Monthly Archives: April 2015

Robert Solow on Sustainability

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A commenter points to a talk from 1991, in which Solow says,

Once you take the point of view that I have been urging on you in thinking about sustainability as a matter of distributional equity between the present and the future, you can see that it becomes a problem about saving and investment. It becomes a problem about the choice between current consumption and providing for the future.

The reader recommended the article for this quip:

It is very hard to be against sustainability. In fact, the less you know about it, the better it sounds.

I recommend the entire article to readers of this blog and indeed to any student of economics. In fact, I would like to hit every graduate school economics professor over the head with it and say, “This is what you should be aiming to enable your students to do when they get their Ph.Ds.”

Solow deals with the concept of sustainability not with a formal model but with a philosophical examination. It is this ability to think like a philosopher that was lost when MIT transformed economics. Ironically, Solow aided and abetted the transformation.

Solow was my dissertation adviser. Although we have grown apart ideologically, my macro memoir explains how I was drawn to him in the late 1970s:

Unlike many of my fellow students, I am not inspired by Dornbusch and Fischer. I do not see the benefit of writing down equations to solve long-term optimization problems as a way of understanding macroeconomics. To me, too much economic relevance is being sacrificed to the altars of mathematical rigor and rational-expectations dogma. That assessment puts me hopelessly out of step with where academic macroeconomics is headed. It binds me to Solow.

Brad DeLong on the Public Sector vs. the Private Sector

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He writes,

Now we know that as bad as market failures can be, government failures can be worse. We badly need new effective institutional forms. But the decreasing salience of “Smithian” commodities in the twenty-first century means that rational governance would expect the private-market sphere to shrink relative to the public.

Pointer from Tyler Cowen.

I think of Brad DeLong as a Jekyll-Hyde character. The bad Brad DeLong snarks and snarls. The good Brad DeLong is insightful. This post is the good Brad DeLong. Read the whole thing. I am only commenting on part of it now. I would like to comment more on his discussion of the risk premium, but I think I need to see a longer, less hurried version of it.

In the quoted passage, his point is that as the share of the economy that produces stuff decreases and the share that provides health care, education, and information increases, we will see more informational asymmetries and externalities. This might mean that we need an expansion of existing government. However, when I think of “new institutional forms,” I think of the organizations of civil society and entrepreneurs.

Recall that Tyler and Alex see informational asymmetry being conquered by the Internet and entrepreneurs who make use of it. Recall also my comments on reputation systems as regulators.

Recall also my catch-phrase: Markets fail. Use markets.

Self-Control and Unemployment

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Jason Collins passes along this not-surprising result from a study by Michael Daly and others.

Analyzing unemployment data from two nationally representative British cohorts (N = 16,780), we found that low self-control in childhood was associated with the emergence and persistence of unemployment across four decades. On average, a 1-SD increase in self-control was associated with a reduction in the probability of unemployment of 1.4 percentage points after adjustment for intelligence, social class, and gender. From labor-market entry to middle age, individuals with low self-control experienced 1.6 times as many months of unemployment as those with high self-control.

This is one reason that it will be difficult to disentangle the effect of single parenting on economic outcomes. If parents of out-of-wedlock children have less self-control than married parents, and if self-control is somewhat heritable, then one could observe poor outcomes for children of single-parent families even if the family environments are not a problem.

Four Forces Watch: Poor Children Have Smaller Brains

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The Washington Post did not put this story on page one.

>New research that shows poor children have smaller brains than affluent children has deepened the national debate about ways to narrow the achievement gap.

Most of the story goes with the assumption poverty causes smaller brain size. But amazingly enough, the story also includes this alternative interpretation:

But James Thompson, a psychologist at University College London, has a third theory.

“People who have less ability and marry people with less ability have children who, on balance, on average, have less ability,” he said. Thompson noted that there is a genetic component to intelligence that Noble and Sowell failed to consider.

“It makes my jaw drop that we’ve known for years intelligence is inheritable and scientists are beginning to track down exactly how it happens,” Thompson said. “The well-known genetic hypothesis has not even had a chance to enter the door in this discussion.”

The story also quotes Charles Murray.

“I would be astonished if children’s brain size were NOT correlated with parental income. How could it be otherwise?”

The politically correct presumption would be that the brain size of poor children can be increased using some government programs. Can we verify that by comparing brain sizes of identical children raised apart? Or by comparing brain sizes of children randomly chosen for pre-school programs with children from a control group?

Murray has more commentary here, including a historical scientific controversy over whether there even exists a relationship between brain size and intelligence among humans.

Do I Heart Elizabeth Warren?

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Simon Johnson writes,

Senator Warren puts forward two main sets of proposals. The first is to more strongly discourage the deception of customers. This is hard to argue against. Some parts of the financial sector are well-run, providing essential services at reasonable prices and with sound ethics throughout. Other parts of finance have drifted, frankly, into deceiving people – on fees, on risks, on terms and conditions – as a primary source of profits. We don’t allow this kind of cheating in the non-financial sector and we shouldn’t allow it in finance either.

…The second proposal is to end the greatest cheat of all – the implicit subsidies received by the largest financial institutions, structured so as to encourage excessive and irresponsible risk-taking. These consequences of these subsidies have already caused massive macroeconomic damage – this is why our crisis in 2008-09 was so severe and the recovery so slow. Yet we have made painfully little progress towards really ending the problems associated with some very large financial firms – and their debts – being viewed by markets and policymakers as being too big to fail.

Pointer from Mark Thoma.

It may seem surprising that I agree with Senator Warren on both of these points. However, I disagree that the Consumer Financial Protection Board is taking the best approach to solving the problem of skilled financial firms exploiting less-skilled consumers. As I wrote here,

Regulated industries are always ready to complain about the cost of complying with bright-line regulations. However, I have the opposite objection. Particularly when it comes to the financial sector, compliance with BLR is far too easy. The bankers are always able to outmaneuver the regulators, staying within the letter of the rules while mocking their spirit.

That essay is where I proposed principles-based regulation as an alternative.

The Case for Taxing College Endowments

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Jorge Klor de Alva and Mark Schneider make the argument.

many of the richest universities in the country–sitting on hundreds of millions, if not billions, of dollars in tax exempt endowments, and garnering tens of millions of dollars of tax deductible gifts every year–receive government subsidies through current tax laws that dwarf anything received by public colleges and universities, institutions that educate the majority of the nation’s low- and middle-class students. For example, we estimate that in 2013, Princeton University’s tax-exempt status generated more than $100,000 per full-time equivalent student in taxpayer subsidies, compared to around $12,000 per student at Rutgers
University (the state flagship)

However, the flaw is not that rich educational institutions benefit more than other educational institutions from tax exemptions. The flaw is that our tax system has designated certain institutions as morally superior to others because they claim non-profit status.

The essay that I wrote on this topic is one of my favorites.

Other tax issues might be moot if instead of taxing income or profits we shifted to a tax on the consumption of goods and services. Such a tax system would place profit-seeking firms and nonprofits on an equal footing. It would continue to exempt donations from tax, but it would equally exempt other forms of saving and investment.

The Fed as Shadow Bank

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What would you call an institution that holds a portfolio of mortgage-backed securities and government bonds, funded mostly by overnight borrowing at an annual interest rate of 0.25 percent?

If Goldman Sachs or Citadel (a hedge fund) did that, we would call it “shadow banking.” That is, the institution is engaging in maturity transformation without being regulated as a bank.

And that is the Fed as it operates today. It pays 0.25 percent interest on “reserves,” which is just a way of saying that the Fed is borrowing at 0.25 percent to fund its portfolio.

It may be worth spending some time thinking about the Fed as just another shadow bank. When other shadow banks do what the Fed does, we call it portfolio management or carry trading or riding the yield curve. We don’t use mumbo-jumbo like “monetary policy” or “inflation targeting” or “quantitative easing.”

The Fed’s role as a shadow bank was less obvious back in the days of textbook central banking, with the Fed’s liabilities consisting of non-interest-bearing reserves and currency, and its assets consisting of short-term T-bills. (Actually, the textbooks had it wrong. The assets were repo loans. The Fed has always been a big player in the Gary Gorton shadow-banking poster child known as the repo market.) Still, I think that if we had always thought about the Fed in terms of shadow banking we would have been on the right track.

Some people call the classic Fed liabilities “money” or “high-powered money.” But I do not find that so exciting. In my view, the market decides what to use as money.

I tend to think that shadow banking affects the economy. As with other forms of banking, when there is more of it, credit conditions are looser, and this makes it easier for businesses to keep experiments going. This can be a good thing–if enough experiments turn out well. It can be a bad thing–if the experiments include too many ideas that are not really sustainable.

However, banking and shadow banking that is centered around portfolios of government securities does nothing to help credit conditions for businesses. It just facilitates crowding out.

So what could be wrong with holding the view that the Fed has never been and never will be something other than just another shadow bank? Most economists would argue that the Fed did important things in the 1970s and 1980s. In the 1970s, it was too loose and we got inflation. In the early 1980s it tightened and inflation went away.

I would say that we could just as easily blame the rest of the shadow banks. Who was it that kept long-term interest rates below inflation in the 1970s? Who was it that made long-term rates shoot up in the early 1980s? I think that one can defend the notion that it was the rest of the shadow banks that did that, and the Fed just kind of followed along.

The Economics of Sustainability

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George Leef writes,

The sustainability movement isn’t interested in the kind of analysis that scholars bring to controversies. It wants zealots, such as the “eco-reps” now employed on many campuses to push the agenda. Recycling, for instance, is always advanced as an imperative for saving the planet. There are trade-off questions about recycling that have caused many people to conclude that its costs often exceed its benefits, but students are not encouraged to think about them.

It strikes me that introductory economics teachers need to include some thoughts on sustainability. Here are mine:

1. The most reliable indication of sustainability is the ability to make a profit at unsubsidized market prices.

2. When people disagree with the market’s judgment, there is a good chance that they are focusing on a cost they can see and ignoring a cost that they cannot see. For example, someone who argues that “eating local” is sustainable probably sees the cost of transporting food but does not see the cost of allocating land and water to inferior uses. Before modern transportation, refrigeration, and food preservatives, more of us “ate local.” Consequently, we wasted land near cities on farms, and that land now is used to house people or has been returned to wilderness.

3. If in order to get people to recycle you need to use subsidies or regulations, then that is a sign that recycling does not save resources and instead wastes them.

4. Remember that one of the laws of science is that in chemical reactions matter is neither created nor destroyed. There is a sense in which production of goods and services does not “use up” physical resources. Instead, it changes the form of matter from something that is relatively useless to something that is relatively useful.

5. The great industries of the world came about because entrepreneurs were able to take abundant, seemingly useless resources and make them valuable. Before internal combustion engines, oil was just annoying gunk. Before computers, silicon was just the main constituent in sand.

6. In a free-market economy, price signals tell consumers and entrepreneurs what can be wasted and what must be conserved. If property rights are clear and market prices are free to move, then there is no need to fear running out of any valuable resource.

7. Public policy is subject to public choice problems, including the bootleggers and baptists problem. I believe that the consensus now is that using corn to fuel cars is not sustainable. If a free market had experimented with using corn to fuel cars, the experiment would have failed and that would be the end of it. However, because there is now a substantial lobby for the ethanol mandate, government policy to enforce the use of corn to fuel cars remains in place indefinitely.

Properly taught, freshman economics has a lot of useful things to say about sustainability.

Kling’s Three Laws

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First, Tyler Cowen writes.

Cowen’s First Law: There is something wrong with everything (by which I mean there are few decisive or knockdown articles or arguments, and furthermore until you have found the major flaws in an argument, you do not understand it).

His other two laws are at the link.

Below are Kling’s three laws, but note that they come from Merle Kling, my late father, who taught political science at Washington University in the 1950s and 1960s. He called them the three iron laws of social science.

1. Sometimes it’s this way, and sometimes it’s that way.

2. The data are insufficient.

3. The methodology is flawed.

I do not claim to have three laws, although I think I could endorse both Tyler Cowen’s and Merle Kling’s. I am willing to stick up for the Null Hypothesis, although it is a hypothesis and not a law.

Paging Jason Collins

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Alex Tabarrok writes,

in the environment in which the mind evolved we often needed to accurately throw things but rarely needed to accurately drop things from moving objects. As a result, we developed excellent heuristics for throwing but not for dropping.

Yesterday, as I was taking a long bike ride, I thought to myself, my physique is much better suited to riding a bicycle than to running. Doesn’t that suggest that my prehistoric ancestors rode bicycles?

Anyway, I wonder if there is too much confirmation bias at work when we tell stories in which evolution explains what we are suited to doing and what we are not suited to doing.

[Update: Commenter Handle’s remarks, picking up on the bicycle example, are wise and worth reading.]