A framework for normative economics

This is a post that Matt really should have written, but unfortunately he’s snowed under at work at the moment. Having said that, it’s not really much more than a plug for Steven Landsburg’s fascinating new paper entitled “The Methodology of Normative Economics”. Economists tend to shy away from making normative judgments: when constructing a social welfare function they claim to be maximising efficiency. Yet the form of that welfare function determines the form of the efficient solution. Moreover, people clearly have strong feelings about what constitutes an appropriate welfare function for a regulator to maximise.

Given that people feel strongly about what form this function takes it makes sense to model people as having preferences over different forms of the welfare function. For a welfare function to be ‘consistent’ it must predict that it is itself the optimal welfare function to use. Landsburg shows that, if rich people care about equity, there is only one such function that exists. Even if people are selfish and don’t care about equitable distribution of income, there are only a limited number of consistent welfare functions.

What I really like about Landsburg’s paper is that it forces economists to confront the normative judgments that they inevitably make when they talk about welfare. Yet it forces them to do so by using an analytical framework that they are comfortable with. Rather than forcing them to make value judgments, it allows them to talk about the normative framework of their model without having to resort to moral or philosophical discourse that they are ill-equipped to deal with.

Check out another of Landsburg’s methodology papers here if this stuff dings your bell.

Is economics vulgar?

The people at no right turn are unhappy with our discussion on torture as an alternative to imprisonment. That’s fine; however the last sentence of their post interested me:

“As for “moral biases”, economics would do well to remove the beam from its own eye, and recognise that it is in fact a rather vulgur monetarist implementation of utilitarianism and hence loaded with moral preconceptions (some quite questionable), rather than the morally-neutral, unbiased science they like to paint it as.” (emphasis added)

I am especially interested in the fact that Idiot/Savant said economics was “loaded with moral preconceptions”. The view of economics as money hungry right wing sociopaths is fairly common, and as a result there must be some reason why people think of economists in this way.

Before covering this, I want to say what I think economics is. Economics is the study of choice. Now there is a descriptive side to this (what is the situation) and a prescriptive side (what choice must be made). The descriptive side is positive, ‘fact’ based, while the prescriptive side is normative, so value laden. A good economist should separate out the descriptive and prescriptive parts of their argument. Ultimately, all economists should agree with the descriptive side of an economist’s statement, but they can disagree about the prescriptive side, as value judgements are different between people. Note: You cannot usually make a choice without value judgements, and even inside economics there is great debate about what constitutes an objective fact. The point is that a good economist will separate these factors out..

There are economists out there who bastardise this process, and will act as if their value judgements are objective facts. This is the case where we get “loaded moral preconceptions” from economists.

What I think irritates people is that people think economists apply values to things. However, if an economist gives something a certain monetary value, this is a value judgement, and can be attacked on that basis. An economist will first try to figure things out without resorting to value judgement, eg if an action makes everyone better off, then that action is objectively better than doing nothing. The ultimate goal at this stage is to model the situation without attaching value to any components.

Once this process is done the economist may want to make a prescriptive statement, this involves implementing some value judgements. While some people say it does make sense to attach values to things, we have to realise that when economists give a monetary value to something it is just as a means ordering the possible choices available (Note that this order is determined by some value judgement). You might say that a value cannot be attached to murder, but you simply have to look at an appropriate set of choices. Eg would you rather be murdered or have your fingers cut off.

James’s post was very good in this regard. He put down the appropriate considerations, and asked whether the way society views them is appropriate, he did not apply any value judgements. He was asking us to reveal our own value judgements to do with the punishment of criminals, to see what choice we would make.

Note:  I do want to have a free and frank discussion about economics applied to social issues, but can we please use a different issue than child abuse and rape.  We can cover the same emotive issues without delving into issues like this directly.

Evidence-based economics

Charles Lambdin doesn’t think this book is right to reject evidence-based medicine. Lambdin thinks the best way to approach medicine is to treat it as a science and apply scientific methods. Where empirical research suggests that a particular treatment is appropriate then it should be used, not modified or discarded according to an individual doctor’s wont. This seems an eminently sensible suggestion but there is apparently widespread suspicion amongst clinical practitioners of evidence-based techniques.

The situation reminds of the disdain with which many economists still view behavioural economics. Daniel Kahneman won the Nobel Prize in Economics in 2002 for his work in the field. Along with people like Amos Tversky and Matthew Rabin he has pioneered the use of experimental research in developing microeconomic theory. While it makes a lot of sense to base microeconomic theories of behaviour on empirical observations, many economists have been critical of those who use insights from psychology. In 2003, Kahneman wrote (JSTOR only):

My first exposure to … economics was in a report … in the early 1970’s. Its first or second sentence stated that the agent of economic theory is rational and selfish, and that his tastes do not change. I found this list quite startling, because I had been professionally trained as a psychologist not to believe a word of it. The gap between the assumptions of our disciplines appeared very large indeed. Has the gap been narrowed in the intervening 30 years? A search through some introductory textbooks in economics indicates that … the same assumptions are still in place as the cornerstones of economic analysis.

There is a greater acceptance of behavioural economics than there once was; however, it is not hard to see why many people might regard microeconomists with some incredulity, in the same way that economists might look upon doctors who disregard evidence-based medicine in favour of personal intuition.

Economic scissors: Trial and error

Supply and demand, the economic scissors. This beautiful diagram explains a significant amount about how economists think:


Now from what I understand, when the two curves cross we have equilibrium. This sets a price where demand and supply are equal. When the price is higher we have a surplus of goods, here some of the firms in the industry can’t sell all their produce, and so they cut prices bringing us to equilibrium. When the price is below equilibrium we have a shortage of goods. In this case competing consumers are supposed to bid up the price until we get to equilibrium.

However, in western society we don’t like to bid up the price, we just sit around. The best example I have of this is my daily pie. I want a chicken pie, I go to the store and they only ever have one, and half the time someone else has taken it. Now instead I buy a curry pie. If the store knew that I also wanted a chicken pie they could have put one more in the oven and I would have paid a higher price, and we would both be better off.   Instead, they think that I have revealed a preference for curry pies and they keep on cooking them.  There is imperfect information here.

How are we supposed to solve the case of the pie, given that western consumers aren’t fond of arguing up the price when there is a shortage. Well I think that firms realise this, and through a process of trial and error they try to increase information, so that they can set the equilibrium price.

The example of this is supermarkets. In a supermarket there always seems to be one type of toilet paper on special. The different manufacturers take turns, lowering there price and sometimes increasing it by more than they dropped it the next week. In this case the firms are trying to discover what the demand curve looks like, they are trying to find out if there is a shortage of their product. Through this process the firm discovers enough information bring us closer to equilibrium, all in the name of maximising profits. How convenient.

Econometricians will rule the world eventually

It sometimes seems that more interesting economic research is done by econometricians than theoreticians, these days. The way to make your name now is to have a knack for finding inventive experimental designs. Here is an interesting paper about the effect of cellphone use on car-crash rates. It uses the discontinuity in cellphone usage rates across peak/off-peak times to evaluate the effect that cellphone usage has on crash rates. In contrast to the prevailing literature, and quite counter-intuitively, they find no significant effect. Another reason for governments to be hesitant about hasty regulation?

Pie-in-the-sky policies

Here at this blog we talk a lot about corrective regulation but rarely
stop to examine current government policy. In reality, most government
tax policy focuses either on revenue gathering or on discouraging
consumption of demerit goods. Infrequently, a corrective tax is
proposed – such as the ‘fart’ tax – and then discarded when it proves
unpalatable to the interest group generating the externality.

The fact is that corrective taxes are usually targeted at a
particular group and, the more precisely targeted they are, the more
efficient they are. These ‘discriminatory’ taxes are the ones least
likely to be implemented by a government wanting to appear fair and
even-handed: taxing specific groups is a sure way to generate
resentment at your policies.

So, if the taxes we want are equally as unlikely to eventuate as to be
magically fixed by ‘the market’, are we really any less removed from
reality than the blinkered free-marketeers that we scoff at?