Maxine Udall (girl economist)

Penny-Wise, Pound-Foolish

Brad Delong, Mark Thoma,  and Paul Krugman on President Obama's most recent serial surrender to begger-thy-country hawks.

Here's Bernard Mandeville's commentary on his Fable of the Bees (which provided an allegorical account of how the side effects of private "vices" (read "consumption" or "aggregate demand") are a public good) courtesy of JM Keynes (General Theory, Chapter 23, VII)

As this prudent economy, which some people call Saving, is in private families the most certain method to increase an estate, so some imagine that, whether a country be barren or fruitful, the same method if generally pursued (which they think practicable) will have the same effect upon a whole nation, and that, for example, the English might be much richer than they are, if they would be as frugal as some of their neighbours. This, I think, is an error.

...

The great art to make a nation happy, and what we call flourishing, consists in giving everybody an opportunity of being employed; which to compass, let a Government’s first care be to promote as great a variety of Manufactures, Arts and Handicrafts as human wit can invent; and the second to encourage Agriculture and Fishery in all their branches, that the whole Earth may be forced to exert itself as well as Man. It is from this Policy and not from the trifling regulations of Lavishness and Frugality that the greatness and felicity of Nations must be expected; for let the value of Gold and Silver rise or fall, the enjoyment of all Societies will ever depend upon the Fruits of the Earth and the Labour of the People; both which joined together are a more certain, a more inexhaustible and a more real Treasure than the Gold of Brazil or the Silver of Potosi.

And here's Keynes comment:

No wonder that such wicked sentiments called down the opprobrium of two centuries of moralists and economists who felt much more virtuous in possession of their austere doctrine that no sound remedy was discoverable except in the utmost of thrift and economy both by the individual and by the state. Petty’s “entertainments, magnificent shews, triumphal arches, etc.” gave place to the penny-wisdom of Gladstonian finance and to a state system which “could not afford” hospitals, open spaces, noble buildings, even the preservation of its ancient monuments, far less the splendours of music and the drama, all of which were consigned to the private charity or magnanimity of improvident individuals.

Apparently we are doomed to repeat history, except this time the Wall Street "knaves" get to shop and party while the rest of us get to be prudent, austere and (presumably) moral all the way to the soup kitchen. I'm sure they'll figure out a way for us to pick up their tab when they run the economy into the ditch again, too.

And you thought economics wasn't a morality play....

Bipartisan?

Simon Johnson on Elizabeth Warren:

Don’t play the Republicans’ game by agreeing to debate “big” vs. “small” government.  This is a complete illusion – just watch the favors that businesses will seek from Republicans on the Hill; not all of these appear “on the government’s balance sheet”, to be sure, but you can talk to the anguished people of Ireland about how exactly supposedly ”pro-business” (and definitely pro-big bank) policies end up costing the taxpayer a lot of money.  (Or just look at how the financial disaster of 2008-09 ended up costing us 40 percentage points of GDP, measured in terms of the increase in our national debt – directly because of how the financial sector ran its customers and itself into the ground.)

The political debate should begin with documenting business practices that are misleading and duplicitous, wherever they occur.

We need transparency and accountability in the financial sector – and in all other parts of our economy.  Elizabeth Warren is exactly the right person to lead this charge, in the first instance from the CFPB.

She should be nominated by President Obama to head the agency.  The fight for her confirmation would make her ideas clear to millions.  Let’s see which senators exactly are willing to argue against greater transparency.

Maxine here: I have no confidence that the Obama administration will effectively leverage Warren's obvious good sense and broad appeal to advance a pro-middle class, pro-Main Street agenda that is entirely consistent with strengthening markets, making them more competitive and boosting consumer sovereignty and confidence. If the past is any indicator of the future, BHO is already trying to figure out what shill the R's will regard as acceptable to head the CFPB.

I do not think "bipartisan" means what Obama thinks it means.

Please read Johnson's full post, it is really excellent.

Hat tip rjs

The Stability of Extremes

I take some comfort in learning that Brad DeLong and Paul Krugman appear to be as baffled as I by the traction that right-wing political and economic ideology seems to achieve, even with those who will be hurt most by it. I also find it reassuring that both men, who have sufficient standing within the discipline to critique it credibly, are willing to critique some of our brethren who have forgotten (or never learned) the economic lessons of the 1930s and 1940s. Admittedly, it's a cold comfort, but a comfort nonetheless.

I want to offer some thoughts about why extreme macroeconomic policy may trump moderate policy. They should be viewed as supplements to Krugman, rather than disagreements with him. Here's Krugman:

The brand of economics I use in my daily work – the brand that I still consider by far the most reasonable approach out there – was largely established by Paul Samuelson back in 1948, when he published the first edition of his classic textbook. It’s an approach that combines the grand tradition of microeconomics, with its emphasis on how the invisible hand leads to generally desirable outcomes, with Keynesian macroeconomics, which emphasizes the way the economy can develop magneto trouble, requiring policy intervention. In the Samuelsonian synthesis, one must count on the government to ensure more or less full employment; only once that can be taken as given do the usual virtues of free markets come to the fore.

It’s a deeply reasonable approach – but it’s also intellectually unstable. For it requires some strategic inconsistency in how you think about the economy. When you’re doing micro, you assume rational individuals and rapidly clearing markets; when you’re doing macro, frictions and ad hoc behavioral assumptions are essential.

In my opinion, the intellectual instability of the Samuelsonian synthesis runs deeper than "strategic inconsistency." I believe it derives from two aspects of the synthesis. One is Samuelson's propagation of the myth that "the invisible hand leads to generally desirable outcomes" has caused real economic and political harm, yet it continues to shape how many if not most economists and non-economists think about the economy. Gavin Kennedy does a much better and more scholarly job than I could of debunking the generalization of Smith's very specific uses of the term "invisible hand" to cover every possible manifestation of something we imagine are the natural benefits of "rational self-interest." (See also a recent post by Kennedy here.) That the economics profession, at least since Samuelson, has sanctified the myth and elevated it to high orthodoxy has in my opinion provided substantial political and ideological cover for those who benefit from laissez faire financial markets. It almost certainly accounts for pushing "the dividing line between micro and macro" in the direction it was "pushed."

The other aspect of the Samuelsonian synthesis that is problematical, at least to me, is its somewhat ad hoc synthesis of macroeconomics and microeconomics, which some have argued isn't a true synthesis. To me it has always looked like an uneasy attempt to reconcile a near-Utopian view of micro markets (ruled by an imaginary all-powerful, all-knowing invisible hand) with a more realistic Keynesian view of less than perfect macro markets. As noted above, it is perhaps no surprise that the tendency outside of the Fed "monasteries" has been to gravitate to micro principles and beliefs that appear to support laissez faire in macro policies, particularly those that affect finance. That the monasteries have a better anchor to reality is also not surprising, but as Krugman notes their "voice" in academic publications (and in promotion and tenure policies I would wager) has been systematically muted.

I also want to suggest another possible source of political instability for moderate macroeconomic policy that I think Krugman misses. It relates to the disconnect between economists' and non-economist voters' perceptions of the merits and effects of macroeconomic policy.

Let me give you an example from a protracted period of stagflation in the US during the 1970's. During the early stages of stagflation, a variety of government interventions aimed at countering a wicked combination of high inflation and high unemployment appeared to be ineffective. This weakened consumer and voter confidence in the government's ability to intervene effectively and produce beneficial macroeconomic outcomes.

I write that last sentence from the perspective of my business men and women relatives and the outrage they felt when wage and price controls were imposed by a Republican president (no less). The point here is that everyone, even non-economists, noticed the wage and price controls and how perfectly unpleasant and ineffective they were. And in the unlikely event that someone wasn't paying attention, the OPEC oil embargo in combination with gasoline price controls and very long lines at gas stations focused attention. Then, after nearly a decade of rapidly eroding purchasing power and high unemployment, interest rates soared as Paul Volcker effectively applied the brakes to inflation by raising interest rates in the early 1980s.

What the average non-economist noticed during the remedial period was the very high credit card and mortgage interest  payments they were making. Had they been economists, they might have rationalized this by noting that housing and other prices were stabilizing. Not being economists, they imagined that if only interest rates were lower and they could still pay the same, now stabilized price for their house, they would be better off. Instead, the "government," by raising interest rates, seemed to be making the banks and mortgage companies better off at the home purchaser's expense. They certainly did not notice, at least not right away, that the economy was slowly being restored to something that in the long run would have been better for them and for their grandchildren had we only been able to sustain it.

Let me emphasize. I'm not telling this story as an economist, I'm telling it from the eyes of members of my family and friends who bought homes or waited in gas lines. Many came out of it convinced, convinced, that the guvmint is always and everywhere the problem. (Most of the businessmen in my family had already concluded this based on the 2 years post-WW II when continuing wage and price controls by the Office of Price Administration forced their suppliers to stop or slow production, while my family members were forced to scour the countryside looking for manufacturers who would supply goods for cash under the counter so my family could stay in business.)

I'm going to suggest that even though many who espouse anti-government ideas may not have directly experienced the 1970s, that period provided the political right with a "teachable moment." Everyone was paying attention, most were noticing that the government seemed to be creating more problems than it was solving, and many became open to the idea that guvmint is the problem. It established an intellectual beachhead from which foot soldiers could advance and reinforce the idea that a democratically elected government constituted in such a way as to protect the people from its own predations and power was in fact the enemy and incompetent to boot.

Now combine carefully fostered distrust of the government, the only thing that might reasonably be expected to stand between us and the private interests of concentrated, unfettered wealth and power, with the myth of an all-wise, all-knowing, beneficent invisible hand embedded in a Utopian free market. Then propagate the myth by a discipline that trains its young: to assume rather uncritically fully-informed, unchanging over time, prudent, industrious, self-interested preferences and behavior; to downplay the "friction" of transaction costs and information asymmetries; to assume that many externalities are or soon will be internalized; that labor and goods markets clear rapidly; that capital is more putty than clay; and until recently that financial markets were both rational and efficient. That many of these same so-trained youth sought employment in the highly lucrative financial sector can only have contributed to the intellectual and political disconnect between Wall Street and Main Street and the dark age of macroeconomics to which Krugman alludes.

It most likely also explains the young assistant professor in economics at a top ten US university who opined at lunch a few weeks ago that "the thing I like most about economics is that there is no truth."

Unfortunately, there are some truths. One is that whatever equilibrium we move to next, we can't go back in time to the fairer income distribution and employment rates and economic growth we had in the 1950's and 60's. We can only go forward with the human, physical and financial capital that we have now. If any of these need to change in order for us to go forward, then we need to tinker with or replace the defective "magneto" now. That's why how we go forward is so important to get right. Our choices will determine whether eventually we restore a fairer distribution of higher output or create a highly unequal and unproductive society that rewards only a few.

We have broken the economy at least twice in the last 100 years and in pretty much the same way both times. And with pretty much the same rhetoric both as we were breaking it and as we were and are attempting to repair it. Yet, as DeLong puts it

Still, here we are. The working classes can vote, economists understand and publicly discuss nominal income determination, and no influential group stands to benefit from a deeper and more prolonged depression. But the monetarist-Keynesian post-WWII near-consensus, which played such a huge part in making the 60 years from 1945-2005 the most successful period for the global economy ever, may unravel nonetheless.

I share DeLong's bewilderment. I would suggest several steps that might remedy this. First, at a minimum economists had better learn to speak and write in parables so that the working classes can understand macroeconomic policy as readily as they understand gas station lines and and as well as they misunderstand payroll taxes, marginal tax rates, and estate taxes. Second, it would help if we could agree on what the message (in 25 (OK, maybe 50) word soundbites) should be.

Finally, it might help if we all acknowledged that moderate and extreme macro polices will almost certainly lead to different macro equilibria and that while both may be efficient, it doesn't necessarily make them both good. Unfortunately, deciding which one is "good" would depend on a normative judgement, which we as a profession have tended to eschew.

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Update: Brad DeLong's longer talk here is a must read. The disturbing conversations with the tea partiers fit with my own anecdotal experience regarding working and business class attitudes towards both macroeconomic policies and the "morality play" that underlies how many non-economists that I know think about the economy.

I'm Thankful for Elizabeth Warren

Huffington Post tells us that

Elizabeth Warren was the first senior Obama administration official to recognize the potentially incendiary impact of a bill that would have made it significantly easier for mortgage companies to foreclose on homes, and her subsequent warnings played a crucial role in persuading the President to veto the measure, according to freshly released documents and people familiar with the deliberations.

The disclosure that Warren was instrumental in halting a bill that would have streamlined the foreclosure process comes as she confronts fierce criticism from Republicans on Capitol Hill for the way she was appointed to construct a new consumer financial protection bureau, and characterizations that she is inclined to take an overly punitive tack with Wall Street.

Overly punitive? Overly punitive???? Overly punitive the way your parents were "overly punitive" when they took away the car keys after you drove drunk and into a ditch? Or "overly punitive" as in treating them like adults and forcing them to play by the rules of the game? Or "overly punitive" as in demanding the same "personal accountability" that is so frequently and lovingly inflicted on the poor and uninsured in hope of helping them to see and mend the error of their allegedly myopic ways?

As I contemplate all that I have to be thankful for on this 2010 Thanksgiving Day, President Obama's appointment of Elizabeth Warren to roles in which she has acted as advocate for those of us that the law and regulation should protect is very near the top of the list. Elizabeth Warren, herself, is even higher on that list. Please join me as I try to fill my heart with gratitude for small glimmers of light.

Happy Thanksgiving!

hat tip, rjs.

There They Go Again

Linda Beale at ataxingmatter notes and demolishes the amazing and imaginary confluence of thought as advanced by a possibly-only-suitable-for-fish-wrap major newspaper on how to reduce the deficit and plunge the US middle class back into indentured servitude at the same time. Beale says it better and more comprehensively than I can.

Obama doesn't seem willing to fight any fight.  He quits before he starts, disgusting liberals who understand that a democracy cannot survive based on the kind of "free market capitalism" espoused by the oligarchs who benefit from it.  So there is already talk of extending the Bush tax cuts for the wealthy, which have nothing at all to do with jobs, entrepreneurship, innovation, or growth of the US economy and everything imaginable to do with elitism, power, and hording of productivity gains for the G.W. Bush fan club of have-mores.

So it is perhaps not so surprising that the WaPo is already declaring that a "consensus is forming on what steps to take in cutting the deficit."  Story by Lori Montgomery, WaPo, Nov. 22, 2010.   Ms. Montgomery takes the pundits and neo-con/neo-lib descriptions as god's truth as she describes "a surprising consensus" around "the sacrifices necessary to achieve those goals [of less debt and smaller government]" being "Big cuts at the Pentagon. Higher taxes, including those on home ownership and health care. Smaller Social Security checks and higher Medicare premiums."  Once again, the neo-con faction has used its corporate-owned media to hone its message that there is no choice (false note of sadness) but to cut those deficit-causing "entitlements" like Social Security and Medicare.

Please read all of Beale's post. She provides a comprehensive and true analysis of the issues and an invaluable list of the Bowles-Simpson Committee members' a priori tax and economic predilections that resulted in (surprise!) recommendations to gut the middle class and the elderly.

hat tip, rjs.

Beggar-Thy-Country Hawks

Paul Krugman on the rational and disturbing aims of irrationally exuberant GOP deficit hawks:

So here’s what the very serious Mr. Simpson said on Friday: “I can’t wait for the blood bath in April. ... When debt limit time comes, they’re going to look around and say, ‘What in the hell do we do now? We’ve got guys who will not approve the debt limit extension unless we give ’em a piece of meat, real meat,’ ” meaning spending cuts. “And boy, the blood bath will be extraordinary,” he continued.

....

The fact is that one of our two great political parties has made it clear that it has no interest in making America governable, unless it’s doing the governing. And that party now controls one house of Congress, which means that the country will not, in fact, be governable without that party’s cooperation — cooperation that won’t be forthcoming.

An insightful post by Peter Dorman on the political economy of inflation hawks that suggests that people hold ideas in their intellectual portfolios for many reasons, some of which may derive from history, context, and experience, and that may or may not reflect proximate or even long-term economic self-interest:

To put it simply: the ideology of hard money, as opposed to the immediate interests it generates, is not calibrated to the direct costs and benefits of economic policies. It reflects instead an intellectual orientation that is reinforced by the experiences and interests of the wealth-holding class as they have accumulated over time and can sometime lead to policies that may harm their portfolios in the short run, as opposition to the current round of quantitative easing may do. The natural selection of beliefs, like that of species, operates in the context of structural factors—the interrelationship between concepts/traits—and does not necessarily optimize over each individual element.

Yes, absolutely.

But how to account for the middle class's "intellectual orientation" as apparently revealed in the last national election when it comes to taxing the wealth-holding class?

Here's wealth-holding Warren Buffet:

"I think that people at the high end, people like myself, should be paying a lot more in taxes. We have it better than we've ever had it," he told ABC's Christiane Amanpour in a clip played on "This Week" on Sunday.

When Amanpour pointed to critics' claims that the very wealthy need tax cuts to spur business and capitalism, Buffett replied, "The rich are always going to say that, you know, 'Just give us more money, and we'll go out and spend more, and then it will all trickle down to the rest of you.' But that has not worked the last 10 years, and I hope the American public is catching on."

I hope so, too.

And from ABC News:

The White House announced on Wednesday that President Obama will award Buffett a Presidential Medal of Freedom, the nation's highest civilian honor, early next year.

Instead of giving Buffet a medal (or in addition to giving Buffet a medal), let's act like we've "caught on" to the intellectual and economic wasteland that is trickle-down economics and take his advice, for heaven's sake. Allow the top marginal tax rate to revert to it's previous (still low compared to other developed countries) pre-Bush level for those making more than $250,000 per year, retain the Bush tax cuts for anyone making less than that. It would stimulate aggregate demand and reduce the deficit. Not only that, it seems to be what most American's want (despite the results of the recent election). A political and economic win-win no-brainer, yes?

Too bad Krugman is right (as usual).

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Addendum: See also this most excellent post by Nancy Folbre on Deficit Hawks, Tax Chickens. It raises some of the who-is-harmed, who-benefits questions that should be part of any economic or political strategy discussion and highlights ways in which voters may be uninformed about harms and benefits of tax and other economic policies in ways that hinder making sound political judgments.

Plotting Public Policy Strategy without Economics?

In my last blog, I suggested that technical solutions to economic problems compete, not just on technical grounds, but on moral grounds. For this reason, economists must learn, if not to make the moral case for technical approaches, to at least understand and communicate the moral ramifications of those approaches.

The traditional view shared by many if not most economists was offered by Edward Glaeser in a recent blog. On that view, competition among public policy strategies is resolved, not by economists weighing technical considerations, but in the political sphere. Glaeser observes that

...the solutions to the budget problem won’t come from the technical expertise of economists but from moral and strategic decisions made by voters and their elected representatives...

...Economists are experts on tactics, not strategy — and the great budget challenge generally requires strategic choices, not tactical ones.

Economics is meant to teach how to think through the wide-ranging consequences of any public policy. If you raise the estate tax, what will happen? Will this deter people from saving money while they are alive? Or will, instead, people save more to keep their heirs whole? If heirs expect to receive less, will this cause them to work harder or marry later? This type of thinking is a crucial part of the budgetary process, but it doesn’t tell us where to cut.

Economics is also meant to help us find ways to reduce inefficiency and make everyone better off.

Yes. And he might have added this question: does forcing heirs of illiquid businesses to sell assets, such as land or physical plant and equipment, to pay estate taxes place the assets back into an asset pool where they can be purchased and used by others more productively, thereby enabling the "creative destruction" that some regard as an important characteristic of capitalist efficiency that benefits us all?

 Glaeser goes on to profess normative ignorance:

How would an economist know whether it is wiser to cut military spending or raise taxes? Our armed forces play an important role in the world, but are they worth the cost? Like many economists, I’m frustrated that foreign affairs experts haven’t convincingly monetized the benefits of wars or military spending. But I can’t do it for them.

Is it better to increase the Medicare eligibility age to 70 or raise taxes? This trade-off is fundamentally a social, moral and political question. Economics can’t tell us if it is better to make life harder for 69-year-olds or harder for the rest of us. Society as a whole needs to make tough choices about whether to raise taxes or to say no to the health-care desires of the elderly.

Hard questions. Especially as stated. I mean, suppose we raise the Medicare eligibility age to 70 instead of raising taxes. Does this really amount to a choice between making life harder for those 65-69 or making life harder for the rest of us? Well, yes, life will only be hard for those 65-69 as long as you can be sure that your parents and grandparents won't become seriously ill between those ages. Of course, if you get real unlucky, and some of us will, someone in your family may have to quit working to care for mom or dad. I'm thinking you'll probably feel some obligation to pay for some of their care or at least move them in with you. Now whose life is harder? You think it will affect your kid's education if you have to divert $100,000 of your savings to pay for your 67 year-old dad's new heart valve? You haven't saved that much? Too bad for dad.

How could we expect someone who is not trained in economics to be able to judge these things? We certainly wouldn't want only economists deciding these things, but it's equally frightening to think of "society as a whole" making these decisions without understanding some economics. Surely that's not what Glaeser meant, yet he says

A budget reflects two things: broad national priorities and the mechanics that deliver on those priorities. Broad national priorities include the decision to spend on armies or health care or education, and the decision about whether to more heavily tax the rich or the middle class. These choices reflect politics and philosophy more than the economics. Only when those choices are made does economics weigh in.[Emphasis added]

Really? Just politics and philosophy? Guns and butter is politics and philosophy, not economics? OK, I'll drop that lesson from Econ 101. What else do economists know that might be useful to the public in formulating public policy? Economists know that labor force participation and wage rates are affected by caregiver duties and obligations, but let's let "society" decide whether to raise taxes or raise the Medicare eligibility age while pretending that the latter won't also affect incentives to work, to invest in human capital, and to produce (not to mention the likely effects on any bequest one had been hoping to make that has now been spent on grandpa's heart bypass).

I daresay that if the political process in the United States resulted in a near universal demand that incomes be equalized, "economics" might bestir itself to "weigh in" with some normative judgements about the wisdom of that decision. At least I hope we would. Right now, however, it appears that voters and taxpayers have a preference for a highly unequal income distribution that favors a very few of the total population. Should economists weigh in on that as we would if the political trend became strictly  egalitarian? Is it efficient to have wealth and power concentrated in the hands of a few? Will "everyone" be "better off" if it persists? If we're in a second best world, will a strategy derived from first-best theory yield an improvement or a decay in total well-being? Might "society" prefer a little inefficiency in exchange for a more level playing field and more opportunities?

What about our assets as a country? Are they all captured by GDP? How should we invest resources to increase output and well-being over time? Can that be left entirely to the private sector when the private sector appears to have mastered the ability to kill the Coase fairy by distorting information about the externalities of production, whether it be tobacco smoke, global warming, under-water mortgages, or the marginal benefit of high-cost me-too drugs and by commandeering the political process that would otherwise reduce the transaction costs of a solution? How will "society" make wise decisions when many of us in the discipline continue to assert, despite real and recent evidence to the contrary, that the private sector is always and everywhere more efficient that government? What private incentives and objectives will result in attaining a societal objective of improved population health? Not the ones we currently have (or are about to revert to) that inordinately reward high-tech curative care and more of it rather than prevention.

And finally, how can we hope that those at the bottom of the economic pyramid will make sound investment decisions, whether with regard to health or to human capital, if "society" doesn't offer them some hope of the two things most likely to yield the return on investment that would justify those investment choices: the expectation of a longer life and a higher wage? If "society" can't offer those up front, then it had best subsidize investments in health and human capital for the poor and disadvantaged, instead of expecting the Horatio Alger fairy to lift them from squalor. Shouldn't we explain this to "society?"

Could we, as economists, at least weigh in (in English, not jargon, not equations, not existence proofs) and provide those of a philosophical and political perspective with a more informed economic perspective on these issues? Something that is more useful than the sound of one neo-classical hand clapping? Here's one of my favorite economists:

It should be the duty of economists to do their best to enlighten the public about the economic aspects of these menacing problems. They are impeded by a theoretical scheme which (with whatever reservations and exceptions) represents the capitalist world as a kibbutz operated in a perfectly enlightened manner to maximize the welfare of all its members.

The "menacing problems" Joan Robinson was referring to in the early 1970's were capitalism's dependence on the arms race and weapons trade for its success, the failure of capitalism to overcome poverty either in capitalist countries or in the developing world, and the growing threats of private sector supply and consumer demand to the environment. Forty years later, the private sector has given us a still possibly too large military-industrial complex, a still deteriorating environment, an outsized corrections-industrial sector, a real-estate bust, a banking system with no fiduciary credibility, and a record high plummet from the middle class into poverty. At least military expenditures and objectives gave us something besides national security, benefits like increased human capital, penicillin, and maybe safer food. It is also worth noting that any resemblance of the United States to "a kibbutz operated in a perfectly enlightened manner to maximize the welfare of all it's members" (I would say rather to maximize total welfare, which almost certainly will not maximize the welfare of each individual) will be pure coincidence and has never been our norm.

Robinson again:

Modern capitalism has no purpose except to keep the show going. To prevent severe unemployment and to keep real wages rising secures the adherence of the workers, growing consumption keeps the public in general complacent, the opportunities for profit encourage industry to expand.

Economists can't just be tacticians. We must have a role in helping voters to understand, formulate, and evaluate alternative strategies. To do that they (and we) must understand and think about all the consequences (moral and economic) of those strategies. They (and we) must think more broadly and more coherently about what are our societal objectives and how we are to balance them against often competing private incentives and objectives, not to mention moral constraints, constraints not only on the ends we seek, but on the means by which we achieve them.

To be fair, many of us do all of this, but we need to do it in ways that reach more people in simple language, not just the readers of blogs. This, in my opinion, is the only way that modern capitalism will evolve in the United States and "keep the show going" in a way that makes "everyone better off."

Technocratic Solutions and Moral Dilemmas

Steve Randy Waldman at Interfluidity has taken to batting at what I regard as the hornet's nest that is the boundary between positive and normative economics. I guess I'll take a few swings, too. Let me start with something that was said a few weeks ago in a gathering of economists:

"Well, if you make a normative judgement then you are not a real economist."

I know what you're thinking (if you're not an economist). You're thinking this is just some outlier economist taking an extreme stance. Or you're thinking, "Gosh darn, when I read Wealth of Nations, it seemed like Adam Smith made the occasional normative judgment. In fact, doesn't the very concept of national wealth seem to embody a normative judgement that it is a Good Thing, else why waste time inquiring into its nature and causes?" Or you're thinking, "Didn't Maynard Keynes occasionally opine normatively on certain aspects of what we now call macroeconomics?" I could go on and on, but you get the idea.

No. Not an outlier, I fear. It was said with conviction by someone whose work I greatly admire and who has a national reputation in his particular corner of economics. It reflects the mainstream of economics as we know it today.

It caused me to reflect.

There is a real beauty in math and the hard science that we have tried to make economics. It stirs me in much the same way that poetry stirs me. At the same time, it satisfies some part of me that really doesn't like to haggle much over solutions to technical problems. The part of me that prefers hard technical problems to soft, squishy human problems. Math has the added advantage that you can often say in 5 equations or a graph or two what would otherwise take you 5 pages to say in words.

I remember the first time I contemplated an Edgeworth box. I took such comfort from it. Me, a child of the merchant class. There it was, this beautiful system where everyone traded to the point where no one could be made better off without making someone worse off, resources were used in the right relative (efficient) proportions to produce the right (efficient) mix and amount of output. It made me happy that I had grown up in the core of this marvelous, poetic construct, scion of the class that reduces friction and makes it work. It seemed to solve all the economic problems that could trouble a generous and benevolent soul.

Or so I thought, young innocent that I was.

After I had lived in the world a bit, questions began to occur to me. What if one person has waaaayyyyy more than the other in our two person, two good, two input world? Under what circumstances might that be fair (or unfair)? What if the person with more of the resources produces children and grandchildren who are, say, lazy, yet over time they retain the resources that could, in the hands of the other person, produce more output? What if the budget constraint that the less advantaged person faces is wholly exogenous in the sense that no amount of industry, frugality, or investment in human capital will yield an outward or upward shift in it because of discrimination by the other person in this little economy? What if the person with more resources is able to control and set prices, thereby relegating the other to permanent resource deprivation? What if the advantaged person obtained his advantage by enslaving or killing the ancestors of the disadvantaged person?

You begin to see why there might be strong preferences to avoid normative questions and their answers, yes?

Fortunately, in grad school I discovered Francis Bator's The Simple Analytics of Welfare Maximization. It helped me to see that that I was not alone in recognizing the beauty of the technical aspects of the problem, nor was I alone in recognizing the ethical limitations of the framework. A few years later, I discovered Amartya Sen, who had this sensible, normative thing to say about Pareto efficiency:

“Being in the core [of the economy], however, is not as such a momentous achievement from the point of view of social welfare. A person who starts off ill-endowed may stay poor and deprived even after the [market] transactions, and if being in the core is all that competition offers, the propertyless person may be forgiven for not regarding this achievement as a ‘big deal.’”

The beauty and underappreciated (by non-economists) strength of economics is that we appreciate, understand, and can offer technocratic solutions to problems that have moral dimensions. Our weakness is that we don't always appreciate that economics is, in fact, a morality play whether we like it or not. My take on Waldman's critique of technocrats was not that he was faulting technocrats for being technocrats or for the technical solutions they were offering. He was making the point that a technically sound solution, no matter how brilliant, is doomed if it doesn't engage voters, taxpayers, lawmakers on moral grounds. (He has posted an follow up here, that I think is consisent with this. If I'm wrong and misrepresenting him, I apologize in advance).

Whether we like it or not, our technical solutions are competing in a morality play scripted by interest groups and mama grizzlies who in 25 words or less conflate small government and something they imagine to be "free markets" with individual liberty, a key justice principle. Most sound techocratic solutions are difficult to convey, must less motivate, in 25 words or less (and the motivation is often moral as well as technical: more for most, more for less, prices as reliable signals of marginal social cost, reducing unemployment, increasing inflation to discourage saving and stimulate spending ... you get the idea). But the larger problem, I think, is that allegedly "amoral" economists view the moral sequelae of sound economic policy, such as banksters' gains (at taxpayer expense), as "side issues" that are irrelevant to restoring the economy, while some of "we the people" view it as one of the most important issues. We end up with....the Tea Party (or, at least, with a large portion of the population who are extremely resentful and angry at being unemployed and underwater while the economy romps upward at least for those whom we bailed out).

Robert Frost once wrote that "something there is that does not love a wall." I think it is also true that something there is that does not love injustice or unfairness. That same "something" is why economics is very much a morality play. We ignore this at our peril. Like Frost's neighbor who could not see the circumstances that rendered a fence unnecessary, I wonder if we in economics aren't sometimes deaf and blind to the changing cirumstances that necessitate recognition that the "fence" we like to imagine between our "amoral" technical solutions and their moral context and sequelae is not only no longer needed, it is harmful in formulating sound policy.

He moves in darkness as it seems to me~
Not of woods only and the shade of trees.
He will not go behind his father's saying,
And he likes having thought of it so well
He says again, "Good fences make good neighbors."

It has been drilled into us from the first day that we set our feet on the path to "economist" that "real economists" do not make normative judgments. The greats who went before us (at least some of them) did not and, so, nor should we. Yet who would be better than we with our technical knowledge to understand and communicate the normative ramifications of it?

This "fence" is not making us good neighbors. Maybe it's time to let the wall between technocratic economics and moral discourse crumble. It seems already to be weakening. I think we would become a better science if we acknowledged at least some of the moral aspects of our technocratic solutions with the same scholarly attention we devote to the technical aspects. An additional unintended benefit of such a change might be that undergrads and non-economists would become more interested in the causes of economic downturns and in reading the Financial Times because we will have helped them to see that both have moral, as well as economic, significance.

Bad (Public) Lenders, Good (Private) Lenders?

Could someone please explain to me why Glaeser's argument for not privatizing Fannie Mae and Freddie Mac could not also be used to justify government ownership (at least temporarily as in bankruptcy) or  strict(er) regulation of private sector mortgage lenders and investment banks?

Here's Glaeser:

If the federal government is going to bail out Fannie and Freddie anyway, the fiscally responsible thing to do is to keep them in government hands.

Why wouldn't the same argument apply to private sector mortgage lenders and investment banks, which we also seem incapable of allowing to fail and that have and are likely to continue to behave just as Glaeser expects Fannie and Freddie to behave if privatized?

...the government can write strict rules that limit their [FM] behavior. They can be forced to charge high fees for guaranteeing mortgages. They can be tightly restricted in the types of mortgages they insure.

If they remain government entities, the leaders of the House can play a large role in designing a structure that won’t cost future taxpayers billions. [MU note: yeah, as long as there's nothing in it for their campaign donors.]

All of that control disappears when the entities become private. They will be able to experiment with new products and cut their fees to expand market share. They will be able to hold billions, or trillions, of dollars in their retained mortgage portfolios. They will be able to go back to exerting enormous political influence.

If an entity is going to be able to gamble with taxpayer dollars, then we are far safer if that entity is a slow-moving government bureaucracy than rather than a nimble, profit-seeking company.

This doesn't read like an endorsement of the private sector or the incentives it generates. Doesn't his argument seem to suggest that current regulatory restraints on private sector lenders and banks are insufficient if our goal is to reduce risk to taxpayers? The other thing about this that disturbs me is that this perspective indirectly propagates debunked myths (and here) about the roles of Fannie and Freddie in the mortgage crisis.

It's funny how government control of lenders is so obviously "good" when they're in the (bad) public sector, but the same behaviors that need to be controlled to save taxpayers become "nimble," "innovative," and "entrepreneurial" when they occur in the (good) private, profit-seeking sector, even though, as far as I can tell, taxpayers are equally at risk (especially if new regs are weakened by the GOP).

I must be missing some nuance.

Faith-Based Economics

I had some spare time yesterday and spent it reading Adam Smith. I was motivated to do this because the phrase "market fundamentalism" has been rattling around in my brain for the last six days. It was prompted by this article by Brad DeLong, Making Religion of Economics, in which DeLong reports on pointless conversations with the "pointless pain caucus"

a group that believes fervently that Americans must be punished with low wages, high unemployment, and reduced government services if the economic outlook is ever to brighten. The rationale for this belief — which requires cutting government spending at a time of consumer retrenchment, ensuring that demand remains low and joblessness high — is akin to those for donning hair shirts on religious holidays: If it hurts it must be good.

After reviewing all the ways in which the PPC's beliefs are refuted by facts, DeLong concludes that

...it is ideological — nay, religious: The Market is good; the Market giveth; the Market taketh away; blessed be the name of the Market. Knowing that the market is good, their task is to figure out why a good market has decreed that employment in America needs to fall by 8 million relative to trend. (It's not unlike grappling with a just and all-powerful God who doesn't mind a tsunami every so often.)

It turns out that Smith sheds some light on pointless pain in his discussion in Wealth of Nations of the effects of religious control of the curricula in European universities on philosophy and philosophical thought prior to and during his time.

Wherein consisted the happiness and perfection of a man, considered not only as an individual, but as the member of a family, of a state, and of the great society of mankind, was the object which the ancient moral philosophy proposed to investigate. In that philosophy the duties of human life were treated as subservient to the happiness and perfection of human life. But when moral, as well as natural philosophy, came to be taught only as subservient to theology, the duties of human life were treated of as chiefly subservient to the happiness of a life to come. In the ancient philosophy the perfection of virtue was represented as necessarily productive, to the person who possessed it, of the most perfect happiness in this life. In the modern philosophy it was frequently represented as generally, or rather as almost always, inconsistent with any degree of happiness in this life; and heaven was to be earned only by penance and mortification, by the austerities and abasement of a monk; not by the liberal, generous, and spirited conduct of a man. [Emphasis added]

"Hmmm," I thought to myself, "I wonder what other similarities between economics and religion there might be? A priestly language, perhaps? One that only the high priests, I mean, economists, understand?" Here's Smith:

When christianity was first established by law, a corrupted Latin had become the common language of all the western parts of Europe. The service of the church accordingly, and the translation of the Bible which was read in churches, were both in that corrupted Latin; that is, in the common language of the country. After the irruption of the barbarous nations who overturned the Roman empire, Latin gradually ceased to be the language of any part of Europe. But the reverence of the people naturally preserves the established forms and ceremonies of religion long after the circumstances which first introduced and rendered them reasonable are no more. Though Latin, therefore, was no longer understood anywhere by the great body of the people, the whole service of the church still continued to be performed in that language. Two different languages were thus established in Europe, in the same manner as in ancient Egypt; a language of the priests, and a language of the people; a sacred and a profane; a learned and an unlearned language.  

Smith describes how religious reformers had to overcome the Church's strong preference for Latin translations of scripture, translations that tended to favor Catholic doctrine. To do this, reformers had to seek the authority of the original Greek and Hebrew scriptures, to be able to read and understand the original (or close to original) documents. (Not unlike those of us who occasionally venture back to the 18th century to read Smith and others.)  It was the demand for knowledge of Greek to read scripture that produced new interest in ancient Greek philosophy and philosophers and eventually countered some of the Church's dominance of philosophy.

Smith was not a fan of concentrated power, religious or otherwise, viewing the Church as

the most formidable combination that ever was formed against the authority and security of civil government, as well as against the liberty, reason, and happiness of mankind, which can flourish only where civil government is able to protect them. In that constitution the grossest delusions of superstition were supported in such a manner by the private interests of so great a number of people as put them out of all danger from any assault of human reason: because though human reason might perhaps have been able to unveil, even to the eyes of the common people, some of the delusions of superstition, it could never have dissolved the ties of private interest. Had this constitution been attacked by no other enemies but the feeble efforts of human reason, it must have endured for ever. But that immense and well-built fabric, which all the wisdom and virtue of man could never have shaken, much less have overturned, was by the natural course of things, first weakened, and afterwards in part destroyed, and is now likely, in the course of a few centuries more, perhaps, to crumble into ruins altogether. [Emphasis Added]

"...the liberty, reason, and happiness of mankind, which can flourish only where civil government is able to protect them." Write that down, put it in your pocket and take it out three times a day and contemplate what it might mean, particularly that last part about civil government protecting the liberty, reason, and happiness of mankind. Then ask yourself, what might be the optimal size of such a government in a large and complex capitalist society? I doubt the answer is "small enough to drown in a bathtub."

Just as the division of labor and growth of commercial exchange eroded feudal power, so also did they erode the power of the Church; as they reduced dependence on feudal barons, so also did they reduce tenancy and dependence on Church lands. Reduced dependence on the Catholic church and clergy and new (Protestant) religious sects gave rise to clergy, some of whom, like Catholic clergy before them, were seen as connected to the sovereign, court, and nobility and therefore seen as out of touch with common people. However, at least in a few countries, a new kind of priest emerged:

In all the presbyterian churches, where the rights of patronage are thoroughly established, it is by nobler and better arts that the established clergy in general endeavour to gain the favour of their superiors; by their learning, by the irreproachable regularity of their life, and by the faithful and diligent discharge of their duty. There is scarce perhaps to be found anywhere in Europe a more learned, decent, independent, and respectable set of men than the greater part of the presbyterian clergy of Holland, Geneva, Switzerland, and Scotland...Where the church benefices are all nearly equal, none of them can be very great, and this mediocrity of benefice, though it may no doubt be carried, too far, has, however, some very agreeable effects. Nothing but the most exemplary morals can give dignity to a man of small fortune.

So concentrated wealth and power, even of a religious organization, or incentives that encouraged competition for the favor of the rich and powerful, yielded a clergy that was well-connected to the sovereign, the courts, the nobility and gentry of the country and out of touch with the common person. But according to Smith, some religions avoided this by removing incentives for clergy to court the wealthy and powerful. Moreover, by eliminating paths to wealth and power, they were able to create incentives where clergy could only compete on morals! Let's read it again:

"Nothing but the most exemplary morals can give dignity to a man of small fortune."

Now there's an argument for taxing the rich at a higher rate.

And, finally, we learn from Smith that just as Wall Street may have siphoned our best and brightest away from that which is "most useful to the publick," so did the liberal reward of clergy tend to siphon the best minds away from European higher education and into the Church.

In countries where church benefices are the greater part of them very moderate, a chair in a university is generally a better establishment than a church benefice. The universities have, in this case, the picking and choosing of their members from all the churchmen of the country, who, in every country, constitute by far the most numerous class of men of letters. Where church benefices, on the contrary, are many of them very considerable, the church naturally draws from the universities the greater part of their eminent men of letters, who generally find some patron who does himself honour by procuring them church preferment. In the former situation we are likely to find the universities filled with the most eminent men of letters that are to be found in the country. In the latter we are likely to find few eminent men among them, and those few among the youngest members of the society, who are likely, too, to be drained away from it before they can have acquired experience and knowledge enough to be of much use to it.

Like the authors of the US Constitution, Smith viewed established and especially state-established religions as politically dangerous, a source of concentrated wealth and political power.

Ironically, it appears that economics, or at least the dominant "pain caucus" part of economics that forms the substrate of current finance and economic policy, is more like religion than science in some respects.  

A superstitious belief in penance, mortification, and austerity. 

A priestly language understood by only a few. 

 "The grossest delusions of superstition... supported in such a manner by the private interests of so great a number of people as put them out of all danger from any assault of human reason."

A distorted labor market that has siphoned human capital and human capacity away from where it would have served the public, the economy, and the country better.

I have to think that Adam Smith would have viewed Wall Street and the misallocated wealth and political power with which it is endowed in much the same way that he viewed religion wedded to political power:

the most formidable combination that ever was formed against the authority and security of civil government, as well as against the liberty, reason, and happiness of mankind, which can flourish only where civil government is able to protect them.

I wonder how the "father of economics" would feel about misguided economic thought providing the liturgy for a religion of pointless pain and economists (not all, but some) serving as the high priests of that "religion?"