Category Archives: PSST and Macro

Economies are Embedded in Cultures

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Peter Richerson, et al, write,

Economic competition is an important and typically peaceful form of CGS.

CGS is “cultural group selection.” Pointer from Joseph Henrich in comments on a Tyler Cowen post.

In my view, cultural group selection fits well with Austrian economics but poorly with Chicago economics. Hayek and others pay attention to cultural norms, while Chicago economics is more purely individualistic. See Erwin Dekker’s book.

For example, if you take the Chicago view that focuses on atomistic optimization by individuals, then racial discrimination seems to be unlikely in a market economy. Someone who is willing to hire blacks seems likely to out-compete someone who only hires whites.

However, suppose that you have a group norm in which refusing to hire blacks is considered cooperation and hiring blacks is considered defection. Also, suppose that groups that are more effective at rewarding cooperators and punishing defectors tend to be more successful. In that case, racial discrimination could persist because of cultural group selection.

The theory of cultural group selection can create discomfort if you like to believe that social outcomes are purely deterministic. Instead, with group selection a wider range of outcomes becomes possible, with the potential for norms and practices to survive that seem arbitrary or even counter-productive. While one might object that this makes the theory messy, I think it is realistic.

I believe that one of the important limitations of what in Specialization and Trade I disparage as MIT economics is that it ignores cultural context. Instead, I believe that the fact that economies are embedded in cultures is very important.

Alan Kirman on Microfoundations

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He writes,

Although in fields such as statistical physics, ecology and social psychology it is now widely accepted that systems of interacting individuals will not have the sort of behaviour that corresponds to that of one average or typical particle or individual, this has not had much effect on economics.

Note that in macroeconomics, an economist will say that a model is “microfounded” if (and, seemingly, only if) you use a representative individual to represent the entire economy. Kirman, like me, objects to this. However, in my opinion one does not need a lot of floofy rhetoric about “complex adaptive systems” to know that this is wrong. It is sufficient to recognize the importance of specialization in the economy.

Modernity is a Package, Continued

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Malavika Nair and G.P. Manish write,

In recent years, many thousands of so-called “untouchables,” or Dalits, members of the lowest group in the Indian caste order, have risen out of poverty to become wealthy business owners, some even millionaires.

By taking advantage of the greater economic opportunity brought about by market reforms, these Dalit entrepreneurs provide us with an important example of the power of markets, not just to bring about economic emancipation, but to fight deeply entrenched social discrimination.

In Specialization and Trade, I argue that most pre-modern specialization was similar to the Indian caste system, in that you were born into your occupation. Part of modernity is getting to choose your occupation, and markets are an essential component of that.

Feel free to return to the book’s web site to peruse and comment on the reviews. One review, by Herbert Gintis, disturbed me. He is entitled to claim that what is right in the book is not original and what is original is not right. However, I found his tone to be snotty and uncharitable, which lowers my estimate of him considerably.

Wisdom from Erik Hurst

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He says,

The facts are real wages moved very strongly with employment across regions. Nevada was hit very hard by the recession, for example, while Texas was hit much less hard. Wage growth, both nominal and real, was about 5 percent higher in Texas than it was in Nevada during the Great Recession.

Pointer from Tyler Cowen.

The point is that we do not have a single aggregate economy. If you think that every state faced identical demand conditions, then the state with the higher real wage growth (Texas) should have had the worse unemployment. And Hurst goes on to point out how the regional data make it difficult to defend the view that wage stickiness is the cause of unemployment. In fact, he refers to work, which I noticed earlier, that suggests a PSST story.

I don’t think I previously knew about this thinking, which also agrees with mine:

When we all come together as individuals, we may create agglomeration forces that produce positive or negative consumption amenities. Thinking about it this way, when a lot of high-income people live together, maybe there are better schools because of peer effects or higher taxes. Or maybe there are more restaurants because restaurants are generally a luxury good. Or maybe there’s less crime because there is an inverse relationships between neighborhood income and crime, which empirically seems to hold. So, while we value proximity to firms, that’s not the only thing we value.

Thoughts on Crowding Out

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Tyler Cowen writes,

None of this has to involve higher interest rates, whether on government securities or corporate bonds, yet still there is an opportunity cost from the new decisions. Do interest rates have to go up every time resources are switched across sectors? No. Will there in general be a significant “multiplier” from these sectoral shifts? I say that question is a category mistake, but if you insist the multiplier could easily be negative rather than positive.

My comments:

The crowding-out that he is talking about refers to specific sets of skills. In GDP-factory macro, there is no wuch thing. We all have the same skills, so if government demands more from the GDP factory, there is no crowding out. From a PSST perspective, or from any sensible economic perspective, if the government hires more workers whose skills are already in demand, this causes crowding out. Since many of the workers who have lost jobs over the past two decades are workers whose skills were of a sort where demand has been falling on a secular basis, chances are that when the government tries to spend more it will tend to increase demand for workers who already have jobs. Hence, crowding out.

Bubbe-Meisis

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It is a Yiddish expression, meaning roughly “an old woman’s superstitions.” Here are three pieces of advice given to my daughter concerning the recent birth of our first grandchild that struck me as bubbe-meisis.

1. If the fetus is below the 10th percentile in estimated weight at the 8th month, the risk of still birth is sufficiently elevated that labor should be induced immediately.

2. If you want your milk to come in, you must not allow the baby to drink any formula.

3. If you allow your newborn to sleep on its stomach instead of its back, the risk of SIDS (sudden infant death syndrome) is very elevated.

If your grandmother said such things, you would probably ignore her. Unfortunately, these opinions were rendered by my daughter’s obstetrician, lactation consultant, and pediatrician, respectively. Hence, they had the force of Authority.

(1) does not take into account: the huge margin of error in fetal weight estimates; the fact that still birth is such an unusual event that unless the fetus is showing clear symptoms of acute distress it is very difficult to find factors that have reliable correlations with still birth; and the fact that different women tend to give birth to infants of different weights. I would bet that our grandson was in the 50th percentile of the weight that was expected for a child of his parents. So his low estimated fetal weight was not a signal of any distress whatsoever.

(2) strikes me as more ideology than science. If the mother is nursing correctly, how soon her milk comes in (or whether it comes in at all) depends on many idiosyncratic factors. Denying the infant any formula at all will mostly serve to starve a baby if the mother’s milk is not available.

(3) Again, we are talking about a rare event where we do not know the causal mechanism. If there is any effect of sleeping on the stomach, it is not materially significant. There has been a small decrease in the rate of SIDS death since the back-sleeping advice started to be given, but there could have been many other factors that changed over this same time period. Meanwhile, as soon as he is put on his back, our grandson wakes and cries, while on his stomach he sleeps like, well, a baby–but he is not allowed to do that.

These bubbe-meisis deal with phenomena that have what James Manzi calls causal density–there are too many potential causal forces at work to have a definitive theory of the process. Many factors can cause still birth. Many factors can cause a mother to be unable to supply enough milk to a newborn. Many factors might be implicated in SIDS.

Nonetheless, most people would rather listen to an Authority who offers a specific causal theory rather than one who says “we don’t know.” So economists who dispense Keynesian bubbe-meisis are listened to, and those of us who say that we don’t know how to create patterns of sustainable specialization and trade are not.

By the way, so far our grandson is doing fine. Our daughter compromised with Authority. She refused to be induced in week 37, and only caved in at week 39. She limited her infant’s intake of formula, but she did not eliminate it altogether. As for sleeping, because he cannot sleep on his back, he tends to fall asleep on someone’s chest (face down, of course). If an Authority knew this, would he or she give the parents a pass to let the baby sleep on its stomach in the crib?

Margins of Adjustment

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Tyler Cowen quotes from the abstract of a paper by André Kurmann, Erika McEntarfer, and James Spletzer

In our data, only 13 percent of workers who remain with the same firm (job stayers) experience zero change in their nominal hourly wage within a year, and over 20 percent of job stayers experience a reduction in their nominal hourly wage. The lower incidence of downward wage rigidity in the administrative data is likely a function of our broader earnings concept, which includes all monetary compensation paid to the worker (e.g. overtime pay, bonuses), whereas the previous literature has almost exclusively focused on the base rate of pay. When we examine firm labor cost adjustments on both the hours and wage margins, we find that firms have substantially more flexibility in adjusting hours downward than wages. As a result, the distribution of changes in nominal earnings is less asymmetric than the wage change distribution, with only about 6 percent of job stayers experiencing no change in nominal annual earnings, and over 25 percent of workers experiencing a reduction in nominal annual earnings.

A few comments.

1. At the link, it says, “Preliminary and incomplete. Do not cite without permission of authors.”

2. This finding, if established, would only damage macro theory to the extent that bonuses and other fringe benefits are the alternative margins of adjustment. If the alternative margin of adjustment is hours, then that would actually serve to reinforce the macro theory that says that real output falls when nominal GDP growth is slower than expected because nominal wages are sticky.

3. I should note that there also are alternative margins of adjustment that can reduce price stickiness relative to list prices. For example, a restaurant could keep its prices constant but reduce portion sizes or quality. A clothing store could keep its list prices constant but change the size and frequency of discounts.

Formalize This

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A commenter asks,

Which formalization would you argue adequately considers specialization and trade? An Edgeworth box?

This is a good question, because mainstream economists cannot “see” anything that is not in a formal model.

My answer in this case is a definite “No.” The Edgeworth box is an example of two-by-two economic modeling. Other examples include the Ricardian model of comparative advantage and the Heckscher-Olin-Samuelson model of international trade.

The most important aspect of specialization and trade is that we specialize in just a few tasks but we enjoy the products of millions of tasks. This fact was noticed by Adam Smith, but it has not been “formalized” in any useful way that I can think of. So the formal modelers are like drunks who have their preferred lamp posts, but the watch that need to look for is somewhere else.

DSGE Models Are Not Micro-founded

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Mark Thoma quotes George Evans,

First, because it is a carefully developed, micro-founded model incorporating price frictions, the NK model makes it possible to incorporate in a disciplined way the various additional sectors, distortions, adjustment costs, and parametric detail found in many NK/DSGE models.

No! There is no specialization and trade in these models. You can call such a model “micro-founded” all you want. It isn’t. These empty modeling exercises do not deserve to be called micro-founded. They do not even deserve to be called economics.

The Future of Mainstream Macro?

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According to Olivier Blanchard,

I suspect that even DSGE modelers will agree that current DSGE models are flawed. But DSGE models can fulfill an important need in macroeconomics, that of offering a core structure around which to build and organize discussions. To do that, however, they have to build more on the rest of macroeconomics and agree to share the scene with other types of general equilibrium models.

Pointer from Mark Thoma.

Actually, he does not even mention what I believe is the main flaw with this approach to macroeconomics. As I point out in Specialization and Trade, that flaw is the failure to include specialization at all. Instead, there is one type of worker producing one type of good. This is obviously unwise once you consider it, but once you consider it you are no longer a respectable macroeconomist.