Monthly Archives: May 2017

An Introduction to Economics

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Economics is the study of human interaction in the production and exchange of goods and services in the context of large-scale societies.

In human interaction, our thoughts affect our behavior. Among all animal species, humans are unique in the extent to which we record information and communicate with one another. Our beliefs, and especially our shared beliefs, vary across cultures and evolve over time. This makes the causal structure in human interaction more complex than that in natural science. We are limited in our ability to predict and control human interaction, including economic behavior.

Economics is focused on human interaction in the production and exchange of goods and services. Political science explores human interaction in the exercise of government power. Sociology explores human interaction in the maintenance of status hierarchies and social norms. Psychology and anthropology explore more fundamental aspects of human interaction, often with a focus on interaction within families or isolated small groups.

Economics is most useful in studying large-scale societies, even though there are some economic concepts that can be applied to just one individual (the so-called “Robinson Crusoe economy”). A large-scale society differs from a family or a small isolated tribe in two important ways. First, it is possible in a large-scale society to have a much higher degree of specialization. Second, in a large-scale society, exchange takes place among people who do not know one another and who do not engage in repeated interactions with one another. To coordinate complex specialization and anonymous exchange, large-scale societies require mechanisms that are not needed in small groups. Economists explore these coordination mechanisms.

Many economists employ a technique in which they set up a simplified version of an economic problem, make some basic assumptions about the goals of individuals, calculate the optimal strategy for each type of individual, and arrive at a mathematical prediction for the outcome. This optimization modeling has come to dominate the research and pedagogy of economics. However, for the purpose of describing human interaction, optimization modeling is rigid, limited, and often misleading. It is best to treat optimization modeling as just one tool of economic analysis, rather than as the essence of economics.

Thoughts on the new class war

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Michael Lind writes,

the theory of the managerial elite explains the present transatlantic social and political crisis. Following World War II, the democracies of the United States and Europe, along with Japan—determined to avoid a return to depression and committed to undercutting communist anti-capitalist propaganda—adopted variants of cross-class settlements, brokered by national governments between national managerial elites and national labor. Following the Cold War, the global business revolution shattered these social compacts. Through the empowerment of multinational corporations and the creation of transnational supply chains, managerial elites disempowered national labor and national governments and transferred political power from national legislatures to executive agencies, transnational bureaucracies, and treaty organizations. Freed from older constraints, the managerial minorities of Western nations have predictably run amok, using their near-monopoly of power and influence in all sectors—private, public, and nonprofit—to enact policies that advantage their members to the detriment of their fellow citizens. Derided and disempowered, large elements of the native working classes in Western democracies have turned to charismatic tribunes of anti-system populism in electoral rebellions against the selfishness and arrogance of managerial elites.

This is a theme of a number of recent essays. In a review of Richard Baldwin’s book on globalization, Christopher Caldwell writes,

But only a tiny fraction of people in any society is equipped to do lucrative brainwork. In all Western societies, the new formula for prosperity is inconsistent with the old formula for democracy.

In the same publication, Angelo M. Codevilla writes,

The 2016 election and its aftermath reflect the distinction, difference, even enmity that has grown exponentially over the past quarter century between America’s ruling class and the rest of the country.

…The government apparatus identifies with the ruling class’s interests, proclivities, and tastes, and almost unanimously with the Democratic Party. As it uses government power to press those interests, proclivities, and tastes upon the ruled, it acts as a partisan state. This party state’s political objective is to delegitimize not so much the politicians who champion the ruled from time to time, but the ruled themselves.

A few remarks.

1. Keep in mind that if a few tens of thousands of votes in key states had come up differently, we would be less interested in essays of this sort.

2. As the authors are aware, the class differences have been simmering for a long time and have been noted by many writers. Lind starts with Galbraith and James Burnham. One could move on to Robert Reich’s “symbol analysts” and David Brooks’ Bobos.

3. I might use the distinction of abstract workers and concrete workers. Concrete workers work with stuff. They are in construction, mining, agriculture, manufacturing, and transportation. They might own small retail and service businesses (think of repair). Abstract workers work with words, numbers, and computer programs. Think of lawyers, accountants, software developers, teachers, and bureaucrats. This abstract-concrete distinction is not a perfect dichotomy (health care, for example, combines a lot of both), but it is useful if we do not get too carried away with it.

4. The status of workers in the concrete sector is threatened in many ways. Outsourcing, machine substitution, ease of firing a non-performer, inefficient firms going out of business, and industries with productivity rising faster than demand all could cause the loss of a concrete sector job.

5. The status of workers in the abstract sector is protected in many ways. A public school teacher or industry regulator need not worry about outsourcing, machine substitution, being fired as a non-performer, having an inefficient employer shut down, or facing a decline in demand. Many abstract workers have protection from having their wages pressured by competition from people who lack their credentials. Workers in the concrete sector believe that their wages can be pressured by competition from people who do not even have citizenship papers.

6. Government and management are mostly abstract functions. So the natural order of things is for the Abstract class to rule over the Concrete class.

7. You have to wonder whether (5) is to some extent a result of (6). That is, maybe the Abstract workers who make the rules have set things up to protect Abstract workers but not Concrete workers. As policy makers rescued the economy from the financial crisis, a lot of Concrete workers lost their homes, but financial executives did not lose their mansions.

8. Lind argues in favor of policies that add protection to workers in the Concrete sector. The libertarian alternative is to provide less protection and government indulgence to workers in the Abstract sector. I do not much care for Lind’s vision. But the libertarian vision is surely a non-starter in reality.

Housing Markets with Income Constraints

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Alex Tabarrok writes,

owner’s equity in real estate is about to exceed it’s 2006 peak

I get the sense that in the cities most constrained by housing supply, markets are very hot at a price just below, say, $1 million, but somewhat tepid once the price gets above, sa,y $1.3 million. If this is an accurate guess of the shape of demand, it could be explained by income constraints. That is, would-be buyers are willing to bid as much as their income will allow, based on mortgage qualification rules. As prices rise, there is a drop-off in the number of potential buyers who can qualify for a loan.

One sign that this is taking place would be that one can find much better value (say, lower cost per square foot) in houses that are priced too high for most buyers to qualify. The most over-priced homes (with the highest cost per square foot) might be the ones that sell in the range where there are many qualified buyers.

If this story is correct, then the current home price boom will run into income constraints. If the typical young professional household can afford a $1.0 million home but nothing more expensive, then prices are going to stop rising once those households have satisfied their demands.

I think we might see that happen this year. This summer could see the last of the bidding wars.

Interesting Sociology

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From a Joint Economic Committee Report.

In the early 1970s, nearly seven in ten adults in America were still members of a church or synagogue. While fewer Americans attended religious service regularly, 50 to 57 percent did so at least once per month. Today, just 55 percent of adults are members of a church or synagogue, while just 42 to 44 percent attend religious service at least monthly.

…Between 1970 and the early 2010s, the share of families in large metropolitan areas who lived in middle-income neighborhoods declined from 65 percent to 40 percent. Over that same time period the share of families living in poor neighborhoods rose from 19 percent to 30 percent, and those living in affluent neighborhoods rose from 17 percent to 30 percent.

…Between 1974 and 2015, the share of adults that did any volunteering who reported volunteering for at least 100 hours increased from 28 percent to 34 percent.

Pointer from Timothy Taylor.

Interesting throughout. Some, but not all, of the findings relate to what I have called Narrower, Deeper, Older. That is, people are drifting away from the sort of lowest-common-denominator activities that require a modest commitment of time. Instead, people prefer narrower niche activities in which they become more deeply involved.

If you look at associational life in terms of the broader, shallower associations of 1960, our social capital is going down. But looking at it in terms of the narrower, deeper associations of today, the analysis is more complex.

Fake Sociology

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But credible enough to pass peer review, apparently.

The paper states that the penis as a form of “’hegemonic masculinity and cultural construction,’ presented in the ‘essence of the hard-on’,” and even argues that man-made climate change is happening because of “patriarchal power dynamics,” brought on by the conceptual penis.

Story here.

It seems to me that this sort of story deserve comments that consist only of puns. Hard science. Scientific Con sensus. Whatever.

Preach it, brother John

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John Cochrane writes,

there is a deep lesson in their style of modeling: Heterogeneity. Misallocation. Dispersion. Inequality. The key lesson is not that “regulation is killing US firms on average.” The US as a whole is doing badly because firms are in the wrong place — misallocation. Each individual firm may feel it’s doing fine. It might consider moving to San Francisco, but say “well, we might be more productive there, but wages are much higher because you have to pay people enough to buy a house, so we wouldn’t make any more money if we were there.” More to the point, a new business who would embody the higher productivity, get workers to move, and put the old unproductive business out of business can’t start.

Macroeconomics and our numbers are designed around the “representative firm” and the “representative worker.” But you are seeing here the macroeconomic effects of microeconomic distortion, and only visible in the amazingly large, widening and persistent differences in productivities, wages, and incomes across areas and companies.

Read the whole post. He discusses two recent papers on the cost of housing supply restrictions. These have gotten a lot of play on other blogs as well. But I emphasize the methodological point. It is very much pro-PSST.

Incidentally, one argument against building more housing that Noah Smith tries to answer is that building more high-quality housing in, say, San Francisco, would simply induce more people to move there. With this “induced demand,” so the argument goes, the cost of living there would not fall. Noah has one response, which is to ask whether the proponents of the argument would go so far as to suggest that destroying housing would lower prices. My alternative response is to say that if “induced demand” is true, then that makes the welfare benefits of more building all the greater.

Human Interaction

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Whereas reason is commonly viewed as a superior means to think better on one’s own, we argue that it is mainly used in our interactions with others. We produce reasons in order to justify our thoughts and actions to others and to produce arguments to convince others to think and act as we suggest. We also use reason to evaluate not so much our own thought as the reasons others produce to justify themselves or convince us.

That is from Hugo Mercier and Dan Sperber, The Enigma of Reason: A New Theory of Human Understanding, a book that I have just started to read.

They call their theory of human reason “interactionist.” They argue that when economists or psychologists find what appear to be errors of human reasoning, we are taking human reason out of its natural context by focusing on individual choice. The authors apparently are going to argue that when human reasoning is used interactively, it works better than one might expect based on looking at the individual capacity to reason.

Regardless of how that argument works out, I think that economists would do well to recognize the interactive nature of human behavior. Treat economics as the study not of autonomous individuals (“human action”) but as the study of humans interacting in the context of production and exchange. Models based on the autonomous individual sometimes work well, but my guess is that once you get beyond the most basic supply and demand story, models become very dependent on the prevailing beliefs, cultural norms, and laws in the society to which one attempts to apply the model.

There is no need for economists to commit to what Deirdre McCloskey derides as the Max U view of human nature. We can instead accommodate the view that man is a cultural animal, and that we learn our habits and beliefs from others.

Taking human beings as social animals subject to various departures from pure rationality, market exchange is still a very defensible mode of human interaction. Markets help to organize large-scale specialization and cooperation. Markets are effective learning mechanisms. If Mercier and Sperber are going to claim that our collective brain works in spite of (and perhaps even because of) the flaws of our individual reason, then I am prepared to claim that the market system is often the best tool for taking advantage of that collective brain.

Road to Sociology Watch

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One of my more recent ideas is that academic economics is on the road to becoming like academic sociology. That is, it will become increasingly driven by a left-wing agenda. Consider the table of contents for the May 2017 issue of the American Economic Review, which is the “papers and proceedings” issue for the latest annual conference of the American Economics Association.

It includes 11 papers from three sessions on gender, plus 3 other papers with “gender” in the title. It includes 15 papers on inequality. These topics account for over 20 percent of the published session papers.

At leading universities, I can think of several conservative economists, but all of them are around 60 years old or older. In 15 years, not even Chicago will have conservatives teaching economics courses.

I should point out that I have nothing against sociology in principle. In fact, it would do economists some good to think in terms of human interaction rather than focus so much on modeling the autonomous individual. If academic sociology were broader than the study of racial and gender, then economics would have much to gain by incorporating insights from sociology.

Have I changed my mind?

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A reader asked,

In light of everything that has happened in the last few years, have you changed your mind on anything.

In the context, this was a question about politics. I think that in general I have become more pessimistic about American political culture.

I think that I would have preferred that the elite stay “on top” as long as they acquired a higher regard for markets and lower regard for technocratic policies. What has been transpired is closer to the opposite. There was a seemingly successful revolt against the elite (although the elite is fighting back pretty hard), and meanwhile the elite has doubled down on its contempt for markets and its faith in technocracy.

I am disturbed about the news from college campuses. A view that capitalism is better than socialism, which I think belongs in the mainstream, seems to be on the fringe. Meanwhile, the intense, deranged focus on race and gender, which I think belongs on the fringe, seems to be mainstream.

The media environment is awful. Outrage is what sells. Moderation has fallen by the wayside.

It seems increasingly clear that no matter who wins elections, my preferences for economic policy get thrown under the bus. The Overton Window on health policy has moved to where health insurance is a government responsibility. The Overton Window on deficit spending and unfunded liabilities has moved to where there is no political price to be paid for running up either current debts or future obligations. The Overton Window on financial policy has moved to where nobody minds that the Fed and other agencies are allocating credit, primarily toward government bonds and housing finance. The Overton Window on the Administrative State has moved to where it is easier to mount a Constitutional challenge against an order to remove regulations than against regulatory agency over-reach.

Outside of the realm of politics, things are not nearly so bleak. Many American businesses and industries are better than ever, and they keep improving. Scientists and engineers come up with promising ideas. Reading Technology Review is a wonderful antidote to reading, say Regulation Magazine. The latter is the most depressing thing I do all month.

A kind review of my book

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From an Amazon reader,

the second edition is much better than the first. It’s nearly three times as long (146 pages vs the original edition’s 54), and more importantly gets the ideas across better. And that’s important because this is a very important idea, one that — if read by everyone — would lead to much more understanding all around.

Nonetheless, the second edition of The Three Languages of Politics landed with a thud on Amazon. It’s a book geared toward political peace. But no one is interested in peace when they think they are winning the war.