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Hive minds of various kinds


One common racist characterization of East Asians is that they are hive creatures, working and thinking collectively like bees or ants, lacking individuality or creative thought. This trope has always annoyed me, but after I lived in Japan, and saw Japanese people behaving more individualistically than most of the Americans I knew, it really became my pet peeve. So you can understand why I am predisposed not to be particularly charitable toward papers with titles like "National IQ and National Productivity: The Hive Mind Across Asia".

The paper, written by Garett Jones of George Mason University and published last year in Asian Development Review, does not argue that people in East Asian countries are unique in forming a "hive mind". It simply claims that they are better at it. The paper's thesis is that IQ is a fundamental ingredient for many of the things that make a country rich. High-IQ people, Jones argues, 1) are more patient and hence tend to save more, 2) cooperate more, and 3) support more free-market policies.

Cooperation is what Jones labels the "hive mind". It's interesting that he chooses to make the "hive mind" phrase part of the paper's title, since the result about cooperation is only one among several main points in the paper. Why? I'm guessing that the existence of the racist "Asian hive mind" trope is not irrelevant to Jones' choice of title. Economists often style themselves as bold, iconoclastic free-thinkers, willing to think and speak the truth when others are constrained by political correctness. To fulfill this self-image, they often go out of their way to say politically incorrect things. This in turn leads other people (i.e. liberals) to respond emotionally, which reinforces economists' self-image of themselves as rational thinkers, and also reinforces their public reputation as racists, sexists, etc. It's a stable equilibrium. But really it just represents an elaborate form of mugging for attention.

Anyway, on to the substance of Jones' paper. The first main claim is that high IQ leads to patience (think of the marshmallow experiment), and hence to higher rates of savings and higher capital-to-output ratios. Well, that may be true, but I feel like it ignores the time-series aspect of the data. For example, few would argue that Japan's average national IQ has dramatically decreased over the past 30 years. But their household savings rate has plummeted from over 16% in 1980 to 2% or less today:


This means Japanese households now save less than American households. How can we square this fact with Jones' IQ-patience-savings based theory of national wealth? I'm not sure we can. Even if IQ does have an effect on savings, we can't expect it to dominate over long periods of time.

Next, Jones makes the argument that high-IQ people cooperate more, and that cooperation raises national wealth. To support this, he cites a large number of game-theory experiments. But it is far from clear to me that this kind of small-group cooperation can easily scale up to the level of a nation, or even a corporation. Again take the example of Japan. Though most Westerners think of pre-modern Japan in terms of its unified and isolationist Edo Period, that was actually just a brief aberration after a long history of bloody internecine warfare, samurai intrigue and assassination, and factionalist strife. In World War 2, Japan's inter-service rivalry put America's to shame, and military staff meetings would often end in brawls between Army and Navy officers. In modern Japanese corporate culture, the public face of harmony is loosely plastered over a seething morass of factionalism that makes it notoriously difficult for Japanese companies to match the nimble strategic shifts of American firms. And don't even get me started on Japanese politics. 

So while I don't deny that Japan is reknowned for small-group cooperation, even if we grant Jones' hypothesis that this cooperation is driven by high IQs, it does not seem always to scale up to larger groups.

Finally, Jones contends that high IQs correlate with support for free-market policies. (This is interesting, since free-market policies seem to be a sort of individualistic belief, the opposite of what you think of when you hear the words "hive mind". Wonder why "Asian Individualism" didn't make its way into the title?) The data here is a paper by Jones' fellow George Mason economist, Bryan Caplan. However, that paper used data only from the United States. It is frankly absurd to argue that the results can be extended to whole nations. Why is it absurd? Because if you try, you'll see that plain, well-known facts baldly contradict Jones' thesis. Using Jones' IQ data set, Scandinavian countries have higher average IQs than America. So if Jones is right, Scandinavia should be more pro-free-market than America. But the opposite is true. (And East Asian countries, while less socialist than Europe nowadays, were not exactly known for their embrace of free markets in the 20th Century.)

Oh, and let's talk about Jones' data set. His data on national IQ comes entirely from the work of Richard Lynn. In his 2002 book, IQ and the Wealth of Nations, Lynn shows North Korea as having a higher national average IQ than Sweden. First of all, right off the bat, that tells me that Lynn's methodology must be crap on a stick. Second of all, it strongly suggests what that methodology in fact was - it's pretty clear Lynn just assumed that since North Koreans are the same race as South Koreans, they must have a similar national average IQ. In other words, Lynn's "data" basically just uses "IQ" as a polite term for "race". (By the way, many others have looked at Lynn's dataset much more closely than have I, and have reached conclusions similar to mine; see, for example, here and here. Hat tip to Cosma Shalizi for pointing these out in an email).

Anyway, in addition to making a few questionable or downright silly arguments, Jones' paper does not do a lot to dispel the "economists are racists" stereotype. What it does do is strengthen my belief that there is a "hive mind" of a different sort at work in certain corners of the economics profession - a self-propagating set of conventional wisdoms and stereotypes that manages to leap from researcher to researcher, department to department...

Update: I really should also mention that part of my antipathy toward this paper comes from the fact that I'm about to come out with a column in support of higher Asian immigration, which Jones also calls for at the end of his paper. I just do not want to be tarred by association with this kind of "research"...
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EconoTrolls: An Illustrated Bestiary


In your journey through the Econ Blogosphere, you will be beset by a great many curious and interesting species of EconoTroll. At first you may be intimidated by their voluminous use of insider jargon, their rough-and-tumble personal attacks, their strenuous insistence that you read the complete works of their movements' founders before participating in any discussion, and above all their sheer persistence and apparent surplus of spare time. But fear not, noble traveler, for I have taken it upon myself to create this Illustrated Bestiary, in order to prepare you for (most of) the characters you will encounter on your way...
_________________________________________________________________________________

An Illustrated Bestiary of the Econ Blogworld

Libertarians

"Run for your life from any man who tells you that money is evil. That sentence is the leper’s bell of an approaching looter."

How they see themselves:

How the world sees them:
Favorite blog: EconLog

Favorite dead economist: Milton Friedman

Will appear in response to posts regarding: Trade, the environment, third-world labor, patents, immigration, education, the environment, sugary soft drinks, anything really

Craziest idea: Eliminate public education and legalize crack 

Special attack: Soaring rhetoric

Secret weakness: memories of the parties they didn't get invited to in college

Notes: This species of troll appears to be on the wane, as left-leaning college women have broadened their taste in men considerably, blunting the anti-liberal ressentiment that led to an explosion in the young angry libertarian male population...


Post Keynesians

"[I]t is always the outliers that are pushing back the curtain of ignorance. It's not the zebra in the middle of the herd, safely away from predators and mishaps, who finds the new food sources for the herd, or alerts the group to impending dangers."

"I'm not going to provide the links, but I called the crisis more precisely than any of those people."

How they see themselves:

How the world sees them:
Favorite blog: Steve Keen's Debtwatch

Favorite dead economist: Hyman Minsky

Will appear in response to posts regarding: Who predicted the economic crisis first

Craziest idea: That anyone is listening

Special attack: Anger

Secret weakness: the fear that Paul Krugman has said everything they've thought of, but better

Notes: When not engaged in bitter denunciation of the "neoclassicals" who supposedly pushed them out of their once-hallowed place in the halls of academia, this species can actually have quite a lot of interesting things to say...


Market Monetarists

"NGDP, NGDP, NGDP, NGDP."

How they see themselves:

How the world sees them:

Favorite blog: The Money Illusion

Favorite dead economist: No one. The spot is being reserved for Scott Sumner, along with thousands of life-sized terra cotta grad students.

Will appear in response to posts regarding: Monetary policy, macroeconomics, any word containing the letters "NGDP"

Craziest idea: Pegging the monetary policy of the world's leading nation to an obscure and highly illiquid futures market

Special attack: NGDP-style kung fu

Secret weakness: Supply shocks

Notes: Having now effectively swayed the Federal Reserve and won essentially all of the Econ Blogosphere to their way of thinking, the Market Monetarists can hardly be classified as "trolls" any longer...


Republicans

"[T]here are 47 percent...who are dependent upon government, who believe that they are victims, who believe the government has a responsibility to care for them...And so my job is not to worry about those people."

How they see themselves:

How the world sees them:

Favorite dead economist: Art Laffer

Will appear in response to posts regarding: taxes, politics, taxes

Craziest idea: Difficult to say, but probably a tie between bankrupting the country with debt, privatizing the prison system, invading Iraq, cutting funding for science, dishing out billions in pork to well-connected no-bid contractors, throwing millions of harmless marijuana users into nightmarish prisons, repressing gays, disenfranchising black voters, forcing millions of "illegal" immigrants into second-class citizen status, and blocking any sensible policy reform through the abuse of supermajority tactics in the Senate...

Special attack: Taking over the entire United States for three decades

Secret weaknesses: hot liberal chicks, fatty food

Notes: See also History, American, all


Austrians

"Cue hyperinflation in 5...4...3..."

"With real money backed by real gold, America experienced the greatest boom in any nation's history. Things were great and the American people flourished."

"No math needed. Read Rothbard. Economics (human action) is logic. Beautiful, simple logic."

How they see themselves:

How the world sees them:
Favorite blog: Zero Hedge

Favorite dead economists: Ludwig von Mises, Murray Rothbard

Will appear in response to posts regarding: Monetary policy, the gold standard, gold, and possibly pyrite

Craziest idea: That fractional reserve banking and fiat money are a conspiracy by the Rothschild family to take away people's freedom

Special attack: Real money, backed by real gold

Secret weakness: cannot withstand being subjected to intellectual contempt

Notes: For more on this odd and often frightening species of troll, please consult the fieldwork of the intrepid naturalist J. Bradford DeLong...


Modern Monetary Theorists

"Sorry, just to expand that further.....the currency would appreciate, but as there would be no market for government debt the govt would be forced to monetize. The increase in currency in circulation would offset the appreciation due to Acme share price increase. Assuming that the rise in Acme share price was due to the vast increase in demand for those shares as a consequence of the total rejection of govt debt as a savings vehicle, it is possible that the effect on the currency would be neutral..."

How they see themselves:


How the world sees them:
Favorite blog: yours

Favorite dead economists: G.F. Knapp, Wynne Godley

Will appear in response to posts regarding: Government debt

Craziest idea: That all of economics can be derived from a few simple accounting identities

Special attack: Jargon, jargon, and more jargon

Secret weaknesses: Mark-to-market accounting, logic

Notes: It has been said of this species of EconoTroll that holding a discussion with one is akin to "administering a Turing Test to a computer designed to impersonate an acute schizophrenic." Travelers are advised to proceed with extreme caution. Fortunately, this dangerous species has many natural enemies, and often the clever wayfarer can escape in the fracas between a Modern Monetary Theorist and an Austrian, Republican, or New Classical.


Marxists

"[it is] simple self-evident reality that the international monetary system was created by, and remains founded on, US military power. "

"capitalism will not be around for ever. An engine of infinite expansion and accumulation cannot, by definition, continue for ever in a finite world."

How they see themselves:

How the world sees them:
Favorite blog: None. Blogs are tools of capitalist oppression. Comment trolls of the world, you have nothing to lose but your word verification!

Favorite dead economist: Marx, duh.

Will appear in response to posts regarding: (actually, not sure about this one)

Craziest idea: Take your pick

Special attack: David Graeber

Secret weakness: the Postmodernist Essay Generator

Notes: We have not seen this species around much in recent years, but the tales of their infestations in far earlier times still make for lively campfire entertainment...


Scientists

"[M]acro is mostly a 'science' without falsification. In other words, it is barely a science at all. Microeconomists know this. The educated public knows this. And that is why the prestige of the macro field is falling."

How they see themselves:

How the world sees them:

Favorite blog: Noahpinion

Favorite dead economist: Are you kidding? That's the only good kind!

Will appear in response to posts regarding: Economic methodology, statistics, math

Craziest idea: That economists should do experiments

Special attack: the "economics isn't science" taunt

Secret weaknesses: bad posture, the knowledge that economists get paid more than they do

Notes: This troll, which periodically ventures into the Econ Blogworld, attempts to intimidate its enemies by the puffing up of its Physics Credentials in a strange sort of dominance display. This tactic can easily be defeated by immediately presenting the troll with a deceptively difficult or even insoluble math problem, and then ridiculing the troll for failing to solve it in short order.


New Classicals

"Krugman's blog post mainly tells us that his deficit in macro-knowledge persists."

"Get a life, Krugman!"

How they see themselves:


How the world sees them:


Favorite dead economists: Frederic Bastiat

Will appear in response to posts regarding: Macroeconomics, history of economics, fiscal policy, stimulus, monetary policy

Craziest idea: That recessions are caused by a combination of A) people forgetting technology, B) people suddenly deciding to take vacations, and C) fear of future socialism by liberal politicians

Special attack: Dissing you anonymously on Econ Job Market Rumors

Secret weakness: the econ job market

Notes: This type of troll, long confined to a series of deep caves in Minnesota, emerged into the surface world and began marauding the landscape in response to attacks by the wizard Krugman. It is the sworn duty of all New Classicals to hunt down their antagonist and make him pay for his crimes. This makes them relatively harmless to travelers not affiliated with this grudge battle...


Uncategorizable

"The magical policy is MY GUARANTEED INCOME plan to auction the unemployed we can put 30M people to work 40 hours per week in less than 1 year this platform immediately reduces the cost of organizing and rehabbing the 12M homes that ARE gong from being owner occupied to rentals and my plan SOLVES for immigration [truncated]" 

How they see themselves:

How the world sees them:

Favorite blog: ...and how many times have you made a single argument against giving taxpayers the freedom to choose which government organizations they give their taxes to you've made ZERO arguments against tax choice don't you think it's just a little strange that you can't even make one argument [truncated] 

Favorite dead economist: ...against tax choice? I don't think it's strange...you know why? Because I know that you really don't want to embarrass yourself. there is no argument about them taking our jobs because IF the employer could hire the cheaper subsidized American he would the left over jobs are ones where there is true unfilled demand    [truncated]

Will appear in response to posts regarding: ...WHY DID YOU BLOCK ME mostly at the low end this field work that robots haven’t replaced yet by his definition my policy is magical bend to my will you haven’t proven yourself enough to get to take potshots why not just root for rampant fires to wipe out the unemployed [truncated]

Craziest Idea: ...when confronted with an insurmountable obstacle it's a good idea to break the obstacle down into smaller components that are easier to handle this is the divide and conquer strategy you'll never convince each and every taxpayer [truncated]

Special attack: ...you are just afraid to engage with my ideas because you know that i am intellectually as far beyond you as homo sapiens is beyond a slug why don't you come over here to boycott the entire government but you certainly will be able to convince every taxpayer to boycott at least one government organization [truncated]  

Secret weakness: nerve gas

Notes: The less said about this most fearsome species of troll, the better.
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Engineering vs. "Science" in macroeconomics


I like Simon Wren-Lewis a lot, not just because he has a beard, but because he's one of the few people still talking about macroeconomic methodology, a subject dear to my heart if not exactly a crowd-pleaser. In this post, he discusses Greg Mankiw's famous partition of macroeconomists into "scientists and engineers".

For those who don't know the history involved, let me give a condensed version. 

1. Before Robert Lucas, macroeconomists used mostly "aggregate" models - stick labor and capital and money etc. into some equations, and out pop GDP and inflation, or something like that.

2. Then Robert Lucas came along and said "These equations might look like they fit the data, but as soon as you try to actually use the equations to make policy, people will see what you're doing and change how they behave. And then your equations will stop working completely." Some people resisted this idea, but eventually it won, and people stopped using the old style of models. (Lucas got a Nobel for this, and for insisting that people use "rational expectations" models...see #3.)

3. People asked Lucas, "OK, so what do we do instead?" Lucas said "Your models have to be based on things that won't be changed by policy. What people want to consume, for example, or the technology that we use to produce things. Those things can't be changed by the government, right?" And everyone said "Uhhh, no, guess not." So Lucas said "OK, base all your models on those things, and you'll be OK. Also, you should assume that people have 'rational expectations'." To which the world replied "Uhhh, OK." Of course, this sort of modeling required the use of microfoundations.

4. The first to take up this challenge was Lucas' friend Ed Prescott. He made a model where the business cycle was caused by changes in technology - if we invent more stuff than usual we get a boom, if we invent less than usual we get a recession. Also, he allowed for business cycles to be caused by changes in people's desire to work - if people suddenly got lazy, we could have a recession. Lucas gave this model his unofficial stamp of approval. (Prescott's model, called the "RBC" model, won him a Nobel.)

5. However, some people came along and said "Wait a second, Prescott's model doesn't fit the facts. In this model, a recession is basically just a big shortage of everything; in a shortage, inflation should go up. But in the past, especially the Great Depression, inflation often goes down in a recession. Recessions must be caused by some kind of general glut, not a general shortage. In other words, there must be some kind of 'aggregate demand shock'." To which the RBC people replied: "Oh yeah? Let's see you put that in math!"

6. So the people who wanted to model aggregate demand shocks thought of some plausible ways that a "general glut" could happen. Greg Mankiw, for example, came up with the idea that "menu costs" could keep people from changing prices. Other people focused on contract theory, money illusion, and other "frictions" that could cause general gluts. But these ideas, though probably pretty realistic, were all very very hard to put into the type of model that Prescott had used (called a "DSGE" model).

7. Then came along a guy named Guillermo Calvo, who thought of a fix: Just assume that some magical force (the "Calvo fairy") keeps people from changing their prices, and voila! Aggregate demand shortage! This mechanism, although obviously a fantasy, was very easy to put into DSGE models. So a bunch of people started doing that. Mike Woodford, for example, used the idea to make models of how monetary policy could stabilize the economy, canceling out shocks to aggregate demand while also guarding against inflation. These models came to be known as "New Keynesian" models, since Keynes had also argued that aggregate demand was what caused recessions. They were also called "saltwater" models, because they were made primarily by people on the coasts, especially at Harvard.

8. The RBC people, who were also called "New Classicals" or "freshwater" (since many worked at the University of Minnesota and the University of Chicago), fought back, deriding the New Keynesians, or saying that the new Calvo-based models didn't satisfy the Lucas Critique.

And here we are today. Wow, OK, that took slightly longer than I thought, but anyway, let's go on.

The 2006 paper by Mankiw about "scientists vs. engineers" should be seen in this historical context, as an attempt to make peace between New Classicals and New Keynesians. If you read it, especially after reading the earlier Robert Barro "good guys and bad guys" diss paper, you'll see it's a very political document. It's basically saying "Look, you New Classical guys are like scientists; you're trying to understand how the world works on a deep level. We New Keynesians are more like engineers; our models may not match what's really going on at the micro level, but they fit the big macro facts, so they're useful for policymaking." Very politic...remember, scientists are generally thought to be smarter than engineers. In fact, Mankiw's distinction reminds me very much of Stephen Jay Gould's attempt to get anti-evolution folks off his back by dividing science and religion into "separate magisteria".

By defending New Keynesian models as "engineering", Mankiw was - I think - essentially admitting that the New Keynesian movement had not really satisfied the Lucas Critique. The DSGE structure of the models was a head-fake in the direction of microfoundations, but by including things like Calvo pricing, the New Keynesian models were really more in the spirit of the old, pre-Lucas "aggregate" models. But the "scientists vs. engineers" idea was also a kind of defense of that old "aggregate" approach - it said "For the purposes of short-term policy making, all you really need is a model that fits the macro data; you don't need something that really represents what's going on at a deep level." In other words, it was very, very similar to the stuff that Simon Wren-Lewis writes on his blog all the time.

But I do not like Mankiw's "scientists vs. engineers" distinction, because although I think it gets the "engineers" part right, I don't really think what the New Classical folks do is especially similar to what actual scientists do. (Mankiw is trying to be a nice guy, a uniter instead of a divider. I am a different sort of guy, for whom dissent and argument are a natural part of the truth-finding process. So don't be surprised if I am less politic than he.)

The whole idea and the whole appeal of New Classical models is that they are microfounded on things that don't change with respect to policy - human tastes and preferences, and technology. The New Classical macroeconomists do often try to match the parameters of these microfoundations to micro data (this is called "calibration"). But rarely if ever do they bother to see if the equations themselves are an accurate description of how economic agents behave. As a result, as I argue in these old posts (Post 1, Post 2), the microfoundations in RBC-type models are almost certainly terribly misspecified descriptions of microeconomic behavior and markets. 

As my advisor (and Greg Mankiw's advisee) Miles Kimball tweeted today when we discussed this topic: "the 'micro foundations [used by New Classicals are] usually not very serious, they're often more like imaginary engineering than science."

Note that if the microfoundations are misspecified, it doesn't matter whether a model satisfies the Lucas Critique or not. Even if "tastes and technology" really are policy-invariant things, if tastes and technology don't really work the way the model says they work, the model will not give you useful advice about policy.

Now, terrible microfoundations might not lead to a terrible model. But if by some lucky happenstance, crappy microfoundations produce a model that matches the macro facts, then it might as well be one of those "aggregate-only" models that Greg Mankiw labels "engineering". In this case, RBC has no theoretical advantage over a New Keyneisan model.

So basically, I charge that the New Classical/RBC/freshwater macroeconomics paradigm is not really science, and not really like science...not yet, anyway. In science, evidence rules all; if a model doesn't fit the evidence you toss it out. And I don't think the microfoundations we have seen in freshwater models pass muster (yet). Until they do, I think that "engineering" - the aggregate models of VARs, or the Calvo-pricing New Keynesian models, etc. - are all we've got.
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Time to Japanic?


The Atlantic has a big story on the impending Japanese crash; one of the authors is the brilliant Simon Johnson. Excerpts:

About half of the Japanese government’s annual budget now goes to pensions and interest payments. As the government has spent more and more to support its growing elderly population, Japanese savers have willingly financed ever-increasing public-sector debts... 
Elderly people hold their savings in the form of cash and bank deposits. The banks, in turn, hold a great deal of government debt. The Bank of Japan (the country’s central bank) also buys government bonds—this is how it provides liquid reserves to commercial banks and cash to households. Similarly, Japan’s private pension plans—many promising a defined benefit—own a great deal of government bonds, to back their future payments. Few foreigners hold Japanese government debt—95 percent of it is in the hands of locals... 
With projected annual budget deficits between 7 and 10 percent of GDP, Japanese savers are essentially tendering their savings in return for newly issued government debt, which is not backed by hard assets. It is backed only by an aging, shrinking population of taxpayers... 
Japan’s taxpayers are already rebelling against small tax increases needed to limit escalating deficits. This leaves little room for hope that future taxpayers will accept the larger tax increases needed to repay debts... 
The economy, roughly speaking, is as healthy as it is likely to become. Yet the government seems incapable of steering away from the cliff... 
A crisis in Japan would most likely manifest as a collapse of confidence in the yen: At some point, Japanese citizens will decide that saving in any yen-­denominated asset is not worth the risk. Then interest rates will rise; the capital position of banks, insurance companies, and pension funds will worsen (because they all hold long-maturing bonds, which fall in value when rates rise); and fears of insolvency will surface... 
The fact that government debt is held mostly by Japanese citizens is not sufficiently reassuring. The same was true in Germany during the 1920s and Russia during the 1990s, yet in both cases the elderly lost their savings to high inflation. Today, Italian and other European savers who hold their own government’s debt are already nervously edging toward the exits...

This prophecy is hardly unique; I have beaten this drum myself. If Japan doesn't change course, it will have a major crisis within the next decade.

If. But what people need to understand is, the Japanese government does have the power to avert a crisis. It is not inevitable.

There is one way that the crisis can definitely be averted: Raise taxes. Japan's fiscal woes can be boiled down to one sentence: Japan has European levels social spending and European levels of aging with American levels of taxation. But this could change; if Japan raised taxes to European levels, crisis would be instantly averted. According to analyses I've seen, this would require raising Japan's taxes from their current level of 32.5% of GDP to somewhere between 40% and 50% of GDP. That's comparable to France or Sweden. Painful, but not impossible.

Now for the rumor (rumor always being a large component in Western analyses of Japan). My sources at the Bank of Japan and Ministry of Finance tell me that domestic Japanese investors are betting that, after all the grumbling and fighting and ending of political careers, Japan's government will suck it up and raise taxes. This, my shadowy sources say, is why pension funds are still willing to put the Japanese people's money into JGBs.

But this story is not really outlandish. It's similar to what we're observing in America right now. U.S. borrowing is at all-time highs, but demand for Treasuries shows no sign of flagging, and most of that demand - more than in the past - is from domestic U.S. investors. Yes, we have shown a reluctance to raise taxes - witness the apocalyptic debt ceiling fight from last year. But if the public really thought the U.S. government was willing to default, domestic Treasury buyers would be heading for the exits. That they are not heading for the exits probably indicates that they believe that when push comes to shove, the U.S. government will suck it up and raise taxes. There are signs that the Republicans are quietly recognizing the necessity of this. At this point, it's just a fight between Democrats and Republicans to see who takes the fall for raising taxes - that's what the "fiscal cliff" is really all about.

Japan seems to be in a similar situation. It is not really unusual or outlandish at all. Everyone in the country still seems to believe that the government will continue to function. The day that that belief falters - or is proven wrong by main force, when interest payments swamp the primary budget - is the day that Japan collapses (the same goes for the U.S.). But if Japan's government is less dysfunctional than the often skittish Western press believes, that day will never come.

(Anyway...oh yeah, I did mention that there might be two ways out of Japan's fiscal trap, didn't I? The other way is to use monetary policy to create negative real interest rates for a very long period of time. If that can be done in a stable way (without accelerating inflation) and if stable growth persists, then Japan can use an "inflation tax" to erode the value of its government debt instead of an actual tax. Econ bloggers (and commenters), who tend to believe that central banks can hit any NGDP target they want, will probably advocate this "solution"...)
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New Atlantic piece: How to beat global warming

My new Atlantic piece is out, entitled "The End of Global Warming: How to Save the Earth in 2 Easy Steps". I kind of disagree with the editor's byline; I don't consider myself an optimist, but more of a hard-nosed pragmatist/realist. Anyway, here's the takeaway from the piece:
So to sum up: The way to save our planet is clear. Step 1 is to embrace natural gas as a "bridge" fuel, limiting the risks from fracking and helping China and other developing countries to switch from coal to gas. Step 2 is to fund research to ensure that the jaw-dropping three-decade plunge in solar power costs continues for two decades more. Natural gas is the temporary ally. Cheap solar is the cavalry that will ride in to finally save the day.  
Preventing catastrophic global warming might still be a long shot. But if we do the right things now, we just might make it.
You can read the whole thing here. The source for the figures about decreasing solar costs is this Scientific American piece by Ramez Naam.

Update: Here is a 2012 analysis by ThinkProgress claiming to show that fracking has been a much smaller cause of emissions reductions than I claim in my Atlantic piece, accounting for only 11% of the decline in U.S. emissions over the last 5 years. But here is a paper by three Harvard engineering professors claiming that over half of the emissions drop is due to gas fracking. I'm not sure who is right, but it is important to note that everything does depend on the facts; if fracking is small potatoes when it comes to emissions reductions, as ThinkProgress claims, then we should soon see emissions reductions plateau, unless there is another recession.
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Has Tim Worstall made the case for one-way free trade?


At Forbes, Tim Worstall attempts a critique (or, in blog parlance, a smackdown) of my last post, on one-way free trade. I want to thank Tim for taking the time to read and respond to my post; although this post is a counter-rebuttal, I don't want it to be taken as angry, resentful, or combative.

The first three quarters of Worstall's post is about the cost structure of the solar industry; since I don't actually know that much about silicon ingots, I'll leave this part alone. However, Worstall's conclusion - that "Yes, unilateral free trade is the answer" - is driven entirely by the last couple paragraphs of his piece. Since these paragraphs contain two or three major errors (depending on how you count), I'll just skip to that part and explain where Worstall goes astray. He writes:

[W]e really don’t care at all whether government can limit risk imposed on US firms. Because we don’t in fact care about US firms at all, at least not in the context of trade. We care only about consumers when discussing trade... 
[T]he sole purpose of all production is consumption. The only relevant question when dealing with...trade is what expands the consumption possibilities of the populace? Not who produces or how, who does the labour to produce nor who profits from it. But only and solely who gets to consume what? If trade increases that consumption then great, we’re all for trade. Which brings us back to the point made at the top about trade being voluntary. No consumer is going to purchase an imported item if it decreases their consumption possibilities. Thus unilateral free trade is indeed what we want simply because that is what best expands consumption opportunities: which is the point of the whole game in the first place. 
The error is in thinking that we care what happens to firms or producers at all.
If you didn't see the errors yet, take a minute now to re-read what Worstall wrote. If you still don't see it, read on.

Worstall is correct when he says this:
[T]he sole purpose of all production is consumption. The only relevant question when dealing with...trade is what expands the consumption possibilities of the populace?
To a first approximation, this is right. Consumption is what creates utility.

However, Worstall uses this fact to conclude that, when analyzing one market, we care only about the consumers in that market, when he says: "[W]e don’t in fact care about US firms at all, at least not in the context of trade." This is false. Consumption happens across the entire economy. Many things are consumed. And every person in the economy is a consumer (or else they would be dead).

So if you look at the market for solar panels, and you consider only what happens to consumers of solar panels, you are in error.

Remember that every producer is also a consumer. Producers purchase their consumption goods using the income that they get from producing things. If producers' income goes down, their consumption must go down too.  Supply-and-demand graphs show that "total surplus" = "producer surplus" + "consumer surplus" + "government surplus". So Worstall's idea that we can forget about solar producers when analyzing the solar market - i.e. that "total surplus" = "consumer surplus", and that producer surplus does not exist - is not correct.

Worstall's second error comes when he says this:
No consumer is going to purchase an imported item if it decreases their consumption possibilities. Thus unilateral free trade is indeed what we want simply because that is what best expands consumption opportunities[.]
To a first approximation, the first sentence is right. But the second sentence does not follow from the first, for at least two reasons.

Reason 1: Externalities. This is the easy one. Suppose I consume energy whose byproduct is toxic waste that  seeps into my neighbor's groundwater supply, poisoning and killing him but leaving me unaffected. My consumption decision has not decreased my consumption possibilities, but it has decreased the consumption possibilities of society as a whole, because my neighbor is now dead.

However, I only put this as "Reason 1" to get it out of the way. Externalities are not even the biggest reason why Worstall is wrong in concluding in favor of one-way free trade. The biggest reason is:

Reason 2: Harmful policies can harm the economy by preventing optimal consumption decisions from being made.

Here is a simple example, using only Econ 101 economics - no externalities, no funny stuff. Suppose there are only 2 countries in the world: the U.S., and China. The U.S. trades with China; on net, we export rice to China, and they export TVs to us. Now suppose that China's government, having been captured by producer interests, decides to protect its rice producers by putting tariffs on rice imports.

This policy will hurt the world, because it causes inefficiencies (deadweight loss). Chinese producers of rice will benefit. Recipients of Chinese government spending will benefit, because they will indirectly receive the revenue from the tariff. U.S. consumers of rice will be helped, because they will pay lower prices. U.S. producers of rice will be hurt, because they will be forced to charge lower prices for their products and will see their sales fall. In total, the harm to China outweighs the benefit to China, and the harm to the U.S. outweighs the benefit to the U.S. (if you don't believe me, imagine scaling up the Chinese tariff to infinity, so that the world reverts to autarky).

(Note how we see Worstall's first error in action; the loss to U.S. producers matters because those producers are also consumers! U.S. rice consumers benefit from the Chinese tariff, but total U.S. consumption falls!)

Now let's consider the following possible U.S. policy: The U.S. government says "China, unless you remove these protectionist policies, we will retaliate by imposing import tariffs on TVs exactly equal and opposite to the tariffs that you have enacted."

Suppose that this threat is credible. China's government is captured by TV and rice producers, so China's government's best response is to eliminate its subsidies and tariffs. The whole world benefits, the United States benefits, and China as a whole benefits. The total consumption possibilities of the United States (and of the world) have been expanded relative to the case of U.S. unilateral free trade.

Note that this example does not rely on externalities, on irrational consumer behavior, on coordination problems, fixed costs, or anything else. It is a pure Econ 101 trade problem with two countries, two goods, supply curves that slope up, and demand curves that slope down. 

So this simple example shows how one-way free trade may be a losing policy, if governments behave strategically. Which was the whole point of my earlier post.

(Note: To anyone who read this post and said "But, consumers can be irrational and short-sighted!", or "But, there are production externalities and coordination problems!", or "But there are transaction costs!", I say: Yes, yes. The point of this post is to show that you need absolutely nothing beyond Econ 101 to show that one-way free trade may be the wrong move.)

Update: Adam Ozimek has some good comments.
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A parable of one-way free trade


Trade policy is the Third Rail of Economics, because economists tell ourselves that free trade is the one thing all reasonable economists can agree on. By questioning free trade policy, I instantly flag myself as a crank. Well, so be it.

The basic idea behind free trade is the idea behind all free-market policies: Trade is voluntary. If private parties did not benefit from a trade, they would simply not engage in it. Using the government to prevent voluntary exchange is stopping people from doing things they want to do, and this is always bad.

However, note that in the case of international trade, there are, by definition, at least two governments involved, not just one. Either one of these governments can take actions that affect trade. Suppose that Government A takes actions that interfere with its trade with Country B. The "free trade" position is that Government B should never take any steps in response to the policy interventions of Government A. In other words, advocates of "free trade" insist that there is no strategic component to trade; that it is always undesirable to use government policy to "cancel out" or counteract the market interventions of another government. Note that this is a stronger claim than in the one-government case. 

As an admittedly muddy and imperfect example of this sort of situation, which I call "one-way free trade", take the recent case of solar subsidies. Starting in 2009, the Obama administration began dishing out loans and grants for solar power companies, since solar power was predicted to be the industry of the future. But starting in 2010, China unveiled subsidies for solar manufacturers and exporters that dwarfed those offered by the U.S. With their profit margins fattened by the subsidies, Chinese companies cut prices drastically in order to grab market share. The price of solar power plunged, dipping below the 7% "Moore's Law" rate at which it had been steadily declining for three decades.

U.S. solar manufacturers, unable to compete with Chinese prices, went bust in droves. Solyndra, the highest-profile failure, was ridiculed as a boondoggle of industrial policy. Somewhat belatedly, the Obama administration imposed "anti-dumping" tariffs on Chinese manufacturers; it is unclear how many U.S. manufacturers have been saved by the tariffs, which have drawn strong disapproval from most economists.

Meanwhile, what happened to those Chinese manufacturers who got all those government subsidies? Patric Chovanec reports:
State subsidies have spawned dozens of Chinese Solyndras that are now on the verge of collapse. 
Unveiled in 2010, Beijing’s 12th Five-Year Plan identified solar and wind power and electric automobiles as “strategic emerging industries” that would receive substantial state support. Investors piled into the favored sectors, confident the government’s backing would guarantee success. Barely two years later, all three industries are in dire straits... 
Chinese solar companies blame many of their woes on the antidumping tariffs recently imposed by the U.S. and Europe. The real problem, however, is rampant overinvestment driven largely by subsidies. Since 2010, the price of polysilicon wafers used to make solar cells has dropped 73%, according to Maxim Group, while the price of solar cells has fallen 68% and the price of solar modules 57%. At these prices, even low-cost Chinese producers are finding it impossible to break even.
Chovanec draws the lesson that Obama's solar subsidies are a bad idea. But to me, the lesson of this episode is broader: it's about policy risk.

The case of Chinese solar subsidies shows that governments do not always act in their own interest. China's attempt to corner the world market for solar power blew up, but it took much of the American (and German) solar industries with it. American and German solar firms whose business models might be perfectly viable in the long run probably never made it to the long run, because of a pointless, suboptimal, foolish suicide attack by the Chinese government. This represents a loss for the entire world.

But what if the U.S. had had tariffs in place (or conditional tariffs in place) before 2010. Chinese subsidies might have been insufficient to put Solyndra and other U.S. companies out of business. Or China might not have tried the subsidies in the first place. Of course, such tariffs would have costs as well. But would those costs have outweighed the benefits of blocking or deterring the disastrous Chinese subsidy binge? I'm not sure.

Yes, I realize that the solar example is not a great one; the U.S. gave its companies grants and loans before China did, and enacted tariffs. The point of the example is to illustrate a more general principle: Companies must always contend with policy risk. With one government and a closed economy, limiting policy risk is easy - just don't interfere in the economy. But in the two-government case, policy risk can also come from a foreign government. An American solar manufacturer, even if they intend to sell only in America, must contend with the risk of suddenly being put out of business by Chinese solar subsidies. - at least, if America's government adheres to a strict "free trade" regime.

The big question, to me, is: Can U.S. government intervention limit the policy risk imposed on U.S. firms by foreign governments? And if so, does the limitation of that risk outweigh the costs of the other market distortions caused by the intervention? Free-traders (i.e. most economists) say "No, never." But I do not see compelling logic in favor of the consensus position. Sometimes the world works according to general equilibrium, but sometimes you need game theory. It seems quite possible to me that "one-way free trade" might not always be superior to a strategic trade policy that requires free trade to be a two-way street.

(Note: It is possible that China's solar subsidies were good for the world, because of global warming. However, from what Chovanec reports, it seems like the subsidies just disrupted the global solar industry without achieving any real technological breakthroughs; if this is true, then China's subsidies will be bad for solar costs in the long term. And in general, I think direct research funding is the best way for government to promote solar cost reduction, followed by subsidies to solar consumers rather than producers.)

Update: For an extremely simple, Econ 101 example of how strategic trade policy might be better than one-way free trade, see this new post.
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The state of the Macro Wars


New Update: The pessimism in this post has been proven (somewhat) wrong. Bernanke just announced that the Fed will buy $40B of mortgage-backed securities every month until the economy improves. This is notable for two reasons. First, unconventional assets are being purchased rather than U.S. government bonds; this sends a strong signal that the Fed is considering the full range (or at least a fuller range) of tools at its disposal. Second of all, the asset purchases are open-ended, meaning that the Fed is targeting a level rather than a growth rate; Bernanke intends to force the U.S. economy to make up the ground it lost in the recent recession, rather than simply to resume the pre-recession growth rate at a permanently lower level. It looks like the Pro-Easing Alliance has the Hard-Money Coalition on the back foot, for now...

*  *  *

It's hard to deny that the Macro Wars have died down. Paul Krugman, whose crusade for fiscal stimulus often made him resemble a bear taking swipes at a horde of angry bees, wrote this today:
I’ve been pounding the drum for Keynesian policies ever since the financial crisis struck; I was one of the few people to talk negatively about Obama’s inaugural address, because it seemed to miss the point that we were suffering from inadequate demand; and I was frantic about the inadequate size of the stimulus. 
So, am I upset over the virtual absence of demand-side rhetoric in Obama’s speech yesterday? 
Let’s be realistic: the public doesn’t get Keynesian economics. The president could use the bully pulpit to try and change that, and I’ve been urging him to do that. But not two months before an election. 
And we know that the administration has demand-boosting on its mind; the American Jobs Act was very much a Keynesian-type plan, and everything I know says that it’s a good view of the kind of thing the inner circle supports. It’s reasonably certain that there will be attempts to provide more demand if Obama wins, and that’s all you can ask for at the moment.
Meanwhile, John Cochrane, Krugman's principal antagonist in the Macro Wars, has called fiscal stimulus "an economically interesting proposition", and has come out against the type of "austerity" being practiced in Europe. And people in general seem to have realized that stimulus is politically feasible when the economy is in free-fall, but generally not during long slow recoveries - "everyone is a Keynesian in a foxhole". The Stimulus War didn't lead to anything remotely resembling a consensus, but all parties (including the various other "sides" in the conflict, like Scott Sumner) seem to want to spend their rhetorical resources elsewhere for the moment.

But another Macro War is brewing out here in the Econosphere. This time, it's about monetary policy. Unlike in the fight over stimulus - an idea that had been out of the academic mainstream for decades - the battle lines in the Monetary Policy War are pretty clearly drawn. On one side we have people who think monetary policy should be focusing on boosting GDP - this includes monetarists like Miles Kimball and David Glasner, "NGDP Level Targeting" evangelists like Scott Sumner and David Beckworth, Keynesians like Krugman, Brad DeLong and Mark Thoma, and monetarist-leaning folks like Karl Smith, Matt Yglesias, Ryan Avent, and Evan Soltas. Although there are flashes of internal dissent, all of these folks are essentially allies; they support the idea of a Fed that is far more active in pumping up growth, by either "printing money and buying stuff", or by promising to do so in the future. And they are backed up by the academic firepower of Mike Woodford, who wrote the book on New Keynesian economics, and has come out in a big way in favor of more monetary easing. Even Tyler Cowen, a big detractor of Keynesian ideas, has cautiously endorsed the idea. (Update: Christina Romer and a number of Fed officials have also come out in favor of more easing.)

The forces arrayed against the Pro-Easing Alliance seem at first glance to be pretty low on manpower. Chief among the econ-bloggy opponents of easing are John Cochrane, John Taylor, and Steve Williamson. They argue that the Fed should worry more about preventing inflation than boosting output. The arguments here are that A) the Fed's ability to boost output is very weak, and B) inflation is a much bigger danger than people realize.

However, the illusion that the Hard Money Coalition is outnumbered is just that - an illusion. Behind them stand a vast shadow army of Wall Street Journal op-ed writers, "Austrians" who believe that loose money is the root of all evil, and Fed officials like Jim Bullard, Narayana Kocherlakota, and Charles Plosser who instinctively worry about inflation first and foremost. That army has been powerful enough to stay the hand of Ben Bernanke, a New Keynesian who as an academic was a champion of an activist Fed.

Furthermore, the battleground is different this time. With stimulus, the audience was Congress, which is strongly biased toward looking like it's doing something. With monetary easing, the target audience is the Fed, which is staffed by technocrats. Most of those technocrats were educated to believe that the Fed's inflation-fighting credibility is its most valuable asset. They were also trained at a time when the 70s were fresh in people's minds and the Depression-like crisis of 2008-present was still far in the future. 

Finally, the deck may be stacked against the pro-stimulus side. Supporters of fiscal stimulus believes that it works independently of expectations, but pro-easing monetarists all admit that expectations are crucial to the success of monetary easing, especially at the zero lower bound of nominal interest rates. This gives the home-court advantage to the Hard Money Coalition. To win, all they have to do is convince the public that the pro-easing consensus is weak enough that promises of easy money into the indefinite future will inevitably be broken. Casting doubt on the expansionary power of the Fed can therefore be a self-fulfilling prophecy.

In other words, monetary easing may be more popular among economists than was fiscal stimulus, but may end up being a harder sell. It's sad to say, but the Macro Wars may seem increasingly like the Trojan War, with the Pro-Easing Alliance playing the role of Cassandra...

(Note: Oh, you want to know which side I'm on? Although I'm skeptical of New Keynesian models and monetarist ideas, I agree with Tyler Cowen that unemployment is obviously a much much much bigger problem than the faint specter of 4% or 6% or even 8% inflation, so we should try quantitative easing, forward guidance, NGDP targeting, etc. So count me on the side of the Pro-Easing Alliance. Though for all the reasons listed above, I'm not too sanguine about our chances of victory...)

Update: Underscoring my pessimism about monetary easing, here Mark Thoma asks economists about the chances that the Fed will implement NGDP targeting (one of the simplest and most-discussed forms of monetary easing) over the next 5 years. Most of the 44 economists answered either "low" (18) or "very low" (13), with some giving "even odds" (8) and a few saying "zero" (4). If surveyed, I would have answered "low", putting me near the median.
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