Monthly Archives: January 2016

The Academic Ecosystem

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About a year ago, Aaron Clauset, Samuel Arbesman, and Daniel B. Larremore wrote

A strong core-periphery pattern has profound implications for the free exchange of ideas. Research interests, collaboration networks, and academic norms are often cemented during doctoral training. Thus, the centralized and highly connected positions of higher-prestige institutions enable substantial influence, via doctoral placement, over the research agendas, research communities, and departmental norms throughout a discipline . The close proximity of the core to the entire network implies that ideas originating in the high-prestige core, regardless of their merit, spread more easily throughout the discipline, whereas ideas originating from low-prestige institutions must filter through many more intermediaries. Reinforcing the association of centrality and insularity with higher prestige, we observe that 68 to 88% of faculty at the top 15% of units received their doctorate from within this group, and only 4 to 7% received their doctorate from below the top 25% of units.

The top graduate schools in any field form a tight club, into which it is nearly impossible to break in. This allows disciplines to easily be captured by fads, because the voices that would reveal the emperor’s nakedness are so completely marginalized.

In economics, I have argued that this phenomenon produced the spread of really silly approaches to macroeconomics, which is still a problem in the profession. This topic will be explored more in what I am calling The Book of Arnold.

The Case Against Economic Sanctions

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Branko Milanovic writes,

They impose a collective punishment, over people who have no influence on the policies for which they are sanctioned.

Pointer from Mark Thoma. There is more at the link.

My view of economic sanctions is that they are an act of war. If you are not willing to declare war against another country, then my presumption is that economic sanctions are morally wrong.

Razib Khan on ISIS

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He writes,

Being a good parent, friend, and a consummate professional. But not everyone is a parent, and not everyone has a rich network of friends, or a fulfilling profession. Ideologies like communism, and religious-political movements like Islamism, are egalitarian in offering up the possibilities of heroism for everyone by becoming part of a grand revolutionary story.

There is much more at the link. Pointer from Tyler Cowen.

I am reading Fools, Frauds, and Firebrands, by Roger Scruton, the British conservative philosopher. Most of you will not want to read it, because it mostly discusses European philosophers. But I came away with some interesting ideas to chew on, and I may attempt to write an essay on the book. One of his points is that the left-right lens through which we view politics is designed not to be analytically sound but instead to tilt things in favor of Communists. The idea is to put fascism on the far right and Communism on the far left. Since everybody hates fascism, the implication is that you should like Communism, or at least cut it some slack.

I think that a more useful organizing axis for political movements might be satisfied vs. disaffected. People who support Hillary or Jeb are satisfied. They do not want to rock the boat. People who support Trump or Sanders are somewhat disaffected. Extremist groups, like ISIS, appeal to people who are extremely disaffected.

Where would you put libertarians on this axis? I would put them much closer to the satisfied end. As ticked off as they are about government and politics, they tend to be basically happy with their own lives.

Still Trolling Anarchocapitalists

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David Henderson writes,

A problem that any stock exchange must deal with is enforcement of contracts. Imagine, for example, that someone sells a stock short, but contrary to his expectations the stock price rises, and he must satisfy his contract by buying the shares come settlement time. What if the short seller balks and doesn’t stick to his agreement? This did not happen often, writes Stringham, because traders had to worry about their reputations.

But couldn’t those who were cheated by short sellers have gone to the government to make the short sellers keep their word? They could not, and the reason is simple. Stringham points out that short selling was illegal and, therefore, going to the government was futile. If anything, those who had wanted to renege on their short-selling contracts could have gone to the government to get it to support their reneging. But Stringham quotes an analyst of the time pointing out that this didn’t happen much. People were expected to keep their commitments and largely did.

This is strong evidence against the claim that complex market transactions between strangers need some form of external government enforcement.

Some remarks.

I am not claiming that private governance in the absence of government support is impossible. I am claiming that it is costly. In this example, my claim would be that short selling is more costly when it is illegal than when it is legal, because short-sale contracts are perceived to be more difficult to enforce when they are illegal. That claim may be incorrect, of course. But I would bet that if you compare markets where short-selling is legal with markets where short-selling is illegal, the transaction costs will be lower in the former.

Also, consider alcohol and drug prohibition. Both of these almost surely raised the costs of transactions, and in both cases violence plays a role in market governance.

Having said that, I would point out that examples of markets that the government treats as illegal are not good examples to prove my point. When government makes something illegal, it artificially raises transaction costs in those markets, because people fear prosecution. So even if costs turn out to be higher in illegal markets, I cannot argue that this is due to absence of government. It may be due to the hostile presence of government.

As far as I can tell, we are left with purely hypothetical thought experiments. Take an example of a complex economic activity that involves a lot of specialization and trade. The famous pencil, or a toaster, or an I-phone. The parties involves in the process of assembling such goods involves do not know one another. They cannot gauge reputations, nor can they even know whether other parties care about their reputations. Now, remove all government enforcement of contracts, and imagine what happens.

What I imagine is that the parties have to come up with multi-layered contractual arrangements and enforcement mechanisms that are incentive compatible and fully state-contingent, so that everyone can be sure that disputes won’t erupt into violence. I am not arguing that this cannot be done. What I am claiming is that these transaction costs will be lower when in the back of everyone’s mind there is the understanding that there are government courts that have coercive powers to enforce decisions.

Government does not provide optimally or costlessly the legal infrastructure that facilitates complex trade among strangers. However, my intuition is that in the absence of government such infrastructure would cost much more to put in place.

Sharing Home Equity

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From an NYT blog post,

With the right financial vehicle, Mr. Rampell said, such a fund could invest to co-own houses in, say, pricey Palo Alto, Calif., making it easier for prospective home buyers to make down payments and reduce their mortgage burden. “They could own 10 percent or 15 percent of your house, so you don’t have to borrow as much,” Mr. Rampell said. “I think there’s a lot of room for more of those kind of new asset classes.”

Pointer from Tyler Cowen.

1. This is not the first time someone has proposed such an idea. In the early 1980s, with sky-high interest rates, somebody came up with the Shared Appreciation Mortgage, where you would get a lower interest rate from the lender in exchange for which the lender would get a percentage of the appreciation in 10 years or when you sold your home, whichever came first.

2. So what is the asset, exactly? I think of it as a second mortgage, with a variable interest rate that depends on the rate of appreciation of the property and on the size of what I would call the “discount,” because the third-party owner is going to pay less than $10,000 for a 10 percent share of a $100,000 house. Why? Because the third party does not get to live in the house and enjoy the implicit rental income. In the extreme case where a third party has 100 percent of the equity but for some reason pays the full $100,000 price. In that case, in exchange for giving up all the equity, the “buyer” would be living in the house rent-free!

3. There are no magic tricks in mortgage finance that make housing affordable to people who cannot save enough for a reasonable down payment. The only way to make housing affordable is for the price of homes to come down to where people can afford them. That’s true even in California, although folks there go through periodic episodes where they refuse to believe it.

Greg Ip on The Big Short

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He says,

But what I think it’s not including in that story is the extent to which these Wall Street guys honestly thought that what they were doing wasn’t that risky. They thought that a Double-A- or Triple-A-rated security had so much protection through various ways, there’s just no way this thing could blow up. And I would say that, in terms of going forward, one of the challenges we as the public and citizens and our government is: How do you create a financial system, how do you create an economy that both gives us the safety that we need to both be happy and to prosper and to take risks without destroying our selves but doesn’t create those fatal levels of complacency?

This is from a Russ Roberts podcast, with much more in the conversation.

The Libertarian Solution to College Sports

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Glenn Reynolds wrote,

If the NFL and NBA want farm teams let the build their own.

The Washington Post has done a nice expose series on the money that gets spent on college sports. But even on its editorial page, the Post only talks about reforms that tinker around the edges.

I agree with Reynolds. I suspect that the romanticization of college sports comes from the same human tendency that produces the romanticization of government. Lots of people will tell you that they hate pro football and hate pro basketball, but they love college sports. Because it is non-profit.

I have the same problem with the Olympics.

And with non-profits organizations.

We over-rate the status of people who do things for “free” and we under-rate the status of those who seek to earn profits.

What was Chicago Economics?

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Bueller? Peter J. Boettke and Rosolino A. Candela write,

Chicago price theory in the Friedman/Stigler/Becker generation was not defined by the comparative analysis of the institutional conditions within which the constant adjustments and adaptations by economic actors to changing conditions produces a tendency towards equilibrium, as it had been under the Knight/Simons/Viner generation. Instead, price theory in the hands of Friedman/Stigler/Becker became an exercise in defining the optimality conditions given any situation within which human actors find themselves.

From the conclusion:

The Chicago “Tight Prior Equilibrium” imposes a logical discipline on the world of human affairs, but it does not invite an inquiry into the diversity of institutions that arise to ameliorate our human imperfections and potentially turn situations of conflict into opportunities for social cooperation. As a result, the “fresh water” economics of Chicago still leaves us thirsty, and the “saltwater” economics of MIT/Harvard cannot serve to quench our thirst, so we must look to those alternative streams of thought for satisfaction in our quest to understand the dynamics of the market process.

In short, as I once put it,

Chicago economics: Markets work, so use markets

Harvard-MIT economics: Markets fail, so use government

Masonomist: Markets fail, so use markets

For Masonomist, the authors substitute the ABC’s. They write,

Outside of the University of Chicago, a “neglected” branch of Chicago price theory emerged among economists Armen Alchian, James Buchanan, and Ronald Coase, who provided an understanding of the market economy not by assuming the conditions [of] equilibrium, but by focusing their analysis on the dynamic adjustments required in the presence of market failures. By drawing attention to institutional solutions and the role of entrepreneurial action in discovering such solutions, they illustrated how market processes ameliorate social conflict and open up the possibility of realizing the gains from productive specialization and peaceful cooperation through voluntary exchange. It is this argument we contend that fulfills Simons’ plea for academic economics, and proves to be a better prophylactic against popular fallacies.

Noah Smith’s Five Books

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He writes,

2015 is the perfect year for me to list my recommendations, since this was a particularly epic time for books about the discipline of economics. In no particular order, here is a short list of good ones:

He goes on to cite books by Bernanke, Rodrik, Thaler, Ebenstein, and Tetlock. Interestingly, all of these books were on my radar screen, but I have not read through any of them, because of issues with the authors that rubbed me the wrong way.

My issue with Bernanke is that I believe that the driver of policy during the financial crisis was Hank Paulson. Bernanke’s role was to make Paulson’s bailout of his Wall Street cronies look intellectually respectable. Maybe I’ll read Bernanke’s book on my trip. I need to make sure that I am reading it with an open mind, but I fear that I will be inclined to view it as just more lipstick on Paulson’s pig.

My issue with Rodrik is that while he correctly sees that economic interventions often are based on analysis that is narrow and imperfectly informed, he thinks that interventionism is still the way to go.

My issue with Thaler is that he does not share Rodrik’s awareness of how economists’ imperfect knowledge can mess things up.

My issue with Ebenstein is that what I think is wrong with Chicago economics is not what he thinks is wrong with it.

My issue with Tetlock is that I don’t buy the reliability of what he does. And what exactly is a superforecaster? Winston Churchill had a horrible record of being wrong on many things. He was wrong during the abdication crisis. He was wrong about Indian independence. He was wrong to return England to the pre-war gold parity. But he happened to be right about Hitler. Probably any sort of “base rate” prediction would have been that Hitler would mellow once he took office and the Nazis could be easily managed. A Tetlockian superforecaster probably would have behaved more like Chamberlain.

James Poterba on the Mortgage Interest Deduction

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He says,

the real place where the tax code provides a subsidy for owner-occupied housing is not by allowing mortgage deductibility, because if you or I were to borrow to buy other assets — for instance, if we bought a portfolio of stocks and we borrowed to do that — we’d be able to deduct the interest on that asset purchase, too. If we bought a rental property, we could deduct the interest we paid on the debt we incurred in that context. What we don’t get taxed on under the current income tax system is the income flow that we effectively earn from our owner-occupied house, what some people would call the imputed income or the imputed rent on the house. The simple comparison is that if you buy an apartment building and rent it out, and you buy a home and you live in it, the income from the apartment building would be taxable income, but the “income” from living in your home — the rent you pay to yourself — is never taxed. This is the core tax distortion in the housing market: the tax-free rental flow from being your own landlord.

Pointer from Timothy Taylor. The interview covers other topics, all interesting.

He goes on to say that it is unlikely that people would accept being taxed on a made-up number representing this “rental flow from being your own landlord.” However, people do accept being taxed on the appraised value of their property, which is arguably also a made-up number. It seems to me that you could tax homeowners on a made-up “appraised rental value” just as easily. Or just tax them a percent of the appraised value, as is done now.

Let’s go with the notion that the goal is to tax owner-occupied and investment property identically. Then my thought is you should just exempt landlords from paying tax on their rental income. But I find the whole notion of how the tax system should and should not work to give me a headache. Even if you start with the idea of a consumption tax, do you want to include the use of housing as consumption? Presumably you do, and then you are right back into these conundrums of rental vs. owner-occupied, are you not?