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'?