24 Oct 2009

The Problem With Pigou

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From an email I wrote to a group of colleagues who were arguing over whether it was really true that fossil fuel use only had negative externalities. (One of the guys was arguing that cheap energy confers benefits on society, just as surely as an opera house.)

Sorry I’m late replying to this; swamped with work. Consumer surplus
refers to the benefit consumers get from the availability of certain
markets, because presumably you keep buying units until the marginal
benefit of the next unit is lower than the unit price. So the idea is
that you gain a surplus on each of the inframarginal units. A lot of
people don’t see how a voluntary trade makes both people better off.
If a gallon of gas has a price of $2.50, then the consumer buys it and
at best is “even” because he swapped out $2.50 in cash for something
that is “worth” $2.50. But obviously that is wrong.

A positive externality means your actions shower benefits on other
people who aren’t in the actual market transaction. Textbook examples
are things like schooling and vaccination. An individual presumably
decides to learn to read, and get vaccinated (or at least his parents
force him to do these things) because the personal benefits outweigh
the personal costs. But it’s in my interest if other people become
literate and vaccinate themselves. (Let’s stipulate that we’re talking
about an effective vaccine. I know a lot of people don’t like the H1N1
vaccine.)

The problem with externalities is that if you push it, just about
every action you take has a million positive and a million negative
externalities. E.g. if I put on smelly socks before going to work,
that’s a negative externality and the government ought to fine me, in
principle. Oh but maybe the odor causes others to think about
workplace odor, causing 5 people to use anti-perspirant who otherwise
wouldn’t have. Thus my wearing of smelly socks confers a positive
externality, and the government should subsidize me, in principle.

So [Mr. Colleague] is definitely right that there are positive externalities
from fossil fuel use, if only because I can dream up positive
externalities from any activity X.

24 Oct 2009

Corporatists 237, Bob Murphy 3

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Wow I’m sorry that I missed this, loyal readers. I really need to stop outsourcing my financial news gathering to places like CNBC. It was only after watching a video interview with “special master for executive compensation” (that’s actually his title, which is hardly less worrisome than “pay czar”) Ken Feinberg that I realized his “90% pay cuts” actually are only pro rated to November and December. (I believe Tokyo Tom in the comments of my knee jerk post was trying to point this out, when he said the decision wasn’t a clawback.) Furthermore, as Feinberg says in the video, everything is back on the table starting in January 2010. (However, some news reports have Feinberg saying the rules will be in place for 2010. The only thing worse than having a pay czar chop your pay by 90%, is not knowing if the pay czar will chop your pay by 90%.)

Don’t get me wrong, I still stand by the general theme of my first reaction: This is a horrible precedent, and will make it all the easier for the government to regulate all financial compensation packages down the road, so long as it gives some bogus finding of “systemic risk.”

But once again I was snookered by the progressive rhetoric, in contrast to the corporatist reality: Thus far 25×7 = 175 people have had two months’ of their salaries altered, after living large on the taxpayer’s dime the first ten months of the year.

This is the real danger of listening to Rush Limbaugh et al.: It’s not that it will turn you into a racist, but rather that it will make you actually believe the progressive rhetoric coming out of the White House. For example, Rush actually think Obama is getting ready to pull all the US troops out of Afghanistan. Riiiight.

Incidentally, I noticed at least three humongous lies in the short Feinberg video linked above. For example, he says there are no plans to move beyond this, and yet I have heard audio–on Rush’s show I believe–where Feinberg says his next task is to figure out the compensation for the #26 – #100 people in each of these companies. He also says that neither the White House nor the Treasury exerted any input at all into his decisions. Well (a) that’s obviously a lie and (b) it would be absurd if they didn’t! Do we really want to believe that Obama would allow one guy unfettered power over seven huge companies?!

24 Oct 2009

Most Days, It’s Embarrassing To Be an Economist

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Silas Barta has a good takedown of this goofy blog post from an economics professor, Daniel Hamermesh, and his attempt to impart the lessons of economics to his students:

Each year in my 500-student principles class I gather a group of eight students and tell them that I will auction a $20 bill to the highest bidder. If two or more students bid the same thing, the difference between $20 and their joint bid will be divided among the winning bidders. They can collude to fix the price just like oligopolists who violate antitrust laws, but they must mark down their bids in secret.

Today seven of the students stuck to the collusive agreement, and each bid $.01. They figured they would split the $20 eight ways, netting $2.49 each. Ashley, bless her heart, broke the agreement, bid $0.05, and collected $19.95. The other 7 students booed her, but I got the class to join me in applauding her, as she was the only one who understood the game.

No one disputes that the collusive agreement does not constitute a Nash equilibrium. No one disputes that, with no other mechanisms in place, it might be naive to assume that everyone would follow through with an agreement, especially as the number of players increased.

But so what? The parts I put in bold above do not follow from pure game theoretic considerations. There is nothing that says we ought to bless or congratulate others for playing a narrowly defined best response; indeed, if you want to go that route, we should be chastising her because it’s in each of our narrow self-interest to make everyone else feel guilty for defecting in cases like this. So this professor can’t have it both ways: He wants to be “non-selfish” by congratulating someone else for something that doesn’t help him personally, and yet the very thing he is congratulating is the student’s unwillingness to be so gracious herself.

I realize I may sound wishy washy and anti-rigorous here; let me assure the casual reader that I “get” game theory. It was my field (analogous to a major) at NYU, the program of which was renowned for its bona fides in this area. The professor telling the above anecdote fits the stereotype that other social scientists have of economists. Economists defend themselves and say, “Hey, our discipline doesn’t tell people to be selfish; we just view the world as it is, not as the sociologists want it to be.” But no, Hamermesh just gave the game away. He was applauding a student for reneging on an agreement in order to benefit herself and screw over her classmates. Moreover, he implies that the other students were stupid and that’s the only reason they too didn’t try to stab each other in the back. It wasn’t that they were naive or too trustworthy; nope, they must not have understood the game.

For what it’s worth, I too used a technique similar to this, when I taught cartels in microeconomics. I would show the class $50 in cash, and say:

OK everyone, I want you to take out a small slip of paper, and put your name on one side. Then on the other side, without letting anyone else see, write a “C” or “D.” Then fold it up, and I’ll collect them. Then I’ll go through and show the class the letters one at a time. After it’s all done, here’s what I’ll do: If there are all Cs, then you all split the money evenly. [There would normally be about 20 kids in the room.] If there is one D, that person gets $40 him or herself, and everyone else gets nothing. If there are two Ds, they each get $15 and everyone else gets nothing. If there are 3 Ds, they each get $8. Finally, if there are 4 or more Ds, nobody gets anything. I’m going to leave the room for 10 minutes and let you discuss it, and then when I come back I want you to write your answer. Don’t write your answer until I come back. Last thing, I won’t ever reveal who the people writing ‘D’ were. I will pay them outside of class.

What’s interesting is that I almost never had to pay any money; in fact I think maybe I never paid any, but I’m not sure. However, after a few semesters of this pattern, I switched it up and used bonus points on the next exam as the reward. The payoff structure was the same: It was weakly dominant (note not strictly dominant, and hence this actually wasn’t a true prisoner’s dilemma) to write a D, because there were scenarios where that would garner you more bonus points, and it would never hurt you to write D. And yet just about always, everyone in the class wrote C when it was points, not money. Presumably this was due to (a) kids felt worse about stealing points from their friends, and (b) the football players threatened to literally beat up defectors when there were exam points on the line.

Anyway, my problem isn’t with Hamermash’s use of a game to keep the class interested. My problem is with him applauding students for defecting, and telling them that’s the right thing to do. Does Hamermash leave a tip in a restaurant when he’s on a road trip at a place he’s not likely to visit again within a year? If so, what a moron! He clearly doesn’t understand the rules of restaurant pricing.

(For more on the problems with typical popularizing of game theory, see my article complaining about Hal Varian’s discussion of the movie A Beautiful Mind.)

UPDATE: I used to put this as a bonus question on the next exam, so I’ll do it here as well, inasmuch as there are some serious econ geeks who frequent these pages: There actually exists a Nash equilibrium in which I pay out money, given the rules described above. So if a class of students had realized it and assigned people the various strategies to play, it would be self-enforcing, at least if we assume that each kid only cares about maximizing how much money he or she gets from me. What is the equilibrium?

23 Oct 2009

A Scary Jim Manzi Post on the Economy

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I hate to see what he writes on Halloween:

WHISTLING PAST THE GRAVEYARD

Some good news from Wall Street:

The improvement in sentiment in Wall Street may be traced almost directly to the encouraging reports which the financial community is receiving from the leading industries of the country, according to investment trust executives. They say that the current rise in security prices is firmly grounded on the improvement in business conditions that began in December.

New York Times
February 14, 1930

Two months later the Dow hit a level it would not see again for about 25 years. Happy Valentine’s Day, pal.

In the Crash of 1929, the Dow lost 48% of its value. Six months later it rallied back 48% (because this was from a starting point half as high, this meant it got back 52% of the loss from the Crash). In 2007 – 2009, the Dow lost 54% of its value. It has now rallied back 54%, or in other words, it has regained 45% of this loss in value.

Japan has gone through a similar process of dealing with an exploded real estate bubble. The Nikkei hit a peak of about 39,000 in 1989. It has moved downwards in a sawtooth pattern for the past 20 years, with big rallies in 95 – 96, 98 – 99 and 03 – 07. Today, 20 years after its peak, the Nikkei is at about 10,000.

It…seems slightly surreal to me to read newspaper trend stores about people getting bored with the incredible austerity of the past, oh, 10 months. Similarly, political debates around cap-and-trade, health care, entitlements, the $100 billion of new schools spending in the stimulus bill with no obvious prospects for improving reading or math skills, and so on that causally describe reducing U.S. economic output or efficiency in support of some lofty goal strike me as entirely detached from the reality of how harsh the real choices in front of us are likely to be.

In case my recent apologetic post on price inflation left some readers without a rudder, let me be clear: Even though I jumped the gun on my prediction of sharp price increases, I still think: (a) The real economy is going to be in the toilet for years, and (b) We are going to see the worst price inflation in US history. I am open to the possibility that (b) is wrong, but I am as confident in (a) as I could be for a general macroeconomic prediction.

Consequently, I personally am using the extra breathing room as a gift. I am currently carrying a lot more credit card debt than I’d like, and–given my views–I really need to redouble my efforts to get serious and start hacking it away.

If I’m right and we are now in the third bubble of the 2000s–first dot-com, then housing market, now US Treasurys–the eventual bust will be worse, the longer the delusion persists. But on the bright side, it gives those of us who see it coming, longer to protect our own households.

When trying to time a bubble, it’s much better to err on the side of leaving too soon.

23 Oct 2009

I’m Glad The Conservatives Are There to Protect the Legacy of the Founders

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A few months ago, Glenn Beck confidently stated that Thomas Paine was an atheist. No, he was a Deist. It’s true that in The Age of Reason Paine was very harsh on the Christian God, but Paine was so offended because he thought the Christian worldview mocked the grandeur of the true Creator of the universe. Does this sound like a quote from an atheist?

But in Deism our reason and our belief become happily united. The wonderful structure of the universe, and everything we behold in the system of the creation, prove to us, far better than books can do, the existence of a God, and at the same time proclaim His attributes.

It is by the exercise of our reason that we are enabled to contemplate God in His works, and imitate Him in His ways. When we see His care and goodness extended over all His creatures, it teaches us our duty toward each other, while it calls forth our gratitude to Him. It is by forgetting God in His works, and running after the books of pretended revelation, that man has wandered from the straight path of duty and happiness, and become by turns the victim of doubt and the dupe of delusion.

Except in the first article in the Christian creed, that of believing in God, there is not an article in it but fills the mind with doubt as to the truth of it, the instant man begins to think. Now every article in a creed that is necessary to the happiness and salvation of man, ought to be as evident to the reason and comprehension of man as the first article is, for God has not given us reason for the purpose of confounding us, but that we should use it for our own happiness and His glory.

I was going to let this one go, except that Glenn Beck doubled down the other day and went on at length with his sidekick along the lines of, “Now look, I’m not saying we all have to agree with everything about the Founding Fathers. For example, Thomas Paine was an atheist. OK, I’m not, I believe in God, but I still think he was right in his description of A-mer-ica.” (Not an exact quote but definitely the spirit of what Beck said.)

Tell you what, Mr. Beck, you don’t know the first thing about Thomas Paine, even though you tell your listeners how avid a historian you are when it comes to the colonial period. I would also venture to say that Thomas Paine knew the Christian Bible better than you (or me); he wrote the first part of Age of Reason from his French prison cell from memory, when he was on the guillotine death row for the shocking crime of saying they shouldn’t kill the deposed king, Louis XVI. (If you don’t know what I’m talking about, readers, you should read up on Thomas Paine. He was so freaking cool.)

OK, then just the other day I heard an ad from the Heritage Foundation during Rush Limbaugh’s show. Again, not an exact quote, but it went something like this: First the narrator read a really cool quote, one that makes you want to throw a Nobama! sticker on your bumper. Then the narrator says, “That was Samuel Adams, one of the patriots who founded our country. And Sam Adams’ weapon was the Constitution. Join the Heritage Foundation today, and receive a free pocket copy of the U.S. Constitution–the liberals in DC don’t want you to know what it says.”

So that sounded a little fishy to me. All the “patriotic” stuff Sam Adams did (and which the British people would rightly have classified as terrorist acts of insurgency) happened before the Constitution was ratified. So I was pretty sure the people who wrote that Heritage ad were bluffing. I checked Wikipedia to see how bad it was, and yep, it’s pretty bad:

Shays’s Rebellion contributed to the belief that the Articles of Confederation needed to be revised. In 1787, delegates to the Philadelphia Convention, instead of revising the Articles, created a new United States Constitution with a much stronger national government. When the Constitution was sent to the states for ratification, Adams expressed his displeasure. “I confess,” he wrote to Richard Henry Lee in 1787, “as I enter the Building I stumble at the Threshold. I meet with a National Government, instead of a Federal Union of States.”[195] Adams was one of those derisively labeled “Anti-Federalists” by proponents of the new Constitution, who called themselves “Federalists”.[196] Adams was elected to the Massachusetts ratifying convention, which met in January 1788. Despite his reservations, Adams rarely spoke at the convention, and listened carefully to the arguments rather than raising objections.[197] Adams and John Hancock, who had reconciled, finally agreed to give their support for the Constitution, with the proviso that some amendments be added later.[198] Even with the support of Hancock and Adams, the Massachusetts convention narrowly ratified the Constitution by a vote of 187 to 168.[199]

Concerned about the new Constitution, Adams made an attempt to reenter national politics. He allowed his name to be put forth as a candidate for the United States House of Representatives in the December 1788 election, but lost to Fisher Ames, apparently because Ames was a stronger supporter of the Constitution, a more popular position.[202] Despite his defeat, Adams continued to work for amendments to the Constitution, a movement that ultimately resulted in the addition of a Bill of Rights in 1791.[203] With these amendments, and the possibility of more, Adams subsequently became a firm supporter of the Constitution.

What do you think, kids? Were the Heritage scriptwriters aware of all the above? Did Glenn Beck know full well the nuances of Thomas Paine’s position on the existence of God? I must confess I am skeptical.

23 Oct 2009

Horwitz on the 1920-1921 Depression

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I’ve actually been working this week–my psyche has yet to adjust to the discomfort–and somehow this post by Steve Horwitz slipped through the cracks. For non-Austrian readers, some quick context:

(1) Many, perhaps most, economists today would say something like, “We know that the Fed made a terrible mistake in the early 1930s, by standing back and letting the money supply fall by 1/3 as panicked depositors withdrew their money from the banking system. The huge deflationary force added insult to injury after the stock market had already crashed, and is why the Great Depression was so awful. Had not Bernanke flooded the system with new money last fall, unemployment would be much higher today than it is.”

(2) In response, many Austrian economists who consider themselves followers of Murray Rothbard say, “That’s nuts. Printing up green pieces of paper doesn’t make us richer. The economy needed to undergo serious rearrangement of resources after the popping of the artificial bubble in 1929. The reason unemployment went so high in the 1930s wasn’t because of the Fed’s unwillingness to print up dollar bills. As proof, look at the depression of 1920-1921, when there was a more severe collapse in the monetary base and price deflation was even more severe.” (I discuss this in great length in my book, but if you are a cheapskate Tom Woods has a good article on it. UPDATE: Tom says this article is a better one to learn about the 1920-1921 experience.)

(3) Steve Horwitz and some other Austrians–typically those who consider themselves followers of Hayek and Kirzner, more than of Rothbard, though the classification is not perfect–disagree. They agree that the Fed screws up things when it prints new money and fuels an artificial boom, but they think the Fed is just committing the opposite mistake if it sits back and does nothing, when the public’s demand to hold money increases during a financial panic. Thus, Horwitz and some other big guns in the Austrian camp agree with Milton Friedman that the Fed’s timidity in the early 1930s contributed to the severity of the Great Depression, and they agree that Bernanke was correct to increase the monetary base last year (though of course they need not, and don’t in practice, agree with how Bernanke chose to get new reserves into the system, namely through bailouts of insolvent financial institutions).

OK now that you’ve got the context, check out Horwitz’s post. He takes the 1920-1921 trump card head-on and argues that it would have been even less painful if the Fed had done what he recommends. In other words, the 1930s was the worst ever, because you had Hoover’s New Deal-lite combined with dumb deflationary Fed policy. The 1920-1921 depression was better than that, but it was still really bad, because you had Harding’s laissez-faire policies combined with dumb deflationary Fed policy.

If I had to give a reaction on the spot, I’d say that I disagree with Horwitz. In particular, I think part of why there was a depression in 1920-1921 was that the huge WW1 bubble was popped, since the Fed had become alarmed by the 20% price inflation. So if that’s right, I don’t see how you could have had the corrective readjustment of resources, without most of the pain that they did in fact experience. Ditto for the fiscal policies: I think there had to be a period of “idle resources” as the US economy reconfigured itself from the arsenal of democracy back into the engine of consumerism.

It’s true, I think if Ron Paul had been elected president and did everything Joe Salerno advised, that there would have been a very severe recession but it would have bottomed out within, say, 6 months. So it does surprise me that the 1920-1921 depression lasted longer than that. Thus, Horwitz could be right.

Last point: Let’s not forget that we’re talking about 1920 here. It’s not as if laid off munitions workers could hop on Monster.com, sublet their apartment on Craig’s List, and then rent a one-way U-Haul to where the new jobs were. I really have no idea how long a massive “free market recession” should have lasted back then, or how high unemployment “should” have been.

23 Oct 2009

Tom Woods and Doug Casey on PBS (!) Debate: Chocolate Anarchy or Vanilla Anarchy?

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Wow, I finally got around to watching the below video that Tom posted a few days ago. You know how normally, if you watch a political discussion on TV the spectrum of the debate is, “Should we steal 50% of taxpayers’ money, or just 48%?”

Well a similar thing happened on this program, except the spectrum was more like, “Should I be an anarchist because of bold assertions about the nature of government, or should I be an anarchist because of the study of history?”

I can’t believe this was on PBS.

BTW Tom, I noticed that he called you an economist and you just nodded. I won’t tell anyone, don’t worry.

22 Oct 2009

Reduce, Reuse, Recycle (Citizens’ Money)

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More fun tax facts: Massachusetts also has a tax on marijuana, but it has yet to collect any revenue from it. On the other hand, in Fiscal Year 2008, the state made almost $39 million from unredeemed deposits on bottles. See pages 26-27 of this pdf.