Thursday, July 9, 2009

Economic Science: Back To The Basics

My book (on lessons from socialism) is about using the grand experiment -- to run an economy efficiently through replacing the market with a plan -- to understand economics. After all, economics is precisely about what an economy is: the question of whether this experiment should work, and why, seems very central. Is an economy by nature a market economy? Or is it just as workable to replace the market with a plan? Or, if not completely replace the market, can you replace bits of it, or guide the market? And, if the latter, then why can't you replace the whole thing (why is that different?) and does the answer to that question have bearing on how well a partial replacement or guidance will work?

So, my interest in economics is very basic: getting back to the basics of what economics is. Getting to the core. And, I think generally this is what Austrian economics is about. Austrian economists do not want to take what other economists have done and add fancy and tangential extensions to it, or mathematically prove something into or out of existence. Austrian economists want to ask fundamental questions about economic systems that often appear easy or obvious, and then carefully and methodically work out the answers.

This is also what makes Austrian economists great teachers: at least a couple of Austrian economists that I know are, in my opinion, at their worst when they attempt to do conventional-type work that they can publish in top journals, and at their best when lecture to students or present to (or publish for) non-academics. Does this mean that Austrian economics is not scientific - that it is only palatable to the uneducated? No, I do not think so at all. Conventional economics is based on absurd, often times bizarre, assumptions. Economists realize this, but excuse it because they hope the simplifications will help to generate useful predictions. Economists then build elaborate models and equations based on these assumptions, and learning all about what they've done takes years of academic training.

However, most of Austrian economic insight is not built on such assumptions, and it is therefore not simplified enough to build elaborate models and equations upon. It therefore does not take years of academic training to understand these basic insights--instead it takes a few hours to begin to understand the basic insights (if they are taught well). After that, of course, they can be more and more deeply understood, and applied to different policy questions, economic questions, and other pursuits.

This also leads me back to where I started: Austrian economics is about the basics. Understanding and applying basic economic principles to questions in daily life. I think this is good. I do not think that we need elaborate models built on absurd assumptions: models are fine, but they are not the really critical thing. The really critical thing is to understand what economic system works best for what ends, and why. This can then answer "how can we increase economic growth?" and "can we help developing countries to grow? why are they poor in the first place?" and "should we nationalize the banks?"

It is highly unlikely that an elaborate economic model built on incredibly simplifying assumptions will answer this first and most fundamental question better than a study of the fundamentals.

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Sunday, June 28, 2009

The Soul of an Academic

Here is a profound quote from The Sisters by Vikenty V. Veresaev, that I think gets to the core of an idealistic academic:

We were going to work together, but somehow neither of us were inclined to. We decided to have a drink. Nurka brought a bottle of port wine. We drank it, and lay down on the bed. I began to "preach" to her. I said there is no such thing as love. There are only sexual needs. She looked at me sadly with her innocent blue eyes; it hurt her to listen to me. She dreams of a "pure" love. I laughed at her and said: "Rubbish! Can a Komsomolka be such an idealist?"

I suddenly remembered and struck my forehead:

"The synopsis! I'd forgotten all about it!"

I sat down at the table and wrote out the synopsis for the lecture.

The next evening came. ... My speech poured out, vivid and unhesitating. I laid down the economic basis, passed to materialism, and so on and so on. ... The young folk were impressed; they're thirsting to be shown the path to the new life. And this is what I longed to say in the concluding words: "Listen all of you! I haven't been speaking seriously, I was making fun of you, I wrote out the synopsis of my speech when I was drunk. It was very easy because there was nothing of mine in it. I have only repeated what others have written before. I have no ideas of my own any more than you have. Tear up your notes and lets begin from the beginning; lets find the way to the new life with our own brains."

I wanted to go home alone, but I had to go with some of the others, and we argued on the way. I got heated trying to prove something, and when I reached home my heart was very heavy and I even cried into my pillow when everyone else in the room was asleep. It appears that, in order to be a charlatan, you must have a great sadness in your soul.

That about sums everything about academia up that I know.

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Thursday, May 21, 2009

The Time Factor

Pete Leeson wrote recently, on the Somali pirate situation, that "the market has spoken," he said:

The market has spoken: Even in today’s pirate-infested waters off Somalia, the low probability of being captured by pirates, together with the fact that pirates release their hostages unscathed, means it’s cheaper--and safer--to go without armed guards.

There were a lot of pretty good responses to this argument in the comments. However, one really fundamental one is this: the market takes time to gather knowledge, respond to incentives and price fluctuations. When we forget this, as Austrians, we look like the neoclassical economist who disbelieves that there is really a dollar in front of his eyes, on the ground, because someone would have already picked it up. As Austrians we should know better.

The planners were right about this. What they got wrong was that a quick government fix would be better. They assumed that government would know, and could then use its swift ability to fix any flaws seen. This is not correct, despite the loud proclamations that we have to "do something" because any quick action is better than nothing--even if the gas truck arrives first, any old liquid is not better than nothing on a house fire. If government's actions both exacerbate the problem, and make it harder to figure out the right solution, it is not better than nothing either.

Government doesn't know, but sometimes the market doesn't know either: before it learns. So, the idea that the "market has spoken" is not necessarily correct. And in some cases, like this one, the "right solution" is based on unknowns, probabilities, and changing circumstances. What this means is that whatever the market "chooses" may or may not work out best. The choice that produces 60% success is a better choice than the one that produces 50% success, if they cost the same, but there is still a 40% chance it will fail.

Then, if it works out poorly, it will be assumed that this was the wrong choice--but it may have actually been the choice with the higher probability of success. It may have been safer, cheaper or wiser, but there is no way to know, at least without a hundred randomized trials. We don't have that--any other similar situation still has a thousand variables, just for the one data point.

If the market chooses, we won't know if it was the right choice. Market purists are wrong to say that the choice was right simply because the market chose it. The choice may be wrong, humans are fallible, information is scarce, and evolving the best choice takes time. Sometimes there simply isn't enough time. There are mistakes and trials along the way. Sometimes it would have been better to choose differently--its a learning process. On the other hand, even if it looks wrong, it may have been right, even as planners point to the failure: statistics are statistics.

If government chooses, we also won't know if they chose correctly. Market purists will say that the choice that emerged in the market was right, because the market chose it. Planners and lovers of the government fix will assume that what government chose was right, because "the people," or the voters, chose it. But, we don't know. We can't know--that is just the fate of being human, and living in a world of time and uncertainty. Life would be pretty boring if this weren't the case, but it makes economics a lot less precise than is usually assumed.

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Wednesday, May 20, 2009

The Five Types of Economist

Yes, its been done many times before. I just had an early morning urge.

1. The Mathematical Economist

"[The mathematical economist] has 30 pages of mathematics, and at the end there emerge the assumptions he put in at the beginning."
- Voprosy Economiki 1948.

The Mathematical Economist should have been a mathematician, but he knew that he would end up teaching community college if he went that route. He also knew how to write down his assumptions (name his variables) at the top of his paper, and repeat them at the end, having done some simple calculus in between. Therefore he knew he could get a top teaching position at a good research university as an economist. The Mathematical Economist has no friends, a wife, two or three children and a bland, pasta-filled life. But he is happy, and has absolutely no idea how the economy works, which makes him smirk whenever he admits it to himself, which is rarely.

2. The Clever Tear-Down Artist

The Clever Tear-Down Artist is the loudest, if not also the most common, kind of economist. The best ones teach at Harvard and win Nobel Prizes. The Clever Tear-Down Artist spends his days writing "one-liner papers" (which are about 10-20 pages) that illustrate cleverly that (if you make certain absurd assumptions) water runs uphill, the Sun actually revolves around the Earth, and Bill Clinton was a faithful husband.

Well established facts are cleverly whisked aside to make room for much more important econospeak and charts and models. Every paper is exciting and pathbreaking, and does it all in just 12 pages! They are great for cocktail parties because they can be explained so easily and they wow the girls. This is important because the Clever Tear-Down Artist is always on a conference loop or book tour, so he finds himself at a lot of cocktail parties.

3. The Whiz-Bang Kid

The Whiz-Bang Kid is a fun breed. He isn't really an economist as much as a clever flame thrower. Unlike the Clever Tear-Down Artist, he means no harm (unless he wants to start a revolution). He isn't interested in poking holes in theory, he is interested in re-writing language. For the Whiz-Bang Kid, 10 pages should be enough to explain the origin of life, and still have space for an homage to his favorite poet. Any one of his papers would win him the Nobel Prize, except that none of them have any content. Although he is brilliant the first time you hear him, and he is clearly smart, after a while it becomes clear that he isn't really saying anything. Probably first in his class, The Whiz-Bang Kid is always chipper and has a beautiful wife. A little quirky, he works hard and everyone likes him. He goes on book tours and possibly becomes a talking head* if he strays too far into policy.

4. The Small Contributor

This breed is excruciatingly boring, which means that they could possibly die off, which would be a great relief. The Small Contributor writes 25-50 page papers offering an extremely well proven argument defending the (already accepted) theory that firms in southeast rural Thailand had seen lower demand for dyed cloth in the 1994-1998 period than in the 1998-2002 period... or at least accepted theory believes that is what this kind of economist writes about, as nobody has actually managed to stay awake through to the end of the title, let alone read a whole paper. It is well established fact that papers written by these economists are tagged "BioHazard" when they reach the peer review office, and quietly passed through without another glance. These economists are either unmarried, or have an equally dull wife, if such a thing is possible for a woman.

5. The Good Economist

...usually either is, or should be, in another department

*I have not included the Policy Wonk, but they are pretty self-explanatory. They wonk.


Tuesday, May 19, 2009

How to be a Great American President

Test "Title"

I have worked out the formula for creating lasting legacy, and an image of true greatness. Someone told me a while back that the American people remember FDR fondly because he carried them through the Great Depression—even if he did make it longer with his bad policies, he was there for the people, and suffered with them (even if he skimmed the cream off the top*).

So, here is the formula:

  1. Run for president right after a stock market crash, preferably with a bank correction, and preferably one that the current president is fudging up.
  2. Enter office and immediately pass a bunch of laws that will slow the correction and lengthen the recession, and bash business a lot, and take them to court; ideally turn the recession into a depression.
  3. Once the recession has set in, begin to transfer powers previously held by other branches to the executive. Don’t forget to reach for the gold, you’ll never get it if you don’t try.
  4. Use these new powers to create a bunch of new wings of government directly controlled by you, and use them to transfer money from one group in society to another—preferably, take from the whole people and give to small groups that will reward you with lots of good publicity and votes.
  5. Most important: make soothing, well-written speeches. Lots of them.

If done right, all the powers over the economy will be nicely controlled from Washington. As written up at the Franklin D. Roosevelt American Heritage Center:

Under the New Deal, the federal government greatly extended its power over the economy. By the end of the Roosevelt years, few questioned the right of the government to pay the farmer millions in subsidies not to grow crops, to enter plants to conduct union elections, to regulate business enterprises from utility companies to airlines, or even to compete directly with business by generating and distributing hydroelectric power. All of these powers had been ratified by the Supreme Court, which had even held that a man growing grain solely for his own use was affecting interstate commerce and hence subject to federal penalties.

Of course, there are other things that you can do to be remembered well, including fighting a long war. But I think those 5 can already bring about a legacy. If we do not learn, history truly does have a way of repeating itself—in this case, likely because someone did learn from history, and wanted to be the next Great American President. Let's not let him.

* John Flynn recalls the scandals that occurred and were well documented by newspapers at the time, of the Roosevelts’ abuses of their position. For example, Elliot Roosevelt had his father convince the A & P Tea Company to loan Elliot $200,000, backed by shares in a Texas radio station. The company went along in order to avoid the New Deal inquiries that Roosevelt could enflame. In 1942, the President gave $4,000 to A & P and demanded the “worthless” stock back. It was worth $1 million, but A & P gave it back to the New Deal architect, and deducted the $196,000 loss off their tax returns.

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Monday, May 11, 2009

Austrian Media Appearances

After watching this excellent Brooklyn libertarian cable interview with Cameron Weber, I started putting together a list of some appearances by Austrian-leaning economists. Here are some I have found and really enjoyed: is one of the bigger-name (but also watered down, and sound-bite filled) choice, it regularly has Peter Schiff and Ron Paul.

Here is an interview with Steve Horwitz.

Bob Higgs, who was brilliant, in a long C-SPAN in depth talk.

Excellent Alex Tabarrok talk at TED.

Finally, here is a Hayek video from his later life.


Wednesday, April 22, 2009

Ideology and Rationality

In an article in the Review of Political Economy on Marx and Schumpeter, there is an interesting mention of Schumpeter's idea of why rational arguments do not dissuade people from socialism.

It reads:

Political attack cannot be met by reason. Reasoned argument may tear the rational garb of attack but it cannot reach the extra-rational impulse that drives it. In any case, in political matters, the masses are generally incapable of seeing where their true interest lies. They see only monopolistic practices, high profits and social inequality. To see the case for capitalism, they would need to see further than the short run, and that requires powers of analysis that are quite beyond them.

In a footnote, the author explains that Schumpeter believes that the rational thinking of most people extends only to everyday concerns and not to broader social and political issues (public choice literature would say that this is because their vote doesn't count anyway, and Bryan Caplan would add that they get comfort at little to no cost believing what they do.)

I think there is some truth to all of this, but why is there such a strong political contingent for socialism, despite so much evidence that it reduces freedom for all and makes every income level in society worse off economically? There is a simple answer.

Consider the following. Imagine that a certain person, lets call him Daniel, is faced with irrefutable logic showing that the socialist society produces an economy in which the income curve is strictly lower than the income curve in a free market society (and one can imagine the same for the 'freedom curve' too). So, the poorest person in the free market society is still richer than the poorest person in the socialist society. The two curves may not differ in relative income either, and in the socialist society, there may even be some at zero income (famine levels).

Faced with this rational argument that free markets are better for everyone, one might think that the rational response to this would be "then they must be better for me, so I should be for free markets!" Perhaps this would be the rational response if he were behind a veil, but he is not. It would also perhaps be a rational response if the way to become wealthy in the two societies was the same--but it is not. In a socialist economy, one gets ahead through politics, schmoozing with the elites, and getting handouts for people in exchange for bribes and power. In a free market economy, one gets ahead by producing things for the customer.

Daniel knows his own talents, so for Daniel what matters is not the absolute level of income in the society over the whole income curve, but where on the curve in each society he personally will land.

So, if Daniel expects to be at position A in the socialist economy, but position B in the free market economy, he will always prefer socialism. Daniel would expect this if he is good at political maneuvering and not so good at creative solutions to fill the demands and desires of his fellow countrymen. This, in a nutshell, is why there will always be a contingent in favor of socialism: its a tragedy of the commons.

The best we can hope for is that most people will take account of the rational argument, and perhaps spread the values and foster the talents of creative entrepreneurship, over the values and talents of politics and schmoozing. Unfortunately, once the rent-seeking begins, it builds upon itself and rewards those values, making it difficult to reverse the trend.

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Friday, April 17, 2009

The Tea Party Protests

I am getting a little annoyed that some people have argued that the Tea Party protests were somehow a corporate funded "astroturf" effort, coordinated by the Republican Party, and that policy wonks rebuttal of that perception is defensive and proves them right. Yes, Republicans and old partisan-oriented groups have jumped on board, but they could not do it without genuine outrage, which is evident in the polls, and they did not organize the 750 protests across the country on tax day.

The people have a message: 84% of Americans are against the current government expansion in the longer term. 44% of Americans are against it even in the short term. The protests were coordinated by different groups in each city--some by Ron Paul groups, some by young conservatives, some by coalitions of different groups. This is no different than the anti-war protests by hodgepodge groups, including partisan ones like Move On, and radical ones, and apolitical ones.

Now, here is a round up of great, and disparate, highlights from the protests.

In NY:

“I think Newt Gingrich is – I think he’s a slime ball,” said Roy Delduco, a self-described Constitutionalist with tattoos up his arm and a shaved head. “I don’t like Republicans. I don’t like liberals either. I don’t like the whole bipartisan system. I think it’s part of the problem.”

Delduco said he wants the Federal Reserve disbanded, the IRS “put in jail” and his taxes lowered. He complained about government spending under both Presidents Obama and Bush.

“We’ve basically bankrupted the dollar, and I’m scared,” he said.

...One young man handed out feathers in homage to the Boston Tea Party; another offered stickers in support of John Galt, the hero of Ayn Rand’s “Atlas Shrugged.”

...Raymond Kwai stood alone in the crowd, holding up a sign that said, in all capital letters, “IF I WANTED TO BE A COMMIE, I’D STAY IN CHINA.”

In San Francisco:

"The government is growing too big," Bernstein said in an interview with CBS News after her speech. "And I grew up in socialism and I've seen it. And this is reminding me more and more of what Poland used to be. I was fortunate to see the transfer from socialism to a free market economy in Poland and i'm very sad to see that the opposite is happening here."

...The San Francisco rally was non-partisan: it attracted Democrats, Republicans, Libertarians, Greens, and independents, many of whom appeared to be supporters of Texas Rep. Ron Paul's 2008 presidential bid

Overall favorite quote: "You can't put lipstick on socialism."

Here is a roundup. Also, check out the coverage by Pajamas Media.

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Thursday, April 16, 2009

Changing the Terms of the Debate

Basically every pro-intervention policy economic argument goes like this:

(1) The neoclassical model says if we do this, output will be lower but

(2) it is naive and unrealistic to believe the neoclassical model represents reality.

Unfortunately, most of the time the free market defender resorts to something like "yes, but it approximates it close enough."

Until we rid economics of the absurd assumptions of the neoclassical model, we will always be on the defensive, and the arguments will be weak. Just think of the eternally frustrating "trickle down" economics description. Yet, very few public figures can explain Austrian methodology, assumptions and models in the soundbite format of modern policy debate; and the public is already familiar with the neoclassical model, and assumes that any free market advocate believes in perfect competition and the tooth fairy.

It is the dominant role of the neoclassical model and synthesis (and mathematical economics) during the twentieth century that brought us belief in the superiority of planning and the supply side/demand side dichotomy. This reminds me of the socialist/fascist dichotomy: they are both wrong and actually similar not opposites. There is an actual alternative on the opposite end of the spectrum, being ignored.

The terms of the debate need to change. In order not to be on the defensive, we need to loudly declare the actual assumptions and structure of our model, and the reasons why it claims that intervention will lower growth, if it does. This is starting - between Freedom Watch and the Ron Paul revolution, the Austrian name is seeing some light of day again. And, now with the Tea Party protests, the tide is turning in the popular mood. Folk Austrianism is trickling in so to say...hopefully with a better face than "trickle down" economics.

There are several Austrian economists working hard to popularize some of the ideas. Lets keep pushing this forward, not be afraid to call it "Austrian" economics, to distinguish it from the neoclassical synthesis, and make sure to point out the major difference: we don't assume that markets produce zero economic profit and everyone is omniscient. We are realistic. You can't wave your hand and say we're naive and so government has to help. They are naive; they are the ones that beleive government produces zero waste and is omniscient.

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Friday, April 3, 2009

Back To The Basics

(Cross-posted at Heritage)

In the New York Times today, David Brooks has a column in which he describes two theories about the financial crisis: “greed” and “stupidity.” The “greed” theory is not what you might be thinking—it is not the simplistic notion that Wall Street is just full of greedy capitalists that swindle the people out of their money. It is a little bit more sophisticated than that, because it involves the government bailing out the banks. They do this, of course, because politicians earn handsome rewards for it. This theory has some merit.

The second theory, “stupidity” is also more sophisticated than it sounds. Wall Street did not know that it was engaged in such risky behavior. The theory as presented blames the complex financial instruments, but one could as easily blame monetary policy, subsidies, bailouts, or policy uncertainty, for creating this ignorance.

Government certainly had a hand in creating this crisis, yet now these same leaders are attempting to blame free markets, and resurrect socialism. Right before our eyes we are seeing the pattern: even as government spending backfires, we cede more control to it, and the love and faith in politicians grows. Even free market economists forget the basics.

Now more than ever, we need to return to the fundamentals. We need to relearn our Adam Smith, our Frederic Bastiat, the roots of liberalism and the morality of freedom. Only if the people understand these basic principles do we have a chance. Then we can see through the politicians, and not let them take our freedom and control our lives.

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