Wednesday, March 25, 2015

Economics: Blah blah blah

Economic comedian Yoram Bauman translates Mankiw's 10 Principles of Economics in this video. The three macro concepts were immediately translated to blah, blah, blah.

Here I want to improve of his efforts and translate some of the many concepts that seem to mystify all who encounter them. Some readers might not agree. Others might have better suggestions. Let me know in the comments. 

Economic Term
Actual Meaning
Accounting unit
Medium of exchange
Medium of exchange
Accounting unit
Accounting unit
Credits and debits (‘promise unit’)
Production function 
Just kidding, economists don't care about time 
Magic attractive force
Current state of the world
Unexplained residual
New recipe
Free Markets
Very specific set of government institutions 
Stylised fact
Deadweight loss
Difference between a real pudding, and the magic pudding
Structural reform
Non-specific legal change to give rich people more power in the name of efficiency
Why aren’t we in equilibrium?
Low wages
Bigger numbers devoid of meaning
Degenerative scientific research programme
Why don’t people agree with me?
Laden with hidden value judgments
State of the world
Opportunity cost
What you could be doing instead
Some other prices
Rent seeking
Buying political favours
Market failure
Real life
Outside the club. Go home.
Pipe dream
Mystical element allowing decisions to be made
Monetary incentives
Short run
Arbitrary time period that makes the model work
Long run
The end of time itself
Perfectly known distribution of possible outcomes
Comparative advantage
Started producing it first
Comparative advantage
Was on/under the land when we conquered
How rich your parents are
Representative agent
One person
Uniform distribution of agents
One person
Property rights
Unspecified institutional setting
Covertly transferring money to people you know
Someone else covertly transferring money to someone they know
Vitally important, but I can’t explain it
AggregationFallacy of composition

Tuesday, March 3, 2015

Coaches’ Calls: Should debt be on the scoreboard?

Guest post by Michael Harris, first published at Medium.
TL;DR version, because it’s long!
  1. There is no reason to think we are nationally living beyond our means at the moment.
  2. There is no “debt and deficit disaster.”
  3. Debt does not mean we (the current generation) are ripping off “our children and grandchildren” (future generations).
  4. It’s the real things that finally matter.
Also: why government budgets are not like household budgets (fallacy of composition; infinity; and printing presses).
1. The scoreboard

On a recent episode of the ABC’s panel show Q&A, radio announcer and former rugby coach Alan Jones declared that “there is a golden rule in sport. You look at the scoreboard. The Labor Party haven’t produced a surplus since 1989,” which certainly sounds like a damning indictment.

But why would that be the thing on the scoreboard? Imagine a football coach looking at the results and details of a match his or her team had convincingly won on the weekend. “OK, so we dominated in terms of share of possession. If we look at ground gained each time we gained possession, we dominated. And, of course, we ended up with twice as many points as the opposition. But look at how many times we dropped the ball! We dropped it twice as many times as the opposition did! This is terrible! You’re all losers!”

This would obviously, and rightly, be seen as the weirdest way possible to judge who won and who lost in that sporting contest. Obviously, the team with the most points wins, regardless of how messy the victory was. A good coach would focus on improving aspects of play that need improvement, but they wouldn’t confuse what’s on the scoreboard with other aspects of performance that contribute to — but aren’t the same thing as — the final score. The team may have dominated the game but still played with fumble-fingers, which would make ball-handling something to work on in training. But it’s not the criterion by which the outcome of the game is finally judged.

Neither is the budget, whether a deficit or surplus is achieved. Unlike a football game, there is no one single final score on which to adjudicate performance, but for a macroeconomy, the trifecta of economic growth, unemployment, and inflation are key indicators that should be up on any “economic performance” scoreboard. The average trend rate of unemployment during the Rudd and Gillard years was 5.1% (a period including the Global Financial Crisis); the average during the period since the Abbott government took office is just above 6%. Inflation is low, with the most recent annualised rate of CPI growth being under 2%, the bottom of the Reserve Bank’s target rate. Too-low inflation, like high unemployment, is symptomatic of a weak economy, a fact reflected in the most recent RBA decision to lower interest rates to a record low. Any sensible score -boarding of the macroeconomy would show that things have definitely not been improving since the 2013 election.

No reasonable analyst would contend that this is entirely the fault of the Abbott government. International conditions are challenging, with Chinese growth slowing, and Europe remaining subdued. The Reserve Bank sets interest rates without government influence, meaning options to manage the economy are few. Any government in power now would find circumstances difficult.

But this is exactly the problem; to manage an economy in difficult conditions requires an accurate understanding of the issues you face, and a willingness to seek — and an ability to listen to — expert advice from professionals on the government payroll whose job it is to provide such advice.

The first — and in current conditions, the worst — mistake to make is to confuse what should be prominently displayed on the scoreboard. As mentioned above, changes in GDP, unemployment and inflation are key magnitudes to monitor. Underpinning those are trends in employment and productivity growth, and international conditions as reflected in our terms of trade. What doesn’t belong in bright lights as a headline indicator is the budget “bottom line”. As a number, the budget outcome is best regarded as an outcome of events in the economy; as a process, the budget is a tool to assist with managing economic performance given all the circumstances it faces. The bottom-line number in any year cannot be finely controlled, and it’s foolish to claim that it can be.

Yet in Australia we repeatedly hear about budget emergencies and debt and deficit disasters. We’re told that we’re living beyond our means, and engaging in intergenerational theft by loading our children up with our debt. So why has political discourse turned so heavily towards treating the annual budget figure as a, if not the, key indicator of economic management? Why has “austerity economics” — with its inevitable focus on short-run budgetary outcomes over everything else — dominated the discussion when budget outcomes are not nearly the most important issues in people’s actual lives?

2. Bad reasons

A worst-case conspiratorial view would have it that “austerity economics” is really code for reducing public expenditure in order to shrink the size — and role — of the state. In this “starve the beast” view, the state is ever-growing as a share of the economy, and this growth must be arrested. Cuts in both tax rates and government expenditure are the intention, but this rather extreme philosophy puts the tax cuts first, in the belief that cutting taxes will reduce revenue and (hence) lead to spending cuts based on the realisation that there is simply less money available for government to spend. Since this contravenes the argument of supply side economics that cutting taxes will increase revenue, it is sometimes posited that starve-the-beast is the post-facto argument to use when it turns out that taxes cut based on supply side arguments have not in fact resulted in the expected revenue increases.

Slightly less conspiratorially, there have been seemingly respectable arguments for austerity economics coming from the economics profession, such as the claim by two leading economists that their evidence showed economic growth was hampered by a country’s high external debt levels, with particular problems emerging when debt levels reached 90% of GDP. Obviously, the principle that correlation does not equal causation applies given that causality could run either way (an economy slowing for other reasons would expect to see its debt-to-GDP ratio rise), and the authors carefully talked of correlations. However, this did not stop their work influencing conservative politicians in both the US and the UK in favour of austerity policies.

(This was not the only academic work used to support austerity economics. “Expansionary austerity” arguments, involving claims that fiscal consolidation improves business and consumer confidence sufficiently to bolster growth, have been proposed by serious academics. But this argument, too, has come under fire.)

Whether legitimate or dodgy, the academic work seems to serve more as a rationalisation than a pure justification for austerity economics narratives. Once you decide to engage in austerity policies, reference to scholarly work that seems to support your approach is convenient to refer to, but not essential to motivating your choice or action in the first place. What makes austerity so compelling in the first place, so that it can be sold to the media and the public as representing plausible and serious policy?

A focus on budget outcomes obviously engages with our intuition about managing our own budget and living within our means. It seems so intuitively simple that it’s obvious; a balanced budget means we are living exactly within our means, and an unbalanced budget means that we are not. In particular, a deficit budget is putting us into debt (successive deficit budgets driving us deeper into debt each year), while a surplus budget is required if there’s existing debt to be paid down (requiring lower spending/higher taxes in future). And if there’s a debt that’s being maintained, clearly it is something that our descendants will be left with to pay back, so we must be impoverishing them, right? Right?

It seems so obvious as to be self-evident. How are we to be convinced that, in fact, this intuition is almost entirely incorrect?

There are at least three reasons that a government budget is not like a household or business budget; so much unlike a household budget that it’s seriously misleading to compare them. They are, in turn, (i) the fallacy of composition problem aka “owing the debt to ourselves”, (ii) the effects of infinity, and (iii) the printing press. Working through these will not only make clear how much a government budget is not like a household budget, but that being in debt does not automatically represent “intergenerational theft” — far from it. But running deficits and accruing debt does have immediate distributional consequences that are worth paying attention to.

3. Government budgets are not like household budgets. Seriously. (Part 1. Fallacy of composition)

Let’s look at the first argument, sometimes referred to as “owing the debt to ourselves”. It’s a basic fallacy-of-composition argument; incorrectly asserting that what’s true of a part is therefore true of the whole. We think of a family/household budget as something run within a household, based on money coming in and going out of that household, just as though it was a single person’s budget, balancing incomings and outgoings. Instead, let’s look at a household budget as if all the debt occurred within the household, with multiple members borrowing from each other.

Think of it this way. There’s a head of the household who manages the “household budget” on a day to day basis. All members of the household earn their own individual incomes, and the head of the household collects a small amount from each of them to help fund collective household expenditures. Other than that, each individual family member manages their own personal budget personally. From time to time, the head of household borrows extra money for urgent household items or investments from other members of the household, writing IOUs that the lending household member can keep in their desk drawers for later repayment. The household head ensures agreed interest payments are made, and is responsible for eventual repayment of the debt. If a surplus fund is not available when any of the debt falls due, the household head simply borrows from another member to repay the one whose repayment is due.

Is the household as a whole impoverished as a result of what are in fact a series of internal transfers? Are future members of the household collectively on the hook for borrowing decisions being made today? The household head may need to increase the amount collected from household members, simply to repay what is owed to some of them, but this is obviously a redistribution of household resources rather than a net loss of household income. Intergenerationally, it is hard to see how all the future children of household members are being impoverished by all the current members.

Two things are worth considering in terms of impacts over time and whether “intergenerational theft” is occurring; first, who is owed repayment (compared to who will be contributing to the household fund in order to build up the surplus needed to make the repayments), and second, what the borrowed funds are used for and whether they have enriching impacts on the household over time. If borrowed funds are used to purchase furniture for common areas in the house, or upgrade the house physically or technologically, those actions will yield benefits to future occupants of the house, in which case it’s hard to see them as having been collectively “stolen from” as the result of the earlier reliance on IOUs.

(It is not for us to wonder why IOUs were used instead of the head of household simply “taxing” the household members more at the time. A deeper analysis could focus on this choice. For now, all we need to look at is the impact on one generation from the choice of a previous generation. It’s clear that the generational impact depends on spending choices made earlier — improving the house in long-lasting ways versus holding more parties, in effect. The pattern of cost-sharing can change based on the use of IOUs versus pure taxation, and that may affect consumption and savings choices of individual household members that flow on to their individual offspring. But the total impact across generations of using debt does not in any way imply future impoverishment.)

Convinced yet? We could look at this a different way, by going back to the Q&A episode we began with. Imagine the 5 guests + host are the entire population of a (tiny) country, with Tony Jones as the head of the country, responsible for its overall finances. Then imagine that Alan Jones and Heather Ridout represent the “rich” members of this society, while Chris Bowen, Jamie Briggs and Corinne Grant are the “less rich” members. Tony Jones runs a balanced budget, until one day he decides to do the following: (1) maintain expenditure as it stands, (2) reduce taxes on the rich folk (Alan and Heather) by cutting the top marginal rate, and (3) issue bonds (IOUs) to cover the difference — the deficit — which Alan and Heather buy up with their extra cash.

The most obvious thing about this is that there is an immediate distributional impact, as opposed to an intergenerational one: Alan and Heather have their tax liability reduced, and end up holding some financial assets they otherwise would not have had. A different tax change — say, an increase in the tax-free threshold — would have different distributional consequences, but these impacts would be felt far more between “rich” and “less rich” than they would between “older generation” and “younger generation.”

Governments do of course borrow “outside the family”, in other words from foreigners. Hence not all of our debt at any time is “owed to ourselves”. But to discuss this at length would require making the point that our domestic savings pool is insufficient for our desired investment, requiring imports of foreign capital, some of which would come in as public borrowing.

4. Government budgets are not like household budgets. Seriously. (Part 2. Infinity)

The above discussion is about the fallacy of composition that is involved in mistakenly treating the government budget as if it were like an individual managing their own finances. The next main difference involves the effects of infinity.

If a household were like a government, then that household would have to effectively live forever. A household led by someone with eternal life and effectively a guaranteed stream of income would be a very safe household to lend money to, and in effect, it would never have to be out of debt because rolling over its existing debt when it came due would be straightforward. The need to be out of debt at some point is a product of finite lifespans. (This is not an argument for always being in debt; just a statement of the fact that always being indebted is feasible.)

Infinity has other weird properties that come into play in working out what different patterns of consumption and investment have over time for a society — in particular, whether we are impoverishing our children by running deficits. With a society of finitely-lived people (I.e. society lasts forever, but individual humans have finite lives as usual), with each generation owning an “endowment” of goods at birth, if we could have each generation give an equally-sized gift of some of their endowment to the older generation, then the oldest generation is better off, and each later generation is no worse off.

This is an example of the weirdness of infinity, where now we are considering an infinite number of generations rather than a single immortal human. Of course, to engineer such a transfer from younger to older requires something akin to a debt transaction; but a more realistic evaluation of the impacts of transfers across generations of this kind involves thinking about (long-lasting) capital goods, population growth and more. UCLA economist Roger Farmer helpfully lists key contributions to the academic literature in this area. Two unsurprising conclusions emerge: first, the analysis is necessarily technical and very difficult for beginners to follow; and second, the answer to the question of whether current debts will cause economic hardship to future generations is ambiguous and depends on the interplay of a number of variables.

Infinity has weird properties. And since nobody knows when a government is going to bring down the shutters and have to clear all its debts — and nobody knows when society will eventually collapse, in which case debts denominated in official currencies are likely to be moot — lenders to the government (buyers/holders of its bonds) simply want to know that their debts owed by the government will be honoured in their lifetimes. A stable government can pay any individual creditor back on a due date by rolling over that debt; effectively, other creditors step in to repay the first.

The fact that people willingly purchase “consols” (bonds without redemption dates, promising an eternal stream of payments) indicates quite clearly that people regard the likely duration of sovereign states as being longer than their own lifetimes.

5. Government budgets are not like household budgets. Seriously. (Part 3. Printing press)

A third reason government budgets cannot be compared directly to household budgets is that government’s can print their own currency. This is an astonishing power that households don’t have.

Printing one’s own currency — and have it be legal tender, and have it be required for payment of taxes owed to the government — is an enormous advantage, which admittedly doesn’t come without consequences, although there are debates about what those consequences actually are and at what stage things become tricky.

Moreover, governments within federated systems (like Australian state governments) and government belonging to monetary unions (like governments of EU states) do not control their own currencies, and have greater restriction on their actions than do governments of independent nations. (Their budgets still should not be regarded as comparable to household budgets, for the previous two reasons.)

6. Conclusions

Where does this leave us?
  1. There is no reason to think we are nationally living beyond our means at the moment. “Living within our means” is a far harder concept to pin down for a government — and for the society it governs — than it would be for a single household. It is not meaningfully understood (let alone measured) by the outcome of a single annual budget. It is also not meaningfully understood by the simple existence of public debt. There are surely better ways to spend the money we’re spending, and different and better ways to raise (more) revenue than we’re currently raising, but it’s hard to have that kind of sensible conversation in a state of alarm.
  2. There is no “debt and deficit disaster.” Debt is one aspect of public finance (and I’ve glossed over much detail around the balance between taxation, borrowing, and money printing, because this post is too long and detailed already), and it’s a thing to be managed sensibly, not a thing to panic about. If we could have that conversation, it would be a significant improvement.
  3. Debt does not mean we (the current generation) are ripping off “our children and grandchildren” (future generations). The choice to finance some activities via debt rather than taxation has distributional consequences, but it’s not obvious that these can or should be cast simply as inter-generational effects, with later generations losing out as a result of our profligacy. Money and assets and liabilities are moving around the place, but the real resource implications (from e.g. infrastructure investments, sectoral adjustments, regional distributions, demographic transitions, productivity implications) are contingent upon subsequent policy choices made.
  4. It’s the real things that finally matter. Whether we’re living beyond our means, and whether the standard of living of future generations will rise or fall, depends on what we deplete and what we improve as we move through time. Our productive capacity, as well as our resource base and environmental quality. If we’re avoiding making productive investments out of a fear of debt—let alone we’re avoiding dealing appropriately with climate change—that’s the clear and present danger for the well-being of people in the future.

Wednesday, February 18, 2015

Housing glut can't stop bubbles

Lindsay David compiled data on Australian home prices recently and found that 52 localities in New South Wales had negative population growth over the decade from 2003-2013. But these places had just as much of a housing price boom as anywhere else, putting to rest once and for all the various arguments that regulatory supply constraints are a key element affecting Australian home prices.

It could be just me, but a town with a 15% population decline really can't be argued to face any sort of housing shortage, indeed arguably this housing glut was insufficient to counteract a 70% price increase over the decade.

Perhaps the answer is that the static demand-supply equilibrium model is an inappropriate tool to analyse the economics of housing.

Thursday, February 12, 2015

Improving 'Neoclassical man' with a gaze heuristic

The gaze heuristic describes the behaviour of people trying to catch ball and is useful when attempting to program robots that mimic human behaviour. Gigerenzer explains that:
The gaze heuristic is the simplest one and works if the ball is already high up in the air: Fix your gaze on the ball, start running, and adjust your running speed so that the angle of gaze remains constant. A player who relies on the gaze heuristic can ignore all causal variables necessary to compute the trajectory of the ball––the initial distance, velocity, angle, air resistance, speed and direction of wind, and spin, among others. By paying attention to only one variable, the player will end up where the ball comes down without computing the exact spot.
We know that dogs follow similar dynamic heuristics when catching frisbees. In more technical terms, dogs follow a 'linear optical trajectory' gaze heuristic. While I thoroughly recommend reading the full paper on frisbee-catching dogs, we can examine the most basic gaze heuristic described by Gigerenzer to show the logic of behaving according to these heuristics in a dynamic world of uncertainty. In essence, I want to show that due to uncertainty human behaviour is dynamic and differs radically from the homo economicus behavioural assumptions almost universally applied in economic analysis. Further, such behaviour can be identified as the mechanism which connects price and investment dynamics in economic systems.

Below I summarise the basic difference in behaviour between neoclassical man, who makes a choice at a particular point in time based on expected probabilities, and dynamic uncertainty women, whose behaviour responds to the dynamics in her environment.

Neoclassical man observes the ball, develops a probabilistic expectation of where it will land, and instantaneously positions himself at the most probable position. Dynamic uncertainty women observes the ball and begins running from her current position towards the ball, linking her run to the ball’s trajectory by fixing her angle of gaze.

We can think about the ball as the environment our catchers respond to. Neoclassical man sees the ball’s position and generates expectations, ignoring its dynamics of velocity and acceleration, or merely developing some expectation about them. In economic models, such behaviour is reflected in static optimising on price levels based on expectations. But to dynamic uncertainty woman, the position of the ball has no effect on her behaviour. Her own velocity is tied to the ball’s velocity through the fixed gaze angle, no matter what her starting positions or progress in her run. Only as the ball accelerates does her action change, and she will accelerate her run as the ball accelerates towards the ground (including changing directions when the ball drifts). In economic terms, the ball is the business environment and each individual catcher is making their running investment decisions in response to that dynamic environment. Using a gaze heuristic this implies matching running speed (investment rate) with the balls speed (rate of change in real demand).

So what happens when the business environment changes? In our analogy, this implies an acceleration of the ball (a change in velocity). We know from experiments on dogs chasing frisbees thrown in order to swing severely that the reaction of a dynamically uncertain dog will be to change paths at the current relative position by adopting a new gaze angle linkage with the ball.

Below we see dogs reacting to a swing in a frisbee throw by updating their gaze heuristic and following a new path in relation to the frisbee’s new velocity. 
Under dynamic uncertainty a change occurs via an acceleration in environmental conditions. In economic systems these environmental conditions could be asset prices, product demand, or some another indicator guiding investment decisions. Remembering of course that investment decisions by businesses in one part of the economy generate the economic conditions that other firms respond to, meaning that economic cycles are emergent phenomena of interacting uncertain agents, be they firms, governments, consumers, banks and other actors in the economy.

Applying the gaze heuristic to investment decisions, where asset prices are the environment to which investment responds, results in an incentive to bring forward investment when the acceleration of asset prices is positive, and an incentive to delay investment when the acceleration of prices is negative.

The 'micro-foundations' for this behaviour requires some explanation. In essence asset owners, be it land, or some other scarce monopoly right, face the decision of when to exercise their option to invest in irreversible capital equipment that takes advantage of those rights – construct a building to package with property rights, build a transmission tower to package with spectrum rights, and so forth. Since the option has a value growth over time without needing to be exercised, the optimal time to exercise will be when its value is increasing at an increasing rate (accelerating).

The cyclical link between asset prices and investment arises because when investment is brought forward it slows the acceleration of asset prices, providing a feedback in the system.

To be clear I show below a stylised cycle that results if people behaved like Dynamic Uncertainty Woman in an economic environment; monitoring the dynamics of asset prices and adjusting the rate at which they invest in new capital in response. We end up with an out-of-sync cycle of asset prices and investment activity.

There is also a very tight link between this behaviour under uncertainty and the numerous empirical relationships observed by Steve Keen between the acceleration of debt, the growth rate of asset prices, and the employment level.

Keen observes that the acceleration of the debt level approximates the rate of change in the price level of relevant asset classes, while my additional input is that investment growth responds to acceleration of prices.

This analysis implies the following relationships: Debt acceleration creates price growth, which creates investment (and employment), but that investment also requires debt funding, leading to more growth, and a cyclical feedback. If price acceleration is a key factor determining investment growth, then perhaps even the third derivative off debt, the jerk, is leading to tangible behavioural results and implying the potential for high degrees of instability in the system. 

To me, it makes perfect sense to first look at human behaviour in dynamic settings before conjecturing about what is or is not optimal by introspection. The widely observed gaze heuristic in humans and other animals provides a clear case where dynamic behavioural rules lead to effective actions in other settings. But the same logic applies in social and economic environments as well. Too often the introspection approach to economic theory overlooks our easily observed biological instincts which evolved in a dynamic and uncertain world.

Monday, January 19, 2015

Economics of how Triple J makes music better

Brendan Markey-Towler
19 January 2015

As I was driving to work today I was treated to the dulcet tones of Peter Garrett’s radio voice as a guest on Triple J – the ABC’s “youth-oriented” radio station. Aside from musing about how much better I like the former contortionist and Midnight Oil front man now that he is no longer a political contortionist (also known as a federal minister – apologies to Mr Garrett, being an Australian I have an instinctive, possibly pathological, definitely worrying prejudice against politicians), I also got thinking about what economics has to say about the quirky little offshoot of Australia’s much loved “Auntie”.

For those who don’t know, the station is a little as if the pirate radio stations in the North Sea during the 1960s had been run by the BBC, funded and sanctioned by the British government. It is deliberately designed with the teenage-to-late-30s demographic in mind and seeks out artists who wouldn’t be in the mainstream of the music industry. The music is almost always that which would be classed as “alternative” – at least until it’s picked up by a major station. The artists are often Australians, Kiwis, and Brits, and less often American than one would expect. It is not uncommon for the guest artists of the station to be doing interviews on their day off work – jobs they hold to survive whilst playing the underground music scene in Australia’s capital and major cities.

The station does not host advertisements, and would be unlikely to attract them anyway if it did, given the size and demographic makeup of its listener base compared to other major radio stations. It does host ABC-quality news and current affairs programs (such as Hack) of a quality rarely available to the bulk of Australians, let alone the listeners of Triple J (who, often being the disaffected youth of our age, are probably the most likely to need its information). With this profile, in the modern commercialised age, the station would not survive on a commercial basis. So why have it? Why should the government continue to take the taxes of everyone to provide a service for the few?

It can be difficult to rationalise the ongoing support of the Australian government for Triple J using standard economic analysis, in which markets are made up of perfectly informed individuals with computational skills that would make your typical Australian blush (and then reach for their tall poppy clipper). As my teacher’s teacher Frank Hahn used to say “we’ll pretend that people know exactly what they want and exactly how to get it”. If everyone knows exactly what they want and exactly how to get it, the justification for Triple J’s basis must rest on market failures – deviations from the perfect competition model.

One failure Triple J might remedy is a lack of information – people don’t know exactly what they want, or exactly how to get it, so Triple J needs to make this information available. This argument is a little weak, given that Triple J has a niche position in the market, such that we would be able to make the case that the vast bulk of the market finds this information not particularly valuable. At least, not to the extent it is economically worthwhile to make the whole population pay for the improvement of information with their taxes.

A second argument is a much stronger, if rather vague one, about “externalities”. Triple J could be argued to have a “positive externality” – a benefit which does not accrue directly to the listeners of Triple J, but rather “spills over” to the rest of the economy – for instance, by supporting a “creative” environment for entrepreneurs in the music and other industries. This argument for Triple J’s existence is a stronger one than remedying information problems, but it is notoriously difficult to identify and measure these benefits using standard economic analysis.

I would offer another rationalisation for the ongoing support of Triple J from evolutionary economics, one which supports the standard economic analysis of Triple J as a source of positive externalities. The existence of Triple J in the Australian music industry generates variety without which the market would not have as high a quality provided to consumers as it does.

Evolutionary economics sees the market economy as an evolutionary system similar, but not identical, to an evolutionary biological system [1]. A market system, of which the music industry is one, consists of ordinary (neither rational nor irrational) human beings within production organisations (bands) trying to compete for the custom of consumers (listeners, via radio stations and album sales).

All evolutionary systems are characterised by the same three step process. In the first stage, a variety of “selection units” (genetic characteristics in biological systems, different products in a market system) is generated, before that variety is subjected to “selection” (by natural selection in biological systems, by consumer choice in market systems), and from this process emerges a set of “retained” selection units (genes which survive in biological systems, products which continue to be sold in market systems). The improvement of “fitness” in the market system comes from the selection by the system amongst the variety of different goods and services (songs in the music industry), some of which are deemed of better quality than others by consumers.

Without variety, the market cannot act to improve quality, and the more variety generated within the market, the better (with some caveats) the overall average quality within the market will be. This is actually a mathematical fact [2], which holds true of all evolutionary systems, including economic systems [3]. In general, the greater the variety within an evolutionary system, the greater will be the rate of increase in its average “fitness”, or quality. The greater the variety generated within a market system therefore, the greater will be the quality of the alternatives on offer to the customers. Many products for consumption, including artistic products, will fail to be selected, and their producers will not succeed, but without the competitive pressure generated by their existence in the first place, we would not have a basis for selection of the highest quality anyway. In evolutionary systems, it is a mathematical fact that strength comes through diversity.

What differentiates the economic system that is the music industry from a biological one is also that the generation of variety in an economic system is purposeful [4], where in biology it is taken to be random [5] or at least well beyond human control. We can ourselves choose to generate variety which helps to drive the evolutionary process. This is why there is a solid economic case for the government’s ongoing support of Triple J.

Triple J acts as a generator of variety for the music market in a manner in which commercial stations simply cannot. Commercial stations, for perfectly legitimate reasons, must be driven by the profit motive. They need advertisers to pay for airtime, which requires that they have a significant listener base, which requires that they play music they understand to be popular to a broad audience. This naturally limits what they can air, and indeed, means they will in all likelihood offers very similar listening to each other (this is very similar to the median voter theorem in economics). They literally cannot afford to air a wide variety of “alternative” music. Triple J, being funded by the government has no such concerns, and is in fact mandated, in effect if not in law, to seek out alternative, and particularly Australian content, and has a forty year history of doing so.

If it were not for Triple J expanding the variety of material in the market, we would find that the overall average quality in the market for music would be lowered, as dictated by evolutionary mathematics. Being unencumbered by commercial concerns, Triple J serves an economic purpose by bringing to the market music which people would otherwise not have known they enjoyed, and which would have been too alternative, and, Catch-22 like, unestablished for a commercial station to take a risk on bringing to the market first.

This means not only that it by itself will provide greater variety, and hence enhance the quality of the overall market, it means that the commercial stations also have a source for new artistic material which they would not otherwise have. It will often be the case that one will hear an artist on Triple J, and a few months later the same artist will be given some airtime on commercial stations, at which point they can become quite successful commercially as well as artistically. I seem to remember that the New Zealand born artist Lorde was noticed by Triple J after filling in at a festival in Australia the station had been covering. Her music, spare and trancelike with more or less only percussion, a bass and vocals is quite unlike anything else in the music industry, certainly the mainstream thereof, and one could make the case it would not have become so well-known had not Triple J been able to establish her music in the market relatively unencumbered by concerns about appealing to a broad segment of the population.

Of course, much of the material aired on Triple J will not become commercially viable, but this is simply a manifestation of the selection processes of the market. What does survive in the market place due to Triple J will enhance the overall quality of the offerings of the music industry.

This is one source of the externalities of the radio station, upon which standard economics builds its strongest case for government intervention in the music industry. Triple J and its listeners do not acquire all the benefit of their activities, some of it spills over into the commercial sphere when the commercial stations pick up an artist who is actually appealing to a broad cross-section of society, but would have been a risky proposition to give airtime to. But also, by providing a variety of music free to air which is alternative, cutting edge, pushing the boundaries and all of these too much so for airing on a commercial station, Triple J provides a platform whereby artists (not always individuals with the greatest access to material resources) can access and influence each other. The station in this manner provides a platform where the variety of miners at the coalface of music can be made available to the public, and learn new ways of advancing along and exploring their own vein.

Triple J is a (comparatively) very cheap [6], somewhat unusual and quite successful example what evolutionary economists call a “national innovation system”. National innovation systems typically involve large scale schemes for providing financial backing to many small projects which would be unable to obtain finance from responsible banks in spite of their promise and potential importance. Often these projects will go on to constitute significant advances in the quality and function of items produced by an economic system, as the mathematics of evolutionary markets dictates. Mariana Mazzucato (2011) has provided a wealth of examples where national innovation systems provided financial means for innovators to obtain the critical mass necessary for many innovations which simply would not have got funding otherwise - such as almost all technology within the iPhone. In the Australian music industry, all Triple J needs to do the same is to give airtime to some songs, at the cost of the wages of the people who run the station, the cost of broadcasting equipment, and the other incidental costs of operating a radio station. It is an excellent example of just how little the government need to intervene in the market sometimes to create a significantly improved market outcome, while leaving the positive aspects of the market process more or less unaltered.

So, on this the 40th anniversary of the foundation of Auntie’s eclectic offshoot, we can reflect once again that Australia is the “lucky country”. I am no expert on Australian political history, but the Whitlam Labor government likely instituted Triple J (Double J as it was then known) in 1974 for reasons other than promoting the generation of variety for evolutionary market processes to create a higher quality market. Much more likely, it was part of the Whitlam government’s vision for a more progressive Australia, to differentiate it in the eyes of the youth from the staid, conservative Menzies era government by reaching out to them with their music. But in trying to give the youth the music their parents disapproved of, the government also (probably inadvertently) instituted one of the most important institutions for the health and strength of the music industry in Australia.

Three cheers for Triple J.

[1]. Pioneers in this field were Nelson, R., Winter, S., 1982, An Evolutionary Theory of Economic Change. Harvard University Press, Cambridge, Massachussetts., while a more modern and generally accepted statement of the framework can be found in Dopfer, K., Foster, J., Potts, J., 2004. Micro-meso-macro. Journal of Evolutionary Economics, 14(3), 263-279.

[2]. Price, G.R., 1970. Selection and Covariance. Nature, 227, 520-521, Price, G.R., 1972a. Extension of covariance selection mathematics. Annals of Human Genetics, 35, 485-490, Price, G.R., 1972b. Fisher's "fundamental theorem" made clear. Annals of Human Genetics, 36, 129-140.

[3]. For instance, Metcalfe, J.S., 1998, Evolutionary Economics and Creative Destruction. Routledge, London., Metcalfe, J.S., 2008. Accounting for economic evolution: Fitness and the population method. Journal of Bioeconomics, 2008(10), 23-49. and Markey-Towler, B., 2014, Law of the Jungle: Firm Survival and Price Dynamics in Evolutionary Markets.

[4].  On this, one would do worse than consult Foster, J., 1997. The analytical foundations of evolutionary economics: From biological analogy to economic self-organization. Structural Change and Economic Dynamics, 8, 427-451. and Witt, U., 1999. Bioeconomics as economics from a Darwinian perspective. Journal of Bioeconomics, 1, 19-34.

[5].  For an emphatic, almost dogmatic defence of this idea, also known as the “central dogma of biology”, see Dawkins, R., 1976, The Selfish Gene. Oxford University Press, Oxford. 

[6].  National innovation systems in the Australian context have been discussed at length by Dodgson, M., Hughes, A., Foster, J., Metcalfe, J., 2011. Systems thinking, market failure, and the development of innovation policy: The case of Australia. Research Policy, 40, 1145-1156.


Dawkins, R., 1976, The Selfish Gene. Oxford University Press, Oxford.
Dodgson, M., Hughes, A., Foster, J., Metcalfe, J., 2011. Systems thinking, market failure, and the development of innovation policy: The case of Australia. Research Policy, 40, 1145-1156.
Dopfer, K., Foster, J., Potts, J., 2004. Micro-meso-macro. Journal of Evolutionary Economics, 14(3), 263-279.
Foster, J., 1997. The analytical foundations of evolutionary economics: From biological analogy to economic self-organization. Structural Change and Economic Dynamics, 8, 427-451.
Markey-Towler, B., 2014, Law of the Jungle: Firm Survival and Price Dynamics in Evolutionary Markets.
Mazzucato, M., 2011, The Entrepreneurial State. Demos, London.
Metcalfe, J.S., 1998, Evolutionary Economics and Creative Destruction. Routledge, London.
Metcalfe, J.S., 2008. Accounting for economic evolution: Fitness and the population method. Journal of Bioeconomics, 2008(10), 23-49.
Nelson, R., Winter, S., 1982, An Evolutionary Theory of Economic Change. Harvard University Press, Cambridge, Massachussetts.
Price, G.R., 1970. Selection and Covariance. Nature, 227, 520-521.
Price, G.R., 1972a. Extension of covariance selection mathematics. Annals of Human Genetics, 35, 485-490.
Price, G.R., 1972b. Fisher's "fundamental theorem" made clear. Annals of Human Genetics, 36, 129-140.
Witt, U., 1999. Bioeconomics as economics from a Darwinian perspective. Journal of Bioeconomics, 1, 19-34.

Tuesday, December 16, 2014

Why is terrorism so frightening?

Brendan Markey-Towler

Yes, it is the bullets, the bombs, the blood. Yes, it is that it could happen any time and to anyone. But these things are somewhat held in common with gangland violence. Yes, it is that the terrorist is indiscriminate, human life is incidental to their cause, and is sacrificed to the end of terrorising a population for a political purpose. But nuclear weapons have similar properties. It is my contention that terrorists are so frightening, in part, because they are madmen.

Madmen are frightening not because they are irrational, quite the opposite. It is the hallmark of madness that the most insane acts are defended and supported by the most rock-solid logic. This logic is based on a most distorted – to “us” the terrorised – interpretation of the facts, but it follows the rules of logic nonetheless. Their argument therefore cannot be fully defeated by reason.

I suggest that the terrorist is so frightening because of this; that at least in part they frighten us because we can’t reason with them. The terrorist shows us that reason has limits, that those limits mean reason can become, to slightly misuse David Hume’s immortal phrase “the slave of the passions”, and that reason can justify the most insane acts. We feel frustrated by the terrorist in much the same way we feel frustrated because we struggle to find an answer to Isaiah Berlin’s question “is the idiot who thinks he is an egg to be condemned solely because he is in the minority?”

The individual who brought terror to our nation recently may have been mad, but he would not have been irrational (in the old-fashioned sense of being “without reason”), and that is why he is so frightening. If the negotiators asked – as I suppose they must have – “why are you doing this?” he would have likely given them many reasons for his actions which could easily have been honed into a logically solid argument. It is possible that no amount of counter-argument, presenting another logically solid argument arrived at by a different interpretation of the facts, could have persuaded him to abandon the reasons for his actions.

We all know what they might have been. While he may not have been claimed as one of their own by the group to whom he pledged his allegiance, the individual deliberately made his act a political one, justified by what he saw as the oppression of Muslims in this country. He would have pointed to the innocents who have been killed by bombs dropped and bullets fired by Australian soldiers in the Middle East, to the recent anti-terrorism laws passed within Australia, the minority status of the Muslim community in Australia as evidence of oppression of Muslims by our government. Since he could not achieve his aims of freeing those he claimed as his brethren by the establishment of an Islamic caliphate via the ballot box and since Australia and its allies have overwhelming military might in a conventional battlefield, to further his aims he had to resort to engaging in what we call terrorism.

Logic on its own cannot defeat his argument, because what differentiates this madness from sanity is not reason, but a different perception of the facts of the world, about which reasoning is all but impossible. We cannot reason with individuals such as these because no logical argument will persuade them to see the world in the way in which we see it.

We could not force him to see by logical argument to see that, yes, Australian bullets and bombs may kill innocent civilians, but the Australian military tries to avoid this where possible, and ultimately it must act because as a nation with the ability to act Australia has the responsibility to act to stop more innocent civilians and children from being killed by extremists’ bullets and bombs, let alone prevent them from growing up in a society where their freedom is severely constrained in the name of God. We could not force him to see that anti-terrorism laws are necessary to prevent harm being brought to civilians within our country, and that there is in fact a great deal of debate even within parliament about the extent to which we as a society can trade off security against our ideals with respect to these laws.

We could not force him to see that our elites understand the glories of the Muslim civilisation without which St Thomas Aquinas would likely never have discovered Plato and Aristotle (burned and buried by early Christians), or European mathematicians the Hindu-Arabic number system which we use to this day, or the stunning design from which our architects draw. We could not force him to see the kindness and inherent decency - which one only really appreciates in comparison with the rest of the world - with which the bulk of the Australian population treat each other irrespective of colour or creed. We could not force him to see that while Muslims suffer as a minority in Australia at the hands of some of our zealots, our nation as a whole, painfully aware of the more shameful aspects of its history of racism and bigotry, is doing credit to the better parts of its history by trying to combat these forces in modern society.

What we see in the terrorist is the most severe and devastating manifestation of an increasingly common phenomenon across our world – the submission of reason to passion, and the resulting construction of logically solid cases for insane views and acts which categorically contradict our humanity. The terrorist perceives the world in a manner consistent with their passionate adherence to an ideology, and uses reason to construct a disturbingly logical interpretation of the world which justifies murder in the name of something supposedly higher than human life.

The terrorist is a more extreme version of the Marxist who takes a refutation of their ideology to in fact be a support thereof - “the soviet economy could not provide bread for its people because western imperialist powers sabotaged the plans of the central planners”. The terrorist is a more extreme version of the creationist or the radical evangelical who argues “dinosaur fossils were put there by god to test our faith”. The terrorist is a far, far, more extreme version of the right wing extremist who sees an Aboriginal community in poverty and feels only that “this community deserves their poverty because they are unwilling to work”. The terrorist is a far, far, far, more extreme version of the most extremist climate change denier – “of course we see evidence of global warming, because climate scientists are paid to find that evidence”. None of these arguments can be refuted on logical grounds alone, because they follow logically from a particular interpretation of the facts of the world, which isn’t completely without foundation, and about which it is extremely difficult to argue. For the terrorist, as with any political fanatic, logic becomes the servant of an ideology, reason is placed categorically above humanity, and only a different perception of the world reveals the madness of the logical system constructed by the extremist.

The problem presented by logic needing to be based on subjectively perceived facts is well known to philosophers, as it presents significant problems for science. The great philosopher of science Imre Lakatos characterised the advance of science by the interaction of “research programs”, systems of logic such as general relativity, quantum mechanics and Newtonian physics, connecting together bits of information in a logical fashion but which, ultimately, are the outcome of assumptions about the world which cannot be tested, and which cannot be reasoned about. A good example of such assumptions is the Leibnitzean principle of sufficient reason – that everything must have a cause. Another is raw materialism - the assumption that all which exists must be something we can see or touch. Science progresses only because (and if) scientists recognise the limits of reason and distance themselves from their identification with a particular research program, in a sense not taking it too seriously, and allowing their ideas to grow or fade according with how well they explain the world. Those who do take the reasoning contained within a particular research program too seriously, and who explain refutations solely on the basis of a particular interpretation of the facts are no longer scientists.

The scientists get around the problem that one can find reason for any view if one interprets the facts in a certain way by standing somewhat aloof to and recognising the bounds of reason, and recognising that it can only be based on assumptions which cannot ultimately be reasoned about. What is true of science, is true of reason in general. The terrorist, as the fanatics and the madmen do, places their perception of the world and the reasoning based upon it above everything else.

The difference between the terrorist who kills to further the cause of setting up a utopian society, and the “Western” government which kills in the name of their citizens lies in the perception they have of the facts of the world and their willingness to hear alternative points of view. We can reason with the “Western” government, we cannot reason with the terrorist, we can only isolate them from the rest of humanity. This, I think, is a special property of the terrorist which makes them so frightening, they kill on the basis of reasoned argument like our governments do, but while we can see their argument is mad and justifies insane acts which are devoid of humanity, we cannot ultimately articulate why other than “we see the world differently to them”.

I think, however, that this realisation offers us a means of fighting the terrorist and thwarting their aims. In cases such as these where no logical argument will persuade an individual to see the world in the way in which we do, we must withdraw from logical arguments and instead affirm the place of humanity above reason fed by ideology in our speech and our deeds.

The difference between the terrorist, or indeed any fanatic, or any madman who believes god or some Fuhrer calls them to some greater purpose, and the sane individual is that the latter admits the limits to reason and places humanity above a reasoned, logical, argument which goes against it. The difference between our nation and the terrorist is that our government does terrible things in our name, but our nation - or at least parts of it - attempts to conduct a reasoned debate about whether these terrible things prevent a total descent into savagery and are the path of lesser evil.

The most disturbing thing about any ideology is that it asserts the primacy of reasoning from a particular ideology over this common humanity. It goes against what Adam Smith called “sympathy”, (more accurately “empathy”) which human beings feel for each other, an ability to understand and feel another’s suffering which drives us to care for each other and minimise the suffering we cause. Smith’s contention was that this feeling of common humanity was the basis of civilisation. We can find evolutionary reasons why this is the case, game theoretical notions of reciprocity, but many individuals in the world feel empathy for one another “just because”. There is no reason, it is simply human.

We can easily find reasons why we should separate ourselves from the Muslims in our community, and to hate them for the fear we feel of them because of what madmen do in their name. The terrorist succeeds when their acts drive us into division, cause us to act against our humanity, so that the terrorist can point and say “look, I told you so, they hate us” and add another stone to their logical fortress. In holding to and affirming our humanity, in treating each other with decency, understanding and kindness and allowing ourselves to let go of ideologies and rationality in favour of empathy and fraternity where the former goes against the latter, we show the insanity of the terrorist for what it is. We show that reason easily becomes the slave of passions and that the idiot who thinks God or some Fuhrer has given him a divine mission to bring about a better world by acts of indiscriminate destruction has such a warped view of the current one that they have left humanity behind. Isolating these individuals from humanity and removing them from a position in which they can do harm comes at a cost, but we show we are different from the terrorist if we fully acknowledge and feel this cost, even if it prevents a descent into barbarity.

What does this mean in practice? It means that in the immediate aftermath of the recent events, the way in which we show as a nation that the individual who perpetrated it was a madman is not by reason. It is by standing up to the individual who understandably launches into an Islamophobic rant and say quite simply, “no, Muslims are welcome here, this was a madman”. We show this individual was a madman by individuals across the nation offering to walk with our fellow citizens who are Muslim and defend them against attacks by frightened individuals in our society who in their terror lash out against anyone who holds to the creed the terrorist claims to hold to. We show the madness of the terrorist by our politicians and our elite standing up and saying “this individual was to Islam what a Provisional IRA bomber is to Christianity and what a Nazi is to German patriotism”. After the immediate hurt and shock has passed, we show our humanity and the madness of the ideological rationalist by those of us who aren’t Muslim treating our Muslim compatriots as we would any other Australian who does not have our colour or creed.

Napoleon paid the British nation its greatest compliment when he called it “a nation of shopkeepers”. That nation, respectful of reason (being the home of Isaac Newton, Charles Darwin, Cambridge and Oxford) but sceptical of its supremacy and committed to a “small” life defeated Napoleonic France with all its heritage of science and rationality. Australia, typically, was paid its greatest compliment when Sam Kekovich said “who cares where they come from, as long as they can handle a pair of barbeque tongs”, and a majority of Australians across the country felt exactly the same way. It may seem simple, perhaps simplistic to say that we can defeat the terrorist by simply being nice to each other. George Orwell felt this way about Charles Dickens’ writings, but realised at the end of his famous essay on the great writer that Dickens deserved his plot in Westminster abbey for his moral leadership. Dickens realised that the best way to show the madness of the miser was to contrast in A Christmas Carol and Hard Times the kindness and simple reasoning of ordinary people against the cold inhuman rationality of Ebenezer Scrooge and Thomas Gradgrind which destroys the people around them.

We can never force the terrorist to acknowledge the value of our way of life, we can never persuade them that their view of reality is warped, all their reasoning is therefore worthless, and their acts disgusting and criminal but we can through affirming our common humanity and rejecting fear and hate – no matter how reasonable it may seem - draw our nation together and isolate the madmen on the fringes who would divide and destroy it.

Monday, December 15, 2014

National hindsight bias day

For balance I follow a few people on Twitter at the opposite end of the political spectrum. I consciously try to avoid confirmation bias, and regularly find there is much agreement across what are often imaginary political divides.

One thing I’ve noticed today, in the aftermath of the Sydney siege, is that the right-wing - the conservatives and nationalists - seem more likely to be suffering a serious dose of hindsight bias, which is
… the inclination, after an event has occurred, to see the event as having been predictable, despite there having been little or no objective basis for predicting it, prior to its occurrence
Many on the right are arguing that because the perpetrator had a criminal history it should have been obvious that he was a risk of committing this sort of insanity.

But this is almost never the case. Almost everyone with a criminal history does not do this. The sheer rarity of such an event is what is causing the media fanfare, and the sheer rarity is why such things cannot be easily foreseen in advance, despite our retrospective justification.

The gunman could have been just about anyone and we would have latched on to some feature of his life that in retrospect appears to offer a prediction of future radical behaviour. Any strange hobby, personality quirk, or previous emotional breakdown would appear to be a reliable signal after the fact.

The world is full of nut-jobs.

I’m quite pleased to see religious leaders joining together, and the community coming to support each other. We should all be thankful that such events are so rare.

In any case, given some of the reactions I want to declare today National Hindsight Bias day.

Sunday, December 7, 2014

The case for 7% stamp duty on property

In the spirit of turning ideas on their head, let me put forward the case in favour of stamp duties on housing transactions. To be honest, it is pretty compelling to me. If I had to rank taxes from best to worst in terms of efficiency and equality, land value taxes would be first best, but stamp duties would be not far behind, huddled together with Tobin taxes and capital gains taxes to make up a top four.

There are three mains arguments in favour of stamp duties - improved price stability, no affordability effects, limited mobility effects.

Price stability
The first point is that stamp duties are not a tax on relocating, but a tax on asset market churn. We know that property bubbles have the characteristic of high transaction volumes arising from speculative buying and selling. Eliminating some of this activity because of its increased costliness will have an indirect effect of stabilising prices to some degree. Additionally, fewer transactions means less waste of resources on the real estate sales industry. Essentially it is a Tobin tax for property markets. If reducing resources devoted to the zero-sum game of trading share markets is a good thing, then the same is true for property markets.

From the perspective of macro stability stamp duties are a massive automatic stabiliser - raising plenty of revenue during the boom, and much less during the bust.

No affordability effects
Valuation theory and practice support the view that stamp duties, although paid for by the buyer, actually come off the price of housing. That is, buyers determine their total willingness to pay a the house, and subtract any transaction costs from that total to arrive at a residual that they can pay to the seller. Empirical studies also support this view.

In terms of effects on home prices, the cost of stamp duty is subtracted from prices, leaving the total purchases costs unchanged. If they also deter speculative sales as I suggest in the previous section, then the net effect of stamp duties on property prices is to reduce them. That’s about the best side-effect from a tax you could hope for.

Limited mobility effects
Some people call stamp duty a tax on mobility. It’s not. There is a whole group of people called renters who are quite a mobile part of the population and avoid the tax entirely. While the evidence suggests that fewer relocations are made by owners (perhaps 8% fewer in a year for a 1% increase in the stamp duty rate), disentangling the speculative motive of such sales from the actual labour force relocation motive has never been attempted, though they must be entwined.

Already a house sale has a combined cost to buyers and sellers of probably close to 8-9% of the house price; from removal costs, lawyers, agents, inspections, loan fees etc. Why not make it 10% by raising stamp duty ? After all, the seller gets a lower price and the buyer pays the same total of house price plus stamp duty. It’s a transfer from current home owners.

In all it stamp duties seem like a pretty reasonable tax in terms of economic efficiency. Perhaps rather than promoting land value taxes as a replacement for stamp duty, a better position is to use land tax revenues to replace more distortionary State taxes such as payroll tax.

While I’m at it
Many economists in tune with the role of land rights in economics have criticised Piketty's book for being a bit loose in the way he aggregates capital. They say that because he conflates improvements and property rights, such as land, a tax on all wealth to reduce inequality, as he proposes, will act like a tax on improvements and land value.

But what they forget is that this is about the second best tax. If a tax on property rights of all sorts (minerals rights, patents, land and so forth) is a first best tax, an incremental tax on wealth is second best. Having this argument is completely counterproductive from a policy perspective.

Tuesday, November 4, 2014

Four books and one film to understand the world

Money, Coordination and Prices (1998)
Fieke van der Lecq

Van der Lecq asks the question 'Why does money exist?' After an extensive review of the many approaches to understanding money, she ultimately argues that the very reason for money may be the same reason that there is often little incentive to change nominal prices. Money provides a broad look at the role of norms, conventions and institutions in coordination - the macro-foundations of micro behaviour, if you will. The point is made clear when she looks at the necessity of meta-assumption in  game theory, the meta-assumptions in game theory that we ignore but are the key reasons there is so little practical application, and so on. It is probably a book for those with a fair bit of economics training.

One stand out section for me was the way coordination requires clues about the behaviour of others. In game theory it is merely assumed, almost always without question, that there is a common knowledge of instrumental rationality. What that assumption is also rational is never quite made clear. But in any case, the way Van der Lecq describes the role of 'focus points', or clues we use to infer the likely behaviour of others. She quotes Schelling
People can often concert their intentions or expectation with others if each knows the other is trying to do the same. Most situations (...) provide some clue for coordinating behavior, some focal point for each person's expectation of what the other expects him to be expected to do (Schelling 1960, p57)
To be the approach in this book to money sits very cleanly with Erving Goffman's approach to coordination, in that we present ourselves in particular ways in different circumstances in order to present the necessary signals for coordination. While I don't have a separate entry for his book The Presentation of Self in Everyday Life, I highly recommend it.

Moral Tribes: Emotion, Reason and the Gap Between Us and Them (2013)
Joshua Greene

A brilliant look at what morality is, how people respond differently to seemingly different framing of the same utilitarian dilemma (mostly centred on the trolley problem). The big message from this book for me is summarised in the passage below.
Morality evolved to enable cooperation, but this conclusion comes with an important caveat. Biologically speaking, humans were designed for cooperation, but only with some people. Our moral brains evolved for cooperation within groups, and perhaps only within the context of personal relationships. Out moral brains did not evolve for cooperation between groups (at least not all groups). How do we know this? Because universal cooperation is inconsistent with the principles of natural selection. I wish it were otherwise, but there's no escaping this conclusion

Economic Indeterminacy (2013)
Yanis Varoufakis

A terrific book focussing on the rather technical aspects of game theory and the hidden assumptions that no one wants to talk about. The big message for me was that all economists, when they truly dig down into the depths of their theory, hit a wall of indeterminacy. Most then do the dance of the meta-axioms to step back from the wall with additional hidden assumptions. To make a career you must continue to dance away from that wall - confronting it casts you as an outsider.

Another important piece in Varoufakis's work is the nature of human conflict, and how it can fit into the picture of rationality. Put simply it can't. And that the puzzle that led Varoufakis down the garden path.

The following passages are insightful.

…young graduates, who spent countless months and years mastering this analysis, they will, indeed, require an heroic disposition to ‘come clean’; to admit that all this investment has led them to the conclusion that conflict is … indeterminate. Those of them who do say this courageously will never get tenure, as their papers will remain unpublished – their models will not have achieved the requisite ‘closure’. And those who maintain silence of the faulty foundations of their analysis, continuing to produce models of greater complexity along the same lines (and on the basis of the same denial of indeterminacy’s actual hold), will become the new blood that keeps neoclassicism fresh and forever dominant within the economics departments of the best universities. 
In this sense, economists do not mind it when other social scientists disparage their model of men and women as unrealistic, as unrepresentative of how people actually think and act, even as downright misleading about the people around us. Their defence is simple: while homo economicus, the instrumentally hyper-rational ideal type, may not exist, it is an excellent benchmark against which to ‘measure’ the rationality of living and breathing humans and, moreover, it represents a very helpful model of the type of behaviour toward which real humans tend the greater their immersion in market competition.   
And when critics of the economists’ theories point out systematic differences between actual behaviour (e.g. in the laboratory) and the behaviour economists predict, the latter resort to the explanation that these differences are the result of the fact that people are not as rational as they, the economists, assume. That if they were truly rational, economic theory would predict perfectly their behaviour. Thus, economists interpret the chasm between observed human behaviour and the behaviour their models predict as a reflection of the divergence between actual and ideal human rationality.

Debt: The first 5000 years (2011)
David Graeber

There are hundreds of reviews of Debt online. This is not a review, but merely a recommendation. The book is long and wonders a little, but you will be rewarded by reading with an open mind. Debt focuses on recasting the nature of financial debt as fundamentally a human relationship - something we all too quickly forget when discussing the modern world of high finance (or should I say modern world of relationships). The following passages make this ‘relationship calculation’ role of debt and money quite clear.
Freuchen tells how one day, after coming home hungry from an unsuccessful walrus-hunting expedition, he found one of the successful hunters dropping off several hundred pounds of meat. He thanked him profusely. The man objected indignantly: 
"Up in our country we are human!" said the hunter. "And since we are human we help each other. We don't like to hear anybody say thanks for that. What I get today you may get tomorrow. Up here we say that by gifts one makes slaves and by whips one makes dogs. 
... The refusal to calculate credits and debits can be found throughout the anthropological literature on egalitarian hunting societies. Rather than seeing himself as human because he could make economic calculations, the hunter insisted that being truly human meant refusing to make such calculations, refusing to measure or remember who had given what to whom, for the precise reason that doing so would inevitably create a world where we began "comparing power with power, measuring, calculating" and reducing each other to slaves or dogs through debt. 
It's not that he, like untold millions of similar egalitarian spirits throughout history, was unaware that humans have a propensity to calculate. If he wasn't aware of it, he could not have said what he did. Of course we have a propensity to calculate. We have all sorts of propensities. In any real-life situation, we have propensities that drive us in several different contradictory directions simultaneously. No one is more real than any other. The real question is which we take as the foundation of our humanity, and therefore, make the basis of our civilization.
Here is another
This is a great trap of the twentieth century: on one side is the logic of the market, where we like to imagine we all start out as individuals who don't owe each other anything. On the other is the logic of the state, where we all begin with a debt we can never truly pay. We are constantly told that they are opposites, and that between them they contain the only real human possibilities. But it's a false dichotomy. States created markets. Markets require states. Neither could continue without the other, at least, in anything like the forms we would rec­ognize today.

The Fog of War (2003)
Errol Morris

Lastly, a documentary that really opened my mind to recent US war history - The Fog of War. It is based on the life of Robert Strange McNamara, and centred on a lengthly interview of him at age 85 reflecting on the nature of war. McNamara was the US Secretary of Defence from 1961-1968, following a period as the President of the Ford Motor Company, and overall was a very influential decision maker in key aspects of US military actions. It is a little scary the way he explains just how close the US was to other wars, including the invasion of Cuba, and how often mistakes are made that cost the lives of millions.

The whole film is on YouTube here, and below is the trailer. It is worth your time.


Monday, October 6, 2014

Grandpa Landsburg, the Rocking-Chair Economist, defends econ tribe

My friend Unlearning Economics has a series of seven posts that pour cold water over the economics profession’s ridiculous defences of their demonstrated incompetence surrounding the financial crisis.

For those who haven’t read them, here’s the seven arguments linked to their respective posts.
  1. But we did a great job during the boom
  2. The Efficient Markets Hypothesis (EMH) claims that crises are unpredictable, so the fact that economists didn’t predict the crisis is not a problem for economics at all
  3. Economists aren’t oracles. Just as seismologists don’t predict earthquakes and meteorologists don’t predict the weather, we can’t be expected to predict recessions
  4. Mainstream economics cannot be blamed for politicians inflating housing bubbles/pursuing austerity/deregulating the financial sector; our models generally go against this. Clearly, we do not have that much influence over policy
  5. We got this one wrong, sure, but we’ve made (or are making) progress in macroeconomics, so there’s no need for a fundamental rethink
  6. Sure, modern macroeconomics is pretty weak. But most economists don’t even work on macro, so they are unaffected
  7. Economists had the tools in place, but we overspecialised and systemic problems caught us off guard
Yesterday I came across an article that includes quite a few of these defences, and displays the strange ways economists often argue. It’s by Steven Landsburg, an economics professor at University of Rochester, and self-proclaimed ‘armchair economist' who is part of the ‘freakonomics’ bandwagon, writing books presenting quirky but shaky results in economics as surprising insights into reality. 

He argues in a senile ‘grandpa’ style - a label used by Matt Bruenig to describe his opponents illogical ramblings over inequality in the ‘Grandpa Sumner debates’. It’s argumentation as you’d expect from uninformed grandpa yelling from his rocking chair and shaking his cane in the air. Maybe I'll call him the 'rocking chair economist' from now on.

The article deserves fisking. Here we go.
As recently as a few months ago, doctors were held in high esteem and educated people believed that medicine could be useful. All that changed, of course, with the medical profession’s stunning failure to prevent or even predict the breakout of ebola in West Africa. Worse yet, many doctors to this very day cling to their old ways of thinking, writing prescriptions, setting broken bones, and performing surgery in bull-headed defiance of the urgent need to jettison everything we know about medical practice and start over from scratch.
Nobody, of course, writes such nonsense about medicine. Why, then, do so many write equivalent nonsense about economics?
This is nonsense attempting to be humour. Maybe Landsburg is unaware of epidemiology, which is entirely devoted to the spread of disease in the population. Governments have guidelines, programs and procedures in place for epidemics, and universities even have whole departments dedicated to this research.

Did economists have a standing warning about economic crises? Or standing plans and programs in place? Did they develop guidelines on how to react and monitor certain types of financial crisis? Did the lobby for ‘economic vaccinations’?

This is a poor attempt at defences 2 and 3.
Most economists failed to predict the 2008 financial crisis and ensuing recession for pretty much the same reason most doctors failed to predict the 2014 ebola epidemic — their attention was, quite reasonably, directed elsewhere. It’s easy to say in hindsight that if economists had paid more attention to the shadow banking system, they’d have seen what was coming. But attention is finite, and if economists had paid more attention to the shadow banking system, they’d have paid less attention to something else.
More nonsense. It is not that economists didn’t predict this particular crisis, but they didn’t even predict the possibility of the crisis. This is completely unlike in medicine, or seismology or any other study of complex systems. Seismologists do predict the chance of earthquakes, and epidemiologists do predict the likely structure of epidemics and study how to contain them.
For a little perspective, have a look at this chart showing U.S.~per capita income in fixed (2005) dollars: 
That little downward blip you see near the top is the recent crisis. The somewhat bigger downward blip in the 1930s is the Great Depression. The moral is that in the overall scheme of things, recessions don’t matter very much. At the trough of the Great Depression, people lived at a level of material comfort that would have seemed unimaginably luxurious to their grandparents. Today, while Paul Krugman continues to lament “the mess we’re in”, Americans at every income level live far better than Americans of, say, 1980. If you doubt that, you surely don’t remember what life was like in 1980. Here’s how to fix that: Pick a movie from 1980 — pretty much any movie will do — and count the “insurmountable” problems that the protagonist could have solved in an instant with the technology of 2014. Or reread any of the old posts on this page.

If you care about human well-being, recession-fighting is small potatoes. It’s that long-term upward trend that matters. And economists, fortunately, understand a lot about what it takes to nourish that trend — things like well-enforced property rights, the rule of law, free trade, sound money, limited regulation and low marginal tax rates. Even more fortunately, economists have managed, however imperfectly and with fits and starts, to impress that understanding on the minds of policymakers. As a result (and going back, at least, to the repeal of the Corn Laws), we’ve had better policies and greater prosperity.
This is an attempt at defence 1: We did great job during the boom. But I still have some bones to pick. First, stating that living standards are higher now that some arbitrary time in the past could have been made at any point in history, regardless of the state of economic knowledge. This is not a defence of economic understanding.

Moreover, saying recessions don’t matter much is like the medical profession saying that cancer doesn’t matter much. After all, every dies, we should be grateful that we are living longer than ever. Aren’t we glad doctors were out there studying other things while taking credit for the fact that people are born at all?

Importantly, Landsburg seems to think that economists can take credit for the development of human society for the last 230 years or so. That’s sheer nonsense.

Even the specific policies that economists believe ‘nourish’ the long run growth trend - well-enforced property rights, the rule of law, free trade, sound money, limited regulation and low marginal tax rates - are pretty debatable, and often wrong.

Is Landsburg suggesting that China would have even more rapid growth if it followed his prescriptions? Or is he just reciting the biblical passages from the mainstream bible.
To throw out all that hard-won knowledge because we failed to prevent a financial crisis would be like closing all the hospitals because doctors failed to prevent an epidemic.
No it wouldn’t. See above.
Moreover, it’s entirely possible that some of the best policies for fighting recessions are inimical to long-term growth. It could easily follow that even if you knew exactly how to fight recessions, you might prefer not to.
Sure. It could be possible. But no one knows this. It is just like saying we could send people to Mars, but then aliens might invade us, so if that’s the case we wouldn’t want to go to Mars. It’s internally logical, but externally pretty stupid.
It’s a very good thing that some economists are trying to understand recessions, and a very good thing that they’re accounting for the lessons of the past few years. It’s also a very good thing that most economists are working in the myriad of other areas where we’re capable of doing good. Another very good thing is historical perspective. The current so-called “mess” that economists have (partly) gotten us into is not just the most prosperous era in human history; it is prosperous beyond the wildest imaginings of your parents’ generation. And yes, economists helped get us here.
I would respond by asking, do economists know more about recessions today than they did a century ago? Not really would be my answer.

Again, he suggest economists should take some credit for the boom, as if they made it happen.

Put your cane down Landsburg and take your medicine.