Heterodox Economist

We should be selfish?

At interfluidity we read yet another attempt to justify orthodox economics. But this justification conflicts with what the orthodox believe:

We build models to make sense of the deviations, so we can correct the "market failure", the human flaw. Our job is not to describe the world as it is, but to understand how it is different from what it ought to be, and to fix it.

The human failure, here, seems to be partly that people are not competely selfish (but they should be?!) We should make people selfish so that the orthodox theory becomes true! Very odd perspective.

Be that as it may, orthodox economists see themselves as describing "what is" and not "what should be." I don't think orthodox economists can accept the perspective offered by interfluidity.

But, returning to theme #1, embedded in the orthodox vision is an ethical notion: an economy should permit people to make choices because it is important to let people make choices. Yet the orthodox deny they have any ethical perspective at all.

So perhaps what appears at interfluidity is correct, but orthodox economists would deny it.

Added: The nature of the relationship between (1) the math models developed by orthodox economists and (2) "the real world" still seems unclear. You'd think by now a good answer would have been provided by the orthodox. And folks find heterodox economics odd.

The Political Economy of the Consumer Price Index

Congress, with the assistance of The Boskin Commission, pressured the Bureau of Labor Statistics (BLS) to change the way it calculated the rate of inflation. This direct political intervention, in the 1990s, into what has generally been a non-political statistical entity requires explanation.

The BLS regularly improves how it estimates the inflation rate by improving the way it calculates the Consumer Price Index (CPI). Annual inflation rates are estimated by year-to-year changes in the CPI. If the BLS announces that the annual inflation rate is 4% this means the CPI grew by 4% over the past year.

By the late 1980s, the BLS was studying how to better account for the "substitution effect." The substitution effect occurs when an increase in the price of, say, apples causes consumers to cut back the number of apples they buy and to substitute, say, oranges in place of apples. Part of the harm of increased prices can be counteracted by changing what you buy.

By the mid-1990s Congress pressured the BLS to introduce substitution effect adjustments more rapidly than the BLS had planned. Congress also put pressure on the BLS to introduce larger adjustments for the substitution effect than the BLS thought the data warranted. By 1998 the BLS gave in to this pressure.

In this posting I'll discuss the reason Congress put pressure on the BLS to alter the way they calculated the CPI. In a later posting I'll consider the role played by conservative economists in this political process and what this says about the way that economics is done within the academic world.

The US Social Security program was created in 1935. From the beginning, political conservatives wanted to reduce the size of the program and, ideally, eliminate it. However, direct attacks by conservatives on Social Security had a political cost: these attacks angered the old folks, who would punish conservatives in the next election.

By the 1990s conservatives figured out how to attack Social Security without drawing attention to themselves. By law, Social Security benefits increase each year by the rate of inflation (as measured by the BLS). If conservatives could get the BLS to generate lower rates of inflation, then the annual increase in Social Security spending would fall below what it otherwise would have been. Such an indirect attack on Social Security would not gut the program but it would, over many years, cause a significant cutback to the Social Security program by continually taking small bites out of the program.

Clever move. And successful.

Some members of the public saw what Congress was up to, but the mass media gave little attention to Congressional hearings on the measurement of inflation. And as the discussion in these hearings often was framed in terms of "the substitution effect," "the virtues of Laspeyres versus Fisher Indexes," and "chain weighting" it is not surprising that the media coverage was not extensive.

The BLS fought a good fight, but in the end it had to make peace with Congress. And a peace mostly on the conservatives' terms. In 1999 the BLS shifted from a Laspeyres index methodology to one based on a Fisher index. Then in 2002, the BLS introduced an additional change to their method to create what they called a "chained CPI." The net result: the inflation rates generated by the BLS were small than they were before. So annual increases in Social Security payments became smaller than they otherwise would have been.

I've only hinted at some of the political, economic, and statistical issues involved in the above process. I'll expand on some of these in a later posting when I consider the role played by conservative academic economists in helping Congress force the BLS to change how they measured inflation.

Dueling sentences: Pigou vs. Kafka

1912 saw the the completion of two major works: A.C. Pigou's The Economics of Welfare and Franz Kafka's first published short story, "The Judgment."

What the heck...let's look at the first two sentences of these masterpieces.

Pigou:

When a man sets out upon any course of inquiry, the object of his search may be either light or fruit--either knowledge for its own sake or knowledge for the sake of good things to which it leads. In various fields of study these two ideals play parts of varying importance.

Pigou has the hope, one reaching back to Francis Bacon, that humans will be able to learn enough about the world (gain light) so that they can control it and to control for the benefit of all people (knowledge/light that gives fruit). Pigou identifies economics as a fruit-bearing activity.

He hopes that with proper understanding of the economy and a proper understanding of what leads to human welfare, "the authorities" will be able to improve things in our very imperfect world. His book, The Economics of Welfare, is an attempt to provide guidance to the government, certainly filled with men of good will, for improving the human condition.

Pigou, strongly influenced by Millsian liberalism, sees the individual as the most important part of society and he wants to respect people by respecting their individuality and, indeed, their subjectivity.

Pigou's book is thoughtful and still worth reading today. In many ways, public finance has not moved much beyond Pigou's work.

Kafka:

It was a Sunday morning when spring was at its most beautiful. Georg Bendemann, a young businessman, sat in his private room on the second floor of one of the low, jerrybuilt houses that stretched along the river in a long row, hardly distinguishable from one another except for their height and color.

This is a classic Kafka story opening. The first sentence is ordinary, indeed trite: it's a beautiful spring day. Okay, Franz, where are we going with this? Why did you write such an apparently uninspired sentence?

The second sentence, however, shoves us from the trite into the Kafka Zone. Kafka writes: the houses are "hardly distinguishable...except for their height and color." But, but, but...the reader asks...how can the houses be almost indistinguishable if they differ by height and by color? But our narrator says they are "hardly distinguishable." What's going on here? Is the narrator confused or are we confused? Are the houses indistinguishable or not? Help!

And then it gets worse.

The short story goes on to mess with the reader in many ways. You can't trust what any of the characters or even the narrator of the story say. They might be mistaken, they might be lying, and/or they might be crazy. Who knows? Characters switch personalities, perceptions, and beliefs mid-sentence. The story ends with the father of the main character announcing to his son, "I now sentence you to death by drowning!" So the main character goes out and jumps off a bridge. End of story.

Pigou's orderly world waiting to be discovered (light) so that good hearted people can improve the world (fruits) is nowhere to be found in "The Judgment."

Both Pigou and Kafka celebrate individuality and subjectivity but they take these things in very different directions. Pigou is concerned with a tangible and real world with stuff you know. Kafka creates a world in which untethered subjectivity makes us doubt that we can know anything at all. We can't even know what makes people do what they do.

Both writers are also centrally concerned with authority. Pigou believes that those running the show can be made aware of the right thing to do and will then implement the right thing (light leads to fruit). In Kafka's world authority is almost random; it certainly isn't well motivated or good. You can't believe the narrator (who the reader generally trusts). One character who is weak, perhaps senile, and at the mercy of the main character suddenly gains power and authority and sentences the main character to death simply by speaking words. Who has authority, how they get it, and what they use it for is inexplicable in Kafka's story. You can't even trust the author to be straight with you.

All of this, of course, on the eve of World War I and the Russian Revolution. By 1920 the world had changed. Pigou's almost Victorian sense of progress, rationality, good well, and reasonable people running things became harder to maintain. Kafka's fictional dream world seemed more real than people wanted and Kafka beget Eliot's 1922 The Waste Land.

One might also argue that Kafka beget, or more likely foreshadowed, Keynes' 1921 Treatise on Probability in which the objectivity of probability was questioned. By Keynes' General Theory the rational calculating investor was shoved aside by a subjective guess-maker lacking relevant information the future, an investor who had more in common with a Kafka character than he did with Marshall's rational businessman.

As much as I like A.C. Pigou, I have to give this match to Kafka.

Sigh.....

Mark Thoma writes:

When I was a first year graduate student, during discussions surrounding the work of Kuhn and Popper we were told something like: It's fine if you want to challenge the neoclassical model. But before doing so, you had better learn the neoclassical model just as well, or better than the people you will be challenging. It was good advice. It did not allow you to avoid learning the neoclassical model thoroughly even if you had doubts about it.

I know heterodox economists who:

• Know the orthodox paradigm as well, or better, than any orthodox economists I've met,
• Know a variety of different heterodox paradigms very well, and
• Can clearly explain why they have decided to pursue a heterodox approach.

I've rarely met an orthodox economist who:

• Really knows the orthodox paradigm (other than being able to just do modeling and repeating stuff they were told in graduate school),
• Have a knowledge of any heterodox paradigm beyond minor variations of orthodox economics, and
• Who can explain why they do orthodox economists (other then say, "but...but...but that's what economics is!")

The best-trained economists (and thinkers) I know are heterodox economists. Lot of good that's done them when they face the economics mafia. ;>

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Added: The problem heterodox economists face is not that they are "poorly trained" but that orthodox economists are "poorly trained": orthodox economists have been bred to know little beyond the orthodox paradigm.

Yes, many heterodox economists are running around who are "poorly trained" (in both orthodox and heterodox economics) but that's true in most fields. Many orthodox economists are "poorly trained" from the point of view of the orthodox paradigm (along with lacking knowledge of any other approach to economics).

From Reserve Army to the Cost of Job Loss

Marx:

...the general movements of wages are exclusively regulated by the expansion and contraction of the industrial reserve army.... (Capital, Vol. 1)

For instance, an increase in unemployment boosted employers' power over workers, and this enhanced power permits employer to push wages down. Unemployment created--and regulated--employers' power over workers.

In his more economistic moments, Marx linked his wage-setting/bargaining process to a theory of population, to a theory of technological change, to a theory of the state, and, indeed, to almost everything. While one can dispute many details in Marx's writing, his analysis of capitalism represents speculative social theory at its best.

Yet, Marx's theory of unemployment-determined bargaining power is flawed. More precisely, while his theory made sense when he was writing in the mid-1800s it is not adequate for modern capitalism.

The development, after 1900, of unemployment insurance, the welfare state, and socialize spending compells us to update Marx's theory. The industrial reserve army (focused on the level of unemployment alone) must be transformed into the "cost of job loss." The cost of job loss acknowledges that the harm caused to workers by unemployment depends on the generosity of unemployment insurance, the level of income supplementing social benefits, and so on.

While the cost of job loss is still under-theorized--and suffers from a lack of relevant empirical studies--it deserves more extensive investigation as little has been done on this concept since the mid-1990s.

When Homer Met Kafka

I misread the first sentence of Metamorphosis,

One morning, as Gregor Samsa was waking up from anxious dreams, he discovered that in bed he had been changed into the ancient poet Homer.

Less disturbing than waking up as a giant insect, but disturbing nonetheless.

Gregor, in his new guise as Homer, finds he must now tell the story of the Trojan war--he must rewrite the Iliad--something that seems beyond his meager abilities.

First, he decides that, like the real Homer, he will start the story by describing the quarrel between Achilles and Agamemnon long after the start of the Trojan War. In this storytelling technique, called in medias res, an author starts his/her narrative not at the beginning but at some critical moment in the story. From this critical moment the storyteller moves backwards and forwards to reveal the action.

The posting below (Be Polite to your Boss) used that technique: the analysis of capitalism started with a capitalist economy that was already operating. It started with the presumption that unemployment existed and that this unemployment shaped the relative power of employers and workers: a critical part of the story of capitalism. From that starting point we can now move backwards and forwards in our understanding of capitalism.

But, then, Gregor has a thought, "No! I will begin at the beginning."

"Furthermore," continues Gregor, "I will start thusly: Assume you have n humans (n >> 0) who want to cause infinite carnage but who have limited weaponry. Assume, also, that you have m gods (m >0) who sometimes have god-like powers which allowed them to escape the scarcity problem. Free lunches for the gods; none for the morals!"

"In fact, forget the narrative stuff. It's so ninth century B.C.E.... l'll develop a mathematical model that describes the Trojan War as the outcome of the simultaneous interaction of humans subject to scarcity and gods not subjected to scarcity. The equilibrium outcome will be defeat for the Trojans and the burial of Hector...that is, if I build my model correctly.... Indeed, the fact that my model will end with the defeat for the Trojans and the burial of Hector shows that my model adequately tells the story of the Iliad."

An orthodox economist might find this second way of telling about the battle of Troy dazzling; others might call it dumb.

Lucky for us, Kafka's Gregor become a large insect and so we never had the Kafkaesque general equilibrium theory of the Iliad. Thank Zeus for small favors.

Thanks

I would be impolite if I didn't thank

http://robertvienneau.blogspot.com/

http://morenotesfromunderground.blogspot.com/

and the always-dashing http://www.maxspeak.org/mt/

for guiding visitors to my humble site.

Be Polite to Your Boss

Employers have power over workers.

This power follows from the following two facts:

• after losing a job, the worker potentially faces a big reduction in his/her standard of living caused by unemployment, and
• after losing an employee, the employer generally can find a replacement worker relatively fast and the loss of income experienced by the employer while looking for a replacement is generally small relative to the employer's total income and wealth.

Because the "cost of job loss" to an employee generally exceeds the "cost of losing a worker" to the employer, the employer has an upper hand in the employer-worker relationship. The worker is more interesting in keeping the job than the employer is in keeping the worker.

This gives to the employer a position of power. Because of this power, the employer:

• tells the employee what to do (rather than the reverse),
• can demand the employee treat him/her with respect and deference,
• can require that the worker will work harder and better than would have been the case if the worker had the power, and
• can expect to keep the residual income (i.e., the profit) generated by the business.

Suppose that all most workers could get a job within hours after being fired or quitting. And suppose employers typically had to wait weeks to replace a worker who left. Workers would be telling employers what to do and employers would be very nice to workers.

What a strange world that would be. It wouldn't be capitalism as we know it. It might not even be capitalism.

A Spectre is haunting me: Gintis and Bowles

Rule of thumb: if Herb Gintis and Sam Bowles think something makes sense, you've got to take it seriously.

So I take their behavioral-game-simulation-post-Walrasian economics seriously. Unfortunately, I haven't followed their recent work and can't say anything about it except that it is innovative. Here is one paper giving an idea of what they do.

My intuition about their work is contradictory:

• On the one hand, their work might be a Trojan horse that sneaks lots of important stuff into orthodox economics (e.g., power, real human motives, and evolutionary change);
• On the other hand, their work might simply be putting solar panels on a Hummer. Solar panels are a good idea but Hummers are a horrid idea. Improving orthodox economics, as Gintis and Bowles seek to do, might extend the life of a flawed economic theory by making it more realistic and interesting. But it would still be flawed.

I'm disappointed that they still use "Pareto improvement"--a dismal ethical notion if there ever was one--as their ethical standard.

Because of my commitments now, I'm unable to look closely at Gintis' and Bowles' work. But I'm looking forward to studying it more closely in the future. (Even if I'll have to learn more about solar panels...I mean behavioral economics and game theory. ;> )

Gintis provoked a response with his recent review of A Guide to What's Wrong with Economics. The review is rhetorically powerful but logically puny. I have nothing else to say about it.

Sam Bowles (standing) and Herb Gintis

He Once Went to Work Without Brushing His Teeth!

UC Berkeley Professor, Harvard Ph.D., Research Associate of the NBER, Clinton Administration official, and much-published-in-mainstream-journals dude Brad Delong really really really wants to be seen as a dangerous outsider. And he's going to hold his breath until he is seen as such.