Friday, June 30, 2017

Chess metaphor for macroeconomics


I think of macroeconomics as being like a chess game. Similar to chess, the world economy is made of many different economic actors with different abilities and placements. The world economy has a structure that is continually evolving. Instead of relying on a particular macroeconomic theory, I think it's more effective to pragmatically analyze the structure of economic actors in an economy to determine the best course of action. In chess, players must also pragmatically analyze the structure of the pieces to make decisions.

Here is what each chess piece represents in the economy:

  • Pawns: low income people
  • Queen: billionaires
  • Rooks, bishops and knights: companies
  • King: planet earth
  • Opponent's pieces: goods and services

Pawns represents a low income people because pawns have the least mobility and are the weakest pieces on the board. If a pawn is able to miraculously reach the other side of the board, they acquire the abilities of a queen. This represents when a poor person through hard work and luck is able to become a billionaire.

The queen represents billionaires because the queen has the greatest mobility and power in the game. Billionaires are the most powerful actors in the economy.

Rooks, bishops and knights represent companies because they have a lot of power but not as much as the queen. Companies are extremely diverse, therefore it's fitting that they can be either a rook, bishop or knight.

The king represents planet earth because if the king dies, the game is over. If planet earth becomes so polluted that it's uninhabitable, it's game over for society. A defensive strategy to protect the king is symbolic of regulations to protect the environment.

The opponent's pieces represent goods and services because the goal of economics is to produce goods and services. The goal of chess is to conquer the opponent's pieces.

When playing chess, it's important that all of your pieces work together. It's important that your pieces back each other up. Unsupported pawns stand no chance of surviving. Pawns need the help of more powerful pieces to make a greater contribution. Bottom line, your pieces must act like a team. Imagine playing a game of chess without moving your queen; you will lose. This is the similar to not taxing billionaires to pay for things that will improve society.

Here's a final quote from Adam Smith which is the one of the early uses of the chess metaphor,
...in the great chess-board of human society, every single piece has a principle of motion of its own, altogether different from that which the legislature might choose to impress upon it. If those two principles coincide and act in the same direction, the game of human society will go on easily and harmoniously, and is very likely to be happy and successful. If they are opposite or different, the game will go on miserably, and the society must be at all times in the highest degree of disorder. (The Theory of Moral Sentiments, 1759)

Saturday, June 17, 2017

What is economics?


What is economics? Here is my answer:

Economics is the study of the production, distribution and consumption of goods and services.

In other words, economics is the study of the economy.

This post is a collection definitions of 'economics' from famous economists. I have divided the definitions into four categories: scarcity, wealth, decision-making and open-ended. This post was inspired by Roger Backhouse and Steven Medema's paper 'On the Definition of Economics'.

For each definition, I have provided a short analysis.

Wealth based definitions


Adam Smith (1723-1790)
"[Economics is] the nature and causes of the wealth of nations." (The Wealth of Nations, 1776)
  • I think Smith's definition in agreement with the definition I stated above. 'Wealth' is a good substitute word for 'goods and services'. 'Nature and causes' is a good substitute for the word 'study'.

Jean-Baptiste Say (1767-1832)
"[Political economy is] the science of production, distribution and consumption of wealth." (A Treatise on Political Economy, 1803)
  • This definition is basically the same as the one I provided above. 'Wealth' isn't as descriptive as 'goods and services' but means the same thing. My only problem with this definition is that the word 'wealth' could be misinterpreted for 'abundance', therefore I prefer the phrase 'goods and services'.

John Stuart Mill (1806-1873)
"[Political economy] is the science which traces the laws of such of the phenomena of society as arise from the combined operations of mankind for the production of wealth in so far as those phenomena are not modified by the pursuit of any other object." (On the definition of Political Economy, 1867)
  • Although this definition is confusing, I agree that economics revolves around the 'wealth'. That's really all this definition is saying.

Thomas Adams (1873-1933), Richard Ely (1854-1943), Max Lorenz (1876-1959) and Allyn Young (1876-1929)
"[Economics is] the wealth-getting and wealth-using activities of man." (Outlines of Economics 4th edition, 1926)
  • I agree that economics has to do with  'wealth-getting' (production) and 'wealth-using' (consumption) but I think this definition would be better if it mentioned 'wealth-distribution'.

Scarcity based definitions


Lionel Robbins (1898-1984)
"[Economics is] the science which studies human behavior as a relationship between ends and scarce means which have alternative uses." (Essay on the Nature and Significance of Economic Science, 1932)
  • This is currently the most influential and popular definition of economics. I'm generally against 'scarce' definitions of economics because I don't think 'scarce' is an accurate mindset for a world with unlimited opportunity.

George Stigler (1911-1991)
"[Economics is] the study of the principles governing the allocation of scarce resources among competing ends when the objective of the allocation is to maximize the attainment of the ends." (The Theory of Competitive Price, 1942)
  • Once again, I don't think economics should be about 'scarce resources'.

Milton Friedman (1912-2006)
"[Economics is] the science of how a particular society solves its economic problems... an economic problem exists whenever scarce means are used to satisfy alternative ends." (Price Theory: A Provisional Text, 1962)
  • I don't think economics should revolve around 'problems'. What about all the good things in life?

Paul Samuelson (1915-2009)
"Economics is the study of how people and society end up choosing with or without the use of money to employ scarce productive resources that could have alternative uses, to produce various commodities and distribute them for consumption, now or in the future, among various persons and groups in society. It analyzes the costs and benefits of improving patterns of resource allocation." (Economics 10th edition, 1976)
  • I agree with this definition except that I would replace the word 'scarce' for 'limited'. But even the word 'limited' is kinda wrong. There are some economic resources I would describe as 'abundant'. Maybe it would be best to just remove the word 'scarce'.

Gary Becker (1930-2014)
"[Economics is] the study of allocation of scarce means to satisfy competing ends." (Economic Theory, 1971)
  • I think this definition is too focused on the 'distribution' and 'consumption' part of economics with not enough emphasis of 'production'.

Robin Bade and Michael Parkin
"[Economics is the] social science that studies the choices that individual, business, government and entire societies make as they cope with scarcity." (Foundations of Microeconomics, 2002)
  • This definition revolves around scarcity. It's as if society is given a pie that must be divided up with no potential to create more pie. This definition doesn't talk about the 'production' part of economics.

Decision-making based definitions


Carl Menger (1840-1921)
"[Economics] is related to the practical activities of economizing men." (Principles of Economics, 1871)
  • What does it mean to economize? According to Google, "to spend less; to reduce one's expenses". Although this definition kinda works, I still think it's really broad and doesn't properly define the boundaries of what economics is.

Alfred Marshall (1842-1924)
"Political economy or economics is a study of mankind in the ordinary business of life. It examines that part of individual and social action which is most closely connected with the attainment and with the use of the material requisites of wellbeing... thus it is on the one side a study of wealth and on the other, and more important side, a part of the study of man." (Principles of Political Economy, 1890)
  • For the most part I agree with this definition. I agree that 'ordinary business of life' revolves around economics. I like how this definition focuses on what is 'most closely connected with the attainment and use of the material requisites of wellbeing'.

Summer Slichter (1892-1959)
"The subject matter of economics is industry; the process by which men get a living... economics studies industry, not as a technological process, but as a complex of human practices and relationships." (Modern Economic Society, 1931)
  • This definition is very similar to Marshall's definition. I agree that economics is all about 'industry' (goods and services) and the 'process by which men get a living' (production, consumption).

James M. Buchanan (1919-2013)
"[Economics is] the study of the whole system of exchange relationships."
  • This definition has too much emphasis on the 'distribution' part of economics while ignoring 'production' and 'consumption'.

David Colander (1947-now)
"Economics is the study of how human beings coordinate their wants and desires, given the decision-making mechanisms, social customs and political realities of the society." (Microeconomics 6th edition, 2006)
  • Although I think this definition is valid for economics, I think its better suited for sociology.

Greg Mankiw (1958-now)
"Economics is the study of how society manages its resources." (Principles of Economics 2nd edition, 2001)
  • This is a broad definition but I think it works. Ultimately, this definition has to do with the production, distribution and consumption of 'resources'.

James Gwartney, David MacPherson, Russell Sobel and Richard Stroup
"Economics is the study of human behavior with a particular focus on human decision-making." (Microeconomics: Private and Public Choice 11th edtion, 2006)
  • This definition seems better suited for psychology.

Open-ended


Jacob Viner (1892-1970)
"Economics is what economists do." (Quoted by Kenneth Boulding in Economic Analysis, 1941)
  • This definition is completely inadequate. What's the point of definitions and words in the first place? Without words and concepts we are lost children in the woods. Philosopher Friedrich Nietzsche says, "The man of action binds his life to reason and its concepts so that he will not be swept away and lost; the scientific investigator builds his hut right next to the tower of science so that he will be able to work on it and to find shelter for himself beneath those bulwarks which presently exist." (On Truth and Lie in an Extra-Moral Sense, 1873)

Sunday, June 4, 2017

EconTalk: six part series on econometrics


Back in March 2016, Noah Smith had a blog post titled, Russ Roberts and the new empirical world. In the post, Smith mentions six episodes from Russ Roberts' podcast Econ Talk that are basically a series on econometrics. I enjoyed listening to this series because it's informative to hear verbal explanations for econometric concepts.

This post is a collection of my favorite quotes from the six episodes.

Ed Leamer on the State of Econometrics (May 10, 2010)

"Economists don't observe feathers in a vacuum. They observe feathers when the wind is blowing, when humidity varies, eagle feathers, duck feathers. Tons of things that will affect the result."

"So when somebody says in the past $100 billion of spending had such and such impact on the U.S. economy, if there was this level of unemployment and this level of growth in the previous period, people are presuming that the same structural relationships that help when those estimates were made will still hold. So even though the cause of the recession might be totally different, even though what the money is spent on might be totally different, implicit in those multiplier arguments is the presumption that it doesn't matter."

"If you want to know: does government spending have a multiplier? Then you need a treatment group and a control group. You need to randomly subject an economy to a burst in spending and see what happens to that economy and contrast that to the control groups that did not get that spending."

"Econometric analysis is really journalism. Journalist's job is to marshal facts and put them together persuasively."

"To think that designing experiments is suddenly going to change economics into an empirical scientific discipline. That's doesn't seem likely to happen."

"All we have, especially in macro is opinions and their either persuasive and well thought out or not."

Joshua Angrist on Econometrics and Causation (December 22, 2014)

"We talk as an ideal the kind of randomized trial or field trial that's often used in medicine to determine cause and effect or to gauge cause and effect."

"Regression is just a way to control for things, to try and hold characteristics of groups that you're trying to compare fixed."

"I can't imagine seeing an empirical paper about cause and effect which doesn't at least show me the author's best effort at some kind of regression estimates where they control for the observed difference between groups."

"Each of these is an attempt to generate some kind of apples to apples comparison out of observational data."

"Sometimes instrumental variables is a method for leveraging experimental random assignment in complicated experiments where the treatment itself cannot be manipulated but there's an element of manipulation in the treatment."

"Regression discontinuity designs are non-experimental researched designed that attempt to mimic an experiment by using the rules that determine allocation to treatment states."

"So some of the evidence in these areas is stronger and weaker. There is certainly a lot of interesting evidence here that's worth discussing. That's my standard."

"Well science is done by human beings. When you come at it from an idealistic view, you're bound to be disappointed."

"One of the most influential documents in the history of social science is Friedman and Schwartz... It's an effort  to get at the causes of the Depression. I think we can do better than Friedman and Schwartz with the tools today. Their work is a benchmark and a worthy benchmark."

Noah Smith on Whether Economics is a Science (December 28, 2015)

"You can often exploit quirks of how policies happen or how the real process works to get clean identification."

"The most important difference with natural experiments is you can't replicate them or repeat because each natural experiment happens only once."

"It's extremely hard to find these clean natural experiments in macro."

"If you're going to believe the results of an experiment you always have to make a leap of faith that all the reasonable stuff has been controlled for, right? That the experimenter has good controls and that's an assumption and a leap of faith you have to make in every science experiment."

"I think the thing about the stimulus is... it's not at all clear. The stimulus was not an actual experiment at all."

"There are some thunderbolt studies but what's much more common is an accumulated weight of studies that all have consistent results... So don't rely too much on these thunderbolt studies even though sometimes they do exist but they're pretty rare."

Adam Ozimek on the Power of Econometrics and Data (February 8, 2016)

"Evidence is good even if it doesn't mean the same thing to everyone."

"I think the research comes out and looks at slightly different angles and adjusts for slightly different mechanisms and we know so much more about the minimum wage than we did 10 years ago... If you look at the literature closely it doesn't look like a draw where two sides just lob evidence back and forth. It looks like progress to me."

"Macro's definitely harder. There's no doubt about that. There's less data. It's harder to isolate partial equilibrium."

"The stimulus act isn't something like the minimum wage. It's not a discrete policy where you turn the fiscal level up and it goes from 0 to a 1 to a 2 to a 3. The stimulus act was like a dozen different things and so to say that research hasn't told us whether the stimulus act was good or not or increased jobs, well I mean you could write a 100 page paper on just what was in it... but I do think that within the stimulus package there are things we can learn and have learned."

James Heckman on Facts, Evidence and the State of Econometrics (January 25, 2016)

"The new techniques are not so new. They involve instrumental variables which I think go back to Philip Wright in 1928. Instrumental variables have been a central part of econometrics for the last 70-80 years."

"Unfortunately the credibility revolution has taken this notion that there's some missing variable out there, some unobservable and we want to control for that unobservable to a new level, to a new extreme so much so there seems to be an obsession with making sure that we don't have this unobservable contaminating our result without asking what question that we're getting from this instrument."

"I think there's been a huge shift away from understanding behavior and moving towards statistical artifacts that are hard to interpret as responses to economic questions. So I think the credibility revolution has been somewhat overstated and not properly appreciated as having really turned focus away from serious economic analysis towards something I think is purely statistical."

"Calibrated models are models looking at some stylized facts that are putting together different pieces of data that are not mutually consistent. I mean literally you take estimates of this area, and estimates from that area and you assemble something that's like a Frankenstein..."

"I think every successful body of social science that use basic models, they've gotten to kind of the core of the idea; not bells and whistles. And bells and whistles are kind of second generation, third generation add-ons. Bells and whistles are often professionally and privately rewarding but maybe not so rewarding for the subject as a contributor to economic knowledge generally and public policy."

"Milton Friedman raised to me some of my first concerns about the credibility revolution. I remember telling him about some work I was doing and you remember the work I was doing was very complicated for its time. He looked at me and said, 'It looks like that kind of work has lots of room for fraud.'"

David Autor on Trade, China and U.S. Labor Markets (March 14, 2016)

"It's not that I think our estimates are cooked or even that sensitive. It's that they might miss other important margins. And I'm happy to concede that point. I mean, we've tried. It's not that we've sort of agreed to just sort of punt on that question. There's probably a lot of ways to look for those missing margins. We really haven't found them."

Monday, May 29, 2017

Macroeconomic experiments


In an earlier post I provided a list of 10 economic statements from famous economists. My goal is to determine the validity of each of these influential statements.

This post is a list of macroeconomic events that can be used to analyze each statement. I'm aware there are many confounding variables impacting these events, but I believe this list is a good starting point for compiling potentially useful macroeconomic experiments.

1. John Maynard Keynes (1883-1946):
"The right remedy for the trade cycle is not to be found in abolishing booms and thus keeping us permanently in a semi-slump; but in abolishing slumps [with fiscal and monetary policy] and thus keeping us permanently in a quasi-boom." (The General Theory of Employment, Interest and Money, 1936)

Key variable: GDP growth

Fiscal policy
  • United States' New Deal (1933-1938)
  • United States in World War II (1939-1949)
  • United States' American Recovery and Reinvestment Act (2009)
  • Greece austerity (2010-now)
Monetary policy
  • Federal Reserve quantitative easing (2008-2014)
  • Bank of Japan quantitative easing (2001-now)

2. Adam Smith (1723-1790):
"By preferring the support of domestic to that of foreign industry, he intends only his own security; and by directing that industry in such a manner as its produce may be of the greatest value, he intends only his own gain, and he is in this, as in many other cases, led by an invisible hand to promote an end which was no part of his intention." (The Wealth of Nations, 1776)

Key variable: GDP growth
  • Union of Soviet Socialist Republics communism (1922-1991)
  • United States free trade (1776-now)

3. Milton Friedman (1912-2006):
"I am in favor of cutting taxes under any circumstances and for any excuse, for any reason, whenever it's possible... because I believe the big problem is not taxes, the big problem is spending. I believe our government is too large and intrusive, that we do not get our money's worth..." (Quoted in Conservatives Betrayed, 2006)

Key variable: GDP growth
  • United States tax policy (1932-1988)
  • Sweden tax policy (1939-1988)

4. Joseph Schumpeter (1883-1950):
"The innovation is hazardous, impossible for most producers. But if someone establishes a business having regard to this source of supply, and everything goes well, then he can produce a unit of product more cheaply, while at first the existing prices substantially continue to exist." (The Theory of Economic Development, 1934)

Key variable: quantity of replaced businesses
  • Walmart (1962-now)
  • Microsoft (1975-now)
  • Amazon (1994-now)

5. David Ricardo (1772-1823):
"Under a system of perfectly free commerce, each country naturally devotes its capital and labour to such employments as are most beneficial to each." (Principles of Political Economy and Taxation, 1817)

Key variable: GDP growth
  • World Trade Organization and China (2001-now)
  • Smoot-Hawley Tariff Act (1930)

6. Friedrich Hayek (1899-1992):
"The misconception that costs determined prices prevented economists for a long time from recognizing that it was prices which operated as the indispensable signals telling producers what costs it was worth expending on the production of the various commodities and services, and not the other way around." (Coping with Ignorance, 1978)

Key variable: price
  • It's hard to think of what specific event can help test this statement. Maybe a good example could be the event that the popularity of an artist takes off and the price of their paintings greatly exceeds the cost of production.

7. John Kenneth Galbraith (1908-2006): "In recent times no problem has been more puzzling to thoughtful people than why, in a troubled world, we make such poor use of our affluence." (The Affluent Society, 1958)
  • This type of statements can't really be judged based off of a single event. It makes more sense to analyze facts and evidence to determine this statement's validity.

8. Robert Owen (1771-1858):
"The advantage of pure, and the disadvantage of impure air are experienced each time we breathe, and all who understand the causes of disease know that an impure Atmosphere is most unfavourable to the enjoyment of health, and an efficient cause to shorten human existence within the natural life of man. It is therefore most desirable that decisive measures should be devised and generally adopted to ensure to all a pure atmosphere, in which to live during their lives." (The Book of the New Moral World, 1836)


Key variable: quality of life indicators
  • United States quality of life
  • Sweden quality of life

9. Robert Thomas Malthus (1766-1834):
"The employment of the poor in roads and public works, and a tendency among landlords and persons of property to build, to improve and beautify their grounds, and to employ workmen and menial servants, are the means most within our power and most directly calculated to remedy the evils arising from that disturbance in the balance of produce and consumption." (An Essay on the Principle of Population 2nd Edition, 1836)


Key variable: unemployment
  • Europe's Marshall Plan (1948-1951)
  • United States' New Deal (1933-1938)

10. Karl Marx (1818-1883):
"The worker's existence is thus brought under the same condition as the existence of every other commodity. The worker has become a commodity, and it is a bit of luck for him if he can find a buyer... " (Paris Manuscripts , 1844)

Key variable: unemployment
  • Industrialization (1800-1900)
  • Computerization (1900-now)

Saturday, May 20, 2017

Tjalling Koopmans: pioneer of optimization models


Tjalling Koopmans (1910-1985) was an influential economist best known for optimization models and applying linear programming to general equilibrium models. He was also director of the Cowles Commission (1948-1955) and is 1975 co-recipient of the Nobel Prize in Economics. The Concise Encyclopedia of Economics says,
Koopmans showed the conditions required for economy-wide efficiency in allocating resources. He like Kantorovich, used his activity analysis techniques to derive efficient criteria for allocating between the present and the future.
Economist Thomas Sargent said,
Koopmans complained that macroeconomic models weren't satisfactory because they didn't handle randomness. (Conversations with Economists by Arjo Klamer)
This post is a collection of quotes from Koopmans talking about the philosophy of economics.

Philosophy of economics


"One is led to conclude that economics as a scientific discipline is still somewhat hanging in the air." (Three Essays, 1957)

"We looked upon economic theory as a sequence of conceptual models that seek to express in simplified form different aspects of an always more complicated reality." (Three Essays, 1957)

"It is worth pointing out that in this particular study our authors have abandoned demand and supply functions as a tool for analysis, even as applied to individuals... [The problem] has been reformulated as one of proving that a number of maximizations of individual goals under interdependent restraints can be simultaneously carried out." (Three Essays, 1957)

Pierre-Simon Laplace and probability theory


Pierre-Simon Laplace (1749-1827) was an influential mathematician and scientist best known for his contributions to probability theory and celestial mechanics. Mathematician Morris Kline says,
Laplace created a number of new mathematical methods that were subsequently expanded into branches of mathematics, but he never cared for mathematics except as it helped him to study nature.
Journalist Kathryn Schulz says,
Pierre Simon Laplace refined the distribution of errors, illustrated by the now-familiar bell curve... Laplace used the bell curve to determine the precise orbit of the planets... By using the normal distribution to graph... individually imperfect data points, Laplace was able to generate a far more precise picture of the galaxy... aggregate enough flawed data, and you get a glimpse of the truth.
 This post is a collection of quotes from Laplace talking about the philosophy of knowledge.

Knowledge


"Imaginary causes have gradually receded with the widening bounds of knowledge and disappear entirely before sound philosophy, which sees in them only the expression of our ignorance of the true causes." (Philosophical Essay on Probabilities, 1812)

"The theory of chance consists in reducing all the events of the same kind to a certain number of cases equally possible..." (Philosophical Essay on Probabilities, 1812)

"All these efforts in the search for truth tend to lead it [the human mind] back continually to the vast intelligence... but from which it will always remain infinitely removed." (Philosophical Essay on Probabilities, 1812)

"The most important questions of life... are indeed for the most part only problems of probability." (Philosophical Essay on Probabilities, 1812)

Marie Curie and the philosophy of science


Marie Curie (1867-1934) was an influential chemist best known for her pioneering work in radioactivity. Wikipedia says,
She was the first woman to win a Nobel Prize, the first person and only woman to win twice, the only person to win a Nobel Prize in two different sciences, and was part of the Curie family legacy of five Nobel Prizes.
This post is a list of quotes from Currie talking about the philosophy of science.

Philosophy of science


"If I see anything vital around me, it is precisely that spirit of adventure, which seems indestructible and is akin to curiosity." (Quoted in Madame Curie: A Biography by Eve Curie Labouisse)

"Life is not easy for any of us. But what of that? We must have perseverance and above all confidence in ourselves. We must believe that we are gifted for something, and that this thing, at whatever cost, must be attained." (Quoted in Madame Curie: A Biography by Eve Curie Labouisse)

"In science, we must be interested in things, not in persons." (Quoted in Madame Curie: A Biography by Eve Curie Labouisse)

"All my life through, the new sights of Nature made me rejoice like a child." (Pierre Curie, 1923)

"I am one of those who think like Nobel, that humanity will draw more good than evil from new discoveries." (Quoted in White Coat Tales by Robert B. Taylor)

"...humanity also needs dreamers, for whom the disinterested development of an enterprise is so captivating that it becomes impossible for them to devote their care to their own material profit. Without doubt, these dreamers do not deserve wealth, because they do not desire it. Even so, a well-organized society should assure to such workers the efficient means of accomplishing their task, in a life freed from material care and freely consecrated to research."