Piketty and Mort Sahl

Timothy Taylor quotes from a recent journal article by Piketty, and then summarizes,

In case you didn’t catch all that, Piketty is noting that r>g is not useful for discussing income inequality, and does not necessarily lead to wealth inequality, and that the future of wealth inequality is highly uncertain. Instead, Piketty argues in JEP that when the difference between r and g is relatively large, it will tend to exaggerate the effect of other changes that make wealth more unequal. As he writes: “To summarize: the effect of r − g on inequality follows from its dynamic cumulative effects in wealth accumulation models with random shocks, and the quantitative magnitude of this impact seems to be sufficiently large to account for very important variations in wealth inequality.”

It was the humorist Mort Sahl who would say, “I am prepared not only to retract anything I said but to deny under oath that I ever said it.”

What I’m Reading

A Critique of Democracy, by Michael Anissimov, and Democracy: The God that Failed, by Hans-Hermann Hoppe. Anissimov claims that Hoppe’s analysis can be used to justify a preference for monarchy over democracy. Anissimov writes,

The proposal for private rather than public government, at its core, is extremely simple: for something to be properly valued and taken care of it [sic], it must be owned. That includes government. If we want a government that is properly taken care of for the long term, it must be owned by someone. That means no democracy. Does this mean we’re sacrificing our “freedom”? No, because I don’t define freedom as being able to cast one meaningless vote among millions in an election.

I have no problem with belittling the value of the voice option. But it is not obvious to me that monarchy would work well.

First, there is the succession problem. As a citizen, I value continuity. A succession crisis, particularly one that turns violent, is going to create bad discontinuity. My reading of history is that monarchies tend to have succession crises.

Second, there is the problem of retaining the exit option. Just as I tend to place little value on voice, I place a high value on exit. Hoppe writes,

States will always try to enlarge their exploitation and tax base. In doing so, however, they will come into conflict with other, competing states.

I am more inclined to think that democracies will tend not vote to go to war purely to engage in expansion, whereas there is nothing to stop a monarch from doing so.

A bit later, Hoppe writes,

A small government has many close competitors, and if it taxes and regulates its own subjects visibly
more than its competitors, it is bound to suffer from the emigration of labor and capital and a corresponding loss of future tax revenue.

I believe that a monarch has a very strong incentive to try to close off the exit option. Our democracy may very well do this by making you forfeit some of your wealth if you give up citizenship. But still, I think that democracies will tend to be looser about allowing their citizens to leave.

End of the Pax Americana?

Fonzy Shazam summarizes a talk by Tyler Cowen.

1. Globalization will decline.
2. There is a myth of the rational autocrat.
3. “Fortress (North) America” will see a continuation of the current stagnating trend.

To me, this sounds as if the underlying theme is the end of Pax Americana. Imagine a world in which irrational autocrats launch wars, and the U.S. is unable/unwilling to stop them. Global trade will decline, and the U.S. will see little economic progress, in part because our progress relies on increased globalization. I cannot tell which way the causal arrows run–from American stagnation to American weakness to an inability to contain armed conflict, or the other way around. In fact, the prospect of increased armed conflict is something that I am imputing–it may not factor into Tyler’s forecast at all.

I have been reading George Friedman’s Flashpoints. One theme that struck me was the way that Europe changed in 1914-1918 from being accustomed to civilization to being accustomed to barbarism. He argues that World War I desensitized people to barbarism, and this in turn made possible Soviet and Nazi atrocities. So far, I have only read the historical parts of the book, not any discussion of the present situation or future scenarios.

On a related note, what should we make of the fact that in response to the murder of one of its citizens, the United States is less forceful than Jordan? Your choices include:

a) Jordan currently has more forceful leadership than the U.S.
b) In fighting ISIS, the United States has a strategy that is more nuanced and will ultimately be more successful.
c) The United States is wisely playing down the significance of terrorism in order to save its resources for dealing with bigger threats.
d) The United States in fact does not have the military capability to defeat ISIS, and attempting a decisively forceful response would only expose that fact.

George Selgin on Calomiris and Haber

He reviews their book Fragile by Design.

the observed interdependence of states and banks isn’t as deep-seated and inescapable as Calomiris and Haber claim. Consequently, keeping bankers and governments from getting too cozy with one another isn’t quite so difficult as they suppose.

Later, Selgin writes,

they seem unaware of the adverse effects of the “bond-deposit” provisions included in misnamed state “free banking” laws. These provisions allowed banks to issue notes only after tendering eligible securities to state authorities for the ostensive purpose of securing the notes’ holders from loss. Calomiris and Haber (p. 169) note that, by making their own bonds eligible for this purpose, states were able to force banks to lend to them “in exchange for their right to operate.” Still they fail to point out that some states force-fed their banks, not “high-grade” bonds (ibid.) but junk ones, and that it was this practice, rather than unit banking, that was the main cause of bank failures during the so-called “free banking” era

…In Canada, in contrast, banks’ almost unrestricted ability to issue notes
contributed to the banking system’s stability no less than banks’ branch networks did.

You may also wish to read my review of the book.

I Disagree with Brad DeLong

He writes,

Martin Wolf’s The Shifts and the Shocks; and my friend, patron, teacher, and (until the last reshuffle) office neighbor Barry Eichengreen ‘s Hall of Mirrors. Read and grasp the messages of both of these, and you are in the top 0.001% of the world in terms of understanding what has happened to us–and what the likely scenarios are for what comes next.

Pointer from Mark Thoma.

These are ultra-Keynesian treatments of the financial crisis and its aftermath. The all-purpose causal variable is a glut of savings and a dearth of government spending.

I cannot prove that this view is wrong. However, I am more convinced by Jeffrey Friedman and Wladimir Kraus, Engineering the Financial Crisis. The easiest way to summarize the book is that (with a nod to a different Kraus) risk-based capital regulations were the disease that they purported to cure.

The Friedman-Kraus story is one in which regulators suffer from the socialist calculation problem. With risk-based capital regulations, regulators determined the relative prices of various investments for banks. The prices that regulators set for risk told banks to behave as if senior tranches from mortgage-backed securities were much safer than ordinary loans, including low-risk mortgage loans held by the bank. The banks in turn used these regulated prices to guide their decisions.

In 2001, the regulators outsourced the specific risk calculations to three rating agencies–Moody’s, S&P, and Fitch. This set off a wave of securitized mortgage finance based on calculations that proved to be wrong.

Friedman and Kraus challenge the basic mindset not only of DeLong but of 99 percent of all economists. That mindset is that the socialist calculation problem, if it matters at all, only matters for full-on socialists, not for regulators in an otherwise capitalist system. In the conventional view, regulators can fail for ideological reasons, or because they are manipulated by special interests. But Friedman and Kraus offer a different thesis. When information discovery is vital, regulators, like socialist planners, are doomed to fail because they are unable to mimic the market’s groping, evolutionary approach to learning.

In Friedrich von Hayek’s Nobel Lecture, The Pretence of Knowledge, he concludes,

The recognition of the insuperable limits to his knowledge ought indeed to teach the student of society a lesson of humility which should guard him against becoming an accomplice in men’s fatal striving to control society–a striving which makes him not only a tyrant over his fellows, but which may well make him the destroyer of a civilization which no brain has designed but which has grown from the free efforts of millions of individuals.

What Friedman and Kraus claim is that well-intended but now well-informed bank regulations were the destroyer, not of an entire civilization, but of a financial system. Like Hayek, they offer a profound critique of mainstream thinking. Like Hayek, they are sadly likely to be ignored.

What I am Reading

1. Michael Shermer, The Moral Arc. I am only a few pages in, and he already has cited Bill Dickens and Bryan Caplan, among others.

2. Jeffrey Friedman and Wladimir Kraus, Engineering the Financial Crisis. This is a re-read for me. They share with me the view that risk-based capital rules contributed heavily to the crisis. They make a very subtle point, though. They do not believe that bankers went all-out to maximize the effective leverage of their banks. Thus, the authors reject the moral hazard arguments of deposit insurance and too-big-to-fail.

The way I would put their argument is this. Suppose that bank managers were, for whatever reason, actually quite concerned about risk exposure. They thought, even if incorrectly, that the value of keeping their franchises intact and avoiding trouble was very important. Even so, with the risk weights that regulators placed on different assets, the effective rate of return on mortgage securities was much higher than that on other asset classes, including low-risk mortgage loans. Thus, the risk-based capital rules, along with the lenient ratings by rating agencies of mortgage securities, served to steer capital into high-risk mortgage loans and thereby into feeding the housing bubble.

In making their argument that the crisis was in my terminology a cognitive failure rather than a moral failure, the authors point out that if bankers had merely wanted to maximize their exploitation of implicit and explicit guarantees, they could have acted differently. They could have held higher-risk, higher-return tranches of mortgage securities. They could have held less capital (before the crisis, major banks tended to have leverage ratios well below regulatory limits).

Apparently, Gregory Clark is Not Most Economists

Gillian B. White writes,

According to the Fed study, about 60 percent of black children whose parents had income that fell into the top 50 percent of the distribution saw their own income fall into the bottom half during adulthood. This type of downward slide was common for only 36 percent of white children.

…Still, most economists lack a clear, definitive explanation for why, after reaching the middle class, many black American families quickly lose that status as their children fall behind.

Pointer from Mark Thoma.

Obviously, she did not read my review of Gregory Clark’s latest book.

Clark suggests that this may reflect that the underlying mean for these ethnic groups may differ, and the higher propensity of middle-income blacks and Hispanics to have their children’s income fall to the bottom third might be due to regression toward a lower mean.

Suppose that you have two populations of men with different height-producing genetic characteristics. The mean height in group A is 5 feet, 9 inches, and the mean height in group B is 5 feet, 7 inches. There is substantial variation within each group.

Now, out of the current generation of men, you select men from each group who happen to be 5 feet, 8 inches. Track the height of their sons. It seems reasonable to predict that, starting with men who are 5 feet 8 inches, the sons of men from group A are likely to be taller than the sons of men from group B. This does not result from social prejudice against men from group B. It is the result of laws of probability.

The Tea Party, McBoehner, and ObamaCare

Tyler Cowen has referred a couple of times to a book by Philip Klein on Republican politics and health care reform. I am not a political analyst, but here is my impression:

1. The most important Republican divide is between the Tea Party and McBoehner. The Tea Party wants policies to change, and McBoehner want most of all to be Senate Majority Leader and House Speaker, respectively.

2. The Tea Party wants to overturn Obama’s policies on immigration and health care. McBoehner wants to loosen environmental regulations and tweak Dodd-Frank, because that is what their friends in business are telling them are priority issues.

3. I think that a conservative consensus on health care reform is there to be formed, but McBoehner are not the ones to form it. I think that the Tea Party is likely to be shafted both on immigration and on health care reform. That might make them a bit ornery during primary season in 2016.

Pete Boettke on Ideology and Economics

He writes,

Market fundamentalism is far from the mainstream of economic thought. The mainstream folks consider their work non-ideological and merely technical because they all share the same tacit presuppositions of political economy. It would be healthy if they looked through a different window, and spent some time reading those Nobel economists I mentioned above, or the Nobel worthy economists I mentioned as well.

Read the whole thing. I had a hard time choosing an excerpt. It also could use more fleshing out, in my view.

What Boettke is wrestling with is an asymmetry between mainstream economics and those of us with a free market bent.

Here is how I would describe the asymmetry. I think that the free-market types understand the main arguments of mainstream economists, but I think that mainstream economists only seem to deal with a straw-man version of free-market economics. Keep in mind, however, the Law of Asymmetric Insight: when two people disagree, each one tends to think that he understands his opponent better than the opponent understands himself.

I think that we on the free-market side understand behavioral economics. We understand asymmetric information. We understand market failure. Thus, we differ from the straw-man version of us that mainstream economists dismiss.

On the other hand, mainstream economists appear to me not to appreciate the two most important arguments that we have. One is the socialist calculation argument. My sense is that mainstream economists either do not believe that the socialist calculation problem is real, or they believe that it only applies to socialist dictatorships. In fact, any government program to spend, tax, or regulate will encounter the socialist calculation problem. That is, government planners face a fundamental information problem themselves. Knowledge is dispersed. What planners do not know is important, and indeed it can be more important than what they claim to know about market failure.

The second argument is the public choice argument. This is often over-simplified as “government officials act based on self-interest.” The deeper issue, which Boettke mentions in his post, is that markets and government should be looked at in parallel as institutions. The market process has certain strengths and weaknesses. Government has other strengths and weaknesses. The mainstream approach simply assumes away all weaknesses of the political process. Once an economist identifies a market failure and a policy to treat it, the next step if to play fantasy despot and recommend the policy.

Finally, I have to say that this is not mere abstract philosophy. The socialist calculation problem is real. It affects financial regulators, who in the period leading up to the financial crisis used crude “risk buckets” to alter the incentives of banks. That approach was woefully information-poor, and it created huge incentives for banks to do exactly what they did with risky mortgages. See Not What They Had in Mind. The socialist calculation problem affects every agency of the government, from the FCC to the FDA to the panel of experts who is supposed to determine which medical procedures to allow.

The institutional weaknesses of government are real. Read Peter Schuck’s book. You can get the flavor of it from his talk and my comments.