I don’t always agree with Paul Krugman…

…but when I do I’ll at least tell you about it.

Two recent Paul Krugman posts (here and here) particularly strike me as accurate.  The first compares the Great Depression to the financial crisis, or Lesser Depression as Krugman calls it.

 

He writes:

What all this also tells us is the folly of using growth from the recession trough as a measure of success: the worse you screw up the original response to the crisis, the better this measure looks!

And the bottom line remains the same: a weak recovery was only to be expected given the kind of crisis we experienced in the waning months of the Bush administration.

The second post essential expands the first point to Latvia.   He explains:

As Reinhart-Rogoff say, rapid growth over a short period following a deep slump does not constitute a success story; by that measure, America was a tower of prosperity in the depths of the Great Depression. It’s much more informative to focus on levels, both of output and of unemployment, and compare them with the pre-crisis peak.

For evidence he points to Latvia’s GDP levels, which has apparently been considered a success.

 

However, as Stephen Williamson points out, Krugman does seem to devalue the importance of asset prices in recoveries in another recent post.  I’ll defer to Williamson’s critique, where he says:

What is a bubble? You certainly can’t know it’s a bubble by just looking at it. You need a model. (i) Write down a model that determines asset prices. (ii) Determine what the actual underlying payoffs are on each asset. (iii) Calculate each asset’s “fundamental,” which is the expected present value of these underlying payoffs, using the appropriate discount factors. (iv) The difference between the asset’s actual price and the fundamental is the bubble. Money, for example, is a pure bubble, as its fundamental is zero. There is a bubble component to government debt, due to the fact that it is used in financial transactions (just as money is used in retail transactions) and as collateral. Thus bubbles can be a good thing. We would not compare an economy with money to one without money and argue that the people in the monetary economy are “spending too much,” would we?

But the bubble component of housing prices after, say, 2000, does not appear to have been entirely a good thing, as it was built on false pretenses. Various kinds of deception resulted in housing prices – and prices of mortgage-related assets – that, by anyone’s measure, exceeded what was socially optimal. As a result, I think we can make the case that pre-2008 real GDP in the US was higher than it would have been otherwise. Further, the housing-market and mortgage-market boom could have masked underlying changes taking place in US labor markets – for example David Autor’s “hollowing out” phenomenon. One could argue that there was a cumulative effect in terms of the labor market adjustments needed, and that these adjustments took place during the recent recession, and are still taking place. See for example this paper by Jaimovich and Siu. That’s why all the long-term unemployed. So that’s not some confusion. People are talking about alternative ideas that have some legs, and may have quantitative significance. Why dismiss them?

Economics Debate du Jour – Free Trade

Free trade is honestly not a topic that is frequently debated in economics; people seem to agree that it nets out to be a good thing, especially in the long term.  For a summary of the ongoing discussion between Noah Smith and Tim Worstall see Adam Ozimek’s comments here; he writes, “Noah Smith and Tim Worstall are having a fun little debate on whether declaring absolute free trade unilaterally is in a country’s best interest, with particular focus on the solar industry.”

Smith introduced the entire discussion in this post, writing:

Companies must always contend with policy risk. With one government and a closed economy, limiting policy risk is easy – just don’t interfere in the economy. But in the two-government case, policy risk can also come from a foreign government. An American solar manufacturer, even if they intend to sell only in America, must contend with the risk of suddenly being put out of business by Chinese solar subsidies. – at least, if America’s government adheres to a strict “free trade” regime.

The big question, to me, is: Can U.S. government intervention limit the policy risk imposed on U.S. firms by foreign governments? And if so, does the limitation of that risk outweigh the costs of the other market distortions caused by the intervention? Free-traders (i.e. most economists) say “No, never.” But I do not see compelling logic in favor of the consensus position. Sometimes the world works according to general equilibrium, but sometimes you need game theory. It seems quite possible to me that “one-way free trade” might not always be superior to a strategic trade policy that requires free trade to be a two-way street.

Skeptical of Smith’s apparent critique of pure free trade, Worstall responds by saying:

Subsidies, trade barriers or not, cheap loans, they’re all very much less important than this major technological change we’ve just been through in the last few years.

And more critically:

But the real criticism is that we really don’t care at all whether government can limit risk imposed on US firms. Because we don’t in fact care about US firms at all, at least not in the context of trade. We care only about consumers when discussing trade.

As Adam Smith pointed out the sole purpose of all production is consumption. The only relevant question when dealing with, say in solar cells, trade is what expands the consumption possibilities of the populace? Not who produces or how, who does the labour to produce nor who profits from it. But only and solely who gets to consume what? If trade increases that consumption then great, we’re all for trade. Which brings us back to the point made at the top about trade being voluntary. No consumer is going to purchase an imported item if it decreases their consumption possibilities. Thus unilateral free trade is indeed what we want simply because that is what best expands consumption opportunities: which is the point of the whole game in the first place.

Smith has the final (so far) word by pointing to a simple, two-state example of deadweight loss.

Suppose there are only 2 countries in the world: the U.S., and China. The U.S. trades with China; on net, we export rice to China, and they export TVs to us. Now suppose that China’s government, having been captured by producer interests, decides to protect its rice producers by putting tariffs on rice imports.

This policy will hurt the world, because it causes inefficiencies (deadweight loss). Chinese producers of rice will benefit. Recipients of Chinese government spending will benefit, because they will indirectly receive the revenue from the tariff. U.S. consumers of rice will be helped, because they will pay lower prices. U.S. producers of rice will be hurt, because they will be forced to charge lower prices for their products and will see their sales fall. In total, the harm to China outweighs the benefit to China, and the harm to the U.S. outweighs the benefit to the U.S. (if you don’t believe me, imagine scaling up the Chinese tariff to infinity, so that the world reverts to autarky).

(Note how we see Worstall’s first error in action; the loss to U.S. producers matters because those producers are also consumers! U.S. rice consumers benefit from the Chinese tariff, but total U.S. consumption falls!)

Now let’s consider the following possible U.S. policy: The U.S. government says “China, unless you remove these protectionist policies, we will retaliate by imposing import tariffs on TVs exactly equal and opposite to the tariffs that you have enacted.”

Suppose that this threat is credible. China’s government is captured by TV and rice producers, so China’s government’s best response is to eliminate its subsidies and tariffs. The whole world benefits, the United States benefits, and China as a whole benefits. The total consumption possibilities of the United States (and of the world) have been expanded relative to the case of U.S. unilateral free trade.

It is with this last point that I want to focus my attention.  What Noah Smith appears to be describing is a brinkmanship/realpolitik-based assessment of the world – a Machiavellian path to prosperity and peace.  The alternative is, of course, a more neo-liberal vision of the world (i.e. Thomas Friedman and the like); essentially the opportunity to succeed in a global market entices interested parties to behave well rather than the fear of retribution for behaving badly.  Either narrative, in my view, rebuts the simplified form of utilitarianism that was presented by Worstall in the section I’ve highlighted above.

I would just further note the implications to the economic and innovative process of the narrow view in the Worstall excerpt.  Not seeing the inspirational, for lack of an immediately apparent better term, value of a free trade environment, at least in a neo-liberal framework, misses one of free trade’s best values.  Worstall is preoccupied with consumption (read: utils) as an end rather than the value of free trade’s intangibles as it relates to innovation.  Taking a long-term view might be beneficial in this discussion, as it would discount the utility of present consumption and allow for some marginal impact from future utility, to borrow from Worstall’s line of reasoning somewhat.  Future utility is obviously lower than present utility, but it will still have an impact on current preferences.  I do not think that Worstall is arguing against free trade, in fact Smith seems to be closer to that argument (at least a prima facie acceptance of free trade as an end good).  Worstall’s argument, however, presupposes a preference for current utility maximization through consumption as the ultimate end.  He seems to think this end is best reached via a general acceptance of free trade but also seems open to alternatives for utility maximization.

Economic Structure

In this BLS report, Adam Ozimek sees structural changes.

 

I’m left thinking there are a lot of implications for unemployment.  Here is a list of some of these thoughts:

1. What does this mean for ZMP theory?
2. What are the intergenerational elements of this structural shift?
3. How does this play into long term unemployment?
4. Does this structural shift simply feed into a new equilibrium at full employment with only slightly fewer workers in construction as the balance sheet components of the recession move from the forefront?

Economics Debate Du Jour – Mobility

First it was Tyler Cowen in January, then Brad DeLong remembered he wanted to respond, Paul Krugman spoke up, then Cowen again and Alex Tabarrok also had some input.
The crux of the debate is found in Tabarrok’s post:

If someone likes the idea of riches going to rags almost as much as they like the idea of rags going to riches then I can see why they would think that Churn is unambiguously better than Stasis. In economics, however, we try to evaluate outcomes with more than our aesthetic preferences or moods and when we look more carefully at the preferences of the people in these societies I see ambiguity or, to be more precise, not much to choose between Stasis and Churn.

Read the posts and their links to get an idea of the argument. My interest is actually in Tabarrok’s next paragraph, when he says:

What about an individual choosing which society to join from behind a veil of ignorance? Again, no go, there is no difference in expected utility between Stasis and Churn from behind the veil of ignorance.

Is that really true? Two questions come to mind for me:

1. Do individuals gain no utility from perceived potential for their offspring?
2. What is the value of intergenerational stability over intergenerational volatility (this is especially relevant for populations with more than the families A, B and C in Tabarrok’s post)?

True the net impact of the churn versus stasis scenarios is the same as far as total utility is concerned and this passes the first and second principles of justice to stick with the Rawlsian examination. However, from behind the veil of ignorance, would people prefer stability or risk?

Why is college expensive?

From Steve Postrel:

My hypothesis is that it is precisely the dumbing down of U.S. education over the last decades that explains the increase in willingness to pay for education. The mechanism is diminishing marginal returns to education.

The pointer comes from Tyler Cowen.

Centralized Government, Taxation and Growth

Marginal Revolution guest blogger Mark Koyama looks at the history of centralization of government, subsequent taxation and growth thereafter of European economes.  He notes:

The implication of this argument is that an increase in the measured size of central government need not have been associated with an increase in the total burden of government. Rather the total deadweight loss of all regulations and taxes could have gone down in the 18^th and 19^th centuries, even as the tax rates  imposed by the central state went up.

Koyama provides the figure below as some evidence.

The Most Upbeat View of Sweatshops Ever

Other than the generally cheerful background music, Matt Zwolinski paints a very non-traditional view of sweatshops in a YouTube video (also linked through Bleeding Heart Libertarians).

The video leads to an interesting intra-blog debate about the legitimacy of sweatshop labor.

(follow the jump for more)

Insurance and Buffets – It’s all the same in economics

From Adam Ozimek at Modeled Behavior’s new Forbes blog:

What do health insurance and all-you-can-eat buffets have in common? The economic theory of adverse selection tells us that neither should exist.

This is the news story that inspired the post.

Adam Smith a Hipster Behavioral Economist?

I’m not saying he liked PBR, but apparently…

Adam Smith was into behavioral economics before it was cool… this seems to be the implication of an article written in 2005 by Nava Ashraf, Colin Camerer, and George Loewenstein that I just came across today.

More on Generational Income Elasticity (Great Gatsby Curve)

Thanks to Marginal Revolution for leading me to a post that talks more about the correlations behind the “Great Gatsby Curve,” which I have discussed before. This led me to look at the correlations for Generational Income Elasticity for the countries originally studied by Miles Corak (page 45) and create the table below.

Perhaps I’ll expand this list later or do more with it, but I thought this was at least worth sharing.

- Tyler