Arnold Kling  

More Thoughts on Masonomics

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Gillian Tett on the Financial ... True or False?...

Tyler and Alex have new textbooks on micro and macro. Both begin with the same anecdote.


In 1787, the British government had hired sea captains to ship convicted felons to Australia...On one voyage, more than a third of the males died and the rest arrived beaten, starved, and sick...

Instead of paying the captains for each prisoner placed on board ship in Great Britain, the economist suggested paying for each prisoner that walked off the ship in Australia. In 1793, the new system was implemented and immediately the survival rate shot up to 99 percent.

That is economics on one foot--incentives matter.

What to do, then, about macroeconomics? In crude Keynesian economics, incentives do not matter. Consumption depends on income, investment depends on animal spirits, and prices have no impact. Much of the post-Keynesian synthesis has been devoted to bringing incentives back into the picture. The results have satisfied neither hard-core microeconomists nor hard-core Keynesians. Tabarrok and Cowen devote some space to Real Business Cycle theory, which is all about incentives. They also devote some space to the sticky-price version of New Keynesianism, in which incentives are combined with imperfect price flexibility.

I think a more promising approach is to look at the macroeconomic impact of signaling. Workers view wage rates as signals of their employer's long-term commitment to their welfare. Thus, a wage cut is a particularly negative signal, and it is difficult to cut wages in a downturn without causing major problems. See Lectures on Macroeconomics, number 4.

Also, as I have been arguing in recent posts, financial markets depend crucially on signaling. Perfect transparency in financial intermediation is impractical--if you can see through the intermediary you could have done without the intermediary and invested yourself. Thus, investorrs necessarily rely on signals when dealing with financial intermediaries. Under those circumstances, it is easy for confidence to fluctuate. We saw in recent years that there was extreme over-confidence in the financial engineering related to home mortgages. Now that confidence is gone. When confidence is high, financial intermediaries enlarge their balance sheets and economic activity expands. See lecture number 9.

So, here are some thoughts on Masonomics in general.

1. Incentives matter. That is central to economics. It also is important for political economy--Masonomics uses public choice, which says that government officials, rather than acting as benevolent omniscient stewards, respond to incentives.

2. Signaling matters. It matters in education, health care, finance, politics, marketing, and personal relationships. I would suggest that if there is to be a Masonomics perspective on macro, then signaling should be central.

3. Institutions matter. Formal and informal rules shape economic behavior, for better or worse. For example, differences across countries in the standard of living are determined largely by institutions.

4. Evolution matters. When others see a lack of planning or central direction as chaos, Masonomists see Hayek's spontaneous order. A system of decentralized trial-and-error decisions works better than many people realize. Central regulation works less well than many people expect.


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COMMENTS (16 to date)
Luke G. writes:

Arguably the most lucid and interesting post on Masonomics yet. Thank you.

claudio shikida writes:

There is a good introduction to the "Masonomics". For years I have been reading some articles from GMU's economic department and I couldn't agree more with your four main points.

I am curious to see the new textbooks...

Tyler Cowen writes:

We do use the signaling idea in the macro text...

Curt Doolittle writes:

Finally something concrete enough to use as an elevator pitch. Very nice.

fundamentalist writes:

Does Masonomics do anything with the monetary theory of business cycles? If not, why?

El Presidente writes:

Arnold,

How do you suppose that for "crude Keyensians" incentives don't matter? I don't get that at all from Keynes. If incentives didn't matter, why would he advocate countercyclical spending? It wouldn't have any effect, right? Not all consumption and/or investment is autonomous, and I don't believe Keynes ever claimed either was completely autonomous. Sounds like you're presenting a convenient and misleading dismissal to clear the field of competing theories. For Keynes, it wasn't a question of whether incentives matter, but which ones matter most, to whom, when, and why.

As far as institutions mattering, I believe they do. However, you and others have pointed out that we cannot deal with our own economy as though it was closed . . . because it isn't. How then do we attribute a country's average standard of living primarily to the institutions within it's own borders? If the largest economy in the world must be subjected to analysis of what is happening outside of it to be properly understood, perhaps some of the smaller societies in the world cannot be so easily dealt with as though their own institution are the primary basis for their respective standards of living. They may offer the greatest opportunity to autonomously _affect_ their average standard of living, but that is not the same as _determining_ their standard of living. Turning our focus back to ourselves, can our institutions be held responsible for stagnant and declining median real wages and polarization of income and wealth? If so, which ones? Seems like we ought to fix those in a jiffy, no? Can institutions provide us with unlimited wealth from limited resources? Resource constraints and competing interests are important to consider, as well as institutions.

blink writes:

How about "costs matter"? I do not see how opportunity costs are obviously covered among the four ideas listed

David writes:

So if signaling matters, can you see large stimulus packages as basically signaling to relevant players that the gov't is 'taking things seriously' and will put up the cash in hard times? Wouldn't the do nothing approach advocated by some masonomists signal that we're not taking the crisis seriously?

Political Observer writes:

Spending doesn't necessarily equate to incentives. If I hire more people to re-read the work of others - while that is spending there is no incentive for the first group of writers to do anything different. Nor is there any incentive for the second group to do anything different. As a result there is no net improvement in our overall quality of life - just more spending. (We can ignore for simplicity the added cost in terms of either taxes or borrowing that supports this spending).

The only arguement for central controls is that the decision makers get to decide rather than the masses. That is the central point of control economies (and to an extent with Keynes as well). When each of us are allowed to act in our own self interest we will make decisions that others disapprove. Rather than accept that each individual is free to chose (and also responsible for the outcome) the central planners want to impose their value system on all others so that only the "right" choices are made. The central planners do not accept that value is subjective. Instead they want to believe that value is objective - what they want is valuable and what you want is waste. So let's stop you from wasting resources so that I can have more of my choices.

Actually not bad work if you can get it!

PiffleDragon writes:

Why didn't those incentives work as well on slave ships?

George writes:

PiffleDragon wrote:

Why didn't those incentives work as well on slave ships?

Maybe a limit on the number of passengers was set in the convict case, and not in the slave case. Then it would make economic sense to just put more slaves on board at the beginning of the journey, to make up for the expected losses. Also I suppose good treatment and good health might lead to successful mutiny in the slave case, since they faced a worse fate.

(Man, it feels icky just to write about people as if they were property.)

Paul Walker writes:

A quick question. Do you know the reference for the quote, from the Tyler/Alex text, you use at the start of this post? I have seen the story many times but have never been able to find a source for it.

El Presidente writes:

Political Observer,

"Rather than accept that each individual is free to chose (and also responsible for the outcome) the central planners want to impose their value system on all others so that only the "right" choices are made."

I'm not sure who you are calling central planners, but isn't this what every law does; constrains the behavior of individuals so that they are prevented from making a "wrong" choice and limiting them to the "right" choices that remain? And if those laws are intended and designed to reduce negative externalities, can we really find fault with them for anything other than failure to achieve their goal?

Curt Doolittle writes:

El Presidente

RE: "... isn't this what every law does; constrains the behavior of individuals so that they are prevented from making a "wrong" choice and limiting them to the "right" choices that remain? "

Your statement however, that "laws are designed to reduce negative externalities", is the root of the problem with law, and with politics in general. We cannot minimize externalities - they're infinite. We can only struggle to stop people from lying, cheating and stealing, it all it's forms, by the use of restitution and punishment.

If we start with "we have laws because we have property, we do not have property because we have laws", then there is only one law, property, and a million stipulations about it's use in circumstances.

We only need one law for civilization to develop. But the ways in which humans will privatize wins and socialize losses are infinite.

Black markets are evidence that property rights are not sufficiently distributed, that there are too few punishments or restitutions imposed, and that the individuals who live in a society lack the personal will, and in some cases the personal will to risk and violence, that is required in order to build a civilization of honest people. And no amount of law will fix a civilization of dishonest people. So, in those cases, law is a religious fantasy employed by a political caste that is very little different from acts of sacrifice and ritual by priests, full of sound and fury but accomplishing nothing. The people suffer.

So, my criticism is that you are making a class statement, and therefore assuming that by the use of laws, some class of people can 'parent' another class of people. Whereas universal property does not require that. It requires only that people consent and are honest and punished for non-consent and dishonesty and violence.

Redistribution, which I am pretty sure is your aim, not 'externalities" is a separate affair. If an individual wants to participate in an economy, and profit from it's citizens, he must redistribute some of the reward, and in particular, he may never accumulate sufficient wealth such that he uses it for political means. In other words, this is simply a contract and fee problem. Not one for laws.

If you want to change the world, take action against individual men who violate the property rights of others. Take action against those who steal from the contract of redistribution. But making laws is just an exercise of prayer. If a law is not a habit it does not exist. Men can only have so many habits.

Teach men the habits of property and it is the only set of habits you need to teach them.


El Presidente writes:

Curt Doolittle,

We cannot minimize externalities - they're infinite . . . If you want to change the world, take action against individual men who violate the property rights of others.

Assuming I wanted to change the world, you propose ubiquitous yet impotent retribution and reprisal rather than any attempt at prevention. How is that even remotely sane?

Howard writes:

Incentives matter because they distort systems that leads to unintended consequences.

Incentives can be targets, or bonuses or gold stars or A grades. They lead to chasing of the incentive and no longer what matters or is the right thing to do.

That's why it was possible for individuals to make millions whilst the financial sector ratcheted up billions in debt.

In the Public Sector incentives in the form of targets and league tables have led to dumb public services.

See John Seddon and his book Systems Thinking in the Public Sector or look to The Systems Thinking Review

http://www.thesystemsthinkingreview.co.uk/


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