Author: JW Mason

Do Prices Matter?

Do exchange rates drive trade flows? Yes, says Dean Baker David Rosnick. Prices matter:

What happens to the economy as the dollar falls? …Over time, Americans notice that British goods have become more expensive in comparison to domestically produced goods. In other words, the price of U.S.-made sweaters becomes cheaper relative to the price of sweaters imported from Britain. This will lead us to buy fewer sweaters from Britain and more domestically manufactured sweaters.

At the same time, the British notice that American goods have become relatively inexpensive in comparison to goods made at home. This means it takes fewer pounds to buy a sweater made in the United States, so the British will buy more sweaters made in the United States and fewer of their domestically manufactured sweaters.

While American producers notice the increased demand for their exports, allowing them to raise their prices somewhat and still sell more than they had before the dollar fell. Similarly, for British exporters to continue selling they must lower prices.
Thus, as everyone eventually adjusts to the fall in the dollar, the trade deficit shrinks. This is not new economics by any stretch…

Indeed it’s not. Changes in prices induce changes in transaction volumes that smoothly restore equilibrium, is the first article of the economist’s catechism. But how much a given volume responds to a given price change, and whether the response is reliable and strong enough to make the resulting equilibrium relevant to real economies, are empirical questions. You could tell a similar parable about an increase in the minimum wage leading to a lower demand for low-wage labor, but as I’m sure Dean folks at CEPR would agree, that doesn’t it mean it’s what we actually see. You have to look at the evidence.

So what’s the evidence on this point? Dean Rosnick offers a graph showing two big falls in the value of the dollar after peaks in the mid-80s and mid-2000s, and falls in the trade deficit a few years later, in the early 90s and late 2000s. Early 90s and late 2000s … hm, what else was happening in those years? Oh, right, deep recessions. (The early 2000s recession was very mild.) Funny that the same guy who’s constantly chastising economists for ignoring the growth and collapse of a huge housing bubble, when he turns to trade … ignores a huge housing bubble.

Still, isn’t the picture is basically consistent with the story that when the dollar declines, US imports get more expensive and fall, and US exports get cheaper and rise? Not necessarily: Dean’s Rosnick’s graph doesn’t show imports and exports separately. And when we separate them out, we see something funny.

Click the graph to make it legible.

In a world where trade flows were mainly governed by exchange rates, a country’s imports and exports would show a negative correlation. After all, the same exchange-rate change that makes exports more expensive on world markets makes imports cheaper here, and vice versa. But that isn’t what we see at all. Except in the 1980s (when the exchange rate clearly did matter, but not in the way Dean Rosnick supposes; see Robert Blecker) exports and imports very clearly move together. And it’s not just a matter of a long-term rise in both imports and exports. Every period that saw a significant fall in imports — 1980-1984; 2000-2002; 2007-2009 — saw a large fall in exports as well. This is simply not what happens in a world where prices (are the main things that) matter.

(This discrepancy between real-world trade patterns and the textbook vision applies to almost all industrialized countries, and always has. It was noticed long ago by Robert Triffin, who brought it up to argue that movements in relative price levels did not govern trade patterns under the gold standard, as Ricardo and his successors had claimed. But it is just a strong counterargument to today’s conventional wisdom that exchange rates govern trade.)

So if changes in exchange rates don’t drive trade, what does? Lots of things, many of them no doubt hard to measure, or to influence through policy. But one obvious candidate is changes in incomes. One of the big advances of the first generation of Keynesian economists — people like Triffin, and especially Joan Robinson — was to show how, just as prices (the wage and interest rates) fail to equilibrate the domestic economy, leaving aggregate income to adjust, relative prices internationally don’t equilibrate the global economy, leaving output or growth rates to adjust. In the short run, business cycle-type fluctuations reliably involve changes in investment and consumer-durable purchases larger disproportionate to the change in output as a whole; given the mix of traded and non-trade goods for most countries, this creates an allometry in which short-run changes in output are accompanied by even larger short-run changes in imports and exports. For a country that runs a trade deficit in “normal” times, this means that recessions are reliably associated with smaller deficits and booms with larger ones. In the long run, there is also a reliable tendency for increments to income to involve demand for a changing mix of goods, with a greater share of demand falling on “leading sectors,” historically manufactured goods. (The flipside of this is Engels’ law, which states that the share of income spent on food falls as income rises.) Given that both a country’s mix of industries and its trade partners are relatively fixed, this creates a stable relationship between relative growth rates and trade balance movements. Neither of these channels is perfectly reliable, by any means — and the whole point of the industrial policy is to circumvent the second one — but they are still much stronger influences on trade flows than exchange rates (or other relative prices) are.

So with that in mind, let’s look at another version of the graph. This one shows the year-over-year change in the trade balance as a share of GDP, the same change as predicted by an OLS regression on total GDP growth over the past three years, and as predicted by the change in the value of the dollar over the past three years. [1]

It will be legible if you click it.

Not surprisingly, neither prediction gives a terribly close fit. But qualitatively, at least, the predictions based on GDP do a reasonable job: They capture every major worsening and improvement in the trade balance. True, they under-predict the improvement in the trade balance in the later 80s — the Plaza Accords mattered — but it’s clear that if you knew the rate of GDP growth over the next three years, you could make a reasonably reliable prediction about the the behavior of the trade balance. Knowing the change in the value of the dollar, on the other hand,wouldn’t help you much at all. (And just to be clear, this isn’t about the particular choice of three years. Two years and four years look roughly similar, and at a one-year horizon exchange rates aren’t predictive at all.)

Here’s another presentation of the same data, a scatterplot comparing the three-year change in the trade balance to the three-year growth of GDP (blue, left axis) and three-year change in the exchange rate (red, right axis). Again, while the correlation is fairly loose for both, it’s clearly tighter for GDP. All the periods of strongest improvement in the trade balance are associated with weak GDP growth, and vice versa; similarly all the periods of strong GDP growth are associated with worsening of the trade balance, and vice versa. There’s no such consistent association for the trade balance and changes in the exchange rate.

If you want to be able to read the graph, you should click it.

The fit could be improved by using some measure of disposable income — ideally adjusted for wealth effects — in place of GDP, and by using some better measure of relative prices in place of the exchange-rate index — altho there’s some controversy about what that better measure would be. And theoretically, instead of just the three-year change, you should use the individual lags.

Still, the takeaway, if you’re a policymaker, is clear. If you want to improve the trade balance, slower growth is the way to go. And if you want to boost growth, you probably are going to have to ignore the trade balance. Personally, I want door number two. I assume Dean Rosnick doesn’t want door one. But what I’m not at all sure about, is what concrete evidence makes him think that exchange-rate policy opens up a third door.

[1] Technicalities. I separately regressed the changes in imports and exports (as a percent of GDP) over three years earlier, on the percentage change over the same period in GDP and in the Fed’s trade-weighted major-partners dollar index, respectively. It’s all quarterly data, downloaded from FRED. The graphs shows the predicted values from the two regressions. This is admittedly crude, but I would argue that the more sophisticated approaches are in some respects less appropriate for the specific question being addressed here. For example, suppose hypothetically that a currency devaluation really did tend to improve the trade balance, but that it also tended to raise GDP growth, raising imports and offsetting the initial improvement. From an analytic standpoint, it might be appropriate to correct for the induced GDP change to get a better estimate of the pure exchange-rate effect. But from a policy perspective, the offsetting growth-imports effect has to be taken into account in evaluating the effects of a devaluation, just as much as the initial trade-balance improvement. Maybe we should say: Academics are interested in partial derivatives, policymakers in total derivatives?
EDIT: Oops! How did I not notice that this article was by somebody named David Rosnick, not Dean Baker? Makes me feel a bit better — I know Dean does share this article’s basic view of trade and the dollar, but I would hope his take would be a little less dependent on textbook syllogisms, and a little more attentive to actual patterns of trade. Clothing from the UK is hardly representative of US imports; to the extent we do import any, it’s like to be high-end branded stuff that is particularly price-inelastic.

FIRE in the Whole

Maybe the most interesting paper at this past weekend’s shindig at Bretton Woods was Duncan Foley’s. [1] He argues, essentially, that it’s wrong to include finance, real estate and insurance (FIRE) in measures of output. Excluding FIRE (and some other services) isn’t just conceptually more correct, it has practical implications — the big one being that an Okun’s law-type relationship between employment and output is more stable if we define output to exclude FIRE and other sectors where value-added can’t be directly measured.

It’s a provocative argument. He’s certainly right that the definition of GDP involves some more or less arbitrary choices about what is included in final output. (The New York Fed had a nice piece on this, a couple years ago, which was the subject of the one of the first posts on this humble blog.) However, I can’t help thinking that Foley is wrong on a couple key points. Specifically:

While in other industries such as Manufacturing (MFG) there are independent measures of the value added by the industry and the incomes generated by it (value added being measurable as the difference between sales revenue and costs of purchased inputs excluding new investment and labor), there is no independent measure of value added in the FIRE and similar industries mentioned above. The national accounts “impute” value added in these industries to make it equal to the incomes (wages and profits) generated. Thus when Apple Computer or General Electric pay a bonus to their executives, GDP does not change (since value added does not change–the bonus increases compensation of employees and decreases retained earnings), but when Goldman-Sachs pays a bonus to its executives, GDP increases by the same amount.

This seems confused on a couple of points. First, unless I’m mistaken, value-added in FIRE is calculated exactly in the way he describes — sale price of output minus cost of inputs. (The problem arises with government, where there is no sale price.) Second, I’m pretty sure there is no difference in the way wages are treated — total incomes in a sector always equal the total product of the sector, by definition. There is a question of whether executive bonuses are properly considered labor income or capital income, but that’s orthogonal to the issues the paper raises, and is not unique to FIRE. In any case, it is definitely not correct to say that higher compensation implies lower earnings in non-FIRE but not in FIRE.

It seems to me that there is a valid & important point here, but Foley doesn’t quite make it. The key thing is that there is no way of measuring price changes in FIRE. That’s what he should have said in place of the paragraph quoted above. The convention used in the national accounts is that the price of FIRE services rises at the same rate as the price level as a whole, so changes in nominal FIRE incomes relative total nominal income represent changes in FIRE’s share of total output. But you could just as consistently say that FIRE output grows at the same level as output as a whole, and deviations in nominal FIRE expenditure represent relative changes in FIRE prices. [2] There’s no empirical way of distinguishing these cases, it really is a convention. Doing it the second way would imply lower real GDP and higher inflation. I think this is the logically consistent version of Foley’s argument. And it would motivate the same empirical points about Okun’s Law, etc.

There’s another argument, tho, which I don’t quite have a handle on. Which is, what are the implications of considering FIRE services intermediate inputs rather than part of final output? If a firm pays more money to a software firm, that’s considered investment spending and final output is corresponding higher. If a firm pays more money to a marketing firm, that’s considered an intermediate good and final output is no higher, instead measured productivity is lower. I think that FIRE services provided to firms are considered intermediate goods, i.e. are already treated the way Foley thinks they should be. But I’m not sure. And there’s still the problem of FIRE services purchased by households. There’s no category of intermediate-goods purchases by households in the national accounts; any household expenditure is either consumption or investment, so contributes to GDP. This is a real issue, but again it’s not unique to FIRE; e.g. why are costs associated with commuting considered part of final output when if a business provides transportation for its employees, that’s an intermediate good?

He raises a third question, about the possibility that measured FIRE outputs includes asset transfers or capital gains. There is serious potential slippage between sale of financial services (part or GDP, conceptually) and sale of financial assets (not part of GDP).

Finally, it would be helpful to distinguish between services where measuring output is practically difficult but conceptually straightforward, and FIRE proper (and maybe insurance goes in the previous category). It seems clear that capital allocation as such should not be considered as part of final output. Whatever contribution it makes to total output (modulo the deep problems with measuring aggregate output at all) must come from higher productivity in the real economy. The problem is, there’s no real way to separate the “normal service” component of FIRE from the capital-allocation and representation-of-capitalist-interests (per Dumenil and Levy; or you could say rent-extraction) components.

But whatever the flaws of the paper, it’s pointing to a very important & profound set of issues. We can’t bypass the conceptual challenges of GDP, as Matt Yglesias (like lots of other people) imagines, with the simple assertion that labor is productive if it produces something that people are willing to pay for. Producing a consistent series for GDP still requires deliberate decisions about how to measure price changes, and how to distinguish intermediate goods from final output. Foley is absolutely right to call attention to these problems, that most social scientists are happy to sweep under the rug [3]; he’s right that they’re especially acute in the case of FIRE; and I think he’s probably right to say that to solve them we would do well to return to the productive/unproductive distinction of the classical economists.

[1] I wasn’t there, but a comrade who was thought so. And he seems to be right, based on the papers they’ve got up on the website.

[2] Or you could say that FIRE output is fixed (perhaps at 0), and all changes in nominal FIRE output represents price changes. Again, this problem can’t be resolved empirically, nor does it go away simply because you adopt a utility-based view of value.

[3] Bob Fitch had some smart things to say about the need to distinguish productive and unproductive labor.

The Financial Crisis and the Recession: Two Datapoints for the Skeptics

One of the most dramatic features of the financial crisis, for those who were following it obsessively in the autumn of 2008, was the near-freezing up of the commercial paper market. Commercial paper is short-term debt sold in markets rather than advanced by banks. It’s mostly very short maturity — days, weeks or months, not years. It’s generally cheaper than other forms of financing, but firms that rely on it need to be able to borrow more or less continuously. Doubts about their financial condition, or even the suspicion that other lenders might have doubts, can quickly push them up against their survival constraint. This is what happened to a number of financial institutions — most spectacularly Lehman Brothers — in the third quarter of 2008. The breakdown in the commercial paper market was one of the things that convinced people the financial universe was imploding, and taking the real economy down with it.
The story, implicit or explicit, was that the suddenly reduced or uncertain value of financial assets, and the seizing-up of the interbank markets, left banks unable or unwilling to hold the liabilities of nonfinancial businesses, i.e., to lend. These businesses found themselves unable to finance new investment or even routine operations, leading to the Great Recession. This is essentially the same story that Milton Friedman told (and Peter Temin, among others, criticized), about the Great Depression, but it’s also more or less the consensus view of the 2008-09 crisis among New Keynesian economists. For example:
A large decrease in the value of asset holdings of financial institutions resulted in dramatic intensification of the agency problems in those institutions … Credit spreads widened and credit rationing became widespread. The diminished ability to finance the acquisition of capital goods resulted in huge cutbacks of all types of investment.

The same story was widespread in the business journalism world, with people like Andrew Ross Sorkin writing, “Commercial paper, the workaday stuff that lets companies make payroll, was suddenly viewed as radioactive — and business activity almost stopped in its tracks.” Most importantly, this was the view of the crisis that motivated — or at least justified — the choice of both the Bush and Obama administrations to make strengthening bank balance sheets their number one priority in the crisis. But is it right? There are reasons for doubt.

Data from FRED. 

See, here’s a funny thing. I haven’t seen it discussed anywhere, but it’s very interesting. The commercial paper of financial and nonfinancial firms, normally interchangeable, fared quite differently in the crisis. Up til then, both had tracked the federal funds rate closely, except in the early 90s (the last by-general-agreement credit crisis) when both had risen above it. But as the figure above shows, in the fall of 2008, right around the Lehmann failure (the arrow on the graph), an unprecedented gap opened up between the interest lenders demanded on commercial paper from financial versus nonfinancial companies.

The implication: The state of the interbank lending market isn’t necessarily informative about the availability of credit to nonfinancial firms. It’s perfectly possible that lots of big banks had made lots of stupid bets in the real estate market, and once this became known other banks were unwilling to lend to them. But they remained perfectly willing to lend to everyone else — perhaps even on more favorable terms, since those funds had to go somewhere. The divergence in commercial paper rates is hardly dispositive, of course, but it at least suggests that the acute phase of the financial crisis was more of a problem for the financial sector specifically than for the economy as a whole

Second. Sorkin calls commercial paper “the workaday stuff that lets companies meet payroll.” This kind of language was everywhere for a while — that the financial crisis threatened to stop the flow of short-term credit from banks, and that without that even the most routine business functions would be impossible.

One of the central political-economic facts of our time is that public discussion of the economy is entirely dominated by finance. The interests of banks differ from those of other businesses on many dimensions; one of them is banks’ dependence on short-term financing. Financial firms are defined by the combination of short-term liabilities and long-term assets; they need to borrow every day; that’s why they’re subject to runs. The fear of not being able to make payroll if you’re cut off, even briefly, from financial markets, is perfectly reasonable, if you’re a bank.
But if you’re not?
In fact, short-term debt is large relative to cashflow only for financial firms. Nonfinancial firms don’t finance operating expenses through debt, only investment. (And inventories and goods-in-progress, which are largely financed by credit from customers and suppliers, rather than from banks.) From Compustat:
Short-term debt as a fraction of total debt

Sector Median Mean
FIRE 0.56 0.55
Non-FIRE 0.16 0.23

Short-term debt as a fraction of cashflow
Sector Median Mean
FIRE 7.53 15.1
Non-FIRE 0.35 0.71

Short-term debt as a fraction of revenue
Sector Median Mean
FIRE 0.78 1.64
Non-FIRE 0.04 0.08

(FIRE is finance, insurance and real estate. Short-term here means maturities of less than a year. Cashflow is defined as profits plus depreciation.)
This isn’t a secret; but it’s striking how different are the financing structures of financial and nonfinancial firms, and how little that difference has penetrated into public debate or much of the economics profession. For the median financial firm, losing access to short-term finance would be equivalent to a 70 percent fall in revenues; few could survive. For the median nonfinancial firm, by contrast, loss of access to short-term finance would be equivalent to a fall in revenues of just 4 percent. Short-term finance is just not that important to nonfinancial firms.
So, the breakdown in short-term credit markets was largely limited to financial firms, and financial firms are anyway the only ones that really depend on short-term credit. I don’t claim these two pieces of evidence are in any way definitive — I’ve got a long paper on this question in the works, which, well, won’t be definitive either — but they are at least consistent with the story that the financial crisis, on the one hand, and the fall of employment and output, on the other, were more or less independent outcomes of the collapse of the housing bubble, and that the state of the banks was not the major problem for the real economy.

EDIT: For the life of me, I can’t get either graphs or tables to look good in Blogger.

Summers on Microfoundations

From The Economist’s report on this weekend’s Institute for New Economic Thinking conference at Bretton Woods:

The highlight of the first evening’s proceedings was a conversation between Harvard’s Larry Summers, till recently President Obama’s chief economic advisor, and Martin Wolf of the Financial Times. Much of the conversation centred on Mr Summers’s assessments of how useful economic research had been in recent years. Paul Krugman famously said that much of recent macroeconomics had been “spectacularly useless at best, and positively harmful at worst”. Mr Summers was more measured… But in its own way, his assessment of recent academic research in macroeconomics was pretty scathing.For instance, he talked about all the research papers that he got sent while he was in Washington. He had a fairly clear categorisation for which ones were likely to be useful: read virtually all the ones that used the words leverage, liquidity, and deflation, he said, and virtually none that used the words optimising, choice-theoretic or neoclassical (presumably in the titles or abstracts). His broader point—reinforced by his mentions of the knowledge contained in the writings of Bagehot, Minsky, Kindleberger, and Eichengreen—was, I think, that while it would be wrong to say economics or economists had nothing useful to say about the crisis, much of what was the most useful was not necessarily the most recent, or even the most mainstream. Economists knew a great deal, he said, but they had also forgotten a great deal and been distracted by a lot.Even more scathing, perhaps, was his comment that as a policymaker he had found essentially no use for the vast literature devoted to providing sound micro-foundations to macroeconomics.

Pretty definitive, no?

And that’s it it — I promise! — on microfoundations, methodology, et hoc genus omne in these parts, at least for a while. I have a couple new posts at least purporting to offer concrete analysis of the concrete situation, just about ready to go.

The Bond’s Eye View of the Ivory Coast

I joked a while back that any statement in the business press that something is good or bad needs to be followed with an implicit “for bondholders.” But it’s not really a joke. Here’s the Financial Times with the view from the bonds of the civil war in the Ivory Coast:

[Laurent Gbagbo’s] generals are negotiating a ceasefire at pixel time while the French think he’ll probably leave Ivory Coast within hours, after a heavy cost in bloodshed. But a brand new day for the Ivorian state?

If you’ve been watching the levitating prices on the country’s (defaulted) 2032 bond, you might think that. Having been rallying for some time, the bond is now priced more generously than before a $29m coupon payment failed in January… This is quite some faith in the ability — willingness — of Gbagbo’s successor, Alassane Ouattara, to resume debt service.

There it is: A new day for the Ivoirian state = resumption of debt payments.

But there’s a more serious point here, too. The only people in the rich world who have both an interest in what happens in the Ivory Coast, and the resources to act on it, are the owners of Ivoirian government bonds.

Of course this isn’t strictly true. There might be foreign owners of private Ivoirian assets. But in fact there doesn’t seem to be many: Of the country’s $11 billion in external debt, $8.5 billion, according to the BIS, is public and all the remaining $2.5 billion private debt is publicly guaranteed. And of course there are firms and speculators in the cocoa industry, but they aren’t going to as interested in the Ivory Coast specifically, and more importantly, they don’t have the same access to the peak institutions of capitalism. It’s the Financial Times, not the Commodities Times or even the International Trade Times. So it’s perfectly natural for the FT to take the bond’s eye view; to a first approximation, the bondholders are the representatives of the capitalist class as a whole with respect to the Ivory Coast.

Why Do We Need Heterodox Economics Departments?

A comrade writes:

Economics is too important to leave it to the mainstream. Economic ideas and economists are very powerful at shaping and influencing the societies in which we live. We, heterodox economists, are a minority and we need our voice be heard. I’m afraid that the radicalism of “I don’t care the mainstream, I do my own thing” is the most conservative strategy. It leaves us as college professors teaching mainstream stuff with a heterodox twist but without any significant influence in the real world. Please, don’t take this wrong. I respect and admire those who like teaching at colleges as a way of life. I’m just saying that as a collective output is a suicide. Our battle is at research universities, central banks, finance ministries, international institutions and think tanks, where the presence of mainstream economist is overwhelming. We need to challenge and persuade them and for that we need to know their theories and methods.

I disagree.

Of course we don”t want to be cloistered. But there are many possible channels by which our work can reach public policy, social movements and the larger world. Shifting the mainstream of economics is only one possible channel and not, in my judgment, the strongest or most reliable one.

To take a personal example: I recently agreed to do some research work for a couple of state-level minimum-wage campaigns,giving them numbers on the distribution of workers who would be covered by the bills by industry and firm size and the profitability of the major low-wage sectors in those states. The people organizing the campaigns are now using those numbers for position papers, talking points for canvassing, op-eds, etc. I even went down to Maryland a couple weeks ago to testify before the legislature.

Of course you need some basic knowledge of econometrics and the relevant literature to do this kind of work. But do you need the kind of knowledge you’d need to be a cutting-edge labor economist? No, obviously not; I’m not a labor economist of any sort. And yet, I would argue, this kind of direct work with practical political campaigns/organizations is at least as likely — more likely, IMO — to produce concrete policy changes and to shift the public debate, than an effort to master the techniques of mainstream labor economics, publish sufficiently on the minimum wage to move the consensus of the profession, and then count on the “official” representatives of the profession to pass the message on to policymakers. Fundamentally, I don’t agree that our battle is at research universities, central banks, etc. Our jobs may be at those places. But our battle is with people engaged in practical political work and organizing. This isn’t (just) a moral stand; I think the implicit assumption that the consensus of the economics profession is first shaped by the quality of the arguments made on various sides, and then transmitted to politics, is not applicable to the real world. If you want to contribute to political change, you need to be part of a political project; winning debates within the economics profession doesn’t help. The recent history of macroeconomics shows that clearly, no?

There’s a second point. The idea that we should be orienting our training around learning to persuade the mainstream assumes that “we” already know what we want to persuade them of. But that’s not the case. On most of the big questions, we don’t have any consensus on what the right answers are, even if we’re confident they’re not what’s taught in most programs. And the project of developing an alternative economics is very different from the project of persuading people of an alternative economics. The second would require talking — and having the tools to talk — with others. But the first requires primarily talking among ourselves. And the first has to come first. Economics is hard! And Marxist, post-Keynesian, feminist, institutionalist economics is just as hard as mainstream economics. (Albeit in different ways — less math, more fieldwork & history.) Unless we — meaning we heterodox/radical economists — are systematically building on each others’ work, there will never be an alternative view to persuade the mainstream of. Which means there needs to be spaces for conversations within radical economics, where we can critique and develop our own approaches, and for getting the training necessary to take part in those conversations.

All of us tend to exaggerate our own intellectual autonomy. (It’s a legacy of the Enlightenment.) We think we’re rational beings, who know what we want and choose the best tools to get it. But , means and ends don’t always separate so cleanly. You say you want a prestigious position only in order to have a better platform from which to advance progressive ideas, but soon enough the means becomes the ends. (I’ve seen it happen!) There can’t be left ideas without a sociological left — without a group of people who feel some objective connection with each other, have shared experiences and interests, share a common identity. Because ideas will accomodate to the situation of the person who holds them. (Erst kommt das Fressen, dann die Moral.) We all think, no not me, but yes us too. If there aren’t at least a few settings in which specifically radical economics is professionally rewarded, we shouldn’t take it for granted that it will continue to exist.

On Other Blogs, Other Wonders

… or at least some interesting posts.

1. What Kind of Science Would Economics Be If It Really Were a Science?

Peter Dorman is one of those people who I agree with on the big questions but find myself strenuously disagreeing with on many particulars. So it’s nice to wholeheartedly approve this piece on economics and the physical sciences.

The post is based on this 2008 paper that argues that there is no reason that economics cannot be scientific in the same rigorous sense as geology, biology, etc., but only if economists learn to (1) emphasize mechanisms rather than equilibrium and (2) strictly avoid Type I error, even at the cost of Type II error. Type I error is accepting a false claim, Type II is failing to accept a true one. Which is not the same as rejecting it — one can simply be uncertain. Science’s progressive character comes from its rigorous refusal to accept any proposition until every possible effort to disprove it has failed. Of course this means that on many questions, science can take no position at all (an important distinction from policy and other forms of practical activity, where we often have to act one way or another without any very definite knowledge). It sounds funny to say that ignorance is the heart of the practice of science, but I think it’s right. Unfortunately, says Dorman, rather than seeing science as the systematic effort to limit our knowledge claims to things we can know with (near-)certainty, “economists have been seduced by a different vision … that the foundation of science rests on … deduction from top-level theory.”

The mechanisms vs. equilibria point is, if anything, even more important, since it has positive content for how we do economics. Rather than focusing our energy on elucidating theoretical equilibria, we should be thinking about concrete processes of change over time. For example:

Consider the standard supply-and-demand diagram. The professor draws this on the chalkboard, identifies the equilibrium point, and asks for questions. One student asks, are there really supply and demand curves? … Yes, in principle these curves exist, but they are not directly observed in nature. …

there is another way the answer might proceed. … we can use them to identify two other things that are real, excess supply and excess demand. We can measure them directly in the form of unsold goods or consumers who are frustrated in their attempts to make a purchase. And not only can we measure these things, we can observe the actions that buyers and sellers take under conditions of surplus or shortage.

One of the best brief discussions of economics methodology I’ve read.

2. Beware the Predatory Pro Se Borrower!

In general, I assume that anyone here interested in Yves Smith is already reading her, so there’s no point in a post pointing to a post there. But this one really must be read.

It’s a presentation from a law firm representing mortgage servicers, with the Dickensian name LockeLordBissell, meant for servicers conducting foreclosures that meet with legal challenges. That someone would even choose to go to court to avoid being thrown out of their house needs special explanation; it must be a result of “negative press surrounding mortgage lenders” and outside agitators on the Internet. People even think they can assert their rights without a lawyer; they “do not want to pay for representation,” it being inconceivable that someone facing foreclosure might, say, have lost their job and not be able to afford a lawyer. “Predatory borrowers” are “unrealistic and unreasonable borrowers who are trying to capitalize on the current industry turmoil and are willing to employ any tactic to obtain a free home,” including demands to see the note, claims of lack of standing by the servicer, and “other Internet-based machinations.” What’s the world coming to when any random loser has access to the courts? And imagine, someone willing to employ tactics like asking for proof that the company trying to take their home has a legal right to it! What’s more, these stupid peasants “are emotionally tied to their cases [not to mention their houses]; the more a case progresses, the less reasonable the plaintiff becomes.” Worst of all, “pro se cases are expensive to defend because the plaintiff’s lack of familiarity with the legal process often creates more work for the defendant.”

If you want an illustration of how our masters think of us, you couldn’t ask for a clearer example. Our stubborn idea that we have rights or interests of our own is just an annoying interference with their prerogatives.

Everyone knows about bucket lists. At the bar last weekend, someone suggested we should keep bat lists — the people whose heads you’d take a Louisville slugger to, if you knew you just had a few months to live. This being the Left Forum, my friend had “that class traitor Andy Stern” at the top of his list. But I’m putting the partners at LockeLordBissell high up on mine.

3. Palin and Playing by the Rules

Jonathan Bernstein, on why Sarah Palin isn’t going to be the Republican nominee:

For all one hears about efforts to market candidates to mass electorates (that’s what things like the “authenticity” debate are all about), the bulk of nomination politics is retail, not wholesale — and the customers candidates are trying to reach are a relatively small group of party elites…. That’s what Mitt Romney and Tim Pawlenty have been doing for the last two-plus years… It’s what, by every report I’ve seen since November 2008, Sarah Palin has just not done.

Are you telling me that [Republican Jewish Committee] board members are going to be so peeved that Sarah Palin booked her Israel trip with some other organization that they’re [going to] turn it into a presidential nomination preference, regardless of how Palin or any other candidate actually stands on issues of public policy?

Yup. And even more: I’ll tell you that it’s not petty. They’re correct to do so. … if you’re a party leader, what can you do? Sure, you can collect position papers, but you know how meaningless those are going to be…. Much better, even if still risky, is assessing the personal commitment the candidates have to your group. What’s the rapport like? Who has the candidate hired on her staff that has a history of working with you? Will her White House take your calls? …

It’s how presidential nominees are really chosen. … Candidates do have to demonstrate at least some ability to appeal to mass electorates, but first and foremost they need to win the support of the most active portions of the party.

It’s not a brilliant or especially original point, but it’s a very important one. My first-hand experience of electoral politics is limited to state and local races, but I’ve worked on quite a few of those, and Bernstein’s descriptions fits them exactly. I don’t see any reason to think national races are different.

It’s part of the narcissism of intellectuals to imagine politics as a kind of debating society, with the public granting authority to whoever makes the best arguments — what intellectuals specialize in. And it’s natural that people whose only engagement with politics comes through the mass media to suppose that what happens in the media is very important, or even all there is. But Bernstein is right: That stuff is secondary, and the public comes in as object, not subject.

Not always, of course — there are moments when the people does become an active political subject, and those are the most important political moments there are. But they’re very rare. That’s why someone like Luciano Canfora makes a sharp distinction between the institutions and electoral procedures conventionally referred to as democracy, on the one hand, and genuine democracy, on the other — those relatively brief moments of “ascendancy of the demos,” which “may assert itself within the most diverse political-constitutional forms.” For Canfora, democracy can’t be institutionalized through elections; it’s inherently “an unstable phenomenon: the temporary ascendancy of the poorer classes in the course of an endless struggle for equality—a concept which itself widens with time to include ever newer, and ever more strongly challenged, ‘rights’“. (Interestingly, a liberal like Brad DeLong would presumably agree that elections have nothing to do with democracy, but are a mechanism for the circulation of elites.)

I don’t know how far Bernstein would go with Canfora, but he’s taken the essential first step; it would be a good thing for discussions of electoral politics if more people followed him.

EDIT: Just to be clear, Bernstein’s point is a bit more specific than the broad only-elites-matter argument. What candidates are selling to elites isn’t so much a basket of policy positions or desirable personal qualities, but relationships based on trust. It’s interesting, I think it’s true; it doesn’t contradict my gloss, but it does go beyond it.

Who Paid for the Paper?

Yglesias weighs in on the New York Times paywall:

It’s always worth emphasizing in these discussions that the widespread view among journalists that readers have traditionally paid for journalism is a mistake. Readers have traditionally paid for paper, ink, and distribution of physical media. The price goal of subscriptions is to cover costs so that you can maximize subscribers without going bankrupt. Then you make money by selling ads.

True that. There’s this idea that what’s killing journalism is that people won’t pay for it now that they have access to free online news sources. But that’s wrong. Circulation revenue is holding up ok for newspapers. What’s collapsed is advertising revenue.

Newspaper Revenue by Source, 1956-2009 ($ Millions)

Source: Newspaper Association of America

The problem isn’t that the public aren’t willing to pay for journalism; it’s that advertisers aren’t. Over the past decade, newspaper subscription revenues are down 5 percent. But display ad revenues are down by a third, and classified ads are down by two-thirds. No doubt it’s emotionally satisfying for newspaper executives to frame the question as whether journalism is worth paying for. But from an economic standpoint the paywall strategy is exactly backwards; it can only accelerate the collapse of advertising revenue that is the real cause of the crisis.

classified advertising … was for years the secret weapon of the newspaper business. Classifieds are not the most glamorous aspect of the newspaper trade… What they are, however, is fabulously lucrative. For decades, whole sections of the newspaper industry were kept afloat by the classifieds. … In the US, the importance of advertising was even greater: a fact which remains true, to a startling extent, when you look at the data which show the balance between revenue earned via sales and advertising. In the UK, which is roughly in the middle of the OECD range, the balance is 50-50. (The global average is 57-43 in favour of advertising.) In the US, the balance is 87 per cent advertising, 13 per cent sales.
I’m not sure where Lanchester gets this exact number; the NAA gives around 80% advertising, before the collapse of the past few years. But the bigger problem with the piece is the suggestion that the problem is finding a new business model for journalism. The whole point is that journalism as such never had a business model, it was only ever a loss leader for the classifieds. That is, it was cross-subsidized by the network rents from connecting buyers and sellers in thin markets. Now those rents are cross-subsidizing Internet search, free email, social networking, for that matter this humble blog. I’d be the last to say the trade was entirely for the better. But no one with a gmail account should say it was entirely for the worse.
Cross subsidies from monopolies are an important and underappreciated form of public good provision in modern capitalism. An interesting aspect of this is the subsidy by its nature is never the result of any straightforward optimization, in the way business decisions are supposed to be. It needs a sociological link with the source of the subsidy. Whether it’s “All the news that’s fit to print” or “Don’t be evil,” the principle only performs its function of legitimating the underlying monopoly if it is, on some level, sincerely held.
All of which is to say that saving newspaper journalism can’t be a matter of restoring its status as a profitable commodity, because it never was.

What Do Bosses Want?

The New York Times paywall is here. Felix Salmon has the details, and what looks like the definitive critique:

What does all this mean for the New York Times Company? I can’t see how it’s good. The paywall is certainly being set high enough that a lot of regular readers will not subscribe. These are readers who would normally link to the NYT from their blogs, who would tweet NYT articles, who would post those articles on Facebook, and so on. As a result, not only will traffic from these readers decline, but so will all their referral traffic, too. The NYT makes more than $300 million a year in digital ad revenue, so even a modest decline in pageviews, relative to what the site could have generated sans paywall, can mean many millions of dollars foregone. On top of that, the paywall itself cost somewhere over $40 million to develop.

Against all that, how much revenue will the paywall bring in?… extra revenues of $24 million per year.

$24 million is a minuscule amount for the New York Times company as a whole; it’s dwarfed not only by total revenues but even by those total digital advertising revenues of more than $300 million a year. … So by my back-of-the-envelope math, the paywall won’t even cover its own development costs for a good two years, and beyond that will never generate enough money to really make a difference to NYTCo revenues. … I just can’t see how this move makes any kind of financial sense for the NYT. The upside is limited; the downside is that it ceases to be the paper of record for the world. Who would take that bet?

(For the record, in the past couple weeks I devoted a few idle moments to considering just how much I would pay for digital access to the NYT, and decided that $15 a month was just about my upper limit. But in fact I won’t pay it, since top news stories will continue to be free on the iPhone.)

What makes this bad decision so interesting is how many other companies seem to make the same kind of bad decisions. And in particular, how completely they overlook the value of the kind of free marketing and brand development that Salmon describes in the first paragraph.

For instance, here’s an interesting new working paper by Yi Qian on the effect of counterfeit goods on clothing brands, which finds

heterogeneous effects of counterfeit entry on sales of authentic products of three quality tiers. In particular, counterfeits have both advertising effects for the brand and substitution effects for authentic products. The advertising effect dominates substitution effect for high-end authentic product sales, and the substitution effect outweighs advertising effect for low-end product sales.

In other words, when someone buys a rip-off pair of Manohlo Blahniks, they may be foregoing a purchase of an authentic pair. But maybe not. And either way, their visible endorsement of the brand increases its appeal to others in a way that the company would otherwise have to spend scarce advertising dollars to achieve. Not surprising, it’s the high-end brands that benefit on net from counterfeiters, since purchasers of counterfeit goods are less likely to be able to afford the real thing and the brand identity is more valuable. This is consistent with other research I’ve seen suggesting that in some cases, the advertising effect outweighs the substitution effect even at the level of the individual consumer — buying a counterfeit handbag (or illegally downloading a piece of music, or whatever) makes a person more likely to subsequently buy that item legally.

(Qian is also co-author of this fascinating survey of the economics of counterfeiting, which identifies a remarkably broad range of theoretical and empirical cases where laxer IP protections turn out to benefit sellers. For instance, there’s evidence that academic journals were able to charge higher prices as a result of the widespread availability of photocopiers starting in the 1980s, because the greater value of journals to subscribers who were now able to make copies of articles outweighed the loss of sales to people who read the copies.)

Sellers of branded goods can’t be unaware of this research, or at least of these general effects. Yet we see sellers of branded goods going to ridiculous lengths to strengthen IP proections, even sellers of high-end goods who are least likely to be harmed by infringement. In effect, these companies, like the New York Times, are going to great lengths to deprive themselves of free advertising. It’s almost like they put a higher value on controlling their brand, than on profiting from it.

Which they probably do.

It makes one think about the Marxist literature on the labor process, and the idea that for capitalists, maximizing the surplus they extract from workers is secondary to maintaining the conditions under which surplus can be extracted at all. This is Stephen Marglin’s argument in his classic article What Do Bosses Do? — that the factory system was not initially adopted because it was any more technically efficient than alternative forms of worker-controlled production, but because of the strategic leverage it gave the owner of capital. He quotes a contemporary article in The Spectator observing that worker-managed cooperatives were competitive with capitalist enterprises:

Associations of workmmen could manage shops, mills and all forms of industry with success, and the immensely improved the conditions of the men, but then they did not leave a clear place for the masters. That was a defect…

Similarly, bloggers and social media may successfully generate immense traffic for the Times, and counterfeiters may successfully build the value of the brands they rip off; but the owners of these properties may not be (only) confused when they object, since this uncontrolled activity has a less of a clear place for the masters.

As Kalecki famously said,

“Discipline in the factories” and “political stability” are more appreciated than profits by business leaders. Their class instinct tells them that lasting full employment is unsound.

Profits come second to power. So when the results of productive labor aren’t appropriated as private property, the class instinct of the bosses of the information industries must tell them this is unsound, even if it’s more immediately profitable than the alternative. As Kalecki says in the same essay, “The fundamentals of capitalist ethics require that ‘you shall earn your bread in sweat’ — unless you happen to have private means.” That, I suspect, is fundamentally why the Sulzbergers et al. object to free ice cream, even when they can make more money by giving it away than by selling it.