Category Archives: Economic education and methods

Trade as a Technology

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A while back, I threatened to put together an introduction to economics that runs counter to the “seeing like a state” tradition in textbooks that Paul Samuelson started. I call this “teaching emergent economics,” and as my thoughts develop I will post them in this category. Here are thoughts on trade as a technology.

1. David Friedman in his textbook, The Economics of Everyday Life, pointed out that we can grow automobiles in Iowa by growing grain, putting it on ships to Japan, and having the ships come back with automobiles.

2. In theory, we do not need to produce anything in order to have an interesting economy. Suppose that several of us receive regular endowments of different goods. Trading among ourselves can produce gains.

3. In an actual economy, we engage in production. However, we engage in production primarily for exchange. Centuries ago, a farmer produced for subsistence. But in the past two hundred years, in advanced countries farmers have produced for exchange.

4. In fact, production for exchange is so important that GDP only measures production for exchange. It counts goods and services that trade at market prices, not the value of home cooking.

5. The fixed-proportions concept of production is very misleading. It is particularly misleading as a way of describing an entire economy. When people think in terms of fixed proportions of resources needed to produce goods, they imagine running out of resources. Instead, as some resources become scarce and their prices rise, substitution emerges. People make different consumption choices. Producers come up with different recipes for producing goods and services.

6. Even without fixed proportions, a production function can be a misleading concept. If you have two economies with identical production capabilities, one economy can be much better off than the other. If the first economy takes optimal advantage of trading opportunities and the second economy does not, then the first economy will be better off. It will appear that the first country has greater “total factor productivity,” although its advantage has nothing to do with production per se.

7. If an entrepreneur invents a new product or a new production process, that necessarily creates a new trading opportunity. If an entrepreneur invents a new trading opportunity (think of eBay), that is equivalent to inventing a new production process.

8. Thus, we can think of entrepreneurs in terms of how they affect trading opportunities. They alter trading patterns in response to price changes that in turn signal surpluses and scarcities. And they test new trading opportunities, sometimes in the form of new products or production processes.

Robert Solow on Sustainability

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A commenter points to a talk from 1991, in which Solow says,

Once you take the point of view that I have been urging on you in thinking about sustainability as a matter of distributional equity between the present and the future, you can see that it becomes a problem about saving and investment. It becomes a problem about the choice between current consumption and providing for the future.

The reader recommended the article for this quip:

It is very hard to be against sustainability. In fact, the less you know about it, the better it sounds.

I recommend the entire article to readers of this blog and indeed to any student of economics. In fact, I would like to hit every graduate school economics professor over the head with it and say, “This is what you should be aiming to enable your students to do when they get their Ph.Ds.”

Solow deals with the concept of sustainability not with a formal model but with a philosophical examination. It is this ability to think like a philosopher that was lost when MIT transformed economics. Ironically, Solow aided and abetted the transformation.

Solow was my dissertation adviser. Although we have grown apart ideologically, my macro memoir explains how I was drawn to him in the late 1970s:

Unlike many of my fellow students, I am not inspired by Dornbusch and Fischer. I do not see the benefit of writing down equations to solve long-term optimization problems as a way of understanding macroeconomics. To me, too much economic relevance is being sacrificed to the altars of mathematical rigor and rational-expectations dogma. That assessment puts me hopelessly out of step with where academic macroeconomics is headed. It binds me to Solow.

Four Forces Watch: Poor Children Have Smaller Brains

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The Washington Post did not put this story on page one.

>New research that shows poor children have smaller brains than affluent children has deepened the national debate about ways to narrow the achievement gap.

Most of the story goes with the assumption poverty causes smaller brain size. But amazingly enough, the story also includes this alternative interpretation:

But James Thompson, a psychologist at University College London, has a third theory.

“People who have less ability and marry people with less ability have children who, on balance, on average, have less ability,” he said. Thompson noted that there is a genetic component to intelligence that Noble and Sowell failed to consider.

“It makes my jaw drop that we’ve known for years intelligence is inheritable and scientists are beginning to track down exactly how it happens,” Thompson said. “The well-known genetic hypothesis has not even had a chance to enter the door in this discussion.”

The story also quotes Charles Murray.

“I would be astonished if children’s brain size were NOT correlated with parental income. How could it be otherwise?”

The politically correct presumption would be that the brain size of poor children can be increased using some government programs. Can we verify that by comparing brain sizes of identical children raised apart? Or by comparing brain sizes of children randomly chosen for pre-school programs with children from a control group?

Murray has more commentary here, including a historical scientific controversy over whether there even exists a relationship between brain size and intelligence among humans.

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.

A Possible Project for Me

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I was thinking of doing a whole bunch of relatively short videos on PSST. The thought process that led me to this was:

1. The Weintraub volume on MIT economics showed how Samuelson shaped the direction of economics, in part with his textbook. I think of his textbook as “seeing like a state” in terms of economics. I think of PSST as the opposite view–very bottom-up.

2. I think one could write a decent textbook that focuses on PSST rather than on the production-and-distribution story that is the focus of neoclassical economics.

3. But nowadays, a textbook is not my medium of choice. The bigger closer library is the Internet, and YouTube in particular.

4. On YouTube, short, punchy pieces work better than long lectures. The challenge for me would be to break my ideas into bite-sized bits and still keep track of them–show the links among them, avoid duplication etc.

Anyway, I think of this as having about a 15 percent chance of going anywhere (it depends on whether I can remain convinced that it is a good idea). The next step would be to put together a draft outline.

Reflections on Paul Samuelson and MIT Economics

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I have finished my first path through the Weintraub volume. Here are my thoughts now:

1. There truly was a dramatic break between pre-war and postwar economics. Before the second World War, you could still see economics as a branch of social and political philosophy. And as philosophers, economists were worried about what they could and could not know. After the war, the discipline became dominated by modeling. Some of that was a long-term trend, and some of it came from the fact that modeling was applied to some aspects of the war effort itself.

2. Samuelson and Solow were part of a transitional generation. They were exponents of the newer modeling culture, but they still had plenty of doubts about the assumptions embedded in models.

3. The next generation of MIT economists, I would argue, was never trained to question assumptions. Once a particular equation had become customary, because a lot of papers used that equation, you just treated the equation as true. Think of the Cobb-Douglas production function, or the expectations-augmented Phillips Curve.

4. Samuelson’s self-image was that of an ideologically neutral technocrat. In the Weintraub volume, Harro Maas writes,

Technicality implied impartiality and detachment. Samuelson thus exemplifies for economics the general move of science in the postwar era to define itself as technical, a move that fit well with the teaching and research profile that MIT developed in the postwar era.

And later,

Samuelson did not consider it his task to be partisan for one particular line of economic policy, or to compromise between opposite policy positions, but to step back, or better “step aside,” and offer an analytical perspective from which to choose.

5. Of course, I would view Samuelson’s very framework as ideologically loaded. Samuelson took a “seeing like a state” approach to economics. Whether it was a social welfare function, a Keynesian multiplier, the doctrine of revealed preference, the Phillips Curve, or the production function, he focused on tools for helping policy makers control an economy. With such tools, the policy maker could know enough to direct economic activity. Samuelson was not troubled by Hayekian concerns about local knowledge.

Genghis Khan on Structural Change in Finance

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Stanley Fischer said,

To conclude, the U.S. financial system has changed a great deal over the past several decades. One of the most important changes has been the rapid growth of the nonbank sector. Many reforms have been adopted for both banks and nonbank financial institutions. But regulation is a cat and mouse game. Regulators need to respond to existing regulatory gaps and to keep pace with further changes. We hope we will succeed in doing so. But we know that we will never be able to identify in advance all the threats to stability that are out there, and that it is therefore all the more critical to maintain and strengthen the robustness of our financial institutions, and of the financial system as a whole.

Read the whole thing. Pointer from Mark Thoma.

Both theoretical and empirical work in macroeconomics tends to ignore structural changes of this kind. On the empirical side, think of econometrics. There are three classes of factors at work in macroeconomics data. One is short-term noise, such as a cash-for-clunkers program adding to auto sales one quarter and subtracting from them the next. Another is cyclical drivers–the sorts of things that your theory suggests as causal factors in macroeconomic fluctuations. Finally, there are structural changes, such as the changes in financial markets that Fischer is talking about.

I do not think that it is possible to sift through these three factors without using judgment. Just dumping the data into your econometrics software is an exercise in garbage-in, garbage-out.

Teach Price Gouging Using Uber

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I was talking with some young people in Boston about getting around during the severe snow. They commented that Uber’s prices would go up by a factor of 4 or more when things got really tough. But they were not angry. They were grateful that the could get transportation at all. And they understood the role that the higher prices played in helping the situation.

Perhaps one could discuss this phenomenon in class. And then ask why the young people did not complain about “price gouging.” Why is it that if a store were to raise prices on snow shovels during a snowstorm that would be price gouging, but Uber’s approach was not price gouging? Why would someone be inclined to favor a regulation to prevent the store from raising the price of shovels during a snow storm?

I suspect that the intuition is that the store’s supply of shovels is presumed fixed, but Uber’s supply of drivers goes up as prices rise. Since the higher price creates a supply response, people can see it playing a constructive role. But with the store and the snow shovels, all you see are higher profits.

Of course, there are two other benefits to higher prices for snow shovels. First, it discourages people who do not really need shovels from hoarding them (if you already have one shovel, you would not go out and buy a second one at a high price). Second, in the long run it encourages stores to keep extra shovels in stock. Knowing that they can make a good return from having a large inventory of shovels in case of a snow storm, the stores will be willing to hold larger inventories than if their profits are constrained.

What I’m Reading

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MIT and the Transformation of American Economics, edited by E. Roy Weintraub. David Warsh cited it and I blogged on Warsh about ten days ago, talking about how other universities’ resistance to hiring Jews enabled MIT to surge ahead. I think it is a fascinating volume, and I don’t think it’s just because I did my graduate work at MIT. A few things I’ve picked up so far.

1. Economic methods changed relatively rapidly between 1935 and 1955. In 1935, economics still looked a lot like a branch of social and political philosophy. By 1955, it was much more technical and policy-oriented, with a shiny scientific veneer. Keynes and the Depression got economists interested in activist government, and the operations research of World War II stimulated much subsequent work on theory, data collection, and policy.

2. Beatrice Cherrier’s essay, and others in the book, describe the emergence of what Samuelson dubbed the “neoclassical synthesis.” You can think of this as an attempt to reconcile Solow’s growth theory, in which saving is good, with Keynesian macro, in which saving is bad. The resolution is to say that the economy is only Keynesian in the short run.

3. In Andrej Svorencik’s essay, we get quantitative support for the view that a few dissertation advisers at MIT have played a dominant role in the profession as a whole. He points out that in my era Dornbusch out-sired Fischer in terms of numbers of students. Still, I continue to hold Fischer responsible for turning macro into a wasteland.

4. In Yann Giraud’s essay, we find that Samuelson’s textbook was bitterly opposed by conservatives, who put pressure on the MIT Administration, which in turn persuaded Samuelson to make changes. If this caving into outside pressure seems surprising, remember that this was the McCarthy era, and most individuals and institutions preferred discretion to waving a red cloak in front of that bull, so to speak.

I am still only part way through the volume.