Cafe Hayek

A Useful List of Economics Links

This list of links promises to be very useful for anyone interested in economics.

Why macro is nonsense

Macroeconomics is mostly ex-post storytelling. If you decide the economy is doing badly, it's because we haven't spent enough of the stimulus (HT: Billy). If you think it's doing well, it's because (as some of my friends explain it to me) the stimulus is already working building confidence. No science here.

UPDATE: Nice example from Dave of the "it's already working" story. Notice from the story that it is impossible to distinguish between "Bernanke saved the country" and "the fiscal stimulus saved the country even though we've spent so little." Not science.

On Economics, Wise and Clever and Good and Bad

Commenting on this post, Daniel Kuehn says

I've always found that story from Krugman about his sci-fi inspirations surprisingly blatant! Still, I wouldn't read as much into it as you are. Krugman is not a dunce, and I'm confident he also accepts your reasoning, that:

"incalculably complex and productive social orders emerge from billions of individual actions, where no one of these actions is meant to achieve anything more than improvement in the welfare of the individual actor"

This is not a unique or rare insight that you're presenting - I'm sure Krugman shares it, even if he differs from you on what to do with it.

Of course the point I make in the post isn't unique or rare -- the economists listed below fully understand it -- but I disagree that Krugman shares it in any meaningful way.

A believer in the existence of buttons to push is either overly impressed with his or her own intelligence or simply unaware of the true complexity of any market economy (or both).

It's true that Krugman is no dunce.  I have absolutely no doubt that his I.Q. is significantly higher than my own -- and, more relevantly and much more impressively, that it is significantly higher than that of 95 percent of all other economists.  But intelligence is not the same thing as wisdom.  In fact, I suspect that, after I.Q. reaches a certain (above-average) level, I.Q. and wisdom are negatively correlated with each other.  Cleverness becomes mistaken for insight.  The two are not at all the same.

Although I admire much of Krugman's academic work, and especially his popular essays explaining the nonsense of talking of nations as being "competitive" or "uncompetitive," nothing in his work reveals that he understands the economic problem to be as complex as I believe it to be.

This failure, alas, is not unique to Krugman.  Too many economists fail on this front.  Too many economists lack the wisdom to distinguish their theories from the reality that those theories are (or ought to be) meant to illuminate.  (My favorite example of this failure is economists' tendency to presume that the closer any industry is to being "perfectly competitive," the greater the contribution to consumer welfare contributed by that industry.)  Too many economists are insufficiently insightful or insufficiently wise to explore the deep premises that inevitably, and typically inadvertently, underlie their theories.

The deepest economic thinkers of the past 50 years, in my opinion, include Hayek, Ronald Coase, Jim Buchanan, Gordon Tullock, Armen Alchian, Harold Demsetz, Julian Simon, Vernon Smith, and Deirdre McCloskey.

I challenge you, for example, to read the Demsetz article linked to just above -- at Demsetz's name -- and not come away with an appreciation for how thinking outside of the box can be mind-expanding.  Likewise, I challenge you to read the Hayek article linked to above and not come away understanding more fully that attempts to 'plan' any economy are childish fantasies -- that the idea of there being any 'buttons' to 'push' is about as absurd a misconception as is possible in the social sciences.

None of these scholars shines especially brightly on the cleverness front.  None of them (with the possible exception of Vernon Smith) dazzles his or her readers with elaborate mathematics or econometrics.  Each scholar is as much a philosopher as an economist.  Each understands that the chief contribution of economics is to further our understanding of how billions of individuals, no one of whom possesses more than an unmeasurably small fraction of the knowledge required to cause a viable and productive economic order to emerge and grow, interact and mutually adjust to each other.

Not one of these scholars excels at supplying formulae and recipes and instructions for how and when to push buttons.  Each of these scholars understands that society is an order to be explained and understood, rather than a machine to be "designed," pushed, pulled, planned, or pummeled into looking like something that any human being imagines it "should" look like.

In short, each of these scholars reasons and analyzes more as a great biologist reasons and analyzes -- and not as a great engineer reasons and analyzes.  Any biologist who proposed a plan for engineering genes so that, say, humans would become stronger or healthier or handsomer or smarter would be laughed out of his or her profession.  Economists, unfortunately, do the equivalent all the time.  It's obscene, really -- and really unfortunate.

A Much-Better (but Unfortunately Overlooked) Distinction Between Microeconomics and Macroeconomics

Daniel Kuehn's comments on this post prompt me to reprise this post from September 2005:

Vulgar Keynesianism

Among the important points Bob Higgs makes here is the one that I make here, but Bob doe so much more effectively than I can ever hope to do.  Here's an especially important passage from Bob's essay:

In fact, “the economy” does not produce an undifferentiated mass we call “output.” Instead, the millions of producers who bring forth “aggregate supply” provide an almost infinite variety of specific goods and services that differ in countless ways. Moreover, an immense amount of what goes on in a market economy consists of dealings among producers who supply no “final” goods and services at all, but instead supply raw materials, components, intermediate products, and services to one another. Because these producers are connected in an intricate pattern of relations, which must assume certain proportions if the entire arrangement is to work effectively, critical consequences turn on what in particular gets produced, when, where, and how.

These extraordinarily complex micro-relationships are what we are really referring to when we speak of “the economy.” It is definitely not a single, simple process for producing a uniform, aggregate glop. Moreover, when we speak of “economic action,” we are referring to the choices that millions of diverse participants make in selecting one course of action and setting aside a possible alternative. Without choice, constrained by scarcity, no true economic action takes place. Thus, vulgar Keynesianism, which purports to be an economic model or at least a coherent framework of economic analysis, actually excludes the very possibility of genuine economic action, substituting for it a simple, mechanical conception, the intellectual equivalent of a baby toy.

Hayek and Keynes

I've spent much time lately re-reading Hayek's and Keynes's works from the 1930s -- reading not as systematically as I would like, but diving into these works with an interest and fervor that I've not felt since the early 1980s.

I highly recommend Bruce Caldwell's splendid "Introduction" to volume 9 of Hayek's Collected Works -- a volume entitled "Contra Keynes and Cambridge."

Also, I highlight this important passage from one of Hayek's essays contained in the just-mentioned volume, "Personal Recollections of Keynes."

Keynes appears to have been misled here by a mistake opposite to that of which he accused the classical economists.  He alleged, with only partial justification, that the classics had based their argument on the assumption of full employment, and he based his own argument on what may be called the assumption of full unemployment, i.e., the assumption that there normally exist unused reserves of all factors and commodities.  But the latter assumption is not only at least as unlikely to be true in fact as the former; it is also much more misleading.  An analysis of the assumption of full employment, even if the assumption is only partially valid, at least helps us to understand the functioning of the price mechanism, the significance of the relations between different prices and of the factors which lead to a change in these relations.  But the assumption that all goods and factors are available in excess makes the whole price system redundant, undetermined and unintelligible.  Indeed some of the most orthodox disciples of Keynes appear consistently to have thrown overboard all the traditional theory of price determination and of distribution, all that used to be the backbone of economic theory, and in consequence, in my opinion, to have ceased to understand any economics [boldness added - and note that Hayek, correctly, accuses Keynes of having assumed full unemployment.].

The notion that all unemployed resources of a certain aggregate class such as "labor" or "land" or "steel mills" are largely identical and interchangeable with other resources in that same class, and, hence, can be easily and profitably employed simply by increasing demands for "labor" or "land" or "steel mills," is the bastard off-spring of lazily thinking in terms of aggregates and forgetting the enormous complexities that are part and parcel of any successful, viable, market economy.

Tyler and Robin slug it out

Well, actually there is not too much slugging. But it's here. I really like the question of whether influential people become more conventional. It is related to Dan Klein's story on groupthink. Tyler's further thoughts here.

Arnold and I at bloggingheads.tv

Arnold Kling and I talk about the state of economics and the current crisis. Here's an excerpt:

Pop Quiz

I heard an ad yesterday on a local Washington, DC, radio station.  I forget the company, but at one point in the ad a spokesman for the company proudly proclaimed "Safety is always our first concern."

Of course, we know what this claim is supposed to mean.  But let's, for purposes of this blog post, be annoyingly pedantic and take the claim literally -- to mean that this firm is always trying to improve safety rather than spending its resources on other fronts.  If taken literally, basic post-1871 economics tells us that this firm's current level of safety is inadequate.  Why?  (Assume that the firm seeks to maximize its profits.)

Use the comments section to write your answer to this pop quiz.

Yeats on the economy and economists

These words keep running through my head, particulalrly the last two lines:

Things fall apart; the centre cannot hold;
Mere anarchy is loosed upon the world,
The blood-dimmed tide is loosed, and everywhere
The ceremony of innocence is drowned;
The best lack all conviction, while the worst
Are full of passionate intensity.

Just not sure which side is my side.

Is Keynesian Economics Really Economics?

In today's Wall Street Journal, Dick Armey very nicely explains why Washington needs less Keynes and more Hayek.  Here's a key paragraph:

Keynes's thinking was a decisive departure from classical economics, because arbitrary "macro" constructs like aggregate demand had no basis in the microeconomic science of human action. As Hayek observed, "some of the most orthodox disciples of Keynes appear consistently to have thrown overboard all the traditional theory of price determination and of distribution, all that used to be the backbone of economic theory, and in consequence, in my opinion, to have ceased to understand any economics."

Who's the Partisan Hack?

Brad DeLong says that his blog is "Reality-Based."  And, indeed, it often offers sound, reasonable, clear-eyed commentary - stuff that I typically find valuable even when I disagree with it; indeed, chiefly when I disagree with it.

But not always.  This post borders on being scurrilous -- and certainly crosses the border from reality into paranoid fantasy.  DeLong calls a number of economists, including my GMU colleague Richard Wagner, "ethics-free Republican hacks."  The offense that sparks this charge is opposition to government "stimulus" of the economy.

The charge is outrageous, for a number of reasons.

First, opposition to government stimulus of the economy is hardly a Republican matter.  Suppose the stimulus were to work.  Are Republicans less interested in restoring the economy to health than are Democrats?  Of course not.  In fact, if the stereotype of the GOP is accurate - namely, that the GOP is the party of business - it would appear quite unlikely that any "hacks" for this political party would oppose steps to improve the business climate.

Of course it's possible that the economic theories and ideas motivating a GOP opposition to a stimulus package are mistaken - but being a poor economist is not at all to be an "ethics-free Republican hack."

Second, on the economics of the matter, opposing such a stimulus package -- for macroeconomic reasons or for public-choice reasons or for both reasons -- is hardly a sign of economic dementia.  It's possible, again, that the stimulus reflects good economics and that opposition to the stimulus (such as is expressed by my colleague Dick Wagner, by Ed Lopez, and by other economists listed by DeLong) reflects weak economic reasoning.  But to treat Keynesian fiscal stimulus as beyond-question appropriate -- to treat economists who reject Keynesian theory and policy as buffoons -- is simply nonsense.  Or worse: such treatment seems like the actions of a political hack.

To claim that government cannot spend resources that it doesn't first acquire from the private sector is hardly bizarre.  To claim that taking resources from the private sector reduces demands in those industries from which the resources are taken is hardly bizarre.  To claim that any economic activity stimulated by increased government spending is offset by economic activity elsewhere slowed by government's need to get the resources it spends is hardly bizarre. Again, such claims might be mistaken -- but what about such claims is so ludicrous as to advertise persons who make them "ethics-free Republican hacks"?

Nothing that I can see.

Third -- and here I can speak only for the handful of persons on DeLong's list of "ethics-free Republican hacks" whom I know personally (such as Dick Wagner and Ed Lopez): many of these scholars would be loathe to identify themselves as Republican.  Dick Wagner is one of the least politically partisan people I know.  He has nary a kind word for any politician, Democrat or Republican.  The idea that Dick Wagner is somehow buttering his biscuits by insincerely writing things that the GOP wants to read, or that he thinks the GOP wants to read, is crazy beyond description.

Fourth, again supposing that fiscal stimulus by government will work and that the economists on DeLong's doo-doo list actually agree (for these suppositions are part of DeLong's premises), it's more likely that such opposition reflects an abundance of ethics rather than an absence of ethics.

It's no ethical challenge to support something that works.  It is, however, a real ethical challenge to oppose something that you believe would work.  Someone opposed as a matter of principle to government intervention into the economy might be sensible or not; but if that person sticks by his or her principles -- if he or she continues to oppose the intervention on moral grounds, or because of a belief that following what is thought to be a wise rule-of-thumb is best even at the cost of making things worse in the immediate case -- that person is ethics-infused, not ethics-free.

Once again, the economics underlying such principles might be mistaken, or the ethics motivating such opposition might be disagreeable, but the persons standing up for what they believe in are quite the opposite of "ethics-free."

I myself am quite skeptical -- for reasons expressed beautifully by Dick Wagner in the quotation that DeLong features -- of the success of any "stimulus" plan.  But even if I were convinced that such stimulus in this case would restore economic health much sooner than it would otherwise be restored, I would still oppose it -- on ethical grounds.

Humility

Winston Churchill is supposed to have said about Clement Atlee that "he was a modest man, but then again, he has much to be modest about."

I thought of that quote reading this extremely honest and thoughtful post from Greg Mankiw where he makes the case for humility when considering the reliability of the Keynesian approach to macro. I'm feeling a lot of that these days myself and I suspect many other economists are as well. We have much to be modest about when it comes to macro.

Arnold the Wise

Arnold Kling at his best.

Interview with Russ Roberts

Here's a great interview with Russ.

"Greed" Is Not an Explanation

Here's a letter that I sent today to National Public Radio:

Mr. Scott Simon, Host
Weekend Edition
National Public Radio

Dear Mr. Simon:

John Lithgow is a fine actor, but his explanation of the current financial turmoil -- as being caused by "greed" -- is inadequate (Weekend Edition, Oct. 4).  Saying that "greed" caused today's problems is like saying that gravity caused the death of someone pushed from the top floor of the Empire State building.  Some things are sufficiently constant in human affairs - and self-interest, even greed, is among them - that they explain nothing.

"Greed" certainly can be unleashed to do harm, but it can also be harnessed to do good.  Any compelling explanation of any observed economic reality must take "greed" as a given while identifying the specific incentives provided by prevailing social institutions.  If these institutions make serving the needs of others the best path to personal gain, then "greed" is harnessed for human betterment.  But if these institutions make predating on others - either through force or fraud, or either intentionally or unintentionally - the best path to personal gain, then "greed" will indeed lead people to act destructively.  In either case, though, it is the institutions and their accompanying incentives, rather than "greed," that explain economic reality.

Sincerely,
Donald J. Boudreaux

Concise Encyclopedia of Economics, 2nd edition

The second edition of the Concise Encyclopedia of Economics is now on-line.  It will prove to be an indispensable resource.  Editor David Henderson has done a remarkably fine job.

No Planning

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

Crusading for a national "energy plan" and upset that WSJ columnist Holman Jenkins isn't on board, T. Boone Pickens asks rhetorically: "My father used to tell me that a fool with a plan is better than a genius with no plan.  So I ask, what's Mr. Jenkins's plan?" (Letters, Sept. 2).

Contrary to Mr. Pickens's assumption, an economy is not simply a gigantic business firm.  An economy is both incomprehensibly more complex than is even the largest multinational corporation, and it has no specific, overriding purpose comparable to a firm's goal of maximizing profits - a purpose by which the performance of each employee and each investment decision is relatively easy to evaluate.  So while plans and some measure of central direction make sense for firms, comparable plans and direction for an economy are poison.  They prevent the on-going decentralized, competitive experimentation from which spring not only progress that is unplanned, but progress whose details could not have been foreseen before they actually materialize.

The Soviet Union famously had plans for its economy; the United States did not.  Which country was the fool?

Sincerely,
Donald J. Boudreaux

Silly Serious Ideas

Warren, a patron of Cafe Hayek, e-mailed me over the weekend to ask what, in my opinion, are "the silliest ideas ever held by serious economists."  I take his question to refer to modern economists - that is, post-1871 and the marginal revolution.  And I take "held by serious economists" to mean "held by a significant number of serious economists."  Finally, I take "silliest" to refer to something worse than mistaken.  The labor theory of value, for example, is mistaken, but it's not silly (at least not if -- like Adam Smith, David Ricardo, and other classical economists -- you've not been exposed to marginalism).  Likewise, the Keynesian notion that more consumer spending is key to creating jobs is mistaken but not silly.

Warren's question is interesting.  I have five candidates for really silly ideas held by serious economists, offered here in no particular order.

1. The belief of many Keynesians (including John Maynard Keynes himself) that modern capitalism suffers a paucity of attractive investment opportunities.

2. The belief -- especially prominent among a number of antitrust scholars in the 1970s and 1980s -- that innovation is a means of monopolistic predation that should be policed by antitrust authorities.  (I wrote on this topic of "nonprice predation" many years ago in Regulation.)

3. The fear that economic growth causes inflation.

4. The theory of Perfect Competition -- and the equally static theory of Monopolistic Competition.

5.  The Phillips Curve notion of an inherent tradeoff between unemployment and inflation.

Dishonorable Mention: the notion that government debt isn't a problem to the extent that it's held domestically -- to the extent that "we owe it to ourselves."  Jim Buchanan's 1958 book, Public Principles of Public Debt, exposed the foolishness of this idea.

On Savings

One of our age's truly great communicators of economics (as well as a first-rate economic scholar) is Steven Landsburg ("the Armchair Economist").  Steve's review, in today's Wall Street Journal, of Ronald Wilcox's Whatever Happened to Thrift? is a gem.  Here's a slice:

The tax code alone is reason to believe that Americans don't save enough. Mr. Wilcox offers a menu of other reasons, not all of them convincing. He repeats the canard, popularized by Robert Frank of Cornell University, that "keeping up with the Joneses" is a force for excessive consumption. One could argue equally well that it is a force for excessive saving. If I am trying to outshine the neighbors' Mercedes, I might well decide to be extra frugal until I can afford a Rolls Royce.

Mr. Wilcox makes another fundamental error when he points to high foreign savings as a cause of excessive U.S. consumption. When foreigners save, U.S. interest rates drop. This makes it smart for Americans to consume more. "More" is not always the same as "excessive."

I add only a point that I'm certain that Steve agrees with, namely, the freer are trade and international capital flows, the less meaningful it is to speak of national rates of savings.  As a worker I care whether or not my employer is modernizing his operations to increase my productivity; I don't care (or shouldn't care) whether the savings used to finance such investments come from Dallas or from Dubai.  As a consumer, I care that savings is available to finance innovations and the production of attractive goods and services; I don't care (or shouldn't care)  -- as long as trade is free -- if any particular such investment takes place over here or over there, or about the nationalities of the persons who supply the savings to finance this and other investments.

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.
....
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.)