A Commenter’s Suggestion

He writes,

May I humbly/respectfully suggest, Arnold, that you consider replacing your economics-is-not-a-science meme with an economics-is-like-applied-science (i.e. engineering and medicine) one.

Reading a draft of Jeffrey Friedman’s next book, I gather that this was John Dewey’s notion. Just as doctors often “treat empirically” (by trial and error), policy science can improve by trial and error.

The parallels with medicine are interesting. Just as it seems to be the case that a lot of health care spending goes to medical treatments with high costs and low benefits, it is the case that a lot of government programs and regulations have high costs and low benefits.

I reject Dewey’s model as a description of actual policy practice. Policy makers almost never design proper trials, and they almost never correct errors. Pretty much every anti-poverty program that has been tried since the 1960s is still around, regardless of how (or whether) it was evaluated.

In my latest book, I argue that the profit system does a much better job of trial-and-error learning. The incentives to learn are much stronger. If you make enough mistakes, you lose money and go out of business. Also, upstart companies are much more willing to attempt a radical innovation than are established organizations, whether those established organizations are corporations or government agencies.

Also, I believe that social phenomena are more complex than the problems that engineers encounter. That is why I see mathematics in economics as pretentious. More than that, it can be harmful, as it focuses economists on building models that are so simple that they are deceptive rather than helpful.

All that said, I prefer that economists present themselves as doctors than as scientists, as long as they make it clear that they have not discovered the cures for the diseases with which they are presented.

Indulging in Confirmation Bias

For my view of the housing bubble. John Geanokoplos and others wrote,

Notice that if we freeze leverage (LTV) at constant levels, the boom gets dramatically attenuated, and the bust disappears.

This statement is based on a simulation of an “agent-based” model for house prices. Pointer from Eric Beinhocker from Mark Thoma.

Beinhocker writes,

rather than predict we should experiment. Policymaking often starts with an engineering perspective – there is a problem and government should fix it. For example, we need to get student mathematics test scores up, we need to reduce traffic congestion, or we need to prevent financial fraud. Policy wonks design some rational solution, it goes through the political meat grinder, whatever emerges is implemented (often poorly), unintended consequences occur, and then – whether it works or not – it gets locked in for a long time. An alternative approach is to create a portfolio of small-scale experiments trying a variety of solutions, see which ones work, scale-up the ones that are working, and eliminate the ones that are not.

American pragmatist John Dewey also thought that technocrats should take an experimental approach. That is not a new idea. (I learned this from Jeffrey Friedman, who sent me a draft from his forthcoming book.) Of course, my view is that I would rather see experiments come from the market than from technocrats.

Later, Beinhocker writes,

A major challenge for these more adaptive approaches to policy is the political difficulty of failure. Learning from a portfolio of experiments necessitates that some experiments will fail. Evolution is a highly innovative, but inherently wasteful process – many options are often tried before the right one is discovered. Yet politicians are held to an impossibly high standard, where any failure, large or small, can be used to call into question their entire record.

I would argue that avoidance of failure is natural in any large organization, not just government. That is why I think that markets are better able to conduct experiments to solve problems.

I found Beinhocker’s essay interesting. However, if we are going to try to improve economics, it is important to include behavioral policy-making and politics into the analysis. Do not simply assume a benevolent, rational technocrat as decision-maker.

Speaking of confirmation bias, a recent Instapundit post linked to an old essay of mine, one which speaks to this comparison between expertise mediated by markets and expertise mediated by government.

Stimulate Demand, Restrict Supply

Zac Townsend writes,

San Francisco’s policies are out-of-line with building almost anywhere else. For example, nowhere in San Francisco do you get density bonuses for affordability (like in New York City) and nowhere in San Francisco can you build as of right (like in almost every other municipality). And, perhaps most importantly, no where else is there a belief that you can solve a housing affordability crisis without encouraging the building of more housing.

Read the whole thing.

In my view, the way to look at public policy in food, health care, education, and housing is that it seeks to stimulate demand and restrict supply. It makes no sense from the standpoint of economic theory, but it makes perfect sense from the standpoint of public choice.

Jason Furman on Tax Reform

He says,

The awkward fact, however, is that more than half of the value of these tax expenditures reflects exclusions from income that actually make it easier for individuals to file taxes. Many tax expenditures allow taxpayers to exclude or deduct income that is not received in cash and would be much harder to measure precisely than wages on a W-2. Taxing home production, imputed rent on owner-occupied housing, pension earnings, inside buildup on life insurance policies, and all government benefits would move the tax system closer to many economists’ ideal “Haig-Simons” concept of taxable income, but would in fact make filing taxes much more complex.

Pointer from Mark Thoma. Keep in mind that Furman is still part of the Obama Administration and so is not completely free to speak his mind. Still, I would bet he believes at least 90 percent of what he says here. I think that the one thing he leaves out is the payroll tax. I would place a high priority on reducing the payroll tax, which I think can be counted as progressive tax reform.

Yes, that was my picture

A friend at dancing last night said that she saw my picture in the NY Times. I could not figure out what she meant, but she was right! If you scroll down in the article, you will see a picture from 2011.

At that hearing, I discarded my prepared remarks and instead called out the other two guys as representing special interests. The Democratic Senator chairing the hearing was not happy. I am actually rather proud of that one.

Incidentally, the Times story is slanted in an odd way. If you know anything about the Fannie Mae lobby in its heyday (and many of its hatchet men are still active), you would say that calling Fannie Mae a victim of lobbying is like calling Donald Trump a victim of harsh rhetoric.

The Higher Education Industrial Complex

The WSJ reports,

Colleges and universities have become one of the most effective lobbying forces in Washington, employing more lobbyists last year than any other industries except drug manufacturing and technology. . .

All that these noble, public-spirited institutions ever ask for is more money with no accountability. What could go wrong?

The failure of political efforts to require more accountability and transparency means that colleges continue to collect billions of dollars annually in student loans with few strings attached, including schools that don’t graduate many of their students and where loan defaults are high.

A lot of people will tell you that higher education is one of the industries that works pretty well in the U.S. all this crony capitalism notwithstanding, I suppose.

Steve Teles Defends Technocrats

He wrote,

greater responsiveness only increases the opportunities for concentrated interests to exert influence over the agencies that are supposed to regulate them. Perhaps ironically, it may be the case that only those regulatory agencies that are able to escape domination by politicians will be able to effectively pursue the goals that those same elected officials wrote into law back when the public was paying attention. Effectiveness, in short, may demand a significant degree of bureaucratic autonomy, rather than democratic control.

…Carpenter’s key insight is that bureaucrats themselves have the power not only to shirk or subvert their principals, but in some cases to guide or even dominate them. The canvas on which he explains how this is possible is the history of one of America’s most powerful agencies, the Food and Drug Administration.

Teles is reviewing a book by David Carpenter, in which the author argues that the FDA’s power stems from its reputation. Because the FDA is highly regarded, it can maintain its independence from Congress.

Teles sees that as a good thing. His model of politics is that there are fleeting demands for regulation, to which Congress responds by establishing an agency. However, once the spotlight is off and the actual regulatory process is underway, the more politically responsive the agency, the more likely it is that the agency will be manipulated by special interests. It is better for the agency to polish its reputation and sustain independent power.

In this model, what is it that limits an agency’s power?

In theory, the loss of reputation leads to a loss of power. When has this happened? The Federal Emergency Management Agency (FEMA) has a terrible reputation, but it has at least as much responsibility as ever. Same with the Transportation Security Administration (TSA). The Environmental Protection Agency (EPA) recently spilled chemicals into the Colorado River, and as far as I can tell it suffered no consequences.

Still, I think that it is fair to say that technocrats focus on their reputations. Bad publicity does attract Congressional attention, and perhaps that makes an agency less aggressive than it otherwise might be.

But reputation-protection, rent-seeking, can be costly. A place like the Fed selects for chairmen who write self-serving memoirs. The question is whether the focus on reputation leads to better behavior or mere image-polishing.

In the private sector, there is the same tension. Reputation can be earned, or it can be manipulated through public relations. But one hopes that the competitive process will eventually expose the manipulators and reward the good performers.

Steve Teles on Rent-seeking

He writes,

State regulation of doctors, Commodity Futures Trading Commission rules for derivatives, and local land-use planning decisions rarely if ever occur to citizens and policymakers as having anything to do with the larger social debate about inequality. If the case is made effectively — if policymakers do start seeing these diverse policies as part of a larger problem — then it would be possible to generate political conflict in arenas that are currently too quiet and uncontested. This happened in the 1970s and 1980s when policymakers connected regulatory capture in areas like trucking and airlines to widespread concern with inflation. It could happen again if policymakers across the spectrum start to believe that rent-seeking, in all its forms, is deeply implicated in the problem of inequality.

Pointer from Mark Thoma.

But are other progressives willing to concede that government intervention in markets has such adverse consequences?

Chris Edwards on Government Failure

He writes,

Consider Medicare. Under Parts A and B, the government pays doctors and hospitals a set fee for
each service provided. That encourages them to deliver unnecessary services because they make more money the more services they bill. As an example, investigations have found that doctors are ordering many unneeded drug tests for seniors.

I think that someone with an opposing viewpoint would say that even though government initiatives are not executed flawlessly and that adverse side effects do occur, the intentions of the programs are good and the positive outcomes are sufficient to outweigh the problems. As Edwards puts it,

It is true, however, that just because a federal policy creates unintended collateral damage does not automatically mean that the overall policy is a failure. Some federal interventions do generate higher benefits than costs. The important thing is that policymakers look beyond the intended effects of their programs and consider how people and businesses may respond in negative ways over the longer term.

As I see it, those of us who are concerned about government failure have to get over the following hurdles with those who disagree.

1. Lead them to think beyond the intention heuristic. “Support for education” sounds good, but that does not automatically justify every government program intended to improve education.

2. Scrutinize the actual design and execution of government programs, rather than assume that both are flawless.

3. Track the cost of government programs. This includes the direct cost paid by taxes, but it also includes the indirect cost of market distortions, including (as Edwards points out) the deadweight loss from taxation.

4. Take into account the organizational dynamics of government programs. That is, agencies and programs tend to persist well beyond the point where they have served a useful purpose.

5. Take into account the public choice aspect of government programs.

Even so, I still do not think that we will get very far. I think that the supporters of Obamacare are aware to some extent of the way that each of these issues has affected the program (perhaps not so much with issue 3). And yet they are very enthusiastic about Obamacare, and they insist that it is working.

A Case of Over-Supply

Steven J. Harper writes,

Amazingly (and perversely), law schools have been able to continue to raise tuition while producing nearly twice as many graduates as the job market has been able to absorb. How is this possible? Why hasn’t the market corrected itself? The answer is that, for a given school, the availability of federal loans for law students has no connection to their poor post-graduation employment outcomes.

Of course, outcomes do not matter when it comes to government support for higher education, or for home ownership. Intentions matter (“everyone needs access to higher education and to home ownership”). And what really matters is rent-seeking.