Agnes Crane writes in today's Wall Street Journal about how blogs by economists are making good economic insights more widely available. Nice mention of yours truly, along with many members of the blogroll. Enjoy!
Category: economists
Score Two for the Home Team
From today's Wall Street Journal, the President makes two excellent selections:
Bush to Appoint TwoTo Economic Council
By a WALL STREET JOURNAL Staff Reporter
July 27, 2005; Page A4WASHINGTON -- President Bush plans to appoint two Dartmouth College economists to the White House Council of Economic Advisers, people familiar with the matter said.
The nominations of Katherine Baicker and Matthew Slaughter are expected this summer, these people said. Ms. Baicker, Mr. Slaughter and a White House spokeswoman all declined to comment.
Ms. Baicker, 34 years old, has been on the Dartmouth faculty since 1998 and served on the council's staff during President Bush's first term. She specializes in health economics and fiscal relations between the federal and state governments.
Mr. Slaughter, 36, has been a business professor at Dartmouth since 2002, specializing in globalization and the behavior of multinational firms. [Ed. Slaughter has been at Dartmouth since 1994, first in the economics department and then, since 2002, at the Tuck School of Business.]
The Council of Economic Advisers advises the White House on a range of economic topics. Ms. Baicker and Mr. Slaughter are to fill spots vacated by Harvey Rosen of Princeton University and Kristin Forbes of the Massachusetts Institute of Technology. The council's only member currently is chairman Ben Bernanke.
Globalization and health care--just the expertise the CEA will need for the next two years. Best of luck to both of them.
Skills Beget Skill
Following the advice of Arnold Kling and Don Boudreaux, I spend a good chunk of time--very productively--reading this interview with Jim Heckman in the Minneapolis Fed's The Region. Harkening back to some earlier posts about Freakonomics and what's right and what's wrong with the economics profession, these paragraphs resonated with me:
We tell stories in nursery school, such as the story of the tortoise and the hare and the story of the little train that could. I read these to my kids, and they were read to me. All these folk tales, all these pieces of wisdom, the fact that a mother's love matters and all this stuff, we tend to dismiss them in our formal models of education policy. We economists like to write down specific technologies and make things very precise. That's a useful discipline, and that's what I am doing with various coauthors. We are making this subject precise. But sometimes I have my doubts. Some of what economists do is to explain to fellow economists what most intelligent people already know. A lot of what economists do is explain to themselves what the rest of the world already knows. There's a real risk of being caught up in that.
However, it's important for policy purposes to make ideas precise, to try to understand which interventions are the effective ones. So I don't think our research is just putting simple ideas into the terminology that economists like. I think there is scientific merit in what we are doing. In fact, I've found that in response to some of the papers we have written, where we write about the critical and sensitive periods of child development, and we use the economists' technologies to explain these ideas, the neuroscientists get very excited. I've had several prominent psychologists coming up to thank me at professional meetings of psychologists for helping them to organize their way of thinking about their life's work. Economics can be very powerful in taking ideas, organizing them in the forms of technology, intervention and basic causal factors. That's why I feel there's a lot for economists to do in this area. But there's also a lot to listen to as well.
Big ideas and good scholarship should cross the conventional disciplinary boundaries. On the substance of the economic issues that Heckman is discussing, I think his views about the importance of noncognitive abilities in generating economic outcomes and the interactions between genetic and environmental factors are fascinating and will grow in importance as more research is done. Here is an insightful part of the Q&A about job training programs:
Region: Is job training effective in any form? Are there any types of programs that do work?
Heckman: Most job training is actually being done in private companies, not in the public sector. And who is more likely to get private job training? People who have higher cognitive and oncognitive skills—the same abilities that helped them get the job in the first place. These people earn high returns to private job training.
Region: So, it's a selection issue.
Heckman: Yes, it's a selection issue. It's a consequence of the dynamics of skill formation that we talked about earlier—that skill begets skill. Public training programs are aimed at the bottom of the barrel, at people who've been put out of schools, or maybe they've been given high school degrees through social promotion but can barely read or write. And the typical, short-term job training program tries to remedy lifetime deficits in a few months. They are based on the hope that society can solve 17, 18 years of neglect of a child with a short-term program that can transform people who have grown up in extreme disadvantage.The dynamics of human skill formation are such that high levels of skills acquired early in life make it relatively easy to acquire later skills; they put the child in a position to benefit from later interventions. It's the self-productivity idea we discussed earlier. There's a growth trajectory, and people with different early conditions start to diverge in their development. Those who receive skills early on are more likely to get jobs and enhance those skills through private job training. Those who don't get those early skills are unlikely to benefit much from short-term public training programs later on.
Enjoy the whole thing.
In Praise of Gene Steuerle
Suppose we just got rid of this thorny democratic process of reforming Social Security and appointed one person to handle the job. My nominee for the position of "Social Security Czar" is Gene Steuerle of the Urban Institute. To see why, follow this link (via Arnold Kling) to his recent testimony before the House Ways and Means Committee. Can we exhume the Voxy for Congressional testimony? Let's just call it an instant classic.
He starts as follows:
The Social Security debate could and should be part of a larger one in which we engage our fellow citizens in choosing the best direction for society as a whole as better things happen to us in the way of longer lives and new health care goods and services. How can we really take best advantage of these new opportunities? How can we spread the gains from this increased level of well-being and wealth to create a stronger nation with opportunity for all? And how should we share the costs?
Instead, the debate is upside down. Due to the ways we have designed our programs and our budgets, every year we spend greater shares of our national income in areas where needs have declined, and then claim we don’t have enough left over for areas—such as education, public safety, children, and anti-terrorism—where real needs remain and have often grown. I sometimes imagine sitting in the Ways and Means Committee room when someone from the National Institutes of Health comes in claiming to have found a cure, though expensive, for cancer. The members of committee, trapped in the logic of our current budget, find that instead of celebrating this advance, they commiserate among themselves about the increased cost for Social Security.
As a member of the baby boom generation, I remember youthful conversations among my cohort, regardless of political persuasion, that centered on what type of government we could help create to best serve society. As now scheduled, our legacy is to bequeath a government whose almost sole purpose is to finance our own consumption in retirement. Not only haven’t we come close to paying for the government transfers we are scheduled to receive, but we plan to pay for them by dwindling almost to oblivion the rest of government that would serve our children and grandchildren.
Yes, it does seem to be a question of priorities. He finishes his introductory remarks with:
Social Security is only part of this problem, but it is an important part for four reasons:
- It sets the standard for how long we should work and who covers the costs
associated with our longer lives and the new medical care we receive;- There are many inequities and inefficiencies in Social Security that are
independent of its size;- By default (in absence of new legislation), Social Security is designed to absorb ever-larger shares of our national income, thereby squeezing out other programs, particularly discretionary expenditures, that are not treated equally in the budget process.
- A number of related employee benefit reforms would likely increase private saving, enhance the well-being of low- and average-income workers in retirement, and improve the solvency of Social Security.
He addresses each of these in turn, and makes the following recommendations (with my numbering):
- Increase the early and normal retirement ages so that at any given tax rate, the system provides fewer subsidies for middle-age retirement and increased revenues, higher annual benefits in retirement, higher lifetime benefits, and a greater portion of resources to those who are truly old.
- Backload benefits more to older ages, such as the last 12 years of life expectancy, so as to progressively increase benefits in later ages when they are needed more and to increase labor force incentives for individuals still in late-middle age, as defined by life expectancy.
- Provide a well-designed minimum benefit to help low-income households and groups with less education and lower life expectancies, while simultaneously reducing poverty rates (relative to living standards or wages) among the elderly.
- Determine family benefits for middle- and upper-income individuals in an actuarially neutral manner by applying private pension standards, making sure that benefits are shared equitably, and reducing or removing significant discrimination against single heads of household, many abandoned spouses, two-earner couples, many divorced persons, those who marry others close to their own age, some who pay significant marriage penalties for remarrying, and those who bear children earlier in life.
- Provide a minimum benefit that extends to spouses and divorced persons as well as workers to provide additional protections for groups that are particularly vulnerable, and as an alternative to free and poorly targeted transfers to higher-income households.
- Count all years of work history, providing an additional work incentive and removing the discrimination against those who work longer.
- Ensure responsible budgetary policy by changing the default rules to guarantee the system automatically moves toward balance—say, through adjustments in the retirement ages or the rate of growth of benefits for higher-income households—whenever the Social Security trustees repeatedly report a likely long-run deficit.
- Reduce the tax gaming used with retirement plans when taxpayers simultaneously report interest deductions while deferring or excluding interest and other retirement plan income from taxation.
- Provide additional incentive for plans that do a better job at providing a portable benefit for all workers, such as using the FICA tax exclusion to finance increased deposits to retirement accounts and guaranteeing all workers in a qualified plan a minimum level of portable benefits.
- Make clearer in the law that employers can use opt-out, not just opt-in, methods of encouraging retirement plan participation—without threat of lawsuit.
- Focus retirement plan incentives more on lower-wage workers, for instance, through an increase in a modified savers credit, which should be adjusted so that it is available for employer, as well as employee, contributions and so that the credit is deposited in retirement accounts.
- Provide safe harbors from lawsuits for designated types of retirement and other benefit plans offered by employers who hire or retain older workers.
- Restore the earnings base for Social Security by increasing the portion of cash wages subject to Social Security tax, capping the tax-free levels of health insurance that can be provided, and dealing with tax preferences for other employee benefits.
Numbers 1 - 7 & 13 deal explicitly with Social Security. Some of them are quite similar to ideas I have expressed in various forms in earlier posts. In brief: raise retirement ages, raise the maximum taxable earnings level, remove disincentives to current work, rationalize the spousal and minimum benefits, and put future solvency on autopilot through modest changes triggered by deterioration in the system's long-term health.
Numbers 8 - 12 deal with changes to private pension plans. With the ongoing growth in defined contribution plans relative to defined benefit plans, it is becoming less clear to me that employers need to be so fundamentally involved in pension plan design. So setting up a universal, lifetime savings account for each person (to which employers could contribute if they want to and with default options that encourage at least modest saving rates) may be the way to go.
Freakonomics on Crooked Timber
The crew at Crooked Timber has cooked up something really interesting on Freakonomics. Five of them review it and then give Steve Levitt a chance to respond. They call it--quite appropriately--a seminar. Read the whole thing. For my part, there were two key lessons.
First, Levitt gives an interesting characterization of his research style:
The only things I’m good at, really and honestly, are asking questions that people seem to find interesting, and figuring out how to trick data into answering those questions. I will never be even a passable sociologist, political scientist, or psychologist. But that is okay. I think the thing that gets a lot of economists into trouble is the false belief that they can be good at everything.
That has been true ever since his undergraduate thesis. Later in that paragraph, he continues:
But, by starting from the position that I don’t know much, I am open-minded enough to co-author with an ethnographer (Sudhir Venkatesh), an econometrician (Jack Porter), a political scientist (Tim Groseclose), and now a journalist (Stephen Dubner). And maybe, in addition to making it safe for someone to publish a book without in a theme in the future, I will make it easier for academics from all social sciences to follow the sort of “adisciplinary” (as opposed to inter-disciplinary) path I’m on.
Adisciplinary--I like that.
Second, in one of the commentaries, Henry Farrell refers to my earlier post on Freakonomics:
Andrew Samwick argues that Levitt represents a continuation of this tradition (for Samwick, Levitt is a sort of Becker on steroids).
Good characterization, though I'd be the last to say Levitt is doping. He then adds some insight as to where I came up short, by trying to push my Chicago-School analogy too hard:
Now this is an interesting characterization of Levitt, and as Samwick argues, Levitt is clearly influenced by the earlier generation of the Chicago school. Still, Samwick is wrong in some very important ways. Levitt, unlike Friedman or Becker, seems to be primarily driven by the specific research question and by the data rather than by the desire to see everything through the lens of economics. When the question and the data point in the direction of interactions that can be modeled using optimization and equilibria, this is where Levitt goes. Thus, his work on cheating among Sumo wrestlers, and (my personal favourite, which isn’t mentioned in Freakonomics) on mixed strategies in football penalty kicks. However, much of Levitt’s work on other topics, including what is perhaps his most widely read article (the piece on abortion and crime rates in future generations) appears to have nothing to do with the economic approach, in either Becker’s formulation or Samwick’s slightly pared-down version of same. Neither equilibria nor optimization come into his story. One can go further – Levitt’s work on choice over names for babies supports a set of assertions that go against the economic model as Becker and Samwick describe it.
Fair enough. With the storage and processing capabilities of modern computing, it is now possible to learn quite a bit more from simple (or not-so-simple) data analysis than in generations past. Among social scientists, I think it is fair to say that economists jumped out to an early lead in using those quantitative methods in their research. Much of my own field of public economics (at least as it is practiced in the U.S.) is now entirely data driven. That doesn't necessarily make it uninteresting--it just means that one can be a leading economist while relying less on core economic theory than in an earlier era. So, perhaps in a reflection of his times, Levitt can also be an economist (albeit an adisciplinary one) who can occasionally take a break from testing a theory of incentives and just ask interesting questions of data.
We should also bear in mind that it may be a bit too early to draw firm conclusions: we don't know if Levitt will settle down into a couple of key areas, like Becker or Friedman, or if the next generation of Chicago School economists will resemble the old school any more than Levitt does.
Continuing with Freakonomics
The comments to my first two posts about Freakonomics provide some interesting discussion. (The thread was continued as well at Stumbling and Mumbling, under Bold, True, or Trivial.) My assertion was that economics is about exactly two ideas--optimization and equilibrium.
I still maintain that this is the right way to think about what economics introduces to any given situation that may be underappreciated by other social science disciplines. This is the context in which Freakonomics is making its contribution. But I shouldn't put words in the authors' mouths on this. Here is their take, in excerpts from the book (p. 13 -14):
Economics is above all a science of measurement. It comprises an extraordinarily powerful and flexible set of tools that can reliably assess a thicket of information to determine the effect of any one factor, or even the whole effect. That's what "the economy" is, after all: a thicket of information about jobs and real estate and banking and investment. But the tools of economics can be just as easily applied to subjects that are more--well, more interesting.
This book, then, has been written from a very specific worldview, based on a few fundamental ideas:
- Incentives are the cornerstone of modern life. ...
- The conventional wisdom is often wrong. ...
- Dramatic effects often have distant, even subtle, causes. ...
- "Experts"--from criminologists to real-estate agents--use their informational advantage to serve their own agenda. ...
- Knowing what to measure and how to measure it makes a complicated world much less so. ...
These are not incompatible with "optimization and equilibrium," but they are much more focused on measurement than frameworks. (That's what makes Levitt such an interesting innovation in the Chicago School.) And the comment by Max, and several good comments by rjw, were about what economics professors would teach their students or others trying to learn the field. They bristled at the notion that I would list "tools" as the essence of the field. I confess, I do tell this to my students in the first meeting of each term, but then I proceed to show them many applications of these tools that are successful to varying degrees.
In fact, the first topic we address in my finance seminar is embodied in these two papers:
Shleifer, Andrei and Lawrence H. Summers, “The Noise Trader Approach to Finance,” Journal of Economic Perspectives, Vol. 4, No. 2 (Spring 1990): 19-33.
De Long, J. Bradford, Andrei Shleifer, Lawrence H. Summers, and Robert J. Waldmann, “Noise Trader Risk in Financial Markets,” Journal of Political Economy, Vol. 98, No. 4 (August 1990): 703-738. (optional)
I teach these papers because the noise trader model represents a thoughtful use of these tools--both optimization and equilibrium. In the mid- to late-1980s, the finance profession had two camps--noise is incidental, and noise is fundamental. In a nutshell, this paper finds a principled middle ground by adding just two reasonable assumptions--that arbitrage is limited (and therefore risky) and that some investors are influenced by sentiment (which is correlated across investors). The end result is a model in which noise traders can survive in a market, despite their tendency to buy high and sell low. There was now a way to model noise as having an impact on financial markets without having to characterize those markets as completely uninterpretable. That innovation has been fundamental to the science of finance over the subsequent 15 years.
We would be remiss as a profession if we did not teach the tools, and it doesn't seem to me to be unnatural that both Freakonomics and my post on it characterize economics by its main tools of analysis (though we differ in the way we have specified those tools). But, as the commenters have pointed out, we would be equally remiss if we suggested (which I did not) that a pre-occupation with technique was the key to success in the profession more broadly. That rests in the thoughtful use of those tools and the ability to see their relevance in a broad range of environments. Ultimately, its ability to do that will determine the success of Freakonomics.
Books and Freakonomics
On Thursday morning, I happened to catch Messrs. Levitt and Dubner on the Today Show discussing Freakonomics. I did a double take at the discussion of this excerpt about what contributes to high test scores for children (p. 172 in the book):
Matters: The child has many books in his home.
Doesn't: The child's parents read to him every day.
So I interrupted the world's most enjoyable 15 minute walk to work with a stop at the new and improved campus bookstore (thank you Barnes and Noble!) to pick up my copy. I read the relevant chapter over some chai.
On the show, they didn't really get to explain why having the books matters while reading them doesn't, which might lead one to believe that spending money on a home library that wasn't used would be a good idea. In the book, the authors' provide a theory--that having books in the home is an indicator for parents who are themselves smart and transmit this genetically or who value education (and instill this in many ways that are more critical than reading the actual books). They do explain the difference between causality and correlation, in this and many other instances.
But what is a parent to do in light of this? What exactly is prescriptive about the finding? The book has a Calvinist thread running through it. How do I know whether buying the book would be useful--maybe I'm the type of person who should have books in his home, because I am smart or I value education--but how do I know? I'll buy the books, just in case, to show that I am predetermined to have high-scoring kids ...
As with linear regression on the Daily Show earlier, the TV roadshow isn't allowing some of the broad points of econometrics to come through. Add the difference between causality and correlation to the things we economists need to be able to explain in just a couple of quick sentences, for a TV audience. I'll take your suggestions in the comments section.
Freakonomics
Steve Levitt appeared on The Daily Show with Jon Stewart on Comedy Central last evening to discuss his new book, Freakonomics (buy
Steve is the next generation of the "Chicago School" of economics, in which the basic price theory of economics is inserted into every social environment imaginable. The original generation--Friedman, Becker, and Stigler--focused on what are by now traditional areas like education, the family, and the law. But I'd wager that even the founders of the School would have to admit that Steve's ability to see the economics in unusual situations is without equal, past or present. The next generation also comes armed with modern computing power and thus a much greater ability to analyze data in support of their claims. I will soon get my copy of Freakonomics and enjoy my chance to read it.
What does it mean to "see the economics" in a given situation? Economics consists of exactly two ideas: optimization and equilibrium. Optimization is the process by which all economic agents--households, workers, firms, governments--achieve their objectives subject to constraints on their resources. It leads to the familiar condition that an activity is undertaken until its marginal reward equals its marginal cost. Equilibrium is the process by which the competing efforts to optimize by these agents form a stable arrangement. An equilibrium is defined by relative prices, and those prices typically form the basis of either the marginal reward or the marginal cost in the individual agents' optimization processes. So "seeing the economics" means figuring out what is driving the optimization and equilibrium in a given context. As I often tell my students, if you cannot see the optimization and the equilibrium in what I am saying, then I am not talking about economics.
Here are the book's chapters, from the Freakonomics website, showing where the authors are looking for optimization and equilibrium:
- Chapter 1: What Do Schoolteachers and Sumo Wrestlers Have in Common?
In which we explore the beauty of incentives, as well as their dark side-cheating. - Chapter 2: How Is the Ku Klux Klan Like a Group of Real-Estate Agents?
In which it is argued that nothing is more powerful than information, especially when its power is abused. - Chapter 3: Why Do Drug Dealers Still Live with Their Moms?
In which the conventional wisdom is often found to be a web of fabrication, self-interest, and convenience. - Chapter 4: Where Have All the Criminals Gone?
In which the facts of crime are sorted out from the fictions. - Chapter 5: What Makes a Perfect Parent?
In which we ask, from a variety of angles, a pressing question: do parents really matter? - Chapter 6: Would a Roshanda by Any Other Name Smell as Sweet?
In which we weigh the importance of a parent's first official act-naming the baby.
On The Daily Show, Jon Stewart thought Chapter 4, in which the book supports a hypothesis that the reduction in crime in the late 1990s was attributable to fewer "unwanted" children in the wake of Roe v. Wade entering their prime criminal years, was the most interesting. He then asked Steve how he "controlled" for other factors that might affect the crime rate, like the number of police. Steve then tried to give an answer based on multiple regression (which he did in an excerpt from the book, shown here). That's got to be a first for late night television.
Ben Bernanke To Be CEA Chairman
From today's White House personnel announcement:
The President intends to nominate Ben S. Bernanke, of New Jersey, to be a Member of the Council of Economic Advisers. Upon confirmation, the President will also designate him Chairman. Dr. Bernanke currently serves on the Federal Reserve System's Board of Governors. In addition, he also serves as Professor of Economics and Public Affairs at Princeton University, a position he has held for twenty years. Dr. Bernanke previously taught at Stanford University, New York University, and Massachusetts Institute of Technology. He earned his bachelor's degree from Harvard University and his Ph.D. from Massachusetts Institute of Technology.
Bernanke is an excellent choice and I wish him the best.
Maybe the Best Econoblog Yet
Nouriel Roubini and David Altig spar today in what I think is the best WSJ Econoblog yet. The topic: Does Overseas Appetite for Bonds Put the U.S. Economy at Risk?
It's a funny question as a lead-in. Generally, when some other country has an "appetite" for something (like U.S. government bonds) that we make, we are not at risk but richer for it. There are some relative price shifts that have distributional consequences (like making U.S. exports relatively more expensive compared to foreign imports), but on the whole, the country is richer. For a variety of reasons, Asian central banks have been willing to not only hold U.S. debt but (via undervalued exchange rates) pay too much for it. At least initially, it's their problem, not ours.
So the real question, and the one that Nouriel and David seek to answer, is whether a potential loss in overseas appetites for U.S. government bonds will put the U.S. economy at risk. I think they both agree that the answer is affirmative, but they disagree on the magnitude and timing of the adjustments. Nouriel is arguing for big adjustments on a possibly sudden time scale (the hard landing), and David is arguing for more gradual adjustments (the soft landing). They come at the issue from every conceivable angle, and so I recommend it (as well as both of their blogs, linked at the right). The discussion is extensively documented.
Where am I on the issue? I've been a fan of Nouriel's for (ahem) 17 years, since he was a TA at Harvard in an undergraduate international macro class that I took, but I tend to agree with David that it is difficult to see the U.S. in a hard landing scenario. We're too big an economy, and our creditors' portfolio holdings are simply too large for them to behave rashly. Unfortunately, that perception that we may be immune from a hard landing has encouraged behavior--over a period of decades, in both the private and public sectors--that makes us a high-borrowing, high-consuming economy. In my view, it is our low national savings rate that puts us at risk, not the propensities of our creditors per se.