Monthly Archives: October 2016

Libertarianism and the Middle Class

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From a commenter.

The most important reason libertarianism is unpopular is that it has no credible agenda to benefit the middle class. Smart conservative writers have realized this, hence “Reform Conservatism”.

Many intellectuals on the right and the center-left share a perverse way of thinking about policy: they think that the poor are the legitimate recipients of government assistance, the middle class is not, and all the various middle-class-benefitting tax subsidies, entitlements, and other programs are unjustifiable bugs, rather than features, of our policy landscape. They fail to realize that a large, stable, prosperous middle class is not an inevitable or natural product of a market economy. . .

I think of the government currently as using the taxes on the rich to help pay for things like defense and non-defense purchases, while using taxes on the middle class to pay for the rest of that stuff plus transfers to the poor and to others within the middle class.

Given that perspective, what should be the balance of within-middle-class transfers vs. transfers from the middle class to the poor?

Thinking as an economist, I view the within-middle-class transfer system as imposing large deadweight losses. Primarily this is due to the need to have high taxes on work (payroll taxes), which drives down employment. There are also some deadweight losses due to rent-seeking, such as the costs imposed on the rest of us by the housing lobby, net of the gains to suppliers of services to the housing market.

If you got rid of the deadweight losses, and gave nothing additional to the poor, you would make the middle class better off. But that gain will not be politically salient.

My point is that I might agree with the commenter on the politics, but on the economics I would have to disagree. The middle class collectively would be better off without the programs that appear to benefit particular factions within it.

Grumpy About Stock Market Trading Volume

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John Cochrane writes,

We know what this huge volume of trading is about. It’s about information, not preference shocks. Information seems to need trades to percolate into prices. We just don’t understand why.

…If you ask a high speed trader about signals about liquidating dividends, they will give you a blank stare. 99% of what they do is exactly inferring information from prices — not just the level of the price but its history, the history of quotes, volumes, and other data. This is the mechanism we need to understand.

I would be so desperate as to posit a taste for trading, aka Adam Smith’s “propensity to truck and barter.” I would actually want to examine what psychological mechanisms make investment managers decide that the portfolio mix that they held one second ago is not the right mix now.

Alex vs. Tyler on Automation

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A ten-minute video. A bit of talking past one another. In short, Alex says that smart machines are making us rich, and Tyler says that only some of us are getting rich.

My favorite line was Tyler’s, talking about the challenges of adapting to technological change. He pointed out that even though the transition from agriculture to manufacturing was largely completed more than 50 years ago, to this days we still have lots of farm subsidies. I would add that by contemporary standards, the agriculture-to-manufacturing transition was gradual. We might expect even more dislocation from the transition to the New Commanding Heights.

Second Thoughts on This Year’s Economics Nobel Prize

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There is something that I find troubling about the Nobel Prize for Hart and Holmstrom, and I want to try to articulate what it is.

Think of their work as consisting of three steps.

1. Identifying some real-world complexities that affect how businesses operate. For example, output may result from both effort and luck. Output may be joint. A worker’s job description may include more than one objective.

2. Construct a mathematical optimization model that incorporates such complexities.

3. Offer insights into designing appropriate compensation systems, including when to outsource an activity altogether.

A big question is: how important is step 2?

In the eyes of the mainstream economics profession, it is extremely important. Without it, you either do not get to step 3, or your claims in step 3 lack reliability and credibility. Step 2 is why Hart and Holmstrom earned the Nobel Prize.

In my view, step 2 is unnecessary. If anything, it tends to get in the way, often creating a barrier to doing step 1 properly, because economists limit themselves to what is mathematically tractable. I think that Hart and Holmstrom sometimes (often?) made good choices in step 1, and that is what accounts for the value of where they arrived at in step 3.

In Specialization and Trade, I offer a number of asides that go from step 1 to step 3 directly (I will put some examples below the fold). In these asides, I am looking at Hart-Holmstrom issues. But I do not think in terms of mathematical optimization. Instead, I think in terms of a dynamic process of trial and error. A manager tries an approach to compensation. As long as it seems to work, it persists. Once it gets gamed too much by the employees, something happens–the manager makes changes, the manager gets fired, or the firm goes out of business.

Another point is that I believe that managers closer to the problem do a better job of solving it. Writing the problem down in mathematical terms makes it seem as though you can solve the problem remotely. It leads a David Cutler to believe that the government can design a compensation system for doctors that will correctly incent “quality health care.” It ignores what I call the “regulator’s calculation problem.”

I have seen several George Mason economists, including Tabarrok, Cowen, and Boettke, praise the Nobel for Hart and Holmstrom. I certainly think that the Nobel committee could have done worse. But in the end, I think Hart and Holmstrom represent a way of doing economics that is too constrained by the arbitrary requirement to use math, too focused on optimization relative to a given problem rather than the dynamics of trial and error, and too inclined to suggest that decisions can be made effectively by remote algorithms (and potentially by regulators who might use such algorithms) when in fact local decision-makers have important information that is not available remotely.
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The Greenspan Fed

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Reviewing Sebastian Mallaby’s biography of Alan Greenspan, Randall Kroszner writes,

The Fed has limited instruments at its disposal—primarily its control over short-term interest rates—and trying to use this tool for “bubble bursting” while still addressing the Fed’s traditional mandates for full employment and low and stable inflation could lead to conflicting prescriptions. Better, Mr. Greenspan believed, to be ready to clean up the debris if a bubble were to burst, as in 1987. Mr. Mallaby argues that the inflation-targeting framework, which focused central banks world-wide on the goal of low and stable inflation in response to their bad behavior in the 1970s when they eased credit in the short run to boost employment, provided an intellectual underpinning for Mr. Greenspan’s approach.

Indeed, it is useful to go back to what economists were thinking back when Olivier Blanchard was writing that “the state of macro is good.” The idea was that the GDP factory slumped when there were inflation “surprises,” in which prices increased more slowly than expected, leading to real wages that were too high. So if the Fed kept the inflation rate predictable (and it might as well shoot for a predictable rate that was low), then everything would be fine.

Some remarks:

1. Now, journalists want to paint Greenspan as a great free-marketeer, as if he spent his career fending off cries for more financial regulation. In fact, there was a consensus in the 1980s that inter-state banking had to arrive and that the Glass-Steagall separation of investment banking from commercial banking was being eroded by innovation. The deregulation that ratified these changes would have happened under any conceivable Fed chairman at that time. Moreover, the deregulation was accompanied by what banking officials were convinced at the time were stronger and more effective regulations regarding safety and soundness. They were particularly proud of risk-based capital regulations, and it was the market-oriented economists of the Shadow Regulatory Committee who warned that those were not adequate to prevent a crisis.

2. The “(dis-)inflation surprise” theory of economic slumps is now gone. The closest thing remaining is Scott Sumner’s slower-nominal-GDP theory of slumps. That one works for the post-financial-crisis recession because real GDP went way down, which (a) meant that nominal GDP growth was slower than previously and (b) tautologically, there was a slump. I am troubled by the tautology aspect.

3. However, the Keynesians who dominate the current macro conversation have different theories. Some like to tell a story about consumer debt. Many like to tell a story about a liquidity trap.

4. Speaking for macroeconomists in general Blanchard is now open to many different ideas. However, the one idea that they will not consider changing is the GDP factory. Thus, the idea that patterns of sustainable specialization and trade matter is not on the radar screen.

The Elite Thinks the Peasants are Revolting

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Jeff Guo writes,

On a wide range of issues, bureaucrats believe that Americans are ignorant. For instance, over half of them say that the public knows little to nothing about government crime programs, child care programs or environmental programs.

He cites a new book that sounds interesting. A couple of my thoughts (not having read the book).

1. I do not think that the problem is so much that the civil servants under-estimate the knowledge and competence of citizens. I think that the problem is that civil servants over-estimate their own knowledge and competence.

2. In a specialized world, it is dangerous to look down on people just because they do not know your own specialty. Of course a typical citizen does not know what a government agency does. But I would argue that a typical government bureaucrat would need a lot of training to work in a modern farm or factory.

3. It is almost as if the bureaucrats are thinking, “Citizens, you are ignorant about the specifics of what we do to run your lives. That ignorance is proof that you are not competent to run your own lives. Therefore, we should have even more power to run your lives.”

Assessing the Obama Presidency

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Greg Mankiw points to the views of various Harvard faculty.

I think that assessing his presidency is a very difficult task.

1. We do not know how the next 8 years will make the Obama Presidency look. If the next President is embarrassingly bad (and Mr. Trump, Mrs. Clinton and even the unlikely Mr. Johnson seem quite capable of that), then he will look better than he does today. On the other hand, if there is a “chickens coming home to roost” event (such as a government debt crisis), he will look worse than he does today.

2. Compared to what? Ken Rogoff writes,

Monday-morning quarterbacks seem to forget just how close we came to a second Great Depression.

I think that the notion that the stimulus saved us from another Great Depression is baloney sandwich on two levels. First, I do not think we were at risk of another Great Depression. Second, I do not think that the stimulus had any net positive effect on employment. But if you agree with Ken, then you have to give President Obama a lot of credit.

Or, consider Obamacare. Compared to what? Compared to some optimal health care reform? Bound to look bad, obviously. But compared to leaving the existing system in place? You have to admit that Obamacare increased the number of households with health insurance. On the other hand, given that health insurance and health outcomes are not closely linked, is that such an achievement?

So the question comes down to, spending a lot of money to get more people health insurance–compared to what? From a health outcomes perspective, the money might have been better spent trying to understand and solve the drug abuse problem. But if the money had not been spent on implementing Obamacare, it might have been spent (either by the private sector or by government) on even less worthy items.

With those caveats, my own views on the Obama Presidency are largely negative (Charles Krauthammer, not surprisingly, also has a negative assessment). I do not believe that Obamacare or the stimulus or Dodd-Frank were good policies. I think that Syria is the most calamitous American foreign policy since Vietnam (among other things, the refugee crisis has caused great stress in Europe). Perhaps President Obama’s defenders want to consider Syria to be a consequence of the invasion of Iraq and to blame President Bush. That may be the right perspective, but if so it reinforces the hazards of trying to assess a Presidency until all of the consequences have played out.

An interesting issue is the relationship of Obama to polarization. His defenders see him as a victim of polarization. His critics see him as a contributor. People are polarized on the subject, as it were.

I see him as a contributor to polarization. I do not think he ever stepped out of his sociology-faculty-lounge mindset, in which conservativism is a pathology. In fact, once he leaves office, I expect him to voice this view quite forcefully.

Instead of seeking genuine compromise with Republican legislators, he offered the attitude that “If you were decent and rational, you would do things my way.” He often had the backing of mainstream media in his confrontations with Republicans in Congress, so that the Republicans, rather than he, were always labeled as obstructionist and usually had to back down. I realize, of course, that from the left’s perspective, Republicans were not decent and rational, and, if anything, President Obama did not get his way often enough.

Hart and Holmstrom win the Nobel

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1. Alex Tabarrok and Tyler Cowen (also here) have the most useful posts.

2. I was very relieved that the prize did not go to a macroeconomist. I do not see how I could write a charitable post if there is another Nobel Prize given for macro. I especially did not want to have to write a post about Bill Buckner getting into Hall of Fame.

3. On Holmstrom, Alex writes,

Suppose that you are a principal monitoring an agent who produces output. The output depends on the agent’s effort but also on noise. It wouldn’t be a very efficient contract to just reward the agent based on output since then you would mostly be responding to noise–punishing hard-working agents when the noise factors were bad and rewarding lazy agents when the noise factors were good. Not only is that unfair–if you setup a contract like this the agents will a) demand that you pay them a lot of money in the good state because they will be taking on a lot of risk that they don’t control and b) the agents won’t put in much effort anyway since their effort will tend to be overwhelmed by the noise, either good or bad. Thus, rewarding output alone gets you the worst of all worlds, you have to pay a lot and you don’t get much effort.

As I read Cosmides and Tooby, hunter-gatherers understood this. You want to let gatherers keep their output, which is not luck-driven, but you want hunters to share output, which is very dependent on luck.

Sometimes, theorists use a lot of math to come up with results that people operating in the real world have arrived at through experience. Indeed, this is a good thing, in my view. Because often the alternative is to come up with results that have no real-world relevance at all.

4. Maybe Cosmides and Tooby should get some consideration for the Nobel.

The Future of the Libertarian Party (and the others)

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On Facebook, Max Marty asked what Gary Johnson could have done differently. He also asks what one thinks of Randy Barnett’s argument that if the Libertarian Party did so poorly this year, it has no hope.

I always thought that Johnson’s only shot was if Mrs. Clinton became non-viable, so that Democrats staring at the prospect of President Trump would try to join with leading Republicans and endorse Johnson. But the Democrats stuck to Mrs. Clinton like glue, and so the Republicans viewed endorsing Johnson as throwing the election to her. Johnson did not get the sort of endorsements he needed in order to seem viable. But I’m not sure he did anything wrong.

As to the permanent irrelevance of the Libertarian Party, although strange and unpredictable things happen, I just cannot come up with a scenario in which the party gets anywhere.

The best hope I can see for small-l libertarianism in this country is in particular states. Utah? New Hampshire? Texas?

However, what is the future of the Democratic Party? In four years, Mrs. Clinton and Mr. Sanders will be four years older, and they are not exactly spring chickens now. Elizabeth Warren will still be polarizing. Tim Kaine will have to defend a dubious record, Barack Obama having left his successor with potential crises in foreign policy, the budget, and health care policy.

And what is the future of the Republican Party? The proportion of the electorate that is white, non-urban, and born before 1960 continues to shrink. The Trump vs. anti-Trump division will not necessarily heal.

Another indication that the future is volatile is that young people are particularly unhappy with both major party candidates.

Scott Alexander on The Revolt of the Public

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He wrote,

Systems are hard. Institutions are hard. If your goal is to replace the current systems with better ones, then destroying the current system is 1% of the work, and building the better ones is 99% of it. Throughout history, dozens of movements have doomed entire civilizations by focusing on the “destroying the current system” step and expecting the “build a better one” step to happen on its own. That never works. The best parts of conservativism are the ones that guard this insight and shout it at a world too prone to taking shortcuts.

Thanks to a commenter for recommending the post. Martin Gurri’s fear in The Revolt of the Public is that exactly the form of nihilism that Alexander fears is what the Internet facilitates.

Here is a thought: If you could push a button that would destroy everyone’s faith in government, in order that they would become receptive to libertarianism, would you do it?

Maybe the question is too ill-specified. But my answer would be “no,” and in that sense I am conservative. I certainly would like to see people change the way that they think about government, so that they wish it to take on more less responsibilities and face fewer more constraints, but I do not want to blow things up so that we can start over.

My view on Clinton vs. Trump has been different. I see Trump’s authoritarian tendencies as almost certain to be restrained by the media, by left-wing elites, and by important elements of the Republican establishment. Even if we grant that Clinton is cautious, how would she react to, say, a government debt crisis or continued escalation of he costs of Obamacare? My guess is that her response would be authoritarian, with more regulation and controls. And there would be no effective institutional opposition.

However, it is not an easy call. I agree that a Trump victory would probably harm conservatism and libertarianism more than a Trump defeat. And that is worth taking into consideration.