Category Archives: books and book reviews

Lots of Megan McArdle

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The video of the event on Megan McArdle’s book is here. My talk starts about 26 minutes in, but I recommend listening to her talk, which starts about 2 minutes in.

If you want to watch Megan and Tyler Cowen discuss the book, you can check out this AEI event this evening at 5:30 eastern time–it will be shown live on line if you are nowhere near DC.

Incidentally, in 2004, I collected a series of essays that I had written, and I self-published a book. Prior to publication, I sent the manuscript to my former thesis adviser, Robert Solow, hoping he would write an endorsement that I could put on the cover. He sent me a peevish letter in response, saying that he looked at one of the first essays in the book and saw that one of my citations was to a “blogger,” and he thought that this showed a total lack of rigor and seriousness on my part.

That blogger was Megan McArdle.

Lots of Diane Coyle

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My review of GDP: An Affectionate History is here.

Overall, one arrives at a mixed verdict on GDP. On the one hand, it is the best way that we have to measure economic capability. On the other hand, because it fails to account for consumer surplus, GDP statistics lead us to take an overly pessimistic view of the economy. There is no Great Stagnation. There is only a widening gap between the rate of economic improvement and our ability to measure that improvement.

Tyler Cowen’s review is here:

Yet markets are developing new innovations whose benefits probably are undervalued by the GDP concept. This is the potential revision to GDP that commands the most attention from Coyle. For instance, consumers attach great value to Facebook, Google and Wikipedia, all of which are absolutely free to their users and do not enter directly into GDP calculations. I would go further yet, noting that the modern world also better matches plans and goals. Perhaps you can meet your ideal spouse on Match.com or at least pick up cheaper collectibles, better suited to your taste, on eBay. Who makes mistaken purchases of music these days, when you can hear a lot of the songs in advance online? Just about everything is reviewed online, which helps us spend with greater effectiveness. These gains are not well-represented by the older methods of calculating GDP.

What I’m Saying

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I am a last-minute fill-in for Brink Lindsey at this event discussing the new book by Megan McArdle. The book is about failure, which is a fascinating topic. My talk should begin shortly after this post goes up. I will try to say that the best way to deal with failure depends on the institution.

An individual needs to fail with a fallback position. Megan discusses this in terms of job search and in terms of living within your means so that you can deal with illness or loss of a job. She also discusses the forgiving nature of the U.S. bankruptcy code.

A small startup firm needs to fail quickly. Find out that you need to rethink your concept after you have test-marketed a prototype that you built in three months, not after you have spent two years in stealth mode trying to implement your grand design.

A large, established firm needs to fail gracefully. Be able to kill the project without killing the company. You might think of Coca-Cola’s recovery from New Coke, but the real graceful failures are the ones we never even hear about. A large firm that fails ungracefully is denying that it is in trouble (Megan uses the example of Dan Rather and Mary Mapes of CBS News, who put out a story based on a forged document and just refused to back down from the story.)

Government cannot do any of these things well. Think of Obamacare. Fallback position? None. Quick failure? No, it is going to be long and drawn out. Graceful failure? No, it is a big, ugly failure.

At one point in Megan’s book, she writes,

There is a scientific name for people with an especially accurate perception of how talented, attractive, and popular they are–we call them clinically depressed.

For government, I think that the only solution is clinical depression.

The Phelps Contention

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A few nights ago, a number of us met over dinner to discuss Edmund Phelps’ book, Mass Flourishing. He contends that starting around 1970s, America’s commitment to modern values started to recede, and we began reverting to traditionalism. That in turn leads to reduced innovation and slower economic growth.

The reaction to this hypothesis from several Baby Boomers and younger discussants ranged from skeptical to apoplectic. Not modern? Us? Civil Rights! Women’s Equality! Four-letter Words! Gay Marriage! Smart phones!

Against those, here are some counterpoints, some of which Phelps has noted:

–decline in the propensity of young adults to move far from their parents (or even out of the house!)

–increase in NIMBYism (often masquerading as environmental concern), blocking development, for example, of airports.

–lower rate of new business formation

–stifling safety regulations (in nuclear power and in drug development)

–resistance to innovation in food production (GMOs)

–demonization of the 1 percent

–hostility to energy production and consumption

What Phelps means by modern values are individualism, self-reliance, and striving for individual excellence. By his standards, he would argue that those values are on the decline. This is a topic that is a bit squishy for economists to try to grasp, but I am not certain that Phelps is wrong.

By the way, I reviewed Phelps’ book here. He says that, contrary to my review, he is an anti-Schumpeterian. I am not sure what he means by that. In any case, he believes that innovation consists much more of small, everyday innovation than it does of dramatic examples such as the internal combustion engine. I tend to agree, and that is one reason that I have been unwilling to side with stagnationists who complain that we have not seen anything Really Big in the most recent two decades.

Treating Conservatism as a Personality Defect

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My latest book review.

In Our Political Nature: The Evolutionary Origins of What Divides Us, author Avi Tuschman interprets political attitudes in terms of human evolutionary strategies. Conservatives have personalities that align with one set of strategies, and liberals have personalities that align with another. It is an intriguing analysis, but one to which I have a number of objections.

Tuschman’s thesis is that conservatism is fundamentally about marrying within the tribe (endogamy). Liberalism is fundamentally about exogamy.

In my own Three Languages book, I try not to demand and oversimplify ideological views. I talk about the three axes as languages that are used to achieve closure on issues and demonize those who disagree. However, I assume that people arrive at their views via reason.

Tuschman does not credit people with reason. However you rationalize your beliefs on immigration or gay marriage, if you are antagonistic it is because you are inclined toward endogamy and if you are favorable it is because you are inclined toward exogamy.

The New Piketty Book and Social Security Privatization

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I have not read it, but Tyler is touting it. Apparently, Piketty argues that it is normal for the return on capital to exceed the growth rate of the economy.

I always thought that this was impossible. Ten years ago, I wrote,

If stock prices grow at 7 percent per year while the economy grows at 2 percent per year, then the ratio of stock prices to GDP (P/Y) fifty years from now will be more than ten times what it is today. How could that happen?

If the price-earnings ratio of the stock market (P/E) stays constant, then in order for P/Y to increase tenfold, the ratio of earnings to GDP (E/Y) has to increase tenfold. However, corporate profits are over 10 percent of national output today, so that if the ratio increases by tenfold, then corporate profits will be more than 100 percent of national output. That is impossible.

Alternatively, suppose that the ratio of corporate profits to national output stays constant. Then we need the P/E ratio to increase by tenfold in order to get a tenfold increase in P/Y. So, if the P/E ratio today is about 25, then in fifty years it will be 250. That would require investors to almost ignore risk and the time value of money in valuing stocks. No one believes that this is possible.

Perhaps Piketty has a better grasp on this than I do. But if the return on capital is going to exceed the growth rate of the economy, then this strikes me as powerful argument in favor of privatizing Social Security, so that people don’t get cheated out of these wonderful returns. Again, I have not read the book (it will be released in about 6 weeks). Does he come out in favor of privatizing Social Security? If not, then why not?

A Robot-Friendly Environment?

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I am still reading The Second Machine Age. The section on the improvements in robotics made me think about creating a city that is robot friendly. Imagine a city with “self-driving car lanes” comparable to bike lanes today. My guess is that self-driving cars could be more efficient without humans.

But why not go further? Instead of making robots adapt to the human environment, why not put RFID’s on every object and surface, to make it easier for robots to operate. The place to try this out might be at an expensive resort or a cruise ship. You could be in your room and say to your phone or wristband, “I am ready for lunch.” You listen to a menu, you make your choices, and robots assemble and deliver your meal. If you are at a golf resort and are ready to play, you could summon a self-driving golf cart to take you around the course. Maybe each hole could adapt to your level of skill, with the location of the pin and various sand traps moving while you come toward the tee.

Fischer Black on the ZLB

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On the topic of aggregate demand, he writes,

When people say that they see shifts in aggregate demand, they mean that they see changes in the match between wants and resources. Thus in a more specific sort of model, high aggregate demand can be a good match. If this is what “aggregate demand” means, we could also call it “aggregate supply.”

That is from p. 87 of the 2010 edition of Exploring General Equilibrium. Basically, he sees a cyclical slowdown as a reflection of capital investments that were made with good intention but turned out to be wrong. In my terminology, people bet on certain patterns of specialization and trade, and those turned out not to be sustainable patterns.

On the Great Depression, he writes,

Firms made investments during the 1920s based on their beliefs about what tastes and technology would be, along many dimensions, during the 1930s. These beliefs turned out to be very wrong, so the investments were not worth much and ability to produce what people wanted was low…

But monetary forces played a big role too…many countries experienced sharp deflation, which drove their nominal interest rates down. Normally, very low nominal interest rates mean a big demand for currency [but] some countries stopped supplying currency passively. This meant a serious breakdown in financial markets.

…the deflations forced short-term nominal interest rates to zero in some countries, and would have made these rates negative were it not for the effective floor at zero. This caused disequilibrium in real asset markets. The real interest rate was forced above its natural level. It was a kind of “currency trap.”

Longer-term nominal interest rates did not fall to zero, because they reflected the chance that the nominal short rate would bounce back to positive levels. But they were artificially high, so longer-term real rates were artificially high, even more so than short-term real rates.

Some notes:

1. He does not believe in AD, but he thinks that the ZLB mattered in the Great Depression. He thinks that the artificially high real interest rates accentuated the mismatches between previous investments and prevailing wants. He does not give any examples. But imagine that you are a farmer, and you invested in farm machinery, and now crop prices are falling. Are you going to throw more money at your investment by buying seeds and fertilizer? Will the bank lend you the money to do so? If growing crops is no longer profitable, then the value of your investment in farm machinery is looking bad.

2. He is saying that just because you observe positive long-term interest rates, that does not mean that the ZLB is unimportant.

3. What about the U.S. in the last five years? On the one hand, we have seen low short-term interest rates. On the other hand, we have not had deflation, so the short-term real interest rate has been low rather than high. Has the long-term real interest rate been artificially high because of the ZLB?

4. In explaining unemployment, I would be inclined to focus more on mismatches involving human capital. In the 1930s, men who had been farm laborers and tenant farmers were thrown out of work by tractors, trucking (which made it possible to shift production away from relatively poor farmland close to cities to better farmland farther away), refrigeration, and so on. Also, workers whose human capital was in cigar rolling or lightbulb glass-blowing found themselves obsolete. In hindsight, these guys should have stayed in school instead of dropping out without completing high school. But as it was, there were too many of them relative to the technology of the 1930s, which ultimately called for a work force with at least a high school education.

Today, I would say that, in hindsight, more people should either have acquired computer skills or prepared for life providing elder care or otherwise engaged in personal services.

Fischer Black: Seeing Capital Everywhere

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After Tyler Cowen told me that my macro book needs more on Fischer Black, I ordered the 2010 edition of Exploring General Equilibrium, which includes a posthumous essay. I will probably have a number of posts on the book.

One way I think of Black is that he sees capital everywhere. In an extreme (and Black does not take things this far), think of the economy as nothing but different forms of capital producing utility. Take the concept of human capital really seriously, to the point (again Black does not take things this far) of looking at a human worker as just another machine.

From the point of view of a firm, the human worker-machine has some capabilities. However, in order to make it productive, you have to set it up, tune it, program it, and coordinated it with other machines. It becomes obsolete when the cost of maintaining and using it exceeds the value of what it produces.

When I ate a piece of toast this morning, I was getting utility out of various forms of capital. These included the refrigerator out of which I took the bread and the toaster oven. However, the bread itself resulted from roundabout production. Seeds were planted, grain was harvested, other ingredients were added, loaves were baked, etc. In order to know how to obtain the bread and operate the toaster oven, I had acquired human capital.

In a world where utility is produced almost entirely by capital, most economic decisions are risky. Any decision today represents a bet on how the world will look tomorrow.

Some remarks on this capital-centric point of view.

1. Standard national income accounting assigns a 2/3 weight to labor’s share of output. But perhaps this is highly misleading. The value comes from the capital embodied in the workers, which includes general human capital (skill usable everywhere) and specific human capital (skills usable on a particular job).

2. Standard national income accounting says that consumption is over 2/3 of output. However, very little output is immediately consumed. When I buy a loaf of bread, I do not consume it immediately. Instead, the bread is an input to consumption that takes place over subsequent days. Although Black does not take things this far, you can think of the bread as capital that, when used, depreciates rapidly and proportionately. This is in contrast to the toaster oven, which depreciates slowly and not exactly proportionately to its use.

3. The value of capital changes as events unfold. A desktop computer from 1987 is not worth much today. Houses in Las Vegas were not worth as much in 2009 as they were in 2005. The ability to shoe a horse is not worth much today. Arguably, a plain vanilla college degree was not worth as much in 2013 as it was in 2006.

4. Black points out that because of adverse selection and moral hazard, human capital investments are harder to diversify than physical capital investments. That is, I cannot sell shares in my future earnings without creating adverse-selection and moral-hazard problems, so I have to retain a large interest in my own human capital.

5. One of Black’s central points is that as events play out, some investments earn good returns and some investments earn bad returns. You will not always see equal amounts of good luck and bad luck. A lot of good luck is a boom. A lot of bad luck is a bust.

6. Black says several times that worker compensation consists of training as well as pay and benefits. When a lot investments do not pan out as hoped/expected, compensation for some humans has to fall. Black points out that if the compensation still includes a lot of training, then the firm may not be able to afford much in terms of wages and benefits. It made me think of unpaid internships as a market response to these circumstances. Of course, dropping out of the labor force is another natural response.

7. In thinking about the current situation, ask yourself which sorts of investments are no longer panning out. At the margin, does it no longer pay to take on a manual worker and train that worker? Health insurance costs are rising, and machines are getting smarter and more dexterous. At the margin, does it no longer pay to hire an American worker with a plain vanilla college education? A web site and a call center in India may be more efficient than an American sales force. Maybe financial institutions have had to cancel a lot of plans to hire plain vanilla college graduates to work in what was once thought to be an ever-expanding lending-securitization industry. Maybe when you factor in health care costs and the time it takes for a worker to get up to speed, the present value of investing in a new college-grad worker is no longer positive.