What do models tell us?

Josh Hendrickson has a new post that defends the use of models that might in some respects be viewed as “unrealistic”. I agree with his general point about models, and also his specific defense of models that assume perfect competition. But I have a few reservations about some of his examples:

Ricardian Equivalence holds that governments should be indifferent between generating revenue from taxes or new debt issuances. This is a benchmark. The Modigliani-Miller Theorem states that the value of the firm does not depend on whether it is financing with debt or equity. Again, this is a benchmark. Regardless of what one thinks about the empirical validity of these claims, they provide useful benchmarks in the sense that they give us an understanding of when these claims are true and how to test them. By providing a benchmark for comparison, they help us to better understand the world.

With all that being said, a world without “frictions” is not always the correct counterfactual.

Taken as a whole, this statement is quite reasonable.  But I would slightly take issue with the first sentence, which is likely to mislead some readers.  Ricardian Equivalence doesn’t actually tell the government how it “should” feel about the issue of debt vs. taxes, even if Ricardian Equivalence is true.  Rather it says something like the following:

If the government believes that debt issuance is less efficient than tax financed spending because people don’t account for future tax liabilities, that belief will not be accurate if people do account for future tax liabilities.

But even if people do anticipate the future tax burden created by the national debt, heavy public borrowing may still be less efficient than tax-financed spending because taxes are distortionary, and hence tax rates should be smoothed over time.

I happen to believe Ricardian Equivalence is roughly true, but I still don’t believe the government should be indifferent between taxes and borrowing.  Similarly, I believe that rational expectations is roughly true, and yet also believe that monetary shocks have real effects due to sticky wages.  I believe that the Coase Theorem is true, but also believe that the allocation of resources depends on how legal liability is assigned (due to transactions costs).  Models generally don’t tell us what we should believe about a given issue; rather they address one aspect of highly complex problems.

Here’s Hendrickson on real business cycle theory:

Since the RBC model has competitive and complete markets, the inefficiency of business cycles can be measured by using the RBC as a benchmark. In addition, if your model does not add much insight relative to the RBC model, how valuable can it be?

[As an aside, I agree with Bennett McCallum that either the term ‘real business cycle model’ means a model where business cycles are not caused by nominal shocks interacting with sticky wages/prices, or else the term is meaningless.  There is nothing “real” about a model where nominal shocks cause business cycles.]

Do RBC models provide a useful benchmark for judging inefficiency?  Consider the following analogy:  “A model where there is no gravity provides a useful benchmark for airline industry inefficiency in a world with gravity.”  It is certainly true that airlines could be more fuel efficient in a world with no gravity, but it’s equally true that they have no way to make that happen.  I don’t believe that gravity-free models tell us much of value about airline industry efficiency.

In my view, the concept of efficiency is most useful at a policy counterfactual.  Thus monetary policy A is inefficient if monetary policy B or C produces a better outcome in terms of some plausible metric such as utility or GDP or consumption.  (I do understand that macro outcomes are hard to measure (especially utility), but unless we have some ability to measure outcomes then no one could claim that South Korea is more successful than North Korea.  I’m not that pessimistic about our knowledge of the world.)

In my view, you don’t measure inefficiency by comparing a sticky price model featuring nominal shocks against a flexible price RBC model, rather you measure efficiency by comparing two different types of monetary policies in a realistic model with sticky prices.

That’s not to say that there are not aspects of RBC models that are useful, and indeed some of those innovations might provide insights into thinking about what sort of fluctuation in GDP would be optimal.  But I don’t believe you can say anything about policy efficiency unless you first embed those RBC insights (on things like productivity shocks) into a sticky wage/price model, and then compare policy alternatives with that model.  I view sticky prices as 90% a given, much like gravity.  (The other 10% is things like minimum wage laws, which can be impacted by policy.)

PS.  Just to be clear, I agree with Hendrickson on the more important issues in his post.  My support for University of Chicago-style perfect competition models definitely puts me on “team Hendrickson”, especially when I consider the direction the broader profession is moving.

(0 COMMENTS)

Read More

Skidelsky on Economics

On our sister website, Law and Liberty, I have a review of Robert Skidelsky’s last book, What’s Wrong With Economics. I was unimpressed by the book. It looks to me like an attempt to build a straw man out of modern economics, which is blamed by Skidelsky for, of course, “neoliberal” policies.

The book is strongly idoelogical but, leaving ideology aside for a minute, I was amazed by the view of the social sciences Lord Skidelsky proposes.

He

is apparently incapable of understanding the pursuit of social science as something different from policy punditry. It is revealing that Skidelsky is puzzled by a quote from Milton Friedman, who charmingly described himself as “somewhat of a schizophrenic”: “On the one hand, I was interested in science qua science, and I have tried—successfully, I hope—not to let my ideological viewpoints contaminate my scientific work. On the other, I felt deeply concerned with the course of events and I wanted to influence them so as to enhance human freedom.” Some economists, political scientists, or philosophers may enter their fields because of their political vision of how the world should be improved. Yet it does not mean that they do not try to challenge their own opinions about the facts. Nor does it mean that they may not be, in pursuing their studies, interested merely in understanding how or why a particular phenomenon happened. Friedman honestly described a difficult navigation which is hardly exclusive to the economist. (Consider a Democratic reporter at the Republican National Convention, for instance.)

The review is here.

(0 COMMENTS)

Read More

It’s Complicated: A Syllogism

Consider this general syllogism:

 

Issue X is complicated.

Perspective Y’s position on X is not complicated.

Therefore, Perspective Y is wrong about X.

 

It’s a solid argument, and one we can apply to endless pressing issues.

 

For instance:

Gender relations are complicated.

MeToo’s position on gender relations is not complicated.

Therefore, MeToo is wrong about gender relations.

 

Or:

Relations with Russia are complicated.

Russia hawks’ position on Russian relations is not complicated.

Therefore, Russia hawks are wrong about Russian relations.

 

Could people misuse this syllogism as an excuse to dismiss any view they don’t like?  Sure.  But it probably matters not, because there’s an infinite supply of such excuses.

Could people use this syllogism to swiftly dismiss views that aren’t worth their time?  Once again, sure.  And that’s a good thing, because we’re running short on time already.

 

 

(0 COMMENTS)

Read More

Economics: Prices, Pri-ces, P.R.I.C.E.S.

It is impossible to understand the economy—that is, the economic consequences of individual actions—without understanding the role that prices play or are prevented from playing. This was a crucial scientific discovery of modern times. For that very reason, microeconomic theory used to be called “price theory.” So it is troubling to observe that many of our contemporaries and even many financial journalists ignore that discovery. Even economists tend to forget it when their moral values or virtue signaling is at stake.

An illustration of the problem was given by a Wall Street Journal feature of August 21 titled “Why Are There Still Not Enough Paper Towels?” The role of prices and price controls is nowhere mentioned. The very word “price” only appears twice, mainly from a management perspective: the competition of “Japan’s low-price cars” in the 1970s and the fact that overcapacity “would not allow you to price in a way that meets customer needs.” This last phrase, from P&G’s chief executive, could be read as referring to prices established on free markets, but it is as close as the story comes to prices. Not surprisingly, the report cannot explain why a shortage of paper towels persists:

The United States of America, heralded as the land of plenty, still doesn’t have enough paper towels. … An average of 21% of household paper products were out of stock at U.S. stores as of Aug. 9

The story’s “economic” explanation is essentially that

[t]he scarcity is rooted in a decadeslong quest by businesses at all levels, handling many different products, to eke out more profit by operating with almost no slack.

In other words, the culprits are bad capitalists who are trying to maximize profits with tricks such as lean manufacturing and just-in-time delivery. The authors do not conclude, but they could as well have concluded, that this is why so few shortages exist under communism and socialism, in Cuba or Venezuela, not to mention the former Soviet Union.

The real reason for persistent shortages, as I explained in many recent Econlog posts (including “Why Shortages Are Not More Widespread,” August 17), is that prices are capped under the threat of government prosecution. It is that consumers are forbidden to bid up prices. It is that bad capitalists are forbidden to maximize profits to respond to consumer demand, except sometimes stealthily. Being an obedient government crony is becoming an easier path than serving consumers.

The featured image of the present post is a photograph I took last week of the gun counter at a major retailer in Maine. It illustrates what a “land of plenty” looks like when price adjustments along supply and demand curves are forbidden.

The Wall Street Journal story has some feebly redeeming value. It provides many examples of why marginal cost increases with production. It hints at the fact that reducing product diversity has been a stealth way of responding to consumer demand despite price controls. But as a purported explanation of why shortages persist, it is at best misleading.

(0 COMMENTS)

Read More

Bannon’s Nationalist Adventure: Natural Justice?

Economists assume that each individual has his own preferences that guide his actions. The moral problem starts when an individual wants to force his preferences on other individuals’ choices. If, for this kind of moral sin, God had wanted to strike Steve Bannon off his horse on the road to Damascus and perhaps punish him with a nervous breakdown, He would have done exactly what He did on August 20: get Bannon arrested by federal agents on a Coast Guard boat.

Bannon is the former Executive Chairman of Breitbart News and Trump adviser. A believer in providential or natural justice (which is of course something different from economics) might think that Bannon’s arrest was a wake-up call or punishment for his protectionist crimes, that is, conspiring to impose his own preferences by force on individuals who want to trade.

I suspect that when Bannon saw the Coast Guard boat approaching the yacht on which he was sailing along the Connecticut coast, his nationalist heart bounced in his manly chest. He must have thought something like: “Here is our great Coast Guard tasked with keeping foreigners and their goods off our coasts (including Mexican rapists if they ever try to get around The Wall). The mighty Coast Guard is here to protect me, an American citizen.”

 

Caravaggio, Conversion on the Way
to Damascus (Wikipedia Commons)

In fact, the Coast Guard was there to arrest him—another instance of a military unit assuming internal police functions, the sort of thing that the Founders feared from a permanent army.

I don’t know if Bannon is guilty of the crimes he is accused of, which have not been proven in court. And I will not discuss here the economics and ethics of the plethora and reach of laws that, in America like in other Western countries, give an air of quasi-inevitability and quasi-normalcy to the words of Lavrentiy Beria, chief of Soviet state security under Joseph Stalin: “Show me the man and I’ll show you the crime.”

It was not the least irony of Bannon’s nationalist adventure of August 20 that the Coast Guard originated from Revenue-Marine, a service created by Congress in 1790 at the request of Alexander Hamilton with the purpose of collecting customs duties—even if, at that time, tariffs were used more to finance a small government than to protect Americans from foreign goods. As usual for a government bureaucracy, mission creep has proceeded.

(0 COMMENTS)

Read More

I Win My Warren Bet

Over three years ago, I made the following bet with my friend Ben Haller:

I therefore offered Ben 2:1 odds against Warren being elected, and he’s accepted.  The bet gets called off if Warren doesn’t run… The stakes are my $100 against Ben’s $50.

Since Warren didn’t even get the vice-presidential nomination, Ben had just conceded the bet.

This brings my cumulative public betting record to 21 wins, 0 losses.

As I’ve conceded many times in the past, every bet contains signal and noise.  You can win via superior insight, or via luck.  A consistent track record of wins, however, is almost all signal.  If an unbroken streak of 21 wins on an immense variety of topics does not confirm the winner’s superior sagacity, what would?

That said, none of my “superior sagacity” let me foresee the pandemic, the global shutdown, or the baffling full recovery of the stock market.  So while none of the outcomes of my bets greatly surprised me, the world still deeply confuses me.  At least I can draw a little comfort from the old adage, “If you’re not confused, you don’t understand what’s going on.”

 

(0 COMMENTS)

Read More

Silence is Stupid, Argument is Foolish

When I was young, I never backed down in an intellectual argument.  Part of the reason, admittedly, was that I was starved for abstract debate.  Before the internet, anyone who wanted to talk ideas had to corner an actual human willing to do the same.  Another big reason, though, was that I didn’t want to look stupid.  A smart person always has a brilliant riposte, right?  And if you shut up, it must be because you’re stumped.

At this stage in my life, much has changed.  Public debates aside, I now only engage in intellectual arguments with thinkers who play by the rules.  What rules?  For starters: remain calm, take nothing personally, use probabilities, face hypotheticals head-on, and spurn Social Desirability Bias like the plague.  If I hear someone talking about ideas who ignores these rules, I take evasive action.  If cornered, I change the subject.

Why?  Because I now realize that arguing with unreasonable people is foolish.  Young people might learn something at the meta-level – such as “Wow, so many people are so unreasonable.”  But I’m long past such doleful lessons.  Note: “Being unreasonable” is not a close synonym for “Agrees with me.”  Most people who agree with me are still aggressively unreasonable.  Instead, being reasonable is about sound intellectual methods – remaining calm, taking nothing personally, using probabilities, facing hypotheticals head-on, spurning Social Desirability Bias, and so on.

In classic Dungeons & Dragons, characters have two mental traits: Intelligence and Wisdom.  The meaning matches everyday English: high-Intelligence characters are good at solving complex puzzles; high-Wisdom characters have a generous helping of common-sense.

Using the game to illuminate life: Running out of things in say in an argument is indeed a sign of low Intelligence, just as I held when I was a teenager.  A genius never runs out of rebuttals.  At the same time, however, joining a fruitless dispute is a sign of low Wisdom.  You have better things to do with your life than tell hyperventilating people all the reasons they’re wrong.  A really wise person won’t merely break off such exchanges, but stop them before they start – and get back to work on his Bubble.

Here, in short, is wisdom: Be not a hostage to your own intellectual pride.

P.S. How do you know if a person plays by the rules until you actually engage them?  Most obviously, watch how they argue with other people!  If that’s inadequate, give promising strangers a brief trial period, but be ready to disengage if things go south.

(0 COMMENTS)

Read More

Reflections on Science and Society

At Grove City College in the 1980s we had required courses which were dubbed “Key Courses” – you had to take survey courses in Religion and Philosophy, Social Science and History, Science, and the Creative Arts.  My Religion and Philosophy course was a year long, and the professor, Professor Reed Davis (now at Seattle Pacific University) — taught us Plato, as well as the Old and New Testament, and Augustine’s City of God and Calvin’s Institutes of Christian Religion.  But Professor Davis also raised questions throughout the course about values and scientific inquiry.

We read and watched Jacob Bronowski’s The Ascent of Man, and I can remember today as if it was just yesterday, particularly the scene where Bronowski is at Auschwitz and he explains to the audience that science doesn’t dehumanize, dogma does.  He wanders over to a pond where the ashes of the deceased were flushed from within the camp, and he explains gas didn’t kill the millions who died in the Holocaust, but arrogance did; dogma did; ignorance did.  And, it is this arrogance, dogma, and ignorance, fueled by a quest for absolute and final certainty, that kills science.  Science and the institutions that make science possible are our bulwark against the dehumanizing terror of totalitarian madness. True science, Bronowski states, stands always at the edge of error, and is a testament to what we fallible humans can achieve despite our imperfections.  It is a deeply moving scene and message.

 

Professor Reed exposed us in that class to the work of the great physical chemist turned philosopher of science Michael Polanyi.  I don’t know how many of my classmates took so quickly to Polanyi, but I did.

I first read Science, Faith and Society and then The Study of Man.  I actually read both of those books before I read any Hayek, and simultaneously as I was reading Henry Hazlitt and Ludwig von Mises for the first time.  I knew nothing of the personal biographies of any of these individuals back in 1979-1980, but their words changed my entire world view, and their arguments have occupied a central place in my mental model ever since.  I would not read much more from Polanyi during my Grove City days. Instead, my reading was focused on studying the classical economists and the economists of the Austrian school, as well as assigned readings in philosophy, law, religion, and history.  I consider my Grove City education fantastic, but even as I was reading these works (and I did do the reading!) and contemplating an intellectual career (legal philosophy was what I was thinking), I did not make learning the top priority in my college life. (Sports and social life dominated).  But, by my junior year and after an invitation to join a “graduate seminar”  with visiting students from Argentina, France, and the US, my focus on becoming a professional economist started to take shape.

 

In 1984, I headed off to graduate school and would eventually be assigned to work with Don Lavoie, the main professor I had been attracted to move to George Mason University to study with.  Don was finishing both Rivalry and Central Planning and National Economic Planning: What is Left?  I was very late to the process, but I had to do the last minute check of references for Rivalry at the Library of Congress, and while not tasked with anything, I did get a chance to read in manuscript form NEP.

And, while reading Lavoie I would encounter Michael Polanyi again.  Different books, but still Polanyi – this time Personal Knowledge.  Now a graduate student and focused on becoming a scholar, my studies were my top priority. Lavoie taught me to really read, not just gather information as I turned pages, but to engage with a text, and in learning to read as a scholar he stressed the importance of hunting footnotes. So, I read Lavoie and I read Polanyi and Thomas Kuhn, and of course Karl Popper and Imre Lakatos. I sought to adjudicate between them related to what I had learned about science from Mises and Hayek, and in particular their critique of scientism.  I had already been persuaded that the greatest evil of the 20th century followed from totalitarianism, and that totalitarianism was a consequence in modern times of an unholy alliance between scientism and statism.  As Bronowski said, arrogance, dogma, and ignorance provide the justification for the killing.

 

I did not yet know anything about the personal biography of these different thinkers, let alone their own intertwined circles of influences back in Europe. These are all things I would learn over the next 30 years of intense study.

Mary Jo Nye’s Michael Polanyi and His Generation is an outstanding window into the life and historical context within which Polanyi would make his scientific contribution and reflections on the nature of the scientific enterprise and its place within a free society.  It also does an amazing job of contextualizing the education of talented young minds in Budapest and Vienna in the first decade of the 20th century, and the vibrant scientific community in Berlin in the 1920s.  Polanyi’s colleagues in Berlin won Nobel Prizes and were leaders in their respective fields, and Polanyi himself was a famous scientists in the field of chemistry and expected that his own work may be honored with such a recognition. When it didn’t happen, he wasn’t bitter, but sought to understand the conventions and practices in operation.  Nye’s book describes how Polanyi, as head of the physical chemistry department at the Kaiser Wilhelm Institute (later Max Planck Institute) in Berlin in the 1920s, attempted to advance his own theories of absorption, but lost out in the competitive process of science.  Polanyi was convinced his was the right theory, but it was not accepted by his colleagues in the discipline.  Polanyi would later explain that a contribution in science is judged by three criteria: plausibility to the existing community; intrinsic interest to the existing community; and creativity and originality of the contribution.  Two of those are very conservative forces, but one is revolutionary. This essential tension in science, Polanyi argued, was critical to the orderly yet progressive advance of knowledge.  Quackery would be held in check, and yet innovation, novelty, and progress will be achieved slowly and surely and knowledge will accumulate.

 

But, in Polanyi’s time, the arrogance, dogma, and ignorance espoused by the fascists was also evident among communists, and so scientific inquiry was truncated not only in Germany but in Soviet Russia. Furthermore, the “men of science” in the UK and the US were parroting the arguments about the purpose of planning in the planned state as the model for scientific advancement.  The very foundation of the scientific enterprise and of the free give-and-take of the scientific community was threatened. The consequence wasn’t just slower progress on fundamental questions, or slightly more quackery on the margins of science, but the destruction of careers, and despair among scientists as knowledge was either destroyed or corrupted by the authorities in power.

 

I cannot stress enough how enjoyable it is to read Nye’s book and learn the details of the history that led Polanyi to switch his focus from scientific pursuits to a philosophical defense of the practice of free scientific inquiry.  The institutions governing the practice of science, like those governing commerce, must be strong and respected by their participants. If they are, the results are both orderly and progressive.  Knowledge advances, and our awareness of the unknown grows, so we strive to continually explore and learn more.  This is how we defeat the dark forces of arrogance, dogma, and ignorance- not through the planning of science, but its opposite, the free play of open debate and continuous contestation. The very success of sciences rests on freedom of inquiry and such freedom is in direct contradiction of any bestowal of special privileges to anyone, including the favored scientists of the established powers.

 

 

 


Peter J. Boettke is University Professor of Economics & Philosophy, George Mason University, Fairfax, VA 22030.


As an Amazon Associate, Econlib earns from qualifying purchases.

 

 

 

(0 COMMENTS)

Read More

The Scientific Look-and-Feel of Public Health

An individual with a human brain can make the following value judgments: (1) maximum health is the most important thing in human life; (2) health must be as equal among individuals as physically possible; and (3) these two value judgments should be imposed on everybody. Once this is done, the most efficient means to pursue these goals can be scientifically studied, using both the medical sciences, economics (including, at the first rank, public choice analysis), and possibly other sciences. (I take a science to be a body of logical theories not disproved by observable facts.)

Of course, it will likely be found that the presence of two objective functions—maximize health and maximize equality—requires trade-offs. For example, some academics and government bureaucrats might have to eschew maximum health in order to equalize their health opportunities with ordinary people. But let’s ignore this complication.

As often, a comment in The Lancet, the venerable British medical and social-justice-warrior journal, can serve as an illustration: see Colin Angus, “Taking Public Health Policy Models Upstream,” March 1, 2020. Once value judgments like those above are accepted, the article does have a scientific look and feel. But, as far as I can see (and I am willing to be proven wrong if I am), it’s merely a look and feel. The medical sciences behind which it hides are of course scientific in any serious meaning of the term but they have nothing to say about how individuals make trade-offs on the basis of their preferences (or biases), how individual choices can be compatible in a social context, and how individual preferences can or cannot be aggregated in any sort of egalitarian way.

The article starts with the moral goal of “the reduction of societal inequalities.” The goal of reducing inequalities is certainly a value judgment that Professor Angus is free to espouse. The word “societal,” though, has no scientific meaning. It can be traced to a Minor Hugo, probably the pen name of Luke James Hansard, a utopian communist and follower of French theorist Charles Fourier. In 1843, Minor Hugo wrote:

Our monetary system, like that of trade, or any other societal occupation, is unfair from first to last.

The term “societal” does not convey anything useful that “social” doesn’t incorporate, except that it looks more serious, gnostic, more like scientific socialism. Still very rare (hence its alchemic value), the term really took off only in the 1960s, according to Google’s Ngram Viewer (see chart below). At that time, scientific students of society and the economy were and still are content with “social”—including in the scientific analysis of welfare economics and social choice. Interestingly, “societal” seems on the wane, but perhaps not in The Lancet.

Interestingly, “societal” is often used by corporations as a PR term to boast of their contributions to “society,” meaning mainly noisy and politically correct “stakeholders.”

The Lancet article also speaks of “economical, cultural, or environmental policies.” “Economical policies”? One might think that the author and his editors want to make tabula rasa of what has been learned before them, but looking scientific and obscure may be a better hypothesis. Later in the piece, though, we encounter the standard expression of “economic policies.”

A minor point also fuels an impression of confusion: the author seems to assume that “financial” and “economic” are synonyms when he mentions some “policies’ redistributive financial effects.” “Economic” normally refers to the use of resources while “financial” refers to claims on those resources—claims of which money is one sort. If the author thinks that economics deals primarily with money and Wall Street matters, he is mistaken, as reading Adam Smith or Jean-Baptiste Say (for example) would show him. Perhaps he should use “financietal”?

The medical sciences are true sciences that have much to say on physical phenomena—the biology of epidemics for example—but nothing on how individuals should make trade-offs between different good things, and very little on how they actually make them.

Academic figureheads of “public health” as we know it sometimes admit that it is a political movement more than anything else. In the fifth edition of his textbook Public Health: What It Is and How It Works (2012), Bernard Turnock writes:

In many respects, it is more reasonable to view public health as a movement than as a profession.

Similarly, the late Elizabeth Fee wrote, in her introduction to George Rosen’s A History of Public Health (2015):

Public health is not just a set of disciplines, information, and techniques but is, above all, a shared social vision.

The public health movement aims to use state force to impose its participants’ moral intuitions on everybody else—or, at best, to persuade some electoral majority to impose their shared values and lifestyles on minorities. No wonder why, when a real epidemic comes, public health is so underwhelming. Of science, public health only has the look and feel.

(0 COMMENTS)

Read More