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May 26, 2010

Latest Posts from Economist's View

Latest Posts from Economist's View

"Towards a New Ethics of Nature"

Posted: 26 May 2010 01:53 AM PDT

Paul Collier says opposition to the plunder of natural resources is often based upon romantic environmentalism or self-denying utilitarianism. But these ethical structures do not provide the "simple common ethics of nature" that is needed to motivate collective worldwide action to stop this plunder from occurring. Instead, he says, we should adopt an ethical principle common among most societies, one that says our obligation to the future is "to pass on equivalent value for the natural assets we deplete":

Towards a new ethics of nature, by Paul Collier, Commentary, Financial Times: Natural assets are valuable and they are vulnerable. The current frontier for their exploitation is the quarter of the earth's land surface home to the bottom billion: hence the new scramble for Africa..., but much of it is weakly governed. Advances in technology will open up those natural assets beneath the oceans and the poles... The governance of these huge areas is even weaker.
Ungoverned natural assets are subject to plunder... Plunder can only be avoided by robust collective action..., ultimately it can only rest on a common understanding by citizens, society by society. ...
 In popular debate the high moral ground has been seized by romantic environmentalists who define our ethical obligation as preservation. Even in the west this can never be more than a minority view. Meanwhile, in the more rarefied technocratic debate, the high ground has been occupied by economic models. The models judge choices about the future by an austere utilitarianism in which future people, however remote, count for just as much as we do. ...
[A] more practical common ethics of nature, around which majorities could mobilize, is latent in most societies. ... Economists should be bringing the insight that natural assets matter not because of their intrinsic purity, but because they are valuable. Our obligation to the future is not to preserve purity but to pass on equivalent value for the natural assets we deplete. If, by converting natural assets into more productive assets, a poor society can escape poverty, then it should do so. ... In an impoverished society, the future will prefer to inherit schools and cities rather than to remain in impoverished purity.
This simple ethical test of whether we are infringing the rights of the future is much closer to how we see our obligations than either utilitarianism or romantic environmentalism. Respecting the rights of the future is manifestly more compelling than basing decisions on the esoteric sanctity of the infinite-horizon utilitarian calculus. Recognizing that the future may want us to use nature rather than preserve it distinguishes humane environmentalists from romantics: we are the custodians of value, not the curators of artifacts. ...

Whereas the ethics of romantic environmentalism and self-denying utilitarianism are both eccentric, the idea that natural assets oblige us to be custodians of value is common to widely differing cultures. ... The struggle to prevent the plunder of nature will be fought mainly in the societies of the bottom billion, which control the current frontier, and in the international conference halls that must regulate the future frontier. Neither is a promising venue. Rallying around a simple common ethics of nature would improve the chances.

"An Outsider's View of Modern Macroeconomics"

Posted: 26 May 2010 12:24 AM PDT

Rajiv Sethi on macro theory:

An Outsider's View of Modern Macroeconomics, by Rajiv Sethi: Following up on a testy exchange with David Andolfatto, Mark Thoma has written a thoughtful post in which he discusses the state of modern macroeconomic theory, the appropriateness of appeals to professional authority, the shortcomings of some canonical models, and the way forward. I posted a brief comment in response, with a few constructive suggestions for mainstream macroeconomists from the perspective of an outsider. I have made these points on various occasions before, and reproduce them here (slightly edited and expanded with links to earlier posts):

  1. Rational expectations is not a behavioral hypothesis, it's an equilibrium assumption and therefore much more restrictive than "forward-looking behavior". It might be justified if equilibrium paths were robustly stable under plausible specifications of disequilibrium dynamics, but this needs to be explored explicitly instead of simply being assumed. 
  2. Think about whether a theory of economic fluctuations should be shock-dependent (in the Frisch-Slutsky tradition) or shock-independent (in the Goodwin tradition). Go back and look at Goodwin's  1951 Econometrica paper to appreciate the importance of the distinction.
  3. Build models in which leverage, collateral, and default play a central role. The work of John Geanakoplos on this is an excellent starting point. He uses equilibrium theory but allows for heterogeneous priors (so differences in beliefs can persist even if they are common knowledge.) More broadly, take a close look at Hyman Minsky's integrated analysis of real and financial activity. 
  4. Do not assume that flexible wages and prices imply labor market clearing. They do in equilibrium (by definition) but wage and price flexibility in disequilibrium can make matters worse. Keynes recognized this, and Tobin explored these mechanisms formally. Arbitrary assumptions of "sticky prices" are not necessary to account for persistent unemployment or under-utilization of capacity.
  5. Finally, show some humility. There are anonymous bloggers out there, some self-taught in economics, who may know more about the functioning of a modern economy than you do.

The last point is directed at David Andolfatto, whose arrogant appeal to professional authority jolted the normally polite Mark Thoma to respond with (justifiable) belligerence. Andolfatto's entire post was dripping with condescension, but I found the following passage particularly disturbing:

DeLong tells us that we can learn a lot of economics from Krugman. You will be forgiven for wondering whether DeLong can even tell whether he is learning economics or not. DeLong is, as far as I can tell, an historian.

As I said on Mark's blog, it could be argued that economic historians (and historians of thought) have had more useful things to say about recent events than the highest of high priests in macroeconomics. Andolfatto seems to be confusing an understanding of modern macroeconomic theory with an understanding of the modern macroeconomy. The two are not the same, and the former is neither necessary nor sufficient for the latter.

Contrast the tone of Andolfatto's post with the following passage from a recent essay by Narayana Kocherlakota, president of the Minneapolis Fed:

I believe that during the last financial crisis, macroeconomists (and I include myself among them) failed the country, and indeed the world. In September 2008, central bankers were in desperate need of a playbook that offered a systematic plan of attack to deal with fast-evolving circumstances. Macroeconomics should have been able to provide that playbook. It could not. Of course, from a longer view, macroeconomists let policymakers down much earlier, because they did not provide policymakers with rules to avoid the circumstances that led to the global financial meltdown.

Because of this failure, macroeconomics and its practitioners have received a great deal of pointed criticism both during and after the crisis. Some of this criticism has come from policymakers and the media, but much has come from other economists. Of course, macroeconomists have responded with considerable vigor, but the overall debate inevitably leads the general public to wonder: What is the value and applicability of macroeconomics as currently practiced?

Kocherlakota goes on to defend the many advances made in macroeconomic research over the past four decades, but openly acknowledges the enormous challenges that remain. He goes on to say:

The seventh floor of the Federal Reserve Bank of Minneapolis is one of the most exciting macro research environments in the country. As president, I plan to learn from our staff, consultants, and visitors.

I hope that some of those visitors (real or virtual) will be voices of dissent from beyond the inner circle of research macroeconomics. It is in this spirit of openness that my comments are offered.

links for 2010-05-25

Posted: 25 May 2010 11:08 PM PDT

Growth Policy versus Stabilization Policy

Posted: 25 May 2010 04:32 PM PDT

I have a new post at MoneyWatch:

Growth Policy versus Stabilization Policy: In economics, as in other disciplines, the important questions change over time. In macroeconomics, there are two big questions and our attention to one or the other changes with the economic events of each era. One question concerns stabilization policy -- keeping the economy as close as possible to the long-run growth path -- and the other is growth policy, i.e. policy that attempts to maximize the long-run growth rate. (There is also work on whether stability and growth are related. More stable economies could grow faster due to reduced uncertainty, but government intervention to stabilize the economy could also stifle growth according to some models, so the relationship is not clear a priori.)

We could go back further than this, but let me pick the story up in the 1970s. ...[continue reading]...

The argument is that we have paid too much attention to growth policy, and not enough to stabilization. Even if the growth policies do pay off in the long-run, the over emphasis on growth has caused a slower recovery and it's not at all evident that's a desirable trade off.

"The Effects of Airline Deregulation: What’s The Counterfactual?"

Posted: 25 May 2010 12:33 PM PDT

Tom Bozzo argues that the case for airline deregulation isn't as clear as many people would have you believe:

The Effects of Airline Deregulation: What's The Counterfactual?, by Tom Bozzo: Matt Welch at the Reason blog takes credit for airline deregulation on behalf of libertarianism:

The "worldview" of libertarianism suggested, back in the early 1970s, that if you got the government out of the business of setting all airline ticket prices and composing all in-flight menus, then just maybe Americans who were not rich could soon enjoy air travel. At the time, people with much more imagination and pull than Gabriel Winant has now dismissed the idea as unrealistic, out-of-touch fantasia. They were wrong then, they continue to be wrong now about a thousand similar things, and history does not judge them harsh enough.

Mark Kleiman observes that transportation deregulation was more directly the progeny of 1970s Brookings-esque neoliberalism (though I'd grant Welch that libertarians got there first), though Kleiman doesn't take issue with the basic claim that deregulating prices and service offerings "was, on balance, a good thing." This argument ultimately rests on the declines in airfares and resulting democratization of air travel that Welch cites; indeed that's what the Brookings-esque neoliberals I know cite when they're defending the deregulatory record.

The catch is that all such economic comparisons must be counterfactual: they must show an improvement not with respect to CAB-set fares of the late-1970s, but rather with respect to what reasonably competent regulation could have produced under the other circumstances of the deregulated era. (This, FWIW, is one of Robert W. Fogel's central insights into what makes economic history economic history.) If the comparison exercise is tough by the (inappropriate) historical yardstick thanks to declines in (average) service quality and the airline industry's trail of fleeced stakeholders, then the counterfactual comparison is going to be tougher still thanks to a couple of factors that should have produced large declines in airline costs and hence fares even in the absence of deregulation.

The factors of note are a pair of technological advancements — the development of high bypass ratio turbofans suitable for shorter-haul airliners and the demise of the flight engineer's job thanks to cockpit automation, both of which have origins predating deregulation — and the long secular decline in oil prices through the deregulated era's zenith prior the crash of the 1990s stock market bubble. Since a regulator could have promoted adoption of the cost-saving technologies and passed the resulting productivity improvements and input cost decreases through to fare-payers using elementary regulatory technologies, deregulation must have produced substantial fare reductions relative to the late CAB era to have a claim to constituting a true improvement.

One of the airline industry's problems is that it isn't "revenue adequate" or able to recover its total costs including a normal return to investors. If you thought airlines were incurring costs efficiently, then moving towards revenue adequacy would require more revenues and hence higher average fares. On the face of things, that wouldn't look good for a regulated alternative providing more secure revenues to the industry. However, there are dynamic efficiency counterbalances to the apparent static inefficiency under regulation: revenue adequacy implies having money for efficiency-improving investments. For instance, U.S. legacy airlines have somewhat notoriously kept relatively aged fleets in the air. Partly, that was a deliberate strategy that blew up when the Goldilocks conditions of the late-90s ended, and partly they don't have the money to turn over their fleets as fast as they arguably should.

The formerly regulated transportation industries shared, to one extent or another, cost structures under which an efficient carrier would go broke under econ 101 perfect competition with prices driven down to marginal costs. So the question isn't so much whether carriers will exercise such market power as they have in order to survive, but how. Real firms might or might not do that better than a real regulator. I do think there's a good case to be made for some degree of pricing and service liberalization with regulatory policing of "excessive" use of market power; that's a one-sentence version of the Staggers Act's approach to the (very successful) freight rail industry.

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