Economics/Finance

In the UK the press and commentariat have been in a huff about Labour’s proposal to levy income tax at 50% on incomes above £150,000. This is supposedly “anti-business” and “sends the wrong signal”, despite the fact that the top rate was higher under Thatcher. Much noise also about the danger that “wealth creators” (whoever they are) may leave and go off to other jurisdictions, concern unaffected by the fact that lots of other countries tax those on high incomes at a steeper rate. All of this is to be expected of course, as is the fact that journalists, who, when spouting right-wing guff, claim to be “reflecting” the views of their readers, continue to spout it when those readers disagree, as in this case.
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The term “New Old Keynesian” was coined by Tyler Cowen a couple of years ago, to describe the revival of the view that the Keynesian analysis of recessions caused by lack of aggregate demand is relevant, not only in the short run (in this context, the time taken for wage contracts to reset, say 2-3 years) but in the long run (5 years or more) as well. When Cowen was writing, in September 2011, the New Depression could still, just about, be seen as a short run phenomenon[1]. In particular, the anti-Keynesian advocates of austerity in the US, UK and Europe were predicting rapid recovery.

As 2014 begins, it’s clear enough that any theory in which mass unemployment or (in the US case) withdrawal from the labour force can only occur in the short run is inconsistent with the evidence. Given that unions are weaker than they have been for a century or so, and that severe cuts to social welfare benefits have been imposed in most countries, the traditional rightwing explanation that labour market inflexibility [arising from minimum wage laws or unions], is the cause of unemployment, appeals only to ideologues (who are, unfortunately, plentiful).

So, on the face of it, Cowen’s “New Old Keynesianism” looks pretty appealing. But what are the alternatives? Leaving aside anti-Keynesian views for the moment, the terminology suggests four logical possibilities: Old Old Keynesianism, Old New Keynesianism, New Old Keynesianism and New New Keynesianism.

But do these logical possibilities correspond to actual viewpoints, and, if so, whose?

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Not from a parody account, it would appear:

Pope Francis’s new Apostolic Exhortation, [Evangelii Gaudium](http://www.vatican.va/holy_father/francesco/apost_exhortations/documents/papa-francesco_esortazione-ap_20131124_evangelii-gaudium_en.html), has been getting some attention today, mostly thanks to its reiteration of some long-standing Catholic doctrine on social justice and the market. So, here is a quiz to see whether you can distinguish statements by Pope Francis from statements by Karl Marx. I figured someone was likely to do this anyway, so why not be first to the market? It’s fair to say that the Pope and Karl Marx differ significantly on numerous points of theory as well as on what people asking questions at job talks refer to as the policy implications of their views. So I don’t think this quiz is very hard. At the same time, I sort of hope it will be picked up, stripped of this introductory paragraph, and circulated as evidence that the Pope and Marx agree on pretty much everything.

### Questions!

> *1.* In a similar way, by raising dreams of an inexhaustible market and by fostering false speculations, the present treaty may prepare a new crisis at the very moment when the market of the world is but slowly recovering from the recent universal shock.

> *2.* … society needs to be cured of a sickness which is weakening and frustrating it, and which can only lead to new crises.

> *3.* In this play of forces, poverty senses a beneficent power more humane than human power. The arbitrary action of privileged individuals is replaced … Just as it is not fitting for the rich to lay claim to alms distributed in the street, so it is also in regard to these alms of nature.

> *4.* Yet we desire even more than this; our dream soars higher. We are not simply talking about ensuring nourishment or a “dignified sustenance” for all people … for it is through free, creative, participatory and mutually supportive labour that human beings express and enhance the dignity of their lives.

> *5.* … the limitless possibilities for consumption and distraction offered by contemporary society. This leads to a kind of alienation at every level, for a society becomes alienated when its forms of social organization, production and consumption make it more difficult … to establish solidarity between people.

> *6.* Today everything comes under the laws of competition and the survival of the fittest, where the powerful feed upon the powerless. As a consequence, masses of people find themselves excluded and marginalized: without work, without possibilities, without any means of escape.

> *7.* In this system, which tends to devour everything which stands in the way of increased profits, whatever is fragile … is defenseless before the interests of a deified market, which becomes the only rule.

> *8.* Inequality eventually engenders a violence which recourse to arms cannot and never will be able to resolve. … Some simply content themselves with blaming the poor and the poorer countries themselves for their troubles; indulging in unwarranted generalizations, they claim that the solution is an “education” that would tranquilize them, making them tame and harmless.

> *9.* The worldwide crisis affecting finance and the economy lays bare their imbalances and, above all, their lack of real concern for human beings; man is reduced to one of his needs alone: consumption.

> *10.* Solidarity is a spontaneous reaction by those who recognize that the social function of property and the universal destination of goods are realities which come before private property.

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That’s the title of my new piece at Jacobin, which links back to a variety of discussions we’ve had here at CT, in particular this one from Ingrid. Mankiw, whom Ingrid cites, offers an implicit defence of the 1 per cent, implying though not quite asserting, that the gains accruing to those in this group (largely senior executives and the financial sector) have been the price we pay for a process that benefits everyone, yielding a Pareto improvement. As Ingrid says, Pareto improvements aren’t as self-evidently desirable as Mankiw assumes. My argument focuses on Mankiw’s factual premise, concluding that the expansion of the financial sector has made the majority of people worse off. This implies that a response to the global financial crisis focused on attacking the financial sector is feasible as well as being, in my view, politically necessary as an alternative to rightwing populism.

Jacobin doesn’t appear to have a comments section, so feel free to comment and criticise here. I’ve had an interesting discussion with Daniel on Twitter already, but it’s not really a great medium when more than a few people are involved.

Actually, that’s an unnecessarily coarse title for this post, which is a pointer to a thoughtful, timely and by all accounts superbly executed play about bankers’ role in Ireland’s financial crisis. Journalist documentary-maker Colin Murphy (full disclosure, an old and dear friend) has written a play called ‘Guaranteed. It tries to get to the heart of what the *%$%ing £$%! happened in 2008, using official documents and interviews with insiders. Let’s just say it’s a little more insightful than Michael Lewis’ back of the taxi/fag packet journalism, and goes gratifyingly against the official grain.

‘Guaranteed’ is in Waterford tonight, Dun Laoghaire on Tuesday and Wednesday, then around the country till the 29th.

A palate cleanser afterward might be Colm McCarthy’s recent piece in the Indo, marking the triumvirate of ECB/IMF/EC and their involvement in Ireland’s forced bail-out out of 10. You may be surprised by who scored highest.

For a while I have been working on a paper on democracy, expert knowledge, and economics as a moral science. [The financial crisis plays a role in the motivation of the paper, but the arguments I’m advancing turn out to be only contingently related to the crisis]. One thing I argue is that, given its direct and indirect influence on policy making and for reasons of democratic accountability, economics should become much more aware of the values it (implicitly or explicitly) endorses. Those values are embedded in some of the basis concepts used but also in some of the assumptions in the theory-building.

The textbook example in the philosophy of economics literature to illustrate the insufficiently acknowledged value-ladenness of economics is the notion of Pareto efficiency, also known as ‘the Pareto criterion’. Yet time and time again (for me most recently two days ago at a seminar in Oxford) I encounter economists (scholars or students) who fail to see why endorsing Pareto efficiency is not value-neutral, or why there are good reasons why one would not endorse the Pareto-criterion. Here’s an example in print of a very influential economist: Gregory Mankiw.
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Economics students from the University of Manchester have set up the Post-Crash Economics Society. The subtitle of their website summarizes their mission:

The world has changed, the syllabus hasn’t – is it time to do something about it?

I am probably getting old but in any case can’t suppress a déjà-vu feeling.

Paris June 2000.
Cambridge University June 2001.
The Kansas City Proposal August 2001.
Harvard University November 2011.

and there surely were more that I don’t recall.

Yet what’s interesting is that the Post-Crash group get strong support from a surprising corner. Is there someone out here/there who can tell us what an ‘early day motion’ in British Parliament precisely means, politically?

Twitter alerted me to an amusing exchange between Chris Auld, posting a list of “18 signs you’re reading bad criticism of economics and Unlearning Economics, responding with 18 Signs Economists Haven’t the Foggiest. UL suggests that Stephen Williamson manages an impressive 9 out of 18 in his review of Zombie Economics (my response here with more from Noah Smith.

Scoring myself against Chris Auld’s list, I’d say I’m in the clear. But quite a few commenters on Zombie Economics have made complaints along the lines of his point 1, that I focus too much on macroeconomics (and finance). The implication is that, even if macro is totally wrong, only a minority of economists do it, and microeconomists are in the clear.

This defense doesn’t work, at least not in general.

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I’m currently reading Scarcity by by Sendhil Mullainathan and Eldar Shafir. At this stage, I’m inclined to sympathise with the unnamed colleague who commented “There’s already a science of scarcity. It’s called economics”. So far, it’s mostly straightforward applications of the observation that time and attention are scarce resources, combined with some fairly familiar observations from behavioral econ on how people fail to optimise either the first-order problems of allocating a tight budget or the second order problem of allocating time and attention to the first-order problem (my terms here, not theirs). However, I’m only part way through, and the authors promise to show how their approach differs from the way in which economists would normally think about this kind of problem.

This post is about a specific and well known observation cited by Mullainathan and Shafir. Faced with paying $100 for an item that could be had elsewhere for $50, most people are willing to put in a fair bit of effort (say, driving for an hour) to get the lower price.[^1] On the other hand if the item costs $1050 and could be had for $1000, people with reasonably high incomes mostly pay up, instead of driving to the other store. This is obviously inconsistent with standard opportunity cost.
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Ingrid links to some fascinating discussion from Philip Mirowski of the role of Swedish domestic politics in the establishment of the Sveriges Riksbank Prize in Economic Sciences in Memory of Alfred Nobel, with emphasis on the way in which claims of “scientific” status for economics helped the claim of the Swedish central bank to independence from government.

In the broader context, it seems pretty clear that, if the idea had arisen even a few years later, it would have been rejected. In 1969, economics really did seem like a progressively developing science in which new discoveries built on old ones. There were some challenges to the dominant Keynesian-neoclassical synthesis but they were either marginalized (Marxists, institutionalists) or appeared to reflect disagreements about parameter values that could fit within the mainstream synthesis.

Only a few years later, all of this was in ruins. The rational expectations revolution sought, with considerable success, to discredit Keynesian macroeconomics, while promising to develop a New Classical model in which macroeconomic fluctuations were explained by Real Business Cycles. This project was a failure, but led to the award of a string of Nobels, before macroeconomists converged on the idea of Dynamic Stochastic General Equilibrium models, which failed miserably in the context of the global financial crisis. The big debate in macro can be phrased as “where did it all go wrong”. Robert Gordon says 1978, I’ve gone for 1958, while the New Classical position implies that the big mistake was Keynes’ General Theory in 1936

The failure in finance is even worse, as is illustrated by this year’s awards where Eugene Fama gets a prize for formulating the Efficient Markets Hypothesis and Robert Shiller for his leading role in demolishing it. Microeconomics is in a somewhat better state: the rise of behavioral economics has the promise of improved realism in the description of economic decisions.

Overall, economics is still at a pre-scientific stage, at least, as the idea of science is exemplified by Physics and Chemistry. Economists have made some important discoveries, and a knowledge of economics helps us to understand crucial issues, but there is no agreement on fundamental issues. The result is that prizes are awarded both for “discoveries” and for the refutation of those discoveries.

Wait, why do we have actually have The Sveriges Riksbank Prize in Economic Sciences in Memory of Alfred Nobel ? If you have ten minutes to spare, Philip Mirowski will give us part of the answer, and tell us about his research project investigating this issue.

Catherine Hill, President of Vassar, at the Washington Post explaining the rapid increase in tuition at elite colleges:

Increased access to higher education would help moderate the expansion in income inequality over time. Yet the increasing inequality itself presents obstacles to achieving this goal.

Real income growth that skews toward higher-income families creates challenges for higher education. The highest-income families are able and willing to pay the full sticker price. Schools compete for these students, supplying the services that they desire, which pushes up costs. Restraining tuition and spending in the face of this demand is difficult. These students will go to the schools that meet their demands.

Hence the proliferation of climbing walls and luxury dorms at selective and highly selective colleges (one college president told me that the climbing wall is a highlight of the college tour at both the private colleges he has led). Highly selective education is a positional good, and wealthy families have become enormously wealthier over the past 30 years and have been having fewer children: what are they going to do with all that money? Compete with each other to get their children into the best possible position, thus bidding up the price of highly elite colleges, making it unaffordable for others. In fact, elite colleges respond by using some of the revenues from those who cheerfully pay full price to subsidize students whose families cannot:

At the same time, many schools are committed to recruiting and educating a socioeconomically diverse student body. At private, nonprofit institutions, this commitment has been supported through financial aid policies.

Telling elite schools to keep down tuition doesn’t help:

Ironically, some of the proposed “solutions” to make higher-education finances sustainable would exacerbate future income inequality rather than address the trends that are creating financial challenges for institutions.

For example, in his 2012 State of the Union address, Obama called on colleges to slow down tuition increases and threatened to reduce public support. “If you can’t stop tuition from going up, the funding you get from taxpayers will go down,” he said. But slow tuition growth not tied to offsetting expenditure savings can result in reductions to financial aid. This is playing out in the private, nonprofit sector. Lower tuition combined with lower financial aid benefits higher-income students and hurts lower-income students.

Of course, public institutions, which are the main resort for lower income families, are different. They are the main resort partly because they have traditionally had a low-tuition, low-aid, model, and I cannot tell you how many students I have talked to who were deterred from applying to more selective private schools by the sticker price, applied only to Madison because it had low tuition, but who, I know, would be in much less debt than they are if they had applied to and attended the more selective, elite, private schools that they spurned because of the sticker price (which they would not have had to pay). Anyway, well worth reading the whole piece.

Alex Pareene at Salon points to a bunch of evidence showing, in essence, that the rich look out for themselves and their kids, and no one else, then to a piece by Andrew Ross Sorkin defending nepotism in the US, and by extension in China. There was a time, not so long ago, when Asia’s reliance on guanxi and similar networking practices was denounced as ‘crony capitalism’, to be contrasted with the pure and hard-edged version to be found in the US. This was supposed to explain the vulnerability of Asian economies to the crisis of 1997, and the stability of the US, then well into the Great Moderation.

A few years later, in the very early days of blogging, I wrote a post pointing out that the eagerness of financial sector workers to congregate in the same physical location, even though their work was supposed to be based on objective evaluation of data transmitted by computer, was pretty good evidence that the “global city” phenomenon, much in vogue at the time, was just guanxi writ large.

I turned that into a magazine article at Next American City (now Next City, whose web site seems to have lost it). Then I wrote a longer and more academic version and submitted it a lot of journals in economic geography, urban geography and so on, none of whom were interested. I think it stands up well in retrospect (much more so than most of the ‘global city’ literature, at any rate), but of course I’m biased.

At any rate, at least now everyone, and not least a defender and beneficiary of the system like Sorkin, is comfortable with the notion that capitalism is a rigged game, in which the ability to fix the next round is part of the prize for winning this one.

Update/clarification I’ve implicitly taken the efficient markets hypothesis as a benchmark, and assumed that features of the financial sector (for example, physical colocation) that can’t be explained by EMH are likely indicators of cronyism. It’s possible to take the view that the financial sector does things that are inconsistent with EMH, but nevertheless socially beneficial. An obvious example is the kind of opaque, over-the-counter derivatives that Dodd-Frank has tried to ban, and that the finance sector is lobbying hard to protect: it seems clear that doing these kinds of deals would benefit from face-to-face contact. So, if such deals are, in aggregate, socially beneficial, my argument fails – the converse also holds.