Zombie Economics

John Quiggin of Crooked Timber has published a book and more, and often talks about Zombie Economics - bad economic theories that just won't die.

He's been taken to task by David Henderson, a prominent libertarian, recently, over his faith in government - Henderson asking well, isn't that a zombie idea that won't die - that governments can be benevolent? 

The easy retort of course is that equally, the belief that governments are always and everywhere malevolent, which underpins all libertarian dogma thinking on anything, is equally a zombie idea by that logic - both points of view are essentially beliefs and some evidence has to be discarded to support each.

Today marks 100 years since a horrific fire at a factory in New York which killed over 100 workers. In the account linked, the horrifying part is that workers couldn't get to the stairway because the doors were locked by factory owners unwilling to let them take breaks for fear of shirking. The more modern practice of timing call centre workers taking pees is kind of similar. In the years since, as the linked article points out, regulation has increased, but attitudes of owners of workplaces hasn't. Limiting pee time may be a whole lot less deadly than locking the only exits from a workplace with flammable materials, but it exposes the same kind of attitude of managers and owners of businesses - a callous disregard for the humanity of this particular input called labour.

So I challenge the libertarians and right wingers around regarding your blind assertion that markets do best and governments are always evil. How are such work practices not evil also? What makes a government so much more malevolent than this? Of course I'll hear a response about health and safety (though maybe I won't since right wingers don't really like that concept any more), but even if you pass legislation on health and safety, it still needs to be enforced. What is the hope of that when Cabinets are filled with MPs with clear corporate ties and interests, exactly?

Economic Logician Displaying Precisely No Logic

David Hendry has just published an excellent working paper on model discovery in economics. Economic Logician (EL) attempts to destroy it but misses the point so badly it's really quite astonishing. I can only conclude he hasn't actually read the paper. I should disclose at the start: Hendry was my PhD supervisor. That may make me a little more liable to be sympathetic towards David's methods, but most importantly it means I've studied them for a long time and am well acquainted with them.

It's hard to know where to start really, but it's clear EL misses the entire point of what Hendry is doing, because it fits precisely within his description of the scientific method:

 

1. Observe regularities in the data.
2. Formulate a theory.
3. Generate predictions from the theory (hypotheses).
4. Test your theory (is it consistent with data?)

 

Hendry's method majors on the fourth part of this list, but is crucially reliant on the first three. We form the General Unrestricted Model (GUM) from all economic theories related to our object of interest (the exchange rate, inflation, interest rates, etc), and from there we make use of Hendry's general-to-specific method to uncover the best possible model fitting the data related to the thing we're interested in.

The new stuff in Hendry's paper that builds on what is standard in PcGets and Autometrics is that non-linear functions of the variables included in the GUM are added to the mixer and a souped up version of what used to be called Dummy Saturation is added. No new variables (exports of cabbage, number of sunny days, etc) are added.

These developments are responses to the fact that economic theory is necessarily simplified, and will often get functional forms wrong (hence the non-linear functions), and also a response to the problem of structural change - things change over time. The latter, dummy saturation, is the product of many years of research, from which the main conclusions are: If they (dummies) doesn't matter, generally they are omitted by the selection procedure, and if they are kept by mistake they won't harm inference (i.e. the other coefficients of variables that matter). But if they matter, then omitting dummy variables will distort inference, and policy conclusions will be flawed as a result.

Because it takes structural change so seriously, the Lucas Critique (another of EL's misfires) is moot. Other areas of Hendry's research (notably in Dynamic Econometrics and with Rob Engle in this paper) make clear that if models found in this manner are to be used for policy analysis, they must be checked for super exogeneity. This means they the model's parameters must be checked for stability over a number of well known policy changes and other periods of structural change. The addition here in Hendry's latest paper of being able to automatically detect such structural change and hence directly control for them only adds to the usefulness of this method for policy analysis and for understanding more about the economy and economic theories.

This is perhaps the biggest misfire of EL - that somehow this Hendry method is least suited to policy analysis. It could not be better suited to it because it follows precisely the four steps above, and takes the most difficult part of it (the last one) very seriously indeed. It is not wedded to one particular theory, which too much pre-Financial Crisis advice arguably was, and takes economic data seriously. What would be better for policy analysis exactly?

Right Wing Christians Have Utter Disregard for the Truth

Well, particularly the person sullying the name of the legitimate Archbishop Cranmer, who died 455 years ago, long before this imposter began writing such false tosh as this. In particular, the insistence often put by right wingers that currently we're paying more in debt interest than we are on health and education.

It's simply false and shows a total disregard for the truth. This website contains all numbers regarding government spending, even back to 1692.

You can play around with the numbers as you wish, and look at how numbers related to spending have changed over the years.  You can even construct interesting plots like the following:

Blue is debt interest, red is health care and green is education. All are expressed as a percentage of GDP to give some scale of the numbers. It should be fairly clear that not since around the early 1970s has debt interest been even near to the size of healthcare spending, and not on education since the early 1960s. It is also noteworthy that debt interest payments were falling into the middle part of the last decade and were flat until 2010, but even with the last few years, interest is much less than either health or education.

Why do right wing Christians like this seek to misrepresent reality so often? I seriously do not understand it. I don't quite get how it can be part of a Christian witness to the Lord Jesus.

The Beveridge Curve

Inspired by a few things, I had a little look into the Beveridge Curve recently.  As the links will show, in the US something curious has happened to the Beveridge Curve since around the middle of 2008.  It appears to have shifted right dramatically:

Some of the commentators in the links have asserted that the change happened after the US government extended the duration of unemployment benefits, although others have noted that even taking into account the theoretically most generous impact of this duration change would not explain all of the movement.

David Andolfatto appears to be on to something, comparing this shift in the Beveridge Curve to previous shifts in Beveridge Curves towards the end of recessions.

I've done a couple of things. First I've looked into the data.  If one wants to spin an unemployment benefits story, one can.  Simply put in dummy variables into a simple Beveridge curve regression; we get something like:

Here, Y is the vacancy rate, X is the unemployment rate.  Standard errors are in parentheses.  Clearly, if one wants to sell a structural break story, one can: Both the impact on the intercept (via dummy D_t) and the slopt (via the interaction of D and X) are strongly significant. The resulting regression lines look like:

Hence the intercept falls in size dramatically, as does the slop of the curve.  Had this happened, it would be really scary stuff: Much higher unemployment rates would be able to coexist with very small declines in the vacancy rate.

However, a regression such as that just run suffers from many, many econometric problems.  Not least both the unemployment rate and the vacancy rate bear all the hallmarks of non-stationary, unit-root time series, and hence a static regression of one on the other, as just carried out, could well be spurious. Additionally, there are many recognised factors that might shift the Beveridge Curve relationship, without affecting its slope.  Economically plausibly, things other than the duration of benefits may have contributed to the scatter plots observed for the Beveridge Curve.

To investigate these possibilities we must specify a model that includes a number of lags of the relevant variables, and also extends the set of relevant variables from just the unemployment rate to other variables capturing the efficiency of the matching process (the current hiring rate for example could be a proxy), the level of long-term unemployed (proxy by those unemployed over 27 weeks), the level of frictional unemployment (those unemployed less than 5 weeks), and the level of labour mobility as well as simply the level/duration of benefits and the level of productivity and labour costs.  This means a very large regression model.

However, one can employ an automatic model selection procedure called Autometrics (in OxMetrics 6) to help. This software is based on the General-to-specific methodology of Sir David F. Hendry and seeks to select the simplest possible model from an initially large model with many candidate explanatory variables.  Such a procedure of model selection would actually find that the 2008 US legislation change to extend unemployment benefits was entirely uninformative for explaining the evolution of the Beveridge Curve, and would actually find a curve with a slope somewhere in-between the two found above, but a curve that is shifting left and right with labour mobility, with long-term unemployment and other factors. I'll save you the details, but I'm writing it up currently, and just plot you the following to give you some idea what was found:

The black line is the Beveridge Curve found after the more detailed econometric investigation allowing for factors that shift the Beveridge Curve. Hence one can see that without these additional variables we have not necessarily identified the Beveridge Curve just by eye-balling the scatter plot. We need to do serious econometric analysis based on economic theory, helpfully augmented by Autometrics, if we are to understand more of what is going on.

However, if you are simply informed by plots and not complicated econometric analysis, an alternative consideration of a scatter plot of the vacancy level and unemployment level in the UK over roughly the same time period may be more persuasive of the idea that it is not unemployment benefits causing what we've seen recently (since there has been no similar increase in the duration of benefits):

All in all, I'm going for the "it's not a structural break caused by the duration of benefits" story, along the lines of that proposed by David Andolfatto.

I don't understand the cynicism

I knew there would be some libertarian jumping on some non-libertarian's comments in the aftermath of the Japan disaster. Russ Roberts provided it. I don't quite understand why libertarians feel the need to twist things other people say. Is it to fit their straw man image of the rest of us?

Russ thinks that because Larry Summers happened to note that in the aftermath of Kobe there was a mini-boost to Japanese GDP that therefore all economists of a Keynesian bent are proposing wars and man-made disasters in order to raise GDP.

For crying out loud - the man simply said the obvious - that rebuilding has to count as economic activity and may thus lead to a positive increment to GDP eventually.  Why the need to go any further?

UPDATE: Another savvy libertarian blogger has got on the case with this, Ryan Young.  He simply wafts uioff on a major tangent based simply on the fact that Larry Summers said there might be an increment to GDP as Japan rebuilds, to go on and suggest that "if this were the case" we should flatten countries repeatedly and rebuild them for maximum economic stimulus.  This, simply, is putting words in peoples mouths.  

Summers does not in any way say "isn't it great Japan needs to rebuild", he simply points out that there will be an increment to GDP.  What is it about this that gets libertarians off so much?  Don't understand.  Summers is not encouraging destroying things to rebuild them, he is simply pointing out an economic fact: The rebuilding will contribute to economic activity.  That's is.  If Young and Roberts think that's not the case, then I think they are the smart economists saying dumb things - what they both accuse Summers or doing.

Prejudiced People Unprepared to Listen

Foolishly I decided to engage in a debate on the Taking Hayek Seriously blog (specifically here and here), thinking maybe some of the folk there might be a little bit more enlightened than they pretend to be, and might like to explain why they are so strong in everything they say (opponents are "brain dead" for example). However, I'm giving up as it is like talking to a brick wall.

I mentioned the information problem in markets, and mentioned both moral hazard and adverse selection, about how these are problems independent of the existence of government.  Of course they aren't though, these folk respond - it's only stupid governments forcing insurance companies to insure these people that creates the problem.

Now, let's just state the definitions of these two things in fairly abstract terms:

Moral Hazard: The probability of the event (being insured against) and the loss incurred are endogenous, i.e. influenced by the applicant/buyer.

Adverse Selection: The buyer or seller in a market has information relevant to trade and incentive to conceal information.

Now it has to be pretty clear to the average person that these two concepts can exist even if there is no government in existence.  If I am HIV positive, it is clearly in my interest to conceal this information if I am duplicitous and want to take out a life insurance policy, since I will get a lower premium as a result.  This is clearly a far-fetched example, but it makes the point - this can exist regardless of whether government exists.

Additionally, even if the government didn't exist, and only private insurers provided insurance against unemployment, this would not change my ability to affect my probability of being made unemployed.

Now we're discussing this entirely independent of any response to the problems in these markets - market or otherwise - we haven't even thought about externality problems which would affect the efficient level of provision of insurance in many markets.

The simple point is, these two things can exist independent of government.  You might have thought that statement self evident.  But clearly not for people like those at Taking Hayek Seriously.