Tuesday, May 26, 2015

Trade, Bribes and Yardsticks

In the conclusion to their 1941 article "Protection and Real Wages," Wolfgang Stolper and Paul Samuelson wrote:
...it has been shown that the harm which free trade inflicts upon- one factor of production is necessarily less than the gain to the other. Hence, it is always possible to bribe the suffering factor by subsidy or other redistributive devices so as to leave all factors better off as a result of trade.
This is an instance of the infamous Kaldor-Hicks compensation criterion, which David Ellerman has shown to be a "same yardstick" fallacy. Ironically, Ellerman took the same yardstick analogy from another paper by Samuelson and elsewhere Samuelson is dismissive of the Kaldor-Hicks criterion.

Ian Little described the K-H criterion as unacceptable nonsense. But, hey, let's fast-track the TPP and maybe one of those winners will toss us a bribe!

The Fundamentals are Sound!

Uh oh.
My bottom line on the economy is: The fundamentals are sound. The underlying momentum in job growth remains solid. I expect wage growth to continue to rise and consumer confidence to continue to pick up steam. Monetary policy will remain highly accommodative—regardless of what may or may not happen with rates this year—which will spur spending. -- John C. Williams

As Sandwichman always says, when they're telling you "the fundamentals are sound," they are unloading.

Piketty Did Not Endorse Social Security Fraud

Kevin Williamson takes us back to some dishonesty we saw a decade ago:
The Left’s favorite economist of the moment, Thomas Piketty, organizes his argument in Capital in the Twenty-First Century around the statement r > g, where r is the rate of return on capital and g is the rate of economic growth ... r > g is a stronger argument for privatizing Social Security than it is for a global capital tax.
After telling workers what they put into the Social Security Fund, he jots off this lie:
That money is not invested, so there is no return on it.
The Trust Fund does put these funds into government bonds which earn the real return to government bonds but I interrupted Williamson’s parade of lies:
Professor Piketty estimates that the return on capital over the coming decades will be between 4 percent and 5 percent; historical returns to equity investments run about 7 percent, but let’s be conservative and split Professor Piketty’s estimate, assuming a 4.5 percent return.
So many rates of return, so little insight. What is at stake here? Let’s assume the risk-free real return is 3 percent and add a 4 percent premium if someone chooses to hold risky stocks instead of government bonds. And let’s also assume some worker was able to accumulate $1 million under Williamson’s preferred world of privatization. Even if this worker was able to avoid the bad advice and huge fees from the financial advisors that Williamson is lobbying for, he is likely to get a 5 percent return if he chooses to put half of his portfolio into stocks and the other half into stocks. After all, this worker knows stocks are risky. I sometimes wonder if the champions of privatization do as their writings seem to suggest they don’t get Finance 101. So back to Williamson’s complaint about our current system:
You pay, officially, 6.2 percent of income up to $117,000 a year for Social Security. Your employer pays another 6.2 percent, and many economists and nine out of ten people who were born at night but not last night assume that you really pay that part, too, in the form of lower wages.
In our example suppose that this has taken $400,000 of our worker’s portfolio and put that into government bonds earning 3 percent. Our worker – who we are assuming knows more finance that apparently Williamson does – redoes his portfolio optimization putting $100,000 of his $600,000 into bonds and the rest into stocks. The basic message is that his retirement income is exactly the same. This is basic finance and maybe I’m being unfair. Maybe Williamson knows all of this. If so, then he has chosen to lie to his National Review readers hoping they are this stupid.

John Nash As Cryptanalyst

Rakesh Vohra of the Game Theory Society reports that not only was John Nash returning from the airport after returning from Norway to receive the Abel Prize in mathematics, its equivalent of the Nobel (the Fields medal is the equivalent of the John Bates Clark award, given for those under 40), which he got for his embedding theorem, which he always viewed as more important than his Nobel prize winning game theory equilibrium, which he considered to be mathematically trivial, despite its wide applicability in economics and other disciplines, but it has only recently been revealed that he had a third major intellectual breakthrough that has only become public since 2012 when the National Security Agency declassified a letter Nash initially wrote in 1950 to its predecessor, the NSA not becoming officially organized until 1952.

In this letter Nash proposed a form of possible encryption used decades later by the NSA based on computational complexity theory, particularly the distinction between N, or polynomial length programs, and NP, or exponential length programs, relative to the key.  While declaring this to be a true distinction, he foresaw the later problem that it might be impossible to prove, and so far it has not been, becoming the greatest unsolved problem of computational complexity theory.  Nevertheless Nash used this as the key to hardening encryption code systems, with his thoughts on this far ahead of any of the thinking at that time, although it took those he wrote to a long time to realize it and follow up on his advice.

This makes me understand a bit more a famous incident in 1958 reported in Sylvia Nasar's book, A Beautiful Mind, although it did not turn up in the movie version.  A. Adrian Albert, chair of the math department at the University of  Chicago, then one of the top in the world, offered Nash a position, with him then in the MIT department.  He turned down the offer on the grounds that he was expecting to shortly be appointed "Emperor of Antactica."  In fact, this was one of the first signs of his developing mental illness, although at the time Albert dismissed this as mere eccentricity, which many brilliant mathematicians exhibit.

What makes this new report from Vohra interesing in light of this is that this secret letter may have been the key to Albert's invitation.  The reason for this was a little known fact even now, that during World War II Adrian Albert was almost certainly the top cryptanalyst in the US, with some of his work remaining classified for decades as well.  Under the circumstances, it is highly likely that Albert was one of the few people who was privy to Nash's letter at the time and understood its significance.  I have no confirmation of this, but the facts about Albert are fairly clear if one googles him properly, with his role in these matters in the US publicly, but not widely, known (I provide a link to his Wiki entry, which is both sparse and contains at least one mistake).  He remains a relatively obscure mathematician, but one , whose importance far outweighs his reputation.

Update:  So, there is more about the Albert-Nash link that I have been thinking about, with a further speculation completely unprovable regarding why it was this year that Nash (with Nirenberg) got the Abel Prize.   First let me note that Abel's work is closely linked to that of Albert, with Abelian groups being a central  focus of Albert's study and linked to the algebraic forms he used in his cryptanalytic (or cryptographic) work.  I also suspect that while officially Nash received the prize for his embedding theorem, the revelation of his letter on computational complexity to the NSA (sent in 1955, closer to the year Albert made his job offer to Nash, with that even more evidence that the secret letter was crucial to that rejected job offer),  The revelation of this letter  may well have provided a tipping point for finally giving the award to Nash, although he had almost certainly been on the list for a long time for the embedding theorem, as he himself considered it his most important work, at least in his public comments, having kept quiet about this letter until its public revelation.

The further wiggle on this is the appearance and success during the past year of the movie about fellow cryptanalyst, Alan Turing, The Imitation Game.  Again, I do not know, but my speculation is that this could not have hurt.  Both Nash and Turing were the prime subjects of popular movies that depicted both their sufferings and their classified work, although in the movie about Nash it did not show his most serious classified work, but rather depicted it as the central part of his fantasy, and his fantasies did involve matters of international peace and war, with himself both the victim of red-tie wearing communist agents as well as thinking he was an international messianic figure who would achieve world peace between the superpowers.  Indeed, the matter of his thinking he would become the Emperor of Antarctica, the ostensible reason he rejected Adrian Albert's job offer, was tied to such fantasies, 1958 being the Internatinal Geophysical Year of Antarctica, when the US and the USSR and 10 other nations signed a treaty to mutually  manage Antarctica.

This matter of the letter was not in Sylvia Nasar's book, but he did work for RAND, although probably not on this openly, with most of his more known work there being on game theory, with him becoming upset there by the Dresher-Flood experiments on the repeated prisoner's dilemma showing agents not using the Nash equilibrium but cooperating a lot in the experiments, including even the very rationalistic, Armen Alchian.  This upset him so much that it would lead him to abandon game theory work, leaving the naming of the prisoner's dilemma game to his major professor, the late Albert W. Tucker.  But, in the end , the more fantastical version in the movie may have been closer to reality, with his close link to the also suffering and highly secret Alan Turing possibly a key to  his eventual  receipt of this prestigious award, clearly the culmination of his life.  It was indeed "going out at the top" that happened in this particular case of a husband-wife death, for better or worse (with their schizophrenic son, Johnny, the clear victim of this situation)..

Further update:  The error that I am aware of in Adrian Albert's Wiki entry is the claim that in 1961-62, he was  the first director of the Communications Research Division of the Institute for Defense Analysis, located in John von Neumann Hall on the Princeton campus, an NSA front research group.  He was the second such director, not the first. (One can find a discussion of Princeton's IDA/CRD unit, no longer on the campus, in James Bamford's seminal book on the NSA, The Puzzle Palace.)

Barkley Rosser

Monday, May 25, 2015

Gnash Equilibrium

Philip Mirowski, Machine Dreams
The mathematical price of demonstrating that every game had a fixed value was the unloading of all analytical ambiguity onto the very definition of the game. Far from being daunted at a game without determinate bounds, Nash was already quite prepared to relinquish any fetters upon the a priori specification of the structure of the game, given that the entire action was already confined within the consciousness of the isolated strategic thinker. The game becomes whatever you think it is. He dispensed with dummies, exiled the automata, and rendered the opponent superfluous. This was solipsism with a vengeance.
Yanis Varoufakis, "The Dance of the Meta-Axioms":
In game theory itself, questions were raised about the plausibility of presuming that rational agents must always select behaviour consistent with Nash’s (1951) equilibrium. In the context of static games it became apparent that disequilibrium behaviour could be fully rationalised and rendered consistent with infinite order common knowledge rationality. Similarly, it transpired that out-of-equilibrium behaviour could be just as rational in finite dynamic games as the equilibrium path proposed by Nash and his disciples.  As for indefinite horizon games, the devastating force of indeterminacy was felt in the form of the so-called Folk Theorem which shows that, in interactions that last for an unspecified period, anything goes. And yet, all applications of game theory, from theories of Central Bank behaviour to industrial organisation, labour economics and voting models, ignore these challenges, assuming that behaviour will remain on the equilibrium path.

John Nash and Ideal Money

I was not aware of this proposal from John Nash:
Nash’s lecture, “Ideal Money and Asymptotically Ideal Money,” centered on the connection between fluctuation in inflation and exchange rates and the perceived long-term value of money. “Good money,” he argued, is money that is expected to maintain its value over time. “Bad money” is expected to lose value over time, as under conditions of inflation … Nash argued that the emphasis on stabilizing the value of currency should extend to the international level, where exchange rates represent currencies’ value relative to each other. He proposed that international exchange rates be fixed by pegging the value of each currency to a standardized basket of commodities, called the “industrial consumption price index.” Such a policy would curtail the ability of central banks to make monetary policy…After World War II, international exchange rates were fixed, with currencies’ value first pegged to gold and later fixed at set ratios. That regime was abandoned in the early 1970s, when increasing inflation forced the United States to devalue the dollar. Nash said his system would be more stable and sustainable than the gold standard because exchange rates would not be seriously affected by fluctuations in any one commodity….Nash responded with caution to the suggestion from an audience member that a system of currencies approaching perfect stability would ultimately produce a system with only one world currency. “There’s nothing wrong with it,” Nash said. But he added, “In practice, I’m a little distrustful of the politicians at the level of the United Nations and elsewhere,” who would be in charge of administering a world currency.
Nash’s lecture was in 2005. While the U.S. did endure the Great Inflation but from 1983 to 2007, we enjoyed the Great Moderation without pegging the dollar to any basket of commodities. But let’s also consider the case of Italy and the EU experiment with a common currency. Over the 26 year period where the Italian lire was free to devalue, Italy’ consumer price index rose by more than a factor of 11, which translates into an average inflation rate of 9.7 percent per year. Since 1999, Italy’s average inflation rate has been only 2 percent. In 2005, things seems to be working well. Of course, we know that the EU experiment has been a disaster during the Great Recession as noted by Barry Eichengreen and Peter Temin:
We describe in this essay why the gold standard and the euro are extreme forms of fixed exchange rates, and how these policies had their most potent effects in the worst peaceful economic periods in modern times. While we are lucky to have avoided another catastrophe like the Great Depression in 2008-9, mainly by virtue of policy makers' aggressive use of monetary and fiscal stimuli, the world economy still is experiencing many difficulties. As in the Great Depression, this second round of problems stems from the prevalence of fixed exchange rates. Fixed exchange rates facilitate business and communication in good times but intensify problems when times are bad.
This reminds me of The Rule of the Games by Ronald McKinnon in 1996:
The Rules of the Game brings together essays, written over the course of thirty years, by a major figure in the field that analyze and compare a wide variety of important international monetary regimes. These range from the establishment of the gold standard in the nineteenth century through Bretton Woods, the dollar standard, floating exchange rates, the European Monetary System, to current proposals for reforming world monetary arrangements.
Nash contributed immensely to game theory but I’m not sure he revisited the issue of international monetary regimes in light of the Great Recession.

Keynes "hadn't got round to it"

...all the difficulties and rigidities which go into modern Keynesian income analysis have been shunted aside. It is not my contention that these problems don’t exist, nor that they are of no significance in the long run... Robert M. Solow, "A Contribution to the Theory of Economic Growth," 1956.
...the shunting aside opened up the opportunity for real-business-cycle theorists such as Finn Kydland and Prescott to use Solow’s steady-state model... for their explanation of short-run fluctuations. Harald Hagemann, "Solow's 1956 Contribution in the Context of the Harrod-Domar Model," 2009.
Far too much has been shunted aside.

The aim of Harrod's and Domar's models, according to Hageman, was "to extend Keynes's analysis into the long run by considering under what conditions a growing economy could realize full-capacity utilization and full employment." As for "the modern type of dynamic [that is, 'growth'] theory," according to Sir Roy Harrod, Keynes "hadn't got round to it":
Mr.  Nicholas Dimsdale:  Why is there so little in the General Theory on the direction of principal determinants of economic growth (which has, of course, been very much the concern of economic policy in the post-war period), and particularly did Keynes see this as a natural extension of handling the problems of unemployment? 
Sir Roy Harrod: I think the answer is no. I think of the timetable of it. Here was Keynes giving all his brains to the General Theory which is not, though it is what you call macroeconomics, dynamic. It is a general theory of how incomes and employment are determined at a given point of time. Then, poor man, he gets ill, the war breaks out, he writes this little booklet of which Austin Robinson has spoken just now, and he is entirely immersed in the war. You see, the use of growth as a regular economic concept had hardly come in before the war:  it has all blossomed among various writers since the war. I don’t see how Keynes can have been expected to have systematic ideas on growth; his systematic ideas related to full employment. The modern type of dynamic theory about what happens through time - he just hadn't got round to it. I am sure that he would have got round to and dealt with it very well; but the timetable of his life and death did not give him an opportunity.
In a 1965 New York Times retrospective on the Keynesian "revolution," John Kenneth Galbraith credited Leon Keyserling as a "tireless exponent of the [Keynesian] ideas. And he saw at an early stage the importance of enlarging them to embrace not only the prevention of depression but the maintenance of an adequate rate of economic expansion." In a subsequent interview, Keyserling was less bashful about the magnitude of his contribution.
Coming over to economic growth in particular, everybody talks about the influence of Keynesian economics. The Keynesian economics is really a static economics. It doesn't deal with economic growth at all. Furthermore, it was developed at a time of worldwide depression. Even Ken Galbraith, in an article in the New York Times a couple of years ago, when he was talking about the influence of Keynesian economics, mentioned me specifically as the one who had introduced the fundamental new factor of the dynamics of economic growth.
Keyserling was a member of President Truman's Council of Economic Advisers, became acting chairman in 1949.and chairman in 1950. His influence can be seen in the evolution of "economic growth" in successive volumes of the Economic Report of the President. In the January 1947 annual report, the term "growth" did not occur. In the midyear report, "economic growth" appeared once. The January 1948 volume contained 17 references directly to economic growth and featured a cheerleading section titled "Our Ability to Grow."

All of this alleged "extending" and "enlarging" of Keynes's analysis had little to do with Keynes's analysis -- other than shunting it aside -- and nothing to do with Keynes's own views about the long term problem, as outlined in his 1943 Treasury memorandum, "The Long-Term Problem of Full Employment" and re-iterated in a 1945 letter to T.S. Eliot:
Not long ago I was at a Conference where the Australians urged that all the Powers in the world should sign an international compact in which each undertook to maintain full employment in their own country. I objected on the ground that this was promising to be 'not only good but clever'. Civis, like the Australians, takes exactly the opposite line. He thinks that we can reach the goal by promising to be 'not so much clever as good '. 
It may turn out, I suppose, that vested interests and personal selfishness may stand in the way. But the main task is producing first the intellectual conviction and then intellectually to devise the means. Insufficiency of cleverness, not of goodness, is the main trouble. And even resistance to change as such may have many motives besides selfishness. 
That is the first, ought-to-be-obvious, not-very-fundamental point. Next the full employment policy by means of investment is only one particular application of an intellectual theorem. You can produce the result just as well by consuming more or working less. Personally I regard the investment policy as first aid . In U.S. it almost certainly will not do the trick. Less work is the ultimate solution (a 35 hour week in U.S. would do the trick now). How you mix up the three ingredients of a cure is a matter of taste and experience, i.e. of morals and knowledge.
It would be anachronistic to fault growth theorist for ignoring Keynes views on the long term problem of full employment. Presumably, Keynes's memorandum and his letter to T.S. Eliot were not available to early "dynamic" theorists. They were published in 1980 in volume 27 of Keynes's Collected Writings. One might wonder, though, why modern growth theorists have subsequently shown no interest whatsoever in re-evaluating their theories in light of those documents.

More remarkable is the complete lack of connection between growth theory and growth as a policy slogan. No, this is not the difference between map and territory. The theoretical models are maps of an abstract territory in which some kinds of features have the same names as the kinds of features on the actual territory -- "labor", "income", "output," "capacity utilization" -- but those labels remain undefined in any way that would correspond to the real features with the same name.

At the other end of the theory/sloganeering spectrum -- in the targeting of increases in GNP/GDP -- the features are also not defined in a way that would enable a consistent and durable system of measurement. Simon Kuznets's 1947 essay on "Measurement of Economic Growth" outlined many of the biases and obstacles in the way of defining and measuring growth." In a subsequent review of the Commerce Department\s National Income and Product Accounts, Kuznets argued that problems of duplication and of ignoring non-market production had not been overcome. In its reply to Kuznets, the department's economists pointed out it would not have been feasible to meet several of his standards. They had a point. But non-feasibility of the alternative does not in itself affirm the adequacy of the status quo.

In conclusion, Keynes's analysis was not "extended" by modern dynamic growth theory nor was it "enlarged" by Leon Keyserling's siphoning off and his sloganeering growthmanship. The analysis was -- in Solow's apt phrase -- shunted aside for a tautological model, just as the policy goal of full employment was shunted aside for the indistinct slogan of "growth."

Who needs a Keynesian policy goal of full employment anyway when the neoclassical model can simply assume full employment?

Sunday, May 24, 2015

More White Space and a Photo or Two...

Is formatting what it all comes down to? Let's keep the message upbeat, familiar and comfortable. A little bonding around a well-liked celebrity (or against a disliked one) and a platitude or two. Above all, NO NEGATIVITY! Keep it light, superficial and unthreatening.

Yeah, right.

Saturday, May 23, 2015


"These and many other mathematical statements don't remotely correspond to observable reality, nor do they have any evidence in support of them." -- Noah Smith,  How 'Mathiness' Made Me Jaded About Economics
Will anything change in the wake of the big mathiness dustup of 2015? Of course not. This is, after all, only a "technical discussion on cavalry tactics at the Battle of Austerlitz" not a searching inquiry into the identity and fundamental commitments of the economics political economy.

In his 1872 review of Thomas Brassey's Work and Wages, Frederic Harrison denounced political economy as a "magazine of untruth," specifying, "Political economy professes to be a science based on observation. But the bitter pedantry which often usurps that name usually assumes its facts, after it has rounded off dogmas to suit its clients."

Today's growth economics assumes the same facts and rounds off the same dogmas as did its magazine-of-untruth counterpart 143 years ago. Up until the 1870s, that dogma was called the wages-fund doctrine. Since the 1950s, it has borne the alias of economic growth. Same difference. The affiliated "fact" is that all blessings flow from the expansion of trade, therefore any impediment to that expansion is anathema.

The rest is rounding off.

Friday, May 22, 2015

Beware of Slogans

...the characteristics of the special case assumed by the classical theory happen not to be those of the economic society which we actually live, with the result that its teaching is misleading and disastrous if we attempt to apply it to the facts of experience. -- JMK, GT 
The human perception system sees a checkerboard with a cylinder, while a basic SSR measurement [surface spectral reflectance] shows squares A and B read the same. “Illusion” implies that our system is fooled, but as far as useful information goes, the checkerboard interpretation is probably better. Try as they might, mathematicians can’t make the computers see the checkerboard. Rather than a demonstration of how easily fooled we are, optical illusions like this one are examples of the brain’s mysterious and irreplicable abilities. It interprets its environment with a sophistication that exceeds our ability to measure and reconstruct physical phenomena. The usual framing has it wrong: Despite A and B having the same SSR, humans are still able to see the checkerboard. -- Malcolm Harris, "Does color even exist?"
How you mix up the three ingredients of a cure is a matter of taste and experience, i.e. of morals and knowledge. -- JMK, Letter to T.S. Eliot

Does David Stockman Want Women to be Barefoot and Pregnant?

Apparently uber-supply-sider David Stockman is back:
There are powerful domestic and international economic forces and welfare state policy impacts—-such as the huge increase in Social Security disability and food stamp recipients—– that are roiling labor force participation rates and weakening labor hours utilized and labor productivity. Yet the Fed is led by a clueless, paint-by-the-numbers Keynesian “conomist” who is trapped in a 1960s “full-employment” time warp. Did she notice this over the last several decades?
So Stockman refers to Janet Yellen as a conomist. Cute! Why did Reagan appoint a historian to head the OMB anyway? Of course those were the days when supply side hacks ruled the White House. But FYI Mr. Stockman – Dr. Yellen is excellent at labor economics. The drop in the employment to population ratio since 2007 has been the result of weak aggregate demand not some alleged change in transfer payment policies that did not happen. Yes, transfer payments rise when we have recessions as they did in 1982. But if Stockman had an ounce of integrity, he might have told his readers that the employment to population ratio for women start rising even before Reagan made the mistake of letting Stockman head the OMB. With more women in the work force, some men have decided to take up more of the responsibility of raising the kids. I guess Stockman wants to return to the 1950’s where women just stayed home – barefoot and pregnant.

Thursday, May 21, 2015

Jeb Bush Adopts Voodoo Economics

Jeb’s father in 1980 got it right with his phrase “voodoo economics”. Of course Papa Bush had to settle for being Reagan’s Vice President. We know George Jr. listened to the Three Stooges (Art Laffer, Lawrence Kudlow, and Stephen Moore). Daniel Strauss reports:
Former Florida Gov. Jeb Bush (R) voiced support for House Republicans' move to switch to a type of budget scoring that assumes tax cuts create economic growth and counterbalance lost revenue. Speaking in New Hampshire on Thursday, Bush was asked about House Republicans' move to adopt the "dynamic scoring" method for scoring budgets. Although critics argue that this approach to scoring is essentially "fairy dust" and "cooks the books" on budget scoring, many Republicans and even a few conservative Democrats have pushed for using the controversial method. In December of last year, House Republicans opted to not reappoint Doug Elmendorf as the head of the nonpartisan Congressional Budget Office, essentially paving the way to adopt dynamic scoring. At the beginning of 2016, House GOPers passed a rule requiring all budgets to use dynamic scoring in budget estimates. Bush first said he was "all in" for eliminating the "bean counters" who use the traditional "static scoring" method. "The House has done this and I think it's the right thing," Bush said in New Hampshire on Thursday. He went on to praise House Ways and Means Committee Chairman Paul Ryan (R-WI), who, in Sept 2014, actually floated the idea that the CBO adopt dynamic scoring. "One of the guys I most respect in Washington D.C. is Paul Ryan. He's thoughtful, he's optimistic, he believes that if you create the right conditions all of us interacting amongst ourselves will create far more benefits for far more people," Bush said.
Hey – I’m no fan of bean counters but could someone tell Jeb that Paul Ryan’s accounting is fraudulent?

Quiz: Denial, Then and Now

  1. Is the end of the world at hand?
  2. Is growth desirable? 
  3. Is growth possible?
  4. What is the real question?
  5. How about just plain old "What is growth?"? 
  6. So what is growth?
  7. Is growth a means to the end of full employment? 
  8. Is growth a bait-and-switch surrogate policy objective in its own right? 
  9. Is growth a quantitative measurement of unmeasurable qualitative change?
  10. What was the basic assumption of The Limits to Growth
  11. Is the economic system self-adjusting?
  12. Why shouldn't the productivity of most natural resources rise more or less steadily through time, like the productivity of labor?
  13. Is that all there is?

Wednesday, May 20, 2015

Napoleon Solow and the Phantom Mechanism

I would like to say why I think that the Doomsday Models are bad science and therefore bad guides to public policy. ... The basic assumption is that stocks of things like the world’s natural resources and the waste-disposal capacity of the environment are finite, that the world economy tends to consume the stock at an increasing rate (through the mining of minerals and the production of goods), and that there are no built-in mechanisms by which approaching exhaustion tends to turn off consumption gradually and in advance. You hardly need a giant computer to tell you that a system with those behavior rules is going to bounce off its ceiling and collapse to a low level. -- Robert M. Solow, 1973
Sandwichman is agnostic on the built-in mechanism fable.

On the one hand, Solow's "built-in mechanism" is a metaphor -- a depiction -- and of course there is no "mechanism" strictly speaking, just as God is not an old man with a long, white beard. There are instead more or less spontaneous reflexes of economic actors that in the aggregate have observable effects. Such reflexes, however, are multitude. The probability of all these reflexes co-ordinating themselves spontaneously and independently -- without help from a Maxwellian demon, Walrasian auctioneer or Invisible Hand -- to produce a conjectured effect far in the future is infinitesimal.
Suppose someone sits down where you are sitting right now and announces to me that he is Napoleon Bonaparte. The last thing I want to do with him is to get involved in a technical discussion on cavalry tactics at the Battle of Austerlitz. If I do that, I’m getting tacitly drawn into the game that he is Napoleon Bonaparte. -- Robert M. Solow
Aside from the multiplicity of so-called mechanisms, there is the slight inconvenience that a homeostatic regulator itself consumes energy to do its work (also known as 'transaction costs'). The more vast and complex the organism being regulated, the more energy the regulator will need to consume. When what is being regulated is the consumption of energy, a contradiction emerges: progressively more energy needs to be consumed to reduce the consumption of energy. There is thus a ceiling on vastness and complexity and a floor on reducing consumption.

It is not the finiteness of resource stocks, but the fragility of self organized natural cycles that we have to fear. Unfortunately, the services provided by these cycles are part of the global commons. They are priceless, yet ‘free’. Markets play no role in the allocation of these resources. There is no built-in mechanism to ensure that supply will grow to meet demand. Indeed, there is every chance that the supply of environmental services will dwindle in the coming decades as the demand, generated by population growth and economic growth, grows exponentially. -- Robert U. Ayres, 1998
Ayres highlighted another fly in the built-in mechanism ointment. To be fair, Solow did acknowledge the externality flaw in the price system. Fixing the flaw, he assured, would be simple and virtually painless:
The flaw can be corrected, either by the simple expedient of regulating the discharge of wastes to the environment by direct control or by the slightly more complicated device of charging special prices — user taxes — to those who dispose of wastes in air or water.  
What stands between us and a decent environment is not the curse of industrialization, not an unbearable burden of cost, but just the need to organize ourselves consciously to do some simple and knowable things.
Now that we know how that organizing ourselves consciously business has worked out, couldn't we please have a built-in mechanism to do that task too? What if there is a built-in mechanism in the price and profit system that militates against the social capacity "to organize ourselves consciously to do some simple and knowable things"?

Not all built-in mechanisms are equal

Finally, even if there was a built-in self-stabilizing market mechanism, it's interaction with natural systems may not lead to the gradual, advance adjustment that Solow conjectured:
We identify and prove that the interaction between a stable natural system and a self-stabilizing market mechanism can lead to cyclical or even chaotic behaviour. A built-in self-stabilizing market mechanism will not always serve the function of stabilization. Under certain conditions, it may increase the amplitude of fluctuations and have the effect of destabilization, as demonstrated in this paper. Therefore, by incorporating a self-stabilizing market mechanism, this model yields a result that contradicts Solow's (1973) conjecture that the market mechanism will have the effect of smoothing the time path of the world economy. -- Hans Gottinger, 1998