Fallingwater

Nominalism versus Essentialism in Economics

Over the last month or so, I've been very slowly making my way through volume 2 of Popper's The Open Society and its Enemies. Popper takes to task three philosophers, Plato, Hegel, and Marx, whom he believes promote totalitarianism. In doing so, Popper makes a very strong case against each of their essentialist attitudes, arguing that philosophical nominalism is the only consistent way to gain scientific knowledge.

I had been aware of the essentialist v. nominalist problem for years, but never really understood what it meant. Part of the reason why, I think, was that I associated nominalism with relativism, which it isn't. This may have been because I heard some third hand version of Ideas Have Consequences, which more or less takes such an understanding for granted. In any case, I hadn't put that much thought into it.

Popper first discusses how Aristotle, the connection between Plato and Hegel, argues in favor of essentialism.  To Aristotle, all knowledge (in contrast to mere opinion) needs to be based on the correct definition of whatever it is one wishes to learn about. That is, one must understand its essence. The example that Popper uses is, what is a puppy? An Aristotelian would reply, "A puppy is a young dog". The "essence" of a puppy is the fact that it is both young and a dog.  

Popper than makes a critical distinction. The essentialist reads the definition from left to right, in his words, "questions are raised by the term that stands, in the definition, on the left side and answered by the defining formula which stands on the right side" [emphasis in original]. The essentialist asks "What is a puppy" and answer it with "a young dog".

Now, to contrast, the nominalist does the opposite, that is, to read the definition from right to left. The question asked isn't "what is a puppy?", but "what shall we call a young dog?"! Popper argues that science cannot and does not ask questions which seek to discover what a puppy is, because "puppy" is nothing more than the name we gave to young dogs! There is never a true essence to "puppy" or "democracy" or "capitalism" or "inflation" because these are all only useful labels we use to refer to "young dogs" or a "society with a representative  and elected government" or whatever else. And, if you disagree with, say, my definition of democracy, that is irrelevant. There is no "essence" of democracy, so if my definition differs from yours, all that means is that we each use the same label to describe something different.

I must agree with Popper's argument and with nominalism. I also see nothing but the most naive and superficial connections between nominalism and relativism. More importantly (and disturbingly) are elements of essentialism in the works of many economists I like. For example, economist Murray Rothbard, while defending the concept of natural law, seems simultaneously to be responding to Popper and failing to understand the importance of nominalism to science. Simply substitute "essence" for "nature"

It is indeed puzzling that so many modern philosophers should sniff at the very term "nature" as an injection of mysticism and the supernatural. An apple, let fall, will drop to the ground; this we all observe and acknowledge to be in the nature of the apple (as well as the world in general). Two atoms of hydrogen combined with one of oxygen will yield one molecule of water-behavior that is uniquely in the nature of hydrogen, oxygen, and water. There is nothing arcane or mystical about such observations. Why then cavil at the concept of "nature"? The world, in fact, consists of a myriad number of observable things, or entities. This is surely an observable fact. Since the world does not consist of one homogenous thing or entity alone, it follows that each one of these different things possesses differing attributes, otherwise they would all be the same thing. But if A, B, C, etc., have different attributes, it follows immediately that they have different natures.lt It also follows that when these various things meet and interact, a specifically delimitable and definable result will occur. In short, specific, delimitable causes will have specific, delimitable effects The observable behavior of each of these entities is the law of their natures, and this law includes what happens as a result of the interactions. The complex that we may build up of these laws may be termed the structure of natural law. What is "mystical" about that? [citation]

Maybe, I wouldn't call that "mystical", but Rothbard's description of science certainly isn't correct. Science doesn't set out with questions like "what is an apple?" or "what is it in the nature of apples to do?". Science observes that objects fall back to earth without some other force propelling them from it. Science formalizes the specific manner in which that tendency occurs and calls that behavior "gravity". Science is not in the position to say whether it is in the nature of being an apple to fall towards the earth, nor is it able to tell you "what gravity is" since gravity is nothing but a label attached to a specific observed phenomena.

Rothbard uses this as a basis then to justify "natural law" amongst human beings, as residing within the "nature" (i.e. "essence") of man. While I still have a certain predilection for natural law, Rothbard's starting point (and his subsequent manner of argument) is untenable.

This is, I suppose an indictment of an economist who isn't staying in the realm of economics, per se, but it is an extremely clear-cut example of a mistaken "essentialist" economist. If we take this a step further, are economists justified in asking what the essence of "inflation" is? Or the essence of the "market"? Economics has been defined as the study of the best allocation of scarce resources; does this fallaciously assume an essentialist mode of thinking?

More of Krugman's Propaganda

Krguman has been the most outspoken supporter of the stimulus package among economists in academia, sometimes going as far as saying that the already enormous price tag will fall short of what is needed to achieve full employment. While Keynesians such as Krugman use several different arguments to justify an increase in government spending, Krugman leans exclusively on the liquidity trap.

The liquidity trap is a theoretical situation where the Fed is handcuffed because interest rates are approaching zero. Besides the recession today in America, the most famous example of this phenomenon is Japan's sluggish economy since the early 1990s.

Author economists have argued that the liquidity trap is irrelevant and a red-herring. Scott Sumner, for example, has argued that the problem is a deflation that resulted from a decrease in the speed each individual dollar moves across the economy (agreeing with Krugman) and that the only thing we need to do is to print more money (disagreeing with Krugman). Technically speaking, he argues that the Fed should target a set increase in nominal gross domestic product, which will automatically neutralize deflationary pressure. For Sumner, the interest rates are an incidental byproduct of the traditional methods of monetary policy, not the driving forces of the recession.

Sumner has received a great deal of press with the growing popularity of his own blog, The Money Illusion. Krugman, this Friday, has seemingly finally acknowledge the existence of Sumner's argument, to which he responds with more boilerplate emphasis on interest rates that doesn't actually discuss Sumner's (or anyone else's) rationale for the dictum, PRINT MORE MONEY.

He concludes with an offhand remark that the case for the fiscal stimulus is "really clear" and a link to another blog post. Okay, I'm interested in seeing a concise justification telling me why a fiscal stimulus is the only option... I click the link. And what do we get? A quick blog post mentioning a fully worked out New Keynesian model of the economy, one which Krugman acknowledges "was written in a hurry, so it’s surely incomprehensible to readers who don’t know the New Keynesian Economics literature, and probably incomprehensible even to those who do." He then restates the boilerplate, that "when monetary policy is up against the zero bound, the optimal fiscal policy is to expand government purchases enough to maintain full employment."

I clicked through the link to the paper and can say will full certainty that less than one half or one percent of Krugman's readership would understand it. I'm a first year PhD student studying the methods Krugman is using, and I have to stare at it for quite a bit to understand the model's assumptions. And this is the "really clear" justification for the fiscal stimulus? I mean, really? Krugman has been writing articles arguing in favor of a stimulus for more than a year, and what he chooses to provide as an intuitive response to someone like Sumner is incomprehensible model building? What does he expect from someone actually willing to follow him down his rabbit hole of hyperlinks? It's almost as if he's cognizant that as emperor, he has no clothes, and needs to throw complicated math at the masses (which is "really clear") to distract them from seeing that.

Even if we lived in a world where everyone has a strong grasp of control theory and differential equations and could understand the gist of the model, the model itself means nothing in this context. The purpose of models is to describe, and to describe they need to make assumptions. But different assumptions are exactly why someone like Sumner disagrees with Krugman. Krugman makes the most classic and worst mistake economists have a tendency of making, which is to assume what you are proving in order to prove it.

When Krugman pulls this type of stuff, he is no longer an economist. He's an ideologue and a propagandist. George Soros coined the snarky term "free market fundamentalism" to portray those arguing against government as holding a religious belief in favor of markets in the face of mounting evidence. While occasionally this may hold water for certain elements of the free market crowd, Krugman's harm as a propagandist far outweigh the harm caused by mediocre financial advice. He deserves the label "fiscal fundamentalist" until he begins to discuss criticisms in a less dishonest manner.

Challenge to George Soros

George Soros recently announced his $50 million investment in a new think thank, the Institute for New Economic Thinking. At least one blog has already sniped Soros for the ironic name of the institute, since its advisory board is an allstar list of economists ensconced in the left/center-left consensus. Soros's belief that more regulation is necessary and will not tend back towards full employment without the help of government intervention is not any newer than Keynes (and in truth Keynes merely popularized unpopular ideas than say anything new). His belief that recent decades are a testimony against all "market fundamentalism" is both an oversimplification of vastly different arguments in favor of capitalism and a misreading of what began the return to freer markets.

Coming out of World War II, planning was the name of the game in Western political economies. Soviet Russia wasn't some supreme failure as we now understand it to have been; most intellectual circles saw it as a more efficient, rational economic system. That, paired with seemingly utopian Old Keynesian Economics, brought forth a rapid expansion of the role of government in the West from the end of the war to the 1970s.

It's easy to forget (or not even learn) how extreme Old Keynesians were in their belief in the power of fiscal policy. While the mantra of the free market Chicago School has been that (paraphrasing), "the level of employment is inevitable, and the only thing you get by printing and spending money is more inflation", Old Keyensians actually believed the opposite, that the level of inflation is inevitable and the only thing you get by printing and spending money is more employment". While Soros may hate "market fundamentalism" in all its forms, especially the Chicago School, even he and his advisory board (hopefully) recognize that one of these statements is much sillier than the other. As a result of decades of policies "informed" by Old Keynesian beliefs, we got the stagflation of the 1970s, something that Old Keynesians believed to be literally impossible. The Chicago School gained credibility and the left moderated into a retrenched New Keynesian School.

The Chicago School and the New Keynesians now constitute the right and left of mainstream neoclassical economics. Both schools, unfortunately, do share a predilection for making very strong assumptions about the rationality and knowledge of human beings when conducting themselves on the market. If the free market were only "proven" by models which made such assumptions, I would be in full agreement with Soros. I am, in fact, inclined to agree with him broadly that those assumptions need to go and that the fields of behavioral economics and behavioral finance are fruitful in loosening these assumptions.

However, in speaking of market fundamentalism, Soros acts like these two schools are the only (or even important or primary) economic justifications for the free market. Namely, New Institutional Economics, the Austrian School, and Public Choice all provide strong justifications against government intervention without invoking a perfectly efficient and well-ordered market beforehand. The uncertainty of all human action is a cornerstone axiom of the Austrian School, while Public Choice Theory does nothing but call into constant question the actions of the government by merely suggesting that public officials and civil servants are no less motivated by self-interest than those in private firms. New Institutional Economics shares more with the Chicago School, but it ultimately focuses on providing an institutional framework that will make the market work best, rather than assuming any free market framework at all will lead to an economically efficient outcome.

Today's deregulated economy did not come from any particular embrace of the Chicago School or one of these other free market schools of thought, but from a rejection from the statist mid-century economic doctrines of Old Keynesianism and economic planning. These deregulations did not go much further than what was prescribed by rejecting what had clearly failed. If Soros wants to truly provide new economic thinking, he should not be paying a bunch of PhDs to come up with new justifications for old statist policies. As I discussed in my review of Animal Spirits last month, pretending to break ground in economic thought in order to justify ultra-specific policy remedies (i.e. Keynesian fiscal spending) does not give you any credibility whatever.

Instead, and this is getting back to that review again, Soros should start with where mainstream economics is wrong theoretically and moving from there. If we want to drop the rationality assumption non-selectively and non-arbitrarily, we should start with the behaviors cognitive psychology has proven are embedded in the human psyche before asserting the "money illusion" once more. That, in essence, is my challenge to Soros: if you want to tear down the edifice of modern economics, start at the theoretical level and go from there. Anecdotes of greed or irrationality shouldn't influence theory. Proven deviations, like Monday Morning Quarterback, should be where new economic thinking should begin. What systemic changes can we make to the market which protects us overconfidence or confirmation bias? To what extent do they interplay with the selfish motives of individuals, since these biases only work contrary to them? If we want a new economic system intrinsically different from the four or so models that everything else boils down to (Capitalism, Socialism, Keynesianism/Interventionism, and Mercantilism), what is that to mean. And if Soros, who really should be pursuing this given his stated goals, is able to achieve funding such a new theory, it would be a worthy use of his money.

Mises.org Audiobooks

The Ludwig von Mises Institute (mises.org) has maintained an impressive collection of free economic literature for a while now, ranging from the seminal work of Austrian economics, Mises' own Human Action, to the earliest bits of esoterica published by free market journalist Henry Hazlitt. The institute possesses the copyright to these works and keeps them in print, but we're treated to these .pdfs out of nothing but the Austrian evangelism in the hearts of its trustees. While I've been haphazardly perusing the contents of the site for the last year, feeling like I've been given the keys to the library of babel, I did not notice until very recently that the institute has gone through the trouble of recording .mp3 audiobooks out of their most popular works. For free. Right this moment, you can legally click on that link and download anarcho-capitalist Murray Rothbard's "The Case Against the Fed" to your iPod. Or, perhaps you're in the mood for some [not at all] light fiction, like Old Right journalist Garet Garrett's "The Driver"? And of course, for reasons I frankly don't understand, the institute apparently paid a professional narrator to record all 900 pages - almost 2 days of audio - of Human effing Action (or he volunteered to narrate it, which is even more frightening).

Anyways, it isn't quite fair or nice of me to make fun of a nonprofit think tank which promulgates a radical economic philosophy that comes very close to my own. In fact, I can't overemphasize how valuable of a service the production of these audio files is. Instead of listening to idiotic sports radio when commuting, I listened to a couple of the books listed in recent weeks: "For a New Liberty" by Rothbard and "The Law" by Bastiat. Neither of those is enough of a true econ book for me to want to get into here, but both are decent enough polemics. Both, however, are extreme in every sense of the word and I would not wish their ferocity upon any political moderate looking to broaden his/her knowledge. If you are said moderate, you should probably start here before jumping in anywhere else.

It's Never an Empirical Question

One cliché among seemingly all economists I find infuriating is, “it's an empirical question.” By this, it is generally meant that the economist has encountered a situation where he or she has found two arguments to be theoretically sound and cannot scientifically choose between them. One plausible “force” goes in one direction and another goes in the opposite direction; the only way to find out which "wins" overall is to look at the data.

To this, Post-Keynesian economist Ronald X. Chase replied,

“An uncertain and ambiguous situation like this arises in a discipline such as economics for various reasons, the most important being the 'softness' of data and questions of interpretation of test results. Thus, for example, whenever hypothesis are not confirmed, it can usually be argued that the data required (additional) information, or that other data should have been used, and/or that the ceteris paribus assumption was violated due to 'exogenous' events which in turn require that additional or different assumptions be 'ad hoc'ed' onto the test model, and so forth. Thus, it happens that seeking refuge in the logical-positivistic argument that empirical outcomes are all that matter, not only begs the question, but is itself a metaphysical rather than a scientific position. As a salient example of this, [neoclassical economist C.E.] Ferguson, after calling for econometric testing, so as to determine the validity of the Cambridge criticisms of neoclassical production theory, went so far as to state that 'Until the econometricians have the answer for us, placing reliance upon neoclassical economic theory is a matter of faith. I personally have faith; but at present the best I can do to convince others is to invoke the weight of [Paul] Samuelson's authority.'

“Metaphysics, as we have noted, plays an important and, in the Schumpeterian frame, a necessary role in the pre-analytic state of theory formulation. However, its constructive utility at the later level of supposedly scientific explanation is an entirely different matter. Metaphysics was never intended to be a device for (theoretic) crisis management!” (from pages 78-79 of this book)

Empirical testing, even done properly, rarely solves anything, especially when an issue is contentious enough for an economist to give up and declare it an empirical question. Macroeconomists have been sitting around for the last forty years staring at data trying to figure whether the aggregate supply curve is a vertical line or an actual curve to little avail, given the enormous disagreement that remains in academia on that point. And since the answer to that one question would tell us immediately whether Keynesian economics is true or not (meaning, whether a stimulus could help) , well, you get the gravity of the situation just from that.

Actually, I think the inanity of declaring certain issues “empirical questions” is even worse than Chase suggests above. In truth, any economic question is an empirical question. After all, the only difference between the theoretical assertions of a neoclassical economists and those of a Marxist economists are the a priori assumptions going into it. In these situations, you have four options

1. Declare one of the arguments stupid.

2. Declare one of the arguments evil.

3. Declare it to be an empirical question.

4. Accept either position as true so long as the assumptions going into its conclusions are true.

I prefer 4. Unfortunately, it's not “scientific”, but at least it's epistemically sound, which is more than you can say about the sociological outcomes of empirical questions.

I think it's also fair to stress something that Chase mentioned in passing- that declaring something to be an empirical question is intrinsically a logical positivist position. In other words, such a declaration assumes the precepts of a philosophy of science that has been dead for decades. I will give it credence to the extent that I give credence to an assumption that logical positivism is true, which is to say that I find it extraordinarily unlikely.

At the same time, I'm unconvinced that economists are really that big into extolling the virtues of logical positivism. When declaring certain issues “empirical questions”, they aren't really saying anything at all, since by the standards of logical positivism, everything is an empirical question. What they're really saying is just a fancy, pretentious way of telling you that they don't know, or that they would prefer not to argue anymore (making “empirical questions” no more than a thought-terminating cliché, which is something I find perfectly believable). Life isn't so simple that we can hope to resolve ambiguities by throwing everything into a regression and seeing what pops out. Hiding behind a veil of pretend science doesn't help when what we should really be doing is better understanding one another's arguments.

Book Reflection - "A Conflict of Visions"

A Conflict of Visions by Thomas Sowell is the best book that I've read for a while. For me, at least, it was one of those books whose thesis was on the tip of my proverbial tongue, but I could not put into words before having read it. Partially, that's because I've read another similar book by Sowell, The Vision of the Anointed, which, despite coming out a few years after Conflict, seems less developed  and more transparently partisan. Although I'll have to think about it much more, Conflict may be the best, closest exposition of my libertarian-ish point of view, with its epistemic framework justifying limited, non-interventionist government all the while emphasizing: Yes, I wish poor people weren't poor; or Yes, I want criminals to become active members of society; but that setting those outcomes as political goals is just going to screw everything up!

Let me take that back a little bit. Sowell demarcates two broad "visions" of how the world operates - the "constrained vision" and the "unconstrained vision"- while refusing to remain unnecessarily dogmatic about how issues must fit with one or both of them. The unconstrained vision sees all knowledge as collectible and knowable by all, and that there are groups of people out there that have been able to aggregate it rationally and find solutions to the problems plaguing society. This vision seeks to identify problems in the results of social processes, such as poverty, to intervene and come up with a solution.

The constrained vision sees knowledge as being necessarily dispersed among all individuals and therefore impossible to meaningfully aggregate in the mind of anyone. This knowledge is expressed and utilized through systemic processes to create optimal outcomes. In addition to the "obvious" systemic process, the free market, Sowell also argues (leaning heavily on F.A. Hayek) that institutions like tradition, rule of law, common law, and the family also possess this form of information. The constrained vision looks at these institutions and understands them further to communicate the incentives which properly motivate people to perform socially beneficial behavior.

To restate succinctly: the unconstrained view focuses on results and asks how a situation may be made better. The constrained view focuses on the process and seeks to avoid the destruction of society.

Sowell, obviously coming from the constrained vision (as do I), maintains an even-handedness in discussing either vision and insists that most political disagreements come from this conflict of visions, not from people being "stupid" or "evil". He provides a list of a surprisingly broad (although econ-heavy) group of philosophers which exemplify either vision. Among the unconstrained visioned, he lists William Godwin, Jean Jacques Rousseau, Voltaire, Condorcet, Thomas Paine,  George Benard Shaw, Harold Laski, Thorstein Veblen, John Kenneth Galbraith, Ronald Dworkin, and Earl Warren. His describes as constrained the views of Adam Smith, Thomas Hobbes,  Edmund Burke, Alexander Hamilton, Oliver Wendell Holmes, Milton Friedman, Thomas Malthus, and F.A. Hayek. My nitpicks are limited to the fact that Sowell seems to cite Godwin, Dworkin, and Hayek a bit too much relative to their popularity, which only suggests he was struggling to find effective citations in heavier hitters. Secondly, and although this is probably pretty stupid of me to say, but I wish he didn't cite Hobbes, Hamilton, or Malthus as those of the constrained vision, because I'd rather not be associated with any of them.

I should also probably say that the reason why I ended up reading this book over Sowell's approximately 500,000 other bits of popular nonfiction was that Steven Pinker, of all people, recommended it. It's not often that a Harvard University professor stands up and takes notice of a book on political philosophy by some old curmudgeon free market type like Sowell, so I figured that I, hopeful future curmudgeon free market type, better get around to reading it. Albeit, Pinker doesn't praise Sowell for turning him into an extreme right-winged libertarian. Instead, he gives Sowell credit as coming the closest in A Conflict of Visions of articulated his point in The Blank Slate. In that, Pinker argues (and I'm going off of wikipedia here since I didn't actually read it yet) against the concept of tabula rasa, which is an arcane, pretentious way of saying that humanity comes into this world as a figurative "blank slate." If you squint a bit, you can see the similarity. The constrained view places limits and intrinsic behavior patterns in humans (Pinker would describe from the standpoint of evolutionary psychology) and wants to create incentives that allow society to function best. The unconstrained view sees humans as a "blank slate" that alternative social organization can improve upon. I don't want to go too far in discussing this because I'm planning on reading The Blank Slate in the near future and may want to talk about it then, but I'd like to give you another reason for wanting to A Conflict of Visions.

One house-of-cards-ish aspect of the book is Sowell's dichotomy between the constrained and unconstrained, and I think it deserves to be looked at a bit more. He admits as much, as I said already, that not every issue fits perfectly, but he also argues that it fits surprisingly well. Mostly, I agree, if for no other reason, then from the standpoint of a single question- does knowledge exist primarily in a form that can be clearly understood and articulated? If you answer yes, you're going to hold the unconstrained vision, no matter what end of the political spectrum you find yourself in. Yes, that includes libertarians, with the very easy example of Ayn Rand. I'm also guessing that anyone answering "yes," has been very confused by the contents of this entry, and while I hope I piqued your interest, the arguments as to why the unconstrained view wouldn't be the case are probably beyond the scope of what I'm trying to accomplish here.

I'd rather discuss the one area that I think Sowell screwed up. As I alluded to, there are portions of the book that are very transparently leaning completely on Hayek. According to him, as Sowell, different bottom-up systems, namely, the market, the family, common law, rule of law, traditions, miscellaneous taboos, and a half dozen other things I'm not thinking of this moment, were developed over a long period of distillation. Meaning, these processes are probably with us today because they helped their respective cultures survive and flourish in competition with others. That isn't to say that those cultures are on some deeper, philosophical level "better" than the ones that didn't, but that through, some (other) stochastic process, certain groups created institutions which were more conducive to the growth of advanced civilization than others.

What Hayek then considers and Sowell doesn't is to group these institutions into what institutions are meaningful only in the "tribe" (the extended family) and those that can be extended to society in general. The market and legal conventions obviously should remain a part of government. But attitudes that govern the way we treat our "tribe" do not necessarily translate into society as a whole when we have no expectation for altruistic love. While "traditional" social processes may continue to be important, effective, and applicable, Hayek also argues that fallacious tendencies towards socialism (among other things) are also rooted within the attempt to apply the social morals of the tribe to the extended order (i.e. society).

Related somewhat to that, Sowell takes it way too far in discussing patriotism and the willingness to fight for one's country in the context of the book. While I agree with him that we should maintain our ability to deter enemies, he also says that siding with your country for the sake of it is part of the constrained vision, which I think is silly. And the extent to which it is "constrained" or "traditional" is certainly irrationally tribal and inapplicable to modern warfare involving America's near hegemony. Yes, American lives may be lost, but it takes quite the imagination to say that our failures in Iraq or Vietnam match those of prehistory (when losing meant the men were killed and the women and children sold into slavery) when human tendency towards patriotism was probably developed. Sowell nearly goes as far as saying that we should only be counting deaths on the American side of the ledger when waging war; while I don't think we should be treating lives as fully commensurate (although I understand why some might want to), it's not reasonable to insist that it's only within the constrained view to take such as harsh standpoint. I don't see how it has anything to do with the way in which knowledge exists in society.

I don't want to end on such a sour note, but I don't think I have much else to say. The points I disagree with this book amount to a handful of pages. I recommend it for anyone.

Book Reflection - “Full House: The Spread of Excellence from Plato to Darwin”

Stephen Jay Gould's “Full House” is first and foremost an evolutionary biology book, one of Gould's primary fields. At its base, however, is a broader discussion of how best to view statistical distributions. According to Gould, commentary myopically focuses on the average or extreme performers in a data set rather than understanding what is really happening in typical observations.

His primary example in evolutionary biology is the belief that evolution brings “progress” or greater “complexity” to all organisms. What scientists and commentators only consider are the dominance of the human mind and the general “trend” in complexity from bacteria to multi-celled organisms to invertebrates to reptiles to mammals to humans. Gould sees no such trend underlying it. The only reason we have observed greater and greater complexity at this end of the distribution is the result of more statistical variation played out over time. Organisms couldn't become any simpler because the starting point of life (bacteria) already approximated the simplest life could get. Meanwhile, there was no reason why one species couldn't get more and more complex so long as the complexity would be neutral or helpful in the propagation of its genes. Therefore, even if we want to see a trend or reason for progress or increasing complexity, what we're actually observing is a broadening of the distribution of different possible genetic outcomes. Gould concludes by forcefully arguing that, contrary to “the age of dinosaurs” or “age of man” diagrams found in most biology textbooks, life always and everywhere has been in the age of bacteria, since that form of life dominates the world in all meaningful senses.

Gould connects this with economics a couple times over the course of the book. He first makes a somewhat naïve objection to “trickle-down”, supply-sided economics, arguing that tax cuts at the highest brackets are not helpful for the economy as a whole, even if a measure like GDP per cap says so. Even though he doesn't mention it by name, Gould is probably getting at the Lorenz Curve, which is a statistical measure of how wealth is distributed across the economy. Which I guess is fine, but this observation isn't exactly new or original, even given that this book is ten years old. He also leaves out the real justification for lowering tax rates, which is to increase economic incentives. People seem to forget this, but before Reagan, the top marginal tax rate in America was 70% (and even higher in Europe before they went through their own adjustment periods). The rich just don't have any reason to work hard if they only take home $0.30 of every dollar they make. Others who are outside the highest tax bracket also have much less reason to put in the effort to enter the bracket. If you don't think through this all the way, you might think, who cares if the rich make another $400,000 a year or not? It's better used in social spending than yachts, obviously. This view, shared by Gould, completely misses one fundamental point- a nontrivial portion of the $400,000 (or whatever) the rich person now gets A) wouldn't have existed were it not for profit-seeking incentives and B) reflects a proportional increase in economic welfare across the economy. It is a payment in exchange for goods and services, many of which the poor or middle class wouldn't have had access to in the absence of the increased incentives. When you decrease incentives through huge marginal tax rates, you destroy wealth by capping how much people should rationally care about doing their best professionally.

Secondly, Gould argues that the mechanism of evolution is far less effective than the mechanisms of social change. Evolution can only eliminate changes randomly brought about by genetic mutation; it cannot never propose them. In contrast, we can propose anything we want in our imaginations and try them out. Gould goes as far as to suggest that social changes follows a Lamarckian pattern [Lamarkian was an explanation of species before Darwin. According to the theory, parents took on characteristics by frequently using a muscle or some skill that they would then pass on to offspring. The classic example is that giraffes have long necks because they stretched them to reach leaves until their necks lengthened]. The "parents", or anyone in society, can create a new idea and strategy and instantaneously pass it on to their "children" just by teaching them it. This contrasts greatly with evolution, where the species must wait for such thoughts to be randomly mutated in the genetic code.

While on certain levels, Gould is right, but trivially. Hypothetically, we can invent any idea we want, but the way we evaluate is only through elimination. Humans can create ways to turn copper to gold, but that doesn't mean an alchemist could will himself to do so as a Lamarckian giraffe could will its neck longer. A proposed change in social norms must still somehow square with reality. It may be very difficult to gauge what "reality" means in social changes that aren't purely technological, but fortunately over the last three hundred year's, we've developed a pretty effective system in determining which of the possible social changes we'll accept as reflecting reality (i.e. strategies, ideas, processes, norms, etc., which will allow us to be happier or to meet our goals in accordance to exogenous constraints). What is the name of this process? The free market. A proposed social change is floated and lives and dies depending on whether people are willing freely to devote their resources (normally time and/or money) in supporting it. Abstractly, although not literally, any social change that is profitable is allowed to propagate; the multitude of other "mutations" die. Exactly as how evolution chooses its winners and losers.

Gould doesn't seem to grasp that. Implicit in his thinking, social change is some form of collective choice where society as a whole (rather than disperse individuals) choose which path of social change we'll go down. Ironically, he firmly grasps the intentionalist fallacy of a pure creationist standpoint (that the incredible working order of life must be designed rather than generated through a bottom-up system like evolution). Gould just doesn't seem to get that the other ultimate bottom-up system, the free market, has the same power in generating efficient outcomes (see Hayek, "The Fatal Conceit" for more on this - that book is more or less this one point). One contemporary philosopher/financial commentator, Nassim Taleb, refers to the operation of the free market in the creation of new technology/etc, as "stochastic tinkering", even going as far as citing evolutionary biologist Richard Dawkins' "The Blind Watchmaker" as serving as the best possible analogous model for the operation of the free market. Social causation isn't the designed "choice" of society; it follows a mechanism nearly identical to the bottom-up approach of evolution.

Lastly, Gould mentions that, in light of the questions about the nature of "progress", society should encourage a certain amount of variation for variation's sake. Perhaps, he suggests, that there is nothing wrong with more Mom & Pop grocers even if they price themselves a bit higher than the Stop n' Shops of the world. I guess this makes sense from the most visceral aspects of variation: who the owner is, marketing and visual merchandising, quirkiness, and so on. Variation in those areas is okay, but Gould also misunderstands what really brings about economic variation (I assume this is an economic question). The way the economy is set up right now, the grocery "industry" is about as varied as you can get. There are some national firms, like Stop n' Shop. There are some large regional firms, like Shaw's-Star Market. There are many small regional firms, like (near where I live), DeMoulas/Market Basket. And there are still many single owner - single store firms, although nowadays they are generally specialty grocers, like Indian foods, organic co-ops, Asian foods, or (especially near me) Brasilian foods. Economically, we aren't experiencing sameness or blandness; we're experience a wide array of strategies owing to the varied size of the firms. You can even take this a step further, as in many cases pharmacists, convenience stores, and gas stations are directly competing with grocers, with many goods available at any of the stores. Even your locally-owned deli is probably stocking many items (like bread and milk) traditionally sold through grocers. The degree of variation is mind boggling, and regulation or other interference would only lessen it.

If Gould wants a social reorganization that brings true variation at the expense of pure efficiency, I have a suggestion, although he wouldn't have liked it. Decrease the power of the U.S. federal government drastically and put it in the hands of the states. Maximize their sovereignty so that they too may stochastically tinker with competing alternatives to forms of laws and social organization, allowing individuals to choose which they find best. We can have welfare states, populist states, and quasi-anarchist states, the existence of which is provided by the national government, which does nothing else. That's the maximum of social variation we can get, right?

Book Review - "Animal Spirits"

I was really looking forward to reading this book. Despite my unkind words for one of the authors (Robert Shiller) in an earlier post, I found his “Irrational Exuberance” to be very persuasive. It made me reject Efficient-Market Hypothesis -the idea that all stocks reflect all information publicly available to the market- without much reservation. Shiller was extremely meticulous and careful in defending each point he made, setting everything up so it seemed pretty much impossible not to agree with him [sidebar: I actually think “The Misbehavior of Markets” by Mandelbrot and Hudson even more conclusive regarding the issue, if anyone is interested]. Shiller, despite the strength of his argument, was even more careful in providing policy prescriptions.  His recommendations boiled down to two suggestions, that economists and other officials in places of power (like the chairman of the Fed or the president of the U.S.) shouldn't entice over-confidence and that we shouldn't institutionally discourage shorting so that there is more downward pressure on prices during a bubble.

Background: "Animal Spirits" is a term created by the most influential economist of the 20th century, John Maynard Keynes. He famously asserted ,

Most, probably, of our decisions to do something positive, the full consequences of which will be drawn out over many days to come, can only be taken as the result of animal spirits—a spontaneous urge to action rather than inaction, and not as the outcome of a weighted average of quantitative benefits multiplied by quantitative probabilities.

In context, he meant that irrational emotions ("animal spirits") controlled the amount of investment that entrepreneurs were willing to gamble. This argument has generally fallen out of favor among mainstream and center-left economists, who now generally make arguments about the limits of the efficacy of monetary policy as a result of the liquidity trap.

I understood, going in, that I was going to be reading an interventionist-leaning book. What I thought was that, given Shiller's (in my mind) credibility and (Nobel Laureate) Akerlof's pedigree, that the titular "Animal Spirits" were carefully chosen cognitive biases that have very strong scientific backing. Namely, confirmation bias, hindsight bias, prospect theory, or similar ones. These are biases embedded in the human psyche in ways that the species may never get around. I could see that. Despite my free market sensibilities, I was very much open to regulating them, especially if they could regulate biases in such a way that would deflate business cycles.

The book doesn't deal with anything resembling them. Instead, it provides a list of "animal spirits" the evidence for which is anecdotal, open to interpretation, and usually both. These animal spirits are then used to argue in favor of, of all things, Keynesian economics, whose messaged eventually becomes the central message of the work.

Keynesian economics is ubiquitous. When you hear people say that the government needs to create jobs, it's Keynesian economics. When people say that we need more liquidity, it's Keynesian economics. When you hear that we need a stimulus, whether it's "conservative" tax cuts or "liberal" spending, it's Keynesian economics. As I said earlier, the current debate of why the government should do either and how that creates jobs is (normally) about the liquidity trap. In the interest of hypothetically remaining impartial, I'm going to set that aside. The authors' justification for deficit spending has nothing to do with that. Their argument is the money illusion.

The money illusion states that people focus on the nominal level of their wages instead of their real wages. Meaning, they like the idea of wages increasing even if the price of goods has increased with it. It also means they freak out and refuse to work if their nominal wages decrease in conjunction with a justified decrease in the price level, therefore creating unemployment. This reaction is irrationality, an animal spirit, according to the authors.

The incredibly academically dishonest step the authors make, however, is asserting that this is the context in which Keynes coined "animal spirit". He referred to this effect in "The General Theory", but only in the response of labor unions during economic downturns, which was perhaps reasonable. Labor unions had little idea that prices were falling during the Great Depression and felt justified in maintaining wages. This wasn't unjustified given the information they had at the time. Keynes's plan was, in the event that this happened, to increase the price level so that merely maintaining the union's nominal wage would effectively decrease the wage in real terms, allowing the employer to hire new workers at what their real wage rate really should be. Keynes didn't refer to it this as an "animal spirit" (look it up in "The General Theory"!), and he shouldn't have. This problem was the ignorance of workers, not the irrationality (animal spirits) of workers. Keynes would be remiss to call it that, and he didn't in his greatest work. Shiller and Akerloft may be correct in describing this effect as something detrimental to unemployment, but they are flat out lying when they refer to it as the animal spirit Keynes talked about. It only makes me think that they are trying to both lean on the Keynes's cachet while dodging a fundamental dismissal of his original argument.

And boy do they ride on the cachet of Keynes's "original meaning." At one point, the authors refer to the the late 1960s when Milton Friedman's free market interpretation began to take hold among economists. I'm not going to begin discussing the technicalities here because I don't want to surpass the 3,000 word threshold, but what Shiller and Akerloft do in response to Friedman's rebuttal is absolutely obnoxious. They go through his argument, accept that it must be somewhat right, and state that we should go somewhere in between, which is perfectly reasonable. What they then do is to tacitly take up the Keynesian argument once more, completely ignoring Friedman's analysis. The scene, sadly is one that takes place again and again throughout the book. Shiller and Akerlof supposedly acknowledge the probative benefit of capitalism, and given that (and the loosest possible definition of markets), they take an extreme leftist point of view, especially from the standpoint of economists.

The strongest piece of evidence that they use to make this point (in contrast to surveys and conjecture) is a study which cataloged the consideration of inflation a sample of Canadian unions took when negotiating wages. Only a minority of these unions used any objective measure of inflation built into their wages, and many of them only did it to a certain extent, such as recalculating only when inflation surpassed an upper limit. This was the closest thing to a real market (rather than people describing the supposed motives for their behavior to a survey or a sociologist), I saw in "Animal Spirits", upon which we could actually make  an economically informed descripion.

And it fails. If we are to look at inflation as Friedman's metaphorical crates of money dropped down by helicopters, where everyone receives an increase in nominal income in accordance with efficient economic allocations, we have nothing to worry about. But they don't. Money enters the economy many different ways. One firm may experience a "typical" 3% increase for the cost of its inputs. Another may experience a 10% decrease. These "hypotheticals" aren't mere hypotheticals; perhaps the former is oil dependent and the latter is a call center which is in the process of outsourcing? A given uniom could well be negotiating based on the expectation of inflation with their own industry and in general, the expected increase in "general" price level could be effectively white noise. In that case (which I think is the most realistic one), we should expect linking wages to CPI to make sense rarely at all, and the extent to which the market does it only demonstrates its consciousness of inflation.

I'm not saying that my counter-arguments irrefutably condemn those proposed by Shiller and Akerlof. Instead, I argue that the best of what they have to say is intuition and innuendo contrary to the formal practices of economics. If the best they have to offer (and I know that they have other arguments in favor of Keynesian economics, but that this was the least ridiculous one), then why should they have credibility at all? In addition to their statements about fiscal policy, each and every one of their secondary arguments (social security, affirmative action) just happen to result in argument in favor of the left. Albeit, I haven't specifically taken on those issues or others in favor of limiting this post to length shorter than "Animal Spirits" itself, but it lessens one's credibility to so "scientifically" interpret selectively chosen pieces of evidence so that they all fall on one preordained side of the political spectrum.

Somewhat tellingly, the authors continually repeat how their point of view is so marginalized in academia and the big bad Chicago School (of which I'm not a member, FYI) blinds their fellow academics. If you go and read the goodreads reviews, approximately 100% (perhaps hyperbole) of reviewers of this book will act really confused and say that the only reason they didn't love the book was because they already heard these arguments in school. Which is to say, "Animal Spirits" isn't anything new. Keynesian economics has already been refuted (in all the important theoretical ways) by, at the latest, the time of Thomas Malthus. Perhaps at this point, I'm showing my ideological cards a bit to much and opening myself for justified criticism in dismissing fiscal intervention so broadly, but "Animal Spirits" doesn't say anything that you won't get by attending EC202 in a center-left school.

The authors also ask, why should we only consider rational motivations when there is so much else to inform us about human action? Prudentially, I would answer that we focus on the interests of the individual because, once you eliminate that, there are no limits to the sociological/psychological/philosophical/religious/whatever arguments you want.  We may inform our opinions based on those factors, but they do not become relevant until they relate to how individuals best allocate their resources to maximize the benefits they receive from them.

More passive-aggressively, I'll refer to a quote from baseball historian and analyst, Bill James.

All discussions have [bulls***] dumps; we need them. Our logic, whatever it is that we are talking about, can never be completely worked out; all subjects worthy of discussion are too complicated to be full encased in logic. Thus, in all discussions, the least precise areas become [BS] dumps, elements of the discussion which are used to reconcile our formal logic to our intuitive sense of right or wrong, justice of injustice, accuracy or inaccuracy, reason or madness, moderation or extremity. 'Psychology' is a common [BS] dump. I am not saying that psychology is not real or that psychologists do not know what they are talking about. What I am saying is that since human psychology affects almost everything within our sight in undocumented ways which are never full understood, psychology inevitably becomes a [BS] dump which can be used to justify or explain what is otherwise unjustifiable or inexplicable.

Book Review - "Money, Markets, and Sovereignty"

“Money, Markets, and Sovereignty”, released this year by Benn Steil and Manuel Hinds (both from the Council on Foreign Relations), provides an extensive yet unconvincing justification for both globalism and the gold standard. Polemical in nature, it methodically abstracts first to the Hellenistic philosophy of Stoicism before retracing the steps of free trade, the nature of money, and financial crises throughout history. It concludes with a thesis guaranteed to infuriate nearly everyone: globalism is essential to economic welfare, but it is completely incompatible with monetary sovereignty.

According to the authors, our public policy situation is unique in history. Never before has such an element of free trade ever been before combined with fiat money. The only other episode of extreme free trade, the Western world from the middle of the nineteenth century to World War I, was coupled with the gold standard. This situation brought with it the Humeian concept of the species flow; trade self-regulated with outflows and inflows of gold. Today we see a much different monetary situation, where everything is effectively linked to the dollar and everyone overseas holds the dollar because they don't trust their own government's fiat money. This is not a stable relationship and cannot last indefinitely. America's dollars have taken the place of gold in bank's around the world, and since the Federal Reserve can print as much as it wants, there is no feedback mechanism the market can use to determine the correct allocations of worldwide imports and exports.

There are a few nitpicks that do not necessarily hurt the authors' overall agenda, but render it far less convincing than it could be otherwise. Mainstream economic orthodoxy is ignored all too much. The international conception of free trade is largely dismissed, and they'll say things (paraphrasing, “floating exchange rates is the contrary to free trade”) that a typical economist would find absurd. They may then justify their statement, but they do not adequately demonstrate why the orthodoxy says what it says. In the course of discussing the gold standard and the Great Depression, they bring up Keynesian economics, oversimplify it as being unwarranted concerns about wage inflexibility or debtors being unable to repay debts in the face of deflation, and leave it at that. Again, this doesn't take away from the legitimacy of what they're arguing, but I do not see how they would expect to make inroads into academia and persuade moderates if they are more or less ignoring them.

Secondly, they use empirics rarely, and when they do, they use it very poorly. The handful of regressions that appear are all single variable graphs with blatant heteroskedacity (an econometrics issue which invalidates statistical significance). They didn't really need the graphs and the relationships they were discussing therein could have been explained intuitively, so I don't understand why they even put them into the book. They only detracted from their credibility.

Lastly, they overstated the degree to which the late nineteenth century was truly on the gold standard. The United States had nontrivial barriers for redemption, had a habit of regulating private banks out of existence, was off the gold standard altogether during the Civil War, dragged its feet when getting back on it, and ham-handed it when it finally did. To name just a few of its derivations. The Bank of England was a bit better, but it still had a functioning, regulating central bank which both monopolized the issue of notes and acted as a lender of last resort. This was not free banking. It was not really the gold standard. In fact, it was managed trade and managed (sovereign) monetary policy. The degree to which that is true then is far less than it is today, but it isn't quite as categorically different as the authors pretend.
I like this book, but that's probably only because I already accepted the thesis. Which means that the book is either A) an excuse for confirmation bias on the part of Austrian economists and like-minded goldbugs or libertarians or B) propaganda targeted at people who have not read that much on mainstream analysis of free trade and international economics. I'm inclined to think it's (A) both for the sake of the authors and because parts of it are too technical for a layman to understand 100% (or it's trying to obfuscate by doing so, which would be worse). (A) is still nothing to be proud. The fact of the matter is that this point of view is SO far off the map of mainstream journalists, politicians, and informed individuals that it can't possibly be taken seriously as something that will persuade them. You're not going to convince Ralph Nader and Patrick Buchanan that free trade is good because the Stoics said so, it's part of the classically liberal tradition, and a bunch of economists agree that it will increase general welfare. You're not going to convince the Democratic Leadership Council or free market republicans that we should blow up the Fed because of this interesting-but-weird historical paradigm you set it in (even if they understand what the hell you're talking about). And least of all are you going to convince academia, which will immediately see this style of argument (perhaps rightly) as the work of propagandizing ideologues. I won't blame any of them.

Economic Rationality

Rationality is a central postulate in mainstream economic thought. It allows economists to focus on the results of the choices of individuals by setting aside possibilities which are not indicative of the general essence of human action . Due to how individual “rationality” is generally defined, an understandable skepticism arises when economic models assume everyone acts in such a way; we all know some grandparent who stubbornly mishandles her money or a high school friend who can't help but to drink himself out of job after job. However, these decisions are not necessarily “irrational” in the accurately defined economic sense. Individuals can only be called irrational in the vernacular sense (that they make unwise or psychologically driven decisions). Unfortunately, some economists have misused the concept similarly as well.

Objecting to economists' use of rationality as the word is commonly understood is elementary: such use is unjustified assumption. By Occam's Razor, our analyses should limit assumptions as much as possible. Even so, this objection completely misinterprets what “rational” means (or should mean) for economists. Rationality means that human beings have goals and they act to achieve those goals. It's not necessarily true that their choices of how to act are accurate. Individuals are self-interested, in the sense that they want to fulfill the goals of themselves, not the goals of others. They are not necessarily selfish, in the sense that they care only about maximizing their pleasure (utility, in economics jargon). These goals could be anything, whether that constitutes getting in shape, putting food on the table for the family, educating one's self, watching a movie, or curing cancer. As defined, everyone is economically rational- the shrewed businessman as much as the child as much as the social worker as much as the sociopath. Rationality is not an unnecessary assumption. Rather, it's the description of human behavior that takes the fewest number of assumptions possible.

This has not kept some economists from myopically equating rationality with narrow selfish behavior. A popular example is Steven Levitt's bestseller, “Freakonomics.” Among other anecdotes, Levitt narrates the story of contemporary Sumo wrestling in Japan. Contrary to the tremendous social suasion encouraging the honor of the wrestlers involved, Levitt finds empirically that wrestlers may be colluding during certain fights so that the lesser wrestler is more likely to enjoy the greater relative benefits of winning the match. He does so by establishing that lesser wrestler wins more than he “should” given chance alone. What Levitt then zeros in on is the wrestler's inevitable selfish, or “profit-maximizing”, behavior. Levitt concludes that the “economic” interpretation of the data is that, on average, wrestlers act reciprocally to one another when these situations arise so that they may expect the same in the future. The author goes on to say to the effect that those who disbelieve his argument predicated on empirics and his rather fatuous form of rationality are mere plebeians tied an silly, outmoded upbringing and culture which are belied by his economic wisdom and scientific “facts.” In reality, there is no scientific rationale for seeing the empirical data that way, except Levitt's assumption of “rationality”, which seems to be more or less the equivalent of seeing the worst in everybody.

It's rather trivial to arrive at a different reading of the data. The wrestler with the poorer record has a greater motivation to do his absolute best, while the wrestler with the worse has less. That requires no conspiratorial collusion, the existence of which is yet another assumption Levitt takes in forming his hypothesis. And there are certainly other possible explanations of the data that are equally legitimate and have not made themselves obvious. Yet, for the sake of intellectual honesty, Levitt may yet be right: maybe the wrestlers really are involved in some huge conspiracy. However, there is no empirical way for us to confirm that, and we should therefore be obliged to viewing his claims with skepticism.

Another topic that frequently is connected with rationality is the Efficient Market Hypothesis, best known through Burton Malkiel's “A Random Walk Down Wall Street.” The hypothesis states that the market (for stocks, bonds, and any other investment vehicles) will set prices such that they represent the best possible estimate of its value. With stocks, for example, the price will represent its present and future dividends. As such, individual investors should not pick and choose particular stock, since they cannot outsmart the market, and should instead invest in index funds so as to spread their risk. Over time, however, especially in recent years, this theory has met widespread skepticism due to massive shocks that cannot possibly represent changes in the underlying value of the investments, as exemplified by the recent crash. This criticism is likely warranted. What is not warranted is using the collective irrationality of financial markets as blunt object with which to bludgeon the concept of individual rationality.

Referring to this as “irrationality” confuses the issue altogether. To paraphrase James Surowiecki, what is desired is for markets to be “accurate”, which connotes something altogether different than “rational”. If we want to know if individuals were acting rationally, we need to be asking questions of another kind. Were they trying to achieve a goal? Were they using the information at their disposal to guide those decisions? I believe the answer to both those questions must be yes. After the fact, perhaps it's clear that they were using incorrect information, but they did not know that. Even someone who was aware of what was really going on was in all likelihood just trying to time exiting the market. Economically, the investors were still rational, even if taking on the features of “irrational exuberance” when taken as a group.

Academics should and do take the crash as evidence against Efficient Market Hypothesis, perhaps not enough. That's fine. But to use it as an excuse for further government intervention is a non sequitur, especially outside of financial markets. A big target for this blunt object has been the teachings of the Chicago School, especially the political and monetary prescriptions of Milton Friedman, which is absurd, as his central contributions had little to do with finance outside of the Fed. And this is precisely because he argued with the correct definition of rationality. His opponents have equated market “irrationality” with Friedman's beliefs in order to Straw Man him out of existence.

See the very recent “The Myth of the Rational Market” as an example of this, as well as many articles by Paul Krugman. See the entire oeuvre of Robert Shiller for a more theoretical justification discussion of the irrationality of markets.

Rationality doesn't, or shouldn't, have anything to do with an individual's ability to make mistakes. Or to fail to act selfishly. Or to act in such a way that does not achieve full employment. If we allow rationality to mean more than what was initially posited, we may accidentally come across a situation where the stock market prices a company perfectly or that some jerk was acting “rationally” to screw his neighbors to make a buck, but such instances do not represent (and in reality, shouldn't have ever had to represent) rationality. We are all rational by acting as we do. Our mistakes and vices contrary to that are our errors. They are not irrationality.