Nominal GDP (NGDP) Targeting and the Supply Chain Knowledge Problem

 Background: The Supply Chain Knowledge Problem

Last year a wrote a post titled The Supply Chain Knowledge Problem addressing what I believed to be some of the core and fundamental drivers of the increase in prices over the last couple years. Describing the knowledge problem as the fundamental problem of economics (and society), 'know how' and 'know what' are spread across many minds and the knowledge required to make anything isn't possessed by any one person, company, or policy maker. And, especially can't be resolved by any central banker. 

In reference to COVID and our economy I used an analogy of an environmental disaster like a forest fire and the recovery of our economy being analogous to an ecosystem. 

"Just as restoring an ecosystem after an environmental disaster requires an understanding of ecology, we must understand the ecology of our markets and supply chains in order to restore our economy and avoid an even worse ecological disaster. We must recognize that the knowledge problem post COVID is more challenging than pre COVID made evident by recent price spikes and shortages that some people could be confusing for monetary inflation."

"COVID and our response to it unfortunately destroyed the ‘know what’ and ‘know how’ that was spread across millions of minds and across decades of building our supply chains. There is no simple blunt monetary or fiscal policy that can substitute for the ‘know how’ and ‘know what’ it’s going to take to rebuild them. It’s going to take time. Prices have to search and signal for the ‘know how’ and ‘know what’ to rediscover and rebuild what was lost."

I have been dreadfully concerned that if we get out of the way and just let 'P' do its job searching and signaling that there would be political pressure to paper over the damage with an excessive increase in interest rates by the Fed, or even worse politicians passing bills in the name of inflation reduction that might make matters worse. And even more dreaded, we'd experience complete economic amnesia manifested by calls for price controls. 

At the same time, a person would be blind not to consider the impact of the expansive monetary policy of the Federal Reserve prior to, during, and after the pandemic, not to mention the aggressive but necessary fiscal response. This made the knowledge problem above seem even more intractable. How much of the current inflation is truly 'inflation' in the monetary sense, and how much is P just doing its job? How can we tolerate temporary price fluctuations and spikes so that P can do its job, and at the same time mitigate what constitutes actual monetary inflation at the same time? 

To this point no economist or commentator has really come close to answering this call of concern. Too few were talking about the fundamental micro foundations of the knowledge problem, and too many had appeared to abandon it completely in pursuit of sky high interest rates. 

Nominal GDP (NGDP) Targeting 

Recently in the essay The Causes and Cure of the 2021-2022 Inflation Surge, David Beckworth provides the synthesis that I was looking for as both a student and consumer of economics. As I read it, NGDP targeting allows us to both address the challenges of monetary inflation while at the same time letting P do its job.

What is NGDP targeting? Beckworth explains:

"NGDP measures total current-price spending on final goods and services in the economy—it is the economy we see in the real world. Put differently, NGDP growth has both real GDP growth and inflation embedded in it. Using this measure creates a monetary policy framework that is called NGDP targeting."

Dr. Beckworth has been carrying the torch for NGDP targeting for quite a while so it's not totally new to me. But I never quite understood the power of it until he put it in the context of our current economic challenges and became the first economist to offer in my mind a satisfactory explanation and policy direction. (As I said above, and full disclosure, I am a consumer and student of economics, not an academic producer of economics, especially not macro, and heavily influenced by the mainline economic thinking of the Austrian, Public Choice, and New Institutional schools).   

In the excerpts below Dr. Beckworth takes the knowledge problem discussed above head on with NGDP targeting:

The distinction, then, between rising inflation caused by supply shocks and inflation caused by excess aggregate demand growth is essential for successful central banking. But therein lies the rub: It is impossible to know this distinction in real time.

So what are central bankers to do? How can they overcome this knowledge problem? 

Instead of trying to divine what part of inflation is due to aggregate demand shocks and should be managed, we should look directly at aggregate demand itself. This approach cuts out the middleman of inflation and goes straight to the underlying source of inflation movements that is amenable to monetary policy.

The amazing thing about this approach is that it provides a clever workaround to the central banker’s knowledge problem. That is, by forcing monetary authorities to focus on stable aggregate demand growth, it keeps trend inflation anchored but allows for temporary inflation caused by supply shocks. 

NGDP targeting allows for price fluctuations caused by supply shocks while still aiming for a stable trend inflation rate.....NGDP targeting, in other words, is a two-for-one deal that gives central banks the inflation cure they are seeking.

He goes on to explain how this approach would have allowed the Fed to get ahead of the curve and act quicker last year regarding monetary inflation and how NGDP targeting can plot a course going forward. This sounds a lot better to me than the rather blunt approaches we have seen to this point with the Inflation Reduction Act and no end in sight interest rate increases that risk papering and plastering over the supply chain problems only to find them again later when we're remodeling our economy after the recession that's projected as a result. Without NGDP targeting, how many remodels can our economy take?

The Supply Chain Knowledge Problem

While current supply chain problems are unpleasant, they really should not be a surprise to anyone that understands the fundamental problem of economics, the knowledge problem. The knowledge problem, originally characterized by Hayek:

"The economic problem of society is not merely a problem of how to allocate given resources....it is a problem of utilization of knowledge which is not given to anyone in its totality."

This can be understood by recognizing that 'know how' and 'know what' are spread across many minds to paraphrase some of the work by economist Kenneth E. Boulding and as discussed in Peter Boettke's Living Economics. The knowledge problem is also exemplified in the words of Leonard E. Read's pencil in his essay I, Pencil, "Not a single person on the face of this earth knows how to make me."

How does this apply to our supply chain issues? Well because 'know how' and 'know what' are spread across so many minds, not a single person on the face of the earth knows how to make anything. As a result, no one has the knowledge to fix our supply chains. Our supply chains are the result of human action but not human design. They are the product of a hidden emergent order. Of course this is a feature and not a bug. As a result most consumers and policy makers usually remain comfortably blind to the knowledge problem and only briefly opened their eyes to notice when the meat counter was empty during the early days of COVID. Many refuse to see on the grounds of political or philosophical reasons, and employ rhetoric and support policy that bites the invisible hand that literally feeds them.

If planners and policy makers have viewed our economy as an engine that would automatically restart after shutting down like the engine of a car at a traffic light, they have committed the folly of every social planner in history. Instead of thinking of our economy and the supply chains that sustain it as a mechanical system that can be engineered by technicians, a better analogy is an evolving ecosystem. Each product we consume and its components have evolved to fit into very specific niches. We must think of our supply chains as habitats that have been threatened by COVID and our response to it.

Just as restoring an ecosystem after an environmental disaster requires an understanding of ecology, we must understand the ecology of our markets and supply chains in order to restore our economy and avoid an even worse ecological disaster. We must recognize that the knowledge problem post COVID is more challenging than pre covid made evident by recent price spikes and shortages that some people are calling inflation. We have to understand that our supply chains evolved over a number of years, even decades, and ‘regrowth’ will take time and things may not grow back to look like they did before.This could mean higher prices now and well into the near future for a number of goods, with some items reaching new higher equilibrium levels as tastes, preferences, and production practices may have changed post COVID. 

But this is not a monetary phenomenon. The stance of monetary policy cannot necessarily be determined simply by the level of interest rates but is a function of money supply relative to demand. Increasing the cost of credit in response to price changes that have non monetary but very micro foundational causes related mostly to supply chain disruptions could be a recipe for disaster. In the same way, we won’t print our way out of the supply chain crisis we are seeing. 

We should also be very careful on the fiscal policy front. Lawmakers are debating a 4 trillionish dollar spending package. We need to go through this with a fine tooth comb to understand how any changes might exacerbate demand given the current supply constraints and ensure that we don’t add additional frictions that would prevent workers from taking a job or businesses from expanding output. It goes without saying that should be very cautious about any hint of price controls during this period of transition.

Additionally we should consider all other supply side frictions including taxes and regulations. We learned during the pandemic the potential of relaxing prohibitions such as those in healthcare which allowed supply to creatively meet demand using telemedicine. What other opportunities exist to help rebuild our supply chains?

Policy makers must think carefully about how to respond going forward. We don't want to add fuel to the fire with misguided monetary, fiscal, and energy policy responses and must be willing to allow new species to emerge as different sustainable patterns of specialization and trade evolve post COIVD. If anything, COVID has reminded us all of the words of Frederick Hayek:"The curious task of economics is to demonstrate to men how little they really know about what they imagine they can design."

Notes and References:

Friedrich Hayek (September 1945). "The Use of Knowledge in Society" (PDF). The American Economic Review. 35 (4): 519–530

Living EconomicsYesterday, Today, and Tomorrow. Peter J. Boettke. 2012.

Who is John Galt....and would he wear a mask?

 It has been said that those that refuse to get vaccinated or wear a mask are acting selfishly. Others are claiming it is a matter of individual liberty and personal freedom to refuse vaccines or to refuse to wear a mask when necessary. (see: https://www.nytimes.com/2021/08/01/opinion/unvaccinated-delta-variant-covid.html?fbclid=IwAR16VNQUky_Ql2s8jIlR_jhg-p9ygt6_MfgsSCnAu5eoZ58sL1tDNi-QZGk). 

"It’s enraging to listen to people complain that wearing a mask or getting a simple shot is akin to an assault on their freedom while children who have no choice bear the brunt of their nonsense."

This makes me wonder, in the ideal libertarian society described as Atlantis in Ayn Rand's Atlas Shrugged, would John Galt have worn a mask or been vaccinated? Would refusing to wear a mask or refusing to get vaccinated be regarded as 'selfish' behavior - frowned upon - or held up as a standard of value?

In her book 'The Virtue of Selfishness' Ayn Rand does not refer to selfishness in the conventional sense. She defines selfishness as the pursuit of one's rational self interest. More specifically, it is to support oneself by one's own effort in non-sacrificial relationships with others. She is very clear that it is not a license to do as one pleases. A 'selfish' brute in the more conventional sense that is motivated by any number of irrational whims, urges, or wishes is not consistent with Rand's standard of selfishness.

To quote specifically:

"the moral purpose of a man's life is the achievement of his own happiness. This does not mean that he is indifferent to all men, that human life is of no value to him, and that he has no reason to help others in an emergency."

To me, COVID19 and the delta variant seem like plausible emergencies where rational self interest and selfishness (at least the way I understand that Rand described it) would very likely mean getting vaccinated and wearing a mask in close places where COVID transmission is likely.

The moral superiority of selfishness is contrasted with the moral cannibalism of altruism and collectivism which are based on the premise of sacrificial relationships between members of society and which fail to recognize that life is an end in itself. Rand writes:

"the principle of trade is the only rational, ethical principle for all human relationships, personal and social, private and public, spiritual and material."

So Rand's ethics implies that in both business and personal relationships, we can practice ethical behavior through non-sacrificial relationships with others, trading value for value in a number of ways that transcend mere market transactions. So how do we apply the ethical principles of selfishness depicted in Atlas Shrugged to the case of COVID? By NOT wearing a mask where necessary and REFUSING the vaccine, one IS refusing to acknowledge the value of other human lives that may be at stake. By contributing to the continuing spread of COVID and its variants, one is fostering sacrificial relationships with others. This is not an exchange that we could say represents 'value for value.' To add some clarity, we are not talking about something minor here like dropping chewing gum on the sidewalk or refusing to clean up after walking one's dog. We are talking about real value for value here (or lack thereof) as it impacts real individuals and not some abstract collective (as Rand would argue - ethics can only apply to individuals). We are talking about putting the health and well being of many lives and the mental well being of children at risk. 

While no claim of authority on ethics is being made here, nor any claim of being an expert in Rand's Objectivism, it seems though that in a rational society like Atlantis, John Galt would have worn a mask and would have taken the vaccine (although others have tried to claim the opposite I am not convinced). Atlantis might have in fact been the first to produce a vaccine (given there would likely be fewer public choice related hurdles to navigate! While there would likely be no laws requiring vaccinations or mask mandates in Atlantis, I have a feeling most folks there taking the oath required to be part of that community would also make the same selfish decision to mask up and take the shot.

"I swear by my life and my love of it - that I will never live for the sake of another man, nor ask another man to live for mine." - Atlas Shrugged

The Problem of Social Cost - COVID Vaccine Edition

Externalities and COVID19

In the simplest way we might define negative externalities as an uncompensated harm to third parties. What does this mean in the context of COVID19? During the pandemic it was possible to unknowingly become infected and either pre-symptomatically or asymptomatically spread it to others. Any behavior you may exhibit going about your daily life could be posing unwanted and uncompensated risks on me and vice versa. These risks and harms could have potentially proliferated throughout the food and healthcare system (as we saw in our food supply chains and currently witnessing in India).

There are a number of remedies for negative externalities. Probably the most well known solution is related to the Coase Theorem named after economist Ronald Coase. In the typical example of environmental pollution, the assignment of property rights and bargaining internalized the externality. Either the polluter pays their neighbors for any harm done, or the neighbors pay the polluter to pollute less. As long as transactions costs are low and property rights are clearly defined both parties can reach an agreeable solution. 

Alternatives to the assignment of property rights and bargaining include taxing or regulating the behavior to get less of it. But without rapid and available COVID testing it was hard to know who to tax or regulate, at least on a person by person basis (and what would that even mean - fines/citations/house arrest?) Similarly, it's hard for two individuals to reach a solution from bargaining.

Unfortunately, this lead to controversial and blunt solutions including lockdowns/shutdowns/capacity restrictions and mask mandates. The genius of Coase was the recognition that externalities are reciprocal. While my pollution may harm you, polluting less harms me. Similarly, shutting down businesses may have reduced the spread of COVID, but it also imposed costs on owners and employees not to mention mental health and other costs. 

Based on field research and game theoretic reasoning, Elinor Ostrom concludes that in many cases social dilemmas like those recognized by Coase can be handled through cooperation:

“If one sees individuals as helpless, then the state is the essential external authority that must solve social dilemmas for everyone. If, however, one assumes individuals can draw on heuristics and norms to solve some problems and create new structural arrangements to solve others, then the image of what a national government might do is somewhat different…National governments are too small to govern the global commons and too big to handle smaller scale problems.”

In many cases we saw and continue to see businesses and other organizations adopting their own related practices to mitigate the risks of COVID. The formation of 'bubbles' and 'pods' are one example. It is an interesting question what social conventions and alternative arrangements to government interventions would have developed in absence of the response we saw from federal, state, and local governments. One silver lining was our system of federalism, that at least allowed different communities to experiment with different ways of dealing with COVID vs a one size fits all blunt federal solution. 

Technology Changes Everything - Vaccines 

Howard Demsetz holds that technology and knowledge play a crucial role in the development and adoption of property rights and the internalization of externalities and social dilemmas:

Changes in knowledge result in changes in production functions, market values, and aspirations. New techniques, new ways of doing the same things, and doing new things-all invoke harmful and beneficial effects to which society has not been accustomed. It is my thesis in this part of the paper that the emergence of new property rights takes place in response to the desires of the interacting persons for adjustment to new benefit-cost possibilities.

Vaccines absolutely change knowledge and tradeoffs about COVID risks and mandate new adjustments to the different cost-benefit possibilities they bring. Once the vaccine is readily available the externality mostly becomes internalized. 

***Once an individual is vaccinated the probability that they can become infected and risk infecting others is very small. They are practically no longer able to pose unwanted and uncompensated risks on others. Likewise, even if a large number of individuals choose to remain unvaccinated, they are no longer able to pose any significant unwanted or uncompensated risks on others if they become infected with COVID. All that is required is individuals are free to obtain the vaccine to protect themselves from those unwanted risks. And those that choose to remain unvaccinated are willingly accepting the risks that go along with that decision.***

Internalizing the externality of COVID does not require herd immunity or that we meet some aspirational goal of vaccinating 70% of the population. There is certainly an additional challenge related to those vaccinated that may be immunocompromised and may not mount the necessary immune response to be protected from the unvaccinated. This calls for a bit more thinking and maybe an additional requirement of a certain percentage of the population be vaccinated and continue mask mandates until that threshold is reached. I'm not sure that percentage is 70%.

***With that exception, given sufficient access and availability, we no longer have uncompensated harms and no longer need the blunt makeshift regulatory solutions (restrictions and lockdowns) or social conventions (masks) we had before.  Sufficient availability means each individual in society has the opportunity to take or avoid the relevant risks of COVID without any need of further restrictions or new social conventions to be built around 'vaccine passports' or the like.***

Instead of putting energy into figuring out a vaccine passport scheme or maintaining excessive restrictions until some large number of people are actually vaccinated, our goal should be to focus that energy on simply making it available for those who want to get it (including children) and combating misinformation about it.

NOTE:  To be clear I am not saying that the unvaccinated pose ZERO risks to others or that they cannot infect other people that are unvaccinated. I'm not saying it is SAFE to be unvaccinated. There will continue to be people infected with COVID if they are unvaccinated and there could still be serious health consequences for some. I am only saying that these risks are becoming willingly accepted and those choosing to go unvaccinated are accepting these risks and the consequences in a way that was NOT POSSIBLE before the vaccine became widely available. The negative effects of COVID cases DO NOT GO AWAY but most of the uncompensated negative effects do go away because those that want to avoid  or at least drastically reduce the risks/costs can easily do so by getting vaccinated. I personally believe there continue to be POSITIVE externalities associated with the vaccine and the more people that get vaccinated the better. I personally received the J&J vaccine. I am in no way whatsoever making an antivax/anti-mask argument, or have intention here to undermine vaccination efforts. 

***UPDATE***  More recent data suggests the tradeoffs have changed. It is not true that those that want to easily avoid the externalities can do so by making the private choice of getting vaccinated. With the new variant and current low levels of vaccination, many more uncompensated harms will materialize.  In broad economic terms the positive externalities (public good aspects) of vaccines extend beyond herd immunity and slowing the spread of the virus to include dampening or reducing new variants. That’s the good news. The negative externalities generated by the unvaccinated extend beyond spreading the virus to selecting for more infectious variants (and of course all the negative health consequences that go with extending the pandemic to include virtual schooling and mental health). We’ve got a long way to go internalizing these externalities.

For example see:  COVID-19 vaccines dampen genomic diversity of SARS-CoV-2: Unvaccinated patients exhibit more antigenic mutational variance. Michiel J.M. Niesen, Praveen Anand, Eli Silvert, Rohit Suratekar, Colin Pawlowski, Pritha Ghosh, Patrick Lenehan, Travis Hughes, David Zemmour, John C. O’Horo, Joseph D. Yao, Bobbi S. Pritt, Andrew Norgan, Ryan T. Hurt, Andrew D. Badley, AJ Venkatakrishnan, Venky Soundararajan https://www.medrxiv.org/content/10.1101/2021.07.01.21259833v1 

References:

The above was a very broad brushed discussion of externalities and the Coase Theorem. For more details see: https://economicsprinciplesandapplications.blogspot.com/2013/03/externalities-coase-ostrom-demsetz.html 

 The Problem of Social Cost. R. H. Coase. Journal of Law and Economics, Vol. 3 (Oct., 1960), pp. 1-44

A Behavioral Approach to the Rational Choice Theory of Collective Action: Presidential Address,

American Political Science Association, 1997. Elinor Ostrom. The American Political Science Review

Vol. 92, No. 1 (Mar., 1998), pp. 1-22

Toward a Theory of Property Rights. Harold Demsetz

The American Economic Review, Vol. 57, No. 2, Papers and Proceedings of the Seventy-ninth

Annual Meeting of the American Economic Association. (May, 1967), pp. 347-359

The Knowledge Problem and Innovation Within Firms

In his podcast Vance Crowe has a discussion with Rick Holton about venture capital and why firms can't innovate. Vance uses a great analogy about the nature of firms and innovation: 

"you think of these large capitalist companies....but once you are inside the walls of a company there's a form of communism that goes on"

This remark is very similar to what Ronald Coase (who won the Nobel prize in economics in part because of his insights about the existence of large firms) said about firms in his famous article The Nature of the Firm. He effectively described firms as little islands of socialism:

"we find “islands of conscious power in this ocean of unconscious co‐operation like lumps of butter coagulating in a pail of buttermilk...Why are there these “islands of conscious power”? 

Indeed why? And how?!  Doesn't this conflict with Hayek? If the very idea of socialism is impossible due to the knowledge problem, then how can firms get away with it? Coase explains:

Outside the firm, price movements direct production, which is coordinated through a series of exchange transactions on the market. Within a firm, these market transactions are eliminated and in place of the complicated market structure with exchange transactions is substituted the entrepreneur‐co‐ordinator, who directs production....the distinguishing mark of the firm is the supersession of the price mechanism.…“related to an outside network of relative prices and costs."

Innovation happens largely as part of the entrepreneur's (including venture capital) response to the uncertainty that firms face and their inability to 'calculate.' The role of the entrepreneur and profit and loss system (capitalism) is to maintain alignment with the 'outside network of relative prices and costs' or else firms could not exist, and we would have no innovation. 

It's the profit system that allows firms to thrive despite their internal struggle with the knowledge problem. The market, venture capital, and the entrepreneurial response to uncertainty represents a set of institutions for managing innovations that are not possible within the planned economies of individual firms. 

References:

The Vance Crowe Podcast. Rick Holton: Venture Capitalist on failed deals why corps can't innovate & helping the imprisoned. March 15, 2021. https://share.transistor.fm/s/0b9824be  (14:50)

Coase, R.H. (1937), The Nature of the Firm. Economica, 4: 386-405. https://doi.org/10.1111/j.1468-0335.1937.tb00002.

The Use of Knowledge in Society. F.A. Hayek. The American Economic Review Vol 35 No 4 (Sept 1945) p. 519-530

See also: The Knowledge Problem in Firms

What is Socialism?

One of history's most important economists, Ludwig von Mises, writes in In Human Action: A Treatise on Economics about two patterns of socialism:

"There are two patterns for the realization of socialism. The first pattern (we may call it the Lenin or the Russian pattern) is purely bureaucratic. All plants, shops, and farms are formally nationalized (verstaatlicht); they are departments of the government operated by civil servants. Every unit of the apparatus of production stands in the same relation to the superior central organization as does a local post office to the office of the postmaster general.

The second pattern (we may call it the Hindenburg or German pattern) nominally and seemingly preserves private ownership of the means of production and keeps the appearance of ordinary markets, prices, wages, and interest rates. There are, however, no longer entrepreneurs, but only shop managers (Betriebsführer in the terminology of the Nazi legislation). These shop managers are seemingly instrumental in the conduct of the enterprises entrusted to them; they buy and sell, hire and discharge workers and remunerate their services, contract debts and pay interest and amortization. But in all their activities they are bound to obey unconditionally the orders issued by the government's supreme office of production management. This office (The Reichswirtschaftsministerium in Nazi Germany) tells the shop managers what and how to produce, at what prices and from [p. 718] whom to buy, at what prices and to whom to sell. It assigns every worker to his job and fixes his wages. It decrees to whom and on what terms the capitalists must entrust their funds. Market exchange is merely a sham. All the wages, prices, and interest rates are fixed by the government; they are wages, prices, and interest rates in appearance only; in fact they are merely quantitative terms in the government's orders determining each citizen's job, income, consumption, and standard of living. The government directs all production activities. The shop managers are subject to the government, not the consumers' demand and the market's price structure. This is socialism under the outward guise of the terminology of capitalism. Some labels of the capitalistic market economy are retained, but they signify something entirely different from what they mean in the market economy.

It is necessary to point out this fact in order to prevent a confusion of socialism and interventionism."

Mises goes on to elaborate on this confusion:

"The system of interventionism or of the hampered market economy differs from the German pattern of socialism by the very fact that it is still a market economy....these are isolated acts of intervention. It is not the aim of the government to combine them into an integrated system which determines all prices, wages and interest rates and thus places full control of production and consumption into the hands of the authorities."

Politicians among the right and the left will often obfuscate policy debates by confusing or modifying these terms.

Vaccines and the Knowledge Problem

 Below is an excerpt from the blog Marginal Revolution:

"Northam’s health department has also forbidden people from crossing county lines to get the vaccine. If the county next to you has an abundance of the vaccine, you can’t get it. Only residents of that county may get their vaccine.These new rules will result in many people either having their vaccination appointment canceled or delayed for months." 

https://marginalrevolution.com/marginalrevolution/2021/01/our-virginia-regulatory-state-is-failing-us.html 

Vaccination clearly represents a public good and arguably falls within one of the legitimate roles of government. That means socially planned vaccine distribution. Chic-fil-A knows how to distribute chicken sandwiches efficiently through their drive through during a once in a hundred year pandemic, but government bureaucrats do not (and fundamentally can not! ) know how to distribute vaccines during a once in a hundred year pandemic.

Socially planned vaccination will demonstrate all of the key characteristics of social planning and socially planned economies: delays, shortages, excess, waste, abuse, arbitrary rules etc. This is NOT a partisan anti-government rant, or even a subjective personal point of view. It is an objective quality of bureaucratic decision making that no economist can deny. It's as much the nature of social planning as it is the nature of dogs to bark.

Socialism Can't Calculate

At the root of these unfortunate consequences is what economist Frederick Hayek characterized as the knowledge problem. Governments allocate resources in a fundamentally different way than individuals do in through the price system. The result is a well coordinated spontaneous order guided by prices that reflect tradeoffs based on the knowledge and preferences of millions of individual decision makers. Governments (via democratic processes and social planning) allocate resources based on the limited knowledge and preferences of a few voters, elected officials, or appointed bureaucrats. The fundamental problem facing all forms of government including democracies is that centralized decision makers never have enough information or proper incentives to act on the information at hand. That's the knowledge problem. Its not just a problem for governments, its also one of the biggest challenges faced by firms too.

Socially planned economies could never achieve the level of knowledge coordination required to give us things we take for granted today like smart phones:

   

 Or even something as simple and basic as pencils:

   

So What is the Answer? Federalism.

The fact remains that vaccination is still a public good and falls squarely and solidly within the scope of government decision making. Operation Warp Speed is a great example of how the national government can achieve some success in this space. By incentivizing production and largely getting out of the way from a regulatory perspective the national government was actually able to facilitate ways for private firms to step in and solve the knowledge problem related to vaccine discovery and production. These kinds of public private partnerships are a model for at least reducing the information loss associated with social planning writ large.

So we are forced into a socially planned vaccination effort. The good news, in the United States at least, instead of putting everything at risk with a single national plan, we get 50 chances to get it right, one in each state. While no one state will be able to necessarily avoid the knowledge problem, some may do better than others and we can learn from successes and failures getting closer to an approximation of the feedback mechanisms provided by the price system. This is one of the strongest arguments for our constitutional republic and federalism that our founders envisioned. 

By flirting with the nirvana fallacy and we might claim that a single national plan would be better than 50 different inconsistent plans - especially if some states prove incompetent. While we might argue that one set of planners (or administration) at the national level could get better results than another (enter political partisanship) that doesn't change the fundamental nature of the knowledge problem. Maybe there are economies of scale that the national government can realize, or maybe it has access to better resources or leadership with more expertise. Would these gains make up for what is lost in the local knowledge that states and counties have that the federal government could never grasp? Devolve as much decision making as possible to the most local level possible. Cooperation between national government, private enterprise, and local initiatives is probably the better answer. In fact, the current approach of the federal government incentivizing the development and purchasing a large supply of vaccines while allowing the states to distribute according to their own plans is consistent with this federalist approach.

Diversification is our best hedge against the the many risks of socially planned decision making. And it's probably the greatest reason our system of government has been able to tolerate a mixed economy as well as it has the last 50 years or so. 

Milton Friedman said: 

"the ballot box produces conformity without unanimity, the marketplace produces unanimity without conformity."

Our experience with a socially planned vaccination effort should provide teachable moments we can point back to in the future when politicians propose planning other aspects of our economy that aren't necessarily national emergencies or public goods. We don't want to introduce unnecessary fragility into our lives by creating unnecessary dependencies on plans whose relative failure or success has to rely on who's in charge. 

Note: In no way should any point above be used as an argument to undermine the effort to vaccinate the public at large.  This is not intended to be a criticism of the current vaccine effort or government. In fact the current approach is largely consistent with the ideals of federalism discussed above. This essay is meant to be totally descriptive and comparative. Getting to 70% + herd immunity is vital to fighting the pandemic. It's a huge public good and every effort by state, federal, and local government agencies and private institutions and individuals deserve great applause. We cannot expect to hold the performance of socially planned efforts against the standards of the price system in terms of their relative ability to solve the knowledge problem. The above is not an attempt to do so, but to illustrate the fundamental differences in resource allocation under a system of social planning compared to the price system. The distribution of vaccines provides a palpable illustration. Neither should this in any way imply that government employees and bureaucrats are incompetent. Everyone responds to incentives. The issue is incentive alignment.

Reference:

The Use of Knowledge in Society. F.A. Hayek. The American Economic Review Vol 35 No 4 (Sept 1945) p. 519-530

More about markets and the knowledge problem:

Models and Assumptions: Efficient Markets, Imperfect Information, Rationality, and Prices 

Economics, Evidence, and High Causal Density

 

 Related:

The use of knowledge in disaster relief: http://www.independent.org/publications/tir/article.asp?a=628

The Government's Response to Hurricane Katrina- A Public Choice Analysis: http://www.peterleeson.com/hurricane_katrina.pdf

Does the Median Voter Theorem Hold Up in the Current Political Climate?

If anything, divisiveness and polarization would describe recent politics (2016-2020). This has made me question my understanding of what's known in public choice as the median voter theorem (MVT). In a post a few years back I wrote the following about the MVT:

"....the median point of the preference distribution will elicit the most votes. Only those laws or candidates with a centrist twist will get the majority of the votes. Only those voters with centrist views will be happy, and it makes it very difficult for candidates to be elected if they want to bring about major reforms. This phenomenon is referred to as the ‘median voter theorem."

Similarly, in his primer article on public choice theory, Pierre Lemieux describes the MVT:

"a simple majority vote will be the ideal (or most favored) alternative that is at the median point of the preference distribution....This explains why, especially in two-party systems, political platforms are so similar"

This was probably my first reading about the MVT, and given the politics of the early 2000s it made sense and led me to believe American politics would most always produce 'moderate' candidates. Others seem to have made similar interpretations about the MVT producing moderates as winners of elections. Economist David Henderson writes in 2017:

"If the Democrats go far to the left of the median voter, what’s the Republicans’ best response if their goal is to win? It’s to go further left themselves"

Economist Tyler Cowen writes in the NYT a few years earlier in 2010:

"Any politician who strays too far from voters at the philosophical center will soon be out of office....In fact, there is a dynamic that pushes politicians to embrace the preferences of the typical or “median” voter, who sits squarely in the middle of public opinion. A significant move to either the left or the right would open the door for a rival to take a more moderate stance, win the next election and change the agenda."

In 2011 when I wrote my post, this all made sense. But recent events leave me with a number of questions about the MVT. Can the MVT explain political candidates as different as Donald Trump and Bernie Sanders? Or even Joe Biden for that matter? How different are voter preferences from the preferences of citizens in general? Are preference distributions bimodal? Maybe within each party the MVT holds but it breaks down at a national level if distributions are bimodal? 

In his piece, Tyler Cowen definitely helps remind us that the MVT has its limitations, and maybe recent politics are testing those limitations:

"Of course, the median voter theorem is far from a complete explanation of politics. Sometimes politicians lead public opinion and talk voters into accepting new ideas, as when President Bill Clinton promoted Nafta. And voters often favor conflicting or contradictory policies, like wanting to pull troops out of Iraq but also not wanting Iraq to explode into chaos."

I have not taken any deep dives in the recent literature, but I found a very insightful post on the London School of Economics blog post written by Richard Bronk. It seems to get to some of the questions I have had recently.

Why have moderate candidates been losing support (and elections)?

"When the financialised version of global capitalism enabled by this consensus ended in the financial crash of 2008 and long years of rising inequality and insecurity, voters were primed to look for radical alternatives to the status quo. Parties pursuing a median-voter strategy – along with the main institutions of the state and most market participants – were locked into what Wade Jacoby and I have called an ‘analytical monoculture’ that left them blind to problems that are not articulated in the language of standard economics and risk management."

How or why might the median voter strategy have failed?

"Only when all elements of the political centre had failed to address their concerns did electors risk voting for ‘anti-system’ alternatives"...[the MVT] assumed that political preferences could be placed on a single continuum (and that disparate underlying values could be converted to a single scale), so that governments could satisfy the preferences of a simple majority of the people and calculate the optimum set of policy trade-offs....[the MVT] underestimated how contested and unstable are the trade-offs between different goals – such as freedom and security, efficiency and equality, medical health and economic growth. There is no one right and rational set of trade-offs for an individual or society"

Is all lost in American (and global) politics? Not necessarily. We could see a return to moderation:

"it may follow that, as anti-system (and often populist) governments are in turn seen to flounder in their management of crises, anti-incumbency may work against the new players themselves.....Voters have noticed that what works to win electoral campaigns does not necessarily solve practical policy problems..."

If any economist might have ideas about how to handle social dilemmas, it would be Elinor Ostrom:

"crisis fatigue may cause voters to shun grand solutions with unknowable consequences and prefer the sort of incremental reform traditionally associated with moderate political parties of left and right. Uncertainty may also increase the voter appeal of the decentralised and ‘polycentric’ approach that Elinor Ostrom argued has the best chance of tackling urgent shared problems – by encouraging diverse experiments in living that engage and involve ordinary voters."

Additional References:

While they do not discuss the median voter theorem, David Beckworth discusses the possibilities of federalism for healing the nations divisive politics with David French: https://macromusings.libsyn.com/david-french-on-political-polarization-in-america-and-its-impact-on-the-2020-elections

Externalities, Coase, Ostrom & Demsetz http://economicsprinciplesandapplications.blogspot.com/2013/03/externalities-coase-ostrom-demsetz.html 

Public Choice Theory. http://economicsprinciplesandapplications.blogspot.com/2011/05/public-choice-theory.html 

Lemieux, Pierre, The Public Choice Revolution. Available at SSRN: https://ssrn.com/abstract=604046 

The Knowledge Problem in Firms

Micromanagement and many of the coordination and alignment problems within firms are actually manifestations of what Hayek characterized as the knowledge problem and was his major and most damning criticism of socialism. It's a limitation of planning and bureaucracy in general and applies to both profit and non-profit organizations. You could characterize Hayek's concept of firms as being 'little islands of socialism in a sea of markets.' The only saving grace for firms is that because bureaucracy and management don't scale so well in the long run the limits of irrationally are eventually tested by the external pressures of the price system which in a capitalist economy results in profit and loss, reorganizations, mergers, or bankruptcies. Creative destruction. Non-profits and government institutions have to rely on other kinds of institutional arrangements to work through these frictions. Better leadership and institutional arrangements can make things better but will ever only go so far solving the knowledge problem. 

Going to Bat for the Constitution

 In the Feb 4, 2013 EconTalk podcast Russ Roberts discusses the constitution with Louis Michael Seidman. Both agree on a really important observation about how we approach the constitution and originalism in practice in the United States:

"if you look at how the Supreme Court settles disputes about political morality in our country today, there's very little that ties that, or nothing that ties that to the Constitution. So, really, the important decisions, like the decision outlawing segregated schools or creating an abortion right or limiting affirmative action or protecting the rights of gay men and lesbians, those decisions have basically no grounding in the Constitution. They are some combination of the Justices' views of political morality, their views of our traditions, their interpretation of their own prior precedents; and if we are going to have a body act like that, I think we need to be honest with the American people and come clean and make clear that that's what it's doing."

That is a good point. Originalism in general is based on the idea that the constitution sets a floor or boundary around the powers of the government. Laws should be interpreted and applied under this view based on the the meaning of the text, as understood by the authors when discernible. Seidman argues in so many ways that this is moot, we aren't doing this now and never strictly did so from the very beginning, so why should we begin to do so today? Why should we pretend to hold ourselves to limits set by our founders some 250 years ago who would have known little about the world we live in today?

At risk of oversimplifying both an originalist view and Siedman's position I'll propose a fable. Suppose in a simple world a government writes a constitution and they only a few clauses. One clause relates to a single law. It states that they will have a speed limit set at 25 miles per hour. The second clause states that this law can be changed with a 4/5 majority of the legislative body or something like that. Now suppose over time it was largely ignored and was never really enforced, no fines no penalties etc.  People just drove at their own whim as fast or slow as they wanted. This seems to parallel loosely the world both Russ Roberts and Seidman agree exists today. 

Now suppose the day comes when a new regime starts a new initiative clocking speeders. A law enforcement officer tickets someone at 70 mph and they end up in court. The textual originalists might argue that according to our written law, this was a clear violation and the speeder should pay the fine. 

However, the legal advocates for the speeder argue that when that law was written few people owned automobiles and most cars were not capable of such excessive speeds on a normal basis especially given the state of the roads at the time. Their argument is that the case should be dismissed based on the view that laws should be interpreted with a more expansive, dynamic, evolving perspective and interpreted in light of changing social and political circumstances. The originalists push back in their opinion, recognizing that society has changed, and maybe 25 mph is no longer a reasonable standard, but it is the role of policy makers, not the court to update this law through the appropriate governing channels (the 2nd clause in our fictional constitution). 

Suppose the defendant wins and in its ruling the court states that speeds up to 70 mph are okay. The government could then post new signs with new speed limits. Citizens and law enforcement can be confident about the laws new meaning and the penalties involved.

Suppose the prosecution wins, and maintains the 25 mph speed limit. After much debate and pressure from voters policy makers go through the channels necessary to vote to change the law so that the new speed limit is 70 mph. 

One might argue, what's the difference if we get the same result? Critics of originalism might argue that its much more pragmatic and expedient to change outdated laws through the court system, because going through the necessary channels may be too time consuming and intensive. Going through the proper channels creates a sluggish and nonreactive government artificially constrained by ideals that may be outdated and irrelevant to current circumstances. 

But this oversimplified fable illustrates perfectly that focusing on the policy outcome completely misses  a much more important question. The most important question is not about policy, or about how time consuming or difficult it is to make policy. Or how much society has or has not changed. And while it is absolutely important to think about the incentives created by decisions and the consequences, there is still a more important question. The most important question is about who makes these decisions. Who is in the better position to recognize that society has changed and we need new laws? Is it the role of unelected judges to make these decisions? Do we send our judges to the bench to go to bat for the policies we like and pitch against the policies we find appalling? Do we really want to leave such important decisions up to an elite bench of unelected jurors that will always have a much more limited pool of knowledge and preferences than the population at large? Or do we send judges to the bench to go to bat for the constitution? 

In Judicial Activism Reconsidered, Economist Thomas Sowell describes our Constitution this way:

“The federal Constitution is "the supreme law of the land," not because it is more moral than state constitutions or state or federal legislative enactments, but because it represents a larger and more enduring majority.Minorities receive their constitutional rights from that enduring majority to which transient majorities bow, not from whatever abstract moral rights are imagined to exist as a brooding omnipresence in the sky.”

Letting judges decide policy represents a transfer of power away from the people. It is undeniably undemocratic. It may certainly seem more expedient to bring about change through the courts but this does not come without serous tradeoffs. Once we start making heroic interpretations of the meanings of words in the constitution it is weakened, and minorities are forced to give up their liberties to whatever transient majority takes power (either in the legislature or as appointed to the court). The short term gain from being able to bypass the amendment process (and shunning consent of the governed) in order to pass some much needed legislation to help some worthy cause comes at a long term cost to our liberty and national well being. This increases the incentives and opens the door for large corporations and special interests to influence our lawmakers, and provides the means for ever more concentration of power and the entrenchment of social classes. While the incentives created by an individual decision are important, we must think more globally about the incentives created when the courts are governed by a philosophy that favors policy making. Elections and politics become more divisive as more and more social norms are being set  by policy at the federal level by both 'conservatives' and 'progressives.' As Pierre Lemieux states in his article The Public Choice Revolution:

“The entire federal budget,” writes Mueller, “can be viewed as a gigantic rent up for grabs for those who can exert the most political muscle.”

Letting judges 'decide' also makes supreme court nominations the circus they have become. Hearings become opportunities to score political points as each party sends their nominees to bat for the policies most aligned with their base. Letting judges decide based on the whims of an ever changing political climate can further lead to bad precedent challenging the doctrine of stare decisis when questions of constitutionality would require overturning previous decisions.

Reforming the Way We View the Courts

We may hear a lot about judicial reform but just as important is reforming the way the public actually views the courts. One of the greatest mistakes by the left and the right is attempting to set social norms at the national level instead of local levels of government where consent is more easily ascertained. The constitution represents the social compact that we as a society agree to live by until it is changed. Until we are able to give it proper deference with regard to policy and our view of the role of the courts, we will not be able to achieve any meaningful reform and the courts as well as the judicial nomination process itself will remain in chaos subject to the changing whims of political climate.

Viewing the constitution as a 'living' document makes supreme court nominations and elections much more contentious and contributes to the increasingly divisive climate we have seen in society over the years. When circumstances arise, we can always escalate policy decisions to the federal level via the amendment process. This allows ultimate flexibility and breathes new life into the constitution. In this sense, it can be viewed as a living document. 

Perhaps there is an argument to be made about having justices on the benches with a diversity of philosophies. Doug Linder makes the point that a court without dissenters is a Court that will not adequately inform us of the costs of and consequences of different rulings. This would certainly be an argument against extreme measures like court packing. If there is an argument for expanding the number of seats on the court, then we should do it in a way that in a worst case achieves some sort of balance of judicial philosophies and possibly a larger pool of justices that rotate on and off the bench in a way to maintain balance.

Finally, we should stop referring to justices as either 'conservative' or 'liberal.' While used in their proper context these terms are meant to refer to an originalist or non-originalist judicial philosophy. But more commonly they give the impression that a justice will decide cases based on the political philosophy closely related to that of the president that may have nominated her. Continuing to refer to justices as 'conservative' or 'liberal' perpetuates the misunderstanding that judges are in a position to make policy decisions and not interpret statute or apply the constitution.

References:

Regulation, vol. 27, no. 3, The Public Choice Revolution. Pierre Lemieux.

Judicial Activism Reconsidered. Thomas Sowell. 1989

Economics, Evidence, and High Causal Density

How do we form our beliefs about the solutions to societies most complex problems? Do we trust data? Theory? Both? What does it mean to base policy on science and evidence?

According to Manski:

"Social scientists and policymakers alike seem driven to draw sharp conclusions, even when these can be generated only by imposing much stronger assumptions than can be defended. We need to develop a greater tolerance for ambiguity. We must face up to the fact that we cannot answer all of the questions that we ask."

I think Russ Roberts puts it well in his EconTalk Episode with Noah Smith:

"Can you think of a study that was so decisively performed in terms of the crossing of t's and dotting of i's that the identification and all the econometric challenges were met with such impressiveness that people on the other side of the debate had to throw up their hands and say, 'Well, I guess I was wrong. I've got to change my view.' Because I can't think of one. I can't think of one. And if that's true, then I would suggest that economics has some serious problems in claiming it's a science."

When it comes to evidence there are lots of challenges. For the most part, in economics and the social sciences it's often impossible to implement randomized controlled trials to identify treatment effects related to policy changes. For the most part we have to leverage observational data using quasi-experimental designs. The challenge for both approaches as Jim Manzi discusses in his book ''Uncontrolled: The Surprising Payoff of Trial-and-Error for Business, Politics, and Society'  is the issue of 'high causal density.'

In an environment of high causal density "the number of causes of variation in outcomes is enormous, and each has significant potential effects compared with those of the potential cause of interest. We don't know enough to list each of them and hold them constant, but if we randomly assign patients to the test and control groups, then these hidden conditionals won't confound our estimate of treatment causality."

Unfortunately in the social sciences, causal pathways are extremely complex. There are always hidden conditionals we may not be able to measure or don't have sufficient knowledge to even consider. Given that hidden conditionals are always present, a well entrenched proponent of a given policy can always find a reason to explain why it has failed to prove itself out in the face of evidence.

But Jim does more than offer criticisms of theory and methods. He introduces the concept of 'Liberty as Means.'  Embracing the concepts of evolutionary economics, he promotes a flexible system of government that sounds a lot like federalism. As he discusses, the mistake we often see from both the right and the left is enforcement of social norms at the national level vs. fostering numerous experiments at the local level.

While economic theory and applied econometrics are useful and powerful tools for policy analysis,  these tools will not necessarily help provide clear cut  always defensible evidence to improve public policy. These methods will never discover a 'Polio vaccine' for policy. It is in fact their shortcomings that provide the strongest argument for our constitutional republic and federalism that our founders envisioned.

Reference: Uncontrolled: The Surprising Payoff of Trial-and-Error for Business, Politics, and Society, by Jim Manzi https://www.amazon.com/Uncontrolled-Surprising-Trial---Error-Business/dp/046502324X/ 

See also: EconTalk: Manzi on Knowledge, Policy, and Uncontrolled

*this is cross posted at: https://ageconomist.blogspot.com/2019/01/economics-evidence-and-high-causal.html?m=0 

Trade, Jobs, and Political and Economic Disruption

 Two podcasts I listen to often include EconTalk with Russ Roberts, and Masters in Business, with Barry Ritholtz. No one could have called the election based on these episodes, and none of the guests  made any projections about it specifically, but each of the these guests below discuss issues that could have been informative about what's been going on in the minds of the electorate. And why non-conventional candidates like Bernie Sanders and Donald Trump had so much appeal. They also question conventional wisdom about the distributional effects of comparative advantage and free trade.

In a past podcast, just over a year ago, Gary Shilling offers some interesting thoughts on trade:(paraphrasing not quoting).

Basically globalization has led to income polarization, with 8 years of zero to no real income growth for a segment of the population and this frustration has been expressed politically through Bernie Sanders and Donald Trump. With regard to Trump, when you strip away the blustering, he may actually be more like an old school centrist politician. When you take the impacts of globalization, the recession, and the slow recovery, conventional politicians don't know how to react. 

I think this is the kind of environment in which it was possible for the 'blue wall' on the electoral map to crumble.

More recently, Aswath Damodaran touches on this: (again paraphrasing)

Brexit should be a warning sign that we've lost perspective. In the aggregate, trade and globalization can be good for the country, but the 55 year old steel worker in Pennsylvania gets little consolation out of the fact that free trade is going to create more world wealth when he says where the heck am I going to get my paycheck next month. 

"We are paying a price for almost deliberate blindness in the financial capitals of the world to the kind of costs that are being created sometimes."

Again this echoes Shilling above. In his paper, "The China Shock: Learning from Labor Market Adjustment to Large Changes in Trade", David Autor takes a very detailed look at these issues and investigates them empirically. David was guest this past year on EconTalk with Russ Roberts. Some highlights:

• one of the standard arguments for free trade and globalization is that it makes the pie bigger, and sometimes the story sounds like some people get larger slices than others, but everyone gets a bigger slice, so on the net everyone is better off. 
• Another way of thinking about this is that trade increases aggregate wealth, and this increase more than offsets the losses for those that are displaced in the labor force.
• Autor points out that yes, gains can offset losses, but the gains are going to different people
• Example: sure consumers gain by saving 5 cents on the broom they buy at Wal-Mart, and if you add up all of those nickels its more than the total losses for people whose lives are ruined.
• But this is little consolation to those whose lives are ruined, it takes years to find alternative opportunities and often at a fraction of the salary they earned before
• In the past, maybe these distributional effects were of less concern because trade largely reflected differences in comparative advantage across different types of manufacturing- for example maybe we would lose jobs manufacturing electronics but make up for it with other jobs building tractors-And balanced trade resulted
• In the past, skillsets were much more congruent across different industries with changing comparative advantages- i.e. it was not extremely difficult to move from manufacturing one good to another if your former job was displaced by trade
• More recently, with globalization, things changed. Instead of reallocating across sectors of manufacturing, countries like China just supplanted manufacturing on a much larger scale. And instead of paying for imports with different exports for which we had a comparative advantage we ran trade deficits (of course with surpluses in capital accounts)
• However, the kinds of investments being made with the new wealth created by global trade are in areas and sectors where skills are not congruent for many workers supplanted by the trade outcomes
• Ultimately we have experienced a sharp decline in demand for labor that has been contractionary

Hence this is the 'stagnation' in real wage growth that so many have been talking about. Could it also be why conventional stimulus and monetary policy has not really moved the needle in terms of economic growth? Is this because our comparative advantage is in services, technology, marketing, research, and engineering and these sectors are not soaking up the excess labor freed up when manufacturers shut down or relocate overseas?

The conventional wisdom has always been with trade, labor and resources that were once tied up in lower valued uses are reallocated to higher valued uses creating more wealth making everyone better off. But Autor is arguing that this just isn't happening or is taking too long. Maybe its the next generation or two that reaps the rewards. But not necessarily. If you've got a good gig and lose it, you may end up living in an area with bad schools, or may not have the resources to provide your children or the next generation with the education and training required to take advantage of the new economy jobs where the gains more than offset the losses from globalization. 

This also makes me wonder...supply side policies designed to promote economic growth and  aggregate wealth (under the terrible misnomer 'trickle down economics' ) might not work quite as well as they used to either given the structural environment depicted by Autor in his paper. But that probably goes the same for fiscal stimulus related to infrastructure. It might boost those sectors related to construction, but the traditional multiplier working its way through manufacturing and labor demand just likely won't work the way the Keynesians believed it would 30 years ago. 

So what is the answer? Surely a world with trade is in aggregate better than one without. Does this mean renegotiating NAFTA? Should we put the brakes on future globalization and phase in tariffs and trade restrictions and slowly fade them out so that sectors can readjust over a few generations? (things Donald Trump may seem in favor of) Or more aggressive and progressive policies called for  to provide a soft landing for those future displaced?  Some combination?  This gets to more spending on a number of programs, healthcare, and education. (things Hillary Clinton would have supported)

I'm not sure what the answer is after considering the incentive effects and the impacts for long term economic growth and development. Not to mention government spending. However, it was the lack of policy response to these questions that made this past election what it was. 

References:

"The China Shock: Learning from Labor Market Adjustment to Large Changes in Trade," by David H. Autor, David Dorn, and Gordon H. Hanson. National Bureau of Economic Research Working Paper, January 2016.

Effects of the Minimum Wage on Employment Dynamics

Jonathan Meer, Jeremy West

NBER Working Paper No. 19262

Issued in August 2013

NBER Program(s):   LS   PE 

The voluminous literature on minimum wages offers little consensus on the extent to which a wage floor impacts employment. For both theoretical and econometric reasons, we argue that the effect of the minimum wage should be more apparent in new employment growth than in employment levels. In addition, we conduct a simulation showing that the common practice of including state-specific time trends will attenuate the measured effects of the minimum wage on employment if the true effect is in fact on the rate of job growth. Using a long state-year panel on the population of private-sector employers in the United States, we find that the minimum wage reduces net job growth, primarily through its effect on job creation by expanding establishments.

http://www.nber.org/papers/w19262

Sent from my iPad

An Estimate of the Impact of Regime Uncertainty on Current Unemployment

From:

http://economicsone.com/2013/07/31/policy-uncertainty-makes-firms-reluctant-to-hire-new-evidence/

  "In their paperUncertainty and the Slow Labor Market Recovery, they present "evidence that heightened uncertainty about economic policy during the recovery made businesses more reluctant to hire workers."

The Causes and Consequences of Antitrust: The Public-Choice Perspective:Amazon:Books

http://www.amazon.com/gp/aw/d/0226556352/ref=redir_mdp_mobile/175-7554683-8132925?keywords=mcchesney%20shughart&qid=1373541581&ref_=sr_1_1&s=books&sr=1-1

"The public-choice approach denies the assumption that government employees act in single-minded pursuit of the public interest, defined as allocative [Pareto] optimality. That belief lacks any theoretical or empirical basis. Oddly enough, many who support a shift in regulation from market to government processes because the market fails to provide the "right" incentives simultaneously disregard the possibility that government institutions also fail to provide the "right" incentives."

Recent Work from Valery Ramey re Multipliers

Owyang, Michael T., Ramey, Valerie A. and Zubairy, Sarah. Are Government Spending Multipliers Greater During Periods of Slack? Evidence from 20th Century Historical Data. [PDF Document]. Federal Reserve Bank of St. Louis. Economic Research Division. Working Paper 2013-004A. January 2013.

Externalities, Coase, Ostrom & Demsetz

Traditionally when it comes to environmental pollution, the general philosophy was that ‘the polluter pays’. A factory polluting the air or water should pay for the damages that are caused. In a much simpler case, if you build a house next to me and you don’t like the smell of livestock waste coming from my property, the traditional philosophy would hold that you could have the government stop my operation. In the article ‘The Problem of Social Cost’ Ronald Coase brought new insight to the way we view social costs and the principle of ‘polluter pays.’

The insight that Coase brought was the reciprocal nature of social costs and externalities and has been referred to as the Coase Theorem. The important elements of the Coase Theorem (in the context of the present example) can be demonstrated as follows:

 1) Yes it is true that my operation is harming you via air pollution

2) However, in stopping me via government or legal intervention (or taxing my waste        production) you are harming me

3) The assignment of property rights and the potential for bargaining results in behavior that is changed or altered to account for the negative impact our choices have on others, regardless of which party is initially assigned property rights

“But the ultimate result (which maximises the value of production) is independent of the legal position if the pricing system is assumed to work without cost.” –Coase, p. 8

Coase says that the issue is that no one owns the air that surrounds my livestock operation and your home. There then follows a dispute over how the air should be used- to absorb livestock odor, or to provide a scent free atmosphere in your back yard. An externality is an uncontracted effect. It’s a harm or benefit that goes uncompensated or is not captured by prices. Whenever the cost of one’s behavior is not factored into a price by which a choice can be valued, I can harm you without compensating you for it. ( i.e. a negative externality exists)

However, if I own rights to the air, then I can choose to pollute the air. If you own rights to the air, then you can prevent me from polluting it. If noone owns the air, then it is first come first served or winner takes all.

That is not the end of the story though. What Coase emphasizes is that if I own the rights to pollute, you can pay me to limit my pollution i.e. buy those rights from me. I can then use the proceeds to alter my livestock nutrition, genetics, and management to reduce the odor my operation is causing. On the other hand, if you own the rights to pollute I can purchase those rights from you, or invest in technology that will allow me to continue my operation without violating your rights. Decisions about how the air should be used will be based on the local knowledge and preferences of both parties. This can be accomplished without major government regulation, or the arbitrary imposition of a tax.

The assignment of property rights and the potential for bargaining results in behavior that is changed or altered to account for the negative impact our choices have on others, regardless of who holds the rights. This is the essence of what is known as the ‘Coase Theorem.”

The Coase Theorem holds in the case of zero transaction costs, and approximately in the presence of transaction costs that limit the bargaining process and establishment of a price that reflects local knowledge and preferences related to the externality.  In the case of high transaction costs, Coase argues that courts should do their best to anticipate the economics involved in making the initial assignment of property rights. Coase recognizes in some cases, governments may do a better job allocating resources in the face of high transaction costs, but is skeptical. Understanding the knowledge problem, and the issues related to government decision making from public choice theory make government intervention a questionable strategy for dealing with social costs.  In later work,

Other Related Work:

Based on field research and game theoretic reasoning, Elinor Ostrom concludes that in many cases social dilemmas like those recognized by Coase can be better handled through cooperation:

“If one sees individuals as helpless, then the state is the essential external authority that must solve social dilemmas for everyone. If, however, one assumes individuals can draw on heuristics and norms to solve some problems and create new structural arrangements to solve others, then the image of what a national government might do is somewhat different…National governments are too small to govern the global commons and too big to handle smaller scale problems.”

Howard Demsetz holds that technology and knowledge play a crucial role in the development and adoption of property rights:

Changes in knowledge result in changes in production functions, market values, and aspirations. New techniques, new ways of doing the same things, and doing new things-all invoke harmful and beneficial effects to which society has not been accustomed. It is my thesis in this part of the paper that the emergence of new property rights takes place in response to the desires of the interacting persons for adjustment to new benefit-cost possibilities.

References:

 The Problem of Social Cost. R. H. Coase. Journal of Law and Economics, Vol. 3 (Oct., 1960), pp. 1-44

A Behavioral Approach to the Rational Choice Theory of Collective Action: Presidential Address,

American Political Science Association, 1997. Elinor Ostrom. The American Political Science Review

Vol. 92, No. 1 (Mar., 1998), pp. 1-22

Toward a Theory of Property Rights. Harold Demsetz

The American Economic Review, Vol. 57, No. 2, Papers and Proceedings of the Seventy-ninth

Annual Meeting of the American Economic Association. (May, 1967), pp. 347-359