Category Archives: books and book reviews

Who Says These Are Public Goods?

Posted on by

By paying for public goods like education and health care, governments can improve efficiency as well as welfare.

That is from John Micklethwait and Adrian Wooldridge, writing in The Fourth Revolution. I have just started to read it, based on Tyler Cowen’s recommendation.

If one of my high school students wrote the quoted sentence, it would receive a bad grade. The standard economic definition of public goods is that they are neither excludable nor rivalrous. That means that once the good is produced, it is hard to stop anyone from enjoying it, and one person’s enjoyment does not interfere with someone else’s enjoyment. National defense and pubic public safety are classic examples. Sanitary conditions in a city would qualify.

However, education and health care do not qualify as public goods under the standard definition. If it chooses to, a school or hospital can exclude non-paying customers from obtaining its services. And your use of a teacher’s or a doctor’s time can reduce my ability to use that person’s time.

Another characteristic of public goods is that the social benefits exceed the private benefits. One can make a case that vaccinations have that property. In theory, driver education would have that property also. However, for the most part, the benefit I receive from your education and health care is extremely low, particularly relative to the benefit that you receive from those goods.

In my opinion, casually making the case that government should pay for health care and education by asserting that these are public goods sounds to me like what Tyler would call “mood affiliation,” not sound reasoning. I hope that his endorsement of the book does not turn out to be mood affiliation.

Matt Bruenig vs. Larry Summers on Piketty

Posted on by

He writes,

He accuses Piketty of confusing gross returns to capital with returns net of depreciation. But in the book, Piketty specifically says that his figures are net of depreciation. If you want to quibble with his specific data or how he accounts for depreciation in it, then you can do that, but you can’t just say “I think he misreads the literature by conflating gross and net returns to capital.” He doesn’t conflate them. He’s careful to explain the importance of depreciation and tries to account for it.

Pointer from Mark Thoma. Unlike Bruenig, Summers is very clear to distinguish Piketty’s data from Piketty’s analysis. The data may include depreciation, but the analysis, in which Piketty argues for an elasticity of substitution between capital and labor greater than one, evidently does not include depreciation. I give this point to Summers, not to Bruenig.

Bruenig goes on,

Additionally, when economists start going into the substitution elasticity stuff (on which Summers himself admits there is not good data), they appear to me to be pushing Piketty into a physicalist capital framework that is totally different from what he is talking about. As I explained in a prior post, Piketty has a social constructivist account of capital. The “capital” he is discussing in his book refers to all tradeable assets that deliver passive returns, not just physical buildings and machines and the like. Models that try to show adding more machines will cause the rate of return to fall proportionally such that the owners of the machines won’t grab increasing shares of the national income do not actually address Piketty’s “capital.” Summers falls into that trap here.

Right. Who cares about all this neoclassical production function, Solow growth model stuff, anyway? Instead, give a “social constructivist account of capital,” and just make statements about how this capital accumulates, earns returns, and becomes concentrated in the hands of a few.

I can be sympathetic to that approach. I would be the last person to defend the neoclassical aggregate production function. But a “social constructivist account of capital” leaves a lot of room for reasonable people to disagree about whether Piketty has discerned the true nature of capitalism or is instead being highly speculative.

Larry Summers on Piketty

Posted on by

Mark Thoma seems to have provided the first pointer, although others surely will follow.

Summers’ review is the most complete evisceration of Piketty’s economics that has been published to date. But Summers suggests that we sniff the rose, never mind the manure that lies underneath. He writes,

Even in terms of income ratios, the gaps that have opened up between, say, the top .1 percent and the remainder of the top 10 percent are far larger than those that have opened up between the top 10 percent and average income earners. Even if none of Piketty’s theories stands up, the establishment of this fact has transformed political discourse and is a Nobel Prize-worthy contribution.

This is reminiscent of Brad DeLong. It strikes me as intellectual charity driven by ideological sympathy. I encourage everyone reading this blog to do the opposite. Reserve your most charitable interpretations for those whose views disturb you, and adopt the most critical-thinking posture toward those whose views please you.

The bulk of Summers’ review consists of just this sort of critical thinking. Summers writes,

Piketty argues that the economic literature supports his assumption that returns diminish slowly (in technical parlance, that the elasticity of substitution is greater than 1), and so capital’s share rises with capital accumulation. But I think he misreads the literature by conflating gross and net returns to capital. It is plausible that as the capital stock grows, the increment of output produced declines slowly, but there can be no question that depreciation increases proportionally. And it is the return net of depreciation that is relevant for capital accumulation. I know of no study suggesting that measuring output in net terms, the elasticity of substitution is greater than 1, and I know of quite a few suggesting the contrary.

I have not seen this point about the confusion of gross and net return made by anyone else. By DeLong’s standards, that means we should dismiss Summers’ argument. But to my eye, it seems like a powerful criticism. [UPDATE: Oops! A commenter points out that Matt Rognlie had made the exact point about gross and net return.]

Remember the scandal over the Reinhart-Rogoff spreadsheet? This strikes me as considerably worse.

Summers also writes,

Rather than attributing the rising share of profits to the inexorable process of wealth accumulation, most economists would attribute both it and rising inequality to the working out of various forces associated with globalization and technological change.

As in the Smithian theory of inequality.

Wading into Probability and Race

Posted on by

I am still only partly through Nicholas Wade’s A Troubled Inheritance, and I am dealing with what I think is a Bayes’ Theorem issue.

For Wade, a race (as in European or African) is a cluster of genes that go together in a sense that is probabilistic rather than absolute. You can identify a person’s race with high probability, based on DNA analysis. Apparently, the cluster of genes involved is large–over 100 different alleles. (I may not have this right. I never took a bio course.)

Suppose that there are 100 alleles of interest, each of which can be “heads” or “tails” (did I mention that I never took bio?). In Europeans, each one has a 55 percent chance of being heads. In Africans, each one has a 50 percent chance of being heads. If you observe a person in which only 40 of the alleles are heads, you can be very confident that this person is an African. There will be 14 times as many Africans as Europeans with 40 or fewer “heads.”

But once you have confidently identified an African, and you want to predict whether the African has heads or tails on a particularly allele, it is still a 50-50 guess. Or, I suppose you could say that in this particular instance, knowing that 40 of the alleles are heads, it is a 40-60 guess.

My point is that you can have a very high probability that someone is an African, conditional on a bunch of genetic characteristics. But at the same time, you can have a not-so-high probability that someone has a particular genetic characteristic, given that someone is an African. (For some characteristics, notably dark skin color, the probability that the African has that characteristic is very high. But the same need not be true for other characteristics.)

The really loaded issues in race have to do with the probability of having a characteristic given that you belong to a race. So far, Wade has not told me anything that indicates that we know much about this. Instead, he tells me we know a sort of reciprocal probability, which is the probability of belonging to a race given that you have a particular set of genetic characteristics. If you know Bayes’ theorem, you know that the one conditional probability need not be close to its reciprocal. I think that the hypothetical result given above makes one wary that there is a Bayesian sort of problem lurking in this book. Bear in mind that I am only part of the way through.

UPDATE: Wade apparently is out as NYT science writer. The reasons have not been disclosed, but I doubt that Bayes’ Theorem was a factor.

UPDATE 2: Commenters point out that Wade has been a former science editor at the NYT for quite some time, so perhaps the story of him being out is a misinterpretation.

The Tribalism Hormone

Posted on by

I am still not very far into Nicholas Wade’s Troubled Inheritance, but I found out something I did not know but which fits well with my world view. It turns out that oxytocin is not some generic “trust hormone” that makes one feel at ease with all sorts of strangers. Instead, describing the implications of recent research by Carsten de Dreu, Wade writes,

Oxytocin engenders trust toward members of the in-group, together with feelings of defensiveness toward outsiders.

A Smithian Theory of Inequality

Posted on by

It seems that Piketty offers one stylized fact about inequality, which is that it rose during the long 19th century, fell during the period of the World Wars and their aftermath, and has risen since. What might explain this?

I would offer a theory in the spirit of Adam Smith: the division of labor is limited by the extent of the market.

My theory is that the more division of labor, the greater the inequality within a nation. Of course, from a world perspective, inequality may go up or down, and in recent decades it has gone way down.

The long 19th century was an era of globalization. World War I interrupted that, and there was little recovery of international trade between the wars. After World War II, trade also was limited. We had the cold war, which isolated the East from the West. We had economic policies in many countries that were anti-trade (remember import substitution?). Finally, in the 1980s, we began to see liberalization in the West, and then greater liberalization in China, India, and some of the former Soviet bloc. Then we had the Internet, which opened up new opportunities for specialization and trade.

This unleashed a new round of globalization, and the “extent of the market” became greater. The business opportunities this created helped to increase inequality within nations. At the same time, incomes increased in India, China, and several other poor countries, so that world inequality fell.

This theory won’t give me a best-selling book. But I think it has merit.

What I’m Reading

Posted on by

It’s the book that you’re not supposed to read. A Troublesome Inheritance: Genes, Race and Human History, by Nicholas Wade. Robert VerBruggen reviews it.

An overarching theme is that while institutions matter greatly — just look at the difference between North and South Korea — it is possible that some institutions are better able to take root if certain genetic adaptations have already taken place. If human populations in some parts of the world, but not others, evolved slightly higher levels of trust, a slightly greater tendency toward nonviolence, and so on — perhaps because population density forced them to live in close proximity to each other, abandon tribalism, and develop states — that might help to explain why some populations have become unusually peaceful, democratic, and economically productive.

It seems that many people disagree with parts of the book, although they disagree with different parts. If I were Brad DeLong, I might say that this proves that the book is basically right. But I’m not and I won’t.

Me on Greg Clark’s Latest

Posted on by

I write,

his findings argue against the need to create strong incentives to succeed. If some people are genetically oriented toward success, then they do not need lower tax rates to spur them on. Such people would be expected to succeed regardless. The ideal society implicit in Clark’s view is one in which the role of government is to ameliorate, rather than attempt to fix, the unequal distribution of incomes.

The book I am reviewing is The Son also Rises, in which Clark argues that social status is highly heritable everywhere in spite of many differences in institutional rules. I spend a lot of the review talking about the statistical basis for Clark’s work.

The Political Economy of Big Banks

Posted on by

David Cay Johnston reviews All the Presidents’ Bankers, by Nomi Prins. He concludes,

But the banks are only big, not strong. Indeed, the “stress tests” to determine if the banks can withstand another financial shock are designed to test only for minor upsets, rigging the game in favor of the Big Six, which all engage in unsound practices, especially trading in derivatives. They remain big because of bad laws and enablers like Geithner and because politicians desperate for campaign donations listen to the pleas of bank owners more than those of customers. So the bankers live in grand style, lavished with subsidies that cost us more than food stamps for the poor. In return for this largesse, the bankers savage our modest savings.

Pointer from Mark Thoma. To me, Johnston’s rhetoric seems over the top, and if all Prin has to offer is rhetoric and conspiracy-mongering, then I see no need to read her book. Nonetheless, if you ask me about the political economy of big banks in this country, I would say that I believe that their profits come from rent-seeking in general and from the too-big-to-fail subsidy in particular. I think that breaking up the big financial institutions would provide a net public benefit.

However, I would caution you that Fragile by Design, by Calomiris and Haber, offers nearly the opposite perspective. For them, it is America’s historical hostility toward large banks, and the consequent fragmentation of banking, that is the original cause of fragility here. I think Prin would have a hard time arguing, as she apparently attempts to do, that concentrated banking has been a feature of the U.S. for over a century, when banking across state lines was all but impossible up until around 30 years ago. The other point in favor of Calomiris and Haber is the stability of Canadian banks, where the big six have a much higher market share than the big six in the U.S.

Ryan Decker on Piketty

Posted on by

He concludes,

ultimately this is a chart book, with plenty of economic data but very little economics.

Pointer from Tyler Cowen. And lest you think that the quoted sentence is a compliment, earlier in the post Decker writes,

By referencing only charts (if even that) for many of his claims, he is feeding the sloppy and destructive “this one chart proves…!” fad that has spread in the blogosphere; a chart is never sufficient to make causal claims or demonstrate optimal policy. In this sense, Piketty does his readers a disservice. He should have asked them to think harder instead of just gazing at graphs.

Many economists, including Jamie Galbraith, Robert Solow, Brad DeLong, Matt Rognlie, and myself, automatically credit Piketty with having a neoclassical production function in the background, with some strong and and unconventional assumptions built in. Decker questions whether Piketty is using a model at all.

After reading Decker’s post, I searched Piketty’s book using Google booksearch for the phrase “production function.” It appears only 9 times, without much in the way of accompanying equations. So maybe Decker is right, although it is still possible that Piketty has some math in his back pocket that he can pull out for us.

I am a critic of the use of math in economics, and that includes a lot of macroeconomics as well as the production function. But at a deeper level, what I am against is making sweeping statements about phenomena that are too complex to be amenable to sweeping statements. Making sweeping statements that are backed up by mathematical equations is bad. Making sweeping statements that are not backed up by math is worse.