Spain’s Cyclical Disorder

I like to read the comments people leave in articles in Spanish sports papers. I find them funny. There’s typically a decent mix of inter-team hate, intra-team hate, and general conspiracy theory. One can find a similar mix in the press of other countries, but not nearly to the same extent as in Spain. What these comments reveal — although there may be some sample bias — is an emerging culture of mistrust, caused in large part by ongoing depression in Spain and political corruption. Strong economies are built on trust, and this emerging culture in Spain can undermine forces of recovery in a country already handicapped by bad structural and counter-cyclical policy.

In “Economics and Knowledge,” Hayek developed a theory of equilibrium incorporating the role of expectations. In a division-of-labor where each agent relies in large part on others, an equilibrium occurs when the expectations of these agents coincide. For example, you, generally speaking, would only continue to work if you were certain that you would receive a paycheck at the end of the week. Businesspeople have certain expectations of the demand for their product, and of profitability. In the real world, expectations are often wrong — businesses fail, stock markets crash, et cetera. In equilibrium expectations are in harmony, so that everyone’s plans coincide.

The term “coordination” is essentially synonymous with “equilibrium.” For disparate expectations to jive, plans must be coordinated. When plans don’t coincide, there’s discoordination. Coordination differs from equilibrium, however, in that it has a more ambiguous definition. It might be useful to think about it as a spectrum. Plans may not be perfectly coordinated, but people’s actions are not always total failures. In fact, most of the time, things work out. When you take your car to the mechanic, he’s there; your paycheck arrives on time; your landlord expects and gets his rent by the monthly deadline; et cetera. We can also think about an economy having a certain degree of order, where equilibrium is maximum order. The better coordinated plans are, the higher the degree of order.

The concept of order can be applied to business cycle theory. Expectations have played a central role in business cycle research since the 1930s. Most firms do not expect a sharp decline in demand. Those that do typically mistime their preparation. A clear example is the 2007–09 financial crisis. Investment banks’ plans did not work out when a significant fraction of their assets dropped in value. The small businesses which went bankrupt had their expectations reverse. In mid-2006, few people thought that they had a large probability of losing their jobs in 2008–09. The business cycle is a period of discoordination — a loss of order.

Spain’s recession, following a housing bubble, has been particularly bad. Indeed, it feels more like a depression. Spain’s unemployment rate is over 26 percent. Much like during the Great Depression, a large fraction of unemployment is the result of bad policy. The IMF estimates Spain’s average outgap gap for 2013 at –4.338, which is comparable to that of the United States. Yet, the U.S.’ unemployment rate is “only” at 6.7 percent. Bad supply-side policy, in conjunction with bad demand-side policy, has made a disaster of an already bad situation. Spain’s structural problems, of course, have existed for a long time, but they were partly hidden by the boom of the early and mid-2000s. Schneider (2011) estimates that the value of production in Spain’s informal (extralegal) sector has been greater than one fifth of Spain’s GDP since ~1994, falling to 19.3 percent of GDP in 2007 — but, no doubt larger after the crash (although, in part because of a decline in GDP). Large extralegal sectors are typically a sign of bad supply-side policy.

Problems in Iberia go beyond bad policy. Spain’s democracy is more fragile than some people realize. The country has passed a few tests for robustness — such as the (quasi-abortive) February 1981 coup —, and high growth during the late 1990s and for much of the 2000s seemed promising. Indeed, many in Spain were looking forward to the day that the country would replace Canada in the G8! But, the country’s economic woes have been joined with corruption issues in government — and the problem crosses party lines: bribery, illegal payments, money laundering, et cetera. Further, regional banks funded local programs, and the relationship between these banks’ balance sheets, their health, and the political support they receive is unclear. These scandals have made it hard for Spaniards to trust their governments, whether national or local. The range of this distrust has spread to the royal family — especially after legitimate corruption charges against some of its members — and elsewhere.

The extent of distrust can be seen in Spain’s changing football (soccer) culture. Referees are always criticized. It’s hard to find an article on a big Premier League game without reading one manager’s criticism of the referee’s handling of a game. There are constant complaints against refereeing in all sports. But, in Spain, it’s especially bad, because complaints have given way to conspiracy theories. There is this notion that the governing body in Spain, RFEF, implicitly or explicitly supports a status quo that favors Barcelona and Real Madrid, the two highest earning football teams in Spain. The theories go as far as to claim that referees make their calls to purposefully help the the two “big teams” (los grandes). And, of course, between the two big teams fans accuse the other club of corruption. Even players have made these accusations — Cristiano Ronaldo and Sergio Ramos, players for Real Madrid, made comments to this effect after last weekend’s match against Barcelona.

There is, in general, an emerging culture that sees corruption and scandal everywhere. Bonds of trust are disintegrating. This can have dire long-term consequences. Trust, in some sense, is an institution; or, it’s a value manifested in certain institutions. Businessmen spend a lot of time and money establishing a relationship of trust with their clients. They offer warranties, they make sure to always leave their customer satisfied (hoping for the relationship to be repeated over time), et cetera. When there is no trust, the economy suffers. The transaction costs to some exchanges can become too high, and trades which would have led to gains for all parties involved simply don’t take place. To put the role of trust into perspective, recall the 2011 paper by Nunn and Wantchekon, finding evidence that slavery created a culture of mistrust, holding development in sub-Saharan Africa back. This is happening in Spain. While political corruption is hard to compare to slavery, the emerging culture in Spain may have dire economic (and political) consequences for years to come.

Mistrust might make political reform more difficult. Note how untrustworthy Ukrainian protestors have been of the “reformed” Ukrainian government. The same is true of Spain, although in different areas and to a different degree. Governments with fragile relationships with their people are going to have a hard time passing structural reforms that may not produce immediate results. Mistrust also makes a situation ripe for regime uncertainty. Uncertainty over the political climate makes business more difficult and less attractive, especially if this business requires large investments. Mistrust can spill over into the private sector in other ways around. Large businesses — which tend to be villainized when it’s the worst off who suffer the most — can lose demand for their product, even if their product confers to the consumer the highest satisfaction relative to other choices. Mistrust can even hurt relationships between small businesses, and even between small time vendors and their customers.

The effects of the business cycle, especially if these effects are made worse by bad policy and political corruption, can influence an economy for many years thereafter. They can make recovery more difficult. When a people lose faith in their institutions of governance, this mistrust tends to spread to other sectors of life, including business. It itself is corrupting, because it changes the institutions which guide economic processes. It limits trade, and when trade is limited we lose out on gains from trade. Countries like Spain (and Greece) are undergoing this transformation, and if this process isn’t reversed, the consequences can become more dire than they already are.

“Narrow” Self-Interest

Jacob Levy, at Bleeding Heart Libertarians, digs up a comment on Hayek and public choice theory, made by Jeremy Shearmur. Shearmur makes what I believe is a mistake in his interpretation of how economists use the term “self-interest,”

Buchanan argued, steadily, that we should treat people as self-interested. But it is clear that this does not work: there seems every reason to believe that people go into politics for a variety of motives, and no special reason to believe that they are motivated by narrow self-interest.

Notice the adjective that he tacks on to self-interest: “narrow.” But, why should we interpret self-interest, as used by economists, to mean the narrow kind and not the broad kind? Most economists, whether implicitly or explicitly, mean “broad,” not “narrow,” self-interest.

How do individuals choose between alternatives? The subjective theory of value that underlies most of modern economic theory assumes that people attach values to various ends, and that they will choose between ends based on these values and their budget constraint. Suppose, for example, that some representative agent holds strong moral beliefs that call for donating half of her income to charity. In other words, because of her moral beliefs, she attaches what we can assume to be a high value on the end of donating half of her income to charity. And, if she donates that money to charity, we can assume that that end was valued higher than all other alternative ends.

Notice how the concept of “narrow” self-interest is difficult to even define. Assume that it’s about money. If economists really believed in “narrow” self-interest they would have to make the case that it was irrational for that representative agent to donate half of her income, because the alternative of not donating any fraction of her income seems like the superior choice. If y is her post-donation income, 2y > y. But, then they would have to deal with the paradox that the end attached to the act of donating half of one’s income is ranked higher than all other alternative ends, including keeping her full income for herself. But, there is no paradox, because economists know — and assume — that individuals will choose based on a set of subjective preferences.

What leads people to interpret the economist’s use of self-interest as having a “narrow” definition is probably the way economists design their models. People tend to interpret these models too literally. Economists use narrow concepts in order to simplify the model. The model itself is only an imperfect tool to understand the much more complex real world. If we included everything that might influence how an individual values alternative ends we would have a very intractable model and it would not be very useful as a tool, despite being more “realistic.” (See how little insight “more realistic” methods have gained us. See how some of the deepest insights in economics have come from extremely simple models.) So, instead we assume they base their decisions on the amount of money alternative ends return, or some other proxy. That’s the thing: when modeling, economists use proxies to simplify the problem.

This speaks to the recent controversy over how physicists interpret economic problems. I feel that many people missed Chris House’s point. People outside the discipline, who learn the methods for their own specialization, oftentimes misinterpret why economists do things the way they do. This model is unrealistic. This model is missing this or that. They assume that economists are ignorant of some fundamental insight. The fact is, however, that this is simply not the case. They miss the point of why economists model the way they do.

Illusion of Purity

The claim that there is such a thing as “pure libertarianism” should puzzle you. What is the definition of “pure libertarianism?” Do we find that definition in Rothbard? Nozick? Hayek? Mises? Rand? Which Rothbard? Nobody’s views are intertemporally consistent. If they were, our views wouldn’t evolve. The answer can only boil down to a definition which equals exactly what you believe “pure libertarianism” is, because you are going to choose between alternatives based on what you agree with. That seems a bit shallow.

Within some range, “pure libertarianism” will inevitably be impure. Few libertarians would doubt Roderick Long’s libertarian credentials, even though he prefers virtue ethics over a certain brand of deontology. Okay, Long avoids the term “capitalism” (according to his Wikipedia entry), so maybe Long is not a “pure libertarian.” But, no serious academic holds a identical set of beliefs with another. There is always some degree of reasonable disagreement. You cannot define a “pure libertarianism” without defining yourself as irrelevant, because the only “pure libertarian” will be you.

If you accept that there is a range of beliefs that can be considered libertarian, how do we determine that range of “reasonableness” (is that a word?)? Mises — except that government nonsense, but it’s okay, because it’s Mises1 —, plus Rothbard, plus Hoppe? Do we exclude Hayek, Buchanan, Friedman,2 Nozick, Gaus (?),…? Surely, you cannot define the range by what is generally agreeable to you, because that defeats the purpose of having a range of reasonable disagreement. You would have a difficult time arguing that Stiglitz’ political views ought to be considered libertarian. Hayek, though? How could the views of one of the most influential academics on libertarian thought not be considered reasonable in the debate on what libertarianism is? It would, of course, be just as absurd the other way around. How could Rothbard’s views not be considered libertarian?

The point I’m making is that any determinant definition of “pure libertarianism” is arbitrary, in that it requires the person writing the definition to choose based on her own judgment. Where is this authority derived from? What if there is some chance that she’s wrong? There is no way to even know whether we believe in “pure libertarianism,” because “pure libertarianism” is impossible to define with certainty. The concept is empty.

So far, most of you may agree with me. But, I don’t want you to agree with me. I want to give you a headache. I am going to take another step forward, making the strong claim that libertarianism as a political philosophy is too exclusive to be useful.

The limits to what is libertarianism will always be arbitrary. But, if we leave those limits up for debate, I think that debate is easier to solve than the one over “pure libertarianism.” At least, we have a fuzzy border around libertarianism. For example, it’s clear that Krugman is not a libertarian. But, Buchanan is — at least, his ideas can directly inform libertarianism. But, here, libertarianism defines only a narrow group of reasonable beliefs over the right institutions of governance. There are reasonable non-libertarian beliefs, as well.

If a group of people join into a division-of-labor, they will have to develop an arbitration process (whether planned or spontaneously) to settle disputes. There will be several orders of rules. Personal defense associations, for example, will appeal to a higher order of rules to settle inter-association disputes. If you are an anarchist who believes that people will settle into communities with more-or-less consistent political views, you should still recognize that people will want to associate with others outside of their community — there are gains from trade by extending the division of labor. People of different communities may come into disputes against each other, and there will need to be a process by which these disputes — where there are two conflicting set of rules — are solved. Let’s call the highest order of rules, and the process by which these rules emerge, the meta-process.

How do rules emerge out of the meta-process. Maybe a dictator is the final word of the law. That doesn’t seem very appealing. Imposing Rothbardian deontology would be dictatorship, because most people would want a completely different set of meta-rules. Further, we have no way of knowing if Rothbardian deontology is right, and we want the meta-process to at least evolve over time, so that its rules can improve. Because we know that there is a range of reasonable opinion on what kind of rules there should be, the process of rule-making should consider a plurality of opinion.

The people governed by the meta-rules will include libertarians, but libertarians are a minority of the total population. Reasonable debate would need to include reasonable non-libertarian beliefs. The meta-process would be a liberal one. It’s hard for me to accept the possibility of both agreeing with the public reason approach and believe in a libertarian political philosophy. Public reason is extremely attractive, because it is consistent with heterogeneity of beliefs and pluralism (i.e. liberalism); maybe a libertarian political philosophy does not make much sense. Libertarianism can’t even describe the ideal society, because if societies include non-libertarians then the rules, in a voluntary society, will be, at least in part, non-libertarian. Public reason leads to compromise, not unanimous consent in favor of one of the extremes.

The libertarian has some preference set on meta-rules. But, you can’t advocate an overarching philosophy of a just political process that requires either belief homogeneity or coercion of the non-believers. Well, I suppose you could. But, calling that philosophy one of “liberty” should raise eyebrows. Libertarianism, then, is not useful at all for the purpose of helping us achieve a free society. But, (public reason) liberalism can. I agree that this might lead us to other uncomfortable conclusions, but that’s no reason to reject my argument. Of course, the catch in believing that there is some probability (0 < p < 1) that a belief is wrong is, well…that your beliefs can be wrong. So, prove me wrong!

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Notes:

  1. I guess Mises’ “partisan biases” don’t matter.
  2. Both Milton and David. Pure libertarianism might require two points. You earn one point for being an anarchist, which David is. You earn another point for being an Austrian. Sorry David. And Milton might as well be Stalin.

Skepticism’s Role in the Growth of Personal Knowledge

There are three possible general reactions to most of my posts on Economic Thought,

  1. You could be persuaded, or you could already agree with me;
  2. You could be angered;
  3. You could be neither persuaded nor angered, just made curious by an interesting problem that you can’t easily solve.

Reactions (1) and (2) are unintended on my part, and I rather you react the way described by (3). Of course, I can’t rule out that some — or all — of my posts simply aren’t insightful, aren’t interesting, or are just obviously wrong, which might justify reactions (1) — although, it would be agreement over something trivial — or (2).

My method of blogging, at least on Economic Thought, bears some relationship to my experience as a student, especially as a student of heterodox economics. This post will include some personal background to help illustrate my general line of reasoning. The topic is also related to the reason I no longer like to be considered a part of an “Austrian” denomination of economics. Some people have asked me about this personal transition, so I will also use this post as an opportunity to write a bit on that, as well.

There is one graph we should all know before I go on (source: SMBC),

knowledge and confidence (2)

I did not know much about economics until 2008, which is when I was introduced to Mises.org, while I was living in Madrid. I became immediately engrossed in the subject. I reached that first peak around 2010, during which the bulk of my Mises.org articles were written. During that time, my thirst for learning was strong, but it was principally motivated as a means of reinforcing my existing convictions. While I made sure to read opposing viewpoints closely, it was mostly intended to avoid criticizing straw men, rather than as a method of looking for weaknesses in my beliefs. I didn’t take my own ignorance seriously. Fortunately, my inclination towards knowing “opposing” intellectual ideas well led to better things.

Heterodox economists like to compare their beliefs to “neoclassical” beliefs. As it turns out, oftentimes it is a comparison between one’s beliefs and what one thinks “neoclassicals” believe. I do not think these comparisons are always wrong, although, even when they are right, they are not always the full story. No (or, very few) economist(s) believes (believe) that a monetary authority can “print wealth.” No economist believes governments are perfect, even when markets are imperfect. Few economists believe that, in general, income inequality caused by differences in marginal productivity is “bad.” Unfair characterization of the ideas you disagree with is not a sin only heterodox economists commit, of course. But, these were problems I was directly aware of, because the main sources I was reading were heterodox. For what it is worth, what turned me off heterodoxy, in general, was not anything Austrian, but actually Steve Keen’s Debunking EconomicsI am not sure how anyone can take that book seriously (to be fair, I was originally less critical of Keen’s work).

Reading “neoclassical” literature and, the truth is that the “neoclassical” tradition is much broader than what that moniker suggests made me realize that there is much more merit in it than many heterodox economists give it credit for. Non-heterodox economists (i.e. the majority) are not fools who are missing basic truths. Indeed, I have learned much more from non-heterodox sources than I have from Austrian or Post Keynesian literature (which does not mean that there is nothing to learn from these latter two — the opposite is closer to the truth). The most important thing I learned, in any case, is that if you think you have an easy case as to why a professional economist is wrong, you are probably making an error. A rule of thumb: given that the analytical capabilities of the average economist is high, what is mainstream (what the majority of economists accept) is a good indication of what is closer to the truth. This is not always true — sometimes good ideas are not sold well, and bad ideas are sold too well —, but it generally is.

Need specific examples of non-heterodox work of great merit? Take a look at, for instance, my summaries and suggested interpretations of some “mainstream” theories: Alchian and Demsetz on information costs, monitoring, and the firm (“Alchian’s Calculation Problem“); Akerlof on information asymmetry and markets (“How to Read ‘Market for Lemons‘”); and Krugman’s economies of scale theory of trade (“Krugman’s Alternative Theory of Trade“). It is also worth remembering that something having merit does not mean that you have to agree with it, or agree with all of it. Consider, for example, my review of Stiglitz’ The Price of Inequality. And, just because you agree with something does not mean you should not question it. Consider, for example, the challenge I pose (in my review) to one of Hutt’s conclusions drawn in The Theory of Idle Resources — specifically, I am not sure that Hutt actually addresses the “Keynesian” concern.

Exposure to “opposing” viewpoints should lead you to become aware of at least two things,

  1. The merit in ideas you might disagree with, either in part or completely;
  2. The possibility of error in your own set of beliefs.

(1) allows you to recognize that many ideas are worth knowing, even if they make you uncomfortable. You do not have to agree with others’ interpretations, you do not need to agree with others’ conclusion, but recognizing that there is much to know packaged in literature that you might not agree with overall helps you pick out the good from the bad, allowing you to refine your set of beliefs. Again, this refinement need not be in the direction the author wants you to go in, but it is a direction that you otherwise would have taken had you not read what you are uncomfortable in.

(2) should make you more open to embracing discomfort. If you recognize that the probability of you not knowing everything, and especially not knowing enough to conclusively reach a determined belief on something, is high enough, you will be more open to reading ideas that contradict your own. This overlaps with (1). Reading ideas that make you uncomfortable, because they make you question what you know, takes you in directions that you otherwise would not have had the opportunity to follow.

That “going in a different direction” is not the same thing as “being persuaded” needs to be stressed. I am a very skeptical person, and I am rarely directly persuaded. Those of you who are charitable enough to comment on my blog, and especially to have a dialogue with me, are probably well aware of this. What I do, rather, is soak in disagreement, think it over for some (often indeterminate) amount of time, and change my views “on my own.” That is, I use my own analytical skills to pick apart the ideas I come across, and I shape my views around what I think is right, or even can be right. Being aware of my own cognitive limitations and of the merit of others’ ideas (even when they are not aligned with my own), however, makes this process much more open. I think this is a good thing. Further, I think our natural inclination to stick with ideas we know, and therefore are comfortable with, is a good weight against “openness.” Meaning, while it is true that there is such a thing as being “too open,” and there is such a thing as being “too skeptical,” the natural tendency to be much less skeptical of what you already believe in makes being “too open” or “too skeptical” practically impossible.

Nozick’s Anarchy, State, and Utopia embodies what I am trying to get at, so allow me to embark in a productive digression. Ask any person who attended last week’s seminar on Nozick’s book and they will confirm the following: I do not agree with many of Nozick’s arguments, and I especially disagree with his main assumptions and conclusions. But, I cannot deny that Anarchy, State, and Utopia is a great book of much merit. Neither can I deny that Nozick’s book will influence the direction of my beliefs.

From what I understand, most libertarians would also disagree with many of Nozick’s arguments. One could convincingly make the case that there are more influential (on fellow libertarians) libertarian political philosophers out there: Rothbard, Hayek, Gaus, et cetera. Yet, Anarchy, State, and Utopia is the source that non-libertarians go to on libertarianism. One reason for this is probably that Nozick was a Harvard professor, and what is most interesting about his book is his critique of Rawls. Another reason — in my opinion, perhaps more important — is Nozick’s exploratory approach to the subject. His intention is not necessarily to persuade you, but to cause you to question your priors (although, in my opinion, he applies this method asymmetrically; i.e. he does not question his own priors as much as he does those of others). Much of the book involves problematizing common approaches to moral intuition: utilitarianism, Rawlsian liberalism, et cetera. It makes you think; you find reason to question your beliefs, which motivates you to explore the problems he delineates. He might not be persuasive, but he will take your thinking in new directions.

In short,

One view about how to write a philosophy book holds that an author should think through all of the details of the view he presents, and its problems, polishing and refining his view to present to the world a finished, complete, and elegant whole. This is not my view. At any rate, I believe that there also is a place and a function in our ongoing intellectual life for a less complete work, containing unfinished presentations, conjectures, and open questions and problems, leads, side connections, as well as a main line of argument. There is room for words on subjects other than last words.

— Nozick (1974), p. xii.

I would take one step further and claim that finished, complete, and elegant wholes are impossible. If we think we have something of that nature, we are falling victim to an illusion.

This is the approach I take on my blog. Consider, specifically, my recent discussion of government, exchange, and libertarianism. I ask whether libertarians suffer from a fatal conceit when judging the merits to non-market institutions of governance. I wonder if large, “centralized” states make sense, even with perfectly plural political institutions. Finally, I make the strong claim that libertarians should be more cognizant of their biases. I am not trying to persuade anybody of my ideas. I am not even completely swayed. Rather, these are frictions on my own thinking, and I think they are applicable to the thinking of others’. I am problematizing beliefs that I find, or (in many case) once found, persuasive. My hope is that these issues are interesting and plausible, and that they will make you, my reader, join me on an exploratory journey.

Should you feel anger towards me, or anybody else who says or writes something that you, with your given set of priors, disagree with? What I mean by “anger” is any emotion that drives you to, for example, accuse another of being a “statist” or a “socialist.” Or, any emotion that leads you to reject without seriously considering. I can sympathize with, on some level, anger towards certain ideas. It is hard for me to take an article that links libertarianism to feudalism seriously, for instance. But, generally speaking, an emotion of anger should signal to you the need for caution. Anger is usually caused by discomfort; rejecting something out of anger means rejecting something you are uncomfortable with. That is not a healthy approach to learning. You should control the natural consequences of those emotions — close-mindedness, primarily. You should always judge an idea with some degree of neutrality, because it is from a position of neutrality that you will best be able to distinguish between good and bad ideas.

Learning is exploratory. There is a vast sea of information and knowledge, most of which we are unaware of. Learning — developing our knowledge and our beliefs — is a process that requires accepting that there is a lot we do not know, a lot we do not know that we do not know (radical ignorance, or the “unknown unknown”), and that what we think we know has some probability of being wrong. My blogging style embraces this framework. My intention is not mainly to communicate what I know, but to communicate possible problems with what I think I know and, oftentimes by extension, problems with what you think you know. I am taking you through an exploratory process that I am going, or have gone, through. I hope that this is the way you interpret what I write.

Quote of the Week

On the difference between an accounting identity and a model,

[T]here is a crucial difference between this law [β = s(avings)/g(rowth)] and the law α = r × β, whch I called the first fundamental law of capitalism in Chapter 1. According to that law, the share of capital income in nationa income, α, is equal to the average rate of return on capital, r, times the capital/income ratio, β. It is important to realize that the law α = r × β is actually a pure accounting identity, valid at all times in all places, by construction. Indeed, one can view it as a definition of the share of capital in national income (or of the rate of return on capital, depending on which parameter is easiest to measure) rather than as a law. By contrast, the law β = s/g is the result of a dynamic process: it represents a state of equilibrium toward which an economy will tend if the savings rate is s and the growth rate g, but that equilibrium state is never perfectly realized in practice.

— Thomas Piketty, Capital in the Twenty-First Century (Cambridge: The Belknap Press, 2014), pp. 168–169.

Capital Accumulation and Growth (Bleg)

How does the size of the capital stock relate to economic growth? Conventionally, one would think it’s a main determinant. As industries become more capital-intensive, labor productivity grows and output per capita increases. But, consider the following two graphs,

Capital in Britain 1700-2010 Capital in France 1700-2010

— Both graphs are from chapter 3 of Thomas Piketty’s Capital in the Twenty-First Century.

Those graphs plot the capital/income ratio for Great Britain and France. Capital is the total monetary sum of a nation’s assets, including net foreign assets, net of depreciation. Income refers to the average annual flow of national income. The total value of capital, in relation to income, looks essentially the same for all other developed countries, although the individual shares attributable to each class of asset vary (although, the U.S.’ capital stock has been historically stable — no shock). Apart from the shock of 1910–1950, and the period of recovery thereafter, the value of capital stock is remarkably stable, even during a century (especially the late 1800s) of tangible growth. This seems to confirm that technology is more important than capital accumulation.

My question is if the aggregation method — which Piketty agrees is flawed (although, for other reasons), but is the best way that he knows of — hides increases in surplus value. The price is a good representative of the value that marginal buyer (and seller) accrue from the exchange, but all buyers higher on the demand curve and all sellers lower on the supply curve earn a surplus value. Am I right to think that measuring capital by its price will not appropriately reflect this surplus value, underestimating the total value of the capital stock? A good example is land. Look at the decreasing share of land in the total national capital stock. That is caused by a fall in the price of land, because of productivity increases (less land necessary to meet the same ends) — but, that doesn’t necessarily mean the value of land has fallen, just that the amount of surplus value has increased. And, we should expect the amount of surplus to increase as the supply of capital increases, right?

Or, am I getting this all wrong?

(For those who haven’t read Piketty’s book, this is not a comment on the arguments he makes in the book.

Also, Piketty explains the shock as a combination of physical destruction during the war, low savings rate, and the period of decolonialization.)

Edit: Pedro Pereira Hors, on Twitter, points me to this article on GDP and surplus value by Arnold Kling. Kling, if I’m reading the article correctly, is essentially making the same point I am.

Governments (and Markets) Fail, but They Can Succeed Too

Don Boudreaux criticizes modern economics for “simply assum[ing]” that governments are able to intervene without being subject to the same, or worse — Boudreaux invokes public choice theory —, imperfections as markets. I am deeply sympathetic to “politics without romance.” But, I find critiques like Boudreaux’s unpersuasive, because they give their intellectual opponents too little credit and they are often susceptible to similar scrutiny. That is, governments may not be perfect, but they are not necessarily entirely worthless, either.

“Free market economists,” for lack of a better term, like to impute onto the intellectual opposition the belief that governments are, for all practical purposes, perfect and that they can realize the supposedly optimal solution these economists calculate on paper. But, this view has never been accurate. In a 2012 paper, Roger Backhouse and Steven Medema correct certain economists’ view on the assumptions and beliefs of the “Cambridge School” welfare economists, such as Alfred Marshall and A.C. Pigou. As it turns out, these economists were often just as skeptical of government as anyone else! The same is true of modern economists. It’s simply not true that any economist assumes: (a) apolitical politics;1 (b) no human imperfections; (c) with more information than markets.

I do agree with, for example, Peter Boettke when he suggests something along the lines of some economists do not take public choice problems as seriously as they should. But, the idea is that the margin at which the costs of applying government-skepticism are higher than the benefits are different for different economists, which is saying something much, much different to what Boudreaux is claiming. Boudreaux’s post presents these scientists as completely unreasonable, making obvious mistakes when drawing conclusions from their beliefs, but this simply is not the case. What does exist is reasonable  disagreement on where public choice and radical ignorance problems become too relevant to choose collective action over private action, but Boudreaux has nothing to say about this, which is why his argument is unpersuasive.

Why do (some) “free market economists” characterize their relatively “pro-interventionism” peers so uncharitably? I don’t think there is any intention of wanting to mislead, or any purposeful deceit in any sense. Rather, I think that free market economists (including me) are much more skeptical of government than the mean, and that the margin at which we draw the line (delineating the proper functions of government, which many libertarians think is zero) is, in absolute terms, very far from that mean. We are so biased — and I use this term in a neutral (statistical) sense — that even the average opinion on government seems unreasonable. Given that some libertarians (not Boudreaux, of course) like to call others “sheep,” I don’t think I’m that far off.

In the introduction to The Better Angels of Our Nature,2 Steve Pinker channels his inner Tversky and Kahneman to explain the average person’s estimate of the probability of crime. He argues that because of the increasing quality of communication technology, we simply hear, watch, and/or read more crime than we used to. While crime has actually decreased over time, the average person today is likely to over-estimate the probability of crime, and even be prone to the belief that crime has increased over time. If someone were to ask us to estimate the probability of, say, murder, because examples easily come to our head — thanks to the news we read, watch, and listen to —, we will guess that probability as being higher than it actually is, maybe even by a wide margin.

The case is the same with government failure, and this is especially true of libertarians. We tend to choose our news sources based on how close their views fit our own, whether we think so explicitly or not. I am someone who thinks of themselves as being open-minded, and open to alternative views. I try to organize my blog roll, to the right, around this mantra. But, I still have more libertarian blogs than I do non-libertarian, and when it comes to actually reading what’s on my blog roll, I tend to choose libertarian over non-libertarian posts. I have been reading more non-libertarian material recently, but my views have changed during that time — in what direction does causality run? Some people rather read Lewrockwell.com, the Wall Street Journal, or Forbes, rather than the New York TimesJacobin magazine, et cetera. If we think that some source of information frequently produces bad information, why would we want to read it? Selection bias has reasonable causes. But, if what we read produces 10x more articles on government failure than any other source, we are probably going to overestimate the relevance of government failure.

Pinker also argues that our standards on crime have significantly grown over time, and the same is true of politics. Our political institutions have gone through tremendous improvements. Hoppe aside, most of us rather live under developed democratic institutions than under a monarchy or dictatorship. We recognize that modern governments are more exchange-based, and less extractive. This is not left-liberal opinionating; Buchanan’s The Calculus of Consent is entirely on political exchange in a representative democracy (the other side of public choice theory that isn’t invoked as often by “free market economists”). Thus, the standards to which we hold government are much higher today than they were 100+ years ago. And, this is a good thing! It means governance has improved.

I am skeptical of government. I think public utilities should be turned over to the competitive market. I think the banking industry can be “deregulated” (or, that private regulation is superior to public regulation, in this case). I am not saying libertarians and other “free market economists” should become government-lovers. What I’m saying is that we need to map our own intellectual position in reference to that of others, and realize that we are the ones close to an extreme. We are the ones who are most likely to overestimate the probability of bad governance (granted, there are many who will underestimate that probability). Thus, when it comes to having intellectual discussions on these problems, we should be more open to what others have to say and less trigger-happy to make uncharitable interpretations of their position.

It’s not that many economists assume governments are perfect, it’s that many “free market economists” assume governments are completely broken.

Addendum: One last attempt to frame my point. A common complaint leveled against a large chunk of “mainstream” economists — I, for example, critiqued Mark Thoma on this topic — is that perfect competition should not be the assumed standard by which to judge markets. The reason markets work exist independently of perfect competition: the institutions which allow markets to overcome problems of the unknown unknown, information asymmetries, externalities, et cetera. The same criticism can be turned around, however. Maybe some libertarians judge government by the unfair standard of perfect governance. Of course governments will fail, but we also need to look at where, and how, they work.

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Notes:

  1. I’m actually not sure what Boudreaux means by “apolitical” politics. I don’t think “political” decision-making is necessarily discoordinating. Certainly, the process of vote trading will have some “political” aspect to it — there has to be a bargaining process between politicians, after all —, but vote trading can be Kaldor-Hicks optimal. It was none other than James Buchanan who made this argument.
  2. I temporarily abandoned Pinker’s book, in favor of Piketty’s Capital in the Twenty-First Century. I read both books’ introductions, and I thought Piketty’s was the most interesting.