Chris Dillow's Blog, page 194

How much?

In economics, the question is often not: is this view correct? but rather: how significant is this?
I was reminded of this by Patrick Minford on the Today programme. He argues that the overshooting of the inflation target is dangerous because it could lead to higher inflation expectations.
This view is not wrong. Instead, the question is a trickier one: how do we weigh the cost of higher inflation expectations against the alternative cost, which is that a tighter monetary policy would have deepened the recession?
And this is the sort of question that arises in most economic policy issues. For example, unlike some lefties, I'm happy to concede that, in theory, higher minimum wages, greater job protection, tougher planning laws and the like depress employment. The question is: to what extent do they do so? Would freer market policies in these areas really reduce unemployment much?
What I'm saying is that economics is a quantitative discipline*. But this runs straight into Stephen Pinker's complaint that a "failure of statistical thinking is the major intellectual shortcoming of our universities, journalism and intellectual culture."
The problem here is not that economists aren't statistical thinkers. A comparison of, say, the Economic Journal and BMJ will show that economists are often more statistically sophisticated than many natural scientists; they have to be if they cannot conduct experiments. Instead, the problem is that economics gets misunderstood by journalists and hence the public.
That interview with Minford highlights three (of many?) reasons for this:
1. Time pressure. Interviewees typically have only a few seconds to state their position. But it takes longer to explain statistical results. The typical item on More or Less, a programme that does explain statistics, lasts longer (I suspect) than interviews or news items in lesser programmes.
2. The adversarial mode encourages binary yes/no thinking. Minford's views are juxtaposed against those of John Gieve. This encourages the impression that either one or the other is right, or that economists don't really know what they're talking about. But I suspect if Gieve and Minford were to talk away from the mic, they would exchange empirical evidence about the scale of the competing costs.
3. Incentives. Even in a radio studio, no-one has an incentive to proportion their beliefs to the evidence; it makes for bad (that is, dull but truthful) radio. And this is - of course - still more true in politics; those campaigning for, say, easier planning laws have incentives to overstate their case. 
In these ways, even apparently "neutral" media serve a pernicious function. They perpetuate bad thinking and (what might or might not be the same thing) a misunderstanding of economics.
* This is not to say that the quantitative methods must always be very sophisticated. I suspect there are diminishing returns to econometrics once we go beyond Peter Kennedy's interocular trauma test (pdf).

The decline of newspapers

This piece by Carl Packman set me thinking: do conventional accounts of the threats to the future of journalism leave out some important causes of that decline?

What I mean is that it's tempting to blame newspapers' troubles on the rise of the internet and on regulation. But I suspect there are other things at work.

One is that news is not a feature of the world, but rather a modern artifice. Niklas Luhmann has written:

We are used to daily news, but we should be aware nonetheless of the evolutionary improbability of such an assumption. If it is the idea of surprise, of something new, interesting and newsworthy which we associate with news, then it would seem much more sensible not to report it in the same format every day, but to wait for something to happen and then publicize it. This happened in the 16th century in the form of broadsides, ballads or crime stories…(The Reality of the Mass Media, p25)

News, he says, is not so much something that happens as something that's manufactured by journalists, according to quite strict conventions.

Secondly, the notion of news and reporting rests upon a contentious epistemological premise - that knowledge can be gathered centrally and expressed explicitly. In a sense, the very notion of news is a rejection of Hayek's stress upon local, fragmentary knowledge and Polanyi's idea of tacit knowledge. You don't have to be an efficient market dogmatist to believe that share prices contain pretty much all the economic and business news you need.

Viewed from these perspectives, "news" is a peculiar and artificial historical contingency. Why should there be a permanent market for it, except through the dull force of habit?

Thirdly, journalism is, tendentially, prone to Baumol's cost disease. The time required to research and write a good story probably hasn't changed much down the years - I write as one who was a journalist in the pre-internet era. This means the productivity of good journalism tends to fall over time relative to the rest of the economy - which means in turn that its relative cost tends to rise.

Naturally, newspaper bosses have fought this, by cutting journalists' pay and by abandoning expensive investigative journalism in favour of tittle-tattle. But there are limits to how far this can be done without alienating readers.

None of this is to deny the role of the internet in accelerating the decline of newspapers. All it is saying is that there are some deeper forces at work - forces which mean that newspapers cannot survive forever in a free market. Whether this is a good thing or not is another issue.

Occupy Wall St: first words

Norm criticises the Occupy Wall Street movement for not having articulate, concrete demands. I sympathise. But shouldn't older leftists like him and me take some blame for this omission?

What I mean is that we have not bequeathed to today's protestors the intellectual, cultural or political resources with which to challenge capitalism effectively.

By this I don't mean merely the far left's decades-long sectarian obscurantism. I mean three other things:

1. From the 80s onwards, the left lost interest in economics and class, and diverted its attention to cultural issues. This meant that some were shocked - shocked! - when  class power was exercised to enrich bankers at the expense of others. It also means that interest in alternatives to capitalism has been lacking.

2. The dominant strain of leftist thinking - especially within the Labour party - has regarded the state as the solution, not the problem. So when state power is used to subsidise bankers whilst  harassing protestors, the left is thrown into confusion.

3. Partly because of the decline of class-based politics, protest since the 1960s has been a peripheral activity - a few hours of narcissism and then a return to everyday life. This is not a significant challenge to the existing order. Instead, as Marx recognized, revolutionary activity must spring from everyday economic life.

Given this lack of foundations, it is harsh to criticize OWS and its international counterparts too much.

Instead, it deserves praise for (at least) two things. One is its "we are the 99%" slogan. In trying to claim majority support, this helps to shift the Overton window leftwards. The other is that it is trying to create a space in which radical ideas can be discussed.

In this sense, OWS should be regarded as first words, not last ones. It might be the start of something big. 

WEHT small government Keynesianism?

Russ Roberts says something intriguing:

Krugman is a Keynesian because he wants bigger government. I'm an anti-Keynesian because I want smaller government.

Paul Krugman himself has already replied to this. But for me, there's a question here: why is there this empirical correlation between attitudes towards Keynesianism and towards the size of government?

I ask because, as Mark Thoma has said, "there is no necessary connection between the size of government and Keynesian stabilization policy."

For example, one could believe that government spending should average (say) no more than 20% of GDP, and yet at the same time favour large discretionary changes in tax or spending to stabilize the economy. "Small government Keynesianism" is not, prima facie, illogical.

Alternatively, one might favour big government precisely because one is sceptical about the ability of discretionary policy to stabilize the economy, and so a large state is needed to provide automatic stabilizers; Dani Rodrik has made just this point.

So, why are there so few small government Keynesians or big government anti-Keynesians?

One reason, I suspect, lies in public choice economics. It's politically easier for governments to increase spending and borrowing in bad times than to cut them in good times. This means that Keynesian policies contain a tendency for a creep towards big government. Libertarians might regard the cost of this as exceeding the benefit - especially if they agree with Lucas (pdf) that the benefits of stabilization are paltry.

There is, though, something else. Keynes himself was a small(ish) government Keynesian, because he thought goods and labour markets were, to adapt Samuelson's dictum, micro efficient but macro inefficient:

I see no reason to suppose that the existing system seriously misemploys the factors of production which are in use. There are, of course, errors of foresight; but these would not be avoided by centralising decisions. When 9,000,000 men are employed out of 10,000,000 willing and able to work, there is no evidence that the labour of these 9,000,000 men is misdirected. The complaint against the present system is not that these 9,000,000 men ought to be employed on different tasks, but that tasks should be available for the remaining 1,000,000 men. It is in determining the volume, not the direction, of actual employment that the existing system has broken down.

This view, however, is not one we hear much of these days. People who believe markets are micro efficient seem to think they are macro efficient too. And "Keynesians" are apt to think markets are micro inefficient as well as macro inefficient - or at least they are keener to point out inefficiencies than efficiencies.

And this leaves me with questions to which I honestly don't really know the answers. Is  Keynes' "micro efficient, macro inefficient" view tenable, in which case an interesting position has been lost, perhaps usurped by loud tribalism? Or was he just wrong?

Forget the forecasts

Richard Exell thinks a recession is likely. Personally, I couldn't care less.  Economic forecasts are both futile and irrelevant.
They're futile because we simply don't have the intellectual resources to predict (pdf) GDP to within the (narrow) margin of error that makes a difference between a "good" and bad "forecast". This is not because of the shortcomings of neoclassical economics, many as they are. It's because human affairs generally aren't predictable. Political scientists can't forecast (pdf) revolutions, criminologists can't forecast riots, marketers can't forecast which products (pdf) will sell and which not. And so on.  As Ambrose Bierce put it 100 years ago in his Devil's Dictionary:

Predict, v.t. To relate an event that has not occurred, is not occurring, and will not occur.

A big reason for this is that social behaviour is an emergent process; quite simple individual behaviour generates complex structures. In economics there are (at least) three types of problem here:
- What'll happen to technical progress? If there are popular new products or processes, we can get a boom in consumer spending or investment as people spend on these. But we can't predict the pace or success of innovation.
- (How) irrational will people be? One issue now is whether bosses' overconfidence will raise capital spending by more than spare capacity, the apparent dearth of investment opportunities and uncertainty depresses it. This is not precisely quantifiable.
- Will individuals' behaviour be correlated or not? If lots of people buy at the same time, we get booms and bubbles. If they try and sell at the same time, we get crashes. But predicting such correlations is impossible.
You might object here that some people did foresee the crisis. I'm not sure. For one thing, if enough people throw darts, some will hit a treble 20 without having any skill. Those who called the crisis were, at best, folk who reasonably pointed out risks and, at worst, charlatans who got lucky without great insight: as far as I can tell (and please feel free to direct me to evidence otherwise), a lot of these did little more than go "Debt. Woooo."
Maybe they'll come a time when we get sufficient knowledge (pdf) of complexity (pdf) to make reliable forecasts. Maybe not. Until, then, though, forecasting is just a way of risking making fools of ourselves.
And, what's more, for no very good purpose.
For almost all policy purposes, we don't need to know next year's GDP. What's the right tax-benefit system, or planning regime, or bank regulation? A GDP forecast is irrelevant to these.
Even orthodox macroeconomic policy doesn't really need forecasts. The conventional Taylor rule doesn't use them. And the debate about whether to loosen fiscal policy or not is about the risks of a debt crisis versus the desire to reduce unemployment, rather than hinging on any forecast.
I suspect that the desire for macro forecasts is a historic legacy. When governments thought they could tweak growth by monetary and fiscal policy means, it needed them. But we are at least 30 years past that stage now. And when firms were big, inflexible behemoths, they needed to forecast next year's demand. Fordist firms needed forecasts. But Zaraist ones don't. It's time we moved into the Zaraist age.

Mass unemployment: here to stay

Today's bad unemployment figures led to Ed Miliband claiming that the government's economic plan is not working. True or not, this misses a bigger point - that mass unemployment is here to stay, pretty much regardless of what policy-makers do.
Let's do some sums. There are just over six million un- or under-employed: 2.56m jobless, 1.27m working part-time who'd like a full-time job, and 2.22m out of the labour force who'd like a job. What would it take to reduce this to three million?
We'd have to create more than three million jobs, because population growth adds around 150,000 to the workforce each year. Over five years, then, we'd need something like 3.75m extra jobs. This represents employment growth of 12.9%.
To generate this, GDP would have to rise by more than this, to account for two things. One is "normal" productivity growth; this has been just under one per cent a year in the last 10 years, implying that the economy can grow almost one per cent a year without creating jobs. The other is that the level of productivity is below its trend now thanks to labour hoarding: output per job was 4.2% lower in Q2 than it was in 2007Q4. This suggests that GDP could grow quite a lot without generating any extra jobs, as firms respond by increasing the utilization of existing labour.
If we put all this together, employment growth of 12.9% over the next five years probably requires a rise in GDP of over 20%. That's 3.7% a year.
This sort of growth has only rarely been achieved in the past - the five years to 1989 being the last time - and compares to the OBR's estimate of trend growth of around 2.1% a year.
So, what can policy-makers do to raise GDP growth by 1.6 percentage points a year?
Very little, even on an optimistic reading. Put it this way. The Bank of England has estimated (pdf) that its first £200bn of QE added around £50bn to money GDP. This implies that to add 1.6 percentage points a year to real GDP growth for five years would require £500bn of QE - even on the grotesquely optimistic assumption that the aggregate supply curve is flat and so none of this money creation adds to inflation.
What I'm saying here is that, unless everyone gets very surprised, mass unemployment is here to stay. Politicians who pretend it can be eliminated by policy measures are just making prats of themselves.
The policy questions should not be merely how to create jobs - important as this is - but rather how to deal with the inequality, unhappiness and potential social tensions that prolonged mass unemployment will cause. And politicians of both parties are showing few signs of answering these.

Outcome bias & cargo cults

Is it time for a Nobel prize for managers? asks Andrew Hill. The Platonic essence of a QTWTAIN, says John.
He's right. The reason for this is that our judgement of managers is clouded by the outcome bias.
When management theorists talk about bosses they very often don't take one early in his career at a firm, and say: "This is his strategy. It's good because x, y, z. He's a good manager. His firm will succeed." Instead, they use hindsight. They take a firm that's succeeded and infer from this that the CEO and the strategy was good. Or they see a firm struggling and infer the CEO is bad.
This is the outcome bias; we judge managers not by the quality of their work, but by their results.  In this sense, management differs - to least some degree - from most of the disciplines which get Nobel prizes. We can assess the work of, say, Chris Sims, independently of anything it has led to. But we rarely assess managers independently of results. This is wrong because it ignores the role of luck. A poor boss could get lucky and succeed and  a good one could get unlucky and fail.
Duncan Watts' Everything is Obvious - which I strongly recommend - gives an example of how tricky it is to slough off outcome bias. He compares the iPod and Betamax video tapes:

The iPod was exactly the kind of strategic play that the lesson of Betamax…should have taught them would fail. The iPod was large and expensive.  It was based on closed architecture that Apple refused to license, ran on proprietary software, and was actively resisted by the major content providers. Nevertheless, it was a smashing success. So, in what sense was Apple's strategy better than Sony's? Yes, Apple had made a great product, but so had Sony. Yes, they looked ahead and did their best to see which way the technological winds were blowing, but so did Sony. And yes, once they made their choices, they stuck to them and executed them brilliantly; but that's exactly what Sony did as well. The only important difference…was that Sony's choices happened to be wrong while Apple's happened to be right.

This sort of thing is, of course common in sport. I've described how Arsene Wenger is the victim of it now. And a new paper shows how NFL coaches are prone to the bias. The authors show that coaches tend not to change their teams' offensive strategies after victories, even if these were narrow, but they often change them after defeats, even if the defeat was very narrow or if it were due to defensive errors rather than attacking ones. They say:

One can easily misinterpret a favorable outcome as justification for a given strategy, overriding more subtle evidence to the contrary.

All of this raises a question. Could it be that management is, to some extent, like a cargo cult? It performs certain peculiar rituals, after which nice things sometimes happen and sometimes not. However its members infer from this not that the rituals are (largely? partly?) irrelevant to the outcome, but instead that some of their performers have skill whilst others do not. And in this way, irrational practices persist, and their luckier practitioners get rich.

The natural party of government

Liam Fox's admission that "mistakes were made" (note the cliched passive voice) in his dealings with Adam Werrity reminds me of a curiosity about this government - that it doesn't seem very good at the nitty-gritty of governing.
By this I don't mean that it has the wrong policies. Errors in policy and administration are inevitable. I mean instead the sheer number of unforced errors that it has made. Fox is just continuing a pattern, for example:
- Theresa May gives the impression that she's basing policy upon a story that's not only a pack of lies, but not even her own lies. Did she really think she could get away with this?
- David Cameron appointed Andy Coulson as his press secretary, despite his being associated with allegations of phone-hacking.
- Andrew Lansley has been unable to explain the point of his NHS reforms; what exactly is the problem to which they are the solution?
- The huge number of "u-turns" the government has done suggests a lack of forethought and/or an inability to prepare public opinion for its policy announcements.
- When Michael Gove closed the Building Schools for the Future programme, it took him five attempts to name the schools that would be affected by this.
- Recent policy announcements, such as on weekly bin collections and raising the motorway speed limit, have been on trivial matters - the sort of things a tired government in its fifth year of office might do, rather than the significant changes we'd expect early in its term.
- The government has failed to find the genuine efficiency savings it promised.
These episodes seem to confirm Zoe Williams' assessment, that we're looking at a government with "no idea what governing entails, let loose on a system with no clue about its structure and mechanisms."
Now, we mustn't exaggerate here. There never was a golden age of wholly competent government: past administrations have contained large numbers of buffoons and mediocrities. Nevertheless, considering the Tories are supposed to be the "natural party of government", they seem remarkably bad at governing.
Which brings me to a hypothesis. Could it be that its incompetence arises precisely because it believes it is the natural party of government? Cameron and his colleagues think they are entitled to rule, and this causes them to under-rate the importance of working hard and following procedures such as ensuring that ministerial meetings had civil servants present. They are like those footballers who believe their natural talents give them a right to be lazy, and who end up slipping out of the game.
This is compounded by another error. If you think your policies are simple common sense, then you'll believe them to be self-evidently right, and so won't bother thinking about details and counter-arguments. You'll ignore the fact that governing is not like bashing out a 1000-word column before breakfast. It's not as simple as that.

An infantile disorder

Norm revisits the old question: why do some leftists not sufficiently oppose nasty governments such as Iran's? He says:

For many left activists, opposing their own and other Western governments is a way of announcing their anti-capitalist [Norm's emphasis] credentials. Even though the regimes and movements this turns them indulgent towards may be no more anti-capitalist than a large investment bank, this section of the left permits itself the illusion that, by making rhetorical noises against imperialism and/or the West, such regimes and movements express - covertly, indirectly - some impulse towards an alternative, more egalitarian form of political economy.

To which I can only quote Robert Robinson; "Would that it were, Mr Geras, would that it were."
I say this because if anti-capitalism were the dominant motive of that section of the left that "indulges" illiberal regimes, then we'd expect to see a lively discussion of alternatives to capitalism.
But this is precisely what's missing. AFAIK the left doesn't have much interest in such alternatives; the relative merits of various non-capitalist ownership structures just doesn't get much discussed - or if it does, no-one brings such  discussions to my attention. When I occasionally suggest a case for workers' democracy, I feel like a crank making a lone call.
"Smash capitalism and replace it with something nicer" seems to be the limit of "anti-capitalists" interest.
Take, for example, the two most prominent left movements - UK Uncut and Occupy Wall Street. Granted, these movements reasonably pride themselves on their diversity and so shy away from specific programmatic demands.
 But as far as I can see, what demands there are fall short of the overthrow of capitalism. UK Uncut's main policies are an opposition to spending cuts and a demand that the rich pay more tax.
The Occupy Wall Street movement has no official list of demands. This list submitted by one supporter contains only one proposal - a "guaranteed living wage income regardless of employment" - that comes close to a genuine transitional demand. Others are libertarianism (open borders) or Keynesian (more infrastructure spending). I suspect the movement is motivated by a desire to energize the left or opposition to "bad capitalism" rather than by full-scale anti-capitalism.
You could fulfill the (stated) demands of UK Uncut and Occupy Wall Street and capitalists would remain in charge of the means of production, distribution and exchange.
What's missing from both is any vision that capitalism can be overthrown and replaced by democratic worker ownership.
Now, we could argue forever about why the left isn't articulating clear alternatives to capitalism. But the fact is that it isn't. Which makes me suspect that the leftists Norm has in mind are not, primarily, motivated by anti-capitalism, but by something rather less coherent.

Animal spirits & ideology

Is it possible to talk ourselves into recession? To what extent do our moods affect economic behaviour? These are of course reasonable questions. But listen to this piece on the Today programme. What do notice?
The thing is, the discussion is entirely about consumer behaviour. A moment's thought, however, tells us that confidence - and especially irrational moods - are more likely to affect corporate spending:
- no individual consumer is big enough to affect the economy. But a few firms are. Extreme pessimism or optimism in a few households, then, is irrelevant - but it might be very important in a few companies.
- There are millions of consumers, whose irrational optimism or pessimism might well cancel out. However, there are a few dozen large corporations that really matter for the economy, and there's less reason to suppose the decisions these take will cancel out, not least because bosses have similar backgrounds and outlooks. As Chuck Prince, ex-CEO of Citigroup famously said, "as long as the music is playing, you've got to get up and dance."
- Bosses are selected for over-confidence and conformity. This makes it more possible that bosses' mistakes - either too optimistic or too pessimistic - will be correlated, and thus that mood swings might affect the economy.
Two facts corroborate these suspicions.
First, economists find it much harder to forecast capital spending than consumer spending. Since 2000, the average error (regardless of sign) in January's forecasts for that year's consumer spending growth has been 1.1 percentage points. The average error in forecasts for investment growth has been 2.7 percentage points. This suggests that conventional models - which focus upon observable factors such as interest rates and incomes - go more wrong in forecasting corporate than consumer spending. Which is a sign that perhaps corporate spending, more than consumer spending, is prone to swings in "animal spirits."
Secondly, the behaviour of a small minority of firms determines whether we get recession or not. In the 1989-91 recession, 10% of firms accounted for 80% of the gross fall in sales and 85% of the gross fall in employment.
All of which raises the question. Why, given all this, should anyone discuss the role of mood and confidence solely in the context of consumer spending?
I fear there's an ideological bias at work - which is all the more pernicious for being subconscious. I mean this in two senses.
First, there's a reluctance to think of boardrooms as being driven by sentiment, psychology and mood. Journalists at least - even now! - think of "senior people" as being hard-headed experts, and only consumers as being ignorant and irrational (when Peter Lunn rightly disputed the latter I suspect he was going off piste).
Secondly, there's a reluctance to acknowledge the role of power in the economy. Yes, consumer spending is determined largely by people's wages and employment security. But what determines those? And what if the decisions that do so are systematically irrational or ill-informed? These are questions which are not to be asked. And in not doing so the BBC helps to avoid capitalists' power and rationality from falling into question.