Author Archive for Peter G. Klein

The Leveraging of Corporate America

11943189016_6a1208edca_bA new NBER paper documents a strong, secular increase in US corporate borrowing during the Keynesian era.

Unregulated U.S. corporations dramatically increased their debt usage over the past century. Aggregate leverage – low and stable before 1945 – more than tripled between 1945 and 1970 from 11% to 35%, eventually reaching 47% by the early 1990s. The median firm in 1946 had no debt, but by 1970 had a leverage ratio of 31%. This increase occurred in all unregulated industries and affected firms of all sizes.

Not surprisingly, this change reflects government policy:

Changing firm characteristics are unable to account for this increase. Rather, changes in government borrowing, macroeconomic uncertainty, and financial sector development play a more prominent role.

Further evidence for the long-term lengthening of the economy’s capital structure, not from technological improvement, but from the government’s policy of always keeping interest rates below their market levels.

More Trouble for Behavioral Economics

Behavioral economics and its close cousin, neuroeconomics, have been all the rage in the last few decades. Behavioral economists claim to go beyond the naive assumptions of neoclassical economics by taking psychology (and neurophysiology) seriously, using laboratory experiments, brain scans, and other techniques to study how economic actors “really” behave under various circumstances. While some Austrians have embraced behavioral approaches, most have tended to dismiss the field, viewing behavioral economics as psychology, not economics. I find behavioral economics an ad hoc mixture of occasionally interesting psychological insights and naive policy recommendations that fit the authors’ particular ideological views (e.g., “soft paternalism”). More important, it’s hard to identify any important substantive contributions coming out of the behavioral literature; hardly anything seems both new and true. (Some neoclassical economists feel this way too.)

A recent NBER paper (gated, unfortunately) points to an important problem in the empirical literature on behavioral responses to stimuli. Economists Rajshri Jayaraman, Debraj Ray, and Francis de Vericourt studied an Indian tea plantation that changed its employment contract, from an output-based system with wages tied to individual performance to a “softer,” more equitable system with higher guaranteed minimum payments to all and weaker performance incentives. Initially, the plantation’s output increased, seemingly supporting the behavioralist claim that strong incentive plans make workers unhappy and lower productivity. However, after the first few months, this effect completely disappears, and worker behavior is entirely explained by a conventional economic model in which workers respond to financial incentives. As the authors put it, using more technical academic language: “an entirely standard model with no behavioral or dynamic features that we estimate off the pre-change data, fits the observations four months after the contract change remarkably well. While not an unequivocal indictment of the recent emphasis on ‘behavioral economics,’ the findings suggest that non-standard responses may be ephemeral, especially in employment contexts in which the baseline relationship is delineated by financial considerations in the first place.”

In my reading, the authors have found what used to be called a “Hawthorne effect,” a temporary response by employees to any change in management practice, workplace conditions, the employment contract, etc. Trying something new, whatever it is, can have a positive effect, but only temporarily.

I think the authors have identified a more fundamental problem with the behavioral social-science literature, namely that the empirical studies typically cover a very short time horizon, so that it is difficult to distinguish transitory from more permanent effects. Many behavioral researchers begin with strong prior beliefs about what they expect to find and, once they think they find it, they stop looking.

Dishonesty and Selection into Government Service

Dick Langlois points us to an interesting NBER paper on self-selection into government service, the results of which will surprise few readers of this blog:

In this paper, we demonstrate that university students who cheat on a simple task in a laboratory setting are more likely to state a preference for entering public service. Importantly, we also show that cheating on this task is predictive of corrupt behavior by real government workers, implying that this measure captures a meaningful propensity towards corruption. Students who demonstrate lower levels of prosocial preferences in the laboratory games are also more likely to prefer to enter the government, while outcomes on explicit, two-player games to measure cheating and attitudinal measures of corruption do not systematically predict job preferences. We find that a screening process that chooses the highest ability applicants would not alter the average propensity for corruption among the applicant pool. Our findings imply that differential selection into government may contribute, in part, to corruption. They also emphasize that screening characteristics other than ability may be useful in reducing corruption, but caution that more explicit measures may offer little predictive power.

The (Austrian) Economist as Public Intellectual

RothbardTurgotNicholas Kristof writes in the Sunday New York Times about the decline of the public intellectual. “Some of the smartest thinkers on problems at home and around the world are university professors, but most of them just don’t matter in today’s great debates.” As Kristof rightly points out, in many academic disciplines, career success comes exclusively from publications in peer-reviewed journals. Writing and speaking for a popular  audience, trying to influence journalists or policymakers, and even using blogs and social media are seen as distractions at best, pandering at worst. I once had a colleague who, as a junior professor, got an opinion piece published in the Wall Street Journal. “There goes his shot at tenure!” was the snarky reply from the senior faculty.

Of course, the great scholars of the Austrian tradition never took this position. Carl Menger started his career as a financial journalist and, after achieving international fame with his Principles of Economics, took a position as tutor to the Austro-Hungarian Crown Prince. Böhm-Bawerk was not only an eminent scholar but a vigorous participant in public debates and three-time minister of finance in the Austro-Hungarian empire. Mises spent most of his career as chief economist for the Vienna Chamber of Commerce, where he spent his days advising businessmen and government officials, his nights and weekends producing his seminal academic articles and books. Murray Rothbard, besides contributing original  theoretical and empirical works in economic theory, the philosophy of science, political economy, and US economic history, was a prolific writer of popular articles and books, a frequent speaker, and a tireless organizer for popular as well as scholarly causes.

The Mises Institute has, since its founding in 1982, pursued a three-way mission emphasizing academic research, teaching, and public outreach. Our faculty include top established and emerging scholars in Austrian economics who are working to develop, integrate, and advance the great tradition established by Menger. They publish in our Quarterly Journal of Austrian Economics and other peer-reviewed journals, present and discuss their work at our Austrian Economics Research Conference and other professional meetings, and otherwise keep the Austrian tradition healthy and strong. But our scholars also contribute to our Mises Daily series, they speak at our outreach conferences, and otherwise work to make the lessons of the Austrian school accessible and relevant to the problems and issues of our day. You can also find their work on our blog, on the Mises View, and wherever else good ideas are discussed. Scholarship is central to our mission, but so is relevance. Perhaps Kristof’s lament will spur other academics to do likewise and embrace the role of public intellectual.

Hydraulic Keynesianism Lives

I believe it was Alan Coddington who coined the term “hydraulic Keynesianism” to describe the typical macroeconomics textbooks of the 1950s, “conceiving the economy at the aggregate level in terms of disembodied and homogeneous flows.” The term also has a great visual quality, bringing forth an image of the economy as a giant machine with pumps and tubes and dials and levers, carefully controlled by wise government planners. (Such a machine was actually built by Bill Phillips of Phillips Curve fame.)

Apparently the Atlanta Fed has produced an educational video, “Money as Communication,” solemnly explaining the vital role of the Federal Reserve System in maintaining price stability. Mike Shedlock provides an amusing point-by-point commentary on the video, which surely ranks among  the best of government propaganda films. I especially liked the image below, taken from the video, which neatly encapsulates the Fed’s view of its own role in the economic system.

price stability

The woman at the keyboard has the wrong hair color to be Janet Yellen, and the man in the middle has too much hair to be Ben Bernanke, but I’m sure the intended audience — schoolchildren and New York Times reporters — will get the idea.

Report from the ASSA Conference

I attended this year’s ASSA conference in Philadelphia. The big story for most attendees was the weather, with a big winter storm leading to delayed and cancelled flights and trains, missed connections, and a slight damper on enthusiasm. It is a huge conference with several thousand participants and hundreds of sessions, panels, receptions, and other events. As you can imagine, with that much activity, the activities included the good, the bad, and the ugly. For most attendees the highlights were probably the speeches by Bernanke and current AEA president Claudia Goldin and lively give-and-take between Larry Summers and John Taylor. (My sympathies lie with Taylor.) I presented a paper on university business incubators, showing that their contributions to innovation and entrepreneurship may be more modest than advertised. Many Austrian economists attend the conference but the Austrian school is not, unfortunately, well represented on the program.

Much of the conference activities take place behind the scenes, as hundreds of colleges and universities interview huge numbers of job-market candidates in hotel suites, lounges, and cattle pens. (Just kidding about the last.) It’s a well-organized market about which much has been written (the AEA even tries to incorporate some economic theory into its market design). The overall experience for students (and recruiters) is highly variable (though not, apparently, as bad as with the Modern Language Association).

I met several young Austrian economists who are looking for jobs, or have recently secured them and are moving their way along the tenure track. This is all to the good, of course. However, I’ve noticed a disturbing trend in recent years, in which young Austrians seem less interested in the substance of their work than in how it will be received; their emphasis is on “playing the game” rather than seeking the truth. You also hear this said of the movement as a whole; unless Austrians get better at playing the game, our movement is in trouble. I’m reminded of Joe Salerno’s distinction between “professional” and “vocational” economists. Of course, Austrians seeking careers in academia need jobs and should be encouraged to follow the appropriate professional steps to market and distribute their work, to improve their teaching, and to maximize their chances at professional success. But we do not measure the health of our movement solely by PhDs granted, positions secured, or articles published.

Hayek and the Mont Pèlerin Society

Friedrich_Hayek_portraitTwo items of note:

1. Ross Emmett’s EH.Net review of The Great Persuasion: Reinventing Free Markets since the Depression by Angus Burgin (Harvard, 2012), which focuses extensively on Hayek and the Mont Pèlerin Society. Ross calls it  ”a subtle and nuanced history,” much better than recent similar books by Stedman Jones (2012) and Mirowski and Plehwe (2009).

2. A piece in National Affairs on Irving Kristol and Gertrude Himmelfarb which discusses Himmelfarb’s interactions with Hayek in London in the 1930s (HT: Nicolai Foss). “Himmelfarb and Hayek discussed, among other intellectual topics, his forthcoming launch of ‘an international Acton Society to promote the ideals of liberty and morality,’ which became the Mont Pelerin Society. . . . Himmelfarb admired Hayek for having linked Acton to Adam Smith and the ‘Manchester school.’ . . . [S]he recapped Hayek’s 1945 lecture at University College Dublin, in which he differentiated between the ‘true individualists’ of the Anglo-Scottish Enlightenment and the ‘false individualists’ of the Continental Enlightenment. . . . This sharp distinction between the two Enlightenments would later prove fundamental to both Himmelfarb’s and Kristol’s own work.”

Mendacious NYT Reporter Smears Economists on Speculation

Thanks to Felix Salmon for quoting me in his take-down of this embarrassing NYT piece on Craig Pirrong and Scott Irwin, two well-known economists who study commodity-market speculation. Basically, the reporter dislikes speculation (which he clearly doesn’t understand), so he assumes any expert with a different view must be a hired gun for various commodity-market firms and groups. The result is a preposterous article riddled with “jaw-on-the-floor” errors, mendaciously edited so the unfounded accusations come first, and the self-contradictions revealed only at the end of the piece. (E.g., the professors are paid consultants for these groups — oh, but they say the opposite of what these groups want, and are actually paid to work on entirely different things.)

As one commentator on my blog described it: “NYT reporter dutifully caters to its dwindling readership’s biases in an attempt to sell newspapers.”

How To Teach Italian

italian_verbs_1_avere_essere_dare_edited-1Mike Konczal objects to the typical sequence of a first-year economics curriculum: a semester of microeconomics, studying individuals, firms, and markets, followed by a semester of macroeconomics, looking at the economy as a whole. Austrian economists generally reject the artificial distinction between micro and macro, as taught in the mainstream textbooks, but most would start with individual human action, the analysis of bilateral then interpersonal exchange, then capital and production before going on to more complex interactions among capitalists, entrepreneurs, workers, and consumers, money and banking, the business cycle, and so on — in a broad sense, micro before macro.

Konczal thinks economists should teach macro first, then micro:

What if macroeconomics came first, before the study of individual markets? If were to reverse the typical curriculum, the first thing undergraduates would encounter wouldn’t be abstract theories about people optimizing, but instead the idea of involuntary unemployment and the idea that the economy could operate below its potential. They’d study the economy in the short-run before going to issues of long-term growth, with professors having to explain the theories on how the two are linked, bringing in crucial concepts like hysteresis.

Then, in the second class, they would get to microeconomics. But that too would be taught backwards. They’d start with institutions, understanding what enables a market economy to exist. Then they’d move on to the issue of firms with market power and externalities. Then, only at the very end, they’d get to the purest abstraction of perfect markets, with a final emphasis on what it means to be the isolated, optimizing Robinson Crusoe at the very end.

Konczal confuses differences in the level of aggregation with differences in theory versus application and “perfect” versus “imperfect” settings, among other problems. (He also seems to know little about how economics is actually taught — some textbooks put macro before micro already, and many programs teach micro and macro as standalone courses that students can take in any order.) But consider his core claim that aggregate phenomena should be studied first, their constituent elements second. How would this work in other settings?

I propose a Konczalian experiment, a two-semester model for teaching Italian literature to American students. In the first semester they examine classic and modern works, in the original language, and discuss them in class. Students choose their favorites and argue the merits of each work, paying particular attention to the professor’s own idiosyncratic preferences. Next they review Italian-language newspapers and blogs and relate literary works to broader social, cultural, and political trends. In the second semester, they learn to read Italian.

Mandela and the Economics of Apartheid

Nelson Mandela, public face of the anti-Apartheid movement and South Africa’s first post-Apartheid president, has died. Much will be written about Mandela in the coming days, but little of it will deal directly with the Apartheid system, particularly its economic aspects. Apartheid is widely misunderstood as a system based purely on racial prejudice, while it was actually a more complex mix of economic controls (primarily, restrictions on capital ownership and movements of labor) and racial separatism — what Tom Hazlett calls “socialism with a racist face.” Apartheid’s political support came primarily from working-class (white) Afrikaners and their labor unions eager to suppress competition from unskilled black labor. As Hazlett notes: ”The conventional view is that apartheid was devised by affluent whites to suppress poor blacks. In fact, the system sprang from class warfare and was largely the creation of white workers struggling against both the black majority and white capitalists.”

The classic treatment of Apartheid as an economic system is W. H. Hutt’s Economics of the Color Bar, first published in 1964. Hutt advocated free markets for capital and labor and strict limits on government intervention in economic affairs. (Hutt, a student of Edwin Cannan at the LSE, was a distinguished labor and monetary economist and a well-known opponent of Keynes; see Peter Lewin’s essay on Hutt for more information.) Leon Louw and Frances Kendall’s 1986 book South Africa: The Solution (republished in 1987 as After Apartheid) offers a thoughtful analysis of South Africa’s economic system, proposing a highly decentralized alternative modeled after the Swiss cantons (see Bettina Bien Greaves’s review here).

Unfortunately, the leaders of the anti-Apartheid movement, Mandela included, viewed Apartheid as a “capitalist” system, turning to Marxism-Leninism as the only viable economic (and political) alternative. When the African National Congress came to power in 1994, it dismantled Apartheid’s system of racial separation, opening up land ownership and labor-market opportunities for all South Africans, but continued to embrace the socialist economic principles that underlie the Apartheid model. As Murray Rothbard pointed out, economic freedom is a better path to racial reconciliation: “Free-market capitalism is a marvelous antidote for racism. In a free market, employers who refuse to hire productive black workers are hurting their own profits and the competitive position of their own company. It is only when the state steps in that the government can socialize the costs of racism and establish an apartheid system.”

photo 1The good news is that there are several libertarian groups in South Africa working to bring about secure property rights, freedom, and peace, including the Mises Institute South Africa, Solidarity, Afrisake, and the Free Market Foundation. I had the pleasure of visiting these groups and their supporters last month during a visit to Johannesburg and Pretoria. To the right is a picture of me with the leadership team of the Mises Institute South Africa. And below is a picture I took of the Mandela house in Soweto, now a museum dedicated to Mandela’s life and the anti-Apartheid movement.