things worth reading – Page 4

Links for September 23

I am going to strive to make these posts weekly. People need things to read.

The trouble with macro. I haven’t yet read any of the latest big-name additions to the “what’s wrong with macroeconomics?” pile: Romer (with update), Kocherlakota, Krugman, Blanchard. I should read them, maybe I will, maybe you should too. Here’s my own contribution, from a few years ago.

Tankus notes. You may know Nathan Tankus from around the internet. I’ve been telling him for a while that he should have a blog. He’s finally started one, and it’s very much worth reading. I’m having some trouble with one of his early posts. Well, that’s how it works: You comment on what you disagree with, not the things you think are smart and true and interesting — which in this case is a lot.

The shape of the elephant. Branko Milanovic’s “elephant graph” shows the changes in the global distribution of income across persons since 1980, as distinct from the more-familiar distribution of income within countries or between countries. The big story here is that while there has been substantial convergence, it isn’t across the board: The biggest gains were between the 10th and 75th percentiles of the global distribution, and at the very top; gains were much smaller in the bottom 10 percent and between the 70th and 99th percentiles. One question about this has been how much of this is due to China; as David Rosnick and now Adam Corlett of the Resolution Fondation note, if you exclude China the central peak goes away; it’s no longer true that growth was unusually fast in the middle of the global distribution. Corlett also claims that the very slow growth in the upper-middle part of the distribution — close to zero between the 75th and 85th percentiles — is due to big falls in income in the former Soviet block and Japan. Initially I liked the symmetry of this. But now I think Corlett is just wrong on this point; certainly he gives no real evidence for it. In reality, the slow growth of that part of the distribution seems to be almost entirely an artifact due to the slow growth of population in the upper part of the distribution; correct for that, as Rosnick does here, and the non-China distribution is basically flat between the 10th and 99th percentiles:

Yes, there does seem to be slightly slower growth just below the top. But given the imprecision of the data we shouldn’t put much weight on it. And in any case whatever the effect of falling incomes in Japan and Eastern Europe (and blue-collar incomes in the US and western Europe), it’s trivial compared to the increase in China. Outside of China, the global story seems to be the familiar one of the very rich pulling ahead, the very poor falling behind, and the middle keeping pace. Of course, it is true, as the original elephant graph suggested, that the share of income going to the upper-middle has fallen; but again, that’s because of slower population growth in the countries where that part of the distribution is concentrated, not because of slower income gains.

It’s important to stress that no one is claiming that Branko’s figures are wrong, and also that Branko is on the side of the angels here. He’s been fighting the good fight for years against the whiggish presumption of universal convergence.

Equality of opportunity and revolution. Speaking of Branko, here he is on the problem with equality of opportunity:

Upward mobility for some implies downward mobility for the others. But if those currently at the top have a stronghold on the top places in society, there will no upward mobility however much we clamor for it. … In societies that develop quickly even if a lot of mobility is about positional advantages, … it can be compensated by creating enough new social layers, new jobs and by making people richer. …

In more stagnant societies, mobility becomes a zero-sum game. To effect real social mobility in such societies, you need revolutions that, while equalizing chances or rather improving dramatically the chances of those on the bottom, do so at the cost of those on the top. … The French Revolution, until Napoleon to some extent reimposed the old state of affairs, was precisely such an upheaval: it oppressed the upper classes (clergy and nobility) and promoted the poorer classes. The Russian revolution did the same thing; it introduced an explicit reverse discrimination against the sons and daughters of former capitalists, and even of the intellectuals, in the access to education.

I think this is right. The principle of equality of opportunity is incompatible, not just practically but logically, with the principle of inheritance. The only way to realize it is to deprive those at the top of their power and privileges, which by definition is possible only in a revolutionary situation. This is one reason why I have no interest in a political program defined, even in its incremental first steps, in terms of equality of income or wealth. The goal isn’t equality but the abolition of the system which makes quantitative comparisons of people’s life-situations possible.

The post continues:

There is also an age element to such revolutions which fundamentally alter societies and lift those from below to the top. The young people benefit. In a beautiful short novel entitled “The élan of our youth” Alexander Zinoviev, a Russian logician and later dissident, describes the Stalinist purges from a young man’s perspective. The purges of all 40- or 50-year old “Trotskyites” and “wreckers” opened suddenly incredible vistas of upward mobility for those who were 20- or 25-year old. They could hope, at best, to come to the positions of authority in ten or fifteen years; now, that were suddenly thrown in charge of hundreds of workers, became chief designers of airplanes, top engineers of the metro. What was purge and Gulag for some, was upward mobility for others.

As this suggests, the overturning ofhierarchies didn’t stop with the revolutions themselves — that was the essential content of the various purges, to prevent a new elite from consolidating itself. I’ve always wondered how much vitality revolutionary France and Russia gained from these great overturnings. There are an enormous number of working-class people in our society, I have no doubt, who would be much more capable of running governments and factories, designing airplanes and subways, or teaching economics for that matter, than the people who get to do it.

We simply do not know — but we can fake it. Aswath Damodaran has a delicious post on the valuations that Elon Musk’s bankers came up with to justify Tesla’s acquisition of Solar City. The basic problem in these kinds of exercises is that the same price has to look high to the shareholders of the acquired company and low to the shareholders of the acquiring company. In this case, the Solar City shareholders have to believe that the 0.11 Tesla shares they are getting are worth more than the Solar City share they are giving up, while the Tesla shareholders have to believe just the opposite — that one Solar City share is worth more than the 0.11 Tesla shares they are giving for it. You can square this circle by postulating some gains from the combination — synergies! efficiencies! or, sotto voce, market power — that allows the acquirer to pay a premium over the market price while still supposedly getting a bargain. Those gains may be bullshit but at least there’s a story that makes sense. But as Damodaran explains, that isn’t even attempted here. Instead the two sets of advisors (both ultimately hired by Musk) simply use different assumptions for the growth rates and cost of capital for the two companies, generating two different valuations. For instance, Tesla’s advisors assume that Solar City’s existing business will grow at 3-5% in perpetuity, while Solar City’s advisors assume the same business will grow at 1.5-3%. So one set of shareholders can be told that a Solar City share is definitely worth less than 0.11 Tesla shares, while the other set of shareholders can be told that it is definitely worth more.

So what’s the interest here? Obviously, it’s always fun to se someone throwing shoes at the masters of the universe. But with my macroeconomist hat on, the important thing is it’s a snapshot of the concrete sociology behind the discounting of future cashflows. Whenever we talk about “the market” valuing some project or business, we are ultimately talking about someone at Lazard or Evercore plugging values into a spreadsheet. This is something people who imagine that production decisions are or can be based on market signals — including my Proudhonist friends — would do well to keep in mind. Solar City lost money last year. It lost money this year. It will lose money next year. It keeps going anyway not because “the market” wants it to, but because Musk and his bankers want it to. And their knowledge of the future isn’t any better founded than the rest of ours. Now, you could argue that this case is noteworthy because the projections are unusually bogus. Damodaran suggests they aren’t really, or only by degree. And in any case this sort of special pleading wouldn’t work if there were an objective basis for computing the true value of future cashflows. I suspect it was precisely Keynes’ experience with real-world financial transactions like this that made him stress the fundamental unknowability of the future.

Uber: The bar mitzvah moment. While we’re reading Damodaran, here’s another well-aimed shoe, this one at Uber. As he says, pushing down costs is not enough to make profits. You also need some way of charging more than costs. You need some kind of monopoly power, some source of rents: network externalities; increasing returns, and the financing to take advantage of them; proprietary technology; brand loyalty; explicit or implicit collusion with your competitors. Which of these does Uber have? maybe not any? Uber’s foray into self-driving cars is perhaps a way to generate rents, though they’re more likely to accrue to the companies that actually own the technology; I think it’s better seen as a ploy to convince investors for another quarter or two that there are rents there to be sought.

Izabella Kaminska covers some of the same territory in what may be the definitive Uber takedown at FT Alphaville. Though perhaps she focuses overmuch on how awful it would be if Uber’s model worked, and not enough on how unlikely it is to.

On other blogs, other wonders.

San Francisco Fed president John Williams writes, “during a downturn, countercyclical fiscal policy should be our equivalent of a first responder to recessions.” Does this mean that MMT has won?

Mike Konczal: Trump is full of policy.

My friend Sarah Jaffe interviews my friend Vamsi, on the massive strikes going on in India.

The Harry Potter books are bad books and and have a bad, childish, reactionary view of the world. So does J. K. Rowling.

The Mason-Tanebaum household has its first byline in the New York Times this week, with Laura’s review of the novel Black Wave in the Sunday books section.

Links for July 27, 2016

Labor dynamism and demand. My colleagues Mike Konczal and Marshall Steinbaum have an important new paper out on the decline in new business starts and in labor mobility. They argue that the data don’t support a story where declining labor-market dynamism is the result of supply-side factors like occupational licensing. It looks much more like the result of chronically weak demand for labor, which for whatever reason is not picked up by the conventional unemployment rate. This is obviously relevant to the potential output question I’m interested in — a slowdown in the rate at which workers move to new firms is a natural channel by which weak demand could reduce labor productivity. It’s also a very interesting story in its own right.

Konczal and Steinbaum:

The decline of entrepreneurship and “business dynamism” has become an accepted fact … Explanations for these trends … broadly fall on the supply side: that increasingly onerous occupational licensing impedes entry into certain protected professions and restricts licensed workers to staying where they are; that the high cost of housing thanks to restrictions on development hampers individuals from moving… But we find that the data reject these supply-side explanations: If there were increased restrictions on changing jobs or starting a business, we would expect those few workers and entrepreneurs who do manage to move to enjoy increased wage gains relative to periods with higher worker flows, and we would expect aggressive hiring by employers with vacancies. … Instead, we see the opposite…

We propose a different organizing principle: Declining business dynamism and labor mobility are features of a slackening labor market … workers lucky enough to have formal employment stay where they are rather than striking out as entrepreneurs …

Also in Roosevelt news, here’s a flattering piece about us in the New York Times Magazine.

John Kenneth who? Real World Economics Review polled its subscribers on the most important economics books of the past 100 years. Here’s the top ten. Personally I suspect Debt will have more staying power than Capital in the 21st Century, and I think Minsky’s book John Maynard Keynes is a better statement of his vision than Stabilizing an Unstable Economy, a lot of which is focused on banking-sector developments of the 1970s and 1980s that aren’t of much interest today. But overall it’s a pretty good list. The only one I haven’t read is The Affluent Society. I wonder if anyone under the age of 50 picked that one?

Deflating the elephant. Here is a nice catch from David Rosnick. Brank Milanovic has a well-known graph of changes in global income distribution over 1988-2008. What we see is that, while within most countries there has been increased polarization, at the global level the picture is more complicated. Yes, the top of the distribution has gone way up, and the very bottom has gone down. But the big fall has been in the upper-middle of the distribution — between the 80th and 99th percentiles — while most of the lower part has has risen, with the biggest gains coming around the 50th percentile. The decline near the high end is presumably working-class people in rich countries and most people in the former Soviet block —who were still near the top of the global distribution in 1988. A big part of the rise in the lower half is China. A natural question is, how much? — what would the distribution look like without China? Milanovic had suggested that the overall picture is still basically the same. But as Rosnick shows, this isn’t true — if you exclude China, the gains in the lower half are much smaller, and incomes over nearly half the distribution are lower in 2008 than 20 years before. It’s hard to see this as anything but a profoundly negative verdict on the Washington Consensus that has ruled the world over the past generation.

By the way, you cannot interpret this — as I at first wrongly did — as meaning that 40 percent of the world’s people have lower incomes than in 1988. It’s less than that. Faster population growth in poor countries would tend to shift the distribution downward even if every individual’s income was rising.

Does nuclear math add up? Over at Crooked Timber, there’s been an interesting comments-thread debate between Will Boisvert (known around here for his vigorous defense of nuclear power) and various nuke antis and skeptics. I’m the farthest thing from an expert, I can’t claim to be any kind of arbiter. But personally my sympathies are with Will. One important thing he brings out, which I hadn’t thought about enough until now, is the difference between electricity and most other commodities. Part of the problem is the very large share of fixed costs — as the Crotty-Minsky-Perelman strain of Keynesians have emphasized, capitalism does badly with long lived capital assets. A more distinctive problem is the time dimension — electricity produced at one time is not a good substitute for electricity produced at a different time, even just an hour before or after. Electricity cannot be stored economically at a meaningful scale, nor — given that almost everything in modern civilization uses it — can its consumption be easily shifted in time. This means that straightforward comparisons of cost per kilowatt — hard enough to produce, given the predominance of fixed costs — can be misleading. Regardless of costs, intermittent sources — like wind or solar — have to be balanced by sources that can be turned on anytime — which in the absence of nuclear, means fossil fuels.

Do you believe, as I do, that climate change is the great challenge facing humanity in the next generation? Then this is a very strong argument for nuclear power. Whatever its downsides, they are not as bad as boiling the oceans. Still, it’s not a decisive argument. The big other questions are the costs of power storage and of more extensive transmission networks — since when the sun isn’t shining and the wind isn’t blowing in one place, they probably are somewhere else. (I agree with Will that using the price mechanism to force electricity usage to conform to supply from renewables is definitely the wrong answer.) The CT debate doesn’t answer those questions. But it’s still an example of how informative blog debate can be when there are people both sides with real expertise who are prepared to engage seriously with each other.

On other blogs, other wonders. Here is a fascinating post by Laura Tanenbaum on the end of sex-segregated job ads and the false dichotomy between “elite” and “grassroots” feminism.

This very interesting article by Jose Azar on the extent and economic significance of common ownership of corporate shares deserves a post of its own.

Here’s a nice little think piece from Bloomberg wondering what, if anything, is meant by “the natural rate” of interest. I’m glad to see some skepticism about this concept in the larger conversation. In my mind, the “natural rate” is one of the key patches covering over the disconnect between economic theory and the observable economy.

Bhenn Bhiorach has a funny post on the lengths people will go to to claim that low inflation is really high inflation.

Books You Could Read

Here are some books I’ve read recently.

W. Arthur Lewis, The Evolution of the World Economic Order

This little book may have the highest insights-per-page density of any economics book I’ve read. This isn’t an unmixed blessing — what you’re getting here are the distilled conclusions of a lifetime’s work in development economics, without any of the concrete material that led to them. The central theme — among many fascinating side-trips — is a basically Ricardian vision of a three-class society in which conditions in agriculture fundamentally determine the possibilities for capitalist development, and landlords are the great enemies of progress.

Among the book’s many virtues is the way it demonstrates how Ricardo’s theories of trade has much more radical implications than the free-trade-is-good bromides it’s usually deployed in support of. As Lewis points out, the Ricardian model clearly shows that it is in the interests of the rich countries that poor countries develop their capacity to produce goods they are already specialized in (i.e. follow their comparative advantage). But it is in the interest of the poor countries themselves (except for the landlords) to develop their capacity to produce the goods currently produced by the rich countries.

Charles Sellers, The Market Revolution

Originally I’d picked up some other history of the pre-Civil War United States. It referred dismissively to the idea that resistance to wage labor and to production for profit had been important to political and social developments in the early United States, and referenced The Market Revolution as the leading example of this now-discredited view. Ah, I thought, that’s the book I should be reading. I was not disappointed. The transition from use-value production by family units to market production by wage (and slave) labor turns out to be a very effective tool for organizing a general political and social history of the US from the end of the War of 1812 to the 1840s.

Richard Dawkins, The Ancestor’s Tale

I’d had this sitting around for ages and for some reason picked it up when I was unpacking a box of books. It’s a history of evolution, told through the conceit of a pilgrimage from modern humans back to the origins of life. Each pilgrim represents the last common ancestor of us and some other group of organisms. It may not be obvious at first but there is a definite number of such meeting points, no more than a few dozen, though obviously there is quite a bit of uncertainty about the more distant ones. It’s a very effective device for telling the story of evolution in an unfamiliar way, and, thankfully, Dawkins’ cranky politics are confined to a few footnotes.

Richard Werner, Princes of the Yen

Someone recommend this book to me in comments on this blog. It’s an original retelling of the story of Japan’s long postwar boom and long post-1980s stagnation that puts monetary policy at the center of both.

The basic argument is that the distinctive features of Japanese capitalism are a product of wartime mobilization, not some ancient features of Japanese culture; Werner’s claim that 1920s Japan was as liberal as the US or UK on most economic dimensions is consistent with other things I’ve read. The central feature of wartime planning that was preserved after 1945 was direct allocation of credit by the state — not officially, but via “window guidance” to banks on the desired volume and direction of lending. Initially this was controlled by the Ministry of Finance but in the 1980s, Werner argues, the Bank of Japan became increasing independent, and the key decisionmakers there — the “princes of the yen” of the title — saw their control over credit as a tool to dismantle the distinctive features of postwar Japanese capitalism. His claim that the crisis was deliberately provoke and prolonged in order to push through a broader agenda of liberalization is highly relevant as a precedent for what’s happening in Europe today — though I have to admit that his evidence for it is more suggestive than dispositive.

Ray Madoff, Immortality and the Law

I stole this from Mike Konczal when I was visiting him last year; he was using it for a piece in The Nation. It’s a fascinating discussion of a question I’d never thought about much before — the legal status of dead people.

The argument is that the US is an outlier, in that it grants dead people no rights over their bodies — instructions about the disposal of remains have no legal force — but grants wealthowners almost unlimited freedom to dispose of their property however they wish. In most European countries, by contrast, children and other family members are entitled to a substantial share of the estate regardless of the wishes of the deceased. Piketty, incidentally, is critical of these rules, on the grounds that they reinforce inherited wealth, but the US has its own ways of maintaining fortunes across generations. As Madoff points out, the “rule against perpetuities” now exists only in law school classrooms. While at one time it was possible to leave wealth in trust only for named individuals, it is now perfectly possible to set up a trust to benefit your decendents unto the last generation. Even better, you can keep your property itself in the trust, allowing your heirs only an income, or the use of it (as with a house); this protects it from the taxman, your children’s creditors, and their own spendthrift ways. Of course the law is not the whole story here; whether the US has the norms and institutions to actually maintain such perpetual wealth remains to be seen.

Elizabeth Kolbert, The Sixth Extinction

If you’ve read Kolbert’s pieces on climate change in the New Yorker then you know what this book is like. It’s a good, readable summary of what we know about the mass extinction currently underway. There’s nothing really new here, but one thing I did learn from it is how much of what’s happening is due to factors other than warming per se. Ocean acidification is responsible for the extinction of coral, which may be completely gone by the end of the century; invasive species and the dissemination of pathogens is the main factor in the decline of bats and amphibians. No matter how familiar you think you are with this stuff there’s always something that hits you. I remember my fascination and disgust as a child when I learned there were frogs that swallowed their eggs and hatched the tadpoles in their stomachs. It turns out there aren’t anymore.

Christopher Boehm, Moral Origins: The Evolution of Virtue, Altruism and Shame

The central claim of Boehm’s previous book is that all the small bands of foragers we know of — the closest analogues to the societies that existed for 99 percent of human history — are strictly egalitarian, with no one (among adult males) allowed to assume authority over anyone else. This contrasts with the modern world of kings, cops and bosses, and even more so with the rigid dominance hierarchies of our nearest primate relatives. And yet there is a striking parallel between the alliances that dominant chimpanzees form to defend their top spot, and the alliances that entire groups of human beings form to prevent anyone from occupying the top spot in the first place.

Boehm’s idea — which I like a lot, though I don’t have any expertise — is that the same basic behavioral patterns, presumably with the same genetic underpinnings, can produce dramatically different kinds of society. An intense dislike of having people above you, plus the ability to form alliances against anyone who tries to move up in the ranks, are the ingredients for a world of chimpanzees, baboons, mafiosos and orcs, where everyone is jealously guarding their spot in the hierarchy and ready to violently retaliate against usurpers who try to cut ahead of them. But the same vigilance against anyone trying to put themselves above you can equally give rise to the absolute democracy of hunter-gatherer bands, or today to political movements like Occupy Wall Street.

The main thing the newer book adds to the story is a more explicit argument that egalitarian norms arose through natural selection, along the same lines as people like Bowles and Gintis. I am not sure this evolutionary turn is a step forward. Like all evolutionary psychology, this consists largely of speculative just-so stories. And it loses one of the most interesting ideas in the earlier work, that the same behavioral building blocks can give rise to both hierarchical and egalitarian forms of society.

As for fiction, I’ve recently read:

It’s a Battlefield, by Graham Greene

Q, by Luther Blissett

The First Bad Man, by Miranda July

The Lists of the Past, by Julie Hayden. (See Laura Tanenbaum’s review here.)

The Member of the Wedding, by Carson McCullers

The Progress of Love, by Alice Munro

Going after Caciatto, by Tim O’Brien

The Hunters, by James Salter

Cities of Salt, by Adulrahman Munif

Crow Fair, by Tom McGuane

My Brilliant Friend, The Story of a New Name, and Those Who Leave and Those Who Stay, by Elana Ferrante

I liked all of them a lot, would recommend them all. Maybe I’ll write mini-reviews in an another post. Or maybe not.

On Other Blogs, Other Wonders

Some links for Nov. 1:

A few links

This Friday, November 6, Mike Konczal and I will be releasing the next piece of the Roosevelt Institute Financialization Project, two reports on “short-termism” in American corporations and financial markets. One report, written by me, is a followup to the Disgorge the Cash report from this spring, addressing a bunch of the most common objections to the argument that pressure for high payouts is undermining investment. (Some of this material has appeared here on the blog, but a lot of it is new.) The other report is a ten-point policy proposal for addressing short-termism, written by Mike, me, and my former student Amanda Page-Hongrajook. There will be an event for the release in DC, featuring Senator Tammy Baldwin. Hopefully it will get some attention from policymakers and the press.

I was pleased to see this new paper from the central bank of Norway, which draws on my work with Arjun Jayadev on debt dynamics. The key point in the Norges Bank paper is that we have to think of debt as evolving historically, not chosen de novo in response to the current “fundamentals.” More concretely: given significant debt inherited from the past, an increase in interest rates will lead to higher, not lower, debt. The shorthand that change in debt is the same as new borrowing, is not a reliable guide to the historical evolution of leverage.

From the paper:

Macroeconomic models typically assume that households refinance their debt each period … with the implication that the entire stock of debt responds swiftly to shocks and policy changes. This simplifying assumption might be useful and innocuous for many purposes, but cannot be relied upon in the current policy debate, where a central question regards if and how monetary policy should respond to movements in household debt. The likely performance of such policies can only be evaluated within frameworks that realistically account for debt dynamics. …

The evidence that perhaps most convincingly points toward the need for distinguishing between new borrowing and existing debt, is the empirical decomposition of US household debt dynamics by Mason and Jayadev (2014). They account for how the “Fisher” factors inflation, income growth and interest rates have contributed to the evolution of US debt-to-income, in addition to the changes in borrowing and lending, since 1929. Their findings clearly show how the dynamics of debt-to-income cannot be attributed to variation in borrowing alone, but has been strongly influenced by the Fisher factors, and often has gone in the opposite direction of households’ primary deficits. …

Discussions of household debt tend to implicitly assume that variation in debt-to- income ratios reflect active shifts in borrowing and lending, which is misguided…. With plausible debt dynamics, interest rate changes have far weaker influence on household debt than a conventional one-quarter debt model implies. Moreover, with long-term debt the qualitative effect of a policy tightening on household debt-to-GDP is likely to be positive..

The bulk of the paper is an attempt to incorporate these ideas into a DSGE model, which I have misgivings about. But that hardly matters since they’ve so clearly grasped the important point.

In the other-than-economics department, here’s a New York Observer article by Will Boisvert from a little while back on universal pre-K. Will is not a big fan of New York’s universal pre-K program, or of the education-based arguments used to promote it. Now, as a New York City parent of a small child, I’m very grateful that UPK exists. And I’m very impressed that the DeBlasio team were able to roll it out as fast as they did — it’s hard to think of another universal entitlement that was implemented so quickly. But Will’s central critique seems on the mark to me. UPK is primarily a benefit for parents — we should mainly think of it as publicly funded daycare. But for various reasons, it’s been sold by its contribution to the human capital formation of 4-year olds, not by the ways it makes parenthood less of a burden for working- and middle-class families. Will’s argument — and here I’m not sure I’m with him — is that this has had real costs in the way the program is structured.

(Incidentally, one of my first published pieces was a rather unfriendly article about current Observer editor Ken Kurson.)

Over at the Angry Bear blog, the very smart Robert Waldmann has got himself worked up over the fact that real private investment has for the first times since 1947 surpassed real government consumption and investment (I > G in the language of the national income identity.) Unfortunately, there is no such fact.

“Real” I and G are index numbers; you cannot compare their magnitudes. All you can compare is dollars. And in terms of dollars, government consumption and investment, at $3.2 trillion, remains slightly higher than private domestic investment, at $3 trillion. In fact, Waldmann’s claim is almsot the opposite of the truth: the current expansion is the first one since the early 1970s in which private investment has not passed government final spending, at least not yet.

“Real” values are supposed to refer to quantities of stuff, not quantities of money. So Waldmann’s claim that real I is greater than real G is equivalent to the claim that the country is producing more kindergarten classes than steel. Talking about the change in the “real” quantity of steel, or in the “real” number of kindergarten classes, is in principle straightforward: just add up tons or bodies in classrooms, as the case may be. But how do you compare the two? Only via their prices. The problem is, the relative price of kindergarten classes and steel varies over time. So which is greater than which, and by how much, will depend on which year’s prices you use. In the case of I and G, if we use current prices, we find that G is slightly greater than I. If we use 2009 prices, as Waldmann does, we find that I is slightly greater than G. If we use, say, 1950 prices, we find that I is almost three times G. Which of these is “true”? None of them — when you’re comparing index numbers, absolute magnitudes are completely arbitrary. And again, when we compare dollar amounts, which are objective, we see that G remains comfortably above I. [1]

I’m not calling attention to this just to pick a fight. (UPDATE: Waldmann now agrees, so no fight to pick.) It’s because I think it’s revealing about the way inflation adjustment confuses people, and especially economists. Even someone as smart and critical-minded as Waldmann can get sucked into treating “real” values as objective measures of physical stuff.

I haven’t been following the Argentine elections closely, but it seems clear that the resolution of the Argentine default is an important frontline in the war between money and humanity. So we have to be interested in whether the elections are won by the candidate promising surrender to the creditors. On the larger set of issues at stake there, I recommend this piece by Marc Weisbrot, whose stuff on Argentina is in general very good.

There’s an interesting conversation going on about the “natural rate of interest.” Here’s one way to think about it. If the government buys enough peanuts, it can presumably raise aggregate demand to the economy to full employment, and/or to a level consistent with some inflation target. Should we call whatever peanut price results from this policy “the natural price of peanuts”? And is there any reason to think that this price, whatever it might be, will be the same as in a Walrasian economy that somehow corresponds to our own “in the absence of distortions or rigidities”? Now substitute bonds for peanuts — to talk about the natural rate of interest means answering both questions Yes.

Anyway, I think Tyler Cowen is mostly on target here.

I was talking about econ blogs at the bar the other night, and there was a general consensus that none of us read as many of them as we used to. Maybe the econblogging moment is over? Still, there are lots of them that are worth your time, if you’re reading this. Here are a few economics blogs I’ve recently started reading regularly: Perry Mehrling; Brian Romanchuk; Marshall Steinbaum. Perry has of course been writing great stuff for decades but he’s only recently taken up blogging. So I think there’s still some life in the format.

[1] Altho it is striking how the trajectory of G has flattened out under Obama. 2010-2015 is the first five-year period since World War II in which there was zero growth in nominal government consumption and investment. The only reason G is still above I, is because private investment fell so steeply between 2006 and 2010. So maybe Waldmann is onto something after all?

Greece Thoughts and Links

Like everyone sympathetic to Greece in the current crisis, I was pleased by the size of the “No” vote in last weekend’s referendum. Even taking into account support from the far right, the 62% for No represents a significant increase in support from the 36% of the vote SYRIZA got in January.

But, I’m not sure how the vote changes the situation in any substantive way. Certainly it hasn’t led to any softening of the creditors’ position. The situation remains what it was before: Greece must comply with the full list of policy changes demanded by the creditors, and any further changes demanded in the future, or else the central bank will keep the Greek banking system shut down. The debt itself is just a pretext on both sides — repayment is not really what the creditors want, and default isn’t really what they are threatening.

I continue to think that the Bank of Greece is the key strategic terrain in this contest. If the elected government can regain control of the central bank — in defiance of eurosystem norms if need be — then it removes the source of the creditors’ power over the Greek economy. There is no need for a new currency in this scenario. If the Bank of Greece simply goes back to performing the usual functions of a central bank, instead of engaging in what is, in effect, a politically-motivated strike, then Greek banks can reopen and the Greek government can finance needed spending without the consent of the official creditors.

More broadly, I think we cannot understand the economics of the situation unless we clearly understand that “money,” in modern economies, refers to a network of promises between banks and not a set of tokens. In this sense, I don’t think it makes sense to think of being in or out of a currency as a simple binary. As Perry Mehrling emphasizes, there have always been overlapping networks of money-contracts, with various economic units participating in multiple networks to different degrees.

Here are a few relevant links, some spelling out my thoughts more, some useful background material.

1. Here is an interview with me on the podcast RadioDispatch. If you don’t mind listening rather than reading, this is my fullest attempt to explain the logic of the crisis.

RadioDispatch interview June 2015

2. I had a productive discussion with Dan Davies on this Crooked Timber thread. Since my last comment there got stuck in moderation for some reason, I’m reposting it here:

From my point of view, the key question is whether the ECB is constrained by, or at least acting in accordance with, the normal principles of central banking, or if it is deliberately withholding support from the Greek banking system in order to advance a political agenda.

Obviously, I think it’s the second. (And I think this is really the only leverage the creditors have — there is no reason that a default in itself should be particularly costly to Greece.) On whether it is plausible that the ECB would (ab)use its authority this way, I think that is unequivocally demonstrated by the letters sent to the governments of Italy, Spain and Ireland during those countries’ sovereign debt crises in 2011. In return for support of those countries’ sovereign debt markets, the ECB demanded a long list of unrelated reforms, mainly focused on labor-market liberalization. There is no credible case that many of these reforms (for instance banning cost-of-living clauses in private employment contracts) were connected with the immediate crisis or even with public budgets at all. I think it can be taken as proven that the EC has, in the past, deliberately refused to perform its function of stabilizing the financial system, in order to put pressure on elected governments.

We can debate how exactly this precedent fits Greece. But I don’t think a central bank that allows its country’s banking system to collapse can ever be said to be doing its job. Every modern central bank — including the ECB with respect to every euro-area country except Greece — will go to heroic lengths, bending or ignoring rules as need be, to keep the payments system operating.

3. Over at The Week, I talk with Jeff Spross about the idea that changes in private financial flows between euro-area countries can be passively offset by balances between the national central banks in the TARGET2 system, avoiding the need to mangle the real economy to produce rapid adjustment of trade flows.

Like many critics of the euro system, I used to think that they had succeeded in creating something like a modern gold standard, and that the only way crises could be avoided was with a fiscal union, so that public flows could offset shifts in financial flows. But I no longer think this is correct, I think that the TARGET2 system can, and has, offset changes in private financial flows without the need for any fiscal payments.

(The Week also had a nice writeup of the Reagan-debt post.)

4. I reached this conclusion after reading several pieces by Philippine Cour-Thimann, who is the source for understanding TARGET2 and its role both in the normal operations of the euro system and in the crisis. I recommend this one to start with. (Incidentally it was my friend Enno Schröder who told me about Cour-Thimann.)

5. One topic I’ve wanted to get into more is the (in my view) limited capacity of relative-price adjustments to balance trade even when exchange rates are flexible. In the past, I’ve made this argument on the crude empirical grounds that Greece had large trade deficits continuously for decades before it joined the euro. I’ve also pointed out Enno’s work showing that the growth of European trade imbalances owes nothing to expenditure switching toward German products and away from Greek, Spanish, etc., but is entirely explained by the more rapid income growth in the latter countries. Now here is another interesting piece of evidence on this question from the ECB, a big new study finding that while there is a substantial fall in exports in response to large appreciations, there is no discernible growth in exports in response to depreciations. This fits with the idea, which I attribute to Robert Blecker, that in a world where prices are mainly set in destination markets rather than by producer costs, changes in exchange rates show up in exporter profit margins rather than directly in sales volumes. And while large losses will certainly cause some exporting firms to exit or fail, large (potential) profits are only one of a number of conditions required for exporters to grow, let alone for the creation of new exporting industries.

6. This is a great post by Steve Randy Waldman.

7. Here’s an interesting find from a friend: In the 1980s, Fidel Castro proposed “a cartel of debtor nations” that would require their creditors to negotiate with them as a group. See pages 278-285 of this anthology.

UPDATE: Re item 2, here’s Martin Wolf today (his links):

The European Central Bank could expand its emergency lending to the Greek banking system. If the ECB were a normal central bank that is exactly what it would do. Greece has a run on its banks. As the lender of last resort, the central bank ought to lend into such a run. If the ECB believes the banks are solvent, it must lend. If the ECB believes the banks are insolvent, it should arrange recapitalisation — by converting non-insured liabilities into equity, by selling banks to new owners or by securing funding from the European Stability Mechanism (ESM).

Unfortunately, the ECB is not a normal central bank…

What to Read on Liquidity

In comments, someone asks for references behind “the point is liquidity, the point is liquidity, the point is liquidity.” So, here are my recommended readings on liquidity.

Mike Beggs: “Liquidity as a Social Relation.” This is the best single discussion I know of the Keynesian view of liquidity. Beside laying out the fundamental conceptual issues, and sketching the historical development of the concept, this piece also has a good discussion of how the definition of liquidity used in monetary policy has been transformed over the past couple decades. This is the first thing I’d recommend to anyone who wants to understand what exactly those of us in the left-Keynsian tradition mean by “liquidity.”

John Hicks: “Liquidity.” A lucid and intelligent summary of where the discussion of liquidity stood 20 years after Keynes’ death.

Jorg Bibow: “Liquidity preference theory revisited: to ditch or to build on it?” A rigorous analysis of the role of liquidity in the Keynesian theory of interest rates, with particular attention to the dynamics of conventional expectations. If you want to know how Keynes’ ideas about liquidity fit into contemporary debates about monetary policy, Bibow is your man. Also worth reading: “On Keynesian Theories of Liquidity Preference,” and Bibow’s book.

J. M. Keynes: chapters 12, 13, 15, 17 and 23 of the General Theory. Also: “The General Theory of Employment”; “The Ex-Ante Theory of Interest.“ The original source. I think the presentation in the articles is clearer than in the book. Beggs and Hicks and Bibow are even clearer.

Jean Tirole, “Illiquidity and All Its Friends.” Within the mainstream, Tirole has by far the best discussion of liquidity that I’m aware of. I have profoundly mixed feelings about his approach but I’ve certainly learned from him — for example, the distinction between funding liquidity and market liquidity is genuinely useful. If you’re tempted to criticize “mainstream” economics’ treatment of liquidity, you need to seriously engage with Tirole first — he incorporates a surprisingly large part of the Keynesian vision of liquidity into an orthodox framework.

Jim Crotty, “The Centrality of Money, Credit and Intermediation in Marx’s Crisis Theory”. Addresses liquidity in a somewhat different context than most of the above — he asks how the specifically monetary character of capitalist production shapes the dynamics of accumulation as described by Marx and his followers. It’s a bit askew to the other pieces here, but the underlying questions are, I think, the same. And it is one of the most brilliant scholarly essays I have read.

Perry Mehrling, “The Vision of Hyman Minsky.” I think this lays out the logic of Minsky’s work better than anything by Minsky himself. Also see Mehrling’s book, The Money Interest and the Public Interest. Everything we need to know about liquidity is in there, though you may have to read between the lines to find it. His “Inherent Hierarchy of Money” is also useful, making the point that any system of payments is inherently hierarchical, with the same instrument appearing as credit at one level and as money at the level below.

EDIT: Should also include Joan Robinson, “The Rate of Interest,” which has a useful taxonomy distinguishing illiquidity in the strict sense from capital uncertainty, income uncertainty and lender’s risk.

By the way, the phrasing the post starts with is taken from Tree of Smoke, Denis Johnson’s Vietnam war novel. (I know that’s not what you were asking.) It’s the best novel I read this year, I recommend it almost unreservedly. There of course the point is Vietnam.

Review of Dumenil and Levy

The new issue of Rethinking Marxism has my review of The Crisis of Neoliberalism by Gérard Duménil and Dominique Lévy. Since RM is paywalled — a topic for another day — I’m putting the full text here.

Incidentally, I do recommend the book, but I would suggest just reading chapters 3-6, where the core arguments are developed, and then skipping to the final three chapters, 23-25. The intervening material is narrowly focused on the 2008-2009 financial crisis and is of less interest today.

* * *

Historical turning points aren’t usually visible until well after the fact. But the period of financial and economic turmoil that began in 2008 may be one of the rare exceptions. If capitalism historically has evolved through a series of distinct regimes — from competition to monopoly in the late 19th century, to a regulated capitalism after World War II and then to neoliberalism after the crises of the 1970s, then 2008 may mark the beginning of another sharp turn.

That, anyway, is the central claim of The Crisis of Neoliberalism, by Gérard Duménil and Dominique Lévy (hereafter D&L). The book brings together a great deal of material, broadly grouped under two heads. First is an argument about the sociology of capitalism, hinging on the relationship between capitalists in the strict sense and the managerial class. And second is an account of the financial crisis of 2008 and its aftermath. A concluding survey of possibilities for the post-neoliberal world unites the two strands.

For D&L, the key to understanding the transformations of capitalism over the past hundred years lies in the sociology of the capitalist class. With the rise of the modern corporation at the turn of the 20th century, it became more problematic to follow Marx in treating the capitalist as simply the “personification of capital.” While the logic of capital is the same — it remains, in their preferred formulation, “value in a movement of self-expansion” — distinct groups of human beings now stand at different points in that process. In particular, “the emergence of a bourgeois class more or less separated from the enterprise” (13) created a new sociological gulf between the ownership of capital and the management of production.

Bridging this gulf was a new social actor, Finance. While banks and other financial institutions predate industrial capitalism, they now took on an important new role: representation of the capitalist class vis-a-vis corporate management, a function not needed when ownership and management were united in the same person. “Financial institutions,” D&L write, “are an instrument in the hands of the capitalist class as a whole in the domination they exercise over the entire economy.” (57) This gives finance a dual character, as on the one hand one industry among others providing a particular good (intermediation, liquidity, etc.) but also as, on the other hand, the enforcers or administrators who ensure that industry as a whole remains organized according to the logic of profit.

The stringency of this enforcement varies over time. For D&L, the pre-Depression and post-Volcker eras are two periods of “financial hegemony,” in which holders of financial claims actively intervened in the governance of nonfinancial firms, compelling mergers of industrial companies in the first period, and engineering leveraged buyouts and takeovers in the second. By contrast, the postwar period was one of relative autonomy for the managerial class, with the owners of capital accepting a relatively passive role. One way to think of it is that since capital is a process, its expression as an active subject can occur at different moments of that process. Under financial hegemony, the political and sociological projections of capital emanated mostly from the M moment, but in the mid-century more from C-C’. Concretely, this means firms pursued objectives like growth, technical efficiency, market share or technological advance rather than (or in addition to) profit maximization – this is the “soulful corporation” of Galbraith or Chandler. Unlike those writers, however, D&L see this corporation-as-polis, balancing the interests of its various stakeholders under the steady hand of technocratic management, as neither the result of a natural evolution nor a normative ideal; instead, it’s a specific political-economic configuration that existed under certain historical conditions. In particular, managerial capitalism was the result of both the crisis of the previous period of financial hegemony and, crucially, of the mobilization of the popular classes, which opened up space for the top managers to pursue a strategy of “compromise to the left” while continuing to pay the necessary tribute to “the big capitalist families.”

Those families — the owners of capital, in the form of financial assets — were willing to accept a relatively passive role as long as the tribute flowed. But the fall in the profit rate in the 1970s forced the owners to recohere as a class for themselves. Their most important project was, of course, the attack on labor, in which capital and management were united. But a second, less visible fight was the capitalists’ attack on the managers, with finance as their weapon. The wave of corporate takeovers, buyouts and restructurings of the 1980s was not just a normal competitive push for efficiencies, nor was it the work of a few freebooting pirates and swindlers. As theorized by people like Michael Jensen, it was a self-conscious project to reorient management’s goals from the survival and growth of the firm, to “shareholder value”. In this, it succeeded – first by bullying and bludgeoning recalcitrant managers, then by incorporating their top tier into the capitalist class. “During the 1980s the disciplinary aspect of the new relationship between the capitalist and managerial classes was dominant,” write D&L, but “after 2000, … managers had become a pillar of Finance.” (84) Today, the “financial facet of management tends to overwhelmingly dominate” and “a process of ‘hybridization’ or merger is under way.” (85)

These are not entirely new ideas. D&L cite Veblen, certainly one of the first to critically investigate the separation of management and control, and to observe that the “importance of securities in ownership of the means of production [gives] … the capitalist class a strong financial character.” But they make no mention of the important debates on these issues among Marxists in the 1970s, especially Fitch and Oppenheimer’s Socialist Revolution articles on “Who Rules the Corporations?” and David Kotz’s Bank Control of Large Corporations in the United States. Most glaringly, they fail to cite Doug Henwood’s Wall Street, whose Chapter 6 gives a strikingly similar account of the revolt of the rentiers, and which remains the best guide to relations between finance and nonfinancial businesses within a broad Marxist framework. While Henwood shares the same basic analysis as The Crisis of Neoliberalism, he backs it up with a wealth of concrete examples and careful attention to the language of the financiers and their apologists. D&L, by contrast, despite their welcome interest in the sociology of the capitalist class, never descend from a high level of abstraction. D&L would have advanced the conversation more if they had tried to build on the contributions of Fitch and Oppenheimer, Kotz, and Henwood, instead of reinventing them.

Still, it’s an immensely valuable book. Both mainstream economists and Marxists often imbue capitalist firms with a false homogeneity, as if the pursuit of profit was just a natural fact or imposed straightforwardly by competition. D&L offer an important corrective, that firms (and social life in general) are only kept subordinate to the self-expansion of value through active, ongoing efforts to enforce and universalize financial criteria.

The last third of the book is an account of the global financial crisis of the past five years. Much of the specifics will be familiar to readers of the business press, but the central argument makes sense only in light of the earlier chapters: that the ultimate source of the crisis was precisely the success of the reestablishment of financial hegemony. In particular, deregulation — especially the freeing of cross-border capital flows — weakened the tools states had previously used to keep the growth of financial claims in line with the productive capacity of the economy. (It’s an irony of history that the cult of central banking “maestros” reached its height at the point when they had lost most of their real power.) Meanwhile, increased payouts to shareholders and other financial claimants starved firms of funds for accumulation. A corollary of this second point is that the crisis was characterized by underaccumulation rather than by underconsumption. The underlying demand problem wasn’t insufficient funds flowing to workers for consumption — the rich consume plenty — but insufficient funds remaining within corporations for the purpose of investment. Just as investment suffered at the end of the postwar boom when the surplus available to capitalist firms was squeezed from below by rising wage claims, it suffered in the past decade when that surplus was squeezed from above by the claims of rentiers. So higher wages might only have made the crisis worse. This argument needs to be taken seriously, unpalatable though it may be. We need to avoid the theodicy of liberal economists, in which the conditions of social justice and the conditions of steady accumulation are always the same.

The Crisis of Neoliberalism is not the last word on the crisis, but it is one of the more convincing efforts to situate it in the longer-term trajectory of capitalism. The most likely outcome of the crisis, they suggest, is a shift in the locus of power back toward managers. Profit maximization will again be subordinated to other objectives. The maintenance of US hegemony will require a “reterritorialization” of production, which will inevitably weaken the position of fincance. There is an inherent conflict between a reassertion of state authority and the borderless class constituted by ownership of financial claims. But there is no such conflict between the interests of particular states, and the class constituted by authority within particular firms. “This is an important factor … strengthening of the comparative position of nonfinancial managers.”

Are we starting to see the dethroning of Finance, a return to the soulful corporation, and a retreat from the universalizing logic of profit? It’s too soon to tell. It’s interesting, though, to see Michael Jensen, the master theorist of the shareholder revolution, sounding a more soulful note. Shareholder value, he recently told The New Yorker, “is the score that shows up on the scoreboard. It’s not the objective… Your life can’t just be about you, or your life will be shit. You see that on Wall Street.” That business serves a higher calling than Wall Street, is the first item in the managerialist catechism. We might look at Occupy Wall Street and the growing movement against student debt in the same light: By singling out as the enemy those elites whose power takes directly financial form, they implicitly legitimate power more linked to control of the production process. Strange to think that a movement of anarchists could be heralding a return to power of corporate management. But history can be funny that way.

Innovation in Higher Ed, 1680 Edition

Does anybody read Bagehot’s Lombard Street any more? You totally should, it’s full of good stuff. It’s baffling to me, as a sometime teacher of History of Economic Thought, that most of the textbooks and anthologies don’t mention him at all. Anyway, here he’s quoting Macaulay:

During the interval between the Restoration and the Revolution the riches of the nation had been rapidly increasing. Thousands of busy men found every Christmas that, after the expenses of the year’s housekeeping had been defrayed out of the year’s income, a surplus remained ; and how that surplus was to be employed was a question of some difficulty. In … the seventeenth century, a lawyer, a physician, a retired merchant, who had saved some thousands, and who wished to place them safely and profitably, was often greatly embarrassed. … Many, too, wished to put their money where they could find it at an hour’s notice, and looked about for some species of property which could be more readily transferred than a house or a field. A capitalist might lend … on personal security : but, if he did so, he ran a great risk of losing interest and principal. There were a few joint-stock companies, among which the East India Company held the foremost place : but the demand for the stock of such companies was far greater than the supply. … So great was that difficulty that the practice of hoarding was common. We are told that the father of Pope, the poet, who retired from business in the City about the time of the Revolution, carried to a retreat in the country a strong-box containing near twenty thousand pounds, and took out from time to time what was required for household expenses…

The natural effect of this state of things was that a crowd of projectors, ingenious and absurd, honest and knavish, employed themselves in devising new schemes for the employment of redundant capital. It was about the year 1688 that the word stock-jobber was first heard London. In the short space of four years a crowd of companies, every one of which confidently held out to subscribers the hope of immense gains, sprang into existence… There was a Tapestry Company, which would soon furnish pretty hangings for all the parlors of the middle class and for all the bedchambers of the higher. There was a Copper Company, which proposed to explore the mines of England, and held out a hope that they would prove not less valuable than those of Potosi. There was a Diving Company, which undertook to bring up precious effects from shipwrecked vessels, and which announced that it had laid in a stock of wonderful machines resembling complete suits of armor. In front of the helmet was a huge glass eye like that of Polyphemus ; and out of the crest went a pipe through which the air was to be admitted. … There was a society which undertook the office of giving gentlemen a liberal education on low terms, and which assumed the sounding name of the Royal Academies Company. In a pompous advertisement it was announced that the directors of the Royal Academies Company had engaged the best masters in every branch of knowledge, and were about to issue twenty thousand tickets at twenty shillings each. There was to be a lottery : two thousand prizes were to be drawn; and the fortunate holders of the prizes were to be taught, at the charge of the Company, Latin, Greek, Hebrew, French, Spanish, conic sections, trigonometry, heraldry, japanning, fortification, book-keeping, and the art of playing the theorbo.

Many of Macaulay’s examples, which I’ve left out here, are familiar, thanks to Charles Mackay and more recent historians of financial folly. (Including everyone’s favorite, the company that raised funds “for an Undertaking which in due time shall be revealed.”) The line about Pope is also familiar, at least to reader of The General Theory: Keynes cites it as an illustration of the position of the wealth-holder in a world where the rentier had been successfully euthanized. But I, at least, had never realized that the diving suit was a product of the South Sea bubble. And I’d never heard of this spiritual ancestor of Chris Whittle and Michelle Rhee.

It would be interesting to learn more about the claims that were made for this company, and what happened to it. Alas, Google is no help. Although, “Royal Academies Company” turns out to be a weirdly popular phrase among the Markov-chain text generators that populate fake spam blogs. (Seriously, guys, this is poetry.) We can only hope that today’s enterprises that promise to give gentlemen a liberal education on low terms (or at least an education in japanning and/or ski area management) will vanish as ignominiously.

Ancient Economists: Two Views

John Cochrane, reporting from the NBER Summer Institute:

The use of ancient quotations came up several times. I complained a bit about Eggertsson and Mehrotra’s long efforts to tie their work to quotes from verbal speculations of Keynes, Alvin Hansen, Paul Krugman and Larry Summers. Their rhetorical device is, “aha, these equations finally explain what some sage of 80 years ago or Important Person today really meant.” Ivan Werning really complained about this in Paul Beaudry’s presentation. What does this complex piece of well worked out “21st century economics” have to do with long ago muddy debates between Keynes and Hayek? It stands on its own, or it doesn’t. (In his view, it did, so why belittle it?)

Physics does not write papers about “the Newton-Aristotle debate.” Our papers should stand on their own too. They are right or wrong if they are logically coherent and describe the data, not if they fulfill the vague speculations of some sage, dead or alive. It’s especially unhelpful to try to make this connection, I think, because the models differ quite sharply from the speculations of the sage. Alvin Hansen certainly did not think that a Taylor interest rate rule with a phi parameter greater than one was a central culprit in “secular stagnation.” I haven’t checked against the speech, but I doubt he thought that inflation would completely cure the problem in the first place.

Sure, history of thought is important; tying ideas to their historical predecessors is important; recognizing the centuries of thinking on money and business cycles is important. But let’s stand up for our own generation; we do not exist simply to finally put equations in the mouths of ancient economists.

But, tying it all up, perhaps I’m just being an old fogey. Adam Smith wrote mostly words. Marx like Keynes wrote big complicated books that people spent a century writing about “this is what they really meant.” Maybe models are at best quantitative parables. Maybe economics is destined to return to this kind of literary philosophy, not quantified science.

(via Suresh, who was also there.)

For the case in favor of ancient economists, here is Axel Leijonhufvud:

According to Sir Peter Medawar

A scientist’s present thoughts and actions are of necessity shaped by what others have done and thought before him: they are the wave-front of a continuous secular process in which The Past does not have a dignified independent existence of its own. Scientific understanding is the integral of a curve of learning; science therefore in some sense comprehends its history within itself.

… Not every field of learning can claim to “comprehend its history within itself.” For the current state of the art to be the “integral of past learning” in Medawar’s sense, the collective learning process must be one that remembers everything of value and forgets only the errors and the false leads. But this requires the recognized capability to decide what is correct or true and what is in error or false. These decisions, moreover, must compel general assent. Once an answer is arrived at, it must be generally agreed to be the answer. The field must be one in which answers kill questions so definitively that the sense of alternative possibilities disappears. …

A science, or a subfield within it, may come to approximate these conditions because of its positive successes. But two other mechanisms that are not so nice will also be at work. First, the people in the field agree that certain questions, which they would have a hard time deciding, are somebody else’s responsibility. So economics among the social sciences, like physics among the natural sciences, had first pick of problems and left the really hard ones, on which their methods did not give them a firm grip, for the younger sister disciplines to deal with as best they might. Second, the insiders to the field will agree to exclude some people who refuse to assent to the manner in which certain important questions have been settled. Both the exclusion of undecidable questions from the field of inquiry and the exclusion of undecided people from the professional group help to achieve collective concentration and intensive interaction within the group. …

These reflections … offer some suggestions about when scientists might find the history of their field relevant and useful to current inquiry. One suggestion is to look for situations when a research program has bogged down, when anomalies have cropped up that cannot be reduced to or converted into ordinary puzzles within the paradigm. Another is to look for cases in which three conditions seem to be met:
a) certain central questions cannot be decided in a way that commands assent,
b) the (for the time being) undecidable questions cannot very well be left for somebody else to worry about, and
c) the people who withhold their assent from some popular suggested answer cannot be ignored or excommunicated.

… Economists are wont to reduce everything to choices. Economics itself develops through the choices that economists make. To use the past for present purposes, we should see the history of the field as sequences of decisions, of choices, leading up to the present. Imagine a huge decision tree, with its roots back in the time of Aristotle, and with the present generation of economists — not all of them birds of a feather! — twittering away at each other from the topmost twigs and branches.

The branching occurs at points where economists have parted company, where problematic decisions had to be made but could not be made so as to command universal assent. The two branches need not be of equal strength at all; in many cases, universal agreement is eventually reached ex post so that one branch eventually dies and falls away. The oldest part of the tree is, perhaps, just the naked trunk; but the sap still runs in some surprising places.

If you want to translate Medawar’s image of science into my decision tree metaphor, you will have to imagine his sciences as fir trees — with physics, surely, as the redwood – majestic things with tall, straight trunks and with live branches only at the very top. Economics, in contrast, would come out as a rather tangled, ill-pruned shrub …

As long as “normal” progress continues to be made in these established directions, there is no need to reexamine the past … Things begin to look different if and when the workable vein runs out or, to change the metaphor, when the road that took you to the “frontier of the field” ends in a swamp or in a blind alley. A lot of them do. Our fads run out and we do get stuck occasionally. Reactions to finding yourself in a cul-de-sac differ. Tenured professors might often be content to accommodate themselves to it, spend their time tidying up the place, putting in a few modern conveniences, and generally improving the neighborhood. Braver souls will want out and see a tremendous leap of the creative imagination as the only way out — a prescription, however, that will leave ordinary mortals just climbing the walls. Another way to go is to backtrack. Back there, in the past, there were forks in the road and it is possible, even plausible, that some roads were more passable than the one that looked most promising at the time. At this point, a mental map of the road network behind the frontier becomes essential.

Boulding on Interest

Kenneth Boulding, reviewing Maurice Allais’s Économie et intérêt in 1951:

Much work on the theory of interest is hampered at the start by its unquestioned assumption that “the” rate of interest, or even some complex of rates, is a suitable parameter for use in the construction of systems of economic relationships, whether static or dynamic. This is an assumption which is almost universally accepted and yet which seems to me to be very much open to question. My reason for questioning it is that the rate of interest is not an objective magnitude… The rate of interest is not a “price”; its dimensions are those of a rate of growth, not of a ratio of exchange, even though it is sometimes carelessly spoken of as a “price of loanable funds.” What is determined in the market is not strictly the rate of interest but the price of certain “property rights.” These may be securities, either stocks or bonds, or they may be items or collections of physical property. Each of these property rights represents to an individual an expected series of future values, which may be both positive and negative. If this expected series of values can be given some “certainty equivalent” … then the market price of the property determines a rate of interest on the investment. This rate of interest, however, is essentially subjective and depends on the expectations of the individual; the objective phenomenon is the present market price…

It is only the fact that the fulfilment of some expectations seems practically certain that gives us the illusion that there is an objective rate of interest determined in the market. But in strict theory there is no such certainty, even for gilt-edged bonds; and when the uncertainties of life, inflation, and government are taken into consideration, it is evident that this theoretical uncertainty is also a matter of practice. What is more, we cannot assume either that there are any “certain equivalents” of uncertain series for it is the very uncertainty of the future which constitutes its special quality. What this means is that it is quite illegitimate even to begin an interest theory by abstracting from uncertainty or by assuming that this can be taken care of by some “risk premium”; still less is it legitimate to construct a whole theory on these assumptions … without any discussion of the problems which uncertainty creates. What principally governs the desired structure of assets on the part of the individual is the perpetual necessity to hedge — against inflation, against deflation, against the uncertainty in the future of all assets, money included. It is these uncertainties, therefore, which are the principal governors of the demand and supply of all assets without exception, and no theory which abstracts from these uncertainties can claim much significance for economics. Hence, Allais is attempting to do something which simply cannot be done, because it is meaningless to construct a theory of “pure” interest devoid of premiums for risk, liquidity, convenience, amortization, prestige, etc. There is simply no such animal.

In other words: There are contexts when it is reasonable to abstract from uncertainty, and proceed on the basis that people know what will happen in the future, or at least its probability distribution. But interest rates are not such a context, you can’t abstract away from uncertainty there. Because compensation for uncertainty is precisely why interest is paid.

The point that what is set in the market, and what we observe, is never an interest rate as such, but the price of some asset today in terms of money today, is also important.

Boulding continues:

The observed facts are the prices of assets of all kinds. From these prices we may deduce the existence of purely private rates of return. The concept of a historical “yield” also has some validity. But none of these things is a “rate of interest” in the sense of something determined in a market mechanism.

This search for a black cat that isn’t there leads Allais into several extended discussions of almost meaningless and self-constructed questions… Thus he is much worried about the “fact” that a zero rate of interest means an infinite value for land, land representing a perpetual income, which capitalized at a zero rate of interest yields an infinite value… This is a delightful example of the way in which mathematics can lead to an almost total blindness to economic reality. In fact, the income from land is no more perpetual than that from anything else and no more certain. … We might draw a conclusion from this that a really effective zero rate of interest in a world of perfect foresight would lead to an infinite inflation; but, then, perfect foresight would reduce the period of money turnover to zero anyway and would give us an infinite price level willy-nilly! This conclusion is interesting for the light it throws on the complete uselessness of the “perfect foresight” model but for little else. In fact, of course, the element which prevents both prices from rising to infinity and (private) money rates of interest from falling to zero is uncertainty – precisely the factor which Allais has abstracted from. Another of these quite unreal problems which worries him a great deal is why there is always a positive real rate of interest, the answer being of course that there isn’t! …

Allais reflects also another weakness of “pure”interest theory, which is a failure to appreciate the true significance and function of financial institutions and of “interest” as opposed to “profit” – interest in this sense being the rate of growth of value in “securities,” especially bonds, and “profit” being the rate of growth of value of items or combinations of real capital. Even if there were no financial institutions or financial instruments … there would be subjective expected rates of profit and historical yields on past, completed investments. In such a society, however, given the institution of private property, everyone would have to administer his own property. The main purpose of the financial system is to separate “ownership” (i.e., equity) from “control,” or administration, that is, to enable some people to own assets which they do not control, and others to control assets which they do not own. This arrangement is necessitated because there is very little, in the processes by which ownership was historically determined through inheritance and saving, to insure that those who own the resources of society are … capable of administering them. Interest, in the sense of an income received by the owners of securities, is the price which society pays for correcting a defect in the otherwise fruitful institution of private property. It is, of course, desirable that the price should be as small as possible – that is, that there should be as little economic surplus as possible paid to nonadministering owners. It is quite possible, however, that this “service” has a positive supply price in the long run, and thus that, even in the stationary state, interest, as distinct from profit, is necessary to persuade the nonadministering owners to yield up the administration of their capital.

This last point is important, too. Property, we must always remember, is not a relationship between people and things. it is a relationship between people and people. Ownership of an asset means the authority to forbid other people from engaging in a certain set of productive activities. The “product” of the asset is how much other people will pay you not to exercise that right. Historically, of course, the sets of activities associated with a given asset have often been defined in relation to some particular means of production. But this need not be the case. In a sense, the patent or copyright isn’t an extension of the idea of property, but property in its pure form. And even where the rights of an asset owner are defined as those connected with some tangible object, the nature of the connection still has to be specified by convention and law.

According to Wikipedia, Économie et intérêt, published in 1947, introduced a number of major ideas in macroeconomics a decade or more before the American economists they’re usually associated with, including the overlapping generations model and the golden rule for growth. Boulding apparently did not find these contributions worth mentioning. He does, though, have something to say about Allais’s “economic philosophy” which “is a curious combination of Geseel, Henry George and Hayek,” involving “free markets, with plenty of trust- and union-busting, depreciating currency, and 100 per cent reserves in the banking system, plus the appropriation of all scarcity rents and the nationalization of land.” Boulding describes this as “weird enough to hit the jackpot.” It doesn’t seem that weird to me. It sounds like a typical example of a political vision you can trace back to Proudhon and forward through the “Chicago plan” of the 1930s and its contemporary admirers to the various market socialisms and more or less crankish monetary reform plans. (Even Hyman Minsky was drawn to this strain of politics, according to Perry Mehrling’s superb biographical essay.)What all these have in common is that they see the obvious inconsistency between capitalism as we observe it around us and the fairy tales of ideal market exchange, but they don’t reject the ideal. Instead, they propose a program of intrusive regulations to compel people to behave as they are supposed to in an unregulated market. They want to make the fairy tales true by legislation. Allais’ proposal for currency depreciation is not normally part of this package; it’s presumably a response to late-1940s conditions in France. But other than that these market utopias are fairly consistent. In particular, it’s always essential to reestablish the objectivity of money.

Finally, in a review full of good lines, I particularly like this one:

Allais’s work is another demonstration that mathematics and economics, though good complements, are very imperfect substitutes. Mathematics can manipulate parameters once formulated and draw conclusions out which were already implicit in the assumptions. But skills of the mathematician are no substitute for the proper skill of the economist, which is that of selecting the most significant parameters to go into the system.