Must-Read: The invisible hand wavers are out in force this week!

Noah Smith: Defending Thaler from the guerrilla resistance: “This… by Kevin Bryan… [who] instead of explaining Thaler’s research, Kevin decided to challenge it, in a rather dismissive manner…

…These criticisms… don’t really hit the mark…. First, a random weird thing. Kevin writes: “Much of my skepticism is similar to how Fama thinks about behavioral finance: ‘I’ve always said they are very good at describing how individual behavior departs from rationality. That branch of it has been incredibly useful. It’s the leap from there to what it implies about market pricing where the claims are not so well-documented in terms of empirical evidence.’”… It’s a very odd quote. Behavioral finance has been very good at documenting asset price anomalies…. This is what Shiller got the Nobel for in 2013…. It’s what Thaler himself is most famous for within the finance field…. In terms of empirical evidence, behavioral finance is pretty solid….

The dismissal that Thaler refers to as “the invisible hand wave”… a claim that markets have emergent properties that make a bunch of not-quite-rational agents behave like a group of complete-rational agents. The justifications typically given for this assumption – for example, the idea that irrational people will be competed out of the market – are typically vague and unsupported. In fact, it’s not hard at all to write down a model where this doesn’t happen – for example, the noise trader model of DeLong et al. But for some reason, some economists have very strong priors that nothing of this sort goes on in the real world, and that the emergent properties of markets approximate individual rationality….

Ethical concerns: Kevin, like many critics of Thalerian behavioral economics, raises ethical concerns about the practice of “nudging”…. There are, indeed, very real problems with behavioral welfare economics. But the same is true of standard welfare economics…. For some reason Kevin chooses to raise ethical concerns only for behavioral econ. Do we see Kevin worrying about whether efficient contracts will lead to inequality that’s unacceptable from a welfare perspective? No…. Worried about paternalism…. Cavalier about inequality….

The invisible hand-wave, again…. This argument makes little sense to me. Most people aren’t Michael Jordan or Einstein. And those people surely didn’t compete all the other basketball players and physicists out of the market. Why does the existence of a few perfectly rational people mean that nudges don’t matter in aggregate? Also, why should we assume that non-Michael-Jordans can quickly or completely learn heuristics that make nudges unnecessary? If that were true, why would players even have coaches? It seems like another case of the invisible hand wave…. Assuming that a market for third-party advice will take care of behavioral problems seems like both a big leap and a mistake….

Kevin’s attacks on Thaler’s research paradigm pretty much uniformly miss the mark…. I half suspect that Kevin… is playing devil’s advocate… taking cheap shots at behaviorism simply because it’s fun. This guerrilla resistance is more like paintball.
…”

Should-Read: Davide Cantoni, Jeremiah Dittmar, and Noam Yuchtman: Religious Competition and Reallocation: The Political Economy of Secularization in the Protestant Reformation: “We document an unintended, first-order consequence of the Protestant Reformation…

…a massive reallocation of resources from religious to secular purposes. To under- stand this process, we propose a conceptual framework in which the introduction of religious competition shifts political markets where religious authorities provide legitimacy to rulers in exchange for control over resources. Consistent with our framework, religious competition changed the balance of power between secular and religious elites: secular authorities acquired enormous amounts of wealth from monasteries closed during the Reformation, particularly in Protestant regions. This transfer of resources had important consequences. First, it shifted the allocation of upper-tail human capital. Graduates of Protestant universities increasingly took secular, especially administrative, occupations. Protestant university students increasingly studied secular subjects, especially degrees that prepared students for public sector jobs, rather than church sector-specific theology. Second, it affected the sectoral composition of fixed investment. Particularly in Protestant regions, new construction from religious toward secular purposes, especially the building of palaces and administrative buildings, which reflected the increased wealth and power of secular lords. Reallocation was not driven by pre-existing economic or cultural differences. Our findings indicate that the Reformation played an important causal role in the secularization of the West…

Must-Read: Royal Swedish Academy of Sciences: The Prize in Economic Sciences 2017: “Richard H. Thaler… ‘for his contributions to behavioural economics’…

…Richard H. Thaler has incorporated psychologically realistic assumptions into analyses of economic decision-making. By exploring the consequences of limited rationality, social preferences, and lack of self-control, he has shown how these human traits systematically affect individual decisions as well as market outcomes…. In total, Richard Thaler’s contributions have built a bridge between the economic and psychological analyses of individual decision-making. His empirical findings and theoretical insights have been instrumental in creating the new and rapidly expanding field of behavioural economics, which has had a profound impact on many areas of economic research and policy…

Must-Read: As I often say, this was nailed by Keynes long ago, in his obituary for his teacher Alfred Marshall. I would add that there is often—and these days, for those on the right, always, as the Gresham’s Law downward spiral wreaks its will—more money and more status to be gained by becoming a hack who chooses the model that pleases your political masters rather than an economist who chooses the model that brings insight:

Simon Wren-Lewis: Economics: too much ideology, too little craft: “Paul Krugman argued… that… belief in the need for new economic thinking after the financial crisis was incorrect…

…but led to some crazy but influential ideas that suited big money and the political right…. I would want to add…. Dani Rodrik… tells the story of how 20 odd years ago he asked an economist to endorse a previous book of his called ‘Has Globalisation Gone Too Far?’. The economist said he couldn’t, not because he disagreed with anything in the book, but because he thought the book would “provide ammunition to the barbarians”. Dani Rodrik argues that this attitude is still commonplace. That attitude is, of course, both very political and very unscientific.

I suspect that something similar might have been going on before the financial crisis…. Mainstream economics contained models that could explain much of why the GFC happened, so little new thinking was required in that sense. But one reason why so few mainstream economists used those models before the event owed at least something to an ideological aversion to regulation, and perhaps also not wanting to bite the hand that feeds you.

One of the features of mainstream economics today is the huge diversity of models that are around. Academic prestige tends to come to those who add to that number. But how do you decide which model to use when investigating a particular problem? The answer is by looking at evidence about applicability. That is not a trivial task because of the probabilistic and diverse nature of economic evidence, and Dani Rodrik describes that process as more of a craft than a science.

So, in the case of the GFC, good craft was in seeing that new methods of spreading risk were vulnerable to system wide events. Good craft was to see, if you had access to the data, that rapid increases in bank leverage should always be a concern. And more generally that arguments that ‘this time was different’ do not generally end well.

In my own discipline, I can think at least one area that should not have got off the ground if the craft of model selection had been applied well. RBC models were never going to describe business cycles because we know increases in unemployment in a downturn are involuntary. If you do not apply the craft well, then what can replace it is ideology, politics or simple groupthink. This is not just an issue for some individual economists, but can sometimes be a concern for the majority.

Keynes:

The study of economics does not seem to require any specialised gifts of an unusually high order…. Is it not… a very easy subject compared with the higher branches of philosophy and pure science? Yet good, or even competent, economists are the rarest of birds.

An easy subject, at which very few excel! The paradox finds its explanation, perhaps, in that the master-economist must possess a rare combination of gifts… mathematician, historian, statesman, philosopher… understand symbols and speak in words… contemplate the particular in terms of the general… touch abstract and concrete in the same flight of thought… study the present in the light of the past for the purposes of the future. No part of man’s nature or his institutions must lie entirely outside his regard…. Much, but not all, of this ideal many-sidedness Marshall possessed…

Cf.: My review of Richard Thaler’s Misbehaving http://amzn.to/2g4KoNZ…

Should-Read: Chye-Ching Huang and Brendan Duke: Vast Majority of Americans Would Likely Lose From Senate GOP’s $1.5 Trillion in Tax Cuts, Once They’re Paid For: “The Senate Budget Committee will vote on a budget resolution that would allow Congress to move forward with tax-cut legislation that adds $1.5 trillion to deficits over ten years…

…The vast majority of Americans would be net losers from such a tax bill, if: (1) The $1.5 trillion in tax cuts were anywhere near as skewed to the top as those in the tax plan that President Trump and congressional Republicans unveiled last week. That plan would deliver 80 percent of its tax cuts to the top 1 percent of households by 2027, the Tax Policy Center (TPC) estimates. (2) The tax cuts were eventually paid for through the types of spending cuts in recent GOP budget proposals, which fall overwhelmingly on low- and moderate-income people. This analysis, following an approach that TPC used in its analysis of the potential ultimate effects of a prior Trump tax plan, captures the frequently overlooked reality of a plan that includes net tax cuts over the next decade: sooner or later, the cost will need to be offset…

Should-Read: External benefits from the development of communities of engineering practice developing around successful labor-intensive manufacturing export industries has been a standard road to economic development since… well, since the days when the mechanized textile industry located itself in the (lower wage) English midlands because London and Amsterdam both had higher-wage things to do with their labor. The problem is that China may well be the last country for which this is possible. So what next for our hopes for development and convergence?

Edward Hadas: Review: Dani Rodrik gives economists a better name: “Straight Talk on Trade: Ideas for a Sane World Economy… this easy-to-read and sometimes loosely connected collection of columns and essays…

…Rodrik rejects the methodological goal of finding one true model for each and every economic variable. He explains that models are always simplifications, leaving out factors that do not seem to be important. But the key factors which influence, say, unemployment rates or technological development are not the same in every time and place. Since the facts change, the models should too. As Rodrik says, “There is virtually no question in economics to which ‘it depends’ is not an appropriate answer”. Rather than search for an explanation which always works, economists should become experts at determining what model is appropriate under which circumstances….

All of the great successes of economic modernisation – from Japan in the 19th century to China under Deng Xiaoping – grew by exporting as freely as they could while sharply restricting imports. Conversely, no poor country has become rich by opening itself totally to the world market. That pattern suggests a useful stylised fact – freedom in trade is not always good for everyone. Over the years, Rodrik has developed this insight in several ways. He argues that workers harmed by new trade patterns have a legitimate complaint. He also bemoans the destabilising effects of cross-border flows of financial capital….

Rodrik’s latest claim is more controversial – and more depressing. He coined the phrase “premature de-industrialisation” to describe the increasing difficulty of economic development. Thanks to the relentless advances of technology, it will no longer be easy to follow the path to wealth pursued by Asian countries, which used low-skilled workers to build up successful export industries. Worse, since protectionist policies are prohibited by international agreement, “few poor countries now have the opportunity to develop simple manufactures for home consumption”. Rodrik argues that in the future, development will have to rely more on services. Since those require far more skills and stronger institutions than manufacturing, fewer countries are likely to succeed….

Rodrik’s readers might appreciate a bit less gloom. “Straight Talk” is pessimistic about the future growth of developing countries, the pace of technological innovation, the strength of democracy and the resilience of China. Rodrik’s basic thesis is that it is hard to prosper in “a global environment that threatens to turn even more hostile”. The travails of the European Union and the rise of demagogues in countries from Turkey (where to Rodrik was born) to the United States (where he has lived for decades) support and understandably colour his views. But as a specialist in development, he might have mentioned some of the seriously good global news – the almost universal increase in life expectancies, the decline in deaths from war or the spread of life-changing mobile phones…

Should-Read: Larry Summers: America’s tax plan is not worth its name: “The US administration’s tax plan… a mélange of ideas put forth without precision or arithmetic…. The claims of Steven Mnuchin, Treasury secretary, Gary Cohn, director of the National Economic Council, and Kevin Hassett, chair of the Council of Economic Advisers, are some combination of ignorant, disingenuous and dishonest…

…We know enough to know that a tax reform plan along the lines of the administration’s sketch will not substantially increase growth, will blow out the budget deficit and will make America an even more unequal place…. The most rapid growth in gross domestic product that the US has seen took place in the 1950s, 1960s and 1970s when top tax rates were nearly twice as high as now…. What about the budget deficit? In order for tax cuts to pay for themselves, as Mr Mnuchin sometimes asserts, they would have to massively spur growth…. It is unlikely they will have any important effect on growth….

Finally, there is the question of fairness. Those secure in their beliefs do not, as Mr Mnuchin did, seek to de-publish studies by apolitical civil servants. There is very little doubt among serious economists that the immediate impact of corporate tax cuts would be to help corporations and that the vast majority of corporate shareholding is concentrated among those at the top of the income and wealth distribution….

This week the world’s finance ministers and central bank governors will gather in Washington for the annual International Monetary Fund-World Bank meetings. These meetings used to be a time when the US urged other countries to respect the laws of economics and arithmetic in formulating economic policies. This time the lecturing should go in the opposite direction. The international community should make sure that US officials have a very uncomfortable week. Just possibly, that will be enough to get the administration economic team to consult their consciences as well as their Twitter accounts.

Should-Attend: Tim O’Reilly and Heather Boushey: Future of Work and What We Can Do About It: Conversation: “What’s the outlook for workers in an economy increasingly dominated by intelligent machines and the global elites who own them?…

…Join the Washington Center for Equitable Growth and tech entrepreneur and author Tim O’Reilly for a discussion of the ideas presented in his newly published book, WTF?: What’s The Future and Why It’s Up to Us. In a conversation with Equitable Growth Executive Director and Chief Economist Heather Boushey, the founder of the eponymous firm O’Reilly Media will explore how new technology networks and platforms are shaping the future of work and what that means for economic inequality, how we live, and the choices we make….

Thu, October 12, 2017 :: 5:00 PM – 7:00 PM EDT :: The Liaison Capitol Hill :: 415 New Jersey Avenue Northwest :: Washington, DC 20001