Myths and Realities « Organizations and Markets

Posts filed under 'Myths and Realities'

Department of “Duh”

| Peter Klein |

It must be acknowledged, however, that a researcher’s political ideology or vested interest in a particular theory can still enter even ostensibly descriptive analysis by the data set chosen for the research; the mathematical transformations of raw data and the exclusion of so-called outlier data; the specific form of the mathematical equations posited for estimation; the estimation method used; the number of retrials in estimation to get what strikes the researcher as “plausible” results, and the manner in which final research findings are presented.

That’s Uwe Reinhardt, writing a NY Times op-ed that could have been titled “A Mainstream Economist Tries to Come to Grips with Kaldor-Hicks Efficiency.” It’s actually a pretty thoughtful and informative discussion that exposes some of the fatal — to my mind, anyway — flaws of the Kaldor-Hicks concept. But Reinhardt implies, unfortunately, that virtually every economist accepts the Kaldor-Hicks principle as a normative standard. There is actually a fair amount of dissent, not only from Austrians but also from people like Jon Elster and John Roemer. As Gary Lawson notes in an excellent survey of welfare economics concepts, the Kaldor-Hicks criterion, in practice, is

as useless as Pareto superiority. Kaldor-Hicks efficiency purchases its coherence by requiring that compensation be hypothetically possible in such a way as to guarantee that each person, by her own standards, does not come away a loser, just as strict Paretianism requires that each person judge herself to be as well off or better off than before. All it takes to make the universe of Kaldor-Hicks-efficient transactions an empty set is one person who sincerely cannot be bought-that is, a person who values autonomy, either his own or that of others, so highly that no amount of after-the-fact compensation could possibly leave him as well off as he would have been had the loss never been inflicted. (without consent) in the first place. In a large population, no legal rule [or other reallocation of resources] will ever satisfy the Kaldor-Hicks efficiency criterion.

4 comments 27 August 2010

The Corporate Hierarchy Dies, Again

| Peter Klein |

Ronald Coase described his 1937 paper on the firm as “much cited, but little used.” He was referring to the academic literature, but these days it seems to apply to the popular press as well. Almost every week brings a new article on the death of the corporate hierarchy: you know, firms only exist to deal with transaction costs, and the Internet has reduced them to almost zero, so who needs firms? This argument shows up again and again. But it’s wrong. Of course there are transaction costs between firms (search, bargaining, enforcement). But there are also transaction costs inside firms (agency and information costs, the Misesian calculation problem). The firm straddles these margins. Both sets of transaction costs matter, and both can be reduced through technological change. Coase was not as clear on this point as he could have been, but Williamson has been explaining it for decades, in terms of “comparative contracting costs.” You have to compare both sets of costs, not just look at one. Why is it so hard to see?

Saturday’s WSJ gives us the latest version of the bogus argument, this time from Alan Murray. Same old story: Internet, transaction costs, Tapscott and Williams, wikipedia, yada yada yada. “Mr. Coase received his Nobel Prize in 1991 — the very dawn of the Internet age. Since then, the ability of human beings on different continents and with vastly different skills and interests to work together and coordinate complex tasks has taken quantum leaps. Complicated enterprises, like maintaining Wikipedia or building a Linux operating system, now can be accomplished with little or no corporate management structure at all.” Yawn. “[T]he trends here are big and undeniable. Change is rapidly accelerating. Transaction costs are rapidly diminishing. And as a result, everything we learned in the last century about managing large corporations is in need of a serious rethink.” Zzzzzzzzzzzzzzz. Mr. Murray, please read The Victorian Internet three times fast and have a report on my desk first thing in the morning. “The new model will have to be more like the marketplace, and less like corporations of the past. It will need to be flexible, agile, able to quickly adjust to market developments, and ruthless in reallocating resources to new opportunities.” Right, no corporations of the past ever tried to do this.

15 comments 22 August 2010

The Organizational Economics of the BP Oil Spill

| Peter Klein |

Now that passions are cooling regarding the BP disaster, it’s time to bring organizational issues into the discussion.

1. Everyone knows about the liability caps and the role they may have played in encouraging moral hazard. Just as bank deposits are guaranteed by government deposit insurance, and large banks themselves are probably Too Big to Fail, liability for property damage from oil spills off US waters is limited to $75 million (plus cleanup costs), based on a 1990 law passed after the Exxon Valdiz spill. This presumably mitigates drillers’ incentives to manage environmental risk. Indeed, oil companies enjoy a very cozy relationship with their ostensible guardians; as the NY Times noted, “[d]ecades of law and custom have joined government and the oil industry in the pursuit of petroleum and profit.” The federal agency that oversees drilling, the Minerals Management Service, rakes $13 billion a year in fees in what amounts to a public-private partnership. And does anyone really think the British government would “stand idly by” if BP’s status as an ongoing concern were threatened by criminal or civil penalties?

2. As Bill Shughart points out, BP did not own the Deepwater Horizon platform, but leased it from a company called Transocean. To Bill this suggests “a classic principal-agent problem in which the duties and responsibilities of lessor and lessee undoubtedly were not spelled out fully, especially with respect to maintenance and testing of the rig’s blowout preventer as well as to the advisability of installing a second ‘blind sheer ram,’ which may have been able to plug the well after the first (and only one then in service) failed to do so.” Would BP have paid more attention to safety if it owned, rather than leased, the platform? (more…)

7 comments 20 July 2010

Political and Methodological Individualism

| Peter Klein |

Further to Nicolai’s post, it is also widely believed that methodological individualism — the chief explanatory principle of economics and rational-choice sociology and political science — implies or justifies political individualism or, even worse, some kind of metaphysical or ontological individualism. “But people are social beings!” cry the critics. Well, sure. Methodological individualism is simply the view that social phenomena should be explained, or understood, in terms of the values, beliefs, plans, and actions of the individual that make up the social whole. It makes no claims about the ultimate source of these values and beliefs, the degree to which people are influenced by society, etc. It is a principle of explanation, nothing more.

Here’s a plain statement from Schumpeter, the guy who coined the term “methodological individualism” (okay, he used methodische Individualismus, and borrowed the concept from Weber), writing in 1908:

[W]e must strictly differentiate between political and methodological individualism, as the two have virtually nothing in common. the former starts form the general assumption that freedom, more than anything, contributes to the development of the individual and the well-being of society as a whole and puts forward a number of practical propositions in support of this. The latter is quite different. It has no specific propositions and no prerequisites, it just means that it bases certain economic processes on the actions of individuals. Therefore the question really is: is it practical to use the individual as a basis and would there be enough scope in doing so, or would it be better, in view of specific problems and the national economy as a whole, to use society as a basis. This question is purely methodological and involves no important principle. The socialists can answer it in terms of methodological individualism and the political individualists in terms of their social concept of things, without getting into conflict with their convictions.

See also the Mises quotes discussed here.

8 comments 18 July 2010

The History of Nikola Tesla

| Peter Klein |

Saturday was Nikola Tesla’s birthday. Here’s Jeremiah Warren’s video in Tesla’s honor:

Tesla was, of course, the great inventor whose technical achievements outshone those of his great rival, Thomas Edison, but who was unable to commercialize any of his discoveries. Tesla, unfortunately, put his faith in intellectual property-rights protection, while Edison emphasized management and marketing. As Danny Quah puts it, “Public relations and entrepreneurial savvy trump the raw intellectual idea.”

1 comment 12 July 2010

Pomo Periscope XX: Thomas Basbøll vs. Karl Weick

| Nicolai Foss |

Karl Weick may not really qualify as a bona fide pomo. He writes well and clearly and much of his work is quite in the mainstream of management research. Still, he has written about the favorite pomo notion of reflexivity (e.g., here), his authority is often invoked in prominent pomo tracts in management (e.g., here), and his notion of sensemaking has a distinct pomo connotation.

Weick’s work has recently been subject to close examination by my CBS colleague, Thomas Basbøll. In a recently published paper, “Softly Constrained Imagination: Plagiarism and Misprision in the Theory of Organizational Sensemaking,” Basbøll argues that Weick’s work suffers from ”significant instances of plagiarism and misreading” (p. 164). Wow! Here is the abstract:

While Karl Weick’s writings have been very influential in contemporary work on organizations, his scholarship is rarely subjected to critical scrutiny. Indeed, despite its open ‘breaching’ of the conventions of much academic writing, Weick’s work has been widely celebrated as ‘first-rate scholarship.’ As it turns out, however, his ‘softly constrained’ textual practices are rendered doubtful by both misreading and plagiarism, which makes his work resemble ‘poetry’ in a much stronger sense than perhaps originally intended. This paper draws inspiration from literary theory to analyze three cases of questionable scholarship in Weick’s 1995 book Sensemaking in organizations, framing them in the context of standard formulations of the methodology of sensemaking drawn from the literature. It concludes that we need to rethink our tolerance of the sensemaking style and re-affirm a commitment to more traditional academic constraints.

Here is Weick’s reply. And here is Thomas’s reply to the reply.

14 comments 24 June 2010

Does Behavioral Economics Offer Anything New and True?

| Peter Klein |

One of my frustrations with behavioral economics is that it often seems to restate common, obvious, well-known ideas as if they are really novel insights (e.g., that preferences aren’t stable and predictable over time). More novel propositions are questionable at best (e.g, the paradox of choice).

Dan Ariely’s column in this month’s HBR is particularly frustrating. He claims as a unique insight of behavioral economics that when people are evaluated according to quantitative measures of performance, they tend to focus on the measures, not the underlying behavior being measured. Well, duh. This is pretty much a staple of introductory lectures on agency theory (and features prominently in Steve Kerr’s classic 1975 article). Ariely goes on to suggest that CEOs should be rewarded not on the basis of a single measure of performance, but multiple measures. Double-duh. Holmström (1979) called this the “informativeness principle” and it’s in all the standard textbooks on contract design and compensation structure (e.g., Milgrom and Roberts, Brickley et al., etc.) (Of course, agency theory also recognizes that gathering information is costly, and that additional metrics are valuable, on the margin, only if the benefits exceed the costs, a point unmentioned by Ariely.)

Ariely says firms should not evaluate CEO’s on stock price, but on a variety of measures. What, for example? Here the story gets a bit murky:

Ideally, they’d vary by industry, situation, and mission, but here are a few obvious choices: How many new jobs have been created at your firm? How strong is your pipeline of new patents? How satisfied are your customers? Your employees? What’s the level of trust in your company and brand? How much carbon dioxide do you emit?

Ariely seems unaware that stock price is the most frequently used measure of firm performance precisely because it is a composite measure that captures all of those things. Stock price reflects the best available information about current and expected future performance — products, jobs, customer satisfaction, etc. Is it a perfect measure? Hardly. But it isn’t obvious how owners or Boards can create their own quantitative, composite measure by by picking their favorite elements, proxies, weighting schemes, and so on, in a way that provides better overall assessments of performance than market valuations. Boards, after all, may be predictably irrational too.

15 comments 21 May 2010

Manne on Fama and French

| Peter Klein |

An open letter to Gene Fama and Ken French from Henry Manne (also running today at Truth on the Market):

Dear Gene and Ken:

I must say that I was totally flabbergasted when I read your recent blog posting on insider trading. I know that your usual posts on investments, which I often cite to friends, are well-informed and empirically supported; your work over the years on these topics is important and influential — and rightly so. Unfortunately, in this post, you have deviated from your usual high quality. Anyone current on the topic of insider trading will recognize that you have been careless in your selection of anti-insider-trading arguments and that you omitted from your brief note the major part of the argument about insider trading: whether and how much it contributes to market efficiency. To say this is a strange omission coming from Fama and French would be an understatement.

Your first error is to assume that the insider trading debate is about informed trading only by “top management.” I suspect that this error may flow from my original argument for using insider trading to compensate for entrepreneurial services in a publicly held company, a matter you do not mention and which I will not pursue here except to note that “entrepreneurial services” does not equate to top management. Strangely no one seems to notice that most of the celebrated cases on the subject have not involved corporate personnel at all (a printer, a financial analyst, a lawyer, and Martha Stewart). (more…)

Add comment 17 May 2010

Raising Rivals’ Costs, Goldman Edition

| Peter Klein |

One could also call this “From the Department of ‘Duh’”:

A powerful alumni network plus bundles of campaign cash mean Goldman will get what it wants — and contrary to the media narrative, what Goldman wants is not laissez-faire.

Politico quoted a Goldman lobbyist Monday saying, “We’re not against regulation. We’re for regulation. We partner with regulators.” At least three times in Goldman’s conference call Tuesday, spokesmen trumpeted the firm’s support for more federal control. . . .

Goldman reported on the conference call that it holds 15 percent “Tier 1 capital,” meaning it is very liquid and not very risky. Goldman can play it safe, you see, without needing a regulation. But regulations prevent smaller competitors from taking the risks needed to compete with Goldman (and every competitor is smaller).

The article is also very good on Obama’s Goldman problem. (Link from Steve Horwitz via Per Bylund.)

2 comments 21 April 2010

IRB Flames

| Peter Klein |

Zachary Schrag’s excellent Institutional Review Blog highlights the discussion on a recent Chronicle post about IRBs. As you can imagine, most of the comments are from frustrated researchers who see the campus IRB as their enemy, not their ally. Sample: “At my current institution, humanities scholars are subject to an IRB that only makes sense for scientists collecting blood and doing life-threatening experiments on small children.” Zach points out that a few comments defend the local IRB, but these comments “are vaguer and less eloquent,” and “none tells a story of an IRB review that proved necessary.”

I suspect that some of this researcher frustration can be alleviated by recognizing that IRBs exist not to protect research subjects, but to protect the university. The IRB’s goal is to prevent the university from being sued or otherwise losing Federal funding. Protecting research subjects, improving research methods, and contributing to the growth of knowledge are incidental.

7 comments 15 April 2010

Why Are the Dutch So Clean?

| Nicolai Foss |

Folk wisdom holds that people stopped bathing after the fall of the Roman Empire. Thus, it is commonly held that all of Europe was, until recently, quite smelly indeed. Some hold the view that this is still the case.

There were serious exceptions, of course. I cannot resist mentioning a particularly well taken example, reported by the prior of St. Fridswides, John of Wallingford, “who complained bitterly that the Danes bathed once a week, combed their hair regularly, and changed their clothes regularly. The result was that English women were easily seduced by the nice-smelling Danes” (here).

A perhaps better-known example of European cleanliness is that of the Dutch. It is also the most seriously researched example. In the 17th and 18th century, visitors to Holland wondered about Dutch cleanliness, indeed, obsession with hygiene. Some have argued that this, somehow, reflected Dutch Calvinism. No, argue Bas van Bavel and Oscar Gelderblom in “The Economic Origins of Cleanliness in the Dutch Golden Age,” the reason is . . . butter! And here is the explanation (Abstract):

This paper explores why early modern Holland, and particularly its women, had an international reputation for cleanliness. We argue that economic factors were crucially important in shaping this habit. Between 1500 and 1800 numerous travellers reported on the habit housewives and maids had of meticulously cleaning the interior and exterior of their houses. We argue that it was the commercialization of dairy farming that led to improvements in household hygiene. In the fourteenth century peasants as well as urban dwellers began to produce large quantities of butter and cheese for the market. In their small production units women, and their daughters, worked to secure a clean environment for proper curdling and churning. We estimate that, at the turn of the sixteenth century, half of all rural households and up to one third of urban households in Holland produced butter and cheese. These numbers declined in the sixteenth century as peasants sold their land and larger farms were set up. Initially the migration of entire peasant families to towns, the hiring of farmers’ daughters as housemaids, and the exceptionally high consumption of dairy products continued to encourage the habit of regular cleaning in urban households. However, by the mid-seventeenth century the direct link between dairy farming and cleanliness was, for the most part, lost.

4 comments 5 April 2010

Quote of the Day: Bartley on the Marketplace of Ideas

| Peter Klein |

I happened to be looking today through Unfathomed Knowledge, Unmeasured Wealth by W. W. Bartley, III, who passed away shortly after this book was published. Bartley, a student and colleague of Karl Popper and the Founding Editor of The Collected Works of F. A. Hayek, was a brilliant and penetrating thinker whose work is not very well known outside of a few professional circles. Unfathomed Knowledge, a book about higher education (with the subtitle “On Universities and the Wealth of Nations”), was written for a general audience and is full of insights about the crazy business of academia. Here’s one passage:

Analogies have often been drawn between a free market in ideas and free markets in goods and services. Yet intellectuals tend to dislike such comparisons. They see the free market in ideas as something on a higher plane, qualitatively different from free markets in commodities and the like. Many of them indeed even hate the marketplace as traditionally conceived, and would want nothing to do, even analogically, with a free market in coal, housing, fish, or petroleum.

Take a few examples. Several scholars, including Edward Shils, of the University of Chicago, strongly protested the analogy when it was drawn by Michael Polanyi at the Congress for Cultural Freedom. One called Polanyi’s comparison between free markets in goods and in ideas “clever but questionable” in that a man who offers commodities in the free market “is not bound by anything” whereas in science one is bound to an objective method. Shils added that members of the scientific community, by contrast to businessmen and traders, act in accordance with overriding standards, a “common law” above and beyond individuals.

Such a position does not withstand examination. Someone offering commodities in a market — far from being “not bound by anything” — is governed by enforceable law relating to fraud, credit, contract and such like. The analogy does have limits, but of a different sort: in the marketplace of ideas, fraud, plagiarism, theft, false advertising (including false claims to expertise and the whole mystique of expertise), “conspiracies of silence,” casual slander and libel, breach of contract, deceit of all sorts are more common than in business — simply because there are few readily enforceable penalties against offenders, whereas “whistle-blowers” are severely punished. This is so especially in those areas (the humanities, social sciences, the arts — as opposed to the profitable fields) where the transaction costs of enforcing such things as property rights, priority claims, or even accurate report5ing usually outweigh the advantage in doing so, and where the transaction costs of trying to defend oneself against such things as slander are prohibitive.

5 comments 25 February 2010

Industry-Level Effects of Government Spending

| Peter Klein |

A consistent theme of this blog’s postings on the financial crisis and recession is that the Keynesians focus on too high a level of aggregation. As economists and management scholars we care primarily about industries, firms, and individuals, not abstract macroeconomic aggregates like GDP, the “price level,” etc. Heterogeneity matters, and the way stimulus programs affect the allocation of resources across firms and industries is as important, or more important, than their economy-wide effects.

A new NBER paper by Christopher Nekarda and Valerie Ramey uses disaggregated industry-level data to examine the effect of the current US stimulus program on output, employment, real wages, and productivity. They find, not surprisingly, that increases in government spending directed toward a specific industry raise that industry’s short-term output and employment but — contrary to New Keynesian predictions — reduce that industry’s real wages and productivity.

Nekarda and Ramey note that stimulus spending has been directed disproportionately to durable-goods manufacturing and that these industries have higher returns to scale than other industries, possibly explaining how reductions in industry-level productivity could look like productivity gains in the aggregate. In other words, stimulus spending reduces efficiency in all industries, but directs resources toward industries that were more efficient to begin with, giving the appearance of a positive aggregate effect. Thoughtful and provocative.

1 comment 22 February 2010

The Capitalist Kibbutz

| Peter Klein|

That’s how the Financial Times headlines this fascinating story about the transformation of many Israeli kibbutzim into partially privatized, profit-seeking, professionally managed entities that act in capital, product, and factor markets just like private firms. There are some similarities with the end of the socialist experiment in Russia: “‘The kibbutz was never isolated from society,’ says Shlomo Getz, the director of the Institute for Research of the Kibbutz at Haifa University. ‘There was a change in values in Israel, and a change in the standard of living. Many kibbutzniks now wanted to have the same things as their friends outside the kibbutz.”

The bottom line, from economist and former kibbutznik Omer Moav: “People respond to incentives. We are happy to work hard for our own quality of life, we like our independence. It is all about human nature — and a socialist system like the kibbutz does not fit human nature.” (Via BK Marcus.)

2 comments 9 February 2010

Brad’s Bloviations, Part #2,235

| Peter Klein |

Brad DeLong accuses non-Keynesians (Austrians, Chicagoites, and other sensible people) of “los[ing] themselves amidst their early-nineteenth century books, one hundred and seventy years behind the state of the art in economics,” just because they think public spending and deficits might be crowding out private-market activity, making it difficult — impossible, actually — to come up with meaningful estimates of “jobs saved” by stimulus spending. If you can get past Brad’s adolescent writing style (anyone citing Bastiat, for example, is “a truly clueless idiot”), you find that he is indeed very “progressive” in his thinking — he’s made it all the way to 1950. Brad, like most Keynesians, is stuck in the C + I + G world of undergraduate macro. His argument is that the stimulus can’t be crowding out private-sector jobs because (a) wages aren’t rising (implying that stimulus-funded workers aren’t being bid away from other potential opportunities) and (b) T-bill prices aren’t falling (suggesting that private employers aren’t competing with the Feds for credit).

Leave aside for the moment that Brad has no idea what wages and bond prices would be in the absence of stimulus. The key problem with Brad’s argument, noted by Russ Roberts, is its reliance on crude macroeconomic aggregates. As pointed out here many times, heterogeneity matters. Sensible economists care not about the aggregate unemployment rate, but the effect of stimulus activity on individual labor markets. Stimulus affects the composition of employment, not just its level. (more…)

8 comments 3 February 2010

Apocalypse Averted

| Dick Langlois |

In a recent post, I lamented the willingness of pundits (and dissenting Justices) to see rights as a consequential exercise: we should restrict the speech of group X, in this case private corporations, because allowing such speech would lead to a bad outcome, in this case the corruption of democracy by corporate interests. (Feel free to substitute here your own favorite candidate for silencing and your own associated bad outcome.) But, of course, those who argue in this manner must also demonstrate that the asserted bad outcome would actually happen. A recent article in the Times — bless some reporter’s or editor’s contrarian heart — asks the question: so, what effect does corporate money actually have on democracy?” The answer seems to be: none at all. One of the economists cited is Peter’s Missouri colleague, and my former student, Jeff Milyo: “There is just no good evidence that campaign finance laws have any effect on actual corruption.”

And while we are at it, a study by the Insurance Institute for Highway Safety finds no effect of cell phone laws on traffic accidents. This hasn’t stopped Connecticut’s Governor from calling for even stricter cell phone laws.

6 comments 31 January 2010

The Era of Laissez-Faire?

| Peter Klein |

One of the established memes about the financial crisis is that it demonstrates the failure of unfettered capitalism, the dog-eat-dog, laissez-faire environment that prevailed in the West over the last few decades, all driven by the ideology of “free-market fundamentalism.” This seems to be a truism among most of the Commentariat. Of course, as pointed out repeatedly on this blog, the truth is virtually the opposite: there was never any “deregulation,” the Bush Administration spent public money like a drunken sailor, and government continued to expand as it always does. But a picture is worth a thousand words, so try these on for size. (US data; click charts for sources.)

One response I sometimes hear is “Sure, there are more regulations and more government spending, but the set of things that should be regulated and the amount of government spending the economy needs are growing even faster!” This is essentially the Krugman-DeLong view about the stimulus: it just wasn’t big enough. Or they say that financial markets were “deregulated,” de facto, because the number of regulations and regulators increased more slowly than the number of new financial instruments and new markets. I wonder, though: are these falsifiable propositions? No matter how big the government is, if there are any problems, it’s always because the government isn’t big enough!

13 comments 28 January 2010

Recession and Recovery: Six Fundamental Errors of the Current Orthodoxy

| Peter Klein |

A very good summary by Bob Higgs of “vulgar Keynesianism,” defined by Bob as the “pseudointellectual mishmash . . . that has passed for economic wisdom in this country for more than fifty years.” The key feature of VK is an emphasis on crude aggregates (“national income,” “the employment rate,” “the interest rate,” etc.) at the expense of relative prices, firm and industry effects, and cause and effect. Echoing one of this blog’s favorite themes, Bob highlights the VK economist’s inability to grasp the concept of capital structure, “the fine-grained patterns of specialization and interrelation among the countless specific forms of capital goods in which past saving and investment have become embodied. In [the VK] framework of analysis, it matters not whether firms invest in new telephones or new hydroelectric dams: capital is capital is capital.”

Update: See also David Henderson on aggregation.

2 comments 14 January 2010

Words of Wisdom from Williamson’s Banquet Speech

| Peter Klein |

The transcript is here. My favorite bit, which can be read as a response to the econ-bashers:

Being hard-headed means that we aspire to tell it like it is — be it good news or bad. Although we take no joy in the downside, it is our duty candidly to confront all circumstances whatsoever. Our abiding concern is with improving the condition of mankind. Myopia, denial, and obfuscation are the enemy.

Only as we admit to and, of even greater importance, come to understand the problems that confront us — be they current or impending, obvious or obscure, real or imagined — by identifying and explicating the mechanisms that are responsible for these problems, can we expect to make informed decisions. Since, moreover, things that we do not understand at the outset sometimes have redeeming purposes, such efforts to get at the essence will often uncover real or latent benefits. Altogether, our capacity to work in the service of mankind increases as complex contract and economic and political organization become more susceptible to analysis.

Tuesday’s Prize lecture, in case you missed my earlier link, is here. I don’t see a video of the banquet speech on the Nobel site, but maybe that’s coming later. (Thank goodness they found time to post the seating chart!)

One tiny nit-pick: Williamson quotes Carlyle’s famous “dismal science” line, implicitly equating “dismal” with “mean-spirited,” but of course Carlyle’s barb had nothing to do with Malthus or scarcity or trade-offs, but with the classical economists’ opposition to slavery, which Carlyle, Dickens, Ruskin, and other literary critics of capitalism strongly supported (1, 2).

5 comments 10 December 2009

Boeing and the Higgs Effect

| Peter Klein |

In their calls for greatly expanding the Federal Reserve System’s and Treasury Department’s roles in the economy, Chairman Bernanke, Secretaries Paulson and Geithner, and their academic enablers have repeatedly emphasized the temporary nature of these “emergency” measures. “History is full of examples in which the policy responses to financial crises have been slow and inadequate, often resulting ultimately in greater economic damage and increased fiscal costs. In this episode, by contrast, policymakers in the United States and around the globe responded with speed and force to arrest a rapidly deteriorating and dangerous situation,” said Bernanke in September. Yeah, no kidding. But, we are assured, the basic structure of our “free-enterprise” system remains soundly in place.

However, as Bob Higgs has taught us, “temporary,” “emergency” government measures are never that. Indeed, virtually all the major, permanent expansions of US government in the twentieth-century resulted from supposedly temporary measures adapted during war, recession, or some other “crisis,” real or imaginary. Cousin Naomi’s “disaster capitalism” thesis is exactly backward: it is socialism, or interventionism, that thrives during the crisis, and Washington, DC never looks back. I mean, does anyone seriously believe that the Fed will deny, or give back, the authority to purchase whatever financial assets it wishes at some future date when it deems the crisis officially “over”? Will the Treasury credibly commit never again to purchase equity or guarantee debt or otherwise protect some major industrial or financial firm after the economy returns to “normal”? Not a chance. Everything the authorities have done in the last two years to deal with this “emergency” will become part of the federal government’s permanent tool kit.

Today’s WSJ has a good example of Higgs’s ratchet effect, a front-pager on Boeing’s dependence on export loan guarantees from the Export-Import Bank, a federal government agency created in — you guessed it — 1934, as a temporary agency to deal with the Great Depression. “No company has deeper relations with Ex-Im Bank than Chicago-based Boeing. Without Ex-Im, aviation officials say, Boeing this year could have been forced to slash production, endangering hundreds of U.S. suppliers, thousands of skilled American jobs and billions of dollars in export contracts.” Bank official Bob Morin is described as “Ex-Im Bank’s rainmaker. His Boeing deals accounted for almost 40% of the bank’s $21 billion in business last year. To help Boeing through the credit crunch, his team has spent the past year developing government-backed bonds that promise to raise billions.” So, a massive industrial-planning apparatus, supposedly born during a temporary crisis, lives on as the lifeblood of a huge, politically connected US company.

Thank goodness all that money flowing to Goldman Sachs is only temporary!

Update: Here’s a short Higgs piece from 2000 on the Ex-Im Bank, appropriately titled “Unmitigated Mercantilism.”

1 comment 9 December 2009

The WSJ on Vertical Integration

| Peter Klein |

It’s not as bad as this 2006 piece from Slate, but Monday’s WSJ front-pager, “Companies More Prone to Go ‘Vertical,’” is underwhelming at best. It shares a few interesting anecdotes about recent vertical mergers, but falls flat on two major grounds. First, like the Slate piece, it assumes that the advances in IT over the last few decades led to some sort of tectonic shift away from vertical integration, against which firms are now reacting by “rediscovering” the benefits of vertical coordination. Actually there’s little evidence for such a shift. Second, and more important, the article doesn’t bother to mention any theories about what vertical integration is and does. There are vague references to commodity-price volatility and the need to “control” the supply chain, but no recognition that risk-management and control over inputs can be achieved through contract as well as integration. Given that one of this year’s Nobel Laureates won the prize for his work on precisely this problem, you’d think some reference to transaction costs might be appropriate. Old Media, R.I.P.

3 comments 4 December 2009

Nirvana Fallacy Alert, #2,535 in a Series

| Peter Klein |

Another mistake in John Cassidy’s ditty on externalities is the claim that Pigou “was reacting against laissez faire — the hands-off approach to policy that free market economists, from Adam Smith onwards, had recommended. Such thinkers had tended to view the market economy as a perfectly balanced, self-regulating machine.” Forget that the British Classicals, Adam Smith in particular, were far from “hands-off” types. Note instead that Cassidy provides no textual evidence of unnamed “free-market economists” viewing the market system as a “perfectly balanced, self-regulating machine.” How could he, when no sensible economist ever wrote or thought such a thing? The free-market economists — actually, virtually all sound economists — have maintained that the market economy works remarkably well, given the limits of human knowledge, our devious character, the brutality of nature, and so on. Paris gets fed, as Bastiat noted, and that is a miracle. Government intervention into markets inevitably makes things worse, the economists argued, not because the market system is “perfect,” whatever that means, but because men are fallible, and giving coercive power to fallible men is — to borrow P. J. O’Rourke’s metaphor — like giving whiskey and car keys to teenage boys. Cassidy’s caricature shows how little he understands what free-market economics is actually all about.

Add comment 1 December 2009

Modest, Slow, Molecular, Definitive

| Peter Klein |

In an oft-cited passage from The Mechanisms of Governance (1996), Williamson describes the research program of transaction cost economics this way:

Transaction cost economics (1) eschews intuitive notions of complexity and asks what the dimensions are on which transactions differ that present differential hazards. It further (2) asks what the attributes are on which governance structures differ that have hazard mitigation consequences. And it (3) asks what main purposes are served by economic organization. Because, moreover, contracting takes place over time, transaction cost economics (4) inquires into the intertemporal transformations that contracts and organization undergo. Also, in order to establish better why governance structures differ in discrete structural ways, it (5) asks why one form of organization (e.g., hierarchy) is unable to replicate the mechanisms found to be efficacious in another (e.g., the market). The object is to implement this microanalytic program, this interdisciplinary joinder of law, economics, and organization, in a “modest, slow, molecular, definitive” way.

A footnote explains the origins of the phrase “modest, slow, molecular, definitive,” tracing them to a (secondhand) quotation from Charles Péguy. Here’s the footnote:

The full quotation (source unknown) reads:

“The longer I live, citizen. . .” — this is the way the great passage in Peguy begins, words I once loved to say (I had them almost memorized) — “The longer I live, citizen, the less I believe in the efficiency of sudden illuminations that are not accompanied or supported by serious work, the less I believe in the efficiency of conversion, extraordinary, sudden and serious, in the efficiency of sudden passions, and the more I believe in the efficiency of modest, slow, molecular, definitive work. The longer I ive the less I believe in the efficiency of an extraordinary sudden social revolution, improvised, marvelous, with or without guns and impersonal dictatorship — and the more I believe in the efficiency of modest, slow, molecular, definitive work.”

Well, we are nothing if not pedantic here at O&M, and in that spirit, I share (with permission) a note from my colleague and former guest blogger Randy Westgren, written to Williamson in January 2007, explaining that the anonymous source has botched the Péguy quotation. Here’s Randy:

After a long search, I found the quote from Péguy that you cite in footnote nine of the Prologue of The Mechanisms of Governance and noted again in footnote eleven of the first chapter. I was not able to find the secondary quote that is printed in the footnote, but I did find the original passage from Péguy. I have been searching for this since The Mechanisms was published, because I could not fathom how Charles Péguy could have denounced sudden, wondrous conversion and sudden, extraordinary social revolution when he was (1) a famously devout Catholic; a mystic whose poetry includes an exceptional hommage to Joan of Arc, and (2) a famously ardent socialist who believed strongly in the overthrow of the bourgeoisie. In fact, after giving up on the Catholicism of his youth while at the École Normale Supérieure, he returned to his faith in the middle of the first decade of the century, when he was in his early 30s. He was slain in the first battle of the Marne in 1914 at the age of 41. (more…)

1 comment 24 November 2009

The Igon Value of Cognitive Dissonance

| Dick Langlois |

Some of you may have seen Steven Pinker’s review of Malcolm Gladwell’s latest book in the New York Times this weekend. Pinker praises Gladwell’s writing and his instinct for interesting topics, but skewers him for his bad grasp of the underlying science of what he writes about, especially statistics. In Pinker’s view, Gladwell is in the end a character from one of his own essays, “a minor genius who unwittingly demonstrates the hazards of statistical reasoning and who occasionally blunders into spectacular failures.” One blunder seems to epitomize Pinker’s assessment: Gladwell’s report on an expert who talks of “igon values” instead of eigenvalues. Pinker call this the igon value effect.

As I read this, I thought back to a department seminar I had attended a couple of days earlier. Keith Chen from Yale gave one of the most dazzling presentations I’ve heard in a long time. He basically demolished 45 years of experimental results in social psychology that claim to have discovered cognitive dissonance in choices. According to this literature, it is among the best-documented results in psychology that people change their preferences after making a choice so as to rationalize the choice and make themselves feel better about their decision. Chen argues — persuasively — that essentially all these results are statistical artifacts. At a much more sophisticated level, social psychologists have fallen victim to the igon value effect. Here is the abstract of a working paper, though it gives only a hint of how clever this research is.

Cognitive dissonance is one of the most influential theories in social psychology, and its oldest experiential realization is choice-induced dissonance. Since 1956, dissonance theorists have claimed that people rationalize past choices by devaluing rejected alternatives and upgrading chosen ones, an effect known as the spreading of preferences. Here, I show that every study which has tested this suffers from a fundamental methodological flaw. Specifically, these studies (and the free-choice methodology they employ) implicitly assume that before choices are made, a subject’s preferences can be measured perfectly, i.e. with infinite precision, and under-appreciate that a subject’s choices reflect their preferences. Because of this, existing methods will mistakenly identify cognitive dissonance when there is none. This problem survives all controls present in the literature, including control groups, high and low dissonance conditions, and comparisons of dissonance across cultures or affirmation levels. The bias this problem produces can be fixed, and correctly interpreted several prominent studies actually reject the presence of choice-induced dissonance in their subjects. This suggests that mere choice may not be enough to induce rationalization, a reversal that may significantly change the way we think about cognitive dissonance as a whole.

Chen was also written up in the New York Times last year.

Oh, and by the way, that was our second seminar of the day. Earlier we listened to Bob Lucas, whom the grad students brought in to give a major lecture. (First time I had met him.) He talked about his paper in the inaugural issue of the new AEA macro journal: “Trade and the Diffusion of the Industrial Revolution.” (There wasn’t actually much trade in it.) Lucas and I had a nice conversation at lunch about Jane Jacobs, who we agreed was fantastic. “She was a theorist!” was Lucas’s assessment. High praise.

7 comments 19 November 2009

Keynesian Anti-Economics

| Peter Klein |

A reader objected to my recent portrayal of Keynes as a crank, as a man who never really studied economics or took it very seriously. Note that I never denied Keynes’s intellect, his great skill as a rhetorician, or his personal charm. But Keynesian economics is, in a sense, non-economics or even anti-economics, in that it ignores or contradicts many basic lessons about the allocation of scarce resources among competing ends. Mario Rizzo feels the same way:

Keynesianism is not concerned with the allocation of resources and related niceties. One can see this is the policy prescriptions of the stimulators. Just get people back to work. If a market is depressed: Prop it up. Labor, other resource-owners and entrepreneurs need to stop worrying about searching for the appropriate use of resources. Bankers have to stop fretting about to whom they should lend. They should abandon their ultra-restraint. Those who are holding money should invest; they should buy bonds. No need to worry about inflation because the potential output of “stuff” (however it is allocated across industries) is above the actual less-than-full-employment output.

Where did my microeconomics go?

Keynes and his followers proudly trumpeted his framework as a re-do of standard economics (what he called “classical,” though Keynes was not well versed in the history of economic thought). Standard economics is OK during periods of “full employment” (another aggregate concept, of course), but not in the “general” case, in which case the Keynesian magic comes into play. Credit expansion, according to Keynes, performs the “miracle . . . of turning a stone into bread.” As Mises noted, “Great Britain has indeed traveled a long way to this statement from Hume’s and Mill’s views on miracles.”

4 comments 17 November 2009

The Amazing Krugman

| Peter Klein |

The man indeed has a unique talent, as described here by the witty and clever Steve Landsburg:

It’s always impressive to see one person excel in two widely disparate activities: a first-rate mathematician who’s also a world class mountaineer, or a titan of industry who conducts symphony orchestras on the side. But sometimes I think Paul Krugman is out to top them all, by excelling in two activities that are not just disparate but diametrically opposed: economics (for which he was awarded a well-deserved Nobel Prize) and obliviousness to the lessons of economics (for which he’s been awarded a column at the New York Times).

It’s a dazzling performance. Time after time, Krugman leaves me wide-eyed with wonder at how much economics he has to forget to write those columns.

The subject is Krugman’s latest proposal to combat unemployment, namely laws making it harder to fire workers, which of course increases the cost of labor, leading firms to hire less of it, increasing unemployment.

10 comments 14 November 2009

Fed Independence and Comparative Institutional Analysis

| Peter Klein |

I’ve written before on Fed “independence” and why I don’t support it. The vast majority of economists, especially the more prominent ones, are strongly in favor of independence and against Congressional attempts to limit the Fed’s discretion in monetary and regulatory policy. The standard argument is that a “politicized” — i.e., accountable — central bank will be more expansionary than an unaccountable central bank, assuming that credit expansion affects output first and prices (inflation) second. Last week’s piece by Kashyap and Mishkin follows this script. On the face of it, this seems absurd, as — to take only the most obvious example — the Greenspan-Bernanke “independent” Fed has been the most expansionist in modern history, with a ballooning money supply throughout the 2000s and near-zero interest rates and injections of giggledysquillions of dollars into the banking sector in the last 18 months. The independence crowd cites cross-country studies finding a negative correlation between central-bank independence and inflation, but these studies are controversial (many problems with reverse causation, omitted variables, sample size, etc.).

My question today is different: Where, in those arguments, is the comparative institutional analysis? After all, in policy analysis, we are always comparing imperfect alternatives. We try to avoid the Nirvana fallacy. Craig does this in his post below, asking if a centralized financial regulator would be less bad than the competing regulatory bodies we have today.

But the macroeconomists entirely ignore this problem. Consider Mark Thoma’s defense of independence:

The hope is that an independent Fed can overcome the temptation to use monetary policy to influence elections, and also overcome the temptation to monetize the debt, and that it will do what’s best for the economy in the long-run rather than adopting the policy that maximizes the chances of politicians being reelected.

This naive wish is simply that, a hope. Where is the argument or evidence that a wholly unaccountable Fed would, in fact, “do what’s best for the economy in the long-run”? What are the Fed officials’ incentives to do that? What monitoring and governance mechanisms assure that Fed officials will pursue the public interest? What if they have private interests? Maybe they’re motivated by ideology. Suppose they make systematic errors. Maybe they’ve been captured by special-interest groups like, oh, I don’t know, the banking industry (duh). To make a case for independence, it is not enough to demonstrate the potential hazards of political oversight. You have to show that these hazards exceed the hazards of an unaccountable, unrestricted, ungoverned central bank. The mainstream economists totally ignore this question, choosing to put a naive faith in the wisdom of central bankers to do what’s right. Guys, have you never heard of public-choice theory?

3 comments 13 November 2009

No Required Ethics Course at Chicago-Booth

| Peter Klein |

Bucking the trend, the Chicago-Booth MBA program will not offer required courses in business ethics (via Cliff). The school “has no set standard for ethical case studies used in the classroom,” according to Executive Director of Faculty Services Lisa Messaglia,”but leaves it up to faculty, instead.”

[T]he business school is disciplined-based, meaning that classes are divided by disciplines such as sociology or psychology, rather than by industries. As a result, she said, professors may use different examples in their lectures, but Chicago Booth “[doesn’t] change required classes based on trends in the economy.”

I’m not keen on the way ethics is taught in most business schools so I’m sympathetic to the Chicago position. Some previous O&M posts on teaching ethics are here, here, here, here, here, and here.

1 comment 10 November 2009

The Hodgson Petition

| Peter Klein |

Several friends and colleagues urged me to sign Geoff Hodgson’s petition on the financial crisis, but I declined. I agree with Krugman that economists have tended to mistake mathematical beauty for truth, but think this has little to do with the financial crisis. As discussed in previous posts, I view the financial crisis and recession as the (predicable!) result of government failure — massive credit expansion by the central bank, mortgage-lending rules and policies designed to inflate the housing market, a state-sponsored cartel of securities-rating agencies — not market failure resulting from unrealistic behavioral assumptions.

I respect many of the signatories to the petition, but statements like this (from Krugman), at the heart of the petition, are preposterous:

[Economists] turned a blind eye to the limitations of human rationality that often lead to bubbles and busts; to the problems of institutions that run amok; to the imperfections of markets — especially financial markets — that can cause the economy’s operating system to undergo sudden, unpredictable crashes; and to the dangers created when regulators don’t believe in regulation. . . . When it comes to the all-too-human problem of recessions and depressions, economists need to abandon the neat but wrong solution of assuming that everyone is rational and markets work perfectly.

“Regulators who don’t believe in regulation?” Paul, what color is the sky on your planet (1, 2, 3)? Notably absent from the petition’s list of villains is the Fed, Fannie and Freddie, the Treasury, or indeed anyone remotely connected with a government body.

Keep in mind it was Krugman himself who wrote in 2002: “To fight this recession the Fed needs more than a snapback; it needs soaring household spending to offset moribund business investment. And to do that . . . Greenspan needs to create a housing bubble to replace the Nasdaq bubble.” St. Alan followed Krugman’s advice to the letter, and here we are today.

9 comments 23 October 2009

QWERTY in the Long Run

| Dick Langlois |

The new issue of Industrial and Corporate Change has an article by Andreas Reinstaller and Werner Hölzl called “Big Causes and Small Events: QWERTY and the Mechanization of Office Work.” Although it’s an interesting paper in many respects, I think it fails in its avowed aim to defend Paul David against the attack of Liebowitz and Margolis. Mostly, they don’t get L&M right (and explicitly get them wrong in footnote 1). The issue is whether the QWERTY keyboard is an example of what L&M call “third-degree” path dependency, that, is path dependency leading to an outcome that is both regrettable ex post and would somehow have been remediable ex ante. The criterion of “remediable” to R&H seems to be whether contemporaries “knew about” superior alternatives. That’s not quite right, of course: the real issue is whether any alternative institutional structure could have done a better job of choosing a standard under the conditions of knowledge at the time. Their only example is the existence of a French “Ideal” keyboard layout (which some people “knew about”) that was swept aside by the tidal wave of the American QWERTY standard (and became AZERTY in France). But they have no evidence about how much better this keyboard was — or if it was better at all. In footnote 1 they cite Donald Norman’s interesting book on design to the effect that the Dvorak keyboard is 10 per cent faster than QWERTY. But (A) Norman’s point in the book is how insignificant this difference is and (B) that doesn’t demonstrate third-degree path dependency, since no one “knew about” the Dvorak keyboard until Dvorak invented it (an extremely laborious process, according to Norman).

Again, I don’t want to be too hard on R&H: I think there’s a lot that’s interesting in the paper, especially the discussion of the mechanization of office work. What really struck me in this context, however, is how irrelevant, or at least dated, the QWERTY saga is. And I say this not for the usual reason: that computers now allow us to have any keyboard layout we like. Rather, what struck me is that the production of documents has long since become demechanized, making even more-than-nominal differences in typing speed irrelevant. Since we now all (or almost all) compose right on the computer, and never send our documents out to the typing pool, manuscript production has become a craft again. What is slowing us down is how quickly we think of something to say, not how fast we can type. And I doubt that, fifties nostalgia notwithstanding, we are unlikely to see the return of the typing pool anytime soon. So, from a historical perspective, QWERTY will have been technically inefficient (though not therefore economically inefficient) only for that brief historical period between the invention of Dvorak and the coming of the personal computer.

The same issue of ICC also has a paper by Ashish Arora and coauthors that’s worth a look.

3 comments 25 September 2009

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