Tag: economics

Allocative Efficiency for Beginners

By James Kwak

I was catching up on some old Planet Money episodes and caught Allen Sanderson of the University of Chicago talking about how to allocate scarce resources. The first day of introductory economics, he says, there are always more students than seats. Say there are forty extra people, and he can only accept ten more into the class. He asks the class: how should the ten slots be allocated? You can easily guess the typical suggestions: by seniority, because seniors won’t be able to take the class later; by merit (e.g., GPA), because better students will contribute more to the class and get more out of it; to the first ten people outside his office at 8 am the next day, since that is a proxy for desire to get in; randomly, since that’s fair; and so on. Someone also invariably suggests auctioning off the slots.

This, Sanderson says, illustrates the core tradeoff of economics: fairness and efficiency. If you auction off the slots, they will go to the people to whom they are worth the most, which is best for the economy as a whole.* If we assume that taking the class will increase your lifetime productivity and therefore your lifetime earnings by some amount, then you should be willing to pay up to the present value of that increase in order to get into the class. An auction therefore ensures that the slots will go to the people whose productivity will go up the most. But of course, this isn’t necessarily fair, especially when you consider that the people who will get the most out of a marginal chunk of education are often the people who have the most already.

Continue reading “Allocative Efficiency for Beginners” →

Is Economics the Problem?

By James Kwak

For a class, I recently read “The Psychological Consequences of Money,” a 2006 article in Science by Kathleen Vohs, Nicole Mead, and Miranda Goode. It describes nine experiments testing how reminding people of money leads them to behave differently — in ways that we should not be proud of. You may have heard of these experiments.

In Experiment 5, participants first played Monopoly, after which the game was cleared except for a large or a small amount of play money; then they were asked to imagine a future with abundant finances or with strained finances (there was also a control group); then someone walked into the room and dropped a box full of pencils. People who saw more money and imagined having a lot of money picked up fewer pencils. In Experiment 7, participants saw a screensaver with currency symbols floating underwater or fish swimming underwater; then they were asked to move two chairs together for a conversation with another person. People who saw the currency symbols placed the chairs further apart than people who saw fish.

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Disclosure Rules for Economists

By James Kwak

In October, Gerald Epstein and Jessica Carrick-Hagenbarth released a paper documenting potential conflicts of interests among academic economists writing about the financial crisis and financial reform. Focusing on the Squam Lake Working Group on Financial Regulation and the Pew Economic Policy Group Financial Reform Project, they found that a majority of the economists involved had affiliations with private financial institutions, yet few of them disclosed those affiliations even in academic publications (where they do not face the word constraints imposed by print newspaper editors), preferring to identify themselves by their universities and as members of prestigious institutions such as NBER. To be fair, they did not find a strong relationship between economists’ affiliations and their positions on financial reform, perhaps because of the small sample and the limited amount of variation in the positions of members of these groups.

Epstein and Carrick-Hagenbarth called in their paper for economists to disclose any potential conflicts of interest, especially when writing for a general audience. This proposal has picked up some steam, first in the blogs (me; Nancy Folbre in Economix; Felix Salmon (“it’s not going to happen: there’s too much money riding on the continuation of the status quo”); Mark Thoma; Mike Konczal; Planet Money) and, more recently, thanks in part to the movie Inside Job, in the mainstream press. According to Sewell Chan in The New York Times, the AEA claims that it will consider a new ethical code or at least disclosure rules for economists — although, in a forthcoming book, “[George] DeMartino describes concerns dating to the 1920s about the influence of business on economic research, and cites multiple calls within the association for a code of conduct — all of which have been rebuffed.”

Epstein and Carrick-Hagenbarth have drafted a letter to the president of the AEA asking for the adoption of a code that requires economists to avoid conflicts of interest and to disclose ties that could create the appearance of a conflict of interest. If you are an economist and would like to sign on, you can email Debbie Zeidenberg (peri at econs dot umass dot edu) by Sunday evening. The full text follows.

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The More Things Change …

By James Kwak

As a holiday gift to myself, I’ve actually been reading a real book, on paper — The Worldly Philosophers, by Robert Heilbroner. The book itself was not a gift to myself; I have my sister’s old copy, which is the 1980 edition. The book is a traditional intellectual history of some of the main figures in economics. As the original was written in 1953, it focuses less on the mathematical line of economics, from Walras and Marshall through Arrow-Debreu to the present, and more on what used to be called political economy: Smith, Ricardo, Mill, Marx, Keynes, etc. It’s not a way to learn economics, but a way to learn something about the historical conditions that helped give rise to some important economic ideas.

But some passages seem oddly relevant today. Discussing the conventional economic wisdom of the early nineteenth century (pp. 121-22):

“They lived in a world that was not only harsh and cruel but that rationalized its cruelty under the guise of economic law. . . . It was the world that was cruel, not the people in it. For the world was run by economic laws, and economic laws were nothing with which one could or should trifle; they were simply there, and to rail about whatever injustices might be tossed up as an unfortunate consequence of their working was as foolish as to lament the ebb and flow of the tides.”

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Free Books and Board Seats

By James Kwak

Here in the blogging world, some of us are very sensitive to the potential appearance of impropriety. A year ago, the FTC published new rules requiring bloggers to disclose cash and in-kind payments they receive for reviewing products. The upshot, for most of us, is simply that now, when we discuss a book, we say if we got a free copy of the book from the publisher. (Although it’s not clear that that disclosure is required, since getting a free copy is something that readers should expect; I don’t think the New York Times Book Review bothers pointing out that, for every book they review, they got a free copy, although they almost certainly did.)

All the more relevant, then, is Gerald Epstein’s post about conflicts of interest in the economics profession.

“Jessica Carrick-Hagenbarth and I did a study of 19 prominent academic financial economists who were members of two influential groups that have played a key role in the financial reform and regulation debate in the U.S. Of the 19 academic economists in these groups, 70% advised, owned significant stock in or were on the board of private financial institutions. But you wouldn’t know by looking at their self-identification in media appearances, policy work or academic papers.”

There are certainly economists who were talking up the housing market in the summer of 2008 without disclosing their financial ties to banks–who were desperately hoping that housing prices would not collapse.

C’mon, guys. I don’t even get very many free books (maybe one per month on average–I decline most of them), and I always disclose that. I know it’s not feasible to list every company that ever paid you to give a speech. But really, if you’re a paid director of a bank and you write about the banking industry, can’t you at least point that out?

Yet Another Reason to Like Elizabeth Warren

By James Kwak

Bob Lawless points me to this 2006 blog post by Elizabeth Warren. Warren describes a first-year contracts class on the case that upheld a fine-print forum selection clause (a clause saying that if you want to sue us, you have to sue us in X jurisdiction–Florida, in this case) on the back of a cruise ship ticket.

Warren’s entire class (Harvard, let me say for the record) insists that, as a factual matter, this decision is good for consumers because . . . well, regular readers of this blog should be able to fill in stock Mickey Mouse economistic hand-waving as well as any first-year law school student. Of course! Forcing people to sue in Florida (or to accept binding arbitration in the forum of the company’s choice) deters frivolous lawsuits and lowers costs for the company, and it can pass those savings onto consumers. Why does it pass those savings onto consumers instead of putting them into shareholders’ (or managers’) pockets? Because in a perfect competitive market, if Alpha Cruise Lines doesn’t, then Beta Cruise Lines will, and Beta will underprice Alpha, . . . Consumers will read the fine print and can make an informed choice between the lower price with the forum selection clause and the higher price without the forum selection clause.

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The Perils of Studying Economics

By James Kwak

Patrick McGeehan at the New York Times recently wrote about a New York Fed study finding that studying economics makes you a Republican. The headline conclusion is that the more economics classes you take, the more likely you are to be a Republican. Majoring in economics or business is also more likely to make you a Republican. (See Table 2 in the original paper.) The study is based on thousands of observations of undergraduates at four large universities over three decades, so it is focused on undergraduate-level economics.

Studying economics also affects your position on several public policy issues. Of seven issues, economics courses were significantly associated with the five following positions (Table 6):

  • Tariffs are bad.
  • Trade deficits are not so bad.
  • The government should not cap oil prices in response to a supply shock.
  • Raising the minimum wage increase unemployment for low-wage workers.
  • Income distribution should not be more equal.

These are all pro-free market, anti-government intervention positions.

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The Role of Government

By James Kwak

Last week Simon gave a talk sponsored by Larry Lessig’s center at Harvard. Afterward there was a dinner and then another question-and-answer session. Jedediah Purdy (another person to write a book while at Yale  Law School; he is now a professor at Duke’s law school) asked a question that I have rephrased as follows (the words are mine, not Purdy’s; I may have also distorted his original question so much that it is also mine):

“You’ve criticized the government for withdrawing from the economic and particularly financial sphere and allowing private sector actors to do whatever they wanted. Do you think the government should simply act so as to correct the imperfections in free markets? Or do you see a positive role for government in determining what kind of an economy we should have?”

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How Supposed Free-Market Theorists Destroyed Free-Market Theory

This guest post was contributed by Dan Geldon, a fellow at the Roosevelt Institute.  He is a former counsel at the Congressional Oversight Panel and a graduate of Harvard Law School.

Over the past year, there has been much discussion about how the financial crisis exposed weaknesses in free-market theory.  What has attracted less discussion is the extent to which the high priests of free-market theory themselves destroyed meaningful contracts and other bedrocks of functioning markets and, in the process, created the conditions for the theory’s weaknesses to emerge.

The story begins before Wall Street’s capture of Washington in the 1980s and 1990s and the deregulatory push that began around the same time.  In many ways, it started in 1944.

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The Limits of Economics

In honor of Mark Sanford and that other guy from Nevada, the fun-loving crowd over at Planet Money has been talking about the economics of adultery, and even got Simon to comment for them. I’m all in favor of a cute model, but I think this is as much a sign of the over-expansion of economic reason as anything else.

Chana Joffe-Walt’s post asks this question of the typical cheating politician: “Didn’t he know he’ll get caught, put his family through hell, exhaust all of us with the details and jeopardize his career? The costs are so great, how could the affair possibly be worth it?”

Well, that assumes that he was going to get caught, and the odds of being caught in an affair are one of those things that are inherently very difficult to measure (and that cheaters are likely to underestimate, because of selection bias). We can see the numerator, but we can’t see the denominator. It also assumes that trading your political career for a steamy affair is a bad outcome. On some level, don’t you suspect that a lot of male politicians do it because they want to impress women, and that affairs are part of the payoff of politics? And what sane person would really want to be in electoral politics anyway?

More generally, the motivations that drive people to want to have sex with people they are not married to, or otherwise live secret lives other than the one they are supposed to live, seem to me not only too complex for a Chicago-school rational-actor model, but even perhaps too complex for a behavioral model. That is, I suspect that this type of behavior involves multiple actors inside the same person: one person who combines the ambitious, values-touting politician; the typical middle-aged man going through a midlife crisis and hoping for someone to validate his self-image; and, of course, the lout who thinks with something other than his brain. I think combining those sides of the psyche into a single utility model and maximizing it subject to a budget constraint (be it money or time) is basically a fantasy. But economists these days wil stop at nothing.

By James Kwak

Causes: Economics

We are not short of causes for our current economic crisis.  The basic machinery of capitalism, including the process of making loans, did not work as it was supposed to.  Capital flows around the world proved much more destabilizing than even before (and we’ve seen some damaging capital flows over the past 200 years.)  And there are plenty of distinguished individuals with something to answer for, including anyone who thought they understood risk and how to manage it.

But perhaps the real problem lies even deeper, for example, either with a natural human tendency towards bubbles  or with how we think about the world.  All of our thinking about the economy – a vast abstract concept – has to be in some form of model, with or without mathematics.  And we should listen when a leading expert on a large set of influential models says (1) they are broken, and (2) this helped cause the crisis and – unless fixed – will lead to further instability down the road.

This is an important part of what my colleague, Daron Acemoglu, is saying in a new essay, “The Crisis of 2008: Structural Lessons for and from Economics.”  (If you like to check intellectual credentials, start here and if you don’t understand what I mean about models, look at his new book.)  To me there are three major points in his essay. Continue reading “Causes: Economics” →