A Nobel for Humility in Economics

Nobel Prize

As you are by now all probably aware, Richard Thaler won this year’s Nobel Memorial Prize in Economic Sciences. All question of whether this is a “real” Nobel can now be laid to rest, since the announcement was made via the Nobel Prize’s official verified Twitter account.

Thaler won the prize for his research in behavioral economics, although he’s far from the first behaviorist to win it — Herbert Simon, Daniel Kahneman, and Robert Shiller all got the big gold medal from Sweden. But Thaler’s work is arguably more wide-ranging and influential than any of those earlier pioneers. And it’s the sheer breadth of Thaler’s research that offers a peek into where the discipline of economics is headed.

Loosely speaking, the economics of the past was a search for a grand unified theory. At first, supply-and-demand was the idea that tied econ together. Later, that was replaced with explicit modeling of economic decision-making as the optimization of a rational economic “agent.” To predict anything from the price of tomatoes in Wyoming to the savings rate in Bangladesh, you would just assume that people maximize utility and companies maximize profit, then write down a mathematical optimization problem that would spit out an answer. This method — sometimes called the neoclassical approach — grew so popular that economists started applying it to sociology, law and politics.

Lots of people justifiably made fun of the unrealistic hyper-rational agents in these economic models. Early behaviorists like Kahneman gained credence by poking holes in the idealized vision of homo economicus. But there was still the hope that a general theory of economic behavior existed and could be found. Kahneman tried to replace standard rational optimization with prospect theory. Behaviorists like Matt Rabin hoped that human irrationality could be represented as small deviations from a single unified theory.

I see Thaler’s research as qualitatively different. Whereas many behaviorists want to replace or tweak the standard theory, Thaler started smashing it left and right. He pointed out anomaly after anomaly. And instead of trying to design a new theory-of-everything to explain the anomalies, he borrowed or created situation-specific theories, such as mental accounting and the endowment effect and so on. Sometimes the theory was a very simple one. Or sometimes, like Shiller, he merely documented where standard theory went wrong, and left the theorizing to someone else.

Critics of behaviorism see this as a flaw. They bemoan the replacement of one theory with many. If you have a different explanation for every situation, the anti-behaviorists say, what’s to stop you from telling just-so stories? These critics tend to see Thaler’s research as a destructive force.

But Thaler isn’t just a bomb-thrower — his approach is far smarter than that. I believe he’s out to create a new paradigm — one that doesn’t rely on a grand unified theory of human behavior.

There’s no reason that economics has to be like physics. Physicists are always trying to unify their theories — to show how what appear to be different forces and principles are actually the same. But human behavior might just not be like that — the way that a person decides which brand of soy sauce to buy might simply be different from the way she decides when to buy Apple Inc. stock. Thaler’s research is all about forcing economists to acknowledge this possibility.

So how can we know which theory to use in which situation? Data. The behavioral revolution goes hand in hand with the empirical revolution now sweeping the wider economics profession. Over the past couple of decades, economists have steadily been theorizing less and measuring more.

Let’s hope this isn’t just a fad, but a fundamentally new paradigm for the field. The old way of choosing between different explanations was to start with the assumption of a grand unified theory and then find the minimum possible deviation that explains the phenomenon in question. The new way should be — and in some cases, already is — to gather a number of plausible explanations and let the data dictate which one applies. Then as economists find theories that each work for a small, limited domain, they can explore other areas where each theory might also apply. Slowly, each successful theory’s domain will expand, and when two of them happen to bump up against each other — that is, when they give equivalent results — economists can work on unifying the two.

This is basically how natural scientists approach the world. Instead of jumping to a conclusion that looks as clean and pretty as physics, economists should more closely follow the methods that physicists actually use.

So behaviorism isn’t really about psychology — it’s about humility. Sometimes things people do can be explained by psychological biases, sometimes by purely rational optimization and sometimes by other things entirely. Thaler is intent on making econ about what works, instead of what we think ought to work. As such, it has the potential to have reach and power far beyond the specific topics Thaler has spent his storied career investigating.

(Bloomberg)

Japan Concerned over Low Inflation

Japan is the graveyard of economic theories. The country has had ultralow interest rates and run huge government deficits for decades, with no sign of the inflation that many economists assume would be the natural result. Now, after years of trying almost every trick in the book to reflate the economy, the Bank of Japan is finally bowing to the inevitable. The BOJ’s “dot plot” shows that almost none of the central bank’s nine board members believe that the country will reach its 2 percent inflation target:

Accordingly, the bank has pushed back the date at which it expects to hit its 2 percent target. That’s a little comical, since by now it should be fairly obvious that the date will only get pushed back again and again. If some outside force intervenes to raise inflation to 2 percent, the BOJ will declare that it hit the target, but it’s pretty clear it has absolutely no idea how to engineer a deliberate rise in inflation. The bank will probably keep interest rates at zero indefinitely, but if decades of that policy haven’t produced any inflation, what reason is there to think that decades more will do the trick?

Some economists think more fiscal deficits could help raise inflation. That’s consistent with a theory called the “fiscal theory of the price level,” or FTPL. But a quick look at Japan’s recent history should make us skeptical of that theory — even as government debt has steadily climbed, inflation has stumbled along at close to 0 percent:

Japan’s situation should also give pause to economists who want to resurrect the idea of the Phillips Curve, which purports to show a stable relationship between unemployment and inflation. Japan’s persistently low inflation comes even though essentially everyone in Japan who wants a job has one.

Basic econ theory says that as the labor market gets tighter, competition should push up wages, which will then boost consumer prices via increased demand and higher costs. In Japan, nothing of the sort has happened — wages and prices show little sign of rising despite the disappearance of unemployment. So much for the Phillips Curve.

So Japan’s experience underscores one central, disturbing truth: Economists really have no idea how inflation works. It is simply a mystery. Macroeconomists have been thinking about inflation for decades, but no real progress has been made in understanding where it comes from or how to produce it with policy.

But that said, is Japan’s lack of inflation really such a bad thing? The country’s per capita growth is pretty low, but that’s just because of population aging. Measured in terms of real gross domestic product per employed person, the country has been growing in recent years:

In other words, despite a near-total lack of inflation, Japan has managed to grow and increase employment. That means Japan is in the midst of that rarest of situations — a disinflationary boom.

In many ways, growth without inflation is the optimal outcome for an economy. Price stability makes it easier for companies and workers to plan their pricing and wage demands, while also reducing uncertainty for investors. Some macroeconomists, especially monetarists, claim that disinflationary booms are rare or nonexistent. But if it really is possible to have growth without inflation, most would agree it should be done.

So despite all the hand-wringing over Japan’s low inflation, in many ways it’s in a goldilocks situation. There’s just one catch — government debt.

Bloomberg View

Middle Eastern Immigrants Make the US Stronger

US

A little more than one week ago, Stanford University mathematician Maryam Mirzakhani died at the age of 40 after a battle with breast cancer. In that short lifetime, she accomplished more than most of us ever will. Mirzakhani was one of the world’s greatest mathematicians — a recipient of the Fields Medal, mathematics’ highest honor.

Mirzakhani’s career was a triumph for the US university system and American scientific prowess. But Mirzakhani was born and raised in Iran. She’s living proof of the advantage immigration gives the US

Americans generally support immigration. But immigrants from the Middle East tend to be viewed less favorably than those who hail from other regions.

The ratio of negative-to-positive opinions of Middle Eastern immigrants is about 2-to-1. What’s more, President Donald Trump campaigned and won on a promise to ban Muslim immigrants.

This outbreak of fear probably is due to geopolitical factors — the Sept. 11 attacks, wars in the Middle East, Islamist terrorism in Europe and the US and the rise ISIS. Some on the American right believe that the West is locked in a clash of civilizations with Middle Eastern Islam.

These fears echo 19th-century worries about Catholic immigration. In the 1800s, nativist agitators warned that an influx of Catholics, mostly from Ireland and Germany, threatened to destroy the American way of life. Of course, nothing of the sort happened — Irish and German immigrants simply became a part of the American economic and social fabric.

There seems little reason to expect that Middle Eastern immigrants will turn out differently. In economic terms, most Middle Eastern Americans are already doing well.

This also is true of Muslim Americans specifically — their income numbers are extremely similar to those of Catholic Americans, which are very close to the US national average. There are some exceptions. Iraqi Americans tend to be substantially poorer than most, probably reflecting the influx of war refugees from the US invasion of that country.

But by and large, Middle Eastern immigrants are flourishing. The reason is that, like Asia and Africa, the Middle East tends to send its better-educated, more entrepreneurial types to the US Muslim Americans, for example, tend to have more schooling than Catholic or evangelical Protestant Americans, and about the same level as mainline Protestants.

Those statistics don’t do justice to the individual contributions that Middle Eastern Americans have made. Mirzakhani was a rare genius, but her success was far from an isolated example.

Everyone knows that Steve Jobs, perhaps the most revered and successful entrepreneur in recent American history, was the son of a Muslim Syrian father. Many innovative US companies have been started by folks of Middle Eastern extraction. Arash Ferdowsi, an Iranian American, co-founded Dropbox Inc., the web-file hosting service, and Bob Miner, also of Iranian descent, co-founded Oracle Corp. Next time you bid on an auction on eBay Inc., thank Pierre Omidyar, a French native of Iranian descent. And next time you get a date on Tinder, thank co-founder Sean Rad, another Iranian American. If you’ve ever made copies at Kinko’s, thank Arab American Paul Orfalea. And if you or your kids enjoy the video games “World of Warcraft” or “Overwatch,” thank Egyptian American Allen Adham.

The list goes on. In science, too, Middle Easterners have been doing great things. For example, there’s Nima Arkani-Hamed, an Iranian American who works at Princeton University as one of the country’s premier string theorists. There’s Nobel prize-winning Lebanese-American chemist Elias Corey. There’s Firouz Naderi, an Iranian American who directed NASA’s successful Mars exploration program. And Turkish American economist Daron Acemoglu is one of the field’s brightest stars. Again, there are many more examples where these came from.

Like Irish, German, Italian or Russian immigrants in previous centuries, Middle Easterners hail from a region that is unfamiliar to most Americans. And like Catholic and Jewish immigrants before them, Muslim-Americans follow a religion that may seem strange and frightening to many. But like those earlier waves of newcomers, Middle Easterners will eventually become just another bunch of regular Americans. Already, there is clear evidence that Muslim Americans, for example, are rapidly becoming more liberal and secular, just like their Christian and Jewish predecessors. American society is simply much better than Europe at integrating newcomers into its social fabric and national polity. This is no surprise, since the US has been a nation of immigrants since the start.

The backlash against Middle Eastern immigrants in the US is an overreaction to global events. The reality of Middle Eastern immigration looks headed for the same happy ending that has defined previous groups of new Americans. This doesn’t mean every Middle Easterner who wants entry should be granted it — vetting is important, and those who seem like a security risk of course shouldn’t be admitted. But cutting off the flow of hard-working, talented, entrepreneurial individuals from the Middle East, as some are now trying to do, would be a significant self-inflicted wound for the US.

Bloomberg

Be Clear-Eyed About Democracy’s Weaknesses

In her new book, “Democracy in Chains: The Deep History of the Radical Right’s Stealth Plan for America,” Nancy MacLean writes that my Bloomberg View colleague Tyler Cowen, by questioning American political institutions, was creating “a handbook…for how to conduct a fifth-column assault on democracy.” As the Hoover Institution’s Russ Roberts pointed out, Cowen’s quote was taken out of context. This is worth noting because Cowen has long been a staunch defender of democracy.

But it’s no secret that Cowen is willing to think critically about the potential weaknesses of the US system. He does this not to attack democratic ideals, but to defend them. If we want to see democracy endure, we must think realistically and pragmatically about its weak points, so that we can focus resources on shoring them up.

It’s very dangerous to indulge in triumphalism about one’s own form of government. Yes, democracies appear to have a modest statistical advantage when it comes to economic growth. But that’s just a statistical trend, not an ironclad proof of economic superiority. Plenty of autocratic countries have experienced rapid growth, from Germany in the 19th century to South Korea and Taiwan in the early 1980s. What’s more, there’s a chance that the modest correlation between democracy and growth is driven by one massive outlier — the US, whose alliance and patronage was undoubtedly a big economic advantage for many democratic countries during the 20th century.

Right now, democracy is being questioned more from both within and without. It’s worth asking if this is because democratic systems have some unique economic challenges that were systematically ignored in previous decades.

Economists have long known that democracy doesn’t always lead to the most economically efficient outcome. The Nobel prize-winning economist Kenneth Arrow famously proved that no democratic political system can give all its citizens what they want in in all situations. Of course, real political systems don’t even come close to optimality, so this finding is a bit academic.

But economic theory also points to a more concrete problem — the difficulty democracies have in providing public goods. One of government’s essential roles is to provide things that benefit people other than those who directly pay for them. Examples include national defense, infrastructure and basic research. Education and health care also have some aspects of public goods, since a healthy and educated populace creates broad benefits for everyone.

Because free markets generally won’t provide enough of these things, government needs to pick up the slack.

When building infrastructure, authoritarian countries don’t have to worry about hurting the few to help the many. China forcibly relocated 1.2 million people to build a dam in the 2000s. Fortunately, that wouldn’t be possible in the US, but it does mean that American companies are often forced to compete against authoritarian rivals that have access to cheaply built world-class infrastructure.

Paying for public goods can also be difficult. People differ both in their ability to pay and in the amount of benefit they derive from the public goods. Typically, countries use different types of taxes to take these two things into account — gas taxes to fund highways, and income taxes that fall more heavily on the rich. But economic theorists have figured out that under a fairly general set of conditions, no tax regime can possibly provide a good deal for all citizens. Either government ends up not providing enough public goods, or it runs a budget deficit.

There is an alternative. It’s possible to balance the budget and provide the optimal amount of public goods, but only if some rich people are forced to pay very high taxes. But the amount of top-level taxation required is so steep that many rich people would rather just quit the system entirely — move to another country, or abolish the government. This fairly general mathematical result probably explains many rich people’s affinity for libertarian ideas.

It also may explain why most democracies carry large amounts of government debt.

Bloomberg View

The US Special Relationship With Britain Needs a Rest

US

Many Americans still regard Britain as the US’s political and cultural parent.

Despite the Revolutionary War and the War of 1812, the US and the UK eventually developed a special relationship that endured throughout the 20th century.

Together, the two defeated the Axis and communism, and established a global order based on free trade and (eventually) universal human rights. But even before that diplomatic alliance solidified, cultural and technological exchange between the two countries was immense — British inventions powered America’s industrial revolution, and British notions of natural rights and tolerance formed the basis of US government.

In economics, British influence on the US has been immense — Adam Smith, Alfred Marshall and John Maynard Keynes are just three of the intellectuals who revolutionized American thinking from across the Atlantic.

Thus, it is with a heavy heart that I write this article: The time has come for a hiatus in this special relationship. The UK is going through a time of extreme internal trouble, and a number of bad ideas are emerging from the chaos. The US needs to reduce, at least temporarily, its reliance on British ideas.

The most obvious example, of course, is Britain’s decision to leave the European Union. The EU has its flaws, but the UK has reacted to those problems in a highly dysfunctional way. First, there was the contentious Brexit referendum, in which ugly racism and anti-intellectualism rose to the fore. Then following the decision to exit, some British leaders began behaving in a less-than-friendly manner toward the remaining EU countries, with a few even threatening to go to war over Gibraltar.

Meanwhile, the UK hasn’t actually completed Brexit yet, and it hasn’t even decided on the details of the separation. So it’s currently enjoying none of the potential benefits of such a split, while already suffering some of the costs. Investment in the British auto industry has plummeted, and is on track to be only about a quarter the level of two years ago.

Brexit has already had a bad influence on the US The rancor of the 2016 presidential election, with its explosion of racial animus and anti-Islamic rhetoric, seemed to echo the UK Brexit referendum. Anecdotally, it’s common to encounter British white supremacists, anti-Semites and Islamophobes on Twitter, demanding that Western civilization be defended by expelling nonwhites, non-Christians and most immigrants. The American right can’t help but be influenced by these regressive ideas, to its great detriment.

But it’s not just the British right that is giving its American cousins bad ideas. The British left has taken the lead in attacking the moderate, centrist economic policy consensus that saw the free world through the 20th century. British intellectuals on the left rail constantly against neoliberalism, the technocratic, economics-based approach to policy-making. They have also been particularly dogged in attacking the economics profession.

Neoliberalism and other advocates of deregulated markets certainly overreached in the years before the financial crisis, and the economics profession — especially macroeconomics — clearly made many mistakes. But blaming centrist technocracy for all the problems of the modern age is an excuse, not an agenda, and it ignores all the good that free trade has done, especially for the poor countries of the world. Meanwhile, Jeremy Corbyn, the leftist leader of the British Labour Party, has praised Hugo Chavez, whose radical policies left Venezuela’s economy in shambles. Anti-Semitism has also surged on the British left.

In other words, where Britain was once a bastion of pragmatism and sensible calm, it is now exporting extremism, some of which finds welcome ground in the United States. This is a sad change from the 1930s, when Keynes helped US President Franklin Roosevelt chart a centrist course between laissez-faire and socialism at a dangerous moment.

But it’s not only radical British ideas that the US should avoid. The UK’s entire industrial policy during the past few decades has been questionable. All developed economies rely heavily on service industries, but in the UK this has been taken to an extreme, with services comprising 80 percent of the economy. Services don’t export very well, which probably helps to explain Britain’s persistent trade deficit. And much of Britain’s service economy centered around finance, which made it more vulnerable than many other nations to the crash of 2008. And the country’s misguided austerity policies made a bad situation worse.

Finally, it’s important to remember that British per capita income stands at only about 74 percent of US levels, compared with about 85 percent for Germany and 89 percent for the Netherlands.

So while it remains an important geopolitical ally, Britain no longer looks like a source of good ideas for the US to follow. Ironically, it’s the two countries’ old Axis foes, Germany and Japan, that now look like the strongest beacons for the United States. Germany’s effective system of collective bargaining has helped make it an export powerhouse, while Japan’s wise macroeconomic management has put the entire country back to work. And both countries, with the memory of their disastrous early 20th century extremism relatively fresh in their collective minds, have mostly avoided the bilious political outpourings roiling the UK and US.

The US would therefore be well-advised to place its special relationship with Britain on the back burner until that troubled country can sort itself out. In its place, the US should forge new special relationships with Germany and Japan.

Bloomberg

How to Clear our Minds

When it comes to economics, we spend most of our time thinking about better ways to organize human activity. This is the main purpose of debates about minimum wage, universal health care, deregulation, taxes and other common economic policies. But it’s worth remembering that the condition of the people matters a lot as well — the best policies in the world won’t guarantee prosperity if the bulk of citizens are sick, illiterate or innumerate.

In the 20th century, universal public education and public health measures became standard policy in every developed country. That increased the capabilities of the workforce — what economists call human capital — immensely. Factory workers could read instructions, office workers could calculate revenues and costs, and people throughout society were mostly freed from the scourge of diseases like polio, whooping cough and tuberculosis. This was a huge win for developed nations, and for human quality of life.

But in the 21st century, rich countries’ economies depend more and more on knowledge industries like technology, finance and business services. Even outside of those industries, almost every worker now has to know how to use office-productivity software, interact with websites or perform other complex tasks. In this new world, humans are being asked to think all the time.

That means US policy makers need to be looking at better ways to upgrade the mental capabilities of the labor force. Unfortunately, a number of things interfere with Americans’ ability to think clearly.

The biggest threat to clear-headedness comes from drugs. The twin epidemics of opioid-painkiller dependence and heroin abuse destroy people’s lives and harm productivity. There is a strong correlation between opioid use and unemployment, and it’s no great stretch to assume that the former helps cause the latter.

A second, much-discussed problem is lead pollution. A flood of research is finding that even small amounts of lead exposure in childhood can lead both to worse academic performance later in life, and to more criminal behavior.

Furthermore, recent evidence suggests that American children are far more exposed to lead than most people realize. Lead paint contaminates soil, lead pipes contaminate drinking water, and a variety of commercial products from cosmetics to electronics contain bits of lead. The US is allowing its people to be poisoned with heavy metals, and both their intelligence and their self-control is being degraded as a result.

But drugs and lead aren’t the only forces preventing Americans from being able to think clearly. Poverty is another. Everyone knows that the US is a very unequal country, but few think about the damage that causes to American minds. A growing body of researchshows that poor people have different brain structures from other people.

Mental problems can and do cause poverty, of course, but poverty also exposes people to many of the forces that are known to cause post-traumatic stress disorder — violence and unstable family situations — in addition to brain-damaging malnutrition. Let’s hope that new long-term studies will clarify just how much poverty damages the brain, although the mechanisms are already pretty obvious.

Violence in general probably causes lots of long-term harm to the minds of American children. The US as a whole has a high murder rate for a rich country — 4.2 homicides per 100,000 people, about three times as high as France or the UK. 

When all these factors are added up, they represent a severe threat not just to Americans’ quality of life, but to the productivity of the US workforce. Policy makers, economists and other intellectuals should start thinking more about how to beat back this multipronged assault on national clear-headedness.

Opioid prescriptions should be curbed and monitored more closely. Policies from countries such as the Netherlands should be copied to beat back the heroin menace. A nationwide program of lead abatement should scour the metal from US soil, drinking water and commercial products. A more robust social safety net should be implemented to cushion the stress and deprivation of poverty. Community policing strategies should be implemented to cut crime by building trust between cops and communities.

In the 20th century, government saved us from disease and illiteracy; in the 21st, it needs to help us clear our minds. 

Bloomberg View

So Many Critics of Economics Miss What It Gets Right

At this point, blanket critiques of the economics discipline have been standardized to the point where it’s pretty easy to predict how they’ll proceed. Economists will be castigated for their failure to foresee the Great Recession. Some unrealistic assumptions in mainstream macroeconomic models will be mentioned.

Economists will be cast as priests of free-market ideology, whose shortcomings will be vigorously asserted. We will be told that economics moves in cycles of fad and fashion. Readers will be reminded that economics deals with humans instead of atoms, making scientific certainty impossible. The piece will end with a call for humility on the part of economists, a more serious consideration of unconventional ideas and reduced prestige for the economics profession.

Writers for the British newspaper the Guardian are especially adept at producing this sort of broadside. The latest one, by John Rapley, is entitled “How economics became a religion,” and it follows the script pretty closely. But by now it feels like the refrain is getting a bit stale.

There are certainly some grains of truth in this standard appraisal. I’ve certainly lobbed my fair share of criticism at the econ profession over the years. But the problem with critiques like Rapley’s is that they offer no real way forward for the discipline. In the wake of the Great Recession, outbursts of anger might have served to awaken economists from their contented intellectual slumber, but at this point a more constructive tone would be preferable. Simply calling for humility and methodological diversity accomplishes little.

Instead, pundits should focus on what is going right in the economics discipline — because there are some very good things happening.

First, economists have developed some theories that really work. A good scientific theory makes testable predictions that apply to situations other than those that motivated the creation of the theory. Slowly, econ is building up a repertoire of these gems.

One of them is auction theory, which predicts how buyers will bid for things like online ads or spectrum rights — Google’s profits are powered by econ theory as much as by search algorithms. Another example is matching theory, which has made it a lot easier to get an organ transplant. A third is random-utility discrete choice theory, which is used in everything from marketing to transportation planning to disaster preparedness.

Nor are econ’s successful theories limited to microeconomics. Gravity models of trade, though fairly simple in nature, have proven very successful at predicting the flow of international trade.

These and other successful economics theories can be used confidently in a wide-variety of real-world situations, by policy makers, engineers and businesses. They prove that anyone who claims that econ theories will never be reliable, because they deal with human beings instead of atoms, is simply incorrect. Of course, economists still make and use a lot of theories that don’t work nearly this well, but writers should recognize and praise the successes more often.

Second, economics is becoming a lot more empirical, focusing more on examining the data than on constructing yet more theories. Economist Daniel Hamermesh classified papers in top economics journals in 2013, and discovered that the discipline has shifted strongly away from theory since the mid-1980s. My Bloomberg View colleague Justin Fox flagged this research back in 2016:

Recently, another team of economists conducted a similar analysis, using machine-learning techniques to classify papers as empirical or theoretical. Their findings echoed those of Hamermesh — econ is paying a lot more attention to data these days. Curbing the proliferation of models and applying more empirical analysis represents a positive trend, because a narrowing set of theoretical papers will be a lot easier to check against the facts.

Third, empirical economics is becoming more directly and immediately relevant to policy matters. A popular new style of research, often called quasi-experimental economics, evaluates the results of policy experiments like Seattle’s recent minimum wage hike or European countries’ acceptance of refugees.

Instead of relying on complex theory or unrealistic assumptions, quasi-experimental studies give immediate clear answers about the results of government action. That won’t make economic theory obsolete, but it vastly increases the speed with which economists can give policy makers reliable feedback.

Finally, even if the economics profession once leaned toward free-market ideology, that is no longer the case. Not only are today’s star economists likely to fall on the left side of the political spectrum, but economists in general are more pro-government than the general public on most issues. In 2013, economists Paola Sapienza and Luigi Zingales compared a survey of economic experts to a survey of the U.S. general public, and found the following:

Leaning Left

Views of economists vs. the public on economic policies

Another, broader study of academic economists in 2006 also found broad levels support for government intervention.

So the caricature of economics as the priesthood of free markets is way out of date. Free-market writers and think tanks may still use simplistic old ideas to justify laissez-faire policies, but among academics, nuance, moderation and complexity prevail. Meanwhile, though ideology probably does bias economists’ results to some degree, evidence shows that the degree of bias is modest.

Instead of trotting out the standard boilerplate critique of economics, pundits should be encouraging and publicizing the positive trends. The image of economics as a hidebound, unchanging discipline is a myth. The field has its problems, sure. There’s still a long way to go. But academics are working hard to make econ more scientific — to create reliable, applicable theories, to gather and understand new data, to provide rapid, useful feedback to policy makers, and to gain a more balanced and refined understanding of the economy. Maybe it’s us writers, not academic economists, who need to catch up with the times.

Bloomberg

America Obsesses About a Russia That Misses the ’70s

Russia Red Square"- Reuters

Americans are seeing lots of stories about Russia in the news these days, mainly because of that country’s attempts to interfere in the US presidential election and other episodes of meddling in other nations’ affairs. This has led many Americans to believe that Russia is the US’s main global rival, and that its president, Vladimir Putin, is some kind of a genius. But a closer look reveals that in the economic arena, Putin hasn’t done so well. While he has managed to avoid an outright crisis, he’s done little to address his country’s fundamental economic liabilities.

For example, Russia’s economic growth has stalled since about 2012. But although income has stagnated, the gains of the 2000s haven’t been reversed — there has been no return to the dysfunction of the 1980s and 1990s. Part of this is due to prudent macroeconomic management. As the economy weakened, Russia let the ruble fall starting in 2014, though the currency has had a good deal of volatility since then.

But through skillful use of informal capital controls and judicious devaluations of the ruble, Putin and his administration managed to prevent a currency crisis without depleting the country’s stock of foreign-exchange reserves.

So while things aren’t looking rosy for Russia, they aren’t dire either — good macroeconomic management has afforded Russia a modicum of stability even in the face of low oil prices.

Still, Russia’s leaders shouldn’t become complacent. In the past, periods of stability have masked structural rot that later came back to bite. Long-term trends contain reason for Russia to worry.

One problem is creeping state control of the economy. A recent policy brief by Simeon Djankov of the Peterson Institute for International Economics reveals the extent to which Russia’s economy has been re-nationalized after the chaos of the 1990s.

While in 2005 the share of private commercial banks in total [Russian] assets was nearly 70 percent, by 2015 it had shrunk to half that percentage…By mid-2015, about 55 percent of the Russian economy was in state hands, with 20 million workers directly employed by the government.

Djankov attributes some of this change to the sanctions the US and Europe placed on Russia after its intervention in Ukraine — deprived of Western financing, many Russian companies turned to the government. But whatever the reasons, the shift toward government industries is bad news. State-owned enterprises tend to have serious corporate governance problems — inadequate transparency, political cronyism and lack of discipline from financial markets. Despite some improvements, Russia’s state-owned companies are still much less productive than its private enterprises.

Russia’s second main problem is excessive reliance on fossil-fuel extraction. As Bloomberg View’s Leonid Bershidsky has reported, about two-thirds of Russia’s exports now come from oil and gas, and some analysts argue that 70 percent of the country’s entire economy is oil-related.

That’s bad for several reasons. First, it creates huge macroeconomic risk — when oil prices fall, Russia’s economy staggers. Oil prices are traditionally very volatile. Having an entire economy depend on something as fickle as global oil prices puts Russia in constant danger. The country’s decline in per-capita gross domestic product in 2015 was probably caused by the plunge in oil prices. And with natural gas rapidly transforming into a global market, its price will also be increasingly determined by factors beyond Russia’s control.

But if short-term risk is a problem, long-term technological change is an even bigger risk. Rapid development in car batteries, combined with the advent of renewable energy, threaten to make Russia’s main commodities less and less central to the world economy. Oil has enjoyed a long reign as a transportation fuel with no real substitutes, but the next decade may see that run of luck come to an end. This is why countries like Saudi Arabia are so keen to diversify their economies.

The long-term threats of economic nationalization and oil dependence should worry Russian leaders. They are uncomfortably reminiscent of the 1970s, when Leonid Brezhnev ruled over a Soviet Union that was outwardly strong but sclerotic and stagnant at its core.

In the 1970s, as today, Russia appeared very formidable on the international stage. The U.S.’s loss in Vietnam weakened its main rival, and high oil prices, caused in part by the Arab oil embargo and the rise of OPEC, hobbled the economies of the West while sending Soviet GDP steadily higher. Soviet influence is generally believed to have hit a high point in that decade. But economic evidence shows that in the 1970s, Russian industrial productivity stopped rising. When oil prices fell in the 1980s, Soviet leaders were not prepared for the shock.

Putin has praised Brezhnev’s leadership, but he should see the 1970s as a warning. Victories abroad, and the troubles suffered by the US, shouldn’t distract him or his administration from the need to put the economy on a stronger long-term footing. Reducing the twin trends of economic nationalization and oil dependence should be top priorities.

(Bloomberg)

Why Americans Feel So Good about a Mediocre Economy

US

A strange thing seems to be happening to the US economy. On surveys, businesspeople and consumers say the future looks bright. But recent economic activity hasn’t appeared very robust.

Andrew Ross Sorkin of the New York Times noted this in a recent article about mergers and acquisitions. A number of surveys have been reporting that chief executive officers are highly optimistic. For example, the website Chief Executive and the Wall Street Journal/Vistage Small Business CEO Survey both report a surge in CEO confidence since the 2016 election, while Business Roundtable’s CEO Economic Outlook Survey finds an average level of confidence.

But as Sorkin reports, M&A activity is at its lowest level since 2013, and has fallen 40 percent in the past two years. Share buybacks have also slowed. Those “hard” numbers indicate that whatever CEOs are saying on paper, they aren’t taking actions that signal confidence in the future of their businesses. Capacity usage, which fell slightly in May, is another indicator of that true business sentiment is far from giddy.

Another example is consumption. The University of Michigan’s Surveys of Consumers show confidence at the highest levels they’ve been since before the crisis.

But again, some hard numbers tell a different story. Retail sales fell in May, and have been relatively lackluster for the entire year so far.

Auto sales are falling as well. Since cars are expensive, long-term purchases, consumers often signal lack of optimism by holding back on the purchase of a new car, choosing instead to drive their old model for a little while longer. So this is another data point that belies rosy consumer confidence numbers. Pending home sales provide a third spot of weakness.

Employment isn’t particularly strong either. Nonfarm payrolls expanded by only 138,000 in May, lower than the 185,000 that had been forecast. That follows another middling month in April and a dismal 79,000 in March.

Why the divergence between the “soft” numbers of confidence surveys and the “hard” numbers of the real economy? One possibility is that this is just a momentary spot of economic weakness, and the numbers that measure sentiment point to better days in the near future. But survey numbers have been rosy for a half-year now, so if these surveys were doing their job of forecasting the real economy, it seems like the good times they predict would have started to show up in the data by now.

It’s also possible that the hard numbers are just very noisy and full of error. That’s always a danger with up-to-the-minute analysis of the latest economic statistics. For example, capacity utilization rose substantially in April, so the slight fall in May might be due to the correction of a random mismeasurement the previous month.

Another possibility is that the seemingly weak “hard” numbers are cherry-picked by me and others. No one knows exactly which economic numbers to trust at any given moment in time. The Conference Board’s index of leading economic indicators was actually up slightly in May. But Morgan Stanley reports a “record gap” between hard and soft numbers in recent months, so the phenomenon seems real.

A third possibility — and one I personally find likely — is that surveys of consumer and business confidence have systematic errors that make them unreliable in certain economic and political climates but not in others.

Surveys have some predictive power, but only a bit. The Index of Consumer Sentiment is believed to explain only 13 percent to 26 percent of the variations in economic output. Similarly, financial surveys have a slight bit of ability to predict the stock market, but only when many are used in conjunction — and even then, the signal is a weak one.

Bloomberg

The World Bank Has Bigger Problems Than Bad Writing

NEW YORK, NY - APRIL 26: Paul Romer of Stanford University speaks at the Disruptive Innovation Awards at The 2011 Tribeca Film Festival at Citibank Building On Greenwich on April 25, 2011 in New York City. (Photo by Slaven Vlasic/Getty Images)

Economists, to put it mildly, are not known for their communication skills. The typical economics paper is written in a formal, stilted style, laden with phrases like “in the following subsection” and “it has been shown that.” Jargon flies thick and fast, interspersed with highly formalized mathematical definitions and propositions. For a non-economist to hack through the verbal jungle of the typical paper is often an impossible task.

Why is econ so abstruse? A simple explanation is that economists are just math nerds who were never forced to communicate well. A hardened cynic might suggest that the purpose is to create a secret language that can only be understood by insiders, in order to thwart outside scrutiny. I suspect that econ is far from the worst offender when it comes to using jargon as an artificial barrier to entry, but it’s possible some of this is going on.

In any case, Paul Romer, chief economist of the World Bank, seems to have tried to change this situation. After assuming leadership of the Bank’s research arm last year, the Development Economics Group, Romer apparently initiated a crusade against stilted writing, even going so far as to count how many times researchers used the word “and.” The researchers were having none of it, however, and successfully campaigned to force Romer to give up leadership of the group. Romer’s budget cuts and elimination of positions within the bank probably didn’t endear him to his subordinates, either.

This is sad, but was probably inevitable. An aggressive, maverick leader rarely succeeds in shaking up a sleepy, hidebound organization overnight. To truly change the institutional culture of a place like the World Bank would take a long time and a lot of painful inside baseball — it’s not the kind of thing that can be accomplished with a quick frontal assault. Romer isn’t the first reformer to get bogged down in that particular organization — President Jim Yong Kim, who attempted a massive restructuring of the Bank in 2014, caused turmoil and even provoked a work stoppage.

So Romer’s efforts were probably always a low-percentage shot. But it was a good try. From an outside perspective, it certainly looks as if the World Bank is an institution in need of great change. And the problem goes far beyond poor communication.

First of all, the Bank’s original mission — to lend money to developing countries — is becoming less and less important. As Center for Global Development researchers Scott Morris and Madeleine Gleave noted in a 2015 report, the rapid growth of the world economy means that most countries just don’t need the bank anymore:

The Bank will continue to play an essential role in a relatively small number of fragile states, but the rest of its core lending model could very quickly become irrelevant to most of its other current borrowers…On its current path, the World Bank will soon enough be viewed as no longer essential.

Morris and Gleave suggest a number of other roles the Bank could step into, including disease response, funding scientific research, making municipal loans or simply acting as a think tank. But this isn’t very encouraging — it paints the picture of an organization shambling onward out of sheer momentum, an expensive bureaucracy looking for a purpose. In 2014, the Financial Times wondered openly if the Bank was “sliding into irrelevance.”

Meanwhile, the World Bank’s sister institution, the International Monetary Fund, has its own problems. Created to make emergency loans to countries in crisis, the IMF advocated fiscal austerity that probably often ended up making the situation worse. In recent years, the Fund’s macroeconomists, led by Chief Economists Olivier Blanchard and Maurice Obstfeld, have almost completely reversed the organization’s standard approach to fiscal policy. But that leaves the uncomfortable question of why the Fund’s institutional culture allowed such a wrongheaded approach to persist for so long in the first place.

A picture is beginning to emerge of global financial institutions that are too hidebound and conservative. Faced with changes in both the global economy and economists’ understanding of recessions, both the World Bank and the IMF have too often resisted change rather than embrace it. It’s worth wondering if the root of the problem comes from the culture of economics.

Economists are, in general, an insular and hierarchical bunch. They are used to having the quality and value of their work judged only by other economists. The outside world is expected to pay economists’ salaries and listen to their advice, but not to question the value of what they do. But when this ivory-tower approach is applied to real-world organizations, the result can be unacceptable institutional inertia.

Perhaps it was this insular culture, rather than just bad writing, that Romer had really intended to shake up. If so, the deck was stacked against him from the start. Making economists open up and engage with the wider world — and make themselves vulnerable to criticism by intelligent outsiders — may be a task too great even for a famous and brilliant individual like Romer.

(Bloomberg)