Wednesday, October 19, 2016

Do economists have physics envy? (Part 2)

Last year I wrote a post called "Do economists have physics envy?". Historian Philip Mirowski (who I notice also got his econ PhD from Michigan!), who literally wrote the book on the interplay between economics and physics, is not too happy with my post. In a recent interview, he explains why:
Let’s take a recent example of a popular contemporary economist blogger, insisting that economists don’t suffer from physics envy. Instead of looking at the history, or the technical issues involved, he just blurts out some random impressions: economists make more money than physicists (I cannot make this stuff up); an economist can talk about how much progress physicists are likely to make, and get taken seriously, but not vice versa (ditto); economic theorists, traditionally, have been free from the constraints of empirical validation (note the total innocence of the history of empiricism in economics); and that equilibrium means something different in economics than in physics.The level of arrogance combined with parochial ignorance is pretty stunning, but not unusual. He has no conception of the historical track record of the disciplines of economics and physics evolving through time, with earlier points of interaction being masked by later developments, and further waves of strange action at a distance. The result would therefore never appear to contemporaries as strict identity.  
Economists with a tad more sophistication may admit something happened in the 1870s, but they go on to insist that a century and a half of further development has produced a set of doctrines that doesn’t necessarily have anything to do with that heritage. So in a weird sort of way, the more sophisticated modern line is that intellectual origins don’t matter to contemporary doctrines. Your average modern economist thinks history has entirely been banished by the activities of subsequent generations. Actually, I would argue against that; it is more plausible to think that it’s a path-dependent process. Neoclassical economists can’t entirely wish away their origins, and there are a number of times where I try to point that out in the book: for example, the eccentric ways in which the early neoclassicals are totally confused about how to deal with production. Moreover, I think the physics origins really instantiates the central metaphor of a market as if it were a kind of machine that takes stuff from a place it’s not supposed to be and puts it in a place that it deserves to be. That leads to this whole idea of allocation as a special phenomenon, which captures the essence of economics. That’s the way the first three generations of neoclassical economists think, in terms of movement in a commodity space. So for them, trade (exchange) is motion in a commodity space. All of these points comprise a deep inheritance of the early appropriation from physics that is really hard to get away from.
A couple of observations here. First, responses that rely on phrases like "I cannot make this stuff up" and "the level of arrogance combined with parochial ignorance", but fail to substantively address the argument in question, are indicative of a degraded discourse. Sputtering disdain is no substitute for an honest attempt to address someone's points. Of course, there's no reason at all that Mirowski should spend time and effort addressing or rebutting my points...but if he's not going to, at least he might consider ignoring my post completely instead of lobbing some sputtering disdain in my direction and moving on!

But anyway. 

Mirowski's work seems to attempt to answer two questions:

1. "How are physics and economics related historically?"

2. "How do current economic methods reflect the legacy of this historical relation?"

But my post was an attempt to answer a different question:

3. "How do economists currently view the discipline of physics?"

Which was related to a fourth question I didn't directly address, namely:

4. "To what extent do economists look to physics for new ideas nowadays?"

Those aren't the same thing. Regarding question 2, it's obvious to anyone who's studied both econ and physics that there are mathematical similarities between the two (e.g. calculus of variations). As for question 1, it's common knowledge that many economists in the past tried to apply physics ideas to econ. So I would never try to dispute those points. For more specifics on exactly how ideas crossed from physics to econ, and on which of those ideas remain to this day, one should probably check out Mirowski's book (though I hope it's written in a different tone than this interview).

But OK, just because economists did get inspiration from physicists in the past doesn't mean they do now. I've never met or heard of a currently working economist who reads physics papers. I'm sure some are out there, but it would seem to be a rarity. In the past, economists probably got lots of inspiration from physics, but I don't think that seems true anymore. Maybe I'm wrong about that, but I don't think so. That still leaves econ models with a legacy of physics influence (as I notice every time I see a Hamiltonian), but the phenomenon of economists looking to physicists for new ideas doesn't seem very pronounced or significant these days.

Now if that's true - and I'm happy to look at any evidence to the contrary - it leads to the question of "Why?" Why would economists draw less inspiration from physics than they used to?

Some reasons might be sociological. That's what my initial post was about. 

First, if economists don't see physicists as having higher status than themselves, they're less likely to look to physics for ideas about how to make models. And my impression is that modern economists, in general, don't see physicists as anyone that they need to emulate or look up to. In my initial post, I cited 1) money, and 2) popular respect as reasons economists probably no longer see physicists as being higher on the academic food chain than themselves.

Second, if economists value different things in their models than physicists do, there will probably be less impetus to emulate physics. In my initial post, I cited 1) empirical predictive power, and 2) symmetry as two things physicists care a lot about and economists value less (though (1) is changing). Econ and physics are just two different epistemic communities

In addition to sociological reasons for economists to take less inspiration from physics than in days of yore, there are also probably methodological reasons. A lot of modern econ theory is based on game theory. Game theory is not very similar to anything in physics - only a few tentative attempts have been made to connect the two, and generally from the physics side. Nash Equilibrium, as Von Neumann pointed out, is not really the same thing as an equilibrium in a physical system. In fact, some people argue that game theory isn't even part of "neoclassical economics," which is the historical strain of thought that Mirowski studies. 

So what does this all have to do with "physics envy"? The term "physics envy" gets tossed around a lot in public discussions of economics. Some people use it to mean that econ just isn't as good at describing reality as physics. Others use it to imply that economists have a pride and confidence in their discipline that only physicists really deserve. Still others use it in a historical sense, to refer to the links that Mirowski and others have written about. And some use it to imply that economists are just failed physicists. 

But I think most people use it as a simple emotive term, a stock phrase that carries an implication of "econ bad, physics good". Obviously most economists would disagree. Some of that is pure chauvinism, of course, but a lot has to do with the diverging methodologies of the two disciplines. And diverging methodologies come partly from sociology, and partly from the fact that these are just two different sciences attempting to answer two different sets of questions.

Monday, October 17, 2016

David Sloan Wilson's econ critique

There's a new website called Evonomics devoted to critiquing the economics discipline. They've got quite a lot of interesting writers and advisors, including (but not limited to) Paul Krugman, Joe Stiglitz, George Akerlof, Robert Shiller, David Colander, Jonathan Haidt, Yanis Varoufakis, David Sloan Wilson, and many more. The site appears to be attracting a ton of traffic - there's a large appetite out there for critiques of economics.

In any case, I noticed David Sloan Wilson is writing a series of posts criticizing econ as a whole, and I thought I'd go through one of them and see what I thought was right, and what I thought was wrong. Wilson can get a little grandiose, likening the econ profession to the orcs of Mordor and himself to Frodo. But let's look past that and talk about the substance. Here are a few points in Wilson's essay that I don't completely agree with.

Economists were very smart, very powerful, and they spoke a language that I didn’t understand. They won Nobel Prizes...Nevertheless, I had faith that evolution could say something important about the regulatory systems that economists preside over, even if I did not yet know the details. After all, financial markets and other regulatory systems are products of cultural evolution, based on psychological processes that evolved by genetic evolution. 
Like I said a while ago, I'm not as confident that evolution is the key to economics. Wilson has spend his career thinking about evolution, and when you have a hammer, everything looks like a nail. But the analogy between cultural evolution and biological evolution is only a loose one -  nobody yet knows how cultural traits get passed on, or even how to define those traits. And there's no guarantee that the principles involved are similar to those that hold in biology. As for genetic evolution being important for economics, that's possible, but I think the overreach of evolutionary psychology - a field that gets criticized as much as econ itself - should give people pause. So I'd be cautious with the cross-disciplinary analogies. But hey, it's surely worth a shot. I don't want to be a naysayer. Give it a try!

Like the land of Mordor, [econ] is dominated by a single theoretical edifice...The edifice is based upon a conception of human nature that is profoundly false, defying the dictates of common sense, before we even get to the more refined dictates of psychology and evolutionary theory. Yet, efforts to move the theory in the direction of common sense are stubbornly resisted.
I'm not so sure I like the emphasis on common sense.. Science usually places a premium on counterintuitive results, and "counterintuitive" is the opposite of "common sense". If common sense was a good guide to reality, scientists wouldn't be nearly so useful, would they? The list of amazing science facts that seem to defy common sense is long - How can matter be both a particle and a wave? Etc. etc.

In econ, common sense might that when two countries trade, one wins and one loses, but the theory of comparative advantage shows that it's very easy for that not to be true. I'm not saying that comparative advantage is always a good theory of trade, but it certainly shows that demanding that all econ theories conform to common sense is overly restrictive.

There is plenty of dissent among economists, and some of the best are working the hardest for change. The folks who award the Nobel Prize in economics don’t like the edifice that much either, and often add their weight by awarding the prize to the contrarians.
The first sentence is definitely true. But I'm not sure Wilson is right about the Nobel a force for rebellion. The Nobel has gone to quite a lot of people whose work forms the very foundation of the "edifice" that Wilson talks about. In fact, the vast majority of the prize winners from the past three decades have worked within the rational, individual-choice framework that Wilson doesn't like. In fact, people like Thomas Sargent, Ed Prescott, and Bob Lucas built the very modern macroeconomics that Wilson recoils at...and they got Nobels for it.

Economists were much more closely attuned to common sense and evolutionary theory before the volcano erupted. Adam Smith observed that people following their narrow concerns somehow combine to make the economy work well, as if guided by an invisible hand. Today we use terms such as emergence and self organization to describe this phenomenon. It is spectacularly demonstrated by social insect colonies.
I also think this isn't really right. Smith was certainly not inspired by modern evolutionary ideas, since On the Origin of Species was published almost a century after The Wealth of Nations. It's not at all clear that Smith believed the "invisible hand" worked analogously to an insect colony; he didn't really specify the mechanism. (Not that insect colony self-organization is a good example of evolution in action, anyway - though ants certainly evolved the biological means to self-organize, the process by which they do so on short time scales is not really very similar to biological evolution in most respects.) In fact, the general equilibrium economics that Wilson doesn't like is supposed to represent Smith's invisible hand.

The people who inhabit the economic models, often referred to as Homo economicus, are driven purely by self-regarding preferences. Mathematically, this means that they care only about maximizing their own interests without reference to anyone else’s interests. What I want cannot depend upon what you want.
Actually, that's not right. When externalities are present, people's utility can depend on other people's consumption. Externalities are very common in mainstream economics, and the concept is taught in every (good) econ undergrad course.

Next, people who inhabit the mathematical kingdom are infinitely wise in pursuit of their self-regarding preferences.
This is, sadly, true. Economists have played around with a number of ways to drop this assumption, but they haven't reached a consensus yet, and - in my opinion - still have far too much trepidation about modeling incompletely-rational behavior.

Once again, these absurd assumptions were driven not by ideological bias but by the tyranny of mathematical tractability. The theory couldn’t be pushed in the direction of common sense because it would become impossible to grind through the equations.
This is partly true. Ideological bias probably does play some part in economists' unwillingness to allow irrationality, or things like social preferences, into their models. Tractability concerns can play a role too. But there's also the underlying problem that it's just very hard to make a general mathematical model of human behavior.

Anyway, I like that Wilson is thinking about economics, and saying provocative, challenging things. There's really very little downside to saying provocative, challenging things, as long as you're not saying them into the ear of a credulous policymaker. At the very least, Wilson will provoke some fun arguments with economists. At best, he'll inspire some to start tinkering around with models based on evolutionary principles. Who knows - that might even get some good results someday!

But in the meantime, I'll keep trying to help nudge Wilson toward an accurate picture of what's going on in the econ world. After all, if you want to be Frodo and sneak into Mordor, you should make sure you have a good map - otherwise you might just end up in New Jersey.


David has a response up at Evonomics. He writes:
What stands out in Noah’s critique of my piece is its complacency. It’s like he’s discussing the arrangement of deck chairs aboard the Titanic. There is no sense of urgency about the failure of orthodox economics theory and the need to place it on a new foundation... 
Noah misses the point when he observes that evolutionary psychology, the study of cultural evolution, and their applications to economics are nascent enterprises. He seems to think that they can be ignored until they have reached some undefined state of maturity. He doesn’t get that when your ship is sinking, you need to build a new ship and move onto it as soon as you possibly can...
I wouldn't say I'm complacent at all. Macroeconomics obviously needs some big changes - the crisis and Great Recession showed that, though it should have been apparent long before. The "boat" of macro definitely has substantial holes in its hull.

OK, so suppose you decide that the boat can't be patched up or repaired, and it's time to abandon ship - to completely change the way we do macroeconomics. How do you know which boat to jump to? If you jump into a non-seaworthy boat, you could be in even bigger trouble than before.

David assumes that evolutionary thinking is a seaworthy boat for macroeconomists to jump into. The basic argument seems to be that evolutionary thinking has been successfully applied in many other areas - or at least, that David has made a career out of claiming that it can be so applied. He writes:
My life’s work gives me a panoramic view of the human-related disciplines such as religion, sociology, the humanities, and the philosophical tradition of pragmatism, to list a small sample. The very fact that I and like-minded colleagues can do this (it is a perspective, not an individual talent) suggests that evolutionary theory has a generality that orthodox economics aspired to and failed to achieve.
Well first of all, just because David has made a bunch of similar claims about how evolutionary thinking can be applied to a bunch of other disciplines doesn't mean those other claims were right. In fact, not knowing much about religion, sociology, or the humanities, I'm not in a position to evaluate them - nor, I suspect, are most of David's readers. But if there's a general consensus that evolutionary thinking has successfully improved and transformed most fields of humanities and social science, I'm not aware of it. I should probably read more.

But more importantly, there's just no reason to think that a conceptual framework that works in one discipline should work in another. Why should ideas that work for religion -- whatever that even means -- also work for economics?? It just doesn't make sense. There's no grand theory-of-theories that tells us that all disciplines and all phenomena must act according to some basic universal underlying principles. Physics methods don't usually work for biology. Why should we think that biology methods work for economics?

Yes, mainstream economic models weren't a lot of help in the crisis or the recession. But how confident can we be that making economic policy based on evolutionary analogies would be any better? Before I believe that, I'll want to see some good hard evidence.

Thursday, October 06, 2016

Freedom of speech in the digital age

I noticed today that the user "Ricky Vaughn" has been kicked off of Twitter. "Ricky" was a key figure in the alt-right on Twitter, which means that he was a proponent of white-nationalism. He thought that nonwhite immigration is ruining America, that it should be stopped, that there are all kinds of natural differences between races, etc. etc. I had a long and pretty civil discussion with Ricky about a year ago, about immigration, etc. I eventually blocked him, not because of anything he did, but because when he replied to or retweeted me it would result in my mentions getting flooded by a hundred screeching Nazis yelling "get in my oven", etc. I just don't have time for that stuff.

Anyway, Ricky has been booted, just as Milo Yiannopolous was booted. The moves echo a general move by conversation platforms to crack down on alt-right harassment - Reddit's banning of the "gas the kikes" subreddit and 4chan's crackdown on GamerGate are other examples.

Obviously this has upset the alt-right a great deal (though with those guys it's hard to tell). The bannings of Ricky and Milo have been met with frantic cries for Twitter and other platforms to uphold "free speech." Many on the left respond that "freedom of speech" only applies to the government, and that private companies can and should do as they please. (This is an interesting reversal of the traditional position, which saw conservatives take a more libertarian stance. It reflects how our culture's dominant values are in the process of switching from traditionalist to modernist.)

In the old days, the liberals would easily win this argument. Newspapers and other traditional media platforms don't just censor, they also edit. They present a very carefully curated set of voices - letters to the editor, op-eds, and articles. No one would argue that the New York Times has a moral obligation to publish op-eds or letters saying "Gas the kikes". The presumption has always been that if you didn't like what the Times was serving up, you could go read a different newspaper, or start your own. In fact, many many people did exactly that. As long as the government didn't send its jack-booted thugs to shut down your paper, freedom of speech was upheld.

However, new media technologies have changed the game. Should our ideal of "freedom of speech" be different in the age of Twitter and Reddit than in the age of the New York Times and the New York Post?

Some say yes. Scott Alexander brings up the important point that many tech platforms are natural monopolies. This applies especially to Twitter and Facebook (though not as much to Reddit). There's only one Twitter, and there's only one Facebook, for a reason - each of these things has a strong global network effect. That's not true of newspapers. Scott sums the dilemma up nicely: 
So instead of “let a thousand nations bloom”, it ended up more like “let five or six big nations bloom that we can never get rid of”.
This argument says Twitter is really more like a public space than a private one. If there can only be one Twitter, then does the company have a moral responsibility to protect unrestricted speech on its platform, above and beyond the responsibility of the New York Times?

I'm naturally sympathetic to this argument. I've always thought that hardcore libertarians take a much too limited view of what constitutes "liberty." Not all power is government power, so local entities like companies do have a moral responsibility to uphold liberty in addition to the government. 

BUT, that's not the end of the story. Remember that in the real world, different freedoms conflict with each other. My freedom to speak my mind on a street corner is compromised if 5 people stand in my face screeching at me at the top of their lungs. But face-screeching is also a form of speech, so if you ban it, those 5 people are having their freedom of speech curbed. 

Traditionally, we usually came down against the face-screechers, with laws against public harassment. Why? I think it's because we recognized that speech that disseminates ideas is more valuable than speech whose purpose is to intimidate others. When forced to choose between two mutually exclusive types of speech, we usually chose to protect the one we deemed less intrinsically harmful to others.

Twitter, as a technology, is unusually conducive to face-screeching. The first reason is that anyone can talk to anyone else. In the real physical world, a mob will find it hard to find you; on Twitter, they always know right where you are. People don't need to get up in your face; they're already there, all the time.

The second reason is that it's very easy to coordinate mobs on Twitter. In the real world, to create a mob, you have to get a bunch of people out of their houses and across town, and you can only recruit the mob from people nearby, and the cops might disperse you while you're forming. On Twitter all you need to create a mob is a hashtag or a call-to-arms by a well-followed leader - the mob forms instantly and can't be dispersed. The sheer volume of harassment on Twitter comes from the fact that there are roving mobs of harassers who spend all day going from target to target. One minute you're talking to your friends and colleagues, the next minute there are a hundred pseudonymous accounts screeching at you. Two hours later they're screeching at someone else, but now you know, if you say the wrong thing, the mob will be back in a heartbeat. 

If you're a really unlucky high-profile person like Leslie Jones (who committed the unpardonable sin of being a black woman and being alive), you become a perennial target, and the mob never goes away until you quit Twitter.

So Twitter, by the nature of its technology, facilitates the kind of speech whose main purpose is the shutting down of other people's speech. It automatically empowers a very small number of harassers - I'm guessing the Twitter Nazis' total population, for example, to be only a couple thousand or so - to intimidate and silence enormous numbers of people who only wanted to say their ideas out loud (or, in Jones' case, just wanted to be there, period).

Twitter knows it has these problems - user growth has flatlined and a number of high-profile users are leaving - and it is finally starting to address them. Human moderation and banning is obviously their first approach. Future strategies might include algorithmic blocking, which Google is already working hard on. But it's possible none of these will work, and the screechers will simply always overpower the non-screechers. That could lead to Twitter becoming a ghost-town, inhabited only by 4chan types, unable to make much money off of advertising. It might be that a technology like Twitter, fun and useful as it is, might not be something that works out in the long run.

But more broadly, internet technologies are forcing us to face a sharper conflict between freedom of idea-expression and freedom of targeted disapproval. The tradeoff faced by Twitter is just an acute version of the tradeoffs faced by Facebook, Google, and any other communication technology with a global network effect. The nature of "speech" changes with the advent of new technology, and our intuitive notion of "freedom of speech" will eventually have to change along with it.  

So what do I think about the banning of Milo, Ricky, and other prominent alt-righters? I'm not at all upset about it. I think it's arbitrary and unfair, and unlikely to bring an end to harassment. But I also think it's probably inevitable. Technologically, banning and corporate censorship seem to be the only way (so far) to create an online world where people who mainly value freedom of idea-expression can coexist with people who mainly value the freedom to yell mean things at other people. That's probably going to lead to a "two-tiered" internet, as Scott Alexander calls it - a "top layer" where everyone plays nice, and a "bottom layer" where genocide jokes and death threats are the order of the day. But maybe that's the only possible long-term equilibrium.

Monday, October 03, 2016

Hunting the Rational Expectations whale

1. Why is Rational Expectations still around, anyway? 

Rational Expectations is (are?) one of the key features of almost every macro model in existence today, and has been for decades. Why? One reason is that it's easy to work with, mathematically - just stick an "E" in front of things, and voila, that's what the agents in your model believe! Another reason is that RE is appealing to folks who think that the government shouldn't be able to trick people consistently. A third reason is that there's just no obvious alternative way of modeling expectations. Classic alternatives like adaptive expectations are rigid, simplistic, and just generally very weak. And more sophisticated alternatives, besides being unwieldy to model, also tend to be hyper-specific - if there are actually a number of different ways that RE fails, each of these models will only catch one of them.

But the real reason is that it's hard to test people's expectations directly. Instead, what macroeconomists do is to just throw the expectations assumption into the model along with a million other things like Euler equations, transversality conditions, industry structure, etc., and then test the model against macro facts. If the model fails to match enough macro facts, or the "right" macro facts, to garner interest, the problem is assumed not to lie with the expectations, but with some other assumption of the model. So RE survives. In Lakatos' jargon, it's part of the "hard core" of modern macro.

2. Observing expectations directly

But in recent years, a few brave souls have started to hunt the great Rational Expectations whale. These intrepid hunters are doing the simple and obvious thing that economists previously didn't dare to do: Just ask people what they expect.

Duh, right? Actually, tons of people have collected and analyzed survey measures of expectations. But there's a reason macroeconomists haven't relied on these surveys much in the past (and it's not just fear of getting yelled at by Bob Lucas). First of all, it's not clear that people's stated expectations have anything to do with their functional expectations. I might say that I think inflation is going to rise, and I might even feel deep in my bones that this is truthy, but does that mean I'm buying TIPS and shorting Treasuries? Not recently, it doesn't. What we care about isn't what people "believe", whatever that means, but what they act as if they believe

So the RE-hunters have to take an extra step - they have to show that stated expectations explain actual behavior. And explaining actual behavior requires assumptions, about all the other stuff that might be affecting behavior. And unless you want to be a "heterodox" person shouting in the wilderness, those assumptions are going to have to come from currently respected theory. So that's what the RE-hunters are now doing - showing that stated expectations, e.g. from surveys, explain behavior well when you stick them into popular theories.

3. The RE-hunters

One of the RE-hunters is Andrei Shleifer, who along with coauthors like Robin Greenwood, Yueran Ma and Nicola Gennaioli has started working with survey expectations in finance. Finance is relatively easy to work with because a lot of the popular models are partial equilibrium. Examples of Shleifer's work include this paper on investor expectations and this paper on CFO surveys and investment. He's also made a general equilibrium asset-pricing model, along with some other co-authors, using extrapolative expectations (which surveys seem to show some evidence for). 

In macro it's a bit harder, since most top people now agree that you need general equilibrium for anything important. So the burden of proof is on the RE-hunters - they have to show that an alternative model of expectations, together with some other fairly standard model elements, can explain macro facts in a general equilibrium type model.

One of the most popular non-RE models is the "sticky information" model of Mankiw and Reis, which says that people update their information with a time lag. Along with Justin Wolfers, Mankiw and Reis showed over a decade ago that survey expectations line up with this model in many ways (though as the comments at the bottom of the paper show, they had difficulty persuading certain folks).

Another popular model is Chris Sims' "rational inattention" model. This says that people only get imperfect information because it's costly to filter out noise. Mike Woodford has also worked with models like this.

4. Coibion and Gorodnichenko

Now there is a powerful new team hunting the Rational Expectations whale: Olivier Coibion and Yuriy Gorodnichenko. In 2012, they showed that survey expectations of macreconomic stuff match many of the predictions of sticky information and noisy information models, using a method that's largely agnostic between the two. In other words, they show that stated expectations look like real expectations no matter which of the two models you believe in.

Then in 2015, Coibion and Gorodnichenko came out with a new paper out that's even more general. Their old approach required them to specify the shocks in the economy, but they figured out a way to avoid having to do this. It's really neat. 

Here's the idea. Forecasters make forecasts of things many years in the future. I might forecast the 2020 inflation rate in 2015. But they also update their forecasts - in 2016 I'll make another forecast of 2020 inflation. In general the 2016 forecast will be different from the 2015 forecast. Under RE, the differerence - called the "forecast update" - should have no relation to the eventual forecast miss. In other words, under RE, if my 2015 forecast for 2020 inflation is 2.5% and my 2016 forecast is 2%, that shouldn't mean that my 2016 forecast is more likely to overshoot than undershoot.

But it does. That's what Coibion and Gorodnichenko show. Forecast updates predict forecast misses. That's consistent with a model where information is "sticky" and one where it's "noisy".

That's the paper's central insight, but it has lots more in it than that. The authors test whether the result could come from forecasters intentionally "smoothing" their forecasts, i.e. giving intentionally stale forecasts in order to cater to some clients. But they don't find evidence for this. 

They also find that the degree of "noisiness" or "stickiness" of information varies depending on what's happening in the economy. After big shocks like 9/11, the amount of apparent stickiness/noisiness goes down. But in the Great Moderation, it went up. So when macroeconomic stuff is more important, people either pay more attention, or spend more effort making accurate projections, or whatever. That reassuring.

So Coibion and Gorodnichenko's new method shows that professional forecasts behave like true expectations for a very wide class of models. Not for all models, obviously, but for two of the mainstream alternatives to RE. And this is independent of all kinds of other things, like consumption behavior, industrial structure, or the nature of the shocks that drive the economy. In other words, it's getting harder and harder to dismiss direct measurements of expectations - maybe you really just can ask people what they believe, and get a useful result!

5. So what?

Interesting note: There are both "behavioral" and "non-behavioral" explanations for this failure of Rational Expectations. Information could be "sticky" or "noisy" because information is costly to acquire and process, or because people are just slow to believe or accept new information. (I call this "Smith's Principle": Any behavioral explanation will have an observationally equivalent explanation based on information structure and/or costs. I can name stuff after myself because this is my blog, hehehe. And because I'm too lazy to find out if anyone else has made this claim.) As the authors point out, it's perfectly possible that a bunch of individually rational but information-constrained agents can produce an aggregate forecast that does not take into account all of the available information in the economy:
This predictability of the average forecast error across agents from forecast revisions is an emergent property in both models, i.e. a property which arises only from the aggregation process and not at the individual level. 
Nice to see economists using the term "emergent property"! In other words, it's perfectly possible to have rational agents without Rational Expectations.

But anyway, if you believe this result, it means two things: 1. that forecasts are good measures of expectations, and that 2. sticky/noisy information should be a much more standard feature of macro models. If on the other hand you disbelieve the result, you must believe that A) forecasts don't represent true expectations, and B) sticky/noisy information models aren't good models, and also C) forecasts fail to reveal true expectations in precisely a way that makes it look like sticky/noisy information models are good!

Now, RE defenders may shrug and say "So what? No one expects RE to be exactly right, it's just a useful approximation." But as Coibion and Gorodnichenko point out, that's not true in this case. Sticky/noisy information models differ in very important ways from RE models. Ways that are very important for policymaking. In other words, by linking their test of RE to a model that we already know has economically significant implications, Coibion and Gorodnichenko's claimed failure of RE must be economically significant too. This isn't just a wrinkle on a largely successful theory; it's a claim that the theory fails in big, critical ways.

Nothing is for certain, especially in macro, but this is another harpoon tossed into the side of the Rational Expectations hypothesis.

(No whales were harmed in the making of this blog post. Noahpinion condemns the practice of whaling, and also believes that whale meat tastes like stale hamachi.)

Monday, September 19, 2016

What do white Americans stand to lose?

An article by Zack Beauchamp in Vox tries to draw a parallel between Donald Trump and the rise of nativist movements in Europe (including Brexit). The similarities do exist: a bunch of angry white people, afraid of immigrants in general but especially Muslims, electing right-wing populist leaders. I don't expect the same outcome here as in Europe, even if Trump manages to win the election, for several reasons:

1. America has a history of pro-immigrant sentiment, which continues to this day. Intermarriage rates are high, supporting George Washington's prediction in 1794:
Whereas by an intermixture with our people, they, or their descendants, get assimilated to our customs, measures, and laws: in a word, soon become one people.

2. Non-Hispanic whites are far less demographically dominant here than in Europe, and even less so among younger generations, meaning that the Trump movement will have to radicalize a far larger percentage of American whites to gain dominance. Highly unlikely.

3. Younger Americans are solidly against Trump. Some of that is demographics and some is an age effect, but a large part of it is probably a cohort effect - younger Americans have grown up with the new nonwhite immigrants and are hence far less likely to think that nonwhites don't represent "real Americans."

So I predict that even a Trump victory, should that occur, will be a last and only hurrah for white nativist racist populism.

However, this doesn't mean that we shouldn't worry about white nativist racist populism. A substantial minority of Americans who are implacably opposed to the nation-state can create all kinds of terrible problems for our country. It can sometimes elect terrible people like Trump to high office. It can elect legislative blocs like the Tea Party that can use veto points to block the functioning of the state, as we found out in 2011. It can dominate local and state governments. If things get extremely bad, it could even resort to terrorism - I see McVeigh as a potential harbinger.

So I think we ought to pay attention to this movement, and think about why these people are angry and afraid. Beauchamp's article suggests that groups' anger is aroused when it seems like another group's status is being raised higher in society:
In order to fully understand why ethnic violence happens, [political scientist Roger Petersen has] argued, we need to appreciate the role of resentment: the feeling of injustice on the part of a privileged portion of society when it sees power slipping into the hands of a group that hadn't previously held it. Drawing on social psychology, he theorized that one of the underappreciated causes of ethnic violence was a change in the legal and political status of majority and minority ethnic groups. 
According to Petersen, that change in status comes from a sense of injustice. Members of dominant groups simply believe they deserve to be the dominant force in their societies, and resent those challenging their positions at the top of the pyramid. 
"Any group that’s been dominant — well, it’s not that easy for them not to be dominant anymore," Petersen tells me. 
This helped explain the puzzle of Kaunas and Vilnius. In Kaunas, the Soviet invasion in 1940 had politically empowered local Jews, who had occupied leadership positions in the Communist Party prior to the invasion and ended up with plum Soviet jobs as a result. This sparked intense feelings of resentment on the part of Kaunas residents, resulting in the vicious pogrom. In Vilnius, by contrast, non-Jewish ethnic Poles held most leadership positions. The Soviet invasion didn’t empower Jews on a large scale, and thus failed to create any resentment toward them. 
In his book, Petersen argues that his theory helps explain the causes of other cases of ethnic violence in Eastern Europe, including the carnage in the Balkans in the 1990s. Other scholars have since found that it could be used to understand communal violence elsewhere in the world. 
A 2010 paper published in the journal World Politics tested Petersen’s theory, looking at 157 cases of ethnic violence in nations ranging from Chad to Lebanon. It found strong statistical correlations between a group’s decline in status and the likelihood that it turns to violence against another group.
Seems reasonable enough. And many people in the media - usually, people on the Left - have declared that it's the imminent or ongoing loss of "white privilege" that is angering Trump voters.

What is "status" in modern America, though? What is "privilege"?

Unlike in Eastern Europe a century ago, most of our jobs and positions don't come from government fiat, but from the workings of the market. And here, it is true that elite whites are destined to occupy a smaller and smaller percentage of the elite, thanks to high-skilled immigration. By taking the intellectual cream of the crop from Asia, the Middle East, and Africa (the best Chinese Americans, for example, now beat the best Chinese people in math competitions, despite being selected from a pool that's outnumbered more than 350 to 1!),  we've ensured that the corporate, scientific, political, and thought leaders of tomorrow will be less and less white. Ivy League discrimination can slow this process down, but it's inevitable.

BUT, the Trump movement doesn't look at all like a movement of elite whites. Instead, it's primarily a movement of the relatively uneducated. And while low-skilled nonwhite immigrants have certainly provided some job competition for these whites, Hispanic immigrants for example certainly aren't doing better than uneducated whites in terms of employment or wages. This doesn't look like a situation in which the American system is awarding jobs to Hispanics that whites aren't getting.

How about college admissions? While the Supreme Court has upheld some affirmative action programs, the practice of privileging historically disadvantaged racial minorities has declined in recent years after being banned in many states. The result has been a decline in black enrollment. So this form of white status is less under threat than in previous years.

Criminal justice? The Black Lives Matter movement might make headway against discriminatory policing and incarceration practices, but as of 2016, these look solidly in place. And it seems unlikely that a reduction in the incarceration of black people would result in an increase in white incarceration. It's not like the cops have quotas of people to throw in prison (I hope)!

How about the tax system? This might be a big one. For decades, Republicans have told white Americans that the tax system represents racial redistribution from whites to blacks and Hispanics. Rush Limbaugh once said that "Obama's entire economic program is reparations," and he said this of Obamacare:
The days of them [racial minorities] not having any power are over, and they are angry. And they want to use their power as a means of retribution. That’s what Obama’s about, gang. He’s angry, he’s gon’ cut this country down to size, he’s gon’ make it pay for all its multicultural mistakes that it has made, its mistreatment of minorities. I know exactly what’s going on.
And he also said this:
Obama has a plan. Obama’s plan is based on his inherent belief that this country was immorally and illegitimately founded by a very small minority of white Europeans who screwed everybody else since the founding to get all the money and all the goodies, and it’s about time that the scales were made even. And that’s what’s going on here. And that’s why the president is lawless, and that’s why there is no prosecution of the Black Panthers for voter intimidation, because it’s not possible for a minority to intimidate the white majority. It’s not possible. It’s always been the other way around. This is just payback. This is ‘how does it feel’ time.
So there's a good possibility that the angry white Trumpians fear the same thing that the GOP has been telling its base to fear since before I was born: that the tax system will be used to crush whites as a form of racial redistribution. As whites shrink as a percent of the electorate, the fear is that they'll simply vote as a bloc to elect leaders who punish whites with racial redistribution policies.

If this is what Trumpians are afraid of, then it really isn't anything different from previous elections. The angry white people are simply more scared than before, because of Obama's 2012 victory, and hence willing to vote for a totally crazy candidate. This interpretation fits with the fact that Trump supporters tend to be better off than their neighbors.

There's one more possible "status" threat, which many on the Right and a few on the Left bring up: a feeling of being in the in-group. In the past, I gather that open expressions of racism by whites were more acceptable in the workplace or in other public places. Ralph Nader, expressing some lukewarm support for Trump, said this:
Well, and you see this when you walk past construction sites and you talk with white male workers, they feel they have been verbally repressed. It’s hard for someone your age to understand what I’m about to say...You can’t say this about that, and you can’t say that about this. And the employer tells you to hush. And perhaps your spouse tells you to hush, and your kids tell you to hush. So they have a whole language that they inherited — ethnic words like Polack. A lot of these people grew up on ethnic jokes, which are totally taboo now. Do you know, Lydia, there are no ethnic-joke books in bookstores anymore?... 
There were Negro-joke books, Jewish-joke books, Polish-joke books, Italian-joke books. They used ethnic jokes to reduce tension in the 1930s, ’40s, ’50s. And they’d laugh at each other’s jokes and hurl another one. But it still flows through ethnic America, you know. There are hundreds of things that people would like to say.
Indeed, many Trump supporters cite "political correctness" as a concern. Even some left-leaning white men are worried about it. This explanation of Trumpism seems to fit with the scattered signs that Trump's rise is emboldening white racist speech and actions across the country.

What this tells me is that some white Americans are afraid of losing something intangible - a kind of cultural cache that allowed them to feel as if they were society's in-group, the cool kids, and that others - blacks, Italian and Polish immigrants, whoever - were the out-group, the marginal Americans, the uncool kids. If the "political correctness" hypothesis is correct, this intangible thing - this nebulous feeling of being in the in-crowd - is even more important than things like jobs, college admissions, or the social safety net.

It seems weird that millions of Americans would march to the polls and vote to put thousands of strategic nuclear weapons in the undersized hands of an obvious narcissistic madman simply out of the fear that they won't be able to think of themselves as the cool kids anymore. But human beings are weird. You almost can't put anything past our species, really.

Anyway, I don't know which of these explanations is right - or if it's something else I haven't even thought of. But I think if we want to avoid a dysfunctional, divided nation, this is something we should think about.

Wednesday, September 14, 2016

The new heavyweight macro critics

I got tired of lambasting macroeconomics a while ago, and the "macro wars" mostly died down in the blogosphere around when the recovery from the Great Recession kicked in. But recently, there have been a number of respected macroeconomists posting big, comprehensive criticisms of the way academic macro gets done. Some of these criticisms are more forceful than anything we bloggers blogged about back in the day! Anyway, I thought I'd link to a couple here.

First, there's Paul Romer's latest, "The Trouble With Macroeconomics". The title is an analogy to Lee Smolin's book "The Trouble With Physics". Romer basically says that macro (meaning business-cycle theory) has become like the critics' harshest depictions of string theory - a community of believers, dogmatically following the ideas of revered elders and ignoring the data. The elders he singles out are Bob Lucas, Ed Prescott, and Tom Sargent.

Romer says that it's obvious that monetary policy affects the real economy, because of the Volcker recessions in the early 80s, but that macro theorists have largely ignored this fact and continued to make models in which monetary policy is ineffectual. He says that modern DSGE models are no better than old pre-Lucas Critique simultaneous-equation models, because they still take lots of assumptions to identify the models, only now the assumptions are hidden instead of explicit. Romer points to distributional assumptions, calibration, and tight Bayesian priors as ways of hiding assumptions in modern DSGE models. He cites an interesting 2009 paper by Canova and Sala that tries to take DSGE model estimation seriously and finds (unsurprisingly) that identification is pretty difficult.

As a solution, Romer suggests chucking formal modeling entirely and going with more general, vague but flexible ideas about policy and the macroeconomy, supported by simple natural experiments and economic history. 

Romer's harshest zinger (and we all love harsh zingers) is this:
In response to the observation that the shocks [in DSGE models] are imaginary, a standard defense invokes Milton Friedman’s (1953) methodological assertion from unnamed authority that "the more significant the theory, the more unrealistic the assumptions (p.14)." More recently, "all models are false" seems to have become the universal hand-wave for dismissing any fact that does not conform to the model that is the current favorite.  
The noncommittal relationship with the truth revealed by these methodological evasions...goes so far beyond post-modern irony that it deserves its own label. I suggest "post-real."
Ouch. He also calls various typical DSGE model elements names like "phlogiston", "aether", and "caloric". Fun stuff. (Though I do think he's too harsh on string theory, which often is just a kind of math that physicists do to keep themselves busy, and has no danger of hurting anyone, unlike macro theory.)

Meanwhile, a few weeks earlier, Narayana Kocherlakota wrote a post called "On the Puzzling Prevalence of Puzzles". The basic point was that since macro data is fairly sparse, macroeconomists should have lots of competing models that all do an equally good job of matching the data. But instead, macroeconomists pick a single model they like, and if data fails to fit the model they call it a "puzzle". He writes:
To an outsider or newcomer, macroeconomics would seem like a field that is haunted by its lack of data...In the absence of that data, it would seem like we would be hard put to distinguish among a host of theories...[I]t would seem like macroeconomists should be plagued by underidentification... 
But, in fact, expert macroeconomists know that the field is actually plagued by failures to fit the data – that is, by overidentification. 
Why is the novice so wrong? The answer is the role of a priori restrictions in macroeconomic theory... 
The mistake that the novice made is to think that the macroeconomist would rely on data alone to build up his/her theory or model.  The expert knows how to build up theory from a priori restrictions that are accepted by a large number of scholars...[I]t’s a little disturbing how little empirical work underlies some of those agreed-upon theory-driven restrictions – see p. 711 of Lucas (JMCB, 1980) for a highly influential example of what I mean.
In fact, Kocherlakota and Romer are complaining about much the same thing: the overuse of unrealistic assumptions. Basically, they say that macroeconomists, as a group, have gotten into the habit of assuming stuff that just isn't true. In fact, this is what the Canova and Sala paper says too, in a much more technical and polite way:
Observational equivalence, partial and weak identification problems are widespread and typically produced by an ill-behaved mapping between the structural parameters and the coefficients of the solution.
That just means that the model elements aren't actually real things.

(This critique resonates with me. From day 1, the thing that always annoyed me about macro was how people made excuses for assumptions that were either unverifiable or just flatly contradictory to micro data. The usual excuse was the "pool player analogy" - the idea that the pieces of a model don't have to match micro data as long as the resulting model matches macro data. I'm not sure that's how Milton Friedman wanted his metaphor to be used, but that seems to be the way it does get used. And when the models didn't match macro data either, the excuse was "all models are wrong," which really just seems to be a way of saying "the modeler gets to choose which macro facts are used to validate his theory". It seemed that to a large extent, macro modelers were just allowed to do whatever they wanted, as long as their papers won some kind of behind-the-scenes popularity contest. But I digress.)

So what seems to unite the new heavyweight macro critics is an emphasis on realism. Basically, these people are challenging the idea, very common in econ theory, that models shouldn't worry about being realistic. (Paul Pfleiderer is another economist who has recently made a similar complaint, though not in the context of macro.) They're not saying that economists need 100% perfect realism - that's the kind of thing you only get in physics, if anywhere. As Paul Krugman and Dani Rodrik have emphasized, even the people advocating for more realism acknowledge that there's some ideal middle ground. But if Romer, Kocherlakota, etc. are to be believed, macroeconomists aren't currently close to that optimal interior solution.


Olivier Blanchard is a bet less forceful, but he's definitely also one of the new heavyweight critics. Among his problems with DSGE models, at least as they're currently done, are 1. "unappealing" assumptions that are "at odds with what we know about consumers and firms", and 2. "unconvincing" estimation methods, including calibration and tight Bayesian priors. Sounds pretty similar to Romer.

Meanwhile, Kocherlakota responds to Romer. He agrees with Romer's criticism of unrealistic macro assumptions, but he dismisses the idea that Lucas, Prescott, and Sargent are personally responsible for the problems. Instead, he says it's about the incentives in the research community. He writes:
We [macroeconomists] tend to view research as being the process of posing a question and delivering a pretty precise answer to that question...The research agenda that I believe we need is very different. It’s hugely messy work.  We build a more evidence-based modeling of financial institutions.  We learn more about how people actually form expectations.  We need [to use] firm-based information about residual demand functions to learn more about product market structure.  At the same time, we need to be a lot more flexible in our thinking about models and theory, so that they can be firmly grounded in this improved empirical understanding.
Kocherlakota says that this isn't a "sociological" issue, but I think most people would call it that. Since journals and top researchers get to decide what constitutes "good" research, it seems to me that to get the changes in focus Kocherlakota wants, a sociological change is exactly what would be required.

Kocherlakota now has another post describing how he thinks macro ought to be done. Basically, he thinks researchers - as a whole, not just on their own! - should start with toy models to facilitate thinking, then gather data based on what the toy models say is important, then build formal "serious" models from the ground up to match that data. He contrasts this with the current approach of tweaking existing models.

My question is: Who is going to enforce this change? If a few established researchers start doing things the way Kocherlakota wants, they'll certainly still get published (because they're famous old people), but will the young folks follow? How likely is it that established researchers en masse are going to switch to doing things this way, and demanding that young researchers do the same, and using their leverage as reviewers, editors, and PhD advisers to make that happen? This doesn't seem like the kind of change that can be brought about by a few young smart rebels forcing everyone else to recognize the value of their approach - the existing approach, which Kocherlakota dislikes, already succeeds in getting publication and prestige, so the rebels would simply coexist alongside the old approach, rather than overthrowing it. How could this cultural change be put into effect?

Also: Romer now has a follow-up to his original post, defending his original post against the critics. This part stood out to me as particularly persuasive:
The whine I hear regularly from the post-real crowd is that “it is really, really hard to do research on macro so you shouldn’t criticize any of our models unless you can produce one that is better.” 
This is just post-real Calvinball used as a shield from criticism. Imagine someone saying to a mathematician who finds an error in a theorem that is false,  “you can’t criticize the proof until you come up with valid proof.” Or try this one on and see how it feels: “You can’t criticize the claim that vaccines cause autism unless you can come up with a better explanation for autism.”
Sounds right to me. The old like that "it takes a theory to kill a theory" just seems wrong to me. Sometimes all it takes is evidence.

Wednesday, August 31, 2016

Books to help you understand Japan

So you want to understand the real Japan. You have a sense that the typical stereotypes are wrong and outdated and full of derp, and you want to go deeper than anime or "crazy Japan" blogs will take you. So you decide to ask your friendly neighborhood Noah: "What books can I read that will help me understand the real Japan at a deep level?"

Unfortunately Noah hasn't had his requisite 3 daily cups of oversteeped black tea, so he grouchily responds: "How about instead of reading a book, you learn the language fluently, live there for a few years, talk to a bunch of people, and learn for yourself?" But then Noah gets his caffeine fix, and the norepinephrine flows freely through his brain, and he says "Oh, BOOKS? Sure, I got books." And walking over to his lovely fake mahogany Wayfair bookshelf, he proceeds to make you the following list:

Culture and Daily Life

1. New Japan, by David Matsumoto

This book, which you can read in an hour or less, basically summarizes a bunch of social psych studies to prove that Japanese culture changed dramatically in the 1980s. Most of the old stereotypes - conformity, group orientation, etc. - used to be pretty true, but now are totally false. Japan used to rate as more conformist, group-oriented, etc. on most measures than the U.S., but now rates as individualistic and independent as the U.S., or more. Feel the power of data destroying your preconceived notions!

2. Nightwork, by Anne Allison

Also from the 90s, but also still relevant. Nightwork is about two things: corporate culture and sex culture. Japan's corporate culture is, without a doubt, the biggest difference between the West and Japan - although Don Draper might find it a little less alien. Sex culture is different too, mostly because most kinds of prostitution are both legal and well-accepted in Japan. This book is about the convergence of the two - about how Japanese companies solidify their corporate cultures by paying for employees to go to pseudo-prostitutes (actually, more like in-house escorts) called "hostesses." Anne Allison, who is one of the best English-language anthropologists who studies Japan, actually lived and worked as a hostess for years to do research for this book. It's really pretty amazing.

See also: Office Ladies and Salaried Men, by Yuko Ogasawara

3. Capturing Contemporary Japan, ed. by Satsuki Kawano

This is just a bunch of vignettes of modern Japanese people's lives. Kind of dry, but pretty wide-ranging.

See also: Bending Adversity, by David Pilling, Goodbye Madame Butterfly, by Sumie Kawakami

4. Fruits, by Shoichi Aoki

This is a picture book of Japanese street fashion from the 1990s. It's mostly just photos, but it also has mini-interviews of colorful kids at the bottom of each page. These are actually excerpted from a magazine of the same name that was popular back then.

See also: Tokyo: A Certain Style, by Kyoichi Tsuzuki

Economics and Business

1. Can Japan Compete?, by Michael Porter, Hirotaka Takeuchi, and Mariko Sakakibara

This is basically a history book about Japan's industrial policy - what it was, where it seems to have worked, where it went wrong (spoiler: almost everywhere, after the 1970s). It also contains Michael Porter's theories about competition, but you really don't need to believe those in order to appreciate the history here.

2. The Japanese Economy, by David Flath

This is an overview for people who have studied econ. The author, David Flath, is a friend of mine (we met on the streets of Tokyo, where he recognized me from my blog photo), and also happens to be the PhD advisor of Karl Smith, the former econ blogger and prof.

See also: Reviving Japan's Economy, ed. by Takatoshi Ito, Hugh Patrick, and David E. Weinstein

3. Reimagining Japan, ed. by Brian Salsberg, Clay Chandler, and Heang Chhor

This is a bunch of articles written write before the big 2011 earthquake, mostly about Japanese business, but also a little about the economy and culture. The authors are a collection of business leaders, writers, consultants, etc.

See also: The Power to Compete, by Hiroshi and Ryoichi Mikitani, Saying Yes to Japan, by Tim Clark and Carl Kay

History and Politics

1. Democracy Without Competition in Japan, by Ethan Scheiner

This book explains a lot about Japanese politics - most importantly, why one party has ruled Japan for most of the postwar period, despite strong democratic norms and a free and fair election system. The reason, according to Scheiner, is that the Japanese fiscal system and electoral system combine to make it easy to basically just buy votes. But you don't have to accept this thesis in order to appreciate the political history here.

2. Japan at War, by Haruko Taya Cook and Theodore F. Cook

Modern Japan's institutions were partially shaped by a big war that almost no one now remembers. This book consists of a bunch of first-hand accounts of Japanese people from that war period. Just remember that these old people's way of thinking is just as alien to that of modern young Japanese people as your grandparents are to you.

See also: The Rising Sun, by John Toland, Dear General MacArthur, by Sodei Rinjiro

3. Japanese Destroyer Captain, by Tameichi Hara

The war memoir of Japan's (probably) best naval captain, this book gives great insight into Japanese military culture. It also shows how traditional samurai culture (the author is from a samurai family) clashed with the modern militaristic culture of WW2-era Japan. Finally, it displays some interesting Japanese cultural quirks - women hitting on men! - that seem to have survived through the ages.

See also: Zero, by Masatake Okumiya, Jiro Horikoshi, and Martin Caidin

On my list to read: Ametora: How Japan Saved American Style, by W. David Marx, Embracing Defeat, by John Dower, Tokyo Vice, by Jake Adelstein

So there you go. Happy reading. If you know of any other books along these lines, send them my way. And remember, even the best books will only scratch the surface of any culture...

Monday, August 22, 2016

Free-market ideology: a reply to some replies

I recently wrote a Bloomberg View post about political-economic ideologies, and how society is quicker to change than individual human beings. The upshot was that free-market ideology seems - to many Americans, and also incidentally to me - to have mostly hit a wall in terms of its ability to improve our lives, and so society will inevitably embrace an alternative, despite the protests of diehard free-marketers.

Bryan Caplan is flabbergasted at the notion that free-market ideology (aka "neoliberalism") has actually been tried in the U.S.:
The claim that "free-market dogma" is the "reigning economic policy" of the United States or any major country seems so absurd, so contrary to big blatant facts (like government spending as a share of GDP, for starters), that I'm dumb-founded.  
This is pretty much exactly the attitude I described in my post! "Of course neoliberalism hasn't failed; we just never really tried it."

David Henderson has a longer and more measured response. He challenges the idea that free-market ideology has demonstrated any failures at all.

Now I could simply make a weak claim - i.e., that free-market ideology seems to have hit a wall, and that in the end, that general perception is much more important than what I personally think. But instead, I'll make the much stronger claim - I'll defend the idea that free-market ideology has, in fact, really hit a wall in terms of its effectiveness.

Exhibit A: Tax cuts. Tax cuts, one of free-marketers' flagship policies, appear to have given our economy a boost in the 1960s, and a smaller boost in the 1980s. But any economic boost from the Bush tax cuts of 2001 and 2003 was so small as to be invisible to all but (possibly) the most careful econometricians. Notably, a number of attempts to encourage savings - capital gains tax cuts, estate tax cuts, and the like - have not halted the steady decline in personal savings rates.

Exhibit B: Financial deregulation and light-touch regulation. It seems clear to me that under-regulation of derivatives markets and mortgage lending played a big role in the financial crisis. The counter-narrative, that government intervention caused the crisis, has never held much water, and has been debunked by many papers. This was a private-sector blowup.

Exhibit C: Light-touch regulation of monopoly. The evidence is mounting that industrial concentration is an increasing problem for the U.S. economy. Some of this might be due to intellectual property, but much is simply due to naturally increasing returns to scale.

Exhibit D: The China shock. While most trade booms seem to lead to widely shared gains, the China trade boom in the 2000s - which free marketers consistently championed and hailed - probably did not. High transaction costs (retraining costs, moving costs, and others) lead to a very large number of American workers being deeply and permanently hurt by the shock, as evidenced by recent work by Autor, Dorn, and Hanson.

Exhibit E: Faux-privatization. True privatization is when the government halts a nationalized industry and auctions off its assets. Faux-privatization is when the government outsources an activity to contractors, often without even competitive bidding. Faux-privatization has been a notable bust in the prison industry, and school voucher programs have also been extremely underwhelming. Charter schools have fared a bit better, but even there the gains have been modest at best.

Exhibit F: Welfare reform. Clinton's welfare reform saved the taxpayer very little money, and appears to have had little if any effect on poverty in the U.S.

Exhibit G: Research funding cuts. The impact of these is hard to measure, but cuts in government funding of research appear to have saved the taxpayer very little money, while dramatically increasing the time that scientists have to devote to writing grant proposals, and increasing risk aversion in scientists' choice of research topics.

Exhibit H: Health care. The U.S. health care system is a hybrid private-public system, but includes a proportionally much larger private component than any other developed nation's system. Free-marketers have fought doggedly to prevent the government from playing a larger role. Our hybrid system delivers basically the same results as every other developed country's system, at about twice the cost. Private health care cost growth has been much faster than cost growth for Medicare and other government-provided programs, indicating that much of our excess cost has been due to the private component of our system, not the public part.

I could go on, but these are the big ones I can think of. In some of these cases, free-market policies seem to have produced some gains in the late 20th century, but by the 21st century all appeared to be either having no effect, or actively harming the economy.

No, this is nowhere near as big a failure as that of communism (though in some ways, notably health care and financial deregulation, we've done worse than the somewhat-socialist nations of Europe). The analogy with communism was a way of illustrating a certain mindset, not to draw an equivalence between the results of neoliberalism and communism.

Also, I personally think there is still scope for many neoliberal policies to improve our economy. Reduced occupational licensing, urban land-use deregulation, simplification of the tax code, and various other kinds of deregulation all seem to show promise. If free-market policies have hit a wall, it's a porous wall - in real life, nothing is as cut-and-dry as in our ideological debates.

But overall, I think the last decade and a half have shown clearly diminishing returns, and sometimes negative returns, from neoliberal reforms. So our society is right to be looking for alternative policy packages. Though that doesn't necessarily mean we'll choose a good alternative - I think Sanders-style socialism would probably be a mistake.

Saturday, August 20, 2016

Heterodox macro - a reply to some replies

The other day I wrote a Bloomberg View post arguing that heterodox macroeconomics is not in any better shape than mainstream macroeconomics. As you might expect, this drew some lively responses.

One or two of the responses seemed to be arguing against the title of my post, rather than the contents. That's understandable, since titles are important. In this case, though, it probably detracted from the debate a great deal. The Bloomberg title people are good, and they usually get things right, but once in a while the title they choose doesn't quite capture the point I'm trying to make. This was one of those cases. The title they gave my post was "Economics Without Math Is Trendy, But It Doesn't Add Up." But actually, this wasn't what I was arguing. My point about non-mathy models wasn't that these are bad, useless, or inferior. It was that they're different from mathy models, and so comparing non-mathy models with mathy ones is an apples-to-oranges comparison. Both types of models have their uses, but you can't really compare one to the other. I make that pretty clear in the text of my post, but most of the people who responded tended to focus more on the title. Oh well. These things happen.

Anyway, on to some of the responses. The numbering here is arbitrary, corresponding to the order in which the tabs were open on my browser. (Note: The ordering has changed; see #4.)

Response 1: Steve Keen

First, we have a response by Steve Keen. Steve, unlike others, did get the point I was making about mathy vs. non-mathy models (Thanks, Steve!), and had some good commentary on the subject:
There is indeed a wing of heterodox economics that is anti-mathematical. Known as "Critical Realism" and centred on the work of Tony Lawson at Cambridge UK, it attributes the failings of economics to the use of mathematics itself... 
What Noah might not know is that many heterodox economists are critical of this approach as well. In response to a paper by Lawson that effectively defined "Neoclassical" economics as any economics that made use of mathematics (which would define me as a Neoclassical!), Jamie Morgan edited a book of replies to Lawson entitled What is Neoclassical Economics? (including a chapter by me). While the authors agreed with Lawson's primary point that economics has suffered from favouring apparent mathematical elegance above realism, several of us asserted that mathematical analysis is needed in economics, if only for the reason that Noah gave in his article[.]
Steve also offers some useful criticism of Milton Friedman's ideas about how to evaluate a model's empirical success (I agree).

Steve also makes the useful point that linearization critically hampers many mainstream models (I agree).

Steve points out that non-mathy models can make qualitative forecasts. That's true. However, my point was that these are often a lot less actionable than quantitative forecasts. A non-mathy model might tell you that private-sector debt is dangerous, but it might not tell you how much of it is dangerous, or how dangerous. For that, you'd need some kind of mathy model. Steve definitely seems to get this point too, though, so I'm not disagreeing.

Steve then discusses overfitting of data, and points out that many mainstream models do this too. That's certainly true, although I think DSGE models tend to be a lot more parsimonious than SFC models or stuff like FRB/US. Actually, overfitting is one of the big criticisms of the most popular DSGE models in use at central banks.

Steve then addresses the idea that heterodox models are similar to mainstream ones. I never said they were, although I said there are some similarities between the FRB/US model and Wynne Godley-type SFC models. In fact, there are some similarities, though there are also differences. But in general, most heterodox models are very different from most mainstream models.

Steve also discusses my (admittedly too brief) mention of agent-based models, and has some good comments:
Largely speaking, this is true - if you want to use these models for macroeconomic forecasting. But they are useful for illustrating an issue that the mainstream avoids: "emergent properties". A population, even of very similar entities, can generate results that can't be extrapolated from the properties of any one entity taken in isolation...Neoclassical economists unintentionally proved this about isolated consumers as well, in what is known as the Sonnenschein-Mantel-Debreu theorem. But they have sidestepped its results ever since...Multi-agent modelling may not lead to a new policy-oriented theory of macroeconomics. But it acquaints those who do it with the phenomenon of emergent properties - that an aggregate does not function as a scaled-up version of the entities that comprise it. That's a lesson that Neoclassical economists still haven't absorbed.
I think this is right. Agent-based models have so far served as a demonstration of the fragility of representative agent models. In the future, they might be much more than that.

So anyway, I'd say I pretty much agree with Steve's response. Good stuff. (Though this person on Reddit had some problems with it.)

Response 2: Ari Andricopolous

Ari has a response as well. His response comes in the form of a list of things that he thinks macro models should not include. The list is:

  1. Microfoundations
  2. Rationality
  3. Loanable funds
  4. Interest rate effects
  5. The financial sector

It's pretty clear that the last item on this list is misplaced, since Ari thinks one should include the financial sector in models.

Whether macro models should be microfounded is a big open question, but I'd like to note that by saying they shouldn't be, Ari is saying that agent-based models are bad. Agent-based models are as microfounded as they come.

As for rationality, I kind of disagree...humans observe and learn and adapt (OK, some more than others, I'll grant). Even though perfect rationality is probably pretty unrealistic, to insist that models totally ignore human observation, learning, and adaptation seems very dangerous for the realism of any model.

As for the loanable funds thing...yeah, OK, sure.

Response 3: Jo Michell

Jo Michell's response might have been the first to go up, but it's later on this list because...the numbering is arbitrary!

Jo, which I believe is short for "Jörmungandr", has a helpful diagram of the "schools" of macroeconomic thought. He also pushes back on the notion that "heterodox" is a useful classification at all:
The problem with ‘heterodox economics’ is that it is self-definition in terms of the other. It says ‘we are not them’ — but says nothing about what we are. This is because it includes everything outside of the mainstream, from reasonably well-defined and coherent schools of thought such as Post Keynesians, Marxists and Austrians, to much more nebulous and ill-defined discontents of all hues. To put it bluntly, a broad definition of ‘people who disagree with mainstream economics’ is going to include a lot of cranks. People will place the boundary between serious non-mainstream economists and cranks differently, depending on their perspective. 
Another problem is that these schools of thought have fundamental differences. Aside from rejecting standard neoclassical economics, the Marxists and the Austrians don’t have a great deal in common.
This is a good and useful point. My Bloomberg post really did bite off more than it could chew. My point was that there wasn't something better and more successful out there that by rights ought to already have displaced the (unsuccessful) mainstream approach. But in making that point, I touched on a number of different types of alternatives that aren't really closely connected. And I left out others (for example, Steve Keen's own work, and the Austrians).

Jo, unfortunately, appears to have gotten tripped up by the title:
Noah seems to define heterodox economics as ‘non-mathematical’ economics. This is inaccurate. There is much formal modelling outside of the mainstream. 
Well, no, I don't define it that way, otherwise I wouldn't have discussed SFC models and agent-based models in my post.

Jo goes on to make some good points about mainstream models, and some of the problems they encounter.

Response 4: Frances Coppola

Frances Coppola, whom I cited in my Bloomberg post, also has a response. I responded to this post earlier, but Frances changed it, so I moved my response down to #4.

Frances still seems to misunderstand my post somewhat, and to have been tripped up by the title:
Noah's core proposition is that economics has no validity unless it is expressed in mathematical terms. He says that economics without mathematics doesn’t add up.
Actually, I didn't make such a claim. Nor do I believe it. What I wrote was:
Broad idea-sketching is certainly a valuable activity. If theorists get lost in the specifics of their models, they can blind themselves to truly new hypotheses and mechanisms that would let them make big, radical changes. I do think this has happened to some degree in mainstream macro...But that doesn’t mean that broad idea-sketching is a replacement for formal models. It’s not an apples-to-apples comparison.
My point is that although non-mathematical econ is often valuable, it's not comparable to mathematical econ. Both have their place. But to say that a non-quantitative theory was successful at predicting the Great Recession, while a quantitative theory failed, is to hold the two theories to very different standards, since "predict" means different things for quantitative theories than it does for non-quantitative theories.

Frances goes on to discuss some of the limitations of purely quantitative models. She's broadly right. She then criticizes some heterodox theorists who, in her opinion, focus too much on math:
Noah's post unfortunately seems to have elicited some rather defensive responses from the heterodox community, along the lines of “But we DO like mathematics!” or even, “Actually our mathematics is better than yours”. But this is to buy into Noah's core proposition. The heterodox economics community should - and, to be fair, in most cases does - reject it outright.  Economics is not, and cannot be, exclusively mathematical...There is no need for the heterodox economic community to be defensive about vagueness.
Again, Frances demonstrates a deep misunderstanding of my thesis. I never said that econ theory should be exclusively mathematical, nor do I believe it. This confusion is partly the result of the title, and partly the result of me just not explaining my thesis well enough.

Anyway, those are the responses I've seen. Thanks to everyone who took the time to respond!