Monthly Archives: November 2015

My Macro Framework

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Scott Sumner and Tyler Cowen have given you theirs. Here is mine.

1. Ditch the concepts of aggregate supply and aggregate demand. Thinking of the economy as if it were a single business, what I call the GDP factory, is misleading. Also, there are two versions of aggregate supply, and no one can keep them straight. Version I treats the GDP factory as operating in a world without prices, or with fixed prices. Version II treats the GDP factory as operating with a sticky nominal wage, so that the profitability of output increases with price.

2. Instead, think of all recessions as adjustment problems. We are in a specialized economy, and at any point in time some people are employed in ways that do not earn a profit. These jobs are unsustainable, and the workers will be let go. Sometimes, the dislocation is temporary, and they can go back to their old jobs. But often the dislocation is permanent.

3. Arriving at sustainable patterns of specialization and trade requires two types of adjustment: static adjustment and dynamic adjustment.

4. Static adjustment means solving for the price vector that clears all markets. What I called Version II is an example of a static adjustment problem–getting “the” real wage to adjust the right level. This problem might exist, but I think it is at most one of many adjustment problems.

5. Dynamic adjustment means entrepreneurial trial-and-error to come up with businesses that employ otherwise-idle workers at a profit. Mathematical models are mostly focused on static adjustment problems, but I think primarily in terms of dynamic adjustment problems.

6. Adjustment is how we get out of a mess. How do we get into messes? To some extent, each unhappy economy is unhappy in its own way. But some elements that one tends to find include Minsky-Kindleberger manias and crashes, sudden changes in credit conditions, sharp movements in important relative prices (oil, home prices), and permanent shifts in the skill structure of work.

7. Kindleberger has a useful concept, which he calls “displacement,” which causes a large shift in wealth. For example, after a war, the winning side can feel wealthier. A bundle of technological innovations or new trading opportunities can have the same effect. The sense of increased wealth that arises from displacement can evolve into a mania. A decade after the end of the first World War, the U.S. experienced a mania. A decade after the end of the Cold War, the U.S. experienced first an Internet mania and then a housing mania.

8. Manias can create unsustainable patterns of specialization and trade and postpone the adjustment to deeper structural change. The mania of the 1920s helped to temporarily disguise the impact of the adjustment to the tractor, the truck, and the electric motor. Many jobs involving manual labor in factories and farms were becoming unsustainable. Ultimately, many of the new jobs were in wholesale and retail trade, but these jobs typically required a high school education. An important part of the adjustment process was that by 1950 a generation of poorly-educated workers had aged out of the labor force. Meanwhile, the U.S. experienced the Great Depression of the 1930s.

9. Similarly, the housing mania of the early 2000s helped to temporarily disguise the impact of the adjustment to the changes brought about by the Internet and globalization. Once again, the composition of the work force appears to be undergoing a shift, as signified by the low rate of labor force participation.

Questions for Garett Jones

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After a quick reading of Hive Mind. The core issue is what he calls the paradox of IQ. That is, among individuals, the correlation between IQ and income is modest. However, among nations, the correlation between average IQ and average income is strong.

How does your high IQ raise my income? Think of four possible explanations for this paradox.

1. Statistical artifact.
2. Proximity effect–I earn more income by living close to people with high IQ’s.
3. Cultural effect–people with high IQ’s transmit good cultural traits to me.
4. Political effect–having people with high IQ in my jurisdiction leads to me enjoying better government.

Can we rule out statistical artifact? Put it this way. Suppose we chose 1000 people at random. Then we create 50 groups of them. Group 1 has the 20 lowest IQ scores. Group 2 had the next 20 lowest IQ scores, etc. Then we run a regression of group average income on group average IQ for this sample of 50 groups. My prediction is that the correlation would be much higher than you would get if you just took the original sample of 1000 and did a correlation of IQ and income. I think that this is because grouped data will filter out noise well. Perhaps the stronger correlation among national averages is just a result of using (crudely) grouped data.

Can we sort out between proximity effects, cultural effects, and political effects? Perhaps a natural experiment involving people from different cultures living moving to different jurisdictions, or people living close to one another but having different cultures?

The most parsimonious proximity effect could be capital per worker. Assume that people tend to invest close to home (Jones calls this the Feldstein-Horioka effect when it applies across countries). Then if high-IQ people invest more wisely, then I will have better capital to work with if I live close to high-IQ people. Or if high-IQ people invest more (because, as Jones points out, they are more patient), then I will have more capital to work with if I live close to high-IQ people. How well does capital per worker serve as a channel for transmitting someone else’s IQ to my income?

Another proximity effect would be strong complementarity in team production (what Jones, following Kremer, calls the O-Ring effect). If the value of my output depends on the value of others in a team, then I will be better off living close to people with high IQ’s.

What happens when you divide the U.S. into fifty states and put teach state into the database with other countries? My guess is that Mississippi will look really good on average income relative to average IQ when you compare it with Denmark. If so, is that because of high capital per worker in Mississippi? A higher trust culture? Or better overall governance than Denmark?

Jaworski and Brennan on Markets in Everything

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Peter Jaworski and Jason Brennan write,

put philosophers out of the business of talking about the moral limits of markets. The interesting questions about markets are not what we may buy and sell, but instead how we should buy and sell it. Certain ways of buying and selling things might be wrong, but that does not mean the thing in question must never be bought or sold. Perhaps buying sex from a desperate woman exploits her, but that does not imply buying sex is always wrong — you could buy it from someone who is not desperate.

The title of their piece is, “If you may do it for free, you may do it for money.”

In The Secret of Our Success, Joseph Henrich endorses the view that traditional customs surrounding marriage and sex served to tamp down violence. In the absence of other cultural norms, the natural propensity of men would be to compete to have many wives, and this competition would be violent.

A lot of the cultural tension concerns what you may do for free. Extramarital affairs are still frowned upon. Norms about premarital sex appeared to loosen for a while, but perhaps the “yes means yes” movement can be viewed as a sort of backlash.

Perhaps some of the fear about allowing markets in sex is that what people can do for money might affect how other people who are doing it for free. For example, there are those who suggest that pornography has adverse effects on the way people behave in relationships.

Deirdre McCloskey Standing on One Foot

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She writes,

What made us rich are the ideas backing the system — usually but misleadingly called modern “capitalism” — in place since the year of European political revolutions, 1848. We should call the system “technological and institutional betterment at a frenetic pace, tested by unforced exchange among the parties involved.” Or “fantastically successful liberalism, in the old European sense, applied to trade and politics, as it was applied also to science and music and painting and literature.” The simplest version is “trade-tested progress.” Or maybe “innovationism”?

What made us rich are the ideas backing the system. And yet the ideas have always been under attack, and we seem to be undergoing a period in which they are attacked with great vehemence by some important elites.

What I’m Reading

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Hive Mind, by Garett Jones.

As far as I can tell, he and Joseph Henrich are unaware of one another’s work. Jones emphasizes what he calls the paradox of IQ. That is, although the correlation between IQ and income is only modest for individuals, it is strong for nations. Henrich, while not discussing this observation, offers an explanation, which is that intelligence is imparted by culture.

Interestingly, both Jones and Henrich make use of the correlation between test of reaction time and IQ tests. Jones says that this suggests that IQ must be an indicator, at least to some degree, of physiological differences among individuals, not just some specific test-taking ability. Henrich says that the comparable performance of chimpanzees and humans on reaction-time tests shows that superior human intelligence is probably more cultural than physiological.

Megan McArdle on Catastrophic Reinsurance

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She writes,

The government would pick up 100 percent of the tab for health care over a certain percentage of adjusted gross income—the number would have to be negotiated through the political process, but I have suggested between 15 and 20 percent. There could be special treatment for people living at or near the poverty line, and for people who have medical bills that exceed the set percentage of their income for five years in a row, so that the poor and people with chronic illness are not disadvantaged by the system.

This is part of asymposium to try to address the problem that pre-existing conditions pose for standard health insurance.

I strongly agree that a simple, minimalist government solution that leaves plenty of room for market innovation would be the best approach.

Online Education Do’s and Don’ts

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From Peter Navarro.

DO break each of the presentations up into short modules. A good guideline is that such modules should be 3 to 7 minutes, and never exceed that limit.

…Do NOT wing it. I always write scripts for everything I record either on camera or as voiceover—umms, ahs, and awkward pauses or rambling threads just don’t cut it with today’s discerning students.

This latter is a problem for me. On the one hand, I um and ah a lot, which argues for scripting. On the other hand, reading a scripted presentation is too boring for me.

In fact, if you ever encounter me giving a live event, you will find the prepared presentation disappointing and the Q&A to be the best part.

All in all, although I have done a lot of instructional Youtube videos, I do not believe that it is my comparative advantage.

Navarro adds this:

After cascades of student complaints, Coursera decided to experiment with the on-demand format, with me as one of their first guinea pigs. With this approach, eager beavers can now “binge” their way through my Coursera courses as fast as Netflix users have gone through a season of House of Cards. At the other end of this on-demand spectrum, slow pokes can turn a normal ten-week race into a six-month marathon—and thereby better avoid contributing to the high drop-out rate symptomatic of MOOCs

I really think that the issue goes beyond this. The idea of a “course” may be an unnatural construct in the on-line world. As a student, you tend to be more interested in the parts than in the whole. When you want to get into a large body of material, a book may be the best format.

The Higher Education Industrial Complex

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The WSJ reports,

Colleges and universities have become one of the most effective lobbying forces in Washington, employing more lobbyists last year than any other industries except drug manufacturing and technology. . .

All that these noble, public-spirited institutions ever ask for is more money with no accountability. What could go wrong?

The failure of political efforts to require more accountability and transparency means that colleges continue to collect billions of dollars annually in student loans with few strings attached, including schools that don’t graduate many of their students and where loan defaults are high.

A lot of people will tell you that higher education is one of the industries that works pretty well in the U.S. all this crony capitalism notwithstanding, I suppose.

De-skilling in the Labor Market

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Beaudry, Green, and Sand write,

the first object of this paper will be to document that the demand for cognitive tasks has actually been declining since 2000. Such a decline in demand has had, and continues to have, a direct impact on more skilled workers, but we go on to show that it has likely had a substantial impact on less skilled workers as well. In particular, we argue that in response to the demand reversal, high-skilled workers have moved down the occupational ladder and have begun to perform jobs traditionally performed by lower-skilled workers. This de-skilling process, in turn, results in high-skilled workers pushing low-skilled workers even further down the occupational ladder and, to some degree, out of the labor force all together. This process had been going on since 2000, but, as argued in earlier papers, the housing boom between 2003 and 2006 masked some of the effects which only become fully apparent after the financial crisis.

Pointer from Mark Thoma (with a couple of clicks in between).

If your main evidence for de-skilling is that people with college education are in jobs that you would not think require college degrees, then there might be another story. That is, credentials do not prove cognitive ability. In fact, we may have observed an increase in the proportion of people attending college who are not really college material and in the number of colleges producing graduates with only high-school level skills. These people would wind up in jobs not requiring great cognitive ability.

Investigating Thought Crimes

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This story says

ExxonMobil (XOM) is under investigation by New York’s top law enforcement officer about whether the global oil and gas giant lied to investors and the public about the risks and financial impact of climate change.

New York Attorney General Eric Schneiderman subpoenaed the Irving, Texas-based firm Wednesday night, seeking financial records, statements and other climate-change-related material dating back to 1977, according to a government official with direct knowledge of the matter. The official discussed the issue on condition of anonymity because the subpoena and other details of the investigation remain secret.

How can we stop this sort of behavior on the part of the NY Attorney General?

My suggestion: have the Texas Attorney General launch an investigation into alleged lying by a major New York firm. Goldman Sachs?