More Thoughts on Economic Methods

Diane Coyle writes,

Rodrik supports the mathematical nature of economics as bringing clarity of meaning, and argues that the subject is far more applied and empirical than its detractors realise. But he criticises large-scale macro models and time series regressions. “I cannot think of an important economic insight that has come out of such models,” he writes. He also flags up the lack of testability of many economic models: they purport to be deductions from theoretical principles, but as they are ‘deduced’ to explain a particular phenomenon (credit rationing, say), then that phenomenon cannot be used to test the model. “Very few of the models that economists work with have ever been rejected so decisively that the profession discarded them as clearly false.”

Pointer from Mark Thoma.

My line is that economists deal in non-falsifiable interpretive frameworks. Read Coyle’s entire post. She makes Rodrik sound like someone I would agree with, although not everything I have read of him would indicate that.

The conversation between Tyler Cowen and Dani Rodrik keeps circling back to methodological issues. For example, Rodrik is wary of overrating randomized control trials. Rodrik suggests that graduate students should spend more time in the real world.

I keep thinking of the quote of Minsky writing that economists are well trained but not well educated. You are trained to solve equations. Nowadays you are trained to do the sort of narrow empirical studies that Rodrik thinks are overrated. But you are not educated in history or financial institutions or secular changes in the economy.

Also, Noah Smith has more to say.

philosophical empiricism is far more frightening for economists than for natural scientists. Living in a world of theoryderp is easy and comforting. Moving from that world into a Popperian void of uncertainty and frustration is a daunting prospect. But that is exactly what the credibility revolution demands.

Read the whole post. As I read it, he thinks that economists will have to reconcile themselves to less theory and more empirical work. I do not really agree:

1. I think that economists rely a lot on what I call interpretive frameworks. These do not have standing in philosophical empiricism, because they are not falsifiable.

2. Philosophical empiricism does not provide a guide to evaluating interpretive frameworks. Unfortunately, economists have not thought about this question. Frameworks become popular because they are tractable or interesting, and they stay popular without ever being evaluated for usefulness.

3. I think that an interpretive framework is strong if it offers explanations in many contexts, if it does not encounter too many anomalies (phenomena that seem to run counter to the framework), and if it is reinforced by other beliefs.

4. Supply and demand is an example of an interpretive framework that is very strong. That is, it seems to explain a lot, one rarely encounters anomalies, and it is consistent with other beliefs that we tend to hold.

5. Keynesian macro is an example of an interpretive framework that is not very strong. Many anomalies have cropped up over the decades: the ability of the U.S. economy to rebound after World War II in spite of the staggering drop in government spending; the breakdown of the Phillips Curve in the 1970s; the failure of many Keynesian stimulus policies in many countries, including the U.S. And Keynesian macro is notoriously inconsistent with many other beliefs that economists tend to hold.

The Third C is Conscientiousness

Broadly speaking, our results point to a quantitatively large and significant role for credit scores in the formation and dissolution of committed relationships. Three sets of empirical results support this conclusion: First, credit scores are positively correlated with the likelihood of forming a committed relationship and its subsequent stability. Second, partners positively sort into committed relationships along the credit score dimension even after controlling for other similarities between the partners. Third, a positive correlation notwithstanding, within-couple differences in credit scores are apparent at the start of relationships. Notably, the initial match quality in credit scores is highly predictive of subsequent separations even when controlling for other factors, such as couples’ use of credit and the occurrence of financial distress.

Jane Dokko, Geng Li, and Jessica Hayes write,

These results lead us to hypothesize that credit scores, in addition to measuring an individual’s creditworthiness regarding the repayment of debt obligations, reveal information about an important relationship skill. We argue that one such skill could be an individual’s general trustworthiness and commitment to non-debt obligations. To make this argument, we turn to survey-based measures of trustworthiness to show that the average credit score of a geographic area (typically a county) is highly correlated with the same area’s average level of trustworthiness. We also find that when individuals have a long exposure to greater trustworthiness, as measured by surveys, they tend to have higher credit scores even years after they leave those areas. Similar to how credit scores predict the formation and dissolution of committed relationships, we find that survey-based measures of trustworthiness also have predictive power for these outcomes. Interestingly, such statistical relevance diminishes when the couples’ credit score levels are controlled for, underscoring the overlapping between credit scores and survey-based measures of trustworthiness.

Pointer from Tyler Cowen.

In mortgage underwriting, they used to talk about the three C’s: collateral (the house, particularly the borrower’s equity in it), capacity (the borrower’s income relative to mortgage payments and other debt obligations), and credit history.

In fact, I think that the third C should be called conscientiousness, one of the Big Five personality traits. The authors of the paper instead use the term trustworthiness. That this trait should matter for relationship stability, and that it is well measured by credit scores, should surprise no one.

I worry that pursuit of this line of inquiry, like research on the role of IQ, will not be good for the career of a young researcher.

Blame the DA’s

John Pfaff says,

Though we have a smaller pool of people being arrested, we’re sending a larger and larger number of them to prison.

the probability that a district attorney files a felony charge against an arrestee goes from about 1 in 3, to 2 in 3. So over the course of the ’90s and 2000s, district attorneys just got much more aggressive in how they filed charges. Defendants who they would not have filed felony charges against before, they now are charging with felonies.

He argues that this, rather than other people’s favorite reasons, accounts for the high incarceration rate. Pointer from Tyler Cowen.

I still have many questions. For example, has the number of mentally unstable, violent individuals gone way up? Or has the proportion of mentally unstable, violent individuals gone way up? Do other countries, with lower prison populations, have fewer mentally unstable, violent individuals? Do they have an alternative way for dealing with such individuals that works better? etc.

Nigerian Entrepeneurs, Not a Scam

The abstract of a study for the World Bank by economist David J. McKenzie reads

Almost all firms in developing countries have fewer than 10 workers, with the modal firm consisting of just the owner. Are there potential high-growth entrepreneurs with the ability to grow their firms beyond this size? And, if so, can public policy help alleviate the constraints that prevent these entrepreneurs from doing so? A large-scale national business plan competition in Nigeria is used to help provide evidence on these two questions. The competition was launched with much fanfare, and attracted almost 24,000 entrants. Random assignment was used to select some of the winners from a pool of semi-finalists, with US$36 million in randomly allocated grant funding providing each winner with an average of almost US$50,000. Surveys tracking applicants over three years show that winning the business plan competition leads to greater firm entry, higher survival of existing businesses, higher profits and sales, and higher employment, including increases of over 20 percentage points in the likelihood of a firm having 10 or more workers. These effects appear to occur largely through the grants enabling firms to purchase more capital and hire more labor.

Pointer ultimately from Tyler Cowen. My cynical thoughts:

1. How does one keep corruption out of such a program?

2. Does this imply that there is an unexploited profit opportunity in lending to would-be entrepreneurs in underdeveloped countries? Note that the money the firms received seems to have been in the form of grants, not loans.

The Basic Social Rule and Dissent

From Elizabeth Warren’s book, as relayed by a review in the NYT.

After dinner, “Larry leaned back in his chair and offered me some advice,” Ms. Warren writes. “I had a choice. I could be an insider or I could be an outsider. Outsiders can say whatever they want. But people on the inside don’t listen to them. Insiders, however, get lots of access and a chance to push their ideas. People — powerful people — listen to what they have to say. But insiders also understand one unbreakable rule: They don’t criticize other insiders.

Pointer from various places–I first saw it from Tyler Cowen.

Remember that the basic social rule is to reward cooperators and punish defectors. I believe that without such a social rule, trust would break down and we could not have markets. However, that does not mean that the social rule is always a wonderful thing. Criminal gangs operate the basic social rule, also–they reward people who cooperate with the gang and punish people who defect from it.

The basic social rule gets applied in politics and in academics. A visitor from Mars would have a really hard time understanding how macroeconomics got into the cul de sac in which it had arrived when Olivier Blanchard wrote that the state of macroeconomics is good. I would say that Dornbusch and Fischer were really good at rewarding cooperators and punishing defectors.

Dani Rodrik on Trade Across Borders

He writes,

A libertarian might view much of the regulatory apparatus of the nation-state as superfluous at best and detrimental at worst. For me, the apparatus is what makes capitalism feasible and sustainable at the national level – and problematic at the global level.

Pointer from Tyler Cowen. Read Rodrik’s whole post.

Suppose that A trades voluntarily with B. Then C comes along and says that this trade harms D, so it should be prevented.

The libertarian position is that we know that A and B are better off, or they would not have done the trade in the first place. We doubt that C is such a wise, benevolent individual that we can trust his judgment that the harm to D is larger than the benefit to A and B.

Now it is true that the benefits of specialization and trade require trust, and it is possible that trust in general is higher when people believe that their government is wise and benevolent. However, I would bet that where you find people trusting their government to interfere with cross-border trade you find less overall trust and worse economic outcomes. It will take some demonstration on Rodrik’s part to convince me otherwise. It is one thing to conjure up “models” in which trade restrictions improve outcomes. I want to see examples of broad improvements in well-being arising from real-world trade restrictions.

Not surprisingly, Don Boudreaux has views on this.

Study Not Needed

Ray Fisman and Daniel Markovits write,

We measured attitudes toward equality by asking hundreds of Americans to distribute a pot of money between themselves and an anonymous other person. Our subjects weren’t making hypothetical choices in responding to the survey—their decisions affected how much real money they would get when the experiment ended.

Pointer from Tyler Cowen. I added the emphasis on “themselves.” That is very different from what redistribution means in political terms. There, it means redistributing other people’s money.

The authors seem to suggest that we should be surprised that rich progressives are reluctant to redistribute their own money. I do not think we needed an experiment to show this. I think we already know from their behavior that rich liberals are averse to redistributing their own money. I believe that surveys have shown that instead conservatives and people lower down the income ladder give larger shares of their income to charity.

Political support for redistribution is costless, especially compared with actually giving away some of your wealth.

Would Universal Health Coverage Help the Poor?

Apparently, Larry Summers wants to stake out that position. Pointer from Tyler Cowen.

I seriously doubt that medical services are the relevant margin for improving the health of the poor. Public health measures I can see. Otherwise, my bet is that economic growth and diffusion of knowledge are the relevant margins.

Of course, if Larry believes otherwise, he is always welcome to donate his own funds to relevant charitable causes. As long as he does not take my money to donate to his preferred causes.

Tyler Cowen after the Republican Debate

He writes,

The two participants who have done the best relating to voters, through the media, are the two former CEOs, Donald Trump and Carly Fiorina.

A priori, you would think that being a professional politician selects exactly for people who can do well in a televised national debate. Yet, from this limited number of data points, it is the CEOs who have the relevant skills.

Politicians make more speeches. CEO’s participate in more business meetings.

Think of making a speech as like playing rhythm guitar on a 1960s pop single. You play continuously, and your job is to give the song atmosphere through your use of volume, tempo, and tone.

Think of participating in a business meeting as like playing lead guitar. You come in for short “fills,” and your job is to move the song from where it has been to where it is going by hitting a few really striking notes at just the right time.

Because there are so many candidates at this point, Republican media events are more like business meetings than speech-making opportunities. So that would be my explanation. I think that the comparative advantage of the lead guitarists will be much less when there are only two or three candidates on stage.

Earnings of College Graduates

Kevin Carey reports,

The Department of Education calculated the percentage of students at each college who earned more than $25,000 per year, which is about what high school graduates earn. At hundreds of colleges, less than half of students met this threshold 10 years after enrolling. The list includes a raft of barber academies, cosmetology schools and for-profit colleges that often leave students with few job prospects and mountains of debt.

But some more well-known institutions weren’t far behind. At Bennington College in Vermont, over 48 percent of former students were earning less than $25,000 per year. A quarter were earning less than $10,600 per year. At Bard College in Annandale-on-Hudson, the median annual earnings were only $35,700. Results at the University of New Mexico were almost exactly the same.

Pointer from Tyler Cowen.