Monthly Archives: April 2015

Reading David Brooks on Character

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After downloading his new book, The Road to Character, I started by skipping to his concluding chapter, where he writes,

The things we call character endure over the long term–courage, honesty, humility. People with character are capable of a long obedience in the same direction, of staying attached to people and causes and callings consistently through thick and thin…They are anchored by permanent attachments to important things. In the realm of intellect, they have a set of permanent convictions about fundamental truths. In the realm of emotion, they are enmeshed in a web of unconditional loves. In the realm of action, they have a permanent commitment to tasks that cannot be completed in a lifetime.

…Wisdom starts with epistemological modesty. The world is immeasurably complex and the private stock of reason is small. We are generally not capable of understanding the complex web of causes that drive events. We are not even capable of grasping the unconscious depths of our own minds. We should be skeptical of abstract reasoning or of trying to apply universal rules across different contexts…The humble person understands that experience is a better teacher than pure reason. He understands that wisdom is not knowledge. Wisdom emerges out of a collection of individual virtues. It is knowing how to behave when perfect knowledge is lacking.

As to whether I will like the entire book, I am worried about two things.

1. The reviews I have read are bland and uninteresting. An interesting book should provoke interesting reviews.

2. My instinct was to skip over the meat of the book, which is his biographical sketches of people whose character he admires. When I get around to reading those, the question is whether I will find them rewarding.

Real Interest Rates and Secular Trends

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Commenter Handle writes,

There’s nothing an entrepreneurial employer can buy to augment his workers to increase their labor productivity. They’re no equipment or anything for him to invest in. There’s no point: labor productivity in NCH sectors cannot be increased.

Well, computers can increase productivity in health care and education, but I get the point. It’s not like you can buy equipment that makes humans 10 or 20 times more productive. Barring strong AI, the only way to make humans much more productive in the NCH sectors is to dramatically re-organize the process, and that does not require a big investment in equipment.

Another trend is the drop in labor force participation. If people do not want to work, then you do not have to buy equipment for them to work with.

But suppose that you could tell stories about trends that imply low interest rates. At some point, low interest rates should make capital projects really attractive. That leads me to the suggestion that risky investments still fact high interest rates, and it is only government debt that enjoys low interest rates. And that leads me to the further suggestion (which I think I can find in Rogoff) that government debt is crowding out investment.

Without government debt to work with, financial intermediaries would have to satisfy the demand for safe, liquid assets by undertaking maturity transformation and risk pooling. That is what financial intermediaries do. But with so much government debt awash in the system, the public’s need for safe, liquid assets is satisfied without financial intermediaries having to do any sort of transformation at all.

What’s Wrong with Keynesian Economics?

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It looks like I will be contributing to a set of essays on this topic. Here is what I am thinking of in terms of an outline.

1. What is Keynesian economics?

I think that there are two important versions. There is the folk Keynesianism of policy makers and journalists, and there is the academic Keynesianism of graduate school and peer-reviewed papers. When pressed to give a narrative interpretation and discuss policy, economists tend to fall back on folk Keynesianism. When other economist object to some basic flaws in folk Keynesian economics, macroeconomists fall back on academic economics. In Greg Mankiw’s terminology, the policy engineer does not make use of the scientific paper, but he can pull a copy out of his back pocket if somebody asks to see it.

What I call Folk Keynesianism is what is used in narrative interpretation and policy discussions. Spending creates jobs and jobs create spending. The Folk Keynesian economy is one in which the price mechanism for adjustment and clearing markets has disappeared. Instead, quantities determine other quantities.

The other version is what I call academic Keynesianism. Think of it as an attempt to introduce re-introduce prices into an otherwise Keynesian economy. You start with Hicks sneaking the interest rate back in as a determinant of investment. Then you have the Phelps volume sneaking the real wage back in as a determinant of employment. Then you have the Lucas critique, which is answered by bringing in intertemporal optimization. You end up with Blanchard’s “state of macro” paper.

2. What is the alternative?

PSST, of course, which interprets macroeconomic phenomena as the problem of coordinating in a world of very complex trading patterns. Compared with folk Keynesianism, PSST fails to offer as compelling a basis for a narrative interpretation and policy discussions. If you want a satisfying narrative that probably is false, then stick with Keynesianism.

3. What can we learn from the data?

There are at least two problems with macroeconomic data. One is the fact that it is non-experimental. We cannot test important hypotheses against one another. It is easy to impose competing narratives on the same data. I might also mention Leamer’s attempts to document patterns in the data.

The other problem is that the classification and aggregation of data is questionable. According to economic theory, education is an investment. But in the national income accounts, what consumers spend on education is called consumption. What government spends on education is government consumption. And even what businesses spend on training is not typically included in investment. If I buy a cell phone for my household, it is consumption. If my company buys me a cell phone, it counts as investment. Much of what is counted as labor income in the national income accounts is actually a return on investment. The concept of “the real wage rate” is ridiculous. Neither the numerator nor the denominator is the same across individuals. Aggregate productivity statistics are also ridiculous.

4. Where did Keynesian economics go wrong? I think it focused too much on (the lack of) price adjustment, and not enough on trial-and-error adjustment. And, more fundamentally, I think it errs by thinking in crude aggregate terms. The economy is not one giant GDP factory. It is a pattern of specialization and trade.

The Middle Man as Information Processor

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Suppose that I am one of three boys at a summer camp. Each of us receives an identical care package, consisting of two bags of pretzels and two boxes of apple juice. I like pretzels and apple juice, but boy A only likes apple juice and boy B likes only pretzels. I trade one bag of pretzels to A for two boxes of apple juice. I trade one box of apple juice to B for two bags of pretzels. [OOPS. This was backwards. I trade the apple juice to A and the pretzels go B] Everyone is happier after the trading, but I wind up with three bags of pretzels and three boxes of apple juice.

How did I end up with so much, without producing any apple juice or pretzels myself? What I did was process information. I used the information about the preferences of the other boys to make them better off while earning a profit for myself. Some further remarks:

1. Because the middle man is an information processor and not a producer, his role is often resented. People talk about eliminating the middle man. But you cannot eliminate the middle man without coming up with an alternative way to process the information.

2. There is a classic article by R.A. Radford, called The Economic Organization of a P.O.W. Camp. See also Michael Munger’s essay.

3. There is often competition, involving multiple middle men. They may use similar methods, or they may use very different methods.

4. Because they are information processors and because there is competition, middle men need to be mentally sharp.

5. Finance is to a large extent a middle-man industry.

The Central Principle of Economics

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Trade is almost always good.

I want to propose that as the central principle of economics. More on that in other posts. In this post, I want to talk about how trade might be bad or might be perceived to be bad.

1. If you hold a gun to my head and demand something, that is bad. In fact, I would say that does not even count as trade.

2. If I buy on the basis of fraud or deception, then the trade is bad. Florida swampland. Snake oil.

3. What if I was not deceived, but afterward I regret the trade? In 1964, the Chicago Cubs traded Lou Brock to the St. Louis Cardinals for Ernie Broglio. The Cubs came to regret that trade. I have made some investments that I regret. But in my view there is nothing unfair or morally wrong about trades that someone later regrets making.

4. What if you are in the desert in danger of dying of thirst, and I offer to sell you a bottle of water for $1000. Is that a bad trade? I would argue that what is bad is the circumstance in which you find yourself, but the trade itself is legitimate. I would argue that even more strongly in the case of buying clothing made in a sweatshop. Assuming that the worker chose to work in a sweatshop over other alternatives that were worse, it is not a bad trade. For more on this issue, I recommend this podcast with Russ Roberts and Michael Munger.

5. Is it bad to trade with people whose cultural or political views you dislike? A lot of people feel that way, but the opposite might well be true. Suppose that you choose to trade solely on the basis of profit. Clearly, that makes you better off. Also, by not discriminating against others on the basis of ethnicity or culture or politics, you are probably helping to make the world a better place.

6. In fact, trade is probably best when it is impersonal. The closer you are to a person, the more doubtful trade becomes. I would not recommend to parents that they pay children to help around the house. Instead, I would recommend telling children that you consider it their responsibility to help around the house (and being specific about what that means).

7. Trade involving a person’s body makes people squeamish. We do not want people selling themselves into slavery. Many people, although not all, oppose prostitution. Many people, although not all, oppose the sale of drugs like heroin or cocaine. Many people, although not all, oppose allowing people to pay for organs to be used in transplants. Among economists, there is more support for legalized prostitution, drugs, and a market for organs than there is in the general population.

8. It could be that one of the reasons that we rely heavily on third-party payments in health care is that we are squeamish about trade that pertains to the body. We prefer to think of the doctor as offering the gift of healing rather than as someone making a trade.

Hayek and Business Management

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Chris Dillow writes,

If extensive knowledge is possible, then bosses might be able to manage big companies well. If not, then centrally planned companies will be inefficient. Sure, perhaps competition will eventually weed out egregious incompetence, but market forces might not grind so finely as to eliminate all inefficiency

Pointer from Mark Thoma.

I cannot emphasize enough how much I agree with this. Because I spent 15 years in business, I got an opportunity to see large organizations close up. I saw that in a large business, the top management cannot keep track of more than about three major initiatives at a time. I saw that compensation systems have to be frequently overhauled, because employees learn to game any system that stays in place for more than a couple of years. I saw the “suits vs. geeks” divide, as specialists in information technology or financial modeling had difficulty communicating with executives who had only general knowledge.

The notion of large, efficient organization is an oxymoron. If you think that large corporations have overwhelming advantages, then you have explained why IBM still dominates the computer industry, while Microsoft and Apple never really got amounted to much of anything. I like to say that if you are afraid of large corporations then you have never worked for one.

Of course, large corporations do exist. That is because as clumsy as they are, they can still be less clumsy than the alternative, which is to break a corporation into a network of contractually related divisions. Nobel Laureate Oliver Williamson tried to address the issue of when to expect a market and when to expect a hierarchy. His answers do not really speak to me, but I do not claim to have better ones.

I do think that government often tilts the scale in favor of large organizations. The high fixed cost of regulatory compliance is one factor. Government has been a key customer in industries like aerospace, information technology, and finance, and the fixed costs of selling to government are very high, because of all of the hoops that you have to jump through.

Joseph Heath on the Roots of Conservatism

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He writes,

There is of course a much-observed tension between the cultural-evolutionary and the free-market versions of conservatism, particularly since the untrammelled free market is the most effective device for destroying traditional institutions that has ever been devised by man. Most of what cultural conservatives and religious fundamentalists hate about the modern world – the rootlessness, hedonism, crass commercialism, loose sexual morality, anti-authoritarianism, and general lack of discipline – is either a direct product of the market, or is a tendency that is dramatically amplified by it. What brings the cultural and the market conservative together is the conviction that these unplanned processes are better than the alternative, which is “social engineering” in the rationalist style.

Read the whole thing. I arrived at it starting from Alex Tabarrok’s link.

Thinking about the quoted paragraph in terms of the three-axes model, I would say that there is a tension about markets in the civilization vs. barbarism axis. A conservative would view productive work as civilized, and markets encourage productive work. However, a conservative would worry that consumer tastes are barbaric, and markets work to satisfy consumer tastes.

Another way in which the market process is civilized from a conservative perspective is that businesses fail. Failure builds character because it reinforces humility. It keeps us from developing too high an opinion of ourselves as individuals or of humanity as a whole. (David Brooks’ latest book, The Road to Character, which I have started reading, seems to stress humility.) In contrast, progressives seem to see government as a tool to eliminate all forms of failure.

Yuval Levin on the Roots of Conservatism

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He writes,

Conservatives tend to see the human person as an incorrigible mass of contradictions: a fallen and imperfect being created in a divine image, a creature possessed of fundamental dignity and inalienable rights but prone to excess and to sin and ever in need of self-restraint and moral formation. This elevated yet gloomy conception of man, deeply informed by the peculiar, paradoxical wisdom of the West’s great religions, sets conservatives apart from libertarians and progressives alike, and sits at the core of most conservative thinking about society and politics.

Don’t worry, he does get to civilization vs. barbarism.

A failure to initiate the next generation of children into the ways of civilization would not only delay or derail innovation but also put into question the very continuity of that civilization. This is why conservatives rarely imagine that our society is on the verge of utopia and frequently (perhaps too frequently) imagine it is on the verge of a breakdown. And it is a crucial reason why conservatives care so deeply about culture.

Another excerpt:

An enormous portion of the conservative worldview becomes clearer when we see the importance this view places on cultural continuity as a function of generational transmission—on the inescapable responsibilities human procreation imposes on each generation. An enormous portion of the progressive worldview becomes clearer when we see the degree to which it is shaped by a desire to be liberated from these obligations—and from the implications of the basic facts and character of human procreation. Many of what we loosely call the “social issues” in our politics involve debates about whether such a liberation is possible or desirable—whether the word choice can be poured like an acid over traditional social arrangements, burning all links of obligation and duty and making responsibility merely optional.

And another:

Conservatives tend not to share in the progressive confidence in technical expertise, doubting that any group of experts could ever have enough knowledge to pull off the feats of management and administration that the Left expects government to achieve.

I have not yet excerpted the parts of the essay that I like the best.

Several of the comments on the essay, many of them critical, are also worth reading. I think that these criticisms reflect the way that many on the right feel that they were “burned” by George W. Bush, who as a candidate appeared to embody many of the intentions of what Levin calls reform conservatism.

1. On domestic policy, what the Bush Administration considered to be tactical concessions turned out to be strategic defeats. No Child Left Behind is a poster child for that. This leads to a question of whether reform conservatism is feasible in practice, or whether it is doomed to founder on progressivism’s “home field advantage” in Washington.

2. Although as a candidate Mr. Bush scorned nation-building, he and other conservatives undertook a costly nation-building exercise in Iraq. Many people do not trust reform conservatives to exercise sound judgment and humility in dealing with barbarism beyond our shores.

I think that if reform conservatives want to overcome the skepticism of others on the Right, they will have to acknowledge this baggage and address these two concerns.

Interpreting Roland Fryer

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He is the latest winner of the John Bates Clark Medal. The announcement reads, in part

Roland Fryer in a series of highly-influential studies has examined the age profile and sources of the U.S. racial achievement gap as measured by standardized test scores for children from 8 months to seventeen years old. Fryer (with Steven Levitt) has shown the black-white test score gap is quite small in the first year of life, but black children fall behind quickly thereafter (“Testing for Racial Differences in Mental Ability among Young Children,” American Economic Review 2013). The racial test score gap is largely explained by racial differences in socioeconomic status at the start of schooling (“Understanding the Black-White Test Gap in the First Two Years of School,” Review of Economics and Statistics 2004), but observable family background and school variables cannot explain most of the growth of the racial test score gap after kindergarten. Fryer’s comprehensive chapter in the Handbook of Labor Economics (2011, “Racial Inequality in the 21st Century: The Declining Significance of Discrimination”) documents that racial differences in social and economic outcomes today are greatly reduced when one accounts for educational achievement gaps. He concludes that understanding the obstacles facing minority children in K12 schools is essential to addressing racial inequality. Fryer has taken up this challenge to study the efficacy of education policies to improve the academic achievement and economic outcomes of low-income and minority children.

His research has a lot of bearing on the Null Hypothesis. Some of his papers contradict the Null Hypothesis, and some do not.

It certainly is intriguing that the racial test score gap is low in the first year of life and rapidly rises early in the school years but that “observable family background and school variables cannot explain most of the growth of the racial test score gap after kindergarten.” Some possibilities:

1. The Null Hypothesis is incorrect, but the school variables that make a difference are subtler than what we now find to be “observable.” Some of Fryer’s other studies might lend some support to this, but other of his studies would not.

2. The Null Hypothesis is correct because test scores performance is dominated by non-school environmental factors.

3. The Null Hypothesis is correct because test score performance is dominated by genetic factors. Then the problem is to explain why the gap appears at age seven (say) but not at age one. The lack of any gap at age one might be due to tests not being able to discriminate ability as well at that age as at later ages. This would give rise to a measurement error problem, one which biases differences toward zero.

Incidentally, someone pointed me to the blogger Isegoria’s link to a journal article entitled Individual Differences in Executive Functions Are Almost Entirely Genetic in Origin. The article comes from 2008, and the finding of 99 percent heritability strikes me as ridiculous. My guess is that if the same person is measured for executive function by two different investigators, the correlation will not be anywhere close to 99 percent. I hereby invoke Merle Kling’s third iron law.

Throw Peer Review Under the Bus?

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From The Independent

Richard Smith, who edited the British Medical Journal for more than a decade, said there was no evidence that peer review was a good method of detecting errors and claimed that “most of what is published in journals is just plain wrong or nonsense”.

…Speaking at a Royal Society event earlier this week, he said an experiment conducted during his time at the BMJ, in which eight deliberate errors were included in a short paper sent to 300 reviewers, had exposed how easily the peer review process could fail.

Pointer from Jason Collins.

What might be better? Off the top of my head, I propose that:

1. No individual study should receive more than a page or two in a journal. Just explain the findings, interpret them, and put all of the methodological details and literature review on the author’s web page. Results from all such papers should be treated as “preliminary and unconfirmed.” Accept any study for publication, including studies with findings of “no significant effect.”

2. Longer articles should be survey articles that focus on studies that have been replicated and confirmed. The survey articles should also report on studies where attempted replication failed or the method was otherwise shown to be invalid.

3. Do not assign high status to researchers just because they get studies published. Instead, assign high status to researchers who attempt to replicate or otherwise confirm other studies and also to researchers whose work is cited favorably in survey articles.