Category Archives: Economic education and methods

Pete Boettke on Economic Reasoning

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He writes,

Sound economic reasoning teaches many things, but perhaps the most important lesson is about the importance of the instituitonal framework for marshalling the self-interest of individuals into publicly desirable outcomes by enabling the judicous negotiation of trade-offs so that the gains from trade and the gains from innovation are realized. Some instituitonal environments promote productive specialization and peaceful social cooperation among individuals, others don’t. Economic reasoning is essentially discursive reasoning in comparative institutional analysis.

I recommend the entire post.

Paul Romer on Physics and Information

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He writes,

There is a crucial distinction between human capital (stored in neurons), and codified information (stored in some external form, such as printed text or bits on a hard drive.)

Anything stored in neurons is a rival good.

A person’s human capital is fully excludable as long as people have legal control over their own bodies. So there are no human capital “spillovers” and no human capital “externalities.”

As the cost of copying codified information goes to zero, it becomes a pure nonrival good.

Pointer from Mark Thoma. Read the whole thing. It relates to my bumper-sticker saying: Information wants to be free, but people need to get paid.

Tariffs vs. Quotas

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Greg Mankiw writes,

rationing under price controls is never perfect. Under rent control, for example, apartments do not automatically go to those who value the apartments the most. The misallocation due to imperfect rationing makes the actual welfare cost of price controls much higher than the standard deadweight loss triangle.

Suppose that the minimum wage is $10. You have one worker who would be happy to work for $8 and another worker who would be happy to work for $10. If the second worker is the one who happens to get the job, you lose $2 of surplus due to what Greg is calling “imperfect rationing.”

I remember being taught the equivalence between tariffs and quotas. But it seems to me that such an equivalence fails by the same reasoning. The quota may be imperfectly rationed, unless rights to sell within the quota are tradable.

Concern with the term “public goods”

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Frances Woolley writes,

in the US, as elsewhere, most public expenditure goes towards redistributive transfers, health and education. Table 2 shows
total government expenditures for 18 OECD countries. Most government expenditures go towards health (7 to 19 percent of government spending), education (7 to 15 percent), and ‘social protection’ programs that more directly redistribute income (19 to 45 percent).
The goods most often cited as public goods are unimportant in terms of overall government expenditure for OECD countries: defense accounts for 1 to 6 percent of spending; public order between 2 and 5 percent of spending.

Pointer from Bryan Caplan.

It is an interesting and wide-ranging essay, difficult to excerpt. Here is another:

substantial insights into the economics of non-rival goods can be gained from the analysis of clubs (for providing local goods that are non-rival but excludable), the theory of natural monopoly (for goods such as Microsoft office where there are substantial initial development costs but the additional cost of an extra Word user is (close to) zero), or the economics of information (for the development of new technologies or drugs, where the manufacture of the new drug may cost a dollar or two per user, making it close to non-rival but the drug development may cost millions). While it is interesting and useful to have a theory for the special sub-set of non-rival goods that happen to be non-excludable also, there too few such goods to justify the place such goods hold in the public economics curriculum

One point she is making is that we should not encourage students to think that the theory of public goods explains or describes the actual role of government.

Don Boudreaux on The Essential Hayek

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It is a project for Canada’s Fraser Institute. It will launch next week.

Boudreaux starts with a “nobody knows how to” introduction. He uses paper and ink as examples of mundane goods that require many different people and specialized tasks to be produced.

As I start my book on specialization and trade, I find myself doing the same thing. This is in a great tradition. Adam Smith used the woolen coat. Leonard Read used the pencil. My thought was to use a bowl of cereal.

Pete Boettke on Methodology

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In a discussion with Aaron Ross Powell and Trevor Burrus, he makes a point that I have made about MIT economics. That is, economists used to debate issues of method in their papers. Then, they stopped debating and just said, in effect, “economists do what economists do.” He suggests that Paul Romer’s “mathiness” discussion may re-open this debate. However, I see most economists trying to duck the issue of method and instead treat Romer’s complaint as applying only to Chicago and Minnesota. Anyway, there is much more in the podcast.

Boettke argues, as he has elsewhere, that there is a “main line” in economics (not mainstream). That main line is often forgotten, and then rediscovered by a “new school.” For example, rent-seeking has been in the main line (Bastiat’s story of candle-makers complaining about the sun) but had to be rediscovered. I think that PSST might very well fit into that category.

The Art of Statistical Scamming in Experiments

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John Bohannon writes,

Here’s a dirty little science secret: If you measure a large number of things about a small number of people, you are almost guaranteed to get a “statistically significant” result. Our study included 18 different measurements—weight, cholesterol, sodium, blood protein levels, sleep quality, well-being, etc.—from 15 people. (One subject was dropped.) That study design is a recipe for false positives.

Usually, I think of health studies as bad because they are non-experimental. But this is a way to scam experimental studies.

Paul Romer Issues a Clarification

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He writes,

I wrote that the economists I criticize for using mathiness are engaged in a campaign of ACADEMIC politics, not one of national politics. Whatever was true in the past, the now fight is over ACADEMIC group identity.

Pointer from Mark Thoma. Read the whole thing. My remarks:

1. As I wrote in my earlier comment on Romer, I see monopolistic competition as prevalent. Perhaps the Chicago school would want to argue that even though in practice we do not see perfect competition, if you make predictions assuming perfect competition, you will typically be correct. But I do not want to speak for Chicago.

2. Romer seems to want to march under the banner of “science” in economics, and I am skeptical of that. Reader Adam Gurri pointed me to an entire book of essays that take such a skeptical position. I am not sure that the essays speak to me, but I am still pondering.

3. In my view, as the economics profession has grown stronger in math, it has grown weaker in epistemology. That is, the generations of economists that came after Samuelson and Solow lost the ability to ask “How do we know that?” They are content to re-use equations simply because they can be found in prominent publications, but (as Noah Smith has pointed out) not because they have been verified empirically, as they would be in physics or another hard science.

There is a slight overlap between Romer’s critique and mine. Romer is saying that economists are choosing models in order to maintain “group cohesion.” I say that they are choosing models based on appeals to authority.

What I wish to claim is that epistemology in economics is really difficult. It is more difficult than in physics. We have a much harder time testing our theories experimentally. We face insurmountable levels of causal density. We do not have a neat, clean answer to the question “How do you know that?” It appears to me that physicists can answer that question in ways that are much more straightforward and compelling. (I am thinking of physics at a high school level. Maybe at the research frontier physics also faces epistemological challenges.)

Because epistemology in economics is really difficult, I think that if you care about epistemology, you are going to find much published research in economics frustrating. That will be true for articles that avoid math as well for articles that use math.

Paul Romer’s Case for Ad Hominem

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He writes,

The only way I can see to protect scientific discourse is to limit entry into the discussions of science. But this MUST NOT BE DONE on the basis of beliefs about what is true. It must instead be based on a demonstrated commitment to the norms of science. As part of this process of defending science, exclusion by shunning, plays an essential role. People who show, by publishing even one Willie Horton paper, that they are not committed to those norms, have to be excluded. So too must the people who promote and encourage Willie Horton papers. In science, “It was my PAC, not me” should not be an acceptable defense.

Pointer from Mark Thoma.

Later, he criticizes positions taken by Milton Friedman and George Stigler against the idea of monopolistic competition. On the narrow issue of whether economists should use the model of monopolistic competition, I am entirely on Romer’s side. I tell my AP econ students that we spend most of our time on the nearly-irrelevant models of perfect competition and monopoly, when in the real world we almost always find monopolistic competition or oligopoly.

But I do not agree with Romer’s larger point. What would it mean to shun Milton Friedman because in Romer’s judgement Friedman’s opposition to the theory of monopolistic competition was politically motivated? Would we discard the permanent income hypothesis, the Friedman-Savage utility function, and the Monetary History of the United States?

As I understand Romer, he is arguing that the scientific norms in economics are so delicate that we must shun economists who fail to maintain certain standards. I look at it differently.

I believe that politics pervades the economics profession. Paul Samuelson’s textbook was a political document, and his claim to scientific neutrality was an exercise in (self-) deception. There is no economist so pure as to be free of bias.

It is not desirable to throw out the ideas of biased economists (indeed, if I am correct, that would mean throwing out all ideas in economics). Instead, the ideas ought to be debated as ideas, without regard to who proposed them. If you think that monopolistic competition matters in growth theory, then you should be able to make that case. You can do very well by pointing out the flaws in other people’s work. But attacking their motives adds nothing to the discussion. To say otherwise is to suggest that all economic discourse should consist of asymmetric insight (claiming to understand your opponents better than they understand themselves). Is that really what Paul Romer wants–to turn economics journals into Paul Krugman columns? If so, then Romer should be shunned.

Uncertainty and the Sources of Profit

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From The Economic Way of Thinking, eleventh edition, by Paul Heyne and others, p. 195:

Profit arises from uncertainty. In the absence of uncertainty, any differences between expected revenue and expected total cost would be competed away and profits would become zero.

That sounds to me like too strong a generalization. Some remarks.

1. It shows the influence of Frank Knight. But would Knight have bought such a strong statement?

2. Economists, including the authors, point out that profits as reported by business include opportunity cost, particularly the opportunity cost of capital. Economic profit is less.

3. Elsewhere, the authors want to insist, reasonably enough, that taxes are paid by individuals, even when those taxes are called corporate income taxes. I would think that consistency would require insisting that profits accrue to individuals, even when they are called corporate profits. But if all profits accrue to individuals, then I do not see how we can separate economic rent from opportunity cost. Maybe Bill Gates made a lot of money from Microsoft because he happens to have a very high opportunity cost. OK, that sounds absurd, but still, he has a higher opportunity cost than someone with less drive and ability starting a software business.

4. Talking about the profits earned by shareholders is tricky. In the portfolio theory of modern finance, there should be no excess return from taking diversifiable risk. Unless I know something that everyone else doesn’t, I will earn on average a lower return by buying shares in a particular stock than by buying shares in the market portfolio. (I think this point tends to cut against point 3 above.)

5. How do patents fit into the story? Firms obtain patents in order to protect profits. Are patents simply government-chartered monopolies, leading to artificial rents? Or are patents a return on investment in research and development? In the latter case, perhaps one would say that if the outcome of research and development were certain, then profits from those activities would become zero.

6. It seems to me that there are other sources of market power that are defensible. I am not talking about defensible in a moral sense, but defensible in the sense that they will not be competed away. For example, there is reputation. If my insurance company has a reputation for being sound, then potential competitors will find it difficult to persuade my customers to switch. Another example is network effects. Wal-Mart has a lot of customers because it has cheap prices. Because it has a lot of customers, it is in a strong bargaining position with suppliers, so it can keep its prices cheap. But if a lot of companies try to create network effects, and some succeed and some fail, is this another case of profit emerging out of uncertainty?

Going back to the quoted paragraph, I think that it is either false or uninteresting. If we do not stretch our definition of uncertainty, then it is false. Alternatively, suppose that we make it true by arguing that profit from investment in intellectual property, reputation, network effects, and so on is only due to the uncertainty involved in such investment. A forced tautology of that sort is not interesting.