Category Archives: PSST and Macro

International Trade and GDP

Posted on by

Tyler Cowen finds an FT story about data from the World Trade Monitor, which calculates that global trade contracted in the first half of 2015.

Global trade is a subset of world GDP. That is, world GDP is a measure of the value of all goods and services traded, whether across borders or not.

Let us assume that world GDP expanded in the first half of this year. What ought we to conclude?

One possibility is that cross-border trade and overall trade are not perfectly correlated, and this is a blip in the relationship. However, another possibility is that GDP is mis-measuring economic activity. The value of government purchases is not market determined. The same might be said for health care and education, in that third-party payments are important.

In other words, there are three components of world GDP: goods and services exchanged at market prices across borders; goods and services exchanged at market prices domestically; and goods and services exchanged at artificial prices. If the first component of world GDP has been contracting, then my guess would be that the second component is, also.

A PSST Story for China

Posted on by

Tyler Cowen writes,

there is significant excess capacity on the real side of the economy. It will be very hard to fix this problem without letting significant numbers of SOEs go under. The central government fears the resulting unemployment, plus the SOEs are the Party’s power base. Yet the leaders know what must be done, and the SOEs have been reformed before. …One danger is that SOE reform leads to a loss of political stability. A second and more likely danger is that reform is incomplete and China ends up full of zombie companies and banks.

Market-oriented economies get rid of heavy accumulations of unsustainable patterns of specialization and trade through financial convulsions. For China, the process will have to be top down.

An interesting question is which sort of economy does better at putting the pieces back together. Offhand, I would say that China could get through a transition with less person-years of unemployment. However, the risk is that the new patterns of specialization and trade are no more sustainable than the ones that are discarded.

An Uninspiring Sentence

Posted on by

With its heavy Scandinavian population, Minneapolis is a key U.S. player in the most avant-garde movement in food today: New Nordic cuisine, based on fish, dairy and cold-weather crops such as rutabagas, mushrooms and radishes.

I’ve missed many a trend in the foodie world, and I can’t wait to miss this one.

From an interesting article on nine cities that supposedly have thriving start-ups in specific industries. My comments:

1. Minneapolis is cited as an exciting place for restaurant start-ups. I call baloney sandwich. If you are an exciting place for a type of business, the business has to produce tradable goods or services. Restaurants do not count. If you want to start a restaurant, do not go to a city where the main growth industry is restaurants. Go to one of the other cities instead.

2. Baltimore and Boston are cited for New Commanding Heights businesses–education and health care, respectively.

3. How does this story affect my claim that cities will be increasingly chosen for their consumption characteristics, not for their production characteristics?

Market Failure and Analytical Failure

Posted on by

Tyler Cowen writes,

The upshot is that economists hold a lot of views whose justifications they cannot articulate very well. I think you would find the same when it comes to the Ex-Im Bank (are you sure it fits the model of strategic trade theory?), the mortgage agencies (what was that externalities argument for home ownership again?) or all sorts of random regulations. The relatively interventionist economists will pull some justification out of a hat, and the relatively pro-market economists will be pretty skeptical.

In The Book of Arnold, I have a chapter called “Policy and Practice” in which I go to great lengths to emphasize the analytical gap between the theory of market failure and actual policy. My prime example is housing policy. I write,

The policy pattern that consists of subsidizing demand and restricting supply is not limited to the housing market. It pervades government regulation of industry. For example, in education, the government subsidizes demand by helping to pay for education, and it restricts supply by limiting accreditation. In health care, government subsidizes demand through Medicare, Medicaid, and various tax breaks and subsidies for obtaining health insurance. Yet it restricts supply by regulating the practice of medicine, requiring a “certificate of need” before a new hospital may be built, and requiring inventors to undertake extensive studies to demonstrate efficacy of their treatments to the satisfaction of the Food and Drug Administration.

From the standpoint of the theory of market failure, the subsidize-demand, restrict-supply pattern almost never makes sense. If there is a market failure that results in under-production of a good, then it makes sense to subsidize both demand and supply. If the market failure results in over-production, then it makes sense to restrain both demand and supply. Subsidies for demand and restrictions on supply inherently work at cross purposes.

However, from the standpoint of another theory, called Public Choice, in which government policy tends to serve concentrated interests rather than address market failures, it is understandable for government to subsidize demand and restrict supply. In a specialized economy, we know that the market for what you produce affects your well-being much more than the market in any one of the myriad of goods and services you consume. Thus, concentrated interests develop on the supply side, not on the demand side. The pattern of subsidized demand and restricted supply is what you would expect to result from successful political action in a specialized economy.

My Latest Project

Posted on by

It is a short book on specialization and trade. I have a first draft, that I plan to edit at least once more before sending it around for comments. Here are the first paragraphs of the forward:

Early in 2015, I came across a volume of essays edited by E. Roy Weintraub called MIT and the Transformation of American Economics. After digesting the essays, I thought to myself, “So that’s how it all went wrong.”

Let me hasten to mention that my own Ph.D in economics comes from MIT, in 1980. Also, the writers of Weintraub’s book are generally laudatory toward MIT and its influence.

Yet I have come to believe that the MIT approach to economics has stifled critical thinking. The critical thinker is always asking the philosopher’s epistemological question, “How do you know that?” The MIT approach suppresses that question and instead presumes that economic researchers and policy makers are capable of obtaining knowledge that many believe is beyond their grasp.2 This is particularly the case in the field known as macroeconomics, whose practitioners claim to know how to manage the overall levels of output and employment in the economy.

What I have set out to write is an introduction to economics as I believe it would have been written had the MIT revolution not taken over the academy. It sets out what I see as important principles of economics, and important issues in social theory in general. Some of the ideas were understood by classical economists but forgotten by the MIT revolution. Other ideas reflect more recent thinking about the factors that enable trust in society.

A few additional notes:

1. There is a Boudreaux-like emphasis on the gains from trade throughout the book.
2. There is a Boettke-like emphasis on the co-ordination problem and on economics as comparative institutional analysis.
3. There are some themes that are not heavily emphasized in Austrian economics, and may even run counter to it. One such theme is that trust is very important for a society’s economic well-being. Trust depends on individual beliefs, cultural norms, and formal institutions. Trust means that people have confidence that rules are being enforced. All enforcement mechanisms come with advantages and disadvantages. People count on government to serve as one important mechanism.
4. Another theme is the that financial intermediation is inherently fragile. Here, I also emphasize trust. I offer a version of the Minsky cycle, but with trust in opaque financial intermediaries, rather than sheer business confidence, as the variable that changes over the cycle.
5. My take on finance and the real economy is very antithetical to monetarism. It also differs, probably in substance and certainly in presentation, from the standard Austrian story of “the” interest rate, “the” structure of production, and malinvestment.

Should I refer to it as The Book of Arnold?

Shake the Kaleidoscope

Posted on by

Josh Constine of TechCrunch reports,

Forbes is building a social networking app exclusively for these millennial leaders, which will launch at its 30 Under 30 Summit in Philadelphia on October 4. The goal is to stoke this community into somewhat of an alumni network that attracts more powerful youngsters to the Forbes empire. It will offer a directory of members, a feed where they can post social media stories or polls, and the option to message each other.

This ties in very loosely to something I have been thinking about, following a conversation with the UK’s Stephen Brien. That is, from a PSST perspective, what can be done to combat a recession? I talked about how World War II created new social ties among American servicemen, leading to businesses being formed by buddies who had met during the war. Stephen coined the expression “shaking the kaleidoscope” to describe doing something that might lead people to create new patterns of specialization and trade.

Experiments with new forms of social networking might be a way to shake the kaleidoscope. Is there a way to foster better connections between people in small-town Ohio and people in coastal cities? Between loud-mouthed sales people and quiet engineers?

When I started an Internet business in 1994, I kept in mind a documentary called “The Compleat Beatles,” in which early on the narrator says that “They were lucky, meeting the right people and playing the right clubs at critical moments in their careers.” This led me to try a lot of networking opportunities, hoping that I would meet the right people. Almost all of my efforts led nowhere, but two of them brought me my key partner and my key software engineer, without whom I would have had no chance. You could say that I shook the kaleidoscope a bunch of times, and a couple of times I got lucky.

Anyway, what I have in mind is not an app or a local happy hour. I am thinking in terms of in-person events that combine people from different backgrounds and different locations. Conferences sort of do that, except that people often have very similar backgrounds and many conference organizers put too much focus on speakers and not enough on creating opportunities for connection.

Suggestions welcome.

Paul Romer and I Could Not Disagree More

Posted on by

He writes,

During my time at MIT, Robert Solow was harshly critical of the new classical macro models pioneered by Robert Lucas, dismissive in a way that seemed to me to skirt uncomfortably close contempt. I recall hearing the same type of criticism from Frank Hahn, who must have been visiting MIT. Looking back, perhaps I misinterpreted them because I was not familiar with the sarcasm and put-downs that were a part of British intellectual life that Solow had to confront in his exchanges with Joan Robinson. But if it sounded like contempt to me, others may have heard it the same way.

…The alternative to derision would have been for skeptics to embrace and extend. This was what Stan Fischer and Rudi Dornbusch, who were supervising almost all of the Ph.D. students at MIT doing anything related to macro, were quietly doing at this time. Fischer, Dornbusch, and their students absorbed the rebel critique of traditional macro, saw what something was missing in the first generation of rebel models, and set about extending them. As a result, Fischer and Dornbusch trained a cohort of Ph.D. students at MIT who put the tools of modern macro to work and as Krugman has observed, turned out to be unusually influential. If Dornbusch and Fischer had set the tone for the response to Lucas and his followers, things might have turned out differently. But because of the inherent instability of acrimony, grievance, and factionalism, they and their students could not undo the effect of the more hostile response.

Pointer from Mark Thoma.

I disagree with this so much that I can actually feel my anger.

1. Romer’s point is that Solow set a bad tone for macro, and all difficulties in the subject flowed from that. I call baloney sandwich. Solow did not set the tone for discussions in macroeconomics in this period. As Romer points out, by this point Fischer and Dornbusch dominated macro at MIT at this point.

2. Solow’s problem with Lucas was that Solow thought that reality should take precedence over microfoundations. Solow equated Lucas’ approach to macro with deciding that because one’s theory could not explain how a giraffe could pump adequate blood to its head that one had proven that giraffes do not have long necks.

3. I think that one problem in macro is that there are many theories that are consistent with observed reality. Freshwater macro happens to be one of the few that does not reconcile with reality. It deserves Solow’s disdain.

4. Romer thinks of Dornbusch and Fischer as heroes. To me, they are villains. They pushed the representative-agent, rational-expectations nonsense that is good for nothing but mathematical, er, self-abuse.

5. Even though Solow is a Keynesian partisan and I am not, I still feel connected to him because we share a view of what is wrong with the way macro has been pursued since the 1970s.

Someone recently emailed me that I should put my memoirs of a would-be macroeconomist on Amazon. For now, it’s freely available, and I think that Romer and others interested in his posts should read it. In fact, if you want to read it on Kindle, I am pretty sure that this file will work.

The Eurozone: a PSST Story

Posted on by

He does not call it that, of course, but in the new Journal of Economic Perspectives, Christian Thimann writes,

widespread structural barriers make job creation in these countries far more arduous than in many other advanced economies, and even more arduous than in some key emerging economies and formerly planned economies. Structural barriers to private sector development are particularly widespread in the areas of labor market functioning, goods market functioning, and government regulation. Evidence from the World Economic Forum’s Global Competitiveness Index and the World Bank’s “Doing Business” dataset confirms the immense size and persistence of these barriers, despite improvements in some countries in recent years.