Tag Archives: economics

Paul Romer and “mathiness”

Paul Romer has attacked a number of fellow economists for relying on what he calls “mathiness” rather than mathematical theory. He believes the study of economic growth and its practical applications have suffered because of this.

Academic politics, like any other type of politics, is better served by words that are evocative and ambiguous, but if an argument is transparently political, economists interested in science will simply ignore it. The style that I am calling mathiness lets academic politics masquerade as science. Like mathematical theory, mathiness uses a mixture of words and symbols, but instead of making tight links, it leaves ample room for slippage between statements in natural versus formal language and between statements with theoretical as opposed to empirical content.

Solow’s (1956) mathematical theory of growth mapped the word “capital” onto a variable in his mathematical equations, and onto both data from national income accounts and objects like machines or structures that someone could observe directly. The tight connection between the word and the equations gave the word a precise meaning that facilitated equally tight connections between theoretical and empirical claims. Gary Becker’s (1962) mathematical theory of wages gave the words “human capital” the same precision and established the same two types of tight connection—between words and math and between theory and evidence. In this case as well, the relevant evidence ranged from aggregate data to formal microeconomic data to direct observation…

The market for mathematical theory can survive a few lemon articles filled with mathiness. Readers will put a small discount on any article with mathematical symbols, but will still find it worth their while to work through and verify that the formal arguments are correct, that the connection between the symbols and the words is tight, and that the theoretical concepts have implications for measurement and observation. But after readers have been disappointed too often by mathiness that wastes their time, they will stop taking seriously any paper that contains mathematical symbols. In response, authors will stop doing the hard work that it takes to supply real mathematical theory. If no one is putting in the work to distinguish between mathiness and mathematical theory, why not cut a few corners and take advantage of the slippage that mathiness allows? The market for mathematical theory will collapse. Only mathiness will be left. It will be worth little, but cheap to produce, so it might survive as entertainment.

aging and deflation

This study says the relationship between aging and deflation (as seen in Japan, but possibly coming to many more countries in the future) depends on whether the aging is driven by falling fertility (which shrinks the work force in absolute terms) or longevity (which shrinks it only in relative terms).

Negative correlations between inflation and demographic aging were observed across developed nations recently. To understand the phenomenon from a politico-economic perspective, we embed the fiscal theory of the price level into an overlapping-generations model. In the model, successive short-lived governments choose income tax rates and bond issues considering the political influence of existing generations and the policy response of future governments. The model sheds new light on the traditional debate about the burden of national debt. Because of price adjustments, the accumulation of government debt does not become a burden on future generations. Our analysis reveals that the effects of aging depend on its causes. Aging is deflationary when caused by an increase in longevity but inflationary when caused by a decline in birth rate. Numerical simulation shows that aging over the past 40 years in Japan generated deflation of about 0.6 percentage points annually.
Here is another study that concludes “a larger share of dependents (ie young and old) is correlated with higher inflation, while a larger share of working age cohorts is correlated with lower inflation.” So maybe it depends to what extent the aging population is dependent on the working population, and whether the working population has additional dependents in the form of children (who will become the next working population). It’s complex, dynamic stuff that is hard to puzzle out.

environmental regulations and profitability

If I understand this somewhat convoluted abstract from Ecological Economics correctly, empirical evidence shows that environmental regulation can actually increase corporate profitability by incentivizing innovation. The data also show that investors believe the exact opposite.

The Porter hypothesis asserts that properly designed environmental regulation motivates firms to innovate, which ultimately improves profitability. In this study, we test empirically the Porter hypothesis and the competing hypothesis that regulation undermines profitability (“costly regulation hypothesis”). In particular, we estimate the effect of clean water regulation, as reflected in the stringency of firm-specific effluent limits for two regulated pollutants, on the profitability of chemical manufacturing firms. As our primary contribution, we contrast the effect of clean water regulation on actual profitability outcomes and its effects on investors’ expectations of profitability. Our results for actual profitability are consistent with the Porter hypothesis, while our results for expected profitability are consistent with the costly regulation hypothesis. Thus, our empirical results demonstrate that investors do not appear to value the positive effect of tighter clean water regulation on actual profitability.

planning theory

This article in the Journal of Planning Education and Research (free for the month of February only apparently) is a nice review of planning theory. It amazes me that the profession of planning seems to be so unsure of itself, and yet has so many important theories and tools to offer to other disciplines. There is a lot of planning going on outside the small field of academically trained urban and regional planning. I like to think of planning as similar to mathematics – it’s a profession for a few, but its theories and tools are used every day by professionals across many fields. Many of us can do moderately complex math by ourselves, and we know we can call on the mathematicians and statisticians for help with the really complex stuff. Similarly, a lot of professionals like engineers and economists are entrusted with the keys to the planning machine. But often, we do it badly because we are not well trained in the theory and tools of planning.

Almost all professionals – planners, engineers, and economists at a minimum – would benefit from better education in general systems theory – what the building blocks of systems are, how they interact with their boundaries, and how their behavior over time is driven by their structure and interaction with boundary conditions, and how they can be manipulated to achieve desired outcomes. Among the professions, engineers and economists probably have the best understanding of systems today, but we tend to define the system boundaries, and the range of desired outcomes that can be achieved, much too narrowly. That is one place planners can come in – facilitating the interaction between technocratic problem solving being done by engineers and economists with the larger socio-economic and environmental context.

What I call “technocratic problem solving” here is essentially what the planners call “rational-comprehensive” planning. In my view, it works very well for the elements of systems that we understand well (managing water resources, food production, and employment, for example). Where it has come under criticism (for example, the failed “urban renewal” programs in the U.S.), I believe the problem is not in the approach, but rather applying the approach to systems we do not understand well has given us a false sense of precision and a false confidence, which has led to failure. A hybrid approach that works very well, in my experience with water resource and environmental planning, is to apply the rational-comprehensive approach to the parts of the system we understand well, and then feed the results into a stakeholder or political process that can deal with the social aspects of the system we understand much less well. Planners can play the critical role in making this process reach a functional outcome. This is how I like to think of the planning profession – as the critical glue that can hold together a coalition of engineers, economists, bureaucrats, businesspeople, interest groups, and members of the public into a coherent whole that can set a direction for our society, then continue to guide it with incremental course adjustments as we go forward.

external costs

Here’s a clear explanation of the rationale for regulating or taxing external costs:

Environmental regulation addresses a particularly striking example of market failure. Markets are generally efficient if companies’ revenues correctly reflect all the benefits that their output bestows on third parties, while their costs reflect all the harms. In this case, maximizing profit leads to maximizing social welfare.

But if production entails environmental damage for which companies do not pay, incentives are distorted; companies may turn a profit, but they function inefficiently in economic terms. So the state “corrects” firms’ incentives by levying fines or issuing bans.

I find this elegant as long as the external costs are relatively small compared to the costs that are reflected in the market. However, what if the costs priced by the market represent only a small fraction of the total cost. Then the idea of taxing the external cost wouldn’t work.

more on oil

Here’s an argument that oil prices are likely to stay low for awhile. Basically, the argument is that the OPEC countries will keep pumping at full capacity and allow prices to fluctuate, thereby forcing the fracking companies to cut production every time prices fall below their costs. This article puts those costs at something like $50.

the only way for OPEC to restore, or even preserve, its market share is by pushing prices down to the point that US producers drastically reduce their output to balance global supply and demand. In short, the Saudis must stop being a “swing producer” and instead force US frackers into this role.

Any economics textbook would recommend exactly this outcome. Shale oil is expensive to extract and should therefore remain in the ground until all of the world’s low-cost conventional oilfields are pumping at maximum output. Moreover, shale production can be cheaply turned on and off.

Competitive market conditions would therefore dictate that Saudi Arabia and other low-cost producers always operate at full capacity, while US frackers would experience the boom-bust cycles typical of commodity markets, shutting down when global demand is weak or new low-cost supplies come onstream from Iraq, Libya, Iran, or Russia, and ramping up production only during global booms when oil demand is at a peak.

Sounds okay except I figure demand will continue to rise, slowly but surely, and drilling technology will continue to get cheaper, slowly but surely. So maybe this will go on for awhile, but one day fracking may be as cheap as traditional oil, and/or the traditional fields may start to run out faster than new ones are being found. Or maybe renewable energy will come to our rescue – I hope so, but cheap oil and gas aren’t going to make that day come any sooner. An international carbon price putting a floor on fossil fuel costs would do it, of course, and would create predictability for everyone, but at the moment it is hard to envision the political will materializing for that.

supply and demand

Mohamed El-Erian says that Saudi Arabia won’t cut its pumping to counteract falling oil prices, for fear of losing market share. He says the normal textbook rules of supply and demand will apply:

Low prices will lead to the gradual shutdown of what are now unprofitable oil fields and alternative energy supplies, and they will discourage investment in new capacity.  At the same time, they will encourage higher demand for oil.

This will all happen, but it will take a while. In the meantime, as oil prices settle at significantly lower levels, economic behavior will change beyond the “one-off” impact.

As costs fall for manufacturing and a wide range of other activities affected by energy costs, and as consumers spend less on gas and more on other things, many oil-importing nations will see a rise in gross domestic product. And this higher economic activity is likely to boost investment in new plants, equipment and labor, financed by corporate cash sitting on the sidelines.

This is where I should say something smart about natural capital or climate change or innovation. Well, maybe I’m just tired tonight.

health care cost-effectiveness

Here is an interesting blog post on the “forbidden topic” of health care cost-effectiveness. It’s hard because at the personal, human level life and health are of course priceless. But at the scale of a country or civilization with limited resources, there are choices to make, and better information should allow better choices.

Research in this area can be difficult to perform. One of the reasons is that it’s not always easy to measure health outcomes. Some things, like death, can be relatively easy to define, but how do you quantify having diabetes,asthma or a seizure disorder?

A robust methodology exists for doing so, based upon the expected utility theory of John von Neumann and Oskar Morgenstern. Asking people to consider what risks they will take to avoid certain health states, a technique known as the “standard gamble,” can yield what we call a utility value. Another method, which asks people to think about the trade-off between a shorter life in perfect health and a longer life in an unhealthy state (this is a “time-trade-off”) can also be used to determine a utility value.

When you take a utility value and multiply it by a number of years, you can calculate “quality-adjusted life years,” or QALYs. So if interventions improve quality or add years of life (or both), the number of QALYs goes up. Taking the cost of a therapy and dividing it by the number of QALYs gained results in a measurement of cost effectiveness.