Wednesday, July 25, 2012

You didn't build that: Both Romney and Obama are wrong

I know I'm late to this party, but I do have a brief comment on this "you didn't build that" charade.

First, it's worth noting that Romney and Republicans did take Obama's remarks out of context in a way which changed their meaning. The most common quote I've seen from the conservatives is, "If you've got a business, you didn't build that." Obviously this sounds like Obama is telling people who have their own business that they don't deserve credit for it--the government did the work for them. That would be offensive and inaccurate. Building a business requires both tremendous effort and a high tolerance for risk. Those who are able to do so deserve the overwhelming majority of the credit, even if luck and government play some role.

But that's not what Obama said. Here's the whole quote:
If you were successful, somebody along the line gave you some help. There was a great teacher somewhere in your life. Somebody helped to create this unbelievable American system that we have that allowed you to thrive. Somebody invested in roads and bridges. If you’ve got a business -- you didn’t build that. Somebody else made that happen. 

Even if you think Obama really believes that government built everyone's businesses, it's a stretch to think he'd say it in public. I think a reasonable reading of the full quote suggests that Obama is simply stating that if you have a business, you didn't build the "American system" that enabled your business to succeed. That's largely true. Business occurs within an environment of things like government-provided infrastructure, the education system, and a set of laws which sometimes are conducive to commerce (sometimes). Fair enough. Romney was disingenuous to claim that Obama thinks Henry Ford didn't build Ford, and all the rest.

But that doesn't let Obama off the hook. He made this statement as part of an argument for higher taxes on the wealthy. His apologists have cited things like roads and schools as examples of things businesses didn't build that justify higher taxes on certain people. But there are two problems with that argument. First, roads and schools and other government-provided amenities aren't the result of some benevolent government entity, providing for its people as a mother feeds a child. Those things are paid for by, well, people, including (and especially) rich people. And I don't hear many people on the right complaining about having to pay for roads and bridges (well, except bridges to nowhere).

Second, the higher taxes Obama wants are not even meant to pay for roads and schools. Current taxes are more than sufficient to finance those items. The taxes Obama wants are meant to pay for our massive warfare/welfare state. Here's a chart from the Center on Budget and Policy Priorities (click for larger image):

Source


Observe that transportation infrastructure and education comprise 5 percent of the federal budget (indeed, state and local government are more relevant for those categories). The overwhelming majority of the federal budget--81 percent!--goes to defense and entitlements, the warfare/welfare state. If you're looking for the drivers of government's insatiable thirst for tax revenue, there they are. Estimate the tax burden needed to actually pay for our whole budget, then divide that number by 20. Now you have roughly enough revenue to pay for the roads and bridges and schools. You could double spending on those items and still be able to lower taxes if it weren't for the warfare/welfare state.

So, setting aside businesses designed to feed at the government trough, it's not clear that Obama's point about a government-created atmosphere helping businesses actually justifies higher taxes on high earners. In short, Obama is using the benefits of infrastructure to justify taxes to finance the ever-expanding warfare/welfare state. That's disingenuous.

Now if only we had candidates with plans to rein in the warfare/welfare state...

Monday, July 23, 2012

Did the financial crisis and recession discredit macroeconomists?

This post is a short essay I wrote for another purpose reviewing Ricardo Caballero's paper, "Macroeconomics after the crisis: Time to deal with the pretense-of-knowledge syndrome." It's not necessary that you read Caballero's paper to understand this post--but if this topic interests you, his essay is a nice starting point. 

Caballero joins others in taking stock of the field of macroeconomics. The paper is motivated by the crisis, but he rightly excuses the profession for failing to predict it. “Knowing [crisis-relevant] mechanisms is quite different from arguing that a severe crisis can be predicted.” He focuses more on understanding economic phenomena. His specific complaints are about overemphasis on the “core” of macroeconomics instead of the “periphery.”

For Caballero, the “core” of macroeconomics consists of researchers employing DSGE models. While noting that general equilibrium is important, he takes issue with these models and what he suggests is economists' excessive reliance on them. In contrast, researchers on the “periphery” focus on specific economic problems without attempting to fit their models into large general equilibrium structures. These simpler models can isolate specific mechanisms and are good sources of intuition, but Caballero notes that their resistance to broader application limits their usefulness.

Caballero avoids making specific suggestions about methodological changes or new approaches. He does advise that economists gain a greater appreciation for complexity, but he does not reject the DSGE framework or its use in policy analysis. His points are well taken. Hayek's admonitions about the pretense of knowledge are just as relevant and necessary today as they were when he made them. That said, however, it is not clear what Caballero is trying to achieve with his essay. Far from taking issue with his central argument, I believe that he has no central argument.

It is true that few macroeconomists provided useful, specific predictions of what would unfold starting in 2005 and continuing to the present day; but, as Caballero notes, prediction is not a reasonable goal of economic science. Understanding economic phenomena, including business cycles and financial crises, is the goal. Caballero provides no evidence that the discipline is lacking in tools for understanding what happened in recent years.

Complaints about DSGE models and rational expectations are widespread. While it is easy to see shortcomings in these approaches, it is not clear that their use rendered economists unable to understand crises. The amplification of financial shocks is easily understood with models suggested by Bernanke and Gertler (1996) or others. The persistence of sluggish output following a crisis is well documented by Reinhart and Rogoff (2009) and others, and the reasons for such sluggishness are not impossible to ascertain using existing models. The discipline's focus on DSGE modeling has not rendered us unable to think about how counterparty risk and uncertainty created demand for bailouts. The portrayal of economists drawing blanks on how to explain the crisis is inaccurate.

Caballero raises interesting questions but fails to demonstrate that we lack the tools to understand the recent crisis. Criticism of the field is most useful if it (a) reveals flaws in our ability to understand economics, or (b) provides new approaches which allow us to dispose of conventions which are unrealistic. Caballero does neither. If the goal is understanding rather than prediction, our commentary is better applied to convincing people outside the discipline to temper their expectations. In the meantime, sufficient incentives exist for individual researchers to improve the science at the margins, as they have been doing and will continue to do.

References

Bernanke, Ben and Mark Gertler. 1996. The financial accelerator and flight to quality. Review of Economics and Statistics 78 no. 1:1-15.

Reinhart, Carmen and Kenneth Rogoff. 2009. This Time is Different: Eight Centuries of Financial Folly. Princeton: Princeton University Press.