Frank Rill Chen: Economics

Today is Milton Friedman Day

Mon, 29 Jan 2007 02:57:50 GMT

Dr. Milton Friedman was perhaps the most influential economist of the 20th Century, and the impact of his ideas will extend far into the future. To honor the man, January 29th is declared as Milton Friedman Day – a celebration of the economist’s positive impact on American life and business, and the spread of the benefits of free markets to nations around the globe. Milton Friedman Day will include a host of activities, including a “Day of National Debate” at universities across the country, a live online discussion on The Economist’s Free Exchange blog, and the premiere of the PBS special, “The Power of Choice: The Life and Ideas of Milton Friedman” (check local listings), among other events.

http://www.miltonfriedmanday.org/index.php

Economics discovers its feelings

Tue, 26 Dec 2006 14:21:46 GMT

Happiness and economics

Economics discovers its feelings

Dec 19th 2006
From The Economist print edition

Not quite as dismal as it was

ECONOMICS is “not a ‘gay science’,” wrote Thomas Carlyle in 1849. No, it is “a dreary, desolate, and indeed quite abject and distressing one; what we might call, by way of eminence, the dismal science.”

Carlyle was a fine one to talk. He was a brooding curmudgeon who thundered against industry, progress and the young science that sought to explain them. He found economists dismal not for the obvious reasons, such as their dry arithmetic or their gloomy preoccupation with scarcity and subsistence. Instead, he took against them because they were so wedded to the idea of happiness.

The economists of his day took their cue from Jeremy Bentham and his “utilitarian” philosophy. They calculated happiness, or utility, as the sum of good feelings minus bad, and argued that the pursuit of pleasure and the avoidance of pain were the sole springs of human action. One even looked forward to the invention of a hedonimeter, a “psychophysical machine” that would record the ups and downs of a man's feelings just as a thermometer might plot his temperature. Such people, Carlyle complained, fancied that man was a “dead Iron-Balance for weighing Pains and Pleasures on”.

The hedonimeter was never invented, and for a century or so economists fell silent about both weights on man's scales. They studied outward behaviour, not inward feelings; choices made, not pleasures taken. But in recent years, economists have become newly confident that they can measure utility as Bentham conceived it: as a quantum of pleasure or pain.

How do they do it? Mostly they just ask people. Daniel Kahneman, a psychologist at Princeton University who won the Nobel prize for economics in 2002, reckons people are not as mysterious as less nosy economists supposed. “The view that hedonic states cannot be measured because they are private events is widely held but incorrect,” he and his colleagues argue. Generally, people can say how they feel at a given moment, on a scale of zero to ten.

And if this smacks of hearsay not science, the new “hedonimetrists” can appeal to other kinds of evidence, better calculated to impress. They can look into people's eyes; or better still, their brains. People who confess to feeling happy also grin more than others. And they mean it: they smile with their eyes (a contraction of the orbicularis oculi facial muscles), not just their mouths. People's self-reports also tally roughly with what electrodes planted on their scalp reveal about the frequency and voltage of electrical waves in their left forebrain, which sparks up when they are feeling good.

Mr Kahneman's most notorious experiment took place in a Toronto hospital over a decade ago. He and a colleague asked patients undergoing a colonoscopy (in which a probe is passed up the rectum) to report their level of discomfort minute by minute. Later, they were asked how they felt about the procedure in retrospect. Their answers were surprising. The test left a worse impression on patient A, for whom it lasted less than ten minutes, than on patient B, who suffered for 24 minutes. Patients' recollections were heavily coloured by the procedure's worst moment and its last moment. The duration of the pain did not seem to make much difference. Patients were happier about a colonoscopy that lasted longer but ended better.

Fallible memories

Mr Kahneman, who is not shy of extrapolation, thinks people often choose to repeat experiences that seem better in retrospect than they did at the time. Contrary to Bentham, the “sovereign masters that determine what people will do are not pleasure and pain, but fallible memories of pleasure and pain.”

If people are bad at recalling their feelings, they are worse at predicting them. They fail to anticipate how a person feels after moving to a new city, losing a limb or winning a jackpot. Prisoners imagine that solitary confinement will be worse than it really is; mothers-to-be think the pain of childbirth will be more bearable than it typically proves to be. And it is not just unusual events that trip people up. According to Mr Kahneman, people struggle to predict how their appetite for ice-cream, low-fat yogurt or music might change in the course of a week of enjoying them. If man is an iron-balance that weigh pains and pleasures, the scales are sadly askew.

As a result, many economists now ignore one of the discipline's dreariest maxims: de gustibus non est disputandum, one does not quarrel over tastes. Robert Frank begins his 1999 book “Luxury Fever” with a long, incredulous description of the Viking-Frontgate Professional Grill, a barbecuer's folly, sporting infra-red rotisserie, rangetop burners and brass trimmings. Such purchases would once have gone unquestioned by economists. The consumer was king: if he spent $5,000 on a grill, a $5,000 grill must be what he wanted. Likewise, if he picked X over Y, a colonoscopy over an enema, pushpin over poetry, his choice should be respected. But now economists like Mr Frank and Mr Kahneman delight in second-guessing such choices, citing the evidence of their hedonimeters.

Have fun

What sumptuary advice do they offer? In general, the economic arbiters of taste recommend “experiences” over commodities, pastimes over knick-knacks, doing over having. Mr Frank thinks people should work shorter hours and commute shorter distances, even if that means living in smaller houses with cheaper grills. The appeal of such fripperies palls faster than people expect, they say. David Hume suggested that “the amusements, which are the most durable, have all a mixture of application and attention in them; such as gaming and hunting.”

But as with any argument involving economists, there is more than one side to it. For one thing, many experiences demand a substantial outlay on commodities: horses, hounds and jodhpurs, for example. And as Bryan Caplan, of George Mason University, points out, many trinkets and fripperies themselves provide a stream of experiences.

Adam Smith thought there was pleasure to be had simply in admiring the craftsmanship of a well-made watch, even if its extra accuracy was of little practical benefit. Bentham appreciated his creature comforts: according to Negley Harte, the University of London's historian, his embalmed body wears a pair of knitted underpants, unlike most of his contemporaries, who simply tucked their shirt-tails between their legs.

And before Mr Frank scoffs at Gillette's latest five-blade shaving system, he should recall Benjamin Franklin's belief that teaching a young man to shave, and keeping his blade sharp, would contribute more to his happiness than giving him 1,000 guineas to squander. The money would leave behind only regret. But self-grooming spares a man “the frequent vexation of waiting for barbers, and of their sometimes dirty fingers, offensive breaths, and dull razors.”

Richard Layard, an economist at the London School of Economics, provides one prominent example of the transformation that some dismal scientists have undergone. He made his mark with his 1991 treatise, “Unemployment”, co-authored with Stephen Nickell and Richard Jackman. On its cover, the book featured the painting “L'Absinthe” by Edgar Degas: a dejected woman and a dishevelled man, two “rather sodden” characters, as one reviewer put it at the time, pass the time and ease their sorrows with a tipple in a Paris café. The book was dedicated to the “millions who suffer through want of work”.

Today, Lord Layard argues, unemployment is no longer Britain's biggest social problem. The number of jobless Britons claiming the dole is now about 960,000. But there are over 1m people receiving incapacity benefits because depression and stress have left them unfit to work.

Lord Layard's latest book has a much jauntier image on its cover: a “happy eccentric” with a fez on his head, a monocle in his eye and a bunch of flowers in his hand. A perky character, one might say. Ambitious, policy-minded economists such as Lord Layard are no longer satisfied with raising the rate of employment. They want to lift the rate of enjoyment too.

That, it turns out, is not easy. Happiness, as measured by national surveys, has hardly changed over 50 years. The rich are generally happier than the poor, but rich countries do not get happier as they get richer. The Japanese are much better off now than in 1950, but the proportion who say they are “very happy” has not budged. Americans too have remained much as Alexis de Tocqueville found them in the 19th century: “So many lucky men, restless in the midst of abundance.”

Lord Layard and Mr Frank both blame habit and rivalry for this stagnation of morale. People grow accustomed to what they have—however much of it there is. Moreover, having a lot of things is not enough if other people have more. A rising tide lifts all boats, but not all spirits.

For economists, this is radical stuff. They traditionally argue that people best serve themselves and the public by minding their own business. Indeed, this laissez-faire attitude is one reason Carlyle attacked them. Economics, he wrote, “reduces the duty of human governors to that of letting men alone”. He was afraid this radical idea would “dissever and destroy most existing institutions of society”.

But Lord Layard argues that we cannot help minding other people's business, as well as our own. Doing well is not enough: we also want to do better than our peers. This status anxiety runs deep in our nature, he says. Vervet monkeys at the top of their social tree enjoy more mates and bananas as a result, but they also exult in their position for its own sake. As with monkeys, so with mandarins. Top British civil servants tend to live longer than their underlings, regardless of other differences in lifestyle, according to the “Whitehall II” studies which have been monitoring thousands of Humphreys and Bernards since the 1980s.

Doing well is not enough: we also want to do better than our peers. This status anxiety runs deep

To clamber up the pecking order, some people slave away nights and weekends at the office. They gain in rank at the expense of their free time. But in making that sacrifice they also hurt anyone else who shares their aspirations: they too must give up their weekends to keep up. Mr Frank reckons that many people would like to work less, if only others slackened off also. But such bargains cannot be struck unilaterally. On the contrary, people compete in costly “arms races”, knowing that if they do not work harder, they will lose their standing to someone who does.

These races are motivated by more than just prestige. As Fred Hirsch argued in his 1977 book, “The Social Limits to Growth”, many good things in life are “positional”. You can enjoy them only if others don't. Sometimes, a quick car, fine suit or attractive house is not enough. One must have the fastest car, finest suit or priciest house.

Think of the scramble for schools, Mr Frank says. Only 10% of kids can go to the top 10% of schools. In many countries, wherever the schools are good, the houses will be expensive. Thus parents who want the best education for their child must overwork to afford a house in a good school district. In doing so, however, they raise the bar for everyone else.

Is mutual disarmament possible? Not without government help, Mr Frank and Lord Layard argue. The exchequer should tax earned income heavily enough to deter one-upmanship, they say.

Despite appearances, this is not a naked example of punitive redistribution—the fiscal politics of envy. Mr Frank and Lord Layard do not want to level the social order. Their aim is much more conservative than that. Their taxes would leave the pecking order intact and envy undiminished. But people would be deterred from acting on the green-eyed monster. The problem these economists want to tackle is not inequality per se. It is that people don't know their place and scramble vainly to improve it. Carlyle, who thought man should content himself with being the worthy follower of worthy superiors, would no doubt have approved.

Go with the flow

Not that Carlyle was workshy. On the contrary, he thought that work was the only lasting measure of a man. As he put it, whatever insight, ingenuity and energy a man had in him “will lie written in the work he does”. And the “only happiness a brave man ever troubled himself with asking much about was, happiness enough to get his work done.”

Economics, on the whole, disagrees. It thinks of labour as a chore. People sell it, at the expense of their leisure time, purely as a means to the end of consumption. Indeed, Carlyle first anointed economics the “dismal science” because liberal economists insisted that American slaves be free to sell their labour in the marketplace like everyone else.

For many people, work is—as traditional economics assumes—just a way to pay the rent. But Carlyle is not the only one to see it as much more than that. In a string of experiments, Mihaly Csikszentmihalyi, of Claremont Graduate University, has handed out pagers to thousands of people who agreed to log their mood whenever prompted to do so. People were, unsurprisingly, at their happiest when eating, carousing or pottering around the garden. But some fortunate people also found deep satisfaction from losing themselves in their work: “forgetting themselves in a function”, as W.H. Auden put it.

It is easier to forget yourself in some functions than in others, of course. In Auden's poem, surgeons manage it “making a primary incision”, as do cooks, mixing their sauce, and clerks “completing a bill of lading”. This happy state, which Mr Csikszentmihalyi calls “flow”, arises most often in work that stretches a person without defeating him; work that provides “clear goals”, “unambiguous feedback” and a “sense of control”.

Where these things are lacking, people can sometimes sculpt their jobs to compensate. For example, Amy Wrzesniewski, of New York University, and her colleagues found hospital cleaners who would hold patients' hands and keep them company, brightening their day as well as scrubbing their rooms. Other researchers noted that hairdressers see themselves as more than just scissors for hire. They serve as emotional confidants for clients they like, and “fire” clients they don't.

Mr Csikszentmihalyi is now one of three scholars behind the “Good Work” project, which aims to make “flow” a more common experience in professional life. The project frets about how to square the “competing demands of excellence, ethics, and earnings”. In some fields of endeavour, such as genetic research, it found that good work was rewarded with professional success; but in others, professional pride and corporate profit seemed to tug in opposite directions. Journalism, apparently, is a “prototypically misaligned profession”, staffed by reporters who want to investigate great affairs of state but read by a public more interested in stories that are “scandalous, sensational, superficial”.

Some fortunate people also found deep satisfaction from losing themselves in their work

What to do? The Good Work project tends to blame the “market” for corrupting craftsmanship. But consumers cannot be made to want what producers care to make. Besides, “it is a thrill unique to a market society to find that people are willing to pay for one's product,” writes Deirdre McCloskey in her latest book, “The Bourgeois Virtues”. Payment is a form of applause; all the more convincing because it is costly. Furthermore, when you spend what you have earned in the market, you can enjoy knowing that you have “pulled your own weight”, taking from the national product no more than you have added to it.

If people are determined to pursue their calling rather than simply taking a job, some professions (surgery, cookery, genetics) may become overcrowded, others undersubscribed. But when a job cannot find enough takers, the market finds ways to ennoble it: first pay, and then status, begin to rise. It becomes economical to automate some aspects of the work, employing machines to do the deadening humdrum toil that men and women are no longer willing to put up with. What remains of the job will be the bits only people can do: tasks that require insight, ingenuity and the human touch. Ms McCloskey recalls the Cincinnati sewerman, interviewed a few years ago on National Public Radio, who earned $60,000 a year and liked to tell girls he was an “environmental” worker.

The dismal sage

Did Thomas Carlyle ever make his peace with the dismal science? Even his admirers admit that his “bigoted dislike of Political Economists withheld him from studying their works” or appreciating their advances. Nor did he soften much in his disdain for the fruits of commercial society: cheaper cotton and swifter railways meant nothing to him; and in his opinion, advertising, or “puffing” as he called it, deserved to be taxed out of existence.

But as any economist could have pointed out, he had a lot to thank commercial society for. Having discovered his vocation as a cultural muckraker, he eventually secured an audience, a market and even the offer (which was refused) of Westminster Abbey as a final resting place. In periods of speedy progress, it seems, stubborn reactionaries at least enjoy a certain scarcity value.

What We Learn When We Learn Economics

Wed, 29 Nov 2006 08:51:56 GMT

From：http://www.inthesetimes.com/November 27, 2006

Is a little economics a dangerous thing?

By Christopher Hayes

There’s a case to be made that the single most intellectually and politically influential neighborhood in the United States is Chicago’s Hyde Park. Integrated, affluent and quiet, the 1.6 square-mile enclave on the city’s south side is like a tiny company town, where the company happens to be the august, gothic, eminently serious University of Chicago. Students at the U. of C. sell T-shirts that read “Where Fun Goes To Die,” and the same could be said of the neighborhood, which until very recently had a bookstore-to-bar ratio of 5:2.

But the university is probably best known for the school of economic thought it has produced. When the Chicago School first emerged in the ’50s, its zealous support of free markets and critique of government intervention were considered reactionary and extreme. Among elites in economics and politics the consensus was, as John Maynard Keynes had argued, that capitalism could only function with regular and robust government management. Indeed, so total was this consensus that in 1971 Richard Nixon announced a plan to impose wage and price caps in order to curb inflation, declaring, “We are all Keynesians now.” Just 25 years later, however, Bill Clinton, the first Democratic president to be re-elected since FDR, announced that the “era of big government is over.” He might as well have said, “We are all Chicagoans now.”

Neoclassical economics, as the Chicago School of thought is now called, has become an international elite consensus, one that provides the foundation for the entire global political economy. In the United States, young members of the middle and upper-middle class first learn its precepts in the academy. Polls routinely show that economists and the general public have widely divergent views on the economy, but among the well-educated that gap is far narrower. A 2001 study published in the U. of C.’s Journal of Law and Economics showed that those with college degrees are more likely to subscribe to the views of neoclassical economists than the general public. This isn’t surprising. At elite colleges, economics is consistently one of the most popular majors (nearly a quarter of undergrads at the U. of C.), and across all schools, introductory economics, often a required course, has been one of the 10 most popular classes for the last 30 years. Graduate schools—from business to public policy to political science to, most notably, law—are now suffused with economic paradigms for understanding not only financial interactions but all human behavior.

Conservatives have long critiqued academia for the ways professors use their position to indoctrinate students with left-wing ideology, but the left has largely ignored the political impact of the way people learn economics, though its influence is likely far more profound. So in order to find out just what students learn when they learn economics, I headed down to Hyde Park, where the University generously let me enroll in “Principles of Macroeconomics” for a quarter.

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Allen Sanderson, 62, has been teaching the intro macro and micro courses at the university for the last 18 years and though he initially appears somewhat grave and understated, it is quickly apparent that he is a master of technique. His lectures skip along, propelled by a series of wry, contrarian quips, each punctuated with a visual rimshot: a slight pause and a thrust jaw. “When you hear, ‘The economics department at U. of C.,’ one’s free association is ‘pro-business, greedy bastards,’” says Sanderson (pause, jaw thrust) in the first lecture. “I tend to think that’s not the case. Greedy bastards we may be, but we’re not pro-business. Republicans tend to be very pro-business. It’s a genetic defect of Republicans. Democrats tend to be anti-business, another genetic defect. We are not anti-business; we are not pro-business. We are pro-choice in the ultimate sense of pro-market. Based on empirical work, macro and micro solutions are probably better worked out by private markets than government intervention.”

His second lecture begins with a thought experiment. Noting that there are only 26 spots left in the class for the 52 students who would still like to enroll, he asks, “How should we figure out who gets to go into the class?” The students—eager, studious and serious—shoot their hands up and offer a variety of ideas: Seniority? First-come, first-serve? Ask prospective students to write an essay? It takes about a minute for a confident young man to give the answer Sanderson’s looking for: “auction by price.”

“As a reasonable indication of how much you want something, how much you’re willing to pay is a pretty good means of measuring,” Sanderson says. “A lot of things in economics will turn in one way or another on price. Price has a lot going for it as a generalized expression of commitment. The thing we don’t like about, say, first-come, first-serve, is that if someone really wants to get in, they could start lining up now. But the problem is that I don’t really benefit from your expression of interest, whereas if you pay me, we both are benefiting.”

This makes sense, but I’m uneasy. Wouldn’t giving a place in class to the highest bidder result in the rich students getting in and the financial-aid kids being left out? And since people don’t have equal amounts of money to spend, how good a measure of desire is price in this situation?

“Random and first-come have the benefit of being fair,” Sanderson says, anticipating the objection. “There’s an interesting dichotomy of fair vs. efficient.” But, Sanderson asks, what, really, is fair? If we think some kind of random lottery drawing was a fair way of getting into the class, would that be a fair way of awarding grades? “Obviously not!,” I think. Why? Sanderson lets us mull that over, but the answer floats up immediately: because I work hard for my grades and I deserve them. In other words, those who work hard and get good grades are like those who work hard and have a lot of money to win spots that are auctioned by price.

“We’re trying to balance these things out,” Sanderson continues. “What’s efficient? What’s fair? Often they are in tension.”

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Efficiency is the Chicago School’s defining value. The free market economists who came before—most notably Austrian Friedrich Hayek—offered a philosophical critique of the political consequences of state regulation and control of the economy. But Milton Friedman, his colleague George Stigler and the entire Chicago School focused on the actual economic problems of state control, namely, inefficiency. They rejected Keynes’ contention that markets function best with routine government intervention and instead harkened back to Adam Smith’s classical conceptions of equilibrium. Chicago School theories gained popularity when global capitalism hit a major funk in the ’70s—a period of slow growth and high inflation. Friedman argued, plausibly, that it was too much government that had caused the problems.

What may seem a subtle rhetorical shift had major consequences. It transformed what had been conservatism’s moral argument about capitalism bestowing the most benefits on those who worked the hardest—and the inherent injustice of a coercive state forcibly redistributing capital—into a technical argument about the inefficiencies associated with non-free-market solutions and the perverse incentives that made any social programs destined to fail. Thus, arguments about the way the world should be were converted into assertions about how the world actually was. Or, to put in terms that economists favor, normative arguments became positive ones.

In the textbook Sanderson uses, author Michael Parkin defines the difference this way: positive statements are about “what is” and they “might be right or wrong.” Normative statements are about “what ought to be” and because they depend on values, they can’t be tested. “Be on the lookout,” Parkin warns, “for normative propositions dressed up as positive propositions.”

Parkin’s warning, however, turns out to be surprisingly difficult to heed. Neoclassical economics smuggles a great many normative wares underneath its positive trenchcoat, both in its assumptions about how humans operate—as individuals rationally maximizing their utility—and its implied preference for “markets in everything.” Because neoclassical economics always presents itself as a value-neutral description of the world, its ideological commitments can be adopted by those who learn it without any recognition that they are ideological. This is the source of some very spirited debate within the field itself. A growing global movement of “heterodox” economists has criticized the ideological confines and blindspots of the neoclassical approach. As Nobel Laureate Joseph Stiglitz put it, the dominance of the neoclassical model is a “triumph of ideology over science.”

In the popular press, however, such dissent is almost entirely absent. When protesters disrupted the 1999 World Trade Organization meeting in Seattle, WTO officials, mainstream economists and the New York Times’ Thomas Friedman ignored the fact that in much of the world neoclassical reforms had failed to produce the promised growth. Friedman went so far as to dismiss the protesters as “flat-earthers.” For Thomas Friedman (and, indeed, Allen Sanderson), people can’t “disagree” with neo-classical economics. They can only fail to understand it.

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As a standard part of his first lecture in both his macro and microeconomics class, Sanderson reads a David Barry quote: “Democrats seem to be basically nicer people, but they have demonstrated the management skills of celery. Republicans would know how to fix your tire, but they wouldn’t stop.”

In the wake of Katrina and Iraq, this might seem quaint, but what Sanderson is doing makes sense. Temperamentally, it reflects his own, libertarian-inflected, “pox-on-both-their-houses” centrism, but his insistence on political equanimity is also crucial to his pedagogical success. Students are most likely to have been exposed to macroeconomic issues within the context of political debates about free trade, the size of the budget deficit, tax rates, etc. In order to assure students that they aren’t just learning a set of political talking points, he must go out of his way to hammer home the fact that what he’s offering is unbiased and nonpartisan: positive not normative, facts not opinion. “I don’t have a dog in this fight,” Sanderson tells the students. So every joke about George Bush is followed by a joke about Hillary Clinton, every shot at a Democrat quickly balanced by a shot at Republicans.

The effect, intentional or not, is that Sanderson appears to represent the exact center of the political spectrum, and that can leave students with a strange perception of just where the center lies. During a discussion of flat, progressive and regressive tax structures, a student asked about the argument against the flat tax. “What’s wrong with the flat rate tax?” Sanderson replies. “Well, the bad thing was that Steve Forbes was the spokesman. It’s not obvious that there’s that much wrong with it. There’s sort of a movement out there for a flat rate tax. Because it strikes some people: What could be fairer than that? It also doesn’t distort incentives. It has a lot going for it.”

It’s true that there’s “sort of a movement” for a flat tax, but those in favor of what would be the single most regressive redistribution of wealth in American history are not located in the political center. Far-right Republicans like former House Majority Leader Dick Armey have long pushed the idea, as have conservative think tanks like American Enterprise Institute and the Heritage Foundation. But politically, it’s a non-starter. The basic notion of fairness that those who get more out of our economy should pay a greater percentage of their income in taxes is deeply embedded in American political culture, even during years of Republican domination. The students sitting around me, I start to fear, are going to walk out of the lecture thinking that the flat tax is a sensible, centrist idea. And as thousands of students pass through classes like Sanderson’s every year, I worry that it will become a sensible, centrist idea.

Sanderson’s politics aren’t one-dimensional, and he certainly isn’t a propagandist. But the fact remains that he has the predispositions of someone who “learned economics from Milton Friedman.” First, there’s a tendency to see trade-offs between equity and efficiency even where they might not exist. Dean Baker, an economist at the Center for Economic and Policy Research and author of the book The Conservative Nanny State, points out that policies can be both fairer and more efficient. For instance, Baker told me, “it is not clear that a flat tax is more efficient than a progressive income tax. This is entirely an empirical question. It is entirely possible that taxing middle-income workers and Bill Gates at a 25 percent rate will create more distortions than taxing middle-income workers at a 15 percent rate and Bill Gates at a 40 percent rate. … They want liberals to say that we care about fairness and they care about efficiency. This is crap. They find ways to justify redistributing income upward and proclaim it to be efficient. The reality is it is not fair and generally not efficient either.”

But when equity and efficiency trade-offs do arise, economists like Sanderson are systematically biased in favor of efficiency because that’s what they are experts on. Efficiency they can measure and analyze. Fairness? That’s the turf of philosophers and politicians. This tendency is most pronounced in discussions of economic growth, and how the benefits of that growth should be distributed. Sanderson paraphrases his Nobel Laureate colleague Bob Lucas, who says that “once you start to think about the benefits of high growth, it’s hard to think about anything else.” In other words, first worry about how best to grow the pie, then how to slice it up. Let efficiency trump equity, create wealth, and then you can use the extra wealth you’ve created to alleviate inequality.

This makes a certain amount of sense. But when this rhetoric comes to dominate our politics, the problem of inequality is never addressed. Now is always the time for growing, later is always the time to address concerns about equity. The result is predictable: In countries that have adopted the neoclassical policy prescriptions (including the United States), there has been an ever-widening gap between rich and poor.

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As taught by Sanderson, economics is a satisfyingly neat machine: complicated enough to warrant curiosity and discovery, but not so complicated as to bewilder. Like a bicycle, input matches output (wind the crank and the wheel moves), and once you’ve got the basics of the model down, everything seems to make sense. As the weeks go by, and I trek down to Hyde Park, fight for a parking space and slip in between the hundred-plus students into the lecture hall, I come to love the class. The more reading I do, the more sense the op-eds in the Wall Street Journal make. The NPR program “Marketplace” becomes interesting. I even know what exactly the Fed rate is. A part of the world that was blurry and obscure begins to come into focus. My classmates seem to feel the same way. “I never thought I’d be interested in economics,” one sophomore told me. “Sanderson convinced me I was.”

The simple models have an explanatory power that is thrilling. Once you’ve grasped the aggregate supply/aggregate demand model, you understand why stimulating demand may lead, in the short run, to growth, but will also produce inflation. But the content of that understanding turns out to be a bit thin. Inflation happens because, well, that’s where the lines intersect. “A little economics can be a dangerous thing,” a friend working on her Ph.D in public policy at the U. of C. told me. “An intro econ course is necessarily going to be superficial. You deal with highly stylized models that are robbed of context, that take place in a world unmediated by norms and institutions. Much of the most interesting work in economics right now calls into question the Econ 101 assumptions of rationality, individualism, maximizing behavior, etc. But, of course, if you don’t go any further than Econ 101, you won’t know that the textbook models are not the way the world really works, and that there are tons of empirical studies out there that demonstrate this.”

Take, for instance, the minimum wage. In Sanderson’s intro micro class, he uses a simple supply and demand model of a labor market to show why a minimum wage will cause unemployment, and therefore be self-defeating. “Most economists, myself included, are opposed to living wage ordinances and minimum wage laws period,” he says. But a series of empirical studies has established that the most recent increase of minimum wage in 1997 had essentially no impact on unemployment. In fact, in October, 650 economists, including five Nobel Laureates, signed a letter advocating an increase in the U.S. minimum wage to $8 an hour.

Of course, some elision and simplification is unavoidable. Sanderson’s not trying to create future economists, but rather give students “some sort of cultural literacy” about how the economy works. He often starts class by leading us through a kind of Socratic deconstruction of a newspaper article that commits some egregious economic sin. About midway through the semester, during the unit we spend learning about how the gross domestic product is computed, he reads to the class from an article in the Chicago Tribune with the headline, “Corporate Giants Dwarf Many Nations.” The piece compares the annual sales of large corporations like Wal-Mart with that of small countries, like Israel, showing that many of the world’s 200 largest corporations are as large as entire national economies, and therefore have a great deal of political and economic clout. After quoting at length, Sanderson points out how implausible it is that 200 companies, with one third of one percent of the world’s workforce, could produce 28 percent of the world’s economic activity. “There’s a word for it,” Sanderson says. “Two words, actually. The first is ‘Horse.’ “

The problem, Sanderson notes, is that “sales” is a terrible measurement for the economic output of a company like Wal-Mart, because it only produces a very small percentage of the value of any product is sells. When you buy pistachios at Wal-Mart, it’s not like those nuts were grown on a Wal-Mart farm. Wal-Mart bought them from someone and then resold them for a profit. “If we were counting GDP, we just want to count what’s the net contribution, what’s the value added?” he explains. “Last year, worldwide Wal-Mart sold $285 billion worth of goods and services, but paid manufacturers $220.” Sanderson’s point is pretty obvious, if you think about it. And yet the article gets it wrong over and over, which nearly sends Sanderson around the bend. “This happens to be the political rhetoric: ‘These 200 corporations dominate the world.’ They don’t. They’re a very small percentage of GDP,” Sanderson says. “Those who are criticizing very large multinational corporations are doing a disservice if they don’t get the math right.”

This contrarian approach is central to Sanderson’s worldview: It’s the counterintuitive, “everyone-says-x-but-really-what-matters-is-y” formulation that has become the staple of magazines like the New Republic and Slate. (A headline from Slate’s October 14 “Underground Economist” column: “Charity is Selfish.”) But as with any counterintuitive rhetoric, what matters is how you define the conventional “intuition” that you’re skewering. And with Sanderson, the target is almost always statist, regulatory and liberal: The idea that you can, indeed, get a free lunch, by, for instance, mandating better incomes for workers by raising the minimum wage. Thinking of economic policy as a series of trade-offs and opportunity costs and, most importantly, unintended consequences is a hallmark of the Chicago School, and it was a constant theme throughout the course: Whenever you try to alter the market, the market extracts its revenge.

In Sanderson’s zeal to play ‘gotcha’ with the press, he too can slant the pure data. That evening, I went online and found that Wal-Mart’s $65 billion of net revenue was still larger than the GDP of 132 countries, including Bangladesh, which has a population of 144 million people. I wrote an e-mail to Sanderson, who promptly wrote back, saying the bigger point was to drive home the problem with inappropriate comparisons and double counting. “I tried to point out that these apples v. oranges comparisons are all over the place,” he wrote, and added that the double-counting error could be found everywhere from the Wall Street Journal to some introductory textbooks. “Thanks,” he wrote, “for continuing the out-of-class dialogue.”

———————————-

Sanderson is so likeable and masterful that the entire quarter goes by with the class eating out of his hand: They take careful notes, class attendance is almost perfect every day and each pre-exam study session is packed. But the final unit of the class is devoted to free trade, and suddenly things change.

Sanderson begins the class by telling us that “in trade, there’s an enormous amount of agreement between economists about what constitutes the truth. The disagreements are between economists and everybody else.” His central contention is that allowing any two given countries to trade their goods freely will necessarily make both countries better off. It’s the same logic, he says, that we use everyday. When you decide to have someone do your dry cleaning or fix your car, you’re deciding to specialize in what you do best, and trade for the other things you need. Specialize and trade: That was Adam Smith’s central insight into the nature of the “wealth of nations,” and, Sanderson says, it remains as true today as it was then.

But when lecturing on trade, Sanderson’s tone is noticeably different. His agenda and ideology are more up front, such that the classes felt for the first time almost—almost—like propaganda. And during these lectures, something incredible happens. The class rebels. Whereas for the duration of the quarter Sanderson had made the students feel as if he was their guide in seeing through the Matrix, suddenly Sanderson morphs from being Laurence Fishburne to the FBI agent in a suit. The class prods and pushes back as if they are being fed spin. As Sanderson talks about the importance of nations specializing in whatever they have a comparative advantage in, a student raises his hand: “Isn’t there a problem if you put all your eggs into one basket, and then if there’s a problem with that sector you’re in trouble?”

That ends that day’s class, but it continues in the next. Sanderson argues that liberalized trade creates more jobs than it destroys. “Free trade creates winners and it also creates losers. It turns out that winners are quantitatively larger than the losers.” A student asks, flat out, “Why are we to believe that?” Sanderson restates his point, but the student holds his ground, saying he’s read that there simply doesn’t exist an accurate measure to figure out how many jobs are being created and destroyed. Sanderson concedes that this is true, but insists it “must” be a net positive.

You can hear papers rustling and side conversations breaking out. Hands begin to shoot up and Sanderson began to sweat noticeably as the mutiny spreads. One student asks about attaching labor or environmental protections to trade deals. Sanderson replies that such stipulations (like requiring workers be paid $14 an hour) simply operate like tariffs, raising the price of goods and “saving jobs in the U.S., union jobs that are relatively high paid, and taking people in developing countries who are not well off and making them poorer. I tend to be against laws that make poor people poorer.”

“OK,” responds the student, who with a beard and long hair looks a bit like the student radical who’s been missing all quarter. “Let’s say the standards are not ridiculous. The workers have a right to organize, or we can’t pollute the only source of the village’s water supply.”

“How do we define what’s ridiculous?,” Sanderson shoots back. “Once you start, it’s very difficult to draw the line, in terms of what workers have. Should other countries not trade with the U.S. because we have capital punishment? Should we not trade with countries that don’t allow abortion? My problem with sweatshops is, quite frankly, the only potential definition is people who work long hours for low wages, and that’s what the U.S. was 120 years ago. A lot of what economics is about is how to increase the world’s income, and not for Bill Gates and Oprah, but for the world’s poor. Unions don’t like trade agreements. They’ve never seen one they like, and they want to find a reason in environmental standards or things like that.”

“We do draw the line every day,” the student responds, not bothering to raise his hand this time. There are hands up all over and the class has now devolved into a free-for-all. “We don’t trade with Burma. We didn’t trade with Iraq. We do trade with Saudi Arabia. It’s not impossible to re-imagine how to draw the line.” Sanderson is not winning this argument. “These are tough issues,” he says, and the class ends.

It occurs to me that Sanderson’s problem is that he’s been too honest about his biases. It’s far more effective to communicate a worldview through subtext than to argue for it explicitly. For eight weeks, Sanderson had been the model of equanimity, the centrist arbiter of competing factions, and because of this students seemed to accept his word without question. But on the very first day of class he’d tipped his hand that he was an “ardent free-trader,” and his clear desire to have students come away believing, as he does, in the benefits of free trade, was backfiring.

By the next class, Sanderson has regrouped, and calmly and methodically leads the class through a Socratic dialogue. Tobacco farmers have lost their jobs because we smoke less: Does that mean we should have the government do something about it? People lose their jobs all the time because the work they do—whether opening envelopes for magazine subscriptions or wrapping Hershey’s Kisses—becomes automated. Trade works the same way as technological progress: While it might put some people out of work, in the end, it makes everyone better off. The class is nodding, attentive and silent.

Furthermore, free trade is a moral imperative because it makes poorer countries better off. “I don’t want to sound like Miss America,” Sanderson says as he wraps up the final class of the quarter. “I think world poverty is where it’s at in terms of where you try to place resources. My sense is that significant redistribution of wealth is probably not the answer. Part of it is that there is not enough wealth to redistribute. There’s not a lot of rich people and too many poor people. And the gap between rich and poor is too vast. It comes down to economic growth, how fast we can make economies grow. Economic growth does tend to raise all boats.”

As the class files out, I see a student I’d talked with a few times over the course of the quarter, an unassuming kid with a long mop of brown hair. I remember a conversation we’d had at the beginning of the semester: “I hope it doesn’t all end up to be wrong,” he’d said, referring to the Chicago School theories he was about to learn. “Like in Latin America. That worries me a bit.”

Six months after the class ended, I e-mailed him to ask whether he was still worried. “I got this e-mail right after my Econ 201 class, the intermediate sequence for the major requirement,” he wrote back. “So it looks like I’m no longer worried that what I’m learning is ‘wrong.’ Actually, the conversation we had doesn’t really make sense to me anymore. I now understand that any one school of economics can’t explain and predict all the intricacies of human economies.”

What he’d come to realize, he wrote, was that “it isn’t a question of correct theory or incorrect theory, but whether or not the results of the implementation of that theory are right or wrong in a moral sense.”

In other words, it’s a question that economics alone can’t answer.

Milton Friedman——A heavyweight champ, at five foot two

Fri, 24 Nov 2006 02:16:13 GMT

Nov 23rd 2006
From The Economist print edition

The legacy of Milton Friedman, a giant among economists

Corbis

IN 1946 two American economists published a pamphlet attacking rent controls. “It was”, recalled one of them many years later, “my first taste of public controversy.” In the American Economic Review, no less, a critic dismissed “Roofs or Ceilings” as “a political tract”. The same reviewer gave the pair a proper savaging in a newspaper: “Economists who sign their names to drivel of this sort do no service to the profession they represent.”

The reminiscing author was Milton Friedman, who died on November 16th, aged 94. In the wake of the Great Depression and the second world war, with the Keynesian revolution still young, championing the free market was deeply unfashionable, even (or especially) among economists. Mr Friedman and kindred spirits—such as Friedrich von Hayek, author of “The Road to Serfdom”—were seen as cranks. Surely the horrors of the Depression had shown that markets were not to be trusted? The state, it was plain, should be master of the market; and, equipped with John Maynard Keynes's “General Theory”, governments should spend and borrow to keep the economy topped up and unemployment at bay.

That economists and policymakers think differently now is to a great degree Mr Friedman's achievement. He was the most influential economist of the second half of the 20th century (Keynes died in 1946), possibly of all of it. In 1998, in “Two Lucky People”, the memoir he wrote with his wife, Rose, he could claim to be “in the mainstream of thought, not, as we were 50 years ago, a derided minority”, and no one could dispute it.

Perhaps Mr Friedman became not only a great economist but also an influential one because he had a love of argument. As a boy he liked to make himself heard. He claimed to have had few memories of a school which he attended in Rahway, the New Jersey town his family had moved to when Brooklyn-born Milton was 13 months old, but he remembered getting a nickname. “I tended to talk very loud, indeed shout”; so when someone mentioned the proverb “Still water runs deep”, he was dubbed “Shallow”.

His classmates could scarcely have chosen a less apt moniker. Directly or indirectly, Mr Friedman brought about profound changes in the way his profession, politicians and the public thought of economic questions, in at least three enormously important and connected areas. In all of them his thinking was widely regarded at the outset as eccentric or worse.

The first of those areas is summed up by “Capitalism and Freedom”, the title of a book published in 1962 (see our review). To Mr Friedman, the two were inextricably intertwined: without economic freedom—capitalism—there could be no political freedom. Governments, he argued, should do little more than enforce contracts, promote competition, “provide a monetary framework” (of which more below) and protect the “irresponsible, whether madman or child”.

Freedom fighter

To show where Mr Friedman thought the limit of the state should lie, the book lists 14 activities, then undertaken by government in America, “that cannot...validly be justified” by the principles it lays out. These include price supports for farming; tariffs and import quotas; rent control; minimum wages; “detailed regulation of industries”, including banks; forcing pensioners to buy annuities; military conscription in time of peace; national parks; and the ban on carrying mail for profit.

Although the state still does a lot of this, it does less than it did; and little if any goes unquestioned. For the abolition of the draft, in particular, Mr Friedman could claim some credit: a surprise, perhaps, to those who saw him as a right-wing ideologue. Conscription—“an army of slaves”, as he put it to William Westmoreland, the army chief of staff—was illiberal: in peacetime, there was no justification for not hiring volunteers at a market wage.

Soon after becoming president, Richard Nixon set up a commission, on which Mr Friedman sat, to examine the argument for abolishing the draft. (Nixon had already been persuaded that it should go.) Conscription was ended in 1973, by which time the Vietnam war had anyway turned public opinion against it. Mr Friedman wrote, “No public-policy activity that I have ever engaged in has given me as much satisfaction as the All-Volunteer Commission.”

Second, Mr Friedman revolutionised how economists and policymakers treated money and inflation. Until he showed otherwise, post-war governments seemed able to trade off unemployment and inflation: a long-term statistical link between the two, known as the Phillips curve after the New Zealander who noted it, appeared to prove as much. By loosening monetary policy, governments could apparently buy a reduction in unemployment at the price of a little more inflation.

This, said Mr Friedman, addressing the American Economic Association as its president in 1967, was an illusion. Pumping up demand pushed down unemployment only by fooling workers into thinking that wages had risen relative to prices, making them more willing to offer their labour. Once the truth dawned and they demanded more pay, unemployment would rise back to its “natural” rate. If governments tried to push unemployment below this rate, in the long run they would succeed only in pushing inflation ever higher. Edmund Phelps, winner of this year's Nobel Prize in economics, made a similar observation at around the same time.

Mr Friedman's work was embellished by others, who modelled firms' and workers' expectations in a more sophisticated way. What really counted, though, was that he had spotted a flaw in economic orthodoxy before it was made obvious by events. In the 1970s rich economies suffered rising inflation and higher, not lower, unemployment, despite governments' efforts to inflate their way out of trouble. Mr Friedman said this was futile: governments simply had to adopt a stable monetary framework. By this he meant setting a target for the growth of the money supply, a rule known as monetarism.

His diagnosis of monetary ills and prescriptions for monetary policy long predated that presidential address. In 1963, with Anna Schwartz, he published “A Monetary History of the United States, 1867-1960”, a monumental labour. The book traced a causal relationship between the rate of monetary growth and the price level. Most eye-catching was its analysis of the Great Depression—or, as the authors called it, the Great Contraction.

The American economy shrank so much between 1929 and 1933, they argued, not because Wall Street crashed, because governments put up trade barriers or because under capitalism slumps are inevitable. No: trouble was turned into catastrophe by the Federal Reserve, which botched monetary policy, tightening when it should have loosened, thus depriving banks of liquidity when it should have been pumping money in.

Hence Mr Friedman's mistrust of independent central banks: “To paraphrase Clemenceau, money is too important to be left to the Central Bankers.” He thought they should limit inflation by targeting the rate of growth of the money supply. Aiming for inflation directly, he thought, was a mistake, because central banks could control money more easily than prices.

Brilliant as his monetary diagnoses were, on the details of the remedy he came out on the wrong side. Controlling the money supply proved far harder in practice than in theory (notably in Britain in the 1980s: Mr Friedman grumbled that the British authorities were going about it in the wrong way). These days many central banks are not only independent of government but also have inflation targets—to which, by and large, they get pretty close. The Federal Reserve has even stopped publishing M3, a broad measure of the money supply. Writing in the Wall Street Journal when Alan Greenspan stood down as Fed chairman in January this year, Mr Friedman did admit that he had underestimated central bankers' abilities—or Mr Greenspan's, anyway.

Third, Mr Friedman laid the foundation of modern theories of consumption. Keynes had posited that as income rose, so would the proportion that was saved. Economic data bore this out only up to a point: though the rich had higher saving rates than the poor, aggregate saving rates did not rise as countries became richer.

Mr Friedman resolved this apparent paradox with a theory known as the permanent income hypothesis, set forth in 1957. People, he suggested, did not spend on the basis of what their income happened to be that year, but according to their “permanent income”—what they expected to have year in and year out. In a bad year, therefore, they might dip into their savings; when they had a windfall, they would not spend the lot. He called the hypothesis “embarrassingly obvious”; but in hindsight, many of the best ideas are. It was good enough, with his work on monetary analysis and stabilisation policy, to win him a Nobel Prize in 1976.

Spreading the word

Getting fellow economists to accept your ideas is one thing; transmitting them to the laity in plain English is another. He was a gifted communicator, like many prominent economists from Keynes to Paul Krugman. For 18 years he had a column in Newsweek. He and Mrs Friedman wrote a bestselling book, “Free to Choose”, published in 1980, based on a television series of the same name. Mrs Friedman, whom he met when they were graduate students in Chicago, was a fine economist too and a sharp editor of her husband's work. She survives him after 68 years of marriage.

Politicians were keen to listen—most obviously Ronald Reagan. Although Mr Friedman met Margaret Thatcher and her government's policies bore a monetarist mark, she was probably influenced more directly by Hayek than by him. Mr Friedman was heartened by Reagan's willingness to support the Fed's tight monetary policy in the early 1980s and by his pro-market, small-government instincts, borne out in less regulation and the tax reform of 1986. He was disappointed by developments after Reagan left office. He would have preferred Donald Rumsfeld, not George Bush senior, as Reagan's vice-president and successor. An appraisal of the Rumsfeld presidency must be left to counterfactual historians.

His most controversial listener was neither Reagan nor Lady Thatcher, but Augusto Pinochet. The Chilean dictator combined ruthless repression with a taste for free markets and monetarism. In the latter, he was advised by the “Chicago boys”, economists educated at the university where Mr Friedman was the leading light. He thought they had the economics right, but insisted that his own connection with Chile was much exaggerated by those who took him to task at demonstrations and in print. In 1975 he spent six days there, met General Pinochet once and wrote to him afterwards with his economic prescription—a conclusion, he believed, that the Chicago boys had already reached.

If Mr Friedman had a favourite economy, it was Hong Kong. Its astonishing economic success convinced him that although economic freedom was necessary for political freedom, the converse was not true: political liberty, though desirable, was not needed for economies to be free. Why, he asked, had Hong Kong thrived when Britain, which controlled it until 1997, was so statist by comparison? He greatly admired Sir John Cowperthwaite, the colony's financial secretary in the 1960s, “a Scotsman...a disciple of Adam Smith, his ancient countryman”. And how much more, Mr Friedman wondered, might America have thrived had it kept its government as small, relative to its economy, as the island entrepot had done?

University of Chicago

That lament showed that Mr Friedman, brilliant and influential though he was, did not win all the fights he picked. Far from it. Education vouchers, which he and Mrs Friedman pushed for many years, have gained intellectual respectability but made limited headway in practice. Government spending, as a share of GDP, did not budge much even under Reagan and is much as it was when he left office. Only last month, Mr Friedman worried in the Wall Street Journal that greater state intervention in Hong Kong would mean that the place “would no longer be such a shining example of economic freedom.”

Rent control, the subject of that “drivel” in 1946, is still being argued over, not least in New York City. Should you be curious about Mr Friedman's co-author, look at the photograph above. Towering next to Mr Friedman is George Stigler, the Nobel economics laureate in 1982: friends and colleagues, they stroll on the Chicago campus, no doubt discussing how to make the world a freer and happier place.

Milton Friedman－－－An enduring legacy

Sat, 18 Nov 2006 04:12:44 GMT

Nov 17th 2006
From Economist.com

One of the most influential economists of the 20th century has died

AFP

MILTON FRIEDMAN won the John Bates Clark Medal, awarded to an outstanding American economist under the age of 40, in 1951. Many consider it harder to win than a Nobel Prize. One of the measures of his greatness is that when he got it, he still had not done any of the work for which he would become most famous. Still to come were the permanent-income hypothesis, his groundbreaking “A Monetary History of the United States” (co-written with Anna Schwartz) and the proposal of a natural rate of unemployment.

These works revolutionised the conduct of central banks around the world. But to non-economists Mr Friedman’s great achievement is not his challenge to Keynesian demand management but the popular writings that challenged a consensus favouring ever-greater state intervention in the economy. This work, too, came long after his peers had recognised him as a leading light. At the time of his death on Thursday November 16th, the 94-year-old economist was still working to spread his ideas about free markets, this time through a documentary for American public television.

It is another mark of his greatness that so many of the ideas that seemed crazy when he came up with them—from blaming the Depression on bad central-bank policy, to school vouchers and the volunteer army—have gained mainstream acceptance. But Mr Friedman always recognised that his success was fragile; free markets and stable money have lots of enemies, particularly among politicians. He has left us a staggering legacy of economic theory and public-policy prescriptions—but is that inheritance growing or shrinking?

Certainly, on the monetary side, Mr Friedman remains a giant. His critics point out that central bankers no longer try to target the money supply directly, but to those who remember the inflationary 1970s it is perhaps more important that futile attempt to push unemployment to zero no longer trigger inflationary spirals. In developed countries politicians may talk like Keynesians, but they behave like monetarists, looking to the central bank, rather than fiscal policy, to stave off inflation and recession.

And what of his other crusades? His proposal of a volunteer military force, once rejected as impractical, is now so deeply ingrained in American culture that politicians who proposed bringing back the draft for the war in Iraq were dismissed as crackpots or worse. His quest to replace anti-poverty programmes with a “negative income tax” that would give cash to the working poor has come to fruition in the form of the earned-income tax credit. This is now the favoured policy prescription on both left and right for boosting incomes at the bottom. School vouchers, too, are making progress, albeit slowly. And where they are not, the idea that students should be able to choose between public schools is nonetheless bringing competition to America’s educational system.

Even outside his homeland, his ideas continue to make inroads. He was pilloried for briefly advising the Pinochet regime in Chile, where his students, “the Chicago boys”, ran economic policy. Thirty years later that oppressive government is gone but his free-market reforms have made Chile the economic star of Latin America. The World Bank and IMF continue to push for stable financial systems and market-based reforms around the world. Proposals like the negative income tax were forerunners of the consensus growing in Europe (and elsewhere) that governments should provide safety nets through taxation and distribution of cash benefits rather than heavy regulation of markets.

But despite Mr Friedman’s work, thickets of regulation thrive in most countries, particularly his homeland. Nor has he succeeded in trimming back the state, which is still growing in many places, including America. Ironically, another legacy may be to blame: income-tax withholding, which he helped to invent during the second world war. The fact that the tax is deducted from most peoples’ pay before it reaches their pockets is perhaps the main reason why the state has been able to grow so large. Mr Friedman deeply regretted this contribution to economic science—but like his other inventions, it will long outlive him.

Short run – Long run

Mon, 09 Oct 2006 11:16:44 GMT

Edmund S. Phelps http://www.columbia.edu/~esp2/
Columbia University, NY, USA

“for his analysis of intertemporal tradeoffs in macroeconomic policy”.

The work of Edmund Phelps has deepened our understanding of the relation between short-run and long-run effects of economic policy. His contributions have had a decisive impact on economic research as well as policy.

Low unemployment and low inflation are central goals of stabilization policy. During the 1950s and 1960s the view of a stable tradeoff between inflation and unemployment was established, the so-called Phillips curve. According to this, the price for reduced unemployment was a one-time increase of the inflation rate. Phelps challenged this view through a more fundamental analysis of the determination of wages and prices, taking into account problems of information in the economy. Individual agents have incomplete knowledge about the actions of others and must base their decisions on expectations. Phelps formulated the hypothesis of the expectations-augmented Phillips curve, according to which inflation depends on both unemployment and inflation expectations.

As a consequence, the long-run rate of unemployment is not affected by inflation but only determined by the functioning of the labor market. It follows that stabilization policy can only dampen short-term fluctuations in unemployment. Phelps showed how the possibilities of stabilization policy in the future depend on today's policy decisions: low inflation today leads to expectations of low inflation also in the future, thereby facilitating future policy making.

Another issue where intertemporal tradeoffs are of central importance concerns the desirable rate of capital formation. By foregoing consumption for investment in physical as well as human capital (education and research), today's generation can raise the welfare of future generations. Phelps clarified possible distributional conflicts among generations. He also showed that all generations may, under certain conditions, gain from changes in the savings rate. Phelps also pioneered the analysis of the importance of human capital for the diffusion of new technology and, hence, for growth.

About paper money

Tue, 19 Sep 2006 03:33:31 GMT

On these principles, it will be seen that it is not necessary that paper money should be payable in specie to secure its value; it is only necessary that its quantity should be regulated according to the value of the metal which is declared to be the standard. If the standard were gold of a given weight and fineness, paper might be increased with every fall in the value of gold, or, which is the same thing in its effect, with every rise in the price of goods.

——David Ricardo (1772-1823) 【On the Principles of Political Economy and Taxation 】

My Rules of Thumb

Sat, 02 Sep 2006 14:40:13 GMT

By N. Gregory Mankiw

Published in The American Economist

My assignment is to describe how I work. I take on this task with mixed feelings. One can easily become vain in the process of public introspection, and vanity is a trait best left private. It is not entirely clear to me why anyone should care about idiosyncrasies--except, perhaps, for my colleagues, students, and family, who have no choice but to live with them.

Yet when other economists write essays of this sort, I enjoy reading them. I like to think that these essays edify me in some way, but at the very least they appeal to the voyeur in me. So, I figured, others may learn from a brief essay about how I work. Or, at least, they may be amused by it.

I have organized this essay around six rules of thumb that I follow as I go about my working life. I have chosen these rules largely for their positive value-- they describe my behavior. I do not pretend that the way I work necessarily holds any prescriptive value for anyone else. But it may. If these rules of thumb ring true to others and help them to run their lives, so much the better.

Rule No. 1:Learn from the Right Mentors

Sat, 02 Sep 2006 14:38:18 GMT

I learned how to practice my trade from four distinguished economists. Perhaps the reason was good career planning on my part. More likely, it was just good luck.

In the spring of 1977, as a freshman at Princeton, I took Principles of Microeconomics from Harvey Rosen. Harvey was an excellent teacher. I remember finding the material easy and, at the same time, feeling that I was learning a tremendous amount. Each lecture was filled with insights that were novel, profound, and so stunningly obvious that it seemed I should have known them all my life. But, of course, I didn't. Principle of microeconomics was the most eye-opening course I have ever taken. All subsequent courses in economics have exhibited the property of diminishing returns.

For reasons that are a mystery to me now, Harvey hired me as a research assistant for the summer after my freshman year. I knew very little economics, for I had taken only the two principles courses. I did know something about computer programming (a fact that surprised my own research assistants, for changes in technology have made this human capital long obsolete). For whatever reason, Harvey did hire me, and the experience proved invaluable. I knew so little that Harvey had to teach me whatever he needed me to know. Spending a summer being tutored by a top teacher and scholar is the best learning experience I can imagine. To this day, I have never learned so much in so short a period of time.

Eventually, my interests drifted toward macroeconomics. As a senior at Princeton, I took graduate macroeconomics from Alan Blinder, another excellent teacher. At the same time, I wrote my senior thesis under Alan's supervision. In the thesis, I tried to make sense of the cyclical behavior of the real wage, which has puzzled macroeconomists at least since the publication of Keynes's General Theory. Part of my senior thesis became a paper co-authored with Alan, which we later published in the Journal of Monetary Economics. More important, as I worked on the thesis, I became convinced that imperfections in goods markets were at least as important as imperfections in labor markets for understanding the business cycle. This conviction eventually led to my involvement in a line of research now called New Keynesian Economics.

When I entered MIT's graduate program in the fall of 1980, Larry Summers was a young assistant professor. Larry's enthusiasm, breadth of knowledge, and quick mind attracted me, and we spoke together at MIT during the year and at NBER during the following summer. When Martin Feldstein brought

Larry to work at the Council of Economic Advisers in September 1982, Larry brought me along with him. I was fortunate to be able to work closely with Larry during the brief period when he was already a great economist but not yet a famous one.

When I returned to MIT, Stanley Fischer served as my dissertation adviser, as he did for a remarkable number of students in my class. Stan was a model of professorial balance. As a lecturer, he gave clear and even-handed presentations in a field that can be confusing and divisive. As an adviser, he encouraged students to pursue their interests with the highest standard of rigor without imposing his own intellectual agenda on them. My dissertation, like most in recent years, was a collection of loosely related papers bound together for the sole purpose of getting a degree. It bore the soporific title, "Essays on Consumption."

When I look back at these four mentors-- Rosen, Blinder, Summers, and Fischer-- I see in them various characteristics that I have developed over time. They are prolific writers. Their research tends to be empirical and policy-oriented. They take teaching seriously.

All of my mentors have shown interest in reaching a broader audience than can be found writing in academic journals. All four of them have taken time away from academia to work in policy jobs in Washington. Three out of four have written textbooks, and two of them have written more than one textbook.

It is easy to see why mentors matter. Mentors determine your professional outlook in much the way that parents determine your personal outlook. Mentors, like parents, give you your values. They teach you what kind of behavior to respect and what to avoid. And they teach these lessons indirectly, more often through their actions than through their words.

The major difference is that your parents are predetermined. You get to choose your mentors.

Rule No. 2: Work With Good Co-Workers

Sat, 02 Sep 2006 14:36:17 GMT

I have been lucky to be able to work with many talented coauthors. In approximate order of appearance, they include Alan Blinder, Bryan Boulier, Larry Summers, Julio Rotemberg, Matthew Shapiro, David Runkle, Avery Katz, Bob Barsky, Steve Zeldes, Jeff Miron, Mike Whinston, John Campbell, Andy Abel, Richard Zeckhauser, David Romer, Larry Ball, Miles Kimball, David Weil, Olivier Blanchard, Susanto Basu, Robert Barro, Xavier Sala-i-Martin, Bob Hall, Niko Canner, and Doug Elmendorf. Some of these co-authors were my mentors, others were my contemporaries (often fellow students at MIT), and still others were students of mine at Harvard. In recent years, I have done most of my research with these co-authors.

Why are co-authors so important for the way I work? One reason is found in Adam Smith's famous story of the pin factory. Smith observed that the pin factory was so productive because it allowed workers to specialize. Research is no different--it is just another form of production. Doing research takes various skills: identifying questions, developing models, providing theorems, finding data, expositing results. Because few economists excel at all these tasks, collaborating authors can together do things that each author could not do as easily on his own. In manufacturing knowledge, as in manufacturing pins, specialization raises productivity. (The puzzle is why Adam Smith chose to ignore his own analysis and write The Wealth of Nations without the benefit of a co-author.)

The second reason I work with co-authors is that it makes my job less solitary. Research and writing can be a lonely activity. It is easy to spend endless hours with a pad and pencil or in front of a computer without human contact. Some people may like that kind of work, but not me. Arguing with my co-authors makes my day more fun.

The third reason I work with co-authors is the most important: a good co-author improves you forever. In the most successful collaborations, both co-authors learn from the experience. A co-author can help you expand your knowledge, improve your skills, and expose your biases. Even after the collaboration is over, you take these benefits with you to future projects. To a large extent, as I have grown older, my co-authors have become my mentors.

Rule No.3: Have Broad Interests

Sat, 02 Sep 2006 14:31:44 GMT

Throughout my life, I have been blessed with broad interests. (Or, perhaps, I have been cursed with a short attention span.) As a child, I had numerous hobbies. I collected coins, stamps, shells, rocks, marbles, baseball cards, and campaign buttons. For pets, I had turtles, snakes, mice, fish, salamanders, chameleons, ducks, and, finally, a cocker spaniel. In high school, I spent my time playing chess, fencing, and sailing. I have long since given up all these activities (although I do have a border terrier named Keynes.)

As a college student, I committed myself to a new major several times each semester, alternating most often among physics, philosophy, statistics, mathematics, and economics. After college my path was indirect and largely unplanned. In chronological order, I spent a summer working at the Congressional Budget Office, a year studying at the MIT economics department, a year studying at Harvard Law School, a summer working at a law firm, a year working at the Council of Economic Advisers, a second year at MIT finishing my PhD, another semester studying at Harvard Law School, and then another semester at MIT, this time as an instructor teaching statistics and microeconomics. In 1985, I gave up my studies in law and became an assistant professor at the Harvard economics department, where in my first year I taught principle of economics and graduate macroeconomics.

Remarkably, I have been at Harvard now for about a decade. Harvard is a wonderful place to work. Yet I often get the itch to leave, just for the sake of doing something different. One thing that keeps me at Harvard is the proximity of the National Bureau of Economic Research. Every year the NBER holds dozens of conferences on various topics with prominent economists from around the world. Having an office at the NBER is a bit like moving to a new university every few days.

My broad interests (short attention span) help to explain my diverse (incoherent) body of work. My research spans across much of economics. Within macroeconomics, I have published papers on price adjustment, consumer behavior, asset pricing, fiscal policy, monetary policy, and economic growth. I have even ventured outside of macroeconomics and published papers on fertility with imperfect birth control, the taxation of fringe benefits, entry into imperfectly competitive markets, and the demographic determinants of housing demand. None of this is part of a grand plan. At any moment, I work on whatever then interests me most.

Coming up with ideas is the hardest and least controllable part of the research process. It is somewhat easier if you have broad interests. Most obviously, broad interests give you more opportunities for success. A miner is more likely to strike gold if he looks over a large field than over the same field over and over again. More important, thinking about one topic can generate ideas about other topics. I started thinking about menu costs and macroeconomic price adjustment, for instance, as I sat in a law school seminar that was discussing monopoly pricing and antitrust policy. Research ideas pop up in unexpected places.

Of course, breadth has its costs. One is that it makes writing grant proposals more difficult. I am always tempted to write, "I want to spend the next few years doing whatever I feel like doing. Please send me money so I can do so." Yet, in most cases, those giving out grant money want at least the pretense of a long-term research plan.

The greatest cost of breadth, however, is lack of depth. I sometimes fear that because I work in so many different areas, each line of work is more superficial than it otherwise would be. Careful choice of co-authors can solve this problem to some extent, but not completely. I am always certain that whatever topic I am working on at that moment, someone else has spent many more hours thinking about it than I have. There is something to be said for devoting a lifetime to mastering a single subject.

But it won’t be my lifetime. I just don't have the temperament for it.

Rule No. 4: Allocate Time and Crew

Sat, 02 Sep 2006 14:29:52 GMT

This is a rule of thumb I have been slow to learn. I used to go to every school that invited me to give a seminar, comment on every paper that a conference organizer asked me to discuss, referee every paper that a journal editor sent me, write every letter of recommendation that a department chairman requested of me, and sit on every committee that a dean asked me to attend.

But no more . Over time, the number of such requests have increased exponentially. Within a few years of going on the Harvard payroll, the cost of saying yes became intolerable. I came to realize that too much professional responsibility can be irresponsible, for it takes time away from the most important tasks--teaching and research. I now turn down the overwhelming majority of offers from seminar organizers, conference organizers, journal editors, department chairmen, and deans.

Deciding which research projects to pursue is the most difficult problem I face in allocating my time. I find it almost impossible to predict how any project will turn out before it is done. And even when I have finished one of my papers, I cannot predict with much accuracy how other people (such as editors and referees) will react to it. My strategy, therefore, is to choose research topics based on what interests me most and, to some extent, on whether I have a good co-author who shares my enthusiasm. Sometimes I work on a topic for awhile and decide that I have nothing new to say. I then force myself to remember the irrelevance of sunk costs and move on to another topic.

One way that I spend quite a bit of time is writing textbooks. I have written an intermediate-level textbook on macroeconomics, which is now in its second edition, and I am now in the process of writing a textbook on the principles of economics. Writing a textbook is a lot of work, and I am

sometimes asked why I choose to spend my time this way. So let me explain.

Textbook writing is form of teaching. As such, it has all the pluses and minuses of teaching. The major minus is that it takes time. And time is an academic's most valuable resource.

Despite the cost, I view textbook writing, like classroom teaching, as a good use of my time. One benefit is pecuniary. Few people in the world earn a living just creating knowledge. Most academics spend some of their time imparting knowledge as well. Giving lectures is one way of imparting knowledge; writing textbooks is another. So far, I have been able to make enough money imparting knowledge to students that I have not had to spend time on other activities, such as paid consulting, to put food on the table.

Of course, the most immediate benefit of classroom teaching and textbook writing is that they allow you to mold the minds of students. Economics is not a straightforward discipline like Newtonian mechanics or Euclidean geometry. Whenever you teach economics, you have wide latitude in choosing what material to include and how to present it. In making these choices, you give your own "spin" to the subject and help determine the views of your students. Although classroom teachers and textbook writers share this responsibility, textbook writers reach a larger audience. For those who want to bequeath their view of economics to the next generation, textbooks are the most efficient medium. Indeed, because textbooks are so important in shaping the field, many of the most prolific writers in academic journals are also textbook authors: Samuelson, Baumol, Blinder, Stiglitz, Barro, Dornbusch, Fischer, and on and on.

A less obvious benefit of classroom teaching and textbook writing is that they stimulate ideas for research. Whenever you have to explain something to someone, either in person or on a printed page, you have to think it through more thoroughly than you otherwise would. Preparing a lecture or drafting a textbook chapter reveals holes in your understanding. And, sometimes, as you try to fill these holes, you get ideas for research. Put simply, imparting knowledge and creating knowledge are complimentary activities. That is why these two forms of production take place in the same firms, called universities.

The final benefit to spending time writing textbooks is that it makes you a better writer. But that brings me to my next topic.