In which Steve Landsburg makes me lose my lunch

Steve Landsburg has a post defending Rush Limbaugh's comments about Sandra Fluke. Landsburg claims that Rush was right to mock Fluke, and was right to request that Fluke send him a tape of herself having sex.

This post really made me want to vomit. It is morally repugnant and disgusting in the extreme. It deserves strong condemnation, and possibly a hurled water balloon filled with the unsavory excretions of an African hyena. It is the most sickening thing I have read in the econ blogosphere, bar none.

But as economists, we are supposed to be dispassionate. We are supposed to overcome our biases and dwell in a realm of pure reason. And so I will rebut Landsburg's post not based on its severe moral failings, but on its logical shortcomings, of which there are many. For the post is not merely offensive, it is poorly thought out.

First, Landsburg mocks Sandra Fluke:

[W]hile Ms. Fluke herself deserves the same basic respect we owe to any human being, her position — which is what’s at issue here — deserves none whatseover. It deserves only to be ridiculed, mocked and jeered. To treat it with respect would be a travesty. I expect there are respectable arguments for subsidizing contraception (though I am skeptical that there are arguments sufficiently respectable to win me over), but Ms. Fluke made no such argument. All she said, in effect, was that she and others want contraception and they don’t want to pay for it... 

Her demand is to be paid. The right word for that is...“extortionist”. Or better yet, “extortionist with an overweening sense of entitlement”. Is there a single word for that?

But whether or not he chose the right word, what I just don’t get is why the pro-respect crowd is aiming all its fire at Rush. Which is more disrespectful — his harsh language or Sandra Fluke’s attempt to pick your pocket? That seems like a pretty clear call to me.

The notion that Sandra Fluke deserves to be ridiculed, mocked, and jeered is, of course, a value judgment. But on what basis is this value judgment made? Apparently, Fluke deserves to be jeered and ridiculed because she is requesting an in-kind transfer payment from the government. Do all people who request in-kind transfer payments from the government deserve to be "ridiculed, mocked, and jeered"? Are people who accept mortgage interest tax deductions "extortionists"? What about old people on Medicare? Or poor people on food stamps? Or college students on Pell Grants? Landsburg's justification for mocking Fluke can just as easily be applied to nearly ever human being in the United States - or, at least, any of us who wouldn't voluntarily give up our in-kind government benefits. By Landsburg's definition, America is made up of nothing but extortonists.

(Of course, I didn't even address the question of how Sandra Fluke intends to compel U.S. taxpayers to pay for her contraception; in my book, "extortion" requires some sort of actual force or credible threat of force.)

Now here comes the part of Landsburg's post that is not only the most vile, but the most logically nonsensical:

To his credit, Rush stepped in to provide the requisite mockery. To his far greater credit, he did so with a spot-on analogy: If I can reasonably be required to pay for someone else’s sex life (absent any argument about externalities or other market failures), then I can reasonably demand to share in the benefits. His dense and humorless critics notwithstanding, I am 99% sure that Rush doesn’t actually advocate mandatory on-line sex videos. What he advocates is logical consistency and an appreciation for ethical symmetry. So do I. Color me jealous for not having thought of this analogy myself.

Again, let's analyze this dispassionately. Landsburg claims that if Rush's taxes pay for Sandra Fluke's contraception, then Rush is entitled to some direct in-kind benefit from Sandra Fluke's sex life (for example, a sex tape to which Rush can...um...you know). This claim, besides being retch-inducing, has two clear logical flaws.

First, from an economic efficiency standpoint, in-kind benefits are inferior to direct cash payments, as Ed Glaeser will tell you. Instead of giving Rush a sex tape, it would be more efficient to simply hand Rush some cash (i.e. reimburse him the amount he paid for the birth control) and let him buy whatever he wants with it. 

Second, by Landsburg's own admission, Sandra Fluke will be having sex whether or not Rush pays for it:

Ms. Fluke is not in fact demanding to be paid for sex. (Not that there’s anything wrong with that.) She will, as I understand it, be having sex whether she gets paid or not.

Therefore, "ethical symmetry" would not entitle Rush to receive direct benefits from Fluke's sexual activity. 

So in addition to being horrendously insulting, Landsburg's point is just flat-out logically unsound.

Bloggers and economists, here's a hint: Just because an idea or argument is offensive to the moral sensibilities of the general public (or of liberals) does not make that idea correct or smart. It is easily possible to slip well below the efficient frontier of the accuracy/acceptability tradeoff. Dr. Landsburg, you have made such a slip here.


Update: Via Brad DeLong, I see that the president of the University of Rochester, where Steve Landsburg is employed, has strongly disavowed Landsburg's disgusting statements. Good.

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Libertarians: Only now, at the end, do you understand...

Charles Koch reveals the true power of the Dark Side...

Given my history of critiquing libertarianism, it would hardly be surprising if I felt a flash of gleeful schadenfreude to see the dismay with which so many movement libertarians are reacting to the Koch takeover of the Cato Institute. But I don't. I just feel sad. Here are a bunch of smart people who truly, honestly believe in their worldview - a worldview that shares some key elements with my own - discovering for the first time that they are in fact merely a proxy army for people who don't take them or their worldview seriously at all.

To those of us outside the movement, the fact that libertarians are a proxy army has always been painfully obvious. The key piece of evidence was always the set of issues that libertarians chose to emphasize. Most Americans share the belief that civil liberties are good, war is to be avoided, and high taxes are bad. But the fact that our country's libertarian movement spent so much time fighting high taxes and so little time fighting the encroaching authoritarianism of conservative presidential administrations was a clear sign that some priorities were seriously out of place. Should we really be more afraid of turning into Sweden than turning into Singapore? The contrast between libertarians' continual jeremiads against taxes and their muted, intermittent criticism of things like warrantless wiretaps, executive detention, and torture was a huge tip-off that the movement was really just some kind of intellectual front for America's right wing.

The thing is, the soldiers in this proxy army didn't seem to realize they were a proxy army. They appeared, and appear, to truly believe in their synthetic ideology; they seemed deeply convinced of the Rand/Nozick idea that taxes and environmental regulation represented a more dire threat to human freedom than the authoritarianism that had been the bane of earlier freedom advocates since Enlightenment. 

Now, however, they are beginning to understand:

[T]he Kochtopus...threatens to swallow up libertarian scholarship in order to regurgitate it as fodder for the social activist tail that seeks to wag the GOP dog in the 2012 elections.Readers should not expect many free market think tanks to speak out against the Koch assault. Too many of them benefit financially from the pocket money doled out by Charles and David Koch through their various well-funded foundations. That pocket money comes at a significant cost. I can assure you that there is no such thing as a free Koch luncheon.

How much did libertarians blind themselves to the true motivations of the people who were throwing money at them? We may never know. But it's certain that the blinders are off now. People working at more explicitly Koch-funded think tanks (such as the Mercatus Center, headed by the econ blogosphere's own Tyler Cowen) must be experiencing some serious cognitive dissonance right about now.

Because the superpower bankrolling America's libertarian movement is simply our version of the right-wing oligarch-and-racist coalition that crops up in every nation from time to time. The American conservative movement wants a strong executive who wields many of the powers of a tyrant of old, in order to "protect" us (from "terrorists," subversive elements at home, or outsiders in general). It wants a justice system oriented toward protecting tradition, group rights, and the social order (like Japan's system). It wants to restrict immigration by nonwhite racial groups. It wants heavy government regulation of personal morality. And it occasionally wants wars of choice.

In other words, it is deeply anti-liberty. 

Some libertarians are belatedly recognizing this:

What does Cato say that no other think tank says? Militarism is… the worst foreign policy for a free market. The War on Drugs is not only unnecessary in a free market, but ending it would be a straightforward implementation of free market principles. And the freedom to buy and sell is a sick joke without robust civil liberties for all. Conversely, most people want their civil liberties partly so that they can earn a living and enjoy economic opportunities. That is what Cato is about. That is also apparently why the Kochs are trying to destroy it.

If I were a meaner-spirited type of person, I would say that this realization is too little, too late - that libertarians spent decades being apologists, water-carriers, and useful idiots for authoritarians, and only now that their masters are reeling in the leash do they suddenly want out. But instead I say: Better late than never. You guys made mistakes before, but now you see the truth. First, realize that the conservative puppeteering of the libertarian movement is not an extremely recent phenomenon, but was always present at some level. And then start thinking about what kind of political agenda and rhetorical emphasis will actually promote liberty in America. 

Freed from the conservative yoke, libertarians will have huge potential to do a lot of real good for this fundamentally libertarian country.


Update: Wil Wilkinson, libertarian writer and former Cato employee, confirms that Cato has been a proxy army for the right, and has many other insightful things to say.

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Why macro is hard (Taylor/Krugman edition)

In the latest volley in the Stimulus Wars (giggle), John Taylor explains why he doesn't think the ARRA, commonly called "the stimulus" or "Obama's stimulus", increased GDP:

For the parts of the packages which include temporary tax rebates or temporary tax cuts I find no significant consumption effect using regression analysis and controlling for other factors that affect consumption. If you look at a chart of the tax rebates in 2008, for example, the evidence is striking: There was a big increase in personal disposable income at the time of the rebate, but no similar change in consumption... 

In the case of the 2009 stimulus package, there was also an attempt to increase significantly government purchases of goods and services. But the evidence is that this attempt largely failed. A special satellite account produced by the Bureau of Economic Analysis shows that federal infrastructure investment—at the peak quarter—increased by only .05 percent of GDP as a result of the stimulus and federal government consumption by only .14 percent... 

While state and local governments received substantial grants under the 2009 stimulus, a statistical analysis by John Cogan and me shows that they did not use these grants to increase their purchases of goods and services as many had predicted. Instead they reduced net borrowing and increased transfer payments.

It's important to realize, as Mark Thoma explains, that Taylor is not saying that stimulus can't work theoretically, but that the specific "stimulus" enacted in the ARRA didn't work.

Tayor makes three separate arguments here. The first is that the tax rebates in the ARRA failed to increase household consumption. This doesn't seem like an incredibly controversial argument, since A) there exist decent ways to forecast what consumption would have been in the absence of the ARRA, and B) Keynesian theories predict that transfer payments make for much worse stimulus than government expenditure. But note that one of those things that forecasts consumption is wealth; when the ARRA was passed, household wealth was plummeting due to the collapse in housing prices, and thus it is possible that the ARRA stopped consumption from collapsing.

Taylor's second argument is that the ARRA failed to increase federal government purchases - i.e., "true" federal stimulus - by much. This definitely matches the evidence gathered by Paul Krugman in a recent series of posts (see here, here, here, and here) showing that total U.S. government expenditure fell during the recent recession. So, not much argument here. 

Finally, Taylor claims that the ARRA did not do much to change government purchases at the state level. This is very hard to prove, since we don't have a good model of state government behavior. Paul Krugman claims that without the ARRA, state expenditure would have fallen even more, because states would have run up against borrowing constraints. Taylor obviously doesn't think that would have happened.

Who's right? It's hard to know, and this really illustrates the main difficulty in doing macroeconomics: lack of a good "counterfactual." History only happens once; it's just damn hard to tell how things would have changed if people had made different decisions, just by looking at what ended up actually happening.

The only reliable way to get a "counterfactual" - and, thus, the only way to tell if a policy worked - is to have a good theoretical model of how policies work. But one of the things required for a model to be "good" is for it to be tested against data. And all too often, the only data we have to test our macro theories is...you guessed it...one single run of history. And that run of history is pretty short - less than a century of quarterly aggregate data on a small handful of variables.

Now, if we could believe in cross-country comparisons, then we could basically have several simultaneous "runs" of history to compare, and this would help us be more certain about our models. But cross-country comparisons are notoriously hard to do, and countries' economies are also dependent on each other to some degree.

This is why, in my opinion, the only way to build really believable and reliable models is to use microfoundations (or, if the macroeconomy is big enough to display emergent properties, to use agent-based modeling). Without those techniques, macro is doomed to be a lot more like history than science. 

Which is not to say macro is doomed! History is not a useless way of understanding the world. Observing and recording events and then making reasonable speculations as to their causes - e.g., saying "I think states would have run up against borrowing constraints without ARRA" - is not a useless endeavor by any means. For thousands of years of human civilization - up until Francis Bacon & co. - that was the only way we had of understanding the world around us, and it did lead to a slow steady increase in human knowledge. It's just that history is a less powerful way of understanding the world than science. If we could make macro a science, that would be awesome.

In the meantime, regarding the current debate, you may ask: Who do I believe, Taylor or Krugman? I guess I mostly side with Taylor here. Krugman is probably right that if there had been no ARRA, states would have spent even less as they bumped up against borrowing constraints. But the states still would have saved a portion of the ARRA money (or passed it on to households as tax rebates or transfers), substantially reducing the ARRA's fiscal multiplier. I believe that direct federal government purchases - increased infrastructure investment - makes for by far the best stimulus. The fact that there was almost none of this in the ARRA was a major, major policy failure. I think that that failure overshadows the small benefit that the ARRA might have had in supporting state purchases. And I think that that is a point on which Krugman and other stimulus advocates would broadly agree.

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Why bother with microfoundations?

Simon Wren-Lewis, Paul Krugman, and Robert Waldmann have posts up discussing whether macroeconomists always need to use "microfoundations" - in other words, whether macro models should always start with some sort of individual optimization. I'll get to their ideas in a minute, but first, some general thoughts.

Why are microfoundations useful? The usual answer is that "microfoundations make models immune to the Lucas Critique." The idea is that the rules of individual behavior don't change when policy changes, so basing our models purely on the rules of individual behavior will allow us to predict the effects of government policies. Actually, I'm not sure this really works. For example, most microfounded models rely on utility functions with constant parameters - these are the "tastes" that Bob Lucas and other founders of moden macro believed to be fundamental and unchanging. But I'd be willing to bet that different macro policies can change people's risk aversion. If that's the case, then using microfoundations doesn't really answer the Lucas Critique.

A better reason to use microfoundations, in my opinion, is that they probably lead to better models. "Better," of course, means "more useful for predicting the future." If our models predict future aggregate macro variables (GDP, etc.) based solely on the past values of those variables, we'll almost certainly be using less information than is available; if we figure out how economic actors are making their decisions, we will have a lot more information. More information = better model. And there are all kinds of ways to observe and model individual behavior - survey data, lab experiments, etc.

So why would we want to use models that don't have microfoundations? Here is Simon Wren-Lewis' answer:

[S]uppose there is in fact more than one valid microfoundation for a particular aggregate model. In other words, there is not just one, but perhaps a variety of particular worlds which would lead to this set of aggregate macro relationships. (We could use an analogy, and say that these microfoundations were observationally equivalent in aggregate terms.) Furthermore, suppose that more than one of these particular worlds was a reasonable representation of reality. (Among this set of worlds, we cannot claim that one particular model represents the real world and the others do not.) It would seem to me that in this case the aggregate model derived from these different worlds has some utility beyond just one of these microfounded models. It is robust to alternative microfoundations. 

In these circumstances, it would seem sensible to go straight to the aggregate model, and ignore microfoundations...

I don't really like this answer. Presumably, there is some set of sets of microfoundations that leads to Aggregate Relationship A and some other set of sets of microfoundations that leads to Aggregate Relationship B. How do you choose which set is better? Well, you could look at survey data and lab experiments to figure out which microfoundations are really in effect. But if you can do that, why do you care about "robustness to alternative microfoundations" in the first place? And if you can't choose which microfoundations are better, why does "robustness to alternatives" matter?

Pretty much any model, in economics or physics or whatever, has a bunch of possible microfoundations that could give rise to it. That fact alone does not make microfoundations less important, since presumably some microfoundations are actually happening, and others aren't!

Here are Paul Krugman's answers to why we might not need microfoundations:

1. Even in microeconomics, we don’t insist on using models built up from maximizing behavior all the time. Exhibit A: supply and demand!...

2. Relatedly, as a practical matter intellectual scratch-pads — approximate version of what we really believe, but stripped down to be tractable — are what one uses for applied economic analysis all the time.If I want to ask what the effects of some shock will be, it rarely makes sense to demand that the analysis always go all the way back to the intertemporal choices of optimizing agents. 

Hmm. I think that incorporating microfoundations into a model is different than starting from microfoundations when applying that model.

3. In the hard sciences, when dealing with complex systems people have often used higher-level, aggregative concepts that seem to work empirically long before they have a full derivation of effects from the underlying laws of physics...Why, then, do some economists think that concepts like the IS curve or the multiplier are illegitimate because they aren’t necessarily grounded in optimization from the ground up?

I think this is where the Lucas Critique comes in. The Phillips Curve is the famous example of why aggregate relationships might not be useful without understanding the microfoundations. That doesn't make aggregate-only models useless, but it should make people cautious about using them.

4. And when making such comparisons between economics and physical science, there’s yet another point: what we call “microfoundations” are not like physical laws. Heck, they’re not even true. Maximizing consumers are just a metaphor, possibly useful in making sense of behavior, but possibly not. The metaphors we use for microfoundations have no claim to be regarded as representing a higher order of truth than the ad hoc aggregate metaphors we use in IS-LM or whatever; in fact, we have much more supportive evidence for Keynesian macro than we do for standard micro.

I think that this is the real argument against microfoundations as they are currently used in macro. Basically, Krugman is saying that the "microfoundations" we now use really deserve to have quotes around them, because they actually don't describe individual behavior.

In other words, our current microfoundations are mostly just garbage.

If this is true - and I think that the evidence overwhelmingly says that it is! - it means that our modern "microfounded" macro models are no more useful than aggregate-only models. The logic should be obvious. Using wrong descriptions of how people behave may or may not yield aggregate relationships that really do describe the economy. But the presence of the incorrect microfoundations will not give the aggregate results a leg up over models that simply started with the aggregates.

In other words, if you put garbage in, you may or may not get garbage out, but why bother putting the garbage in in the first place?

(Note: if you started to angrily type out the reply "But all models are wrong!", please refer to my 2nd Principle for Arguing With Economists. You are wrong.)

When I look at the macro models that have been constructed since Lucas first published his critique in the 1970s, I see a whole bunch of microfoundations that would be rejected by any sort of empirical or experimental evidence (on the RBC side as well as the Neo-Keynesian side). In other words, I see a bunch of crappy models of individual human behavior being tossed into macro models. This has basically convinced me that the "microfounded" DSGE models we now use are only occasionally superior to aggregate-only models. Macroeconomists seem to have basically nodded in the direction of the Lucas critique and in the direction of microeconomics as a whole, and then done one of two things: either A) gone right on using aggregate models, while writing down some "microfoundations" to please journal editors, or B) drawn policy recommendations directly from incorrect models of individual behavior.

Brad DeLong puts this rather more pithily:

I now have the most bizarre image in my mind: 

A seminar at the Library of Alexandria in 300 A.D., with an astronomer trying to provide micro foundations in the form of calculations of how large their wings must be and how fast their wings must beat for the angels to push the planets on their tracks through the quintessential spheres…

Thus it seems to me that the microfoundations revolution has not really gotten us very far yet. I would be willing, of course, to be convinced otherwise.

So what to do? The answer is clear: macroeconomists should continue using aggregate relationships for now, and try to check these against the best microfoundations available. But in the meantime, recognize that these aggregate models will have severe limitations until microeconomists come up with better explanations of individual behavior. Which, of course, they are working on.

But note that there is also a political danger here. Macroeconomists who desire a certain policy conclusion - for example, that fiscal stimulus never works - may be tempted to continue to use bad microfoundations that support that conclusion, even when microeconomists have found something better. This is sometheing the profession should work to avoid, by actively recognizing that microfoundations that fit the micro data are inherently preferable to those that do not.


Update: Paul Krugman, commenting, has a good point about what kind of predictions we should expect from economic models. Big qualitative predictions ("quantitative easing will cause runaway inflation") are more important than precise quantitative ones ("GDP growth will be 1.7% next quarter"). I agree, of course. When I say models should "predict the future," this is really what I mean.

Update 2: Richard Serlin points out that aggregation is a huge challenge for microfounded models, since complex systems often have chaotic properties. Very true. But that doesn't mean that just observing the aggregate will give you more information! What you need to handle complexity and chaos is a ton of computing power and some agent-based modeling, as is done in weather forecasting. This can provide a very important check on non-agent-based models that make simplifying assumptions in order to aggregate individual agents.

Update 3: Peter Dorman is of the opinion that the reason our current microfoundations are crappy is that the entire framework by which microeconomics is now done - equilibrium analysis and optimizing behavior - does not describe reality. I'm not willing to go that far (and besides, what about game theory?), but if he's right, it would certainly strengthen my case substantially.

Update 4: Andrew Gelman and Peter Dorman are basically on the "our current microfoundations suck, and we should get better ones" bandwagon.

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A sketch of a model of higher education

I've had a model of higher education rolling around in my head for quite a while now, and I never had the time or energy to put it on paper. But then I read this post by Frances Woolley, which contains some ideas that are extremely similar to mine, so I thought I'd sketch out the basic idea of the model in a blog post.

Woolley asks why research is more important for a professor's career than teaching:

[W]ithin academia, research has higher status than teaching. The question is, why?... 

Perhaps research is highly valued because it is in short supply...But scarcity cannot explain why dime-a-dozen mediocre researchers are accorded higher status than excellent teachers...[and e]ven a scarce commodity will have a low price if there is not much demand for it... 

I think [research has higher status than teaching] is because research output is a signal of ability...Teaching just does not work as a signal in the same way. First, top rate teaching is extraordinarily difficult to measure... 

Second, I don't know if teaching performance is as highly correlated with intelligence, creativity, and originality as research performance is.

Basically, Woolley conjectures that research is valuable as a signal of unobservable teaching skill. I think that this is an excellent answer, for a reason that Woolley doesn't even mention: past research is paid more than future research.

Think about Joe Stiglitz' salary. Stiglitz has, by almost any measure imaginable, done a huge amount of great research. And he gets paid a very high salary. But how much great research do we expect Stiglitz to do in the future? He's old! And he's involved in other things, like speaking, getting involved in policy debates, etc. He is not really getting paid to do research. And, crucially, Stiglitz is getting paid a lot more than any economist whose best research years are ahead of her! If you look at total salary expenditure by universities, my bet is that you will find the same pattern - much more money being spent on past research than on future research.

Of course, from the labor supply side, this still functions as an incentive to do good research (so you can get paid more in the future). But from a demand side perspective, why the heck should a university pay professors for work they did in the past, when they were employed somewhere else? Unless universities are voluntarily internalizing the positive externality from research - i.e. unless universities just want to do good for the world by making research a well-rewarded activity - we must conclude that universities are not actually paying for research.

What are they paying for? I conjecture that they are paying for prestige. If Joe Stiglitz works at my university, it raises my university's prestige.

Why would a university want to raise its prestige? Well, if Woolley's conjecture is correct, prestige is a signal of teaching quality: a Columbia education is generally assumed to be better than an Ohio State education, in part because Columbia has more prestigious professors. So suppose that human capital is very important, but also difficult to observe; in this case, the prestige of your alma mater signals how valuable an employee you're likely to be, because of the fact that education matters, not in spite of it (as in the typical "signaling model" of education).

So here's a question: Why would universities care about prestige? Well, it might allow them to charge undergrads higher prices; Columbia tuition is certainly higher than Ohio State tuition. That in turn might lead to administrators (i.e. the people who make the hiring decisions) getting paid more, particularly if the number of administrators needed is proportional to the number of undergrads (so that higher tuition means higher expenditure-per-undergrad means more expenditure-per-administrator). Administrators trying to maximize their own salaries would then have an incentive to pay a lot of money for someone like Joe Stiglitz. (Full disclosure: I like and admire Joe Stiglitz. And naturally I can't pass up a chance to bag on Ohio State.)

So, to reiterate, here is a sketch of the Noah Smith (or perhaps Smith/Woolley?) Model of Higher Education:

1. The human capital benefit of an undergraduate education is highly sensitive to unobservable differences in teacher quality.

2. Past research accomplishments are a strong signal of teacher quality.

3. Thus, professors with stronger research records allow a university to charge more tuition per undergrad, increasing the salaries of administrators.

4. Although human capital signaling is itself inefficient, this system benefits society by providing a subsidy for the production of research, which as an almost completely nonrival good, is underprovided by the private sector. If teaching quality were observable, this research subsidy would not exist.

5. Extension: America's "legacy student" system (basically, auctioning off a few false ability signals for huge amounts of money, at only a small cost to the school's prestige) gives American universities an edge over foreign universities in terms of prestige, but it also increases the amount that America's university system subsidizes research. This may mean that the legacy system is good for the world.

Anyone can, of course, feel free to take this model and run with it if you like it (and if you do, feel free to include me as a co-author, or not, as you like). It definitely needs some serious empirical work to support each link in the chain. But notice that this model wouldn't just answer the question of why research is paid highly, it would (partially) answer the question of the value of universities to society as a whole, AND the question of why the dual research/teaching structure of the university has proven so durable over the years. And it would possibly point to ways in which the system could be tweaked to boost the degree to which it subsidizes basic research (some of these ways might seem very counterintuitive, e.g. admitting legacy students!).

And if you can see reasons why this model I've sketched is obviously wrong, please let me know, of course.

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I care about rich people, but not about their riches.

An incredibly interesting article in Bloomberg this week reveals the devastating power of the economic phenomenon known as "habit formation." Basically, if you have enjoyed a high-consumption lifestyle in the past, it is extremely painful to switch to a lifestyle of moderate consumption. This is why so many finance-sector workers are unhappy right now, despite being so much richer than the vast majority of Americans - they are doing great relative to others, but not so good relative to the astronomical heights they reached in the early 2000s.

Conservatives sometimes use habit formation to try to get sympathy for the rich. When we redistribute income, they say, we have to realize that the rich are actually hurt, since they have gotten used to consuming a certain amount, and raising their taxes will bump them down to a less lavish lifestyle. We should care about the rich people too, they say. But most conservatives don't say this too loudly, because the instincts of the public are more Rawlsian than Benthamite; people are likely to respond by saying "Oh boo hoo hoo, no vacation in Aspen this year! Cry me a river!"

In other words, I think most people don't really care that much about the happiness of the rich. 

But I do.

I do care about the happiness of the rich. Why? Because most people I know are rich. Not in the vacation-in-Aspen sense, but compared to the vast majority of people on planet Earth. My family and friends are all in the top 50% of household income in the U.S., which makes them some of the richest people in the world. And I care about my family and friends. So I care about rich people. And because I realize this, when I see the vacation-in-Aspen crowd feeling bad, I have sympathy for them. I don't like to see those people sad.

Now, this doesn't mean I'm worried about raising taxes on the rich. Yes, habit formation will make higher taxes more of a blow, but let's face it - there is just not enough wealth in the world to keep the consumption habits of America's rich people growing at the rate they grew in the 2000s. A correction will be painful, but one way or another it is inevitable.

And to be honest, all this discussion of income and wealth seems to me to be a bit beside the point. We live in a world of incomplete markets, where the things that rich people really care about - the things upon which most of their happiness hinges - are not things that can be bought with money (or else they would have bought them). These are things like good friends, a feeling of accomplishment, a positive outlook, personal interests, individual expression, and the feeling of being a good person.

One especially important area, I should point out, is family. Research indicates that divorce, for example, results in a huge and long-lasting decline in happiness. Rich people can buy vacations in Aspen, but as things stand, no amount of money will keep their families together. In fact, higher divorce rates in rich countries may explain a large part of the Easterlin Paradox (the finding that people in rich countries aren't much happier than people in poor countries).

I am somewhat of a believer in Maslow's Hierarchy of Needs. Money can buy you security, and it can get you respect, but as things stand it still can't buy you love. And so when I worry about the problems of rich people, I worry much more about their personal emotional issues than their consumption habits.

Rich folks, you don't need a giant bonus. You don't need lower taxes. You don't need another vacation in Aspen. What you need is a hug.

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Thursday Roundup (3/1/2012)

Blogging's been sparse lately. Here's some Thursday links to feed your Noahddiction:

1. Barry Ritzholtz reminds us that liquidity in financial markets can actually be a bad thing. On a somewhat related note, John Cochrane points out that high-frequency trading is a zero-sum game.

2. Steve Williamson explains the two main ways that financial crises fit into economic models: A) as amplifiers of shocks, or B) as generators of multiple equilibria. Naturally, both things could be important at the same time.

3. Steve Randy Waldmann reminds us that unit labor costs have been falling, not rising, in most rich countries, including almost all European countries, and in particular have been converging across Europe (as basic theory would predict). This weakens the argument of those who claim that high union-driven labor costs are the cause of Europe's woes. It also provides support for the notion of factor price equalization - the thesis that the stagnation in rich-world incomes is due to the massive China Labor Dumb of 2000-present.

4. Steve Williamson gives some arguments in favor of the auto bailouts.

5. The Incidental Economist reminds us of an important fact from first-year microeconomics: Although the First Welfare Theorem says that (under certain conditions) free markets are efficient, the Second Welfare Theorem says that (under only slightly more restrictive conditions), redistribution is efficient too! So before you use the Welfare Theorems as a justification for free markets, remember that. (H/T Thoma).

6. Menzie Chinn points out that government purchases - i.e., the government actually spending money on stuff - have been going down, not up. What has been going up are transfer payments. Attention conservatives: "Shift resources from transfers to public investment" is a better position than "Cut taxes no matter what."

7. Simon Wren-Lewis argues that even if the macroeconomy does not contain emergent properties, aggregate models with no microfoundations can be preferable to models with microfoundations, since different sets of microfoundations can produce the same aggregate behavior. But he admits that chucking microfoundations is a very dangerous thing to do, and I agree.

8. Here's Wren-Lewis again, with an explanation of why the "LM" in "IS-LM" should be ditched. The argument is probably familiar to anyone who has taken an intro grad macro class.

9. Karl Smith claims that the rich-world investment drought is not about "stagnation," it's about "deindustrialization." Tyler Cowen politely coughs his throat and points out that those are, um, the same thing. Cowen win.

10. Finally, here is an absolutely righteous takedown of Jagdish Bhagwati by the perspicacious Peter Dorman, who is rapidly usurping my rightful place as the sheriff of the econ blogosphere. He's out-pinioning Noahpinion!

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