Sunday, May 27, 2012

Tsunamis, Growth, Stocks and Flows, and the Broken Window Fallacy

Just a great piece by Ryan Young in The American Spectator entitled “A Tsunami of Bad Economics”:

Japan was hit by a tsunami last year on March 11. …  What’s the upside to this natural disaster? I’ll be blunt. There isn’t one. But some economists think there is.

To come to such an inhumane conclusion is to forget the economic discipline’s most fundamental lessons. … As it turns out, Japan’s GDP is growing twice as fast as America’s. 

This is a simple mistake to make if the Keynesian model is the basis for your thinking about macroeconomics: higher employment is always good.

But, this goes back to Bastiat’s broken window fallacy: you shouldn’t conclude that breaking a window is a good thing because it creates work when it is fixed.

The reason people get to this point is that they are only thinking about flow variables (current work) not stock variables (past work embodied in current capital). Accountants are very careful about this: that’s why they use balance sheets and income statements. Public policymakers … not so much.

Think about it: we run our macroeconomies based on GDP. This is a flow variable. Where’s the stock variable? We simply don’t think about it much in macroeconomics. Mostly we do this because national wealth is difficult to measure. That’s a reason for being careful, not a reason for ignoring stock variables.

Imagine for a minute that the tsunami never happened. Japan’s GDP growth would probably be slower; Krugman is almost certainly correct on that. And yet, a tsunami-less Japan would be better off. …

As far as the economy goes, all that reconstruction spending would instead go to creating brand new wealth, as opposed to merely replacing what people already had to begin with. It is better to build than to rebuild.

This sort of mistake simply doesn’t happen if you’re using a growth model as the basis for your thinking. In that model, 1) a reduction in capital (from, say, a tsunami) clearly makes you worse off because it leads to lower output and per capita income, and 2) it also will lead to a higher growth rate because it takes you further away from the steady state. But, there isn’t any way you’d view that as a good thing because # 1 clearly causes # 2 in the growth model.

Via Cafe Hayek.

Friday, May 18, 2012

Tim Worstall Nails the Problem with Keynesian Macro


… It’s the politics of Keynesianism that clearly does not work. Doesn’t in fact matter whether it actually works as economics, the incentives to politicians mean that it never will work in practice. [emphasis added]

I’ve been making bits and pieces of this point for 20 years.*

Today, I have lots of students who come in to class with a predisposition to believing that there is no truth at all to the Keynesian paradigm. I think the work of new classical economists over the last 40 years has established that while the Keynesian prescription is not particularly powerful, it’s effects in practice are not zero. But probably not large enough to seriously worry about either.

So, Keynes and Keynesians are, at a minimum, at least a little bit right about the economics.

Now it’s important to put a tiny digression right here: macroeconomists of the last generation have also established the primacy of the “low tech” of culture and social institutions for explaining the lion’s share of individual well-being.

Back to Keynesian macro, and how politicians actually practice it:

Let us, for a moment, accept the basic Keynesian premise, that we should run great big stonking deficits to provide fiscal stimulus in the middle of a recession/depression.

That also means that we should run great big stonking budget surpluses in the middle to end periods of the largest and longest economic booms in advanced country history.

They don’t quite have to be symmetrical …

But there does have to be … some connection between the general size of them.

Now, look around you, we’ve got countries that are, or have been, running deficits of 5, 10, 15% of GDP …

OK, hands up, who can imagine anyone running a 2 or even 3% budget surplus consistently for some years, let alone 5 or 10%?

And that’s the rub: politicians everywhere claim that we are permanently in a position where they can ignore half the theory that’s a little bit correct, and all of the theory that explains the rest.

* Anyone who thinks I’m coming at this from a non-Keynesian perspective ought to go and read my dissertation. It’s pretty pure Keynesianism that I outgrew. Unfortunately, given the revival of stimulus spending, it’s actually started to get cited in the literature again. Pity those poor fools don’t actually call the author; he might tell them the flaws.

Saturday, May 12, 2012

Repeat After Me

Every time you hear someone in the legacy media mention that some piece of economic or financial data has hit a new record, run it through this mental filter before taking it seriously:

Via applied mathemagics.

Saying something is a new world record will catch your attention, but it doesn’t necessarily make something important.

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Germans Call It a Bailout, We Call It Missouri

It’s hard in America to understand how screwed up the European Union is.

Part of the reason is that we’re way more of a union than they are.

Derek Thompson at The Atlantic produced this graphic:

This is a bit difficult to understand, so let me walk you through it.

  • The first row of numbers is the share of the economy for states. The last entry on the right is 5 big states combined together.
  • The bars in the chart are the ratio of federal outlays paid out to a state divided by federal revenues that come in from a state. So, Missouri gets a lot more than it pays for.
  • The bottom row of numbers does the same thing for Europe. Portugal and Greece are “states” that are about the same relative size as Missouri and Tennessee.

The U.S. makes places like Missouri work by supporting them. Essentially this is welfare for states.

Thompson’s position, is that if bigger European economies did this for Greece and others, the problems might go away.

I don’t think that follows, but it is a useful idea to carry forward.

Via I Love Charts.

Tuesday, May 8, 2012

Hayek On Exhaustible Resources

The ultimate resource is human ingenuity:*

The "fixed" character of minerals has been a siren song to economists who saw less when there was really more. The mineral economist should never forget that what resources come from the ground ultimately depend on the resources in the mind.

Hayek via Bradley via David Henderson of EconLog.

* This is why Paul Romer made the point that 40,000 years ago we were painting (cave walls) with iron oxides, while today we are painting (hard drives) with iron oxides. The capital in the raw material is the same, but technology has augmented the productivity we get out of it.