- Some Pundit Meta On Our Twin Crises - Paul Krugman
- Fake News With Reporting on Disability - Dean Baker
- The ideology of "the market" - Stumbling and Mumbling
- The untapped potential of humanitarian economics - VoxEU
- Is Productivity Growth Becoming Irrelevant? - Adair Turner
- A new model of organization? - Understanding Society
- Refugees have little effect on native worker wages - VoxEU
- Markets Opened as Guild Monopolies Declined in the 16th Century - ProMarket
- Cronyism, & the demand for redistribution - Stumbling and Mumbling
- Can the Fed and ECB Work Together To Reduce Imbalances? - Brad Setser
Saturday, July 22, 2017
Friday, July 21, 2017
"It’s basically about spite":
Health Care in a Time of Sabotage, by Paul Krugman, NY Times: Is Trumpcare finally dead? Even now, it’s hard to be sure, especially given Republican moderates’ long track record of caving in to extremists at crucial moments. But it does look as if the frontal assault on the Affordable Care Act has failed.
And let’s be clear: The reason this assault failed wasn’t that Donald Trump did a poor selling job, or that Mitch McConnell mishandled the legislative strategy. Obamacare survived because it has worked — because it brought about a dramatic reduction in the number of Americans without health insurance, and voters ... don’t want to lose those gains.
Unfortunately, some of those gains will probably be lost all the same: The number of uninsured Americans is likely to tick up over the next few years. So it’s important to say clearly, in advance, why this is about to happen. It won’t be because the Affordable Care Act is failing..., when Trump threatens to “let Obamacare fail,” what he’s really threatening is to make it fail.
On Wednesday The Times reported on three ways the Trump administration is, in effect, sabotaging the A.C.A.... First, the administration is weakening enforcement of the requirement that healthy people buy coverage. Second, it’s letting states impose onerous rules like work requirements on people seeking Medicaid. Third, it has backed off on advertising and outreach designed to let people know about options for coverage. ...
And there may be worse to come: Insurance companies, which are required by law to limit out-of-pocket expenses of low-income customers, are already raising premiums sharply because they’re worried about a possible cutoff of the crucial federal “cost-sharing reduction” subsidies that help them meet that requirement.
The truly amazing thing about these sabotage efforts is that they don’t serve any obvious purpose. They won’t save money — in fact, cutting off those subsidies ... would probably end up costing taxpayers more money than keeping them. They’re unlikely to revive Trumpcare’s political prospects.
So this isn’t about policy, or even politics in the normal sense. It’s basically about spite: Trump and his allies may have suffered a humiliating political defeat, but at least they can make millions of other people suffer.
Can anything be done to protect Americans from this temper tantrum? In some cases, I believe, state governments can insulate their citizens from malfeasance at H.H.S. But the most important thing, surely, is to place the blame where it belongs. No, Mr. Trump, Obamacare isn’t failing; you are.
Thursday, July 20, 2017
- Minimum Wage and Job Loss: Seattle Study Is Not the Last Word - NYTimes
- The Problem With Trump's Steel Tariffs - Annie Lowrey
- Buyer beware - American Economic Association
- In Conversation: Robert Solow - Equitable Growth
- Asymmetric policies - Stumbling and Mumbling
- Yes, Financial Crises Do Bring Hangovers - Justin Fox
- Modelling the Macroprudential Balancing Act - Bank Underground
- Capital accumulation, private property, and inequality in China - VoxEU
- The Cycles of Cities - Tim Taylor
- Redlining Never Went Away - Noah Smith
- Growth and volatility before and after the Global Crisis - VoxEU
This ridiculous Republican propaganda is exactly why we need the CBO: Tuesday I wrote about the GOP’s systematic efforts to discredit and disempower any independent voice — media, the Congressional Budget Office, the Office of Government Ethics — that tries to hold government accountable.
Today we have a great example of the ridiculous propaganda that Republicans expect the public to swallow in the absence of such independent critics and scorekeepers.
The Washington Examiner has gotten its hands on a Trump administration “analysis” (I use that word loosely) of the Consumer Freedom Amendment, a proposal from Sen. Ted Cruz (R-Tex.). ...
Talk to literally any economist, including conservative ones, and you’ll learn that this idea would lead to adverse selection, a huge spike in premiums for sick people..., a proliferation of mini-med junk plans that cover virtually nothing..., and a possible death spiral. A more detailed explanation of this phenomenon is here. ...
Contrary to the predictions of economists everywhere, the HHS propaganda document claims that the Cruz amendment would cause insurance coverage to go up and premiums to fall. Astoundingly, even premiums for people in the Obamacare-compliant plans — which, again, economic theory suggests would get stuck with only the very sickest, most expensive Americans — would allegedly decline relative to current law. ...
This is garbage, and exactly why we need nonpartisan scorekeepers like the CBO. ...
Wednesday, July 19, 2017
- The Healthcare Debacle: The Roles of Ignorance and Evil - Paul Krugman
- The economics of BBC pay - Stumbling and Mumbling
- Should Labour triangulate over Brexit? - mainly macro
- How will households react to the real income squeeze? - Bank Underground
- Japan's ‘glass ceiling’ and ‘sticky floor’ - VoxEU
- Global Value Chains and Productivity - Tim Taylor
- Facts, frictions & "mainstream" economics - Stumbling and Mumbling
- Credit misallocation during the European financial crisis - VoxEU
- The Economic Constraints on China’s Geostrategic Ambitions - Brad Setser
Tuesday, July 18, 2017
This Expansion Will End in a Fizzle, Not a Bang: The Fed is growing increasingly concerned that this expansion will end like the last two, with a collapse in asset prices that brings down the economy. That concern will lead the central bank down the path of excessive tightening. Worse, that logic misses a key point. In both of the last two cycles, there was a sizable imbalance in the economy that extended beyond financial assets themselves. So far, the current environment lacks such an imbalance. That suggests the expansion ends with more of a fizzle than a bang. ...[Continued at Bloomberg Prophets]...
Monday, July 17, 2017
"Will this vileness prevail?":
Republicans Leap Into the Awful Known, by Paul Krugman, NY Times: Sometime in the next few days the Congressional Budget Office will release its analysis of the latest version of the Republican health care plan. Senator Mitch McConnell is doing all he can to prevent a full assessment... Nonetheless, everyone expects a grim prognosis.
As a result, White House aides are already attacking the C.B.O.’s credibility, announcing in advance that whatever it says will be “fake news.” So why should we believe the budget office, not the Trump administration? Let me count the ways.
First, this White House already has a record of constant, blatant lying about health care that is, as far as I can tell, without precedent in modern history. ... If they say something, the default assumption should be that they’re lying.
Second, the C.B.O. is hardly alone in its negative assessments of Republican health care plans. In fact, just about every group with knowledge of the issue has reached similar conclusions. ...
Third, contrary to White House disinformation, the C.B.O. actually did a pretty good job of predicting the effects of the Affordable Care Act, especially when you bear in mind that the act was a leap into the unknown: We had very little experience of how an A.C.A.-type system would work. ...
Finally — and this seems to me to be the most compelling argument of all — predicting the effects of destroying the A.C.A. is much easier than predicting the consequences when it was enacted, because what the Senate bill would do, pretty much, is return us to the bad old days. Or to put it another way, what McConnell and Senator Ted Cruz are selling is a giant leap into the known, taking us back to a system whose flaws are all too familiar from recent experience. ...
So while careful, nonpartisan modeling, the kind the C.B.O. excels in, is important, you don’t need a detailed analysis to know what American health care would look like if this bill passes. Basically, it would look like pre-A.C.A. Texas, where 26 percent of the nonelderly population was uninsured.
And lack of insurance wouldn’t be the only problem: Many people would have “junk insurance” — insurance with deductibles so large or coverage limitations so extensive as to be effectively useless when needed. ...
Will this vileness prevail? Your guess is as good as mine... But the mere possibility that this much cruelty, wrapped in this much fraudulence, might pass is a horrifying indictment of his party.
I have a new column:
Here’s Why We’re Not Prepared for the Next Recession: When will the next recession hit the economy? Nobody knows for sure, but we can be certain that sooner or later the economy will experience another downturn. When that happens, will monetary and fiscal policymakers have the ability to respond effectively?
The inevitability of another recession is evident in a graph of the unemployment rate. ...
- Slow productivity growth may not be the 'new normal' for the US - VoxEU
- The Pricing Answer to Traffic Congestion - Tim Taylor
- On BBC bias - Stumbling and Mumbling
- Why Do Cities Become Unaffordable? - Robert J. Shiller
- The Cyclical Sensitivity in Estimates of Potential Output - NBER
- The OBR’s risk assessment lacks context - mainly macro
- Cost of living and per capita incomes in U.S. cities - FRED Blog
- An Open Letter to the Honorable Randal K. Quarles - Cecchetti & Schoenholtz
- Can temporary affirmative action policies have lasting effects? - AEA
- Monetary Policy for a central bank with no balance sheet - Nick Rowe
- The Stock Market Is Doing About the Same as Always – Kevin Drum
- Ted Cruz’s Giant Leap Into The Known - Paul Krugman
Saturday, July 15, 2017
How to Think Like an Economist (If, That Is, You Wish to...): I have long had a "thinking like an economist" lecture in the can. But I very rarely give it. It seems to me that it is important stuff—that people really should know it before they begin studying economics, because it would make studying economics much easier. But it also seems to me—usually—that it is pointless to give it at the start of a course to newBs: they just won't understand it. And it also seems to me—usually—that it is also pointless to give it to students at the end of their college years: they either understand it already, or it is too late.
By continuity that would seem to imply that there is an optimal point in the college curriculum to teach this stuff. But is that true?
What do you think?
+ + + +
Every new subject requires new patterns of thought; every intellectual discipline calls for new ways of thinking about the world. After all, that is what makes it a discipline: a discipline that allows people to think about a subject in some new way. Economics is no exception.
In a way, learning an intellectual discipline like economics is similar to learning a new language or being initiated into a club. Economists’ way of thinking allows us to see the economy more sharply and clearly than we could in other ways. (Of course, it can also cause us to miss certain relationships that are hard to quantify or hard to think of as purchases and sales; that is why economics is not the only social science, and we need sociologists, political scientists, historians, psychologists, and anthropologists as well.) In this chapter we will survey the intellectual landmarks of economists’ system of thought, in order to help you orient yourself in the mental landscape of economics.
Economics: What Kind of Discipline Is It? ...
- Kenneth Arrow Commemoration - Larry Summers
- The New Climate Of Treason - Paul Krugman
- What’s Wrong with the Price-Specie-Flow Mechanism, Part II - David Glasner
- So Many Critics of Economics Miss What It Gets Right - Noah Smith
- Incentives, effort, and performance in higher education - VoxEU
- The US Labor Market is Still Losing Ground Relative to Trend - Douglas Campbell
- Trumponomics philosophy: it doesn’t suck enough to be poor - C. Rampell
- Follow the Balance of Payments Breakevens of the Oil Exporters - Brad Setser
- On contradictory risk attitudes - Stumbling and Mumbling
- Why German wages need to rise - mainly macro
- Y2K Everyday? - Digitopoly
- FedViews - FRBSF
Friday, July 14, 2017
"the last act in a long con":
The Cruelty and Fraudulence of Mitch McConnell’s Health Bill, by Paul Krugman, NY Times: A few days ago the tweeter in chief demanded that Congress enact “a beautiful new HealthCare bill” before it goes into recess. But now we’ve seen Mitch McConnell’s latest version of health “reform,” and “beautiful” is hardly the word for it. In fact, it’s surpassingly ugly, intellectually and morally. Previous iterations of Trumpcare were terrible, but this one is, incredibly, even worse. ...
The most important change in the bill ... is the way it would effectively gut protection for people with pre-existing medical conditions. The Affordable Care Act put minimum standards on the kinds of policies insurers were allowed to offer; the new Senate bill gives in to demands by Ted Cruz that insurers be allowed to offer skimpy plans that cover very little, with very high deductibles that would make them useless to most people.
The effects of this change would be disastrous. Don’t take my word for it: It’s what the insurers themselves say. ...
Or to put it another way, this bill would send insurance markets into a classic death spiral. Republicans have been predicting such a spiral for years, but keep being wrong: ...Obamacare ... is stabilizing, and doing pretty well in states that support it. But this bill would effectively sabotage all that progress.
And let’s be clear: Many of the victims of this sabotage would be members of the white working class, people who voted for Donald Trump in the belief that he really meant it when he promised that there would be no cuts to Medicaid and that everyone would get better, cheaper insurance. So why ... is there even a chance that it might become law?
The main answer, I’d argue, is that ... conservative ideology always denied the proposition that people are entitled to health care; the Republican elite considered and still considers people on Medicaid, in particular, “takers” who are effectively stealing from the deserving rich.
And the conservative view has always been that Americans have health insurance that is too good, that they should pay more in deductibles and co-pays, giving them “skin in the game,” and thus an incentive to control costs.
So what we’re seeing here is supposed to be the last act in a long con, the moment when the fraudsters cash in, and their victims discover how completely they’ve been fooled. The only question is whether they’ll really get away with it. We’ll find out very soon.
- The US Treasury’s missed opportunity - VoxEU
- Cross-Border Spillovers of Balance Sheet Normalization - Lael Brainard
- Charter schools do more than teach to the test - Microeconomic Insights
- Does arbitrage always improve market efficiency? - Microeconomic Insights
- Children’s well-being, black student loan debt - Brookings
Thursday, July 13, 2017
- Takers and Fakers - Paul Krugman
- Table Russia, Focus on Health Care - The New York Times
- Retracing the history of UK banking - Bank Underground
- Western Civilization and Presidential Hypocrisy - Larry Summers
- Endogenous growth and lack of recovery from the Global Crisis - VoxEU
- The measurement and understanding of economic inequality - Robert Solow
- More Evidence for the 'Self-Induced Paralysis' Thesis - Douglas L. Campbell
- Inevitability of the need for economic growth—the nth time - globalinequality
- Comparing Companies to Nations - EconoSpeak
- Chinese modernization c. 1930 - Understanding Society
- An Update on Labor Force Participation - macroblog
- We Don’t Need No Education - Paul Krugman
- The Bandwidth for the KPSS Test - Dave Giles
- Refugees in Germany - IGM Forum
- The danger of dismissing market failures - Brookings
- Rooftop Solar Is No Match for Crony Capitalism - Noah Smith
- Tally Sticks and the Fundamentals of Money - Tim Taylor
Wednesday, July 12, 2017
How Market Power Leads to Corporate Political Influence, by Asher Schechter: Neoclassical economic theory assumes that firms have no power to influence the rules of the game. A new paper by Luigi Zingales argues: This is true only in competitive product markets. When firms have market power, they will seek and obtain political influence and vice versa.
In 2016, the advocacy group Global Justice Now published a report showing that 69 of the world’s largest 100 economic entities are now corporations, not governments. With annual revenues of $485.9 billion, Walmart topped all but nine countries. As the world’s corporations continue to grow bigger and more profitable, so does the power and influence they wield: multinational corporations employ vast armies of lobbyists, lawyers, and PR people across borders and continents, and they have more than enough resources to capture regulators and elected representatives the world over.
Yet, the prevailing economic definition views firms as merely “a nexus of contracts” with “no power of fiat, no authority, no disciplinary action any different in the slightest degree from ordinary market contracting between two people.” How is it possible to reconcile these two views? A new paper by Luigi Zingales (Faculty Director of the Stigler Center and one of the editors of this blog) tries to bridge this gap.
The Medici vicious circle
The neoclassical model of the firm, notes Zingales, is a reasonable description of firms operating in highly competitive markets, where firms have little incentives and fewer resources to distort the rules of the game. Little incentives because in a neoclassical framework firms are relatively small, and thus the costs of these activities tend to exceed their share of the benefits. Fewer resources, because a competitive market does not provide firms with abnormal profits to spend in lobbying activities.
The opposite is true in concentrated markets, where firms enjoy sufficiently high profits to spend in lobbying activity. Some market power is particularly important to gain political influence when cash bribes are relatively rare, writes Zingales. In such an environment, firms gain political power through promises of future benefits. Only if firms have significant market power do they have rents to allocate. At the same time, firms’ promises of future rents are credible only to the extent that firms are expected to be around in the future, a prospect greatly enhanced by the existence of some barrier to entry in the markets in which they operate. Thus, firms can gain political power only when they have significant market power. ...
Why recessions followed by austerity can have a persistent impact: Economics students are taught from an early age that in the short run aggregate demand matters, but in the long run output is determined from the supply side. A better way of putting it is that supply adjusts to demand in the short run, but demand adjusts to supply in the long run. A key part of that conceptualisation is that long run supply is independent of short run movements in demand (booms or recessions). It is a simple conceptualisation that has been extremely useful in the past. Just look at the UK data shown in this post: despite oil crises, monetarism and the ERM recessions, UK output per capita appeared to come back to an underlying 2.25% trend after WWII.
Except not any more: we are currently more than 15% below that trend and since Brexit that gap is growing larger every quarter. Across most advanced countries, it appears that the global financial crisis (GFC) has changed the trend in underlying growth. You will find plenty of stories and papers that try to explain this as a downturn in the growth of supply caused by slower technical progress that both predated the GFC and that is independent of the recession caused by it.
In a previous post I looked at recent empirical evidence that told a different story: that the recession that followed the GFC appears to be having a permanent impact on output. You can tell this story in two ways. The first is that, on this occasion for some reason, supply had adjusted to lower demand. The second is that we are still in a situation where demand is below supply. ... [explains] ...
All this shows that there is no absence of ideas about how a great recession and a slow recovery could have lasting effects. If there is a problem, it is more that the simple conceptualisation that I talked about at the beginning of this post has too great a grip on the way many people think. If any of the mechanisms I have talked about are important, then it means that the folly of austerity has had an impact that could last for at least a decade rather than just a few years.
- The myth of the German jobs miracle - Matthew Klein
- How do credit supply shocks affect the real economy? - Mian, Sufi, Verner
- Cross-Border Spillovers of Balance Sheet Normalization - Lael Brainard
- Does the Journal System Distort Scientific Research? - Miles Kimball
- Young Men Give Up Work for Video Games? Be Skeptical - Noah Smith
- Trump’s Security Vision Leaves Little Room for Plowshares - Eduardo Porter
- The Fed Gets Optimistic About Inflation - Narayana Kocherlakota
- The unhappiness of the US working class - Brookings
- The CICE comedy - Le blog de Thomas Piketty
- Arm's-Length International Trade - Tim Taylor
- Responding to Urban Decline - FRB Richmond
- A New Puzzle à la Fama - Econbrowser
- Inflation Target - IGM Forum
Tuesday, July 11, 2017
- Why Single-Payer Health Care Saves Money - Robert Frank
- Formerly True Theories - Paul Krugman
- Trump Nominates Randal Quarles to Oversee Wall Street Banks - NYTimes
- The secular rise in personality traits - VoxEU
- Global value chains shed new light on trade - Brookings Institution
- What’s Holding Back Business Formation? - FRBSF
- The New Abnormal in Monetary Policy - Nouriel Roubini
- Impact of Macro Surprises Changed After Zero Lower Bound - Dallasfed.org
- Dealing with Imperfect Instruments III - Marc Bellemare
- On Matthew effects - Stumbling and Mumbling
- How the Fed Changes the Size of Its Balance Sheet - Liberty Street
- Populism and the Economics of Globalization - NBER
- Measuring the impact of austerity - mainly macro
- How Healthy is the Global Financial System? - Mohamed A. El-Erian
Monday, July 10, 2017
There are three good reasons why Republicans, in their quest to fund tax cuts for the wealthy, can't find an alternative to Obamacare that avoids "a huge rise in the number of uninsured":
Three Legs Good, No Legs Bad, by Paul Krugman, NY Times: Will 50 Republican senators be willing to inflict grievous harm on their constituents in the name of party loyalty? I have no idea.
But this seems like a good moment to review why Republicans can’t come up with a non-disastrous alternative to Obamacare...
Suppose you want to make health coverage available to everyone..., the Affordable Care Act went for ... the so-called three-legged stool.
It starts by requiring that insurers offer the same plans, at the same prices, to everyone... This deals with the problem of pre-existing conditions. On its own, however, this would lead to a “death spiral”: healthy people would wait until they got sick to sign up, so those who did sign up would be relatively unhealthy, driving up premiums, which would in turn drive out more healthy people, and so on.
So insurance regulation has to be accompanied by the individual mandate, a requirement that people sign up for insurance, even if they’re currently healthy. And the insurance must meet minimum standards: Buying a cheap policy that barely covers anything is functionally the same as not buying insurance at all.
But what if people can’t afford insurance? The third leg of the stool is subsidies ... for those with lower incomes. For those with the lowest incomes, the subsidy is 100 percent, and takes the form of an expansion of Medicaid.
The key point is that all three legs of this stool are necessary...
Republicans ... ideas involve sawing off one or more legs of that three-legged stool.
First, they’re dead set on repealing the individual mandate...
Second, they’re determined to slash subsidies — including making savage cuts to Medicaid — in order to free up money ... to cut taxes on the wealthy. The result would be a drastic rise in net premiums for most families.
Finally, we’re now hearing a lot about the Cruz amendment, which would let insurers offer bare-bones plans with minimal coverage and high deductibles. These would be useless to people with pre-existing conditions, who would find themselves segregated into a high-cost market — effectively sawing off the third leg of the stool.
So which parts of their plan would Republicans have to abandon to avoid a huge rise in the number of uninsured? The answer is, all of them.
After all these years of denouncing Obamacare, then, Republicans have no idea how to do better. Or, actually, they have no ideas at all.
June Employment Report Recap, by Tim Duy: A generally upbeat June 2017 employment report supports the Fed's case for additional monetary tightening, most likely in the form of balance sheet action in September followed up by a 25bp rate hike in December. Moreover, the solid pace of job growth will encourage the Fed to maintain 2018 policy projections as well. Although the unemployment rate ticked up, ongoing job growth at this pace will eventually push it back down. Weak wage growth continues to restrain the Fed from accelerating the pace of easing; the tepid pace of wage gains suggests the Fed's estimates of full employment remain too high.
Nonfarm payrolls rose by 22sk in June, above expectations. Moreover, both April and May were revised higher. The three month and twelve month paces are just below 200k. Job growth continues to slow, but the rate of decline is very shallow:
Looking into the future, temporary help payrolls continues to climb after the transitory slowdown in 2015:
This typically indicates sustained broad job growth in future months. Further evidence of a solid job market is visible in the accelerating of aggregate hours worked:
Payroll growth remains above the roughly 100k the Fed believes is necessary to hold the unemployment rate constant once demographic impacts outweigh cyclical impacts on labor force growth. For June, however, the unemployment rate ticked up on the back of higher labor force participation:
Still, the Fed won't take much relief in the gain. For all intents and purposes, labor force participation has been move sideways since 2014:
The monthly variance so far has been just noise.
Despite low unemployment, wage growth remains anemic:
One would have expected a pickup in wage growth if the economy were indeed operating substantially beyond full employment. This gives the Fed something to think about in the latter half of this year - they don't want to choke out growth too quickly if the natural rate of unemployment is in fact much lower than current estimates. Still, concern that wage growth will soon spike if their estimates are correct encourage most Fed policymakers to keep their foot gently on the brake.
Bottom Line: Even as weak wage growth couples with soft inflation to raise a bit of caution among central bankers, the overall tenor of the labor markets remains sufficient for the Fed to maintain its tightening bias. They really need softer job numbers to thrown in the towel on their expected policy path for 2017 and 2018.
- Trump’s behavior is the biggest threat to U.S. national security - Larry Summers
- When Was The Golden Age Of Conservative Intellectuals? - Paul Krugman
- The crisis of positive-sum capitalism - Stumbling and Mumbling
- Ben Bernanke, in Denial? "When Growth is Not Enough" - Douglas L. Campbell
- The Liberal Conscience (Bertrand Russell Edition) - Roger E. A. Farmer
- On the Identification of Network Connectedness - No Hesitations
- Collective bargaining in OECD countries - VoxEU
- Mending the Gap? - Economic Principals
- Against Charisma - mainly macro
- Wage Growth Slows Sharply - Dean Baker
Saturday, July 08, 2017
"Why is there such an enormous gulf between what economists know and what they say in public?":
What Economics Models Really Say A Review of Economics Rules: The Rights and Wrongs of the Dismal Science by Dani Rodrik (Norton, 2015) Peter Turchin University of Connecticut Seshat: Global History Databank: [This work is made available under the terms of the Creative Commons Attribution 4.0 license, http://creativecommons.org/licenses/by/4.0/ ]
The blurb on the jacket of Economics Rules says, “In this sharp, masterful book, Dani Rodrik, a leading critic from within, takes a close look at economics to examine when it falls short and when it works, to give a surprisingly upbeat account of the discipline.” I heartily agree with nearly all of this, with the exception of the “upbeat” part. As I will explain toward the end of this review, my view of economics, and, especially, of the role that economists play in public policy, is much more critical.
A central theme in the book is the role of mathematical models in economics. Formal models in economics and other social sciences are often disparaged. According to the critics (who include some economists, many other social scientists, and the overwhelming majority of historians), models oversimplify complex reality, employ unrealistic assumptions, and deny “agency” to human beings.
Rodrik rejects this critique. According to him, mathematical models— “simplifications designed to show how specific mechanisms work by isolating them from other, confounding effects”—are the true strength of economics. A simplified description of reality is not a shortcoming, it’s the essence of a good model.
My own training was in mathematical biology, and as a graduate student during the 1980s I saw the tail end of the “Math Wars” in ecology. By the 1990s the war was won, and any respectable department of ecology and evolution had to have on faculty at least one modeler. Today, the great majority of ecologists agree that a science cannot become a Science until and unless it develops a well-articulated body of mathematical theory.
In the social sciences, different disciplines made this transition at different times, with economics leading the pack and laggards, like history, undergoing this transition only now (hence cliodynamics—“history as science”; it’s worth noting that most American historians consider history not as a social science, but as one of the humanities).
I was, thus, a bit bemused to read Rodrik’s defense of mathematical models (haven’t economists resolved the Math Wars already?). But it’s an excellent defense—all aspiring cliodynamicists should read Economics Rules, if only for this reason.
The list of reasons why we need mathematical models in a scientific discipline is familiar to all who have extensive experience in modeling (and for those who don’t have such experience, I suggest you read Chapters 1 and 2 of Economics Rules). Models clarify the logic of hypotheses, ensure that predictions indeed follow from the premises, open our eyes to counterintuitive possibilities, suggest how predictions could be tested, and enable accumulation of knowledge. The advantage of clarity that mathematical models offer scientists is nicely illustrated in the following quote from Economics Rules: “We still have endless debates today about what Karl Marx, John Maynard Keynes, or Joseph Schumpeter really meant. … By contrast, no ink has ever been spilled over what Paul Samuelson, Joe Stiglitz, or Ken Arrow had in mind when they developed the theories that won them their Nobel.” The difference? The first three formulated their theories largely in verbal form, while the latter three developed mathematical models.
The value of the book, however, is in more than just weighing in on the usefulness of mathematical models. As Rodrik notes early in the book, “economics is by and large the only social science that remains almost entirely impenetrable to those who have not undertaken the requisite apprenticeship in graduate school.” And economics is “impenetrable” not because of mathematical models, at least not to someone trained in mathematical natural sciences (the math is universal), but because economists have developed an entirely distinct jargon that sets them apart from other disciplines and creates artificial barriers to understanding the many truly worthwhile insights from economics models.
Because I have not “undertaken the requisite apprenticeship”, I found very useful Rodrik’s explanations of the insights generated by such classic models in economics as the First Fundamental Theorem of Welfare Economics, the Principle of Comparative Advantage, and the General Theory of Second Best. Particularly illuminating were the discussion of what happens to the fundamental result of a model when we start systematically relaxing various assumptions on which it depends. This part of the book, together with the references that Rodrik provides, could serve as a basis for an excellent mini-course on what economics theory really tells us.
And a general take-home message that emerges from this discussion is that if we want to understand Big Questions—when do markets work or fail, what makes economies grow, and what are the effects of deficit spending—there is not one fundamental model, “the Model”. Instead, we need to study an array of models, each telling a partial story.
So far so good. But Rodrik, in my opinion, goes too far in denying the value of general theory. At one point he writes, “society does not have fundamental laws— at least, not quite in the same way that nature does.” And: “the same theory of evolution applies in both Northern and Southern Hemispheres,” but “economic models are different.”
Not really. Let’s take the theory of evolution. It’s not a single model. It’s a theoretical framework that includes hundreds, perhaps thousands of special case models, each telling only a partial story. To give an example, textbooks on evolutionary theory often start with a single-locus two-allele model (which gives us the famous Hardy-Weinberg Equilibrium). But you will need different models for haploid organisms (such as bacteria, who have a single unpaired chromosome), or for organisms reproducing asexually; and yet another set of models for phenotypic selection. Despite such diversity of modeling approaches, there is a theoretical unity in evolutionary biology. In particular, the conceptual framework of evolutionary theory provides a set of guidelines for the theoreticians on which model to use in which context.
And I don’t see how the situation is different in economics (and, more generally, social sciences). Yes, there is a multiplicity of models in economics, but you can’t just select one randomly (or worse, “cherry pick” among the results to suit your ideological agenda). There are rules for choosing appropriate models, and Rodrik devotes Chapter 3 of his book to explaining general principles of model selection in economics. In other words, theoretical frameworks are not simply compendia of models, they also include model selection rules (and a few other things).
Rodrik, thus, sells short the potential for general theory in social sciences. Naturally, economics, in particular, does not have such an elaborate, well-articulated, and empirically validated theoretical framework as evolutionary biology (and evolutionary biology, in turn, lags behind many subdisciplines of physics). But who is to say that economics will not develop to the same level in the future? We’ll see if we live long enough.
Let’s now shift gears and talk about Chapter 5, “When Economists Go Wrong.” To make the following discussion concrete, I will focus on a particular theoretical result in economics, the Principle of Comparative Advantage, and what this principle implies for trade policy. In popular press, of course, comparative advantage is always used as a justification for advocating free trade. Rodrik does an admirable job explaining why, under many conditions, free trade can lead to really negative consequences for economies and populations of countries that open themselves to international competition. For example, there is strategic behavior. A country may choose to protect its domestic industry with high tariffs and subsidize its exports in order to gain market share. Perhaps its leaders don’t understand the Principle of Comparative Advantage, not having the benefit of apprenticeship in economics. Or perhaps they care more about their country's long-term survival in an anarchic international environment than about making immediate profit.
In one particularly revealing passage in the book, Rodrik writes,
consider how opening up trade—one of the key items of the Washington Consensus—was supposed to work. As barriers to imports were slashed, firms that were unable to compete internationally would shrink or close down, releasing their resources (workers, capital, managers) to be employed in other parts of the economy. More efficient, internationally competitive sectors, meanwhile, would expand, absorbing those resources and setting the stage for more rapid economic growth. In Latin American and African countries that adopted this strategy, the first part of this prediction largely materialized, but not the second. Manufacturing firms, previously protected by import barriers, took a big hit. But the expansion of new, export-oriented activities based on modern technologies lagged. Workers flooded less productive, informal service sectors such as petty trading instead. Overall productivity suffered. [italics are mine]
Washington Consensus outcomes in Latin America and Africa stand in sharp contrast with the experience of Asian countries. … Instead of liberalizing imports early on, South Korea, Taiwan, and later China all began their export push by directly subsidizing homegrown manufacturing. … All of them undertook industrial policies to nurture new manufacturing sectors and reduce their economies’ dependence on natural resources.
As Rodrik correctly stresses, these cases do not prove that standard economics is wrong. In short, “someone who advocates free trade because it will benefit everyone probably does not understand how comparative advantage really works.”
Models that were developed for “the way markets really work—or fail to work—in low-income settings with few firms, high barriers to entry, poor information, and malfunctioning institutions, these alternative models proved indispensable”—by telling us why countries that followed the Washington Consensus failed, and those who threw it to the wind succeeded.
But then how does one explain that nearly all economists—96 percent— strongly agree with the following statement: “Free trade improves the productive efficiency and offers consumers better choices, and in the long run these gains are much larger than any effects on unemployment” (Politicians Should Listen to Economists on Free Trade, by Bryan Riley, The Heritage Foundation, Feb.1, 2013; this was from a survey conducted by the University of Chicago’s Booth School of Business).
Rodrik argues that “the problem has to do more with the way economists present themselves in public than with the substance of the discipline.” “In public, the tendency is to close ranks and support free markets and free trade.”
But why is there such an enormous gulf between what economists know and what they say in public? One possible explanation is that policies, such as free trade, while often harming broad swaths of populations, tend to benefit narrow segments of economic elites. Perhaps the critics from the left (and a few “heterodox economists”) are right when they charge that economists speak what the powers-that-be want us to hear.
Whatever the explanation, I cannot agree that Rodrik’s book gives us “a surprisingly upbeat account of the discipline.” Economics may be a vibrant discipline, but most of the richness of its insights is hidden in academic publications behind the shield of specialist jargon, impenetrable to those who have not taken the requisite apprenticeship. And by closing ranks and unconditionally supporting free markets and free trade, economists have failed us, the general public. This is why we need more books like Economics Rules—so that we can find out what economics models really tell us.