A DY2PVSC Post I Wish I Had Written

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From someone who prefers to blog anonymously.

Economics is a science, but it is a very politicized science. The Medicaid study, with its ambiguous results, offered justification for the policy proposals of both supporters and opponents of ACA, for example. Both sides were offering an incomplete picture of the study in this debate, but both sides were also correct the claims they made even if they strategically left out inconvenient findings.

Pointer from Tyler Cowen.

Read the whole thing. He is reacting to a column by Raj Chetty, and I had a similar reaction. While proclaiming the scientific virtues of economics, Chetty was sneaking in his own biases, through a selective presentation of results.

The more important point is that we all are tempted to do this, and we need to work hard to resist such temptation. One of the reasons for my occasional DY2PVSC posts (“Did you two people visit the same country”) is to try to pair up research that supports one side with research that supports the other.

They Change Their Minds

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Vernon Smith writes,

My mother was a socialist and her Wichita friends were Marxian socialists; she had only an eighth grade education but that did not keep her from running for Kansas State treasurer on the Socialist ticket. In 1936 when I was nine years old I helped pass out program leaflets for Norman Thomas, candidate for President against Roosevelt. He used to complain that Roosevelt got elected by stealing his program. At 18 (1945) I would have been a member of the YPSL (Young People’s Socialist league).

This is from a very interesting project to ask Nobel Laureates to describe the evolution of their ideological views. Pointer from Tyler Cowen.

Some remarks:

1. Several other Nobel laureates were socialists at one point, although none remained so at the time they responded to the survey. Those of you who are under 55 may have a hard time appreciating how central the issues of socialism, Communism, and anti-Communism were in the middle of the twentieth century. In fact, if you don’t understand the role that the socialist ideal played in American intellectual life from 1930 until at least 1960, you cannot fully understand that period.

2. As we start to see more Nobel laureates born after 1950, I expect to see a sharp drop-off in the number for whom socialism played any role at all in their intellectual development. In a way, this is too bad, because I think that it is easier to get stuck feeling comfortable as a conventional liberal than as a socialist. To be a socialist, you have to think through how socialism can work in theory and how it has worked out in practice, and sooner or later you become are likely to change, particularly if you study economics. It seems that once a former socialist becomes skeptical, he or she can wind up almost anywhere else on the ideological spectrum. In contrast, if you just think that “government can do good things,” that is a more robust point of view. You are less likely to undergo a period where you are reconsidering everything.

3. There is not a social conservative among the lot.

4. I never would have guessed that Peter Diamond was a conservative who read National Review in his younger days. In those days, I imagine a nice Jewish boy would have gotten in less trouble sneaking Playboy into the house.

5. In a summary analysis, Daniel Klein says that of the 21 Nobel Laureates he has been able to determine has having moved ideologically, 16 moved in what he calls the classical liberal direction, while 5 moved the other way.

6. I myself have migrated in the classical liberal direction from the far left (not socialist, though). You can read an essay I wrote about that if you buy Marc Guttman’s book.

The Obamacare Suits/Geeks Divide

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The New York Times reports,

One specialist said that as many as five million lines of software code may need to be rewritten before the Web site runs properly.

1. There is zero chance that rewriting five million lines of code is the answer. Either the solution is a lot simpler or there is no solution other than to start over.

My instinct from the outset was that starting over was the right answer. I am not alone.

2. The other day, President Obama said, “No one is madder about the Web site than I am, which means it’s going to get fixed.”

Or, as Michael Palin and John Cleese would put it, Wake up, Polly!

3. In response to the WaPo story, I wrote a letter to the editor, which they published (mine is the third letter on this page). This is not a technical screw-up, and it will not be fixed by technical people. It is an organizational screw-up. And until that is recognized, it probably will get worse. I write,

In my experience, communication failures between technical staff and management reflect an atmosphere of fear and lack of mutual respect.

I call this the suits-geeks divide. I saw it during the financial crisis, when it was evident that many mortgage credit-risk geeks warned of problems at their firms but management went out of the way not to listen. Merrill Lynch and Freddie Mac were particularly well-documented cases.

4. Every year, I have my high school students pair off and present proposals to start a new business. Two questions I always ask are “What are the critical management functions?” and “What would somebody experienced in this business know that you do not know?”

Suppose that President Obama and Secretary Sebelius were in the class, and they proposed starting the world’s largest health insurance brokerage. I would expect them to be able to identify as key management functions: marketing, customer education, insurance company partnership management, pricing and underwriting standards, and operations.

Somebody who had experience with creating a health insurance brokerage business would know that the systems problems are more complicated than just putting up a web site. In the background, the system needs to communicate with the systems at several government agencies and at the insurance companies. That changes it from a simple technical project to a complex, time-consuming, project involving business and technical staff.

You build a complex, mission-critical system through a process of continual negotiations among business units and technical people. You do not treat it as a procurement process. You cannot just write up a spec, put it up for bid, and parcel it out to dozens of contractors.

The development of the computer system probably would fall under operations, but you would want a project executive with a lot of authority to negotiate with all of the business units and to make project decisions. When conflicts arise, the project executive should be able to go straight to the CEO and get them resolved.

The project executive’s main focus is keeping the project’s complexity from getting out of control. The project executive must have the authority to trim features in order to meet deadlines.

You go through a lot of analysis and many painful meetings before anyone writes a line of code. The technical staff have to be able to challenge the business units, because sometimes the business unit asks for something to be done in a really complicated way, when a much simpler solution is available to solve the business problem.

One of the worst things that can happen on a systems project is to find yourself revisiting the business-technical negotiations process after writing a lot of code. If that is what is happening now, this project is in an unbelievable amount of trouble.

5. I suspect that the technical problems are mere symptoms. Probably what is fundamentally messed up in this health insurance brokerage business is the org chart.

6. In business, you need clear lines of authority and accountability. The bureaucratic tendency is to seek the opposite–to blur authority and avoid blame. This is a big challenge in the private sector. However, I think it tends to be even more difficult to overcome in government.

7. For Christmas, someone should give President Obama and Secretary Sebelius a copy of The Mythical Man-month.

[update: good PBS interview with several mythical-man-month allusions]

[update: Clay Shirky’s tweet echoes this theme.

Sentences to Ponder

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From Jason Brennan.

Certain Austrian economists, take note. You ain’t gonna win in economics by doing philosophy of economics. It’s not because the world’s unfair, but because it’s fair.

Read the whole post. I think that it is fair to offer methodological criticisms of specific papers and even of entire lines of research. But….well, what Jason Brennan said.

The Forgotten Sixties

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Frank Diebold reports,

I am sad to report that Lawrence R. Klein has passed away. He was in many respects the father of modern econometrics and empirical macroeconomics; indeed his 1980 Nobel Prize citation was “for the creation of econometric models and their application to the analysis of economic fluctuations and economic policies.”

Pointer from Tyler Cowen.

In my macro book, I talk about the 1960s as The Little Moderation, in order to stress its similarity to the Great Moderation of 1986-2007. However, another term might The Forgotten Sixties. Some of what has been forgotten is the excitement that was generated by macroeconometrics. Economists who made significant contributions in this area were awarded several of the early Nobel Prizes–Frisch and Tinbergen (1969, the first year of the Nobel in economics), Koopmans (1975), and Klein (1980). Yet I will venture to guess that one cannot find a single graduate school syllabus today that mentions the work of those laureates.

The same holds for the leading policy makers of the era. Who under the age of 50 has heard of Walter Heller or Otto Eckstein? I assume that Alan Greenspan will be long remembered and will continue to receive credit for the presiding over The Great Moderation (his culpability for the financial crisis is still being assessed). During the Little Moderation, the Federal Reserve received no credit. The Fed Chairman was William McChesney Martin, who today is remembered only for the “punch bowl” metaphor, which he evidently borrowed.* In the 1960s, everybody attributed good economic performance to fiscal policy, not to the Fed.

The macroeconometricians and the Kennedy-Johnson economists were at the top of the economics profession in the 1960s. As the Great Stagflation gathered force in the 1970s, they lost all of their prestige. Hence, the Forgotten Sixties.

*In October of 1955, he said,

The Federal Reserve, as one writer put it, is in the position of the chaperone who has ordered the punch bowl removed just as the party was warming up.

Pointer from Timothy Taylor.

Greenspan and the Housing Bubble

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Scott Sumner writes,

I really don’t care whether money was about right during 2005-06, or slightly too easy. Either way it wasn’t at all unusual compared to earlier periods of our history. Indeed during most of my life policy was far more expansionary during cyclical expansions than 2002-06.

John Taylor and some libertarian/Austrian economists judget Alan Greenspan as guilty for greatly exacerbating the housing bubble by keeping interest rates too low for too long. Scott Sumner exonerates Greenspan. I do, too, although for a very different reason. Sumner’s argument is that nominal GDP was not so far out of line. That is a fair point.

I would say that I find the strength of the link that Taylor finds between the Fed Funds rate and the housing market to be implausibly strong. The interest rates faced by borrowers are determined in the bond market, and the Fed’s influence there tend to be weak.

The other argument comes from the left, where it is suggested that Greenspan’s benign view of the markets blinded him to the excesses in credit creation that were fueling the bubble. In hindsight, this argument is compelling. Knowing what we know now, we can say that the Fed should have questioned the AAA ratings of securities backed by sub-prime loans, stress-tested banks on their exposure to a decline in house prices, and yelled “Danger!” about the collapse of credit standards at Freddie Mac and Fannie Mae. However, back when it mattered, in 2005 and 2006, not even the Bakers and the Shillers and the Krugmans who were talking about a housing bubble were recommending those actions.

Land Price Appreciation and Consumption

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David Altig writes,

why should there be a “wealth effect” at all? If the price of my house falls and I suffer a capital loss, I do in fact feel less wealthy. But all potential buyers of my house just gained the opportunity to obtain my house at a lower price. For them, the implied wealth gain is the same as my loss. If buyers and sellers essentially behave the same way, why should there be a large impact on consumption?

This was the crux of his blog post, although he later crossed it out because a colleague suggested it was oversimplified. Pointer from Mark Thoma.

Some comments:

1. When land prices rise, we are looking for asymmetries between the behavior of the winners from higher land prices (home owners) and the losers from higher land prices (non-owners). Conversely, when land prices fall, the winners are non-owners and the losers are owners. If the winners and losers behave symmetrically, then the effect on overall consumption should not be large.

2. As Altig points out, it could be that access to credit behaves asymmetrically. Owners experience large swings in access to credit to finance consumption via home-equity extractions, while non-owners do not experience such swings.

3. There may be a Shillerian channel, based on expectations of house price changes. That is, the effect of past changes in house prices is symmetric. However, as prices rise, owners tend to be people with high expectations for future price increases. They expect their wealth to rise, and they spend some of these anticipated gains. If non-owners had similar expectations of rising land prices and were symmetrically concerned about future increases in their living costs as a result, then they would save more. But they are not symmetrically concerned.

4. If we get out of the AS-AD framework and into the PSST framework, a broad-based land-price bubble might be less distorting than an uneven land-price bubble. A broad-based bubble creates too many real estate agents, mortgage loan officers, and homebuilders. An uneven bubble causes all sorts of ancillary businesses to locate differently. Entrepreneurs open restaurants and high-end shopping centers in booming areas*, and then when the bubble bursts they are stuck with bad investments.

*But why are they not closing such businesses in lagging areas?

Jeffrey Friedman on Voter Ignorance

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He writes,

the libertarian conclusion does not follow from the rational ignorance premise. Rational ignorance theory blames public ignorance on the low incentive to become a well-informed voter. Raise the incentives and you solve the problem. One way to raise the incentives would be to make government far more powerful than it now is, so that everyone had a much higher stake in electoral outcomes. Another solution would be to turn state power over to highly knowledgeable experts who would be fired or even fined if their policies didn’t work.

Yet another solution was suggested by Bryan Caplan: pay voters to become informed.

While voter ignorance is a problem for fans of democracy, it is not an insurmountable problem. Elite hubris is the killer. Yes, voters think they know more than they do about public policy. But elites also think that they know more than they do. And it is the elites who end up more dangerous. Read Jeffrey Friedman’s whole essay.

Ideology and Macroeconomics

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Scott Sumner writes,

I am amazed by how many proponents of fiscal policy don’t understand that it’s symmetrical. Fiscal policy doesn’t mean more government; it means more government during recessions and less government during booms, with no overall change in the average level of government. Anyone who doesn’t even get to that level of understanding, who doesn’t think in terms of policy regimes, is simply not part of the serious conversation.

I agree with the first two sentences, but not with the last.

Yes, in theory, there should be economists who, as they argued for more stimulus in 2009, should at the same time have been arguing for entitlement reform or other reductions in future spending. Other things equal, the bigger debt that we have accumulated over the past five years would make a non-ideological macroeconomist want to propose tighter fiscal policy somewhere down the road.

But “nonideological” and macroeconomics are nearly oxymorons. Name a prominent economist who believes that fiscal expansion is important during recessions and who also is to the right of the median economist on issues like school choice or taxing the rich or the usefulness of regulation. Or try to name a prominent economist who is to the left of the median economist on those issues and who does not believe that fiscal expansion is important.

I know that I was more to the left generally 30 years ago, and I was a confirmed Keynesian. I am more to the right today, and I am a skeptic of Keynesianism.

I do not think that being on the left (right) on other issues necessarily causes you to be a supporter (skeptic) of Keynesianism. However, I do think that people try to avoid affiliative dissonance and cognitive dissonance.

Cognitive dissonance is an issue because if your general view is that market failures are small and difficult for government to correct, then it is hard to fit Keynesianism in with that belief. If your general view is that market failures are significant and require government intervention, then it is hard to fit the skepticism toward Keynesianism in with that belief.

Affiliative dissonance is my own expression. It just means that if the people with whom you feel an affinity on issues W, X, and Y take a position on issue Z with which you disagree, that makes you uncomfortable. Other things equal, this will make it easier to get you to change your mind on issue Z.

We know from Daniel Kahneman (and others) that we are good at rationalizing opinions that may be arrived at on the basis of intuition. I am not saying that therefore we will never find truth in macroeconomics. What I am saying is that if you close your ears every time you detect someone’s ideology embedded in what they say about macroeconomics, then you will not hear anything.

Some Important Principles of Economics

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What would I consider to be some important principles of economics that I want my students to walk away with?

1. Market processes promote long-term growth. The market processes of specialization, exploiting comparative advantage, and creative destruction have benefits that are widely dispersed in the long run. These processes impose short-term costs on those who have invested in physical and human capital made obsolete.

2. Competition is a regulatory mechanism. For example, the ability of a business to exploit consumers or workers is attenuated by competitive forces. Businesses do not like competition. They lobby for policies that stifle competition. Often, such lobbying is successful. Competition is far from perfect as a regulatory mechanism. It is possible to be too optimistic about how well it can work. It is also possible to be too optimistic about the prospects for fixing the flaws in markets using government regulation.

3. Human cooperation is difficult to achieve. The conditions under which large organizations can operate without internal friction are never satisfied. Aligning incentives is more difficult in the real world than it might appear to be in the abstract.

4. Economists need two hands. The conditions under which markets will produce optimal outcomes are never satisfied. The conditions under which a government official can act as an omniscient, benevolent central planner are never satisfied.