I tried a couple weeks ago, but I let the weather forecasters frighten me out of it. I will be back in Boston on October 5th and 6th. Either lunch time or dinner time would work. We will discuss my latest book, Specialization and Trade. If interested, email me at arnold at-sign arnoldkling.com and let me know which time works best for you. I will try to work something out.
Category Archives: PSST and Macro
What’s Wrong with Keynesian Economic Theory?
That is the title of a new book, edited by Steven Kates. It is published by Edward Elgar ($$$). I am one of the contributing authors.
My essay argues that Keynesians use two very different approaches in marketing their ideas. First, they use a simplistic approach (“spending creates jobs and jobs create spending”) to talk to politicians and the general public. Second, because among trained economists it is indefensible to ignore prices and instead talk about quantities depending on quantities, Keynesians talk in academic circles in an entirely different fashion.
I say that that fatal flaw in both approaches is aggregation–treating the economy as a GDP factory. This makes it impossible for Keynesians (or for macroeconomists in general) to think about the issue of patterns of sustainable specialization and trade. The PSST story is that some patterns of trade become unsustainable as tastes and technology change, and addressing this requires a trial-and-error process to evolve new sustainable patterns.
In terms of policy, the Keynesian assumption that all work is done in the same GDP factory suggests that government can fix a recession without knowing any specifics about the characteristics of unemployed workers. In reality, worker skills are heterogeneous, and there is no guarantee that a fiscal stimulus will be relevant to the workers who are having difficulty adjusting to new circumstances.
I reprise some of these points in Specialization and Trade, which is priced so that an entity other than a library might wish to purchase it.
Economic Data in 1946
One commenter pointed out that RGDP fell by over 12% between 1945 and 1946, and that lots of women left the labor force after WWII. So does a shrinking labor force explain the disconnect between unemployment and GDP? As far as I can tell it does not, which surprised even me. But the data is patchy, so please offer suggestions as to how I could do better.
You could do better by taking the RGDP figure with a tablespoon of salt. The way that the Commerce Department adjusts nominal GDP for price changes is pretty unreliable for that period. Part of the reason is that there was so much shifting between public sector output (who knows how much of that is “real” vs. nominal?) and private sector output, and part of the reason is that as you move away from the base year (either many years ahead or many years behind) the adjustment process gets screwy. 1946 is now many, many years away from the base year that is used to calculate real GDP. I think that if you can find old publications from the Commerce Department, you will see very different patterns of real GDP for 1946, resulting from shifts in the base year from 1958 to 1975 to ….
I think that for 1946 you are safer sticking to nominal GDP numbers.
By the way, here is a piece I wrote on that period.
Friedman and Samuelson
I think of Specialization and Trade as an attempt to redirect economics away from the path that it followed after the second World War. This recently produced the following train of thought.
Who has been the most influential economist since 1945? I am inclined to go with Paul Samuelson, and that is implicit in the book. But some people might have said Milton Friedman. In neither case, do I think that the influence on academic economists was good. [somewhat related: Tyler Cowen’s simple theory of recent intellectual history, which he apparently still propounds]
With the public, their impact differed. Friedman argued that people should admire markets and be wary of government. Samuelson said it the other way around. Those of us who agree with Friedman approve of Friedman’s influence. Those who agree with Samuelson disapprove of Friedman’s influence.
Back to academic economists. I think that both Friedman and Samuelson were guilty of promoting economic methods that involved imitating hard science (at least as they thought of science as being practiced). Instead, in my book I argue that economic analysis can yield frameworks of interpretation, but economic hypotheses are not verifiable the way that they are in chemistry or physics.
In macroeconomics, Friedman enjoyed influence starting in the 1970s, because the Solow-Samuelson Phillips Curve broke down and Friedman’s alternative view that emphasized monetary policy seemed to work better. However, my view is that both monetarism and Keynesianism are misleading as interpretive frameworks.
In fact, what started out as monetarism ultimately degenerated into deity-worship of the Fed chairman. First it was Paul Volcker, who slew the dragon of inflation. Then it was Alan Greenspan, the Maestro of the Great Moderation. Until in hindsight he became the Randian ideologue, who turned the banks loose to create a financial crisis. The crisis came on Ben Bernanke’s watch, and he is deified as the man who saved us from another Great Depression.
I think that the effect of each of those three on the economy is vastly over-rated. Instead, I think that financial markets and the economy in general simply took the course that they took, and story-tellers wrongly attribute the outcomes to the policies of the Fed at the time.
Lunch Costs
Abha Bhattarai writes in the WaPo:
An increasing number of Americans are ditching $10 sandwiches and $12 salads in favor of food from home, according to new data from the research firm NPD Group. Lunch traffic is slowing at restaurants around the country, with weekday lunch visits down 7 percent compared to a year ago, the steepest decline since the beginning of the recession, data show.
I found the article interesting, although I think you should take the statistical reporting with a grain of salt, pardon the pun.
I am not part of the dining-out culture, but I do not spend much time on food preparation.. Apart from a few fruits and vegetables, I tend to go with prepared foods from the store.
In general, I expect people to increase their consumption of food prepared by others. In a world of specialization and trade, the costliest lunch of all is the one that you spend a lot of time making yourself.
Intellectual Yet Idiot
Nassim Nicholas Taleb coins that phrase, writing
What we have been seeing worldwide, from India to the UK to the US, is the rebellion against the inner circle of no-skin-in-the-game policymaking “clerks” and journalists-insiders, that class of paternalistic semi-intellectual experts with some Ivy league, Oxford-Cambridge, or similar label-driven education who are telling the rest of us 1) what to do, 2) what to eat, 3) how to speak, 4) how to think… and 5) who to vote for.
I have had a couple of people compare my Specialization and Trade to Taleb’s work. For what it is worth, my thoughts on the similarities.
1. We both believe that highly-educated experts over-estimate what they know.
2. We both doubt the ability of “science” to understand the human world, including the economy.
3. We both think that statistical analysis as commonly practiced is unreliable.
4. We are both outsiders relative to academia at present.
I think that Taleb is a much more colorful writer. I tend to be more risk-averse, both in terms of substance and style.
James Tobin’s Presidential Address
Robert Waldmann brings it up. Tobin delivered it in 1971, and it was published in 1972.
Pointer from Mark Thoma.
As I remember it, Tobin suggested thinking of an economy with two industries and wages rigid downwards. Suppose that demand shifts away from industry X to industry Y. Because wages do not fall in industry X, you get unemployment there. Because wages do rise in industry Y, the overall rate of inflation goes up. Note, however, that with more inflation, the real wage in X falls, which means less unemployment there than otherwise.
This simple story gives you an explanation for both stagflation and the Phillips Curve. The point that Waldmann is making is that macroeconomists did not need to take the detour that they took in the 1970s. They could have stayed on the path that Tobin laid out for them. My thoughts:
1. It is amazing how much better you can do if you break up the GDP factory into two industries. I think you can do even better with more disaggregation, but the modeling would be much hairier.
2. I agree that macro would have done better to follow this path. However, macro still would not be very good. The problem of too many plausible causal factors chasing too little data is insurmountable. See my science of hubris paper, as well as the recent Paul Romer screed.
3. The sociology-of-economists question of how macro remained (and continues to be) stuck for so long is quite interesting. See Daniel Drezner’s piece (for which I also thank Thoma). As you know, my explanation is that Stan Fischer became the Genghis Khan of macro.
Paul Romer, Macroeconomics, and Trouble
In the last three decades, the methods and conclusions of macroeconomics have deteriorated to the point that much of the work in this area no longer qualifies as scientific research. The treatment of identification in macroeconomic models is no more credible than in the first generation large Keynesian models, and is worse because it is far more opaque. On simple questions of fact, such as whether the Fed can influence the real fed funds rate, the answers verge on the absurd. . .The larger concern is that macroeconomic pseudoscience is undermining the norms of science throughout economics. If so, all of the policy domains that economics touches could lose the accumulation of useful knowledge that characteristic of true science, the greatest human invention.
Pointer from Mark Thoma. I am on board with the above passage, but soon Romer writes
To appreciate how far backwards our conclusions have gone, consider this observation, from a paper published in 2010, by a leading macroeconomist:
… although in the interest of disclosure, I must admit that I am myself less than totally convinced of the importance of money outside the case of large inflations.
Romer could be talking about me, except for the “leading macroeconomist” part.
Anyway, he goes on to argue that the disinflation that took place in the early 1980s is evidence that monetary policy matters. My comments.
1. I agree that for those (few) of us who doubt the importance of monetary policy, the “Volcker disinflation” represents the most difficult data point.
2. Still, Romer appears to me to distort things. He calculates a rise in the real interest rate of 5 percent. But I believe that a lot of that comes from inflation falling–not just the Fed raising nominal rates.
3. Long-term interest rates rose dramatically as well. Arguably, the “Volcker disinflation” should be called the “bond-market vigilante disinflation.”
4. In general, although much of Romer’s critique focuses on the identification problem and the challenge of teasing out causality, it is impossible for him (or anyone) to demonstrate that changes in the money supply are exogenous rather than endogenous.
Overall, I agree with Romer that the methodological challenges in empirical macro are daunting–I would say overwhelming. For my take, see Macroeconometrics: The Science of Hubris.
I am just quibbling over the one instance which he argues demonstrates an empirical truth.
Book Discussions
If any readers are willing/able to organize a group interested in Specialization and Trade, I am willing/able to travel to talk with such a group. I think about 10-20 people would be a good size. I am particularly interested in speaking to autodidacts in their 20s and 30s.
There are several topics in the book which, in hindsight, could have been developed further. One of them that I have been thinking a lot about recently is the long shadow cast by World War II on economic thinking and policy. In the book, I do mention that all of the major nations fighting the war used central planning to a considerable extent. But other points are worth noting, including:
1. In Great Britain, major industries were nationalized from the post-war period all the way up to the late 1970s, when Margaret Thatcher took over as Prime Minister.
2. In the U.S., price controls were used during the war to fight inflation, and the belief in price controls died hard. If I recall correctly, many in the Truman Administration wanted to continue controls after the war, and they were disappointed when Congress abolished them. As late as the early 1970s, the Nixon Administration attempted to go the price-control route, with disastrous results.
3. Another challenge during the war and the post-war period was the potential for labor unions in key industries, such as steel and coal, to bring the economy to its knees. In the decades following the war, Presidents had to resolve major strikes by cajoling (or even forcing) industry and labor leaders to accept settlements. Finally in the 1980s, both Thatcher (coal miners) and President Reagan (air traffic controllers) won important confrontations with striking workers. Many on the left are still bitter about this. They long for the days when unions were more of a force.
4. Because the wartime economies were centrally planned, a lot of economic research involved developing tools for such planning. Prior to the war, the idea of representing an entire economy using mathematical symbols and equations to represent inputs and outputs was adapted from the Soviet Union by Wassily Leontief, who was awarded the Nobel Prize in 1973. After the war, MIT economists, notably Robert Solow (who had studied with Leontief at Harvard), thought that Leontief’s model of production was both too detailed and too rigid. They worked on solutions to the problem of optimizing output that involved linear programming, resulting in an important textbook on programming techniques by Joseph Dorfman (Harvard), Paul Samuelson, and Solow.
5. Also, the MIT economists developed and elaborated on the concept of an aggregate production function. This eliminates the detail by aggregating “capital” and “labor” inputs and treating the economy as a GDP factory. This generated an extensive, but now largely forgotten, literature, including the so-called Cambridge Capital Controversy.
6. The advantage of the aggregate production function is that there are mathematically tractable ways to represent substitution between capital and labor. The Constant Elasticity of Substitution production function, which includes Cobb-Douglas as a special case, was another topic that filled the journals of the early 1960s with now-forgotten articles. I recall that in the early 1970s one of my undergraduate professors, Bernie Saffran, pointed out to us that econometricians trying to estimate the CES production function were trying to tease second and third derivatives out of data where you could be lucky merely to find that the first derivative had the correct sign.
New Commanding Heights Watch
Two posts from Matthew Klein.
96 per cent of America’s net job growth since 1990 has come from sectors known to have low productivity (construction, retail, bars, restaurants, and other low-paying services were responsible for 46 percentage points of total growth) and sectors where low productivity is merely suspected in the absence of competition and proper measurement techniques (healthcare, education, government, and finance explain the remaining 50 percentage points)
since 1990. . .a whopping 88 per cent of the total rise in the price level boils down to four sectors of the US economy [health care, education, housing, and prescription drugs]:
Pointer from Tyler Cowen. There is much to chew on, and probably much to quibble about. What I want to suggest is that the relative price shifts involving the New Commanding Heights sectors of health care and education in relation to goods-producing sectors ought to be considered much more important than the comparatively trivial amounts by which the “aggregate price level” (a concept for which I have little use, but so be it) has wiggled around.
Over the past 25 years we have had major structural shifts in the economy. I claim that those structural shifts have played a larger role than monetary policy in the behavior of employment and “the aggregate price level.” But if you look at both the journalistic accounts and the academic literature, I am confident that you will find many more mentions of monetary policy than of structural change in interpreting economic events. If I had any influence, that would change.