Monthly Archives: March 2020

Macroeconomics and the virus crisis

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Tyler Cowen writes,

First, consider the relatively optimistic view: Covid-19 will have effects akin to what economists call a seasonal business cycle — which is to say, it will be over quickly and without much lasting damage.

. . .This less sanguine option might look like this: The Chinese economic slowdown leads to a permanent loss of momentum and a global recession. At the same time, with Lombardy closed down, the Italian government defaults, but the European Union is unable to resolve the matter (and the associated bank failures) in a timely and resolute manner. Governments vacillate between policies that make it easier for people to stay at home to limit the spread of the disease and policies designed to get them back in the workplace.

The U.S. would be caught up in the general loss of confidence, as well as the contagion from European banks. . .

Let’s distinguish primary effects from secondary effects, short term and long term.

Primary effects are reductions in activity in certain industries that are a pretty direct result of the virus crisis. Secondary effects would be reduction in activity that take place because people who lose their livelihoods in a directly-affected industry at some point will have to cut back on purchases, and that will affect industries that otherwise you might think would escape problems.

The airlines take a short-term hit from a primary effect. Conferences and other events are being canceled, governments are making it harder to fly into or out of certain countries, and many of us are questioning the wisdom of taking discretionary trips. But at some point air travel will get back to normal.

Cruise ships would seem likely to take a long-term hit from a primary effect. My guess is that some of the fifty-somethings who have watched this crisis unfold have sworn off ever going on a big cruise ship when they reach retirement age, so I would lower my long-term estimates for demand in that industry (and presumably the short-term demand falls of a cliff).

Will the hit to convention traffic be short-term or long-term? What if video conferencing proves its effectiveness? Corporations might decide to save on travel expenses long after the virus scare is over.

Also, there are primary effects that come from disruptions to the international production system, commonly referred to as the supply chain. Some of these are merely short term. But long term, firms will be thinking about building in some redundancy or reducing the use of overseas suppliers. If China no longer needs to build manufacturing facilities, then they do not need to import any materials from the U.S. to build them.

Conventional “aggregate demand” policies would seem to me to be useless for dealing with primary effects. And it’s possible that the secondary effects will not be so severe. So the economists who are eager to flap their gums about what the Fed should be doing might instead want to just hold off for a while.

If there are large secondary effects, they probably will operate through the banking and financial sectors. Banks and shadow banks are often highly levered, meaning that a small adverse development can make a firm go bankrupt. And financial institutions are often intertwined, so that one bankruptcy can lead to another. As the saying goes, when the tide goes out, you find out who is swimming naked.

Perhaps governments have to be included as being among the highly levered financial institutions. Tyler mentions the government of Italy, which seems to be having considerable difficulty with the virus and is in a precarious financial situation.

When financial institutions are worried about their own survival, they are less likely to help the firms that are suffering from short-term primary effects to ride out the storm. So an airline that could still be viable if it could get some loans to tide it over might instead have to declare bankruptcy.

The specific nature of the primary effects argues against thinking that conventional fiscal or monetary stimulus will work. Instead, such policies strike me as equivalent to pouring gasoline all over a car in the hope that some of it seeps into the fuel tank.

In theory, what you want is precisely targeted support, aimed at keeping alive the firms that deserve to survive short-term effects. But what you are likely to get instead are policies that mostly favor firms that do not need help or other firms that deserve to fail.

The introverted anthropologist

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I found the Tim Ferriss/Tyler Cowen podcast very worthwhile, probably more than you will. Points that struck me were:

–Tyler talks about economics as a branch of anthropology.

–Tyler says that he is very even-tempered and rarely unhappy.

–Although it is structured as Tim interviewing Tyler, about 2/3 of the way through, Tyler turns the tables and starts interviewing Tim. One of Tyler’s questions is “What is your theory of you?”

This led me to think that

1. There is a tendency for introverts or guys who are on the spectrum to become anthropologists. My anthropological theory of this is that everyone needs to understand other people in order to get along in the world. Some people are born with or quickly develop instincts for doing that, and they don’t have to think about it much. Those of us who start out with deficits in that area will compensate for those deficits by developing coping strategies. We use our conscious minds to try to figure out what makes human beings tick in general and what makes particular human beings tick. To the extent that we are systemizers, we tend to prefer economics or anthropology to psychology.

2. My theory of me is that I grew up with some innate introversion compounded by an absence of siblings. I had a lot of cognitive ability, which I used to try to acquire social skills intellectually. I became an economist/psychologist/anthropologist/sociologist/political scientist out of necessity. I suspect something similar of Ferriss, of Tyler, of Robin Hanson, of Scott Alexander, . . .

3. Like Tyler, I think that I am almost always in a good mood. Even when I am depressed, I am not sad, if that makes any sense. At the low end of my personal Minsky cycle I lack creativity and energy, but I am still happy. My blog persona is much crankier than I am in real life.

4. Tyler says that it is important to make people feel good about themselves. I agree intellectually, but I have a strong urge to challenge people when I think they are wrong. Even though I know that writing a negative book review is like telling a new mother that she has an ugly baby, I still do it. Tyler will not. If he says that a book “arrived in my pile” or that he “liked it but didn’t finish it,” I infer that it sucked. When I read a bad book, or a bad blog post, the only way I can restrain myself is to self-regulate and avoid commenting. That fails when I am commissioned to review a book and I don’t feel I can turn down the request (more often, I will turn down the request). Or occasionally, as with Deaths of Despair or Phishing for Phools, I feel compelled to shout that the Nobel Laureate wears no clothes.

5. Tyler is currently fascinated by the problem of discovering and developing talent. When I was a middle manager at Freddie Mac, that is the aspect of the job that gave me the most satisfaction, by far. Whenever another department hired one of my staff away from me at a big salary increase, I loved it, feeling that it validated my talent-development skills. The best was when I brought someone in as a financial analyst in Financial Research. This was over the mild objections of an HR person, who complained that the young man had no finance background. Within a year, he was hired away by the Corporate Finance department, and he kept getting promotions (way above me), ultimately becoming the head of a different department with a couple hundred people and a ton of profit-loss responsibility.

My conversation with Eric Weinstein

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I talked about one area where we disagree and one area where we agree.

Let’s start with where we disagree. I take the conventional economic view in favor of international trade, and you differ.

Let me see if I can steel-man your argument. You say that American workers, as citizens of this country, should have a right to access to job opportunities that give them a decent way of life. If we are willing to have their family members go off to fight wars in the name of protecting the rest of us from terrorists, then we certainly owe them protection from having their jobs taken away by outsourcing to Chinese factories.

My counter will be that international trade is isomorphic with other economic actions that you are more likely to approve. Outsourcing to a factory in China and taking away a factory worker’s job is not very different from developing Uber and taking away a taxi driver’s job or a rental-car agent’s job.

Our prosperity comes from breaking production down into steps. When you break the process down into steps, you get more efficiency. This goes back to Adam Smith’s pin factory. Breaking a process into steps can involve what most economists call capital, but the Austrian economists use the term “roundabout production,” which I like. When a farmer uses a tractor instead of a horse to pull a plow, this is roundabout production–manufacturing the tractor becomes a step in the farming process.

International trade is another form of roundabout production. As David Friedman put it, one way to manufacture an automobile is to grow wheat, put it on a ship to Japan, and have the ship turn around carrying an automobile.

The process of breaking production down into steps is mind-boggling in its complexity. There are so many conceivable ways to break down a production process into different steps. How are we to know which is best? The answer is that the price system co-ordinates the process. Prices inform entrepreneurs about the costs of alternative patterns of specialization.

The profit system directs the evolution of the process. As new ideas are tried, the most efficient ones prove sustainable, as indicated by profitability. Less efficient patterns of specialization and trade are weeded out by losses.

Thus, progress proceeds by creative destruction. Ways of life that are tied to a particular step in the production process are bound to be undermined if a new production process emerges that is more efficient. A society cannot enjoy the benefits of economic progress without incurring the cost of job destruction. The market treats work as a bug, not a feature, and it tries to get rid of it.

Back to the comparison of outsourcing to a factory in China or developing Uber. You might be tempted to say that when Uber changes the process of providing people with car rides, at least it doesn’t use Chinese labor in the process. But is that really the case? For Uber to work, somebody has to take the step of adding computer and communications capacity, and that probably uses components imported from China. Consumers need smart phones in order to hail rides, and those phones are partially manufactured in China. And even if there were no Chinese workers involved in the steps to create Uber rides, would that be any consolation to the taxi drivers and rental-car agents who lose their jobs?

If you want to suggest policies for making economic progress less painful for people whose jobs are displaced, that would be very constructive. But insinuating that economists are engaged in a conspiracy to hide the truth about international trade isn’t constructive–it’s just scapegoating.

On the area where we agree, I said,

I’m more in agreement with you on what you call the DISC, which I believe stands for Distributed Information Suppression Complex. Although once again, it sounds a bit too conspiratorial for my taste, and I prefer to think of it in terms of an emergent phenomenon.

Think of life in academic research as consisting of two games. If you play Game One, you pose important questions within your field and try to answer them. If you play Game Two, you try to climb the ladder of prestige by participating in the latest fads and fashions and by ingratiating yourself to people who are in a position to help you get jobs and publication acceptances. Let me use the Game One, Game Two model to offer my take on the DISC.

1. I can imagine a world in which the strategies for playing Game One and Game Two are basically the same. When that sort of Divine Coincidence exists, you will see a very vibrant academic discipline.

2. I don’t think that anyone ever consciously chooses between playing Game One and Game Two. We just go with our instincts. When I was in grad school in the late 1970s, my instinct just happened to be to play Game One. But by that point in time in economics, the profession was selecting away from Game One types and in favor of particularly ruthless Game Two types.

[Note: As John Cochrane wrote recently,

Self-interest, for people to preserve hard-won human capital, and for institutions to support research that keeps them going, is a powerful explanatory force. Even if individuals do not respond to this incentive, and are all pure in their pursuit of ideas, selection is a powerful explanatory force. Economics is a good way to explain economics!

]

The Game Twoers of my era wrote dissertations on Rational Expectations Macroeconomics, which I thought was a dead end. Nothing that has happened since has changed my mind about that.

When I was on the job market, an assistant professor from Amherst came to MIT to interview all of us on the market that year. I gave him a copy of my job market paper, and I talked about it with him. He never offered me an opportunity to audition for a job at Amherst. But he did subsequently publish my exact idea, including a new term that I introduced, called “reputation price,” meaning the price that consumers would expect to see at a store based on their last purchase there. He published it in the Quarterly Journal of Economics, which has typically been a top-five journal, although at that time it was more in the 6-10 tier. No attribution to me of course. I was lucky just to get a version of my dissertation published in Economic Inquiry, a much lower-tier journal.

Why didn’t I go after the guy? My dissertation supervisor, Robert Solow, advised me not to. Even though I am still bitter about the Amherst guy (who got tenure), and bitter about Solow’s nonchalance about it, I have to admit that there is nothing that going after the guy would have done to improve my life, which has turned out pretty well if I may say so.

Anyway, such was my introduction to Game Two.

3. I think that in the last half of the twentieth century, Game Two economics produced little gain from a Game One perspective, and arguably a net loss.

4. I agree very much with your view that academic economists have been slow to come to terms with the fact that the Internet enables businesses to deliver content to consumers at essentially zero marginal cost, but with some fixed costs. One of my lines is that “Information wants to be free, but people need to get paid.” If you want to say that this implies widespread market failure in a textbook sense, I could agree to that. But widespread market failure in no way ensures widespread government success.

Note that there is no link, because this conversation only took place in my imagination.

Giving globalization a bad name

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Reacting to a post by Peirre Lemieux on the coronavirus, Alberto Mingardi writes,

Will people learn the lesson, and realize that a closed economy is poorer, as Pierre hopes? I fear not. Though the emergency measures somehow provide us with a preview of the kind of country the economic nationalists would like us to live in, they will quickly turn the tables, blaming the virus on globalization, and making trade with China the villain of the story. Italy’s reaction to coronavirus is convincing other countries to treat Italians as we treat ourselves – limiting direct flights, imposing quarantines, etc. This will also increase the perception that reliance on international trade is a weakness, thereby fueling a renewed rhetoric of the marvels of autarky. Sure enough, when people travel they carry their diseases with them: this is not news. Prepare for a new nationalist narrative built around this idea.

I agree. I don’t think that this will make people appreciate globalization–quite the opposite.

Incidentally, I think that this makes it unlikely that President Trump will suffer a political setback because of the coronavirus. Closing the border is his signature issue, and the Democrats have staked out a position as the “resistance” to that. I know that they think they can benefit from this crisis, but I would be surprised if they do.

As for the economics of the crisis, I see it in terms of a PSST story. Many patterns of specialization and trade depend on globalization. The conventional wisdom seems to be that the central banks will be prominent actors, but I could not disagree more. I would suggest that instead of monitoring the Fed, one should watch the transportation hubs–especially ports–and manufacturing centers. To the extent that the attempts to contain the virus cause those places to be shut down, patterns of specialization and trade will be broken, and there won’t be anything that the Fed can do about it.

In my view, Scott Sumner and Jason Furman and other macroeconomists who apply a monetarist or Keynesian “model” are simply not capable of interpreting the world as it really exists. That is a harsh judgment, but I cannot be more gentle.

As Peter Zeihan puts it,

Modern manufacturing is a logistical marvel that taps hundreds of facilities in dozens of countries, but that system is based on frictionless international trade. Break just a few links and the entire network collapses. A modern car has about 2000 parts. If you are missing ten, you’ve got a large paperweight.

I suspect that for the economy, the best-case scenario is that authorities gradually decide that it’s not such a crisis, they let everyone go about their business, and whoever gets the virus, gets it. The worst-case scenario is that clusters of cases continue appearing, and each appearance leads authorities to strangle more transportation and production centers. If the latter happens, then I am pretty sure you will find the PSST paradigm more useful in explaining and predicting outcomes.

Paula Bolyard draws an interesting analogy with the Y2K computer scare. If that analogy proves correct, then we should be closer to the best-case scenario. But one thing about the Y2K scare is that it had a definite endpoint–by mid-January of 2000, doomsday was a dud. I only see the coronavirus panic ending when the media can no longer attract eyeballs to the story.

As to the outlook for the virus itself, consider three scenarios:

1) the proportion of people exposed to the virus approaches 100 percent

2) the proportion of people exposed to the virus approaches 0.

3) the proportion of people exposed to the virus approaches some middle number.

I am not a virologist, but this virus seems optimized for spreading. So wouldn’t you bet on 1)?

Suppose that the virologists in the media successfully convince us to become OCD handwashers and germophobes. Will that actually be able to stop the virus? What other consequences, good and bad, might accompany such a change in culture?

Note that I wrote this at the end of February, adding the Bolyard paragraph on March 2 and the references to Peter Zeihan and Jason Furman on March 6. By the time this post appears, I may have to correct some of my claims in light of developments.

UPDATE: John Cochrane has thoughts. Also, Scott Alexander. And Tyler Cowen.

On Garett Jones’ latest book

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I review 10 % Less Democracy.

At a time of populist ascendance, his theme is bracingly countercultural.

I suggested that the editors that we might want to allude to the Bernie Sanders phenomenon as making the book particularly timely, but they demurred.

In the end, I find providing checks on the voters to be the wrong solution to the wrong problem. Once you get lots of Fear Of Others’ Liberty, the FOOLs are all rooting for the exercise of government authority. I doesn’t matter whether you label it “the will of the people,” “technocratic independence,” or “state capacity,” the bottle is still filled with poison.

On Peter Zeihan’s latest book

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It is called Disunited Nations. From the introduction:

What’s been different in recent decades is that geography has been suspended somewhat, enabling deep global economic interconnections. We’ve come to see those connections as a great strength; they are turning into weakness before our very eyes.

Of course, those words were written even before the media discovered the term “coronavirus.” UPDATE: Today, Zeihan posted his take on the coronavirus, and it is exactly what a reader of his book would expect.

Much later in the book, Zeihan writes,

On the farm, we marry young, we work young, and die young. In the city, we marry old, work old, and die old.

In explaining the decline in family size, he argues that industrialization/urbanization is the main cause. Adults who run family businesses, especially farms, usually value children. So a more rural society will have more children. Furthermore, cities are very crowded. Because living space is expensive, an urban society will have fewer children.

One virtue of this explanation for declining family size is that it applies to countries that did not go through the American sexual revolution but still have experienced declining family size as they urbanized. Also, it occurs to me that perhaps the Baby Boom can be attributed in part to the way that suburbs relieved the crowding of cities.

It makes me wonder more generally about the social effects of a shift from family businesses to corporations. What sort of cultural changes result from that? Have other countries succeeded in protecting family businesses, and if so, has this helped maintain birth rates? I suspect that the answer is “no.”

On Ross Douthat’s latest book

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I have finished my first pass through The Decadent Society. I had a hard time following the last quarter of the book, so I may have to re-read it. These are my current impressions:

On the plus side:

1. Many of his sentences and phrases sparkle, e.g. “roving tent-revivalism of TED talks” (p. 10)

2. Many of the data points that he cites are fascinating, e.g. that economic growth accounted for 92 percent of the increase in share prices from 1952 to 1988, but subsequently economic growth accounted for just 24 percent of the increase in share prices. Much of the remainder comes from “a reallocation of rents to shareholders,” according to a paper by Daniel L. Greenwald and others.

Note that I had to search for the paper in Google Scholar, as Decadent Society includes no footnotes or endnotes. Fortunately, Douthat mentioned the title of the paper (he does not mention the authors); elsewhere, he cites literature without giving a clue about where to find it.

On the minus side, I found myself troubled by questions that Douthat bypasses. One question I have is whether technology is moving too rapidly or too slowly.

Are self-driving cars not prevalent because (a) the technology is not up to expectations or (b) the culture is too resistant? I would argue that it is the latter. If we had the spirit that we had 120 years ago, self-driving cars would be on every road. If 120 years ago the culture had been what it is today, we would still be mostly using horses. Too many of us are middle-aged and old, and hence novelty-averse; and too many of the middle-aged and old do not have prospects for grandchildren, and that makes people lose interest in the future.

Folks like Peter Thiel and Tyler Cowen would say that technology is moving too slowly, and we are missing out on economic progress that otherwise might be obtained. On the other side, one could argue that technology is moving too quickly relative to our culture’s ability to adapt, and that is why we are seeing so much wealth inequality, populist discontent, and political derangement. Douthat wants to include both the too-rapid and too-slow theses under “decadence.”

Another instance where I wanted deeper thinking is when Douthat tries to draw out implications from a UN projection that Africa’s population will reach four and a half billion by the turn of the next century. He sees this leading to a large migration from Africa to an otherwise depopulating Europe. But first I would like to see the numbers compared–Douthat sees hundreds of millions of Africans migrating, but is the declining birth rate in Europe sufficient to provide space for hundreds of millions?

Also, I wonder how Africa manages to get to four billion without running into Malthusian constraints. Right now, they certainly don’t have the productive capacity to do it. And it’s not as if the developed world is going to be able to spare the output to support billions of Africans, when our dependency ratios will already be straining the ability of working people to support pensioners. I have difficulty believing a demographic projection that seems to require billions of people living in cities with no food.

On Mary Eberstadt’s latest book

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In a review of Primal Screams, I wrote,

When a tribe is formed out of families, members feel secure in their status. One’s identity is established as a father, mother, sibling, uncle, aunt, or grandparent.

In contrast, when a “forced pack” is constructed out of isolated individuals, there are constant struggles to resolve the uncertainty over who belongs and where members fit in relation to one another. Eberstadt suggests that under such circumstances:

… some people, deprived of recognition in the traditional ways, will regress to a state in which their demand for recognition becomes ever more insistent and childlike. This brings us to one of the most revealing features of identity politics: its infantilized expression and vernacular.

Her thesis, about which I raise doubts in my review, is that young people turn to identity politics to try to address needs that are unmet in today’s weak family environment. I can imagine Eberstadt reading the David Brooks essay to which I referred last week and coming out with her own primal scream.

Russ Roberts and Yuval Levin

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They discuss Levin’s A Time to Build in a podcast. Levin says,

I think when reporters complain about Donald Trump–as they rightly do, in a lot of ways–they should think about whether what Trump is doing relative to what the Presidency is supposed to be isn’t very similar to what a lot of political reporters are doing relative to what journalism is supposed to be. They are engaging in a kind of indulgent performative version of the real thing that makes the real thing much harder to do.

There is a lot of interesting material here. I recommend the whole podcast.

Hating on China

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Marco Rubio says,

Losing industries to China was not an “unintended consequence” of liberal trade and financial policies; it was very often the goal. It required an assumption that middle-class American fami­lies would be better off with cheaper imported goods and better financing terms on consumer debt. It required the assumption that the American economy would be better off with financial services as its comparative advantage. The reason these assumptions are wrong is not because the changes they brought weren’t managed properly, or not pursued consistently enough, but because the underlying belief about what makes for a good society is not true.

Re-read that paragraph and substitute for China “Uber” or “Walmart” or “the Internet.”

And when you read about “financing terms” and “financial services” think about what sector is running up debt at an insane pace.

As you can tell, reading the interview got my libertarian hackles up. In my view, Washington does more damage to the American economy than China, by far.