There is really only one achievement that gives economists public credibility: the ability to reliably explain (and preferably predict) macroeconomic phenomena. The recent economic crisis has left many professional economists shrugging. Standard models and textbook economics don't offer explanations. Even new-fangled behavioral economics research can't explain why an overheated housing sector managed to kneecap the entire world economy. August economists George Akerlof and Robert Shiller propose a theory that they claim will explain recent events in Animal Spirits , which is a term stolen from the theory of none of other than the revived John Maynard Keynes.
Akerlof and Shiller actually enumerate five animal spirits: confidence, fairness, corruption, money illusion, and stories. Keynes simply observed that animal spirits, perhaps a code for irrational behavior, could take hold in financial markets. Akerlof and Shiller explore the effects of their animal spirits in specific economic circumstances. In the process, they try to answer the kinds of questions that give economists panache. Why do economies go into depression (and what could we do about it)? Why can't some people find a job? Why are financial prices volatile when expected earnings are not? Why are minorities poor?
The book is well-written and interesting. It variably connects recent research in behavioral economics (e.g., Ernst Fehr on fehr-ness) and historical economic theory (e.g., Milton Friedman on, well, everything) to current examples of economic questions. It endorses an activist role for government in cases where animal spirits prevent smooth functioning of markets.
Perhaps the least satisfying element is the volume's brevity. Expanding the theory to additional examples would certainly be entertaining. However, the academics surely anticipate that this will happen. Engaging minds will construct and test hypotheses, provided of course that convincing measures of stories and confidence can be found. Reasonably extensive research on corruption, fairness, and money illusion exists.
Sunday, January 31, 2010
Thursday, January 21, 2010
Book Review: Nudge
I am admittedly late to the party in reading this popular book by University of Chicago faculty members Richard Thaler and Cass Sunstein. It is a popular interpretation of the work by behavioralists on the effects of framing and choice architecture. The authors endorse thoughtful choice architecture in light of known proclivities of humans to make decisions which might not be in their best long-term interests. The idea is that by providing people with a "nudge," they are more apt to make the "right" decision. The authors are fairly consistent in this message, although a couple of early digressions on daylight savings time, social interactions, and the Rev. Jim Jones confuse the reader into thinking that nudges cause ineffective substitution effects, information cascades and peer effects, and who-knows-what, respectively. After about the fourth chapter the authors settle into a groove that illuminates their central point.
The nudge framework is presented as an alternative to both unbridled (and often overwhelming) choice and to direct command via governmental proscription. Framing effects have been pretty well explored in the academic literature on behavioral and experimental economics. The book was released in 2007 and in paperback in 2008. It was apparently influential in shaping the thinking of some members of Obama's administration, of which Sunstein is one.
I am broadly sympathetic with the attention that could maybe should be paid to choice architecture. If advertisers and marketers have learned the lessons, and there seems to be plenty of evidence that they have, then perhaps others responsible for public and private decision-making (either their own or that of other people) can also benefit from these insights. While the authors do an admirable job of anticipating their critics in a chapter near the end of the book, they don't explicitly address one of my concerns about libertarian paternalism, their ostensibly-oxymoronic moniker for profligate governmental nudging.
Economists are perhaps unique in their uniform objective of efficiency--most other disciplines, including the subset of behavioral economists--acknowledge the richness of other possible motivations for human decisions. So what makes a decision "right?" Which outcome should we nudge towards? To take a concrete example, consider the nudge inherent in proposed changes to laws for labor union formation: instead of an anonymous ballot, advocates endorse changing the choice architecture so that workers need only sign a (non-anonymous) card. This is pretty clearly the type of nudge that Thaler and Sunstein are talking about. Changing the default is a simple way to affect the outcome of infrequent decisions like unionization. But who gets to decide that more unionization is a good thing? On what grounds? The apparent answer is the party in power, implying that nudges can be undone and reversed as political winds change. On these grounds I'm not sure that nudges are likely to "improve decisions about health, wealth, and happiness;" it seems more likely that they are simply a tool to effect different decisions. So far as there is broad agreement about goals (healthier food choices reduce public health expenditures), nudges are useful. When (potentially clandestine) agendas are forwarded, as in the labor unionization case, nudges take on a less Pareto-improving shine.
The nudge framework is presented as an alternative to both unbridled (and often overwhelming) choice and to direct command via governmental proscription. Framing effects have been pretty well explored in the academic literature on behavioral and experimental economics. The book was released in 2007 and in paperback in 2008. It was apparently influential in shaping the thinking of some members of Obama's administration, of which Sunstein is one.
I am broadly sympathetic with the attention that could maybe should be paid to choice architecture. If advertisers and marketers have learned the lessons, and there seems to be plenty of evidence that they have, then perhaps others responsible for public and private decision-making (either their own or that of other people) can also benefit from these insights. While the authors do an admirable job of anticipating their critics in a chapter near the end of the book, they don't explicitly address one of my concerns about libertarian paternalism, their ostensibly-oxymoronic moniker for profligate governmental nudging.
Economists are perhaps unique in their uniform objective of efficiency--most other disciplines, including the subset of behavioral economists--acknowledge the richness of other possible motivations for human decisions. So what makes a decision "right?" Which outcome should we nudge towards? To take a concrete example, consider the nudge inherent in proposed changes to laws for labor union formation: instead of an anonymous ballot, advocates endorse changing the choice architecture so that workers need only sign a (non-anonymous) card. This is pretty clearly the type of nudge that Thaler and Sunstein are talking about. Changing the default is a simple way to affect the outcome of infrequent decisions like unionization. But who gets to decide that more unionization is a good thing? On what grounds? The apparent answer is the party in power, implying that nudges can be undone and reversed as political winds change. On these grounds I'm not sure that nudges are likely to "improve decisions about health, wealth, and happiness;" it seems more likely that they are simply a tool to effect different decisions. So far as there is broad agreement about goals (healthier food choices reduce public health expenditures), nudges are useful. When (potentially clandestine) agendas are forwarded, as in the labor unionization case, nudges take on a less Pareto-improving shine.
Monday, January 11, 2010
Book Review: Superfreakonomics
Steven Levitt and Stephen Dubner follow on the tremendous success they enjoyed with their initial effort, Freakonomics, by pushing the envelope beyond sumo wrestlers to hookers.
The final chapter has been the source of virtually all discussion about this book. I'd embed the hyperlinks, but I'm way too lazy. Instead of joining the plaintive cries of heresy by those who would prefer faster and more immediate action to counteract limate change, or the more reasonable queries about the facts as Levitt and Dubner present them (e.g, DeLong), I'd like to address my concern as an economist. I expect Levitt to get the economics right, even if Dubner wrote most of the chapter.
In trying to be provocative and a little cute, the authors suggest that geoengineering might be a cost-effective way to offset emissions. Maybe it is. Certainly some of its proponents are wicked smart guys (e.g., Myhrvold). Forget about the engineering problems--they are easy to solve--the underlying problem is that the climate is a public good. We can't prevent anyone on the planet from experiencing the same climate as the rest of us, and one individual does not preclude another from experienceing the climate. So the economic issue involved in forestalling global cliamte change is a public good provision problem.
Public goods are not always provided in optimal quantites by private actors (sometimes they are--lighthouses, for example) for any number of reasons. One reason that Copenhagen was such a miserable failure is that nobody figured out how to solve the strategic interaction problem inherent in the necessary multilateral action. All of Europe can preach what it wants, but if China and India head in the opposite direction, the aggregate effect will be negligible.
Again, the problem is not that we don't know how to curtail emissions--we do. We can put a price on carbon, which will provide a valuable incentive. There are a number of good ways to do this through tradable permits, taxes, or other instruments. The problem is in imposing/enforcing that price everywhere in the world when there is a strong incentive to cheat.
Pumping sulfur dioxide into the stratosphere will supposedly alter the climate and could be calibrated to just offset warming due to anthropogenic emissions. Great. But geoengineering is also a public good. Levitt and Dubner blithely ignore the issues of public good provision. Who decides where, how much, and when to pump the gas into the air? Who pays for it? What happens if someone doesn't want to pay their share?
Levitt and Dubner's basic insight is maybe there's a cheaper way to get to the objective stated in the Stern report. Fine. But their proposal in no way moves us any closer to the geoengineering solution. Albeit the relatively low price tag sugegsts that a small number of wealthy indidivudals could unilaterally affect the global climate, but who would trust them? Did anyone else get scared by SPECTRE in all of those Bond movies? After all of the schlock about thinking "freaky," or like an economist, exploring the hidden side of everything, ..., I expected more from the authors.
The final chapter has been the source of virtually all discussion about this book. I'd embed the hyperlinks, but I'm way too lazy. Instead of joining the plaintive cries of heresy by those who would prefer faster and more immediate action to counteract limate change, or the more reasonable queries about the facts as Levitt and Dubner present them (e.g, DeLong), I'd like to address my concern as an economist. I expect Levitt to get the economics right, even if Dubner wrote most of the chapter.
In trying to be provocative and a little cute, the authors suggest that geoengineering might be a cost-effective way to offset emissions. Maybe it is. Certainly some of its proponents are wicked smart guys (e.g., Myhrvold). Forget about the engineering problems--they are easy to solve--the underlying problem is that the climate is a public good. We can't prevent anyone on the planet from experiencing the same climate as the rest of us, and one individual does not preclude another from experienceing the climate. So the economic issue involved in forestalling global cliamte change is a public good provision problem.
Public goods are not always provided in optimal quantites by private actors (sometimes they are--lighthouses, for example) for any number of reasons. One reason that Copenhagen was such a miserable failure is that nobody figured out how to solve the strategic interaction problem inherent in the necessary multilateral action. All of Europe can preach what it wants, but if China and India head in the opposite direction, the aggregate effect will be negligible.
Again, the problem is not that we don't know how to curtail emissions--we do. We can put a price on carbon, which will provide a valuable incentive. There are a number of good ways to do this through tradable permits, taxes, or other instruments. The problem is in imposing/enforcing that price everywhere in the world when there is a strong incentive to cheat.
Pumping sulfur dioxide into the stratosphere will supposedly alter the climate and could be calibrated to just offset warming due to anthropogenic emissions. Great. But geoengineering is also a public good. Levitt and Dubner blithely ignore the issues of public good provision. Who decides where, how much, and when to pump the gas into the air? Who pays for it? What happens if someone doesn't want to pay their share?
Levitt and Dubner's basic insight is maybe there's a cheaper way to get to the objective stated in the Stern report. Fine. But their proposal in no way moves us any closer to the geoengineering solution. Albeit the relatively low price tag sugegsts that a small number of wealthy indidivudals could unilaterally affect the global climate, but who would trust them? Did anyone else get scared by SPECTRE in all of those Bond movies? After all of the schlock about thinking "freaky," or like an economist, exploring the hidden side of everything, ..., I expected more from the authors.
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