Monday, August 22, 2016

Free-market ideology: a reply to some replies


I recently wrote a Bloomberg View post about political-economic ideologies, and how society is quicker to change than individual human beings. The upshot was that free-market ideology seems - to many Americans, and also incidentally to me - to have mostly hit a wall in terms of its ability to improve our lives, and so society will inevitably embrace an alternative, despite the protests of diehard free-marketers.

Bryan Caplan is flabbergasted at the notion that free-market ideology (aka "neoliberalism") has actually been tried in the U.S.:
The claim that "free-market dogma" is the "reigning economic policy" of the United States or any major country seems so absurd, so contrary to big blatant facts (like government spending as a share of GDP, for starters), that I'm dumb-founded.  
This is pretty much exactly the attitude I described in my post! "Of course neoliberalism hasn't failed; we just never really tried it."

David Henderson has a longer and more measured response. He challenges the idea that free-market ideology has demonstrated any failures at all.

Now I could simply make a weak claim - i.e., that free-market ideology seems to have hit a wall, and that in the end, that general perception is much more important than what I personally think. But instead, I'll make the much stronger claim - I'll defend the idea that free-market ideology has, in fact, really hit a wall in terms of its effectiveness.

Exhibit A: Tax cuts. Tax cuts, one of free-marketers' flagship policies, appear to have given our economy a boost in the 1960s, and a smaller boost in the 1980s. But any economic boost from the Bush tax cuts of 2001 and 2003 was so small as to be invisible to all but (possibly) the most careful econometricians. Notably, a number of attempts to encourage savings - capital gains tax cuts, estate tax cuts, and the like - have not halted the steady decline in personal savings rates.

Exhibit B: Financial deregulation and light-touch regulation. It seems clear to me that under-regulation of derivatives markets and mortgage lending played a big role in the financial crisis. The counter-narrative, that government intervention caused the crisis, has never held much water, and has been debunked by many papers. This was a private-sector blowup.

Exhibit C: Light-touch regulation of monopoly. The evidence is mounting that industrial concentration is an increasing problem for the U.S. economy. Some of this might be due to intellectual property, but much is simply due to naturally increasing returns to scale.

Exhibit D: The China shock. While most trade booms seem to lead to widely shared gains, the China trade boom in the 2000s - which free marketers consistently championed and hailed - probably did not. High transaction costs (retraining costs, moving costs, and others) lead to a very large number of American workers being deeply and permanently hurt by the shock, as evidenced by recent work by Autor, Dorn, and Hanson.

Exhibit E: Faux-privatization. True privatization is when the government halts a nationalized industry and auctions off its assets. Faux-privatization is when the government outsources an activity to contractors, often without even competitive bidding. Faux-privatization has been a notable bust in the prison industry, and school voucher programs have also been extremely underwhelming. Charter schools have fared a bit better, but even there the gains have been modest at best.

Exhibit F: Welfare reform. Clinton's welfare reform saved the taxpayer very little money, and appears to have had little if any effect on poverty in the U.S.

Exhibit G: Research funding cuts. The impact of these is hard to measure, but cuts in government funding of research appear to have saved the taxpayer very little money, while dramatically increasing the time that scientists have to devote to writing grant proposals, and increasing risk aversion in scientists' choice of research topics.

Exhibit H: Health care. The U.S. health care system is a hybrid private-public system, but includes a proportionally much larger private component than any other developed nation's system. Free-marketers have fought doggedly to prevent the government from playing a larger role. Our hybrid system delivers basically the same results as every other developed country's system, at about twice the cost. Private health care cost growth has been much faster than cost growth for Medicare and other government-provided programs, indicating that much of our excess cost has been due to the private component of our system, not the public part.

I could go on, but these are the big ones I can think of. In some of these cases, free-market policies seem to have produced some gains in the late 20th century, but by the 21st century all appeared to be either having no effect, or actively harming the economy.

No, this is nowhere near as big a failure as that of communism (though in some ways, notably health care and financial deregulation, we've done worse than the somewhat-socialist nations of Europe). The analogy with communism was a way of illustrating a certain mindset, not to draw an equivalence between the results of neoliberalism and communism.

Also, I personally think there is still scope for many neoliberal policies to improve our economy. Reduced occupational licensing, urban land-use deregulation, simplification of the tax code, and various other kinds of deregulation all seem to show promise. If free-market policies have hit a wall, it's a porous wall - in real life, nothing is as cut-and-dry as in our ideological debates.

But overall, I think the last decade and a half have shown clearly diminishing returns, and sometimes negative returns, from neoliberal reforms. So our society is right to be looking for alternative policy packages. Though that doesn't necessarily mean we'll choose a good alternative - I think Sanders-style socialism would probably be a mistake.

Saturday, August 20, 2016

Heterodox macro - a reply to some replies


The other day I wrote a Bloomberg View post arguing that heterodox macroeconomics is not in any better shape than mainstream macroeconomics. As you might expect, this drew some lively responses.

One or two of the responses seemed to be arguing against the title of my post, rather than the contents. That's understandable, since titles are important. In this case, though, it probably detracted from the debate a great deal. The Bloomberg title people are good, and they usually get things right, but once in a while the title they choose doesn't quite capture the point I'm trying to make. This was one of those cases. The title they gave my post was "Economics Without Math Is Trendy, But It Doesn't Add Up." But actually, this wasn't what I was arguing. My point about non-mathy models wasn't that these are bad, useless, or inferior. It was that they're different from mathy models, and so comparing non-mathy models with mathy ones is an apples-to-oranges comparison. Both types of models have their uses, but you can't really compare one to the other. I make that pretty clear in the text of my post, but most of the people who responded tended to focus more on the title. Oh well. These things happen.

Anyway, on to some of the responses. The numbering here is arbitrary, corresponding to the order in which the tabs were open on my browser. (Note: The ordering has changed; see #4.)


Response 1: Steve Keen

First, we have a response by Steve Keen. Steve, unlike others, did get the point I was making about mathy vs. non-mathy models (Thanks, Steve!), and had some good commentary on the subject:
There is indeed a wing of heterodox economics that is anti-mathematical. Known as "Critical Realism" and centred on the work of Tony Lawson at Cambridge UK, it attributes the failings of economics to the use of mathematics itself... 
What Noah might not know is that many heterodox economists are critical of this approach as well. In response to a paper by Lawson that effectively defined "Neoclassical" economics as any economics that made use of mathematics (which would define me as a Neoclassical!), Jamie Morgan edited a book of replies to Lawson entitled What is Neoclassical Economics? (including a chapter by me). While the authors agreed with Lawson's primary point that economics has suffered from favouring apparent mathematical elegance above realism, several of us asserted that mathematical analysis is needed in economics, if only for the reason that Noah gave in his article[.]
Steve also offers some useful criticism of Milton Friedman's ideas about how to evaluate a model's empirical success (I agree).

Steve also makes the useful point that linearization critically hampers many mainstream models (I agree).

Steve points out that non-mathy models can make qualitative forecasts. That's true. However, my point was that these are often a lot less actionable than quantitative forecasts. A non-mathy model might tell you that private-sector debt is dangerous, but it might not tell you how much of it is dangerous, or how dangerous. For that, you'd need some kind of mathy model. Steve definitely seems to get this point too, though, so I'm not disagreeing.

Steve then discusses overfitting of data, and points out that many mainstream models do this too. That's certainly true, although I think DSGE models tend to be a lot more parsimonious than SFC models or stuff like FRB/US. Actually, overfitting is one of the big criticisms of the most popular DSGE models in use at central banks.

Steve then addresses the idea that heterodox models are similar to mainstream ones. I never said they were, although I said there are some similarities between the FRB/US model and Wynne Godley-type SFC models. In fact, there are some similarities, though there are also differences. But in general, most heterodox models are very different from most mainstream models.

Steve also discusses my (admittedly too brief) mention of agent-based models, and has some good comments:
Largely speaking, this is true - if you want to use these models for macroeconomic forecasting. But they are useful for illustrating an issue that the mainstream avoids: "emergent properties". A population, even of very similar entities, can generate results that can't be extrapolated from the properties of any one entity taken in isolation...Neoclassical economists unintentionally proved this about isolated consumers as well, in what is known as the Sonnenschein-Mantel-Debreu theorem. But they have sidestepped its results ever since...Multi-agent modelling may not lead to a new policy-oriented theory of macroeconomics. But it acquaints those who do it with the phenomenon of emergent properties - that an aggregate does not function as a scaled-up version of the entities that comprise it. That's a lesson that Neoclassical economists still haven't absorbed.
I think this is right. Agent-based models have so far served as a demonstration of the fragility of representative agent models. In the future, they might be much more than that.

So anyway, I'd say I pretty much agree with Steve's response. Good stuff. (Though this person on Reddit had some problems with it.)


Response 2: Ari Andricopolous

Ari has a response as well. His response comes in the form of a list of things that he thinks macro models should not include. The list is:

  1. Microfoundations
  2. Rationality
  3. Loanable funds
  4. Interest rate effects
  5. The financial sector

It's pretty clear that the last item on this list is misplaced, since Ari thinks one should include the financial sector in models.

Whether macro models should be microfounded is a big open question, but I'd like to note that by saying they shouldn't be, Ari is saying that agent-based models are bad. Agent-based models are as microfounded as they come.

As for rationality, I kind of disagree...humans observe and learn and adapt (OK, some more than others, I'll grant). Even though perfect rationality is probably pretty unrealistic, to insist that models totally ignore human observation, learning, and adaptation seems very dangerous for the realism of any model.

As for the loanable funds thing...yeah, OK, sure.


Response 3: Jo Michell

Jo Michell's response might have been the first to go up, but it's later on this list because...the numbering is arbitrary!

Jo, which I believe is short for "Jörmungandr", has a helpful diagram of the "schools" of macroeconomic thought. He also pushes back on the notion that "heterodox" is a useful classification at all:
The problem with ‘heterodox economics’ is that it is self-definition in terms of the other. It says ‘we are not them’ — but says nothing about what we are. This is because it includes everything outside of the mainstream, from reasonably well-defined and coherent schools of thought such as Post Keynesians, Marxists and Austrians, to much more nebulous and ill-defined discontents of all hues. To put it bluntly, a broad definition of ‘people who disagree with mainstream economics’ is going to include a lot of cranks. People will place the boundary between serious non-mainstream economists and cranks differently, depending on their perspective. 
Another problem is that these schools of thought have fundamental differences. Aside from rejecting standard neoclassical economics, the Marxists and the Austrians don’t have a great deal in common.
This is a good and useful point. My Bloomberg post really did bite off more than it could chew. My point was that there wasn't something better and more successful out there that by rights ought to already have displaced the (unsuccessful) mainstream approach. But in making that point, I touched on a number of different types of alternatives that aren't really closely connected. And I left out others (for example, Steve Keen's own work, and the Austrians).

Jo, unfortunately, appears to have gotten tripped up by the title:
Noah seems to define heterodox economics as ‘non-mathematical’ economics. This is inaccurate. There is much formal modelling outside of the mainstream. 
Well, no, I don't define it that way, otherwise I wouldn't have discussed SFC models and agent-based models in my post.

Jo goes on to make some good points about mainstream models, and some of the problems they encounter.


Response 4: Frances Coppola

Frances Coppola, whom I cited in my Bloomberg post, also has a response. I responded to this post earlier, but Frances changed it, so I moved my response down to #4.

Frances still seems to misunderstand my post somewhat, and to have been tripped up by the title:
Noah's core proposition is that economics has no validity unless it is expressed in mathematical terms. He says that economics without mathematics doesn’t add up.
Actually, I didn't make such a claim. Nor do I believe it. What I wrote was:
Broad idea-sketching is certainly a valuable activity. If theorists get lost in the specifics of their models, they can blind themselves to truly new hypotheses and mechanisms that would let them make big, radical changes. I do think this has happened to some degree in mainstream macro...But that doesn’t mean that broad idea-sketching is a replacement for formal models. It’s not an apples-to-apples comparison.
My point is that although non-mathematical econ is often valuable, it's not comparable to mathematical econ. Both have their place. But to say that a non-quantitative theory was successful at predicting the Great Recession, while a quantitative theory failed, is to hold the two theories to very different standards, since "predict" means different things for quantitative theories than it does for non-quantitative theories.

Frances goes on to discuss some of the limitations of purely quantitative models. She's broadly right. She then criticizes some heterodox theorists who, in her opinion, focus too much on math:
Noah's post unfortunately seems to have elicited some rather defensive responses from the heterodox community, along the lines of “But we DO like mathematics!” or even, “Actually our mathematics is better than yours”. But this is to buy into Noah's core proposition. The heterodox economics community should - and, to be fair, in most cases does - reject it outright.  Economics is not, and cannot be, exclusively mathematical...There is no need for the heterodox economic community to be defensive about vagueness.
Again, Frances demonstrates a deep misunderstanding of my thesis. I never said that econ theory should be exclusively mathematical, nor do I believe it. This confusion is partly the result of the title, and partly the result of me just not explaining my thesis well enough.


Anyway, those are the responses I've seen. Thanks to everyone who took the time to respond!

Monday, August 15, 2016

Is Firefly overrated?


The whole world is in need of a break from the madness, and someone on Twitter asked me to do a blog post about whether Firefly is overrated. So instead of econ or politics or serious stuff, let's talk about a television show that got canceled 13 years ago! :-)

The answer to the question in the blog post title is: "Of course not." In the strictest sense, no sci-fi show is overrated, because people in general ought to watch more sci-fi and less of whatever they're watching now. Science fiction has taken over movies, but not TV. Fortunately, with great programs like Black Mirror, Stranger Things, etc., there's still lots of good stuff out there.

But Firefly, more than probably any other show, holds a special place in the heart of my generation of geek-Americans. It's consistently at the top of user-generated lists of the best sci-fi shows ever. It's the subject of countless...OK, I'm not even going to finish this paragraph, because we all know that all geeks love Firefly like economists love envelope theorems.

Well, maybe not all geeks. A few have been known to write grumpy Tumblr posts about how the show is racist and/or sexist. But aggrieved identity-politics driven Tumblr rants are like death and taxes, except that Peter Thiel can escape the latter two. 

But buried deep within those overdone rants, I see the seeds of something that really did make Firefly different from other sci-fi TV shows - besides the snappier dialogue and Western motif, I mean. It has to do with the culture the series drew on for its mythos. Firefly was, at its root, a Southern show.

First of all, there's the well-known connection of the Firefly backstory to the Confederacy - Joss Whedon has said that the show was inspired by a Civil War novel. The Browncoats are the Rebs, and the Alliance is the U.S. Mal is the outlaw/pioneer/cowboy who went West after the Lost Cause was lost. Everyone knows that. But Firefly's connections to the South are more cultural than political. Almost every character on the show is some sort of traditional Southern stereotype.

Mal is the classic ideal of the Southern gentleman. He's brave, rigidly honorable, quick to violence...gallant, protective, and respectful toward women. He's sharp and clever but no intellectual. I imagine him as a planter's son from Virginia, who can trace his ancestors back to the Cavaliers in the English Civil War.

Jayne is the poor white Southern guy. He's the overseer, the patroller, the farm hand. He's tough, mean, not too bright, selfish, opportunistic, uneducated, and a bully. He's often the villain of the show, barely kept in check by Mal's aristocratic alpha-male dominance. He's shown improving a bit as the show goes on, though of course it was canceled before this could get very far.

Inara is the fallen Southern belle - the kind of woman who once ruled a plantation, then was forced to prostitute herself to make ends meet after the war, but who still maintains some kind of honor and dignity. An R-rated Scarlett O'Hara. 

Wash and Zoe are the Yankees (despite the fact that Zoe fought for the Browncoats, which is something I suspect Whedon threw in to muddy the parallels a bit). Wash is a geek, effeminate, playing with his dinosaur toys - Jayne calls him "little man." He's somewhat dominated by his wife, who is strong, independent, and sexually uninhibited. They're also a mixed-race couple, which of course was a Southern stereotype of the North. Shepherd Book is a black man whose violent past has been tamed by the civilizing power of Christianity. Kaylee is a simple backwoods country girl. The doctor and River are also Yankees, though they are external plot drivers and hence less stereotypical. 

And as a Southern show, Firefly is notably devoid of intellectual characters. There are no scientists on Serenity - Simon the doctor is the closest thing, and his uppity smarty-pants attitude earns him repeated face-punches from the dashing Mal. Kaylee, the engineer, works by intuition alone.

So the characters are mostly from Southern culture, but so is the theme of the show - it's all about honor. Mal's honor is central to his decent, noble conduct, and is the reason the Serenity crew is sympathetic instead of being a bunch of rascally piratical n'er-do-wells (which they probably would be if the show were Japanese or British). Serenity's captain is an upright man in a lawless, dirty world.

But honor is also the reason why Serenity is out there in space in the first place. Mal and the rest could presumably go live as Alliance citizens - it's not clear how repressive the Alliance government is, but the people seem to be pretty wealthy. We don't know what cause the Browncoats were fighting for. But it's pretty clear that Mal went to space to become an outlaw because his sense of honor makes him refuse to knuckle under to his conqueror. "You can't take the sky from me," as the theme song's lyrics go.

And this, really, is why I was always a little dissatisfied with Firefly. In most space opera shows, the cosmos is vast, exciting, full of wonders - the final frontier. Humans go to space because it's our destiny. We go in search of our better selves - to learn new science, to meet aliens, to teach others about our culture and learn about theirs, and to bring a better, more just order to the Universe. In Star Trek (The Original Series and The Next Generation) we go just to go. In Babylon 5 and Deep Space 9 we go to make the galaxy safe for liberal values. In Robotech and Farscape we go to fall in love with aliens (hey, why the hell not). Battlestar Galactica and Space Battleship Yamato are darker shows about survival, but also depict a struggle to preserve liberal values in the face of overwhelming existential threats. Now you know I've watched way too much space opera in my life.

But in Firefly, why do we - meaning the crew of Serenity - go to space? It's not for a higher purpose. There's no science being done, no galaxy being saved. The show's theme song may be about freedom, but unlike many of the people around them, Mal and his crew aren't colonists. They aren't going to found a new, more liberal republic on the virgin soil of a distant world. They aren't going to build a city on a hill. They have no quest, they seek no knowledge, they fight for no cause, they meet no aliens. Their existence is simply a big fat middle finger to the government in the distance.

And that's fine. It's fun, it's exciting, it makes for some great gunfights. But it doesn't resonate with me. I grew up in Texas, but I don't really have the Southern honor culture, and even if the Civil War hadn't been about slavery the Lost Cause would have little or no romance for me.

That's why Firefly, as fun and as well-written and as adorable as it was, can never be the Greatest of All Time as far as I'm concerned. I mean, guys - you're in space. You're on a spaceship. You're flying around from planet to planet, and instead of looking out the window at the incredible sweep of the unknown, you're thinking about your honor, and how you lost a war, and how to earn your next dollar. There's nothing wrong with that, but it's not the stuff of inspiration. I don't know about y'all, but when I gaze up at the night sky, I hope my first thought isn't "Damn...somewhere out there is a place where I could evade some federal regulation."

Tuesday, August 09, 2016

No, U.S. elections are not "rigged"


Tyler Cowen, my esteemed Bloomberg View colleague, has a post about Donald Trump's comments predicting a "rigged" election. Though Tyler states explicitly that he is not defending Trump's comments, the post certainly reads like a defense. Tyler's main points seem to be:

1. Elections really are "rigged" in some sense, and

2. Accusations of election "rigging" often come from the Left.

I don't want to put words in Tyler's mouth, though, so I'll repost much of his post:
[O]ver the last few years or indeed decades I also have seen the following: 
1. Numerous arguments insist that money buys elections and campaign finance reform is imperative... 
2. Numerous arguments that Republican-backed voter registration requirements are keeping significant numbers of voters, most of all minority voters, away from the polls... 
4. Do we not all teach the Gibbard-Sattherthwaite theorem to our Principles classes on week three?  In case you forget, the theorem shows that under some fairly general assumptions elections processes are manipulable in a rigorous sense... 
5. A related branch of social choice theory, stemming from Dick McKelvey’s work in 1979, suggests that when the policy space has more than one dimension, the agenda setter in Congress has a great deal of power and typically can shape the final outcome... 
6. Major political scientists from schools such as Princeton tell us that elites determine policy and ordinary voters have very little say in what happens... 
7. The American electoral system is designed to give the two major parties a huge initial advantage... 
How many Democrats have alleged that the 2000 Presidential election was rigged?  Or that today most Americans want some form of tougher gun control, but that the system is rigged against that outcome happening?
Many people are not a big fan of this post. I would count myself among that number. Here are my points in response to Tyler:


Point 1: Let's not muddy the definition of "rigged". 

When most people hear the word "rigged" in the context of an election, they probably think that means the results have been falsified - that the numbers of votes recorded for each candidate differ meaningfully from the number actually cast.

To most people, a "rigged" election probably does not mean that the franchise ought to have been extended to disenfranchised groups. For example, in 19th century America, women could not vote. That was bad. But were all 19th century American elections therefore "rigged"? Most people would say no. Similarly, there is a good argument for extending the franchise to 17-year-olds in America right now. If we eventually do that, would that mean that all elections in the 20th century were "rigged"? Again, most people would say no.

Similarly, I've never heard of anyone who says that tactical voting is a form of election-rigging. Since tactical voting is universal (that's what Gibbard-Satterthwaite is about!), it also doesn't seem very helpful to label this a form of "rigging".

How about campaign finance? There are certainly a few people on the Left in America who would define this as election-rigging. I personally think that's silly. First of all, most evidence shows that money doesn't really give that much of an electoral advantage. Second of all, stringent campaign finance laws - such as those found in Japan - will still result in some groups and individuals having disproportionate power over election outcomes. Again, it seems worse than useless to define something that is inevitable and universal in a democracy as "rigging".

The only item Tyler mentions that seems to me like it could significantly count as vote-rigging is intentional disenfranchisement of voters who are officially afforded the franchise. For example, if eligible voters are intentionally and systematically purged from voter rolls to produce a certain outcome, that probably counts as "rigging". There is at least an outside possibility that this sort of manipulation made a difference in Florida in the 2000 election, thus throwing the election to Bush.

But when Trump says that the election will be "rigged", he doesn't mean any of these things - he's suggesting that vote totals will be falsified.


Point 2: Watering down the definition of "rigging" gives aid and comfort to those who would deligitimize our democracy.

If politicians like Trump consistently claim that election results are falsified, it erodes confidence in the electoral process itself - the people on the losing side will distrust the results of any election. That seems like it could eventually lead to a lot of bad outcomes. Election losers, convinced they actually won the vote, could become more intransigent and refuse to work with winners. Polarization could increase, eventually leading to outright civil conflict and the disintegration of the nation. Support could increase for military coups to depose election winners on the grounds that these winners were not elected legitimately. In other words, false claims of election-rigging seem pretty clearly to lead to the breakdown of our institutions, our democracy, and our country itself.

Now, I think those are bad things. Maybe Tyler disagrees. Though he has affirmed his support for democracy in the past, his mind might have changed since 2008. Certainly not all of his colleagues at GMU support democracy as the best system. Similarly, Tyler might believe that the United States of America ought to be split up, along regional, economic, or ethnic lines - or that nation-states themselves shouldn't exist. Certainly, there are others who do believe this.

But I believe that countries where democracy has lost its popular legitimacy, like Russia, Turkey, and Thailand, have not seen good outcomes over the past couple of decades. I also pretty strongly believe in nation-states, and in the United States nation-state in particular. So I think that when Tyler claims that U.S. elections are "rigged" in any substantial sense, it is probably a bad thing.

Of course, I support calls for ensuring that the franchise be extended as broadly as possible, and I'm interested in improving our campaign finance laws, but - see Point 1 - I don't think that calling for these reforms is anything even remotely similar to making allegations of election-rigging.


Point 3: Just because some on the Left do this doesn't make it OK for Trump to do it, nor is there an equivalence between the two.

Yes, there are some people on the Left in America who claim from time to time that elections, especially Democratic primaries, are "rigged". These claims are very rare, but I have heard them, especially from diehard Sanders-then-Stein supporters in the current election. Here is a Salon column alleging "rigging", but defining rigging down much as Tyler does. Here is an Inquisitr article alleging true election-rigging, i.e. vote-falsifying.

I see these allegations as obviously false, reprehensible, and dangerous in much the same way Trump's are. But to point out that "the Left does it too!" only reinforces the need to fight back against delegitimization of our democracy. It does not merit a shrug or a "Hey, dude, both sides do it".

Also, there is an asymmetry here. Diehard Sanders-then-Stein supporters are a fringe, and there will always be a fringe in politics. Trump is the nominee of one of the two major parties. Al Gore certainly never alleged vote-rigging in 2000, even after everything that happened in Florida. There is no equivalence at all here, and to try to draw one is a de facto defense and excusal of Trump's dangerous, unacceptable behavior.


So for these reasons, I am not a big fan of Tyler's post. American elections are not perfect, but - unless there is major evidence that has not yet come to light - they're pretty darn good. And Trump's questioning of their legitimacy is truly unprecedented, and not a part of partisan business-as-usual.


Updates

On Twitter, Rajeev Ramachandran hits the nail on the head:
[T]here's a diff b/w "systematically favours X" and "result won't depend on votes actually cast". The first calls for reform. The second is a call to armed insurrection.
Yes. Exactly. I couldn't have said it better (as evidenced by the fact that I didn't!).

Here is some new evidence that Republicans, but probably not Democrats, are starting to question whether votes are counted accurately in American elections. I view Tyler's post as contributing to this very negative and asymmetric trend.

As Trump intensifies his campaign to preemptively delegitimize the election result, Tyler's post is looking more and more spectacularly ill-timed...

Saturday, July 30, 2016

How are Milton Friedman's ideas holding up?


I recently wrote a Bloomberg View post about consumption Euler equations, and how these are increasingly being targeted as a broken piece of macroeconomics. I traced the idea back to Milton Friedman and the Permanent Income Hypothesis, and Bloomberg decided (wisely) to go with Friedman for the headline. "Economists Give Up on Milton Friedman's Biggest Idea" is probably going to get orders of magnitude more clicks than "Economists Search for Replacement for Infinitely Lived Perfectly Far-Sighted Model of Consumption Smoothing".

BUT, anyway, Emily Skarbek decided that Uncle Miltie needed some defending, and wrote a blog post praising his legacy. Most of the post discusses stuff that I didn't touch on in my Bloomberg post, since I was only talking about the PIH. So I decided to do a post about Milton Friedman's overall legacy - actually, much too big a topic to do justice to in one post, but hey, that never stopped anyone before, so what the heck! I pitched it to Bloomberg, and they said "But didn't you just do a Milton Friedman post??", so on the blog it goes.

For some reason, Friedman is treated a bit like a secular saint in policy discussions. If you criticize "Idea X", fine. We can have an argument. But if you criticize "Milton Friedman's Idea X", then WHO ARE YOU, LOWLY WORM, to criticize the great FRIEDMAN?? If you say government is a lot more useful and important than Reagan and Thatcher and Art Laffer and Friedrich Hayek and Ed Prescott and Greg Mankiw think, well, fine, that's your opinion. But if you say government is a lot more useful and important than Milton Friedman thought, then you're wrong wrong wrong and don't you know that Friedman proved government was bad in the 70s?? Etc.

OK, I might be exaggerating as an excuse to use lots of capital letters and italics, but Friedman is such a towering intellectual that criticizing him does feel a bit like tipping a sacred cow. Fortunately I'm from Texas, where cow-tipping is a way of life.

So I, a nobody, shall proceed to grade the multifarious ideas of the great Friedman. Let's start with his macroeconomic ideas, and leave the policy ones for a follow-up post. As of 2016, how is each of Friedman's ideas holding up?


PART 1 - MACRO IDEAS

1. Permanent Income Hypothesis

As I wrote for the Bloomberg post, economists figured out by the 90s that the PIH doesn't look strictly true - there are lots of hand-to-mouth consumers out there. And natural experiments tend to find that people consume windfalls to a fair degree. What we don't know is why some consumers smooth and some consume hand-to-mouth, or whether and how it's state-contingent. Yes, the idea of a mechanical hand-to-mouth consumption function is dead - many people obviously are forward-looking to some degree under many conditions. But the strong form of the PIH - perfectly forward-looking consumption smoothing - doesn't look like a good approximation to reality.

Oh, and here's Skarbek's defense of the concept:
It seems to me that the PIH is a useful way to understand personal investments decisions over one's lifetime. For example, why young people who expect (even if inaccurately in many cases) to have high earnings after college incur student loans instead of directly entering the workforce. Or why people take out 30 year mortgages to buy homes.
Sorry, but "I have seen instances of people borrowing large amounts of money" doesn't tell us much about consumption smoothing. But even if it did, these are not good examples. A mortgage doesn't entail taking on net debt, since the value of the loan is the same as the value of the asset you acquire. And education is generally regarded as investment, not consumption (though some might argue). So, no.

A more sophisticated defense of the PIH is that we can always find some utility function that makes it look like people are smoothing consumption. But this defense is also bad, because A) it makes the PIH totally vacuous, and B) utility-function-mining is just going to get you something that fails out of sample, and you'll have to go mine for a different function, etc.

But the most common defense is: "But the PIH doesn't say all consumers are perfect smoothers, only that people do some amount of consumption smoothing." Fair enough; β>0 is technically a hypothesis, right? But if your hypothesis is only about a sign and not a magnitude, it generally isn't that useful.

Grade: C


2. Money growth targeting/k-percent rule

This idea was adopted in the U.S. between 1979 and 1982. But as Bennett McCallum has documented, the Fed failed to hit its targets:


[T]he Fed did not succeed in improving its record of money stock control. Instead, the realized growth rates for the years ending in the fourth quarter of 1980, 1981, and 1982 were again outside the specified target range, as indicated in Table 1-3. And monthly values of the growth rate were highly variable, as can readily be seen from Figure 1-1. This is especially striking, of course, because the special operating procedures of 1979-1982 were designed precisely for the purpose of improving money stock control so as better to achieve the monetary growth targets!
As it turns out, central banks just aren't very good at controlling the money supply. McCallum also speculates on what effects the failed attempt to target money growth rates might have had:
What, then, were the results of this experiment? In one respect the Fed's attempts were successful: by September 1982 the U.S. inflation rate had been reduced from around 11 or 12 percent (per year) to a magnitude in the vicinity of 4 or 5 percent. Other aspects of the outcome were not as planned, however, and were highly unpopular with the public and with most commentators. Of these undesirable side effects, four will be mentioned. First, short-term interest rates rose to levels unprecedented in U.S. history. Over the month of May 1981, for example, the 90-day Treasury bill rate averaged 16.3 percent. Second, the extent of month-to-month variability of interest rates was greater than ever before. Third, in 1981 a recession began that was the most severe since the Great Depression of the 1930s; the nation's overall unemployment rate climbed over 10 percent in the second half of 1982. So while the economy was relieved -- at least temporarily -- of the inflationary pressures that it had been experiencing for about a decade, this relief was apparently obtained at the cost of an unwelcome recession and the associated loss in output.
In any case, the failure of money supply targeting caused central banks to switch to a mix of interest-rate targeting and inflation targeting. 

Grade: D-


3. Quantity Theory of Money

This is probably Friedman's most famous idea - the notion that "inflation is always and everywhere a monetary phenomenon." Unfortunately, it's hard to tell if it's right, because it's a vague idea. First, you have to define the money supply (Are bonds money? Etc.). Next, you have to specify the lag of the effect - if money has a long and variable lag on inflation, as Friedman thought, it'll be hard to pin it down empirically. But anyway, tests appear to be generally in favor of the hypothesis. Here's an abstract from a 2001 discussion paper by Paul DeGrauwe and Magdalena Polan:
Using a sample of about 160 countries over the last thirty years we test for the quantity theory relationship between money and inflation. When analysing the full sample of countries we find a strong positive relation between the long-run inflation and money growth rate. The relation is not, however, proportional. The strong link between inflation and money growth is almost wholly due to the presence of high (or hyper-) inflation countries in the sample. The relationship between inflation and money growth for low inflation countries (on average less than 10% per annum over the last 30 years) is weak. We find that the long-run average inflation and country-specific factors have a significant influence on the strength of the relationship. We also confirm that money growth and output growth are orthogonal in the long-run; i.e. higher growth rates of money do not lead to higher growth rates of output.
And here is a table from their literature review:


So, generally pretty good support for Friedman's idea in high inflation countries (which are probably the main cases Friedman and everyone else cared about), though not so much when inflation itself is low. In particular, at the Zero Lower Bound (or maybe just more generally in a long disinflationary stagnation after a financial crisis), velocity seems to fall off substantially:


So although high inflation appears to coincide with high money supply growth, the correlation does seem to break down for economies like ours and Japan's.

Also, studies like these can't isolate causality, so there's always the possibility that high inflation itself boosts the money supply, by increasing bank lending and/or politically forcing the central bank to print more money. To my knowledge, this is not well-known.

Grade: B


4. Friedman Rule

This is the idea that nominal interest rates should be set at zero. It generally contradicts the k-percent money growth rule, unless setting rates at zero just happens to make the money supply grow at a constant rate (how much of a PR badass are you if you can get your name on two mutually contradictory rules?). Interestingly, the Friedman Rule is based on Neo-Fisherism - it says that rates should be at zero because in the long run, low interest rates are deflationary and mild deflation is what we want.

The idea that deflation is good has probably not stood the test of time, as most people agree that it has been damaging to Japan's economy. People have generally agreed on inflation targets of 2 percent, rather than negative inflation targets. But interestingly, zero or near-zero nominal interest rates have now become the global norm, at least in the developed world:


So it seems to me that no one really knows what to make of the Friedman Rule. Everyone is doing it, but for essentially the opposite of the reason than Friedman envisioned. It's a weird world out there, folks.

Grade: C+


5. Rejection of Fiscal Stabilization Policy

This appears to have been a big bust. Whatever monetary policy has or hasn't done, it has proven incapable, by itself, of pulling economies out of long slumps. Meanwhile, most of the evidence we have - which is weak evidence, because it's macro, but nevertheless is all we have - seems to indicate that fiscal policy works, even if we don't understand exactly why it works (see here, here, and here for example). Moreover, there is a growing recognition that what often matters is the combination of fiscal and monetary policy, and that fiscal policy can cancel out the effects of monetary policy. This may be why governments around the world still engage in fiscal stimulus when times get rough.

The poor quality of macro data saves Friedman from getting an F on this one.

Grade: D


6. Floating Exchange Rates

Lots of countries have certainly gotten into trouble trying to peg their exchange rate too high - this generally leads to a devaluation, capital flight, and a "sudden stop." But some countries (China) seem to have gotten some good results by pegging their exchange rates low during their catch-up growth phase, while using capital controls to prevent inflation. Also, a lot of countries have "managed floats", where they pretend to float their currencies but don't really do it. Anyway, to my knowledge, the data is just too poor and sketchy here to know which kind of exchange rate regime is really optimal, or whether this depends on the situation. Basically, I think we don't know much more about this now than we did in Friedman's day. Though I could be wrong.

Grade: Incomplete


7. Natural Rate of Unemployment

Basically, this is just the idea that unemployment is mean-reverting to some slow-moving number. Looks pretty true for the U.S., less so for other developed countries:


Of course, you can claim that in the other developed countries, big structural shifts happened that changed the natural rate. Unfortunately, that's just a fudge factor, and attempts to explain these changes with easily observable structural changes (e.g. taxes) haven't gone so well.

One one level, it's pretty obvious that there's some floor to unemployment - there will always be people between jobs, and people who don't want to work but who claim they do. The presence of a natural floor means that if a country keeps trying to put everyone to work, but keeps suffering negative shocks, unemployment will appear to oscillate. You can then draw an average line through that bouncy time series and call it the "natural rate". But in this case, the real things would be the unemployment rate floor and the average size of recessions - not the "natural rate".

So it's just not clear how useful this concept is, without some way to anticipate what the "natural rate" should be.

Grade: C+


8. Adaptive Expectations

This is the idea that people's expectations of future inflation (or other economic variables) is basically just some moving average of recent past inflation.

In fact, we do see that people's past inflation experiences tend to influence their expectations, but at a very very long time lag - basically, people's entire life. And it might be a lifetime average rather than a moving average.

Anyway, it seems to me that if you write down models with a simple, precisely specified model for adaptive expectations, with fixed lags etc. etc., it won't fit the data very well. But things like Bayesian priors and inattention will create learning effects that make expectations look like they have an adaptive component. People don't use Friedman-style adaptive expectations in models anymore, but A) it's unclear whether what they do use works well, and B) more sophisticated learning-based models seem to be popular. So this seems like a case where a simple Friedman idea contains an important principle that shouldn't be taken too far, and inspired a line of work that is interesting and still in progress.

Grade: B


9. Friedman-Savage Utility Function

Most decision theory researchers now realize that risk aversion can be positive or negative depending on the size of the gamble. Friedman's specific form for the utility of consumption is probably not that useful, but the basic idea - which has persisted into theories like prospect theory, salience theory, and others - is sound. People definitely do seem to buy both life insurance and lottery tickets.

Grade: B


10. Friedman Test

Sure, looks legit.

Grade: A


Overall Grade: C+

Friedman's macro ideas were enormously influential, and probably made very crucial points at the time they were introduced. However, they suffer from one fatal flaw: They are macro ideas. Macreconomics does not easily yield its truths to the probing mind, given uninformative data and the complexity of the thing. Plus, it's likely that big structural changes make it such that the discipline has few eternal verities - what describes the economy well in 1976 might have little to do with the events of 2016. So while "C+" looks like a harsh grade, I'm not sure what other macroeconomic thinker has done better. My favorite macroeconomists, like Bob Hall or Chris Sims, tend to be much more cautious and circumspect than Friedman - the smartest researchers seem to have realized that big, Friedman-style ideas will almost always fail to a substantial degree.

Coming up next: Friedman's policy ideas!

Thursday, July 21, 2016

Trump happened because conservatism failed


Tyler Cowen (now a Bloomberg View colleague of mine) took a crack at this question back in February, and I've been thinking about it ever since. Here's my unified theory of why a guy like Trump managed to take over the Republican party this year, when nothing similar had ever happened before in living memory.

First of all, a note about causality. Most events are the result of a chain of causes - if one link in the chain falls apart, the event doesn't happen. This is not the way human intuition naturally thinks about causality - we instinctively imagine each event as the sum of causal factors, and attribute some percent of responsibility to each factor. But with a causal chain, each link is responsible for 100% of the causality. Just like the marginal value of a right shoe and the marginal value of a left shoe are both equal to 100% of the total value of a pair of shoes.

So I think that Trump is a special human being. He's a reality star, a possibly-faux-billionaire celebrity who's really good at overselling himself, and has essentially no scruples. There aren't many of those in the United States who want the job of president. In fact, there is probably only one. If Trump had been killed in a car accident in 2014, we might be looking at a much more typical Republican candidate, with the Republican establishment retaining a shaky but intact grasp on the party.

But that's just one link in the chain - one precondition for the Trump Takeover. I think there are two other main links here: 1. The dramatic weakness of the Republican establishment, and 2. The existence of a Trump-friendly voter bloc in the first place.

In the past, the Republican presidential candidate was usually a gray, bland figure, a stalwart conservative but not a fire-breathing one, a man who had worked his way up the ranks. Romney, McCain, Bush II, Dole, and Bush I all fit this description - Reagan was the only possible exception within my lifetime, and even he didn't deviate too far from this model. As a conservative, the Republican nominee would support tax cuts, a business-friendly attitude, a tough-guy attitude toward America's enemies and rivals, and traditional family values based on Christianity. That's what conservatism was.

But in the past fifteen years, the three pillars of conservatism - economic, foreign-policy, and social conservatism - have all had huge, dramatic failures.

Economic conservatism had two big failures. The first failure was when the Bush tax cuts failed to reverse income stagnation:


The second failure was when a lax regulatory climate appeared to give rise to a financial crisis that devastated the job market. That second shock was so huge that it has all kinds of people questioning neoliberalism itself - big, comprehensive alternative policy paradigms like protectionism, socialism, and industrialism are now being openly considered. Those alternatives may or may not gain traction. But certainly, the formula of "cut taxes and let businesses do as they see fit" is now pretty discredited. Some older intellectuals continue to fight doggedly for this economic program, but nowadays they are rightfully ignored.

Simple truth: Economic conservatism failed in the 2000s and 2010s.

Next, foreign policy conservatism. This failed during the George W. Bush administration, when Bush turned bellicose rhetoric into bellicose reality with the disastrous Iraq War. The Iraq War was a disaster because despite winning the war pretty handily and taking low casualties, we received no gains. We spent massive amounts of money and thousands of lives, and temporarily wrecked our international prestige, only to turn Iraq from an unthreatening petty dictatorship into a failed state and a breeding ground for ISIS. It was a failure of the modern conservative approach to war itself.

A more minor failure was the seeming emptiness of Bush's bellicose rhetoric when it came to actual threats. Under Bush's watch, Putin's power grew inexorably, and North Korea got nukes, while Bush barked impotently. This wasn't nearly the kind of disaster that Iraq was, but it probably unsettled some Americans, and it certainly unsettled the foreign-policy establishment.

So foreign-policy conservatism failed in the 2000s.

Finally, social conservatism. This was the biggest failure of all. Social conservatism promised to restore family values by promoting Christianity and resisting things like gay marriage. But as Charles Murray and many others have documented, working-class white America professes more traditional values, but doesn't practice them. On the whole, working-class whites are no longer going to church, are no longer getting married (or staying married), and are having kids out of wedlock - in other words, traditional family values are dying among the very people who were most receptive to social conservatives' message. Here's a graph from the Washington Post:


Social conservatism also failed to make its case to young Americans. Secularism is rising rapidly. Gay marriage enjoys wide support, especially among the young. Americans have resoundingly rejected the values pushed on them by Christian conservatives in the 80s, 90s, and 00s. Here's a graph from Pew:


So social conservatism also failed in the 2000s and 2010s.

Add all this up, and what do you get? A massive, total failure of all three pillars of modern conservatism within a 15-year period. It's little wonder, therefore, that Trump voters were unwilling to vote for Republicans who offered them only more of the same - the same economic policies that seemed to cost them their jobs and businesses and wages, the same foreign policies that embarrassed their country, the same social policies that had done nothing to save their families. Even when the conservative ideology was offered with maximum fire and vitriol, in the person of Ted Cruz, they weren't willing to bite. So they looked around for something else, and Trump was there.

So that leaves us with the final link in the chain: the question of why Trumpism filled the void that conservatism created with its rapid collapse. Why are Trumpians Trumpians in the first place? That's a question I don't think I know how to answer. It's probably something having to do with race, religion, tribalism, xenophobia, etc. It very well might have something to do with globalization and import competition from China. Or it might just be a faction that was there all along, and supported conservatism for a while out of convenience. Or all three. Or something else. I don't know.

But whatever the reason for Trump's support, a necessary piece of the Trump takeover equation was the collapse of the conservative ideology. That epochal event should be a lesson to us all - it's what inevitably happens to an ideology when it succumbs to overreach, dogmatism, and an echo chamber.

I hope I don't ever have to watch the same thing happen to the American left.

Tuesday, July 19, 2016

Criticisms of NGDP futures targeting


Zak David, a quant trader, recently wrote a post criticizing Scott Sumner's idea of NGDP futures market targeting. Sumner fired back with a defense of the idea, and Zak responded with an update to his post.

I want to see if I can explain Zak's ideas in a little greater detail. Basically, he's right.

To recap, the original NGDP futures targeting idea goes something like this:

1. The Fed sets an NGDP target (say, 5%).

2. The Fed then offers to enter into any number of NGDP futures contract with anyone who wants, at a price equal to the target. So if I take a $1000 long position in these futures, and NGDP comes in at 10% (double the target), I get $2000 back. If I take a $1000 short position, and NGDP comes in at 2.5% (half the target), I get $2000 back. And so on. The Fed is always on the other side of the deal, and I can make as many of these deals as I want (assuming I can post sufficient margin).

3. The Fed then makes monetary policy automatically in response to people entering into these contracts with it. If a person takes a long position in NGDP futures, the Fed tightens a bit to make sure NGDP doesn't actually come in above target.

Zak had three main criticisms of this idea:
A) Informed traders will not trade in this market,
B) Manipulators will trade in the market, and
C) Data revisions will introduce noise into monetary policy.

I'll ignore (C) and try to explain (A) and (B). Keep in mind that I'm not saying anything new in this post; just restating Zak's argument in my own words.

First, let's talk about why informed traders - the people we want to trade these contracts - won't even show up. Suppose I have some knowledge that the Fed doesn't, about macroeconomic forces. For example, suppose I see a big inflationary shock coming that, if the Fed doesn't counteract it, will raise NGDP to 10%. Will I take a long position in an NGDP futures contract in the market described above, thus revealing my private information to the Fed and helping it make better policy?

It depends. IF the Fed hits its NGDP target on average, then I will not. Because in that case, on average, I would lose money betting on the Fed not hitting its target. Why the heck would I bet good money on 10% - or 2%, or 6%, or 5.001% -- when the probability distribution of NGDP is distributed symmetrically around 5%? A negative expected return with positive risk? No thanks!

If the Fed DOESN'T hit its target on average, then I might be able to make some money entering into this futures contract. But if the NGDP futures targeting mechanism doesn't lead to the Fed hitting its target on average, why the heck would we want to use that mechanism to make monetary policy in the first place??

So IF the mechanism works, no informed traders would use it. Hence, whatever information they have about macroeconomic shocks will NOT reach the Fed.

That is criticism (A).

OK, so who definitely would trade in that futures market? Manipulators.

Suppose I'm just some deep-pocketed jerk with zero knowledge of the macroeconomy, and I want to make some free money at the expense of the country and the bond markets. Here's what I do. First, I sell TIPS and buy Treasuries - in other words, I bet against inflation. Then I take a huge amount of long positions in NGDP futures. The Fed tightens monetary policy. My TIPS go down relative to my Treasuries, and I pocket the spread. Then I take a bunch of short positions in NGDP futures -- at the exact same price as before -- to net out my previous long position.

I have manipulated the TIPS and Treasury bond markets. I have caused monetary policy to change. And I have made arbitrage profits.

This is bad, because it introduces noise into monetary policy, and it also causes the bond markets to be less efficient.

That is criticism (B).

Both of these criticisms are valid. In other words, an NGDP futures targeting policy as stated above would introduce zero information to the making of monetary policy, while introducing a nonzero amount of noise. You'd be better off setting monetary policy according to  a random number generator, because at least then you wouldn't be letting crooks rig the bond markets.

So Zak David is correct. The idea is not sound. If you want to use NGDP futures targeting to set monetary policy, you're going to have to think of a much better system than the one described above.

(Fun bonus point: Why doesn't criticism (A) apply to all financial markets? That's probably the biggest question in the field of market microstructure. Check out the Glosten-Milgrom model and the Kyle model for two classic answers to that question.)


Updates

1. Everybody is asking me to link to these old posts (post 1, post 2) by Mike Sankowski criticizing Sumner's idea. Check them out if you're interested in this debate (and if you're not, why have you read this far?).

2. As expected, Scott Sumner fires back. He accuses Zak and me of disbelieving the EMH. Well, does anyone think the EMH holds when the government pegs the price of assets? If the government offered to buy and sell infinite amounts of Tesla stock futures at the price of $200 a share, would that market be efficient? No, it would not. Would $200 be the best estimate of Tesla's future earnings? No, it would not. Scott, just because you call something a "market" doesn't mean it's efficient.

Sumner seems to have thought very little about how markets actually become efficient. Scott, you need price discovery. Which means you need informed traders to trade. Informed traders' trades are the mechanism by which information gets from the world into the price. If informed traders don't trade, the price is based on some combination of A) noise, and B) manipulation. Informed traders only show up if they can profit by trading on their information. For informed traders to profit, someone else must lose money. In most models of market microstructure, the money is lost by liquidity traders (sometimes called "noise traders", though that term is now usually used to mean fools who trade overconfidently on false information).

In Sumner's "market", the only liquidity trader is the Fed itself. If the Fed sets policy such that A) informed traders can make money trading against the Fed, and B) the Fed offers infinite liquidity, that means that informed traders can make infinite money at the Fed's expense. But the Fed controls policy. It can make very, very, very sure it does NOT lose infinite money to informed traders. If the Fed provides infinite liquidity, the only way for the Fed to make sure that it doesn't lose infinite money to informed traders is for the Fed to make sure it doesn't lose any money to informed traders. (Note that this would most likely involve setting monetary policy to overreact to any trade.)

Hence, an informed trader would have to be dumb to trade in Scott's market, because trading in Scott's market means fighting the Fed and losing. Hence, no informed traders will show up. So the only traders who do show up will be A) liquidity/noise traders, B) fools, and C) manipulators. Hence, if the Fed sets monetary policy in reaction to trades in Sumner's market, it will set monetary policy purely in reaction to noise and/or manipulation.

Wednesday, July 13, 2016

When will China make its move?


I'm now reading Paul Kennedy's The Rise and Fall of the Great Powers, so I thought I'd ask a disturbing, alarmist, but important question. If China makes a bid to overturn the U.S.-led global order by military force, when will that bid come?

(This sounds like a job for...amateur made-up political science!)

First, two preliminary questions: 1) Will such a bid really come? And 2) What would it look like?

My answer to (1) is "maybe, maybe not." So far, there have been several modern examples of great powers not trying to overturn the existing order by force. The UK dominated the seas and built a huge maritime empire, but never tried to leverage its global power to dominate the other great powers of Europe; instead, it tried to maintain a balance of power that allowed it to be rich and secure. The U.S. made a few aggressive moves in the early 1900s, but only reluctantly joined World War 1, and then tried to go isolationist in the interwar years - it eventually became a hegemon, but only reluctantly. And the Soviet Union made a lot of threatening moves and came close to fighting the U.S., but backed off repeatedly. So there's plenty of precedent for new powers refusing to try to overthrow the old ones by force - in fact, the only real violent attempts in the industrial age came from Germany (twice) and Japan. But there still seems to be a decent chance that China will launch an attack against the U.S.-led coalition, given the "Thucydides Trap." So let's consider what happens if it does attack.

As for question (2), my guess is that it would be a naval attack in the South China Sea (against the U.S.) or in the East China Sea (against Japan, which would then call for help from the U.S.). Tensions have been rising slowly but inexorably in both places. A decisive naval victory against the U.S. would A) push American power out of Asia and establish Chinese hegemony in its backyard, and B) cause the U.S.' allies all over the globe to realize that America could no longer protect them, thus effectively ending America's position as a global hegemon. Such a conflict probably wouldn't go nuclear - the U.S. signaled its willingness to die to protect Germany, France, and the rest of Europe from the USSR in the Cold War, but it seems unlikely that it would do the same just to protect freedom of the seas in Asia. So if an attack comes, I expect it to be China trying to sink our Asian fleet. If it does that, it wins.

OK, now on to the main question: When will such an attack come, assuming it comes? Let's imagine we live in a worst-case version of a Paul Kennedy world, where great powers only care about hegemony, rather than the welfare of their people, etc. In that case, this becomes like the old Econ 101 question of when to cut a forest. Basically, if China is going to attack, it will do so whenever the opportunity cost of attacking - i.e., the benefit of waiting - drops below a certain threshold.

What are the benefits of waiting to attack? Basically, continued economic growth and technological progress. If we're in a Paul Kennedy type world, a larger economy means more military power, which means A) a higher chance of beating the U.S., and B) a higher chance of dominating Asia and the world after beating the U.S. Better technology means the same.

So if we're in a Kennedy world, we can think of GDP, maybe with some extra exponent on productivity, as the percent chance of getting "flow hegemony" in the objective function after an attack. But before the attack, flow hegemony is zero (because in this cynical world, power doesn't matter if you don't use it to rule the world). And there's some time discount rate too. So basically, when China's economic growth and productivity growth slow down below some threshold rate (representing the discount rate in their hegemony objective function), that's the time to attack.

Chinese GDP growth has already slowed substantially:


Current official figures are at around 6.6%, though the true figure may be closer to 5%. And many people think that only an unsustainable, unproductive debt-laden construction boom is keeping growth at that pace -- once it ends, many expect China to have to deal with the financial overhang from the boom, which could lead to a decade of slow growth. Productivity growth is much harder to measure, but what few data points we have point to a slowdown in recent years.

One big factor will definitely drag down Chinese growth in the years to come: population shrinkage. According to government estimates, the country's working-age population (15-60) has been declining since 2012, and has now shrunk by 26 million. The decline is projected to continue, accelerating sharply between 2020 and 2025:


Even an immediate baby boom wouldn't affect this number until 2030, so the repeal of the one-child policy will not change anything for a while - and given the low fertility of other Asian countries, and the lack of much interest in having more kids, it seems unlikely that the long-term effect of the repeal of the one-child policy will actually arrest China's population decline.

So after 2020, there will be a sharp decline in China's working-age population. If the "debt overhang" people (Chris Balding, Michael Pettis, etc.) are right, China will also have to deal with another sharp slowdown in growth sometime in the next few years. Meanwhile, productivity is slowing down as China reaches the technological frontier and is thus less able to acquire new tech through FDI joint ventures, forced tech transfers from multinationals, or industrial espionage.

All of this points to a Chinese attack sometime in the remaining years of this decade. IF, of course, they decide to attack at all, and if GDP enters the objective function in the way I just hypothesized.

In any case, after 2020, China's "window" for a successful overthrow of the U.S. might close. Rapid population aging and labor force decline, the slowdown of catch-up growth, and (possibly) the overhang from decades of debt buildup might do more than just reduce the benefit of continuing the "peaceful rise" strategy. They might actually cause severe domestic unrest in China, forcing the country to turn its energy toward domestic security matters. And even if that doesn't happen, China's inevitable economic slowdown may simply weaken the country's total military power, allowing the U.S. and its allies - perhaps including a fast-growing India - to retain hegemony into the indefinite future.

So I think that if China does decide to take the more violent, aggressive great power path, we can expect some action within the next few years.

Sunday, July 03, 2016

Economist gekokujo


"Gekokujo" (下克上) is a Japanese word meaning "low overcoming high". It refers to when the people lower down in a hierarchy rise up and overthrow those above them. Rebellions, mutinies, and populist uprisings are all gekokujo. The word was often used in conjunction with coup attempts by lower-level military officers in the years before WW2. Japan, it turns out, is a lot less hierarchical - or at least, obedient - of a place than people think.

One culture I know that is very hierarchical is the econ profession. It has a centralized job market. Academic hiring is heavily weighted toward candidates from top departments. And it's sort of an open secret that old, famous professors can essentially publish whatever they want in top journals, which gives these old famous people enormous clout.

As in most academic fields, publishing in one of a few top journals is key to career advancement. But in recent years, more and more top-journal publishing has been dominated by one single journal: the American Economic Review:


In econ, the standards for what constitutes good research and what constitutes bad research are less clear than in the natural sciences (though far clearer than in the humanities). That adds to the suspicion among the lower ranks of the profession - grad students, younger profs, profs and students from lower-ranked departments, etc. - that successful economists got where they are by sucking up to old famous people. "It's a sleazy profession," a young and talented assistant prof once confided to me, over a beer. "I'd advise you to get out of it." (I ended up taking his advice.)

Anyway, it makes sense that econ would be ripe for some gekokujo. And it also makes sense that the rebellion would erupt from the Econ Job Market Rumors forum.

Almost everyone except EJMR regulars despises EJMR. The site has a fair amount of the sexism and other aggression so common on anonymous internet forums (it's been called "4chan for economists", which in my opinion is a bit of an insult to 4chan's creativity and sense of humor), but that can't account for the near-universal visceral hatred that most economists feel toward the place. Most people who tell me how much they hate EJMR talk about what one PhD student called its "insecurities, careerism, and insane status and hierarchy obsession." Essentially, EJMR vacillates between slavish worship and bitter disdain for the top people and organizations in the profession. These people deeply believe that they need to suck up to the big dogs to get the brass ring, and even though they go along with it - econ jobs, with their high salary, lucrative consulting gigs, and intellectual prestige, tend to be a pretty nice brass ring - they don't like having to do it. So if econ is going to have an equivalent of the gung-ho young Japanese officers who launched repeated coup attempts in the 1930s, it stands to reason they'd come from EJMR.

It also stands to reason that the target of the uprising would be the AER, one of the profession's most important gatekeepers. So I was hardly surprised to see a publication scandal involving EJMR and the AER. Essentially, EJMR people started accusing an AER editor of 1) favoritism and bias, and 2) overlooked citations. These are typical academic sore points, and of course this dispute obey's Sayre's Law. But I also see it as a proxy for a wider dissatisfaction with the centralized, hierarchical, and somewhat arbitrary nature of a lucrative and prestigious profession.

There's a possible political angle here too, though I don't want to play it up too much. The AER editor being accused of favoritism, and the young authors accused of being the beneficiaries, are all women. The paper is a reduced-form empirical paper of the type that is taking over more and more of econ publishing. And the paper's policy conclusions are that unemployment is bad and that poverty could be transmitted from generation to generation by mechanisms other than genetic ability.

Like Japanese army officers in the 1930s, EJMR people tend to be right-leaning types in addition to careerists. The few times I could bring myself to read EJMR, I always saw a combination of A) disdain for political liberalism, B) disdain toward "reg monkeys" (a pejorative term for economists who do reduced form empirics), and C) bitterness toward women in general and toward allegations of sexism in the econ profession. It seems possible to me that many smart young conservative men were drawn to study economics, attracted by its traditional support for free markets and its traditional skew toward the male demographic - but that when they arrived, they found a profession increasingly tilted toward the left, increasingly populated by women, and increasingly accepting of the use of reduced-form regressions that can easily be interpreted as making a case for government intervention. George Borjas, who came out in support of the rebels, is certainly known to lean pretty strongly to the political right. This episode of EJMR gekokujo might be part of a more general backlash against these trends by angry young conservative men who feel that the econ elite, by favoring women and/or liberal politics, is depriving them of their just desserts.

Or not. That was just a thought I had, and it seemed kind of interesting, so I wrote it down. Don't take these musings of mine as any kind of evidence that left-right politics or gender politics is actually involved. But whatever the larger political context (or lack thereof), it clearly seems to me like a case of econ's "bottom feeders" (as one top economist called EJMR's denizens) rising up against the masters of their lucrative, prestigious little universe. I wouldn't be surprised to see more such "incidents", as Japanese history politely refers to them.


Update

Regarding the sexism thing, someone sent me the following screenshot from an EJMR thread discussing this post:


I don't think this kind of thinking totally dominates EJMR, and I don't know how much it's motivating this particular uproar. But I do think there's a fair amount of it there, which is why I mentioned it. It's also why I didn't try to comment on the merits of the case...I don't like pseudo-corruption and favoritism, and it certainly seems like a pervasive problem in econ, but I'm also pretty wary of joining what might turn out to be a sexist witch hunt...

Also, check out some interesting comments from someone claiming to be a recent job candidate. He or she raises a great point, which is that in the age of empirical economics, data access is really important, and that many young and/or struggling economists are mad about top institutions getting preferential early access to data. Early access allows simple, easy analyses - which many non-top economists are perfectly capable of doing - to get published in top journals, because the data is novel. That, argues the commenter, is causing a lot of anger in the lower ranks of the profession, some of which might be getting displaced as anger against perceived nepotism (which is actually a different issue). That rings true to me, and I will definitely follow up on the data access issue...