Monday, December 22, 2008

Failures of imagination?

There's an excellent (long) article on the role and response of academic economists in the current crisis/recession/apocalyse/trendy-noun over at the Boston Globe. Not a lot of it is tremendously surprising, but it does interview a lot of big names in the profession to get their opinions. The rub is this: why didn't economists see all this coming, and what now for the profession?

There are (at least) two distinct kinds of failure that are possible here. The first one is a failure in reality, a failure to see things coming. The second is a failure of imagination, a failure to imagine what would happen as a result of that unforseen thing. In today's terms, the first would be a failure to predict that everything would go all to hell, while the second would be a failure to predict the consequences if things had gone to hell.

If you ask me, the first one is forgiveable. The article quotes Laurence Ball as saying "Nobody ever sees anything coming," he says. "Nobody saw stagflation coming, nobody saw the Great Depression coming, nobody saw Pearl Harbor or 9/11 coming. Really big, bad things tend to be surprises", which might be a tad extreme but is a sentiment I can agree with. It takes an extreme fatalist to think that we can see everything coming if we just try hard enough. 

However, the second might not be forgiveable at all. It represents a failure of contingency planning. One might stem from the other: if I think it's very, very unlikely to rain, I might not want to waste too much time planning my umbrella strategy. If, however, we believe the article's claim that "some warned of a housing bubble, but almost none foresaw the resulting cataclysm. An entire field of experts dedicated to studying the behavior of markets failed to anticipate what may prove to be the biggest economic collapse of our lifetime", then we should be a bit perturbed. Again, the failure to see something coming is forgiveable, but to see it coming and fail to imagine the consequences is just plain strange. 

This is a little scary, but I confess I have very little idea of how I, an economist, would be able to attack macroeconomic questions. I disagree with the first half of this (though not the second, which is that failure of imagination again):

"We have a very restrictive set of language and tools, and we tend to work on the problems that are easily addressed with those tools," says Jeremy Stein, a financial economist at Harvard. "Sometimes that means we focus on silly questions and ignore greater ones."

Similarly, I'm sceptical of this:

"...many of the models used to explain and predict the dynamics of financial markets or national economies have been scrubbed clean, in the interest of theoretical elegance, of the inevitable erraticism of human behavior. As a result, the analytical tools of the trade offer little help in a crisis, and have little to say about the sort of collapses that led to this one."

I am a believer in the predictive and descriptive power of the abstract model. Instead, the view I relate to is that of Jeffrey Kling:

"What we're experiencing now is a good old-fashioned financial panic... This is perhaps the biggest scale, but on some level it's not that different."

I think the economist's toolbox - the one that contains no doctrine, no assumption, just method - is well equipped to understand most everything. Unfortunately, the principle of 'garbage in, garbage out' applies to economics as much as it does to computer programming; perhaps the real failure is not of the discipline of economics, but the imagination of those who practice it. We are, of course, not rewarded by universities or journal editors for asking questions like "if there is a housing bubble, and if it bursts, then what?" Those questions aren't "research"; they're not rewarded and we don't have time for them. How can we be surprised that we were surprised?

Christmas redux

It's Christmas time again. Tim Harford's on the case of that gift-giving economics article I talked about back in January, with typical accuracy:

"Waldfogel’s work is often misinterpreted as suggesting that gift-giving is pointless. That is not true. He explicitly excluded the sentimental value of gifts from his calculations, and, of course, the sentimental value is part of the purpose of giving presents."

More than that, though; his positivist reading of the original article leads to some very sensible, common-sensical normative prescriptions:

"the economists Sara Solnick and David Hemenway have discovered that we prefer unsolicited presents to those we have specifically requested... All this points to the optimal gift-giving strategy: you need to minimise the deadweight loss while maximising the sentimental value. This suggests buying small gifts and striving for emotional resonance. Look for something inexpensive, and consider supplementing it with a letter, a photo, or time spent together."

Prescriptions we can all relate to.

Friday, November 21, 2008

Monday, October 20, 2008

More ultimatum game ignorance

I wonder what it is about the ultimatum game that makes for journalistic error? More of the same from Emily Yoffe in Slate:

We like to think we go through life as rational beings. Much of economic theory is based on the notion that humans make rational choices (which may mean that economists don't get out much). 

"Rationality" is a model, and admits any form of behavior. It does not say how someone "should" behave.

In 1982, some economists came up with a little game to study negotiating strategies. The results showed that rationality is subservient to more powerful drives—and demonstrated why human beings so easily conclude they are being wronged. The idea of the "ultimatum game" is simple. Player A is given 20 $1 bills and told that, in order to keep any of the money, A must share it with Player B. If B accepts A's offer, they both pocket whatever they've agreed to. If B rejects the offer, they both get nothing. Economists naturally expected the players to do the rational thing: A would offer the lowest possible amount—$1; and B, knowing $1 was more than zero, would accept. Ha!

This is the Nash Equilibrium of the game, if both players cared only about money. It has nothing to do with "rationality". 

In the years the game has been played, it's been found that almost half the A's immediately offer to split the money—an offer B's accept. When A offers $9 or even $8, B usually says yes. But when A's offer drops to $7, about half the B's walk away. The lower A's offer, the more likely the B's are to turn their backs on a few free dollars in favor of a more satisfying outcome: punishing the person who offended their sense of fairness. This impulse is not illogical; it is essential. 

Only the hypothetical economists in the article found it illogical, and they're not real. Once more: rejection of a lowball offer in the ultimatum game is rational under the entirely realistic assumption that people care about more than money. Please stop attacking the straw economist who disagrees with that statement.  

Thursday, October 2, 2008

Economist versus economist

This mostly innocuous entry at the Freakonomics blog is comparing the rejection of offers in the ultimatum game (where I propose a division of some money, you either accept or reject, we get the money if you accept but don't if you reject, and then we go home) to the rejection of the 'bailout' of the financial sector. It raised my ire with this:

Many economists cannot understand why they’d do such a thing. To an economist, an offer of even 1 percent would be worth accepting since it is free money, and because for the second player it is ultimately irrelevant how much money the first player takes home.

But most people do not think like economists. When offered 10 percent or 20 percent or even 30 percent of the total, they are disgusted by the inequity — and willing to pay the price for that disgust by rejecting the offer.

Show me a scrap of evidence that "many economists cannot understand why they’d do such a thing." Pardon my language, but that's bullshit. Really, what the hell. In fact, it's so infuriatingly ridiculous that I'm going to be forced to actually say something as clearly and calmly as I can, but I'm going to have to do it in boldface:

Economists are capable of feeling things.

Phew. No, seriously, the quotation claims that:
  1. Economists don't understand that people care about things.
  2. Economists don't feel feelings.
  3. Economists do not conduct life in the same way as people who actually care about things.
Give me a break. 

Saturday, September 27, 2008

Big picture

Neat little story related by Tim Harford:

Shortly after the Soviet Union collapsed, a Russian bureaucrat travelled to the west to seek advice on how the market system functioned. He asked the economist Paul Seabright to explain who was in charge of the supply of bread to London. He was astonished by the answer: "Nobody."

I like that because it is astonishing that these things take care of themselves (well, not that bread is wandering in to London by itself, but you see what I mean). It's also a fun reminder of the massive economic policy differences that are possible in the world - a reminder of the size of the question "how should I/we/the country allocate resources". 

Thursday, September 25, 2008

What's next for economics?

Not every scientist is working on a cure for cancer, but it's surely one of the big open questions in medical science. Does economics have a cure-for-cancer question, one that every economist would sell his soul to answer?

A thought experiment: there's an economics seminar or lecture about to take place, in an hour, at a location an hour away from you. You hear a rumor about the content of this seminar. What credible rumor would make you jump in the car and high-tail it to the scene?

Again, being that it's probably foolhardy to speculate on what the next "big idea" might be, this might be an unanswerable question. Nevertheless, if it's not possible to think of an example, we might have a problem on our hands. Is this question different in economics than in other fields? 

Broadly, there are three things that might qualify. First would be the uncovering of a new piece of evidence, a Dead Sea scrolls-type discovery that would be vital for some purpose or another. What might that be in economics?

Second, and related, would be proving of some unproven result. Whether an unproven provable theory can logically exist in economics is debatable; in theoretical economics, we're always subject to the underdetermination problem that skews the definition of "proof"; the theories are always logically consistent from within, and nothing is provable from without. In empirical work, we face not just the problem of where the evidence for our groundbreaking proof comes from, but if it is conceivable that the evidence could realistically exist to make such a proof. There a "proof" could rest on clever data collection or a new econometric technique that can interpret the real-world data in a usefully new way. 

Third, we might have some methodological development, perhaps of the kind that saw "information" formally brought into the methodological fold in the 1970s. Whether this could rightly be called a methodological breakthrough is again not clear: is it not just a new application of the existing methodology? 

Could neuroeconomics, partway closing the underdetermination door, do the trick? Will the modeling of complex systems by powerful computers help? All I know is that fewer than 1% of economics seminars are genuinely interesting in and of themselves (that is, apart from the paper and to the terminally curious); what could boost that ratio?

Friday, September 19, 2008

More investment banking schadenfreude

I have to mention a New York Times op-ed in which Roger Cohen can barely contain his glee at the fate of the "masters of the universe" who may now be seeking alternate employement. I sympathize:

When I taught a journalism course at Princeton a couple of years ago, I was captivated by the bright, curious minds in my class. But when I asked students what they wanted to do, the overwhelming answer was: "Oh, I guess I’ll end up in i-banking."

Try teaching economics, sir! We're the ones who really get to see squandered potential: in economics classes, it's beyond overwhelming. And get this:

According to the Harvard Crimson, 39 percent of work-force-bound Harvard seniors this year are heading for consulting firms and financial sector companies (or were in June). That’s down from 47 percent — almost half the job-bound class — in 2007.

Isn't that a little bit tragic? Is the only thing we can offer our smartest young people a career in consulting and banking? Is it the only thing our smart young people want to do?

Tuesday, September 16, 2008

Hey, look, it's a financial crisis

Nothing like a good financial mess to underscore just how little anyone really understands the "economy". By which I probably mean the financial system. I think. There's also nothing like a good financial mess to slaughter in cold blood any chance I ever had of convincing anyone that economics is not the same as finance

Fortunately, the economics behind everything from risk trading to bailouts is very simple, even as the financial system manages to be opaque enough to make a lot of people look confused and silly. Even better, pretty much everyone understands that economics: for example, 'moral hazard' can mean something as simple as 'if the government is willing to bail out a bank when it's in trouble, risks for that bank are less risky so they might be willing to take more risks'. Of course, then you might well ask 'more than what?' or 'how risky?', but the idea is solid. Even the trading of risk is not especially difficult to grasp, because we're all familiar with the concept of insurance, and it's in exactly the same spirit, perhaps with a bit of hot potato thrown in as the risk gets chopped up and passed around. 

But the system? I think that's pretty confusing. The BBC has valiantly compiled a little glossary of some of the jargon, but we're already in very, very deep; too deep for that glossary to be helpful. Sure, it might turn some otherwise baffling sentences into plain English, but what if I don't know, say, what the stock market is, what is does, what it means? What good is a passage like this one to me:

Not far behind was Royal Bank of Scotland, whose shares ended down 10.2% at 189.1p. Barclays fared better, its shares closed down 2.53% at 308p.

Hell, what good is that to anyone? What is it saying? For those of us who know what the stock market does, maybe because we've studied finance, were simply interested or just have that little piece of information in our heads, it means something, but how many people is that? It's just as bad as using the word 'economics', which I've already argued is usually meaningless

It must be hell to try to write about a financial crisis for a lay audience. There's a perfect parallel between the entanglement of the institutions themselves and the contortions of language needed to explain it. Of course, personally, and I realize this is a terrible thing to admit, I'm experiencing delightful schadenfreude over the whole affair, so I admit to being less sympathetic than curious. 

Strange quotations

I'm scratching my head at this one from Barack Obama:

He added, "Senator McCain – you can’t run away from your words and you can’t run away from your record. When it comes to this economy, you’ve stood firmly with George Bush and a failed economic theory, and what you’re offering the American people is more of the same."

I struggle to even offer a guess as to what 'economic theory' he's talking about. 

Saturday, September 13, 2008

Goods, marketing, preferences and the Genius

I've gotten used to ignoring iTunes pining for one upgrade or another - seems to happen every other time I start it up - but, this time, the promise of the Genius was too tempting to ignore. 

The Genius is a new gadget attached to iTunes that is designed to create "smart" playlists at the touch of a button; pick a song from your library and it'll create a playlist made up of songs that fit well with the one you picked. If that sounds familiar, it's because it's precisely the same idea that personalized internet radio (my favorite is Pandora) has been trading on for a few years, with the obvious difference that Pandora and its cousins are capable of creating playlists built on more than one song or genre and that they can play you songs you don't own. Both Genius and Pandora are working on a collective wisdom principle - learning what to recommend based on what you like and on what people like you like, and so on. Actually, that even sounds a bit like the supposed basis for Goggle's search algorithm, right?

Anyway, I've been crying out for this: shuffle in iTunes is precisely useless, and I'm pleasantly encouraged by early returns from Genius. What's all that got to do with economics?

Well, what do we assume about preferences? We've always tried to be agnostic about what people like, which was neat for keeping us honest but made us a little fuzzy on where they come from or how they might change. Genius and Pandora are, arguably, operating on a person with malleable preferences, who's persuadable that she likes what's being connected. For these to be valuable products, there must exist preference for convenience (having playlists made for you rather than doing it yourself) or surprise (for hearing unexpected songs). 

Or could it be as simple as information? Perhaps these things are most valuable as informers, letting us know what goes well with our music or showing us new music that we might like. Again, slightly non-traditional consumer theory, although imperfectly informed consumers isn't a new idea in economics or in life. Strangely, iTunes seems to be at a distinct disadvantage here; sure, this new gadget is designed to recommend things to you to buy at the iTunes store, but it's not a pure free-preview model like Pandora. Nevertheless, we're in the territory of deterministic preferences, and in particular the role of advertising.

The most commonly asked question about advertising in economics has been 'informative or not?', and there's the balance between these two functions: am I being coerced or informed when Genius tells me what songs I'm missing that would go well with one I own? The strict segregation of preferences and the tangible world of goods and budgets that is used in consumer theory is violated a little by this kind of thing; we get into nice philosophical questions like how to define a good. Are my preferences changing when I learn about these awesome songs I'm missing out on?

Wednesday, September 10, 2008

Economics From The Heart

A brief interlude to recommend "Economics From The Heart", a collection of short Paul Samuelson columns from the 60s through the 90s. Doesn't look like it's in print, but you can get it used for cheap on Amazon. It's entertaining stuff, not just as a document of historical op-ed economics:

Billy Graham's book on angels sold well, one presumes primarily to non-angels. Intellectuals have a propensity to write books that are read only by intellectuals and therefore do not sell well. This despite the propensity of intellectuals to read books. That is all intellectuals are good for: to read, write and talk about books and ideas.

Tuesday, September 9, 2008

Measurement again

From the New York Times:

During the boom years of the Bush presidency — remember them? — economic growth was an especially unreliable indicator of how most Americans were doing.

Our problem, again, is that semantically dead word 'economics'. 'Economic growth' is an especially fun one, not least because it actually refers to growth in GDP, which is something that's kind of confusing anyway. Look at this catalog of misery:

The numbers were impressive, but the gains were lopsided, benefiting executives and investors far more than hourly workers and salaried employees. Because the growth was fueled by reckless lending and borrowing, it created an illusion of wealth even as many Americans lost ground...

The government reported that the economy grew at a surprising 3.3 percent in the second quarter, while productivity (the measure of how much workers accomplish per hour) soared. Unfortunately, those bounces did not mean a rebound in the lives of most Americans.

Growth rose, but so did unemployment. Productivity surged, but wages fell. Fixing that disconnect is the central economic challenge for the next president.

Increased exports were responsible for last spring’s strong economic growth numbers. But selling more abroad has not led to more manufacturing jobs or working-class pay raises at home.

Oh my. One point is that the popular metrics - like 'growth' - clearly aren't capturing everything that's relevant, but we knew that. Another would be that it's therefore pretty odd that we continue to use the word economics when, lo, it's actually two degrees away from making sense: first, it usually means something like GDP or unemployment or productivity or something, and second, even that wouldn't actually tell a proper story. 

Yet a third point is that the title of the article is "Real Life Economy": seems like there's a bit of a trust issue developing with the metrics the media reports when they talk about 'the economy'. Economists look silly again, but was it their fault? And are we surprised?

Saturday, September 6, 2008

Using economics to talk policy

A few years ago I took a course called "Economics of OECD Countries" with a wonderful teacher, Gavin Cameron, who sadly passed away recently. It was really an economic history course; we took a few big, general, flexible models from macroeconomics and used them to talk about the last hundred years in the rich countries of the world - the Great Depression, oil shocks, the 'Golden Age' of growth, the rise of computers, productivity. It wasn't an especially politicized class, just nuts and bolts economics, but I'll be forever grateful not just for learning a bit of history but for learning that a little model goes a long, long way.

For instance: the BBC website had a piece a while back about the presidential candidates' economic policies with this passage:

Mr McCain has endorsed "supply side economics", calling for more tax cuts for business to boost economic growth and sharp cuts in spending programmes.
Mr Obama, on the other hand, wants more domestic spending, particularly on health care, and has indicated that he is not averse to higher taxes on the rich to pay for it.

Again, I'm not going to start analyzing policy, but I really like - no sarcasm here, I promise - that the same debates that have cropped up again and again through the history of economic policy as an actual thing are still here. A crude characterization would be to call Obama Keynesian, on the strength of what the article is saying; it's the famous injection of spending by the government to try to prop everything up, the great policy success of the original Keynesian era. That was the one that dragged America out of the Great Depression. 

Or did it? Surely a bold stroke to open the government's wallet when the whole country is broke, but, of course, there's plenty of wiggle room for debate. One of the many things we talked about in our course was the role of war spending in providing a natural bounce out of the Depression. Same concept, different reasons. 

McCain's being painted in the BBC article as a supply-sider, which is something of a dirty little epithet around the Dem-leaning economics faculties of the world. Paul Krugman made his journalistic bones (as opposed to his impressive academic record) with "Peddling Prosperity", a big chunk of which was devoted to a critique of what came to be called supply-side economics. Perhaps I'm reaching a bit here, but you could plausibly argue that supply-side policy grew out of monetarism, which was itself the big weapon against the oil-shock driven recession of the 1970s. Keynesianism versus monetarism was the big debate in economic policy, and it lives still into the 21st century.

As a teacher, the beauty of these debates is that they don't need fancy techniques, or math, or number crunching, to be explained. Naturally some of the academics who've spent their careers on policy questions are doing very complicated things, but to explain - in simplified form, but correctly - what was driving the problems of the 30s, the 70s, or whenever, and the logic behind the policies that were tried, is easy. It takes a bit of clear reasoning and is even easier if we are willing to use a few simple diagrams, both commodities that go a long, long way in economics. It's possible, even, to boil the whole mixture off to a supply-and-demand story. Don't roll your eyes, though: there's a reason why that's the most famous, most reproduced little model in economics, and how awesome that we can use it to talk about the biggest policy issues of the last century.

Many economics courses are 'tooling up' courses, where you learn those models, the diagrams, the math; what is even more crucial are those courses like the one Professor Cameron taught me, the ones where we use those tools to think about interesting things. It's truly staggering how simple the tools are that we used, truly gratifying to learn how far even the simplest little insight can go. 

Saturday, August 30, 2008

Unexpected economics

Market forces in Gailileo's "Dialogue":

The deeper I go in considering the vanities of popular reasoning, the lighter and more foolish I find them. What greater stupidity can be imagined than that of calling jewels, silver, and gold "precious," and earth and soil "base"? People who do this ought to remember that if there were as great a scarcity of soil as of jewels or precious metals, there would not be a prince who would not spend a bushel of diamonds and rubies and a cartload of gold just to have enough earth to plant a jasmine in a little pot, or to sow an orange seed and watch it sprout, grow, and produce its handsome leaves, its fragrant flowers, and fine fruit. It is scarcity and plenty that make the vulgar take things to be precious or worthless; they call a diamond very beautiful because it is like pure water, and then would not exchange one for ten barrels of water.

Friday, August 29, 2008

Positive bias and normative bias

The opposite of analysis is bad cliché, a sloppy knee-jerk. It's whenever an innocent-looking question in Econ 1 provokes a response that is answered with a phrase like "greedy companies"; it might even be whenever economics is confused with "business" or "finance", because, after all, what short-circuits economic analysis faster than pinning a label of bias on economists?

Not that you couldn't defend such a label. After all, it certainly looks like economists are biased when your first contact with them as a student of the subject is our friendly principles course. What a delicate balancing act, though. Bryan Caplan quotes Paul Krugman:

When the latest batch of freshmen shows up for Econ 1, textbook authors and instructors still try to separate students from their prejudices. In the words of the famed economist Paul Krugman, they try "to vaccinate the minds of our undergraduates against the misconceptions that are so predominant in educated discussion."

Make no mistake, there's a reason why it's so difficult to play devil's advocate to argue against the very real work of introductory economics courses. Is there a fundamental difference between positive bias and normative bias? Normative bias is opinion, and represents healthy disagreement: "I believe the minimum wage should be raised, even if it raises unemployment, because those people who do work at minimum wage are impoverished", or "I believe the minimum wage should not be raised, even given that those who work at minimum wage are impoverished, because it might wreak havoc with the labor market". Both acceptable, both, arguably, representative of what you might call "normative bias".

Positive bias is more problematic. It could be accurately called "being wrong". That's the kind of problem that leads the designers of introductory economics courses to swing wildly to the extreme of trying to batter the bias out, looking suspiciously like indoctrination in the process. Think of how disheartening it is, though, to face a whole class who have heard about "competition" with Russia, China, India, whatever country is the current flavor of Evil, and try to teach the theory of comparative advantage. A very real challenge for economists is to explain the (deceptively simple) positive theories that form the foundation for the argument in favor of trade (personal and international), markets, government, etc etc, while walking the tightrope across the normative ravine.

The challenge, then: is a student who says "globalization hurts America" wrong? Is this a positive bias or a normative bias? More accurately: is this an opinion or a misreading of fact? What about a student who uses the sinking-feeling phrase "greedy oil companies" when asked to evaluate the effects of a gas tax? Here's a passage from that Bryan Caplan article:

People tend, for example, to see profits as a gift to the rich. So unless you perversely pity the rich more than the poor, limiting profits seems like common sense.

Yet profits are not a handout but a quid pro quo: If you want to get rich, you have to do something people will pay for. Profits give incentives to reduce production costs, move resources from less-valued to more-valued industries, and dream up new products. This is the central lesson of The Wealth of Nations: The “invisible hand” quietly persuades selfish businessmen to serve the public good. For modern economists, these are truisms, yet teachers of economics keep quoting and requoting this passage. Why? Because Adam Smith’s thesis was counterintuitive to his contemporaries, and it remains counterintuitive today.

And again, on international trade:

How can anyone overlook trade’s remarkable benefits? Adam Smith, along with many 18th- and 19th-century economists, identifies the root error as misidentification of money and wealth: “A rich country, in the same manner as a rich man, is supposed to be a country abounding in money; and to heap up gold and silver in any country is supposed to be the best way to enrich it.” It follows that trade is zero sum, since the only way for a country to make its balance more favorable is to make another country’s balance less favorable.

Even in Smith’s day, however, his story was probably too clever by half. The root error behind 18th-century mercantilism was an unreasonable distrust of foreigners. Otherwise, why would people focus on money draining out of “the nation” but not “the region,” “the city,” “the village,” or “the family”? Anyone who consistently equated money with wealth would fear all outflows of precious metals. In practice, human beings then and now commit the balance of trade fallacy only when other countries enter the picture. No one loses sleep about the trade balance between California and Nevada, or me and iTunes. The fallacy is not treating all purchases as a cost but treating foreign purchases as a cost.

My own bias is to worry that we mistakenly strangle normative bias out of the economics classroom by too-much, too-soon overzealousness. Yet how else will we be able to impart the simple, counterintuitive lessons that will help us to fight positive bias?

Tuesday, August 26, 2008

Samuelson's "Economics"

Isn't this just a marvelous observation:

What sex is to the biology classroom, stocks and investment riskiness is to the sophomore economics lecture hall. That chapter on personal finance, put there to keep hard-boiled MIT electrical engineers awake, helped make introductory economics the largest elective course at hundreds of colleges.

That's from Paul Samuelson's article (pdf) discussing the 50th anniversary of the publication of his economics textbook. What a perfect quotation it is: students enroll in economics courses to learn about the stock market, despite it being, really, secondary to the discipline, and by indulging them we made economics courses wildly, unimaginably popular. Even Samuelson saw it!

Then again, Samuelson seemed to see a lot of things more clearly than most. Justin Wolfers at the Freakonomics blog discusses the textbook, and says this:

And while modern textbooks typically begin with a list of the dozen or so key lessons of economics, Samuelson begins with a single claim: “The first lesson in economics is: things are often not what they seem.”

This is the enduring brilliance of Samuelson's book. He would never have had the audacity to write down a list of "principles" in some misguided attempt to simplify or to circumvent argument or to hook a bored student; he discussed, sensibly, correctly, reasonably, lucidly. Even after he delivers his "first lesson" in the first chapter of the book, Samuelson gives a few examples then says:

...each of the above seeming paradoxes will be resolved. Once explained, each is so obvious that you will wonder how anyone could ever have failed to notice it. This again is typical of economics.

That's how it feels to study economics. Things might not at first be what they seem, but soon they are revealed to be exactly what they seem, and my goodness how did it ever seem otherwise.

That first chapter is rightly championed by Wolfers. It shows precisely why it's such a tragedy that Samuelson's textbook doesn't still dominate, why it's a tragedy that we now have textbooks that put the cart before the horse and show questionable "principles" up-front rather than discussing what's about to happen, then developing them patiently. Can this be beaten:

It is the first task of modern economic science to describe, to analyze, to explain, to correlate these fluctuations of national income. Both boom and slump, price inflation and deflation, are our concern. This is a difficult and complicated task. Because of the complexity of human and social behavior, we cannot hope to attain the precision of a few of the physical sciences. We cannot perform the controlled experiments of the chemist or biologist. Like the astronomer we must be content largely to "observe." But economic events and statistical data observed are unfortunately not so well behaved and orderly as the paths of the heavenly planets. Fortunately, however, our answers need not be accurate to several decimal places; on the contrary, if only the right general direction of cause and effect can be determined, we shall have made a tremendous step forward.

There you have a perfect, simple explanation of the problem of measurement. Here's more, this time on positivism and its limits:

At every point of our analysis we shall be seeking to shed light on these policy problems. But to succeed in this, the student of economics must first cultivate an objective and detached ability to see things as they
are, regardless of his likes or dislikes... there is only one valid reality in a given economic situation, however hard it may be to recognize and isolate it. There is not one theory of economics for Republicans and one for Democrats; not one for workers and one for employers...

This does not mean that economists always agree in the
policy field... Ethical questions each citizen must decide for himself, and an expert is entitled to only one vote along with everyone else.

Reading that collection of reminisces (same pdf as earlier) on the 50th anniversary of the book, I'm humbled again by how groundbreaking Samuelson's textbook must have been. We must fight, fight and fight over again to make sure that the foundations of his book - the true principles of economics - live on and on.

Sunday, August 24, 2008

Common sense versus science

We've all seen those faintly ludicrous reports of scientific studies confirming the obvious. Can something be so obvious that it doesn't qualify as research? Where is the line across which we have to devote po-faced time and valuable cash to figure something out? That's what I was wondering while reading Benjamin Friedman's review of "Nudge", the new Big Idea book (and obviously the one getting the most press, what with the Obama association) from Richard Thaler and Cass Sunstein. It begins:

Yes, there is such a thing as common sense — and thank goodness for that.

So far so good.

Few people will be surprised to learn that the setting in which individuals make decisions often influences the choices they make. How much we eat depends on what’s served on our plate, what foods we pick from the cafeteria line depends on whether the salads or the desserts are placed at eye level, and what magazines we buy depends on which ones are on display at the supermarket checkout line. But the same tendency also affects decisions with more significant consequences: how much families save and how they invest; what kind of mortgage they take out; which medical insurance they choose; what cars they drive. Behavioral economics, a new area of research combining economics and psychology, has repeatedly documented how our apparently free choices are affected by the way options are presented to us.

The knock on behavioral economics as a discipline is that it's all a bit obvious. Even the things that are supposed to be revelatory are a bit "yeah, we know"; one classic example is the somewhat underwhelming finding that when people know they're drinking a more expensive wine they like it better than one they know is cheaper. The two obvious questions: are we surprised that people's enjoyment of a wine is influenced by its price? And is it research worth conducting?

Of course, sometimes "common sense" could be wrong, and the whole point of science is to confirm, reject or quantify phenomena in the world around us. For example, there was a lively debate - is it still ongoing? - about whether "institutions" or health was more important in fostering economic growth; the common sense answer is probably to say, well, neither good infrastructure or good health ever hurt anyone, did they? On the other hand, it would be nice to know, if it was possible, the hierarchy, especially if you really want growth but don't have an infinite budget to encourage it.

Behavioral economics is asking questions on a different order of magnitude than that, but the same logic is probably applicable, that in that field, as in all in economics, we might sometimes seem to be masters of the obvious - a lot of economics is common sense with a fancy outfit on - but, I guess, someone has to do it.

Saturday, August 23, 2008

Off-topic: innovation, names, duplication

Only because it's a really cool article and I just discovered it, and not because it really has anything to do with anything, "In The Air" by Malcolm Gladwell in the New Yorker is well worth a read. It's about a fascinating organization called Intellectual Ventures, but there are just a bunch of fun little snippets. A couple:

This phenomenon of simultaneous discovery—what science historians call “multiples”—turns out to be extremely common. One of the first comprehensive lists of multiples was put together by William Ogburn and Dorothy Thomas, in 1922, and they found a hundred and forty-eight major scientific discoveries that fit the multiple pattern.

In the nineteen-sixties, the sociologist Robert K. Merton wrote a famous essay on scientific discovery in which he raised the question of what the existence of multiples tells us about genius. No one is a partner to more multiples, he pointed out, than a genius, and he came to the conclusion that our romantic notion of the genius must be wrong. A scientific genius is not a person who does what no one else can do; he or she is someone who does what it takes many others to do. The genius is not a unique source of insight; he is merely an efficient source of insight.

Surely it must be getting harder to have simultaneous discovery, in a world where research communities are global and transmission is very fast? Gladwell's article goes on to talk about something like the standing on the shoulders of giants concept of building on the existing body of knowledge, speculating that multiples are proof of inevitability of inventions or discoveries.

What about economics? Are economic researchers building on existing research? It can sometimes seem that the questions we ask are so specific and arcane that the chance of simultaneous "discovery" is low; so much so that's it's tempting to wonder if we should even be using the word "discovery". I wonder what, if anything, we could attach the word to in the history of economics? Obviously hindsight is 20/20, but it's difficult to see what really was new or difference-making in the field, going back as long as you care. What has the discipline of economics done for us?

And what will it do, then? Gladwell's article talks about a group of smart people who get together to try to invent stuff. What "economic" (however they choose to interpret the word) questions would such a group want to tackle, if any? Where is the innovation coming from in our field? I look at the list of Nobel prize topics, and, don't get me wrong, I like finding things out for their own sake, but what are these things really doing, either practically, for the world, or simply for the body of knowledge we call economics? Of course we're not supposed to be able to see where the next huge idea is coming from - that's the whole point - but if we haven't had a really important idea from, or even an important question for, academic economists for so long, if ever, isn't a little pessimism forgivable?

I'm often tempted to argue, not entirely facetiously, that the methodology of economics and its status as a grounds for "discovery" was pretty much done 70, 80 years ago, and the rest is just application, gravy and statistical analysis. Even if that were true, would it be such a bad thing?

Friday, August 22, 2008

Arguing without moving

Doesn't it sometimes seem like two arguers are actually saying the same thing in slightly different ways? The devil's in the semantics, or something, and a three-headed book review by Jonathan Derbyshire in the Guardian seems uncannily to be presenting a classic case applied to -what else? - economic man.

Here's a bit about Tim Harford's approach in "The Logic of Life":

Yet for all the demotic breeziness of their style, both writers have a serious purpose. In Harford's case, it is to defend a version of rational choice theory, which tries to explain human behaviour in terms of the maximisation of individual preferences or "utility". On this model, which Harford thinks applies more or less universally, human beings respond to trade-offs or incentives: "When the costs and benefits of something change, people change their behaviour." The important point for Harford is that those costs needn't be financial...

Proponents of rational choice theory say that to act in accordance with the cost-benefit principle is to behave "rationally" - in a distinctive (and drastically circumscribed) sense of the word. And Harford's contention is that we're much more rational than we're inclined to think. There's a "rational explanation", it seems, for more or less everything: for the shortage of eligible men in New York City, for instance, or for the evolved biological preferences of men and women.

We're again in a world where it's impossible to know exactly what drives people to make decisions, but where we can speculate that there are reasons for this or that decision, and speculate on what those reasons might be. But then here's this, in discussion of Robert Frank's "The Economic Naturalist":

One problem with this approach is that it seems to apply better to an ideal creature called Homo economicus, whose preferences are perfectly consistent, than it does to flesh-and-blood human beings... Homo economicus would never change his preference for a roast beef sandwich over chicken salad just because the waitress remembers they've also got tuna on the menu.

This is a reference to a classic "behavioral" result; but, then again, says who? It's of course possible to rationalize anything, as the behavioral school well knows when it invariably goes on to try to write down a model of a decision maker who would display these or other preferences. Aren't we still in a Harford world, where we can identify a potential justification for any superficially weird-looking decision? I don't see any difference between these "behavioral" results and this:

Frank's book, meanwhile, is based on an assignment he gave to students taking his introductory course in economics at Cornell University. The students were asked to pose and answer a question about observed events or behaviour, and what they came up with certainly wasn't the staple fare of Economics 101: why did kamikaze pilots wear helmets, they asked. Why is coyness often considered an attractive attribute? Why do women endure the discomfort of high heels?

All these phenomena obey what Frank calls "economic logic", the fundamental law of which is the cost-benefit principle. This says that an action ought to be taken only when the extra benefit that accrues from taking it outweighs the extra cost. So when a woman decides to squeeze her feet into a pair of stilettos, for example, she has weighed the benefit of being "more likely to attract favourable notice", as Frank somewhat coyly puts it, against the costs of discomfort.

Finally we get Stephen Marglin's "The Dismal Science" (uh oh):

Marglin argues that to think about people as always rationally calculating their self-interest is at odds with the way non-economists think about people... And you don't have to agree with Marglin that the way of life of the Amish people of Pennsylvania is the best counter-example to that to think there's something drastically wrong with it.

That kind of reasoning is an F. First of all, self-interest does not equal concern only for my own material outcome: I can, like, perhaps, the Amish people appropriated as an example, be self-interestedly concerned with my peers. I absolutely cannot believe that anyone finds it difficult to fit the behavior of someone who, for example, donates to charity into a utilitarian model of the kind economists use every day. Yet these are the examples we come up with to try to "disprove" the "rationality" of "economic man"?

Tuesday, August 12, 2008

Ideology, politics, economics

Simply excellent paragraph from Free Exchange:

I have trouble with any ideological reading of the economics, because the two (ideology and economics) so rarely fit well together. I don't want to elect a free-market supporter or an interventionist. I want to elect someone who will carefully consider the issues and determine that here the government ought to assign pollution property rights, while here the government should reduce licensure, and so on. I want, in short, someone with enough intellectual heft to know the difference between good policy and good politics.

This promotes the idea a kind of cipher-wonk as a political leader, which is an interesting idea - do we want ideology-free politicians? - but I think extrapolating the point to economics in general is worthwhile. Ideology and economics really don't get on, and perhaps a lot of the misuse and misunderstanding of "economics" in political stumping and election coverage is indeed due to that tension, that ideology infests politics more than it can get into economics.

The very concept of positivist economics is precisely what the Free Exchange quotation is invoking when arguing that we should be electing someone who can do a proper analysis - an objective analysis - instead of someone whose prejudices and ideology biases them consistently in one direction or the other, regardless of the evidence.

Laudable? Probably. The sticking point, again, is that pesky word ought, as in "I want to elect someone who will carefully consider the issues and determine that here the government ought to assign pollution property rights, while here the government should reduce licensure, and so on." Then we're back to square one: we can elect our wonk, who does an objective analysis before enacting any policy, but at some point we need to figure out which option to take, and all the objective analysis in the world can't prescribe; again, there's no such thing as technocratic economics. Surely that makes it impossible to avoid ideology in politics? Surely, also, that's why sterilizing economics can't also sterilize economic policy. We can do that economic analysis, but we always have to answer the normative question of what we want if we are to make use of it.

Friday, August 8, 2008

Economics versus sociology: economic imperialism again

The BBC, or at least Alan Connor in the Magazine, is of the opinion that economics is thieving turf from sociology:

There's actually nothing new in explaining how people decide or why people believe - it's called sociology. But if your boss wouldn't want to be caught with a sociology book in their luggage, there is now a range of delicious bite-sized chunks in books with titles like The Undercover Economist, The Rogue Economist and The Hidden Side Of Everything. Economics - once academia's dry "dismal science" - has decided to get tough.

The article's talking about some of the hot books, books from that sublimely irritating 'big idea' genre, that might be making waves among whoever reads them. At very least we know that they haven't learned the true history of the phrase 'dismal science'; more importantly, is the economics/sociology charge justified?

The question of economic imperialism is a familiar one, and I think one that comes from the supreme flexibility of economic modeling to be applied - for better or worse - to things that are pretty far away from what 'economics' is perceived to be. The gulf separating what economics is 'supposed' to be about from what its method can be used for is wide, and in it we can find the charge that economics is stealing from all over the place.

I wonder if the Connor quotation couldn't equally well read "it's called psychology", anyway. The kind of back-to-basics positivist modeling economists do these days naturally blurs the boundaries between disciplines that, maybe, were only ever separated by their topic of interest rather than their idealized toolbox for investigating those topics.

One of the titles specifically mentioned in the article is "Nudge" by Richard Thaler and Cass Sunstein; I haven't read the book, but I am irked by the Magazine article's summary of it. See if you can guess why:

The Buzzwords:

Econs (people that are perfectly rational but sadly imaginary)

The libertarian paternalism ideas are sometimes quite neat, the idea being that freedom of choice can be maintained but the framework of the choice changed - the famous example being requiring opt-out instead of opt-in to increase enrollment in pension funds - but, of course, even the brains behind something like that shouldn't be claiming to have proved irrationality. Just use a different word! Please! Mechanical or something, maybe?

Wednesday, August 6, 2008

The received wisdom of 'market capitalism'?

I don't know what to think of "Economics Does Not Lie" by Guy Sorman in the I-just-learned-it-existed City Journal. It's reasonable and well-argued, even as it seems to push the buttons of the anti-economics set, and even as it seems to commit many of the same sins as those pesky "principles of economics". The agenda seems to be a vigorous defense of the capitalist economy - almost too vigorous, with plenty of pro-America, anti-'western Europe' digs. Weird? Hold that thought.

In the meaty bit of the article, Sorman begins:

If economics is finally a science, what, exactly, does it teach? With the help of Columbia University economist Pierre-André Chiappori, I have synthesized its findings into ten propositions... The more the public understands and embraces these propositions, the more prosperous the world will become.

OK, so I'm interested; seems like what we have might be an alternative list of what Mankiw calls "principles" (I despair of ever actually getting a proper use of the word in this context). Sorman discusses them at length, but here's the list:

1. The market economy is the most efficient of all economic systems.
2. Free trade helps economic development.
3. Good institutions help development.
4. The best measure of a good economy is its growth.
5. Creative destruction is the engine of economic growth.
6. Monetary stability, too, is necessary for growth; inflation is always harmful.
7. Unemployment among unskilled workers is largely determined by how much labor costs.
8. While the welfare state is necessary in some form, it isn’t always effective.
9. The creation of complex financial markets has brought about economic progress.
10. Competition is usually desirable.

First of all, I don't disagree with the assertion that "almost all top economists—those who are recognized as such by their peers and who publish in the leading scientific journals—would endorse" this list, although that's obviously verging on the tautology of the clique. As a list of the received wisdom, it's not bad at all, then.

Nevertheless, though this is a relatively less noxious list than Mankiw's 'principles', it can maybe be taken as received wisdom, but certainly not as axioms (not, to be clear, that Sorman makes any such claim). Where it fails, it fails because it suffers from the same diseases. What, for example, am I to make of the first one? Exactly what is the 'market economy' most efficient at achieving? Correct me if I'm wrong, but you can't just be 'efficient' in and of itself, right?

Aside from these familiar complaints of mine, there are a couple of other things worth mentioning, most especially this claim:

Now only one economic system exists: market capitalism.

Not only untrue, but completely untrue. Just as no country has ever tried to implement a wholly communist allocation of resources, no country has ever tried to implement a wholly capitalist allocation of resources. The accurate statement would be that the "markets with government" hybrid system is the dominant one in the modern world - as I've talked about before. As Jeffrey Tucker at the Mises blog points out in his response to Sorman's article, Sorman himself isn't even talking about "market capitalism", but about the hybrid system, which is further testament to its ubiquity.

Remember that thought we were holding? Here's the very last line of the article:

His article was translated from the French by Ralph C. Hancock.

Might the agenda simply be a reflection of the precariousness of the ideology of markets in France? Not such an outlandish proposition...

Friday, August 1, 2008

Economics = devil's advocacy

There's some low-key furore over in Chicago over the naming of a new research institute after Milton Friedman: here's a little background from the New York Times. The real joy in the story comes from the "protest letter" sent to the powers-that-be by a ton of Chicago faculty, and John Cochrane's double-barreled destruction of said letter.


As usual, academics need to waste two paragraphs before getting to the point, which starts in the first bullet.

If academic writing stopped wasting ink, I'd eat all my hats. The point of the protest seems to be that the signatories don't want to be associated with the evils of "the neoliberal global order", "monetization", "globalized capital", etc etc, which are apparently inexorably linked to poor ol' Friedman, and Chicago. Leaving aside the issue of whether naming a research institute after Friedman would invite some kind of new or extra, real or perceived bias to the actual work of that institute, Cochrane makes a stab at devil's advocacy:

The content of course is worse. There isn’t even an idea here, a concrete proposition about the human condition that one can disagree with, buttress or question with facts. It just slings a bunch of jargon, most of which has a real meaning opposite to the literal. “Global South,” “neoliberal global order,” “the service of globalized capital,” “substitution of monetization for democratization.”

It's a familiar problem for all economists. Everything we're perceived to believe in and stand for - whether or not we do - is simply evil, enemy of the environment, the people, democracy(?), happiness, community, the poor. I mean, I'm super sympathetic to the perception that economics has an agenda; as I've argued with tedious regularity, the pollution of the beautifully hopeful positivist method by normative judgment - the very sin positivism tried to prevent - is the great tragedy of the teaching of economics, but, by god, when we have to argue against this kind of jargon with no intellectual content, is it any wonder we end up sounding like the frontline warriors of 'capitalism'?

Monday, July 28, 2008

Close to the ground

Hey, it's John McCain time again! The Free Exchange blog has this (under the nifty headline 'Tsk-onomics'), on the familiar topic of McCain's support for the gas tax 'holiday'. Congress doesn't like it, economists don't like it, so far so familiar.

Apparently McCain's getting slammed for being rubbish at answering questions on this, and other, policies he's advocating, but let's leave that to the analysts. There's a fun exchange quoted from a George Stephanopoulos chat with McCain:

STEPHANOPOULOS: Not a single economist in the country said it’d work.

MCCAIN: Yes. And there’s no economist in the country that knows very well the low-income American who drives the furthest, in the oldest automobile, that sometimes can’t even afford to go to work.

I think it's neat that presidential candidates get chips by opposing economists, and I don't mean that as an offended economist; I think it's interesting. Anyway, is there any merit in that particular McCain quotation? Or, to paraphrase: is economics too far from the ground? Is it too esoteric to properly understand the actual, real implications of its preditions, its recommendations?

The classic case, I think, might be the globalization debate, the protectionism debate: typical economist's position might be 'trade good because it allows specialization based on comparative advantage, cheap stuff, more to go around etc'; the counter-argument could run 'trade bad, erodes localism which we like, hurts those people whose livelihood depends on those things that their country will stop producing when trade makes it cheaper to get those things from other countries'.

Now, sure, the response to the latter is usually 'yes, yes, we know some people lose out, compensate the losers', but is that particularly constructive? Are we blind to the real, tangible content of the disagreement with the 'economist's answers'? Do we splutter and get indignant with John McCain because he had bad policies, or because we don't really get the argument?

When we say 'your gas tax holiday plan sucks, aha!', we lose friends and alienate people; could we actually make economists a little cuddlier and meet McCain halfway? How can we deal with the problems he's referring to, that people feel like they're struggling to get by? We don't deal with it by ridiculing, that's for sure. There's no need to compromise if you think a gas tax holiday isn't right, so by all means make that case, but every time an economist is painted into a corner as an enemy of the prosperity of the common man, we must argue our way out double-quick, as a matter of principle and credibility.

Wednesday, July 23, 2008

Education, or, What do people do?

David Glenn in the Chronicle asks 'what explains the growing gap in wages?' The arguments covered run that the number of people going to college hasn't kept pace with the demand for skill by employers, and that the slowing of educational attainment has caused wage inequality to increase. I'm biased towards any argument for universal education, even up to the college level (whether this would really increase the level of 'skills' is another matter, but I think that's secondary), but I'm also a little skeptical that massively expanding higher education would bring down wage inequality in the way Glenn and his cited studies speculate.

First we have to worry about the usual signaling story - is college just an indicator that someone's smart rather than something that makes them smarter? - but more than that, what would people do? What do people do? The 2000 US census has this (pdf link):

Management, professional and related: 33.6%
Service: 14.9%
Sales and office: 26.7%
Farming, fishing and forestry: 0.7%
Construction, extraction and maintenance: 9.4%
Production, transportation and material moving: 14.6%

'Production occupations' on their own make up 8.5%. Now, a potted history of modern development might go something like this:

1) agriculture; we don't all have to be farmers anymore, let's start making stuff: industrial revolution
2) cheap global trade in stuff; we don't all have to make stuff anymore, let's do professional services
3) now what?

If you are even willing to entertain that kind of a story, you have to wonder what it would really mean in the labor market to hypothetically educate everyone to college level (again, I like it for its own sake; not trying to argue against education). Buying the skills angle from the Chronicle article probably means believing that if we educate everyone they can all get the kind of Wall Street/banking/consulting/legal jobs that are typical of the direction OECD economies are heading in, right? Perhaps some of the scientists can do tech research, but for a bunch of college graduates you're looking at a lot of things that don't exactly scream 'tangible production'.

That's not quite the same as the argument the Chronicle's citations are opposing, which is to say that wage inequality has gone up as demand for skilled labor has fallen; it's more to say that the whole production side of the US economy is just a whole lot different than it was when wages were more equal. We've got a chicken/egg problem: if we educated everyone, would
a) everyone, and thus the country, be more productive, and if so in what industry;
b) the wage gap close by bringing the bottom up and the top down;
c) a lot of college graduates work in unexpected places;
d) the breakdown of occupation change in some way, and if so in what way?
The last one would be very interesting, but which way would it go? Would we simply have yet more bankers and consultants, or would there be a more fundamental shift? Is it possible to get by on a smaller service sector, or would we end up with the same service sector populated by college grads?

Tuesday, July 22, 2008

Dinner party advice for the economist

From The Economist's Free Exchange blog, comes some dinner party advice, based on Justin Wolfers:

JUSTIN WOLFERS discusses a common problem for the economist bon vivant—people are always asking you what's going to happen to such and such economic variable. Will the economy go into recession? Will the Federal Reserve raise interest rates? Should I sell my shares in Bear Stearns?

Very true. It's no fun at all to have to admit to being an economist.

On the Venn diagram of 'what people think of when they meet someone who introduces themselves as an economist', macroeconomic stuff (inflation, unemployment) and finance (stocks, commodities, assets) are huge whopping great circles, much bigger than they are on the 'what economists do' diagram. Hence the point of this site, I suppose.

Anyway, here's some advice:

Henceforth, when asked about oil prices, simply throw out some jargon, use phrases like "short-run volatility", and then suggest that the price in three months' time, or indeed a year, will be the same as it is today.

I love it.

Saturday, July 19, 2008

Dead left

Just a quick note to strongly endorse the excellent article on Naomi Klein's "The Shock Doctrine": Dead Left by Jonathan Chait in The New Republic. There's a long deconstruction of Klein's argument. He ends with this:

What makes Klein's thesis so odd, and so awful, is that in fact there is an unlimited supply of raw material, an abundant basis in reality, for the sorts of arguments that she wants to make. The last two decades certainly have seen the global spread of absolutist free-market ideology. Many of the newest adherents of this creed are dictators who have learned that they can harness the riches of capitalism without permitting the freedoms once thought to flow automatically from it. In the United States, the power of labor unions has withered, and prosperity has increasingly come to be defined as gross domestic product or the rise of the stock market, with the actual living standards of the great mass of the population an afterthought. Corporations, which can relocate nearly anywhere around the world, have used their flexibility as a cudgel against workers, who do not enjoy the privileges of mobility. Domestic policy has aggressively sharpened income inequalities, and corporations have enjoyed unfettered influence to a degree not seen in a hundred years. And the president did start a war without paying the slightest bit of attention to the country that he would be left occupying or how its people would react.

All these things are true. And all these things are enormous outrages and significant problems. It's just that they are not the same outrage or the same problem. And Naomi Klein's relentless lumping together of all her ideological adversaries in the service of a monocausal theory of the world ultimately renders her analysis perfect nonsense.

Ignore the past, and it shall teach thee?

So why don't we teach much economic history anymore? An article in the Chronicle by Russell Jacoby asks this question, with similar for the history of psychology and philosophy, by wondering why Marx doesn't feature on your typical economics syllabus.

The analogy is probably to the natural sciences. Once we scientificize (is that a word?) economics, it becomes more reasonable to follow the path of the naturals - after all, the history of chemistry, for example, might be interesting, but it doesn't necessarily help you be a better chemist. Economists try to answer very specific, answerable questions: methodology becomes crucial, and while the foundation of methodology is important, it's not it. Here's what Jacoby says on the topic:

The flight from history marks economics and philosophy as well. Economics looks more and more like mathematics, in which the past vanishes. Sometimes it even looks like biopsychology. A recent issue of the American Economic Review includes numerous papers under the rubrics of "Neuroscientific Foundations of Economic Decision-Making" and "Cognitive Neuroscientific Foundations of Economic Behavior." But can we really figure out today's economic problems without considering whence they came?

Of course, my prejudice is the history of thought for its own sake is worthwhile. I want to know how economics evolved; how the foundations of the subject and a couple hundred years of thought brought us to where we are today. However: it's useful like that more to people like me with a predisposition to wonder about the philosophy of the subject than it is to those who are more interested in learning the tools to form and evaluate policy, for example. If I want to advise on school vouchers, to pluck one example, it doesn't necessarily help me to know the history of economic thought; I need to know the evidence on school vouchers. Obviously.

The 'economics as toolbox for analysis' - positivist, scientific economics - maybe doesn't need the past. Research building on research, like we do as academic economists, doesn't need the foundation of the history of thought. Seeing the evolution of the subject, and the little battles over the big issues of days gone by, might, however, make studying the subject as an undergraduate more interesting. Perhaps we could have both: the toolbox-y courses and the intellectual history, for-their-own-sake courses. Why do we need to justify the history only as something that contributes to the toolbox, especially when that might not even be true?

Maybe that's why courses in economic history or the history of economic thought are not as widely offered as you might expect. Maybe they'd be nice or interesting, but very few academic economists are historians or scholars of thought; we're scientists now. What faculty wants to teach a course so wildly unrelated to their other work, their research?

Thursday, July 17, 2008

Economists talk weird

I was going to rant a bit about "Lessons in Love, by Way of Economics" by Ben Stein from the New York Times, but, and I didn't even think this was possible, the whole thing is too ridiculous to justify it. Suffice to say it's more bad PR for the poor econ set.

One of my least favorite things about economists is that we often seem more prone to talking about normal stuff in economics-speak. You'd like an example?

In every long-term romantic situation, returns are greater when there is a monopoly.

Good grief. I mean, who is reading a bunch of aphorisms about 'love' translated into economics jargon and thinking 'awesome article'? Plus, as an added irritant, half the dodgy analogies are to finance, not economics, viz "[t]he returns on your investment should at least equal the cost of the investment" etc etc.

Who knows, maybe there could be something interesting under that title. What I hoped might crop up in an article with such a title might be something about the things people want, the monetizing of economics versus the rich motivations of life. From the tail end of the article:

Ben Franklin summed it up well. In times of stress, the three best things to have are an old dog, an old wife and ready money.

OK. It's the old "no-one ever died wishing they'd spent more time at the office" bit. Shouldn't that apply to economists too? Then why are economists so keen to spend all their time at the office by talking about normal stuff in economics jargon? That's tiresome, not fun.

Wednesday, July 16, 2008

What is a 'good'?

One very important concept in economics is 'goods'. They're one of the most fundamental building blocks of the tangible side of economics. If economics is about resource allocation, 'goods' are what the resources are being allocated towards. What is a 'good'?

It's not quite so simple as just a thing, like a TV or a sandwich; 'goods' are anything - any thing - that one can allocate resources towards that contains value for that allocator (rather confusingly, 'services' are 'goods' too, by this definition; so is something like 'charitable contributions'). Yes, we're going to have to plunge into the pool of abstraction. First of all, we have to think about time and space: is a hot coffee in the morning in winter in New England the same as a hot coffee in the afternoon at a swim-up bar in the summer in the Caribbean? Doubtful.

We have two broad strategies, as economists, for dealing with that problem. One might be to say, well, people have different preferences at different places, at different times. That's difficult to work with because we have to try and hit a moving target, so to speak, and since we can't know preferences for sure anyway we sure can't know changes in them either. A second might be to say, those two coffees are different goods. That's also difficult to work with because then it's difficult to compare things at all.

In fact, in either case it will be very difficult to generalize. On the individual level, knowing how you allocated your resources in this situation at that time doesn't help me describe what you did or predict what you'll do in the future: if I see what you did at 11a.m. on Thursday when faced with the decision of coffee versus tea, how can that help me figure out what you might do at 10a.m. on Friday when faced with the same decision. These aren't necessarily the same 'goods' at both times, and in any case, the difference might not just be the time or something else that I can measure; it might be your mood or whether you're especially tired or just feel like a nice cup of tea for some mystical reason.

Seems trivial, but raise that to the level of the market for coffee, or the global coffee industry, or the impact of consumer decisions on the American economy, and the difficulty of defining a 'good' has snowballed into modeling chaos. For example, it's impossible to properly think about the current climate in the market for oil without thinking of the market for oil in the future. Of course, in the real world, the financial world, it's well understood that things vary in space and time: that's why we have things like futures markets, which let you buy 'thing X at time Y' (which is just a special case of 'good X now', really). These things are considered separate (though connected) markets, with separate prices.

And that's just how they were treated by economists as we developed microeconomics. The definition of a good was allowed to be very, very flexible and abstract, so that these 'things' don't just vary in physicality but in time, space, functionality, and so on and so forth.

It's not just time and space, though. An example: think of a college education. Is the good being sold by universities a 'college education'? Is it a 'degree from college X'? Is it a 'college education of quality Y from college X'? The signaling model by Michael Spence wondered (and I obviously paraphrase wildly) if people would still pay for a college education if it the education was intrinsically worthless but had the value of 'signaling' that you were willing to give up four years to prove that you were great.

Should it be surprising that the cost of a college education has been rising despite there being a bigger supply of colleges? Maybe not, if our definition of the 'good' includes 'quality', perceived or actual; it's easy to build a new college, but impossible to build a new college with a reputation to rival Oxbridge or the Ivy League. The supply of that good, whatever it is, is fairly well fixed. Econ 101 is obsessed with 'supply and demand' analysis; the fact is, supply and demand analysis takes you very, very far if you're prepared to speculate properly on what a 'good' is.

This is all quite similar to the corporate strategy mantra of identifying your 'core competencies' and defining the industry. For example: railroads and train companies aren't 'the railroad industry', but 'the transport industry', competing with airlines and buses, and maybe even 'the food industry' if they serve food, etc etc. That leads us dangerously close to the kind of 'provider of transport services' corporate-speak euphemisms that plague so many firms, but it's pretty much the same question as how to define a good in economics.

Monday, July 7, 2008

Game theory often looks silly

From Tim Harford's blog:

"Game theorists know all about the centipede game:

One instance of the centipede game is as follows. A pile of $4 and a pile of $1 are lying on a table. Player I has two options, either to “stop” or to “continue.” If he stops, the game ends and he gets $4 while Player II gets the remaining dollar. If he continues, the two piles are doubled, to $8 and $2, and Player II is faced with a similar decision: either to take the larger pile ($8), thus ending the game and leaving the smaller pile ($2) for Player I, or to let the piles double again and let Player I decide. The game continues for at most six periods. If by then neither of the players have stopped, Player I gets $256 and Player II gets $64. Figure 1 depicts this situation. Although this game offers both players a very profitable opportunity, all standard game theoretic solution concepts predict that Player I will stop at the first opportunity, getting just $4.

Except, nobody really thinks this is the way players would behave in reality. The optimal strategy seems sociopathic; isn’t it worth playing cooperatively in the hope that the other player will do the same thing? (Unlike much real human interaction, standard game theory does not accomodate the “hope” that someone else will play suboptimally: optimal play is to be expected at all times. )"

Game theory is very clever and very useful, but often seems very naive. When it's used in economics, it's arguably the part of economics most hamstrung by the scattershot application of the "money=utility" fallacy. If you want your game theoretic result to be predictive or descriptively powerful, you must (must must) try really hard to make the payoffs reasonably accurate; in Harford's quoted example the assumption is that the players care only about cash and that, as Harford says, they aren't willing to take a shot on the other player prolonging the game. At the risk of being tautologically critical: can you read the setup of that game and not entertain the idea of waiting? I remember being taught the centipede game in David Myatt's excellent game theory course as an undergrad; he showed us the 'crazy centipede' variant, which wondered exactly that: what chance of you choosing to continue the game is enough to make me also want to continue?

The kicker to me is that 'game theoretic predictions' are overwhelmingly often not as successful for the players as alternative strategies, even when we're just measuring 'success' in the same cash-payoff terms as the theory. This is just what Harford goes on to describe:

But Ignacio Palacios-Huerta (best known to Undercover Economist readers as discovering that strikers and goalkeepers play optimal strategies in penalty-taking) and Oscar Volij gave the centipede game to skilled chess players. They found that the chess players were far more likely to play optimally; grandmasters always played optimally and took the $4. Hyper-rationality can be a disadvantage. (Or did the experiment discover something else: that chess grandmasters are sociopaths?) Palacios-Huerta and Volij don’t speculate. My guess is that they have discovered something about the rationality rather than morality or empathy of chess players, but I may be wrong.

It really does just beg for the 'behavioral economics' explosion: if predictions aren't great, and in any case are less profitable than reality, we're up the creek without a paddle or a boat.

Friday, July 4, 2008

Classifying economics: humanity or science?

How should the discipline of economics be classified within academia - does it belong to the arts, sciences, social sciences, humanities? A wonderful article called 'The Burden of the Humanities' by Wilfred McClay in the Wilson Quarterly got me thinking about that this morning.

Even if we go by something so simple as what degrees are offered in departments of economics there doesn't seem to be much consensus. While the Bachelor of Arts remains perhaps the most common undergraduate degree in economics, the Bachelor of Science isn't unheard of; indeed, the London School of Economics, one of the most recognizable schools for the subject, awards the BSc. At Oxford University, the undergraduate degree is the BA, but at postgraduate level the MSc - is this a good reflection of the journey up the hill of science, math and statistics that we economists make on the course of our study? If so, why do so many North American universities - NYU, Yale, Brown, Toronto, etc etc - award the MA as a postgraduate degree (albeit in the US usually as a consolation prize for those abandoning the PhD)? What about something like Economics and Finance? Is that more BSc-ish than just economics?

Do we belong to the humanities or to science? This question is obviously closely tied to the ethos of economics teaching, especially the positivist teaching method and the quantification of the discipline. If your economics education focuses on the political, moral, philosophical, historical, intellectual parts of economics, it sounds more like the humanities. If it focuses on the mathematical, statistical, empirical, experimental, computational parts, it sounds more like science, or at the very least, 'social' science. Maybe since there's no 'standard' blend of these two categories in an economics degree it's right that we don't know which degree is more appropriate; all I know is that the scientific categories are much, much more prevalent in the content of US undergraduate economics education than the humanities categories.

McClay's essay talks about the defining characteristics of humanities, borrowing first from the National Endowment for the Humanities definition which allows the humanities to include, among other things:

"those aspects of social sciences which have humanistic content and employ humanistic methods..."

This would seem to allow economics into the party, since it is closely concerned with human behavior, especially microeconomics which is obsessed with how people make choices and decisions. Or is it? Historically, macroeconomics has often relied on a characterization of a country as a big machine, to ask how, for example, exchange rates interact with interest rates, or whatever. There has to be a human element buried somewhere, unlike in the natural sciences, but it's not the focus. McClay addresses just this point:

"But this can be stated more directly. The distinctive task of the humanities, unlike the natural sciences and social sciences, is to grasp human things in human terms, without converting or reducing them to something else: not to physical laws, mechanical systems, biological drives, psychological disorders, social structures, and so on. The humanities attempt to understand the human condition from the inside, as it were, treating the human person as subject as well as object, agent as well as acted-upon."

You could plausibly argue that the history of economic thought has been a reduction of the human to something else; this is valuable because it allows us to abstract from the uncertain world of how people behave into a place where we might be able to draw plausible, tangible conclusions, but just as it's taken the discipline into a place of backlash where 'behavioral economics' wants to recover a keen interest in the way humans operate, it might have carried away much claim we had to be part of the humanities. Of course this also implies that a bunch of the psychological-type economics that's so very popular at the moment might arguably be 'humanities', but that probably overstates the case, since psychology itself isn't usually considered as such.

McClay argues further about the tendency towards science and away from the humanities:

"For many Americans... [the humanities go] against the grain. After all, we like to think of ourselves as a practical people. We don’t spend our lives chasing fluffy abstractions. We don’t dwell on the past. We ask ­hard headed questions such as Where does that get you? How can you solve this problem? What’s the payoff? If you’re so smart, we demand, why aren’t you rich?"

There's a strong similarity between this line of argument and the tendency towards science within economics itself, and perhaps all the same questions apply there. If I imagine arguing that we should have more normative content in economics courses, I immediately imagine being challenged, 'where does that get you?', 'what's the payoff?'. Plus, as a nice bonus, 'why aren't you rich?' could, in another context, be a very pithy summation of the boneheadedness of economists towards the normative metrics of happiness or success.

The weird paradox, however, is that, to this eye, the practical value of the majority of economics research is very difficult to find; I know science for its own sake is still science, pushing the bounds of knowledge etc etc, and I know the charge can be leveled at any subject, but still, for better or worse, 'what's the payoff?' is a question we could rightfully ask in response to any claim of economics to be a science.

And what do we lose when we drop the humanistic from economics? McClay says:

"For you can’t really appreciate the statuary of our ­country—­our political and social and economic ­institutions—­or know the value of American liberty and prosperity, or intelligently assess America’s virtues and vices against the standard of human history and human possibility, unless you pay the price of learning the ­stories."

This is certainly true of the abandonment of economic history and the history of economic thought as fields of study in so many departments of economics. If we can argue for economics as science or as humanity, why have we dropped all humanistic study of it? Won't we lose the 'stories', the lessons of the past, the normative context, the ability to critically evaluate the scientific results that we might be able to squeak out of our modeling and empirical analysis?

Finally, McClay ends discussing the role of the humanities in contributing to the attainment of 'happiness' or satisfaction in life.

"...the lure of a pleasure-swaddled posthumanity may be the particular form of that temptation to which the Western liberal democracies of the 21st century are especially prone.

One of those things left behind may, ironically, be happiness itself, since the very possibility of human happiness is inseparable from the struggles and sufferings and displacements experienced by our restless, complex, and incomplete human natures. Our tradition teaches that very lesson in a hundred texts and a thousand ways, for those who have been shown how to see and hear it."

In the context of the study of economics, can't we make a similar argument? It's not just that economics may have contributed heavily to the 'happiness as goal' business, or to the wedding of income, GDP and money to 'wellbeing'; By abandoning the humanistic in the teaching of our subject, don't we neglect to show the next generation how to see and hear the humanistic as it relates to the organization of our economies, our world? Economics is not a technocracy. We need to understand its humanistic foundations if we are to wield its tools and arguments as experts.