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Dinosaur Economics vs. Actual Real Life

Here is Robert Barro on Keynesian multipliers (or lack thereof).

Barro believes that there is no multiplier, that multipliers are a “free lunch” and therefore can’t exist in “regular economics”. Furthermore he states that there is “no theoretical or empirical support for the Keynesian position”.

I don’t entirely disagree with the first statement, but I do think that it is a mischaracterization to refer to multipliers as a “free lunch”. The second statement I just flat out disagree with, and it is a disagreement in substance rather than syntax.

The theoretical evidence for Keynesian position is everywhere. It is in Keynes’s General Theory, it is in the countless papers that have been published over the last 80 years by a myriad of economists, including some from Barro’s own department at Harvard. Empirical evidence of anything in macroeconomics is impossible to come by. It really depends on your definition of empirical. Literally, it means “from observation”, but the problem with the study of economics is that so-called “economists” can look at the same thing and arrive at two completely different “empirical” conclusions… i.e. stimulus doesn’t work because we still have unemployment vs. stimulus does work, we just didn’t do enough.

Macroconditions can get interpreted a number of different ways depending on the ideologies of the interpreter, and that is the fundamental problem with prescriptive economics. This isn’t a problem that is unique to social sciences: look at the current “debate” about global warming. It only takes a small handful of people or data points to challenge the “consensus”. Climate scientists have it easy; they are 90% in agreement. Within economics, there are hundreds, if not thousands, of different models. Each one gets tweaked and changed constantly. None of them predict economic trends with any degree of accuracy or consistency, NONE of them. They are almost all situational, describing what happens correctly the 1% of the time that the model and reality are in sync.

But all that aside, I called this post Dinosaur Economics vs. Actual Real Life because Barro and many of his colleagues at Harvard are ideologically biased towards economic ideas that should be extinct.

“In regular economics, the central ideas involve incentives as the drivers of economic activity. Additional transfers to people with earnings below designated levels motivate less work effort by reducing the reward from working.”

He calls it “regular economics” to normalize his own biases. What he means by “regular” economics is what could roughly be called neoclassical economics, the body of thought that goes back to Adam Smith and essentially ends with the Monetarism of Milton Friedman (actually it doesn’t really end there, but unfortunately economists have been unable to push any new paradigms into the sphere of public policy since then). Behavioral economics, the profession’s current best chance at redeeming itself, has a lot to say about what motivates people to do things in different situations. Incentives don’t work the way Barro would like them to; I can understand his desire, it makes economics very easy when we assume all actors are rational and have agency over their choices.

In addition, the financing of a transfer program requires more taxes—today or in the future in the case of deficit financing. These added levies likely further reduce work effort—in this instance by taxpayers expected to finance the transfer—and also lower investment because the return after taxes is diminished.

What Barro says here about taxes is wrong. There is very little evidence to show that people work less because of higher taxes. Most people work the same regardless of taxes. Some people might work more because of higher taxes, to maintain the same level of income. The effects are ambiguous. Certainly, millionaires and billionaires will be more likely to invest and build businesses in areas with lower taxes, but today’s tax rate is completely unhinged from today’s deficit. Deficits will have to theoretically be paid for eventually, but there is no correlation between budgeted deficits/surpluses and expected tax rates. The expectations are what is most important when it comes to investment decisions. A dearth of leadership from both sides of the aisle has created a situation where investors have no idea about what future tax policy will be like. The dimmer ones may be temporarily assured by the (relatively small) austerity measures in the latest budget, but Washington seems to be more preoccupied with petty political bickering instead of coming up with a plan (any plan) about economic strategy. In any case, weak austerity has been Washington’s half-assed signal to the markets that it takes the deficit seriously. The problem is that the markets see how weak Washington’s actual resolve is, and there is also the nagging fact that there is disagreement, even between the big wigs on Wall Street, of whether austerity is the best course of action.

But enough of that: my real critique of Barro is that his model is archaic and much too simple for him to feel as strongly as he does about his ideological footing. Sadly, the models he seems to use are the same ones that they have taught econ undergrads for the last 80 years. It is akin to Newtonian physics: certainly an excellent way aim a cannon or even put a man on the moon, but it goes to shit when we start talking about black holes or quantum mechanics. Barro’s folk economics makes sense when you are talking about household balance sheets or you are using a gross over-simplifaction to make a point about deadweight loss or crowding out, but in today’s world of globalization, floating exchange rates, and modern central banking, it is essentially worthless as anything but a pedagogical tool. Physics students do not learn Einstein’s original theory of relativity when they go to school, instead they get a more recent model that corrects Einstein’s errors. Economics is not like this. The theory being taught to today’s undergrads is old and outdated, proven to be wrong or incomplete… yet it still gets taught, I think because it is “easy”, the same way Newtonian physics is easier than quantum mechanics.

The point I am trying to make is that people like Barro are what is holding economics back as a science and profession. They are not scientists, they are ideologues. They don’t ask questions, they offer prepackaged explanations that match their ideological bias. This is why they defend their responses by referring to the “classics”, all of which have been written long ago by long dead authors. This is why they have to make unstated assumptions and baseless assertions (Barro’s piece is writhe with both, too many for me to find utility in highlighting). Part of this is laziness, part of it is political. Economics is big money, especially for a Hoover fellow/Harvard faculty guy like Barro. To get where he is, you have to cast your lot with the establishment, and they are more usually more interested in staying established than rocking the boat in the name of the truth (and nothing helps you stay established quite like low capital gains taxes or payroll tax ceilings).

There are two ways to view Keynesian stimulus through transfer programs. It’s either a divine miracle—where one gets back more than one puts in—or else it’s the macroeconomic equivalent of bloodletting. Obviously, I lean toward the latter position, but I am still hoping for more empirical evidence.

At least he is still holding out for more evidence, the hallmark of a true scientist. I guess there is hope after all.

I could be out of my league calling out Barro; he is a well known and respected economist and I am shit. But I can read the texts and analyze the data and do the math, and I can’t see how Barro’s meager piece for the WSJ is anything but a gross and misleading diatribe against something that he is personally uninterested in addressing responsibly. As an “expert”, he is doing a disservice to his fans, students, colleagues, and readership.

Categories: Economics
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