go up much. The deficit might even be smaller than it would have been with a full-blown depression. If we pay for the extra spending by printing money that will be discreetly drained away later, or by selling government bonds with rock-bottom interest rates, there won't even be much effect on the nominal national debt. So I wish everybody would just quit worrying so much. If there's any case against the stimulus, it has to be about all the non-stimulating things that are in there, like AMT relief. But that's just political horse-trading.

The important thing is that fiscal policy and monetary policy are working together for once. When they don't, we have disasters. In this case, the fiscal stimulus to aggregate demand has to run parallel to the repair of the financial markets and aggressive monetary ease. One without the other won't do much good.

Krugman/Brooks on the Economy

Paul Krugman is at his best in yesterday's article – explaining real world economics in understandable ways. His article talks about how we can get out of this recession, and his analysis is not encouraging. Here is a nice passage that would be very helpful in an introductory macro class:

So will our slump go on forever? No. In fact, the seeds of eventual recovery are already being planted.

Consider housing starts, which have fallen to their lowest level in 50 years. That's bad news for the near term. It means that spending on construction will fall even more. But it also means that the supply of houses is lagging behind population growth, which will eventually prompt a housing revival.

Or consider the plunge in auto sales. Again, that's bad news for the near term. But at current sales rates, as the finance blog Calculated Risk points out, it would take about 27 years to replace the existing stock of vehicles. Most cars will be junked long before that, either because they've worn out or because they've become obsolete, so we're building up a pent-up demand for cars.

The same story can be told for durable goods and assets throughout the economy: given time, the current slump will end itself, the way slumps did in the 19th century. As I said, this may be your great-great-grandfather's recession. But recovery may be a long time coming.

David Brooks, on the other hand, in the aptly titled "Money for Idiots," makes the case for government intervention, and explicitly addresses the moral hazard problem involved with bailing people out when their problems are the result of bad choices:

The stimulus package handed tens of billions of dollars to states that spent profligately during the prosperity years. The Obama housing plan will force people who bought sensible homes to subsidize the mortgages of people who bought houses they could not afford. It will almost certainly force people who were honest on their loan forms to subsidize people who were dishonest on theirs.

And later:

These oscillations are the real moral hazard. Individual responsibility doesn't mean much in an economy like this one. We all know people who have been laid off through no fault of their own. The responsible have been punished along with the profligate.

It makes sense for the government to intervene to try to reduce the oscillation. It makes sense for government to try to restore some communal order. And the sad reality is that in these circumstances government has to spend money on precisely those sectors that have been swinging most wildly — housing, finance, etc. It has to help stabilize people who have been idiots.

I do not have much confidence in my own understanding of the macroeconomics involved, but it seems to me that the issues in these two articles are central to understanding the times we are in.

David Brooks on Urban Economics

I just had a little bit of a surreal experience reading Brooks' article today. I was expecting some behavioral economics or stimulas package concerns, but instead, I got to read an interesting reflection on urban economic trends, circa 2009, as well as (and this is the surreal part) his allusions to our (adopted) mother homeland - the Netherlands.

He hypothesizes that the economic crunch will get U.S. Americans back to thinking about an eco- and pocket-book friendly lifestyle - inner city, pedestrian/bicycle centered, etc., you know, like Amsterdam, he says.

"Well, Amsterdam is a wonderful city, but Americans never seem to want to live there. And even now, in this moment of chastening pain, they don’t seem to want the Dutch option."

He cites several conclusions from a recent Pew study suggest that, well, no really, we still want urban sprawl. We still want a spread out, car-dependent lifestyle, although now we want it with some scenic views - hence the preferences for Denver, San Diego, Portland, San Antonion, and the like. And, we still prefer McDonalds (for its drive-through, he takes that to mean) than to Starbucks (for its casual conversational, urban lifestyle I think he believes it stands for).

So, his conclusion is that:
"And that [McDonalds prefs > Starbucks prefs], too, captures the incorrigible nature of American culture, a culture slowly refining itself through espresso but still in love with the drive-thru. ...The results may not satisfy those who dream of Holland, but there’s one other impressive result from the Pew survey. Americans may be gloomy and afraid, but they still have a clear vision of the good life."

I had a different reaction to the Pew survey results. We are gloomy, afraid, and have a clear vision of the good life - for me - not for an entire community. We have a long ways to go before urban policies actually look at the effects of polices on the most vulnerable, too. Of course no one in the Pew survey wants to live in the city, who in their right mind, let alone those with kids, would want to live in the U.S. inner cities as they are now with horrible schools and crime poor infrastructure. They are the result of long years of tax and zoning polices that cared nothing about the effects on the community, only on the individual, and mostly the wealthy individuals, at that. And the point about McDonald's is not necessarily about drive-through. It is also an indoor playground that is actually one of the few places families can go with their kids and relax and be with other adults at the same time. Much more Amsterdam-like than what most of us would assume. (Yes, I admit, I have many hours of experience with that.)

Well, I have just about had all the news on the economy and the painful and confusing (to me) stimulus debate and bleary economic reality I can handle. When I need cheering up I often turn to Tom Bodett (yes, the Motel 6 guy). He's intelligent, funny, and helpful at telling the story of our realities in ways that make me smile rather than wince. Anyway, I really enjoyed and recommend his "Red State Blues" story (even thought is is a few years old), especially the line that seemed to explain why at the end of my week, after commuting back and forth soaking up my fix of NPR, I just don't have that spring in my step anymore...

Blue State people, on the other hand, chase their Zoloft down with iced chai while they listen to twelve hours a day of public radio programming which ceaselessly and thoughtfully points out in genteel and condescending tones that we are all pretty much screwed.

Of course, now, even the regular news concurs with that.

Taylor's analysis of the crisis

John B. Taylor of Stanford has an analysis of the financial crisis as an op-ed in today's Wall Street Journal. He is so anxious to prove that government action caused the crisis that he ends up not making  a lot of sense.

He claims the first mistake was excessive monetary ease during 2003-05, which created the housing bubble. Later on, he says it was a mistake to ease monetary policy after August 2007, a move he says created the short-lived bubble in oil prices in 2008. (How these bubbles get burst remains mysterious.) In standard monetary theory, excessive monetary ease is supposed to create inflation, i.e., a general rise in the price level, NOT a change in relative asset prices. General inflation remained remarkably tame throughout the decade. I hesitate to blame the Fed for bubbles it could not have reasonably foreseen.

Taylor also asserts that the problem in the markets was not liquidity, but rather counterparty risk. Therefore, he claims that adding vast amounts of liquidity to the system was the wrong approach. He seems to think there are two kinds of financial crisis that call for different policy approaches. I think he is wrong. All financial crises start off as a concern about the risks of dealing with certain counterparties. As the dominos fall and the list of toxic assets lengthens, the demand for liquidity increases, and things spiral downward from there. No matter how the crisis began, the demand for liquidity has to be satisfied before confidence can be restored and risky assets can begin trading at appropriate prices again.

I think he is also wrong about the low interest rates of the mid-aughts leading to excessive risk-taking. The standard theory of financial crisis suggests that high interest rates, not low ones, lead to greater risk. Moreover, the housing bubble contributes to the problem. 

But the main thesis--that the crisis was not caused by "any inherent failure or instability of the private economy"--is undercut by his own list of "complicating factors": the overuse of subprime and adjustable rate mortgages, excessively complex mortgage-backed securities, and irresponsible behavior by the ratings agencies. Add that to the unpredictable market bubbles in residential real estate and oil, and you have the recipe for disaster.

Teaching Institutionally?

David Brooks (yeah, I read him a lot) wrote another interesting article, this one about a book by Hugh Heclo titled On Thinking Institutionally. Brooks uses the following quote as a foil:

A few years ago, a faculty committee at Harvard produced a report on the purpose of education. "The aim of a liberal education" the report declared, "is to unsettle presumptions, to defamiliarize the familiar, to reveal what is going on beneath and behind appearances, to disorient young people and to help them to find ways to reorient themselves."

He then explains how "thinking institutionally" is preferable. It asks that people adopt the roles that are given to them within the institutions that they find themselves, and that they be faithful to their rules and obligations out of respect for those around you.

This made me think about some of the readings and discussions from the recently completed Kuiper seminar.

I am uncomfortable with the philosophy of teaching that the Harvard professor espouses. The "question everything" attitude is an academic mask that can be used to make cynicism look respectable. Academic work that is based on "unsettling, defamiliarizing, and disorienting" seems fundamentally destructive. It is easy to fall into the trap of teaching "critical thinking" as if it means tearing apart artifacts and taking them out of context, as if pulling apart someone's work into its smallest contemptible parts is the same as knowing it. This does a disservice to our colleagues, the material we study, and most importantly, it leaves our students empty.

Instead we should strive to embrace what Susan Felch has called a "hermeneutic of delight," in which we teach students to think carefully about an artifact by understanding it completely, approaching it charitably, and then finally searching for ways to improve it. The result is scholarship that is no less rigorous, and it is more complete. Most importantly it instills in students a sense of intellectual decorum that is often lost, and preserves wonder and hope. I suspect that this is what most good teachers do instinctively, though it does not seem to be the norm in the academy overall.

Back to Brooks' article: this "thinking institutionally" idea seems to be very compatible with a hermeneutic of delight. Instead of tearing apart conventions and institutions, we should always start by understanding how and why they were developed, how they are helpful, and only then, how they can be improved. I will try to teach public finance this way as we examine many different policies. It is easy to dismiss many policies as the result of this or that ideology which I reject, but that easily devolves into the cynicism that I would like to avoid.

Brooks on Economics

David Brooks' latest article for the New York Times is about economics and the recent crisis. I am very uncertain about his message, but I thought the last few lines were thought-provoking:

Right now political and economic confidence levels are running in opposite directions. Politically, we're in a season of optimism, but despite a trillion spent and a trillion more about to be, the economic spirit cowers. Mechanistic thinkers on the right and left pose as rigorous empiricists. But empiricism built on an inaccurate view of human nature is just a prison.