Economics/Finance

Steven Landsburg, perennial bete noire of people who want to say that economists aren’t an entirely baleful influence on public debate, is doing his poor man’s version of Freakonomics again over at Slate and attracting an entirely fair amount of opprobrium for doing so (via Matthew). This week, we have the “counterintuitive” “result” (note two different flavours of scare quotes here; the first set are mocking Landsburg for constantly referring to things as “counterintuitive” when they are actually just silly, while the second set is there in order to indicate that his argument is intended to resemble a result from economics, but is no such thing) that turning off the ventilators of patients too poor to pay their medical bills is the right and even the moral thing to do. I don’t think anyone was ever likely to have been convinced by this, but below I present an argument which might help to sort out cases in which economists might have something useful to add to a debate of this kind, from cases like this where they probably don’t.
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A commenter in “our previous post”:https://crookedtimber.org/2005/12/21/posner-forgets-himself/ points to “this chat session”:http://www.washingtonpost.com/wp-dyn/content/discussion/2005/12/20/DI2005122001142.html with Posner, hosted by the _Washington Post_. Besides forgetting everything he ever learned about public choice theory, Posner also seems to have abandoned the cost-benefit methods which made him famous. He is now convinced that radical uncertainty is not amenable to probabilistic analysis:

*Question*: … Nothing in the Constitution does (or could) provide a guarantee of safety. I suspect that I am statistically much more at risk of being run over by a car than of being killed by a terrorist (even though I live within five miles of the White House). Should the government ban all automobiles to protect me?

*Richard Posner*: If your premise were correct, your conclusion would follow. But how do you know you’re at less risk of being killed by a terrorist than being run down by a car? The risk in the sense of probability of being killed by a nuclear bomb attack on Washington, a dirty-bomb attack, an attack using bioengineered smallpox virus, a sarin attack on the Washington Metro (do you ever take the metro?), etc., etc., cannot be quantified. That doesn’t mean it’s small. For all we know, it’s great. Better safe than sorry.

How far this all is from the confidence with which Posner “typically slaps probabilities on things”:https://crookedtimber.org/2004/12/06/posner-and-becker-comedy-gold in order to justify some policy. Here he is arguing about preventive war in 2004:

Should imminence be an absolute condition of going to war, and preventive war thus be deemed always and everywhere wrong? Analytically, the answer is no. A rational decision to go to war should be based on a comparison of the costs and benefits … Suppose there is a probability of .5 that the adversary will attack at some future time, when he has completed a military build up, that the attack will, if resisted with only the victim’s current strength, inflict a cost on the victim of 100, so that the expected cost of the attack is 50 (100 x .5), but that the expected cost can be reduced to 20 if the victim incurs additional defense costs of 15. Suppose further that at an additional cost of only 5, the victim can by a preventive strike today eliminate all possibility of the future attack. Since 5 is less than 35 (the sum of injury and defensive costs if the future enemy attack is not prevented), the preventive war is cost-justified.

I guess his epistemological position has changed a great deal in the meantime. Incidentally, about “forty two thousand people a year”:http://www-fars.nhtsa.dot.gov/ are killed in automobile accidents in the United States. Do the math yourself.

Given the unwillingness of the Bush Administration to offer any policy response to the massive growth in the US trade and current account deficits, it is not surprising to observe a steady stream of theories explaining that such deficits can be sustained indefinitely.

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Interesting article by Steve Landsburg in Slate about how to calculate the opportunity costs for future income of becoming a mother. He’s reporting a study by Amalia Miller (pdf), who claims that delaying childbirth for a year in your twenties increases your prospective income by 10%. I was most interested in the method, and am even more interested in hearing what economists have to say about the method and the findings (open invitation). Landsburg on the method:

How does Miller know her findings are reliable? It would never do for her to simply compare the wages of women who gave birth at different ages. A woman who gives birth at 24 might be a different sort of person from a woman who gives birth at 25 and those differences might impact future earnings. Maybe the 24-year-old is less ambitious. Or worse yet (worse from the point of view of sorting out what’s causing what), maybe the 24-year-old started her family sooner precisely because she already saw that her career was going badly.

So, Professor Miller did something very clever. Instead of comparing random 24-year-old mothers with random 25-year-old mothers, she compared 24-year-old mothers with 25-year-old mothers who had miscarried at 24. So, she had two groups of women, all of whom made the same choices regarding pregnancy, but some of whom had their first children delayed by an act of chance.

I’ve spent a lot of time trying to work out what’s been going on with income and consumption inequality in the United States. Partly that’s because the subject is of interest in itself and partly because social and economic developments in the English-speaking world often (not always) follow the lead of the US.

However, there seem to be lots of contradictions in the data, and between data and popular perceptions, for example regarding social mobility and consumption inequality. I’ve finally managed to sort out what seems (to me, at any rate) to be a coherent account of what’s going on. A list of the main points follows, with supporting links, some of which may require registration/subscription. I’ve tried to indicate which bits of the story reflect my judgements, and which are drawn from the literature.

Comments and criticism on this are most welcome.

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What with one thing or another, thinking among the thoughtful is now turning to the subject of getting out of Iraq. As someone who opposed getting in there, I just wanted to set down a quick note on an important point; just as I always insisted before the invasion[1] that the question was not “War?” but “this war now?”, it also has to be taken into account that the question now is not “Withdrawal?” but “withdrawal now?”.
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Norman Geras has a “little post on inequality today”:http://normblog.typepad.com/normblog/2005/11/deeply_wrong.html . I’m happy to report that Geras still believes that inequality is a bad thing. However, he can’t let the matter go without writing a few lines directed at those whom he sees as America’s detractors, who made a fuss about the inequality exposed by Hurricane Katrina despite the manifest inequalities of their own societies.

bq. As if the issue was somehow absent before Katrina, isn’t with us continuously. Or as if it was an issue specific to America, and not a general feature of capitalist societies – in which the circumstances of many people’s lives are permanently of a sort that it would horrify others luckier and more privileged to be plunged into.

Well, yes, all capitalist societies _are_ unequal societies. But they are not unequal to the same degree, and among advanced capitalist societies the United States happens to be a significant outlier. Taking the “Gini coefficient as an indicator”:http://www.nationmaster.com/graph-T/eco_dis_of_fam_inc_gin_ind&int=-1 , the US comes in with a score of 45 with other “anglosphere” countries being closest to it among developed countries. Moreover the US does very badly compared to those other countries on measures such as the UN’s Human Poverty Index (17th out of 18 selected OECD countries in in the “2005 report”:http://hdr.undp.org/reports/global/2005/pdf/HDR05_HDI.pdf (pdf) , p. 231). So emphasising America’s peculiar position is not, contra Geras, an indication of irrational anti-Americanism but a reflection of the harsh facts.

I’ve “complained in the past”:https://crookedtimber.org/2003/07/22/learned-friends/ about the lack of an SSRN equivalent for political scientists (while APSA has put together a portal site for papers, it still leaves something to be desired; e.g. no stable permalinks). Now SSRN has created a new “working paper series”:http://www.clpenet.ca/mission.html which aims to bring together “international studies in comparative law and political economy.” This looks to be a great resource – the idea is to bring scholars in relevant fields of comparative politics, comparative law, international political economy and economic sociology into a single debate. There’s a lot of fascinating work on new modes of international and domestic governance – but it’s difficult to keep track of, because it’s split across several disciplines.Worth “signing up for”:http://hq.ssrn.com/jourInvite.cfm?link=LSN-RES-all-inclusive-journal.

I’ll leave it to John Q to “comment”:https://crookedtimber.org/2005/10/24/bernanke-appointed-us-fed-chairman/ on the upcoming Bernanke era at the Fed. But the “New York Times article”:http://www.nytimes.com/2005/10/25/business/25profile.html?hp&ex=1130212800&en=c3800de0e066c491&ei=5094&partner=homepage about his appointment is funny:

*White House Gamble Pays for a Princeton Professor*

Even before President Bush named Ben S. Bernanke as chairman of the Council of Economic Advisers this spring, Mr. Bernanke decided to gamble. He sold his home in New Jersey last year and told friends that, instead of returning to a tenured professorship at Princeton University, he was taking a chance that President Bush would elevate him from obscurity as a Federal Reserve governor to a top political appointment.

The gamble paid off.

It’s Nerves of Steel Bernanke! He takes the chance of selling his lovely home in a prime Princeton location — at the peak of a huge real estate bubble! He bets that he will be appointed to the Fed, bravely facing the bleak and frightening possibility that — should Bush choose someone else — he would be snapped up by the top-ranked economics department of his choice. He knows no fear!

Don’t get me wrong: I think Bernanke is a good guy, and he was the obvious choice for the job. I just like the way the Times is spinning it. If anything, the fact that he can make a decision with no real downside look like a bet-the-farm gamble suggests he has what it takes to chair the Fed.

Ben Bernanke has been appointed to replace Alan Greenspan, who’s been Chairman of the US Federal Reserve for just about as long as I can remember (the Volcker squeeze was in the early 80s, so he hasn’t been there forever, but it often seems that way).

Bernanke was the obvious candidate, but there was always the possibility that Bush would decide to mend fences with the base by appointing some obscure* supply-sider a la Harriet Miers.

Bernanke’s appointment suggests a general bias towards an expansionary monetary policy . He was prominent in saying that the Fed would not tolerate deflation, and could print money if necessary. More recently, he’s taken a very relaxed view of the US current account deficit, seeing it as the inevitable counterpart to a ‘global savings glut’. I agree with him on the first point but not on the second; there’s a significant risk that the wheels will fall off the entire policy, leading to a rapid depreciation of the dollar and an uncontrolled increase in interest rates.

Market movements were consistent with this analysis (stock prices went up, the dollar fell and the 10-year bond rate rose), but weren’t very big, suggesting that no-one is expecting really big changes.

* This is a redundancy, as there are no prominent supply-siders in the US economics profession. That is, not in the sense of supply-side popularised by Jude Wanniski and Arthur Laffers, although Mundell shares the supply-side liking for a gold standard. Almost all economists are supply-siders in the sense that they think attention should be paid to the supply side of the economy as well as the demand side.

Discussion of game theory inevitably brings up the question of whether game theory relies on an assumption of rational behavior, and, if so, whether this is a weakness or a strength. Rather than respond, I thought I’d dig up this old post from my long-abandoned (but still planned-to-be-revived-one-day) Word for Wednesday series. I’ve added a couple of links and made some minor changes.

Shorter JQ: the word ‘rational’ has no meaning that cannot better be conveyed by some alternative term. Avoid it.

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The excellent “Equality Exchange”:http://mora.rente.nhh.no/projects/EqualityExchange/ — a repository for papers about the theory and practice of equality from philosophers, political scientists, sociologists, lawyers and economists — has moved. Adjust your bookmarks for the new site, and take the opportunity to have a look around one of the most valuable resources for political theorists and philosophers.

The latest Nobel Prize award to Aumann and Schelling has generated a bit of discussion about the value or otherwise of game theory. Generally speaking, economists are enthusiastic about game theory and other social scientists less so. Although I admire the work of Aumann and (even more) Schelling, as economists go, I’m a game-theory sceptic, for a fundamental reason I’ll try, probably unsuccessfully, to explain.

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Tom Schelling and Robert Aumann have been awarded this year’s Bank of Sweden Memorial Prize. Tyler Cowen at Marginal Revolution provides some information about both of them (“Schelling”:http://www.marginalrevolution.com/marginalrevolution/2005/10/schelling_and_a_1.html, “Aumann”:http://www.marginalrevolution.com/marginalrevolution/2005/10/robert_aumann_n.html). Schelling’s work is probably the better known of the two outside of economics, because in addition to being excellent it’s very readable. I use a chunk of his classic “Micromotives and Macrobehavior”:http://www.amazon.com/exec/obidos/ASIN/0393090094/kieranhealysw-20/ref=nosim/ in my undergraduate social theory class, for instance. We read a bit of _The Wealth of Nations_ and then we read some Schelling, partly in order to get across the idea that co-ordination can be disaggregated and bottom-up process, and partly to see that markets are also a special case of a bigger class of co-ordination problems.

From an outsider’s perspective, and speculating a bit on the politics of it all, the result seems like an interestingly balanced way to mark the rise of game theory in economics. While Schelling’s work is analytically acute (and the man himself is famously sharp in discussion), it is not presented in a technical mode. You can sit down and read the essays. Aumann, on the other hand, represents a much more mathematized wing of the field, proving theorems and developing new conceptual tools with precise formal properties. So, for instance, while Schelling can write essays like “Strategic Relationships in Dying” and “The Mind as a Consuming Organ”, Aumann’s papers have titles like “The Bargaining Set for Cooperative Games” and “Subjectivity and Correlation in Randomized Strategies.” The prize committee has seemed to make these kind of balanced choices on other dimensions before, sometimes in consecutive years (Merton and Scholes followed by Sen) sometimes in the same year (Kahneman and Vern Smith).

On a side note, I’m not surprised to “learn from Tyler”:http://www.marginalrevolution.com/marginalrevolution/2005/10/schelling_and_a_1.html that Schelling was his mentor. You can see it in the way he thinks about problems.