Friday, March 07, 2008

Has Economics Changed?

During a class not too long ago I was asked to state my favorite academic. Because I'd read his work not long before, and CEO pay is so out of control, I mentioned Lucian Bebchuck.

I'm also a major fan of David Colander. Pick any one of his diverse set of articles and you'll likely find something thought-provoking. In some ways, however, he seems to be almost like a sociologist or philosopher studying economics. Right now I'm reading The Changing Face of Mainstream Economics, in which he argues that mainstream economics has changed, and that today it is held together by its "modeling approach to economic problems" (p. 2). He believes that it is undergoing a paradigm shift.

Perhaps that's true. He should certainly know better than myself. But most of the papers that I read reflect the same old economics, and most economists do not seem so interested in difficult-to-quantify concepts such as information asymmetries and externalities. It seems as if most economists would rather run simple regressions or input-output analyses. However, Colander believes that minute "stealth changes" (p. 4) are happening, unbeknownst to the agents of change themselves.

If we were to judge by the internet, then the most influential economists in the world are the George Mason economists of Marginal Revolution, Cafe Hayek, and Econlog. These guys seem to be everywhere. I don't like them much -- they seem to be shills for industry, and just plain lazy. (Consider Kling's offhand comment that dogs impose more of a burden on the environment than SUVs, without any research.) They aren't exactly mainstream, either, but their views are fairly stereotypical.

What am I trying to say? I'm not happy with mainstream economists, but I'm fairly happy with economics theory. Information asymmetries, externalities, marginal analysis -- these are helpful for looking at the world. I'm just disappointed that so few economists seem to use these in the way they should: advocating greater transparency, taxes on pollution, subsidies for external benefits, and things like a national, federally-funded Health Savings Account plan. Further, the defense of things like CEO pay by way of pointing out its correlation with market capitalization strikes me as incredibly naive -- as if there was a dearth of "good chief executives".

But perhaps the blame should not be placed on economists in particular, but rather on humans in general. After all, how could people be so stupid as to think that only people who have previously worked as a CEO are good candidates, and worth hundreds of millions of dollars? And have they learned their lessons now, as these high-flying executives run corporate America into the ground?

Is it so hard to understand why executives who have no long-term stake in their companies might do a poor job? Corporate executives should be paid their bonuses in restricted stock grants -- and restricted for the long-term. By long-term I do not mean a year. I mean five years. In the meantime, let them live on a reasonable salary.

EDIT: Here is my response to Professor Bourdreaux.

15 comments:

dave smith said...

I think you truly do not know what you are blogging about--you are really, really ignorant about 1) what economists advocate and 2) why economists advocate what they do.

I'd bet a majority of economic adademics would would be favoriable to the things you suggested in the post.

Anonymous said...

Obviously, you believe in government intervention. No wonder you are blind.

undergroundman said...

Economists have had the ear of power for over a century now. During that time, they haven't pushed for meaningful increases in transparency or pollution taxes, despite the clear theoretical and practical reasons to do so. And they continue to do this.

Check out the history of the World Bank and the IMF. Look at the mortgage crises currently happening. As I said, I have respect for economic theory, but somehow economists are mainly idiots. For all their talk of rationality dominating human behavior, they're usually walking examples of irrational behavior: they choose academia instead of profits in private industry, and don't even really bother to implement their theories.

Anonymous said...

I shouldn't even waste my time, but...

Try this: http://gregmankiw.blogspot.com/2006/10/pigou-club-manifesto.html

Additionally, an academic's choices are perfectly reasonable. Faced with the choice between industry and study, they gain more utility from study than extra dollars earned.

Think of it this way. If your boss told you that you could work 261 days in a row and be paid 1.5 times your yearly rate plus have the rest of the year off, you might decide that you would rather work the normal 5 days a week for the whole year. The extra money is not enough to persuade you to sacrifice your sanity.

These are rational choices that these people make. Just because you wouldn't make them, or the majority of people wouldn't doesn't mean that they are acting irrationally.

...but then again, I shouldn't have wasted my time

undergroundman said...

I'm well-aware of Mankiw's Pigou Club. But that was 2 years ago. Pigou introduced this concept nearly a hundred years ago. Now some elite economists push for it, only after it's already trickled down to the mainstream -- and even then, in a fairly marginal way. Sure, you hear a lot about how most economists favor gas taxes, but they don't really make it a priority when push comes to shove.

As far the rational choice for academia: sure. But why not invest and make money that way? Bernanke currently has a net worth of 2.5 million, as one of the most powerful and allegedly market-savvy men in the world. Most economists disdain the stock market because of the EMT, yet it's clear that people can consistently produce excess returns.

It's not irrational per se to choose academia, but it is walking evidence against something that economists hold dear -- that financial incentives dominate people's behavior. The fact is that many other things dominate behavior as much if not more than finances. And it's sad that it's only recently that behavioral economics has even come up, and had to be pushed forward by psychologists rather than economists. Instead, many economists spend their time doing mathematical analyses which turn out to be trivial, unnecessary, or dangerously flawed.

There's even an argument to made that economists, with their flawed mathematical models, have done more damage to financial markets than they have helped them. See, for example, Nassim Taleb, who argues that the Black-Scholes model discounts highly improbable, catastrophic events. This mortgage crisis was enabled by economists.

Most economists could probably benefit a whole lot from studying other fields. That's consistent with the theory of decreasing marginal benefits. Yet you don't see economists studying other fields that much. Most of them are just market fundamentalists. They didn't even push for increased transparency until the catastrophe has hit us in the face -- see Paulson's remarks today at the Department of the Treasury. Too little, too late. The dirty details of banks will probably still be kept hidden (i.e. off-balance sheet stuff, detailed FDIC reports, ect.).

All I've said are that imperfect information, externalities, and irrational behavior (while academia is not irrational, much other behavior is) dominate modern markets. I don't see what you find so controversial about that. And it's also a fact that these things have been neglected.

Another interesting fact: mainstream economists discount heterodox economics without even studying them. There is an argument to be made that our current loose-money policies have been extremely damaging to the economy. Milton Friedman, along with the Austrians, have made that argument. These policies can be attributed to mainstream economists directly. Have you glanced at Shadowstats.com?

bartman said...

Basically, you think economists should advocate for what you think is important just because you think it is important.

You really should learn what the terms "positive" and "normative" mean to an economist before saying things like that. You'll look a lot less uninformed.

BTW, you're dead wrong about the GM crowd, they advocate for free markets, not for industrialists. Corporations do not like free trade.

bartman said...

Another point: you are making the claim (in your last comment) that economistg believe that people are profit (or cash) maximizers.

I don't know of a single economist who makes that claim. Economists claim that people are utility maximizers, and cash is not always a perfect substitue for happiness. I could make more cash if I took a second job driving pizzas in the evening, but I don't, because I value the time more doing other (non-cash-generating) things.

We also claim that rationality is a general condition, not a universal one. In the presence of incomplete knowledege and finite time we make imperfect decisions, but we usually do what we think is in our own best interests when we make those decisions. Or are you claiming that people are knowingly and actively irrational?

If you're going to attempt to criticize economics, you really should be slightly conversant with the basic building blocks of it.

undergroundman said...

You really should learn what the terms "positive" and "normative" mean to an economist before saying things like that. You'll look a lot less uninformed.

Normativity is embedded in all positive work. Think about that a second. Besides, I'm not claiming that I'm not normative -- but I have a reason for my opinions, as other people do theirs. I simply think that most mainstream economists haven't really reasoned through their opinions that well.

BTW, you're dead wrong about the GM crowd, they advocate for free markets, not for industrialists. Corporations do not like free trade.

Think about what you just said for for a moment. Corporations use imported raw materials (as well as intermediate goods, and labor). The estimated cost to steel-consuming corporations in the US far exceeds the benefits to steel-producing corporations, according to all economic analysis I've read. That's just one example among many. The fact that some corporations lobby hard against free trade is not evidence against this.

Or are you claiming that people are knowingly and actively irrational?

I would say that lots of my friends are knowingly and actively irrational, yes -- they know it's stupid of them to do a lot of drugs, eat bad, and spend all their money, but they do it anyway. You disagree? On some level they don't realize how stupid it is, sure.

However, recent economic theory suggests that people are systematically irrational. I'm not talking about valuing one thing over another. I'm talking about the work by Kahmeman, among others, that points to irrationality as something fundamental to humans -- in the sense that they make decisions which can't be justified as "beneficial" in a peculiar, individual way. Here is a short review of what I'm talking about. The more controversial area comes in something like voting. I had a professor who tried to tell me that not voting was a rational choice, because people believe their votes don't count and value their leisure more. I don't see that as rationality, however. Rational agents would realize the importance of elected officials in their lives.

You're obviously not an economist, so don't say "we". Unless you'd care to prove me wrong? In particular, you're claim that "corps don't like free trade" is a red flag.

As far as government intervention in the economy -- the low-hanging fruit is increasing transparency. I've mentioned ways to do that very easily numerous times. Another low-hanging fruit is increasing investor democracy. But ultimately the government stepping in and, say, forcefully halting a bubble is not always a bad thing.

Anonymous said...

Read Mancur Olson and Helen Milner.

The benefits of free-trade are diffuse whereas the benefits of protection are concentrated.

Anonymous said...

how many strawmen can you use in one paragraph?

undergroundman said...

The benefits of free-trade are diffuse whereas the benefits of protection are concentrated.

Yup. But many corporations realize that, and like free trade. Plus, the tit-for-tat tariffs provide a strong incentive for corporations to support free trade.

how many strawmen can you use in one paragraph?

Why don't you point out one of them? ;)

How many different people are commenting here?

vimothy said...

It's ironic, undergroundman, that you seem to have this Nassim Nicholas Taleb / G.L.S. Shackle like disdain for economics, yet you go after the academics at GMU, which is the faculty in the US least guilty of NNT's accusation, viz. that they can solve everything with bell curves and PPFs. That's why it's called Cafe Hayek and not Cafe Black-Scholes or Pigou.

undergroundman said...

Vim: It's fallacious to reason that just because one theory is bad (Black-Scholes) it's all bad. As I said in my post:

I'm not happy with mainstream economists, but I'm fairly happy with economics theory. Information asymmetries, externalities, marginal analysis -- these are helpful for looking at the world. I'm just disappointed that so few economists seem to use these in the way they should: advocating greater transparency, taxes on pollution, subsidies for external benefits, and things like a national, federally-funded Health Savings Account plan.

I like economic theory. Not all of it, but most of it. Every economist should recognize that their models are flawed -- they are abstractions. So some inferences that you make from these flawed models will be flat out wrong -- for example, that oligopolies won't exert market power. But other inferences -- that externalities reduce net welfare for society, are pretty easy to make and not wrong at all. These are the low-hanging fruit. They should be addressed.

Given that perfect information is a condition for a perfectly competitive market (and a condition for the Coase theorem, as well), I find it sad that most mainstream economists, and esp. private ones, advocate for destroying the government rather than using it as a clearinghouse for information. Constructing databases on products, companies, governmnent spending ect. could go a long way. Only recently did a lwa pass mandating that the CPSC make a database of products and complaints. Instead of pushing for this, some economists (Friedman) have pushed for eliminating the CPSC. And, on the whole, you don't hear a lot of calls for information transparency.

Economists are a mixed bag. There's a ton of good, and a ton of bad. The theory is often good, but the practice is often bad. That's all I'm saying. It's not a strawman argument. It's a reasoned opinion.

I look forward to hearing a rebuttal, and I'm sorry if I've offended.

As far as the GMU crowd, I've found that they are mainly status quo apologists and shallow thinkers. Yes, they may not be exactly mainstream, but that doesn't mean I like them. In general, I like the theory of mainstream economics more than the theory of heterodox economics.

Anonymous said...

This is an old blog entry, but I've just stumbled on it and I feel compelled to comment.

I also find that there is bad information peddled everywhere, and that the peddlers are shills and lazy. Furthermore, I I also find it incredible that some people are so stupid as to think certain things.

Only I find that all the bad, lazy, stupid, shills happen to agree with the author of this blog.

There, I've made my argument as eloquently as undergroundman ... which is to say, rather poorly, but at least good enough to appear here, apparently.

Anonymous said...

"how many strawmen can you use in one paragraph?

Why don't you point out one of them? ;)"

For one:

"...something that economists hold dear -- that financial incentives dominate people's behavior."

I'd be curious to see whether you can find a single economist who has ever said anything like that. Maybe you can. A lot of people are economists. Essentially, economics is the study of tradeoffs. Tradeoffs may be entirely financial, partly financial, or entirely non-financial.

--sw