Box No. 11: PUBLIC GOODS Public goods are a product or service that benefits the whole community. They are not optimally or well distributed by "free markets". This is primarily because they are characterized by: (1) value that has benefits everyone, even those who do not purchase them (i.e. immunizations protect the unimmunized by herd immunity - these are socially desired free riders!), (2) often require large investment costs that are too expensive for any individual or corporation to make by itself and earn a reasonable rate of return, (3) require a higher level of administration than any individual or company can arrange and (4) have value that accrues over time and is difficult to price properly. In the current ideological distortion of economic fundamentals the police, the military, water resources, communication frequencies, among other items are being privatized though at high expense and inefficiently.

Bravo!

Especially the item 10. "Economics" is so concerned about appearing scientific that they exclude anything that cannot be measured reliably. Power cannot be measured reliably. It is easily recognized, but quite unmeasurable.

The result? Economic theory is established in a world without power relationships. Granted there are discussions about what happens when a supplier has power over a purchaser or about the arcane issues in Agency theory, but when it comes time to establish government policies, all such discussions are simply ignored. And they are rightfully ignored because there is nothing really useful there. They simply don't offer compelling ideas.

What happens when economics is applied to government? Government should consist of the organizations and systems that provide goods and services which cannot be properly valued by using market based economic transactions, but are clearly needed. Police and fire services quickly come to mind. The current Republican idiots running Texas government are trying to convert many major highways into toll roads and sell them to investors - one Spanish firm comes to mind - I am sure the governor will get a large consulting fee if that one goes through. The theory is that the investors will provide more efficient services. What in fact they will do is provide dead minimal services they can get away with while charging the maximum revenue allowed by law for the 40-50 year period of the contract and take that money out of state somewhere as profit. It's not like there are any real innovations in running a toll road that can be applied to make it more efficient. The art has been around for centuries, and most of the research has been done by governments to begin with. And since a toll road is automatically a monopoly, there is no economic incentive to improve the system.

But that is the level at which economics is applied to government policy. "Free Market - Private investors - Ugh. Good! Government - Ugh. Bad." Yeah, government is bad for the corrupt idiots who don't what anyone watching as the steal the public blind.

My current bitch with economics is the idea that if you want some service provided better, then you structure a financial reward system that rewards the production of better services. Merit Pay for teaching is an example. It would be great if it could possibly work. Find out what economic inputs and teaching processes provide better education outcomes and reward those who provide the better teaching processes when the students demonstrate that at the end of the year they are better educated than they were at the beginning.

Only - we don't know how to measure successful education outcomes well, especially in a period as short as one year. Even if we did, we don't understand the process well enough to know what education techniques good teachers do better than mediocre ones do. We don't even know for sure what part of the education process is a group process and what part is an individual process. To top it off, we cannot tell what education the students bring with them and what they do on their own.

This means that any "merit pay for teachers" system is going to be administered by either supervisors or by a committee using god only knows what for criteria. That means that if if teachers are "Economic Men" and want to maximized their personal income, then their focus needs to be on gaming the system of determining merit pay, rather than on teaching students above a bare minimum level so as to not appear incompetent. Don't educate - teach to the test. Get poor students to drop out, then shift them to other accounting systems so that they don't count against you. Need I describe all the ways No child Left Behind has failed? [Schools used to provide patronage jobs is an entirely different issue, and again is one that cannot be solved by using Economic theory.]

I don't have my thoughts on economics formed into neat little boxes yet as you have, but I do know that economics as a system of thought is merely that - a system of thought that often provides a surprising insight into measurable human behavior, but it is far from the imaginary solution to all things social and group-based. Since it does not measure power, it almost invariably screws up in political situations.

Max has reached that place where only a red roadster can prevent spontaneous immolation -- probably, a Miata.

Excellent, Max.

Thanks Bloke. I took out most of the acronyms.

Not to razz you too much, but I think that a large problem with economics as a whole, is that a lot of the time it tries to describe emotional, cultural and social behavior through raw numbers. Which just doesn't work. In all of your cases, this is really is what is happening.

Economics can be useful to try and predict various results. Sort of like being an economic weatherman, per se. The problem is that the variables at play are so complex and almost unpredictable at a micro level, to render the prediction unreliable.

I guess what I'm saying is that economics needs to be taken out of the sciences, and put into the humanities, so to speak. This will probably require a complete reboot of the entire field..which is probably a good thing..

I don't think economics can be considered a true science, either. Statements of the obvious (supply and demand) aren't the same as fundemental "laws" of nature (E=mc squared). Saying that economic, or any other kind of, decisions fundementally are rational always assumes there is something called "rationality" that exists outside individual beliefs, fantasies, needs and obssessions.
Economics should be shifted back to the "by guess and by God" catagory.

Exactly. My short-form version of this is "economics is sociology that thinks it's physics."

Gross Domestic Product (GDP). Add up all the quantities in the supply and demand models over the year ("final goods and services") and you get GDP.

Huh? To think that all along I thought the GDP was the total market value of all the goods and services produced within the borders of a nation during a specified period.

Actually, it's pollution that's the distortion in the market place because it is a cost assumed by society in benefit of the polluter. Environmental regulations correct this.

Apropos a liberal blog, how is the enabling foundation of law and courts, weights and measures, certification of purity, etc., factored into economic equations?

Economies aren't even possible absent orderly society, at least somewhere in the world.

Not quite, Ad. GDP does not include intermediate goods used to produce other goods in the nation and time period in question, since that would be double counting.

In my opinion, there are few if any natural laws of economics and those that perhaps once existed melted away when man left the hunter-gather stage of his evolution and moved onto farms and into villages and cities. Further the geometric progression of technology in the past 300 years has also played hob with the existence of natural laws in economics.

Current establishment orientated economics appears to be the creation of the ruling managerial/ownership class in order to justify, by providing iron clad talking points (laws,) that small subset’s usual and far too large slice of the pie. Even the jargon of economic theory sometimes appears to be a device designed to force a period of study, at the hands of an Economics establishment, on those interested economic policy where those with opinions differing from that establishment’s opinions can be weeded out of a rather elite club. See it our way and we’ll allow you to join the club…the furnishings and opportunities are nice.

True, GDP is a straightforward arithmetic calculation unencumbered by abstract "supply and demand models."

Most economics affirms that some foundation of government to enforce contracts etc. is necessary for capitalism to function. So that's at least one thing I can't complain about.

But do they want to pay for it? Do they assign a value to it or only say some amount (unspecified) is necessary? Which economists argue in favor of more of it?

"The entire traditional macro apparatus fails to allow for the interventions of large foreign lenders who aren't dumb enough to believe what the textbooks say."

Savicky is completely wrong about this. It is a well established part of open economy macroeconomics that the higher the degree of interntional capital (funds) mobility, the less the effect of government deficits in increasing interest rates and the greater the effect of deficits in increasing the deficit in the trade balance. In the liminting case of an economy too small to have a significant effect on world interest rates with perfect capital mobility, deficits have no effect on the interest rate at all and only increase the deficit in the trade balance.
I suggest that he inform himself of this by reading chapter 5 in Mankiw's intermediate Macroeconomics test, including the appendix on the large open economy.

"Power looms over economic transactions, except in economic theory. Workers do not hire capitalists."

Sawicky is right on about this one. One of the central features of the New Classical Economics, in both the monetary and real business cycle versions is that cyclical unemployment is caused by the unemployed workers choosing leisure. This proposition blindly ignores the fact that the increased unemployment during a recession is not caused by workers voluntarily quitting their jobs and choosing to remain unemployed but, rather, by being told by their employers that they are no longer needed even though they would have been perfectly willing and even eager to keep working at the wages they were being offered.

It would have been very instructive for some of the new classical economists to go to Flint, Michigan during the Bush I recession and explain to the unemployed auto workers that the reason that they were unemployed was because they were choosing leisure. They would have gotten some teeth knocked out and some ribs broken, but they would have learned a lot more about how economies function during recessions than they were learning from their ivory tower theories.

Whether something is a science or not does not rest on how good the predictions are. It is all about how the questions are asked regarding any unknown phenomenon.

As I argued above, physicists have an easier to study subject than economists do. Relatively speaking, of course.

Take a social science research methods course and you will learn what true science is all about. It starts with description, goes to hypotheses, proves or disproves them, refines the questions and recycles. The consistent and reliable predictions are sometimes thrown off of that process, but they merely indicate that science has taken place. They are not themselves what science is.

True science is about how the questions are asked and what is done to answer those questions.

[I once had a letter to the editor on the subject published in "Analog," and they garbled it horribly in printing it. Here I have a chance to control for that.]

Max:

Attacking neo-classical economics is just too easy! A few of points of my own:
1] they unabashedly say they don't care about the creation of wealth, their system is only supposed to be about the allocation of wealth;
2] the theory of the firm has come a long way since the 1930's and no one really thinks firms maximize profits;
3] economics, contrary to the supposition of some of the posts here, cannot predict anything: it's their dirtiest secret that their models fail completely to predict the economy with any precision;
4] the neo-classical agenda is to defend something they call "the market" which they see as some abstraction, but which they cannot define because to do so would introduce real live human beings rather than the automatons that inhabit their models;
5] neo-classicism is so riven through with nonsensical assumptions that they are embarrassed to defend them in public: rational expectations, perfect information, etc are so absurd as to be ridiculous. When they do defend themselves they can only offer up the weak notion that all their effort has given them "some useful insights" into the way the economy works.
6] So divorced from the real world is the orthodox system that pretty much anything we come across in reality is regarded as a "market failure" i.e. it is deficient, and inefficient, with respect to the theory. No other science regards the real world as a "failure" instead they actually seek to explain it!

In short the whole neo-classical enterprise has taken the study of economics down an ideologically conceived dead end. This wouldn't matter except that they have duped politicians of both parties into thinking that economics is a serious science on a par with physics etc. It is not. Nor can it be until the choke hold of neo-classicism is broken. One example: if market allocation is so superior to the alternative, generically known as central planning, why is it that all the firms I know manage themselves using planning rather than market forces? Clearly the market is not "best" for a vast array of transactions.

One final point: two weeks ago the Supreme Court held that companies can restrict the discounting of their products. This represents a clear introduction of a market inefficiency from the orthodox point of view: surely markets [if they are as wonderful as we are led to believe] should be allowed to discount. I would have thought the neo-classical crowd would be up in arms attacking the Court's finding. But no. One of the groups siding with big business were the infamous economists from Chicago, the epicenter of orthodoxy! Their argument was that by allowing prices to be fixed at higher levels we would encourage and protect firms who innovate thus increasing our choices and increasing long run competition. It's amusing that they never seem to apply price rigging to labor costs. A higher minimum wage would surely have the same effect in the labor markets as price fixing in the product markets has.

Let's admit it: economics professors do not study or teach anything about the economy; they study and teach about their own hermetically sealed right wing utopian system.

We should build an alternative while ignoring and de-funding the neo-classicists.

'All Life is Problem Solving'

"I guess what I'm saying is that economics needs to be taken out of the sciences, and put into the humanities, so to speak. This will probably require a complete reboot of the entire field..which is probably a good thing.."

NO, NO, NO!!!

The problem with economics is that ideology plays much too much of a role, and that there is too little science. While economics can never achieve the level of accuracy of the physical sciences, it can and should be make much more scientific.

The first step: No published empirical result, no matter how carefully the researh has been conducted, should be accepted as established until it has been independently reproduced by other researchers working independently.

"Their argument was that by allowing prices to be fixed at higher levels we would encourage and protect firms who innovate thus increasing our choices and increasing long run competition."

The implications of this assertion have not been fully realized. This argument is simply invalid in a perfectly competitive economy where there is freedom of entry and exit and firms sell undifferentiated goods. But a case for it (not neccessarily a valie one) can be made in an economy that consists of differentiated oligopolies. This is a tacit admission by the Chicagoans that real world market economies are not approximations of perfectly competitive market systems, but, rather, are differentiated oligopolistic systems.

Traditionally the Chicago school had argued that while actual market economies were not pricesely like the perfectly competitive model, they were close enough approximations thereof, so that the results predicted by the theory of perfect competion could be applied to them. If they are dominantly differentiated oligopolies, this argument no longer holds.

The government functions of providing essential infrastructure are paid for out of taxes, of course. They are the public equivalent of overhead to a private organization.

Don't let the Libertarian and Republican free-marketers fool you. They either ignore the costs of the social overhead of the economy, or they try to shift those costs from themselves to someone less able to avoid paying those costs.

When the social costs of the SEC and auditing standards are not paid then the financial markets collapse. That was what led to Enron and WorldCom. The super-smart guys realized that no one else avoiding paying the costs of good audits, but they could get away with it. All they had to do was convince Congress that they did not need such "leashes." And they did. Sen. Phil Gramm as head of the Banking Committee did a good job of removing financial controls on business, and his wife Wendy working at the SEC rewrote the regs so that Enron was not covered. She then went on Enron's Board of Directors when she left the SEC.

The failed infrastructure of decent auditing led to the growth and then failure of Enron in particular. Instead of the taxpayers paying, the costs were shifted to the stockholders, the employees, and the electric rate-payers, particularly in California. [I am less personally knowledgeable about Worldcom and the earlier Sunbeam cases.]

I expect to see the reintegration of the old Baby Bells to result in similar costs. I just don't know when or who will actually pay those costs.

This was political economics in action, and while the accounting industry still discusses it, Economists rarely do. Nor, to my knowledge, do Political Scientists or Policy people.

Broadband should be a free economic infrastructure item as it is in countries like South Korea. The economy will be less robust with the reintegrated AT&T in control. But the guy with the power to control the business today sets the rules, preventing entrepreneurs from growing up and creating new businesses here in the U.S. If those potential entrepreneurs could afford lobbyists, then they would already be rich and would also be fighting to prevent changes in the economy that destroyed the value of their sunk costs. Today's wealthy hate Schumpeters' creative destruction in the economy. That's why there are so many super conservative millionaires (usually the ones who inherited the fortune, not the one who created it.) They are the ones financing the conservative "think" tanks - to protect their fortunes and status.

And those forecasts, to have any chance of success, have to ignore the basic tenets of orthodox economics. Any prediction made on the basis of text book economics has little or no value: are the people who you proffer as examples using the text book, or are they using some other system/technique they find useful? Besides, as you know full well, any addition of information will reduce the uncertainty of planning in business which is an inherently risky proposition. So paying for forecasts and gathering as much advice as you can makes sense even if the forecaster is using some personal "know how" they happened to have picked up along the way. To turn your point around: if economics was as successful as it claims to be why don't all businesses employ economists to forecast for them? If the value was obvious they surely would.

Why does the head of the Federal Reserve Board, who teaches orthodoxy, ever have to guess at anything? Why can't he predict accurately what rates are going to be? The theory he teaches states unequivocally that I, let alone he, know, what those rates will be: it is an essential part of the theory that everyone knows everything. Take away rational choice and perfect information etc and the theory erodes to nothing more than a few "insights" very quickly. I don't have a problem with that erosion: it might open the door to new and better theorizing. When physicists theorize about gravity they seek more than a few insights, they seek to explain and predict in the real world. Orthodox economics does neither.

Businesses employ far fewer economists than they used to for precisely my reason: economics, at its heart, is not about the real economy, it is about some hypothetical one where real people don't live. People like you who probably don't know exactly what your preferences will be ten years from now.

I do not undervalue those insights, but to dignify them as a successful theory is foolish and misleading. It is unethical for economists to represent that they have more than a few insights: real people are affected by the application of economist's theories. It would be nice to think that those theories were in contact with reality.

'All Life is Problem Solving'

"The theory he teaches states unequivocally that I, let alone he, know, what those rates will be."

This is incorrect. The theory allows for errors due to events occurring after one's expectations hhave been formed.

But nevertheless, the dominance of the theory of "rational" expectations as the established theory of expectations formation is the most serious handicap in current macroeconomics. It ignores the fact that the gathering of information and the evaluation of its economic implications can be very expensive, so expensive that most people are rationally ignorant of the things "rational" expectations assumes they know.
For macroeconomics to make real progress in becoming truly scientific, this defective theory of expectations formations has to be replaced.

We desperately need some balance here. Hopefully Krugman of DeLong will chime in as they have in the past.

Captain:Thank you. Allow me to correct myself: this thread is predominantly about orthodox theory. I agree that the entire economics profession includes all sorts of other people with a variety of other ideas: the Post-Autistic Economics web site is evidence of that. The problem is that they do not get much coverage, and they certainly do not influence public policy. Max started us off by attacking orthodoxy: with that restriction my comment stands.

Perhaps you know: how many heterodox economists are there in [say] the top ten economics faculties? And do the undergraduate classes at those schools teach anything other than orthodoxy? For example: is transaction cost economics [mentioned by someone else above, and hardly radical] part of a core curriculum? How about evolutionary economics? Marxist economics? Feminist economics? I agree that economics is a diverse subject, just not in the standard texts, most schools, and in public policy.

And besides, last I looked, the economy, the one we actually live in, is defined by its imperfections and asymmetries, by it unknowns and its variety. Teaching economics should surely begin with that empirical background. Thus my point: economists as long as they begin with perfection are not talking about the economy. Let me repeat: this does not decry the insights they have picked up along the way, it just means they don't have a theory sufficient to anchor public policy in the way they often represent.

I do not want to imply that all economists are "ideologues": but I do believe that if they teach orthodoxy they are perpetuating a very weak theory in the guise of a stronger truth. That is unethical. There is nothing wrong with saying we just don't have a good theory, but that we are working on it. That is not what most economists do: they seem to argue that they have "the answer". I just don't think they do. I suppose my larger point is that if economists want to influence public policy they had better be right in their theorizing: they owe it to society. I wouldn't want to go to a doctor who only had a few insights into health, I would want something a little more robust.

Finally: I have yet to read any op-ed articles by mainstream economists decrying the Supreme Court decision I mentioned above. Perhaps I missed them.

'All Life is Problem Solving'

Captain: I believe it was Lord Robbins back in the 1930's who wrote that economics was the study of the allocation of scarce resources. His paper helped define the move by the subject into a strictly allocative arena. What else is general equilibrium theory? What else is a Pareto Optimum, than an allocation according to some arbitrary, a priori, assumption? General equilibrium theory is exactly an allocation system and it still is the core of economic theorizing. In orthodoxy, other things like growth and wealth creation are shoe-horned in to defend the core.

Absolutely Robert Lucas and many others "think about them". How kind of them! It's the theory we are discussing not their personal thoughts.

And forgive my ignorance. I don't think we should be throwing personal brickbats at each other. I take it you care deeply about economics as I do. The subject is profoundly important: this thread is an example of that!

'All Life is Problem Solving'

Captain: Precisely and well put. The problem is that efficiency is itself an elusive topic. The argument I have with you is that you seem to believe that economics has resolved what "efficiency " is. I don't. For instance is efficiency really rooted in rational choice theory as general equilibrium theory would have us believe? Or is rationality bounded by our inability to see and understand everything? If the latter then orthodox theory is flawed and doesn't give us the answers you argue it does.

It is not as simple as orthodoxy preaches.

'All Life is Problem Solving'

My objection was with the assertion that economics is ONLY concered with the allocation of wealth.

Theorists like Lucas not only think about the creation of wealth, but there is a tremendous amount of research going on in the area of growth theory, which deals with this topic.

A large part of macroeconomics deals with business cycles and the theory of employment and unemployment, which, except in the case of real business cycle theory, is not fundamentally concerned with the allocation of wealth.

When people make statements that I think are patently ignorant, I say so. No apologies.

All you say strikes me as accurate excepting the ...may have inherent laws.... At least you said may...

:-)

I'm not opposed to the study of Economics, I just believe it is a liberal art, all be it an important art, not a science. And like the product of any art, economic theory and its application shines in the eye of the beholder and the affected...or not.

"BTW how can there be an "error" in my expectations after the event? Surely they were my expectations as best I knew at the time?"

The error is that the outcome is different than what one expected and made one's economic decisions on.

A truly rational theory of expectations formation using the rational behavior criteria in orthox economic theory would be based on the proposition that people will allocate additional resources to the collection of information and the evaluation of its economic implications as long as the expected additional return (marginal expected benefit) is greater than the additional cost (marginal cost) of gathering and evaluating this information. At the point at which these are equal the process would stop and no additional information would be collected and evaluated. If the collection and evaluation of economic information is expensive, and there are good resons for believing that it would often be, people would not collect and evaluate this information because it would be inefficient to do so and be rationally ignorant of it. Therefore using orthodox economic theory one can demonstrate that the orthodox theory of "rational" expectations is not, in general, valid, although it MAY be in some highly organized markets.

There is a humorous story about a Hindu economist explaining reincarnation to his class.

"If you are a good, and virtuous, economist, you will be reincarnated as a physicist."

"If you are and bad and evil economist, you will be reincarnated as a sociologist."

This is a discussion of the social networking philosophy of economists.
Yes?
The parallels seem pretty clear.

My accusation of ignorance was not directed at you, but, rather, at the original message I was criticising. It is also directed at some of Sawicky's posings. I find your posts to be intelligent and challenging.

"It is, however auxiliary, because the core remains allocative."

The core of microeconomics is and needs to be allocative. In a fundamental way growth theory must also be about allocation, since it tracks the implications over time of the division of current output between current consumption and the production of goods that will increase consumption in the future.

"I suspect it has to be that way since to talk about wealth generation substantively introduces subject matter that orthodoxy would prefer to avoid in order to remain "positive"."

But theories about economic growth include discussions about the "golden rule level of capital."

" The unnatural rate of unemployment. Economists used to say it was 6.0, maybe 5.5 percent. Lower would give rise to ruinous inflation. The huge social benefits of another couple of percentage points less unemployment were -- are -- implicitly discounted. Current rate is 4.5. 'Nuff said."

Are you really this ignorant or are you dishonestly trying to mislead your readers. It is a well known fact that the "natural" rate of unemployment is not a natural constant, but can change over time, for example, if the structure of the labor market changes. It is well known that it has, in fact changed over time. (O.K. natural rate of unemployment is a misleading term. That is a valid criticism.) The natural rate of unemployment steadily rose from the end of WWII until the 1980s and has since decreased again. Pushing the unemployment rate below 6% in the 1980s would have caused accelerating inflation.

=== It is a well known fact that the "natural" rate of unemployment is not a natural constant, but can change over time, for example, if the structure of the labor market changes. ===

Captain: I totally agree with you here. But in my mind it highlights the challenge economics faces: it seems callous, to put it mildly, to talk of a "natural rate of unemployment" considering the human cost associated with the lack of a job; but the system clearly needs some slack so as to avoid a breakdown. Economics needs some serious PR!

The issue that Max seems to be driving at is the relentless response by orthodox economists that "the market" is better at softening the social cost than government intervention is. It makes economics as a whole, rather than the orthodox only, seem unconcerned with the individual even though their theory is based upon rational individuals. Most regular folks would like their community/government to help ameliorate the burden of unemployment and that implies intervention in the market.

I just don't see how you can separate economics from broader social theory at that point.

'All Life is Problem Solving'

Of course an open economy model is going to do what you say, or anything else you want.

Meanwhile, in actual policy debates the reigning 'model' is IS/LM where foreigners are paralyzed. In other words, we forget about foreigners and lament that an increase in the budget deficit will push up interest rates.

Again, it's the distinction between the practical impact of simple models on one hand, v. the endless sophistication of more advanced theory.

I was talking about 'Radek,' not you, pacr.

O Captain, my Captain -- a changing natural rate is just unnatural. 1980 coming after the oil conniptions I think gives you too easy an argument. The better juncture would be Greenspan in the 90s. How much worse off would we have been if he had listened to Martin Feldstein and subscribed to a NUR?

I've had more than one English teacher flat out tell me that a reading interpretation was wrong. Yet, go to another English teacher and they will accept my conclusion. The weird thing, both of them can be right, even if their results are mutually exclusive.

Economics is the same. One economist sees a pattern of results and comes to one conclusion. Another economist looks at the exact same results and comes to a different conclusion. Again, both of them can be right, even if their results are mutually exclusive.

Contrast that to a physics. One physicist sees a set of results and comes to one conclusion. Take it to another physicist and they'll see the came conclusion. You'd have to take it to a thousand physicists before you get some disagreement. Even then, someone is wrong because there can only be one result that actually happened, not two.

Economics may be a step above the liberal arts in that they at least attempt to apply the scientific method. But, economics isn't much beyond an art.