Arnold Kling: Economics>Macro

Arnold Kling is right that Macroeconomics is only a subset of economics – and as a result a failure in macroeconomics does not damn the whole economic method.

However, I think he might be giving macroeconomists a bit of a free ride here.  Think of it this way – microeconomics has evolved to generalise hypotheses and make them testable.  Microeconomists have also been careful to posit counter-factuals to their cases and discover necessary and sufficient conditions for their results.  The strength of microeconomics has lead to a burgeoning industry in “Freakonomics” style books.

Macroeconomic theory has followed micro, attempting to solve general economic situations from “individual rationality” and even applying some game theory.  However, as soon as the business hit the fan – they dumped their attempts at a framework and rushed back to arbitrary debates on the size of the “multiplier”.

Recent debates have illustrated that macroeconomists are really just “play economists” – stating that they believe in scarcity, and want to study the allocation of resources, but don’t want to put in the hard yards that microeconomists have.  Where is the general equilibrium theory?  Where is the study of multiple, heterogeneous, agents interacting in a dynamic system with poor information and imperfect institutional arrangements.  Do macroeconomists actually have a general framework (based on methodological individualism) that they agree on – like microeconomists do.

Some people posit that the separation between micro and macro is like the difference between general relativity and quantum physics – these people would have us believe that there is only one step left between reconciling these divergent disciplines and having a “general theory”.  However, doesn’t that give macro a little more credit than it deserves?

Note:  This post is supposed to be contentious – I would like to hear how macroeconomists would go about answering the claims I’ve made in this post :)

The one thing broken by this crisis …

Update: Clive Crook has a better discussion of what is going on than I do (original here) – and how irritating it is – than I do. I’m embarrassed to say that I’m a few days behind on my blog reading, so I only saw this after writing my post :(

Even if nothing else is broken in the economy, there is one thing that has been irrevocably smashed.

My belief that academic economists in the US would be able to use the economic tools developed over the last 200 years to objectively frame issues during a crisis – and then transparently discuss the different value judgments they hold in order to inform policy.

Compare this belief I held to reality – where we have had ridiculously partisan arguments, where intelligent economists have just told everyone that other intelligent economists are morons (eg), and that their own conception of what is going on IS the truth (something economists don’t have the ability or knowledge to say).

Economists have a framework stemming from methodological individualism – a framework that frames problems. Even though “describing” and “predicting” are too value laden for us, my own view is that good economists will try to build inside this framework first before adding value judgments to get the “description” and “prescription”. Instead all we have seen is random conjecture based on ideological fervour. Saying that this disappoints me would be an understatement …

Something’s missing …

Just saw this cartoon by Mike Moreu on the outsourcing of call centre staff (ht Nigel Pinkerton):

791126Source (Mike Moreu on Stuff)

Job security isn’t the only difference – the other is wages. The artist forgets to mention that they have job security because they are paid significantly less than a New Zealander would accept. Implicitly this tells me that NZer’s could have had job security – if they had accepted lower wages …

There are two further things that I take from this.

  1. New Zealander’s are now getting a service more cheaply – as the cost is lower,
  2. The workers overseas are made better off – as they now have jobs at a wage they are willing to work at.

Unless we value the NZ call centre workers significantly more than we value Telecom consumers and people in Manila we can’t possibly complain about this situation. However, NZer’s are complaining. To me this implies that we value people in Manila significantly less than we value people in New Zealand – a view that appears very similar to straight out racism in my mind …

A sure way to increase uncertainty

Is it me, or did Treasury Secretary Tim Geithner make matters worse with his announcement about the TARP today.

Given how long people have been waiting for a “solution” from government, statements like:

We are exploring a range of different structures for this program, and will seek input from market participants and the public as we design it

Seem a bit soft. Surely the market thought that the US government had already done this!

In fact, the market did think this – which is why the DOW collapsed. You increase uncertainty, you reduce the value of capital – it’s as simple as that:

Source (The Austrian Economists)

Labour skills and sticky wages: Is the problem worse now?

The mass unemployment in the 1930’s has sometimes been put down to “stick wages”. Fundamentally, the value of labour fell but the price didn’t – leading firms to cut back on employment at a faster rate than would have been socially optimal.

Since then, wage stickiness appears to have eased to some degree: Unions are less powerful than they were, and employees have a greater level of understanding about why firms may have to cut nominal wages – leading to less of a psychological impact (Note: These statements are just conjecture – if you don’t agree with them feel free to state in the comments, we could really do another post on it :) ).

However, does that mean that the underlying issue of labour market adjustment has abated? The short answer is no.

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