Category Archives: Economic education and methods

Rights and Consequences

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I read the latest (final? I hope not, because I have some critical comments) draft of Tyler Cowen’s Stubborn Attachments, which he describes as follows:

I outline a true and objectively valid case for a free and prosperous society, and consider the importance of economic growth for political philosophy, how and why the political spectrum should be reconfigured, how we should think about existential risk, what is right and wrong in Parfit and Nozick and Singer and effective altruism, how to get around the Arrow Impossibility Theorem, to what extent individual rights can be absolute, how much to discount the future, when redistribution is justified, whether we must be agnostic about the distant future, and most of all why we need to “think big.”

One of the issues that Tyler raises that I think ought to be resolved somewhat differently is that of the role of rights in consequentialism. In a sense, basic rights, like property rights, dangle awkwardly in a consequentialist philosophy. If I can create more happiness by giving your corn to someone else, why should you have the right to keep it?

I am inclined to give a Hayekian account of why you should have the right to choose whether to eat, plant, trade, or donate your corn. That is, you are likely to know the best of use of your corn, including the best moral use of it, thanks to your local knowledge. Thus, the consequences are likely to best if you make the decision rather than I make the decision.

In fact, in cases where we think that you are not competent to make the decision (a child, or someone with severe mental deficiencies), we do not treat property rights as absolute. Thus, our intuition about rights is tied up with the issue of how much we respect the person’s local knowledge.

One view of moral philosophy is that our intuitions are basically right, and it is the philosopher’s job to come up with a system of thought that accounts for and perhaps codifies our intuitions. While I would not go to this extreme, it is always something to consider in moral philosophy.

On the other hand, if you told me that economists’ intuitions about what constitute high-quality research are basically right, and the job of economic epistemology is to come up with a system of thought that accounts for and perhaps codifies our intuitions, I would be inclined to object. But perhaps I am willing to say that it something to consider in economic epistemology.

Six Breakthrough Ideas in Economics (?)

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In the opinion of The Economist, they are:

1. Akerlof’s Market for Lemons
2. Minsky’s Financial Cycle
3. The Stolper-Samuelson Theorem (Wikipedia explanation).
4. The Keynesian multiplier
5. The Nash equilibrium
6. The Mundell-Fleming trilemma (Wikipedia explanation).

Pointer from Greg Mankiw.

In Specialization and Trade, I discuss many of these ideas.

I mention (1) as an example of economists finding a theoretical market failure for which markets have found solutions. Used cars are sold with guarantees, or with information provided by third parties, or by reputable dealers.

I endorse something like (2), although I offer a different mechanism for the financial cycle. Minsky describes it in terms of the risk proclivities of capitalists. I describe it in terms of the trust that people place in financial intermediaries.

I do not discuss (3) specifically, but I do say that the “two-by-two” model of international trade is an example of economic modeling that is more misleading than insightful. In any case, of all of the Heckscher-Ohlin-Samuelson results, I would have picked factor-price equalization over Stolper-Samuelson.

I explain why (4) is a terrible idea.

I do not mention (5) by name, but I do describe the maintenance of cultural norms from a game-theoretic perspective.

I do not discuss (6), but I argue against monetarism, and thus I implicitly discount the trilemma.

Where are the Servants?

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I asked this question five years ago. Recently, on Facebook, Nathan Smith wrote,

Consider the following hypothesis. Once upon a time, there was a notion of “respectability.” Society, represented chiefly by the gossip of housewives, imposed honesty, chastity, and maybe some degree of piety, not so much by force as by public opinion. And I think that mere “respectability” qualified one for certain jobs, such as child care, handling money, personal service, etc. Nowadays, tolerance and the Sexual Revolution have abolished the category of respectability, but there are still a lot of jobs where people don’t need special skills but do need to have good character, so some filter is needed. So education has become the new respectability. . .A whole social stratum finds it hard to get access to jobs they could do, because our nonjudgmental society refuses to circulate the information about people’s characters that potential employers need, and the substitute for respectability, education, can’t be universal because, while everyone could be chaste and honest, many don’t have the academic ability to succeed in college, and/or can’t afford it. So personal service, which almost vanished during the economically egalitarian mid 20th century, but would be well worth reviving today, doesn’t make a comeback for lack of an identifiable class of respectable people whom the rich would allow to be present in their homes. . .

My thoughts.

1. There are a lot of jobs that involve personal care. Elder care and child care are what I have in mind.

2. What Smith calls “character” might be described as conscientiousness.

3. I do not get the impression that the personal care market fails in any dramatic sense. That is, I do not get the impression that there are many conscientious people willing to take jobs in personal care who are unable to find such jobs. If such a market failure were to present itself, it could be solved by entrepreneurs forming companies to vet and guarantee the quality of individual providers of elder care and child care.

4. Not that Smith was responding to my original post, but there I was suggesting that the high concentration of wealth would imply not so much that every middle class family should have personal servants but that rich people should have hundreds or thousands of personal servants. I think it is an instructive issue to ponder, but I have not come up with any new theories in the past five years, although I would add that the “supply problem” might include the fact that there are many people who are not conscientious.

Three Abstracts that Caught My Attention

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1. Roland Fryer.

This paper explores racial differences in police use of force. On non-lethal uses of force, blacks and Hispanics are more than fifty percent more likely to experience some form of force in interactions with police. Adding controls that account for important context and civilian behavior reduces, but cannot fully explain, these disparities. On the most extreme use of force – officer-involved shootings – we find no racial differences in either the raw data or when contextual factors are taken into account. We argue that the patterns in the data are consistent with a model in which police officers are utility maximizers, a fraction of which have a preference for discrimination, who incur relatively high expected costs of officer-involved shootings.

2. Emi Nakamura, Jósef Sigurdsson, Jón Steinsson.

We exploit a volcanic “experiment” to study the costs and benefits of geographic mobility. We show that moving costs (broadly defined) are very large and labor therefore does not flow to locations where it earns the highest returns. In our experiment, a third of the houses in a town were covered by lava. People living in these houses where much more likely to move away permanently. For those younger than 25 years old who were induced to move, the “lava shock” dramatically raised lifetime earnings and education. Yet, the benefits of moving were very unequally distributed within the family: Those older than 25 (the parents) were made slightly worse off by the shock. The town affected by our volcanic experiment was (and is) a relatively high income town. We interpret our findings as evidence of the importance of comparative advantage: the gains to moving may be very large for those badly matched to the location they happened to be born in, even if differences in average income are small.

3. Ran Abramitzky, Leah Platt Boustan, Katherine Eriksson.

Using two million census records, we document cultural assimilation during the Age of Mass Migration, a formative period in US history. Immigrants chose less foreign names for children as they spent more time in the US, eventually closing half of the gap with natives. Many immigrants also intermarried and learned English. Name-based assimilation was similar by literacy status, and faster for immigrants who were more culturally distant from natives. Cultural assimilation affected the next generation. Within households, brothers with more foreign names completed fewer years of schooling, faced higher unemployment, earned less and were more likely to marry foreign-born spouses.

Heinz D. Kurz on Classical Economics vs. Marginalism

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I was sent a review copy of the book, Economic Thought: A Brief History. A few excerpts:

The classical economists emphasized the asymmetries between social classes in terms of differences in economic property and political power. . .landlords. . .as Smith put it in The Wealth of Nations, “they love to reap where they never sowed.”

…these economists started to see the interdependence of economic units as a central analytical theme. The task of political economy was to analyze the entanglement of intended and unintended consequences that resulted from the actions of self-regarding agents.

…While David Hume had maintained that man is “but a heap of contradictions” and reason “the slave of the passions,” marginalist economic thought became preoccupied with simple, linear characters who know what they want and efficiently pursue it. . .

…While the classical authors had started their analyses with a view to society. . . stratified in different classes, the marginalists began their analysis from the single needy individual.

…The marginalist concept of given preferences, depicted in a utility function (defined in terms of a given and constant set of goods), also does not provide for the emergence of new goods and hence has no way of dealing with dynamic cases. It therefore should not come as a surprise that with marginalism attention initially shifted away from questions about development and economic growth to questions about the allocation of resources toward alternative uses.

In writing a “brief” history of economic thought, any author faces a challenge of when to cut a discussion short and when to let it go on. I did not agree with some of Kurz’s choices. My overall reaction is that I found the book stimulating but not spectacular.

I am interested in the relationship among the issues on which economists focus, the approaches that they develop, and the shortcomings of those approaches. If you’ve read Specialization and Trade, then you know that I think that modern economists have taken an approach that is defective in important respects. I offer the hypothesis that they took this approach in part because of the salience in the aftermath of the second World War of the challenge of producing the combination of ships, planes, tanks and other weapons that would best meet military objectives. They came up with methods that were useful for addressing this challenge but which were inappropriate for describing an economy with many more useful goods and services and a much higher degree of specialization.

Models, Assumptions, and Predictions

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Think of a model as a set of assumptions (do I owe Quine and Duhem a citation here?).

These assumptions produce a set of predictions. The “predictions” need not be about the future. They may be explanations of events or patterns of events observed in the past.

When a model’s predictions turn out to be true, the model should be rated highly if and only if it is very difficult to obtain those predictions from other models. In order to have the best chance of being rated highly, a model should make many predictions, at least some of which are contrary to predictions made by other models.

When a model’s predictions turn out to be false, the model should be rated highly if and only if the failure is interesting. What does that mean?

Suppose that we classify the assumptions in a model as either verified or doubtful. A verified assumption is an assumption that can be demonstrated to hold true in the situation in which a prediction is being made. A doubtful assumption is one that either cannot be verified or is even known to be false.

If a model makes false predictions, then one or more of the doubtful assumptions does not hold. If there are many doubtful assumptions, then we do not know which one, and we learn almost nothing from the prediction failure. At the other extreme, if there is only one doubtful assumption, then a prediction failure is interesting in the sense that it tells us that this doubtful assumption does not hold and this has important consequences.

So you want to try to eliminate doubtful assumptions. One way to do this is to generalize a model. That is, if your model assumes that there are two factors of production, can you get the same result if there are many factors of production? If so, then you have eliminated the assumption of two factors of production as a doubtful assumption. Another way to eliminate doubtful assumptions is to demonstrate using data that the assumptions hold.

In short, we should rate highly a model when

(a) if almost all of its main predictions are true, at least some of them differ from the predictions made by other models

(b) if some important main predictions are false, there is a very limited set of doubtful assumptions that might explain the false predictions

My guess is that very few economic models could be rated highly by these criteria.

Good Models Fail in Interesting Ways

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Consider three monetarist models.

(1) If the Fed reduces the rate of growth of high-powered money relative to recent trend, this will slow the growth rate of nominal GDP.

(2) If the Fed raises the Fed Funds rate above the interest rate on medium-term bonds, this will slow the growth rate of nominal GDP.

(3) If the Fed lowers the expected future growth rate of nominal GDP, then this will slow the growth rate of nominal GDP.

Model (3) is less likely to fail, in the sense that lower expected future growth of nominal GDP is very likely to be correlated with lower growth in nominal GDP. However, when model (1) or model (2) fails, the result is interesting. Because model (3) is not likely to fail in an interesting way, it is, in my view, an inferior model.

Over the years, economists have developed many criteria for evaluating a model. I think that if you ponder the subject, and you review situations where we learn from models and where we do not, you might agree with me that a good model is a model that is capable of failing in interesting ways. Bad models are models where either (a) failure would be met with indifference, perhaps because we already know that several key assumptions are implausible, or (b) where “success” is so heavily built into the model–as in (3) above–that there is nothing to be learned from confronting the model with evidence.

Thoughts on the use of Models in Economics

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The term “model” can mean many things.

1. To an engineer, a model might be something like a flight simulator. It attempts to replicate actual conditions so well that it can be used to train a pilot who then moves on to operate in the real world. Economists sometimes treat their models this way. Think of models used to forecast the impact of tax changes, or think of Jonathan Gruber’s model used to predict the impact of Obamacare on the health insurance market. In my view, most of the time the accuracy of these sorts of exercises is often far over-stated.

2. In economics, models are often used for a different purpose. The economist writes down a model in order to demonstrate or clarify the connection between assumptions and conclusions. The typical result is a conclusion that states

All other things equal, if the assumptions of this model hold, then we will observe that when X happens, Y happens.

For example, X could stand for “a firm raises its price” and Y could stand for “the demand for its product goes down.”

3. Model failure is usually more interesting than model success.

Suppose that we observe a situation where X happens and Y happens. Does that confirm the model? Because there typically are other models that can explain such a pattern, we usually do not draw strong conclusions based on such evidence.

However, suppose that we observe a situation where X happens and Y does not happen. Does that refute the model? I would say that what it refutes is the prefatory clause “other things equal, if the assumptions of this model hold.” That is, we may conclude that other things were not equal or that the assumptions of the model do not hold.

In my book, I use the example of a college that raised its tuition and experienced a subsequent increase in applications for admission. I do not say that the law of demand fails to hold. Instead, I say that other things were not equal. In particular, the college also raised its level of financial aid. Thus, although its “list price” went up, the discounted price faced by many applicants went down.

The prefatory clause in economic models makes it difficult to draw scientific conclusions from real-world observations. When X and Y occur as predicted, we cannot confirm any one model, because other models are consistent with result. When they do not occur as predicted, we only know that the prefatory clause was violated–the assumptions of the model were not met or other things were not equal.

Often, we cannot say anything very interesting about which assumptions were not met or which things were not equal. For example, the model of an aggregate production function is used to predict that differences in output per worker will be proportionate to differences in capital per worker. When this fails, there are many possible reasons: workers may differ in their human capital; physical capital may not be measured or aggregated correctly; output may not be measured or aggregated correctly; institutional differences may matter. etc.

In fact, the primary use of the aggregate production function model is to examine its failure, which is called “the residual.” Economists place an interpretation on this residual, calling it “total factor productivity.” They interpret the rate of change in this residual over time as “productivity growth.” They interpret the change in the rate of change in this residual as “change in the trend rate of productivity growth.”

Robert Murphy on Mises and Economic Calculation

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Murphy writes,

If a particular operation is unprofitable, that means that it absorbs resources that have a higher monetary value than the outputs it produces. In other words, everyone else in society outside of that operation thinks that its input resources are more valuable than its output goods (or services). This is feedback from everyone else telling the people running this operation: “You are reducing the value of economic resources available to the rest of us, so consider carefully what you have been doing. Is there a tweak you can make to your enterprise, so that you absorb fewer inputs and/or produce outputs that the rest of us value more highly?”

I often point out that government-promoted recycling operations tend to be unprofitable. For me, this creates a presumption that the value of the output in recycling is less than the cost of the inputs. In short, recycling wastes resources.

Read the whole essay. This is the sort of analysis that ought to be stressed to first-year (and later) economics students.

What I’m Reading

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Scientific Perspectivism, by Ronald N. Giere. Based on a reader’s suggestion that I try to get up to speed on philosophy of science since the 1960s. He is trying to find a middle ground between scientific objectivism and social constructionism. The former says that there is absolute truth, and science is the process for discovering it. The latter says that all scientific beliefs are socially constructed, and hence none can claim to be Truth.

From p. 15:

Perspectivism makes room for constructivist influences in any scientific investigation. The extent of such influences can be judged only on a case-by-case basis, and then far more easily in retrospect than during the ongoing process of research. But full objectivist realism (“absolute objectivism”) remains out of reach, even as an ideal. The inescapable, even if banal, fact is that scientific instruments and theories are human creations. We simply cannot transcend our human perspective, however much some may aspire to a God’s-eye view of the universe. Of course, on one denies that doing science is a human activity. What needs to be shown in detail is how the actual practice of science limits the claims scientists can legitimately make about the universe.

In economics, we want to make is seem as though the “science” is objective, and all policy differences are ideological. In fact, differences of “scientific” opinion are not so objective. Many economists process this as “the other guy is a blinkered ideologue, but I’m not.” But nobody has a God’s-eye view of the economy.