Axel Leijonhufvud vs. MIT Economics

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He writes,

For concreteness, think of a controlled experiment in a natural science as an example of a closed system. The conditions of an experiment controlled in this sense are never met or approximated in macroeconomics. (Adding more variables to the right handside of our regression equations will never get us there). But in constructing intertemporal models – such as in DSGE – we insist on the make-believe that the macroeconomy is a closed system

Link found here, thanks to a pointer from Mark Thoma.

Leijonhufvud was an early influence on me, and I still feel a strong affinity towards him.

From Genes to Institutions?

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According to Jason Collins, Oded Galor and Quamrul Ashraf will soon write,

there is little evidence to support the claim that the variation in institutions across societies is driven by differences in their endowment of specific genetic traits that might govern key social behaviors.

I believe that in Hive Mind Garett Jones endorses the view that higher average IQ can lead to better institutions. So I will want to read the Galor-Ashraf paper when it appears.

Racism Everywhere

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Carlos Lozada writes,

“So many prominent Americans, many of whom we celebrate for their progressive ideas and activism, many of whom had very good intentions, subscribed to assimilationist thinking that has also served up racist beliefs about Black inferiority,” Kendi writes. They did so by promoting freedom but forgetting equality; by placing the burden of combating racism on black shoulders, not white ones; by implicitly accepting notions of inferiority, no matter how righteous their indignation; by conflating anti-racist claims and racist fears in an effort to claim a moralizing middle ground.

He is reviewing a book by Ibram X. Kendi, along with another book also focused on the history of racism by Nicholas Guyatt. It is too bad that Lozada did not include (and probably will never read) Thomas C. Leonard’s Illiberal Reformers. Lozada would have learned that racism became “scientific” in the latter part of the 19th century, and that American progressive economists too the lead in developing and implementing policies, including the minimum wage, that were intended to prevent “race suicide.”

The theory of race suicide was that members of inferior races could subsist on less than what superior races required. This meant that inferior races could drive wages below what the superior races needed to live on. Hence, the need for a minimum wage.

By the way, while I am not especially keen to read Kendi’s book, I would be curious to know what he means by “assimilationist thinking” and why it is a boo-phrase.

Why Fewer Publicly Traded Firms?

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Alex Tabarrok writes,

The total number of firms has dropped far less than the number of publicly traded firms, so in part this is probably due to laws affecting publicly traded firms in particular such as Sarbanes-Oxley. But there has also been a drop in the total number of firms. As a result, concentration ratios have increased which suggests that competition might have fallen.

Some possible stories.

1. The number of manufacturing firms declines as manufacturing declines as a share of GDP. Meanwhile, in the growing sectors of health care and education, government creates huge barriers to entry. It seems to actively encourage consolidation in health care.

2. The Internet and globalization create winners-take-most markets in several categories. Think of how many department stores were killed off by Wal-mart.

3. Lots of consolidation in finance. Remember that as recently as the 1970s banks were not allowed to cross state lines, so we probably had more banks than was efficient well into the 1990s.

I am not ready to buy the story that competition has fallen across the board. One of the big stories of the past couple decades is the big rise in prices in education and health care and the much slower rise in prices for manufactured goods. To me, that goes along more with a story of government policies to subsidize demand and restrict supply in the former sectors.

PSST: the idea is spreading

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Mark Muro writes,

Adjustment happens, but it’s a far more painful process than the models and textbooks have imagined. Policy, and the economists, should take it seriously.

Pointer from Mark Thoma.

Difficulty with adjustment is the essence of the PSST story for recessions. If the economy were a GDP factory, then the factory foreman would be temporarily confused about which job to give to which person. Of course, for the factory foreman, substitute the set of entrepreneurs and potential entrepreneurs.

Muro cites three recent papers, two of which I have covered. The new one is by Danny Yagan, who writes,

living in 2007 in a below-median 2007-2009-fluctuation area caused those workers to have a 1.3%-lower 2014 employment rate. Hence, U.S. local labor markets are limitedly integrated: location has caused long-term joblessness and exacerbated within-skill income inequality. The enduring impact is not explained by more layoffs, more disability insurance enrollment, or reduced migration. Instead, the employment outcomes of cross-area movers are consistent with severe-fluctuation areas continuing to depress their residents’ employment. Impacts are correlated with housing busts but not manufacturing busts, possibly reconciling current experience with history. If recent trends continue, employment rates are estimated to remain diverged into the 2020s—adding up to a relative lost decade for half the country. Employment models should allow market-wide shocks to cause persistent labor force exit, leaving employment depressed even after unemployment returns to normal.

The standard remedies for adjustment, including trade adjustment assistance, and worker re-training, are among the least effective programs government has ever tried. Not surprisingly if decentralized entrepreneurs are having calculation problems, the socialist calculation problem proves worse.

The Rise of Mortgage Credit

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Describing on a paper by Oscar Jorda and others, John Hamilton writes,

This “hockey stick” in mortgage lending was accompanied by a similar pattern in real house prices. These too had been largely stable for nearly a century. Since 1950, house prices have grown faster than inflation around the world.

My guess is that as of 1950, when the rise in mortgage credit began, there was too little mortgage borrowing. My guess is that since about 2000, there has been too much mortgage borrowing. In Minsky terms, we went from hedge finance in 1950 to speculative finance in the 1990s to Ponzi finance thereafter. Ponzi finance means that people get loans who cannot repay them except by getting new loans.

Earth Day Thoughts

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Environmentalists and economists share a common interest in the use of scarce resources. However, environmentalism all too often lapses into primitivism, which is the instinct that humans should revert to prehistoric lifestyles.

For example, consider an ethic of leaving nature exactly as you found it. For a hunter-gatherer, this is a reasonable ethic. If you deplete one of your sources of food, that’s it.

As humanity discovered cultivation, industrialization, and digitization, we have transcended the limits of what we can hunt and gather. As Paul Romer points out, we obey the laws of physics. Our activities neither create nor destroy matter. What we do is transform matter into different forms that are more useful to us.

In this modern world, where we better ourselves by transforming matter, the price system is our guide to making the best use of resources. Environmentalists tend to be hostile to the price system, and instead they tend to want to impose their own rules for using resources.

One way to reconcile environmentalism with economics and the price system is to use the theory of externalities to propose ways for government to fine-tune prices, using taxes and subsidies. However, government technocrats will only imperfectly calculate externalities. These technical flaws do not preclude government intervention, but even an enlightened benevolent despot would be conservative about intervening because of the calculation problem.

An even bigger concern is that we do not have enlightened, benevolent despots. Instead, we have rent-seeking interest groups. And we have demagogues who appeal to primitivism.

I wish that economists would do more to expose the problems with primitivism. I cringe when I see college campuses espousing primitivist ideology under the guise of “sustainability” while their economics professors remain silent.

I have an extensive treatment of this issue in the forthcoming Specialization and Trade, where I include more facts and less rhetoric.

American Economic Geography

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In the NYT, Parag Khanna writes,

The Northeastern megalopolis, stretching from Boston to Washington, contains more than 50 million people and represents 20 percent of America’s gross domestic product. Greater Los Angeles accounts for more than 10 percent of G.D.P. These city-states matter far more than most American states — and connectivity to these urban clusters determines Americans’ long-term economic viability far more than which state they reside in.

Pointer from Tyler Cowen.

Khanna’s bottom line:

the next president has to move beyond platitudes and implement a serious policy of leveraging new infrastructure investment from home and abroad and backing the shift toward a new urban political economy built around transportation engineering, alternative energy, digital technology and other advanced sectors.

In other words, we’ve had too much organic growth in cities. From now on, it needs to be planned. Needless to say, I do not (note correction) share in this assessment.

The Mervyn King Book

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It is called The End of Alchemy. I can give it faint praise, but not much more than that.

1. It is long-winded.

2. I share his view that risk-based capital regulations inject a false sense of precision into bank regulation.

3. His main idea is this:

The aim of the PFAS [Pawnbroker for all seasons] is threefold. First to ensure that all deposits are backed by either actual cash or a guaranteed contingent claim on reserves at the central bank. Second, to ensure that the provision of liquidity insurance is mandatory and paid for upfront. Third, to design a system which in effect imposes a tax on the degree of alchemy in our financial system.

Here is how I understand the idea would work. A bank would make a risky loan of, say, $100. The bank and the central bank would agree that in an emergency the loan could be sold to the central bank for, say, $90. In that case, the bank could finance up to $90 of the loan with deposits. This would replace deposit insurance, risk-based capital regulations, and other attempts to reconcile the desire to prevent the bank from failing with the need to address moral hazard.

I do not see how this can handle modern financial instruments. Take AIG, for example. Their problem was that liquid liabilities appeared seemingly out of nowhere, as “collateral calls” on the credit default swaps that they had written on mortgage securities. There is no way that this contingency would have been built into King’s system. King writes,

No doubt there would be other practical issues to resolve, but the reason we employ high-quality public servants is to solve such problems.

That was the exact sort of hand-waving that came with the original TARP proposal to buy up the “toxic assets” in order to fix the financial system. Those of us who understood the financial instruments involved knew that it was impossible to work that way, and TARP as implemented did not work that way at all.

4. Perhaps of all the high-level officials involved in central banking over the past twenty years, King’s thinking is the most nuanced, realistic, and humble. And yet his ideas did not impress me. This is going to sound really arrogant, but I do not believe that the central bankers know enough about finance to be able to fulfill their promise to stabilize financial markets.

Three Axes and Communism

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A reader asks,

how does conservative opposition to Communism (in the second half of the 20th century) fit on the civilization-barbarianism axis? I’m not sure that the Soviet Union or communist China are really thought of as “barbarians”. It seems weird that the main competitor in a space race can be a “barbarian”.

Put yourself in the mindset of 1950. In America, religion is still sacred, so to speak. Recall that Churchill described Lenin as a bacillus sent on a train from Germany into Russia. There was a fear that Communism was like a spreading infection, with many in the west having succumbed to the disease. There was some awareness of Stalin’s butchery of his own people (although this awareness increased considerably a few years later). There was much awareness that Communist “show trials” had mocked the rule of law.

Communists were not primitive in the sense that many environmentalists today are primitivists at heart. The were not medieval like Islamists. But they were against religion, family, and freedom, and they appeared to be willing to use any means, including lies and violence, to spread their ideology. That was sufficient for conservatives to view Communism as barbaric. In fact, conservatives’ characterization of Communists as barbaric greatly disturbed Americans on the left, who saw anti-Communism as extreme and irrational.

Among libertarians, Rand was very anti-Communist, but Rothbard was inclined to blame America for the Cold War. Thus, there was no consensus libertarian position on Communism.

Progressives, like Galbraith and Samuelson, admired the Soviet Union for its engineering achievements. Conservatives thought that Soviet engineering prowess made them more threatening, not less so.

Communism