Grasping Reality on TypePad, by Brad DeLong

Sit down some evening and watch the news on the TV, or scan the magazine covers in the supermarket. If you are me, you will be struck by the extent to which they focus on seven topic areas:

1. The personal doings of the beautiful, the powerful, and the rich—and how to become more like them.
2. The weather.
3. Local threats and dangers, especially to children.
4. Amusements—usually gossip about the past or about our imaginary friends, frenemies, etc. (it is amazing how many people I know who have strong opinions about Daenerys Stormborn of House Targaryen--many more than have any opinions at all about her creator George R.R. Martin).
5. How to best procure necessities and conveniences.
6. Large scale dangers (and, rarely, opportunities): plagues, wars, the fall and rise of dynasties.
7. “The economy”: unemployment, spending, inflation, construction, stock market values, and bond market interest rates.

Now of these seven the first six are common--or at least have strong analogies--in human history. The seventh is not. The local price of food has been of general interest; the supply and demand of traded goods has been of interest to merchants, the wealth or lack thereof of particular individuals and cities has been of interest to money-lenders, yes. But the economy? We only begin to see the word in the eighteenth century, as the phrase “home economics”--teaching how to cook, how to sew, how to clean, and how to budget--finds its first word replaced by “political” and “political economy” becomes a study of how the government managers should do for the state the things that a household manager does for a household. So why does “the economy” and its study--”economics”--become a concept that needs a label?

I think I have the answer. When we look into the deep past and consider the evidence--especially the skeletal evidence that finds adult humans around the year 1 little more than five feet tall--and the fact that it looks as though there were 5 million humans in 8000 B.C.E., and 500 million in 1500. we find a worldwide economic growth rate--an annual rate of growth of global real GDP--of 0.05%/year across the centuries from 8000 B.C.E. to 1500 That is not five percent per year, that is one-twentieth of a percent per year. Compare that to today: worldwide average real GDP growth of 4% per year. The fact is that we today see 80 times as much economic growth and change as our pre-1500 ancestors did. What took 80 years to accomplish then in terms of construction and investment and new technology and so forth takes us one year now. Today economic change is a very big deal: it determines what kind of job you will have, and if you will have a job, and how you will live ten or twenty years from now--if not tomorrow. Thus in any previous era the idea that one should pay attention to somebody called an “economist” who could tell you about how something called the “economy” was changing using a discipline called “economics”--would have been simply silly.

So when the rest of you listen to us economists, what do you hear?

You hear that at some deep level human sociability is built on gift-exchange. And on top of this deep gift-exchange sociability we have built an economic system of decentralized market exchange mediated by tokens called “money” that are acceptable to each of us as payment or repayment because they are acceptable to all of us, and so enlarged our gift-exchange networks from small thick-tie ones to a global thin-tie one. This has made possible an extraordinarily productive division of labor. You hear that organizing economic life around decentralized exchange has marvelous advantages. Because one person’s enjoyment and use of a particular item reduces the available options of others. It makes sense for a rational social system to make a person feel the effect of their actions on the opportunities and choices of others. Assigning exclusive property rights and requiring a person to pay a market price for the privilege of their transfer makes that happen.

Now market systems can and do go awfully, horribly wrong. But when they go wrong it is because markets are very good at getting people to respond to incentives, and they go wrong when we do not like the pattern of incentives that the market provides.

One major potential flaw is if we do not like the distribution of wealth. Another is that, even when the distribution of wealth is right, the market system can provide the wrong incentives. The brilliant Ronald Coase of the University of Chicago--still productively at work as an economist even though his age is now in the three figures--said that any arrangement of property rights will do about as well as any other. He adduced as his canonical case the locomotive that occasionally throws off sparks that burn the nearby farmer’s crops. If the railroad has a duty of care not to burn the crops, Coase said, the railroad will attach spark-catchers if it is cheap and makes sense to do so and pay damages if it is expensive and doesn’t make sense to do so. If the railroad has no duty of care, Coase said, then the farmer will offer to pay the railroad to install spark-catchers, and spark-catchers will be installed if the potential damage to the crops is greater than the cost of the spark-catcher. Thus the same decisions will be made whatever the property rights are, as long as there are property rights. If there aren’t--then the crops burn, and lawyers grow fat.

This seems to me to be wrong. If there is no duty of care on the part of the railroad, it doesn’t just asked to be bribed to install a spark-catcher. It builds the most spark-generating engine it possibly can to cause as much of a chance of fire as possible. And then it demands that the farmer become its serf before it will install the spark-catcher.

Getting institutional property rights wrong in details can be immensely damaging.

And economies can go badly wrong in other ways--as ours is going badly wrong right now, with an adult employment-to-population ratio of 58.5% when we ought to have 63%, and when the only excuse my friends in the Obama administration offer is that Europe is doing much worse. Note that the mutually-acceptable tokens that serve to make our extensive division of labor possible because people know what they are worth--the cash money and the AAA-rated safe savings vehicles--cannot reliably be produced by private firms: the investment banks tried to produce AAA-rated safe savings vehicles in the form of derivatives on mortgage pools, and look how that turned out. They have to be created by the ultimate too-big-to-fail entity--the government.

When the government does not create “enough” money and safe savings vehicles you have an excess demand for them, an excess supply of everything else, and high unemployment and idle factories.

When the government creates “too much” money and safe savings vehicles, you have an excess supply of them and an excess demand for everything else--which means inflation.

And the government’s proper task is made much more difficult by the fact that what is “enough” jumps around as the set of savers and investors do their behavioral-economics thing: the Kindlebergian cycles of displacement, profit, transformation, boom, speculation, enthusiasm, mania, crisis, panic, revulsion, and discredit.

The big lessons from economists’ τεχνε are (i) a bias toward freedom, choice, decentralization, and individual responsibility; (ii) knowledge systems of decentralized market exchange have important emergent properties that depend on close knowledge of and careful reasoning from institutional details; (iii) a fear that getting those details wrong produces horrible outcomes; and (iv) a recognition of the importance of government to get details right and to act as a balance wheel when the set of savers and investors do their behavioral-economics thing.

That is how we economists try to sell ourselves: giving technical advice about what to do now that our species has made a choice to organize our very large--now seven-billion human wide--social division of labor largely through decentralized arms-length market exchange built on gift-exchange sociability. The aim is, as John Maynard Keynes said, to be a profession that performs a very useful but not overwhelmingly important role in understanding the economy and how to treat it in a way analogous to the way that dentists perform a useful but not overwhelmingly important role in understanding teeth and how to treat them.

Yet was there ever a dentist who attempted to reshape, in the interest of dental hygiene, the shape of human destiny in the way that Keynes in the interest of economic hygiene tried to do pretty much every day?

Here is Keynes reviewing Leon Trotsky’s Where Is Britain Going?:

In its English dress it emerges in a turbid stream with a hectoring gurgle which is characteristic of modern revolutionary literature translated from the Russian.... If only it was so easy! If only one could accomplish by roaring, whether roaring like a lion or like any sucking dove!... [Trotsky] assumes... that a plan exists, and that nothing remains except to put it into operation.... [But] we lack more than usual a coherent scheme of progress, a tangible ideal. All the political parties alike have their origins in past ideas and not in new ideas--and none more conspicuously so than the Marxists. It is not necessary to debate the subtleties of what justifies a man in promoting his gospel by force; for no one has a gospel. The next move is with the head, and fists must wait.

Did ever any humble dentist write so?

On the one hand, Keynes claims to be asserting only a very minor kind of authority and to be giving merely technical advice about adjustments needed to achieve self-evidence and obvious goals like full employment, price stability, and healthy increases in productivity--like the dentist saying: “you should brush your molars much longer in the morning” and “that tooth has to come out now or you will be in real trouble”.

On the other hand, Keynes then leverages his professedly limited technical and technocratic expertise to attempt to banish from participation in high politics entire schools of political and moral thought, entire mass movements with their utopian aspirations, and to silence via their exclusion from valid technocratic debate the prophets of those schools of thought and mass movements.

And Trotsky is indeed a prophet--as Edmund Wilson wrote in his To the Finland Station:

[Trotsky writes:] "If the prince was not succeeding in peacefully regenerating the country, he was accomplishing with remarkable effectiveness the task of a more general order for which history had placed him at the head of the government: the destruction of the political illusions and the prejudices of the middle class." "History used the fantastic plan of Gapon for the purpose of arriving at its ends."... History, then, with its dialectical Trinity, had chosen Prince Svyatopolk-Mirsky to disillusion the middle class, had propounded revolutionary conclusions which it had compelled Father Gapon to bless.... These statements make no sense whatsoever, unless one substitutes for the words “history” and “dialectic of history” the words “Providence” and “God”...

It is not just Trotsky and his followers whom Keynes wishes to banish. He would apply the same to those advisors part of President Barack Obama who speaks of how because the current Lesser Depression has compelled households to tighten their belts that the government needs to tighten its. As he said back in 1931:

It seems an extraordinary imbecility that this wonderful outburst of productive energy [in the boom] should be the prelude to impoverishment and depression. Some austere and puritanical souls regard it both as an inevitable and a desirable nemesis on so much overexpansion, as they call it; a nemesis on man's speculative spirit. It would, they feel, be a victory for the mammon of unrighteousness if so much prosperity was not subsequently balanced by universal bankruptcy. We need, they say, what they politely call a 'prolonged liquidation' to put us right. The liquidation, they tell us, is not yet complete. But in time it will be. And when sufficient time has elapsed for the completion of the liquidation, all will be well with us again. I do not take this view. I find the explanation of the current business losses, of the reduction in output, and of the unemployment which necessarily ensues on this not in the high level of investment which was proceeding [during the boom]... but in the subsequent cessation of this investment. I see no hope of a recovery except in a revival of the high level of investment. And I do not understand how universal bankruptcy can do any good or bring us nearer to prosperity...

There is more than a little inconsistency and tension here...

You can live with this inconsistency and tension, or you can resolve it in one of several ways...

We are here at Notre Dame. At Notre Dame it is impossible to think about issues of history and moral philosophy without thinking of Alasdair Macintyre and his brilliant After Virtue, one of the best and most important works in the field in my lifetime. Economists seek to leverage a narrow claim to limited technical and technocratic expertise to banish and dispel Trotsky and all his works. Alasdair Macintyre, by contrast, seeks to banish and dispel economists--for we are the archetype of what he regards as one of the most unhealthy and poisonous diseases of modernity, the disease of the character of “managerialism”.

Now if I turn out to be incredibly brave, in the final version of this paper I may pick a fight with Alasdair Macintyre Mark 1981.

If I were to do this, I would say that Macintyre’s belief that we should hope for a civilization led by St. Benedicts (preferred) or Trotskys (less preferred) but not managers (bad) is simply totally wrong. I would point out that Keynes was totally correct in wanting to exclude a Trotsky from the public sphere. Trotsky’s ideas about good organization of the economy were easily seen as and turned out to be a horrible disaster, even from the perspective of a Trotsky’s values--especially from the perspective of Trotsky’s values. Since Trotsky as a prophet promised, first, that he knew a better managerial way of organizing the economy, that that first step was false undercut his claims about the further steps he wanted to take. And I would point out that, say, a St. Benedict’s belief that The One Who Is loathes artificial means of birth control is, from a managerial perspective, unholy: we consider the consequences of discouraging barrier methods in our age of the AIDS epidemic, we look at the large benefits in terms of parents’ ability to raise their children when they can easily and effectively choose number and spacing.

If I were to do this, I would invoke the Managerialism of Fear. I would conclude that managers with a bias toward freedom, choice, decentralization, and responsibility produce good results alongside a civilization of bewildered individuals lacking moral certainty. By contrast, prophets produce a civilization filled with confident fanatics who then commit gravely immoral actions--and who afterwards have nothing to say but: “Will you please send Lazarus down here with a damp cloth?”

I am not sure I am that brave.

And let me note that Keynes at least half-buys Macintyre’s critique that economic managerialism teaches bad values. But Keynes believes that the Kingdom is still a century off, and while it is a century off the world is so poor that needs of the body take precedence and the children of light must be devious. And Macintyre believes that the Kingdom is at hand.

In the last days before the coming of the Roman Empire from Marcus Tullius Cicero in Rome to his best friend Titus Pomponius Atticus in Athens:

You cannot love our dear [Marcus Porcius] Cato any more than I do; but the man--although with the finest mind and the greatest trustworthiness--sometimes harms the Republic. He speaks as if we were in the Republic of Plato, and not among the filth of Romulus...

Whatever you may think about economists’ desires to use their technical and technocratic expertise to banish both Trotsky and St. Benedict from any high places in the public sphere, there is the prior question of whether here and now--among the filth of Romulus--they deploy any proper technical and technocratic expertise. We seem to gain a new example of this every week.

This week the example is provided by Carmen Reinhart and Kenneth Rogoff--brilliant, hard-working economists both, from whom I have learned immense amounts. They believe that the best path forward for the large North Atlantic economies is for them to shrink their government deficits quickly begin to pay down government debt. I believe that the best path forward for these economies is for them to expand their government deficits now and let the debt grow until either economies recover to normal levels of employment or until interest rates begin to rise significantly. The issue is how large are the risks and costs associated with a high and rising national debt in a country that controls its own money supply as long as its domestic interest rates remain low.

Let me give the explanation of why I disagree with Reinhart and Rogoff that I have been giving at seminars around the country this winter and spring. Let me start by putting up the Owen Zidar graph of the their data, which shows the relationship between economic growth and debt for industrialized countries since World War II:

And this is what I have been saying:

RR present a correlation--not a causal mechanism, and not a properly-instrumented regression. There argument is a claim that high debt-to-GDP and slow subsequent growth go together. They cannot the question of which way causation runs. Suppose that we consider two cases: a multiplier of 1.5 and a multiplier of 2.5, both with a marginal tax share of 1/3. Suppose the growth-depressing effect lasts for 10 years. Suppose that all of the correlation is causation running from high debt to slower future growth. And suppose that we boost government spending by 2% of GDP this year in the first case. Output this year then goes up by 3% of GDP. Debt goes up by 1% of GDP taking account of higher tax collections. This higher debt then reduces growth by... wait for it... 0.006% points per year. After 10 years GDP is lower than it would otherwise have been by 0.06%. 3% higher GDP this year and slower growth that leads to GDP lower by 0.06% in a decade. And this is supposed to be an argument against expansionary fiscal policy right now?

And this isn’t the graph that you were looking for. You want the causal graph. That, worldwide, growth is slow for other reasons when debt is high for other reasons or where debt is high for other reasons is in this graph, and should not be. Control for country and era effects and Owen reports that the -0.06% becomes -0.03%. As Larry Summers never tires of pointing out, (a) debt-to-annual-GDP ratio has a numerator and a denominator, and (b) sometimes high-debt comes with high interest rates and we expect that to slow growth but that is not relevant to the North Atlantic right now. If the ratio is high because of the denominator, causation is already running the other way. We want to focus on cases of high debt and low interest rates. Do those two things and we are down to a -0.01% coefficient.

That is as concise and simple an explanation of why I disagree with Reinhart and Rogoff as I can give. And if you are not a professional economist and have managed to understand that, I salute you. I think we have by far the better of the technocratic argument. More important, however, is that when we stay at the level of the technical economics are differences are small. It is when we venture out of data collection and statistics into policy advocacy that the differences become very large indeed. Matthew O’Brien quotes Senator Tom Coburn’s report on Reinhart and Rogoff’s briefing of the Republican Congressional Caucus in April 2011:

Johnny Isakson, a Republican from Georgia and always a gentleman, stood up to ask his question: "Do we need to act this year? Is it better to act quickly?"

"Absolutely," Rogoff said. "Not acting moves the risk closer," he explained, because every year of not acting adds another year of debt accumulation. "You have very few levers at this point," he warned us.   Reinhart echoed Conrad's point and explained that countries rarely pass the 90 percent debt-to-GDP tipping point precisely because it is dangerous to let that much debt accumulate. She said, "If it is not risky to hit the 90 percent threshold, we would expect a higher incidence."

The reality is that there is no "90% threshold". That there appears to be one in Reinhart and Rogoff's original paper is just an artifact of their non-parametric statistical procedures, not to be taken seriously.

But they do. And it is very clear that even today Reinhart and Rogoff have had a much greater impact on the public debate than my side has.

Thus the key problem. Technical details matter. Conclusions must be taken by non-economists on faith in economists’ expertise. But because political and moral commitments shape how we economists view the evidence, economists will never reach conclusions with a near-consensus--even putting to one side those economists who trim their sails out of an unwarranted and excessive lust for high federal office. And note that neither Carmen Reinhart nor Kenneth Rogoff have such a lust.

We do not live in the Republic of Plato. We live in the Sewer of Romulus. Should you pay attention to economists? You have to. You have no choice. You all have to listen. But you have nearly no ability to evaluate what you hear.

Heaven help you. I cannot.