Cafe Hayek

The Pessimistic Bias

Reading the comments on this post (which in many ways are very much like the comments on many other posts, both here at the Cafe and on other blogs) prompts me to make a couple of points that I've put off making for too long now.

In his indispensable book, The Myth of the Rational Voter, my GMU colleague (and EconLog's) Bryan Caplan finds powerful evidence that non-economists suffer from the "pessimistic bias," which Bryan defines (on page 45 of his book) as

a tendency to overestimate the severity of economic problems and underestimate the (recent) past, present, and future performance of the economy.

Russ and myself (because we're economists?) and many of the commentors here at the Cafe are not pessimistic about the long-run.  Problems come; problems are solved.  Inability to see the details of the future scare many people; this inability doesn't scare me.  As long as individuals have a sufficient quantum of freedom, their self-interest and creativity and inevitable competition will "solve" almost any problem over the long-haul.  It's a pattern repeated countless times over the past two-hundred years in capitalist countries.  (Please, please don't trot out the Great Depression as a counter-example.  First, it was clearly worsened by the Federal Reserve's catastrophically bad monetary policy, and by the worldwide spread of protectionism -- helped along by the Smoot-Hawley tariff.  More importantly, there's compelling evidence that the risks of full-throttle socialization of the economy were then real enough to scare investors away until the mid-1940s.  And even this greatest of all of America's depressions lasted only ten or fifteen years, depending on how you define the end of the Depression.)

Being optimistic doesn't mean being blindly insistent that the future will always be better than today.  Take away enough freedom and, kaboom!, the economy implodes.  (Or should I instead say "moobak!"?)  Fortunately, though, the capitalist economy is so remarkably robust that it can take lots of beatings -- lots of interventions -- lots of unnecessary taxation -- lots of foolish dissing -- and keep on keeping on at raising living standards.

I'm more optimistic today than I was ten or twenty years ago about just how much counterproductive regulation and taxation the capitalist economy can take before it really starts to fail.  But my sense is that the American economy still retains enough freedom -- that property rights remain sufficiently secure -- to ensure continued economic growth over the long run.

I remain bullish over the long run.  Very bullish indeed.
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My second point is that it is a curious phenomenon that those who want more government control over the economy tend to be those who insist that the American economy has performed poorly over the past thirty-five years.  Again, as regular patrons of the Cafe know, Russ and I are quite sure that the economy has done very well during these years, even for poor and middle-class workers.

But if I were a pro-regulation and high-tax kinda guy, why would I dispute the claim that America's economy has performed remarkably well for everyone even since 1973?  Why would I not say "See, the government programs enacted from the New Deal forward are working!"  At no time during the past 35 years has Uncle Sam's budget been severely reduced.  During those years, some welfare programs have been scaled back, while others have been expanded and even newly created.  Trade is freer today, but the post-WWII trend toward freer trade began in the 1940s, long before those allegedly blissful years of the early 1970s.  Since the early 1970s, some regulations have been repealed, while others have been created at both the state and national levels. 

In short, despite what some pundits mysteriously assert, America during the past twenty-five to thirty-five years has emphatically not been a laissez-faire society.  Not even close.  So why do so many persons on the political left see in the economic data of the past three decades a compelling case for even greater government control over our lives and pocketbooks?  And why don't more of these same persons on the left respond to those of us who advocate less government by pointing to the evidence of continued and widespread growth in prosperity by saying proudly "See!  We're right and you're wrong: government intervention does work well!"

I believe that I know the answer to my (non-rhetorical) question, but this post is long enough, so I'll end it here.

Our Economy Is Not a Child's Erector Set

Here's a letter that I sent today to the New York Times:

Like Gail Collins, I was unimpressed with George Bush's speech yesterday to the Economic Club of New York ("George Speaks, Badly," March 15).

But I disagree with Ms. Collins that "in times of crisis you would like to at least believe your leader has the capacity to pretend he's in control."  A defining characteristic of this economy that produces such enormous abundance for us all (and yes, despite the current downturn, it continues to produce prodigiously) is that no one is "in control."  Indeed, no one could possibly be "in control."  A far greater danger to Americans' prosperity than a President with a poor speaking style and a penchant for standard-fare political shenanigans is the spread of the belief that economic salvation lies in having someone "in control."

Sincerely,
Donald J. Boudreaux

Remember, no one knows, no one has ever known, and no one can possibly know, all that is necessary to make even the ubiquitous commercial-grade pencil.  It's astonishing how prevalent is the view that economies are "run" by people pulling levers -- or should be, or could be, run by people pulling levers.  This misconception is the economics equivalent of the belief that the earth is flat, or that volcanoes won't erupt if they are fed a sufficient number of virgins.

I Worry Much Less About the Reality than About the Reactions

Brian Wesbury, writing in today's Wall Street Journal, offers excellent reasons why the anxiety over the current state of the economy is overblown.  Here are some key paragraphs:

Beneath every dollar of counterparty risk, and every swap, derivative, or leveraged loan, is a real economic asset. The only way credit troubles could spread to take down the entire system is if the economy completely fell apart. And that only happens when government policy goes wildly off track.

In the Great Depression, the Federal Reserve allowed the money supply to collapse by 25%, which caused a dangerous deflation. In turn, this deflation caused massive bank failures. The Smoot-Hawley Tariff Act of 1930, Herbert Hoover's tax hike passed in 1932, and then FDR's alphabet soup of new agencies, regulations and anticapitalist government activity provided the coup de grace. No wonder thousands of banks failed and unemployment ballooned to 20%.

But in the U.S. today, the Federal Reserve is extremely accommodative. Not only is the federal funds rate well below the trend in nominal GDP growth, but real interest rates are low and getting lower. In addition, gold prices have almost quadrupled during the past six years, while the consumer price index rose more than 4% last year.

These monetary conditions are not conducive to a collapse of credit markets and financial institutions. Any financial institution that goes under does so because of its own mistakes, not because money was too tight. Trade protectionism has not become a reality, and while tax hikes have been proposed, Congress has been unable to push one through.

Which brings up an interesting thought: If the U.S. financial system is really as fragile as many people say, why should we go to such lengths to save it? If a $100 billion, or even $300 billion, loss in the subprime loan world can cause the entire system to collapse, maybe we should be working hard to build a better system that is stronger and more reliable.

Pumping massive amounts of liquidity into the economy and pumping up government spending by giving money away through rebates may create more problems than it helps to solve. Kicking the can down the road is not a positive policy.

The irony is almost too much to take. Yesterday everyone was worried about excessive consumer spending, a lack of saving, exploding debt levels, and federal budget deficits. Today, our government is doing just about everything in its power to help consumers borrow more at low rates, while it is running up the budget deficit to get people to spend more. This is the tyranny of the urgent in an election year and it's the development that investors should really worry about. It reads just like the 1970s.

The good news is that the U.S. financial system is not as fragile as many pundits suggest. Nor is the economy showing anything other than normal signs of stress. Assuming a 1.5% annualized growth rate in the fourth quarter, real GDP will have grown by 2.8% in the year ending in December 2007 and 3.2% in the second half during the height of the so-called credit crunch. Initial unemployment claims, a very consistent canary in the coal mine for recessions, are nowhere near a level of concern.

I would add that one major cause of the collapse of so many U.S. banks during the Great Depression was the fact that branch banking in the U.S. was highly restricted.  This restriction on branch banking (1) denied banks the opportunity to diversify their operations geographically.  (See, for example, this paper by my GMU colleague Carlos Ramirez.)  (Also, Canada, which had no restrictions on bank branching, suffered, I think, only one bank failure during the Depression.), and/or (2) reduces competition among banks, thus making them less efficient.

Landsburg on Stimulus

In today's Washington Post, Steve Landsburg speaks much good sense about so-called "economic stimulus."  Here are the closing sentences:

Ultimately, the only solution to unemployment is for displaced workers to get retrained and find their way back into the workforce. The new stimulus package only delays that process by propping up dying industries for a while and postponing the day of reckoning. Ultimately, there will be just as much hardship because the stimulus package can't last forever. Why spend all this money trying -- and probably failing -- to delay the inevitable?

My Stimulus Plan

In today's edition of the Christian Science Monitor I present my own version of a "stimulus plan."  Here's my concluding paragraph:

Sound money, low taxes, and free trade might not "stimulate" the economy today, but this combination will surely increase its vigor over the long-run.

Camp Keynes and Camp Classical

Today's New York Times has this op-ed by Len Burman.  I sent the following letter in response:

To the Editor:

Len Burman argues that repealing the Bush tax cuts two years early, in 2009, will stave off recession ("Make the Tax Cuts Work," January 23). He reasons that "If people knew that their tax rates were going up next year, they'd work to make sure that more of their income is taxed at this year's lower rates."  And investors would "cash out their capital gains now to avoid paying higher taxes later."

If Mr. Burman's economics are correct, his proposals are far too modest.  Why not propose that Uncle Sam announce that in 2009 he will raise income-tax rates to 100 percent and confiscate all investment property?  Think of the enormous outpouring of work that will result in 2008!  And because looming confiscation in 2009 will cause the cashing out of ALL investments in 2008, the resulting economic stimulus would dwarf that which would follow from merely raising capital-gains taxes next year.

Sincerely,
Donald J. Boudreaux

One of the fundamental problems with Mr. Burman's argument is his inappropriate obsession with the short-run (namely, 2008).  People might well work harder during 2008  if they expect higher rates of personal-income taxation in 2009.  Mr. Burman clearly focuses on the additional spending that he supposes will emerge from this extra income earned in 2008.  But if Milton Friedman's permanent-income hypothesis is correct, people are unlikely to spend much of this income today, knowing that their income-earning profiles haven't risen permanently (and, because of higher taxes starting in 2009, likely have fallen).  (Of course, the promised higher capital-gains taxes in 2009 will do their part to discourage the productive investment of this income.)

It's not excessively over-simplified to divide pundits on this "stimulus" issue into two camps:.

Denizens of the first camp -- call it Camp Keynes --  believe that willingness of consumers to spend money lavishly is the chief fuel of economic progress.  Even the prospect of lower after-tax returns to investments won't much discourage investors from running their factories and stores at a fast clip if consumers will spend, spend, spend.

Residents of second camp -- call in Camp Classical -- understand that taxes discourage investments, and that investing for the long-run is crucial for economic progress.  These campers know that spending power is the reward, and not the fuel, of economic growth.

Fama on Corporations and CEO Compensation

Back around 1987 I recall hearing the then-Dean of the George Mason University School of Law, Henry Manne, predict that the wave of legislation sweeping through state houses to protect corporations from hostile takeovers (and, hence, protect incumbent corporate managers from losing their jobs) will result in an increase in corporate misbehavior.

In this interview with The Region (a publication of the Minneapolis Fed), Eugene Fama makes a similar point:

Region: In  the early 1980s, you authored three key pieces regarding principal-agent  conflicts [due to differing incentives of an organization’s  owners and employees] and how they play out efficiently in various types of organizations. How have your ideas evolved in light of transformations in the corporate world?

Fama: I  haven’t spent a lot of time on these issues since then, but they keep  popping up. I haven’t seen anything that would cause me to change my  opinions generally, but something that has bothered me is the drying up of the  takeover market due to the installation of antitakeover provisions by most companies, enabled by state legislatures.      

Region:  Poison pills and the like?

Fama:  Right, and that is very unhealthy, I think, for the corporate world  because it takes away the threat of outside takeovers, which is very important for the economy.

Region: A  form of market discipline.

Fama: Yes,  it’s a unique discipline that corporations have that other forms of  organization don’t have. For example, it’s very difficult to attack the  University of Chicago in that  way. It doesn’t need a takeover defense because there’s no real way to attack it. For a corporation, on the other hand, there was a way. That allowed corporations to have expert boards because the board wasn’t the court of last resort. But the institution  of all antitakeover amendments threw a wrench in the process.

[Anyone who hasn't yet read Manne's classic paper  "Mergers and the Market for Corporate Control" (Journal of Political Economy, April 1965) should do so forthwith.  Its insights are keen and important yet sadly too-little understood.]

But here, in the same interview, is what Fama says about CEO compensation:

Region:  Another issue those papers touched on was compensation of CEOs, a  controversial question in recent years. How do you view the suggestion that         some CEOs are overcompensated?

Fama: If  the [compensation] process gets captured by the CEO, then it can get  corrupted. But if what you’re seeing is a market wage, then I don’t know  why you would say it’s too high. If it’s a market wage, it’s a market  wage. I don’t know of any solid evidence that the process was corrupted.  So my premise would be that you’re just looking at market wages.  They may be big numbers; that’s not saying they’re too high. It’s easy to  say that people are paid too much, but when you’re on the other side of  the fence trying to hire high-level corporate managers, it turns out not to  be so easy.

As patrons of the Cafe might easily guess, I am -- like Fama -- not especially hot'n'bothered by CEO compensation.  But it strikes me that Fama here skirts close to being inconsistent.  Surely the use of antitakeover statutes to protect incumbent managers from market forces at least partially corrupts the market for managers and, hence, might be at least partly responsible for the height of some CEOs' salaries.  (Of course, if this is true, the way to correct the problem is to repeal the antitakeover legislation.)

Tyler's Latest in the Times

My GMU colleague -- and blogger extraordinaire -- Tyler Cowen's monthly New York Times column is never to be missed.  This month's column (published today and entitled "So We Thought.  But Then Again...") is no exception.  Here's a teaser from Tyler's column:

There has been plenty of talk about “predatory lending,” but “predatory borrowing” may have been the bigger problem. As much as 70 percent of recent early payment defaults had fraudulent misrepresentations on their original loan applications, according to one recent study. The research was done by BasePoint Analytics, which helps banks and lenders identify fraudulent transactions; the study looked at more than three million loans from 1997 to 2006, with a majority from 2005 to 2006. Applications with misrepresentations were also five times as likely to go into default.

Many of the frauds were simple rather than ingenious. In some cases, borrowers who were asked to state their incomes just lied, sometimes reporting five times actual income; other borrowers falsified income documents by using computers. Too often, mortgage originators and middlemen looked the other way rather than slowing down the process or insisting on adequate documentation of income and assets. As long as housing prices kept rising, it didn’t seem to matter.

In other words, many of the people now losing their homes committed fraud. And when a mortgage goes into default in its first year, the chance is high that there was fraud in the initial application, especially because unemployment in general has been low during the last two years.

Concise Encyclopedia of Economics, 2nd Edition

One of the most useful resources that I've taken advantage of during the past 15 years is David Henderson's Concise Encyclopedia of Economics (originally the Fortune Encyclopedia of Economics).  Its entries are written in crystal-clear language and, together, they cover an impressively large range of topics.

The first edition remains online here; I just discovered that the second edition has just been published by Liberty Fund.  I'll order mine now.  I encourage each of you to order a copy.  It's a genuine gem.

Miracles Performed Beneath Marble Domes

Rep. Bill Sali (R-Idaho) understands economic processes.  Here's his smack-down of minimum-wage legislation.  (HT to Amit Varma at India Uncut.)

"Your Call Is Very Important to Us"

I ruminate today, in the Christian Science Monitor, on spending time waiting on hold.

The Benefits of Trade

My GMU Economics colleague (and founder of the indispensable Econ Journal Watch) Dan Klein here explains why economists left, right, and center strongly support free trade.  Here's part of Dan's message:

Free international trade increases the extent of the market. International buyers and sellers thicken the market, and make the markets for specialized goods more competitive and reliable. That's what makes further specialization justified in the minds of entrepreneurs. They go forward with specialization, and they enhance productivity. They make things used by people the world over.

That's why we all gain from increases in the extent of the market. Large, thick, international markets invite the productivity investments, and the result is better stuff at lower prices for all of us.

Today, the extent of the market is vast. That's one reason why humanity is better off than in the past. People in China are part of a great chain of beings, a chain that works to make stuff for humanity. Humanity would be happier still if the market were free of protective duties and quotas.

The Essence of a Masonomist

Arnold Kling very eloquently explains the uniqueness of economics as taught and researched at George Mason University.  Here's an excerpt:

At MIT and other bastions of mainstream economics, most economists are to the left of center but to the right of the academic community as a whole. These economists are known for saying, in effect, "Markets fail. Use government."

Masonomics says, "Markets fail. Use markets."

Somewhere along the way, mainstream economics became hung up on the concept of a perfect market and an optimal allocation of resources. The conditions necessary for a perfect market are absurdly demanding. Everything in the economy must be transparent. Managers must have perfect information about worker productivity and consumers must have perfect information about product quality. There can be nothing that gives an advantage to a firm with a large market share. There cannot be any benefits or costs of any market activity that spill over beyond that market.

The argument between Chicago and MIT seems to be over whether perfect markets are a "good approximation" or a "bad approximation" to reality. Masonomics goes along with the MIT view that perfect markets are a bad approximation to reality. But we do not look to government as a "solution" to imperfect markets.

Masonomics sees market failure as a motivation for entrepreneurship. As an example of market failure, let us use a classic case described by a Nobel Laureate, which is that the seller of a used car knows more about the condition of the car than the buyer. Masonomics predicts that entrepreneurs will try to address this problem. In fact, there are a number of entrepreneurial solutions. Buyers can obtain vehicle history reports. Sellers can offer warranties. Firms such as Carmax undertake professional inspections and stake their reputation on the quality of the cars that they sell.

Masonomics worries much more about government failure than market failure. Governments do not face competitive pressure. They are immune from the "creative destruction" of entrepreneurial innovation. In the market, ineffective firms go out of business. In government, ineffective programs develop powerful constituent groups with a stake in their perpetuation.

I'm proud to be a Masonomist.

Boettke on the New Laureates

While I remain disappointed that the Nobel Prize in Economic Science has yet to be awarded to Gordon Tullock, Armen Alchian, Harold Demsetz, and Jagdish Bhagwati, after reading this essay (from today's Wall Street Journal) by my GMU colleague Pete Boettke I'm more impressed with yesterday's award than I was when I first heard it.

Here are the opening paragraphs:

Yesterday Leonid Hurwicz, Eric Maskin and Roger Myerson won the Nobel Prize in Economic Science for their pioneering work in the field of "mechanism design." Strangely, some have used this occasion to disparage free-market economics. But the truth is the deserving recipients owe a direct debt to free-market thinkers who came before them.

Mechanism design is an area of economic research that focuses on how institutional structures can be manipulated by changing the rules of the game in order to produce socially optimal results. The best intentions for the public good will go astray if the institutional arrangements are not consistent with the self-interest of decision makers.

Nobel, 2007

Hurwicz, Maskin, and Myerson share it.

The Inner Cowen

GMU economist and blogging superstar Tyler Cowen was interviewed on today's NPR program Morning Edition.  Listen in!

And read Tyler's latest book, Discover Your Inner Economist.  It's truly outstanding.

When economists disagree

In the latest EconTalk, I talk with David Henderson about whether it's reasonable to presume that economists agree on various issues such as the minimum wage, trade, the causes of growth or the sources of inflation. I used to agree with David that in the area of microeconomics, there is much more consensus than in macroeconomics. Lately, I'm not so sure. At the end of the conversation, I raise the issue of incentives. As the market for talking economists has expanded, I believe that economists do more talking and that the reward for taking polemical stands has increased.

"Faith" In Free Trade?

The blogosphere doesn't lack for good commentary on this article that appeared in yesterday's New York Times -- an article that suggests that (1) the vast majority of economists are advocates of laissez faire, and that (2) those few economists who dissent from this dogmatic position are treated as scum by the rest of the benighted profession.

Alex at Marginal Revolution hits this nonsensical nail square on the head, and Greg Mankiw makes some important points.

I weigh in here only to express my on-going problem with Dani Rodrik's complaint (also featured prominently in the NYT article) that most economists have a "faith" in free trade -- a faith that keeps us from looking at arguments and evidence on trade with open eyes and minds.  Because Rodrik isn't blinded by any such faith, he (he implies) is a more objective scholar.

I don't want here to rehearse debates over the meaning of the term "faith."  I would say that I have no "faith" in free trade; rather, the evidence and the theory of free trade are powerful enough to convince me that it is practically superior to any form of protectionism if the goal is widespread prosperity.  Faith is required when neither evidence nor theory support whatever proposition you choose to (or happen to) believe.  Even if Rodrik is correct about the errors and oversights of traditional trade theory and evidence, it is an unjustified smear to say that those who accept these as the basis for supporting a policy of free trade do so as a matter of "faith."

But my problem with Rodrik's position runs even more deeply.  If it's true that theory and evidence in favor of protectionism are sufficiently strong to warrant economists abandoning their conclusion that free-trade policy is generally sound, then why shouldn't economists -- led by Dani Rodrik -- also start exploring the potential benefits of intra-national protectionism?  Surely a scholar not benighted with the free-trade "faith" ought to take seriously the possibility that, say, Tennesseeans could be made wealthier if their government in Nashville restricts their ability to trade with people in Kentucky, Texas, Rhode Island, and other states?

Indeed, such an objective scholar should be open also to the possibility that residents of Nashville can be made wealthier if their leaders restrict their ability to trade with people in Knoxville, Memphis, Chattanooga, and other locales in that state.

I suspect that if someone proposed to Dani Rodrik that he explore the wealth-creating potential of state-level protectionism, he would refuse.  He would likely (and correctly) say that it's ridiculous on its face to suppose that such protectionism would make the people of Tennessee as a group wealthier over time.  If my suspicion is correct, then to what would Rodrik himself attribute his out-of-hand dismissal of the notion that Tennessee tariffs might well make Tennesseeans richer?  Would he realize to his chagrin that he is a benighted, faith-based non-scholar?  Or would he instead understand that the case for an extensive, market-driven division of labor is so strong -- and that the political border that separates Tennessee from other states is so economically meaningless -- that it would be as pointless for a serious economist to explore the economic potential of Tennessee protectionism as it would be for a serious oncologist to try to cure a patient of cancer by bleeding that patient with leeches.

Where Externalities Lie

Here's a letter that I sent today to the Wall Street Journal.

To the Editor:

Like many others, Professor Hendrik Van den Berg insists that "we need to raise the price of gasoline by introducing a tax that reflects the congestion, environmental and national security costs of oil" (Letters, July 3).  I disagree.

First, government already taxes oil production and gasoline.  How does Prof. Van den Berg know that the current level of taxation is inadequate?  Second, government itself is a steamy swamp of negative externalities.  Not only do politicians and bureaucrats spend other people's money, they do so overwhelmingly while under the influence of special-interest groups.  The only tax that we should raise is one that increases the cost of using government.

Sincerely,
Donald J. Boudreaux

I am consistently amazed at the way so many persons -- including (especially?) economists -- cleverly identify real or imagined externalities in private markets and then propose political "solutions" for these alleged problems as if the government officials who will design and implement these "solutions" are wise, well-informed, and pure of motive.

Birthdays

Today is John Maynard Keynes's birthday.  Were he still alive he would be 124.

It is also -- in something of an irony of history -- the formal birthday of Adam Smith.  If you visit Smith's grave in Edinburgh (you can find a close-up picture here) you'll see his birthday listed on his gravestone as June 5, 1723.  But I understand (from where I can't now recall) that Smith was born a few days or a few weeks earlier and that June 5th is the date on which he was baptized.

Still, happy birthday to two influential economists, one of them whose works are great and timeless.

The Double Thank-You

The latest column by John Stossel (of ABC News) is splendid.  I especially like this observation:

How many times have you paid $1 for a cup of coffee and after the clerk said, "thank you," you responded, "thank you"? There's a wealth of economics wisdom in the weird double thank-you moment. Why does it happen? Because you want the coffee more than the buck, and the store wants the buck more than the coffee. Both of you win.

Yep.

Nudging Us -- With Advice, or with Guns?

At the Wall Street Journal's Econoblog, Mario Rizzo, one of my former professors at NYU, recently debated the University of Chicago's Richard Thaler on "libertarian paternalism." 

The following is from Thaler's opening remarks:

In light of human limitations, Cass Sunstein and I argue for policies that we call libertarian paternalism. Although the phrase sounds like an oxymoron, we contend that it is often possible to design policies, in both the public and private sector, that make people better off -- as judged by themselves -- without coercion. We oppose bans; instead, we favor nudges.

Consider two examples, both designed to increase savings. The first is to enroll people, automatically, into savings plans -- while allowing them to opt out. The second is the Save More Tomorrow plan, which allows employees to commit themselves now to increasing their savings rates later, when they get raises. Both approaches have been remarkably successful.

Well-chosen default rules are examples of helpful "choice architecture." Since it is often impossible for private and public institutions to avoid picking some option as the default, why not pick one that is helpful?

And what's next here is excerpted from Rizzo's contribution:

It is a good thing to help people make better decisions. But law requires us to go beyond intention. What is the appropriate standard for better decisions? Thaler and Sunstein say it's what people would do if they had "complete information, unlimited cognitive abilities, and no lack of willpower." This is a very ambitious standard that could tax the abilities of even well-meaning policymakers.

Can we discover "true" preferences through individuals' statements that they are too fat and save too little? Talk is cheap. These could be expressions of mere desire, not a real willingness to make trade-offs between values. We all want to have more savings and more consumption, too.

Moreover, the public sector is not governed by science or even by behavioral economists, but by ambitious people with limited cognitive abilities, lack of willpower, and faulty memories, not to mention expanding waistlines. Whom should we trust more: individuals who face the costs and benefits of their own choices, or politicians and bureaucrats who do not?

I encourage you to read the entire, interesting debate here.

By the way, you can hear here a podcast that Russ did with Thaler back in November 2006.  And here you can hear a podcast that Russ did with Ed Glaeser, who is critical of the concept of "libertarian paternalism."

Still Living at 108

Were he still alive, Hayek would today celebrate his 108th birthday.  To mark this occasion, I offer this quotation from the book that I believe to be Hayek's most profound: Law, Legislation, and Liberty: Rules and Order (Vol. 1, 1973), p. 72:

Legislation, the deliberate making of law, has justly been described as among all inventions of man the one fraught with the gravest consequences, more far-reaching in its effects even than fire and gun-powder.  Unlike law itself, which has never been 'invented' in the same sense, the invention of legislation came relatively late in the history of mankind.  It gave into the hands of men an instrument of great power which they needed to achieve some good, but which they have not yet learned so to control that it may not produce great evil.

Ten Really Good Books

My latest column in the Pittsburgh Tribune-Review discusses ten of my favorite economics books, aimed at a general audience, written in the 20th century.

Learn Public Choice

The 2007 Public Choice Outreach seminar, held on George Mason University's Fairfax campus, will be held July 12-15.  Speakers include, among others, Bryan Caplan, Georg Vanberg, Bart Wilson, Todd Zywicki, and yours truly.

Students are encouraged to apply!

Golden Straw Man

In response to this note that Paul Krugman has in the current issue of The New York Review of Books, I sent this letter:

Dear Editor:

Discussing Milton Friedman's monetary economics, Paul Krugman says that "he showed himself much less doctrinaire and much more realistic than many of his acolytes: many conservative economists are drawn to visions of a restored gold standard or a world currency, dismissing the problems such a system would create" (Letter, April 12).

Krugman utterly distorts the views of market-oriented economists.  Only a tiny, insignificant fringe advocates a gold standard.  Many more - influenced by the works of F.A. Hayek, Ben Klein, Gordon Tullock, Larry White, George Selgin, and Kevin Dowd - support competition among money issuers.  This proposal is as far from advocacy of a gold standard or a "world currency" as one can get.

Krugman's creation and destruction of straw men is deplorable.

Sincerely,
Donald J. Boudreaux

Some Basic Economics

The economics of steel daggers and rent-control: here's my latest column in the Pittsburgh Tribune-Review.

Klein on economists

Dan Klein makes the case that economists should embrace reality and admit we're not really scientists without values studying society in a petrie dish. He wants us to emulate Smith and Hayek.

Fudenberg on Behavioral Economics

Drew Fudenberg has a superb, constructively critical review of some recent work in behavioral economics.  It appears in the September 2006 issue of the Journal of Economic Literature.  In particular, it's a review of a collection of articles gathered under the title Advances in Behavioral Economics (2003).

My sense is that the findings of behavioral economists are important.  If individuals consistently act differently enough from the way they are assumed to act in standard economic models, the usefulness of these models for promoting our understanding of reality must be questioned.

The jury is still out, in my view, on how robust are the findings of behavioral economists.  But that there is something potentially important here cannot, I believe, be doubted.  No less a light than Hayek worried about the consequences of the fact that we human beings, who today live in a global economy marked by an indescribably deep division of labor, are evolved to survive in small hunter-gatherer groups.  (See, for example, Hayek's last book, The Fatal Conceit (1988).)  Why suppose that our basic psychological make-up is especially well-suited to a modern economy?

Of course, even if we conclude that each of us is much less rational than mainstream economists typically assume us to be, it is hardly true that a strong case is thereby made for government intervention or even for abandoning the assumption -- for purposes of evaluating public policy -- that people's actions reveal their preferences.  Here's Fudenberg, from page 707 of his review essay, on this point:

Even if we believe people do make systematic errors in evaluating how various choices will influence the appropriately defined measure of their "welfare," we might not trust that the government or policy analysts would make better evaluations.  For this reason, it is consistent to believe both that people make mistakes and that government policy should (with a few exceptions) be based on the assumption that people's actions and ex-ante predictions are the best guide to what is in their own interests.

Like Humidity in New Orleans....

The world, it is trite to say, is unpredictable.  Indeed so.

But there are exceptions to this rule.  There is a sizable handful of predictions that I would bet my pension will prove accurate at least 99 out of 100 times.  I predict, for example, that next year every football team that wins a big game will feature a gigantic lineman dumping the contents of a Gator Aid cooler over the happy head of the team's Head Coach....  I predict that every American politician seeking office will claim to know what "the American people" want and that he or she is most trustworthy champion of that collective desire.... I predict that Paul Krugman's next New York Times column will self-righteously accuse the Bush administration or "conservatives" of evil-intentions and evil-doings....  And I predict that every political strongman will blame "speculators" for many of the  economic ills that befall the citizen-victims of their countries.

And lo!  Lookie here!

Meat cuts vanished from Venezuelan supermarkets this week, leaving only unsavory bits like chicken feet, while costly artificial sweeteners have increasingly replaced sugar, and many staples sell far above government-fixed prices. 

President Hugo Chavez's administration blames the food supply problems on unscrupulous speculators, but industry officials say government price controls that strangle profits are responsible.

The above is from this report filed today by an AP reporter in Caracas.

(Hat tip to Cafe commentor Aschkan.)

TANSTAAFT

In a comment on Russ's recent post on global warming, "ben" says

Actually you are surrounded by free lunches. You are typing on one, wearing one, and you drive one. Technology is a free lunch.

Although I understand ben's point -- and agree with what I take to be its thrust -- I disagree with it.  It's true that technology -- indeed, the entire global division of labor -- brings to each of us goods and services that, in the absence of this system, none of us would enjoy.  Each of us consumes incalculably more than each of us could, on our own, produce.

But at the risk of being pedantic, these things aren't free.  They exist only because people put forward their time and energy and resources to help produce them.  There is a cost to our prosperity -- but it is a cost well worth paying.

Here's an analogy.  A friend of a friend (so I'm told!) once bought a copy of Adam Smith's Wealth of Nations in a used-book store deep in the heart of the state of Georgia.  The buyer paid just a few dollars for the book (say, $10).  The buyer soon discovered that the book is a first edition.  The buyer then sold the book for a princely sum (say, $10,000).

Is it accurate to describe his profit here as free?  I think not.  It cost the person who got it $10.  True, in this case, the profit was unusually large and unusually unexpected.  But, nevertheless, it did not fall upon the person free of charge.  He -- the person who profited -- had to sacrifice something of value to get the profit.

Even if the bookstore owner had given the book to the customer free of charge, the profit would not be free.  Someone -- in this counter-example, the bookstore owner -- incurred a cost in order to give rise to the profit.

I think it to be a mistake to identify genuine profit -- true benefits whose values unambiguously are greater than the costs people incur to create these benefits and to secure these benefits -- as free.

Promoting Economic Communication

The economic way of thinking -- to use the title of my favorite textbook -- is essential for grasping the complex reality that we call economy and society.  Also essential is clear and compelling communication of economic insights to a broad audience.

Alas, too few good economists have excelled at talking crisply and vividly to non-economists.  The great communicators -- Milton Friedman, Walter Williams, Thomas Sowell, Steven Landsburg, Russell Roberts, and (of course) Frederic Bastiat -- are the exceptions.

We here at GMU Economics are doing our share to help remedy the problem: Russ Roberts teaches a graduate seminar each year for students who wish to enhance their skills at translating their economic knowledge into compelling prose.

Another effort underway along these general lines is being sponsored by the Market-Based Management Institute (along with the Association for Private Enterprise Education).  Here's the link to their Economic Communication Contest.

I urge students to enter, and professors to alert promising students to this opportunity.

Who's the Impractical Theorist?

As both an economics and a law student, I was very lucky in the professors I had.  Fritz Machlup's International Trade course at NYU will always rank among the intellectual highlights of my life.

Another truly great teacher is Leland Yeager, from whom, at Auburn University, I learned much about money, banking, macroeconomics, and political philosophy.  Leland is a scholar's scholar: careful, thorough, brilliant, learned, wise, and possessing not a whiff of self-importance.  (See also this wonderful article, by Bill Breit, Ken Elzinga, and Tom Willett, on Leland.)

I recently discovered a monograph Leland wrote back in 1954, entitled Free Trade: America's Opportunity.  (Although long out of print, the wonders of the market enabled me to buy a copy for $9.99.)  This monograph bursts with wisdom and insight -- for example, consider Leland's response to those persons who assert that free trade is good "in theory" but not so good "in practice."

The Protectionist actually takes pride in his narrow viewpoint.  He sticks to plain facts -- clear examples of benefit from Protection or of damage from foreign competition.  He does not concern himself with remote, intangible, theoretical consequences.  Thank God, he is no impractical theorist who never met a payroll!  If he happens to be a watch lobbyist, he must struggle for patience with the poor understanding of Congressmen who never had practical experience in retailing watches.  If he is a fishing-tackle man, he pities the ignorance of trade-agreements negotiators who never had practical experience in manufacturing fishing tackle.  He scorns the theorist's "over-all" view of the economic system and sticks to the down-to-earth case-by-case approach.  In so doing, he refuses to consider the decisive heart of the tariff controversy.

[Leland then offers this quotation from Norman Campbell, What is Science? (1952)]:

The plain man -- I do not think that this is an overstatement -- calls a "theory" anything he does not understand, especially if the conclusions it is used to support are distasteful to him.... It is only because he does not understand "theory" that the plain man is apt to compare it unfavorably with "practice," by which he means what he can understand.

The practical man is apt to sneer at the theorist; but an examination of any of his most firmly-rooted prejudices would show at once that he himself is as much a theorist as the purest and most academic student; theory is a necessary instrument of thought in disentangling the amazingly complex relations of the external world.  But while his theories are false because he never tests them properly, the theories of science are continually under constant test and only survive if they are true.  It is the practical man and not the student of pure science who is guilty of relying on extravagant speculation, unchecked by comparison with solid fact.

For all his vaunted realism, the Protectionist theorizes without knowing it.  Furthermore, his haphazard theories are far less able to stand inspection than those of the trained theorists whom he scorns [pp. 33-34; original emphasis].

The next time you hear someone praise the "practical" insights about trade issuing from people such as Ross Perot, Lou Dobbs, or the well-meaning but economically uninformed business executive who pleads with Congress for protection from competition, remember the above slice of wisdom from Leland Yeager.