Mill's Wage Fund and Interventionism

While Diana has been thinking about experts in the last year or so (see below), I have still been thinking about interventionism. Like her, I see this everywhere once I begin to think about it.

One of the great formations of this argument was by Ludwig von Mises. He took socialism seriously, and being from Vienna, he saw some of the many different forms socialism can take. Having sat in Cafe Central near the Ring Strasse in Vienna and sipped strong coffee, I can somewhat relate to the revolutionary ideas of Trotsky. However, being a native English speaker, I have always had a deep love for the debate waged in England and for too long under-appreciated the continent. I think that Mises looked to Mill for a strong defense of Socialism precisely because he knew the importance of the English tradition for the way economics was headed. After all, Mill was not in it for the revolutionary ideas, and both Mill and Mises took seriously the critique of capitalism where they found its critics to be intellectually honest.

Today, when I was making my history of thought test, I thought about how the intervention concept might relate to Mill's wages fund. Not to downplay Mises, but Mill's concept of the wages fund states that there is a certain amount of profit (revenue from capital) that can go to labor, a forerunner of the idea of labor's share of income. If the labor share of income is somewhat stable (an assumption that has empirical backing), then trying to raise the wage will cause unemployment. Now the cause of the unemployment is somewhat subtle. Mill didn't formulate the theory in a way modern economists can understand. That is to say he didn't use math. So, in an important way, we don't know exactly what he meant. However, if we follow my connection to the labor share of income, then the theory is not entirely useless as a pattern prediction.

This brings me to what Diana and I have been working on. Pattern predictions are statements about regularities in the world. They are not like neoclassical models because they are not expected to be replicated or to exist as controlled experiments. Misesian a priorism, in my opinion, is best categorized as pattern prediction. Mill had his own connections to a priorism. This has derogatorily been called the "Ricardian Vice" meaning the drastic oversimplification of economic models. When Mill is read this way, he is clearer. We raise the minimum wage (through unions) then that amount available for wages is distributed to the lucky recipients of the higher wage. The other portion of the labor employed loses this amount, but not in wages but by losing their jobs.

Now, I am going to be ahistorical. What do we learn from this example? How can employers pay more for labor than what it is worth under a competitive market. I think the answer to this is very simple. There must be some capital substitution (here is a modern example). Because wages rise the employer expects to see more productivity from that wage. The best way to do this is to increase capital investment. If wages are going to remain high for some time, the plant needs better machines which will increase productivity and drive down the number of labor hours needed to run the plant. We do need capital investment, but over-investment can be defined here as the rate which increases the unemployment rate.

This hardly redeems Mill, but it does suggest that Mill was on to something. Like Mises, he found a place where well intended interventions disrupted the rate of growth in capital and the cost of this acceleration in growth is passed onto those with the lowest skills in society. I find this much more intuitive and would love to test it to see if the intuition holds.

Pattern predictions state that all interventions create disruptions. Lipsey and Lanchaster still made the argument most clearly to their contemporary economists in the late 1960s. However, Mises made the point in a way that was meant to be understood by well-intended policy makers. Other examples include: Robert Higgs who talks about intervention when he says war help to grow the size of government through a ratchet effect. Buchanan talks about intervention coming directly as a result of not having a binding budget constraint on government. Al Roth applies the term repugnance to a wide category of interventions. My dissertation work tried to take this last piece and connect it to the story of the rise of economics in the last 300 years. I continue to find examples that confirm my reading. I still think that economics is the story of pointing out that interventions have consequences. Often, as in the case of Mill's wages fund, these consequences have high human costs among the least-well-off in society. It that lesson could be learned, I think most support for society wide interventions would erode.

Why Don't We Update?

I have been working on a project that investigates the institutional constraints on expert advice in development economics. Specifically, I have been using PT Bauer’s work from the 1950s on Indian Economic Policy and West African Trade as an example to argue that the quality of expert advice is constrained by how experts relate to their subjects. The idea is that when experts and their subjects operate within the same network of reward and feedback mechanisms, experts will be more likely to internalize negative feedback and update. When experts operate in a network of rewards and feedback that is separate from the network of their subjects, on the other hand, they are further removed from potential negative feedback and therefore much less likely to learn and update their theories to comport with real world evidence (see aidwatchers.com from more recent evidence of this problem in development economics).

Ever since I started working on this project, I have been subject to confirmation bias, i.e. everywhere I look, I see my theory in action. The same thing happened as I was reading Barry Eichengreen’s most recent book, Exorbitant Privilege. Eichengreen argues in this book that the Fed bares at least partial responsibility for the 2008 financial crisis because its monetary policy was too loose. According to Eichengreen, the FED had followed the Taylor rule in setting interest rates throughout most of the nineties and early 2000s. The Taylor rule derives the target short-term interest rate from the divergence between actual inflation and the desired level of inflation, as well as between actual GDP and potential GDP. Eichengreen suggests that fears of deflation led the Fed to diverge from the rule in 2002 when instead of raising rates, as the rule would have prescribed, it chose to keep them at low levels to prevent a Japanese style deflationary crisis.

I am as far away as any academic economist could be from being an expert on monetary policy, but as I am reading Eichengreen’s description of Fed policy in 2002, I cannot help but being reminded of current FED policy. Fears of deflation have been cited for almost 2 years now as a reason for historically low rates. And, the FEDs most recent increase of the Fed Funds Rate by 25 basis points seems timid given the recent good news about a recovering US economy and what the Taylor rule would prescribe. I might be wrong about the connection between 2002 and today, but if there is any resemblance between economic conditions then and now I cannot help but wonder what it is that keeps the experts at the Fed from updating and learning?

Eichengreen also cites the ‘pseudoscientific nature’ of an increased mathematization of the financial industry as one of the reasons for the excessive risk taking that lead up to the crisis. Yet, everywhere I look, I see academic economists advocating the use of ‘quantitatively rigorous techniques’ without ever indicating what the limits of quantitative analysis might be (Nassim Taleb being the exception). Again, I cannot help but wonder why we do not update? What is it that keeps the economics discipline from learning? Why do we not change our strategy in the face of disconfirming evidence? Every fool will learn not to make the same mistake twice, but as academics (the same is true for economic policy makers) we seem to be blind to real world evidence.

Given the implications of my theory about why it is that economists are so bad at predicting policy, it is not hard to see why we keep making the same mistakes over and over again. Just like development economists, academic economists in general are removed from their subjects. Ben Bernanke will eventually return to his job at Princeton University where he already has tenure. Why should he be worried about the consequences of his bad theories in action? Similarly, most academic economists around the country, who continue to preach the need for quantitative rigor already have jobs with tenure and will keep those jobs whether or not their theories have any practical relevance. Maybe the recent proposal by the Utah legislature to get rid of tenure is not such a bad idea after all. However, I am doubtful whether that would suffice to bring the theory underlying policy prescriptions into closer alignment with reality. What are some good proposals for reform of academia that might make us as a discipline more realistic?

Public School, Home School, Private School

There is an interesting note here by Bryan Caplan one of my professors at GMU.

In trying to understand what makes libertarians different than other groups in terms of their almost religious devotion to squabbling with each other, he points out the following squabble:

"Libertarians have favorable views of home schooling - even though conventional private schooling is equally consistent with libertarian principles."

Diana and I were having a conversation (off-line) the other day where we talked about the difference between moving market arguments forward and being a cheerleader for the market. This conversation rose because I was reading Amartya Sen's new book, The Idea of Justice. In that book, on p. 12-15 he introduces his take on the central problem with discussing justice. He gives an example, three children and one flute.

• Anne is the only one with the skill to play the flute, and asserts that she should get it.
• Bob asserts that since he has no other toys and Ann and Carla have many, he should get it.
• Carla tells us that she made it and that it represents many months of labor.

Picking among these options is supposed to demonstrate your commitments to a theory of justice. If you defend Carla based on the grounds that she will no longer make flutes if her produce is confiscated, then you might be a utilitarian results-oriented libertarian. If you favor Bob, you are supposed to be dominated by social consciousness and favor redistribution. A utilitarian could also choose Anne saying that the music created is more valuable than the loss to Carla.

I fall in the category of results-oriented libertarianism. Other people who support Carla, can also assume that people who make property should have that property regardless of the outcome, that it is a right. This comes from a long tradition of natural rights theory that I will just flag and encourage you to look up elsewhere.

How does this relate to schooling? Well, I am a fan of Homeschooling. I understand it to be an important part of history, many people have been educated in the home and done quite well. I bias my approach to people like Thomas Jefferson, but I have also met quite a few home schooled individuals who are enrolled in Ivy League graduate programs and they seem to have capabilities far beyond those other "normal" Ivy Leaguers who went to more traditional schools. My approach here has been: great results, great program.

For a social scientist to admit that he has allowed availability bias to shape his understanding of an issue is to become a better social scientist. I recently had a discussion with an educator in the state of Utah who assured me that the biggest problem facing Utah public education are home schoolers who join public schools late (like 5th grade age, 10-11) and who are completely illiterate, absolutely without letters. It then becomes a burden on the classroom. Her reaction to this was to say that home schooling, at least in Utah, was more of a burden than a benefit -- something that really speaks to me and my results oriented understanding.

Caplan's question helps me put a firm finger on my methodological problem. I never defined what goal I think education should reach at the primary level. I have always hated what I see as brain washing by well-meaning but hopelessly uninformed public educators (the ones that take the job for the salary, not the ones that chose it as a vocation). I thought the incentive structure was wrong. I also wrongly ignored private schools which I assumed to be only marginally different, and that margin must be, I figured, elitist rhetoric and inculcation of a consumer mentality.

What Caplan's question requires me to do is to re-examine my thinking on School Choice and imagine not a loose and disaggregate home school network, but a continuum between home schools, small private schools that accommodates home schools, and private schools. This refocuses the question on school choice and the very real lack of it over the past century. Public schools certainly have a place in this mix, but we need to better understand the factors that make a public school work vis-a-vis a private school and a more open solution for kids, like the ones I met who that are currently studying at Ivy League universities, need a great deal of flexibility to thrive. Home schooling is not for everyone. It is not even for most people. But, we can support parents who want to craft a unique educational experience for their children by offering choice.

Parents have a right to their children's future, in my approach, not because the children are "theirs" in some unimpeachable way, but because we believe that they are the best people to decide for the children. Most parents love the child irrationally much. This is hard to replicate in any other property rights scheme. However, we should facilitate good decisions by allowing for systems of rules to help parents fulfill their overcommitment to their children's success. In the case of homeschooling parents who don't teach their children to read.... I can't defend their right to be in control of their children's education. I just don't see it.

--Update--

Related video by David Schmidtz: Short(2:36)

It is not about winning a race, it is about children becoming the best they can become.

Hayekian reading of Rawls

In the spirit of this blog, I my goal is to present some of my thoughts in an informal way and leave the heaving lifting of revision and fact checking for later. By way of a disclaimer, I am just thinking through the issues and recalling my impressions from the authors.

I want to start from a premise. I assume that people in society would be willing to make the least-well-off better if that cost us 10% or less of our income in taxes. Some of us would go to 20% and some even higher. I simply assert that as far as I know, everyone would be happy to tithe to the church, give that same amount to government, or donate to a charity if clear causal line between their sacrifice and the improvement of the least-well-off was made.

What the market advocates have always used as an excuse is that charity distorts capital processes and wrecks the price signals in the market in the aim of charity. We, those of us that privileged markets in the war between private and public choice, have a general distaste for help that creates dependence. We emphasize this distortionary effect. This tendency of ours has always been viewed as cold hearted. Hayek, with his capital theory explains why distortions occur and persist when people manipulate the price signals and try to distort outcomes.

What I don't think is clear in this statement is that the damage done to the least well of from these manipulations is greater than the damage done to those with more resources. The difference of a few percentage points in opportunity for the least-well-off is greater when you are trying hard to string things together to escape the cycle of poverty.

This is why I find Hayek's take on John Rawls as an interesting academic question. If Rawls wants to maximize the minimum, what does that mean in practice?

The hard-line approach is always to avoid anything beyond local charity because we don't want the government distorting price signals in the aggregate. However, what is the maximum standard of living that we can achieve for the least-well-off (accounting for the weight we assign their independence)? If we foreclose opportunities and create cycles of poverty through intervention, this does not make the least-well-off better. For the very hard core anti-government person this is the end of the argument.

I want to go further.

What do we think is the best we can do to increase the welfare of the people left out from the riches of the rest of us? What is the system most likely to deliver this? I agree that unintended consequences of intervention are very diruptive and this disruption falls disproportionately on the poor; this is the positive analysis. But maybe we can talk about this in terms of calories? There has to be a standard we would all accept. What is the minimum where we can draw a line and say, "that's it!"? What is the line which is the best we can do through intervention. Certainly this is greater than non-zero intervention...

If I have a Hayekian reading of Rawls, then I am looking for the costs in terms of disruption of opportunities and the benefits in terms of some universal measure of well being transfered to the least well off. Clearly we give aid in disasters like Haiti. Clearly we give out water filters for the poor in the developing world. Some measures of aid are simply beyond the measure of distortion, right? Do we really want to say that mosquito nets as charity are a net negative for the developing world?

What is at state here is the uncertainty of aid. We can't give aid when we feel like it. If there are cycles in aid then that is what distorts the production process. If we give a steady supply of aid, then this allows productive resources to reallocate and still gain the benefit of the capital injection. There has to be a theory of aid that comports well with a Hayekian capital theory. I just wonder if we can draw a clean line in capital theory where charity does not distort our analysis.

Government Revenue

Government revenue, in the aggregate sense, comes from three sources: inflation, taxes, and the issuing of debt (treasury securities).

However, I do not think it is common to sum these sources of revenue and track the total share of GDP which is attributable to these sources of revenue. While inflation and taxes are unambiguously helpful for the government's position, the servicing of the debt is a budget item itself. Inflation does its part to eat away at this balance, but it is none-the-less a liability.

In the recent discussion of the budget what seems to be playing in the center of the spotlight is the issue of raising taxes. However, it is one very small semantic step to view inflation as a flat tax. Ricardo argued that bonds were taxes, but just delayed. So why are these other measures of taxes not more obvious to people? When we raise the level of borrowing, we are committing to future taxes. In short, we may see a growing government, but we are going to wrongly attribute the growth to the current period -- we have been growing all along, so says the spending.

Like a corporation, the issuing of debt is an important part of doing business. Everyone who owns a home understands this lesson. When you qualified for your mortgage, the high number that you were given for the amount you could afford was calculated on the principle that your payment could be as high as 55% of your monthly income (assuming you had no other monthly liabilities). The only question that I have is why we don't think about government the same way we think corporate or individual finances.

Recent reports suggest that government spending is likely to grow to 30% of GDP. This is a huge growth from the historical average which trended in the last half of the century just under 25% of GDP. Basically we will see a growth in government by 20% if these forecasts are correct. That is a large number, but it is nowhere near the debt ratio that businesses and individuals carry. If we view our government as a corporation, then we are OK.

Of course, being an economist, I have an "on-the-other-hand" qualification. Government sits astride a society consisting of individuals and corporations. In welfare theory we assume that government exploits rates of return which are higher than market rates. The issues an omniscient and benevolent governor chooses is one burdened with incentive problems sufficient to make it difficult or impossible to solve in the absence of government intervention. One example of this is the interstate highway system. Investment in infrastructure has been calculated to outperform market returns consistently, yet was not something historically provided at the scale that the Eisenhower system provided. This proved necessary for much of the economic growth that surrounds our cities and higher population density areas. This is strong argument in support for infrastructure. [I ignore the opportunity cost argument for this money]

I do think we should invest in infrastructure; but is it necessarily something we should do as a government? New technology is allowing private capital to be available at precisely the same time that the federal government is hitting a wall with their ability to raise revenue. Bonds are constrained by threats of sovereign debt crises in Europe and inflation is widely understood to cause pervasive damage. This means that any increase in taxes possible is already spoken for. It has to fund existing social security obligations. It is fortunate for us that we can turn to private capital to fund some of the public goods that we have traditionally thought of as public works projects.

Take toll roads for example. Tolling used to be something that we thought was prohibitively costly. We hate toll booths and paying people to sit there all day and collect money faces rising wages and collective bargaining. Now we have E-Z pass and various new GPS technologies private firms (just like Facebook, credit card companies, and others) can manage the pricing of our activities based on our use of the services. The path is open for taking things off of the government budget. I am convinced that technology has solved many of the problems we used to rely on government to solve.

The role of government is open for debate, but I suggest that we can be much more clear about what role that that government should play. If we want to fund programs that provide social justice, that is great. However, let us be clear now about evaluating the impact of health care, education, social security. Are we getting what was promised? These central issues for government are possible to disentangle from the role government plays in managing business. For the role that government plays in regulating industry, I am less convinced after the banking bail-outs that government can do this well at all. It becomes hard to have lawmakers write good laws when all of the information they get about the industry comes from those standing to benefit from the legal changes.

I am hoping that technology is a solution to these problems. Technology helps to eliminate many of the market failures that cause the need for intervention. Technology may decrease monitoring costs for abuses of the system. In short, I am hoping for an increase in transparency. Maybe technology will even help to means-test the provision of social security so that we can help those that need it and avoid the bloodletting predicted in most deficit forecasts. If we want to help the least-well-off, why do people with very high salaries qualify for social security? This might be a first step in decreasing spending.

Reading Groups

Everywhere I have lived I have tried to participate in reading groups. I love reading, but there is nothing quite like sharing those thoughts about your reading with others who reflect the enthusiasm you have for a work. I wonder if this makes me unusual among readers, the fact that I like to verbalize the content.

Since beginning graduate school I have tried to organized reading groups for already published papers and for working papers. To me this was clear, we had to talk about the papers to really understand them. It is interesting to me to observe the different things one can take away from an article. Especially since that article was honed and refined presumably to contribute an isolated incremental insight to the larger literature.

Today, I have spent time reading a wonderful piece by a friend and colleague. This paper has many good aspects, but I struggle in my own ability to critique writing. There is always room for improvement, but how do we suggest this without displaying our own ego. I have a broken mechanism for knowing if the insights that I offer are tangents to the author's purpose or if they are salient points helpful in revision.

So much of what we do with writing is to take stabs in the dark. How do I know this speaks well to the audience? Because it is similar to something that has worked in the past. People assume that writing is an art. This would imply that we have an innate sense of good writing. I probably thought that at one point, but I have learned over the years that it is a craft. The important difference is that it is not something you are born with, you must develop the muscles, so to speak. It is learned through hard work and working with others to understand and appreciate what they need to see in order to find common ground with your intended topic. Often that common ground is vanishingly small.

I have many times grabbed a published paper whose title or abstract attracted me, only to realize that the author was overselling a particular aspect of the piece or was very unsuccessful at convincing me that it was more than a tangent. I am left thinking that I either missed something, or the article was poorly written. How can I do anything but assume that the fault lies in my own understanding? I have my own troubles communicating ideas, but we all have confidence that the referee process is one that at least certifies a minimum standard of literacy. So I am frustrated. Either the state of the craft in our journals is low, or I am missing the point.

As opposed to writing things "off-the-cuff;" journal articles are polished. So how do we do this polishing? I think that paper workshops are great. We get to see what other people are doing and gauge our own progress against theirs. I am very fortunate to have such a group to participate in this process with. However, I wonder sometimes if it is really possible to have the fully frank discourse that is necessary to refine the craft. Since we are not trying to simply get by the challenge is greater. We are writing to correct what we see as errors in the existing literature, not just pad a CV. How can I court the type of frank feedback that I need to develop my own writing?

I wonder if others feel that their writing is a process of discussion. I always feel from other writers that I encounter that they learn to write for themselves. We joke in academia that articles are written for 5 people to read (if you are lucky). I can see the progress in my writing, however, I want to develop more than the ability to get by. I would like to court the type of reactions that will make me embarrassed when I make my usual battery of mistakes. At the end of the day I am looking for the opportunity to develop by assuming that I know very little compared to what I will one day absorb about writing.