On the state of economics

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I have a long essay on the scientific status of economics in National Affairs. A few excerpts from the conclusion:

In the end, can we really have effective theory in economics? If by effective theory we mean theory that is verifiable and reliable for prediction and control, the answer is likely no. Instead, economics deals in speculative interpretations and must continue to do so.

Young economists who employ pluralistic methods to study problems are admired rather than marginalized, as they were in 1980. But economists who question the wisdom of interventionist economic policies seem headed toward the fringes of the profession.

This is my essay in which I say that academic economics is on the road to sociology.

Education Realist on Hansonian education reform

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He or she comments,

Harmful interventions:
Ending tracking
De-emphasizing demonstrated test scores on difficult tests in favor of grades.
Increased legal protections for discipline disasters.

…Costly interventions:
Special education now gives additional money to 1 out of 8 kids and we see nothing for it. …We spend billions on “English language instruction” …ELL from the 60s on was designed on the expectation that ELL kids would be illegal immigrants from across the border.

Now that I think of it, it is easy to imagine a lot of Hansonian practices cropping up in education. There is no equivalent of the FDA process for screening out bad or ineffective protocols. New curricula and practices are introduced faster than they can be evaluated. It is classic case of what statistical process control guru W. Edwards Deming would term “tampering.”

What to Study?

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Scott H. Young writes,

Assuming you were to fulfill that high-minded goal of education, how would you do it?

I find it doubtful that the traditional university curriculum would be the best way to do that. Probably the best way wouldn’t involve an institution at all, but be something you undertook on your own.

He proposes a curriculum in terms of 10 years. I have converted it into percentages:

30 percent immersion in foreign cultures
10 percent philosophy
5 percent religion
5 percent world history
20 percent math and sciences
10 percent art
5 percent music
5 percent meditation
5 percent economics and psychology
5 percent practical skills (carpentry, sewing, etc.)

My comments:

1. A lot depends on what you assume somebody knows when they leave high school. 3

2. A lot also depends on what you take to be the goal. Let us suppose that the goal is to learn in a well-rounded way.

3. Off the top of my head, some tweaks:

10 percent philosophy
15 percent math and sciences (emphasize statistics and biology, not so much advanced math or advanced physics)
5 percent world history
15 percent human culture (including economics, politics, sociology, and psychology)
10 percent arts and literature (art, music, dance, literature)
10 percent personal fitness (sports, exercise, meditation)
10 percent practical skills (include cooking, computer programming)
25 percent immersion in foreign cultures

4. Learning is social. Who are you spending time with? That is a major issue. I think that Tyler Cowen, who provided the pointer, would agree.

Housing Finance Today

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Ike Brannon writes,

The private market for mortgage-backed securities all but dried up in the aftermath of the Great Recession, so Fannie and Freddie are the only games in town. If they won’t buy a mortgage–or if there is any possibility that it could declare ex post that mortgage it purchased did not, in fact, meet its exceedingly strict standards and could be returned–a home loan will simply not be made in most instances.

Prior to 2008, politicians saw lenders as making type II errors, meaning that they did not lend to borrowers who probably would repay their loans. So they imposed “affordable housing goals” on lenders.

After 2008, politicians saw lenders as making type I errors, meaning that they made loans that borrowers did not repay. So they extracted “settlements” from big banks that were involved in lending prior to the crisis. And they made it known that Freddie and Fannie could force lenders to repurchase any loans that go bad, unless the underwriting file is pristine.

So now, the situation is what it is. It’s dangerous to make a loan with any chance of default. Brannon thinks that GSE reform will solve the problem. My guess is that what we have now, while not optimal, is better than what we would actually end up with if there were “reform.”

I also think that the reluctance to make loans that might default is due to more than just the possibility that Freddie and Fannie will make you buy back the loans. You have to somehow convince banks that they won’t be shaken down by attorneys general any time there is an opportunity.

Fundamentally, I would like to see a mortgage market free from political interference. I just don’t think we will ever see that.

How to Handle the payments system

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The commenter suggests,

simply nationalize the “deposits taking and transaction processing” function of the banking industry? Everyone gets a zero-service-fee fully electronic (no paper checks) account at the Federal Reserve

Picture this as a retail version of the Fed Funds market. To simplify, I would not have any interest on Fed Funds.

Let’s say that I keep most of my liquid assets with a money market fund. But when I want to add to my Fed Funds, I sell money market fund shares and the money market fund transfers Fed Funds out of its account and into my account. When I want to buy things, I send money from my Fed Funds account to the Fed Funds account of the seller. Maybe I use a debit card to execute the transaction. Maybe I use my phone.

The idea is that this insulates the payment processing system from the solvency of financial institutions. These Fed Funds accounts would not be vulnerable to runs.

There would still be financial institutions doing bank-like things, including holding long-term risky assets and issuing short-term riskless (supposedly) liabilities. They could still get in trouble. And the government probably would still want to regulate them, in order to steer credit toward its preferred uses, including financing its own debt.

But it is an interesting thought-experiment.

The null hypothesis: do I really believe it?

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A commenter writes,

surely students who took statistics with you know statistics better than students who didn’t take statistics at all, right? The null hypothesis taken to the extreme would suggest that having taken your- or any- statistics course, should provide no benefit in understanding statistics at all.

If we define the intervention as “took a statistics course” vs. “did not take a statistics course,” then I believe that the intervention worked for some students. However, if we define it as “took a statistics course with Dr. Kling” vs. studied the material some other way, then I would not bet against the null hypothesis.

The same commenter writes,

Arnold, are you of the belief that educational outcomes would be the same if we got rid of schools altogether? That almost seems to be what you’re implying here.

Again, this raises the question of what is the relevant experiment. (I have often not been clear on this.) For example, if you want to compare home schooling with standard schooling, I would not be willing to bet against the null hypothesis. But if you compare standard schooling with no schooling, you are talking about something else entirely.

Learning from other humans is an essential trait of human nature. To hold dogmatically to the null hypothesis, one would have to suggest that the amount and type of learning that children undertake is a function only of their individual characteristics and of the culture in which they are embedded. It does not depend on the way that the institutions of schooling are structured.

The institutional structure does affect resource allocation with respect to teaching and learning. I would speculate that our school system probably makes more efficient use of resources than would a system in which schools did not exist. I would speculate that it makes less efficient use of resources than would a system of vouchers and competition rather than government-managed schools.

Would I go far as to say that the only difference that schools make is in resource allocation, not in outcomes? I doubt that such an extreme position is warranted. But statistically, educational interventions tend to affect resource allocation much more than outcomes. For educational interventions within roughly the current institutional setting, the null hypothesis is not an iron law, but it is an empirical regularity.

Hansonian Schooling?

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A commenter writes,

The most difficult part of this worldview for me to reconcile has been to convince myself that the subset of negative-impact health interventions can have a large enough magnitude of an effect to counteract the health interventions that have a strong evidence base of a positive effect.

…

do you think that some educational interventions have a negative impact, and thus offset positive effects elsewhere? If so, what is the nature of those negative-effect interventions?

1. The commenter does not cite Robin Hanson, so I must make sure that readers are familiar with this paper.

2. I think that in both health care and education, other factors affect outcomes a great deal.

3. In the case of health care, individual genes and behavior, along with public health and cultural trends, are very important. Health care providers work on very small margins. Sometimes they make things better, and sometimes they make things worse. To justify the huge resources that we spend on health care, I think you have to value the occasional benefits very highly and assume that those resources could not be used more effectively on individual and collective efforts aimed at prevention.

4. In the case of education, individual genes and behavior, along with the overall cultural environment, are very important. Educators work on very small margins. Sometimes they make things better, and sometimes they make things worse.

5. Do the interventions that make things work exactly offset those that make things better? I think not. I am optimistic that health care providers and educators do more good than harm. But I think that interventions work on small margins, so that the average benefits turn out to be insignificant relative to the costs.

Facts, Feelings, and Filters

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A commenter writes,

Arnold’s argument that economics is about using particular frameworks as lenses for interpretation is also quite postmodern.

Well, sort of.

Consider three statements.

a) Amazon announced its intention to purchase Whole Foods.

b) Amazon should not be allowed to purchase Whole Foods.

c) Amazon’s purchase of Whole Foods damages the prospects of other grocers.

(a) is an example of a fact. (b) is an example of a feeling.

(c) is an example of an observation based on a filter, in that it depends on one’s framework of interpretation. You might think one way if you see Amazon’s move as intensifying competition in the grocery industry. You might think differently if you see it reducing competition and/or as a signal that there is value in national grocery franchises (what if Google or Facebook decide they also want to own grocery stores?). And, yes, the drop in stock prices for other large grocery chains says that investors favor one interpretation more than another. But my point is that the interpretation is contestable.

Some more remarks.

1. In 20th-century philosophy, the Logical Positivists seemed to dismiss the concept of filters. They would regard (c) as an attempted fact-claim. Anything other than a fact-claim or a feeling is a dogma.

2. The Post-modernists take the opposite view. Every statement comes through a filter. This would make every statement contestable, including (a).

3. I wish to take an intermediate position. I believe that there are scientific observations and laws that are not contestable, but I also believe that filters are very important. Synonyms for filters include frameworks of interpretation, models, theories, and paradigms.

4. In Specialization and Trade, I argue against the dominant filter in macroeconomics, which I call the GDP factory.

5. In The Three Languages of Politics, I argue that progressives, conservatives, and libertarians each use distinctive linguistic filters. If you make an argument using terms that correspond to (for example) the progressive’s linguistic filter, a progressive will approve that argument, while it will fail to resonate with a conservative or libertarian.

6. In both books, I am suggesting that people think they see truth, but there are different plausible filters that would change their outlook.

7. However, I do not go so far as to say that there is no truth, and that any belief system is as good as any other. Instead, I am saying that sometimes there is more than one plausible filter. If you are sending a man to the moon or building a computer, you had better use the consensus scientific filters. In other realms, where causal density is high, no filter is robust.

8. If you want to be wise, you need to acknowledge the anomalies that cast doubt on your filters. Otherwise, you end up treating your filter as a sacred tribal doctrine.

9. There is a prominent version of post-modernism that I would term Left Post-modernism. Strictly speaking, post-modernism should lead one to be aware of many possible filters and skeptical of one’s own filters. In contrast, Left Post-modernism puts everything through the filter of race and gender and is entirely lacking in self-doubt. For example, in Sunday’s WaPo, Tung Yin writes,

Mass killings look the most like terrorism when their perpetrators seem the most alien from the Judeo-Christian, white majority.

This is Left Post-modernism treating its filter as a sacred tribal doctrine, ignoring some pretty obvious contrary evidence. Just off the top of my head, the Irish Republican Army and the Baader-Meinhof gang were labeled terrorists.

The WaPo itself has an analysis on line (not in print, that I could see) of Friday’s terrorist stabbing in Jerusalem, which is focused on “who they were working with and for.” That is one distinctive feature of terrorism, which is that the perpetrators claim to act on behalf of an organization that engages in terrorism. But far be it from Yin to admit that the term “terrorism” is anything other than a racist epithet.

Speaking of Friday’s attack, in which an Israeli policewoman was stabbed to death before the attackers were killed, The BBC notoriously headlined the incident “Three Palestinians killed after deadly stabbing in Jerusalem.” This is how they prefer to filter such news (although in this rare instance, following Israeli outrage the BBC later changed the headline). The WaPo filtered the news even more effectively, because I did not see any coverage of the incident at all in its print editions. It might otherwise disturb the narrative that the WaPo put forth prominently in recent Sunday editions, in which the Palestinians suffer from checkpoints for no reason under “occupation.”

The WaPo news and Outlook sections are now all Left Post-modernism, all the time. The editorial page is sometimes more broad-minded, but I have given up on the heavy-handed filtering disguised as reporting and analysis. For news, I look elsewhere.

The Grumpy Bank Holding Company Proposal

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John Cochrane writes,

For $100 of assets, and $100 of bank equity, let, say, $10 of that equity be traded — enough to establish a liquid market. Then, let $90 of that equity is held by a downstream entity or entities— a fund, special purpose vehicle, holding company or other money bucket. I’ll call it a holding company, and return to legal structures below. The holding company, in turn, issues $10 of holding company equity and $80 of debt.

The good news is that the bank can never fail, and if the holding company becomes insolvent, Cochrane suggests that it could quickly force debt holders to accept a new mix of (less) debt and some equity.

The bad news is that the debt of the bank holding company, which is the closest thing to bank money in his world, will not trade at par. It will trade at a discount, which will be small if the bank seems to be doing well and large if the bank seems to be doing poorly. For transaction purposes, that sort of money is noisy, so it will not really work. If it would work, then nobody would be bothered by a money market fund that can “break the buck.” In order to avoid breaking the buck, money market funds have to stick to non-risky assets.

I think that in order to work as money, financial liabilities have to trade at par. If a firm has risky assets and most of its liabilities trade at par, then I think it has to be subject to runs (assuming no deposit insurance). I don’t see any way around that.

Charter Schools and the Null Hypothesis

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Neerav Kingsland writes,

Overall, CMOs are delivering +.03 SD effects over three years in both reading and math. These gains are driven by the fact that students benefit from CMOs the longer they stay in them

In this context, CMOs are charter school management organizations, not collateralized mortgage obligations.

I still think that the overall picture tends to support the Null Hypothesis, although I believe that charter schools are capable of saving a lot of money while producing the same (null) effect as government schools. For a related meta-analysis, see Tyler Cowen’s post on a survey article on school vouchers.