The Economics of Sustainability

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George Leef writes,

The sustainability movement isn’t interested in the kind of analysis that scholars bring to controversies. It wants zealots, such as the “eco-reps” now employed on many campuses to push the agenda. Recycling, for instance, is always advanced as an imperative for saving the planet. There are trade-off questions about recycling that have caused many people to conclude that its costs often exceed its benefits, but students are not encouraged to think about them.

It strikes me that introductory economics teachers need to include some thoughts on sustainability. Here are mine:

1. The most reliable indication of sustainability is the ability to make a profit at unsubsidized market prices.

2. When people disagree with the market’s judgment, there is a good chance that they are focusing on a cost they can see and ignoring a cost that they cannot see. For example, someone who argues that “eating local” is sustainable probably sees the cost of transporting food but does not see the cost of allocating land and water to inferior uses. Before modern transportation, refrigeration, and food preservatives, more of us “ate local.” Consequently, we wasted land near cities on farms, and that land now is used to house people or has been returned to wilderness.

3. If in order to get people to recycle you need to use subsidies or regulations, then that is a sign that recycling does not save resources and instead wastes them.

4. Remember that one of the laws of science is that in chemical reactions matter is neither created nor destroyed. There is a sense in which production of goods and services does not “use up” physical resources. Instead, it changes the form of matter from something that is relatively useless to something that is relatively useful.

5. The great industries of the world came about because entrepreneurs were able to take abundant, seemingly useless resources and make them valuable. Before internal combustion engines, oil was just annoying gunk. Before computers, silicon was just the main constituent in sand.

6. In a free-market economy, price signals tell consumers and entrepreneurs what can be wasted and what must be conserved. If property rights are clear and market prices are free to move, then there is no need to fear running out of any valuable resource.

7. Public policy is subject to public choice problems, including the bootleggers and baptists problem. I believe that the consensus now is that using corn to fuel cars is not sustainable. If a free market had experimented with using corn to fuel cars, the experiment would have failed and that would be the end of it. However, because there is now a substantial lobby for the ethanol mandate, government policy to enforce the use of corn to fuel cars remains in place indefinitely.

Properly taught, freshman economics has a lot of useful things to say about sustainability.

Kling’s Three Laws

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First, Tyler Cowen writes.

Cowen’s First Law: There is something wrong with everything (by which I mean there are few decisive or knockdown articles or arguments, and furthermore until you have found the major flaws in an argument, you do not understand it).

His other two laws are at the link.

Below are Kling’s three laws, but note that they come from Merle Kling, my late father, who taught political science at Washington University in the 1950s and 1960s. He called them the three iron laws of social science.

1. Sometimes it’s this way, and sometimes it’s that way.

2. The data are insufficient.

3. The methodology is flawed.

I do not claim to have three laws, although I think I could endorse both Tyler Cowen’s and Merle Kling’s. I am willing to stick up for the Null Hypothesis, although it is a hypothesis and not a law.

Paging Jason Collins

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Alex Tabarrok writes,

in the environment in which the mind evolved we often needed to accurately throw things but rarely needed to accurately drop things from moving objects. As a result, we developed excellent heuristics for throwing but not for dropping.

Yesterday, as I was taking a long bike ride, I thought to myself, my physique is much better suited to riding a bicycle than to running. Doesn’t that suggest that my prehistoric ancestors rode bicycles?

Anyway, I wonder if there is too much confirmation bias at work when we tell stories in which evolution explains what we are suited to doing and what we are not suited to doing.

[Update: Commenter Handle’s remarks, picking up on the bicycle example, are wise and worth reading.]

What Isn’t Wrong with Macro?

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David Andolfatto is in a very different place than I am. He writes,

what part of the above manifesto do you not like? The idea that people respond to incentives? Fine, go ahead and toss that assumption away. What do you replace it with? People behave like robots? Fine, go ahead and build your theory. What else? Are you going to argue against having to describe the exact nature of government policy? Do you want to do away with consistency requirements, like the respect for resource feasibility. Sure, go ahead.

Pointer from Mark Thoma. Elsewhere, Mark points to interesting comments by Noah Smith.

Some of the parts of mainstream macro that I do not like:

1) that there is a single representative agent who is the consumer and owner of the one firm.

2) that this representative agent never has to use trial and error to figure out what might be a profitable business, much less what might be a profitable pattern of trade involving many businesses.

3) that this representative agent cannot hold more than one expectation about the future. Instead, there is the very anti-Hayekian notion of “rational expectations” which assumes away local information.

4) that “money” and “the price level” are objective, precisely determinate quantities, rather than part of a consensual hallucination.

5) that you can wave your hands and talk about “financial friction” in models in which financial intermediaries are redundant.

And those are just off the top of my head.

The Crowding-Out of Financial Intermediation

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Timothy Taylor points to an IMF report, which says,

The investment slump in the advanced economies has been broad based. Though the contraction has been sharpest in the private residential (housing) sector, nonresidential (business) investment—which is a much larger share of total investment—accounts for the bulk (more than two-thirds) of the slump

I have an argument that this represents crowding out, caused by increased government deficits. However, this is not textbook crowding out, in which the government increases the demand for savings, raising interest rates and reducing investments.

Instead, it is crowding out of financial intermediation. Recall that my view of financial intermediation is that the public wants to issue risky, long-term liabilities and hold safe, short-term assets. Financial intermediaries accommodate this by doing the opposite.

When the government incurs large deficits, it issues safe, short-term liabilities. This crowds out private financial intermediation, because much of the demand for safe, short-term liabilities is satisfied by government debt. Think of the public holding a $100 balance sheet. Without government deficits, financial intermediaries might hold $100 in risky, long-term investments and issue $100 in safe, short-term securities. Instead, with $100 in government bonds issued to financed deficits, the public’s demand for safe, short-term securities can be satisfied with zero investment. Financial intermediation goes away altogether, or just consists of intermediaries who issue safe securities backed by government bonds.

Regulators and the Socialist Calculation Problem

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My latest essay is on Engineering the Financial Crisis, by Jeffrey Friedman and Wladimir Kraus. I think that their book demonstrates that regulation falls victim to the socialist calculation problem.

Centralizing risk assessment through regulatory risk weights and rating agency designations has several weaknesses. Local knowledge, such as detailed understanding of individual mortgages, is overlooked. At a macro level, regulators’ judgment of housing market prospects were no better than those of leading market participants. Moreover, regulators imposed a uniformity of risk judgment, rather than allowing different assessments to emerge in the market.

Does More Government Debt Reduce Interest Rates?

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This is a random idea that is almost surely wrong. And if it is wrong, it will be wrong in a way that seems obviously stupid. So don’t expect me to stick with it.

Without blaming Nick Rowe, I started thinking about this when he wrote,

By “secular stagnation” I mean “declining equilibrium real interest rates”.

Most explanations of secular stagnation say it is caused by a rising desire to save and/or a falling investment demand. Call this the “Saving/Investment Hypothesis”.

But there are lots of different real interest rates. For example, the real interest rate on Bank of Canada currency is around minus 2%. (That currency pays 0% nominal interest, and the Bank of Canada targets 2% inflation). But people are willing to hold currency, despite that, because it is very liquid. But all assets differ in their liquidity. More liquid assets will have a lower real yield than less liquid assets. And if an asset becomes more liquid over time, its real yield will fall over time.

What if there is a sharp rise in the supply of government debt? The standard view is that this tends to raise interest rates, as debt absorbs more savings.

The alternative view I am putting out there is that government debt offers liquidity (in the limiting case, think of it as a very close substitute for money). If the supply of liquidity goes up, then there is less demand for banks to manufacture liquidity out of risky assets. The public wants fewer deposits backed by loans on fruit trees and instead is happy to hold mutual funds containing government bonds.

The result is fewer fruit trees planted. We would observe a decline in interest rates on low-risk assets and an increase in interest rates (or a loss of credit availability altogether) for risky investment projects.

Think of this as government debt crowding out private investment, even though the interest rate on safe assets, particularly government debt itself, can remain low and perhaps even fall as the crowding out gets larger. Again, this is probably wrong.

The Lost Art of Political Dialogue

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Adam Garfinkle writes.

Second, disagreements were understood as natural and healthy; disputes civilly aired were believed to reveal the better way forward. Dialogic discourse rather than dictatorial narratives held pride of place. Socrates, not Plato’s philosopher-king, prevailed.

Third, defeat in political contests came to be seen as inherently provisional and temporary; there is always the next election. That realization, in turn, conduces to compromise and conciliation, other means of rendering politics something other than a continuously zero-sum proposition.

I strongly recommend reading the whole thing.

It is possible for people who disagree about politics to conduct a dialogue in order to clarify the nature of the disagreement. However, that notion has been discarded. Instead, the objective is to get the other guy to shut up. This intellectually inferior and divisive approach pervades the culture on campus and on line.

‘Scott Alexander’ on the Growth Mindset

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He writes,

if you’re not familiar with it, growth mindset is the belief that people who believe ability doesn’t matter and only effort determines success are more resilient, skillful, hard-working, perseverant in the face of failure, and better-in-a-bunch-of-other-ways than people who emphasize the importance of ability. Therefore, we can make everyone better off by telling them ability doesn’t matter and only hard work does…

A rare point of agreement between hard biodeterminists and hard socialists is that telling kids that they’re failing because they just don’t have the right work ethic is a crappy thing to do. It’s usually false and it will make them feel terrible. Behavioral genetics studies show pretty clearly that at least 50% of success at academics and sports is genetic; various sociologists have put a lot of work into proving that your position in a biased society covers a pretty big portion of the remainder. If somebody who was born with the dice stacked against them works very hard, then they might find themselves at A2 above. To deny this in favor of a “everything is about how hard you work” is to offend the sensibilities of sensible people on the left and right alike.

Read the whole thing. I found it difficult to excerpt.

The view that I hold, which is not based on any studies and is just my opinion, is that effort matters a lot, but that the propensity to undertake effort is more genetic than environmental.

In a school setting, my sense is that you get good effort and results if you happen to have a cohort of students who compete to impress one another in terms of classroom accomplishments and who encourage one another to do their best. (Imagine having a Michael Jordan in the class, pushing everyone on his “team” to be better.) If there is a way for a teacher to influence that, to create such an atmosphere where otherwise it would not exist, I would like to know the secret. My guess is that setting up teams and having competitive games is a way to trick students for a day or two, but I don’t think it creates the overall mentality that I have in mind.

Reputation Systems as Regulators

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Tyler Cowen and Alex Tabarrok write,

In recent times, information technology has made it easier to observe a seller’s reputation and to contribute to the formation of a seller’s reputation at low cost. Yelp, Angie’s List, and Amazon Reviews all make it easy for past buyers to report their observations on seller quality and for future buyers to observe a seller’s accumulated reputation.

This might mean that we need less regulation. Other possibilities:

1. We have always had the means to use reputation systems as an alternative to regulation. But regulation is the preferred outcome of the political system, perhaps for bootleggers and baptists’ reasons. The advent of better information and technology actually does not change the relative economic and political advantages of regulation.

2. One issue with reputation systems is that there is an ongoing temptation to game them. Consider “search engine optimization” or “social media marketing.” Surely there are folks out there offering to get your business top rankings on Yelp. Given that gaming will work at least sometimes, is an unregulated equilibrium necessarily the best?

3. It becomes harder for new entrants to break into a market governed by reputation than one governed by regulation. Obtaining a license from a regulatory agency might be easier than obtaining visibility in a rating system.