Tag Archives: Economics

Evidence for Tribalism in Economics

While economists like to pretend otherwise, humans are social animals.
By Blair Fix – The ideal of science is beautifully summarized by the motto of the Royal Society: nullius in verba. It means ‘take nobody’s word for it’. In science, there is no authority. There are no gods, no kings, and no masters. Only evidence.

In this post, I reflect on how ‘taking nobody’s word for it’ cuts against some of our deepest instincts as humans. As social animals, we have evolved to trust members of our group. Among these group members, our instinct is to ‘take their word for it’. I call this the ‘tribal instinct’.

When we do science, we have to fight against this tribal instinct. Not surprisingly, we often fail. Rational skepticism gets overpowered by the instinct to trust members of our group. If the group happens to be powerful — say it dominates academia in a particular discipline — then false ideas get entrenched as ‘facts’.

This is a problem in all areas of science. But it’s a rampant problem in economics. The teaching of economics is dominated by the neoclassical sect, which has managed to entrench itself in academia. Among this sect, I believe, tribal instincts trump the rational appeal to evidence. more>

Updates from McKinsey

Climate risk and response: Physical hazards and socioeconomic impacts
By Jonathan Woetzel, Dickon Pinner, Hamid Samandari, Hauke Engel, Mekala Krishnan, Brodie Boland, and Carter Powis – After more than 10,000 years of relative stability—the full span of human civilization—the Earth’s climate is changing. As average temperatures rise, climate science finds that acute hazards such as heat waves and floods grow in frequency and severity, and chronic hazards, such as drought and rising sea levels, intensify.

In this report, we focus on understanding the nature and extent of physical risk from a changing climate over the next one to three decades, exploring physical risk as it is the basis of both transition and liability risks.

We estimate inherent physical risk, absent adaptation and mitigation, to dimension the magnitude of the challenge and highlight the case for action. Climate science makes extensive use of scenarios ranging from lower (Representative Concentration Pathway 2.6) to higher (RCP 8.5) CO2 concentrations. We have chosen to focus on RCP 8.5, because the higher-emission scenario it portrays enables us to assess physical risk in the absence of further decarbonization.

In this report, we link climate models with economic projections to examine nine cases that illustrate exposure to climate change extremes and proximity to physical thresholds. A separate geospatial assessment examines six indicators to assess potential socioeconomic impact in 105 countries. We also provide decision makers with a new framework and methodology to estimate risks in their own specific context.

We find that physical risk from a changing climate is already present and growing. Seven characteristics stand out. Physical climate risk is:

Increasing: In each of our nine cases, the level of physical climate risk increases by 2030 and further by 2050. Across our cases, we find increases in socioeconomic impact of between roughly two and 20 times by 2050 versus today’s levels. We also find physical climate risks are increasing across our global country analysis even as some countries find some benefits (such as expected increase in agricultural yields in countries such as Canada).

Spatial: Climate hazards manifest locally. The direct impacts of physical climate risk thus need to be understood in the context of a geographically defined area. There are variations between countries and within countries. more>

Productivity Does Not Explain Wages

As long as we believe the neoclassical farce, we will know nothing about what causes prices.
By Blair Fix – Let’s start with the evidence trumpeted as proof that productivity explains wages. Looking across firms, we find that sales per worker correlates with average wages. Figure 1 shows this correlation for about 50,000 US firms over the years 1950 to 2015.

Mainstream economists take this correlation as evidence that productivity explains wages. Sales, they say, measure firms’ output. So sales per worker indicates firms’ labor productivity. Thus the evidence in Figure 1 indicates that productivity explains (much of) workers’ income. Case closed.

Yes, sales per worker correlates with average wages. No one disputes this fact. What I dispute is that this correlation says anything about productivity. The problem is simple. Sales per worker doesn’t measure productivity.

To understand the problem, let’s do some basic accounting. A firm’s sales equal the unit price of the firm’s product times the quantity of this product:

Sales = Unit Price × Unit Quantity

Dividing both sides by the number of workers gives:

Sales per Worker = Unit Price × Unit Quantity per Worker

Let’s unpack this equation. The ‘unit quantity per worker’ measures labor productivity. It tells us the firm’s output per worker. For instance, a farm might grow 10 tons of potatoes per worker. If another farm grows 15 tons of potatoes per worker, it unambiguously produces more potatoes per worker (assuming the potatoes are the same).

The problem with using sales to measure productivity is that prices get in the way. Imagine that two farms, Old McDonald’s and Spuds-R-Us, both produce 10 tons of potatoes per worker. Next, imagine that Old McDonald’s sells their potatoes for $100 per ton. Spuds-R-Us, however, sells their potatoes for $200 per ton. The result is that Spuds-R-Us has double the sales per worker as Old McDonald’s. When we equate sales with productivity, it appears that workers at Spuds-R-Us are twice as productive as workers at Old McDonald’s. But they’re not. We’ve been fooled by prices.

The solution to this problem seems simple. Rather than use sales to measure output, we should measure a firm’s output directly. Count up what the firm produces, and that’s its output. Problem solved.

So why don’t economists measure output directly? Because the restrictions needed to do so are severe. In fact, they’re so severe that they’re almost never met in the real world. more>

There is No Economics without Politics

Every economic model is built on political assumptions
By Anat Admati – There is absolutely no way to understand events before, during, and since the financial crisis of 2007-2009 while ignoring the powerful political forces that have shaped them. Yet, remarkably, much of the economics and finance literature about financial crises focuses on studying unspecified “shocks” to a system that it largely accepts as inevitable while ignoring critical governance frictions and failures. Removing blind spots would offer economists and other academics rich opportunities to leverage their expertise to benefit society.

The history of financial economics is revealing in this regard. By the second half of the 20th century, when modern finance emerged as part of economics, the holistic approach of early thinkers such as Adam Smith—which combined economics, moral philosophy, and politics—was long gone. Narrow social-science disciplines replaced the holistic approach by the end of the 19th century. In the 20th century, economists sought to make economics formal, precise, and elegant, similar to Newton’s 17th-century physics.

The focus in much of economics, particularly in finance, is on markets. Even when economists postulate a “social planner” and discuss policy, they rarely consider how this social planner gets to know what is needed or the process by which policy decisions are made and implemented. Collective action and politics are messy. Neat and elegant models are more fun and easier to market to editors and colleagues.

Lobbyists, who engage in “marketing” ideas to policymakers and to the public, are actually influential. They know how to work the system and can dismiss, take out of context, misquote, misuse, or promote research as needed. If policymakers or the public are unable or unwilling to evaluate the claims people make, lobbyists and others can create confusion and promote misleading narratives if it benefits them. In the real political economy, good ideas and worthy research can fail to gain traction while bad ideas and flawed research can succeed and have an impact.

Having observed governance and policy failures in banking, I realized that the focus on shareholder-manager conflicts is far too narrow and often misses the most important problems. We must also worry about the governance of the institutions that create and enforce the rules for all. How power structures and information asymmetries play out within and between institutions in the private and public sectors is critical. more>

How ergodicity reimagines economics for the benefit of us all

By Mark Buchanan – The principles of economics form the intellectual atmosphere in which most political discussion takes place. Its prevailing ideas are often invoked to justify the organization of modern society, and the positions enjoyed by the most wealthy and powerful. Any threat to these ideas could also be an implicit threat to that power – and to the people who possess it. Their response might be brutal.

In the real world, through the pages of scientific journals, in blog posts and in spirited Twitter exchanges, the set of ideas now called ‘Ergodicity Economics’ is overturning a fundamental concept at the heart of economics, with radical implications for the way we approach uncertainty and cooperation. The economics group at LML is attempting to redevelop economic theory from scratch, starting with the axiom that individuals optimize what happens to them over time, not what happens to them on average in a collection of parallel worlds.

The new concept is a key theme of research initiated by Peters about a decade ago, and developed with the collaboration of Gell-Mann and the late Ken Arrow at SFI, and of Alex Adamou, Yonatan Berman and many others at the LML. Much of this view rests on a careful critique of a model of human decisionmaking known as expected utility theory.

But there is one odd feature in this framework of expectations – it essentially eliminates time. Yet anyone who faces risky situations over time needs to handle those risks well, on average, over time, with one thing happening after the next. The seductive genius of the concept of probability is that it removes this historical aspect by imagining the world splitting with specific probabilities into parallel universes, one thing happening in each.

The expected value doesn’t come from an average calculated over time, but from one calculated over the different possible outcomes considered outside of time. In doing so, it simplifies the problem – but actually solves a problem that is fundamentally different from the real problem of acting wisely through time in an uncertain world. more>

Updates from Chicago Booth

Why banning plastic bags doesn’t work as intended
Benefits of bag regulations are mitigated by changes in consumer behavior
By Rebecca Stropoli – As well-intentioned bans on plastic shopping bags roll out across the United States, there’s an unintended consequence that policy makers should take into account. It turns out that when shoppers stop receiving free bags from supermarkets and other retailers, they make up for it by buying more plastic trash bags, significantly reducing the environmental effectiveness of bag bans by substituting one form of plastic film for another, according to University of Sydney’s Rebecca L. C. Taylor.

Economists call this phenomenon “leakage”—when partial regulation of a product results in increased consumption of unregulated goods, Taylor writes. But her research focusing on the rollout of bag bans across 139 California cities and counties from 2007 to 2015 puts a figure on the leakage and develops an estimate for how much consumers already reuse those flimsy plastic shopping bags.

This is a live issue. After all those localities banned disposable bags, California outlawed them statewide, in 2016. In April 2019, New York became the second US state to impose a broad ban on single-use plastic bags. Since 2007, more than 240 local governments in the US have enacted similar policies.

She finds that the bag bans reduced the use of disposable shopping bags by 40 million pounds a year. But purchases of trash bags increased by almost 12 million pounds annually, offsetting about 29 percent of the benefit, her model demonstrates. Sales of small trash bags jumped 120 percent, of medium bags, 64 percent, and of tall kitchen garbage bags, 6 percent. Moreover, use of paper bags rose by more than 80 million pounds, or 652 million sacks, she finds. more>

Related>

Why economics must go digital

By Diane Coyle – One of the biggest concerns about today’s tech giants is their market power. At least outside China, Google, Facebook, and Amazon dominate online search, social media, and online retail, respectively. And yet economists have largely failed to address these concerns in a coherent way. To help governments and regulators as they struggle to address this market concentration, we must make economics itself more relevant to the digital age.

Digital markets often become highly concentrated, with one dominant firm, because larger players enjoy significant returns to scale. For example, digital platforms incur large upfront development costs but benefit from low marginal costs once the software is written. They gain from network effects, whereby the more users a platform has, the more all users benefit. And data generation plays a self-reinforcing role: more data improves the service, which brings in more users, which generates more data.

To put it bluntly, a digital platform is either large or dead.

As several recent reports (including one to which I contributed) have pointed out, the digital economy poses a problem for competition policy.

Competition is vital for boosting productivity and long-term growth because it drives out inefficient producers and stimulates innovation. Yet how can this happen when there are such dominant players?

Today’s digital behemoths provide services that people want: one recent study estimated that consumers value online search alone at a level equivalent to about half of US median income.

Economists, therefore, need to update their toolkit. Rather than assessing likely short-term trends in specific digital markets, they need to be able to estimate the potential long-term costs implied by the inability of a new rival with better technology or service to unseat the incumbent platform.

This is no easy task because there is no standard methodology for estimating uncertain, non-linear futures. Economists even disagree on how to measure static consumer valuations of free digital goods such as online search and social media.

And although the idea that competition operates dynamically through firms entering and exiting the market dates back at least to Joseph Schumpeter, the standard approach is still to look at competition among similar companies producing similar goods at a point in time. more>

Too much theory leads economists to bad predictions

By Peter A Coclanis – In economics, as a result, both economic history and (especially) the history of economic thought withered for a generation or two.

So what accounts for the recent change of course? For starters, there was the Great Recession – or ‘Lesser Depression’, as Krugman called it in 2011 – which seemed to a few influential economists such as Ben Bernanke, Carmen Rinehart, Ken Rogoff and Barry Eichengreen similar in many ways to other financial crises in the past. But there were other factors too, including the general retreat from globalisation, and the renascence of both nationalist and authoritarian movements around the world, which sounded the death knell for Fukuyama’s benign new world.

As ‘history’ returned, so too has a degree of acceptance of historical approaches among social scientists, who sense, however vaguely, that though history might not repeat itself, it often rhymes, as Mark Twain (might have) put it.

Thinking historically, of course, entails both temporal and contextual dimensions and, in addition, often requires a significant amount of empirical work. Indeed, finding, assembling, analysing and drawing accurate conclusions from the bodies of evidence that historians call data is not for the weak of heart or, more to the point, for those short of time.

So, bottom line: economic forecasters would profit from thinking a bit more about history before gazing into their crystal balls, or at least before telling us what they see. more>

We need to rethink our economic assumptions

By Isabel V. Sawhill – To defeat Trump in the upcoming election, Democrats are advancing a set of proposals engineered to excite their base: a single payer health system, college for all, a guaranteed jobs program.

All are worthy of debate but perhaps the problems go deeper. Perhaps they go to the core of our beliefs about how the world works, what makes the economy tick, and how this relates to human welfare.

The dominant paradigm right now is what is sometimes called Neoliberalism which I define as a belief in the efficiency of markets. Those on the left believe that a market economy needs more than a little help from government. There are social costs and benefits that markets ignore; economic downturns are not self-correcting; and a lack of competition or transparency can harm consumers.

By addressing these and other shortcomings, government can free the market to do what it does best. Still, the central belief is that markets are the most efficient way to organize a society and by extension optimize individual freedom.

Critics of this paradigm note that it is fundamentally flawed. Human beings are not just consumers, they don’t always behave rationally, and they don’t always maximize their own well-being. They need a sense of community, they care about the welfare of others, and their sense of what matters goes well beyond a larger GDP. They respond not just to economic incentives but to the desire for respect from their peers, to social norms, and to moral or religious principles.

There is an efficient allocation of resources to go with every possible allocation of dollar votes and the distribution of dollar votes should be a communal decision arrived at by democratic means.

At the core of the neoliberal theory – arguably its most influential precept — is the idea that people are paid what they are worth.

If incomes are unequal it’s because skills and talents are unequal. The rich deserve their riches because, for the most part, they earned them. The poor lack income because they have too little education or the other skills needed to get ahead.

There is a lot that’s ignored in the wages equal marginal productivity equation: the asymmetry of bargaining power, the difficulty of discerning who contributes what, the stickiness of established wage norms and employment relationships, and the lack of competition. more>

What Happens When You Believe in Ayn Rand and Modern Economic Theory

The reality of unfettered self-interest
By Denise Cummins – “Ayn Rand is my hero,” yet another student tells me during office hours. “Her writings freed me. They taught me to rely on no one but myself.”

As I look at the freshly scrubbed and very young face across my desk, I find myself wondering why Rand’s popularity among the young continues to grow.

The core of Rand’s philosophy — which also constitutes the overarching theme of her novels — is that unfettered self-interest is good and altruism is destructive. This, she believed, is the ultimate expression of human nature, the guiding principle by which one ought to live one’s life. In “Capitalism: The Unknown Ideal,” Rand put it this way:

Collectivism is the tribal premise of primordial savages who, unable to conceive of individual rights, believed that the tribe is a supreme, omnipotent ruler, that it owns the lives of its members and may sacrifice them whenever it pleases.

By this logic, religious and political controls that hinder individuals from pursuing self-interest should be removed.

The fly in the ointment of Rand’s philosophical “objectivism” is the plain fact that humans have a tendency to cooperate and to look out for each other, as noted by many anthropologists who study hunter-gatherers. These “prosocial tendencies” were problematic for Rand, because such behavior obviously mitigates against “natural” self-interest and therefore should not exist. more>