Monday, September 15, 2014

Is math "falsifiable"?



Ooooh, another chance to babble on about philosophy of science!

Kevin Bryan writes:
Arrow’s (Im)possibility Theorem is, and I think this is universally acknowledged, one of the great social science theorems of all time. I particularly love it because of its value when arguing with Popperians and other anti-theory types: the theorem is “untestable” in that it quite literally does not make any predictions, yet surely all would consider it a valuable scientific insight.
But Arrow's Theorem is a math result. It takes some definitions of mathematical objects as given, and it shows a relationship between those mathematical objects. Of course you can't "falsify" it with empirical observation, any more than you can "falsify" Jensen's Inequality.

I really hope there aren't "Popperians and other anti-theory types" running around out there complaining that math results are useless because they're non-falsifiable. There are at least two reasons that would be silly.

Reason 1: Pure math results tell us about what we can and can't do with math itself. For example, suppose we knew that it was impossible to factor an integer in polynomial time. That would have important implications for cryptography. Math itself is a technology, so math results can give us useful technological advancements.

Reason 2: Pure math results are necessary for math to be useful for engineering. One big reason - the main reason, I'd argue - that we make mathematical theories is because the math seems to correspond to real observable phenomena. As long as that correspondence holds, then we can predict things about the world just by doing math. To "use" a theory means to assume that the correspondence holds - to simply do the math and assume that it's going to give you useful results, without having to go re-test the theory each and every time. If you don't let yourself make that assumption, then all mathematical theories are useless for engineering purposes.

Modern engineers can do a hell of a lot of cool stuff just by doing math using theories from physics and chemistry, without re-testing those theories every time they want to build an airplane or synthesize a polymer. And computer scientists can do a hell of a lot of cool stuff just by telling their computers to do pure math. So if there are "Popperians" going around saying pure math isn't useful, they should think again.

Anyway, the rest of Kevin's post is quite interesting, and the philosophy-of-science literature it links to is even more interesting - here are a couple more papers in that literature: (paper 1, paper 2, paper 3). And here's the paper that started the discussion. Neat stuff. As blog readers must have already guessed, I've actually considered just quitting finance and working on this stuff instead, and maybe someday I will. When I'm old, perhaps...

Thursday, September 11, 2014

Arbitrary value systems are arbitrary



Is there an arbitrary system of values that will justify capitalism? Sure. There's an arbitrary system of values that will justify anything. Matt Bruenig is therefore fighting an uphill battle:
There is no general framework of morality or justice that supports laissez-faire capitalism. This is a problem of course for those who wish to argue on behalf of it. When you talk to such people, a familiar argumentative pattern emerges that I have come to call Capitalism Whack-A-Mole.
Them: Capitalism is right because people should get what they earn through their hard work. 
Me: But...one-third of the national income goes to capital owners who have done no work at all for that income. If you really believe the economic system should distribute according to hard work, then you’ve got to at least tax capital income at 100%... 
Them: Capital owners may not produce anything to get that one-third of national income, but they got it through voluntary transactions. I am just against force and for voluntarism. 
Me: Transactions are not voluntary. They are coerced through systems of property ownership. You only trade with someone because there is a gun at your head to keep you from simply grabbing the thing that you trade for. There is nothing voluntary about that... 
Them: Capitalist institutions may require violent coercion to enforce, but they make everyone very rich. We’d be much poorer, even at the bottom of society, if we got rid of them. 
Me: OK. So you support using violent coercion in order to make sure people are well off. But people, especially the poor that you are now concerned with, are better off in Social Democratic systems than they are in laissez-faire capitalism. The diminishing marginal utility of money, by itself, justifies significant tax and transfer schemes under a “making everyone as well off as possible” analysis.
If I were trying to justify capitalism with an arbitrary ("deontological") system of values, I would not stop with the three simple examples Matt gives here. I would just move the goalposts. For example:

1. "Capitalism should reward either hard work or risk-taking. Thus, both labor and capital income are justified."

2. "I support conditional voluntarism, not absolute voluntarism. The government should use violence only to protect property rights, and for nothing else. Property rights are defined as blah blah blah..."

3. "I am a pure Benthamite, I care about the sum of utilities; I do not care about the poor more than the rich."

...and so on. In fact, I've heard people say all of these things in defense of capitalism. Matt might manage to smack these down as well by finding some way in which capitalism does not exactly conform to each. But the defenders of capitalism will simply make a small tweak. Matt will be playing Capitalist Whack-a-Mole for all eternity, because unlike classic Whack-a-Mole, the number of holes from which moles can emerge is not finite.

There is actually a mildly intellectually interesting philosophical question here, which is: "Is there a finite set of ethical principles that will yield a set of rules of capitalism whose cardinality is larger than the cardinality of the set of ethical principles?"

I suspect there is, but I also don't care, because I am a Humean, and I reject all clearly delineated ethical rules in favor of fuzzily defined, intuitive principles.

Wednesday, September 10, 2014

Thursday Roundup, 9/11/2014


Yee hawg, blawgers. It's time for your weekly-or-possbly-biweekly-(I'm-not-sure-if-"biweekly"-means-once-every-two-weeks-or-twice-a-week-and-I'm-too-lazy-to-look-it-up) roundup of links from around the magical world of the econ blawgosphere!

Me on BV

1. In which I attempt to explain New Keynesian models to BV readers

2. I broke the telepathy story before anyone else, but no one noticed...

3. The "Great Vacation" still has trouble explaining stagnant real wages

4. Olivier Blanchard thinks policymakers pay attention to DSGE models. Ha.

5. Our military spending doesn't outweigh everyone else's as much as people think

6. Perhaps we should consider a strategic partnership with Iran

7. Anti-scientism is bad bad news


From Around the Econ Blogosphere

1. Dan Wang (a welcome new voice in the blogosphere) explains why Peter Thiel believes in technological stagnation. Fortunately, unlike Thiel's earlier National Review article, the case does not rest on the idea that the U.S. government is massively understating the rate of inflation.

2. John Cochrane is going to take people who use sloppy vocabulary when talking about bank capital over his knee and give them a hiding! Go cut Pappy Cochrane a switch!

3. On many measures, Obama outperforms Reagan. Shhhh!!!

4. Steve Williamson, Mage of St. Louis, casts a spell of shadow over the Phillips Curve, money supply targeting, wage-price spirals, and the entire notion that low interest rates cause inflation. If you're sure you know how inflation works, read Williamson and tell me if you're still so sure.

5. David Andolfatto shows that deflation ain't so bad as long as you see it coming, thus refuting an argument that very few people make. Tell that to the HINDENBURG, Andolfatto. In other news, I've decided that David should be a Count, because "Count Andolfatto" just sounds right, doesn't it?

6. Roger Farmer has invented an easier way of estimating DSGE models with multiple equilibria. There's a math error on page 22. Can you spot it?

7. The Tim Harford is a bird that lives in the marshes of England. It's lonely cry echoes out across the night, sounding for all the world like "Inflation! Inflation!" But none are there to hear.

8. Noah Smith Smackdown Watch: Brad DeLong trolls Yours Truly. But only a little bit.

9. Everyone knows that Minsky saw the 2008 crisis coming, right? Everyone knows that if you just read Minsky, you'd know how financial crises work, and why they happen, right? Well maybe everyone is WRONG. BAM.

10. Kazuma Shuhleezy says that "data scientists" are really just statisticians with a sexier name. He is correct.

11. Narayana Kocherlakota: The 70s are over, people. Does that mean the Franco-Prussian War is over? Oh wait, wrong 70s. Anyway, yes. Everyone who's stuck in the 70s should read Kocherlakota and take his words to heart, but of course won't.

12. Chuckle darkly at the excuses of the manager of a failed hedge fund. Then realize that he's a bazillion times richer than you will ever be, and weep gently onto your keyboard, in the process causing you to accidentally "good" a really lame post on EJMR.

13. Should we use TFP as a measure of welfare? Not if it's mismeasured, say I. There's evidence that labor utilization actually leaks into our TFP measures, so this idea might not be as snazzy as it sounds. Interesting idea, though.

14. Chris House makes a good point, which is that Noah Smith is always right about everything DSGE models are actually a subset of Agent-Based Models.

15. Brad DeLong tells the epic tale of the evolution of the yield curve over the last decade. Or at least, an epic tale that may or may not have anything to do with the evolution of the yield curve over the last decade.

16. Robert Murphy lets loose on Gene Fama's Nobel acceptance speech. Moral of the story: Always account for opportunity costs. (Other moral of the story, which Murphy fails to mention: Inflation, too.)

17. These days it takes longer and longer to pay for a college degree, right? Wrong.

Friday, September 05, 2014

Wages and the Great Vacation, cont.



Casey Mulligan has a response on his blog to a recent Bloomberg View column of mine about wages and the "Great Vacation" hypothesis. In that column, I basically just said that flat real wages are a puzzle for explanations of the post-2009 stagnation that rely on government paying people not to work (the "Great Vacation" idea). Casey doesn't like this. Let's go through his points...
Naturally, a supply-demand decomposition exercise is enhanced by looking at both the quantity and price of labor, also known as the wage rate. That's why my book on the recession starts off with various indicators of wage rates and their dynamics (see chapter 2 beginning on page 9).
Well then I guess my article was not exactly news to Casey.
Three or four decades of labor economics research are of great assistance in this exercise.
Well, I guess they've got to be good for something.

I kid, I kid!
[A] reduction in labor supply could be associated with reduced cash earnings even while it was increasing employer costs: 
1. A reduction in labor supply could reduce the quality of labor, with workers putting in less effort, or doing less to maintain their skills, or become less attached to the labor market.  This tends to reduce cash earnings per hour because each hour is less productive.  These have been major factors in the analysis of women's wages, where most economist believe that women's hourly earnings increased as a consequence of supplying more (see Becker 1985, Goldin and Katz 2002, Mulligan and Rubinstein 2008, and many others). See also some of the literature on unemployment insurance such as Ljungqvist and Sargent's paper on European unemployment.
True, but don't things like unemployment benefits and Social Security Disability only go to the unemployed? Slacking off at your job does not result in the government mailing you a check. Why would a rise in welfare-type benefits cause people to slack more? Are they sitting there at their desks feeling depressed, thinking "Dang, I could be earning almost this much if I quit my job"? I guess it's possible, but unlikely, especially given the decreased rate of quits in recessions.
A reduction in labor supply or demand could increase the average quality of labor through a composition bias.  See p. 17ff of my book and the references cited therein.
Wouldn't this tend to increase wages, or am I being dense? Do I have to go to p. 17ff?
Because of fringe benefits, cash hourly earnings are not the same as employer cost.  As employer health insurance expenditure has been growing over time, the growth of cash hourly earnings has substantially under-estimated the growth of employer cost.
OK, but did these non-cash benefits start to increase more in the years following 2009? Nope. They flattened out just like wages. So the point I made in my article applies to this kind of compensation as well.
Labor economists have also long studied the incidence of supply and demand impulses: that is, the effects of supply and demand factors on both wage rates and the quantity of labor. The consensus is that: (a) labor demand is more wage elastic than labor supply and (b) labor demand is even more wage elastic in the long run than it is in the short run. 
Suppose that the reduction in the quantity of labor were 50% due to demand factors and 50% due to supply factors, and that we had overcome all of the measurement issues cited above. Result (a) means that wages would fall in the short run, because supply shifts translate more into labor quantity than into wage rates while, in comparison, demand shifts translate more into wage rates than labor quantity. In this example, it would be wrong to conclude from reduced wage rates than supply is less important than demand for explaining the change in the quantity of labor. 
To put it another way, if we found that wage rates (properly measured) were constant, but didn't know the relative contribution of demand and supply factors to the quantity change, result (a) tells us that the majority of the labor quantity change was due to supply factors. With a labor supply elasticity of 0.5 and labor demand elasticity of -3 (reasonably conservative short run estimates), the constant wage rate result means that 86 percent of the quantity change was due to supply factors and only 14 percent due to demand factors. In the long run, labor demand is even more wage elastic, and the share attributable to labor supply is even closer to 100%. 
To put it yet another way, if it were true that labor demand explained the majority of the change in labor quantity, then employer costs (properly measured) would have fallen dramatically.
I think it's very important to correct for the trend here. Real wages have been flat since the crisis and recession, it's true, but were growing strongly before that. Also, continued productivity growth since the recession seems to indicate that real wages have fallen substantially relative to the long-term trend.

As for the inelasticity of labor supply, it had always been my understanding that the macro evidence showed a fairly high elasticity of labor supply. You'd certainly expect Mulligan, whose theory of unemployment is based on a rise in implicit taxes arising from benefit phase-outs, to take this view. Without looking at his parametrization, I can't tell if the "inelastic labor supply" story is numerically consistent with the "benefit phase-outs caused the stagnation" story, but the two stories do seem to be somewhat at odds. In other words, if you think unemployment is due mainly to people being paid not to work, then it seems like you have to think that people's work decisions respond a lot to how much you pay them.

As for the long run, the period we're talking about is something like 2009-2012, so it doesn't seem that long to me.

In other words, the flattening of wages since the recession still seems like a puzzle for these theories. And I didn't even mention sticky real or nominal wages...

(Note: I was a little unfair in lumping Mitman's theory in with the "supply shock" stories, because his model uses search frictions to make unemployment insurance reduce labor demand. I still think his model is probably pretty wrong, though!)

Monday, September 01, 2014

Is America's health care underperformance a myth?



Argh. Cliff Asness is a true supervillain - he has succeeded in forcing me to think about health care. On Twitter, I repeated the factoid that America's health care system is worse than that of other advanced nations, and Cliff directed me to this article of his, alleging that this talking point is a myth. The whole article is too big to take on in one post, so I'll stick to looking exclusively at his "Myth #4":
Myth #4: Healthcare costs are very high in the United States compared to socialized countries
This section itself is broken into multiple points, so let's take a look at them.
Many of the surveys of “outcomes” that show other countries spend less for similar or better healthcare than the United States are just intentionally disingenuous (i.e., they lie). The ultimate example is the U.N.’s 2000 World Health Report, which has been extensively cited by progressives and the media...[T]he study included high-speed auto fatalities and murders in their assessment of a country’s life expectancy, and then progressives cited that life expectancy to indict the U.S. healthcare system. Well, Americans drive more often on a more extensive highway system than most others, and we sadly have more crime than many. Reputable studies exclude these fatalities as, while tragic, they are not the fault of the healthcare system and should not be used to judge or modify the healthcare system. With these fatalities excluded, the U.S. ranks 1st in the world on life expectancy. With them included, we rank 19th, as reported in the 2000 study cited so often by ObamaCare advocates.
Actually, with both violent fatalities (which include suicide) and traffic fatalities included, we rank 42nd. But anyway, Cliff's point is an important one. Still, I don't think he makes the case. Here's why.

First of all, this study, by Robert Ohsfeldt and John Schneider, uses data from 1980-1999; hence, it is between 34 and 15 years out of date. There is some evidence that the U.S. has fallen behind a bit since then. One way to see the old-ness of the study is to observe that the gap between the U.S. and the other rich countries was very small, with or without traffic and violent fatalities!

Read this WSJ article for a balanced look at the Ohsfeldt and Schneider study. Also, a quick Google will find some studies that look at more disaggregated metrics - for example, this 2012 study, which gives survival rates for various types of cancer. There are many, many other sources like this out there.

The upshot, though, is that in terms of life expectancy, and most other outcomes, the U.S. and European/Asian systems are doing about equally well. The U.S. simply spends a much much larger portion of its GDP to achieve this performance. Similar results for 1.5 or 2 times the price? That's a crap outcome, as a businessman like Cliff should know!

Cliff also accuses the U.N. of basically lying to make the U.S. health system look bad:
Perhaps even more insidiously, most of the U.N.’s 2000 World Health Report does not really even rank healthcare outcomes. The actual oft-quoted final rankings, with the United States ranking poorly, are an average of many different ratings, many of them explicitly about how “socialized” or “progressive” a healthcare system is. For instance, their rating system gives 25 percent weight to “financial fairness,” and if one goes through their other categories you find they again are not rating who lives or dies or lives better (you know, healthcare outcomes), but how much the healthcare system has such things as “respect for persons” (this is part of the 12.5 percent weight they gave to “responsiveness,” which is separate from the 12.5 percent weight they gave to “responsiveness distribution,” whatever on Earth that is). The report goes further, judging these things with such objective measures as “respect for dignity” and “autonomy.” In total, more than 60 percent of a country’s score in this survey was some measure of progressive desires, not what you or I would call a healthcare outcome. And, as in our auto example above, much of the rest contained expressly anti-American flaws. That we pay for the United Nations to lie about us is a topic for another day.
I don't have anything to say about this, but I never heard about those ratings anyway, and I don't think advocates of U.S. health reform really talk about them much. So I will skip over this part.

Cliff's later points address this somewhat, so let's proceed:
Part of the reason we spend more is other countries have price controls and we don’t. For instance, they restrict the amount drug companies can charge much more than we do. That sounds great; price controls save us money! But if nobody pays for new drugs, they don’t ever get created. Without these controls, our consumers here indeed pay more, but that funds much of the life-saving and life-extending healthcare innovation available for Americans and the rest of the world. It is frankly unfair that the world is free-riding off us. Free-riding means they let us pay for the innovation that benefits them at lower cost. But if nobody pays for the innovation, the innovation just does not happen. If we try to free-ride off ourselves, it doesn’t work—innovation dies for us too. U.S. consumers paying fair prices (not government restricted artificially low prices) does lead to higher U.S. healthcare costs, but the alternative is far worse: Joining the world in severely limiting prices, and not seeing the next generations of new innovations and improvements.
This is another important point, though I wish Cliff had provided some evidence.

The U.S. spends 18% of GDP on health care; Germany spends 11%. Are you telling me that we spend 7% of our GDP - one trillion dollars a year - on health innovation? Actually, since some health innovation is done in other OECD countries, it's an even bolder claim - that $1T should represent the difference between what we spend on health innovation and what we would spend if we were able to "free ride" as much as Germany. That's a lot of health innovation spending. Health research spending is only about a tenth of that, actually. (Research is not the only type of innovation, of course, but it seems like the bulk of it, especially given that many R&D expenses are tax-deductible, so it's in companies' interest to classify as much innovation as "research" as possible.)

So the argument is that our exorbitant health care prices go to fund innovation, which Europe and Japan then get for cheap or free, by free-riding. But how does this free-riding work? How do they just take our technology?? Maybe ideas are just in the air, and technology spreads by casual conversation among doctors at international conferences, by cheap reverse-engineering, by industrial espionage, etc.

But if this is true, then health technology is non-rival and non-excludable - it's a public good! And a public good is a market failure. And if health technology is a giant, $1 trillion market failure, we shouldn't expect a free-market system to work very well. You can try to patch things with a patent system, but that will always be an incomplete solution. So if all this free-riding is going on, it's a powerful argument that much medical innovation should be done by the government, not by private companies.

Cliff continues:
Americans lead less healthy lifestyles than much of the developed world. Americans historically value freedom more than other countries and cultures. We value it for its own sake, even if it sometimes leads to a worse outcome. But we mostly value it because these choices are personal. Frankly, some would sacrifice some health to eat what they want and avoid the StairMaster. Freedom isn’t always sugar-free. Our American choices are costing us more, and raising the healthcare cost figures progressives love to cite. But they are our choices to make, not theirs to gainsay.
I will spare the snarky comments about public health, hand-washing, sewer systems, the CDC, blah blah blah. Those comments write themselves.

What's less clear is that people in Europe and Japan are less free. Getting good health advice from your doctor isn't slavery. Being taught healthy habits in school isn't slavery. If you think either one of those things is slavery, you're a doofus. A doofus who is entitled to his doofus opinion, but a doofus nonetheless. (Note: This is a value judgment!)

(Actually in some ways we live healthier lifestyles than people in other countries. We smoke less, for example. Obesity is the main difference. It's a little amusing how the right has turned to extolling the virtues of land-whale-itude in recent decades...)

Cliff:
We spend more on end-of-life care than more regulated societies with socialized medicine or systems closer to it. That’s our choice.
Is it? A lot of that higher spending is higher prices, which could reflect higher demand, or which could reflect inefficiencies in the system (or paying for innovation, but I covered that above). I'm going to go with "inefficiencies," since Americans usually don't even know the prices of the health care services they buy. How can you make an informed, free consumer choice when you don't even know the price of what you're buying?

Cliff:
The cost of a healthcare system is not just what we spend directly on it, it is also how much the healthcare system helps or hurts the overall economy. If socialized medicine slows economic growth, then this is part of its cost, perhaps a big part, and is left out of the simple analyses (looking at direct expenditure divided by GDP) that are so common.
But if the government forbade us from spending money on health care, we'd just spend it on other stuff we like. In real terms, if government forbade us from using real resources to create health care services, we'd use those resources on something else we want a bit less. Substitution would mitigate the effect of price controls, etc., not exacerbate them.

Cliff:
Lawyers. We got lots, they have far fewer. We can separately debate how to design our legal system (some of my libertarian friends advocate for a large role for lawyers), but the size and scope of legal action here dwarfs most of the world. It leads to doctors practicing tremendous amounts of “defensive medicine.”
This is a sensible point, but as with most of these points, it's not backed up by any numbers or evidence. Tort reform could theoretically be a big money-saver, but in practice it doesn't look like a game-changer.

This brings us to the end of Cliff's so-called "Myth #4". The main take-away is:

1. We pay much much more than other countries for about the same quality of health care.

2. Some part of this may be due to innovation externalities, but these must necessarily represent a market failure.

Anyway, I do think Cliff's points are important. I think medical innovation is very important and under-studied, and I do think it represents some (though not most) of the price difference between America and other countries. I do think that tort reform is a good idea and should be tried. I do think that the difference between America and the rest of the OECD is not in health outcomes, it's in the cost we pay to achieve those outcomes. And I do think that the medical system can't entirely fix the obesity problem.

But these points do not convince me that the American health system is doing better than those of other rich countries. Cliff's main point is that the American quasi-market system, while not perfect, does many things better than the non-market systems of places like Germany, the UK, or Japan. But it seems to me that getting "bang for the buck" for the modal or median person is not one of these things. Cliff's "Myth #4" seems like no myth, but fact.

Sunday, August 31, 2014

The Axis is back



More BS amateur geopolitical thinking from yours truly.

In 2002, David Frum came up with one of the more boneheaded rhetorical blunders in American speechwriting history when he coined the term "Axis of Evil" to describe a motley collection of totally unrelated rogue states. Evil it was in varying degrees, but it was no Axis. The states were not allies, and two of them were actually bitter enemies. Nor did they pose any threat to the United States.

But while we were messing around in Iraq, babysitting Sunnis and Shiites, burning our international prestige with a blowtorch, and spending trillions, something very ominous was happening. The actual Axis - something very like the coalition we faced in World War 2 - was reconstituting itself, like some sort of demonic fantasy-novel creature that gets defeated and dispersed but never really dies.

Of course, I'm talking about Russia and China, which have occasionally been dubbed the "Axis of Authoritarianism", though Frum's boneheadedness has probably soured people on "Axis" nicknames for a while. But nevertheless, I think the analogy is apt.

What happened in World War 2 was basically this: Two small, powerful states (Germany and Japan) tried to conquer the large Asian land empires next to them (Russia and China) while those giga-empires were in a moment of weakness. Eventually the little guys would have lost, but the U.S. hastened that loss by intervening on behalf of the big countries. The U.S. conquered the Axis countries and reconstituted them as economically strong but military weak mostly-isolationist states, setting them up as buffers against the two now-very-pissed-off empires. The big empires, Russia and China, opted for a system (communism) that was economically non-viable in the long term but in the short term gave them organizational capacity that allowed them to repel external military threats (obviously this happened earlier in Russia). The system they adopted put them in ideological conflict with America, the country that had just saved their butts, and America won the ensuing ideological struggle when communism turned out to be a long-term loser. This outcome was hastened by a bitter split between Russia and China, which showed that shared ideology is never a guarantee of durable geopolitical friendship.

OK, that brings us to 2000. Post-Cold War, Russia and China have both adopted systems that look a little bit like the systems of the countries that whooped up on them in World War 2. Putin's Russia is a nationalist country that places a lot of emphasis on race, and scapegoats minorities like gays, while not really having an economic ideology - a little like Nazi Germany, but far less insane, and much more dependent on natural resource exports. China is now a bureaucratic directed-capitalist state with a strong independent confident military, a feeling of national resentment over past mistreatment by powers near and far, and a feeling that its destiny is to dominate East Asia - a little like Imperial Japan, though less beset by domestic terrorism.

Meanwhile, the strategies being used by Russia and China are a little similar to those used by the actual Axis. Russia is gobbling up co-ethnic neighboring states, much as Hitler gobbled Austria and the Sudetenland. China is bullying the neighbors (though not grabbing territory outright quite yet, as Japan did). And the two have formed a friendship of convenience rather than a strong cooperative alliance, much like Germany and Japan did in the Axis. The similarity is probably because Europe and East Asia each lends itself to a certain geopolitical power-building approach.

Ideologically, neither Russia nor China is interested in foisting a universalist ideology on the world - but neither were Nazi Germany or Imperial Japan. Hitler didn't want everyone to agree that Germans were racially superior, he just wanted people to bow to him and do what he said (or die, or both). Same with Japan. It wasn't until the Cold War that competing trans-national global ideology really came into play (though it had been in play in some other conflicts in history.) The new Axis is generally more authoritarian than its opponents, generally respects human rights less, generally favors less stable borders (despite Chinese B.S. rhetoric about national sovereignty), and is generally more militarily aggressive (Iraq notwithstanding). These characteristics are what make the Axis the Axis and the Allies the Allies. But that's not what the conflict is about.

What the conflict is about, is domination of Eurasia, the big continent. I don't know why countries want to dominate this landmass - it seems kind of dumb to me - but they do. This time instead of unusually tough periphery countries trying to conquer and replace the core, the big core countries have got their act together (more or less) and are ready to retake their "rightful" place as emperors of the big continent. Meanwhile the little countries on the periphery, in Europe, East Asia, and Southeast Asia, just want to be independent from the power of the core countries. The U.S., halfway around the world, tries to play balancer and stabilize everything. The "Axis" is just whoever is trying to dominate Eurasia this week, and the "Allies" are just the U.S. plus whoever in Eurasia would rather not be dominated. Until either A) everyone realizes that dominating the vast expanses of interior Asia is pointless, or B) those expanses become populated and economically self-sufficient and divided up into a bunch of stable countries, an Axis will periodically form, and be countered by some Allies.

So that's kind of how I see things. The Axis is, for all intents and purposes, back. That doesn't mean we need to fight it in an apocalyptic war like last time. In fact, that would be a singularly bad idea. With nukes now involved, the cost is way too high. But we are probably in for a protracted struggle, unless the big core Eurasian countries suffer another falling-out or suffer some kind of surprising internal collapse.

Thursday, August 28, 2014

Thursday Roundup, 8/28/2014



Ride em, cowblogs!

Me on BV

1. Japan needs the hammer of private equity to smash the rotting edifice of corporate inefficiency

2. RBC models: The null hypothesis that there is no business cycle

3. Let's make sure not to discriminate against Chinese-Americans if we go to war with China

4. In which I cast doubt on a study about marriage

5. Economics is neither science nor literature, but a third intellectual culture

6. Different groups are treated differently under the law in America


From Around the Econ Blogosphere

1. Acemoglu and Robinson think that people want central governments to protect people from local bullies. Libertarians, take note. Speaking of libertarians, it turns out that many American "libertarians" don't hold very libertarian beliefs.

2. Cathy O'Neil on why the Fields Medal is st00pid. She is correct. And by "correct" I mean "I agree". Also see Frances Coppola on why we give too much respect to Nobelists relative to other scholars.

3. Surveys claim to have found that Americans are a lot more conformist, and less individualistic, than Europeans. Hive minds, indeed.

4. Kevin Grier unleashes a hellacious rhetorical slap at Market Monetarism. OUCH OUCH OUCH

5. Tim Harford: Are monopolies quietly taking over our economy? Unsettling.

6. A well-known econ blog commenter gives a list of reasons not to believe Shiller's CAPE-based warnings about an overpriced stock market.

7. Scott Sumner claims that the switch to true fiat money (post-Bretton Woods) was the mother of all black swans. But he's wrong: Nassim Taleb is the mother of all black swans. See, I just called Nassim Taleb a girl, ha ha ha.

8. John Cochrane says the Fed has mostly done the right thing since the financial crisis. John Taylor's head just exploded. But his hair, curiously, is intact.

9. Michael Strain of AEI argues that we need better infrastructure. If conservatives really jump on this bandwagon, then I say it's morning in America.

10. A great list of quotes by economists dissing economics. It's not clear if they're just talking about macro, though.

11. Is active management dying? Sometimes these days it feels like the whole finance industry is a non-pressurized balloon with a hole in the side, slowly losing air. If so, will that hold down the salaries of econ profs, for whom the finance industry is one of the main outside options? But this question would take us too far afield.

12. Dan McFadden might be my favorite economist. Watch him give a talk about decision-making. Then bow before his awesome awesome-itude.

13. Tyler Cowen says that the way economists measure "trends" and "cycles" has some major problems. Tyler Cowen is quite correct. And by "correct" I mean "the data seem to agree".

14. Tim Harford: 4% inflation target 4% inflation target 4% inflation target 4% inflation target 4% inflation target 4% inflation target 4% inflation target 4% inflation target 4% inflation target...oh dash it all, we'll never get a 4% inflation target.

15. All MMT people should watch Chris Sims talk about how he thinks money and inflation work. Also, all MMT people should dress in gold spandex and throw tomatoes at cars while playing "She Loves You" by the Beatles on kazoos and doing a little bow-legged jig.

16. Josh Brown talks about how the toughest part of being a financial adviser is helping people curb their behavioral biases. Even harder than drinking liquid magma while wrestling a python.

17. Mark Buchanan asks why economists are so obsessed with the Arrow-Debreu result. My answer: Because a cabal of gynecologists and realtors has been secretly promoting Arrow-Debreu since the end of World War 2.

18. Bob Murphy thinks Scott Sumner is using the EMH like a just-so story to "explain" anything he sees in financial markets. Bob Murphy, perhaps a bit uncharacteristically, makes a really good point.

19. Are red-light cameras a form of tax farming? I wouldn't have asked that question if I didn't think the answer was "yes"...

20. Cardiff Garcia summarizes, and dares to gently critique, Autor's Jackson Hole paper.

Tuesday, August 26, 2014

I still don't understand the philosophy of Bayesian probability



Brad DeLong is having an extremely fascinating conversation with an E.E. Doc Smith deus ex machina character, an emulation of a Princeton professor, looser emulations of two famous dead probabilists, and a made-up Greek mediator himself about the philosophy of Bayesian probability (see also here). DeLong focuses on the question of whether probabilities should be "sharp" - i.e., whether we should always say "I believe the probability of the event is x%" (as Bayesians always do), or whether we should say something along the lines of "I believe the probability of the event is between x% and y%."

But I want to focus on a deeper question, which is: What is a probability in the first place? I mean, sure, it's a number between 0 and 1 that you assign to events in a probability space. But how should we use that mathematical concept to represent events in the real world? What observable things should we represent with those numbers, and how should we assign the numbers to the things?

The philosophy of Bayesian probability says that probabilities should be assigned to beliefs. But are beliefs observable? Only through actions. So one flavor (the dominant flavor?) of Bayesian probability theory says that you observe beliefs by watching people make bets. As DeLong writes:
Thomas Bayes: It is simple. [Nate Silver assigning a 60% probability to a GOP takeover of the Senate in 2014] means that Nate Silver stands ready to bet on [Republican] Senate control next January at odds of 2-3. 
Thrasymakhos: “Stands ready”? 
Thomas Bayes: Yes. He stands ready to make a (small) bet that the Majority Leader of the Senate will [not] be a Republican on January 5, 2015 if he gets at least 2-3 odds, and he stands ready to make a (small) bet that the Majority Leader of the Senate will not be a Republican on January 5, 2015 if he gets at least 3-2 odds.
DeLong is very careful to write "a (small) bet". If he wrote "a bet", we would have to introduce Nate Silver's risk aversion into our interpretation of the observed action, if the bet size were large. DeLong is assuming that a small bet will get rid of Silver's risk aversion.

However, there's a problem: DeLong's assumption, though characteristic of the decision theory used in most economic models, does not fit the evidence. People do seem to be risk-averse over small gambles. One (probably wrong) explanation for this is prospect theory. Loss aversion (one half of prospect theory) makes people care about losing, no matter how small the loss is. To back out beliefs from bets, you need a model of preferences. And that model might be right for one person at one time, but wrong for other people and/or other times!

But isn't that just a practical, technological problem? Why do we need real-world observation in order to define a philosophical notion? Well, we don't. We already defined a probability as a real number between 0 and 1 (which gets assigned to the latter slot in the tuples that are the elements of a probability measure). That's fine. But the Bayesian philosophical definition of probability, if it is to be more than "a number between 0 and 1," seems like it has to include a scientific component. The Bayesian notion of "probability as belief" explicitly posits a believer, and ascribes the probability to that real, observable entity (note: This is also why I think the "Weak Axiom of Revealed Preference" is not an axiom). If we can't observe the probability, then it doesn't exist - or, rather, it goes back to just being "a number between 0 and 1".

So can't we just posit a hypothetical purely rational person, and define beliefs as his bet odds? Well, it seems to me that this will probably lead to circular reasoning. "Rational" will probably be defined, in part, as "taking actions based on Bayesian beliefs." But the Bayesian beliefs, themselves, will be defined based on the actions taken by the person! This means that imagining this purely rational person gets us nowhere. Maybe there's a way around this, but I haven't thought of it.

Does all this mean that the definition of Bayesian probability is logically incoherent? No. It means that defining Bayesian probability without reference to preferences (or other decision-theoretical rules that stand in for preferences) is scientifically useless. In physics, a particle that interacts with no other particles - and is hence unobservable, even indirectly - might as well not exist. So by the same token, I claim that Bayesian probabilities might as well not exist independently of other elements of the decision theory in which they are included. You can't chop decision theory up into two parts; it's all or nothing.

I assume philosophers and decision-theory people thought of this long ago. In fact, I'm probably wrong; there's probably some key concept I'm missing here.

But does it matter? Well, yes. If I'm right, it means the argument over whether stock prices swing around because of badly-formed beliefs or because of hard-to-understand risk preferences is pretty useless; there's no fundamental divide between "behavioral" and "rational" theories of asset pricing.

It's also going to bear on the more complicated question Brad is thinking about. If you're talking to people who make decisions differently than you do, it might not be a good idea to report a number whose meaning is conditional on your own decision-making process (which your audience does not know). So that could be a reason not to report sharp probabilities to the public, even if you would make your own decisions in the standard Bayesian-with-canonical-risk-aversion way. But what you should do instead, I'm not sure.

Friday, August 22, 2014

A slight clarification about the "end of labor"


MIT prof and economic policy advisor David Autor has written an excellent new paper about labor market polarization, which you should read. In that paper, he cites an article I wrote for The Atlantic last year, discussing the possibility of "the end of labor." Mr. Autor makes it sound as if I believe the "end of labor" is coming, but in fact, I only think this is one possibility among many. The point of my article - which was inspired by this Larry Summers talk - was that the "end of labor" is something we should prepare to deal with, even if there is only a low probability of it happening. The mechanism for the "end of labor", of course, could be such a huge degree of skills-based labor market polarization that even small labor market frictions would be capable of creating huge amounts of equilibrium unemployment; alternatively, it could be a continuation of the trend of increasing capital share of income, as discussed in this paper.

The Atlantic, of course, got to pick the title of my piece (as all magazines do with all pieces), and understandably went with something attention-catching rather than something that would reflect the uncertainty I tried to express in the article itself.

But in any case, thanks to Mr. Autor for the mention.

Monday, August 18, 2014

RBC models we can believe in?



At Bloomberg View, I wrote an article trying to explain the basics of RBC models to the masses, and give a little history-of-thought. Of course anyone who actually knows the situation will realize that my treatment is pretty simplistic, but you try explaining RBC in 800 words to people who know nothing about modern academic macro, in a way that's entertaining and grabs eyeballs. It is harder than it sounds. ;-)

Anyway, the post only talked about the original, historical RBC model, and mentioned a couple follow-ups, such as news shock models. But if you define "RBC" as "any macro models where aggregate uncertainty is mainly driven by productivity shocks," then the field gets a lot wider. 

In fact, if you put a gun to my head and asked me why recessions happen, first I'd kiss my ass goodbye, but then I'd say that some of them happen because of sector-specific productivity shocks, amplified by network effects and by some departures from Rational Expectations. Actually, there are a number of models popping up that try to model something like this, and I think it's a hugely interesting literature. Here are a couple examples, with abstracts.

"Noisy Business Cycles", by George-Marios Angeletos and Jennifer La'O (2009)
This paper investigates a real-business-cycle economy that features dispersed information about the underlying aggregate productivity shocks, taste shocks, and, potentially, shocks to monopoly power. We show how the dispersion of information can (i) contribute to significant inertia in the response of macroeconomic outcomes to such shocks; (ii) induce a negative short-run response of employment to productivity shocks; (iii) imply that productivity shocks explain only a small fraction of high-frequency fluctuations; (iv) contribute to significant noise in the business cycle; (v) formalize a certain type of demand shocks within an RBC economy; and (vi) generate cyclical variation in observed Solow residuals and labor wedges. Importantly, none of these properties requires significant uncertainty about the underlying fundamentals: they rest on the heterogeneity of information and the strength of trade linkages in the economy, not the level of uncertainty. Finally, none of these properties are symptoms of inefficiency: apart from undoing monopoly distortions or providing the agents with more information, no policy intervention can improve upon the equilibrium allocations.

"The Network Origins of Aggregate Fluctuations", by Daron Acemoglu et al. (Econometrica 2012)
This paper argues that in the presence of intersectoral input-output linkages, microeconomic idiosyncratic shocks may lead to aggregate fluctuations. In particular, it shows that, as the economy becomes more disaggregated, the rate at which aggregate volatility decays is determined by the structure of the network capturing such linkages. Our main results provide a characterization of this relationship in terms of the importance of different sectors as suppliers to their immediate customers as well as their role as indirect suppliers to chains of downstream sectors. Such higher-order interconnections capture the possibility of “cascade effects” whereby productivity shocks to a sector propagate not only to its immediate downstream customers, but also indirectly to the rest of the economy. Our results highlight that sizable aggregate volatility is obtained from sectoral idiosyncratic shocks only if there exists significant asymmetry in the roles that sectors play as suppliers to others, and that the “sparseness” of the input-output matrix is unrelated to the nature of aggregate fluctuations.

And just for fun, I'm going to throw in "Intermediate Goods, Weak Links, and Superstars: A Theory of Economic Development", by Charles I. Jones (2008), which bills itself as a theory of development, but seems like it could pretty easily be modified to be a business-cycle theory for developed countries.

(Also there's this Gabaix paper, which is about firm-level heterogeneity. I originally included it here, but it doesn't really fit with the others so I took it out. Heterogeneity is a very different story from networks and complexity. Still, good to see heterogeneity getting more attention.)

The basic idea here is actually pretty simple. Angeletos actually said it, when he came to present his paper at Michigan: "One firm's productivity determines other firms' demand." In other words, these network models go way beyond the traditional, typical framework of aggregate supply and aggregate demand. (Other models also do this, but usually across time rather than across firms or sectors.) 

Like I said, if you held a gun to my head, I would say that something like this is actually going on in the actual economy. Why? Because aggregate shocks are sometimes really hard to identify. There were the oil price shocks in the 1970s and Volcker's tightening in the early 1980s, but a lot of recessions don't seem to be externally provoked. So maybe that means there is some kind of random mass-psychological sentiment thing going on, or maybe it means that recessions are sunspots caused by the interaction of a whole bunch of frictions, and thus completely unknowable. But this network/linkage idea seems like a promising alternative to those unhappy possibilities. That doesn't mean I think any of these models is right - they're all going to have empirical issues, because they are basically proof-of-concept papers. But I suspect they're on to something that many have expected for a long time - the idea that economic fluctuations are the result of the complexity of economic systems.

But explaining to Bloomberg View readers that these models may or may not deserve the moniker "RBC" would have distracted from my main point, which is to teach people a little about the history of macroeconomic thought (read: academic politics in the macro field), so someday I can explain my theory of why Mike Woodford is the most important macroeconomist in the world. But now I'm getting ahead of myself...

Thursday, August 14, 2014

Thursday Roundup, 8/14/2014



Thursday Roundup is back! Saddle up, blog junkies.

Me on BV

1. Silicon Valley is solving the big problems (warning: sappiness)

2. The trend is your friend til the bend at the end (or, why "put option illusion" fools investors)

3. Barack Obama is no foreign policy wimp

4. Why I don't mind if someone calls me "stupid"

5. How hedge funds can "sharpen their Sharpe ratios" at investors' expense (featuring cool papers by Goetzmann et al. and Agarwal & Naik)


From Around the Econ Blogosphere

1. Alex Tabarrok continues to sound the alarm on FDA over-regulation of biomed technology. See also here.

2. Mark Thoma: The perennial disagreement among macroeconomists is due to a toxic mix of bad data and politics. Old news, but useful to repeat.

3. Miles Kimballl on how to turn your kid into a math person. No cyborg enhancements involved.

4. Mencius Moldbug has quit blogging. Street protests explode in cites across the globe. Antidepressant use spikes. Just kidding.

5. Roger Farmer thinks Mike Woodford is wrong about the irrelevance of QE. Good to see people realizing that Mike Woodford is the world's most important macroeconomist.

6. Data scientists are out there earning more than econ profs. Actually, data scientists have similar skill sets to empirical econ researchers.

7. Brad DeLong thinks about the philosophical problems of Bayesianism. This is something I've wondered about for a while, and I'm still not satisfied.

8. Bryan Caplan wonders if economics is based on common sense or not. This is something I've often wondered about. Most sciences prize "counterintuitive" findings. Does econ? Should econ? Should the other sciences, for that matter?

9. Robert VerBruggen thinks helping poor women delay childbearing could be a way to fight poverty.

10. John Cochrane and Anat Admati continue to fight the good fight for increased bank capital requirements. Thought: How about making them dependent on bank size, as a way of discouraging TBTF? (Not a new thought, but still a thought.)

Wednesday, August 13, 2014

Chris House on stimulus spending



Back in March, Chris House wrote a blog post explaining why he thinks that tax rebates make better stimulus than government spending. He concludes that tax rebates are the best form of stimulus, and that government spending projects should only be undertaken if the projects would pass a cost-benefit test in the absence of any stimulus effect. House:
If a project doesn’t meet the basic cost / benefit test, then it shouldn’t be funded, regardless of the need for stimulus...If the social value of a government project exceeds its social cost then we should continue to fund the project whether we are in a recession or not. If the social value falls short of the social cost then, even if the economy is in “dire need” of stimulus we should not fund it. If we really need stimulus but there are no socially viable projects in the queue then the government should use tax cuts... 
If the direct social benefit of a bridge is $100, then all the government needs to consider is whether the cost of building the bridge is greater or less than $100. If you then tell me that, because we are in a recession, there are additional stimulus benefits from the project (e.g., the workers who build the bridge take their new wage income and buy goods and services from other businesses further stimulating demand, increasing employment, and so on.), the government should exclude these additional benefits from its calculation.
I don't understand this assertion at all. It makes no sense to me.

Let's consider a simple numerical example. Suppose that the economy is in a recession. And suppose that, because of the Zero Lower Bound or whatever, the pure fiscal "multiplier" is substantial. Specifically, suppose that $100 of tax rebates will increase GDP by $110. In this case, stimulus spending is a "free lunch."

Now suppose that instead of doing tax rebates, the government can build a bridge. The social benefit of the bridge is $90, and the bridge would cost $100. In the absence of stimulus effects, therefore, the bridge would not pass a cost-benefit analysis. For simplicity's sake, suppose that spending money on the bridge would create exactly the same stimulus effect as doing a tax rebate - spend $100 on the bridge, and GDP goes up by $110 from the stimulus effect.

In this case, the net social benefit of spending $100 building the bridge is $90 + $110 - $100 = $100.
And the net social benefit of spending $100 on a tax rebate is $110 - $100 = $10.

Bridge wins!

In fact, it turns out that the bridge wins even with a pure multiplier of less than 1! As long as the multiplier is greater than 0.2, in fact, it's worth it for the government to build the bridge. This will mean that the apparent multiplier of bridge-building will far exceed the "pure" multiplier. In this case, the apparent multiplier from bridge-building will be 2.

This fits the results of Auerbach and Gorodnichenko (2012). It also fits with the simple Keynesian theories you'd read in an Econ 102 textbook. It also fits the results of Bachmann and Sims (2011). And if true, it means Chris House is completely wrong.

Now let's relax the assumption that the pure stimulus effect is equal for the two cases. Suppose that government spending creates waste, for example. Or suppose that due to the particular nature of the mechanism that makes stimulus effective in the first place, the people who build the bridge will tend to stick most of their fee in a bank instead, rather than spending it as people would do if they got a tax rebate. Concretely, suppose that due to government waste or reduced stimulus effect, the pure stimulus benefit of building the bridge is only $30 instead of $110 (a pure multiplier of only 0.3 for government spending vs. 1.1 for tax rebates).

In that case, the net social benefit of building the bridge is $90 + $30 - $100 = $20. Bridge still wins! House is still wrong!

The difference between bridge-building and tax rebates can be stated in simple terms. If you give people a tax rebate, they may stick the whole thing in the bank, completely negating the stimulus. If you pay unemployed people to build a bridge, they may stick 100% of their earnings in the bank - but now you have a new bridge.

So basically, I don't see how House is doing his cost-benefit analysis. His conclusion is diametrically opposed to Econ 102 textbook Keynesianism, which is fine, but I feel like there should be some justification. Almost everyone - even John Taylor! - thinks that infrastructure spending makes better stimulus than tax rebates, not worse. Chris House asserts that the exact opposite is true, and that's fishy.

Sunday, August 10, 2014

Yes, women's labor force participation matters



A bunch of social-conservative types on Twitter keep telling me that women's labor force participation doesn't matter for GDP growth. As evidence they keep linking me to this post by Scott Alexander. Here's Scott's case:
[W]hy did the entry of women into the workforce produce so little effect on GDP? Here’s the graph of US women’s workforce participation: 
 
And here’s the graph of US GDP. 
 
In about 50 years – 1935 to 1985 – we went from 20% of women in the workforce to 60% of women in the workforce. Assuming a bit under 100% of men in the workforce, that’s an increase of almost 50% over the expected trend if number of women in the workforce had stayed constant. 
I’ve already admitted I find the fixedness of the GDP trend bizarre. But how on Earth do you unexpectedly raise the number of people in the workforce by 50% and still stick to exactly the same GDP trend? 
The idea here is that the GDP growth trend looks so smooth that it has to be a law of nature. But that's certainly not the case for other countries. For example, here's a graph for Japan, on a log-log scale:



If Japan's growth rate were constant, that line would be straight. Instead, it's concave, meaning that growth slowed substantially over time. So we know that countries' economic growth rates are not fixed laws of nature - they can be affected by events.

So what were some of the events that affected U.S. GDP growth over the last century? Here's total labor force participation in the U.S. from 1948 to 2014:



As you can see, there was a big increase between around 1968 and around 1989. A lot of that was women entering the workforce (and men not leaving).

Now what else affects GDP? Population, but U.S. population growth was pretty constant. How about productivity? David Beckworth has a good graph:



We see that from the late 1960s through the mid-1900s, productivity stagnated noticeably. So the gains from increased labor force participation was one of the things that counteracted the productivity slowdown at that time.

In other words, when Scott asks:
Are we imagining here that if women hadn’t entered the workforce, GDP would have suddenly deviated downward from the trend, and totally by coincidence women rushed in to save the day?
The answer is: Yes!

(Now, one might wonder if TFP and LFPR are related. When more people work, does productivity go down? Interesting question. Economists usually assume the two are unrelated. And there are definitely lots of episodes in which the two move in the same direction instead of canceling out - Japan in the 1990s is one of these, since female labor force participation and TFP both abruptly flattened out in that decade. But some people have argued that higher employment slows down TFP in some situations. Suffice it to say that this is a minority viewpoint, but can't be ruled out.)

Actually, there have been a number of economists who have looked at a bunch of factors and tried to isolate the effect of female labor force participation on growth. Here is a summary of much of the relevant research. The conclusion is that yes, female labor force participation does contribute substantially to per capita GDP. The puzzle Scott presents us with is actually no puzzle.

Scott also asks this question:
And then when we ran out of interested women to add to the work force, again by coincidence the GDP stabilized back to its trend line?
The answer is: No. Growth has been slower since women stopped joining the labor force. The trend is your friend til the bend at the end! Scott's GDP graph is zoomed-out, so it's hard to see the "bend at the end", but it's there. There was an acceleration of productivity growth in the late 90s and early 2000s, which - again - partially canceled out the end of women's entry into the labor force. But since then, growth has been slower; there has been no return to the growth rates of the 1960s or even the 1990s.

Now, a couple of caveats. Caveat 1 is that "home production" is not counted in GDP, but matters for living standards. Caveat 2 is that women's labor force participation can affect fertility (by decreasing it or by increasing it), which may affect long-run TFP growth, and will certainly affect total GDP by changing the population size.

But the idea that women's entry into the labor force has been unimportant for GDP is not correct. My advice to social conservatives looking to give economic justifications for traditional gender roles: Stop linking to this post.

Saturday, August 09, 2014

Let me explain Japan for Westerners


"Do you want to know our secrets?
Oops, sorry, we don't have any."


(If you just want the quick explanation without all the preamble, skip to the last paragraph of this post.)

There are three common mistakes that many Westerners make when observing or analyzing Japanese culture. First, they essentialize it - they assume there are some core things that never change, and that you can understand these things by studying samurai culture, or stuff like that. Second, they exoticize it - they assume that Japanese culture is very different from Western culture, and that there are deep secrets that only Japanese people themselves understand. Third, they homogenize it - they assume that the difference between Japanese individuals or subcultures is much smaller than the group difference between Japan and other cultures.

To be fair, many Japanese people also make these mistakes, and many Westerners also make a couple of those mistakes when thinking about their own cultures. But the mistakes are especially common among Westerners visiting - or, sometimes, living in - Japan.

The blog Wait But Why is one of my favorites, and I don't want this post to be interpreted as an insult directed at Tim Urban, the blogger. But in a recent post about a visit to Japan, Tim did all three of the things that I mentioned above. Let me quote him at great length:
7) The culture is lovely to interact with, fascinating to observe, and impossible to understand... 
Japanese foreignness is really about what goes on in the depths of the mind, not the zany cartoon ads. 
It makes sense that the differences between Japanese culture and a culture like that in America would run deep. At the core of American life are European cultural roots and a Judeo-Christian value system—both of which have at one time or another influenced much of the rest of the world, through imperialism and missionary activities. But Japan spent most of its history being unusually isolated, both as an official policy and through its ability to resist forceful cultural immersion—it’s one of the few places to A) never be occupied by another country, and B) keep almost all Christian missionary activity out, making it a rare country that has been able to evolve mostly untouched by others. 
Add to this the somewhat secretive, exclusive nature of Japanese culture, and you have a pretty boggling situation for an outsider... 
As my time in Japan went on, I began getting the very distinct impression that in spite of being treated wonderfully, I was not part of the club. Nor did it seem that anyone had any interest in helping me to join it. When it comes to anything beyond the Outer Shell—who the Japanese people really are, why they act the way they do, and what they’re thinking—I know about as much now as I did before my visit. 
Given that my trip was short and I don’t speak Japanese, this isn’t a huge surprise—but what did blow my mind was talking to expats who had been living in Japan for years and spoke fluent Japanese. Without exception, each of them told me that the Japanese treat them like outsiders and that that’s not going to change. One of them was half Japanese, spoke the language without an accent, had lived there for the last ten years and was married to a Japanese man, and she said she was a permanent outsider after being raised in France. 
A visitor to any country is an outsider to the culture there—what makes Japanese exclusivity unusual is both the extent of its stubbornness and the fact that Japan is a large and prosperous world power—usually the exclusive club phenomenon is the stuff of smaller groups, often those who have faced some kind of adversity together. 
The explanation, to me, comes back to Japan’s isolated history and the fact that the cultural gap between foreigners and Japanese runs especially deep. You can speak the language perfectly, but when the Japanese are known for speaking to each other in a very specific, indirect way (someone described it like talking to someone in a semi-circle instead of a straight line) and the foreigner just doesn’t really know how to do that, they’re not part of the club. When the Japanese are horrified at the prospect of losing face and a foreigner doesn’t understand what it would even feel like to lose face, they don’t know what it feels like to be Japanese, so there will always be a distance between them.
You can see all three of the processes I discussed at work here. First, there is the essentialization - Tim explains Japan's supposedly unique culture in terms of its "isolated history". Second, there is the exoticism: Tim thinks there are strange, unknowable things going on in the "depths of the mind" of "secretive" Japanese people, to which neither he nor any non-Japanese person is privy. Third, the idea that Japan is a homogeneous "club" is clearly in evidence.

Tim is certainly right that as a foreign visitor with no local language skills, he had no real chance of fitting in. Imagine a Laotian dude, who, speaking not one word of English, shows up in Vermont and starts walking around wondering when he's going to really be in the American "club." That's you in Japan, buddy! 

But Tim also talked to expats who made the same complaint, and in fact, I've heard it from a number of expats myself. Certainly not all, though - I showed Tim's post to an American expat writer in Tokyo the other day, and he snorted and said (I'm paraphrasing): "If you go around thinking you don't fit in, you'll never fit in."

That's really the key, I think. How do you ever know that you fit in, anywhere? Suppose you're walking around your hometown, talking to people. You feel like you understand them, they understand you, you're one of them. It makes sense, after all - you come from the same place, maybe you're the same race. But what if you're wrong? What if they all secretly think you're a weirdo, and they're all just too polite (or scared, or apathetic, or mean) to say it?

The answer is, you don't know. You make an assumption. And in Japan, many Westerners make the opposite assumption - they think that they'll be perpetually regarded as outsiders by the secret core of the Japanese psyche that no one who's not Japanese will ever truly see. When you make that assumption, it's going to be damn hard to fit in, even if the assumption happens to be wrong! By assuming everyone around you sees you as an alien, you'll act like someone who expects to be treated as an alien. And people around you are going to see you as weird because of that. It's a self-fulfilling prophecy.

(Now, it is true that most Westerners in Japan do not speak Japanese and do not live in Japan. And so Japanese people will generally approach a Westerner with the assumption that (s)he does not speak the language. To English-speaking expats who have worked hard to become fluent in Japanese, I guess this can seem off-putting. But English speakers are unique - they grew up in countries that reasonably expected all foreigners to show up speaking the local language. If you meet a Laotian guy in Vermont, you don't try to speak to him in Laotian. And I guess some English-speakers in Japan expect the same treatment. But the reason we expect the Laotian to speak English is not because we've let him into the secret "club" of American society - it's because the British Empire conquered the largest empire in world history, and America produced 1/3 to 1/2 of global GDP in the years following WW2. English is a global language; Japanese is not.)

Why do I call the three attitudes - essentialization, exoticization, and homogenization - "mistakes"?

Essentialization is a mistake because it causes you to miss cultural shifts. If you think that Japan's culture of "lifetime employment" stems from some deep feudal history and thus will never change, then when it actually does start to change, you'll ignore it or disbelieve it. Essentialization thus blinds you to reality. I think it also contributes to negative trends in international relations - after all, if Japanese culture today is the same as in the 1930s, doesn't that imply that Japan is still a murderous, fascist society underneath a superficial veneer of pacifism? Actually, lots of people do think that about Japan, especially in Korea. I think this idea is wrong, and has poisoned relations between those countries.

Exoticization is bad because of the reason I mentioned above - it's a self-fulfilling prophecy. There's no more surefire way of turning yourself into a permanent outcast than assuming you are one.

Homogenization, though, is the worst of the bunch. It's really just a form of stereotyping. Nearly every bad effect of racial stereotyping is also an effect of national/cultural stereotyping. In both instances, you end up treating people you meet based on what group they're a part of, instead of what they're like as an individual. That can easily lead to stuff like this.

Homogenizing other people is really just another way of voluntarily alienating yourself. Japanese people, as they walk down the street or sit on a train, are not looking at each other and thinking "Wow! We are all the same!" They're thinking "I wonder if that guy is going to shove past me like a jerk," or "Wow, she's cute," or "Look at that silly outfit." They're constantly thinking about each other as individuals. So why shouldn't we think of them as individuals too?

Personally, I've lived in Japan for a total of about three years, on and off, over my life. These days, when I go there, I have Japanese people try to speak to me in English...but I also have Japanese people speak to me in Japanese and get annoyed when there's a word I don't know. I've had people act obviously fake toward me, and I've had people talk about their deepest personal issues and cry on my shoulder. I've had Japanese friends share a worried look with me when some weird Japanese stranger comes up and tries to talk to us. I've never felt any more out of place there than in, say, Michigan, or Long Island.

But that's just me. I'm probably weird. If you want to start learning that Japanese people are not much different than the people you grew up with, friend a few on Facebook - most Japanese people use it - and start reading their posts (use Google Translate or Rikaikun if you can't read Japanese). You'll quickly see that the stuff they post for their own friends is a little different than what Americans post - less politics, more lengthy updates about their own lives - but not particularly alien either. Sure, FB posts don't let you stare straight into someone's soul, but they're a lot better guide to what Japanese people are really like than walking around Tokyo talking to disgruntled expats.

If you don't want to spend the time and effort to do that, then just let me give you my clear, simple, Explanation of Japan for Westerners: Japan is a collection of rocks with some human beings on it. That's the vast majority of what you need to know.

Basic Income is good because it's basic




Mike Konczal has a post attacking the libertarian support for Basic Income. Paul Krugman approves. Basically, Konczal argues that the mix of programs we have now works just fine.

I think Konczal is wrong, for a one, er, basic reason. Basic Income, unlike the programs we have now, will be politically easy to raise once it's in place.

Redistribution programs (the good ones anyway) are designed to help a lot of people and hurt a few. But this means that the constituency opposing redistribution is much more concentrated and focused than the constituency in support of it. As Mancur Olson might tell you, this makes redistribution a tough sell politically.

But if you have one big, high-profile redistribution program, you can get enough popular support to overcome the concentrated opposition of the rich people footing the bill. As an example, look at the minimum wage, which gets big popular support. The Democrats can go back to the minimum wage again and again as a populist issue.

But that's not true for the whole array of redistribution programs we currently have. If the Democrats want to increase the strength of the safety net as a whole, they have to mount a populist campaign for each one of its components. That's hard to do. So a lot of the components of the safety net get left behind, or killed by Republicans when no one is looking.

Such a fate would never befall a Basic Income. It would be in the spotlight all the time.

In fact, by endorsing Basic Income, libertarians are walking right into a trap. Anti-redistributionists' great fear has always been that the masses will use the power of majority rule to simply vote themselves more money. As things stand, the fragmentation of our redistribution programs makes it easier for the anti-redistributionists to punch holes in the safety net. If the fragmented system were replaced with one universal, high-profile program, the result would be a huge political gift to redistributionists.

Libertarians will eventually realize this, and their tentative support for Basic Income will vanish. But pro-redistribution liberals should not be so quick to dismiss the idea just because it came out of the mouths of their opponents in a moment of confusion.

Friday, August 08, 2014

Can the Fed set interest rates?


Most people think that in normal times - i.e. when the Federal Funds Rate is well above zero - that the Fed is able to set that interest rate through open market operations. You don't hear a lot of people saying that OMOs have no effect on interest rates.

But that's exactly what's implied by the famous "Wallace Neutrality" paper, also known as Wallace (1979). Neil Wallace was a leading light of the "New Classical" or "freshwater" generation of macroeconomists who revolutionized the discipline in the 70s and 80s. He is one of the main intellectual predecessors of Steve Williamson, Randy Wright, and the rest of the current "New Monetarist" or "money search" movement.

Wallace shows that if the government works in a very specific way, then Open Market Operations can't change interest rates. Specifically, the government has to set fiscal policy to exactly cancel out monetary policy, by making sure that OMOs leave A) government consumption, B) taxes and transfers, and C) income distribution completely unchanged. 

In other words, Wallace Neutrality is very much like the so-called "Sumner critique" of fiscal policy. It says that fiscal policy can cancel out monetary policy if it wants to. That makes sense, at least in an idealized world, and it implies that monetary policy is inextricably bound up with fiscal policy, which is interesting.

But I don't think Wallace Neutrality should be our jumping-off point or "base case" for thinking about how monetary policy works!

In a recent post about QE, John Cochrane wrote:
[S]tandard theory makes a pretty clear prediction about [QE's] effects [on interest rates]: zero.  OK, then we dream up "frictions," and "segmentation," and "price pressure" or other stories.
The "standard theory" he's talking about is the Modigliani-Miller result. But Modigliani-Miller is about the value of firms, not of government bonds. So what he's really talking about is Wallace Neutrality, which bills itself explicitly as "A Modigliani-Miller Theorem for Open-Market Operations."

But Wallace neutrality is not Modigliani-Miller, for two reasons.

First, a sufficient condition for Modigliani-Miller to hold is the existence of frictionless complete markets. But that is not sufficient for Wallace Neutrality to hold - for that, you need a certain government policy rule. We can think about frictionless complete markets as a sort of "natural base case", and that sort of makes sense. But it doesn't really make sense to use a certain government policy rule as a "base case", especially when that policy rule seems nonsensical in the first place (Why the heck would the fiscal authority try to exactly cancel out the monetary authority's actions??). Modigliani-Miller seems deep and fundamental, while Wallace Neutrality seems more arbitrary and specific. 

Second, the government is a policy-maker, not a price-taker. Its decisions create the overall economic environment in which agents act. So even a small departure from Wallace Neutrality-enforcing behavior, or from the other conditions required for Wallace Neutrality, will allow the Fed to target interest rates, simply by doing enough OMOs. See Miles Kimball on this point.

In other words, when someone says that Modigliani-Miller doesn't hold, it makes sense to ask "Why not?" But when someone says Wallace Neutrality does hold, it makes sense to ask "Why?"