In Good Company

I am having trouble getting my brain up and running after 5 days in Miami and 5 more at DisneyWorld.  I didn’t see much evidence of recession in Orlando, as lots of people were paying $70 for the privilege of waiting 30 minutes in line for a 2 minute ride on a malfunctioning elevator (AKA “Tower of Terror.”)  Speaking of elevators, did anyone see this video of Mundell?  Sean Rushton summarizes the key argument:

Part Two of Mundell’s analysis is the most intriguing and least understood aspect. He argues that, as the real-estate bubble burst, large quantities of fresh liquidity were demanded by the public and banks. In summer 2007, the world’s central banks supplied it and no liquidity crunch developed. But by summer 2008, spooked by rising inflation, the U.S. Federal Reserve failed to provide adequate cash, leading to dollar scarcity. Four key symptoms of tight money appeared within months: the dollar rose 30 percent against the euro; gold fell 30 percent; oil fell 80 percent; and the inflation rate dropped from 5.5 percent to negative levels. As a result, Mundell believes, Lehman Brothers collapsed, the stock marketwent into free fall, and a near-panic ensued. This phase was entirely preventable and constitutes one of the worst mistakes in Fed history, Mundell says. The crisis eased in early 2009, as the Fed upped the money supply, but the damage was done.

Arnold Kling did a post on this quotation entitled “Mundell as Sumnerian?”   When I first read the title I thought I was receiving an undeserved honor.  Mundell is a Nobel Prize winner and I’m just an economist from a small university that is often confused with an over-stuffed British luxury automobile.  But then I noticed that Kling wasn’t honoring me, but rather dissing Mundell:

Anyway, he seems to espouse a view that tight money caused the severe financial and economic downturn, which puts his elevator on the same floor as that of Scott Sumner.

This refers to Nobel Laureate Robert Mundell. Back when I was in grad school, Mundell was treated by the MIT faculty as: (a) a mythic figure in open-economy macroeconomics; (b) someone to whom Rudi Dornbusch owed a huge intellectual debt; and (c) someone whose elevator no longer went to the top floor.

In any case, I’m still honored to be compared to a Mundell that has slipped a few floors.  But shouldn’t the title of the post have been “Is Sumner a Mundellian?”

2.  The disreputable Arnold Kling

I don’t have time to offer views on the current debate over financial reform, but Kling has lots of good posts that mostly reflect my views here, here, here and here.  In the final link Kling responds to a Russ Roberts observation with the following comment:

Would the economic damage have been worse? All respectable people say, “yes.” I happen to disagree, but I don’t see a way of proving my case. Go back and re-read what I wrote early in October of 2008. I haven’t changed my mind one bit.

I really wish we could run the experiment where we repeat the same financial euphoria but no country’s banks get bailed out. They just get shut down, with depositors getting first crack at the assets, followed by other senior debt-holders.

Once more Kling disrespects me, as I entirely agree with his observation.  For some reason I feel more comfortable associating with disreputable folks like Mundell and Kling, rather than those who hold respectable views.  Of course I reached my conclusion on this issue for somewhat different reasons than Kling.  He denies that the current recession was due to a demand shock.  I argue that it was, but also that if the banking system really had imploded in 2008 then the Fed would have been forced to undertake the sort of “nuclear option” for monetary policy that FDR employed in 1933, albeit price level targeting through OMOs, rather that gold price adjustments.  In that case any losses would have been sunk costs, and much more importantly the net losses to banks would have been much smaller than what actually occurred, as asset prices would not have imploded.

3.  Eichengreen on China:

In fact, both sets of critics have it wrong. China was right to wait in adjusting its exchange rate, and it is now right to move gradually rather than discontinuously. …

China successfully navigated the crisis, avoiding a significant slowdown, by ramping up public spending. But, as a result, it now has no further scope for increasing public consumption or investment.

To be sure, building a social safety net, developing financial markets, and strengthening corporate governance to encourage state enterprises to pay out more of what they earn would encourage Chinese households to consume. But such reforms take years to complete. In the meantime, the rate of spending growth in China will not change dramatically.

As a result, Chinese policymakers have been waiting to see whether the recovery in the US is real. If it is, China’s exports will grow more rapidly. And if its exports grow more rapidly, they can allow the renminbi to rise. …

Evidence that the US recovery will be sustained is mounting. As always, there is no guarantee. … Because the increase in US spending on Chinese exports will be gradual, it also is appropriate for the adjustment in the renminbi-dollar exchange rate to be gradual. …

Chinese officials have been on the receiving end of a lot of gratuitous advice. They have been wise to disregard it. In managing their exchange rate, they have gotten it exactly right.

Exactly.  Eichengreen was absolutely correct when he suggested (perhaps half-jokingly) that the world would be better off if all the big economies tried to simultaneously engage in beggar-thy-neighbor policies.  (His research had shown that those policies triggered recovery from the Great Depression.)  And now he is right about China.

HT:  Mark Thoma.

4.  Epistemic closure

When I was on vacation I was wondering if the case against Goldman Sachs was really as weak as it seemed at first glance.  I figured that right-wingers would rally to GS’s defense, but wondered what the left would think of the case.  Here is Paul Krugman:

If you want to argue that Wall Street is corrupt, fine; but don’t use emails showing Goldman employees crowing over their success in shorting housing — which is ugly but doesn’t amount to wrongdoing — to make your point.

Here I’ll make the slightly disreputable argument that “if even the other side agrees with me, I must be right.”

I made a nice return on ‘junk bond’ investments in the 1990s, so count me as someone not shocked by the colorful adjectives in GS emails.  Does this mean GS did not violate the law?  Here is where I would fall back on my post-modernism.  There is no yes or no answer to that question.  If one wants to get highly technical, I suppose that every single big bank in America is violating the law on an almost daily basis.  How could it be otherwise?  Our business law system is unimaginably complex, the legal equivalent of the distance to Alpha Centauri.  (“Show me the man and I’ll find you the crime.”)  The real question is:  If the SEC knew these facts about GS, but the 2007-08 financial crisis had never occurred, would GS have been prosecuted?  Or to put it another way; is the prosecution political? 

Brilliant intellectuals who dabble in politics will often find themselves disappointed by the reasoning skills of many of their supporters.  In the Krugman post he scolds other liberals for making a series of foolish arguments.  This must feel awkward, as the liberal blogosphere has recently revived the meme of conservative stupidity (a theme that goes back at least to Mill.)  There are actually two separate issues here; stupid elites and stupid rank and file.  For instance, this post by Yglesias argues that the GOP rank and file are ignorant on health care reform, and asks whether right-wing pundits will point this out.  In fact, lots of right-wing pundits have criticized the phony Republican arguments about taking Medicare away from grandma and also noted the hypocrisy of Mitt Romney during this debate.   In an earlier post I complained about the anti-intellectual attitude among many Republicans during the health care debate.

But calling rank and file voters stupid is actually pretty silly.  Of course average people are not experts.  Of course average people are prone to hold silly conspiratorial views.  Lots of Republicans believe conspiratorial theories about Obama, and lots of Democrats believe conspiratorial theories about Bush and 9/11, or oil companies and gasoline prices.  Indeed even among Congressman it is easy to find silly statements by members of both parties.  Has Guam tipped over yet?

In this post Krugman makes a different argument, that the intellectual elite of the right has a closed mind on macroeconomic issues.  In my view there really is a difference between the right and left wing elites, but it is more complicated than Krugman and others realize.  Off the top of my head I’d guess that 80% of intellectuals are left-leaning liberals, 10% are conservatives, 5% are dogmatic libertarians and 5% are pragmatic libertarians.  Because I am in the latter group, I naturally feel we are the smartest.  If forced to defend that proposition I’d point to the highly disproportionate number of economics Nobel Prizes won by pragmatic libertarians (defined as those who support small government policies for broadly consequentionalist reasons.)

On the other hand people like Bartlett and Yglesias are probably on to something when they point to the differences between liberal and conservative intellectuals.  If the liberal talent pool is 8 times bigger, and if roughly the same number of liberal and conservative positions must be filled as Congressional staffers and think tank members, then maybe the average conservative intellectual really is less bright.

This raises the more fundamental question of why intellectuals tend to lean to the left.  I have argued that as one becomes more educated, one becomes more utilitarian.  You see “the other” in a more sympathetic way if you’ve travelled a lot, or (what amounts to the same thing) read a lot of high-brow novels.  Intellectuals tend to care about the downtrodden, and also see lots of “unmet needs” that it would, at first glance, seem to call for more government programs.

Then why are so many Nobel Prize winners to the right of center?  Not because they aren’t utilitarians, but rather because they take a second glance at the effects of government programs.   If you want to talk about epistemic closure, consider how few left-of-center intellectuals realize that the standard model of economics, even as presented in textbooks written by economists who are left of center, gives very little support for the great mass of government programs that are cherished by liberals.  Here are the key market failures:

1.  Inequality—The solution is redistributive taxes.

2.  Externalities (and second-hand smoke is not an externality)—The solution is Pigou taxes.

3.  Monopoly—The solution is antitrust laws.  And with free entry the only plausible problem is price-fixing cartels.  Even anti-merger laws are of dubious value.

4.  Public goods—only a few goods such as lighthouses and medical research meet the criteria, and even lighthouses are a dubious example.

But that’s about it.  The SEC?  The FDA?  OSHA?  I have no idea how these or 90% of other government activities can be justified. 

Does imperfect information call for regulation?  I doubt it, but if so then provide the information.   The free-rider problem with medical insurance?  OK, but Singapore has shown that this problem can be solved with the government spending 1% to 2% of GDP (plus forced saving), not the 8% contemplated by Obama.  There really is no justification for big government in the sort of model provided in economic textbooks written by liberals.  Most left-leaning intellectuals don’t realize this; indeed they find my views to be slightly nutty.  That’s epistemic closure. 

Here’s a quotation from Krugman:

It’s been painfully obvious since the crisis broke that people at Minnesota, or even many people at Chicago, have no idea what New Keynesian economics is all about. I don’t mean they disagree, or think it’s garbage, they literally have no idea what the concepts are.

I think Krugman exaggerates this problem (to some extent they simply don’t buy the Keynesian model), but I do agree that the fresh water economists have grown increasingly ignorant of the importance of demand shocks.  But at a broader level exactly the opposite problem occurs.  Most right wing liberals (including me) know far more about left-leaning liberals, than vice versa.  Why?  Partly for the reason that Canadians know more about Americans than Americans know about Canadians.  There are far fewer of us.  But also because right wing economics is much more counterintuitive that left wing economics.  Thus the left tends to assume that free market supporters like me are either motivated by greed, or stupidity, or by a sort of religious fervor, aka “market fundamentalism.”

PS:  I wasn’t able to keep up with things while on vacation.  Marginal Revolution was all I had time to read.  I had planned a post defending utilitarianism after reading Tyler Cowen’s defense of Bryan Caplan.  But perhaps it’s time to move on.  So I’ll just leave you with the slightly enigmatic title of my planned defense of utilitarianism; if you wish you can try to work out my convoluted argument:

“Imagine 6 Trillion Bryan Caplans”

PPS:  Why we need vouchers.


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17 Responses to “In Good Company”

  1. Gravatar of Nick Rowe Nick Rowe
    28. April 2010 at 16:07

    Welcome back Scott! It seems your brain is up-to-speed again.

    But forget the US for a bit; I think it’s time for you to look at Europe.

  2. Gravatar of Nick Rowe Nick Rowe
    28. April 2010 at 16:07

    Welcome back Scott! It seems your brain is up-to-speed again.

    But forget the US for a bit; I think it’s time for you to look at Europe. Comparisons to the 1930′s?

  3. Gravatar of ssumner ssumner
    28. April 2010 at 16:50

    Nick, Yes, I’ve had several requests. I thought your post on the Holy Roman Empire was great, I can’t add much. But I will try to do something on comparisons to the 1930s.

  4. Gravatar of dWj dWj
    28. April 2010 at 16:51

    Are you familiar with, and deliberately alluding to, “The Lighthouse in Economics”, by Coase? I just came across it in January; it may be that everyone else was aware of it before then.

  5. Gravatar of rob rob
    28. April 2010 at 18:02

    Scott, welcome back. i suspect the reason more intellectuals are liberals is because they arent motivated to be intellectually honest. i usually lie about my political beliefs because i dont see the point in being honest. the recent South Park opener was about Tiger Woods and all guys everywhere pretending to argue (in front of women) that they didnt understand why just because a guy was rich and famous they would sleep with a bunch of women. i suspect most forms of liberal argument are similiarly motivated. im not looking at you and your new yorker profile, krugman.

    i suspect there are many private mencious moldbugs who become krugmans in public.

  6. Gravatar of ssumner ssumner
    28. April 2010 at 18:43

    dWj, Yes, I was alluding to Coase.

    rob, There may be a bit of truth in what you say, especially for areas where the PC police are very active. Thus one must say that differences between gays and straights are genetic, not upbringing, while differences between men and women are not genetic, but rather cultural. I suspect that people don’t really believe everything they say about these sensitive areas. But in economics I think most liberals really do sincerely believe that big government is best (although obviously they don’t support each and every specific program.)

    Off topic, but Tyler Cowen recently linked to a study showing that US Latino life expectancies were higher than any other country in the world, including Japan. Does anyone know if that data source is reliable? The figure seems mind-boggling. The Asian-American number is even higher, but what surprises me about the Latino figure is that the average educational level and wage level of Latinos is relatively low, and of course we have all the uninsured in this country. There are roughly 45 million Latinos in the US–that is a statistically significant sample. Isn’t it odd that there isn’t even a tiny country like Andorra where people live as long as American Latinos? If anyone knows anything about this odd data, I’d be very interested.

  7. Gravatar of Chris Chris
    29. April 2010 at 06:42

    I’ve come to take a cynical view of externalities, in that they are just an excuse for people to impose a policy that they like to impose. That is, I see people talk about externalities all the time but ignore the textbook solutions to them.

    For example, people talk about secondhand smoke as if it was an externality (though I agree with David Henderson’s take that it isn’t). However, even if secondhand smoke was an externality, I can’t find anything in economic theory that suggests that an across-the-board smoking ban in the efficient solution (wouldn’t a tax be, or some sort of licensing system which limits the number of licenses?). Likewise, I agree that environmental pollution is an externality, but are there any examples of Pigouvian taxes out there? People might point to gas taxes, but aren’t those more user fees for the roads? Plus, has any state really calculated external damages from driving and set the gas tax accordingly? Traffic congestion is a classic negative externality but as far as I know, congestion pricing is never seriously discussed as a solution. Instead, things like mass transit are. People might point to cap-and-trade as an economic theory-based solution to global warming, but the textbooks suggest that a carbon tax is the more efficient solution. And, I think that many externalities are small scale (such as a loud neighbor or barking dog) and best handled privately or locally. So really, with regards to the theory of externalities, what is the point?

  8. Gravatar of scott sumner scott sumner
    30. April 2010 at 04:42

    Chris, Those are very good points, but I’d like to take a more positive view of Pigovian taxes. Perhaps economists are just ahead of the curve. You do have congestion pricing in Singapore, London and Stockholm. Maybe other countries will eventually catch on.

    You are right that it is ironic that the few areas where government action is called for, are some of the same areas where they don’t do what the textbooks suggest. The same is true for anti-trust. Their focus is often on things like predatory pricing and mergers, not prize fixing, which is the real problem. And the government is the biggest creator of monopoly through barriers to entry.

  9. Gravatar of Mark A. Sadowski Mark A. Sadowski
    30. April 2010 at 06:50

    Scott,
    Glad you’re posting again.

    I read Sean Rushton’s description of Mundell’s address before I actually listened to Mundell. It seemed to me that he saw a different video than I did. I’m referring not to his description of part 2 but his description of part 1 and 3 of Mundell’s analysis.

    It seemed to me that while Mundell ascribed part of the 2002-2007 expansion to a low dollar he did not really blame the housing bubble on the dollar’s value as Rushton claims. Mundell spends some time talking about tax policy and financial innovation as causes. Furthermore Rushton claims that Mundell wants a strong dollar as part of a super currency region but what I heard was merely Mundell speaking out in favor of stable exchange rates.

    In short Rushton seems oblivious to the fact that his description of Mundell’s part 2 analysis completely contradicts his description of part 1 and part 3. I’ve seen similar missreading of Mundell in the past by dollar hawks and it irritates me. Being in favor of stable exchange rates is not the same as wanting a contractionary monetary policy.

    P.S. Your posts are a lot more coherent than Mundell’s somewhat meandering speeches.

  10. Gravatar of pireader pireader
    30. April 2010 at 15:32

    Professor Sumner –

    Public goods—only a few goods such as lighthouses and medical research meet the criteria, and even lighthouses are a dubious example.

    Are you denying that such basic government services as military defense, law enforcement, a court system, mandatory vaccinations, recording of real-estate ownership, chartering of limited-liability corporations, care for orphans, etc. are public goods?

    Please describe a plausible society (or better, point to a real one) where these services are privately contracted for without massive welfare losses?

  11. Gravatar of Doc Merlin Doc Merlin
    30. April 2010 at 18:53

    @Chris: complete agreement

  12. Gravatar of scott sumner scott sumner
    1. May 2010 at 10:16

    Mark, Thanks for that info. I relied on Rushton’s summary, and haven’t actually watched the video. Would you say he was accurate in the specific part I quoted (i.e. the second half of 2008?)

    You are right that Mundell is not a dollar hawk. When money is too tight, he favors easier money. When it is too easy, he favors tight money.

    Pireader, Good point. Let me clarify. I have always thought the term ‘government’ is best defined as the entity with a monopoly on force. So I define government as the entity that controls the army, police, courts, etc. I was thinking in terms of what else government should do. I should have made that assumption explicit.

    Regarding orphans, I would include that under income redistribution, although I agree that it might belong under public goods. I have doubts about mandatory vaccinations. I agree there is a public good issue there, I just have doubts as to whether it is serious enough to call for mandatory actions by the government. But I have an open mind on the issue. I didn’t mean to suggest lighthouses and research were the only examples, just that the actual role of government is much larger than what is justified in textbooks.

    Many of the activities you describe are done privately in America. We have private arbitration of disputes between business. I think there are more private police (security services) than government police. More and more prisons are privately run. There are private orphanages run by charities. I get vaccinated by a private doctor. I think there is a town in Georgia of about 80,000, where everything is contracted out. (Sandy Springs?) although I imagine the police are contracted out to other governments. Having said all that, I agree that government has to do a great deal in absolute terms, but I think they should do much less relative to what they do now. I think the optimal government would be smaller than the Singapore government, which itself is pretty small as a share of GDP. If Singapore legalized drugs, privatized companies and housing, and deregulated where there is no reason for regulation, it would be close to my ideal.

    I also think that the smaller the jurisdiction, the more the government should do. It makes more sense for a suburb of 25,000 people to have government schools, than a city of 2,000,000.

  13. Gravatar of Mark A. Sadowski Mark A. Sadowski
    1. May 2010 at 11:28

    Scott wrote:
    “Would you say he was accurate in the specific part I quoted (i.e. the second half of 2008?)”

    I thought that was implicit in my comment. What Mundell said throughout was indeed very Sumnerian.

  14. Gravatar of ssumner ssumner
    2. May 2010 at 06:08

    Thanks Mark.

  15. Gravatar of James James
    2. May 2010 at 08:11

    “right wing liberals”

    Not a phrase I have heard before.

  16. Gravatar of Easily Ignored Insights Easily Ignored Insights
    2. May 2010 at 14:55

    [...] puts me in mind of this comment on epistemic closure from Scott Sumner (scroll down to item 4): If you want to talk about epistemic closure, consider how few [...]

  17. Gravatar of ssumner ssumner
    3. May 2010 at 05:53

    James, I use if for people like me who share the utilitarain values of liberals, but who think free markets are the best way to get there. Milton Friedman is another example. I sometimes call right wing liberals “pragmatic libertarians” and contrast us with the more dogmatic libertarians who think taxation is theft, and is immoral even if it raises total utility.

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