Economics

/ / 0 comments

Poor Adam

Summer vacation is winding down, I have spent a great deal of time reading papers and books and not enough time doing useful things, so naturally I am continuing to bellyache about modern economics.

Perhaps its that ‘end of summer feeling’, but suddenly I feel bad for Adam Smith. I really do. Remembered as he is for a casual, if powerful, metaphor he always gets mentioned as the progenitor of modern economics. This is a strictly Anglo-Saxon view of course – the Physiocrats, especially Quesnay and Turgot,  were mucking around with various theories before him, and the world was awash with pamphlets, by people like Mun, Petty, and Gresham in England, explaining sundry aspects of trade and so on well before he ever uttered the fateful phrase “a hidden hand”.

Like those before him, Smith was trying to explain what he saw around him. There seemed, to his eye, to be a chaotic burgeoning of local activity, the emergence of factories with production broken down into different steps, businessmen [not, unfortunately, businesswomen] getting together to collude and rig the market, a rapid increase in wealth, and yet a perception of a kind of order on the surface of commerce. To Smith’s eye the local or lower level chaos and this aggregate or higher level order appeared to be a paradox. The two were in contradiction. So, being an inquisitive type, he sought to locate the method, the apparatus, or the mechanism that reconciled them. And by so doing launched economics down its modern path. The scope of his question was more novel rather than his answer. The paradox could only be resolved, he suggested, by postulating the existence of an integrating force, or set of forces, that brought the self-interest of individuals into alignment with the overall, and apparent, betterment of society as a whole.

Thus was born both classical economics and support for modern right wing ideology. Two for one.

The point being that those forces were not controlled by any central authority. Indeed they existed despite and in confrontation with such a central authority. Attempts to defy the forces were doomed and mistaken. Resistance was futile. The authorities, in Smith’s day this meant a King, Queen, Emperor or Empress, could ordain commercial activity, but that ordinance would inevitably diminish the wealth of nations not enhance it.

No. Society, and especially commerce, was best left to self-integrate or self-regulate, and whatever popped out at the end was the best we could all hope for.

Now we must give Smith his due: he foresaw plenty of problems with unfettered business. The proclivity to collude being a salient example. And he argued there were some activities that commerce couldn’t, or wouldn’t, organize well. In this respect he is more modern than his modern followers.

None of this is why I feel sorry for him. He opened our eyes to the complex system that is the economy and the emergent properties that it exhibits at different levels. He didn’t conceive it this way. He couldn’t. The notion of complexity as we now know it didn’t exist. So he used metaphors and notions that were commonplace back in the mid 1700’s. His question was a great one. Our issues are with his language and thus the narrative of his solution. It denied emergent order even though that is precisely the apparent paradox he sought to explain.

No, I feel sorry for him because is is associated – due to his unfortunate metaphor and its subsequent hold over economics – with over two centuries of error. Not just error, but a compounding or increasing error.

He opened the path followed by the great classical economists. Ricardo, Marx, Mill and even Marshall all conceived of great systems driven by even greater fundamental forces that were inevitable. As a footnote: I regard Marx as very Ricardian in this sense. That was bad enough. Worse, he enabled the thinking of Walras whose quixotic and dire search for total order, bedeviled as it is by the mirage of general equilibrium, has perverted the course of economics since the late 1800’s. The Walrasian tradition came to dominate economics at the expense of most all else and lingers on despite the death blow of Arrow-Debreu back in the 1950’s. It was death blow, as I have argued before, because it demonstrated the utter impracticality of the entire enterprise. Nonetheless so haunted, or infected, by the hidden hand had economics become that attempts to rid ourselves of it all failed. Indeed in the modern era it flourished in the hands of Friedman, Lucas, Prescott and their ilk.

So determined were all these folk to establish the supremacy of the great forces that authority could not control, that they drove ever deeper into the bizarre in order to do so. They gave up trying to explain what they saw around them. They abandoned Smith’s question altogether. They took his paradox and dismantled it. At first they sought to explain only the lower level of activity – the behavior of individuals and small business firms. Their problems mounted almost immediately. People seemed to be arbitrary and capricious. They were greedy. They defied neat categories and acted in spite of themselves. So, gradually, all these traits were eliminated from analysis. People were re-invenetd in order to make analysis more tractable. Slowly, but surely, as all the humanity was squeezed out an economics of individual behavior emerged. Nowadays we call it micro-economics. And it is utterly wrong. In its desperation to corral us into an analytical framework it starts from the end and works backwards.

It says, in a nutshell, that since we know(don’t we?) that society is rational and maximizes its resources, the behavior we see, even its more absurd aspects, is a manifestation of this rationality. The preferred activities of us all are revealed by our actual activities. They are one and the same. And since they are the outcome of the rationality we all exhibit they can be shoved into the logically consistent and highly abstract mechanisms economists have constructed to model them. This, you will no doubt have noticed, not a process of enquiry into the world as it is, but is rather an enquiry into the world as economist would like it to be in order to model it. And the more formal the attempt to model the more extreme the eradication of the world outside. Reading most any modern micro-economics textbook is like reading science fiction. It is to enter an imagined world inhabited by made up beings who act and react only according to made up rules. There is no life. Or at least no life Smith would recognize. Nor you. Nor I. But it is accepted and propagated endlessly by economics professors indoctrinated into it.

Smith would be embarrassed to be associated with the fiction.

Now comes the good part.

Having created this fantasy and having come to believe it portrays certain truths about the world, economists – those in the dreamworld anyway – dispense advice designed to bring the world around us into line with their fantasy. So instead of explaining the world they try to construct one. Instead of helping us understand how the economy works they instruct us as to how it would work if only we lived out their fantasy.

This is the exact antithesis of Smith’s project. Yet they do it as part of what they see as his legacy. They simultaneously deface his work and look back to him as iconic. More particularly they ignore him. Smith was intensely attached to the world around him. Most modern economists are intensely attached to their fantasy world.

The final step away from the world about us and thus the final step in closing out humanity from the subject was the sudden urge to ensure that any observation or theorizing about the second part of Smith’s paradox, the order up top, could only be valid if it conformed to the rules made up for the fantasy down below. Aggregate or macro-economics, largely invented by Keynes outside of the fantasy tradition, had to be re-jigged so as to be equally fictional. It had to root itself in the quicksands of micro.

It is all very clever. Remarkably complete and very logical. It sounds highly relevant too. When taught superficially it sounds as if it is addressing the world in the way that Smith intended. That is it sounds as if it is answering current questions about real things. But lurking just off stage is a host of fictional characters, made up forces, kluged rules, and rickety analyses upon which that illusion is built. It all mimics well. It explains only itself. It is all a tour de force of imagination not of scientific enquiry. Its brilliance blinds us to its irrelevance. And, in a curiosity of all fiction, it cannot be “wrong”. Since it is internally consistent, complete, and rigorously conceived it cannot be faulted on its own terms. It is thus “right” within those terms.

As a shiny artifact or a piece of art it works well. As an explanation of reality?

Well, let’s just say “poor Adam” and leave it at that.

 

/ / / 0 comments

Some Thoughts On Economics

My instinctive entry point into economics is through business. What is called the “Theory of the Firm” plays a key role in shaping what I see, think, and try to explain. Business, of course, gets frequent mention throughout economics, with most varieties of general theory claiming to place it somewhere inside the theoretical constructs. But pick up almost any textbook and the treatment of business is at best a weak caricature and at worst a laughable display of ignorance. Economics as it exists today in its mainstream form is of no use whatever to anyone seeking to understand the reality of business. Our extant theories of the firm are failures in that they attempt to see the world through a neoclassical lens whilst that lens obscures anything remotely real from view in an effort to retain the equilibrating perfection of the closed system envisaged by Walras. The contradiction between the pursuit of equilibrium explanations and the open ended nature of the real world defeats neoclassicism at the starting gate and dooms it to subsequent nonsensical irrelevance.

But it must mean something to someone since it is still, despite its evident silliness, the most preferred theory within the profession.

In this context I have to attribute a great honor to the Arrow-Debreu effort to complete the Walrasian episode. Arrow-Debreu deserves our constant indebtedness. It shows, definitively, how the Walrasian tradition cannot be an explanation for a real economy. It achieves completion by imposing such horrendously, and obviously, unreal constraints on itself that it proves Walras wrong. It is thus great science. It is the falsification of a tradition shown to be worthless.

On another matter: mainstream economists have never adequately, in my opinion, responded to Coase’s challenge of 1937. He asked simply: if markets do what classical economists and their followers say they do, why do firms exist? They ought not. That they do suggests something is very wrong at the heart of orthodox thinking. So I add the ‘Coase conundrum’ to Arrow-Debreu as adding weight to the critique. Mainstream economics is alchemy.

I am aware of the post-Coase tradition of ‘transaction costs’. Williamson represents the clearest version of this tradition. He seems, though, to be more concerned in not upending neoclassical thought than in explaining why firms exist. Asset specificity, cheating, agency issues and the like are nice ideas. Important ones. But they sit ill at ease within a theoretical world where everything is neatly defined and all information equally available. Such things cannot exist in the weightless world of neoclassical thought. So all Williamson and his ilk have done is to redefine the Coase conundrum. Instead of the original ‘why do firms exist’ we now have ‘why do transaction costs exist’. Nothing fundamental has been explained.

Then there is the problematic relationship of economics with information. References to information abound. Reputations have been made discussing it or its absence. Asymmetrical information is another challenge to orthodoxy that is too often ignored. Information about things is patchy in the real world. Very patchy. It is non-existent with regard to the medium and long term future. Yet this never deters the neoclassical theorists. They march along as if asymmetry was an inconvenience that can be assumed away for simplicity’s sake, rather than a dagger in the heart of their work.

Uncertainty and complexity characterize the real world. Certainty and simplicity characterize neoclassical economics. Hence it irrelevance. It is complicated though, as Arrow-Debreu shows. It has to be. Its epicycles weigh it down. But no amount of clever formalism can turn unreality into reality, just as lead is pretty tough to turn into gold. This doesn’t mean that neoclassical economist aren’t very bright. They are. They have to be to to tend to those epicycles. Newton, after all, spent more time on alchemy than on recognizable physics. No indeed, they are very bright. Just wrong.

There are, of course, other forms of economics. I find particular relevance in anything that considers evolution as a guideline. The economy seems to act in a very Darwinian way: variation, inheritance, and selection help explain the apparent paradox of both persistence and change within the same system.

Then again, learning seems paramount. Perhaps the economy is a giant learning device in the mode of Popper. Trial and error. Falsification of hypotheses. The adoption of successful routines, and then their replication, is exactly what goes inside business. Firms then can be viewed as search engines exploring the space of possible combinations of ideas. They grope around on the edge of our knowledge looking for new things to combine, and whenever they succeed they expand that space of the possible. They move our boundary deeper into the infinite. In this view growth is limitless, constrained not by resources, but by our imagination and thus our ability to make and do more with less. It is an optimistic rejection of Malthusian and neo-Malthusian gloom. Although Malthus was onto something. He saw dynamics and change. He had processes in mind. So I am with Keynes and his disappointment that economics followed Ricardo and not Malthus.

This thought leads me to another: firms covet information. They actively prevent its spread. They use all sorts of institutional methods to prevent information leaking out beyond their borders. Economics thus has to be institutional in some way, as Veblen well knew. Firms rely on them.

Control of its boundaries is critical to a firm. Information beyond its borders cannot accrue profit. Only information within its boundaries can add value. Setting those boundaries correctly is a major task of management. Insourcing versus outsourcing is the common parlance. Understanding the boundaries and calibrating against the market is what goes on.

But is this correct?

What do firms do with the knowledge they acquire?

They in-form. By this I mean they impose order. They tease order from prior disorder. And by so doing create value. For it is order that we seek. Ordered resources. Only resources that have been accumulated and ordered can satisfy our needs – basic or otherwise. When we consume we extract those resources by destroying the order. This is the entropy that Georgescu-Roegen mentioned. From this persecutive an economy is a fight against entropy. The physical world is dominated by an incessant tendency towards disorder. Things dissipate. They depreciate. Useful resources are scattered and become useless. Only creativity – the creativity embodied in all life – can stave off entropy. Then only locally. Then only temporarily. There is no equilibrium in such a system, only a perpetual fight, a dynamic against disorder.

Think it through: the iron in a motor car is not lost when it rusts in a scrap yard. The iron remains. It just isn’t in a useful form. The in-forming has become dis-formed. The order lost. Thus the value destroyed.

So economics is about learning new ways of imposing order. And it does this in the face of uncertainty. So as our learning produces more complex ways to impose order the economy becomes more fragile, more entangled, more interdependent, and in need of more control to offset those things. Imposing order takes time and space. It takes energy. It takes planning. It requires ever greater control over the process of ordering.

Thus the need for firms.

They are spaces, both physical and logical, within which our practical knowledge is deployed to impose order on resources. This imposition requires energy and skill. Energy can come from labor or it can come from more basic sources. Skill can come from current labor or it can come from the embodiment of past labor. For current capital is simply the ordering – the inheritance and selection of – past learning in the form of useful machinery or equipment. The substitution of labor for capital or vice versa tells us that neither if fundamental. The energy and skill are.

Energy and knowledge deployed to order resources for subsequent disordering. That’s the economic process.

The apparent smooth surface of an economy – the supposed matching of supply with demand – has beguiled us long enough. It is emergent. It belies the seething below the surface. It cannot be predicted by understanding the lower levels. It just is. It is illusory to think otherwise. Building upwards from below does not necessarily end up with the whole. Nor does decomposing the whole necessarily end up with the constituent parts. Supply and demand are an accounting of the contest between creativity and entropy. The artifacts associated with them are important to our understanding of allocation, but not at all to the more fundamental issue of growth.

That is a question of knowledge. Of the institutions and culture needed to exploit that knowledge. And of the way in which we solve problems and add order to our environment.

One last thought: primary and secondary knowledge. They are my way of parsing the total knowledge. Primary knowledge is the replicated and selected part. It is coded. It is thus easily re-used. It is also thus reliable. It is the source of efficiency. Or rather I should say pseudo-efficiency, since in the face of open ended discovery and uncertainty there can be no such thing as certain efficiency. Primary knowledge is what firms embody into the routines that constitute production. Either a machine or labor can perform the routine. It is the routine that is paramount. And a routine is simply a discovered or learned solution to a problem. Firms prefer primary knowledge because of its ease of replication and its reliability. It gives them control within their space over the outcome of the in-forming process.

Secondary knowledge, in contrast, is inefficient. It is more complex. It is the intelligence to solve problems ad hoc. It is thus essential for learning. New problems negate the validity of old knowledge. Novelty – exploring the edge or our possibilities – cannot be discovered, shaped, and made useful without intelligence. And this is where evolution does not help. Our exploration of novelty is directed. It is not random. Chance may play a role, but our exploration is highly contingent on what came before. Innovation is never ex-nihilo. It builds on the foundation. It moves outwards from the center. Nor does innovation take place only at the edge or our knowledge. It can take place deep inside. For discovery is not just of new knowledge, but of new applications for old knowledge. Having a store of intelligence – what I call secondary knowledge – is essential to both forms of discovery. But is is expensive. This is because there is no certainty of outcome.

Primary knowledge replicates old order. Secondary knowledge creates novel order. Business translates novelty into processes consisting of routines based upon innovation. It thus translates secondary into primary knowledge and extracts value by so doing. As long, that is, as the primary knowledge is not superseded by novelty.

Creativity fending off entropy. Knowledge and learning at the heart of it all. Problem solving. Dynamic, constant, unpredictable, and fraught with uncertainty. No direction. No equilibrium. Riven through with asymmetries. The temporary imposition of order on our surroundings so that we can survive and enjoy life.

Economics in the real world.

Or at least that’s what I think.

/ / , , , , , , , , / 0 comments

Mid Summer Blues

No I haven’t disappeared. This is mid-summer and the living is supposed to be easy. And it would be were it not for the perpetual lunacy in Washington. I wonder whether America has ever been this ill served by its collective leadership.

Last week were treated to an outpouring of enthusiasm based upon the new GDP numbers. Growth was 1.7%. Wow. In normal times, back before the banks trashed the economy, the endless bailouts, various fiscal showdowns, tepid reforms, and Congressional gridlock – you know all those years ago – a 1.7% growth rate would have been greeted as the harbinger of bad times. Now, in our new world, people get almost giddy over it. Such is the distortion to our perspective that the failure of our leadership has wrought that we genuinely laud a weak report. It is as if we are so starved that any small morsel looks like a veritable banquet.

How did America get to be so small?

Small in attitude. Small in outlook. Small in opportunity. And small in scope.

The so-called land of opportunity is clearly gone. And we behave as if we want it gone. Nowhere is there the anger at the lack of leadership needed to break free of the mediocrity into which we have settled. Or, rather, the mediocrity into which we have been forced to settle.

I think if more people realized that our economic plight could be solved quite easily had we the courage to attack the problem they would rise up against the Washingtonian elite that throttles everything.

Within that elite, with it stunning lack of imagination and its numbing groupthink, lies the cause of our malaise. The rotten employment figures last week – 162,000 new jobs – and that weak GDP figure are the deliberate outcome of the actions of our leaders. Stagnation has become acceptable to them. They are scared. They are rudderless. They have no ideas. And they simply squabble.

The Republicans in the House have now voted forty – yes 40 – times to repeal Obamacare. This is farce. Worse, it isn’t humorous farce. They cannot succeed, yet they continue these entirely symbolic acts. At taxpayer expense. I have no clue in which world they now exist, but it isn’t this one.

The Republicans also continue their objection to each and every move the White House makes, no matter whether they previously espoused the same policy. This is not opposition. This is obstruction. Opposition is constructive and presents an alternative. Repetitive negation is no alternative.

This comes across starkly in the discussion – if that is what we can call the mud slinging – over the Federal budget.

The divisions within the GOP are now so deep that they cannot even bring a bill to the floor of the House. They disagree so strongly with each other. The extremists treat the sequester level of government spending as the starting place for further cuts – they want to get rid of all social spending if they can. Another group wants to roll back the sequester and start over at a higher, and less severe, level. This conflict produces gridlock within the Republican caucus, leaving the Democrats bemused onlookers.

It will get worse.

The budget is supposed to be in force by October 1st. That’s when the Federal fiscal year for 2014 begins. So we will be hearing about a succession of budget – aka appropriations – votes during September. Such is the gridlock, however, that it is extremely unlikely any substantive votes will take place. The Republican split prevents them bringing any of the multitude of annual appropriation bills to the floor for a vote. They failed just last week in such an effort. So the specter of a government shutdown looms once more.

Once we are beyond October 1st. Congress will fund government through what is called “continuing resolution” legislation. That is, they simply vote to keep that last budget continuing until they vote for a new one. This presents a sitting target for the extremists. All they have to do is to block a continuing resolution and funding ceases. This year is ripe for such obstruction. It is the first full year of funding for Obamacare, which the extremists revile. Any bill that includes health care reform funding will be fought over tooth and claw. This year, too, Speaker Boehner is demonstrably weaker – his control over the GOP caucus is diminished to the point of being negligible. This makes eruptions from the extremists very likely. Then, too, the gap between the House and Senate Republicans has widened. Indeed the dialog between them has almost vanished. The Senate GOP, or at least a big chunk of it, would like to adopt a more constructive approach and has thus lost patience for the trench warfare the House loves to toil away in. So we are likely to get two very different versions of Republican budgets, adding more confusion and reducing the prospect for progress.

In the middle of all this Republican dysfunction we have the Democrats who appear to be losing patience, and are less likely to lend Boehner a hand in passing legislation. Given that the Republican majority is split so badly, to get any legislation passed will need a bi-partisan vote. Currently the Democrats see no need to help Boenher find a way out of the hole he dug for himself.

It gets worse.

The law governing the sequester budget cuts has them kicking in a few days after Congress adjourns. But the Republicans are fearful that Obama may use adjournment to tinker with appointments to some of the huge number of empty jobs that Congressional opposition has opened up. So they want to extend the legislative session as long as they can. This means that the fights over the sequester will most likely take place sometime in January or February – a good four or five months into the 2014 fiscal year. If nothing else this will add confusion for the media reporting on the budget wars because it adds another moving part to an already helter-skelter legislative program. And the media is not renowned for understanding these things when they are static, let alone when they are in motion.

Phew.

Then, naturally, there is the idiocy of the Obama administration and its obsession with discredited economists.

The bun fight that broke out over the Bernanke succession is both unseemly and unnecessary. Apparently Obama has a clear preference for Larry Summers. Equally apparently, most Democrats don’t. Summers will always be associated with the go-go years of Clinton, with Robert Rubin, with ill-fated bank deregulation, with opposition to derivative regulation, and a host of other errors. His arrogance has prevented him from any form of public contrition. His political ineptitude is legendary. And his intellectual vanity epic. Yet he continues to exert a hold over Obama. That his name even came up in the context of the Fed chairmanship – a position demanding diplomacy as well as an economic know-how – is baffling.

More baffling still is that Obama first turned to Tim Geithner to sound him out for the job. Really?

Between them Geithner and Summers created a bulwark within the administration preventing effective bank reform. Neither is qualified, on that score alone, to be Fed chairman.

Finally, in this list of gloom, we have Obama’s clockwork like calls for a “grand bargain” on the budget. By grand bargain he invariably means significant cuts to social programs in exchange for a few negligible tax increases. This time he is calling for a cut to the corporate tax rate and a concurrent reform of that tax to close loopholes.

By the way: I have never understood the logic behind social spending cuts. We are told these programs are somehow unaffordable at some future date, and are thus likely to need cutting back. And in order to avoid those future cutbacks we have to cut them back now. So we are being forced to make cuts … in order to avoid future cuts. And the logic here is what exactly?

Anyway, never has an Obama made a more pointless proposal. Most large corporations pay little or no tax. So the top line tax rate is irrelevant. Those same corporations have bought and paid for Congress through their lobbying and donation efforts. The chance that we get tax reform that isn’t twisted out of all recognition by special interest pressure is zero. So Obama’s call was senseless.

Then again, being the acute Washington insider that he is, Obama knows all this. He was simply playing to the audience, whilst knowing full well that he could have said anything and the Republican reaction would have been the same.

Which is to say they would oppose him.

And this is why the mid-summer blues are particularly blue this year.

We have all this to look forward to.

Time to go to sleep under the tree and to dream of when 1.7% GDP growth invoked concern and not good cheer. Those were the days. I wonder whether we will ever get back there.

/ / , / 0 comments

Simple Model Mania

Economics, as we all know, is a bit of a shambles. There’s plenty of good stuff sitting about, and there’s plenty of bad stuff. On any given day we can witness two Nobel prize winners disagree and put forward totally contradictory theories to support radically different sets of policy advice. One example at the moment is the continual warnings we gat about the imminence of high inflation. One side says we are doomed because all the money the Fed has been tolerating in the economy will cause prices to rise – this is a variant of the old “too much money chasing too few goods” argument. The other side says this won’t happen because the money is all idle in bank reserves and will stay there as long as the economy sputters and interest rates stay stuck at or near zero – no one wants to do anything with all that money, so it is irrelevant and certainly won’t end up chasing too few goods. So far the evidence supports the latter, but the former don’t stop, and they don’t revise their ideas either. The two sides just shout at each other. The public has a right to be bewildered.

Milton Friedman has always been associated with the “too much money chasing too few goods” idea. He is well known for saying that inflation is always and everywhere a monetary phenomenon. But that’s because he wanted it to be. It fitted his view of the world.

One of the reasons economics is a shambles is that economists have an obsession with simple models. This is not new. It goes all the way back to the subjects roots. Quesnay’s obsession was a model that showed the flows of activity through three sectors of the economy. As if everything could be reduced to just three such sectors, and as if each sector was predictable, stable, and no one went off the script prescribed by Quesnay. This was in the mid 1700’s just before Adam Smith inadvertently shoved economics lurching off into deep unreality by mentioning – just once mind you – something about the effects of an invisible hand.

This is s brilliant metaphor. It is an awful basis for a model. Ever since he wrote about it economist have been obsessing over it. They see order everywhere on the surface and disorder everywhere beneath. They ask: how come? And, as they say the rest is history. What’s worse is that Smith made this remark right as the real sciences – let’s not dignify economics with that moniker – were careening off into a deterministic, mechanical, and ultra certain cul-de-sac. Well not really a true cul-de-sac. Newtonian physics remains very useful for some explanations and predictions. It just isn’t complete and it needed gentle correction, which is what Einstein did.

The problem is that economics never had its Einstein. It has stayed stuck in the past. It works relentlessly on adding ever more epicycles to its rational, reductionist, and ultra-certain view in order to accommodate the inconvenience of empirical contradiction. It stays simple. Very simple. This is so it can break things apart and study the pieces. Then it hopes that the bits just modeled behave nicely when they are thrown back into the pool.

Which they rarely do. The world is vastly complex and not amenable to simple modeling. Things may mimic the model for a while, but sooner or later the relationship changes and a new simple model is called for. There aren’t many, if any, truly lasting phenomena that economics explains well. And it can’t predict for toffee. Not that prediction is the be all and end all. It would nice, however, to get things right more consistently.

Let’s get back to Milton Friedman.

He has an undeserved reputation. He was very good at self promotion, and managed to have the good fortune to possess a simple model to present as an alternative to the Keynesian view losing its gloss in the late 1970’s. He was in the right place at the right time.

One of his ideas, the one for which he won the Nobel prize, is the Permanent Income Hypothesis. In a nutshell the PIH says that consumers make decisions about how much to spend or save based upon their estimate of their lifetime income, and not their current income. This is because people generally earn more later in life, and, knowing this, are willing to overspend – i.e. borrow – when they are young, and underspend – i.e. save or pay down debt – when they are older. This is important because it helps explain why consumption patterns are less volatile than incomes. People keep spending despite a drop in temporary income.

An alternative idea to explain consumer habits is the Relative Income Hypothesis first put forward by James Dusenberry back in the late 1940’s. It has a distinctly Veblen like flavor. It says that consumers are influenced, not by their lifetime incomes, but by what others are spending. People, it argues, want to keep up with the Jones’s.

Now. Friedman had to reject RIH. That’s why he invented PIH.

Why did he have to?

Because one implication of RIH is that consumers are influenced by social and institutional factors. This is the Veblen flavor coming through. It implies that consumers are not behaving purely along rational lines, and, worse, that economics has to take into account social and institutional stuff Friedman and his followers want to chuck out. This is so offensive to the simple world view Friedman built all his thinking up from that it had to be rejected and replaced with a hypothesis in line with that simple world view.

In my view neither PIH nor RIH is correct in and of itself. There are decisions, home buying for instance, where PIH looks pretty good. There are other’s, fashion and iPods, where RIH seems to come into play. The point being that the obsession to reduce everything to simple ideas that can be put into simple models, condemns economics to misunderstand, and therefore not explain, reality. People are far too nuanced and unpredictable to be shoved completely into either PIH or RIH. They bounce about. The truth is that there are likely plenty more explanations as well. Perhaps there are twenty hypotheses each explaining a little bit. But, since that makes modeling complicated, economists stay well away from reality.

So scared are economists of abandoning their simple views and simple model mania that they would, apparently, prefer to become irrelevant rather than change.

One last example, one that might shock. Growth.

We live at the latter end of an extraordinary event. Humanity has just gone through an unprecedented period of growth. Over two hundred years and counting. In the context of our entire history this is so abnormal as to scream for an explanation. Average incomes and wealth did not change much for centuries. Thousands of years of near subsistence for the vast majority of our ancestors, and a not much better life even for the kings, queens and sundry elites. At least by our standards. Then a sudden rush to wealth. Why?

Given this outrageous anomaly you would think economics would have a water tight explanation for growth. It doesn’t. It really doesn’t. Textbook economics cannot explain, from within its set of ideas, how that rush to wealth came about. It cannot explain the Industrial Revolution. It cannot explain why it began in England. It cannot explain its consequences. And it is hopeless at explaining whether growth is the new normal. Robert Solow had a shot at it in 1957. He wrote a paper that is regarded as ‘seminal’ by economists. It is relatively straightforward in its thinking, but better at its math. So of course it is famous. The problem with Solow’s theory is that it fails to explain well over half of all growth. About two thirds of growth seems to be caused by something that falls outside of the basic parameters of economics. It just sits there as a residual. Solow’s Residual. Yes, this is the economy we are talking about.

Let’s not be too harsh. Solow didn’t think he would get an explanation, he wanted to highlight to extent of the impact of technology and other stuff that sat outside economic theory at the time. Plus people like Romer and Lucas have embellished and expanded on Solow. Romer, for instance, had the temerity to make technological innovation an economic factor inside the economy and not something that dropped from the skies onto it. Clever that. Whoever would have thought that businesses innovate to try to make a buck? Certainly not economists. Well, not all anyway. And not the sort that write the basic textbooks.

Keeping technology outside and not inside the economy is another example of what happens when you allow your simple view and your desire to keep your models simple, drive your thinking.

By the way, that 50% to 60% of all growth that Solow couldn’t explain is still a bit of a mystery. But now it has a clever sounding name: Total Factor Productivity.

Here’s what I think: until we drop the obsession with simplicity, and until we embrace the complexity of reality we won’t resolve this conundrum. By that I mean that the causes of Total Factor Productivity are just as much social, institutional, cultural, and political as they are economic. That is to say that economics needs to change to incorporate those things alongside complex ideas, or it needs to admit it cannot explain the economy.

Then again much of economic theory has little to do with the economy and a lot to do with itself. So, maybe, we are stuck with simple model mania.

That’s embarrassing. We have to ask sociologists, political theorists, and historians what’s going on in the economy?

What are economists for? Wall Street model building?

Simple!

 

/ / , , , , , , , / 0 comments

Ready, Set, Stop

It’s well into summer. The hot spell is over for now and cooler air has settled into Vermont. The flowers are doing well. The bear that visits us occasionally is looking extremely healthy. The birds are singing, and the frogs are enjoying the pond. Oh. And the Republicans are getting desperate.

Really, really desperate.

Their problem is that as the roll out of Obamacare finally gets under way it seems to be, well, working. Not exactly great, but pretty darned good. For the record I still don’t like it, but that’s just me being a purist. I would have preferred a single payer solution, or Medicare for everyone. Judging by the apoplectic fits now convulsing parts of Washington my dream will have to stay on hold. After all it’s the purpose of health care reform to improve health, not cause heart attacks.

It is, however, coming very close to causing hear attacks.

When it was revealed that reform in New York was going to slash the cost of health care insurance by half – some reports suggested two-thirds – the collective groan we all heard was from the Republicans in Congress. The House, under extremist GOP control, has voted nearly forty times to repeal Obamacare. Indeed those repeal votes, none of which matter and all of which consume valuable time better deployed on real problems, are now the way we set our Congressional clocks. Time in Washington is measured by the spaces between each anti-Obama vote held in the House. Whereas time was once accelerating, and whereas it practically stopped a couple of months ago as Congress bickered over immigration, it is now about to pick up again.

So here we go.

Ready, set, stop.

With the stop being yet another fight over the debt limit.

A rational person might be forgiven for thinking we ought to be past these ultimatum driven bouts of brinkmanship. After all the Federal budget is now under control – albeit for the wrong reasons – and so the scary upward trajectory for the debt is now beginning to drop back to earth. Or at least it will as long as we don’t muck things up too much. The fever has broken. The patient is getting better. No one can be pleased with how we all arrived at this relatively happy place, it was all accidental rather than deliberate, but let’s not quibble. Some of us never thought we had a debt problem, but those who, in their error, did must now realize their panic was unnecessary.

The facts don’t lie. We don’t have a budget or debt problem. Not right now at least.

But the Republicans don’t look at facts. They talk amongst themselves. They don’t adjust to the change in our fiscal fortune and tone down their deficit reduction rhetoric because that was never, ever, their issue. It isn’t the government debt that concerns them. It is government itself. They want to cut it. And cut it whether it is doing a good, bad, or an indifferent job. Their goal is not to improve government or make it more cost effective. It is to eliminate it.

You can imagine, therefore, their horror when they realize that Obamacare, that much hated extension of government, is actually a good thing and will help lots and lots of Americans. Nothing could be worse. A government program that works. A government program that voters will love. A government program that does exactly what it set out to do. There is nothing on earth, not even a truckload of Mexicans crossing into Texas, not even a Moslem peace movement, that can destabilize the Republicans the way Obamacare can.

And is.

Yes. These are desperate times for Congressional Republicans. America is about to get a cheaper and more comprehensive health care system.

So. What to do?

Scorched earth. The GOP is going all Leninist. It is going to destroy the economy to save us from ourselves. How noble.

Or at least that’s the plan.

As summer begins to wind its way towards fall we will begin to see the workings of this last ditch strategy. The plan, as we now know it, is to link the debt ceiling to Obamacare. If we want the debt ceiling to be raised, then Obamacre must go.

The first shots have been fired. House Republicans introduced legislation to cut enormous chunks of funding from a series of secondary targets. Environmental protection, national parks, scientific research, new drug approval and other hated symbols of government waste and interference are all on the hit list. No one expects the 29% cut in environmental protection, or in drug approval, to get enacted. The point is to force the Democrats to use up their ammunition defending such horrible things, and to bring into focus that all options to cut the deficit and avoid the need for a debt ceiling increase have been exhausted. Then battle can be joined.

The narrative will go like this: the GOP will say that they will not hold us all hostage if, and only if, Obamacare is shelved. Absent such total capitulation, then they will send us over the cliff, renege on our debts, and create mayhem across the world as our debt is not repaid. Interest rates will hurtle upward, retirees will find their portfolios full of worthless paper, and our economy will implode. For a party that continually prattles on about the need to pander to markets by getting government cut down to size, this is an extraordinary amount of damage to inflict on those markets.

Just because Obamacare works.

It isn’t as if the Republicans have ever come up with their own health care reform. It hasn’t dawned on them to develop one. So they have no plan ‘B’.  Just the same old plan ‘A’.

Obstruct, say no, and stop.

And play hostage games over and over again.

Somewhere deep in their bunker, hidden far away from the real world, and receiving only the warped reports of loyalists, the Republican leadership must believe hostage taking is a good plan. Their hysteria is matched only by the fantasy world they appear to inhabit. Both are extreme. Both are contorted. Both are deeply anti-social. Both are so cynical as to be sickening to those of us who are not ensconced alongside them.

What will become of their last ditch histrionics? What will become of us? Who knows.

Ready, set …

«< 71 72 73 74 75 >»