Posts Tagged ‘faith’

Buiter on the eurozone

Thursday, December 8th, 2011

Former LSE economist Willem Buiter is predicting dire consequences from breakup of the eurozone.

Consider the exit of a fiscally and competitively weak country, such as Greece – an event to which I assign a probability of about 20-25 per cent. …. Balance sheets would become unbalanced and widespread default, insolvency and bankruptcy would result. Greek output would collapse.

Greece would temporarily gain a competitive advantage from the sharp decline in the new Drachma’s value, but … [s]oaring wage and price inflation would restore the uncompetitive status quo. ….

Disorderly sovereign defaults and eurozone exits by all five periphery states – an event to which I attach a probability of no more than 5 per cent – would … trigger a global depression that would last for years, with GDP likely falling by more than 10 per cent and unemployment in the West reaching 20 per cent or more. Emerging markets would be dragged down too.

Exits by Germany and other fiscally and competitively strong countries could be even more disruptive. …. I consider this highly unlikely, with a probability of less than 3 per cent. …. Everyone, except lawyers specialising in the Lex Monetae, would become much poorer.

Even if a break-up of the eurozone does not destroy the EU completely and precipitate the kind of conflicts that disfigured the continent in the past, the case for keeping the show on the road seems rather robust.

Willem Buiter, “The terrible consequences of a eurozone collapse“, Financial Times, 8 December 2011.

Willem Buiter (1949-) was a member of the Bank of England’s Monetary Policy Committee from June 1997-May 2000. He joined the London School of Economics in September 2005, then left in November 2009 to take up a position as Chief Economist of Citigroup.

For the record, after the September 2008 collapse of Lehman Brothers, Buiter made a strong plea for the UK to adopt the euro:

The message of this paper is that the global financial crisis that started in August 2007 provides another powerful and sufficient argument for the United Kingdom to join the EMU and adopt the euro as soon as technically possible. This new financial stability argument for UK membership in the EMU is separate from and in addition to the conventional optimal currency arguments for joining, which have also become more persuasive in the past few years.

Willem Buiter, “Why the United Kingdom Should Join the Eurozone“, International Finance 11:3 (Winter 2008), pp. 269–282.

Readers might question whether Buiter’s current advice is any more useful than his advice three years ago to the UK was.

European reaction to Robert Lucas

Tuesday, September 27th, 2011

Via Mark Thoma, here is a European response to the Wall Street Journal‘s weekend interview of Nobel Laureate Robert Lucas.

When he [Lucas] is asked about Europe, he talks about the cost of high taxes. From the interview:

For the best explanation of what happened in Europe and Japan, he points to research by fellow Nobelist Ed Prescott. In Europe, governments typically commandeer 50% of GDP. The burden to pay for all this largess falls on workers in the form of high marginal tax rates, and in particular on married women who might otherwise think of going to work as second earners in their households. “The welfare state is so expensive, it just breaks the link between work effort and what you get out of it, your living standard,” says Mr. Lucas. “And it’s really hurting them.”

No doubt that (theoretically) high taxes could discourage effort but is this statement empirically relevant? Below is a chart of marginal tax rates … and the female employment to population ratio for the age range (25-54) for 2010 … (the chart looks similar if we look at a different age range or male participation rates).

Do we see more or less effort in countries with high tax rates? Not obvious. In fact, in the sample I have selected there seems to be a positive correlation, not a negative one. …. The US appears as a country with low taxes but also low levels of effort.

Antonio Fatás, “Macroeconomics: Evidence or Ideology“, Antonio Fatas and Ilian Mihov on the Global Economy, 26 September 2011.

Mr Fatás teaches economics at INSEAD, an international business school. He has an undergraduate degree (1987) from the Universidad de Valencia and a PhD (1993) from Harvard University.

This is yet another example of what I call “faith-based economics”: High taxes must discourage work, no matter what the evidence shows!

econometrics of the death penalty

Wednesday, May 25th, 2011

Gebhard Kirchgässner surveys econometric studies published in the last ten years on effects of the death penalty, and shows how simple it is to produce results that do or do not support the deterrence hypothesis. This is an important paper. I recommend that you download and read it in its entirety, but nonetheless attempt to summarize the author’s main message below.  (more…)

faith-based health economics

Saturday, May 14th, 2011

Princeton University economist Uwe Reinhardt explains that private health insurers can and do control premium growth by shifting costs to household budgets, but there is no evidence that they are able to control total spending on medical care. To argue otherwise, he writes, is “faith-based analysis”.

The annual Milliman Medical Index, released earlier this week by Milliman Inc., the Seattle-based employee-benefit consulting and actuarial company, … is particularly timely as the nation considers proposals to reduce sharply the role of the federal government in financing health care, along the lines proposed by Paul D. Ryan, Republican of Wisconsin and chairman of the House Budget Committee.

…. The index’s great virtue is that it includes not only the employer’s and employee’s contributions to the premium for P.P.O. coverage but also the out-of-pocket expenses the family has under the plan. ….

The estimated average cost of health spending from all sources for a typical privately insured American family more than doubled in the last decade, to $19,393 in 2011 from $8,414 in 2001.  ….

[P]rivate nonprofit and commercial health-insurance plans have at their disposal cost-control mechanisms that traditional Medicare has been denied by statute — for example, selective contracting with preferred providers that offer the insurer lower prices, or various direct interventions to control the volume of health services.

In addition, private nonprofit or commercial health insurers can offer other advantages that traditional Medicare has not, like disease management, wellness programs and better coordinated care — advantages that, in principle, are empirically demonstrable if they exist.

But the Milliman data do not suggest that superior control over total health spending — as opposed to controlling premium growth through cost-shifting to private household budgets — is among the industry’s strengths. To argue that the industry can do so is, at this point, faith-based analysis.

Uwe E. Reinhardt, “Would Privatizing Medicare Lead to Better Cost Controls?“, Economix, 13 May 2011.

Thanks to Mark Thoma for the pointer.

fiscal multipliers

Tuesday, February 8th, 2011

Unemployment in the US continues to be high despite the stimulus program enacted by the federal government in March of 2009. Some argue that this proves that the stimulus was too small; more is needed. Others question the validity of a key implication of Keynesian economics, that when demand is low, government spending can bridge the gap and have a multiplier effect on demand. The multiplier is defined as change in real GDP divided by change in government spending, so a multiplier greater than unity is essentially a ‘free lunch’: GDP goes up by more than the amount of government spending. A multiplier smaller than unity indicates that government spending is crowding out some private spending. A multiplier of zero means that all government spending crowds out private spending, and has no stimulus effect at all.

Sceptics of high Keynesian multipliers frequently cite the work of Harvard’s Robert Barro, a New Classical economist who has estimated government spending multipliers for the United States that are smaller than unity during periods of war, and close to zero in peacetime.

I have estimated … that World War II raised U.S. real defense expenditures by $540 billion (1996 dollars) per year at the peak in 1943–44, amounting to 44% of trend real GDP. I also estimated that the war raised real GDP above trend by $430 billion per year in 1943–44. Thus, the multiplier was 0.8 (430/540). ….

We can consider similarly three other U.S. wartime experiences—World War I, the Korean War, and the Vietnam War—although the added defense expenditures were much smaller in comparison to GDP than that for WWII. When I combined the evidence for all four wars, I got an overall estimate of the multiplier of 0.8, the same value as before. ….

When I attempted to estimate directly the multiplier associated with peacetime government purchases [from 1942 to 1978], I got a number that was statistically insignificantly different from zero.

Robert J. Barro, “Voodoo Multipliers“, Economists’ Voice (February, 2009).

High multipliers are only plausible when demand is low and there are no constraints on supply. During wartime supply constraints are the norm, and are often so severe that governments ration consumer goods. Nor would Keynesian multipliers be high during all periods of peacetime – rather, only when demand is low. Keynesian multipliers are relevant at the present time only if the US economy is in a severe recession and is not supply-constrained.

A new paper from the prestigious NBER (National Bureau of Economic Research) examines the period 1939-1941, the recessionary period just before World War II, to shed light on this debate. The authors show that the US fiscal multiplier was 1.9 through mid-1941, but falls to 0.9 if data are included from the second half of 1941, when capacity constraints began to appear.

Co-authors Robert Gordon and Robert Krenn conclude that nearly 90 percent of the economic recovery that took place between the first quarter of 1939 and the last quarter of 1941 can be attributed to fiscal policy innovations. ….

This paper highlights a paradox in the study of fiscal multipliers: even though proponents of fiscal policy stimulus to cure a weak economy operate in an environment of low capacity utilization, most of the actual episodes of rapid fiscal expansion have taken place either prior to or during wartime episodes in which capacity constraints were operative (including World War II, the Korean war, and the Vietnam war). An ideal test case for measuring the fiscal multiplier occurred in the six quarters between mid-1940 and late-1941, prior to the Pearl Harbor attack. Previous analysts assumed that this period represented a fair test of the multiplier effect, because the unemployment rate was 9.9 percent on average during 1941. However, this paper shows that capacity constraints did exist in 1941, particularly in the second half of the year. The fiscal stimulus in 1940-41 was partly crowded out not by any increase in interest rates, but rather by capacity constraints in critical area s of manufacturing that became increasingly binding in the second half of 1941. Therefore, estimates of fiscal multipliers for 1940-41 are only relevant to low-utilization situations like 2008-10 if they are based on the evolution of the U. S. economy through mid-1941 and exclude the effect of the capacity-constrained last half of 1941.

After reviewing evidence from the 1940-41 editions of Business Week, Fortune, and The New York Times, Gordon and Krenn document that the American economy went to war starting in June 1940, fully 18 months before Pearl Harbor. In February 1941 fully one percent of the American labor force was at work building army training camps for 1.4 million new draftees. Employment in ship-building to expand the U. S. Navy and to supply Lend-Lease aid to Britain accounted for another one percent of the labor force in 1941. As early as June 1941, capacity utilization had reached 100 percent in the production of iron and steel and durable goods of all types.

… Gordon and Krenn … show that private consumption and investment actually declined in the last half of 1941, as shortages of steel prevented auto companies from satisfying demand, and shortages of aluminum needed for aircraft production suppressed civilian production of everyday pots and pans. As a result, the government spending multiplier is 1.9 when estimated through mid-1941 but only 0.9 when measured through the end of 1941.

Robert J. Gordon and Robert Krenn “The End of the Great Depression“, NBER Working Paper No. 16380 (September 2010).

The summary above was compiled by Matt Nesvisky for The NBER Digest, February 2011.

Robert J. Gordon teaches economics at Northwestern University and is author of the popular text Macroeconomics, now in its 10th edition. His co-author Robert Krenn is employed by a proprietary trading firm in Chicago’s financial district. Their paper should satisfy Keynesian sceptics, but probably won’t, because empirical evidence seldom has any effect on economics as faith.

science and religion

Wednesday, September 8th, 2010

Cambridge University philosopher Tim Crane notes that more people today turn to religion than to science. The widespread popularity of religion, he feels, is due not to ignorance or irrationality, but rather to “the kind of intellectual, emotional and practical appeal that religion has for people, which is a very different appeal from the kind of appeal that science has”.

Taken as hypotheses, religious claims do very badly: they are ad hoc, they are arbitrary, they rarely make predictions and when they do they almost never come true. Yet the striking fact is that it does not worry Christians when this happens. In the gospels Jesus predicts the end of the world and the coming of the kingdom of God. It does not worry believers that Jesus was wrong (even if it causes theologians to reinterpret what is meant by ‘the kingdom of God’). If Jesus was framing something like a scientific hypothesis, then it should worry them. Critics of religion might say that this just shows the manifest irrationality of religion. But what it suggests to me is that that something else is going on, other than hypothesis formation. ….

Tim Crane, “Mystery and Evidence”, NY Times Opinionator, 5 September 2010.

Claims in economics often do as badly as religious claims, for much the same reason: “they are ad hoc, they are arbitrary, they rarely make predictions and when they do they almost never come true”. Moreover, like religious claims, they can never be disproved. See my posts on “economics as faith“.

economics as faith (8)

Wednesday, April 14th, 2010

FT columnist John Kay provides another example of what I have dubbed ‘faith-based economics’, this one drawn from high theory rather than vulgar econometrics.

[Advanced macroeconomics today is] associated with the idea of rational expectations – which might be described as the idea that households and companies make economic decisions as if they had available to them all the information about the world that might be available. If you wonder why such an implausible notion has won wide acceptance, part of the explanation lies in its conservative implications. Under rational expectations, not only do firms and households know already as much as policymakers, but they also anticipate what the government itself will do, so the best thing government can do is to remain predictable. Most economic policy is futile.

John Kay, “Economics may be dismal, but it is not a science”, Financial Times, 14 April 2010.

The appeal of “economics as faith” is almost always political.  Heretic John Kay discards the efficient market hypothesis (EMH) and dynamic stochastic general equilibrium (DSGE) as useless theories, concluding “There is no universal economic theory, and new economic thinking must necessarily be eclectic. That insight is Keynes’s greatest legacy.”

Eugene Fama on efficient markets

Tuesday, March 9th, 2010

The Efficient Market Hypothesis (EMH) states that asset prices reflect all known information that impacts their value. This thesis fell into disrespect (to put it mildly!) after the 2008 financial crisis. A few acolytes, however, have managed to keep the faith. This small group includes Eugene Fama (1939-), a Chicago economist who, until recently, was on everyone’s short list of candidates for a Nobel Prize. Fama is often thought of as the father of EMH.

Professor Fama drafted his professional autobiography for publication in the Annual Review of Financial Economics. I was curious to see if his views had changed, and to find out if he had any regrets in the wake of the financial collapse of 2008. I was surprised to learn that he still believes in the efficiency of markets, and is totally unrepentant. He acknowledges, however, that “market efficiency per se is not testable” so must be assumed. EMH is a clear example of what I have dubbed “economics as faith”. Here are some brief excerpts from Fama’s autobiographical essay.

Finance is the most successful branch of economics in terms of theory and empirical work …. I have been doing research in finance almost since its start …. It has been fun to see it all, to contribute, and to be a friend and colleague to the giants who created the field.

My [1965 PhD] thesis and the earlier work of others on the time-series properties of returns falls under what came to be called tests of market efficiency. I coined the terms “market efficiency” and “efficient markets,” but they do not appear in my thesis. They first appear in “Random Walks in Stock Market Prices,” … reprinted in the Financial Analysts Journal (1965). ….

The joint hypothesis problem is generally acknowledged in work on market efficiency after [my main contribution to the theory of efficient markets -] Fama (1970), and it is understood that, as a result, market efficiency per se is not testable. The flip side of the joint hypothesis problem is less often acknowledged. Specifically, almost all asset pricing models assume asset markets are efficient, so tests of these models are joint tests of the models and market efficiency. Asset pricing and market efficiency are forever joined at the hip.

Eugene F. Fama, “My Life in Finance”, 4 March 2010.

Thanks to Greg Mankiw for the pointer.

innovation is not R&D

Wednesday, December 16th, 2009

But is R&D innovation? John Kay explains.

When we talk about innovation, we visualise men and women in white coats with test tubes and microscopes. Outside many university cities around the world there are biotechnology estates established by governments that believe high technology is the key to a competitive future. The funds that governments provide to support innovation are all too often appropriated by large companies that are better at forming committees to pontificate about what the global village will want in the future than they are at assessing what their customers want today. ….

Last month the [UK’s] National Endowment for Science, Technology and the Arts picked up this point. For years research and development scorecards have dutifully recorded how much pharmaceuticals companies spend on the search for new drugs and the expenditure of governments on defence electronics. But a Nesta report, presenting plans for a new innovation index has now recognised that most of the spending that promotes innovation does not take place in science departments. The financial services industry may have been Britain’s most innovative industry in the past two decades – perhaps too innovative – but practically none of the expenditure behind that innovation comes under “R&D”. And the same is true in retailing, media and a host of other innovative industries.

John Kay, “Innovation is not about wearing a white coat”, Financial Times, 16 December 2009.

An ungated version of this column will soon be posted here.

A pilot version of pilot version of NESTA’s Innovation Index can be downloaded here.

Data will be added over the next 12 months, and the Index will be extended to incorporate public sector innovation. NESTA promises then to update the Index each year with new data.

I was excited and eager to learn more, but became very disillusioned by the time I reached page 14 of the pilot report:

The second component is what macroeconomists describe as Total Factor Productivity (TFP). This is the measure of productivity growth that is not accounted for by the growth in factor inputs, such as physical capital or labour quality, and is generally attributed to better ways of doing things, including the broader benefits of technological advances and improved processes. In the approach used in the Innovation Index, in which the private benefits of investments such as R&D are captured separately, TFP includes the spillover benefits of innovation investment.

This methodology shows that between 2000 and 2007, labour productivity grew at an annual average of 2.7 per cent per year. Innovation contributed 1.8 per cent, or approximately two-thirds of the growth experienced.

NESTA, “The Innovation Index: Measuring the UK’s investment in innovation and its effects”, November 2009.

TFP is the residual that is left after regressing output on inputs, i.e. the residual of an aggregate production function. I have discussed all the problems with this methodology in a series of seven thoughts titled “economics as faith”. To locate these posts, type “economics as faith” into the search bar, or click on the “production functions” tag.

The first component of the Index is somewhat better. It consists of adding up all expenditure on R&D (really!), plus all expenditure on design, training, market research, etc. etc.. “However, R&D represents only 11 per cent of the investment in innovation ….” In other words, 89% of all innovation expenditure is excluded from the R&D budgets of private firms. So far, so good. But NESTA then uses “a growth accounting approach … to understand the effect of these [expenditures] on productivity growth.” This requires measures of aggregate productivity, reliance again on “economics as faith”.

I did not look at the third and last component of the Index, “a set of metrics that can be tracked to assess how favourable a climate the UK is for innovation”, so will not comment on that. I also do not know how – or whether – the three components will be combined to form a single index.

economics as faith (7)

Monday, October 12th, 2009

The data of most economies are filled with apparently inconsistent series. By choosing among them, one can produce almost any estimate of productivity growth imaginable.

Alwyn Young “Gold into Base Metals: Productivity Growth in the People’s Republic of China during the Reform Period”, Journal of Political Economy 111:6 (2003), p. 22.

As Professor Young acknowledges, all growth accounting exercises should be taken with more than a grain of salt. Nonetheless growth accounting is a growth industry for academics. A recent study of China and India reaches new lows, however, in presenting questionable findings without providing the reader with caveats of any kind. The American Economic Association published it last year in their prestigious Journal of Economic Perspectives. Somehow it made it past the editors. I report only on the authors’ adjustment of labour input for skill levels – a glaring example of the general low quality of the piece.

Growth accounting provides a framework for allocating changes in a country’s observed output into the contributions from changes in its factor inputs—capital and labor—and a residual, typically called total factor productivity. ….

This approach is based on a production function in which output is a function of capital, labor, and a term for total factor productivity. …. [L]abor … is adjusted for … skills; we use average years of schooling as a proxy for skill levels and assume a constant annual return of 7 percent for each additional year of education.

Young (2003) provides a useful overview of Chinese statistics on educational attainment …. [H]is analysis of the relationship between earnings and years of schooling finds surprisingly low returns. ….

As noted earlier, our human capital index assumes that each additional year of schooling raises labor force productivity [in China and India] by 7 percent [even though Young (2003, p. 1246) found effects a fraction of that size for China.] This [7%] figure is based on a large number of empirical studies relating wages and years of schooling.

Barry Bosworth and Susan M. Collins, “Accounting for Growth: Comparing China and India”, Journal of Economic Perspectives 22:1 (Winter 2008), pp. 45–66.

The empirical studies alluded to are ‘Mincer equations’ – the regression of wage rates on levels of schooling and (sometimes) experience – and there are literally thousands of these studies. They almost always show that more schooling is associated with higher wages, but this does not prove that schooling increases productivity.

Suppose that schools exist only to screen students for ability, and that school attendance has no effect at all on productivity. In such a world, schooling is privately profitable but socially wasteful. Workers who complete more years of schooling are more productive and enjoy higher wages than workers who drop out of school. But increasing everyone’s consumption of schooling by a year has no effect on productivity or wages! Once there is a large pool of ‘schooled’ workers, employers will find that they have to demand a university degree for jobs that used to require only a high school diploma, because completion of high school no longer signals sufficient intelligence to handle the job. All this is well-known but is disregarded by the authors, who literally pull a 7% figure out of the air and inappropriately apply cross-section regression results to macro models of growth.

Barry Bosworth is Senior Fellow of Brookings Institution in Washington, DC. Susan M. Collins is Dean of Public Policy, Gerald R. Ford School of Public Policy, University of Michigan.