Thursday, May 5, 2016

Growth analogies, microfoundations and Mathematical Biology of Social Behavior

You want MICROfoundations? In Mathematical Biology of Social Behavior, Nicolas Rashevsky attempted "the next step" of examining the social interactions of individuals in terms of the mathematical biophysics of the central nervous system. He paid special attention to economic questions of wealth, distribution, motivation, learning, rationality, habit, imitation, individualism and collectivism.

Rashevsky's mathematics must be seen as exploratory and often is qualified by the admission that assumptions are unrealistic but that more realistic assumptions make the math intractable. The results thus offer insights, not "conclusions." The contrast with alleged microfoundations as practiced by contemporary mainstream economists couldn't be starker. The latter embrace unrealistic assumptions as a feature, not a bug, because it enables them to crank out conclusions based on biases they are seeking to confirm.

Simon Kuznets on growth:
Growth is a concept whose proper domicile is the study of organic units, and the use of the concept in economics is an example of that prevalent employment of analogy the dangers of which have been so eloquently stressed recently by Sidney Hook. 
Sidney Hook on analogy:
As an argument it is formally worthless and never logically compelling. An argument from analogy can be countered usually with another argument from analogy which leads to a diametrically opposed conclusion. ...
At best an analogy can only suggest a plausible conclusion whose validity must then be established on other grounds. The uncritical use of analogies is the bane of much historical writing, particularly when the resemblances lack clear definition or when they are blurred and presented as identities. ...  The belief that society is an organism is an old but fanciful notion. It can only be seriously entertained by closing the eye to all the respects in which a group of separate individuals differs from a system of connected cells, and by violently redefining terms like "birth," "reproduction," and "death." 
Gregory Bateson on schizophrenia:
...the ‘word salad' of schizophrenia can be described in terms of the patient’s failure to recognize the metaphoric nature of his fantasies. In what should be triadic constellations of messages, the frame-setting message (e.g., the phrase 'as if') is omitted, and the metaphor or fantasy is narrated and acted upon in a manner which would be appropriate if the fantasy were a message of the more direct kind.

Wednesday, May 4, 2016

The Microfoundations of the Weeds in the Garden Model

Last fall John Cochrane argued:
Sclerotic growth is the overriding economic issue of our time. From 1950 to 2000 the US economy grew at an average rate of 3.5% per year. Since 2000, it has grown at half that rate, 1.7%. From the bottom of the great recession in 2009, usually a time of super-fast catch-up growth, it has only grown at two percent per year. Two percent, or less, is starting to look like the new normal…Our economy is like a garden, but the garden is choked with weeds. Rather than look for some great new fertilizer to throw on it, why don’t we get down on our knees and pull up the weeds? At least we know weeding works! …Cleaning out the weeds also needs a large effort of simple governance. The President has to revisit and rewrite the mass of executive orders and memos. The Congress has to get serious and pass laws that are actually laws, not thousand page instructions for agencies to figure things out. It has to get around to repealing laws everyone understands are bad — the Jones act restricting shipping, the ban on oil exports, and so on — and reforming laws that everyone understands need to be reformed. It needs to actually follow its own budget law. The heads of agencies will have to renew the staff and reorient them to growth-oriented policy, and undertake a sweeping house-cleaning of regulations and procedures. They will have to implement managerial techniques such as pervasive cost-benefit analysis, regular retrospective review, and sunsets.
I was so tempted to go snarky and ask what are the microfoundations of the weeds in the garden model of economic growth? Noah Smith did the heavy lifting for us:
Most of the so-called growth policies Cochrane and other conservatives propose don't really target growth at all, just short-term efficiency. By pretending that one-shot efficiency boosts will increase long-term sustainable growth, Cochrane effectively executes a bait-and-switch.
Brad DeLong notes Cochrane is up to his old tricks:
Sclerotic growth is America’s overriding economic problem. From 1950 to 2000, the U.S. economy grew at an average rate of 3.5% annually. Since 2000, it has grown at half that rate—1.76%. Even in the years since the bottom of the great recession in 2009, which should have been a time of fast catch-up growth, the economy has only grown at 2%. Last week’s 0.5% GDP report is merely the latest Groundhog Day repetition of dashed hopes…The third camp (mine) holds that the U.S. economy is simply overrun by an out-of-control and increasingly politicized regulatory state. If it takes years to get the permits to start projects and mountains of paper to hire people, if every step risks a new criminal investigation, people don’t invest, hire or innovate. The U.S. needs simple, common-sense, Adam Smith policies. America is middle-aged and overweight. The first camp says, well, that’s nature, stop complaining. The second camp looks for the latest miracle diet—try the 10-day detox cleanse! The third camp says get back to the tried, true and sometimes painful: eat right and exercise.
I guess we will eat healthy foods from that garden once we remove the weeds. Brad complains that a Cochrane chart of per capita income and some “ease of doing business” index is “Extraordinarily Unprofessional!” I was about to comment – where are the microfoundations but someone beat me to this again.

Prayer - Science = 0

Yes, it’s okay to talk about climate change right now. The devastating natural disaster in Fort McMurray is "consistent" with climate change.


The Fort Mac wildfire is horrific. Miraculously, no people have been killed. Saying that the unseasonably hot conditions in Alberta are "consistent with" climate change is not to say that they are "caused by" anthropogenic global warming. But there is no jurisprudential rationale here for requiring that guilt be established beyond a reasonable doubt. On the contrary, the precautionary principle is the appropriate standard for evaluating the possible connection. 

A lot of people go on social media to offer their prayers for the people affected by the disaster. There's nothing wrong with that. But what gets the Sandwichman's goat are the sanctimonious edicts against "politicizing" the disaster by mentioning the connection to climate change. "Now is not the time." And if not now, when?


Tuesday, May 3, 2016

Does Kevin Williamson Understand Keynesian Economics?

On July 12, 2003, Kevin Williamson wrote:
Draconian cuts. Indeed. This is all very good, and it deserves to become law. But it also offers a dramatic illustration of how difficult it is to cut spending without cutting the areas where the spending actually happens. This may be a minuscule cut in terms of overall federal spending.. That is why spending reductions on those kinds of programs are never really enough: You have to eliminate the program entirely. Conservative populists sometimes get mocked for promising to cut entire cabinet agencies, but, in the long term, that is the most promising model for achieving a healthy fiscal balance. Obligatory reminder: None of this matters very much without entitlement reform and controls on defense spending. Non-defense discretionary spending, i.e. the stuff everybody promises to cut or cap, is a small part of federal spending.
In other words, Williamson was pushing fiscal austerity hard. On May 1, 2016, he wrote:
President Obama’s term in office was preceded by a housing crisis and a subsequent recession for which he was as much to blame as anyone then in government — which is to say, not very much….President Obama insists — straight-facedly — that in the context of a wrenching financial crisis, the United States under his leadership performed better than any major economy in modern history. That isn’t even close to being true, of course. Obama’s presidency will coincide with a remarkably weak recovery, with GDP essentially treading water. His presidency will be the first in modern times to fail to coincide with at least one year of 3 percent economic growth.
I will turn the microphone over to Jonathan Chait and then return:
Williamson does not acknowledge the source of Obama’s claim. To be sure, the Reinhart-Rogoff finding is not gospel, but Williamson does not provide any argument against it or even provide any indication he has heard of it. Nor does Williamson provide any evidence to contradict Obama’s conclusion. Refuting the claim that the U.S. has outperformed other economies that have emerged from a financial crisis would mean naming one or more economies that have undergone a financial crisis and then enjoyed faster growth than the U.S. has since 2008. Williamson does not do so. Instead, he compares Obama’s recovery to previous recoveries from nonfinancial recessions. (And the metric he picks — whether or not the economic exceeded 3 percent growth in a single year — is ludicrously cherry-picked, as if a recovery is measured by the growth rate in its best single year, to count George W. Bush’s historically anemic economy as a success.) This follows Williamson’s assertion that Obama’s claim is false “of course” — apparently it is so obvious he needn’t bother providing even a single piece of relevant evidence against it. Update: I didn't even notice this on my first pass, but Williamson uses the term "fiscal crisis" when he means "financial crisis." A fiscal crisis is related to a country's government budget. A financial crisis is related to a country's financial system. These are completely different things.
Part of Williamson’s argument was that fiscal policy choices have little to do with the growth rate of the economy. And yet most economists blame the weakness in the U.S. economic recovery on the state and local fiscal austerity that led to an overall fall in real government purchases after 2010. Had Williamson had his way – we would have also had massive Federal austerity. In other words, Williamson had his way, our economy would likely be as bad as Europe’s.

Monday, May 2, 2016

Joan Robinson and Beggar Thy Neighbor Policies

Many thanks to Barkley for his tribute to Joan Robinson, which included this interesting line:
In 1937 she wrote her influential essay on "Beggar thy neighbour policies," which made the concept associated with competitive devaluations widely known, although the term had appeared before previously, used once by Adam Smith and also by a British economist named Gower in 1932.
Her critique is part of Part III of her Essays in the Theory of Employment. She goes beyond calling competitive devaluations a zero sum game by suggesting that they might raise interest rates, which would worsen a global depression. I’m not sure I entirely agree. Ben Bernanke recently noted:
Competitive depreciation became a contentious issue during the Great Depression. During the 1930s, the international gold standard collapsed, but it did so in a staggered way, with countries abandoning the gold standard at different times. The currencies of countries that left gold relatively early (like Great Britain, in 1931) depreciated relative to the currencies of countries that stuck with gold longer (like France, which left gold in 1936). The economies of countries that left gold earlier were also seen to recover more quickly from the ravages of the Depression. Some economists of the period, such as Joan Robinson of the University of Cambridge, argued that the recovering countries were doing so primarily through “beggar-thy-neighbor” policies of undercutting other nations in export markets.[1] In modern lingo, they were saying that depreciation was a zero sum game; gains for one country came only at the expense of other countries. However, over time, the recovery from the Depression became global, even as nations’ export shares and currency values stabilized. What was not adequately appreciated by Robinson and her contemporaries was that a country’s abandonment of the gold standard did more than affect the value of its currency: It also freed the country to use more expansionary monetary policies, which increased demand and incomes at home. The increases in total demand, for both domestic and foreign goods, served to promote recovery in output and trade in all countries, ultimately proving far more important than the temporary trade diversions created by changes in exchange rates. In other words, the monetary easings that followed the collapse of the gold standard amounted to a positive sum game.
Of course we are no longer on a gold standard even if Ted Cruz wants us to return to one. Bernanke had much more to say about these issues. Given that the 2016 campaign has revived populist notions of using trade protection in an attempt to shift the burden of weak aggregate demand from one nation upon another, we have another reason to consider the considerable contributions of Joan Robinson.

The Legacy of Joan Robinson

Over a week ago Joan Robinson came up in connection with the ongoing controversy over Gerald Friedman's analysis of Bernie Sanders's economic plan.  When criticized for apparent problems with it he declared that those who understand what he is doing are "Joan Robinson economists."  In going after him, Justin Wolfers ridiculed him for this, referring to such people as a "sub-tribe of Keynesians," which is not inaccurate, but somehow comes across as very sneery.  Noah Smith took this up, declaring that this was the coup de grace by Wolfers, and a commenter on his thread, "Britonomist," dismissed Robinson as someone who admired the North Korean economy, "maybe the worst economy ever in the world," with Noah thanking him for this piece of information.  I made some comments on this there, with pgl picking up on this for some further discussion.  Other than to note the reasonableness of  Peter Dorman's request for  Friedman to provide his model publicly for people to figure out what he is doing (which is becoming less and less important as Bernie's chances of getting the nomination seem to be approaching epsilon), I have no comments on all of that contretemps.  Rather, on thinking about it I shall  return to Joan Robinson and talk about her and her legacy for modern economics, given that various people have been using her name in vain.

Joan Violet Maurice Robinson (1903-1983) was without doubt the most important woman economist born before 1930 and maybe still the most important woman economist ever.  While she would end her days as a radical leftist, she came out of an elite background, her father a baronet and a major general in the British army in WW I, with her maternal grandfather a famous surgeon who taught at Cambridge University and one of maternal uncles a polymath who advised Winston Churchill.  She was close to her father, who was forced to resign from the British army near the end of WW I for publicly reporting on misconduct by the government in managing the war.  In his final years until his death in 1951 he lived with his daughter in her half of the house she shared with her husband, E.A.G. (Austin) Robinson, whom she married in 1925, who himself was an important Keynesian economist, adviser of the British government, and founder of the International Economic Association, with them producing two daughters.  A story I have from a primary witness is that she had a graduate seminar in her half of the house, and one time there was an unpleasant odor there.  The participants realized that her father was sitting in a chair in the room dead.

While she nearly got a Nobel Prize, and certainly deserved one, she suffered professionally from being a woman.  She was only appointed a Lecturer at Cambridge in 1937, well after she had already published several highly innovative and influential  works.  She was only made a Full Professor at Girton College at Cambridge University (which she had attended) in 1965, the year her husband retired from his professorship.  Rumor has it that she came closest to receiving the Nobel  Prize in 1975, the year Kantorovich and Koopmans got it for linear programming (which created a major stink among mathematicians who said that at a minimum George Dantzig should have shared it).  I do not know if she was thought of as a possible third for them or a replacement for them, perhaps with Piero Sraffa sharing, who also never got one while arguably deserving it, who could have shared it credibly with Leontief in 1973 for input-ouput analysis.  The Encyclopedia Britannica reports that her leftwing political views may have played a role in her not getting it.  I also heard it from a primary source that Assar Lindbeck, the committee's dominant figure then, once said that if either Joan Robinson or James Buchanan got it, it would be over his dead body, although  Buchanan did get it in 1986, with Lindbeck still on the committee and not dead, although Joan Robinson had  been dead for three years by then.

As evidence that she was clearly in contention in the mid-70s, I shall report something I observed on an elevator in the New York Hilton during the 1973 AEA meetings (the first I ever attended).  Lionel McKenzie, another who never got the prize but should have, was talking to somebody else.  McKenzie told this other person that "they are going to give it to Joan Robinson next for her Economics of Imperfect Competition, but she will refuse it."  As it was, she never got the chance to do so.

 Speaking of that 1933 book, that was her first major publication and remains one of her most important, indeed worthy of a trip to  Stockholm in and of itself.  Among other things in it, she invented the word "monopsony."  While she later wrote less about monopolistic competition, one can see that it remained very much on her mind if one reads her excellent 1977 article in the JEL, "What are the Questions?" a good overview of how she viewed economics near the end of her life.  She spends quite a bit of it going on about the issue of monopoly power and its importance.  I note that this is one area where her concerns are very relevant to current economics, with many now posing that increased monopoly power in the US economy may be playing a role in secular stagnation.

She was indeed a core Keynesian, one of the three people thanked by Keynes himself in the Preface to his 1936 General Theory.  She also supported Kalecki, whom Keynes had in to  Cambridge, but by all accounts did not like.  In 1937 she wrote her influential essay on "Beggar thy neighbour policies," which made the concept associated with competitive devaluations widely known, although the term had appeared before previously, used once by Adam Smith and also by a British economist named Gower in 1932.

In 1941 she published her famous Essay on Marxian Economics, in which she rejected the labor theory of value and basically supported redoing Marx along Keynesian and Sraffian lines.  She would indeed later praise both Maoist China and North Korea, but saw China in particular  as possibly offering another way of modifying Marx along useful lines.  However, Robinson was always known for her pithy remarks, and one from that era was "There is only one thing worse than being exploited, and that is not being exploited" (that is, unemployed).

The 1950s may have seen the high water mark of her work.  She set off the Cambridge  capital theory debates with her 1954 paper in the Review of Economic Studies, "The production function and the theory of capital," in which she took apart the idea of aggregate capital, with Paul Samuelson in 1966 agreeing that she was right.  The first time I ever met Samuelson (in the early 70s) I gave him a hard time about this issue, and he just completely agreed with her and said that capital must be modeled as being heterogeneous.  One of the more hidden but very important roles she played in the 1950s was to work on Piero Sraffa to finally complete his short, but important, 1960 book, Production of Commodities by Commodities: A Prelude to a Critique of Economic Theory.  He had been working on it for 35 years, but it was still only a prelude to a critique, not a critique itselfn.  Samuelson claimed that if he had published it in 1930, he would indeed have shared the Nobel Prize with Leontief.

In 1956 she published what is probably her magnum opus, although now widely ignored, The Accumulation of Capital, which in contrast to her later critiques of analytical equilibrium analysis in favor of looking at "historical time," was in fact a study of various equilibrium growth models, many of  which she provided amusing names  for such as "bastard golden age" and "creeping platinum age."  She did not generally use formal equations but rather favored figures and graphs backed up by clear verbal descriptions and discussions.  Apparently in 1949 Koopmans asked her to be on the board of the Econometric Society, but she refused on the grounds that she did not want to be part of something that produced things she could not read.  After 1960 her work increasingly moved towards more methodological issues, such as her 1962 Economic Philosophy, as well as work looking at development issues, especially in India, but also her highly controversial work on China and North Korea.

I commented on the China and North Korea matters in the linked-to threads from Noah and pgl, but I shall repeat some major points here.  Regarding North Korea, she visited there in 1964.  She accurately reported that its economy was performing much better than that of South Korea, which many now may not believe, but was true,with a real per capita income probably twice that in the South.  What happened was that the South did not grow after the Korean War in the 1950s under the corrupt Syngman Rhee.  It took off after he was overthrown by the military dictator Park Chung Hee (whose daughter is currently the president in the South), who instituted a strong indicative planning drive run through state-owned banks until  he was assassinated in 1979.  During the 1950s the North Koreans had  successfully followed a Stalin-style command centrally planned forced industrialization, which had resulted in impressive results by 1964.  While it continued to grow for some time after that, the South began to catch up, surpassed it in the early 1970s, and, of course, today is far ahead of the now seriously impoverished North, although it has been able to produce nuclear  weapons.  In 1977, in a single paragraph, she predicted the North would absorb the South. She may not yet have become aware that the South was ahead of the North in per capita income, but she may have been more influenced by the absorption of South Vietnam by North Vietnam only two years earlier in 1975.  She was not completely out of it on her observations of the Koreas.

She can be more sharply criticized regarding her views of China, regarding which she wrote a book defending the cultural revolution.  Apparently before  she died she pulled back on some of her admiration for Mao, but this is clearly an area that one can criticize her political and economic views more than on her observations on the Koreas, where indeed North Korea really was ahead of South Korea when she made her most detailed study of them. But she wrote much more about China than about the Koreas, visiting there on several occasions, although she visited India many more times.

The final, and maybe most important, influence of Joan Robinson today is on Post Keynesian economics, or post-Keynesian economics, with her preferring this latter spelling, the British version.  Indeed, although I cannot  prove it, I have heard it that she was the one who  coined this term, as she did so many others.  That there are two spellings is due to Paul Samuelson also using this term with her spelling to describe what we now call his "neoclassical synthesis," with him referring to "post-Keynesian eclecticism," which supposedly represented his position.  When American Post Keynesians got seriously going in the 1970s, led by Paul Davidson who founded the Journal of Post Keynesian Economics,they favored that spelling to distinguish themselves from Samuelson's formulation, which the British and other non-Americans were never bothered by. In any case, Joan Robinson is widely viewed as perhaps the founder of the movement, varied and eclectic as it is today, or at least the godmother and main inspiration of the movement.  But I  note that it has many sub-varieties, with the Wikipedia entry on it having a curious "family tree" that has 8 different boxes: Keynes's inner circle (which included  Robinson and her husband), Cambridge Keynesians (which also  included Robinson), early North American Post Keynesians, Kaleckians, Sraffians, Fundamentalists, Kaldorians (I show up on that list), and Modern Monetary, with some other lists adding Institutionalists, and with some people loosely on the tree but not in any box or founding one such as Keynes himself, Richard Goodwin, G.L.S. Shackle, and Hyman Minsky (who always claimed he was not a a "Post Keynesian"), along with some others.

So when Gerald Friedman wrote of "Joan Robinson economists," I think that he had in mind the general current set of Post (or post-) Keynesian schools, even if he may or may not have been thinking about any particular one.  I note that Bernie Sanders's top economic adviser on his Senate committee is Stephanie Kelton, on leave from UMKC, who is allied with the modern monetary (not to be confused with the "new monetarist") school, one of those listed in the Wikipedia family tree (and she is in that box there).  But I know that many others like  Bernie Sanders, and most think well of Joan Robinosn, even if they may not all necessarily agree with Gerald Friedman's analysis.  But then again, as Peter Dorman has noted, we have not yet actually seen his model, so one can think what one wants, I guess.  But clearly various aspects of Joan Robinson's thought and career are both relevant and currently influencing many economists today, including many who have never heard of  her through some of her ideas simply entering into basic textbooks, such as "monopsony."

Barkley Rosser

Note on 5/3/16:  Upon further checking while Joan Robinson did discuss golden ages in her The Accumulation of Capital, it was only in the later Essays in the Theory of Economic Growth, 1965, that she expounded most fully on the theories of bastard golden ages and creeping platinum ages, although apparently she initially wrote about them prior to that book.  Also, just for the record, she did use equations from time to time, if only sparingly.

Saturday, April 30, 2016

Revenue Neutral. Politically Neutered.

Yesterday I was asked to write a comment on the debate over initiative I-732 in Washington State which would establish a revenue-neutral carbon tax, and I wrote several paragraphs.  Today, after sleeping on it, I realize there is a simple point to be made.

Here’s the background: The Washington initiative is loosely modeled on British Columbia’s carbon tax.  It would cover about 3/4 of the economy, taxing carbon at $25/ton.  Revenues would be offset by eliminating the main business tax, shaving the state sales tax by a point, and increasing low income tax rebates.  A group, Carbon Washington, was formed to promote it.  Meanwhile, another group, the Alliance for Jobs and Clean Energy, bringing together unions, social justice activists and more militant environmentalists, has publicly opposed the initiative.  They demand that revenues be funneled into social service programs and public investment.  The rhetoric has been heated; I attended a talk the other day in which supporters of I-732 were described as racists.

I have serious problems with the Alliance position, but I’ll put that aside for now.  Let’s talk about this “revenue neutral” thing.  Why would someone want a carbon tax to be revenue neutral, especially in a state with serious fiscal constraints like Washington?  I can think of two reasons.  First, it telegraphs to conservatives that there is nothing “big government” about the proposal: you can vote for the initiative while swearing on a stack of Road to Serfdom’s.  Second, it’s what results when you rebate the money.  The publicity of Carbon Washington has trumpeted both of these.

The first argument is a loser.  (1) The number of conservatives who believe climate change is a serious problem that requires government action but will only support a proposal if it leaves the size of government precisely unchanged is vanishingly small.  This is a political concession without an upside.  (2)  Meanwhile, by catering to the small government crowd, Carbon Washington has deeply alienated almost the entire left side of the political spectrum—the natural base for a vibrant climate movement.  Using carbon money to eliminate a business tax doesn’t help matters, and the formula used for tax offsets opens the door to the possibility that the system will be revenue negative in some years.

The second argument gets it backward.  It’s true that rebating the carbon money will result in revenue neutrality (or something close to it), but it’s the rebate, not the neutrality, that matters.  Putting a price on carbon, whether through taxes or auctioned permits, transfers money from the pockets of consumers to the government.  This is regressive, since it’s effectively a sales tax, one that low income people can hardly avoid.  But rebating the money is a second transfer, from the government back to the people.  The point of a well-designed rebate, like an equal per capita dividend, is that the combined system with both transfers is progressive, contributing to greater equality at a time when equality is in very short supply.  From a political perspective, you want to be able to argue this.  Revenue neutrality is only a means toward this end; why would you make that your selling point?  Lots of government handout schemes could be revenue neutral, but what people presumably care about is whether the overall revenue system is fair.

Conclusion: drop this revenue neutrality nonsense.  Propose carbon pricing systems that promote equality.  Don’t take the side of the ideological enemies of public action.  Return carbon money for social justice, not because there is some intrinsic value in keeping revenues just where they are.

Friday, April 29, 2016

Carbon Politics

I’ve always appreciated David Roberts’ voice in debates about climate policy.  He reads widely, looks for the strong points of arguments he otherwise disagrees with, and is open to changing his mind.  Even now, when I think he’s been substantially captured by a particularly blinkered stream within the climate change policy world, he’s still worth looking at.  Alas, however, his drift toward the Breakthrough Institute view of things is nearly complete.

It would take a book or more to explain why it won’t be possible to simply regulate, subsidize and innovate our way to climate stability.  (I’m writing it now in fact.)  Let’s skip over all that stuff for now.  Here I’d like to say a few words about the politics of climate policy.

Begin with DR’s position in a nutshell: Climate policy is constrained by public acceptance as revealed by polling and other empirical indicators.  The public will not support a price on carbon sufficient to achieve meaningful emissions reductions, but it will accept regulations such as fuel economy mandates and shutting down coal plants that are equivalent in their effects to a much stiffer carbon price.  Public opinion is even more of a constraint given the expectation that the fossil fuel industry will strenuously oppose any serious policy initiative at all: you need a lot of political approval to counterbalance them.  To the extent there is a political upside to carbon pricing it comes from the additional revenues it generates, which can be earmarked for popular spending programs on energy R&D and infrastructure.  These have the potential to create their own constituency, which will provide a political base for further climate action in the long run.

Full disclosure: he makes his case partly in response to a posting of short briefing papers by the Scholars Strategy Network (SSN), one of which is mine.  You may discount my reactions accordingly.

Anyway, I think there are two big holes in DR’s critique.  The first is that he doesn’t measure policy against its purpose.  If the goal is climate stabilization—and what else would it be?—the benchmark is the IPCC’s carbon budget for a 2/3 chance of keeping global temperature increases to 2º C or less.  That translates to roughly a 4% decline in global carbon emissions every year from now to the complete phaseout of fossil fuels.  (Delay makes the job harder, of course.)  For political and equity reasons, richer countries will need to cut even more, and the US, with its outsized per capita emissions, will need to cut more than that: an annual 8% cut is in the ballpark.  Now, I can hear DR’s voice in my ear.  You’re completely nuts.  This is so far beyond the bounds of political feasibility it’s a form of mental illness, not policy analysis.  I’d agree, except that the numbers are not a matter of choice—they’re dictated by the physics, chemistry and biology of the problem and the laws of arithmetic.  We’re a lot more likely to find unanticipated flexibility in politics than in the science of climate sensitivity.  From where I sit, DR’s position is the one that has issues with the reality principle.

That brings us to the second hole, the political system itself and its implications for what kinds of policies are feasible.  The implicit assumption behind DR’s piece is that we live in a democratic society where public opinion determines political outcomes: the more support there is for a policy, the more likely it is to be adopted.  Visually, he has in mind something like this:


Public support, as measured by polling, is on the horizontal axis; high carbon prices with revenue rebates are on the left with small minorities backing them, while low prices coupled with spending on green energy get majority approval.  The prospects for being adopted are represented by the vertical axis, and the upward-sloping line tells us that the more support a policy has, the better its chances of being enacted.

Would that it were so.

Now here instead are three diagrams from the groundbreaking study by Gilens and Page based on a database of 1779 policy initiatives they have assembled and analyzed.  The first is the relationship between public support at the median income level and the probability of adoption—flatland.


For the vast majority of the citizenry, it doesn’t matter what they think.  Of course, political popularity can make or break the careers of politicians, and that’s not a trivial effect, but the record of policy adoption moves independently from the electoral ups and downs of parties and politicians.  There is no democratic machinery in the US (or I suspect other large, wealthy countries) that converts the popularity of a proposal into prospects for enactment.

The second diagram illustrates what democracy looks like, but it applies only to the preferences of voters at the 90th percentile, which Gilens and Page take as representative of “elites”.  Their preferences do get translated into outcomes.


The third is interesting; it represents the relationship between political mobilization around an issue, as reflected in the formation of pressure groups and their lobbying and similar activities, and the probability that the issue will be decided their way.


Collective action works!  The problem is that mobilization requires resources, and resources are concentrated in a few hands.  But not always: Gilens and Page find that when bottom-up issue groups come together they can be just as effective as the top-down variety.

What does this all mean for climate policy?  First, that the absence of widespread public support for various policy initiatives is not a constraint, just as its presence would not be a basis for success.  (I suspect that public support for a policy tends to increase after its adoption, in a sense providing democratic justification ex post, but I don’t know of any empirical evidence on this one way or the other.)  By comparison, the move to privatize public education has gained considerable ground in the US without any indication of broad public support.  Elite preferences really do matter more.

Second, what really matters is the development of a dedicated mass movement for serious climate policy.  We can see it beginning to come together, but it still has a long way to go.  I think Theda Skocpol nailed it in her meticulous analysis of the failure of cap-and-trade in 2009: opinion polls, like votes in Congress, is more an effect than a cause of political action, and to get the job done that action needs to maximize citizen mobilization.  This model is in the background of my own paper on the SSN website, which is about overcoming the disagreement over the use of carbon revenues that currently impedes the development of a unified movement in Washington State.

In the grand scheme of things, DR occupies one end of the political optimism spectrum, where the existing political framework sets unbudgeable limits to what can be accomplished, a position I’ve referred to earlier as the politics of futility.  The other end is the pure willfulness of some portions of the left, for whom, if policies fall short, it can only be due to not enough of us wanting them badly enough—a shortfall of spirit.  In between is a large realm of empirically guided, pragmatic radicalism, keeping one eye on the world as it is today and the other on the prize.  I think DR used to be in this space, and he’s welcome back whenever he decides to rejoin it.

Wednesday, April 27, 2016

Incidence of the Soda Tax

Paul Krugman comments on an interesting debate between Bernie Sanders and Hillary Clinton:
So Sanders and Clinton are arguing about soda taxes — Clinton for, as a way to raise money for good stuff while discouraging self-destructive behavior, Sanders against, because regressive.
Let’s concede the presumption that low income households spend a greater share of their limited income on Coca Cola than high income households but take a look at the incidence of a tax:
A tax incidence is an economic term for the division of a tax burden between buyers and sellers. Tax incidence is related to the price elasticity of supply and demand. When supply is more elastic than demand, the tax burden falls on the buyers. If demand is more elastic than supply, producers will bear the cost of the tax.
Of course this is the standard competitive model. Let’s assume such a model with a horizontal supply where the marginal cost of making and selling a bottle of Coke is $1. Imposing a tax equal to $0.20 per bottle will raise the price of a bottle of Coke to $1.20 a bottle with the full incidence on consumers. One could argue, however, that Coca Cola is closer to a monopoly. Let’s imagine in your town that the demand for soda is given by P = a – b(Q), where P = price, Q = quantity, a = 3, and b = 0.01. The competitive market solution puts the price before new tax at $1 and Q = 200. But if Coca Cola has a monopoly, then it raises the price to $2 by reducing Q to 100. In this monopoly model, a $0.20 tax raises the price from $2 to $2.10. In other words, part of the incidence of the soda tax would be borne out of profits rather than simply from consumers. Of course, I’m assuming a simple monopoly model with a linear demand curve. I’ll leave this question of who bears the actual incidence of a soda tax for the capable economists on either Team Bernie or Team Hillary.

Tuesday, April 26, 2016

Could A Higher Minimum Wage Increase Employment?

One of the debates among the Democrats is how much to raise the minimum wage. The President wants it near $10 an hour, Mrs. Clinton is talking about $12, while Bernie Sanders and others are saying $15. Of course Team Republican freaks out as to how any increase in this wage floor will cause job losses. As David Henderson noted:
As is well known in economics, a skillfully set minimum wage, in the presence of monopsony in the labor market, can actually increase employment…To say that a firm has monopsony power is to say that the supply curve of labor to the firm is upward-sloping. That is, the firm is not a price-taker in the labor market. So when the firm that employs n workers and pays Wn per worker wants to hire one additional worker, it needs to pay more to each worker than it paid when it hired n workers. Call this new wage Wn + x. But that means that the cost of hiring that n + 1st worker is not the wage, Wn + x, that the firm pays the worker: it's that wage, Wn + x, plus x times n. The reason: it pays all the other n workers that increment, x, also. Because the firm recognizes this, it hires up to the point where the value of marginal product = Wn + x + x*n. Now, if the government skillfully sets a minimum wage a little above Wn + x, the firm knows that it can't reduce the wage by hiring fewer people and also knows that it won't raise the wage by hiring a few more people and so it hires more people. The main reason people started talking about monopsony in the context of the minimum wage in the 1990s was the study, and later the book, by David Card and Alan Krueger.
Let’s flesh this out in a hypothetical town called Old Haven – which is loosely based on the one company town where Yale dominates the labor market for certain types of labor. Let’s assume that Old Haven used to have lots of law firms hiring secretaries with the labor demand curve (D) given by c – d(Wage) and the labor supply curve (S) given by a + b(Wage) with a = negative 8000, b = 84,000, c = 1,960,000, and d = 80,000. I have pegged my example such that a perfectly competitive market would have generated a wage rate = $12/hour and employment = 1 million secretaries. One day Old Haven woke up to the horrors of Cellini & Barnes, which basically merged all of its law firms into a monopsonist that wanted to lower the wage rate to $7.94 an hour but realized it had to obey the local minimum wage of $8 an hour. Cellini & Barnes ends up hiring only 664,000 secretaries. The good news is that the local citizens rebelled and decided to pass a minimum wage of $12 an hour, which induced Cellini & Barnes to hire 1 million secretaries. I wonder if such a development would ever lead Mark Perry to write:
Recent evidence from Old Haven’s experiment of raising its minimum wage by 50% has shown that such changes in certain situations can lead to a 50% increase in employment.
Of course, a later proposal might be put on the ballot to raise this minimum wage even further at which point the Wall Street Journal starts going really crazy. Speaking of going crazy - Ed Resner (former McDonald’s CEO) writes:
I can assure you that a $15 minimum wage won’t spell the end of the brand. However it will mean wiping out thousands of entry-level opportunities for people without many other options. The $15 minimum wage demand, which translates to $30,000 a year for a full-time employee, is built upon a fundamental misunderstanding of a restaurant business such as McDonald’s. “They’re making millions while millions can’t pay their bills,” argue the union groups, suggesting there’s plenty of profit left over in corporate coffers to fund a massive pay increase at the bottom. In truth, nearly 90% of McDonald’s locations are independently-owned by franchisees who aren’t making “millions” in profit. Rather, they keep roughly six cents of each sales dollar after paying for food, staff costs, rent and other expenses. Let’s do the math: A typical franchisee sells about $2.6 million worth of burgers, fries, shakes and Happy Meals each year, leaving them with $156,000 in profit. If that franchisee has 15 part-time employees on staff earning minimum wage, a $15 hourly pay requirement eats up three-quarters of their profitability. (In reality, the costs will be much higher, as the company will have to fund raises further up the pay scale.) For some locations, a $15 minimum wage wipes out their entire profit. Recouping those costs isn’t as simple as raising prices. If it were easy to add big price increases to a meal, it would have already been done without a wage hike to trigger it. In the real world, our industry customers are notoriously sensitive to price increases
Arcos Dorados Holdings is the largest franchisee and is publicly traded. While its operating margin is around 6%, it also pays royalties equal to 5% of sales to McDonald’s. It reports payroll expenses equal to about 20% of sales. If it were true that there was no effect on menu prices, then a 50% increase in payroll costs would leave these joint profits at around 1% of sales. But here is the problem with this assumption – the minimum wage increase would apply to the competitors of McDonald’s as well. Higher prices for Whoppers will provide room for a modest price increase in Big Macs.

Monday, April 25, 2016

Is the Road to Hell Paved with Pareto Improvements?

In a large multiplayer prisoner’s dilemma, any change in any one individual’s strategy doesn’t affect anyone else, so a player can know that defection will be a Pareto improvement. We might say that the problem of social evil is that the road to hell is paved with Pareto improvements. -- Ted Poston, “Social Evil,” Oxford Studies in Philosophy of Religion, Volume 5
Poston's "social evil" is what previous authors have called a social trap or, more famously, the tragedy of the commons.

A Pareto improvement is a change that makes at least one person better off without making anyone worse off. According to the standard fable, voluntary exchange results in a Pareto improvement because each party in the exchange gets something they wanted more than what they gave up for it.

A prisoner's dilemma involves a situation where the individual payoff to each player for defection is better, regardless of whether the other player defects or co-operates but the collective payoff is maximized when both players co-operate.

In a large multiplayer prisoner's dilemma game, defection by some players may have no effect on the other players' outcomes, while defection by a large number of players may have catastrophic effects after some vaguely defined tipping point has been reached. Within limits, defections thus appear to result in a Pareto improvement, where some players are made better off and no one is made worse off.

In Fights, Games and Debates, Anatol Rapoport presented a production and exchange model that deserves to be much better known. It is a very elementary model and thus, as Rapoport warns repeatedly, the results should not be taken as a faithful depiction of what is likely to happen in reality. However, it offers some critical insights into "common sense" assumptions and specifically into the idea of Pareto improvement, which is also based on extreme simplification.

Rapoport's production and exchange "society" consists of two people who each produce goods and exchange with each other a uniform, fixed ratio of their products. The individuals derive utility from the goods they produce and, presumably, can increase their utility by exchanging some of the goods they produce for the different goods their counterpart produces.

Effort to produce those goods, however, is a disutility. The utility from goods increases logarithmically as the quantity of goods increases but the disutility of effort increases in proportion to the amount of effort expended.

Agents in this model can only change their utility by increasing or decreasing their own effort and output. Thus, plotted on a graph, X can only move along the x-axis and Y can only move along the y-axis. Under the stipulated conditions, a stable equilibrium can only be achieved when the utility of the proportion retained by each producer is larger than the disutility of effort.That is to say, the proportion retained cannot be too small and the disutility of effort cannot be too large.

In the absence of a stable balance, any relaxation of effort by one of the agents will lead to parasitism by that agent as the other will immediately compensate by increasing effort, the first agent will slack off more to compensate for the increased effort of the other -- and so on.

But even in the presence of a stable equilibrium, the total utility of the two agents, at the balance point, will be less than the total would be without exchange, as long as their production/effort decisions are guided solely by their own utility rather than by some agreement about how to link their production effort to achieve a "social optimum." This outcome is contrary to the "common sense" interpretations of Pareto improvement and Pareto optimality. As Rapoport cites his mentor, Nicolas Rashevsky, it turns out that:
The only 'ethics' which leads to the attainment of maximum joint utility in the model of society we have considered is the 'egalitarian ethic,' in which the concern for self and for other are of equal weight.
It would be easy to dismiss Rapoport's conclusion as pertaining only to very restrictive premises. This is a point that Rapoport reiterates throughout his exposition. But the objection applies equally to Pareto's model.

Vilfredo Pareto is not readily perceived as a proponent of the egalitarian ethic. In his model, though, Rapoport unpacked a tacit premise of Pareto that rational agents would act "as if" guided by some unacknowledged intuition of linkage -- one might even call this invisible intuition "moral sentiments."

Furthermore, the restrictiveness of Rapoport's assumptions may not be as unrealistic as it seems at first. The fixed ratios of exchange can be relaxed to merely widespread similarities in the ratios of exchange. The specification for a stable equilibrium that the proportion of an individual's product exchanged does not exceed the proportion retained can be rationalized by the fact that there is a roughly equal number of hours of unpaid household work performed in the world as there are waged hours of labor. All this is before we move on to the issue of "multiplayer games" -- of a society in which individual actions that ostensively do no harm may accumulate into "social evil."

In Beyond the Invisible Hand, Kaushik Basu examined the issue of outlawing yellow dog contracts, as the Norris-LaGuardia Act did in 1932:
It could he claimed that if one worker prefers to give up the right to join trade unions in order to get a certain job that demands this of workers, then this may be a Pareto improvement. But if such yellow dog contracts are made legal, then lots of firms will offer these contracts, and the terms for jobs without a yellow dog clause may deteriorate so much that those who are strongly averse to giving up the right to join unions will he worse off in this world. 
Basu proceeds to consider labor standards in cases in which there are multiple equilibria. He asks, "Should the law be used to set a limit on the number of hours that a worker is allowed to work?" His answer -- backed by reference to supporting empirical studies -- would earn the scorn of economists who fancy a lump of labor behind every proposal for shorter hours:
A statutory limit on work hours can, by limiting the supply of labor, push up the hourly wage rate, and it is possible that at this higher wage rate people would not want to work that many hours. In other words, the labor market may have two or more equilibria, in which case banning the long work-hours equilibrium is fully compatible with a commitment to the Pareto principle.
Unpacking Pareto optimality and Pareto improvement, as Rapoport's model of production and exchange does, undermines the premise of the road to hell being paved with Pareto improvements. If there is indeed a tacit moral sentiment, a secret egalitarian ethics at the heart of the Paretian idea, then any violation of trust will impose a loss of utility on everyone else -- perhaps even on the violator. Those individuals gains through defecting were only "improvements" assuming an ethical vacuum. What is the point of building a road to a hell when one is already there? In an ethical world, violations of trust are losses of utility.

UPDATE: I have made a pdf copy of the section on the production and exchange model in Rapoport's Fights, Games and Debates. Below is the equation for the utilities of the two members of the society:
In "An Empirical Refutation of Pareto-optimality?" Rupert Read argued that the empirical evidence in Wilkinson and Pickett's The Spirit Level suggests "the remarkable normative conclusion of making the Pareto principle, far from the “conservative” device it is often taken to be, a potential agent of radically-egalitarian/socialist distributive justice." I am arguing here that Rapoport's production and exchange model suggest a mathematical demonstration of the same unexpected conclusion. 

On Those Clueless Establishment Economists and Free Trade

I was curious what Bernie Sanders meant on Meet the Press yesterday with his line about how it was too late for “establishment economists”. I have never heard of Michael Stumo and I bet neither has Team Bernie. But this claim struck me as silly:
Establishment economists will defend to the death the idea that trade does not destroy jobs. Yes, I’m serious. They believe that. Really. Instead, they say, job losers move into other jobs so there is no net job loss.
He goes onto to bash TPP which is not more about protecting patents and less about free trade. But his new research is a great paper by David Autor, David Dorn, and Gordon Hanson:
Adjustment in local labor markets [after trade liberalization] is remarkably slow, with wages and labor-force participation rates remaining depressed and unemployment rates remaining elevated for at least a full decade after the China trade shock commences. Exposed worker experience greater job churning and reduced lifetime income. At the national level, employment has fallen in U.S. industries more exposed to import competition, as expected, but offsetting employment gains in other industries have yet to materialize.
Autor, Dorn, and Hanson are confirming what anyone familiar with the Stopler-Samuelson theorem would have predicted. Even if these workers found another job – their real wages would fall by more than the price of goods at Wal-Mart. I have no clue who establishment economics may be but those of us who studied international economics were not surprised by these research results. Incidentally this version has a picture that includes Paul Krugman as if he does not understand the Stopler-Samuelson proposition. C’mon man!

Sunday, April 24, 2016

Hysteresis and 9/11

Noah Smith says I got mad at Gerald Friedman. What makes me mad are cheap shots like this:
Honestly why would anyone positively cite Joan Robinson - she literally endorsed the economy of North Korea
In the 1970’s, there were very few women graduate students seeking Ph.Ds in economics. One of my professors suggested we need more role models like Joan Robinson. I would say his office made me think of what libraries must have looked like in the 19th century except for the fact that it was dominated by papers by Dr. Robinson. She may have been very liberal but she was also a first rate economist. Her The Economics of Imperfect Competition for example should be required reading for all Econ 101ers. But let me get straight to the point by asking what Brad DeLong meant here:
These are principal causes of "hysteresis". I do not believe that the output gap is the zero that the Federal Reserve currently thinks it is. But it is very unlikely to be anywhere near the 12% of GDP needed to support 4%/year real growth through demand along over the next two presidential terms. We could bend the potential growth curve upward slowly and gradually through policies that boosted investment and boosted the rate of innovation. But it would be very difficult indeed to make up all the potential output-growth ground that we have failed to gain during the past decade of the years that the locust hath eaten
The comments from JW Mason to my post indicate a couple of things. He is mad at me and he is also interpreting these lines differently than I do. I will offer an analogy to what Brad was saying that goes back to the fall of 2001, which was very painful for residents of New York City. I bet a lot of my neighbors on the morning of September 12, 2001 wishes they had Brad’s “magic wand” so it would be September 10 with the Twin Towers still standing and those 3000 lost souls still alive. Maybe it was the home run from Mike Piazza but many New Yorkers quickly wanted the rebuilding of the World Trade Center to start very soon. Sure it would take time but then again we had a 1.8% output gap at the end of 2001 according to even perhaps a conservative CBO estimate. And many of us were angry that the politicians took so long to get this rebuilding started. But we did and the World Trade Center is rebuilt. And in the current economy, many of us are saying we need to rebuild the subway system, Penn Station, and even our airports. My complaint with Friedman as well as Mason is that they are claiming liberal economists argue we are at full employment and should not be doing fiscal stimulus. Here is one of JW’s examples:
LMGTFY: http://www.bradford-delong.com/2016/02/no-we-cant-wave-a-magic-demand-wand-now-and-get-the-recovery-we-threw-away-in-2009.html. I'm directly quoting his post. Really, are you incapable of imagining that genuine disagreement is possible on this issue?
This is sad as I have noted that there is disagreement on the size of the output gap with Brad noting it may be bigger than others think. Brad also is arguing that aggregate demand stimulus alone could raise the employment to population ratio to 62.5%. So Brad cannot be one of those liberal economists who is arguing we should not do vigorous fiscal stimulus now. Nor can this charge be levied at Krugman, Stiglitz, or Summers. So who are they referring to? Noah notes:
On Twitter, Mason clarified that when he talks about "the people running the show," he meant the Republicans, not Krugman, the Romers, et al.
OK! Are these folks those “establishment economists”? If JW is referring to Robert Lucas, the term “liberal” is odd. And if the Federal Reserve is listening to Lucas, I will concede this is a big mistake. In my post, my anger was from the blatant misrepresentation of what others have been saying. I was applauding the efforts to enhance the original Gerald Friedman attempt at analysis. I will just say this. If Bernie Sanders does become President, he is going to need a credible economic model even before we sit down at our next Thanksgiving feast. Waiting until a few graduate students present their findings next summer will not be soon enough. But let me get to what I think Noah’s point was:
Friedman and Mason seem to be arguing that our belief about the facts should be driven, at least in part, by our desire to avoid a feeling of powerlessness. They also seem to be saying that if the facts seem to support conservative policies, even a tiny bit, we should reinterpret the facts. I don't like this approach. It seems anti-rationalist to me, and I think that if wonks behave this way, they'll end up recommending lots of bad policies.
This is really a damning comment on the level of that “schlock economics” charge levied at Romer by Lucas. Look – when I was in school, I was told politics is cool. I will admit Bernie Sanders is considered hip, which is fine. Noah is suggesting economists should be nerds, which is likely good advice. Call me a nerd.

Saturday, April 23, 2016

Equus II

Keynes:

Keynesianism: 

Robert Lucas – Keynesian?

What is a Keynesian? My definition is any economist who recognizes that an insufficiency of aggregate demand can lead to what Paul Krugman dubbed PLOGs – prolonged large output gaps. In the late 1970’s a certain class of macroeconomics called the New Classical school decided we Keynesians were witch doctors practicing junk science. This view dominated certain aspects of academia for 30 years. Krugman’s latest drew a lot of comments from the left but there was one odd one that defended what Robert Lucas wrote back in early 2009. This defense got me to re-read those comments, which included this admission from the dean of the New Classical school:
At the end of 2008, U.S. GDP was about 5 percent below trend. People measure trends in different ways, but 2007 wasn't a great year either. The consensus forecast predicts something like 8 percent below trend by the end of this year.
Lucas’s use of “trend” was a bit odd but it is true that the CBO estimate of the output gap at the end of 2008 was 5% and things did get worse in 2009. Some of us are convinced that neither trends nor the CBO is the final word on potential output and I have suggested that 8 years into the Great Recession we still have a 5% output gap. Now that is a PLOG! But let’s give Professor Lucas a little credit for not arguing we never deviate from full employment. His discussion continued by going all Friedman-Schwartz on us as if monetary policy alone could quickly end the output gap. In fact the Bernanke FED did go all Friedman-Schwartz on us with a huge monetary stimulus. Some of us think they should have done more but a lot of the right wing complained it was excessive stimulus. Lucas, however, noted:
I've already said I think what the Fed is now doing is going to be enough to get a reasonably quick recovery committed.
OK – this prediction turned out to be quite wrong. But hindsight is 20/20. Lucas slammed Christina Romer for recommending massive fiscal stimulus. There were two parts of this critique:
But, could we do even better with fiscal stimulus? I just don't see this at all. If the government builds a bridge, and then the Fed prints up some money to pay the bridge builders, that's just a monetary policy. We don't need the bridge to do that. We can print up the same amount of money and buy anything with it. So, the only part of the stimulus package that's stimulating is the monetary part. But, if we do build the bridge by taking tax money away from somebody else, and using that to pay the bridge builder -- the guys who work on the bridge -- then it's just a wash. It has no first-starter effect. There's no reason to expect any stimulation. And, in some sense, there's nothing to apply a multiplier to. (Laughs.) You apply a multiplier to the bridge builders, then you've got to apply the same multiplier with a minus sign to the people you taxed to build the bridge. And then taxing them later isn't going to help, we know that.
I’m not sure why this right wing crowd laughed but one would have hoped Robert Barro might have whispered to Professor Lucas that he just misrepresented the Barro-Ricardian equivalence proposition. Krugman certainly jumped on this nonsense from Lucas:
think about what happens when a family buys a house with a 30-year mortgage. Suppose that the family takes out a $100,000 home loan (I know, it’s hard to find houses that cheap, but I just want a round number). If the house is newly built, that’s $100,000 of spending that takes place in the economy. But the family has also taken on debt, and will presumably spend less because it knows that it has to pay off that debt. But the debt won’t be paid off all at once — and there’s no reason to expect the family to cut its spending right now by $100,000. Its annual mortgage payment will be something like $6,000, so maybe you would expect a fall in spending by $6000; that offsets only a small fraction of the debt-financed purchase. Now notice that this family is very much like the representative household in a Ricardian equivalence economy, reacting to a deficit financed infrastructure project like Lucas’s bridge; in this case the household really does know that today’s spending will reduce its future disposable income. And even so, its reaction involves very little offset to the initial spending.
We needed more fiscal stimulus back in 2009 and we needed to sustain it for longer. We still need a lot of infrastructure investment. In New York City, the good news is that we have decided to spend $4 billion on LaGuardia Airport and another $3 billion on Penn Station. And what we need to spend on our subway system is staggering. But I don’t want to be a selfish New Yorkers here. If there is any concern about deficit spending, let those very rich Republicans on the Upper East Side pay more in taxes to extend the new Second Avenue line to south Manhattan. But let’s get to the part the latest right wing critic of Krugman was noting. Someone asked Lucas the following:
In the last session, we had quite an animated discussion which spilled over into the lunch about models on fiscal multipliers, what they are. On the one extreme, we have models by people like Mark Zandi at Moody's who say that the fiscal multiplier for the spending initiatives we're discussing are on the order of 1.5. On the other hand, we have people like Robert Barro at Harvard who say there's zero or negative. How would you go about applying the Lucas critique to these types of models to sort of educate us in how we should think about the validity of these models?
Lucas replied:
It's her first day on the job and somebody says, you've got to come up with a solution to this -- in defense of this fiscal stimulus, which no one told her what it was going to be, and have it by Monday morning. So she scrambled and came up with these multipliers and now they're kind of -- I don't know. So I don't think anyone really believes. These models have never been discussed or debated in a way that that say -- Ellen McGrattan was talking about the way economists use models this morning. These are kind of schlock economics. Maybe there is some multiplier out there that we could measure well but that's not what that paper does.
Mark Zandi was McCain’s economic adviser in 2008 who had the good sense to tell the Senator we had a Keynesian problem. Of course the Senator failed to listen to his own economic adviser. Lucas was criticizing Dr. Romer for using Zandi’s model. Now we see criticism from the left for her use of this same model. Go figure! But to be fair – his model is probably best tossed into the waste bin given what we know now. Did I say hindsight is 20/20?