Second Year Update

I was much more successful at keeping you all in the loop about first year stuff. That's a big year in an econ PhD, so it's maybe natural to be more conscious of everything going on. As with any "first year," it is also a confusing time. You don't know how everything works and you're just trying to get by.

Second year is much more... routine. I taught a course on Micro 101 last fall, which I'm teaching again this spring. That's slightly new, but not that much of a change from being a TA. Courses that I'm taking are like courses from last year. Not a lot of the changes from first to second year are overly stressful.

So that's my long justification for not blogging more about second year. It's mundane...

But since this is my blog and I can be as self-indulgent as I want (and because a few relatives actually care), I figured I give an update of what is going on for me as I'm about to start the spring semester.

Like last year, two big things on my plate right now are courses and teaching. However, courses are a smaller role than during first year. While I need to pass two "field" exams in the spring (monetary and public economics), courses aren't overly burdensome. (I probably should have focused on coursework more last semester...) They can be 100% of your focus, if people want them to be, but they don't have to be. First year courses have to be your main focus.

So I don't have a lot of courses that I worry about and I only teach once a week... What do I do with my time in the second year? That's a great question and I'm not quite sure. I guess the answer is "research," whatever that means, trying to come up with something original. It's not easy.

I'm in the transition stage, learning how to produce independent research. It's a completely different struggle than anything I've done before, but it's also a lot of fun. There is lots of freedom to explore ideas that I want, compared to classes. I appreciate that every day.

I get to wake up and read papers that interest me. That's pretty neat.

I won't claim to know what it means to do research. I certainly haven't figured it out. But the approximation that I'm working with for me involves reading, writing, staring at a whiteboard full of equations, and occasionally looking through data. I probably put too much time into the reading part, but it's a lot more fun than staring at the whiteboard all day and making no progress.

Since theory interests me more than empirical work, my "hard work" involves the same stuff as Raj and Sheldon.

Unfortunately, the past semester of research has ended up in more circles and dead-ends than actual progress and insights. I feel like my research ideas completely change every week. I've learned a lot about what I don't want to do and what doesn't make any sense. It's a confusing process... But we will see if any of it turns out.

Things I'm Working On (And Excited About)

Friends and family often ask what I'm working on, so let me try to explain:

  • A large part of my semester was spent working on a project about inequality and coordination, using something called global games. I'm looking at how inequality changes the ability of people to work together on projects, say a large investment. Imagine there are two types of people, rich and poor. If those groups are very very different from one another, they might have a hard time working together and coordinating. I need to do more data work and expand the model, but my simple model matches some simple empirical aspects. We will see where it goes, but it has been a fun project to start on.
  • The most progress I've made is on a paper about entrepreneurship and coordination. I have an early, early, early.... early draft up if you want to check it out. In it, I'm thinking through the relationship between coordination (a recurring theme for me) and entrepreneurship. If people need to coordinate their actions, such as buyers and sellers going to a farmer's market together, there can be trouble. If everyone believes that everyone is staying home, then staying home is self-fulfilling and is the outcome. In the paper, I look at how entrepreneurs can help avoid this problem. If economists look at the bigger picture, with the entrepreneur involved, the image changes. Let me know what you think. I'm presenting this at a conference in the spring.
  • The most frustrating project has been a paper I'm trying to write on interpreting optimal taxation papers. I'm trying to formulate a way of talking about optimal taxation without being purely about normative policy recommendations. To do that, I have to figure out how everyone else is talking about optimal taxation. The problem is that no one articulates what they mean when they have a result that says "optimal taxes are increasing..." How are we to interpret such statements? No one can tell me what those papers mean, so I don't know how to formulate my counter. In fact, it's odd to be thinking about a counter when you don't know what you're actually countering... I'm also presenting this, if I ever get my argument together.
  • My most recent project is looking what it means to do "optimal taxation," if the government is not perfect. If the government doesn't perfectly maximize the utility of it's citizens, what can we say about their own desired tax system? To do that, I'm building a model that combines regular optimal taxation, where the government wants to help people out as much as possible, and a monopolist model, where the government wants to get as much as possible and reach the top of the Laffer curve. I'm thinking that reality has governments somewhere between perfectly benevolent and perfectly malevolent. Maybe this model can generate some insights.

Don't ask me if I'm working on the same things next month. They might completely change. I'd love to hear if people have any ideas about these projects, based on an admittedly short and confusing summary.

But, that's what my life is now in second year, if anyone is interested. I'm doing less coursework than most classmates, so I need to replace that time with other stuff: trying to make sense of these four projects and not go insane.

Wish me luck!

Best (Old) Journal Articles I Read in 2015

One of the few sad things about becoming a grad student is that I read books less and less. That means less econ and less non-econ books. Well, the non-econ group was limited before too... According to Goodreads, I only read 28 books in 2015, down from the 70's a few years ago. But most of those are textbooks or collections of articles that I read enough of to justify saying I "read" them.

Economics, at least much of modern economics, is dominated by journals and that is reflected in my reading habits. Whenever my wife asks what I did all day and I say "read and wrote" (it should be the reverse, whoops), that means articles. I still probably actually read more than I should (compared to skimming/"reading" for research).

Because of this, I can't do those fun posts about the best books I read in 2015 like other blogs or like I did last year. I need to get back to books soon... I miss books :'(

Anyways, where was I? Oh yes. Those old articles.

Well, some of the articles I read were actually good and after some feedback on Twitter I decided to do an end of the year recap of those articles. Most of them I read since June for silly-things-about-Phd-programs reasons.  I'm thankful for many of these suggestions which came from my good friends on social media. They might seem a bit eclectic, but I liked them... The one's related to my research are marked with a *, if anyone can reconstruct what I'm working on. In no particular order, (some gated)

Come to think of it. They weren't all old. I'm still read some new articles too that were a lot of fun.

So there they are. They each taught me a lot and were fun for me to read. I don't know how many other people will find them fun, but I sure did.

I can't imagine how much fun stuff I'll get to read in 2016. I love this job!

Profits under Competition

My last post probably generated more confusion than clarity. Let me try to clarify some conceptual points that might help bring my thinking into focus. In that post, I was trying to work through the inequality/rents connection. I argued that the standard way I've seen it presented doesn't make sense to me. I tried to argue that increasing rents is neither necessary, nor sufficient for increasing inequality. In the more speculative parts of the post, I suggested why I think this confusion exists.

Let me try to make a related point that I might clarify what I have in mind. I'll try to be less speculative and simply present basic economic theory.

Let me tell the story I've heard:

Economics rents, sometimes associated with monopoly rents, are often presented in opposition to the perfectly competitive market. They are two "extreme" forms of markets. It's said that in the perfectly competitive markets profits are driven to zero. However, with a monopolist in the figure below, quantity supplied is "restricted" to Qm. This drives up the price of the good the monopolist sells to Pm, which allows him to make a producer surplus, profit, or a monopoly "rent," whatever one wants to call it.

Monopolists are bad, because they generate a deadweight loss shown in the figure. In addition, because monopolists make profit, this creates an incentive for firms to try to make themselves a monopolist. If for example, a firm can get the government to prevent other firms from producing a produce, then a firm will lobby for such protections. This lobbying is called "rent-seeking," which I talked about in the last post. Rent-seeking is wasteful.  That's another reason that monopoly rents are bad.

Therefore, the contrast presented is between perfectly competitive markets with zero profits, which is sometimes endowed with a positive connotation, and monopoly markets with profits, which is sometimes endowed with a negative connotation. Rent-seeking is thrown in for good measure.

That's not the actual theory though.

The sleight of hand came when defining the perfectly competitive market. A perfectly competitive market does not require zero profits. Let me say that again. A perfectly competitive market does not require zero profits. My students make this slip often, which is my fault as an instructor.

Perfect competition doesn't require zero profits in the Econ 101 version or the fancy math versions we learn in graduate school. We can make assumptions that lead to zero profit in the long run, but zero profits is neither part of the definition of a competitive market, nor a direct implication.

Take the standard example below with an upward sloping supply curve and downward sloping demand curve.

This market can be perfectly competitive. There are no externalities and everyone takes prices as given.

But there are still profits. Only good number Q* has zero profit. Inframarginal goods before that make a profit, or economic rent.

As is hopefully clear from this, profits or rents cannot be used to distinguish the monopoly case from the perfectly competitive. In both, firms make profits. Nor can we use "income" as a proxy for rents, because of what I said in the last post.

The connection between income, rents, inequality, competition is just not tight enough to make inferences between two of them. Remember that when someone tries to use "rents" to make you react like Pavlov's dog. "Rents" are not enough for positive predictions, let alone for normative policy implications.

Institutional Details

We need to have a more subtle theory to make these connections. This is where we need to look at the property rights structure and broader institutions that a market is a part of. Such institutional details are the way to distinguish monopoly from competitive markets, "good" profits from "bad" profits.

This means looking at the rules of the game, not looking at the outcomes of the game, say by looking through the balance sheet. In the article mentioned in my previous post, Dean Baker hints at the institutional details, but mainly focuses on outcomes, such as revenue.

If one examines a market, say in pharmaceuticals, and wants to judge whether "rents" are increasing or decreasing, we need to look at the rules of the game. Are patents extended? Is it harder to get drugs approved? That's the evidence of increased rents from monopoly privilege, not the increased revenue or accounting profit.

Distinguishing these two aspects is vital for talking about clearly about monopoly rents and inequality. Once we've established an increase in rents associated with monopoly privilege, then we can possibly see a connection to inequality.

Rents vs. Rent-Seeking

If this post sounds confused, it is probably because it is. I'm trying to work through what people mean when they use the word "rent." They seem to slide between rents and rent-seeking, which are connected but different things.

Few words in the discussions of inequality are more of a non-sequitur than "rents." Going back to Ricardo, the word conjures up images of landed aristocracy charging high prices to the poor who work the land. Because rents are sometimes used as on the face of it evidence of a problem, I try to be cautious anytime the word is thrown around.  It's too easy for me to get mixed up. So when I saw a new paper from Dean Baker (HT: Nick Bunker)  on rents, I needed to make sure the terms were clear.

First, what do we mean by rents? Let's take Baker's definition.

“Rent” is used to refer to an income that is generated that exceeds what would be needed to meet the same economic purpose given an alternative set of institutional arrangements. (p. 2)

Right away, I'm confused. Is it helpful to talk about the "same economic purpose" under different institutional arrangements? If we are playing a different game (chess vs. checkers), how does one tell what actions have the same purpose? Making a ten ton steel nail in the Soviet Union is not the same thing as making that under capitalism.

For sake of generosity of reading, let's say we can define the same economic purpose. Now the question is what is the "alternative set of institutional arrangements"? If I make $15,000 teaching undergrads, but would make $0 teaching under an institutional arrangement that permits slavery, is it useful to say my whole teaching salary is rent? I guess we could define rents that way, but I don't think we want to.

I'm guessing that's why I've never seen "rent" defined (as Baker defines it) in any economics textbook or course.

Defining Rents

From what I've learned which is admittedly little, rent is almost the economic equivalent of "profit." It's market value minus cost.

That is, economic rent is the difference between the actual payment received (the hire-price) and the lowest payment the owner would have been willing to accept. (Hirshleifer et al. 2008, p. 402)

Defined as a return in excess of a resource owner's opportunity cost. Tollison (1982)

An economic rent is simply the market value of resource in its highest valued use minus its market value in its second highest use. Thinking in pure dollar terms, it is the price paid minus what it could have been sold for in another market. If people define value and cost properly, economic rents are equivalent to economic profits. Reading Baker's piece with this definition in my mind, I don't see the connections that he makes.

Rents get associated with "excessive" fees and income in the Baker paper. With my definition, it's not clear that rents have anything to do with "excessive" prices.

Excessive can't simply mean greater than zero. In one way, rents are always greater than zero. Trivially, the highest valued use is above the second highest valued use. This can't be what people are worried about when they worry about rents. The fact that 10 > 8 is nothing to get worried about. There must be something else that worries people.

Perhaps, it is not any rents that matter, but only "excessive" rents means an increase in rents. That seems to be Baker's focus. But that can't be it either, since rents are neither necessary, nor sufficient for high incomes, which is the connection that Baker tries to make.

To see how rents are not necessary for high income, consider an extremely skilled person such as LeBron James. To simplify matters, let's assume he only cares about money. (This isn't an important assumption, but helps with the clarity.) According to Google, his salary is $24 million for 2016. Clearly, that's a high income by any standard.

Does that mean he has high rents? Not necessarily. That would be like seeing high revenue and saying a company has high profits. They're conceptually distinct. To see if he has rents, we'd need to know the cost side for him. If he wasn't playing in Cleveland, would his salary be much lower? It's not clear to me that it would be. Therefore, his opportunity cost of playing for Cleveland is high also, whether we are talking about alternatives that include playing for Miami, playing in the NFL, or making commercials. Therefore, any increase we see in his salary does not imply there is an increase in rents.

Do higher rents mean a higher salary? Not necessarily. What if opportunity costs drop dramatically? That would mean a higher rent without any change in income. In fact, you could see a drop in income associated with higher rents. Consider supply and demand drawn below. The rents are the difference between price and marginal cost (the supply curve). If opportunity cost drops, that leads to a shift of the supply curve. Price, which is income in a labor market, drops while rents for each person increase.

So we have neither a necessary, nor sufficient connection between rents and income. That's the reason I'm hesitant anytime someone is trying to make the rents-inequality connection. Maybe it's obvious to others. It's not to me.

However, the empirical work that Baker presents is about income increases. Rents are a trickier thing to deal with.

Rent-Seeking

Do people mean "rent-seeking" when they discuss rents and inequality? Rent-seeking for government protection does involve a logical connection between rents and income, if the right assumptions are made on the cost structure. Tullock taught us this back in the 1960s. (Well I didn't learn it until years later, given that I wasn't born yet in 1967...) People will lobby for government protection to limit quantity in a market, such as the AMA restricting the number of doctors. The reason they engage in this rent-seeking is to drive up their own profits or rents.

I think that's what Baker is getting at. At least, that seems his focus in the sections on patents and on professionals.

In the last three decades as a matter of policy, these monopolies have gotten considerably stronger and longer. (p. 5)

The most highly educated professionals, most notably doctors, enjoy far higher pay than their counterparts in other wealthy countries. This is due to the fact that they have been largely able to protect themselves from both domestic and international competition. (p. 16)

If that's the argument Baker is pushing, he needs to provide empirical evidence on the rent-seeking behavior, not the income. He hints at rent-seeking and gives some estimates of savings from ending patents, however these estimates don't seem to be based on calculations of rent-seeking. But again, I'm not sure what people are usually talking about since they use odd definitions or slide between different terms.

I'm not sure of much though...

 

Self-Driving Cars and the Market for Ethics

People are talking all over (in my small world, at least) about the ethics of self-driving cars. Self-driving cars inherently face ethical decisions. Cars must be programmed to make these ethical decisions, trading off different costs including the relative value of people's lives. The MIT Technology Review asks:

How should the car be programmed to act in the event of an unavoidable accident? Should it minimize the loss of life, even if it means sacrificing the occupants, or should it protect the occupants at all costs? Should it choose between these extremes at random? (See also “How to Help Self-Driving Cars Make Ethical Decisions.”)

The answers to these ethical questions are important because they could have a big impact on the way self-driving cars are accepted in society. Who would buy a car programmed to sacrifice the owner?

That's an interesting discussion and I'm glad people are having it. The article highlights some work using experiments to try to understand how people would make these trade-offs.

I'm not an ethicist, nor a computer program, so I don't have much to add to those conversations. But I'm an economist and know a little about spend time thinking about markets. What interests me about the situation is how markets might arise between different ethical systems. People will be able to choose (and pay for) software that makes different ethical decisions for them. Have we seen that before?

The beauty about a market in ethical systems is the same as the beauty of a market in other issues. Markets won't rely on the research of economists, but the choices of individuals who have to make these trade-offs. The decisions of disparate people are given a voice through the market.

(I doubt that governments will let such markets work for long before mandating certain ethics, but indulge me for a moment that governments allow markets to operate. A later post might deal with how government would mandate a certain ethical system.)

Imagine Larry, animal lover. He has a real fondness for all animals, especially large animals: deer, moose, rhinos, whatever. He believes it is wrong to harm these animals. When given the choice between a 100% chance of killing an endangered rhino and a 0.1% chance of killing a person, he'd save the endangered rhino. That's the ethical trade-off that he chooses for himself.

Now Larry's friend, Sarah, doesn't care for animals as much. She puts more value on saving the person and in this situation would choose to save the person. In a world without markets, what are self-driving cars to do?

That's where the beauty of markets come in. Markets developed to coordinate marginal trade-offs across people. Markets in ethics (as in groceries) give the consumers more options between goods. If Larry and Sarah want different software and are willing to pay the different costs of making and using that software, they can pick out the feature of their car, just like they pick out leather seats.

Now that seems odd. People can choose among ethics at the same level as the type of seat? We don't often make such obviously ethical decisions, but who knows about in the future? We have markets now in ethical decisions that would have seemed odd to our ancestors: free-range beef, "fair" trade coffee, environmentally friendly. People can pay for their different preferences. Self-driving cars seem a little different, because the decision is so explicitly ethical. The owner gives specific weights to the value of lives, animals, and property. Just because it is explicit doesn't mean it is fundamentally different than the market for grass-fed beef. Markets would still work to coordinate people's choices in this market.

If people have expensive tastes, like they want to avoid every squirrel on the road, they must pay for that through better, more expensive technology. Each individual would be able to make such trade-offs for himself. Markets do that.

People, whether they realize it or not, will explicitly buy a utilitarian

Maybe people will not want to make these decisions and they will simply take whatever Google or Uber gives them. But maybe not. Maybe vegans will form a strong enough group to have a market that values animals highly. A beauty of markets is that no one needs to know in advance. The market will develop spontaneously as people learn more.

Legal Questions

Of course, markets do not operate in a vacuum. All markets function in a system of more or less protected property rights. How property rights come to be defined in the self-driving car market will have huge implications for how the market develops. Particularly, liability laws will change the marginal trade-offs people face.

Take an extreme example where owners of self-driving cars have zero responsibility for the damage that their car causes. In that property right system, any marginal trade-off that the driver is facing tilts toward protecting the driver. This is Econ 101. Since he does not pay anything if he imposes a cost on other people (by hitting them), he will hit choose a software/ethics that has a higher chance of hitting people outside of his car to protect him inside. I doubt many people hope for that property right structure to develop.

A more realistic example would involve liability similar to what drivers face today. Drivers have to pay some amount to hurt victims or damaged property. If liability develops in a successful way, we return to a situation where people have to pay people for costs the car imposes on outsiders.

In the ideal liability world, this might greatly simplify the calculations for the software. The software can simply choose the route that minimizes expect costs, which include costs to the driver, vehicle, and liability.

Where exactly these calculations will go, I have no idea. But I'm excited to see how it develops, if the state allows for a market to develop which would allow people to "vote" for what they value through what they buy.

How do you think a market might develop? Let me know in the comments.

Two Cheers for (Good) Theory

Everyone is having a grand-ole time cheering about the "new" empirical wave of economics. Write-ups about the recent Nobel winner, Angus Deaton, have talked all about his influence on data analysis:

His method of careful analysis of data from household surveys has transformed four large swaths of the dismal science: microeconomics, econometrics, macroeconomics and development economics.

He has brought microeconomics — traditionally a field populated by theorists — into closer connection with the data. Partly because of his influence, modern microeconomists are more likely to spend their days knee-deep in large-scale data sets describing the real-world decisions made by millions of people, and less likely to be mired in Greek-letter abstractions.

Much of the empirical revolution in economics has been enabled by the tools that Mr. Deaton developed. These tools reimagine the role of economic theory, using it to organize and interpret the tidal wave of data coming from the hundreds of household surveys conducted around the world each year.

Bloggers have gone nuts over it, but it's not only them. The John Bates Clark award has been heavy on the empirical micro lately;

(E)ssentially changing this prize from “Best Economist Under 40” to “Best Applied Microeconomist Under 40”. Of the past seven winners, the only one who isn’t obviously an applied microeconomist is Levin, and yet even he describes himself as “an applied economist with interests in industrial organization, market design and the economics of technology.”

I get it. Increased data and computational power have allowed us to do things we couldn't do 10 years ago. It has exploded.  Plus, for the blogosphere, the data turns into pretty pictures that we can all uuuhhh and aaawww at. FiveThirtyEight and others have made a whole industry out of this.

It's great. I love it.

But theory is ultimately the force that drives our understanding of the world. As Hayek wrote, the abstract is primary. That's why I love seeing Rakesh Vohra come to the defense of theory. I know; shocking that a theorist would defend theory... It's short, snarky, and spot on, as blog posts should be. (And hard to excerpt it so read it.)

If you'll indulge me and let another theorist try to defend the first theorist, using theory... I'll use a theory to try to think through the marginal benefits of theory and empirical work. I think Supply and Demand is a pretty useful theory for thinking through things... But I might be biased.

Let me try my best at making pretty pictures. (If FiveThirtyEight wants me to start designing charts for them, I'm available. Call me.)

Suppose because of a technology "shock" the marginal cost of empirical work declines. This causes a shift to the right of the supply curve of empirical work, lowering the marginal value of empirical work.

supplyshift (1)

This LOWERS the marginal value of empirical work. The next regression gives less value than before the technology shock.

If you believe, like I do, that empirical work and theoretical work are complements, then this should cause a shift of the marginal benefit of theoretical work. I don't think that markets adjust instantaneously, so there might be lag for the theory market to adjust to the change in the empirical market.

demandshiftIf this model gives us any insight into the markets for research, I'd say it says the exact opposite of the standard conclusion.

The marginal value of theory is now HIGHER, because of the "data" revolution. If today is between the shock and the final adjustment of theoretical work, the marginal value of the theory will continue to grow.

So I'll get back to my theory work...

Nobel Predictions and Wishes

 

 

It's that time of the year again where people are abuzz about who made the cut and who didn't. No. I'm not talking about the MLB playoffs. I'm talking about the Nobel Prize in Economics.

It's the time of the year where geeks like me get giddy with excitement. For a moment, an economist makes headlines. It's a fun time, the closest we come to the excitement of a sport.

Since this is my blog and I can do whatever I want, I thought I'd post my completely arbitrary predictions about who will win. Disclaimer: if you believe these predictions are based on any scientific procedure, I have an ocean front property in Arizona to sell you.

Prediction:

  • Robert Barro - "for his contribution to the theory of economic growth"

Wishes (and why):

  • Israel Kirzner - "for his contributions to the theory of entrepreneurship"
    • Because he's my favorite living economist. The opening of his book Competition and Entrepreneurship is the reason I became an economist. I can still remember reading it in the library. My blog is named after his first book. Need I say more about how I'm a fan of Kirzner?
  • AndreiShleifer and RobertVishny - "for their contributions to the study of corporate governance and finance"
    • Shleifer is one of the most creative economists in the last few decades. His work on regulation, behavioral economics, and law and economics is top notch.
  • Randall Wright andNobuhiroKiyotaki - "for their contributions to the theory of money."
    • Wright is teaching my monetary class next semester. I enjoy his work enough and would love to say I studied with a Nobel winner. I know it's stupid, but hey, why not cheer for the home team?

There we are. With the full backing of science, my prediction and hopefuls.

What do you guys think?

P.S. I don't care that the Economics Nobel isn't a "real" Nobel.

Altruism, Welfare, and Refugees

I have a hard time making sense of the world without simple models. The recent refugee situation/crisis out of Syria is one example where thinking through simple models has helped me make sense of small part of it. Let's see if people agree.

Consider two countries, both with 100 people and a government. Each has 40 rich people and 60 poor. The poor make $10 per day and the rich make $100. The only thing that is different between these two countries is how they set governmental policies.

In country 1, all people vote in an altruistic way to redistribute so that all wages are equal. Everyone agrees to redistribute. After redistribution, each person has $46. In country 2, each person is selfish and wants to use the state to take money from others. In a simple vote, the poor vote to redistribute income1. Again each person now has $46.

If policy is set in such a way, or this social welfare function that I've assumed approximately holds, we are left with the same prediction for what policy will be: complete redistribution. How could we differentiate whether a government's policy is more like 1 ("altruistic") or 2 ("taking")?

Now imagine another policy issue: whether to let another person outside of country 1 or 2 move to that country. This person has $0. Here, the two countries set different policies. If policy was set altruistically or benevolently, country 1 would let the person it. Country 2 would not.

What do we see around us? It's not controversial that we see both redistribution and immigration restrictions, although not completely. That suggests to me that governmental policy is more like country 2 than country 1. Policy is not to help the poor, but to take from some and give to others.

Of course, country 1 isn't the only world consistent with redistribution and no immigration. A SWF where people are altruistic nationalists (people are altruistic but only to people within the imaginary border that we call a country) would work too. There are probably many more.

What policy would distinguish between "taking from the rich" and altruistic nationalism?


1. I assume the poor can't take all the money for themselves. I could come up with a voting scheme that would make this the outcome, but that is beyond the scope of this post.

Emphasis of Economics and Math

Yesterday's post tried to lay out why I believe the fundamental difference between Austrians, Chicago school, and Samuelsonian economists is only one of emphasis. Thinking more about it, I was reminded about an interview with Kirzner that also bring in the use of math in economics (one of my favorite topics to get myself in trouble).

In an interview for Liberty Fund, Kirzner says the following (54:20):

If one believes that the description and analysis of equilibrium states constitutes the central task of economic analysis, then the role for mathematics is clear and indisputable because mathematics can and should and is able to grapple with the meaning of an equilibrium state... and to the extent that's all one has to do, then mathematics would be fine. The problem is, as Austrian see it, is that that is mere footnote to what economists ought to and should be doing, that is understanding the market process.

If I keeps things like this in mind, I am forced to be more sympathetic to different approaches. The reason some people don't use mathematics is because it is not well equipped to analyze what those people think is important. The reason other people force everything into mathematics is because they do want to analyze equilibrium states.

The same applies to non-math differences. In Becker's textbook, the focus is on describing how whole markets work. If that's what I want to do, his aggregation techniques might appeal to me. If I think the study should be that actions of individuals, I will not want to aggregate in such ways. It's a difference of emphasis, compared to anything antithetical.

This whole point might be trivial, but I forget it. I doubt I'm the only one.

Of course, that just kicks the can. Then the question becomes, not what techniques and models should we use? But, what is worth studying? And I wish I had an answer for that... If you do, let me know.

Update:

Michael Harris tweeted at me something I found quite interesting.


I think that gets at one important aspect. If Austrians wanted to study the same things as non-Austrians, they would use the same tools. I'd bet the reverse is also true.

Austrians vs. Chicago School vs. Samuelsonians: *Only* a Difference of Emphasis

A long, long time ago, I had the bold idea to work through three textbooks in economics from three different perspectives: Murray Rothbard's Man, Economy, and State, George Stigler's Theory of Price, and Mas-Colell, Whiston, and Green's Microeconomic Theory, or as I separate them: Austrian, Chicago, and Samuelsonian.

Boy, was I naïve then? I also set myself the goal of trying to translate these texts into short blog posts as a way to learn. While I gave up on the blog posts (to no-one's disappointment), I kept reading each book. Almost two years later I can report that I've finished working through each book. Worked through, not necessarily understood everything...

I chose this strange task, because I had always been fascinated by different approaches to economics. What does it mean to do economics? How have different people answered that problem? All these questions are generally things grad students aren't supposed to worry themselves with.

I couldn't help it.

While my perspective can never be completely balance to judge these three books, I worked hard to give each a friendly reading. As I'll explain, reading each with a friendly eye was extremely valuable. Maybe I even understand a thing or two from each book. I definitely understand more thoroughly why different economists believe different approaches are the right way to go. I'm more sympathetic to the disagreements in presentation and style. Honest people just have disagreements on what is important.

A Few General Thoughts

This post is about  my thoughts after studying each book. If you want to read this as a comment on different "schools" of thought, go ahead, but I'm focusing on the books. However, there is an inherent problem in reading too much into this, because I'm talking about textbooks, compared to pioneering research. Deal with that as you wish.

I came into this project most sympathetic to Rothbard's approach, but left sympathetic to Stigler's. At no point was I a fan of MWG, probably because grad school forced me to study MWG, while the others were simply "for fun." There is a dryness is MWG that is hard to handle, although it was more wordy and entertaining than a lot of the references I used for first year. What does that say about graduate school?

MWG is clearly the most advanced in terms of mathematics and is only workable for grad students. There is no value in studying it before you know the math. Stigler reads like an intermediate text these days, but funnier and clearer. Man, Economy, and State is basically an intro textbook, so it's accessible. Sorry, Rothbardians. It's true. That's not an insult.

Luckily for me though, Rothbard throws in comments that an intro student would glance over, but are food for thought for an economist. Anyone who tries to disregard his book because it seems simple is missing out on lots of insights. It was definitely worth going through for me, even after reading Mises's Human Action a few times. If you're someone who is sympathetic to Austrian economists and would read with an eye to learn from it, it is worth the read. If you're going to read it just to find holes, it's not worth the investment. Finding holes is too easy if the reader doesn't appreciate the Austrian approach.

Similarly, if you're going to read MWG and stop on page 116 because the term "social welfare function" appears without a sneer, fine. You're not going to learn. If you absolutely reject the use of mathematics in economics as a Mises Institute presenter said in a speech to students (48:00), the same thing will happen. You cut yourself off from a whole world of economists.

If you pick of Stigler and laugh at the fact that he doesn't define axioms to start from, you're missing out. Does everyone get my point? Read these books to learn from a grow, not criticize. That's my goal in general.

A Difference Of Emphasis

The rest of this post is where I am going to get in trouble...

While I went into this project expecting to see completely different approaches to economics, the books were remarkably similar. This might make sense when one remembers that each book is still within neoclassical economics, roughly Walrasian, Marshallian, and Austrian. Nothing is heterodox. However, I was surprised. I had learned economics on the internet where everyone spends their days criticizing how dumb the "other" side is.

No. Each method is valuable in its own way.

The distinction comes from each book's particular emphasis, what the authors think is important. The emphasis of MWG is on a completely closed, axiomatic system, defining every part of a model and solving for an equilibrium. For Stigler, the emphasis is on simple, intuitive models that can applied to many problems. For Rothbard, I see the emphasis on coordination of production through prices. Of course there is Rothbard's emphasis on his form of praxeology and being able logically derive economic theory. Yeah, yeah, yeah.

But this is a "peculiarity of presentation."

Speaking about various school of thought in 1933, Mises (p. 288) wrote that

these three schools of thought differ only in their mode of expressing the same fundamental idea and that they are divided more by their terminology and by peculiarities of presentation than by the substance of their teachings.

Just to see how many people I can make mad, this quote still applies to neoclassical schools of thought in 2015, as exemplified by Rothbard, MWG, and Stigler. Mises didn't believe this even by 1957. But I'll disagree with The Master.

Each book's main focus is what Hayek called the pure logic of choice. Given some axioms, derive implications about people's choices. Each books focuses on equilibrium, even though they may have different ways of dealing with disequilibrium. Each has their demand curves sloping downwards, although MWG and Stigler might allow for hypothetical "Giffen goods." Each talks about markets that work to coordinate everyone's actions.

Of course there are also some differences in the tools that people will get hung up on.

  • MWG's theorem/proof style is confusing to people who didn't study that type of math.
  • Rothbard's rejection of advanced mathematics, indifference curves, or cardinal utility might confuse many economists.
  • Stigler's hand-waving, trying to balance between rigor and applicability might turn both sides off.

Yes, if you want to read the three books only looking for the differences, there are plenty of faults in all books.

However, I consider these ancillary to the general topic. None of these should stop readers from being able to learn economics from each book. These are all still *micro* texts. They deal with individual, purposive action. The have buyers and sellers interacting in a market. They have models to capture this. They are working to understand how markets work. Again, all are within the same neoclassical tradition.

The authors change the presentation of the material, but I don't see the fundamental issues that arise from these distinctions. Certainly nothing that would make it impossible for all three groups of economists to learn from one another.

Austrians may disagree with omitting discussions about the structure of production. MWG fans might miss the formal game theory in the other two books. I'll argue that the more fruitful way to read this disagreements is not worry about it. MWG thinks game theory is one of the important topics; the other do not (and they are old). Rothbard spends 300 pages on production; the others do not. Each book has a set of priorities. Space is limited.

Now, I'm sure some people will say that I do not appreciate the importance of some of these differences. They may say that cardinal/ordinal utility is too important to just brush aside. Or math is too fundamental that anything without math isn't "real economics." Fine. Spend your days tearing down the other approach. I'm not sure that is fruitful.

If person A says that the important thing in economics is having a model derived from axioms of preferences, but person B says the important part is having an easily applicable model, how are we to decide? Certainly, it is not a matter of science. I have my thoughts on what are important things to include and what are not. However, I see that as closer to disagreements over favorite band than to substantive disagreements that would hinder learning from each other.

To all economists, this is a plea saying that "the other guy" is not as crazy as you might think. That is my main take-away from reading these books. Authors have thought through economics seriously, but happens to disagree with you. You are only hurting yourself if you don't learn from him.

Moving Forward

I am constantly looking for common ground for research. I want to use insights from all of these and will keep reading in each traditions, particularly their approach to the core theory through textbooks. It helps me understand the hidden assumptions in each framework and clarifies these ideas in my teaching. I'm working through Kirzner's Market Theory and the Price System, Becker's Economic Theory, and Krep's Microeconomic Foundations. Wish me luck! And tear me apart in the comments :)