Hoover not laissez-faire, redux

I feel icky because I sense I’ve wondered into some age-worn ideological battle… but if you need more evidence Hoover was an interventionist, Prof. Caplan has it.

To be fair, and balanced, I should mention the obvious. Pointing out intervention in the economy sometimes leads in disaster isn’t to say all interventionist policies are bad. The calm, reasoned thing to do — something, perhaps, normal people would do — would be to pick a normative framework (e.g. efficiency) or two (e.g. economic depravity) and evaluate individual policies for their “goodness” along those dimensions. Did a given depression-era policy increase the number of unemployed? Did it encourage growth? How many people did it save from starving to death? Did it increase wages at the bottom of the distribution? What was the average “wage” for the working poor and the unemployed before and after the policy? From a macro perspective, were prices/wages more or less sticky during the 30’s? Does the relative success of money policy in other countries co-occur with more price-adjustment friendly policy (e.g. union busting)? Did redistributionist fiscal policy have the effect of neutralizing the distributional effects of monetary policy? What’s the implied weight depression-era policy makers had on policy meant to help alleviate economic depravity relative to efficiency improving policy? Maybe all that Woodford crap giving policy makers objective functions will actually have some use…

He’s catching up

Professor Rauchway now seems to be ok with the idea that Roosevelt’s policies prolonged the depression. There’s a trade-off between policy oriented towards increasing economic efficiency and policy oriented towards reducing economic depravity.

There’s a larger sense in which we’d like to know if Roosevelt got this trade-off right. Yes, make-work programs helped ensure people didn’t starve to death, but was there too many make-work programs in the sense that a lot more people were unemployed for longer of periods of time because of them? How to talk about optimal policy when the trade-off itself bridges normative frameworks?

Art as investment

Fellow grad student, Bed Mandel, has a paper coming out in AER ((holy shit!)) called Art as an Investment and Conspicuous Consumption Good (pdf):

This paper provides a simple and empirically plausible model of artworks as investment vehicles. It reconciles the observation that average financial returns for collectibles are low and volatile with the theory of consumption-based asset pricing. Art assets are appealing both for their ability to transfer consumption over time and their use as signals of wealth, as in the literature on the demand for luxuries. Adding art value into utility, returns also reflect this ‘conspicuous consumption’ dividend; as a result, average financial returns are low. Risk premia for artworks are predicted to be modest or even negative.

He cites Veblan, but the best line is the last:

In a boast, a friend once told me that his art was a better investment than all other assets, including …financial securities and real estate. Accounting for his utility in telling me so, that is indeed likely.

Oh, and Prof. Kling, you’ll notice equations 5-7 are Euler equations. I defy you make the claim that Ben is just “producing stochastic calculus porn to satisfy [his] urge for mathematical masturbation.” I’d say you actually learn something about Art looking at those equations.

BTW, Ben is on the job market this year. Snap him up before its too late!

A better left blogosphere…

this post has the potential to dramatically change my mind about a number of things. Its long but worth it.

In any case, I’ve never seen a better example of moving the conversation forward:

[T]here is now no time for tolerance of the three objections to this analysis [Feds are in effect controlling the risky rate of interest as they do the risk-free rate] and this plan of action [the “bailout”], roughly: (1) it’s immoral, (2) it’s unfair, and (3) it can’t work in the long run. To expand a bit:

1. It’s immoral because people have a right to be treated like adults–which means that they have a right not to be rescued by the government from the consequences of their bad judgment, and we are violating that right.
2. It’s unfair because feckless greedy financiers who caused the problem ought to lose money and aren’t–or aren’t losing enough money–and because feckless greedy imprudent thriftless borrowers who caused the problem ought to lose money and aren’t–or aren’t losing enough money.
3. It won’t work–at least not in the long run.

I dismiss objection (1). It is made, mostly, by those who speak for the Princes of Wall Street. Note that the Princes of Wall Street themselves are not opposed to what the Federal Reserve and the Treasury and the congress doing–anything, anything at all that promises to raise asset prices is something that each of the Princes of Wall Street would trade at least one of their organs of generation for. But those who speak for the Princes of Wall Street–well, they really believed that the Princes earned their fortunes by virtue of their virtue–their intelligence, their nerve, their skill, and their willingness to run great risks for great rewards. The idea that there is a public safety net to catch the Princes when they all fall off the tightrope at once–that they are not actually rugged Randite individualists running great risks–that they are people in the right place at the right time with enough low animal cunning to cover themselves with glue and then step outside at 57th and Park or on Canary Wharf as the money blows by so that a bunch of the money sticks to them–well, this strikes those who speak for the Princes of Wall Street on the editorial page of the Wall Street Journal or in Investors’ Business Daily as a betrayal of the moral order.

The response to objection (1) is that the people who make it need to grow up. There is no more a John Galt or a Jane Galt than there is a Santa Clause. There are no Randites in a financial crisis–or no even quarter-sane Randites. The fact that there is a safety net in a financial crisis is something that has been obvious to everything with a spinal column for at least a century and a half–that’s what central banks are for, for Jeebus’s sake! The Princes of Wall Street did not earn their fortunes by virtue of their virtue, their intelligence, their nerve, their skill, and their willingness to run great risks, et cetera, et cetera, low animal cunning, glue, money sticks as it blows by.

The response to objection (2) is “tough.” Yes, it is important to design the elements of the rescue package in such a way as to give as few windfalls as possible to the undeserving feckless, greedy, imprudent, thriftless, et cetera. We will do what we can within the law to make sure as few gains ill-gotten survive going forward. But as Federal Reserve vice chair Don Kohn says, it is bad public policy to hold the jobs of tens of millions hostage in an attempt to teach a few feckless financiers (or even somewhat more thriftless borrowers) even a much-deserved lesson.

The response to objection (3) is that it was first made by Karl Marx at the end of the 1840s: that the problem is not overspeculation but rather overproduction, and cannot for long be solved by paliatives that address overspeculation only:

Karl Marx and Friedrich Engels: Neue Rheinische Zeitung Revue (1850): Speculation regularly occurs in periods when overproduction is already in full swing. It provides overproduction with temporary market outlets… but then precipitating the outbreak of the crisis and increasing its force…. What appears to the superficial observer to be the cause of the crisis is not overproduction but excess speculation, but this is itself only a symptom of overproduction. The subsequent disruption of production does not appear as a consequence of its own previous exuberance but merely as a setback caused by the collapse of speculation…

Marx was wrong then–the business cycles of the 1850s were not the harbingers of a world-wide communist revolution and not the expression of the dialectical contradictions of capitalism. “Overproduction” does not necessitate a crash. “Overproduction” simply means that the economy has built a lot of capital, and that a bunch of that capital is not going to be worth what the rich people who invested in it had hoped, and in the aftermath the economy’s real interest rate will be low. Big whoop–a low long-term real interest rate. All historical evidence suggests that stage III policies can work. And that avoiding them definitely for reasons of ideological purity does not work.

Wow. Arguing to abolish the Fed is crazy talk, no? If it is and so we admit the world is not first-best and a central planner must control a price (the risk-free interest rate), what theorem or moral principle tells us they shouldn’t control two? In my dazed thinking sitting in my brothers apartment 10 blocks north of Wall Street six hours before the market opens, all I can fall back on are slippery slope arguments… if two prices, why not three? ten? hundreds? all prices?

We know central control of all or most prices is bad, bad, bad, but does it follow that control of two (but, of course, not the one) is bad too? Notsneaky wants to know what the most important unsolved problems in economics are. The proper size of government gets my vote.

There needs to be a well-considered response to Prof. Delong’s post (or at least this section of the post). I’m just simply not up to the task. Let this just serve notice of excess demand for such a response.

Tax data vs survey data

Prof. Delong links to Brad Setser who a couple months ago was lamenting over this chart:

Notice the negative growth numbers for the bottom 90th percentile.

The data are from Piketty and Saez. Curiously, these authors don’t analyze the income shares of the bottom 90th percentile. They say this is because before 1945 most people were exempt from filing tax returns except top earners. But I suspect they think these data are a bad measure of bottom 90th percentile even after that because in the working paper, the published paper, the comment and the “summary for the broader public” the shares of the bottom 90th percentile are never reported. In any case, this means whoever at the WSJ that created the chart extrapolated from Piketty and Saez’s data on top income shares and didn’t take the data directly from them.

Tax data have a number of problems, all addressed in their paper. There’s evasion, exemptions, and income shifting. Also, because most taxes are filed by family instead of by individual, tax data can only be used to look at family incomes. This means some of the trends will be the result of demographic changes (i.e. families differentially getting smaller in each income percentile).

But Piketty and Saez use tax data, instead of survey data (e.g. Census), to analyze top income shares because given there’s no random sample, the top of the top have a proper representation in the data set. In a random survey, its unlikely you’ll end up surveying one of the 14,836 families that make up the top 0.01% earners. They’re using the right data for the job, but the job isn’t to analyze shares of the bottom.

That’s why we have survey data. And I happen to have survey data, the 2000 Census and the 2006 CPS, sitting on my desktop. By my figuring, wages of the bottom 90th percentile went up by 5% between those years.

So, we should fight over what data is better, but its at least important to know that survey data gives a different answer than tax records. Its a bit premature to conclude, as Setser did, “Most Americans didn’t benefit from the expansion of the past few years.” That said, a 5% increase is meager over 6 years. I won’t be throwing any parties.

Devastating disproof of homo economicus

Line jumping. This is the reason economics — objective maximizing, incentive following rational agent-based analysis — is terrible at explaining human behavior. Some guy gets pissed off because some ass-clown cut in line and suddenly homo economicus can be thrown out the window?

I’m generally receptive to the other social sciences’ concern with norms and such, but this is just ridiculous. Economics, and its h.e. fiction, isn’t meant to explain particular cases of human behavior; economists attempt to explain whole patterns of behavior. Start with the assumption that people respond to incentives and you can get a long ways in explain those patterns.

But its not just patterns being explained. I suppose the sociologist’s observation that there’s a “don’t jump lines in particular ways in particular circumstances” norm and that norm is enforced even when its not in agents’ immediate best interests to do so constitutes a pattern. I’m tempted to say economists only look at significant patterns of behavior, but who are we to say what is significant. That said, there’s a certain scope to economic patterns that seems to be larger, in some sense, than those patterns of behavior studied in anthropology or sociology. Perhaps I’m being a little self-serving in this belief, though.

I’m also tempted to say economists, in contrast to the other social sciences, study patterns that are context independent. To do economics all you have to do is assume people follow incentives, show incentives exist and then verify the expected behavior matches that of h.e. This doesn’t seem true in the other disciplines where frame (psychology), culture (anthropology) or group context (sociology) matter a lot.

Of course, there exist norms that underpin the economy. The propensity to trade, to trust, etc allow for the existence of markets in the first place. But studying the foundations of markets doesn’t preclude the study of the markets themselves.

Chemistry is physics yet physicists don’t do chemistry. Chemist persist in their fiction of discreet atoms and they’ve done pretty good science doing so. Economists might be able to hack together some good science with their fiction too.


Everyone knows physicists are the smartest of them all. Thus, prefixing your field’s name onto the word “physics” provides automatic doubleplusgoodness. At least it means you can publish economics in physics journals. Example:

Rising cost of oil ‘due to speculation’ – [E]conophysicists Didier Sornette of ETH Zurich, Switzerland, and Wei-Xing Zhou of the East China University of Science and Technology, together with Ryan Woodard of ETH Zurich, claim that speculation must have driven some of the escalation in oil prices. They have found evidence for a “bubble” — an indicator of speculation — in prices since 2003, when the cost of an oil barrel was four times lower than it is today.

Bubbles are a controversial topic in academic finance because there is no clear way to define them. However, Sornette’s group says it can pin them down by examining the precise rate of growth in prices.

In an economy without speculation, the price of commodities tends to grow by a fixed percentage every year; this is an exponential rate of growth. But when an economy is influenced by speculation, the percentage increase can grow too. This gives rise to a power-law growth or, as the researchers call it, a “super-exponential growth”.

Sornette’s group has looked at three different models to see if oil prices exhibit super-exponential growth…The researchers found that all three models fitted the oil-price data well, implying that the growth has indeed been a bubble (Physica A submitted; preprint at arXiv:0806.1170v2).

Could it be that there is no financial speculation, but that the demand for oil from China and India is growing super-exponentially, like a bubble? Sornette’s group cites figures on world oil supply and demand from the International Energy Agency that suggest this cannot be the case. Sornette told physicsworld.com that he is “99% certain” speculation is influencing current oil prices.

Sornette group first came up with his theory of super-exponential growth as a symptom of economic bubbles in 1996. In 2005, they used it to predict the burst of the US housing bubble.

Basically, prices have been going up really fast and the authors have noticed this pattern in prices is associated with speculative bubbles when supply and demand aren’t changing much. To say oil prices have gone up due to speculation, they have to rule out large shifts in supply and demand.

The authors make the decent assumption that supply — by which, I think they mean oil coming out of the ground — doesn’t change that fast. Their job, they say, is to show demand didn’t change that much. Given small changes in demand and small changes in supply, the price increases must be due to speculation. They use demand and supply data from some non-publicly available source to assess the speed of demand shifts. Its not clear what these data are, but, charitably, they must be quantity data where the difference in supply in demand is the change in inventories. So they’re using quantity data to assess demand shifts. They don’t find big changes in quantity, so they assume small shifts in demand.

In other words, they ignore elasticities. Apparently, its ok to ignore behavioral responses in econophysics. I guess this is understandable given physicists don’t have to worry much about they budget constrained, preference maximizing behavior of quarks.

The problem is if supply (or demand) for oil is inelastic, even small changes in demand (or supply) will induce large changes in price and the authors method for determining the existence of speculation goes out the window. I’m guessing both demand and supply for oil are inelastic so it could be both demand shifts caused by China and supply shifts caused by speculators inducing the large price increases. Given the huge rise in demand and the fact that inventories are finite (thus limiting the effect of speculators), it seems more likely the price changes are due to the former rather than the latter.

UPDATE: Rapture is near… I’m really liking the bloggy version of Paul Krugman.

Marxist Fallacy

Thanks to Rodrik’s literary style (as quoted in the previous post), we can skip right over the technical issues… What does Stolper-Samuelson tell us if owners of factors own diversified portfolios of those factors?

Let me set this up a little:
Its the Marxist Fallacy to assume people can be neatly divided into classes. Marxist talk about the proletariat and the bourgeoisie; economists talk about high and low skill workers. Both commit the Marxist Fallacy.

For Marx, exploitation by bosses of workers drove wage differences and he ignored the fact that most people, while being someone’s underling, are someone else’s boss. The facts he didn’t confront are that the customer is always right (and we’re all customers) and that there’s very few leaf nodes in social graphs. Also, most people know the statistics on the percentage of Americans that own stocks; Marx’ narrative of capital against labor doesn’t make sense.

For economists, skill, measured by years of schooling, determines wage differences. The more skilled you are — i.e. the more hours you spend in the classroom — the more productive you’ll be on the job and thus the higher you’ll be paid. Economists ignore other types of skill.

With a change in trade or some other economic innovation, the Marxist Fallacy leads to an interpretation of the Stolper-Samuelson theorem like this:

The theorem does not identify who exactly will lose out. The loser in question could be the wealthiest group in the land. But if the good in question is highly intensive in unskilled labor, there is a strong presumption that it is unskilled workers who will be worse off.

Rodrik is conflating the supply of unskilled labor inputs and the suppliers of those inputs. There may be less demand in the U.S. for unskilled labor inputs, but that doesn’t necessarily mean there’s a reduction in the demand for the suppliers of that labor. A person may “own” both skill and unskilled factors, but only provide one to the labor market. This seems strange in the context of the binary skilled/unskilled framework, but in a more realistic multi-dimensional framework, this seems more tenable. For example, suppose skills can be decomposed into communication skills and tool-using skills. Trade may make demand for the latter decrease but the demand for the former increase, but the same person may have both types of skill. Who is hurt by trade in this case?

Given the special nature of labor supply ((its constrained by the 24-hour day and its lumpy… but I don’t think a spelled out theory would need to use these features of labor)), disentangling input supply and their suppliers is important. If before trade, tools-wielding was higher paid than communicating, then the person with both skills would supply only the first. After trade, when relative factor prices change and communication skills get higher paid, that person will change his or her supply. What’s the overall impact on the wage structure?

I don’t think Stolper-Samuelson gives us an answer.

More reasons why we should treat morals as ethical preferences

Economists don’t know where preferences come from. They might come from god or culture or genes. Whatever. We don’t care. ((Or we do but we’re just not paid to care.))

If preferences are more or less constant within individuals over relatively short periods of time, it doesn’t matter where they come from. If people optimize over preferences today, resulting in some behavior, they will behave the same way tomorrow when optimizing over the same preferences ((Yes, framing matters. But there’s a fix for this: just extend the product space to include frames… I like apples on Tuesday, but oranges on Wednesday; I prefer apple-Tuesdays and orange-Wednesdays.)). The pragmatic case for taking preferences as the primitive objects of analysis is just that they’re so powerful at predicting behavior and doing policy analysis.

Treating morals as preferences over how one wants other people to act sidesteps moral reasoning (i.e. consideration of what are the correct morals) and allows for analysis to focus on predicting behavior or on policy issues.

Moral reasoning is important and I’m not saying it shouldn’t be done. As Haidt points out, though, it is often done by white upper-middle class liberals and as such reflects the moral intuitions of that particular sub-culture. The universe of moral intuitions is much broader and, more importantly, some of those non-white, non-upper middle class, non-liberal moral intuitions are held by people that don’t feel the need to rationalize or vocalize moral intuitions. Why should extra weight be given to those moral intuitions that happen to have been articulated best?

In any case, the point is that moral reasoning is tangential to many of the policy issues we’re interested in such as the optimal size of moral communities. Why not abstract away from the issues moral reasoning raises if given the opportunity?

PS – I know that I’ve been a bit cryptic on some of these topics. I’m a little busy ramping up to teach a course this summer and finishing my first chapter in my dissertation (fingers crossed). I hope to circle back to these issues, fleshing out them when I do.

Effect size matters

Mark Thoma:

People who believe consumption is driven, in part, by the consumption of neighbors and friends will like these results [open link].

What does it mean to believe consumption is driven in part by consumption of those people around you. This seems obviously true. I won’t even know certain products exist without observing the consumption habits of my friends and neighbors. I suppose, then, I believe consumption is driven in part by the consumption of others. I suspect, given the first link is to a discussion of Robert Frank’s book Falling Behind, Thoma is talking about something more. He means that people care about status and keeping up with the Joneses; they care about consumption not because of the utility it provides directly but because it makes them higher status. Status is a zero-sum game, so this is a bad, bad, bad thing.

Frank doesn’t believe, or at least his narrative suggests as much, that consumption is in part driven by status seeking. Frank’s book makes the argument that most consumption is status consumption. He isn’t claiming the existence of status seeking; he’s claiming it is a substantial economic issue. In econometrics, this distinction is the one between statistical significance and economic significance.

The paper Thoma points us to shows evidence for the existence of status seeking, but it doesn’t show a big effect size. Neighbors of people that win new cars are 5% more likely to buy a car themselves. This is a statistically significant result, but is it economically significant?

Well, 5% increase in likelihood to buy a car is significant in money terms. If a winner has 10 neighbors and new cars cost $30k, then we’d expect $15k worth of cars bought. One might be tempted to aggregate this up, but Thoma suggest the problem with doing this:

That is, when everyone wins the lottery, the social effect may have more impact on the type of spending than on the total amount that households spend.

If everyone’s winning cars, then nobody will need to keep up with the Joneses. Even still, this large money value seems like a large effect.

The question, though, is how much does status consumption matter relative to non-status consumption. Calculating the money value — the standard way for economists to calculate “economic significance” — doesn’t seem to get at this issue. The way I see it, a 5% effect suggests status consumption doesn’t matter that much. The study showed when a neighbor increases his status by a $30k car (a substantial increase in status I’d think) this only induces an increase of status spending by $1.5k. It seems if status mattered, that number would be closer to $30k.

Statistical significance always has us comparing the estimated effect against zero. If its very unlikely the effect is zero, then we say the effect is statistically significant. Testing economic significance, on the other hand, doesn’t require us to compare the effect against zero. For something to be economically significant it has to deviate from the proper counterfactual. This counterfactual can be given by gut instinct or by economic theory, but in either case the counterfactual may be far from zero.

My gut tells me “status consumption matters” means we should expect an effect size in this case close to 100%. Your gut may tell you something different, but it seems unlikely zero is what Frank’s gut tells him.