Plan and Counterplan

Economic Science: Back To The Basics

2009-07-09T08:53:00.006-04:00

My book (on lessons from socialism) is about using the grand experiment -- to run an economy efficiently through replacing the market with a plan -- to understand economics. After all, economics is precisely about what an economy is: the question of whether this experiment should work, and why, seems very central. Is an economy by nature a market economy? Or is it just as workable to replace the market with a plan? Or, if not completely replace the market, can you replace bits of it, or guide the market? And, if the latter, then why can't you replace the whole thing (why is that different?) and does the answer to that question have bearing on how well a partial replacement or guidance will work?

So, my interest in economics is very basic: getting back to the basics of what economics is. Getting to the core. And, I think generally this is what Austrian economics is about. Austrian economists do not want to take what other economists have done and add fancy and tangential extensions to it, or mathematically prove something into or out of existence. Austrian economists want to ask fundamental questions about economic systems that often appear easy or obvious, and then carefully and methodically work out the answers.

This is also what makes Austrian economists great teachers: at least a couple of Austrian economists that I know are, in my opinion, at their worst when they attempt to do conventional-type work that they can publish in top journals, and at their best when lecture to students or present to (or publish for) non-academics. Does this mean that Austrian economics is not scientific - that it is only palatable to the uneducated? No, I do not think so at all. Conventional economics is based on absurd, often times bizarre, assumptions. Economists realize this, but excuse it because they hope the simplifications will help to generate useful predictions. Economists then build elaborate models and equations based on these assumptions, and learning all about what they've done takes years of academic training.

However, most of Austrian economic insight is not built on such assumptions, and it is therefore not simplified enough to build elaborate models and equations upon. It therefore does not take years of academic training to understand these basic insights--instead it takes a few hours to begin to understand the basic insights (if they are taught well). After that, of course, they can be more and more deeply understood, and applied to different policy questions, economic questions, and other pursuits.

This also leads me back to where I started: Austrian economics is about the basics. Understanding and applying basic economic principles to questions in daily life. I think this is good. I do not think that we need elaborate models built on absurd assumptions: models are fine, but they are not the really critical thing. The really critical thing is to understand what economic system works best for what ends, and why. This can then answer "how can we increase economic growth?" and "can we help developing countries to grow? why are they poor in the first place?" and "should we nationalize the banks?"

It is highly unlikely that an elaborate economic model built on incredibly simplifying assumptions will answer this first and most fundamental question better than a study of the fundamentals.

The Soul of an Academic

2009-06-28T21:44:00.003-04:00

Here is a profound quote from The Sisters by Vikenty V. Veresaev, that I think gets to the core of an idealistic academic:

We were going to work together, but somehow neither of us were inclined to. We decided to have a drink. Nurka brought a bottle of port wine. We drank it, and lay down on the bed. I began to "preach" to her. I said there is no such thing as love. There are only sexual needs. She looked at me sadly with her innocent blue eyes; it hurt her to listen to me. She dreams of a "pure" love. I laughed at her and said: "Rubbish! Can a Komsomolka be such an idealist?"

I suddenly remembered and struck my forehead:

"The synopsis! I'd forgotten all about it!"

I sat down at the table and wrote out the synopsis for the lecture.

The next evening came. ... My speech poured out, vivid and unhesitating. I laid down the economic basis, passed to materialism, and so on and so on. ... The young folk were impressed; they're thirsting to be shown the path to the new life. And this is what I longed to say in the concluding words: "Listen all of you! I haven't been speaking seriously, I was making fun of you, I wrote out the synopsis of my speech when I was drunk. It was very easy because there was nothing of mine in it. I have only repeated what others have written before. I have no ideas of my own any more than you have. Tear up your notes and lets begin from the beginning; lets find the way to the new life with our own brains."

I wanted to go home alone, but I had to go with some of the others, and we argued on the way. I got heated trying to prove something, and when I reached home my heart was very heavy and I even cried into my pillow when everyone else in the room was asleep. It appears that, in order to be a charlatan, you must have a great sadness in your soul.

That about sums everything about academia up that I know.

The Time Factor

2009-05-21T22:45:00.003-04:00

Pete Leeson wrote recently, on the Somali pirate situation, that "the market has spoken," he said:

The market has spoken: Even in today’s pirate-infested waters off Somalia, the low probability of being captured by pirates, together with the fact that pirates release their hostages unscathed, means it’s cheaper--and safer--to go without armed guards.

There were a lot of pretty good responses to this argument in the comments. However, one really fundamental one is this: the market takes time to gather knowledge, respond to incentives and price fluctuations. When we forget this, as Austrians, we look like the neoclassical economist who disbelieves that there is really a dollar in front of his eyes, on the ground, because someone would have already picked it up. As Austrians we should know better.

The planners were right about this. What they got wrong was that a quick government fix would be better. They assumed that government would know, and could then use its swift ability to fix any flaws seen. This is not correct, despite the loud proclamations that we have to "do something" because any quick action is better than nothing--even if the gas truck arrives first, any old liquid is not better than nothing on a house fire. If government's actions both exacerbate the problem, and make it harder to figure out the right solution, it is not better than nothing either.

Government doesn't know, but sometimes the market doesn't know either: before it learns. So, the idea that the "market has spoken" is not necessarily correct. And in some cases, like this one, the "right solution" is based on unknowns, probabilities, and changing circumstances. What this means is that whatever the market "chooses" may or may not work out best. The choice that produces 60% success is a better choice than the one that produces 50% success, if they cost the same, but there is still a 40% chance it will fail.

Then, if it works out poorly, it will be assumed that this was the wrong choice--but it may have actually been the choice with the higher probability of success. It may have been safer, cheaper or wiser, but there is no way to know, at least without a hundred randomized trials. We don't have that--any other similar situation still has a thousand variables, just for the one data point.

If the market chooses, we won't know if it was the right choice. Market purists are wrong to say that the choice was right simply because the market chose it. The choice may be wrong, humans are fallible, information is scarce, and evolving the best choice takes time. Sometimes there simply isn't enough time. There are mistakes and trials along the way. Sometimes it would have been better to choose differently--its a learning process. On the other hand, even if it looks wrong, it may have been right, even as planners point to the failure: statistics are statistics.

If government chooses, we also won't know if they chose correctly. Market purists will say that the choice that emerged in the market was right, because the market chose it. Planners and lovers of the government fix will assume that what government chose was right, because "the people," or the voters, chose it. But, we don't know. We can't know--that is just the fate of being human, and living in a world of time and uncertainty. Life would be pretty boring if this weren't the case, but it makes economics a lot less precise than is usually assumed.

The Five Types of Economist

2009-05-20T07:38:00.004-04:00

Yes, its been done many times before. I just had an early morning urge.

1. The Mathematical Economist

"[The mathematical economist] has 30 pages of mathematics, and at the end there emerge the assumptions he put in at the beginning."
- Voprosy Economiki 1948.

The Mathematical Economist should have been a mathematician, but he knew that he would end up teaching community college if he went that route. He also knew how to write down his assumptions (name his variables) at the top of his paper, and repeat them at the end, having done some simple calculus in between. Therefore he knew he could get a top teaching position at a good research university as an economist. The Mathematical Economist has no friends, a wife, two or three children and a bland, pasta-filled life. But he is happy, and has absolutely no idea how the economy works, which makes him smirk whenever he admits it to himself, which is rarely.

2. The Clever Tear-Down Artist

The Clever Tear-Down Artist is the loudest, if not also the most common, kind of economist. The best ones teach at Harvard and win Nobel Prizes. The Clever Tear-Down Artist spends his days writing "one-liner papers" (which are about 10-20 pages) that illustrate cleverly that (if you make certain absurd assumptions) water runs uphill, the Sun actually revolves around the Earth, and Bill Clinton was a faithful husband.

Well established facts are cleverly whisked aside to make room for much more important econospeak and charts and models. Every paper is exciting and pathbreaking, and does it all in just 12 pages! They are great for cocktail parties because they can be explained so easily and they wow the girls. This is important because the Clever Tear-Down Artist is always on a conference loop or book tour, so he finds himself at a lot of cocktail parties.

3. The Whiz-Bang Kid

The Whiz-Bang Kid is a fun breed. He isn't really an economist as much as a clever flame thrower. Unlike the Clever Tear-Down Artist, he means no harm (unless he wants to start a revolution). He isn't interested in poking holes in theory, he is interested in re-writing language. For the Whiz-Bang Kid, 10 pages should be enough to explain the origin of life, and still have space for an homage to his favorite poet. Any one of his papers would win him the Nobel Prize, except that none of them have any content. Although he is brilliant the first time you hear him, and he is clearly smart, after a while it becomes clear that he isn't really saying anything. Probably first in his class, The Whiz-Bang Kid is always chipper and has a beautiful wife. A little quirky, he works hard and everyone likes him. He goes on book tours and possibly becomes a talking head* if he strays too far into policy.

4. The Small Contributor

This breed is excruciatingly boring, which means that they could possibly die off, which would be a great relief. The Small Contributor writes 25-50 page papers offering an extremely well proven argument defending the (already accepted) theory that firms in southeast rural Thailand had seen lower demand for dyed cloth in the 1994-1998 period than in the 1998-2002 period... or at least accepted theory believes that is what this kind of economist writes about, as nobody has actually managed to stay awake through to the end of the title, let alone read a whole paper. It is well established fact that papers written by these economists are tagged "BioHazard" when they reach the peer review office, and quietly passed through without another glance. These economists are either unmarried, or have an equally dull wife, if such a thing is possible for a woman.

5. The Good Economist

...usually either is, or should be, in another department

*I have not included the Policy Wonk, but they are pretty self-explanatory. They wonk.

How to be a Great American President

2009-05-19T11:27:00.003-04:00

Test "Title"

I have worked out the formula for creating lasting legacy, and an image of true greatness. Someone told me a while back that the American people remember FDR fondly because he carried them through the Great Depression—even if he did make it longer with his bad policies, he was there for the people, and suffered with them (even if he skimmed the cream off the top*).

So, here is the formula:

Run for president right after a stock market crash, preferably with a bank correction, and preferably one that the current president is fudging up.
Enter office and immediately pass a bunch of laws that will slow the correction and lengthen the recession, and bash business a lot, and take them to court; ideally turn the recession into a depression.
Once the recession has set in, begin to transfer powers previously held by other branches to the executive. Don’t forget to reach for the gold, you’ll never get it if you don’t try.
Use these new powers to create a bunch of new wings of government directly controlled by you, and use them to transfer money from one group in society to another—preferably, take from the whole people and give to small groups that will reward you with lots of good publicity and votes.
Most important: make soothing, well-written speeches. Lots of them.

If done right, all the powers over the economy will be nicely controlled from Washington. As written up at the Franklin D. Roosevelt American Heritage Center:

Under the New Deal, the federal government greatly extended its power over the economy. By the end of the Roosevelt years, few questioned the right of the government to pay the farmer millions in subsidies not to grow crops, to enter plants to conduct union elections, to regulate business enterprises from utility companies to airlines, or even to compete directly with business by generating and distributing hydroelectric power. All of these powers had been ratified by the Supreme Court, which had even held that a man growing grain solely for his own use was affecting interstate commerce and hence subject to federal penalties.

Of course, there are other things that you can do to be remembered well, including fighting a long war. But I think those 5 can already bring about a legacy. If we do not learn, history truly does have a way of repeating itself—in this case, likely because someone did learn from history, and wanted to be the next Great American President. Let's not let him.

* John Flynn recalls the scandals that occurred and were well documented by newspapers at the time, of the Roosevelts’ abuses of their position. For example, Elliot Roosevelt had his father convince the A & P Tea Company to loan Elliot $200,000, backed by shares in a Texas radio station. The company went along in order to avoid the New Deal inquiries that Roosevelt could enflame. In 1942, the President gave $4,000 to A & P and demanded the “worthless” stock back. It was worth $1 million, but A & P gave it back to the New Deal architect, and deducted the $196,000 loss off their tax returns.

Austrian Media Appearances

2009-05-11T16:07:00.003-04:00

After watching this excellent Brooklyn libertarian cable interview with Cameron Weber, I started putting together a list of some appearances by Austrian-leaning economists. Here are some I have found and really enjoyed:

http://freedomwatchonfox.com/ is one of the bigger-name (but also watered down, and sound-bite filled) choice, it regularly has Peter Schiff and Ron Paul.

Here is an interview with Steve Horwitz.

Bob Higgs, who was brilliant, in a long C-SPAN in depth talk.

Excellent Alex Tabarrok talk at TED.

Finally, here is a Hayek video from his later life.

Ideology and Rationality

2009-04-22T10:21:00.006-04:00

In an article in the Review of Political Economy on Marx and Schumpeter, there is an interesting mention of Schumpeter's idea of why rational arguments do not dissuade people from socialism.

It reads:

Political attack cannot be met by reason. Reasoned argument may tear the rational garb of attack but it cannot reach the extra-rational impulse that drives it. In any case, in political matters, the masses are generally incapable of seeing where their true interest lies. They see only monopolistic practices, high profits and social inequality. To see the case for capitalism, they would need to see further than the short run, and that requires powers of analysis that are quite beyond them.

In a footnote, the author explains that Schumpeter believes that the rational thinking of most people extends only to everyday concerns and not to broader social and political issues (public choice literature would say that this is because their vote doesn't count anyway, and Bryan Caplan would add that they get comfort at little to no cost believing what they do.)

I think there is some truth to all of this, but why is there such a strong political contingent for socialism, despite so much evidence that it reduces freedom for all and makes every income level in society worse off economically? There is a simple answer.

Consider the following. Imagine that a certain person, lets call him Daniel, is faced with irrefutable logic showing that the socialist society produces an economy in which the income curve is strictly lower than the income curve in a free market society (and one can imagine the same for the 'freedom curve' too). So, the poorest person in the free market society is still richer than the poorest person in the socialist society. The two curves may not differ in relative income either, and in the socialist society, there may even be some at zero income (famine levels).

Faced with this rational argument that free markets are better for everyone, one might think that the rational response to this would be "then they must be better for me, so I should be for free markets!" Perhaps this would be the rational response if he were behind a veil, but he is not. It would also perhaps be a rational response if the way to become wealthy in the two societies was the same--but it is not. In a socialist economy, one gets ahead through politics, schmoozing with the elites, and getting handouts for people in exchange for bribes and power. In a free market economy, one gets ahead by producing things for the customer.

Daniel knows his own talents, so for Daniel what matters is not the absolute level of income in the society over the whole income curve, but where on the curve in each society he personally will land.

So, if Daniel expects to be at position A in the socialist economy, but position B in the free market economy, he will always prefer socialism. Daniel would expect this if he is good at political maneuvering and not so good at creative solutions to fill the demands and desires of his fellow countrymen. This, in a nutshell, is why there will always be a contingent in favor of socialism: its a tragedy of the commons.

The best we can hope for is that most people will take account of the rational argument, and perhaps spread the values and foster the talents of creative entrepreneurship, over the values and talents of politics and schmoozing. Unfortunately, once the rent-seeking begins, it builds upon itself and rewards those values, making it difficult to reverse the trend.

The Tea Party Protests

2009-04-17T10:38:00.005-04:00

I am getting a little annoyed that some people have argued that the Tea Party protests were somehow a corporate funded "astroturf" effort, coordinated by the Republican Party, and that policy wonks rebuttal of that perception is defensive and proves them right. Yes, Republicans and old partisan-oriented groups have jumped on board, but they could not do it without genuine outrage, which is evident in the polls, and they did not organize the 750 protests across the country on tax day.

The people have a message: 84% of Americans are against the current government expansion in the longer term. 44% of Americans are against it even in the short term. The protests were coordinated by different groups in each city--some by Ron Paul groups, some by young conservatives, some by coalitions of different groups. This is no different than the anti-war protests by hodgepodge groups, including partisan ones like Move On, and radical ones, and apolitical ones.

Now, here is a round up of great, and disparate, highlights from the protests.

In NY:

“I think Newt Gingrich is – I think he’s a slime ball,” said Roy Delduco, a self-described Constitutionalist with tattoos up his arm and a shaved head. “I don’t like Republicans. I don’t like liberals either. I don’t like the whole bipartisan system. I think it’s part of the problem.”

Delduco said he wants the Federal Reserve disbanded, the IRS “put in jail” and his taxes lowered. He complained about government spending under both Presidents Obama and Bush.

“We’ve basically bankrupted the dollar, and I’m scared,” he said.

...One young man handed out feathers in homage to the Boston Tea Party; another offered stickers in support of John Galt, the hero of Ayn Rand’s “Atlas Shrugged.”

...Raymond Kwai stood alone in the crowd, holding up a sign that said, in all capital letters, “IF I WANTED TO BE A COMMIE, I’D STAY IN CHINA.”

In San Francisco:

"The government is growing too big," Bernstein said in an interview with CBS News after her speech. "And I grew up in socialism and I've seen it. And this is reminding me more and more of what Poland used to be. I was fortunate to see the transfer from socialism to a free market economy in Poland and i'm very sad to see that the opposite is happening here."

...The San Francisco rally was non-partisan: it attracted Democrats, Republicans, Libertarians, Greens, and independents, many of whom appeared to be supporters of Texas Rep. Ron Paul's 2008 presidential bid

Overall favorite quote: "You can't put lipstick on socialism."

Here is a roundup. Also, check out the coverage by Pajamas Media.

Changing the Terms of the Debate

2009-04-16T17:12:00.002-04:00

Basically every pro-intervention policy economic argument goes like this:

(1) The neoclassical model says if we do this, output will be lower but

(2) it is naive and unrealistic to believe the neoclassical model represents reality.

Unfortunately, most of the time the free market defender resorts to something like "yes, but it approximates it close enough."

Until we rid economics of the absurd assumptions of the neoclassical model, we will always be on the defensive, and the arguments will be weak. Just think of the eternally frustrating "trickle down" economics description. Yet, very few public figures can explain Austrian methodology, assumptions and models in the soundbite format of modern policy debate; and the public is already familiar with the neoclassical model, and assumes that any free market advocate believes in perfect competition and the tooth fairy.

It is the dominant role of the neoclassical model and synthesis (and mathematical economics) during the twentieth century that brought us belief in the superiority of planning and the supply side/demand side dichotomy. This reminds me of the socialist/fascist dichotomy: they are both wrong and actually similar not opposites. There is an actual alternative on the opposite end of the spectrum, being ignored.

The terms of the debate need to change. In order not to be on the defensive, we need to loudly declare the actual assumptions and structure of our model, and the reasons why it claims that intervention will lower growth, if it does. This is starting - between Freedom Watch and the Ron Paul revolution, the Austrian name is seeing some light of day again. And, now with the Tea Party protests, the tide is turning in the popular mood. Folk Austrianism is trickling in so to say...hopefully with a better face than "trickle down" economics.

There are several Austrian economists working hard to popularize some of the ideas. Lets keep pushing this forward, not be afraid to call it "Austrian" economics, to distinguish it from the neoclassical synthesis, and make sure to point out the major difference: we don't assume that markets produce zero economic profit and everyone is omniscient. We are realistic. You can't wave your hand and say we're naive and so government has to help. They are naive; they are the ones that beleive government produces zero waste and is omniscient.

Back To The Basics

2009-04-03T15:28:00.002-04:00

(Cross-posted at Heritage)

In the New York Times today, David Brooks has a column in which he describes two theories about the financial crisis: “greed” and “stupidity.” The “greed” theory is not what you might be thinking—it is not the simplistic notion that Wall Street is just full of greedy capitalists that swindle the people out of their money. It is a little bit more sophisticated than that, because it involves the government bailing out the banks. They do this, of course, because politicians earn handsome rewards for it. This theory has some merit.

The second theory, “stupidity” is also more sophisticated than it sounds. Wall Street did not know that it was engaged in such risky behavior. The theory as presented blames the complex financial instruments, but one could as easily blame monetary policy, subsidies, bailouts, or policy uncertainty, for creating this ignorance.

Government certainly had a hand in creating this crisis, yet now these same leaders are attempting to blame free markets, and resurrect socialism. Right before our eyes we are seeing the pattern: even as government spending backfires, we cede more control to it, and the love and faith in politicians grows. Even free market economists forget the basics.

Now more than ever, we need to return to the fundamentals. We need to relearn our Adam Smith, our Frederic Bastiat, the roots of liberalism and the morality of freedom. Only if the people understand these basic principles do we have a chance. Then we can see through the politicians, and not let them take our freedom and control our lives.

Changing Places: Europeanization as a Good Word

2009-03-25T12:29:00.002-04:00

(Cross-posted at Heritage)

The financial crisis has exposed a trend that has been in the works for some time. Since the fall of communism, some of the more socialist countries have learned lessons from the Soviet collapse: free markets work, and government planning does not. Meanwhile, the capitalist countries have slept through these lessons, and have been slowly becoming more socialist.

The financial crisis has made this crystal clear. For example, US car companies, and now auto parts dealers, have received bailout money. Sweden, every liberal’s favorite social-democratic country, has let their signature car company, Saab, fail.

While the US Federal Reserve has been finding creative ways to print our way out of this financial mess, the European Central Bank has resisted this doomed inflationary policy. The European Union is actually concerned about high taxes, inflation, and excessive spending.

From the formerly communist Czech President of the European Union, we have a warning that Obama’s spending frenzy is a “road to hell,” but from the formerly free market United Kingdom, we have the Prime Minister calling for a Global New Deal.

It seems that, in the 21st century, “European style economy” might come to mean “free market” and “American style capitalism” might be a new term for “socialism.”

For Keynesians, Too Much Is Never Enough

2009-02-06T16:24:00.001-05:00

The New York Times has an article on the “stimulus attempt” in Japan in the 1990s. The article describes two points of view: American economists who think that it partly worked, but did not go far enough, and everyone in Japan, who thinks it was a colossal waste, which they will have to repay for decades, and a waste which turned their economy into one large public works project.

The article also provides some insight into how large a stimulus these American economists think is necessary to get the economy moving. A little bit of math shows that their target size would be even more massive than anything we’re currently debating, and would cripple the economy, not stimulate it.

The article explains:

After years of heavy spending in the first half of the 1990s, economists say, Japan’s leaders grew concerned about growing budget deficits and cut back too soon, snuffing out the recovery in its infancy, much as Roosevelt did to the American economy in 1936. Growth that, by 1996, had reached 3 percent was suffocated by premature spending cuts and tax increases, they say. While spending remained high in the late 1990s, Japan never gave the economy another full-fledged push, these economists say.

They also say that the size of Japan’s apparently successful stimulus in the early 1990s suggests that the United States will need to spend far more than the current $820 billion to get results. Between 1991 and 1995, Japan spent some $2.1 trillion on public works, in an economy roughly half as large as that of the United States, according to the Cabinet Office. “Stimulus worked in Japan when it was tried,” said David Weinstein, a professor of Japanese economics at Columbia University. “Japan’s lesson is that, if anything, the current U.S. stimulus will not be enough.”

If Japan’s economy is half the size of the American economy, then these economists would suggest that we spend at least $4.2 trillion over four years, or more than $1 trillion per year. To not “cripple the stimulus in its infancy,” we’d have to sustain this for significantly longer than just four years. Deficit financed public works costing more than $1 trillion per year, over, let’s say, eight or ten years – this is supposed to stimulate the economy? This would obviously cripple the economy! When spelled out like this, it is hard to imagine any economist seriously suggesting that America should, or could, borrow that kind of money and create that kind of long-term public sector employment.

Instead, it seems that Keynesian economists are simply running out of excuses as to why previous experiments in spending “stimulus” plans have failed to produce good results.

Learning and Bureaucracy

2009-02-03T14:27:00.003-05:00

The market is an evolutionary process, in which selection forces actors to learn, and price conveys the information necessary for that learning. The pressure on the individual to innovate (or face losses) is not a pressure applied strictly to firm owners and managers- it is also applied to workers and job-seekers.

The Iraqi band Acrassicauda recently acquired refugee status and settled into a nice New Jersey metal band lifestyle. One of them explained their prior training and conditioning:

“We’re good at process,” said Mr. Riyadh, 24, who has previously used the name Marwan Hussain. “Going to the U.N.H.C.R.,” he said, referring to the United Nations High Commissioner for Refugees, “standing in a queue for three or four hours. We’re good at that. But musically, we need to practice.”

This reminded me of what Irina Pantaeva said of her training in Soviet Russia:

Neither of us knew how the fashion business worked in the West. That models carry thick books full of glossy pictures, and that they made appointments and worked with agents. We knew only what we had learned in Russia: if you want something, go to where it is and be prepared to wait.

In a bureaucratic country or system, there is no pressure applied that can force the individual to work, learn, innovate, or generally train themselves. Instead, they learn to wait on lines, fill out paperwork, and ask others for handouts. Expect a lot more of this kind of learning as government continues to rapidly grow, and a lot less innovation and new technology.

Tried and Failed Policies Resurfacing as Stimulus

2009-01-30T15:24:00.003-05:00

(Cross-posted in part at Heritage)

The “cash for clunkers” plan recently proposed in Congress would provide subsidy for a new car purchase to anyone willing to have their current car destroyed. But the economic rationale is eerily similar to the New Deal program most widely agreed to be a catastrophic failure: his agriculture plan that slaughtered pigs. The reasoning goes like this:

Crushing the old car has two benefits. First, it ensures that the consumer's purchase of a more efficient vehicle actually has a net environmental benefit. Second, it prevents a glut of used cars on the market, which would reduce trade-in values for new car buyers, which would cut into the sales incentive effect.

This was the same misguided reasoning that led to the slaughter of six million pigs and plowing under of about half the crop area under cultivation. The head of the Agricultural Adjustment Administration argued that:

People who believe that we ordered the destruction of food are merely the victims of their prejudices and the misinformation that has been fed to them by interested persons. What we actually did was to stop the destruction of foodstuffs by making it worth while for farmers to sell them rather than to destroy them.

In other words, the destruction of crops and livestock would ultimately lead to less waste because prices would be lifted, and so farmers would have more incentive to produce. However, despite vigorous defense by the administration, it is now known that most of the meat went to waste and it was an abysmal failure. Government cannot do a better job than the market in setting prices, and government’s destruction of output will never lead to increased output. It was a failure of economic reasoning – which is now coming back in vogue.

Another failed policy being considered is the mandate to buy American:

The stimulus bill passed by the House last night contains a controversial provision that would mostly bar foreign steel and iron from the infrastructure projects laid out by the $819 billion economic package.

This policy is almost precisely the one put into force during the period of railroad subsidies. According to The Myth of The Robber Barons, transcontinental railroads receiving subsidies had charters that required they only buy American-made steel. But American rails, made with American steel, were of lesser quality than some foreign brands, and this drove their maintenance costs up. This was one of many reasons why subsidized railroads performed extremely poorly compared to private ones.

Yet, here we are again using subsidies that distort incentives, and adding to the problem by passing mandates that will drive up costs and produce inferior products. This new “hope and change” we’re seeing is simply a return to the failed economic reasoning of the New Deal.

The Golden Age of Political Entrepreneurship is Here

2009-01-29T10:52:00.001-05:00

(Cross-posted at Heritage)

As Joel Kotkin detailed in the Washington Post this weekend, the Wall Street Bailout and Trillion Dollar Deficit Plan being pushed through Congress this month mark the transfer of power from commercial cities like Chicago, New York, and San Francisco, to Washington DC.

In the business world, campaign contributions and lobbying efforts have replaced cost cutting as the way to maximize profit. Going to Washington with hands outstretched can prevent bankruptcy, and can provide a stimulus to the bottom line. Competing without such government aid is becoming more and more difficult, and rebels who shun such tactics are a dying breed.

This “political entrepreneurship,” or use of political power in place of competition, is not new. In fact, as far back as the “robber baron” age, some businesses preferred to use the power and purse of Congress, rather than have to do the hard work of cost cutting and innovation necessary to be a successful market entrepreneur. The true “robber barons” were not businessmen competing freely in the market, but those businessmen who gained monopoly advantage by lobbying Congress and buying market power.

Today, we still have some “robber barons,” protected by government and producing shoddy products, but we also have endless more miles of red tape on regular business, an incomprehensible tax code with favors for special interests, and subsidies and “pork” for every conceivable interest group request. It. Yet with all this spending and protection, we’re told we need more “stimulus,” and we need to “protect” more jobs.

In the academic world, two developments are driving the movement from economics to politics. The all-round analysis of economics, which can take into account all interactions and effects of various policies, has been abandoned for narrow subtopics and mathematical abstractions. Meanwhile the economists themselves have taken political views and ignored economics in their policy recommendations (for example, Paul Krugman).

But, the movement away from rational and realistic economics – the realization that there are limited resources and limited time, and that we cannot at once waste time digging holes and filling them up again, and also be productive and create prosperity – and toward politics – the art of deception, favoritism and trading favors – will necessarily bankrupt the country.

Obama Invokes Keynes and FDR, and Promises a Return to Central Planning

2009-01-21T15:29:00.002-05:00

(Cross-posted at Heritage)

While he spoke about moving forward, and promised change as we look toward the future, in fact President Obama’s inaugural address was firmly entrenched in discredited policies of the past; policies that never worked.

For example:

Now, there are some who question the scale of our ambitions — who suggest that our system cannot tolerate too many big plans. Their memories are short. For they have forgotten what this country has already done; what free men and women can achieve when imagination is joined to common purpose, and necessity to courage.

His words here are very reminiscent of Roosevelt’s words at the start of the Great Depression. But, our memories are indeed short, if we forget that Roosevelt’s plans were actually huge failures.

Next, Obama invokes J. M. Keynes to support his call to planning, once again invoking a discredited idea from the past:

What the cynics fail to understand is that the ground has shifted beneath them — that the stale political arguments that have consumed us for so long no longer apply. The question we ask today is not whether our government is too big or too small, but whether it works — whether it helps families find jobs at a decent wage, care they can afford, a retirement that is dignified.

Keynes argued that the inefficiency of government spending compared with private spending did not apply during periods of recession. He reasoned that when the economy was not at full-employment (i.e. during a recession) government was “better than nothing.” Government could inject the economy with money, by borrowing and spending it, and put the unemployed to work.

Of course, even if borrowing is helpful during these periods, it could still be spent privately (with tax cuts). So, Keynes had to argue that tax cuts are too slow, and that people saving the money, as they might do when given a tax cut, is not as good as government spending the money. However, Keynesian theories have not been supported by reality, and his proofs have long ago been abandoned by economists. Yet, Obama is embracing this new trend toward the past.

Finally, Obama promises that the programs that work will remain and those that fail will be discontinued: “Where the answer is yes, we intend to move forward. Where the answer is no, programs will end.”

Supposedly, this is a major difference from the past – when, apparently, government cared less about whether the programs were working. Of course, it is rare that a government program is ever ended. As Reagan put it, “There is nothing more permanent than a temporary government program.” It is also impossible to know whether a program is “stimulating the economy.” Those that benefit from them can make this known to all, but those that suffer cannot know or prove that it is the program that makes them suffer: the damage is indirect because it caused by high taxes, the crowd-out of private business, and so on. So, a true cost-benefit analysis of any given program is impossible.

Obama has promised nothing more than a return to the 1930s; to the old discredited economic theories and the old discredited policies of central planning.

Conversation on Poverty

2009-01-14T20:55:00.006-05:00

An old friend, James, who helped train me in Perl many years ago, recently came to me with a request: he wants to work on the problem of poverty, internationally and domestically, from a new perspective. His belief is that, rather than throwing money at the problem in the form of welfare or foreign aid, the development of personal micro-level capability is required. In the inner city, this means responsibility, inner peace in place of negative influence, and opportunity. Internationally, it means the tools of exchange and opportunity, and the ability to direct entrepreneurial drive into productive pursuits.

This is clearly the direction that programs are headed, though slowly. Welfare programs have been reformed toward these ends, and development economics has moved from supporting foreign aid in the form of blank checks, to building institutions; micro-loans and in-kind support for education have replaced cash that went directly to support dictators. But many of the new programs have been twisted to produce outcomes similar to the old programs, and poverty is still a major problem.

My friend came to me because I work at the Heritage Foundation, and he felt that the loudspeaker that Heritage possesses on the policy stage might serve this issue well. The idea is to build a bridge between the left-wing "peacemaking" groups, the right-wing responsibility advocates and the libertarian anti-state-programs people.

James says he hopes to understand the impact, if any, of wide-spread training in constructive conflict resolution and other proven-effective peace-building techniques. His hypothesis is that educating people to effectively cultivate peace in their lives and relationships will at worst make them more productive and save the rest of us a lot of money, and at best, result in a more secure world. He can advocate for policy in various left-wing peacemaking communities, while I can advocate among the "rightwing" such as Heritage, and the libertarian community and academia.

I pointed James to Pete Leeson's excellent lecture for FEE on development. He enjoyed it a lot and wrote the following email in reply. The email below, although it is just some rambling thoughts, brings up so many important questions and ideas that touch on so many of the issues that George Mason economists, in particular, are working on, that I was inspired to share it and invite thoughts from the best minds I know. Please share your reactions, questions, apprehensions, and references to relevant studies. Let's get a conversation going, and see what we can come up with. I've spoken to a couple of people at Heritage, and if we can come up with something, they may be on board.

I recommend listening to Pete's lecture if you aren't familiar with his take on development economics, as it is a great starting point for this conversation. This is what James is referring to in the email.

First, this is so interesting for me! I'm so pleased to be able to learn this stuff - thanks so much for sharing your knowledge! I have a ton of questions...

I was impressed with the talk, of course. There's a lot to learn there, and I'm sure that a lot or all of it holds water, but I keep thinking that it's all well and good, but it doesn't seem to take into account certain significant realities...

I whole-heartedly agree with the self-interested actor model here, just looking at it from a different perspective. The self-interest of the most powerful actors is likely the cause for the state of the world - or is that a tautology?

I'm under the impression that the US government, through covert means, has been intentionally undermining the well-being of poor, resource-rich countries for the last 50 years - whenever and wherever they can - in order to amass power and wealth for US corporations (link). I wonder if there's any discussion of that - or what is the understanding of that - within Heritage? Were those actions taken to shore up private property rights for the citizens of those countries, or so that we could own everything and they could remain in abject poverty? It's going to be a long wait indeed before the populations of these countries create good institutions if they're constantly being torn down by such well-funded and organized outside forces.

One form of aid that strikes me as the logical next step after hearing the talk is: we should send people in to teach all developing peoples about the benefits of private property rights... it couldn't result in any corruption and would cause the population to create their own enlightened institutions. What do you think?

One other thing I'm interested in is this: my understanding is that economists in general start with the idea that people are motivated by a need to be useful - so people want to produce more or something like that in order to be more useful. This belief - I understand - leads to measures such as GDP, which measure cash value but not other resource or human happiness. I'm more of the opinion that people are motivated by a desire to be happy, to have no problems. When people are not very good at taking care of themselves, they seek to enrich themselves but after people get good at taking care of themselves, which often includes having some stable means of self-support, they start to look to take care of other people (people are always surrounded by problems - first their own, and then others'). There are some economic thinkers who've come up with measures which try to take this kind of thinking into account - the Genuine Progress Indicator is one example. Do you know anything about this? I'd love to hear your reactions to these kinds of things.

When I look around, a lot of people are working awfully hard to cultivate happiness. Yet, given all the effort expended, there doesn't seem to be the abundance in terms of human happiness that I would have thought. We have so many technological marvels, so much infrastructure, we know so much about the universe and the world, and yet people don't seem to be much better off for it in terms of either individuals' own ease and inner peace, or peace between people either domestically or internationally. I know that significant progress can be made to achieving genuine long-term happiness if we apply ourselves, but it seems that not enough resources have been devoted to making this a reality. That's what I'm talking about, not aid. I'm talking about finding out what's the best way to cultivate peace for everyone, and teaching people so they can become engines of peace in their lives and communities.

Thanks again - this is fascinating for me. I'm sure that I'm asking a few stupid questions here. After all, I'm a pre-econ 101 person. I'll browse fee.org... I wonder if there's anywhere you might point me to get a basic education?

Those are just some thoughts and questions that James had, he will join us in the comments. Note that he brought up some very interesting, I think, theoretical questions, practical questions, and ideas. He is very open minded, I hope you will join him in this good spirit. Please make use of the open comments.

Update: On a related note, I may be working with the "Protecting American Sovereignty" group at Heritage on their initiative to prevent the movement toward One World Government, or toward world governance (international regulatory regimes), through advocating freer markets and freer trade instead, to combat global financial unease. Because security, as well as economic security, is of great concern to them, terrorism is a major issue for them. For this reason, development and combating poverty through institution-building and trade also fit into that program. Perhaps this could be one way of bringing this initiative to Heritage.

What Socialists Mean by Capitalism

2009-01-06T08:28:00.007-05:00

I'm currently reading Le Grand and Estrin's book Market Socialism.

I have often complained that socialists misunderstand the market. Sometimes they do. Sometimes they understand it better than most conventional economists. Sometimes the most hard core Marxist will come so close to understanding the libertarian view - like Bukharin for instance.

Le Grand and Estrin did seem to understand markets in the introduction - at least as well as many "mainstream" economists.

Then an amazing passage occurred.

In this passage, these proponents of Market Socialism revealed that they distinguished "capitalism" from "liberalism" -- their use of "capitalism" was not synonymous with markets, but was distinguished from laissez-faire free market libertarianism. They still preferred market socialism to liberalism, but the complaints against capitalism are not complaints against free markets per se, but against a certain form of market system, which they call capitalism, but which arguably is really corporatism or crony capitalism.

Capitalism places the economic power in the hands of capital and its owners. Traditional socialism gives power exclusively to labour: the dictatorship of the proletariat, preferably exercised through a centralized authority. And the "New Right"--actually better characterized as traditional liberalism-- claims to locate power in the hands of the individual--particularly the individual citizen and consumer.

This is very interesting. Of course, I have argued this and heard whiff of this in socialist literature before, when they argue that the "ideal" of free markets is not possible, that concentration is delivering power into a few hands (a la Bukharin & Lenin, based on Marx), and so on, implying that it would be different if free markets did exist. Similarly, Lange's market socialist model was based on the use of state power to create a perfect market-- implying that if markets were less monopolized then they would be OK. But this is still a unique passage. Given this characterization,

In the following, replace "capitalism" with "corporatism" in your mind. It continues a bit below:

Full blooded capitalism is unattractive because it exploits labour through its monopoly of employment and because it exploits consumers through monopolizing goods markets. Traditional socialism expropriates capital and subordinates the interests of consumers to the interests of the workers. Indeed, with its penchant for centralization, it is far from clear that even the workers are properly taken care of. Liberalism puts people's livelihoods and their savings at the mercy of consumer taste and fashion; its emphasis on the narrow rights of individuals jeopardizes the collective activities of the community and hence the community itself.

What is needed is a model of society where power is more evenly distributed between these groups; where the interests of owners of capital, of workers, and of consumers are all taken into account with none taking automatic priority.

This struck me as fascinating. Now, I don't personally see how the group which liberalism represents - everyone - needs to be supplemented with the groups favored in corporatism and in socialism, which are partial. Nor that the interests of some "community" of individuals must be represented. In a free market (liberalism) such a group can form and defend itself, since all the individuals are protected by the system. But, the authors seem to believe that protection of each person, without protection of groups, leads to a loss of community-ness. Perhaps.

The fact that socialists have directed their main fight against corporatism this whole time and not against the free market is a critical point that we would do well to remember - and to make clear the distinction as often as possible. We have hardly tasted true liberalism, and socialists have tended not to start with models. In general, they, being people sympathetic to socialism and hence a softer sort of person, saw injustices in the world and began there. Seeing injustices, and seeing the market used by those with power and money, they blamed capitalists and they blamed the market. They did analyze different kinds of market societies, but they threaded them together in a dialectical historical account.

Market socialists are able to distinguish corporatism from liberalism. Starting there, the arguments are much easier to defeat. As above, sometimes it just boils down to "with liberalism, you lose the sense of community." There are some good books on how that isn't the case - that the opposite is true. When the state encroaches, as through welfare programs, it replaces community. In fact, the authors themselves cite "protection from the family" as a key feature of the welfare state (p. 21).

I'll post more on this book, maybe later today even.

update: I forgot to mention: Marxists describe the "crises" of centralizing capitalism, the movement from more to less competition, and consolidation into fewer hands. If capitalism is seen as rent-seeking driven corporatism, this makes sense. As rent-seeking drives policy, it necessarily does concentrate power into fewer hands, and also creates recurring crises (business cycles). As an example, consider how fixhousingfirst.com is calling for new increased low-income housing policies for its constituency, despite the fact that it was likely these policies which drove the housing bubble and caused the current crisis.

Update 2: I will also post more on this another time-- I would like to consider Marx and Bukharin's arguments in particular against "capitalism" as they may be estimated from a public choice perspective, as against corporatism (or mercantilism). It is possible that some Austrians have already done this - as it seems many Austrians see that Marx was really arguing against crony capitalism and not free markets - but probably not enough.

Then this can be tied together with the later market socialism literature and analysis. Marx was wrong with his labor theory of value, but perhaps right with his concentration, crises and ultimate end in planning (if he was studying the rent-seeking society); market socialists like Lange were wrong with their perfect competition models, but right in some of their understandings of the benefit of prices and competition. Very recent market socialists (like those above, and like Stiglitz) have greater understanding of many of the Austrian points than conventional economists. Perhaps bringing together all the good understandings of these various socialists could be useful in contributing to new, better models, and to a greater understanding of interventionism.

If You Can't Explain It, It Probably Isn't Right

2008-12-28T09:17:00.004-05:00

I spoke to a non-economist today about the housing crisis, credit crunch, financial crisis, bailouts and recession. She had some basic insights about supply and demand, listened and agreed with me that the policies were likely to blame (regulations pushing low-income loans, interest rates, subsidies and so on), and we agreed that expanding these policies would make it difficult for entrepreneurs to spur recovery. My explanation was consistent with - in fact was pretty much exactly - the Austrian position.

Could a Keynesian explanation and solution have been as easily explained? The person I spoke to was not predisposed toward a free market solution or a government answer. I wonder if some of the credit crunch explanations that get into all the complexities are necessary, and with their confusing intricate details and delicate cures, whether they are able to get at the essence of something so big and far-reaching.

Of course, some simple explanations - especially ones that blame some minority group - are a distraction, scapegoat. So, perhaps if the explanation is complicated, it is unlikely to be right, but if it is simple it could be right or wrong. Then it just comes down to common sense. Since anyone is able to understand it, it comes down to being rational and honest in examining the logic. What do you think?

A Taste of the Control Inherent in Planning

2008-12-16T10:19:00.005-05:00

Hayek said "Economic control is not merely control of a sector of human life which can be separated from the rest; it is the control of the means for all our ends."

This is very true, and key to understanding why the experiments with socialism have inevitably led to totalitarian dictatorships. It is also critical to remember when we little by little feed government power, the power to control our economic lives, and hence our lives in toto.

A fascinating reminder of what economic control truly means comes from the excellent - truly golden - book The Soviet Economic System: A Legal Analysis. Especially those of you who enjoy law and economics both, and "libertarian theory" on Leviathan and freedom, should check it out.

So, here Ioffe and Maggs here are discussing ownership in the Soviet Union, and describing the rights of the state firms, who possess "operative administration" rights, but are not owners. The state is the legal owner, and they investigate whether it can also be considered the de facto owner. They also consider what it means that "the state" is the owner -- of course, it turns out to mean that the Politburo and Secretary are the real owners. In any case, here they are describing the actual rights of the firm. It turns out that some of the restrictions on "possession, use and disposition" which apply to those holding only "operative administration" include strict limitations to use the property for planned purposes only and not to "sell postcards if you are a pharmacy," and that all money must reside in "funds" to be used for specific activities - investment, purchases, wages, depreciation, etc. The state bank which holds the funds ensures that the seller and buyer in any exchange both have the appropriate rights and use the appropriate funds, etc. And then here is the golden paragraph:

An examination of the legal provisions established for goods produced, goods which are the result of production rather than a fund for production, is useful for a full comprehension of the operative administration exercised by a producing entity. In this case, the rightholder has the rights of possession and disposition, but not the right of use. To use its own product, the economic entity must transfer the requisite portion of it from goods produced to production or other funds. If the goods produced are subject to planned distribution, then, in order to acquire its own product, the producer must be included in the plan of distribution issued by the planning agencies. Violations of this rule lead to legal sanctions. If the goods produced are excluded from planned distribution, then, in order to acquire its own product, the producer must have adequate resources in a monetary fund that may be employed for such an acquisition, and when part of the entity's product becomes a part of its fund of physical goods, the price of the product thus obtained must be deducted from the appropriate monetary fund and added to the amount of gain resulting from the sale of the product.

Yes. If you want to use some of the paper that your paper factory makes, you must be part of the planned distribution. Even if the distribution of paper is not being planned out - miraculously - this year, then you must sell the paper to yourself within the guidelines of the use of your monetary funds and adjust your balance sheet to reflect that you fulfilled output and simply sold to yourself some amount of the paper, which you were able to pay for out of your budget for purchases.

Now, I suppose that many firms do this kind of accounting anyway - to ensure that they are not being wasteful. However, the key thing to note here is who is in charge of all of this: the state. And "violations are subject to legal sanctions." This is entirely another kind of "accounting" when this is taken to heart.

The Real Danger of World Government

2008-12-11T10:00:00.003-05:00

(Cross-posted at Heritage)

Even more than rent-seeking and government expansion here at home, the greatest danger of a left-leaning Obama administration may be the danger of capitulation to a new world government.

In the past, “One World Government” has been seen as a rallying cry of a fringe group, not something that many in the mainstream would either fear or desire. But, suddenly today it is on the lips of world leaders. The recent financial crisis is being blamed on a lack of world government.

The Financial Times reports:

Jacques Attali, an adviser to President Nicolas Sarkozy of France, argues that: “Global governance is just a euphemism for global government.” As far as he is concerned, some form of global government cannot come too soon. Mr Attali believes that the “core of the international financial crisis is that we have global financial markets and no global rule of law”.

But, the financial crisis was not caused by a lack of international regulation. Financial crises in the past have tended to occur more due to intervention than due to lack of regulation, and each of the banks that failed in this crisis was regulated by at least one country. Monetary policy was a major cause of the 1929 stock market crash and is implicated in just about every other crash.

In addition to dangerous monetary policy, one of the underlying causes of the Asian financial crisis of the late 1990s was government industrial policy, “As part of their industrial policy, governments have directed funds toward favored industries at low rates of interest… This leads to excess lending to the companies that are well-connected and who may have bought influence with government officials.”

This is the same kind of corruption and rent-seeking we’ve been seeing back here at home, with Fannie Mae and Freddie Mac, and in other areas of government. Extensive government reach into markets is what causes crashes and recessions – not a lack of even more expansive government reach.

These leaders want not only to abandon capitalism as we know it, but they want to force these ideas upon all countries by regulating companies at the international level. This kind of anti-market world governance would not make peace more likely, nor would it make free trade more possible or financial crises less frequent.

It Will Never Be Enough

2008-12-09T13:37:00.000-05:00

(Cross-posted at Heritage)

A Christian Science Monitor article this morning argues that Roosevelt didn’t spend enough to jolt economy into recovery. Only when spending skyrocketed for World War Two did the economy recover (unemployment finally dropped, of course this was because everyone was mobilized either as soldier or to support the war effort – creating things which were then destroyed in fighting the war). The Article claims that “One big reason is that President Roosevelt didn’t spend enough to really boost the economy, historians say.”

Notice, that it isn’t economists that argued that the programs should have been bigger in order to boost the economy, but historians. This is like getting a philosopher’s opinion on astrophysics. It’s nice, but it shouldn’t be taken as expert.

The article goes on to point out that many economists do think that government spending can stimulate an economy. So, let’s examine this argument a little more closely. After 1929 and before World War Two, federal expenditures tripled as a percent of Gross Domestic Product. If we tripled federal expenditures as a percentage of GDP today, that would mean an additional 8.2 trillion dollars in government spending each year. That is because federal expenditures are already 20 percent of GDP.

Perhaps we don’t have to also triple the government’s role to have the same “stimulus” as Roosevelt. One might argue it is the amount of spending as a percentage of the economy that matters. Roosevelt added about seven percentage points overall of additional annual federal spending (bringing spending from about 3 percent of GDP to about 10 percent).

An additional seven percentage points of GDP today constitutes an additional $1 trillion per year. This is a lot less than 8.2 trillion, but it is still nothing to sneeze at. Yet, are we not already pouring in this much to the financial bailouts? This is the same amount of additional government spending already – hence the need for journalists to argue that FDR’s additional spending wasn’t enough.

The problem is that government spending will never be enough to stimulate the economy. Just think about it this way. We have GDP of about $42,000 per capita. The federal government spends about 20% of GDP. In England, government spends about 45 percent of GDP and GDP per capita is about $33,000. In Sweden, the government spends about 50 percent of GDP and GDP is only $32,000 per capita. In France, it is 53% and $30,000. As we all know, in countries where government spends approximately 100 percent of GDP hardly any output or value is created. This insight formed the basis for such respected indices as the Index of Economic Freedom.

So, the idea that injecting a jolt into the economy by having government spend more as a percent of GDP is highly suspect. If what Roosevelt spent was not enough – despite tripling the government expenditures at the time – we should wonder whether any amount will ever be enough.

Using the Lessons from Socialism

2008-12-07T20:23:00.002-05:00

As part of something I recently wrote, I made the following argument about the potential uses for studying comparative economic systems. I wonder how many readers will agree:

I am particularly drawn to the study of more extreme and pure systems. I believe these offer the best chance to draw out universal laws. Careful study of systems which avoid mixing of different incentive structures may present the best opportunity to view a single behavioral or systemic result, as if isolating it in a laboratory. Some of the results of this kind of analysis confirm basic economic laws and theory, such as the importance of the profit motive for keeping costs low and quality high. Even analysis illuminating such well known theory can be an effective learning tool, highlighting economic insights important for theoretical models.

Often economists begin with the simplest form of a model, and then begin to add to the model the complexities of reality. Similarly, the model which is the pure economic structure may be such an extreme example as to simplify the lesson. Yet, the economist can then adjust the simple lesson with the modifications seen in less extreme examples of the policy. The advantage of the pure economic system is that its implementation of the policy is the pure form and may represent the noise-free truth underlying other implementations.

One example is the socialist policy of eliminating unemployment which parallels less extreme policies undertaken in market economies. The lessons from the Soviet attempt to eliminate unemployment are interesting. Planning labor entirely was too difficult; for most periods most labor was free. Working was mandatory and extreme measures were taken to keep all workers employed, including forcing the manager to personally find a new job for each worker laid off. Yet, unemployment remained at about the “natural rate” for the duration of the Soviet socialist experiment. The negative effects of the labor policy included incredible labor inefficiency, underemployment, and a rigidity across the whole economy as firms could not adjust to changes introduced because they could not attract the necessary specialized skilled labor.

Similar lessons can be found with regard to investment and interest rates, monetary policy, and the need for marketing and middlemen among other areas. In the pure socialist economy, the extreme results can be seen across the whole economy, and are easy to study. The lessons can then help to inform or confirm theoretical models, or be combined with them in order to better describe potential policy consequences.

My original argument was going to make a slightly different case, which I ended up not feeling able to defend well. I originally argued not just that a lesson could be extracted, but that a pure isolated truth could be extracted and put into a model, which then could be modified to reflect the differences seen in less extreme policy manifestations. I believe that, but I am not sure I can defend it as of yet. Then again, it isn't really much different than what I say above - it is just that I reduced the claim to "lesson" instead of "model". I am curious what others think about this: are we not learning enough from economic systems such as socialism, which in many cases offer the most pure version of policies which we also pass in market countries?

A Collective Delusion

2008-12-01T11:57:00.004-05:00

Pete Boettke, over at AE, posted about the Keynesian legacy. I have some thoughts on that, in particular, I agree that belief in those models represent the economists' collective delusion. I question why we have fallen for them - for private joy or public purse - and I fear that our policies are still colored by them.

I fear that economists have a herding mentality that grasps onto popular figures and then economists cling to the models of these "brilliant" chosen ones. But those who are chosen are not brilliant, they are only popular -- they generally have, like Keynes or Marx, gotten the ear of government. They come up with simplistic models that are easily used to churn numbers or explain phenomena, even though a child could see right through them.

When I took intermediate macro we used Mankiw's book. It was filled with Solow, Keynesian AS/AD, phillips curve, and on and on. I could barely believe that it was for real. None of it made any sense, none of it had any microfoundations (read: basis in reality).

I spent class time with a horrified gawking stare frozen on my face, wondering about the future of mankind if these were our leading economists, and asking the most basic of questions ("If savings is what drives growth according to the Solow model, then wouldn't communism work just as well or better than capitalism? Where are policies and institutions in this model?") and get answers such as "Well, this is just to simplify and explain the basics. Those details can be added later."

And I would be left wondering, about Solow and Keynes: who decided that the aggregate level of saving is more important than whether an individual, or a collective or government owns that savings? Who decided that aggregate investment is more important than whether it is private investment or investment by government in make-work programs? Doesn't it matter if the economy is split 90/10 private or 50/50 private or 10/90? When these models were being made economies spanned that whole spectrum, and yet these guys did not seem to think it mattered who was consuming resources - government or private consumer - who was investing or saving, just so long as the aggregate totals fit into the equations and made them balance nicely.

There were other problems - contradictions about what was better, savings or consumption? and so on - but the idea that private and public spending could be considered equal after the experiment with socialism and the interventionist state was well under way was just crazy. How could anyone think these models were useful at all? These seemed like child's play, fantasy, mind candy maybe. But not important, not something economists or policymakers should be using.

Why would economists fall for these models? And perhaps even worse: why do so many economists still cherish them, and hold them in esteem? What is this collective delusion? Is it that they love the "logic game" of it? Or is it the political clout they love? If they feed politicians with what they want to hear, they will be famous and win a Nobel -- isn't that better than being a no-name who sticks to reality? Isn't it more fun to make convoluted logic games, and be out in the public square?

Clearly for personal gain it is better for economists to engage the delusion. But this kind of absurd modeling still finds voice, and still drives our policies: "President-elect Obama's economic team is counting on investment in America's wind energy infrastructure to create thousands of jobs in a wide range of industries and help preserve existing jobs in other areas, particularly manufacturing."

Our government officials must "create jobs" by subsidizing or publicly providing work in specific targeted sectors. This will spur consumption (aggregate demand) and prevent collapse. This is all based on aggregate factors, and entirely devoid of microeconomic factors. We're also planning on propping up sectors despite their paying 3x normal salaries, by taxing regular workers, without concern over the need for the industry or the company to fail if it isn't profitable. We prevent jobs from "going overseas" as if trade is a bad thing.

Have we learned nothing about the failure of these models? Is this all political, is it useless to appeal to common sense?

The Efficient Muffin Hypothesis

2008-11-30T12:50:00.004-05:00

During this financial "crisis" and subsequent bailout, some Austrian economists have surprised me with their optimism. Essentially, they argued that the market will pull through. Even if stupidity got us into the mess, and stupidity was going to compound the mess, so long as the market is allowed to chug along we will always ultimately "grow our way out." In the end, these Austrians argued, we would end up better off after the crisis and bailouts are all over (say, a few years hence) than we were before the whole thing started. We might have been even better off had we not passed some of the stupid policies, but we would only lose growth, we would not shrink in real terms.

Austrians also talk a lot about inflationary policy, or other kinds of foolish policies that governments engage in for a short term fix, despite having bad longer term consequences, as being like a drinking binge. They then argue that you can't cure a hangover with more drinking.

Now, if original hedonistic policy is like the binge drinking of a wild night, then the morning is the time for recovery. And if, in fact, if a semblance of protection for private property rights is all it takes to "grow our way out" then we can pretty much use whatever hangover cure we want, and be alright.

We can call this the "efficient muffin hypothesis," because the muffin we eat for breakfast manages, as it breaks down, to metabolize away the worst of the negative effects of our night of drinking. This theory says that we will make it through the hangover and to complete recovery fairly quickly. We can even have a mimosa with the muffin to take the edge off.

The inefficient muffin hypothesis, then, would state that in fact any old hangover cure may not work, the effects of these policies may compound each other, and we may never recover. In this scenario, the muffin cannot purge the poison, nor can time alone, and permanent damage may have been done.

Now, if the efficient muffin hypothesis is true this has significant implications. If, so long as the market is not completely banned, the wee market left can always "grow us out" of any idiocy of government policy, then we might have to take a second look at whether these policies are so bad. A night of drinking ain't a bad thing, sometimes.