Economics/Finance

We’ll be doing a seminar on Dani Rodrik’s new book _One Economics, Many Recipes_ in the nearish future. Originally, the seminar was going to go upshortly after the book’s launch, but the book got out into the stores earlier than originally planned. Those who have an interest in buying the book so as better to follow the discussion can do so at “Powells”:http://www.powells.com/partner/29956/s?kw=dani%20rodrik%20one%20economics%20many%20recipes or “Amazon”:http://www.amazon.com/gp/redirect.html?ie=UTF8&location=http%3A%2F%2Fwww.amazon.com%2FOne-Economics-Many-Recipes-Globalization%2Fdp%2F0691129517%3Fie%3DUTF8%26s%3Dbooks%26qid%3D1193945280%26sr%3D8-1&tag=henryfarrell-20&linkCode=ur2&camp=1789&creative=9325.

“Brad DeLong”:http://delong.typepad.com/sdj/2007/10/james-scott-and.html has a review of James Scott’s _Seeing Like a State_ which I found pretty useful in clarifying some of my disagreements with him (Brad, not Scott). What he sees as a fundamental problem in Scott (that Scott is a Hayekian in denial, and that his denial of his intellectual heritage leads him erroneously to claim that markets are harmful to human freedom) I see as pointing to an important, but underplayed set of themes in Scott’s argument. Which is to say that I would have liked Scott to develop the reasons why he disagrees with Hayek more explicitly, but I think that they are clearly present in the book, and are in some respects at least, compelling. [click to continue…]

Following up my post on consumption and living standards in the US, there was a fair bit of discussion of what’s been happening to leisure. Juliet Schor and others have argued that the long-term trend towards reduced hours of work and more leisure reversed some time in the 1970s, and people have been working harder since then. A study by Aguair and Hurst (the final QJE article is subscription-only, but I found a preliminary version here) has been widely quoted as proving the opposite (here, for example, by Tyler Cowen) and the abstract seems to support this interpretation, saying “We find that a dramatic increase in leisure time lies behind the relatively stable number of market hours worked between 1965 and 2003.”

However the data periods don’t exactly match up. It turns out that, using any of the definitions of leisure considered by Aguair and Hurst, the majority of the increase in leisure time took place between 1965 and 1975, and most measures show little change since 1985.

There’s an important gender/family dimension too. On Aguair and Hurst measures 1 and 2 (which exclude child care), leisure time for women peaked in 1985 or 1993 and has declined since then, while leisure time for men has been increased marginally since 1985.

So that readers can make their own comparisons, I’ve extracted the relevant table, which is over the fold. I’d say it matches Schor’s story (increasing leisure until the late 70s followed by a decline) at least as well as that suggested by the authors (“dramatic” long-term increases in leisure)

There’s lots more data in the Aguiar and Hirst paper and one point worth noting is that the trend in the distribution of leisure time is the opposite of that in income. High income, high education people have experienced a significant decline in leisure relative to those with low income and low education. That somewhat offsets the growth in income inequality over the same period. Also, combined with the gender pattern I already mentioned, it almost certainly means that educated women have, on average, less leisure than in the late 1970s.

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One of the striking features of US economic data is that, at least on its face, it shows that most measures of median income (wage rates, household incomes and so on) haven’t changed much in recent decades. Here’s a fairly typical example, reporting that American men in their 30s have, on average, lower wages than their fathers did at the same age. Median household income did a bit better in the decades after 1970, because of greater labour force participation by women, but hasn’t shown any any clear increase since about 2000. Average household size may have decreased a little bit, but the effect is not large. In summary, the general evidence is that the average (median) American depending on labour income hasn’t seen a significant improvement in real income for a long time.

That doesn’t seem to square with casual observation suggesting that consumption of most things by most people has gone up. Of course, savings have declined, but that can scarcely be the whole story. An obvious implication of declining incomes is that, if consumption of some things has gone up, consumption of others must have gone down. This is all the more so, given that there are new items of consumption (computers, for example) that didn’t even exist a few decades go, leaving less for expenditure on goods and services that were available then.

So, I’m always on the lookout for examples suggesting that consumption of some category of good or service has declined in real, quality adjusted terms.

Here’s one example I’ve found. According to the NYT, Americans have worse teeth now than a decade ago.

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“Tyler Cowen”:http://www.marginalrevolution.com/marginalrevolution/2007/10/leonid-hurwic-1.html on the Nobel prize going to the mechanism design crowd.

In other words, no incentive scheme, no matter how clever, can get people to tell the truth. Grove, Clarke, Tideman, and Tullock lurk in the hallways. Note that a second price auction (let everyone bid and the winner pays the price of the next highest bid) fails in terms of Paretian optimality. The government takes the second price bid from the winner, but what should it do with the money? Either the government wastes resources by destroying wealth, or it redistributes that wealth in some way but then the resulting redistribution in turn feeds back into bids and we can no longer derive truth-telling as optimal (but is this really a practical problem?; my fear is that the entire incentive-compatibility literature has never gotten at the real reason why we don’t run the entire economy as a second-price auction.)

One of my favourite papers of all time, Gary Miller and Thomas Hammond’s “Why Politics is More Fundamental Than Economics: Incentive Compatible Mechanisms are Not Credible,” “makes exactly this argument”:http://jtp.sagepub.com/cgi/content/abstract/6/1/5 (link to abstract: full paper is behind paywall for non-academics, unfortunately) using clear language and simple mathematics. It also makes clear (a) that the problem doesn’t vanish if the surplus goes to a private actor rather than government, hence suggesting that many private sector schemes to elicit information etc are similarly problematic, (b) that one plausible historical solution has been to elicit the creation of bureaucratic norms of professionalism that encourage administrators not to behave as selfish rational actors and (c ) that the surplus problem is, properly considered, where politics enters into the argument, and a way of getting at the real reasons why we don’t run the economy using these mechanisms.

Also notable is another paper that “Tyler links to”:http://www.marginalrevolution.com/marginalrevolution/2007/10/was-the-indian-.html on whether the Indian caste system was efficient or not. As Tyler notes politely, and Chris Hayes “more pungently”:http://www.chrishayes.org/blog/2007/oct/14/mainstream-economics/, this is a weirdly functionalist paper in the way that many economic analyses of institutions are weirdly functionalist. The professional deformity of the institutional economist is to seek explanations of institutional origins and change grounded in efficiency. In fairness, I should acknowledge that the professional deformation of the political scientist (and of many economic sociologists) is to seek explanations of institutions grounded in power and distributional questions, but it seems to me that this professional deformity gets things right _a lot more often_ (institutions that are genuinely grounded in the desire to promote collective efficiency are relatively rare, and the Indian caste system is rather obviously not one of these rare exceptions).

Update: see further “Jim Johnson”:http://politicstheoryphotography.blogspot.com/2007/10/2007-nobel-prize-economics-mechanism.html for a more detailed account of how mechanism design “unintentionally …establishes the fundamental importance of _politics_”. On distribution v. efficiency, see also this very interesting “new _AJS_ article”:http://www.indiana.edu/~tbsoc/AJS%20article.pdf (via “OrgTheory”:http://orgtheory.wordpress.com/2007/10/14/interests-and-the-creation-of-new-institutions/ ) which seeks to assess the merits of distributional and efficiency theories in explaining the origins of transnational private regulation. Finally, those looking for some (mathematically pretty hairy) intro materials on mechanism design theory should go to “Michael Greinecker”:http://yetanothersheep.blogspot.com/2007/10/readings-on-mechanism-design.html.

I’ve just noticed (thanks to Facebook) that my friend Martin O’Neill had “a splendid article on inheritance tax in last week’s New Statesman”:http://www.newstatesman.com/200710080002 . This is currently a hot topic in British politics, as Labour have reacted concessively to a populist Tory attack on the tax. You should read the whole thing, as Martin gives a very cogent explanation of why we should learn to love inheritance/estate taxes and of what’s wrong with the arguments against them. Martin concludes with a Rawlsian suggestion for progressive reform:

bq. To return from abstract arguments to concrete policies, what should Labour do about IHT, in reaction to the Tory proposals? The answer comes from an unexpected direction. The American philosopher John Rawls, in his final book Justice as Fairness, suggests that a just society should have a system of IHT that taxed beneficiaries rather than estates. In that way, inheritance could be taxed much more like income, and hence inheritance tax could be made progressive, through orienting it towards receivers rather than donors. Large estates need not attract any taxation, as long as they were dispersed among a number of relatively disadvantaged recipients. At the same time, even small estates could be taxed heavily if they were all left to others who were themselves already wealthy. Under this system of IHT, there could be no objection that the state was stopping middle-income families from “setting something aside” for their children. But, at the same time, this form of IHT would prevent wealth-transfers which greatly widened existing inequalities.

This Matt Yglesias post has already made it on to my colleague Andy McLennan’s door. It’s short enough to quote in full

I’m not sure I understand why Greg Mankiw thinks economists “don’t understand tipping.” When I was learning economics, I learned that people are utility-maximers and that whenever you see some behavior that doesn’t seem explicable in purely financial terms that must be because people are deriving utility from the foregone financial advantage. Thus, as any economist could tell you, people tip because of the utility they derive from the tipping in much the way that economists can explain all aspects of human life.

Have I ever mentioned that philosophers tend to think that economics is vacuous? Which isn’t to say that you shouldn’t listen to economists. These days, they tend to know a lot of math, and math is a very useful thing.

Matt omitted the irony alerts, but I tried to spell out the same point here.

Given any data on any observed set of problems involving the selection of one or more choices from a set of alternatives, the observed choices can be represented as the maximisation of an appropriately specified function.

Playing straight man to Matt, that doesn’t mean utility functions are useless – the functional representation lets you do lots of math that is much harder if you try to work directly with preferences. But any competent economist knows that utility isn’t an explanation of observed choices, it’s a way of representing them. The representation is simpler if choices satisfy some minimal consistency requirements, like transitivity (if you prefer A to B and B to C then you should prefer A to C).

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Alberto Alesina and Francesco Giavazzi at “VoxEU”:http://www.voxeu.org/index.php?q=node/596.

Our point is that the goals that are traditionally held dear by the European left – like protection of the economically weakest and aversion to excessive inequality and un-earned rewards to insiders – should lead the left to adopt pro-market policies. What has often been the norm in Europe from the 60s until recently – heavy market regulation, protection of the status quo, an enormous public sector which rewards not the very poor but the most-connected and requires highly distortionary taxation, universities which often produce mediocrity in the name of egalitarianism (while the very rich get a good education anyway, somehow) –all end up decreasing efficiency and justice at the same time. … A good example can be found in the labour market. In Italy, Spain, and France, the labour market is split. The young are hired with temporary contracts which offer no social security and no prospects. When the contract expires, the employer opts not to renew it, so as not to run the risk of having to convert temporary hires into permanent employees who would de facto immediately acquire the right never to be fired. Reforms that eliminate this duality by making the entire labour market flexible with an appropriate scheme of unemployment compensation would not only reduce unemployment but, most importantly, would favour the really poor and the young entry-level workers.

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Via John Gruber, here is a striking series of photographs of workers in toy factories in China. I wish I had seen them yesterday, because this morning I did a midterm review in my social theory course and, in quick succession, students asked me about Smith’s idea of the invisible hand and about Marx’s concept of commodity fetishism.

_Update_: More photos, from their originator, here.

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Via “Tyler Cowen”:http://www.marginalrevolution.com/, this “IHE article”:http://www.insidehighered.com/news/2007/10/03/heterodox covers the right orthodoxy vs. left heterodoxy debate in economics again, and seems to end up implying that it’s mostly happening in the heads of heterodox economists. For my money, that’s far too strong a conclusion – there is “genuine evidence”:http://www.atypon-link.com/AEAP/doi/pdf/10.1257/0895330053147976?cookieSet=1 that economics training pushes grad students further to the right, weeds out radical ideas etc. It may indeed be true that heterodox types exaggerate the degree of uniformity among the orthodox, but that is a somewhat different argument. Be that as it may, I found the article’s extensive discussion of Daniel Klein’s “counter-insurgency” against leftwing economists to be pretty interesting. According to the article, Klein starts from the position that economics should be a classical liberal creed, and that “the burden of proof should be on those who wish to intervene in markets.” Fair enough if that’s yer ideological druthers. But then he argues that:

there is also a bias, perhaps unconscious, in the media: “Basically they’re social-democratic periodicals, and probably journalists, writing those articles talking almost exclusively … to people on the left.”

This is a … striking claim – there’s plenty of survey evidence (Jonathan Chait discusses this in his recent book) that journalists tend to have somewhat right-of-center views on economic issues. I doubt that Klein (whose bread-and-butter appears to be survey evidence on professionals’ attitudes) is unaware of this; the only conclusion that I can come to is that Klein believes that the vast majority of people in the US, including many people who would be considered to be on the right and indeed consider themselves to be so, are in fact social democrats. If only, says me.

Clarification: Daniel Klein says in comments below that he was specifically referring to the journalists who wrote the pieces for The Nation, In These Times, the NYT and the Atlantic. This is, to me, a considerably more defensible claim with respect to The Nation and ITT (I’m skeptical about the NYT being social democratic on economic issues and the Atlantic is a resolutely centrist publication) , and suggests that I simply didn’t understand what seemed to me to be a pretty odd statement.

Andrew Leigh has pointed me to a recent study of US bankruptcy (paywalled, but the abstract is over the page). which concludes that the increased variability of income, and exposure to expense shocks such as medical expenses are not important factors in explaining the dramatic increase in bankruptcy rates since 1970. (I’ve seen a blog link to this also, but can’t find it now).

Count me as unconvinced. The main reason for rejecting income shocks is an explanation of bankruptcy is that, in the model of the paper, households should respond to increasing variance of permanent shocks by increasing precautionary savings. This appears to impute to households a much higher level of ex ante information about future income shocks than they actually possess, and also to rely critically on strong assumptions about rational planning. The whole credit card business is centred on the fact that lots of people (about half the population) don’t pay their monthly balances down to zero and therefore carry semi-permanent debt at very high interest rates. It’s hard to imagine that people who have trouble managing their credit cards are computing, in advance, the income risk they face and making precautionary savings to offset this.

That’s not to discount the importance of the ‘supply side’, in terms of easier access to credit, which has assisted people in managing increasingly risky income and expenses, at the cost of steadily increasing debt-income ratios. But you have to look at both sides of the story, and this paper rules out one side by assumption.
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Those interested in John’s post below should also take a look at Cosma Shalizi‘s long awaited, long heralded, post on econophysics, which went up yesterday. Following quickly on the heels of part IV of “dsquared’s Freakonomics review”:http://d-squareddigest.blogspot.com/2007/09/freakiology-yes-folks-its-part-4-of.html, this is surely a sign that End Times are upon us (biblical authorities seem to disagree on what the Third Sign is going to be; I leave plausible speculations thereon as an exercise for the reader).

Over at Cosmic Variance, Sean Carroll offers some admittedly uninformed speculation about utility theory and economics, saying

Anyone who actually knows something about economics is welcome to chime in to explain why all this is crazy (very possible), or perfectly well-known to all working economists (more likely), or good stuff that they will steal for their next paper (least likely). The freedom to speculate is what blogs are all about.

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This “Dean Baker piece”:http://www.prospect.org/csnc/blogs/beat_the_press_archive?month=09&year=2007&base_name=nyt_libels_germany_on_unemploy from a few days ago on how the _New York Times_ misrepresents the German welfare state got some well deserved attention. While I wholeheartedly agree with Baker’s basic point, I think that he perhaps lets the economics profession off the hook a little too easily. [click to continue…]