Ten-cent economic hypothesis of the day, keeping-up-with-the-Joneses edition — June 4, 2014

Ten-cent economic hypothesis of the day, keeping-up-with-the-Joneses edition

This Matt Yglesias post (about a Houston-area day spa for babies [sic]) makes me wonder if the following has been formalized appropriately. Imagine some microeconomic decision like how large a house to buy. Some part of that decision will come from your actual desire to own a larger or smaller home. Some part will come from zoning (maybe you *can’t* buy a 1000-square-foot ranch-style home in the gated community). And some part will come from a pointless arms race between neighbors: I need to have a larger house than you, and you need to have a larger one than me, and so we proceed, more and more garishly.

That last motive is a collective-action problem: I don’t actually care *where* I end up, so long as I end up ahead of you; you, of course, think the same way. This is an arms race, in other words. During the Cold War, neither the Soviet Union nor the U.S. *wanted* to build up a nuclear arsenal; they were both forced to, because neither side could credibly commit to the other that it would disarm. So it is, I think, with housing. If there were some way to forcibly disarm both of us — if there were a single superpower, to continue the analogy, with a monopoly on violence that could bring both the Soviet Union *and* the United States to heel, well then the problem would be solved.

As it happens, we have such a superpower in the United States. It’s called the U.S. government, and it has a magical power called “taxation”. Imagine if we taxed the wealthy to such an extent that they no longer had the choice to participate in housing arms races and could only buy ordinary-sized homes. In some sense they might not mind this: if the point is to get ahead of your neighbor, and your neighbor is getting taxed at the same high level as you are, you’re both reasonably happy with the situation. Of course, you’d be happier if you both had more money, but by stipulation you were already forced to throw money into a zero-sum pursuit of larger homes; now you’re just forced to throw money to the federal government.

I don’t claim that wealthy people would raise no tantrums at all if they were forced to pay higher taxes, but I *do* wonder whether much consumption among the wealthy is fundamentally about this sort of wasteful arms race.

There’s probability ε, for some very small ε, that economists haven’t already run through this idea. … Indeed, a moment’s Googling suggests that I’m talking about a positional good; Veblen’s (“conspicuous consumption”) name comes up, as I should have expected. Time to read some Veblen.

What I’m looking for, though, is a formal estimate of how much economic waste goes into the pursuit of positional goods, and maybe a theory of optimal taxation based around it. I wonder if any of you lovely people have seen such a thing.

You should go read Robert Solow’s review of Piketty’s Capital in the Twenty-First Century — April 24, 2014
“This graduation speech teaches you everything you need to know about economics in 297 words” — no it doesn’t — April 20, 2014

“This graduation speech teaches you everything you need to know about economics in 297 words” — no it doesn’t

Whoever wrote this headline decided to annoy a whole lot of people. Indeed, the whole thing is probably a nice big exercise in trolling. So rather than feed the trolls, I will reply in kind with very little text.

Whenever you read about how individuals behave in an economic sense, you should immediately come back with at least one question:what happens if everyone behaves that way? So for instance, that speech talks all about incentives, which are economists’ favorite things. I have an incentive to go to college, say, because doing so increases my expected lifetime income. But what if everyone goes to college? If everyone’s education increases by the same amount, will everyone’s income go up by the same amount?

Or similarly: we all have an incentive, let’s say, to live in a quiet place on the water. But since we all have that incentive, we all decide to move to a quiet place on the water. Now we all live on the water, crowded in with each other, and it’s no longer quiet or peaceful.

Or we all would like our kids to be able to walk to school safely. But they won’t be able to walk safely unless our neighbors believe that it’s safe. So some of us decide to drive our kids to school. Now there’s no safety in numbers, so our kids aren’t safe. So everyone drives their kids to school. So it’s no longer safe for our kids to walk to school.

Or see Klinenberg: used to be that, during heat waves, thousands of people would leave their homes and go sleep in public parks in Chicago. That little wave of revulsion you just felt explains why no one does that anymore. And since no one does that anymore, people have to sleep indoors during heat waves, because they no longer have safety in numbers outside. But lots of people can’t afford air conditioning; in particular, the most marginalized populations cannot afford air conditioning. So they die alone in their apartments.

The moral here should be entirely obvious: what I do depends upon what you do. It makes very little sense, in a lot of contexts, to talk about what you want — what your “incentives” are — without talking also about what I want, or vice versa.

Shorter version of all of the above: read Tom Slee. Really. Go read him as soon as you can. His book is a necessary corrective to the trite Sargent speeches (and, I’m coming to worry, to the Voxes) of the world.

Changing my mind about BitCoins — March 31, 2014

Changing my mind about BitCoins

This Freakonomics episode changed my mind. And that’s not something I say often about Freakonomics.

I think actually what it did is lower my expectations. BitCoin, or something like it, seems like it’ll live on — or at least *should* live on — because it removes the credit-card intermediaries. The show brings up a really good example: immigrant communities who send remittances back to their families every month are often paying extortionate fees to do so, and they’re the last people who can afford such fees. Removing the intermediaries, so that I can send you money without any transaction overhead, is a good thing. And the euthanasia of the rentier is something strongly to be desired.

Note what this *isn’t* saying — note what *isn’t* relevant here. BitCoins *as a currency* are not the important thing, necessarily. You can divorce BitCoins from the libertarian fever dreams of a Federal Reserve-free world.

You can also abstract away from BitCoin itself. Whether BitCoin survives is irrelevant; what you should want is for decentralized transaction-processing services to persist.

Go listen to the podcast. It’s a good one.

Not to cavil with Krugman, but … — March 7, 2014

Not to cavil with Krugman, but …

Today he says that “private-sector wages…continue to run well below pre-crisis levels”, and uses this graph to support that claim:

Average hourly earnings of all employees

He’s not being quite accurate. As you can see from the y-axis, that’s year-over-year *growth* in hourly wages. Since the y-axis is everywhere above zero, we conclude that wages have always been growing. They’ve just been growing less than they were before the crisis.

…Which is Krugman’s point, I think. The main argument for increasing interest rates is to keep inflation in check. Inflation might be running amok if labor costs are skyrocketing. Labor costs are not skyrocketing; they’re under control. If interest rates need to rise now because labor costs are out of control, then they needed to rise back in 2007-2009 as well.

My buddy FRED will show you average earnings, as opposed to year-over-year change in earnings.

Honestly, this was probably just a typo on Krugman’s part. In context it’s obvious what he meant. But I would be shocked if the typo didn’t start propagating.

Dani Rodrik, “Economics: Science, Craft, or Snake Oil?” — February 2, 2014

Dani Rodrik, “Economics: Science, Craft, or Snake Oil?”

This is a great piece, by the author of the exceptional [book: Globalization Paradox] (which I read years ago and never reviewed; shame on me). One of the basic themes underlying that book — and, I gather, underlying Rodrik’s [book: One Economics, Many Recipes] — is that reality is complicated, and that economics can give you diverse conclusions depending upon your assumptions. Different assumptions are appropriate for different contexts. Free trade doesn’t always, for instance, make the world a better place in the short run; there are winners and losers, and it’s not clear that the gains to the winners outweigh the losses to the losers (particularly if we attach ethical weight to a more-equal distribution of income). Only if you introduce the assumption that the winners can compensate the losers does this conclusion start to make sense.

There’s nothing wrong with assumptions; as the great John Tukey said, “Without assumptions there can be no conclusions.” If you’re going to argue that mathematics or science or economics has a poor track record in decision-making, the natural reply is, “Compared to what?” Compared to your gut, it’s not at all obvious that economics has done poorly.

Where the discipline does sin, according to Rodrik, is in telling a different story to the outside world than it does to its students. Graduate economics seminars, says Rodrik, very carefully tease out all the assumptions that make the conclusions true; what shows up in the newspapers does not (“free trade good; free markets good; industrial planning bad”).

Naturally, though, if you’re going to use economics for real-world decision-making, you need some way of testing which assumptions apply in a particular case. You need data. But doubly-blinded controlled experiments in economics are few and far between, if not outright impossible. So the discipline will always suffer from an abundance of models and a dearth of practical advice on how to use them.

Here I’m reminded of the very excellent “Deconstructing the argument for free trade”, particularly this bit:

> President Truman [allegedly] got so tired of hearing economists tell him “on the one hand…” that he wished for a one-armed economist. But frequently the best advice we can give is a menu of effects that flow from different choices. Trying to come up with a valid measure of the *net* effects is above our pay grade.

It’s a plea that economists show some humility. But since that seems to be in short supply, perhaps we need a belt-and-suspenders approach: the public, and policymakers, need to understand the limits of the discipline that they rely on.

(Rodrik link at the top via Cosma Shalizi’s Pinboard.)

How low an unemployment rate can we tolerate? — November 20, 2013

How low an unemployment rate can we tolerate?

On the occasion of Jared Bernstein’s and Dean Baker’s publishing an essay on how low an unemployment rate we can tolerate before inflation spirals out of control, it’s worth linking back to a something I wrote in 2010 about James Galbraith’s views on the matter.

Even supposing that there actually is a NAIRU (i.e., a level of unemployment below which inflation will start accelerating), and even supposing that something bad will happen if we cross below that line, it’s not as though we lose control of the ship right then. At that point we know what happens: the Federal Reserve jacks up interest rates, unemployment skyrockets (particularly as mortgage rates rise and employment in the housing sector collapses), and inflation drops back down. It’s happened before. We have control over this. Doesn’t the Federal Reserve just need to signal that it takes its dual mandate seriously? If everyone believes that the Federal Reserve will bring the hammer down if inflation rises too high, what’s the big deal? Better to let inflation rise too high because unemployment was allowed to drop too low, and correct the problem later, than allow millions of people to remain involuntarily idle.