Tuesday, December 06, 2016

More about the Econ 101 theory of labor markets

I've received many good responses to my post about the "Econ 101" (undifferentiated competitive partial equilibrium short run) theory of labor markets. But there are a couple responses that I got many times, which I think are worth discussing in detail.

To recap: I pointed out that the Econ 101 theory can't simultaneously reconcile the small sizes of the labor market responses to immigration shocks and minimum wage increases. I said this implies that the Econ 101 theory isn't a good way to think about labor markets, and that instead we should pick another go-to mental model - general equilibrium, or search and matching theory, or monopsony, etc.

Two common responses I got were:

1. "Immigration doesn't just shift labor supply; it shifts labor demand too."

2. "Labor is probably very heterogeneous, so one S-D graph shouldn't have to fit both these facts at once."

The first response is a very good one. I like it a lot. What it means is that we should always think about labor markets in terms of general equilibrium, not partial equilibrium. 

An essential part of partial equilibrium thinking (or as David Andolfatto likes to call it, "Marshall's Scissors") is that the supply and demand curves can shift independently of each other. This is not apparent just from drawing the graphs, but if you think about it, it's obvious. If any shock - a storm, a policy change, a change in the price of a substitute or complement, etc. - shifts both curves in the same direction, the effect of shocks on both price and quantity will be indeterminate. Econ 101 doesn't allow you to reason from a price change, but it should allow you to reason from a price change and a quantity change.

Immigration shifts labor demand because of general equilibrium effects. Realizing that more labor is now available in a certain city, more companies will move there or start up there, in order to take advantage of the demand for goods and services from the new immigrants. That will push the price of labor back up to where it was before the immigrants came. If that shift happens quickly, studies won't show any sizable dip in wages from the influx of immigrants. General equilibrium is harder to think about than partial equilibrium (quick mental exercise: what are the general equilibrium results of a minimum wage hike?), but in the case of labor, the evidence shows that the simpler theory just won't cut it.

OK, on to response #2. It might be the case that immigrants don't compete directly with native-born workers, but fill economic niches that previously were mostly left unfilled. It might be that if we sliced the data in just the right way, we could find a slim subgroup of people whose wages are clobbered by immigration. In fact, George Borjas has tried to do exactly this. But any properly trained empirical researcher will recognize this as data mining. 

Meanwhile, some people claim that minimum wage and immigration affect two very different segments of the labor market. That's certainly possible, but both types of studies are usually about low-wage, low-education workers. Many limit themselves to teenagers, and find the same thing. How much more granularity do you want?

The problem with invoking extreme heterogeneity to explain seemingly incommensurate labor market facts is that it turns predictive theory into useless just-so stories. Assuming unobservable characteristics - or mucking around in the data til you find some that seem to work - introduces free parameters into the model, meaning it can never really be compared with data. Heterogeneity assumptions are just the proverbial epicycles. Without some assumptions about which segment of the labor market the theory applies to, the Econ 101 theory becomes totally useless.

So while some degree of labor market heterogeneity is real, the more it gets invoked, the more it weakens the overall theory. Theories should always be penalized for sticking in more parameters.

Anyway, those were two thoughtful and interesting categories of responses. I also got a few that were...well...a little less deep.  ;-)

Saturday, December 03, 2016

An econ theory, falsified


















Tuesday, November 29, 2016

You and whose army?

"Political power grows out of the barrel of a gun"
- Mao Zedong

















Friday, November 25, 2016

Are current trends in econ methodology just fads?

The Economist has an article about the booms in machine learning and randomized controlled trials (RCTs). The article is written in a snarky tone, and mostly talks around the question of whether these methodologies are overhyped, but overall it seems to be making a case that they are:
[J]udging by the tendency of those writing economic papers to follow the latest fashion, a “herd” would be [the] best [collective noun to describe economists]. This year the hot technique is machine learning, using big data... 
Economists are prone to methodological crazes...[N]ew methods also bring new dangers; rather than pushing economics forward, crazes can lead it astray, especially in their infancy... 
A paper by Angus Deaton, a Nobel laureate and expert data digger, and Nancy Cartwright, an economist at Durham University, argues that randomised control trials, a current darling of the discipline, enjoy misplaced enthusiasm... 
Machine learning is still new enough for the backlash to be largely restricted to academic eye-rolling.
As its main piece of evidence for the faddishness of economics, the article presents the following graph:

To me, this graph (which is just for NBER working papers) shows the opposite of what the article claims. Looking at the chart, I see a bunch of more-or-less monotonically increasing lines. Remember that the y-axis here is percent of total papers, so if these techniques are fads, we'd expect these lines to mean-revert. Instead, almost all the lines just go up and up for 15 to 30 years. To me, that says most of these things are not overhyped fads - at least, not yet.

There are two possible exceptions. Lab experiments had a brief downturn for a few years starting in around 2002, though they shortly resumed their upward climb, and are now way above their 2001 peak. DSGE models have been decreasing slowly since 2010, though they're still strongly up over the last decade.

Given the seeming non-faddishness of the lines on this chart, a better hypothesis would seem to be that these new techniques are driven by new technology. The internet and computerization have made it much easier to collect, transfer, and analyze data. Processing power and software packages like Dynare have made it much easier to numerically solve DSGE models. These are factors that the Economist article does not consider.

If new technology, not academic herd behavior, is responsible for most of the methodological trends of the last 30 years, it implies that the changes are here to stay. New technology doesn't go away (unless you live in an RBC model, which we don't). It's possible that the boom in empirical methods in general is working through a backlog of old theories that were not testable until recently, and that the empirical wave will subside once that task is complete. But that's very different from empirical techniques being fads.

(I do think there is a possibility that DSGE is somewhat of a fad, and that the decline in the last 5 years is a new trend instead of a blip. This is partly because of definitions. OLG models are dynamic general equilibrium models, and many are stochastic, but they aren't called "DSGE". But I also think DSGE might decline because theory in general is declining.)

In any case, the Economist article does not marshal any strong arguments that machine learning has been overdone. Its only actual evidence comes from the book Weapons of Math Destruction. That book is about algorithmic decision-making can have unintended, morally dubious consequences for society. It has little to do with the question of whether machine learning techniques are useful for econometrics. The book itself is important and well-written, but the Economist article's reference to it seems random and out of place.

As for RCTs, the Economist's argument against them comes entirely from the famous paper by Angus Deaton and Nancy Cartwright. It will be interesting to see whether this argument eventually stems the tide of RCT usage. But I highly doubt that RCTs will go away any time soon, since for many questions there is simply no other technique in existence that can provide credible answers. RCTs have, importantly, never gone away in medicine.

So I don't think the Economist article gives us much reason to believe that machine learning and RCTs are faddish. Yes, it's true that economists (like everyone) don't generally use new tools optimally when they first come out, and learn better ways to use them as time goes on. Yes, it's true that methodologies can influence which questions get asked (the "streetlight" problem), and that open-minded economists should try to break out of the mental boxes their methodologies create. But it's not yet appropriate to conclude that new empirical techniques represent fleeting fads, as opposed to real progress.

Monday, November 21, 2016

Steve Bannon and the Last Crusade

I heavily doubt Steve Bannon is the anti-Semite many on the left now claim he is. It's mostly based on one thing that his wife said that he said, about not wanting to send his kids to school with whiny Jewish girls. It's hearsay, about one thing he said in private years ago, which isn't even that anti-Semitic. Bannon has also publicly stated that he has "zero tolerance" for the anti-Semitic elements of the alt-right. (This Breitbart article, by David Horowitz, is sometimes cited as evidence of anti-Semitism, but it's actually just criticizing Bill Kristol for not being sufficiently pro-Israel!)

I also hear a lot of claims that Bannon is a white nationalist. Some are based on stuff he allowed to be published at Breitbart (e.g., this), but many seem to rely on one thing he said while interviewing Donald Trump, in which he worried that too many immigrant CEOs would reduce "civic society." That's not something I agree with, since I'm strongly and categorically in favor of skilled immigration. But it certainly by itself doesn't peg him as a white nationalist, especially when he vigorously and publicly and explicitly denies being a white nationalist. So if you think he's B.S.-ing about that, your case will have to rely on Breitbart articles.

So what does Bannon believe in? The main articulation of his worldview that I know of comes from this 2014 speech. Essentially, Bannon's worldview seems to have three main pillars:

1. The fruits of capitalism should be more broadly distributed.

2. The West is in a war with radical Islam and must prevail.

3. Secularism contributes to the weakness of the West.

Here's where he talks about Pillar #1, his economic philosophy:
[C]apitalism really generated tremendous wealth. And that wealth was really distributed among a middle class, a rising middle class, people who come from really working-class environments... 
But there’s a strand of capitalism today — two strands of it, that are very disturbing...One is state-sponsored capitalism...The second form of capitalism that I feel is almost as disturbing, is what I call the Ayn Rand or the Objectivist School of libertarian capitalism...It is a capitalism that really looks to make people commodities, and to objectify people...So I think the discussion of, should we put a cap on wealth creation and distribution?... 
The central thing that binds [my movement] together is a center-right populist movement of really the middle class, the working men and women in the world who are just tired of being dictated to by what we call the party of Davos...[T]here are people in New York that feel closer to people in London and in Berlin than they do to people in Kansas and in Colorado, and they have more of this elite mentality that they’re going to dictate to everybody how the world’s going to be run.
This "center-right populism" is basically a cross between FDR, Bernie Sanders, and Ross Douthat. Bannon also lambastes "crony capitalism", and says that he thinks a Judeo-Christian ethic facilitates a more equitable form of capitalism.

Bannon criticizes secularism, which is pretty standard for religious conservatives, and which also reminds me of Ross Douthat. In fact, Bannon's ideas sound a lot like the "reform conservatism" that had been making the intellectual rounds before Trump showed up on the scene.

But the one place where Bannon comes out very strongly against an external enemy is when he talks about radical Islam:
[W]e’re at the very beginning stages of a very brutal and bloody conflict...the people in this room, the people in the church, [need to] bind together and really form what I feel is an aspect of the church militant...to fight for our beliefs against this new barbarity that’s starting.. 
[L]ook at what’s happening in ISIS...That war is expanding and it’s metastasizing to sub-Saharan Africa. We have Boko Haram and other groups that will eventually partner with ISIS in this global war, and it is, unfortunately, something that we’re going to have to face, and we’re going to have to face very quickly...[W]e’re now, I believe, at the beginning stages of a global war against Islamic fascism... 
I believe you should take a very, very, very aggressive stance against radical Islam...If you look back at the long history of the Judeo-Christian West struggle against Islam, I believe that our forefathers kept their stance, and I think they did the right thing. I think they kept it out of the world, whether it was at Vienna, or Tours, or other places… It bequeathed to use the great institution that is the church of the West.
Bannon's view is that radical Islam is attacking the West, and must be defeated by a united Judeo-Christian West.

This is part of a very very long strain of thought. Europeans and Middle Easterners have been fighting each other for basically all of recorded history. Two heavily populated regions, mostly but not completely separated by natural barriers, naturally tend to come into conflict at their borders. The millennium of wars between Christendom and the Islamic Umma was actually a sequel to the wars between the Greco-Romans and the Persians, and maybe even to the Trojan War and the Late Bronze Age Collapse. So this is a clash of civilizations that has been going on essentially forever.

Bannon's call for a "church militant" and a "church of the West" is basically similar to the Holy Leagues that fought the Ottomans in the 1500s. It's not a call to invasion, like the original Crusades, but rather a defensive move. Bannon is calling on the Catholic Church in particular, but also Christianity, Western capitalism, and all other unifying institutions of the West, to act as unifying and motivating forces to fight this struggle.

This is perfectly understandable. Al-Qaeda killed thousands of innocent American civilians on 9/11, and carried out a bunch of other smaller attacks on the West. ISIS has attacked the West a few times, and has horrified the world with its gruesome videos. Barbaric indeed.

But I believe that Bannon fundamentally misunderstands what's going on with radical Islam. Some of the malign energy of al-Qaeda, ISIS, and other radical Islamic groups has been directed against the West and against Christians, yes. But most of it has been directed at other Muslims in Muslim countries. Only a very small part of what we're witnessing is a continuation of the eternal clash between Europe and the Middle East. Most of it is an internal civil war within the Islamic Umma.

Let's look at the main wars currently being fought by radical Islamic forces. These are:

  • Syrian Civil War (~470,000 dead)
  • 2nd Iraqi Civil War (~56,000 dead)
  • Boko Haram Insurgency (~28,000 dead)
  • War in Afghanistan (126,000 dead)
  • Somali Civil War (~500,000 dead)
  • War in Northwest Pakistan (~60,000 dead)
  • Libyan Civil War (~14,000 dead)
  • Yemeni Civil War (~11,000 dead)
  • Sinai Insurgency (~4,500 dead)

This is a lot of dead people - maybe about 2 million in all, counting all the smaller conflicts I didn't list. But almost all of these dead people are Muslims - either radical Islamists, or their moderate Muslim opponents. Compare these death tolls to the radical Islamist terror attacks in the West. 9/11 killed about 3,000. The ISIS attack in Paris killed 130. The death tolls in the West from radical Islam have been three orders of magnitude smaller than the deaths in the Muslim world.

Three orders of magnitude is an almost inconceivable difference in size. What it means is that only a tiny, tiny part of the wars of radical Islam is bleeding over into the West. What we're seeing is not a clash of civilizations, it's a global Islamic civil war. The enemy isn't at the gates of Vienna - it's at the gates of Mosul, Raqqa, and Kabul.



So I think Bannon should relax. Radical Islam will punch itself out. It's a brief, violent outpouring of reaction against internet-borne modernity, and against stagnant and repressive local regimes. It has weak popular appeal, little organization, few adherents, few weapons, and almost no safe territory anywhere on the planet. The Western attempts to help local Muslims defeat radical Islam, which have been largely successful everywhere, have not required a church militant or a Crusading spirit - in fact, they were pretty cheap and low-risk.

Many conservatives also fear that Muslim immigrants will become a fifth column in the U.S., a group with strong anti-American sentiments, committed to destroying the country from within. In fact, nothing like this is happening. Muslim immigrants in the U.S. are marrying out of the faith at increasing rates. The same pressures of modernity that have increased secularism among Jews and Christians are secularizing Muslims in the West. A lot of American Muslims now celebrate Christmas. (A few Muslims in the West, spurred by the incredibly bad example of ISIS, are even converting to Christianity, which just goes to show how radical Islam is backfiring.)

In other words, secularism isn't a dagger in the heart of Western resistance to radical Islam. It's one of the key forces that will eventually cause Muslims in the West to assimilate into broader Western society - just as it has done for non-Orthodox Jews, and many others.

So I think Steve Bannon should rethink his view on the war against radical Islam. If you think secularism is bad for society, fine. But we definitely don't need to transform our society in order to resist a radical Islamic menace. In fact, the menace was always mostly a danger to other people, far away. And they're whupping its ass. Meanwhile, Islam in general does not look like a threat to the Western way of life.

Monday, November 14, 2016

The real danger

Right now, lots of people are afraid of the wave of racist and sexist harassment incidents that erupted in the wake of Trump's electoral victory. Lots of other people are thinking more long-term, worrying about policy changes (Roe v. Wade, deportations, restrictive immigration laws, health care). Relatively few, as yet, seem to be worried about the further long-term degradation of America's institutions (Daron Acemoglu has a great essay about this).

But there's one danger that dwarfs all of these: the looming specter of great-power war.

Here, via Matthew White, is a visual depiction of deaths from war and genocide during the 20th century. I've annotated it a bit (my explanations are in blue):

As you can see, the vast majority of the war deaths happened as the result of two great-power wars, World War 1 and (especially) World War 2. Major democides during these periods - Stalin's purges and famines, the Nazi genocides, the Armenian genocide, etc. - were generally an outgrowth of regimes that came to power as a result of these wars. The world wars produced the totalitarian states of Russia, China, and Germany. There are exceptions, of course - Japan's militarist state came about despite its light involvement in WW1. But overall, great-power war tends to give birth to extremist regimes who do terrible things, who start more wars, and who use wars as excuses to do terrible things.

In The Better Angels of Our Nature, Steve Pinker uses extensive evidence to document that violence on Earth has declined over time. Both war and violent crime cause less suffering to the average human being than they did before. But he also shows that the decline has not been monotonic. There have been periodic eruptions in which war and crime soared. As Pinker documents, the vast majority of war deaths are caused by great-power wars, which are relatively rare events. So while it's good to be optimistic about the overall decline in violence, it's wrong to take it for granted. When the Big Boys come out to fight, all bets are off.

Why is this true? One theory of violence that Pinker puts forth is the "leviathan" theory. When there is a higher power making sure that everyone plays nice, violence is low. As people gradually learn to appeal to the authority rather than to settle their disputes between themselves - which requires doing preemptive violence to build up a fierce reputation - the culture of violence ebbs. 

But barring the intervention of God or the creation of a world government, there is no authority on Earth more powerful than Great Power countries - currently, the U.S., China, and Russia. Therefore, when these countries fight, there's no one to stop them. And when they focus on fighting each other, they're also unable to police the weaker nations. So "leviathan theory" explains why great-power wars not only cause titanic amounts of destruction, but lead to lasting rises in violence.

The last great-power war ended six decades ago, in 1953. Since then, many people have concluded that nuclear weapons have made great-power war obsolete. The failure of the U.S. and USSR to fight each other during the Cold War lends some credence to this theory. But it's also possible that institutional memory from the World Wars was simply strong enough to make the U.S. and USSR prudent and cautious. 

That institutional memory is probably gone now. Everyone who fought in WW2 or the Korean War is too old to govern. Meanwhile, there are some ominous signs. With the election of Trump, all three of the Great Powers now have a strongman at the helm. Xi Jinping's power is unprecedented since the days of Mao, Putin's since the days of Stalin, and Trump's...well, we'll see.

Strongmen are decisive and can get thing done, but they're also unpredictable. A strongman may be for peace one day and war the next. What's more, strongmen tend to have big egos. Trump is friends with Putin today, but what happens if the two alpha males get into a pissing contest? 

What's more, the number of flashpoints between the Great Powers is increasing. Russia has rattled its saber at the NATO-protected Baltics, and China has steadily ratcheted up its attempts to claim the whole South China Sea. 

A war between two of the Great Powers need not go nuclear, but it would be hard to stop it from doing so. If one strongman leader backed down after a loss in a limited, conventional war, he would have to choose between humiliation and probable loss of power at home, or doubling down and escalating the war. Escalation seems likely. And as for the idea that nuclear weapons are just too horrible and too powerful for anyone to seriously contemplate using - well, they said the same thing about the new artillery weapons that were developed before World War 1. Yet that was no deterrent to war. 

So this is the biggest danger of a Trump presidency. But it's not all about Trump, by any means. U.S. voters didn't put Xi or Putin in power, and those threats would be there even if Clinton were in the White House. But I think it's hard to argue that Trump, with his personalistic style and big ego, doesn't increase the risk.

Great-power war is the huge, terrible danger looming over us all. In the medium term - i.e. over the next couple of decades - it's by far the biggest risk to human life, freedom, security, and quality of life. 

Wednesday, November 02, 2016

The collapsing math genius gender gap

Via Allison Schrager, Andy McAfee, and others, here comes a chart of the gender gap in upper-tail SAT scores:

As you can see, the ratio has drifted downward at all levels, but at the 0.01% level (about 3.7 standard deviations of the combined score distribution, if you assume normality) it has fairly dramatically collapsed. When Ronald Reagan was elected, girls made up only 7% of the top performers. By the time Clinton took office, it was 20%. As of Obama's reelection, it was 28%.

The key piece of information here isn't the current level of the gender gap, it's the recent rate of change. This sort of rapid shift implies that there's lots going on here that's not genetic - unless biological gender differences can change radically from decade to decade.

It's highly unlikely to be a change in the SAT math section. The SAT math section is the same damn thing year after year after year. "Do you know the ratio of sides of a 30-60-90 triangle?" "Can you factor a quadratic expression, using only a paper clip and bubblegum?" "What was the color of Napoleon's white horse?" And so on.*

If it ain't biology, and it ain't a measurement problem, it must be environmental forces that are causing the gender gap to collapse. And whatever these environmental forces are, they're strong stuff.

Knowing that strong environmental forces are present doesn't rule out inherited ability differences. It could be that there are two forces at work, and that the ratio will eventually settle into its "natural," biologically determined perfectly meritocratic level. But Occam's Razor - or really, any penalty term for model complexity - says that a one-factor model beats a two-factor, all else equal. In other words, if strong environmental forces were still present in 2006, it's a decent bet that they weren't completely gone as of 2011. So this doesn't kill the genetic-determinist position, but it weakens it.

OK, so who cares? Well, this is relevant to a recent Journal of Economic Perspectives article by Amanda Bayer and Cecilia Rouse, entitled "Diversity in the Economics Profession: A New Attack on an Old Problem". Bayer and Rouse show that the percentages of PhDs and undergrad degrees awarded to women in the econ field have remained flat for the past two decades:

What this says is that an econ degree isn't just an upper-tail IQ test. If it is, the gender gap would have shrunk since the days of Soundgarden and flannel shirts.

So what is causing the gender gap in econ? Preferences are one possibility. Maybe women just don't like econ as much as men. SAT scores are a great proxy for IQ, but they're a pretty terrible proxy for the desire to spend your life selling a bunch of skeptical colleagues on the merits of your own mildly challenging variation on a highly stylized benchmark model with poor data fit, or sifting through the historical record for plausibly exogenous natural experiments. There's no reason to expect math-geniuses to desire that life in strict proportion to their math-geniusy-ness.

Sociology is another possibility. The econ boys' club might be shutting out the ladies. Perhaps they're afraid that a girl will accidentally brush their arms at a seminar, infecting them with incurable icky girl-cooties. Knowing certain economists, I wouldn't be surprised if this is exactly their fear. Or maybe some women think econ has way too high a fraction of creepy libertarian dudes who will subtly try to sink their careers in a misguided attempt at revenge against the cheerleaders who wouldn't sleep with them in high school. Knowing certain economists, I wouldn't be surprised if this is exactly their fear.

So anyway, yes, I guess at the end of the day this is just another "Girls RULE!" post. Are we tired of "Girls RULE!" posts yet? Hell no. You know me. I never get tired of anything.

*Answers: 1. 1/2/sqrt(3), 2. Trick question, as we're all out of bubblegum, and 3. C

Wednesday, October 19, 2016

Do economists have physics envy? (Part 2)

Last year I wrote a post called "Do economists have physics envy?". Historian Philip Mirowski (who I notice also got his econ PhD from Michigan!), who literally wrote the book on the interplay between economics and physics, is not too happy with my post. In a recent interview, he explains why:
Let’s take a recent example of a popular contemporary economist blogger, insisting that economists don’t suﬀer from physics envy. Instead of looking at the history, or the technical issues involved, he just blurts out some random impressions: economists make more money than physicists (I cannot make this stuﬀ up); an economist can talk about how much progress physicists are likely to make, and get taken seriously, but not vice versa (ditto); economic theorists, traditionally, have been free from the constraints of empirical validation (note the total innocence of the history of empiricism in economics); and that equilibrium means something diﬀerent in economics than in physics.The level of arrogance combined with parochial ignorance is pretty stunning, but not unusual. He has no conception of the historical track record of the disciplines of economics and physics evolving through time, with earlier points of interaction being masked by later developments, and further waves of strange action at a distance. The result would therefore never appear to contemporaries as strict identity.  
Economists with a tad more sophistication may admit something happened in the 1870s, but they go on to insist that a century and a half of further development has produced a set of doctrines that doesn’t necessarily have anything to do with that heritage. So in a weird sort of way, the more sophisticated modern line is that intellectual origins don’t matter to contemporary doctrines. Your average modern economist thinks history has entirely been banished by the activities of subsequent generations. Actually, I would argue against that; it is more plausible to think that it’s a path-dependent process. Neoclassical economists can’t entirely wish away their origins, and there are a number of times where I try to point that out in the book: for example, the eccentric ways in which the early neoclassicals are totally confused about how to deal with production. Moreover, I think the physics origins really instantiates the central metaphor of a market as if it were a kind of machine that takes stuﬀ from a place it’s not supposed to be and puts it in a place that it deserves to be. That leads to this whole idea of allocation as a special phenomenon, which captures the essence of economics. That’s the way the ﬁrst three generations of neoclassical economists think, in terms of movement in a commodity space. So for them, trade (exchange) is motion in a commodity space. All of these points comprise a deep inheritance of the early appropriation from physics that is really hard to get away from.
A couple of observations here. First, responses that rely on phrases like "I cannot make this stuff up" and "the level of arrogance combined with parochial ignorance", but fail to substantively address the argument in question, are indicative of a degraded discourse. Sputtering disdain is no substitute for an honest attempt to address someone's points. Of course, there's no reason at all that Mirowski should spend time and effort addressing or rebutting my points...but if he's not going to, at least he might consider ignoring my post completely instead of lobbing some sputtering disdain in my direction and moving on!

But anyway. 

Mirowski's work seems to attempt to answer two questions:

1. "How are physics and economics related historically?"

2. "How do current economic methods reflect the legacy of this historical relation?"

But my post was an attempt to answer a different question:

3. "How do economists currently view the discipline of physics?"

Which was related to a fourth question I didn't directly address, namely:

4. "To what extent do economists look to physics for new ideas nowadays?"

Those aren't the same thing. Regarding question 2, it's obvious to anyone who's studied both econ and physics that there are mathematical similarities between the two (e.g. calculus of variations). As for question 1, it's common knowledge that many economists in the past tried to apply physics ideas to econ. So I would never try to dispute those points. For more specifics on exactly how ideas crossed from physics to econ, and on which of those ideas remain to this day, one should probably check out Mirowski's book (though I hope it's written in a different tone than this interview).

But OK, just because economists did get inspiration from physicists in the past doesn't mean they do now. I've never met or heard of a currently working economist who reads physics papers. I'm sure some are out there, but it would seem to be a rarity. In the past, economists probably got lots of inspiration from physics, but I don't think that seems true anymore. Maybe I'm wrong about that, but I don't think so. That still leaves econ models with a legacy of physics influence (as I notice every time I see a Hamiltonian), but the phenomenon of economists looking to physicists for new ideas doesn't seem very pronounced or significant these days.

Now if that's true - and I'm happy to look at any evidence to the contrary - it leads to the question of "Why?" Why would economists draw less inspiration from physics than they used to?

Some reasons might be sociological. That's what my initial post was about. 

First, if economists don't see physicists as having higher status than themselves, they're less likely to look to physics for ideas about how to make models. And my impression is that modern economists, in general, don't see physicists as anyone that they need to emulate or look up to. In my initial post, I cited 1) money, and 2) popular respect as reasons economists probably no longer see physicists as being higher on the academic food chain than themselves.

Second, if economists value different things in their models than physicists do, there will probably be less impetus to emulate physics. In my initial post, I cited 1) empirical predictive power, and 2) symmetry as two things physicists care a lot about and economists value less (though (1) is changing). Econ and physics are just two different epistemic communities

In addition to sociological reasons for economists to take less inspiration from physics than in days of yore, there are also probably methodological reasons. A lot of modern econ theory is based on game theory. Game theory is not very similar to anything in physics - only a few tentative attempts have been made to connect the two, and generally from the physics side. Nash Equilibrium, as Von Neumann pointed out, is not really the same thing as an equilibrium in a physical system. In fact, some people argue that game theory isn't even part of "neoclassical economics," which is the historical strain of thought that Mirowski studies. 

So what does this all have to do with "physics envy"? The term "physics envy" gets tossed around a lot in public discussions of economics. Some people use it to mean that econ just isn't as good at describing reality as physics. Others use it to imply that economists have a pride and confidence in their discipline that only physicists really deserve. Still others use it in a historical sense, to refer to the links that Mirowski and others have written about. And some use it to imply that economists are just failed physicists. 

But I think most people use it as a simple emotive term, a stock phrase that carries an implication of "econ bad, physics good". Obviously most economists would disagree. Some of that is pure chauvinism, of course, but a lot has to do with the diverging methodologies of the two disciplines. And diverging methodologies come partly from sociology, and partly from the fact that these are just two different sciences attempting to answer two different sets of questions.

Monday, October 17, 2016

David Sloan Wilson's econ critique

There's a new website called Evonomics devoted to critiquing the economics discipline. They've got quite a lot of interesting writers and advisors, including (but not limited to) Paul Krugman, Joe Stiglitz, George Akerlof, Robert Shiller, David Colander, Jonathan Haidt, Yanis Varoufakis, David Sloan Wilson, and many more. The site appears to be attracting a ton of traffic - there's a large appetite out there for critiques of economics.

In any case, I noticed David Sloan Wilson is writing a series of posts criticizing econ as a whole, and I thought I'd go through one of them and see what I thought was right, and what I thought was wrong. Wilson can get a little grandiose, likening the econ profession to the orcs of Mordor and himself to Frodo. But let's look past that and talk about the substance. Here are a few points in Wilson's essay that I don't completely agree with.

Economists were very smart, very powerful, and they spoke a language that I didn’t understand. They won Nobel Prizes...Nevertheless, I had faith that evolution could say something important about the regulatory systems that economists preside over, even if I did not yet know the details. After all, financial markets and other regulatory systems are products of cultural evolution, based on psychological processes that evolved by genetic evolution. 
Like I said a while ago, I'm not as confident that evolution is the key to economics. Wilson has spend his career thinking about evolution, and when you have a hammer, everything looks like a nail. But the analogy between cultural evolution and biological evolution is only a loose one -  nobody yet knows how cultural traits get passed on, or even how to define those traits. And there's no guarantee that the principles involved are similar to those that hold in biology. As for genetic evolution being important for economics, that's possible, but I think the overreach of evolutionary psychology - a field that gets criticized as much as econ itself - should give people pause. So I'd be cautious with the cross-disciplinary analogies. But hey, it's surely worth a shot. I don't want to be a naysayer. Give it a try!

Like the land of Mordor, [econ] is dominated by a single theoretical edifice...The edifice is based upon a conception of human nature that is profoundly false, defying the dictates of common sense, before we even get to the more refined dictates of psychology and evolutionary theory. Yet, efforts to move the theory in the direction of common sense are stubbornly resisted.
I'm not so sure I like the emphasis on common sense.. Science usually places a premium on counterintuitive results, and "counterintuitive" is the opposite of "common sense". If common sense was a good guide to reality, scientists wouldn't be nearly so useful, would they? The list of amazing science facts that seem to defy common sense is long - How can matter be both a particle and a wave? Etc. etc.

In econ, common sense might that when two countries trade, one wins and one loses, but the theory of comparative advantage shows that it's very easy for that not to be true. I'm not saying that comparative advantage is always a good theory of trade, but it certainly shows that demanding that all econ theories conform to common sense is overly restrictive.

There is plenty of dissent among economists, and some of the best are working the hardest for change. The folks who award the Nobel Prize in economics don’t like the edifice that much either, and often add their weight by awarding the prize to the contrarians.
The first sentence is definitely true. But I'm not sure Wilson is right about the Nobel a force for rebellion. The Nobel has gone to quite a lot of people whose work forms the very foundation of the "edifice" that Wilson talks about. In fact, the vast majority of the prize winners from the past three decades have worked within the rational, individual-choice framework that Wilson doesn't like. In fact, people like Thomas Sargent, Ed Prescott, and Bob Lucas built the very modern macroeconomics that Wilson recoils at...and they got Nobels for it.

Economists were much more closely attuned to common sense and evolutionary theory before the volcano erupted. Adam Smith observed that people following their narrow concerns somehow combine to make the economy work well, as if guided by an invisible hand. Today we use terms such as emergence and self organization to describe this phenomenon. It is spectacularly demonstrated by social insect colonies.
I also think this isn't really right. Smith was certainly not inspired by modern evolutionary ideas, since On the Origin of Species was published almost a century after The Wealth of Nations. It's not at all clear that Smith believed the "invisible hand" worked analogously to an insect colony; he didn't really specify the mechanism. (Not that insect colony self-organization is a good example of evolution in action, anyway - though ants certainly evolved the biological means to self-organize, the process by which they do so on short time scales is not really very similar to biological evolution in most respects.) In fact, the general equilibrium economics that Wilson doesn't like is supposed to represent Smith's invisible hand.

The people who inhabit the economic models, often referred to as Homo economicus, are driven purely by self-regarding preferences. Mathematically, this means that they care only about maximizing their own interests without reference to anyone else’s interests. What I want cannot depend upon what you want.
Actually, that's not right. When externalities are present, people's utility can depend on other people's consumption. Externalities are very common in mainstream economics, and the concept is taught in every (good) econ undergrad course.

Next, people who inhabit the mathematical kingdom are infinitely wise in pursuit of their self-regarding preferences.
This is, sadly, true. Economists have played around with a number of ways to drop this assumption, but they haven't reached a consensus yet, and - in my opinion - still have far too much trepidation about modeling incompletely-rational behavior.

Once again, these absurd assumptions were driven not by ideological bias but by the tyranny of mathematical tractability. The theory couldn’t be pushed in the direction of common sense because it would become impossible to grind through the equations.
This is partly true. Ideological bias probably does play some part in economists' unwillingness to allow irrationality, or things like social preferences, into their models. Tractability concerns can play a role too. But there's also the underlying problem that it's just very hard to make a general mathematical model of human behavior.

Anyway, I like that Wilson is thinking about economics, and saying provocative, challenging things. There's really very little downside to saying provocative, challenging things, as long as you're not saying them into the ear of a credulous policymaker. At the very least, Wilson will provoke some fun arguments with economists. At best, he'll inspire some to start tinkering around with models based on evolutionary principles. Who knows - that might even get some good results someday!

But in the meantime, I'll keep trying to help nudge Wilson toward an accurate picture of what's going on in the econ world. After all, if you want to be Frodo and sneak into Mordor, you should make sure you have a good map - otherwise you might just end up in New Jersey.


David has a response up at Evonomics. He writes:
What stands out in Noah’s critique of my piece is its complacency. It’s like he’s discussing the arrangement of deck chairs aboard the Titanic. There is no sense of urgency about the failure of orthodox economics theory and the need to place it on a new foundation... 
Noah misses the point when he observes that evolutionary psychology, the study of cultural evolution, and their applications to economics are nascent enterprises. He seems to think that they can be ignored until they have reached some undefined state of maturity. He doesn’t get that when your ship is sinking, you need to build a new ship and move onto it as soon as you possibly can...
I wouldn't say I'm complacent at all. Macroeconomics obviously needs some big changes - the crisis and Great Recession showed that, though it should have been apparent long before. The "boat" of macro definitely has substantial holes in its hull.

OK, so suppose you decide that the boat can't be patched up or repaired, and it's time to abandon ship - to completely change the way we do macroeconomics. How do you know which boat to jump to? If you jump into a non-seaworthy boat, you could be in even bigger trouble than before.

David assumes that evolutionary thinking is a seaworthy boat for macroeconomists to jump into. The basic argument seems to be that evolutionary thinking has been successfully applied in many other areas - or at least, that David has made a career out of claiming that it can be so applied. He writes:
My life’s work gives me a panoramic view of the human-related disciplines such as religion, sociology, the humanities, and the philosophical tradition of pragmatism, to list a small sample. The very fact that I and like-minded colleagues can do this (it is a perspective, not an individual talent) suggests that evolutionary theory has a generality that orthodox economics aspired to and failed to achieve.
Well first of all, just because David has made a bunch of similar claims about how evolutionary thinking can be applied to a bunch of other disciplines doesn't mean those other claims were right. In fact, not knowing much about religion, sociology, or the humanities, I'm not in a position to evaluate them - nor, I suspect, are most of David's readers. But if there's a general consensus that evolutionary thinking has successfully improved and transformed most fields of humanities and social science, I'm not aware of it. I should probably read more.

But more importantly, there's just no reason to think that a conceptual framework that works in one discipline should work in another. Why should ideas that work for religion -- whatever that even means -- also work for economics?? It just doesn't make sense. There's no grand theory-of-theories that tells us that all disciplines and all phenomena must act according to some basic universal underlying principles. Physics methods don't usually work for biology. Why should we think that biology methods work for economics?

Yes, mainstream economic models weren't a lot of help in the crisis or the recession. But how confident can we be that making economic policy based on evolutionary analogies would be any better? Before I believe that, I'll want to see some good hard evidence.

Thursday, October 06, 2016

Freedom of speech in the digital age

















Monday, October 03, 2016

Hunting the Rational Expectations whale

1. Why is Rational Expectations still around, anyway? 

Rational Expectations is (are?) one of the key features of almost every macro model in existence today, and has been for decades. Why? One reason is that it's easy to work with, mathematically - just stick an "E" in front of things, and voila, that's what the agents in your model believe! Another reason is that RE is appealing to folks who think that the government shouldn't be able to trick people consistently. A third reason is that there's just no obvious alternative way of modeling expectations. Classic alternatives like adaptive expectations are rigid, simplistic, and just generally very weak. And more sophisticated alternatives, besides being unwieldy to model, also tend to be hyper-specific - if there are actually a number of different ways that RE fails, each of these models will only catch one of them.

But the real reason is that it's hard to test people's expectations directly. Instead, what macroeconomists do is to just throw the expectations assumption into the model along with a million other things like Euler equations, transversality conditions, industry structure, etc., and then test the model against macro facts. If the model fails to match enough macro facts, or the "right" macro facts, to garner interest, the problem is assumed not to lie with the expectations, but with some other assumption of the model. So RE survives. In Lakatos' jargon, it's part of the "hard core" of modern macro.

2. Observing expectations directly

But in recent years, a few brave souls have started to hunt the great Rational Expectations whale. These intrepid hunters are doing the simple and obvious thing that economists previously didn't dare to do: Just ask people what they expect.

Duh, right? Actually, tons of people have collected and analyzed survey measures of expectations. But there's a reason macroeconomists haven't relied on these surveys much in the past (and it's not just fear of getting yelled at by Bob Lucas). First of all, it's not clear that people's stated expectations have anything to do with their functional expectations. I might say that I think inflation is going to rise, and I might even feel deep in my bones that this is truthy, but does that mean I'm buying TIPS and shorting Treasuries? Not recently, it doesn't. What we care about isn't what people "believe", whatever that means, but what they act as if they believe

So the RE-hunters have to take an extra step - they have to show that stated expectations explain actual behavior. And explaining actual behavior requires assumptions, about all the other stuff that might be affecting behavior. And unless you want to be a "heterodox" person shouting in the wilderness, those assumptions are going to have to come from currently respected theory. So that's what the RE-hunters are now doing - showing that stated expectations, e.g. from surveys, explain behavior well when you stick them into popular theories.

3. The RE-hunters

One of the RE-hunters is Andrei Shleifer, who along with coauthors like Robin Greenwood, Yueran Ma and Nicola Gennaioli has started working with survey expectations in finance. Finance is relatively easy to work with because a lot of the popular models are partial equilibrium. Examples of Shleifer's work include this paper on investor expectations and this paper on CFO surveys and investment. He's also made a general equilibrium asset-pricing model, along with some other co-authors, using extrapolative expectations (which surveys seem to show some evidence for). 

In macro it's a bit harder, since most top people now agree that you need general equilibrium for anything important. So the burden of proof is on the RE-hunters - they have to show that an alternative model of expectations, together with some other fairly standard model elements, can explain macro facts in a general equilibrium type model.

One of the most popular non-RE models is the "sticky information" model of Mankiw and Reis, which says that people update their information with a time lag. Along with Justin Wolfers, Mankiw and Reis showed over a decade ago that survey expectations line up with this model in many ways (though as the comments at the bottom of the paper show, they had difficulty persuading certain folks).

Another popular model is Chris Sims' "rational inattention" model. This says that people only get imperfect information because it's costly to filter out noise. Mike Woodford has also worked with models like this.

4. Coibion and Gorodnichenko

Now there is a powerful new team hunting the Rational Expectations whale: Olivier Coibion and Yuriy Gorodnichenko. In 2012, they showed that survey expectations of macreconomic stuff match many of the predictions of sticky information and noisy information models, using a method that's largely agnostic between the two. In other words, they show that stated expectations look like real expectations no matter which of the two models you believe in.

Then in 2015, Coibion and Gorodnichenko came out with a new paper out that's even more general. Their old approach required them to specify the shocks in the economy, but they figured out a way to avoid having to do this. It's really neat. 

Here's the idea. Forecasters make forecasts of things many years in the future. I might forecast the 2020 inflation rate in 2015. But they also update their forecasts - in 2016 I'll make another forecast of 2020 inflation. In general the 2016 forecast will be different from the 2015 forecast. Under RE, the differerence - called the "forecast update" - should have no relation to the eventual forecast miss. In other words, under RE, if my 2015 forecast for 2020 inflation is 2.5% and my 2016 forecast is 2%, that shouldn't mean that my 2016 forecast is more likely to overshoot than undershoot.

But it does. That's what Coibion and Gorodnichenko show. Forecast updates predict forecast misses. That's consistent with a model where information is "sticky" and one where it's "noisy".

That's the paper's central insight, but it has lots more in it than that. The authors test whether the result could come from forecasters intentionally "smoothing" their forecasts, i.e. giving intentionally stale forecasts in order to cater to some clients. But they don't find evidence for this. 

They also find that the degree of "noisiness" or "stickiness" of information varies depending on what's happening in the economy. After big shocks like 9/11, the amount of apparent stickiness/noisiness goes down. But in the Great Moderation, it went up. So when macroeconomic stuff is more important, people either pay more attention, or spend more effort making accurate projections, or whatever. That reassuring.

So Coibion and Gorodnichenko's new method shows that professional forecasts behave like true expectations for a very wide class of models. Not for all models, obviously, but for two of the mainstream alternatives to RE. And this is independent of all kinds of other things, like consumption behavior, industrial structure, or the nature of the shocks that drive the economy. In other words, it's getting harder and harder to dismiss direct measurements of expectations - maybe you really just can ask people what they believe, and get a useful result!

5. So what?

Interesting note: There are both "behavioral" and "non-behavioral" explanations for this failure of Rational Expectations. Information could be "sticky" or "noisy" because information is costly to acquire and process, or because people are just slow to believe or accept new information. (I call this "Smith's Principle": Any behavioral explanation will have an observationally equivalent explanation based on information structure and/or costs. I can name stuff after myself because this is my blog, hehehe. And because I'm too lazy to find out if anyone else has made this claim.) As the authors point out, it's perfectly possible that a bunch of individually rational but information-constrained agents can produce an aggregate forecast that does not take into account all of the available information in the economy:
This predictability of the average forecast error across agents from forecast revisions is an emergent property in both models, i.e. a property which arises only from the aggregation process and not at the individual level. 
Nice to see economists using the term "emergent property"! In other words, it's perfectly possible to have rational agents without Rational Expectations.

But anyway, if you believe this result, it means two things: 1. that forecasts are good measures of expectations, and that 2. sticky/noisy information should be a much more standard feature of macro models. If on the other hand you disbelieve the result, you must believe that A) forecasts don't represent true expectations, and B) sticky/noisy information models aren't good models, and also C) forecasts fail to reveal true expectations in precisely a way that makes it look like sticky/noisy information models are good!

Now, RE defenders may shrug and say "So what? No one expects RE to be exactly right, it's just a useful approximation." But as Coibion and Gorodnichenko point out, that's not true in this case. Sticky/noisy information models differ in very important ways from RE models. Ways that are very important for policymaking. In other words, by linking their test of RE to a model that we already know has economically significant implications, Coibion and Gorodnichenko's claimed failure of RE must be economically significant too. This isn't just a wrinkle on a largely successful theory; it's a claim that the theory fails in big, critical ways.

Nothing is for certain, especially in macro, but this is another harpoon tossed into the side of the Rational Expectations hypothesis.

(No whales were harmed in the making of this blog post. Noahpinion condemns the practice of whaling, and also believes that whale meat tastes like stale hamachi.)