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I've created a resource page for The Case Against Education's calculations of education's selfish and social returns.  This work is the tentatively final version of what I blogged last June.

Start with the slideshow.  If that piques your interest, the remaining resources allow you to carefully check my number crunching. 

I'm interested in all comments and criticism.  But my first priority is rooting out demonstrable errors in my formulas.  I will happily treat to lunch anyone who alerts me to one or more non-trivial demonstrable errors. 

Remember: The selfish and social value of correcting me now is far greater than it will be after publication!

P.S. I've also updated my c.v.


I started writing The Case Against Education in 2011.  I'm still not done, but I'm shooting for release in 2017.  What's taking so long?

Almost the opposite of writer's block.  The book is taking a long time because I've repeatedly realized I needed more space to do justice to the richness of the topic.  Economists, psychologists, sociologists, and education researchers have written libraries on education, and I take my time digesting their contributions.  As a result, the book has turned into an "accordion project": When I start writing a chapter, I realize what I have to say requires more than a chapter. 

The current organization:

Table of Contents



Chapter 1: The Magic of Education

Chapter 2: The Puzzle Is Real: The Ubiquity of Useless Education

Chapter 3: The Puzzle Is Real: The Handsome Rewards of Useless Education

Chapter 4: The Signs of Signaling: In Case You're Still Not Convinced

Chapter 5: Who Cares If It's Signaling?  The Selfish Return to Education

Chapter 6: We Care If It's Signaling: The Social Return to Education

Chapter 7: Nourishing Mother: Is Education Good for the Soul?

Chapter 8: The White Elephant in the Room: We Need Far Less Education

Chapter 9: 1>0: We Need More Vocational Education

Chapter 10: Four Chats on Human Capital, Signaling, and Life Well-Lived


Chapters 5 and 6 were originally supposed to be a single chapter.  Now I've spent 16 months writing them.  Still, I have no complaints.  The Case Against Education will be the most research-intensive book I'll ever write, and I have the good fortune to be able to toil until I'm pleased with the quality of the work.


David R. Henderson

Dom Armentano

David Henderson

Following a few of links in Bryan Caplan's latest post, I came across this book (zero-price as a pdf) edited by Walter Block. Titled I Chose Liberty, it's a series of essays on how various libertarians or close-to libertarians came to their views. I confess that it's the kind of book I love, if done right. My favorite kind of book has always been autobiographical. In 1967, when I had just finished my summer job and was about to start going to college, I read Sammy Davis Jr.s Yes I Can, and it made a big impression on me. In the late 1970s, after I finished my dissertation and used the Ph.D. to help me become a resident alien,

I took time to read The Autobiography of Malcolm X, and liked it way more than Bryan Caplan did. Admittedly, at the age of 27, I read it less carefully than Bryan did also.

Block's book is not the kind of thing that I would recommend reading cover to cover. Instead, dip in and read about someone you're interested in, and then someone else, etc. The one I read this morning that I found fascinating was by Dominick T. Armentano.

It's not long and so I'll give only a few quotes here:

I was reading Friedman and Hayek and especially Hazlitt by that time and frequently asking "outrageous" questions in class. There were never any serious answers, of course, only smirks and ridicule. I would often make appointments to meet professors after class to pursue issues, but few ever showed. Indeed, what I remember most about those undergraduate years is the almost complete "liberty blackout" in economics classes.

This rings a bell with my experience in my one undergrad econ class during my last year of college, 1969-70.

How he got excited about digging into antitrust cases:

Wilcox, et al. simply assumed that government antitrust policy promoted the "public interest" and that the firms convicted under the Sherman Act had actually raised prices and reduced outputs as standard monopoly theory predicted. Certainly the students who studied the Wilcox text had no way of knowing what actually transpired from an economic perspective in the classic antitrust cases since the author chose not to tell them. At the end of my first year of teaching, I decided to write an antitrust book to fill in the story that Wilcox and other textbook authors had omitted. The Myths of Antitrust: Economic Theory and Legal Cases (1972) was an attempt to do a major "revisionist" history of antitrust theory and policy. The State of Connecticut had an excellent law library in Hartford and so I buried myself in legal decisions and trial record material for almost four years. (We had no "research assistants" at the time; I did ALL of the research for Myths myself and wrote every word of text. If there are errors or omissions, blame me.) My intention was to discover what actually happened in the classic antitrust cases from an economic perspective. Did the firms abuse consumers and was antitrust a legitimate response to monopolization? Additionally, I wanted to tell the story of the classic antitrust cases in the context of the actual historical development of the industry.

And don't miss the well-deserved parental pride about his son, Paul Armentano. I had always wondered if there was a connection between the two. That acorn didn't fall far from the tree.


My debate partner, Vivek Wadhwa, has made feminists so angry that he's decided to stop talking about sexism in the tech industry.  The New York Times on the conflict:
Women in tech criticized Mr. Wadhwa for clumsily articulating their cause. They said he was prone to outrageous gaffes, including once referring to women at tech companies as "token floozies," a phrase Mr. Wadhwa later blamed on his poor English.

Critics also argued that Mr. Wadhwa's message to women -- that they should become more confident to survive in the tough world of tech -- was outdated and could backfire on the women who followed it.

And when he was called out on those points, Mr. Wadhwa, who conceded that he can be "a hothead," adopted a defensive -- even wounded -- tone on Twitter.


The whole episode could be written off as a mere Twitter-fueled kerfuffle. But the women who have criticized Mr. Wadhwa say the battle carries a bigger message.

That he became a spokesman for women in tech despite their questions about his message is, they say, symptomatic of an industry that seems bent on listening to men over women, even when the men aren't especially qualified to comment.


"I don't think that the feminist movement, as a whole, was ever that interested in figuring out how to work with Vivek," said Elissa Shevinsky, co-founder of a messaging company called Glimpse.

But it is not enough, in this complex and delicate issue, to simply have one's heart in the right place. "I think his intentions are good, but his message and his voice are actually damaging women," said Sarah Szalavitz...

While reading this piece, I had an epiphany.  There are three main kinds of social movements:

1. Those that don't get angry.

2. Those that get angry at their enemies.

3. Those that even get angry at their friends.

Yes, there's an undeniable continuum.  But most social movements are easy to pigeonhole because they're far from the cutoffs.  Most fit in the #2 category.  They have classic myside bias: us-versus-them, have your buddies' backs, go Team Blue/Team Red.  Movements in category #2 are worthy of condemnation for their shortages of common sense and common decency. 

But such movements are innocent compared to those in category #3.  There's no point naming names; you know the leading examples.  These movements care so little about truth that they construct a system where members fear to speak until they know with confidence what the other members want to hear.  Normal movements tune out serious criticism from their enemies; category #3 movements turn off mild criticism from their friends.  With predictable results.

Category #1 is, of course, the most sparsely inhabited.  But instances do exist, and they meritoriously tower over the competition.  All truths come from people.  Category #1 movements foster truth by putting people at ease to candidly speak their minds.  This hardly guarantees the attainment of truth; but then again, nothing does.  Refusing to be angry at your enemies helps you avoid totally wrong ideas.  Refusing to be angry at your friends helps you make roughly right ideas righter.

It would be suspiciously convenient if I thought that the main social movements with which I affiliate all fall into Category #1.  But alas, they don't.  Libertarianism is a standard category #2 movement.  Its members express anger every day, but overwhelmingly against liberals, conservatives, and socialists.  While there's in-fighting, few libertarians worry about offending their teammates.  In my youth, I even got to witness old-school Objectivism first-hand, a category #3 movement par excellence.

But happily, I have managed to locate and join some category #1 movements.  I see no reason why George Mason economics bloggers shouldn't count as a movement.  I've been part of it for over a decade.  And I can honestly say we eschew anger against out-group and in-group alike.  If that's too tightly-knit for you, I'll also name the open borders movement.  What you see on Open Borders: The Case is what you get face-to-face: An admirably calm community of thinkers.

None of this means that well-functioning movements will be moderate or compromising.  Sometimes the truth is extreme and uncompromising - and when it is, well-functioning movements will be extreme and uncompromising.  But it does mean that well-functioning movements greet fellow travelers with open arms.  They search for intellectual value, not intellectual transgressions.  And they look upon even self-styled enemies as potential fellow travelers.

P.S. Open Borders Day is March 16.  I trust the supporters and fellow travelers of open borders to stay classy and show the world what a category #1 movement looks like. 


I can almost guarantee that you won't have a clue what this post is about just by reading the title. How does it fit on an economics blog? Because it's about psychic rewards from helping make things work and go smoothly.

I had an experience this morning that led to a certain feeling and I've often had this kind of experience leading to this kind of feeling. I realize that I've never shared this with anyone. I wonder if other readers have had this kind of experience.

I was about to walk across a street at a corner where there is a 4-way stop. It's one of the busier corners in Monterey and so there's usually a fair amount of traffic. A pedestrian can really slow things down because when he walks across, he might be walking in front of a vehicle whose turn it was or whose turn it was about to be. Then that vehicle has to wait and other drivers at the other 3 stops aren't so sure who's going to go. That one pedestrian crossing can slow each of the 4 drivers waiting, and therefore the drivers behind them, unless one driver sees the situation and, knowing the pedestrian will "block" for him, goes out of turn. Still, even with that other aware driver, there's more waiting than there would have been without the pedestrian.

When I started to cross the street, I noticed a medium-sized Monterey bus that would then have to wait until I got past him in front of him to the other side. I sized up the situation quickly and realized that I could avoid stopping any of the flow if I jay-walked slightly and went behind him. So I caught the driver's attention, pointed at myself, and then pointed to the space behind him. The driver got the point, waved, and drove into the intersection.

So I helped make things work better. Here was my interesting physical reaction. I actually felt a part of my brain feel warm and fuzzy. It's hard to describe, but it was a pleasurable feeling and it's one I've often had in social situations where I see a Pareto-improving move I can make and I make it.

My question: Have any of you had similar experience where you help make things better for others with no pecuniary reward and no expectation of such a reward, and then had that warm fuzzy feeling in your brain?

Or am I just weird?



In my recent post "Krugman's Priceless Economics," I criticized a recent column by Paul Krugman in which he argued against thinking about labor markets in terms of supply and demand. I quoted the following from his article:

Specifically, this view [that wages are set by supply and demand] implies that any attempt to push up wages will either fail or have bad consequences. Setting a minimum wage, it's claimed, will reduce employment and create a labor surplus, the same way attempts to put floors under the prices of agricultural commodities used to lead to butter mountains, wine lakes and so on. Pressuring employers to pay more, or encouraging workers to organize into unions, will have the same effect.

But labor economists have long questioned this view. Soylent Green -- I mean, the labor force -- is people. And because workers are people, wages are not, in fact, like the price of butter, and how much workers are paid depends as much on social forces and political power as it does on simple supply and demand.

I had no reason to wonder why he decided to use butter as an example of a good for which price floors create a surplus. I assumed that it occurred to him off the top of his head or that he had seen it in a past economics lecture or economics textbook.

Well, it turns out that he did see it in an economics textbook. In fact, he (or his co-author) wrote it in an economics textbook. The example is from Microeconomics by Paul Krugman and Robin Wells.

Not only did Krugman and Wells write the example of price floors creating surpluses but, more important, given his current view, they used that example to explain how a price floor called the minimum wage creates a surplus of labor, with this important difference: whereas governments buy the surplus butter, no government buys the surplus labor.

And this textbook is not from the 1990s, when Krugman often used standard price theory to explain the problems with government interventions. This textbook is from 2009.

HT to Robert Murphy, who himself hat-tipped Jeremy Hammond.

Now that I'm hat-tipping Robert Murphy, I should point out that he makes an important point about the absurdity of using private voluntary behavior, as Krugman did, to argue from government imposing that behavior economy wide. A quote from his piece:

[I]t is a very strange argument to say, as Krugman does, that since we observe Walmart raising wages voluntarily, that therefore having the government force other firms to do so involuntarily won't cause any major problems.

Look, Target just announced that it will lay off thousands of workers as part of a package to save $2 billion over two years. So should Stephen Moore write an op ed arguing that the government should require all existing firms to lay off thousands of workers, because the possible downsides are obviously smaller than what conventional wisdom suggests?


Over the years I've argued that economists are horribly confused about the concept of "income." They use income for tax incidence discussions and also economic inequality, whereas on theoretical grounds consumption is clearly the appropriate variable. And yet until a few minutes ago I never realized just how confused we were (which I guess means I was equally confused).

I did a post over at MoneyIllusion on real wages, and commenter Foosion directed me to a Paul Krugman post on the topic. Krugman tries to show that real wages have done poorly, but is only able to do so by deflating the wage series by the CPI. I used the PCE, which is preferred by most experts, and found a significant rise in real wages since the 1990s. But it was this comment by Krugman that left me scratching my head:

My second chart shows real GDP per household -- nominal GDP, deflated by the consumer price index, divided by the total number of households; and compares it with median household income, both expressed as indexes with 1979=100. We've had substantial income growth since then, but very little for the median household, because so much of it has gone to the top.
Now it's a free country, and Krugman can define "real GDP" any way he likes. But the term 'real GDP' has a pretty well accepted meaning among economists, and it's definitely not NGDP/CPI. Instead, real GDP is NGDP divided by the price index of the goods that make up NGDP, i.e. the GDP deflator.

At this point I realized that I was being too hard on Krugman. After all, GDP is just another term for gross national income. And economists have been using the CPI to deflate income data of all sorts for decades. But the fact that we've been doing it doesn't make it any less insane. Let's look at some basic definitions (sorry David).

GDP = C + I = C + S = GDI

So in a simple model with no trade or government, national income has two parts, consumer goods and investment goods. Obviously if we want to calculate the real value of consumption, we ought to use the price level of consumer goods (the CPI or the PCE). And if we want to calculate real income/output, we'd deflate using the price level of all goods, consumer and investment. And yet how often do you see economists calculate real income by using the CPI or the PCE? Indeed I made this mistake in my MoneyIllusion post, using the PCE. The correct deflator is the GDP deflator. (Yes, it gets more complicated with government and trade, but that doesn't excuse this fundamental error.)

Perhaps economists are interested in the purchasing power of income under the assumption that all income was consumed. But in that case GDP would equal C, and investment would be zero. So the two price indices would be identical. As long as GDP does not equal C, it makes no sense to deflate income with the CPI or the PCE.

If you are still reluctant to give up on the notion that the "cost of living" should be measured in terms of consumption price indices, I think I know why you are confused. Yes, in a sense the CPI or PCE is the deflator that is appropriate for living standards comparisons, but that means our bigger mistake is that we are using income as a measure of economic wellbeing, whereas all our economic models tell us that consumption is the appropriate variable.

Unless I'm mistaken this is embarrassing. First the economics profession ignores the implications of their models by using income where consumption is appropriate. That's already pretty bad. Then to make matters worse we don't deflate income with the appropriate price index, the one for all of income, not just consumption. Instead we deflate income (i.e. C+I) with a consumption price index. We use the wrong indicator of well being, and then pick the price index that would be appropriate if we'd chosen the right indicator of well-being!

Does this matter? Not before 1970. But since then it matters a lot. Commenter E. Harding sent me a graph showing that since 1970 the CPI has risen far faster than the PCE, and even the PCE has risen more than the GDP deflator. This mistake explains much of the phony claim that "real income" has stagnated since the 1970s. (Although many articles also make other mistakes, ignoring fringe benefits like health insurance, or government transfers.)

Screen Shot 2015-03-04 at 11.47.03 PM.png

PS. Unfortunately I had to shrink this graph to fit the 400 pixel max at Econlog. The fast rising red line is the CPI, the green is the PCE and the blue is the GDP deflator.

Update: I misinterpreted the graph sent to me by E. Harding. The blue line was the price index for the business sector. In this new graph the GDP deflator is added, and is very slightly above the PCE. So the problem is less worrisome than I assumed.

Screen Shot 2015-03-05 at 9.04.06 AM.png


The answer to the question I asked in the title seems as if it should be "Yes." And not just "yes," but "Obviously yes."

Yet economist John Whitehead says that one can't conduct cost-benefit analysis of a policy. Specifically, he writes:

The costs of cap and trade do not outweigh the benefits. It might be the case that the costs of a climate policy, any climate policy, outweigh the benefits. But cap and trade is a policy instrument, not something for which you conduct a benefit-cost analysis. The economics says that if the government decided to undertake climate policy, cap and trade would be one of the most cost-effective ways of doing it.

Notice his third sentence. Cap and trade is a policy instrument. But, contrary to Whitehead, you can conduct cost/benefit analyses of policy instruments. You would compute the costs and compute the benefits. It might be difficult to get a handle on those things, especially on the benefits. But in principle it's doable. So the answer to the question I raised in the title is "Yes."

Whitehead seems to be saying that one can do only cost-effectiveness analyses of policy instruments. That's true only if you can't compute benefits.

By the way, in the same post Whitehead also addresses the issue of carbon taxes with offsetting reductions in other taxes. Although he doesn't address the issue directly, I'll bet dollars to doughnuts that he is not aware of this article and the important tax-interaction issue it addresses.

HT to Mark Thoma.

CATEGORIES: Cost-benefit Analysis


David R. Henderson

Illegal Means Illegal

David Henderson

What's the difference between Silk Road and e-Bay?

George Washington University political science professor Henry Farrell recently wrote a piece titled "Dark Leviathan." He states his case so well that I won't try to paraphrase it. Instead, I'll quote one of the opening paragraphs:

[Ross] Ulbricht built the Silk Road marketplace from nothing, pursuing both a political dream and his own self-interest. However, in making a market he found himself building a micro-state, with increasing levels of bureaucracy and rule‑enforcement and, eventually, the threat of violence against the most dangerous rule‑breakers. Trying to build Galt's Gulch, he ended up reconstructing Hobbes's Leviathan; he became the very thing he was trying to escape. But this should not have been a surprise.

It's true that "this should not have been a surprise." It's the kind of thing you would expect in illegal markets.

Farrell tells how various unscrupulous actors took advantage of Silk Road's structure to cheat others. Assuming he has his facts right, there's nothing I object to in his account. He also nicely weaves various findings in game theory into his account.

You might be saying at this point, like Mona Lisa Vito in My Cousin Vinny, "So what's your problem?"

My problem is Farrell's conclusion, or, more exactly, the third line in the last paragraph of his conclusion. Here's the last paragraph:

Ulbricht's carelessness brought about the early demise of Silk Road. But if he hadn't been stupid, the marketplace would have soon collapsed under its own weight, or become the creature of larger organisations with a far greater capacity for violence. The libertarian dream of free online drug markets that can magically and peacefully regulate themselves is just that: a dream. Playing at pirates is only fun as long as the other players are kids too. The trouble is, once adults with real swords appear, it may be too late to wake up.

You can't have the "libertarian dream of free online drug markets" unless drug markets are, in fact, free. But, as Farrell well knows, they're illegal. As I put it in my 1991 article "A Humane Economist's Case for Drug Legalization" (UC Davis Law Review, Spring 1991, Vol. 24, No. 3, p. 664):
[D]rug laws make it difficult for drug producers and sellers to establish reputations for supplying high-quality, reliable drugs.

So Farrell's whole discussion, while it is a well-needed (again, assuming his facts are true) tonic for people who think that online markets in illegal drugs won't have big problems, tells us precisely nothing about how free markets would work. In short, "illegal" means "illegal."


I just reviewed all 50 responses to my original Ukraine prediction challenge.  Seven comments did not make unconditional predictions, and two were obvious jokes.  Here's how I scored the remaining 41 sets of predictions:

1. My last post named six major facts about what happened during the last year:

2. Responses got one point for correctly predicting each of these facts.

3. Response lost one point for predicting anything contradictory to each of these facts.

4. Responses were neither rewarded nor penalized for failing to address these six points, or for making other predictions.  My apologies to everyone who made correct predictions I didn't score; many made good points, but I wanted to keep scoring simple and consistent.

5. I tried to grade the responses blind, but only via deliberate inattention rather than a serious blinding protocol.

The resulting histogram has a mean of -.29 and a standard deviation of 1.08, with a maximum of +2 and a minimum of -4.

The winner of the Ukraine Prediction Challenge was Hansjörg Walther, with a score of +2 out of a possible +6.  His original forecast:

My prediction is very similar to David Friedman's:

- Russia will secure control of the Crimea (or already has).
- There are protests from Western governments, but nothing serious.
- Then a deal is brokered to let people in the Crimea vote on staying within Ukraine or joining Russia, which is easy to sell as self-determination.
- And the probable outcome would be that the Crimea accedes to Russia.

Putin will not try to gobble up Eastern Ukraine or even Ukraine as a whole. That would be a precedent where Western governments would get nervous (although even in this case my guess is that it would be just talk, but a higher risk something goes wrong).

And then there is no clear-cut line where to cut up Ukraine. For the Crimea there are rather recent borders you can refer to. With many people in Ukraine who are favorable to Russia, Putin has much more leverage than otherwise. And he would have a chance to influence Ukrainian politics again. With a split, he would create a second Poland that is headed for the EU and hostile to Russia.

I gave Walther one point for calling the formal annexation of Crimea, and another point for predicting no action by Western governments serious enough to lead to NATO fatalities, with zero lost points for contradicting any of the the other four major facts. 

I suspect that Tetlock will not be surprised by the results.  If he'd like to comment, you'll be the first to know.


As regular readers of my posts on Econlog know, although I am often critical of Paul Krugman, I defend him when he's doing good economics (here, for example). His New York Times column yesterday, though, "Walmart's Visible Hand," essentially throws out basic price theory. Thus the title of this post.

The context is that Walmart has announced that it will raise wages for 500,000 employees. He uses this fact to reach this conclusion, which he states up front:

Second, and arguably far more important, is what Walmart's move tells us -- namely, that low wages are a political choice, and we can and should choose differently.

Already, that's an interesting statement for an economist to make: the fact that a private employer raises wages tells us the "low wages are a political choice." No, it doesn't tell us that. It tells us simply that a private employer raised wages. To establish that Walmart raised wages for political reasons, Krugman would have to make that case. Instead he moves on because he has bigger fish to fry.

Krugman challenges the idea that wages are set by supply and demand. After stating that conservatives believe this, he admits (he even uses the word "admit") that so do many economists.

But he doesn't think that's true. He writes:

Specifically, this view [that wages are set by supply and demand] implies that any attempt to push up wages will either fail or have bad consequences. Setting a minimum wage, it's claimed, will reduce employment and create a labor surplus, the same way attempts to put floors under the prices of agricultural commodities used to lead to butter mountains, wine lakes and so on. Pressuring employers to pay more, or encouraging workers to organize into unions, will have the same effect.

But labor economists have long questioned this view. Soylent Green -- I mean, the labor force -- is people. And because workers are people, wages are not, in fact, like the price of butter, and how much workers are paid depends as much on social forces and political power as it does on simple supply and demand.

Actually, this view not imply that "any attempt to push up wages will either fail or have bad consequences." We economists who believe that wages are set by supply and demand also believe that if the supply falls (shifts left on a graph of supply and demand) or if demand increases (shifts right on a graph of supply and demand), then an increase in wages will have good consequences. And that, after all, is the context for Krugman's article: not a government attempt to raise wages but an employer's decision to do so.

Also, wages are like the price of butter. This has nothing to do with the fact that the workers are people. Remember that the workers are selling their services--their hours--not themselves.

Then we get where he really wants to go: advocating higher minimum wages and more bargaining power (although he does not name the specific changes in law that he wants) for labor unions.

First, on minimum wages, Krugman, as is his wont, emphasizes only one part of the literature, the part that finds "little or no negative effect on employment" and treats that as an "overwhelming conclusion" of the so-called "natural experiments" with the minimum wage, rather than as the conclusion of one part of the natural experiment literature.

Second, on unions, Krugman argues that the "sharp increase in unionization" after World War II reduced income disparities. But here's where he is most "priceless." The bottom line of the literature on the effects of unions and wages, most of the literature coming from the 1950s and 1960s, and much of it summarized by the "dean of labor economics," H. Gregg Lewis of the University of Chicago, was that unionization in the one quarter of the labor force that was unionized raised wages for those workers by about 10 to 15%. But, of course, with higher wages, the amount of labor demanded fell. Where did these workers go? They went to the non-union sector. That shifted out the supply of labor there. So wages for the 75% of workers who were not unionized were 3 to 4% lower. The only way this would reduce income inequality is if the 25% of the workers who were in unions would otherwise have had wages below the wages of the 75% not in unions. Unfortunately, many of the non-union workers had lower wages to begin with. So the effect of unions on income inequality was, at best, not clear.

Krugman concludes:

What this means, in turn, is that engineering a significant pay raise for tens of millions of Americans would almost surely be much easier than conventional wisdom suggests. Raise minimum wages by a substantial amount; make it easier for workers to organize, increasing their bargaining power; direct monetary and fiscal policy toward full employment, as opposed to keeping the economy depressed out of fear that we'll suddenly turn into Weimar Germany. It's not a hard list to implement -- and if we did these things we could make major strides back toward the kind of society most of us want to live in.



I've done numerous posts pointing out that prior to 2008, New Keynesian economists believed the fiscal multiplier was roughly zero. Paul Krugman used to say that aggregate demand was essentially whatever Alan Greenspan wanted it to be. Jared Pincin sent me another great example from a 2006 textbook by Brad DeLong and Martha Olney:

As a rule, today's Federal Reserve does routinely neutralize the effects of changes in fiscal policy. Swings in the budget deficit produced by changes in tax laws and spending appropriations have little impact on real GDP unless the Federal Reserve wishes them to" (pg. 399). They also write on pg. 400: "The rule that prevails today and probably will prevail for the next generation is that the Federal Reserve offsets shifts in aggregate demand created by the changing government deficit.
At this point many Keynesians will respond that the zero lower bound (now the minus 0.75% lower bound) changes everything. But that certainly wasn't the view a recently as a decade ago. Here are some examples of mainstream economists pre-2008:

1. Frederic Mishkin said that monetary policy remained "highly effective" at the zero bound.

2. Ben Bernanke agreed, and suggested the BOJ do level targeting.

3. Lars Svensson said currency depreciation was a "foolproof" way of escaping a liquidity trap.

4. Paul Krugman spoke of the need to "promise to be irresponsible," i.e. a higher inflation target.

A decade ago I was right in this New Keynesian mainstream. I believed the central bank could and should keep NGDP growing at a fairly stable rate. I believed that the fiscal multiplier was roughly zero. Like Bernanke and Mishkin, I believed low interest rates to not imply money is easy. Etc., etc.

Some Keynesians cite Keynes's famous quote:

When the facts change, I change my mind. What do you do?
There are two problems with this argument.

1. I see no facts that would have led a sensible person to abandon the zero multiplier view.

2. Many Keynesian roll their eyes at zero multiplier claims, as if they are obviously absurd. How can an idea that was right in the New Keynesian mainstream in 2006, when the Japanese liquidity trap was already well understood, suddenly become a cranky heterodox view in 2009? Especially given the complete failure of the 2013 "test" of the anti-austerity theory. If nothing else, anti-austerian Keynesians are engaging in intellectual dishonesty any time they ridicule the arguments of the stimulus skeptics. After all, they believed those things just a few years ago.

If someone I hadn't seen since 2006 bumped into me, they might say to me; "I thought you were a centrist on macroeconomic policy. What made you decide to suddenly become an extremist?" My response would be that I am still a centrist; it's the rest of the New Keynesians that have migrated to the view that Krugman called "Vulgar Keynesianism" in 1997.

Which reminds me of one of the most unfortunate technological innovations in the history of art, the disastrous invention of the talking picture:

Screen Shot 2015-03-03 at 10.23.25 AM.png
PS. What picture is most diminished by the invention of sound (actually talking)? My vote is Titanic. Woulda been a great silent flick.


A year ago I challenged EconLog readers to make unconditional predictions about the Ukraine conflict:
Challenge: In the comments, go on the record and predict what will actually come of the emerging Ukrainian-Russian conflict.  Only unconditional, falsifiable predictions count.  No claims like: "Unless the EU acts..." "If Russia comes to its senses..." or "This will be a very different world."  Make specific claims about what will actually happen by a specific date.

In a year I'll revisit your comments and rank their accuracy with the benefit of hindsight.
Before I carry out the promised ranking, this is what's actually seems to have happened:

Anyone seriously dispute any of these facts?  Any major facts I'm omitting?


In one of this month's two Feature Articles, "Who Is Harmed by Insider Trading?", Charles L. Hooper takes a look at insider trading. Specifically, whom does it hurt.

A key paragraph:

Insider "hurt" Uninformed Buyer by nabbing Uninformed Buyer's unexpected and unearned windfall. How can Insider be less deserving than someone who isn't deserving at all? Insider, after all, is making the stock market more efficient by disseminating important information, while Uninformed Buyer's actions are equivalent to background noise.

Read the whole thing.


One thing that regulators, and regulation's enthusiasts, rarely get is that private businesses will do their best to off-set the impact regulation has on them. This is particularly true in instances in which regulation is considered the second-best option to outright punishment.

That is the case of Uber, which is being punished pretty much everywhere in Europe for embodying a less corporatist alternative to the traditional taxi-license system, that we believe suits the "European social model" so well. Many city governments react to Uber coming to town, due to the lobbying of vested interests: taxi drivers move around not just people, but voters too, and they are commonly considered quite influential. Uber's strategy is certainly rather new, and problematic, as it seems conceived to force a regulatory shift at some point. But Uber also faces the opposition of those who cannot make peace with the fact that innovation happens, and sometimes new technologies, or new bundles of technology, can make laws as written in the books basically obsolete.

The Spanish authorities have banned Uber in the country, but instead of going home, the American company has decided to adopt a different business model: if they cannot carry human beings around, why not goods?

Professor of Business Administration Juan Pablo Vazquez Sampere here suggests that regulators may have done Uber a favour.

That's because Uber has decided that the company will switch from transporting people to transporting food in Barcelona. This is how it works: Restaurants in (initially) four neighborhoods within the city can order an Uber transport for just 2.5 euros. The Uber driver will deliver the order to the customer in less than 10 minutes. Uber makes 20% of the 2.5 euros. Uber has promised that its delivery drivers will be required to pay taxes as a condition of employment.

Sampere maintains that "One of the most effective ways to launch a successful disruptive innovation in a highly regulated industry is by building your business model in the 'other' category". By gaining traction in the food distribution market, Uber may get big and "important" enough, in Spanish society, to be able to go back, at a certain point, to the original plan and offer taxi-like services. His article is well worth reading.

CATEGORIES: Regulation


Most Americans are okay with educational "tracking" - measuring potential, then tailoring each student's education to his measured potential.  But if you advocate extending or expanding the role of tracking, most Americans resist.  Suppose you propose, for example, that the bottom third of high school students get vocational education instead of college prep.  Americans suddenly rally behind feel-good egalitarian slogans like, "We have to make sure that every student has the opportunity to live up to his full potential."

Taken literally, such slogans damn not only the extra tracking we could have, but the tracking we've already got.  All tracking is a trade-off between two evils.  Classicists call them Scylla and Charybdis, statisticians call them Type 1 and Type 2 error.  But let's just call them Overlooked Potential and Wasted Resources. 

The evil of Overlooked Potential: The tougher your tracking, the more qualified students you fail to teach.  The evil of Wasted Resources: The laxer your tracking, the more unqualified students you teach to fail.  Accept no one, and you won't waste a penny, but you'll also miss every opportunity to do good.  Accept everyone, and you'll miss no one - but you'll burn a fortune of time and money on Hail Mary passes. 

Every system - the status quo included - strikes a balance between Overlooked Potential and Wasted Resources.  But almost no one explicitly argues that what we currently do strikes the optimal balance.  Why not?  Probably because accepting Overlooked Potential for the greater good is, in Philip Tetlock's phrase, a taboo trade-off.  Saying, "Sure, I don't like overlooking potential; but I'm even more opposed to wasting resources" sounds terrible - no matter how trivial the Overlooked Potential and how massive the Wasted Resources. 

How do Americans cope with their silly scruples?  They salve their consciences by pretending that the problem of Overlooked Potential only emerges if tracking extends or expands.  This preserves a modicum of common sense; at least we won't abandon tracking altogether.  But if tracking is currently underused, Americans' taboo trade-off blockades any further progress.  Is it possible that more robust tracking might deprive someone somewhere of a valuable opportunity?  Uh... yes; it is a big world.  Then robust tracking gets vetoed, regardless of its upside.

Is there any evidence that tracking is currently underused?  Sure.  Partly under the influence of the No Child Left Behind Act, high schools today teach as if every student is a future college graduate.  But most aren't; indeed, over 20% of high school freshmen don't even earn a normal high school diploma.  Furthermore, many college grads don't get college-type jobs.  I submit that these disparities between aspiration and results are, in themselves,  strong signs that tracking is underused.  Stricter tracking wouldn't magically turn more students into successful college graduates.  But it would prepare the majority of students who won't get college-type jobs for the careers they're actually going to have.  

Perhaps I'm wrong about this; maybe the status quo is wise beyond my ken.  But I'm not wrong to think that the trade-off between Overlooked Potential and Wasted Resources is socially taboo.  And as long as this trade-off is socially taboo, we should assume that the case for stricter tracking is intellectually stronger than it looks


David R. Henderson

Consider the Substance

David Henderson

In Econlog's sister blog, Online Library of Law & Liberty, Lauren Weiner makes an important distinction. Left wing pundit David Corn has accused Fox News Channel's Bill O'Reilly of exaggerating in telling about his experience in Argentina during and after the Falklands War. Conservative radio host Hugh Hewitt went after Corn.

Lauren Weiner writes:

David Corn, coauthor with Daniel Schulman of the Mother Jones article, was questioned at length by the conservative radio host Hugh Hewitt. In a telephone interview, Hewitt challenged Corn's credibility in two ways, trying to establish a political motive and a personal motive for why he would attack Bill O'Reilly. In lawyerly fashion, Hewitt probed for evidence of what everyone who is familiar with David Corn already knows: that he's on the political Left and disdains O'Reilly's conservative views. Along with suggesting that O'Reilly's scalp was being sought purely as a tit-for-tat for the mainstream (read: liberal) media casualty over at NBC, Hewitt injected the fact that David Corn had been a paid commentator on Fox but was let go. The implication was that he bore a personal grudge against the cable channel.

Ms. Weiner adds:
Sympathize with Hewitt though I often do, and find fault with Corn though I often do, I came away thinking that this interview did not get to the heart of the matter. Whether or not the political and personal motives that Hewitt discerned were there, what if the Mother Jones article nonetheless contained a grain or maybe more than a grain of truth?

She ends the piece beautifully:
When the debate heats up, and the cry is raised, "Consider the source!"--we ought to consider more than the source. We ought to consider the substance.


There are certain topics that are extremely hard to explain to the average person. Interest rates are one of those topics. I've often argued that interest rates don't really matter that much; they are a sort of epiphenomenon of monetary policy. I've also argued that the ECB adopted a tight money policy in 2011, and that this triggered a double-dip recession. And what's the easiest way for the average person to visualize the ECB's tight money policy? The fact that in 2011 they raised their interest rate target from 1.0% to 1.25%, and then to 1.50%. But if interest rates don't matter very much, how could mere 50 basis point increase cause a recession, especially given that they soon started cutting rates again?

One problem is that most people think we are always in the short run. No matter how many times you teach students that tight money raises rates in the short run (liquidity effect) and lowers them in the long run (income and Fisher effects), when the long run actually comes around they will still see the fall in interest rates as ECB policy "easing". And this is because most people think the term "short run" is roughly synonymous with "right now." It's not. Actually "right now" we see the long run effects of policies done much earlier. We are not in an eternal short run. That's the real problem with Keynes's famous "in the long run we are all dead."

I'm going to try to explain why even a 1 basis point increase in the interest rate target could cause a Great Depression, and then afterwards explain why interest rates actually aren't very important at all. Bear with me.

In most macro models, interest rate pegging is a knife-edge equilibrium. If the rate is pegged slightly below the natural rate, the economy will spiral up into hyperinflation. If slightly above the natural rate we'll spiral into hyperdeflation. That's because when you peg the interest rate above or below the natural rate, the resulting movement in the economy starts pushing the natural rate further and further away from where you are pegging interest rates. You gradually get further and further off course.

Perhaps an auto steering analogy will help. Suppose you set off west across the Bonneville Salt Flats. You try to lock the steering at a position where you will go straight west, but the wheel is accidentally set 1 millimeter off center. After 100 yards the car has drifted an inch to the right. That's not too bad, it seems like you won't end up too far off course. But here's the problem, the error will gradually get worse and worse. After 200 yards you'll be 3 or 4 inches off course, and after that the car will rapidly deviate further and further to the right. The path will be a gradual curve to the right, and before very long you'll be headed straight north. (Don't ask for details, I took calculus 40 years ago.)

Why don't we see real world central banks make even more errors than they do? Because they usually adjust the steering as they see the economy go off course. They adjust their interest rate peg up or down (and do QE at near zero interest rates.) That's like a driver nudging the wheel a bit to the left or right as he observes the car drift slightly off course. It's easy for drivers to do, and it's easy for central banks to do. When they produce bad policy (as the ECB did in 2011) it's because they were trying to produce the policy we now judge as bad---they were trying to reduce eurozone AD to bring down inflation.

Over at MoneyIllusion a commenter thought I'd disagree with this analysis by Brad DeLong:

Taylor says the Federal Reserve kept interest rates two percentage points to [sic, 'too'] low for three years. If you are buying a long-duration asset like housing, such an interest rate break leaves you willing to pay 6% more than you would otherwise have been willing to pay. Are we really supposed to build a 50% nationwide housing bubble on top of the 6% impetus? Only a market already fully infected with the bubble disease could see such a small impetus have such a large impact.
I actually agree with DeLong. Although a tiny change in interest rates might cause the money supply to gradually change in such a way as to create rapid NGDP growth, the actual policy done by the Fed did not do that in the early 2000s, at least no more so than in the 1950s, 60s, 70s, 80s, or 90s. So while in retrospect policy may have been a bit too expansionary, it didn't miss by all that much. And yet the house price boom was much more dramatic than during more inflationary decades.

Now perhaps interest rates worked on house prices through some channel other than NGDP growth. In that case I'd point to DeLong's argument, the interest rates were not off base enough to explain such a dramatic price increase. If you are looking at interest rates and home prices from a microeconomic perspective, then you throw out the knife-edge equilibria models, and use common sense. Oddly, while a one basis point interest rate increase can cause a Great Depression in a macro model, it's very hard to see how even a 200 basis point rate cut lasting three years can boost home prices by 50% in a microeconomic model.

Here's another way of making the same point. Monetary policy matters because money is the medium of account, the driver of NGDP. If the government were able to reduce interest rates via a non-monetary mechanism (say a smaller budget deficit) then you'd expect a far less dramatic impact on the economy, as compared to Fed policy moving rates around. With Fed policy it's the change in the monetary base (relative to base demand) that really matters, interest rates are simply the signaling device that people focus on.

The 2011 ECB tightening mattered because:

1. The ECB has a monopoly on the euro base, and hence controls the path of AD.

2. The two rate increases were a signal they wanted to slow the growth in AD.

3. AD growth did in fact slow sharply.

Any two of those would not be enough, but combining all three we can assume that the ECB was the cause of the sharp slowdown in AD growth after 2011. The size of the rate increase is totally irrelevant. The eurozone didn't have a double dip recession because slightly higher rates discouraged people from borrowing, but rather because the ECB caused eurozone M*V growth to slow sharply.


David R. Henderson

Krugman's Bait and Switch

David Henderson

Paul Krugman has a post on the importance of MIT economists in policy discussions. Had he simply made the point that they are highly influential, his post would have been fine. We could still argue about which of the influences have been good and which have been bad, but there is no doubt that MIT graduates have had a large role in policy debates.

Here are the people he lists, along with the years that they were granted their Ph.D.s:

Ben Bernanke 1979
Olivier Blanchard 1977
Mario Draghi 1976
Paul Krugman 1977
Maurice Obstfeld 1979
Kenneth Rogoff 1980

Paul then goes beyond that, to compare the influence of MIT and the influence of another source of much of recent economic thinking: the University of Chicago. There's nothing wrong with making such a comparison and, with a fair comparison, I wouldn't be surprised if MIT, for good or ill or, more likely, a mixture, does come out as more influential.

But here's how he does it:

You might ask, how does this list compare with similar lists you might draw up for other schools, Chicago in particular? The answer, I'd submit, is that there is no comparison. It's true that the more or less Keynesian view of macroeconomics common to everyone on this list is by no means unchallenged in the real world; but the anti-Keynesians don't really turn to academic economists for guidance. When a politician like Scott Walker tries to appeal to the conservative macro brains trust, it's not some version of the Chicago Boys -- it's Stephen Moore, Art Laffer, and Larry Kudlow.

See what he did? He measures the Chicago influence by the fact that Scott Walker and, presumably, other Republican politicians, don't seek advice from Chicagoans.

But wait. If the criterion for influence is, as it seems in Paul's mind to be, whether U.S. politicians who are considering running for President call on economists for advice, then wouldn't it then be reasonable to ask from whom Democratic politicians--Hillary Clinton, say, or Elizabeth Warren--are seeking advice? I don't know the answer to that question, but that is the relevant question Paul should be asking, given his criterion for Chicago. But here's what I'm willing to bet at even odds: Neither of them has sought advice from any of the six people he listed. Here, for example, is a recent NY Times piece that mentions Clinton's advisors on economic policy: none of them is named in Paul's list above.

And here's what I'm willing to bet at 10 to 1 odds: Neither of them has sought advice from one particular person on the list: Paul Krugman.

This is not to say that they wouldn't do better if they did seek his advice. If they asked textbook Paul (or 1990s Paul--take your pick), as opposed to New York Times Paul, if there were significant downsides to raising the minimum wage, they might get the answer that there are. If they were to ask Slate Paul, as opposed to New York Times Paul, if it's a good idea to insist on higher wages for third world people who work in "sweatshops," they would get a good answer.


David R. Henderson

William McGurn's Analogy

David Henderson

In a piece titled "Snow(den) blind: Libertarians' telling 'hero'," William McGurn, a former George W. Bush speechwriter and Wall Street Journal columnist, and currently editorial page editor of the New York Post, writes:

The libertarians who champion Snowden will claim that the secrets he published were embarrassing to the government but not damaging to our security. There's [sic] two points to make about this addled thinking.

First, what Snowden released wasn't about the NSA listening in on conversations about your private marijuana patch.

To the contrary [sic], much of it is about how America goes about its intelligence work, including the Congressional Budget Justification Book that includes detailed information on our intelligence priorities and operations.

Second, say you oppose the NSA program and believe it a good thing it was exposed. Does that make Snowden is [sic] a hero?

If the answer is yes, ask yourself this: Was Sammy "The Bull" Gravano -- a hitman with the Gambino family -- also a "hero" because he coughed up secrets that helped take down John Gotti, the "Teflon Don"?

It's an elementary distinction, between those who honorably serve our nation and those who betray her.

The libertarian inability to make it with Ed Snowden helps explain why libertarians have a long ways [sic] to go before the American people will ever elect one president.

This comes right at the end of his op/ed. Why do I mention that? Because normally when you try to end a piece with a telling analogy or metaphor, you want it to be the crescendo that cinches the argument.

This one didn't work.

McGurn is obviously trying to portray Edward Snowden as the bad guy. I would have thought he would want to use his analogy to portray the NSA as the good guy. But in his analogy, while he has Snowden as Sammy "The Bull" Gravano, he has the NSA as John Gotti. That's not exactly a strong endorsement.

I reacted negatively to McGurn's piece. But on second thought, McGurn is comparing the NSA to a famous ruthless American mobster. McGurn says that we libertarians have a long way to go. I agree with him. But his own analogy shows that we seem to be making progress with a major editorial writer by the name of--William McGurn.

CATEGORIES: Liberty , moral reasoning


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