Category Archives: History of Thought

Piketty on Becker

From the seventh footnote, in chapter 11,

Becker never explicitly states the idea that the rise of human capital should eclipse the importance of inherited wealth, but it is often implicit in his work. In particular, he notes frequently that society has become “more meritocratic” owing to the increasing importance of education (without further detail). Becker has also proposed theoretical models in which parents can bequeath wealth to less gifted children, less well endowed with human capital, thereby reducing inequality. Given the extreme vertical concentration of inherited wealth (the top decile always owns more than 60 percent of the wealth available for inheritance, while the bottom half of the population owns nothing), this potential horizontal redistribution effect within groups of wealthy siblings (which, moreover, is not evident in the data, of which Becker makes almost no use) is hardly likely to predominate.

— Thomas Piketty, Capital in the Twenty-First Century (Cambridge: Belknap Press, 2014), p. 616.

Gary Becker, and the Theory of Human Capital

Gary Becker, who Greg Mankiw rightly describes as “one of the greatest economists,” has passed away. I know Becker’s research indirectly, for the most part. If you haven’t had the opportunity to read any of his work, there is a list of great open-access papers at Marginal Revolution.

I was reading Gary Becker’s encyclopedia entry at EconLog. This paragraph caught my attention,

In the early 1960s Becker moved on to the fledgling area of human capital. One of the founders of the concept (the other being Theodore Schultz), Becker pointed out what again seems like common sense but was new at the time: education is an investment. Education adds to our human capital just as other investments add to physical capital. For more on this, see Becker’s article, “Human Capital,” in this encyclopedia.)

I wondered why it took so long for the concept of human capital to become an explicit component of the discussion. I remember recently having a conversation on the lack of recognition of “human capital” in Austrian literature, even as late as Mises’ Human Action. The idea wasn’t explicitly considered in length at the time. It didn’t strike many bright people, others brilliant, as relevant, or significant.  Like Becker’s encyclopedia entry says, “human capital” seems like commonsense. But, it was Becker and Schultz who made it commonsense, in the middle of the 20th century — roughly 160 years after The Wealth of Nations.

But, we have to remember that there was a time when education was seen as consumption, or at the very best an investment with an insignificant return,

The pre-modern aristocracy was a social elite defined by investments in hostage capital, and their education was another important case in point… [T]he emphasis was on knowledge that was not practical and had few alternative uses. The young gentlement was to learn ancient languages such as Greek and Latin in his study of classic literature and other liberal arts. Time was invested in learning music, dance, taste, and good manners. There was an outright avoidance of any type of training in the trades or skills, and a professional education was tolerated only for younger songs.

— Douglas Allen, The Institutional Revolution (Chicago: University of Chicago Press, 2012), pp. 68–69.

A “professional education” is what we know as an “education” today. The majority of people, a little over 100 years ago, did not receive one. If they had, it would have come at an intolerable opportunity cost. It simply did not pay to “go to school.” Think about what we learn in school. It would have been worthless to the median, or even average, person in the mid-19th century. Latin and Greek was practiced mainly amongst aristocrats, because belonging to that social class required that investment — it was a price; the cost of the risk of being banished, with useless knowledge outside of their old “job.”

True, many people did learn a trade, and all professions required varying levels of both general and specific knowledge. But, it was taken for granted. You are a blacksmith, because that is where your comparative advantage is. Nobody asked where that comparative advantage came from. Someone had to learn the trade, and that required an apprenticeship. But, on average, these educations weren’t as long, and broad, as the ones we’ve become accustomed to today. Maybe it took 160 years for “human capital” to become explicit because, empirically, its relevance was too subtle.

Gary Becker published his book, Human Capital, in the 1960s. I don’t think it’s a coincidence. Education was becoming increasingly important for the upper middle class before the world wars, but it was only after the Second World War that a “professional education” — from a very young age to late adolescence and, increasingly, early twenties — became truly enjoyed by a broad middle class. Household incomes were growing, and the G.I. Bill provided funding for U.S. soldiers during and after the Second World War. By the 1960s and 1970s, advanced educations were becoming increasingly common amongst discriminated social groups, especially women. This was the empirical fact that made relevant an explicit concept of human capital.

During the late 19th and throughout the 20th century, a broad, “professional” education gradually became more-and-more valuable. An advanced degree soon became useful for securing a person a relatively high-paying job. It signaled certain analytical skills, creativity, and the ability to read information, interpret it, and apply it. The concept of “human capital” was developed in the mid-20th century, because of this change in the value of an education. By that time, the transformation was too obvious for a brilliant economist like Gary Becker to miss.

The Good, the Very Good, and the Exceptional

I still think K > R. But, a good and fair point against any interpersonal comparison is that there is a division of labor within economics, and therefore all economists contribute on their own margins. I am sympathetic to the argument that interpersonal comparisons between economists are difficult, because the type of work being done is not the same. Still, I think that we can broadly distinguish between different caliber of economists. It’s not that there are bad economists and there are good economists. It’s that there are good economists, there are very good economists, and then there are exceptional economists.

Economists do many different things. First, not every economist goes into research or academia. Second, within academia, economists fulfill different roles. Some are pushing on the frontiers of the science, typically focusing on a relatively narrow field within the discipline. Others are great teachers. Others are able to critically dissect their peers’ work, apply it, and/or communicate it well. There is a division of labor, and every member is valuable, needed, and greatly contributes to the science.

Still, like with any division of labor, I think we have an objective, if rough, sense of which are the most prestigious and highly rewarded roles. The narrower the market, the easier interpersonal comparisons are — we can rank between doctors, for example. Further, it usually is the case that these upper-end roles are more difficult to earn, and that they typically go the best. Which employee, for instance, is most likely to be hired for a new managerial position? The most qualified. Within that organization, there will be some members who are so exceptional that they will eventually be chosen to fill the most prestigious positions.

Those who push on the frontiers and are able to gain acres of ground, rather than inches, are of a different kind. And I don’t mean coming up with vague, and often unpersuasive (even if they’re right), ideas. Nobel winners and those of similar caliber are able to make a vague idea explicit, really flesh it out, and defend interesting implications that draw the attention of their peers. The kind of ideas economists of this caliber are coming out with make you think about the world differently. It’s no surprise that many of these exceptional theories seem “clear” in retrospect, because of how well it was developed and communicated by the exceptional economist.

Mises’ theory of price formation and economic calculation really shook up the profession during the 1920s, because it forced a large chunk of academics to think about the possibility of socialism very differently. The same is true of Hayek’s work on the communication of decentralized knowledge. I’d mention his business cycle research, but his efforts there, as judged by his peers, were largely unsuccessful (although, I think undeservingly). Buchanan taught us to look at government as an economist would. Exceptional economists think in exceptional ways.

This brings me to make a related comment (see this Bob Murphy piece): what did I mean when I said that Mises and Krugman are comparable? I don’t mean they are equally good economists. I prefer Mises (I also prefer Hayek). Others prefer Krugman. We can have an endless debate, and I’m not interested in that. The point is, they are comparable in that they are both exceptional economists, regardless of how they rank between themselves. Suppose there’s a test that can give us an objective measure of the quality of a physicist, and it turns out that Einstein was a better physicist than Newton (for the sake of argument). It seems wrong to claim that their quality isn’t comparable in magnitude.

Some ask: how can we trust the profession to decide which ideas are of higher quality? There are people who are suspicious of the profession, because they think the general “mainstream,” or “neoclassical,” approach to economics is all wrong. I think the belief that the bulk of economists are missing obvious insights is nonsense. Similarly, it is completely unjust to accuse the majority of the profession of being poor economists, or of intellectual dishonesty. The type of people who become economists are strong analytical thinkers, they are interested in ideas, and are very intelligent. So, yes, the aggregate judgment of the profession is an important gauge of quality.

There are economists who even other economists will consider superior in their field. Krugman is one of them. Mises is another. No matter how they rank between each other, the fact is that they are both exceptional and comparable in that sense.

K > R

This post has nothing to do with Piketty; it’s all about Krugman > Rothbard. Or, why Paul Krugman is a better economist than Murray Rothbard was. My argument might be somewhat controversial to a handful of Austrians, but it really should not be. K > R does not imply that Rothbard was a poor economist, or even that he was not a good economist. The fact is, however, that Krugman is an exceptional economist, and Rothbard was just “above average.” I’ve received some flak for making this argument in passing, here — I also once compared Krugman to Milton Friedman (not in beliefs, of course) —, and it might be worth it to provide some evidence.

Truth is, the evidence screams. Krugman was the main player in a theoretical breakthrough made during the 1960s and 70s: economies of scale can explain trade, without having to make any of the assumptions of Ricardian comparative advantage. He also was in the vanguard with his work on exchange rates and crises. And, while Krugman is not known as a macroeconomist, much of his work in this area is widely cited. In short, Krugman’s academic career is characterized by a reasonable amount of high quality output. And, a fraction of his work is responsible for a major change in worldview (what earned him his Nobel Memorial prize).

The quality of Rothbard’s output (as an economist) is less obvious. Man, Economy, and State is Rothbard’s magnum opus, but it’s hard to think of a single idea original to Rothbard that has been seen as a major theoretical breakthrough. One could argue that Rothbard, as a “heterodox” economist, was at a disadvantage. Maybe, but it’s just as hard to think of a major single idea original to Rothbard that has been widely accepted even within his own school of thought (e.g. monopoly theory). His best book is, perhaps, a great textbook, but as a piece of economic research it’s not comparable to Krugman’s work — even if it’s more than what the average economist accomplishes in a lifetime. Other than MES, Rothbard does not have another important book on theoretical economics, and no academic paper really comes to mind as impressive (in the context discussed in this post).

Here’s the test: would economics be worse off if either Rothbard or Krugman never existed? In the case of the former, economics wouldn’t even notice. In Krugman’s case, on the other hand, we would be short a very simple, straightforward, and clear model of the role of increasing returns in trade, and therefore short of the implications Krugman was able to draw thanks to his model. We would be just as unable to explain part of real world trade patterns, because we would still be trapped within the “Ricardian box.” Think of a production possibilities frontier, where the curve shows the limits to current economic thought — Krugman produced outside the curve, Rothbard produced inside the curve.

I am not disparaging Rothbard. I am not saying that Rothbard’s work is useless. I, in fact, enjoy reading Rothbard. (I enjoy reading Rothbard even though I disagree with many of his ideas; you should be able to do the same with Krugman — as I often do.) He, no less, was crucial for the revival of the Austrian school. He is seen as a major intellectual forebearer to many modern Austrian economists. He was clearly an important guy. But, he is simply not comparable to Krugman as an economist.

Jon Finegold's books by Rothbard

My Rothbard credentials

Neither is it because Rothbard is an Austrian. I think Hayek and Mises are comparable to Krugman. Mises’ socialist calculation problem was a major theoretical breakthrough, and it was very influential for the profession. It changed the terms of the socialist calculation debate — a controversy that is difficult to value from a modern point of view, but that at the time was very important. Hayek was, maybe, less influential (although, I don’t entirely agree), but his work on business cycle theory has influenced a large fraction of economists, and at one point was seen as important work in the vanguard (between ~1931–37). Hayek’s institutional economics also influenced modern institutionalism; not just the likes of Ostrom, Williamson, and Coase, but also economists from different traditions, such as Douglass North. It’s no surprise Hayek also won the Nobel Memorial prize; Mises probably would have won it had it been awarded earlier.

Wrong economics versus correct economics offers Rothbard no help here, either. Rothbard could often be very wrong, as evidenced by his critique of fractional reserve banking. But, that’s an eternal debate, and it’s better to go down a separate route. Krugman’s academic work is usually right, and it’s never entirely wrong. If you don’t appreciate Krugman’s trade theory, you just don’t know it. If you can’t think of anything of value in Krugman’s work, you simply haven’t read it. (And this is all too often the case with some of Krugman’s biggest haters.) This seems like a strong claim, but it doesn’t appear so strong when you read some of the common “internet” criticisms:  (a) he assumes homogenous capital; (b) mathematics can’t tell us anything about economics; (c) perfect competition cannot exist in the real world (which somehow makes it useless as a tool, and it also, somehow, makes imperfect competition useless as a tool); et cetera. These are just throw away lines to dismiss a line of reasoning without having to really consider it or think about it. They are either very silly (i.e. the arguments v. math and monopolistic competition as tools), or they don’t change anything (i.e. you could, I suppose, explicitly include capital heterogeneity in your model — an infinite set of inputs? —, but one wonders what use that would be).

As an academic economist, Krugman’s major ideas are novel and visionary, he is relatively flexible in his argument (a relatively simple formal model, with generalized results), and usually right. Rothbard, on the other hand, was very often wrong, which is ironic given the status he ordained on “watertight” praxeology. Finally, ignoring right v. wrong, Rothbard did not produce a game-changing idea. His influence — on a very small number of economists — is constrained to popularizing theories that may have otherwise died, which has its value, but value which is incomparable to the value added by Krugman’s research.

The Academic Legacy of Hayek’s Business Cycle Theory

Tomorrow, I’ll be taking the GRE; so, I’m behind in my reading — I’m still (slowly) working my way through R.W. Clower’s Monetary Theory (a great collection of essays) and David Glasner’s Free Banking and Monetary Reform. I’ve also started re-reading Daniel Kuehn’s recent piece for Critical Review, “Hayek’s Business Cycle Theory: Half-Right” (here is the working paper version). My intention is to ultimately comment on the whole thing, but for now I have a few words about a claim Daniel makes in the introduction,

[F]or decades most macroeconomists have considered Friedrich A. Hayek’s work on the business cycle inconsequential…

I’m not sure this is true.

In 1974, Friedrich Hayek and Gunnar Myrdal were awarded the Nobel Memorial prize, “for their pioneering work in the theory of money and economic fluctuations.” Why was Hayek awarded the Nobel prize for a theory that, according to Daniel, most macroeconomists have considered “inconsequential.”

Robert Lucas published “Unemployment in the Great Depression” in 1972, when he was developing an intertemporal theory of the business cycle (in 1979, he published “An Equilibrium Model of the Business Cycle“). Lucas and others would turn this into a “real business cycle” (RBC) model. While the dynamic forces of the business cycle are different than those suggested by Hayek, the intuition behind RBC is very similar to that of Austrian Business Cycle Theory (ABCT).

Both ABCT and RBC try to explain the business cycle within the context of rational agents, who are always trying to maximize their respective functions. In order to explain why rational agents end up acting in a way that leads to the business cycle, both Hayek and Lucas pointed to price distortions and both believed that ultimately only money could be responsible for an intertemporal disequilibrium (see Kyun Kim, Equilibrium Business Cycle Theory in Historical Perspective). In his 1977 paper, Lucas even modeled overinvestment leading to the business cycle.

In fact, Lucas went as far as to cite Hayek’s business cycle theory as one of the main intellectual precursors of real business cycle theory.

Another economist, although by that time he had probably lost most of his presence in the profession, who returned to Hayekian business cycle theory was John Hicks. In 1973, Hicks published Capital and Time, developing his own “neo-Austrian” theory. G.L.S. Shackle was another economist who continued to discuss and develop a Hayekian capital theory, relating it to the business cycle. Of course, both G.L.S. Shackle and John Hicks were directly influenced by Hayek, when the latter was still at the London School of Economics during the late 1930s and early 1940s.

Perhaps Hayek’s theory had been largely forgotten during the Keynesian Revolution of ~1940–1960, although I think even this claim is a stretch, but by the late 1960s, Hayek’s research program began to be taken in various directions. None of them in the direction an Austrian would prefer,  but still in ways directly linked to some of the basic building blocks of ABCT. So, I cannot agree with Daniel. Hayek’s business cycle research, whether explicitly or implicitly, has been front and center in macroeconomics since, at least, the 1970s. His 1974 Nobel Memorial prize represents this re-emergence in the academic debate.

Austrians who, at the time, were leading the school would know better than me, but it’s a shame that Austrians didn’t join the debate in the leading journals — that is, it’s a shame they didn’t adopt RBC’s modeling techniques to try to model their own story, at a time when their general approach began to spread throughout the profession. But, it seems to me there was much more emphasis in breaking away from equilibrium theory; that’s what I get from, for example, Rizzo’s and O’Driscoll’s The Economics of Time and Ignorance. Mises died in late 1973; Rothbard was the intellectual leader of the school and saw no benefits in going in the direction of RBC; Hayek was involved in social theory (he also published a couple of monographs on monetary theory, but this was a limited excursion); others were looking to pursue an intellectual relationship with the Post Keynesians; etc. I think we missed out on a golden opportunity, and we’re much worse off because of it.

Friedman and the Demand for Money

Milton Friedman argued that the demand for money is stable. But, he didn’t mean that the demand for money is constant, or that it fluctuates around a stable mean; rather, he posited a stable demand function, meaning a stable relationship between income, the price level, relative rates of return, and the demand for money,

The quantity theorist accepts the empirical hypothesis that the demand for money is highly stable — more stable than functions like the consumption function that are offered as alternative key relations. This hypothesis needs to be hedged on both sides. On the one side, the quantity theorist need not, and generally does not, mean that the real quantity of money demanded per unit of output, or the velocity of circulation of money, is to be regarded as numerically constant over time; he does not, for example, regard it as a contradiction to the stability of the demand for money that the velocity of circulation of money rises drastically during hyperinflations. For the stability he expects is in the functional relation between the quantity of money demanded and the variables that determine it… On the other side, the quantity theorist must sharply limit and be prepared to specify explicitly, the variables that it is empirically important to include in the function. For to expand the number of variables regarded as significant is to empty the hypothesis of its empirical content; there is indeed little if any difference between asserting that the demand for money is highly unstable and asserting that it as a perfectly stable function of an indefinitely large number of variables.

— Milton Friedman, “The Quantity Theory of Money: A Restatement,” in R.W. Clower, Monetary Theory (Middlesex: Penguin, 1973), pp. 108–109.

When economists argue that Friedman was wrong, and that the demand for money is not stable, what they mean is that the same function that fits the data between, say, 1940–50 cannot predict the demand for money between, say, 1980–90.

Money as a Capital Good

I remember, in response to a Hans-Hermann Hoppe article, Walter Block was wondering whether he and William Barnett were wrong to classify money as a capital good, rather than in its own category of general medium of exchange.

For what it’s worth, Milton Friedman is on his side,

To the ultimate wealth-owning units in the economy, money is one kind of asset, one way of holding wealth. To the productive enterprise, money is a capital good, a source of productive services that is combined with other productive services to yield the products that the enterprise sells. Thus the theory of the demand for money is a special topic in the theory of capital; as such, it has the rather unusual feature of combining a piece from each side of the capital market, the supply of capital, and the demand for capital.

— Milton Friedman, “The Quantity Theory of Money: A Restatement,” in R.W. Clower (ed.), Monetary Theory (Middlesex: Penguin, 1973 [1969]), p. 95.

Yeager on Why Money Disequilibrium is Unique

A longer-than-usual excerpt,

Exceptions hinging on excess demands for non-currently produced goods other than money are not inconceivable but would be economically unrealistic. In the General Theory, Keynes remarks that a deficiency of demand for current output might be matched by an excess demand for assets having three “essential properties:” (a) their supply from private producers responds slightly if at all to an increase in demand for them; (b) a tendency to rise in value will only to a slight extent enlist substitutes to help meet a strengthened demand for them; (c) their liquidity advantages are large relative to the costs of holding them. Another point that Keynes notes by implication belongs explicitly on the list: (d) their values are “sticky” and do not adjust readily to remove a disequilibrium.

Money is the most obvious asset having these properties. Keynes asks, however, whether a deficiency of demand for current output might be matched by an excess demand for other things instead, perhaps land or mortgages, Other writers have asked, similarly, about other securities, works of art and jewelry.

My answer is no. Such things might be in excess demand along with but not instead of money. Money itself would also be in excess demand. One reason is that all other exchangeable things trade against money in markets of their own and at their own prices expressed in money. (This is rue even of claims against financial intermediaries if their interest rates count as corresponding, inversely, to prices.) An excess demand for a good or a security tends to remove itself through a change in price or yield. If, however, interest rates should resist declining below the floor level explained by Keynes and Hicks, people would no longer prefer additional interest-bearing assets to additional money, and any further shift of demand from currently produced goods and services to financial assets would be an increase in the excess demand for actual money in particular. (If stickiness or arbitrary controls should keep prices and yields of financial assets from adjusting and clearing the market, the situation would be essentially the same as in the case of price rigidity of other assets…). The monetary interpretation of deficient demand for current output thus does not depends on any precise dividing line between money and assets; if money broadly defined is in excess demand, money narrowly defined must be in excess demand also. Unlike other things, money has no single definite price of its own that can adjust to clear a market of its own; instead, its market value is a reciprocal average of the prices of all other things. This “price” tends to b sticky for reasons almost inherent in the very concept of money.

— L.B. Yeager, “The Medium of Exchange,” in R.W. Clower (ed.), Monetary Theory (Middlesex: Penguin, 1973 [1969]), pp. 51–53.

Money and Economic Calculation

A second difficulty arises in barter. At what rate is any exchange to be made? If a certain quantity of beef be given for a certain quantity of corn, and in like manner corn be exchanged for cheese, and cheese for eggs, and eggs for flax and so on, still the question will arise — how much beef for how much flax, or how much of any one community for a given quantity of another? In a state of barter the price-current list would be a most complicated document, for each commodity would have to be quoted in terms of every other commodity, or else complicated rule-of-three sums would become necessary. Between one hundred articles there must exist no less that 4950 possibles ratios of exchange and all these ratios must be carefully adjusted so as to be consistent with each other, else the acute trader will be able to profit by buying from some and selling to others.

All such trouble is avoided if any one commodity to be chosen and its ratio of exchange with each other commodity be quoted. Knowing how much corn is to be bought for a proud of silver and also how much flax for the same quantity of silver, we learn without further trouble how much corn exchanges for so much flax. The chosen commodity becomes a common denominator or common measure of value, in terms of which we estimate the values of all other goods, so that their values become capable of the most easy comparison.

— W.S. Jevons, “Barter,” in R.W. Clower (ed.), Monetary Theory (Middlesex: Penguin, 1973 [1969]), pp. 27–28.

Pigou’s Dynamic Equilibrium

The term “stationary state,” as used by economists, is…not linguistically apt. The idea that it was meant to convey is not, as the word suggests, that of non-motion but that of rotation at a constant speed, neither accelerating nor decelerating. Consider then an economy in a stationary state in that sense, or, what comes to the same thing, in any state restricted to a time interval short enough to allow accelerations or decelerations as may be taking place to be ignored. In a moving picture of this all the several stocks…remain constant in size. No additions to or subtractions from any of them take place, which implies that there is no net investment or disinvestment and no change in the size of the population of working age. The shape of the waterfall is unvarying, but the place occupied at one moment by this drop in the next moment occupied by that one.

— A.C. Pigou, “Money, A Veil,” in R.W. Clower (ed.), Monetary Theory (Middlesex: Penguin, 1973 [1969]), p. 31.