Reconciling Hayek’s and Keynes’ views of recessions

 

Paul Beaudry, Dana Galizia, 1 June 2014
The views of Hayek and Keynes about the causes and consequences of recessions are often presented as opposing. According to Hayek, recessions are working out excessive investments, whereas Keynes regarded them as demand shortages. This column argues that these perspectives are not mutually exclusive. Recessions may reflect periods of liquidation but this could be associated with inefficient adjustment involving unemployment and precautionary savings. Stimulative policy may be desirable even if it delays the full recovery.
Full Article: Reconciling Hayek’s and Keynes’ views of recessions

Reconciling Hayek’s and Keynes’ views of recessions
Sun, 01 Jun 2014 00:00:00 GMT

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On Gary Becker

 

Gary Becker, as you must surely know by now, has passed away. This is an incredible string of bad luck for the University of Chicago. With Coase and Fogel having passed recently, and Director, Stigler and Friedman dying a number of years ago, perhaps Lucas and Heckman are the only remaining giants from Chicago’s Golden Age.

Becker is of course known for using economic methods – by which I mean constrained rational choice – to expand economics beyond questions of pure wealth and prices to question of interest to social science at large. But this contribution is too broad, and he was certainly not the only one pushing such an expansion; the Chicago Law School clearly was doing the same. For an economist, Becker’s principal contribution can be summarized very simply: individuals and households are producers as well as consumers, and rational decisions in production are as interesting to analyze as rational decisions in consumption. As firms must purchase capital to realize their productive potential, humans much purchase human capital to improve their own possible utilities. As firms take actions today which alter constraints tomorrow, so do humans. These may seem to be trite statements, but that are absolutely not: human capital, and dynamic optimization of fixed preferences, offer a radical framework for understanding everything from topics close to Becker’s heart, like educational differences across cultures or the nature of addiction, to the great questions of economics like how the world was able to break free from the dreadful Malthusian constraint.

Today, the fact that labor can augment itself with education is taken for granted, which is a huge shift in how economists think about production. Becker, in his Nobel Prize speech: “Human capital is so uncontroversial nowadays that it may be difficult to appreciate the hostility in the 1950s and 1960s toward the approach that went with the term. The very concept of human capital was alleged to be demeaning because it treated people as machines. To approach schooling as an investment rather than a cultural experience was considered unfeeling and extremely narrow. As a result, I hesitated a long time before deciding to call my book Human Capital, and hedged the risk by using a long subtitle. Only gradually did economists, let alone others, accept the concept of human capital as a valuable tool in the analysis of various economic and social issues.”

What do we gain by considering the problem of human capital investment within the household? A huge amount! By using human capital along with economic concepts like “equilibrium” and “private information about types”, we can answer questions like the following. Does racial discrimination wholly reflect differences in tastes? (No – because of statistical discrimination, underinvestment in human capital by groups that suffer discrimination can be self-fulfilling, and, as in Becker’s original discrimination work, different types of industrial organization magnify or ameliorate tastes for discrimination in different ways.) Is the difference between men and women in traditional labor roles a biological matter? (Not necessarily – with gains to specialization, even very small biological differences can generate very large behavioral differences.) What explains many of the strange features of labor markets, such as jobs with long tenure, firm boundaries, etc.? (Firm-specific human capital requires investment, and following that investment there can be scope for hold-up in a world without complete contracts.) The parenthetical explanations in this paragraph require completely different policy responses from previous, more naive explanations of the phenomena at play.

Personally, I find human capital most interesting in understanding the Malthusian world. Malthus conjectured the following: as productivity improved for some reason, excess food will appear. With excess food, people will have more children and population will grow, necessitating even more food. To generate more food, people will begin farming marginal land, until we wind up with precisely the living standards per capita that prevailed before the productivity improvement. We know, by looking out our windows, that the world in 2014 has broken free from Malthus’ dire calculus. But how? The critical factors must be that as productivity improves, population does not grow, or else grows slower than the continued endogenous increases in productivity. Why might that be? The quantity-quality tradeoff. A productivity improvement generates surplus, leading to demand for non-agricultural goods. Increased human capital generates more productivity on those goods. Parents have fewer kids but invest more heavily in their human capital so that they can work in the new sector. Such substitution is only partial, so in order to get wealthy, we need a big initial productivity improvement to generate demand for the goods in the new sector. And thus Malthus is defeated by knowledge.

Finally, a brief word on the origin of human capital. The idea that people take deliberate and costly actions to improve their productivity, and that formal study of this object may be useful, is modern: Mincer and Schultz in the 1950s, and then Becker with his 1962 article and famous 1964 book. That said, economists (to the chagrin of some other social scientists!) have treated humans as a type of capital for much longer. A fascinating 1966 JPE [gated] traces this early history. Petty, Smith, Senior, Mill, von Thunen: they all thought an accounting of national wealth required accounting for the productive value of the people within the nation, and 19th century economists frequently mention that parents invest in their children. These early economists made such claims knowing they were controversial; Walras clarifies that in pure theory “it is proper to abstract completely from considerations of justice and practical expediency” and to regard human beings “exclusively from the point of view of value in exchange.” That is, don’t think we are imagining humans as being nothing other than machines for production; rather, human capital is just a useful concept when discussing topics like national wealth. Becker, unlike the caricature where he is the arch-neoliberal, was absolutely not the first to “dehumanize” people by rationalizing decisions like marriage or education in a cost-benefit framework; rather, he is great because he was the first to show how powerful an analytical concept such dehumanization could be!

On Gary Becker
afinetheorem
Mon, 05 May 2014 02:17:29 GMT

Slavery Can’t Last in an Otherwise Free Market?? Maybe it can.

I think the conclusion below that slavery would always go away is wrong.

The suggestion is that labor is most valuable  when free because incentives are a much more cost-effective  way of  inducing  production that force.  So:  slaves could borrow and buy their  freedom; be more  productive; pay off the  loans; and enjoy their  more productive freedom.  Alternatively, other  capitalists could buy  the  slaves and put them to  work as free laborers driven by incentive not the whip.  The assumption being that the free state is  when labor is  most  valuable and markets put  resources  to their highest  and most valued use.

The problem  is I  think that perhaps the  wealth  distribution is different  with slavery.  Slave  owners are wealthier and may  have a ‘taste’ for  slaves.  Outside of  theory:  Slavery has a long history; and much research suggests  that  US  slavery would  have gone  on  for  a much  longer period, but for the  civil  war.

 

My latest at Mises Canada. To entice you, I’ll just quote the concluding paragraphs:

The above story is just to get the logic across. I am trying to show why, IF we agree with Mises that slavery is unproductive relative to free labor, that it could not last in an otherwise free market economy. Over time, incremental moves such as the above would transform the slaves into self-owners, because that would be the most efficient outcome, setting aside moral considerations.

Think of it like this: Imagine if, during the night, gnomes took all of the cartons of cigarettes from the homes of smokers, and deposited them in the homes of non-smokers. The legal system now said that the non-smokers were the owners. Wouldn’t market forces soon move the cigarettes back into the possession of the smokers?

By the same token, under a free market economy, if for some reason the property titles to particular human beings initially started out in the hands of other people, market forces would soon return everyone to a state of self-ownership.

Slavery Can’t Last in an Otherwise Free Market
Bob Murphy
Sat, 01 Mar 2014 19:54:07 GMT

Style Versus Content

 

Paul Krugman pauses to wonder why he’s been characterized as immoderate when — according to him — “there’s not a lot of air between my views and those of, say, staff economists at the Fed.” His conclusion: “What was radical, if you like, was my style, not my content.”

Bingo. Krugman’s detachment from mainstream economics is indeed a matter more of style than of content. But one symptom of that detachment is his failure to recognize that style is all that matters. Economics is most valuable not as a repository of received truths, but as a way of thinking — a way of thinking that has proved itself extraordinarily valuable as a bulwark against nonsense and claptrap. It’s that way of thinking — the style of economics — that Krugman so often and so depressingly abandons.

Here’s an example: The minimum wage is much in the news these days. There’s some controversy over whether a minimum wage hike would substantially reduce employment. Krugman, in a recent column, reported that he’d reviewed the evidence and concluded that the employment effect would be quite small. From this, he jumped to the conclusion that a minimum wage hike is a good thing.

But the economic style of thinking does not allow such leaps in logic. It demands that we recognize that any income transferred to low-wage workers has to come from someone else, in this case from the owners and customers of businesses that employ a lot of low-wage workers. (Probably more from the owners in the short run and more from the customers in the long run, as some of these businesses disappear and prices accordingly rise.) And then it demands that we ask why these particular people should foot the bill. Why not finance a transfer to low-income workers through general tax revenues, or via a specific tax on, oh, say, newspapers, as opposed to an implicit specific tax on McDonald’s hamburgers?

Anyone, left, right or center, can write about how minimum wages might affect low wage workers. The economist’s unique contribution is to insist that you’re not done until you think about how it might affect the typical Wal-Mart shopper (who, incidentally, has a substantially below-average income). By ignoring that question, Krugman chose to write not as an economist, but as a partisan hack. That’s a style choice, and it goes to the heart of why so many economist have stopped taking him seriously.

This is not an isolated lapse. When Krugman wrote to endorse boycott threats to enforce better working conditions in Third World countries, he wrote about the potential good that could come from those threats, while completely ignoring the potential harm. You don’t need an economist, let alone a Nobel laureate, to point out the potential benefits of boycott threats, just as you don’t need an economist to point out the potential costs. What you need an economist for is to insist that you account for both the costs and the benefits and that you try to construct some sort of intellectual framework for weighing them against each other. Krugman was so interested in stating his conclusion (i.e. his content) that he forgot to include any of his reasoning — or even to acknowledge that reasoning is called for. Once again, he adopted the style of a hack.

What might he have done better? Let me offer this old blog post of mine as an example. Unlike Krugman, I drew only tentative conclusions. But also unlike Krugman, I tried to lead the reader to see both sides of the story, and more importantly to suggest ways of estimating the relative importance of various factors. I’m sure it’s imperfect, but it’s at least an honest attempt to engage the reader in the economic way of thinking. Krugman, by contrast, prefers to do your thinking for you, except on those occasions when he skips the thinking part altogether.

These are not isolated lapses. If you want more examples, start here.

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Style Versus Content
Steve Landsburg
Wed, 05 Feb 2014 07:01:21 GMT

Is tech outcompeting other forms of signaling, such as clothing expenditures?

It is amazing to think about how much of the reason we want money and wealth isn’t what it can  for us.  It’s what we hope it can do for our status.

The car you drive, and house you live in once you are past a certain level doesn’t make you much more comfortable, but  it may affect how you think others think about you. 

That’s often what motivates striving – status and affecting what others think of you.  If you care less you are much more free.

The article below relates to how spending is crucial  for teens, who may be the most status conscious of all.

For teenage boys, maybe:

Another factor chipping away at teenage retailers may be the shifting priorities among young people. Where clothing was once the key to signaling a teenager’s identity, other items may have become more important and now compete for their dollars.

“Probably the most important thing a teenage boy has is his smartphone,” said Richard Jaffe, an analyst at Stifel Nicolaus. “Second, is probably his sneakers. Third, maybe, we get to his jeans.”

What may trump all of those, Mr. Jaffe said, are gaming systems, especially over the last few months, because Xbox and PlayStation both released new game consoles in 2013. That may have taken a bite out of what teenagers had to spend on clothes.

The Elizabeth A. Harris article, which focuses on declining teen expenditures on retail clothing, is interesting throughout.

Is tech outcompeting other forms of signaling, such as clothing expenditures?
Tyler Cowen
Sun, 02 Feb 2014 17:25:22 GMT

An Imperfect System–Free enterprise/Democracy

Prosperity means change and that often leaves many behind: the older; the less educated; the geographically immobile; those who just can’t adapt for a lot of reasons. Joseph Schumpeter called this creative destruction, and it is certainly a product of capitalism in the past and now. Free enterprise and free exchange and commercial activity is the best path to a wealthy and growing economy; but I also believe it is unable without a state build safety net to provide for the victim of creative destruction that society as a whole benefits from.

If find it odd that it is often acknowledged that democracy is just the best of the flawed forms of human governance – it isn’t perfect. Few who advocate free enterprise have the equivalent humility to acknowledge that it is the best way manage resources of the alternative available – but it isn’t perfect. I acknowledge both that market economies are the best way to build a society in the face of scarcity, but are far from perfect.

The Great Labor Dump

 

One of my favorite teachers at Michigan was a self-effacing but brilliant labor economist named Mike Elsby. Mike has sadly decamped for Scotland, but he continues to turn out excellent papers. One of his latest, a Brookings conference paper, takes on a hugely important question that has been on everyone’s minds of late: Why has labor’s share of income declined in advanced countries?

There are basically three competing stories. These are:

1. Robots. Technology has made it cheap to replace humans with automation, driving profits up and wages down.

2. Unions. The relentless decline of organized labor in rich countries has robbed workers of their bargaining power, causing owners to scoop up the surpluses.

3. China/India. The end of the Cold War caused a huge, relatively well-educated labor force to be suddenly dumped onto world markets. A glut of labor on the market means the return to labor goes down and the return to capital goes up.

Mike Elsby and his coauthors find support mostly for story #3. In their own words:

U.S. data provide limited support for…explanations based on the substitution of capital for (unskilled) labor to exploit technical change embodied in new capital goods…[I]nstitutional explanations based on the decline in unionization also receive weak support…[W]e provide evidence that highlights the offshoring of the labor intensive component of the U.S. supply chain as a leading potential explanation of the decline in the U.S. labor share over the past 25 years. (emphasis mine)

This finding disagrees with some other recent papers, such as Karabarbounis and Neiman (2013), who support the “robots” story. Read Elsby et al. to see the particulars of the argument. 

Anyway, this is an important piece of research that everyone should know about. Stories about the Rise of the Robots are scary and seductive, but if Elsby is right, then this is more of a concern for the future than the past. And the decline of unions is sad in many ways, but it seems to be a symptom of labor’s decline rather than a cause.

So what do we do to bring back labor’s share of income? We wait. The Great Labor Dump can only happen once. When it’s over – when insanely huge amounts of investment in China have saturated that country with capital, for example – labor’s share will bounce back.

…unless, of course, by that time we really are facing the Rise of the Robots.

The Great Labor Dump
Noah Smith
Sun, 08 Dec 2013 14:35:00 GMT

Q: What do you get when you cross environmentalists with Tea Partiers?*

 

A: Common ground on the bad environmental economics of the ethanol mandate.

The summary:

This week, the EPA is expected to announce changes to the ethanol mandate, a 2007 law that requires energy companies to mix billions of gallons of ethanol into gasoline and diesel fuels. After six years in the mix, corn-based ethanol has lost its popularity, and a diverse group of critics is calling for the law’s repeal.

Why are environmentalists in favor of a rollback/repeal?

Though ethanol fuel releases less carbon dioxide than other kinds of gas, many question if the side effects of production are worth it…Growing corn requires fertilizer, which requires natural gas to make. Fertilizer also has contaminated rivers and drinking water, says the report. And ethanol factories usually burn coal or gas, which dumps carbon dioxide into the atmosphere.

Why are Tea Partiers in favor of a rollback/repeal?

Other opponents complain the mandate — like any energy subsidy — is free market poison, claiming it “distorts fuel markets and will raise gasoline prices, especially as the increased blending requirements collide with declining demand for gasoline,” reports Politico.

Strange bedfellows indeed.

And who is in favor of keeping the mandate?

Meanwhile, the ethanol industry is asking the AP to retract the story. “At best, the AP article is lazy journalism, but at worst, it appears purposefully designed to damage the ethanol industry,” American Coalition for Ethanol Executive Vice President Brian Jennings said in a statement to the press. “There was an incredibly reckless disregard for the truth in the handiwork of this hit-piece.”

And who is the American Coalition for Ethanol?

ACE is a non-profit, membership-based organization with about 1,500 members including:

• ethanol producers
• farmers
• investors
• the agriculture community
• industry suppliers
• rural electric cooperatives
• others supportive of ethanol.

Hmmmm.

*Partial credit if you answered ‘Tim’

Q: What do you get when you cross environmentalists with Tea Partiers?*
Tim Haab
Wed, 13 Nov 2013 14:53:48 GMT

Zandi Testimony: Economy Poised for Growth, Congress must Fund the Government and Pay the Bills

 

Economist Mark Zandi is providing testimony this morning to the Joint Economic Committee: Written Testimony of Mark Zandi Chief Economist and Co-Founder Moody’s Analytics

The impasse in Washington over funding the federal government and increasing the Treasury debt ceiling is significantly damaging the economy. Stock prices are grinding lower and consumer confidence is weakening. The economic harm will mount significantly each day the government remains shut and the debt ceiling is not raised. If policymakers are unable to reach agreement on these issues by the end of October, the economy will face another severe recession.
To resolve the budget impasse, policymakers should not add to the significant fiscal austerity already in place, which is set to last through mid-decade. Tax increases and government spending cuts over the past three years have put a substantial drag on economic growth. In 2013, this fiscal drag is as large as it has been since the defense drawdown after World War II.
Moreover, because of fiscal austerity and the economic recovery, the federal government’s fiscal situation has improved markedly. The budget deficit in just-ended fiscal 2013 was less than half its size at the recession’s deepest point in 2009. Under current law and using reasonable economic assumptions, the deficit will continue to narrow through mid-decade, causing the debt-to-GDP ratio to stabilize.
As part of any budget deal, lawmakers should reverse the sequester. The second year of budget sequestration will likely have greater consequences than the first, affecting many government programs in ways that nearly all agree are not desirable. A sizable share of the sequestration cuts to date has involved one-off adjustments, but future cuts will have to come from lasting reductions in operational budgets.
It would of course also be desirable for lawmakers to address the nation’s long-term fiscal challenges. Although the fiscal situation should be stable through the end of this decade, the long-term outlook remains disconcerting. If Congress does not make significant changes to the entitlement programs and tax code, rising healthcare costs and an aging population will swamp the budget in the 2020s and 2030s. Both cuts in government spending and increases in tax revenues will be necessary to reasonably solve these long-term fiscal problems.

And his conclusion:

Washington’s recent budget battles have been painful to watch and harmful to the economy. Political brinkmanship creates significant uncertainty and anxiety among consumers, businesses and investors, weighing on their willingness to spend, hire and invest.
Despite this, the economic recovery is more than four years old, and the private economy has made enormous strides. Business balance sheets are about as strong as they have ever been, the banking system is well capitalized, and households have significantly reduced their debt loads. The private economy is on the verge of stronger growth, more jobs and lower unemployment.
The key missing ingredient is Congress’ willingness to fund the government and make sure all its bills can be paid. If policymakers can find a way to do these things in the next few days, almost regardless of how awkward the process is, the still-fragile recovery will quickly become a self-sustaining expansion.
We are close to finally breaking free from the black hole of the Great Recession. All it takes is for Washington to come together.
emphasis added

A Republican advisor giving testimony to Congress, and telling Congress they are the problem. Ouch.

Zandi Testimony: Economy Poised for Growth, Congress must Fund the Government and Pay the Bills
Bill McBride
Fri, 11 Oct 2013 14:34:00 GMT

The Coase Theorem and Big Business

 

Copyright, The New York Times Company

Big businesses, especially those with large shares of the markets in which they sell, are sometimes thought to harm the economy because they sell to customers with little fear of competition from other sellers. Big businesses charge too much, the argument goes, and all customers can do in response is to purchase less. (The seller understands that customers respond to high prices by purchasing less, but the high profit margins are thought to more than compensate for the lower volume.)

If the industry had more sellers, or the customers themselves were in charge of production, prices would be lower, consumers would buy more and in aggregate the industry’s sellers would produce more and need more employees.

This “monopoly view” is that dominant businesses result in less industry production and employment than would emerge in a competitive marketplace.

Consistent with the monopoly theory of big business, the federal government, especially the antitrust division of the Department of Justice, is authorized to punish businesses that are thought to be too large for the efficient operation of their marketplace, and in some instances to break them apart.
In the labor market, unions can sometimes be a dominant seller, and on that front there are opposing “monopoly” and “bargaining” theories, as I noted in last week’s post. The bargaining theory of labor unions suggests that they limit the economic damage that they do.

The same sort of bargaining theory is present in the antitrust field. A big business should not be satisfied with a high-price/low-volume outcome, even if it yields more profits than a low-price/high-volume outcome, because a price above marginal cost of production is inefficient: there may be ways that the buyer can be given a better deal and enhance the seller’s profits.

Profs. Kevin Murphy, Edward Snyder and Robert Topel of the University of Chicago have written about some of the results of bargaining between big businesses and their customers. Big businesses often offer volume discounts, quote nonlinear prices and give loyalty incentives to customers. All these policies can encourage customers to purchase more, perhaps in a quantity similar to what they would buy in a many-seller market with lower prices. If the bargaining view of monopolies is correct, then the monopoly view of big business has exaggerated the degree to which dominant sellers harm the economy.

While one point of view is that federal antitrust policy is not vigorous enough, Professor Coase reminds us that it is easy to exaggerate the economic problems created by dominant sellers.

The “Coase Theorem” and Big Business
Casey B. Mulligan
Wed, 18 Sep 2013 13:03:00 GMT