James Buchanan, RIP

I met him only once, briefly, and it was this past summer. He was clearly diminished, but still remarkably sharp for a man in his 90s.

Buchanan's influence will be felt by those who study constitutional economics, law and economics, and theories of logrolling. My sense is that outside of those areas his (direct) influence has slipped in recent decades, although that impression may be incorrect. In any case, he helped resurrect political economy as a field of study distinct from welfare economics. I do a very different sort of political economy from him, and yet I am in his debt. Early neoliberal institutionalists in IPE built some of their work off of his foundation, see e.g. this 1982 article by Keohane which laid the groundwork for After Hegemony, and which cites Buchanan alongside Coase.

Here is his Wikipedia page. Here is his Google Scholar page. Here is his 1986 Nobel Memorial Prize lecture, which concludes with the question which motivated Buchanan's entire career:

How can we live together in peace, prosperity, and harmony, while retaining our liberties as autonomous individuals who can, and must, create our own values?

What We Have Here Is a Failure to Regulate

If you follow the same blogs as me you will have noticed an ongoing debate about workplace regulation. I'm not going to link to all the posts -- which by now number in the dozens -- but the key players have been the Bleeding Heart Libertarians, Crooked Timber, Marginal Revolution, Matt Yglesias, and Modeled Behavior. Two of those blogs are written by economists, one libertarian and the other... well I'm not quite sure how to categorize Modeled Behavior; one blog that is decidedly of the academic left, although from various factions of it; one blog of the academic non-economist right; while Yglesias seems to take his positions somewhat a la carte these days.

Perhaps predictably, given the roster, these groups are talking about different things. Moreover, they are talking about different things in different ways. As it happens I've spent a decent amount of time reading, thinking, and writing about regulation so maybe I can help clarify.

When economists think about regulation, they are coming from at least one of two schools of thought: those emphasizing the welfare-enhancing potential of regulation, and those emphasizing the welfare-destroying potential of regulation. Let's call the first school the "Utilitarians". Let's call the second second school "Public Choice". The first tradition has its roots in Smith, Hume, and (JS) Mill, but really takes off with Vilfredo Pareto, Arthur Pigou, and other 20th century economists. The second tradition gets a lot from Rousseau and Marx, but in its contemporary form has been best expressed by folks like Stigler and Peltzman.

The Utilitarians believe that regulation can be used to enhance social welfare by correcting market externalities. This is a situation in which the cost of a market actor's actions are not borne by her, but are passed on to someone else. (Alex Tabarrok made reference to this idea specifically at one point.) In this case, society has moved off of the Pareto frontier; total utility is below potential. Regulation is a tool by which we can move the equilibrium back up to its optimum.

A classic example concerns a firm that pollutes a river as a byproduct of its manufacturing; those who live downstream are the ones who suffer the most from the pollution, but they receive no profit from the production. Arthur Pigou suggested one mechanism for dealing with this -- taxing it at a sufficiently high rate as to bring private and social costs back in line, and redistributing the proceeds -- but regulating (i.e. limiting or outright prohibiting) the activity will often serve the same purpose.

The Public Choicers acknowledge that in this specific set of cases regulation can be welfare enhancing for society as a whole. But they posit another set of cases in which it will not be. That is because regulations, being restrictions, have a tendency to reward market incumbents and punish new entrants. The net result is an uncompetitive market prone to inefficiencies and other bad things.

Suppose the firm in the previous example acquires a market advantage by polluting. Once it has driven all of its competitors out of business, it then acquiesces to regulation restricting its activities. But all other firms must also adhere to this regulation. Because the incumbent firm is already capturing economies of scale and has a dominant market share, it will be very difficult for new entrants to be successful. The dominant firm may even initiate the regulation to prevent, e.g., a new firm from coming in, moving further upstream, and polluting there. The resulting lack of competition is also Pareto suboptimal. So the Public Choicers argue that eliminating the regulation -- and with it the concomitant barriers to entry -- can actually enhance aggregate societal welfare by fostering new competition, thus moving society back up towards the Pareto optimum*.

Both of these stories can be true in certain cases. It seems to me that Matt Yglesias and the Marginal Revolutionaries have been trying to tease out which is more true in the real world, in which cases, and whether the best thing to do is to increase regulation or decrease it. To do this they do the only thing they can do: refer to stylized models, simple intellectual exercises (would you trade being searched for contraband in exchange for an extra dollar an hour?), and what empirical evidence exists.

When the academic left thinks about regulation they are not thinking about to reach Pareto frontiers. They are not using stylized models**, as they reject the core assumptions of those models***. They are skeptical of econometric studies which, as Henry Farrell rightly notes, are susceptible to selection bias and questionable causality. In general, they have little use for the positive theories of regulation. What they care about are normative properties of outcomes as they exist in the actual world.

Instead of thinking about how to maximize Pareto optimality, the left is thinking about how power inequalities condition outcomes. There are two ways to translate this back into the economists' language: the first is to say "I care every bit as much about where along the Pareto frontier we fall as the fact that we're on it... the distribution of the pie is as important as the size of it"; the second is to say "I don't give a good goddamn if we're on the Pareto fronter at all... I want to improve the lot of labor, and particularly the poorest and weakest among the laborers".

Both of these reject the positive political theories of the economists. Or, actually, they (implicitly) accept them as intermediate steps in a necessary chain, but not as the culmination. If what matters to you is where along the Pareto frontier the actual distribution of utility between capital and labor lies, then you (implicitly) accept the positive Utilitarian theory of regulation as being welfare-enhancing in aggregate; you just think there's one more step to be taken which can be justified on normative grounds. If what matters to you is to improve the lot of labor full stop, then you accept the positive Public Choice account of regulation as being inherently redistributionary, adding a normative preference for redistributing from capital to labor.

So now we have four end points:

1. Utilitarians: The point of regulation should be to maximize social utility, so the biggest concern is reaching the Pareto frontier. This means regulating in the case of market failure but not otherwise, and the instances of actual market failure -- defined as deviation from the Pareto frontier -- are pretty rare. (The Bleeding Heart Libertarians' position)

2. Public Choice: Most of the time regulation will maximize private utility, not social utility; at minimum that will often be an unintended consequence. So the biggest concern is to limit regulation in order to reach the Pareto fronter. (The Marginal Revolutionaries's position)

3. Social Democracy: The point of regulation should be to maximize social utility as a preliminary step towards shifting the ex post distribution of aggregate utility along the Pareto frontier more towards labor. (The Matt Yglesias position)

4. Marxist/Post-Marxist: The point of regulation should be to maximize the well-being of labor, not capital, so who cares where the Pareto frontier is, even assuming I believe such a thing exists? (The Crooked Timber position, at least among some of them)

Despite what those involved in this argument might have you believe, these are all coherent theoretical positions. But as each of them have noted of the others at one point or another, they have all been somewhat detached from empirical reality. For example, are workplace regulations trying to correct a market externality? This question has been danced around but not really answered. For positions #1-3 the answer to this matters quite a lot. For position #4 not so much. Nor do any of them really get at the implications of power, although the CTers have come closest. Power matters quite a lot for #4 and somewhat for #2, but not at all for #1 and only a bit (and in different ways) for #3. 


There is a lot more to be said on these points, but this is long enough so I'll have to save it for another post. 

*This doesn't actually deal with the pollution problem of course.

**I'm not actually sure about this. I believe they have some model(s) in mind -- they must -- but they haven't clearly articulated what it is. In response to a Twitter query, Henry Farrell listed as some influences Jack Knight (a Tar Heel), Sam Bowles, and "no-bullshit Marxism which happens to work". Fair enough, although I'd prefer a clearer exposition on what that looks like in reference to this discussion. Chris Bertram, one of Farrell's co-bloggers at CT, has previously espoused (at least elements of) bullshit Marxism which does not happen to work, so perhaps that's his model. I imagine the left are coming at this from a variety of perspectives, which is fine.

***At least they think they do. In some cases I think they believe these assumptions are more severe than they actually are, so they're really rejecting a straw man. E.g., Farrell's repeated reference to "perfect competition", but labor models have moved well beyond perfect competition without markedly changing many of the relevant results. (Both Alex Tabarrok and Tyler Cowen have noted this, too, I believe.) Anyway, at least some of the left's interlocutors seems to be working from the even simpler, and even more unrealistic, model of monopsony. This obviously requires major assumptions too. At times the way they describe labor markets is in quasi-feudal terms; I doubt even Marx would have truck with that.

Redistributive Cooperation, Redux

News regarding global banking regulations:

Bankers and lawyers said the proposals, if approved, would push up capital requirments and could making buying and selling assets – as opposed to holding them to maturity – far less profitable.  

The proposal is expected to hit institutions with large trading desks, such as Barclays, Goldman Sachs and Deutsche Bank, particularly hard.  

Higher capital requirements could also make it harder for some European banks to gain any advantage over their US rivals when they have to stop trading with their own capital under the US Volcker rule.

This should come as no surprise to those who have followed the academic literature on global banking regulations. It's basically following the playbook of an old article by Oatley & Nabors:

1. Financial distress in the U.S. leads to domestic calls for re-regulation.  

2. Some of these regulations would put U.S. firms at a competitive disadvantage vis-a-vis their international competitors. 

3. These regulations get extended into the international arena to shift some of the costs from American firms to their foreign competitors. The U.S. is able to do this because of their relative power within the global financial system.

It's nice when academic research actually helps us understand the world. Timely too, because Dani Rodrik wrote an op-ed arguing that this type of theorizing isn't any good:

The most widely held theory of politics is also the simplest: the powerful get what they want. Financial regulation is driven by the interests of banks, health policy by the interests of insurance companies, and tax policy by the interests of the rich. ...

It’s the same globally. Foreign policy is determined, it is said, first and foremost by national interests – not affinities with other nations or concern for the global community. International agreements are impossible unless they are aligned with the interests of the United States and, increasingly, other rising major powers. ...

Yet this explanation is far from complete, and often misleading. Interests are not fixed or predetermined. They are themselves shaped by ideas – beliefs about who we are, what we are trying to achieve, and how the world works. Our perceptions of self-interest are always filtered through the lens of ideas.

Sure. But sometimes the simple logic works pretty damn well.

(Note that this applies to the post just below this one as well.)

Shout It From The Rooftops

Phil Arena says that we need to take political economy seriously (bold added):

What does concern me, though, is the cult of democracy worship that pervades IR (and much of political science, though IR scholars seem to be the worst about this). And this has come to rest heavily, in recent years, on the claim that democratic leaders have an incentive to provide public goods while leaders of other regimes do not. Unfortunately, the evidence that this is the case comes almost entirely from statistical analysis of data that is non-randomly missing and pertains to goods that are not public goods (see this paper for more details). The difference is important if you want to make claims about democracy working for everyone, not just the winners of the political process. There's good evidence that it does not (see here, or of course, virtually all of the public choice literature, which I truly wish more IR people would read -- a great primer for which can be found here).

Amen. Even true public goods have to be paid for by somebody; politics is about who pays for them, and who enjoys them. But the bigger point is that what many think of as public goods (e.g. roads, schools, health care) are definitionally not. It seems like many people confuse public goods with egalitarianism, but they are not at all the same. Many in IPE make the same mistake.

My impression that comparative politics may have some of the same democracy-worship proclivities as IR, for the same (misguided) reasons. Selectorate theory is, after all, a comparative theory before it's an IR theory. This type of question doesn't seem to be high on the American politics research agenda either.

All politics is about distribution. Whatever it's other faults, at least Acemoglu and Robinson get that part right.

The Effect of Lobbying

UNC poli-sci professor Frank Baumgartner had his research on lobbying featured in Miller-McCune (then NYTimes, then Monkey Cage):

The real outcome of most lobbying — in fact, its greatest success — is the achievement of nothing, the maintenance of the status quo. “Sixty percent of the time, nothing happens,” says Frank Baumgartner, one author of the book and a political science professor at the University of North Carolina at Chapel Hill. “What we see is gridlock and successful stalemating of proposals, with occasional breakthroughs. We see a pattern of no change, no change and no change — and then some huge reform.”

But those large reforms — such as health care for 32 million uninsured Americans under President Barack Obama, the scheduled phase-out of the estate tax under President George W. Bush, and the normalization of trade relations with China under President Bill Clinton — are far more often linked to a change in who inhabits the White House than to campaign contributions or K Street hires.

The weak link between money and policy change is counterintuitive but understandable, the authors say. The balance of power in Washington already hugely favors the rich. The status quo reflects the considerable advantages the wealthy have managed to secure in the law, down through the generations.

“If they really wanted something, they probably already have it,” Baumgartner says.

Lee Drutman has a somewhat different interpretation:

But, to me, 40 percent is actually an astonishing success rate.

Sure, this may not look like much if your starting assumption is that special interests own Washington, and that all a clever lobbyist needs to do is approach a Congressman with the promise of a campaign check and that poor helpless Congressman will practically be begging to fete that lobbyist with most indefensible corporate giveaway.

But, on the other hand, if you’ve spent any time in Washington, and you know how hard it is to get just about anything done, 40 percent is definite batting champion territory.

And the big point of the study is actually about the difficulty of change: the status quo is really, really sticky in Washington, in good part because on most important issues there are forces mobilized on both sides, and every action on one side provokes an equal but opposite reaction on the other side. Forces fight each other to stalemate for years. But then then, suddenly, there is movement – and whoever has won the war of positioning is likely to win the war of motion.

But the problem is that nobody – not even the cleverest of lobbyists – really knows which ideas and issues are likely to break and when.

The two views are not mutually-exclusive.

What Do Americans Want?

Will Wilkinson argues that Americans don't value the type of government spending that we get:

My sense is that, despite the U.S.’s historically relatively modest level of government spending, the composition of U.S. spending is such that U.S. taxpayers get less of value in return for their tax dollars than do taxpayers in many places with higher taxes and higher levels of government spending. Which is to say that when using GDP per capita as a proxy for welfare, the U.S. comes off better than it should relative to, say, Canada or Sweden. ...

The U.S. is an notable anomaly in the happiness data. Average self-reported life satisfaction rose with GDP per capita over the last several decades in almost all wealthy liberal democracies, but not so much in the U.S. The idea that the unusual composition of U.S. government spending gives Americans unusually poor value for their tax dollars might help explain this.

I think this is exactly wrong. Americans constantly complain about nebulous government waste, true, but they complain even more loudly whenever anyone proposes cutting anything. Wilkinson cites military spending, airport security, and education as examples of wasteful spending that make Americans unhappy. Does he think that a politician could be elected running on a platform of decreasing American military spending, cutting education, and slashing airport security? Of course not. If Americans truly didn't value those things, then this should not be so.

How this compares cross-nationally I don't know. I don't think it's implausible that different polities demand different types of government spending from their governments, but that to me that backs up my point: in democracies, the level of and composition of public expenditure is roughly what the media voter prefers. Is there any reason to expect the median voter in Canada to demand the same things as the median voter in America? Is there any reason to expect the median voter in America to be happier if the US government changed its budget to reflect Canadian preferences? Why does Wilkinson think that the French get what they want out of government spending but that Americans do not? What sort of model of politics is he using? These are not things that Wilkinson wants, of course, but his very next post is about how democracy means never getting everything you want.

I think a better explanation is that Americans do value security, military predominance, and public education very highly, and the reason why self-reported happiness is lower is because the country has had a very rough decade pretty much across the board. Terrorist attacks, two wars, a lost decade economically, increasing income inequality, rapidly deteriorating public and private finances... the naughties were hard on America, especially after the post-Cold War euphoria and economic boom of the 1990s.

Who Wants to Elect a President?

The other day I drank a few glasses of red wine and worried about time inconsistency problems inherent in democracies. Today, Jamie Whyte (guest-blogging at Steven Landsburg's digs) suggests replacing democracy with a "jury system" of appointing leaders. The thought's not without merit, but it immediately made me think of a lesser (i.e. one that isn't centered around baseball or golf) Kevin Costner movie. That's not good.

A few years ago Marginal Revolution proposed electing presidents via reality show. Could it really be any worse?

Inconsistent Thoughts on Time-Inconsistency Problems

Since the financial crisis, many have argued that we need to restructure the incentives that bankers face by extending their time horizons. See, e.g., this post by Brad DeLong. In its best manifestation it's not a principle-agent argument, but rather the opposite: shareholders incentivize management to maximize short run profit at the expense of long run stability. Bankers respond to those incentives by maximizing short run profit, sacrificing long run stability in the process if necessary, and reap large rewards for doing so. All fine and good, except this creates systemic risk, which is a negative social externality. If taxpayers are going to give the banking sector an implicit explicit bailout guarantee, then we should be able to legislate the way that banks behave -- including how bankers are compensated -- in order to bring private interests in the banking sector more in line with the public interests of society to not have to pay for their mistakes. This, in effect, means limiting the input of shareholders and management.

The wisdom of this is not apparent to me, since the "public interest" in the run up to the recent crisis seemed to be extending credit to everyone everywhere, which is why policy and practice shifted in that direction, but right now I'm more interested in extending the logic to other contexts to see where it leads. Let's assume that the public is purely interested in maximizing long run stability over short run profits. Is this a laudable goal?

The same logic could be used to argue against democracy. Democratic leaders also must balance short run incentives against long run interests. After all, if a politician loses an election it doesn't matter what her long run policy preferences are, since she won't be in office to enact them. Political scientists don't agree about much, especially across subfields, but I imagine that we could get a large majority to agree that politicians privilege short run constraints over long run outcomes, especially in democracies. So we often see spikes in government spending before elections, even if this causes fiscal problems in the longer run. Greece We often see leaders fail to slash inflation near elections, despite the adverse consequences of inflation on long run economic health, because the resulting economic decline will hurt their re-election chances. Episodes of trade protectionism often follow a similar logic, where long run inefficiencies are entrenched because of short run political incentives. I know that Dr. Oatley is developing an argument along these lines with regards to American macroeconomic policy; he can elaborate if he likes.

Yet I rarely hear calls to limit or abandon democracy. True, we often pay lip-service to checks and balances, but generally not for the reasons I've described. (And even that is subject to preference; witness the "Abolish the Senate" movement.) This begs a question: Why would we demand something of the private sector that we wouldn't even consider for the public sector? Is there an implicit positive model of politics that explains the separation? Or a normative model of justice? I'm having difficulty seeing it. To me it looks more like cognitive dissonance.

Some have called for CEO compensation to be dependent on the performance of a firm over the medium run. Suppose we did the same with laws? Any significant change in policy must first be subject to a 5-10 year review process. If it hasn't been revoked in that period, then it becomes law. Obviously we'd have to exempt some policy areas, like natural security, from such a long lag. But the debate over energy policy or health care policy would look a lot different if lawmakers weren't subject to immediate pressures that track the election cycle.

This is probably a really bad idea, and I'm not actually endorsing it. (For evidence of how bad it is, here's Thomas Friedman endorsing its logical extreme: technocratic authoritarianism.) But I am thinking about it. After all, we try to depoliticize some aspects of social management, like monetary policy, for precisely this reason.

The point is to think more seriously about why we want to shift incentives along time horizons in some situations but not others. What is the justification for treating some issue areas differently from others?

True Words

What the matrix says is that if you look at today's American politics, you have to either support central planning or support a political party that hates intellectuals. If you are an intellectual who believes in decentralized markets, it's not an appealing choice.

That is Arnold Kling, describing why his two new books are important. By "central planning" Kling does not mean the Politburo (at least I don't think that's what he means), but rather a too-strong faith in the ability of technocrats.

Over Thanksgiving, I had a conversation on this topic with a family member who has also worked for the Republican Party. I described to him why the McCain/Palin ticket was so abhorrent to me that I ended up voting for Obama/Biden despite much trepidation. What I said was that while I disagreed with Obama on a great many issues, and hoped he was lying about others, at least he was surrounding himself with very smart people who could give him good advice. People like Goolsbee, Furman, Cutler, the Romers, Summers, Thaler, Blinder, Galbraith, Tyson, and Volcker. I don't agree with all of these people on everything, but I do think that they approach economic analysis honestly and with real care. If Obama took these people seriously, I thought, the economy would be in pretty good hands.

McCain, on the other hand, surrounded himself with ideologues with little or no formal training in economics (and was forthright about his own lack of understanding). People like Gramm, Hassett, Fiorina, and Luskin. The only actual economists that McCain consulted were Holtz-Eaken and Laffer. The former embarrassed himself in the campaign while the latter's views have been routinely distorted by McCain and the rest of the GOP. By the end of the campaign, McCain was mostly relying on Joe the freaking Plumber for his supply of economic policy platitudes.

In other words, to me the choice was between sensible, smart people who had some views that were somewhat different from mine and dangerous ideologues who had proven themselves wrong about nearly everything over the past 10-20 years. My vote went to the group I thought would be better technocrats, and nothing McCain or Palin have said or done since then has made me regret it, despite the fact that I have not been especially happy with all of Obama's decisions.

That said, I'm not actually sure that Kling has his matrix exactly right. Despite a lot of talk about the virtues of decentralized markets, the recent record of the GOP shows a strong pattern of susceptibility to corporate and other lobbyists. This is certainly true of Palin (Kling's example of an anti-intellectual supporter of decentralized markets), and not how a true believer in the virtues of decentralized markets would legislate. To be sure, Democrats are also successfully lobbied by interest groups. Since the political scientist in me expects lobbying to always be somewhat successful no matter which party is in control, the choice (in this case) was simply between the intellectuals and the anti-intellectuals, and that's not much of a choice at all.

Until the GOP can fill in the bottom-right blank in Kling's matrix, they'll have a difficult time winning votes from people like me, and I suspect there are a lot of us.

(ht: MR)

Incentives Matter

President Lula da Silva doesn't understand public choice theory. He also can't outsmart a cheeky Newsweek reporter:

Newsweek: You often criticize the privatization process. But thanks to the sale of state companies even the poorest Brazilians have cell phones, and former public companies like Vale have become world-beaters under private ownership.

Lula: But the state could have done the same things.

Newsweek: Except that it didn't.

Lula: It didn't because the Brazilian elite used public companies for their own ends. When you do that, any company will go broke, anywhere in the world.

Er, yep.

Via KPC, who also quote Lula's views on the state of Venezuelan democracy.