Category Archives: Economic education and methods

What is the Meaning of Credibility?

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A recent survey of leading economists, called the IGM forum, asked two questions about CBO forecasts.

Question A: Forecasting the effects of complex legislative actions is hard, so even competent, non-ideological and non-partisan projections could differ substantially from outcomes.

Question B: Adjusting for legal restrictions on what the CBO can assume about future legislation and events, the CBO has historically issued credible forecasts of the effects of both Democratic and Republican legislative proposals.

The answers were overwhelmingly affirmative for both. I have been following the IGM forum for years, and you rarely see such a strong consensus.

What does the term “credible” mean?

Does the affirmative answer to question B mean that the forecasts are accurate enough that policy makers should take them seriously? John Whitehead seems to think so. Pointer from Mark Thoma.

Or does the affirmative answer to question A mean that the forecasts are not accurate enough to reliably guide policy? Russ Roberts and I would tend to think so.

Anyone, including Russ or me, who criticizes economic methods faces the following argument.

1. Policy has to be based on some model and some forecast.

2. A formal model or a statistical forecast is more rigorous than intuition/opinion.

3. Therefore, the best approach is to use formal models and statistical forecasts.

I think that the problem comes in the way that one interprets point (1). Consider two possibilities:

1a. Policy has to be based on a “model” and a “forecast” which rule out any empirical analysis of how policy is formulated and implemented. Also, the “model” and the “forecast” can ignore the possible evolutionary responses of decentralized activity, including possible emergent market solutions to the problem that the policy is intended to solve, as well as innovations responding to the policy that mitigate its effects or that produce unintended adverse consequences.

1b. Policy has to be based on a “model” and a “forecast” which do take into account empirical public policy and dynamic market responses to the original problem and to the proposed solution.

If we interpret point 1 as “1b,” then I accept the logic that a model is better than no model and a forecast is better than no forecast.

If we interpret point 1 as “1a”, then the argument is a swindle. Models that ignore empirical public policy and dynamic market responses are not necessarily better than intuition/opinion, and they should not be regarded as credible.

Taking into account these requirements for credibility, CBO forecasts are not credible. Using them may very well do more harm than good.

Household Production, Continued

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The insightful Handle writes,

free YouTube videos combined with cheap and quick home delivery of tools and parts have made my own home, computer, and auto repairs much more worth my time than trying to arrange for an experienced professional.

I get it that having a YouTube video that tells me how to fix my toilet can lower the time it takes me to do it myself. But the Internet also makes it easier for me to find a cheap handyman. Overall, I think that my propensity to spend time fixing things myself has gone down rather than up over the past decade. Not that it was very high to begin with.

Another commenter writes,

I think Prof. Kling misunderstood Prof. Cowen’s point. Less household production as share of GDP is not necessarily a bad thing and the best number may very well be 0%.

However, household production is generally not included in the GDP figures, even though it arguably should be. If actual GDP, including household production, used to be 37% higher than measured GDP, but now is only 20% higher than measured GDP, then the growth in actual GDP over the period has been even lower than the pretty dismal numbers we are observing.

Hence, this statistic supports Prof. Cowen’s hobby horse of the Great Stagnation, regardless of how one feels the ideal percentage of GDP household production ought to be. I think he is right on this point.

In a follow-up, the commenter writes,

My neighbor and I live in identical houses and we are equally messy. Initially, we both clean our own houses and nothing is added to measured GDP.

Then we decide to pay each other $100/week to clean each other’s house. Suddenly, measured GDP is $10k/year higher than it used to be. But economically nothing has changed. This suggests that we ought to include our cleaning labors in GDP regardless of whether we clean our own houses or each other’s.

I think this is misleading. I prefer to look at it this way:

1. Suppose you are willing to pay me $100 for 5 hours of cleaning services. Then that puts a value on my time of $20 an hour.

2. Now, suppose that I decide to spend 5 hours cleaning my own house. You want to say that I have produced $100 of output.

3. I would say instead that the 5 hours I spend cleaning my own house is a waste of time!

Maybe if you assume that the most valuable work I can do is cleaning houses, then you are sort of right. But if I am a surgeon, then you are pretty much wrong. And I claim that as an economy gets more efficient at using specialization, you become less and less right and more and more wrong.

In terms of comparing well-being now with well-being 50 years ago, suppose that most of the reduction in housework is due to the prevalence of permanent-press clothes rather than having to iron them. Suppose that our entire (market-based) GDP consists of shirt production. It would be really nice if the GDP calculation subtracted the need for ironing from the cost of today’s shirts. But it could only show up as a quality adjustment that I suspect is too sophisticated to be captured in the statistics.

Suppose that actual shirt production remains the same as it was 50 years ago. Then measured GDP might be the same, also (it could be a little higher, if the statisticians pick up some of the quality adjustment). But the alternative concept, of GDP + household production, has gone down from 50 years ago, because we have stopped ironing. To me, that makes GDP + household production a stupid concept. It has things exactly backwards.

If you are going to add anything household-related in GDP, it ought to be leisure, not housework. If you show me that leisure + GDP is not growing very much, then I would count that as an argument for a Great Stagnation. But I am not the least bit persuaded by a measure of GDP + housework.

Household Services: I have a different take

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Timothy Taylor reports,

The value of household services was equal to about 37% of GDP in 1965, but is currently equal to about 23% of GDP.

Tyler Cowen implies that this is a bad thing.

I think of it this way.

“Household production” is inefficient. In the limit, if you produced everything you consume and consume nothing that you do not produce, then you will be at subsistence level–if you are lucky. Our standard of living depends entirely on specialization and trade.

If a surgeon mows her own lawn, it means either one of two things.

a) she likes to mow lawns, so this represents consumption; or

b) this is a market failure, and she would much rather get paid for doing another surgery and use that money to pay for lawn mowing and other things, but for some reason she cannot.

What the Commerce Department is doing is imputing a value to the time that people waste doing housework. All that tells us is the value is lost by not enabling those people to engage in specialization and trade instead of doing housework. It is a measure of market failure.

And of course this imputed (i.e., artificially made-up) value has gone down relative to GDP, because people (women, mostly) are spending less time on housework and more time engaged in specialization and trade. This means that there is less market failure nowadays than there was back then. We should be happy that the number is going down, and we should hope that it heads toward zero.

Sociologists and Humility

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Neil Irwin writes,

If the White House Council of Social Advisers did exist, one of its great challenges would be to convert some of these findings into actual policy proposals that might help. Part of the ascendance of economics in the policy-making sphere comes from the fact that economists tend to spend more time looking at specific legislative or regulatory steps that could try to improve conditions.

And trying to solve social problems is a more complex undertaking than working to improve economic outcomes. It’s relatively clear how a change in tax policy or an adjustment to interest rates can make the economy grow faster or slower; it’s less obvious what, if anything, government can do to change forces that are driven by the human psyche.

He is referring to sociological research that shows, for example, that the decline in blue-collar jobs has an effect on men’s sense of identity. In the article, the sociologists come across as jealous of economists, because policy makers respect economists.

I do not think that economic advice is necessarily better than advice based on sociology. I disagree with Irwin that economic issues are more clear-cut.

I do believe that economists have less humility than the sociologists. I would actually score that as a point for sociology.

On the other hand, sociology is blinded by ideology. Sociologists only want to interpret the world through the lens of power and privilege. That is their hammer, and everything looks to them like a nail.

Economists as individuals may be no less ideological. But the profession as a whole has much more ideological diversity than does sociology. That may not last. I believe that the trend is for conservative economists to fall in status, and if this keeps up, academic economics will look like sociology in another decade or two. In the meantime, I hope that economists somehow develop the humility of sociologists, but I fear that may not happen.

Justin Fox Inadvertently Makes the Case Against Empiricism

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On the question of whether Federal workers are overpaid relative to private sector workers, He writes,

The Federal Salary Council, a government advisory body composed of labor experts and government-employee representatives, regularly finds that federal employees make about a third less than people doing similar work in the private sector. The conservative American Enterprise Institute and Heritage Foundation, on the other hand, have estimated that federal employees make 14 percent and 22 percent more, respectively, than comparable private-sector workers.

Pointer from Mark Thoma. My comments:

1. The empirical estimates are supposed to “control for” the many factors that could affect salaries: benefit packages, education level of workers, other measures of skill, etc. But obviously, there is no clear and unambiguous choice of how to control for these factors, or else everyone would get the same estimate. Ed Leamer hit the profession over the head with this 35 years ago.

2. Could you have predicted ahead of time which organization’s “research” would find a result favorable to Federal workers and which organization would find unfavorable results? Of course you could. So how do you sustain the belief that normative economics and positive economics are distinct from one another, that economic research cleanly separates facts from values?

3. A number of us have observed that the rate of exit from the public sector to the private sector is not terribly high, and that the ratio of applicants to vacancies in public sector jobs is not terribly low. If public sector pay were too low, you would expect government agencies to be rife with unfilled positions, due to high exit and low entry.

4. Point (3) is an example of what Noah Smith would dismiss as “casual intuition.” But in this instance, I would argue that casual intuition has a higher signal-to-noise ratio than does formal empiricism.

Economists, Empiricism, Humility, etc.

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Peter Dorman writes,

what passes for empiricism in economics at present is often deficient in an empiricist, self-critical spirit and methodology. At the same time, the debates over topics like the minimum wage, the effects of charter schools on educational outcomes and the like are on a vastly higher plane when they are about data sets and analytical assumptions than the certitude of my unquestioned beliefs against the certitude of yours. It’s also a cheap and not altogether forthcoming dodge to respond to econometric disputes with a flip “There is never a clean empirical test that ultimately settles these issues.” (Roberts) That’s a epistemology.

Pointer from Mark Thoma.

Adam Ozimek writes,

Calls for skepticism of empirical economists also need to be matched with “compared to what?” Often those arguing for more humility about empiricism aren’t actually embracing humility, but instead are making space for their own narratives that are no less humble. For example, Russ says he doesn’t know how many jobs NAFTA has created or destroyed because “thousands and thousands of jobs are created every month and it is very difficult, perhaps impossible to know which ones are related to NAFTA.” Certainly, humility with regard to this question is useful. But then at the end of that paragraph Russ tells us he believes “trade neither destroyed nor created jobs on net.” Zero is not the same as “I don’t know,” nor is it necessarily any more humble than some specific estimate with wide confidence intervals.

…Economists do disagree on whether the direct effect of immigrants on native wages is a small positive or small negative. But they agree it is small. It’s easy to take this conclusion for granted as somehow common sense. But the truth is that, in the absence of the empiricism, the claim that immigration has held back wages by 20% for everyone would be much harder to argue against.

Noah Smith adds,

Theories can be wrong, stylized facts can be illusions, and empirical studies can lack external validity. But where does casual intuition even come from? It comes from a mix of half-remembered theory, half-remembered stylized facts, received wisdom, personal anecdotal experience, and political ideology. In other words, it’s a combination of A) low-quality, adulterated versions of the other approaches, and B) motivated reasoning.

If we care about accurate predictions, motivated reasoning is our enemy. And why use low-quality, adulterated versions of theory and empirics when you can use the real things?

Pointers from Tyler Cowen, who adds

A lot of the bias in empirical methods comes simply from which questions are asked/answered.

I say “amen” to that. For example, in the health care policy debate, the empiricists at CBO are telling us how many people would “lose” their health insurance under the GOP proposal. If you want to, you can question the CBO’s empirical estimates (their forecasts for Obamacare were, in the words of Avik Roy, “way off”). But that is not where I think the debate should go.

Instead, I think we ought to be talking about the real meaning of “insurance” in the context of health care. I think we ought to talk about the pros and cons of individuals having less “coverage” and making their own decisions about medical procedures with high costs and low benefits vs. having more “coverage” but subject to restrictions placed on them by bureaucrats. I think we ought to be talking about the issue that Timothy Taylor raised the other day, namely, should we be spending less on medical services and more on other things that are conducive to better health. (Note that Taylor’s post is grounded in formal empiricism.)

Perhaps we ought to be listening to Dierdre McCloskey’s view that economics is a discipline that uses rhetoric. I think that Russ Roberts and I would complain about the pseudo-scientific rhetoric that gets used.

Noah Smith’s use of the rhetorical phrase “the real things” is an example of the sort of language that lacks humility. It implies that there is a great distance between casual observation combined with theoretical introspection on the one hand and formal empirical work on the other, with the implication that the latter dominates the former. I would say that in some cases it is the former that is unreliable and in other cases it is the latter.

I hope that we can all agree that a lack of humility consists of pretending to know something for certain when it is in fact doubtful. We can then argue about what sort of approaches to economics are conducive to humility or a lack thereof.

Again, I have a longer essay on this topic, but it will not appear until this summer.

Russ Roberts on Economic Methods

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He writes,

fundamentals like income or even changes in income over time are somewhat measurable with some precision, [but] we are notoriously unreliable at the things the world really cares about and asks of our profession: why did income for this or that group go up by this or that amount? What will happen if this or that policy changes? Should the subsidy to college education be increased or decreased and if so, by how much? These much-demanded answers for precision and an understanding of the complex forces that shape the world around us are precisely the questions we are not very good at answering.

It is a long essay, difficult to excerpt. Pointer from Tyler Cowen.

I am writing an even longer essay along similar lines. Currently, the hope is to have it come out this summer.

In physics, you have what is known as “effective theory.” That is, you have a theory, like Newton’s laws, which works very well for certain problems. Moreover, physicists can tell you where it works and where it does not work.

The problem in economics is that we have speculative interpretations which we try to pretend are effective theories. For reasons that Russ Roberts goes into, we cannot get rid of conflicting speculative interpretations.

Positivism, Progressivism, and Economics

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Steven Hayward writes,

for Progressive politics, the positivist distinction between facts and values, which corresponds to the distinction between administrative questions and political questions. . .preserves for the rulers alone freedom of choice and action. The “scientific” elites of the administrative state

I am taking this quote quite out of context. Please read the entire essay.

Back when I took Introduction to Philosophy, the professor taught positivism as an approach to epistemology, which deals with the question of how we know what is true. The positivist answer is that there is logical knowledge and empirical truths. Logical truths are embedded in the definitions of terms. Empirical knowledge comes from observation. Statements that are neither logical nor empirical are dogma.

The term dogma is meant to apply to statements such as “Jesus is the son of God,” or “Sodomy is wrong.”

Nowadays, it seems that what positivism means to Hayward (and others, including McCloskey) is the doctrine that we can and should separate fact from opinion, knowledge from preference, the news page from the editorial page. It links to progressivism in that the progressive imagines an ideal political system as one in which the voting public expresses preferences and then the experts with the knowledge design and execute policies to satisfy those preferences. It links to orthodox American economics, because those economists have always thought of themselves as having the knowledge needed in order to play the expert role.

Note that the progressive model cannot handle a situation in which the public expresses a preference not to be governed by experts. Such a preference does not compute.

There are some heterodox economists on the left and the right who deny that the facts/values distinction can be maintained. I think they have a point.

Let’s take as an example the effect of the minimum wage on employment. In principle, the question of how the minimum wage affects employment falls on the “facts” side of the facts/values divide. In practice, I think it is fair to say that the easiest way to predict where an economist will come out on the question of how the minimum wage affects employment is to find out where the economist stands on some other issue that divides left and right. So an economist who supports a higher military budget is likely to predict a larger adverse effect of an increase in the minimum wage on employment than economist who supports a smaller military budget. That is because the military spending issue and minimum wage policy “affiliate” with one another, even though they have essentially nothing to do with each other.

Still, I do not have a problem with the facts/values distinction in principle. I do not mind if economists try to keep facts and values separate, however much this tends to fail in practice. What I object to the most is the claim that economists have expertise that enables them to operate the administrative state as it exists today.

Charles Taylor on Social Science

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From Philosophy and Social Science, chapter one, page 56.

Human science is largely ex post understanding. Or often one has the sense of impending change, of some big reorganization, but is powerless to make clear what it will consist in: one lacks the vocabulary. But there is a clear asymmetry here, which there is not (or not supposed to be) in natural science, where events are said to be predicted from the theory with exactly the same ease with which one explains past events and by exactly the same process. In human science this will never be the case.

The chapter was sent to me by a reader. Taylor makes much use of the term “interpretation,” as do I. I insist that economics consists of many frameworks of interpretation and few testable hypotheses, whereas in natural science it is the other way around.

An example that I give in my book is determinants of relative wages (between, say, men and women). One framework of interpretation is that of human capital. Another framework is power and privilege. There are many observations that fit both frameworks. There are some observations that better fit the human capital frameork, and there are some observations that better fit the power and privilege framework.

As an example of Taylor’s point, consider the financial crisis of 2008. It was predicted by no economic model. Yes, some economists had a model of the housing market that said “this is a bubble,” but none of them saw how the collapse of the bubble would tear through the financial system (as we know from the Big Short, a few oddball hedge fund guys did). And yet, all sorts of economists insist that they can interpret the financial crisis. As John Cochrane once said to me, many economists have the audacity to interpret the financial crisis as proving that they were right all along!

The Economics of a Border-Adjustment Tax

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Timothy Taylor writes,

Most countries around the world and all high-income countries other than the United States have “border adjustments” in their tax code, but a key point to recognize is that border adjustments are typically part of a value-added tax–not the corporate income tax.

. . .the Trump administration proposal for revising the corporate income tax is actually a first-cousin-once-removed of a value-added tax.

Taylor cites scholars of various political persuasions in support of this analysis. Greg Mankiw makes a similar point. If you prefer taxing consumption to taxing saving and labor, then you should get to know the economics of the border-adjustment tax in the context of a shift from taxing corporate profits to taxing corporate net revenue.

But John Cochrane points out

a tax system in which you tax $100 of sales, but offer $99 of deductions (costs, wages, earnings retained for investment), then tax only the last $1, then tax that $1 again as personal income, would seem to offer lots of room for shenanigans on just what gets deducted. Along with interesting financial engineering to “invest” more earnings and pay less dividends and interest.

The more radically you reform taxes, the more you risk creating new distortions, both foreseen and unforeseen.

Tyler Cowen has a point about politics.

I say anything complicated they will just screw up, and the lack of transparency in the plan means eventually it will lead to a tax hike and furthermore a good deal of favoritism and rent-seeking along the way. Best hope is simply that they cut the corporate tax rate and don’t do much else on that front.

It is true that lowering the corporate tax rate would reduce the malincentive effects of loopholes in the tax. Lowering the stakes involved would lower the rent-seeking. Also, simply lowering the rate seems less risky (see John Cochrane’s whole post.

The economic theory of how a border-adjustment tax should work is worth knowing. However, theory tends to apply to concepts in the abstract. In practice, a lot of tax policy turns on what gets defined as taxable and what does not. And those regulatory and legislative decisions are where the rent-seeking and the distortions kick in.