we should remember the Big Facts. For example, one the Big Facts in finance is that active equity fund managers rarely beat the market for very long, at least after fees. This, as much as Campbell Harvey’s statistical work reminds us to be wary of the hundreds of papers claiming to find factors that beat the market.
Pointer from Mark Thoma
This is a good example of asking, “What else would be true?” When you are inclined to believe that a study shows X, consider all of the implications of X. In the example above, Dillow is suggesting that if one finds that there is some factor that allows one to earn above-market returns, how do we reconcile that with the fact that we do not observe active fund managers earning above-market returns?
Recall that I raised a similar question about the purported finding that in the United States worker earnings have gone nowhere as productivity increased. This should greatly increase the demand for labor. It should greatly increase international competitiveness, turning us into an export powerhouse. Since I do not see either of those taking place, and since many economists have pointed to flaws in the construction of the comparison of earnings and productivity, I think this makes the purported finding highly suspect.
In contrast, consider the view that assortative mating has increased and plays an important role in inequality. I have not seen anyone say, “IF that were true, then we would expect to observe Y, and Y has not happened.”
I think that this is the way to evaluate interpretive frameworks in economics. Consider many possible implications of an interpretive framework. Relative to those implications, do we observe anomalies? When you have several anomalies, you may choose to overlook them or to explain them away, but you should at least treat the anomalies as caution flags. If instead you keep finding other phenomena that are consistent with the interpretive framework, then that should make you more comfortable with using that framework.
High average productivity does not imply high marginal productivity and monopolistic competition resists profit lowering.
Isn’t the basic issue here that active fund managers pretty much are the market? How is the average fund manager going to beat the average fund manager?
As a corollary, a successful fund manager may garner more assets under management while at the same time being able to raise his/her fees (as well as losing some motivation to work as hard).
“In contrast, consider the view that assortative mating has increased and plays an important role in inequality. I have not seen anyone say, “IF that were true, then we would expect to observe Y, and Y has not happened.””
If that were true, we would see a bimodal height distribution (more inequality of height), but this has not happened.
Only if we believe that people are mating by height. I certainly have no firsthand or other evidence of that.
http://journals.plos.org/plosone/article?id=10.1371/journal.pone.0054186
Perhaps the effect is not strong enough to break through randomness in child height?
Compare that weak sauce to assortive mating Arnold is talking about:
The point here is to go through the exercise. So I do believe slightly less in assort at I’ve mating. OTOH, autism and allergies seem to be rising. IQ bimodalization?
“active equity fund managers rarely beat the market for very long, at least after fees.”
If you want to know if beating the market is possible, you need to look before fees, not after fees.
While you’re at it, “by what odds ratio would we see the evidence we see, if the theory is / isn’t true?”. Granted “what else would be true” is the winning meme of the two and is perfectly suitable as a prompt for idea-generating mode (after which you can run numbers).
Arnold wrote: Recall that I raised a similar question about the purported finding that in the United States worker earnings have gone nowhere as productivity increased. This should [1] greatly increase the demand for labor. It should [2] greatly increase international competitiveness, turning us into an export powerhouse.
I see [2] but not [1]. Could you explain more clearly? My initial view is that Increased productivity means less labor is needed to produce the same or more goods and services. So the first thing more productivity implies is less demand for labor. The only way it could demand more labor is indirectly, something like “owners of more-productive capital get more surplus to spend, so they demand more goods and services and therefore demand the labor used to produce those.” But there are all sorts of complications that might even make that statement untrue. For example, what if the luxuries demanded by capitalists with more surplus were also produced more productively? Or what if the more-productive capital plant only wanted a few high-skilled workers, so demand for them when up while overall labor demand went down, since many workers are not high-skilled. Also, in the special case of US wages, they are clearly depressed by increased competition from immigrants.* With enough immigration, wages can keep falling even as capital becomes more and more productive. Does that explain the US wage story?
(*Gentle reader, please don’t waste electrons disputing this. If you don’t know what Tata Consulting is or why Silicon Valley uses so much immigrant labor, you are too ignorant to contribute anything useful.)
This is how I read Arnold with regards to (1). If the price of X stays flat and the value of X rises, then we should see X in higher and higher demand. In econ terms, the marginal benefit of X now exceeds the marginal cost of X for more units of X than before. It of course is true that people might need to buy less X to meet their needs, but it’s also the case that they get more surplus from X per dollar spent.
Consider it from the perspective of stocks. If the S&P collectively doubled its earnings per share and dividends tomorrow, what would happen? On one hand, people would feel wealthier and perhaps feel less of a need to save (say a 50 year old who was formerly getting $25,000/yr in dividends is now getting $50,000/yr, and decides to stop saving). Conversely, others might find the dividend yield extremely attractive and be very willing to bid up the price of the stock. My own intuition is that the latter effect will dominate, and the value of the S&P would more or less double.
I thought about this a bit more and realized that we have to account for international trade as well as immigration. Per the famous Stolper-Samuelson Theorem we can easily imagine that increased productivity (due to capital improvements) in the US accompanies declining average wages, because wages go up in other countries where low-skilled labor is even cheaper than in the US.
I think he refers to the assumption of marginal labor productivity that would typically made in discussion involving homogeneous aggregates that would basically imply that if gdp got cheaper we should buy more gdp.
This method of evaluating and using interpretive frameworks sounds very much like Popper’s description of the scientific method.