What Magic Tricks do People Actually Use Smoke and Mirrors For?

by Robert H.

The Washington Post declares that much of 2011's austerity was "not real," simple budgeting tricks, mostly consisting of programs that were already scheduled to be cancelled anyway.  Tyler Cowen, who is fond of being pessimistic when it comes to balancing budgets, exults.

Sorry, deficit scolds, but you don't get to have it both ways on this.  If a department is only helping balance the budget on paper, not making "real" cuts, I can think of two ways to think about it:

1. It is real deficit reduction.  Spending less money is spending less money, it doesn't "not count" because the decision to do so was already in the pipeline.  Just so, congress letting programs die and not routing their funds to new programs is a significant political victory, and a blow to people who claim that bureaucracies never shrink and congress is never responsible for public choice reasons.
2. It is gimmicks, but that's good.  Much of the deficit was caused by smoke and mirrors and/or bad accounting, so we can get rid of it with smoke and mirrors and/or good accounting.   Turns out the deficit wasn't as bad as we thought, we just needed some better accounting practices.

Deficit scolds seem to want to reject one but not fully think through two.  If I can reduce our deficit with an accounting trick, it means that part of the deficit was the result of dumb accounting.  Whoever drew up the baseline didn't realize that that program was slated to be cancelled anyway, so I get to make a reduction vs the baseline just by letting a program that was going to die die.  And that is just as good of news as actually enacting austerity, because it has the same basic result: we are closer to balancing the budget.   Basically the lesson here is either "the deficit wasn't as bad as we thought, some of it was mostly the result of poor accounting and we've cleaned that up" or "hooray, congress was able to exercise real restraint and reduce the deficit!"  Neither result is "fake," it's either a political victory or accounting innovations getting us meaningfully closer to a balanced budget than we thought we were.

Now a deficit scold can respond with, "Maybe, but this is still low hanging fruit.  There won't be many more accounting innovations that will reveal the budget situation to be better than we thought, and/or there won't be many more ways congress can save money just by letting programs die."  And I agree!  But did anyone on earth think the first round of deficit reduction wouldn't go after low hanging fruit?

Troop Bickering Paradox

I'd like to enthusiastically follow my new co-blogger's suggestion and bicker with the troops as much as possible.  As I consider a well-researched screed into all the reasons we should not argue with the troops, I realize I cannot launch into said screed now without arguing with the troops.  Alas, I am beaten before I begin.  Check-mate.  Quite a gambit.

The best I can do is offer this instructional video on bickering that others may succeed where I have failed:

Welcome to blog Sarah. 

The Housing Bubble that Wasn't

We had a lot of fun doing a back and forth with imminent economist John Quiggin when we first started the blog (here, here and here).  John is adamantly opposed the the Efficient Markets Hypothesis.  An argument commonly featured in his book is that some asset will go up and then go down, which we in retrospect call an asset price bubble.  For instance, the Tech bubble boom and burst and the recent housing bubble boom and burst in the U.S.  What would be more impressive for John to do (and more lucrative for the reader), would be for John to have written a book predicting large asset bubble crashes, and then he could publish a second book to gloat.

Fortunately, we have the next best thing, which is blogging.  And Quiggin has made some predictions on his blog, for instance, this post called "The Housing Bubble" on Australian housing (Aug. 2003):

All of these factors have combined to produce a bubble in the residential housing market that can fairly be described as unprecedented. As measured by the REIA median house price series, average house prices nearly doubled in most Australian cities between 1997 and 2003...

There can be little doubt that the prices of houses and urban land have reached unsustainable levels, and that they must decline in real terms. The main concerns for economic management relate to the speed and extent of this decline. If prices fall 40 per cent over one or two years, which would only bring them back to the levels prevailing in 2000, widespread financial distress is certain and a recession highly probable.

Thanks to some nifty work by the economist and a hat tip to Scott Sumner, we can look back and see how valid Prof. Quiggin's bubble seeing glasses were: 

                                  '

Turns out the bubble didn't pop.  So if it doesn't pop, is it really a bubble?  If we can only recognize bubbles after they've popped, then the term bubble really has no meaning at all.  Unpredictable falls in the prices of assets certainly doesn't violate the EMH.  

Constitution Class Posting

My favorite podcast, econtalk, delved into con law this week, and boy was it a confused conversation!

Basically a law professor, Louis Michael Siedman, raised some objections to the constitution that lawyers have known about for a while.  Then Russ Roberts, who is a smart economist but doesn't really follow constitutional law, tried to single handily invent all the responses to those arguments.  But there's no need to do that, because people have been thinking about this stuff for a while!

I don't remember all the ins and outs, but this is basically how I think the debate should go:

Should this still be law?

I. Constitutional problem
A. Siedman: sees two big difficulties with the constitution.

i.. The inter-temporal difficulty.  Why should past people get to bind present people?  The foundational generation wasn't smarter or wiser, it was, if anything smaller and less informed. Why is the vote of some dude who has been dead for 200 years more important than my vote?

ii.. The counter-majoritarian difficulty.  Democracy is good, right?  Why does the minority of white, propertied males in the late 1780's get to make the rules?  Why do they override a current majority?

B. Responses

i. Pre-commitment is important for the part of the constitution that deals with PROCESS.  What day you hold an election, how many congressmen there will be, how long they serve, etc are all questions that 1. don't really have super important right answers over the long term, and 2. in the here and now can have huge effects.  If you say "you know what, senators can now serve for EIGHT years" you lock in the current democratic majority.  But what effect that will have 200 years from now is harder to say.  So, rather than put all that process stuff up for big huge political fights in the now, we just let people in the deep dark past pre-commit us to a certain political process.

ii. We don't want to expose to majoritarian outcomes certain RIGHTS.  There are lots of reasons we should adopt a pre-commitment strategy with rights.  For example, these could be things we are pretty confident people get right most of the time, but where there might be pressure in certain situations to get it wrong.   We can just sort of airily commit to stuff like, "yeah, free speech is great!" in the here and now, effectively constraining us when we the pro-baby-rape nazi starts spouting his nonsense.

iii. The founders *were* smarter because they lived in a CONSTITUTIONAL MOMENT.  At certain times the whole of the body public is moved to engage in and change our most basic laws.  The 1780's.  The 1860's.  The 1930's.  The people are thinking more clearly about this stuff in constitutional moments, and we should make some things only changeable when they can be changed with the sort of super majority you get during those special times.

iv. We don't trust democracy because we FEAR THE MOB.  Or ARE FASCISTS.  Or whatever.  The basic structure of Siedman's constitutional problem is, "we all agree in majority rule, why depart from it?"  The answer here is, "because I don't agree with majority rule!  The majority sucks!  We should pre-commit to my policies because my policies are right and the people will probably f*** it up."  This was something Russ, a libertarian skeptical that government will stay limited in a purely-majoritarian state, was trying to articulate.

v. TRADITION.  Laws work in large part because of cultural norms.  This by necessity makes people in the past more important than modern people for governing how modern people behave (they set the norms!) and gives a reason we shouldn't blindly try to chart our own course in everything.  Norms make society work, lets not start questioning and rehashing them just because they are in the constitution!  This is something Siedman was very strongly fighting against.

vi. No one wants to rename the USS CONSTITUTION, the oldest commissioned warship in the world.

The USS Non-Binding Norms Subject to Majoritarian Outcomes under sail

II. The legal problem.

A. Siedman also says that the Supreme Court isn't really following the constitution and should fess up to it.  He's less calling for us to ignore the constitution and more calling for us to be honest about ignoring the constitution. This isn't really a constitutional argument, it is a broader legal argument rooted in the INDETERMINACY DEBATE.  To what extent is the law determinant?  That is, to what extent do those little rules and cases on sheets of paper determine actual outcomes in courts and legislatures?

B.  I don't really want to debate this because it's a huge question in the law, just sort of point out how inferior Siedman's argument is.  Basically he says "here are some examples of people explicitly not following the constitution, even by their own lights.  Therefor people should just admit that the constitution doesn't do anything important and no one follows it."  But the mere fact that the constitution didn't bind some people in some cases doesn't prove it is all a sham.  Obviously there is ground between "people always follow the constitution and it determines everything" and "people never give up their policy goals because they think they are unconstitutional and the constitution effectively does nothing."  The Supreme court can be hypocrites only some of the time, and the rest of the time the constitution is guiding their decisions and doing real work.  So a few specific examples of hypocrisy doesn't prove the constitution a sham.

C. As a side point, observe that if this is true and the constitution doesn't bind or limit us, the inter-temporal and counte-rmajoritarian difficulties go away.

The Worst Pun

Arnold Kling (man, how many posts have I written commenting on something he's said?  I have no defense other than that he is thought-provoking and smart, while having views that differ from mine just enough to fuel posting) has a post on the riddle of social security.  Why do we subsidize retirements?

If it's a riddle, it's a very old one.  Bismark invented the welfare state in the 1880's, and the third major law he passed, in 1889, was The Old Age and Disability Bill.  Enter social security insurance on the world stage.  The fact that old age is linked with disability in that legislation tells the whole tale: in this crazy modern world in which we live in, for some people retirement is what happens when you decide to stop working and play golf.    But for most people in history (and now?) old age isn't dominated by leisure so much as it is dominated by having a crappy body.  In 1880's Germany, being an old person is basically the same thing as being a disabled person -- you physically can't work for a decent wage.  So Otto says,

„[...] the actual complaint of the worker is the insecurity of his existence; he is unsure if he will always have work, he is unsure if he will always be healthy and he can predict that he will reach old age and be unable to work. If he falls into poverty, and be that only through prolonged illness, he will find himself totally helpless being on his own, and society currently does not accept any responsibility towards him beyond the usual provisions for the poor, even if he has been working all the time ever so diligently and faithfully. The ordinary provisions for the poor, however, leaves a lot to be desired [...].“

Auto Van Biz-Mart

For a lot of Americans, there is still some truth in the idea that old age leaves people less able to support themselves and is a form of disability (IE, if they had a very physically active line of work or if they are low skill and mostly sell their manual labor).  But in a white collar world with age discrimination laws that is increasingly not true (or at least, the wage hit old people take is more marginal), and I think you are increasingly seeing a new justification for SSI.  There is an element of hope to it.  Lots of people have to work shit jobs they hate their entire life.  Subsidizing retirement is a way to give those people meaningful hope -- there's gold at the end of the crap rainbow! -- which both makes the working people happy in its own right (lives with hope are better!) and probably gets people to buy into society more (remember, Bismark didn't implement the welfare state because he believed in it, he implemented the welfare state to keep social order in a world increasingly dominated by class struggle).  I think this is what people talk about when they talk about lives deserving "dignified retirements" -- everyone deserves a little hope at the end.

But those two things have different policy implications.  If we feel bad for old people because "old" is a form of disability and the elderly can't work, we feel bad for all old people.  But if we want to give working people an element of happiness and dignity to look forward to at the end of their lives, we can means test SSI.  Rich people can buy their own dignified retirement just fine, thank you. I suspect that, as the justification for the program increasingly moves from the first to the second thing, the system will start to look (and be) more explicitly redistributive.

John Cochrane on New Keynesian Models

John Cochrane wrote a wonderful post on thinking his way through New Keynesian models.  Its quite wonkish, but it is great insight into how a top economist thinks about the world and models.  Also, I thought Karl Smith gave a thoughtful rebuttal.

Feel free to get deep in the weeds of both posts, but essentially John lays out a simplified world as a New Keynesian might see it, and a simplified world as a New Classical, John Cochrane type might see it and related each to why consumption is low and growing slowly, which lead me to comment:

This is a great, great post.

Under the PIH view, why is the nominal rate zero and the real rate negative 2 percent? The marginal product of capital is negative? Preference shifts lead to value future consumption more than the present? Bad regulation today is just a portent of worse regulation to come?

It sure *looks* like we are at the ZLB. When inflation expectations rise, short term nominal rates don't move and short term real rates become more negative.

I'd love to here how PIH/neoclassical/neo-Cochrane? view explains that.

Essentially, I'm asking how does John Cochrane's preferred model explain the zero lower bound and negative interest rates.  I've argued, before that, specifically in John's narratives the zero lower bound seems like a coincident.  For instance, he argues more expansionary monetary policy is neither like to help or hurt, which with the fed funds rate constrained at zero seems remarkably coincidental.  I was surprised by how hard he bit down on that bullet, in direct response to my comment:

It doesn't. We are at the ZLB, and the real interest rate on government bonds is negative. (Private parties borrow at higher rates, and risk premia are much more important than most macro says.)

The question is, how relevant is this fact for understanding the level of consumption. The PIH is not "the" model. As I wrote to the point of ridiculous repetition, it is a grossly oversimplified model, useful (maybe) for digesting one part of what's going on. It does not say WHY income fell, and in the big picture it alludes to, understanding the wedges in the economy's prodcutive capacity is key. 

So, at this level of abstraction, the question is, does it really matter that we are at the ZLB and real interest rates on government bonds are -2%, not the usual +1%? Is that the key most important fact and distortion causing our doldrums? Or is that a fact, an interesting, fact, but a secondary epicycle, that we don't really need for reducing the big picture down to one equation in a blog post? 

The art of economic modeling includes a lot of throwing out "realism" so you can get the important big picture. 

Does he seem annoyed?  I hope not, and not just because he could squash my future career like a bug, but because he's one of my favorite economists.

I think the key is this, "a secondary epicycle, that we don't really need for reducing the big picture down to one equation in a blog post?"  To John, the Zero Lower Bound, the negative interest rates are a side show.  There might be an interesting "epicycle" to explain it, but basically understanding the slow recovery is the same at a 4% nominal rate as a 0% nominal rate.  To me, the puzzles must be linked.  The market for risk free capital isn't clearing and conventional monetary policy is impotent.  We had a great recession, and now the recovery is incredibly slow.  My intuition suggests that those facts are central to any story that tries to understand the economy.  John thinks the ZLB is quite possibly just a distraction from what is really goin on.

Debaters of the Lost Minarchs

Arnold Kling has capped off a great conversation with Michael Humer and Bryan Caplan about why non-libertarians reject libertarianism (you can follow links back through Kling's various posts). Kling ultimately comes to the conclusion that the moral case for libertarianism isn't appealing to lots of people and the consequentialist case should be emphasized. As someone who has rejected the moral case for libertarianism but been persuaded to support a lot of libertarian policies on consequentialist grounds, that sounds about right to me.

But that still leaves the question, why *do* people reject the moral case for libertarianism, rooted in freedom and the harm principle? I've been thinking about why I reject it, and this is what I've come up with:

1. It doesn't accord with my every-day reality. In our society, only bad people live according to the harm principle (IE, the ability to use force to defend yourself and your property is heavily limited.  You can't use force to retrieve stolen property or property owed to you, can't use lethal force to protect property, can't use force to protect yourself from a non-imminent but very real threat, etc.  The state can do all these things).  It seems weird to take behavior that is illegal and immoral in the context of our society and then say everyone has a natural right to do it.

2. It's not simple. Take a basic statement of the harm principle, "the only purpose for which power can be
rightfully exercised over any member of a civilized community, against his will, is to prevent harm to others." That is, on its face, not a libertarian statement. Taking money from person A and giving it to starving person B arguably prevents harm from happening to B.  

To get to libertarianism, you have to start with a more complex harm principle, something like, "the only justifiable use of force is to protect people and their property from the force of others."  But now we have to come up with an argument for how materials in nature can morally be converted to property, what other ways I can morally acquire property, the extent of my property rights, define "uses of force" (IE, is a harmless trespass on your property really a use of force?  Is conversion by fraud?  Many thieves do not use coercion or the threat of coercion, they are just sneaky), explain how we can enforce contracts (are contracts really just a subset of property rights?), etc.  Nozick got this: it is hard to prove that people should adopt a minarchy from first principles.  He was constantly being forced to make subtle distinctions, to paper over whole genres of argument, to say "we need to think harder about this," etc.  I'll keep re-reading Nozick and keep reading others, but the moral argument for libertarianism is complex, has to answer lots of questions, and, to my mind, has not done so satisfactorily in a number of instances.  I suppose I'll keep blogging about what all those are in future posts.

3.  Libertarians seem to miss a lot of basic moral impulses.  People like fair shakes, like equality of opportunity,  dislike gross inequality in results, abhor human suffering, and are willing to tolerate, praise, and even force redistribution as a result.  There are a lot of contradictory impulses that animate our intuitive moral senses, and "enforce the harm principle" is only one of them. Robin Hood isn't a hero because he fights taxes, he's a hero because he fights unjust taxes and because he redistributes wealth. 

4. Once you get away from talking about the harm principle and start talking about maximizing freedom and minimizing coercion, it's not clear to me from first principles that libertarian states do that.  On the one hand, "freedom" and "coercion" have dimensions beyond "freedom from state coercion." On the other, it's not clear to me that a minarchy would actually coerce people less than a state with more powers.

5. Libertarians don't seem to pay much attention to culture and how government interacts with culture.  I once said on this blog that when a big man with a club meets a little man with a prosperous farm in the state of nature, a conservative worries the barbaric big man will kill and loot the little man, the liberal worries the brutish big man will enslave and rule over the little man, and the libertarian thinks they'll work out a contract by which the little man pays the big man for defense.  In point of fact we don't know what would happen, because it would depend entirely on the cultures, dispositions, and circumstances of the two dudes.  Same tribe?  Different tribes?  Warring tribes?  No tribes?  Ingrained cultural norms about hospitality?  Etc.  Libertarians seem to me to have a one-size-fits-all solution, when it seems to me that a minarchy (and certainly anarcho-syndicalism) could only work under a limited, some-what fantastical and a-historical set of cultural norms.  To a large extent this is a consequentialist critique, but it bleeds over into a philosophical one -- the philosophical libertarian argument would be stronger if it addressed a variety of societies full of a variety of people, rather than limiting itself (mostly) to state-of-nature societies full of pretty rational people.  

6. While we are on the subject, it is not obvious to me that state of nature analysis beats veil of ignorance analysis, or why either is better than using the real world as a starting point.

7. To be clear, I don't think anyone has made a first-principles case for why the state should have lots of power either.  Again, to me it comes down to consequentialism. 

8. My consequentialist analysis heavily tinges all this.  I think a minarchy, much less anarcho-syndicalism, would suck.