Friedman and Samuelson

I think of Specialization and Trade as an attempt to redirect economics away from the path that it followed after the second World War. This recently produced the following train of thought.

Who has been the most influential economist since 1945? I am inclined to go with Paul Samuelson, and that is implicit in the book. But some people might have said Milton Friedman. In neither case, do I think that the influence on academic economists was good. [somewhat related: Tyler Cowen’s simple theory of recent intellectual history, which he apparently still propounds]

With the public, their impact differed. Friedman argued that people should admire markets and be wary of government. Samuelson said it the other way around. Those of us who agree with Friedman approve of Friedman’s influence. Those who agree with Samuelson disapprove of Friedman’s influence.

Back to academic economists. I think that both Friedman and Samuelson were guilty of promoting economic methods that involved imitating hard science (at least as they thought of science as being practiced). Instead, in my book I argue that economic analysis can yield frameworks of interpretation, but economic hypotheses are not verifiable the way that they are in chemistry or physics.

In macroeconomics, Friedman enjoyed influence starting in the 1970s, because the Solow-Samuelson Phillips Curve broke down and Friedman’s alternative view that emphasized monetary policy seemed to work better. However, my view is that both monetarism and Keynesianism are misleading as interpretive frameworks.

In fact, what started out as monetarism ultimately degenerated into deity-worship of the Fed chairman. First it was Paul Volcker, who slew the dragon of inflation. Then it was Alan Greenspan, the Maestro of the Great Moderation. Until in hindsight he became the Randian ideologue, who turned the banks loose to create a financial crisis. The crisis came on Ben Bernanke’s watch, and he is deified as the man who saved us from another Great Depression.

I think that the effect of each of those three on the economy is vastly over-rated. Instead, I think that financial markets and the economy in general simply took the course that they took, and story-tellers wrongly attribute the outcomes to the policies of the Fed at the time.

Status Games

Tyler Cowen writes,

In essence, (some) media is insulting your own personal status rankings all the time. You might even say the media is insulting you. Indeed that is why other people enjoy those media sources, because they take pleasure in your status, and the status of your allies, being lowered. It’s like they get to throw a media pie in your face.

With material goods, we can play a positive-sum game. With status goods, the game is zero-sum. In a footrace, someone finishes first, someone finishes second, and so on. If I move up, someone else must move down.

Political power tends to act like a positional good.

New Commanding Heights Watch

Two posts from Matthew Klein.

First

96 per cent of America’s net job growth since 1990 has come from sectors known to have low productivity (construction, retail, bars, restaurants, and other low-paying services were responsible for 46 percentage points of total growth) and sectors where low productivity is merely suspected in the absence of competition and proper measurement techniques (healthcare, education, government, and finance explain the remaining 50 percentage points)

Second

since 1990. . .a whopping 88 per cent of the total rise in the price level boils down to four sectors of the US economy [health care, education, housing, and prescription drugs]:

Pointer from Tyler Cowen. There is much to chew on, and probably much to quibble about. What I want to suggest is that the relative price shifts involving the New Commanding Heights sectors of health care and education in relation to goods-producing sectors ought to be considered much more important than the comparatively trivial amounts by which the “aggregate price level” (a concept for which I have little use, but so be it) has wiggled around.

Over the past 25 years we have had major structural shifts in the economy. I claim that those structural shifts have played a larger role than monetary policy in the behavior of employment and “the aggregate price level.” But if you look at both the journalistic accounts and the academic literature, I am confident that you will find many more mentions of monetary policy than of structural change in interpreting economic events. If I had any influence, that would change.

Asking Different Questions

Tyler Cowen writes,

note that essentially none of those income gains went to rural areas. That meant a 7.4% wage gain for larger cities — does the raise the import of the case for deregulating building?

I think that he took his figures from the Census report, but I cannot be sure. I think that “wage gain” should be “income gain,” but again I cannot be sure.

I would ask different questions:

1. Does it raise the import of the case for looking carefully at making cost of living adjustments that differ by location? If the cost of living fell in rural areas, then they had some real income gains. If the cost of living soared in larger cities, then they had less real income gains than are reported if one uses an aggregate price index as the denominator in a real income estimate.

2. In which location–rural areas or large cities–are government transfer payments a larger share of household income? My guess is that transfers make up a larger share in rural areas. In that case, in spite of (1), the report may under-estimate the relative economic strength of larger cities.

Economies are Embedded in Cultures

Peter Richerson, et al, write,

Economic competition is an important and typically peaceful form of CGS.

CGS is “cultural group selection.” Pointer from Joseph Henrich in comments on a Tyler Cowen post.

In my view, cultural group selection fits well with Austrian economics but poorly with Chicago economics. Hayek and others pay attention to cultural norms, while Chicago economics is more purely individualistic. See Erwin Dekker’s book.

For example, if you take the Chicago view that focuses on atomistic optimization by individuals, then racial discrimination seems to be unlikely in a market economy. Someone who is willing to hire blacks seems likely to out-compete someone who only hires whites.

However, suppose that you have a group norm in which refusing to hire blacks is considered cooperation and hiring blacks is considered defection. Also, suppose that groups that are more effective at rewarding cooperators and punishing defectors tend to be more successful. In that case, racial discrimination could persist because of cultural group selection.

The theory of cultural group selection can create discomfort if you like to believe that social outcomes are purely deterministic. Instead, with group selection a wider range of outcomes becomes possible, with the potential for norms and practices to survive that seem arbitrary or even counter-productive. While one might object that this makes the theory messy, I think it is realistic.

I believe that one of the important limitations of what in Specialization and Trade I disparage as MIT economics is that it ignores cultural context. Instead, I believe that the fact that economies are embedded in cultures is very important.

The Case for Sticking with the Null Hypothesis

Jesse Singal writes,

As things continue to unfold, there will be at least some correlation between which areas of research get hit the hardest by replication issues and which areas of research offer the most optimistic accounts of human nature, potential, and malleability.

Pointer from Tyler Cowen.

Studies that show significant effects of educational interventions are right in this wheelhouse. That is why until they are scaled, replicated, and shown to have durable effects, you should view accounts of such studies with skepticism.

Wisdom from Erik Hurst

He says,

The facts are real wages moved very strongly with employment across regions. Nevada was hit very hard by the recession, for example, while Texas was hit much less hard. Wage growth, both nominal and real, was about 5 percent higher in Texas than it was in Nevada during the Great Recession.

Pointer from Tyler Cowen.

The point is that we do not have a single aggregate economy. If you think that every state faced identical demand conditions, then the state with the higher real wage growth (Texas) should have had the worse unemployment. And Hurst goes on to point out how the regional data make it difficult to defend the view that wage stickiness is the cause of unemployment. In fact, he refers to work, which I noticed earlier, that suggests a PSST story.

I don’t think I previously knew about this thinking, which also agrees with mine:

When we all come together as individuals, we may create agglomeration forces that produce positive or negative consumption amenities. Thinking about it this way, when a lot of high-income people live together, maybe there are better schools because of peer effects or higher taxes. Or maybe there are more restaurants because restaurants are generally a luxury good. Or maybe there’s less crime because there is an inverse relationships between neighborhood income and crime, which empirically seems to hold. So, while we value proximity to firms, that’s not the only thing we value.

Trump Explanation to Flatter the Left

Arlie Russell Hochschild writes,

You are patiently standing in the middle of a long line stretching toward the horizon, where the American Dream awaits. But as you wait, you see people cutting in line ahead of you. Many of these line-cutters are black—beneficiaries of affirmative action or welfare. Some are career-driven women pushing into jobs they never had before. Then you see immigrants, Mexicans, Somalis, the Syrian refugees yet to come. As you wait in this unmoving line, you’re being asked to feel sorry for them all. You have a good heart. But who is deciding who you should feel compassion for? Then you see President Barack Hussein Obama waving the line-cutters forward. He’s on their side. In fact, isn’t he a line-cutter too? How did this fatherless black guy pay for Harvard? As you wait your turn, Obama is using the money in your pocket to help the line-cutters. He and his liberal backers have removed the shame from taking. The government has become an instrument for redistributing your money to the undeserving. It’s not your government anymore; it’s theirs.

Pointer indirectly from Tyler Cowen.

She sees this as a narrative that explains Trump. Perhaps she is correct. But it is suspiciously self-serving to the sociologist-author who is proud to be more properly attuned to the oppression of minorities) and uncharitable to the Trump supporters.

I am not the first person to notice that many economists came up with books after the financial crisis of 2008 that purported to show how the crisis confirmed their worldview. Yet none of these economists predicted the crisis. For example, Joseph Stiglitz will gladly tell you that the crisis confirmed his worldview, even though he notoriously co-authored a paper which concluded that Freddie Mac and Fannie Mae were completely sound.

So with the unexpected emergence of Donald Trump, I get very suspicious of “explanations” that flatter the author and members of the author’s intended audience.

Instead, I again recommend the Martin Gurri explanation, which he wrote before Trump became a candidate.

Thoughts on Crowding Out

Tyler Cowen writes,

None of this has to involve higher interest rates, whether on government securities or corporate bonds, yet still there is an opportunity cost from the new decisions. Do interest rates have to go up every time resources are switched across sectors? No. Will there in general be a significant “multiplier” from these sectoral shifts? I say that question is a category mistake, but if you insist the multiplier could easily be negative rather than positive.

My comments:

The crowding-out that he is talking about refers to specific sets of skills. In GDP-factory macro, there is no wuch thing. We all have the same skills, so if government demands more from the GDP factory, there is no crowding out. From a PSST perspective, or from any sensible economic perspective, if the government hires more workers whose skills are already in demand, this causes crowding out. Since many of the workers who have lost jobs over the past two decades are workers whose skills were of a sort where demand has been falling on a secular basis, chances are that when the government tries to spend more it will tend to increase demand for workers who already have jobs. Hence, crowding out.

What Was Glass-Steagall?

I don’t think that Robert Reich actually knows.

Some argue Glass-Steagall wouldn’t have prevented the 2008 crisis because the real culprits were non-banks like Lehman Brothers and Bear Stearns. But that’s baloney. These non-banks got their funding from the big banks in the form of lines of credit, mortgages, and repurchase agreements. If the big banks hadn’t provided them the money, the non-banks wouldn’t have got into trouble. And why were the banks able to give them easy credit on bad collateral? Because Glass-Steagall was gone.

Pointer from Alex Tabarrok. Reich seems to think that Glass-Steagall was some sort of magical regulation that allowed regulators to keep banks from making unwise loans.

In fact, my understanding (like most commentators, I have not actually read the law itself) is that it was intended to separate commercial banking from investment banking. That is, one type of institution could take deposits and make loans, and another type of institution could underwrite securities. It started to fall apart in the 1970s, when money market funds were invented, allowing investment banks to issue debt that looked a lot like deposits. This caused banks to complain that financial activity was going to shift out of banks, which was going to hurt banks and make bank regulation irrelevant. The 1980s were spent with lobbyists and legislators trying to work out a fair way for commercial banks to compete in investment banking and vice-versa.

Ironically, what Reich is describing, with commercial banks lending to investment banks, shows that the two were still somewhat separate even ten years ago. I am willing to be corrected, but as far as I know, there was nothing in Glass-Steagall to stop a commercial bank from lending to an investment bank. Repurchase agreements and lines of credit were not forbidden. And when Reich says that non-banks received mortgages from commercial banks, he is completely unhinged.

I continue to believe that the Nirvana Fallacy it what drives a lot of analysis of the financial crisis, and of government intervention in general. That is, if you believe that Nirvana is achievable through government intervention, then if we have disappointing outcomes it must be because government is being held back from intervening the way it should.

The overall Atlantic piece to which Tyler refers includes comments from some left-leaning economists that are actually reasonable concerning the irrelevance of Glass-Steagall. But on the whole, the left is locked into its Nirvana fallacy of financial regulation.