Econ question: if a child is renting an apartment for $X, and the parents have a spare apartment that they are currently renting out for $Y, would it help or hurt the economy if the child moved into that apartment instead? Consider the cases X<Y, X=Y, X>Y.
If I moved into that apartment instead, would that help or hurt the country’s economy as a whole?
Good question, not because it’s hard to answer, but because of how pervasive the wrong answer is, and the implications for policy for economists getting it wrong.
If your parents prefer you being in their apartment to the forgone income, they benefit; otherwise they don’t.
If you prefer being in their apartment to the alternative rental opportunities, you benefit; otherwise, you don’t.
If potential renters or the existing ones prefer your parents’ unit to the other rental opportunities and they are denied it, they are worse off; otherwise, they aren’t.
ANYTHING beyond that—anything whatsoever—is Goodhart-laden economist bullsh**. Things like GDP and employment and CPI were picked long ago as a good correlate of general economic health. Today, they are taken to define economic health, irrespective of how well people’s wants are being satisfied, which is supposed to be what we mean by a “good economy”.
Today, economists equate growing GDP—irrespective of measuring artifacts that make it deviate from what we want it to measure—with a good economy. If the economy isn’t doing well enough, well, we need more “aggregate demand”—you see, people aren’t buying enough things, which must be bad.
Never once has it occurred to anyone in the mainstream (and very few outside of the mainstream) that it’s okay for people to produce less, consume less, and have more leisure. No, instead, we have come to define success by the number of money-based market exchanges, rather than whether people are getting the combination of work, consumption, and leisure (all broadly defined) that they want.
This absurdity reveals itself when you see economists scratching their heads, thinking how we can get people to spend more than they want to, in order to help the economy. Unpack those terms: they want people to hurt themselves, in order to hurt less.
Now, it’s true there are prisoner’s dilemma-type situations where people have to cooperate and endure some pain to be better off in the aggregate. But the corresponding benefit that economists expect from this collective sacrifice is … um … more pointless work that doesn’t satisfy real demand .. but hey, it keeps up “aggregate demand”, so it must be what a sluggish economy needs.
Are you starting to see how skewed the standard paradigm is? If people found a more efficient, mutualist way to care for their children rather than make cash payments to day care, this would be regarded as a GDP contraction—despite most people being made better off and efficiency improving. If people work longer hours than they’d like, to produce stuff no one wants, well, that shows up as more GDP, and it’s therefore “good”.
There’s the underground economy—I’ve seen claims about the size of it, but how would you check them?
There’s everything people do for each other without it going through the official economy.
And there’s what people do for themselves—every time you turn over in bed, you are presumably increasing value. If you needed paid help, it would be adding to the GDP.
I don’t understand where you acquired this view of economists. I am an economist and I assure you economists don’t ascribe to the “measured GDP is everything” view you attribute to them.
This absurdity reveals itself when you see economists scratching their heads, thinking how we can get people to spend more than they want to, in order to help the economy. Unpack those terms: they want people to hurt themselves, in order to hurt less.
This is not an accurate portrayal of what Keynesians believe. The Keynesian theory of depressions and recessions is that excessive pessimism leads people to avoid investing or starting businesses, which lowers economic activity further, which promotes more pessimism, and so on.
The goal of stimulus is effectively to trick people into thinking the economy is better than it is, which then becomes a self-fulfilling prophesy; low quality spending by government drives high quality spending by the private sector.
If you wish to be sceptical of this story (I’m fairly dubious about it myself), then fine, but Keynesians aren’t arguing what you think they’re arguing.
If you wish to be sceptical of this story (I’m fairly dubious about it myself), then fine, but Keynesians aren’t arguing what you think they’re arguing.
No, that’s precisely what I assumed they’re arguing, and I believe my points were completely responsive. I will address the position you describe in the context of the criticism in my rant.
The Keynesian theory of depressions and recessions is that excessive pessimism leads people to avoid investing or starting businesses, which lowers economic activity further, which promotes more pessimism, and so on.
The goal of stimulus is effectively to trick people into thinking the economy is better than it is, which then becomes a self-fulfilling prophesy;
Now, unpack the meaning of all of those terms, back to the fundamentals we really care about, and what is all that actually saying? Well, first of all, have you played rationalist taboo with this and tried to phrase everything without economics jargon, so as to fully break down exactly what all the above means at the layperson level? To me, economists seem to talk as if they have not done so.
I would like for you to tell me whether you have done so in the past, and write up the phrasing you get before reading further. You’ve already tabooed a lot, but I think you need to go further, and remove the terms: recession, depression, stimulus, excessive, pessimism, invest, and economic activity. (What’s left? Terms like prefer, satisfaction, wants, market exchange, resources, working, changing actions.)
Now, here’s what I get: (bracketed phrases indicate a substitution of standard economic jargon)
“People [believe that future market interactions with others will be less capable of satisfyng their wants], which leads them to [allocate resources so as to anticipate lower gains from such activity]. As people do this, the combined effect of their actions is to make this suspicion true, [increasing the relative benefit of non-market exchanges or unmeasured market exchanges].
“The government should therefore [purchase things on the market] in order to produce a [false signal of the relative merit of selling certain goods], and facilitate production of [goods people don’t want at current prices or that they previously couldn’t justify asking their government to provide]. This, then, becomes a self-fulfilling prophecy: once people [sell unwanted goods due to this government action], it actually becomes beneficial for others to sell goods people do want on the market, [preventing a different kind of adjustment to conditions from happening].”
Phrased in these terms, does it even make sense? Does it even claim to do something people might want?
People [believe that future market interactions with others will be less capable of satisfyng their wants]
That was a very useful exercise since it helped me identify the key point of disagreement between you an Keynesianism. If I’m right, you’re coming at this from a goods market perspective i.e. “I, a typical consumer am not interested in any of these goods at these prices, so I’m going to not buy so much”, whereas the Keynesians are blaming this kind of attitude: “I, a typical consumer am fearful of the future. While I want to buy stuff, I’d better start saving for the future instead in case I lose my job” and it’s the saving that triggers the recession (money flows out of the economy into savings, this fools people into thinking they are poorer and the death spiral begins).
A couple of other contextual points:
1) The monetary stimulus that Keynes recommended was based on governments running deficits, not necessarily spending more. Cutting taxes works just as well
2) Keynes was trying to reduce the magnitude of boom-bust swings, not increase trend economic growth rates. As such he prescribed the opposite behaviour in boom times, have government run surpluses to tamp down consumer exuberance. This is less widely known since politicians only ever talk about Keynes during recessions, when it gives them intellectual cover to spend lots of money.
3) The Keynesian consensus is not universal. Arnold Kling’s “recalculation” story is much closer to your picture, and you’ll notice he doesn’t advocate stimulus, but rather waiting to see how people adjust to the new economic circumstances.
4) GDP is the preoccupation of macroeconomists. Microeconomists (like me) care much more about allocative efficiency, which is to say to what extent are things in the hands of the people who value them most? So there’s a whole branch of the profession to which your initial GDP-centrism comment does not apply.
It’s points 3 and 4 in particular that lead me to object to your claim that economists are obsessed with GDP. To my way of thinking, it’s politicians that are obsessed with GDP because they believe their chances of re-election are tied to economic growth and unemployment figures. So they spend a lot of time asking economists how to increase GDP, and therefore economists more often than not to discuss GDP when they appear in public.
That was a very useful exercise since it helped me identify the key point of disagreement between you an Keynesianism. If I’m right, you’re coming at this from a goods market perspective i.e. “I, a typical consumer am not interested in any of these goods at these prices, so I’m going to not buy so much”, whereas the Keynesians are blaming this kind of attitude: “I, a typical consumer am fearful of the future. While I want to buy stuff, I’d better start saving for the future instead in case I lose my job” and it’s the saving that triggers the recession (money flows out of the economy into savings, this fools people into thinking they are poorer and the death spiral begins).
It’s still not clear to me that you’ve done what I asked (taboo your model’s predicates down to fundamentals laypeople care about), or that you have the understanding that would result from having done what I asked.
What’s the difference between the “goods market” perspective and the “blaming this kind of attitude”/Keynesian perspective? Why is one wrong or less helpful, and what problems would result from using it?
Why is it bad for people to believe they are poorer when they are in fact poorer?
Why is it bad for more money to go into savings? Why does “the economy” entirely hinge on money not doing this?
Until you can answer (or avoid assuming away) those problems, it’s not clear to me that your understanding is fully grounded in what we actually care about when we talk about a “good economy”, and so you’re making the same oversights I mentioned before.
you’re making the same oversights I mentioned before.
No, I’m not making those oversights because I am a) not a Keynesian and b) not a macroeconomist. My offering defences of this position should not be construed as fundamental agreement that position.
This is quickly turning into a debate about the merits of Keynesianism which is not a debate I am interested in because stabilisation policy is not my field and I don’t find it very interesting, I got enough of it at university. I’m going to touch on a few points here, but I’m not going to engage fully with your argument; you really need to talk to a Keynesian macroeconomist if you want to discuss most of this stuff. For one thing my ability to taboo certain words is affected by the fact I don’t have a very solid grip on the theory and I don’t spend much of my time thinking about high level aggregates like GDP.
Now here’s the best I can do on your bullet point questions, sorry if it doesn’t help much, but it’s all I’ve got:
1) The difference is that Keynesians believe savings reduce the money supply by taking money out of circulation, this makes them think they are poorer, which makes them act like they’re poorer, which makes other people poorer.
2) Because it starts with an illusion of poverty. The first cause of recessions in a Keynesian model is “animal spirits”, or in layman’s terms, irrational fear of financial collapse. Viewed from this perspective, stimulus is a hack that undoes the irrationality that caused the problem in the first place (and because it’s caused by irrationality they can feel confident it is a problem).
3) This is actually one of my biggest problems with Keynesian theory. If it strikes you as counter-intuitive or silly, I’m not going to dissuade you.
One final point:
The reason I replied to your initial comment in the first place, was your suggestion that all economists are obsessed with maximising measured GDP over everything else.
But many economists don’t deal with GDP at all. When I was learning labour market theory we were taught that once people’s wage rate gets high enough, one could expect them to work fewer hours since the demand for leisure time increases with income. There was never a suggestion that this was anything to be concerned about, the goal is utility, not income.
In environmental economics I recall reading a paper by Robert Solow (the seminal figure in the theory of economic growth) arguing that it was important to consider changes in environmental quality along with GDP, to get a better picture of how well off people really are.
I look at what I have been taught in economics, and I simply can’t square it with your view of the profession. Some kinds of economists tend to be obsessed with growth, but they tend to be economists who specialise in economic growth. The rest of us have other pursuits, and other obsessions.
Alright, I’ll let anyone judge for themselves if the canonical Keynesian replies reveal a truly grounded understanding of what counts as “helping the economy”.
you really need to talk to a Keynesian macroeconomist if you want to discuss most of this stuff. For one thing my ability to taboo certain words is affected by the fact I don’t have a very solid grip on the theory …
Forget Keynesian theory for a minute: I want to know if you have the understanding I expect of whatever theory it is you do endorse. Can you taboo that theory’s terminology and ground it layperson level fundamentals? Can you force me to care about whatever jargon you do in fact use?
Because, at risk of sounding rude, I don’t think you’ve acquired this “Level 2” understanding, and I don’t think you’re atypical among economists in lacking it—from what I’ve read of Mankiw, Sumner, and Krugman, they don’t have it either.
(btw, you call yourself an economist but don’t have a grip on Keynesian theory? Isn’t that pretty much required these days?)
One final point: The reason I replied to your initial comment in the first place, was your suggestion that all economists are obsessed with maximising measured GDP over everything else.
But many economists don’t deal with GDP at all. …I look at what I have been taught in economics, and I simply can’t square it with your view of the profession. Some kinds of economists tend to be obsessed with growth, but they tend to be economists who specialise in economic growth.
Sure—I only meant that economic policy advocates who are concerned about aggregate economic variables are obsessed with GDP as one of those variables, but that should be assumed from context. Obviously, you’re not going to care about GDP in your capacity as a microeconomist of company behavior.
Because, at risk of sounding rude, I don’t think you’ve acquired this “Level 2” understanding … (btw, you call yourself an economist but don’t have a grip on Keynesian theory? Isn’t that pretty much required these days?)
On macro policy I doubt I have level 2 understanding. I had to take papers in macro at university, and I was able to get reasonable grades on them, but level 0 or 1 understanding is sufficient to do that.
My guess is that if you asked a Keynesian why they care, they would say that boom-bust cycles create uncertainty and fear in people because they don’t know if they’re going to lose their job (and they want their job, or they’d have already quit) and by taming the boom-bust cycle people will have a more certain and therefore more pleasant life).
Equally if you asked a development economist, they would point to the misery in third world countries and for wealthy countries point out that productivity growth means being able to do more with less, and whether you want to have more, or want to do less, that’s a win. Unemployed people are by definition people who want a job but don’t have one, so concern about unemployment is easy to work out.
And as for me, well the reason I care about allocative efficiency is that allocative efficiency is the attempt to match reality to people’s preferences as well as is possible under current constraints. How do we use our resources and knowledge to create the things people want and how do we get them to the people who want them the most?
The market does a pretty good job of this most of the time, but it does fail sometimes. And when it fails there are things government can do to improve matters, but the government can fail too, so you have to balance out the imperfections of the market and the imperfections of government and try to work out which set of imperfections is more problematic. If I succeed, or if people like me succeed then people will have more of what they want, be that flat screen TVs, or cars or clean air or time with their families. Not everything falls within economics’ purview of course, love and truth and beauty are things I can’t help with. But for everything else, my goal is to help the market to match infinite wants with finite resources, and imperfect information.
Sure—I only meant that economic policy advocates who are concerned about aggregate economic variables are obsessed with GDP as one of those variables, but that should be assumed from context.
Perhaps it should have been, but I failed to assume this. And microeconomics is a lot wider than company behaviour, it covers pretty much everything but GDP and unemployment.
And as for me, well the reason I care about allocative efficiency is that allocative efficiency is the attempt to match reality to people’s preferences as well as is possible under current constraints. How do we use our resources and knowledge to create the things people want and how do we get them to the people who want them the most?
That wasn’t the question or contributory thereto, though it shows you can ground one concept.
The question is, whatever model/theory you have of the economy, are its predicates fully grounded in what laypersons care about? You mentioned things people care about, but not how they fit into the model that you advocate.
Allocative efficiency is what I work with. If you asked me why I care about GDP, my response would be, “I don’t, particularly”.
As for my economic model, I can’t give you a full rundown in a comment, but here’s the short version:
1) Level 1 is the fully ideal version, unrealistic, but useful for grounding the whole thing in people’s preferences. It basically rests on the notion that if you make a battery of assumptions voluntary exchange will result in allocative efficiency, if person A values something more than person B then they will trade, either directly or through side trades until person A has it. Yes there are a lot of reasons this doesn’t work in practice, but that’s level 2.
2) Level 2 picks at all those assumptions in level 1. Things like externalities (like pollution) imperfect information, irrational behaviour, imperfect competition, transaction costs and other git in the gears. These things cause violations of the assumptions in 1, and therefore prevent potentially efficiency-enhancing trades from occurring. The academic work at level 2 is focused around identifying these problems and considering possible solutions a government could introduce to correct for them.
3) Level 3 looks at the ability of government to effectively implement the policies identified at level 2. Theories like social choice theory (the ability of voting systems to effectively aggregate votes into social preferences) and public choice theory (how well do governments act as agents of the voting public). The academic work at level 3 is focused around identifying the limitations of real world governments, and identifying the side-effects of badly implemented policies.
Level 1 is all about individual preferences, not attempting to measure them directly because you can’t, but rather in setting up a system so people can sort it out themselves.
As for how GDP factors in, well they it doesn’t directly. Macro and micro aren’t integrated, they haven’t been since Keynes. You learn about them indifferent courses, people tend not to specialise in both, so there’s a gap there. Hence the reason I don’t care about GDP per se.
Now productivity I care about, because higher productivity means more resources for people to trade with and more preferences can be satisfied. I care about unemployment because it implies people are willing to make a trade, but unable to do so due to some bug in the system, either a level 2 problem (market failure), or a level 3 problem (government failure).
I am an economist and I assure you economists don’t ascribe to the “measured GDP is everything” view you attribute to them.
Aside from the standard arguments about the shortcomings of GDP, my principal objection to the way economists use it is the fact that only the nominal GDP figures are a well-defined variable. To make sensible comparisons between the GDP figures for different times and places, you must convert them to “real” figures using price indexes. These indexes, however, are impossible to define meaningfully. They are produced in practice using complicated, but ultimately arbitrary number games (and often additionally slanted due to political and bureaucratic incentives operating in the institutions whose job is to come up with them).
In fact, when economists talk about “nominal” vs. “real” figures, it’s a travesty of language. The “nominal” figures are the only ones that measure an actual aspect of reality (even if one that’s not particularly interesting per se), while the “real” figures are fictional quantities with only a tenuous connection to reality.
It’s pretty easy to get this sort of view just reading books. In my (limited) experience, there are a fair percentage of divergent types that are not like this—and they tend to be the better economists.
You may like Morgenstern’s book On the Accuracy of Economic Observations. How I rue the day I saw this in a used bookstore in NY and didn’t have the cash to buy it..
I’m going through Morgenstern’s book right now, and it’s really good. It’s the first economic text I’ve ever seen that tries to address, in a systematic and no-nonsense way, the crucial question of whether various sorts of numbers routinely used by economists (and especially macroeconomists) make any sense at all. That this book hasn’t become a first-rank classic, and is instead out of print and languishing in near-total obscurity, is an extremely damning fact about the intellectual standards of the economic profession.
I’ve also looked at some other texts by Morgenstern I found online. I knew about his work in game theory, but I had no idea that he was such an insightful contrarian on the issues of economic statistics and aggregates. He even wrote a scathing critique of the concept ot GNP/GDP (a more readable draft is here). Unfortunately, while this article sets forth numerous valid objections to the use of these numbers, it doesn’t discuss the problems with price indexes that I pointed out in this thread.
It’s pretty easy to get this sort of view just reading books. In my (limited) experience, there are a fair percentage of divergent types that are not like this—and they tend to be the better economists.
Could you please list some examples? Aside from Austrians and a few other fringe contrarians, I almost always see economists talking about the “real” figures derived using various price indexes as if they were physicists talking about some objectively measurable property of the universe that has an existence independent of them and their theories.
You may like Morgenstern’s book On the Accuracy of Economic Measurements. How I rue the day I saw this in a used bookstore in NY and didn’t have the cash to buy it..
Thanks for the pointer! Just a minor correction: apparently, the title of the book is On the Accuracy of Economic Observations. It’s out of print, but a PDF scan is available (warning -- 31MB file) in an online collection hosted by the Stanford University.
I just skimmed a few pages, and the book definitely looks promising. Thanks again for the recommendation!
Could you please list some examples? Aside from Austrians and a few other fringe contrarians, I almost always see economists talking about the “real” figures derived using various price indexes as if they were physicists talking about some objectively measurable property of the universe that has an existence independent of them and their theories.
I meant personally—I did my undergrad in economics. I’m extremely skeptical of macroeconomics and currently throw in with the complex adaptive system dynamicists and the behavioral economists (and Hansonian cynicism; that’s just me). But, to give an example, Krugman has done quite a bit of work in the complexity arena.
I just skimmed a few pages, and the book definitely looks promising. Thanks again for the recommendation!
Yeah, you’re welcome! The first I heard of that book was someone using the example of calculating in-flows and out-flows of gold. Each country’s estimates differed by orders of magnitude or something like that, and even signs.
It’s not so much a matter of being overconfident as it is not listing the disclaimers at every opportunity. The Laspeyres Price Index (the usual type of price index) has well understood limitations (specifically that it overestimates consumer price growth as it doesn’t deal with technological improvement and substitution effects very well), but since we don’t have anything better, we use it anyway.
“Real” is a term of art in economics. It’s used to reflect inflation-adjusted figures because all nominal GDP tells you is how much money is floating around, which isn’t all that useful. real GDP may be less certain, but it’s more useful.
Bear in mind that everything economists use is an estimate of a sort, even nominal GDP. Believe it or not, they don’t actually ask every business in the country how much they produced and / or received in income (which is why the income and expenditure methods of calculating GDP give slightly different numbers although they should give exactly the same result in theory). The reason this may not be readily apparent is that most non-technical audiences start to black out the moment you talk about calculating a price index (hell, it makes me drowsy) and technical audiences already understand the limitations.
“Real” is a term of art in economics. It’s used to reflect inflation-adjusted figures because all nominal GDP tells you is how much money is floating around, which isn’t all that useful. real GDP may be less certain, but it’s more useful.
You’re talking about the “real” figures being “less certain,” as if there were some objective fact of the matter that these numbers are trying to approximate. But in reality, there is no such thing, since there exists no objective property of the real world that would make one way to calculate the necessary price index correct, and others incorrect.
The most you can say is that some price indexes would be clearly absurd (e.g. one based solely on the price of paperclips), while others look fairly reasonable (primarily those based on a large, plausible-looking basket of goods). However, even if we limit ourselves to those that look reasonable, there is still an infinite number of different procedures that can be used to calculate a price index, all of which will yield different results, and there is no objective way whatsoever to determine which one is “more correct” than others. If all the reasonable-looking procedures led to the same results, that would indeed make these results meaningful, but this is not the case in reality.
Or to put it differently, an “objective” price index is a logical impossibility, for at least two reasons. First, there is no objective way to determine the relevant basket of goods, and different choices yield wildly different numbers. Second, the set of goods and services available in different times and places is always different, and perfect equivalents are normally not available, so different baskets must be used. Therefore, comparisons of “real” variables invariably involve arbitrary and unwarranted assumptions about the relative values of different things to different people. Again, of course, different arbitrary choices of methodology yield different numbers here.
(By the way, I find it funny how neoclassical economists, who hold it as a fundamental axiom that value is subjective, unquestioningly use price indexes without stopping to think that the basic assumption behind the very notion of a price index is that value is objective and measurable after all.)
The most you can say is that some price indexes would be clearly absurd (e.g. one based solely on the price of paperclips), while others look fairly reasonable (primarily those based on a large, plausible-looking basket of goods)
Very true. A good general measure in human economic systems should NOT merely look at the ease of availability of finished paperclips. It should also include, in the “basket”, such things as extrudable metal, equipment for detecting and extracting metal, metallic wire extrusion machines, equipment for maintaining wire extrusion machines, bend radius blocks, and so forth.
Thank you for pointing this out; you are a relatively good human.
By the way, I find it funny how neoclassical economists, who hold it as a fundamental axiom that value is subjective
Here’s a crude metric I use for gauging the relative goodness of societies as places to live: Immigration vs. emigration.
It’s obviously fuzzy—you can’t get exact numbers on illegal migration, and the barriers (physical, legal, and cultural) to relocation matter, but have to be estimated. So does the possibility that one country may be better than another, but a third may be enough better than either of them to get the immigrants.
For example, the evidence suggests that the EU and the US are about equally good places to live.
I don’t think that’s a good metric. Societies that aren’t open to mass immigration can have negligible numbers of immigrants regardless of the quality of life their members enjoy. Japan is the prime example.
Moreover, in the very worst places, emigration can be negligible because people can be too poor to pay for the ticket to move anywhere, or prohibited to leave.
But “given perfect knowledge of all market prices and individual preferences at every time and place, as well as unlimited computing power”, you could predict how people would choose if they were not faced with legal and moving-cost barriers—e.g. imagine a philanthropist willing to pay the moving costs. So your objection to this metric seems to be a surmountable one, in principle, assuming perfect knowledge etc. The main remaining barrier to migration may be sentimental attachment—but given perfect knowledge etc. one could predict how the choices would change without that remaining barrier.
Applying this metric to Europa versus Earth, presumably Europans would choose to stay on Europa and humans would choose to stay on Earth even with legal, moving-cost, and sentimental barriers removed, indeed both would pay a great deal to avoid being moved.
In contrast to Europans versus humans, humans-of-one-epoch are not very different from humans-of-another-epoch.
Off the top of my head, I know that Finland had negligible levels of immigration until a few years ago. Several Eastern European post-Communist countries are pretty decent places to live these days (I have in mind primarily the Czech Republic), but still have no mass immigration. As far as I know, the same holds for South Korea.
Regarding emigration, the prime example were the communist countries, which strictly prohibited emigration for the most part (though, rather than looking at the numbers of emigrants, we could look at the efforts and risks many people were ready to undertake to escape, which often included dodging snipers and crawling through minefields).
First, there is no objective way to determine the relevant basket of goods, and different choices yield wildly different numbers.
The basket used is based on a representation of what people are currently consuming. This means we don’t have to second-guess people’s preferences. Unique goods like houses pose a problem, but there’s not really anything we can do about that, so the normal process is to take an average of existing houses.
Second, the set of goods and services available in different times and places is always different, and perfect equivalents are normally not available, so different baskets must be used.
Which is a well understood problem. Every economist knows this, but what would you have us do? It is necessary to inflation-adjust certain statistics, and if the choice is between doing it badly and not doing it at all, then we’ll do it badly. Just because we don’t preface every sentence with this fact doesn’t mean we’re not aware of it.
Just to avoid confusion among readers, I want to distance myself from part of Vladimir_M’s position. While I agree with many of the points he’s made, I don’t go so far as to say that CPI is a fundamentally flawed concept, and I agree with you that we have to pick some measure and go with it; and that the use of it does not require its caveats to be restated each time.
However, I do think that, for the specific purpose that it is used, it is horribly flawed in noticeable, fixable ways, and that economists don’t make these changes because of lost purpose syndrome—they get so focused on this or that variable that they’re disconnected from the fundamental it’s supposed to represent. They’re doing the economic equivalent of suggesting to generals that their living soldiers be burned to ashes so that the media will stop broadcasting images of dead soldier bodies being brought home.
I wouldn’t be in a good position to determine if it’s lost purpose syndrome since I’m an insider, but I would suggest that path dependence has a lot to do with it.
Price indices are produced by governments, who are notoriously averse to change. And what’s worse the broad methodology is dictated by international standards, so if an economist or some other intelligent person comes up with a better price index they have to convince the body of economists and statisticians that they have a good idea, and then convince the majority of OECD countries (at a minimum) that their method is worth the considerable effort of changing every country’s methodology.
On my blog I suggested using insulin prices as a good proxy for inflation. That should be pretty easy for economists to find, even historical data. One economists could find the historical data for one country and use it as a competing measure. No collective action problem to solve there! Just a research paper to present.
(Though I can’t find it on google searches, but economists should be able to get access to the appropriate databases.)
The technology to manufacture insulin has been getting a lot cheaper since the late 1970s when bacteria were first used to synthesize insulin (before that it had to be extracted from animals). That process has become even easier since the process for growing E. coli has become much more efficient.
True, that was just one layman’s brief pondering of an alternate metric, and I hadn’t realized the secular technology trend. I was mainly looking for something that can’t be debased because then people will die, but that is also has minimal volatility in demand, supply, and speculation, and requires numerous inputs so as to smooth out the effect of local shocks.
And perhaps I’m running into a Goodhart trap myself—today, the problem seems to be inflation being hidden via product degradation, but if I pick a metric mainly optimized for that, it will get worse over time. So finding a good or basket that covers all those would require more work—but product debasement is pretty clearly being ignored today.
(Note that precious metals are sold in a way that prevents them from being secretly debased, but also are heavily influenced by global extraction rates, and are heavily speculated on and hoarded.)
True, that was just one layman’s brief pondering of an alternate metric, and I hadn’t realized the secular technology trend. I was mainly looking for something that can’t be debased because then people will die, but that is also has minimal volatility in demand, supply, and speculation, and requires numerous inputs so as to smooth out the effect of local shocks.
Anything that has numerous inputs will likely be something which is complicated to manufacture and therefore will have increasing efficiency as the technology improves. I can’t think of a single good that fits your criteria and hasn’thad substantial technological advancements of how it is made in the last 30 years. This sort of approach might work if one had very steady data for some long historical period with not much technological advancement.
That’s making your inflation rate strongly tied to one particular technology. A breakthrough making insulin synthesis easier, or increased diabetes rates, would affect insulin prices but not the rest of the economy.
Economists could calculate error bars that would say how closely the calculated aggregate figures approximate their exact values according to definitions. This is normally not done, and as Morgenstern noted in the book discussed elsewhere in the thread, the results would be quite embarrassing, since they’d show that economists regularly talk about changes in the second, third, or even fourth significant digit of numbers whose error bars are well into double-digit percentages.
However, when it comes to the more essential point I’ve been making, error bars wouldn’t make any sense, since the problem is that there is no true value out there in the first place, just different arbitrary conventions that yield different results, neither of which is more “true” than the others.
Economists could calculate error bars that would say how closely the aggregate figures approximate the exact value as defined. This is normally not done, and as Morgenstern noted in the book discussed elsewhere in the thread, the results would be quite embarrassing, since they’d show that economists regularly talk about changes in the second, third, or even fourth significant digit of numbers whose error bars are well into double-digit percentages.
There’s an old joke: “How can you tell macroeconomists have a sense of humour? They use decimal points.” I’ll admit spurious precision is a problem with a quite a bit of economic reporting. Remember that these statistics are produced by governments, not academics and politicians can have trouble grokking error bars.
the problem is that there is no true value out there in the first place, just different arbitrary conventions that yield different results, neither of which is more “true” than the others.
Actually, that’s not really the case. There is an ideal, it’s just you can’t do it. If you knew everyone’s preferences and information and endowments of income, you could work out how people’s consumption would change as real incomes and relative prices changed so you could figure out what the right basket of goods is to use for the index at every point in time (the right bundle is whatever bundle consumers would actually pick in a given situation).
But in practice you can’t get the information you’d need to do this, and that information would be constantly changing anyway. In practice what statistical agencies do is develop a basket of goods based on current consumption and review it every decade or so. This means the index overestimates inflation (the estimates I’ve seen put it at about 1 percentage point per year) because when prices rise, people change their consumption patterns and we can’t predict how until it’s already happened.
This is a flawed procedure, but it’s not arbitrary, its an honest effort to approximate the ideal price index as well as we can, given the resources at our disposal.
There is an ideal, it’s just you can’t do it. If you knew everyone’s preferences and information and endowments of income, you could work out how people’s consumption would change as real incomes and relative prices changed so you could figure out what the right basket of goods is to use for the index at every point in time (the right bundle is whatever bundle consumers would actually pick in a given situation). But in practice you can’t get the information you’d need to do this, and that information would be constantly changing anyway.
To the best of my understanding, what you write above seems to concede that even under the assumption of omniscience, when we consider different times and/or places, with different prices, incomes, and preferences of individuals—and different sets of goods available on the market, though this can be modeled by assigning infinite prices to unavailable goods—there is, after all, no unique objectively correct way to define equivalent baskets of goods. You could calculate the baskets that would actually be consumed at each time and place, but not the ratio of their true values (whatever that might mean), which would be necessary for their use as the basis for a true and objective price index.
Am I wrong in this conclusion, and if I am, would you be so kind to explain how?
In practice what statistical agencies do is develop a basket of goods based on current consumption and review it every decade or so. [...] This is a flawed procedure, but it’s not arbitrary, its an honest effort to approximate the ideal price index as well as we can, given the resources at our disposal.
I would be really grateful if you could spell out what exactly you mean by “the ideal price index” when it comes to comparing different times and places, given my above observation. Also, you ignore the question of how exactly baskets are “reviewed,” which is a step that requires an arbitrary choice of the new basket that will be declared as equivalent to the old.
Moreover, different kinds of “honest efforts” apparently produce very different figures. The procedures for calculating official price indexes have been changed several times in recent decades in ways that make the numbers look very different compared to what the older methods would yield. (And curiously, the numbers according to the new procedures somehow always end up looking better.) Would you say, realistically, that this is purely because we’ve been moving closer to the truth thanks to our increasing knowledge and insight?
You could calculate the baskets that would actually be consumed at each time and place, but not the ratio of their true values (whatever that might mean), which would be necessary for their use as the basis for a true and objective price index.
The concept of “true value” is incoherent, at least in my model of reality. The correct price to attach to a good at any time is its market price at that time. If you had the set of information I listed in my last comment, you’d have the market prices, since they’re implied by the other stuff.
Also, you ignore the question of how exactly baskets are “reviewed,” which is a step that requires an arbitrary choice of the new basket that will be declared as equivalent to the old.
I think we’re using different definitions of arbitrary. To me, arbitrary means that there is no correct answer, and all options are equally valid. I don’t accept that as a legitimate description of the process, there are judgement calls, but ambiguity is inevitable in the social sciences, you either get used to it, or find something else to study. Now if you’re using arbitrary in the way I’m using ambiguous, then I don’t think we disagree, except that I think it’s less problematic than I think you do, since as soon as you start dealing with people things get so complex that ambiguity is inevitable.
And curiously, the numbers according to the new procedures somehow always end up looking better.
Now, here you have a point. The Laspeyres Index is biased up, it may be an honest effort, but not one that’s Bayes correct. But Bayesian rationality has not penetrated through the discipline at this time, and as such a biased estimate is allowed to remain, primarily because there’s no methodologically clean way to remove the bias (you’d need to be able to predict things like quality changes and how people change their spending patterns in response to price changes) and without a background in Bayesian probability theory I think most economists would baulk at adding a fudge factor into the calculation.
The concept of “true value” is incoherent, at least in my model of reality. The correct price to attach to a good at any time is its market price at that time. If you had the set of information I listed in my last comment, you’d have the market prices, since they’re implied by the other stuff.
It might be valuable to talk about a “true value” of a given good to a given agent. Yes, the correct price to buy or sell a good at is always the market price; but whether I want to sell at that price or buy at that price depends on how much I want the good. If I sell, then the “true value” of the good to me is less than the current market price; and if I buy, then the “true value” of the good to me is greater than the current market price. In general, the “true value” of a given good to a given agent is the price such that, if the market were trading at that price, that agent would be indifferent regarding whether to buy or sell that good.
The concept of “true value” is incoherent, at least in my model of reality.
I heartily agree—but what is a price index, other than an attempt at answering the question of what the “true value” of a unit of currency is? What are the fabled “real” values other than attempts at coming up with a coherent concept of “true value”?
The correct price to attach to a good at any time is its market price at that time. If you had the set of information I listed in my last comment, you’d have the market prices, since they’re implied by the other stuff.
Yes, but even given perfect knowledge of all market prices and individual preferences at every time and place, as well as unlimited computing power, I still don’t see how this solves the problem. We can find out the average basket consumed per individual (or household or whatever) and its price at each time and place, but what next? How do we establish the relative values of these baskets, whose composition will be different both quantitatively and qualitatively?
To clarify things further, I’d like to ask you a different question. Suppose the moon Europa is inhabited by intelligent jellyfish-like creatures floating in its inner ocean. The Europan economy is complex, technologically advanced, and money-based, but it doesn’t have any goods or services in common with humans, except for a few inevitable ones like e.g. some basic chemical substances, and there is no trade whatsoever between Earth and Europa due to insurmountable distances. Would it make sense to define a price index that would allow us to compare the “real” values of various aggregate variables in the U.S. and on Europa?
If not, what makes the U.S./Europa situation essentially different from comparing different places and epochs on Earth? Or does the meaningfulness of price indexes somehow gradually fall as differences accumulate? But then how exactly do we establish the threshold, and make sure that the differences across decades and continents here on Earth don’t exceed it?
I think we’re using different definitions of arbitrary. To me, arbitrary means that there is no correct answer, and all options are equally valid. I don’t accept that as a legitimate description of the process, there are judgement calls, but ambiguity is inevitable in the social sciences, you either get used to it, or find something else to study.
Well, if macroeconomists and other social scientists were just harmless and benign philosophers, I’d be happy to leave them to ponder their ambiguities in peace!
Trouble is, to paraphrase Trotsky’s famous apocryphal quote, you may not be interested in social science, but social science is interested in you. In the present Western political system, whatever passes for reputable high-profile social science will be used as basis for policies of government and various powerful entities on its periphery, which can have catastrophic consequences for all of us if these ideas are too distant from reality. (And arguably already has.) Macroeconomics is especially critical in this regard.
but what is a price index, other than an attempt at answering the question of what the “true value” of a unit of currency is? What are the fabled “real” values other than attempts at coming up with a coherent concept of “true value”?
No, no. A price index is an attempt to work out how much things cost relative to what they used to cost. Real GDP is an attempt to measure how much stuff is being produced relative to how much stuff was being produced. GDP is not an attempt to determine what that stuff is worth in a metaphysical or personal sense, the production is merely valued at its market price (adjusted for inflation, in the case of real GDP). To a pacifist, the portion of GDP spent on the military is worth less than nothing, but it’s still part of GDP because it was stuff that was produced.
Or does the meaningfulness of price indexes somehow gradually fall as differences accumulate?
Yes, the closer the consumption patters of the two economies being compared, the more useful the comparison is. If there were no common goods between two economies it would be impossible to compare them meaningfully. As to where to draw the line, well I wish I had a good answer for you, but I don’t. All I can say is that the value of the comparison decays over “distance” (meaning differences in consumption patterns).
Some economists have created more specialised indices for long-run comparisons; William Nordhaus created a price index for light (based on hours of work per candela-hour) from the stone age to modern times. This is a little unusual at the moment since macroeconomists don’t usually do comparisons over long time periods (it’s fiendishly hard to get data going back before the 20th Century on most indicators), but it shows you that we are aware of the limitations of our tools, including price indices.
In the present Western political system, whatever passes for reputable social science will be used as basis for policies of government and various powerful entities on its periphery, which can have catastrophic consequences for all of us if these ideas are too distant from reality. Macroeconomics is especially critical in this regard.
I agree wholeheartedly, good quality policy advice is something I take very seriously. The social science we have has significant limitations, but right now, we don’t have anything better. I very much doubt the quality of our policy would improve if politicians paid less attention to their advisers than they do at the moment. So we do what we can, help thing along as much as our knowledge and the institutional frameworks decisions are made will permit. What else can you do?
Some economists have created more specialised indices for long-run comparisons; William Nordhaus created a price index for light (based on hours of work per candela-hour) from the stone age to modern times. This is a little unusual at the moment since macroeconomists don’t usually do comparisons over long time periods (it’s fiendishly hard to get data going back before the 20th Century on most indicators), but it shows you that we are aware of the limitations of our tools, including price indices.
That’s a very interesting paper (available here), thanks for the pointer!
As with nearly all papers addressing such topics, parts of it look as if they were purposefully written to invite ridicule, as when he presents estimates of 19th century prices calculated to six significant digits. (Sorry for being snide, but what was that about spurious precision in economics being the fault of politicians?) However, the rest of it presents some very interesting ideas. Here are a few interesting bits I got from skimming it:
The mathematical discussion in Section 1.3.2. seems to imply (or rather assume) that even assuming omniscience, a “true price index” (Nordhaus’s term) can be defined only for a population of identical individuals with unchanging utility functions. This seems to support my criticisms, especially considering that the very notion of a human utility function is a giant spherical cow.
The discussion in the introduction basically says that the way price indexes are done in practice makes them meaningless over periods of significant technological change. But why do we then get all this supposedly scientific research that uses them nonchalantly, not to mention government policy based on them? Nordhaus is, unsurprisingly, reluctant to draw some obvious implications here.
Nordhaus considers only the fact that price indexes fail to account for the benefits of technological development, so he keeps insisting that the situation is more optimistic than what they say. But he fails to notice that the past was not necessarily worse in every respect. In many places, for example, it is much less affordable than a few decades ago to live in a conveniently located low-crime neighborhood, and this goal will suck up a very significant percentage of income of all but the wealthiest folks. Moreover, as people’s preferences change with time, many things that today’s folks value positively would have been valued negatively by previous generations. How to account for that?
More to the same point, unless I missed the part where he discusses it, Nordhaus seems oblivious to the fact that much consumption is due to signaling and status competition, not utility derived from inherent qualities of goods. I’m hardly an anti-capitalist leftie, but any realistic picture of human behavior must admit that much of the benefit from economic and technological development ultimately gets sucked up by zero-sum status games. Capturing that vitally important information in a price index is a task that it would be insulting to Don Quixote to call quixotic.
Finally, I can’t help but notice that in the quest for an objective measure of the price of light, Nordhaus seems to have reinvented the labor theory of value! Talk about things coming back full circle.
Overall, I would ask: can you imagine a paper like this being published in physics or some other natural science, which would convincingly argue that widely used methodologies on which major parts of the existing body of research rest in fact produce spurious numbers—with the result that everyone acknowledges that the author has a point, and keeps on doing things the same as before?
As with nearly all papers addressing such topics, parts of it look as if they were purposefully written to invite ridicule, as when he presents estimates of 19th century prices calculated to six significant digits. (Sorry for being snide, but what was that about spurious precision in economics being the fault of politicians?)
[facepalm] OK, I’m not making any excuse for that. Given the magnitude of his findings he doesn’t even need them to make his point.
The mathematical discussion in Section 1.3.2. seems to imply (or rather assume) that even assuming omniscience, a “true price index” (Nordhaus’s term) can be defined only for a population of identical individuals with unchanging utility functions. This seems to support my criticisms, especially considering that the very notion of a human utility function is a giant spherical cow.
Yes, you can’t produce a true price index. But less-than-true price indices can still be useful.
Nordhaus considers only the fact that price indexes fail to account for the benefits of technological development, so he keeps insisting that the situation is more optimistic than what they say. But he fails to notice that the past was not necessarily worse in every respect. In many places, for example, it is much less affordable than a few decades ago to live in a conveniently located low-crime neighborhood, and this goal will suck up a very significant percentage of income of all but the wealthiest folks.
But houses keep getting bigger and you have to account for that too. Besides which, housing is no more than a third of most people’s income, at least it is in my country. That is a significant percentage, but it’s still less than half. And things keep getting better (or no worse) in the remaining two thirds.
More to the same point, unless I missed the part where he discusses it, Nordhaus seems oblivious to the fact that much consumption is due to signalling and status competition, not utility derived from inherent qualities of goods.
Assuming it’s even possible to adjust for that, I’d really want to apply the adjustment to GDP, not prices. Signalling isn’t a matter of cost but rather value.
Finally, I can’t help but notice that in the quest for an objective measure of the price of light, Nordhaus seems to have reinvented the labor theory of value! Talk about things coming back full circle.
No, you’re confusing cost and value. The labour theory of value is the theory that the value of a good derives from the labour taken to produce it. If Nordhaus were using this theory he’d be arguing that the value of light keeps falling. Measuring cost with labour is another thing entirely.
Overall, I would ask: can you imagine a paper like this being published in physics or some other natural science, which would convincingly argue that widely used methodologies on which major parts of the existing body of research rest in fact produce spurious numbers—with the result that everyone acknowledges that the author has a point, and keeps on doing things the same as before?
No. I recognise this is a problem. I can only imagine they thing it’s too had to correct for technological change robustly, but that’s not really an excuse. If you can’t do it well, it’s generally still better to do it badly than not at all. And I didn’t realise the research was that old (I’ve actually never read the paper, I read a summary in a much more recent book). Apparently macroeconomists have more catch-up to do than I thought.
This sentence of yours probably captures the heart of our disagreement:
If you can’t do it well, it’s generally still better to do it badly than not at all.
We don’t seem to disagree that much about the limitations of knowledge in this whole area, epistemologically speaking. Where we really part ways is that I believe that historically, the whole edifice of spurious expertise produced by macroeconomists and perpetuated by gargantuan bureaucracies has been an active force giving impetus for bad (and sometimes disastrous) policies, and that it’s overall been a step away from reality compared to the earlier much simpler, but ultimately more realistic conventional wisdom. Whereas you don’t accept this judgment.
Given what’s already been said, I think this would be a good time to conclude our discussion. Thanks for your input; your comments have, at the very least, made me learn some interesting facts and rethink my opinions on the subject, even if I didn’t change them substantially at the end.
(Oh, and you’re right that I confused cost and value in that point from my above comment. I was indeed trying to be a bit too much of a smartass there.)
This sentence of yours probably captures the heart of our disagreement:
If you can’t do it well, it’s generally still better to do it badly than not at all.
Yes, I think so. It’s not that I think that macroecoonmics has covered its self in glory, it hasn’t. But this really is literally the only way to learn for those guys. And I believe it’s worth it in the short run, though I’m less sure of that, than I was before we started this. Maybe those macro guys should go try micro or something.
Given what’s already been said, I think this would be a good time to conclude our discussion. Thanks for your input; your comments have, at the very least, made me learn some interesting facts and rethink my opinions on the subject, even if I didn’t change them substantially at the end.
Heh. Yeah, I’m going to go out on a limb and guess that Nordhaus didn’t subtract off the previously-free sunlight lost to global dimming and the attenuation of natural sources of nightlight due to interference from artificial light.
This is NOT to say I’m endorsing some kind of greenie move toward a pre-industrial time just so we can see the undimmed sky or have less “light pollution”. I’m just saying that ignoring natural and informal sources of wealth is a bad habit to get into.
A price index is an attempt to work out how much things cost relative to what they used to cost. Real GDP is an attempt to measure how much stuff is being produced relative to how much stuff was being produced. GDP is not an attempt to determine what that stuff is worth in a metaphysical or personal sense, the production is merely valued at its market price (adjusted for inflation, in the case of real GDP). To a pacifist, the portion of GDP spent on the military is worth less than nothing, but it’s still part of GDP because it was stuff that was produced.
But now we’re back to square one. Since different things are produced in different times and places, to produce these “real” figures for comparison, we need to come up with a way to compare apples and oranges (sometimes literally!). Now, if economists just said that they would consider an apple equivalent to an orange for some simple Fermi problem calculation, I’d have no problem with that.
However, what economists use in practice are profoundly complicated methodologies that will tell us that an orange is presently equivalent to 1.138 of an apple, and then we get subtle arguments and policy prescriptions based on the finding that this means an increase in the orange-apple index of 2.31% relative to last year. Here we enter the realm of pure nebulosity, where the indexes and “real” figures stop being vague heuristics where even the order of magnitude is just barely meaningful, and acquire a metaphysical existence of their own, as “real” variables to be calculated to multiple digits of precision, fed into complex mathematical models and policy guidelines, and used to measure reified true, objective value.
Yes, the closer the consumption patters of the two economies being compared, the more useful the comparison is. If there were no common goods between two economies it would be impossible to compare them meaningfully. As to where to draw the line, well I wish I had a good answer for you, but I don’t. All I can say is that the value of the comparison decays over “distance” (meaning differences in consumption patterns).
So, here is a straightforward question then: how do we know that it is meaningful to do comparison across, say, between the U.S. in 2010 and the U.S. in 1960 or 1910? What argument supports the assumption that the differences between them are small enough?
The social science we have has significant limitations, but right now, we don’t have anything better. [...] So we do what we can, help thing along as much as our knowledge and the institutional frameworks decisions are made will permit. What else can you do?
Sometimes it’s safer to just leave things alone if you don’t know what you’re doing. Presenting dubious conclusions and questionable expertise as scientific insight leads to the equivalent of dilettante surgery being performed on entire countries by their governments, sometimes with awful consequences, and with even worse ones threatening in the future. (Prominent macroeconomists will in fact agree with me, it’s just that they’ll claim that their professional rivals are the dilettantes, and only they are true experts who should be listened to.)
Here we enter the realm of pure nebulosity, where the indexes and “real” figures stop being vague heuristics where even the order of magnitude is just barely meaningful, and acquire a metaphysical existence of their own, as “real” variables to be calculated to multiple digits of precision, fed into complex mathematical models and policy guidelines, and used to measure reified true, objective value.
So, here is a straightforward question then: how do we know that it is meaningful to do comparison across, say, between the U.S. in 2010 and the U.S. in 1960 or 1910? What argument supports the assumption that the differences between them are small enough?
I would be careful about using a price index over that kind of time frame, I don’t actually know how macroeconomists treat it, but I have read books that point out the inherent difficulty of making comparisons over long time periods (where long means more than about 20 years), and that if you’re trying to capture differences in standard of living over a long period one should try to account for differences in product quality and product mix over time. Of course that’s incredibly hard to do, and I don’t know how seriously this issue is treated in macroeconomics, but it should be taken seriously.
Sometimes it’s safer to just leave things alone if you don’t know what you’re doing.
I strongly agree. However, there are two limiting factors when applying to this logic to policy advice:
1) If you don’t give a politician any advice, their reaction won’t be to do nothing, it will be to do whatever they think is a good idea. The average macroeconomist may not know a lot, but they know enough that their advice will probably help a little. I do think that macroeconomists should be less willing to offer active advice, as opposed to “we don’t understand this problem, the best thing to do here is nothing”, but politicians have a strong aversion to doing nothing in the face of a crisis, and if their advisers keep telling them to do politically unpalatable things, they’ll find advisers that will tell them what to hear.
2) You can’t run experiments in macroeconomics, the only way to acquire data on how well an intervention works is to try it (multiple times in multiple countries) and find out how it goes, and even then you end up arguing what would have happened if you did nothing. That means that if you don’t try to fix and/or prevent macroeconomic problems you don’t get any better information on how to fix future ones. Maybe that’s an acceptable trade off, but I’m sure you can see why macroeconomists don’t think so. Also bear in mind that what brought macro into its own as a discipline was the Great Depression. Maybe it’s worth risking some bumps in the road to try to work out how to stop something like that happening again.
Prominent macroeconomists will in fact agree with me, it’s just that they’ll claim that their professional rivals are the dilettantes, and only they are true experts who should be listened to.
Yes, it’s depressing how much a macroeconomists’ opinion on what caused the recent troubles matches up with their political ideology. But it’s a function of the low quality of evidence available, in Bayesian terms when you only have access to weak evidence, your prior matters more than when the evidence is strong. The inevitable influence politics has on the discipline doesn’t help either. Politicians are all too keen to build up economists who are telling them to do things they want to do anyway.
If some price indexes are “clearly absurd”, then they apparently have some value to us—for if they were valueless, then why call any particular one “absurd”? If they yield different results, then so be it—let us simply be open about how the different indexes are defined and what result they yield. The absence of a canonical standard will of course not be useful to people primarily interested in such things as pissing contests between nations, but the results should be useful nonetheless.
We commonly talk about tradeoffs, e.g., “if I do this then I will benefit in one way but lose in another”. We can do the same thing with price indexes. “In this respect things have improved but in this other respect things have gotten worse.”
We commonly talk about tradeoffs, e.g., “if I do this then I will benefit in one way but lose in another”. We can do the same thing with price indexes. “In this respect things have improved but in this other respect things have gotten worse.”
Sure, but such an approach would deny the validity of all these “real” economic variables that are based on a scalar price index. In particular, it would definitely mean discarding the entire concept of “real GDP” as incoherent. This would mean conceding the criticisms I’ve been expounding in this thread, and admitting the fundamental unsoundness of much of what passes for science in the field of macroeconomics.
Moreover, disentangling the complete truth about what various price indexes reveal and what they hide is an enormously complex topic that requires lengthy, controversial, and subjective judgments. This is inevitable because, after all, value is subjective.
Take for example two identically built houses located in two places that greatly differ in various aspects of the natural environment, society, culture, technological development, economic infrastructure, and political system. (It can also be the same place in two different time periods.) It makes no sense to treat them as equivalent objects of identical value; you’d have a hard time finding even a single individual who would be indifferent between the two. Now, if you want to discuss what exactly has been neglected by treating them as identical (or reducing their differences to a single universally applicable scalar factor) for the purposes of constructing a price index, you can easily end up writing an enormous treatise that touches on every aspect in which these places differ.
There could be indirect consequences of the decision in question, resulting from counter-intuitive effects on the existing economic process, on lives of other people not directly involved in the decision. The relevant question is about estimate of those indirect consequences. However imprecise economic indicators are, you can’t just replace them with presumption of total lack of consequences, and only consider the obvious.
If potential renters or the existing ones prefer your parents’ unit to the other rental opportunities and they are denied it, they are worse off; otherwise, they aren’t.
To the extent that the indirect effects go beyond this, standard mainstream metrics in economics don’t measure them, because they are essentially independent of how well off others have become as a result of these rental decisions.
To the extent that the indirect effects go beyond this, standard mainstream metrics in economics don’t measure them, because they are essentially independent of how well off others have become as a result of these rental decisions.
Well, maybe there are no such consequences (which is not obvious to me), but that’s what I meant.
Never once has it occurred to anyone in the mainstream (and very few outside of the mainstream) that it’s okay for people to produce less, consume less, and have more leisure.
Really? Because I hear economists talk about the value of leisure time quite frequently.
IMO, most economists don’t fetishize GDP the way you suggest they do.
You seem to be denying the benefits of Keynesian stimulus in a downturn. That position is not indefensible, but you’re not defending it, you’re just claiming it.
Really? Because I hear economists talk about the value of leisure time quite frequently. …IMO, most economists don’t fetishize GDP the way you suggest they do.
Both of these are contradicted by the fact that no economist, in discussion of the recent economic troubles, has suggested that letting the economy adjust to a lower level of output/work would be an acceptable solution.
Yes, they recognize that leisure is good in the abstract, but when it comes to proposals for “what to do” about the downturn, the implicit, unquestioned assumption is that we must must must get GDP to keep going up, no matter how many make-work projects or useless degrees that involves.
You seem to be denying the benefits of Keynesian stimulus in a downturn. That position is not indefensible, but you’re not defending it, you’re just claiming it.
I most certainly am defending it—by showing the errors in the classification of what counts as a benefit. If the argument is that stimulus will get GDP numbers back up, then yes, I didn’t provide counterarguments. But my point was that the effect of the stimulus is to worsen that which we really mean by a “good economy”.
The stimulus is getting people to do blow resources doing (mostly) useless things. Whether or not it’s effective at getting these numbers where they need to be, the numbers aren’t measuring what we really want to know about. Success would mean the useless, make-work jobs eventually lead to jobs satisfying real demand, yet no metric that they focus on captures this.
Downvote explanation requested. This looks like a reasoned reply to MichaelBishop’s criticism, and I’m interested in knowing how it errs and how Michael’s comment doesn’t, and how this is so obvious.
Yes, they recognize that leisure is good in the abstract, but when it comes to proposals for “what to do” about the downturn, the implicit, unquestioned assumption is that we must must must get GDP to keep going up, no matter how many make-work projects or useless degrees that involves.
[Didn’t downvote.] This is silly. The ‘leisure’ of unemployment is concentrated on a few, and comes with elevated rates of low status, depression, suicide, divorce, degradation of employability, etc.
That’s a misinterpretation of what I was suggesting as the alternative. Lower output + more leisure doesn’t mean the “leisure” is concentrated entirely in a few workers, making them full-time leisurists who starve. Rather, it means that anyone who wants to work for money would work fewer hours and have a lower level of consumption, not zero consumption.
Furthermore, the lower consumption is only consumption of goods purchased with money; with significant restructuring, labor with predictable demand (like babysitting) can be handled by cooperatives that avoid the need to pay for it out of cash reserves.
I don’t deny that make-work programs allow workers to show off and practice their skills, retaining employability. I criticize economists who miss this benefit. But if you’re going to spend money to get this benefit, you should spend it in a way that directly targets the achievement of this benefit to the workers, rather than on make-work projects that only achieve this benefit as a site effect, and which waste capital goods and distort markets in the process.
That’s a misinterpretation of what I was suggesting as the alternative. Lower output + more leisure doesn’t mean the “leisure” is concentrated entirely in a few workers, making them full-time leisurists who starve. Rather, it means that anyone who wants to work for money would work fewer hours and have a lower level of consumption, not zero consumption.
Unfortunately, in the United States, you really would end up with much more of the former and less of the latter. Europe would be better off, though, thanks to different labor laws; would you suggest that the United States adopt something like France’s maximum 35 hour workweek, or Germany’s subsidies to part-time workers?
Currently, hours worked per week is positively correlated with hourly wages; one person working 80 hours a week usually makes more money than two people who both work 40 hours a week. Also, specifically wanting to do part-time work is a bad signal to employers. It signals that you’re not committed to your job, that you’re probably lazy, and that you’re weird. So, absent government intervention, you probably won’t see people voluntarily reducing their working hours.
Both of these are contradicted by the fact that no economist, in discussion of the recent economic troubles, has suggested that letting the economy adjust to a lower level of output/work would be an acceptable solution.
This is because it isn’t. A “lower level of output/work” means that people, on average, are going to be poorer. And the way our economy is set up (in the United States at least), reducing output/work by 1% doesn’t mean that each person works 1% less, produces 1% less, and consumes 1% less, it means that 1 in 100 people lose their job, can’t find another one, and become poor, while the rest keep going on as they have been. So, when output/work falls, you don’t get more leisure, you get more poverty.
And I disagree that most stimulus spending ends up being directed to “worthless” projects. Maybe they’re not the best value for money, but even completely worthless make-work projects are still effective at wealth redistribution. Furthermore, if people are willing to lend the government money for really, really low interest rates (as demonstrated by prices of U.S Treasury securities) then isn’t that a signal that it’s an unusually good time for the U.S. government to borrow and spend—that the economy wants more of what the government produces and less of what private industry produces?
This is because it isn’t. A “lower level of output/work” means that people, on average, are going to be poorer. And the way our economy is set up (in the United States at least), reducing output/work by 1% doesn’t mean that each person works 1% less, produces 1% less, and consumes 1% less,
This I think reflects a status-quo bias. When the per capita GDP was lower in 2000, or 1990, the economy managed to employ a higher percentage of people. While you’re right that current institutions, inertia, and laws prevent shorter workweeks, that is an argument for removing these barriers, not an argument for trying to game the GDP numbers in the (false) hope that this will somehow translate into sustainable employment because of the historical correlation.
And I disagree that most stimulus spending ends up being directed to “worthless” projects. Maybe they’re not the best value for money, but even completely worthless make-work projects are still effective at wealth redistribution.
Okay, but that still looks like a case of lost purposes and fake utlity functions. If you’re spending money to redistribute, then spend the money to redistribute! Don’t spend it on a project that hogs up real resources just to get a small side-effect of transferring money to people you want to help. (“What’s your real objection” and all.) If it’s important that they feel they earn the paycheck, then require that they take job training.
And the reason I call the projects worthless is this (and it doesn’t require an ideological commitment to being against government projects): people couldn’t justify asking the government to provide these things before the recession. But if the recession is a contraction of productive capacity, then the projects we commit to should also contract—it should look like an even worse deal.
The fact that the government can issue debt cheaper doesn’t change this fact. The reduced productive capacity is a real (i.e. non-nominal) phenomenon. The greater ease with which government can procure resources does not mean our aggregate ability to produce them has increased; it just means the government can more easily increase its share of the shrinking pie. That still implies that our “choice set” is being reduced, and the newer, larger wastefulness of these projects will have to show up somewhere.
If the fundamental determinant of reduced unemployment is whether the economy has entered into (as Arnold Kling says) sustainable patterns of specialization and trade, then temporary stimulus projects can’t accelerate this, because they’re by definition not sustainable: after they’re over, we’ll just have to readjust again.
I must emphasize, as I did in this blog post, that this does not mean we should give suffering families the finger because “it would be inefficient and all”—the fact that they (under a stimulus project) are working, feeling productive, and getting a paycheck is very significant, and definitely counts as a benefit. It’s just that you should help them a way that doesn’t inhibit the economy’s search for efficient use of factors of production, nor (significantly) favor these families over the ones that are going to be screwed again when the projects have to stop, and the hunt for re-coordination starts anew.
While you’re right that current institutions, inertia, and laws prevent shorter workweeks, that is an argument for removing these barriers, not an argument for trying to game the GDP numbers in the (false) hope that this will somehow translate into sustainable employment because of the historical correlation.
Oh, definitely.
Okay, but that still looks like a case of lost purposes and fake utlity functions. If you’re spending money to redistribute, then spend the money to redistribute! Don’t spend it on a project that hogs up real resources just to get a small side-effect of transferring money to people you want to help. (“What’s your real objection” and all.) If it’s important that they feel they earn the paycheck, then require that they take job training.
I basically agree with this; if you want to redistribute, then certainly it’s better to just redistribute than to “employ” people to do completely useless things. (For example, extending unemployment benefits is a form of redistribution.)
And the reason I call the projects worthless is this (and it doesn’t require an ideological commitment to being against government projects): people couldn’t justify asking the government to provide these things before the recession. But if the recession is a contraction of productive capacity, then the projects we commit to should also contract—it should look like an even worse deal.
Well, what matters is the opportunity cost. A project that wasn’t worth doing before can become worth doing if the better alternatives aren’t there anymore; a contraction of productive capacity doesn’t have to affect all sectors of the economy equally. For example, people in a country experiencing an oil shortage may find that investing in more expensive, non-oil energy sources has become worthwhile; it’s worse than what used to be possible, but it’s the best remaining alternative. Given that people are willing to lend to the federal government more cheaply now than before the recession, the new equilibrium might end up involving more “investment in government”, not because government has become more productive, but because the alternative investments have gotten worse.
And I’m not necessarily sure that absolute productive capacity went down all that much in the current recession. During the Great Depression, the factories were still there, there were people willing and able to operate the factories, and there people who wanted the goods the factories could produce, yet the factories were idle, the would-be factory workers were unemployed, and the would-be consumers didn’t have the goods they wanted. (The Keynesian position is that there was a collapse in aggregate demand, leading to a general glut, followed by a reduced output level.)
Economists who argue for stimulus spending on Keynesian grounds understand that GDP is not a perfect measure and that the value produced by stimulus projects may be less than the value produced by ordinary spending. See, for instance, this Brad DeLong post, where he estimates the net benefit of the stimulus and counts the useful stuff produced using stimulus money as being only 80% as valuable as the dollar amount would suggest. Or, as he writes:
The extra people put to work produce $110,000 of useful stuff—that’s a benefit. … However, because we are pulling forward spending from the future into the present—spending the $92,000 now rather than in the future—we are buying stuff too soon, and because the government is all thumbs we are to some degree buying less valuable stuff than we woul ordinarily by buying. Figure a 20% discount—that’s an $18,000 cost.
See, for instance, this Brad DeLong post, where he estimates the net benefit of the stimulus and counts the useful stuff produced using stimulus money as being only 80% as valuable as the dollar amount would suggest.
I’ll accept that compliment, backhanded though it might be :-) (I canceled out the downmod you got for that comment—no offense taken.)
I would appreciate, though, if you could (as best you can) tell me what it was I said that led you to believe I’m capitalistish (in the sense that you meant), or that I would otherwise disagree with my above GDP rant. No need to dig up links, just tell me whatever you remember or can quickly find.
I’m not doing this to make you feel foolish for having said what you did (like I’ve been known to try with you …), but because I want to know what it is that gives of these impressions of my views, and whether I should be using different terms to describe them.
As I’ve said before, I have a love-hate relationship with libertarianism. I believe largely what I did ten years ago about the proper role of government, but much of what self-described libertarians advocate is sharply contrary to what I considered to be my libertarian view.
An interesting question. Here are some initial thoughts:
In terms of broad economic aggregates, it won’t make any difference. If you rent the room off your parents for a market rate, GDP is exactly unaffected, people are paying the same money to different people. If you rent it for less than market rate, GDP is lower, but this reflects deficiencies in measured GDP since GDP uses market prices as a proxy for the value of a transaction (this is fine for the most part, but doing your child a favour is an exception conventional methodology can’t deal with). So from a macroeconomic perspective I’d say it’s a wash either way.
Microeconomically, there could be some efficiencies in you renting from your parents. If they trust you more than a random stranger (and let’s hope they do) they will spend less time monitoring your behaviour (property inspections and the like) than they would a random stranger, but the value of your familial relationship should constrain you from taking advantage of that lax monitoring in the way a stranger would. This mean that your parents save time (which makes their life easier) and no one should be worse off (I assume the current tenant of their room would find adequate accommodation elsewhere).
However, one note of caution. If you were to get into a dispute of some sort with your parents over the tenancy, this could damage your relationship with your parents. If you value this relationship (and I assume you do), this is a potential downside that doesn’t exist under the status quo. Also, some people might see renting from your parents as little different to living with your parents which (depending on your age) may cost you status in your day-to-day life (even if you pay a market rate). If you value status, you should be aware of this drawback.
So in summary, the most efficient outcome depends on three variables:
1) How much time and effort do your parents spend monitoring their tenant at the moment?
2) How likely is it that your relationship with them could be strained as a result of you living there?
3) How many friends / acquaintances / colleagues do you have that would think less of your for renting from your parents (and how much do you care)?
I think that a majority of economists agree that in many downturns, it helps the economy if people, on the margin, spend a little more. This justifies Keynesian stimulus. Therefore, the economy would be helped if your choice increases the total amount of money changing hands, presumably if you rent the apartment for $X when X>Y. My impression is that in good economic times, marginal spending is not considered to improve economic welfare.
I think that a majority of economists agree that in many downturns, it helps the economy if people, on the margin, spend a little more. This justifies Keynesian stimulus. Therefore, the economy would be helped if your choice increases the total amount of money changing hands …
Imagine that the “economy” is sluggish, and that a widget maker currently profits $1 on each widget sale. Now, consider these two scenarios:
a) I buy 100 widgets that I don’t want, in order “to help the economy”. b) I give the widget-maker $100. Then, I lie and say, “OMG!!! I just heard that demand for widgets is SURGING, you’ve GOT to make more than usual!” (Assume they trust me.)
In both cases, the widget-maker is $100 richer, the real resources in the economy are unchanged, and the widget-maker has gotten a false signal that more widgets should be produced. Yet one of those “helps the economy”, while the other doesn’t? How does that make sense?
If you believe that either one of those “helps the economy”, your whole view of “the economy” took a wrong turn somewhere.
I agree that both a) and b) would have a similar effect in that the widget manufacturer puts to work resources (labor, machines) which would otherwise not be utilized. I wouldn’t recommend either a) or b) because there are many more efficient ways to stimulate the economy. One that my father, who happens to be an economist, has promoted is a temporary tax credit for new hires. More detail. If there are some roads you were going to build a couple years from now, speeding up that investment is probably a good idea in an economic downturn. I’m not defending legislation that actually got passed… I try not to pay too much attention.
I agree that both a) and b) would have a similar effect in that the widget manufacturer puts to work resources (labor, machines) which would otherwise not be utilized. I wouldn’t recommend either a) or b)
Then why did you say this, in the very comment I was replying to?
Therefore, the economy would be helped if your choice increases the total amount of money changing hands,
That’s the same as recommending a)!
because there are many more efficient ways to stimulate the economy
It doesn’t matter that you can think of better ways; the problem is with a view of the economy that regards either of a) or b) as “good for the economy”. And you in fact hold that view.
We were asked a sort of odd question which was which apartment choice would help the economy when not taking into account the individuals preferences about apartments. Those preferences in fact dominate the overall effect on the economy. I wouldn’t recommend anyone personally attempting Keynesian stimulus.
Increasing the amount of money changing hands only helps in certain circumstances, and even then it is not necessarily the dominant effect.
What about the examples of intelligent stimulus I offered?
Coming back to this question after a few years, I was able to find a surprisingly simple Econ 101 answer in five minutes. To zeroth order, there’s no change because the amount of goods and services in the economy stays the same. To first order, allowing a deal to be freely made usually increases total value in the economy, not just the value for those making the deal; so this deal is good for the economy iff both sides agree to it.
That sidesteps all complications like “the parents are happy to help their child”, “the apartment might have facilities that the child doesn’t need”, etc. I guess reading an econ textbook has taught me to look for ways to estimate the total without splitting it up.
Suppose you’re in a country that grows and consumes lots of cabbages, and all the cabbages consumed are home-grown. Suppose that one year people suddenly, for no apparent reason, decide that they like cabbages a lot more than they used to, and the price doubles. But at least to begin with, rates of production remain the same throughout the economy. Does this help or harm the economy, or have no effect?
In one sense it ‘obviously’ has no effect, because the same quantities of all goods and services are produced ‘before’ and ‘afterwards’. So whether we’re evaluating them according to the ‘earlier’ or the ‘later’ utility function, the total value of what we’re producing hasn’t changed. (Presumably the prices of non-cabbages would decline to some extent, so it’s at least consistent that GDP wouldn’t change, though I still can’t see anything resembling a mathematical proof that it wouldn’t.)
Trouble is, all these macroeconomic metrics that can be precisely defined have only a vague and tenuous link to the actual level of prosperity and quality of life, which is impossible to quantify precisely in a satisfactory manner. Moreover, predicting the future consequences of economic events reliably is impossible, despite all the endless reams of macroeconomic literature presenting various models that attempt to do so.
Thus, if you want to ask how your choice will affect the nominal GDP for the current year or some such measure, that’s a well-defined question (though not necessarily easy to answer). However, if you want to interpret the result as “helping” or “hurting” the economy, it requires a much more difficult, controversial, and often inevitably subjective judgment.
That’s only one of the main problems with GDP. Here’s a fairly decent critique of the concept written from a libertarian perspective (but the main points hold regardless of whether you agree with the author’s ideological assumptions): http://www.econlib.org/library/Columns/y2010/HendersonGDP.html
In addition to these criticisms, I would point out the impossibility of defining meaningful price indexes that would be necessary for sensible comparisons of GDP across countries, and even across different time periods in the same country. The way these numbers are determined now is a mixture of arbitrariness and politicized number-cooking masquerading as science.
It is certainly true that some people make too much of GDP, but those numbers can be pretty helpful for answering certain research questions. Let’s not throw the baby out with the bath water.
To continue on your metaphor, it’s not clear to me if there is a baby worth saving there at all. Even if there is, the baby is submerged in an enormous cesspool of filthy and toxic bathwater that’s been poisoning us in very nasty ways for a long time.
To be clear, you are suggesting we might not lose anything by giving up measuring and using GDP figures? I’ll side with the majority of the economics profession… they aren’t perfect but they mostly use GDP data in a reasonable way.
Just so we’re on the same page, could you explain what it would look like if economists’ collective wisdom were actually so bad that you would agree they use GDP data in an unreasonable way?
Because you can’t just look at the fact the top economists all agree—they’d do that even if the field were collectively garbage. There has to be some real-world entanglement which would reveal the failure of their ideas, and I want to know what you expect such a failure to look like.
I’m a sociologist*, and there is nothing sociologists like to do more than point out where economists go wrong. So if GDP was a worthless figure, I expect the real world entanglement that one of my fellow sociologists would have convinced me of that already.
I’m not saying economists never overinterpret GDP figures, and I’m not saying the consensus of macroeconomists is always correct.
Though I think we might both be better served by quitting conversation and reading actual experts (I don’t claim to be one) I would like to make sure we’re on the same page about the implications of your criticism. Are you not saying that it is essentially worthless to attempt to study economic growth or business cycles empirically because the data is so poor?
*if you can be one without having completed your dissertation yet.
I’m a sociologist, and there is nothing sociologists like to do more than point out where economists go wrong. So if GDP was a worthless figure, I expect the real world entanglement that one of my fellow sociologists would have convinced me of that already.
This sounds to me like a case of mistakenly thinking “someone would have noticed!”. What exactly would sociologists have noticed and hasn’t happened? Remember, “my echo chamber in academia agrees with me” doesn’t count as evidence!
And, FWIW, sociologists (and a lot of the left in general) do complain about GDP—they’re the ones spearheading the push to use alternate metrics like “Gross National Happiness” and other things. I think a lot of them are nutty, but at least they’re identifying values that need to be looked at.
Though I think we might both be better served by quitting conversation and reading actual experts (I don’t claim to be one) I would like to make sure we’re on the same page about the implications of your criticism.
But I have read the experts! Top economists like Greg Mankiw, Paul Krugman, and Scott Sumner blog and lay out their arguments in detail, and their (economic basis for making their) arguments are exactly as I have portrayed them! Sumner in particular believes (mistakenly imo) that nominal GDP is a crucial measure.
Krugman certainly relies heavily on measuring real GDP growth and equates it with progress. And James_K, who claims to be an economist, just came out of the woodwork and endorsed exactly what I’ve accused economists of, though asserting (with a basis I’m shaking) that they don’t really make that big of a deal out of GDP.
Are you not saying that it is essentially worthless to attempt to study economic growth or business cycles empirically because the data is so poor?
With the currently studied data, yes, though with different measures, better progress could be made. In the past I’ve suggested measuring non-cash and non-market production, subtracting certain “bad” activities from GDP (i.e. things which represent a response to destruction, as it’s indicative of merely replacing some capital with other capital), measuring product degradation in calculating CPI, and using insulin as a better inflation gauge.
if you can be [a sociologist] without having completed your dissertation yet.
Hey, I’m fine with calling you one if you’re fine with calling me an engineer despite just having a bachelors and years of field work but not a P.E. license.
I agree that GDP is imperfect. If it were easy to perfect then it would have been done already. Should more resources be devoted to the issue? Probably. I support the use of multiple measures of wealth and well-being. But I do think that when GDP goes up, that usually indicates good things are happening. Other indicators usually track it.
I’m not trying to deny you’ve noticed a problem, I just think that you’re overstating it because even though GDP is imperfect, there is still a lot to be learned from empirical research that uses it.
If we’re going to do metaphors, then yes, you’re right, but we also have to make sure we’re not drinking the bathwater. The bathwater is for bathing, not for drinking. GDP should be used a very rough cross-country comparison, not as a measure of how well the economy’s general ability to satisfy wants changes over short intervals.
Interestingly enough, I was arguing roughly your position a few years ago. But now, seeing how economist deliberately prioritize GDP over the fundamentals it’s supposed to measure, I can’t even justify defending it for purposes other than, “The US economy is more productive than Uganda’s.”
The essay at the link talks about government waste. Is it meaningful to talk about waste in business, or should it all be considered to be at least educational?
Regarding the end-products, one essential difference is that if a business can find private consumers who will purchase its product with their own money and of their own free will, this constitutes strong evidence that these customers assign some positive value to this product, so it can’t be fairly described as “waste.” In contrast, for many things produced by the government, no such clear evidence exists, and even if one is not of particularly libertarian persuasion, it seems pretty clear that many of them are wasteful in every reasonable sense of the term. Yet all consumer and (non-transfer) government spending is added to the GDP as equivalent.
When it comes to waste generated by inefficiencies, miscalculations, employee misbehavior, and perverse incentives, some amount of wasteful efforts and expenses is obviously inevitable in the internal functioning of any large-scale operation. It does seem pretty clear that in most cases, the incentives to minimize them are much stronger in private businesses than in governments, though unlike the previous point, this one is a matter of degree, not essence. However, when it comes to the GDP accounting, there are important differences here.
The reason is that all non-transfer spending by the government will be added to the GDP, whereas spending by businesses is added only if it constitutes investment (as opposed to mere procuring of the inputs necessary for production). As far as I know, the exact boundary in the latter case is a matter of accounting conventions, though in most cases, it does seem clear which is which (e.g. for a trucking company, buying fuel is not an investment, but buying new trucks is). Therefore, whatever the actual amount of wasteful spending by businesses might be, not all of it will be added to the GDP, unlike the wasteful spending by governments.
Thanks for that link. I hadn’t realized Henderson had written that, let alone just a few months ago! Its recency means he could critique the stimulus arguments of the last two years, making basically the same arguments I do.
My only complaint is that he noted that leaving off non-market exchanges (i.e. maid becoming wife) causes GDP to be understated, when he should have discussed its impact on the rate of change in GDP, which is more important.
My (admittedly simple-minded) answer would be “other things being equal it has no effect at all”.
Each day you and your parents do whatever it is you do, creating a given amount of wealth (albeit perhaps in such a way that it’s impossible to say exactly how much of this wealth you personally created, rather than your colleagues, or the equipment you use). Then a bunch of wealth gets redistributed in a funny way (through wages and rents being paid). But changing the way that wealth is redistributed doesn’t affect the ‘total rate of wealth-generation’ which is what GDP is trying (sometimes unsuccessfully, as James_K says) to measure. In just the same way, getting a pay rise doesn’t in itself help the economy (but it may have been caused by you doing more valuable work, which does help).
I’m pretty sure this is wrong. If I have a spare apartment and start renting it out, I’m creating wealth, not just redistributing it. So changing the pattern of who rents from whom should influence the total amount of wealth created.
Though I should clarify that when I talk about “the size of the economy” I’m talking about something intangible—the ‘wealth of the nation’, or more precisely the ‘nation’s rate of wealth-creation’ - rather than simply GDP. Perhaps GDP will reflect the changing rents, perhaps not, depending on which type of GDP we’re talking about (I seem to recall that there are several, including a ‘spending’ measure and an ‘income’ measure.)
But we’re not talking about someone renting a previously empty apartment, we’re talking about a change of occupier. The ‘wealth’ of the apartment is merely being ‘consumed’ by someone else.
Suppose without loss of generality (?) that the person who was previously in your parents’ apartment is now in your old apartment. Then we can describe the change as follows:
Two people have swapped apartments.
They may be paying different rents from before.
Neither 1 nor 2 in itself changes the size of the economy. (Although, if a rent goes up because an apartment is more desirable then that changes the size of the economy.)
Apartments don’t have a single intrinsic “desirability” value. Different people assign different values to the same apartment. If you think about it, the fact that different people can value a thing differently is the only reason any deals happen at all. The sum you agree to pay is a proxy for the value you place on the thing.
No, you can’t assume without loss of generality that the person who was previously in my parents’ apartment will be willing or able to move to mine. It depends on the relationship between X and Y.
No, you can’t assume without loss of generality that the person who was previously in my parents’ apartment will be willing or able to move to mine. It depends on the relationship between X and Y.
But the set of living spaces is the same as before. Can’t we assume for simplicity that, even if it’s not as simple as two people swapping places with each other, what we have is a ‘permutation’ such that all previously occupied houses and apartments remain occupied?
Then once again we can factor the change into (1) a permutation and (2) a change of rent, and ask whether either of them changes the wealth of the nation. I’m pretty sure that (2) in itself has no effect—it’s just a ‘redistribution’ between landlords and their tenants. Whether (1) has an effect depends on whether or not we’re including the fact that different people may make different assessments of desirability (i.e. whether different people have different preferences about the kind of apartment they’d like to live in.)
Of course you’re quite right that different people do have different preferences—I was merely ignoring this for simplicity—but in any case the statement of the problem says nothing explicit about your or anyone else’s preferences, it only talks about X and Y. Are your apartment-preferences supposed to change depending on the values of X and Y?
You’re right that (2) has no effect, but (1) probably does have effect. I thought we could somehow guess the effect of (1) by looking at X and Y, but now I see it’s not easy.
There is other information you want to consider. Tax rates for example, and whether or not the economy is in the sort of downturn that would benefit from stimulus or not.
Regardless, the effects on aggregate supply and demand will be tiny. How much you and your parents value these alternatives is what matters most.
I’m not asking about what I should decide, I’m asking about the sign of those tiny effects on the country as a whole. Is it actually a difficult question in disguise? Why? I know next to nothing about economics, but the question sounds to me like it should be really easy for anyone qualified.
I think the best way to measure it in any meaningful way would be to consider the same scenerio with millions of people doing it instead of just one, but even then it doesn’t look like it makes much of a difference.
This is a good point. What happens in this individual case would be dominated by random facts about the individuals directly involved. If you imagine the same situation repeated many times, 100 should be plenty, the randomness cancels out.
I am struggling to convey this, so I’ll have to think about it more.
For now, though: I do think that differences in the initial conditions would be propagated by adaptive individuals and institutions (rather than smoothed away). That should lead to bifurcations and path dependencies that would generate drastically different outcomes. Enough that averaging them would be meaningless.
Why do you think repeating it many times would converge? Are the statistical limit theorem conditions really met? I don’t think so..
None of this really explicitly says that you wouldn’t be able to at least figure out the sign of the change. It might be computationally intractable but qualitatively determinable in special cases.
Econ question: if a child is renting an apartment for $X, and the parents have a spare apartment that they are currently renting out for $Y, would it help or hurt the economy if the child moved into that apartment instead? Consider the cases X<Y, X=Y, X>Y.
Good question, not because it’s hard to answer, but because of how pervasive the wrong answer is, and the implications for policy for economists getting it wrong.
If your parents prefer you being in their apartment to the forgone income, they benefit; otherwise they don’t.
If you prefer being in their apartment to the alternative rental opportunities, you benefit; otherwise, you don’t.
If potential renters or the existing ones prefer your parents’ unit to the other rental opportunities and they are denied it, they are worse off; otherwise, they aren’t.
ANYTHING beyond that—anything whatsoever—is Goodhart-laden economist bullsh**. Things like GDP and employment and CPI were picked long ago as a good correlate of general economic health. Today, they are taken to define economic health, irrespective of how well people’s wants are being satisfied, which is supposed to be what we mean by a “good economy”.
Today, economists equate growing GDP—irrespective of measuring artifacts that make it deviate from what we want it to measure—with a good economy. If the economy isn’t doing well enough, well, we need more “aggregate demand”—you see, people aren’t buying enough things, which must be bad.
Never once has it occurred to anyone in the mainstream (and very few outside of the mainstream) that it’s okay for people to produce less, consume less, and have more leisure. No, instead, we have come to define success by the number of money-based market exchanges, rather than whether people are getting the combination of work, consumption, and leisure (all broadly defined) that they want.
This absurdity reveals itself when you see economists scratching their heads, thinking how we can get people to spend more than they want to, in order to help the economy. Unpack those terms: they want people to hurt themselves, in order to hurt less.
Now, it’s true there are prisoner’s dilemma-type situations where people have to cooperate and endure some pain to be better off in the aggregate. But the corresponding benefit that economists expect from this collective sacrifice is … um … more pointless work that doesn’t satisfy real demand .. but hey, it keeps up “aggregate demand”, so it must be what a sluggish economy needs.
Are you starting to see how skewed the standard paradigm is? If people found a more efficient, mutualist way to care for their children rather than make cash payments to day care, this would be regarded as a GDP contraction—despite most people being made better off and efficiency improving. If people work longer hours than they’d like, to produce stuff no one wants, well, that shows up as more GDP, and it’s therefore “good”.
How the **** did we get into this mindset?
Sorry, [/another rant].
What isn’t reflected in the GDP is huge.
There’s the underground economy—I’ve seen claims about the size of it, but how would you check them?
There’s everything people do for each other without it going through the official economy.
And there’s what people do for themselves—every time you turn over in bed, you are presumably increasing value. If you needed paid help, it would be adding to the GDP.
I don’t understand where you acquired this view of economists. I am an economist and I assure you economists don’t ascribe to the “measured GDP is everything” view you attribute to them.
This is not an accurate portrayal of what Keynesians believe. The Keynesian theory of depressions and recessions is that excessive pessimism leads people to avoid investing or starting businesses, which lowers economic activity further, which promotes more pessimism, and so on.
The goal of stimulus is effectively to trick people into thinking the economy is better than it is, which then becomes a self-fulfilling prophesy; low quality spending by government drives high quality spending by the private sector.
If you wish to be sceptical of this story (I’m fairly dubious about it myself), then fine, but Keynesians aren’t arguing what you think they’re arguing.
No, that’s precisely what I assumed they’re arguing, and I believe my points were completely responsive. I will address the position you describe in the context of the criticism in my rant.
Now, unpack the meaning of all of those terms, back to the fundamentals we really care about, and what is all that actually saying? Well, first of all, have you played rationalist taboo with this and tried to phrase everything without economics jargon, so as to fully break down exactly what all the above means at the layperson level? To me, economists seem to talk as if they have not done so.
I would like for you to tell me whether you have done so in the past, and write up the phrasing you get before reading further. You’ve already tabooed a lot, but I think you need to go further, and remove the terms: recession, depression, stimulus, excessive, pessimism, invest, and economic activity. (What’s left? Terms like prefer, satisfaction, wants, market exchange, resources, working, changing actions.)
Now, here’s what I get: (bracketed phrases indicate a substitution of standard economic jargon)
“People [believe that future market interactions with others will be less capable of satisfyng their wants], which leads them to [allocate resources so as to anticipate lower gains from such activity]. As people do this, the combined effect of their actions is to make this suspicion true, [increasing the relative benefit of non-market exchanges or unmeasured market exchanges].
“The government should therefore [purchase things on the market] in order to produce a [false signal of the relative merit of selling certain goods], and facilitate production of [goods people don’t want at current prices or that they previously couldn’t justify asking their government to provide]. This, then, becomes a self-fulfilling prophecy: once people [sell unwanted goods due to this government action], it actually becomes beneficial for others to sell goods people do want on the market, [preventing a different kind of adjustment to conditions from happening].”
Phrased in these terms, does it even make sense? Does it even claim to do something people might want?
That was a very useful exercise since it helped me identify the key point of disagreement between you an Keynesianism. If I’m right, you’re coming at this from a goods market perspective i.e. “I, a typical consumer am not interested in any of these goods at these prices, so I’m going to not buy so much”, whereas the Keynesians are blaming this kind of attitude: “I, a typical consumer am fearful of the future. While I want to buy stuff, I’d better start saving for the future instead in case I lose my job” and it’s the saving that triggers the recession (money flows out of the economy into savings, this fools people into thinking they are poorer and the death spiral begins).
A couple of other contextual points: 1) The monetary stimulus that Keynes recommended was based on governments running deficits, not necessarily spending more. Cutting taxes works just as well
2) Keynes was trying to reduce the magnitude of boom-bust swings, not increase trend economic growth rates. As such he prescribed the opposite behaviour in boom times, have government run surpluses to tamp down consumer exuberance. This is less widely known since politicians only ever talk about Keynes during recessions, when it gives them intellectual cover to spend lots of money.
3) The Keynesian consensus is not universal. Arnold Kling’s “recalculation” story is much closer to your picture, and you’ll notice he doesn’t advocate stimulus, but rather waiting to see how people adjust to the new economic circumstances.
4) GDP is the preoccupation of macroeconomists. Microeconomists (like me) care much more about allocative efficiency, which is to say to what extent are things in the hands of the people who value them most? So there’s a whole branch of the profession to which your initial GDP-centrism comment does not apply.
It’s points 3 and 4 in particular that lead me to object to your claim that economists are obsessed with GDP. To my way of thinking, it’s politicians that are obsessed with GDP because they believe their chances of re-election are tied to economic growth and unemployment figures. So they spend a lot of time asking economists how to increase GDP, and therefore economists more often than not to discuss GDP when they appear in public.
It’s still not clear to me that you’ve done what I asked (taboo your model’s predicates down to fundamentals laypeople care about), or that you have the understanding that would result from having done what I asked.
What’s the difference between the “goods market” perspective and the “blaming this kind of attitude”/Keynesian perspective? Why is one wrong or less helpful, and what problems would result from using it?
Why is it bad for people to believe they are poorer when they are in fact poorer?
Why is it bad for more money to go into savings? Why does “the economy” entirely hinge on money not doing this?
Until you can answer (or avoid assuming away) those problems, it’s not clear to me that your understanding is fully grounded in what we actually care about when we talk about a “good economy”, and so you’re making the same oversights I mentioned before.
No, I’m not making those oversights because I am a) not a Keynesian and b) not a macroeconomist. My offering defences of this position should not be construed as fundamental agreement that position.
This is quickly turning into a debate about the merits of Keynesianism which is not a debate I am interested in because stabilisation policy is not my field and I don’t find it very interesting, I got enough of it at university. I’m going to touch on a few points here, but I’m not going to engage fully with your argument; you really need to talk to a Keynesian macroeconomist if you want to discuss most of this stuff. For one thing my ability to taboo certain words is affected by the fact I don’t have a very solid grip on the theory and I don’t spend much of my time thinking about high level aggregates like GDP.
Now here’s the best I can do on your bullet point questions, sorry if it doesn’t help much, but it’s all I’ve got: 1) The difference is that Keynesians believe savings reduce the money supply by taking money out of circulation, this makes them think they are poorer, which makes them act like they’re poorer, which makes other people poorer.
2) Because it starts with an illusion of poverty. The first cause of recessions in a Keynesian model is “animal spirits”, or in layman’s terms, irrational fear of financial collapse. Viewed from this perspective, stimulus is a hack that undoes the irrationality that caused the problem in the first place (and because it’s caused by irrationality they can feel confident it is a problem).
3) This is actually one of my biggest problems with Keynesian theory. If it strikes you as counter-intuitive or silly, I’m not going to dissuade you.
One final point: The reason I replied to your initial comment in the first place, was your suggestion that all economists are obsessed with maximising measured GDP over everything else.
But many economists don’t deal with GDP at all. When I was learning labour market theory we were taught that once people’s wage rate gets high enough, one could expect them to work fewer hours since the demand for leisure time increases with income. There was never a suggestion that this was anything to be concerned about, the goal is utility, not income.
In environmental economics I recall reading a paper by Robert Solow (the seminal figure in the theory of economic growth) arguing that it was important to consider changes in environmental quality along with GDP, to get a better picture of how well off people really are.
I look at what I have been taught in economics, and I simply can’t square it with your view of the profession. Some kinds of economists tend to be obsessed with growth, but they tend to be economists who specialise in economic growth. The rest of us have other pursuits, and other obsessions.
Alright, I’ll let anyone judge for themselves if the canonical Keynesian replies reveal a truly grounded understanding of what counts as “helping the economy”.
Forget Keynesian theory for a minute: I want to know if you have the understanding I expect of whatever theory it is you do endorse. Can you taboo that theory’s terminology and ground it layperson level fundamentals? Can you force me to care about whatever jargon you do in fact use?
Because, at risk of sounding rude, I don’t think you’ve acquired this “Level 2” understanding, and I don’t think you’re atypical among economists in lacking it—from what I’ve read of Mankiw, Sumner, and Krugman, they don’t have it either.
(btw, you call yourself an economist but don’t have a grip on Keynesian theory? Isn’t that pretty much required these days?)
Sure—I only meant that economic policy advocates who are concerned about aggregate economic variables are obsessed with GDP as one of those variables, but that should be assumed from context. Obviously, you’re not going to care about GDP in your capacity as a microeconomist of company behavior.
On macro policy I doubt I have level 2 understanding. I had to take papers in macro at university, and I was able to get reasonable grades on them, but level 0 or 1 understanding is sufficient to do that.
My guess is that if you asked a Keynesian why they care, they would say that boom-bust cycles create uncertainty and fear in people because they don’t know if they’re going to lose their job (and they want their job, or they’d have already quit) and by taming the boom-bust cycle people will have a more certain and therefore more pleasant life).
Equally if you asked a development economist, they would point to the misery in third world countries and for wealthy countries point out that productivity growth means being able to do more with less, and whether you want to have more, or want to do less, that’s a win. Unemployed people are by definition people who want a job but don’t have one, so concern about unemployment is easy to work out.
And as for me, well the reason I care about allocative efficiency is that allocative efficiency is the attempt to match reality to people’s preferences as well as is possible under current constraints. How do we use our resources and knowledge to create the things people want and how do we get them to the people who want them the most?
The market does a pretty good job of this most of the time, but it does fail sometimes. And when it fails there are things government can do to improve matters, but the government can fail too, so you have to balance out the imperfections of the market and the imperfections of government and try to work out which set of imperfections is more problematic. If I succeed, or if people like me succeed then people will have more of what they want, be that flat screen TVs, or cars or clean air or time with their families. Not everything falls within economics’ purview of course, love and truth and beauty are things I can’t help with. But for everything else, my goal is to help the market to match infinite wants with finite resources, and imperfect information.
Perhaps it should have been, but I failed to assume this. And microeconomics is a lot wider than company behaviour, it covers pretty much everything but GDP and unemployment.
That wasn’t the question or contributory thereto, though it shows you can ground one concept.
The question is, whatever model/theory you have of the economy, are its predicates fully grounded in what laypersons care about? You mentioned things people care about, but not how they fit into the model that you advocate.
Allocative efficiency is what I work with. If you asked me why I care about GDP, my response would be, “I don’t, particularly”.
As for my economic model, I can’t give you a full rundown in a comment, but here’s the short version: 1) Level 1 is the fully ideal version, unrealistic, but useful for grounding the whole thing in people’s preferences. It basically rests on the notion that if you make a battery of assumptions voluntary exchange will result in allocative efficiency, if person A values something more than person B then they will trade, either directly or through side trades until person A has it. Yes there are a lot of reasons this doesn’t work in practice, but that’s level 2.
2) Level 2 picks at all those assumptions in level 1. Things like externalities (like pollution) imperfect information, irrational behaviour, imperfect competition, transaction costs and other git in the gears. These things cause violations of the assumptions in 1, and therefore prevent potentially efficiency-enhancing trades from occurring. The academic work at level 2 is focused around identifying these problems and considering possible solutions a government could introduce to correct for them.
3) Level 3 looks at the ability of government to effectively implement the policies identified at level 2. Theories like social choice theory (the ability of voting systems to effectively aggregate votes into social preferences) and public choice theory (how well do governments act as agents of the voting public). The academic work at level 3 is focused around identifying the limitations of real world governments, and identifying the side-effects of badly implemented policies.
Level 1 is all about individual preferences, not attempting to measure them directly because you can’t, but rather in setting up a system so people can sort it out themselves.
As for how GDP factors in, well they it doesn’t directly. Macro and micro aren’t integrated, they haven’t been since Keynes. You learn about them indifferent courses, people tend not to specialise in both, so there’s a gap there. Hence the reason I don’t care about GDP per se.
Now productivity I care about, because higher productivity means more resources for people to trade with and more preferences can be satisfied. I care about unemployment because it implies people are willing to make a trade, but unable to do so due to some bug in the system, either a level 2 problem (market failure), or a level 3 problem (government failure).
James_K:
Aside from the standard arguments about the shortcomings of GDP, my principal objection to the way economists use it is the fact that only the nominal GDP figures are a well-defined variable. To make sensible comparisons between the GDP figures for different times and places, you must convert them to “real” figures using price indexes. These indexes, however, are impossible to define meaningfully. They are produced in practice using complicated, but ultimately arbitrary number games (and often additionally slanted due to political and bureaucratic incentives operating in the institutions whose job is to come up with them).
In fact, when economists talk about “nominal” vs. “real” figures, it’s a travesty of language. The “nominal” figures are the only ones that measure an actual aspect of reality (even if one that’s not particularly interesting per se), while the “real” figures are fictional quantities with only a tenuous connection to reality.
It’s pretty easy to get this sort of view just reading books. In my (limited) experience, there are a fair percentage of divergent types that are not like this—and they tend to be the better economists.
You may like Morgenstern’s book On the Accuracy of Economic Observations. How I rue the day I saw this in a used bookstore in NY and didn’t have the cash to buy it..
EDIT: fixed title name
I’m going through Morgenstern’s book right now, and it’s really good. It’s the first economic text I’ve ever seen that tries to address, in a systematic and no-nonsense way, the crucial question of whether various sorts of numbers routinely used by economists (and especially macroeconomists) make any sense at all. That this book hasn’t become a first-rank classic, and is instead out of print and languishing in near-total obscurity, is an extremely damning fact about the intellectual standards of the economic profession.
I’ve also looked at some other texts by Morgenstern I found online. I knew about his work in game theory, but I had no idea that he was such an insightful contrarian on the issues of economic statistics and aggregates. He even wrote a scathing critique of the concept ot GNP/GDP (a more readable draft is here). Unfortunately, while this article sets forth numerous valid objections to the use of these numbers, it doesn’t discuss the problems with price indexes that I pointed out in this thread.
realitygrill:
Could you please list some examples? Aside from Austrians and a few other fringe contrarians, I almost always see economists talking about the “real” figures derived using various price indexes as if they were physicists talking about some objectively measurable property of the universe that has an existence independent of them and their theories.
Thanks for the pointer! Just a minor correction: apparently, the title of the book is On the Accuracy of Economic Observations. It’s out of print, but a PDF scan is available (warning -- 31MB file) in an online collection hosted by the Stanford University.
I just skimmed a few pages, and the book definitely looks promising. Thanks again for the recommendation!
I meant personally—I did my undergrad in economics. I’m extremely skeptical of macroeconomics and currently throw in with the complex adaptive system dynamicists and the behavioral economists (and Hansonian cynicism; that’s just me). But, to give an example, Krugman has done quite a bit of work in the complexity arena.
Yeah, you’re welcome! The first I heard of that book was someone using the example of calculating in-flows and out-flows of gold. Each country’s estimates differed by orders of magnitude or something like that, and even signs.
There are a number of reasonably priced copies on amazon.
Oh good, they certainly weren’t that reasonable the last I checked.
It’s not so much a matter of being overconfident as it is not listing the disclaimers at every opportunity. The Laspeyres Price Index (the usual type of price index) has well understood limitations (specifically that it overestimates consumer price growth as it doesn’t deal with technological improvement and substitution effects very well), but since we don’t have anything better, we use it anyway.
“Real” is a term of art in economics. It’s used to reflect inflation-adjusted figures because all nominal GDP tells you is how much money is floating around, which isn’t all that useful. real GDP may be less certain, but it’s more useful.
Bear in mind that everything economists use is an estimate of a sort, even nominal GDP. Believe it or not, they don’t actually ask every business in the country how much they produced and / or received in income (which is why the income and expenditure methods of calculating GDP give slightly different numbers although they should give exactly the same result in theory). The reason this may not be readily apparent is that most non-technical audiences start to black out the moment you talk about calculating a price index (hell, it makes me drowsy) and technical audiences already understand the limitations.
James_K:
You’re talking about the “real” figures being “less certain,” as if there were some objective fact of the matter that these numbers are trying to approximate. But in reality, there is no such thing, since there exists no objective property of the real world that would make one way to calculate the necessary price index correct, and others incorrect.
The most you can say is that some price indexes would be clearly absurd (e.g. one based solely on the price of paperclips), while others look fairly reasonable (primarily those based on a large, plausible-looking basket of goods). However, even if we limit ourselves to those that look reasonable, there is still an infinite number of different procedures that can be used to calculate a price index, all of which will yield different results, and there is no objective way whatsoever to determine which one is “more correct” than others. If all the reasonable-looking procedures led to the same results, that would indeed make these results meaningful, but this is not the case in reality.
Or to put it differently, an “objective” price index is a logical impossibility, for at least two reasons. First, there is no objective way to determine the relevant basket of goods, and different choices yield wildly different numbers. Second, the set of goods and services available in different times and places is always different, and perfect equivalents are normally not available, so different baskets must be used. Therefore, comparisons of “real” variables invariably involve arbitrary and unwarranted assumptions about the relative values of different things to different people. Again, of course, different arbitrary choices of methodology yield different numbers here.
(By the way, I find it funny how neoclassical economists, who hold it as a fundamental axiom that value is subjective, unquestioningly use price indexes without stopping to think that the basic assumption behind the very notion of a price index is that value is objective and measurable after all.)
Very true. A good general measure in human economic systems should NOT merely look at the ease of availability of finished paperclips. It should also include, in the “basket”, such things as extrudable metal, equipment for detecting and extracting metal, metallic wire extrusion machines, equipment for maintaining wire extrusion machines, bend radius blocks, and so forth.
Thank you for pointing this out; you are a relatively good human.
That is a very poor inference on their part.
Here’s a crude metric I use for gauging the relative goodness of societies as places to live: Immigration vs. emigration.
It’s obviously fuzzy—you can’t get exact numbers on illegal migration, and the barriers (physical, legal, and cultural) to relocation matter, but have to be estimated. So does the possibility that one country may be better than another, but a third may be enough better than either of them to get the immigrants.
For example, the evidence suggests that the EU and the US are about equally good places to live.
I don’t think that’s a good metric. Societies that aren’t open to mass immigration can have negligible numbers of immigrants regardless of the quality of life their members enjoy. Japan is the prime example.
Moreover, in the very worst places, emigration can be negligible because people can be too poor to pay for the ticket to move anywhere, or prohibited to leave.
But “given perfect knowledge of all market prices and individual preferences at every time and place, as well as unlimited computing power”, you could predict how people would choose if they were not faced with legal and moving-cost barriers—e.g. imagine a philanthropist willing to pay the moving costs. So your objection to this metric seems to be a surmountable one, in principle, assuming perfect knowledge etc. The main remaining barrier to migration may be sentimental attachment—but given perfect knowledge etc. one could predict how the choices would change without that remaining barrier.
Applying this metric to Europa versus Earth, presumably Europans would choose to stay on Europa and humans would choose to stay on Earth even with legal, moving-cost, and sentimental barriers removed, indeed both would pay a great deal to avoid being moved.
In contrast to Europans versus humans, humans-of-one-epoch are not very different from humans-of-another-epoch.
Excellent point—although I would pay a good deal to move to Europa, given a few days worth of air and heat.
A fair point, though I think societies like that are pretty rare. Any other notable examples?
Off the top of my head, I know that Finland had negligible levels of immigration until a few years ago. Several Eastern European post-Communist countries are pretty decent places to live these days (I have in mind primarily the Czech Republic), but still have no mass immigration. As far as I know, the same holds for South Korea.
Regarding emigration, the prime example were the communist countries, which strictly prohibited emigration for the most part (though, rather than looking at the numbers of emigrants, we could look at the efforts and risks many people were ready to undertake to escape, which often included dodging snipers and crawling through minefields).
The basket used is based on a representation of what people are currently consuming. This means we don’t have to second-guess people’s preferences. Unique goods like houses pose a problem, but there’s not really anything we can do about that, so the normal process is to take an average of existing houses.
Which is a well understood problem. Every economist knows this, but what would you have us do? It is necessary to inflation-adjust certain statistics, and if the choice is between doing it badly and not doing it at all, then we’ll do it badly. Just because we don’t preface every sentence with this fact doesn’t mean we’re not aware of it.
Just to avoid confusion among readers, I want to distance myself from part of Vladimir_M’s position. While I agree with many of the points he’s made, I don’t go so far as to say that CPI is a fundamentally flawed concept, and I agree with you that we have to pick some measure and go with it; and that the use of it does not require its caveats to be restated each time.
However, I do think that, for the specific purpose that it is used, it is horribly flawed in noticeable, fixable ways, and that economists don’t make these changes because of lost purpose syndrome—they get so focused on this or that variable that they’re disconnected from the fundamental it’s supposed to represent. They’re doing the economic equivalent of suggesting to generals that their living soldiers be burned to ashes so that the media will stop broadcasting images of dead soldier bodies being brought home.
I wouldn’t be in a good position to determine if it’s lost purpose syndrome since I’m an insider, but I would suggest that path dependence has a lot to do with it.
Price indices are produced by governments, who are notoriously averse to change. And what’s worse the broad methodology is dictated by international standards, so if an economist or some other intelligent person comes up with a better price index they have to convince the body of economists and statisticians that they have a good idea, and then convince the majority of OECD countries (at a minimum) that their method is worth the considerable effort of changing every country’s methodology.
That’s a high hurdle to cross.
On my blog I suggested using insulin prices as a good proxy for inflation. That should be pretty easy for economists to find, even historical data. One economists could find the historical data for one country and use it as a competing measure. No collective action problem to solve there! Just a research paper to present.
(Though I can’t find it on google searches, but economists should be able to get access to the appropriate databases.)
The technology to manufacture insulin has been getting a lot cheaper since the late 1970s when bacteria were first used to synthesize insulin (before that it had to be extracted from animals). That process has become even easier since the process for growing E. coli has become much more efficient.
True, that was just one layman’s brief pondering of an alternate metric, and I hadn’t realized the secular technology trend. I was mainly looking for something that can’t be debased because then people will die, but that is also has minimal volatility in demand, supply, and speculation, and requires numerous inputs so as to smooth out the effect of local shocks.
And perhaps I’m running into a Goodhart trap myself—today, the problem seems to be inflation being hidden via product degradation, but if I pick a metric mainly optimized for that, it will get worse over time. So finding a good or basket that covers all those would require more work—but product debasement is pretty clearly being ignored today.
(Note that precious metals are sold in a way that prevents them from being secretly debased, but also are heavily influenced by global extraction rates, and are heavily speculated on and hoarded.)
Anything that has numerous inputs will likely be something which is complicated to manufacture and therefore will have increasing efficiency as the technology improves. I can’t think of a single good that fits your criteria and hasn’thad substantial technological advancements of how it is made in the last 30 years. This sort of approach might work if one had very steady data for some long historical period with not much technological advancement.
That’s making your inflation rate strongly tied to one particular technology. A breakthrough making insulin synthesis easier, or increased diabetes rates, would affect insulin prices but not the rest of the economy.
Would error bars be a bad thing?
Economists could calculate error bars that would say how closely the calculated aggregate figures approximate their exact values according to definitions. This is normally not done, and as Morgenstern noted in the book discussed elsewhere in the thread, the results would be quite embarrassing, since they’d show that economists regularly talk about changes in the second, third, or even fourth significant digit of numbers whose error bars are well into double-digit percentages.
However, when it comes to the more essential point I’ve been making, error bars wouldn’t make any sense, since the problem is that there is no true value out there in the first place, just different arbitrary conventions that yield different results, neither of which is more “true” than the others.
There’s an old joke: “How can you tell macroeconomists have a sense of humour? They use decimal points.” I’ll admit spurious precision is a problem with a quite a bit of economic reporting. Remember that these statistics are produced by governments, not academics and politicians can have trouble grokking error bars.
Actually, that’s not really the case. There is an ideal, it’s just you can’t do it. If you knew everyone’s preferences and information and endowments of income, you could work out how people’s consumption would change as real incomes and relative prices changed so you could figure out what the right basket of goods is to use for the index at every point in time (the right bundle is whatever bundle consumers would actually pick in a given situation).
But in practice you can’t get the information you’d need to do this, and that information would be constantly changing anyway. In practice what statistical agencies do is develop a basket of goods based on current consumption and review it every decade or so. This means the index overestimates inflation (the estimates I’ve seen put it at about 1 percentage point per year) because when prices rise, people change their consumption patterns and we can’t predict how until it’s already happened.
This is a flawed procedure, but it’s not arbitrary, its an honest effort to approximate the ideal price index as well as we can, given the resources at our disposal.
James_K:
To the best of my understanding, what you write above seems to concede that even under the assumption of omniscience, when we consider different times and/or places, with different prices, incomes, and preferences of individuals—and different sets of goods available on the market, though this can be modeled by assigning infinite prices to unavailable goods—there is, after all, no unique objectively correct way to define equivalent baskets of goods. You could calculate the baskets that would actually be consumed at each time and place, but not the ratio of their true values (whatever that might mean), which would be necessary for their use as the basis for a true and objective price index.
Am I wrong in this conclusion, and if I am, would you be so kind to explain how?
I would be really grateful if you could spell out what exactly you mean by “the ideal price index” when it comes to comparing different times and places, given my above observation. Also, you ignore the question of how exactly baskets are “reviewed,” which is a step that requires an arbitrary choice of the new basket that will be declared as equivalent to the old.
Moreover, different kinds of “honest efforts” apparently produce very different figures. The procedures for calculating official price indexes have been changed several times in recent decades in ways that make the numbers look very different compared to what the older methods would yield. (And curiously, the numbers according to the new procedures somehow always end up looking better.) Would you say, realistically, that this is purely because we’ve been moving closer to the truth thanks to our increasing knowledge and insight?
The concept of “true value” is incoherent, at least in my model of reality. The correct price to attach to a good at any time is its market price at that time. If you had the set of information I listed in my last comment, you’d have the market prices, since they’re implied by the other stuff.
I think we’re using different definitions of arbitrary. To me, arbitrary means that there is no correct answer, and all options are equally valid. I don’t accept that as a legitimate description of the process, there are judgement calls, but ambiguity is inevitable in the social sciences, you either get used to it, or find something else to study. Now if you’re using arbitrary in the way I’m using ambiguous, then I don’t think we disagree, except that I think it’s less problematic than I think you do, since as soon as you start dealing with people things get so complex that ambiguity is inevitable.
Now, here you have a point. The Laspeyres Index is biased up, it may be an honest effort, but not one that’s Bayes correct. But Bayesian rationality has not penetrated through the discipline at this time, and as such a biased estimate is allowed to remain, primarily because there’s no methodologically clean way to remove the bias (you’d need to be able to predict things like quality changes and how people change their spending patterns in response to price changes) and without a background in Bayesian probability theory I think most economists would baulk at adding a fudge factor into the calculation.
It might be valuable to talk about a “true value” of a given good to a given agent. Yes, the correct price to buy or sell a good at is always the market price; but whether I want to sell at that price or buy at that price depends on how much I want the good. If I sell, then the “true value” of the good to me is less than the current market price; and if I buy, then the “true value” of the good to me is greater than the current market price. In general, the “true value” of a given good to a given agent is the price such that, if the market were trading at that price, that agent would be indifferent regarding whether to buy or sell that good.
Yes that is a coherent definition of true value. It’s not a concept that maps well to price indices though.
James_K:
I heartily agree—but what is a price index, other than an attempt at answering the question of what the “true value” of a unit of currency is? What are the fabled “real” values other than attempts at coming up with a coherent concept of “true value”?
Yes, but even given perfect knowledge of all market prices and individual preferences at every time and place, as well as unlimited computing power, I still don’t see how this solves the problem. We can find out the average basket consumed per individual (or household or whatever) and its price at each time and place, but what next? How do we establish the relative values of these baskets, whose composition will be different both quantitatively and qualitatively?
To clarify things further, I’d like to ask you a different question. Suppose the moon Europa is inhabited by intelligent jellyfish-like creatures floating in its inner ocean. The Europan economy is complex, technologically advanced, and money-based, but it doesn’t have any goods or services in common with humans, except for a few inevitable ones like e.g. some basic chemical substances, and there is no trade whatsoever between Earth and Europa due to insurmountable distances. Would it make sense to define a price index that would allow us to compare the “real” values of various aggregate variables in the U.S. and on Europa?
If not, what makes the U.S./Europa situation essentially different from comparing different places and epochs on Earth? Or does the meaningfulness of price indexes somehow gradually fall as differences accumulate? But then how exactly do we establish the threshold, and make sure that the differences across decades and continents here on Earth don’t exceed it?
Well, if macroeconomists and other social scientists were just harmless and benign philosophers, I’d be happy to leave them to ponder their ambiguities in peace!
Trouble is, to paraphrase Trotsky’s famous apocryphal quote, you may not be interested in social science, but social science is interested in you. In the present Western political system, whatever passes for reputable high-profile social science will be used as basis for policies of government and various powerful entities on its periphery, which can have catastrophic consequences for all of us if these ideas are too distant from reality. (And arguably already has.) Macroeconomics is especially critical in this regard.
No, no. A price index is an attempt to work out how much things cost relative to what they used to cost. Real GDP is an attempt to measure how much stuff is being produced relative to how much stuff was being produced. GDP is not an attempt to determine what that stuff is worth in a metaphysical or personal sense, the production is merely valued at its market price (adjusted for inflation, in the case of real GDP). To a pacifist, the portion of GDP spent on the military is worth less than nothing, but it’s still part of GDP because it was stuff that was produced.
Yes, the closer the consumption patters of the two economies being compared, the more useful the comparison is. If there were no common goods between two economies it would be impossible to compare them meaningfully. As to where to draw the line, well I wish I had a good answer for you, but I don’t. All I can say is that the value of the comparison decays over “distance” (meaning differences in consumption patterns).
Some economists have created more specialised indices for long-run comparisons; William Nordhaus created a price index for light (based on hours of work per candela-hour) from the stone age to modern times. This is a little unusual at the moment since macroeconomists don’t usually do comparisons over long time periods (it’s fiendishly hard to get data going back before the 20th Century on most indicators), but it shows you that we are aware of the limitations of our tools, including price indices.
I agree wholeheartedly, good quality policy advice is something I take very seriously. The social science we have has significant limitations, but right now, we don’t have anything better. I very much doubt the quality of our policy would improve if politicians paid less attention to their advisers than they do at the moment. So we do what we can, help thing along as much as our knowledge and the institutional frameworks decisions are made will permit. What else can you do?
James_K:
That’s a very interesting paper (available here), thanks for the pointer!
As with nearly all papers addressing such topics, parts of it look as if they were purposefully written to invite ridicule, as when he presents estimates of 19th century prices calculated to six significant digits. (Sorry for being snide, but what was that about spurious precision in economics being the fault of politicians?) However, the rest of it presents some very interesting ideas. Here are a few interesting bits I got from skimming it:
The mathematical discussion in Section 1.3.2. seems to imply (or rather assume) that even assuming omniscience, a “true price index” (Nordhaus’s term) can be defined only for a population of identical individuals with unchanging utility functions. This seems to support my criticisms, especially considering that the very notion of a human utility function is a giant spherical cow.
The discussion in the introduction basically says that the way price indexes are done in practice makes them meaningless over periods of significant technological change. But why do we then get all this supposedly scientific research that uses them nonchalantly, not to mention government policy based on them? Nordhaus is, unsurprisingly, reluctant to draw some obvious implications here.
Nordhaus considers only the fact that price indexes fail to account for the benefits of technological development, so he keeps insisting that the situation is more optimistic than what they say. But he fails to notice that the past was not necessarily worse in every respect. In many places, for example, it is much less affordable than a few decades ago to live in a conveniently located low-crime neighborhood, and this goal will suck up a very significant percentage of income of all but the wealthiest folks. Moreover, as people’s preferences change with time, many things that today’s folks value positively would have been valued negatively by previous generations. How to account for that?
More to the same point, unless I missed the part where he discusses it, Nordhaus seems oblivious to the fact that much consumption is due to signaling and status competition, not utility derived from inherent qualities of goods. I’m hardly an anti-capitalist leftie, but any realistic picture of human behavior must admit that much of the benefit from economic and technological development ultimately gets sucked up by zero-sum status games. Capturing that vitally important information in a price index is a task that it would be insulting to Don Quixote to call quixotic.
Finally, I can’t help but notice that in the quest for an objective measure of the price of light, Nordhaus seems to have reinvented the labor theory of value! Talk about things coming back full circle.
Overall, I would ask: can you imagine a paper like this being published in physics or some other natural science, which would convincingly argue that widely used methodologies on which major parts of the existing body of research rest in fact produce spurious numbers—with the result that everyone acknowledges that the author has a point, and keeps on doing things the same as before?
[facepalm] OK, I’m not making any excuse for that. Given the magnitude of his findings he doesn’t even need them to make his point.
Yes, you can’t produce a true price index. But less-than-true price indices can still be useful.
But houses keep getting bigger and you have to account for that too. Besides which, housing is no more than a third of most people’s income, at least it is in my country. That is a significant percentage, but it’s still less than half. And things keep getting better (or no worse) in the remaining two thirds.
Assuming it’s even possible to adjust for that, I’d really want to apply the adjustment to GDP, not prices. Signalling isn’t a matter of cost but rather value.
No, you’re confusing cost and value. The labour theory of value is the theory that the value of a good derives from the labour taken to produce it. If Nordhaus were using this theory he’d be arguing that the value of light keeps falling. Measuring cost with labour is another thing entirely.
No. I recognise this is a problem. I can only imagine they thing it’s too had to correct for technological change robustly, but that’s not really an excuse. If you can’t do it well, it’s generally still better to do it badly than not at all. And I didn’t realise the research was that old (I’ve actually never read the paper, I read a summary in a much more recent book). Apparently macroeconomists have more catch-up to do than I thought.
This sentence of yours probably captures the heart of our disagreement:
We don’t seem to disagree that much about the limitations of knowledge in this whole area, epistemologically speaking. Where we really part ways is that I believe that historically, the whole edifice of spurious expertise produced by macroeconomists and perpetuated by gargantuan bureaucracies has been an active force giving impetus for bad (and sometimes disastrous) policies, and that it’s overall been a step away from reality compared to the earlier much simpler, but ultimately more realistic conventional wisdom. Whereas you don’t accept this judgment.
Given what’s already been said, I think this would be a good time to conclude our discussion. Thanks for your input; your comments have, at the very least, made me learn some interesting facts and rethink my opinions on the subject, even if I didn’t change them substantially at the end.
(Oh, and you’re right that I confused cost and value in that point from my above comment. I was indeed trying to be a bit too much of a smartass there.)
Yes, I think so. It’s not that I think that macroecoonmics has covered its self in glory, it hasn’t. But this really is literally the only way to learn for those guys. And I believe it’s worth it in the short run, though I’m less sure of that, than I was before we started this. Maybe those macro guys should go try micro or something.
Same here, it’s been fun.
How much did it cost a cave man to walk outside? Or are we including the time he spent digging renovations to put the sky-light in his roof?
Heh. Yeah, I’m going to go out on a limb and guess that Nordhaus didn’t subtract off the previously-free sunlight lost to global dimming and the attenuation of natural sources of nightlight due to interference from artificial light.
This is NOT to say I’m endorsing some kind of greenie move toward a pre-industrial time just so we can see the undimmed sky or have less “light pollution”. I’m just saying that ignoring natural and informal sources of wealth is a bad habit to get into.
Reading paper to see if I can guess them right...
ETA: Ohhhhhh! Can I call ’em or what?
James_K:
But now we’re back to square one. Since different things are produced in different times and places, to produce these “real” figures for comparison, we need to come up with a way to compare apples and oranges (sometimes literally!). Now, if economists just said that they would consider an apple equivalent to an orange for some simple Fermi problem calculation, I’d have no problem with that.
However, what economists use in practice are profoundly complicated methodologies that will tell us that an orange is presently equivalent to 1.138 of an apple, and then we get subtle arguments and policy prescriptions based on the finding that this means an increase in the orange-apple index of 2.31% relative to last year. Here we enter the realm of pure nebulosity, where the indexes and “real” figures stop being vague heuristics where even the order of magnitude is just barely meaningful, and acquire a metaphysical existence of their own, as “real” variables to be calculated to multiple digits of precision, fed into complex mathematical models and policy guidelines, and used to measure reified true, objective value.
So, here is a straightforward question then: how do we know that it is meaningful to do comparison across, say, between the U.S. in 2010 and the U.S. in 1960 or 1910? What argument supports the assumption that the differences between them are small enough?
Sometimes it’s safer to just leave things alone if you don’t know what you’re doing. Presenting dubious conclusions and questionable expertise as scientific insight leads to the equivalent of dilettante surgery being performed on entire countries by their governments, sometimes with awful consequences, and with even worse ones threatening in the future. (Prominent macroeconomists will in fact agree with me, it’s just that they’ll claim that their professional rivals are the dilettantes, and only they are true experts who should be listened to.)
I happen to agree that macroeconomists are overdoing it on the level of precision they can provide. Arnold Kilng (himself a macroeconomist) made this same point in a blog post last year: http://econlog.econlib.org/archives/2009/03/paragraphs_to_p.html
I would be careful about using a price index over that kind of time frame, I don’t actually know how macroeconomists treat it, but I have read books that point out the inherent difficulty of making comparisons over long time periods (where long means more than about 20 years), and that if you’re trying to capture differences in standard of living over a long period one should try to account for differences in product quality and product mix over time. Of course that’s incredibly hard to do, and I don’t know how seriously this issue is treated in macroeconomics, but it should be taken seriously.
I strongly agree. However, there are two limiting factors when applying to this logic to policy advice: 1) If you don’t give a politician any advice, their reaction won’t be to do nothing, it will be to do whatever they think is a good idea. The average macroeconomist may not know a lot, but they know enough that their advice will probably help a little. I do think that macroeconomists should be less willing to offer active advice, as opposed to “we don’t understand this problem, the best thing to do here is nothing”, but politicians have a strong aversion to doing nothing in the face of a crisis, and if their advisers keep telling them to do politically unpalatable things, they’ll find advisers that will tell them what to hear.
2) You can’t run experiments in macroeconomics, the only way to acquire data on how well an intervention works is to try it (multiple times in multiple countries) and find out how it goes, and even then you end up arguing what would have happened if you did nothing. That means that if you don’t try to fix and/or prevent macroeconomic problems you don’t get any better information on how to fix future ones. Maybe that’s an acceptable trade off, but I’m sure you can see why macroeconomists don’t think so. Also bear in mind that what brought macro into its own as a discipline was the Great Depression. Maybe it’s worth risking some bumps in the road to try to work out how to stop something like that happening again.
Yes, it’s depressing how much a macroeconomists’ opinion on what caused the recent troubles matches up with their political ideology. But it’s a function of the low quality of evidence available, in Bayesian terms when you only have access to weak evidence, your prior matters more than when the evidence is strong. The inevitable influence politics has on the discipline doesn’t help either. Politicians are all too keen to build up economists who are telling them to do things they want to do anyway.
If some price indexes are “clearly absurd”, then they apparently have some value to us—for if they were valueless, then why call any particular one “absurd”? If they yield different results, then so be it—let us simply be open about how the different indexes are defined and what result they yield. The absence of a canonical standard will of course not be useful to people primarily interested in such things as pissing contests between nations, but the results should be useful nonetheless.
We commonly talk about tradeoffs, e.g., “if I do this then I will benefit in one way but lose in another”. We can do the same thing with price indexes. “In this respect things have improved but in this other respect things have gotten worse.”
Constant:
Sure, but such an approach would deny the validity of all these “real” economic variables that are based on a scalar price index. In particular, it would definitely mean discarding the entire concept of “real GDP” as incoherent. This would mean conceding the criticisms I’ve been expounding in this thread, and admitting the fundamental unsoundness of much of what passes for science in the field of macroeconomics.
Moreover, disentangling the complete truth about what various price indexes reveal and what they hide is an enormously complex topic that requires lengthy, controversial, and subjective judgments. This is inevitable because, after all, value is subjective.
Take for example two identically built houses located in two places that greatly differ in various aspects of the natural environment, society, culture, technological development, economic infrastructure, and political system. (It can also be the same place in two different time periods.) It makes no sense to treat them as equivalent objects of identical value; you’d have a hard time finding even a single individual who would be indifferent between the two. Now, if you want to discuss what exactly has been neglected by treating them as identical (or reducing their differences to a single universally applicable scalar factor) for the purposes of constructing a price index, you can easily end up writing an enormous treatise that touches on every aspect in which these places differ.
I’ve heard that the trick works less well each time it’s used (perhaps within a limited time period). Is this plausible?
There could be indirect consequences of the decision in question, resulting from counter-intuitive effects on the existing economic process, on lives of other people not directly involved in the decision. The relevant question is about estimate of those indirect consequences. However imprecise economic indicators are, you can’t just replace them with presumption of total lack of consequences, and only consider the obvious.
I didn’t ignore the indirect consequences:
To the extent that the indirect effects go beyond this, standard mainstream metrics in economics don’t measure them, because they are essentially independent of how well off others have become as a result of these rental decisions.
Well, maybe there are no such consequences (which is not obvious to me), but that’s what I meant.
Really? Because I hear economists talk about the value of leisure time quite frequently.
IMO, most economists don’t fetishize GDP the way you suggest they do.
You seem to be denying the benefits of Keynesian stimulus in a downturn. That position is not indefensible, but you’re not defending it, you’re just claiming it.
Both of these are contradicted by the fact that no economist, in discussion of the recent economic troubles, has suggested that letting the economy adjust to a lower level of output/work would be an acceptable solution.
Yes, they recognize that leisure is good in the abstract, but when it comes to proposals for “what to do” about the downturn, the implicit, unquestioned assumption is that we must must must get GDP to keep going up, no matter how many make-work projects or useless degrees that involves.
I most certainly am defending it—by showing the errors in the classification of what counts as a benefit. If the argument is that stimulus will get GDP numbers back up, then yes, I didn’t provide counterarguments. But my point was that the effect of the stimulus is to worsen that which we really mean by a “good economy”.
The stimulus is getting people to do blow resources doing (mostly) useless things. Whether or not it’s effective at getting these numbers where they need to be, the numbers aren’t measuring what we really want to know about. Success would mean the useless, make-work jobs eventually lead to jobs satisfying real demand, yet no metric that they focus on captures this.
Downvote explanation requested. This looks like a reasoned reply to MichaelBishop’s criticism, and I’m interested in knowing how it errs and how Michael’s comment doesn’t, and how this is so obvious.
[Didn’t downvote.] This is silly. The ‘leisure’ of unemployment is concentrated on a few, and comes with elevated rates of low status, depression, suicide, divorce, degradation of employability, etc.
That’s a misinterpretation of what I was suggesting as the alternative. Lower output + more leisure doesn’t mean the “leisure” is concentrated entirely in a few workers, making them full-time leisurists who starve. Rather, it means that anyone who wants to work for money would work fewer hours and have a lower level of consumption, not zero consumption.
Furthermore, the lower consumption is only consumption of goods purchased with money; with significant restructuring, labor with predictable demand (like babysitting) can be handled by cooperatives that avoid the need to pay for it out of cash reserves.
I don’t deny that make-work programs allow workers to show off and practice their skills, retaining employability. I criticize economists who miss this benefit. But if you’re going to spend money to get this benefit, you should spend it in a way that directly targets the achievement of this benefit to the workers, rather than on make-work projects that only achieve this benefit as a site effect, and which waste capital goods and distort markets in the process.
Unfortunately, in the United States, you really would end up with much more of the former and less of the latter. Europe would be better off, though, thanks to different labor laws; would you suggest that the United States adopt something like France’s maximum 35 hour workweek, or Germany’s subsidies to part-time workers?
Currently, hours worked per week is positively correlated with hourly wages; one person working 80 hours a week usually makes more money than two people who both work 40 hours a week. Also, specifically wanting to do part-time work is a bad signal to employers. It signals that you’re not committed to your job, that you’re probably lazy, and that you’re weird. So, absent government intervention, you probably won’t see people voluntarily reducing their working hours.
This is because it isn’t. A “lower level of output/work” means that people, on average, are going to be poorer. And the way our economy is set up (in the United States at least), reducing output/work by 1% doesn’t mean that each person works 1% less, produces 1% less, and consumes 1% less, it means that 1 in 100 people lose their job, can’t find another one, and become poor, while the rest keep going on as they have been. So, when output/work falls, you don’t get more leisure, you get more poverty.
And I disagree that most stimulus spending ends up being directed to “worthless” projects. Maybe they’re not the best value for money, but even completely worthless make-work projects are still effective at wealth redistribution. Furthermore, if people are willing to lend the government money for really, really low interest rates (as demonstrated by prices of U.S Treasury securities) then isn’t that a signal that it’s an unusually good time for the U.S. government to borrow and spend—that the economy wants more of what the government produces and less of what private industry produces?
This I think reflects a status-quo bias. When the per capita GDP was lower in 2000, or 1990, the economy managed to employ a higher percentage of people. While you’re right that current institutions, inertia, and laws prevent shorter workweeks, that is an argument for removing these barriers, not an argument for trying to game the GDP numbers in the (false) hope that this will somehow translate into sustainable employment because of the historical correlation.
Okay, but that still looks like a case of lost purposes and fake utlity functions. If you’re spending money to redistribute, then spend the money to redistribute! Don’t spend it on a project that hogs up real resources just to get a small side-effect of transferring money to people you want to help. (“What’s your real objection” and all.) If it’s important that they feel they earn the paycheck, then require that they take job training.
And the reason I call the projects worthless is this (and it doesn’t require an ideological commitment to being against government projects): people couldn’t justify asking the government to provide these things before the recession. But if the recession is a contraction of productive capacity, then the projects we commit to should also contract—it should look like an even worse deal.
The fact that the government can issue debt cheaper doesn’t change this fact. The reduced productive capacity is a real (i.e. non-nominal) phenomenon. The greater ease with which government can procure resources does not mean our aggregate ability to produce them has increased; it just means the government can more easily increase its share of the shrinking pie. That still implies that our “choice set” is being reduced, and the newer, larger wastefulness of these projects will have to show up somewhere.
If the fundamental determinant of reduced unemployment is whether the economy has entered into (as Arnold Kling says) sustainable patterns of specialization and trade, then temporary stimulus projects can’t accelerate this, because they’re by definition not sustainable: after they’re over, we’ll just have to readjust again.
I must emphasize, as I did in this blog post, that this does not mean we should give suffering families the finger because “it would be inefficient and all”—the fact that they (under a stimulus project) are working, feeling productive, and getting a paycheck is very significant, and definitely counts as a benefit. It’s just that you should help them a way that doesn’t inhibit the economy’s search for efficient use of factors of production, nor (significantly) favor these families over the ones that are going to be screwed again when the projects have to stop, and the hunt for re-coordination starts anew.
Oh, definitely.
I basically agree with this; if you want to redistribute, then certainly it’s better to just redistribute than to “employ” people to do completely useless things. (For example, extending unemployment benefits is a form of redistribution.)
Well, what matters is the opportunity cost. A project that wasn’t worth doing before can become worth doing if the better alternatives aren’t there anymore; a contraction of productive capacity doesn’t have to affect all sectors of the economy equally. For example, people in a country experiencing an oil shortage may find that investing in more expensive, non-oil energy sources has become worthwhile; it’s worse than what used to be possible, but it’s the best remaining alternative. Given that people are willing to lend to the federal government more cheaply now than before the recession, the new equilibrium might end up involving more “investment in government”, not because government has become more productive, but because the alternative investments have gotten worse.
And I’m not necessarily sure that absolute productive capacity went down all that much in the current recession. During the Great Depression, the factories were still there, there were people willing and able to operate the factories, and there people who wanted the goods the factories could produce, yet the factories were idle, the would-be factory workers were unemployed, and the would-be consumers didn’t have the goods they wanted. (The Keynesian position is that there was a collapse in aggregate demand, leading to a general glut, followed by a reduced output level.)
Economists who argue for stimulus spending on Keynesian grounds understand that GDP is not a perfect measure and that the value produced by stimulus projects may be less than the value produced by ordinary spending. See, for instance, this Brad DeLong post, where he estimates the net benefit of the stimulus and counts the useful stuff produced using stimulus money as being only 80% as valuable as the dollar amount would suggest. Or, as he writes:
Well, at least that is 20% closer to the mark!
Nice to see this kind of thinking from a capitalistish.
I’ll accept that compliment, backhanded though it might be :-) (I canceled out the downmod you got for that comment—no offense taken.)
I would appreciate, though, if you could (as best you can) tell me what it was I said that led you to believe I’m capitalistish (in the sense that you meant), or that I would otherwise disagree with my above GDP rant. No need to dig up links, just tell me whatever you remember or can quickly find.
I’m not doing this to make you feel foolish for having said what you did (like I’ve been known to try with you …), but because I want to know what it is that gives of these impressions of my views, and whether I should be using different terms to describe them.
As I’ve said before, I have a love-hate relationship with libertarianism. I believe largely what I did ten years ago about the proper role of government, but much of what self-described libertarians advocate is sharply contrary to what I considered to be my libertarian view.
An interesting question. Here are some initial thoughts:
In terms of broad economic aggregates, it won’t make any difference. If you rent the room off your parents for a market rate, GDP is exactly unaffected, people are paying the same money to different people. If you rent it for less than market rate, GDP is lower, but this reflects deficiencies in measured GDP since GDP uses market prices as a proxy for the value of a transaction (this is fine for the most part, but doing your child a favour is an exception conventional methodology can’t deal with). So from a macroeconomic perspective I’d say it’s a wash either way.
Microeconomically, there could be some efficiencies in you renting from your parents. If they trust you more than a random stranger (and let’s hope they do) they will spend less time monitoring your behaviour (property inspections and the like) than they would a random stranger, but the value of your familial relationship should constrain you from taking advantage of that lax monitoring in the way a stranger would. This mean that your parents save time (which makes their life easier) and no one should be worse off (I assume the current tenant of their room would find adequate accommodation elsewhere).
However, one note of caution. If you were to get into a dispute of some sort with your parents over the tenancy, this could damage your relationship with your parents. If you value this relationship (and I assume you do), this is a potential downside that doesn’t exist under the status quo. Also, some people might see renting from your parents as little different to living with your parents which (depending on your age) may cost you status in your day-to-day life (even if you pay a market rate). If you value status, you should be aware of this drawback.
So in summary, the most efficient outcome depends on three variables: 1) How much time and effort do your parents spend monitoring their tenant at the moment? 2) How likely is it that your relationship with them could be strained as a result of you living there? 3) How many friends / acquaintances / colleagues do you have that would think less of your for renting from your parents (and how much do you care)?
I hope that helps.
I think that a majority of economists agree that in many downturns, it helps the economy if people, on the margin, spend a little more. This justifies Keynesian stimulus. Therefore, the economy would be helped if your choice increases the total amount of money changing hands, presumably if you rent the apartment for $X when X>Y. My impression is that in good economic times, marginal spending is not considered to improve economic welfare.
Imagine that the “economy” is sluggish, and that a widget maker currently profits $1 on each widget sale. Now, consider these two scenarios:
a) I buy 100 widgets that I don’t want, in order “to help the economy”.
b) I give the widget-maker $100. Then, I lie and say, “OMG!!! I just heard that demand for widgets is SURGING, you’ve GOT to make more than usual!” (Assume they trust me.)
In both cases, the widget-maker is $100 richer, the real resources in the economy are unchanged, and the widget-maker has gotten a false signal that more widgets should be produced. Yet one of those “helps the economy”, while the other doesn’t? How does that make sense?
If you believe that either one of those “helps the economy”, your whole view of “the economy” took a wrong turn somewhere.
I agree that both a) and b) would have a similar effect in that the widget manufacturer puts to work resources (labor, machines) which would otherwise not be utilized. I wouldn’t recommend either a) or b) because there are many more efficient ways to stimulate the economy. One that my father, who happens to be an economist, has promoted is a temporary tax credit for new hires. More detail. If there are some roads you were going to build a couple years from now, speeding up that investment is probably a good idea in an economic downturn. I’m not defending legislation that actually got passed… I try not to pay too much attention.
Then why did you say this, in the very comment I was replying to?
That’s the same as recommending a)!
It doesn’t matter that you can think of better ways; the problem is with a view of the economy that regards either of a) or b) as “good for the economy”. And you in fact hold that view.
We were asked a sort of odd question which was which apartment choice would help the economy when not taking into account the individuals preferences about apartments. Those preferences in fact dominate the overall effect on the economy. I wouldn’t recommend anyone personally attempting Keynesian stimulus.
Increasing the amount of money changing hands only helps in certain circumstances, and even then it is not necessarily the dominant effect.
What about the examples of intelligent stimulus I offered?
Coming back to this question after a few years, I was able to find a surprisingly simple Econ 101 answer in five minutes. To zeroth order, there’s no change because the amount of goods and services in the economy stays the same. To first order, allowing a deal to be freely made usually increases total value in the economy, not just the value for those making the deal; so this deal is good for the economy iff both sides agree to it.
That sidesteps all complications like “the parents are happy to help their child”, “the apartment might have facilities that the child doesn’t need”, etc. I guess reading an econ textbook has taught me to look for ways to estimate the total without splitting it up.
Here’s another question to chew on:
Suppose you’re in a country that grows and consumes lots of cabbages, and all the cabbages consumed are home-grown. Suppose that one year people suddenly, for no apparent reason, decide that they like cabbages a lot more than they used to, and the price doubles. But at least to begin with, rates of production remain the same throughout the economy. Does this help or harm the economy, or have no effect?
In one sense it ‘obviously’ has no effect, because the same quantities of all goods and services are produced ‘before’ and ‘afterwards’. So whether we’re evaluating them according to the ‘earlier’ or the ‘later’ utility function, the total value of what we’re producing hasn’t changed. (Presumably the prices of non-cabbages would decline to some extent, so it’s at least consistent that GDP wouldn’t change, though I still can’t see anything resembling a mathematical proof that it wouldn’t.)
What exact metric do you have in mind?
I’d be about equally happy if offered a solution in terms of GDP or some more abstract metric like “sum of happiness”.
Trouble is, all these macroeconomic metrics that can be precisely defined have only a vague and tenuous link to the actual level of prosperity and quality of life, which is impossible to quantify precisely in a satisfactory manner. Moreover, predicting the future consequences of economic events reliably is impossible, despite all the endless reams of macroeconomic literature presenting various models that attempt to do so.
Thus, if you want to ask how your choice will affect the nominal GDP for the current year or some such measure, that’s a well-defined question (though not necessarily easy to answer). However, if you want to interpret the result as “helping” or “hurting” the economy, it requires a much more difficult, controversial, and often inevitably subjective judgment.
Of course, gdp only measures goods and services sold, not “household production.”
That’s only one of the main problems with GDP. Here’s a fairly decent critique of the concept written from a libertarian perspective (but the main points hold regardless of whether you agree with the author’s ideological assumptions):
http://www.econlib.org/library/Columns/y2010/HendersonGDP.html
In addition to these criticisms, I would point out the impossibility of defining meaningful price indexes that would be necessary for sensible comparisons of GDP across countries, and even across different time periods in the same country. The way these numbers are determined now is a mixture of arbitrariness and politicized number-cooking masquerading as science.
It is certainly true that some people make too much of GDP, but those numbers can be pretty helpful for answering certain research questions. Let’s not throw the baby out with the bath water.
To continue on your metaphor, it’s not clear to me if there is a baby worth saving there at all. Even if there is, the baby is submerged in an enormous cesspool of filthy and toxic bathwater that’s been poisoning us in very nasty ways for a long time.
To be clear, you are suggesting we might not lose anything by giving up measuring and using GDP figures? I’ll side with the majority of the economics profession… they aren’t perfect but they mostly use GDP data in a reasonable way.
Just so we’re on the same page, could you explain what it would look like if economists’ collective wisdom were actually so bad that you would agree they use GDP data in an unreasonable way?
Because you can’t just look at the fact the top economists all agree—they’d do that even if the field were collectively garbage. There has to be some real-world entanglement which would reveal the failure of their ideas, and I want to know what you expect such a failure to look like.
I’m a sociologist*, and there is nothing sociologists like to do more than point out where economists go wrong. So if GDP was a worthless figure, I expect the real world entanglement that one of my fellow sociologists would have convinced me of that already.
I’m not saying economists never overinterpret GDP figures, and I’m not saying the consensus of macroeconomists is always correct.
Though I think we might both be better served by quitting conversation and reading actual experts (I don’t claim to be one) I would like to make sure we’re on the same page about the implications of your criticism. Are you not saying that it is essentially worthless to attempt to study economic growth or business cycles empirically because the data is so poor?
*if you can be one without having completed your dissertation yet.
This sounds to me like a case of mistakenly thinking “someone would have noticed!”. What exactly would sociologists have noticed and hasn’t happened? Remember, “my echo chamber in academia agrees with me” doesn’t count as evidence!
And, FWIW, sociologists (and a lot of the left in general) do complain about GDP—they’re the ones spearheading the push to use alternate metrics like “Gross National Happiness” and other things. I think a lot of them are nutty, but at least they’re identifying values that need to be looked at.
But I have read the experts! Top economists like Greg Mankiw, Paul Krugman, and Scott Sumner blog and lay out their arguments in detail, and their (economic basis for making their) arguments are exactly as I have portrayed them! Sumner in particular believes (mistakenly imo) that nominal GDP is a crucial measure.
Krugman certainly relies heavily on measuring real GDP growth and equates it with progress. And James_K, who claims to be an economist, just came out of the woodwork and endorsed exactly what I’ve accused economists of, though asserting (with a basis I’m shaking) that they don’t really make that big of a deal out of GDP.
With the currently studied data, yes, though with different measures, better progress could be made. In the past I’ve suggested measuring non-cash and non-market production, subtracting certain “bad” activities from GDP (i.e. things which represent a response to destruction, as it’s indicative of merely replacing some capital with other capital), measuring product degradation in calculating CPI, and using insulin as a better inflation gauge.
Hey, I’m fine with calling you one if you’re fine with calling me an engineer despite just having a bachelors and years of field work but not a P.E. license.
I agree that GDP is imperfect. If it were easy to perfect then it would have been done already. Should more resources be devoted to the issue? Probably. I support the use of multiple measures of wealth and well-being. But I do think that when GDP goes up, that usually indicates good things are happening. Other indicators usually track it.
I’m not trying to deny you’ve noticed a problem, I just think that you’re overstating it because even though GDP is imperfect, there is still a lot to be learned from empirical research that uses it.
Oh boy, we should bring Taleb in here.
If we’re going to do metaphors, then yes, you’re right, but we also have to make sure we’re not drinking the bathwater. The bathwater is for bathing, not for drinking. GDP should be used a very rough cross-country comparison, not as a measure of how well the economy’s general ability to satisfy wants changes over short intervals.
Interestingly enough, I was arguing roughly your position a few years ago. But now, seeing how economist deliberately prioritize GDP over the fundamentals it’s supposed to measure, I can’t even justify defending it for purposes other than, “The US economy is more productive than Uganda’s.”
The essay at the link talks about government waste. Is it meaningful to talk about waste in business, or should it all be considered to be at least educational?
Regarding the end-products, one essential difference is that if a business can find private consumers who will purchase its product with their own money and of their own free will, this constitutes strong evidence that these customers assign some positive value to this product, so it can’t be fairly described as “waste.” In contrast, for many things produced by the government, no such clear evidence exists, and even if one is not of particularly libertarian persuasion, it seems pretty clear that many of them are wasteful in every reasonable sense of the term. Yet all consumer and (non-transfer) government spending is added to the GDP as equivalent.
When it comes to waste generated by inefficiencies, miscalculations, employee misbehavior, and perverse incentives, some amount of wasteful efforts and expenses is obviously inevitable in the internal functioning of any large-scale operation. It does seem pretty clear that in most cases, the incentives to minimize them are much stronger in private businesses than in governments, though unlike the previous point, this one is a matter of degree, not essence. However, when it comes to the GDP accounting, there are important differences here.
The reason is that all non-transfer spending by the government will be added to the GDP, whereas spending by businesses is added only if it constitutes investment (as opposed to mere procuring of the inputs necessary for production). As far as I know, the exact boundary in the latter case is a matter of accounting conventions, though in most cases, it does seem clear which is which (e.g. for a trucking company, buying fuel is not an investment, but buying new trucks is). Therefore, whatever the actual amount of wasteful spending by businesses might be, not all of it will be added to the GDP, unlike the wasteful spending by governments.
Thanks for that link. I hadn’t realized Henderson had written that, let alone just a few months ago! Its recency means he could critique the stimulus arguments of the last two years, making basically the same arguments I do.
My only complaint is that he noted that leaving off non-market exchanges (i.e. maid becoming wife) causes GDP to be understated, when he should have discussed its impact on the rate of change in GDP, which is more important.
I recommend going to an econ textbook for good questions.
My (admittedly simple-minded) answer would be “other things being equal it has no effect at all”.
Each day you and your parents do whatever it is you do, creating a given amount of wealth (albeit perhaps in such a way that it’s impossible to say exactly how much of this wealth you personally created, rather than your colleagues, or the equipment you use). Then a bunch of wealth gets redistributed in a funny way (through wages and rents being paid). But changing the way that wealth is redistributed doesn’t affect the ‘total rate of wealth-generation’ which is what GDP is trying (sometimes unsuccessfully, as James_K says) to measure. In just the same way, getting a pay rise doesn’t in itself help the economy (but it may have been caused by you doing more valuable work, which does help).
I’m pretty sure this is wrong. If I have a spare apartment and start renting it out, I’m creating wealth, not just redistributing it. So changing the pattern of who rents from whom should influence the total amount of wealth created.
Though I should clarify that when I talk about “the size of the economy” I’m talking about something intangible—the ‘wealth of the nation’, or more precisely the ‘nation’s rate of wealth-creation’ - rather than simply GDP. Perhaps GDP will reflect the changing rents, perhaps not, depending on which type of GDP we’re talking about (I seem to recall that there are several, including a ‘spending’ measure and an ‘income’ measure.)
But we’re not talking about someone renting a previously empty apartment, we’re talking about a change of occupier. The ‘wealth’ of the apartment is merely being ‘consumed’ by someone else.
Suppose without loss of generality (?) that the person who was previously in your parents’ apartment is now in your old apartment. Then we can describe the change as follows:
Two people have swapped apartments.
They may be paying different rents from before.
Neither 1 nor 2 in itself changes the size of the economy. (Although, if a rent goes up because an apartment is more desirable then that changes the size of the economy.)
Apartments don’t have a single intrinsic “desirability” value. Different people assign different values to the same apartment. If you think about it, the fact that different people can value a thing differently is the only reason any deals happen at all. The sum you agree to pay is a proxy for the value you place on the thing.
No, you can’t assume without loss of generality that the person who was previously in my parents’ apartment will be willing or able to move to mine. It depends on the relationship between X and Y.
But the set of living spaces is the same as before. Can’t we assume for simplicity that, even if it’s not as simple as two people swapping places with each other, what we have is a ‘permutation’ such that all previously occupied houses and apartments remain occupied?
Then once again we can factor the change into (1) a permutation and (2) a change of rent, and ask whether either of them changes the wealth of the nation. I’m pretty sure that (2) in itself has no effect—it’s just a ‘redistribution’ between landlords and their tenants. Whether (1) has an effect depends on whether or not we’re including the fact that different people may make different assessments of desirability (i.e. whether different people have different preferences about the kind of apartment they’d like to live in.)
Of course you’re quite right that different people do have different preferences—I was merely ignoring this for simplicity—but in any case the statement of the problem says nothing explicit about your or anyone else’s preferences, it only talks about X and Y. Are your apartment-preferences supposed to change depending on the values of X and Y?
You’re right that (2) has no effect, but (1) probably does have effect. I thought we could somehow guess the effect of (1) by looking at X and Y, but now I see it’s not easy.
There is other information you want to consider. Tax rates for example, and whether or not the economy is in the sort of downturn that would benefit from stimulus or not.
Regardless, the effects on aggregate supply and demand will be tiny. How much you and your parents value these alternatives is what matters most.
I’m not asking about what I should decide, I’m asking about the sign of those tiny effects on the country as a whole. Is it actually a difficult question in disguise? Why? I know next to nothing about economics, but the question sounds to me like it should be really easy for anyone qualified.
I think the best way to measure it in any meaningful way would be to consider the same scenerio with millions of people doing it instead of just one, but even then it doesn’t look like it makes much of a difference.
This is a good point. What happens in this individual case would be dominated by random facts about the individuals directly involved. If you imagine the same situation repeated many times, 100 should be plenty, the randomness cancels out.
So you might think. Sensitivity to initial conditions!
care to explain why we should expect sensitivity to initial conditions to matter in the particular example being discussed here?
I am struggling to convey this, so I’ll have to think about it more.
For now, though: I do think that differences in the initial conditions would be propagated by adaptive individuals and institutions (rather than smoothed away). That should lead to bifurcations and path dependencies that would generate drastically different outcomes. Enough that averaging them would be meaningless.
Why do you think repeating it many times would converge? Are the statistical limit theorem conditions really met? I don’t think so..
None of this really explicitly says that you wouldn’t be able to at least figure out the sign of the change. It might be computationally intractable but qualitatively determinable in special cases.