Has big business "captured" the economics profession?

The idea of regulatory capture is a good one, and it’s the principal explanation that academic economists offer for why regulators often — as a rule, in fact — don’t act as firm and wholly independent judges of those they’re meant to regulate. Whether they’re working to make manufacturers meet safety standards, or banks avoid undue risks, regulators rarely act as stern overseers, and often end up softening regulations to appease industry desires. It’s not generally because they’re incompetent or corrupt (although that’s sometimes true). Regulators are human beings, and hold opinions which can be influenced by others. They happen to interact mostly with those they regulate, and so end up getting influenced by the regulated — not surprisingly, in ways that favor those parties.

For example, regulators need information to do their jobs, and cooperation with those they regulate is a good way — probably the best way, and almost certainly the easiest — to get it. They try to get along with those they regulate, and that implies some give and take, some understanding and sympathy. Moreover, as regulators needn’t always remain regulators, prospects for later employment also play a role. A while back, my Bloomberg Views colleague Megan McArdle summarized the natural logic of regulatory capture. It’s not really surprising at all (although it may be surprising that we don’t do more to at least try to avoid it).

Economists are rightly proud of this analysis. It’s an example where thinking carefully about ordinary human behavior, as people do their best to meet their goals and get along with one another, goes a long way to explaining an important phenomenon. However, I suspect that economists may be less happy , possibly even a little alarmed, with the direction in which one of their tribe — Luigi Zingales of the University of Chicago — suggests the analysis ought to be extended.

What about economists themselves? Are they the free authors of their ideas, or are they, like regulators, significantly influenced in their thinking by their interactions with business interests? Zingales suggests the latter — and argues that we should, therefore, consider economists’ views with considerable skepticism. Overall, he concludes, the profession and its publications most likely display a significant pro-business and pro-markets bias, because many economists are captured.

Read the whole thing at Medium.com.

Slow steaming is still dreaming -- a response to Paul Krugman

I've just published a response to Paul Krugman's criticism of my recent Bloomberg article on limits to growth. It's over at Medium.com in the new collection Bull Market. I don't think Krugman's arguments carried a lot of weight, as you'll see. First paragraphs below....

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A few days ago I wrote a column in Bloomberg exploring some ideas about possible physical (and biological/ecological) limits to economic growth. I pointed out that total global energy consumption continues to grow even as we learn to use energy ever more efficiently. And I suggested — based on empirical data from the recent past — that there’s little reason to believe, as many economists quite confidently do, that our energy use will soon “decouple” from economic expansion, enabling us to fly off into a future of unlimited betterment through increasing economic output, even as we come to use less and less energy. I also examined a few reasons why continuing to use ever more energy is a certain path to ever worsening ecological problems; it’s really not a wise option.

Economist and prolific New York Times columnist Paul Krugman was irritated, even exasperated, and fired off an “acerbic rebuttal” (to use Noah Smith’s elegant description). He was aggravated that I, as a physicist, was weighing in on topics he thinks should be left to economists. He also suggested that I was just recycling an old argument originally put forth by other physical scientists, which his fellow economist William Nordhaus had completely demolished long ago. Now Krugman had to rise up to do it again! How tiring!

But Krugman’s actual argument was surprisingly weak, and I think grossly misleading, so here’s an attempt to bring a little more clarity to the discussion. I do think Krugman is a brilliant columnist, and I agree with him on lots of things, maybe even most things. But he very much has the wrong end of the stick on this one.      Read more here.

Economic numerology

A few days ago, Paul Krugman made reference in one of his columns to some data compiled by the US Energy Information Administration on trends in energy use over the past few decades. The data touch on the question of how much energy different nations use to generate $1 of GDP. Are we getting more or less efficient in our use of energy? The numbers, as Krugman argued, show we’re generally getting more efficient. Below I’ve listed the numbers for US energy usage from the year’s 2001 through 2011, in sequential order, from left to right, separated by commas, the units being BTUs per dollar of GDP:

8,482.307, 8,459.179, 8,274.763, 8,178.463, 7,944.349, 7,688.294, 7,671.837, 7,543.901, 7,414.716, 7,503.361, 7,328.424

So you see, the amount of energy used to generate each bit of GDP is going down. Same is generally true for other nations. Fair enough. I’m not going to question that.

But isn’t there something fishy about these numbers? The energy units are BTUs, and the final entry says we used precisely 7,328.424 BTUs per dollar of GDP in 2011. There are 7 specific digits reported in this number, implying that we know our energy/GDP figure to an accuracy of 1 part in 10 million. It’s incredibly impressive. Think about that “.424" at the end. It’s not “.425" or “.423" but exactly “.424".

Is this at all meaningful? Of course not. It’s ridiculous. Unfortunately, this kind of illusory accuracy infects economics and finance quite widely. It may not be the most important issue in the world — even writing about it makes me feel like a grumpy old man — but we’d all think more clearly if we paid more attention to the numbers. So, what’s wrong here?    Read the rest in the new collection Bull Market at Medium.com

Political polarization -- now WORSE THAN EVER!!!!

I do think the above image captures a truth. But I'm also not convinced that the forces driving politics from the Democratic side are all that much better. Anyway, I have a new thing up at Medium.com on political polarization and how it is worse now than ever, according to voting patterns in congress:

Political polarization and gridlock. It’s worse that ever, or at least it seems that way. In fact, it is worse than it has been for 65 years. That’s the conclusion of a recent study by researchers who looked at the history of political polarization in the US since 1949, as judged by congressional voting records. The study found that cooperation between members of different parties is now lacking more than ever before. Things were actually a lot better back in the Nixon era, even during the most divisive days of the Vietnam War and Watergate, when a President and Vice President were forced to resign, and even in the aftermath of the assassinations of Martin Luther King Jr. and Robert F. Kennedy.

The whole (short) thing is here.
 

Is the Internet messing up our economies?

I just published a short essay reviewing the amazing book Who Owns the Future? by Jaron Lanier. It is published as part of a new business collection over at Medium.com, where I'll be writing with a number of other business and finance writers. First two paragraphs below. I really encourage everyone to buy and read this book. It's changed my entire perspective on the Internet and how it is affecting our economic lives:

Imagine that someone told you that three of the biggest stories of the past few years — the financial crisis, exploding economic inequality, and the National Security Agency spy scandal — weren’t actually different stories at all. Different in detail, yes, but essentially identical in their deeper cause. The cause, they go on to say, wasn’t greed or fear or the age of terrorism or anything else linked to human fallibility, but technology — specifically, computation and its networked manifestation, the Internet. Sound crazy?

Well, it doesn’t if you hear out Jaron Lanier’s full argument. Lanier is a Silicon Valley guru and one of the pioneers of virtual reality technology; he’s helped build today’s technological reality and is anything but a Luddite about technology and its potential for helping people. But he does think the Internet has gone off the rails, that we’re developing it in the wrong way, benefiting technology more than people, and by design driving our economies into the swamp. I’ve come a little late to Lanier’s book of last year — Who Owns the Future? — but I think it’s one of the most important things I’ve read in a decade.

Read the whole thing here.

How to build roads without destroying the Earth

And one more from Bloomberg:

The human race faces a huge quandary: The economic growth required to support increasing living standards around the globe will, if we continue with current practices, inevitably put the planet under extreme and unsustainable stress. The case of road construction shows how the process might be managed -- and how difficult it will be to do so.

Global population and economic activity won’t keep growing as they have since the Industrial Revolution. If they did, the ever-accelerating path would lead to absurd infinities somewhere around 2050 or 2060. Growth will hit natural limits well before then: We'll either destroy our environment, or we'll learn to act very differently. As the late computer visionary James Martin wrote in his book "The Meaning of the 21st Century," what's needed is a revolution in skills and means for managing the consequences of our explosive technological growth so people can keep improving their well-being while also preserving the planet.

Consider the relatively simple challenge of building roads. Humans have already laid some 30 million miles of roadways and are on course to build about 20 million miles more by 2050, a 60 percent increase in 40 years. Almost all will be built in developing nations and regions of huge biodiversity. New routes are today penetrating many of the world’s most precious surviving wildernesses, including the Amazon, New Guinea, Siberia and the Congo Basin.

This activity is a perfectly understandable response to human needs. Industry is seeking valuable resources such as timber or oil, farmers are clearing new land for crops, governments are trying to make transportation and trade easier. Unfortunately, there's far too little coordinated effort to reduce the environmental impact. As a result, wildlife habitats will suffer huge losses and ecosystems will be destroyed, ultimately undermining Earth's capacity to support human life as well.

New research by a group of environmental scientists suggests that better coordination could go a long way toward avoiding this disaster. The key is that vast tracts of settled land, where ecological damage is already significant and probably irreversible, still aren't very productive. Better access to fertilizers and modern farming technologies would greatly boost the productivity of such areas, thereby reducing the need for development in more sensitive areas.

The researchers have produced a global map showing places on Earth where new roads or road upgrades could have big human benefits, and others where little benefit would be expected despite large environmental costs. If countries worked together, such information could be used to guide road building over the coming decades, helping to preserve the fragile biosphere without compromising beneficial economic growth.

Such a global zoning plan would allow building to take place in an intelligent way. Inevitably, of course, it would also mean that some local interests would have to give way to global demands. Governments, individuals and firms would sometimes be constrained by the needs of the greater whole. That's what coordination implies, and it's what we need if we're going to preserve our world and still boost agriculture to meet the global demand for food, which will likely double by 2050.

Will it happen? The prognosis is not good. Politicians are too focused on the next election -- and often too corrupt or beholden to local economic interests -- to think globally and for the long term. For many conservatives and libertarians, any step toward even minimal global governance seems to produce near hysteria, even when it's obviously beneficial. Markets aren’t likely to help much, either: Research has shown that they're not good at reflecting the costs and benefits of events that might happen 10 or more years in the future. Humans are naturally inclined toward inaction in the face of great uncertainty.

The challenge is the same for handling the biggest looming problems of global growth such as climate change and water supply. Instead of turning inward and closing off, humans need to cooperate and coordinate on an unprecedented scale. In essence, we're in a race to learn fast enough to avert our own demise. If we want to win, we'll have to change strategy soon.

Economics beyond shocks??

Place a lit cigarette in an ashtray in a closed room where the air is perfectly still. As everyone knows, the smoke will rise, but not in a simple regular flow; the rising flow is unstable, begins to wobble, and then breaks out into a tangled mess -- turbulence. You don't need any outside cause or shock to the rising smoke to make it happen.

Economies do highly irregular things too, as a rule, going through repeated booms and busts, and yet economists seem quite hesitant to see such fluctuations as the result of similar natural instability. In recent decades, at least, they seem to have greatly preferred the idea that fluctuations around average growth must be caused by "shocks" to the economy of some kind. Noah Smith recently gave a nice summary of  the Real Business Cycle theory of Kydland and Prescott, which Prescott and colleagues are still pushing today:

Here’s how recessions work. Sometimes, scientists and engineers invent less new stuff than normal. Fewer new inventions this year mean fewer new inventions next year, too. Anticipating this, companies invest less, and they also cut workers' wages. When wages go down, workers decide to take a vacation instead of work. Voila -- a recession!

Actually, I’m kidding. I don’t think this is how recessions work at all. But the theory I just described is a real macroeconomic theory. It came out in 1982, and its name is the Real Business Cycle model. In 2004, its creators, Edward Prescott and Finn Kydland, won a Nobel Prize for their work. The theory inspired a generation of researchers, and became the dominant theory in certain places, such as the University of Minnesota.

You might be forgiven for thinking that Real Business Cycle theory, or RBC for short, doesn’t deserve its moniker. Just as the Holy Roman Empire was none of the above, RBC theory doesn’t seem to have much to do with business or cycles, and for that matter doesn’t sound particularly real. Most people think that recessions are caused by asset-price crashes, by disturbances in the financial sector, or by Federal Reserve tightening of the money supply.

RBC says we’re all wrong about that. The financial sector, RBC adherents claim, isn't important. Asset prices crash because people see a recession coming ahead of time and act accordingly. And the Fed, according to Prescott in a recent interview, has no more effect on the economy than a rain dance has on rain. In fact, RBC is really sort of a giant null hypothesis -- a claim that the phenomenon known as the business cycle is just an illusion, and that recessions are the normal, smooth functioning of an efficient economy.

In Bloomberg, I've written about some new work that puts this RBC theory into a very new light. It suggests, in fact, that theories of this basic class, if examined more closely, actually predict the existence of inherent instabilities in economies. Specifically, if you relax even slightly some of the heroic assumptions usually employed in such theories -- regarding agents' perfect rational foresight, or the ability of firms to adjust their output instantaneously to changing economic conditions -- then these models become unstable, so that large recessions will happen even without any external shocks, simply because of coordination failures within the economy.

More people should know about this work, which is the result of a serious collaboration between some physicists AND economists. Full text of the Bloomberg piece below:

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Economists still don't know what makes it happen. An economy thrives for years, and then suddenly, without warning, falls into a hole. Unemployment soars until somehow, sooner or later, growth resumes. Every economy on the planet has experienced these painful, mysterious and apparently unavoidable slumps.

Among academics, the most popular theory is the Big Shock, which has many variations. In this view, you get a recession when some big thing like an oil crisis whacks the economy, causing a corresponding reaction. Conservative economists assume individuals and businesses will react in the best and most rational possible way, creating an optimal economic response, so the government shouldn't get involved. Others take the less extreme view that governments and central banks, acting wisely, can intervene to help an economy recover.

A few economists instead prefer what you might call the amplification theory. They suggest that interactions between different parts of an economy might make it possible for even tiny shocks to have big consequences, much as a spark in a parched forest can trigger a vast fire. A small downturn for an auto manufacturer might hurt its suppliers, undermining their ability to supply other auto makers and creating a growing cascade of distress. The cause is less the shock and more the links that amplify it.

For most economists, that's the end of the discussion: Recessions are either the result of big shocks, or of small shocks with amplification. They ignore a third possibility: that an economy might sometimes get seriously out of shape with no shock at all. The omission is odd, because this way of thinking was quite common in economics some 50 years ago.

Fortunately, a group of economists and physicists is reviving the old “no shocks” idea. Interestingly, they start with a mathematical model of the economy built by Big Shock theorists -- specifically, the so-called Real Business Cycle model, which still garners lots of attention from economists. Like many mainstream economic models, it assumes that individuals and businesses make perfectly rational, optimal decisions, which lead the economy to a stable economic equilibrium. The new research then makes some adjustments to this picture: It assumes that individuals, rather than having perfect foresight when predicting future prices, sometimes make small errors. The result is radically different. The interactions of firms and individuals now create an ongoing turbulence with sporadic recessions arising from a natural lack of coordination, without any shocks at all.

The researchers go on to show that if you make the model more realistic along any of a number of dimensions -- firms taking a little time to adjust their production to new levels, for example, rather than doing so instantaneously -- you always end up with an inherently unstable economy. The conclusion is pretty much the opposite of what the Real Business Cycle theory's creators originally intended. They wanted to defend the notion that markets work perfectly, not to entertain the possibility that recessions might reflect an inability of markets to coordinate supply and demand. Their own model actually destroys that hope.

It's an amusing and ironic outcome, with implications beyond recessions. For years, many economists have argued that their assumptions of perfect rationality, self-interest and equilibrium are merely convenient elements in valuable thought experiments; they learn about the real world despite the manifestly false assumptions. That position now looks completely indefensible. It looks more as if Big Shock theorists are worried that relaxing their assumptions will lead to some very different and very inconvenient conclusions.

This isn't to say that we know for sure what really causes big recessions. Big shocks, little shocks and inherent instability may all play a role. It will take some honest science to figure that out.