Archive for November, 2008

The Impotence of the Economists, Part II

| Peter Klein |

The financial-market bailout is one thing. While most economists, rightly in my view, strongly opposed the Paulson plan, one can at least imagine intelligent arguments for it. The proposed auto-industry bailout is something else entirely. Does any economically literate person support it? Industry bailouts are textbook examples of the fallacy of composition, taught in every Econ 101 class. When I teach it I use exactly this kind of example (bailing out Chrysler in 1980, bailing out the airline and insurance industries after 9/11, etc.). Saving the X industry simply harms the Y and Z industries, while substituting the political process for the market in determining the allocation of resrouces. And yet, here we go.

Along these lines, here are some sentences to ponder from David Yermack, writing in today’s WSJ:

In 1993, the legendary economist Michael Jensen gave his presidential address to the American Finance Association. Mr. Jensen’s presentation included a ranking of which U.S. companies had made the most money-losing investments during the decade of the 1980s. The top two companies on his list were General Motors and Ford, which between them had destroyed $110 billion in capital between 1980 and 1990, according to Mr. Jensen’s calculations.

I was a student in Mr. Jensen’s business-school class around that time, and one day he put those rankings on the board and shouted “J’accuse!” He wanted his students to understand that when a company makes money-losing investments, the cost falls upon all of society. Investment capital represents our limited stock of national savings, and when companies spend it badly, our future well-being is compromised. Mr. Jensen made his presentation more than 15 years ago, and even then it seemed obvious that the right strategy for GM would be to exit the car business, because many other companies made better vehicles at lower cost. . . .

Over the past decade, the capital destruction by GM has been breathtaking, on a greater scale than documented by Mr. Jensen for the 1980s.

See also: Lynne Kiesling.

15 November 2008 at 1:18 pm 5 comments

What Deregulation?

| Peter Klein |

We noted previously a major flaw in the “deregulation-caused-the-financial-crisis” meme spreading rapidly throughout the MSM: namely, there wasn’t any. If I can quote from the comment section of another blog, here’s Jerry O’Driscoll making the same point:

[T]here has been no deregulation of the financial markets since 1999 (Gramm-Bliley Leach). And that act did not repeal the Glass Steagall Act of 1933, . . . but amended it (Sections 20 and 32 of GS being repealed), and some other banking statutes. Mostly the act legitimized financial market developments already in place, and provided a new regulatory structure (so much for deregulation).

I recognize that policy lags are long and variable, but Sandy [Ikeda] cites events from 1992, 1997 and 1999 [as drivers of the crisis]. He can’t cite any later because there weren’t any. Affordable housing goals go back to the 1930s and, in contemporary form to 1968-70. Again, those are really long policy lags. . . .

Finanical services remains one of the most highly regulated indsutries, perhaps second only to health care. Non-existent deregulation can’t explain the current crisis.

The policy change that occurred in the relevant time frame was the easing of monetary policy by the Greenspan Fed. From a high of 6.5% in May 2000, the Fed Funds rate was cut down to 2% in Nov. 2001 and remained there or below for 3 years. For one full year, it was at 1%. The real rate was negative for approx. 3 years. Negative real interest rates are inevitably inflationary, often causing asset bubbles.

14 November 2008 at 10:07 pm 3 comments

Group Blog of the NYU Austrian Economics Colloquium

| Peter Klein |

It’s ThinkMarkets, written by the members of the NYU Austrian colloquium (formerly currently known as the Colloquium on Market Institutions and Economic Processes). The group includes Mario Rizzo, Bill Butos, Gene Callahan, Young Back Choi, Sandy Ikeda, Roger Koppl, Chidem Kurdas, and Joe Salerno. The colloquium was established in the 1980s by Israel Kirzner, who is still an occasional participant.

14 November 2008 at 10:30 am 2 comments

Towards Beyond

| Lasse Lien |

We all know that there is an enormous amount of papers published under the title “Beyond . . . (insert whatever)” and “Towards . . . (insert whatever).” On the theory that using these words in the title almost ensures publication (I admit sampling on the dependent variable here), I have decided to take this to the limit in a series of four papers.

The first one will have the snappy title: “Towards Beyond.” The second: “Beyond Towards.” The third: “Towards Towards.” And finally, the most ambitious one: “Beyond Beyond.” I only have the titles so far, so I am interested in coauthors who can fill in the rest. But given these great titles I consider this a trivial task, and insist that I get to be first author.

14 November 2008 at 4:46 am 14 comments

A Silver Lining

| Peter Klein |

As I mentioned in a recent talk, one good thing to come out of the bailout disaster is the diminished reputation of St. Alan the Wise. It was fun watching the same Congressional clowns who months earlier praised the “Maestro” as the greatest Fed chair in history slap him down for failing to prevent the housing bubble. Of course, Greenspan, like these clowns, ignored the issue of credit expansion, expressing regret only that he had put “too much trust” in market forces. Ha! 

Now Paulson, never too popular in the first place, is suffering a similar fate, as he abandons the Troubled Asset Relief Program — the rationale for the bailout itself — and praises Congress for giving him the broad authority to do, well, whatever the hell he wants. Oh, please, let Bernanke be next!

BTW, Bob Higgs continues to offer some of the best commentary on the disaster — the political, journalistic, and educational disaster, I mean, not the supposed economic disaster. I hope his term, “Bailout of Abominations,” catches on.

Update: The Economist puts it this way: “One of the most humbling features of the financial crisis is its ability to humiliate policymakers who, thinking that they have a bazooka in their closet, soon discover that it is a mere popgun.”

14 November 2008 at 1:48 am 3 comments

Bill Shughart’s Review of Prophet of Innovation

| Peter Klein |

It’s in the December 2008 issue of Managerial and Decision Economics. Excerpt:

Many readers, as I did, will close Prophet of Innovation with a feeling of dissatisfaction. On the plus side, McCraw’s life of Joseph Alois Schumpeter is not as dauntingly long as it seems: Nearly 30% of the volume is devoted to notes and other end matter, and so the text runs to a more digestible 506 pages. Generous line spacing and a respectable number of archival photographs speed the pace of reading.

On the minus side, Prophet of Innovation pales in comparison with the recent and far more penetrating biographies of John D. Rockefeller, Sr. by Ron Chernow, of J. P. Morgan by Jean Strouse, and of Andrew Mellon by David Cannadine. In the end, one doesn’t know Joseph Schumpeter quite as fully as one now knows those titans of industry. And we certainly don’t know him as well as we know Robert Skidelsky’s John Maynard Keynes, who was born the same year (1863). Something is missing from Prophet of Innovation, perhaps because McCraw chose not to be “concerned with Schumpeter’s economic thinking, narrowly construed” (p. xi). That choice, in my judgment, fatally compromises any attempt to tell the story of a man who lived and breathed economics over a distinguished, remarkably productive academic career that spanned four decades, taking him from the classrooms of the University of Vienna, where he (and Ludwig von Mises) studied under Eugen von Böhm-Bawerk, to Harvard Square.

13 November 2008 at 12:40 pm Leave a comment

New Blogs of Interest

| Peter Klein |

12 November 2008 at 10:39 pm 1 comment

Historical Origins of “Open Science”

| Peter Klein |

An interesting piece on science and patronage by Paul David, with a comment by Ken Arrow:

The Historical Origins of “Open Science”: An Essay on Patronage, Reputation and Common Agency Contracting in the Scientific Revolution

Paul A. David, Stanford University & The University of Oxford

This essay examines the economics of patronage in the production of knowledge and its influence upon the historical formation of key elements in the ethos and organizational structure of publicly funded “open science.” The emergence during the late sixteenth and early seventeenth centuries of the idea and practice of “open science” was a distinctive and vital organizational aspect of the Scientific Revolution. It represented a break from the previously dominant ethos of secrecy in the pursuit of Nature’s Secrets, to a new set of norms, incentives, and organizational structures that reinforced scientific researchers’ commitments to rapid disclosure of new knowledge. The rise of “cooperative rivalries” in the revelation of new knowledge, is seen as a functional response to heightened asymmetric information problems posed for the Renaissance system of court-patronage of the arts and sciences; pre-existing informational asymmetries had been exacerbated by the claims of mathematicians and the increasing practical reliance upon new mathematical techniques in a variety of “contexts of application.” Reputational competition among Europe’s noble patrons motivated much of their efforts to attract to their courts the most prestigious natural philosophers, was no less crucial in the workings of that system than was the concern among their would-be clients to raise their peer-based reputational status. In late Renaissance Europe, the feudal legacy of fragmented political authority had resulted in relations between noble patrons and their savant-clients that resembled the situation modern economists describe as “common agency contracting in substitutes” — competition among incompletely informed principals for the dedicated services of multiple agents. These conditions tended to result in contract terms (especially with regard to autonomy and financial support) that left agent client members of the nascent scientific communities better positioned to retain larger information rents on their specialized knowledge. This encouraged entry into their emerging disciplines, and enabled them collectively to develop a stronger degree of professional autonomy for their programs of inquiry within the increasingly specialized and formal scientific academies (such the Académie royale des Sciences and the Royal Society) that had attracted the patronage of rival absolutist States of Western Europe during the latter part of the seventeenth century. The institutionalization of “open science” that took place within those settings is shown to have continuities with the use by scientists of the earlier humanist academies, and with the logic of regal patronage, rather than being driven by the material requirements of new observational and experimental techniques.

See also this and this on science funding. And of course Hayek’s Counter-Revolution of Science (free full text!) should be consulted.

11 November 2008 at 10:02 am 3 comments

B-School Naming Rights Up to $300 million

| Peter Klein |

At Chicago, anyway, now home to the Booth School of Business.

Here’s an interesting (if slightly dated) Business Week story on B-school naming rights. Wisconsin has taken the most innovative approach, announcing earlier this year that in exchange for $85 million it would pledge not to name the school for 20 years

Here at Organizations and Markets we are committed to honest and open inquiry, free from restrictions imposed by corporate or individual sponsors. However, if you’d like to have this blog named after yourself, we’ll toss those principles right out the window. Send all inquiries to

10 November 2008 at 11:05 am 10 comments

Price Gouging: The Latest Victims

| Peter Klein |

Please join me in support for poor, beleaguered gas station owners, the victims of unconscionable price gouging by ruthless consumers who are taking advantage of market conditions to reduce their demand for gasoline, driving down the price by nearly $2 per gallon over the last four months. Fortunately, governments are swinging into action. Georgia governor Sonny Perdue issued this statement: “The financial crisis has disrupted the consumption of gasoline, which will have an effect on prices. However, we expect the prices that Georgian gasoline station owners receive at the pump to be in line with changes in consumers’ incomes and the prices of substitutes and complements. We will not tolerate consumers taking advantage of Georgian business owners during a time of emergency.”

10 November 2008 at 10:09 am 12 comments

My Research Assistant Thinks This Is Funny

| Peter Klein |

But I don’t get it. (From PhD Comics.)


9 November 2008 at 4:24 pm 2 comments

Undisputed Knowledge

| Lasse Lien |

Someone recently had the nerve to ask me for examples of undisputed knowledge generated from the social sciences. I.e., things we “know” that are both uncontroversial and does not require a lot of assumptions that are themselves in dispute (or not always true). . . .

I must admit that it was surprisingly (embarrassingly) difficult to come up with something that would qualify a strict interpretation of these criteria. Drawing a blank and under pressure to save face, I suggested that perhaps there would be universal agreement that there is nothing we can universally agree on. But then I realized that this would be an example of the liars paradox. I mean, it’s a logical impossibility that we can all agree that we cannot agree on anything.

So I guess my heroic defense of the social sciences boiled down to the claim that we can agree on only one thing, which unfortunately is a logical impossibility. . . .

7 November 2008 at 7:10 am 21 comments

Halo Alert

| Peter Klein |

Phil Rosenzweig’s excellent Halo Effect takes to task the typical “guru” book in business, one that picks a few successful companies, describes their business practices, and attributes success to those practies, without any attempt to design a “controlled experiment.” As I wrote last year:

The most common problems are sampling on the dependent variable (i.e., choosing a sample of high-performing companies and explaining what their managers did, ignoring selection bias) and using independent variables based purely on respondents’ ex post subjective assessments of strategy, corporate culture, leadership, and other “soft” characteristics. The latter is the “Halo Effect” of the book’s title. When a company’s financial or operating performance is strong, managers, consultants, journalists, and management professors tend to rate strategy, culture, and leadership highly, while rating the same strategies, cultures, and leadership poorly when a company’s performance is weak. It’s as if the authors of “guru” books have never taken a first-year graduate course on empirical research design. Or, as Rosenzweig puts it (p. 128): “None of these studies is likely to win a blue ribbon at your local high school science fair.” Ouch.

Look for a series of Halo-style analyses of the Presidential contest. Today’s NY Times, for example, contains a lengthy profile of the Obama campaign, “Near-Flawless Run Is Credited in Victory,” which recapitulates the Obama campaign’s hodge-podge of tactics, some good and some bad, without trying to isolate and identify the effects of particular tactics. The writers note that Obama’s chief strategists, David Axelrod and David Plouffe, have never before been involved with a successful campaign, which right away makes you wonder how “flawless” their strategy could have been. Still, the Times describes almost everything the campaign did as exactly right. Had Obama lost, no doubt the same pundits would be calling the same hodge-podge of tactics an obvious failure, placing the blaime on Alexrod and Plouffe and praising the McCain campaign’s own strategy and tactics. Post hoc, ergo propter hoc!

5 November 2008 at 2:41 pm 5 comments

The Emergence of English Commercial Law

| Peter Klein |

lex1The English system of commercial law or the lex mercatoria has been described as an example of “spontaneous order,” a set of rules that emerged without central direction and yet provided remarkable stability and favorable institutional environment for trade. Harold Berman and Bruce Benson, among others, have written extensively on this. Here’s an interesting paper by Daniel Klerman on the early history of English commercial law, framed as a comparison of the English and Ottoman systems:

Thirteenth-century England was a commercial backwater whose trade was dominated by foreigners. To accommodate and encourage foreign merchants, England modified its legal system by creating legal institutions which were available to both domestic and foreign traders. Among the most important of these institutions were streamlined debt collection procedures and mixed juries composed of both Englishmen and foreigners. By introducing institutions which treated locals and foreigners equally, England created a level playing field which enabled English merchants to become increasingly prominent in the later Middle Ages. England’s ability to modernize its law was facilitated by the secular nature of English law, the representation of merchants in Parliament, and legal pluralism. Medieval England contrasts sharply with the early modern Ottoman Empire. The latter created special institutions for foreign merchants, which eventually put Ottoman Muslims at a competitive disadvantage.

5 November 2008 at 10:52 am 1 comment

Food Miles

| Peter Klein |

My favorite economic geographer, Pierre Desrochers, has written (along with his better half, Hiroko Shimizu), a critique of the “food-miles” approach to measuring environmental impact.

As modern food production and distribution becomes ever more complex and globalized, a “buy local” food movement has arisen. This movement argues that locally produced food is not only fresher and better tasting, but it is also better for the environment: Because locally produced food does not travel far to reach your table, the production and transport of the food expend less energy overall. The local food movement has even coined a term, “food miles,” to denote the distance food has traveled from production to consumption and uses the food miles concept as a major way to determine the environmental impact of a food.

This Policy Primer examines the origins and validity of the food miles concept. The evidence presented suggests that food miles are, at best, a marketing fad that frequently and severely distorts the environmental impacts of agricultural production. At worst, food miles constitute a dangerous distraction from the very real and serious issues that affect energy consumption and the environmental impact of modern food production and the affordability of food.

See also these comments from Peter Gordon.

5 November 2008 at 12:46 am 1 comment

Beware of Geeks Bearing Formulas

| Peter Klein |

The entrepreneur, writes Mises in one of my favorite passages, “is a speculator, a man eager to utilize his opinion about the future structure of the market for business operations promising profits.” The entrepreneur relies on his “specific anticipative understanding of the conditions of the uncertain future,” an understanding that “defies any rules and systematization.”

This passage was in my mind today as I read the WSJ front-pager about the computer models used by AIG to analyze asset risk. Poor Gary Gorton, who designed many of AIG’s models, is put on public display. AIG’s catastrophic failure is likely to fuel skepticism about the use of such models for risk analysis, though Gorton maintains the problem was the application of the models, not their basic design. (His Yale colleague Ian Ayres will likely agree.) Longtime skeptic Warren Buffet has the best line: “Beware of geeks . . . bearing formulas.”

Today’s paper also includes an item on Harry Markowitz, including this:

As with all new information tools at our disposal, applying portfolio theory to investing entails its share of trial and error. Mr. Markowitz admits some people might object to asking him how to repair the credit crisis. “You, Harry Markowitz, brought math into the investment process,” he imagines some people thinking. “It is fancy math that brought on this crisis. What makes you think now that you can solve it?”

He draws a line between his portfolio theory and its later misapplication. “Not all financial engineering is always bad,” he says, “but the layers of financially engineered products of recent years, combined with high levels of leverage, have proved to be too much of a good thing.”

Update (Nov. 5): See this related piece from the Times.

3 November 2008 at 3:00 pm 3 comments

New Issue of Strategic Entrepreneurship Journal

| Peter Klein |

Volume 2, number 3 of the Strategic Entrepreneurship Journal, a special issue edited by Sharon Alvarez and Jay Barney on “Opportunities, Organizations, and Entrepreneurship,” is now out. It features my paper “Opportunity Discovery, Entrepreneurial Action, and Economic Organization,” Nicolai’s paper with Kirsten Foss, “Understanding Opportunity Discovery and Sustainable Advantage: The Role of Transaction Costs and Property Rights,” and several others of interest. The abstracts from my paper and the Foss & Foss paper are below the fold. (more…)

3 November 2008 at 10:22 am Leave a comment

Needed: A Little Cost-Benefit Analysis

| Peter Klein |

Andrew Gelman, Nate Silver, and Aaron Edlin estimate the the probability of any given vote being decisive in Tuesday’s US election is about one in 60 million. Residents of a few states, like New Mexico, Virginia, New Hampshire, and Colorado, are especially important: their chance is one in 10 million. Oh, did I mention that your vote doesn’t matter?

Cliff sent me a couple of amusing items on People Who Don’t Get It. Here’s one on a young Chicago woman who can’t decide between McCain and Obama, and is “probably going to cram the night before the election and really study them both.” Gee, I wonder which candidate is going to win Illinois? And here’s a wonderful cartoon from the 1932 Chicago Tribune, “How to Vote Intelligently in the Primary.” Ah, where are the Colonel McCormicks of today?

2 November 2008 at 10:16 pm 11 comments

Things You Learn from David Gordon

| Peter Klein |

Nicolai has written on great beards in philosophy. From David Gordon’s talk this morning on “Money and Philosophy” I learn that Thomas Aquinas, among his many other distinctions, was also the heaviest of all the great philosophers. Apparently his church had to install a special altar with a large cutout so Aquinas could take communion. According to David, Aquinas’s only possible rival for the title of heaviest great philosopher is David Hume.

1 November 2008 at 10:31 am Leave a comment

Interviews with Alchian, Coase, Kirzner, Manne

| Peter Klein |

The Liberty Fund has put online several interviews from its Intellectual Portrait Series. Of particular interest to O&M readers:

Update (Nov. 2): Manne link fixed.

    1 November 2008 at 9:44 am Leave a comment

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