Category Archives: Uncategorized

Macro Musings

This week I was a guest on David Beckworth’s Macro Musings podcast. We discussed my policy brief on the labor standard as well as monetary policy more generally. Here is a link for those interested.

Updates

A couple of updates:

  • The topic of this month’s Cato Unbound is J.P. Koning’s proposal for the U.S. to issue a large denomination “supernote” and to tax that note as a way of punishing illegal activity. I will be contributing to the discussion this month along with James McAndrews and Will Luther. You can read J.P.’s lead essay here. The response essays will be linked below the lead essay. My response essay will appear next week.
  • My paper with Alex Salter and Brian Albrecht entitled “Preventing Plunder: Military Technology, Capital Accumulation, and Economic Growth” has been accepted at the Journal of Macroeconomics. I think that this paper is based on a really interesting idea (biased, I know). The basic idea is that military technology is a limiting factor for economic growth. We also suggest that both economic growth (at least to some degree) and state capacity could be driven by this common factor.

Monetary Policy as a Jobs Guarantee

Today, the Mercatus Center published my policy brief on the idea of a “labor standard” for monetary policy that was first proposed by Earl Thompson and David Glasner.

Towards an Alchian-type Approach to Political Economy

In my previous post, I discussed what I called the sleight of hand of an Olson-approach to political economy. The basic idea of that post was that Olson’s theory of concentrated benefits and dispersed costs is often used to malign policies deemed to be inefficient. The sleight of hand aspect is as follows. First, the economist deems a particular policy to be inefficient using a standard theoretical model. Second, the economist hypothesizes that the reason we have such an inefficient policy is due to special interests getting what they want because the costs are dispersed. Third, the economist examines either in historical detail or through regression analysis the role of special interests in getting the policy implemented. Fourth, if special interests are found to have had an effect on the policy being put into place, the economist concludes that the reason we have this inefficient policy is due to special interests. However, the inefficiency of a particular policy is determined by some theoretical model. The empirical finding that special interests had a marginal effect on the policy’s implementation is then used to explain why we got this inefficient policy. Whether or not this is the correct interpretation of the empirical result depends critically on whether the theoretical assertion is true!

Let me elaborate on this point using an example. Consider the example of pollution, which is a principles of microeconomics textbook version of an externality. Suppose that in the absence of special interests, such as environmental groups, pollution would go untaxed. Empirical evidence would show that a tax on pollution was due to the influence of special interest groups (the environmental groups). If we had no concept of externalities and we used the perfectly competitive model as our benchmark model, the conclusion would be that special interests were to blame for this inefficient policy. However, since this is a commonly understood externality, one would not conclude that special interests were to blame for an inefficient policy. On the contrary, the special interest groups would be the reason for implementing the socially optimal policy. In other words, finding evidence of the role of special interest groups does not tell us anything about what is efficient or what is optimal. To do so, we need an explicit theoretical argument or model. Not only that, to come to the correct conclusion we need a correct theoretical model in the sense that it addresses relevant factors, such as externalities.

In my previous post, I criticized economists for too often simply asserting that a policy is inefficient and subsequently applying Olson’s model to explain why we get such stupid, inefficient policies. I also argued that political economy should shift to using an evolutionary argument. In that post, I was short on some of these details. As a result, in this post I want to outline what I meant by this.

In 1950, Armen Alchian published a paper entiled “Uncertainty, Evolution, and Economic Theory.” In that paper he outlines an evolutionary approach to economic theory. Specifically, he argues that it might be misleading to describe firms as profit-maximizers. The reason is that when firms face decisions, there might be a distribution of outcomes across each decision. If these distributions overlap, then it doesn’t make sense to think of the firm as maximizing anything. For example, one distribution might have a higher average profit, but also be associated with a greater variance in profit than some other possible decision. So if firms aren’t maximizing profit, what are they doing?

Alchian suggested that we think of firms as practicing trial-and-error and imitation. Firms try certain things to see what works and imitate things that worked for other firms. Along the way, some firms benefit from good luck and other firms suffer from bad luck. Nonetheless, through this process of trial-and-error, imitation, and uncertainty, the profit mechanism ultimately determines what firms are able to stay in the market and what firms must leave the market. Firms that earn a profit are able to continue operating. Firms that are losing money will be forced to drop out of the market. The profit and loss mechanism therefore selects for firms who are making a profit. This might be due to the firm’s decision-making or it might be due to luck (or some combination of the two). Nonetheless, the economist should be able to explain the success (or lack thereof) of firms. An economist can look at the characteristics and decisions shared by the surviving firms and contrast those characteristics and decisions of the firms that have left the market. In doing so, one can get the sense of the role of decision-making and luck as well as the types of decisions that have proven successful and unsuccessful.

In my view, political economy would benefit from the same sort of approach. Rather than start with a baseline model to determine whether some policy is efficient or not, one should start with the policy itself.

1. What was the primary justification for the policy? More importantly, under what grounds could we consider the policy to be efficient? These questions help to set a much more relevant benchmark than some abstract model of the economist’s choosing.

2. Once these questions have been answered, the economist has some general idea about the conditions under which the policy would be considered efficient. Now, one can take an evolutionary approach to the policy. Did the policy survive for a long time and/or is it still around? What other states or countries have adopted the same or similar policies? How did states and/or countries adopting the policy perform along the relevant dimension in comparison to others? Did any other states/countries have similar policies and abandon them? What happened if they did?

The answers to these questions help to determine the conditions under which the policy survived and the relative success of those places that implemented the policy. This can help to determine if the policy actually achieved what it was supposed to and/or whether the policy is consistent with conditions under which it could be considered efficient. In addition, if the policy seems to have been an efficient response to a particular problem, it is then possible to examine why some places got rid of it and had to bear the cost of doing so thereafter.

In short, I think that it would be useful to do something in political economy with respect to government policy today that Pete Leeson has done with policies and institutions of an earlier time and place. Leeson’s work often starts by examining some policy, law, or institution that seems completely weird, strange, or backwards. He then starts with the premise that it must have been efficient. He outlines the conditions under which the policy or institution would have been efficient and then tests that theory by examining what would have to be true for his efficiency hypothesis to be correct. This approach to political economy or public choice is clearly enlightening, judging by Leeson’s publication record. However, I notice a reticence on the part of many political economists and public choice economists to take the same approach to more recent policies and institutions. The attitude toward more modern policies and institutions seems to be that we “know” that policy X or institution Y is inefficient because economic theory tells us so. Therefore we need to explain why it exists. But how do we “know” this any more than we “know” that trial by battle was a backwards and barbaric practice of no practical use? Leeson’s work showing that trial by battle was a good way of eliciting the true value that particular claimants placed on land was actually quite efficient. So maybe we should be a bit more humble about modern policy as well.

The Sleight-of-Hand of Olson-esque Public Choice

“Long-surviving democracies could therefore hardly have been dominated by the charlatans, simpletons or crooks that economists typically portray in characterizing democratic representatives.” — Thompson and Hickson (2000)

The early days of public economics (at least as a distinct field) were essentially normative. The basic idea was that economists could use economic theory to examine market failures and devise policies that correct for those failures. A quintessential example is the case of externalities. Suppose, for example, that a particular type of production produces pollution. This cost is not limited to the firms or those working for firms. This cost affects (potentially) all members of society. The social cost of production is therefore greater than the private cost. Since firms are unlikely to internalize this social cost, they tend to produce “too much.” In order to correct for this, the economist would likely recommend taxing production at a sufficiently high level to reduce production to the socially optimum level (i.e. the level that takes into consideration both the entire cost). In this world, the economist largely plays the role of technocrat, identifying market failures and offering corrective policies.

James Buchanan, one of the pioneers of what is now called public choice theory, suggested that public economics should take a different approach. In particular, he suggested that public economics should concern itself with positive economics (i.e., an analysis of “what is” rather than “what should be”). The field of public choice recognized that the process through which policy is enacted requires the deliberate actions of politicians and other policymakers as well as voters and special interest groups.

One view of policymaking that emerged in the public choice literature is most closely identified with Mancur Olson. According to this view, the democratic process contains policymakers who are capable of supplying policy and the general public who have demands on policy. The general public will tend to form coalitions, which we might call special interest groups. As the name implies, these groups are organized around a common interest. These interest groups then go to politicians and other policymakers with their concerns and petition for policies that provide direct benefits to their group. This process tends to be effective for special interest groups because politicians are self-interested. A politician cares about getting re-elected. As such, the politician has an incentive to give the special interest groups want they want because the benefits are concentrated within the group, but the costs are dispersed throughout society. Since the costs are so small for the average voter and/or taxpayer, the marginal cost of taking action to oppose the policy exceeds the marginal benefit.

The usefulness of this theory is that it enables economists to explain the existence and persistence of inefficient policies. One shouldn’t be surprised to observe inefficient policies if those policies are providing concentrated benefits and dispersed costs. This is no doubt an insightful positive approach to the behavior of politicians and the process of policy determination.

Despite the theory’s usefulness in explaining “what is”, empirical applications of this theory often engage in a sleight-of-hand technique. For example, some public choice scholars studying a particular policy will start their analysis by using economic theory to examine a particular policy. If the policy is found to be inefficient in theory, it is natural to ask why the policy exists. One hypothesis is that this is simply an example of Olson’s theory. The public choice economist can then go back and analyze who benefits from the policy and what politician(s) supported the policy to see whether it is a simple application of concentrated benefits and dispersed costs. In the case of simple legislation, the public choice economist might even estimate a regression model of the likelihood that a particular legislator voted in favor of the policy using data on special interest influence.

The reason that I say that this application of Olson’s theory is a sleight-of-hand is as follows. This sort of analysis starts with the idea that the policy is inefficient and then empirically examines whether this is a case of special interest influence. But this is an empirical test used to justify a theoretical conclusion. In other words, economists identify a theoretical inefficiency and determine empirically that the reason the policy exists is due to the influence of special interests.

Why does this matter?

First, this approach to public choice is making a similar sort of mistake that early public economics was making. The economist starts with a theoretical model and analyzes the policy within the context of the model. If the policy is inefficient in the model, then the economist is left to explain why such an inefficient policy exists. But what if the model is wrong? What if the policy is correcting for an inefficiency that the economist ignored?

Second, this sort of empirical evidence can never tell us whether or not the policy is inefficient. In fact, it would be surprising if one didn’t find evidence of special interest influence on legislation. This is because special interests will promote their own interests, regardless of whether the policy is welfare-improving. So an economist will be likely to observe special interest influence both in cases when the special interests bring an inefficiency to the attention of policymakers and when they are just looking for a giveaway.

For a proper analysis of this Olson-based approach, economists need to develop a much better understanding of the black-box nature of the political process. The idea that special interests shape policy is not surprising. However, different political systems will select for particular policies. Countries with a given set of institutions might select for policies that appear to be inefficient, but in reality are efficient responses to some social problem previously ignored by economists. Other institutional structures might select for giveaways to special interests.

For the Olson-based approach to be useful for evaluating the efficiency properties of policy requires an evolutionary approach. Thus, the analysis of policy requires returning to the point at which the policy was adopted and attempting to identify what inefficiency the policy could possibly be aimed at eliminating. Did the policy persist and for how long? Then, one can look for whether other places adopted similar policies. If so, did the policy persist and for how long? Does the policy seem to have eliminated these inefficiencies? Among the places that didn’t adopt the policy, did they turn out better or worse in regard to this supposed inefficiency? Why did some places adopt the policies and not others? What are the institutional differences that explain what policies were selected for?

The answers to these questions seem substantially more important than the results of some probit regressions of yay or nay votes.

In Memory of John Murray

This post is a bit different than normal. Most of my posts are about the minutiae of economic theory or controversies. Today’s post is personal. All of us in academia have a number of important people who have helped us in our intellectual journey and career. I have been fortunate enough to have a number of such people in my short career. One of these people was John Murray.

I first met John as an undergraduate. At the time I was a history major, but I had started to take an interest in economics. I went to see John in his office, he being the undergraduate adviser at that time. We had not met before that day. In fact, I could not have taken more than 3 courses in economics at that time. I remember that he was delighted that I was interested in economics given that I was currently a history major. After all, John was an economic historian. When I took John’s course in economic history, it really opened my eyes to thinking about history in a completely different way. I could tell, even then, that he really enjoyed the unique perspective that economists brought to the study of history. He also had a dry sense of humor that I enjoyed.

John and I always kept in touch. When I accepted my job at the University of Mississippi, John had just accepted his position as the J. R. Hyde III Professor of Political Economy at Rhodes College. He thought that it was funny that we had accepted jobs just an hour drive from another. After we moved, I invited John down here to give seminars and he invited me up there to give a seminar. The last few years, he made a habit of coming down to Oxford to have lunch with me about twice a year. While these were technically lunches, we would often chat for a couple of hours when he would visit. We would talk about our kids and our research and he would always give me advice. We would also talk about the craziest economic theories that we thought might be correct. He also loved that I had recently taken an interest in applying modern macro to historical events. At our last lunch together in October, he was especially excited to talk about how I’d recently been given tenure and how much I had accomplished from that day I initially met him in his office.

I say this was our last lunch because John died last Tuesday. He was 58 years old.

John was not only a great mentor, but an excellent scholar. John’s work on the communes of the religious group known as the Shakers is an important work on the role of incentives in the context of particular institutional environments and should be a staple of law and economics courses. He also wrote a fascinating book on an early form of health insurance in the U.S., industrial sickness funds. He was also on the editorial board of the Journal of Economic History and Explorations in Economic History. His Google Scholar page is here. I imagine that all scholars want their work to be remembered fondly. So hopefully readers will pursue some of these links.

John was one of the most genuinely nice people that you could ever meet and he had a great laugh. He was the first person in his family to go to college and once upon a time he was a high school math teacher. Having grown up in Cincinnati, he was also a Reds fan, which I am proud to say I never held against him. His Rhodes webpage has a really great description of his life and his research in his own words, which can be found here.

The last interaction I had with John was through email a couple of weeks ago. I had sent him one of my latest papers and he told me that he was really excited to read it and discuss it. Our next lunch would have been planned for the next month or so. I wish now that I’d scheduled it sooner. I miss those lunches already. All I can hope is that John is somewhere saving me a seat for our next lunch.

The Bullionist Controversy

My paper entitled, “The Bullionist Controversy: Theory and New Evidence” has been accepted at the Journal of Money, Credit, and Banking. Here is the abstract:

The Bullionist Controversy in the United Kingdom is one of the first debates about the determination of the price level and the exchange rate under a paper money standard. Despite the importance of the debate in the development of monetary theory, there remains little empirical evidence that uses modern, multivariate time series techniques. The evidence that does exist provides support for the Anti-Bullionist position. The purpose of this paper is to review the debate and develop a dynamic general equilibrium model that is capable of capturing key features of the 19th-century British financial system. The model is estimated using Bayesian procedures to test the competing hypotheses. The paper provides support for the Bullionist position.