Monthly Archives: January 2017

Todd Zywicki on Consumer Finance Regulation

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He writes,

Market-replacing regulatory strategies seek to limit choice and competition through prohibitions or restrictions. . .A market-reinforcing regulatory strategy, by contrast, seeks to promote competition and choice

That is from his essay in the compendium, Reframing Financial Regulation.

Think of the government as giving guidance to consumers. This could be justified for financial products, for medical care, or for nearly any product or service that poses cognitive challenges for consumers. Market-replacing regulation provides guidance in the form of prohibition. Market-reinforcing regulation is intended to provide guidance in the form of disclosure.

It strikes me that one approach might be for the government to create an artificial intelligence program to advise consumers in these areas. You could make a phone call to the advisory service, speak in natural language, and get advice. Once you get the advice, you can take it or leave it.

This advisory service need not be perfect. The question is whether it could be better than market-replacing regulation or with other imperfect attempts at market-reinforcing regulation.

Mike Munger and Russ Roberts on the Basic Income Grant

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I found listening to this podcast very frustrating. I just have a very different conception of how a basic income grant works.

You have two parameters to play with. One is the size of the grant, and the other is the income tax rate (let’s go with a flat tax to keep the arithmetic simple). Together, they determine the breakeven income, that is the amount of income someone earns where the tax and the grant cancel out.

For example, suppose that the grant is $20,000 and the tax rate is 20 percent. In that case, if I earn $100,000 then I pay $20,000 in taxes and that just offsets my $20,000 grant. If the BIG is administered by the IRS, at $100,000 a year the IRS and I don’t exchange any money. If I earn $80,000 then the IRS pays me $4000 (20K in BIG minus 16K in taxes), and if I earn $120,000 then I pay the IRS $4000.

Note that this works out exactly the same as a negative income tax with rate of -20% for people earning less than $100,000 a year.* So when Russ says that a negative income tax is better than a BIG, he loses me.

Now, I think that a $100,000 breakeven point is not a good choice. But if you want to get to a lower breakeven point, you need a lower BIG, a higher tax rate, or some combination of the two.

I prefer a lower BIG, say, $10,000 per person, perhaps even less. People who need more and cannot earn it can get help from charity or local governments, which are closer to the family in need and can be more in touch with individual circumstances.

But I also think that a tax rate of 25 percent would not be too high. So with a $10,000 BIG and a 25 percent tax rate, the breakeven point would be $40,000 in income for a single individual.

Incidentally, I also disagree with Russ that our current programs are not problematic in terms of high implicit marginal tax rates. Even if every single program has only a gradual fall-off in eligibility, the combination of programs has fall-offs that for some people make the marginal tax rate on additional income 100 percent or higher.

One issue with a BIG, and with assistance programs of all kinds, is the treatment of households vs. individuals, or adults vs. children. Suppose that the BIG is $10,000 per single adult. Does a household with two adults and two children get $40,000? Or some other number?

Finally, if you only want people to spend assistance on “merit goods,” you can provide the BIG in special savings accounts that can only be used for housing, education, food, and health care. See my early posts in the category of Setting Economic Priorities.

*Mathematically, draw a line with the equation Y = $20,000 – 0.2X [corrected–I had written $40,000], where Y is what the individual nets from the IRS and X is the person’s income. If you think of the line as starting from the coordinate (0; $20,000) and going to the right, then you have a BIG. If you think of the line as starting from the coordinate (100,000; 0) going to the left, you have a negative income tax. But it’s the same line!

Duncan Watts on Methods

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He wrote,

the problem with social science is not so much that it has one theory for one thing and another theory for another thing6, but rather that it has many theories for the very same thing. Even worse, these theories — although often interesting and plausible when considered individually — are fundamentally incoherent when viewed collectively. I then argue that this incoherency problem arises not only because of a lack of appropriate data for evaluating social scientific theories, but also because of the institutional and cultural orientation of social-science disciplines, which have historically emphasized the advancement of particular theories over the solution of practical problems. Finally, I argue that one possible solution to the incoherency problem is to reject the traditional distinction between basic and applied science, and instead seek to advance theory specifically in the service of solving real-world problems.

I recommend the entire essay (thanks to Michael Gibson for bringing it to my attention).

My perspective on Watts’ proposal for “solution-oriented social science” is that it addresses the question of how to test theories. Consider three options.

a) undertake a statistical analysis

b) try it out as a public policy, but be prepared to modify it should it fail to work as expected.

c) try it out by starting a business based on it

I think that a lot of us have lost confidence in (a). There are too many important causal variables that cannot be controlled for in the real world. Esther Duflo seems to argue for (b). I think that economists ought to be more aware of (c) and less eager to try (b). Of course, problems in sociology or political science may be less amenable to private entrepreneurial solutions. Watts’ point is that (b) and (c) are viable approaches for arriving at reliable knowledge.

at no point does the existing system for producing social scientific knowledge either facilitate or reward the activity of reconciling disparate frameworks. As a result, facts and theories pile up in an incoherent heap

In economics, I think that we also have the opposite problem. We fail to consider other frameworks that might work as well as our preferred framework.

Another excerpt:

theories in social science tend to rise and fall in popularity more like works of fiction than of science, gaining support for reasons other than their ability to account for empirical observations.

The Economist as Entrepreneur

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Beatrice Cherrier comments on Esther Duflo’s AEA lecture, “The economist as plumber.”

She wanted economists to reconceive economic agents, policy-makers and bureaucrats as bounded “humans” embedded in wider power structures and cultures, and to realize that thinking goods ideas is not enough to improve the latter’s welfare. “Incentive architecture” is thus needed, and economics expertise is especially relevant because it deals with behavioral, incentive and market equilibrium issues. The recent success of (some) “nudge” has given some salience to benefits of crafting incentives carefully, for instance by fixing regulations to prevent firms from exploiting loopholes. Plumbing was also beneficial for economics as science, she continued, as it helped generate counterfactuals by randomizing on entire markets. Plumbing also shines the spotlight on issues theorists had previously ignored, like how important the default scenario is. Economics as plumbing requires a more pragmatic and experimental mindset, she concluded, as it requires them to make decision without having a full knowledge of the system to be tinkered (“tinkering” was one of the keywords of the speech).

I recommend the whole post. Pointer from Mark Thoma.

When I think of trial-and-error tinkering to try to solve a problem, I think of an entrepreneur.

In fact, we might be better off thinking of policy-oriented economists as state-backed entrepreneurs. That is, while ordinary entrepreneurs have to convince investors to back their ideas and convince customers to pay for their offerings, state-backed entrepreneurs have to convince politicians to back their ideas.

I am not very enthusiastic about state-backed entrepreneurship. I believe that the market does a more rigorous job of experimentation, evaluation, and evolution.

I am glad to see alternatives to the image of the economist as a white-coated scientist. However, I do not think it should be replaced by an image of droopy-pantsed plumber. I am afraid that a more accurate image is of an entrepreneur who is trying to short-cut the market by pitching business ideas to a political audience. And we should be cognizant that politics is an inferior arena for trying out entrepreneurial schemes.

Tyler Cowen on Culture and Economics

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He writes,

how do differences of culture — however defined — interact with traditional economic mechanisms involving prices, incomes, and simple comparative statics? Are those competing explanations, namely cultural vs. economic? Ought they to dovetail nicely in some kind of broader explanation? Or might the cultural factors in some manner be “reduced” to questions of more traditional economics? Some combination of the above? Something else altogether? And, from among these and other options, what principles of differentiation rule how “culture” and “economics” will be related in a particular problem?

That to me is the most important unsolved problem in economics and indeed in social science more broadly.

1. I do not think that problems get “solved” in economics the way that they do in physics. We come up with interpretive frameworks, the way that historians do. Some of our frameworks, like supply and demand in microeconomics, seem pretty robust. Others are flimsier and faddish.

2. My current definition of culture is: socially communicated thought patterns and behavioral tendencies.

3. Economic behavior fits within this definition of culture. There is plenty of social communication involved in determining how people conduct themselves in markets.

4. There is tension here, in that a lot of our interpretive frameworks start with very individualistic assumptions. People are presumed to make their own choices, given the opportunities and constraints that they face.

5. The individualistic models get you somewhere when the other cultural factors are held constant. Fix the country and look at narrow slices of time and specific industries, and you have a good chance using ordinary economics. But a lot of interesting questions (why did different countries achieve what McCloskey calls The Great Enrichment at different times? why is southern Italy poorer than northern Italy? why did mortgage securitization balloon and then collapse? why is labor force participation declining?) are affected by cultural factors that differ across time and/or location. That’s when standard economics alone falls short.

Different Types of Expertise

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Something bothered me about the way that Tyler Cowen framed the issue of rule by experts vs. popular rule. He refers to David Levy and Sandra Peart’s new book, which I started reading. I think I am going to be bothered by their framing, also. Let me try to articulate my issue.

Last year, I was not happy with the way my bike brakes were working, and I took the bike into the shop. An “expert” diagnosed the problem as a worn brake cable and replaced the cable. The brake worked much better with the new cable, so as far as I can tell the diagnosis and the remedy were correct.

I believe that economics is fundamentally different from bicycle brake repair. We are not experts in the same sense that my bike mechanic was an expert. Let me try to explain why that is the case.

We know what a brake is supposed to do. It is much harder to give an account of what a financial system (or example) is supposed to do.

We can describe in complete and comprehensive terms how a bicycle brake should work. We cannot do that with a financial system.

A bicycle brake was built from a design. Knowledge of how it was designed can help us to fix it. The financial system emerged. There is no design specification to which we can refer.

When brakes are not working well on a bike, there are a limited number of possible causes. When a financial system does not work well, there are more possible causes than we can list.

Theories about brakes are easily tested under controlled conditions. Theories about financial systems are not.

The brake itself does not have beliefs that affect its behavior. The participants in the financial system do have beliefs that affect the behavior of the system.

It is possible to gain some wisdom from studying economics, just as it is possible to gain some wisdom from studying history. But it is not possible to attain the sort of expertise in economics that one can attain as a physicist, plumber, or bicycle repairman. To encourage such analogies is unwise.

Daniel Little on the Evolution of Disciplines

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He writes,

academic disciplines are in fact highly contingent in their development, and that there is no reason to expect convergence around a single “best” version of the discipline. The history of disciplines should better be understood in analogy to the brachiation and differentiation associated with the evolution of species and sub-species over time — lots of contingency, with a consequent specialization of the intermediate results to the demands of a particular point in time. This implies that a discipline like sociology or political science could have developed very differently, with substantially different ideas about research questions and methods.

I take the view that economics evolved in the wrong direction in the United States, particularly following the second World War, as it followed down the path laid out by Paul Samuelson. Some of my thoughts on this are expressed in Specialization and Trade. More thoughts are on the way in a long essay.

Economists and Mr. Trump

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Justin Wolfers writes (not Justin Fox, as I mis-typed earlier) that at the recent American Economics Association meetings,

Over three days of intense discussions, I didn’t encounter a single economist who expressed optimism that Mr. Trump’s administration would be good for the economy. The optimists were those who thought Mr. Trump would not have the energy to actually implement his agenda; the pessimists’ thoughts veered toward disaster.

Pointer from Mark Thoma.

It is possible that they are correct. However, I doubt it. While I disagree with Mr. Trump on immigration and trade, and I condemn his interventions with individual business decisions, I think that these will cause relatively little harm. This harm could be more than offset by reining in regulations, replacing Obamacare, and/or tax reform.

What is true is that Mr. Trump and the professoriate have an adversarial relationship. Mr. Obama takes his world view from the faculty lounge of the sociology department, and he very much respected academic credentials. Mr. Trump is the opposite.

I think that credentialed economists deserve a bit more respect than what we receive from Mr. Trump, but much less than what many American Economics Association members seem to think we are entitled to. I think that Justin Wolfers’ colleagues are fantasizing about a scenario in which Mr. Trump causes an economic disaster so that the status of academic economists shoots up. But I do not think see this as a very likely scenario.

On the generic topic of academic expertise in government, Tyler Cowen writes,

when it comes to the nuts and bolts of governance, typically I would prefer to be ruled by the Harvard faculty, even recognizing the biases of experts. They understand the importance of applying expertise to complex problems, and they realize many issues do not respond well to common-sense fixes. The citizenry usually cannot make good decisions, or for that matter expert appointments, when technocracy is required.

I tend to focus on what I call the knowledge-power discrepancy. Joe Citizen may have less knowledge than Professor Jones, but Professor Jones could be more dangerous. That is because Professor Jones may over-estimate his suitability for telling other people what to do.

Compared with academics, business executives and military leaders have more experience with the challenge of implementing ideas. A good business executive would not take it for granted that a web site is going to work. A good general would emphasize all of the difficulties and risks of trying to shape the Middle East.

Timothy Taylor on Homo Narrativus

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He writes,

Homo sapiens likes to protest that all conclusions come from a dispassionate consideration of the evidence. But again and again, you will observe that when a certain homo sapiens agrees with the main thrust of a certain narrative, the supposedly dispassionate consideration of evidence involves compiling every factoid and theory in support, as well as denigrating those who believe otherwise as liars and fools; conversely, when a different homo sapiens disagrees with the main thrust of certain narrative, the supposedly dispassionate consideration of the evidence involves compiling every factoid and theory in opposition, and again denigrating those who believe otherwise as liars and fools. Homo sapiens often brandishes facts and theories as a nearly transparent cover for the homo narrativus within.

That is his gloss on Robert Shiller’s recent address to the American Economic Association.

Noah Smith on Higher Education Policy

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He writes,

As long as the number of available college spots remains roughly fixed, reducing the price of college will have only a very modest effect in creating broad-based economic opportunity.

My recommended solution is to focus on increasing the number of college spots available. Those could be four-year university slots, or vocational education — a mix of both would probably be best. But the key is that supply should go up.

Pointer from Mark Thoma.

Of course, from an economic point of view, Smith’s point is spot on. However, the Kling Theory of Public Choice is that public policy will always choose to subsidize demand and restrict supply. That is what is most in the interest of incumbent suppliers, who are the drivers of public policy.