Category Archives: PSST and Macro

Kevin Erdmann responds to Dean Baker

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Erdmann writes,

we imposed the “inevitable” bust on the owner-occupier housing market. Instead of looking for ways to stabilize mortgage markets, lending was largely cut off to the bottom half of the market from 2008 on, and we can see the devastating effect if we look within cities, most of which look like Atlanta, where low tier prices took a post-crisis hit to valuations, frequently of 30% or more. This has caused the market price of low tier homes to drop below the cost of construction, causing new building to dry up in low tier housing markets.

Read the whole post. Note especially the first chart. My thoughts:

1. That first chart depicts construction spending as a percent of GDP. Baker did the same thing. This makes 1986-1990 appear similar to 2006-2010. But the denominator, GDP, was rising in the early period and falling in the latter episode. So the slump in the numerator, construction spending, was probably much more pronounced in the latter period.

2. Some of the credit tightening in the mortgage market was inevitable. You could not keep lending on generous terms to non-owner occupants. At some point, the speculators had to get squeezed out.

3. But the political crackdown on mortgage lending was severe. I remember that it seemed as though in 2009 the only people who could get mortgages were those who did not need them.

4. Some day, people may look back at “quantitative easing” as a credit crunch. It steered banks toward holding interest-bearing reserves rather than lending to the private sector. I think of it as a credit-allocation scheme, in which government debt was favored (by the Fed, which n-tupled the size of its balance sheet) and private investment was dis-favored.

5. Instead of looking at aggregate demand, try to think of 2007 to the present from a PSST perspective. Perhaps patterns of specialization and trade related to the construction boom became unsustainable around 2007. Other patterns became unsustainable when the government took over the credit markets in 2008 and 2009. Other patterns became unsustainable when the Obama-era zeal for regulation had an impact. Only recently have new patterns of trade been emerging significantly faster than old patterns disappeared.

The Night of Two Dreams

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Here, I am going to give my views on (a) how the conscious mind and the unconscious mind relate; and (b) the state of the economy today and how it got there. I am going to choose a roundabout approach, based on two dreams. I had these dreams and remembered them while I was in the middle of reading Michael Pollan’s How to Change Your mind. The dreams occurred the night after I wrote the previous post. As of this writing, I am somewhat farther along in the book, but still not finished. My theory of dreams is that they allow the unconscious mind to play with stuff that they have picked up during the day. Continue reading →

Nathan Smith

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On Facebook, he writes,

The most overrated economist in the world is Daron Acemoglu; the most underrated may be Arnold Kling. For years, I’ve been getting more and more disillusioned with economics, as the noise of pointless rent-seeking “publications” (the term is a falsehood because articles are more public on SSRN than in a subscription journal) marginalizes fresh insight, and excessive respect (to the point of sycophancy) for legacy ideas and a few academic stars prevents newer and truer ideas from capturing the heart of the discipline. I’ve been wanting to write a book that builds economics from the ground up in a new way, rethinking the basics, selecting a truer set of ideas and integrating them into a new curriculum that would do more to help people understand capitalism… but what publisher would take me seriously? And then I found that Arnold Kling has written it! This is a well written book with good explanations, but more importantly, he picks the right ideas, the ones that aren’t just gimmicks or too unrealistic fort the gap with reality to be bridged, the ones that really matter and have limitless applications and are worth understanding and reflecting on. And then he sequences them well so that they build on each other. I’d like to see this book adapted to become the standard textbook for college freshmen studying economics. If you want to understand capitalism, this is the book I’d recommend.

He is plugging Specialization and Trade. So I’ll plug his (semi-dormant) blog, called Reinventing Economics.

Debating Daniel Jelski

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He criticized my moonshot essay in which I attacked neoclassical economics. I appreciate that he took the time to read it and consider it seriously. But I want to reply to two of his points.

1. He writes,

My old professor in general chemistry (Norman Nachtrieb–now deceased) told us that “science is the art of successful approximation.” Ideal gas law is valid as long as intermolecular forces are assumed to be negligible. A step in an engine cycle is adiabatic as long as no appreciable heat escapes into the environment. The words “negligible” and “appreciable” are purposely left vague, and depend on how precise an answer one actually needs in the result.

I do not believe that the neoclassical model of two factors of production is a decent approximation for any purpose. In the essay, I explain why the concept of aggregate labor productivity is not a useful approximation.

The main claim of the neoclassical model is that factors of production are compensated according to their marginal productivity. We do not observe this in practice. The neoclassical model says that all “labor” is compensated identically at the rate w, and all “capital” is compensated identically at the rate r. Instead, we observe heterogenous wage rates and heterogeneous returns on various forms of investment.

The neoclassical model says that the main cause for variation in wage rates should be the amount of capital per worker. To explain the difference in wages between a construction worker in the U.S. and a construction worker in Mexico, you should be able to point to much higher capital per worker in construction in the U.S. But it turns out that very little of this “capital differential” is tangible. A lot of it reflects cultural differences in management and social norms.

Suppose that you wanted to explain why software engineers are paid more at Google than at some other firm. According to neoclassical theory, that must be because their marginal product is higher at Google. But you cannot even begin to measure “marginal product.” They are working on teams that create a joint product. So the neoclassical claim is vacuous in this case–you can neither confirm nor refute it.

2. Jelski writes,

Contrary to Mr. Kling, I think culture changes are on a generational timescale–roughly 30 years.

If this is true, it does not refute my point that cultural change is accelerating. When did cultural change start occurring at a generational timescale? Probably not before the 20th century. Go back several hundred years, and hardly any cultural change took place over the span of a generation.

Suppose we were to look at measures of economic change. I think the economy is becoming more specialized at a faster rate than before.

How many companies broke into the top 100 between 2000 and 2010, and how does that compare with the number that broke in between 1980 and 1990?

How many new occupations were created between 2000 and 2010, and how does that compare with the number created between 1980 and 1990? (note: the BLS may not have been able to track this accurately)

Take the top five occupations in 1980, and calculate the change in the percentage of the labor force engaged in those occupations in 1990. Then take the top five occupations in 2000, and calculate the percentage of the labor force engaged in those occupations in 2010. If change is accelerating, then we should see a much bigger drop in the recent period.

A moonshot to overthrow neoclassical economics

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Tyler Cowen gave me an idea. He described his personal moonshot. He wrote,

My goal is to be the economist who has most successfully used the internet as a platform to foment broad enlightenment.

He elaborates on this, creating a concise statement of his mission as a public intellectual.

So I did something similar. Please read Overthrow Neoclassical Economics: my personal moonshot. It begins,

My personal moonshot is that I wish to be a leader in overthrowing neoclassical economics.

…As I see it, neoclassical economics is characterized by two essential propositions.

1. Production is a process that employs two primary factors — labor and capital.
2. The distribution of returns to labor and capital reflects their respective contributions to the production process.
There are many economists, particularly on the left, who reject (2) in favor of theories of distribution that stress the role of political power. This criticism may have merit. But my criticism is more fundamental than that. I reject (1) as a useful description of the contemporary economy.

In neoclassical economics, individual productivity is inherent in the technology and the amount of capital per worker. In reality, it is way more complicated than that. Indeed, there are power relationships, but it is way more complicated than that. Technology and relative power are not sufficient to determine individual productivity and compensation. Everything depends on who you are teamed up with, how you are organized, the overall culture in which you are embedded, and other factors, including ongoing dynamics and expected future changes.

The case against policy analysts

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Robin Hanson writes,

On the other side, however, are most experts in concrete policy analysis. They spend their time studying ways that schools could help people to learn more material, hospitals could help people get healthier, charities could better assist people in need, and so on. They thus implicitly accept the usual claims people make about what they are trying to achieve via schools, hospitals, charities, etc. And so the practice of policy experts disagrees a lot with our claims that people actually care more about other ends, and that this is why most people show so little interest in reforms proposed by policy experts. (The world shows great interest in new kinds of physical devices and software, but far less interest in most proposed social reforms.)

Tyler Cowen adds,

Policy analysis, while it often incorporates behavioral considerations, when studying say health care, education, and political economy, very much neglects the fact that often both the producers and consumers in these areas have hypocritical motives. For that reason, what appears to be a social benefit is often merely a private benefit in disguise, and sometimes it is not even a private benefit.

Some comments of my own.

1. This is where George Mason has a very distinctive point of view. Bryan Caplan’s The Case Against Education will be out soon. There is Hansonian medicine. And of course The Elephant in the Brain.

2. My minor contribution is to say that whatever the policy analyst inputs to the policy process, the output is usually policies that subsidize demand and restrict supply. See my book Specialization and Trade.

3. And of course there is the whole Hayekian theme that about what policy analysts do not know about complex problems.

It is too bad that there is so much resistance to these ideas, all of which seem persuasive to me.

Disaggregating the economy: California

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Carson Bruno wrote,

between 2009 and 2014, the Silicon Valley metro areas – a region that accounts for just 1/5th of the state’s population – accounted for 50% of California’s private industry real GDP growth.

Steve Baldwin adds,

a far more accurate assessment of [California’s] economy, [Richard] Rider writes, would be per capita GDP as compared to the rest of the country. After adjusting the GDP figures to account for the cost of living (COL), the Golden State ends up with a paltry 37th place ranking within the U.S.A., with a $45,696 per capital GDP. Even rustbelt states, such as Michigan and Ohio, have a higher adjusted per capita GDP.

There are parts of California where adjusting for the cost of living makes incomes lower than they might otherwise appear to be. Other parts of California have low incomes, but this is alleviated slightly by a lower cost of living.

It is difficult to think of California as a homogeneous economy with a single GDP factory. It is even more problematic to try to look at the entire United States through that lens.

Disaggregating the economy: product scanner data

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David Argente, Munseob Lee, and Sara Moreira write,

In this paper, we exploit detailed product- and firm-level data to study the sources of innovation and the patterns of productivity growth in the consumer goods sector over the period 2006Q3–2014Q2. Using a dataset that contains information on the products of each firm and the characteristics of each product, we document new facts on product reallocation. First, we find that an important component of reallocation of products happens within the boundaries of the firm. Second, the largest changes in product quality come from new firms launching new varieties and from small firms expanding to other product lines. Third, we document that product reallocation within firms is procyclical. Fourth, we find that within-firm product reallocation is larger in high productive firms and firms that invest more in R&D. Finally, we quantify how important how product reallocation affects firm-level productivity growth and and innovation as reflected by changes in their total factor productivity.

NOTE: I am quoting a version that is labeled VERY PRELIMINARY AND INCOMPLETE. The published version is gated. Pointer to the published version from Tyler Cowen.

Apparently, during the recession, firms reduced the pace at which they added new products and retired existing products. I interpret this as a slowdown in investment.

As a first approximation, this is not supportive of my view of a recession as a breakdown of existing patterns of specialization and trade. One would expect to see an increase in the retirement of existing products if my view were correct.

One way to rescue my view would be to say that firms respond to a deterioration in the sustainability of existing patterns of specialization and trade by reducing their investment in creating new patterns. This seems like a counterproductive response, except that it does conserve cash in the short run.

Economic segmentation

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Jerry W. Thomas wrote,

What is market segmentation? At its most basic level, the term “market segmentation” refers to subdividing a market along some commonality, similarity, or kinship. That is, the members of a market segment share something in common.

I have argued before that the economy is illegible. By that I mean that aggregate measures of labor input, capital input, “the” price level, and output are useless when the economy is dominated by services and the value of labor and capital is dominated by intangible elements. Aggregate measures of “the” standard of living are useless when housing expense, which is a large component of living costs, is so divergent across locations.

Instead, I believe we need to think in terms of multiple economic realities. Perhaps one way to address this would be to start with market segmentation analysis. In the marketing world, demographic analysts have sorted U.S. zip codes into clusters of similar consumer tastes. Suppose that we were to find occupational clusters, consisting of people with similar industry groups and similar skill types.

Next, imagine a matrix, with occupational clusters down the side and consumer market segments across the top. Might we see interesting patterns?

We might think about the occupational clusters in terms of the traditional theory of international trade. What do they produce? What do they tend to consume? Which clusters supply savings to other clusters, and which receive savings? How much of each cluster’s economy is internal trade and how much is external trade? What are the terms of trade (exchange rate) between a cluster’s imports and its exports, and how have the terms of trade changed over time?

I am thinking that perhaps this is the next big theme I will be working on. That is, the illegibility of the economy as measured using traditional statistics and the possibility of getting more useful information by thinking in terms of multiple economic realities.

The Servant Aggregators

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Several years ago, I asked,

In an economy where some folks are very rich and many folks are unemployed, why are there not more personal servants?

Recently, someone pointed me to Umair Haque’s column from two years ago.

I’m going to call it a Servitude Bubble. For the simple reason that it is largely based on creating armies of servants. You can call them whatever buzzwords you like — “tech-enabled always-on super-hustling freelance personal brand capitalists”. But the truth is simpler. The stuff of the Servitude Bubble makes a small number of people something like neofeudal masters, lords with a corncucopia of on-demand just-in-time luxury services at their fingertips. But only by making a very large number of people glorified neo-servants…butlers, maids, chauffeurs, waiters, etcetera.

Dog walkers, Uber drivers, etc. My question was answered.

But it’s not just a few rich people with access to these services.