Econ Journal Watch Watch

Ostensibly, the mission of Econ Journal Watch "watches the journals for inappropriate assumptions, weak chains of argument, phony claims of relevance, and omissions of pertinent truths. Pointed, constructive criticism" in order to provide "pointed, constructive criticism."  That seems like a noble endeavor.  Yet, apparently business is slow, because in the last volume Econ Journal Watch decided to publish David O. Cushman's moderation of a blog argument between Mankiw, Delong, and Krugman.  So I suppose now we should amend the name to Econ Journal and Blog Watch, which is a pretty herculean task.

A problem with Cushman's comment is that he attributed a position to Krugman that he never had, and Krugman voiced his displeasure.  So they've given him even more space to try to explain why Krugman saying "growth should be higher after severe recessions" is the same as saying "I completely agree 1000% with the administration forecast."  But don't focus so much on the note itself, focus on the fact that it is a note on a comment about a blog debate.  Why is this worth journal space?

Mankiw, Delong and Krugman are having a legitimate academic debate and the beauty of blogs is that we get a sneak peek at those debates (and people aren't always nice).  I thought the beauty of Econ Journal Watch was that it would be watching academic journals.  It should be an outlet for all the interesting criticisms of papers that are too important to be left unpublished, but not important enough to end up in anything but an obscure journal.  It should be publishing all the important comments that we worry journals themselves are rejecting (as it makes them look bad).  For instance, if a slightly different model makes all of a papers results go away, and that model seems relatively justified, then we know that paper's results are at the least not very robust.

If David Cushman wants to moderate a blog debate, I think Econ Journal Watch should tell him that his own blog would be an appropriate outlet.  On second thought, perhaps I should just lengthen the second paragraph into a few pages parsing the relevant quotes, and submit it to Econ Journal Watch.  Think they'll publish a comment on a note on a comment on a blog debate?

HT:  Tyler Cowen

Baby Got Monopoly Pricing

The story so far:  Jonathan Coulton wrote a great cover of baby got back, Glee ripped the cover off (everything from Coulton's melody to a note-for-note copy of the arrangement) without contacting or citing Coulton, and John Cheese wrote awesome satire of it.

Glee was wrong to not cite Coulton and give him a shout-out, but the idea that they robbed Coulton is stupid. The important thing to note here is that, if you think Glee "stole" the song from Coulton, needed to get permission from Coulton, or should owe money to Coulton (under just laws), what you are really saying is, "Sir-Mix-Alot should have to pay Johnathan Coulton when Glee covers Baby Got Back."

That's because "copyright" is another word for "monopoly."  If you have a copyright on Baby Got Back, you have a complete monopoly over copies and most derivative works based on Baby Got Back.  And if you have a monopoly, you charge monopoly prices, IE, "as much as the market will bear."  So let's say Coulton comes along and covers your song, then Glee covers his cover.  In one world Glee only has to pay you, the original artist, (that's this world, under our current laws).  In another world, we say, "Coulton really poured a lot of creativity into that, and it is impressive.  Glee not only has to pay you but also him if they cover his cover, to reward the creativity."  Does this result in Glee paying more than they would in world one?  No, because in both worlds there is a monopoly,  in both worlds the rights to the song cost as much as the market will bear, and  "as much as the market will bear" means just that.  So if Glee isn't paying any more, how would they go about paying Coulton and Sir Mix-a-lot?  Easy, Sir Mix-a-lot would have to get less.

If you think Glee ripped off Coulton (other than by being jerks and not citing him), you aren't mad that Glee took money from Jonathan Coulton, you are mad that Sir Mix-a-lot did.  The issue here isn't whether the evil hacks at Glee should get to rob artists, it's whether one artist (Coulton) should get to take money from another (Sir Mixalot).

Return Predictabilty

Predictability has become a term of art in Finance.  That is to say, when we say it, it doesn't mean what it usually means.  If I ask, are returns predictable?  I don't mean, can I say for certainty if this stock or the market as a whole will go up.  I don't even mean, can I tell good investments from bad ones?  Return predictability means, can I use some information today to judge what the expected future return over some horizon will be?

Suppose that the long run average for stock returns is 8%.  The question, then, is the expected return on stocks over the next year always 8%.  This would be true if stocks followed a random walk, which for a long time was a basic assumption in Finance research.  If stocks follow a random walk, then all the ups and downs that prices take are just random fluctuation around an average return.  Stock returns would not be predictable.

Instead suppose that while the long run average is 8%, the expected return in any given year will vary over states of the economy.  When times are great and the economy is booming perhaps the expected return to stocks over the next year are 5%.  That is, stocks don't seem that risky, so stock prices are already pretty high and expected returns are a little bit low.  When times are terrible like the end of 2008 and prices go really low perhaps expected returns rise much higher, say 12%.  Stocks are risky.  No one wants to hold risk, as times look pretty bleak, so in order to hold on to stocks investors have to be compensated with a higher expected return.

Intuitively, I think predictability makes a lot of sense, but it's still an open question in finance as the empirical evidence is mixed.  Stocks are quite volatile, so the amount of data required to answer the question is immense.  Not to mention, dividends move as well.  Perhaps, it isn't the expected return that's changing it's the expected future dividend stream.  That is, the price of the market didn't go down, because the expected return went up, it went down because future profits/growth are likely to be low. 

Do good ideas usually win?

So the last hundred years have been a pretty good one for the triumph of good ideas.  Trade in goods got much freer, apartheid ended in several states, communism is pretty much done for, lots of European states made smart labor market reforms and got government increasingly out of business ownership, Latin America became democratic, the west started regulating pollution, the welfare state, etc.  Great stuff!

It's given me a huge bias towards good ideas, and made me really dislike disingenuous arguments.  When people who hate the welfare state try to get rid of it under the guise of hating deficits, it bothers me.  When people who want far reaching gun control talk like they only support little niggling increases in gun restrictions, it bothers me.  When people who want to legalize marijuana pretend like they care about the hemp industry, I get miffed.  The fact that they talk themselves into sincerely believing these positions doesn't much help, either.  Don't these people know that good ideas win out!?  If they really think their ideas are so great, why not just argue them honestly?!  You may win short term gains by watering ideas down, but ultimately you are weakening your long-term goals by keeping your great arguments and beliefs under a bushel.  If your ideas are right we'll all be better off when you fight for them honestly and win.  If they are wrong we'll all be better off when you argue for them honestly and lose.  Just be honest!

But looking at history, I certainly can't claim good ideas always win out, at least over an acceptable time frame.  "Let's import some black slaves to man our farms" was a pretty terrible idea, but lasted for centuries. "Let's have open borders" was a great idea, but I only know of one country in the modern world that really tried it and we stopped.

So is my bias wrong?  Do good ideas always (or usually) win out, or should I get more comfortable with hypocritical arguments?

Climate Change vs. Fiscal Crisis

There has been a spirited debate about whether people should compare the long-term debt to climate change.  Here's  former Treasury official Steve Rattner, quoted by Joe Scarborough:

"We are putting millions of tons of carbon in the air every day; we are also adding billions of dollars to our future entitlement obligations every day. We are borrowing (stealing?) from our children to pay far more in benefits to seniors than we are paying into the system.We have something like $60 trillion in unfunded liabilities to Medicare and Social Security. Paul Krugman would like us to just wait until those programs run out of money, at which point those unfunded liabilities would be just that much larger."

In other words, just like Krugman doesn't want us to wait when it comes to addressing climate change, he shouldn't want us to wait when it comes to addressing the deficit.

Krugman has responded to these types of arguments, and you can read that, but I think he's a little too clever and subtle to thoroughly convince the economically ignorant (aka, me) .  So I propose a simpler distinction that can illuminate the difference between climate change and the deficit: you can put off a future problem until it is a present problem, but once a problem shows up and bad things start happening, it is impossible to ignore the problem.  It will affect you.

And that's climate change.  Climate change is here.  Global temperatures are up.  Extreme weather events are up.  Climate change is doing bad things, to us, right now (key words in that article, "which has already begun to cause trouble").  You simply can't argue that climate change won't have bad consequences, it is having them.

That's not true with the deficit.  Fiscal crisis is not here (in America).  Inflation is not up.  Interest rates are not up.  Yields on treasuries are not up.  Etc.  For the time being, the deficit isn't doing anything bad.  If you are worried about America having a fiscal crisis because of its deficit, you are worried about the future.  We don't have that problem yet.  And even if you disagree with that, you have to acknowledge that Krugman thinks the deficit isn't doing anything bad right now, just like he thinks climate change is.

So yeah, that's the distinction.  When a bully is threatening you from across the playground, you can ignore him.  When he's punching you in the face, you've got to deal with it (or at least, have a really good reason why you should still ignore himt).  That's not proof that Krugman is right -- sometimes you shouldn't ignore the bully across the playground -- it's just proof that the comparison is dumb.

You Can't Spell "Balanced Budget Amendment" without "A Damnable, Dumb, Decent Gent"

I agree with Arnold Kling that the Keynsian reasons for government running a deficit (IE, to stimulate the economy in a downturn) aren't very convincing.  But I strongly disagree with his conclusion that we should, therefor, adopt a balanced budget amendment.  I have five reasons for opposing a balanced budget amendment, in order from what I think is the worst to the best reason:

1.  Even if balanced budget amendment is a great idea in theory, I have some practical problems with it..  For one, the Republican party keeps wanting the balance budget amendment to cap the size of government and impose a super-majority requirement on tax increases.  I have opinions about how big government should be and about whether we should raise taxes, but I think future generations should get to make those decisions for themselves without the constitution tipping the scales.  I don't expect democrats, if they ever get around to wanting a balanced budget amendment, will be any better at keeping their other partisan goals out of it.

Secondly, I think the balanced budget requirement should be phased in.   I don't really want to see what happens if we force congress to cut a lot of spending or raise a lot of taxes over night; it's a body that works better over time.

2. I thinks sovereign debt promotes international peace.  If people invest in each others' governments, there is suddenly an international constituency for promoting stability in other countries, not going to war with them, and for promoting sounder budgetary and economic practices in your debtor nations.  If I loan a lot of money to Iran, I suddenly have strong feelings about war with Iran.  This doesn't always work to preserve peace and insure good policies, obviously, but I've got to think it has some sort of effect, and on balance I think the effect is positive (especially as the world gets more democratic, since a main negative effect is creditors propping up debtor dictatorships).  Balanced budgets means no government debt means (at the margin) more war.

3. I like the idea of a government not having to radically reform itself every time there is a downturn. Imagine we are in the great moderation and have a mild one year downturn, hurting tax revenue and increasing welfare expenditures   Is it really good to make the government  raise taxes and/or slash spending in order to keep the budget balanced?  Then come back a year later and undo their work?  That seems, to me, like 1. It would increase uncertainty a good deal, and 2. It would create a bonanza of lobbying.

Borrowing through recessions lets us keep the laws constant regardless of the business cycle.  That is probably a good thing.

4. I just don't see the harm.  The welfare state is well over a century old, but fiscal crises and default, especially in large, developed nations, are really rare.  I think Kling's article is especially telling here: his big example of why balanced budget amendments are good and not having them is bad is showing how much more indebted Canadian provinces (who can borrow) are to US states (who often can't).  This, according to Kling, makes them more likely to default.  But Canada is 146 years old.  When, exactly, are these provinces going to get around to defaulting?  When is the debt going to make something bad happen?

Don't get me wrong, countries can mismanage their debt, and healthcare costs/demographics are putting big pressures on debt to GDP ratios.  But "pressure" doesn't mean inevitable default.  Historically, countries have done a decent job of reforming and rolling back the welfare state when it starts causing major problems (See Thatcherism.  Over 25 years British government spending as a percent of GDP fell by over 15 percentage points), and there is every chance countries will rise to this challenge (see the trillions of dollars in deficit reduction over the next ten years we've already enacted, and the fact that both parties want to enact more).  

The story I think Kling wants to tell is, "for political economy reasons, welfare states that can borrow will get more and more indebted until there is a fiscal crisis.  So we can't let welfare states borrow."  To me, reality looks more like, "For over a century now, the the vast bulk of welfare states have done an effective job of managing their debt to gdp ratio and avoiding fiscal crises.  They might screw up their power to borrow, but they might screw up any power we give them."  

5. Keynesians could be right!  It's a big step to go from thinking people are wrong to making their policy recommendations unconstitutional.

As a final matter, it makes intuitive sense to me that borrowing let's governments shift costs into the future, when the public will be richer and able to bear costs with less loss of utility.  Even though future people are paying more (thanks to interest), they might suffer less (because they are richer).  I worry that this is one of those things in economics that seems intuitively right but is in fact wrong, though, so I don't list it as a reason.  

Those Lying (Economist) Eyes

Dan Ariely points us to this paper:

Senders received 15 Euros every time they indicated a green circle, and only 14 when they communicated that the circle was blue. Receivers earned an even 10 euros regardless of the color, and so were unaffected by either the truthfulness or dishonesty of the senders.

That is, by design, no monetary harm is done by lying to either person in the experiment, but lying is beneficial to the liar.

The results showed little difference in honesty as a factor of socio-demographic characteristics or gender. A student’s major, however, was a different story. As it turned out, those in the humanities, who were the most honest of all, told the perfect truth a little over half the time. The broad group of “other” was a bit less honest with around 40% straight shooters. And how about the business and economics group? They scraped the bottom with a 23% rate of honesty.

That is, economics students were much more likely to tell a harmless lie that's in their own self-interest.  Dan is quite troubled by this.  I am fairly certain that I would lie in this experiment, but I am much less troubled by that.

 I would like to see the study where the payouts are reversed.  Let the sender only lie to benefit the receiver.  Is an economist more likely to lie for the other person's benefit as well, if it is at no cost?  If so, then perhaps the students are learning to think hard about independently about policies, laws and rules of thumb that they've grown up with, precisely what we are trying to teach them.