Communists are evil, capitalists are good?

I'm always intrigued by reading what Austrians have to say; that's Austrian economists, also commonly referred to as libertarians. Here's a great example of this: Ethel Rosenberg: Born Bad?, David Henderson | EconLog | Library of Economics and Liberty

The thing that intrigues me most is how their economics is infused with morality - questioning whether communists (socialists in American speak) are bad (evil), and hence by implication, libertarians and capitalists are good.

I was discussing this overlaying of economics with morality with a friend over the weekend; as economists we do attempt to conduct positive analysis, or value-free economics. It's once we add values that we end up on the right of left of the political spectrum - positive economics simply states how things are, and attempts to model (understand) them.

Hayek is generally associated with having stated that to add any kind of morality to economics (e.g. "that outcome isn't fair!") is unnecessary and unhelpful, and thus it's quite odd that a libertarian in David Henderson (and Bryan Caplan) is essentially doing just that in ascribing evil to particular economic outcomes and those that promote them.

I sense there's also some kind of contradiction going on. Henderson points out that some communist sympathisers in the US on strike stopped others from going to work, interfering with their right to do so, and that that was evil, or bad. Now the justification I'm sure that the communists would bring up for that is that by restricting the rights of the few (the black legs), they increased the lot of the majority of workers being exploited in that particular situation. Hence they'd appeal to a bigger picture.

Which is what libertarians do all the time in essence. When someone complains about a specific market outcome, a libertarian will usually jump upon them, pointing out the bigger picture - as economists we know that under certain circumstances, the market will provide the optimal allocation of resources. In asserting there should be a free market outcome rather than any kind of intervention, libertarians in effect deny the rights of exploited workers for the benefit of the many (whoever the many actually is).

In not inclined to believe this. Essentially, to take any side in this is to elevate the rights of some group of market participants above the others. It's to deny the idea that all people can be evil, including the owners of businesses who can deny workers safe working conditions and other things we take for granted, because they can appeal to something that will always exist, regardless of how much libertarians wish it didn't: The government. While government exists it will always be lobbied by company owners, and always be persuadable.

The appropriate way around this difficulty is to design mechanisms such that it is harder for governments to be lobbied. Yet it is precisely mechanism design that libertarians reject out of hand, claiming that there is no way that a single entity in a market could possibly have all the necessary information to design such a system. The point I believe they have missed is that in designing such a system, the designers need not know all the information that exists spread around the marketplace, they simply need design a system such that it is always in the interests of firms not to lobby government, and government not to favour particular firms. I don't know what form that mechanism would take, but I'm not about to rule out ever finding such a mechanism.

Recognition!

Despite having been mainly dormant for quite a while as I spend time blogging on my all too many other obscure blogs, it appears this blog has been indexed on www.econacademics.org, which is pretty exciting.

At all times, one can think about the links between at least morality and economics, and hence econometrics, but I set this blog up as an attempt to specifically think about Christianity in the context of econometrics. It won't harm anyone (assuming I get any hits!) if I restate my main drive behind setting this up.

It's quite widely believed that Christians are those that stick their heads in the sand, believe the world is just as old as Genesis says and ignore all science - in fact, hasn't science disproved Christianity?

I'll bypass those who would quibble over whether economics is a science. For them: To the extent that we observe events, propose theories and test those theories in economics, it is a science in that it is falsifiable. It is an observational science on the whole, since experiments on grant, macroeconomic scales are pretty much impossible (and unethical).

Back to the point; Christians are those who believe that there is a creator behind everything, someone written about in the Bible. This is not a falsifiable theory, any more so than belief in an absence of a God. The realm of religious belief is entirely separate from the realm of science - we cannot falsify any theory about the existence of God, nor should we really bother.

What we do in science, and hence in economics, is we observe events within the world (well, the universe I guess) and try to explain how they happened. Understanding more about this world we live in is thus perfectly consistent with a Christian faith, just as it's perfectly consistent with being agnostic, or atheist. Because understanding the processes that led to where we are is very different to trying to get a grasp on the meaning of why we are here.

When we enter into the whole meaning area, we depart from science and end up with, as said, theories that cannot be proven or falsified one way or another.

I'll hopefully blog here reasonably frequently now this blog has been "recognised", and in doing so explore further the links, making use of recent events and/or recent research I come across...

Today's Nobel Announcements

I've been thinking all day about why today's announcement of the 2011 Nobel Prize in economics going to Chris Sims and Tom Sargent bugs me.

I always think it a little odd when others get perplexed about a particular award, and I think it's because this award is ostensibly in my own area of research that I'm irked a little. I'm also a little biased towards my PhD supervisor who in an ideal world would have his Nobel by now, but instead must sit back as two folk he gave ideas to continue enjoy the acclaim from their Nobels (that they got in 2003). He does have a Knighthood though to placate him, which is good.

But back to the point; what is it that bothers me about these two fantastically intelligent and insightful scholars getting acclaim for their many works over the years? They pointed out the huge gaping problems in traditional macroeconometric models of the 1970s which generally had simplistic economic theory structures based on macroeconomic identities rather than any kind of optimising agents, and we all know the economy is made up of optimising agents. Sims promoted the use of VARs, while Sargent is best known for fearsome theoretical macro models and technical wizardry, which has helped bulk up macro theory in response to these old, simplistic models.

It's not this theory aspect that bothers me. Macroeconometrics should be informed by what theory is. It's impossible to try and do some macroeconometrics without some theory to motivate you - how would you know where to even start without it?

I think it's the kind of empirical macro they espouse that bothers me. And the belief that those that practice it that this kind of macro lets the data speak too is something that bothers me.

The kind of empirical macro that these guys epitomise is US empirical macro, which still forces the data into straight-jackets. The only difference is that the new straight jackets have structure - microfoundations, i.e. assumptions about behaviour based on the principles of microeconomics. Empirical macroeconomists, the ones Williams lauds in the linked article above, all use methods like GMM heavily, and for one reason - you force the data into particular forms motivated by theory without testing these forms.

That Sims is credited with the move towards Bayesian VARs says it all. Bayesian econometrics is a classic case of people deciding that traditional methods that let the data speak don't give us the results we want, so we'll tweak those results with our own particular "know how", embodied in priors.

The problem is, what if we are wrong? What if this new structure is completely and utterly wrong? Ideally, it would lead to progress - we learn from where we're wrong, and we then find better ways to model the things we're struggling to model. My hope is this happens, but when the estimation methods remain so heavily wedded to the economic theory, it's very hard to see that happening.

I don't want this post to be entirely negative, and un-constructive. The essential point is this: I believe, as Sims and Sargent claim, that the data should be allowed to speak. I also believe macro theory has a huge role to play, but it should be a role subservient to the evidence from the data; the data should not continue to be subservient to macroeconomic theory and the curse of plausibility.

Data are allowed to speak if we ensure that all statistical assumptions placed upon a model are found to be satisfied; if the statistical model we fit is checked for its fit, and we only proceed once we are convinced that fit is acceptable. I could be wrong, but I just don't think Sims and Sargent work this way.

My Supposed Hubris

I do macroeconometrics, if pushed to define one of my research areas. This is a classic area for criticism by those towards the right of the political spectrum, not least Arnold Kling. Kling has an essay entitled Science of Hubris, in which he carries out his usual attack on what he calls scientism, i.e. any attempt to put really precise numbers on things that we can't be precise about. In Kling's mind, we just can't be precise about any kind of economic aggregate, notably GDP, or investment, because there's just too much going into them, and these aggregates are made up of very different things too.

So essentially, he dismisses the entire field of applied macroeconomics because statistical agencies aren't able to add things up particularly well, and because, well, economists shouldn't be thinking in such broad terms; they should only be thinking at the microeconomic level. Those who practice is, apparently, are the very epitome of hubris; that is, to have "excessive pride or self confidence" as my Mac's Dashboard dictionary tells me.

Of course, anyone who puts their head up above the parapet is liable to accusations of hypocrisy, but folk like Kling at EconLog, and Boudreaux at Cafe Hayek are remarkable examples of precisely this. Kling and Boudreax (and others on their respective blogs) have remarkable confidence in one thing, and one thing only: The price mechanism in a fully free market. They are scornful and incredibly bitingly sarcastic (esp. Boudreaux) of those who dare to suggest anything otherwise, who dare to imagine that government intervention could possibly be a useful thing. To be that requires a heck of a lot of hubris, from what I can see.

And it's not limited to that; Russ Roberts and David Henderson at EconLog had a number of posts about Ideological Turing Tests, and how those on each side of a debate characterise the other, declaring (of course), that those on the right, those nearer to the libertarian school of thinking, were much better than those anywhere else on the spectrum at accurately describing the position of their opponents. Then just today, a post about confidence, where the application is not to Austrians with their remarkable over-confidence in the price mechanism in many inappropriate contexts but, yes, you guessed it, Keynesians (or at least, their crude caricature of them). Utterly stunning the amount of times I think about pot calling kettle when I read Hayekian/Austrians on their blogs.

But back to macroeconometric models. What I struggle to understand is this. If an econometric model is built that happens to include all the relevant explanatory variables for an aggregate variable (e.g. inflation) such that the residuals are white noise, then to all intents and purposes, that aggregate variable has been explained. A humble presentation of such a model would not make bold predictions about the future (forecasting is entirely different to macroeconometrics), but would instead make suggestions at what had been learnt from this exercise. But Kling and those in his camp would disregard it entirely.

Kling et al suggest that one of the most dangerous things about Keynes and his teaching was that he let loose governments and convinced the common man that there was intellectual rigour behind their own whims and desires. Equivalently though, via their scepticism of absolutely everything other than what they previously believed in, Kling et al promote an unhelpful atmosphere of scepticism through which genuine academic progress is hindered - all because of their ideology rather than any desire to be scientific in their pursuit of knowledge.

Kling on form

Arnold Kling was clearly on form this evening. Not only did he post the article about the "stupidest argument for stimulus", he is also attempting to slaughter a paper he hasn't even read by saying "Suffice to say that there are many ways to go wrong if you don't think things through carefully."

It's hard not to be snarky when someone attempts to destroy a paper they haven't even read by saying that many things can go wrong if you don't think things through carefully. Think something like "perhaps I'll read the paper before slaughtering it"?

I should really stop....

...however, I do keep reading blogs by libertarians. Here's one, where Arnold Kling describes another economist as using the "stupidest argument for stimulus". Apparently, that argument is that teachers are being laid off, and it's stupid because schools could instead be reducing salaries for teachers instead, if they valued these teachers so highly.

Now, of course Kling is averse to just about any argument in favour of fiscal stimulus because he is averse to just about any argument for government intervention it would seem (because the market always performs better - despite unending amounts of economic theory and empirical evidence to the contrary).

However, I think most of all it's just inconsistent of him. He says it's stupid because in economics there's always another way. Yet I suspect that when faced with the assertion "the deficit needs cutting", he wouldn't describe statements like "we must cut spending if we're going to cut the deficit" as stupid, even though perfectly equally, we could raise taxes to cut the deficit.

Maybe I'm just stupid, but I don't see what the difference is, and why Kling is also not advocating the stupidest of arguments, just because there is another perfectly reasonable way to do the same thing.

Looking at Data, US Style

The US is heading towards some kind of agreement on its rather odd thing called a debt ceiling - it would seem some level of debt above which the Federal Government cannot go.

Seems like a good time to have a little look at the data to try and disentangle the politics from the economics. I've come across a couple of major arguments thrown around by people concerned in one way or another about the US level of Federal Debt. One is that it's all the fault of the Republicans due to the Bush tax cuts - the only surpluses since 1960 essentially came under Clinton (1998-2001), before Bush cut the taxes. The other argument is nested there - that there's been precious few surpluses post-war any old how - the US is clearly on some unsustainable pathway...

Bush passed two tax cutting laws during his presidency, in 2001 and 2003, which are marked on as black lines in the upper plot below, which is the Federal deficit, and also Federal receipts and spending, since 1790:

It would seem fairly clear that once the first act is passed, the fledgling Federal surplus vanishes. Of course, that could be coincidence, and wasn't helped by the small recession the US suffered around the time, after the dot.com bust.

However, it's hard to escape the fact that a trajectory towards budget surpluses was reversed, since even in the good times of the mid- to late-2000s, when the US economy was booming, there was no return to budget surpluses. Clearly if you reduce the amount that people pay in taxes, then receipts will fall - rocket science this is not.

Now, has the US been on an unstable debt bender since the 1960s? To help out here, the bottom panel of the above graph looks at US debt, as a percentage of GDP. Post WW2 right up to about 1980, the debt-to-GDP ratio is falling - so after 1960 - and in fact after 1950, when deficits become the norm much more than surpluses, still the US debt-to-GDP ratio falls and falls.

This highlights something that those on the right seeking to paint the current situation as unsustainable fail to notice: If growth is high, then deficits are not unsustainable, necessarily. It involves a much more in depth look at the situation than can be afforded in a blog post, but the point is: The current situation needn't be unsustainable for the US. Clearly, 10% deficits are unsustainable, but nobody, not even rabid lefties (inasmuch as they exist in the US), are suggesting that 10% deficits remain forever. When 6% of the output of an entire country is lost, it is inevitable that tax receipts will fall, and expenditure on unemployment benefits will rise.

 

The bottom line is this: Given the level of deficits post-Bush tax cuts, something likely does need to change. The right would say "current spending levels are unsustainable", but what they fail to add is the condition, namely "given current tax levels". An equally valid position is "current tax levels are unsustainable given current spending levels". Given the thirst for the public sector in the US, tax levels need to be higher than they were reduced to under Bush. And of course, here is where politics enter in; the Bush tax cuts are said by many on the left to have been a political manoeuvre to get lower spending in the future - and it's now, in these debates over the debt ceiling, where they hope to get their way. But the point is: Current spending levels aren't necessarily the thing that is unsustainable; equally, it's current tax levels that are unsustainable. Something I don't think right wingers are quite so happy to accept...

A Little Bit of Looking at the Data

Today the Daily Mail is again talking about how the UK was on the edge of an economic apocalypse before George Osborne saved the day! Some things never change.

What would be more interesting would be to actually look at the economic data beneath the political and journalistic hyperbole, wouldn't it?

I'm writing up some long overdue notes for some lectures I did on fiscal policy, and I figured I'd just have a little look at the government deficit in the context of real GDP growth in the UK over the past 30 years. Here's what the two data series look like:

Why am I doing this? Well because when an economy enters a recession, things economists call automatic stabilisers kick in: Benefits are paid to people made unemployed, and income and corporation tax receipts fall since less profits are made and less income is earned. These two effects will make a budget deficit worse regardless of how profligate a government is, so long as it provides unemployment benefits, and runs an income and corporation tax system.

So what about the biggest recession in 70 years kicking in? Surely that's going to have quite an impact on government finances, right? Looking at the two series above, we can see that indeed the recession we just emerged from was deeper than anything since 1980, and indeed the government deficit was also deeper. It's interesting to note the 1992 recession, post-ERM. After that, there is quite a large budget deficit for quite a while. Interestingly enough, that deficit only becomes a surplus after 1997.

However, we should really think about taking the data seriously, shouldn't we? Eyeballing only gets one so far. Now both series are probably stationary (econometric speak), but clearly show persistence - GDP growth is strong for a while, then weak, deficits tend to hang around like bad stains. So we should think about a dynamic econometric model. The real beauty of such models (say, an Autoregressive Distributed Lag model) is that we can let the data tell us about the long run solution, or error correction reformulation as it's called in the linked paper. This is the long-run relationship between the two variables: So if real GDP growth is at its expected value, what do we expect the deficit to be?

This way we can say: How far out of equilibrium are we right now, compared to economic history? I'm not going to bore anyone with the details (email me if you'd like them, I'm more than delighted to provide), but of course it's fascinating to look at something like this and see just how much we are currently teetering on the brink. The red line in the following diagram shows us exactly how far out of equilibrium we are currently:

The deficit and real GDP growth are also plotted there still. The red line is equilibrium, or how much too high or too low is the deficit given the state of the economy. The important thing is that this is estimated over real data, and it should also be said that this is data starting in 1981, so 16 years of a Conservative government then followed by 13 years of Labour - it's a nice mix of the two.

So we see the impact of the financial crisis with a big positive movement which looks bad, right? That is until you realise that this is saying that the deficit was not large enough given the size of the contraction in real GDP! Calculations, based on the data, says that at the height of the recession, when real GDP contracted at 6%, the correct deficit given past UK economic history (16 years of Conservatives), excluding all economic theories, the deficit should have been an eye-watering 22% of GDP, not the trifling 9% it was at this point (2009Q2). Only as we entered 2010 did the equilibrium relationship (called ECM) turn negative, suggesting the deficit is too high now, and even by 2010Q3 it had not reached the depths of disequilibrium (a deficit too high) it reached in 1994.

Interesting stuff. Are we teetering on the brink of an economic apocalypse? Were Labour reckless with public finances? Not if you consider economic data taking into account Conservative policies between 1981 and 1997, at any rate.