Saturday, August 27, 2011

Blogging on hold

Blogging will be on hold until at least September 12, and possibly until October. For all those of you who feel the need to email me and yell "When you gonna write another BLAWG post?!" (you know who you are), please try to satisfy your Noahpinion cravings by staring at this cute picture of a lion.

Thursday, August 25, 2011

Japan's low unemployment is easily explained

Tyler CowenKarl Smith, Scott Sumner, and Matt Yglesias raise a question about the Japanese economy: Why is Japan's unemployment rate so low (<5%) when Japan's growth has been so low for so long?

This is not a puzzle to me. I actually know not one, but two or even three good answers to this question.

Answer 1: Many women in Japan do not work. The unemployment rate is the percent of the labor force who can't find work; if a bunch of women say "I am a housewife and am not looking for work" when the economy turns bad, that will drastically reduce the unemployment rate. This 2010 report from the Bank of Japan finds that the labor force participation rate is 5 percentage points higher in the U.S. than in Japan, with the entire difference due to women. If housewifery were completely cyclical, that right there would be enough to make up the entire difference between the U.S. and Japanese unemployment rates. So comparing U.S. and Japanese unemployment is comparing apples and oranges, because of differing gender roles.

(Note: for this explanation to work, the female labor force participation rate has to go up and down cyclically; i.e., in bad times there must be some housewives who would be willing to work if times were good, and who are therefore actually unemployed. There is some evidence that this has been happening since 1990. This is kind of the mirror image of the claim that some long-term American "unemployed" people are only halfheartedly looking for work while being supported by their families.)

Answer 2: Japan's per capita growth was not so bad in the 2000s. Karl Smith gets this right; Japan's shrinking population makes for low headline growth, but in per capita terms they did just as well as us in the last decade. Check it out:

See? Not too shabby! (Of course, per capita growth since '08 has been horrible, so this doesn't solve the whole puzzle.)

Answer 3:  Falling real wages. Observe:

Wages plummeted in the recession, but they were falling even in 06-07, when things were doing better than they had been since the 80s. If real wages fall, unemployment will not rise as much for a given growth slowdown.

(Note: One place that falling real wages will show up is if companies or governments that feel a social obligation to maintain employment levels will shift regular employees to low-wage make-work jobs in a recession. The thought that this may be happening occurred to me as I observed the massive armies of rent-a-cops thronging the streets of Tokyo and Osaka on my most recent visit. But to find out if this is really happening, would have to look in the productivity statistics, and I am too busy to go do that.)

So to me, low Japanese unemployment is not a puzzle at all. The problem, if anything, is overdetermined; given housewives, falling real wages, and robust per-capita growth in the 2000s, the real puzzle might be why Japanese unemployment is so high. (The solution to this counter-puzzle may be that some young people say they are looking for jobs but aren't really; see Karl Smith's graph of youth unemployment.)

(Final note: A word to the wise...if you ever do an image search for "Japanese housewife," make sure SafeSearch is ON.)

Update: Looking at more data, I'm starting to really doubt that my first explanation is driving much of the "puzzle," here, since female labor force participation hasn't fallen much in this recession (unlike in the recession of the late 90s, when it fell by quite a bit). I therefore think falling wages must be driving most of it.

Sunday, August 21, 2011

Are we replacing robots with Chinese people?

OK, REALLY, dissertation committee, this is my last blog post for a while. PROMISE.

But this Tyler Cowen article was too good to pass up. I just had to blog it. The article is about new data that show that productivity growth has stagnated since 2009. There's lots of good stuff in the article, but I want to focus on one part that really caught my eye:
One problem may be offshoring by American companies, as stressed in a study by Michael Mandel, chief economic strategist of the Progressive Policy Institute, and Susan Houseman, senior economist with the W. E. Upjohn Institute for Employment Research. Some productivity gains from the manufacturing of the iPad are captured by workers in China, who make important parts of the device, rather than by American workers. American companies often save on costs by finding lower wages abroad, not by enhancing the abilities of American workers. That would help explain why measured productivity has often been high over the last decade while despite year-to-year variation domestic wages and job creation have been flat.
I've been critical in the past of Mike Mandel's thesis. After all, productivity gains from outsourcing are real. Suppose I am a guy who designs and builds widgets. Hiring cheap Chinese workers to make my widgets more cheaply boosts my productivity almost the same, in the short term, as inventing a robot to make my widgets more cheaply (minus the small amount I pay the Chinese workers).

BUT...productivity is not the same thing as technology. This is a fact that often gets ignored, since economists tend to treat the two as being equivalent. But they are not. In particular, trade can boost productivity without any new technology being invented. This is what Mandel claims has been responsible for the large productivity gains in the U.S. over the past 10 years. I tend to believe him.

So why should we care whether our productivity comes from robots (technology) or from cheap Chinese labor (trade)? One answer - and I feel like this is what Cowen and Mandel may have been getting at - is that one may crowd out the other. And this brings me to the theory of endogenous growth.

Paul Romer (a physics undergrad like me!) invented the theory of endogenous growth back in the 80s. The idea is that technological progress does not simply arrive out of nowhere, but is a byproduct of economic activity. Since ideas are a nonrival production input (a.k.a. a "public good"), there is no guarantee that the market will produce enough of them. Some growth models may be a lot better at innovation than others, and policy can make a big difference. If we're not channeling enough of our economic output into the production of new technology, we'll all be poorer down the line.

And here's the interesting part. Romer's first crack at a theory of endogenous growth was this 1987 paper. His model uses this very interesting assumption:

I also assumed that an increase in the total supply of labor causes negative spillover effects because it reduces the incentives for firms to discover and implement labor-saving innovations that also have positive spillover effects on production throughout the economy.
In other words, if we suddenly get access to a bunch of cheap Chinese labor, we don't bother to invent robots. Then tomorrow, when the cheap Chinese labor runs out, we find ourselves without any robots.

This is just an assumption, of course. Even if the model works well, the assumption may be wrong. But it's an interesting idea, isn't it? What's even more interesting is that this exact same idea is one of the leading explanations for the "Great Divergence" between Europe and China that began around the 1600s. The idea is that European countries, flush with capital but short of labor, invented modern industrial technologies to compensate for their labor scarcity, while China, with a huge labor surplus, felt no need to invest in fancy machines. For more technical formulations of this notion, see Basu & Weil (1998), and this recent survey by Allen. But the basic idea is pretty clear: cheap humans crowd out robots.

So here's the question: what if our slow rate of innovation is due not to an inexplicable slowdown in the arrival of new ideas, but from the fact that China has made the discovery of those ideas less urgent? If that were true (and I'm only raising the possibility), what would be our best response? Would shutting ourselves off from cheap Chinese labor force us to become like 1600s Netherlands and invent a bunch of cool robots? Or would it just cause companies to pack up and leave the U.S. entirely, rendering us a protectionist backwater? If there is a "negative labor spillover" going on, is our only choice simply to wait until it runs out? And is it already running out?

I can't claim to have the answers. But I feel like Mike Mandel and Tyler Cowen (and Paul Romer and Basu & Weil) are on to something here.

Saturday, August 20, 2011

Sadly, macroeconomics IS based on common sense.

This article by Stephen Moore in the WSJ basically sums up the economic viewpoint of naive conservatives. Key excerpts:
I'm surprised how many students tell me economics is their least favorite subject. Why? Because too often economic theories defy common sense... 
How did modern economics fly off the rails? The answer is that the "invisible hand" of the free enterprise system, first explained in 1776 by Adam Smith, got tossed aside for the new "macroeconomics," a witchcraft that began to flourish in the 1930s during the rise of Keynes. Macroeconomics simply took basic laws of economics we know to be true for the firm or family—i.e., that demand curves are downward sloping; that when you tax something, you get less of it; that debts have to be repaid—and turned them on their head... 
As Donald Boudreaux, professor of economics at George Mason University and author of the invaluable blog Cafe Hayek, puts it: "Macroeconomics was nothing more than a dismissal of the rules of economics."..."All economic problems are about removing impediments to supply, not demand," Arthur Laffer reminds us.
I won't bother to rebut the article, since David Glasner and Paul Krugman do a good job of it. I just want to add two points. 

First of all, a minor point. Students do not hate macroeconomics because it is counterintuitive. They hate it because it has more math than they expected it to have. A lot of econ students are business majors who simply don't think of themselves as "math people," and are surprised to find themselves in an applied math course. But this is kind of unavoidable; since so much of business requires math skills these days, MBA types will have to toughen up some time, and econ classes are as good a time as any. Cheer up, business majors, taking derivatives builds character!

But anyway, on to my main point. Moore is wrong; much of macroeconomics is, in fact, based on "common sense" very similar to Moore's! I am referring, of course, to the "neoclassical" (or "freshwater" or "RBC") school of macro, whose theories have more-or-less dominated the field since the early 80s. These theories use plenty of math, but no more than their chief rivals, the Neo-Keynesian theories. The reason neoclassical models retain such popularity is that their assumptions are considered plausible by many economists - in other words, the assumptions seem like "common sense."

What are those assumptions? Well, they're pretty much the same as Stephen Moore's! "Real" business cycles are assumed to be driven by supply shocks, as Moore feels they must be. These supply shocks can take the form of technology shocks, or changes in people's willingness to work - as in Moore's example of his lazy son, unemployment in freshwater models is often a result of people deciding to "sit on their duff." As for taxes, neoclassical theorists assume that the Frisch elasticity of labor supply is really high, meaning that income taxes strongly discourage people from working. And neoclassicals assume that fiscal stimulus causes people to anticipate higher future taxes ("the money has to come from somewhere!"), rendering stimulus ineffective.

To reiterate: 1) All of these assumptions are exactly the same as Moore's "common sense." 2) Models that use there assumptions are widely accepted because the assumptions are considered plausible - i.e., because they are "common sense." And 3) The implications of these models - that fiscal stimulus, taxes, and unemployment benefits are bad for the economy - are exactly what Moore's "common sense" leads him to conclude.

In other words, Stephen Moore's intuition has allowed him to reproduce much of freshwater macro in his head. Should we conclude that common sense is in fact a very good tool for understanding the economy? Or should we conclude that the highly formalized math of freshwater macro is little more than window-dressing for a conservative worldview that people believe in because it just sort of feels right? I tend to lean towards the latter, given how little use common sense has been in the development of physics, chemistry, biology, and psychology. But who knows. Maybe I am wrong, and economics is in fact simpler and more intuitive than the natural sciences.

In any case, Stephen Moore should cheer up. Every business-cycle theory that has won a Nobel Prize since 1981 is squarely in line with his common sense.

Update: Stephen Williamson thinks that this post was meant to ridicule Ed Prescott. Far from it! Williamson must be thinking of this postthis post, and this post. ;-)

Wednesday, August 17, 2011

Envy, or self-esteem?

More interesting thoughts on envy from the guys at the Cato blog. Bryan Caplan says we should "count our blessings"; I agree, though that's easier said than done. David Henderson says that he got rid of his envy of rich people by convincing himself that rich people earned what they have.

I think you may encounter that story a lot among libertarian people. Libertarians tend to believe very strongly that people earn every penny they make - and, therefore, that the poor deserve their poverty. This belief may often be, as Henderson points out, a way of coping with envy.

I guess that's why I can let myself be so skeptical of the notion that high incomes are "deserved"; I was never envious of rich people. This is a result of my own childhood experiences My father was a lower-middle-class professor, and his brother was a rich entrepreneur. I got to see both lifestyles up close. And you know what? They weren't that different! My dad and my uncle both love their jobs, they both enjoy the same things (sports, movies, cooking, dirty jokes), they each have two kids and a house etc. My uncle's mid-life crisis car is a Porsche, my dad's is a what?

What I was learning about was the diminishing marginal utility of consumption It sucks to be poor, but being rich is not much better than being middle-class. For me, that tacit knowledge freed me from any sense of income envy.

The fact is, a lot of income is not "earned" in the marginal product sense. Some is, but some is a function of luck; some lucky plays in the financial market, a lucky business idea, a lucky personal connection. But who cares? I'm fine with that, because I don't envy the lucky.

I think a lot of people are like me, instead of like David Henderson. I doubt there are a lot of poor people out there who go around feeling resentful because they can't afford sports cars and mansions. But I do think there are a lot of poor people out there who go around feeling like "losers" because their jobs are not prestigious. And I think this is the real problem with inequality.

In American culture, the word "successful" is a synonym (euphemism?) for "rich." There seems to be a widespread notion that the rich are "winners" who have defeated the poor in some sort of ultimate game. I personally could never stand that point of view. There are plenty of people out there who just want a middle-class lifestyle. They want a family, a job they like, friends, a comfortable life, a sense of pride in their work, and a community. Maybe a dog or a cat. If you dumped a pile of money in their laps they'd surely take it, but they don't see their lives as "unsuccessful" because they don't have cabins in Aspen.

And yet I think there are a substantial number of people who do buy into this notion, that your bank account makes you a "winner" or a "loser." And I think that a great deal of the negative behavior that we see among America's poor people - drug use, broken families, violence - is a result of that feeling of loserhood. Contrast this with Japan. Over here, they treat sushi chefs or (perhaps) rent-a-cops as skilled professionals. Even cashiers and clerks get respect, just because they have a job and show up on time and do their best. A man who works his whole life in a restaurant doesn't feel so ashamed of his "loser-hood" that he feels the need to compensate by abandoning his kids and sleeping around. And he doesn't feel that a high-risk career as a drug dealer is his only ticket to "winner-hood." And best of all, he doesn't feel such a need to pretend he's rich that he spends his whole paycheck every month.

I wish we had more of that in America. Rather than shaming people who mention inequality, I think we should simply spread the idea that there is more than one dimension of success. It's a lot more satisfying to count your blessings when your blessings aren't all in your bank account.

(OK, last post for a while. Gotta work!)

Tuesday, August 16, 2011

The libertarian solution to inequality

The libertarian movement often has a very odd notion of "liberty." Here is yet another case in point.

Reviewing a book about happiness, George Mason University professor and Cato Institute blogger Bryan Caplan writes:
[The author] suggests that large differences in relative income can have a large influence on happiness...[but even if he] is right about the unhappy effects of income comparison, you shouldn't conclude that redistribution is the solution. Yes, you could fight inequality of income. But you could just as easily fight comparison of income. Instead of praising those who "raise awareness" about inequality, perhaps we should shame them, like the office gossip, for spreading envy and discontent.
So, the libertarian solution to the problem of inequality is to socially persecute anyone who talks about inequality?

Maybe I'm in the crazy minority here, but it seems to me that this kind of social persecution would make people feel less free, not more. Who wants to live in a society in which certain topics are verboten? Would we really be happier if the words "Gini coefficient" were NSFW? And, more fundamentally, when did restricting the free flow of information - by any means, governmental or social - increase our liberty?

Like I said, a very odd notion of what the word means.

Add to this the fact that Caplan's solution probably wouldn't work. Michael Lewis describes something like this in Liar's Poker, in which no one at his company ever mentions money, bonuses are kept secret, etc. The hush-hush attitude only makes people more determined to ferret out the information, and everyone at the company remains obsessed with relative pay. Information wants to be free, Dr. Caplan! But even supposing this "shame" system could suppress information about inequality, I have a feeling it would just make people all the angrier on those rare occasions when the fact of inequality made itself apparent. A problem you're not allowed to talk about is twice as annoying. Shouting "Quitcherbitchin" is not going to raise our aggregate happiness.

The bottom line, libertarians, is that people care about what they care about. Telling them "No, do NOT care about that, care only about my arbitrary, rigid, and counterintuitive definition of liberty!" is not going to win your movement a lot of followers in the long term.

Sunday, August 14, 2011

The Krugman/Mulligan debate: a possible resolution

Over at the New York Times, Paul Krugman and Casey Mulligan have been having a debate. Mulligan says that seasonal variation in teen employment shows that labor supply, not labor demand, is behind high unemployment. Krugman responds that since firms make employment decisions way ahead of time, we can still see teens get hired in the summer based on prior commitments.

I have a different potential explanation for the pattern. First (in a shameless plug for the University of Michigan) I will link to this 2007 AER paper by Robert Barsky, Christopher House, and Miles Kimball. The paper is a two-sector New Keynesian sticky-price model of the economy. The sectors are the durable goods sector and the nondurable goods sector. Business cycles are driven by demand shocks, which act through sticky prices.

The key result of the model is that business cycles are entirely caused by demand shocks to the durable goods sector. It's not that hard to explain the intuition. Since durable goods (buildings, vehicles, machines) last a long time, it's very easy for firms and consumers to change the timing of their purchases of durable goods; if prices are too high, just wait to buy (and if everyone does this, it's a recession). But nondurable goods are things we need a constant stream of (think food, gas, electricity). We can't delay our purchases of those, so we smooth our consumption of them, buying about the same amount in recessions and booms.

This effect would explain why teens get hired in the summer even when full-time workers can't find a job. The reason is that teens work almost exclusively in the nondurables sector - food preparation, hospitality, grocery stores, etc. Since nondurables demand holds up in a recession, you'd expect to see the normal seasonal employment pattern hold up for teens. But there can still be a deficiency in demand for durables sector employment, which is why full-time workers can't find jobs.

(Side note: this two-sector model also gives a good reason for using core inflation, not headline inflation, as a barometer of business cycles, since things like food and energy are nondurables.)

Anyway, I think this two-sector model resolves the "Mulligan puzzle" in a fairly simple manner. A two-sector explanation would allow the seasonal pattern of teen employment to persist even over a very long period of low demand. No labor supply shocks are needed.

Friday, August 12, 2011

Do property rights increase freedom? (Japan edition)

Update: I wrote this post in the summer of 2011, while working in Tokyo. But this year, in the summer of 2012, I went back to Tokyo for two weeks and discovered some interesting changes. In particular, 1) lots of parks that had been gated were now free to the public, 2) trashcans had been installed on the upper levels (not the platforms) of many train stations, and 3) I noticed more benches on the side of the street than I had noticed before. I thought to myself: Did people in the Tokyo city government read this blog post and respond?? Well, probably not; I don't want to get delusions of grandeur. But maybe the same issues I had noticed had also been noticed by the people of Tokyo, who wanted their public goods back. In any case, I have resolved to ask people about this next time I'm in the neighborhood. 

I think I'll take a break from looking at the macroeconomic situation and going "FFFFFFFFFFFFUUUUUUUUUUUU", and talk a little about philosophy.

Since the dawn of time, libertarians have equated property rights with freedom. Intuitively, this makes a lot of sense: if the government can come and confiscate your stuff, or tell you what to do with it, you don't feel very free at all. But libertarians tend to take this basic concept to its maximal extent; the more things are brought within the cash nexus, the more free we become. No limits, no exceptions. A direct implication is that the more government functions we can privatize, the more free we will be.

But is that right? What would it really feel like to live in a society where almost every single thing is privately owned and priced? 

Walking around urban Japan, I feel like I am seeing a society that is several steps closer to that ideal than the United States. You may have heard that Japan is a government-directed society, and in many ways it is. But in terms of the constituents of daily life being privately owned and marginally priced, it is a libertarian's dream world.

For example, there are relatively few free city parks. Many green spaces are private and gated off (admission is usually around $5). On the streets, there are very few trashcans; people respond to this in the way libertarians would want, by exercising personal responsibility and carrying their trash home with them in little baggies. There are also very few public benches. In cafes, each customer must order something promptly or be kicked out; outside your house or office, there is basically nowhere to sit down that will not cost you a little bit of money. Public buildings generally have no drinking fountains; you must buy or bring your own water. Free wireless? Good luck finding that!

Does all this private property make me feel free? Absolutely not! Quite the opposite - the lack of a "commons" makes me feel constrained. It forces me to expend a constant stream of mental effort, calculating whether it's worth it to spend $4 to sit and rest for 10 minutes, whether it's worth $2 to get a drink.

Then again, I'm on foot. How about that great enabler of personal freedom, the automobile? People with cars don't fare much better here in Japan. All highways are toll roads (actually the roads are government-owned, but financed specifically with toll revenue instead of out of general funds). And cities don't provide parking spaces, free or otherwise, so you have to park at a privately owned garage. This makes driving a lot less of a "free" activity, since you have to carefully plan your route and destination and parking place. You can't just hop in your car and drive from place to place unless you have cash to burn.

Noticing all this has driven home the realization that the existence of a government-owned "commons" often makes people feel more free, not less. Sure, the commons is financed through taxation, and sure, that means that people generally don't receive benefits exactly equal to what they pay. But the difference can be small, and is often canceled out by the fact that you only pay once rather than a million billion times.

That's right: irreducible transaction costs are a fly in the libertarian soup. Completing an economic transaction, however quick and easy, involves some psychological cost; you have to consider whether the transaction is worth it (optimization costs), and you have to suffer the small psychological annoyance that all humans feel each time money leaves their bank account (the same phenomenon contributes to loss aversion and money illusion). Past a certain point, the gains to privatization are outweighed by the sheer weight of transaction cost externalities. (Note that transaction costs also kill the Coase Theorem, another libertarian standby; this is no coincidence.)

If you don't think Japan's property system really sounds all that annoying, just imagine taking it to its absurd extreme. Imagine if we could privatize city streets and create ownership rights for the air. Every time you walked out your door, you would have to pay some fraction of a cent for the privilege. Every time you took a breath, you would pay a far tinier fraction for the chemical changes caused by your respiration. These prices would be fairly close to your willingness-to-pay, and these prices might change from day to day, or even hour to hour! So you would probably have to check to see whether it was worth it to step outside your house. Does that sound like "freedom"?

Now, there are a few people for whom Japan's constant micro-transactions are not very onerous. Some are so rich that all the costs are negligible; they can afford to just not ever think about the $2 they just paid for water (note that they are not optimizing). And there are some business owners for whom their own restaurant or office is a private kingdom in which they never have to pay to stretch their legs. But in any society, the vast majority of people are going to be neither rich folks nor owners of brick-and-mortar businesses (see Zipf's Law). For most of us, the constraints will bind.

Libertarians like to think of "freedom" as axiomatic; the definition is just something we assume. But most people define freedom the way we define everything else - by feeling and intuition. We know freedom when we see it. And it is no coincidence that the English word for "liberated" also means "zero price" (this is not the case in Japanese). A society in which the government appropriates someone's tax money to provide parks, and trashcans, and drinking fountains, and benches, and highways, and sidewalks, and parking spaces doesn't fit the libertarian ideal of freedom...but it feels more free.

You can decide for yourself which kind of freedom matters more to you.

Update: Japanese blogger Himaginary and one of the commenters both point out that the situation I'm describing is really more about Tokyo than about Japan in general. I admit it, ya got me. I lived for 2.5 years in Osaka before, which had a lot more trashcans, benches, etc. So there was a bit of hidden Kansai-Kanto rivalry in this post... ;-)

Update 2: It also turns out to be true that a lot of things like benches and drinking fountains used to be there and were taken away because of liability lawsuits by human rights campaigns! (And yes, many trashcans were removed because a cult once put poison gas in a trashcan.) So if parts of Japan have elements of libertarian utopianism, it's certainly not due to any actual libertarians...

Update 3: In response to this post, one commenter on Himaginary's blog writes (translated):
We can't call a place where people have to buy a coffee just to have a place to sit down a 'free country'.
Another writes (translated):
Japanese people are often said to be a 'collective' or 'cooperative community', but actually they are ridiculously individualistic...the community (?) doesn't even guarantee social security, and people aren't required to make personal sacrifices...actually, this is an extremely libertarian country.

Update 4: Some are arguing that Tokyo has a lot of parks and benches and drinking fountains. I won't get into that argument, since I don't have data on benches and drinking fountains, and since parks are partly a function of population density. So I'll just say that this post is based on my own observation of Tokyo, and agrees with the observations of people I spoke to before writing the post. ;-)

Wednesday, August 10, 2011

Greg Mankiw thinks Obama's stimulus worked

Here is a video of Greg Mankiw's August 8 appearance on Larry Kudlow. At 3:27, Mankiw says:
Fiscal policy is going to be a drag going forward as the stimulus wears out.
The end of stimulus will be a drag on growth. So what Mankiw seems to be saying is that the Obama stimulus increased economic growth.

Note that Mankiw has stated numerous times that he is a "stimulus skeptic." In general, he has been coy on the subject. On one hand, he has never claimed outright (as have many prominent "neoclassical" economists) that stimulus is incapable of boosting growth, and he has extolled the virtue of tax cuts (though he has left it unclear whether he believes they work via demand-side effects). But he has also said that he doesn't think Obama's stimulus was very effective, and he linked uncritically to a paper that purported to show that the stimulus destroyed jobs overall.

Now, Mankiw seems to have revealed that, like John Taylor, he's a closet Keynesian...or, at least, that his views on the effects of government spending on growth are more nuanced than he usually admits one might be led to believe from the amount and variety of criticism he has leveled at the ARRA. And by saying that the stimulus will soon "wear out," he is also admitting that his concern that "a spending-based stimulus to address the current short-term crisis might lead to a long-term increase in the size of government" was overblown. 

As Bob Lucas once said, "I guess everyone is a Keynesian in a foxhole." We're certainly in a foxhole right now.

Update: Note that Mankiw's statement is certainly compatible with the view that the Obama stimulus worked, but wasn't worth the price. So this post is less of a political "gotcha" than simply an observation that, deep down, a lot of stimulus skeptics implicitly believe that an Old Keynesian model has some truth to it.

Update 2: As a commenter points out, Greg Mankiw is indeed a "New Keynesian" - indeed, he could be considered the founder of the New Keynesian movement (which has been attacked pretty strongly by Neoclassical economists like Robert Barro). However, New Keynesian models are basically monetarist; though recessions are caused by demand shocks, there is no place for fiscal policy (at least, not until people have started trying to put fiscal policy back into New Keynesian models very recently). Mankiw has not been as hostile to the idea of fiscal stimulus as the Neoclassicals, but he has made it pretty clear that he doesn't think government spending does much to raise output.

Update 3: Commenter Ptuomov reminded me of this Mankiw policy paper from earlier this year. In the model Mankiw uses in the paper, fiscal policy is almost never useful, and can only be useful in a very limited set of circumstances (which Mankiw makes it clear he does not believe reflect our current reality). So IF Mankiw really believes in the model he uses in this paper, then musn't he believe that Obama's stimulus came at a time when those very specific circumstances held?

Update 4: From Brad DeLong, more circumstantial evidence that Greg Mankiw believes in Old Keynesian theories.

Update 5: But for true Closet Keynesianism, you can't beat the Tea Party. Wow.

Update 6: Smacked down by Mankiw. But note that my "tying myself in knots" was an attempt to be "nuanced", since I didn't actually want to "label [Mankiw] a hypocrite"...

Update 7: Brad DeLong weighs in.

OK, I have decided to stop posting updates. I almost regret writing this post, actually. In my attempt to show that Mankiw was sympathetic to the Old Keynesian point of view, I unfortunately seem to have ended up causing some offense (the "hypocrite" thing), which was certainly not my intent. And then I was led to try to parse the totality of Dr. Mankiw's actual views on stimulus, which turned out to be quite difficult (they are indeed nuanced). So I think I'll wrap up, by saying:

1) There is still a question in my mind as to why Dr. Mankiw has spent so much time and effort publicly criticizing the stimulus, when his views on it are so nuanced. However,

2) It turns out that Dr. Mankiw's quote on Kudlow was perfectly consistent with the theoretical papers he has written, meaning that the quote did not really reveal anything new. Certainly, the quote revealed no hypocrisy.

And I'll just leave it at that.

Monday, August 08, 2011

Republicans own this downgrade

I would like to think that I am not a shill for the Democratic Party. I realize that my extreme liberalism on social issues biases me toward looking at the GOP as an enemy tribe. So whenever I find myself thinking "Dang it, there are no two ways about it, Republicans got us into this mess," I first sit down and think of all the reasons why I'm wrong

But when it comes to this downgrade and the market crashes that have followed, I just can't see any reasonable case for political neutrality. I agree strongly with Felix Salmon, Paul Krugman, Greg Ip, Menzie Chinn, Jeffrey Frieden, and James Surowiecki that the dovngrade is not about the U.S. debt level (which is not that high, given interest rates, historical precedent, and international comparisons), but about the dysfunctionality of American politics. And the dysfunctionality of American politics is all about the Republican party -"an extremist right that is prepared to create repeated crises rather than give an inch on its demands," to borrow Krugman's phrase - but also about a system riddled with institutional tripwires (debt ceilings, filibusters, etc.) that allow that minority faction to hold the rest of the government hostage. S&P - which seems to operate on intuition rather than on any kind of math or model - seems to have simply smelled the crazy fumes emanating from the Tea Party. I smell them too.

Republicans, of course, say otherwise. They claim that the downgrade is really about the level of U.S. government debt. Just for the sake of argument, let's grant them this unlikely assertion, and then let's ask the question: Who, then, is responsible for all this debt?

And although I tried my best to think of reasons why this isn't the case, I just can't avoid the answer: Republicans. The Republicans created the national debt.

Here is a graph of historical U.S. gross federal debt levels as a percent of GDP:

The graph is divided by presidential administration. The obvious fact is that, until the 2008 mega-recession hit, all of the increases in debt happened under Republican presidents. But the president is not a dictator, and so we should also look at a graph that breaks it down by which party controlled Congress:

Looking at this, it's much less clear that Republicans caused the debt, since the one instance of declining debt happened under a Republican congress. So we'll have to dig deeper into the historical record to find out whether my claim is truth or hackery.

The 1980s

The U.S. federal debt declined pretty steadily from WW2 to 1980, at which point it began to increase pretty steadily (What changed? Answer coming up...). The period of 1981-1992 saw a near-doubling of debt, from about 34% of GDP to about 66%. This happened under two Republican presidents (Reagan and Bush I) and a Democratic congress.

What policy changes were made in the 80s? Well, income taxes went down. Here is a picture of U.S. tax revenues as a percentage of GDP:

As we can see, the fall in revenue in the 80s wasn't huge - maybe 1% of GDP over the decade. This is partly because the economy grew fast enough to offset some of the tax cuts that Reagan made in 1981. But it is also because Reagan, worried that his tax cuts would lead to exploding deficits, raised taxes during the remainder of his presidency.

Another policy change was an increase in defense spending. Here is a picture of U.S. defense spending as a percent of GDP:

The Reagan-era  defense buildup was actually pretty small - about 1.5% of GDP over what we were spending in the Carter era.

So neither Reagan's tax cuts nor his defense buildup were particularly huge. The thing is, they were sustained.  Even a small deficit adds up over time, and sure enough, by the end of the Reagan-Bush era, our national debt was almost double what it had been at the start, despite solid economic growth for most of that period.

Caveats: Of course, as I noted before, Democrats controlled Congress during this entire era. Since Congress is the entity that votes on the budget, shouldn't I be blaming the Dems? Or at least dividing the blame equally? Well, there are two reasons why I place the lion's share of the responsibility on Reagan. First of all, lower taxes and increased defense spending were Republican priorities, not Democratic ones. Basically, Reagan got his way! And second of all, federal non-defense spending (as a percentage of GDP) took a sharp dip in the 80s, and only recovered to its previous level by the end of Bush I's term. So even if Dems wanted an increase in domestic spending in the 80s, they didn't get one. "The beast" didn't exactly starve, but it went on a diet. So again, Reagan seems to have got what he wanted despite the Democratic-controlled congress. 

I conclude that  Republican presidents, and not Democratic legislators, were responsible for the 1980s debt runup.

But - and this is more guesswork on my part than hard fact - Reagan seems to have done more than just boost the debt during his term. By shifting us from an era of steadily falling debt numbers to steadily rising ones, he seems to have created a political "new normal" - a green-light to future U.S. politicians to continue the debt binge. Don't take my word for it - this idea came straight out of the mouth of Dick Cheney. In the jargon of public finance, Reagan shifted us from an AGV mechanism (balancing budgets by taxing the rich) to a Groves-Clarke mechanism (running deficits in order to please everybody). And since Reagan was a Republican, it seems only natural that the GOP would be more eager to embrace the new, debt-fueled politics - it was the party's new road map to victory.
The 1990s

In the 90s, the runup in debt was halted, then temporarily reversed. The big showdown came in 1993, when Clinton rammed through a massive batch of spending cuts and tax increases. Every single Republican in Congress voted against the bill, and it passed by one vote. I repeat: every single Republican voted against the bill.

But the bill passed, and it worked. The rise in debt was halted (see graph above). In the latter half of the 90s, the new higher tax rates and lower spending rates were maintained even as economic growth accelerated, leading to a fall in gross federal debt back to below 60% of GDP. A Democratic president and congress therefore seem responsible for the brief drop in debt levels that occurred during the 90s.

Caveat: Congress, however, was controlled by Republicans from 1994-2000. These Republicans attempted to slash federal spending; their effort was blocked by Clinton in the government shutdown of 1995. It is easily possible that, if Clinton had allowed these spending cuts to take place, debt would have fallen by even more than it did. It is even possible that such a victory would have led Republicans to conclude that spdnding cuts were a viable path to electoral success, and relied on spending cuts instead of the mix of tax cuts and spending increases that Bush II eventually implemented. We'll never know.

Caveat 2: The rise in GDP during the late 90s is sometimes attributed to Clinton's policies (including the 1993 deficit reduction), but Clinton himself attributes it to luck. So while Clinton should get the credit for halting the long debt climb of the Reagan-Bush I years, by his own admission he should not get the credit for the fall in debt that followed. Nobody should.

The 2000s

The 90s made a lot of people think that the debt rise of the 80s had been a one-time thing, and that we would hold steady around 60% of GDP, a manageable number. The 2000s proved them wrong. As you can see from the above graph of tax revenue, Bush II's tax cuts were truly enormous - over 5% of GDP. These were passed by a Republican congress. And spending rose strongly during Bush II's tenure, on both defense (wars and homeland security are not included in the above chart), and on entitlements (Medicare Part D). As a result, debt began to rise again, hitting the low 60's in 2007 before the big crash and recession.

Again, we saw debt rising as a percent of GDP during an economic expansion under a Republican president who got most of what he wanted from Congress.

Caveat: Bush tried to balance out the Medicare expansion with a large stealth cut in Social Security payments ("privatzation"). This was blocked by Democrats. Democrats could possibly have allowed Bush to shift entitlement spending from Social Security to Medicare instead of raising it overall, but they chose not to. So Democrats bear some of the responsibility for Bush's deficit increase.

The Crisis

Despite the raft of tax cuts enacted as part of Obama's 2009 stimulus bill, the fall in GDP from the recession was so large that taxes have risen as a percentage of output. Spending, however, has risen even more, mostly due to automatic stabilizers - unemployment insurance and the like - rather than to active policy choices on the part of government. Also, to truly measure the impact of a regime's policies, one ought to compare the beginning and end of the regime, and Obama's presidency (and the current divided congress) isn't over yet. So I will reserve judgment on who bears responsibility for the runup in debt that has occurred since 2008.

Note that this debt runup, unlike the ones under Reagan, Bush I, and Bush II, has occurred during an economic contraction (where the GDP denominator is shrinking), rather tan during an expansion (when debt should logically fall as a percent of GDP). That is very important.

But even if you were to follow the pure Republican party line and blame all of the increase on Obama, note this: Debt is now approaching 100% of GDP, which is over the 90% level that Kenneth Rogoff like to talk about. If the Reagan-Bush I debt runup had not occurred, we would only be at 70%. If the Bush II tax cuts had not occurred, we would probably be around the same level or slightly higher. If neither Republican debt binge had occurred, anyone who tried to question U.S. solvency would be laughed out of the room.

So this is why, even if for some reason we chose to willfully ignore the fact that the S&P downgrade is about nutty Tea Party Republicans and broken U.S. institutions rather than about debt levels, we would still have to conclude that it was the GOP brought us to this point.

That's why, try as I might to avoid getting political about things, I just can't be neutral. No Democrat (to my knowledge) ever said that "deficits don't matter." No Democrat (to my knowledge) ever said that a sovereign default was a good idea. Whether it's debt-ceiling brinksmanship or irresponsible deficit spending, the Republicans own this downgrade.

As do the 50% or so of Americans who voted for those Republicans.

Thursday, August 04, 2011

In which John Quiggin intellectually pulpifies Stephen Williamson

Being the mild and nonconfrontational guy that I am, I was a little embarrassed to give this post such a combative title, but after implying that I couldn't pass Wash U's prelims, Dr. Williamson just might be due for a little needling. ;-)

The intellectual pulpification in question involves a post by Dr. Williamson that reviews a book, "Zombie Economics," written by the economist John Quiggin. Williamson introduces Quiggin thusly:
What is Quiggin's claim to fame? His early work is an odd mix of agricultural economics and decision theory, but he seems to have distinguished himself mainly in public policy. He writes regularly in the mainstream media, writes a blog, and Zombie Economics appears to have sold well. 
Now, what is Quiggin up to in Zombie Economics? Roughly, Quiggin is the Australian farm team in the Krugman/Thoma/DeLong league.
Although I would probably give at least one toe to be described as the "Krugman/Thoma/DeLong farm team," I thought this to be mildly disparaging, and potentially a little unfair. So I looked up John Quiggin on Wikipedia and learned the following:
Quiggin is one of the most prolific economists in Australia, illustrated by his output over diverse, high-quality journals[1] and by citation frequencies in the period 1988-2000.[2] He is among the top 500 economists in the world according to IDEAS/RePEc.[3] He is best known for his work on utility theory. Quiggin has frequently been awarded and recognised for his research, including twice receiving Federation Fellowships from the Australian Research Council.[4]
And who is Stephen Williamson? I looked him up on Wikipedia as well, and found the following:
Stephen Williamson (28 June 1827 – 16 June 1903) was a founder of the Liverpool shipping company Balfour Williamson & Co. and a Scottish Liberal Party[1] politician.
Oh wait, wrong Stephen Williamson. Where's the disambiguation page? Turns out there isn't one, because Stephen Williamson, the Robert S. Brookings Distinguished Professor of Arts and Sciences at Washington University, apparently does not meet Wikipedia's cutoff for significance.

(Don't take it too hard, Steve. I tried to get myself on Wikipedia, and they booted me. Even when I claimed to be the founder of string theory and son of Sean Connery. But I digress...)

Anyway, Williamson's post is intended as a comprehensive takedown of Quiggin's book. Zombie Economics is about five big ideas that Quiggin thinks have outlived their usefulness. These ideas are:
1. The Great Moderation.
2. The Efficient Markets Hypothesis. 
3. Dynamic Stochastic General Equilibrium 
4. Trickle-down economics 
5. Privatization
Williamson goes through these one by one, and purports to show that Quiggin doesn't know what he's talking about. So I'll stick to the same format. Quiggin has a partial response on his own blog, upon which I will draw as I go through Williamson's points. 

Warning: brutal pulpification is imminent.

Williamson Point #1:
The Great Moderation: Quiggin is a little confused on this one, as the Great Moderation simply characterizes a set of properties of US aggregate time series. From about 1985-2007, inflation was lower and less variable, and real GDP was less variable about trend than had been the case previously. Quiggin is certainly correct, though, in finding fault with those (Ben Bernanke included) who wanted to argue that the Great Moderation was due to a regime change in economic policy. If policy was so great, it should have done a better job over the last four years.
So, according to Williamson, Quiggin is "confused" because he uses the term "The Great Moderation" to describe the notion that certain changes in aggregate time series from '85-'07 represented a structural change. Williamson then criticizes everyone who actually did think that it was a structural change. And he uses the phrase "Quiggin is certainly correct." So how is Quiggin the one who is confused, here? Williamson is dissing Quiggin over a semantic point, then substantively agreeing with him. Not much of a takedown...

Williamson Point #2:
The Efficient Markets Hypothesis: For Quiggin this is "the idea that prices generated by financial markets represent the best possible estimate of the value of any investment." Here, Quiggin is badly confused, but maybe the finance practitioners are not helping him out much. Market efficiency is simply an assumption of rationality. As such it has no implications. If it has no implications, it can't be wrong.
First, I will unleash Quiggin himself, who points out that a theory with no implications is a worthless waste of time:
That’s right, Williamson not only defends the EMH on the basis that it’s not even wrong, but follows up by making the same claim about the whole of modern macro. Those are, quite literally, his only criticisms of these chapters. His commenters (none of whom seem particularly favorably inclined towards me) try to suggest that isn’t the most effective line of attack, but he comprehensively misses the point.
Yes, Stephen Williamson defended a theory by saying that it can't make any predictions about the real world. You read that right.

But it gets worse. The EMH is most certainly NOT an "assumption of rationality." The EMH does not even require rationality in order to be correct; it requires only that the aggregate effect of individual investors' irrationalities not be predictable. And Williamson also seem not to realize that Quiggin's statement of the EMH is perfectly legitimate; it is the "strong form" of the EMH, as stated by Eugene Fama. Conclusion: Stephen Williamson does not know what the Efficient Market Hypothesis is.

(Random note: I like the EMH. I don't think it's completely correct, but I think it's the unique starting point from which any analysis of financial markets should begin. As opposed to, say, DSGE macro, which is just some random thing that doesn't work. Anyway...)

Williamson Point #3:
Dynamic Stochastic General Equilibrium: Quiggin claims that this is "the idea that macroeconomic analysis should not concern itself with economic aggregates like trade balances or debt levels, but should be rigorously derived from macroeconomic models of individual behavior." I can hear you snorting with laughter. Why is "but" in that sentence? Like the "efficient markets hypothesis," DSGE has no implications, and therefore can't be wrong. Indeed DSGE encompasses essentially all of modern macroeconomics. Which of our models is not dynamic, with uncertainty (and therefore stochastic), and with some equilibrium concept.
I hesitate to say this, but Stephen Williamson appears also to not understand DSGE. If he thinks it has no implications, I mean. DSGE is not just "some equilibrium concept," but a very specific one: the dynamic, stochastic generalization of the general equilibrium framework of Arrow, Debreu, and McKenzie. This means that DSGE does have implications - for example, that markets clear and that agents are price takers. Those things can be wrong, as can the results that follow from them (e.g. the Law of One Price). So Stephen Williamson's attempted defense of DSGE, which was looney in the first place ("It has no implications! It's utterly useless and therefore unassailable! Gurrrrhhh!"), also happens to be flat-out wrong.

Williamson Point #4:
Trickle-down economics: This one puzzled me. For the previous three zombie ideas, Quiggin is confused, but I could see where the confusion might come from. However, while the words "trickle-down economics" are familiar to me, I have a hard time associating that idea with the mainstream ideas of any academic economists. about dynamic Laffer effects, as posited by John Cochrane? I'm pretty sure John Cochrane is a mainstream academic economist. He's on Wikipedia, at any rate.

Williamson Point #5:
Privatization: Here, Quiggin offers a litany of government privatization efforts gone awry. If I wanted to, I could take this evidence as supporting the hypothesis that government is really bad - so bad that it can even screw up privatization.
Sure, if you wanted to. If I wanted to, I could take the Mongol Conquests as evidence supporting the hypothesis that Radiohead is the Best Band Ever. It's called "intellectual dishonesty."

Anyway, Quiggin also points out that Williamson doesn't offer any evidence to refute the book's claims. This is true. It's as if Williamson thought that he could refute Quiggin's entire book by tossing off a quick and sloppy mix of vague handwaving, semantic nitpicking, utter devaluation of the theories Quiggin is attacking, complete and utter mischaracterization of those same theories, and lame personal jabs.

I score this Quiggin: 5, Williamson: 0. (Or maybe Williamson: -1, given that he thinks "not even wrong" is a feature rather than a bug.) Pure and utter pulpification.

Oh well. At least Stephen Williamson can take comfort in the fortunes he's made off of the Balfour Williamson & Co. shipping venture. Oh wait...that's the wrong Stephen Williamson! Dang you, Wikipedia!!!

Supply-side vs. demand-side recessions

Tyler Cowen links to an interesting post about the deflationary impact of the internet. This is interesting not just because it illustrates how technological change impacts the economy, but because it tells us something about recessions. Namely, it tells us that our current recession - like all of the other ones in recent memory - was caused by deficiencies in demand, not in supply. 

Does output falter because people don't want to buy as much stuff, or because we become unable to make as much stuff as we used to? This is a debate that has gripped the macroeconomics profession for many decades. Which is kind of surprising to me, because it is so obvious that demand shocks are the culprit.

The reason is prices. If recessions are caused by negative supply shocks, then we should see falling output accompanied by rising prices (inflation). If recessions are caused by negative demand shocks, we should see falling output accompanied by falling prices (disinflation or deflation).

Draw a supply-demand curve for the whole economy, and it looks like this:

A negative shock to supply - for example, a resource shortage or an increase in harmful government regulation or a "negative technology shock" - will shift either the long-run aggregate supply curve or the short-run aggregate supply curve (or both) to the left. The new equilibrium will have lower output and higher prices. However, a negative shock to demand - for example, an increase in the demand for money - will shift the aggregate demand curve to the left; the new equilibrium will have lower output and lower prices.

In all of the recent recessions, faltering output has been accompanied by lower, or even negative, inflation. This means that demand shocks must have been the culprit. If "uncertainty about government policy" were really the cause of the recession, as many conservatives claim, then we would have seen prices rise - as companies grew less willing to make the stuff that people wanted, stuff would become more scarce, and people would bid up the prices (dipping into their savings to do so). I.e, we would have seen inflation. But we didn't see inflation.

So it seems that the stories that conservatives tell about the recession - "policy uncertainty," "recalculation," or even a "negative shock to financial technology" - are not true. The stories that everyone else tells about the recession - "a flight to quality," "increased demand for safe assets," etc. - look much more like what basic introductory macroeconomics would predict.

Of course, conservatives don't necessarily believe in the graph I included above. They may dismiss the idea of a downward-sloping AD curve (and an upward-sloping SRAS curve), and imagine that the AD curve is just a flat line (or maybe even an upward-sloping line?). In that world, supply changes, and only supply changes, determine the level of output, and demand changes, and only demand changes, determine the price level.

That's where the blog post that Cowen linked to comes in. In a world in which deflationary recessions (such as our current one) are caused by negative supply shocks, then positive supply shocks should also leave prices unchanged. In particular, an improvement in technology would cause us to produce more stuff at the same price, rather than more stuff at lower prices. However, if the internet is deflationary, it shows that positive supply shocks do, in fact, decrease prices. The AD curve slopes down, as it should.

The basic point here is about the dangers of doing what Larry Summers calls "price-free analysis". If you ignore prices, it is possible to convince yourself that recessions are caused by technology getting worse, or by people taking a spontaneous vacation, or by Barack Obama being a scary socialist. If you pay attention to prices - as all economists should - it becomes harder to believe in these things.

So the question is: Do conservative-leaning economists push these stories because they believe that we live in a world that is vastly more complicated than anything that can be described in Econ 102? Or is it just because they choose to ignore Econ 102 completely?