Back in 2000, Robin Hanson wrote a paper entitled "Shall We Vote on Values, But Bet on Beliefs?", which offered a way forward for economics in the 21st century. Unfortunately his ideas were ignored (and even ridiculed) and today we are still stuck in 20th century economics. In the future, our current approach will be regarded as Stone Age economics.
I will illustrate the problem with modern economics by discussing the impact of extended unemployment insurance. Last spring, Paul Krugman suggested that the elimination of the emergency extended unemployment program in 2014 was not leading to more jobs, thus refuting the claims of conservative opponents of the program. In earlier posts he suggested that ending the extended UI program would mean less fiscal stimulus, and hence more unemployment. As we'll see, this prediction turned out to be as ill timed as his famous "test" of market monetarism comment, which occurred a year earlier. Nonetheless, at the time it looked like Krugman might be right, as the first quarter of 2014 was weak (perhaps due to bad weather.) In addition, Congress was still debating an extension, which would have applied retroactively to those still unemployed.
In numerous posts over at TheMoneyIllusion, I suggested that the 99-week extended unemployment insurance program had probably increased the unemployment rate by about 0.5%. That's perhaps 700,000 people, which is significant, but not the major cause of high unemployment during the recession. I always acknowledged that this was little more than a guesstimate.
Now Tyler Cowen directs us to a fairly rigorous academic study that uses a "difference in difference" approach and estimates that ending extended UI led to an additional 1.8 million jobs in 2014:
We measure the effect of unemployment benefit duration on employment. We exploit the variation induced by the decision of Congress in December 2013 not to reauthorize the unprecedented benefit extensions introduced during the Great Recession. Federal benefit extensions that ranged from 0 to 47 weeks across U.S. states at the beginning of December 2013 were abruptly cut to zero. To achieve identification we use the fact that this policy change was exogenous to cross-sectional differences across U.S. states
and we exploit a policy discontinuity at state borders. We find that a 1% drop in benefit
duration leads to a statistically significant increase of employment by 0.0161 log points.
In levels, 1.8 million additional jobs were created in 2014 due to the benefit cut. Almost
1 million of these jobs were filled by workers from out of the labor force who would not
have participated in the labor market had benefit extensions been reauthorized.
Obviously this study is far superior to my guesstimate. And in a sense it does support my side of the debate I'm having with Keynesians, who (falsely) accuse me of promoting the "lazy worker" theory of unemployment. So I should jump on this result, right? Especially since I can't find any flaw in their empirical work (although honestly I just skimmed the paper.)
In fact, I'm not being a good Bayesian, I'm not shifting my prior view that extended UI cost about 700,000 jobs, although I am widening the band around that estimate to include 1.8 million as a plausible estimate. I'll try to explain my stubbornness, and I want smarter, less biased people to tell me if I am wrong.
In 2012 the US created about 2.25 million jobs, and in 2013 it created about 2.35 million jobs. In late 2013, before it was known that extended UI would be repealed, most economists seemed to expect 2014 to be at least as good as the previous two years. The markets also seemed to expect continued growth, although unfortunately we lack good RGDP and NGDP futures markets. But my sense was that 2014 was likely to be similar to 2013, and it seemed to me that forecasters in academia and the asset markets both expected a similar result.
In fact, employment growth in 2014 was 2.95 million, a number quite likely to be revised higher in the next year or two. That's why I still think 700,000 is a decent ballpark guesstimate. I just don't find it plausible that job growth would have suddenly plunged to 1.15 million in 2014, if nothing had been done about extended UI. I saw nothing going on in terms of "shocks" that would have suddenly caused job growth to slow.
Here's where Robin Hanson comes in. Under his "futarchy" plan, prediction markets would decide matters of fact ("beliefs") that have implication for policy, and voters and policymakers would decide the values that get embedded in policy. In this case, two prediction markets would have been set up in late 2013, to predict jobs growth during 2014. One market would be conditional on Congress extending the emergency benefits, and the other market would be conditional on the program being ended.
If the markets agreed with me, the difference would have been about 700,000. If they agreed with Marcus Hagedorn, Iourii Manovskii, and Kurt Mitman, the difference would have been 1.8 million. If they agreed with Krugman it might have been negative (fewer jobs if the program ended.) Think of the market forecast as a sort of meta-study, which efficiently incorporates Krugman's arguments, my arguments, and the empirical work in the study mentioned above.
When I forecast the effect of X, this is exactly what I try to do. I try to guess what the market would guess. Thus I think eurozone QE is something, but not a game changer, because that seems to be what the markets expect, based on their responses to QE news stories.
There is a mountain of evidence that the "wisdom of crowds" can aggregate many disparate views much more effectively than any individual researcher. So why didn't economists follow Hanson's lead? Perhaps we are a bit arrogant, thinking we are smarter that the markets. Maybe we like the idea of economists being a sort of cult of "high priests" that hold the secrets of the temple. It's a flattering position to be in.
I'm not suggesting that this sort of difference in difference study has no value. Just the opposite. It can provide useful information to markets. So please don't take this post as a criticism of this very fine study. Rather I'm saying that when policymakers in Washington decide whether to extend UI, or raise the minimum wage, they should look to market forecasts of the effect of policy. But first someone needs to spend the extremely small amount of money required to set up these prediction markets. I'm trying to do my part.
Most contemporary economists would find Hanson's blog to be a bit "weird." Economists of the 22nd century will wonder why everyone wasn't a Hansonian back in 2015.