Year: 2017

Robert Shiller delivered the Presidential Address for the American Economic Association on the subject of \”Narrative Economics\” in Chicago on January 7, 2017. A preliminary version of the underlying paper, together with slides from the presentation, is available here.

Shiller\’s broad point was that the key distinguishing trait of human beings may be that we  organize what we know in the form of stories.  He argues:

\”Some have suggested that it is stories that most distinguish us from animals, and even that our species be called Homo narrans (Fisher 1984) or Homo narrator (Gould 1994) or Homo narrativus (Ferrand and Weil 2001) depending on whose Latin we use.  Might this be a more accurate description than Homo sapiens, i.e., wise man? Or might we say \”narrative is intelligence\” (Lo, 2007), with all of its limitations? It is more flattering to think of ourselves as Homo sapiens, but not necessarily more accurate.\”

Shiller goes on to make a case that narratives play a role in economic activity: for example, the way people act during the steep recession of 1920-21 and the Great Depression, as well as in the Great Recession and the most recent election. To me, one of his themes is that economist should seek to bring the narratives of these times that economic actors were telling themselves into their actual analysis by applying epidemiology models to examine actual spread of narratives, rather than bewailing narratives as a sort of unfair complication for the purity of our economic models.

Near the start, Shiller offers the Laffer Curve as an example of a narrative that had some lasting force. For those not familiar with the story, here\’s how Shiller tells it (footnotes omitted):

Let us consider as an example the narrative epidemic associated with the Laffer curve, a diagram created by economist Arthur Laffer … The story of the Laffer curve did not go viral in 1974, the reputed date when Laffer first introduced it. Its contagion is explained by a literary innovation that was first published in a 1978 article in National Affairs by Jude Wanniski, an editorial writer for the Wall Street Journal. Wanniski wrote the colorful story about Laffer sharing a steak dinner at the Two Continents [restaurant] in Washington D.C. in 1974 with top White House powers Dick Cheney [at the time, a Deputy Assistant to President Ford, later to be Vice President] and Donald Rumsfeld (at the time Chief of Staff to President Ford, later to be Secretary of Defense]. Laffer drew his curve on a napkin at the restaurant table.  When news about the \”curve drawn on a napkin\” came out, with Wanniski\’s help, the story surprisingly went viral, so much that it is now commemorated. A napkin with the Laffer curve can be seen at the National Museum of American History … 

Why did this story go viral? Laffer himself said after the Wanniski story exploded that he himself could not remember the event, which had taken place four years earlier. But Wanniski was a journalist who sensed that he had the elements of a good story. The key idea as Wanniski presented it is, indeed, punchy: At a zero-percent tax rate, the government collects no revenue. At a 100% tax rate the government would also collect no revenue, because people will not work if all the income is taken. Between the two extremes, the curve, relating tax revenue to tax rate, must have an inverted U shape. …

Here is a notion of economic efficiency easy enough for anyone to understand. Wanniski suggested, without any data, that we are on the inefficient side of the Laffer curve. Laffer\’s genius was in narratives, not data collection. The drawing of the Laffer curve seems to suggest that cutting tax rates would produce a huge windfall in national  income. To most quantitatively-inclined people unfamiliar with economics, this explanation of economic inefficiency was a striking concept, contagious enough to go viral, even though economists, even though economists protested that we are not actually on the inefficient side of the Laffer Curve (Mirowski 1982). It is apparently impossible to capture why it is doubtful that we are on the inefficient side of the Laffer curve in so punch a manner that it has the ability to stifle the epidemic. Years later Laffer did refer broadly to the apparent effects of historic tax cuts (Laffer 2004); but in 1978 the narrative dominated. To tell the story really well one must set the scene at the fancy restaurant, with powerful Washington people and the napkin.

Here an image of what mus be one of history\’s best-known napkins from the National Museum of American History, which reports that the exhibit was \”made\” on September 14, 1974, and measures 38.1 cm x 38.1 cm x .3175 cm, and was a gift from Patricia Koyce Wanniski:

Did Laffer really pull out a pen and start writing on a cloth napkin at a fancy restaurant, so that Jude Wanniski could take the napkin away with him? The website of the Laffer Center at the Pacific Research Institute describes it this way:

\”As to Wanniski’s recollection of the story, Dr. Laffer has said that he cannot remember the details, but he does recall that the restaurant where they ate used cloth napkins and his mother had taught him not to desecrate nice things. He notes, however, that it could well be true because he used the so-called Laffer Curve all the time in classroom lectures and to anyone else who would listen.\” 

In the mid-1980s, when I was working as an editorial writer for the San Jose Mercury News in California, I interviewed Laffer when he was running for a US Senate seat.  He was energy personified and talked a blue streak, and I can easily imagine him writing on cloth napkins in a restaurant. When remembering the event 40 years later in 2014, Dick Cheney said:

It was late afternoon, sort of the-end-of-the-day kind of thing. As I recall, it was a round table. I remember a white tablecloth and white linen napkins because that’s what [Laffer] drew the curve on. It was just one of those events that stuck in my mind, because it’s not every day you see somebody whip out a Sharpie and mark up the cloth napkin at the dinner table. I remember it well, because I can’t recall anybody else drawing on a cloth napkin.

The point of Shiller\’s talk is that while a homo sapiens discussion of the empirical evidence behind the Laffer curve can be interesting in its own way, understanding the political and cultural impulse behind tax-cutting from the late 1970s up to the present requires genuine intellectual opennees to a homo narrativus explanation–that is, an understanding of what narratives have force at certain times, how such narratives come into being, why the narratives are powerful, and how the narratives affect various forms of economic behavior.

My own sense is that homo sapiens can be a slippery character in drawing conclusions. Homo sapiens likes to protest that all conclusions come from a dispassionate consideration of the evidence. But again and again, you will observe that when a certain homo sapiens agrees with the main thrust of a certain narrative, the supposedly dispassionate consideration of evidence involves compiling every factoid and theory in support, as well as denigrating those who believe otherwise as liars and fools; conversely, when a different homo sapiens disagrees with the main thrust of certain narrative, the supposedly dispassionate consideration of the evidence involves compiling every factoid and theory in opposition, and again denigrating those who believe otherwise as liars and fools. Homo sapiens often brandishes facts and theories as a nearly transparent cover for the homo narrativus within.

When you are thinking about investing in a mutual fund , here\’s an impolite but seemingly relevant question to ask: How wealthy were the parents of the manager of the fund?  Oleg Chuprinin and Denis Sosyura raise this question in \”Family Descent as a Signal of Managerial Quality: Evidence from Mutual Funds\” (August 2016, NBER Working Paper No. 22517). The paper is not freely available online, but Jay Fitzgerald offers a short accessible overview in the December 2016 NBER Digest. As Fitzgerald writes:

\”This study relies on hand-collected data from individual U.S. Census records on the wealth and income of managers\’ parents. The researchers also identified and verified fund managers via Morningstar, Nelson\’s Directory of Investment Managers, and LexisNexis Public Records. They ultimately identified hundreds of fund managers, most born in the mid-1940s, whose parents\’ Census records were in the public domain. They then examined the performance of hundreds of actively managed mutual funds focused on U.S. equities between the years 1975 and 2012.

\”The researchers find that mutual fund managers from wealthier backgrounds delivered `significantly weaker performance than managers descending from less wealthy families.\’ Managers from families in the top quintile of wealth underperformed managers in the bottom quintile by over one percent per year on a risk-adjusted basis.\” 

Here\’s a figure to illustrate the findings. The results show monthly returns in \”basis points,\” which means that 20 is actually .2%. Fund managers whose parents came from the highest wealth quintile performed the worst, while fund managers whose parents came from the lowest wealth quintile performed the best.

What\’s going on here? It seems unlikely that skill levels are distributed in this way across families. Instead, the plausible explanation offered by the authors is that it\’s a lot easier for people from high-wealth families to become fund managers, and a lot harder for people from low-wealth families to do so. Because those who start in low-wealth families face more barriers in becoming a fund manager, only the most very highly suited and skilled actually work their way into such a job. Fitzgerald notes some other differences, too:

\”Indeed, in tracking career trajectories of mutual fund managers, they find that the promotions of managers from well-to-do families are less sensitive to their performance. In other words, managers who are born rich are more likely to be promoted for reasons unrelated to performance. In contrast, those born into poor families are fewer in number and are promoted only if they outperform. They also find that fund managers from less-affluent families who do make it into top ranks are more active on their job: they are more likely to trade and deviate from the market, whereas those born rich are more likely to follow benchmark indexes.\” 

The study is interesting to me on both conceptual and practical grounds. On conceptual grounds, it\’s difficult to measure the extent of favoritism to those from more-wealthy families, or equivalently, the extent of bias against those from less-wealthy families. After all, those who come from families with greater wealth may often have an advantage because their families were in a better position to invest in their human capital, or else because of social favoritism, and it\’s not easy to find data that will distinguish between the two. But in the example of mutual funds, the measure of job performance is very simple–it\’s just the return on the fund. So if those from high-wealth families don\’t (on average) measure up as managers of mutual funds, it certainly smacks of favoritism toward them

On practical grounds, there\’s no particular reason to believe that the underlying takeaway from the paper applies only to mutual funds. When those who face  higher barriers to success manage to overcome those barriers in any occupation, it may often be a sign that their competence level is not just high, but exceptionally high.

A lot of the US discussion about international trade seems to assume that we can simultaneously discourage the importers and encourage the exporters. But this belief assumes, implicitly, that importers and exporters are different firms. If the US firms that import have a lot of overlap with firms that also export, then if you impose costs on these firms by hindering their imports, you will also make it harder for them to export.

In fact, the main US importers do have a lot of overlap with the main US exporters. J. Bradford Jensen offers a useful figure in a blog post at the Peterson Institute for International Economics,: \”Importers are Exporters: Tariffs Would Hurt Our Most Competitive Firms.\” For example, out of the 2,000 US firms that are in the top 1% of exporters, 36% are also in the top 1% of importers; conversely, of the 1,300 US firms that are in the top 1% of importers, 53% are also in the top 1% of exporters.

The figure emerges from ongoing work by Andrew B. Bernard, J. Bradford Jensen, Stephen J. Redding, and Peter K. Schott. For a recent example, see their working paper \”Global Firms,\” available as National Bureau of Economic Research Working Paper #22727 (October 2016). Or for an earlier overview of this work, the same four authors wrote \”Firms in International Trade,\” which appears in the Summer 2007 issue of the Journal of Economic Perspectives.  As they note in the NBER working paper:

\”Research in international trade has changed dramatically over the last twenty years, as attention has shifted from countries and industries towards the firms actually engaged in international trade. … [M]uch of international trade is dominated by a few “global firms,” which participate in the international economy along multiple margins and account for substantial shares of aggregate trade.\” 

Jensen explains further in the PIIE blog post:

\”First, it is costly for firms to start importing and exporting—effort and investments are required to start doing each. This implies that only the most productive firms will engage in importing or exporting. Once a firm starts importing, it reduces the firm’s costs and thus makes it possible to export. Similarly, exporting increases a firm’s revenue and this makes it possible for the firm to import. These two aspects of firm behavior are intertwined and both would be damaged by higher tariff costs.

\”In a world with these types of interdependent firm decisions, small decreases in trade costs (such as reductions in tariffs) can have magnified effects on trade flows, as they induce firms to serve more markets, export more products to each market, export more of each product, source intermediate inputs from more countries, and import more of each intermediate input from each source country. But the process can work in reverse. Hence, policies to restrict imports, such as tariffs, that are intended to help a nation’s firms can end up hurting its most successful producers, for whom importing is part and parcel of exporting and a central pillar of their overall business strategy.\”

Engels offers several interrelated counterarguments. One is that the Malthusian arguments offers capitalists a rationalization for treating the poor as a \”surplus population\” and that \”nothing should be done for them except to make their dying of starvation as easy as possible.\” Engels calls this \”the immorality of the economist brought to its highest pitch.\” Instead, Engels argues that there is not a problem of surplus population, but instead a problem of \”surplus wealth, surplus capital and surplus landed property.\”  Instead, Engels argues that workers produce a surplus. He writes that \”every adult produces more than he himself can consume, that children are like trees which give superabundant returns on the outlays invested in them …\” In Engels\’s view, if all the interests of capital and labor are fused together, so that workers can share in what they have produced, \”overpopulation\” will not occur.

Finally, Engels argues that the Malthusian argument neglects the power of science to increase argues production. He writes: \”[T]here still remains a third element which, admittedly, never means anything to the economist – science – whose progress is as unlimited and at least as rapid as that of population. … [S]cience advances in proportion to the knowledge bequeathed to it by the previous generation, and thus under the most ordinary conditions also in a geometrical progression. And what is impossible to science?\” It made me smile a bit to contemplate Engels offering a defense of rising output driven by technological progress (and apparently no need for market-based incentives to raise output) as a central part of his challenge to Malthus.

Here\’s an excerpt from Engels\’s 1844 essay, in which he includes a number of pleasantly snarky comments about economists in general:

Malthus, the originator of this doctrine, maintains that population is always pressing on the means of subsistence; that as soon as production increases, population increases in the same proportion; and that the inherent tendency of the population to multiply in excess of the available means of subsistence is the root of all misery and all vice. For, when there are too many people, they have to be disposed of in one way or another: either they must be killed by violence or they must starve. But when this has happened, there is once more a gap which other multipliers of the population immediately start to fill up once more: and so the old misery begins all over again. …  The implications of this line of thought are that since it is precisely the poor who are the surplus, nothing should be done for them except to make their dying of starvation as easy as possible, and to convince them that it cannot be helped and that there is no other salvation for their whole class than keeping propagation down to the absolute minimum. Or if this proves impossible, then it is after all better to establish a state institution for the painless killing of the children of the poor .. whereby each working-class family would be allowed to have two and a half children, any excess being painlessly killed. Charity is to be considered a crime, since it supports the augmentation of the surplus population. Indeed, it will be very advantageous to declare poverty a crime and to turn poor-houses into prisons, as has already happened in England as a result of the new “liberal” Poor Law.
Am I to go on any longer elaborating this vile, infamous theory, this hideous blasphemy against nature and mankind? Am I to pursue its consequences any further? Here at last we have the immorality of the economist brought to its highest pitch. What are all the wars and horrors of the monopoly system compared with this theory! … 

If Malthus had not considered the matter so one-sidedly, he could not have failed to see that surplus population or labour-power is invariably tied up with surplus wealth, surplus capital and surplus landed property. The population is only too large where the productive power as a whole is too large. The condition of every over-populated country, particularly England, since the time when Malthus wrote, makes this abundantly clear. These were the facts which Malthus ought to have considered in their totality, and whose consideration was bound to have led to the correct conclusion. Instead, he selected one fact, gave no consideration to the others, and therefore arrived at his crazy conclusion.

The second error he committed was to confuse means of subsistence with [means of] employment. That population is always pressing on the means of employment – that the number of people produced depends on the number of people who can be employed – in short, that the production of labour-power has been regulated so far by the law of competition and is therefore also exposed to periodic crises and fluctuations – this is a fact whose establishment constitutes Malthus’ merit. But the means of employment are not the means of subsistence. Only in their end-result are the means of employment increased by the increase in machine-power and capital. The means of subsistence increase as soon as productive power increases even slightly. Here a new contradiction in economics comes to light. The economist’s “demand” is not the real demand; his “consumption” is an artificial consumption. For the economist, only that person really demands, only that person is a real consumer, who has an equivalent to offer for what he receives. But if it is a fact that every adult produces more than he himself can consume, that children are like trees which give superabundant returns on the outlays invested in them – and these certainly are facts, are they not? – then it must be assumed that each worker ought to be able to produce far more than he needs and that the community, therefore, ought to be very glad to provide him with everything he needs; one must consider a large family to be a very welcome gift for the community. But the economist, with his crude outlook, knows no other equivalent than that which is paid to him in tangible ready cash. He is so firmly set in his antitheses that the most striking facts are of as little concern to him as the most scientific principles.

We destroy the contradiction simply by transcending it. With the fusion of the interests now opposed to each other there disappears the contradiction between excess population here and excess wealth there; there disappears the miraculous fact (more miraculous than all the miracles of all the religions put together) that a nation has to starve from sheer wealth and plenty; and there disappears the crazy assertion that the earth lacks the power to feed men. …

At the same time, the Malthusian theory has certainly been a necessary point of transition which has taken us an immense step further. Thanks to this theory, as to economics as a whole, our attention has been drawn to the productive power of the earth and of mankind; and after overcoming this economic despair we have been made for ever secure against the fear of overpopulation. We derive from it the most powerful economic arguments for a social transformation. … Through this theory we have come to know the deepest degradation of mankind, their dependence on the conditions of competition. It has shown us how in the last instance private property has turned man into a commodity whose production and destruction also depend solely on demand; how the system of competition has thus slaughtered, and daily continues to slaughter, millions of men. All this we have seen, and all this drives us to the abolition of this degradation of mankind through the abolition of private property, competition and the opposing interests.

Yet, so as to deprive the universal fear of overpopulation of any possible basis, let us once more return to the relationship of productive power to population. Malthus establishes a formula on which he bases his entire system: population is said to increase in a geometrical progression – 1+2+4+8+16+32, etc.; the productive power of the land in an arithmetical progression – 1+2+3+4+5+6. The difference is obvious, is terrifying; but is it correct? Where has it been proved that the productivity of the land increases in an arithmetical progression? The extent of land is limited. All right! The labour-power to be employed on this land-surface increases with population. Even if we assume that the increase in yield due to increase in labour does not always rise in proportion to the labour, there still remains a third element which, admittedly, never means anything to the economist – science – whose progress is as unlimited and at least as rapid as that of population. What progress does the agriculture of this century owe to chemistry alone – indeed, to two men alone, Sir Humphry Davy and Justus Liebig! But science increases at least as much as population. The latter increases in proportion to the size of the previous generation, science advances in proportion to the knowledge bequeathed to it by the previous generation, and thus under the most ordinary conditions also in a geometrical progression. And what is impossible to science? But it is absurd to talk of over-population so long as “there is ‘enough waste land in the valley of the Mississippi for the whole population of Europe to be transplanted there”; so long as no more than one-third of the earth can be considered cultivated, and so long as the production of this third itself can be raised sixfold and more by the application of improvements already known.

Every now and again, I\’ll post a cartoon suitable for tacking up on a bulletin board, or blending into an economics lecture. Here\’s a useful reminder from Honest Abraham Lincoln himself for 2017. Thanks to all readers who take a few minutes out of their day, now and then, to spend time looking at quotations from the Internet on this site.

This particular image is from cheezburger.com, but versions of it are all over the web.  I like this version because of the glasses. And yes, you can find message boards and social media where people plaintively ask something like: \”Is this really true?\”