Is Job Creation Really Impossible?

This is a strong conclusion to a good post from Krugman:

My point, then, is that this claim — and the lionization of high earners as people who make a vast contribution to society [via job creation] — is not, in fact, something that comes out of the free-market economic principles these people claim to believe in. Even if you believe that the top 1% or better yet the top 0.1% are actually earning the money they make, what they contribute is what they get, and they deserve no special solicitude.

Here are his assumptions earlier in the post: "Yet textbook economics says that in a competitive economy, the contribution any individual (or for that matter any factor of production) makes to the economy at the margin is what that individual earns — period." The upshot being that the entire idea of a "job creator" is misguided. All of the value that factors of production add to the economy is recouped by those factors of production, and none "trickles down" to anyone else.

Correct me if I'm wrong, but doesn't the relevant "textbook economics" assume not only a competitive market but also constant returns to scale and no spillover effects? How often do we think all three of these things hold? Doesn't a Keynesian view of the world explicitly claim that in a depression there are often scale returns to be captured, as well as positive spillover effects from investment? How else could the Obama administration (like all administrations) claim that it has "saved or created" so many thousands of jobs via fiscal policy?

Minimum Wage 101

Kevin Drum and Karl Smith are having a go-around about the effect of minimum wages on employment. There is the famous Card/Krueger study (and others) showing that increases in the minimum wage do not adversely affect employment rates, and a bunch of other studies plus basic economic reasoning suggesting that they do. Drum weights the former more heavily, Smith weights the latter more heavily, but they can both be right. The effect of a price floor of any kind depends on where the floor is set relative to the competitive equilibrium. In the graph above (originally used to depict a basic relationship between capital ratio regulations and bank behavior, but the same principle works here), a floor below the equilibrium has no effect on behavior. Think of this as a minimum wage below the market wage, or (perhaps) the Card/Krueger finding. In the graph below, the floor is above the market equilibrium, so behavior is altered.



The point is that the effect of a minimum wage change will depend on many factors besides the minimum wage itself. In a depressed labor market, with many potential low (or zero) marginal product workers, the demand curve for labor shifts left, the equilibrium price falls, and a minimum wage increase is more likely to retard employment rates than it would in a robust labor market where the demand curve shifts right and equilibrium price rises.

Many people argue that a relaxation of payroll taxes would help boost employment. If that is true, then a minimum wage increase would decrease employment, at least for workers at the margin where any of this is relevant. That may not be many workers (as Drum claims), but given the depressed labor market today it is probably a lot more than it would have been in 2005.

Also keep this in mind: if a minimum wage is successful it must set a floor above the competitive equilibrium, and therefore must reduce employment. Maybe that shows up in hours worked or price increases rather than crude employment rates but it has to be there somewhere. A wage floor below the equilibrium doesn't change anything, and is therefore unsuccessful.

The Problem with Economics Is the Economists

Brad DeLong continues his trend of being unhappy with modern macroeconomics:

The most interesting moment at a recent conference held in Bretton Woods, New Hampshire – site of the 1945 conference that created today’s global economic architecture – came when Financial Times columnist Martin Wolf quizzed former United States Treasury Secretary Larry Summers, President Barack Obama’s ex-assistant for economic policy. "[Doesn’t] what has happened in the past few years,” Wolf asked, “simply suggest that [academic] economists did not understand what was going on?”

Here is the most interesting part of Summers’ long answer: “There is a lot in [Walter] Bagehot that is about the crisis we just went through. There is more in [Hyman] Minsky, and perhaps more still in [Charles] Kindleberger.” That may sound obscure to a non-economist, but it was a devastating indictment. ...

Asked to name where to turn to understand what was going on in 2008, Summers cited three dead men, a book written 33 years ago, and another written the century before last.

It's a good piece, and Krugman assents, so let's turn the mic over to Kindleberger to find out why he thought macroeconomics suffered, during his 1985 AEA Presidential address:

In a recent paper, unpublished I believe, George Stigler discussed "the imperialism of economics," which, he claims, is invading and colonizing political science-through public choice theory and the economic theory of democracy-law, and perhaps especially sociology, where our soon-to-be president-elect, Gary Becker (1981), has extended the reach of economics into questions of the family, marriage, procreation, crime, and other subjects usually dealt with by the sociologist. "Imperialism" suggests super- and subordination, with economics on top, and raises the question whether as a profession we are not flirting with vainglory.

My interest has long been in trade, and I observe that economics imports from, as well as exports to, its sister social sciences. In public choice, we can perhaps explain after the event whose interest was served by a particular decision, but we need political science to be able to forecast which interest is likely to be served, whether that of the executive, the legislature, the bureaucracy, some pressure group-and which pressure group or, in the odd instance, the voters. Individuals act in their own interest, let us grant, but a more general motive of emulation may be drawn from sociology as Adam Smith was aware in the Wealth of Nations (1776, p. 717), as well as in The Theory of Moral Sentiments (1759 (1808), I, p. 113). I want today to borrow one or two ideas from political philosophy, and to conduct a conversation with a new, impressive, and growing breed of political scientists working on international economic questions...

In reading recent books on macroeconomic policy by leading governmental economists under both Democratic and Republican administrations, the late Arthur Okun (1981) and Herbert Stein (1984), I have been struck by how little attention the authors paid to international repercussion.

What Kindleberger is saying is that we can't examine the macroeconomy as if it were a machine that occasionally needs a tuneup. It's not. It's the product of political interactions that are designed to benefit some groups over others, and it takes place in an international context. To the extent that modern economics is a big utility-maximization problem, as if reaching the Pareto-frontier was the goal of public policy, modern economics is irrelevant. What Kindleberger is saying, then, is that ceteris is generally not paribus. Pretending that it is corrupts your whole analysis. Or, to put it into econometrics terms, ignoring international context and political systems creates a huge omitted variable bias in economics.

In a sense, I view my role (and that of other IPE people) in the intellectual universe as explaining to economists why their theories are either wrong or irrelevant. Showing how the variables they omit are causally significant. Unlike Krugman, it isn't surprising to me, or probably anyone in IPE, that the ECB is pursuing contractionary monetary policy when unemployment in Spain is 21%. The ECB isn't interested in the least in Spanish unemployment. It's interested in protecting finance in the European core. I don't need to subscribe to a pop psychology of masochism -- "pain caucus" -- to explain why we didn't get a bigger stimulus package. I don't need to vilify bankers to explain why we massively skewed public policy in ways that led to the financial crisis.

Economists sometimes mention politics, usually in reference to why their pet models don't work, but they rarely consider that pragmatic study of the economy outside of the political and social context it exists in makes little sense. The original political economists -- Hume, Mill, Marx -- understood this, as did the more recent political economists that Summers recommended to Wolf -- Minsky and Kindleberger. What Summers is really saying to Wolf is that the only interesting or useful economists are political economists. The interesting question is not whether Keynesian mechanics are better than Austrian mechanics, or whether saltwater fish is more nutritious than freshwater fish. The interesting question is who is driving the vehicle, and where they're taking it. Trying to locate the precise fiscal multiplier in a liquidity trap is thus like arranging your living room for party with no invited guests: an interesting exercise, perhaps, but really what's the point?

Similarly, it's silly to study a national macroeconomy outside of its international context. I'm not just talking about trade and foreign investment as substantive topics; I'm talking about how all domestic economic policies are conditioned by international circumstances. To ignore them is to discard major explanatory variables. Again, the early political economists realized this... it was the primary concern of Smith, Ricardo, Marx, and others. Kindleberger realized it. Some contemporary economists do -- including Krugman on his best days and DeLong most of the time, Eichengreen is obviously great -- but many do not.

I don't writes this as someone who dislikes economics as a discipline. I studied it in undergrad, and I still like it a lot. I think there's a lot of value in developing models that work in a first-best world, even if we're never in a first-best world. It is nice to know the landscape of the possible, and economic theory can help us understand preference formation, among other things. Economics has given us a lot of tools -- theoretical and methodological -- that can be applied in ways that help us advance our political understanding. But I chose to study IPE (rather than economics) in graduate school because I wanted to know how the world works, not how it could work. I share DeLong's interest in the history of thought in political economy (in fact, much of that interest was sparked by reading his blog while an undergrad), so when I decided to go to grad school I ruled out econ departments almost immediately for the reasons he describes. But I don't think the problem is solely a lack of teaching of economic history; it's that economics cast aside politics with the marginal revolution, and never got it back.

The "I'd Gladly Pay You Tuesday For a Hamburger Today" Theory of Economics

Munger took some time before getting his eyes lasered today to say this:

To have an effect on economic activity, tax cuts have to be credibly permanent.

The assumption here is that people will recognize that present tax cuts will be offset by future tax increases, so unfunded tax cuts will have no effect on behavior: people will just sit on the money until they have to pay it back. And that's true if people are atomistic Friedmanite permanent-income-smoothing fully-forward-looking individuals with complete and perfect information about their future incomes. We know this from theory that is deduced from those assumptions, and if those assumptions hold, then the conclusions also hold.

But the assumptions of theory do not necessarily hold. All of those descriptors above are wrong or at least (I'm being very generous) probabilistic rather than certain, so the question becomes empirical, not theoretical. And the empirical record, as far as I can tell, is completely bollocks-upped.

I can easily imagine a situation in which someone offers to give me money today, on the condition that I have to pay it back tomorrow, and I nevertheless alter my behavior and spend it rather than save it. That's how credit -- the foundation of the capitalist economy -- works. Mastercard does not have to credibly promise me a free $500 that I will never have to pay back in order for me to spend. They only have to promise me $500 today. If I think spending $500 today is worth paying back $525 tomorrow -- say, because I'm unemployed, or my house is at risk of foreclosure, or I just got furloughed at work, or... -- then I just might do it.

Example: the cash-for-clunkers program is routinely criticized for doing nothing more than pulling future spending into the present. But that was the whole point. And it worked! There were a lot of car purchases during that window that would have been spread out otherwise. (IIRC, Munger took advantage of this himself, but I can't find the post now so it could have been someone else in my RSS.) Of course people with clunkers would eventually buy a new car, but the government decided that they wanted them to buy a car today, not tomorrow. As it happens I think that was a poor choice of priorities, as I think most (not all) of this grand Obama/GOP bargain to be a poor choice of priorities, but the problem wasn't that cash for clunkers didn't work; the problem was that it was a silly and expensive tradeoff.

This is something that has always confused me about rational expectations econ, but then my econ education ended in undergrad. I can't even pretend to have a great grasp on the advanced literature, so possibly all these objections are easily overcome. If so, I'm sure someone will set me straight.

UPDATE: I've been grading finals all day (All Done!) so I didn't see Angus' relevant reply until just now. Angus believes in rational expectations, PLUS seems to have a zero percent discount rate, and still finds (to his apparent surprise) that he himself doesn't act as if these were his true beliefs. People, doesn't this tell you all you need to know? If a true believer rat expectations doesn't act like he should, who will? Yikes!

UPDATE 2: I'm still catching up on my RSS, and now I see Munger wrote a follow-up post in which he describes a scenario in which a car dealer offers a customer a loan, to be repaid with interest, if the customer is willing to purchase a car today rather than after he has saved up enough to pay the full sticker price in cash. Munger views this scenario as absurd. I view this scenario as basically the single most typical durable goods transaction in the world. One of us has to be wrong.

Who Says We've Got Economics Envy?

Cowen Tabarrok says it should be the other way around:

(Economics, and perhaps social science in general, seems behind its time compared say with political science.)

That is mostly (I think) in reference to the incorporation of psychology and experimental methods into political science. The post is about what ideas are behind their time.

(Updated to note correct MR writer. Thanks Anon.)

Hatchet Job

Charles Ferguson, the maker of Inside Job, is losing credibility almost by the day. I previously discussed here and here how he's got the history of the U.S. economy, financial crises, and regulation wrong. But those mistakes are at least somewhat academic, if pretty basic. In his anti-Summers companion piece, however, Ferguson reveals that he is simply not a reliable source:

In 2005, at the annual Jackson Hole, Wyo., conference of the world's leading central bankers, the chief economist of the International Monetary Fund, Raghuram Rajan, presented a brilliant paper that constituted the first prominent warning of the coming crisis. Rajan pointed out that the structure of financial-sector compensation, in combination with complex financial products, gave bankers huge cash incentives to take risks with other people's money, while imposing no penalties for any subsequent losses. Rajan warned that this bonus culture rewarded bankers for actions that could destroy their own institutions, or even the entire system, and that this could generate a "full-blown financial crisis" and a "catastrophic meltdown."

When Rajan finished speaking, Summers rose up from the audience and attacked him, calling him a "Luddite," dismissing his concerns, and warning that increased regulation would reduce the productivity of the financial sector.

Brad DeLong digs up this "attack":

I speak as a repentant, brief Tobin tax advocate, and someone who has learned a great deal about the subject, like Don Kohn, from Alan Greenspan, and someone who finds the basic, slightly Luddite premise of this paper to be largely misguided. I want to use an analogy, not unlike the one Hyun Song Shin did, but to a rather different conclusion.

One can think of the history of transportation over the last two centuries as reflecting a gradual and determined move away from arm’s length transactions. People once supplied their own power. Then, they started carrying on transportation using tools that they owned. Then, they increasingly relied on tools that other people owned that were provided by intermediaries.

In that process, the volume of transportation activity increased very substantially. Over time, people became almost entirely complacent about the safety of the transportation arrangements on which they relied. Large sectors of the economy came to be organized in reliance on the capacity of planes to fly and trains to move. The degree of dependence on individual hubs—like O’Hare Airport—increased substantially. The worst accidents came to be substantially greater conflagrations than they had ever been in an earlier era.

Yet, we all would say almost certainly that something very positive and overwhelmingly positive has taken place through this process. Something that is overwhelmingly positive for individuals is that the number of people who die in transportation-related episodes is substantially smaller than it was in an earlier era.

The best single way to think about the process of financial innovation is as representing a similar process of movement across spaces, spanned not by physical space, but by different states of nature. It seems to me that the overwhelming preponderance of what has taken place has been positive. It is probably true that—as we didn’t use to have transportation safety regulation and we do now—an evolving system does require an evolving regulatory response.

But it seems to me that one needs to be very careful about stressing the negative aspects of the evolution, relative to the positive aspects of the evolution. I was going to make the same point that Don Kohn made about the Japanese financial system and the Scandinavian financial system standing out for the magnitude of damage done and the reliance on vanilla banking, relative to other activities.

Something similar could be said about the history of U.S. business cycles. The history of the business cycles prior to 1970 would place very substantial reliance on problems that came out of the financial sector and the regulation of the financial sector.

I was surprised by the tone of the recommendation around the incentives because it seems that if you take what is the central, most plausible area of concern that is suggested by what takes place in the paper, it is the notion that speculation involves negative feedback over a certain range, then positive feedback once you get outside of that corridor, and that process is very substantially exacerbated by hedge fund phenomena. Indeed, if one looks at the Shleifer-Vishny paper that Mr. Rajan refers to, hedge funds and the behavior induced by hedge funds and hedge fund liquidations are the central example. Yet, hedge funds would be the primary example we have of a financial institution where those who were running it did in fact have, as Raghu Rajan recognized in his comment on Long-Term Capital Management, very substantial wealth that was involved.

While I think the paper is right to warn us of the possibility of positive feedback and the dangers that it can bring about in financial markets, the tendency toward restriction that runs through the tone of the presentation seems to me to be quite problematic. It seems to me to support a wide variety of misguided policy impulses in many countries.

I would say as a final example of what has come out of the discussion for the 1987 crisis is that if those who wish to protect their assets had bought explicit puts rather than portfolio insurance, the situation would have been substantially more stable. That also argues for the benefits of more open and free financial markets, rather than for the concerns they bring.

Summers' critique is not dismissive at all. He deals with Rajan's argument with respect and interest. He acknowledges the strengths of it (as he sees them), and clearly expresses where and why he disagrees.

DeLong says that, despite Ferguson's mischaracterization, Rajan was right and Summers was wrong. If you take a short view (i.e. 2005-2010), Rajan clearly is right and Summers clearly is wrong. But if you take a long view, as Summers is obviously trying to do, it's not so clear. Has the "increased transportation" of finance really hurt the global economy over the past 50 years? 150 years? There have been a multitude of booms and busts during that span, but in the end it's hard to argue that we should entirely forego checking accounts and ATMs and electronic transactions and futures contracts and etc. These innovations have added an enormous amount of value to society, and in general has made the economy much safer and secure than it would otherwise be.

I still want to see Inside Job. But I'll be watching with a more skeptical eye now.

Economics of the Somali Pirate Business Model

This semester, I'm teaching four recitation sections of POLI 150: Intro to International Relations here at UNC (which is being taught by Dr. Oatley with Sarah and Will as fellow TA's). In each recitation I always like to spend the first five to ten minutes of class talking about current news and events in international politics and try to connect the theories and frameworks that we are teaching our students to the real world so they see that what they're learning actually does have value and provides explanatory power over topics outside of the classroom.

For my Wednesday afternoon recitation, after whatever pressing new events (this week it was the coup in Niger, the Winter Olympics, Greek sovereign default, and the Dalai Lama meeting) that they bring up have been explored, somehow the conversation always turns to pirates, how Somali piracy works, how and why countries respond to pirate attacks, etc. It's a great topic to discuss anarchy, collective action problems, bargaining, state vs. non-state actors and informal networks and markets. It seems like my obsession with pirates is starting to rub off on my students as each week they're bringing up new interesting questions and finding really awesome articles like the one I'm linking to below.

I was going to go into detail about this article, but instead I'm just going to completely outsource this post to Wired Magazine who provide an absolutely fantastic analysis of the incentives, costs and benefits facing not only Somali pirates but "shippers, insurers, private security contractors and numerous national navies" operating off the coast of Somalia. This is just an absolute must-read. Here is the opening:

The rough fishermen of the so-called Somali coast guard are unrepentant criminals, yes, but they're more than that. They're innovators. Where earlier sea bandits were satisfied to make off with a dinghy full of booty, pirates who prowl northeast Africa's Gulf of Aden hold captured ships for ransom. This strategy has been fabulously successful: The typical payoff today is 100 times what it was in 2005, and the number of attacks has skyrocketed.

Like any business, Somali piracy can be explained in purely economic terms. It flourishes by exploiting the incentives that drive international maritime trade. The other parties involved — shippers, insurers, private security contractors, and numerous national navies — stand to gain more (or at least lose less) by tolerating it than by putting up a serious fight. As for the pirates, their escalating demands are a method of price discovery, a way of gauging how much the market will bear.
The risk-and-reward calculations for the various players arise at key points of tension: at the outset of a shipment, when a vessel comes under attack, during ransom negotiations, and when a deal is struck. As long as national navies don't roll in with guns blazing, the region's peculiar economics ensure that most everyone gets a cut.

All of which makes daring rescues, like the liberation in April of the Maersk Alabama's captain, the exception rather than the rule. Such derring-do may become more frequent as public pressure builds to deep-six the brigands. However, the story of the Stolt Valor, captured on September 15, 2008, is more typical. Here's how it played out, along with the cold, hard numbers that have put the Somali pirate business model at the center of a growth industry.

Some very interesting tidbits:

An ordinary Somali earns about $600 a year, but even the lowliest freebooter can make nearly 17 times that — $10,000 — in a single hijacking. Never mind the risk; it's less dangerous than living in war-torn Mogadishu.

The insurance business is a gamble. Insurers know that some ships will be hijacked, forcing the companies to dispense multimillion-dollar settlements. However, they know the chance of this happening is minuscule, which by the calculations of their industry makes it worth issuing policies. In 2008, only 0.2 percent of ships sailing Somali waters were successfully hijacked.

(The hat tip goes to Paula, one of my students in class who found and emailed me the article).

Economics Smackdown

Dan Drezner lays the smackdown on economics in this little bit of commentary from Marketplace.

For decades, there was a clear but unspoken pecking order in the social sciences. Economists were royalty, and every other discipline was part of the peasantry. Economists were treated as real scholars, with their very own Nobel Prize and everything.

Political scientists, on the other hand, were mocked for having the word "science" in the title. The old joke goes that an economist who switches to studying political science raises the average intelligence of both disciplines. It's not true, but the perception is powerful. Powerful enough for Sen. Tom Coburn to have tried scrapping National Science Foundation funding for "poli sci" earlier this year.

Coburn's effort failed, however, and for good reason -- 2009 was a banner year for political scientists, and a not-so-banner year for economists.

Drezner as always provides insightful commentary with some good jokes in overviewing how 2009 treated political scientists vis-a-vis economists. Hopefully the demand for political scientists continues well past 2013 so that us puny grad students who were crazy enough to embark on this journey through the world of political science will be able to find a job.

Since When are Economists Comedians?!

University of Chicago Economics Professor and current member of the Council of Economic Advisors Austan Goolsbee takes a crack at stand-up at the DC Improv:

(ht: McMegan and Mankiw)

Stand-up Economist

The Stand-up Economist, Dr. Yoram Bauman, did stand-up at the 2009 meetings of the American Economic Association. This man is hilarious and the video is very entertaining. I wonder what would happen if I tried to become the "Stand-up Political Scientist." I'd probably be juggling 6-8 part-time jobs like Bauman and not taken seriously by academic departments. Scratch that idea.

(ht: Mankiw)

Krugman vs. Cochrane

Paul Krugman stirred up a lot of conversation in the blogosphere and in the Ivory Tower recently with his NY Times article on the state of macroeconomics. Will has done a very good job covering Krugman's piece and John Cochrane's response for this blog. I wanted to throw my unsolicited two cents out there and engage the pieces that have been written.

I agree with Will and John Cochrane that Krugman is using his recently awarded Nobel Prize, along with his tenured, endowed Princeton professorship and his NY Times blog and column to push a partisan agenda and has been quite misleading in many of his writings as of late (which Will also covered here). Many of the claims/arguments he puts forward in the NY Times article are not well informed, incoherent, at times disingenuous and some even border on personal attacks on well-intentioned economists. However, I do believe that if he wants to turn himself into a money-making political hack, that's his business. I don't see anything wrong with him using his column and Nobel fame to convince others that Keynesian economics is the answer to all of the world's problems; I just wish he was more honest as he goes about it.

Cochrane does a good job calling out Krugman for the mistakes in his article and taking him to task for personally attacking other economists. He also provides a very good defense of mathematical economics, model creation and assumption building. His arguments for using advanced mathematics as a way of checking and proving logical arguments is quite good. He's right in that there are things we can't do with prose that can be done quite well with math, economics being one of them. And I'm sure he'd also agree that there is still a need to translate these models and equations into words so that the rest of the mathematically challenged world can understand what is going on; this is what Krugman should be doing with his column as Cochrane makes clear. His explanations of the economics, especially where Keynesians and Monetarists differ were sound and enjoyable, and showed key differences in positions between the camps and where he believed Krugman was wrong.

Even with all of the good things Cochrane does in his piece, he fails in some of the same ways Krugman does. They're both deeply ideological (which is clearly evident in their writing) and obviously have an agenda that they each want to promote. They both take extreme positions, Cochrane for unfettered, free market capitalism and Krugman, an expansionary view of government's role in society and expansionary government spending. Granted Krugman does it misleadingly in a NY Times article with a veiled political agenda, but Cochrane also has his own political agenda and interests that he seeks to promote.

It's pretty clear that unfettered, free market capitalism just does not work and his attempt to put a large part of the blame for the economic collapse on government intervention is clearly misleading. Moral hazard and government promoted excessive risk-taking are definitely to blame. But denying that the idea of self-regulation of banks was a bad one, as well as believing that a lack of regulation and oversight in other markets were solely the fault of the government is misleading and wrong. He criticizes the role of the government as regulator and argues that the problem started with the over-regulation of commercial banks. He believes that government did a poor job with its regulatory responsibilities (he's correct there), but denies the role that business interests and the push for unfettered capitalism played in dismantling the regulatory structure that had previously been in place as well as the culture and ideological leanings within regulatory agencies that believed a lack of oversight was a good thing because it was in the best interest of the banks and other large financial corporations to not be overexposed and take on too much risk and that they could police themselves. He would also have us believe that the market alone, with a little bit of help from the Fed, would have pulled us back from the brink last fall. It's pretty clear that without massive government intervention one year ago this weekend, the meltdown surely would have been much, much worse, not better.

Cochrane's portrayal of Krugman as equivalent to that of a "global warming skeptic, an AIDS-HIV disbeliever, a creationist" within his field is both ignorant and wrong. There is much consensus in medicine, environmental science and evolutionary biology on those three issues. In economics, I don't believe that sort of consensus exists, nor should it at the moment. There is much within economics that is not black and white, that simply cannot be proved with the rather limited toolbox that we have as scholars and the limited data that we have at our disposal to study such convoluted and difficult problems. It is not a verifiable fact that Neo-Classical Economics holds the key to knowledge within the field of economics and I hope even Neo-Classicists can acknowledge that. In my opinion, the Keynesians and the Neo-Classicists are both well short of the truth and have a lot to learn from each other as well as from emerging fields like behavioral economics.

Both of these men have been doing great scholarly work in economics for a long time. One, Krugman, has gained vast fame and fortune as of late, is trying to disseminate his work and beliefs to the masses and entrench his position in economic lore for many years to come. The other, Cochrane, sees his life's work, his beliefs and his ideology being poo-pooed on by a Nobelist he feels is being misleading, by government officials whom he feels are making bad economic decisions and by other lay people whom he believes are blaming the wrong people for the recent economic misery. Both have their own agenda and both are trying to ensure that their view of the economic world survives to breathe another day. Be careful how much stock you put into each of their viewpoints.

Some good videos

Daniel Drezner v. David Frum on North Korea, Iran, and John Bolton.

Will Wilkinson v. Tyler Cowen on neurodiversity, the internet, autism and beauty with lots of economics.

More on Pirates!

This post continues my obsession with the economics of piracy and the lifestyles of modern day pirates. I woke up this morning to a post over at The Economist's Free Exchange blog that linked over to an interview that Scott Carney did with a Somali pirate. The interview is really interesting. Here are some interesting excerpts (click the link above to read the entire conversation):

From what I’ve seen, initial demands tend to be about 10 times the previous publicized ransom, is this a rule of thumb?

We know that we won’t get our initial demands, but we use it as a starting point and negotiate downwards to our eventual target. But as a rule, yes, that’s about right.

Does the length of a hijacking change the ransom that pirates are willing to accept?

Yes. Armed men are expensive as are the laborers, accountants, cooks and khat suppliers on land. During long negotiations our men get tired and we need to rotate them out three times a week. Add to that the risk from navies attacking us and we can be convinced to lower our demands.

How much does it cost to outfit a pirate mission?

A single mission with 12 armed men and boats costs a little over $30,000. But a successful investor has to dispatch at least three or four missions to get lucky once.

How are the pirates organized? (Are there pirate leaders, financiers, and specialists?)

The financiers are the most important since they organize and plan the big shot operations and are able to pay running cost[s]. Financiers always need to forge deals with traders, land cruiser owners, translators, business people to keep the supplies flowing during operations and manage the logistics. There is a long supply chain involved in every hijacking.

Miss Teen South Carolina on Economics

From Marginal Revolution. I'm really surprised she was allowed to go on for so long. This is amazing.

See more funny videos and funny pictures at CollegeHumor.

And because we love this video so much:

Political Science and Economics Professors

Via Blattman. Really interesting post on political science and economic majors and the (I guess) demand for more (at least that's what the three grad students who write on this blog hope!)

This is the ratio of BA majors to faculty in private universities with ranked programs:

The graph comes from a new article in the JEP by William Johnson and Sarah Turner. Political Science seems to be the big outlier, with economics and psych not far behind.

The meshes with my experience: poli sci has become the largest major at Yale (even more so since the crisis) and we cannot hire fast enough--almost 8 junior faculty offers per year for at least three years.

Part of the explanation could be that econ, psych and poli sci are more easily taught to large groups (i.e. a more efficient technology) but I find that hard to believe.

The authors find some evidence that it's because econ professors are more expensive:

But here again we see the poli sci outlier.

The whole paper is good. Their conclusion: it's all politics.

All the more reason for so many new political scientists?

Oil is creeping back up.

Gas prices have increased by 20% over the last month (and jumped 90 cents since January), and the price of a barrel of oil has more than doubled since February closing at $66.31 at the end of trading on the NYMEX on Friday afternoon. With the daily news cycle fixated on the appointment of Sonia Sotomayor to the U.S. Supreme Court, the erratic (but, not really) actions of the DPRK and their recent nuclear test, Susan Boyle coming in second on Britain's Got Talent, and of course Prince Harry visiting New York City on his first official U.S. visit, the talk of increasing oil prices has been relegated to the back pages barely getting attention from policymakers and the media. 

This increase comes at a pretty bad time for most Americans. With the unemployment rate hovering at about 9% and the much anticipated summer driving season getting underway, a steep rise in the pump price of gasoline may put a dent in summer vacation plans and family budgets. Granted, oil prices are still half of what they were last summer when they peaked somewhere in the $140-150 a barrel range. But with American families feeling the pinch, a 20% increase in gas prices, especially in only 31 days with future increases expected throughout the summer, may cause Americans to cut spending even more than they already have. 

Analysts were expecting the low cost of gas to provide an incentive for families to hit the road this summer, thereby providing businesses with a stimulus of sorts. The expected increase in spending may not happen, at least not to the level that was expected, which may threaten the slim hope for a recovery beginning in the third quarter. Francisco Blanch, energy strategist at Merrill Lynch, said crude prices are nearing levels where "they could put the embryonic economic recovery at risk." 

"There's way too much optimism about a driving season lift," said Tom Kloza, chief oil analyst for the Oil Price Information Service, who believes that higher prices, in conjunction with the recession, will dampen the typical summer travel surge. Kloza said the impact will be especially painful in economic "sore spots" like California, Florida, Arizona and the rural South.

So, why have prices jumped so much lately? Well, OPEC announced further output cuts a few weeks ago but decided not to touch production at it's most recent meeting, although not all member countries are complying with the aforementioned cuts. These cuts are having an impact on oil prices, although the impact may be less than most expect because of the cheating going on. US supplies have dwindled recently, a sign that demand may slowly be increasing. (We know how this supply-demand function affects the price of oil. For PoliSci and Econ students, see Oatley's IPE text or Krugman and Obstfeld's International Econ text for an in depth explanation.) 

There is also talk from analysts and politicians of increased speculation in the oil market as of late. Bernie Sanders of Vermont is calling for federal regulators at the Commodity Futures Trading Commission to crack down on speculators arguing that "rising oil prices during a global recession, while demand has eased, is a very unusual moment. There is more oil sitting around than ever before, so there is no supply problem. U.S demand is the lowest it's been in at least a decade. What we are looking at now is not the fundamentals of the economy. What we are looking at is speculation on Wall Street."

The flip-side to this argument is that these ups and downs in the oil market are simply market reactions to future expectations. Expectations of increased future demand may be driving the increases in oil prices, which is to be expected if you believe the recent words of Summers and Bernanke and the talk of the beginning of a recovery in the third and fourth quarters of 2009. (Although I will point out that the definition of a recovery varies across academia and the policy world.) Most see recovery as merely the return of economic growth even if growth is painstakingly slow (somewhere in the .1-.2% of GDP region). This slow positive growth may not justify such a dramatic increase in oil prices. As always, the best explanation combines all of these factors and describes the rise in oil prices as a function of creeping demand, dwindling supply, market expectations, some speculation, OPEC output cuts and even the political environment in oil-producing states. 

Quote of the weekend.

I posted a link a couple of days ago to Barry Eichengreen's recent article "The Last Temptation of Risk" in The National Interest. But I thought I'd isolate a key bloc of paragraphs for our readers, in case you hadn't had the time to read the piece or clicked on the link and decided it was far too long, especially on a nice early summer weekend to read: 

WITH THE pressure of social conformity being so powerful, are we economists doomed to repeat past mistakes? Will we forever follow the latest intellectual fad and fashion, swinging wildly—much like investors whose behavior we seek to model—from irrational exuberance to excessive despair about the operation of markets? Isn’t our outlook simply too erratic and advice therefore too unreliable to be trusted as a guide for policy?

Maybe so. But amid the pervading sense of gloom and doom, there is at least one reason for hope. The last ten years have seen a quiet revolution in the practice of economics. For years theorists held the intellectual high ground. With their mastery of sophisticated mathematics, they were the high-prestige members of the profession. The methods of empirical economists seeking to analyze real data were rudimentary by comparison. As recently as the 1970s, doing a statistical analysis meant entering data on punch cards, submitting them at the university computing center, going out for dinner and returning some hours later to see if the program had successfully run. (I speak from experience.) The typical empirical analysis in economics utilized a few dozen, or at most a few hundred, observations transcribed by hand. It is not surprising that the theoretically inclined looked down, fondly if a bit condescendingly, on their more empirically oriented colleagues or that the theorists ruled the intellectual roost.

But the IT revolution has altered the lay of the intellectual land. Now every graduate student has a laptop computer with more memory than that decades-old university computing center. And she knows what to do with it. Just like the typical twelve-year-old knows more than her parents about how to download data from the internet, for graduate students in economics, unlike their instructors, importing data from cyberspace is second nature. They can grab data on grocery-store spending generated by the club cards issued by supermarket chains and combine it with information on temperature by zip code to see how the weather affects sales of beer. Their next step, of course, is to download securities prices from Bloomberg and see how blue skies and rain affect the behavior of financial markets. Finding that stock markets are more likely to rise on sunny days is not exactly reassuring for believers in the efficient-markets hypothesis.

The data sets used in empirical economics today are enormous, with observations running into the millions. Some of this work is admittedly self-indulgent, with researchers seeking to top one another in applying the largest data set to the smallest problem. But now it is on the empirical side where the capacity to do high-quality research is expanding most dramatically, be the topic beer sales or asset pricing. And, revealingly, it is now empirically oriented graduate students who are the hot property when top doctoral programs seek to hire new faculty.

Not surprisingly, the best students have responded. The top young economists are, increasingly, empirically oriented. They are concerned not with theoretical flights of fancy but with the facts on the ground. To the extent that their work is rooted concretely in observation of the real world, it is less likely to sway with the latest fad and fashion. Or so one hopes.

The late twentieth century was the heyday of deductive economics. Talented and facile theorists set the intellectual agenda. Their very facility enabled them to build models with virtually any implication, which meant that policy makers could pick and choose at their convenience. Theory turned out to be too malleable, in other words, to provide reliable guidance for policy.

In contrast, the twenty-first century will be the age of inductive economics, when empiricists hold sway and advice is grounded in concrete observation of markets and their inhabitants. Work in economics, including the abstract model building in which theorists engage, will be guided more powerfully by this real-world observation. It is about time.

Should this reassure us that we can avoid another crisis? Alas, there is no such certainty. The only way of being certain that one will not fall down the stairs is to not get out of bed. But at least economists, having observed the history of accidents, will no longer recommend removing the handrail.

An Open Letter to Economists

From Harvey Mansfield, political theorist, and it could be subtitled "How then should we live?" (the actual subtitle is "Is the overly predicted life worth living?"). Via Tyler Cowen, who linked to the article but did not venture a response. Here's Mansfield's conclusion:

Economics needs to stop trying to duck responsibility for what it recommends. It needs to examine the whole of life and to focus on the virtue or virtues of different ways of life. It should give over talk about "preferences," as if human desires were given facts unaffected by the science of economics. It should abandon the crude positivism that claims that one can study facts without giving advice, or that one can confidently predict without causing people to believe in one's predictions. It needs to replace its false modesty with true moderation.

I doubt Mansfield will receive many answers from economists. All through my economics education I was constantly told that the study of economics is about what is possible to do, not what should be done; that question was reserved for the theorists, philosophers, and clerics. Modern economics is too tied to positivism to take Mansfield's advice, even if it wanted to (and it almost certainly does not). The old political economists -- J. S. Mill, Smith, Ricardo, Marx -- were centrally preoccupied with just this sort of normative question, but modern economists are proud to leave them to others. There are still a few strands of political economy happy to engage the debate, but all too often conclusions are a pure function of priors, so the interaction leaves something to be desired.

I'm not as sure as Mansfield that this state of things is so terrible. After all, there's something to be said for gains from specialization, and different scholars have different comparative advantages. Expecting quantitative methodologists or formal theorists to spend much time parsing normative concerns is just as silly as expecting philosophers to learn advanced game theory. We can have both: positivists to tell us the range of possible outcomes, and normativists to help us decide which outcomes to pursue. All to say, I don't think Mansfield's intended audience is capable of responding the way he wishes they could, and that's probably okay.

Macroeconomics: Dismal Once Again

Economics used to be called "the dismal science" because of its Malthusian predictions: economies were always on a feast-or-famine cycle: the long-run standard of living was not high, and the long-run standard of living did not change. The Industrial Revolution changed all that (we think!), but that doesn't mean that the "dismal" tag doesn't still have its uses. Gregory Clark, chair of the Econ department at UC-Davis, says the state of the macroeconomic discipline is dismal, and not getting much better:

The debate about the bank bailout, and the stimulus package, has all revolved around issues that are entirely at the level of Econ 1. What is the multiplier from government spending? Does government spending crowd out private spending? How quickly can you increase government spending? If you got a A in college in Econ 1 you are an expert in this debate: fully an equal of Summers and Geithner.

The bailout debate has also been conducted in terms that would be quite familiar to economists in the 1920s and 1930s. There has essentially been no advance in our knowledge in 80 years.

I got an A in Econ 1 and Econ 2, but I pray that I'm not an expert in this debate, and I know that I'm not the equal of Summers and Geithner. Still, I know I can do better than this:

Recently a group of economists affiliated with the Cato Institute ran an ad in the New York Times opposing the Obama's stimulus plan. As chair of my department I tried to arrange a public debate between one of the signatories and a proponent of fiscal stimulus -- thinking that would be a timely and lively session. But the signatory, a fully accredited university macroeconomist, declined the opportunity for public defense of his position on the grounds that "all I know on this issue I got from Greg Mankiw's blog -- I really am not equipped to debate this with anyone."

Ouch.

(ht: DeLong)

What Is This 'Politics' Of Which You Speak?

Wilkinson unwittingly explains why I decided to become an international political economist rather than an international economist:

The deeper problem, I think, is that the textbook theory doesn’t have any politics in it. In macroeconomics textbooks, government is a benevolent central planner beyond politics. It is assumed, for simplicity’s sake, that governments can act in perfect compliance with theory. It is also assumed that theory is settled before coming to a policy problem, that motivated disagreement over theory is not an essential element of democratic policymaking. But of course, there is politics, which trashes hope of either consensus on or compliance with theory. And that’s how we ended up with the legislative monstrosity actually under consideration in Congress.

Economists are often befuddled when politicians act "irrationally" by not putting standard economic theory into practice, and when voters reward them for this sort of behavior*. Strangely, the answer to the conundrum is often explained best by the economists' best friend: incentives. Politicians, interest groups, and the electorate all respond to their own incentive structures, and quite often that leads to "perverse" economic outcomes. Political scientists, on the other hand, spend our days looking at precisely these questions, and we even (sometimes) have answers to them! See, for example, this recent post by Dr. Oatley. Unfortunately, Wilkinson (and most of the rest of the commentariat) seems to be completely unaware that international political economy exists as a formal discipline.

Still, the whole post is worth reading. Two Nobel Prize-winning economists make appearances, and Wilkinson lays into Krugman's style as a commentator.

*Public choice economists do better at this. But public choice economists are a relatively new breed, and comprise a small minority of economists. Additionally, the public debate over the stimulus bill is being conducted by old-school macroeconomists, economic historians, and international economists. Public-choicers have barely had a cameo.