Mankiw’s Principles of Economics Part 6: Markets Are Usually A Good Way to Organize Economic Activity

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The introduction to this series is here.
Part 1 is here.
Part 2 is here.
Part 3 is here.
Part 4 is here.
Part 5 is here.

Mankiw’s sixth principle of economics is: Markets are Usually a Good Way to Organize Economic Activity. There are six paragraphs of explanation. About half say that central planning as in Communist Russia doesn’t work, culminating with this:

Central planners failed because they tried to run the economy with one hand tied behind their back – the invisible hand of the marketplace. Page 11.

Mankiw says that in a market economy, the decisions of a central planner are replaced by decisions of millions of market participants. Firms decide what and how much to make, and households decide where to work and what to buy. It is wonderful how this system is so successful at “organizing economic activity to promote overall economic well-being.” The magic is prices.

As a result of the decisions that buyers and sellers make, market prices reflect both the value of a good to society and the cost to society of making the good.

But, when government interferes with the market and prevents prices from adjusting to supply and demand, disaster awaits. Thus, taxes “adversely affect the allocation of resources, for they distort prices and thus the decisions of households and firms.”

Mankiw doesn’t define the terms market, or marketplace. That fits perfectly with Mirowski’s Second Commandment of Neoliberalism: Thou Shalt Erase Distinctions. Here is his discussion in full:

What sort of “market” do neoliberals want to foster and protect? It may seem incredible, but historically, both the neoclassical tradition in economics and the neoliberals have both been extremely vague when it comes to analytical specification of the exact structure and character of something they both refer to as the “market” Both seem overly preoccupied with what it purportedly does, while remaining cavalier about what it actually is. For the neoliberals, this allows the avoidance of a possible deep contradiction between their constructivist tendencies and their uninflected appeal to a monolithic market that has existed throughout all history and indifferently across the globe; for how can something be “made” when it is eternal and unchanging? This is solved by increasingly erasing any distinctions among the state, society, and the market, and simultaneously insisting their political project is aimed at reformation of society by subordinating it to the market. Emphasis in original.

While neoliberals do not define market, they assert that it is perfect, as Mirowski’s Third Commandment says: Thou Shalt Worship “Spontaneous Order”. Neoliberals assert that markets are emergent phenomena, and are inevitable and perfect. The theory of Natural Law is thus updated for the 21st Century with a metaphor from biology.

Just as Mirowski says, it is difficult to see what Mankiw means by market. There is nothing to be learned from his statement that the market economy consists of the decisions of millions of firms and households, not least because it ignores the decisions of hundreds of thousands of governmental units, controlling the spending of about 1/3 of the GDP. And it’s difficult to understand how the many thousands of rules that govern many thousands of markets can be translated into formal language, let alone into mathematical terms. Mankiw relies on a sort of collective understanding to provide sufficient clues that the average reader will know what he means, which is part of the problem. If the textbook doesn’t define things so that everyone is talking about the same thing, it is dangerous because people assume others agree with them when they don’t. The lack of a definition is a signal of sloppy thinking.

Mankiw gives us mushy statements like markets promote overall economic well-being. The only people who can participate in markets are those with money. The level of participation is directly related to how much money one has. The fact is that markets cater to people with lots of money, those who can buy whatever they want. When resources or goods are actually scarce, markets allocate them to those with money. When there is plenty, markets can serve those with less money. But markets will never do anything for poor people.

I’m stunned by the nonchalant statement that households decide where to work. I’m equally stunned by the idea that taxes distort markets because they affect spending decisions. It goes with his forgetting to mention government as a market participant. If we didn’t have taxes, that would distort markets too, because people would have to buy protection and roads and a lot more.

If, as Manikw claims, markets measure the value of goods to society, then the values of goods to society are determined by the rich. Markets do not include all the costs of production and therefore that part of Mankiw’s statement is false, assuming it meant anything measurable.

This entire statement of principle is useless as a guide to anything specific. Again, I realize this is just an introduction, but students treat it as accurate. It’s easy to remember and it will stick with people long after they leave school.

I’ve written several posts on the nature of markets as used in introductory economics courses, including this one and the linked posts, and more at Firedoglake, including this one. If you go to this link and search for Bernard Harcourt, or for masaccio markets, you can find much more. For anyone not aware of it, FDL is no more, and all my posts can be found at Shadowproof.com., but you have to search. Here’s my definition of market:

A market is the set of social arrangements under which people buy and sell specific goods and services at a specific point in time.

Social arrangements means all of the things that constrain and organize human action, including laws, regulations, social expectations, conventions, and standards, whether created or enforced by governments, institutions or local traditions.

With that definition, Mankiw’s Principle No. 6 becomes more or less true, though meaningless. My definition carries no pretense of fairness or social justice. It doesn’t suggest that the market is perfect at any point in time; instead it suggests that markets can and should be the subject of social action to insure social goals. Maybe that’s a good reason for neoliberals and their friend Mankiw to avoid providing their own definition. After all, as Adam Smith tells us:

Consumption is the sole end and purpose of all production; and the interest of the producer ought to be attended to, only so far as it may be necessary for promoting that of the consumer. The Wealth Of Nations, Book IV Chapter VIII, v. ii, p. 660, para. 49.

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Mankiw’s Principles of Economics Part 5: Trade Can Make Everyone Better Off

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The introduction to this series is here.
Part 1 is here.
Part 2 is here.
Part 3 is here.
Part 4 is here.

Mankiw’s fifth principle is: Trade Can Make Everyone Better Off. He says that that my family competes with other families for jobs, and when we shop, we compete with others to find the best prices. But if we cut ourselves off from the market, we would have to grow our own food, make our own clothes, and build our own houses. “Trade allows each person to specialize at what he or she does best, whether it’s farming, sewing, or home building.” In the same way, nations can specialize in what they do best. In both cases, people get a wider range of choices at lower prices.

It’s obvious that there are too many humans for us to exist on this planet without the kind of trade Mankiw is talking about. There isn’t enough arable land to support the huge number of tiny farms we would need to set this up, even if we wanted to, and I don’t think that’s what people want. And the way Mankiw explains it, it all seems so natural, probably because we’ve been hearing it all our lives. Everyone knows people like to trade for things. Our most ancient ancestors traveled to trade goods, and to party and marry across groups. Codification of this idea goes back at least as far as Adam Smith.

It is the maxim of every prudent master of a family, never to attempt to make at home what it will cost him more to make than to buy…What is prudence in the conduct of every private family, can scarce be folly in that of a great kingdom.
The Wealth Of Nations, Book IV Chapter II, pp. 456-7, paras. 11-12.

As long as you have lots of money and better things to do, that makes sense. If you have spare time and the means, why not grow your own food and make your own cloth, and save your money for things you can’t make? I assume that was the case for many Britons of Smith’s day. As a maxim, I assume it has much older roots. It’s easy to see why people who live in Whitby, England are specialists in making jet jewelry: the jet there is perhaps the finest in the world, and people have been working it into jewelry for centuries. In the same way, it’s easy to understand that a small town in 18th C. England is better off with a professional blacksmith than with a forge in every home.

People in India have been making beautiful cotton textiles for centuries, as I learned from Empire of Cotton by Sven Beckert. Those textiles were shipped around the world for most of recorded history, until what Beckert calls War Capitalism began to take control of it in the 17th Century. For a very brief discussion of the role of cotton in Gandhi’s India, see this.

What we now know is that owners of capital decide where investments are made. With low transportation costs globally, capitalists are able to locate businesses anywhere. The point is that when specialization reaches a certain level, the role of the craftsman comes to a bitter end, replaced by selling fast food or tending children. This is precisely what happened with cotton. Rich merchants stopped importing finished goods, and stopped using independent weavers in distant parts of the world, and built plants with capital intensive machines in Northern England. The price of cotton textiles went down, but millions of India’s workers lost their incomes, and millions of Africans were sold into slavery to raise cheap cotton for shipment to England. Trade didn’t make them better off.

Of course, it happens all the time. One excellent example is aircraft manufacture. Boeing’s principle resource was once its amazing workers, especially its engineers and assembly line workers in northwestern Washington. But its executives wanted the big bucks, so when it came time to build the Dreamliner, they broke that system to replace those skilled workers with cheaper unskilled labor all around the world, and increased their own salaries. Then the entire system broke down. Here’s a timeline of the known failures of the Dreamliner. Currently, Boeing estimates it is losing $23.2 million on each sold aircraft. Much of this can be blamed on stupid management decisions about production. Boeing CEO James McInerny got about $29 million in 2014 compensation, and the chief of commercial aircraft, Ray Connor, got $16 million. This is payment for abject failure. I guess they benefited from trade.

Maybe that’s why Mankiw’s fifth principle is couched in such weak language. Here’s a better statement: trade can make some people better off, especially if we ignore all the people it makes worse off.

We also see how beautifully this principle supports Mirowski’s Eighth Commandment of Neoliberalism: Thou Shalt Keep Thy Cronyism Cosmopolitan, which teaches the importance of free flows of capital. The capital needed to make aircraft and textiles can be sent wherever labor is cheapest, including South Carolina. That’s neoliberal freedom. You will recall that most of the British assault on India was led by the East India Trading Company, an early corporation. These stories tell us that Mankiw’s fifth principle works well with Mirowski’s Tenth Commandment: Thou Shalt Not Blame Monopolies and Corporations. They are simply not responsible for any of the misery their trade policies hurt. And finally, see how Smith’s maxim works with the average person’s understanding of economics, that what is good for the household is good for the nation.

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Mankiw’s Principles of Economics Part 4: People Respond to Incentives

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The introduction to this series is here.
Part 1 is here.
Part 2 is here.
Part 3 is here.

The Fourth Principle of Economics, which N. Gregory Mankiw assures us is accepted by almost all economists is: People Respond To Incentives. This is obviously true, so it’s good that almost all economists agree. Neoliberals agree as well; it’s the basis of their understanding of human nature that people respond to money, and not much else.

Here are the examples. When the price of apples goes up, people buy fewer apples, and “…apple orchard owners decide to hire more workers and harvest more apples.” Supply and demand are the direct result of incentives. Taxes can be used as incentives. If the gasoline tax goes up, people drive smaller cars, switch to public transport and buy hybrids. If the price goes high enough, they might even switch to electric cars. Incentives can have unintended consequences. Seat belt laws led to a higher number of accidents, and more accidents involving pedestrians. There are two longer examples, one on changes resulting from the gas price hikes from 2005 to 2008, and one on the way bus drivers are paid in Chile.

It’s no doubt true that generally as prices rise, the amount purchased falls. It’s probably the case that the relationship isn’t continuous. People don’t watch the price of apples at all. When they are at the store or the market to buy they don’t say to themselves “prices are up a penny a pound, so I’ll just buy a bit less.” Instead, they compare apples to other fruits and even vegetables and as long as the prices seem about right, they buy. It takes a pretty good price jump foror people to notice the exact price per pound. On the other hand, maybe people think Fuji’s are about as good as Gala’s, so if one is cheaper, they buy them. Or if one set looks tastier for some reason, they buy those.

The idea that the orchard owners harvest more or less depending on the price seems equally inadequate. Of course, once harvest season is over, there won’t be any more harvesting, so all decisions have to be made during the short season when the apples are at the proper stage of ripeness. If owners think the prices will be higher, maybe they will harvest more. Or, maybe they harvest all they can to protect the trees and the fields, and only sell if the price is right, and feed the rest to the cows. I don’t know enough about running an orchard to have an opinion, but apparently Mankiw does.

The second example, gasoline taxes, supports the idea that demand can be manipulated by society for its own good. I don’t think that was Mankiw’s point though. We return to this idea in Principle 8.

The discussion of seat belt changes shows typical short-term thinking. Assuming that the study Mankiw cites is accurate, and I note he describes it as controversial, in the short term, people acted in a more risky way after the passage of seat belt laws. Here’s a chart from the Statistical Abstract produced by the Census Bureau in 2012 with more recent statistics.

change2

Those statistics tell a different story. They say that the incentive created by one set of changes can be changed once the actual outcomes are known. Cars have become more and more safe, and with the recognition that some of the changes produced bad driving, people were able to find ways of making cars safer in ways that defeated the original incentives.

You’ll note that the deaths of pedestrians were down, too, but that doesn’t tell us much. The number of pedestrians overall may be down.

Finally we have the bus driver example in Chile. It comes from Austan Goolsbee, and explains that drivers paid by the passenger work harder than drivers paid by the hour, including taking the shortest routes between two points when there is a lot of traffic. It doesn’t tell us anything about the response of bus riders who don’t get picked up, oe of other people trying to drive on the same streets as racing bus drivers.

So, everyone agrees that people respond to incentives. The question is how people respond to incentives. Mankiw tells us that economists are social scientists, and their field is centered on understanding human behavior. If these examples are typical of economic thinking, the understanding of behavior is rudimentary and reductive. It’s fair to assume that models built on rudimentary and reductive ideas may produce strange and untrustworthy results.

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Mankiw’s Principles of Economics Part 3: Rational People Think At The Margin

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The introduction to this series is here.
Part 1 is here.
Part 2 is here.

Mankiw’s third principle: Rational People Think At The Margin. His definition is:

Rational people systematically and purposefully do the best they can to achieve their objectives, given the available opportunities.” Principles of Macroeconomics 6th Ed. at 6

He defines marginal change: a small incremental adjustment to a plan of action. He teaches that rational people often compare the results of marginal changes to make decisions. Finally we get to his major premise:

A rational decision maker takes an action if and only if the marginal benefit of the action exceeds the marginal cost.

The first example is dinner. The choice, Mankiw says, is not between fasting and eating like a pig, but whether to eat another spoonful of mashed potatoes. At exam time, the choice is not blowing them off versus pulling all-nighters, but whether to put in an hour on your notes or goof off for that hour. His next example is seat prices for airplanes. The airline should sell seats at the price above the marginal cost of flying the passenger. Then we get the water/diamonds example. Water is essential for life, but it’s cheap. Diamonds are an extravagance, but they are very expensive.

All of this is in support of a central element of neoliberal and mainstream economics, that economies can be modeled by treating them as made up of rational agents. This idea fits neatly into Mirowski’s commandments of neoliberalism, specifically number 6: Thou Shalt Become The Manager Of Thyself. This means that individuals must learn to act rationally to decide upon a set of investments in themselves and changes in their behavior that will improve your appeal to people with money so they will give you money to work for them.

The food example is straight-forward enough, but how is the choice made? Some people are raised to clean their plates, and they do even if they could have skipped the last few forkfuls. Some people feel differently about meat than about French fries or carrots. Some people are abstemious, and always leave food. Others make the choice at the outset, by serving themselves a fixed amount and then eating all of it. Suppose the person would prefer to eat the last few bites of pork chop and skip dessert? If all these are rational choices for individuals, what possible generalization about eating is there? What, if anything, can this principle predict? How would Mankiw use that idea to model eating dinner?

The study example is fascinating. I remember my college days, and I ‘m sure I didn’t rationally choose whether to goof off with my friends or to study for finals. I chose, but it was random. And how would you calculate the benefit of one hour of study versus one hour of relaxing? Is that a real possibility?

The airline example is obvious to anyone familiar with basic business principles. It certainly isn’t an indication of “rationality” in the sense Mankiw is using the term. It merely requires an understanding of the difference between fixed costs and variable costs.

Then there’s the water/diamonds example. Here’s Mankiw’s explanation, so you won’t think I’m being snarky:

The reason is that a person’s willingness to pay for a good is based on the marginal benefit that an extra unit of the good would yield. The marginal benefit, in turn, depends on how many units a person already has. Water is essential, but the marginal benefit of an extra cup is small because water is plentiful. By contrast, no one needs diamonds to survive, but because diamonds are so rare, people consider the marginal benefit of an extra diamond to be large.

So water is cheap because people have a lot of it? Of course, there is plenty of water in most parts of the country, in our commonly held lakes, rivers, underground acquifers, and water run-off. As a commonly-owned asset, it’s free, if you could get it. But it has to be cleaned, delivered, and disposed of. That means the real question is why do we have a lot of clean water at the tap and few diamonds? The real reason is that our ancestors decided to make sure we all had clean water to drink, and explicitly chose to keep the “free market” out of it.

There are plenty of diamonds, though they are hard to find and dig up. The diamond business is controlled by a monopoly that artificially restricts the supply. Our ancestors made sure that didn’t happen to water. To see this clearly, think about the price of a bottle of water at the movies. There we have artificial scarcity, produced by the theater’s policy against bringing in snacks. Just ask yourself whether you want to buy your water from a profit-maximizing monopoly, say the Comcast or the DeBeers of water. Maybe you’d like to buy your water from the private company that didn’t have a system in place to detect the foul chemicals in the water supply of Charleston, WV?

So now let’s see how this rationality principle works in practice. Consider retirement savings. What would it mean operationally to say that people act rationally when making decisions about saving and preparing for retirement? What does this principle tell them to do? How should they invest? What should they do to protect themselves against losing big in those investments? What happens if they are hurt and can’t work, or if their spouse gets hurt and they need to quit work to take care of them? How do you calculate the value of a dollar today against the value of that dollar in retirement? For a short lesson in the prevalence of financial literacy, look at this paper, or this site.

Finally, it isn’t just one choice. There is a chain of choices in life, each one eliminates other choices and creates new choices and possibilities, each with its own probability of success. In the retirement example, you might have a 75% chance of correctly guessing at how much to save, a 95% chance of getting an honest financial adviser, a 60% chance that the investments will be very successful, and related chances of less good outcomes. Your chances of getting the best result are about 43%, and that’s before you consider the general state of the economy when you need money, continued good health, unexpected possible current uses for your money, good relations with your partner and your partner’s success in contributing, and all the other variables. That tells you that most people will be somewhat successful, a few will be wildly successful, and a fair number will crash and burn. The reality is that most families have very little success, and are dependent on Social Security and Medicare for a decent retirement. Even people who do reasonably well need those social arrangements to secure a good retirement.

This analysis shows that the margin plays little or no role in the lives of ordinary humans. It’s just a construct used to simplify human life in a way that permits economists to justify their use of calculus.

Here are some possible conclusions:

1. This principle makes sense when considered in the very short run, like the mashed potatoes example. For any longer term, it feels more or less random, mostly because there is no way to determine the probabilitiies. Some people get lucky and win the game of life. Others don’t get lucky. The number of things that seem perfectly rational at a point in time either work, or they don’t, and the results are unpredictable. That accords with my understanding of markets as minute by minute affairs. In the longer run, investment and housing markets are a real threat to the marginal thinking of Mankiw’s rational people.

2. We all want to think we are pursuing their goals systematically and purposefully, Mankiw’s definition of rational people. We want to believe our success is the result of their personal skill, and many people apparently feel justified in looking down on, and even punishing, the losers. I’d say the reality is that it’s better to be lucky than rational.

2. By deciding that the economy is full of rational people, the door opens to armchair speculation. Hmmm, says Mankiw, if I were faced with a bowl of mashed potatoes, here’s how I’d decide how much to take. I’m rational, so that means everyone would act that way. So, I’ll model mashed potato eating based on purely rational me. In exactly the same way, they figure out how they prepare for retirement, and draw conclusions about the way rational people act and build that into their models. No.

3. I do not think this is the definitive discussion of the role of rationality in human decision making. The entire subject of rational agents has been subjected to criticism on philosophical and practical grounds, and I hope to get to it at some point.

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Mankiw’s Principles of Economics Part 2: The Cost of Something Is What You Give Up To Get It

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The introduction to this series is here.
Part 1 is here.

Mankiw’s second principle is The Cost of Something Is What You Give Up To Get It. Mankiw explains that you have to include opportunity costs in your calculations. His example is college: the actual cost of going to college includes tuition, but not necessarily all of the costs of room and board, because you need food and a place to sleep whether or not you go to college. It also includes the money you didn’t earn by going to work instead of going to college.

Before I read Mankiw’s explanation, I thought we were going to get a discussion of the way an economist might calculate costs. That was not to be. Maybe I have to buy his Principles of Microeconomics. In the express language Mankiw chooses, you are the sole standard for calculating costs. That kind of calculation fits perfectly with the neoliberal canon of Philip Mirowski. It’s part of Number 6: Thou Shalt Become The Manager Of Thyself for sure, and it complements Number 3: Thou Shalt Worship “Spontaneous Order”, meaning the market.

Again, non-specialist students will likely remember the principle, and will repeat it mindlessly when talking about value and cost, even though this discussion doesn’t include value or even price. This is a license to ignore all the costs that are not visited upon the neoliberal You. Smoking may not make you sick, but smoking makes some people sick directly and others indirectly. The neoliberal You hopefully doesn’t pay those costs, so they aren’t included in the calculations of the neoliberal You. Computers have a number of components that are dangerous to the health of people. Those costs aren’t paid by the neoliberal You, so they aren’t included in the calculation of costs. Coal burning is a major contributor to climate change, but maybe those costs won’t be paid by the neoliberal You, so they don’t count.

Well, perhaps that wasn’t Mankiw’s intent. He does discuss externalities as something government can correct maybe, sometimes, after a fashion, and at a cost to efficiency. The notion of opportunity costs arises directly from Principle 1: People Face Trade-offs. Most likely the only point of the second principle is to make sure there a nice round ten.

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Mankiw’s Ten Principles of Economics 1: People Face Trade-offs

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The introduction to this series is here.

The first of the Ten Principles of Economics laid down by N. Gregory Mankiw is “People Face Trade-Offs”. Principles of Macroeconomics, 6th Ed. 2012, p. 4. In language more suited to a high school textbook than a best-selling college textbook, he provides several examples. If you study economics for five hours, then you can’t spend that time studying something useful, like welding or English Literature. If parents have a certain amount of money, every dollar they spend on rent can’t be saved, or used to buy food. Then, as if society were a person, and faced trade-offs in exactly the same way (government is just like a household) he gives two macro examples. First:

The more a society spends on national defense (guns) to protect its shores from foreign aggressors, the less it can spend on consumer goods (butter) to raise the standard of living at home.

There is also a trade-off between a clean environment and a high level of income. If companies have to pay for environmental contamination, they make smaller profits, pay lower wages, or raise prices or some combination. This is the last example:

Another trade-off society faces is between efficiency and equality. Efficiency means that society is getting the maximum benefits from its scarce resources. Equality means that those benefits are distributed uniformly among society’s members. Emphasis in original.

Mankiw explains this by saying that government policies that help those in need, like unemployment insurance or welfare reduce efficiency, because, and I quote because otherwise you’ll think I’m being snarky:

When the government redistributes income from the rich to the poor, it reduces the reward for working hard; as a result, people work less and produce fewer goods and services. In other words, when the government tries to cut the economic pie into more equal slices, the pie gets smaller.

The statement that individuals face trade-offs in consumption of goods and services as well as every other human activity is vacuously true. We get one life, and at any point in time can only do one thing. If we do one thing we cannot do another. So what’s the point of this principle? I think it’s not the principle itself, but the examples. Each supports the principles of neoliberalism, as described by Philip Mirowski in this article.

Mankiw’s first two examples are folksy and disarming. Let’s try a similar version:

Angela has a problem: should she summer with her mom on Martha’s Vineyard, or should she summer with her dad on their ranch in Montana? Jane has a problem: should she pay her utility bill, or should she buy the drugs she needs to control her Parkinson’s Disease? Since these are two individuals, you can see that the problems they face are identical. Both will suffer if they make the wrong decision, and both will suffer anyway because of the knowledge they could have chosen otherwise. The rich and the poor are just the same: people struggling with trade-offs. Or, from Mirowski on neoliberalism: [9] Thou Shalt Know That Inequality Is Natural.

Things get more complicated at the macro level. The third example, guns or butter, is as abstract as the first two are concrete. Mankiw makes it seem that “defense” is a consumer good, like Hummel Figurines or orange marmalade. The government just goes down to the defense store and buys as much as it wants. He doesn’t talk about how those decisions get made at the social level, and doesn’t talk about who gets the benefits of those guns and who pays the costs of the foregone butter, or whether there are better ways to keep aggressors away than bombing their countries. He turns the example into a concrete fact, with no context. The choices made in the US and other countries about how much “defense” to “buy” would make a really interesting case study in macroeconomic behavior, and just defining terms would be really helpful to public discourse. That’s certainly not the point of the Mankiw textbook.

One of the goals of neoliberalism, Mirowski’s Number 5, is to change the idea of democracy from one of participation by citizens in determination of social policy to one of consuming state services, like defense. Guns v. butter shows how that notion gets into people’s heads. Given the level of corruption in the system, in the broad sense of Zephyr Teachout in her excellent book, Corruption in America, it’s also an example of crony capitalism, part of Number 8. There’s a lot more to unpack in the guns and butter example, but let’s move on.

The environmental example is fascinating. From the very beginning of this country, companies polluted lakes, rivers and the air, to keep costs low and prices down. No one did anything. Then when citizens started complaining about their ability to breathe the air and drink the water, and the rich people and their corporations act all outraged, like they have a right to pollute. Mankiw ignores this history, and ignores the obvious fact that dumping pollutants everywhere hurts everyone in general, and some people dramatically; and profits only a few. Again, the entire issue of pollution and environmental destruction would make fascinating case studies in economics. Mankiw’s discussion supports Mirowski number 10: Thou Shalt Not Blame Monopolies and Corporations.

Finally, there is the trade-off between equality and efficiency. Mankiw’s explanation about the negative effects of a progressive income tax on economic efficiency is flatly wrong. For my explanation, see this and this and this. For a short view, does Mankiw think the economy in the 50s was less efficient strictly because of high income and estate taxes on the rich? I’d love to see a paper showing how that happened. Piketty and Saez suggest a top tax rate of 80%. Here’s a short article explaining their thinking, and here’s an impenetrable paper that lies below it.

I assume Mankiw was referencing Arthur Okun’s 1975 book Equality and Efficiency: The Big Trade-Off. Okun postulated that there was a trade-off between equality and economic efficiency from his armchair, and he discusses the implications for policy in this excellent piece. By 1995, it was clear that the facts did not support his speculation. This paper is a review of literature and discussion of exactly how wrong Okun was: Lars Osburg, The Equity/Efficiency Trade-off in Retrospect. Subsequent work has made this even more clear. Mankiw ignores all the evidence and new theory to the contrary, choosing to continue to support an unmeasured armchair theory Mirowski number 9: Thou Shalt know that Inequality is Natural.

The point of this discussion is that textbooks have an outsized influence on people, particularly on non-specialists. They may not recall the argument, but they will recall the examples and the general approach, especially when those are common in discourse, and not contravened by other authorities. I know this from my own college education. It has taken years for me to shed the parts that don’t conform to the reality of life as I have lived it and seen it.

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“Technical Difficulties”: United Airlines Grounded, NYSE Halted, What’s Next?

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[graphic: WSJ.com's July 8th error message]

[graphic: WSJ.com’s July 8th error message]

This is a working post for discussion of today’s outages. United Airlines grounded its flights for roughly two hours this morning; the FAA’s advisory indicated an automation-related issue, and subsequent communications from United said it was a “network connectivity” problem.

UAL also briefly grounded flights on June 2nd, due to “automation issues.”

Now the New York Stock Exchange has halted all trading shortly before noon, cancelling all open orders, due to “technical difficulties.”

There are reports that CNBC and WSJ websites are down, but they could simply be swamped by traffic.

Who’s or what’s next?

UPDATE — 12:55 pm EDT —

Looks like CNBC may only have had a brief burp due to high traffic as there are no further complaints about service interruption. WSJ’s website has been slowly working its way back to normal service; the media outlet posted an abbreviated versionfor 15-20 minutes once its technical problems had been resolved. No indication yet that anything apart from high traffic volume may have spiked the site.

UPDATE — 1:35 pm EDT —

You know what cracks me up, in a ha-ha-ouch kind of way? FBI Director Jim Comey puling about the need for back doors into technology in front of Congress today, while a major airline and the most important stock market in the world demonstrate exactly how ugly it could get if hackers with malicious intent used the back doors he demands for evil rather than good. The “technical difficulties” both UAL and NYSE experienced today could be duplicated by hackers using back doors.

The U.S. Government is an aircraft carrier, very slow to turn even when under fire. Hackers are speedboats. Asking for back doors across all technology while facing myriad fleet-footed nemesis is like chasing 38-foot Cigarette Top Gun speedboats with a carrier. Unless the carrier can see Cigarettes coming from a distance and train gun on them, Cigarettes will fly up its backside. The U.S. Government has already proven it can’t see very far ahead, stuck in a defensive posture while using its offense in ways that only ensure more attacks.

UPDATE — 2:20 pm EDT —

Fortune reports the NYSE halt was due to a “failed systems upgrade.”

Right. Upgrade. Let’s roll out an upgrade in the middle of the week, in the middle of the month, when both China’s stock market and Europe’s banksters are freaking out. Let’s not manage traders expectations in advance of the day’s trading, either.

Somebody needs to retake a course in Change Management 101 — or there’s some additional explaining required.

Reuters assures us, too:

The U.S. Department of Homeland Security said there were no signs” that the problems at NYSE and United Airlines stemmed from “malicious activity,” CNN reported.

Good to know, huh? Can’t believe they went to CNN for that.

UPDATE — 3:30 pm EDT —

The buzz since 2:00-ish pm is that Anonymous *might* be to blame for the NYSE “glitch.” The Hill, Salon, and a few other outlets reported about a cryptic tweet from @YourAnonNews late last evening:

Untitled

But another Anonymous affiliate laughed it off, saying:

NYSE_TechGlitches_Tweet_237PM_08JUL2015

Timing is incredible, though; the NYSE, WSJ, and UAL outages all happened concurrent with a Congressional hearing at which FBI Director Jim Comey discussed the need for back doors into everything. What an incredible series of coincidences today.

UPDATE — 3:55 pm EDT —

Best take by far on today’s NYSE “technical difficulties”, gonzo reporting with a feminine touch from Molly Crabapple:

I was met by fires in the streets, the screams of the dying tourists and the shouts of former traders offering sacrifices to their new gods

UPDATE — 5:00 pm EDT —

NYSE re-opened again around 3:00 pm EDT, with trading a bit jittery. Financial news outlets speculated the market closed at 17,515.42, down -261.49 (-1.47%) due to concerns over China’s tanked stock market and Greece’s EU debt woes. The Shanghai market had closed the previous day at 3,507.19 down -219.93 (-5.90%).

Feeling iffy over the Shanghai index, Hong Kong’s Hang Seng Index closed at 23,516.56 down -1,458.75 (-5.84%); Japan’s Nikkei 225 closed at 19,737.64 down -638.95 (-3.14%).

But these Asian markets weren’t affected by the NYSE’s technical difficulties today. Wonder how they will open on July 9th their local time — flat or down? I wouldn’t put my money on an uptick, but I’m not a financial adviser, either.

I imagine the bars and pubs around Wall Street saw greater-than-average action. I might put money on that.

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Revolutionary Changes in Economics

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In this series, I tried to learn what Thomas Kuhn’s The Structure of Scientific Revolutions meant for economics. In this post, I suggested a possible paradigm for neoliberal economic theory. It uses the Ten Principles of Economics preached by N. Gregory Mankiw in his best-selling economics textbook, the general principle of maximization of economic efficiency, and a method suggested by David Andolfatto of the St. Louis Fed. Let’s assume the goals of neoliberalism fit the parameters described by Philip Mirowski in this article. I think my proposed paradigm can be used to generate the economic theory those parameters require, and I think that suits the goals of the people who fund academic neoliberalism just fine.

As Kuhn describes them, scientific revolutions take the form of a wholly new way to look at things, like an optical illusion. Where once our eyes told us that the sun revolves around the earth, now we know that it’s just the opposite. Not just is the earth not the center of the universe, we are on a small planet on the outskirts of a small galaxy, whirling around in a monstrously large physical space until entropy ends it. Since publication of Kuhn’s essay in 1962, there has been some discussion of such paradigm changes in economics, but as the series shows, I think old ideas do not die, but come back to haunt us, just as John Maynard Keynes said:

… the ideas of economists and political philosophers, both when they are right and when they are wrong, are more powerful than is commonly understood. Indeed the world is ruled by little else. Practical men, who believe themselves to be quite exempt from any intellectual influences, are usually the slaves of some defunct economist. Madmen in authority, who hear voices in the air, are distilling their frenzy from some academic scribbler of a few years back. I am sure that the power of vested interests is vastly exaggerated compared with the gradual encroachment of ideas. Not, indeed, immediately, but after a certain interval; for in the field of economic and political philosophy there are not many who are influenced by new theories after they are twenty-five or thirty years of age, so that the ideas which civil servants and politicians and even agitators apply to current events are not likely to be the newest. But, soon or late, it is ideas, not vested interests, which are dangerous for good or evil. Chap. 24 Sect. 5, The General Theory of Employment, Interest and Money.

I don’t know where Keynes got the optimism in the second half of that quote, any more than his seeming optimism about the end of laissez-faire theories. The ideas of Hayek and Friedman and their laissez-faire government-hating chest-beating right wing capitalism-worshipping true believers are still dominant nearly a century later. It just goes to show that if you capture the minds of the young, especially the young elites with textbooks like Mankiw’s, it’s mostly impossible to change their minds with mere facts and natural experiments from the real world.

Still, I think it’s quite possible to change some minds, or I wouldn’t bother with this. And there are new ideas, ideas just as revolutionary as any that Kuhn describes. One example is taxation. For centuries, people believed that the function of taxes was to provide the revenues to run the government. That may have been true in an age of gold. But in an age of fiat money, it’s just not true. Here’s a 1946 discussion by Beardsley Ruml, head of the New York Fed, explicitly stating this truth, and then offering justifications for taxation:

1. As an instrument of fiscal policy to help stabilize the purchasing power of the dollar;
2. To express public policy in the distribution of wealth and of income, as in the case of the progressive income and estate taxes;
3. To express public policy in subsidizing or in penalizing various industries and economic groups;
4. To isolate and assess directly the costs of certain national benefits, such as highways and social security.

This, of course, is the basis of Modern Money Theory. Here’s a quote from a readable and cogent explanation from L. Randall Wray:

But in the case of a government that issues its own sovereign currency without a promise to convert at a fixed value to gold or foreign currency (that is, the government “floats” its currency), we need to think about the role of taxes in an entirely different way. Taxes are not needed to “pay for” government spending. Further, the logic is reversed: government must spend (or lend) the currency into the economy before taxpayers can pay taxes in the form of the currency. Spend first, tax later is the logical sequence.

In the same way, most of us were taught that banks and other savings institutions were intermediaries between savers/depositors, and borrowers/investors. The role of the banks was to direct the accumulated assets of a society into their most profitable uses. No. Banks don’t need deposits to make loans. That idea, which I remember learning in Econ 101 at Notre Dame a very long time ago, is false. The bank merely makes book entries, one set to loans receivable, and one to deposits. This model is called finance and money creation in this 2014 paper by Zoltan jakab and Michael Kuhof of the IMF. Here’s the abstract:

In the loanable funds model of banking, banks accept deposits of resources from savers and then lend them to borrowers. In the real world, banks provide financing, that is they create deposits of new money through lending, and in doing so are mainly constrained by expectations of profitability and solvency. This paper presents and contrasts simple loanable funds and financing models of banking. Compared to otherwise identical loanable funds models, and following identical shocks, financing models predict changes in bank lending that are far larger, happen much faster, and have much larger effects on the real economy.

I remember learning about bank multiplier effects and the importance of reserves in determining the amount of money in circulation. It was one of those bizarre things that seemed logical until you realized that there was no particular reason to think any bank could or would actually lend all that money sensibly. Yet, as Jakob and Kuhof say, that is the theory incorporated into standard models of the economy. They create a new model using the financing theory, and get completely different predictions. These graphs are from the paper. The dotted lines are the predictions under the loanable funds model, and the solid lines are from the financing and money creation model.

graphs for post

At one level, this is just another reason to distrust economic models, because their basic assumptions are simply wrong. At another, it demonstrates that the standard paradigm is useless, because it treats the finance sector are irrelevant. And at another level, the new model demolishes the idea that the role of the bank is to intermediate savings. Savings are irrelevant to the main role of the bank, which is not to insure that savings are rewarded, but to make sure banks are rewarded.

Of course, such revolutionary changes won’t affect anyone not exposed to them and to their basis. And the wrong ideas will stay in textbooks for decades, insuring that generations will have them imprinted. No wonder nothing changes.

The proposed paradigm is set out here. In future posts in this series, I’ll attempt to show how each element contributes to the neoliberal economic theory that dominates the national discourse, and see whether I can find an optical illusion in each, leading to a better although not revolutionary understanding.

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Kuhn and Economics: A Summary

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In a series of posts which you can find here, I have been trying to formulate an answer to the question why has neoliberal economics not been tossed out in the wake of its total failure as demonstrated by the Great Crash. I’ve used as a lens Thomas Kuhn’s seminal essay: The Structure of Scientific Revolutions. I am totally dissatisfied with the usual progressive explanations of bad faith, whether in the form of the ubiquitous quote from Upton Sinclair: “It is difficult to get a man to understand something, when his salary depends on his not understanding it;” or direct or indirect accusations of intellectual dishonesty or corruption. The world is more complex, and we need to think more deeply, especially if we want to change things. Here is a list of the most important things I think I learned from the exercise.

1. Kuhn argues that science cannot proceed without a paradigm. That seems true in the hard sciences, but it seems inadequate as a description of the social sciences. Even so, there it remains an important insight. This series offered insights because I used the paradigm paradigm to examine a specific problem.

2. Following Mark Blyth, it seems that there are a number of schools of economics. These include neoliberals, post-Keynesians, Austrians, rational expectations theorists, and real business cycle theorists; to which we can add Modern Money Theorists, Marxians, and perhaps Piketty and his colleagues. Each of these has a paradigm through which it tries to organize the vast amount of data and theory we have accumulated over the centuries. Each has its own incommensurate ideas about what counts as data and about how to interpret the data. In other words, they each have a definition of truth, and their truth claims cannot be settled inside their paradigms, as Kuhn tells us is true about the hard sciences.

That means that the decisions about which, if any, of these schools dominates at any point in time has nothing to do with some transcendent truth, but rather with a struggle over politics.

3. This view was reinforced by a reading of Keynes’ delightful essay The Death of Laissez-Faire, which actually didn’t die despite Keynes best efforts, but lives on in the grifter stylings of Grover Norquist and the rest of the zombie right wing. If Keynes caouldn’t kill it, it is permanent.

4. It is further reinforced by Bronfenbrenner’s suggestion that paradigms in the social sciences are not replaced outright as Kuhn argues, but are met by an antithesis, and eventually fall into a new synthesis. I suggest that Paul Samuelson follows this approach in his textbook, based on the back inside cover. In a Hegelian or Marxian world, this is supposed to represent progress, but I’ve always thought of it a just something different that might or might not be useful in a specific social situation.

5. I laid out the seeds of a paradigm for neoliberal economics in this post. In passing I pointed out that Mankiw’s principles are couched in bland language, but they can easily be interpreted to carry out the neoliberal program. See 8. below. Again in passing, I note that tweaking them, and setting up a slightly different paradigm can produce a better solution to the problems our economy faces. That is an exercise for another day.

6. One crucial problem that arises from the existence of many schools of economics is that each can claim that there are no tests that disprove it. As Kuhn and others point out, that’s because the meaning of facts and truth is determined by the paradigm, and neither facts nor truths are commensurate across paradigms. That’s why the likes of Gary Becker and N. Gregory Mankiw can claim that the Great Crash was not a problem for neoliberal economics. What looks like a failure to a person who got hammered looks like the normal course of events to an ideologue married to a paradigm.

7. The neoliberals recognized the importance of politics in economics long before the liberals. They wrote their views into textbooks, which have a thin veneer of science and a thick veneer of authority, and used them to indoctrinate generations of college grads who only took one or two economics classes. They also arranged to have the basic tenets taught in high school classes mandated in many states on the wonders of capitalism. As Kuhn explains, the textbook is the authoritative teaching tool for creating new scientists and presumably new followers of the dominant school of economics. The tenets of neoliberal economics are taught as if they were the only way to understand capitalism, and any other set of ideas are communist or socialist, by which we are to understand they are evil.

8. One factor Blyth doesn’t discuss is why neoliberal economics has such a hold on the populace. Certainly a big part of that is the domination of authoritative discourse through the textbook process in point 7. Another crucial point is that without quite saying so, Mankiw’s principles of economics play directly to the prejudices of the a large segment of the voting public. Take the first one as an example: People face trade-offs. Some people face the trade-off between summering in the Hamptons or on Martha’s Vineyard. Others face trade-offs between rent and food. These are the same thing to neoliberals, who sneak in a bunch of outmoded Benthamite utility. And these are also the same for a huge number of conservatives. Suck it up and pick. It’s your fault for not being rich.

The rich people who dominate elections and the public discourse in general can rely on those principles in anodyne form to pacify the liberals while dog-whistling to their base of conservatives.

9. As a result, the voices of authority on economic matters don’t have to listen to anyone who disagrees with them. They have a base of voters who think it’s great to screw the poor and don’t even necessarily want to accept anything that comes from the government.

10. We need to focus attention on the political nature of economic paradigms. Neoliberal economics failed. We need to hammer home the failure, to undermine the authority of neoliberals on economic matters.

UPDATE
Here are links to the posts in this series with a note about each.

1. The Two Prongs of the Neoliberal Project. This is a justification of the inclusion of economics at this blog. It is also a general introduction to neoliberal economic theory.

2. Paradigms in Economics. This is an introduction to Kuhn’s theory of scientific revolutions and an introduction to a theory of paradigms in economics.

4. Paradigm Change in Science and Economics. This is a discussion of Kuhn’s explanation for paradigm change in science, and begins the discussion of the comparable problem in economics.

5. A Possible Paradigm for Neoliberal Economics. N. Gregory Mankiw’s textbook lists 10 principles of economics. This post takes those and a simple methodology as a possible paradigm for neoliberal economics. In passing, I discuss an actual paradigm change that seems to meet the requirements of Kuhn’s analysis.

6. Pragmatic Aspects of Paradigm Change According to Kuhn. This addresses Kuhn’s argument that even in the hard sciences, paradigm change requires persuasion, because the superiority of an alternative paradigm cannot be tested inside a different paradigm. This idea is applied to economics, and specifically to textbooks.

7. Keynes on Paradigm Change. John Maynard Keynes calls for the death of laissez-faire, especially in its virulent form of demanding that government do nothing. Economic ideas don’t die.

8. Paradigm Change Through Authority and Arguments about Truth. This is a discussion of a more sophisticated approach to changes in economics paradigms through a paper by Mark Blyth. Blyth offers a grounded approach to the problem of change as a result of authority and persuasion.

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Paradigm Change Through Authority and Arguments about Truth

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So far in this series, we have encountered a number of answers to my central questions: why hasn’t neoliberal economic theory been thrown out as a result of its horrifying failure? Why hasn’t the paradigm change theory of Thomas Kuhn’s The Structure of Scientific Revolution worked? If Kuhn were right, then the utter failure of the neoliberals would lead to its rejection and replacement by a new paradigm.

Most of the people who followed Kuhn pointed to differences between the natural sciences and the social sciences as part of the reason. That led to explanations like the dialectic, in which an idea is met with an antithesis and eventually a synthesis emerges which solves the tension, but it then attracts its own antithesis, and so on. Another possibility is that bad ideas don’t ever die. We saw that with Keynes’ discussion of the end of the silly ideas of laissez-faire; he points to a number of reasons for its long life.

We might next look at the pendulum idea of intellectual history. There’s an excellent example of this in a paper by Ravi Kanbur of Cornell, The End Of Laissez-Faire, The End Of History, And The Structure Of Scientific Revolutions I’m going to skip that one, though, because I don’t think much of pendulum theories. They don’t help us see the forces that drive the swings. Instead, I’ll look at this paper by Mark Blyth, Paradigms and Paradox: The Politics of Economic Ideas in Two Moments of Crisis. Unfortunately, this excellent paper was published by Wiley, which is trying to screw money out of people, so perhaps you could find it through your library. Here’s the abstract.

This article argues that there is a paradox at the heart of Hall’s “Policy Paradigms” framework stemming from the desire to see both state and society as generative of social learning while employing two different logics to explain how such learning takes place: what I term the “Bayesian” and “constructivist” versions of the policy paradigms causal story. This creates a paradox as both logics cannot be simultaneously true. However, it is a generative paradox insofar as the power of the policy paradigms framework emerges, in part, from this attempt to straddle these distinct positions, producing an argument that is greater than the sum of its parts. In the second part of the article, I discuss the recent global financial crisis, an area where we should see third-order change, but we do no not. That we do not strengthens the case for the constructivist causal story.

This article starts as a discussion of a paper by Peter Hall on the shift of ecocnomic paradigm by the Thatcher government from Keynesian to neoliberal. The “Bayesian” story mentioned in the abstract is the standard version of Kuhn’s theory. It says that the normal process of change in institutional governance is cumulative: “an additive function of policy errors that begin with settings, moves to instruments, and then leads to goals as a function of environmental pressures.” Suppose a policy and a paradigm are accepted by the institutions of government and the private sector as controlling in a certain area. As things change and evolve, the institutions first change the settings, hiking or lowering interest rates or taxes, for example. Then they add or delete the instruments through which the policy is put into practice, perhaps adding a new tax or a new deduction. Only if these fail do questions about the paradigm itself come to the fore. These are the three orders of change in this discussion. Paradigm change only comes in the third order.

The alternative is the “constructivist” view. Blyth isn’t as direct in the definition of this idea, but here’s the general idea. The Bayesian view is that there are “transcendent, objective, and empirical standards through which observations of events and other ‘facts’ can be judged.” In the constructivist view, “Truth is a series of intersubjectively held conventions regarding “the way the world works” among a given community at a given moment.” The Bayesian view is probably eventually true in the natural sciences, even if new data or events can be interpreted in several ways under different paradigms that might exist at some point in time. It is much less true in the social sciences. There, different paradigms produce different facts. As an example, Blyth points to the claim of the monetarists (the sheep’s clothing of the neoliberals) that Keynesianism failed in the 1970s in a way that monetarism didn’t. Within the Keynesian paradigm, that wasn’t so, but the monetarists seized control of the narrative, and the bad performance of the economy was taken as evidence of failure of Keynesianism. Blyth says that the key step was the construction of the evidence of the performance of the economy by the monetarists as failure.

Blyth claims that the 70s did not constitute a natural test of Keynesianism, for reasons he discusses in footnote 8 and are beyond my power to assess. I’ll add that the solution of the monetarists was to hike interest rates and hike unemployment to ridiculous levels to stamp out inflation. The result was a catastrophe for the middle class and the working class, and it made life even more miserable for the poor. There was no reason to stomp on workers to end inflation, but there was a determination to protect the interests of the rich. This, I think, is the direct opposite of any policy Keynes would support.

In the constructivist view, then, truth is a matter for contest among the people allowed to participate in the discourse. Blyth quotes Hall:

Politicians, officials, the spokesmen for social interests, and policy experts all operate within the terms of political discourse that are operative within the nation at a given time, and the terms of political discourse generally have a specific configuration that lends representative legitimacy to some social interests more than others . . . and defines the context in which many issues will be understood (Hall 1993, 289).

This analysis focuses our attention on the actual decision-makers, not just the economists themselves, but the group with authority in any given setting to determine the bounds of discourse. Blyth points out that each of the schools of economics, rational expectations theorists, real business cycle theorists, post-Keynesians and Austrians, along with the neoliberals and the outright laissez-faire school of political economics, have explanations for the Great Crash, but they are all incommensurate, totally different paradigms. The argument, the social argument, is over which will dominate the discourse. That is a sociological problem, not a problem of economics.

Blyth uses this framework to analyze the persistence of neoliberal economics. I’ll summarize them

1. It takes time to work out a new system.

2. After Kuhn, people expect an all or nothing change. It’s quite possible that we have a failure of a paradigm, but no new paradigm to replace it.

3. Economics professors have tenure, and a huge stake in preserving their status.

4. Institutions like the World Bank, the IMF, the European Community Bank and others are slow to change for the same reasons economics professors won’t change.

5. The neoliberal consensus had taken such deep root and its adherents were in control of so many institutions that there was no way to get the public involved in demanding change. The few prominent economists calling the neoliberals out had to spread their attacks over such a huge area that there was insufficient firepower.

Blyth concludes:

… the singular lesson of the recent crisis for the policy paradigms model is that the sociological can trump the scientific precisely because the locus [of] authority did not shift despite the facts. Mere facts will (sometimes) not be allowed to get in the way of a good ideology. Being seen to fail, Obama’s stimulus, for example, can trump actual failure, such as Eurozone austerity packages. In such a world, the “truth” about the crisis and the ideas that made it possible really does depend upon what the most powerful members of a group (or society) consent to believe.

This explains why nothing changed: the people who define the policy also define the evidence and the tests that might question the policy. But there’s more, for another day.

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