Budget Puzzle

Tuesday, November 16th, 2010

The New York Timesbudget puzzle certainly makes fixing the budget seem easy enough. (Like Arnold Kling, I love the way they let you simply choose to cap Medicare spending growth. How hard could it be?)

Math Mastery

Monday, August 30th, 2010

Aretae remarks that Arnold Kling only thinks that he’s talking about economics, when he’s really describing many fields:

I suspect that a big reason that mathematics took over economics is that it gives you a sense of mastery. Indeed, it may give you a false sense of mastery. As you learn mathematical economics, you realize that you are getting really good at doing something that only a small group of people is able to master. And you get the sense that because you completed a mathematical proof that you accomplished something. It is very seductive.

The Spirit of Independence

Wednesday, July 7th, 2010

Intellectuals tend to believe that ideas cause attitudes, Lee Harris says, though it is far more often the other way around:

Several years ago, while attending a street festival in the small town of Tucker, Georgia, I came across a booth sponsored by the local libertarian society. At the time, I did not realize that my encounter would generate my next book. I only remember being struck by the question asked of everyone who visited the booth that day: “So who owns you?”
To most of [those who wandered into the booth that day], the question “So who owns you?” seemed to come with the force of a revelation, and they responded with a decided and often emphatic, “Nobody owns me.” Which is to say, someone may own other people, but certainly does not own me.

Lee Harris sees this as evidence that many people are natural libertarians. Arnold Kling does not; he emphasizes the last bit of that excerpt:

I think that most people resent being told what to do, and yet such people are not libertarians when it comes to other people being told what to do.

I have a stronger criterion for natural libertarianism. When you see other people doing something that really offends you, are you willing to see the state allow that behavior to continue? Only if you can answer “yes” are you a natural libertarian. I think that there are very few natural libertarians.

The McCarthy Era Never Ended

Wednesday, April 28th, 2010

The McCarthy era never ended, Arnold Kling notes; Congressional hearings are still all about self-promotion:

The objective of every Congressperson at every hearing is to get on the evening news by bullying a witness. The only question I have is whether McCarthy is the one who started it, or whether he happened to be the one guy who got called out on it.

Too bad somebody at Goldman could not have called out a Senator. It must have been tempting to say, “Look. You can’t make a market by bending over backwards giving buyers every reason not to buy and sellers every reason not to sell. Sophisticated investors understand how we operate. Just like everybody who goes to play blackjack understands that some of the cards are dealt face down. You can complain that you think all the cards should be face up, but that would totally change the game. Do you hold to such high standards in your election campaigns? Do you think your disclosure of the consequences of your votes is honest? Do you disclose how lobbyists told you to vote? Do you go out of the way in your campaigns to give people all the possible reasons not to vote for you? You want to tell me about my responsibility to my clients? How would you like to hear my opinion about your responsibility to your constituents?”

Blame deflection. That is what this whole financial “reform” theater is all about.

The Looting Scenario

Tuesday, April 13th, 2010

A few years ago, Arnold Kling saw a great race between Medicare spending and technological progress (“Moore’s Law”):

Four Scenarios Moore’s Law Fails Moore’s Law Succeeds
Medicare is Reformed Low Gear Capitalist Utopia
Medicare is Not Reformed Economic Implosion Affordable Welfare State

The Singularity is behind schedule and the ruling class doesn’t seem to know what it’s doing, which could lead to an economic implosion or looting scenario:

Douglass North famously said that when the institutions of a society reward piracy, ambitious people become pirates. When the institutions reward wealth creation, people create wealth. In finance, our institutions did much to reward piracy in the past decade.

In the Looting Scenario, what is going to be rewarded is what we call rent-seeking. Basically, over the next twenty years, wealth transfer by government will be much more important than wealth creation — and the amount available for transfer could actually decline. For example, I expect that benefits for the elderly will become increasingly means-tested and savings will be increasingly taxed, to the point where the marginal return to saving will approach zero. If the marginal return to saving is low, and government deficits are high, then capital formation is going to be low. It’s hard to see how you get rapid innovation in that kind of world.

The Looting Scenario is one in which public employees and pensioners have the incentive to just take as much as they can while they can get it. It is a scenario in which people talk about the deficit, and wise heads say we must do something about it, but the only politically feasible approach is to raise taxes. Even so, it turns out that higher tax rates bring in less revenue than projected, because of the incentives to consume leisure and engage in black-market activity.

Seven years ago, it would not have occurred to me that our ruling class would be so bad that the Looting Scenario would be likely. My guess is that, even among libertarians, just about everyone else still has faith that our ruling class will not let the Looting Scenario take place. However, I think it is one of the higher-probability scenarios out there. Where others think of the upper bound of incompetence as, say, Jimmy Carter or George Bush, I think about truly historic blunders that make Carter and Bush seem brilliant. I see our current economic strategy as comparable in folly to the “search and destroy” strategy in Vietnam or the mass offensives of World War I. So, if I sound crazy on this blog, that is where I am coming from.

Western markets are like Western medicine

Wednesday, March 10th, 2010

What suffered most in the Great Depression, John Nye says, was trust — impersonal social trust:

The idea of impersonal social trust was the most dramatic accomplishment of industrial civilization’s rise from the 18th to the early 20th century. The greatest achievement of early modern economic growth was not the Industrial Revolution itself, but the way in which the leading Western economies began to move away from highly parochial, narrow networks of personal exchange and came to rest instead on increasingly complex national and international commercial networks of impersonal exchange. The networks were mediated by competition, but also by an Adam Smithian understanding that strangers’ seeking their own gain amongst each other could lead to universal benefit. Praxis and theory reinforced each other.
In some ways, FDR did not so much break from normalcy as return to it. It helps to recall that large-scale systems based on anonymous exchange were a recent phenomenon. The system of orderly, global trade developed in the 19th century under the financial and political leadership of the United Kingdom, and backed by the gold standard, produced growth and prosperity. But it also produced plenty of social disruption and downward as well as upward mobility. It certainly never inspired the kind of devotion that nationalist and communal ideology more readily induce, as suggested by the rise of fascism during the interwar period. The world’s experience with democracy and market capitalism was limited. The more common experience by far consisted of political systems that allowed limited access to property rights and trade, reserving the most exalted benefits for elites who treated control of the political economy as their reward for preserving peace.

This older, more organic order, which even today represents the default for most nations, has the advantage of being both stable and intuitively natural. So thoroughly has the West taken for granted the triumph of the more abstract liberal nation-state that its denizens must remind themselves how fragile its origins were and how little emotional loyalty it has commanded. Indeed, the evidence suggests that few people trust large-scale systems of commerce. It is much easier to focus on political economy as a system of extended associations in which successes or failures can be attributed to individuals or groups for whom we feel either loyalty or loathing. Despite the prevalence of market behavior throughout history, it has rarely trumped communal corporate identity, especially in hard or frightening times. Abstractions do not generally prevail over concrete social relations because personal trust is more readily attained and maintained than impersonal trust.
Seen as a reversion to older habits, the odd mix of regulation, make-work, intervention, protectionism, nationalism and (as in Germany and elsewhere) anti-Semitism that characterized the Western policy response to the Depression suddenly seems less like an incoherent flaying in all directions and more like elements of a uniform retrenchment in social relations. What all these habits had in common, in all the countries in which they loomed large, was their role in spurning the system of abstract, anonymous and international exchange for more parochial, inward-looking responses to danger. So afraid of the new were they that some national elites followed this path of retrenchment to the point of utter self-destruction. Indeed, the severity with which people rose to tear up or overturn that still new system, despite the unprecedented prosperity it had wrought, seems indisputable testimony to how paper thin support for liberal trading regimes truly was.
In a sense, Western markets are like Western medicine: Just as an outbreak of incurable plague would lead to both a renewed search for sound cures and an atavistic appeal to folk remedies, so the Depression stimulated both productive thinking about the sources of business instability as well as destructive appeals to extreme nationalism, protectionism and military aggression.

As Arnold Kling adds, it is more natural to live in a world of Mafia Godfathers than one with fair, open, competitive markets.

Opting for Enslavement

Wednesday, March 3rd, 2010

One chapter in Africa: A Biography of the Continent is about slavery within Africa:

A history of slavery in Africa claims that between 30 and 60 percent of the entire population were slaves during historical times. If this is correct, then the number of people enslaved in Africa far exceeded the number taken from the continent by the slave trade.
In this part of Africa [Mozambique] famines were frequent and made terrible depredations, but occurred in some areas more than in others, and people from the affected lands would crowd into unaffected areas where food was to be found. They bought food with anything they possessed, including their own freedom, voluntarily making themselves the slaves of those who would give them sustenance. Desperate individuals would even destroy an item of value belonging to a wealthier neighbor, knowing that the punishment for this symbolic act would be enslavement.

This leads Arnold Kling to think about those opting for enslavement:

1. One of the most potent ways to accumulate wealth and power is to have other people work for you. Karl Marx was not wrong on this. It was true in Classical times, it is true for the owners and managers of large firms, and it is true for politicians, for whom all of us labor in order to pay taxes. Indeed, in Unchecked and Unbalanced I offer calculations which suggest that some relatively ordinary politicians have power that is greater than that of leading billionaires.

2. The ideal of freedom and equality may be unrealistic, with only rare exceptions. It could be that the most natural human condition is one of dominance and submission. You can start from a different equilibrium, but somehow you end up with a few people in dominant positions and most people submitting, some quite willingly, to domination.

3. Markets can offer freedom and equality when the option for exit is viable. Instead, if I am totally dependent on my employer for a job (that is, my next best alternative is something with a much lower wage rate), then I must behave very submissively toward my employer. How many people are in such a position? Government workers strike me as an obvious example — many of them would be unable to earn as much in the private sector, particularly now. So they would tend to be highly submissive. In fact, nowadays a lot of people would go nearly to the lengths of described in the last sentence quoted above if it would allow them to be employed by (enslaved by?) the government.
6. Today, we think of Marxists as authoritarian. An alternative view is that at least some Marxists sincerely wanted freedom and equality, but that dominance-submission is such a natural equilibrium that the only way to replace the capitalist version of dominance and submission was with a statist-authoritarian version.

7. For libertarians, the outlook is always going to be precarious. It is not just that there are people who desire to enslave others. It may be very natural for most people to opt for enslavement.

The Right of Exit

Wednesday, February 24th, 2010

Arnold Kling argues that the right of exit is important in order to limit government power:

I sometimes think that what kept the U.S. government small in the early 19th century was not so much the Constitution as the fact that people kept leaving the then-current United States for adjacent territories. The option to exit would have made it quite difficult for government to grow large and intrusive.

A Portable Cash Register

Tuesday, February 9th, 2010

The iPad, like the Kindle, is a portable cash register, Arnold Kling says:

With a Kindle, wherever you are, you are in a bookstore, with your credit card handy. There’s nothing wrong with that. I own a Kindle, and I’m happy with it. But it’s really not necessary to have to pay for one. I’ve shelled out much more for books on my Kindle than I did for the Kindle itself. The only reason not to give the Kindle away for free is that you would wind up putting it in the hands of consumers who are not all that interested in books.

Regardless of the price at which the iPad is sold, it is going to generate plenty of revenue. For Steve Jobs, getting people to pay for it is a bit like Tom Sawyer getting his friends to pay for the privilege of doing his whitewashing work for him.

Except that Apple and Amazon don’t make much profit off of media sales — yet.

Ayn Rand’s Disagreeable Niche

Sunday, January 24th, 2010

Arnold Kling describes Ayn Rand’s niche:

  1. In terms of the psychological factor known as Agreeableness, I speculate that people who tend to lean libertarian tend to be low relative to the average person. We place relatively low value on going along to get along.
  2. Those of us who are low on Agreeableness really resent situations in which Agreeableness confers high status. When we think that guys are winning approval, status, and girls by expressing nice-sounding political opinions, we get ticked off.
  3. Rand makes a virtue out of being low on Agreeableness. This is almost unique in literature. Few other writers, if any, use their writing to express and advocate for low Agreeableness. Instead, most writers either are dispassionate or are strongly Agreeable. When people who are low on Agreeableness encounter Rand, they feel that they have found a rare soulmate.
  4. In my own life, I have had to work very hard to overcome my low Agreeableness. I can think of many situations in which I failed to do so, at some cost to my position on the career ladder. To this day, people with very high status trigger my disagreeableness in ways that I cannot really control (see my posts on Jonathan Gruber).
  5. I encountered Rand’s work relatively late in life. My reactions were mixed.
  6. One could argue that my own writing is aimed at the same niche. Perhaps it is all an elaborate justification for low agreeableness.

The Entrepreneurial Personality vs. the Bureacratic Personality

Friday, January 22nd, 2010

Arnold Kling looks at the entrepreneurial personality vs. the bureacratic personality:

The entrepreneur wants to test ideas empirically. The bureaucrat wants to say “no” a priori. Large organizations need bureaucrats, because otherwise they would waste too much organizational capital (human as well as financial) trying out bad ideas. Entrepreneurs start with less organizational capital to lose, so they are the ones that you want to try out risky ideas.

Only in desperate situations will organizations turn to entrepreneurs (I am thinking of wars, when the military will dismiss some of its bureaucratic leaders and elevate some entrepreneurial ones.) Haiti looks like a desperate situation.

The Protocol Society

Monday, January 4th, 2010

In the 19th and 20th centuries, we made stuff, David Brooks says — corn and steel and trucks. Now, we make protocols — sets of instructions:

A software program is a protocol for organizing information. A new drug is a protocol for organizing chemicals. Wal-Mart produces protocols for moving and marketing consumer goods. Even when you are buying a car, you are mostly paying for the knowledge embedded in its design, not the metal and glass.

A protocol economy has very different properties than a physical stuff economy. For example, you and I can’t use the same piece of metal at the same time. But you and I can use the same software program at the same time. Physical stuff is subject to the laws of scarcity: you can use up your timber. But it’s hard to use up a good idea. Prices for material goods tend toward equilibrium, depending on supply and demand. Equilibrium doesn’t really apply to the market for new ideas.

The shift from stuff to protocols is the subject of From Poverty to Prosperity, by Arnold Kling and Nick Schulz:

“From Poverty to Prosperity” includes interviews with major economists, and it is striking how they are moving away from mathematical modeling and toward fields like sociology and anthropology.

What really matters, Edmund S. Phelps of Columbia argues, is economic culture — attitudes toward uncertainty, the willingness to exert leadership, the willingness to follow orders. A strong economy needs daring consumers (Phelps says China lacks this) and young researchers with money to play with (Romer notes that N.I.H. grants used to go to 35-year-olds but now they go to 50-year-olds).

A protocol economy tends toward inequality because some societies and subcultures have norms, attitudes and customs that increase the velocity of new recipes while other subcultures retard it. Some nations are blessed with self-reliant families, social trust and fairly enforced regulations, while others are cursed by distrust, corruption and fatalistic attitudes about the future. It is very hard to transfer the protocols of one culture onto those of another.

That Old College Lie

Monday, December 21st, 2009

Claiborne Pell — of Pell Grant fame — died at age 90 earlier this year:

What the encomiums to Pell failed to mention is that his grants have been, in all the ways that matter most, a failure. As any parent can tell you, colleges are increasingly unaffordable. Students are borrowing at record levels and loan default rates are rising. More and more low-income students are getting priced out of higher education altogether. The numbers are stark: When Pell grants were named for the senator in 1980, a typical public four-year university cost $2,551 annually. Pell Grants provided $1,750, almost 70 percent of the total. Even private colleges cost only about $5,600 back then. Low-income students could matriculate with little fear of financial hardship, as Pell intended. Over the next three decades, Congress poured vast sums into the program, increasing annual funding from $2 billion to nearly $20 billion. Yet today, Pell Grants cover only 33 percent of the cost of attending a public university. Why? Because prices have increased nearly 500 percent since 1980. Average private college costs, meanwhile, rose to over $34,000 per year.

It’s all part of that old college lie, Kevin Carey says:

The average graduation rate at four-year colleges in the bottom half of the Barron’s taxonomy of admissions selectivity is only 45 percent. And that’s just the average–at scores of colleges, graduation rates are below 30 percent, and wide disparities persist for students of color. Along with community colleges, where only one in three students earns a degree, these low-performing institutions educate the large majority of Pell Grant recipients. Less than 40 percent of low-income students who start college get a degree of any kind within six years.

Are colleges just enforcing high academic standards? Hardly:

A 2006 study from the American Institutes for Research found that only 31 percent of adults with bachelor’s degrees are proficient in “prose literacy” — being able to compare and contrast two newspaper editorials, for example. More than a quarter have math skills so feeble that they can’t calculate the cost of ordering supplies from a catalogue.

America’s higher education has a reputation for being the best in the world, but this is driven by the high quality of a few prestigious institutions and their students. No one really knows how good most colleges are — how well they teach and how much their students learn:

The information deficit turns college into what economists call a “reputational good.” If you go to the store and buy a shirt, you can learn pretty much everything you need to know before you buy it: the material, where it was made, how to clean it, and so on. College is different. You’re paying up-front for professors you’ve never met and degree programs you probably haven’t even chosen yet. Instead, you rely on what other people think of the college. Of course, some students simply have to go the college that’s nearest to them or least expensive. But if you have the luxury of choosing, in all likelihood, you choose based on reputation.

If college reputations were based on objective, publicly available measures of student learning, that would be okay. But they’re not, because no such measurements exist. Instead, reputations are largely based on wealth, admissions selectivity, price, and a generalized sense of fame that is highly influenced by who’s been around the longest and who produces the most research. Not coincidentally, these are the factors that drive the influential U.S. News & World Report rankings that always rate old, wealthy, renowned institutions like Harvard and Princeton as America’s best colleges.

The influence of reputation is exacerbated by the fact that most colleges are non-profit. For-profit institutions succeed by maximizing the difference between revenues and expenditures. While they have strong incentives to get more money, they also have strong incentives to spend less money, by operating in the most efficient manner possible. Non-profit colleges aren’t profit-maximizing; they are reputation-maximizing. And reputations are expensive to buy.

The economist Howard Bowen wrote the classic treatise on how reputation-seeking influences university behavior. He called it the “revenue-to-cost” phenomenon. Essentially, colleges don’t figure out how much money they need to spend and then go get it. Instead, they get as much money as they can and then spend it. Since reputations are relational — the goal is to be better than the other guy — there is no practical limit on how much colleges can spend in pursuit of self-glorification. As former Harvard President Derek Bok wrote, “Universities share one characteristic with compulsive gamblers and exiled royalty: There is never enough money to satisfy their desires.” Inevitably, much of that money comes from students.

The information deficit rewards and sustains these inclinations. In the absence of independent information about quality, consumers assume that price and quality are the same thing. At the trend-setting high end of the market, higher education has become a luxury good, the educational equivalent of a Prada shoe. These are unusually nice shoes, of course, just as Harvard is an unusually good university. But in both cases consumers aren’t paying for quality alone — they’re also paying extra for scarcity and a prominent brand name, the primary value of which is to signal to the rest of the world that they’re rich and connected enough to pay the price.

While most colleges aren’t in Harvard’s league and never will be, they pay attention to industry leaders. Luxury schools set standards for faculty salaries, student amenities, and other expensive things that ripple through the higher education sector as a whole. The status-seeking mindset is infectious. Colleges all want to become more important, and they all know how to get there — spend and charge more.

Indeed, they have little choice. Ten percent of the U.S. News rankings are based on spending per student, with additional points for high faculty salaries and other costly items. If an innovative college found a way to become more efficient and charge less while maintaining academic quality, its U.S. News ranking would actually go down.

Carey argues that publishing more data on college outcomes would result in a better market, but Arnold Kling notes that this presumes that the problem is on the supply side — that colleges want to hold back information:

The Masonomics view is that the problem is more on the demand side — the role that signaling plays in creating perceptions of value.

A point that I keep making about higher education is that it is, like the Harvard-Goldman filter, a form of recursive credentialism. To get certain jobs, you need certain credentials. And the most important credential of all is that you must signal your support for credentialism.

A commenter by the name of agnostic adds that supply and demand are both at work in the higher ed bubble:

The big problem on the supply side is that, just as with the recent finance bubble, managers of assets (the college officials who admit and oversee students) are paid according to volume of assets managed — more students means more tuition and more donations (and maybe more grants if those new students are from “disadvantaged” groups).

They are not paid according to ROI or anything like that. So it wouldn’t matter if we did what Carey says and publish more data like probability of flunking out, probability of graduating in 4 years, loss given flunking out, etc.

These incentives push sub-elite colleges to take in as many students as possible, just as banks took in whatever garbage they could get their hands on.

And as Charles Calomiris pointed out in the context of finance, the true demanders of grade inflation, re-centering of the SAT, etc., is the buy side. If it were the sell side — students, their teachers, parents, etc. — every buyer (college) would know it was a joke and adjust the grades and scores they received accordingly.

Rather, the buy side wants students with inflated grades and test scores because sub-elite colleges need to pass similar regulatory hurdles to admit students — maybe not as formalized as financial reg rules, but still, you can’t admit a bunch of students whose average GPA and SAT is 1.0 and 900. Inflate them to 2.0 and 1000, and would-be regulators or castigators of college admissions boards now have less of a basis to complain.

Hell, the colleges even cherry-pick the best score you got on each sub-test of the SAT. If you take it more than once, only your best math score shows up and only your best verbal, even if on different tests. That’s a smoking gun that the buy side is driving grade inflation, not the demand side.

Trial and Error

Wednesday, December 9th, 2009

Atul Gawande says something that Arnold Kling believes to be true — that transforming healthcare will require trial and error — and something he believes to be false — that we have no choice but to rely on government:

Gawande has no concept of the relative ability of government and markets to deal with ambiguity. He thinks that markets are unable to adopt new processes without government pressure. He thinks that government is well equipped to experiment.

There indeed are examples of markets that do not evolve effectively. There are examples of government-led experiments that pay off. But mostly it is the other way around. The incentives work much better in markets. In markets, the tendency is to reward success and to punish failure. In government, failed programs persist, and success receives no special reward.

The Public Purpose of Banking

Thursday, December 3rd, 2009

The difference between a bank and a non-bank is that a bank has a reserve account at the Fed:

Ultimately, the Govt creates all reserves, so why not just have the Govt make loans directly? Because we do not want the Government to make credit decisions, they are too likely to dole out money to politically connected constituencies, while starving worthwhile, but unconnected borrowers. You can see this today, as banks and unions get Billions, while shop keepers, dry cleaners, manufacturers, and restauranteurs shutter their businesses and go on the dole. An institution that makes loans it knows will not be paid back is not making loans at all, it is making gifts, and the operational bankruptcy of the FHA is a great example of this in action. Many adjectives come to mind: corrupt, wasteful, abominable, unfair, fraudulent, etc. This is the opposite of Responsible Governance. Barry, we really expected more.

So, to keep responsible lending, we put private capital infront of public capital and ask that private capital take the first loss on loans it makes which turn out to be bad. Ultimately, taxpayer money is there as backup, but it should not be directing investment. We call this institutional arrangement a “bank”.

This simple sensible construct is utterly lost on policy makers and the commentariat alike. For banking to do the job it is meant to do (ie. make loans that will be paid back), a bank should be required to keep all loans it makes on its books until maturity.

(Hat tip to Arnold Kling.)