Monday, September 19, 2016

What do white Americans stand to lose?


An article by Zack Beauchamp in Vox tries to draw a parallel between Donald Trump and the rise of nativist movements in Europe (including Brexit). The similarities do exist: a bunch of angry white people, afraid of immigrants in general but especially Muslims, electing right-wing populist leaders. I don't expect the same outcome here as in Europe, even if Trump manages to win the election, for several reasons:

1. America has a history of pro-immigrant sentiment, which continues to this day. Intermarriage rates are high, supporting George Washington's prediction in 1794:
Whereas by an intermixture with our people, they, or their descendants, get assimilated to our customs, measures, and laws: in a word, soon become one people.

2. Non-Hispanic whites are far less demographically dominant here than in Europe, and even less so among younger generations, meaning that the Trump movement will have to radicalize a far larger percentage of American whites to gain dominance. Highly unlikely.

3. Younger Americans are solidly against Trump. Some of that is demographics and some is an age effect, but a large part of it is probably a cohort effect - younger Americans have grown up with the new nonwhite immigrants and are hence far less likely to think that nonwhites don't represent "real Americans."

So I predict that even a Trump victory, should that occur, will be a last and only hurrah for white nativist racist populism.

However, this doesn't mean that we shouldn't worry about white nativist racist populism. A substantial minority of Americans who are implacably opposed to the nation-state can create all kinds of terrible problems for our country. It can sometimes elect terrible people like Trump to high office. It can elect legislative blocs like the Tea Party that can use veto points to block the functioning of the state, as we found out in 2011. It can dominate local and state governments. If things get extremely bad, it could even resort to terrorism - I see McVeigh as a potential harbinger.

So I think we ought to pay attention to this movement, and think about why these people are angry and afraid. Beauchamp's article suggests that groups' anger is aroused when it seems like another group's status is being raised higher in society:
In order to fully understand why ethnic violence happens, [political scientist Roger Petersen has] argued, we need to appreciate the role of resentment: the feeling of injustice on the part of a privileged portion of society when it sees power slipping into the hands of a group that hadn't previously held it. Drawing on social psychology, he theorized that one of the underappreciated causes of ethnic violence was a change in the legal and political status of majority and minority ethnic groups. 
According to Petersen, that change in status comes from a sense of injustice. Members of dominant groups simply believe they deserve to be the dominant force in their societies, and resent those challenging their positions at the top of the pyramid. 
"Any group that’s been dominant — well, it’s not that easy for them not to be dominant anymore," Petersen tells me. 
This helped explain the puzzle of Kaunas and Vilnius. In Kaunas, the Soviet invasion in 1940 had politically empowered local Jews, who had occupied leadership positions in the Communist Party prior to the invasion and ended up with plum Soviet jobs as a result. This sparked intense feelings of resentment on the part of Kaunas residents, resulting in the vicious pogrom. In Vilnius, by contrast, non-Jewish ethnic Poles held most leadership positions. The Soviet invasion didn’t empower Jews on a large scale, and thus failed to create any resentment toward them. 
In his book, Petersen argues that his theory helps explain the causes of other cases of ethnic violence in Eastern Europe, including the carnage in the Balkans in the 1990s. Other scholars have since found that it could be used to understand communal violence elsewhere in the world. 
A 2010 paper published in the journal World Politics tested Petersen’s theory, looking at 157 cases of ethnic violence in nations ranging from Chad to Lebanon. It found strong statistical correlations between a group’s decline in status and the likelihood that it turns to violence against another group.
Seems reasonable enough. And many people in the media - usually, people on the Left - have declared that it's the imminent or ongoing loss of "white privilege" that is angering Trump voters.

What is "status" in modern America, though? What is "privilege"?

Unlike in Eastern Europe a century ago, most of our jobs and positions don't come from government fiat, but from the workings of the market. And here, it is true that elite whites are destined to occupy a smaller and smaller percentage of the elite, thanks to high-skilled immigration. By taking the intellectual cream of the crop from Asia, the Middle East, and Africa (the best Chinese Americans, for example, now beat the best Chinese people in math competitions, despite being selected from a pool that's outnumbered more than 350 to 1!),  we've ensured that the corporate, scientific, political, and thought leaders of tomorrow will be less and less white. Ivy League discrimination can slow this process down, but it's inevitable.

BUT, the Trump movement doesn't look at all like a movement of elite whites. Instead, it's primarily a movement of the relatively uneducated. And while low-skilled nonwhite immigrants have certainly provided some job competition for these whites, Hispanic immigrants for example certainly aren't doing better than uneducated whites in terms of employment or wages. This doesn't look like a situation in which the American system is awarding jobs to Hispanics that whites aren't getting.

How about college admissions? While the Supreme Court has upheld some affirmative action programs, the practice of privileging historically disadvantaged racial minorities has declined in recent years after being banned in many states. The result has been a decline in black enrollment. So this form of white status is less under threat than in previous years.

Criminal justice? The Black Lives Matter movement might make headway against discriminatory policing and incarceration practices, but as of 2016, these look solidly in place. And it seems unlikely that a reduction in the incarceration of black people would result in an increase in white incarceration. It's not like the cops have quotas of people to throw in prison (I hope)!

How about the tax system? This might be a big one. For decades, Republicans have told white Americans that the tax system represents racial redistribution from whites to blacks and Hispanics. Rush Limbaugh once said that "Obama's entire economic program is reparations," and he said this of Obamacare:
The days of them [racial minorities] not having any power are over, and they are angry. And they want to use their power as a means of retribution. That’s what Obama’s about, gang. He’s angry, he’s gon’ cut this country down to size, he’s gon’ make it pay for all its multicultural mistakes that it has made, its mistreatment of minorities. I know exactly what’s going on.
And he also said this:
Obama has a plan. Obama’s plan is based on his inherent belief that this country was immorally and illegitimately founded by a very small minority of white Europeans who screwed everybody else since the founding to get all the money and all the goodies, and it’s about time that the scales were made even. And that’s what’s going on here. And that’s why the president is lawless, and that’s why there is no prosecution of the Black Panthers for voter intimidation, because it’s not possible for a minority to intimidate the white majority. It’s not possible. It’s always been the other way around. This is just payback. This is ‘how does it feel’ time.
So there's a good possibility that the angry white Trumpians fear the same thing that the GOP has been telling its base to fear since before I was born: that the tax system will be used to crush whites as a form of racial redistribution. As whites shrink as a percent of the electorate, the fear is that they'll simply vote as a bloc to elect leaders who punish whites with racial redistribution policies.

If this is what Trumpians are afraid of, then it really isn't anything different from previous elections. The angry white people are simply more scared than before, because of Obama's 2012 victory, and hence willing to vote for a totally crazy candidate. This interpretation fits with the fact that Trump supporters tend to be better off than their neighbors.

There's one more possible "status" threat, which many on the Right and a few on the Left bring up: a feeling of being in the in-group. In the past, I gather that open expressions of racism by whites were more acceptable in the workplace or in other public places. Ralph Nader, expressing some lukewarm support for Trump, said this:
Well, and you see this when you walk past construction sites and you talk with white male workers, they feel they have been verbally repressed. It’s hard for someone your age to understand what I’m about to say...You can’t say this about that, and you can’t say that about this. And the employer tells you to hush. And perhaps your spouse tells you to hush, and your kids tell you to hush. So they have a whole language that they inherited — ethnic words like Polack. A lot of these people grew up on ethnic jokes, which are totally taboo now. Do you know, Lydia, there are no ethnic-joke books in bookstores anymore?... 
There were Negro-joke books, Jewish-joke books, Polish-joke books, Italian-joke books. They used ethnic jokes to reduce tension in the 1930s, ’40s, ’50s. And they’d laugh at each other’s jokes and hurl another one. But it still flows through ethnic America, you know. There are hundreds of things that people would like to say.
Indeed, many Trump supporters cite "political correctness" as a concern. Even some left-leaning white men are worried about it. This explanation of Trumpism seems to fit with the scattered signs that Trump's rise is emboldening white racist speech and actions across the country.

What this tells me is that some white Americans are afraid of losing something intangible - a kind of cultural cache that allowed them to feel as if they were society's in-group, the cool kids, and that others - blacks, Italian and Polish immigrants, whoever - were the out-group, the marginal Americans, the uncool kids. If the "political correctness" hypothesis is correct, this intangible thing - this nebulous feeling of being in the in-crowd - is even more important than things like jobs, college admissions, or the social safety net.

It seems weird that millions of Americans would march to the polls and vote to put thousands of strategic nuclear weapons in the undersized hands of an obvious narcissistic madman simply out of the fear that they won't be able to think of themselves as the cool kids anymore. But human beings are weird. You almost can't put anything past our species, really.

Anyway, I don't know which of these explanations is right - or if it's something else I haven't even thought of. But I think if we want to avoid a dysfunctional, divided nation, this is something we should think about.

Wednesday, September 14, 2016

The new heavyweight macro critics


I got tired of lambasting macroeconomics a while ago, and the "macro wars" mostly died down in the blogosphere around when the recovery from the Great Recession kicked in. But recently, there have been a number of respected macroeconomists posting big, comprehensive criticisms of the way academic macro gets done. Some of these criticisms are more forceful than anything we bloggers blogged about back in the day! Anyway, I thought I'd link to a couple here.

First, there's Paul Romer's latest, "The Trouble With Macroeconomics". The title is an analogy to Lee Smolin's book "The Trouble With Physics". Romer basically says that macro (meaning business-cycle theory) has become like the critics' harshest depictions of string theory - a community of believers, dogmatically following the ideas of revered elders and ignoring the data. The elders he singles out are Bob Lucas, Ed Prescott, and Tom Sargent.

Romer says that it's obvious that monetary policy affects the real economy, because of the Volcker recessions in the early 80s, but that macro theorists have largely ignored this fact and continued to make models in which monetary policy is ineffectual. He says that modern DSGE models are no better than old pre-Lucas Critique simultaneous-equation models, because they still take lots of assumptions to identify the models, only now the assumptions are hidden instead of explicit. Romer points to distributional assumptions, calibration, and tight Bayesian priors as ways of hiding assumptions in modern DSGE models. He cites an interesting 2009 paper by Canova and Sala that tries to take DSGE model estimation seriously and finds (unsurprisingly) that identification is pretty difficult.

As a solution, Romer suggests chucking formal modeling entirely and going with more general, vague but flexible ideas about policy and the macroeconomy, supported by simple natural experiments and economic history. 

Romer's harshest zinger (and we all love harsh zingers) is this:
In response to the observation that the shocks [in DSGE models] are imaginary, a standard defense invokes Milton Friedman’s (1953) methodological assertion from unnamed authority that "the more significant the theory, the more unrealistic the assumptions (p.14)." More recently, "all models are false" seems to have become the universal hand-wave for dismissing any fact that does not conform to the model that is the current favorite.  
The noncommittal relationship with the truth revealed by these methodological evasions...goes so far beyond post-modern irony that it deserves its own label. I suggest "post-real."
Ouch. He also calls various typical DSGE model elements names like "phlogiston", "aether", and "caloric". Fun stuff. (Though I do think he's too harsh on string theory, which often is just a kind of math that physicists do to keep themselves busy, and has no danger of hurting anyone, unlike macro theory.)

Meanwhile, a few weeks earlier, Narayana Kocherlakota wrote a post called "On the Puzzling Prevalence of Puzzles". The basic point was that since macro data is fairly sparse, macroeconomists should have lots of competing models that all do an equally good job of matching the data. But instead, macroeconomists pick a single model they like, and if data fails to fit the model they call it a "puzzle". He writes:
To an outsider or newcomer, macroeconomics would seem like a field that is haunted by its lack of data...In the absence of that data, it would seem like we would be hard put to distinguish among a host of theories...[I]t would seem like macroeconomists should be plagued by underidentification... 
But, in fact, expert macroeconomists know that the field is actually plagued by failures to fit the data – that is, by overidentification. 
Why is the novice so wrong? The answer is the role of a priori restrictions in macroeconomic theory... 
The mistake that the novice made is to think that the macroeconomist would rely on data alone to build up his/her theory or model.  The expert knows how to build up theory from a priori restrictions that are accepted by a large number of scholars...[I]t’s a little disturbing how little empirical work underlies some of those agreed-upon theory-driven restrictions – see p. 711 of Lucas (JMCB, 1980) for a highly influential example of what I mean.
In fact, Kocherlakota and Romer are complaining about much the same thing: the overuse of unrealistic assumptions. Basically, they say that macroeconomists, as a group, have gotten into the habit of assuming stuff that just isn't true. In fact, this is what the Canova and Sala paper says too, in a much more technical and polite way:
Observational equivalence, partial and weak identification problems are widespread and typically produced by an ill-behaved mapping between the structural parameters and the coefficients of the solution.
That just means that the model elements aren't actually real things.

(This critique resonates with me. From day 1, the thing that always annoyed me about macro was how people made excuses for assumptions that were either unverifiable or just flatly contradictory to micro data. The usual excuse was the "pool player analogy" - the idea that the pieces of a model don't have to match micro data as long as the resulting model matches macro data. I'm not sure that's how Milton Friedman wanted his metaphor to be used, but that seems to be the way it does get used. And when the models didn't match macro data either, the excuse was "all models are wrong," which really just seems to be a way of saying "the modeler gets to choose which macro facts are used to validate his theory". It seemed that to a large extent, macro modelers were just allowed to do whatever they wanted, as long as their papers won some kind of behind-the-scenes popularity contest. But I digress.)

So what seems to unite the new heavyweight macro critics is an emphasis on realism. Basically, these people are challenging the idea, very common in econ theory, that models shouldn't worry about being realistic. (Paul Pfleiderer is another economist who has recently made a similar complaint, though not in the context of macro.) They're not saying that economists need 100% perfect realism - that's the kind of thing you only get in physics, if anywhere. As Paul Krugman and Dani Rodrik have emphasized, even the people advocating for more realism acknowledge that there's some ideal middle ground. But if Romer, Kocherlakota, etc. are to be believed, macroeconomists aren't currently close to that optimal interior solution.


Updates

Olivier Blanchard is a bet less forceful, but he's definitely also one of the new heavyweight critics. Among his problems with DSGE models, at least as they're currently done, are 1. "unappealing" assumptions that are "at odds with what we know about consumers and firms", and 2. "unconvincing" estimation methods, including calibration and tight Bayesian priors. Sounds pretty similar to Romer.

Meanwhile, Kocherlakota responds to Romer. He agrees with Romer's criticism of unrealistic macro assumptions, but he dismisses the idea that Lucas, Prescott, and Sargent are personally responsible for the problems. Instead, he says it's about the incentives in the research community. He writes:
We [macroeconomists] tend to view research as being the process of posing a question and delivering a pretty precise answer to that question...The research agenda that I believe we need is very different. It’s hugely messy work.  We need...to build a more evidence-based modeling of financial institutions.  We need...to learn more about how people actually form expectations.  We need [to use] firm-based information about residual demand functions to learn more about product market structure.  At the same time, we need to be a lot more flexible in our thinking about models and theory, so that they can be firmly grounded in this improved empirical understanding.
Kocherlakota says that this isn't a "sociological" issue, but I think most people would call it that. Since journals and top researchers get to decide what constitutes "good" research, it seems to me that to get the changes in focus Kocherlakota wants, a sociological change is exactly what would be required.

Kocherlakota now has another post describing how he thinks macro ought to be done. Basically, he thinks researchers - as a whole, not just on their own! - should start with toy models to facilitate thinking, then gather data based on what the toy models say is important, then build formal "serious" models from the ground up to match that data. He contrasts this with the current approach of tweaking existing models.

My question is: Who is going to enforce this change? If a few established researchers start doing things the way Kocherlakota wants, they'll certainly still get published (because they're famous old people), but will the young folks follow? How likely is it that established researchers en masse are going to switch to doing things this way, and demanding that young researchers do the same, and using their leverage as reviewers, editors, and PhD advisers to make that happen? This doesn't seem like the kind of change that can be brought about by a few young smart rebels forcing everyone else to recognize the value of their approach - the existing approach, which Kocherlakota dislikes, already succeeds in getting publication and prestige, so the rebels would simply coexist alongside the old approach, rather than overthrowing it. How could this cultural change be put into effect?

Also: Romer now has a follow-up to his original post, defending his original post against the critics. This part stood out to me as particularly persuasive:
The whine I hear regularly from the post-real crowd is that “it is really, really hard to do research on macro so you shouldn’t criticize any of our models unless you can produce one that is better.” 
This is just post-real Calvinball used as a shield from criticism. Imagine someone saying to a mathematician who finds an error in a theorem that is false,  “you can’t criticize the proof until you come up with valid proof.” Or try this one on and see how it feels: “You can’t criticize the claim that vaccines cause autism unless you can come up with a better explanation for autism.”
Sounds right to me. The old like that "it takes a theory to kill a theory" just seems wrong to me. Sometimes all it takes is evidence.

Wednesday, August 31, 2016

Books to help you understand Japan


So you want to understand the real Japan. You have a sense that the typical stereotypes are wrong and outdated and full of derp, and you want to go deeper than anime or "crazy Japan" blogs will take you. So you decide to ask your friendly neighborhood Noah: "What books can I read that will help me understand the real Japan at a deep level?"

Unfortunately Noah hasn't had his requisite 3 daily cups of oversteeped black tea, so he grouchily responds: "How about instead of reading a book, you learn the language fluently, live there for a few years, talk to a bunch of people, and learn for yourself?" But then Noah gets his caffeine fix, and the norepinephrine flows freely through his brain, and he says "Oh, BOOKS? Sure, I got books." And walking over to his lovely fake mahogany Wayfair bookshelf, he proceeds to make you the following list:


Culture and Daily Life

1. New Japan, by David Matsumoto

This book, which you can read in an hour or less, basically summarizes a bunch of social psych studies to prove that Japanese culture changed dramatically in the 1980s. Most of the old stereotypes - conformity, group orientation, etc. - used to be pretty true, but now are totally false. Japan used to rate as more conformist, group-oriented, etc. on most measures than the U.S., but now rates as individualistic and independent as the U.S., or more. Feel the power of data destroying your preconceived notions!


2. Nightwork, by Anne Allison

Also from the 90s, but also still relevant. Nightwork is about two things: corporate culture and sex culture. Japan's corporate culture is, without a doubt, the biggest difference between the West and Japan - although Don Draper might find it a little less alien. Sex culture is different too, mostly because most kinds of prostitution are both legal and well-accepted in Japan. This book is about the convergence of the two - about how Japanese companies solidify their corporate cultures by paying for employees to go to pseudo-prostitutes (actually, more like in-house escorts) called "hostesses." Anne Allison, who is one of the best English-language anthropologists who studies Japan, actually lived and worked as a hostess for years to do research for this book. It's really pretty amazing.

See also: Office Ladies and Salaried Men, by Yuko Ogasawara


3. Capturing Contemporary Japan, ed. by Satsuki Kawano

This is just a bunch of vignettes of modern Japanese people's lives. Kind of dry, but pretty wide-ranging.

See also: Bending Adversity, by David Pilling, Goodbye Madame Butterfly, by Sumie Kawakami


4. Fruits, by Shoichi Aoki

This is a picture book of Japanese street fashion from the 1990s. It's mostly just photos, but it also has mini-interviews of colorful kids at the bottom of each page. These are actually excerpted from a magazine of the same name that was popular back then.

See also: Tokyo: A Certain Style, by Kyoichi Tsuzuki


Economics and Business

1. Can Japan Compete?, by Michael Porter, Hirotaka Takeuchi, and Mariko Sakakibara

This is basically a history book about Japan's industrial policy - what it was, where it seems to have worked, where it went wrong (spoiler: almost everywhere, after the 1970s). It also contains Michael Porter's theories about competition, but you really don't need to believe those in order to appreciate the history here.


2. The Japanese Economy, by David Flath

This is an overview for people who have studied econ. The author, David Flath, is a friend of mine (we met on the streets of Tokyo, where he recognized me from my blog photo), and also happens to be the PhD advisor of Karl Smith, the former econ blogger and prof.

See also: Reviving Japan's Economy, ed. by Takatoshi Ito, Hugh Patrick, and David E. Weinstein


3. Reimagining Japan, ed. by Brian Salsberg, Clay Chandler, and Heang Chhor

This is a bunch of articles written write before the big 2011 earthquake, mostly about Japanese business, but also a little about the economy and culture. The authors are a collection of business leaders, writers, consultants, etc.

See also: The Power to Compete, by Hiroshi and Ryoichi Mikitani, Saying Yes to Japan, by Tim Clark and Carl Kay


History and Politics

1. Democracy Without Competition in Japan, by Ethan Scheiner

This book explains a lot about Japanese politics - most importantly, why one party has ruled Japan for most of the postwar period, despite strong democratic norms and a free and fair election system. The reason, according to Scheiner, is that the Japanese fiscal system and electoral system combine to make it easy to basically just buy votes. But you don't have to accept this thesis in order to appreciate the political history here.


2. Japan at War, by Haruko Taya Cook and Theodore F. Cook

Modern Japan's institutions were partially shaped by a big war that almost no one now remembers. This book consists of a bunch of first-hand accounts of Japanese people from that war period. Just remember that these old people's way of thinking is just as alien to that of modern young Japanese people as your grandparents are to you.

See also: The Rising Sun, by John Toland, Dear General MacArthur, by Sodei Rinjiro


3. Japanese Destroyer Captain, by Tameichi Hara

The war memoir of Japan's (probably) best naval captain, this book gives great insight into Japanese military culture. It also shows how traditional samurai culture (the author is from a samurai family) clashed with the modern militaristic culture of WW2-era Japan. Finally, it displays some interesting Japanese cultural quirks - women hitting on men! - that seem to have survived through the ages.

See also: Zero, by Masatake Okumiya, Jiro Horikoshi, and Martin Caidin


On my list to read: Ametora: How Japan Saved American Style, by W. David Marx, Embracing Defeat, by John Dower, Tokyo Vice, by Jake Adelstein

So there you go. Happy reading. If you know of any other books along these lines, send them my way. And remember, even the best books will only scratch the surface of any culture...

Monday, August 22, 2016

Free-market ideology: a reply to some replies


I recently wrote a Bloomberg View post about political-economic ideologies, and how society is quicker to change than individual human beings. The upshot was that free-market ideology seems - to many Americans, and also incidentally to me - to have mostly hit a wall in terms of its ability to improve our lives, and so society will inevitably embrace an alternative, despite the protests of diehard free-marketers.

Bryan Caplan is flabbergasted at the notion that free-market ideology (aka "neoliberalism") has actually been tried in the U.S.:
The claim that "free-market dogma" is the "reigning economic policy" of the United States or any major country seems so absurd, so contrary to big blatant facts (like government spending as a share of GDP, for starters), that I'm dumb-founded.  
This is pretty much exactly the attitude I described in my post! "Of course neoliberalism hasn't failed; we just never really tried it."

David Henderson has a longer and more measured response. He challenges the idea that free-market ideology has demonstrated any failures at all.

Now I could simply make a weak claim - i.e., that free-market ideology seems to have hit a wall, and that in the end, that general perception is much more important than what I personally think. But instead, I'll make the much stronger claim - I'll defend the idea that free-market ideology has, in fact, really hit a wall in terms of its effectiveness.

Exhibit A: Tax cuts. Tax cuts, one of free-marketers' flagship policies, appear to have given our economy a boost in the 1960s, and a smaller boost in the 1980s. But any economic boost from the Bush tax cuts of 2001 and 2003 was so small as to be invisible to all but (possibly) the most careful econometricians. Notably, a number of attempts to encourage savings - capital gains tax cuts, estate tax cuts, and the like - have not halted the steady decline in personal savings rates.

Exhibit B: Financial deregulation and light-touch regulation. It seems clear to me that under-regulation of derivatives markets and mortgage lending played a big role in the financial crisis. The counter-narrative, that government intervention caused the crisis, has never held much water, and has been debunked by many papers. This was a private-sector blowup.

Exhibit C: Light-touch regulation of monopoly. The evidence is mounting that industrial concentration is an increasing problem for the U.S. economy. Some of this might be due to intellectual property, but much is simply due to naturally increasing returns to scale.

Exhibit D: The China shock. While most trade booms seem to lead to widely shared gains, the China trade boom in the 2000s - which free marketers consistently championed and hailed - probably did not. High transaction costs (retraining costs, moving costs, and others) lead to a very large number of American workers being deeply and permanently hurt by the shock, as evidenced by recent work by Autor, Dorn, and Hanson.

Exhibit E: Faux-privatization. True privatization is when the government halts a nationalized industry and auctions off its assets. Faux-privatization is when the government outsources an activity to contractors, often without even competitive bidding. Faux-privatization has been a notable bust in the prison industry, and school voucher programs have also been extremely underwhelming. Charter schools have fared a bit better, but even there the gains have been modest at best.

Exhibit F: Welfare reform. Clinton's welfare reform saved the taxpayer very little money, and appears to have had little if any effect on poverty in the U.S.

Exhibit G: Research funding cuts. The impact of these is hard to measure, but cuts in government funding of research appear to have saved the taxpayer very little money, while dramatically increasing the time that scientists have to devote to writing grant proposals, and increasing risk aversion in scientists' choice of research topics.

Exhibit H: Health care. The U.S. health care system is a hybrid private-public system, but includes a proportionally much larger private component than any other developed nation's system. Free-marketers have fought doggedly to prevent the government from playing a larger role. Our hybrid system delivers basically the same results as every other developed country's system, at about twice the cost. Private health care cost growth has been much faster than cost growth for Medicare and other government-provided programs, indicating that much of our excess cost has been due to the private component of our system, not the public part.

I could go on, but these are the big ones I can think of. In some of these cases, free-market policies seem to have produced some gains in the late 20th century, but by the 21st century all appeared to be either having no effect, or actively harming the economy.

No, this is nowhere near as big a failure as that of communism (though in some ways, notably health care and financial deregulation, we've done worse than the somewhat-socialist nations of Europe). The analogy with communism was a way of illustrating a certain mindset, not to draw an equivalence between the results of neoliberalism and communism.

Also, I personally think there is still scope for many neoliberal policies to improve our economy. Reduced occupational licensing, urban land-use deregulation, simplification of the tax code, and various other kinds of deregulation all seem to show promise. If free-market policies have hit a wall, it's a porous wall - in real life, nothing is as cut-and-dry as in our ideological debates.

But overall, I think the last decade and a half have shown clearly diminishing returns, and sometimes negative returns, from neoliberal reforms. So our society is right to be looking for alternative policy packages. Though that doesn't necessarily mean we'll choose a good alternative - I think Sanders-style socialism would probably be a mistake.

Saturday, August 20, 2016

Heterodox macro - a reply to some replies


The other day I wrote a Bloomberg View post arguing that heterodox macroeconomics is not in any better shape than mainstream macroeconomics. As you might expect, this drew some lively responses.

One or two of the responses seemed to be arguing against the title of my post, rather than the contents. That's understandable, since titles are important. In this case, though, it probably detracted from the debate a great deal. The Bloomberg title people are good, and they usually get things right, but once in a while the title they choose doesn't quite capture the point I'm trying to make. This was one of those cases. The title they gave my post was "Economics Without Math Is Trendy, But It Doesn't Add Up." But actually, this wasn't what I was arguing. My point about non-mathy models wasn't that these are bad, useless, or inferior. It was that they're different from mathy models, and so comparing non-mathy models with mathy ones is an apples-to-oranges comparison. Both types of models have their uses, but you can't really compare one to the other. I make that pretty clear in the text of my post, but most of the people who responded tended to focus more on the title. Oh well. These things happen.

Anyway, on to some of the responses. The numbering here is arbitrary, corresponding to the order in which the tabs were open on my browser. (Note: The ordering has changed; see #4.)


Response 1: Steve Keen

First, we have a response by Steve Keen. Steve, unlike others, did get the point I was making about mathy vs. non-mathy models (Thanks, Steve!), and had some good commentary on the subject:
There is indeed a wing of heterodox economics that is anti-mathematical. Known as "Critical Realism" and centred on the work of Tony Lawson at Cambridge UK, it attributes the failings of economics to the use of mathematics itself... 
What Noah might not know is that many heterodox economists are critical of this approach as well. In response to a paper by Lawson that effectively defined "Neoclassical" economics as any economics that made use of mathematics (which would define me as a Neoclassical!), Jamie Morgan edited a book of replies to Lawson entitled What is Neoclassical Economics? (including a chapter by me). While the authors agreed with Lawson's primary point that economics has suffered from favouring apparent mathematical elegance above realism, several of us asserted that mathematical analysis is needed in economics, if only for the reason that Noah gave in his article[.]
Steve also offers some useful criticism of Milton Friedman's ideas about how to evaluate a model's empirical success (I agree).

Steve also makes the useful point that linearization critically hampers many mainstream models (I agree).

Steve points out that non-mathy models can make qualitative forecasts. That's true. However, my point was that these are often a lot less actionable than quantitative forecasts. A non-mathy model might tell you that private-sector debt is dangerous, but it might not tell you how much of it is dangerous, or how dangerous. For that, you'd need some kind of mathy model. Steve definitely seems to get this point too, though, so I'm not disagreeing.

Steve then discusses overfitting of data, and points out that many mainstream models do this too. That's certainly true, although I think DSGE models tend to be a lot more parsimonious than SFC models or stuff like FRB/US. Actually, overfitting is one of the big criticisms of the most popular DSGE models in use at central banks.

Steve then addresses the idea that heterodox models are similar to mainstream ones. I never said they were, although I said there are some similarities between the FRB/US model and Wynne Godley-type SFC models. In fact, there are some similarities, though there are also differences. But in general, most heterodox models are very different from most mainstream models.

Steve also discusses my (admittedly too brief) mention of agent-based models, and has some good comments:
Largely speaking, this is true - if you want to use these models for macroeconomic forecasting. But they are useful for illustrating an issue that the mainstream avoids: "emergent properties". A population, even of very similar entities, can generate results that can't be extrapolated from the properties of any one entity taken in isolation...Neoclassical economists unintentionally proved this about isolated consumers as well, in what is known as the Sonnenschein-Mantel-Debreu theorem. But they have sidestepped its results ever since...Multi-agent modelling may not lead to a new policy-oriented theory of macroeconomics. But it acquaints those who do it with the phenomenon of emergent properties - that an aggregate does not function as a scaled-up version of the entities that comprise it. That's a lesson that Neoclassical economists still haven't absorbed.
I think this is right. Agent-based models have so far served as a demonstration of the fragility of representative agent models. In the future, they might be much more than that.

So anyway, I'd say I pretty much agree with Steve's response. Good stuff. (Though this person on Reddit had some problems with it.)


Response 2: Ari Andricopolous

Ari has a response as well. His response comes in the form of a list of things that he thinks macro models should not include. The list is:

  1. Microfoundations
  2. Rationality
  3. Loanable funds
  4. Interest rate effects
  5. The financial sector

It's pretty clear that the last item on this list is misplaced, since Ari thinks one should include the financial sector in models.

Whether macro models should be microfounded is a big open question, but I'd like to note that by saying they shouldn't be, Ari is saying that agent-based models are bad. Agent-based models are as microfounded as they come.

As for rationality, I kind of disagree...humans observe and learn and adapt (OK, some more than others, I'll grant). Even though perfect rationality is probably pretty unrealistic, to insist that models totally ignore human observation, learning, and adaptation seems very dangerous for the realism of any model.

As for the loanable funds thing...yeah, OK, sure.


Response 3: Jo Michell

Jo Michell's response might have been the first to go up, but it's later on this list because...the numbering is arbitrary!

Jo, which I believe is short for "Jörmungandr", has a helpful diagram of the "schools" of macroeconomic thought. He also pushes back on the notion that "heterodox" is a useful classification at all:
The problem with ‘heterodox economics’ is that it is self-definition in terms of the other. It says ‘we are not them’ — but says nothing about what we are. This is because it includes everything outside of the mainstream, from reasonably well-defined and coherent schools of thought such as Post Keynesians, Marxists and Austrians, to much more nebulous and ill-defined discontents of all hues. To put it bluntly, a broad definition of ‘people who disagree with mainstream economics’ is going to include a lot of cranks. People will place the boundary between serious non-mainstream economists and cranks differently, depending on their perspective. 
Another problem is that these schools of thought have fundamental differences. Aside from rejecting standard neoclassical economics, the Marxists and the Austrians don’t have a great deal in common.
This is a good and useful point. My Bloomberg post really did bite off more than it could chew. My point was that there wasn't something better and more successful out there that by rights ought to already have displaced the (unsuccessful) mainstream approach. But in making that point, I touched on a number of different types of alternatives that aren't really closely connected. And I left out others (for example, Steve Keen's own work, and the Austrians).

Jo, unfortunately, appears to have gotten tripped up by the title:
Noah seems to define heterodox economics as ‘non-mathematical’ economics. This is inaccurate. There is much formal modelling outside of the mainstream. 
Well, no, I don't define it that way, otherwise I wouldn't have discussed SFC models and agent-based models in my post.

Jo goes on to make some good points about mainstream models, and some of the problems they encounter.


Response 4: Frances Coppola

Frances Coppola, whom I cited in my Bloomberg post, also has a response. I responded to this post earlier, but Frances changed it, so I moved my response down to #4.

Frances still seems to misunderstand my post somewhat, and to have been tripped up by the title:
Noah's core proposition is that economics has no validity unless it is expressed in mathematical terms. He says that economics without mathematics doesn’t add up.
Actually, I didn't make such a claim. Nor do I believe it. What I wrote was:
Broad idea-sketching is certainly a valuable activity. If theorists get lost in the specifics of their models, they can blind themselves to truly new hypotheses and mechanisms that would let them make big, radical changes. I do think this has happened to some degree in mainstream macro...But that doesn’t mean that broad idea-sketching is a replacement for formal models. It’s not an apples-to-apples comparison.
My point is that although non-mathematical econ is often valuable, it's not comparable to mathematical econ. Both have their place. But to say that a non-quantitative theory was successful at predicting the Great Recession, while a quantitative theory failed, is to hold the two theories to very different standards, since "predict" means different things for quantitative theories than it does for non-quantitative theories.

Frances goes on to discuss some of the limitations of purely quantitative models. She's broadly right. She then criticizes some heterodox theorists who, in her opinion, focus too much on math:
Noah's post unfortunately seems to have elicited some rather defensive responses from the heterodox community, along the lines of “But we DO like mathematics!” or even, “Actually our mathematics is better than yours”. But this is to buy into Noah's core proposition. The heterodox economics community should - and, to be fair, in most cases does - reject it outright.  Economics is not, and cannot be, exclusively mathematical...There is no need for the heterodox economic community to be defensive about vagueness.
Again, Frances demonstrates a deep misunderstanding of my thesis. I never said that econ theory should be exclusively mathematical, nor do I believe it. This confusion is partly the result of the title, and partly the result of me just not explaining my thesis well enough.


Anyway, those are the responses I've seen. Thanks to everyone who took the time to respond!

Monday, August 15, 2016

Is Firefly overrated?


The whole world is in need of a break from the madness, and someone on Twitter asked me to do a blog post about whether Firefly is overrated. So instead of econ or politics or serious stuff, let's talk about a television show that got canceled 13 years ago! :-)

The answer to the question in the blog post title is: "Of course not." In the strictest sense, no sci-fi show is overrated, because people in general ought to watch more sci-fi and less of whatever they're watching now. Science fiction has taken over movies, but not TV. Fortunately, with great programs like Black Mirror, Stranger Things, etc., there's still lots of good stuff out there.

But Firefly, more than probably any other show, holds a special place in the heart of my generation of geek-Americans. And it really is a great show. It's consistently at the top of user-generated lists of the best sci-fi shows ever. It's the subject of countless...OK, I'm not even going to finish this paragraph, because we all know that all geeks love Firefly like economists love envelope theorems.

Well, maybe not all geeks. A few have been known to write grumpy Tumblr posts about how the show is racist and/or sexist. But aggrieved identity-politics driven Tumblr rants are like death and taxes, except that Peter Thiel can escape the latter two. 

But buried deep within those overdone rants, I see the seeds of something that really did make Firefly different from other sci-fi TV shows - besides the snappier dialogue and Western motif, I mean. It has to do with the culture the series drew on for its mythos. Firefly was, at its root, a Southern show.

First of all, there's the well-known connection of the Firefly backstory to the Confederacy - Joss Whedon has said that the show was inspired by a Civil War novel. The Browncoats are the Rebs, and the Alliance is the U.S. Mal is the outlaw/pioneer/cowboy who went West after the Lost Cause was lost. Everyone knows that. But Firefly's connections to the South are more cultural than political. Almost every character on the show is some sort of traditional Southern stereotype.

Mal is the classic ideal of the Southern gentleman. He's brave, rigidly honorable, quick to violence...gallant, protective, and respectful toward women. He's sharp and clever but no intellectual. I imagine him as a planter's son from Virginia, who can trace his ancestors back to the Cavaliers in the English Civil War.

Jayne is the poor white Southern guy. He's the overseer, the patroller, the farm hand. He's tough, mean, not too bright, selfish, opportunistic, uneducated, and a bully. He's often the villain of the show, barely kept in check by Mal's aristocratic alpha-male dominance. He's shown improving a bit as the show goes on, though of course it was canceled before this could get very far.

Inara is the fallen Southern belle - the kind of woman who once ruled a plantation, then was forced to prostitute herself to make ends meet after the war, but who still maintains some kind of honor and dignity. An R-rated Scarlett O'Hara. 

Wash and Zoe are the Yankees (despite the fact that Zoe fought for the Browncoats, which is something I suspect Whedon threw in to muddy the parallels a bit). Wash is a geek, effeminate, playing with his dinosaur toys - Jayne calls him "little man." He's somewhat dominated by his wife, who is strong, independent, and sexually uninhibited. They're also a mixed-race couple, which of course was a Southern stereotype of the North. Shepherd Book is a black man whose violent past has been tamed by the civilizing power of Christianity. Kaylee is a simple backwoods country girl. The doctor and River are also Yankees, though they are external plot drivers and hence less stereotypical. 

And as a Southern show, Firefly is notably devoid of intellectual characters. There are no scientists on Serenity - Simon the doctor is the closest thing, and his uppity smarty-pants attitude earns him repeated face-punches from the dashing Mal. Kaylee, the engineer, works by intuition alone.

So the characters are mostly from Southern culture, but so is the theme of the show - it's all about honor. Mal's honor is central to his decent, noble conduct, and is the reason the Serenity crew is sympathetic instead of being a bunch of rascally piratical n'er-do-wells (which they probably would be if the show were Japanese or British). Serenity's captain is an upright man in a lawless, dirty world.

But honor is also the reason why Serenity is out there in space in the first place. Mal and the rest could presumably go live as Alliance citizens - it's not clear how repressive the Alliance government is, but the people seem to be pretty wealthy. We don't know what cause the Browncoats were fighting for. But it's pretty clear that Mal went to space to become an outlaw because his sense of honor makes him refuse to knuckle under to his conqueror. "You can't take the sky from me," as the theme song's lyrics go.

And this, really, is why I was always a little dissatisfied with Firefly. In most space opera shows, the cosmos is vast, exciting, full of wonders - the final frontier. Humans go to space because it's our destiny. We go in search of our better selves - to learn new science, to meet aliens, to teach others about our culture and learn about theirs, and to bring a better, more just order to the Universe. In Star Trek (The Original Series and The Next Generation) we go just to go. In Babylon 5 and Deep Space 9 we go to make the galaxy safe for liberal values. In Robotech and Farscape we go to fall in love with aliens (hey, why the hell not). Battlestar Galactica and Space Battleship Yamato are darker shows about survival, but also depict a struggle to preserve liberal values in the face of overwhelming existential threats. Now you know I've watched way too much space opera in my life.

But in Firefly, why do we - meaning the crew of Serenity - go to space? It's not for a higher purpose. There's no science being done, no galaxy being saved. The show's theme song may be about freedom, but unlike many of the people around them, Mal and his crew aren't colonists. They aren't going to found a new, more liberal republic on the virgin soil of a distant world. They aren't going to build a city on a hill. They have no quest, they seek no knowledge, they fight for no cause, they meet no aliens. Their existence is simply a big fat middle finger to the government in the distance.

And that's fine. It's fun, it's exciting, it makes for some great gunfights. But it doesn't resonate with me. I grew up in Texas, but I don't really have the Southern honor culture, and even if the Civil War hadn't been about slavery the Lost Cause would have little or no romance for me.

That's why Firefly, as fun and as well-written and as adorable as it was, can never quite be the Greatest of All Time as far as I'm concerned. I mean, guys - you're in space. You're on a spaceship. You're flying around from planet to planet, and instead of looking out the window at the incredible sweep of the unknown, you're thinking about your honor, and how you lost a war, and how to earn your next dollar. There's nothing wrong with that, but it's not the stuff of inspiration. I don't know about y'all, but when I gaze up at the night sky, I hope my first thought isn't "Damn...somewhere out there is a place where I could evade some federal regulation."

Tuesday, August 09, 2016

No, U.S. elections are not "rigged"


Tyler Cowen, my esteemed Bloomberg View colleague, has a post about Donald Trump's comments predicting a "rigged" election. Though Tyler states explicitly that he is not defending Trump's comments, the post certainly reads like a defense. Tyler's main points seem to be:

1. Elections really are "rigged" in some sense, and

2. Accusations of election "rigging" often come from the Left.

I don't want to put words in Tyler's mouth, though, so I'll repost much of his post:
[O]ver the last few years or indeed decades I also have seen the following: 
1. Numerous arguments insist that money buys elections and campaign finance reform is imperative... 
2. Numerous arguments that Republican-backed voter registration requirements are keeping significant numbers of voters, most of all minority voters, away from the polls... 
4. Do we not all teach the Gibbard-Sattherthwaite theorem to our Principles classes on week three?  In case you forget, the theorem shows that under some fairly general assumptions elections processes are manipulable in a rigorous sense... 
5. A related branch of social choice theory, stemming from Dick McKelvey’s work in 1979, suggests that when the policy space has more than one dimension, the agenda setter in Congress has a great deal of power and typically can shape the final outcome... 
6. Major political scientists from schools such as Princeton tell us that elites determine policy and ordinary voters have very little say in what happens... 
7. The American electoral system is designed to give the two major parties a huge initial advantage... 
How many Democrats have alleged that the 2000 Presidential election was rigged?  Or that today most Americans want some form of tougher gun control, but that the system is rigged against that outcome happening?
Many people are not a big fan of this post. I would count myself among that number. Here are my points in response to Tyler:


Point 1: Let's not muddy the definition of "rigged". 

When most people hear the word "rigged" in the context of an election, they probably think that means the results have been falsified - that the numbers of votes recorded for each candidate differ meaningfully from the number actually cast.

To most people, a "rigged" election probably does not mean that the franchise ought to have been extended to disenfranchised groups. For example, in 19th century America, women could not vote. That was bad. But were all 19th century American elections therefore "rigged"? Most people would say no. Similarly, there is a good argument for extending the franchise to 17-year-olds in America right now. If we eventually do that, would that mean that all elections in the 20th century were "rigged"? Again, most people would say no.

Similarly, I've never heard of anyone who says that tactical voting is a form of election-rigging. Since tactical voting is universal (that's what Gibbard-Satterthwaite is about!), it also doesn't seem very helpful to label this a form of "rigging".

How about campaign finance? There are certainly a few people on the Left in America who would define this as election-rigging. I personally think that's silly. First of all, most evidence shows that money doesn't really give that much of an electoral advantage. Second of all, stringent campaign finance laws - such as those found in Japan - will still result in some groups and individuals having disproportionate power over election outcomes. Again, it seems worse than useless to define something that is inevitable and universal in a democracy as "rigging".

The only item Tyler mentions that seems to me like it could significantly count as vote-rigging is intentional disenfranchisement of voters who are officially afforded the franchise. For example, if eligible voters are intentionally and systematically purged from voter rolls to produce a certain outcome, that probably counts as "rigging". There is at least an outside possibility that this sort of manipulation made a difference in Florida in the 2000 election, thus throwing the election to Bush.

But when Trump says that the election will be "rigged", he doesn't mean any of these things - he's suggesting that vote totals will be falsified.


Point 2: Watering down the definition of "rigging" gives aid and comfort to those who would deligitimize our democracy.

If politicians like Trump consistently claim that election results are falsified, it erodes confidence in the electoral process itself - the people on the losing side will distrust the results of any election. That seems like it could eventually lead to a lot of bad outcomes. Election losers, convinced they actually won the vote, could become more intransigent and refuse to work with winners. Polarization could increase, eventually leading to outright civil conflict and the disintegration of the nation. Support could increase for military coups to depose election winners on the grounds that these winners were not elected legitimately. In other words, false claims of election-rigging seem pretty clearly to lead to the breakdown of our institutions, our democracy, and our country itself.

Now, I think those are bad things. Maybe Tyler disagrees. Though he has affirmed his support for democracy in the past, his mind might have changed since 2008. Certainly not all of his colleagues at GMU support democracy as the best system. Similarly, Tyler might believe that the United States of America ought to be split up, along regional, economic, or ethnic lines - or that nation-states themselves shouldn't exist. Certainly, there are others who do believe this.

But I believe that countries where democracy has lost its popular legitimacy, like Russia, Turkey, and Thailand, have not seen good outcomes over the past couple of decades. I also pretty strongly believe in nation-states, and in the United States nation-state in particular. So I think that when Tyler claims that U.S. elections are "rigged" in any substantial sense, it is probably a bad thing.

Of course, I support calls for ensuring that the franchise be extended as broadly as possible, and I'm interested in improving our campaign finance laws, but - see Point 1 - I don't think that calling for these reforms is anything even remotely similar to making allegations of election-rigging.


Point 3: Just because some on the Left do this doesn't make it OK for Trump to do it, nor is there an equivalence between the two.

Yes, there are some people on the Left in America who claim from time to time that elections, especially Democratic primaries, are "rigged". These claims are very rare, but I have heard them, especially from diehard Sanders-then-Stein supporters in the current election. Here is a Salon column alleging "rigging", but defining rigging down much as Tyler does. Here is an Inquisitr article alleging true election-rigging, i.e. vote-falsifying.

I see these allegations as obviously false, reprehensible, and dangerous in much the same way Trump's are. But to point out that "the Left does it too!" only reinforces the need to fight back against delegitimization of our democracy. It does not merit a shrug or a "Hey, dude, both sides do it".

Also, there is an asymmetry here. Diehard Sanders-then-Stein supporters are a fringe, and there will always be a fringe in politics. Trump is the nominee of one of the two major parties. Al Gore certainly never alleged vote-rigging in 2000, even after everything that happened in Florida. There is no equivalence at all here, and to try to draw one is a de facto defense and excusal of Trump's dangerous, unacceptable behavior.


So for these reasons, I am not a big fan of Tyler's post. American elections are not perfect, but - unless there is major evidence that has not yet come to light - they're pretty darn good. And Trump's questioning of their legitimacy is truly unprecedented, and not a part of partisan business-as-usual.


Updates

On Twitter, Rajeev Ramachandran hits the nail on the head:
[T]here's a diff b/w "systematically favours X" and "result won't depend on votes actually cast". The first calls for reform. The second is a call to armed insurrection.
Yes. Exactly. I couldn't have said it better (as evidenced by the fact that I didn't!).

Here is some new evidence that Republicans, but probably not Democrats, are starting to question whether votes are counted accurately in American elections. I view Tyler's post as contributing to this very negative and asymmetric trend.

As Trump intensifies his campaign to preemptively delegitimize the election result, Tyler's post is looking more and more spectacularly ill-timed...

Saturday, July 30, 2016

How are Milton Friedman's ideas holding up?


I recently wrote a Bloomberg View post about consumption Euler equations, and how these are increasingly being targeted as a broken piece of macroeconomics. I traced the idea back to Milton Friedman and the Permanent Income Hypothesis, and Bloomberg decided (wisely) to go with Friedman for the headline. "Economists Give Up on Milton Friedman's Biggest Idea" is probably going to get orders of magnitude more clicks than "Economists Search for Replacement for Infinitely Lived Perfectly Far-Sighted Model of Consumption Smoothing".

BUT, anyway, Emily Skarbek decided that Uncle Miltie needed some defending, and wrote a blog post praising his legacy. Most of the post discusses stuff that I didn't touch on in my Bloomberg post, since I was only talking about the PIH. So I decided to do a post about Milton Friedman's overall legacy - actually, much too big a topic to do justice to in one post, but hey, that never stopped anyone before, so what the heck! I pitched it to Bloomberg, and they said "But didn't you just do a Milton Friedman post??", so on the blog it goes.

For some reason, Friedman is treated a bit like a secular saint in policy discussions. If you criticize "Idea X", fine. We can have an argument. But if you criticize "Milton Friedman's Idea X", then WHO ARE YOU, LOWLY WORM, to criticize the great FRIEDMAN?? If you say government is a lot more useful and important than Reagan and Thatcher and Art Laffer and Friedrich Hayek and Ed Prescott and Greg Mankiw think, well, fine, that's your opinion. But if you say government is a lot more useful and important than Milton Friedman thought, then you're wrong wrong wrong and don't you know that Friedman proved government was bad in the 70s?? Etc.

OK, I might be exaggerating as an excuse to use lots of capital letters and italics, but Friedman is such a towering intellectual that criticizing him does feel a bit like tipping a sacred cow. Fortunately I'm from Texas, where cow-tipping is a way of life.

So I, a nobody, shall proceed to grade the multifarious ideas of the great Friedman. Let's start with his macroeconomic ideas, and leave the policy ones for a follow-up post. As of 2016, how is each of Friedman's ideas holding up?


PART 1 - MACRO IDEAS

1. Permanent Income Hypothesis

As I wrote for the Bloomberg post, economists figured out by the 90s that the PIH doesn't look strictly true - there are lots of hand-to-mouth consumers out there. And natural experiments tend to find that people consume windfalls to a fair degree. What we don't know is why some consumers smooth and some consume hand-to-mouth, or whether and how it's state-contingent. Yes, the idea of a mechanical hand-to-mouth consumption function is dead - many people obviously are forward-looking to some degree under many conditions. But the strong form of the PIH - perfectly forward-looking consumption smoothing - doesn't look like a good approximation to reality.

Oh, and here's Skarbek's defense of the concept:
It seems to me that the PIH is a useful way to understand personal investments decisions over one's lifetime. For example, why young people who expect (even if inaccurately in many cases) to have high earnings after college incur student loans instead of directly entering the workforce. Or why people take out 30 year mortgages to buy homes.
Sorry, but "I have seen instances of people borrowing large amounts of money" doesn't tell us much about consumption smoothing. But even if it did, these are not good examples. A mortgage doesn't entail taking on net debt, since the value of the loan is the same as the value of the asset you acquire. And education is generally regarded as investment, not consumption (though some might argue). So, no.

A more sophisticated defense of the PIH is that we can always find some utility function that makes it look like people are smoothing consumption. But this defense is also bad, because A) it makes the PIH totally vacuous, and B) utility-function-mining is just going to get you something that fails out of sample, and you'll have to go mine for a different function, etc.

But the most common defense is: "But the PIH doesn't say all consumers are perfect smoothers, only that people do some amount of consumption smoothing." Fair enough; β>0 is technically a hypothesis, right? But if your hypothesis is only about a sign and not a magnitude, it generally isn't that useful.

Grade: C


2. Money growth targeting/k-percent rule

This idea was adopted in the U.S. between 1979 and 1982. But as Bennett McCallum has documented, the Fed failed to hit its targets:


[T]he Fed did not succeed in improving its record of money stock control. Instead, the realized growth rates for the years ending in the fourth quarter of 1980, 1981, and 1982 were again outside the specified target range, as indicated in Table 1-3. And monthly values of the growth rate were highly variable, as can readily be seen from Figure 1-1. This is especially striking, of course, because the special operating procedures of 1979-1982 were designed precisely for the purpose of improving money stock control so as better to achieve the monetary growth targets!
As it turns out, central banks just aren't very good at controlling the money supply. McCallum also speculates on what effects the failed attempt to target money growth rates might have had:
What, then, were the results of this experiment? In one respect the Fed's attempts were successful: by September 1982 the U.S. inflation rate had been reduced from around 11 or 12 percent (per year) to a magnitude in the vicinity of 4 or 5 percent. Other aspects of the outcome were not as planned, however, and were highly unpopular with the public and with most commentators. Of these undesirable side effects, four will be mentioned. First, short-term interest rates rose to levels unprecedented in U.S. history. Over the month of May 1981, for example, the 90-day Treasury bill rate averaged 16.3 percent. Second, the extent of month-to-month variability of interest rates was greater than ever before. Third, in 1981 a recession began that was the most severe since the Great Depression of the 1930s; the nation's overall unemployment rate climbed over 10 percent in the second half of 1982. So while the economy was relieved -- at least temporarily -- of the inflationary pressures that it had been experiencing for about a decade, this relief was apparently obtained at the cost of an unwelcome recession and the associated loss in output.
In any case, the failure of money supply targeting caused central banks to switch to a mix of interest-rate targeting and inflation targeting. 

Grade: D-


3. Quantity Theory of Money

This is probably Friedman's most famous idea - the notion that "inflation is always and everywhere a monetary phenomenon." Unfortunately, it's hard to tell if it's right, because it's a vague idea. First, you have to define the money supply (Are bonds money? Etc.). Next, you have to specify the lag of the effect - if money has a long and variable lag on inflation, as Friedman thought, it'll be hard to pin it down empirically. But anyway, tests appear to be generally in favor of the hypothesis. Here's an abstract from a 2001 discussion paper by Paul DeGrauwe and Magdalena Polan:
Using a sample of about 160 countries over the last thirty years we test for the quantity theory relationship between money and inflation. When analysing the full sample of countries we find a strong positive relation between the long-run inflation and money growth rate. The relation is not, however, proportional. The strong link between inflation and money growth is almost wholly due to the presence of high (or hyper-) inflation countries in the sample. The relationship between inflation and money growth for low inflation countries (on average less than 10% per annum over the last 30 years) is weak. We find that the long-run average inflation and country-specific factors have a significant influence on the strength of the relationship. We also confirm that money growth and output growth are orthogonal in the long-run; i.e. higher growth rates of money do not lead to higher growth rates of output.
And here is a table from their literature review:


So, generally pretty good support for Friedman's idea in high inflation countries (which are probably the main cases Friedman and everyone else cared about), though not so much when inflation itself is low. In particular, at the Zero Lower Bound (or maybe just more generally in a long disinflationary stagnation after a financial crisis), velocity seems to fall off substantially:


So although high inflation appears to coincide with high money supply growth, the correlation does seem to break down for economies like ours and Japan's.

Also, studies like these can't isolate causality, so there's always the possibility that high inflation itself boosts the money supply, by increasing bank lending and/or politically forcing the central bank to print more money. To my knowledge, this is not well-known.

Grade: B


4. Friedman Rule

This is the idea that nominal interest rates should be set at zero. It generally contradicts the k-percent money growth rule, unless setting rates at zero just happens to make the money supply grow at a constant rate (how much of a PR badass are you if you can get your name on two mutually contradictory rules?). Interestingly, the Friedman Rule is based on Neo-Fisherism - it says that rates should be at zero because in the long run, low interest rates are deflationary and mild deflation is what we want.

The idea that deflation is good has probably not stood the test of time, as most people agree that it has been damaging to Japan's economy. People have generally agreed on inflation targets of 2 percent, rather than negative inflation targets. But interestingly, zero or near-zero nominal interest rates have now become the global norm, at least in the developed world:


So it seems to me that no one really knows what to make of the Friedman Rule. Everyone is doing it, but for essentially the opposite of the reason than Friedman envisioned. It's a weird world out there, folks.

Grade: C+


5. Rejection of Fiscal Stabilization Policy

This appears to have been a big bust. Whatever monetary policy has or hasn't done, it has proven incapable, by itself, of pulling economies out of long slumps. Meanwhile, most of the evidence we have - which is weak evidence, because it's macro, but nevertheless is all we have - seems to indicate that fiscal policy works, even if we don't understand exactly why it works (see here, here, and here for example). Moreover, there is a growing recognition that what often matters is the combination of fiscal and monetary policy, and that fiscal policy can cancel out the effects of monetary policy. This may be why governments around the world still engage in fiscal stimulus when times get rough.

The poor quality of macro data saves Friedman from getting an F on this one.

Grade: D


6. Floating Exchange Rates

Lots of countries have certainly gotten into trouble trying to peg their exchange rate too high - this generally leads to a devaluation, capital flight, and a "sudden stop." But some countries (China) seem to have gotten some good results by pegging their exchange rates low during their catch-up growth phase, while using capital controls to prevent inflation. Also, a lot of countries have "managed floats", where they pretend to float their currencies but don't really do it. Anyway, to my knowledge, the data is just too poor and sketchy here to know which kind of exchange rate regime is really optimal, or whether this depends on the situation. Basically, I think we don't know much more about this now than we did in Friedman's day. Though I could be wrong.

Grade: Incomplete


7. Natural Rate of Unemployment

Basically, this is just the idea that unemployment is mean-reverting to some slow-moving number. Looks pretty true for the U.S., less so for other developed countries:


Of course, you can claim that in the other developed countries, big structural shifts happened that changed the natural rate. Unfortunately, that's just a fudge factor, and attempts to explain these changes with easily observable structural changes (e.g. taxes) haven't gone so well.

One one level, it's pretty obvious that there's some floor to unemployment - there will always be people between jobs, and people who don't want to work but who claim they do. The presence of a natural floor means that if a country keeps trying to put everyone to work, but keeps suffering negative shocks, unemployment will appear to oscillate. You can then draw an average line through that bouncy time series and call it the "natural rate". But in this case, the real things would be the unemployment rate floor and the average size of recessions - not the "natural rate".

So it's just not clear how useful this concept is, without some way to anticipate what the "natural rate" should be.

Grade: C+


8. Adaptive Expectations

This is the idea that people's expectations of future inflation (or other economic variables) is basically just some moving average of recent past inflation.

In fact, we do see that people's past inflation experiences tend to influence their expectations, but at a very very long time lag - basically, people's entire life. And it might be a lifetime average rather than a moving average.

Anyway, it seems to me that if you write down models with a simple, precisely specified model for adaptive expectations, with fixed lags etc. etc., it won't fit the data very well. But things like Bayesian priors and inattention will create learning effects that make expectations look like they have an adaptive component. People don't use Friedman-style adaptive expectations in models anymore, but A) it's unclear whether what they do use works well, and B) more sophisticated learning-based models seem to be popular. So this seems like a case where a simple Friedman idea contains an important principle that shouldn't be taken too far, and inspired a line of work that is interesting and still in progress.

Grade: B


9. Friedman-Savage Utility Function

Most decision theory researchers now realize that risk aversion can be positive or negative depending on the size of the gamble. Friedman's specific form for the utility of consumption is probably not that useful, but the basic idea - which has persisted into theories like prospect theory, salience theory, and others - is sound. People definitely do seem to buy both life insurance and lottery tickets.

Grade: B


10. Friedman Test

Sure, looks legit.

Grade: A


Overall Grade: C+

Friedman's macro ideas were enormously influential, and probably made very crucial points at the time they were introduced. However, they suffer from one fatal flaw: They are macro ideas. Macreconomics does not easily yield its truths to the probing mind, given uninformative data and the complexity of the thing. Plus, it's likely that big structural changes make it such that the discipline has few eternal verities - what describes the economy well in 1976 might have little to do with the events of 2016. So while "C+" looks like a harsh grade, I'm not sure what other macroeconomic thinker has done better. My favorite macroeconomists, like Bob Hall or Chris Sims, tend to be much more cautious and circumspect than Friedman - the smartest researchers seem to have realized that big, Friedman-style ideas will almost always fail to a substantial degree.

Coming up next: Friedman's policy ideas!