An “ecosystem” of relative prices
I just noticed an article on the industrial research limited site discussing how NZ needs to think. Money quote is:
What I take from that is we need to think laterally, not literally. When we think about investing in particular sectors, we must realise we will need capabilities that aren’t necessarily obvious to us. We just won’t know what types of knowledge we are going to need to build particular parts of our economy.
The interesting thing is that many economists agree with some of what the author mentions in their piece, in terms of discussing scale and the inter-relationships of firms – but from this loose description there is no clear role for policy, or understanding.
In truth, we need to understand the idea behind inter-relationships in a way consistent with methodological individualism. Then given that theory, we need to go back to data truly quantify what is going on – given the framework that this theory provides. From there, we can try to decipher if policy can help of not.
And any such theory relies strong on relative prices – contrary to the inference the article appears to be making, we do not have a command and control economy, and the government is not trying to work out the allocation of resources. Relative prices, both implicit and explicit, are the driving force of any description of what is going on in New Zealand – and our starting point, and final discussion in terms of policy needs to rely on these.
Think about it, we are told how these firms rely on each other, how they add value to each other, and in each others markets. This doesn’t make an “externality” in the traditional sense, it just tells us that we have firms whose markets are interconnected – and as a result, there will be some implicit contracts between these firms (and implicit prices) that help to share the surplus of their trade. In an extreme case, when the benefit is enough, and the outside contracting is weak enough, these firms would horizontally (or vertically depending on the relationship) integrate.
The fact that firms are inter-related doesn’t suddenly provide a role for government. The fact that scale matters for output does not mean that FORCING an increase in the population distribution will increase welfare.
Update: Bill discussed this here. And Eric. How did I miss it when I read both of those blogs daily … I blame my new Kindle for making me focus on Mill instead of my blog reading.
Sidenote: I have to mention this statement:
Because New Zealand doesn’t have a truly large city by international standards, we must work harder at innovation to compensate for our economic geography and collaborate as if we were a city of four million people.
I have tried to be kind in the rest of the piece, but I have to admit that this statement is blatantly ridiculous.
Two things:
- The benefits of population density in large cities come very much from population density – saying we are a city doesn’t do anything to change this.
- More importantly, saying we need to “innovate more” because of our disadvantages doesn’t necessarily make sense – it depends on the marginal benefit of innovation relative to the cost. If our distance from market reduces the marginal benefit from innovation, then this statement isn’t just wrong – its harmful if its followed through with.
I love to hear scientists describe the potentials for technology, and discuss the production possibilities they face. But they really should get an economist to join the party when it comes to discussing issues of allocation – given that this is the economists area of expertise.
The moral imperative of amoral theorising
Oddly, most economists see their subject as divorced from morality. They liken themselves to physicists, who teach how atoms do behave, not how they should behave. But physicists do not teach to atoms, and atoms do not have free will. If they did, physicists would and should be concerned about how the atoms being instructed could change their behavior and affect the universe.
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My colleague Gary Becker pioneered the economic study of crime. Employing a basic utilitarian approach, he compared the benefits of a crime with the expected cost of punishment (that is, the cost of punishment times the probability of receiving that punishment). While very insightful, Becker’s model, which had no intention of telling people how they should behave, had some unintended consequences. A former student of Becker’s told me that he found many of his classmates to be remarkably amoral, a fact he took as a sign that they interpreted Becker’s descriptive model of crime as prescriptive. They perceived any failure to commit a high-benefit crime with a low expected cost as a failure to act rationally, almost a proof of stupidity.
The dangers of writing widely
Pankaj Mishra is “…the author of “Temptations of the West: How to be Modern in India, Pakistan, Tibet and Beyond,” “The Romantics: A Novel” and “An End to Suffering: The Buddha in the World.”” He doesn’t know anything about economics or economic history and yet writes about it on Bloomberg as though he is an expert. When speaking to an expert audience that is dangerous, and perhaps a little foolish.
Rothbard memorably wrote that
…it is no crime to be ignorant of economics, which is, after all, a specialized discipline and one that most people consider to be a ‘dismal science.’ But it is totally irresponsible to have a loud and vociferous opinion on economic subjects while remaining in this state of ignorance.
You could easily substitute any discipline for ‘economics’ and it would be as true. Why is it that people with so little expertise are so willing to pass judgment?
For economics it may be the familiarity with the subject matter since everybody lives it every day. While an ignorance of Abelian rings is obvious to us, the gaps in our knowledge of optimal taxation are less so. The everyday language of economics and its subject matter seem familiar enough that people feel they have an intuitive understanding of the subject. While it is fantastic to have such engagement with the discipline, it often seems to lead to overconfidence in untrained commentators. For instance, Mr Mishra might have been hesitant to voice an opinion on the Bourbaki project, yet he felt no such qualms about commenting on the reasons for economic growth.
It may also be that the same lack of kjnowledge precludes people from understanding the limits of their knowledge. Bertrand Russell boldly claimed that “…those who feel certainty are stupid, and those with any imagination and understanding are filled with doubt and indecision.” However, modern research by Dunning and Kruger suggests that the effect has more to do with knowledge than intelligence. Their experiments show that those who are ignorant in a subject vastly overestimate their own skills. Yet, with only a little bit of tutoring, they gain a far better understanding of their level of understanding.
The lesson I take from all this is that poor writing about economics is a consequence of too little economic education. As economists we all have a role to play in helping people to understand the basics of our discipline. Every time we turn up our nose at a casual discussion about economics among non-experts we are promoting the spread of misinformation by our omission. Rather than just pointing and laughing at people who are plainly wrong we should be there to help.
It’s a hard road, trying to figure out what economists love
Personally, I love movies about epic historical dramas, or potatoes – but this is hardly representative of economists.
And when it comes to economics two things hold true:
- Economists actually agree about a lot more things than people realise.
- Many of the things people think we agree upon we don’t.
With this in mind I thought I’d have a quick look at the policies economists love that were put up over on Kiwiblog.
The third one states that economists would love if corporate tax was taken away – because it really is double taxation on an income stream, and an inefficient form of redistribution. This is true.
However, I wouldn’t say that economists widely agree that we should set corporate taxes at zero – especially since there is some debate about whether we should be taxing investment/interest income. There is an agreement that we should treat all investment classes the same, but less of a consensus about the level of taxation then there used to be.
On that note comes point four. Yes, economists generally prefer consumption taxes to incomes taxes – but the way to view this is as a cut in the tax on interest income … as a tax on labour income and consumption are equivalent, implying that an income tax in of itself is a tax on labour and interest income.
This comment in particular is disturbing:
Eliminate all income and payroll taxes. All of them. For everyone. Taxes discourage whatever you’re taxing, but we like income, so why tax it? Payroll taxes discourage creating jobs. Not such a good idea. Instead, impose a consumption tax, designed to be progressive to protect lower-income households.
A tax on income and a tax on consumption both reduce real after-tax income – by taxing one instead of the other we don’t “magically” discourage different things … this is confusing partial equilibrium logic with a more general view of the economy which is appropriate for discussing tax.
On top of this, a switch from income to GST taxes is an immediate transfer from savers to borrowers – is this fair?
Five is tax carbon because it’s “bad”. But is this really the reason? I was under the impression that in a small open economy like NZ we tax carbon due to raise funds for a potential Kyoto liability – as any “externality tax from global warming” would not do anything because we are so small. Hence why there needs to be international co-operation.
Six is legalise weed. There is wide agreement here that something should be done, and a general swing towards legalisation and treatment of addicts as suffering from a mental health issue rather than a criminal one. There are so many medical benefits that can be obtained from cannabis and to get more information about strawberry cough weed you can check this out. Legalising canabis can be beneficial for many people but I’m pretty sure we could also find many economists that feel that legalising may provide an inappropriate signal that could lead to worse outcomes – after all, it is well known that when you explicitly give something a price people do treat it differently.
Note: I am pointing out there are issues here – even though many of these policies are central to my own view of what is appropriate. See, I can attempt to be objective 😉