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The Best Paragraph I've Read on the State of Economics

Mon, 08 Feb 2010 12:10:53 +0000

Maxine Udall makes a point I've often made, though in a way I wish I had phrased it:

Now add to this the promotion and tenure policies at even second rate economics departments that require and only reward publication in journals that favor morally vacant, mathematically rigorous, theoretically obtuse existence proofs that more often than not bear no relation to reality as we know it. One is then left with an economics literature that few people, including some who have majored in economics as undergrads, can truly understand, either in its content or in its relevance to the important moral and economic issues that confront us today.

Udall, in my view erroneously, believes that a 'reality-based' economics would be more Keynesian:

Keynes, who advocated that government play a role in moderating the effects of peaks and troughs in the business cycle through regulation of investment banking and automatic demand stabilizers (for example, unemployment compensation and jobs creation through public works) became conflated (perhaps intentionally) with "socialism" and "communism."...

Economics, mathematized and divorced from moral philosophy, was effectively neutered after WW II, at the point when its relevance to "serious economic argument" might have been established and developed. The outcome was perfectly aligned with market forces that would continue to shift the national narrative in ways that would finally succeed in convincing people that "government is the problem". It culminated in repeal of Great Depression era regulation, thereby freeing investment bankers for unfettered speculative gains supported by a seemingly unfettered single-payer credit default safety net.

Which is all fine and good, except for the fact that for Keynesian fiscal stimulus to work you need to waive away a number of real world complications. Non-mathematical theories can " bear no relation to reality as we know it" as well.

Udall also states:

World War II provided the massive Keynesian stimulus needed to haul us out of depression and to cement Keynes ideas about the roles that government could and should play both during economic downturns and to prevent them.

This neglects to take into account the evidence that U.S. military and foreign spending did not go up until 2 years of rapid U.S. economic growth.

The Best Paragraph I've Read on the State of Economics originally appeared on About.com Economics on Monday, February 8th, 2010 at 12:10:53.

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Climate Research vs. Economics Research

Tue, 02 Feb 2010 07:57:14 +0000

Craig Newmark posts an excerpt from a Andrew Simms column:

Orthodox economics is based on simplifications that so distort the real world as to make it unrecognisable, yet its basic tenets are credulously repeated on an almost daily basis in national newspapers and on television news. A genuinely evidence-based approach to economic policymaking would not produce a system remotely like the one we have, the business-as-usual version that many climate sceptics seem so eager to defend. Given its task, the vast range of subjects covered, the thousands of scientists involved, and the sheer size of its reports, what's stunning about the IPCC's work is that comparing it to any economic analysis used to actually run the world is like comparing the complete Oxford English Dictionary to a guide to slang published by the Sunday Sport.

Newmark's reaction?

That's really a low blow. Mandatory two-point deduction. Your next foul, sir, you will have to forfeit the fight.

My reaction?

Simms has a point.

More specifically - there is a lot of really good applied economics research out there that uses realistic assumptions, real world data and produces useful outcomes. Then there are theory papers which are nothing but mathematics posing as economics. Models with assumptions such as:

Heterogeneous agents.
Absurd market demand curves (e.g. Demand is a constant r until the price p_r then it falls to zero.
Input prices that do not vary with demand.
No production externalities. Ever.
Agents with perfect information (they know the cost structure, strategies and inventory levels of their competitors).
Zero transaction costs.
Long run marginal cost curves with a single local minimum.

That's just off the top of my head. I should crack open an issue of Econometrica and find hundreds more.

A fan of Milton Friedman's The Methodology of Positive Economics would respond that it does not matter how absurd the assumptions seem. All that matters is how valid and accurate the model's predictions are. But since most economics models (particularly in macroeconomics) are not easily directly testable nor easily falsifiable, I question how much value we should place on a model with absurd assumptions.

Climate Research vs. Economics Research originally appeared on About.com Economics on Tuesday, February 2nd, 2010 at 07:57:14.

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Marginal Utility in Economics

Mon, 01 Feb 2010 18:10:24 +0000

I get quite a few questions on marginal utility, so I thought I'd create a primer for those of you who are completely new to economics. Please see: Marginal Utility in Economics.

Marginal Utility in Economics originally appeared on About.com Economics on Monday, February 1st, 2010 at 18:10:24.

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Why Is There So Much Esoteric Math in Economics Grad Programs?

Fri, 29 Jan 2010 07:56:32 +0000

Stephen Gordon asks a question I continually asked myself as a Ph.D. student at the University of Rochester:

Why does anyone care about the distinction between convergence in probability and almost sure convergence?

I'm teaching two econometrics classes this term (master's and PhD), and I just covered the parts on asymptotic theory. In both lectures, I stumbled badly at explaining the difference between these two forms of convergence: my heart simply isn't in it...

I've never heard of empirical study where the distinction between the two forms of convergence made a difference...

Why do we force our students to learn these things?

As an aside, undergraduates in economics are often surprised how little economics there is in graduate programs outside of fields courses such as Labor Economics and Public Finance.

Although from an empirical perspective it probably doesn't make sense in the slightest to worry about the distinction between the two types of convergence, I am quite certain it makes a difference in theory papers. Unlike most economists, I tend to use 'theory paper' in a pejorative sense, because too many theory papers:

Make assumptions that cannot possibly be true and are not reasonable simplifications of the 'real world'.
Are non-falsifiable, do not make predictions, or have so many free parameters they can be used to predict anything.

You need to know this math in order to be able to publish 'theory papers'. The larger question should be, "why does the economics profession put any value on this work?"

Why Is There So Much Esoteric Math in Economics Grad Programs? originally appeared on About.com Economics on Friday, January 29th, 2010 at 07:56:32.

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A Public Health Problem That Can't Be Solved With a Pigovian Tax or Sin Tax

Thu, 28 Jan 2010 15:25:37 +0000

From Reuters:

Shaving 3 grams off the daily salt intake of Americans could prevent up to 66,000 strokes, 99,000 heart attacks and 92,000 deaths in the United States, while saving $24 billion in health costs per year, researchers reported on Wednesday...

Salt, which contributes to high blood pressure and heart disease, is widely overused in the United States, with 75 to 80 percent coming from processed food. Men typically consume 10.4 grams per day. For women, the average is 7.3 grams. Its use is rising.

A reduction of 1 gram would prevent 11,000 to 23,000 strokes, 18,000 to 35,000 heart attacks and 15,000 to 32,000 deaths from any cause, the researchers reported in New England Journal of Medicine.

My stock answer is to proclaim Sin Tax!, however that would not work here, for a couple of reasons:

Assuming the Reuters article means salt and not sodium, I would guess that a sin tax would have to be at least 10 cents a gram to have any noticable impact. That would make the tax on a 1kg box of Sifto table salt that currently sells for $1.69 equal to $100. Not going to happen.
Memories of Gandhi's Salt March

I am not sure what the answer is - but here the answer is almost certainly not a sin tax or Pigovian tax.

A Public Health Problem That Can't Be Solved With a Pigovian Tax or Sin Tax originally appeared on About.com Economics on Thursday, January 28th, 2010 at 15:25:37.

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Income Elasticity and the Sex Trade

Thu, 28 Jan 2010 12:08:20 +0000

Price Elasticity of Demand is the most well-known of all the elasticities in economics. Income Elasticity of Demand, however, is equally as important when considering how the demand for a product and service changes over time (due to economic growth or the business cycle). The Toronto Star has an unusual article on income elasticity: Recession means tough times for sex workers. (Note: article may not be safe for work).

Income Elasticity and the Sex Trade originally appeared on About.com Economics on Thursday, January 28th, 2010 at 12:08:20.

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Can Exports Get the U.S. Out of Their Slump?

Thu, 28 Jan 2010 07:58:08 +0000

From Mark Thoma:

The problem is that if (net) exports don't lead the way, then consumption or investment must fill the void if the private sector is going to take care of this on its own. But neither of those seems likely to grow fast enough to accomplish this, at least not anytime soon, and there's some question whether they will return to their pre-crisis levels, consumption growth in particular.

Paul Krugman's point -- the quote is from a bit over a year ago -- was that if consumption, investment, and net exports can't support the growth we need to maintain employment, then government must use aggressive measures to bridge the gap until the private sector can make the necessary adjustments.

On the surface, this logic seems to make sense. In economics 101 we learn that the size of the economy is calculated through the following equation:

Y = C + I + G + (X - M), where

C = consumption

I = Investment

G = Government Spending

(X - M) = Net Exports (eXports - iMports)

If C and I cannot grow 'fast enough', then the growth needs to come from government spending (G) or exports (X) (or a drop in imports).

The problem with this logic is it confuses an accounting identity for an economic model. There is an implicit ceteris paribus assumption in the Thoma/Krugman argument suggests that if X rises, it will not cause changes to any of the other variables. It is fairly straight forward to think of two scenarios where a rise in X will be offset by a decrease in another variable:

American companies ship products to Canada that otherwise would have been consumed domestically. X up, C down.
American companies ship products to Canada. Canadians demand U.S. dollars to pay for those goods. U.S. dollar rises vis-a-vis the loonie. Canadian goods now relatively cheaper to Americans, who increase their imports of Canadian goods. X up, M up which offsets (partially or fully) the rise in X.

To be clear - I am not suggesting that increased exports will not increase U.S. economic growth. But you cannot determine that from this analysis. Confusing an accounting identity with an economic model is an elementary mistake - I'm surprised a Nobel Prize winner would fall into that trap.

Can Exports Get the U.S. Out of Their Slump? originally appeared on About.com Economics on Thursday, January 28th, 2010 at 07:58:08.

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Good Thing We Had All That Stimulus

Thu, 28 Jan 2010 07:47:24 +0000

Mark Thoma linked to some terrific data from the Dallas Fed which shows just how awful the labor market has been during this recession, relative to past recessions. Greg Mankiw has a terrific graph showing that the labor market is far worse than what the Obama team predicted would happen without any stimulus.

It would be reasonable to conclude that the stimulus has been useless at best and counterproductive at worst which is exactly what I predicted would happen. There are, of course, other explanations. Given that U.S. labor market is in a worse position than the 'no stimulus' prediction, it is difficult to argue that the problem with the stimulus is that it was too small. Of course the usual suspects will continue to argue just that.

Good Thing We Had All That Stimulus originally appeared on About.com Economics on Thursday, January 28th, 2010 at 07:47:24.

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Health Costs and Medical Conditions

Thu, 28 Jan 2010 07:28:49 +0000

My colleague Mary Hartley with some data I do not believe I had seen before:

On average, "obese people spend $1400 more a year on health care compared to someone of normal weight," says Eric Finkelstein, the foremost authority on the economics of obesity in the United States. And whether you, your employer, or the government picks up the tab, obesity is running up the health care bill.

I know I have been beating this drum for some time, but it would seem to me that increasing taxes on "junk food" and using the revenue to decrease income taxes is as close to a free lunch as you will ever see in economics. The population will get healthier, health care costs will decrease and economic growth will rise due to lower income taxes.

Now, this will not solve all of America's health care issues:

But just so you know, obesity-related health conditions account for only 9.1 percent of the $4.3 trillion dollars spent on health care last year.

I believe that reducing these expenses by 20% is not unreasonable. This would be a savings of 80 billion dollars - not an insignificant sum. But we do not have to stop there as I have argued before. Related policies include:

Increased 'sin taxes' on alcohol and tobacco.
Pigovian taxes on air pollution.
With the added revenue from 1 through 3, increase transfers to the poor (through, say, an guaranteed annual income. Poverty is a source of early mortality, so by fighting poverty we also improve health outcomes). Use the rest to finance tax cuts to corporate income and income tax rates.

Economics shows that we have the opportunity to increase health and reduce health care expenses - now all we need is a politician brave enough to suggest it.

Health Costs and Medical Conditions originally appeared on About.com Economics on Thursday, January 28th, 2010 at 07:28:49.

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Is Fiscal Stimulus Science or Faith?

Thu, 21 Jan 2010 12:44:45 +0000

A continuation of: Brad DeLong Realizes The Stimulus Didn't Work - And Draws Entirely The Wrong Conclusion.

We had extensive fiscal stimulus and the economy is in worse shape than the 'here is what will happen if we do not implement fiscal stimulus' projections.

That does not necessarily mean that fiscal stimulus does not work. However, can there ever be a possible piece of evidence that shows fiscal stimulus does not work? Seems to me that any outcome can be spun as showing the effectiveness (or for that matter the non-effectiveness) of fiscal stimulus. That is, the fiscal stimulus hypothesis is non-falsifiable. The true believers will never stop believing.

Even though fiscal stimulus does not work in theory and there is no evidence it works in practice, trying to disprove the effectiveness of fiscal stimulus feels a little like trying to disprove that God exists. It makes me question how scientific macroeconomics truly is.

Is Fiscal Stimulus Science or Faith? originally appeared on About.com Economics on Thursday, January 21st, 2010 at 12:44:45.

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