Thursday, December 5, 2013

Meltdowns and Mankiw

Two classic tantrums caught my attention this week, and they are both promising signs for the future of humanity (at least in some small way).

The Australian group-think collective and former news outlet had a dummy spit over the rise of, well, competitors practising journalism. John Quiggin sums up a few hilarious take-downs, but here is another

The second tantrum, although not so new this week, is from the top 1%’s economic propaganda consultant N. Gregory Mankiw. It’s a rant about how Mankiw finds it ‘hard to square the rhetoric of the left with the economist’s standard framework’.

There are many responses to Mankiw’s article - here, here, here, here, here.

Together these rants reveal the current desperation of the entrenched elites in Australia and the US. Their cushy rent-seeking positions are being eaten away by a more informed new generation. Occupy Wall Street was a massive boost for those seeking greater equality and stimulated a widespread interest in the power structures that dominate corporate and political life. Any changes that stem from this I hope will be for the better, though I fear that like any group with their backs to the wall, the elites will come out swinging with the introduction of crazy laws protecting their interests. 

Change doesn’t come easy. 

I want to spend some time now also discussing why Mankiw’s thinking epitomises problems with mainstream economic analysis in general. 

When I suggested that Mankiw’s rant is fairly representative of mainstream economic thinking, I was immediately faced with this question on Twitter
Why is Mankiw's terrible attempt at philosophy representative of mainstream economic theory?
Since you can’t explain much in 140 characters or less, I figured I may as well elaborate on that point here. Which is that Mankiw sets up fictitious model worlds in which we are asked to consider the role of inequality. These worlds are meant to be representative of economic models of near perfect markets, while at the same time, they application of the model is inconsistent with its core properties (if you in equilibrium there can be no shocks, nor a rise in inequality). To be clear, this is exactly how economics is taught, which should be no surprise since Mankiw is one of the most popular economics textbook authors. 

He concludes that
It is, I believe, hard to square the rhetoric of the left with the economist’s standard framework
Which is to say that if you believe the core economic models, you can't buy into debates about inequality.

This ignores the important issue that inequality is completely unable to be understood with the core models of economics where a mystical 'representative agent' stands in for all individuals. As soon as any degree of disaggregation occurs, such that inequality can exist, we aren't in that model world of economics anymore!  

Mankiw starts by having us imagine a world of ‘perfect economic equality’. One he describes as ‘an equilibrium in which everyone earns exactly the same income’. To any economically literate reader, this reads ‘markets are complete and perfect and all are in equilibrium’. So far, he adheres to the fantasy world of the core model of economics.

Then we are to imagine that in this utopian model world an entrepreneur with an idea for a new product emerges, such as his example entrepreneurs Steve Jobs and J.K. Rowling. Through voluntary exchange, people buy this new product and these entrepreneurs get rich. So what’s wrong with that?

Nothing, so long as we forget the model!

In the model world Mankiw sets up, these entrepreneurs cannot get rich because markets are competitive and all profits are zero. They cannot sell their product for anything above its cost as consumers will substitute to any one of an infinite array of alternative goods being produced. We will simply return to the previous equilibrium.

He starts with a clear economic model, then he leaves out selected elements of it so the result suits his political agenda. 

Later in the paper, he raises the common mainstream view that there is a trade-off between equality and efficiency. This is a very common view that I see in many papers and presentations, and I almost never let a presenter get away with it.

The apparent trade-off arises in a different model world where we are already at some perfect equilibrium and wish to make a change in favour of equality. Because changes are costly, moving from this equilibrium to one with more equality has a cost.

What is hidden here is that when you profess an equality-efficiency tradeoff using this model logic, you must ignore include the costs of moving from the current equilibrium to another, but ignore the costs of maintaining the status quo equilibrium.  

Unlike in the model, in reality, the distribution of wealth is always and everywhere a product of the institutions we create. In this reality, the important question is, why are current institutions that allow the current degree of inequality so much less costly than the ones that allow less inequality? 

Later, Mankiw elaborates the foundation of his view in why inequality is justified in the section “Listening to the Left”, where he simply asserts that the rich have earned their ‘just deserts':
My own reading of the evidence is that most of the very wealthy get that way by making substantial economic contributions, not by gaming the system or taking advantage of some market failure or the political process.
Of course he thinks that. In his model world it is impossible for political processes to be gamed, therefore he simply asserts that the model outcome must be the reality! 

Given all this weaving, ducking, and model trickery, either Mankiw 1) doesn’t believe the models he has been teaching for the past two decades, or 2) he is applying them willy-nilly to support his own moral and political stance. 

I suggest a little of both.

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